The US$208 billion asset lender was shut down by US regulators after losses in its bond portfolio and failed attempt to get new funding caused a bank run and a liquidity crisis. — AFP photos
IT’S been a tumultuous month for banks as Friday, March 10, 2023, saw the second largest failure of a US bank, Silicon Valley Bank (SVB), after the shuttering of Washington Mutual in 2008.
The banking world, thought to have been neutered of its excessive and systemic risk potential following drastic regulatory tightening in the wake of 2008’s Global Financial Crisis (GFC), saw these concerns resurface following the collapse of SVB which is the 16th largest US bank by asset size.
The US$208 billion asset lender was shut down by US regulators after losses in its bond portfolio and failed attempt to get new funding caused a bank run and a liquidity crisis. This was followed by failure at Signature Bank, another US bank.
The episode caused a stir in the equities market the following week especially in Asian markets as investors questioned the health of the banking sector.
Concerns of liquidity remains unabated. Statement by US regulators that depositors of SVB will be able to receive their deposits, implicitly guaranteeing the deposits, led to some calm in the market.
However, mid-week saw renewed concerns of banks’ liquidity, this time in Europe when the biggest shareholder at Credit Suisse Bank made a statement that it cannot increase its holdings. As a result, Swiss national bank stepped in to offer a liquidity lifeline.
The banking turmoil in the US began on March 8, when Silicon Valley Bank reported that they sold US$21 billion worth of long-term bonds at a loss of US$1.8 billion to shore up capital and meet customer withdrawals and subsequently abandoned a share sale of US$2.5 billion.
The move spooked the markets and some of the bank’s clients, the bank mainly serves tech companies and high net worth individuals, began to pull money out of the bank, and the news spread out causing more depositors to flee. On the next day, depositors initiated US$42 billion of withdrawals.
Almost all of the deposits at SVB are uninsured, as the Federal Deposit Insurance Corporation (FDIC) only insures up to US$250,000 per individual. By Friday, SVB was insolvent as the deposits were negative and US regulators took over the bank over the weekend.
Subsequently, depositor began to flee banks with smaller asset base with high uninsured deposits and those banks had to liquidate assets and /or raise capital. The cascading situation led to the closure of other smaller regional banks such as Silvergate Bank (voluntary liquidation), Signature Bank and most recently First Republic Bank.
Assessing the impact of US banks failure
Since SVB was the first, MIDF Amanah Investment Bank BHhd (MIDF Research) looked closely to assess whether there is a contagion to Malaysia.
To note, SVB was founded as a small California lender 40 years ago, and built a powerful niche during the tech boom, funding tech companies’ growing affinity for debt. The rationale for these tech companies was to stay private for longer and avoid diluting founders’ equity positions.
SVB was also a critical lender to venture capital (VC) and private equity (PE) firms that was increasingly utilising leverage. This led it to grow its position to the 16th largest bank by asset size in the US.
“The pandemic saw central banks globally loosening its monetary policy. As a result, cheap money found its way to the tech sector, as VCs and PEs pile in investments into the sector.
“SVB was a beneficiary of this influx of investments with its deposits ballooning from USD60b in 2019 to USD200b in 2022. While SVB saw its deposits swelled, it did not grow its loans book at the same rate.
“It seems to us that this was not a case of excess or improper lending practice. In fact, it seems that SVB was being prudent by parking this influx of deposits into US government bonds, one of the safest asset class.
“But looking further, most were in long dated guvvies. Nevertheless, SVB investment seems risky as it is concentrated in long term tenure. We understand that 44 per cent of its assets was in bonds with tenure of more than 10 years.
“This may seem prudent if not for the US Fed aggressively hiking rates in 2022.
“It should be noted that long term bonds are most sensitive to interest rate changes and subject to revaluation losses in the event of rising interest rates. We should also note that it is not as easily traded to quickly convert into cash in the case of rise in demand for deposit withdrawal.”
Realising some of the losses led to a classic case of a bank run. The rise in interest rates caused an asset-liability mismatch as bond yields spiked up.
MIDF Research noted that SVB’s bond portfolio saw its value declined by US$15 billion, nearly wiping its shareholders’ fund of US$16 billion if this losses are realised.
