A guide to the banking crisis: What happened and what comes next?
Joshua Warner March 28, 2023 4:12 AM
Markets have been rocked by the biggest banking crisis since the 2008 financial crash.
The 2023 banking crisis
A banking crisis on both sides of the Atlantic has triggered fears about the health of the global financial system in 2023, with two of the biggest banking failures in US history and the rushed rescue deal for embattled Swiss outfit Credit Suisse sending shockwaves through the markets.
But how did it happen and what comes next?
Why did Silicon Valley Bank collapse?
The Federal Reserve and other central banks have hiked interest rates to their highest level since the 2008 financial crisis as they try to contain persistently high inflation, but this made life more difficult for many of Silicon Valley Bank’s clients, dominated by fast-growing but often loss-making businesses that still require lots of cash to keep going.
Rising rates led to venture capital drying up and made it more expensive for clients to borrow money, forcing them to tap into their deposits. SVB struggled to keep up with the pace of withdrawals, which left it short on the cash it needed to fulfil all the requests.
To plug the hole, it sold a chunk of its investment portfolio. The problem was, it sold it for a $1.8 billion loss because the portfolio included bonds that had lost a value thanks to higher interest rates reducing their yields.
SVB was in a tight spot because over half of its total assets were in its investment portfolio after the bank decided to turn deposits, which customers can redeem on demand, for held-to-maturity bonds that needed to be kept for the long-term. Importantly, those bonds would have proven profitable if they were held to maturity but SVB was forced to sell at a loss as more deposits were withdrawn, especially as it had not undertaken sufficient interest rate hedging.
The fiasco prompted SVB to try and raise fresh capital to bolster its balance sheet but this was ultimately unsuccessfully. The move set off a siren that the bank was financially unstable and led to some influential venture capitalists telling the businesses they were invested in to start pulling their money from SVB, which only exacerbated the situation. Clients didn’t want their money in SVB and investors didn’t want to throw good money after bad.
Unable to raise fresh cash or find a buyer quickly, SVB was closed by regulators on Friday March 10, 2023. It is the second biggest bank failure in US history, and the largest collapse since the 2008 financial crisis. SVB was the 16th largest bank in the United States that had over $200 billion of assets and $340 billion of client funds on its books at the end of 2022, predominantly from fast-growing startups in areas like tech and healthcare. In fact, SVB was the bank of choice for nearly half of all US venture-backed startups.
First Citizens BancShares buys SVB assets
We found out in late March that First Citizens BancShares is buying deposits and loans from failed Silicon Valley Bank. First Citizens was the favourite to buy the assets due to its reputation for snapping-up collapsed banks.
This will see it take on around $110 billion worth of assets, $56 billion worth of deposits and $72 billion of loans. It is also taking on 17 SBV branches.
The news has caused First Citizens shares to pop higher. Not only does the move allow First Citizens to grow swiftly but investors have also warmed the to the price tag it has agreed to pay. For example, the loan book is being purchased at a 20% discount – saving some $16.5 billion! Regulators have also lent First Citizens $35 billion in cash and given it access to another $70 billion worth of funding to ensure it has what it needs to cover SVB’s uninsured deposits. This is important as First Citizens needs more capital on hand because it now has significantly more assets on its books.
Regulators have also said First Citizens will have to absorb the first $5 billion worth of losses from SVB, but will step in and cover any amounts above this.
In return, First Citizens has offered ‘equity appreciation rights’ linked to its share price, which could see it pay as much as $500 million to regulators depending on how its share price performs over the coming years. Not a bad price for a deal that will significantly grow First Citizens while providing protection from further downside risk.
The deal finds a home for the majority of SVB’s assets, although regulators are left with around $90 billion of securities and other assets from SVB – including the bonds that lost value and plunged SVB into trouble in the first place.
The Federal Deposit Insurance Corp said the collapse of SVB has cost its deposit insurance fund around $20 billion, representing about 15% of its total.
Why did Signature Bank collapse?
Another domino fell just two days after SVB was closed when Signature Bank was shut down by regulators. This was the third largest banking collapse in US history after Signature also struggled to cope with a rush of withdrawals from clients, which only worsened as news of SVB’s failure ripped through the markets and caused Signature’s clients to panic.
