14/03/2023
Silicon Valley Bank collapse.........
In the first major US banking collapse since the Global Financial Crisis, and second largest banking failure in U.S. history, Californian based Silicon Valley Bank (SVB) was placed into administration over the weekend, as regulators stepped in to begin dealing with the fallout. Many are drawing comparisons to the Lehman Brother’s bankruptcy in 2008, but whilst this situation is serious and likely has broader implications, SVB was a particularly niche operation, catering primarily for venture capital and technology start-ups.
Markets are scrambling to understand the contagion risk for both customers and counterparties, which will likely become clearer during the week. Bond markets are responding by discounting the likelihood of further interest rate rises, now betting the Fed will shortly pause to assess the lagged impact. The biggest concern to US regulators is the risk to other regional and non-Systemically Important Financial Intuitions (SIFIs), who may be vulnerable to similar bank runs.
So what happened??
Last Wednesday, the yield on a 2-Year Treasury climbed to 5.07% - its highest level since before the financial crisis. It has currently fallen back to 4.6%, partly in response to mild wage readings in the February jobs report, but primarily because of the collapse of Silicon Valley Bank (SVB). The demise of SVB does not reflect general weakness in the U.S. economy or in the banking system. Rather SVB’s unusual mix of assets and liabilities that made it particularly vulnerable to the Fed’s recent aggressive tightening. Investors in the week ahead will be watching this story unfold along with a key reading on February inflation figure. This collapse could represent a “braking point” for the US Fed, taking a 50-basis point hike off the table for next week’s FOMC meeting and raising the possibility of an early end to the now year-old tightening cycle.
As of the end of last year, Silicon Valley Bank was 16th largest U.S. bank, with $209 billion in assets. However, it only had 16 domestic branches, but it had more than quadrupled its client deposits over the past five years by catering primary to startup companies and the venture capital firms that fund them. This explosive growth led to three associated vulnerabilities:
• First, 93% of their deposits were corporate, (rather than from Individual/Mum & Dad investors), compared to a median of 34% among the largest 10 U.S. banks. As a consequence, 84% of their deposits exceeded the FDIC $250,000 limit and were thus uninsured. This meant that, unlike the average commercial bank, SVB was very vulnerable to a traditional bank run, which occurs when depositors, on mass, withdraw their money for fear that they won’t be able to get it later.
• Second, largely as a result of their explosive growth, the majority of SVB’s assets were in high-quality fixed income securities rather than in loans. While this reduced the credit risk of their asset base, it left them vulnerable to a sharp rise in interest rates, particularly if they had to sell these assets and book losses in a higher interest rate environment, which what happened to fund the withdrawals.
• Third, venture capital investment has slowed in recent quarters, reflecting a general tech downturn. This has forced startup companies to burn through cash more quickly, reducing deposits – a significant problem for a bank with so much of its deposit base coming from this sector.
These vulnerabilities go a long way towards explaining the sudden collapse of SVB and also provides some reassurance about the health of the banking system as a whole. Most banks have far more diversified deposit bases and none of the major banks have anything like the same exposure if all their fixed income assets were marked to market to reflect current interest rates.
Due to this, the US Fed could feel forced to ease rates earlier and more than currently anticipated, in sharp contrast to Chairman Powell’s comments last week.
This should set up a slow-growth, low-inflation and low-interest-rate environment for the middle of this decade, and ultimately provide support for both stocks and bonds after a very difficult 2022 and volatile start to this year.
