Top 3 BMO Global Markets Interview QuestionsLast Updated:
During the past week Hemingway’s famous quote regarding how one goes bankrupt came to mind frequently: gradually, then suddenly. Just two weeks ago, with equity markets gathering steam and yields falling across the curve, Chair Powell tried to talk up market pricing for the next rate hike from 25bps to 50bps.
This seemed prudent, and some would argue it still is when looking at the data we’ve received recently: core inflation came in slightly above expectations again, jobless claims came in slightly below expectations, building permits came in soundly above expectations, and forecasts for Q1 2023 GDP continue to be revised up.
In other words, the economy appears to still be going strong. But the problem with most economic indicators is that they’re (by definition) backwards looking, and it’s never a given that suddenly the economy might find itself trending sharply downwards. This is what Larry Summers frequently cites as the “off the cliff” moment.
The past week was dominated by news of both Silicon Valley Bank (SIVB) and Silvergate being put into receivership by the FDIC. This caused a jolt of volatility into markets that was latter smoothed out through the announcement that the uninsured depositors of both banks would have their deposits backstopped thereby relieving any risk of uninsured depositors getting back less than the money they had deposited.
And, more notably, the Fed announced the introduction of the Bank Term Funding Program (“BTFP”) which allows banks to pledge their US treasuries, agency MBS, and other qualifying (largely credit risk free) assets at par value in exchange for a loan with a maturity of up to a year. In other words, if a bank needs cash, and has assets (unpledged collateral), they can pledge those assets to the Fed and get an immediate infusion of liquidity.
This is so essential because the issue that many regional banks have faced – to make a broad generalization – wasn’t that they were assuming too much credit risk, rather they were assuming too much duration risk. And, in a rapidly rising rates environment, long-dated duration bought at very low yields are going to cause large (paper) losses if sold before maturity as yields rise (and prices fall). But, of course, if you hold those securities that have large (paper) losses until maturity, it’s fine as you know you’ll get back par.
There’s a deep irony that much of the post-GFC financial regulations tried to coerce banks into being a bit more boring: taking less credit risk by keeping hordes of cash and cash-like (i.e., treasuries) on their balance sheet, which was accomplished partly through tightened risk weighted asset calculations (which made it more costly for a bank to have riskier assets on its balance sheet).
This is something, even though it seems a bit anachronistic, that I talked about a bit in the course because post-GFC regulation has had a wholesale impact on the structure of every trading floor (it’s not just that proprietary desks are largely a thing of the past, banks need to be much more careful with how they allocate balance sheet to desks given that some desks, by virtue of the assets being traded, require significant balance sheet to be devoted to them).
Anyway, in the end, it was the large-scale purchases of assets devoid of credit risk that were treated as ultra-safe, and their inability to be sold without incurring losses due to the rapid rate increases, that precipitated the bank run that led to the collapse of SIVB. Because it was recognized that if these banks ever needed to sell their ultra-safe, long-duration assets (that have significant unrealized losses) to meet a large increase in deposit withdrawal requests then these banks would potentially be insolvent.
Importantly, the collapse of SIVB and others, even though the immediate danger was quickly resolved by a swift intervention, has led to a massive amount of volatility in treasuries...
In this post we’ll adhere to a similar structure to the past few months: going through some interview-style questions that then allow us to talk about the major themes currently impacting markets. (Although, just to be clear, the answers below provide a level of depth you’d never be expected to really give in an interview).
BMO Global Markets Interview Questions
Below are some questions that you can poke around using the links below. If you’re curious, in the members area of the course I’ve put in a few research reports on SIVB that’ll give you a more detailed picture than I’ll be able to in these relatively short questions and answers...
- What has all the regional bank turmoil of the past week done to Fed hike expectations?
- Many think that the Fed is done hiking for this cycle. If the Fed were to continue to hike, beyond what’s currently priced into Fed Futures, why would that be?
- Some have said that SIVB was quite unique as a bank and what happened to it shouldn’t be extrapolated too widely. What’s their rational for saying that?
What has all the regional bank turmoil of the past week done to Fed hike expectations?
In short, it took the implied terminal rate (the highest rate the market is expecting the Fed to reach) from ~5.7% on March 9 to ~4.7% in under a week. If that sounds like a radical repricing – given that the treasury market is the most deep and liquid market in the world – then you’d be right.