Like SVB, virtually all of its deposits came from businesses and around 90% of all deposits at both banks were uninsured, meaning they were not covered by guarantees provided by the Federal Deposit Insurance Corp (FDIC). That left deposits vulnerable if the banks fell into trouble, encouraging clients to shift their money out and into more financially-stable institutions.
That may have drawn the eye of regulators that were scrambling to find other vulnerabilities in the system following the demise of SVB, leading to the abrupt closure of Signature Bank on March 12, 2023.
New York Community Bank buys Signature Bank assets
New York Community Bank agreed to buy substantially all of Signature Bank’s deposits and nearly $13 billion in loans, sending the share price higher after securing them at a discount to make it among the few banking stocks trading higher now than it was before the crisis started. The assets are being taken over by NYCB’s subsidiary Flagstar.
Ratings agency Fitch said the purchase of assets from Signature Bank would not impact its ratings and brokers have bumped-up their target price on the NYCB following the news. DA Davidson upgraded NYCB to Buy and Raymond James resumed coverage with a Strong Buy.
That leaves the FDIC looking for a buyer for about $60 billion worth of Signature Bank loans, bonds and other assets – including Signature’s cryptocurrency unit Signet. The FDIC has estimated that the collapse of Signature Bank cost its insurance fund around $2.5 billion.
What about the collapse of Silvergate?
It is worth noting that another bank, Silvergate, was actually the first to buckle after crumbling just days before SVB. The bank, known for its close ties to the cryptocurrency market, entered voluntary liquidation after its balance sheet succumbed to a rush of withdrawals as depositors demanded their money back. It was also being plagued by an investigation by the US Department of Justice over transactions with the now defunct FTX and Alameda Research, both of which rocked crypto markets after imploding last year.
Unlike SVB and Signature, the bank was not rescued by regulators but instead entered voluntary liquidation and started to wind down operations, pledging to fully repay deposits.
Liquidity crisis spreads to US regional bank stocks
Fears of a broader banking crisis quickly started to spread as markets fretted more businesses and consumers would start withdrawing their money from smaller institutions in fear they could lose their cash.
A bank run is self-fulfilling in nature – fear of it makes it happen and creates a flywheel effect that sees the withdrawal of deposits accelerate, escalating the problem and quickly making it a much bigger issue for the wider financial system.
This sparked fears for smaller regional lenders in the US and has hit the shares of stocks like Western Alliance, East West Bancorp, Fifth Third Bancorp and KeyCorp – all of which are still trading far below where they sat before the crisis erupted.
Will the big banks save First Republic?
One of the hardest hit regional banks has been First Republic, which has lost 88% in value since the crisis began. Clients started taking their money out of the bank and placing it into larger, more financially-stable banks as the threat of contagion mounted.
That left First Republic short on cash and in need of a lifeline. Fortunately, a group of the largest US banks comprised of JPMorgan, Bank of America, Citigroup and Wells Fargo stepped-up and pledged to take $30 billion of their deposits and inject it into First Republic to strengthen its finances and send a message that the banking industry was strong and working together.
Unfortunately, that hasn’t been enough to save First Republic. Bloomberg has reported that JPMorgan is considering a new rescue plan for First Republic that could see some or all of that $30 billion in deposits be turned into equity to provide the troubled bank with fresh capital.
Media reports suggest First Republic is now weighing up all of its options, including a potential sale to a larger rival. This would be from a distressed position considering its weak liquidity position has led to First Republic being downgraded to junk status by ratings agencies. It could also try to shrink itself if it can’t raise fresh funds by selling off chunks of the business, including some of its loan book, in order to generate cash while simultaneously cutting costs.
Will more banks collapse?
We have seen swift and decisive action taken by central banks, regulators and government officials as they try to stamp-out the threats facing the global financial system and the contagion spreading through the markets.
However, they are showing reluctance to take action unless it is necessary. Markets have been calling for a blanket guarantee on all US deposits to provide the certainty the industry needs, but these calls have so far gone unheeded.
The FDIC currently insures deposits up to $250,000, but the idea has been floated to increase this and provide new protections for uninsured deposits. The hope is that deposits will stabilise and the action already taken will be enough, but more measures could be needed if markets demand it. US Treasury secretary Janet Yellen said the FDIC could insure all deposits on a ‘case-by-case determination’ if any more failures pose a risk to others.
