SVB Reveals Sector Cracks, Opportunities
Also Interesting
MACRO
▪ The failures of SVB and Signature Bank reveal fragilities within the U.S. banking system, particularly as it pertains to regional insitutitions (see below). Yet, we believe the situation presents some positive takeaways from a bondholder perspective. The situation will likely lead to tigher banking regulation going forward, enhancing the perception of the sector’s credit quality. Furthermore, we believe the economic ramifications (also below) point to less inflationary pressure going forward, which may indicate a supportive backdrop for fixed income spread sectors considering the relatively healthy economic backdrop (save for inflation).
▪ As we contemplate regulators’ moves to stem contagion, each step raises its respective questions. For example, the Fed’s Bank Term Funding Program that offers loans to depository institutions at OIS + 10 bps for eligible Treasury securities and MBS, which will be valued at par, is backed by a $25B buffer from the Treasury’s Exchange Stabilization Fund to cover potential losses. In essense, we view the buffer as a form of implicit capital injection into the banking system, which carries political ramifications. In addition, the program raises the issue of the stigma associated with its use (once borrowing is made public). The situation with SVB’s balance sheet and its available-for-sale securities also raises the question of how the Fed will assess borrower solvency regarding use of the program.
▪ We believe there will be tangible economic effects from SVB’s collapse. Although about 20% of U.S. credit provision flows through banks, with the remaining majority flowing through the capital markets, the bank provisioning is signficant at about $6.5T, and a retrenchment could inhibit credit creation, especially among smaller, regional banks.
▪ The fallout also extends to our expectations for monetary policy. Following Friday’s solid, but mixed, U.S. payroll report, we anticipated a 50 bps hike in the Fed funds target at next week’s FOMC meeting. However, at this point, we see a 25 bps hike on the way to a peak Fed funds rate of 5.5%, which is consistent with our prior views. Looking toward the second half of 2023, we believe SVB’s collapse adds impetus to the rationale for multiple, precautionary rate cuts towards the end of the year.
▪ The situation also broaches into the political realm given what we view as an implicit liquidity injection into the banking system and questions regarding government-related backstops for all unisured depositors (in addition to the issue of whether the Deposit Insurance Fund is large enough to implicitly cover uninsured investors). It otherwise opens some precarious questions about the government’s role within the sector.
