An Update about Recent News in the Banking Industry
As many of you are aware, we witnessed a historic chain of events last week following the failure of Silicon Valley Bank (Ticker: SIVB), the nation’s 16th largest bank with over $175 billion in customer deposits. This is the largest collapse of a U.S. bank since Washington Mutual folded in 2008.
Prior to this weekend, Silicon Valley Bank was far from a household name to the average American, despite its 40-year history and status as a highly respected player in the technology sector with thousands of U.S. venture capital-backed startups as customers. Now, the crisis naturally raises the question as to whether where there is smoke there is also fire.
In periods of heightened volatility and uncertainty specific to the health of our financial institutions, investors rightfully require assurance that their bank deposits are not at risk and that their “safe money” is indeed safe.
We aim to provide wise counsel and help our clients answer the questions that are most top of mind:
- What exactly happened and what are the implications for the broader banking system?
- What actions have U.S. authorities taken, and will that be enough to restore confidence?
- Where do we go from here and what measures need to be taken to ensure the security of our hard-earned savings?
“Gradually, and then Suddenly”
Silicon Valley Bank’s issues were quite unique to its business model and customer base, and not necessarily indicative of the broader health of the banking system. The problems stem from the wave of cash deposits into the bank during the post-Covid “boom times” for the venture capital and startup ecosystem. The bank used many of those funds to purchase long-dated U.S. Treasury Bonds and Agency Mortgage-Backed Securities at historically low interest rate levels.
Fast forward to 2022, when the Federal Reserve began raising interest rates to combat inflation. In addition to the value of the long-term bonds on Silicon Valley Bank’s balance sheet declining amid rising interest rates (bond prices and interest rates are inversely related), its depositor base was increasingly withdrawing cash amid the tech sector’s recent slowdown. This forced the bank to liquidate many of its securities at a loss, which ultimately led to cascading fears of a bank run and eventually, the Federal Deposit Insurance Corporation (FDIC) stepping in on Friday to assume control of the bank.
Relative to other banks, Silicon Valley Bank’s heavily concentrated depositor base made it more susceptible to a bank run given the correlated behavior of its customers. Per J.P. Morgan, “SIVB was in a league of its own: a high level of loans plus securities as a percentage of deposits, and very low reliance on stickier retail deposits as a share of total deposits. Bottom line: SIVB carved out a distinct and riskier niche than other banks, setting itself up for large potential capital shortfalls in case of rising interest rates, deposit outflows and forced asset sales.”
While the bank was certainly in a “league of its own,” the banking system felt – and continues to feel – the ripple effect. While not of the same magnitude or degree of concentration, several other regional banks maintained close ties to the technology sector:
- Just days before Silicon Valley Bank’s downfall, Silvergate Capital Corp., the crypto industry’s biggest bank, announced it would be shutting down.
- Regulators announced late Sunday that that it had taken over Signature Bank to protect its depositors, making Signature the third-largest bank failure in U.S. history.
- First Republic Bank and PacWest Bancorp, also with lending portfolios heavily tied to venture capital and real estate, are experiencing significant stock price declines.
U.S. Authorities Announce Extraordinary Measures
The biggest risk of any bank run is the corresponding effect on confidence and the potential for contagion to affect otherwise healthy financial institutions. To that end, U.S. authorities unveiled emergency measures on Sunday to quell concerns of systemic risk and to provide bank customers full and immediate access to all their deposits, both insured and uninsured.
The full press release from the U.S. Department of the Treasury can be seen here, but in short, for both Silicon Valley Bank and Signature Bank:
- Equity shareholders and certain unsecured debtholders will not be protected.
- Senior management of those banks has been removed.
- Depositors will be made whole.
- Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.
- Taxpayers will not bear any losses.
- Additional funding will be available to other eligible depository institutions to ensure banks are able to meet the needs of their depositors.
We applaud the swift and decisive action taken collectively by the Treasury, Federal Reserve, and FDIC to strengthen public confidence and add layers of resiliency to the U.S. banking system.
While we fully expect short-term volatility to persist, particularly among regional bank stocks and the financial sector, today’s broad stock market performance does not indicate widespread concern for systemic risk.
Investors are also looking ahead to next week’s Federal Open Markets Committee meeting. All eyes will be focused on the Fed on March 22nd as it announces what, if any, additional rate hikes are in store. Just last week, markets were pricing in a high probability of a 50-bps increase in the Fed Funds rate. Now, considering the events of the past few days, market participants are leaning toward expectations of only 25 bps, or perhaps even no hike at all. Time will tell, but the strong bond market performance today may signal that the long anticipated “Fed pause” may be approaching sooner than later.
Your Portfolio and Your Cash
For broadly diversified investors, exposure to the stocks and bonds of Silicon Valley Bank, Signature Bank, and other troubled banks is immaterial. For illustrative purposes, as of 1/31/2023, the Vanguard Total Stock Market ETF (VTI) had 0.04% in SVB Financial Group and 0.02% in Signature Bank. At Savant, our evidence based approach to investing is grounded in humility and purpose – built to withstand the impact of SVB’s failure and other idiosyncratic market events.
This past week has been a harsh reminder of the importance of safety above all else when it comes to our cash and other savings vehicles. Now is an appropriate time to revisit FDIC insurance coverage, money market funds, and other considerations for managing liquidity.