In this podcast, Nigel Barnes chats to Kokkie Kooyman and Ben Kooyman about the current US banking crisis. They talk about what happened earlier this month, why it happened and how far the effects are being felt. Kokkie manages the Denker Global Financial Fund and Ben is an equity analyst on the global financials team – so they’ll also cover how the fund has been affected in the last two weeks and what we expect going forward.
I’m joined this morning by the Kooymans. It sounds like a title of a new Netflix series actually! Ben is here with me in the office, and Kokkie is joining us from Amsterdam in Northern Europe, where he’s on annual leave. Thanks for taking a bit of time out to speak to everyone, Kokkie.
I really want to get a handle on what’s been happening in the financial sector over the last couple of weeks. There’s been a huge amount of news flow, certainly around some of the banks in America, and some market pressure. So maybe we could just start there. Ben, please turn the clock back a week or two and tell us what’s happened and why.
Thanks, Nigel. I think the important starting point is that these banks’ end of Q4 results were regarded as being well capitalised, healthy and quite profitable. What’s happened since then is there was a specific bank, Silicon Valley Bank, which was concentrated in Silicon Valley, which lent to a lot of fintechs which were generally not profitable. They had been a beneficiary of the low interest rate environment, so they’d been taking risks they otherwise wouldn’t have. Due to this almost being ‘hidden’ by the interest rate environment, the bank was growing incredibly quickly, and most people hadn’t picked up on the risks of the bank. Well, recently it started coming out that the Fed had picked up on potential problems, but the market in general hadn’t.
The banks, until this point, had been focusing on solvency ratios – which give an indication of a bank’s ability to survive a longer period of stress – and capital ratios had generally been focused on that. All the banks screened quite well on this.
But what happened is: As Silicon Valley Bank’s customers (which I’ve mentioned, were mostly non-profitable tech start-ups) came under stress with the higher rates, they started to withdraw quite quickly from the Silicon Valley-based deposit base. That caused quite a run on the bank, and their money started to go out. And as rumours started circulating on Twitter that there were potential problems there, one thing led to another and it just kept on increasing.
What made the problem worse is that they had a really high uninsured deposit base (91%), which made clients scared that if the bank were to go under, they were not insured for it and they would lose everything. So, money quickly started leaving their system.
Also, although it’s normally not a problem, banks have available-for-sale and held-to-maturity bond portfolios. These, as the name indicates, are held to maturity, so the plan isn’t usually to sell them. However, as Silicon Valley Bank had this liquidity problem, they had to start selling these bonds at a loss. As they sold those, to raise capital again they also had to do a share issue. As they were about to do that, the Fed stepped in and took them into supervision. That was the end of Silicon Valley Bank as a listed company.
Unfortunately, all these issues made the market worried about which other banks could have similar problems. The first bank in the headlines was Signature Bank. What made Signature Bank unique is that they had crypto… well, they didn’t have crypto exposure, but they facilitated crypto transactions on their Signet platform and they took crypto deposits, which are stablecoin, so theoretically there was no real crypto exposure in their lending.
What made it worse was that Silvergate had just fallen over a week prior, due to unrelated circumstances to Silicon Valley Bank, except that crypto had also probably been fuelled by the lower interest rates. Silvergate didn’t make as much news because they managed to give all their clients back their deposits, so there was no loss for the general consumer. It’s just that the bank also closed down, so the market was quite sceptical about crypto.
Next, the market focused on which banks had a high uninsured portion, were quite concentrated and potentially had been lending quite quickly in this environment (so maybe taking undue risks). Signature Bank, unfortunately, fell into that category.
On the Wednesday, when Silicon Valley went down, they gave an update which showed they were quite well positioned. They still actually had deposit inflows in their main business. But with the fear that came through over the next two days, they lost $40 billion worth of deposits, which they couldn’t withstand and over the weekend they were closed down.
