Last week, a major lender in the US, Silicon Valley Bank (SVB), went bankrupt. They were the 16th largest bank in America, with about $200bn in assets and specialised in lending to startups, with a heavy focus on the technology sector. SVB helped firms in their early phases, often long before larger banks and lenders would consider them. As the growth of tech boomed in the last 10 to 15 years, so did SVB. Deposits quadrupled between 2017 and 2021, while its loan book tripled during the same period. So, what happened?
An explanation
- Banks make money on the spread between the interest rate they pay on deposits and the interest rate they charge borrowers or receive from investments, holding very little of the assets in cash
- SVB had made a big investment into long-dated US government bonds, and whilst these are perceived to be safe from default risk, they are exposed to interest rate risk (prices fall when rates rise and vice versa)
- To cover recent withdrawal demands, SVB was forced to liquidate its bond holdings, which, because of higher interest rates, had seen prices fall, crystallising a loss for the bank
- It tried to cover this loss through a $1.75bn capital raise
- This only led to worried customers demanding more deposits from the bank, which led to its collapse
Shareholders have said SVB “failed to disclose how rising interest rates would undermine its business model”. Furthermore, in 2010 the Financial Accounting Standards Board (FASB) suggested that accounting for financial instruments (including loans) should be at fair value. This regulation was never fully implemented, but there is an argument to say that if it had been, the position of SVB may have been more transparent.
Banks
Source: Refinitv
What happens now?
Federal insurance covers deposits at US banks up to $250,000. This will usually protect the cash that an individual keeps in a bank account, but it is unlikely to cover the funds a company might keep. Despite this, last week the US government assured the market that depositors would have full access to all their cash. The British government over the course of the weekend brokered a deal for HSBC to purchase the UK arm of SVB for £1, to secure jobs and businesses.
Yesterday, US and European stocks rose as nervousness around banks eased and the world’s central banks calmed investors with promises to maintain financial stability. The Swiss National Bank said it would step in to offer liquidity to lender Credit Suisse, and 11 Wall Street banks have provided a $30bn injection for First Republic, a regional US lender. Despite this, short-term uncertainty remains, with Credit Suisse shares falling another 8% today, at time of writing.
Bowmore portfolios
Within core Bowmore portfolios we have held an allocation to banks since 2021, with the view that a rising interest rate environment allows banks’ margins to widen and profits grow. This direct allocation has come under pressure of late, as short-term volatility and risk aversion is priced into markets. Though portfolio values have fallen so far this month, we have seen positive returns from our technology, corporate bond and government bond allocations, with many of our other themes, such as sustainable energy and healthcare, holding up well, relative to the wider sell-off.
The SVB collapse and subsequent market sell off has driven dovish sentiment through central banks. As recently as last month Jerome Powell, the Federal Reserve (Fed) chairman, was eyeing up further 0.5% rate hikes, but there is now a 90% chance we will see the Fed raise by only 0.25% next week. In some quarters, there are calls for rises to be paused altogether and for the quantitative tightening presently being employed by the Fed to be revised. A softer outlook for central banking policy will be supportive for markets in the longer term.
Source: Refinitiv – Market returns as at 16/03/2023
