Gavin W. Stephens
Director of Portfolio Management
Director of Portfolio Management
In recent days, state banking authorities and the FDIC have closed three banks: Silvergate, Signature Bank, and Silicon Valley Bank (SVB). Both Silvergate and Signature Bank held a niche in lending to cryptocurrency firms, an activity generally understood as risky business. SVB’s collapse has thus gathered more attention, both because of its seemingly more conventional operation and its larger size.1 Below we offer our thoughts on the drivers behind SVB’s collapse, the potential effects on the economy and the markets, and what we at Goelzer are doing in response.
In addition to answering your questions about these events and their potential effects, our private client advisors and institutional consultants are also available to discuss your banking relationships and offer guidance on ways to help ensure your deposits are secure.
On Thursday March 9th, the stock of SVB fell more than 60% in response to increasing concern over the bank’s solvency. Those concerns continued to build toward the end of the week, resulting in an increasing rate of cash withdrawals from the bank’s customers. The rapid increase in withdrawals led the FDIC to put the bank into receivership on Friday, March 10th and for the FDIC, Federal Reserve, and the Treasury Department to launch emergency lending tools to ensure that all depositors (including those with deposits above the FDIC’s $250,000) would have access to their funds the following Monday. The emergency lending tools are further intended to improve liquidity across the banking system and prevent future bank runs such as the one that doomed SVB.
A combination of unstable deposits and unrealized bond losses precipitated SVB’s demise. Over the past three years, SVB had taken in tens of billions of dollars from venture-capital clients; following the onset of the COVID-19 pandemic and, through its aftermath, SVB was a unique beneficiary of the cheap-money era and the explosion in start-up technology companies, receiving an increasingly large number of deposits from these customers. During this period, SVB’s deposits nearly tripled to just under $200 billion and SVB purchased an increasingly large amount of long-dated U.S. Treasury and mortgage-backed bonds. And while this practice is common in the banking industry, the extent of SVB’s bond buying was not. As a percentage of deposits, SVB’s bond portfolio was nearly double that of its regional-banking peers.2
The bonds that SVB purchased were risky. These bonds were issued in a period of low interest rates, which made their values highly sensitive to any future increases in interest rates. SVB’s bond portfolio had excessive duration, which, in other words, meant the value of the bank’s assets would fall as interest rates rose. As the most rapid interest-rate increases in 40 years unfolded throughout 2022, the extraordinary mismatch between SVB’s liabilities (short-term deposits from a concentrated customer base) and its assets (long-term bonds with significant unrealized losses) became more acute. This mismatch and growing concern over the bank’s solvency led more customers to withdraw their funds. As these withdrawal demands increased, the bank was forced to sell bonds and announce additional plans to raise cash.
The ensuing alarm only increased the pace of deposit withdrawals from SVB’s concentrated customer base and led to the bank’s swift failure.
In the aftermath of these bank failures, the questions we most often hear include “Is this a ‘black swan’ event?” or “Could this be part of a bigger problem?” Although we cannot answer those questions with certainty, we are inclined to answer “yes” to both.
The failure of these three banks seems attributable to their unique business models and misplaced management of risk. Those factors would lead toward classifying these failures as “black swans.” Customer concentration, in these cases from corporate customers in the start-up technology and cryptocurrency industries, increased the likelihood of concentrated deposit flight. As an SVB executive mentioned to The Financial Times, “It turned out that one of the biggest risks to our business model was catering to a very tightly knit group of investors who exhibit herd-like mentalities.”3 In addition, SVB’s aggressive purchasing of long-dated, low-yielding bonds placed its financial health at risk by making the value of its assets vulnerable to rising interest rates. The combination of customer concentration and poor risk management appears to support that these events were of the idiosyncratic sort.
On the other hand, the three recently failed banks are not the only financial institutions that are susceptible to higher interest rates. While the aggressive actions of the FDIC, the Federal Reserve, and the Treasury Department should forestall future bank runs, the effects of higher interest rates on other members of the financial system (brokers, insurance companies, asset managers, hedge funds, and so on) will be known only with the passing of time. History makes us respect that these risks can remain underappreciated for extended periods before emerging with startling clarity. The underperformance of the broader financial sector within major stock indexes shows that other investors have similar concerns.
More obvious, we think, is the dampening effect that these struggles will have on economic growth and interest rates. The failure of a large regional bank such as SVB is likely to make similar banks nervous, leading to tighter lending standards, slowing loan growth, and an overall disinflationary effect on the economy. In the face of these challenges, we think the Federal Reserve is likely to slow its pace of interest-rate increases and that interest rates will settle lower than we anticipated only two weeks ago.
Our proprietary stock and bond strategies hold no positions from any of the recently failed banks. We do hold some stock and bond positions issued by companies within the regional banking sector, and these positions have underperformed the broader stock and bond markets over the past week. Because we do not see these companies facing the same liquidity risks as SVB and similar banks, we continue to hold them in our portfolios and will monitor these positions carefully.
In addition, we should note that we at Goelzer build well-diversified strategies, both among asset classes and within asset classes. Diversification has helped portfolios through this period of heightened volatility. For example, on Monday, March 13th, while the U.S. regional bank stock index declined 7.7%, the S&P 500 Index declined only 0.2%, and an index representing a portfolio of 60% U.S. stocks and 40% U.S. bonds increased 0.3%. These comparative returns show the importance of diversification, both within asset classes and among them.
Finally, we remain acutely aware of the stress that these recent events can have on our clients. Our client advisors and portfolio managers are available to address your questions or concerns, whether those relate to the economy, the markets, the banking industry, or your own deposits. Please feel free to reach out to any member of the Goelzer team if you would like more information on any of these issues.
1 At the beginning of the year, SVB was largest holding in KBW Regional Bank Index. Bloomberg, SPDR S&P Regional Banking ETF (KRE), holdings as of December 31, 2022.
2 Cameron Crise, “Life Really Does Move Pretty Fast These Days.” Bloomberg. March 10, 2023.
3 Tabby Kinder, et al. “Silicon Valley Bank: The Spectacular Unravelling of the Tech Industry’s Banker.” Financial Times. March 12, 2023.
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