It’s hard for banks to come back after losing ‘trust and confidence’
“Everyone has a plan until they get punched in the mouth’ – Former World Heavyweight Champion, “Iron” Mike Tyson
Financial institutions are the strangest of vehicles, and I’ve been told many times the same about the people who work in them! Anyways, we have this thing called “money” that we don’t want to put under the mattress in case the burglars come. So, we walk into a shiny building called a bank (if you can find a branch these days) and give the money to the bank to keep it safe. These days, to save time we get our employer to direct-credit to the bank what’s left of our pay slip after the tax man has become involved. The bank then takes some of that money, which incidentally I can withdraw tomorrow should I choose, and deposits it somewhere (usually at a Central Bank or in our case the Reserve Bank of New Zealand (RBNZ)) for a longer term. Technically this is called a duration mismatch whereby the bank invests for, say, two years (i.e. they can’t get it back tomorrow) or they lend it to a borrower, who either can’t or isn’t obliged to repay it tomorrow. The difference between what they pay you for the deposit (interest) and what they earn (interest also) from the RBNZ or lenders is effectively known as a Net Interest Margin or a spread. Said another way, you give me money and I pay you two percent interest and either bank it or lend it (for a longer period) and receive four percent: I make a two percent spread – genius! It’s such a great idea that I conclude that because I have your deposits, and you don’t “all” need them at once, I can loan more money than I have deposits (i.e. leverage) and therefore I have a big duration mis-match. Said another way, we buy houses here in New Zealand (long/lifetime assets – 30 years) and we fund them (mortgages) with short term, say two year fixed, or even floating rate mortgages (same-same). Wouldn’t it be nice to have a 30-year fixed term mortgage, Grant?
I wrote last week about Silicon Valley Bank’s (SVB) demise – a run on the bank caused by a collapse in investor confidence as SVB posted losses from marking to market its long-duration treasury holdings – and what I think it means for us here in NZ. Well there’s been more action this week in global banks with the Swiss Government ushering in UBS to acquire Credit Suisse for just US$3.2 billion to stave-off (hopefully) the latter’s demise and shore-up the European banking sector. We have seen the Federal Reserve and its Swiss equivalent, the Swiss National Bank act to shore-up and backstop these and other financial institutions to stop contagion and restore confidence. Thank you, merci and danke!
Case Study 1, SVB again…
SVB (the poster child of all things tech and Silicon Valley and ESG…) had until late last year been receiving lots of deposits from tech firms (that investors gave them) to hold safe so they can pay staff and create new shiny things worth billions when they list their shares on the stock exchange. So, SVB in receiving capital faster than they knew what to do with it (think US$30bn to US$130bn in a fast two years) did the thing (I explained above) and in-turn deposited funds with the Federal Reserve and loaned huge sums out mainly to other tech companies. Smart. Then two weeks ago after lots of sharp interest rate rises, a cascade of tech-sector layoffs and tech-sector company valuations being cut, the depositors (with a steer from entrepreneur Peter Thiel’s Founders Fund) decided not to have all, too much or indeed any of their money at SVB and quickly started moving their money out (US$42 billion was withdrawn in one day). This is the aforementioned “run on the bank” – everyone wants their money now and the bank has lent it longer term (leveraged) and can’t fund the withdrawals: duration mismatch 101. Although the US Government (via the Federal Deposit Insurance Corporation) will protect a depositor up to US$250,000, some 98% of depositors at Silicon Valley Bank had more than that (so you are on your own above that and fast becoming a creditor). Next step is contagion – it spreads to other banks (First Republic Bank which is a very well-run regional bank has seen its market capitalisation shrink from US$26 billion to US$3 billion in a week) – same story: run on the bank.
Case Study No 2, Credit Suisse…
Credit Suisse, a 167-year-old Swiss Investment Bank and Wealth Manager collapsed earlier this week. To put things in perspective, the assets of the Swiss banking sector, at 448%, are the highest relative to its GDP of any developed country and Credit Suisse accounted for around two thirds of the total. The same measure for our banks is a mere 188% here in New Zealand (and the Aussies own most of them). In a deal overseen, if not structured by the Swiss Government, UBS agreed to acquire Credit Suisse for US$3.2 billion. The deal lets Credit Suisse walk away from its obligations to repay US$17.3bn of Additional Tier One (AT1) bonds – ouch – although we now see the lawyers for these debtholders suing the banks for this default. Big picture: at its peak prior to the GFC, Credit Suisse’s share price was US$70, today it is below US$1… It’s hard to point to exactly what it was, a major long-term shareholder, Harris Associates, selling, some high-profile and senior resignations, losses on various and often times sophisticated financial instruments won’t have helped. The coup de grace was undoubtedly Saudi National Bank (Credit Suisse’s largest shareholder with 9.9%) emphatically refusing to extend any further help.
The key takeaway: banks are a lot of things, but the most important thing is “trust and confidence” – lose either or both and it’s hard to come back.
These two case studies and the knock-on effects are very specific to the US regional banks and two (albeit large) Swiss banks: banks down under are very different beasts, are robust and are behaving well.