Weekend Reading #208

Photo by Hatice Yardım on Unsplash

This is the two-hundred-and-eigth weekly edition of our newsletter, Weekend Reading, sent out on Saturday 11th March 2023.

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What we’re thinking

The past few days in the banking space have been very much the case of a trickle escalating into a deluge. Earlier in the week, Silvergate Bank pulled the plug on its business, announcing plans to wind down the bank and preserve whatever value remained. But just one day later, another familiar name showed up on the casualty list: Silicon Valley Bank (SIVB).

As we write this, SIVB has in the past two days lost more than 85% of its market value, with headlines emerging about their lack of success at fundraising and their subsequent engagement of advisors to seek a sale. At c. $36 in the pre-market at 1.30pm on Friday, it would have been unimaginable for SIVB shareholders just 2 days ago that they would find themselves in this situation, when the stock closed at $264/share.

(Last minute Friday night edit: SIVB is now officially shuttered in order to protect its deposits, while its stock has remained suspended since the Friday opening bell – a tricky situation for anyone with a short position open in the stock.)

Yet aside from their names starting with the same two letters, SIVB and Silvergate’s problems are quite different – sure, at their very root all bank problems can get bucketed into a few general segments, but where Silvergate had a crypto connection, and potentially entanglements with the law, Silicon Valley Bank had a very different clientele: VCs and their investee companies. Being in trouble can come in very different degrees.

No surprise nonetheless that the news of Peter Thiel’s Founders Fund advising companies to withdraw money from SIVB exacerbated their problems, effectively triggering an on-demand bank run. That's what everyone sees, but the underlying problem was really a duration mismatch between the long-dated (and high quality) treasury/MBS securities they held on their books and the demand deposits of their depositors. Mind you, this decision wasn’t a malicious one per se – in fact, it was probably very prudent and compliant. (As an aside, a book of mortgage loans was also what Silvergate held on their books against their clients’ deposits).

But obedience doesn’t make up for losing money. The move in rates over the past year on this duration mismatch was the reason for them having to crystallise their unrealised P&L on the bond book – without that mismatch, they would be good for the money with their depositors... if their depositors could wait. One could chuckle at how their downfall came as a result of overleveraged exposure to treasuries and MBS rather than their PE/VC related client book, but as we pointed out back in 2019, the scale of the liquidity flowing into PE/VC pools was gargantuan. That scale itself likely led to the mismatch in the books.

That brings us to the bigger question of how much more unrealised losses we can see materialise – especially when it is entirely permitted to book these reserve securities as “Held to Maturity”, which exempts banks from marking price fluctuations to P&L, or at least as “Available for Sale”, which only marks the price fluctuations into “other comprehensive income” rather than outright P&L. In the case of these bond holdings, “eventually” everything will be ok – assuming “eventually” comes.

The risk now is that the little regional banks that pivoted in the past few years to providing niche banking services which the big banks didn’t want to touch that are now feeling the brunt of the pain. Is this a systemic/contagion event? Probably not for the likes of JP and Citi, but for the smaller banks, things are getting dicey.

Underlying all of this are the poster children of “not marking prices to market”: the world of Private Equity and Venture Capital. On one hand, they’re the innocent bystanders, potentially victims, of what’s happening with the banks. But if the banks were to be looked upon as being at fault for not marking their books and provisioning appropriately on the (very credible) promise that they will get their money back from the US government eventually, then surely the inability (and/or unwillingness) of private market managers to do the same to their investment books is the greater fault?

After all, unlike the US government, the promise of making money back on any part of a private equity/venture capital book isn’t necessarily ironclad, and in much more need of trust in a higher power than believing in the US dollar itself.

What we’re reading

I read this gargantuan piece called “Roots of the Donbass Wars” by a guy called Peter Nimitz. Firstly it is 15,000 words so don’t just sit down for a cursory glance. It is a history of the region which could probably have filled a fat, non-fiction book if expounded upon fully. In it Nimitz makes abundantly clear that it is a very complex picture and not simply a case of a nutcase aggressor invading for imperialistic reasons. He writes of all the other players in the mix and contextualises it well with lots of historical analysis and opinion. Here is what ChatGPT had to say about the article (quite useful tool!)