On Monday, we woke up to news that the markets were worried about the next bank. And the next bank in line was First Republic (the current name most of the news has been going on about). They are nowhere near the rest. Silicon Valley and Signature both had around 90% uninsured portions and were very concentrated. First Republic was a lot less concentrated, had been a much more established bank, had been spun off of Bank of America and had an uninsured deposit base of 73%. But still, it was next in the crosslines. So, there was quite a big withdrawal of their deposits as well. Between the Fed opening up a discount window and the large banks stepping in and giving them $30 billion worth of cash lines to use, for the moment it seems the situation has stabilised – but the market is still fearful of how this will potentially end and which other banks are potentially affected.
Where we stand now in the US, is that a lot of the deposit flows which have been sitting in these mid caps and small caps, are going to the bigger banks because the market is worried. JPMorgan, Bank of America and Citi have been getting huge inflows of deposits from these smaller banks. We’ve got the Fed standing behind them now, but until we have certainty on where their deposit bases stand and what their current deposit levels are, I think the market might be a bit worried. The big number we’ll see is on the Q1 results. Then we’ll get a proper idea of where the banks stand.
The Fed made a facility available for the banks to stand behind. In the first week, there was $160 billion worth of usage that banks tapped. First Republic was $110 billion of that, so it was a huge portion. The numbers released on Thursday showed that the facility has stood still, so it seems as if it’s stabilised and no new banks have had to tap that facility.
The European banks and the rest of the emerging market banks are on a totally different footing, and their balance sheets are structured very differently (which we won’t go into detail on now).
There’s the one big bank in Europe, Credit Suisse, which has actually been having problems since 2015. So, this is nothing new (as listeners who’ve been following the bank will know, they’ve been in quite a few scandals and losses recently). Unfortunately, with Credit Suisse, as a big bank but in a very small country of Switzerland, as international depositors also started fearing the worst, they started withdrawing a lot of their deposit base from Credit Suisse. And now, they have to be taken up by UBS due to this huge deposit withdrawal.
That’s the big summary of where we are now.
So, just to summarise: We’ve got this group of smaller, niche banks in America, they’re regionally based, have client bases in the tech sector and a lot of the deposits are uninsured. That’s caused the background to this issue. You talk about the larger banks, Ben. Do you think that they are at risk here?
No. As I said, the previous crises were all caused by solvency. This is very much a liquidity crisis. Due to capital constraints and requirements, they are actually regulated differently and have to be much stricter on their liquidity. Even before this, they were in a much stronger liquidity position. That, coupled with the fact that they are actually getting big inflows from deposits from the smaller banks, we believe there is zero to no risk of them from that liquidity crisis.
All right, good. I want to come back to the Credit Suisse situation perhaps a little later. Kokkie, to turn to you now. The fact is, we might see this continue in America a little bit. In terms of the individual banks that Ben has been talking about, which of them were held within the Denker Global Financial Fund? Please give us a bit of background as to the impacts on the portfolio.
Yes. Nigel, thanks. We held Signature Bank. It was always one of the very entrepreneurial, fast-growing banks. We really liked the business model and way in which they were doing things. As you say, they were very niche but, actually, they understood their niche and they were pioneers. In essence, once trust in the system went – specifically the deposits, as triggered by Silicon Valley Bank – then depositors just looked at their deposits with Signature and said, “I’m pulling as well”.
We were with Signature Bank and we are not sure if one is going to get anything back. The bank is being dismembered, so to speak, and sold off. It was at a 1.5% position in the fund. The other positions were on KeyCorp, US Bancorp, JPMorgan and Citi, which are all very big banks and generally have been benefiting, with the exception of KeyCorp. But the other three, Citi, JPMorgan, US Bancorp, were part of the rescue package that helped to stabilise the system.
KeyCorp was a bit special, also more regional. We like it very much. It’s a very, very good bank, with very good operating metrics and it’s the 22nd largest bank in the US (which has around 4,000 banks). KeyCorp took a bit of pressure but it’s coming back strongly. Also, the CEO has been stating that they are receiving deposits. It’s very sad about Signature Bank. We really thought it was a very good bank, and they were swept away by the tide.
Yes, sure. And in terms of the portfolio, Kokkie, over the last couple of weeks have you been making any changes to the US component within the portfolio?