Furthermore, it led to the drying in funding and tech companies, clients of SVB, started to burn or pull cash. This need to meet withdrawal demand, and expecting continued interest rates rise, SVB sold its US$21 billion available-for-sale assets at a loss of US$1.8 billion, and attempted to raise further US$1.25 billion via common stock to investors and an additional US$500 million of mandatory convertible preferred shares.
This may have led depositors to speculate that SVB is facing some problems. In addition, 96 per cent of SVB deposits were uninsured, so the depositors withdrew their deposits and this snowballed, resulting in a classic case of a bank run.
By Thursday, SVB clients attempted to withdraw US$42 billion worth of deposits causing a liquidity crunch and US regulators to step in.
‘Not as severe as 2008 crisis’
The investing community became worried that we could see the starting point of a repeat of the Global Financial Crisis in 2008.
However, MIDF Research noticed one difference, whereby 2008 was an episode of excess where credit practice was loosen as mortgages were securitised and traded, despite its quality.
“It should be noted that since the quality of these mortgage backed securities was a suspect, its value could decline to nil. In contrast, US government bonds will revert to its original price upon maturity, so any losses are temporary.”
Against the backdrop of a sharp sell-off in US, EU and Japan bank shares, other stress situations quickly surfaced; long-beleaguered Credit Suisse was forced to turn to the Swiss Central Bank for liquidity support (50b Swiss francs) while First Republic Bank (FRB), the 14th largest with a similar asset-liability mismatch as SVB, saw its share price plunged by about 70 per cent before a group of large US banks stepped in with a USD30b liquidity-boosting deposit.
Not to be outdone, Moody’s cut its outlook on the US banking system to negative, citing a “rapidly deteriorating operating environment”.
Global banking Armageddon, then? Not quite, says Maybank Malaysia and regional head of equity research Anand Pathmakanthan.
“Firstly, only a handful of mid-sized US banks share the same vulnerabilities that felled SVB i.e. an exceptionally large share of the asset base being comprised of interest rates-battered fixed income, the latter largely funded by relatively footloose uninsured (large) deposits.
“Secondly, the US Fed has rushed to the rescue, not just by pointing out banking system capital and liquidity levels are far healthier versus during the GFC, but by also decisively deploying “lender of last resort” bazookas- all depositors of SVB and FRB, insured or not, will have complete and immediate access to their deposits.
“The Fed will also provide financing to banks for one year to meet depositor withdrawals via a new Bank Term Funding Program (BTFP) – crucially, debt securities collateral pledged to access the BTFP will, extremely generously, be accepted at face value rather than marked-to-market valuations.
“Coupled with (ironically) comforting ‘business as usual’ interest rate hikes by the EU (50bps) and US (expecting 25bps), and likely mergers and acquisitions, markets should gradually settle.”
RHB Research reaffirmed their opinion that Malaysian banks remains isolated from the turmoil surrounding US banks. — Bernama photo
Analysis: Malaysian banks remain ‘relatively unscathed’
BUT what of Malaysia? Analysts with RHB Investment Bank Bhd (RHB Research) reaffirmed their opinion that Malaysian banks remains isolated from the turmoil surrounding US banks.
“Firstly, as mentioned, the situation in the US is so far contained among the mid and small-sized US banks which began as a ‘bank run’ at SVB.
“For context, the combined assets of these banks that was affected were relatively small, which totalled 2.4 per cent of the total assets of the US banking system. For contrast, 70 per cent of total assets of the US banking system is held by its top 10 largest bank,” it said in reaction to SVB’s shutdown.
“Secondly, Malaysian banks has healthy capital ratios, with the banking system’s common equity tier 1 capital ratio (CET1) at 15.2 per cent and tier 1 capital ratio (Tier 1) at 15.7 per cent, compared to the average CET1 and Tier 1 ratios of the 10 largest US bank of 13.2 per cent and 11.7 per cent respectively.”
To note, three of the US banks that were taken over by regulators had CET1 ratios between 11.2 and 15.4 per cent; and Tier 1 ratios of 9.2 to 12.1 per cent. All the banks that ran into liquidity problems had a significant portion percentage of uninsured deposits, (three out of four of the banks had more than 80 per cent deposits uninsured).
“Thirdly, Malaysia banks were not hit by the gigantic losses in US Treasuries, which US and European banks hold, due policy rates rising aggressively in the US compared to Malaysia.”
