Important Investment Update: SVB Failure

Gary Aiken March 15th, 2023

Fifteen years ago this week, Bear Stearns collapsed and was purchased by JP Morgan for $2 per share and a mountain of government assistance. This March, we have witnessed three banks, Silvergate, Signature, and Silicon Valley, taken into receivership by the FDIC. Bank failures have been exceedingly rare since the end of the Financial Crisis. The hallmarks of bank failures are usually the same, and this cycle is proving to be no different.

Commercial banks profit by combining money from investors, creditors, and depositors and making loans. While it seems simple and can be, the more complex a bank’s operations are, the more ways it can all go wrong. We are still learning why the banks that have failed this cycle failed. Ultimately, their management made poor decisions — decisions that any investor could make. We tell our clients as investors to diversify their assets, to consider when they might need the money they plan to invest, and to choose an advisor who will prudently watch over their investments. In the case of Silicon Valley Bank, it seems they were too concentrated, forgot about the time value of money, and didn’t devote enough resources to risk management.

SVB’s depositor base overlapped significantly with the companies to which they lent money or in which they were making investments. As the tech economy has faced a downturn, those companies’ deteriorating prospects meant they were drawing down their deposits at SVB and losing value as creditworthy investments for the bank at the same time. Concentration risk meant great returns on the way up and accelerating problems on the way down.

As a tech-focused bank, SVB’s deposits grew quickly as the post-COVID tech boom economy exploded; it took in more cash than it could reasonably loan out and had to do something with that money. Bank regulations and accounting standards led management to conclude that they should invest the excess cash from deposits in outsized investments into seemingly “safe” government bonds and government-backed mortgages. But, when interest rates go up, bond prices go down. The further out in the future those bonds’ maturities are, the more sensitive those bonds are to the interest rate/price dynamic. When the value of those mismatched bond investments fell as interest rates increased, the bank teetered on insolvency.

Concentration and investment risk should have been and could have been handled effectively by prudent risk management. Banks often seek to diversify the types of loans they make and the borrowers they lend to. They diversify amongst checking, savings, certificates of deposit, and bonds. They diversify amongst installment loans, mortgage loans, and business loans. Many banks in the same circumstances decided to make investments that properly aligned with the time frame of their liabilities (deposits). This is called “Asset/Liability Management.” More prudent banks (we hope) who took on long-term exposure to interest rates hedged that risk with derivatives that would provide an offset if rates went up. Finally, it appears that SVB did not even have a Chief Risk Officer for a significant amount of time. A $200 Billion bank should not be without experienced, conservative leadership in that area.

And so, we’ve reached the point at which we stop blaming SVB and start asking the next logical questions. Where were the regulators? Who else is like SVB? What other landmines are out there? Does this mean something for the larger economy, or is it confined to a small group of tech and cryptocurrency-focused banks? Economic philosophers will start to ramble on about “moral hazard.” This is the point in the conversation where we start pulling out Warren Buffett quotes, like “you find out who’s swimming naked when the tide rolls out.” My own personal quote that I’ve shared with your Concord Wealth Partners advisors is that “Unsustainable practices eventually end, sometimes abruptly and with substantial consequences.”

The Federal Reserve kept interest rates at an extremely low level for thirteen years following The Great Recession of 2008-09. They flooded the economy with cheap money, distorting valuation and encouraging malinvestment both in the government and private sector. Now in the face of historic inflation, they have increased interest rates by nearly 5 percentage points in a year while shrinking the money supply for the first time in a generation. The unsustainable practices have ended. We are now at the “and with substantial consequences” phase. For Concord clients, we are sticking close to the vest in bonds — short duration, high quality, floating rate where possible. We are equal weight/underweight in stocks — we prefer value stocks with reasonable valuations and businesses that can sustain dividends. We continue to think that U.S. stocks provide a better investment opportunity set than international companies, given the uncertainties around the War in Ukraine and China reopening.

There will undoubtedly be opportunities to invest as the tide rolls out. There will be naked swimmers as Buffett says, but the receding sea will also reveal beautiful seashells for us to collect. Our metal detector may find valuable treasures left behind by others who left the beach in a hurry. If we can understand the risks we’re taking, the time frame under which we can take those risks, and prudently evaluate opportunities within our risk tolerance constraints, we will be set up for long-term results that enable us to meet our investing goals.

Reach out to your advisor to learn more about our approach to current market conditions.

Photo Credit: rarrarorro –

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