This past Friday, our Chief Investment Officer Ronald G. Albahary, CFA® sent out the email below to clients:
— As most of you are likely aware, today [March 11, 2023] financial regulators closed Silicon Valley Bank (SVB), the nation’s 16th largest bank. The FDIC (Federal Deposit Insurance Corp.) has been named the receiver and they have created the Deposit Insurance National Bank of Santa Clara to take over the deposits.*
SVB has been a core banker to the venture capital community–to funds, companies, and founders–for 40 years. The speed at which SVB went from viable entity to being closed is head-spinning, but the FDIC having so quickly stepped in reflects hard lessons learned from the Global Financial Crisis. According to the FDIC, this is the second-largest bank failure in US history after Washington Mutual’s failure in September 2008. A link to the FDIC announcement is available here.
Speaking to our contacts in the industry, the general sense anecdotally is that much of SVB’s asset quality is strong and that uninsured depositors could receive a significant amount, if not all, of their capital back. But this remains to be seen as the process will take time.
What precipitated this event?
While the situation is complicated and not all the facts are known, what is known is SVB had experienced a significant decline in their deposits due primarily to less available funding in the venture capital space. To resolve their deposit issues, SVB was compelled to sell US Treasuries at a loss and had announced an aggressive effort to raise equity capital to shore up their balance sheet.
SVB’s CEO mismanaged the messaging of the capital raise, creating concern regarding the bank’s financial stability. This in turn broke down belief in the bank, leading to a classic bank run. A contributing factor is that SVB had a monolithic client base within the venture capital space among founders and venture capital funds that made possible the coordinated withdrawal of capital. Some of the most influential leaders in the VC community directed their portfolio companies to remove their capital.
We are actively reaching out to our managers to assess their exposure related to uninsured deposits and lines of credit with SVB. It is too early to provide many specifics. With that said, some General Partners (not many thus far) have deposits with SVB that exceed FDIC-insured limits, but the amounts have tended to be small percentages of their overall portfolios. Additionally, our analysts are looking at any equity or credit exposure in the liquid equity and credit strategies that our clients are invested in. On the latter front, the exposures appear to be de minimis. We will communicate early and often as we get our arms around this very fluid situation.
Is this the proverbial canary in the coal mine?
SVB’s situation looks idiosyncratic given its concentration on the venture capital community. But we cannot discount the risk that this one node on the neural network of the financial system can present for the broader financial markets.
One seemingly isolated event can have knock-on effects, either driven by the domino effect of interconnected financial relationships or simply the contagion of fearful psychology. What we do know is this is one of the unintended risks of the Fed’s aggressive rate hikes, something we have referenced in our quarterly commentaries. Will there be more unintended consequences? That is possible but not necessarily in the banking sector, which seems to have healthy balance sheets and more diversified business models. Rather, the potential for further turbulence is probably more likely across the credit markets.
On a positive note, SVB’s meltdown puts financial stability back on the table for the Federal Reserve, which ironically may be good for equity markets as the Fed could walk back its recent hawkishness and take a more deliberate approach to further rate increases. While the Fed is seemingly not too concerned about creating some form of recession, creating a banking crisis is certainly not an outcome they desire. Another possible positive outcome could be a realization by both parties that the Congressional brinkmanship related to the debt ceiling may not be worth the potential risk and cost.
While this situation continues to unfold and its consequences are unknown, as stated earlier, the regulators learned a lot of valuable lessons from the Global Financial Crisis that they are and will be applying to keep this event contained. Consider that from 2008 through 2022, according to the FDIC, 536 banks failed totaling over $712 billion in assets. While many of those failures occurred in the first three years of that timeframe, nearly 40% occurred thereafter**. Certainly, with all the risks already present, a large bank failure can certainly heighten investors’ risk aversion. However, as we said recently during our client webinar, the flip side of risk is opportunity. With a long-term timeframe and well-designed financial and investment plans, your portfolios have been built to weather adversity with specific exposures that can take advantage of the dislocations that occur when risk aversion grips markets.
In closing, we don’t take this type of event lightly. We are actively monitoring the potential for knock-on effects in other parts of the economy and markets and will keep you apprised as we learn more.