Recently, a group of mid-cap and small US banks triggered the first banking crisis since the global financial crisis (GFC) of 2008. Is this something to worry about (ala GFC), and what impact will this have on the large diversified US banks in which we are invested?
To date, the impact of higher interest rates on bank shares has been mostly positive. This is understandable because banks earn more money when rates increase – bad loans become a problem later. The exception has been a bank like Credit Suisse, the Swiss lender, which has displayed very poor risk controls in recent years.
However, over the past few days, the impact of higher interest rates on the banking industry is becoming evident. Higher rates have withdrawn liquidity from the economy, and asset prices have been severely affected. As a result, 2022 was a terrible year for asset prices.
Find out more about the banking mini-crisis here.
Certain banks have not managed higher rates very well. Silicon Valley Bank (SVB), a lender to the tech sector, is one such culprit. Flush with deposits, SVB invested in long-duration bonds, which were hit hard by rising interest rates. This depleted the equity on the bank’s balance sheet, causing consternation among clients and resulting in a run on the bank. Silvergate, another culprit, has, over time, focused more and more on the crypto sector. Confidence in this sector has been severely affected over the past year. As investors assess the inherent risks in the banking industry, there are likely to be other banks that fail the confidence test. These will typically be those that have not managed the risks on their loan books well or have not been conservative enough on balance sheet management. The partial lifting of regulations for smaller banks under the Trump administration may have made matters worse. Some will argue for further regulation of these small to mid-tier banks.
Our approach at Anchor has been to invest in the larger, well-diversified, heavily regulated banks. JP Morgan Chase (JPM) is one such bank that has been a core investment for our clients. JPM is well-capitalised and is subject to regular stress tests by the US Federal Reserve (Fed). These tests show how JPM would handle sharp rises in interest rates etc. – the smaller banks do not face the same level of scrutiny. JPM has also been extremely conservative in managing its balance sheet in this rate cycle. Jamie Dimon, the CEO, has stated how wary they are of taking on duration on their balance sheet, and it is no surprise that JPM has avoided the types of capital losses that have slayed a bank like SVB. In our view, many large US banks, like JPM, Citigroup, Bank of America etc., are in a group apart from the smaller banks mentioned above. They are heavily regulated, well diversified, and well managed. Therefore, we recommend retaining our investments in the sector and, where appropriate, consider taking advantage of these depressed share prices.
We do not believe this banking crisis – arguably a mini-crisis – will spread to the well-run giants. If anything, depositors are likely to shift their funds to the larger banks – a flight to safety.
Confidence will remain frayed until this period passes. However, the US Fed has responded promptly to guarantee customers’ deposits at SVB – beyond the typical US$250,000 level. It is plausible that this will be extended to other banks that run into difficulty.
“There are more banks than bankers” is what Warren Buffet has often reminded us of. This latest crisis is evidence of that.
Read more about a perspective on the banking crisis here.
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