On March 10, US regulators shut down Silicon Valley Bank (SVB) following a run by its depositors. On March 12, New York-based Signature Bank was also closed by regulators. These two bank failures are the largest since the 2008 Global Financial Crisis, and initially left billions of US dollars in uninsured deposits stranded given the Federal Deposit Insurance Corporation (FDIC) only protects deposits up to a limit of USD250,000.
However, a subsequent joint statement by the US Treasury, the Federal Reserve, and the FDIC, announced that all depositors, including those whose funds exceed the maximum government-insured level, will be made whole. Overall this was reassuring to financial markets – notwithstanding that US bank equity prices fell significantly. Systemic fears at the moment seemed contained as US bank credit default swap (CDS) pricing remained stable.
SVB is the 16th largest US bank and is a key lender in the US start-up ecosystem, with clients mostly start-ups across the tech sector. While the quality of its assets was good, the bank’s liabilities had surged over the last few years driving its loan-to-deposit ratio to an unsustainable low of 42%1 (versus the US banking sector average of 68%2). Therefore, as interest rates increased SVB could not generate sufficient income, and its final blow was its failure to raise more funding from equity investors. In the case of Signature Bank, a high proportion of its excessive leverage stemmed from deposit liabilities linked to cryptocurrencies.
The immediate impact of these events on direct stakeholders closest to these entities is that while customer deposits in both banks will be protected, equity and bond holders in both SVB and Signature Bank will be almost completely “wiped out”. This is a similar experience to 2008 where investors were also wiped-out (net of asset sales) by the defaults of Bear Stearns and Lehman.
The two banks collapse invokes memories of Lehman’s insolvency in 2008. The larger question now is whether the two recent bank failures are contained, stock-specific / idiosyncratic events, or symptomatic of wider systemic stress.
Lehman’s collapse was primarily due to its overexposure to poor-quality Mortgage-Backed Securities (MBS) and Collateralised Debt Obligations (CDOs) amid rising defaults in underlying mortgage payments and a weak economic backdrop. The threat of wider systemic failure back then was due to large counterparty risks from exposures to Lehman, and many US banks having poor quality assets, a lack of capital buffers and limited bad debt provisions.
In the case of SVB and Signature Bank, as alluded to above, SVB’s clientele are mainly entities in the tech start up scene, while Signature Bank has large exposures across the crypto space. In contrast to 2008, where the credit quality of assets collapsed making some banks insolvent, this latest shock is more a reflection of excessive leverage and liability mismatch driving failure. Unlike the more established banks, SVB, being a concentrated rather than a diversified lender, had struggled to grow its assets over time while its liabilities surged.
The main unknowns at this point are the financial market linkages between the venture capital funds, the potential spill over effects to the tech sector, and the broader impact on the wider banking system.
Notwithstanding the above, regulators are keenly aware of how a bank failure can adversely impact market sentiment, and the wider system. As such, they should be better positioned to pre-empt the knock-on effects and manage them accordingly. The rapid joint statement by US policymakers that all deposits would be made good is very encouraging. But equally important is that all the key financial soundness indicators (FSIs) across the US banking sector on average are robust and significantly stronger than in 2008 – e.g capital adequacy is much higher, loan-to-deposit ratios are healthy, and Non-Performing Loans (NPLs) are well-covered by provisions.
It seems there will be buyers for some of SVB’s assets, as HSBC announced plans to buy SVB’s UK arm on March 13. Fullerton’s investment teams believe that quality assets will find buyers which will help to foster an orderly wind down. By and large, we view this as an idiosyncratic and isolated event.
As of end February 2023, Fullerton’s public market investment portfolios have no direct exposure to both entities.
1 FT Due Diligence newsletter, March 2023
2 Refinitiv DataStream, 2023