A rapid-pace bank collapse adds pressure for investors and the Fed

ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL

WEEKLY MARKET PERSPECTIVES — March 13, 2023

According to Barron's, SVB’s deposits grew from over $70 billion in June 2020 to nearly $200 billion at the end of March 2022. Given banks’ need to do something useful with their deposits, SVB chose to invest the bulk of their deposits in government bonds with longer-dated maturities and when rates were very low. Fast forward, and over the last year or so, SVB customers (e.g., in the start-up space) began consistently drawing down cash deposits to fund business operations and the like (as IPO activity dried up), finally creating a liquidity event that SVB could not manage through. Notably, by the second half of ’22, the backup in rates no longer benefited SVB’s net interest income, with the Fed raising rates aggressively.

What seems obvious in hindsight is that SVB invested in long-dated bonds and ultimately had an asset mismatch when rates backed up quickly, leaving it unprepared to deal with a quick drawdown in its deposit base. While the epicenter of the banking issue is squarely centered on a situation mainly unique to SVB and the types of customers it served, that didn’t stop investors from quickly turning their anxiety to other California banks. As a result, and combined with last week’s collapse of Silvergate (a cryptocurrency-focused bank), several regional banks came under intense selling pressure by the end of the week.

As one might suspect, banking stocks and Financials as a whole faced severe selling pressure as a result of SVB’s failure. The S&P 500 Financials Index lost 8.5% last week, while the KBW Bank Index shed an astounding 16.0%. For the KBW Bank Index, last week’s declines were its worst since March 2020, when the Index shed nearly 19.0% in one week at the height of the COVID-19 pandemic. More broadly, the S&P 500 Index lost 4.6%, posting its worst week of performance since September. The NASDAQ Composite fell 4.7% in its worst week since November. The Russell 2000 Index (which carries over 30% of its market capitalization across small-cap Financials and Healthcare combined) dropped 8.1%. All eleven S&P 500 sectors closed the week lower. Consumer Staples (down 1.9%), Utilities (down 2.9%), and Healthcare (down 4.0%) helped modestly mitigate some of the selling pressure. Notably, in an environment where short-term interest rates have risen this year, the 2-year U.S. Treasury yield made its biggest two-day downward move since 9/11 and Black Monday in 1987. The 2-year yield ended the week at 4.59%, after touching 5.80% following Fed Chair Powell’s appearance in front of the Senate Banking Committee on Tuesday. The 10-year and 30-year U.S. Treasury yields ended the week at 3.69%, with both term structures backing off recent yield highs. The U.S. Dollar Index was little changed on the week, Gold rose +0.7% to $1,872.60 per ounce, and West Texas Intermediate (WTI) oil fell 3.8% to $76.53 per barrel.

Regulators and the Fed take action; the Fed now facing added pressure for their next rate decision

On Sunday, regulators and the Federal Reserve employed measures to make all depositors at SVB and Signature Bank (a crypto-focused bank that failed over the weekend) whole. The Fed will also provide a loan facility to all banks if needed to help prevent similar runs on the bank. Importantly, the strength of a financial institution often comes down to the underlying confidence the market, investors, and customers place in said entity. The lightning-fast collapse of SVB last week should remind investors how precious that confidence is and how critical it is for financial institutions to maintain trust and liquidity — especially during times of stress. That said, bank stocks have come under selling pressure over recent weeks. Rising interest rates, growing fears of a recession, deposit risks, and potential losses on security holdings eroding bank stability and profitability have weighed on the industry group. However, the underlying strength and stability of the major U.S. banks are not an issue, in our view.

Yet, SVB’s unexpected need to raise capital, losses booked on low-risk security holdings, and ultimate failure last week (at a time when others in the industry are warning about deposit pressures) are putting investors on guard. Importantly, capital reserves across the major U.S. banks are on solid footing, and each has multiple levers to pull to maintain liquidity and meet depositor needs. As a result, investors and depositors should feel confident the U.S. financial system can weather higher rates and a potential recession. In our view, years of stringent Federal Reserve stress testing against various adverse economic scenarios and higher required capital cushions compared to pre-financial crisis levels have placed major U.S. banks in a position of strength with the ability to weather multiple headwinds. With that said, most major U.S. banks have recognized over several quarters that the macroeconomic environment (including threats from higher interest rates) could become more challenging. Thus, most banks have set aside earnings to reserve against potential loan losses or unforeseen risks. As a result, while we expect Financials as a group to face increased volatility over the near term and as the rate/economic environment evolves, we believe the system is well capitalized and positioned to weather incoming challenges.