Rob Hajduch, Managing Director, Taxable Credit Research

Editor’s note: As of March 9, 2023, SVB was not on USBAM’s approved list of issuers, and there are no holdings or exposure to SVB or its parent company, SBV Financial Group (SIVB), in any USBAM-managed fixed-income separate account or money market funds.

The abrupt failures of SVB Financial Group (SVB) and Signature Bank and the resulting market turbulence that followed conjured up a lot of unpleasant memories among those who were privileged to experience the 2008 Global Financial Crisis. Given that the banks’ failures were so sudden and followed closely behind crypto lender Silvergate Capital’s (Silvergate) announcement that it was winding down its operations, it is not entirely surprising that headlines have been littered with speculation as to who is next. While we are abundantly cognizant of the potential for contagion risk, we are not of the opinion this event will trigger a full-blown systemic crisis for the broader U.S. regional banking sector. 

Common to both Silvergate and SVB were narrow franchises that focused on specialized segments of the economy. SVB specialized in offering banking and financial services to startup companies in the technology and healthcare sectors, with a disproportionate percentage of its loans channeled through venture capital and private equity funds. In this particular Federal Reserve tightening cycle, it has been atypically aggressive in raising interest rates, and headline data suggests that technology and healthcare have been more adversely impacted than the broader economy. Demand for new loans has slowed in tandem with business activity in those sectors, and SVB’s $420 million loan loss provision in 2022 indicates that its borrowers began experiencing stress and had difficulty servicing existing loans. The loan loss provision for 2022 exceeded the aggregate set aside since 2015 by $13 million. 

Characteristically given SVB’s business focus, its largest borrowers were also its biggest depositors, and throughout 2022, they began to draw down balances to fund their operations. Between the end of the first quarter of 2022 and year-end, SVB experienced deposit attrition approaching 13%. By contrast, across our approved regional bank cohort, total deposits increased 4.75% on average over the same time period. The ironic twist is that across 2020-2021 SVB had experienced deposit growth far exceeding that of the broader regional bank peer group such that even with the recent outflows its deposit base at the end of 2022 was 179% higher than it was at the end of 2019 against a 40% average increase among our approved peer banks. 

Absent loan growth, SVB invested excess cash in U.S. Treasury and agency bonds and its securities portfolio at the end of 2022 was equivalent to 55% of its total assets, versus 19% on average among the peer banks. The overrepresentation of low yielding earning assets, coupled with the bank being compelled to pay higher rates to maintain deposit balances squeezed profitability, with SVB’s net interest margin in 2022 39% lower than it was in 2019. The same measure for the peer group declined by 6% over the same time period. The ill-advised liquidation of its entire investment portfolio on March 9 to reposition into higher yielding securities that crystallized a $1.8 billion loss proved to be the breaking point.

Upon deeper examination, SVB’s demise does not give the impression that it was driven by weakness in the regional bank sector but rather by the bank’s highly specialized business model that was concentrated by borrower, depositor, and to a degree geographically. Approved regional banks have more diversified loan portfolios that are more granular than SVB’s and are less reliant on investment securities to drive profitability and have broader deposit gathering infrastructure. 

Moreover, we are reassured by the urgency that federal regulators have demonstrated in resolving the bank and containing the fallout, including invoking the systemic risk exception and the introduction of the Bank Term Funding Program (BTFP) on March 12. The systemic risk exception allows the FDIC to make all depositors whole regardless of insurance eligibility while the BTFP allows banks to borrow against securities at the Discount Window at par value for up to a year. The Federal Reserve additionally loosened margin requirements for traditional Discount Window credit to be consistent with the BTFP. Although we are not looking to add to regional bank exposure, taking the FDIC and Federal Reserve actions in tandem allow us to be comfortable in maintaining our current positions in the sector.