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Wednesday, February 28, 2024

What’s happening in the banking world?

What’s happening in the banking world?

March 14, 2023

Over the past week, Silicon Valley Bank (SVB) came under intense pressure and was forced to enter receivership. SVB had just over $200 billion in assets, making it the largest bank failure since 2008. Federal regulators then also shut Signature Bank, which had over $100 billion in assets and was heavily tied to the crypto industry. Some other regional banks are seeing their share prices swing wildly, along with evidence of accelerated but so far not dramatic withdrawals. On Sunday, the Federal Reserve announced measures guaranteeing depositors at both failed banks would get full access to all their funds. 

While unnerving in general and dramatic for those directly associated with these institutions, we urge investors in general to stay calm and avoid emotional reactions within their own investment portfolios held at sound institutions. Once again, the unpredictable nature of markets has lent support to the concept of maintaining a diversified approach, both at the asset class level and within stocks. It is important to be aware of where your assets are held and what protections you have.  

What led to the SVB closure? 

The demise of SVB is a consequence of decisions made by SVB during the pandemic era period of ultra-low (often negative overseas) interest rates. Fortunately, the specific situation at SVB appears to be more of an outlier than systemic. Most bank failures are due to recession or bad loans. 

This one was not.

SVB accumulated massive growth in deposits between 2019 and early 2022, a time when interest rates were very low. It invested these deposits in bonds to capture modestly higher interest rates than it was paying depositors. When the Fed increased rates, however, the price for these bonds fell. In fact, 2022 ended up being the worst year for bonds in decades – and by a significant margin. The situation likely would have been manageable had the bonds been given time to mature, but the bank experienced rapid withdrawals, which forced it to sell bonds and realize losses.

It appears SVB was somewhat unique in that it assumed significantly more duration risk than most peers by buying bonds with longer maturities that were more sensitive to interest rate changes. 

Its client base was also different. SVB catered to technology startups, and its clients were primarily smaller companies and wealthy individuals associated with the startup ecosystem. This client base tends to follow each other to some degree. New deposits started to slow as the startup world contracted in a difficult 2022. Then, as rates rose, it was relatively easy for existing clients to quickly move large amounts of deposits to other instruments to earn higher yield. Late last week prominent venture capital investors accelerated or completed the bank’s demise by suggesting portfolio companies withdraw funds. In contrast, most banks have greater diversification among depositors and higher stickiness.  

What actions has the government taken? 

Regulators including the Federal Reserve, Federal Deposit Insurance Corp., and the Treasury Department acted quickly to ensure depositors of SVB and Signature Bank will have full access to their money, regardless of FDIC limits. Equity and bond holders of the banks remain subject to significant losses. 

The government also created the Bank Term Funding Program, which will allow other banks with safe assets such as Treasuries to bring them to the Fed and swap them for cash for up to a year. This should help if other banks run into liquidity problems like SVB did. These actions are a big step to help restore confidence and have been of great relief to depositors of the two failed banks.  

How may this impact the broader economy and capital markets? 

Significant bank failures sap confidence and can cause liquidity to dry up as participants attempt to assess where risks may lie. Despite the government actions, other major banks remain at some risk of panic by depositors. Another failure would not be surprising, but a string of them, or an even larger institution going under feels unlikely to us.  

On a positive note, unlike 2008, which involved massive credit losses and defaults, most of the current problems stem from the duration mismatch described above, which are easier to understand and entail more modest losses as a percentage of assets. For the most part, banks remain well capitalized. Commercial real estate loans may come under further pressure with higher rates and lower occupancy rates, but we do not see a meaningful likelihood of anything resembling the subprime crisis. 

We expect a modest hit to economic activity as a direct result of SVB. Market reaction outside of the banking industry so far has been mixed. Many investors are grabbing onto the idea that the Fed will be forced to stop or dramatically slow additional rate hikes to maintain calm, and perhaps start to cut rates sooner.  

Bonds have initially rallied, with Two Year Treasury yields dropping around 1% in a matter of days. Both US and International stock markets are lower since SVB started making headlines, but not dramatically. For the past several months, equity markets have been primarily fixated on interest rates and the Fed, so it is entirely possible stocks will rally on the news if significant contagion to other major banks can be avoided. While we don’t know how the Fed will react, the initial drop in interest rates is meaningful enough to be a bullish factor for stocks if it holds. Today’s Consumer Price Inflation report showed prices are still rising but leaves room for the Fed to consider a range of actions.   

Putting it together, we view this crisis as boosting short-term volatility and uncertainty but at least equally likely to end up supporting higher stock valuations in the mid-term. In all of this, the path of inflation will probably remain the most important variable. Meanwhile, mid-sized banks can expect more regulation, which can be both good and bad.

The bottom line  

We appreciate that bank failures can be scary and that many are directly impacted by the rapid developments at these companies. SVB was a significant participant in the technology world and acted as a great partner to many innovative companies. All of this is very sudden and unfortunate. 

If you would like to discuss how these events may impact markets or your personal financial situation, consider signing up for our free financial tools. Eligible individuals can receive a complimentary portfolio review and conversation with a financial professional.

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Craig Birk, CFP®

Contributor

Craig is the Chief Investment Officer at Empower Personal WealthTM. He oversees portfolio management and leads the Empower Personal Strategy Investment Committee, focused on translating technology improvements into better financial lives. Craig has been widely quoted in the Wall Street Journal, Bloomberg, CNN Money, the Washington Post and elsewhere. He has managed assets for institutional and retail investors for over two decades. Prior to Empower, he was the Chief Investment Officer at Personal Capital, and he has also held a senior portfolio management role at Fisher Investments.

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