SVB shareholders and bondholders to be bailed in and lose out.
Moves to keep depositors whole on both sides of the Atlantic should prevent wider banking turbulence.
Issues must still be addressed over costs of capital, venture capital valuations, the role of regulators and rating agencies and the direction of interest rates in the wake of SVB’s collapse.
Will investors now Buy The Dip or Sell The Rally?
“It was Ernest Hemingway who asked, ‘How do you go bankrupt? Two ways. Gradually, then suddenly.’ Silicon Valley Bank’s share priced peaked in November 2021 and its customers had begun to steadily withdraw their money ayear ago before the final dash to retrieve cash last week, so the author’s axiom has proved its worth yet again” says AJ Bell investment director Russ Mould. “But investors now have so much more to ponder, because in the case of SVB, they are going to be bailed in and therefore lose out, while its American depositors are to be kept whole by a new liquidity scheme, backed by the US authorities and British ones by HSBC’s swoop for the bank’s UK assets.
There are three issues to be addressed:
1. How much damage can be done by the end of a period of free-and-easy money?Interest rate increases from central banks the world over – 367 in 2022 and another 40 already in 2023 according to www.cbrates.com – are doing what they are supposed to do, which is cool down the economy and financial markets. Companies’ cost of capital has gone higher and a return to the carefree days of zero-interest-rate-policy (ZIRP) is unlikely, because of the fight against inflation. Firms whose business models relied on an artificially low cost of capital are going to struggle, if not outright fail. Those who survive may need to cut costs. The US move to protect SVB’s depositors, and thus fledgling tech firms’ cash, will prevent immediate closures, but there are still likely to be casualties further down the road. Nor should it be forgotten that SVB boomed during the 1998-2000 technology, media and telecoms (TMT) bubble and then survived the 2000-03 bust (albeit after a major share price collapse). The boom was even bigger in 2000-2021 and it now looks like the fall from grace will be all the harder this time, to perhaps raise questions over other (speculative) asset classes which thrived thanks to the colossal fiscal and monetary stimulus applied during COVID and lockdowns.
2. Will the valuation of some private equity (PE) and venture capital (VC) funds come under closer scrutiny? Even as stock and bond markets took a hammering in 2022, owners of private equity and venture capital funds and portfolios remained serene. Valuations generally were not adjusted lower, even as interest rates rose, exits through stock market flotations became harder to achieve (and only then at lower prices) and share prices of already-quoted peers and rivals took a pasting. Again, the end of the ZIRP era means higher discount rates in those discounted cash flow (DCF) calculations often used to value young companies that are loss-making and cash-consumptive today, but potentially very profitable and cash generative in the future. To value these firms, a DCF attempts to put a net present value (NPV) on those future cash flows. The lower the discount rate, the higher the NPV of those future cash flows and the higher the theoretical value of the equity. But the reverse applies, and the higher the discount rate goes (as interest rates rise) and the lower the NPV, the lower the theoretical valuation of the equity and therefore the fledgling firm.
3. Have investors forgotten that higher interest rates are not just about higher net interest margins for banks, but possibly increased bad loan costs, too?Banking stocks have had a good run on both sides of the Atlantic as investors have warmed to the thought of higher interest rates leading to higher net interest margins on loan books. Net interest margins have indeed gone up at the Big Five in the UK and the Big Four Main Street banks in the USA.