Yellen has said the action taken so far ‘was necessary to protect the broader US banking system’ and has suggested they are not interested in saving individual banks.
Yellen has said ‘similar actions could be warranted if smaller institutions suffer deposit runs that pose the risk of contagion,’ and reports suggest US authorities are considering providing more support for the banking industry by expanding the emergency lending facility it has supplied to those with liquidity issues, providing them more time to get their balance sheets in better shape.
US officials have stressed that the actions taken over SVB and Signature Bank have been taken to stop the problem from spreading to other institutions and protect depositors, but have refused to call it a bailout. Instead, it says shareholders will be wiped out. Meanwhile, Credit Suisse, a larger behemoth regarded as one of those potentially ‘too big to fail’, has been thrusted upon its more disciplined rival UBS, while bondholders will also lose out.
The situation will improve for any banks still feeling the pressure if markets calm down and depositors grow more confident about the security of their cash. Markets are eagerly keeping an eye out for any new signs that another domino will fall. Confidence remains fragile and it won’t take a lot to revive the haunting memories of the last financial crisis – and markets are also having to grapple with the impact the banking crisis is having on the path of interest rates….
Banking crisis: What does it mean for interest rates?
The Federal Reserve and other central banks are in a tough spot. They want to keep raising interest rates to combat persistently high inflation, which remains far above desired levels, but need to provide some stability for the financial system after higher rates triggered the chaos we have seen in recent weeks.
The Federal Reserve went ahead with another 25bps rate at its last meeting but toned down its statement to give it flexibility to pause the interest rate hiking cycle in May depending on incoming economic data.
‘Crucially, the median FOMC member did not change his/her expectations for end-2023 interest rates from 5.1%, suggesting roughly one more rate hike over the next nine months. Though they’re not as pessimistic as markets, Fed policymakers are still projecting a median of three 25bps rate hikes next year, suggesting that the rate hiking cycle is near, if not already at, its end,’ said our head of research Matthew Weller.
Markets are currently 50:50 torn between another 25bps rate hike at the Fed’s next meeting and it pressing pause and leaving them unchanged, according to the CME FedWatch Tool. Analysts now believe interest rates will peak in 2023, although the debate about the height of the terminal rate continues.
Fed chair Jerome Powell repeatedly emphasized that the impact of the stresses in the banking system will tighten credit and may serve as a pseudo ‘rate hike’ in terms of its impact on the economy.
Banks and commercial real estate exposure
There have also been rumblings about the banking industry’s exposure to the commercial real estate market, which is emerging as the next area of concern for markets.
Put simply, the fear is that a wave of loans on commercial properties is due to be renewed over the coming years and, with interest rates now markedly higher than when the original loans were agreed, companies will not be able to afford them – leading to more failures (and therefore defaults) and causing considerably larger problems for the economy.
Plus, higher rates have also hurt property valuations, suggesting some could be squeezed from both ends, and the banking crisis has caused concerns that credit availability will already tighten going forward. Adding to the woes is the fact demand for some properties, such as offices, has also waned as more companies embrace a hybrid way of working since the pandemic, while stores have also been hit as companies shift online.
JPMorgan said US regional lenders account for around 70% of all commercial real estate loans in the US, and say this remains a ‘major concern’. If these smaller lenders struggle or fail then that will tighten the cash available to lend to the commercial real estate market, making it more difficult for businesses to source capital or refinance existing debt.
What caused the Credit Suisse crisis?
It didn’t take very long for the threats facing the US banking system to spread over the Atlantic and rip through Europe.
At the forefront of the troubles on the continent was Credit Suisse. The 167-year old bank, a big player in Europe and the second largest lender in its home country of Switzerland, was already seeing clients withdrawing their money last year as they become increasingly worried about the state of the bank, which has been ensnarled in a series of scandals and legal problems over the years – from being caught up in the Greensill Capital debacle to the fall of Archegos Capital.
That left it extremely vulnerable as clients responded to the chaos in the US and started taking action to protect their money.
Things got worse when Ammar Alkhudairy, the chairman of Saudi National Bank, which has a 10% stake in Credit Suisse, said the firm would not provide any more financial assistance to the bank because regulatory rules wouldn’t allow it to increase its stake. That spooked investors and clients even further as it signalled raising equity would be difficult and that major shareholders would not emerge as Credit Suisse’s white knight if called upon. Alkhudairy has since resigned from his role, citing personal reasons. However, speculation is rife that he has left after contributing to the tailspin in Credit Suisse shares during the crisis.