“The article states the conflict in Donbass is not simply a product of Russian aggression but rather a complex conflict involving various actors with competing interests, including the Ukrainian government, Russian-backed separatists, and foreign powers such as the United States and European Union.

“The article argues that the conflict in Donbass is a result of a combination of factors, including regional identity, ethnic and linguistic divisions, geopolitical positioning, and foreign intervention. The author emphasizes the importance of understanding the complexity of the conflict to find a resolution and bring peace to the region.”

His substack seems great too. I haven't quite dug in yet, but articles as diverse as about Chad, Kazan and even Alexander the Great sure tickle my fancy.

I was never a believer in the ESG nonsense as peddled by asset managers to try and attract AUM. For sure, studies have shown that in some cases and when implemented correctly, a sound environmental, social and governance approach, can lead to positive outcomes. But the virtue signalling in recent years was nauseating. And make no mistake, it was (and still is) all done to attract more big money clients who themselves are virtue signalling to their base. Idealistic investing has never worked. Markets don’t care about that stuff. Markets cut through it all. In light of this, it's no surprise I enjoyed this article by Rupa Subramanya in The Free Press, where she digs deep into ESG and unsurprisingly has some rather sobering conclusion DC

What we’re listening to

A new find is the Empire podcast with Jason Yanowitz and Santiago Santos, a pair who have been around for some time in the crypto markets. They had a chap called Dan Matuszewki on the podcast. Matuszewki is better known by his Twitter name, CMS. The conversation covers the recent Coinbase blockchain announcement and a few other bits and pieces but for me it was of value to hear about another investor and his process, as well as his current thinking on the market. A good new addition to my running listening list.

I also listened to an interview with Credit Suisse’s Jonathan Golub on the Alpha Exchange podcast. Golub is Head of US Equity Strategy and Quant research, but he has been around a long time and there is lots to pick up. His overriding view is that the US economy is incredibly strong and for the Fed to make a dent in demand to bring down inflation they will have to go much higher on rates. That though would cripple the economy so he thinks they will make a half-hearted attempt to go up some more and then ultimately declare victory, which leaves us in a higher for longer inflationary environment. Lots of other useful bits too and not too long. For market participants its better than a research note. DC

What we’re doing

Nestled in a cul-de-sac in one of the quiet little streets behind St James’s St (certainly not a “quiet alley” as one would normally call such a street), the Royal Ocean Racing Club was the venue for a long-overdue meet up with Christian and Rowena, from our fund administrators Opus, who were in town to receive an award. Interestingly, despite the ostensibly posh exterior and the undoubtedly high-end address, the RORC was pretty laid-back as far as clubs in that area of town are concerned. Unfortunately, we’re not members, so it’s not somewhere we can simply walk back into, but the idea of a sailors’ club in the heart of town is definitely an appealing one!

This week, I had the opportunity to attend the EMEA FIX conference in London. The conference brought together professionals from the financial industry to discuss the latest trends, challenges, and developments in the field of electronic trading. The conference covered a range of topics, including best practices in trading technology, regulatory updates, and innovations in the industry. Although it was quite interesting to see how the conference diverged between the ‘true’ FIX tech stream and the other more commercial vendor sided discussions which tended to be a little more predictable. However, those that did participate in the technical aspects did seem to know their stuff and it was useful to see how FIX Orchestra has now developed to the point to which the working group responsible have described it as an initial workable version.

For the weekend, I'm currently in Edinburgh, Scotland. Despite the cold weather, I'm enjoying exploring the city's historic sites and (after writing this, some of the city’s nightlife). There's something charming about walking along the cobblestone streets and taking in the old architecture. I've also been trying out some of the local cuisine and have had some delicious meals so far (with a deep-fried mars bar is next on the list to try). It's been a relaxing break from the usual hustle and bustle of London. The only horrendous part of the trip so far was the plane journey up where the turbulence was perhaps the most that I have ever experienced in my life. HS