GVA Bulletin – SVB Financial

What happened at SVB?

During the trading day on Friday, banking regulators closed SVB Financial and appointed the FDIC as receiver. The parent company of Silicon Valley Bank, SVB was the 16th largest bank in the U.S. and was the key financial institution for venture capital tech companies.

Is this the beginning of a repeat of the Great Financial Crisis (GFC) (2007-2009)?

Very likely not. It is important to state from the outset that the SVB collapse was not a result of the style of reckless lending that nearly sent the global financial system down a black hole roughly 15 years ago. Instead, it was a result of SVB’s particularly poor credit risk management of their securities portfolio at a time when the U.S. Federal Reserve has been raising interest rates aggressively. This is almost nothing like the GFC, as the U.S. banking system as a whole is generally sound and well capitalized today (it was not at all back in 2008). Instead, it’s more like a 1930s style bank run where depositors suddenly lost confidence in a financial institution and many wanted their deposits back effectively at the same time.

What exactly did SVB do wrong with their securities portfolio?

The following is an oversimplification but gets to the bottom line. SVB got flooded with deposits during the post-COVID boom through 2021. The bank took a good chunk of these deposits and bought long-term bonds in order to generate an interest rate on these deposits. For example, SVB held 43% of their assets in mortgage-backed securities (MBS) versus an average of just 12% for their large bank peers. So, when interest rates started rising sharply in 2022 and long-term bonds were plunging as much as -30% or more, the value of the assets that SVB held were insufficient to cover the value of the deposits held for their customers. Short sellers picked up on this disparity and started driving SVB’s stock price down, which increased the strain on the financial condition of SVB. By last Thursday in the wake of a series of triggering events (threatened Moody’s credit rating downgrade, botched capital raise attempt, etc.), SVB suddenly started to collapse.

So why does the collapse of SVB matter?

Because SVB Financial is not alone in being a U.S. bank that thought they were acting responsibly by acquiring top quality long-term bond assets with the intent of holding them to maturity but unwittingly finding themselves in dire straits financially due to the rapid tightening of monetary policy by the U.S. Federal Reserve. Thus, the worry across financial markets over the weekend has been “who’s next?” in the U.S. banking system. Tech start-ups throughout Silicon Valley went to bed Wednesday night not thinking twice about their financial liquidity, but by Friday afternoon they suddenly found they couldn’t make payroll (file this under “holy crap” as well). To highlight how quickly SVB Financial collapsed, consider that regulators typically prefer to get to the weekend before closing a bank, but in the case of SVB they had to intervene in the middle of the trading day on Friday – this is how quickly everything at SVB went up in smoke. Putting this all together, if you’re a business owner across the U.S. this weekend, you may start wondering whether the thousands (or millions) in deposits at your local/regional bank may also be at risk. If you didn’t already late last week, you might think about withdrawing your deposits on Monday. This is how contagions start.

So what did the U.S. Treasury Department, the U.S. Federal Reserve, and the FDIC all do this weekend?

This is what I’ve been watching closely all weekend. In the wake of the SVB Financial collapse on Friday, these three had to come up with a plan and issue a joint statement with a major response to the problem before Asian markets opened on Sunday evening. After failing to coordinate a sale of SVB to another bank by Sunday afternoon, they came up with the following – close New York based Signature Bank (SBNY), guarantee all deposits, launch the Bank Term Funding Program that enables any Fed member U.S. bank to get a loan for the par value of their “qualifying assets” for up to one year, and reassurance that the Fed discount window is “open and available”.

Will this response be enough?

Capital markets cheered the move going into the overnight on Sunday and have stabilized in the trading days since, but only time will tell. All of these programs are great, but it doesn’t take away the fact that many U.S. banks all across the country have varying degrees of the same problem – they hold long-term assets that have meaningfully depreciated in value against deposit liabilities that can be redeemed by withdrawal at any point in time.

What are the broader implications of what has taken place this weekend?

What really matters in the wake of the SVB Financial collapse in my view is beyond the immediate term. The big three (Treasury, Fed, FDIC) had the tools to “fix” this problem. The key question was not really “if” but “how”. The solution is not great, but probably good enough to stem the bleeding in the immediate-term and put a giddy up under risk assets on Monday.

The much bigger issue now is the following: policy makers including the Fed have been engaged in a major inflation dogfight over the past year. This has required the Fed to tighten monetary policy aggressively including raising interest rates by nearly five percentage points in less than a year. Despite all of these efforts, inflation is still high and has become increasingly slow to come back down.

Now, in the wake of the SVB Financial collapse, a major systemic risk in the financial system has been laid bare for all to see. The Fed has already had to abruptly ease monetary policy effectively in response to this crisis, and this is a problem in the banking system that is not going away anytime soon.

This is now placing the Fed in a precarious position going forward. Cut interest rates to provide relief to banks feeling SVB like pain, and you fan the flames of inflation that are still burning uncomfortably hot. Continue to raise interest rates to fight inflation, and you place additional pressure on banks already buckling under the weight of higher interest rates to date. Even if the Fed stops hiking rates any further, they may not have done enough to date to defeat inflation, and the problem with the banks is not fixed either.

We will learn more about how the economy and capital markets respond to this unfolding situation in the coming days.

Eric Parnell, CFA | Chief Market Strategist, Great Valley Advisor Group

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Investment advice offered through Great Valley Advisor Group (GVA), a Registered Investment Advisor. I am solely an investment advisor representative of Great Valley Advisor Group, and not affiliated with LPL Financial. Any opinions or views expressed by me are not those of LPL Financial. This is not intended to be used as tax or legal advice.

Please consult a tax or legal professional for specific information and advice.

Eric Parnell, CFA Chief Market Strategist

Eric Parnell is the Chief Market Strategist for Great Valley Advisor Group. Eric applies his expertise in finance and economics to manage multi-asset portfolios, mitigate risk, deliver advice that promotes informed decision-making, and facilitate investors achieving their short-and long-term investment goals. He leads the GVA Asset Management platform overseeing the management of asset allocation models for GVA advisors and their end clients.

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