Two Major Questions and Our Responses
By, Russ Hill, Executive Chairman
You’ve likely been reading a good deal about Silicon Valley Bank and banks in general. We have as well, and we think there are two major questions to be answered:
- Do our client portfolios or HH have any serious exposure or risk from the banking system?
- What are the likely effects of the recent bank failures’ investments on investments in general?
The first question is much the easier to answer. Neither HH nor any client portfolios had any significant exposure to any of the failed banks: Silicon Valley Bank (“SVB”) was the largest, followed by New York-based Signature Bank and finally, Silvergate in San Diego. We say “significant” since SVB would have been part of any large cap index, but takes up such a small part that it would be difficult to even measure our clients’ exposure in dollar terms.
The Unravelling of Silicon Valley Bank
The fundamental problem at SVB was one that faces all banks: they borrow “short.” Deposits made in the bank may be called away at any time to lend “long” to businesses and homeowners. The protective elements for deposits include both bank capital and regulations that are meant to control risks. It is the actual, fundamental purpose of our banking system to undertake this series of risks to facilitate our economic activity.
SVB, the most important of the failures, was a clear outlier compared to most major banks in several ways. They had almost no insured, retail deposits; they had a very high loan-plus-investments-to-deposits ratio; and they had an enormous industry concentration in technology, including startups. What did this fact pattern imply?
- Retail (personal) bank accounts tend to be very “sticky” – they don’t move often and, since they are insured anyway by the FDIC, hardly anyone has much concern over those banks that focus on retail customer accounts. Uninsured business accounts do have a concern. In SVB’s case, this concern may have been offset by other business benefits until losses grew too large to ignore.
- In a low interest-rate environment, SVB management carried a large, longer-term bond portfolio to offset deposits from their interest-sensitive technology business account holders, attempting to generate a profitable “spread.” But they did not shorten the duration of bond holdings as interest rates rose sharply, thus suffering large write downs of value in their portfolio.
- Because of the industry concentration of technology and venture capital in SVB’s client base, communications among the depositors was very rapid, creating classic conditions for a “run” on the bank.
Why did management of SVB act as they did? That will be an interesting story to figure out. As Andy Kessler, an opinion columnist for the Wall Street Journal said: “Was management hubristic, delusional, or incompetent? Sometimes there’s no difference.”
But maybe there’s more to the story.
It appears that both Signature, with a similar pattern of deposits to SVB, and Silvergate, a crypto lender, had specific management issues – as well as a politically undesirable exposure to crypto.
What Comes Next?
The second question I posed at the beginning about the impacts of these failures is more nuanced and complex.
At the most direct levels, we expect a good deal more volatility in the markets as the Fed’s need for caution regarding inflation-fighting interest rate increases conflicts with their concerns about banking capital and operations.
Federal regulators’ immediate solution – providing deposit insurance for otherwise uninsured depositors and creating a funding mechanism for bank collateral – would seem to have the effect of alleviating concerns about banking stability. But this comes at the cost of easing monetary conditions just when the Fed wanted them to become more restrictive. So we’ll be paying close attention to inflation and interest rate expectations.
The financial services sector is but one element of our equity investments; as always, we believe in holding broadly diversified portfolios. As we see it, the more important effects on returns will be:
- Whether or not we enter a recession – we think it’s more likely than not.
- The shape of that recession, if it occurs – which we think likely to be fairly shallow, and
- The ultimate impacts on tech investing from the loss of SVB.
We will continue to monitor these impacts as they unfold in the coming weeks and months, including Credit Suisse.
Thank for your confidence; we take your well-being seriously.
Halbert Hargrove Global Advisors, LLC (“HH”) is an SEC registered investment adviser located in Long Beach, California. Registration does not imply a certain level of skill or training. Additional information about HH, including our registration status, fees, and services can be found at www.halberthargrove.com. This blog is provided for informational purposes only and should not be construed as personalized investment advice. It should not be construed as a solicitation to offer personal securities transactions or provide personalized investment advice. The information provided does not constitute any legal, tax or accounting advice. We recommend that you seek the advice of a qualified attorney and accountant.