Josef Pschorn and Philipp Graxenberger from XAIA Investment deal very intensively with the international credit markets and comment for us below on the current events surrounding Silicon Valley Bank.
The bankruptcy of Silicon Valley Bank
Just three months ago, Silicon Valley Bank (SVB) was the sixteenth largest bank in the United States. Last Friday, the U.S. bank, which specializes in startups, was closed and placed under government control. On 8. On March 3, the U.S. credit institution announced that it had sold a portfolio of U.S. government bonds and mortgage-backed securities (MBS) at a loss of USD 1.8 billion and intended to strengthen its balance sheet with an emergency capital increase of USD 2.25 billion. The following day, customers withdrew $42 billion in deposits – more than a quarter of total deposits. As a result, the institution could no longer maintain its business operations and had to be closed due to the threat of insolvency and imminent liquidity problems.
Shareholders and bondholders hit
Second-largest bank failure in U.S. history hits shareholders and bondholders hardest. Deposits are protected in the U.S. up to a cap of 250.000 USD guaranteed by the Federal Deposit Insurance Corporation (FDIC) and will be paid out in full this week. However, in SVB's case, due to its client structure – technology companies, venture capital firms, and high net worth individuals – only 6% of deposits were below the upper limit.
The success of the tech scene from 2020 was the reason for the growth in bank deposits. At the time, the bank decided to invest in long-dated U.S. government bonds and MBS – assets whose prices fell particularly sharply in value when the U.S. Federal Reserve raised interest rates. The U.S. tech industry also suffered from tighter central bank policy as VC financing dried up and companies continued to burn cash, leaving SRP averaging 14.5 billion. USD in deposits lost per quarter. Higher interest rates reduced the value of the banking book while deposits dwindled. The cardinal mistake was an overly aggressive investment book and too sloppy risk management, where interest rate risks were not adequately hedged.
Help for savers but no bailout
To limit the impact on customers and market participants arising from the failure, the U.S. government, Fed and FDIC have worked out a solution under which all savings deposits of affected banks in excess of the FDIC-backed cap will be protected. To prevent future liquidity problems for banks, a new facility (Bank Funding Term Program) was established to help banks obtain liquidity when they need to service large cash outflows. It was also decided that shareholders and bondholders should bear losses and not receive a bailout from the government.
Stricter regulation in Europe
The impact on the European banking landscape appears to be small at this stage. Thus, regulation in Europe is much stricter in terms of interest rate sensitivity of investment books. In addition, deposits are much better diversified. However, this does not preclude the possibility that, in the event of a panic, deposits could be withdrawn and banks in Europe could also be wound up. The currently much-maligned Credit Suisse seems particularly vulnerable here, but also smaller challenger banks, such as z.B. MetroBank from the United Kingdom.
In the context of the current cycle of interest rate hikes, events such as the Silicon Valley Bank failure and the LDI crisis in the U.K. are undesirable side effects in the fight against persistently high inflation. Policymakers and central banks again demonstrate that systemic risks are quickly and consistently contained in times of tighter central bank policy. Central banks' current goal is to reduce inflation by cooling the economy without jeopardizing financial stability. This should prevent unintended consequences, such as a renewed financial crisis.
Too early for end of interest rate hikes?
The interest rate market viewed the SVB rescue as a potential end to the rate hike cycle. This assumption may prove to be premature, as inflation has historically only been curbed by higher interest rates. Turning away from rate hike cycle only makes sense if inflationary trends recede or systemic risks in interest rate and credit market get out of control. It is therefore probably still too early to speculate on a change in central bank policy.
Opportunities in hedging strategies
Recent events are forcing both investors and risk managers in major banks to adjust their positions to the new environment. Volatility created by bond sales and increased hedging activity creates opportunities for strategies that benefit from relative differences between investment and hedging instruments. If the selling pressure on bonds continues, opportunities in bank bonds could also become significantly more attractive.