SVB And The Current Bank Liquidity Issues
By now, you are probably aware that the past week has seen the first bank failures since the Financial Crisis of 2008. When Silicon Valley Bank (SVB) failed last Friday, it was the 16th largest bank in the United States, with assets exceeding $200 billion. Over the course of four decades, SVB had become the tech sector's preferred bank. Its deposits grew especially rapidly since 2019, in the wake of the COVID epidemic stimulus and consumer investment in technology (SVB's balance sheet grew by approximately 250% in that time). Unfortunately, a series of poor investment decisions ultimately led to the bank's demise.
Here's what led to Silicon Valley Bank's collapse:
- Many tech companies deposited cash for payroll and other business expenses in SVB. This resulted in a non-typical, less-sticky deposit base, with over 85% of their deposits uninsured by the FDIC. Their average depositor had $4 million at the bank.
- As cash flowed into SVB, the bank invested a large portion of its deposits in long-term U.S. government bonds, including mortgage-backed securities (MBS).
- Since bond prices have an inverse relationship to interest rates, the values of these bonds fell as the Fed raised rates to fight inflation.
- These investments may not have been problematic had the bank been able to hold the bonds to maturity; however, with the tech sector being hit particularly hard by the current economic environment, many of SVB's customers began withdrawing their deposits.
- The bank was forced to sell its bond holdings at a deep discount to meet customers' withdrawal requests.
- On March 8, 2023, SVB announced a $1.75 billion capital raise; this announcement spooked customers and investors and ultimately led to a run on the bank as more customers withdrew their funds.
- Since most of SVB's customers are businesses, the withdrawals happened quickly; thus, two days after the announcement to raise capital, the bank collapsed.
- SVB's collapse marks the largest U.S. bank failure since the global financial crisis.
On Sunday, Signature Bank of New York became the second bank to fail due to a liquidity crisis when state regulators announced its closure. With almost a quarter of its $110 billion in assets from the cryptocurrency sector, it was also heavily involved with technology companies. Together, these failures represent the second and third-largest bank failures in U.S. history, trailing only the 2008 failure of Washington Mutual.
What do these bank failures mean for the financial sector and overall economy?
Naturally, many investors are wondering if this is the beginning of another financial crisis. While we cannot definitively answer that question, we do know there are reasons to believe it will not.
- With the implementation of the Bank Term Funding Program (BTFP), the U.S. government contained immediate concerns of widespread contagion by guaranteeing all customer deposits in both banks.
- To counter the risks posed by unstable deposits and losses on bond portfolios, the Federal Reserve unveiled a new program allowing banks to borrow funds backed by government securities to meet demands from deposit customers.
- The government is not saving the banks; they will stay collapsed unless an outside buyer(s) can revive them; in addition, their shareholders and some unsecured creditors aren't protected by the guarantees.
- U.S. banks are generally far better capitalized than they were ahead of the global financial crisis, and their lending standards are far more stringent, putting them in a better position to deal with potential bank runs and loan defaults.
- Both failed institutions were somewhat uncommon in that they relied far more on large corporate funding from early-stage companies than the great majority of their peers.
Looking ahead
Many uncertainties remain for both the technology and banking sectors. Technology companies, especially the early-stage group, have already been negatively impacted by inflation, rising interest rates, and the threat of economic recession. However, the government's actions to insure all deposits of the banks have helped ease concerns over their access to cash. Since the announcement was made, QQQ, an exchange-traded fund that tracks the technology-heavy Nasdaq-100 Index is up 4.17%.
Unfortunately for the banking sector, the same could not be said, as most bank stocks fell further through Wednesday. Indices of both large money-center and regional banks are down close to 25% over the past week. We could easily see other banks who made similar errors with their deposit base and/or investment portfolio fall prey to the same stress that brought down SIVB and SBNY. While clearly concerning, this could also become an investment opportunity in well-capitalized financials with a strong brand and management.
We should also consider the possibility the sudden failures of these two large financial institutions, along with the recognition that there may be others with similar issues, may cause the Fed to reevaluate its plan to continue raising rates.
A note on Charles Schwab
We are keenly aware that Schwab Bank's sweep money market fund is where some of our clients' cash is held. However, the vast majority of our cash holdings reside in "position-traded" money markets that are not part of the Schwab Bank portfolio.
Early articles shared concerns regarding the bank's longer-dated "Held to Maturity" portion of its bond portfolio. Since then, however, analysts from several major firms have noted Schwab's strong liquidity position.
The bank said Monday it had "access to significant liquidity," including an estimated $100 billion of cash flow from cash on hand, portfolio-related cash flows, plus new assets. It is also important to note that approximately 82% of deposits held by Schwab Bank are insured, falling under the Federal Deposit Insurance Corporation's limit of $250,000. As mentioned earlier, this significantly contrasts SVB's insured deposits by approximately 15%.
The bank liquidity issue continues to evolve. First Republic and Credit Suisse have both been battered by rumor and market volatility. This is nothing new for the Swiss bank. It has struggled for several years. First Republic's issues are, however, closely related to Silicon Valley Bank’s.
We will continue to monitor the situation and provide more information as appropriate. In the meantime, please don't hesitate to contact us if you have additional questions or concerns.
Sincerely,
Your CCA Team