What led to this point?
In its normal course of business, SVB’s deposits grew from just over US$60 billion in the first quarter of 2020 to more than triple (just under US$200 billion) by Q1 2022. SVB in turn had invested in mortgage-back-securities and U.S. treasury bonds. As interest rates rose over the last year in rapid succession, the market value of these bonds fell to less than what SVB had paid for them. By the end of 2022, their assets had fallen in value by more than US$17 billion. Into 2023, the situation worsened as rates kept surging.
As a result of changes to the banking rules following the Great Financial Crisis, banks have been allowed to classify bonds in an unrealized loss position as securities held to maturity in order to recognize that their loss didn’t reflect their capital risk. In reality, these securities have themselves virtually no risk of default as they are U.S. government securities or carry government guarantees. The value of the bonds fell simply due to the fact they pay interest at a much lower rate than newer bonds.
However, at the same time, tech companies and startups came under pressure. The challenges at tech companies (cost management, lack of new funding) were heavily reflected in SVB’s client base. New deposits dwindled and withdrawals increased. To satisfy these withdrawals the bank had to sell the securities they were supposed to hold until maturity, thus realizing the losses. What was unlikely became reality. And at that point, the loss carried on these assets was bigger than the whole of the bank’s book value.
Last Thursday, customers tried to withdraw US$42 billion in deposits fearing that SVB would fail. The demand pushed SVB into failure, as they did not have enough money to give back to all its customers.
By Friday, March 10, SVB had failed resulting in the U.S. Federal Reserve (the Fed) stepping in over the weekend.
What did the authorities do?
Earlier we said that the securities held to maturity by SVB held virtually no risk, and that the losses were for the time being unrealized losses as a result of a rapidly rising interest rate environment. In recognition of this, and to quell the potential of financial contagion, the Fed stepped in over the weekend and launched a new program.
The Bank Term Funding Program (BTFP) is a facility that will loan money to banks for up to a year, and take collateral of their long-term and short-term needs, with their long-term assets serving as collateral valued at par. Simply put, this program is designed to prevent another bank coming under pressure due to the same circumstances at SVB.
Further, U.S. regulators stepped in to guarantee all the deposits in SVB in order to restore confidence in the financial system.
The response should help to soothe investors worried about additional bank runs or the risk a fresh financial crisis would trigger a recession.
What is our view?
In our view we believe the current situation with SVB is very different from what transpired during the Great Financial Crisis – and parallels to the collapse of Lehman Brothers is unwarranted.
The Great Financial Crisis was brought about by the massive leverage of the global financial system. It was a systemic failure of credit oversight with the banks holding on to effectively worthless assets. In today’s case, bank assets are of much higher quality with much less leverage. The Fed’s BTFP should provide short-term relief for banks holding U.S. Treasury securities that have fallen in value as a result of higher interest rates.
While this is a failure by the Fed to recognize the unintended consequences in their inflation fight, we believe the steps taken will contain the potential spread of contagion. It will remain to be seen if confidence in the banking system remains intact after such an event, but if the Fed learned one thing from the Great Financial Crisis, it is to never let confidence in the financial system fail. We expect additional support by the Fed should it be warranted.
We believe a near-term pause in rate hikes by the Fed is becoming more likely – which bodes well for bonds and potentially equity markets. A pause may come as soon as next week. In the meantime, we expect market volatility to increase in the coming days until confidence is restored. Despite the near-term volatility we don’t believe this will result in a renewed bear market. At the same time, the current situation highlights the benefit of a well-balanced portfolio whereby bonds provide a benefit with an offset to equity market volatility.
Obviously, this is a rapidly moving situation, and we will keep you updated along the way.
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