March 21, 2023
Over the last two weeks, investors have witnessed the regional bank failure of Silicon Valley Bank (SVB), and its peers have come under intense scrutiny as the market tries to understand what/why it happened and what the broader implications may be. With respect to
SVB, it was a large player in the venture capital (VC) and private equity space who primarily served a niche customer base rather than traditional retail deposits. This focus by SVB on institutional/VC clientele resulted in a riskier balance sheet posture with a very high level of loans/securities as a percentage of deposits and a low reliance on retail deposits. Consequently, SVB was particularly vulnerable in the event of rising interest rates and depositor outflows, which they experienced over the last year or so.
In the first quarter of 2023, as inflation remained persistent and rates continue to march
higher, SVB was forced to sell some of its high-quality, longer duration securities at a loss to
meet client demands when they requested deposits back. This resulted in a $1.8 billion loss. As news quickly spread of this realized loss, panic set in across their client base and led to a
requested withdrawal of $42 billion in just one day alone. On Friday, March 10th, the bank
entered into receivership by the FDIC and a very thorough review of the previous few days’
events was initiated by government officials at the FDIC, Federal Reserve and U.S. Treasury.
During this review, officials identified some other similarly positioned institutions (Silvergate
Capital & Signature Bank), and action was taken to protect depositors (insured and uninsured). Importantly, the government protections do not apply to investors or management of these banks.
Financial markets have been working to digest these recent bank struggles, and investors
are trying to grasp how much additional risk may remain across the financial sector. It is important to recognize that the largest banks in the U.S. remain healthy and well capitalized. This is not like 2008-2009, when balance sheets industry-wide were in question. In fact, the largest banks have come together to support and replenish liquidity at struggling regional banks as a show of strength. We believe that this duration mismatch between high quality assets and deposit liabilities, as well as poor risk management, is a relatively isolated case to institutions that have tailored their business to concentrate on riskier client types and other corporate accounts rather than traditional retail deposits.
While we do not like to see companies fail in any industry, as long-term investors we recognize this is part of a capitalist market structure and believe this reinforces the critical nature of risk management and due diligence within the investment process. At Grant Street, we believe diversification protects portfolios against significant impacts from these events. We do not expect widespread banking failures at this time. We continue to monitor the market environment and will adjust portfolios accordingly.
Sincerely,
Grant Street Asset Management, Inc.
Investment Committee