A customer stands outside of a shuttered Silicon Valley Bank (SVB) headquarters on March 10 in Santa Clara, California.Justin Sullivan
The bank run that killed SVB Financial Group this week is sending a warning to investors who have flocked to some of the larger financial firms – including Canada’s biggest banks – in search of stability and dividends. Bank shareholders are now wondering: Is this the place to be if another financial crisis is brewing?
The good news is that many observers believe that the threat of a bigger financial crisis is being overstated. The bad news is that the stock market doesn’t believe them, if the sharp downturn in bank stocks is any indication.
The KBW Nasdaq Bank Index, which tracks 24 U.S. stocks including Citigroup Inc., JPMorgan Chase & Co. and Bank of America Corp., fell 7.7 per cent on Thursday, wiping out US$52-billion of value among the four largest banks and marking the index’s most severe one-day decline in nearly three years.
The fireworks continued on Friday, with the index down 3.1 per cent.
The scary part here for Canadian investors is that their beloved Big Six bank stocks, hugely profitable and widely held for their rich dividends, were caught in the selloff. Canadian bank stocks, on average, fell 1.9 per cent on Thursday and another 2.1 per cent on Friday.
Explainer: What happened to Silicon Valley Bank, and what its collapse means for banks and investors
Investors are now mulling the possibility that one troubled corner of the financial universe – that would be SVB Financial, a Silicon Valley lender based in Santa Clara, Calif. – could emerge as a source of contagion to the broader financial system, at a time when investors are already worried about a looming recession as central banks raise interest rates to tame stubbornly high inflation.
SVB suffered a run on its deposits amid withering confidence among its customers. The lender disclosed on Wednesday that it had sold US$21-billion in bonds – at a significant loss – to shore up its finances. It was also attempting to raise capital through additional share issuance, but on Friday became the second-biggest bank failure in U.S. history.
The fear is that the drama will emanate to other lenders, the way that Bear Stearns’s failure in 2008 exacerbated the U.S. subprime mortgage crisis, kneecapped lenders worldwide and contributed to a full-blown financial crisis.
The initial response from a number of observers is that investors are overreacting. They believe that SVB’s problems are specific to the lender and the impact is largely tied to the venture capital ecosystem; the broader banking sector has sufficient funds, or liquidity, to absorb losses.
“We want to be very clear here,” Morgan Stanley analysts said in a note on Friday morning. “We do not believe there is a liquidity crunch facing the banking industry, and most banks in our coverage have ample access to liquidity.”
Bank of America analysts said that big banks remained safe bets because of their large cash reserves, diversified revenue streams and strong credit profiles.
Gerard Cassidy, a U.S. bank analyst at RBC Dominion Securities, pointed out that SVB’s balance sheet was unusual among U.S. lenders: Its particular mix of longer-dated bonds and large variable-rate deposits in a rising interest rate environment – where bonds fall in value and deposits become costlier – “is toxic.”
“SVB’s deposit and asset mix differs significantly from that of all the other top 20 banks, which in our view implies that other banks are not expected to experience anything similar to SVB,” Mr. Cassidy said in a note.
Still, the lender’s difficulties this week highlight the concern that rising interest rates are not only weighing on economic activity. Higher rates might also be exposing problems in areas that had looked healthy. Consider that, as recently as Tuesday, SVB’s share price was up 16 per cent in 2023 (prior to the failure).
The stock market may now be pricing in a riskier environment, especially if the Federal Reserve maintains a bias toward hiking interest rates even more. The Fed’s actions have driven up short-term bond yields above longer-term bond yields, in what is known as an inverted yield curve, and offering a warning to investors.
“As it has done often in the past, the inverted yield curve has been signalling since last summer that something could break in the financial system if the Fed continues to tighten monetary policy,” Ed Yardeni, of Yardeni Research, said in a note.
Meanwhile, near-cash investments such as money market funds look more appealing than flailing stocks, offering yields that rival bank dividends.
Rising risks don’t have to be bad, of course. Investors who can stomach volatility can buy cheaper bank stocks with bigger dividend yields, and simply hold on until things settle down. But the holding-on part could be challenging.