In 2022, the US Federal Reserve (Fed) raised its Fed Funds Rate by 400bps compared to Bank Negara Malaysia which raised its Overnight Policy Rate (OPR) by 100bps.
As a result, US government bonds recorded negative total returns of minus 16 per cent since the beginning of 2022 until March 2, 2023 compared to Malaysia government bonds which generated a positive 3.1 per cent return over the same period.
From a ratings perspective, local ratings agency RAM Ratings Bhd (RAM) does not expect the knock-on impact from the failure of SVB and two other smaller US banks to have a rating impact on Malaysian banks.
“SVB’s collapse was triggered by massive withdrawals following depositors’ concerns over significant unrealised losses from its “held to maturity” (HTM) bond portfolio amounting to US$15 billion – equivalent to almost all the bank’s equity,” it said in a report.
“Compared to SVB, we see fundamental differences in the business and balance sheet profiles of commercial banks in Malaysia. Domestic commercial banks typically engage in more lending activities as opposed to relying on bond investments which are exposed to market volatility.”
RAM highlighted that the proportion of domestic banking system assets invested in bond securities is less than 25 per cent. SVB, on the other hand, had more than 50 per cent of its asset base in such securities, which led to huge unrealised losses amid rapid and steep interest rate hikes in the US.
“Moreover, less than 40 per cent (on average) of bond holdings in Malaysia’s eight major banks are classified as HTM while the rest are marked to market,” it highlighted.
“This means that fair value losses on bond securities are already largely reflected in the banks’ capital position.
“In contrast, SVB classified almost 80 per cent of bond securities as HTM (only a little over 20 per cent were marked to market), indicating that unrealised losses had not yet been reflected in its equity.”
Meanwhile, fair value losses in Malaysian banks were also significantly smaller, thanks to Bank Negara Malaysia’s (BNM) milder pace of rate hikes and banks’ prudent strategy of holding shorter-tenure bonds in recent times.
“Loans and deposits domestically are diversified across sectors in comparison to SVB’s heavy focus on the tech sector and start-ups. Banks in Malaysia are predominantly funded by customer deposits, with high granularity. Their liquidity profiles are also sound with a liquid assets to deposits ratio of around 20 per cent and a net loans to deposits ratio of 88 per cent.
“According to BNM, domestic banks have no direct exposure to the three failed US banks.
The central bank’s robust prudential oversight and good track record – which have been evident in previous financial crises – should ensure the continued financial stability of the Malaysian banking system.
“SVB collapsed after a loss of confidence caused a bank run. In Malaysia, banks’ credit fundamentals remain robust and resilient, supported by strong regulatory supervision to weather heightened volatility in global financial markets.”
Malaysia’s banking system has other stopholds to protect against SVB-level crisis.
MIDF Research explained that BNM governance is strict and (relatively) uniform.
The central bank does not incorporate an asset-sized tier-based system – previous finance industry consolidations have led to a more manageable number of banks to govern.
“Instead, regulation demarcations centre mostly between development financial institutions (DFIs), locally-incorporated foreign banks (LIFBs), Domestic banks and Islamic Banks,” MIDF Research said, adding that community banks are largely left unregulated.
“As a result, the industry standard is a lot more uniform: following the Global Financial Crisis, risk management and disclosure can be classified as relatively strict under BNM’s regime – in fact, the local banking industry can be hallmarked by high capital ratios across the board.
“A core contributor blamed for SVB’s risk oversight was the fact that they did not have a chief risk officer (CRO) for the majority of 2022. Note that the appointment of both a risk committee and CRO is mandatory in a local setting, as stated in BNM’s Risk Governance Policy Document.
“Banks also must submit company-run stress test results twice a year, as stipulated by BNM’s Stress Testing Policy Document.”
RAM believe the recent collapse of SVB and two smaller banks in the US will have no rating impact on domestic banks. — AFP photo
Malaysian banks still performing well into 2023
IN spite of the recent sell-off of banking stocks, analysts are urning bullish on banks again.
Researchers with Hong Leong Investment Bank Bhd (HLIB Research) noted that the market has broadly baked in negative headwinds into forward expectations, which thus, reduced the odds of downside surprises and tip the sector’s risk-to-reward profile to be more favourable.
