Last week, Silicon Valley Bank (SVB) was frequently in the news. This evolving story has had an effect on equity and bond markets. We reached out to various fund company fund managers for their thoughts on what happened and where we go from here.
- Lack of confidence resulted in a run on deposits with Silicon Valley Bank (SVB)
- SVB is a regional bank in California where Technology and Life Sciences companies banked
- Cash-flow negative companies withdrew large, non-FDIC deposits requiring SVB to crystallize steep losses from its bond portfolio to fund withdrawals. This caused further concerns spiraling into further withdrawals
- The US Federal Government will keep depositors whole for both SVB and Signature Bank
- This is effectively a bailout and will become highly politicized despite being necessary
- Regulators will take further steps to prevent further contagion, this is unlikely a repeat of the Global Financial Crisis
- SVB Financial Group had approximately $210 billion dollars in assets, and $175 billion in deposits, at the time of receivership
- This represents the 2nd largest banking failure in U.S. history, behind 2008’s Washington Mutual which had assets valued at about $386 billion in today’s dollars
- March 12th – New York State financial regulators announced the closure of Signature Bank (ticker: SBNY), a commercial bank with $110 billion in assets
- Depositors at these large institutions were only insured for up to $250,000
- Evening of March 12th – the Federal Reserve, Treasury Department, and Federal Deposit Insurance Corporation (FDIC) announced forceful action to lower the risk of financial contagion:
- Treasury has instructed the FDIC to make whole all deposits of both banks, not just those accounts under the $250,000 threshold
- The Federal Reserve has introduced a generous new emergency lending facility which will make loans of up to a year to depository institutions (Bank Term Funding Program – BTFP)
The focus of the Fed has shifted from fighting inflation to ensuring the stability of the financial system. The fear of contagion in the liquidity crisis triggered a rally in the bond markets. Yields plummeted by over 50bps in 2-year Treasury bond this morning, reversing the speculation earlier last week that the Fed may need to raise rates further to tame the sticky inflation. 10yr Treasury also fell by about 20bps. Based on this morning’s pricing, the market no longer expects the Fed to be able to raise rates by more than a quarter point and is in fact pointing to a possible rate cut by summer this year
This is not a financial crisis… This classic “bank run” is reminiscent of a certain September 2008. However, 15 years later, the situation differs in several fundamental ways, including two in particular. First, the speed at which government agencies intervened. By Friday, just three days since SVB’s demise, the Federal Deposit Insurance Corporation (FDIC) took control of the bank. By Sunday evening, the Fed, the FDIC and the U.S. Treasury announced that all (above the usual 250k) bank deposits would be covered. In addition, the Fed set up a loan facility that allows other potential troubled banks to borrow against the face value (par) of the bonds they hold rather than being forced to sell them at heavy losses in the markets. In short, while the monetary and fiscal authorities’ belated response in 2008-09 ensured that they would face
That said, for now, it is probably on the macro front that the consequences are most significant, with markets now expecting only one rate hike this year, compared to a minimum of four hikes barely a week ago. To put things in perspective, this change in expectations took 2-year yields 109 bps lower in just three days, a move that is comparable only to the infamous October 1987
- The evolution of risks to financial stability will be a key factor into the Fed’s near-term thinking above and beyond their goal of achieving the dual mandate of price stability and maximum employment.
- We view a 25 basis point rate hike as the most likely outcome at the next FOMC meeting on March 22. Given the fluidity of the situation, a pause is also possible with rate cuts and a 50 bps hike even more remote at this juncture.
- Irrespective of what the Fed ultimately decides, it seems probable that lending standards will tighten further meaning less access to credit for borrowers and a higher cost of capital, resulting in slower economic growth. This reinforces our longstanding view that a U.S. recession is on the horizon.
- We believe the events of the last few days have amplified recession risk over the coming year, and we continue to advocate positioning for elevated volatility with a tilt toward defensive, high-quality equities, dividends.
TD Asset Management
Is there a risk of contagion?
While we suppose that the following months may reveal more isolated surprises among smaller, regional banks, fundamentally, we do not currently see evidence of broader, systemic issues. The U.S. banking system has over 4,000 FDIC insured commercial banking institutions, which means there are some banks that tend to have concentration risk of deposits to a specific sector/industry – and this is the primary cause for SVB’s troubles.
Does this have any implications for Canada?
We see this having a very limited effect for the Canadian financial system. There are only 34 banks in Canada, and more importantly, the big 6 banks account for vast majority of banking activity. Like their systemically important American counterparts, their deposit bases are fairly diversified. If anything, the risk to Canadian banks would be on the asset side, particularly if mortgages become stressed. Even there, loan-to-value ratios on these assets are fairly comfortable, implying ample cushion for the largest, most stable banks in the country
Conclusion and Positioning
Every tightening cycle comes with unexpected events, and the recent distress of U.S. regional banks is a good example. The Fed’s balancing act has become more complicated as the central bank seeks to harmonize inflation with employment while ensuring financial stability. Being positioned in fixed income will likely prove profitable, particularly given the higher yields we’ve seen in the last year versus the prior decade. With the acceleration of rate cuts, it would be wise to have a conservative exposure among equities, with a focus on Quality and Value.
Sources: AGF, Dynamic Funds, Franklin Templeton, National Bank, NEI Investments, TD Asset Management