March 10, 2023
Yesterday, we discussed the negative impact on bank deposits and assets from the Fed’s QT operations. The Fed’s QE program resulted in rapidly rising bank deposits and support for asset values as the central bank became the largest source of demand for bonds. The current QT program has the opposite effect with declining bank deposits and declining asset values. At last check, the Fed’s QT operations were draining bank deposits by an estimated $100B per month. Bank assets are mostly comprised of Treasury and mortgage backed bonds. We’ve seen the cumulative impact that QT and Fed rate hikes have had on bond prices, and banks are now sitting on a mountain of unrealized losses in their bond portfolios. When the Fed went down the path of tightening and QT, there were worries that something would break, and it just did.
On Wednesday, SIVB gave a mid-quarter update that included strategic actions and ~$2B common equity raise. The bank also announced that deposit outflows have been $5B higher than they expected when they last gave guidance for the quarter. Banks have many sources of liquidity, including the Federal Home Loan Bank (FHLB) where borrowing is easy and inexpensive. But rather than turning to the FHLB or other sources to fund those outflows, the bank decided to sell its entire Available for Sale (AFS) bond portfolio for a ~$2B realized loss. The $2B capital raise was likely meant to offset the realized loss. Unfortunately, the bank was raising common equity at levels below Tangible Book Value (TBV), which means the capital raise was going to be dilutive to TBV and selling pressure only intensified. This happened to several banks during the financial crisis.
The recency of the financial crisis and the systemic issues that followed generates questions about it reoccurring today. All banks are facing deposit outflows from QT, but the liquidity issue at SIVB is specific to that bank and exacerbated by a customer base of startup companies. Startups are under immense pressure themselves to raise capital, and deposits at SIVB have suffered as a result. Most banks have diversified business models and diverse customer base. Large banks have more liquidity than smaller banks and better managed in regards to risk with far more oversight from regulators. The largest banks are tested every year, sometimes twice a year and their unrealized securities losses are already counted in capital. Large banks have larger asset deposits at the Fed with strict liquidity coverage ratios.
The experience at SIVB probably means other banks will refrain from selling AFS and realizing large losses. Banks are far more likely to compete for deposits by raising the interest paid to customers. It’s also likely that the Fed reduces or halts its QT program, which explains today’s large rally in bond prices.