Important Investment Update: SVB Failure

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 – stock.adobe.com

Investing involves risks, and investment decisions should be based on your own goals, time horizon, and tolerance for risk. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost. The forecasts or forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice. The market indexes discussed are unmanaged and generally considered representative of their respective markets. Index performance is not indicative of the past performance of a particular investment. Indexes do not incur management fees, costs, and expenses. Individuals cannot directly invest in unmanaged indexes. Past performance does not guarantee future results. The Dow Jones Industrial Average is an unmanaged index that is generally considered representative of large-capitalization companies on the U.S. stock market. Nasdaq Composite is an index of the common stocks and similar securities listed on the NASDAQ stock market and is considered a broad indicator of the performance of technology and growth companies. The MSCI EAFE Index was created by Morgan Stanley Capital International (MSCI) and serves as a benchmark of the performance of major international equity markets, as represented by 21 major MSCI indexes from Europe, Australia, and Southeast Asia. The S&P 500 Composite Index is an unmanaged group of securities that are considered to be representative of the stock market in general. U.S. Treasury Notes are guaranteed by the federal government as to the timely payment of principal and interest. However, if you sell a Treasury Note prior to maturity, it may be worth more or less than the original price paid. Fixed income investments are subject to various risks, including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications, and other factors. International investments carry additional risks, which include differences in financial reporting standards, currency exchange rates, political risks unique to a specific country, foreign taxes and regulations, and the potential for illiquid markets. These factors may result in greater share price volatility. Please consult your financial professional for additional information. This content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and they should not be considered a solicitation for the purchase or sale of any security.

Concord Asset Management, LLC (“CAM” or “IA Firm”) is a registered investment advisor with the Securities and Exchange Commission. CAM is affiliated, and shares advisory personnel with Concord Wealth Partners. CAM offers advisory services, including customized sub-advisory solutions, to other registered investment advisers and/or institutional managers, including its affiliate, Concord Wealth Partners, LLC. CAM’s investment advisory services are only offered to current or prospective clients where CAM and its investment adviser representatives are properly licensed or exempt from licensure.

The information provided in this commentary is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. IA Firm is neither a law firm nor a certified public accounting firm, and no portion of the newsletter content should be construed as legal or accounting advice. A copy of IA Firm’s current written disclosure Brochure discussing our advisory services and fees is available upon request or at https://concordassetmgmt.com/.

Please Note: If you are an IA Firm client, please remember to contact IA Firm in writing if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. IA Firm shall continue to rely on the accuracy of the information that you have provided. Please Note: If you are an IA Firm client, please advise us if you have not been receiving account statements (at least quarterly) from the account custodian.