Too small to save?

Following the turmoil surrounding the collapse last week of the 800-pound tech lending gorilla, Silicon Valley Bank, we examine some of the collateral damage.

In exploring the collateral damage of the SVB fallout, we’re not referring to the bank’s depositors – including many of the bank’s corporate customers and their venture capital sponsors – who were graciously made whole by the largesse of the US Federal Reserve after it became clear that the Federal Deposit Insurance Corporation would not preside over a whirlwind takeover of SVB’s assets last weekend.

Ironically, it was the very technology that undoubtedly contributed to SVB’s success that played a critical role in accelerating its demise. The chatter over Twitter, to say nothing of SVB getting caught with a slew of low-yielding, long-duration Treasury securities during a rapid and unforgiving rate tightening cycle, didn’t exactly help.

But we digress. This is about collateral damage, and winners and losers. First, the losers. Perhaps we might refer to them as “too small to save”?

By this time it is clear that poor asset-liability management, as well as the order in which SVB chose to raise capital, contributed to its downfall. But its cash-management issues were hardly representative of many of its regional bank competitors and others in meeting their funding needs.

Nevertheless, the entire regional banking sector got pummelled, to say nothing of smaller community banks that finance so much of small business, both in the public markets and by their worried depositors who lost confidence in the ability of those banks to perform a basic banking service – protecting their customers’ deposits.

The Fed, which it could be argued bears no small responsibility for overextending massive liquidity to the banking system and then rapidly pulling away the punchbowl, rode to the rescue with another four letter acronym to provide a backstop to funding for smaller banks – the BTFP (or bank term funding program), which essentially insures that banks will have access to a $25 billion lending resource. This is courtesy of the Treasury’s Exchange Stabilization Fund, using Treasuries and other securities, valued at par, for an entire year.

Nevertheless, Charles Peabody, a founding partner and president of independent bank research firm Portales Partners, wrote in a client note on Sunday that Portales thinks “hundreds of community banks could fail during 2024 and 2025”, which means that the FDIC will be faced with “a constant need” to replenish its deposit insurance fund reserves. All this at a time when the price of Credit Suisse’s credit default swaps went sky high.

Peabody tipped Goldman Sachs as its number one candidate to take over SVB’s attractive $74 billion loan book. As it happens, Goldman served as financial adviser to SVB, before its collapse a week ago, on its strategy to shore up capital with a plan to sell $2.25 billion of securities to the public after it became clear that Moody’s was preparing to downgrade its ratings on the bank. Goldman also served as the counterparty to SVB’s $1.8 billion loss-producing sale of the long-dated Treasuries, which some believe, had it followed a share offering instead of preceding it might have prevented a run on SVB and perhaps kept if from collapsing.

“There is a good chance the meltdown of SVB could have been avoided had they chosen to raise equity before they sold assets at a severe loss, ” says Ted Koenig, chairman and chief executive officer of private credit asset manager Monroe Capital, which in late February agreed to buy Horizon Technology Finance Management, a venture lender with $1 billion of assets.

“It didn’t have to happen this way, and now all these regional banks are paying the price,” Koenig says.

All this comes amid a turning credit cycle, with the Fed’s own quarterly Senior Loan Officer Survey, released in January, already showing signs of stress in the banking sector, well before the problems surfaced, or at least became public, at SVB.

David Rosenberg, founder and chief strategist of Rosenberg Research, wrote earlier this week that “there is no better indicator” than the survey to predict the outlook on the credit cycle, and this one’s a doozy.

“Using C&I lending as an example, and based on the significant tightening in the Q1 2023 data, we can expect a rise in the default rate to approximately 9 percent towards the end of the year,” Rosenberg wrote, a considerable increase from the current 2 percent pace.

“Connecting the dots to loan loss provisions, using the big five banks as a proxy (Goldman Sachs, Wells Fargo, JPMorgan, Bank of America, and Citi) points to $17 billion needing to be set aside by the end of the year,’’ something that will prove to be a “big impairment” to the earnings outlook.

But perhaps the big banks, beneficiaries of a huge bailout themselves in 2008, can take some comfort from the outflow of deposits from regional banks into their own coffers.

As for other winners in all this – one thing that can be said with certainty is that some players in private lending stand to benefit greatly, both from the SVB debacle and the general liquidity crunch that undoubtedly will follow.

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