The demise of Sillicon Valley Bank (SVB) led to the share prices of far larger and more consequential banks tumbling, despite the rescue of the stricken bank in the UK being organised quickly.
The issue for SVB was the various ways in which higher interest rates can negatively impact asset prices, according to Gilles Moëc, group chief economist at Axa.
This has already been seen in the decline in the share prices of UK high street banks and technology-focused funds.
Investors such as Alex Wright, who runs the Fidelity Special Situations fund, have significant exposure to banks – though not SVB – on the basis that higher interest rates mean banks can earn more from the bonds and cash they are required to own for regulatory reasons.
But while all banks own fixed income assets for regulatory purposes, SVB appears to have switched into predominantly long duration bonds in 2022, according to reports in our sister title the Financial Times.
Long duration bonds are usually expected to do best when a recession is expected. As in a downturn investors expect central banks to cut interest rates, making bonds with longer durations and higher yields more attractive.
SVB’s problem was that when markets expect interest rates to rise sharply and over a prolonged period of time, the initial reaction is to buy short-dated bonds, as they are less sensitive to rate rises.
As funding conditions dried up for early stage technology companies, many had to dip into their cash reserves, and in response to this SVB started to sell off its bond holdings to raise capital.
But because it was selling long duration bonds at precisely the time the market wanted short duration, it had to incur large losses, wiping out its capital position.
Rob James, a veteran banks analyst and current manager of the Premier Miton Financials Capital Securities fund, says the problem is with the business model.
He says: "By focusing on start-up and early stage tech businesses, SVB had an unusual balance sheet. Tech businesses tend to ‘burn’ cash, that is, they spend more cash than they earn. So over time their deposit balances decline as the money is spent, and then climb again with each round of capital raising from tech investors. Their demand for loans is relatively low.
"On the SVB balance sheet deposits totalled $173.1bn (£142.3bn) at the end of December 2022 compared with loans of $73.6bn. Rather than holding the excess in cash, as Barclays does, SVB placed their bet and invested in long-term US treasuries in order to earn as much interest as possible."
He says in normal times this does not matter, but because interest rates rose very quickly in the US in 2022 the price of long-dated debt fell very quickly.
