Written by: Caleb Tucker, CFA®, Director of Portfolio Strategy
With the failures of Silicon Valley Bank (SVB) and Signature Bank (SBNY) we’ve seen the second and third largest bank failures of all time happen within a week. There seem to be two logical questions to be asked. How did this happen? Should we be concerned?
To address the first question, we need to go back to recent history and the low interest rates that were used to stimulate economic activity throughout the pandemic. The low rates had far reaching impacts, with one of the most important being the creation of a boom cycle for tech companies. These tech companies made up a huge portion of the depositors at SVB, which created excessive concentration risk for the bank. Banks like JP Morgan and Bank of America have about 30% of their deposits from retail clients like you and I. SVB on the other hand had only 2.7% of their deposits from stickier retail depositors like us. This created the environment for a failure, but the catalyst of the failure was disastrous risk management on the part of the bank. Banks are required to hold a certain portion of their assets in highly liquid investments, like US treasury bonds. Typically, when banks make these investments, they hedge the risk of interest rates rising. The term “hedge” simply means that they protect themselves from taking losses in the event that rates increase and hurt the value of their bond portfolios. SVB did not do this. On top of the lack of hedging, SVB held a relatively large portion of their assets in securities like treasuries and mortgage backed bonds. In fact, 55.4% of their total assets were in these types of securities, compared to 22.2% on average for other institutions. This meant that just like many of us last year, SVB lost money on their investment portfolio as the Federal Reserve hiked rates to combat inflation. At the same time, their client base made up of tech companies began to withdraw cash because their access to other forms of funding diminished as rates went higher. Once the inflows from tech companies turned into outflows, SVB was in real trouble and eventually failed. SBNY had similar issues after a bet on cryptocurrency banking went south and depositors quickly withdrew funds in the aftermath of the SVB collapse.
The second question is really the most important- should we be concerned? The short answer is “no.” The biggest potential concern would be the risk of contagion from these banks failing, but as was highlighted in the previous paragraph, other large US banking institutions are not in the same situation as SVB. After the Great Financial Crisis in 2008, regulations have made banks’ balance sheets much stronger. The large US banks have a much more diverse funding base and prudent risk management procedures. With the joint measures from the Treasury Department, Federal Reserve and FDIC, depositors at SVB and SBNY will be made whole. This move protects many businesses that stood to lose significant amounts of money and more importantly gives confidence to depositors at other banks that they do not need to rush to withdraw funds.
Finally, no Merit managed strategies have direct exposure to SVB or SBNY. The only exposure to either institution would come in the form of indirect exposure through an index fund. This indirect exposure is negligible and would not constitute a noticeable portion of any model portfolio.
Please reach out to us if you have any questions. While we do not believe the SVB or SBNY failures are a sign of things to come, we will continue to closely monitor developments in the banking sector.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Merit Financial Group, LLC, an SEC registered investment adviser. Merit Financial Group, LLC and Merit Financial Advisors, are separate entities from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss.