One of the first things a cub banker – or cub trader to be more precise – is taught is that markets can remain irrational for longer than one can remain solvent. Thus the wisdom of no lesser individual that John Maynard Keynes who was maybe the 20th century’s most influential economist. If not the most influential, then at least he is the most quoted and the bit that reminds us all how easy it is to get one’s tailfeathers singed by taking a rational approach to an irrational business is right up there. By the close of business last night, investors in US banks will be thinking just that as the sector suffered one of its worst sessions since the dark days of Lehman Brothers’ failure.
By the close of business, the shares in JP Morgan, widely regarded as the world’s best bank, had lost 5.4%. The other big money centre banks had just as bad a day with Bank of America and Wells Fargo both off by 6% and Citicorp down by 4%. So, with Fed Chairman Jay Powell just having used his Capitol Hill testimony on Tuesday and Wednesday to reassure lawmakers that the banking system is sound and resilient what got into markets that might have caused such a panic? The answer is SVB. Europeans will know SVB as the Swiss Volksbank, now part of the already troubled Credit Suisse but to Americans it means Silicon Valley Bank and the name tells you more than you need to know. SVB Corp operates Silicon Valley Bank and as the name might infer, it does most of its business right there in America’s fabled tech hub.
Recently, and in light of the rising cost of money, fears have begun to develop with respect to the bank’s exposure to tech start-ups. The passing of the money-for-nothing era cannot but have increased pressure on large swathes of the tech industry which have for years and with impunity been able to remain cash-flow negative. A year ago today on March 10th, 2022 Fed Fund rate had still 0%- 0.25% and had been so since March 16th, 2020. On March 17th, 2022, less than a year ago, the Fed moved for the first time and seven moves and not quite 12 months later they stand at 4.50% – 4.75%. The FOMC meets next in on March 20th/21st and a further 50 bp tightening is all but writ in stone.
Quite why SVB’s customers should have chosen now to question the soundness of the bank’s loan book is unclear but question it they have and have in droves begun to withdraw deposits. This manifested itself in the bank’s proposing to come to market in order to raise US$ 1.75 bn in capital for it to remain liquid upon which more depositors became worried, decided it to be prudent not to hang around and what resulted is nothing other than a good old run on the bank. The decline in the standing of SVB hasn’t exactly occurred overnight. Its stock had closed on Wednesday at US$ 267.83 which was a pretty sharp retreat over the past year, having peaked on March 29th, 2022 at US$ 597.16 . But then it all went belly-up and lost 60.41% in a day to close last night at US$ 106.04 and the selling has gone on in the aftermarket so that the final mark is a further 23% lower at US$ 82.90. The rats are leaving the sinking ship…and they are taking the plug with them.
But is the situation really that bad? Is the bank bankrupt or only insolvent and if it is the latter, is this the moment where the authorities should be stepping in and organising a rescue? My guess is that they will and that Silicon Valley Bank will live to fight another day. But why the panic across the entire banking sector? Fact is that interest rate landscape has over the past 358 days changed beyond recognition but stock markets have so far not really priced those shifts into the share price of banks. JP Morgan’s share price had, until it yesterday tripped over itself, been at a 12 month high, largely predicated on banks making good in a rising interest rate environment. The higher rates go, the less impact the odd extra basis point here and there in credit spreads shows up. Its not a quiz. But with entirely risk free 3 month US Treasury bill rates at 4.89% and 6 month bills even at 5.11%, why would anybody feel the need to leave cash hanging around in the bank?
So, not only is the cost of money rising, banks are also experiencing a decline in what are known as free deposits, money which sloshes around in current accounts and which generally pays either nothing or next to nothing in interest. When underlying rates were at or close to zero and when T-bill were trading in negative territory there was nothing wrong with holding balances in current accounts. The landscape has changed and depositors are beginning to wake up to the possibility of letting the government make their cash work for them.
