First things first, we’d like to arrange an initial chat
Last week started on Sunday, really. The US Government took control of Silvergate and Signature banks. It had already orchestrated a bail-out of Silicon Valley Bank (SVB) on Friday.
Upon re-opening on Monday, markets saw a full-blown panic, resulting in most regional banks’ stock prices dropping by 40%. Another bank that faced risk is First Republic, on the West Coast.
Mistakes in Risk Management?
There was more to it all than just plain risk management mistakes. These banks were relying on customer deposits to offer mortgages and buy long-date assets (i.e. Treasuries).
While short term interest rates were at zero, they did not need to remunerate the accounts of savers. They could have bought securities yielding 3% to 3.5%. When the Fed kept on hiking rates, a number of savers withdrew their money to put them into money market funds yielding at least 4%.
Issues with Liquidity and Funding Led to Underperformance
Two consequences arose from this: (1) a liquidity issue for these banks to cope with the withdrawals, and (2) subsequently a funding cost issue, since replacing these deposits with borrowings in financial markets carried a minimum cost of 5% to 6% – so assets were earning 3.5% and new borrowings were at 6%.
This led to equities underperforming across the board and fixed income rallying to new highs (all interest rate increase expectations were unwound). This resulted in wild movements in short-term interest rates.
Early in the week, global equities had lost around 3% and closed at -1% to -1.5%; on the back of commitments by the Fed, the FDIC and the US Treasury to inject sufficient liquidity in the system and guarantee deposits of the three stricken banks.
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