Following the failure of US bank Silicon Valley Bank (SVB) last Friday, the Fed, the US Treasury, and the Deposit Insurance Corporation (FDIC) announced in a statement issued yesterday that they would make additional funds available to guarantee the payment of all SVB deposits.
After this, many are wondering what the consequences will be not only for other banks but also for the economy in general and especially for investors. Below, experts from several fund managers give their views on the matter.
Allianz Global Investors
This event had the potential to destabilize part of the US financial market and trigger further sell-offs – justified or not. This explains why the US Federal Reserve acted promptly this past weekend under the systemic risk exemption, by guaranteeing all the bank’s depositors. The Fed also put in place a new facility – the Bank Term Funding Program – to provide an additional source of liquidity against high-quality securities, “eliminating an institution’s need to quickly sell those securities in times of stress”.
This should reduce substantially the risk of a “domino” banking crisis and a vicious sell-off cycle, as banks should be able to keep their assets on the balance sheet, instead of being forced to sell them on the market and realize losses. This is especially critical in an environment of rising interest rates, as the market value of those assets will remain under pressure if considered mark-to-market.
The financial markets should react positively to the Fed’s prompt action as it has removed a layer of systemic risk in the banking sector, strongly associated with the Lehman Brothers crisis of 2008.
But one should not be complacent. The new Bank Term Funding Program should allow the Fed to continue to focus on its core target, which is to bring core inflation under control by raising leading rates.
This could trigger further weakness in the economy and a softening of core inflationary pressures, which is the ultimate goal of the Fed, especially considering the latest – strong – labour market data from last week.
This confirms our opinion that we are due for a weaker phase in US equities, especially as valuations remain on the higher side and margins deteriorate.
This outlook supports our recent reduction in US equities in multi-asset portfolios. Given the rising risk of a financial accident – as borne out by the SVB collapse – we were not the only ones to be positioned this way.
After the recent rapid rise in US interest rates, we have reversed our position in US treasuries to a more positive stance – at least tactically. This should be supported by further Fed action to weaken the economy and tighten financial conditions. But investors should note that these actions could fuel another round of moral hazard and misallocation of resources – and caution should be the watch word in the coming period.
Monica Defend, Director of Amundi Institute; Vicent Mortier, Group CIO; and Matteo Germano, Deputy Group CIO from Amundi
No systemic risk from SVB failure, but watch out for areas of vulnerability
Market reaction: bond markets have been extremely volatile with extraordinary movements in the 2-year yield, with its biggest 1-day drop since 1982. Equity markets also sold off, particularly in the banking sector, including in Europe where we believe the move was mainly due to profit-taking after strong performance since the start of the year.
Why we believe this is not a systemic risk: while being a negative for the market, the SVB failure is more of an idiosyncratic story rather than a systemic issue. Compared to the Lehman crisis, the bank is not leveraged, has no big derivatives exposure, and no relevant global connections. Yet, this event highlights the need to carefully assess the lagging impacts of higher rates, particularly when it comes to non-systemically important financial institutions and some other non-banking financial institutions, which lack strict regulation.
View on the banking sector: since the Great Financial Crisis, the big systemic banks are well capitalised and highly regulated. Overall we favour large banks versus small banks. Particularly in Europe, the sector is in far better shape compared to the previous crisis and we don’t see any risks, such as the one the US regional banking sector is exposed to, amid its better management of duration risk and stringent regulatory requirements. The effect on banks could be more connected to their earnings trajectory, which is our focus at the moment. Overall, this event adds to the case of selection and differentiation among banks.
Possible impact on Central Bank policy: While we believe the Fed will remain committed to fighting inflation, it will have also to assess the impact of the current crisis and its potential spillovers, as the macro scenario remains fragile and the overall assessment is not easy given the lagging effect of policy actions on the economy. The tightening of financial conditions stemming from the SVB crisis may lead to a less aggressive Fed than expected only one week ago and could force the ECB to reassess its policy path. Yet market moves have been extreme and we believe now is not the time to fight the Fed, as inflation remains a key factor to watch.
Overall investment stance: overall we confirm a cautious stance as with the inversion of the yield curve suggests some cracks may start to appear. We remain cautious regarding equity and high-yield credit, with a regionally diversified approach, including exposure to Chinese equity, which appears more insulated from the epicentre of the recent turmoil.
