By John Lau
March 14, 2023 – Over the weekend, three major U.S. banks failed, and the Fed announced a new lending facility to shore up the banking sector; investors are being painfully reminded of 2008 and are wondering 1) What’s happening? 2) What does it mean for them and their accounts? 3) Is this a time to get out of the markets?
We know that this is creating anxiety, so I want to offer our analysis of what’s happening in the markets and the banks specifically, and to specifically answer the following questions:
- What’s happening with SVB and other banks?
- Why is it happening?
- Did the Fed actions over the weekend solve the budding crisis?
- What’s the impact on monetary policy and inflation?
- Is this a bearish game-changer for the broader market?
What’s happening with SVB and other banks?
On Friday of last week, Silicon Valley Bank (SVB), the 16th largest bank in the U.S., failed and was seized by the FDIC. It is the largest bank failure in U.S. since Washington Mutual during the financial crisis. Then, on Sunday, Signature Bank of New York (SBNY) also failed and was taken over by the FDIC. Like Silvergate Capital and SVB, Signature Bank had a lot of crypto exposure. In sum, three large banks failed in less than a week.
In response, the Fed and Treasury Department announced on the weekend that 1) all depositors at SVB and SBNY, including FDIC insured and non-insured, will be made whole and have access to their deposits on Monday, and 2) the Fed also created a new lending facility, the Bank Term Funding Program (BTFP), which will provide one year loans to banks and accept Treasuries and agency mortgage backed securities (Fannie/Freddie MBSs) as collateral at par value (not current market values—this is important. See further discussions below).
Do the moves by the government solve this crisis? Not entirely, but they help.
The government’s weekend moves are helping in two ways: One is to help address the local economic risk, and the other is to help remove much of a larger scale run risk. Let me explain:
First, the local economic risk. Thousands of companies have money at SVB and SBNY and the vast majority of them have deposits in excess of the $250k FDIC limit. So, if those uninsured deposits are lost, then they will have no money to meet payroll, pay suppliers, etc. So, there’s a real economic risk here. By making all SVB and SBNY depositors whole and having access to their deposits, including FDIC insured and non-insured, this risk is temporarily averted.
The second risk is much bigger. SVB and SBNY failed, in part, because of a lack of interest rate risk management. These banks bought long dated bonds over the past several years and didn’t manage their duration or interest rate risk. So, as rates rose over the past year and longer dated bonds dropped in value, it eroded their capital base and bonds they valued at par (100) were worth much less. This is likely a problem of varying degrees across most (if not all) banks in the U.S. and represents a real threat to the system should a large-scale run develop. However, the Fed has removed much (not all) of this risk by accepting these bonds from banks at par, thereby eliminating the need for banks like SVB or SBNY to fire sale U.S. Treasuries or mortgage backed securities during times of stress.
The government’s response to SVB and SBNY does not, however, guarantee uninsured deposits across the banking system, and they are still at risk. So, we should expect a lot of deposit movement in the coming days (companies and people moving money to diversify risk and try and get close to, or under, that 250k level). That could easily result in more stress to banks and no one should be surprised if we see more regional bank failures in the coming weeks. Bottom line, the government response (guaranteeing all deposits at SVB and SBNY and creating the BTFP) helps and makes a broader bank run extremely unlikely, but it doesn’t solve the problem of 1) Bonds that have lost value and 2) Risk associated with uninsured deposits.
At Robertson Stephens, we will continue to work with Schwab and Fidelity to ensure your assets are secure. To understand how Schwab and Fidelity protect client assets, including securities, SIPC protection and FDIC coverage, you may click here for more information: Schwab. Fidelity.
Will This Make the Fed Less Hawkish?
The market seems to think so, but I’m not so sure. The market is aggressively pricing that this whole saga will make the Fed less hawkish, as Fed Fund futures are pricing in a 25% chance of no rate hike in March and a terminal fed funds rate of just 4.625% (meaning this hike in March will be the last one). Looking back over the last twelve months, at least five separate times since the start of the bear market in 2022, investors have been overaggressive in assuming the Fed is going to get less hawkish, and that’s led to “head fake” rallies multiple times throughout 2022 and most recently in early 2023 (remember before all this bank drama Powell was hawkish and stocks dropped), and I am concerned it could be happening again with the banking crisis. The banking stress is a risk, but inflation is still at 6% and creating the BTFP will expand the Fed balance sheet at a time when it’s trying to shrink it (the Fed is actively engaged in Quantitative Tightening). Barring this regional bank stress metastasizing into a full blown national banking crisis (something that is very unlikely), I am not convinced that the Fed will stop hiking rates in the near term; if anything, this could end up ultimately providing stimulus to the economy and cause the Fed to hike more in the longer run.
Is This a Bearish Gamechanger and a Reason to Raise Cash? Not Yet.
