Philip Straehl is the global head of research for Morningstar’s Investment Management group. In his role, he oversees the group’s capital markets research and chairs the asset allocation committee.
Tyler Dann, CFA, is head of research, Americas at Morningstar Investment Management, LLC.
- The closure and wind-down of Silicon Valley Bank SIVB has led to considerable stress in equity markets, particularly among shares of regional banks, as well as fear of contagion.
- There are unique elements to SVB that contributed to its demise, including its client base and risk controls.
- While we are likely not fully “out of the woods” yet, we view the regulatory response as appropriate and likely adequate, which should head off contagion fears.
- As long-term, fundamental, wisely contrarian investors, we’re exploring ways to benefit from a potential dislocation in banking stocks, while being mindful of the risks.
Silicon Valley Bank, one of the 20 largest banks in the United States in terms of assets, has collapsed. It was the second-largest bank failure in U.S. history. A second (slightly) smaller bank, Signature Bank SBNY, also folded in similar fashion. In the case of both banks, the FDIC—an independent agency of the U.S. government that provides insurance to bank depositors—was appointed as the receiver. Put simply, FDIC took over these troubled financial institutions, with the intention to create the best outcome for bank depositors.
The SVB/Signature story has a lot of components, but ultimately boils down to an old-fashioned bank run. A flood of withdrawals from depositors destroyed these banks. How could this happen? This type of situation, while complex-sounding, is fairly simple: There were not enough cash and liquid assets available that could be sold to fund deposit outflows, without wiping out the bank’s equity capital base. That’s in part because banks are not required to carry enough cash to fund 100% of their deposits. According to regulations, they’re allowed to invest multiple dollars (think $10, in round numbers) for every dollar of deposits. These investments, which could be in the form of loans to customers or invested in marketable securities such as U.S. Treasuries or mortgage-backed securities, are generally longer-term in nature, and are not always able to be sold or otherwise harvested at a profit.
Some people have made comparisons to gym memberships. If every gym member showed up at the same time, not everybody would be able to work out. Banks are similar: If every depositor wants to pull their money at the same time, not everyone can get their money back.
Why Is SVB Unique?
For SVB in particular, the growth trajectory of its deposit base, the concentration of its customers, the peculiarity of its portfolio, and the relative lack of risk controls around the portfolio are unique factors. Per public filings, SVB’s deposit base jumped from $49 billion at the end of 2018 to $189 billion at the end of 2021. Venture capital funding was at all-time highs during this period and startups receiving funding often put the proceeds into SVB bank accounts. Putting that growth in perspective, SVB’s deposit base grew by approximately 57% per year in this period while industry deposit growth was only 12% per year, according to Morningstar’s research. As well, close to half its deposit base originated from technology companies, and most of those were early-stage technology companies. Traditional retail deposits, which tend to be stickier and tend to be smaller than the $250,000 insured by the FDIC, composed a relatively small portion of SVB’s depositor base, making it more prone to a bank run.
As deposits grew rapidly at SVB, the bank increasingly purchased fixed-income investments. The bonds they purchased (predominantly mortgage-backed securities) were high-quality, but were long in duration, with the weighted average maturity over 10 years. Shortly after making these investments, the Federal Reserve began one of its most aggressive rate-hiking periods in history. As interest rates rose, the value of these bonds fell. While in theory, the bond losses only existed on paper (if SVB held the bonds until maturity, it would get all its money back, plus interest), the “mark-to-market,” or unrealized, losses from these investments were significant, exceeding the company’s tangible equity capital. Observing this, depositors became skittish, started redeeming their money, and SVB became a forced seller of many of those bonds to meet redemptions. The paper losses turned into actual losses and laid the foundation for the rush to the exit by SVB’s depositors.
Is This a Lehman Moment?
While the collapse of another bank (Lehman Brothers) was at the epicenter of the global financial crisis in 2008, we believe that the recent bank failures are significantly less likely to trigger a global banking crisis. The speculative excesses that caused the financial crisis of 2008-09 were rooted in an economywide bubble in the real estate market, propelled by a large amounts of cheap debt funding that flowed into real estate securities. These leveraged and insufficiently capitalized owners of real estate securities created a fault line in the financial system, causing a global banking crisis as the price of real estate assets started declining and leveraged investors faced margin calls.
This time around, the speculative excess appears to have been in concentrated in niche segments of equities and alternative asset markets such as companies related to cryptocurrencies. Unlike the economywide debt binge that dominated the period leading up to the global financial crisis, venture capital tends to be equity-funded. Consequently, if venture companies fail, the loss typically ends with the investor, rather than being transmitted through the financial system as a bad debt. Additionally, bank balance sheets are largely a function of the regulatory response to the global financial crisis, and are significantly stronger than they were in the period leading up to 2008.
We would argue that while the rapid rise in Treasury yields has caused some short-term losses for the banking industry that are substantive, industry capital levels are better positioned to weather the storm. We also believe the regulatory response from the Fed, the FDIC, and the Treasury Department has been quick, unified, and substantive. The addressing of insured and uninsured depositors at SVB and Signature, as well as the opening of a borrowing window for short-term collateralized funding available at very attractive interest rates and terms should head off any concerns around systemic risk of a collective “run on the bank” moment.
First, let’s cover portfolio exposure to SVB. This stock was listed on the Nasdaq stock exchange and thus was held by many investors. Some indirect exposure is therefore likely for investors that hold a diverse portfolio using mutual funds or exchange-traded funds. In the case of Morningstar’s managed portfolio range, we expect the maximum exposure to be less than 0.5%, often far less, depending on the strategy used.
Regarding knock-on effects, in the short term, we would not be surprised to see market volatility remain elevated, reflecting the increased uncertainty around potential outcomes. In particular, the financial services sector, most notably regional banks, could remain under strain for some time. However, as long-term, valuation-driven, fundamental, and wisely contrarian investors, this type of setup is one that we would use to begin searching for opportunities. We would look for our valuation work, coupled with our assessment of fundamental risk and investor expectations, to be our guide in determining whether, when, and by how much to increase our investment in the banking industry, as well as other sectors that could be affected.
We currently have a balanced viewpoint of U.S. financials, with a “medium” conviction rating assigned. From a valuation perspective, the sector looks relatively cheap (the second cheapest, behind communication services) but recent events have increased uncertainty, so careful portfolio construction is warranted. One issue is that the earnings can be quite volatile and cyclical, but bargain prices can present themselves as investors flee from uncertainty. Armed with research, we stand ready to adapt, and will monitor both the opportunities and risks very closely.
The opinions, information, data, and analyses presented herein do not constitute investment advice; are provided as of the date written; and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this document. Except as otherwise required by law, Morningstar, Inc or its subsidiaries shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. It is important to note that investments in securities involve risk, including as a result of market and general economic conditions, and will not always be profitable. Indexes are unmanaged and not available for direct investment.
This commentary may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.
The Report and its contents are not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Morningstar or its subsidiaries or affiliates to any registration or licensing requirements in such jurisdiction.
This information has been accurately reproduced, as received from Morningstar, Inc. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.
The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.
If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. Any decision to invest should always be based upon the details contained in the Prospectus and Key Information Document (KID), which may be obtained from MeDirect Bank (Malta) plc.