This article was taken from the March 2023 issue of Market Insight. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications
In March 2023, a significant intervention unfolded, involving the US government and leading US banking institutions in reaction to issues at a select few US regional banks. In just a few days, three previously unknown banks - Silicon Valley Bank (SVB), Signature Bank, and First Republic – were bought by larger players in the sector to prevent a collapse. Events were not limited to the US, as the Swiss banking system also experienced issues. Credit Suisse was acquired by rival UBS, as deposits continued to decline in the wake of a succession of scandals and failed restructuring plans.
Amid the news of issues at SVB, the S&P-500 financial sector declined nearly 15% in a matter of days as market participants battled with concerns around more widespread issues in the financial sector. European banking shares also wobbled, with Swiss giant UBS down 19%, along with other names listed in the region. It was not just the share prices that took a tumble, however, given the nuances of the takeover of Credit Suisse. Some holders found their bonds had been repriced to zero as part of the UBS takeover deal, causing the European subordinated banking debt sector to experience a sharp decline. The securities in question were Additional Tier One (AT1) bonds, a debt instrument lower down the quality spectrum in the capital structure that forms a part of a bank’s regulatory capital. Subordinate bonds of other European banks followed suit, with prices declining over fears of the security of the bonds.
In the following weeks, a wave of stabilisation took place in the banking sector, buoyed by the proactive measures taken by government bodies and industry leaders. Consolidation occurred, as large multinational institutions acquired smaller banks, in a concerted effort to restore confidence in the sector. Notably, SVB, renowned for its focus on serving technology and innovation companies, was in a pivotal position as it was acquired by First Citizen Bank – and the UK arm was sold to HSBC for £1.
Among this, First Republic Bank was also in the spotlight, receiving funding offers from the Federal Reserve and JP Morgan. In a collaborative effort to gather liquidity and secure the bank's position, US$70bn was provided from JP Morgan, alongside a liquidity pool from eleven other banks, amounting to US$30bn. This, amongst the increased monitoring of the financial system and heightened liquidity levels, bolstered confidence and restored faith in the resilience of the banking sector.
Since the issues, the banking sector has performed well. We have seen a rewarding recovery in the European market, with many posting record profits and double-digit gains in their shares. A year on from the strategic acquisition, UBS's share price has shown a remarkable increase of 60%. This surge not only highlights investor confidence but also attests to the success of the integration of Credit Suisse. The synergy between the two entities has begun to materialise, evidenced in a substantial US$3bn in cost savings and it is hoped these will expand further in the future. Additionally, it has anticipated a 27% increase from its 2023 dividend and the restart of share buybacks this year. This is not only specific to UBS, as the higher interest rates have aided banks profitability, enabling banks NatWest and HSBC to report significant dividends and take part in buyback schemes.
Many investors will remember the banking sector issues experienced during the financial crisis. Still, the industry has come a long way since, and the recent wobbles experienced appear to be cast aside as the more prominent names in the industry have proved their stability. Banks have de-levered and strengthened their balance sheets, lending practices have improved considerably, and the risky activities once seen within some institutions are no longer. These events are all positive from a credit risk perspective, and it is no surprise to see financials as the largest sector within many fixed-income fund managers’ portfolios. On the equity side, higher levels of profitability via returns on equity, increased dividends, and announcements of large-scale buyback programmes could prove positive for share price returns. Banks in general are on sound footing, but their revenue models will be tested over the next year, as they adapt to the new competitive dynamics.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance.