Beyond the near-term turmoil, there may need to be a re-evaluation of the regional banking model in the United States, according to a recent panel hosted by Stephen Dover, Head of Franklin Templeton Institute. The panel discussed the latest developments and investment implications—including a move to money market funds.
Uneasiness about the health of the banking sector has spread from Silicon Valley Bank to other US regional banks, and also across the Atlantic to Europe. This contagion is reminder that fear itself can be a self-fulfilling prophecy. This unfolding stress, plus the ninth consecutive Federal Reserve (Fed) interest-rate increase and the likelihood of more rate increases to come has led to a near freeze in new corporate debt issuance, even for the companies with the highest credit ratings. However, financial markets are essentially pricing in that the Fed is wrong, and that growth will cool and rates will drop by year end. The Fed’s monetary policy plans and the current market outlook are irreconcilable. Which view is right? We gathered four experts across various areas of the financial sector to help to dissect what the risks are and where the opportunities might be. Following are highlights of our discussion. Watch the full replay here.
- The current banking problems are not a repeat of the global financial crisis (GFC), when the bank assets were of low quality. Bank deposits seem to be less at risk, and banking business models have been meaningfully de-risked in the United States and Europe since the GFC.
- The banking system will almost certainly need more oversight and perhaps regulation—much of this will be focused on the regional banks. We continue to see investment opportunities within regional banks, but each bank will need to be evaluated on a case-by-case basis, not as a group.
- The spread between money market fund rates and bank deposit rates has caused many bank depositors to move to money market funds. In order to pull this money back to the banks, commercial paper and Treasury rates (where money market funds typically invest) will likely need to re-adjust downwards and/or banks will have to offer higher rates on deposits. How this gap normalizes will be an important indicator to watch.
- Private credit will likely be one of the beneficiaries in the aftermath of the regional banking crisis, replacing some of the current regional bank loans. The Additional Tier 1 bonds (AT1 or preferred1) of Credit Suisse were devalued causing disruption in this market. This may be an area of investment opportunity as the AT1 (preferred) debt of larger banks remains high quality.
- Longer term, there may need to be a re-evaluation of the regional banking model in the United States, which could lead to higher credit spreads, fewer services (aka, no more free checking, rewards, etc.), and shifting more interest-rate risk to borrowers through a reduction in fixed-rate loans.
Read next: It seems that it's hard for S&P 500 to move away from $4000 area| FXMAG.COM
We want to thank Miguel del Gallego (Senior Research Analyst, ClearBridge Investments, US Financials, Regional and Small Banks), Ivor Schucking (Research Analyst, Western Asset Management, US Financials), Bill Zox(Co-Portfolio Manager, Brandywine Global, High Yield and Corporate Credit Strategies), and Muhammad Waqas (Benefit Street Partners, Senior Research Analyst, Financial Services) for their participation in the discussion.
Stephen Dover, CFA
Chief Investment Strategist,
Franklin Templeton Institute
Endnotes
- An AT1 is a form of Contingent Convertible (CoCo) bond which a bank struggling financially does not have to repay.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.
Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline.
Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors or general market conditions. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
Investing in private companies involves a number of significant risks, including that they: may have limited financial resources and may be unable to meet their obligations under their debt securities, which may be accompanied by a deterioration in the value of any collateral and a reduction in the likelihood of realizing any guarantees that may have obtained in connection with the investment; have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors’ actions and changing market conditions, as well as general economic downturns; are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on the portfolio company and, in turn, on the investment; generally have less predictable operating results, may from time to time be parties to litigation, may be engaged in rapidly changing businesses with products subject to a substantial risk of obsolescence, and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position.
Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector.
Source: From a deep dive into the banking sector | Franklin Templeton
