Well, a lot has happened over the last week making this week’s note a bit challenging. So, today we’ll write about what the government has done to mitigate the runs at small and regional banks and what has happened as a result of last week’s bank run.
As we discussed last week, Silicon Valley Bank failed due to a liquidity crisis brought about by a surge in withdrawals coupled with the forced sale of its AFS assets at a loss. The FDIC stepped in a week ago to stop the bleeding and protect depositors. Over the weekend, the FDIC and Federal Reserve Bank instituted a new bank liquidity facility called the Bank Term Funding Program or BTFP.
The Bank Term Funding Program provides emergency liquidity to banks by allowing them to borrow against their existing AFS and HTM assets. The bank can pledge their AFS or HTM assets (which may currently have unrealized losses) at face value to the Fed in exchange for a one-year loan. This new facility mitigates the need for banks to sell their AFS/HTM assets at a loss due to short-term liquidity needs. It should resolve the issue that led to SVB’s collapse.
In addition to the BTFP, the FDIC has stated that all deposits at the failed banks would be available—not just the insured deposits. This isn’t the normal procedure in a bank seizure. Uninsured depositors usually have to wait for the bank to either be sold or for the bank’s assets to be liquidated and dispersed to claimants. The FDIC’s action with SVB effectively “insured” all deposits.
These two programs by the government were designed to eliminate the fear of deposit loss and forced realized losses for equity holders. They should have stopped the bank runs and falling bank stocks. They didn’t.
Over the last week, hundreds of billions of dollars moved away from small and regional banks to the “Big Four”. As the capital left, shares of small and regional banks continued their swift decline.
First Republic Bank was particularly hard hit. Its stock declined over 23% this week until 11 other major banks were persuaded to deposit $30 billion in uninsured funds with the bank. As we wrote last week, we don’t see critical issues at the big banks and expect those companies to benefit from the current crisis in small banks. Bank of America and JPMorgan Chase noted this week that they could barely keep up with the enormous inflows of deposits.
Despite the government’s new programs and the massive inflow of new capital into the mega banks, their stocks sold off all week. The KBWB Bank Index fell 4.5% this week after a 15.6% decline the week before. JPMorgan stock alone is down over 12% during March. This doesn’t make a whole lot of sense to us and we expect that over the long-term the big banks will provide solid returns for investors at these prices.
Other financial markets had extreme reactions to the bank failures as well.
In just one week, the expected Fed Funds rate at year end declined from 5.5% to 3.5%. Fed Funds futures are now pricing in massive interest rate cuts after May. This enormous shift in Fed Funds Futures led to the largest yield decline on the 2 Year Treasury Bond since the Crash of 1987. In the last three days, the yield on the 2 Year fell by 100bps (1.0%). This move in rates was a 13 standard deviation event, meaning it is so rare we should never see it in our lifetimes.
Bond market volatility has exploded higher also and is now back to levels last seen during the 2008 financial crisis.
We are often asked why we continue to have an allocation to high quality public bond markets. This is why. When crisis events happen, investment grade bonds go up. The US Aggregate Bond Index has risen by 3.5% this month as fear has spread through the markets. Longer-term treasury bonds are up 7.9% over the same period.
As Fed Funds Futures collapsed this week, many institutional investors booked large losses. We are hearing rumors of many hedge funds who blew up this week as they were short interest rates. As these trades unwind, other markets have also been impacted. Oil markets have had a meaningful reaction to this move in FFFs. Most inflation hedges involve oil futures positions, so as inflation expectations collapsed this week, oil markets had violent reactions as funds scrambled to take off their inflation hedges. US Crude Oil prices have fallen by 12% over the last week and a half. We expect more volatility in the oil markets until the hedging unwind is completed.
Precious metals, usually a safe haven asset during crisis, surged higher in lock step with bonds. Silver was up over 9% with gold moving 9% higher as well. Gold miner stocks are up 12% since the SVB collapse. We have owned both Silver and Gold Miners as hedges to our exposure to financials and energy. They are finally doing their jobs in the portfolios.
We could go on forever in this week’s note, but we’ll cut it off here. Like we mentioned last week, expect high levels of volatility over the next few weeks.
