Is Silicon Valley Bank Sell-Off A Canary?
The SPDR S&P Regional Banking ETF (KRE) fell more than 8% last week, reacting to news related to Silicon Valley Bank (SIVB) and Silvergate Bank (SI)—both contending with capital/liquidity issues. Investors sold down positions in other banks as well, fearing broader issues than just these two institutions. Exaggerating the decline was likely the fact that SIVB management was on the conference circuit last week painting a rosier picture of the business than seems to be the reality. So, the news came as a big surprise to the Street.
What was the issue?
Both banks are funded by a unique set of depositors: SIVB by Venture Capital (VC) funds and their principals and SI by deposits related to cryptocurrency (most banks have little or no exposure to VC or crypto deposits). Both banks made fateful decisions to invest the majority of those deposits in intermediate duration securities (including Treasuries) ahead of much of the rise in interest rates; ill-timed as their source of deposits dried up in 2022. The draw on the VC deposits by the VC Funds (without replenishment by investors) and drawdown on crypto deposits by the crypto firms meant that both banks needed access to capital after having already invested the majority of their deposits.
SIVB chose to rip the band-aid off by selling securities at a loss and attempted but failed to raise $2.5 billion in an equity offering and is now up for sale. SI was forced to wind down operations.
The natural first question is whether recent events are symbolic of a broader issue. Our take is (mostly) no. These issues that SIVB and SI had to contend with are of their own doing and unique to their business model (concentrated deposit bases in volatile industries and capital bases with market exposure). And yet, more broadly, the Fed has raised interest rates meaningfully over the last year with the goal of slowing the economy and reigning in lending and spending. So downstream impacts like these shouldn’t be a surprise to investors. To be clear, we do not think there is a systemic issue in the banking sector, but we know that the economy will slow from its current pace. How that ultimately manifests itself will be unique to each business.
Finally, it’s worth underscoring what we often say at times of uncertainty: diversification and risk management (for investors…and for financial institutions) are critical elements of prudent asset allocation.
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