Not only was the volatility of treasuries, as you can see in the preamble pic, at levels not seen since the financial crisis, such a rapid fall in the front end of the yield curve over just a week hadn’t been seen since the 1980s.
In other words, the market went from anticipating that the Fed would need to hike continually over the next few meetings, partly due to the words of Chair Powell in past weeks, to believing that the Fed was effectively done hiking this cycle: maybe, at best, inching out one or two more hikes.
When this repricing was happening, in the wake of the collapse of SIVB while it was still uncertain what (if any) resolution would be found, Goldman was the first among banks to come out with the radical suggestion that the Fed wouldn’t hike at its next meeting and would instead initiate a pause (similar to what the Bank of Canada has now done).
What’s perhaps most remarkable is that the yield curve hasn’t bounced back that much after such a comprehensive response from policy makers was introduced. Market participants know that the Fed always will jawbone about raising rates until something breaks and they’re betting that significant stress among some regional banks will be what makes the Fed stop – and they’ll never get started again this cycle.
Many think that the Fed is done hiking for this cycle. If the Fed were to continue to hike, beyond what’s currently priced into Fed Futures, why would that be?
Nearly every bank has said that the Fed is likely to pause during their upcoming meeting (i.e., Goldman) or raise 25bps and then pause (i.e., Barclays). So, it’s worth thinking about how this radical departure from where we were just a few weeks ago could be wrong.
If you’ve been reading these posts for some time, it’s worth revisiting the gilt crisis post from this past summer. The gilt crisis, in my view, was a much more serious situation that could have caused meaningful economic dislocation and thus required a much more direct intervention into market functioning.
In the end, after a change of government and much political handwringing, the market calmed and the Bank of England, despite facing a deteriorating economic situation, continued to raise rates. It recognized that the gilt crisis was something they could use tools to alleviate while still marching forward with their hiking plans to cool inflation.
So, the Fed could continue along its rate hike path – likely keeping to modest 25bps hikes as opposed to 50bps as was contemplated just a few weeks ago – to continue cooling inflation. At the same time, it can use its expansive authority to ensure that the localized issue surrounding HTM securities (i.e., treasuries and agency MBS on the books of regional banks that have significant unrealized losses) are dealt with through the BTFP to keep market confidence.
Put in much simpler terms: the Fed could look through this crisis, recognizing that it was a crisis precipitated by higher rates, sure, but that it can also be dealt with separately and doesn’t need to derail getting to the point of having significantly restrictive rates as to cool inflation (which, in the end, is one half of its dual mandate!).
This would be particularly true if inflation continues to come in hot and forward-looking inflation indicators, such as wage inflation, continue to run at a rate incompatible with getting back to target anytime soon.
Some have said that SIVB was quite unique as a bank and what happened to it shouldn’t be extrapolated too widely. What’s their rational for saying that?
Note: Below is a very quick summary but, if you’re curious, there’s some good research reports from Goldman in the members area you can read for more depth.
You can think about any bank as being comprised of liabilities (deposits from customers) and assets (loans that have been made and other assets held on the balance sheet). Silicon Valley Bank, as the name implies, was the go-to bank for many tech companies.
In fact, the vast majority of their deposits were above the insured ($250,000) threshold and there was (in retrospect) unbelievable sector concentration risk...
Therefore, through the 2020-2021 pandemonium that swept the tech industry there was an onslaught of new deposits from corporate clients (i.e., proceeds from raising fresh rounds or from going public, etc.).
This put SIVB in a bit of a bind. It was getting a ton of deposits (liabilities!), but it couldn’t turn around and loan out those deposits quickly enough to qualified people or businessess. So, instead, it just stuffed the cash it was getting from depositors into ultra-safe assets such as treasuries and agency MBS.
This seemed quite prudent and safe. But, through 2022-2023, as the Fed began raising rates, two things were happening: new deposits began to slow to a trickle and the price of those ultra-safe assets began to drop (not due to their credit risk changing, but just due to yields rising!).
