Timely & Relevant News: Further Discussion Of The Silicon Valley Bank Collapse

Tuesday, March 14, 2023

As a follow up from our recent timely and relevant communication, SVB Failure: What, Why and How, our team continues to pay close attention to the developments pertaining to this matter. Federal agencies have moved to protect depositors - regardless of the FDIC insurance limits of $250k. This has fascinating implications for the entire banking system.

Will This Situation Lead To More Regional Banks Failing?

Fed officials said they would also increase available liquidity to banks through a new facility – the Bank Term Funding Program. This facility will offer loans of up to one year to banks that pledge U.S. Treasury securities, mortgage-backed securities and other collateral at par. This means that banks can obtain liquidity without incurring the losses that come from selling Treasuries and agency mortgage-backed securities, which have declined in value as a result of rising interest rates. These actions were designed to limit the risk of further bank runs on small- and mid-sized banks.  

That said, these actions essentially give affected banks a year to get their balance sheets in order. They do not remove the underlying loss created from rising interest rates; they just buy time for bank executives and regulators to manage it. The expectation is that the combination of deposit guarantees and the provision of liquidity will be enough to stem the contagion and avoid additional deposit runs.

The Regulatory Environment

As a consequence of these actions, the regulatory environment will likely tighten from here for small- and mid-tier banks. Regulators may require these banks to hold more capital, which in turn will structurally lower their profitability. Regulatory changes can be phased in over multiple years, similar to what we saw after the global financial crisis.

The regional small- and mid-tier banks have generally traded at a premium to large money center banks as they generated higher growth rates and are subject to lower capital requirements and less regulation. In addition to regulation, the events of the past week will likely lead corporate treasurers to rethink or possibly diversify their banking relationships. This dynamic could make it more challenging even for the best small banks to attract and retain deposits.

What Are The Risks To Larger Banks?

Big money center banks are better diversified, well capitalized, generally more liquid and subject to much more stringent regulations than small banks. The differences include much higher capital requirements, liquidity requirements, leverage limitations, frequency of stress testing and treatment of the mark-to-market securities portfolios — avoiding the kind of asset liability mismatch that brought down SVB.

Will The Fed Postpone Raising Rates?

The Fed statement recently said: "The board is closely monitoring conditions across the financial system and is prepared to use its full range of tools to support households and businesses and will take additional steps as appropriate."

The failure of sizable regional banks combined with the shock to the banking sector will likely accelerate the tightening of financial conditions, thus making an economic slowdown or an outright recession more likely.

The Fed will likely delay rate hikes next week in the wake of these developments. Although a 25-basis point rate hike is not completely off the table. If financial markets stabilize, then the Fed will pivot back to inflation fighting. The central bank will want to separate liquidity operations from inflation progress. The recent strength in employment nonfarm payrolls shows that elevated inflation remains a risk.

Our team is closely paying attention to new developments pertaining to this matter, including a variety of signals and indicators to make wise and appropriate investment decisions.

If you have specific questions or would like to discuss your own investment strategy or financial planning needs, we welcome you to call us at 302.234.5655 or email us at contactus@covenantwealthstrategies.com to set up time to discuss further.


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