23 March 2023

    Banking sector update: Calm after initial concern

    Over the last two weeks, US banks Silicon Valley Bank and Signature Bank have been shut down by regulators, and troubled Swiss bank Credit Suisse was acquired by its rival UBS. We explain what happened and what this means for investors and financial markets – and why there are some differences between the current situation and the GFC.

    The largest bank failures in decades

    Events began unfolding on 8 March when Silicon Valley Bank (SVB), a bank focused on Silicon Valley and new tech ventures, announced that it had decided to sell billions of dollars’ worth of bonds at a loss and was seeking to raise more than $2 billion in capital to shore up its balance sheet. This sparked concerns around the bank’s liquidity and solvency, which led many customers to attempt to withdraw their deposits from the bank. Two days after the initial announcement, the bank was put into receivership by the regulators.

    The initial view was that the collapse of SVB was a company specific issue, and that any contagion would be limited. This was proven incorrect as the receivership of SVB on the Friday created fear of further failures, which became self-fulfilling as customers began pulling deposits from other regional banks, including Signature Bank.

    On Sunday 12 March regulators stepped in and closed Signature Bank, citing systemic risk as they tried to prevent a spreading banking crisis. The banking regulators stated that depositors of both banks would be repaid, and that liquidity would be provided to assist other regional banks in meeting deposit withdrawals.  We owned a small position in Signature Bank in some of our funds. We have written the value of our Signature Bank holdings down to zero, as at this stage it is unlikely there will be any recovery of value as the bank is wound down.

    The fallout was not restricted to the US. The ripple effects reached troubled European bank Credit Suisse, which was already grappling with several of its own issues. Following a dramatic share price collapse and contagion concerns, the Swiss regulators quickly stepped in to provide liquidity to try and give confidence to depositors and investors. This did not prove sufficient, and Switzerland’s largest bank, UBS, agreed to buy its ailing rival.

    Fisher Funds has no exposure to Silicon Valley Bank. We also have no exposure to Credit Suisse shares or its ‘alternative tier 1’ bonds which have been in the press recently.   

    A crisis of confidence driven by a unique set of circumstances

    While bank failures are not uncommon in the US, a failure of this size is extremely rare. The failure of SVB was very different to the failure of some of the banks during the global financial crisis that had made risky loans. It was instead caused by a run on the bank, with lots of depositors all trying to pull their deposits at the same time.

    The speed of this bank run was also exceptional. By way of comparison, during the GFC Washington Mutual customers withdrew $16.7 b in deposits during a 9-day bank run (~9% of total deposits). In SVB’s case, it is estimated that depositors tried to remove around $42 b, or 25% of total deposits over the course of two days.

    SVB’s demise was most likely due to a combination of a mismanagement between deposits and investment securities; and its concentrated commercial deposit base.

    Like many banks, SVB saw an unprecedented increase in deposits during the COVID period. SVB’s deposits tripled in two years as its customer base of technology start-ups saw record growth in funding during this period of easy money and deposited these funds with SVB. Looking for somewhere to put all this money, and perhaps thinking these deposits would be sticky – SVB’s management invested these new deposits in low-risk but long-dated securities (for example, 5-year government bonds or mortgage-backed securities).

    As interest rates began to increase, SVB had effectively locked in a low rate of return on these securities and depositors suddenly had higher yielding alternatives to park their money. Banks were forced to either pay higher interest rates to keep these deposits or see them go elsewhere. Deposit balances decreased at the banks, and this was particularly pronounced at SVB as venture capital funding dried up and technology companies and start-ups started burning through their cash. SVB’s deposits decreased by $25b in 2022. This trend continued in 2023, forcing SVB to raise cash to cover these outflows.

    In addition, increasing interest rates drove the value of those long-duration investment securities down – meaning in theory the bank may not have enough assets if all the depositors asked for their money back at once. While this very rarely happens – no depositor wanted to be the last one left. As one start-up founder stated, “the best place to be in a bank run is first out the door”. The bank’s actions to raise capital alarmed customers, and they started to take their money out of the bank, resulting in a rush for the door.

    The impact was exacerbated by the high concentration of depositors. SVB’s business was almost entirely built around the venture capital industry, banking nearly 50% of start-up technology and healthcare companies in the US, most of these based in the West Coast. This had two flaws. Firstly, SVB had a small customer base of around 40,000 customers within a single industry. It only takes a few large customers to leave to raise concerns, and the venture capital industry is a tight-knit community – so news quickly spread. Secondly, while deposits under $250,000 are effectively insured by the regulatory agencies, 95% of SVB’s customer base were above this limit and had no such recourse – and therefore believed that the most prudent action was to take their money out of the bank. 

    While more information is slowly coming to light, it is not clear why Signature Bank was also targeted. It had a different business model to SVB. It had a larger and more diverse customer base than SVB and did not have the same exposure to long-duration investment securities. This was a bank that had survived and even thrived during prior crises such as the GFC. One potential trigger was a high percentage of uninsured depositors from large commercial rather than retail clients, but we should gain more clarity as further information is disclosed.

    There are some differences between the current situation and the GFC

    The recent events have raised concerns around a wider banking or market crisis. Banking crises are often more about human emotions than they are about fundamentals, which make them inherently difficult to predict. While much is still uncertain, there is some important context on the differences between current events and the GFC:

    • The banking sector is in far better shape today than it was before the GFC. Asset quality is much higher, capital ratios have improved, and regulation is much stronger.

    • These banks were not very big. While SVB’s deposit base of $200 billion sounds large, it is only a tiny fraction of the $20 trillion of total US banking deposits. To add some context, JP Morgan, the largest US bank, has over $2 trillion of deposits.

    • As discussed, the failure of SVB was quite unique and very different to the failure of some of the banks during the global financial crisis that had made risky loans.

    • Regulators in the US and Europe have both taken quick and decisive action. The failure of SVB was essentially caused by a run on the bank, with many depositors trying to pull their deposits at the same time. The Federal Reserve and Swiss regulators have moved to remove this risk by pledging significant liquidity support to the impacted banks.

    This is a fast-moving and fluid situation, and we are monitoring events closely. We will provide further information as events progress.

    This article was originally published on 16 March and was updated on 23 March reflecting information available at that time.

    If you would like to talk to someone about your investment strategy, the team at Fisher Funds are here to help. Please contact us or get in touch with your adviser.