What should or should not be in your safe deposit box? With the rise of electronic storage, demand for safe depot boxes has fallen, causing some banks to eliminate their safe deposit box operations.
The recent failures of Silvergate Capital, Silicon Valley Bank (SVB), and Signature Bank are concerning and confusing. It is hard not to have flashbacks to 2008/2009 when 165 banks failed, according to FDIC.gov, including the largest bank failure in US History – Washington Mutual. Watching any company close is disheartening, but the spectacularly quick implosion of SVB, the 16th largest bank in the US was nothing short of stunning.
There are some factors that are unique to these bank failures; including the concentration of clients in venture capital and/or cryptocurrency, high amount of depositors that were uninsured for deposits above the FDIC limit of $250,000, and poor risk management strategies. The concentration of clients caused concerns to spread quickly. The fast pace of social media and the ability to move money online accelerated the demise. The amount of uninsured deposits plays a key role. If a majority of the account balances were under $250,000, there would be no concern from the account holders.
Banks take deposits and pay interest to the account holder of certain types of accounts – money market, CDs, savings, and some checking accounts. They make money by lending out the deposited money at a higher interest rate than they are paying to the account holders. However, the stimulus money that flooded the economy during the COVID pandemic was hard to lend out as economic activity slowed due to COVID restrictions. This led many banks to look for alternative ways to put the deposited money to work. In the case of SVB, they chose to invest in long dated government bonds. These bonds, if held to maturity, pay back the original amount the bond was sold for plus interest.
US Government bonds are considered the safest asset in the world. In fact, they are considered the “risk free” asset. That doesn’t mean the price stays the same the entire time a security is owned. The price will fluctuate with changes in interest rates. When rates go up, bond values drop and vice versa. The Federal Reserve raised rates from 0% in March 2022, to 4.25% by December 2022. The increase in rates produced one of the worst years of bond returns in US history, with the benchmark US Bloomberg Barclays Aggregate Bond Index down 13% for the year.
SVB had invested in long term bonds to try and generate more income versus short term bonds. This led to a mismatch in the timing of their assets and liabilities, with short term deposits backed by long term bonds. There are other banks that may be facing a similar set of circumstances as the banks that have recently failed. The quick response of the US Treasury, FDIC, and Federal Reserve has slowed further bank failures by guaranteeing that account holders can access full deposits, even those above the FDIC limit, and by providing banks with the ability to exchange long term bonds for short term bonds without realizing a loss.
So where does this leave us?
The failures have highlighted the impact of rising rates on the financial system, and the economy in general. Market participants were expecting further rate hikes at the Federal Reserve’s meeting next week. In fact, the discussion wasn’t about whether they would vote to raise rates, rather it was how much they would be raising rates – 0.25% or 0.50%. Market expectations have now shifted dramatically to the open question of whether rates will be raised, left unchanged, or potentially cut. We expect volatility to remain elevated in the short term, as investors try to assess the path of interest rates and search for other cracks in the economy with the financial sector specifically highlighted.
Our clients had very minimal exposure to the stocks of the failed banks. SVB and Signature were both part of the S&P 500 index. Funds that track the S&P 500, such as the Vanguard Institutional Index fund (VINIX) had less than 0.1% invested in the two banks as of December 31, 2022. Diversification has helped offset the loss in market values of these two banks, but wider risks remain. Additionally, pressure on venture capital, and by extension private equity markets could continue to grow. We have no direct exposure to venture capital or private equity funds.
What happens from here will be largely determined by the actions of the Federal Reserve at their meeting next week. With the Federal Reserve officials currently in a quiet period ahead of the meeting, it is just a guess what will happen at this point. We will continue to stay disciplined in our investment approach, defensive with the securities we hold, and well diversified to avoid company risk. If you have questions or concerns about your investments or the health of our bank, please reach out to your team at Central Trust, we are here to help.
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