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  • Writer's pictureAndre Dirckze

Update on US bank collapse

Following the closure of the US regional bank Silicon Valley Bank (SVB) last Friday and Signature Bank on Monday, here is an update on everything we know about the banks' closures. IPL can confirm that there is no direct exposure to SVB, Signature Bank, or any other US regional bank in the IPL models. As discussed further below, we believe the Australian Financials sector exposure in the portfolio should be fundamentally resilient to contagion from the US bank problems, though market perceptions of all bank stocks may change in the near term.



Background


Following the 2008 financial crisis, regulators imposed stricter regulations on banks whose failure could jeopardise the financial system due to their size, complexity, and global reach. Improved planning to wind down operations in the face of catastrophic losses were among the measures, as were requirements to stockpile additional capital. Large regional banks, on the other hand, were exempt from some of these rules.


SVB, a regional bank, was the 14th largest bank in the United States, and it expanded rapidly during the recent tech boom. Until last year, its tech sector clients were receiving and depositing large cash inflows from capital raisings and IPOs into SVB accounts, so they had little, if any, need for loans. Whereas a major Australian bank would typically lend depositor capital to other clients (for example, to homeowners as mortgage loans), SVB ended up investing a large portion of its depositor capital in long-term US government bonds and mortgage-backed securities (MBS). Unrealised losses on these bond and MBS investments accumulated as US interest rates rose and the entire yield curve moved higher (and bond prices fell), and SVB did not hedge their interest rate exposure.


Meanwhile, the interest rate hikes caused tech sector funding to dry up in 2022, which meant that those client firms began withdrawing cash deposits from SVB. To fund these withdrawals, unrealised loss-carrying assets such as US treasuries and MBS had to be sold, eroding the bank's capital base and necessitating an immediate capital injection, causing alarm and precipitating a bank run late last week.


SVB was closed and placed into receivership by US regulators on Friday. The regional Signature Bank was also closed down by US authorities last night due to an asset-liability mismatch.


THE PRESENT -THE US AUTHORITIES ANNOUNCEMENT


On Monday we received a joint statement from the US Department of Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC).


“After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.


We are also announcing a similar systemic risk exception for Signature Bank, New York, New York, which was closed today by its state chartering authority. All depositors of this institution will be made whole. As with the resolution of Silicon Valley Bank, no losses will be borne by the taxpayer. Shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.


Finally, the Federal Reserve Board on Sunday announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.” 1


WHAT COMES NEXT?


a few years ago, a few years ago. This is not a bailout, because SVB and Signature Bank shareholders and unsecured creditors will not be protected.


The bank depositor bailout now operates as follows:

1. The Fed transfers funds to the FDIC as needed.

2. On Monday, the FDIC makes all deposits available (Monday evening, Australian time).

3. The FDIC then sells the banks' assets, which takes time.

4. The difference between the cost of depositor bailouts and the proceeds from asset sales is the actual amount lost by the FDIC.

5. The FDIC then charges the other banks a “special assessment” (or levy) to cover those losses, “as required by law,” and then pays the Fed back with the funds it collected from the other banks.


PORTFOLIO EXPOSURES


On Monday, an analysis of the WEG portfolios confirmed that there is no direct exposure to SVB, Signature Bank, or other US regional banks as a result of the portfolios' limited US equity exposure. The portfolios' indirect exposure to banks in other geographic markets via regional equities should be much less vulnerable to the problems specific to the US banking system, but it is possible that these events will have a negative impact on investor perceptions of the "riskiness" of all financial stocks globally. The portfolios' significant exposure to the Australian Financials sector has the potential for a short-term "negative halo," but it's important to remember that ASX-listed banks are subject to very different, and generally more stringent, capital regulation than US regionals.


The allocation of the portfolios to the Australian Financials sector and hybrid securities is heavily skewed towards the four major Australian banks, which have deposit bases diversified across millions of retail customers and whose deposit capital allocation is heavily skewed towards Australian mortgages and, to a lesser extent, domestic business loans. The Australian majors significantly tightened their lending standards in the late 2010s, then increased loss provisions and capital buffers during the COVID era, and the rapid recovery of their share prices in late 2020 demonstrates their far greater resilience.


While perceptions of all financial stocks may be negatively impacted in the short term, we believe that investors and security pricing will eventually recognise the relatively strong fundamentals of the portfolios' Australian financials exposures. As always our portfolios are with a long-term perspective.



Andre Dirckze

CIO

Wealth Effect Group




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