Does Banking Bust Spell Disaster? What Investors Need To Know About the Banking Buzz

Does Banking Bust Spell Disaster? What Investors Need to Know About the Banking Buzz

The back half of last week was headlined by significant pressure on the banking industry, leading investors to recall scars left from 2008. Although frightening, the series of events and ultimately the collapse of Silicon Valley Bank are not indicative of impending doom within our financial system. Below we provide background on Silicon Valley Bank, the series of events that led to its demise, and what we view as pertinent takeaways.

Who is Silicon Valley Bank? 

Silicon Valley Bank is a specialty bank whose primary deposit base is venture capital vs. more stable consumer deposits like other banks. The bank primarily caters to startups and the investors that fund them; an insular ecosystem that has taken a big hit since the Fed began raising rates. The bank was the 16^th largest in the U.S. as of the end of 2022, with ~209bn in assets.

What happened?

SVB Financial Group (SIVB), the parent company of Silicon Valley Bank, plunged on March 9th and 10th after a run on deposits ultimately doomed the company. The progression was as follows:

1. SVB surprised investors by relaying that it lost ~$2bn selling assets following a larger than expected decline in deposits.
2. Specifically, the company sold a large chunk of bond holdings, which were at a loss due to rising interest rates, in an effort to enhance its cash position / shore up its balance sheet.
3. Investors dumped the stock, spooking customers and sparking a run on the bank as tech clients rushed to pull their deposits over concerns about the bank’s health.
4. Bankers at Goldman had arranged for the bank to sell additional equity on Thursday to bolster the bank’s capital position, but as the stock kept tumbling and more customers pulled their deposits, the deal fell apart.
5. On Friday (3/10/23) as the stock collapsed, trading was halted, and the FDIC took control of the bank via a new entity (Deposit Insurance National Bank of Santa Clara), to which the bank’s remaining deposits were transferred.

What does this mean?

Is this the start of a credit crisis? No – SIVB is a specialty bank. It is unique relative to the broader banking system, as the firm’s funding source is venture capital as opposed to more stable consumer deposits. Thus, we perceive the events that led to SIVB’s collapse as isolated.

This should not have a lasting impact on other banks as, in our view, the banking landscape overall is much better capitalized than pre Financial Crisis. Much has changed since 2008, including the imposition of more stringent capital requirements. Although it may take a recession to show investors at large that banks are on sounder footing than they were in 2008, we maintain that belief.

The recent news does not change the narrative for long-term investors. Massive tightening of financials conditions can heighten the short-term risks the come with investing in the equity market. Price deterioration of assets that serve as collateral within businesses can appear, which can expose stocks to short-term volatility. Periods of selling pressure in the equity market are normal even in bull markets, in which the average intra-year decline for the equity market is 9%.

Rapid tightening of monetary policy often exposes problems in the lending / debt markets. It is challenging to gain clarity on what is lurking beneath the shadows in lending markets, as organizations outside of the banking system (e.g. insurance firms, private equity) can provide capital to borrowers. Further, there remains an elevated amount of borrowed capital on investor books, which may be deployed to complex (and often risky) trading strategies. Rapid asset deterioration can exacerbate the market impact, of which investors should be aware.

Despite elevated risks, long-term investors have been here before. This is the seventh monetary tightening process since 1980. Some have created issues and subsequent market declines, and some have not. And even for the periods that resulted in price declines, stocks ultimately settled at higher prices. As for the current situation, we believe that issues in some areas of the banking system are not systemic – and we would caution investors from rushing into the conclusion that a repeat of the 2008 Financial Crisis is unfolding.

The Fed is willing to sacrifice some short-term pain (weaker growth) for long-term gain (lower inflation). Long-term investors should too. 5- and 10-year inflation expectations reside in the 2-2.5% range, which has historically coincided with the highest valuations for equity markets. Despite the potential volatility that may arise in the weeks and months to come, we remain positive on long-term equity market returns.