Silicon Valley Bank Collapse – Judgement Day – 10 Key-takeaways
The collapse of a major US bank doesn’t come as a surprise given the current macroeconomic backdrop with the recent strong and fast rise in interest rates.
In this context, the failure and closure of Silicon Valley Bank (SVB) will not be the last significant bank, corporate or property casualty in the current cycle and in 2023.
Let me share with you our 10 key-takeaways:
1) The SVB Collapse is Self-inflicted
The collapse of SVB is self-inflicted as the bank’s leadership failed to optimally balance profitability with liquidity (not sufficiently raising deposit rates), wrongly assessing funding risk (fickle institutions vs lethargic retail investors) and misjudging the interest rate development (investing in high risk long term bonds and running huge book losses). The subsequent failure of raising capital was SVB’s final blow and the rest is history.
2) Misalignment of Incentives Remain Root Cause
Once more misalignments of incentives (privatizing profits and socializing losses) let the bank’s leadership act in an ultimately fatal way. The SVB failure largely is an idiosyncratic event – however not the only one out there.
3) Investors and Clients Should Blame Themselves
Investors and clients can only blame themselves for their misfortune. It is amply clear that counterparty risks matter – they matter big time in a fast and massively tightening monetary environment. They ignored at their own risk that Central Banks are in no mood to pivot in order to regain damaged credibility.
4) Back to Basics – Hold Liquidity in Safe Banks
Stick to the back to basics rule – essential cash holdings should not be parked in non-systemic banks. Needless to say, yield and safety are a trade-off and you can’t have the cake and eat it.
5) Don’t Blame the FED
Don’t shoot the messenger nor the policymakers. The FED’s mandate includes inflation, employment and financial system stability but not rescuing individual financial institutions and facilitating a morally hazardous behavior by bank leaderships engaging in inappropriate risk taking.
6) Don’t Expect a Bailout – FDIC Auction
In any major bank casualty the response and actions by policymakers are of decisive importance. A Government bail-out (tax payers money) is and very rightly is a no-go (and definitely in a pre-Presidential election year), particularly, in a non-systemic bank situation.
The optimal solution is a successful FDIC led auction leading to a substantial and credible financial institution acquiring SVB and assuring continuity for clients and counterparties.
7) Control of Contagion Risk
US policymakers will be guided to avoid any bank run, contagion risk and a general loss of trust. Trust, trust, trust is a ‘conditio sine qua non’ in banking but clearly not enough – it needs to be paired with transparency, accountability and alignment of interest. The SVB collapse will result in more intense scrutiny of small and midsized banks and, ironically, once more lead to accelerated capital and asset flows towards large systemic banks.
8) More Casualties – Active Management and Selectivity Key
The ongoing tight monetary policy and lagging effect of significantly higher interest rates will go on to break more weak links and result in more casualties in financial institutions, corporates and properties. Consequently, investors will become more sensitive to liquidity and solvency risks and the dispersion of returns and risks between winners and losers will widen. Consequently active management, selectivity and customization will be key to performance success.
9) European Banks Particularly Exposed
The European banks recently performed well as they benefitted from omitting to pass on higher rates to their clients and not suffering major loan losses as of yet.
European banks remain significantly more vulnerable and structurally less attractive than US banks. We would continue to avoid the weakest European banks with the lowest valuations, worst equity price performances and lowest credit ratings.
10) Investment Conclusions – Flight to Safety and Contrarian Risk Taking
The first reaction in capital markets on a major bank collapse is heightened volatility, risk aversion and flight to safety. At the same time it is highly attractive to capture optimal entry points into quality equities. The US financial sector which is highly competitive and has been and will be very rewarding for shareholders.
Article by Beat Wittmann, Chief Investment Strategist at Key Family Partners SA