The failure of Silicon Valley Bank (SVB) on Friday morning, and of Signature Bank of New York on Sunday, understandably has many of us concerned and questioning what’s happening in US financial markets. While we don’t claim to have all the answers, this letter is an attempt to begin addressing those concerns. We encourage you to contact your advisor directly with any additional questions you may have.
Silicon Valley Bank (“SVB”) specialized in providing banking services to technology and healthcare start-ups. It provided financing to almost half of US venture-backed technology and health care companies and over 70% of US venture capital funds.1 Most of SVB’s clients were early-stage companies and funds that relied on SVB for both lending (e.g., business loans) and cash management services (e.g., checking accounts).
SVB experienced a classic run on the bank. Several forces came together to push it into insolvency:
Our direct exposure to SVB in our standard 100% equity portfolio is approximately one basis point (~0.01%). Our direct exposure to regional banks, beyond just Silicon Valley Bank, is approximately 0.63% of our standard equity portfolio. For a portfolio with a typical 60/40 portfolio, that works out to 0.006% exposure to SVB and a 0.38% exposure to regional banks as an industry.2
However, when we take a broader view, there are sure to be second order effects emanating from the failure of SVB. Those knock on effects will likely fall hardest on the venture capital community and their underlying portfolio companies. According to Mercer Consulting (not affiliated with Mercer Advisors), over 70% of US venture funds relied on SVB for lending and banking services. The disappearance of such a large, systemically important bank from the venture capital ecosystem will likely result in mark downs in valuations for underlying portfolio companies and higher financing costs for venture funds and portfolio companies alike going forward.
The issues with several regional banks aside, the US banking system appears to be well-capitalized. The collective thinking is that the issues impacting SVB and other regional banks are unlikely to impact the broader economy or spread to larger banks. We generally agree with this assessment.
That said, the dramatic developments of the past few days make it clear that certain corners of the US banking system are under significant stress. The Fed’s rate hikes are clearly having unintended consequences on other areas of the US economy. As a result, there is an increasing probability that the Fed will pause future planned rate hikes at next week’s FOMC meeting until it has more information on the health of US banks and the economy. Additionally, futures markets are currently pricing in interest rate cuts beginning in July 2023—with a target implied policy rate of 3.75% by the end of 2023 (down from a current rate of 4.75%).3
Having navigated multiple market crises over the past 25 years, I’ve learned several important lessons that should serve us well in the current environment.
First, the best advice in times of turmoil is to simply hit the pause button. The worst thing we can do is overreact and make long-term decisions based on short-term news. There is real wisdom in putting some distance between stimulus and response.
Second, we’ve planned for this. Great financial planning is, ironically, ultimately about preparing for when things don’t go as planned. Things like emergency reserves, portfolio diversification, and regularly revisiting our risk tolerance and liquidity needs are all about managing the reality that the future is ultimately unknowable. Planning prepares us for when things don’t go as planned.
Finally, every crisis has a beginning, a middle, and an end. This one too shall pass. The past 25 years have seen a plethora of market challenges. Remember the dot-com implosion of 2000? The contested presidential election of 2000? The terror strikes of 9/11? The accounting scandals at Enron, WorldCom, and others? The financial crisis of 2008? The US downgrade of 2011? The Covid-induced market selloff of March 2020? The presidential election of 2020? Markets overcame all of them and more. There’s no reason to think now should be any different.
If you should have any questions, we encourage you to contact your wealth advisor directly.
1 Mercer Consulting
2 FactSet, Inc.
Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.
All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the content provided comes from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. This material is for educational and illustrative purposes only and does not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy.
Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Diversification and asset allocation do not ensure a profit or protect against a loss.
This document may contain forward-looking statements including statements regarding our intent, belief or current expectations with respect to market conditions. Readers are cautioned not to place undue reliance on these forward-looking statements as actual results may vary in a materially positive or negative manner.