Not long before that, Viet Hustler had warned about the risk of twin crisis linked between public debt risk and banking financial sector risk: When bond yields rise high, the balance sheet value of banks decreases, prompting bank run from depositors (see old article here and in-depth analysis below). The Silicon Valley Bank (SVB) event, from one of the banks honored as the “best” in the US to the brink of bankruptcy within 48 hours, has confirmed this latent “twin crisis” risk.
Whether banking crisis can be avoided largely depends on the FDIC's resolution approach for SVB, the way banks and authorities reassure the crisis.
This week's macroeconomic article from Viet Hustler will focus on analyzing potential risks to the financial system and “twin crisis” to the economy from the SVB event last week.
Summary of SVB's collapse
Swift collapse within 48h
SVB was one of the banks that benefited the most during the 2020-2021 period when the Fed maintained low base interest rates to support businesses:
This bank's customers are mostly technology companies, less affected by the pandemic and benefiting from easy borrowing …
Therefore, during 2019-2022, deposits into SVB increased significantly compared to other banks.
With abundant deposits, SVB invested a large amount into fixed income, especially US Treasury bonds:
At that time, SVB proudly claimed they had a “high-quality, liquid balance sheet” with 62% of assets stored in cash and fixed incomes.
Of which 92% fixed income portfolio is Treasuries and MBS/CMOs.
However, throughout 2022, due to the impact of the Fed's hawkish interest rate and monetary policy, US Treasury bond yields continuously increased.
The peak was US bond yields rising to the highest level in 16 years last week.
Rising interest rates and current Treasury bond yields increase the deposit interest rates SVB must pay to depositors, however income from coupon payment of old fixed incomes that SVB bought in the past remains low.
Therefore, SVB faced a severe decline in net income margin: down -17% compared to previous earnings forecasts.
Meanwhile, rising Treasury bond yields also caused the real value of the old bonds SVB holds on balance sheet to decline.
This bank faced warnings from Moody’s about the possibility of downgrading the credit rating due to unrealized losses on balance sheet.
On Wednesday 03/08, to cover the loss on balance sheet, SVB announced
Selling their +21 billion USD fixed income investment portfolio, and recording a -1.8 billion USD loss
Raising an additional +1.25 billion USD from issuing common stock and +500 million USD preferred stock.
The announced -1.8 billion USD loss, although not too severe, triggered the subsequent bank run storm:
Within more than 24 hours, the amount of deposits withdrawn en masse reached - 42 billion USD, especially by a large group of SVB's customers which are Venture Capitals.
SVB quickly lost liquidity, SVB's stock fell more than -60% in value within 24 hours.
Regulators closed SVB at noon on Friday (03/10) and seized the bank's assets. FDIC took over for investigation (and possibly bankruptcy proceedings if the bank is not bailed out).
Depositors panicked about whether they can get their money back: FDIC announced SVB's branches will reopen next Monday but does not guarantee depositors can withdraw all their money.
FYI: FDIC's insurance limit for depositors is only 250,000 USD/account. However, most SVB customers have accounts larger than this insurance limit.
Causes behind SVB's collapse
Objective causes: Fed's interest rate policy pushed bond yields to record highs.
This significantly affected the real value of the bonds SVB holds and net interest margin, creating holes in this bank's balance sheet.
Subjective causes: from weak financial risk management model.
On SVB's side: This bank held a large amount of fixed incomes (especially Treasury bonds and MBS), sensitive to inflation and interest rates, but did not hedge interest rate and inflation risks at all.
The maturity of the actual fixed income investment portfolio and the hedging-adjusted investment portfolio of SVB were the same at the end of 2022.
=> this bank hardly hedged inflation risk.
SVB held approximately 120 billion USD in investment assets but did not hedge interest rate risk:
Other derivatives categories hedging interest rate risk were all empty except SWAP (only ~5.27 billion USD)
In addition, SVB could “game the system” with an extremely risky business model thanks to the small scale of the bank's investments.
In fact, banks with assets under 250 billion USD will not be subject to stricter oversight from regulators like large banks.
This is a major loophole in banking system management, contributing to this second-largest bank collapse in US financial history.
Impact of the SVB event on the economy
Impact on the tech startup ecosystem in Silicon Valley
The tech companies most severely affected so far:
Currently, companies are facing problems paying salaries to employees and operating costs because their accounts are almost in a “frozen” state.
Startup companies may also only be reimbursed 250,000 USD (FDIC insurance level) and not recover the majority of their remaining huge deposits.
This could lead to debt defaults and bankruptcy of these companies.
For companies that can hold on, staff cuts to save costs will be further intensified to compensate for the lost funds.
