There’s a funny saying about the Federal Reserve: It keeps raising rates… until it breaks something.
Well, it looks like this time around, that “something” was Silicon Valley Bank.
Silicon Valley Bank, a holding of SVB Financial Group (NASDAQ:SIVB) went from being the 16th-biggest bank in the U.S., with about $209 billion in total assets, to nothing in less than a week.
So, what exactly happened to Silicon Valley Bank?
That’s the question I’ll answer for you in today’s Market 360 article. We’ll also review the impact Silicon Valley Bank’s collapse had on First Republic Bank (NYSE:FRC), and I’ll explain how we knew to avoid both banks well before their falls.
Plus, I’ll share where you should consider investing your money instead.
Let’s dive in.
What Happened with Silicon Valley Bank
Last week, Silicon Valley Bank proposed a $2.25 billion secondary offering to shore up a significant loss in its portfolio. However, this triggered a run on the bank’s assets after Peter Thiel’s Founders Fund advised startups to withdraw their money.
To make matters worse, out of Silicon Valley Bank’s $173.2 billion in deposits, only $21.7 billion was insured. So, there was also a real risk that the companies with uninsured deposits might not get their money back.
Investors panicked and SIVB shares plunged more than 60% on Thursday and then another 60% in pre-market trading on Friday. Trading was halted on Friday, and banking regulators stepped in and took over SVB Financial.
The Federal Deposit Insurance Corp. (FDIC) will retain all of the deposits in SVB, and it is expected to merge the bank with a larger financial institution. This will ensure that all depositors are protected, regardless of FDIC insurance limits.
Following Silicon Valley Bank’s downfall, I know there are some fears circulating that it could be the next Lehman Brothers, as it is the second-largest bank to collapse since Washington Mutual went under back in 2008.
High Interest Rates Hurt the Bank
If this is something you’re worried about, let me assure you that’s not true.
The reality is Silicon Valley Bank’s troubles were tied to rising interest rates. Thanks to startups and technology companies depositing millions of dollars into the bank, its total deposits rose to approximately $175.4 billion by December 2022. To take advantage of the deposits, Silicon Valley Bank invested $80 billion into mortgage-backed securities at about a 1.5% interest rate.
But when the Federal Reserve began to aggressively hike key interest rates last year and bond yields climbed higher – values dropped and SVB Financial found itself with a big capital problem on its hands.
I should also add that the yield curve has been inverted since July, as the two-year Treasury yield is above the 10-year Treasury yield. (As of this morning, the two-year Treasury yield stood at 4.03% and the 10-year Treasury was holding at 3.6%.) An inverted yield curve is lethal to banks, as it hurts their profitability. So, it’s no surprise that Silicon Valley Bank ran into problems.
The next big bank to fall was First Republic Bank, which just received $70 billion in emergency liquidity from the Fed and J.P. Morgan. Here in Palm Beach, near where I’m at in Florida, there is a run on First Republic’s deposits, and some folks are incurring early withdrawal penalties on certificates of deposit (CDs).
Naturally, the folks in Palm Beach are skittish after the Bernie Madoff disaster as well. Many lost money in leverage municipal bond products sold by Citibank and other financial institutions back in 2008. As long as the yield curve remains inverted, there is a risk of a contagion that other banks may fail the Fed’s capital requirements. The good news is the Fed has opened their discount window for a year (up from 90 days) to any troubled banks.
A joint statement by the Treasury Department, the Federal Reserve and the FDIC said they are taking actions that “fully protects all dispositors” in Silicon Valley Bank. That, as we’ve seen so far this week, has helped to calm financial markets.
Now, one thing I find interesting about Silicon Valley Bank is that many folks considered it a good buy before the collapse. In fact, just last month CNBC’s Jim Cramer was hyping up the stock…
“This company [Silicon Valley Bank] is a merchant bank with a deposit base that Wall Street has mistakenly been concerned by,” Mr. Cramer said. He also noted that Silicon Valley Bank was “less dependent upon private equity and venture capital offerings.” Mr. Cramer believed the stock was “cheap” and stated that “you could argue that SVB 40% up is barely a drop in the bucket.”
Wall Street Is Right to Be Concerned
The fact of the matter is Wall Street had every right to be concerned because Silicon Valley Bank’s fundamentals were terrible. Looking back at just the last four quarters, earnings had declined steadily – from $7.92 per share in the first quarter of 2022 to $4.62 per share in the fourth quarter of 2022. For the first quarter of 2023, earnings were expected to fall further to $4.50 per share. Revenue was anticipated to drop 12.5% year-over-year to $1.4 billion, down from $1.6 billion in the year prior.
Those who took Mr. Cramer’s advice and bought Silicon Valley Bank were hit hard, but those who followed my Portfolio Grader would’ve known to stay far away from SIVB. The stock hasn’t been considered a “Buy” since March 2022, and it has been stuck at a D-rating since last September, making it a “Sell.” Following last week’s drama, Portfolio Grader revised it lower to an F-rating.
Institutional buying pressure had also dried up, as evidenced by the stock’s F-rating for its Quantitative Grade.
I should add that First Republic Bank doesn’t fare well in Portfolio Grader either. It’s held a D-rating since last August. So, again, folks following my Portfolio Grader would’ve avoided the 60%+ hit the stock took on Monday, as well as its 33% fall last week.
The truth is that, at the end of the day, fundamentals matter. The market has narrowed, and we remain in a 15% market, where only the top 15% of the stocks in my Portfolio Grader have emerged as market leaders. Even before Silicon Valley Bank’s collapse, its fundamentals were not cutting it.
So, I encourage you to stick with companies that boast strong earnings and sales growth. If you’re not sure where to look, then give my Growth Investor service a try. My Growth Investor stocks are characterized by 38.9% average annual sales growth and 283.8% average annual earnings growth.
Plus, my Buy List stocks are only trading at 7.6X median trailing earnings, and the average dividend yield is 3.93%. So, low price-to-earnings ratios and strong dividend growth coupled with positive sales and earnings should support my stocks in the upcoming months.
Click here to become a member of Growth Investor today and receive full access to my Buy List stocks.
Editor, Market 360
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