Just shortly after the collapse of Silicon Valley Bank (SVB) and Signature Bank, news of UBS taking over Credit Suisse (CS) brought the stability of the banking sector into the spotlight and intensified fears of a repeat of the 2008 Financial Crisis. Investors would come to learn that the downfall of Credit Suisse was not caused by rising interest rates, but rather an amalgamation of issues over the years. The company has been struggling with missteps and compliance failures that cost it billions and led to several overhauls of top management; it has been hit with fines and penalties related to tax evasion, and misplaced bets, among other issues. More recently, the bank posted its biggest annual loss since the financial crisis in 2008, with nearly $8 billion lost in 2022, and received news that the Saudi National Bank (the bank’s biggest backer) was not prepared to put up more money to support it. This was the ‘straw that broke the camel’s back’.
The fact that three banks have failed in succession may be worrisome, but it is also important to keep in mind that bank failures are not uncommon.
Source: Federal Deposit Insurance Corporation, USA Today
SVB and CS: Poor Risk Management
Although the bank failures stemmed from fundamentally different issues, they shared a common root cause of poor risk management. Against the backdrop of one of the fastest interest rate hikes in history, this became the catalyst in distinguishing between fundamentally sound businesses from those that have been poorly managed. As explained by Economist Douglas Diamond, a Nobel prize winner in recognition of his research on banks and financial crises, the Fed policy was not the main reason for SVB implosion, instead, it was that “SVB deployed just about every bad policy on the asset and liabilities sides of its balance sheet”. On a similar note, as aforementioned, Credit Suisse’s meltdown was triggered by a series of idiosyncratic events that was brought to the fore by rising interest rates. “It is only when the tide goes out do you learn who has been swimming naked.” – Warren Buffet
A Repeat of the 2008 Financial Crisis?
Concerns about a contagion event triggering another full-blown financial crisis, similar to the one in 2008, have emerged. The question on many investors’ minds is whether a repeat of the 2008 crisis is imminent. While this possibility cannot be completely ruled out, this is not the base case. Post-2008, banks are more tightly regulated and more well-capitalized. This time, regulators have taken swift measures to prevent bank failures. Jefferies Financial Group Inc. analysts have also indicated that the UBS acquisition of CS has eliminated the risk of a contagion effect that could negatively impact the entire banking sector.
On a separate note, those that are concerned about Credit Suisse’s AT1 bonds being wiped out before equity holders should note a few points. 1. The bonds did what they were designed to do; which was to absorb losses and protect other bond holders. 2. Should bonds take losses before equity holders? This is not usually the case. A report by Bloomberg Intelligence explained that Credit Suisse’s AT1 bonds were unique in that they had a clause that allowed for permanent write-downs (a reminder to do proper due diligence!).
How Are We Positioned?
We have zero exposures to Credit Suisse equity or bonds, and limited exposures to bank equities as highlighted in our previous update on SVB. We also have been in close communication with our underlying fund managers to understand the impact of recent developments – overall, our portfolio is nicely positioned away from the epicentre of the recent crisis.
While the direct impact from the fallout has been minimal, investors should brace for some ‘spillover’ from the epicentre. For instance, ‘recovery’ positions are expected to be volatile in this environment i.e. Small-caps and European equities, though this is offset by the more resilient ‘stability’ positions i.e. Healthcare equities. As long-term investors, what matters is their fundamentals are intact and valuations attractive – this ensures that they will do well beyond any short-term volatility.
Takeaway
We reiterate that a crisis similar to 2008 is not our base case at this moment. In periods of volatility and declines, there will always be a knee-jerk reaction leading to large swings in the market: this can uncover previously unknown risks, but also present opportunities. As long as we are properly diversified, investors can avoid any significant permanent capital loss so that they can stay in the game and compound long-term returns. There will also always be spillovers into areas that may not be directly impacted: for those who can see past the noise, this is the time to look for opportunities.
