1) What’s happened with SVB and other banks, 2) Why it’s happening, 3) If Fed actions over the weekend solves the budding crisis, 4) Impact on monetary policy and inflation and 5) If this is a bearish game changer.
On Friday Silicon Valley Bank, the 16th largest bank in the U.S., failed and was seized by the FDIC, marking the largest bank failure in U.S. since Washington Mutual during the financial crisis. Then, on Sunday, Signature Bank of New York (SBNY) also failed and was taken over by the FDIC. Like Silvergate Capital and SVB, Signature Bank had a lot of crypto exposure. In sum, three large banks failed in less than a week.
In response, on Sunday night the Fed and Treasury Department announced that 1) All depositors at SVB and SBNY, including FDIC insured and non-insured, will be made whole and have access to their deposits Monday. 2) In a flashback to the financial crisis, the Fed has created a new lending facility, the Bank Term Funding Program (BTFP), which will provide one-year loans to banks and accept Treasuries and agency mortgage-backed securities (Fannie/Freddie MBSs) as collateral, and the lending facility will value the bonds at par (not current market values—this is important).
Do The Moves By the Government Solve This Crisis? No, But They Help.
There are two main risks associated with what’s happening: First is a local economic risk. Thousands of companies have money at SVB and SBNY and the vast majority of them have deposits in excess of the $250k FDIC limit. So, if those uninsured deposits are lost, then they will have no money to meet payroll, pay suppliers, etc. So, there’s a real economic risk here.
The second risk is much bigger. SVB and SBNY failed, in part, because of a lack of interest rate risk management. These banks bought long dated bonds over the past several years and didn’t manage their duration or interest rate risk. So, as rates rose over the past year and longer dated bonds dropped in value, it eroded their capital base and bonds they valued at par (100) were worth nothing close to it. This is likely a problem of varying degrees across most (if not all) banks in the U.S. and represents a real threat to the system should a large-scale run develop.
However, the Fed has removed much (not all) of this risk by accepting these bonds from banks at par, thereby eliminating the need for a bank like SVB or SBNY to fire sale U.S. Treasuries or MBSs during times of stress.
However, while this lending facility does significantly reduce the changes of a larger bank run, it will not eliminate immediate stress on the banks, especially the regional banks (they’re at the heart of this crisis).
The core issue going forward is the liability associated with uninsured deposits (deposits in excess of $250k). The government’s response to SVB and SBNY does not guarantee uninsured deposits across the banking system, and they are still at risk. So, we should expect a lot of deposit movement in the coming days (companies and people moving money to diversify risk and try and get close to, or under, that 250k level). That could easily result in more stress to banks and no one should be surprised if we see more regional bank failures this week.
Bottom line, the government response (guaranteeing all deposits at SVB and SBNY and creating the BTFP) helps and makes a broader bank run extremely unlikely, but it doesn’t solve the problem of 1) Bonds that have lost value and 2) Risk associated with uninsured deposits.
Will This Make The Fed Less Hawkish? The market thinks so, but I’m not so sure.
The market is aggressively pricing that this whole saga will make the Fed less hawkish, as fed fund futures are pricing in a 25% chance of no rate hike in March and a terminal fed funds rate of just 4.625% (meaning this hike in March will be the last one).
I do not agree with this assessment. The banking stress is a risk, but inflation is still at 6% and creating the BTFP will expand the Fed balance sheet at a time when it’s trying to shrink it (the Fed is actively engaged in Quantitative Tightening).
Is This A Bearish Gamechanger and a Reason to Raise Cash? Not Yet.
The natural reaction to this weekend’s headlines is to make a parallel to 2008, but we don’t think that’s appropriate because in the end, the underlying assets at these regional banks are money good (they are U.S. Treasuries and MBSs and the housing market isn’t collapsing). 2008 was the collapse of the real estate market. Meanwhile, regulation of larger banks is more stringent, and the government is ready to act to help (as we saw this weekend).
I think the better analogy is the savings and loan crisis of the late 1980’s, where a sub-set of banks with direct exposure to an industry (in that case oil and gas) failed, and it created ripple effects across smaller lenders, but never threatened the broader banking system. That situation did not cause material market stress or declines. The markets during this time period were down about 36% total as opposed to 50% in 2008.
Stepping back, we have advocated for conservative positioning, using rallies to ensure appropriate levels of risk and volatility, and overweighting defensive sectors and value, and something like this happening has been part of the reason why. Hiking cycles cause stresses, every time. And this is why we want to remain conservatively positioned as we weather this economic and market period.
That said, I do not think the volatility of the last week is a bearish gamechanger. Yes, it’ll increase volatility. But the medium- and long-term outlooks aren’t materially more negative now than they were two weeks ago, we continue to advocate holding core stock and bond holdings with an emphasis on defensive sectors (utilities/staples/healthcare), low-volatility ETFs (SPLV) and value, and small cap stocks because that should weather the continued volatility better than growth stocks.
Going forward, we will be watching for any further signs of contagion in markets. For now, this appears to us more of a targeted risk for regional banks and an earnings headwind for financials more broadly, but not a systemic issue that requires abandoning long- term financial goals for preserving capital.
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