Bank Failure Drama: Actions You Can Take to Mitigate Risk

As you likely know by now, two banks failed in the last week. This marks the first collapse of a U.S. bank since 2020, and two of the three largest bank failures ever. In the aftermath, we’re left to question what happened, how will it affect our industry and is there anything we should be doing in response?

The short answer is that it’s too early to know the full impact. But so far, rates have been volatile, with a trend to the downside. Lock volumes are up, which is always a beneficial side effect for the mortgage industry during a crisis. Otherwise, there are no major crises brewing specific to the mortgage world so far.

Nevertheless, it’s important to remain focused on areas of possible risk as the banking drama continues to unfold. Read on to learn more about the situation at hand and actions you can take to mitigate risk.

What happened?

Let’s talk about Silicon Valley Bank (SVB), the bank that started this crisis. SVB was a fast-growing bank that catered mostly to large corporate clients, including startups and tech firms. As it grew from 2020 – 2021, SVB was investing in long-term bonds, like Treasuries and MBS, with an average yield of about 1.79%.

Going into 2022, as rates rose, depositors were pulling more funds from the bank to fund operations, while also demanding higher returns on their money on deposit. Meanwhile, SVB found itself with an average 1.79% return on assets that had lost much of their value over the preceding 1.5 years. So, short-term rates rose in concert with Fed tightening, while the prices of SVB’s longer-duration assets fell as customers were drawing down their accounts. After selling a piece of its devalued bond portfolio for a large loss, SVB announced it needed to raise capital. This announcement caused panic to ensue, and we saw a classic run on the bank, which sealed SVB’s fate.

What’s the fallout so far?

SVB was quickly placed in receivership, along with Signature Bank (which was closed “in light of market events”), and the government and pundits alike have stated that the system is well capitalized.  Also, apparently all deposits will be covered. Regardless, Black Knight will continue to monitor activities for indications of further impact.

The bond market has net rallied since the weekend not just in a flight to quality, but also on some adjustment of Fed rate hike expectations. A week ago (prior to the SVB collapse), the markets had no expectation that the Fed would pause increasing the funds rate, but today there is roughly a 50% chance of no rate increase at the next meeting. However, with the speed of market adjustments, we need to keep our eyes on it.

How will any of this affect our industry?

Time will likely tell, but for now, here are some considerations to keep in mind. We’ll post future updates as the market continues to rapidly evolve. In the meantime, check in with your hedge advisor!

• Volatility has increased: Watch the market, and consult your hedge advisor regarding trade timing, bid/offer spreads and cross-hedges.
• Margin calls possible: As of this writing, we are still below price levels we saw in February, but if the rally continues, margin calls could become an issue.
• Price basis: If this rally continues, and we see volume spike or liquidity tighten for other reasons, we may see basis increase.
• Dealer exposure: To avoid unnecessary margin calls and uneven counterparty exposure, be sure to check your use of multiple dealer lines. Keep your coverage spread across dealers. This is a sound practice, regardless of market conditions.
• Warehouse bank and investor exposure: We’ve seen no news related to any warehouses or investors being in financial trouble, but as critical as these entities are to our existence, now could be a good time to check in, and to ensure you have multiple, adequate coverage.
• Pull-through: As with any rally, pull-through may suffer in the near term. Work with your hedge advisor to monitor and make adjustments as needed.
• Renegotiations: As with any precipitous rate drop, you may see a higher rate of incoming renegotiation requests. It’s time to dust off the 2020 playbook here. Also, if we do see a continued rally, pad margin. This would be the time to stockpile some reserves for potentially prolonged volatility, higher fallout and other needs.

This is clearly an ongoing story that has only just begun, but it pays to be informed, diligent and prepared. If nothing else, take some time to review your counterparties and any policies that govern them and other areas of your capital markets practices. Also, be sure to communicate with counterparties and your hedge advisor.

Check back for future posts if this persists and/or expands.

Nothing herein shall be construed as, nor is Black Knight providing, any legal, trading, hedging or financial advice.