Market Flash Update – Credit Suisse’s Meltdown
What Contributed To Credit Suisse’s Meltdown
Just shortly after the collapse of Silicon Valley Bank (SVB) and Signature Bank, news of UBS taking over Credit Suisse (CS) brought the stability of the banking sector into the spotlight and intensified fears of a repeat of the 2008 Financial Crisis. Investors would come to learn that the downfall of Credit Suisse was not caused by rising interest rates, but rather an amalgamation of issues over the years. The company has been struggling with missteps and compliance failures that cost it billions and led to several overhauls of top management; it has been hit with fines and penalties related to tax evasion, and misplaced bets, among other issues. More recently, the bank posted its biggest annual loss since the financial crisis in 2008, with nearly $8 billion lost in 2022, and received news that the Saudi National Bank (the bank’s biggest backer) was not prepared to put up more money to support it. This was the ‘straw that broke the camel’s back’.
The fact that three banks have failed in succession may be worrisome, but it is also important to keep in mind that bank failures are not uncommon.
SVB and CS: Poor Risk Management
Although the bank failures stemmed from fundamentally different issues, they shared a common root cause of poor risk management. Against the backdrop of one of the fastest interest rate hikes in history, this became the catalyst in distinguishing between fundamentally sound businesses from those that have been poorly managed. As explained by Economist Douglas Diamond, a Nobel prize winner in recognition of his research on banks and financial crises, the Fed policy was not the main reason for SVB implosion, instead, it was that “SVB deployed just about every bad policy on the asset and liabilities sides of its balance sheet”. On a similar note, as aforementioned, Credit Suisse’s meltdown was triggered by a series of idiosyncratic events that was brought to the fore by rising interest rates. “It is only when the tide goes out do you learn who has been swimming naked.” – Warren Buffet
A Repeat of the 2008 Financial Crisis?
Concerns about a contagion event triggering another full-blown financial crisis, similar to the one in 2008, have emerged. The question on many investors’ minds is whether a repeat of the 2008 crisis is imminent. While this possibility cannot be completely ruled out, this is not the base case. Post-2008, banks are more tightly regulated and more well-capitalized. This time, regulators have taken swift measures to prevent bank failures. Jefferies Financial Group Inc. analysts have also indicated that the UBS acquisition of CS has eliminated the risk of a contagion effect that could negatively impact the entire banking sector.
On a separate note, those that are concerned about Credit Suisse’s AT1 bonds being wiped out before equity holders should note a few points. 1. The bonds did what they were designed to do; which was to absorb losses and protect other bond holders. 2. Should bonds take losses before equity holders? This is not usually the case. A report by Bloomberg Intelligence explained that Credit Suisse’s AT1 bonds were unique in that they had a clause that allowed for permanent write-downs (a reminder to do proper due diligence!).
How Are We Positioned?
We have zero exposures to Credit Suisse equity or bonds, and limited exposures to bank equities as highlighted in our previous update on SVB. We also have been in close communication with our underlying fund managers to understand the impact of recent developments – overall, our portfolio is nicely positioned away from the epicentre of the recent crisis.
While the direct impact from the fallout has been minimal, investors should brace for some ‘spillover’ from the epicentre. For instance, ‘recovery’ positions are expected to be volatile in this environment i.e. Small-caps and European equities, though this is offset by the more resilient ‘stability’ positions i.e. Healthcare equities. As long-term investors, what matters is their fundamentals are intact and valuations attractive – this ensures that they will do well beyond any short-term volatility.
Takeaway
We reiterate that a crisis similar to 2008 is not our base case at this moment. In periods of volatility and declines, there will always be a knee-jerk reaction leading to large swings in the market: this can uncover previously unknown risks, but also present opportunities. As long as we are properly diversified, investors can avoid any significant permanent capital loss so that they can stay in the game and compound long-term returns. There will also always be spillovers into areas that may not be directly impacted: for those who can see past the noise, this is the time to look for opportunities.