Navigating Fragile Banking Sectors with Ismael Pellicer

We had the privilege to hear from Ismael Pellicer, Fund selector at Morabank to get his views and insights into the recent challenges faced by the banking sector. Ismael's expertise and analysis shed light on the fine line between fear and opportunity within the industry. In the wake of the March 2023 crisis, where banking institutions like the Silicon Valley Bank experienced liquidity and confidence issues, Ismael's perspective offers crucial observations on the implications of mismanagement and financial irregularities.

The fragility of the banking sector was highlighted in March 2023 when mismanagement and financial irregularities led to a liquidity crisis. The Silicon Valley Bank faced significant losses as technology companies withdrew their deposits, while sharp rate hikes by the Federal Reserve worsened the situation. Similar cases emerged, raising questions about prevention and recurrence. This article explores potential risk mitigation measures and assesses the likelihood of future challenges in the sector.

There is always a fine line between fear and opportunity. In this case, March 2023 was a clear example of how fragile parts of the banking sector can be when management is not entirely good and certain financial irregularities occur. When there is volatility, there might be good opportunities in the market.

The Silicon Valley Bank case was triggered by a liquidity and confidence crisis due to the massive withdrawal of technology companies’ deposits in search of better returns. The bank's underlying portfolio was invested in high quality bonds with long maturities and very sensitive to duration. With the Fed's sharp and rapid rate hikes this portfolio fell sharply in price and in the face of withdrawals they had to liquidate with huge losses.

Similar cases were Signature Bank, First Republic Bank or Western Alliance Bancorporation.

Many of us wonder if this could have been avoided or if this was a one-time event?

To the first question, theory tells us yes. Hedging the duration of the portfolio much better would have avoided other types of risks. Another option could have been to invest the portfolio with other kind of securities, even if it "sacrificed" some return without taking on as much risk.

To the second question, the answer is even more complicated. In our view, such rapid and sharp rate hikes always have some spillover effect on the economy. Sometimes the first-round effects take time to arrive, but as time goes on the second or third round effects start to kick in. In this case, we believe that this type of regional banks within a niche sector and with a very specific activity, may continue to suffer in the coming months and we would not rule out the possibility of seeing new cases of default.

After an event like this, we stay calm and gather all the information available from our analysts and various trusted counterparties to make our own judgment. Secondly, we quantify what the real exposure is.

Then, we evaluate if there is a risk of sector or geographic contagion. In this particular case, it is very important to assess whether there is a systemic risk of failure in other banks.

Once all this information has been compiled, and with the conclusions drawn, we act accordingly.

In addition, I want to highlight the quick and surgical appearance of different public institutions like the Fed or FDIC to tackle every fear that was related to the banking sector. I think that they were crucial in order to recover the confidence of investors. In the end, it is all about confidence.

We currently believe that there is a very small probability of systemic risk in large American or European banks. Despite we remain cautious, we believe that there may be good opportunities, most on debt issuances like subordinates, by being very selective and diligent in a sector where there has been an overreaction in certain assets.

We would like to extend our sincere gratitude to Ismael for his invaluable contributions and insightful analysis on the fragility of the banking sector. Ismael's expertise and thoughtful observations have provided us with a deeper understanding of the challenges faced by financial institutions, as exemplified by the Silicon Valley Bank crisis. Make sure to follow our LinkedIn page to get regular updates on event announcements, industry insights and more thought-provoking content.

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