What does the collapse of SVB mean for investors?

The issue for SVB was the various ways in which higher interest rates can negatively impact asset prices, according to Gilles Moëc, group chief economist at Axa.

This has already been seen in the decline in the share prices of UK high street banks and technology-focused funds.

Investors such as Alex Wright, who runs the Fidelity Special Situations fund, have significant exposure to banks – though not SVB – on the basis that higher interest rates mean banks can earn more from the bonds and cash they are required to own for regulatory reasons. 

But while all banks own fixed income assets for regulatory purposes, SVB appears to have switched into predominantly long duration bonds in 2022, according to reports in our sister title the Financial Times. 

By focusing on start-up and early stage tech businesses, SVB had an unusual balance sheet.Rob James, Premier Miton

Long duration bonds are usually expected to do best when a recession is expected. As in a downturn investors expect central banks to cut interest rates, making bonds with longer durations and higher yields more attractive.

SVB’s problem was that when markets expect interest rates to rise sharply and over a prolonged period of time, the initial reaction is to buy short-dated bonds, as they are less sensitive to rate rises. 

As funding conditions dried up for early stage technology companies, many had to dip into their cash reserves, and in response to this SVB started to sell off its bond holdings to raise capital.

But because it was selling long duration bonds at precisely the time the market wanted short duration, it had to incur large losses, wiping out its capital position.

Rob James, a veteran banks analyst and current manager of the Premier Miton Financials Capital Securities fund, says the problem is with the business model.

He says: "By focusing on start-up and early stage tech businesses, SVB had an unusual balance sheet. Tech businesses tend to ‘burn’ cash, that is, they spend more cash than they earn. So over time their deposit balances decline as the money is spent, and then climb again with each round of capital raising from tech investors. Their demand for loans is relatively low.

"On the SVB balance sheet deposits totalled $173.1bn (£142.3bn) at the end of December 2022 compared with loans of $73.6bn. Rather than holding the excess in cash, as Barclays does, SVB placed their bet and invested in long-term US treasuries in order to earn as much interest as possible."

Rising interest rates hurt – who knew?Gilles Moëc, Axa

He says in normal times this does not matter, but because interest rates rose very quickly in the US in 2022 the price of long-dated debt fell very quickly. 

The reason this may not be an existential crisis for the entire banking system is that, even if the high street banks are currently nursing large paper losses on their bond portfolio, because they do not presently have to sell the bonds to raise capital depositors are not fleeing their bank. 

Moëc says the actions of the Federal Reserve probably mean the problem will not infect other banks at this time.  

The market’s response has been to sell off the shares of most European and US banks on the basis that the value of their capital reserves must be called into question, potentially forcing them to raise more capital, diluting the equity or debt positions of current investors.

William Dinning, chief investment officer at Waverton, says the major impact on markets may be that interest rate expectations for the next year are radically different, with the previous expectation of multiple interest rate rises in the US now turning to a view that interest rates could be cut three times by the end of January 2023. 

Dinning notes that the 10-year US government bond price has risen sharply since the collapse of SVB, and that this is a financial asset to which people usually turn when they wish to add less risk to portfolios.

Which other entities have business models that are unsuited to the step change in interest rates?Adrian Hull, Aegon Asset Management

But his view is that right now (as of March 13) markets are operating in a state of fear, so it is hard to make longer-term judgements on the impact.

Adrian Hull, global head of core fixed income at Aegon Asset Management, says that while the actions of the Fed have soothed investors' fears that there could be a systemic problem in the banking system, the events around SVB have made the market ponder which parts of the economy are more generally vulnerable to higher interest rates.  

He says: “The markets worry and today that worry has pushed risk assets (such as non-government bonds and equities) lower in price. There remain lingering concerns, not so much around systemic banking issues, but rather which other entities have business models that are unsuited to the step change in interest rates?”

Hull says higher interest rates have reduced the amount of liquidity in investment markets, and markets are presently pondering which investments are vulnerable to this. 

Moëc sums up the market’s current reactions rather sardonically as: “rising interest rates hurt – who knew?”

Contagion conundrum

Filippo Allaoti, head of financials within the credit team at Federated Hermes, says the problem with SVB was not so much with it being a bank but instead with it being almost uniquely a bank for technology companies. 

At a time when interest rates are rising, companies that are not profitable, or profitable but have lots of debt, are most susceptible to higher borrowing costs, and he says this means that SVB was uniquely in trouble and that its demise is not reflective of wider problems within the banking sector.

He notes: “There are no listed European banks with a similar business model. Central banks have ample tools to support institutions with liquidity, including entire banking systems.”

The problems SVB faced are not applicable to the large banks.Rupert Thompson, Kingswood

Rupert Thompson, chief economist at Kingswood, agrees that SVB’s issues are not typical of the wider banking sector, saying: “While the collapse of SVB triggered memories of the global financial crisis, this time it really should be different.

"SVB was very much focused on tech start-ups and ran into problems as the rise in interest rates had led to deposit withdrawals and was forcing it to sell its government bond holdings at a loss.

"The problems SVB faced are not applicable to the large banks which do not face a run on their deposits and generally benefit, rather than suffer, from higher interest rates.”

That view is also shared by Paul Diggle, deputy chief economist at Abrdn, who says rather than the collapse of SVB signalling a crisis in the banking industry, it will mean conditions become even tougher for technology companies and those invested in that area of the market. 

He adds the events surrounding SVB have shown the consequences of higher interest rates on some segments of the economy, and this may lead contribute to rates being cut. 

Moëc says the events surrounding SVB are likely to make the Fed more cautious about the pace and scale of rate rises, but he also feels rates will continue to rise in the coming months.

The collapse of SVB may be a temporary market event, but even such events can scar clients portfolios for the long term, making whatever outcome is achieved deeply relevant for advisers.

David Thorpe is investment editor at FTAdviser