“Also, we believe the prominence of FY23 net interest margin (NIM) slippage may be smaller than initially feared and asset quality risk remains tame,” it said.
“Besides, we do not foresee Malaysian banks suffering from the same fate as SVB.
“All in all, we advocate to employ a more trading-oriented strategy as we believe the market will stay choppy. As such, we tactically upgrade the sector to overweight.”
The performance of KLFIN index has been dull since HLIB Research’s sector downgrade in early December 2022.
This was caused by concerns and poor sentiment over lesser overnight policy rate (OPR) hikes in 2023 and higher cost of funds, leading to net interest margin (NIM) slippage; weaker loans growth; subdued treasury income performance, along with insufficient loan loss cover in the event of sharp asset quality deterioration.
“Now seeing that banks’ share prices have pulled back, we are tactically turning bullish on the sector again,” HLIB added.
“In our view, the market has more or less baked in headwinds into forward expectations, which hence, reduce the odds of downside surprises and tip the sector’s risk-to-reward profile to be more favourable.
“Although the banking sector has to contend with less OPR hikes this year (our base case assumption is only a single time, 25bps increase), we are beginning to notice easing competition for fixed deposits (FD), thanks partially also to slower loans growth outlook.
“In turn, we reckon NIM compression would not be as prominent as initially feared; large domestic banks like Maybank, CIMB, and Public have guided FY23 NIM slippage of more than five to 10bps.”
That said, it believed Bank Negara Malaysia (BNM) may potentially raise the statutory reserve requirement (SRR) ratio, where it currently stands at two per cent versus pre-pandemic level of 3.5 per cent.
Based on its calculations, every 50bps SRR increase and assuming a four per cent interest yield forgone would shave banks’ earnings by only one per cent.
“Like before, we are not overly worried with gross impaired loans (GIL) ratio inching up as we believe banks are better equipped versus prior slumps; the large pre-emptive allowances built up in FY20 to FY22 to fight Covid-19 pandemic woes and latency in credit loss from OPR hikes, act as robust buffer to pillow for any short-term asset quality weakness.
“Besides, FY23-FY24 NCC assumption pencilled in by both us and consensus are fairly elevated (above the normalised run-rate but below FY20-FY21’s level; including pre-emptive provisions, it becomes on par to global financial crisis (GFC) highs.
“Also, we are relieved by the sector’s lofty loan loss coverage (LLC, 97 per cent) and steep collateral value against gross loans (77 per cent).
RAM: Malaysian banks resilient against headwinds
RAM Ratings has maintained a stable outlook on the Malaysian banking sector in conjunction with the release of its latest commentary, Banking Insight: On Steady Footing.
“Robust loss absorption buffers, diversified funding and well-controlled asset quality risks continue to anchor the domestic banking system’s resilience.
“Malaysian banks are well positioned to face potential asset quality deterioration arising from inflationary pressures, higher interest rates and the threat of slower global growth,” highlighted Wong Yin Ching, RAM’s co-head of Financial Institution Ratings.
“We further believe the recent collapse of SVB and two smaller banks in the US will have no rating impact on domestic banks,” she added.
“We expect loan growth to still be led by the Islamic banking sector, which contributed over 80 per cent of the industry’s growth in 2022. Declining loan applications in the last few months amid rising interest rates signal weaker credit demand.
“That said, China’s emergence from isolation should stimulate business loan growth as it is a significant contributor to Malaysia’s trade and tourist arrivals,” Wong said.
GILs could edge up as the higher cost of living and the 100-bp cumulative rate hike in 2022 impinge on borrowers’ repayment capability, especially those in the lower income group and smaller enterprises.
The continued phasing out of remaining loan forbearance measures could also push up delinquencies although the average proportion of domestic loans under relief in eight selected banking groups has reduced to below three per cent.
The industry’s GIL ratio was relatively stable at 1.72 per cent as at end-2022 (2021: 1.68 per cent).
“We believe credit quality weakening will be contained, considering banks’ prudent underwriting standards. The GIL ratio could steadily increase to a still-healthy two per cent by end-2023,” Wong adds.
RAM estimates a credit cost ratio of around 25bps in 2023 (2022: 29bps).
