Banking shares have crashed across the globe after widespread falls in the US over fears that problems at a small tech focused lender will spark fresh turmoil in financial markets. But are concerns of contagion and another “Lehman moment” overdone?
Judging by the falls in the US on Thursday, investors are clearly rattled. Around US$52bn was wiped off the market value of the four largest US banks alone linked to fears over the value of lenders’ bond portfolios. Falls have extended to Europe with all leading financial institutions nursing hefty losses.
The sell off in JPMorgan Chase, Bank of America, Citigroup and Wells Fargo was sparked by difficulties at Silicon Valley Bank which late on Wednesday, revealed it had lost roughly US$1.8bn following the sale of a portfolio of securities valued at US$21bn, which it offloaded in response to a decline in customer deposits.
The losses prompted the bank to announce a share sale to shore up its capital position. Sound familiar? It all has echoes of the contagion that spread from the collapse of Lehman Brothers in 2008 following the subprime mortgage crisis, albeit on a somewhat larger scale.
The steep losses on the sale of the SVB securities soon shifted attention to the risks that might be lurking in the bumper bond portfolios held by other US banks, many of which invested an influx of deposits during the pandemic into long-dated securities. As interest rates have risen the value of these holdings has fallen sharply.
Recent data from the Federal Deposit Insurance Corporation, a banking regulator, showed US lenders were sitting on roughly US$620bn of combined unrealised losses in their securities portfolios.
The rising paper losses have coincided with a drop in deposits at banks, as savers search for higher yields at a time when the Federal Reserve keeps on raising interest rates. The worst-case scenario for banks would be that they might have to follow SVB by selling some of their securities at a loss to cover deposit withdrawals.
But that feels unlikely, at least amongst the big players. There are reasons to believe that the issues at SVB are company, rather than industry, specific.
As Neil Wilson at markets.com put it: “SVB does not represent the wider US banking sector, albeit the plummet in SVB stock clearly hit sentiment. It seems as though SVB was just gripping the wrong end of the stick with regards to rising interest rates, parking way too much of its assets in long-dated bonds which it thought safe but are now worth a lot less.”
The bank which caters to California’s tech industries, grew rapidly alongside those industries and as customers deposited in huge sums it invested heavily in long-term, fixed-rate, government-backed debt securities.
This left it exposed to a double whammy. On the asset side of the balance sheet, higher rates decreased the value of those long-term debt securities while on the liability side, higher rates meant less money coming into the tech sector and as such, a lower supply of cheap deposit funding.
This has led to a squeeze on profitability rather than liquidity given its predominantly business-based client roster. Businesses are more highly price sensitive than retail investors about deposits and as rates increase will expect their deposits to yield more.
But few other banks will have as high a proportion of business deposits as SVB and as such their funding costs won’t rise as quickly.
A report in the Financial Times noted at Fifth Third, a typical regional bank, deposit costs only hit 1.05% in the fourth quarter while at the banking mammoth Bank of America, the figure was 0.96%, compared to 2.33% at SVB.
SVB is also highly geared to securities which form 56% of total assets compared to 25% at Fifth Third, and 28% at Bank of America. Still high numbers, and there will be a drag on profits, but banks with more diversified and balanced businesses should see less impact.
Of course, the banking sector thrives on confidence. If enough people think SVB’s problems are the tip of the iceberg than contagion could spread.
As Craig Erlam at Oanda put it. "Ultimately, what we're seeing today is a very defensive response to a series of events that have left investors with many more questions than answers and fearing further ripple effects in the financial sector."
But while runs on banks, can, do and will happen banking executives and regulators will be hoping SVB’s issues are little more than a local difficulty than a full blown banking crisis.