The natural reaction to this bank saga is to make a parallel to 2008, but we don’t think that’s appropriate because in the end, the underlying assets at these regional banks are high quality investments (they are U.S. Treasuries and mortgage-backed-securities and the housing market isn’t collapsing). A better analogy would be the savings and loan crisis of the late 1980’s, where a subset of banks with direct exposure to an industry (in that case oil and gas) failed, and it created ripple effects across smaller lenders, but never threatened the broader banking system. That situation did not cause material market stress or declines.
Stepping back, we have continued to follow a defensive allocation mix and advocated for conservative positioning, using rallies to ensure appropriate levels of risk and volatility, and something like this happening has been part of the reason why. Hiking cycles cause stresses, every time. And this is why we want to remain conservatively positioned as we weather this economic and market period. That said, I do not think the volatility of the last week is a bearish gamechanger because the medium- and long-term outlooks aren’t materially more negative now than they were two weeks ago, and for those with longer time horizons we continue to advocate holding core stock and bond holdings with an emphasis on defensive sectors, low-volatility ETFs and value, because that should weather the continued volatility better than higher-beta portions of the market. Meanwhile, we will be watching for any further signs of contagion in markets, and will continue to make adjustments as required. For now, this appears to us more of a targeted risk for regional banks and an earnings headwind for financials more broadly, but not a systemic issue that requires abandoning long-term financial goals for preserving capital.
Our clients rely on us for timely information, and our job is to deliver.
Disclosures
Investment advisory services offered through Robertson Stephens Wealth Management, LLC (“Robertson Stephens”), an SEC-registered investment advisor. Registration does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. This material is for general informational purposes only and should not be construed as investment, tax or legal advice. Please consult with your Advisor prior to making any investment decisions. The information contained herein was compiled from sources believed to be reliable, but Robertson Stephens does not guarantee its accuracy or completeness. Investing entails risks, including possible loss of principal. Past performance does not guarantee future results. This material is an investment advisory publication intended for investment advisory clients and prospective clients only. Robertson Stephens only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of Robertson Stephens’ current written disclosure brochure filed with the SEC which discusses, among other things, Robertson Stephens’ business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. © 2023 Robertson Stephens Wealth Management, LLC. All rights reserved. Robertson Stephens is a registered trademark of Robertson Stephens Wealth Management, LLC in the United States and elsewhere.
For information about Robertson Stephens, go to www.rscapital.com.
What the Bank Failures Mean for Markets?
By John Lau
March 14, 2023 – Over the weekend, three major U.S. banks failed, and the Fed announced a new lending facility to shore up the banking sector; investors are being painfully reminded of 2008 and are wondering 1) What’s happening? 2) What does it mean for them and their accounts? 3) Is this a time to get out of the markets?
We know that this is creating anxiety, so I want to offer our analysis of what’s happening in the markets and the banks specifically, and to specifically answer the following questions:
What’s happening with SVB and other banks?
On Friday of last week, Silicon Valley Bank (SVB), the 16th largest bank in the U.S., failed and was seized by the FDIC. It is the largest bank failure in U.S. since Washington Mutual during the financial crisis. Then, on Sunday, Signature Bank of New York (SBNY) also failed and was taken over by the FDIC. Like Silvergate Capital and SVB, Signature Bank had a lot of crypto exposure. In sum, three large banks failed in less than a week.
In response, the Fed and Treasury Department announced on the weekend that 1) all depositors at SVB and SBNY, including FDIC insured and non-insured, will be made whole and have access to their deposits on Monday, and 2) the Fed also created a new lending facility, the Bank Term Funding Program (BTFP), which will provide one year loans to banks and accept Treasuries and agency mortgage backed securities (Fannie/Freddie MBSs) as collateral at par value (not current market values—this is important. See further discussions below).
Do the moves by the government solve this crisis? Not entirely, but they help.
The government’s weekend moves are helping in two ways: One is to help address the local economic risk, and the other is to help remove much of a larger scale run risk. Let me explain:
First, the local economic risk. Thousands of companies have money at SVB and SBNY and the vast majority of them have deposits in excess of the $250k FDIC limit. So, if those uninsured deposits are lost, then they will have no money to meet payroll, pay suppliers, etc. So, there’s a real economic risk here. By making all SVB and SBNY depositors whole and having access to their deposits, including FDIC insured and non-insured, this risk is temporarily averted.
The second risk is much bigger. SVB and SBNY failed, in part, because of a lack of interest rate risk management. These banks bought long dated bonds over the past several years and didn’t manage their duration or interest rate risk. So, as rates rose over the past year and longer dated bonds dropped in value, it eroded their capital base and bonds they valued at par (100) were worth much less. This is likely a problem of varying degrees across most (if not all) banks in the U.S. and represents a real threat to the system should a large-scale run develop. However, the Fed has removed much (not all) of this risk by accepting these bonds from banks at par, thereby eliminating the need for banks like SVB or SBNY to fire sale U.S. Treasuries or mortgage backed securities during times of stress.
