Click the “Download” button on the right to access this week’s Investment Strategy Notes, which dive into timely economic and market trends with takeaways for investors.

Below is a transcript of this week’s video:

Shares of SVB Financial Group, the parent of Silicon Valley Bank, fell over 62% through Thursday last week and was closed by California regulators on Friday, and handed over to the Federal Deposit Insurance Corporation (FDIC) to manage the liquidation of its assets. The broad financial sector experienced notable declines alongside this closure. Over the weekend, the U.S. Treasury, Federal Reserve and FDIC made a joint announcement to address SVB and another insolvent bank, Signature Bank in New York (SBNY), stating that customers of both banks would be made whole regardless of how much they held in their accounts. So, what exactly happened and what does this all mean?

Silicon Valley Bank had carved out a niche presence in providing financial services to private capital and venture-backed enterprises. In 2021, SVB saw a mass influx of deposits. As those deposits grew, SVB purchased a large amount of publicly traded bonds. Meanwhile, the Federal Reserve was embarking on one of the swiftest tightening cycles in decades. As interest rates rose, the value of those securities fell, leading to sizable unrealized losses. This in and of itself was not necessarily problematic, so long as SVB could hold bonds to maturity.

However, it became clear SVB would need to take steps to further raise cash on its balance sheet, as Silicon Valley customers under pressure in the current economic environment withdrew deposits from the bank. Rumors of the bank’s difficulty spread, and withdrawals from large uninsured depositors accelerated. The bank attempted to recapitalize itself, but those efforts failed last week, and SVB succumbed to what seems a rather traditional bank run.

Notably, Silicon Valley Bank was the 16th largest bank in the U.S., and investors were already beginning to speculate about how systemically important it was, what the impact would be on Silicon Valley and private equity and venture capital space, as well as whether any other banks faced similar difficulties.

Based on a comparison to other large banking peers, SVB’s situation does look somewhat unique. Its difficulties were the result of both its unique position as a financial service provider to start-ups, the impact of the Fed’s swift rate hikes on parts of its balance sheet and the fact that the vast majority of the bank’s deposits were not insured by the FDIC.

Outside this list of top-20 banks, Signature Bank appears to have had a similar magnitude of uninsured deposits.

This all led to the coordinated actions by regulators over the weekend, which combined with the uniqueness of SVB’s situation, should limit the impact on Silicon Valley as well as the magnitude of further contagion in the banking sector.

While the narrow circumstances surrounding SVB and the swift involvement of regulators should make contagion less likely, we believe that banking difficulties are a symptom of economic difficulties as much as a contributing factor. As a result, while investors should not panic, they should remain cautious of other future impacts from the Federal Reserve’s rapid rate-hike cycle.

So to summarize:

• U.S. equity markets fell considerably last week, driven by bank shares and the closure of Silicon Valley Bank, the 16th largest bank in the U.S.
• SVB had a niche in services for tech startups, but its lack of diversification and poor balance sheet management contributed to its demise.
• Rising rates led to losses on its balance sheet and large withdrawals of customer deposits in what ended in a classic run-on-the-bank.
• The second largest failure in the U.S. banking history is notable, but SVB’s situational uniqueness and swift action by regulators should limit the magnitude of contagion.
• Still, from a broader perspective, the failure of SVB and SBNY is symptomatic of the impact of rising rates and associated economic weakness – reasons enough for some ongoing investor caution.