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The Banking Crisis

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The failure of Silicon Valley Bank (hereafter SVB) lit a fuse and so began the banking “crisis” that to this day unfolds. First Republic Bank caught fire and the banking sector, both in Europe and the United States, feels the heat.

Regulators stepped in to control the damage and guaranteed all SVB deposits, including those above the $250,000 FDIC insured limit. No telling how severe the crisis would have been had they not acted quickly. Over 90% of SVB’s deposits are rumored to have been over the $250,000 limit. SVB shareholders were wiped out, save for a possible settlement down the road. It remains to be seen what the future holds for the various parts of SVB but it is likely it will be sold in pieces. SVB declared bankruptcy. It took forty years to build Silicon Valley Bank and less than a week for it to implode.

U.S. Regulators, Moody’s, and Blackrock all warned SVB before the collapse that their investment portfolio presented a significant risk. The bank’s liabilities (deposits) were short-term and their investments in bonds were long-term. Interest rates were low for so long that it felt safe to extend their bond maturities to a much later date in the future. Long-term bonds tend to be very volatile and decline in price as interest rates rise. SVB sold these long-dated bonds that were carried on their books at cost, or “held to maturity” issues, at a significant loss. This loss, and the perceived need to shore up deposits, is the spark that lit the fire. Well-respected venture capitalists warned of problems at SVB and depositors ran for safety, moving deposits out of SVB to larger banks. The end result was a run on the bank.

Like SVB, First Republic Bank is a local, northern California bank. They share many high-net-worth clients with SVB, many of whom are in the technology sector. Regional and small banks are a vital part of local communities. They hold deposits and loan funds to small and mid-sized businesses as well as individuals. First Republic Bank did not and does not have liquid funds to shore up the damage from significant deposit withdrawals. The large, multi-national banks joined forces last week and infused First Republic Bank with $30 billion of funds.

The rating agencies, Moody’s and Standard & Poor, downgraded First Republic debt to junk.

Stock prices of all multi-national and regional US banks declined in March which is not unexpected given the vast amount of uncertainty and fear the crisis would spread. A week has gone by with time to digest the SVB failure and concerns for regional banks. Many US bank stock prices are higher today. Credit Suisse, a troubled Swiss bank, was bailed out by UBS bank.

Maybe the tide has turned, and a major financial crisis is averted. First Republic has hired JP Morgan to advise them on strategic alternatives, including a sale of the bank. First Republic stock is 35% higher today, but still down 86% for the month. The US government is looking at ways to guarantee all bank deposits if the crisis worsens. We’ll see what happens, but confidence seems to be restored – for now.

What then is the fallout from this crisis? More government regulation would mean regional and community banks would be required to hold more capital in the future. This could mean fewer loans available to individuals and small and mid-sized companies. The liquidity these banks provide is the engine that drives our economy. If lending standards are tightened and less funds are available, we can expect a slower, weaker economy. The fear of bank solvency could be replaced by a greater fear of recession. This could impact stock prices. Portfolio representation in multiple asset classes and diversification of stock portfolios reduces risk.

SVB’s failure was caused by very low interest rates for a very long time. SVB’s poor financial management and lack of caution in the face of rising interest rates caused significant losses and ultimately the bank’s failure. This event was idiosyncratic, meaning it was unique to SVB and not a result of widespread bank failure. First Republic shares common clients and geography with SVB and Credit Suisse has had problems for some time. The decline in bank stocks, even those less impacted, was aggravated by fear the problems would spread throughout the banking industry. SVB’s problem looks to be unique and severe relative to other banks.

It is not clear how all this will play out. As advised before, we recommend deposits no greater than the $250,000 FDIC insured amount at any one bank unless larger amounts are guaranteed. The overall stock market has been minimally impacted by this turn of events, down less than 1% this month. Bond prices have been volatile. It appears the fall out from the banking crisis is isolated and not materially impacting other sectors of the stock market. Diversification pays off in these situations.