Walker Webcast: Is the SVB Collapse Cause for Fear? Ares Capital’s Michael Arougheti Has Some Answers

When Willy Walker, Walker & Dunlop Chairman and CEO booked Ares Capital’s Director, Co-Founder, CEO and President Michael Arougheti for the March 15, 2023 Walker Webcast, the latter acknowledged that at first, he was concerned about filling the entire hour.

Then came the collapses of Silicon Valley Bank and Signature Bank. So the topic was set. While the two discussed various topics (including the importance of back-to-office and ESG), the webcast’s main focus was on the SVB collapse and its impact on the overall financial system.

Arougheti’s discussion focused on two points: Mark-to-market and behavioral psychology. As a recap, SVB was forced into a mark-to-market position. In other words, to raise liquidity, the bank had to sell its long-term maturities at a substantial loss. But this scenario isn’t specific just to SVB, Arougheti said. Certainly SVB’s asset liability management (ALM) was poor. But few financial institutions – including the Federal Reserve – are immune from a mark-to-market scenario.

“The difference between SVB and some of the larger banks is the nuance between ‘available for sale’ and ‘hold to maturity’ accounting within the banking system, and to the quality of the deposits,” Arougheti explained. “SVB got caught in that mismatch between the quality of the deposits, the concentration of the deposits and the balance sheet.” But from the balance sheet construction standpoint, he added, there isn’t much difference from SVB and the larger banks.

“That’s something people really need to digest,” he pointed out. “There’s always so much debate about mark-to-market, the risk and value of it. At the end of the day, if you’re not (in a) mark-to-market (position), you’re good. But the minute you have to take that mark, it gets very painful.”

Then there was the behavioral psychology aspect of the situation.

“In the good old days, banks would close at noon on Friday, and they’d reopen Monday,” Arougheti commented. “If there was a run on the bank, there’d be a line out the door of people trying to get their money.” But the venture capitalists’ run on SVB was vastly different – and Arougheti made no bones about the fact that the VCs were one of the villains in the SVB downfall. “Here, there were people withdrawing their cash from the back seats of taxicabs,” Arougheti said. “We saw $42 billion leave that system in a matter of hours, so we’re in a different paradigm.”

Both quick-moving markets and free-flowing information expanded the situation from a potentially SVB-isolated issue to questionable confidence in the banking system. Noted Arougheti: “You’re really reminded how fragile the banking system and economy can be when you factor in that confidence and behavioral psychology.”

While he agreed that the response to the crisis was appropriate – like a guarantee on uninsured deposits and access to the funds—he suggested that it wasn’t quite enough. “The reality is, if you’re a fiduciary on the institutional side or an individual, you know the amount of deposit flows that are still flowing out of small and mid-size banks to the G-SIBs (Global Systemically Important Banks) are pretty substantial,” Arougheti said. “A pretty big subset of the population is moving money out of the system, and that’s going to have a lot of knock-on effect. The Fed’s going to need to keep an eye on that.”

Arougheti also cautioned that any new regulations should focus on capital flows versus a one-size-fits-all potential solution. Industry consolidation is likely, he noted, adding that “a regional lender in the southeast U.S. right now is having a completely different experience than Silicon Valley Bank. Maybe what comes out of this, alongside obvious consolidation, is maybe a rethink of a rate cap framework in order to make sure capital is flowing well.”

One bright spot in the situation is a still-strong economy, consisting of an active labor force. Another positive is what Arougheti called “covid overhang,” referring to still-existing household liquidity.

Additionally, Arougheti said the capital markets will eventually figure things out. “This is obviously pretty critical,” he added. But with every crisis that you, I and others on this call have been through, (we know that) capital finds its way to opportunity, and it generally does so in an innovative way that’s good for the borrower and good for the investor. I think that we’re going to see the same thing happen here.”

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