The only thing markets are watching, at the moment, is the fallout from the Silicon Valley Bank (SIVB) collapse last week. As nearly 50% of the global tech sector banked with SVB, it became an immediate, systemic economic crisis. Around the globe, central bankers and Treasury Departments spent the weekend looking to stem crises across the banking industry.
On Sunday, the U.S. Treasury, Federal Reserve, and FDIC stepped in and acted decisively to protect the economy and bulwark the banking system. Their plan effectively involves the mass bailout of uninsured depositors to stop a wave of possibly crippling defaults across the tech sector.
The reality, in hindsight, is that SVB was an accident waiting to happen in plain view, wholly reliant on a single sector rather than on diversified funding sources. And the bank has now been shown to have been totally incompetent at the basics of managing banking risk.
And they’re not the only one…
SVB committed the cardinal banking sin of borrowing short from its tech firm depositors and lending long by investing in long-dated “available-for-sale” Government bonds, and “hold-to-maturity” illiquid corporate bonds.
As interest rates rose and depositors found they needed more money, the bank “discovered” the rise in interest rates had hammered the value of its liquid Treasury portfolio. And if it sold its hold-to-maturity illiquid bonds, it would trigger such a loss as to make the bank immediately insolvent.
When banks die, they die fast. It reminds me of the classic quote from Ernest Hemingway in The Sun Also Rises: “How did you go bankrupt? Two ways. Gradually, then suddenly.”
It’s liquidity that kills banks. All it takes is a mere hint of crisis. Depositors fear the bank doesn’t have the money to repay everyone, and scramble to get their money out before it’s too late.
A Metaphorical Virus, and BAC
SVB is not alone in catching the virus has infected the U.S. banking industry.
The disease is a result of, in the past few years, banks being flooded with deposits, which they then largely invested in long-term, government-backed bonds, such as mortgage-backed securities (MBS). But now that rates have gone up, these banks have significant, unrealized losses on those bonds. If they were to be forced to sell those securities (such as happened to SVB), those losses would be realized.
Yes, realizing the losses would take a big bite out of some banks’ equity. But all the major banks would still have a solid equity cushion if this happened.
Of course, it’s not great that banks have all these securities that they bought when interest rates were near zero. It will be a drag on profits for years. But it will not put them into the same situation as SVB and a few other similar smaller banks.
Most banks still benefit from higher rates, as their loan portfolios reprice. For example, let’s look at Bank of America (BAC).
The bank has half a trillion dollars of agency-backed mortgage securities down in 10 years or more, yielding just 2.1%. That’s not good—the yield is well below current market yields. And unless rates return to the lows of a few years ago, near zero, any sale of these bonds before maturity will generate a big loss.
But you need to zoom out further to get a proper picture. Bank of America also has a trillion dollars in loans that will pay more interest as rates rise. It also has another half trillion dollars in cash and reserves to meet withdrawals, or to invest at higher rates.
Overall, the higher rates that sunk SVB will help Bank of America.
I believe the big winners from the SVB fiasco will be the big banks. Bank of America, JPMorgan Chase and other big banks are already crowing about how, in the past week, they were inundated with new accounts, as everyone fled smaller lenders in favor of the larger banks and their “fortress balance sheets.”
Here is how a Financial Times article on this phenomenon opened: “Large U.S. banks are being inundated with requests from customers trying to transfer funds from smaller lenders, as the failure of Silicon Valley Bank results in what executives say is the biggest movement of deposits in more than a decade.”
Bank of America will benefit as it is one of the preeminent banking franchises. It is the second-largest U.S. money center bank by assets, and is one of the top deposit gatherers in the U.S. And, the bank also has one of the top retail lending footprints, as well as one of the top corporate franchises, in the U.S., plus one of the largest online retail brokerages in Merrill Edge and one of the largest advisor forces through Merrill Lynch Wealth Management. Bank of America is a top-five global investment bank and one of the largest U.S. issuers of credit and debit cards.
Let’s not forget that scale and scope are increasingly important as the role of technology in banking grows. Bank of America is seeing increasing mobile adoption, has access to data on millions of customers, and has one of the biggest tech budgets ($10 billion) in the industry.
The current turmoil makes Bank of America stock a buy, especially with it having fallen recently to a 52-week low of $27.87. BAC’s dividend yield is now up to 3.03%. And yes, the Fed could tell the banks to stop paying dividends. But that is unlikely as the situation currently stands. Things would have to get much worse.
BAC is a buy anywhere under $30.
One final note about the current crisis: they say lightning never strikes twice, but consider this: in 2007, Joseph Gentile was the CFO of Lehman Brothers’ global investment bank, which was central to the 2008/09 financial crisis. Gentile was also the Chief Administrative Officer of SVB!