Gilles Moëc, Chief Economist at AXA Investment Managers
The Treasury and the Fed worked swiftly on emergency measures to provide more protection to SVB depositors than what the FDIC deposit insurance scheme implies. There is normally a cap at USD 250k per depositor, which makes sense to protect household deposits but is very small when dealing with mostly corporate accounts (according to press reports 85% of SVB deposits are above the FDIC threshold). As per the terms of the joint statement of the Treasury, the Fed and the FDIC issued on Sunday night European time, “SVB depositors will have access to all of their money starting Monday, March 13”, invoking the “Systemic Risk Exception” which had been widely used during the Great Financial Crisis of 2008. This is not a bailout – no government protection for SVB bondholders for instance has been mooted – but the idea there is probably to avoid a potentially painful migration of deposits from other small to mid-sized banks (SVB’s balance sheet stood at little over USD 200bn) towards larger institutions, as well as nipping in the bud the emergence of a chain of liquidity and solvency issues in the tech sector. The sector was already particularly sensitive to the current macro configuration: since it combines high capital expenditure at the onset and in most cases yield profits only in the long run, it does not deal well with a rise in the risk-free interest rate. The demise of one of its sources of funding (SVB) is not going to help.
Action to protect depositors is complemented by generous liquidity action directed at the small to mid-sized banks. The fact than another credit institution – Signature Bank, a bank roughly half the size of SVB which was heavily involved in crypto currencies– was also closed by its supervisor on Sunday could create the impression that another “domino series” could start. The new Bank Term Funding Program (BTFP) announced on Sunday will provide loans of up to one year in length to “banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par”. The notion that collateral will be accepted “at par” is very important: at a single stroke it means that banks’ liquidity will be offered against financial assets which are going to be considered as not having been affected by the recent declines in prices, and without the “haircuts” that the Fed normally requests to reduce its own risk. In this case, it’s a USD 25bn “backstop” provided to the Fed by the Treasury which will do the risk mitigation.
Filippo Alloatti – Head of Financials (Credit) de Federated Hermes Limited
Silicon Valley Bank (SVB) had problems with its SV (Silicon Valley) more than its B (Banking) aspect. The problems faced by SVB were more related to its clients and the industries it served (the technology and venture capital sectors located in Silicon Valley) rather than issues related to its core banking operations. The bank’s deposit base was heavily concentrated in these sectors, and the bank’s financial performance was affected by the economic conditions of these industries. With $140 billion invested in long-dated treasuries before the current tightening cycle, leading to a $2.25 billion capital drawdown and botched capital raise plan.
SVB was exempt from tight Basel 3 liquidity ratios and instead only mandated a quarterly liquidity report. Small banks like SVB can avoid taking negative mark-to-market on bonds portfolio against their (Common Equity Tier 1) CET1, artificially bolstering their solvency capital.
However, when assets need to be sold for liquidity purposes, the loss goes straight to CET1, leading to a significant loss in solvency capital.
Emergency measures were taken to protect SVB and Signature Bank New York (SBNY) depositors by invoking the systemic risk exception, allowing regulators to backstop uninsured deposits. The Fed’s Bank Term Funding Program (BTFP) was announced, offering loans up to a year, accepting qualifying collateral at par to allow banks to create liquidity from their bond portfolios without recognizing unrealised losses.
There are no listed European banks with a similar business model. Central banks have ample tools to support institutions with liquidity, including entire banking systems.
Jérémie Boudinet, Head of Investment Grade Credit, La Française AM
The failure of SVB and even Signature Bank and Silvergate Bank are not, in our opinion, a danger for the US or the global banking system. However, they clearly show the lack of regulatory oversight on the shadow banking industry and the dangers of banks that are reliant on a fragile deposit basis. The current inflation and rate outlook is posing a clear threat to the shadow banking industry, which has grown rapidly at the expense of the banking sector. While the banking sector cannot escape the macro- and micro-economic misfortunes of the shadow banking industry, it is not responsible for the excesses that have spread out these past years and should not suffer that much from these defaults thanks to (i) their balance sheet robustness, (ii) high amounts of liquid assets, and (iii) potential regulatory forbearance, as was the case during the Covid-19 pandemic.
Rohan Reddy, Director of Research de Global X
Lessons Likely Learned & The Path Forward
Banking Partner Diversification: Even with post-2008 regulations, institutional and non-institutional clients will look to diversify their banking partners to limit risk, if they aren’t already. As we can see from some of these public company filings post-SVB collapse, many did not concentrate their deposit holdings at one institution. They were largely spread out amongst other banking partners. This thought will likely be re-affirmed after these events.