Yes. Over the last few months and almost year, the property and casualty (P&C) insurers, which did exceptionally well as they benefited from the tailwinds, were starting to get expensive. So, we reduced those a bit and increased our weightings in US Bancorp and Key. Both of them had fallen more than 30%. It’s totally ridiculous where the share prices have gone to, so it gave us a very good opportunity to add to those. So, we switched from the insurers that were expensive into the banks that we like that had fallen a lot.
Thank you. Ben, coming back to you now, let’s unpack this European banking situation. Could you give us a bit more background to Credit Suisse? From my understanding, the Credit Suisse story is a much longer story. You talk about going back to 2015. This is an organisation which has been struggling for a long period of time.
Yes, it’s been struggling over the last eight years or so. I think five of those years have been losses. When we were there in London at their investor day in 2015, the then-CEO wanted to decentralise Credit Suisse a lot more and give each division a lot more autonomy. That works if a bank is running quite well. Each person has their own autonomy to do what they want. Unfortunately, in this case, it looks like each division wasn’t working well. The rest of the bank, and obviously the leaders, weren’t quite up to it.
There were a lot of mistakes. Credit Suisse has four large parts. It’s got its asset management division, which does quite well. It’s got its wealth management division, which also does quite well. And then it’s got its Swiss private bank which does well. But a lot of the problems have come from its investment banking division. And the problem with investment banking is when you get things wrong, it can go horribly wrong. There were quite a few bad clients which they made huge losses on. A good investment, which they tried to be, is all about scale. As it started losing scale, the investment bank started running at a huge loss – which does mean, in general investment banking, there’s a lot more risk but normally you try and get the reward out of it. They had the risk, and they weren’t getting any reward, which is also why Deutsche Bank is now next in line. It has been running quite profitably and been running a lot smoother but as an investment bank it will automatically carry more risk.
Yes, so Credit Suisse had those problems and due to a lot of these losses they were always capitally a lot more constrained. I think they had three or four CEOs over the last period. As with any business, when you’re having problems, your staff start leaving. The guy who is in charge of UBS’ wealth management came from Credit Suisse. He left in 2019. They’ve struggled to retain talent. I think one thing just led to another, and they got to the situation where we are today.
Have you ever held Credit Suisse in the portfolio?
I think we held it, maybe for a month… not for the last three years, I don’t think. I think we did quite well out of it once, when it got to ridiculously cheap levels at that point, for where we thought it was. Then it rebounded quite strongly, and we sold. So yes, never for a long period and never a big position.
Yes, and it just didn’t meet the criteria in terms of quality?
It just doesn’t, for a long-term investment, no.
UBS, we’ve held on and off for a long time. It’s actually also done quite well for us. It’s been a great bank. We sold it towards the end of last year, not because of something specifically with regards to UBS. It’s just that, as a wealth manager and asset manager, a large portion is quite exposed to the market. And it had done really well, and on a valuation metric, we saw better risk-reward elsewhere.
At this point, after taking over Credit Suisse, it becomes huge – which is great for its scale and very important for its business lines. But with all the particulars and things which are going to run through the business, now that it’s taking over such a big bank with no planning (almost forced on them), it’s an interesting investment. I wouldn’t want to take that risk at this point when there’s opportunity elsewhere.
So you’re going to keep an eye on things and see how it plays out over the course of the next few months before you make those decisions?
Okay, that seems fair. You touched on Deutsche Bank there. Do you think there’s any significant issues with Deutsche or other European banks that we might see in the next week or two?
So, just on the other European banks first… Firstly, they’ve got different capital requirements, which helps a lot, and so they’ve come into this from a totally different position. Also, the US, as Kokkie mentioned, has 4,000 banks – there’s a lot of competition – where the European countries generally have two or three huge banks. The competition for deposits is a lot less in Europe. And this crisis has been caused by a deposit run, so that automatically makes them a lot less risky for the current situation. And they’ve all generally got excess capital and are quite liquid, so we’re not particularly worried about any of the specific banks.
Deutsche Bank, as an investment bank, is always potentially at risk, due to the fact that you’ve got an investment bank with positions. But the last three years hasn’t shown any particular stress. They’ve been profitable. They’ve done the right things. Their liquidity is a lot stronger than Credit Suisse’s. They have also got, as Credit Suisse, a lot of international clients, where Deutsche Bank is a lot more German focused as well.
