Monday, March 27, 2023

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Because Silicon Valley Bank and Signature Bank were toxic banks

Because Silicon Valley Bank and Signature Bank were toxic banks

Crisis of American regional banks and asset allocation. The analysis by Andrea Delitala, Head of Euro Multi Asset at Pictet Asset Management

Over the weekend, two non-significant American banks were placed into receivership: they are in fact the sixteenth ( Silicon Valley Bank or SVB ) and the twenty-ninth ( Signature Bank ) American bank. In particular, SVB, known for its activity in Silicon Valley, has caused a sensation, even if everything seems to already start from some crunch among banks and, above all, among cryptocurrency platforms.

These two US banks have suffered a toxic combination of securities losses: they had suffered a major negative impact on their portfolios as rates hiked in 2022. To this was probably added, especially in the case of Silicon Valley Bank, a significant drop in deposits. Furthermore, this bank started from a high ratio between assets and a rather low liability in terms of deposits: therefore, little stability in terms of liabilities, which put it in particularly fragile conditions.

As intervention measures by the financial authorities, beyond the ever-present protection by statute through interbank agreements on depositor deposits of up to $250,000, a facility was also quickly put in place by the Fed, under to which banks can have access to up to $25 billion in funding – against collateral guarantees – which will be valued at 100% and up to one year in duration.

Guarantees should also be extended on deposits above $250,000: it is, in essence, a fairly effective safety net.

Still, the market worried. In fact, the fear remains, albeit residual, of a contagion to the banking system, which is effectively subject to capital losses. There is talk of some important names such as, for example, Bank of America which allegedly suffered more than 100 billion losses on the securities component, with a potential erosion of equity capital.

In these cases, as soon as one turns to the market for capital increases, there is a risk of reacting with a run on the bank and the withdrawal of deposits, as actually happened for SVB. However, we believe that the facilities made available by the Fed are adequate from a systemic point of view. Instead, there is a more local and limited issue for smaller banks. This is because, due to regulatory issues, they have been penalized more because they are more subject to the withdrawal of deposits when there is a greater advantage of direct investment in other alternative instruments, such as, for example, market funds, to which many depositors have turned.

The consequences for the financial markets

Some traces will certainly also remain in monetary policy decisions as regards the two open questions: where the rates stop and when the withdrawal of liquidity through Quantitative Tightening stops. It is very likely that what we are seeing involves a closer terminal rate. Until recently, we had revised it higher following rather high inflation data, around 5.5%. Now it is reasonable to think that it will settle at around 5%.

On the other hand, it will be necessary to understand on the basis of the evolution of the news in recent days whether it is appropriate to interrupt the withdrawal of liquidity.

Basically, the market is reacting very emotionally these days, with a divergence in the behavior of the stock and bond markets. Bonds are once again a safe haven: we have seen a great rally in bonds – especially American bonds – across the curve, even starting from the short end. The short term, up to two years of yield, has seen a drop in higher yields now close to a percentage point within a few sessions, a movement that seems to us exaggerated and perhaps due to an overreaction due to panic. The long part, on the other hand, seems more sustainable, and we thought it was even before this story. Stocks, on the other hand, are penalised: risk premiums open up and we think it's normal for them to undergo corrections.

On the dollar we see a compromise situation: on the one hand it remains a safe haven; on the other hand, being the epicenter of the earthquake in America, the currency is not benefiting as much as one would think.

Obviously these are days of panic, in which it is difficult to make a definitive assessment of what is happening. However, we do not consider it systemic. We are taking profits on the good part of the duration we had acquired in our portfolio: this shows that the return to normal correlations allows to build a robust portfolio. These will actually be positive days for our MAGO fund thanks to the contribution of the bonds. On the other hand, on the equity side we had already taken protection, particularly on the VIX and also on Europe. We therefore reiterate that it is necessary to be cautious about equities, but bonds could at this point have a better adjustment. However, we are considering putting back some hedging positions on the American 2-year which seems to us to be the result more than anything else, at this moment, of a "squeeze".

This is a machine translation from Italian language of a post published on Start Magazine at the URL on Sat, 18 Mar 2023 08:21:26 +0000.