Welcome to the latest edition of LGA Insights!

We originally launched this newsletter to provide you with access to LGA’s latest research and ideas on family enterprise continuity and have been honored and humbled by the early response. In just a few short months, over a thousand readers have joined our global community and are now using these insights to support their continuity.

To say thank you to our readers, we’re excited to introduce a new regular feature — the Family Enterprise Risk Monitor — which will focus on macroeconomic and geopolitical risks that all enterprising families should be tracking as they navigate an increasingly complex and uncertain world. Whether it’s stubbornly high inflation, sudden bank failures, struggling commercial real estate, energy and commodities shocks, rising tensions with China, de-dollarization and regional trade blocs, or shifting tax policy, the Family Enterprise Risk Monitor will provide you with a high- level understanding of how these risks are likely to affect your investment and operating portfolios in the months and years ahead.

These fresh insights will be authored by the newest member of the LGA’s global team: Dimitris Valatsas a seasoned macroeconomist who has helped countless families around the world navigate complex geopolitical, financial, and economic challenges. We’re sure you’ll enjoy his unique perspective on the world and encourage you to reach out to him at valatsas@lga.global to learn more.

We’re also eager for your feedback more generally on what you like best about LGA Insights and what we could do even better. Please feel free to email us at insights@lga.global — we’d love to hear from you.

Thanks again for subscribing and enjoy the first edition of the Family Enterprise Risk Monitor.

Warmly,

-Devin

Meet our newest team members

 

This newsletter is authored by Dimitris Valatsas, the newest member of the LGA team joining us as an Advisor.

Training for a Bank Run

From a macroeconomic perspective, both the failure of SVB and the forced takeover of Credit Suisse are a consequence of monetary tightening: higher interest rates and declining central bank balance sheets.

The same forces are at play here that caused the collapse of cryptocurrencies, a strong dollar, and last year´s selloff in tech stocks. So long as policy remains tight, more financial trubulence should be expected.

Policymakers acted forcefully in both cases, demonstrating that they will not tolerate a major bank failure—though shareholders and in some cases bondholders will not be spared.

The global financial system has plenty of vulnerabilities, including assets linked to commercial real estate. It is unlikely Credit Suisse will be the last victim of this crisis.

Whether families are operators, investors, or both, this crisis is a healthy reminder to re-examine Treasury operations, banking relationships, liquidity reserves, and concentrated exposure to the financial sector more generally.

The story in brief: Last month, Silicon Valley Bank (SVB) failed following a run-on deposits. Its (separately-capitalized) UK subsidiary almost failed and was sold off to HSBC for £1. Soon after, Signature Bank of New York also failed; and Swiss behemoth Credit Suisse was forcibly sold to its domestic rival, UBS.

The family angle: both SVB and Credit Suisse were very significant institutions for families and family businesses— highlighting how exposed families are to turbulence in the financial system. Thankfully in this case, all depositors and most (but not all) creditors were protected; shareholders were not spared.

Unlike in the leadup to the global financial crisis, SVB had not invested in obscure securities of dubious value. Instead, it was holding significant quantities of high-quality, highly-liquid, but also highly interest-rate sensitive bonds. In other words, this is a very different financial crisis to 2008.

The family angle: traditional “diversification” strategies such as a 60/40 portfolio tend to fail spectacularly during times of high inflation. Is your portfolio sufficiently diversified with the types of assets that outperformed during past inflationary periods? Who should be having these conversations? Have they had them yet?

The big picture:when the Fed hikes, things break—and things in the financial sector tend to break first. Since it started hiking in March 2022, the Fed’s moves have broken a 2-year rally in crypto, a 12-year rally in tech stocks, and a 40-year rally in bonds. In other words, the tightening affected virtually anyone with a balance sheet.

Bonds were hit especially hard, a jarring development for investors used to considering them a relative safe haven. In real terms, 10-year U.S. treasuries lost ~24% of their value in 2022—their worst performance since at least 1870. ). This is especially bad for entities that hold bonds. Because yields have been so low, those holding them have primarily been entities forced to do so by regulators: banks, insurance funds, and pension funds.

When interest rates rose, the value of SVB’s assets declined—eventually causing their highly concentrated, highly mobile depositor base to panic. Once a bank run starts, the rational action is to join it—and that’s exactly what depositors did, causing a liquidity crisis and SVB’s ultimate failure.

This was also the first major bank run in the age of social media and banking apps, ay least in the U.S.-in China these things happen all the time. Thanks to social media, herding has become more efficient and more effective, turning every bank run into a sprint. It is worth remembering that Credit Suisse´s market troubles, too, began in the social media rumor mill last fall. Ultimately, the regulatory authorities Will have to design a more resilient banking system. But between now and then social media will continue to pose a threat to banks.

Somewhat astonishingly, even large public companies held significant amounts of cash in uninsured deposits with SVB—Roku, for example, held $487 million dollars in an uninsured account. Prior to the debacle, the FDIC only insured the first $250,000 for any depositor. Had the regular procedure been followed, Roku would have found itself some $486,750,000 out of pocket.

Once panic had set in at SVB, at regional banks across the U.S., and at the highest levels of government, the FDIC, Federal Reserve, and Treasury declared SVB (at the time of failure, the 16th biggest bank in the United States) “systemically important” and bailed out all depositors in full, in addition to starting an emergency liquidity program for banks at the Federal Reserve (the Bank Term Funding Program). The program is relatively technical, but in practice it means that the liquidity run that took down SVB should not happen to any other major U.S. bank.

