Market Update – Banking Sector

What you need to know about Silicon Valley, Credit Suisse and the banking sector

Our Lifestyle Financial Planners work with our clients to educate them on the long-term nature of investments, and to build resilient financial plans. Each Attivo Lifestyle Financial Plan is carefully aligned with our client’s attitude to risk and their ability to weather the ups and downs of the market – as well as being regularly reviewed and rebalanced to keep them on track.

As Attivo clients will already know, the best thing to do during nearly any market turbulence is to remain calm and wait it out. It’s usually easier to do that when you’ve got the facts about what’s happening, so we’ve put together an overview of the recent news from the banking sector to keep you up to date.

Remember that your Attivo Planner is always on hand to help with any questions you have about your personal investments and circumstances.

Silicon Valley

The collapse of Silicon Valley Bank on 10 March, followed by that of Signature Bank two days later, has generated widespread market volatility. Concerns centre on the impact that ongoing, unprecedentedly high interest rates could have on the banking sector.

Unlike during the banking crisis of 2008, it is small and medium-sized banks that are now under pressure. Both Silicon Valley and Signature had business models highly concentrated in one sector, and both were over-exposed to assets (such as long-term fixed-rate government securities) whose value fell as a result of rising interest rates.

The technical reason for the collapse of Silicon Valley Bank (SVB) is that it was a ‘pure duration mismatch between deposit liabilities and high-quality bond assets’ [Source: FT].

What does that mean?

• SVB’s key customers were California’s tech industry and the bank had grown as quickly as the customers it financed.
• The pandemic saw a huge rise in speculative finance and the tech start-ups needed to store the cash the venture capitalists and Private Equity (PE) firms were handing out to them.
• SVB was a small bank and was unable to lend out the deposits at the same rate as they were rolling in. As a result, it invested (mainly) in long-term fixed-rate government securities (Treasuries).
• This is where you get a duration mismatch as it exposed the bank to a big problem with rising interest rates. On the asset side of the balance sheet, the value of these longer-term debt instruments fell. On the liability side the money started to dry up and with it the flow of new deposit funding.

The main problem was not a liquidity squeeze like we saw in 2008, but a squeeze on profitability. Businesses, if rates move higher, want to see this reflected in the rate/return they receive. The problem is that the rates on the asset-side of the balance sheet were fixed. So, the bank was a force-seller of $21bn of bonds as it needed to re-invest into shorter-duration bonds to increase the yield. It then had to raise more capital to replace the losses on the bonds that it was forced to sell. Therefore, higher rates hurt SVB on the liability side more than they helped it on the asset side.

Credit Suisse

Following the demise of SVB further tensions developed, but this time within Europe. Credit Suisse has become the focal point when it halted trading on March 15^th after 20% fall in its share price. The ramifications were felt across the banking sector, with the fear that the market was possibly heading towards another financial crisis.

Credit Suisse has been somewhat of a problem child for several years now, with several Chairmen and CEO’s rotating through the company in an effort to stabilise its deteriorating share price following a raft of negative headlines and results. The share price has fallen by c.70% since its post-Covid highs in March 2021, and even further if you go back to post the financial crisis. The catalyst for this recent sell-off appears to be largely down to the Saudi National Bank stating that they would not increase their equity exposure further from their 9.9% holding. What’s not clear however is whether this is all due to restrictions from European regulators, or if something deeper resides.

It’s important to note that this is not the same situation as Silicon Valley Bank (SVB). In the case of Credit Suisse, their bond exposure is short in duration (so less susceptible to rate increases) and, here’s an important bit, its interest rate exposure is also hedged (any losses on rate rises were effectively offset).

The rationale for Credit Suisse’s sell-off is completely independent from SVB’s, however the timing of this news could not have been much worse.

What does this mean for markets?

As a result of measures brought in after the financial crisis in 2008, most banks are well diversified and have plenty of cash reserves (liquidity). The assumption is that the risk to the rest of the banking sector is low. In the US, authorities have acted swiftly to mitigate the impact on customers, prevent contagion and try to restore confidence.

Nevertheless, the value of bank shares in Asia and Europe slumped earlier this week, with Spain’s Santander and Germany’s Commerzbank seeing a 10% drop in their share prices at one point. Among the UK banks, HSBC shares fell 4.8% and Barclays dropped 3.8%.

Credit Suisse has also needed both liquidity and backing. On 16 March the Swiss National Bank (SNB) lent SwFr 50bn (USD 45bn) to Credit Suisse to strengthen its liquidity and over the weekend a rescue deal has been agreed with UBS, the only other Swiss international bank.

Attivo’s Head of Proposition has been speaking with industry experts and economists who share the view that markets overall are expected to remain volatile until there is further evidence that the situation has been contained. Central banks have received a wake-up call to be cautious with further interest rate hikes from this point onwards. There is common belief that although the collapse of US bank Silicon Valley Bank has sent shockwaves through financial markets, the lender’s sudden demise is not expected to trigger another financial crisis akin to that of 2008.

 

Please note: this update is intended to provide a factual account of events. Performance figures quoted are factual and this summary is intended as commentary only. Past performance is no guarantee of future returns. The value of your investment can go down as well as up. You could get back less than you invested.