The past month has been scary for investors, thanks to several bank scares and collapses. This month, US banks Silicon Valley Bank and Signature Bank went under, with Silvergate Bank now winding down. But the biggest rescue was that of Swiss giant Credit Suisse Group.
Here are six crucial lessons for investors following this latest banking crisis.
1. Concentration risk matters (1)
Founded 40 years ago, Silicon Valley Bank (SVB) became a leading lender to US tech start-ups and venture-capital investors. More than half of all leading US tech start-ups banked with SVB.
This intense concentration of clients in a single sector contributed to SVB’s undoing. Its exposure to tech firms left it highly vulnerable to ‘deposit flight’ as tech-savvy businesses all rushed to withdraw deposits at the same time.
2. Concentration risk matters (2)
During the tech bubble of 2020/21, SVB’s deposits surged enormously, soaring from $49bn in 2018 to $102bn in 2020, to $189bn in 2021. SVB parked this tsunami of cash in a portfolio of US Treasury bonds and mortgage-backed securities worth $91bn.
As interest rates rose in 2022/23, this bond portfolio’s value collapsed by $15bn. This heavy loss ultimately contributed to SVB’s ultimate demise. Presumably, its risk team didn’t expect rates to rise so far, so fast. When they did, pain followed.
3. Concentration risk matters (3)
Credit Suisse also messed up with concentration risk. It sought out ultra-high net worth (UHNW) clients (those in the top 0.01% of global wealth).
As worries over Credit Suisse’s solvency grew, these wealthy clients withdrew huge sums from the wobbling Swiss bank. As tens of billions of dollars fled, the bank was undone by its focus on one client sector — just like SVB.
4. Interest rates matter
As global inflation took off in 2021, interest rates were set to rise in 2022.
Until 15 March 2022, the US Federal funds rate was 0% to 0.25%. Now it stands at 4.75% to 5%, having been lifted by another 0.25 percentage points (pp) yesterday. Meanwhile, the Bank of England’s base rate has leapt from a low of 0.1% to 4.25% today, following a 0.25pp hike yesterday.
As interest rates rise, values of fixed-interest securities (including government and corporate bonds) fall. Alas, these risky banks held huge numbers of ultra-low-yielding bonds just as the cycle turned.
5. Liquidity matters
A liquidity crisis happens when investors have to raise cash quickly by selling assets, sometimes at a loss.
All four of the above ailing banks had liquidity problems as they started selling large, concentrated portfolios of securities to raise fast cash. Falling into a liquidity trap is a rookie error that these banks’ risk managers could and should have avoided.
6. Management matters
Lastly, quality of management is paramount for all businesses. For at least a decade, Credit Suisse has been poorly run. It has stumbled from one crisis to another, paying billions of dollars in fines. In the past, I’ve referred to this bank as Debit Suisse and DisCredit Suisse.
Personally, I will learn from this crisis. First, I will keep diversifying my portfolio to avoid concentration risk. Second, I’ll keep some high-quality, highly liquid assets for when I need cash urgently. Third, I will avoid all businesses where I don’t trust the leaders!
The post 6 investing lessons from the failures of Credit Suisse and Silicon Valley Bank appeared first on The Motley Fool UK.
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