Now the issue, as JPM sums up nicely below, is that you can classify the securities you bought on the balance sheet as hold-to-maturity (HTM) and not mark them to market (i.e., reflect the price declines when yields raise) as long as you don’t sell them prior to maturity. But, if you ever do sell any HTM securities, then you need to mark to market a wide swath of them (the accounting rules get a bit complex, but the point is selling any of your HTM securities requires you to suddenly realize a large loss by marking to market your other HTM securities).
“Banks can designate these securities as being “available-for-sale” (AFS) or in 'hold-to-maturity' (HTM) portfolios instead. SIVB was one of the banks that relied extensively on HTM treatment for its growing securities portfolio: since 2019, its AFS book grew from $14bn to $27bn while its HTM book grew from $14bn to $99bn. Selling HTM securities is complicated, since it results in larger parts of the portfolio being suddenly marked to market, which can in turn then result in the need for a capital raise.”
What happened with SIVB is that new deposits dried up, as the tech sector slowed due to the higher rates environment, and there began to be a slow trickle of deposit withdrawals. Then folks began to realize that if SIVB ever needed to sell their HTM securities to meet withdrawal requests they’d realize a large (not paper!) loss that perhaps would lead to them being insolvent (i.e., no longer having an equity buffer). In other words, everything was largely fine if they didn't have to remark their HTM securities. But, if they ever did need to, that'd raise serious concern about their overall solvency.
This concern then precipitated a classic bank run that led to nearly $42bn of funds trying to flow out of SIVB on Thursday March 9 and its ultimate collapse into receivership by the FDIC (as previously discussed).
This is an incredibly quick overview but to get back to our initial question, the reason why SIVB was such a unique situation relative to others can be thought of in multiple parts...
First, it had incredibly high levels of sector concentration (in a sector known for its boom and busts). This made its inflows and outflows of deposits very volatile. All else being equal, if you're a bank you want predictable, steady deposit inflows and outflows. Volatility in deposits (either in or out) always makes it a challenge to manage your balance sheet.
Second, because of how many deposits they accumulated through 2020-2021, this led them to invest in ultra-safe fixed-rate investments (i.e., treasuries and agency MBS) that had their prices fall significantly when the fastest rate hike cycle in forty years got underway.
Third, the makeup of SIVB’s deposits are quite unique as well: the vast, vast majority were technically uninsured (although policy makers have effectively guaranteed them now) so it made sense, from each company’s perspective, to withdraw their deposits and move them to JPM, BofA, etc. on the off chance that SIVB may actually falter. In other words, when folks began smelling smoke, or perhaps just hearing about others smelling smoke, they rushed for the exits – and tried taking $42bn of deposits with them in just one day!
As we saw in the aftermath of SIVB – as a collection of regional banks traded down over 50% in just a few days – there’s always a risk of a self-fulfilling contagion occurring (i.e., otherwise reasonably well capitalized banks facing an unwarranted bank run).
But many have taken a more sanguine view of all of this: recognizing that SIVB was unique along a number of vectors and that this crisis was not driven, fortunately, by credit issues but rather an idiosyncratic mix of sector concentration issues and ill-timed long-duration investments in ultra-safe assets. It’s always credit issues causing stress in banks that you want to worry about – asset-liability mismatches are much easier to grapple with.
The past week caused volatility across every asset class – none more so than rates – and, as the dust currently settles, many are beginning to think more deeply about what has really been done.
This includes many recognizing that while the BTFP facility was (likely) essential to restoring confidence – by essentially getting rid of the issue of significant deposit withdrawals resulting in realizing losses on HTM securities, thereby blowing a hole in the balance sheet of the impacted bank – it’s also arguably just QE in another name (the Fed’s balance sheet grew around $300bn since the crisis began but, in my view, the Fed's actions have been appropriate and this really is fundamentally different than QE -- despite what some financial commentators suggest).
Hopefully this post has been somewhat approachable and not too in the weeds. As it pertains to BMO itself (which we haven’t touched on through this post!) they’re an exceptionally strong player in Canada and have been increasing their footprint in the US significantly (especially in rates).
If you happen to have interviews approaching, then reading up a bit on SIVB, etc. would be worth doing as it’s radically reorientated the rates market and caused many market participants to change their views (i.e., Goldman suggesting a pause is imminent and that the risk of a recession has risen). But be sure to also focus on other types of sales and trading interview questions and make sure you have a firm understanding of what sales and trading is (i.e., desk structure, the roles that exist, etc.).