Unless you’ve been undergoing a digital detox, you’re likely aware that two U.S. regional banks have now been closed. Silicon Valley Bank, on Friday March 10, and Signature Bank, two days later. Additionally, on March 14 Credit Suisse, a major European bank, announced “material weakness” in its financial reporting processes, meaning there could be misstatements in its last two years’ financial statements. As a result, their stock traded down to an all-time low. It’s another stumble in a long line of missteps for the bank and although the timing couldn’t be worse, the Credit Suisse situation is unrelated to the U.S. bank failures.
What just happened?
This week’s troubles with U.S. banks have been largely firm specific and not necessarily systemic. Overall, media coverage has been extensive, so we’ll just hit the high-level points on the two U.S. banks.
Silicon Valley Bank was heavily exposed to the tech industry. For the most part, this has been a good thing as technology companies have grown at a faster rate than other businesses for quite some time, and Silicon Valley Bank participated in that growth. Unfortunately, as rates have risen it’s been harder to raise capital, causing many tech firms to draw down deposits with the bank.
Without getting too technical, Silicon Valley had bought longer dated bonds that fell in value as interest rates rose. The bank expected to hold these bonds for the long term but were forced to sell at a significant loss to fund the withdrawals, causing it to need additional capital. When that capital couldn’t be raised, U.S. regulators took over the bank. It’s important to note that this was a self-inflicted wound for the bank. Had Silicon Valley been more conservative in the securities they held (i.e., held shorter dated bonds), this situation could have been avoided.
Signature Bank’s situation was different. The bank was better diversified but did have a concentration in crypto, with up to a quarter of its deposits from that space. There have been some high-level failures in the crypto area recently (FTX and Silvergate), so it’s not particularly surprising that after the Silicon Valley Bank failure, withdrawals from Signature would be elevated.
Ultimately, the regulators closed the bank due to a “significant crisis of confidence in the bank's leadership” as they weren’t getting reliable and consistent data over the weekend. Again, this was a situation that could have been avoided with better communication.
Sunday, U.S. financial regulators announced that all depositors of both U.S. banks will be made whole (deposit insurance in the U.S. is typically capped at $250,000). Regulators also took other steps to provide liquidity to the system to specifically address the situation Silicon Valley Bank found itself in by allowing banks to borrow money from a new Fed program called BTFP (Bank Term Funding Program). Collateral can be pledged at par so banks don’t have to sell assets at a loss.
In Europe, the Swiss National Bank (their central bank) has pledged to loan Credit Suisse over $50B to support the bank. European banks have had many difficulties since the Global Financial Crisis, so this isn’t the first rodeo for central banks over there.
This central bank support should go a long way to calming the waters in both the U.S. and Europe. We suspect that regulators will provide more support if needed to stabilize the system. Fortunately, unlike the Great Financial Crisis, these bank failures don’t appear systemic so more support may not be necessary – although it's comforting for the market to know it’s there.
It’s interesting to note that the Canadian regulatory system for banks is more conservative. For instance, all Canadian banks must mark to market* their securities portfolios each quarter in calculating their capital ratios. As mentioned above, this is not required for U.S. regional banks. Had Silicon Valley been following the same rules as Canadian banks, they would have been forced to make adjustments along the way.
The difference in the regulatory system is one of the main reasons why bank failures in Canada are very rare, while the U.S. has had over 500 banks fail in the last twenty years. We usually don’t hear about the U.S. bank failures as they aren’t as big as the two this week.
There’s an expression that the Fed raises interest rates until something breaks. We are now at this point. Prior to this week’s events, it was assumed that the Fed would continue to increase rates to fight against inflation. That’s now in question and there’s a good chance the Fed will pause at its next meeting, which is scheduled for next week.
U.S. banks will likely now pull back on lending and keep their liquidity at higher levels to guard against sudden withdrawals. This, in turn, should slow down the economy – perhaps faster than expected – and likely increase the odds of a recession this year, which many expected anyway. Ironically, the slow down could also lower inflation which would be welcomed news. Make no mistake, inflation is still enemy number one and should the Fed pause and inflation doesn’t come down, rates will rise.
Crises come and go. This is not meant to minimize their impact. Some are very significant, others less so. As investors, each market disruption needs to be analyzed to see the impact on our client portfolios so we can assess the risk and opportunities and make adjustments along the way.
We know that once this U.S. banking situation is over, a new shock will present itself that will need to be addressed. It can be uncomfortable, but it’s also normal. The antidote to these shocks is to avoid the noise and stay invested for the long term, while also being properly diversified. For those with a long-term view, disruptions can be an opportunity to invest in great assets at discount prices.
* “Mark to market” refers to the practice of recording the fair value of an asset or liability based on the current market price, or the price of a similar asset or liability.
Sources: Bloomberg, FactSet
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