Flash update: the recent events in the US banking sector and the case of Silicon Valley Bank

Giordano Lombardo, CEO and Co-CIO di Plenisfer Investments SGR

Marketing communication for professional investors in Italy

In this brief note, we summarise our view on the recent events in the US banking sector, by answering a few questions  from clients. Then we comment on our current portfolio positioning.

Is Silicon Valley Bank just a bad apple? At first sight, yes. Most of its deposits came from corporates rather than individuals, and the bank was very aggressive in lending to start-up businesses, growing its balance sheet extremely rapidly (+250% from 1Q 2019 to 4Q 2022). Plus, the bank was very aggressive in the management of its balance sheet, taking duration risk. The portion of uninsured deposits at SVB before the bank run was 89% of total deposits.

Is the situation at SVB really unique? No. Leaving aside the reckless behavior of SVB management (complete failure of interest rate risk management) and the incredible lack of supervision on a bank which had close to $250 bln of assets, its balance sheet issues related to the bond portfolio  are not unique to it.  As the usually perma-bearish Nouriel Roubini remarked, US banks are sitting on “$4620bln of unrealized losses with only $2.2 trillions of equity” (CNN, 12/03/2023).

What is the ultimate reason? Recent and past monetary policy.  The current events are a direct consequence of the unusual monetary policy of the last few years.  It is an extreme case of a more generalized problem: unrealized losses on banks’ balance sheet due to a sudden increase in interest rates.  The FED first injected an inordinate amount of money into the economy until 2021. A sizable chunk of this liquidity found its way into the coffers of banks, in the forms of MBS and Treasuries. Then, the Fed said interest rates would remain low for a long time (inflation “temporary”). When it changed its course in 2022 and raised rates rapidly and dramatically, some banks found themselves sitting on significant unrealized losses in the bond portfolios.  

Is the US banking system at risk? No. The US government has stepped in to avoid a more general bank run, with an open-ended promise to make whole all deposits over US$250,000. Disaster has been averted. Beyond this, the numbers of the US banking system are quite solid, even considering the comparison with 2008.  The reserve coverage ratio standing above 200% is higher than in the ‘00s,  which means that banks are well prepared for a possible increase in non-performing loans. Tier1 capital ratio at 13-14%% is very elevated by historical standards (source: FDIC).

What will happen next? A turnaround in monetary policy.  In a sense, we have already had a turnaround in monetary policy.  Just as September’s gilt meltdown forced the Bank of England to back pedal on its announcement of aggressive quantitative tightening, so this crisis has made clear that the Fed’s commitment to quantitative tightening is unlikely to prove robust either. Funding the banks through liquidity measures is not “technically” Quantitative Easing (the Fed is not buying bonds) but it has the same effect:  expanding its balance sheet.

Is the Fed going to reduce rates soon? No. We continue to believe that the Fed is not likely to go to the extreme in its battle against inflation, even if that will mean to engage in financial repression. There is too much debt in the system, both in the private and public sector, and the service of this debt could become unsustainable. If a new crisis will emerge, it will be in the sectors that benefitted most from the zero-rate policy of the past, which are most exposed to the sudden increase in rates.  Any new crisis will be met with the same medicine:  another government backstop, more money-printing, and more currency debasement.

But we are not there, yet. For the time being the Fed is likely to try and keep up to its commitment to keep a tight policy to combat inflation.

How is our portfolio, Plenisfer Destination Value Total Return, positioned? From a broad macro perspective, we believe the unfolding events are bearish for US assets and the US dollar. We also continue to think that a diversification approach based on the traditional 60/40 portfolio is not suited to address the likely continuing volatility.

We continue to focus our portfolio on Asian and European names among the compounders and in the income strategy.  In currencies, we have a large exposure to Euro (45% of the fund). In interest rates, we maintain a steepening strategy on the US yield curve.

Our exposure to gold (8%) may stabilize the performance in the current period of volatility, thanks to its low correlation with the market trends in the major asset classes. We also continue to believe in idiosyncratic equity names, in particular in China and in European industrials

Regarding our positioning towards the US financial sector, we don’t have any exposure in the equity space, and only 1% in a bond issued by the largest and strongest of US banks (JP Morgan).

In Europe, we are exposed to 12% of corporate bonds issued by financials (of which 4,2% in Cocos) and we don’t have any exposure to the stocks of banks. [1]

[1] Holdings / Allocations subject to change. This document does not constitute an investment advice to buy or sell the presented securities. This Fund is not a guaranteed product. Investments bear risks.  You may not recover all of your initial investment. Investment may lead to a financial loss as no guarantee on the capital is in place.

Fund Factsheet - Plenisfer Investments Sicav Société d'investissement à capital variable (SICAV) Luxembourg" - Destination Value Total Return ("Fund" or "Sub-Fund")

Investment Objective and Policy: The objective of this Sub-Fund is to achieve a superior risk-adjusted total return over the market cycle. The goal is value creation through risk-adjusted total return. Achieving long-term capital appreciation and underlying income through a long-term focus on valuation and market cycles is key to achieving the Sub-Fund's objectives. Benchmark: SOFR Index: The Fund is actively managed and references the Performance Fee Benchmark for the performance fee's calculation purpose. The Sub-fund does not use a Benchmark for investment purpose.

Legal structure: UCITS - SICAV

Investment Manager: Plenisfer Investments SGR S.p.A.

Management Company: Generali Investments Luxembourg S.A.

Launch date: 04/05/2020 (share class EUR ACCUMULATION)

Subscription/Redemption process: Valuation day, 13:00 Luxembourg time (T)/ Redemption: Valuation day, 13:00 Luxembourg time (T) + 5

Minimum subscription: € 500,000 share class I; € 1,500 share class R

Currency: USD

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