Banking Turmoil: The Investors Perspective

Mar 2023

This past weekend, the surprising and abrupt closures of two of the largest U.S. banks sent shockwaves across global markets.  Moreover, it prompted the Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and Treasury, to meet over the weekend to ensure the stability of financial markets and our banking system.  The news is reminiscent of what happened in September 2008, the crescendo of the financial crisis, when several notable banks went insolvent.

The abrupt closures of Silicon Valley and Signature Banks, two of the largest banks in the U.S. (by asset size), occurred within hours of each other.  Investors have on their minds whether this will result in further insolvency at other banks, how it might impact markets and the economy, how it affects investors, and how it affects the money they have at their bank.

What happened

These two banks, Silicon Valley Bank (SVB) in particular, took on some significant assets since 2020 from venture capital and private equity firms.  In addition, as the graphic below shows, the bulk of SVB’s assets, or as much as 95%, were uninsured assets (assets above the $250,000 FDIC-insured amount).

How did they have so many depositors with more than $250,000?  In SVB’s case, they catered mostly to start-up and emerging companies (Roku, Etsy, and Shopify to name a few) and not your typical consumer banking customer.  Their deposit growth was exponential the past five years, and because they couldn’t loan out all of their assets, they bought Treasury bonds and similar securities that matured far into the future.

Furthermore, when the bank reported its 2022 year-end results in early 2023, Moody’s rating agency noticed they had massive unrealized losses on the bonds they owned.

In early March, Moody’s said they were at risk for a credit downgrade.  When some customers saw that the bank was considering raising capital to shore up its balance sheet, they started withdrawing their cash.  There is little doubt SVB’s management did a poor job managing its assets and did not adequately assess the risks, including what would happen if rates rise on their bonds and how they would react if depositors suddenly withdrew their cash.

These actions led to massive withdrawals at the bank.  In Signature’s case, they had more depositor diversification than SVB.  Still, some of their deposits are cryptocurrency customers, so customers feared Signature was headed toward credit rating declines like SVB.

It’s different this time

The collapse of SVB and Signature is unlike the financial crisis of 2008.  Back then, the financial crisis was the result of banks and other investment firms holding mortgage bonds that were worth significantly less than the original purchase prices.  Moreover, the assets backing those bonds, residential real estate, were declining due to massive mortgage loan defaults by customers.  As a result, the inflated residential appraisals hid the risks of owning those mortgage securities and caused several noteworthy banks to collapse.  These collapses resulted in massive credit contraction, eventually hurting the economy and causing massive layoffs.

The shuttering of two large banks is more aligned with having concentrated customer bases and poor asset management by the bank’s officers.

The response

It should be no surprise that the government responded quickly to these failures.  To their credit, government agencies, including the Federal Reserve, Treasury Department, and FDIC, met this past Sunday to set up vehicles to ensure that all depositors could access their money if needed.  They established these backstops for depositors because they deemed Silicon Valley and Signature Banks to be “systemic risk exceptions,” which meant without protecting depositors, it posed too much of a threat to the banking system.

Market/economic impact

Fortunately, despite these two failures (three if we include Silvergate Bank, a much smaller bank than SVB and Signature), the banking sector is in far better shape than it was 15 years ago.  Although the closures of SVB and Signature have been the largest since 2008, experts believe the sector will recover and be even stronger.

However, as we’ve learned, with any financial crisis, there will no doubt be regulatory proposals to help avoid a repeat.  The politics of this will also play out over the coming weeks, so investors need to filter out the noise as both political parties try to blame each other for what happened.

Despite higher interest rates, the current economy is more resilient than most economists anticipated, and hopefully strong enough for the banking sector to manage this situation.  However, if these closures result in credit/loan contraction, it could slow down the economy more quickly.  Our team plans to continue watching for any signs.

Investor impact

When the dust eventually settles, it is hard to know the ripple effects that will emerge from these bank closures.  Treasury Secretary Janet Yellen quickly assured investors that our banking system is sound and resilient and that regulators have the tools necessary to prevent further trouble.  It is not surprising to hear this from government officials as they want to prevent people from thinking the worst.

From a client standpoint, our portfolios had very little exposure (probably less than 0.50%) to SVB or Signature Banks.  Most of their exposure comes from the S&P 500 Index funds.  However, the banking and financial sectors are core areas in our U.S. larger-company and foreign value-oriented mutual funds.  As a result, we’ve seen declines in those funds, but they haven’t been material.  Our Investment Committee continues to like the positioning of our value funds and wouldn’t be surprised if managers take advantage of this recent weakness to find bargains–we expect them to.

From a longer-term view, these market shocks generally do not change our view of investing and asset allocation.  As bad as this appears, and we probably haven’t heard the last of it, they are healthy for the market and the banking sector.  So, expose the bad seeds, learn lessons, and move forward.

Thus far, it is too early to tell how markets may respond if more banks announce problems, but the recent swift actions by the government should be a calming force for now.  Of course, the story is still unfolding as I complete this commentary, so our investment team will continue closely monitoring developments in this fluid situation.

Concluding comments

The abrupt closures of two large banks are not a passing story.  While there may be other bank issues that arise, the swift actions taken by the Federal Reserve and Treasury Department should go a long way in restoring faith in our banking system. Thus far, the market’s response has been positive, which is why investors should never overreact to a few days of declines.  However, it does make sense for investors to reassess their own risks and adjust their investment allocations accordingly.

If you have any concerns about your banking relationships and how to best protect your cash on hand, please do not hesitate to contact your advisor for solutions.

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