A troika of the Fed, Treasury and regulators stepped in to help calm nerves in the wake of the Silicon Valley Bank (SVB) collapse. SVB is an outlier in many ways, but it is too early to call the all-clear on the sector; it’s a risk from the aggressive rate-hiking environment. So far the system looks fine, but it needs to be treated with caution ahead, just in case.
The demise of Silicon Valley Bank was fast, super fast. It started on Wednesday as SVB took a US$1.8bn loss on a forced USD$21bn bond liquidation from its available-for-sale portfolio; it then announced an intention to raise US$2.25bn in capital to help plug the gap.
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Thursday then saw material deposit outflows, and the SVB stock collapsed. Inevitably, with trust gone, Friday saw SVB go down. The regulators stepped in, with the FDIC acting as receiver in a clean-up exercise. An attempted auction process began over the weekend, seeking suitors.
There has already been a degree of market contagion, on fears of replication in other banks. All banks hold securities, for various reasons. In the traditional banking model, deposits raised are used to underwrite loans.
Banks have the option to invest in bonds as an alternative to writing loans, and this is most applicable where, for whatever reason, there is either not enough demand for loans, or the terms on writing loans are less appealing. Unusually, SVB employed far more of its deposit base in long-dated bonds than in writing loans. This meant it was more susceptible than most banks to the performance of its bond portfolio.
Moreover, SVB’s bond portfolio had a large longer-dated fixed-income component. As rates rise, the value of this portfolio fell. This would damage the running yield on such a portfolio, pressuring the implied interest rate margin down.
Under pressure, liquidation of the bond portfolio crystallised losses, necessitating the subsequent need to raise capital. Banks that hold either a lower proportion of bonds to loans (most do) and/or hold more of their securities in floating rates would be far less susceptible to an SVB-type repeat.
But that does not mean that there aren’t other SVBs out there. Treasury Secretary Janet Yellen in fact alluded to the possibility that there may indeed be some and that the Treasury was monitoring some other banks.
So far, it seems that the potential problem banks are few, and importantly do not extend to the so-called systemically important banks. But even if that’s the case, there is still a fear that contagion risks are uncomfortably elevated.
In the end, the banking system is a game of trust. So there needs to be some assurance that system breakdown risk is low. But crucially, we have assurance that system breakdown risk is low.
Source: THINK – ING’s latest economic and financial analysis. (Authors are Padhraic Garvey, CFA, Regional Head of Research, Americas and Suvi Platerink Kosonen, Senior Sector Strategist, Financials)