The markets are proving to be surprisingly resilient despite all the bad banking news thrown their way. Of course, both Silicon Valley Bank and Signature Bank have all passed from this world, but it seems only a matter of time before another shoe drops. First Republic has been in the cross hairs ever since the SVB news broke, and the stock is down -90% this year. It lost -47% this week alone.
But given all the talk about blanket deposit guarantees, First Republic’s problems aren’t generating the same amount of fear the SVB’s failure did. The fall in the stock is more a reflection of a couple things: 1) even if the bank survives, recapitalization will likely wipe out the existing shareholders, or 2) in the event the FDIC takes over the bank, the equity piece of the capital structure will be zero’d out even if depositors are made whole.
Or at least that’s how it usually works in the U.S. In Switzerland the whole capital structure thing is a little more open to interpretation (something you don’t expect from the Swiss). Last weekend’s shotgun marriage of Credit Suisse and UBS led to some significant losses for Credit Suisse’s bond holders while their equity holders received a bit over $3.2 billion. Maybe because the Saudi’s are big investors?
But I might be too cynical. As it turns out, the Saudi’s took a bath in Credit Suisse. Only four months ago the Saudi National Bank became the large shareholder in the bank, paying $4.12/share for their 9.88% interest. UBS paid only $0.82/share to buy the whole thing. Yea, that’s a -80% loss in twenty weeks. Takes real professionals to do that!!
This story isn’t over. German and French bank stocks were hammered on Friday. For example, Deutsche Bank lost about -9% on Friday (it’s crazy to think that investors in Deutsche haven’t made money in this company since the late 80’s).
Another weekend another shotgun marriage?
Between a Rock and a Hard Place
In years past, panic in the banking sector would quickly lead to rate cuts from global central banks. This time is different though. The Fed has created credit facilities to provide liquidity to stressed banks while the Swiss authorities offered guarantees to UBS to take a problem off its hands. Central banks are still worried about inflation.
Just in the last few days:
- On March 16th, the European Central Bank hiked rates by a half-point.
- Then just days after the Credit Suisse problem emerged, the Swiss central bank hiked a half-point as well. They were pretty clear that they don’t see the stress in the banking system impacting the real economy in Switzerland. Who knows, they might be right!!
- The Bank of England hiked by a quarter-point this week.
- Same with the Norwegian central bank.
- Finally, our own (beloved??) Fed hiked by 25bps on Wednesday.
The Fed did temper their enthusiasm for future rate hikes a bit. The language around the move didn’t pre-commit to future hikes like we’ve seen at previous meetings. The closely followed ‘dot plot’ basically shows no further changes this year.
For what it’s worth, the market is leaning towards rate cuts later this year, as you can see below.
It’s hard to make out in the chart above, but the market is pricing in basically a full percentage point of cuts by December. The market has been wrong for some time now, but much will depend on what happens to bank lending later this year.
QE is Back on the Menu
This latest banking crisis is unlike the problems in the 80’s, 90’s 2000’s. Back then there was always a credit event – think the commercial real estate blowup in the late 80’s, various Latin American defaults in the 80’s and 90’s, or housing in 2007/2008. In each case loan quality was the problem.
This time around it’s a combination of a couple things: 1) losses on liquid government and mortgage bonds, and 2) deposit flight. The deposit flight piece is fascinating. In a world of banking apps and easy deposit transfers, money if fleeing low yielding bank deposits for higher paying money funds. You can see below that money funds have picked up about a half-trillion dollars since this time last year while bank deposits are down $623 billion.
And given that the ‘too big to fail’ banking cadre (Citi, Wells, JP, BofA) have hoovered up deposits lately, the impact on the smaller banks is even more pronounced.
As I mentioned earlier, the Fed has created credit facilities to help the banks out. And banks are tapping the Fed’s credit lines like there is no tomorrow.
So, something weird is actually taking place. The Fed is taking away with one hand (rate hikes) while giving with the other (emergency lending). The loans are so large that it has almost totally reversed the Fed’s efforts at Quantitative Tightening (QT) that started in April of last year.
Cue the quote from the Godfather – “Just when I thought I was out, they pull me back in!” (Sorry, couldn’t resist).
What should we be watching? Obviously, teetering bank share prices are going to be a key metric. But with the credit facilities in place, it’s tough to make the case that any one bank somehow presents a systemic risk problem for the economy.
The bigger deal will be what happens with lending in the coming months. If banks are worried about raising cash and building bullet proof balance sheets they aren’t going to be keen to commit to long-term loans. Already lending standards were tightening before SVB blew up, as you can see from the red line below. Will commercial and industrial loan growth rollover soon?
This could hold the key to what happens to the economy next year.
(Other) Charts We Found Interesting
- The amount of uninsured deposits took off right around COVID. Another unanticipated side effect of the COVID stimulus programs.
- There is certainly a case to be made for increasing the FDIC limit – it’s near the lows as a percent of GDP going all the way back to 1934.
- You know who liked to buy Austria’s century bond? Insurance companies. Talk about a long duration asset taking it on the chin.
- The U.S. government's fourth quarter interest payments came in at an annualized rate of $852.6 billion.
- Fascinating piece on AI/Large Language Models/ChatGPT and what it means for the price of software in the years to come (https://skventures.substack.com/p/societys-technical-debt-and-softwares) – hint: it’s probably going to get a lot cheaper.
- This seems appropriate – The correct name for a group of swans on the ground is a Bank.
Have a good weekend.
Charles Blankley
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