After much speculation and panic in the market following the collapse of Silicon Valley Bank (SVB), the US Federal Reserve and US policymakers confirmed that all depositors of SVB, Silvergate Bank and Signature Bank (the latter two subsequently failed) will be made whole starting today. Regulators also announced a new facility to provide liquidity to banks under stress.
A good old fashioned bank run
SVB Financial, parent company of Silicon Valley Bank (SVB), announced that it was "repositioning" its balance sheet with security sales and a capital raise late last week. The biggest problem was that it had short-term liabilities (deposits) but its asset base was long term (mainly in longer duration US treasuries). As an investment, US treasuries are quite safe, but recent volatility in interest rate markets have resulted in "unrealised" losses in these instruments. Furthermore, an asset-liability timing mismatch resulted in SVB being forced to "realise" these losses.
The bank sold $21 billion of its available for sale (AFS) securities to be reinvested into shorter-duration US treasuries, and said it was raising a further $2.25 billion of equity to support its capital ratios as the sale was going to trigger a $1.8 billion after-tax loss. SVB said it was also "terming out" its funding by adding $15 billion of longer-dated borrowings and hedging to protect against further increases in rates.
News that SVB was facing a liquidity crunch saw thousands of depositors withdraw large sums of money from their accounts - there was a run on the bank.
SVB was then shut down by regulators because it had inadequate liquidity and was now facing insolvency. This was the largest bank failure since 2008 and the second largest in US history after the Washington Mutual Failure in that same year. SVB held about $209 billion in assets.
Fears of contagion?
Most US banks saw a strong improvement in capital, funding, and loan/deposit ratios since the bank-triggered Global Financial Crisis in 2008. However, there have been exceptions like SVB. SVB specialised in private equity and venture capital funding and deposit taking, mainly in the technology space. Comparatively speaking, the bank had a high level of loans as a percentage of deposits, and its deposit base was large and lumpy. As an example, an average bank with a large retail deposit base will have many more clients, and although smaller, the deposits will be more regular (i.e., monthly salaries). For SVB, deposits came when private equity and venture capital firms raised new capital - something that has become increasingly difficult to come by in the currently out-of-vogue technology space.
While it was well understood by the weekend that SVB was different enough from other US banks that it did not signal liquidity issues at other institutions, the fear was now that anything less than 100% depositor bailout would trigger other bank runs. SVB's clients were mostly uninsured, and the deposits were comparatively large per client. Silvergate and Signature were the two main banks for crypto companies which also limits how far one can extrapolate their failures as systematic events.
The new facility
On Sunday, the Fed announced that it has launched a new facility called the Bank Funding Term Program. The idea is to provide banks with an alternative to pledge their bond holdings (outside of the open market) when in need of raising liquidity to meet deposit outflows. The bonds will be valued at par, so negative mark-to-market from unhedged bonds (a major issue for SVB) will not be considered with this facility.
This means that depositors funds will be safe if the par value of the bank's assets meet its liabilities (the deposits). Practically speaking, the SVB failure (and subsequent failures) should now be contained.
Negative market sentiment
Global financial stocks stayed remained under pressure at the start of the weak as investors remained weary in the wake of Silicon Valley Bank's (SVB) collapse.
Investors are now pondering whether the Fed "broke something" by hiking rates too aggressively to combat inflation. Treasury yields climbed substantially during this period (prices fell) - leading to the mark-to-market asset base of banks declining. Liquidity has also become a concern.
Some market participants now believe it is quite possible that the Fed will stop hiking interest rates even as inflation remains quite high. A pause may help the current liquidity situation, but it may have a negative impact on the inflation outlook. The uncertainty of how Fed policy will evolve in the wake of the SVB collapse could see markets remain volatile over in the coming days and weeks ahead.
