Global Market overview including SVB and Signature Collapses
Date: 14 March 2023
Author: Ben Hakham
Topics covered: SVB & Signature collapses – idiosyncratic NOT systemic… US banking sector is 2x better capitalised than period ahead of GFC… Fed is squeezing not breaking the system…
Those who benefitted from ultra low rates will suffer the most… PE’s and VC’s have been investing at the wrong price.
The key question to ask re: the collapse of Silicon Valley Bank (SVB) and Signature Bank is, Systemic or idiosyncratic? In both cases, the word is idiosyncratic.
SVB was largely funded through the bond market. Its customers numbered less than 40,000 despite it being the country’s 16th largest bank. It was also the banker to more than half of technology and biotech start-ups in the US.
Many of these start-ups are funded by a relatively small number of very influential venture funds in Silicon Valley. As soon as this group instructed their investee companies to pull deposits, the rout inevitably led to a closure.
Many of the deposit accounts were significantly above the $250,000 FDIC insured levels. Roku, a streaming company, had to warn on Friday that it held more than $400mn in cash deposits at SVB, 25% of its total liquid assets.
No bank can survive a major run-on deposits.
By its very essence, a bank is a leveraged beast. It uses its deposits as the security to borrow in the interbank market on margin and lend on long term rates. The higher the deposit base, the less borrowing it has to do and the lower cost of capital.
In the case of SVB, the balance sheet was stretched, and the short/long rate inversion meant it was heavily squeezed.
This is not the fault of the FED. It was the fault of the bank. It was way too leveraged, way too concentrated in one category and had very concentrated customer base, who if spooked, could cause major damage.
Likewise, as of September 2022, 25% of Signature’s bank’s customer base was crypto related. At the time of writing, Janet Yellen and the FDIC have confirmed that whilst taxpayer bail-out is not going to occur, the deposits appear to have been protected through 3rd party acquisition (SVB) or a bridge facility/bank (Signature) where deposits may well be protected on a 1:1 basis.
In the meantime, other regional money centre banks came under severe share price pressure on Friday.
First Republic, a San Francisco based bank, fell more than 30% in the last few days on SVB’s woes. However, First Republic, as an example has an average deposit size in its consumer division of less than $200,000 and its commercial division has an average deposit size less than $500,000. No single sector accounts for more than 9% of deposits.
First Republic’s tier 1 ratio is at 11.6%. First Republic is an example of the strength of the US banking system since the GFC. Banks are in general 2x better capitalised and are forced into releasing regular and deep stress test analysis to the authorities.
We have been very cautious about the markets and the impending economic slowdown. However, on this occasion, we do not see that the collapse of SVB and Signature are precursors of a deeper fracture in the financial system.
There was no collapse in the bond markets on Friday. This is even ahead of a rescue plan that’s likely to be announced this morning.
What it is a sign of is that at the margin of the financial system, those businesses that thrived in an ultra-low interest rate environment are now getting hurt.
Whether it was start-up companies raising capital at excessive valuations, or their bankers or for that matter their venture funders, the rising rate environment has broken their business model.
We mentioned last week that the reason why we have not felt the full effects of the rising rate environment has been because rates have risen very fast and most consumers have not felt the full effects in their mortgages.
This is one example where at the margin, the hurt is kicking in.
Over leverage and its effects are coming home to roost. The impact will be painful to those groups that benefitted the most over the last ten years. This will include over leveraged real estate investors and many investee companies of private equity.
However, at the heart of the economic system lies a well-capitalised banking system with a customer base that has a relatively healthy personal balance sheet as compared to the period ahead of the GFC.
Clearly, as the high rates begin to show themselves in the form of higher mortgage rates and higher funding rates for the corporate sector, the squeeze will begin to impact the wider society’s ability to spend.
This is the point.
The Fed is not looking to create systemic risk but rather squeeze the consumer into spending significantly less and removing the threat of inflation.
The Fed can claim some small victories.
Friday’s unemployment rate release is a sign of the system slowing. Feb’s 3.6% rate is beginning to creep higher vs Jan’s 3.4%. Unemployment may well need to get to 5% and above before the Fed can take its foot off the interest rate accelerator pedal.
Inflation gets released tomorrow.
Consensus expectations are for 6% vs January’s 6.4% print. A figure near consensus will calm the market and illustrate that the Fed is on course.
In the meantime, do not be surprised or shocked when you hear of more collapses in certain parts of the financial system.
Watch out for RE developers, highly leveraged PE companies, highly leveraged crypto investors, and their funders.
It is a surprise to us that both Private Equity firms and Venture Capital firms have been suggesting that valuations YoY have fallen by high single to low double-digit figures 2022 to 2023.
Many of these major firms have been shoring up investee company balance sheets from their large, uninvested cash piles at the ‘wrong’ valuations in order to prop up their NAV reporting.
There is little doubt in any sensible investor mind that the unlisted private investment market will have suffered at least the same as the listed marketplace over the last year.
Private companies faced and face the same slack demand as listed companies.
In fact, during stressed times, customers tend to converge onto the better capitalised larger end of the market. ie the smaller unlisted private market will have suffered even more.
This is not reflected in PE and VC valuations.
This may well be another victim of the current environment. PE and VC fund vintages of the last 2-4 years have invested at the wrong price.
The effects will be seen over the next 1-2 years. PE and VC investing over the next 12-18 months, at realistic valuations and where the investor dictates the valuation to the investee company is far better placed to make strong returns over the next 5-7 years.
About the Author
Traderoutes Capital LLP*
“Ben acts as a CIO for a number of major family offices globally”.
*Authorised & regulated by the Financial Conduct Authority (FCA)