It’s being called the biggest American banking downfall since the 2008 financial crisis – and it could spell lower mortgage rates for Canadian borrowers.
The possibility that rate hikes could be off the table both north and south of the border was bolstered this weekend on the news that Silicon Valley Bank – one of the largest tech financiers in the States – has been abruptly shuttered by regulators.
The Federal Deposit Insurance Corporation (FDIC) seized $175B of the California-based bank’s deposits on Sunday, following a deep run on capital by its clients. The financial institution's plummet happened in rapid succession when it found itself overleveraged on its bond holdings in the face of rising interest rates. It announced last Wednesday that it would need to sell off its balance sheet at a loss, with another US$2.25B in funding sought to square up.
That resulted in panic among its investors, who are predominantly in the tech and healthcare fields; SVB reportedly funds nearly half of all American venture-backed tech and healthcare companies, with US$209B in total assets at the end of 2022. SVB’s stock tanked shortly after its announcement, with trading halted by Friday morning.
However, given how swiftly regulators took action, the “contagion” to the rest of the banking sector should be fairly limited, with FDIC announcing both insured and uninsured deposits will be returned to SVB’s creditors.
How SVB’s downfall could force a Fed rate hold
Nonetheless, the tech bank’s expeditious decline has raised sharp anxiety in the markets, on fears it could kick off a new financial crisis and recession.
That in turn has quickly thrown cold water on expectations of immediate further rate hikes from the US Federal Reserve; prior to SVB’s tumble, it was widely anticipated that the Fed would need to return to a steeper rate hike trajectory, as inflation remains stubbornly high.
But some analysts were swift to change their calls on SVB’s news, most notably Goldman Sachs. The investment bank has abruptly changed their tune from expecting a half-point Fed hike on March 22 to none at all.
According to investor commentary from Goldman’s Chief Economist Jan Hatzius, this “recent stress in the banking system” will prompt the Fed to take their foot off the monetary policy gas pedal, with “considerable uncertainty” that it will continue its hiking plan into the spring. Goldman also changed their call for the terminal rate, now expecting it to end at 5.25% - 5.5%, rather than their previously forecasted 6%. This in turn will support the Bank of Canada’s plan to hold its Overnight Lending Rate, without risking potential currency devaluation.
Markets are reacting sharply to this barrage of change; while the dust is still settling, early expectations the Fed will wind up at a half-point lower terminal rate has led to a free fall in bond yields; investors are both encouraged by the promise of lower rates for longer, and are also seeking “safe haven” holdings amid rising fears of financial instability.
As a result, Government of Canada five-year yields, which largely inform the pricing of fixed mortgage rates, have plunged to 2.872% as of publishing time Monday morning. That’s a difference of over 30 basis points overnight, and down nearly 70 basis points from just five days ago. Two-year yields, which are mirroring the drop in US treasuries, have also fallen a rapid 40-basis points (the largest one-day decline since 1987).
It’s just the latest dip in the roller coaster yields have been on thus far this year; up until last week, they had steadily trended higher since January on expectations of steeper Fed rate hikes and rising inflation, putting upward pressure on fixed mortgage rates.
It’s too soon to know whether discounts are on the way for the fixed cost of borrowing, but should this trend be sustained, borrowers are likely to see lower fixed rates in the days to come.
Variable-rate mortgage borrowers could be set for some relief, too, as these latest bond moves suggest the market is pricing in a potential two rate cuts by this summer from the Bank of Canada.
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The impact on Canada
The good news is that SVB’s downfall shouldn’t have deep fallout for Canadians. While the bank had a massive presence in the US tech space, Canadian firms have relatively little exposure to it.
As put by Scotiabank economist Derek Holt, the bank’s comparably small size and prompt response by regulators will also limit the damage it poses to the American financial system, and by extension, Canada’s.
“SVB’s failure roiled financial markets but I’m not of the view that it is an existential threat to the financial system. SVB was a relatively small, undiversified bank with just over US$200B in assets in a US$24 trillion banking system,” he wrote in an economic analysis note.
“SVB was focused upon risky new tech ventures and it was caught flat footed by the Fed’s rapid rate increases. Regulators have moved swiftly to shutter SVB, make its insured depositors whole through the FDIC and issue receivership certificates to uninsured depositors to be paid out of the proceeds of a potential sale of what’s left of the bank. Its failure is being absorbed within the financial system and so far, there are few signs of contagion.”
Canada’s banking regulator OSFI has also stepped in to take control of the bank’s Canadian operations, with potential plans to sell off the business. In a release, OSFI Superintendent Peter Routledge clarified that the bank did not offer deposits to Canadian businesses directly, further limiting the impact on Canadian tech firms.
“By taking temporary control of the Canadian branch of Silicon Valley Bank, we are acting to protect the rights and interests of the branch’s creditors,” he stated. “I want to be clear: The Silicon Valley Bank branch in Canada does not take deposits from Canadians, and this situation is the result of circumstances particular to Silicon Valley Bank in the United States.”
The bottom line
From a mortgage rate perspective, these recent events could spell lower fixed mortgage rates in the short term, should the drop in bond yields be sustained. If you’re currently shopping for a mortgage, it’s a good idea to keep a keen eye on how fixed-rate offerings may change in the coming weeks, and to get a rate hold to protect any potential discount from further market fluctuations.
The growing narrative that SVB will force the US Fed into a rate hold stance could also pose a shift in monetary policy expectations for both the Fed and Bank of Canada, further enforcing the possibility that rate hikes are off the table for the foreseeable future... along with a growing chance of actual rate cuts.