What Happened at SVB Financial, and What It Means for the Rest of Us

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Federal regulators have shut down Silicon Valley Bank, a major lender to start-ups in tech, after its parent company disclosed losses that sparked fears about other banks and sent shares across the industry plummeting.

Shares of SVB Financial Group (ticker: SVB), the owner of the lender, were halted Friday after plunging 60% on Thursday, which one analyst called the “stone anchor” of undervalued securities. Bank deposits should go to other institutions, but this still leaves a lot of questions.

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What exactly happened at the top of the list, and is it cause for concern. A closer look at the first question posed in the banking sector reveals that the answer to the second is “probably not”.

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how do banks make money

Most banks profit when interest rates are rising because the interest they charge customers on loans grows faster than the amount they pay depositors to hang onto their cash. A profitability metric known as net interest income or NII is used to track that.

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It shows how much money a bank brings in from loans to companies or individuals – how much it pays out to depositors and other sources of funds. The more money it makes on the former and the less it owes to the latter, the more cash flows into the bottom line and the higher goes the NII.

While the Federal Reserve sets short-term interest rates, its target for borrowing costs is not what banks offer when lending. The two run in tandem, but the latter is always high. And as anyone who’s ever taken out a mortgage or personal loan knows, borrowers tend to pay increases more quickly than banks’ rates on savings accounts or certificates of deposit.

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When the Fed raises rates, banks can charge borrowers more while dragging their feet on raising interest rates for depositors. This was reflected in the recent earnings season, when NII climbed with higher rates.

What can be wrong

When rates rise, however, banks also face higher borrowing costs. Late repayments, or failing to pay at all, could hurt them if the higher rates lead to an economic downturn.

The key issue at the moment is that rising rates erode the value of a bank’s fixed-income portfolio: the bonds fetch lower prices, the bank must resell them because potential buyers can buy new issues with higher interest rates. Are. If customers withdraw enough money, banks may want to tap their fixed-income holdings to raise cash.

This is where SVB got into trouble.

SVB serves mostly commercial customers, depositors who are more sensitive to the rates they can find elsewhere in the market. It also had a high proportion of start-ups as customers, businesses that depended on infusions of cash from investors to keep the lights on.

This worked well when money was plentiful and interest rates were near zero in 2021. But investors are no longer willing to fund those start-ups, so deposits at SVBs dwindled as new companies continued to burn through cash.

At the same time, SVB held an unusually high proportion of low-yielding fixed-rate securities that were not scheduled to mature for some time. To raise cash, they had to be sold at a time when higher rates made them less valuable, leading to losses. To offset those losses, it tried to raise more cash, issuing stock in an unfavorable environment.

California regulators closed the bank on Friday, but not before the owner’s stock had its worst week on record, plunging nearly 63%. Because it was insured by the Federal Deposit Insurance Corporation, this body would ensure that depositors would be able to access FDIC-insured funds. it was the first failure FDIC-insured bank since October 2020.

trouble with svb

The problems with SVB have been apparent to at least some people for some time. It ranks at the bottom among banks in terms of yield on its assets and growth in NII, according to lists compiled in October by Oppenheimer analyst Chris Kotovsky. He used the term “stone anchor” to describe SVB’s bondholding until Jan.

He says that SVB had a lot locked up in “illiquid, low-yield assets”. In retrospect, he said, the money should have been spread across a range of other instruments, from floating-rate securities to deposits at other banks.

It was also unfortunate that almost all of its clients were “companies with corporate treasurers whose full-time job is to manage money,” Kotovsky said. “If the fed funds rate is 4% they want around 4% on their money, and they have relationships with more than one bank, so it’s easier to move money.”

SVB did not immediately respond to a request for comment.

What does this mean for other banks

From all this it appears that the problems are specific to SVB, and that there are not many comparisons to be made between other banks. As RBC Capital Markets analyst John Arfstrom put it, SVB is in a “highly unusual situation without a roadmap.”

Although analysts say it is not impossible for other banks to face similar issues, David Trainor, CEO of investment research firm New Constructs, argues that the financial health and diversified portfolios of other banks should protect them.

All banks are dealing with the loss of value of their bond portfolios, but this is less of a problem if the lenders are not required to sell those securities. Most banks’ securities are more diversified, as are their customer bases, reducing the likelihood that trouble in one sector will cut into deposits.

As rates have risen, even average consumers are suddenly scrutinizing the interest rates they’re earning on their accounts. This could force banks to pay more on customer deposits, especially deposits held by corporates and wealthy customers. But given the hassle involved in switching banks, this is unlikely to cause serious trouble for lenders.

Kotovsky said, “After work I’ll bet you a beer that when first, second and third quarter earnings are reported, it won’t be fundamentally different for all the other big banks than analysts ” “We won’t know until October, but by the time we see the third quarter results, I think it will be an event for most of the industry.”

Write to Teresa Rivas at [email protected]

Credit: www.marketwatch.com /

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