While we highlighted the main shock of Silicon Valley Bank (SVB) in a previous blog post, the secondary effects of their demise were still largely unknown. The ripple effects of their collapse, however, are starting to become clearer, both domestically and internationally.
While SVB may have been the poster child, it was in no way the only bank facing the same risks.
First Republic Bank (FRC) was founded in 1985 and prided itself on a careful lending culture and exceptional client service, which led it to cater to a wealthier demographic with large deposits in excess of the FDIC limits. As FRC customers saw what transpired at SVB, they began to question the safety of their own deposits.
Within a week, FRC lost 40% of its deposits ($70B) and its ability to continue to operate is now under intense scrutiny. On March 16th, FRC announced that it had received $30B in uninsured deposits from eleven large banks to provide a backstop. Additionally, FRC borrowed between $60B and $149B from the Federal Reserve (Fed) and the Federal Home Loan Bank (FHLB).
While this largely covers its liquidity concerns, it brings up another issue: the cost of capital. In essence, many banks used zero-cost customer deposits and locked in 1.5%-2.0% returns but are now faced with having to pay 4.0%-5.0% on deposits as depositors demand higher rates. This is not sustainable.
While the effects of sharp rises in interest rates have largely plagued US institutions over the last couple weeks, this past weekend saw the first international casualty—Credit Suisse. Credit Suisse was the second largest bank in Switzerland with a history of 167 years. In addition to poor lending standards, the bank has been wrought with scandal. The Swiss National Bank (SNB) feared what happened at SVB could soon transpire at Credit Suisse. As such, the SNB essentially forced UBS to acquire Credit Suisse for $3B and assume $5B in losses. In exchange, SNB would provide UBS with $100B in liquidity and backstop $9B in losses.
Why Are Regional Banks Important?
According to the Wall Street Journal, banks outside of the top 25 account for nearly 40% of all outstanding loans and nearly 70% of all commercial real estate lending.
These banks are vital to the US economy. JPMorgan and Bank of America do not want to service small business loans; they are focused on serving large institutional clients. Regional banks lend to small and medium-sized business that might be otherwise ignored, thus their importance. If regional banks experience large customer withdrawals, pull back on providing loans to preserve liquidity or struggle to navigate interest rate pressure, we could see fallout in this space. But, if there is one thing we’ve learned in times of economic stress, it’s that there will likely be government intervention.
What Policies Have Been Put in Place to Prevent More Aftershocks?
- Bank Term Funding Program: Within two days of the SVB failure, the Fed, in conjunction with Treasury Secretary Yellen and the FDIC, announced the Bank Term Funding Program (BTFP). This should provide banks with additional liquidity to cover customer withdrawals without having to sell securities at a loss. While this program is only in place for a year, the hope is that customers no longer rush to withdraw money on the fear that their bank is not liquid.
- International Coordination: This past weekend, the Fed and a number of international banks announced that they would work together to provide liquidity on a global scale and ease the strains on the supply of credit to households and businesses.
- FDIC Limit Review: It was announced on Monday that the US Treasury Department was reviewing whether federal regulators had emergency authority to lift the cap on FDIC insurance limits without having to go through Congress. The last cap raise came in 2008 when the coverage was raised from $100K to $250K for an individual account.
- Smaller Bank Support: Lastly, Treasury Secretary Yellen has signaled that similar deposit guarantees would be warranted for small banks that suffer bank runs if they are deemed to pose a risk of further contagion.
While these are largely Band-Aids, they buy the Fed time to evaluate the situation and chart a path forward for US interest rates. We will hear an update from the Fed today. Our team is watching this situation very carefully. Please don’t hesitate to reach out if you have questions or concerns. As always, we appreciate the trust you place in us.
The opinions expressed are those of PYAW’s Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed.
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