As headlines follow the news of the Silicon Valley Bank (SVB) and now Signature Bank failures, concerns and anxiety over the resulting uncertainty and market volatility are to be expected. Here, Arnerich Massena Co-CEO and Chief Investment Officer Bryan Shipley, CFA, CAIA, and its Investment Committee provide some context for the headlines and what we see coming as we move into the next stages of the process.

We detail the story below, but the key points to understand are:

• The Federal Reserve and Treasury Department announced on Sunday that all deposits will be fully guaranteed, including uninsured amounts over the FDIC-insured level of $250,000.
• The guarantee will come through the use of the Deposit Insurance Fund (DIF), not taxpayer dollars, and will also make more funding available to the banking system. This should be viewed as a backstop for depositors as opposed to a bailout of the banking sector.
• We believe this response will help ease the uncertainty that plagued the market on Thursday and Friday.

Some context and history:

Uncertainty and volatility dominated the headlines as last week came to a close on the news that Silicon Valley Bank (SVB) essentially failed overnight. The Federal Deposit Insurance Corporation (FDIC) announced on Friday that it had taken over the bank and will assume operational control. SVB has been the fastest growing bank over the past four years, expanding to become the 16^th largest bank in the United States. This growth was fueled by a niche focus on the technology industry and venture capital sectors and the tremendous success of that space over the past decade. SVB suffered from what effectively was a 1930s-style “run on the bank” that occurred with vicious quickness given the speed of transactions and information in today’s day and age. SVB marks the largest significant bank failure since the 2008 Global Financial Crisis.

Corporate customers of SVB were left wondering what the regulatory response would be while scrambling over the weekend trying to grasp what awaited them when markets opened on Monday. Many businesses feared what steps they would have to take to simply meet payroll for their employees and pay their bills, or even facing the uncertainty of the survival of their business if their assets were frozen for an extended period. Asset managers, who oversee everything from private equity and venture capital funds to publicly traded mutual funds, scrambled as well to identify where the potential risks might be within their portfolios and how to navigate an uncertain future.

This loss of confidence stemmed from an issue that we have routinely discussed with clients over the past two years, where long-duration fixed income assets have not rewarded bond investors adequately for the potential risk of rising interest rates. Those risks became very evident in 2022 as the Federal Reserve combatted a spiking inflationary environment by raising interest rates and thus hurting bond holders’ presumed value. During the period of dramatic growth for SVB, the bank elected to invest in longer duration bonds with marginally higher interest rates and, given the rise in rates, those bonds now carry values significantly lower than their purchase level and are thus insufficient to facilitate a surge in client demand for their deposits back. In effect, SVB had a duration mismatch between how they were investing customer deposits versus the obligation of fulfilling those deposits if requested by clients.

The largest concern was that these events might have led to a contagion that could have crippled confidence in smaller and more medium-sized regional banks, driving consumers to just a handful of the largest global banks to seek a safe haven for their savings, and causing further bank runs.

Where are we now?

On Sunday evening, regulators within the Treasury Department and Federal Reserve announced a joint statement to provide stability to markets by guaranteeing deposits (including uninsured amounts above the fully FDIC-insured level of $250,000), through the use of the Deposit Insurance Fund (DIF) — not taxpayer dollars, as well as making more funding available to the banking system. As part of this action, they also announced the shuttering of Signature Bank, one of the main banks for cryptocurrency companies, citing similar concerns. Officials took this extraordinary step of designating SVB and Signature Bank as systemic risks to the financial system, allowing them the authority to back uninsured deposits and reassure confidence in the entire financial system.

While the start of Global Financial Crisis (GFC) was nearly 15 years ago, investors are scarred from the systemic stress that event placed on the entire financial system and overall economy. In this instance, the issue is not nearly of the same magnitude of the programs rolled out during the GFC. This appears to be isolated to a couple of financial institutions with poor risk management that led to inadequate liquidity and a sudden loss of confidence.

Going forward

We believe the Federal Reserve’s and Treasury’s response on Sunday will help ease the uncertainty that plagued the market on Thursday and Friday. This should be viewed as a backstop for unsuspecting depositors as opposed to a bailout of the banking sector. Both SVB and Signature Bank’s stock valuations will effectively be wiped out as a result of the mismanagement of their assets versus the expected liquidity of their liabilities, particularly given that they worked with such a volatile and higher-risk set of clients. This represents a proper outcome for companies that lack adequate risk controls and oversight. The response should help re-establish confidence for both retail and corporate customers, preventing any contagion that could have crippled confidence.

We anticipate that markets will welcome the response of the Fed and Treasury Department, though we expect caution as investors navigate this evolving and volatile environment.