The government’s response to SVB and SBNY does not, however, guarantee uninsured deposits across the banking system, and they are still at risk. So, we should expect a lot of deposit movement in the coming days (companies and people moving money to diversify risk and try and get close to, or under, that 250k level). That could easily result in more stress to banks and no one should be surprised if we see more regional bank failures in the coming weeks. Bottom line, the government response (guaranteeing all deposits at SVB and SBNY and creating the BTFP) helps and makes a broader bank run extremely unlikely, but it doesn’t solve the problem of 1) Bonds that have lost value and 2) Risk associated with uninsured deposits.
At Robertson Stephens, we will continue to work with Schwab and Fidelity to ensure your assets are secure. To understand how Schwab and Fidelity protect client assets, including securities, SIPC protection and FDIC coverage, you may click here for more information: Schwab. Fidelity.
Will This Make the Fed Less Hawkish?
The market seems to think so, but I’m not so sure. The market is aggressively pricing that this whole saga will make the Fed less hawkish, as Fed Fund futures are pricing in a 25% chance of no rate hike in March and a terminal fed funds rate of just 4.625% (meaning this hike in March will be the last one). Looking back over the last twelve months, at least five separate times since the start of the bear market in 2022, investors have been overaggressive in assuming the Fed is going to get less hawkish, and that’s led to “head fake” rallies multiple times throughout 2022 and most recently in early 2023 (remember before all this bank drama Powell was hawkish and stocks dropped), and I am concerned it could be happening again with the banking crisis. The banking stress is a risk, but inflation is still at 6% and creating the BTFP will expand the Fed balance sheet at a time when it’s trying to shrink it (the Fed is actively engaged in Quantitative Tightening). Barring this regional bank stress metastasizing into a full blown national banking crisis (something that is very unlikely), I am not convinced that the Fed will stop hiking rates in the near term; if anything, this could end up ultimately providing stimulus to the economy and cause the Fed to hike more in the longer run.
Is This a Bearish Gamechanger and a Reason to Raise Cash? Not Yet.
The natural reaction to this bank saga is to make a parallel to 2008, but we don’t think that’s appropriate because in the end, the underlying assets at these regional banks are high quality investments (they are U.S. Treasuries and mortgage-backed-securities and the housing market isn’t collapsing). A better analogy would be the savings and loan crisis of the late 1980’s, where a subset of banks with direct exposure to an industry (in that case oil and gas) failed, and it created ripple effects across smaller lenders, but never threatened the broader banking system. That situation did not cause material market stress or declines.
Stepping back, we have continued to follow a defensive allocation mix and advocated for conservative positioning, using rallies to ensure appropriate levels of risk and volatility, and something like this happening has been part of the reason why. Hiking cycles cause stresses, every time. And this is why we want to remain conservatively positioned as we weather this economic and market period. That said, I do not think the volatility of the last week is a bearish gamechanger because the medium- and long-term outlooks aren’t materially more negative now than they were two weeks ago, and for those with longer time horizons we continue to advocate holding core stock and bond holdings with an emphasis on defensive sectors, low-volatility ETFs and value, because that should weather the continued volatility better than higher-beta portions of the market. Meanwhile, we will be watching for any further signs of contagion in markets, and will continue to make adjustments as required. For now, this appears to us more of a targeted risk for regional banks and an earnings headwind for financials more broadly, but not a systemic issue that requires abandoning long-term financial goals for preserving capital.
Our clients rely on us for timely information, and our job is to deliver.
Disclosures
Investment advisory services offered through Robertson Stephens Wealth Management, LLC (“Robertson Stephens”), an SEC-registered investment advisor. Registration does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. This material is for general informational purposes only and should not be construed as investment, tax or legal advice. Please consult with your Advisor prior to making any investment decisions. The information contained herein was compiled from sources believed to be reliable, but Robertson Stephens does not guarantee its accuracy or completeness. Investing entails risks, including possible loss of principal. Past performance does not guarantee future results. This material is an investment advisory publication intended for investment advisory clients and prospective clients only. Robertson Stephens only transacts business in states in which it is properly registered or is excluded or exempted from registration. A copy of Robertson Stephens’ current written disclosure brochure filed with the SEC which discusses, among other things, Robertson Stephens’ business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. © 2023 Robertson Stephens Wealth Management, LLC. All rights reserved. Robertson Stephens is a registered trademark of Robertson Stephens Wealth Management, LLC in the United States and elsewhere.
For information about Robertson Stephens, go to www.rscapital.com.
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