The family angle: we have heard of many families who banked with SVB at every level—ownership, business, and wider family; a potentially catastrophic risk. Does your family bank at the same place as your family business banks? If so, it may be time to revisit the wisdom of keeping that many eggs in a single proverbial basket.

The sticking point: For 12 months, interest rates have been rising everywhere—except, alas, in your checking account. According to the FDIC (link), the U.S. national deposit rate on February 21, 2023 was 0.06%– that’s how much retail savers get on their checking account on average. The effective fed funds rate (which is what wholesale savers get) was 4.58% There is clearly friction in the banking system that has prevented depositor flight. And make no mistake -your banker is pocketing the difference; J.P. Morgan made a tidy $225M per day in net interest income in 4Q22, its best quarter ever.

The Swiss connection: Credit Suisse was by far the highest-profile victim of the current banking crisis. The bank, which held 531 billion Swiss francs in assets the end of 2022.
was forcibly sold to its main domestic rival, UBS. Problems at CS had been brewing for years and the bank’s fragility was well known to investors throughout 2022. In the end, Swiss (and global) regulators were simply unwilling to risk the failure of such a major financial institution.

A Credit Suisse failure would have been closer to a Lehman moment than SVB and thus a far bigger headache for policymakers. As one of 30 global systemically important banks (G-SIBs; full list here), Credit Suisse had a far bigger financial footprint than the U.S. regional banks that failed. The bank may well have been solvent in the long run—but regulators had no interest in finding out the hard way.

The family angle: though its global influence had been declining over the past few years, Credit Suisse Wealth Management has been servicing global family businesses for decades. Its forced sale is a reminder that bigger is not necessarily better when it comes to banking relationships—and that even multi-century longevity is no substitute for sound strategy and risk management.

The next big thing could be anything, but investors are currently focused on real estate—in particular commercial real estate (CRE) in the United States and residential real estate in countries with sharp falls in home prices, such as Canada, Australia, and New Zealand.

Commercial Real Estate is on everyone’s mind and for good reason. The post-COVID trend toward remote work has permanently diminished the value of office properties, which may now be worth less than the loans attached to them. Depending on who you ask, commercial real estate prices dropped 3.5% in the U.S. last quarter—and that was before the current banking crisis. Morgan Stanley analysts recently predicted a 40% slump for CRE prices.

But do the numbers and the problem seems less cataclysmic—office buildings that are impacted by new ways of working only make up ~16.7% of the total CRE market, the rest
being spread across multifamily homes, industrial, and other commercial real estate. And though smaller banks have higher exposure to CRE as a whole, office exposure still accounts for ~3% of total regional bank assets. In other words, even a once-in-a-generation slump would not bring down the banking system—though investors with direct exposure would still feel the pain.

Refinancing assets will be the great challenge for CRE investors, operators, and asset-holders. It is important to remember that there is no guarantee that interest rates will only go lower fron here: delaying is a risky strategy. The reality is that for some of these properties, such as downtown offices, long-term demand may never recover to pre-COVID levels.

The family angle: higher interest rates and market volatility are likely to be with us for a long time— the 2020s will be very different to the 2010s. Is your family’s portfolio (both financial and operating) are well positioned for the new macroeconomic and financial environment?

This is the first installment of monthly series on Risk, wich will become a subset of the LGA Insights newsletter, bringing you actionable insights on global developments, tailored to the specific needs of family businesses and family offices.

Each month, our team of experts will help your family stay ahead of the curve by bringing you nonpartisan, globally minded, institutional-grade geopolitical and macroeconomic analysis. If you want to speak with Dimitris or the LGA Risk Management team, please click here. If you want to learn more about LGA’s continuity advisory services, please visit lga.global. And please feel free to email us at hello@lga.global with any questions, comments, suggestions, or opportunities to collaborate.

Thank you for joining the global community of families who use these insights to support their continuity. We look forward to seeing you at the webinar.

This online discussion will be hosted by LGA´s Managing Partner Devin DeCiantis and our newest Advisor and resident macroeconomist Dimitris Valatsas. 

The next edition of LGA Insights will be published in May and focus on the cruicial topic of Education. We look forward to sharing more with you in the next edition of LGA Insights!

Sincerely,

Your LGA Team

Disclaimer
This newsletter is a general communication being provided for informational and educational purposes only. It is not designed to be a recommendation for any specific investment product, strategy, allocation, or any other related purpose. By receiving this communication, you agree with the intended purpose as described above. Any examples used in this material are generic, hypothetical and for illustrative purposes only. Any statements on financial market trends are based on current market conditions, constitute our judgment, and are subject to change without notice.

We believe the information provided here is reliable but should not be assumed to be accurate or complete. The views and strategies described may not be suitable for all investors. None of LGA, its affiliates or representatives is suggesting that the recipient of this newsletter or any other person take a specific course of action or any action at all. Prior to making any investment or financial decision, an investor should seek individualized advice from financial, legal, tax, and other professionals that take into account the particular facts and circumstances of an investor’s own situation.

This newsletter should not be construed as a solicitation or an offer to buy or sell any securities or financial instruments. Predictions, forecasts, and estimates for any and all markets should not be construed as recommendations to buy, sell, or hold any security—including but not limited to mutual funds, money market funds, futures contracts, exchange traded funds, or any other similar instruments.