After a year of dramatic rate increases, the negative effects are causing stress within the banking system as evidenced by the regulatory takeover of Silicon Valley Bank (SVB) on Friday. The failure of the $209B bank was the second largest in US history. What happened? In many cases, banks will fail due to defaults/losses within their lending portfolios but this was not the case with SVB. The bank’s balance sheet became impaired as the value of the US Treasuries and mortgage backed securities they owned dropped in value due to the drastic rise in rates over the last several months. SO, interest rate risk took down this bank, not reckless lending (from what we know as of Friday).
The Fed’s dramatic change in interest rate policy is not isolated to SVB. Across all FDIC banks, there were about $620 billion worth of unrealized losses in securities portfolios as of the fourth quarter. Clearly, the regulators are actively monitoring this situation and stocks of other midsized lenders such as First Republic Bank and Signature Bank were halted on Friday morning so this is something to watch.
The challenge for banks in this environment is competition for the yield on their deposits. In a zero interest rate environment, depositors keep their money in the bank as there is no yield in the T-Bill market. However, the graphic below of the yield curve shows a very attractive rate on T-Bills of up to 5% thanks to the Fed pushing up interest rates. This means depositors have an incentive to pull cash out of their savings accounts and buy short-term government securities which depletes cash at banking institutions.
This is the same scenario as a run on the bank only it is based on incentives and not fear. The unintended consequence is that banks are at risk of mismatching depository redemptions and the tenor of their securities holdings. If the securities holdings are underwater then you have a situation like SVB and the regulators will shut down the bank if they are unable to raise equity capital.
The Stock Market
This issue within the banking sector was not lost on the stock market this week as the S&P closed slightly below the green trend line. The selling looked impulsive into the Friday close which may carry into next week and losing the 12/22 low at $375 will open up the door to lower prices. We are now down 7.5% from the high established on 2/2 and there looks to be more downside ahead.
Economic Data
- The nonfarm payroll report for February was reported at +311k higher and the private sector contributed 265k of these jobs. As you can see in the graphic on the right, most of the job gains are coming from the leisure/restaurant sector while technology companies continue to downsize their headcount.
- The unemployment rate is now 3.6% as the 177k person increase in the household survey was more than offset by the rise of 419k in the labor force size.
- Initial jobless claims rose back above 200k for the first time since the first week of January at 211k, up from 190k last week and 16k more than forecasted.
- The employment to population ratio rose to 80.5%, returning to the pre-pandemic level in February 2020.
- The February Challenger survey showed the 77,770 job cuts show “February’s total the highest for the month since 2009….”.
- The Bank of Canada took a break on rate increases and went unchanged at their rate policy meeting this week.
- The Reserve Bank of Australia increased by 25 bps to 3.6% but signaled that they may take a break as inflation looks to have peaked.
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President, Kisco Capital