Experts have their say after collapse of lender raises questions about banking sector stability and rate hike prospects
It’s been a frenzied few days in the financial markets as investors witnessed the end of three U.S. banks, including the largest implosion of a U.S. banking institution since the Great Financial Crisis of 2008 and the second-largest in history.
That catastrophe involved Silicon Valley Bank, the biggest bank for tech startups, which collapsed on Friday after issuing a Wednesday statement saying it needed to raise US$2.25 billion to shore up its balance sheet. That triggered a bank run with depositors withdrawing over US$42 billion from their accounts.
The post-mortem points to two major causes of death for SVB. The first is the Federal Reserve’s aggressive rate hikes, which saw interest rates in the U.S. rise from 0.25% to 4.5% in 2022.
“They usually hike until they break something – the debate this time around was what they would break,” Greg Taylor, chief investment officer at Purpose Investments, said in a commentary. “We found that out last week with the largest bank collapse in the U.S. since the Global Financial Crisis.”
A commentary from BC-based Dixon Mitchell Investment Counsel also pointed to the bank’s own “lackadaisical” approach to risk management. “Rumours had been swirling for some time that SVB was headed toward (if not already in) violation of its regulatory capital requirement, which was precipitated by a significant duration mismatch between its liability book — i.e. customer deposits — and its asset base, represented primarily by mortgages purchased near the top of the fixed income market,” the note said.
In an interview with Wealth Professional, Arthur Salzer, founder, CEO and co-CIO at Northland Wealth Management, said it’s common for banks to not mark the assets on their books to market. In SVB’s case, it was forced to realize losses as it sold assets to meet its depositors’ demand for liquidity.
“Where Silicon Valley Bank really went wrong is they didn’t have interest rate protection on their portfolio. If you’re running a bank, you can’t be greedy … you must buy derivative insurance,” he says. “I think if they had done that properly, the mark-to-market losses would have been overcome or minimized.”
According to Salzer, it’s normal for banks as a sector to face severe insolvency risks once a decade. And while the SVB affair might evoke concerns about the coming of a second Great Financial Crisis, he doesn’t expect that to be the case here.
“This is simply an issue of: what is the accounting value versus the market value of assets that the banks hold after a very large interest rate increase? It’s not an overleveraged system like we saw in ’08, so you won’t necessarily get the same cascading dominoes,” Salzer says. “Once everybody slows down, the banking system will work through this lack of liquidity.”
To prevent contagion to other regional banks and restore confidence, U.S. regulators moved quickly over the weekend to backstop uninsured deposits at SVB. For its part, the Office of the Superintendent of Financial Institutions (OSFI) seized control of the failed bank’s Canadian branch to “protect the rights and interests of the branch’s creditors.”
“I want to be clear: the Silicon Valley Bank branch in Canada does not take deposits from Canadians, and this situation is the result of circumstances particular to Silicon Valley Bank in the United States,” Superintendent Peter Routledge said in a statement.
For Salzer, the government actions taken to contain the risks from SVB reflect a “heads I win, tails you lose” reality in the current financial system.
“Unfortunately, the financial system today claims it’s privatized when it’s making a lot of money … shareholders get capital gains and dividend increases, and executives get large bonuses,” he says. “However, when the opposite happens, the losses are being socialized, and the average citizen has to subsidize the losses.”
The fallout from SVB’s collapse led to a broad selloff in financial stocks across North America last week, which included the evaporation of nearly $20 billion in value from Canada’s top banks in four days. But according to Dixon Mitchell, Canadian banks are well positioned and not likely to suffer the same fate.
“In Canada, our banks boast very favourable liquidity positions, with coverage ratios rising by
8% on average in the most recent fiscal quarter,” the firm said in its note. As well, Canadian banks experienced deposit growth of 4% in the second half of 2022 vs. a decline of 2% in the US over the same period. The asset bases of Canadian banks are also very well diversified, spread across residential and commercial real estate loans, and corporate and unsecured (credit card) lending.”
The collapse also introduces a seed of doubt as to what the Federal Reserve’s next move will be. Fed Chair Jerome Powell caused a stir in the markets last week with some hawkish signals on Capitol Hill, but the possibility of vulnerabilities similar to SVB’s lurking in other banks’ balance sheets could cause the U.S. policy rate-setting body to think twice about another hike.
“Every datapoint remains important, and we still need to see inflation subside,” Taylor said in his note. “If [the next US CPI reading] shows we’ve seen the peak in rates, it will be time to lengthen duration and lock in these higher yields.”
"According to the U.S. Department of Labor, American consumer prices rose 6% from a year earlier, down from 6.4% in January and the 40-year high of 9.1% reached in June."
Aside from U.S. banks’ ability to weather additional pressure, Salzer says it’s important to take note of where the country is in its election cycle.
“It’s a presidential election next year, and typically the Fed wants to be out of the way, not increasing rates, or not seem to be affecting the economy or financial system during a presidential year,” he says. “They need to get done by November this year in December. … I think they're a lot closer to the end of raising rates, than not.”