“We expect loan loss charges to drop further as huge management overlays were frontloaded at the height of the health crisis.
“Some banks have already factored partial overlay writebacks into their credit cost guidance for the year,” observed Sophia Lee, RAM’s co-head of Financial Institution Ratings.
The banking system has robust loss absorption buffers – the eight banks registered a GIL coverage (including regulatory reserves) of 132 per cent as at end-2022 (end-2019: 107 per cent). The industry’s common equity tier-1 capital ratio was a sturdy 14.9 per cent on the same date.
In other corporate news, Malaysia’s five new digital bank licensees are expected to come online starting in the second half of 2023. RAM said focus of the digital banks is on the underserved, in line with BNM’s discussion paper on Financial Inclusion Framework 2023-2026.
“Although they each have an existing captive ecosystem to leverage on, digital banks face numerous challenges,” RAM said.
“They will have to expand their franchise outside their ecosystems, secure stable funding, design suitable products for their target segments and effectively manage risk and pricing – all this while operating cost-efficiently.
“The threat to incumbents will be limited in view of the temporary maximum asset threshold of RM3 billion for digital banks and the heavy investments that traditional lenders have sunk into their digital agendas.
“As Malaysian banks align themselves to address climate risks in line with regulatory requirements, we expect to see more banks offer and tailor more products (including green, sustainability-linked or transition financing) to help clients and businesses decarbonise, which may offer a way to gain advantage over their competition.”
At this time, exposure appears to be limited and while several companies within Asia’s venture capital and tech start-up sectors have exposure to these banks, they appear to be small in scale and few have openly
Regional uncertainty continues to weigh as markets worry about sector health
ENORMOUS uncertainties continue to weigh on sentiment as markets worry about the health of banking sectors, the potential economic fallout arising from the collapse of SVB and implications for central banks, most of which are still trying to tame inflation.
Manulife Investment Management (M) Bhd co-head of global macro strategy Sue Trinh considered possible channels through which the contagion might be transmitted to Asia.
She said, at this time, exposure appears to be limited and while several companies within Asia’s venture capital and tech start-up sectors have exposure to these banks, they appear to be small in scale and few have openly admitted to seeing major losses.
“If problems in the United States (US) and European banking systems were to become more acute and investor risk aversion to spike, it’s fair to say that Asian economies with large current account deficits – and therefore are reliant on foreign capital flows – will be most affected,” she said in a statement.
Trinh said domestic credit conditions are likely to tighten; financial conditions have tightened since March 9, although conditions remain looser than they were in the middle of last year. However, lower confidence and greater risk aversion among domestic banks could result in weaker lending growth.
More broadly, tighter credit conditions and slower global economic growth will likely increase the risk of non-performing loans.
Understandably, she said the most exposed economies in the region would be those that have experienced sharp increases in interest rates and a significant rise in debt servicing costs – South Korea, for instance, could be a concern here.
Economies with many financial institutions with low regulatory capital could be left more vulnerable than others, and India could be a candidate in this regard, she noted.
“Tighter global financial conditions could also weigh on Asian exports as demand weakens.
“Economies that are particularly dependent on trade with the US and the eurozone would be most affected; Vietnam, Malaysia, and Taiwan would fall into this category,” she shared.
Trinh said if this were to happen, some central banks in the region may be forced to hike further than otherwise would be the case to support their currencies.
This is primarily a risk for those economies that have limited foreign currency reserves and are, as a result, highly dependent on foreign capital flows.
“Thailand, the Philippines, India, Indonesia, and Malaysia have become increasingly concerning in this regard,” she said.
Crucially, potential contagion to Asian banks emanating from this SVB episode seems limited; banks in the region are well-capitalised and direct exposures are small in scale. In addition, liquidity coverage ratios are high and deposit bases also tend to be stickier.
It’s also worth noting that corporate deposits are well-diversified across industries.
“In our view, direct contagion from the recent banking scare to Asia is largely limited, to the extent that financial and macro stability positions of economies in the region are generally more robust than previous crises,” she said.
Far more important to the Asian regional outlook is the event’s impact on global growth, the US dollar funding conditions and strength.
“If the global economy manages to avoid a hard landing, and the greenback funding costs remain low (with the US dollar staying below its 2022 peak), Asia should be able to weather the storm,” she added.
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