SVB and bank runs

Silicon Valley Bank was wound up by the regulator.

It matters, because SVB was the 16th largest bank in the US.

That’s bad, and the first high profile banking victim for a while.

Now, normally banks make more money when rates go up.

The way a bank normally gets into trouble in a higher rate environment is because they made a whole bunch of bad loans to low quality credits who then default.

SVB have managed to go belly up not through poor credits, but through poor interest rate risk management.

SVB had 93% of the deposit base uninsured (no federal deposit insurance guarantees), with those deposits funding tech/VC type activity (there’s a reason it is called the Silicon Valley Bank!). That alone is a shaky enough mismatch between how you raise the money vs how you lend it out, and that imbalance is worth keeping in mind as you go through the below.

Problems originally got underway when all those tech-based businesses, who were burning cash flows in their underlying companies, and were shut out of equity capital markets through the sell-off in tech/growth-style companies, needed to access those deposits.

Now SVB had much of the deposits in turn invested in high quality liquid assets (HQLA), with most of it in fixed rate bonds (actually, plenty of RMBS, but we’ll not go too deep here, into conversations of convexity).

Those bonds are/were experiencing mark to market losses, as yields rise.

Normally, not a problem! You can just hold to maturity, yes? And banks do classify the invested deposits as AFS (available for sale) and HTM (hold to maturity), and SVB had them as mostly HTM, so no mark to market risk?

Sure, unless there’s a run on the bank.

Unless those uninsured depositors get worried about everyone else pulling out there money. Unless those depositors were wanting their money back because of cash burn in their underlying companies.

Then the bank, like a fund manager, has to meet those redemptions, by selling down the HQLA assets.

In which case the losses are realised. No hold to maturity, to get the face value of the bond back.

And boom.

What foreshadowing does SVB have for macro markets?

Well, perhaps not much directly. It’s not going to spark material counterparty risks, or contagion risks, to the banking sector at large.

And having the regulator step in to wind up the bank is a good thing, acting swiftly. It’s way better than the counterfactual of letting things fester. They will “probably” seek to make deposit holders whole, as they sell off the assets. Given that the bonds of SVB are trading well above zero, it suggests there should be enough (given that deposits are above most bonds, in turn above equity, in the capital structure).

But it is emblematic that we are at the stage where “stuff breaks”, in the rate hiking cycle.

Stuff always breaks, that’s how the Fed knows to pause, usually the “stuff that breaks” is the labour market, where job growth tanks, and the unemployment rate rises. But asset prices falling is a part of that.

We are quite defensively positioned across all of our strategies, DAA funds, direct equities. We are quite defensively positioned because of precisely the above sorts of things. So seeing them happen doesn’t compel us to get more defensive, or to get “more worried”. We were already worried.

If there’s a real pull back in markets, great, we’ve got loads of defensive assets that can be rolled into now cheaper (as in, prospectively cheaper) risky assets.

And over the long run, that would be a very good thing, for ex ante returns.