The SVB Bank Collapse and What It Means For You
On Friday March 10, the world woke up to headlines that Silicon Valley Bank (SVB) had “failed.” Bank failures, though rare, are nothing new and the story roughly plays out the same each time. Runs start with higher-than-anticipated demands for cash that turn into a contagion as depositors become fearful they won’t be able to get their money out and withdraw it, even though they don’t need it right then. The speed at which the SVB collapse happened showed us what a run looks like in an age when information travels almost instantaneously and money can be requested from anywhere via a simple request from a phone.
The Federal Deposit Insurance Corporation (FDIC) was established expressly to prevent the fear that drives bank runs. If depositors are guaranteed they will get their money back, there is no need for panic and small dislocations don’t turn into full-blown explosions with wide-reaching collateral damage. The challenge for SVB and Signature Bank, which was also shut down by government regulators over the weekend, was that the vast majority (up to 97%) of depositors had exceeded limits for FDIC coverage.
SVB was also particularly susceptible due to its concentrated depositor base of startups and small technology companies. In the pandemic, many of them became flush with cash and parked it at SVB. SVB, seeking yield and safety, invested it in longer-dated Treasury bond and other government backed securities. As higher interest rates hit the tech sector and startups particularly hard, companies began withdrawing cash at a faster rate. At the same time, the value of SVB’s longer-dated bonds fell. This pattern had been going on for multiple months until last week when SVB announced the sale of securities at a loss to cover withdrawals. That announcement triggered broad concern and the fear that SVB would not be able to cover the full amount of their deposits. Whether that would have ultimately been true or not remains unclear.
To avoid further panic and contagion risk across the banking system, the FDIC stepped in and took over the bank on Friday, following up with a guarantee to cover all deposits at SVB and Signature Bank, even those above the standard insurance limit. Given the commitment to cover deposits for these two banks, it seems likely they would do so for others. They also extended very attractive loan arrangements that can be used by any bank. Many believe these actions should be more than enough to provide stability.
While the government has stepped in to cover depositors, this intervention is far different than what happened in 2008 when the government also bailed out bond and equity shareholders. With the government takeover, the equity of SVB is worthless as is that of Signature Bank. Thankfully, the ETFs we recommend in our core portfolio had immaterial exposure to these stocks (< 0.1%).
However, our core portfolio overweighs U.S. small-cap value ETFs that have exposure to many other regional bank stocks which have been hit hard by association. Fear-driven market pullbacks are never fully logical, so one never knows what will happen in the next few days and weeks, but there are good reasons to believe that SVB and Signature Bank were outliers in many respects and that other small and medium-sized banks are in a stronger position.
It is very common in fear-driven market declines for small-cap stocks to suffer greater losses and then rise more quickly during a recovery than the broader market. The COVID crash in March of 2020 was the most recent example of this phenomenon. We believe one reason small-cap value stocks have historically delivered returns higher than the broad market is their greater volatility in times of stress. To be in a position to capture the potentially higher returns and diversification benefit of investing in these stocks, we must stay the course.
Anytime there is stress in the financial markets, it is an opportunity to assess whether we are taking undue risk. Investing is never risk free, but our goal is always to maximize our return for a given amount of risk. There are already some good reminders coming out of the current situation:
- Make sure the cash you hold at any given bank is below the FDIC insurance limit. There are plenty of good options to help you do this even for cash balances in the millions. If you, someone you know, or the business you work for is in this situation, please reach out to us and we can help direct you to solid options based on the specific needs.
- Reassess any concentrations you may have in your wealth. One of the major reasons SVB was susceptible to a bank run was the concentration of its depositor base and the high exposure in its investments to a single risk – rising interest rates. The likelihood of any given company going bankrupt is small, but the consequences can be catastrophic if a significant portion of your wealth and livelihood are tied to a single entity. The power of diversification across all aspects of your current and future wealth should not be underestimated as an effective means of protection.
Financial market stress and the associated volatility can be unnerving. We strive to provide peace of mind by designing our portfolios to keep clients on track to reach their goals through a variety of market conditions.
Disclosure: All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be taken as such.