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Market Update
March 27, 2023

The Banking Mayhem Continues

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Week Ending 24th March, 2023

With Credit Suisse (CS) rescued, attentions switched to Deutsche Bank (DB) whose shares fell almost -15%. Its CDS (the cost of buying bond insurance against it defaulting) spiked to over 2.20% (from just 1.42% two days ago) on stability worries.

DB is profitable, has good momentum and strong metrics (capital, liquidity). Its unrealised bond losses are negligible and already factored into their capital adequacy. Litigation risk is down sharply while its leverage is at its lowest since the 1990s. It has three, perceived weaknesses: (1) its commercial real estate book (despite being diversified with a Loan To Value of some 61%); (2) It has a large derivatives book (despite having been thoroughly inspected) and (3) It has a liquidity coverage ratio of 140% (despite stable deposits and no outflows). So DB is in no way comparable to CS. However, because it has undergone several restructurings in the past, that’s what contagion psychology does – it’s still on people’s minds

All Eyes On The FED

It was all eyes on the Fed this week as the FOMC (Federal Open Market Committee) convened to communicate its rate decision and, critically, issue a statement.  The statement tends to paint a picture of how they see the world in the months ahead. To our surprise, they chose to hike rates another 0.25% despite a tightening in financial conditions.

The Fed Funds Rate (FFR) band is now 4.75% to 5.00%. Normally, the Fed gives some colour, in advance, of their intentions thus limiting the element of surprise. Instead, given the stresses in the banking system, they remained silent. To put these stresses into context, JPM analysts estimate the most vulnerable banks are likely to have lost some $1tn in deposits since last year - with half of these outflows occurring in March alone following the SVB collapse!

Of the total $17tn in bank deposits, $7tn are not insured by the Federal Deposit Insurance Corporation and of these $1tn depositor outflows, half went to Money Market (MM) funds and the rest to larger, US banks. The Fed issued a much more balanced statement: they removed previous wording in which they referred to inflation as having eased. They continued to acknowledge labour market strength and elevated inflation but, also acknowledged, recent events have meant parts of the banking system have emerged as an area of concern resulting in tighter financial conditions (impacting household & business credit) which could well weigh down on the economy and inflation.

The Fed was not alone in hiking rates this week – both the Swiss and UK Central banks hiked rates. The BoE narrative is still one of uncertainty as it closely monitors price pressures which it believes are peaking with a watchful eye on consumers and their debt burdens.

Credit Suisse and UBS entered into a “merger” agreement on Sunday following the intervention of three parties: (1) the Swiss Government, (2) the SNB (its Central Bank) and (3) the Swiss Regulator (FINMA). UBS will end up as the surviving entity upon the closing out of the merger. The price is CHF3bn in stock and UBS will assume losses of up to CHF5bn. The price represents just 1% of CS’s peak stock price in 2007. It leaves a combined entity even bigger than the SNB itself!

Silicon Valley Bank update: The Regulator (FDIC) extended the deadline (originally set to last Friday’s close) and have also expanded the pool of institutions they are willing to consider. FDIC is even open to accepting bids from non-bank buyers. There has been a reluctance, by regional lenders, to take on SVB’s assets given their write-down and long duration but FDIC did say “There has been substantial interest from multiple parties and the FDIC and the bidders need more time to explore all options in order to maximise value and achieve an optimal outcome”.

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Market Overview.