Silicon Valley Bank: Managing Contagion In The Banking Sector
On March 10, 2023 the FDIC was appointed as receiver of Silicon Valley Bank (“SIVB”) based in Santa Clara, California. This is the largest domestic bank failure in more than a decade. How a bank with a $20 billion equity market cap just a month ago, could collapse so quickly is a stark reminder of how relatively rapid interest rate increases may affect an institution that was ill equipped to handle these conditions. Despite the Fed’s widely telegraphed path for interest rates, SIVB held approximately 78% of its portfolio in longer dated US government backed securities, designating these as “Held to Maturity (HTM)”. This meant that although the value of these securities was negatively impacted by rapidly rising rates, they were not “marked to market”. The balance of its portfolio was held as “Available for Sale (AFS)” which requires daily repricing. If the HTM portfolio was marked-to-market on 9/30/22, the loss would have been 1.35x greater than the bank’s tangible common equity. Banking regulators usually refer to a bank in this condition as insolvent.
Negative sentiment steadily built until a late week torrent of withdrawals forced the bank to seek additional capital on an emergency basis. With capital becoming more scarce and increasingly expensive, SIVB clients began to rapidly withdraw capital. The liquidity drain forced sales of depressed fixed income securities (prices of bonds decline as rates interest rise), and news continued to spread that SIVB was in trouble. After SIVB’s desperate attempts to raise more capital failed, it was only a matter of hours before the FDIC took over. After initially promising only to guarantee deposits within the $250,000 FDIC insurance limit, the Treasury and the Fed have now announced that they will guarantee all deposits regardless of size. https://home.treasury.gov/news/press-releases/jy1337. At this writing, these guarantees were applied to SIVB and the just shuttered Signature Bank of New York (“SBNY”). It appears that the Fed will similarly backstop other institutions experiencing similar liquidity issues; accept their portfolios as collateral for short term funding.
The last few days, we have fielded many inquiries relating to recent events and their affect on your 5C managed portfolio? 5C has no direct exposure to Silicon Valley Bank and very limited exposure to regional banks that might be experiencing liquidity issues. Our main custodians have provided assurances that they have no significant exposure to SIVB and no liquidity issues. One important distinction from 2008’s financial crisis is that this is not a credit quality problem, but rather an interest rate and duration problem. The government has indicated that it will provide sufficient liquidity for all government guaranteed debt regardless of current market price; this should relieve pricing pressure on collateral.
We continue to emphasize diversification across asset classes; our bias within the fixed income space has been towards shorter-term high grade fixed income which should provide near term stability for our managed portfolios. We note that buried under the headlines of SIVB’s receivership were unmistakeable indications that the overall US economy and its labor market remain robust. In our opinion, this strength will make the SIVB debacle an unpleasant but non-systemic episode and the Federal Reserve may pause but will not abandon its anti-inflation fight.
