March 15, 2023

This morning’s sharp selloff in Credit Swiss shares reminds us that banking crises, even if relatively well-contained, tend to create ripples in the aftermath.

Last week, financial markets were shaken as Silicon Valley Bank (SVB), the California bank subsidiary of SVB Financial Group (SIVB), fell into FDIC receivership. SVB is the first FDIC-insured institution to fail since 2020 and the largest by assets since Washington Mutual failed in 2008. Prior to the latest distress, the bank held more than $200 billion in assets. SVB’s failure was then followed by another over the weekend, crypto-focused Signature Bank. The news, not surprisingly, caused market participants to speculate if there will be another shoe to drop. For some, these developments have brought back painful memories of the financial crisis 15 years ago.

Those of us who have lived through the Bear Stearns, Lehman Brothers, and Washington Mutual (to name only a few) financial collapses are shuddering at the thought history may be about to repeat itself.

• Thankfully, as we wrote yesterday, there are important reasons why we think this time may in fact be much different.
• Unlike the subprime mortgage-backed securities and esoteric collateralized debt obligations that turned out to be toxic assets, and were ultimately (near) worthless, the securities at issue today are AAA-rated U.S. Treasury and Agency mortgage-backed securities.
• However, despite the fact that these securities will mature at par (there is virtually zero default risk), the aggressive Fed rate hiking campaign has put downward pressure on older bond prices, and these securities are trading at deep discounts to par.
• The sudden need for liquid capital forced SVB to liquidate high-quality assets at these deep discounts, which turned a liquidity crisis into a solvency crisis.

In response, the Fed introduced a new facility - the Bank Term Funding Program (BTFP) that will act as an additional source of liquidity for high-quality securities, eliminating an institution's need to quickly sell those securities in times of stress, which should reduce broader contagion risks.

Meanwhile, Overseas!

In short, we are confident the European banking regulators will not let Credit Swiss fail and create contagion across the global banking system as we saw in 2008. We expect them to have a similar response as we have seen here in the US.

In conclusion:

• Confidence is vitally important for financial institutions where TRUST is a key asset. That confidence will take some time to be restored. Sharp losses in European banks like we are seeing today will not help U.S. banks regain that confidence.
• Guaranteeing deposits at Silicon Valley Bank (SVB) and Signature Bank (SBNY) was an important step toward moving beyond this crisis. Regulators, who will almost certainly expand and tighten capital and liquidity rules for midsized banks and subject them to stress tests, will take the next step.
• Private equity and asset management buyers will be another important piece of moving beyond this crisis by purchasing distressed bond portfolios from troubled institutions. We’ve seen some of this activity already, which is encouraging. Anyone have Warren Buffett’s cell phone number?
• In this environment with additional, important steps required to restore confidence in U.S. banks, we would not a buyer of the U.S. banks just yet. Also consider higher deposit costs, constrained lending opportunities, and perennial “crisis” discounts may make the opportunities look more attractive than they are. That doesn’t mean some of the winners coming out of the crisis won’t be good long-term investments, it just may not be easy.
• A Fed pause may help as soon as next week.

The government’s actions to backstop deposits and provide short-term funding to banks that need it, will greatly reduce the odds of a systemic crisis. However, we may see a bit more market volatility than we would like to see in the short term, but this is not another 2008.

As always, please do not hesitate to contact me if you have any questions or concerns.