The subsequent drop in equity, with the share price having hit all-time lows, and of its bonds, with the cost of insuring them against default hitting dangerous levels, prompted Credit Suisse to open discussions with regulators on Wednesday March 15, 2023.
That resulted in Credit Suisse becoming the first major global bank to secure an emergency lifeline since the last financial crash as regulators agreed to provide a CHF50 billion ($54 billion) liquidity facility to ensure it had the cash it needed to cover deposits.
UBS to takeover Credit Suisse
The Swiss National Bank moved quickly to provide as much certainty as possible and said it would provide all the liquidity necessary to keep Credit Suisse going. In the meantime, it was holding talks with the largest lender in Switzerland, UBS, and encouraging it to take its smaller rival under its wing as the lifeline failed to prevent Credit Suisse’s share price plunging further.
Swiss president Alain Berset said the outflow of funds from Credit Suisse meant it was ‘no longer possible to restore market confidence’ and that the takeover by UBS was necessary.
UBS, despite reports suggesting it was reluctant to complete a merger with its beleaguered peer, agreed to take Credit Suisse over on March 19, 2023.
UBS low-balled its first offer and said it would pay just CHF0.25 on the day that SVB collapsed but this was rebuffed by Credit Suisse, which balked at the $1 billion price tag. UBS returned with an improved offer of CHF0.76 a share in stock, tripling the value to CHF3 billion. It also agreed to assume CHF5.4 billion in losses as part of the deal after the Swiss government provided a loss guarantee for an even larger sum of around CHF9 billion.
UBS has said it will remain ‘rock solid’ after it buys Credit Suisse and the deal cements its position as the world’s largest wealth manager. It plans to downsize Credit Suisse’s investment banking business in order to reduce risk and align it with its more conservative approach. That plan will be welcome in the current environment. For Credit Suisse, which at its peak was once worth almost CHF75 per share, it is has proven to be a slow and painful end.
Credit Suisse AT1 bondholders wiped out
Switzerland’s financial regulator FINMA made a controversial decision as part of Credit Suisse’s rescue plan after writing down the value of $17 billion worth of the bank’s additional tier-1 (AT1) bonds down to zero. That meant the bondholders with these AT1s were wiped out. Other debt instruments, such as tier-2 bonds, were not impacted by the decision.
The reason why that sparked a debate is because bondholders usually rank higher than shareholders when a business fails and often entitled to any money being distributed before investors. FINMA’s decision to prioritise shareholders over bondholders rattled the AT1 market and caused a broader selloff in other forms of bank debt as investors worried over the security of their investments.
FINMA argues it was all in the terms and conditions. ‘The AT1 instruments issued by Credit Suisse contractually provide that they will be completely written down in a ‘viability event’, in particular if extraordinary government support is granted,’ FINMA said. ‘As Credit Suisse received extraordinary liquidity assistance loans secured by a federal default guarantee on March 19, 2023, these contractual conditions were met for the AT1 instruments issued by the bank.’
While there are still concerns impacting the bond market, UBS recently bought back some debt it issued not that long ago when the turmoil was going on to provide a friendly message to bondholders caught up in the drama and provide some more confidence. Plus, European regulators have tried to calm fears by saying that losses would be imposed on shareholders before bondholders going forward to try and signal that the Credit Suisse situation is a one-off and not a new shake-up of the food chain.
What’s going on with Deutsche Bank?
Markets have been looking for the next potential domino to fall in wake of the Credit Suisse crisis and Deutsche Bank has been shaky. The alarm was sounded by a spike in Deutsche Bank’s credit default swaps, which are a form of insurance against default. A rise suggests the risk of default is greater.
That happened because investors became worried that Deutsche Bank, which has also had its share of scandals and problems over the years like Credit Suisse, could succumb to a similar fate as its Swiss peer despite having reported 10 consecutive quarters of profits following a prolonged recovery. Plus, the decision to wipe out Credit Suisse AT1 bondholders also sparked fears among Deutsche Bank bondholders that they too could lose out if the German outfit hits trouble.
Things have since settled down, although markets are keeping a close eye on Deutsche Bank.
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