by Randy Loving, CFA, MONTAG Portfolio Manager
Historically how the Fed impacts the banking industry
The Federal Reserve started raising rates on March 17th of 2022. Historically, there is a one-year lag between a change in monetary policy and its impact being felt in the real economy. Close to exactly a year later, Silicon Valley Bank (SIVB) was taken over by the FDIC on March 10th of 2023. SIVB was not your typical bank, instead they catered to venture capital funds and the companies they funded. Around 50% of start-ups funded in the United States were being funded through SIVB. This resulted in a concentrated number of large depositors that were very interconnected both in business and socially. With rates low at the time, in 2020 and 2021 the bank grew substantially through acquisitions and the growth of its venture capital customers who suddenly were flush with low-cost funds to invest.
A perfect storm of bad timing
Just prior to the Fed commencing its rate increase cycle, SIVB changed how it managed its balance sheet. They allowed their assets, made up of loans and bonds, to be greater in value than deposits. Over the coming year, as interest rates went from 0% to 4.75% the value of the bonds which the bank had purchased since 2020, began to show large unrealized losses. The predicament became that if SIVB was forced to sell the bonds and realize the losses, it would cause the bank to violate regulatory requirements.
An attempt to right the ship
By March of 2022, SIVB created a strategy to raise capital through a stock offering to mitigate the need to sell the bonds at a loss to cover withdrawals. This influx of money would help raise much needed capital to meet regulatory requirements. As the news of this plan traveled, it actually spooked SIVB clients and other savvy investors, who took to Twitter with their comments. This in turn set in motion what has become the first large bank run sparked by a viral social media discussion.
Silicon Valley Bank and the impact on the banking system
So now what? Typically the Fed guarantees all deposits in US Banks up to $250,000 per depositor. In response to the closure of SIVB and other banks over last weekend, the Fed announced that for any affected bank, deposits above $250,000 per depositor would also be covered. In addition, the Fed opened a new lending facility for banks to exchange their bonds for cash at the par value to help with liquidity to meet withdrawals.
What is to come?
In our opinion the banking industry is again going through significant change which is likely to end with an increase in regulation around deposits. This could ultimately affect the willingness and ability for banks to lend which may cause the economy to cool. In past cycles, when banks reduce their willingness to lend, the economy weakens and we may see a recession in the months ahead. There will be a lot of discussions in the future about the regulatory impact and new requirements that will most likely be introduced. MONTAG will be following this matter and managing holdings in the financial sector closely.
MONTAG recommends for further and individualized potential impacts, that you reach out to your financial advisor.
The information provided is for illustration purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action to be taken. These analyses have been produced using data provided by third parties and/or public sources. While the information is believed to be reliable, its accuracy cannot be guaranteed.