On March 10th, 2008, rumours spooked the stock market that Bear Sterns, a NYC-based global investment bank, could be on the brinks of bankruptcy. Just a few days later, Bear Stearns publicly admitted that it was in a liquidity crunch, and the situation was so bad that the U.S. Government had to arrange for J.P.Morgan to buy out the company. Bear Sterns was the first domino to fall in the Global Financial Crisis of 2008-2009. 

Exactly 25 years later, March 10th, 2023, Silicon Valley Bank (SVB), the 16th largest bank in U.S., the backbone to many startups and venture capitals in Silicon Valley area, was shut down by regulators. On Friday. the California Department of Financial Protection and Innovation announced that it was taking over and closing the distressed bank to protect deposits, naming the Federal Deposit Insurance Corporation as its receiver. The closure marks the biggest bank failure since the 2008 financial crisis and the second-largest in U.S. history after Washington Mutual collapsed during that industry-wide meltdown.

The Dow Jones Industrial Average dropped for a fourth consecutive day, finishing 345.22 points lower, or 1.07%, to close at 31,909.64. The S&P 500 lost 1.45% to settle at 3,861.59. The Nasdaq Composite shed 1.76% to end at 11,138.89. All the major averages capped off the week with losses. The Dow fell 4.44% to post its worst weekly performance since June. The S&P dropped 4.55%, while the Nasdaq lost 4.71%.

In light of this major market event, we want to keep investors informed about how we're viewing the situation and what we're doing to the portfolio.

What Caused SVB To Fail?

The failure of Silicon Valley Bank is raising questions about the overall financial sector, which includes our holdings Wells Fargo (WFC) and Morgan Stanley(MS). Shares of Wells Fargo, Morgan Stanley, and the broader banking sector have faced pressure due to the SVB saga over the past couple of days. Morgan Stanley continued its slide Friday, closing down 2.3%. However, Wells Fargo turned positive by day’s end, gaining more than half of a percent.

SVB is a very different kind of bank than Wells Fargo and Morgan Stanley, and its distinct characteristics are central to what’s unfolded over the past few days. SVB’s problems stem in large part from its tech startup and venture capitalist customer base. The Federal Reserve’s interest-rate hiking campaign has tightened financial conditions, making it harder for the many startups that bank with SVB to raise additional outside capital. In this environment, startups were using up a lot of money that had been deposited in SVB bank accounts to run their businesses. Client cash burns has been two times higher than pre-2021 levels, SVB said Wednesday, leading to lower-than-expected deposits.

Looking to shore up its financial position, SVB sold $21 billion worth of assets — including U.S. Treasury bonds— booking a $1.8 billion after-tax loss in the process. To understand why those bonds were sold at a loss, remember what’s happened lately with rates. Bond prices move inversely to yields. As policy rates controlled by the Fed went higher and higher over the past year, that meant the bond yields were rising and bond prices were declining in value. SVB intended to take those proceeds and reinvest them in shorter-term assets, which are less sensitive to changes in interest rates.

Other banks may also be sitting on paper losses on some parts of their bond portfolio. However, as JPMorgan analysts pointed out in a note to clients Friday, larger banks like Wells Fargo have considerably better liquidity and diversified deposits that should allow them to avoid needing to sell a bunch of securities like SVB did.

Our Bank Holdings Differ From The Failed SVB

Our investment thesis in Wells Fargo is a turnaround story. We believe the story is still intact, which gives us the confidence to see through some of the near-term headwinds the bank may face regarding net interest margin (NIM). The rise in interest rates has helped Wells Fargo make more money from NIM, the difference between what it pays customers for their deposits and what it charges for loans. However, some of that benefit is being offset now, as rates have reached a point where customers may look to move deposits to higher-yielding alternatives such as money-market funds. This is putting upward pressure on banks’ deposit costs, which basically means they’re paying a higher rate to entice savers to keep money in their accounts. This could challenge Wells Fargo’s net interest margin, to some degree. At the same time, Wells Fargo’s very low deposit beta — the percentage of an interest rate hike that gets passed on to customers — should mean it is hurt relatively less than peers.

More generally, CEO Charlie Scharf has continued to make progress on moving Wells Fargo beyond its scandal-ridden past and, eventually, having a regulator-imposed asset cap removed. We’re willing to be patient with the stock while that plays out and management maintains expense discipline. 

Wells Fargo still finished down nearly 12% week to date, compared with the S&P 500 financial sector’s decline 6.87% over the same stretch. The stock was still above breakeven year to date compared to the S&P 500′s less than 1% gain in 2023.

Morgan Stanley (MS), on the other hand, is a different bank than Wells Fargo, and our confidence in its multiyear transformation under CEO James Gorman has not wavered. Morgan Stanley is now more of an asset management firm, with a fee-based business model that provides stability to earnings compared with its investment-banking roots.

Morgan Stanley shares remained under pressure Friday and dropped 8.4% for the week. However, the stock has been an outperformer so far in 2023 and remained up 5.9% year to date. We’re waiting to hear more from Morgan Stanley, but its fee-based business model should help protect it from interest rate-related challenges.

The bottom line, while both Wells Fargo and Morgan Stanley have clear differences with SVB and face more regulatory scrutiny, we’re not using recent weakness in their stock prices to buy additional shares just yet.