Crisis of Confidence

April 2023

Silicon Valley Bank (SVB), specializing in catering to the unique banking needs of startups, positioned itself as a trusted financial institution to nearly half of all startups in the United States who contributed the lion’s share of its deposit base. Notably, the bank’s reliance on traditional retail deposits was limited, accounting for a mere 8% of its overall deposit funding. Against the backdrop of a pandemic-ravaged economy characterized by near-zero interest rates, the venture capital industry and startups experienced an extraordinary bull market, with venture capital investment in the US almost doubling from Q4 2020 to Q4 2021. Consequently, SVB’s deposits surged from $61.8 billion (USD) in December 2019 to $189.2 billion just two years later. Over this period, the Bank took the opportunity to expand its hold-to-maturity (HTM) portfolio, critically, by significant investment in long-term US treasury bonds.

SVB’s concentrated client base started to draw down its deposits and, before long, the illiquid Californian bank began selling assets to keep up. On March 8th, SVB Financial Group announced that it had already sold virtually all its available-for-sale assets (AFS) and billions of dollars of its HTM treasury bonds. The bonds that were sold had an average maturity of 3.8 years and yield of 1.8%. Relatively unattractive in the current bond market, the sales registered an after-tax loss of $1.8bn. The announcement also included the bank’s plan to raise $2.25 billion of capital for “general corporate purposes”.

Interestingly, a regulatory filing from Californian State Regulators found that the bank was “in sound financial condition prior to March 9th”. SVB’s adoption of significant duration risk suggests that the bank did not foresee the extent of interest rate pressure to come. It also likely overestimated the loyalty of its deposit base. Accurately or not, SVB’s depositors considered the announcement a declaration of inadequacy and in the 24 hours to follow, no one wanted to be the last person out of the bank. Depositors rushed to withdraw their funds, attempting to take out US$42 billion (equivalent to roughly $29 million per minute), while the share price plummeted by 60%.

The bank run would eventually topple the 16th largest bank in the United States and the largest to fail since the GFC.

Unsurprisingly, banks across the world were put under the microscope and scrutinised by anxious depositors and investors alike. Banks that were already considered higher risk as well as banks with existing controversy and questionable history were picked apart. It wasn’t long before contagion reached Signature bank (SBNY) a smaller, New York City based institution which was closed by State and Federal Regulators on the 12th of March. Following SVB and SBNY, First Republic Bank became the next most severely impacted American institution, with its shares plummeting by almost 90% this month. After a $30 billion infusion from larger firms fell short, industry CEOs are exploring additional support while new regulatory measures are being considered in attempts to allow the bank time to shore up its balance sheet or hunt for a deal.

In Europe, Credit Suisse (CSGN), a Swiss bank considered one of 30 banks systemically important to the global economy was identified as the principal industry weak point. After the persistent underperformance, scandals and mismanagement of recent years, the 166-year-old bank did not escape the scrutiny being focussed on the

industry. With stakeholders already dissatisfied and anxious, US Regulators delayed the publication of CSGN’s Annual Report, citing “material weaknesses in financial reporting”. For Credit Suisse, the final nail in the coffin came from Ammar Al Khudairy, (now resigned) chairman of Saudi National Bank (CSGN’s largest shareholder), who publicly stated that he had “absolutely” no interest in increasing his position in CSGN. Had SVB not brought such intense scrutiny upon the industry, the bank may have endured these events in a similar manner to the scandals of previous years. However, CSGN was unable to survive this crisis of confidence, and, in little time, its share price hit an all-time low of US$0.72, leading to a historic government-brokered deal for its $3.3bn sale to Swiss rivals UBS.

Back home, we haven’t yet felt the damaging fallout to the same extent as the US or Europe, and RBA Assistant Governor, Christopher Kent has reassured markets by declaring that our banks are “unquestionably strong” with capital and liquidity positions safely above APRA requirements.

Even with some relief being provided by the developments of the UBS deal, the purchase of Silicon Valley Bank by First Citizens BancShares Inc. and the consideration of additional regulatory support, it is difficult to foresee what will happen next. Gold and Bitcoin, alternate stores of value, have seen strong performance amid the crisis, suggesting that some investors recognise vulnerabilities in the traditional system and expect further volatility.

Distrust and scepticism in the banking system will not be overcome overnight. The banks who suffered the worst were generally targeted for different reasons with the market resembling a seek-and-destroy missile at times. As such, it is imperative that banks across the world bolster the confidence of their stakeholders and consider the ever-relevant sentiment of John Keynes, being “Markets can remain irrational longer than you can remain solvent”

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