What Banks Are Failing?

The fallout from the collapse of Silicon Valley Bank will likely have severe consequences for a vast number of businesses over the next couple of months.

Indeed, what began as a fairly localized problem restricted to some regional US banks is now threatening to become a major global crisis.

For instance, shares in the Zürich-headquartered investment banking group Credit Suisse fell a massive 25% mid-week, sending shock waves throughout the market. The company is considered to be systemically important to the sector as a whole, and any signs of trouble are keenly monitored.

In fact, it was the firm’s earlier warning of “material weaknesses” in its financial reporting controls that triggered the most recent sell-off. However, comments from the chief of the Saudi National Bank didn’t help either. Regarding whether he would be increasing his 9.9% stake in the Swiss organization, chairman Ammar al-Khudairy said he would “absolutely not” be adding to his company’s position.

No matter. Credit Suisse trades at a historically low $1.98, having lost almost 90% of its value in the last five years. But where might the carnage end? And which companies are most at risk?

Source: Unsplash

Why Are Financial Institutions So Vulnerable?

Unlike the famous collapse of Lehman Brothers in 2008, the source of SVB’s woes didn’t actually originate from the lending of bad loans.

As it happens, Silicon Valley Bank had a relatively robust business operation, with its focus on the tech space and other adjacent industries spurring its securities revenue by 54% year-on-year to $152 million.

No, the cause of SIVB’s issues was a kind of interest rate risk that made its longer-term maturity assets worth less today than when first acquired. FDIC Chairman, Martin Gruenberg, talked about this not so long ago, claiming that “most banks have some amount of unrealized losses,” with those totaling about $620 billion at the close of 2022.

That said, as Gruenberg also points out, this isn’t usually a problem for the majority of institutions – so long as they don’t have to sell. There might even be a near-term benefit to rising interest rates, as banks often see a boost to their bottom line from the extra income generated through the loans they make themselves.

But this wasn’t the case for SVB. The company’s customers had been accessing their deposits in greater volumes over the last twelve months, and, needing the cash to cover these unexpected withdrawals, Silicon Valley made the disastrous decision to sell its long-dated government bonds to cover the outgoing funds.

However, the firm then announced its intention to raise additional capital to plug the hole from the losses it made on the sale of its bond portfolio. This gave the impression the business had an acute liquidity dilemma, causing a run on the bank on March 8.

While it’s clear what events led to Silicon Valley Bank being shut down by regulators, it’s not quite so obvious if they apply to other banks too. The fact the Fed has been willing to underwrite the deposits held by SVB and Signature Bank – another outfit that had its assets seized for similar reasons – signals to the wider industry that many of the short-term risks have been removed.
Moreover, for this reason, the Federal Reserve also created the Bank Term Funding Program (BTFP). This program will provide eligible depository institutions with loans so that they won’t need to sell high-quality securities to meet the needs of their depositors.
But, in reality, things are more complex. There are still headwinds on the horizon that could see this scenario turn into an emergency, and the market is only too eager to sniff out the next failing institution to insulate itself from any brewing catastrophe.

So, Which Banks Are At Risk Of Contagion?

The ramifications of SVB’s demise are growing graver by the day. With the fear that so many banks are compromised through the “unrealized losses” on their balance sheets, it’s no surprise that the financial sector has witnessed such huge share price drawdowns recently.

One company that’s received lots of attention lately is Bank of America. The bank’s held-to-maturity bond portfolio is said to be the most vulnerable to interest rate rises and would realize a loss north of $100 billion if it were to sell those assets at present value.

However, accounting rules mean that these institutions don’t have to record those losses unless the debt is actually sold. Interestingly, other large banks – such as JPMorgan Chase and Wells Fargo – also have portfolios with similarly depressed valuations.

Naturally, Bank of America’s stock has dropped in response to the SVB debacle, falling almost 20% in the last month. Nevertheless, BAC and its big-cap peers are having a resurgence in fortunes right now.

For example, with fear gripping the market, many businesses have pulled their funds from smaller banking ventures, depositing them with larger, so-called “too big to fail” enterprises instead.

Consequently, this desire to shelter cash under the umbrella of big Wall Street institutions is a boon for BAC, with some reports suggesting that it’s received an extra $15 billion in new deposits since the disintegration of Silicon Valley Bank.

Obviously, there’s a flip side to this: regional banks are getting hit hard – and it’s difficult not to think this predicament will only worsen. Although protections exist to stop banks from going under straight away – the BTFP’s loans are only for one year – if they lose all their custom today, there won’t be a viable business tomorrow.

And that’s exactly what’s happening. Once well-received brands like First Republic Bank have already been downgraded to junk status, with others likely not far behind.

Yet, from an investment point of view, this presents opportunities. For example, First Republic’s nonperforming assets comprise just 5 bps of its total assets, while its 37 years of consistent profitability hints at its superior durability.

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