Contagion or contained: banks in focus
After a turbulent week for the banking sector, our experts assess the implications.
The collapse of US lender Silicon Valley Bank has been followed a week later by news that UBS is taking over troubled Credit Suisse. Both announcements caused turbulence for share prices across the banking sector. However, the two banks ran into difficulty for largely different reasons.
Silicon Valley Bank’s troubles stemmed from a client base dominated by tech start-ups, whose deposits the bank invested in US Treasuries and similar securities. As the US Federal Reserve (Fed) raised interest rates sharply, the value of these securities fell. At the same time, higher interest rates also caused funding for start-ups to start drying up, and these companies began to withdraw deposits from SVB.
Credit Suisse’s share price has been declining for the past two years. This has largely been due to the impact of risk management failures, such as the bank’s exposure to Archegos Capital Management which failed in 2021. Credit Suisse announced a new turnaround plan in October 2022 but this was seen as insufficiently aggressive by the market. That, plus share price pressure around a CHF4 billion capital raise, prompted a significant outflow of deposits from the bank.
What was announced in Switzerland over the weekend?
Justin Bisseker, European Banks Analyst, said: “Credit Suisse is being taken over by UBS with the Credit Suisse shareholders being paid CHF3 billion in UBS stock. Regulators persuaded UBS to do the deal to preserve financial stability. The alternative would have been disorder with an even sharper fall in the Credit Suisse share price and negative implications for the global perception of the stability of Swiss banking.”
What does this mean for European bank shares?
Justin Bisseker said: “Banking is really a confidence game. There is no bank in the world that can survive if every single depositor goes in and pulls out their money. That's where good regulation and prudence are crucial.
“It's politically unacceptable for depositors to lose money. And so you have to be sure that you have a system that works, where depositors don't lose money, and where the government doesn’t have to step in.”
“For the broader pan-European sector, this deal should 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.”
Jonathan Harris, Global Credit Investment Director, said: "The situation the banking sector faces is very different and much less severe than that of the financial crisis of 2008. Bank businesses are much more conservative, capital is multiple times higher than it was in 2008, liquidity is closely regulated and central banks are in a much better place to respond given their experiences since 2008.
"Nevertheless, confidence has clearly been shaken, and so it remains important that all of the relevant authorities address the perceived weaknesses in the banking system to restore that confidence."
What has happened to Credit Suisse’s AT1 bonds?
One eye-catching part of the rescue deal for Credit Suisse is that, while equity holders are receiving CHF3 billion in UBS shares, the value of CHF16 billion 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 such as this. However, the expectation was that equity holders would take losses before AT1 bond holders.
Justin Bisseker said: “This decision will cause some dislocation in the AT1 market, especially for riskier names in the sector. This was a decision by FINMA (the Swiss Financial Markets Supervisory Authority) and not part of the UBS offer. It speaks to the strain the Credit Suisse business was under.”
Jonathan Harris said: "“In effect, Swiss regulation had been tweaked to make it possible to impose total loss on holders of Credit Suisse’s AT1 debt to get the deal done, despite AT1 debt being senior to equity in the capital structure. The European Banking Authority and Bank of England have put out separate statements, distancing the EU and UK banks respectively from this decision. These statements are important as they confirm that AT1s in the European Union and UK can only be bailed-in following equity being written down to zero.”
Could emerging market banks be affected?
David Rees, Senior Emerging Markets Economist, said: “The direct threat to emerging market (EM) banks from recent banking sector events in the US and Switzerland appears limited. Viewed from the top down, few EMs exhibit signs of excessive credit growth that have usually been a precursor to past crises, while key metrics such as loan-to-deposit ratios do not appear particularly stretched.
“Perhaps the greater risk is that problems in developed market banks morph into a deeper financial crisis that disrupts global capital flows. In this downside scenario, EM interest rates would remain higher for longer, weighing on growth and driving up defaults.”
What about the wider economic implications?
Azad Zangana, Senior European Economist and Strategist, said: “People are on the lookout for contagion risk. But when you look at the stresses in the real economy, there aren’t that many; we don’t have many loan defaults at the moment. Although new borrowing has fallen and the housing market has cooled, labour markets are holding up much better than expected.”
More on banking turmoil: Investor Download podcast
Recent events have sparked broader concerns about the health of the global banking sector.
Speaking on Tuesday 14 March – after the SVB failure but before UBS’s takeover of Credit Suisse – bank equity analysts Justin Bisseker and Andre Reichel joined the Investor Download to discuss the SVB fallout and the stability of the banking sector.
Click here to listen to the podcast.
Interested to read more investment insights? Click here.
This document is issued by Schroder Investment Management Australia Limited (ABN 22 000 443 274, AFSL 226473) (Schroders). It is intended solely for wholesale clients (as defined under the Corporations Act 2001 (Cth)) and is not suitable for distribution to retail clients. This document does not contain and should not be taken as containing any financial product advice or financial product recommendations. This document does not take into consideration any recipient’s objectives, financial situation or needs. Before making any decision relating to a Schroders fund, you should obtain and read a copy of the product disclosure statement available at www.schroders.com.au or other relevant disclosure document for that fund and consider the appropriateness of the fund to your objectives, financial situation and needs. You should also refer to the target market determination for the fund at www.schroders.com.au. All investments carry risk, and the repayment of capital and performance in any of the funds named in this document are not guaranteed by Schroders or any company in the Schroders Group. The material contained in this document is not intended to provide, and should not be relied on for accounting, legal or tax advice. Schroders does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this document. To the maximum extent permitted by law, Schroders, every company in the Schroders plc group, and their respective directors, officers, employees, consultants and agents exclude all liability (however arising) for any direct or indirect loss or damage that may be suffered by the recipient or any other person in connection with this document. Opinions, estimates and projections contained in this document reflect the opinions of the authors as at the date of this document and are subject to change without notice. “Forward-looking” information, such as forecasts or projections, are not guarantees of any future performance and there is no assurance that any forecast or projection will be realised. Past performance is not a reliable indicator of future performance. All references to securities, sectors, regions and/or countries are made for illustrative purposes only and are not to be construed as recommendations to buy, sell or hold. Telephone calls and other electronic communications with Schroders representatives may be recorded.