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Special Market Commentary: March 2023 – Translating the Turmoil

Translating the Turmoil

March 16, 2023

By Robert F. Taylor, CFA

The past few days have brought two of the three largest bank failures in U.S. history, which have elevated fears throughout the financial sector and the broader market. Silicon Valley Bank (SIVB) in California and Signature Bank (SBNY) in New York both collapsed and were seized by regulators, on a scale trailing only the Washington Mutual (WaMu) collapse in 2008 at the height of the financial crisis. Similarly, each institution suffered a collapse in confidence, resulting in a classic “run on the bank” as depositors quickly withdrew their money and left each bank in an unsound financial condition.

Banks operate under a simple business model: they take in deposits (liabilities to the bank) and make loans and other investments (bank assets) against those deposits, capturing the spread between the two. Banks diversify their asset bases in several ways. One is to invest in different types of assets including loans, stocks, bonds, and real estate. Another is to invest in assets with different risk profiles, on a spectrum from high-risk, high-return assets to low-risk, low-return assets. Bank runs often begin when a group of depositors determine that a bank’s asset base has declined in value to a point where the bank has or may become insolvent.


Unlike WaMu, which was a traditional savings and loan institution with a broad deposit base, SIVB and SBNY were “unique” banks that catered to a specific clientele. In the case of SIVB, these consisted primarily of startups and early-stage companies, and SBNY had high exposure to cryptocurrency companies. As of December 31, 2022, SIVB’s balance sheet reflected $212 billion in total assets. These included $74 billion in high-risk loans to startups, but also $117 billion in low-risk U.S. Treasury and Agency securities. In a twist of irony, SIVB’s high-risk loan book wasn’t what started the bank run; instead, SIVB’s problems arose out of fair value estimates for its government securities portfolio along with the nature of its depositors.

Remember that bond prices move in the inverse of yields – bond prices go down when yields go up, and vice versa. The sharp rise in yields over the past year put SIVB’s bond portfolio in a significant loss position. While the decrease in value would be reflected in the bank’s financial statements, no actual losses would have been incurred unless the bank was forced to make a sale. Under normal circumstances, SIVB would just hold the bonds until maturity and receive 100 cents on the dollar.

SIVB’s customers and depositors were Venture Capital (VC) funded startups whose cash is vital to sustain their operations. SIVB’s deposit base had grown to $173 billion by the end of 2022, 95% of which sat outside the limits of FDIC protection. The bank’s problems first came to light last Thursday, 3/9 when SIVB announced a highly dilutive capital raise and the sale of a portion of the securities portfolio which incurred a $1.8 billion loss. The VC community immediately recognized these actions as indicative of a liquidity crunch and began advising their portfolio companies to pull deposits. As depositors pulled their funds, totaling $48 billion on Thursday and Friday alone, SIVB was forced to sell more assets at a loss, ultimately wiping out the bank’s equity position. Despite being a New York bank, SBNY also had ties to the California VC community and suffered a similar fate. The rest is history.

Over the past week bank stocks have been falling because they all have bond positions that are impacted to varying degrees by the current interest rate environment. Investors are nervous that the Federal Reserve will be forced to continue raising rates to control inflation, placing even more pressure on bank balance sheets. The problem is most acute in the regional and small bank space as those institutions hold less “reserves” (cash available to fund deposit requests) than large banks do.

With a lower cash-to-asset cushion, smaller banks are more at risk should deposit flight intensify. The business of banking is ultimately one of confidence. Recognizing that confidence was slipping, the Federal Reserve and U.S. Treasury responded Sunday, 3/12 with two major policy programs intended to stabilize the banking system. The programs promise to provide substantial liquidity support to banks facing deposit outflows while attempting to lower the perceived risk of continuing to hold uninsured deposits. Whether the programs ultimately have the desired effect will play out in the coming weeks and months. Further, bank regulation and capital requirements will likely need to be reassessed, and Congress and regulators are already in motion with discussions. But one of the biggest impacts these events have had is to temper the pace of expected rate hikes as the Fed will likely want to “slow down” to assess the situation.

Foster Victor client portfolios have very limited large bank exposure and no direct exposure to mid- and small-sized banks. The bank positions we do hold are of recognizable, well-capitalized institutions that we feel will be able to weather the current storm and ultimately emerge stronger in the end. We continue to keep a watchful eye for opportunities and emerging risks in the banking space and will act accordingly should the need arise.

On a related note, we would like to emphasize that your investment accounts at Charles Schwab are not subject to the same risks of traditional bank accounts. Brokerage accounts are “segregated” assets and are not at risk in the unlikely event of a corporate failure. This brochure explains these differences in greater detail. Furthermore, our analysis of Charles Schwab as a corporate entity shows that it is very conservatively managed with a strong balance sheet. We have no reservations about our partnership with them as the custodian of your assets. If you have any concerns, please reach out to our team with any questions.

Shannon Dermody

Shannon DermodyTEST

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