Our team at KLR has been watching the Silicon Valley Bank situation closely since mid-last week and our portfolios were prepared for the volatility. Fortunately, there were quick actions taken by the FDIC and Washington over the weekend to maintain confidence and stem any further damage in the banking system and financial markets. Here’s a closer look at what we know so far.

What happened?

Late last week, there was a rapid collapse of SIVB (ticker), SVB Financial Group, the parent company of Silicon Valley Bank after a more than 60% decline in the stock price Thursday into Friday and stock trading was halted on Friday morning.

Some things to note:

• It is the second largest bank failure (Washington Mutual) in US history after a run on deposits.
• The panic surrounding SVB kicked off Wednesday after crypto bank Silvergate Capital closed. Then whispers of liquidity issues at SVB turned into a self-fulling prophecy.
• Venture-capital investors had advised startups to pull their money out of SVB in droves, citing the liquidity concerns.
• The company then said it would book a $1.8 billion after-tax loss on sales of investments and seek to raise $2.25 billion by selling a mix of common and preferred stock. It then could not raise that equity capital.
• The bank was shut down on Friday in under 48 hours, an unbelievably quick period of time for a large regional bank to collapse.

Who took control of SVB?

The FDIC has taken control of the bank via a new entity it created called the Deposit Insurance National Bank of Santa Clara.

Keep in mind that:

• All of the bank’s deposits have been transferred to the new bank.
• Contagion started to hit the regional banks hard on Thursday and into this week.
  • Signature Bank, chartered in New York, was then closed down over the weekend.
  • Shares of First Republic Bank, which caters to business owners and wealthy individuals, were hit hard down 20% on Friday. It was down another 60% on Monday, but seems to be recovering quite a bit along with other banking institutions as of Tuesday morning.
  • Some larger banks and their share prices were lower on contagion fears, but that has since mostly dissipated.
  • The KBW Nasdaq Regional Banking Index was down nearly 20 percent before recovering on Tuesday.
• The government then took major steps to prevent more contagion and issues in the banking system, by promising to make all depositors whole at SVB and Signature no matter what the amount was.

Why did this happen?

SVB is a relatively large regional bank that focuses on lending to startups, VC firms, and technology companies. They were one of the few companies with a large VC incubation funding platform. Over the Covid pandemic, with tech and VC companies doing well, clients parked billions of dollars in deposits with SVB. The bank then bought tens of billions of dollars of longer-term U.S. Treasuries and government-backed mortgage securities. There wasn’t much risk involved in this until the Fed started aggressively raising rates last year. With each rate hike and longer term interest rate risk, the value of those securities fell drastically and SVB had unrealized losses of more than $17 billion.

Concurrently, SVB’s deposit inflows reversed to outflows as clients burned through cash and capital dried up for the tech and startup community. To meet client demands and reinvest at higher interest rates, SVB started selling those fixed income securities at significant losses worth billions of dollars. They then tried to raise equity capital, which alarmed clients further and spooked stock investors. The stock collapsed in trading over two days, the equity capital wasn’t raised and the FDIC came in to assume control.

The main issue stemmed from the fact that SVB concentrated on a very specific clientele (tech, startups, Venture Capital- VC) as opposed to a typical bank who services a diverse client base. Also, the fact that a very large chunk of their biggest clients demanded all of their money in such a short period of time did not help. It essentially forced the bank to shut down as the losses from their bond portfolio and inability to raise capital prevented the bank from having the cash to distribute to depositors.

The VC community did not help itself, but the bank also severely failed to oversee risk and provide adequate controls in a time of crisis. It is a lesson in failure to account for asset and liability management.

Which other banks are affected and why?

• Fortunately, the largest banks are much more well capitalized than in 2008, but this type of contagion risk will be idiosyncratic depending on each bank’s security holdings and lending/deposit practices.
• As of now, the largest banks stock prices are stable, and government agencies are monitoring liquidity.
• Regional banks will be most at risk, especially smaller banks with significant exposure to the tech, healthcare startups, and VC communities (Silicon Valley, Greater Boston, other metros that are tech centers, etc..)

What does it all mean for the markets and the economy? What will we be watching for in the coming weeks?

It is never a good thing when a large, publicly traded bank fails, especially at the speed SVB failed. This is alarming to investors, deposit holders, creditors, and lenders of all shapes and sizes. The broad markets only fell in a relatively small way so far (around 1-3% depending on the index, positive as of Tuesday). Markets seem to be stable for now, but we will know more in the coming days as we process who has exposure to SVB and where there might be panic.

Again, fortunately, larger banks are well capitalized and seem to be generally unscathed from this collapse. Much of this has to do with the fact that SVB was mainly a tech and startup focused bank, but did have other departments it added, such as Boston Private, a wealth firm with a large presence in New England and the greater Boston area.

The tech industry may find that access to capital has significantly decreased and cost of capital should increase across all industries. The challenge the FDIC that will face is finding a potential buyer for SVB’s assets as selling to a larger bank would further increase financial institution concentration and could create another too big to fail situation. Much of the excesses of the Covid era economy and easy money policies are being removed.

The positive to come out of this (if considered positive) is that the Fed may take pause considering this event, stable inflation and wage growth, and a “goldilocks” jobs report from Friday. There is now a stronger chance that we may be getting very close to the end of rate hikes, much of it depending on the next couple inflation reports. Fixed income markets rallied heavily over the last several days with yields collapsing across the yield curve raising the value of treasury fixed income securities.

Regarding our KLR Wealth Clients

We have no direct exposure to SVB stock in our model portfolios. We have very small amounts of exposure to a few regional banks, but we continue to monitor our exposure to all banks and any companies that may be affected. We have been very defensive, quality cash flow focused, active, and discerning in our manager selection and in turn our stock exposure.

We are and have been significantly underweight tech, especially profitless tech, which should shield us from large tech sector fallout and losses. We’ve had this underweight in our portfolios as higher interest rates tend to crush profitless firms with significant debt burdens/low quality balance sheets. We are overweight investment grade fixed income securities across all of our models which hold bonds. This gives us a strong cushion for equity losses in the near term and should continue to do so as investors “fly to quality”.

We remain hyper focused on our exposure and will continue to monitor the situation closely. Feel free to reach out to me or the wealth team with any questions.

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