SVB sell-off shows where market weaknesses lie, but contagion unlikely

The sell-off in Silicon Valley Bank (SVB) shares this week does not suggest wider stress embedded in the US banking landscape. Although there are corners of the market that should now come under renewed scrutiny, we believe contagion will be limited and some larger institutions may even benefit from the fallout.

The move in SVB’s shares that wiped US$9.6 billion off its market value this week has been dramatic enough to prompt California regulators to step in to shut the bank and appoint the Federal Deposit Insurance Corporation as receiver. But we think that the risk of contagion from this incident remains low, and that larger global corporate and investment banks could even benefit from the stress.  

SVB’s positioning had placed it in a particularly tricky spot, with its deposit portfolio concentrated on mid-market growth tech firms backed by venture capital (VC), many of which are now withdrawing deposits to fund operating expenditures. New VC funding, meanwhile, has been slow to roll in. SVB had taken the opportunity in periods of high liquidity to load up on long-term, fixed rate securities that are now, in some instances, significantly underwater compared with when they were purchased.

The turning point for SVB came on Thursday when it announced losses on securities sales. Anticipating an interest rate environment that would be higher for longer, the company said it would be holding a stock offering to shore up its balance sheet. This was a pivot from the bank’s earlier positioning on rate expectations and this lack of clarity spooked investors. That concern is warranted in part because banking is the only sector where perception can become reality, where customers can withdraw their deposits due to general worries about the market rather than basing decisions solely on the bank’s fundamentals.

Other small regional banks with similarly concentrated deposit dynamics - whether from VC, high-net-worth individuals, or elsewhere - could also be susceptible to this sort of funding volatility or problems stemming from how they deploy cash. Although SVB’s situation was unique in many ways, some similar institutions are still under pressure today, and it remains difficult to know how this will play out. Those with deposit portfolios centred on commercial customers are more at risk: one business client chasing higher rates could take US$100 million out of a bank’s door on any one day, in contrast to retail banks where it would take thousands of customers making the same decision to have a similar impact. 

Larger banks with more diversified funding strategies and varied deposit bases are more resistant to these issues, even in the current environment of higher rates and quantitative tightening reducing liquidity. Global corporate and investment banks or even larger regional banks are likely to be safe from contagion associated with SVB, and there could even be an opportunity here (carefully) to buy the dip. Some of the US’ largest banks and brokers were up on Friday after a difficult day before, suggesting that people are more comfortable with their highly liquid balance sheets and diversified deposit bases.

While SVB’s closure does not necessarily mean that there is a wider risk to the banking system, it is a reminder that there will always be subsectors that are vulnerable as the environment changes. SVB was a weak link in an otherwise tight liquidity paradigm, and even though the current economic backdrop is challenging for banks, most are still liquid with diversified deposit bases. This challenge remains existential rather than fundamental.