A decade-long policy of virtually zero interest rates impacted assets globally and built the everything bubble. It would be naive of us to think that the unraveling of this would not cause things to break. Last week, we saw it occur with the implosion of two large crypto and venture capital-focused banks. These institutions (Silvergate and SVB Financial) saw exponential deposit growth as the bubble grew into these asset classes, while they were able to pay virtually nothing in interest. Then, instead of loaning the deposits out to fund viable businesses and assets, they invested them into long-term Treasuries at rates less than 2%, or into illiquid and likely worthless crypto bets. As crypto and VC funded companies needed to raise cash and pull out their money, these banks had to realize massive losses due to the liability mismatch.
Smaller banks have different regulatory standards than the larger banks that we tend to invest in. Long-term investments that are held for that purpose, don’t impact the capital ratios of smaller banks, but do impact the capital ratios of larger banks. This allowed the smaller banks to skate by in the face of large losses in their investment portfolios due to the rapid rise of interest rates, but big banks are already marked to market on their balance sheets, so everything is reflected. When these smaller banks had to sell assets to meet funding needs upon rapid deposit withdrawals, the losses impacted their capital ratios. These risks are exactly why we have avoided owning these risky names. Not all banks are the same and we’ve kept our focus on those with a multitude of funding sources, low cost deposits, and that will benefit from this fintech disruption.
As investors and customers pull out of these over-aggressive banks, inevitably many of the deposits will flow to the big banks such as JP Morgan, Citigroup, Bank of America and Wells Fargo. It definitely isn’t fun going through market panics, but understanding the root cause is very important. When markets are in a panic, nearly everything is sold off, regardless of fundamentals. If you don’t know the rationale behind your investments, or if you are simply momentum-based, you might wrongfully sell into the panic. As the drama subsides, markets should see a substantial recovery, as these don’t seem to be long-term systemic issues.
Every year there seem to be a few of these crises that same existential at the time, but prove to be rather short-lived. I think that what we saw this week was idiosyncratic banking institutions that took outrageous risks and are now dealing with the reckoning. Investing is not about chasing what is hot. Many market participants had huge paper gains on these companies built on the backs of this risk taking, only to see it all evaporate as the tide went out. Ultimately, this selloff has created extremely attractive buying opportunities, but this is not a year when one should take big risks. We’ll keep things relatively conservative, except will swing big on those true no-brainer opportunities, and there are a few great ones out there for sure.
On Sunday night, US Financial Regulators stepped in and took decisive action, which should go a long way towards halting the panic. They shut down Signature Bank, which was another crypto time-bomb, and then they protected all deposits for all the afflicted banks, including those over $250K. All depositors at those banks will have full access to their money on Monday. In addition, the Fed opened a window where banks can exchange bonds at par value to generate liquidity, which means they no longer would have to sell them and eat a loss if they face a run on the bank like we saw last week. This was a very smart decision that I’d expect to be well received. Here is an article, which outlines this in more detail: