Will the Silicon Valley Bank collapse reach Aussie shores?
Here we go again. Last year it was FTX, then Silicon Valley Bank (SVB) said “hold my beer”.
The collapse of SVB represents the second largest bank failure in history. It’s also set off a bank run on regional US banks.
The US Federal Reserve has stepped in to save the day with another one of its puts, which has probably saved the US banking system (let’s save the moral hazard conversation for another time).
Bank runs are by nature contagious. Can this contagion reach Australia? If it does, it will be felt first and foremost in the credit market. So I reached out to two of the top performing fixed income managers in FY22: Pete Robinson, Head of Investment Strategy for Challenger Investment Management's Fixed Income division, and Ken Liow, Head of Strategy & Risk at Realm Investment House.
Get up to speed
If you’re not across the SVB saga, here’s the short version of what’s gone down.
SVB borrowed short and lent long, as do virtually all banks.
There’s just one problem. SVBs client base is made up of tech companies and venture capital firms. These firms are flush with cash, making them good for the deposit book but not so good for the lending book.
So what to do with all the deposits? For SVB, the answer was to invest most of it in long duration bonds - US treasuries and agency mortgage-backed securities. These are safe investments… if held to maturity.
But, for whatever reason, the bank didn’t hedge its interest rate risk. So as rates soared, the present value of its bonds collapsed, making SVB [probably] insolvent on a mark to market basis.
The bank mentioned this in the footnote of one of its financial documents. The market noticed the footnote, which in turn kicked off an old-fashioned run on the bank.
The bank went into damage control by selling equity and its liquid assets. But it was too little, too late. SVB has now taken the mantle as the second largest bank failure in US history.
The bank run then swallowed up Signature Bank, making that the third largest bank failure in US history.
To arrest the bank run and restore confidence in the market, the US Federal Reserve has stepped in to provide liquidity to banks in order to protect depositors. However, shareholders and VC have been left holding the bag.
Risk to Australia
When the US market sneezes, the Australian market usually catches a cold. So far, the cold has been mild.
“Australian Bank equity prices have fallen in price, but it is not disorderly,” says Liow.
Nor is Australian Bank issued debt showing distress.
“The Australian banking system has significant settlement funds that should help avoid a liquidity issue here,” adds Liow. “Bank capital levels are much higher than during the GFC and liquidity levels are closely monitored by APRA. This helps to maintain confidence.”
Robinson also doesn’t see any immediate flow-on to Australian banks in the short-term.
What will be interesting, according to Robinson, is what the situation means for Aussie banks over the medium term.
On the deposit side, we may see Aussie banks increase rates.
“For the most part, borrowers have benefited because mortgages haven’t matched the hikes in the cash rate, but that may change as banks compete for deposits,” says Robinson.
Likewise, the lending side could see some changes.
“Do they term out their debt? Or do they tighten up lending?”
Liow’s focus at the moment is on the disposal of SVB’s loan book.
“Approximately 30% of this book was in loans to technology companies which are considered to be economically exposed, and the realised value of these will affect the carrying value of levered loans on this sector.”
“The flow-on effects could create issues in collateralised loan obligation (CLO) warehouses and otherwise make credit harder to come by in a sector which is already experiencing a decline in economic performance.”
Will this lead to a pause in rates?
Finally, there’s been talk about what this means for the US rate cycle. Goldman Sachs has already said that “In light of recent stress in the banking system, we no longer expect the FOMC to deliver a rate hike at its March 22 meeting with considerable uncertainty about the path beyond March.”
Robinson doubts the situation will lead to a pause in and of itself, but it’s too early to tell.
“The actions they’ve taken will arguably allow [the Fed] to continue hiking rates because the issues they were created, which were losses in bank government bank debt and mortgage backed debt, have been alleviated by this facility,” says Robinson.
That potentially gives them more room to hike.
“If they hadn’t done anything, it would’ve been tougher to see the hikes continue because there would’ve been broader issues in terms of the availability of credit across the market.”
Yet it’s still unclear what uninsured depositors do with their money, and this is something the Fed will be watching closely.
“If I’m a depositor in the US, notwithstanding the announcements that have been made, I’m still moving my uninsured money to a money market fund or one of the big mega banks such as a JP Morgan or Bank of America. I still think that happens, but the degree to which that happens is an open question.”
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David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.
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