💵 Capital Is No Substitute For Confidence

In partnership with Utrust, the only crypto payments gateway your business needs 👇

David & Tim booked holidays for 'a quiet week in March' when there definitely wouldn't be a banking crisis. Perfectly planned. The Veteran's looking at lessons from the past couple of weeks 👇

We start with a picture: this is the chart of a bank that had recently received a $30 billion injection of capital from a consortium of some of Wall Street's biggest firms.

Can you tell that from the chart? Nope, nor can I...

Even now, it's trading a touch lower at 14.26

Let's look at two more charts...

KRE, the S&P Regional Banks ETF and SX7E, the Euro Stoxx Bank index, neither of which were having a particularly good time of things...

Then we turn to the sorry tale of Credit Suisse - a bank that had been teetering on the brink for some time, thanks to a combination of family office Archegos blowing up and the bank's links to the Greensill debacle.

Don’t get fooled into thinking that CS wasn't sailing close to the wind before all this.

Oh no, the bank had far from lilly-white reputation and was no stranger to a regulatory slap on the wrist and a punitive fine or “two”.

Then, of course, the Federal Reserve moved to backstop the US banking sector. As JP Morgan points out, the Fed stands ready to inject up to $2 trillion into US money markets to aid liquidity. The central bank has also opened up $ swap lines to overseas central banks and institutions.

In doing so, the Fed's potentially unwinding its own quantitative tightening efforts and balance sheet reduction.

Which is probably one good reason for the bounce in risky assets we've seen since then...

Marquee Finance

And while the Federal Reserve isn't likely to run out of money, the FDIC or Federal Deposit Insurance Corporation fund stood at just $128 billion at the end of 2022.

A chunk of that capital has already been committed to guaranteeing retail deposits at SVB, Signature Bank and Silvergate and who's to say that there won't be other significant claims on that (dwindling?) pool of capital before too long.

At minimum, there will be losses for the FDIC, because that's the nature of insurance 👇

Coming back to Credit Suisse, the SNB engineered a takeover of the business by rivals UBS - a forced marriage that reminded me of Lloyd's purchase of HBOS in January 2009.

Look how well that worked out for Lloyds shareholders...

The SNB created a storm among investors who help to fund banks through their purchase of AT1 or Additional Tier capital bonds. These are loss-absorbing bonds designed to take a hit if a bank gets into trouble.

Investors buy them for their high coupon or interest payment and they hold them because they believe that a bank failure is an unlikely event (what short memories some people have).

In the event of a bank failure, the AT1 holders could expect to undergo a debt-to-equity conversion, hence the instrument's other name, Co-Cos or contingent convertibles.

However, in this instance, the effective administrator of Credit Suisse, the Swiss central bank decided that the AT1 holders would have to fall on their swords and eat 100 % of their loss. Effectively missing out on the takeover by UBS. It seems that the regulator had this power and it was in the prospectus for CS’s AT1 issuance...

You don't get 10% yields and low risk.

Credit Suisse stockholders, who would typically rank last in a default, will at least get a few centimes back on the franc from the UBS takeover.

Cue an enormous row about seniority in default between the AT1 holders (see below) and the SNB, a row that will very likely end up in the courts.

The ground has shifted under the feet of those who provide working and regulatory capital to banks and that could mean a more expensive cost of capital and smaller balance sheets going forward.

One of the leading lights of debt and credit markets tweeted the following, as the collapse of Credit Suisse was brewing. 👇

Have a look a Weinstein’s CV - if he doesn't like AT1 capital bonds, and that was before the SNB decision, it's not clear to me why anyone else should.

So what's my point - what's the takeaway?

Well, in the last two or three weeks we have seen a tectonic shift in the markets and confidence in the banking system that is a cornerstone of the global financial markets.

We have seen on two occasions that capital is no substitute for confidence 

Remember this headline from March 15th 👇

Yes the Fed (and the SNB) may have plugged the leaks for now but I have no doubt that the plumbing of the world's financial system is creaking under the strain of recent events - it won't be long before a new leak appears.

The next shoe to drop may well be outside the banking system (where confidence seems to have stabilised). Financial regulators have long warned about the risks lurking in shadow-banking and private equity.

As have we... 👇

If (when?) this sector takes a hit, confidence will be far harder to recover...