What’s Next for Banks and Markets?

You have likely seen headlines over the past few days regarding regional bank failures and Federal Reserve actions to support depositors. FBB’s team of analysts and advisors has been evaluating the situation and working to analyze the implications for broader markets and portfolios. Our bottom line is that the initial intervention by the Federal Reserve and U.S. Treasury should allow financial markets to settle and recover. However, we anticipate additional choppiness in the days and weeks ahead as investors start to price these new uncertainties into stocks.

What exactly is going on?

In short, investor fears are rising as a few regional banks feel pressure from all sides. Silicon Valley Bank (or SVB), the 16^th largest bank in the United States, is central to this story. During the past several years SVB became the bank of choice for cutting-edge, technology startups. As deposits from these startups rolled in, SVB’s deposits more than tripled from 2020 to March 2022. The bank invested them primary in long-term Treasury bonds, which carried relatively low yields at the time. The fast-moving interest rate environment of the last 12 months depressed the value of these same Treasury bonds.

When the market for startup technology companies cooled in 2022, many of the bank’s customers dipped into deposits to fund operations. The bank was forced to sell its long-dated bonds at a loss in order to return cash to its depositors. Making matters worse, contagion fear spread throughout Silicon Valley, and other depositors began to line up to retrieve their deposits from the bank. What resulted in the end is almost poetic—an old-fashioned, George Bailey-era, bank run “did in” the bank of choice for cutting edge tech startups of today.

This is Not 2008

Looking beyond SVB, investors have been selling shares of other regional banks, fearful that they could follow a similar downward spiral. It’s important to note that the securities on the balance sheets of most banks are similarly concentrated in relatively safe assets such as U.S. Treasuries. This is entirely different than 2008 when banks retained an inordinate amount of highly speculative, toxic debt on their balance sheets.

Recent volatility in the pricing of Treasuries has been driven by the upward and swift rise of interest rates that began last March. One of the finer points of the Federal Reserve’s plan is to allow the banks to post these assets as collateral at 100 cents on the dollar, thus negating the need to sell safe assets at a loss today, which are nearly certain to recapture their full value as they mature. Still, markets are prone to trade on sentiment in the near term. At the moment, selling pressure continues to focus on the regional banking sector, which comprises less than 1% of the S&P 500.

Thus far, broader markets appear to be weathering this storm with little impact. Looking ahead, we will be watching upcoming catalysts, including Federal Reserve action on interest rates, which could further impact investor sentiment and stock prices.

If you have additional questions, we encourage you to reach out directly to your FBB Portfolio Manager.

Michael Mussio, CFA, CFP®
President

Michael Bailey, CFA
Director of Research