An Update from our Head of Equity: Silicon Valley Bank

James Penn
March 17, 2023

The world of finance has been rocked in the past few days by the collapse of Silicon Valley Bank last weekend.

SVB, as it was known, was a major regional bank in San Francisco which specialised in dealing with, and lending to, the tech sector. It had over $200bn in deposits so was not a small institution by any means, though it was not considered a ‘globally significant financial institution’ like some of its better-known peers such as JP Morgan, and was therefore not subject to the same level of scrutiny and regulation.

The bank had a very good track record and was considered an important partner by the tech sector. It had not been reckless and its lending book was considered prudent.

However, it came unstuck through its bond portfolio, having invested in government bonds at much lower yields two to three years ago when interest rates and Treasury yields were much lower. Over the past year this bond portfolio has lost money as a direct result of rising interest rates (bonds lose money when interest rates rise). At the same time, tech investors have needed to call on their cash reserves (which formed SVB’s deposit book) owing to capital markets not being open and to funding shortfalls as the economic environment has got tougher.  

In the middle of last week SVB stunned markets by revealing it had made a $1.8bn loss by crystallising losses on its bond portfolio in order to fund these deposit outflows. SVB tried to raise capital but this proved impossible as the share price crashed. In a rerun of what happened at Northern Rock Building Society in the UK in 2007, depositors saw the share price collapsing and took their money out in a classic bank run – all too easy these days at the push of a button when confidence goes and the herd mentality takes over.

About $50bn, or a quarter of the deposit base, left the bank on Thursday and Friday last week. The Federal Deposit Insurance Corporation at the weekend decided that this capital flight had gone too far and stepped in to take over the bank, wiping out shareholders and bondholders.

There had been talk that the FDIC would only guarantee deposits up to the US statutory guarantee of $250,000, which was put in place at the time of the financial crisis to prevent bailouts and the ‘too big to fail’ syndrome.

If this had happened it would have been disastrous, as about 90% of the deposit base exceeded the $250,000 level and depositors would have lost much, or most, of their money. This would have caused devastation in the tech sector and led to the collapse of many start-up firms. It would have also led to bank runs at other smaller, regional banks, which would have probably led to a hard landing and serious recession in the US.

Thankfully, the FDIC decided to protect depositors in full, both at SVB and at Signature, a regional bank specialising in the crypto sector with about $90bn in deposits which was also ‘shuttered’ by the FDIC.

A serious sell-off in equities, and particularly bank stocks, followed on Monday on fears that the world was heading for another financial crisis.

Our portfolios had no exposure to SVB, or Signature, or Credit Suisse, and our bank holdings are focused on larger cap companies with very little exposure to mid-cap or regional banks. Our view is that the sell-off in equities on Monday was overdone given that investor fears relate to bank liquidity, which the Fed is addressing, rather than solvency. We believe there is no serious concern over the value of balance sheets as there was in 2008, and we are hopeful that the additional liquidity and lending facilities that were put in place by the Fed and FHLB (Federal Home Loan Bank) over the weekend, as well as the guaranteeing of deposits at SVB and Signature, will stem further panic.

Depositors with balances above the $250,000 at other banks will see what has happened and hopefully conclude that in the chance of their own bank getting into difficulties their own deposits will be guaranteed by the FDIC, and that there is therefore little point or benefit in moving them. In the wake of this swift action, we are also hopeful that spill-over effects into Europe or the UK can be minimised. The fact that the Swiss Central Bank on March 16th decided to aid Credit Suisse with $54bn of funding has helped sentiment in relation to financials.

The situation remains highly fluid and there may be a higher level of volatility over the next few weeks in the wake of what has happened, but our view is that there is no particular reason for selling and exiting the market at this point. We may see that central banks around the world moderate their language about the need for further rate hikes, and indeed increase interest rates by less than currently anticipated, which would help markets significantly.

Disclaimer: The views, thoughts and opinions expressed within this article are those of the authors and not those of any company within the Capital International (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security or to make a bank deposit.

Continue reading