Update on Silicon Valley Bank collapse
Update on Silicon Valley Bank
Wednesday 15 March, 2023
Update on Silicon Valley Bank provided with the assistance of Hymans Robertson
Summary
-
Silicon Valley Bank (SVB), a medium-sized California-based bank, was shut down by regulators on 10 March. The bank was adversely impacted by depositors withdrawing cash, alongside losses in their bond portfolios.
-
There are several factors that were specific to SVB, which suggest it is not indicative of broader risks to financial stability. US regulators have stepped in to try and minimise contagion.
-
Banking stocks around the world have fallen significantly, but government bonds rallied, in part, due to expectations that this may put a pause to future interest rate rises.
What has happened?
Silicon Valley Bank (SVB), a medium-sized California-based bank, was shut down by regulators on 10 March, due to inadequate liquidity and insolvency. SVB was especially exposed to liquidity constraints, as it held most of its assets in loans and securities and had very low reliance on “stickier” retail deposits. Most of the bank deposits were from early-stage ventures and technology start-up companies, making the bank riskier than other banks.
During the post-covid venture capital (VC) boom, SVB received a huge influx of deposits. The bank invested a large proportion of these in long-duration securities, such as US Treasuries. As interest rates increased over 2022/23, it caused the market values of these bonds to decline. SVB was forced to liquidate a portion of its securities at a loss, to cover customer withdrawals. The crystallisation of these losses led to depositor panic over the solvency of the bank, as over 90% of the bank’s deposits are above the Federal Deposit Insurance Corporation (FDIC) insurance limit of $250k.
The deposit outflows and bond sales revealed the losses on the bonds held by the bank. This prompted further deposit withdrawals by the concentrated depositor base, which led to regulators closing the bank. Signature Bank, a bank with a similar deposit profile and financial position to SVB, this time with crypto-linked depositors, was also seized and shuttered by regulators over the weekend.
The US Treasury, the FDIC, and the Federal Reserve announced on Sunday that they would fully protect depositors, with any losses to deposit holders to be covered by a levy on the banking sector in general. This is different to the bailouts undertaken in 2008, as they will not be funded from taxpayers’ money. HSBC has stepped in to purchase the UK arm of SVB, which mitigates the risk of immediate cashflow risk and failures at UK start-ups, which bank with SVB.
Immediate market reaction and outlook
Financial sector stocks sold off sharply last week, dragging global equities lower. Government bonds however, rallied considerably - partly reflecting safe-haven demand, but also on expectations that the recent financial instability might mean central banks raise interest rates less than previously expected. Market volatility across both equities and bonds also picked up and the dollar weakened (on the back of the potential for fewer central bank rate rises).
In the near-term, recent developments might sway central banks to hike in smaller increments or temporarily pause interest rate increases. Markets have moved to price in this likelihood.
We expect markets to remain volatile in the coming weeks, but the major banks appear in much stronger financial health than in 2008, with much greater amounts of capital available. As noted above, the major banks also have far more diversified depositor bases and sources of funding than SVB and Signature Bank.
Will the risks be contained?
There are several factors that were specific to SVB, which suggest it is not indicative of broader financial stability risks. Firstly, the VC sector concentration of the bank’s depositor base increased its risk, relative to others, meaning SVB deposits were highly aligned to VC companies’ cashflow needs. Secondly, a very high proportion of SVB’s deposits are not covered by the FDIC. The aim of deposit insurance schemes, like the FSCS in the UK, is to prevent bank runs, by protecting customers’ deposits. Thirdly, a very high proportion of liquid assets were held in long-duration bonds, which have suffered large mark-to-market losses amid the aggressive interest rate hiking cycle in 2022.
The regulator’s prompt interventions should limit the potential scale of further runs on deposits at other banks. Furthermore, the large systematically important financial institutions and major banks have much stronger capital positions than in 2008, and also have far more diversified depositor bases and sources of funding than SVB.
In general, we think contagion risk for European and UK lenders is less pronounced, given minimal exposure to tech and crypto lending, less competition for deposits amongst the major European banks, and the tendency for European Banks to hold short-dated bonds, limiting the potential size of losses in the event of forced asset sales. There is a chance though that smaller, regional US banks with a similar business model to SVB also get into trouble.
Impact on portfolios
The broader market fallout will have a greater impact on portfolios. Equity markets have felt the most pain since the news broke, meaning higher risk portfolios will have underperformed lower risk portfolios over the past few days (with bonds rallying, lower risk portfolios were better protected).
Over the short-term, we expect market volatility to remain elevated. However, over the medium term, the potential of a less aggressive Federal Reserve could provide some support to equity markets and other growth assets.
Risk warning
This communication is issued and approved by Lonsdale Services Ltd. It is based on its understanding of events at the time of the relevant preparation and analysis. The information and opinions contained in this document are provided by Lonsdale and are subject to change without notice and should not be relied upon when making investment decisions. The value of your investments and the income from them may go down as well as up and neither is guaranteed. Investors could get back less than they invested. Past performance is not a reliable indicatorof future results.
Changes in exchange rates may have an adverse effect on the value of an investment. Changes in interest rates may also impact the value of fixed income investments.
The value of your investment may beimpacted if the issuers of underlying fixed income holdings default,
or market perceptions of their credit risk change.There are additional risks associated with investments in emerging or developing markets. The information in this document does not constitute advice, nor a recommendation, and investment decisions should not be made on the basis of it. The material provided should not be released or otherwise disclosed to any third party without prior consent from Lonsdale.