The world is a very different place to the one it was when Paribas first declared at the end of 2007 that some of its supposedly clever structured investments were beyond being valued, even by its highly trained quant teams. For a brief time it became clear that there is more to the lending game than a PhD in advanced mathematics or theoretical physics and the ability to construct complex models based on perceived correlations and historic defaults. At that point – and I was there right in the middle of it – more heed was being paid to default statistics within a sector or segment of a sector than to the cashflows of any particular company. How could it be? The quants could write the programmes but most of them had never actually looked at a company balance sheet. Their bosses on the other hand didn’t have a clue when it came to the complex maths but rather than admit it, simply nodded their heads. Now, however, that the cost of funds has so dramatically risen, a little more work needs to be done and a more nuanced understanding of the borrowing entities’ business and cash flows is called for. I suspect that the powers that be at Silicon Valley Bank have a pretty good idea what they and their borrowing clients are doing. But bank runs are not rational and against that and panicking depositors there is no cure.
As far as the other banks are concerned, the JPMs and the BoAs, a repricing of the expected cost of funds might be in the offing, and with that in mind, a rerating. The banking issues of 2007/2208 which ultimately led to the GFC and in subsequence to the GEC were not about assets and asset quality but about liabilities and about the explosive rise in the cost and in some cases the near impossibility of funding the balance sheet. As the interbank market which had stood at the centre of the game hit the buffers and as banks found themselves with books they could no longer fund at the expected cost, if at all, they also found themselves obliged to unload assets into a market with no bid which had become, with all the other banks trying to do the same thing at the same time, offered only. The trigger was not poor asset quality but an inability to fund. Those with financial flexibility mopped up as much of the supply overhang as they could and make tidy fortunes once the market had calmed and sensible valuations had once again been placed on assets.
During the GFC, central bank rates did not rise although it did follow on a period during which between June 2004 and June 2006 the US central bank had raised rates no less than 17 times, each one by 25 bps, which had taken Fed Funds from 1.0% to 5.25%. So is the surprise, SVB aside, not that banks are in investors’ cross-hairs but that it has not happened a lot sooner? With the banks going down the tubes, the rest of the stock market has gone with it and we seem to have finally hit the skids, a condition which has been long forecast but which has so far refused to take root. At the time of writing Asia is carrying on the wave of selling which hit New York on Thursday and Europe will no doubt end up having done more of the same.
The monthly US employment report is on the docket today with the consensus forecast for a significantly reduced number of jobs having been created in the past month. The 517,000 reported in February was a big surprise so the revision will be of huge interest. Economists reckon 225,000 will be the new number, albeit with the unemployment rate remaining unchanged at 3.4%. Initial claims, reported yesterday, pointed to rising unemployment. I’ve been trying to find something akin to a steady trend in the labour market. I give up.
Soho House to Soho House …
Elsewhere, Soho House has decided to rebrand itself as….Soho House. The rather exclusive members club which makes a great fuss about not being exclusive listed in New York under the rather silly name of MCG or Members’ Collective Group. The group has barely ever made a profit but has kept with the well-established practice of expanding and expanding so that its lack of profitability can be explained by ongoing capital investment. I know of its exclusivity as the group’s “country seat” – Soho Farmhouse – is not 10 minutes’ drive from here and I was there on Sunday night to see in its spectacular cinema “All Quiet on the Western Front”. The film, by the way, is a masterpiece of film making but somehow not entirely satisfying. More to the point, it completely fails to explain where the title comes from which is, for those who don’t know Remarque’s book, its totally ironic closing line. So, Soho House has appreciated that in the luxury goods market it is advisable to retain the brand name. Ferrari would never dream of rebranding itself as Modena Lifestyle Motors. Since listing in July 2021 at US$ 12.50/share, it has performed abysmally and closed last night at US$ 6.46, albeit that that’s a great deal better than its December low of US$ 3.08. Maybe a higher level of name recognition will help. Making a bit of dosh would of course also be a possible way forward.
Write to us with your comments to be considered for publication at email@example.com