There was a lot of news over the weekend regarding problems within the banking sector. Although this continues to be a fluid situation, here is the latest we know and some of our thoughts:
Regulators acted fast and are backstopping all depositors at Silicon Valley Bank (SVB) and now Signature Bank. It appears all depositors will have access to their money today...and going forward. Markets will have to digest the repercussions of these moves in the short term, but there should not be any systemic risk in the bank system due to the regulators’ actions.
So, what happened? Well, we see two big mistakes made by SVB that caused this; interestingly enough, both mistakes are lessons that all investors should learn.
- SVB had a concentrated customer base. Too many of their deposits were from the venture capital/private equity/crypto space, which were all “hot money” areas. Here is the problem: Just as any investor, they should have diversified their customer base. This was a classic “bank run” as this close-knit community all headed for the doors quickly together. This would be akin to NCM investing all of a retiree’s money in the S&P 500 in 2000 (after the S&P did so well in the 90’s) and then withdrawing 4% a year from it. Most likely, that retiree would have run out of money within 15 years. SVB should have known they had a big risk with the makeup of their depositors just like we know we would have too much risk if we placed all of a client’s assets in just the S&P 500 (As you know, we always preach diversification away from any one single asset class).
- SVB made another classic investor mistake: They “stretched” for yield. They took in billions of dollars from their customer base as the tech market soared for years, and they invested too much of it in LONG-TERM bonds. As a result, they had a mismatch of short-term deposits (that could be withdrawn on a moment’s notice) with long-term bonds. While the credit quality of the bonds used as collateral is not the issue (…which is why this problem is not like 2008 at all), the issue is that this only works when interest rates stay low! The bank failed to think about what could happen if/when interest rates go up. Prices of long-term bonds can decline significantly if interest rates go up very quickly. The bottom line: Depositors demanded the cash back (which again, was tied up in these long-term bonds) immediately, and the bank was forced to sell them at much lower prices, thereby taking huge losses. This would be similar to us investing all of a retiree’s nest egg in long term bonds to “stretch for that higher yield” a few years ago and now when those bonds are marked down 25%-40%, having to sell them. This is why we’ve always cautioned against stretching for yield and have been very cognizant of how much money we allocated to long-term bonds.
In summary, markets may very likely be volatile in the short term, but eventually things should settle down as there should not be any systemic issues based on what we know at this time. That said, the management of SVB should be held accountable for their poor management and their equity and debt holders should suffer as well.
NCM Capital Management
Disclosures: This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of NCM Capital Management, LLC and are subject to change at any time based on market and other conditions and NCM does not undertake to update or supplement its newsletter or any of the information contained therein. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable. There is no guarantee that the investment strategies discussed above will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Investment advisory services are offered through NCM Capital Management, LLC, an SEC-registered wealth advisory firm domiciled in New Jersey. This communication is not to be construed or interpreted as a solicitation or offer to sell investment advisory services. For additional information about NCM Capital Management, LLC, you may request a copy of our disclosure statement as set forth on Form ADV.