Tax filing deadline Tue, Apr 18, 2023

We want to address the recent bank failures and the regional bank turmoil that has dominated the
headlines over the last 72 hours. Last Friday, liquidity concerns resulted in the failure of Silicon Valley
Bank, the second largest collapse in U.S. History, behind Washington Mutual in 2008. This collapse was
proceeded by the collapse of Silver Gate Capital earlier in the week and Signature Bank last night. I will
discuss each of these failures briefly and then share our thoughts on how this plays out as we go
forward for both the financial sector and the broader U.S. equity markets.

What happened and why?

Before we discuss the bank failures, I want to first revisit the events that occurred earlier in the week
when Chairman Powell testified before Congress. It was his testimony that originally rattled the markets
as he discussed the Federal Reserve raising rates faster than had been anticipated. His hawkish tenor
indicated that rates could advance another 1% to 1.25% above the current level. This pace of rate
increase had not been factored into the markets and drove much of the early week volatility. While
inflation and rising rates is its own unique challenge, we cannot ignore the interplay this has had on the
recent bank failures. Before we look at the policy response, lets quickly touch on each bank.
Silver Gate and Signature Bank – Both of these banks were involved in the crypto space but in different
ways. Silver Gate was a crypto lender and the collapse in Bitcoin and the failures of FTX put tremendous
pressure on the bank. Signature bank predominantly a real estate lending bank but had a concentrated
focus on holding cryptocurrency deposits. These deposit holders had values well above the FDIC
insurance level of $250,000 and become concerned with the safety of their deposits. In fact, almost
100% of Signatures deposits were uninsured which left the bank very exposed as outflows begin. These
two banks were niche lenders with limited diversification. I don’t think their failures should be a
foreshadowing of a systemic problem.

Silicon Valley Bank (SVB) was larger and different but also had a narrow scope in lending to start-ups
particularly, in the tech space. This space exploded during the pandemic with well-funded venture
capital money. Roughly 86% of SVB deposits were above the $250,000 insured level which also made
them vulnerable to withdrawals. SVB saw an explosion in deposits during the tech boon (2020 and
2021) that outpaced the banks customer loan demand, so they ended up investing a significant amount
of these deposits in long-term government bonds. While these investments did not have credit risk
there was a great deal of interest rate and duration risk. When interest rates started increasing it
reduced the value of their bond investments. This coupled with the slow down in the tech space and
lack of venture capital funding led many of these start-ups to dip into their cash reserves. These net
drawdowns forced the bank to sell their bonds at losses which ultimately spiraled into a run on the

What was the government’s response?

The U.S. Government took decisive action over the weekend to halt a potential banking crisis known as a
“run on banks.” In an extraordinary measure by the Treasury Department, Federal Reserve and FDIC
they put out a joint statement assuring all depositors at the failed institutions that they could access to
their money today, including those with deposits over $250,000. Furthermore, late last night they
announced an expansive emergency lending program that is intended to prevent a wave of bank runs
that would threaten the stability of the banking system and economy as a whole. The lending facility
will allow banks that need to raise cash to pay depositors to borrow that money from the Fed, rather than having to sell Treasuries other securities at losses. Under the new program, banks can post their
investment securities at original face value as collateral and borrow from the emergency facility. In
short, the government does not intend to bail out the shareholders or management of the banks but
they will do what is needed to protect the depositors.

What should you do?

In short, there is no need to panic. Swift steps were taken to shore up the confidence in our banking
system. The institutions that failed were niche banks with a narrow focus and limited diversification. If
you have deposits at a single institution above the insured levels of $250,000 ($500,000 for joint
accounts) you may want to consider spreading this to another bank or a money market fund and a
brokerage firm. Please contact us if you would like to discuss money market fund investments.
The bond market has had a huge reversal in response to the recent developments. It is appearing that
the rate hikes Powell and company were foreshadowing earlier last week won’t happen. Future markets
are now indicated that the March increase could be as little as zero or at most .25% and there is growing
consensus that this will now be the last increase. While we believe the Fed very much wants to get
inflation closer to their target range of 2%, we also believe they will be data dependent. Often a shock
like we just experienced with the banking crisis can tighten financial conditions more quickly than a
continual rise in short-term rates. The quick actions over the weekend should shore up confidence in
the banking system and the reversal in future rate hikes should bode well for both the equity and fixed
income markets as we move forward.

My advice is to not get caught up in the current crisis. Investors have a tendency to sell when they are
scared and buy when they are comfortable and this is usually a reliable recipe to sell low and buy high.
We have never believed that timing the market is prudent, and we don’t think this time is any different.
Market timing requires you to be right twice – when you get out and when you get back in. As we have
learned from past crises, these things can reverse quickly and if you are stuck on the sidelines, it is very
difficult to make up lost ground. Valuations look much more attractive and now is a great time to stick
with your structured long-term plan.

We thank you for your continued trust in our firm and we look forward to prosperous years ahead


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