In just a few days, global financial and monetary conditions have dramatically changed. The collapse of the comparatively small Silicon Valley Bank (SVB) in California will likely have big implications for Ontario and GTA real estate – this week’s Tembo Financial blog will explain how. On March 10th, 2023, SVB experienced a bank failure after succumbing to a bank run. Too many of its clients rushed to withdraw their cash from deposits in the bank. SVB reported revenues of some $7.4B U.S. in 2022, a net income of about $1.5B, and some $180B in deposits. In comparison, TD Bank reported revenues of over $42B and made a very substantial $14.3B in net income in 2021 with trillions of assets under management (AUM). SVB was a small but profitable bank by North American standards, largely catering to the U.S. venture capital, tech., and start-up community on the West Coast.
When the pandemic hit, the tech. space saw massive booms in stock valuations and activity. Working from home and shifting to remote work required big investments in technology as companies and organizations rushed to adapt. This boom in economic activity coupled with fiscal and monetary stimulus resulted in huge cash reserves and deposits flowing into SVB. The bank decided to use this influx of deposits to buy large quantities of long-term U.S. bonds. At the time, U.S. bonds were paying pathetically low interest rates (coupons) given the ultra-low interest rate environment. SVB did what most banks do when they have large amounts of cash, they invest in safe assets – and what’s safer than U.S. Treasury bills? However, when the stimulus taps ran dry, and interest rates were increased, the value of all of those bonds fell given that newly issued bonds pay much higher coupon rates.
Tech-centric companies went scrambling for cash as economic activity slowed and interest rates rose, thus increasing debt servicing costs. Note the large number of significant layoffs that have been announced in the tech. space in recent weeks and months. Meta, the parent company of Facebook, recently announced an additional 10,000 layoffs to what was already hammered down. With SVB’s deposits evaporating, the bank was left with no choice but to sell its previously bought bonds at big losses to scoop up liquidity. In the days leading up to its eventual failure, SVB tried to raise money, borrow, and attempt everything possible to accommodate the large scale withdrawals that were continuing. In the end, the bank lost the confidence of the market, and was simply unable to continue. SVB was left with a large number of bad debts that it couldn’t cover. As a result, the bank’s financial situation rapidly deteriorated, and it was ultimately taken over by the Federal Deposit Insurance Corporation (FDIC).
The collapse of SVB had a significant impact on the Silicon Valley community, as many of the bank’s clients were start-ups and small businesses that relied on the bank for funding. The bank’s failure also highlighted the risks associated with the high-risk lending practices that were prevalent in the financial industry. The Federal Reserve and the U.S. Treasury responded to the failure of SVB by guaranteeing all deposits, even those above the insured limit of $250K. They also seized similarly sized Signature Bank in New York, fearing an identical bank failure caused by similar factors. The big worry is that contagion throughout the international financial system will spread and damage the global banking system and economy. Credit Suisse, a massive European bank, has already received a pre-emptive bailout of over $50B from the Swiss Central Bank given rumours that it is close to failing. All of this spells trouble, and no one knows who else is weak, or what comes next.
What does it mean for us?
The key word is contagion. It will remain to be seen if global financial institutions will escape from the contagion that many fear. If big banks start falling, there will be huge international financial implications that no one can predict. What we expect at Tembo is that the Fed’s interest rate hiking cycle will probably be over now. This will mean that the BOC will also look very carefully at protecting the Canadian banking system, enhancing monitoring, and preparing for worst case scenarios. Higher rates are going to be a very tough sell right now. We could begin to see interest rate cuts to take pressure off of banks. This is all hypothetical, but as the adage goes, the Fed hikes until something breaks. SVB was the sound of a bone crunching. There is now a potential that the BOC will cut rates by 25 basis points at its next meeting on April 12. The world we live in is so volatile that everything can change overnight.
Fed traders believe that rate cuts are now on the horizon, as the economy cannot accommodate higher rates anymore and the banking system is under extreme pressure. Expectations are that rates in the U.S. will fall to 3.8% by the end of the year. If central banks start cutting rates, they will be signalling that the fight against inflation will take a backseat to protecting the big banks. Going down that track will be inflationary, will result in higher bullion prices, and will likely be bullish for crypto. The hope is that downward inflationary trends are strong enough and sustainable enough to overcome a fall in interest rates. Time will tell. Lower rates in Canada could make the property price declines banks are predicting milder, and could lessen the chances of a recession. Let’s hope inflation keeps falling. 