The warning for Australia from the collapse of SVB

The spectacular collapse of Silicon Valley Bank (SVB) has sent shockwaves through Wall Street as fears of contagion gather speed. The bank’s demise can be traced to two primary causes:

1. It bought bonds of long duration at near-record low rates from 2019-2021 and as interest rates rose sharply, the losses from these bonds, combined with leverage, had a serious impact on its balance sheet.
2. As the bank tried to raise capital, its vulnerabilities garnered the attention of large tech company customers, who pulled money out of deposits, causing a run on the bank.

The question for investors here is how the bank’s closure will impact Australia. Here are some ideas.

Direct effects

A host of Australian listed companies are disclosing banking relationships with Silicon Valley Bank.

These include hotel software provider Siteminder and family tracking app Life360.

Ownership Matters also says EBR Systems, LayBuy Group, Straker Transactions, Whispir, and Nightingale also have relationships.

The announcement by the US authorities that depositors will be made whole has mitigated this risk but there may be delays in getting full access to the funds.

What other companies are exposed to major bond losses? 

The hunt is on for other companies and sectors that are vulnerable to losses on long-duration bonds. While these losses would be of concern, it only becomes a serious issue if companies become forced sellers of these bonds.

Already, regional US banks are coming under scrutiny from unrealised bond losses on their balance sheets. And brokers such as Charles Schwab have significant unrealized losses too.

One sector that hasn’t been mentioned is the insurance sector. Most global insurers have significant exposure to long duration bonds due to the nature of their business model that seeks to match their assets with liabilities. Inevitably, there will be large unrealized losses on many insurer balance sheets and the big questions are how well they are capitalized and whether they have forced to raise capital or sell assets because of these losses. 

If any global insurers do have issues, the impact would be felt globally.

Is Australia’s financial system vulnerable? 

Directly, it’s highly unlikely. According to the RBA, Australian bank assets invested in tradeable securities is close to 5% of total assets, compared with 20% for overseas banks.

The banks are also subject to liquidity coverage standards to ensure they would have enough capital in case of an SVB-like ‘run on the bank’ situation.

Finally, the banks are held to regulatory standards such as interest rate risk in the banking book (IRRBB) which ensures they hold a certain amount of capital to withstand higher interest rates. And over the past 12 months, the major banks have had to significantly increase such capital in response to higher rates. 

Theoretically, the banks should benefit from rising interest rates as it benefits their net interest margins. That’s exactly what happened through much of 2022. But late last year, into this year, those margins have been crunched by increased competition in the mortgage market.  

Yet, while Australia’s financial system should escape a direct fallout from SVB’s closure, its vulnerabilities may receive greater scrutiny: 

1. Reliance on overseas funding

About one-third of funding for the financial system relies on wholesale debt (debt from institutional investors) and 20% is funded from overseas.

2. Concentration on loan book in residential property 

Part of SVB’s downfall was that its reliance on the tech sector for most of its deposits. Australia banks have a different yet comparable issue: an extreme concentration of their loan book in real estate. About 60% of their loans are to housing, and a further 7% to commercial property. 

Most of the housing loans are variable rate, that are susceptible to rising interest rates. With household debt to income at around 190% and the size of the residential property market around 6x the size of Australia’s annual GDP, any further downturn in property prices could have large ramifications for the banks and the economy.

Both these risks shouldn’t be downplayed as they’ve played a part in prior Australian economic downturns. As mentioned in a previous article, the early 1990s recession was caused by loose bank lending and over-exposure to real estate – in this case to commercial property, which fell in cities such as Sydney by 40%. Many banks collapsed including the State Bank of Victoria, the State Bank of South Australia, the Teachers Credit Union of Western Australia, and the Pyramid Building Society in Victoria.

In the 1930s, Australia was seriously impacted by the Great Depression principally due to its reliance on overseas funding for public works. When prices for commodities such as wool went south, that overseas funding quickly dried up, draining capital from our financial system when it needed it most.

And in the 1890s, a massive housing boom turned bust, combined with skittish overseas funding being pulled, sent the country into an economic depression.