RBCPF - SVB Financial's Collapse Is Poised To Help Not Hurt The Big Banks

2023-03-12 00:48:12 ET

Summary

• SVB Financial's historic and quick collapse sent shockwaves around the markets last week, with fears running deep of bank runs on broader institutions.
• Companies across the business world are poised to rethink their deposit structures to avoid similar events to those facing businesses that banked with SVB.
• Given the systemically important nature of large US financial institutions and the government's proclivity to never let them fail, they appear set to receive significant inflows in the near future.
• Massive inflows of low interest-bearing deposits are likely to serve as a large tailwind to NII during this time period.

Check your calendars because it sure feels like 2008 after the last week in the markets. SVB Financial's ( SIVB ) historic collapse has thoroughly rattled markets, with many fearing that the contagion will spread to others throughout the banking sector.

The financials group as a whole had a week only a mother could love with banks, large and small, selling off precipitously upon news of SVB's attempted capital raise after the close of business March 8th.

What Happened?

First off, it is important to note that SVB Financial was not a typical mainstream bank. Certainly, they did hold deposits with the general public but by and large, this was a bank focused on the venture capital and start up market.

Generally, SVB specialized in serving businesses that were deemed traditionally risky among the large banks and SVB carved out a solid and highly profitable niche with biotech and technology startups... during the ultra-low rate period.

When rates began to rise in March 2022 is when SVB's business model truly began to be tested. SVB, during ultra-low rates, was simply flooded with cash by its deposit base, leading the company to heavily invest in long dated treasury securities paying paltry interest rates. Once rates began to rise, the company had a serious problem.

Not only were the treasuries they purchased losing value at a substantial rate, but the VC and startup customers they serve were failing at an increased rate given market conditions and withdrawing money at an increased rate.

The announcement on March 8th that the bank had sold off its marketable securities (at a significant loss) and proposed a $2.25 billion secondary offering sparked a panic among its interconnected customers. Peter Thiel, the controversial investor with a long roster of VC company's, along with others such as Union Square and Coatue Management blasted emails around silicon valley demanding its VC businesses withdraw funds immediately, culminating in what can only be considered a classic bank run. Customers withdrew a staggering $42 billion in deposits in a period of only 24 hours.

Just like that, a top 20 US bank, ranked by assets, was put completely out of business in literally 48 hours, marking the 2nd worst bank failure in US history.

Before the ink even dried on the FDIC takeover of SVB Financial, investors were on the hunt for the next victim. Quickly, investors circled PacWest ( PACW ), Signature Bank ( SBNY ), Western Alliance ( WAL ), First Republic Bank ( FRC ), and even Charles Schwab ( SCHW ) as potential next victims.

Bank runs and failures are more a product of psychology than of actual assets as they become a self-fulfilling prophecy, people believe the bank will fail, so, they in turn, make it fail by withdrawing all funds from the bank... Rinse and repeat until it becomes a systemic emergency.

SVB Financial certainly had its issues, however the bank, by financial metrics, was not in true danger of failing organically if not for the historic run on deposits it faced on March 8th.

While it is unclear if this contagion will spread to the regional banks listed above, or to Charles Schwab itself, but what is clear is that the government has made it abundantly clear that certain banks in the system are considered untouchable and ones that it will simply not allow to fail. Those banks are likely set to prosper, at least in the short term.

The List Of Untouchables

The little known Financial Stability Board is an international body that monitors and makes recommendations about the global financial system. Members of this board include Michael Barr, the vice chair of the Federal Reserve along with Gary Gensler, the chair of the SEC and Nellie Lang, undersecretary of the Department of Treasury.

The FSB, each year, puts out a list of global systemically important banks and the most recent report was released on November 21st, 2022. In this report, basically we are treated to a list of banks that governments around the world will simply not allow to fail.

On the most recent list, 8 banks domiciled in the USA are listed, along with 2 Canadian banks.

Systemically important banks in the United States and Canada

Name Tier (higher = greater importance)

Bank of NY Mellon ( BK ) 1

Bank of America ( BAC ) 3

Citigroup ( C ) 3

Goldman Sachs ( GS ) 2

JPMorgan Chase ( JPM ) 4

Morgan Stanley ( MS ) 1

Royal Bank of Canada ( RY ) 1

State Street ( STT ) 1

Toronto-Dominion ( TD ) 1

Wells Fargo ( WFC ) 1

___________________________________________________________

Source: www.fsb.org

The above 10 banks have seemingly been publicly identified as "too big to fail". This label is both a blessing and a curse to the banks listed above because it is abundantly clear that governments will never allow banks on this list to fail; and as such, deposits, in my opinion, are likely to be 100% backed, regardless of the FDIC amount by the US and Canadian governments.

This unwritten government guarantee comes at a high cost however as regulations and scrutiny of banks in this category is likely to continue to be extremely unforgiving. Example one would be the Wells Fargo asset cap initiated in 2018, that somehow remains, even today, on the company.

In the case of the SVB collapse, I believe the banks listed above are set to receive large inflows of deposits as businesses around the nation rethink banking relationships.

It remains to be seen if businesses with large deposit accounts at SVB will be made whole, however, companies in general are very unlikely to take a chance at losing significant capital; and just where are the places that can basically 100% guarantee deposits? The 10 banks listed above.

This massive inflow of capital I believe we are likely to see flowing into the above banks will allow each of them to significantly raise the net investment income generated from these deposits given the low interest paid out to depositors and significant spread likely to be earned in treasuries by the banks.

Fears had been rising of late regarding the NII spreads earned by the big banks given that prior to this crisis, big banks had been forced to increase interest paid to depositors accounts and in addition, had been seeing large net outflows of deposits chasing higher and higher interest income. Thanks to SVB, this fear, to me, seems like a headwind potentially turning into a tailwind.

Bottom Line

It is much too early to tell if the SVB collapse will be a pivotal moment for markets, however, it is a symptom of the ever increasing pressure from the Federal Reserve on the financial system. Regional banks certainly look set to potentially see carnage if the fear continues to spread.

The result, at least in my eyes, is likely to be that the big banks are set to grow ever larger and even more systemically important in the near future. This dynamic is likely to see big bank earnings rise in the quarters to come as the new money flows in and NII increases dramatically.

Longer term however, in my opinion, this will increase the scrutiny and oversight of big banks even further, leading to greater inefficiencies and bloated compliance costs.

In the short-term, I view big banks as quite cheap and are highly likely to outperform during the next 6-12 months. Longer term, I view big bank prospects with skepticism as increased regulation, bureaucracy and oversight is likely to choke expenses significantly in years ahead.

I look forward to your comments below. Thank you for reading and good luck to all!

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