Echoes Of '08? Don't Bank On It

The GMO Focused Equity team has evaluated banks in the context of our Quality Strategy for 20 years, using both quantitative and fundamental analysis to invest in high-quality banks with healthy financials and in our opinion responsible management practices. We are not exposed to the banks currently in crisis, but with the industry in turmoil, we have been examining the triggers to measure risk levels across the global banking sector.

The Fall of SVB and the Threat of Contagion

In many ways, Silicon Valley Bank (SVB) was an oncoming train wreck hiding in plain sight. It faced a fairly unique combination of issues that were exacerbated by today’s similarly unique market environment:

  • 52% of SVB’s deposits were from private equity and venture capital-backed start-ups. As growth companies melted down in 2022, these start-ups burned through cash, drawing down their deposits. As a result, deposit accounts at SVB had been falling sharply for nine months.
  • With rates rising at the fastest pace in decades, SVB experienced rapid deterioration of its net interest yield (NIY). 1 Higher rates meant SVB had to chase deposits by offering higher yields, increasing its deposit yield by 2.2% in 2022. Meanwhile, it was invested heavily in fixed-rate, long-duration securities, with a smaller amount in higher-yielding loans, 2 and so its investment yields were only up 1.4%. As a result, SVB had a difficult time maintaining its NIY. In fact, in Q3 2022, a period when most banks had rising NIYs, SVB’s overall NIY actually started falling.
  • A full realization of SVB’s Available-for-Sale (AFS) and Held-to-Maturity (HTM) securities losses would have roughly wiped out tangible book.

As has been widely reported, the tightly networked deposit base reacted to these worrying signs by accelerating deposit withdrawals in February, forcing SVB to sell its entire AFS portfolio and realize those losses, ultimately ending in the bank’s collapse.