Ten Observations from the Collapse of Silicon Valley Bank and Signature Bank of New York

Note: This situation is obviously still unfolding, but in the interim we felt it prudent to get a few thoughts out to clients with regards to what has transpired over the past few days.

1. Silicon Valley Depositors Were Always Going to be Made Whole: We discussed this situation on Friday in our investment committee meeting and this always seemed like the likely outcome. Although the bank was highly concentrated in terms of clientele and types of depositors, that concentration would have been political suicide to spurn. Yes, FDIC insurance limits are a real thing (sort of), but leaving thousands of businesses unable to run payroll and abandoning the heart of innovation and technology in America was never going to be politically palatable. There were several options, but ultimately when no bank stepped in to buy SVB it was inevitable that the FDIC, Treasury and Federal Reserve would figure out a package to make depositors whole.
2. This is not a “Bail Out” in the Traditional Sense: I’m sure there is a real winner from all this, but it’s hard to discern who that would be. One thing is for sure, however, the winner is not the shareholders of the bank or the banks management team/board. Those folks are being wiped out – both at Silicon Valley and Signature. There could be legal fallout for insider stock trades and that could certainly worsen the damage for those individuals. But the banks themselves did not “win” from this. They’re done.
3. This is not Funded Directly by Taxpayers: The joint press release issued Sunday evening notes, “No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.” The same is said of Signature Bank. Ultimately, banks are going to pay for this through their affiliations with the FDIC. That may seem like a raw deal for other banks, but remember: Banks need confidence in banks and this is a measure attempting to restore faith. Also, these banks are likely to see inflows of capital in the form of deposits as 1. Two banks have now gone under and 2. Some depositors may start spreading their capital around a bit more.
4. Many Banks are More Stable than Stock Prices Indicate: Market participants built themselves into a tizzy over the weekend. As mentioned on our podcast this morning, our investment committee was plugged in all weekend and in constant communication. We, as professionals and fiduciaries, were trying to anticipate new information and analyze news as coherently as possible. We are not always right, but we do try to maintain discipline. Candidly, some of the market reaction to other banks today seems nothing short of chaotic. What we’ve learned (even since Sunday night) is that the government does not want to see banks fail and tools are being readily made available to keep that from happening. Yet, some banks are trading like the government did nothing. To be clear: There are still some very weak banks out there and others may find themselves in the same situation as Silicon Valley or Signature. But that is not indicative of the entire sector. At the time of this writing, the S&P Banking Sector ETF was down 6.5% and the Regional Bank ETF was down nearly 15%. That seems quite overblown as a whole.
5. Bonds Should Price Up: The Federal Reserve is now offering a new Bank Term Funding Program (BTFP) to assist banks whose asset values erode enough to cause a liquidity crunch. Through this program the Fed will essentially purchase assets at full par value to help banks out on a short-term basis. When they do that, the pricing of these securities (and similar securities) will rise. This will relieve banks but also show bumps in assets held by other investors (including Narwhal clients in some instances). This may even create opportunities for exits on fixed income positions on a case-by-case basis.
6. There are Still Downside Risks: The parties involved (FDIC, Treasury, Federal Reserve) acted quickly and robustly to quell concerns. I would not be surprised to see further action and the typical government playbook seems to be this: 1. Try a little bit of a good thing, 2. Do a lot more of a good thing, 3. Do so much of a good thing that it becomes a bad thing. If I had to guess, we’ll see the BTFP funding increase from $25 billion (what was announced last night) to something significantly larger. There will be a risk associated with that – namely the potential for inflation to persist as a large pocket of assets receive a boost in price for no real reason. This potential outcome is being completely ignored by the media. CNBC is calling for a peak in rates as we speak. But even if the program stays at $25 billion and no other action is taken, a bank’s failure goes beyond the situation for depositors. The depositors are being made whole, but countless lending programs and lines of credit offered by these two banks have been wiped out. Silicon Valley Bank, in particular, was known for lending to non-profitable businesses as a part of its Venture Capital-friendly structure. Where will those companies go to get funding? Other banks don’t really do that type of lending. Undoubtedly a large number of new and/or struggling businesses will fail and with that failure will come a rise in unemployment, etc. The Fed may not hate that as they’ve been trying to manufacture unemployment for the past 12 months, but will that economic slowdown offset the perks of higher asset prices as it relates to what the Fed needs to do? We don’t yet know.
7. The Fed Must Continue: In the absence of a definitive answer to the question above, it is our belief that the Federal Reserve must continue on with an interest rate hike in the March meeting. It may seem like they’re talking out of both sides of their mouth to 1. Make things easier for banks while 2. Making economic conditions more difficult, but we’ve seen two-handedness globally over the past two years and I don’t think that’s out of the question. The market seems to think that a rate hike is off the table. Maybe the market is correct, but Jay Powell and company have been slow to deviate course in the past. We think a rate hike remains appropriate. If we get one next week, some equity investors may react like the cry baby venture capitalists who banked with Silicon Valley Bank. Look for a slew of tweets in ALL CAPS TO SHOW EMOTION.
8. We Must Contextualize These Banks’ Failures: Most likely, these two banks are nothing like the banks you use. Silicon Valley had an aggressive concentration with venture capitalists, their firms, and their portfolio companies. Signature Bank had a massive concentration in the crypto space. It would be a misstatement to say these two banks are similar to most banks as it relates to their clientele, deposit/withdrawal behaviors or their approach to managing risk. Further, any kind of business can fail. Banks are not an exception. This headline is quite scary: Two Banks Fail in 48 Hours, Including One of the Nation’s 20 Largest. For context: If we combined these two banks they’d be roughly 1/10th the size of the nation’s largest bank. What’s more, bank failures happened quite often in years past. There was a 15-year stretch in the 1980s and 1990s that saw 1,617 banks collapse – that’s an average of more than two bank failures per week for fifteen years! It’s easy to point fingers and claim regulators were asleep at the wheel, but the reason these collapses are so jarring is that they’ve become so infrequent.
9. These Failures Were Isolated: I think part of why the powers that be were so willing to fix this problem so quickly was because these situations were so isolated. The FDIC, Treasury and Federal Reserve were worried about contagion and early market trading today seems to justify that concern. But these banks did not fail because of any one single policy that is broadly averse to the entire financial system. We can’t really blame inflation or interest rates or the president or other political players for the collapse. These banks were poorly managed. Assets and liabilities were mismatched. That’s how banks fail.
10. Charles Schwab Bank vs. Brokerage: Like many banks, Charles Schwab has not been immune to the calamity in today’s trading (and last week’s for that matter). Charles Schwab does offer banking services and if you are a banking customer of Schwab’s and are worried about deposits on the banking side (which we do not have access to), we would recommend either a. moving those assets elsewhere or b. purchasing a money market fund. Within brokerage accounts (which again, is a distinct business offering from the bank) we have worked to have all cash below FDIC insurance limits to mitigate risk. Our view is that Schwab, which has very little above-FDIC-limit exposure on the banking side, remains stable. We are comfortable with the brokerage business model as clients’ fully-paid-for securities are isolated from the organization’s other capital.