Are we in another financial crisis?

I claimed that the crisis of Silicon Valley Bank (SVB) and Credit Suisse were isolated cases, specific to those institutions, and there is no financial contagion. Then we get all these headlines about Deutsche Bank being next. What’s going on?

Well, I still claim it is not contagion, but there is lots of FUD (Fear, Uncertainty and Dobut). Interestingly, Deutsche Bank has been a sick bank of Europe for a while (sick, not sic as in cool).

Deutsche Bank is a global bank covering domestic finance, but also payments, transaction banking and investment banking worldwide, but it is also a bank that has been struggling for years with its place in the world. I’ve said this for a long time, and asked in 2020: is Deutsche Bank a scrambled egg of banking?

We now see a bank run on Deutsche Bank and, after SVB and Credit Suisse, everyone thinks we are in a financial collapse like 2008. It’s not. As CNBC points out: "analysts were left scratching their heads as to why the bank, which has posted 10 consecutive quarters of profit and boasts strong capital and solvency positions, had become the next target of a market seemingly in 'seek and destroy' mode".

There is a big difference between 2008 and today. 2008 was a systemic collapse of banks in Europe and America who bet large on debt: Collateralised Debt Obligations (CDOs) and Mortgage Backed Securities (MBS). This is nothing like that.

The issue today is a bunch of banks with different issues. Signature Bank bet on cryptocurrencies and got it wrong; SVB placed all their liquidity in illiquid assets that couldn’t be cashed in when customers asked for their money back; and Credit Suisse had serious mismanagement issues when their auditor forced them to admit to making ‘materially false and misleading statements’ in their annual report.

This leads us to Deutsche Bank, which has been struggling for years. Again, as I said three years ago:

Now run by Christian Sewing who took over from John Cryan (July 2015 – April 2018), who succeeeded Anshu Jain and Jürgen Fitschen (2012-2015), who took over from long-term leader Josef Ackermann (CEO, 2002-2012) ... you can always spot a bank in crisis when their leader changes regularly.

Josef Ackermann probably oversaw the period where the bank created all of the issues it deals with today: technology that is not fit for purpose, global growth that failed, a structure that is unsustainable, an inability to compete with the big US banks ... oh, and a bank that put profit before morals.

So, where are we today? On Friday, after a third day of losses, Deutsche Bank sank more than 12% due to the cost of insuring the German giant's bonds against the risk of default. What? Yep, the risk of a credit default, where the bank can no longer pay its debts, rose and, due to the cost of credit default swaps – where a bank insures its debts in the markets – rose so high that the bank became exposed.

It does relate to Credit Suisse, as Credit Suisse saw its debt instruments based upon Alternative Tier 1 debt instruments fail. Nicknamed AT1s, Credit Suisse was forced to write down $17 billion of its AT1s as part of a forced takeover by UBS last week. This has led to many in the investment markets questioning AT1s. What are AT1s? AT1 bonds are a $275 billion sector also known as “contingent convertibles” or “CoCo” bonds. They are used by the big banks to act as shock absorbers if the bank’s capital falls below a certain threshold. At that point, they can be converted into equity or written off.

Credit Suisse’s CoCo bonds were wiped out when the Swiss Government made the decision they should be merged with UBS. I guess it was natural that Deutsche Bank would be the next port of call. Deutsche’s 7.5% AT1 dollar bonds fell by 1 cent to 74.716 cents on the dollar, pushing the yield up to 22.87%. That yield is double what it was just two weeks ago, according to Tradeweb data, and this is what has caused the scare over Deutsche shares.

Is this contagion? I still say no.

Is it a financial crisis? I still say no.

Is it a crisis of some banks? I would say yes.

I don’t see this crisis bringing down BNP Paribas, JPMorgan, DBS or other Tier 1 banks. I do see this as a house of cards of banks with different whose issues are now exposed. But another financial crisis? Probably not.

After the 2008 crisis, banks have had to shore up their Tier 1 capital ratios, liquidity and cash. This is down to Basel III, which ordered all major banks to do this under Liquidity Capital Ratios and Net Stable Funding Ratios. Interestingly, Silicon Valley Bank was not subject to such ratios, as it was treated as a domestic bank by the Federal Reserve, and the CoCo issues with Credit Suisse might call Tier 1 capital into question but, in general, most banks are far more resilient today than they were in 2008.

Andrew Bailey, Governor of the Bank of England, certainly thinks this is true.

“I don’t think it’s a repeat of 2008 at all,” Bailey said in a pooled clip for broadcasters last Thursday.  “We’ve obviously increased the regulation of the banking system since then ... [and] learned a lot of lessons in the financial crisis. Of course we keep learning lessons. I’m confident that in this country we are in a much stronger position. Their capital is stronger, their funding is stronger, and so far I think we’ve seen the signs that they’ve come through that robustly.”

There again, he is not likely to see the banks are all doomed. Having said that, you cannot predict the market movements, as they are not predictable. As Citigroup noted: “We view this as an irrational market ... the risk is if there is a knock-on impact from various media headlines on depositors psychologically, regardless of whether the reasoning behind this was correct or not.” Equally, as Citi's CEO Jane Fraser noted, mobile apps have given us the ability to move millions of dollars with a few clicks of a button mark, which is a sea change for how bankers manage and regulators respond to the risk of bank runs.

It also intrigued me that a seasoned banker stated that he never invests in bank shares. Writing in The Financial Times, Terry Smith [CEO of Fundsmith and rated the number 1 banking analyst in the Reuters and Institutional Investor surveys 1984-89] states: “it is precisely because I understand banks that I never invest in their shares”.

Why?

I never invest in anything that requires leverage to make an adequate return … despite massive leverage, and the risk which accompanies it, returns from the banking sector are inadequate … [and] even if the bank you are invested in is well run it can still be damaged or destroyed by a general panic in the sector.

#nuffsaid