An unfolding banking crisis - or not - potential market reaction

19 de mar. de 2023

It could get pretty crazy in the markets this week, and it may start on the futures open at 9am AEDT – headlines have been rolling in today and everyone is on edge for answers – it's complex, but I’ll try and explain what we’re looking out for.

Let us first focus on the US banks – they are a central focus and really the big issue at hand.

EU banks are quite different, they didn’t see the same sort of rapid deposit growth as US banks post-pandemic and had a greater propensity to put depositors' cash on the ECB’s balance sheet – unlike US banks who bought a load of high-quality assets for the coupon income. But they did so at near-zero yields and as the Fed hiked rates these assets fell dramatically in value and by far more than the banks were getting from the interest (i.e., the fixed coupon payment).

Credit Suisse is the key issue in Europe, but that is a very different story – more on that below.

Back in the US - The major concern I see here is the FDIC (fdic.gov/resources/deposit-insurance/) stipulated last week that they will cover non-insured deposits held with a bank over 250k (250k was always the limit deposits would be insured up to in case of a failed bank). SVB Bank’s full deposit base was told they would be made whole, but the market quickly understood that it wasn’t a banking-wide blanket guarantee – it was an implicit guarantee, and each future bank that failed will be considered on a case-by-case basis.

To have a wholesale guarantee covering EVERY BANK DEPOSIT needs congressional sign-off and that is very unlikely - this is key to market sentiment. We also heard last week that the Fed had set up a new credit/liquidity facility and enhanced existing ones for banks that needed liquidity – the idea here was that banks could get capital from the Fed and pledge assets they hold on their balance sheet (USTs, mortgages etc) as collateral and to get capital for a predefined period at the ‘par’ value (rather than the more distressed price they are trading now – let’s say 80c in the $1.

Given we’ve seen the Fed’s balance sheet increase by 300b last week as mid & smaller banks took them up on these loans, this shows how much they needed the capital (bad) but some see this as a form of QE (Quantitative Easing) and hence we’ve seen gold rally strongly and eyeing all-time highs

Essentially, it’s not QE, but it is positive for risk assets because it means if we do see further deposit outflows banks won’t now need to sell assets for a what would be a loss – which was one of the major issues with SVB Bank.

As said, gold rallied hard (+3.6%) and the USD fell…. gold printed new ATHs in AUD, GBP, and JPY terms – Equity markets, however, were sold…The US2000 (which has a decent representation of US mid-sized banks) fell 2.6%. Gold futures are above 2k and but in spot gold we eye an all-time high (ATH) of $2075 in USD terms.

There was talk on Friday that “dozens” of other banks may fail soon as depositors take their cash and run. In fact, the WSJ said 186 banks are facing the same issues/pressure as SVB bank - this has the market on edge, and they crave an even bigger response.

We’re hearing today that a group of 110 US banks is requesting full FDIC insurance for all deposits regardless of the amount – this would give depositors absolute peace of mind not to pull capital from the bank and place the funds in ultra-safe money market funds. These funds flow are opaque but incredibly important.

For perspective, if any bank fails from here and the FDIC does not make all depositors whole the market will take this as a systematic event, regardless of the bank – it will rock the markets in a massive way – which is why it won’t happen at this point.

Case in point, and this is very important - Late last week we heard First Republic Bank (FRC) had been given a 30b injection of deposits from 11 of the biggest US banks. A private market response is old school and shows the banking industry is working together. The globally systemic banks looking after the smaller banks is 100% designed this liquidity to show their faith in the FDICs deposit insurance.

Why? These banks are all non-secured creditors for FRC and, in theory, could lose it all if First Republic go under and the FDIC doesn’t pay out.

Unfortunately, on Friday shareholders didn’t take heart on this incredible action and sold FRC’s equity down 33% and the share price now eyes new lows – clearly, not a great look and this resonated through US equity markets. Deposit holders may get it all back, but equity holders’ wont…the KRE ETF (S&P regional bank ETF) closed -6%.

There were/are worries that SVB financial will not get a buyer – talk is First Citizen Bank are looking at this acquisition – if true, that would be a risk positive.

Warren Buffett held talks with a number of regional bank CEOs in the last 2 days – Buffett did this well in 2008 by taking a stake in Goldman and in 2011 in BoA – he is a vulture, but the kingmaker in times like this – he has an incredible war chest of cash and will pick up distressed assets all day.
Buffett won’t buy the float of these banks obviously but taking stakes could send a message of confidence to equity investors and maybe depositors – we listen for news flow and headlines on this tonight and Monday. It could move markets.

In Europe, it's all about Credit Suisse – Unlike many US banks, CS are fine from a liquidity perspective – they had a huge capital injection from the Swiss Nat Bank late last week to buy them time, but its capital levels are pretty good.

Their issue is the confidence equity investors have in its business model, notably around the investment bank (IB) division. They lost their biggest shareholder – Harris Associates - recently who had held size for 20 years but liquidated on frustrations about how on the IB business performing and its strategic direction. They also had a bunch of ‘bad luck’ with Greensill and Archegos insolvencies.

All the talk in UBS will buy its wealth management and asset management business and divest its IB business.

Clearly the big moves from the SNB show CS are ‘too big to fail’ but will UBS pull it off by the Monday futures open?

Depositors are ok as they are backed by the SNB, but if there is no deal by Monday markets could ask ‘what if’…CS will absolutely drive EU equity markets and the EUR.

Scenarios:

So, a lot to play for – we could get Buffett doing his thing, married with UBS buying parts of CS – risk assets will fly – unclear how the USD trades as this is good news for both the US and EU, but I suspect if UBS buy CS this will dominate and EURUSD rallies hard and gold rallies too. It will increase the prospect of the Fed hiking this week.

Conversely, we don’t get clear headlines by equity futures open on UBS/CS and risk takes a bath as traders pay up for risk-off hedges….pricing risk here is difficult.