What is happening with Banks? SVB, Credit Suisse debacles and FDIC InsuranceMar 22, 2023
I'm sure you have heard by now about the Silicon Valley Bank and SVB Financial Group and how they failed as a bank and then, over the weekend, Credit Suisse bank began to collapse and the Swiss government stepped in to bail them out. Now other banks are also experiencing problems. Is this systemic or an isolated issue...
What is happening? First, let’s look at Silicon Valley Bank (SVB): the Swiss government brokered a deal for UBS to buy Credit Suisse at a fraction of their value just a few days before. These are both concerning events so I wanted to reach out and answer some of the questions you may have.
How It Happened:
There were a number of influences that together spelled the downfall of the bank.
From 2020 through 2021, Silicon Valley Bank took in incredibly high deposits through PPP loans and through clients that were taking their companies public through a Special Purpose Acquisition Vehicle (SPAC). SVB took those deposits and decided to invest in long-term bonds, such as mortgages and treasuries, while interest rates were low.
2022 was a very different year. Silicon Valley Bank’s unique customer base of private companies started to need cash and, as a result, pull their deposits. In addition, interest rates also increased, which negatively impacted the mark-to-market value of its longer-term bonds.
In an effort to appropriately deal with the impacts of its mark-to-market losses, the bank used a valid accounting change to consider those bonds “held to maturity.” (Any bonds that are held to maturity do not need to be updated with the market value but can be held on the books at cost.)
Unfortunately, you cannot hedge interest rate risk for bonds in the “held to maturity” category, meaning the bank could not appropriately hedge interest rate risk for these longer-term bonds (of which they had many).
The combination of reducing deposits, too few assets that were marked at the market (or consistent with the current market value), and growing withdrawals forced the bank to sell their held-to-maturity bonds. When they sold these assets, the paper losses became realized, and those losses effectively overwhelmed the bank's equity, causing the bank to fail.
All of this happened over the course of a week — and mostly over a two-day period. The stock was worth $267.83 close of business Wednesday and worthless by the close of business Friday.
Did Silicon Valley Bank do anything wrong?
SVB did not break any written rules, but they did not effectively hedge their interest rate risk. Poor risk management ultimately spelled their doom. It would have been easy enough to reduce purchases of so many long-term bonds back in 2021, but the appeal for the bank to make a little bit more money on their deposits was likely too strong.
Also, how many market participants expected the Federal Reserve to raise interest rates so much so quickly? They were unprepared for the shifting market environment.
Some have said it was a “bank run.” Is that right?
Yes, there are really a few reasons why depositors pulled their money out. Many depositors needed money because their startup businesses were not as successful as anticipated due to the market environment. And, perhaps more damaging, an unusually high amount of uninsured deposits came from a small concentration of tech start ups and hedge funds. When this small group simultaneously decided to exit and withdrawal from these deposit programs it resulted in a mass exit all at once. This groups exit created a crisis of confidence and further depositor withdrawals.
Is the risk the same for the big banks (over $250B in assets)?
No. Big banks are stress-tested regularly to ensure they are sufficiently capitalized to absorb losses during stressful conditions while meeting obligations to creditors and counterparties and continuing to be able to lend to households and businesses. Additionally, the Fed has already stepped to provide stability by providing substantial additional liquidity to the banking sector.
Large banks and most well managed regional banks have more effectively hedged their interest rate risk. As a result, large banks and most U.S. based regional banks are not prone to the same degree of risks as Silicon Valley Bank. However, risks remains as no doubt some additional poorly managed, likely smaller banks, will no doubt also experience some troubles. The good news is that FDIC covers depositors up to certain limits regardless of a bank’s size.
What happened to Credit Suisse?
Credit Suisse has been riddled with scandals for years and a crisis of confidence had been brewing for quite some time (as evidenced by its stock decline over the last few years). A string of scandals over many years, top management changes, multi-billion dollar losses, massive exit of deposit dollars in the fourth quarter and fears of massive bond losses combined to cause panic and the ultimate destruction of this 167-year-old Swiss lender. Its failure shows just how fragile the global banking system is and its collapse, had it not been rescued by UBS, could have had far reaching systemic global ramifications to the financial sector. Fortunately, the Swiss government convinced a hesitant UBS to come to the rescue and this has calmed the global financial markets for the time being.
Impact on the market?
At this point it’s unclear how this will impact the market in the long run but for now the financial markets are very volatile. But the Fed and the banking sector appears to have fought off systemic collapses as least temporarily; but, the problems have not gone away. Domestically, some believe that the Fed must stop raising interest rates immediately to stem the losses of these poorly performing long-term bonds on bank balance sheets, while others think the Fed needs to continue to raise rates to combat inflation. This week will give some clarity as the Fed is meeting and will be voting on the next interest rate moves.
One thing is certain: bond market volatility, as measured by the MOVE Index, is likely to be heading higher. The bond markets seem to be signaling challenges ahead. Last year, when the MOVE index increased, financial conditions tightened, the stock market declined, and the economy slowed. A similar scenario could be the case again in 2023.
As for banks, the fear now is that depositors will exit smaller regional banks (whom may fiscally healthy currently) in search of a perceived higher level of safety with the larger "too big to fail" type banks. This could cause problems at what are otherwise healthy banks. Discussions and programs are underway to prevent this self-fulfilling prophecy. Mergers may be accelerated due to these risks also and thus lead to further consolidations of the banking industry.
It’s important to recognize events like this do happen in the markets. Please keep in mind that we invest for long-term returns and at times like these, our defensive strategies really provide piece of mind. Further, depositors at banks, both big and small, will be okay if deposit amounts are within the FDIC insurance limits. Equity holders of the troubled banks however, may not fair so well.
I encourage you to follow reputable news sources for more minute-to-minute developments.