Is the Collapse of Silicon Valley Bank a Repeat of 1907 or 2008?
Last week, the U.S.’s sixteenth largest bank, Silicon Valley Bank (“SVB”), collapsed. Following Washington Mutual in 2008, SVB is now the second largest bank failure in U.S. history. As its name implies, SVB was highly concentrated to the technology sector. In fact, some estimate that half of all venture capital dollars flowed through SVB over its 40-year history.
In a nutshell, here’s what happened.
Back in 2021, SVB invested excess capital in low interest mortgage-backed securities and U.S. Treasuries. There wasn’t credit risk because the bonds would eventually mature. However, their prices were highly sensitive to a change in interest rates because they wouldn’t mature any time soon. As rates rose, the bond prices fell – a lot. At the same time, its technology-centric clients started to burn through their cash balances at a higher pace. Consequently, SVB was forced to sell some of these bonds and in the process, took a $1.8 billion loss. SVB disclosed the loss on Thursday and said it would raise $2.25 billion by selling additional equity. The market did not like that and the share price fell a dramatic 65%. Because of these concerning headlines, deposit holders made a “run on the bank” by withdrawing funds. Trading of SVB’s stock was halted before the market opened Friday and the FDIC took control of the bank that same day.
This event is a sobering reminder that banking is not built on loans and deposits – it depends on trust and confidence. If customers lose confidence that their money is safe and begin to make withdrawals, the bank won’t survive if the snowball of withdrawals evolves into an avalanche.
The failure of one bank can then spill over to another if customers of an entirely different bank feel their savings could be at risk. For that reason, many U.S. regional banks have seen their market capitalizations materially deteriorate since Thursday. To reassure all deposit holders nationwide, the U.S. government announced on Sunday that it would guarantee 100% of all SVB deposits (not just the first $250,000 that is federally insured).
It spilt over into other countries, however, even affecting the share prices of Canadian banks too. Almost $19.7 billion, or 5%, of the market value was wiped out last week from our major domestic banks. We have no concerns about our Canadian banks. In fact, CIBC’s CEO purchased almost $3 million of his company’s stock on Friday at $58.08/share. Unlike their U.S. peers, Canadian banks survived the 2008-09 financial crisis without a single bank cutting its dividend. In the 15 years since, regulators have required the banks to save additional capital on their Balance Sheets and issue loans more selectively. Furthermore, Canadian banks are diversified between personal loans, business loans, wealth management, insurance, and capital markets.
A day before we heard about the trouble with SVB, Federal Reserve Chair Jay Powell was telling Congress that interest rates may need to increase sooner, faster, and stay elevated longer. The expectation was for a 50 basis point rate hike next week. So much for that. After SVB’s collapse, the market is now pricing in a 25 basis point hike next week (we’ll see if that happens) and expects cuts to start in July. By the end of this year, the bond market is suggesting that rates could be 150 basis points less than today. Rate cuts in Canada are also being priced in by the market.
In 2008, we experienced a financial crisis. Many banks failed and the ones that survived have the scars to remember. Unlike right now, the quality of loans was horrid. Borrowers lacking the income and collateral were nevertheless provided with debt. These same borrows had no ability – and in some cases, no intention – of ever paying back the money.
In 1907, the U.S. banking system experienced its most serious crisis to date. The failure of the Knickerbocker Trust Company, one of the largest institutions at the time, led to a subsequent run on the banks. Today, the central bank and FDIC would have intervened (as it did on Sunday). At the time, however, neither had been created. Instead, JP Morgan (the person) and several of his Wall Street friends personally offered to guarantee bank deposits. This calmed depositors and the bank runs dissipated.
Is this a repeat of 2008 or 1907? We think the latter.
In response to the selloff, did we buy any U.S. financials? It was tempting, but we did not. We believe the regional U.S. banks will face higher costs, more regulation, and less certainty going forward. In fact, the Bank of America said it had received $15 billion in new deposits since last week. We believe the rate hiking cycle is now over and are eyeing other sectors for new investments for clients. Technology stocks, for example, suffered greatly while the Fed hikes rates. This week, the sector caught a bid and we believe it will continue to rally.
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