SVB Financial, aka Silicon Valley Bank, shut down Friday morning prompting shares of regional banks to fall. Silicon Valley Bank is mostly known for its venture capital and tech startups. It is also home to a major bank for venture-backed companies.
These companies who run payroll each week, held their funds in a typical corporate checking account. So, deposits and liabilities were located within one bank.
Many tech companies that accessed capital or loans through SVB also held their deposits with the bank. In fact, SVB, advised customers that it was mandatory to leave their cash with the bank. This would be similar to a provision of gaining access to borrowed funds.
How did the bank fail?
Investors/customers wanted to pull their deposits from SVB because they were not paying enough relative to Treasuries. (T-Bills) However, the number of investors pulling funds caused SVB to need more cash on hand. This forced SVB to raise additional capital by selling its investment portfolio.
Where economies and banks of the past had significant liquidity, deposits soared at banks that invested the monies primarily in fixed-income securities. This means that depositors are likely to park their deposits with banks who provide the strongest level of accessibility and guarantee.
If you’re a business owner who wants to park retained earnings in your bank account, you want to know that your deposits are safe. With risk management controls in place, banks take on deposits and invest the funds into ultra safe securities. They invest in fixed income of the highest quality.
Fixed-income securities are sensitive to interest rate hikes – the massive hikes we’re seeing. So as the Fed continues to hike, the inverse relationship between interest rates and bonds saw the value of bonds go down as yields went up. This caught banks like SVB off-guard. SVB primarily invests in long-term bonds, which they typically hold and have never had to report on. This puts them in a bind. The fall in bond value results in unrealized losses because SVB has to convert their bonds and sell them at current market prices. This equates to mega losses and funding concerns, as the value of SVB’s portfolio is less than they modeled.
Understanding Bond Mechanics and Interest Rates
Let’s say you’re an investor who wants to hold bonds in your portfolio. Last year, you could have lent out your capital to the Federal Reserve or the Bank of Canada for about 1.3% yield or interest rate.
Yes, the interest rate last year was not very appealing. But because you need to preserve your capital for the next 5-10 years, you bought the safest instrument you could find. You chose treasuries issued by the United States.
A year after you bought your bonds at 1.3%, the Federal Reserve issues new bonds. They are doing so in hopes of raising more capital. Since, interest rates have skyrocketed over the last year to battle inflation, the interest rate on the new issues is nearly 3 times higher than last year’s issue.
Investors who own last year’s bonds will need to negotiate with investors to make it worthwhile to buy them. After the discount or loss is applied, the investor sells the old bond and now has regained their capital. If the investor’s objective remains the same, they can now go out and buy the new higher interest rate bond. The assumption being that they want to preserve their capital.
The option to buy higher paying interest on new issues is naturally reducing the market value of similar risk and older issued securities.
How are bank share prices reacting to the news?
As I write this communication, First Republic Bank share price is down 82% over the last 3 trading sessions. Other financial services companies and Canadian Banks are also down. This includes Charles Schwab Corp, JP Morgan Chase, Bank of America, Citigroup, and all major Canadian Banks.
Bitcoin, a decentralized cryptocurrency without a central authority is up 8%. Interesting.
Are we likely to see a 2nd financial crisis like what happened in 2008?
No – I believe this is highly unlikely and today’s situation is extremely different especially in Canada & Europe.
In both regions you have high asset quality and not the same competition on deposits. From a Canadian perspective, not only should the failure of SVB not have significant negative implications for our banks, but we should actually view this as further vindication of the Canadian banking model, one which a few large and diversified players dominate.
The big lesson of SVB’s collapse is that the US banking sector needs to become more Canadian, and whether regulators get on board with that or not, the reality is that this is what we will likely see anyway as deposit balances in the US shift even more strongly away from smaller players and towards the large money center banks.
Closing
SVB is a relatively small bank but like the big banks, they too have large bond portfolios and market will draw parallels. At least in the short term.
The bigger concern for banks today is the following:
- Will this cause a domino effect?
- 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.
It’s too early to tell if we should be deploying capital to the banking sector however, we will continue to monitor the situation. If we believe a buying opportunity is worth the consideration, we will be in touch.
For now, my objective is to keep you all inform.
Talk soon,
Michael
Source of Data: Y-Charts, a web based, paid subscription financial research and analysis platform for asset managers and advisors. Prices/Yield for Canadian and U.S. 10-year treasuries was based on Feb 28, 2022, data. Charles Schwab Corp, JP Morgan Chase, Bank of America, Citigroup, Royal Bank, TD Bank, Scotiabank, BMO, CIBC, National Bank and Bitcoin price was based on Mar 13, 2023.
Disclaimer:
Nothing on the website shall be construed as an offer to buy or a solicitation of an offer to buy any services or products. Commissions, trailing commissions, management fees and expenses may be associated with investments. Products are not guaranteed, their values change frequently, and past performance may not be repeated. Mandeville Private Client Inc. is a member of the Investment Industry Regulatory Organization of Canada and a member of the Canadian Investor Protection Fund.
This publication contains the opinion of the writer. The information contained herein was obtained from sources believed to be reliable, but no representation or warranty, express or implied, is made by the writer, Mandeville, or any other person as to its accuracy, completeness, or correctness. This publication is not an offer to sell or a solicitation of an offer to buy any securities. The information in this publication is intended for informational purposes only and is not intended to constitute investment, financial, legal, tax or accounting advice.
I do not hold a beneficial long position in the shares of SVB, FRB either through stock ownership, options, or other derivatives. I do hold a beneficial long position in Bitcoin. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
What happened with Silicon Valley Bank?
