SVB is the second-largest bank failure in history – it was shut down Friday by California’s financial regulator. The bank is the 16th largest in the U.S., with $209 billion in assets as of Dec. 31, according to the Fed. While part of the deposits are under protection of the Federal Deposit Insurance Corporation (FDIC) the broader impact to silicon valley companies will be know only in a few weeks ahead.
In a last rescue attempt to reestablish the financial balance, after the loss of $1.8B following the fire sale of $21B in securities and numerous client account cancellations, SVB offered the sale of common and convertible preferred stock. But this came a few hours too late!
What was SVB pain trade?
SVB Financial, aka Silicon Valley Bank got caught up by mis-estimating the power of rising interest rates. The Bank invested a large part of the deposits made by its clients into treasuries which trade market-to-market while deposits taken in from their clients’ trade at par value! Obviously, there is a duration mismatch which worked well in favor of the Bank while interest rates were declining – but for now, the opposite is true.
SVB is the first big Fed victim. Also victim of sequence of events such as government excess stimulus (deposits surge while Treasury yields were very low), Fed on “autopilot” (only interested in creating the psychology of anchored inflation expectations, and a last low interest rate environment.
Assuming that the labor were to create inflation was illusionary! For the last 30 or so years, inflation got exported and the labor market adjusted for the new conditions again and again. Actually, wages have not kept up with historic inflation – in fact, the middle class job were rationalized over time and a bunch low level service jobs were created or selective jobs at the very high end of the salary scale.
The market conditions that we experienced ever since the dot.com crisis in 2001, encouraged investors and corporations to take more risk than necessary. On the top of this, banks with a concentrated deposit base are not supervised well enough. In the case of SVB, the fire sale of its own Tier 1 assets created its own failure. is clearly a risk and so are large unrealized losses in available -for-sale and held-to-maturity securities as compared to Tier 1 ratios.
A recent report from JP Morgan showed that taking into account unrealized losses in AFS and HTM reduces the Tier1 ratio of regional banks by about a third on average. Tightening of lending standards already happening will only accelerate from here. Cost of deposits for regional banks will just continue to increase so do we expect th number of failures. US Corporate credit is going to be the hot topic for the remaining of the year.
Ramifications for the broader market
The bigger concern for banks is
- Will this cause a domino effect, aka bank runs on other institutions, and if so, where to the clients take their funds?
- Will banks start to increase their deposit rates to retain clients and avoid the same debacle?
- Increasing deposit rates will eat into banks’ net interest margins significantly, posing further issues.