“Longing Cracks”: How the SVB bankruptcy rocked European banks

As their companies’ stocks plummeted this week, a small group of European bank bosses sat down to a dinner of saffron risotto, salmon and asparagus in London and agreed that the market reaction to the collapse of a California lender was overdone.

CEOs insisted investors underestimated the strength of European banks’ balance sheets “in terms of liquidity, capital, earnings and asset quality,” said Davide Serra, founder of investment boutique Algebris Investments and host of the dinner.

Europe’s banks “are the strongest in 30 years – if there was ever a moment of panic, it’s not now,” Serra added.

Until US regulators took over Silicon Valley Bank last week after rising interest rates eroded its balance sheet, some bankers in Europe were only vaguely aware of the tech-focused bank’s 40th anniversary.

Since then, the fallout has been swift and brutal, as investors dumped European bank stocks.

“The rise in interest rates has been so rapid that cracks are showing,” said Kevin Thozet, a member of the investment committee of French asset manager Carmignac.

“The risk management of large European banks differs greatly from that of regional US banks. The risks are lower because they are largely covered and secured. But still, where was this risk shifted to? We do not know that, yet.”

Credit Suisse was the catalyst for much of the pain that swept across Europe, from France’s BNP Paribas and Société Générale to Spain’s BBVA and Britain’s Barclays.

The Swiss bank – already under severe pressure after a series of scandals, deposit outflows and a radical restructuring plan – was hit hard after a top shareholder ruled out further investments.

The pain in European banking stocks was only halted when Credit Suisse agreed to a CHF50 billion central bank bailout on Wednesday night.

On Friday morning, banking indices were back in positive territory for the second straight day, ending the worst two-day decline since the Russian invasion of Ukraine.

“The flight in European bank stocks this week doesn’t seem to be making much sense,” said a European regulator, as governments from Paris to Berlin urged investors to keep their cool and dismissed notions of a system-wide problem.

“It appears to be a question of general confidence rather than a specific issue investors are focused on.”

But the troubles at Credit Suisse are far from over and the episode has raised red flags for the industry. By the end of Friday, Europe’s Stoxx 600 banking index had lost another 2.6 percent and was down 15 percent for the week.

The collapse of the SVB followed the fall in value of its long-dated government bonds and highlighted the unexpected consequences of long-awaited rate hikes. Investors say the UK pension crisis, triggered by rising gilt yields, was an early warning of the dangers ahead.

Like the SVB, European banks hold large bond portfolios whose paper values ​​have fallen due to interest rate hikes. But a far smaller portion of them are marked as “available for sale” on their books, meaning their values ​​need to be adjusted, unlike bonds that are held to maturity.

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European banks have invested 6 percent of their assets in “available-for-sale” portfolios, while their total investments make up 18 percent of their total balance sheets, analysts at ABN Amro estimated. This compares with 14 percent of the “available for sale” investments at the SVB and a share of the investments in the assets of 57 percent.

“This should make them less vulnerable to sharp valuation changes,” said ABN Amro analysts.

In addition, so-called unrealized losses from such valuation changes are taken into account in the calculations of capital requirements and their application in Europe, where all banks, regardless of size, are subject to stress tests and strict prudential and liquidity requirements. In the US, a 2018 rollback of some regulatory requirements under President Donald Trump exempted companies like the SVB or some banks with assets of up to $250 billion from such scrutiny.

The structure of SBV’s deposits, which was technology-focused and 96 percent uninsured, compounded its problems.

“Overall, European banks rely on diversified sources of funding, with sticky household deposits accounting for 30 percent of all liabilities,” analysts at rating agency Standard and Poor’s said, adding that selling bond portfolios and realizing losses is a “last resort”. .

“I’m not really concerned about the asset quality risk for European banks,” said Jérôme Legras, head of research at Axiom Alternative Investments, a Paris-based finance specialist with $2.2 billion in assets under management. “They have unused provisions from Covid and the lending criteria have been quite strict. Risk costs will increase, but from a very low level. It’s not a big concern.”

Frustration with this week’s sharp correction was evident. A CEO of a European bank said investors failed to realize how much the sector had changed since the collapse of Lehman Brothers in 2008.

“We have five to eight times as much liquidity,” said the CEO. “There isn’t the industry-wide sickness that was the US subprime mortgage problem of 2008.”

However, despite the confidence of many regulators and bankers, Credit Suisse remains an imminent risk. The news on Wednesday evening that liquidity was secured was “a great relief,” said one of the 26 Council members of the European Central Bank.

That allowed the ECB to go ahead with its previously announced plans to raise its deposit rate by half a percentage point to 3 percent on Thursday, the highest level since the 2008 financial crisis. “It stopped the panic,” the council member said. “It should buy some time while the Swiss find a solution.”

However, if no solution can be found, several top bankers in Europe and Switzerland said the respite could be short-lived – for Credit Suisse and for the sector.

“Investors are looking for the vulnerability. In Europe, that’s Credit Suisse,” said a banker in Paris. “At this point, it’s more about reputation than anything objective to do with their numbers.”

Additional reporting by Olaf Storbeck in Frankfurt and Laura Noonan in London