The SVB Fallout: What It Means for ETFs

A lot is unfolding in real time. Some securities in BMO Equal Weight US Banks Index ETF (ticker: ZBK) and BMO Equal Weight US Banks Hedged to CAD Index ETF (Hedged Units) (ticker: ZUB) have been halted, leading to the bid/​offer spreads on these two ETFs widening out. 

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Detailed summaries about what happened with Silicon Valley Bank (ticker: SIVB-US) can be found at various news sites, so we will recap the key specifics:

• Silicon Valley Bank (SVB) is a regional bank rooted in the Bay Area, offering tech and startup companies a range of products — including loans, cash management, deposit services, commercial finance etc. 
• Due to interest rates being at historic lows in the wake of the pandemic, many of SVB’s customers became flush with cash, which saw its deposit balance grow significantly in recent years.
• Typically a bank will take deposits and loan them out at a higher rate through commercial loans, mortgages etc.
• However, given that demand for loans was weak, the majority of deposits were invested in ​“risk-free” securities such as treasuries and/​or Mortgage Backed Securities.
• Because rates were low before the Fed started raising rates, yields were paying next to nothing, which forced SIVB to take on duration risk to extract more yield.
• When the Fed started raising rates, this caused the bonds held by SVB to lose value.
• For banks, the securities can be placed in two portfolios:
  • Available for Sale (AFS): These securities are marked-to-market.
  • Held to Maturity (HTM): These securities are assumed to be held to maturity so are not marked-to-market, however, a sale of any bond in this portfolio forces a trigger of the entire portfolio to be marked-to-market.
• Because of Fed rate hikes, SVB’s HTM portfolio (if marked-to-market) would have been more than the common equity that supported the bank’s balance sheet
• Last week, SVB tried to raise capital through an equity raise, which led many to speculate that they were in trouble and caused many depositors to withdrawal deposits.
• SIVB shares traded down from US$267.83 on Wednesday to US$106.04 Thursday and then did not open on Friday, before failing and then going into receivership on Friday.

Over the weekend

• On Sunday, Signature Bank also went into receivership, with the U.S. Treasury, Federal Reserve and Federal Deposit Insurance Corporation (FDIC) issuing a joint statement saying the bank is closed for good.
• Signature Bank was a traditional banking institution, but also a primary lender for digital assets including cryptocurrency exchanges
• U.S. regulators then said depositors at SVB and Signature will not lose any money and will have access to money Monday morning, even for accounts in excess of $250k (which is the FDIC limit). 
• President Biden then reaffirmed this at a press conference this morning in a move to try to calm markets.

Q: Since SVB and Signature are just regional banks and the FDIC does not insure accounts greater than $250k, why did regulators have to make all depositors whole?

• This move was done to prevent a bank run on other regional banks. If you are a depositor at another regional bank and regulators did not make depositors whole, the likely reaction is that customers would be withdrawing money right away, which eventually makes the fear of bank run turning into a self-fulfilling prophecy. 
• Backstopping banks and making everyone whole is a move to restore faith in the banking system, in the hopes of preventing widespread panic.
• Even though the demise of SVB and Signature (and Silvergate) were due to its exposure to startups and crypto-related ventures, the risk is that it causes contagion in other regionals (that aren’t necessarily at risk).

Q: Why are other regionals selling off today?

• Largely, because markets fear that the regulators’ move to make depositors whole isn’t enough to calm customers. Keep in mind, the regulatory action makes the depositors whole — not the shareholders — which President Biden reaffirmed on Monday. 
• Its also possible that the market is repricing securities by assuming a marked-to-market value on the HTM portfolios of regionals.

Q: Does this cause the Fed to pause on interest rates?

• A lot can happen between now and the Fed’s meeting next Wednesday on March 22. The market is pricing in essentially a 50/50 chance the central bank does a 25bps rate hike next week. If we see U.S. regional banks continued to be stressed over the next week, it would be unlikely to see a rate hike as it would place further stress on the banks. As we have stated repeatedly on the Views from the Desk podcast, it takes 18-24 months for rate hikes to fully trickle into the economy. The full impacts have not been fully felt yet. 
• This is why long bonds are up today as further rate hikes are becoming less probable and the likelihood of rate cuts this year have increased. 

Q: Is this a short-term event, and can this be worse than March 2020?

• Hard to determine at this point. The impact currently seems contained to regional banks and, provided that the regulators’ move to make depositors whole is enough to calm depositors, it could be confined specifically to regionals with exposure to startups. 
• March 2020 was very different than the current sell-off. Three years ago, the whole global economy was shut down and it impacted all sectors. This sell-off has, thus far, been only specific to one sub-portion of one sector: banking. At the time of writing, all broad markets have rallied back with the Dow Jones Industrial Average, Nasdaq 100 and the S&P 500 Composite up on the first trading day after the crisis hit.