Hello,

Financial journalists have been scrambling over the last four days to explain the swift collapse of Silicon Valley Bank (SVB) late on Friday afternoon. Whilst much will be written, here is our attempt, albeit simplistic, to summarise in 300 words. Traditionally, banks generate profit by lending long at higher rates (think mortgages) and borrow at shorter, lower rates (think current accounts). The spread, or difference between the two, is the main driver of ‘net interest income’ (NII). Generally, banks have enjoyed greater NII as rates have risen. Herein lies the rub for SVB.

Given the name it’s no surprise that many of SVB’s main clients are in the tech/venture capital space. These companies became incredibly cash rich during the pandemic and flooded SVB with deposits. Which is all fine, but SVB struggled to lend this money out long term (mortgages, longer dated business loans) and therefore couldn’t maximise their NII. The most obvious option is to invest this excess capital in government bonds. Most banks (particularly those subject to Basel III rules) stick to the shorter end of the curve – this reduces the return but attempts to minimise the maturity mismatch between the assets (the bonds) and the liabilities (the current accounts).

However, SVB pushed their investments further out the yield curve to chase return. As we all now know (as seen in bond returns in 2022) these longer dated bonds are hit harder in rising interest rate environments. All fine, if you don’t have to (a) mark to market your bonds (b) liquidate the investment and can simply hold to maturity. 

Now, remember the deposit base? Those firms struggled in 2022 and had to run down their own deposits, prompting withdrawals from SVB. After a while, this forces the bank to liquidate those bond investments to pay out the deposits, thus crystalising the paper loss. The economic backdrop worsens, rumours begin to fly, and the ‘doom loop’ gathers pace until ultimately there isn’t sufficient assets (bonds and lending) to cover the liability liquidity calls (current and deposit accounts). And all that, is how we can still experience a classic bank run in 2023.

As always, if you wish to discuss anything in this newsletter in further detail, please do get in touch.

Weekly Investment News

Last week saw a choppy period for US equities as the tech-orientated and California-based Silicon Valley Bank went into receivership. Financials sector stocks suffered on Friday as the news was announced and markets became volatile. US Treasuries however performed well as a partial flight to safety took hold and investors also banked on a 50-basis point rate rise being announced by the Federal reserve this month.

The yield on the benchmark US 10 Year Government Bond fell by 36 basis points to 3.55% as a result, offering somewhat of a reprieve to fixed income markets after rising in recent weeks. This sentiment was further helped by the release of the February Jobs Report last week which despite indicating a still tight labour market, displayed that wage growth declined in the US in February. The report showed that the US added 311,000 jobs last month, above economists’ expectations and that wage growth increased by 0.2%, lower than economists’ expectations. While this paints a confounding picture of the US economy, the reduction in wage growth weakens the Fed’s argument for a tighter monetary policy. Although the labour market remains tight, the consensus from investors is that the report transpired to be softer than feared.

Elsewhere eurozone stocks ended their 2023 winning spree and hit their lowest in seven weeks, dragged down by broader downturns in financials and US stocks, returning -2.2% for the week. Meanwhile the Bank of Japan’s last policy meeting under outgoing Governor Haruhiko Kuroda left its ultra-loose monetary policy unchanged. The BoJ kept overnight interest rates at -0.1% and maintained its yield curve controls. The controversial policy is in focus for many investors recently as the BoJ remains isolated in comparison to its global central bank peers during global inflation. Japanese equities suffered as a result returning -0.5% in local terms.

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