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Investors are bracing for the fallout from the Silicon Valley bank

Editor’s note (March 12): Since this story was published, the Federal Reserve and the Treasury Department have said that all Silicon Valley bank depositors will be fully protected.

It takes th Carrot out to discover who has been swimming naked – and on March 10 a particularly large skinny diver was caught in the buff. Silicon Valley Bank (svb), America’s 16th largest lender, was placed under receivership by regulators after a failed attempt to raise operating capital on its deposits. As officials frantically try to contain the crisis, panicked investors are looking for more of the naked body.

When a bank goes bust, the fears usually start with other financial institutions, which could end up either because of their connections to the failed institution, because they use similar business models or simply because investor sentiment deteriorates. In a panic, even smaller banks with strong businesses could lose depositors to larger, more organized competitors. svbIts failure to raise capital or sell itself to a larger group dragged down regional bank shares, which fell by about a fifth last week. The share price of First Republic Bank, another San Francisco-based bank, fell 34% over the same period.

With just over $200 billion in assets at the end of 2022, svb It falls short of institutions like Bank of America or Morgan Stanley, which are known as globally important banks with trillions of dollars in assets. svb It also has one of the highest corporate deposit ratios among U.S. banks, is more volatile than retail banks, and has a lot more loans and bonds relative to deposits. Consequently, the rapid rise in interest rates hit the bank hard. Michael Cymbalist of JPMorgan Asset Management noted this svb It was in a “world of its own” in terms of duration risk – the threat that rising interest rates posed to its portfolio.

Signs of broader distress in the US financial system were limited when markets closed on March 10th. Credit default swaps on regional lenders debt are uncommon or illiquid; Those of the larger institutions were scanty. Five-year debt swaps issued by Morgan Stanley rose from 78 to 96 basis points last week, with higher values ​​meaning higher cost of insuring against default. But the same instruments reached highs of 139 through October, and 1,300 basis points during the worst global financial crisis in 2007-2009.

Another avenue of distress was found among the companies depositing the bank. 93% of all bank deposits are not covered by the federal insurance, which only applies to those with less than $250,000. The immediate losses will be concentrated in the technology companies. svb Specializing in Lending startups with assets and income. Despite its modest size relative to the huge US banks, svb It boasted that it worked with nearly half of the American technology and life sciences companies backed by ventures in the past year. As long as deposits remain unavailable, urgent expenses such as debt repayments and payroll are at risk.

The blow to the sector could mean a period of risky behavior by technology companies and investors. Roku, a streaming hardware company, said it had $487 million in the bank in a regulatory filing on March 10. Nor is she svbThe activities are geographically concentrated as the name suggests. The make-up of the company’s international depositor base has not been disclosed, but it has a presence in Britain, China, Germany and India, among others. On March 10th, the Bank of England sought to put the British arm of the bank into bankruptcy proceedings.

The spillover effects are already visible in the cryptocurrency markets. price usdc, a stablecoin that is supposed to be pegged to the value of the dollar, fell to $0.88 on March 11. Circle, the payments company that manages usdcconfirmed that about $3.3 billion of its $40 billion reserves had been deposited svb. Investors also fled usdcthey piled into Tether, another dollar-pegged stablecoin, which rose to $1.03.

The last way to overcome adversity concerns the assets held by the failing enterprise. Selling complex structured products in illiquid markets can suddenly drive down prices, weakening the balance sheets of other financial institutions. It is unlikely that this will be true svbIn this case, since more than 60% of the company’s reported assets are in the form of US government bonds, or cash — both highly liquid markets. However, the recession will focus attention on companies and institutions with similar portfolios. These include some very large financial institutions in Asia. Japanese and Taiwanese insurers hold hundreds of billions of dollars in foreign bonds.

Three options await us svbGuarantee, sale or liquidation. Despite panicked pleas for help from a handful of Silicon Valley luminaries, the government’s bailout policies seem tough. On March 12, US Treasury Secretary Janet Yellen said officials were concerned about depositors, but there would be no bailouts for investors and owners. The Dodd-Frank Act, a cornerstone of banking regulation enacted after the global financial crisis, bans taxpayer-funded bailouts of individual firms.

According to media reports, the organizers started an auction of SVB on the evening of March 11th, which is expected to end, with or without a deal, by the evening of March 12th. When the bank was in business, there were few institutions that could buy it. US regulations prohibit mergers that result in the creation of an entity with more than 10% of US deposits, which excluded the country’s largest lenders as buyers: Bank of America, JPMorgan and Wells Fargo. But this restriction is no longer prohibited now then svb in receivership. Jupiter may find it an attractive prospect to acquire relationships svb It has with all the variety in Silicon Valley.

The statement from hundreds of venture capital firms in which they have expressed their support for the Bank, published on March 11, may be useful. Selling will depend on the potential buyer’s degree of comfort with a value svborigins. Assessing losses in its bond portfolio should be easy enough, however svb It managed to make a lot of loans – $74 billion through the end of 2022. svb Thought this is high quality. It only keeps $636 million, less than 1%, in reserve for losses. Strangers may disagree.

Without the bailout or sale, the liquidation will proceed. This process will be most evident by the relative fluidity of the svbDepositors’ assets, which means that depositors may have a proportion of their uninsured funds returned soon, even while their total losses are still unknown. Depending on how the cards fall out, and their consequences svbits clients and counterparties will be a major test for the US regulatory system – perhaps the biggest since the global financial crisis.

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