It takes a good old bank failure to move central banks to the sidelines
Where do I start? As many of you are aware by now, there were two bank failures in the USA over the last few days and all heck has broken loose. On top of that, Credit Suisse in Europe is also under pressure as it teeters. Investors are justifiably concerned and the markets are on the decline at least in the short term.
Let me begin by what happened. The first is Silicon Valley Bank (SVB) that collapsed due to a run on deposits. This was the second largest USA bank failure in history and of significance as it was also the 16th largest bank in the USA. SVB was primarily based in California. It consisted of a portfolio of higher risk loans to technology startup companies. On Monday it had a run on deposits to the tune of $41B and wasn’t able to cover a deposit run of that magnitude. Banks take deposits and subsequently lend that money out at higher rates to earn the interest spread. They don’t have cash sitting around to cover large withdrawals.
What exasperated the problem were two things. First, we are in the age of social media and rumours and news of a problem at the bank were flying that day. Clients of SVB are primarily technology savvy individuals that live in a world of social media. Rumours and news magnified the problem whether they were accurate or not. Second, it is now easy to move money around quickly using online tools provided by the banks. The ease of movement of money can be quick and swift, and doesn’t allow for easy management of the situation.
There was also the demise of Silvergate Capital Corp in NYC that was idiosyncratic in the sense that it was nothing more than a one-model cryptocurrency bank, and in the grand scheme of things really doesn’t matter to the overall issue of bank stability.
In light of the SVB collapse, depositors and investors are naturally concerned about contagion in the sector on a global basis. Is this a structural issue that is destined to repeat itself? To address this concern, the US government stepped in and guaranteed ALL deposits across the banking system. As a note, this was not a bailout SVB. It was only a guarantee on deposits.
Credit Suisse in Europe is also teetering on instability and its major Saudi shareholder announced that it would not inject any more money into the bank to support it. Credit Suisse has been struggling for a while now and this is not new news, however, the issue is magnified in light of the SVB collapse.
Other than concern about contagion in the global banking sector, what are the knock on effects of the SVB collapse?
First, is the opportunity to invest in top quality banks that have declined in value as investors paint all banks with the same negative brush. I believe the global banking sector and especially the North American banking sector is well capitalized. Financial regulations and oversight have increased exponentially after 2008 and the system is well positioned to handle major blows to the system.
I don’t see a collapse of the system and therefore believe there is opportunity to buy our current top quality bank names in the portfolio. I see the biggest and strongest banks benefiting from the acquisition of new clients and deposits on a move to safety by customers. I added to each of our bank holdings yesterday in small amounts and will consider more investment as the situation unfolds.
Note that portfolios are well diversified across sectors and companies, and our investment in banks is a moderate and appropriate level in our portfolios. We do not carry an overweight position in banks and all our bank investments are in top rated and top quality banks.
Second, the SVB issue will cause the Bank of Canada and Federal Reserve to reconsider more aggressive rate hikes moving forward. The USA Federal Reserve was expected to increase rates next week by 50 bps and now that is more likely to be 25 bps or no increase. The question for central banks is whether they have raised rates too quickly and aggressively to the point at which it has caused too much stress on the banking system and borrowers. Concern in light of this situation is whether their actions will tip the economy into a much deeper recession versus an anticipated soft landing. They are likely going to have to tread a lot lighter in the coming months to see how this all plays out.
Interestingly, the markets are now anticipating a 50 bps rate CUT before summer by the Federal Reserve. This is something that wasn’t anticipated to happen until 2024. The peak interest rate in the USA has also declined from a recent 6% down to a more manageable 5.5% or lower.
Inflation will be closely watched as central bank policy has been squarely focused on raising rates to cool the economy and force inflation down. Inflation is improving albeit slowly. If it doesn’t continue to decline in the months ahead, I believe rate hikes will resume after the banking sector issues abate.
Overall, I see stability in the banking sector, investor concerns over bank stability easing, further opportunities for investment in our best picks in the banking sector, and an overall positive reaction to a pause in interest rate increases by North America central banks.
Hang tight. We are monitoring the situation, our bank holdings, and portfolios ongoing. We will adapt and pivot as more information unfolds.
Be well.
Miles…