In light of the recent developments in the banking sector, we at Bruellan would like to provide you with reassurance as to our cautious approach regarding this sector and significant underweight.
Discretionary mandates managed by Bruellan have no exposure to US regional banks (such as Silicon Valley Bank or Signature) nor to Credit Swiss, and exposure to banks more generally is limited. To be specific, our BAM European fund has only a 2.7% position in Mediobanca, while our BAM Swiss (all caps) and Dynamic Swiss funds have a 4% position in UBS, and our BAM Swiss Family a 4.6% position in Swissquote. The BAM US, BAM Global Equity and Dynamic Tactical funds have no exposure at all to banks.
With regards to the recent bank failures, our take is the following: the tightening cycle may continue to put pressure on banks, but the current situation is not comparable to that of 2008. First, it is important to note that the issue does not pertain to excessive leverage and risky investments as was the case in 2008. The problem today lies in client withdrawals of their money, forcing the banks to sell their high-quality bonds at a loss before maturity – turning a liquidity shortage into a solvency problem.
As for Credit Suisse, after its share price plummeted following an accumulation of bad news, the Swiss National Bank and the country’s regulator issued a message reminding the group that it met the capital and liquidity requirements, as imposed on systemic-type institutions. In the wake of this, the SNB provided a credit facility of CHF 50 billion.
Secondly, it is worth acknowledging that regulators and the Federal Reserve have taken prompt action to address the liquidity problem and restore confidence in the financial system. Over the weekend, measures were implemented to contain the risk of spillover and guarantee the deposits of affected banks. Additionally, facilities have been opened to assist banks in borrowing against their bond portfolios.
Chart 1: Banks’ financial strength has improved markedly since the Great Financial Crisis (as evidenced by the EU banks’ Tier 1 ratio).
Third, today’s financial environment today is very different to 2008. Since the Global Financial Crisis, new regulations have been imposed to improve bank capitalisations, reduce leverage and increase transparency in financial transactions. Banks are now required to hold high-quality capital to absorb losses during times of financial stress. Additionally, regulators conduct stress tests to assess the sector’s resilience. As a result, banks are much less leveraged and have a better capital position. The European banks’ Tier 1 ratio has for instance risen from 8% in 2008 to 16.8% today (the Tier 1 ratio being a measure of a bank’s financial strength, comparing its core capital, such as common equity, to its total riskweighted assets – see chart 1).
Chart 2: Sovereign interest rates have plummeted over the past week amid economic uncertainty
The Swiss government bond yield curve has for instance shifted down by more than 50 basis points across all maturities. Looking at the 10- year maturity in particular, its yield has fallen from 1.5% to 1%.
In the short term, banks in Europe are growing their profits by passing on the higher interest rates to borrowers while not increasing those paid on deposits. Their profitability thus continued to improve during the most recent earnings season. And while the risk has spilled over from regional to large banks, a significant part of their asset base is not deteriorating. Sovereign yields are falling (see chart 2), signalling a more accommodative central bank stance, which is lifting the sovereign bond segment of banks’ balance sheets.
Chart 3: The propagation of risk across economies and sectors has been contained.
As an example, the cost of insurance against default risk (CDS) in Europe within the high yield segment remains below the levels of 2020 and 2022.
In conclusion, while tightening cycles always cause some stress, we do not believe that we are at the onset of another financial crisis. Banks are in much better financial health,consumer leverage is considerably lesser (the household debt to GDP ratio has dropped from 98% in 2008 to 72% today), economies are experiencing growth and central banks are likely to become less restrictive (the Fed “pivot”?). Restoring confidence in the financial system is crucial, with governments and central banks playing a vital role in this regard. Should their actions fail to restore confidence, the risk of this episode turning into a broader crisis will increase. We take the current market conditions seriously and are actively monitoring the situation to ensure that risks do not spill over within and across asset classes (see chart 3).
Florian Marini, CFA, CMT
Chief Investment Officer
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