Blain’s Morning Porridge – March 14th 2023: SVB Crisis – Time to Put Yer Buying Boots on?
“If you want to crush capitalism, the easiest way to do it will be to ease interest rates to pander to market stability.”
This Morning – SVB is a crisis averted, but the market wasn’t paying close attention which spells opportunity. There are bigger risks from central banks being distracted from fighting inflation and normalising rates. That’s the real crisis!
Where are the fireworks? Day 4 of the Silicon Valley Bank crisis – and it’s all a bit complex and even confusing. Strip it down to the basics, and there are three major questions for the market to consider:
- Is this going to prove a systemic banking crisis leading to a repeat of the 2008 Global financial crisis?
- No! That’s a good thing.
- Is the ongoing SVB crisis going to distract central banks from the fight against inflation and normalising interest rates?
- That’s potentially a very bad thing.
- Is this going to be a trigger for a wider general market selloff/correction?
- This is going to focus the market on the real value of financial assets.
Let’s start with banks.
Up in the virtual mega-mind that is Shard Towers, my colleagues and I spent y’day thinking about banks, the solutions hammered out over the weekend, and the underlying strength of the western economies. Meanwhile, it was carnage out there in bank stocks. The rest of the market was busy dumping banking names – and not thinking about what had just occurred.
It all made us feel quite greedy. If you can keep your head when all around are losing theirs and blaming it on you… and trust yourself when all men doubt you… then there are good reasons to think banks look cheap and investible…
Why? The secret of any really, really good Central Bank instrument or policy announcement is that it shouldn’t actually ever need to be used. Successful “Do whatever it takes” comments by central bank governors work best when the mere words have the required effect on markets. Offering clear solutions to calm a run on the bank sector is much more effective than Jimmy Stewart explaining banking to the townsfolk in It’s a Wonderful Life..
Yesterday the US bank market went into free fall on the absolute certainty every single mid-sized bank would fail. Investors panicked as they looked at bank capitalisations and their ability to withstand runs, ignored the facts, and concluded a tidal wave of systemic crisis would sink all boats.
Been there, seen that… yada, yada, yada…
It was a morning of noise and confusion. Stocks kept slipping even after the US authorities had collectively and decisively acted to guarantee all depositors, to shutter SVB, (the UK allowing a trade sale of the British Bank to HSBC), and avoid a contagious rout in Tech stocks. The market seemed to miss the Fed had introduced a new form of QE – the Bank Term Funding Programme which basically looks, feels and smells like a window willing to lend 100% on collateral – no matter what the market says that collateral is worth – effectively removing duration/term risk from bonds.
Clearly SVB got it wrong. 100% focus on a single sector. A non-discrete depositor/funding base, $29 bln of AFS assets and $100 bln of HTM illiquid assets.. assume a $30 bln loss on the HTM portfolio based on yields rising from 1% to 5%, and trying to finance themselves in crisis… Never works.
The mercy killing of SVB is one thing – its shareholders have been wiped, but the new QE programme is critical. It should reassure investors that any moderately competent US bank with modest leverage, a diversified funding base, and assets in the form of bonds to post at the Fed will survive this crisis. Any bank can now monetise its illiquid Hold-to-Maturity bonds to bolster liquidity, (making a run on the bank far less likely), if that becomes necessary – which it shouldn’t because it’s there as a backstop!
It all rather puts SVB into context as a one-off. Brought low by misunderstanding the value and liquidity of its bond portfolios vs the liquidity needs of its customers. Does it mean every bank around the world that’s been spanked by the SVB crisis is a screaming buy? Not quite.. but they may be cheap – even though it’s clear the perceived stock benefits to banks from a rising rate environment are tenuous. Banks will have to pay more for their funding, so their upside is capped.
Yesterday was a moment of over-reaction – which spells opportunity.
My US stock-picking colleague Julian Wheeler was looking at the US victim banks. One particular name is First Republic Bank. It crashed over the weekend, opening at $26 on Monday morning, down from $81. Clearly it was a case of imminent disaster, clearly the next bank to collapse…. which would further have fuelled the mood of banking selloff across the markets. Yet, buying the bank at its’ bottom y’day could have netted a 20% return as the market began to grasp what was happening. In fact; when the stock was trading down around $25, Julian confidently predicted a close at $35. He was wrong. It reached $41! but then fell to $31, by which time he was well out!
So.. let’s put the threat of imminent worldwide banking collapse on the back of SVB and a few dodgy crypto shills behind us.
