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Macro and Market

What We Know About the Collapse of Silicon Valley Bank

SVB’s fall demonstrates the value of diversification and company-specific risk management in the banking sector.

03/17/2023
Looking up at a skyscraper labeled 'bank'.

Key Takeaways

The recent shutdown of Silicon Valley Bank (SVB) highlights the tumultuous impact of rapidly rising interest rates on certain financial companies.

SVB’s downfall was company-specific and not indicative of widespread problems in the banking sector, in our view.

The SVB failure underscores diversification’s critical role in tempering volatility across stock, bond and cash holdings.

The insolvency of Silicon Valley Bank (SVB) and two smaller regional banks has created chaos for the banking sector and more uncertainty for investors. Indeed, the rapidly rising rate environment has created challenges for all banks. But these failed entities assumed specific risks, including highly concentrated client bases, which ultimately contributed to their downfall.

With contagion fears mounting, our investment teams are actively assessing the broader impact on banking securities, U.S. and global financial markets and client portfolios.

In the meantime, the situation accentuates a fundamental tenet for investors: Diversification. SVB’s technology sector-focused client base and concentrated investment portfolio led to heightened risk exposure for the bank. For investors, the bank’s downfall highlights the importance of diversifying assets, including cash holdings.

Why Did SVB Fail?

Between 2019 and 2022, SVB’s bank deposits more than tripled, compared with growth of approximately 37% for the banking industry.1 The bank invested those deposits primarily in longer-maturity, fixed-rate U.S. Treasury and agency securities at prevailing interest rates, which were notably lower than they are today.

The bank’s challenges began to surface in early 2022 when the Federal Reserve (Fed) embarked on an aggressive rate-hike campaign and escalated from there:

  • As interest rates rapidly rose, the value of the bank’s bond holdings — particularly its longer-duration securities --declined.

  • The bank needed to pay higher interest rates on its deposits to keep existing account holders and attract new business.

  • However, SVB’s large venture capital client base wasn’t attracting enough new deposits to offset bank withdrawals.

  • With withdrawals growing, management had to sell securities to raise cash. But those securities had declined in value, given the rising-rate environment.

Deposits Exceeded FDIC Limits

Approximately 90% of SVB’s deposits exceeded the $250,000 insurance limit of the Federal Deposit Insurance Corp. (FDIC). This factor, combined with the losses tied to the bank’s bond sales, worried stock and bond investors. Panic and a run on the bank’s deposits ensued, culminating in the FDIC’s takeover of SVB’s operations on March 10.

The mass withdrawal of SVB deposits differed from previous bank failures, which were sparked by credit risk. With a portfolio of U.S. Treasury and agency bonds, SVB had minimal credit risk exposure. SVB’s troubles stemmed from liquidity risk, or not being able to generate sufficient cash to meet depositors’ withdrawal demands.

Fed, Treasury Stepped In

Within two days of the FDIC takeover, the U.S. Treasury guaranteed all deposits at SVB, including those exceeding the insured limit. Additionally, the Fed announced the Bank Term Funding Program, which will allow banks with liquidity needs to borrow against high-quality securities at par value.

Does SVB’s Collapse Signal Widespread Danger for Banks?

Banks and financial institutions have important roles in every economy and remain key components of the U.S. equity market. The financials sector comprises approximately 12% of the broad U.S. stock market, as measured by the Russell 3000® Index. Most regional banking stocks reside in the small-cap value universe, with a 17% weighting in the Russell 2000® Value Index.2

Company-Specific Risks Led to SVB’s Downfall

The recent banking sector turmoil calls attention to the interest rate and liquidity risks facing all banks. But some banks are better than others at managing those risks. We believe SVB’s downfall was company-specific and not indicative of a coming contagion in the regional banking industry.

However, the revelation of SVB’s risky business practices has led to renewed investor scrutiny of the entire banking sector. In the near term, we expect this analysis to generate heightened volatility and uncertainty in the U.S. and elsewhere.

Market's Fears May Be Misplaced

As is typical after such unsettling events, contagion fear explodes, prompting investors to aggressively slash risk exposure. We’re seeing this phenomenon play out with the recent steep sell-off of U.S. and European banking stocks.

However, we expect this emotional selling to eventually subside. Financial institutions with broad deposit bases, diverse revenue sources, good credit underwriting and strong capital ratios will ultimately stand out, potentially leading to outperformance.

Our Portfolios Focus on Banks We Believe Are Financially Sound

We continue to believe select regional banks offer opportunities. Our research suggests valuations are 40% below average, reflecting recent headlines but ignoring strong liquidity levels at most banks.

We generally favor banks with diverse customer bases, significant liquidity and strong credit histories. For several months, our bond portfolios have focused on higher-credit-quality securities. In general, they hold larger regional banks subject to more stringent and regular regulatory reviews than SVB due to the size of their assets.

Across American Century Investments, analysts are reviewing our banking exposure to ensure our holdings appear financially sound and aligned with each portfolio’s objectives.

What Does This Bank Turmoil Mean for Interest Rates?

In the wake of this banking sector unrest, investor expectations for interest rates continue to waver. We expect sharp rate swings as the market attempts to gauge how the Fed will respond at its March 21-22 monetary policy meeting.

Ultimately, we believe inflation and still-strong employment data will keep the Fed in rate-hike mode for the next few months. In our view, the recent steep drop in short-maturity Treasury yields was likely overdone, triggered by expectations for an unlikely near-term shift in Fed policy. We expect short-maturity yields to reverse course and start rising again.

We also expect intermediate-maturity interest rates to remain volatile. However, yields in this maturity range are sensitive to recession risk. While intermediate-maturity yields may jump temporarily, we believe the overall trend will be downward as recession appears likely.

How Should Investors Navigate the Latest Market Turbulence?

We believe the events of the last several days stress the value of diversification. As always, we encourage investors to remain disciplined and avoid reacting to short-term market swings. In our view, investing across multiple asset classes is the prudent approach in all market environments.

In today’s market, with short-term interest rates on the rise, it’s important not to overlook your cash holdings. Investing in savings accounts for FDIC protection and money market funds for potentially higher yields may help you meet your short-term goals.

Additionally, it’s important to remember that market dislocations often create opportunities. We suggest investing with experienced professionals who have the insights, conviction and discipline to recognize and potentially capitalize on attractive opportunities when they’re significantly undervalued.

Author
Victor Zhang
Victor Zhang

Chief Investment Officer

Senior Vice President

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Data as of 3/13/2023. Source: FactSet.

Data as of 3/8/2023.

Diversification does not assure a profit nor does it protect against loss of principal.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.