SVB Financial, aka Silicon Valley Bank, shut down Friday morning prompting shares of regional banks to fall. Silicon Valley Bank is mostly known for its venture capital and tech startups. It is also home to a major bank for venture-backed companies.
These companies who run payroll each week, held their funds in a typical corporate checking account. So, deposits and liabilities were located within one bank.
Many tech companies that accessed capital or loans through SVB also held their deposits with the bank. In fact, SVB, advised customers that it was mandatory to leave their cash with the bank. This would be similar to a provision of gaining access to borrowed funds.
How did the bank fail?
Investors/customers wanted to pull their deposits from SVB because they were not paying enough relative to Treasuries. (T-Bills) However, the number of investors pulling funds caused SVB to need more cash on hand. This forced SVB to raise additional capital by selling its investment portfolio.
Where economies and banks of the past had significant liquidity, deposits soared at banks that invested the monies primarily in fixed-income securities. This means that depositors are likely to park their deposits with banks who provide the strongest level of accessibility and guarantee.
If you’re a business owner who wants to park retained earnings in your bank account, you want to know that your deposits are safe. With risk management controls in place, banks take on deposits and invest the funds into ultra safe securities. They invest in fixed income of the highest quality.
Fixed-income securities are sensitive to interest rate hikes – the massive hikes we’re seeing. So as the Fed continues to hike, the inverse relationship between interest rates and bonds saw the value of bonds go down as yields went up. This caught banks like SVB off-guard. SVB primarily invests in long-term bonds, which they typically hold and have never had to report on. This puts them in a bind. The fall in bond value results in unrealized losses because SVB has to convert their bonds and sell them at current market prices. This equates to mega losses and funding concerns, as the value of SVB’s portfolio is less than they modeled.
Understanding Bond Mechanics and Interest Rates
Let’s say you’re an investor who wants to hold bonds in your portfolio. Last year, you could have lent out your capital to the Federal Reserve or the Bank of Canada for about 1.3% yield or interest rate.
Yes, the interest rate last year was not very appealing. But because you need to preserve your capital for the next 5-10 years, you bought the safest instrument you could find. You chose treasuries issued by the United States.
A year after you bought your bonds at 1.3%, the Federal Reserve issues new bonds. They are doing so in hopes of raising more capital. Since, interest rates have skyrocketed over the last year to battle inflation, the interest rate on the new issues is nearly 3 times higher than last year’s issue.
Investors who own last year’s bonds will need to negotiate with investors to make it worthwhile to buy them. After the discount or loss is applied, the investor sells the old bond and now has regained their capital. If the investor’s objective remains the same, they can now go out and buy the new higher interest rate bond. The assumption being that they want to preserve their capital.
The option to buy higher paying interest on new issues is naturally reducing the market value of similar risk and older issued securities.
How are bank share prices reacting to the news?
As I write this communication, First Republic Bank share price is down 82% over the last 3 trading sessions. Other financial services companies and Canadian Banks are also down. This includes Charles Schwab Corp, JP Morgan Chase, Bank of America, Citigroup, and all major Canadian Banks.
Bitcoin, a decentralized cryptocurrency without a central authority is up 8%. Interesting.
Are we likely to see a 2nd financial crisis like what happened in 2008?
No – I believe this is highly unlikely and today’s situation is extremely different especially in Canada & Europe.
In both regions you have high asset quality and not the same competition on deposits. From a Canadian perspective, not only should the failure of SVB not have significant negative implications for our banks, but we should actually view this as further vindication of the Canadian banking model, one which a few large and diversified players dominate.
The big lesson of SVB’s collapse is that the US banking sector needs to become more Canadian, and whether regulators get on board with that or not, the reality is that this is what we will likely see anyway as deposit balances in the US shift even more strongly away from smaller players and towards the large money center banks.
Closing
SVB is a relatively small bank but like the big banks, they too have large bond portfolios and market will draw parallels. At least in the short term.
The bigger concern for banks today is the following:
It’s too early to tell if we should be deploying capital to the banking sector however, we will continue to monitor the situation. If we believe a buying opportunity is worth the consideration, we will be in touch.
For now, my objective is to keep you all inform.
Talk soon,
Michael
Source of Data: Y-Charts, a web based, paid subscription financial research and analysis platform for asset managers and advisors. Prices/Yield for Canadian and U.S. 10-year treasuries was based on Feb 28, 2022, data. Charles Schwab Corp, JP Morgan Chase, Bank of America, Citigroup, Royal Bank, TD Bank, Scotiabank, BMO, CIBC, National Bank and Bitcoin price was based on Mar 13, 2023.
Disclaimer:
Nothing on the website shall be construed as an offer to buy or a solicitation of an offer to buy any services or products. Commissions, trailing commissions, management fees and expenses may be associated with investments. Products are not guaranteed, their values change frequently, and past performance may not be repeated. Mandeville Private Client Inc. is a member of the Investment Industry Regulatory Organization of Canada and a member of the Canadian Investor Protection Fund.
This publication contains the opinion of the writer. The information contained herein was obtained from sources believed to be reliable, but no representation or warranty, express or implied, is made by the writer, Mandeville, or any other person as to its accuracy, completeness, or correctness. This publication is not an offer to sell or a solicitation of an offer to buy any securities. The information in this publication is intended for informational purposes only and is not intended to constitute investment, financial, legal, tax or accounting advice.
I do not hold a beneficial long position in the shares of SVB, FRB either through stock ownership, options, or other derivatives. I do hold a beneficial long position in Bitcoin. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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