Last week certainly did not play out how we anticipated. The week was about Federal Reserve (Fed) Chair Jerome Powell’s congressional testimony and the February jobs report.
Instead, we got a shockingly fast collapse of a financial institution with over $200 billion in assets. This turned the market’s focus toward the banking system’s stability, and the systemic risks banks might face. Silicon Valley Bank (SVB), the California bank subsidiary of SVB Financial Group (SIVB), fell into FDIC receivership. Meanwhile, late Sunday, regulators closed Signature Bank (SBNY), an FDIC-insured New York state commercial bank with total assets of $110 billion. SVB is the first FDIC-insured institution to fail since 2020 and the largest by assets since Washington Mutual failed in 2008. The news has caused market participants to speculate if another shoe will drop.
Many market participants are focusing in on SVB’s losses in its securities portfolio as a key cause for its demise, and participants are also tying the bank’s fall to the Federal Reserve’s (Fed) rising rate policies. We believe Fed policies were only partially to blame, as SVB’s niche customer base and lack of earning asset diversification (i.e. an unusually large portfolio of marketable securities relative to assets) also contributed to the bank’s failure.
We do not believe the SVB and SBNY bank failures are a deeper sign of things to come. However, we are paying close attention to ongoing developments in the banking sector and other industries for hints of widespread contagion. Indeed, more banks may come under distress (72 FDIC-insured banks have failed over the last ten years), but we are not expecting SVB and SBNY to be the first steps to a systemic crisis. SVB had distinctive operating aspects that we believe contributed to its downfall. Unique exposures at SBNY (crypto) likely caused that institution to suffer a lack of diversification in its depositor base.
Background of SVB Financial Group ($SIVB) & Signature Bank ($SBNY)
SIVB is a bank holding company serving emerging and middle-market growth companies in targeted niches, focusing on the technology and life-sciences industries. The company’s operations include a limited international presence, a U.S. wealth unit, a commercial bank, an investment bank, and a fund manager. Before the current distress, the bank (SVB) held $212 billion in assets and $175 billion in deposits.
SVB’s unique combination of bank depositors (individuals and institutions exposed to weakness in venture/start-up valuations) and degradation of its asset portfolio caused the institution to become troubled when faced with unusually large depositor withdrawals. Many withdrawals, driven partly by SVB’s customer exposure to distress in the venture capital industry and its lack of stickier retail deposits, caused SIVB to sell marketable assets at losses to cover those withdrawals. This added further stress to its balance sheet as more fixed-income securities were marked to market at much lower valuations. The news flow about SVB’s position intensified the withdrawal outflow, ultimately resulting in the FDIC stepping in.
Signature Bank is a full-service commercial bank serving privately-owned business clients, owners, and senior managers. The bank provides personal banking products and services, including investment, brokerage, asset management, and insurance. What SVB was to the venture capital market, Signature Bank was to the crypto-based companies.
Assessing the Market Impact
Our team meets weekly to analyze and discuss capital market conditions and to adjust our market views accordingly. The full impacts of the situation have likely not made their way through the entire financial system. As such, we will continue to monitor the bank industry and macro conditions and communicate any changes to our views as needed. Currently, our thoughts are as follows;
- We believe investors should react cautiously to the SVB and SBNY developments as sentiment around bank conditions remains fragile. Depositors in other banking institutions could react irrationally to the recent failures. We believe tactical investors should maintain their multi-asset allocations at or near benchmark levels.
- Today, the preferred stock sector may offer a tactical opportunity to add some risk to portfolios while bypassing some of the inherent risks of equities. Diversification is key!
- Meanwhile, overall conditions should improve based on regulator backstops, in our view, but recent damage to sentiment should be respected, at least for now.
- We believe no changes to well-balanced allocations need to be made for longer-term strategic investors.
At the time of this writing, we hear that Fed officials are contemplating several measures to ensure stability in the banking system. Any such developments will likely be viewed as a positive by the market. However, we also anticipate that depositors at other California banks may become uneasy and seek to withdraw funds. Reuters reported this occurrence at a First Republic Bank in California (ticker: FRC). The risk of this type of sentiment activity and the late-Sunday news on Signature Bank causes us to operate with tactical caution at this juncture, particularly regarding bank stocks.
Should you wish to discuss more of what happened to the banks or the impact it has on markets moving forward, we recommend contacting your advisor directly to schedule a call.
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