Market Observations – March 2023
Not another Banking Crisis!
What has happened?
Silicon Valley Bank (SVB) and Signature Bank, both based in the US, have collapsed. In simple terms the cause of the collapse has been a mismatch between assets and liabilities, coupled with these banks taking more risk with deposits than a ‘normal’ bank would do. This risk taking worked when interest rates declined, but as interest rates rose, rapidly, they have caused losses.
At the weekend the US Federal Reserve announced an emergency lending facility that guaranteed that all depositors in SVB and Signature Bank could retrieve their funds. In the UK, HSBC have purchased SVB’s UK business for £1, thereby transitioning depositors to HSBC.
Will this happen to other Banks?
SVB and Signature were particularly focused on Private Equity, Venture Capital, Technology and Crypto clients and the peculiarities surrounding those businesses and assets over the last few years. There are concerns surrounding some of the other smaller US banks linked to these industries, but the larger US banks have wider client bases and are more regulated than the smaller banks.
This is a liquidity issue affecting two badly run US banks. Other smaller US banks may be in trouble, but this is very different from the global financial crisis in 2008. None of our preferred funds had any direct exposure to SVB or Signature but we have seen falls in other bank assets which will have had an impact in the short term. In UK and Europe, following the global financial crisis, regulators increased regulations, funding, and liquidity requirements on Banks. This means that UK and European banks operate with a large surplus of cash, which exceed the demand for loans. The example of Barclays has been provided by one of our fund managers.
Across the bank, in December 2022, Barclays had loans to customers of £398.8bn. It also had deposits from customers of £545.8bn, a surplus of £147bn. That surplus alone represents 26.9% of the entire deposit base. But on top, as a result of other funding put in place by Barclays, it had a liquidity pool of £318bn in total. Of this, its balances at central banks total £248bn. Its central bank cash balances, on their own, could repay 45% of the entire deposit base.
What are the implications?
There is evidence to suggest in the US that there have been movement of balances from smaller banks to larger ones. This might have the effect of raising the cost of deposits for those smaller banks, as an incentive for their customers to stick with them, which will reduce their profitability. But these affect profitability, not their existence.
There has also been regulatory response in the US already to stem the contagion. The Fed has introduced a new term funding scheme which allows banks to borrow against their bond holdings at the par value of the bonds rather than the current, somewhat lower, value. The idea being that there will be no need to sell the bonds and crystallize losses.
Investors have sought safety in government bond markets, causing bonds to rally globally. Prior to the SVB collapse markets has begun to price in a 50bps hike in US rates at the next FOMC meeting. The probability of this has all but gone away. Equities and particularly Bank shares have declined. In the UK the entire banking sector is on single digit P/E multiples despite healthy, well covered, dividend yields. In Europe bank valuations remain low despite rallying over 100% since November 2020.
Markets are febrile, but SVB is not an important bank that will break the system. However, it is symptomatic of the unprecedented monetary tightening that central banks have undertaken over the past 10 months. Central bank policies are starting to hurt and there seems to be no case for reversing course.
Chris Davis
Chief Investment Officer