As we have been watching the Silicon Valley Bank (SVB) and, to a lesser extent, Signature Bank drama unfold, we wanted to provide our clients with an update on the situation and what impact it may have on our portfolios. As the old saying goes: \u201cThere are decades when nothing happens, and there are weeks when decades happen.\u201d<\/p>\n
Let\u2019s start with a quick intro. SVB is known as the bank for start-ups and emerging technology companies. They have been in the business of providing banking services to companies funded by venture capital since the 80s. In the early days, this was not a well-serviced segment of the banking market, and SVB really thrived in the 90s tech boom expanding over the years to become the 16th<\/sup>\u00a0largest bank in the US. SVB grew from its original business into more traditional private banking and mortgage lending, even becoming one of the largest lenders to wineries in the US. They have financed notable companies such as Cisco, Fitbit, Airbnb, and Pinterest, among others. As of December 30th<\/sup>, 2022, SVB held $209 billion in total assets, with $175.5 billion in total deposits.*<\/p>\n The next part of the SVB story: how does a bank with $209 billion in assets and $175.5 billion in deposits get taken over by the Federal Deposit Insurance Corporation (FDIC)? To fully understand why, we must go back to the beginning of the COVID-19 pandemic, March 2020. The bank\u2019s deposits were $62 billion at the time and began rapidly expanding as governments, traditional investors, and venture capital firms poured money into technology and healthcare companies. By March 2021, SVB had doubled its deposits to $124 billion. This turned out to be a double-edged sword because it forced SVB to invest a record amount of deposits in a short period of time.<\/p>\n SVB chose to invest those deposits into long-term government bonds and mortgages. At face value, this made sense at the time, as interest rates were at all-time lows. The best way for SVB to maximize its profits on this new deposit base was to invest in longer-term bonds, which had the highest yields at the time.<\/p>\n Banks make money by paying short-term interest on deposits, like in your chequing or savings accounts, and receiving long-term interest on investments like mortgages (in the US, mortgages are 30-year terms and do not renew) and other types of lending. In early 2021 there was also lots of venture capital available to fund their start-up clients, so SVB was not concerned about their clients needing capital to fund operations.<\/p>\n As the calendar flipped to 2022, the market narrative began to change. Inflation began to cause interest rates to rise, which decreased the market value of the long-term bonds and mortgages that SVB had invested in. As we noted in our most recent market outlook, 2022 was one of the worst years on record for long-term bonds, including government bonds. Venture capital investors also started to guard their capital, and funding became less available. By late 2022 many startup companies began withdrawing their deposits from SVB to fund operations.<\/p>\n 2022 was the perfect storm for SVB, and 2023 was the rogue wave that capsized them.<\/strong>\u00a0The government bonds that SVB had invested in were marked down by $15 billion in market value by December 31, 2022. There were little venture capital assets coming in the door, and many startups were requesting withdrawals to fund operations. Short sellers, who profit when a company\u2019s stock value falls, began to view SVB as their top short-selling idea. Rumors swirled that Moody\u2019s Credit Rating Agency would downgrade SVB\u2019s credit worthiness which would significantly impact the bank\u2019s credibility. To raise capital to fund these withdrawals, SVB realized $1.8 billion in capital losses in early March 2023. SVB then began selling an additional $21 billion in assets, borrowed $15 billion and attempted to raise $2.25 billion in emergency equity to help fund the increasing withdrawal demand. This was not enough to satisfy Moody\u2019s, and on March 8th<\/sup>\u00a0they downgraded SVB\u2019s creditworthiness. This led legendary tech investor Peter Thiel and many other private equity firms to urge companies they had invested in to withdraw their deposits.<\/p>\n By March 9th<\/sup>, $42 billion in withdrawals had been requested, and the bank was in a negative cash balance of $958 million. This is known as \u201ca run on the bank,\u201d which is when many depositors rapidly withdraw their capital. This all caused SVB\u2019s stock value to plummet further (it lost 60% of its value in 2022) until it was halted from trading on the morning of March 10th<\/sup>. Later that same day, the FDIC issued an order taking possession of SVB. This is the largest failure of a bank since the 2008 financial crisis and the second largest in US history in today\u2019s dollar terms.<\/p>\n The FDIC acted swiftly to calm markets and is searching for a buyer of SVB. They have also announced that they will be providing backing for all depositors (insured and uninsured) at SVB (they have reached a similar agreement with Signature Bank).<\/p>\n It should be pointed out that the FDIC stepping into insure deposits is not a bailout of SVB or Signature Bank like in 2008. The FDIC has stepped in to ensure depositors at SVB and Signature Bank are not harmed. The majority of which are smaller businesses that need capital to fund business operations like payroll. They are not bailing out the shareholders or bondholders of these banks, which will be wiped out, which was not the case in 2008. In theory, there should be no taxpayer capital used in this exercise as the bonds that SVB holds should mature at par over time which will be used to pay back the FDIC.<\/p>\n There are many headlines out there that the failure of SVB and Signature Bank is the second and third largest bank failures in US history. While attention-grabbing, those figures are in today’s dollars. They do not account for inflation. While we never like to see any bank or large business fail, it does happen from time to time and is part of the economic cycle. These occurrences happen when there is stress in the economy and financial system. We have seen this before.<\/p>\n It is also important to put rhetoric aside and focus on facts. The first question investors should ask is, “how big is SVB relative to the larger banks in the US or our Canadian \u201cBig 5\u201d?” The largest banks in the US (JP Morgan, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley) all have assets well north of $1 trillion USD, and the \u201cBig 5\u201d Canadian Banks all have assets above $800 billion. As we know now, it\u2019s not necessarily about the assets on hand but their liquidity and market value. The regulatory framework governing these larger banks is much stricter than the ones that are governing smaller banks like SVB. The market value of the assets at the above institutions has not dropped the +10% that SVB\u2019s assets dropped due to higher interest rates. SVB assets represent 0.96% of the total US Banking assets that the Federal government follows as part of its monitoring of Banks over $300 million in assets. They are a VERY small fraction of the US and global financial system.<\/p>\n In client portfolios, we are continuously adjusting to market conditions. Last week we trimmed our equity exposure with the expectation that upcoming economic data would cause volatility. In The Love Letters to end 2022 and start 2023, we pointed to expected volatility in the equity market during the first quarter of 2023 due to the consequences of interest rate hikes. This led to a neutral position in client portfolios with an overweight to fixed income, in particular to long-term government bonds, which have rallied significantly during this crisis. We have cash on hand, ready to deploy once the market calms down and opportunities present themselves.<\/p>\n The current bank system stress has led the market to believe that the Federal Reserve will significantly slow their rate hiking path and cut rates more aggressively towards the end of 2023. This should come as a relief to many interest-rate payers in the US. We are seeing interest rate cuts for Canada get priced into the back half of 2023. We will be paying particular attention to the outcome of the next Federal Reserve meeting later in March. Those minutes will be particularly telling as to the Federal Reserve\u2019s reaction to this. Calm has returned to the markets, and it seems that there will be an orderly withdrawal of deposits from SVB and Signature Bank thanks to the actions of the Federal Reserve, Treasury Department, and FDIC.<\/p>\n As always, if you have any questions or comments, please feel free to reach out to a member of our Team. How can we help?<\/p>\n