Two weeks ago, everything “seemed” fine. Markets were still focusing on higher inflation numbers in January, and were pricing in a Federal Reserve fed funds rate hike of up to 50 bps (0.50%) at the next Fed meeting. Now the narrative has quickly changed (“Look – A Squirrel!”). Fast forward to today, two regional banks (Signature Bank, Silicon Valley Bank) failed and a large global bank (Credit Suisse) in Europe is in the headlines again with apparent struggles.
The market is increasingly focused on potential contagion and spillover to other regional banks and potentially issues at the larger banks. This has put downward pressure on the financials sector at large and a rush to “safer” assets. In addition, the market is no longer pricing in a potential 50 bps hike by the Fed next week, the markets are pricing in either 25 bps hike or no rate hike. Looking forward, the market is pricing in Fed rate cuts this summer. It doesn’t take long for the market to get scared and impact markets very quickly.
This should be a clear reminder that anything can happen in the markets at any time. The expectation that should be had is that there is always uncertainty. There will always be something that surprises the markets, pushing markets lower or higher over a very short period of time. Even with a well thought out process, great macro insights, perfect investment models, something will always wreck havoc.
In this instance, even with regional banks’ stocks getting hit hard, the pressures with Signature Bank and Silicon Valley Bank are somewhat unique. Silicon Valley Bank had a high concentration of clients/depositors in the high tech, start up and venture capital space. Signature Bank had exposure to the crypto industry. If you haven’t been paying attention, these high growth industries have been hit hard as capital has dried up and investors have lost appetite for speculation. It shouldn’t be a surprise that these two banks would have problems in this environment. These poorly risk-managed banks did not have a diversified multi-industry sticky depositor base and did not appropriately hedge their interest rate risk, thus leading to significant pressures.
I do not believe these two specialized regional banks are a systemic issue that will proliferate to high quality, diversified banks with solid management teams and strong risk controls.
In Europe, Credit Suisse has had issues for years. It is not a surprise that it is having more prevalent issues today. I cover an investment manager that had a position in Credit Suisse but had recently sold all of its position, an indication of lack of conviction for the company. For me, this is an indication of a potential capitulation for Credit Suisse and potentially the Swiss National Bank to step in. I think the last think the Swiss government wants is a huge failure of Credit Suisse.
Government Backstops
The U.S. government is probably very cognizant that keeping people calm is priority number one. No one wants a 2008 financial crisis repeat. To try to calm some fears, the Federal Reserve, FDIC and U.S. Treasury set up a depositor backstop for both Signature Bank and Silicon Valley Bank depositors. All depositors will be made whole. In addition, the three government entities created another backstop for all banks, called the Bank Term Funding Program (BTFP) which allows any bank to borrow capital for up to a year, utilizing their high quality securities (Treasuries, etc.) as collateral. The benefit of this program is that all banks have new access to liquidity if they need it, and their collateral can be priced at par, rather than mark to market. As interest rates have moved higher, the price of bonds have declined, which if banks sold these securities, would need to take a recorded loss and could snowball to the downside. No one wants this, so the Fed is allowing banks to price their collateral at par (i.e. $100/bond) versus at a lower market price (i.e. $80/bond).
Summary
I don’t think this is another 2008 financial crisis. The largest U.S. banks have strict oversight by government officials and have stronger balance sheets and less exposure to risky assets than they had back then. If regional bank clients are nervous with their local bank, they may go to the larger banks, providing additional liquidity and potential safety in these larger, more important banks. If there are additional pressures felt in the financial system, I’m fairly confident that the U.S. government will do whatever it takes to avoid catastrophic failure.
But we all know, anything can happen at any time. Do not forget that.