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Good morning. Welcome to jobs day. Forecasters think there were 205,000 jobs added in February. They thought something similar last month, before the real January number, more than half a million jobs, blew everyone away. Since then, many have taken to waving away strong January data as a warm-winter fluke. Another bumper payrolls report today will be harder to dismiss. Email us: [email protected] and [email protected].
Silicon Valley Bank
Shares in Silicon Valley Bank fell 60 per cent yesterday, after the company said it had made major changes to its balance sheet and would raise new equity. That is a big move but not — in the context of markets broadly — a particularly big story. After Thursday’s whipping, SVB’s market cap is just $6bn.
What is a very big story is that banks in general sold off sharply on the news. The KBW bank index fell 8 per cent. Look at it this way: yesterday’s 5.4 per cent sympathetic decline in JPMorgan Chase represents a far larger decline in value ($22bn) than the decline in SVB’s own stock ($9.5bn). The shudder across the banking industry suggests that what went wrong at SVB is emblematic of a bigger problem. Is it?
The short answer is no. Saying this makes me acutely nervous; it is much safer for a financial journalist to predict a disaster that does not materialise than to dismiss the possibility of one that does. But SVB’s problems arise from balance sheet peculiarities that most other banks do not share. To the degree that other banks have similar problems, they should be much milder. There is one important addendum, though: in banking, failures of confidence can take on a life of their own. If enough people think SVB-style problems are widespread, bad stuff could happen. The banks will spend the next few days saying “we won’t need to take writedowns or raise equity.” This will not soothe anyone’s nerves; on the contrary, it will sound like an echo of 2007-8.
So let’s start with the facts. SVB’s problems can be summed up with a chart:
SVB caters to California’s tech industries, and has grown fast alongside those industries for years. But then, with the explosion of speculative financing in the coronavirus pandemic boom, deposits (dark blue line) rose super-duper fast. SVB’s core customers, tech start-ups, needed somewhere to put the money venture capitalists were shovelling at them. But SVB did not have the capacity, or possibly the inclination, to make loans (light blue line) at the rate the deposits were rolling in. So it invested the funds instead (pink line) — overwhelmingly in long-term, fixed-rate, government-backed debt securities.
This was not a good idea, because it gave SVB a double sensitivity to higher interest rates. On the asset side of the balance sheet, higher rates decrease the value of those long-term debt securities. On the liability side, higher rates mean less money shoved at tech, and as such, a lower supply of cheap deposit funding.
This does not mean that SVB was facing a liquidity crisis in which it would not meet withdrawals (although, again, any bank that screws up badly enough in any way can face a sudden run). The main problem is profitability. Businesses, unlike retail depositors, are highly price sensitive about their deposits. When rates rise, businesses expect their deposits to yield more, and will move their money if this doesn’t happen. Most retail depositors can’t be bothered. And SVB’s depositors are overwhelmingly businesses.
The yield on SVB’s assets is anchored by the level of long-term government bonds bought when rates were low; meanwhile, its cost of funding is rising fast. In the fourth quarter, its cost of deposits rose 2.33 per cent, from .14 per cent in the final quarter of 2021. That’s bad but not lethal: the company’s interest-bearing assets yielded 3.36 per cent in the fourth quarter, up from 1.99 per cent, rendering a tightening but still positive spread. But deposit costs will keep rising as more deposits roll over, even in the absence of further rate increases.
That’s why SVB sold $21bn of bonds. It needed to reinvest those funds in shorter-duration securities, to increase yield and to make its balance sheet more flexible in the face of any further rate increases. And then it needed to raise capital to replace the losses made in those sales (if you buy a bond when rates are low, and sell it when rates are high, you take a loss).
Why won’t most other banks face a similar crisis? First, few other banks have as high a proportion of business deposits as SVB, so their funding costs won’t rise as quickly. At Fifth Third, a typical regional bank, deposit costs only hit 1.05 per cent in the fourth quarter. At gigantic Bank of America, the figure was 0.96 per cent.
Second, few other banks have as much of their assets locked up in fixed-rate securities as SVB, rather than in floating-rate loans. Securities are 56 per cent of SVB’s assets. At Fifth Third, the figure is 25 per cent; at Bank of America, it is 28 per cent. That is still a lot of bonds, held on bank balance sheets at below their market value. The bonds’ low yields will be a drag on profits. This is no surprise and no secret, though, and banks with more balanced businesses than SVB should be able to work through it.
Most banks’ net interest margins (asset yield minus funding cost) will soon start to compress. This is part of a normal cycle: when rates rise, asset yields rise quickly and the deposit costs catch up. Gerard Cassidy, banking analyst at RBC, expects NIMs to peak in the first or second quarter and decline from there. But everyone knew this was coming before SVB hit the rocks. RBC held its annual banking conference this week, at which all the major regional banks spoke. Only one (Key Corp) lowered its guidance for net interest income.
For most banks higher rates, in and of themselves, are good news. They help the asset side of the balance sheet more than they hurt the liability side. Of course, if rates are higher because the Fed is tightening policy, and that policy tightening pushes the economy into recession, that is bad for banks. Banks hate recessions. But that risk, too, was well known ahead of SVB’s very bad day.
SVB is the opposite: higher rates hurt it on the liability side more than they help it on the asset side. As Oppenheimer bank analyst Chris Kotowski sums up, SVB is “a liability-sensitive outlier in a generally asset-sensitive world”.
SVB is not a canary in the banking coal mine. Its troubles could cause a general loss of confidence that hurts the sector, but that would require a different metaphor: shouting fire in a crowded theatre, perhaps. Investors should keep calm and keep their eyes on fundamentals.
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