“Banking is a very good business if you don’t do anything dumb.” Warren Buffett

 

Human memory is fascinating. Who hasn't forgotten an important appointment or even a birthday of a loved one? On the other hand, painful memories are engraved forever in our minds and often reemerge.

 

I felt this reemergence on Thursday, when Silicon Valley Bank announced that it had taken a loss of 2.5 billion dollars on its bond portfolio in order to have access to cash. At first, this announcement did not affect the stock market very much, but as always, doubt and suspicion quickly invaded them.

 

The last banking crisis centered around a false assumption: that real estate is constantly increasing. This prompted stakeholders to borrow heavily and speculate on real estate. The banks made two costly mistakes. For one, they listened to this song and secondly, they had an infallible confidence in the financial products linked to these mortgages.

 

American banks experienced a magical period between 2020 and 2021. The government was sending too much money to people and on the other hand, businesses and the stock market were doing very well. The savers' money was deposited in bank accounts, quicker than the bank could lend the money out. Finding no way to deploy capital intelligently, the banks did what they had to do, they acted stupidly.

 

More precisely, the banks took money from the savers, which was billions of dollars, and bought medium-term bonds from the American government. This enabled them to collect a return of 1.5% on average, considering that the rates paid to savers were close to zero.

 

All of us know what happened afterwards. 2022, brought a huge interest rate increase. This hit equities and bonds hard. The banks, therefore, saw the value of the bonds that they purchased, melt like snow in the sun.

 

Savers, facing high inflation, began to spend their money and move it from their bank account to the bond market, as the yields eventually became attractive. Each of these withdrawals and the rise in the rates paid by the banks on deposits and GICs have attacked the bank’s liquidity because they froze the money in American bonds.

 

As long as banks have access to cash, they can usually weather this issue without too much trouble. In the case of the Californian banks, a time came when they couldn't wait any longer and had to sell the bonds (and realize the losses!) in order to pay the savers. So, the company must reach out to the financial markets, explain what's going on and ask for a capital injection. At this moment, confidence evaporates at the speed of light.

 

Today, the question that is on everyone's mind is whether there will be contagion to another bank. Unlike 2008, when the banks happily exchanged their financial products linked to mortgages, here the problem is unique to each firm. No bank has been smarter than the other. They all used the same tactics to increase profits, but to a lesser degree.

 

I'm fascinated by American banks because they always find ingenious ways to lose money,  while the classic way still works! Churchill once said "Never let a good crisis go to waste", and in that vein, already having no direct or indirect exposure to the banking sector, we seek to find opportunities in this crisis.

Although banks are not our favorite companies, there is always a price at which we would be attracted to some of them. How the misfortune of some can bring happiness to others.