Market Commentary
Silicon Valley Bank collapse has minimal impact on ATBIM funds
By ATB Investment Management Inc. 17 March 2023 5 min read
Diversification within the funds ensures long-term resilience during these kinds of market events
The collapse of Silicon Valley Bank (SVB) last week has been making headlines in financial media, and concern about its impact abounds. From the perspective of ATB Investment Management, the direct exposure to the Compass Portfolios and ATBIS Pool funds (the funds) was immaterial.
Exposure through the S&P 500
The funds had a small direct exposure through the S&P 500 Indexed holdings, of which SVB was a member.
The S&P 500 Index tracks the 500 largest publicly traded companies in the US weighed by the size of the company. SVB in S&P 500 was roughly a 0.1% weight as of the end of February. The Compass Portfolios excluding Compass Conservative, and ATBIS US Equity Pool have holdings in the S&P 500 but only at 20-25% of the overall US equity portion of the funds.
This means the ATBIS US Pool (which is composed entirely of US equities) had the largest weight in SVB across all ATBIM funds at about 0.025%. The rest of the Compass funds (which are diversified globally), at most, had a roughly 0.01% weight for Compass Maximum Growth, and less for each of the other less equity-heavy funds.
A quick look into SVB’s background and its path to failure
- SVB was launched in 1983 to meet the financing needs of the burgeoning tech community (hence, “Silicon Valley”), and grew over time to be the 16th largest US bank.
- During the pandemic, its deposits grew faster than its loan book, and SVB decided to purchase longer-dated treasury bonds.
- When the US Federal Reserve raised rates by 4.5% over the past year, bond values fell.
- Initial withdrawals forced SVB to sell some of its bonds last week, at a loss of $1.8 billion.
- When this information became known, there was a run on the bank, which led to its eventual collapse on Friday, March 10.
SVB’s failure appeared to have stemmed primarily from:
- A failure to properly hedge their interest rate risk. There are restrictions and heavy reporting requirements around liquidity and bank capital for large (too-big-to-fail) banks. However, it is less restrictive for smaller banks such as SVB.
- SVB had a relatively non-diverse depositor base in that a disproportionate amount was smaller tech and venture cap firms.
Seeing as this is the largest US bank failure since the financial crisis of 2008, SVB’s decline has drawn comparisons to that period, and has raised concerns as to whether a similar situation may materialize again.
To contrast this event from 2008 though, SVB was a failure from a mismanagement of interest rate risk. This risk is often and quite easily hedged, and is well managed by larger banks deemed globally or domestically systemically important. Hedging is instrumental for proper bank balance sheet management.
The 2008 crisis stemmed from a much broader problem involving mortgage risk and loan impairment. Loan and mortgage impairment is something that is far more difficult to hedge, and ultimately impacted all US banks during that period. Exasperating the problem, bank capital ratios at the time were also at much lower levels than today meaning the margin for error for significantly impacting equity holders was far smaller—the change in global regulations in the wake of the financial crisis imposed reforms designed to mitigate risk requiring higher bank capital and liquidity ratios.
Exposure to other banks in the funds
Beyond the immaterial direct exposure to SVB, the funds do have direct exposure to other banks which could experience volatility as the market digests the news of SVB.
For equities in the funds, the most prominent bank equity exposure is in Canada with Royal Bank, TD, CIBC, National Bank, Bank of Nova Scotia, and BMO composing about 5% of the global equity exposure.
In the US and International, it is relatively less where all bank positions combined total about another 2.5%. The only active holding in the US is JPMorgan Chase & Co, and overseas there are four smaller positions with two in Europe, one in Singapore, and one in India.
The majority of these holdings are considered globally or domestically systemically important financial institutions, and therefore have far greater scrutiny on their liquidity positions, hedging practices, and stress test results. We do not foresee similar asset liability mismatches that led to SVB’s demise.
Fixed income backed by financials may experience some volatility also. The funds have bond holdings in bank-backed bonds. Roughly 8% of the fixed income holdings are those backed by Canadian banks such as Royal Bank and TD. Another 4% bonds are held with non-Canadian banks including Bank of America, Morgan Stanley, Goldman Sachs, and Credit Suisse. Within these bank bond holdings, overall the price has appreciated with yields moving back down over the last few days. Within the portfolios, Credit Suisse holdings are seeing the most volatility and are down a few percent, but they only represent about 1% of the overall fund’s fixed income holdings.
Federal Reserve backstops deposits to contain risk of contagion
The Federal Reserve stepped in with swift action in order to maintain confidence across the banking sector and stem risks from any further deposit withdrawals in the system. Their Bank Term Funding Program (BTFP) will provide a backstop in the event depositors at other banks decide to withdraw money. If there is a shift in behavior from Canadian or overseas depositors looking to withdraw additional funds, we would expect to see similar backstops from central banks in those regions.
Overall, equities have declined the past few days, but for balanced investors, yields have also declined significantly. The bond portion of the portfolio therefore has offset much of the volatility from equities as bond prices rise.
At ATBIM, we are watching this unfold closely but given that we have limited direct exposure, we are also looking for potential opportunities that may arise from this developing situation. Longer term, we would expect to see more regulation on some of these smaller regional banks that may have had more leeway in risk-taking than appropriate.
One potential near-term impact is how this collapse may affect the Federal Reserve’s considerations for its interest rate policy. Will it remain steadfast in its goal to bring inflation back down to its desired target level and allow more potential cracks in the system? Or does it take a pause and re-assess the risks, enough to maybe even consider a rate cut?
That path remains to be seen.
This report has been prepared by ATB Investment Management Inc. (“ATBIM”) which manages the Compass Portfolios and ATBIS Pools. ATBSI is a member of the Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Investor Protection Fund (CIPF). ATBIM, ATB Securities Inc. (“ATBSI”), and ATB Insurance Advisors Inc. are wholly owned subsidiaries of ATB Financial and operate under the trade name ATB Wealth.
Opinions, estimates, and projections contained herein are subject to change without notice and ATBIM does not undertake to provide updated information should a change occur. This information has been compiled or arrived at from sources believed reliable but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. ATB Financial, ATBIM and ATBSI do not accept any liability whatsoever for any losses arising from the use of this report or its contents.
This report is not, and should not be construed as, an offer to sell or a solicitation of an offer to buy any investment. This report may not be reproduced in whole or in part; referred to in any manner whatsoever; nor may the information, opinions, and conclusions contained herein be referred to without the prior written consent of ATBIM.
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