Things that go bump in the night… at the bank, Silicon Valley Bank
Bonds. Who would have thought we would be describing bonds as things that would scare the daylights out of some of the biggest names in Silicon Valley?
As most of us know, bonds had a rough year last year. One for the history books. We saw it in portfolios with the Bloomberg US Aggregate Bond Index down over 13% for 2022. As interest rates rose, existing bonds declined in value.
Is it better or worse to know that we weren’t alone?
It was actually this historic decline in the value of existing bonds throughout 2022 that brought Silicon Valley Bank to its knees. In short, depositors were withdrawing money faster than anticipated so the bank had to sell off some of their reserves. Those reserves were held in Treasury bonds that had declined in value along with virtually every other existing bond.
If one can hold those bonds to maturity, they are redeemed at face value and there is no harm; no foul. The gigantic caveat: if one is forced to liquidate to, say – meet depositor demands for withdrawals in the midst of a bank run – then it's lights out. The bank was forced to sell those bonds at a loss which perpetuated an old fashioned bank run in the world’s epicenter of technology and innovation. Silicon Valley Bank closed their books with a negative $958M cash balance after customers withdrew $42B last week.
Most of us, like the Markets, just want to know if it can happen again and where the contagion might spread. While nothing is absolute, it seems we should all take comfort in two major factors.
First: The wreckage holding the headlines has been focused in two sectors: technology (Silicon Valley Bank, First Republic) and crypto (Signature Bank, who as of last September had a quarter of deposits related to the crypto currency industry). These are both sectors that have experienced major disruptions in the past year – apart from the rest of the economy which, in spite of The Fed, keeps chugging along.
Second: Capital structures and regulation. Regional banks, deemed less important systemically than those that are “too big to fail”, have different rules. The giant banks had to note their losses on bond portfolios last year, as they were happening. The regional banks were allowed to proceed as is, from an accounting standpoint. There is already lots of finger pointing and blaming underway. (Remember Barney Frank? Of Dodd Frank fame or infamy, depending on your perspective. Mr. Frank was the former Chairman of the House Financial Services committee and a major advocate of tighter banking regulation after the 2008 Financial Crisis. He’s on the Board at Signature Bank.)
It is worth noting here that banks and most investment firms (Park Avenue Securities included) hold client assets very differently from one another. Unencumbered client assets are not part of the Firm’s balance sheet at most investment firms. They are segregated. Pershing holds (custodies) assets for Park Avenue Securities clients. These are also segregated from Pershing’s balance sheet when unencumbered. Said another way – they are not available for a bank to loan against.
Another item of note: the FDIC did exactly what they were established to do and then some. In the case of both Signature Bank and Silicon Valley Bank, FDIC is insuring deposits well beyond their normal limit of $250,000. Everyone is being made whole. Banks pay into the FDIC. It is not on us, as taxpayers, to foot this bill. (And the regulators are taking those bonds that have declined in value as collateral at their face value… good news for banks & depositors. Happy to dig in if anyone has questions on this.)
What will the Fed do next?
As of this morning, the Market has been up over 2% and is now up just under 1% with a skew to the downside. The short term is always anyone’s guess, even more so these days. The thinking seems to be that this weekends’ bank failures throw the door open for the Fed to pause or reverse course and lower interest rates. Major analyst expectations range from a quarter point increase next week to a decrease in the Fed Funds Rate. Sort of the Wild West of forecasting!
On the one hand, economic data remains stubbornly resilient. On the other hand, we keep hearing in strategist commentary, “The Fed doesn’t stop raising rates until they break something.” Like a bank or two. (Ooops… did we do that?)
This remains a time to be steadfast, know what you own and why you own it. Reach out to your advisor with questions and hang in there. History tells us, over and over, these things resolve. The path to recovery might prove to be longer and windier than we’ve become accustomed to but we will still get there.
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