SVB collapse a sign of pain coming from end of easy-cash era

Risks were brought to the fore last week as US tech specialist Silicon Valley Bank was shut by California banking regulators on Friday, sparking a rout in bank stocks. SVB was seeking funds to offset a hit on a $21 billion bond portfolio due to surging rates, as customers withdrew deposits.

Central banks meanwhile are shrinking their balance sheets by offloading bond holdings as part of their fight against hot inflation.

Some of the potential pressure points could be:

Banks

Banks have shot up the worry list as the SVB rout hit bank stocks globally on contagion fears. European banks slid on Friday after JPMorgan and BofA shares fell over 5% on Thursday.

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SVB’s troubles stemmed from deposit outflows as clients in the tech and healthcare sectors struggled to raise cash elsewhere, raising questions over whether other banks would have to cover deposit outflows with loss-making bond sales too. In February, US regulators said US banks had unrealised losses of more than $620 billion on securities, underscoring the hit from rising interest rates.

Germany’s Commerzbank issued a rare statement playing down any threat from SVB.

For now, analysts saw SVB’s issues as idiosyncratic and took comfort from safer business models at larger banks. BofA noted European banks’ bond holdings have not grown since 2015.

“Normally speaking, banks would not be taking big duration bets with deposits, but with such rapid rate rises it is clear why investors could be worried and are selling now and asking questions later,” said Gary Kirk, partner at TwentyFour Asset Management.

Darlings no more

Even after a first-quarter surge in stock prices, higher rates have dampened the willingness to take punts on early-stage or speculative businesses, especially as established tech firms have issued profit warnings and cut jobs.

Tech firms are reversing pandemic-era exuberance, cutting jobs after years of hiring sprees. Google owner Alphabet plans to axe about 12,000 workers; Microsoft, Amazon and Meta are together firing almost 40,000.

“Despite being a rate sensitive investment, NASDAQ has not responded to the implications of interest rates. If rates continue to rise in 2023, we may see a significant sell-off,” said Bruno Schneller, a managing director at INVICO Asset Management.

Default risks

The risk premium on corporate debt has fallen since the start of the year and signals little risk, but corporate defaults are rising.

S&P Global said Europe had the second-highest default count last year since 2009.

It expects US and European default rates to reach 3.75% and 3.25%, respectively, in September 2023 versus 1.6% and 1.4% a year before, with pessimistic forecasts of 6.0% and 5.5% not “out of the question.”

And with defaults rising, the focus is on the less visible private debt markets, which have ballooned to $1.4 trillion from $250 billion in 2010.

In a low rate world, the largely floating-rate nature of the financing appealed to investors, who can reap returns up to the low double digits, but now that means ballooning interest costs as central banks hike rates.

Crypto winter

Bitcoin staged a recovery at the start of the year but was languishing at two-month lows on Friday.

Caution remains. After all, rising borrowing costs roiled crypto markets in 2022, with Bitcoin prices plunging 64%.

The collapse of various dominant crypto companies, most notably FTX, left investors shouldering large losses and prompted calls for more regulation.

Shares of crypto-related companies fell on March 9, after Silvergate Capital Corp, one of the biggest banks in the cryptocurrency industry announced it would wind down operations and sparked a crisis of confidence in the industry.

For sale

Real estate markets started cracking last year and house prices will fall further this year.

Fund managers surveyed by BofA see China’s troubled real estate sector as the second most likely source of a credit event. European real estate reported distress levels not seen since 2012 by November, law firm Weil, Gotshal & Manges found.

How the sector funds itself is key. Officials warn European banks risk significant profit hits from sliding house prices, which is making them less likely to lend to the sector.

Real estate investment management firm AEW estimates the sector in UK, France and Germany could face a 51 billion euro debt funding gap through 2025.

Asset managers Brookfield and Blackstone recently defaulted on some debt tied to real estate as interest rate hikes and falling demand for offices in particular hit property values.

“The reality that some of the values out there aren’t right and perhaps need to be marked down is something that everyone’s focused on,” said Brett Lewthwaite, global head of fixed income at Macquarie Asset Management.