SVB Collapse: Small and Mid-Sized Banks Under Pressure

U.S. regulators unveiled a contingency plan on Mar. 12 to avert a financial crisis following the collapse of Silicon Valley Bank.

Two banks failing within three days has Wall Street on alert even though the Federal Reserve stepped in on Sunday and said all depositors would receive their money.

While the customers of the two banks varied greatly, Silicon Valley  Bank in California worked with tech companies and venture capitalists and Signature Bank in New York had some crypto clients, these two failures "likely will raise questions about some small- and mid-sized banks," wrote Paul Christopher, head of global investment strategy at Wells Fargo Investment Institute (WFII) on Mar 12.

Both of the banks that collapsed had the same thing in common - their "overexposure to assets whose values come under pressure as interest rates rise and their concentrated business models," he said.

Concerns of contagion and that more banks would be shuttered by the Federal Deposit Insurance Corporation (FDIC) are unfounded, he said.

Risk to the remainder of the banking industry is low since "most" banks are well capitalized and have diversified balance sheets, Christopher wrote.

Silicon Valley Bank's investments into long-dated Treasuries was ill-timed and the bank's investment team should have sold them in March and June of 2022 to "avoid the mounting losses," Lucilio (Louie) Coutous, former president and CEO at American Plus Bank in Arcadia, Calif., who was a senior bank examiner at the FDIC for 16 years, told TheStreet.

Bad Bet on Treasuries

"The longer they waited the worse it got for them," he said. "It just doesn’t make sense from a risk management perspective."

SVB was forced to sell the bonds in its portfolio of investments at a $1.8 billion loss. The California bank's failure, which is the second-largest of a bank in U.S. history, has shaken many investors. It was the result of a bank run, caused by the firm’s announcement that it planned to raise $2.25 billion by issuing new common and convertible preferred shares to shore up its finances after the bonds were sold. 

Banks who invested in long-dated Treasuries and mortgage-backed securities saw their values crumble, declining "on paper since interest rates have risen," Christopher wrote. 

As the Federal Reserve raised interest rates to combat increasing inflation, depositors also sought higher yields for their cash. Banks were forced to sell their long-duration assets in order to have cash to give depositors when they withdrew their money and transferred them to banks giving them higher rates. 

"These sales recognize losses that previously had only been on paper," he wrote. "Some banks will be obliged to write-down capital, but we do not believe this problem affects the banking system as a whole."

The financials equity sector saw the stocks of SVB's parent company, SVB Financial, tank earlier in the week as investors punished the company. Wells Fargo maintains its neutral rating on the financial sector.

The large banks are "well-capitalized and have passed rigorous stress tests administered by the Fed," Christopher wrote.

No Liquidity Crunch, Morgan Stanley Says

Most banks have set aside "reserves to cover potential losses that may occur in a recession," he said. 

Despite the tightening of financial conditions, loan growth has "remained steady," Christopher wrote. "However, even with higher rates, net interest margins have fallen below pre-pandemic levels."

Investment bank Morgan Stanley said the banking industry is not facing a liquidity crunch.

"Most banks in our coverage have ample access to liquidity .. it is reasonable that market focus on the trajectory of interest rates will revert to the labor market and inflation,” the bank wrote in a research report.

Goldman Sachs said that the banks it analyzes are "well in excess of their regulatory minimums with the G-SIB averaging 12.3% .. all of the negative marks from higher rates that banks took through their capital last year on their available for sale portfolios has already flowed through..”