The wealth manager’s view
Daniel Casali, chief investment strategist, Evelyn Partners Investment Management
The spectre of a systemic banking crisis has created significant volatility in equity and bond markets in the wake of the collapse of Silicon Valley Bank (SVB) in the US and the fears over Credit Suisse in Europe.
Looking ahead, three potential scenarios for the future direction of markets present themselves – the most optimistic being these events prove isolated, the problems are brought under control, confidence returns to markets and the economy remains resilient. In this situation, the Fed would continue its original plan to keep rates tight throughout 2023.
A second scenario would mean banks become more risk-averse as financial conditions deteriorate. Small-bank lending would fall, which would hurt economic activity and lead to a higher number of defaults, while more problems could emerge in the financial sector. In this case, the Fed may be forced to cut interest rates later in the year.
The final scenario is a deep banking crisis, where economic activity contracts sharply, leading to a prolonged recession. This would prompt the Fed to cut interest rates immediately and force it to inject more liquidity into the financial system to reduce the risk of contagion.
Arguments can be made for and against each but the midway scenario is our base case. We have already seen a fall in bank lending over recent months. As risk aversion and regulatory scrutiny of small banks increases, aggregate lending is likely to fall.
This will hit economic activity, leading to more defaults and further tightening of lending conditions, which could threaten the stability of the financial system. If it reaches this point, central banks and financial regulators would step in.
We have refrained from making knee-jerk decisions as we continue to assess the fallout from these events: there are a lot of moving parts and it will be important to monitor the situation as it evolves.
The fund manager’s view
Simon Murphy, fund manager, VT Tyndall Real Income Fund
In the space of just two weekends, we saw the second and third-largest bank failures, by assets, in US history – SVB and Signature Bank, respectively. This has been followed by the hastily arranged sale of Credit Suisse to UBS, after it became clear not even a $54bn (£43bn) credit line from the Swiss National Bank would be sufficient to shore up client confidence in the ailing franchise.
Without wishing to downplay the seriousness of these events, our view remains a ‘2008 redux’ is not particularly likely. Unlike in 2008, this seems to be first and foremost a liquidity issue not a solvency one, given much greater capital buffers are in place at both the global and regional banks this time.
Furthermore, following the global financial crisis, the authorities have the tools and experience to deal with liquidity issues quickly, which is exactly what we have been seeing occur.
Clearly markets are now extremely volatile but, moving forward, it will be key to focus on the reaction function of governments and central banks, not today’s headlines. Aside from actions relating to specific banks, the most likely reactions now are the slowing or stopping of interest rate hikes and the provision of additional liquidity to markets, such as the increase in US dollar swap lines announced by the big central banks towards the end of March.
If you believe, as many do, that liquidity is the predominant driver of equity market performance then, in due course, it is likely to become a positive influence once again.
The analyst’s view
Justin Bisseker, European banks analyst, Schroders
Banking is really a confidence game as there is no bank in the world that can survive if every single depositor decides to pull out their money at the same time. This is where good regulation and prudence are crucial.
It is politically unacceptable for depositors to lose money – so you have to be sure you have in place a system that works, where depositors do not lose money and where the government does not have to step in.
For the broader pan-European sector, the UBS deal ought to take the risk of a disorderly implosion of Credit Suisse off the table. That is a material positive for banks. Credit Suisse was an isolated case
in European banking. There is no read-across here to other banks.
One eye-catching part of the rescue deal for Credit Suisse is that, while equity holders are receiving chf3bn (£2.65bn) in UBS shares, the value of chf16bn of additional tier 1 (AT1) bonds is being written down to zero. AT1 bonds are a type of bank debt designed to take losses during a crisis – however, the expectation was that equity holders would take losses before AT1 bondholders.
As a result, this decision is likely to cause some dislocation in the AT1 market – especially for riskier names in the sector. This was not a part of the UBS offer but a decision by Finma, the Swiss Financial Markets Supervisory Authority, which speaks to the strain the Credit Suisse business was under.
The fund buyer’s view
Nick Wood, head of fund research, Quilter Cheviot
Left field events, such as the collapse of SVB, can give us some of our best insights into how a fund manager operates. For every underperforming investment, there can be plenty of excuses from the manager but, when a stock goes to zero, there can be only one conclusion: the manager made a mistake.
For fund selectors, the conversation with the manager in these circumstances can be very illuminating. First, do they accept this was a poor decision? Every manager makes mistakes, of course – that is why a good ‘hit rate’ for the proportion of successful investments is only around 60% – but not all are happy to admit to them.
Second, these situations really shine a spotlight on stock analysis. Anyone who spends any time on Twitter, for example, will find multitudes of in-depth analysis being produced on the shortfalls of SVB.
As a generalist fund selector rather than an expert banks analyst, this offers a unique chance to really assess the analysis the manager undertakes themselves.
There can be no positives from a large company collapsing but such events do allow us to take a much closer look at a manager – whether that be their temperament, analysis, risk framework or other aspects of their process.
For those of us lucky enough to see fund managers face to face, this is an opportunity not to be wasted. I suspect we will be given more in the next few years.
See also: Banking sector turmoil is a liquidity squeeze not a solvency crisis like 2008
This article first appeared in the April edition of Portfolio Adviser Magazine
