Liquidity and Volatility Take Center Stage This Week

U.S. Investors are chasing safety, amid the Silvergate crypto situation and Silicon Valley Bank (SVB) failure, as concerns about financial stability bubbled up this week. This morning’s SVB/FDIC closure even overshadowed the morning’s jobs report that was relatively positive on wage inflation. Bank of America has already pointed out that investors have pulled $500 million from equity funds and have piled $18.1 billion into cash and $8.2 billion into bonds this week. The 2-year Treasury yield rallied as much as 24 basis points this morning and the KBW Bank Index dropped by as much as 19% during the week. Those are dramatic shifts and a signal that uncertainty is elevated.

So, how do we decipher these events? The Silvergate event was a classic “all-in” situation involving crypto funds, but the SVB failure has investors and bank analysts asking fundamental questions like: What other banks are saddled with low-interest rate bonds with losses? What other banks are fighting to keep deposits in place? Why didn’t someone (regulator, analyst) see this coming and the big question, could SVB possibly be a canary in the depository coal mine? First Republic, another firm that specializes in startup funding already had its shares halted after dropping more than 50%.

It creates concern around depositories and the sources they are using to fund their balance sheets. But it should only be a concern for banks and credit unions that fund with volatile liquidity sources. SVB’s balance sheet was almost entirely funded by corporate and money market deposits from the same venture technology groups that it lent to. These are volatile by nature and there was very little in the way of “core” or sticky funding on their balance sheet, even if it showed up on a call report as a checking account. These technology startup depositors burn through cash/deposits, especially as rates rise. That is a problem by itself but even more problematic when you combine that with their portfolio makeup. As of their December 2022 call report, SVB’s portfolio yield was 1.75%. With the portfolio yield that low it indicates that SVBs portfolio was primarily made up of bonds purchased during the low-rate cycle of 2019 – 2021 and therefore heavily under water. In fact, the unrealized loss of their portfolio was about 15% of the portfolio’s total value, and at -$17.7 billion was larger than their Tier 1 Capital of roughly $17 billion. So, they had hot money deposits/funding and a bond portfolio that was most likely too long with large losses. That is a recipe for problems.

From a pure ALM standpoint this seems like it should have been picked up in their contingency funding and contingency capital plans. Both plans require extreme stress testing. Most of our clients have adequate core funding and contingent liquidity sources available, but it is never a bad time to review the stress scenario sections of the contingency funding plan and contingency capital plan we produce each year and make sure the board/ALCO are aware of the results.