A full banking crisis isn't apparent in the SVB wreckage

By Paul J. Davies

The market still appears to be hunting for weakness among some smaller U.S. banks and even across Europe after U.S. authorities stepped in to guarantee deposits at Silicon Valley Bank. This makes little sense: There should be no snowballing of runs on banks. But profit expectations could be trimmed at many firms, which could justify some ― but far from all ― of the price declines.

The Federal Reserve brought out its bazooka Sunday, guaranteeing funds for any bank whose depositors might have been clicking "withdraw" over the weekend. The central bank saw clear potential for a systemic crisis in the closures of SVB and Signature Bank and acted to kill it before it got started.

In Europe, the much smaller local office of SVB in the U.K. was easily absorbed into HSBC Holdings Plc in a private solution negotiated by regulators swiftly over the weekend. The chances of contagion were far smaller in Europe anyway, in part because rules designed to ensure that banks can cope with a sudden wave of deposit withdrawals apply to many more institutions than in the U.S.

SVB was knocked over by a combination of its highly concentrated deposit base and very large unrealized losses on Treasuries and mortgage bonds. There are no other publicly traded U.S. banks with balance sheets that look similar to SVB's, according to Bloomberg Intelligence's Herman Chan.

But on Monday morning, investors continued to react as if more were equally endangered. Shares in another California-based lender, First Republic Bank, dropped more than 60 percent in pre-market trading, even though its deposit base and assets are more diversified than SVB's. First Republic had only 8 percent of its deposits from venture capital and private equity related businesses and funds, versus 52 percent for SVB, and it had a much smaller portfolio of bonds, according to analysts at UBS Group AG.

Still, investor jitters and whatever the Fed was hearing at the weekend from banks about deposit flows were enough for U.S. regulators and the Treasury to deem that there were real risks for the wider banking system. The response was a system-wide solution, pledging cash in exchange for all Treasuries, agency debt and mortgage-backed bonds without any discount being applied to face value. That is like quantitative easing on demand for the financial system: No bank should fail for want of cash.

In the U.K. and Europe, there are even fewer financial firms that might look anything like SVB or Signature Bank, or Silvergate Bank, a third lender that was shuttered last week. HSBC has bought SVB's U.K. operations for a nominal ￡1 ($1.20), taking responsibility for ￡6.7 billion worth of deposits and getting in return ￡8.8 billion of assets. HSBC's U.K. bank had nearly ￡280 billion of deposits at the end of 2022, so SVB will be easily swallowed. HSBC said the tangible net assets of the business it has bought were expected to be about ￡1.4 billion. It will likely book a decent profit on the trade, which the bank will reveal in future.

This is a neat and quick solution reached because SVB U.K. was so small and there was little chance of any direct contagion from its problems. However, European bank stocks were still getting heavily sold Monday.

Fearful investors were focusing on holdings of bonds that are likely a source of unrealized losses. European banks hold €1.6 trillion ($1.7 trillion) of government bonds on their balance sheets, with Italian and Spanish lenders holding the largest shares at €466 billion and €279 billion respectively, according to Bloomberg Intelligence. Given the rise in European interest rates, many of these bonds will have fallen in value in the past year, but that doesn't mean that banks are suddenly much more risky.

Banks only lose money on these bonds if they are forced to sell them, otherwise they'll just get repaid the full value when the securities mature. They'll only need to sell the bonds if they suddenly need to pay out deposits ― and they would have to repay a lot. Banks in the U.K. and Europe are subject to stricter liquidity rules than those in the U.S., which means they are forced to keep a higher level of cash and easily sellable assets against their deposits.

Also, banks in Europe were already holding more cash than regulators require as they get ready to repay special low-cost loans from the European Central Bank this year, known as TLTROs, according to Moody's Investors Services. At the same time, the only bonds that could cause banks to book unrealized losses are those that they hold at historic cost in so-called hold-to-maturity buckets. For the majority of large European banks, these bonds account for less than 10 percent of all assets, according to analysts at Jefferies Financial Group Inc. At SVB, those holdings were 43 percent of its assets at the end of 2022. On top of that, Monday's bond rally driven by the fear in markets is already wiping out the unrealized losses.

Many banks are likely to see profit forecasts cut if this episode leads to official interest rates peaking sooner. Also, the costs of bank deposits are still rising to catch up with the rate rises that have already happened, so banks' lending margins could peak sooner rather than later, too. For banks that are already weakened, or struggling with strategy, a margin squeeze and any prolonged spell of tensions will be very unhelpful. That's likely the main reason why Credit Suisse Group AG, along with other banks deemed to be among Europe's weakest, saw its stock take another pasting on Monday. But an earnings hit for many banks isn't a crisis for the entire financial system.

This article was published in Bloomberg and distributed by Tribune Content Agency.