The Lex Newsletter: fear and loathing in California, Zurich and a bank branch near you

Dear reader,

If you have ever wondered what a banking crisis is, look around. In the past fortnight, Silicon Valley Bank and two other specialist US lenders have collapsed. And the Swiss National Bank and Wall Street have propped up Credit Suisse and First Republic with liquidity and deposits.

Other institutions will need rescuing before the dust settles. Savvy acquirers will pick up some attractive assets on the cheap. The pace of interest rate rises will slow, regardless of what central bankers and economic pundits say at present. The net interest margins of banks will widen less than expected. US regional banks will incur tighter regulation.

During recent suckers’ rallies in the US market, Lex predicted further bumps, stumbles and left-field challenges before big economies adjusted to higher rates. We had not expected anything as bad as this.

Amid such technicalities as hold-to-maturity bond hedging, it is easy to forget the basic flaw of the banking industry. It depends for its survival on trust outweighing fear in the minds of depositors. They can pull their funds at will. The bank cannot realise its loans quickly. Mass withdrawals — or the threat of them — can easily topple a lender

Runs represent the triumph of terrified individualism over placid mutuality. It may be personally rational to pull uninsured deposits before your bank’s immediate liquidity is exhausted. It is collectively irrational to destroy an institution that benefits everyone.

Financial analysis can be a false friend in such circumstances, a problem the Lex team has been acutely aware of this week. Banks are relatively strong by historic standards. That strength can be complacently quantified. Financial panic is unquantifiable and therefore easy to downplay. But it can still overwhelm solvent financial institutions by making them illiquid.

A timeline of Lex notes is the easiest way to tell the extraordinary story of the past week. For convenience, I’ll identify these by the UK date of online publication, in priority over the timing of the local event they describe.

Friday March 10: Silicon Valley Bank (SVB) collapses following a run by its depositors. Lex notes that unrealised losses on bond holdings are a widespread vulnerability of US banks. SVB’s concentrated base of depositors — mostly high-tech start-ups — is a narrower problem. We point to the danger of contagion to First Republic and PacWest.

Sunday March 12: US financial authorities mount an auction of SVB assets. Unsurprisingly, this proves abortive. The collapse will, however, create opportunities for tech giants and venture capitalists to buy distressed start-ups.

Monday March 13: HSBC shows opportunism of its own by buying the UK subsidiary of SVB for £1. This looks like a good deal. It allows boss Noel Quinn to onboard entrepreneurial customers, a group he favours. It should buy him some UK political kudos, supposing politicians are capable of gratitude. The asset base of SVB UK is usefully diverse.

The original sin of the parent was the concentration of asset risk via a portfolio of dull, long-dated US municipal bonds whose value was trashed by interest rate rises. Bond maths is the new Nemesis of banks.

By Monday, US regulators had guaranteed all the deposits of SVB and Signature Bank, which had also collapsed. The Federal Reserve and JPMorgan Chase contributed $70bn of backstop liquidity to First Republic Bank. This lender has some similarities to SVB.

The intervention failed to arrest a share price slump. “Fear can easily chase rational thought from the market,” Lex wrote.

Tuesday March 14: Bank shares tumbled in Tokyo. Mitsubishi UFJ Financial Group registered a 17 per cent drop from the moment SVB cratered. Lex reckoned the weakness of Japanese banks reflected high exposure to US bonds and fears that the Bank of Japan would now continue to keep rates low.

Shares in US regional banks made a modest recovery when New York opened. First Republic, PacWest, Western Alliance, Zions Bancorp and UMB Financial were among them. A drop the day before channelled fears of instability. This is partly the result of a 2018 bank relief law that raised the threshold for US financial institutions to qualify as systemically important — and suffer stricter regulation — from $50bn to $250bn in assets. Most US regional banks limbo under that bar.

Wednesday March 15: A full-blown crisis erupted at Credit Suisse, the weakest of Europe’s big banks after its largest shareholder, the Saudi National Bank, dismissed suggestions it should inject fresh equity.

Amid the panic, Credit Suisse was trapped in a three-way doom loop between depositors pulling money, rising bond default insurance prices and falling shares, which dropped as much as 30 per cent intraday.

The fact that the bank appealed to the Swiss National Bank for support strongly suggests large commercial banks were increasingly unwilling to transact with it, despite a 150 per cent liquidity coverage ratio.

Thursday March 16: Overnight, the SNB put up SFr50bn ($54bn) in extra liquidity. Credit Suisse swiftly mounted a SFr3bn senior bond repurchase. That highlighted the securities as a fourth element in the doom loop. Notional yields of these supposedly high-grade instruments had risen as high as 150 per cent.

The Swiss bank insisted it would continue with a complex restructuring. But circumstances have changed. A simpler streamlining, perhaps involving UBS, is required.

Happy days — for the moment — for US alternative asset managers such as Blackstone and Apollo. Their growing private credit funds have long lock-ins, which protect them from depositor runs. And the scale of their resources for their old métier of buyouts now allows them to do deals primarily in equity, albeit that returns may be less.

Friday March 17: A deposit injection of $30bn into First Republic by JPMorgan, Citigroup, Wells Fargo and others was an intelligent attempt to calm market panic, we reckoned. But it impressed Lex more than the market — the stock had dropped another 23 per cent by lunchtime in New York.

It is increasingly likely that First Republic will, at the least, need an open-ended promise of liquidity support from the Fed. And that may simply prompt Armageddon to move on somewhere else.

Contagion is raging like a forest fire. When the financial authorities douse it in one place, it soon flares up somewhere else.

Non-apocalyptic news

This has been a decent week for high-earning British executives, some of whom are readers of this column. The government introduced a three-year, 100 per cent tax deduction for business investment in its annual Budget. It also abolished the cap on tax-free pension saving, though an incoming Labour government would reinstate it unless you are a doctor.

Lex last week saluted increased scope for final salary pension scheme buyout deals, though this was before the banking crisis made steady rate rises less likely. The buyouts simplify corporate cash flow and improve the covenant of scheme members and pensioners.

Soon all those wealthy oldies may be bombing around the countryside in Porsches purchased with the chancellor’s largesse. The German sports-car maker is doing nicely. We think its valuation niche will inevitably sit below Ferrari and above VW.

Things I have enjoyed this week

I am still reading Edward Gibbon’s The History of the Decline and Fall of the Roman Empire.

I also enjoyed the FT’s Helen Thomas ticking off the UK’s fickle tech entrepreneurs.

One of my children made the mistake of expressing an interest in the life of Charles Darwin. We are therefore watching an old BBC TV drama on that subject. It is long, slow-paced and very calming.

I recommend boring 1970s TV to anyone who is finding the semi-collapse of western banking a little too stressful.

Enjoy your weekend,

Jonathan Guthrie
Head of Lex

To comment on this on any other aspect of Lex, please email me at Lexfeedback@ft.com