pre-Spring housecleaning in the banking sector
Silicon Valley Bank
For Northern California entrepreneurs, having a Silicon Valley bank account was like sporting a Birkin bag or driving a Porsche–a clear signal that you’d made it.
Unfortunately, it was also almost inconceivably badly managed as a bank. A huge portion of its investments were in long-dated Treasuries, bought when interest rates were close to zero and unhedged against the possibility of higher interest rates. This meant losses were inevitable as the Fed normalized interest rate policy as the pandemic waned. Warnings from government regulators and outside consultants about this risky posture, as well as the lack of management information systems, were ignored.
Adding to risk, the bank was very highly vulnerable to the possibility of mass withdrawals on the deposit side of the balance sheet. That’s because the average account size was $4 million, meaning 90+% was above the $250,000 limit for being eligible for Federal deposit insurance.
More than that, Jim Cramer of CNBC touted the stock as “cheap” at $320 a share a month or so ago.
The house of cards came crashing down as the bank began to have gigantic withdrawals–reportedly $42 billion in a single day–and a belated attempt to raise new funds failed. The bank was closed by the authorities ten days ago.
CS has been the bad boy of Swiss banking for as long as I can remember. It wasn’t a case of plain vanilla incompetence in asset-liability structure the way it was with Silicon Valley Bank. It was more the company it kept–drug dealers, money launderers, fraudsters of all ilks. None of that did the bank in, though. It looked like it would be able to continue to limp along, until the announcement by its largest shareholder, the Saudi National Bank, that it wouldn’t/couldn’t provide more equity to help address potential liquidity problems. The result was a government-forced acquisition by UBS at a price that all but wiped out existing shareholders.
One twist in the story: contingent convertible bonds. These are weird (to my mind, anyway) instruments that have been around for decades. Traditional convertibles are income instruments that are issued at a discount to prevailing rates, offset by an option for the holder to convert into stock at, say, a 30% premium to the issuer’s stock price at the time of the offering. So if good things happen, the holder is rewarded. Contingent convertibles, called “co-cos” or AT1s, do the opposite. They are issued at a premium interest rate, with an issuer option to convert them into common stock if the underlying business goes south.
I’ve never understood the attraction.
Credit Suisse had $17+billion of the se on its balance sheet. They’ve all been converted, wiping that debt away.
where to from here?
Morgan Stanley, which had predicted a US equity index fall of up to 25% during the first quarter and gradual improvement after than, appears to be saying that banking woes are the canaries in the coal mine or, to mix metaphors, the first of many shoes that will drop in the near future. My sense is that we’re much closer to the end of bad news than that.
The big winners during all this have been cryptocurrencies and beaten down tech stocks. So far this year, the Russell 2000 (pure US earnings) is flat, the S&P (half US, half foreign) up slightly and NASDAQ up by about 10%. I’d be happy with a flat market from here, where stock and industry selection would be paramount.