Banking Customer Diversification: As we’ve seen with Silvergate (crypto clients) and SVB (VC backed clients), banking institutions may view diversification of their customer base in a much more favorable light after these events unfolded. Although concentrated client bases can yield brand recognition, loyalty, and ultimately major returns during boom periods, the ramifications during down periods can be significant or in extreme cases like these, business enders.
Systematic Risk: Most are of the opinion that the SVB events do not pose a systematic risk or does not seem indicative of systematic risk. Most economic metrics would indicate as such, so there is a good chance this is a “limited contagion” event segmented to the VC & PE backed funding world. It is worth noting that SVB was not on the FSB’s list of systematically important banks. SVB had $175 billion in customer deposits. US GDP in 2021 was $23 trillion. In and of itself, this wouldn’t cause more mainstream issues. The $175 billion won’t evaporate either, depositors are likely to get decent to substantial portions of the deposits back. It’s mainly the element of time that is unknown.
Economic Impact: The SVB events may not have a significant true economic impact in and of itself. However, it has caused both paper losses and book losses for equity and credit holders of banking institutions, and PE/VC firms. Startups in general, both in Silicon Valley, and otherwise, may face issues in the near-term so there could be some idiosyncratic impacts. But overall, the economic impact appears to be muted beyond investor losses. The funding environment could dry up temporarily as investors assess these sort of risks, combined with the current market environment.
General Outlook: The market impact may be isolated more specifically in the Financials sector, and certain banks may trade at a discount to book value for the foreseeable future. However, as we discussed above, there do not appear to be major cracks in the economy. Credit spreads and labor markets are fairly tight. Unprofitable and pre-revenue companies were already highly scrutinized by the market over the last couple years, so an event like this is more likely to add credence to the theory that better quality companies will be more well off. Large, diversified banking institutions like JP Morgan and Bank of America may be winners in scenarios like this, if smaller and more concentrated or regional banks see business shifted elsewhere. But overall, the events of the last few days are unlikely to lead to some black swan macro risk or tail event.
Julien de Saussure, Financial Bond specialist at Edmond de Rothschild Asset Management
In a nutshell, Silicon Valley Bank had to realize over the last few weeks significant mark-to-market losses on their US treasuries bond portfolio (due to the aggressive rate hike) to honor liquidity on their deposit base. Unable to raise equity to fill the loss, SVB was seized by the FED over the weekend and is now in receivership. To ensure liquidity and deposit access, FED instructed overnight a new facility called BTFP (Bank Term funding Program). Essentially this program ensures for US banks 1-year funding at 5% (1Y OIS+10bp) against their US Treasuries bond and other eligible securities they hold at par, therefore offsetting the materialization of losses on the banks UST portfolio.
Our view for our European Financials
- Underlying risks on some pockets of the banking system are always there and this justifies why market is always very prudent with the banking sector.
- The main risk is clearly not solvency but liquidity impacting solvency (UK LDI mini crisis in November 2022, Credit Suisse outflows, SVB and even the likes of Banco popular in the past showed that)
- It is very important to have a close look at a bank deposit basis, its level of sophistication, its profile. It is especially true in times of rising rates where short term treasuries offer a competitive alternative. Managing deposit beta adequately and in accordance with the specificities of its deposit base is key.
- For European banks, it is more a warning than anything else and SVB is much more an idiosyncratic situation with very specific depositor base linked almost entirely to the tech sector. In Europe, most of the banks have diversified deposit base with significant share of retail deposits.
- Also, from accounting and regulatory standpoint, large US banks and all European banks have to reflect the impact of the mark to market effect in their AFS portfolios in their CET1 every quarter. This is not the case for small and regional bank in the US, hence the one off huge loss for SVB. This episode may actually challenge the investor convention that US banks and regulators are smarter than their European peers, as indeed MTM losses on a US treasuries portfolio is not unpredictable.
- We believe Europe is sufficiently different from the US that European banks with their tighter regulation, low valuations, strong earnings momentum. But clearly the sector outlook got more complicated and volatility will likely resume.
- Specifically in the US, we believe the regulatory landscape will probably have to evolve, for regional banks. As we can attest from European banking – re-regulation is a long-term process with profitability impact.