What does the collapse of SVB and Credit Suisse mean for SA?
SA has not been spared the chaos afflicting global financial markets in March, with the JSE having now erased the year’s gains, touching 72,000 points — the lowest level since December 20 — as investors face instability in the global financial system amid the fallout from the collapse of Silicon Valley Bank in the US and Credit Suisse in Europe.
Business Day spoke with James Turp, fixed income portfolio manager at Sanlam Investments to make sense of it all.
To what extent does the collapse of these two large banks add to the uncertainty in the already strained global environment?
This year has already been a tale of two halves. We kicked off with an extensive appetite for riskier assets as the search for increased investment returns seemed to reset in line with the calendar year-end and anticipation around the cooling of global inflation and an end to monetary policy tightening.
Fast forward to March and a positive headline is hard to find. A mini US banking sector crisis and the bailout of a major Swiss bank have returned investors to a defensive stance.
On existing evidence the US situation seems to be limited to banks in the technology sector, with the failure of SVB and Signature Bank. These tech sector players were different from traditional banks due to their lower levels of liquidity, concentrated banking activities and lack of funding diversification. They failed to hedge their fixed to floating rate exposures, which is not the case with SA banks.
SVB incurred quick cash withdrawals as concerned depositors sought higheryielding alternatives in the money markets. Forced to liquidate fixed-rate asset holdings to meet these demands, SVB crystallised losses due to interest rates now being higher. Fortunately for the US banking system, the problem seems fairly contained.
Credit Suisse on the other hand, is both interesting and a concern. Swiss banks have long been perceived as pillars of financial strength, but the news of developing problems cast doubt on this as they appeared to result ultimately from poor risk management at the institution.
Credit Suisse was bailed out and sold to UBS [Union Bank of Switzerland] but in this process $16bn of its bonds were written off, a first for this type of debt instrument.
For context, after the 2007/2008 global financial crisis, reforms were taken to protect the system from similar future events. The introduction of capital loss-absorbing bonds sought to strengthen banks’ balance sheets and avoid contagion risk, by transferring the risk from depositors to bondholders. The expectation was that if a bank was deemed non-viable by a regulatory authority, these bonds could be written off to restore capital ratios to viable levels without using equity or cash deposits, as long as the amount of such bonds in issue are sufficient to restore viability levels. If not, then the bank would be placed into resolution (bankruptcy) and the bonds would only be used after the larger quantity of common equity (shares) was written down.
In Credit Suisse’s case, however, the bonds were written down and the bank sold before it was technically deemed bankrupt, leading to the procedure being questioned.
So far, global markets have recovered from their worst levels but concern and risk aversion are still to be expected. What is the likely spillover to the SA financial system and economy and could a similar event affect local bonds?
In SA, our banks generally differ from the banks affected by developments in the US, primarily for the following reasons: SA banks enjoy higher levels of liquidity, better quality capital, more diverse banking activities and sources of funding, particularly in relation to retail deposits. As such the banks here are not as exposed to such concentrated risk developments.
The “big five” banks in SA are deemed systemically important by the regulator and as a result also issue these capital loss absorbing subordinated bonds and additional Tier 1 bonds to protect depositors in a similar manner, adding to these institutions’ financial integrity.
It is worth noting that the value of these bonds presently in issue is considered low by global standards and smaller than the levels believed to be required to return capital levels sufficiently in a technical point of non-viability. As such, in the event of such a bank being deemed non-viable by the regulator, the likelihood of a similar kind of write-off occurring (ahead of common equity) though possible, appears unlikely as the regulator would not make this distinction from the bank being considered bankrupt.
It is worth mentioning that thanks to strong regulation of our domestic banks their capital ratios are healthy by global standards and there are considerable buffers in place before such an event would be likely.
What does it all this mean for policy in both the US and SA?
The US Federal Reserve decided to raise rates by 25 basis points on Wednesday night. This appears to be close to the end of their tightening cycle with mention made of the banking crisis in the US being equivalent to a further 50 basis points of tightening. From here the US futures market is pricing rate cuts by year-end of about 70 basis points.
Regarding local rates, with the upcoming MPC [monetary policy committee] meeting next week, and after taking into consideration our slightly higher monthly inflation data released on Wednesday, the coin is once again in the air for a possible further hike of 25 basis points.
It is very possible though that the MPC assumes a more cautious stance, holding rates steady this time and preferring to assess the effects of the accumulated 375 basis points of hikes already made since the repo rate low of 3.5% in 2021, in a move that also considers the extremely weakened economic growth outlook domestically.
Where do you see SA markets going while jitters remain in the global banking system?
So far our markets have largely been insulated from the US and European events.
The rand and bonds have strengthened on the perceived more dovish move by the federal open market committee on Wednesday, improving the outlook for rates.
The SBV and Credit Suisse developments do, however, | add to the volatility markets are suffering now and a lot will depend on the decision by the MPC.