Overview
March witnessed the collapse of 16th and 19th largest banks in US and 167-years old Credit Suisse in Europe. This would result in sharp tightening of lending as well as increase the cost of business for banks; thus, hastening the economic slowdown. It is also pushing more inflows into diversified fixed income funds, which provide superior risk-adjusted returns.
Inflation: continues to glide down
US headline inflation rate moved further down from the peak of 9.1% (June’22) to 6% (Feb’23). As detailed in Silverdale Monthly Commentary: Feb’23, the drop in rentals is resulting in fall in ‘Shelter’, with lag of 6-8 months, pushing down the core inflation below 6% to 5.5% (Feb’23).
Figure-1: 8-months of consecutive decline in YoY headline inflation
Labour market: flickering signs of weakness
The unemployment rate crawled up from 3.4% (Jan’23) to 3.6% (Feb’23). Importantly, about 90% of all jobs created in past 12 months have been part-time / temporary jobs. Further, the number of new job postings has taken a sharp dive.
- Source: Vontobel, Mar’23
Figure-2: Majority of job created in past 14-months are part time jobs
Furthermore, wage per hour has been slowly climbing down. These cracks in the labour market, could become fissures, with tightening of lending standards.
Figure-3: Tighter lending standards will adversely impact jobs market
Fed tightening usually ends in accidents
It is inconceivable that the fastest ever rate hike would not result in some accidents: SVB, CS, etc. are precursors. Hence, it is critical to stick to high quality and be well diversified.
- Source: ING Research, Mar’23
- Source: Macrobond, ING Research, Mar’23
Figure-4: Fed tightening cycle usually breaks something
SVB & CS: What, Why & Implications
Almost half of US-venture backed tech and life-sciences companies banked with Silicon Valley Bank (SVB). These ventures did record amount of fund-raising and deposited it with SVB, sky-rocketing its deposits by 86% in less than one year. SVB invested most of these funds into long-dated US treasuries and mortgage bonds. As the interest rates increased multi-fold, the market prices of these securities fell very sharply (estimated 20%+). Being a small bank (with less than US$ 250 billion of assets), SVB was exempt from making provision for MTM losses. When SVB depositors started withdrawing money, It was forced to sell these securities, resulting in MTM losses becoming realized losses, inducing the Federal Deposit Insurance Corp (FDIC) to seize the bank.
Figure-5: Growth in SVB deposits (92% were non-transactional)
The collapse of SVB, led to flight in deposits from the regional banks into larger banks and into fixed income: money market funds which hit new high of US$ 5.1 tn. This deposit flight has hurt all US regional banks, which provide 38% of all loans in US (including 67% of all loans to commercial real estate sector), and would result in lower credit availability.
- Source: BofA Research, Mar’23
- Source: Silverdale, SVB Filings, March 2023
Figure-6: The US small and medium-size banks share of loans (%)
The US banking sector has over US$ 620 billion of MTM losses, half of which is due to HTM (Hold-To-Maturity) securities, which are not marked-to-market prices. SVB collapse would trigger change in classification / accounting of HTM securities. Thus, increase cost of funding.
Across the Atlantic, Credit Suisse was victim of decades of poor management, caught in the inferno sparked by irresponsible media headlines, fanned by social media, and fuelled by internet banking. It resulted in shot-gun merger into UBS, with Additional Tier 1 (AT1) being the collateral damage. Wiping out AT1 bonds before equity wipe-out broke the AT1 market, till non-Swiss regulators came to assure the markets of structural superiority of AT1 over equity. We did not own any Credit Suisse AT1 in Silverdale Bond Fund or any of Silverdale Fixed Maturity Funds.
While bank failures will push US / Europe into slowdown with spike in unemployment (see Figure-3 above), nevertheless, as detailed in Silverdale Monthly Commentary: Jan 2023, US is entering into economic slow-down with strong consumer, corporate and banking balance-sheets, which implies relatively lower default rate, which means relatively higher risk-adjusted returns for investors. Further, pausing of Fed rate hike will act as huge tailwind for bond investors.
- Source: Federal Reserve, WSJ, March 2023
This excludes US$ 1.1 tn of MTM loss of US Fed Reserve
Figure-7: Fed pause is positive for bonds (US Aggregate Index)
Takeaway: Attractive income in bonds
Our flagship Silverdale Bond Fund (SBF) continues to be positioned to take advantage of the high carry offered by quality bonds, with 77% high quality Investment Grade bonds and a duration of 1.7 years; yet, having high leveraged YTM of 17%, pointing towards higher potential returns for investors. Historically, as volatility dust settles (as seen in Nov’22-Feb’23 period), the fund tends to outperformance the indices and peer group.
Silverdale Fixed Maturity Funds (FMPs) continue to maintain adequate headroom and Interest Rate Swaps (IRS) and are on track for their envisaged returns.
Thank you for your trust in Team Silverdale.
DISCLAIMER
THIS COMMENTARY IS AN INTEGRAL PART OF AND SHOULD BE READ ALONG WITH THE FUND FACTSHEET FOR MARCH 2023. This document is written for the benefit of and is being communicated exclusively to Accredited Investors or Institutional Investors as defined under the Securities and Futures Act (Cap. 289) of Singapore. The above commentary does not provide a complete analysis of every material fact regarding the market, industry, security, portfolio, or any Silverdale fund. It is not a recommendation to buy or sell any security nor an investment advice. The portfolio holdings, opinions and information may change without notice and the actual results may differ from the said opinions and estimates. The contents of this document, including any narrative, does not constitute an offer to sell or a solicitation of any offer to buy the units or any Sub-Fund or class of the Silverdale Fund VCC (the “Fund”) or any of the funds managed or advised by Silverdale Capital Pte Ltd., and is strictly for educational purpose only. The distribution of the shares of the Fund may be restricted in certain jurisdictions. It is the responsibility of the person or persons in possession of this communication to inform themselves of, and to observe all such restrictions, all applicable laws, and regulations of the relevant jurisdiction, including of any applicable legal requirements, exchange control regulations and taxes in the countries of their respective citizenship, residence, and domicile. Any subscription for units or shares must be made solely based on the Fund’s private placement memorandum, applicable class supplement) and Subscription Documents (together “the Offering Documents”). Past performance is not an indicator of future performance. The Fund uses leverage and invests in financial derivative instruments. Please refer to the Offering Documents for Risk Factors. Nothing in this document is intended to constitute legal, tax, securities or investment advice or opinion regarding the appropriateness of any investment, or a solicitation for any product or service. Please seek opinion from independent professional adviser before taking any decision based on this document.
- Source: Bloomberg, PGIM Investments, March 23