Sundry Photography
The Silicon Valley Bank (SIVB) collapse has sparked fears about potential contagion across the financial system. Greg Bonnell speaks with James Hunter, Bank and Insurance Analyst at TD Asset Management, about the implications of the latest crisis on financial markets.
Transcript
Greg Bonnell: Financial markets are laser-focused on the fast-moving developments surrounding Silicon Valley Bank. Joining us now to put the situation in context, James Hunter, Banks and Insurance Analyst at TD Asset Management. Always good to have you with us, James.
James Hunter: Thanks a lot, Greg.
Greg Bonnell: This is a tall order right off the top, but a lot has happened in a very short period of time. So just walk us through exactly what did happen and why, and then we’ll get into some of the implications, I guess.
James Hunter: For sure. What happened is that Friday around lunchtime, regulators closed the Silicon Valley Bank. That is a pretty meaningful bank out in California. They focus on technology companies, a lot of startups, and it will actually be the second-largest bank failure in the US ever. So it’s a pretty significant development, obviously.
Regulators also closed another bank. We learned that on Sunday. That’s in New York, a little smaller. And so investors are stunned by these developments. It’s moving equity values around a lot, and there’s a lot of concerns about it spreading wider throughout the sector.
Greg Bonnell: So let’s talk about those concerns because obviously, before the past couple of days, I would forgive anyone for really– who doesn’t keep a careful eye on this like we do– for even knowing what Silicon Valley Bank was. And now it’s all over the headlines. Let’s put it in context as to what happened to them, what happened to the other bank, and what it actually means for the broader system.
James Hunter: Yeah, OK. So if we start with why this happened, it happened specifically at Silicon Valley for a couple of reasons. So the first is on the liability side of the balance sheet in terms of deposits. Silicon Valley had only 3% of their deposit base in amounts under $250,000. And that’s a magic number because that’s where the FDIC deposit insurance would kick in at that level.
And so what it means is that they didn’t have a lot of mom-and-pop retail investors. They had small business owners. A lot of these founders of tech startups, they’d have a couple million of cash in the bank. And at the first sign of trouble, they started yanking those deposits, so that’s specifically what happened to that piece.
And again, maybe I’ll just reiterate. It’s 3% of their deposits were really small, and that compares to an industry standard of 40%. So it’s a very meaningful difference.
The other thing was on the asset side of their balance sheet. They had over half of their assets in securities, and that’s quite a bit more than the industry standard of 20%. And what they did with those securities is they put them in long duration bonds. Those long duration bonds decreased in value as interest rates moved higher, and that created this mismatch between– on the balance sheet. And that’s specifically what caused this to happen.
Greg Bonnell: So some factors there that are clearly very much related and sort of singular at the Silicon Valley Bank. At the same time, over the weekend, you talked about the market concern. I mean, we saw it heading into the weekend, so we did see regulators act.
We did see the Fed step in. We did see a new lending program. Explain that a bit to us and what they were trying to achieve.
James Hunter: Yeah, so what regulators wanted to do was step in to restore confidence that there wasn’t going to be a wider spread panic. So what they’ve agreed to do is make sure that all the deposit holders will get their money back. And it doesn’t matter if they’re above or below that $250,000 threshold, so that’s important. It means that people don’t have to rush out to their own bank tomorrow morning, if they bank at a regional bank, and get concerned.
So what they’ll do now is they’ll try to sell SVB to some other financial institution, what’s left of it. That would be great, but we don’t know if that’s going to work out. The existing equity holders, they sort of get wiped out. We don’t know how much the bondholders will get back. But the deposit holders will be okay, so that helps stem the panic.
The other thing that they’ve done is establish sort of a lending program now for all the banks in the banking system. And what it will allow them to do is access money directly from the SEC and the Treasury, and they can exchange for that securities. They can pledge them as collateral, and they’ll take them at par. So it doesn’t matter if they’ve got $0.80 on the dollar, $0.60 on the dollar. The Fed will take them at par, and that really helps with the liquidity issue.
Greg Bonnell: So as the depositors are kept whole through these actions that we’ve seen just unravel over the past couple days, at the same time, we are seeing a market reaction in terms of the stocks. Let’s talk about the investment thesis around the US banks and perhaps how it has shifted just in the past couple days, given all these developments.
James Hunter: Yeah, for sure. We had a favorable view of the banks last year. And that had some ups and downs over the year, but in general worked out well because the banks, they benefit from rising interest rates. As we entered this year, we were thinking, well, interest rates, they’re slowing the economy down. There’s going to be rising concerns about credit.
So we were getting a little bit more cautious on the banks. We had no idea that something like this was going to happen. It is a big shock, and I think it’s a problem for the investment case in the short term. And that’s because people are going to be concerned about the equity values of these banks.
They need to look at liquidity. They need to look at funding. You sort of have the horrors– the memories of going back to the financial crisis. That’s not going to happen this time. We are way stronger.
And so I think it’s hard to get too negative on the banks. They’ve become quite cheap. The share price reactions have been violent, so there’s probably some opportunities amongst the highest-quality banks. But broadly for the sector, it’s a bit of a concern.
Greg Bonnell: I know the policies of the US Federal Reserve aren’t necessarily your focus, but there is a role to be played here in terms of the aggressive rate hikes we’ve seen over the past year or so. Some of the things that are happening in terms of bank assets– the Fed clearly has some thinking to do. In about a week, they have another rate announcement.
James Hunter: Yeah. Yeah, and I think what would happen is this will be part of the mosaic that they’re looking at in terms of the economic data and how the economy is evolving. But it would be surprising if they did a 50 basis point rate hike in a couple of weeks. That would be a surprise. I think people, at this point, would be expecting 25 basis points.
But it is also possible that they go in a different direction. And I think the bigger picture is that this is sort of one of those steps along the road of the interest rate cycle that should mark we’re close to the end of the hiking cycle. That would be my intuition. And as you allude to, I think there are implications for the broader sector. As you look out a year or two years, there could be new regulations that come in in the future to help prevent this kind of thing happening in the future.
Greg Bonnell: Yeah, to sort of sum up the idea of what’s happened because so much has happened– you did a great job of breaking it down. I mean, basically over the weekend, if someone wasn’t paying attention– and we were paying very careful attention– the idea that regulators saw a problem. The Fed saw a problem or really wanted to head off a problem and sort of bought in what they hope, I guess, is a solution so you won’t end up with a wider event.
James Hunter: That’s exactly right. Yeah. They’ve acted decisively and quickly to make sure that this remains an isolated incident and doesn’t spread to the broader sector. So that is encouraging in the here and the now, although you can’t tell that in the share price reactions today. And I think that reflects a broader realization of where the economy could be a year or two from now and where the fundamentals of the banks could be a year or two from now. I don’t think they’re very likely to be better than they are today.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