A problem with the liquidity crisis is that things can change overnight, and there could be a risk. But at this point, and with everything we’ve seen, I don’t see any reason to fear Deutsche Bank is next in line.
Thank you, Ben. Kokkie, obviously the buck stops with you in terms of the Denker Global Financial Fund. For some time now, we’ve been talking to investors about the fact that in a rising interest rate environment there’s a margin expansion which is generally good for core components of the financial sector. In the last couple of weeks we’ve seen share price falls, and I’m sure that’s attractive to you in terms of valuations. So how do you see things going forward? What’s your view? Give us a bit of background there to finish off please.
The rising interest rate environment was very good for banks and it gave the extra icing on the top but also very important because they came from such very low interest rates. In Europe and Switzerland, interest rates were negative. Coming from negative to zero to going back to, let’s say, 3-4% made a huge difference. That is most probably over, and we will see interest rates going back, but not to where they were. So the banks’ status quo, where they will be in 2023/2024 compared to, let’s say, 2018/2019, will still be a lot better. And you can see that in returns on capital that they are delivering.
The rest of the banks have been focusing a lot on cost cutting during this year, so they’re very sound and very solid now. And actually, with all the volatility, the prices have come back down to levels where they are just so attractive – as they were in 2008, after Covid and after the Russian invasion. In the last five years, when you think about it, we’ve had three severe incidents in February/March, where the market and banks tanked. Each time, we thought that it was a severe event – Covid, with the global economy being shut down; the Russian invasion, with significantly higher oil and food prices and war – and each time, the banks, from those low valuation levels, despite the risk environment ahead, bounced back. We think this time is going to be the same. The banks and the insurers we’re invested in screen very attractively, and the market has become too negative on the prospects. If it stabilises, and we think it should, then you should see a fairly strong pullback, as we saw in the past.
There are still risks. There’s a lot of commercial real estate that’s potentially still under water. We’ve done a lot of work on which banks have commercial real estate exposure. None of them have very big exposures. This is a problem that’s been with us since Covid.
Then there are a lot of emerging markets that are sitting with very high debt levels, with higher interest rates, who are going to battle to pay. We’ve already seen that in Ghana. We saw that in Zambia. We saw that in Egypt. So there are a lot of risks out there, and then potentially private equity firms, hedge funds.
All of those could still be shown up, but none of them should be big enough, at this stage, to really cause strain in the banking system at large. You can always have one bank who has a big exposure to a hedge fund or something that just causes problems. But we can’t see anything on the horizon at the moment.
We think the situation should stabilise, but it will be a bit worrying for the next two or three weeks and then I think we’ll have clarity. But your best investments are made in times of stress, so it depends on investors’ risk appetites. If you’ve got an appetite for risk, you should be investing now. If you haven’t, then you should wait a few weeks.
I remember, Kokkie, when we talked through the pandemic, we were saying never to waste a good crisis.
So, your message to investors would be: If you’ve got a risk appetite, then add to your position, because the valuations look good at the moment. If you’re more concerned about risk, just sit tight for the moment and see how this plays out. Would that be your message to investors?
Yes. We’re certainly using the cash that we did have in the portfolio. We’ve been starting to invest specifically in the US banks, because they fell the most and they look the most attractive. But even in Europe now, again, things like ING and so are all starting to look very attractive again.
I think we might have lost Kokkie, up in Amsterdam. Ben, let me come back to you to finish off. Would you concur with Kokkie’s comments?
Yes, definitely. He’s mentioned the US banks. We’d actually been taking out some of our European exposure to the US before this unwound. Now, the European banks are coming back quite strongly, with less risk in most regards. We haven’t yet started reallocating to Europe, but it’s definitely a potential thought process. But, definitely, we’re quite happy with the upside at this point.
Thanks Ben and Kokkie (although I’m not sure he can hear me now). This is a fast-moving situation, and I know that you have a lot of focus on these banking organisations around the world. So, if things do change markedly in the next week or two, we’ll do another quick podcast to update people. Thank you for the background as to what’s been going on and for giving us that insight.
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