This will exacerbate the ongoing wave of layoffs in the tech startup sector.
Therefore, currently, Silicon Valley is hoping that SVB will be bailed out by the government.
Will the collapse of SVB lead to systemic financial risk (systemic risk)?
There are many conflicting opinions surrounding whether the collapse of SVB will cause a financial crisis like the case of Lehman Brothers in 2008 or not?
Below, Việt Hutsler will analyze the possible contagion risks in the financial system from this SVB event:
Impact on the financial system is certain
Starting from Venture Capital funds (funds investing in startups):
SVB is the bank for nearly 50% of startups backed by Venture Capitals (VCs) in the US.
Of which, 40% of tech startups and healthcare services (backed by VCs) are customers of SVB.
If tech startups go bankrupt or simply face capital problems, Venture Capitals are the first financial companies affected.
Impact on Crypto:
Circle has confirmed that 40 billion USDC (equivalent to 33 billion USD) is reserved at SVB. The floor price of USDC quickly dropped to 0.77.
Coinbase announced a temporary suspension of withdrawals over the weekend while banks are still closed.
Impact on the banking system and the risk of widespread bankrun:
Not surprising that the bank selloff wave occurred right on Friday (03/10) when a series of bank stocks declined in value:
Because, after the 2008 financial crisis, although the banking system is closely managed, most of the management is focused on large banks that affect the national or global system SIBs, G-SIBs (Systemic Important Banks and Global Systemic Important Banks)...
The possibility that banks smaller than SVB “circumvent the rules” like SVB is very high.
In addition, most banks hold treasury bonds as risk-hedging assets.
Therefore, all banks face the possibility of value decline on their balance sheet to some extent.
Facts:
One-third of deposits in the US are held in “small” sized banks.
Small banks may hold more bonds than large banks:
The total assets of small banks are 6.8 trillion USD but only 680 billion invested in stocks (lower than the stock investment ratio of large banks).
And for the most part, investors and depositors can be analyzed as above.
=> With this fearful psychology, the risk of a widespread bankrun against other banks is possible.
If all small banks could go bankrupt within 48 hours like SVBs, the possibility of a banking crisis is very high.
However, not every bank holds as much investment assets in particular and fixed income in general as SVB.
Whether a banking crisis can occur or not completely depends on the level of “ripple effect” of this event, as well as how regulatory agencies and banks handle the crisis and “reassure” public opinion in a timely manner.
For example: Algebris immediately reassured investors by pointing out that its asset and investment portfolio is different from SVB….
Twin Crises: the relationship between “banking crisis” and “public debt crisis”.
The SVB incident is a wake-up call for the Fed's aggressive short-term interest rate hikes.
Fed needs to be more cautious about the impact of interest rates on the bond market and the banking system:
Based on past data, there is a strong correlation between public debt crisis (starting from rising bond yields) and systemic banking crisis (figure below).
Causes:
Banks and credit institutions hold a large amount of government bonds as a form of safe assets, and collateral in the interbank market and repos.
When bond yields rise, the real value of old bonds held by banks decreases, causing their balance sheet to shrink.
Currently, on the balance sheet, banks are holding approximately ~ -700 billion USD in unrealized losses due to inflation and interest rate risks.
The risk will be further amplified by depositors' fear psychology leading to bank-run and reducing the liquidity of the banking system.
Twin crisis could lead to a “triple” crisis when banks stop lending to businesses or increase borrowing costs, making the investment environment difficult and leading to economic contraction and economic crisis in most sectors.
Therefore, the collapse of the 2nd largest bank in US financial history could be a warning to the Fed about what the Fed has traded off by choosing the rapid interest rate hiking path in the recent period.
The market predicts the Fed will pivot sooner and faster after the SVB event last week:
CONCLUSION
The collapse of SVB bank marks the 2nd largest failure in the US financial sector in economic history. SVB being on the verge of bankruptcy stems from both subjective and objective causes for this bank:
The objective cause is the Fed's interest rate policy pushing up Treasury bond yields (the main asset type held by this bank). This causes the value of bonds held by SVB to decline. The crisis is further amplified by depositors' concerns leading to widespread bankrun, driven by Venture Capitals.
The subjective cause comes from SVB's poor risk management, as this bank held too many fixed income assets but did not address hedging inflation and interest rate risks.
This SVB incident is a wake-up call for twin crisis risks to the Fed; the Fed needs to be more cautious about the impacts of its interest rate policy on the bond market and finance.
However, will the SVB event trigger a banking crisis like Lehman Brothers in 2008? This depends on the FDIC's handling approach and the US government's decision on bailout, as well as how banks in the global financial system manage the crisis.
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