Sebastian Mullins, Multi-Asset Fund Manager, Schroders

 

Considerations

Whilst we could not predict the exact circumstances of any particular crisis, the type of problems surrounding SVB are not wholly surprising given the rate of monetary tightening following a period of exceptional stimulus.  They are unlikely to be the last of such events.

 

The problems that have arisen reflects a combination of factors including :

• poor management at the individual bank level (in SVB’s case a concentrated customer base (tech) and limited hedging of either loan or security risk which resulted in large unrealised losses as yields increased, these losses were then realised as assets were sold to fund the depositors withdrew their funds. These losses extinguished the bank’s capital base;
• regulatory failure with respect to the smaller end of the US banking sector (those with total assets<$US250b aren’t held to standards with regards regulatory scrutiny and stress testing as the bigger banks);
• the implications of monetary policy tightening and liquidity withdrawal. Policy tightening is designed to withdraw liquidity and re-price risk in the economy and business models that prospered in a free money / abundant liquidity environment were always likely to come under pressure.

 

The Fed has moved quickly to limit the contagion from SVB through both guaranteeing depositors and announcing a term funding program to ensure banks and other related institutions can meet their obligations to depositors and manage their liquidity requirements. They are keen to ensure the contagion to the broader banking sector is minimised and confidence in the US banking sector is restored. Avoiding a GFC repeat is paramount. These steps are positive and we hope effective over time. If not, more will likely be done.

 

The market has also jumped to the conclusion (given the pricing of 2-Yr US treasuries) that this will force a U-turn in Fed policy (tightening to easing). We don’t share this view for several key reasons:

• that the extent of the rally in US 2-Yr treasuries likely reflects short covering by hedge funds who had recently moved to price further aggressive tightening by the Fed. At this stage we see it as volatility rather than a change in trend;
• that challenges in the US 2nd tier banks are to be expected (and probably required) to dent confidence and slow growth in order to bring inflation under control. The Fed can’t reasonably expect to raise rates 8 times in less than 12 months for a total increase of 450 bps in the FFR and not expect damage to be done; and
• that core inflation in the US (and globally for that matter) remains way too high. They may pause, or slowdown to get more clarity but they unlikely to pivot until clear evidence of moderating inflation is present (US CPI data (tonight 14/3) will provide some greater insight here). Financial distress together with moderating demand indicators (including the labour market) would be helpful but unlikely to be persuasive enough at present given the labour market remains relatively tight

 

Global Value Team – Andrew Williams, Investment Director – Value Equities at Schroders

 

Recent events are certainly concerning for anyone invested in small US banks that have a material bias towards uninsured corporate depositors.

 

The specific details of why and how SVB failed are important. SVB’s client base was niche and overwhelmingly skewed towards technology companies (indeed, it was set up to do precisely this back in 1983). A boom in VC funding in 2020/21 drove a near tripling in SBV’s largely uninsured deposit base, with the bank investing these deposits in long-dated securities.

 

In the wake of materially higher interest rates and a much tougher VC funding environment over the last 12 months, deposits started to move back out of the bank at the same time as the value of all those purchased securities was coming down. So long as the bank didn’t have to sell the securities, the losses would remain unrealised. However, with the deposit base shrinking, SVB were forced to start selling down the securities book, dragging losses into the P&L and negatively impacting their capital buffers.

 

When management took the decision to try and sell $21bn of securities last week – crystallising a $1.8bn loss that would require an equity raise to rebuild capital – the rush for the exit by uninsured depositors accelerated and a liquidity crunch quickly became a solvency issue. This has the potential to be quite embarrassing for US regulators. However, depositors appear unlikely to lose money (including in the UK, with HSBC mopping up SVB UK for just £1; an immaterial acquisition for HSBC – adding just 0.2% to HSBC’s c.$3trn balance sheet – but a potentially crucial one for SVB’s UK tech client base).

 

So in short, it appears as though a lot of the issues are quite specific to SVB as a very narrow, US technology-focused lender. However, more generally, these events are a reminder that banks are businesses that critically depend on the confidence of depositors and investors. There are much larger capital buffers than in the past and liquidity regulation in Europe has been designed to limit the risks from deposit outflows and / or other funding shortages.

 

However, a rapid loss of depositor confidence can still be a fatal shock for any bank. It’s possible we could see investors punish banks with undiversified client bases on the back of the SVB collapse, especially where depositors are uninsured (i.e. non-retail).

 

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Issued in March 2023 by Schroders Investment Management Ltd registration number: 01893220 (Incorporated in England and Wales) which is authorised and regulated in the UK by the Financial Conduct Authority and an authorised financial services provider in South Africa FSP No: 48998

 

ENDS