The second issue is rates.
Will central banks now pause further rate hikes in order to sustain the stability of markets? Lots of young, yet very senior bank commentators who look good and meet the diversity quotients on BBerg and CNBC think they should. They have only ever worked in markets when Central Banks have been the tail wagging the market dog with absurdly low interest rates whenever prices coughed or sneezed. There is a growing consensus the Fed will stall plans to further hike interest rates. The expectations curve has moved to rates starting to fall in the late spring! Some analysts even expect a 25 pb cut at the coming FOMC meeting.
If central bankers are serious about the long-term stability of their Economies, Jobs, Growth and Markets that provide the basis for savers to afford their retirements, then… get real and stay the course on normalising higher rates and quoshing inflation.
To ease rates now would just exacerbate the mistakes of the last decade. That way lies madness! The root of the current instability in markets is inflation, which remains high and needs addressed, but also the ongoing effects of the decade of monetary experimentation and distortion as a result of QE and artificially low interest rates. Normalising interest rates is critical not just to restore the normal functioning of price setting mechanisms, but also to reimpose pricing discipline and financial common sense on the way markets thinks.
Artificially low interest rates do not stimulate investment, growth and productivity gains. Nope. The proof from the last decade is it generates corporate greed with management preferring stock buybacks to redistribute wealth to themselves and the owners, while stifling pay, raising inequality, while low rates discourage investing in new plant and productivity gains. Artificially low rates create speculative bubbles, investments in pipedreams, and fuelled all the stupidities of Crypto, Spacs, NFTs and FYJs. (Pause for breadth and effect….)
If you want to crush capitalism, the easiest way to do it will be to ease interest rates to pander to market stability. Time for some central bank tough love.
The third issue is Markets.
Although the SVB crisis is about liquidity and bank solvency – it always is – it highlights a growing crisis in the unsustainability of asset valuations and a dearth of market liquidity. Market stability is one of the key functions of the Fed. In the last few days they have acted decisively to address systemic failures in the banking system. Ove the last 15 years, their actions have massively impacted and changed markets – not necessarily in positive ways.
They still have to address the distortions of the QE era. To give you the scale of the problem: from 2010-2022, the size of the US economy grew by 40% as measured as GDP. At the same time, the value of the stock market grew by 270%. I keep asking how that is possible – no one can explain.
Interestingly, John Authers on Bberg this morning points out the KBW Index of US Big Banks has now mean reverted to the same level it was back in March 1998! Mean reversion is a fact!
The crisis that is coming is about unsustainable valuations as the lessons sink in. Let me give you a quick rule of thumb on valuations to apply to your current market marks… (Please feel free to suggest others and amend these rules.) Remember, any asset is only worth what someone else believes it is worth.
- You can 100% value a treasury or gilt because it’s the risk free rate and liquid bond with 100% predictable cash flows.
- You can 75% value a high grade asset backed bond based on its cashflow profile, diversification, security and market history.
- You can 50% value a high grade corporate bond because you can predict its likely default, and even in illiquid markets there will probably be a bid..
- You can 25% value a junk bond based on default probability and the likelihood it will be completely illiquid in times of stress.
- You can 10% value private debt based on cashflows, history, and default probabilities – but with the knowledge it’s as liquid as set concrete.
- You can 0% value private equity as the prices are set between managers and lawyers with a vested interest to keep that valuation high…
- Equity is worth what the market says it is.
And on that… go figure where markets go next…
Five Things To Read This Morning
FT SVB collapse forces rethink on interest rates and hits bank stocks
FT Ken Griffin: US capitalism is “breaking down before our eyes”
BBerg Fed Battle Plan for Inflation Shredded by Financial Turmoil
BBerg “QE in Another Name”: New Bank Backstop Points to End of QT
WSJ Fed Interest Rate Path Called Into Question
Out of time, and back to the day job, looking for bargains in banking!
Strategist – Shard Capital
The greatest bargain is surely HSBC’s ability to buy a bank that was doing just fine only a week ago for one pound. Granted they bought it blind and only time will tell but they didn’t exactly over pay.
And on moral hazard did the US authorities consider a token haircut – say a 95% payout to depositors to avoid systemic repercussions but remind everyone of importance of risk management? Not sure they did…
Wonder if SVB is Bear Stearns
Saved … phew !!
Fed dicing with moral hazard and reasserted its ‘power’ by letting Lehman fail.
Wonder who will be 2023’s Lehman.
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