Executive summary:
- Following the collapse of SVB and Signature Bank, the market’s scrutiny of more vulnerable banks in the system—including First Republic and Credit Suisse—is to be expected
- European regulators have announced they will not force bank mergers like the one that took place between Credit Suisse and UBS
- While the details of vulnerable banks that have come under market scrutiny have varied, in all instances, depositors have been made whole. We expect this trend to continue.
In my article a week ago following the Silicon Valley Bank (SVB) collapse, I shared our view that SVB was not an indication of broad systemic risk. That view was widely shared by the many managers with whom we had discussed these developments. We and the managers we work with continue to hold that view today. But as is generally the case, the exceptions often prove the rule. Note: a handful of banks have been in the news in the last week out of over 4,000 FDIC-insured U.S. banks.
The latest on First Republic
The developments over the last week were rather predictable, including the market’s scrutiny of the more vulnerable banks in the system—an outcome which we stated was likely to occur. This is exactly what has happened in the week since, with intense focus on First Republic and Credit Suisse. The reasons for these banks moving into the market’s cross hairs are easily understood.
In the case of First Republic, it had a remarkably similar business model and capital structure to Silicon Valley Bank. Fortunately for First Republic, the Federal Reserve (Fed)’s response to SVB was the creation of a facility by which banks could borrow money from the Fed to meet depository outflows, while putting up their U.S. Treasury and government guaranteed mortgage-backed securities at par value as collateral for those loans. This will allow First Republic to avoid realizing selling those securities (losses due to the sharp interest-rate increases over the past year, not credit risk) and keep its capital intact.
In addition, the big money-center banks injected $30 billion in capital into First Republic to further address the market’s crisis in confidence. These efforts have, so far, allowed First Republic to survive, but investor and customer confidence still remains elusive. As is often the case, just because a bank “shouldn’t” fail does not mean that it won’t if confidence fails. In the end, to re-establish confidence, First Republic may need to seek a stronger bank buyer. It’s also possible that regulators may make that choice for the bank. Interestingly enough, while First Republic is under further pressure in today’s trading, the regional bank industry is actually rallying.
The latest on Credit Suisse
In the case of Credit Suisse, the Swiss lender had been the subject of many recent events that called into question the effectiveness of its management over the last several years. The bank already was suspect to many market participants, and the combination of an increased focus on banks—created by SVB—and a statement (arguably taken out of context) by Credit Suisse’s largest shareholder on March 15 quickly made it the new target of market focus.
Hoping to stave off a potential banking crisis, over the weekend, Swiss regulators forced a merger with the other major systemically important bank in Switzerland, UBS. There is some controversy pertaining to how the regulator handled the merger. For instance, while shareholders were not wiped out and did receive something on the merger, some bond holder positions were wiped out. If other regulators follow suit, that could create some unnecessary risk, but it is important to note that European regulators already have announced they will not follow the same path as the Swiss. Expect lots of litigation on this.
The bottom line
Ultimately, the banking industry remains well capitalized, but the intense interest-rate increases over the past year have exposed weaker banks—and there will likely be more examples to come. While the details of a specific bank’s vulnerability will vary from bank to bank, as they have already, what is true is that in all the cases discussed, the depositors of these banks have remained whole and regulators have acted meaningfully and quickly to address the issues. We expect that to be the case going forward as well. We will continue to monitor markets closely and will continue to share our views with you as events unfold.