There are a lot of complex questions relating to the collapse of Silicon Valley Bank (SVB) that will go unanswered for years. Following the banks’ fall from grace, and causing perhaps one of the most frantic banking crises since 2008, investors and depositors, and even government committees remain puzzled over the legitimacy of America’s banking system and the future risks that could be bubbling underneath the surface.
Considering how these events unfolded over several months, which was a culmination of poor risk management, inadequate regulation, bulging interest rates over the last two years, and liquidity issues; novice investors could learn from these failures alongside their more seasoned peers.
The expert saying that goes “If it grows like a weed then it probably is one” fits well within the conversation of SVB. Being bullish over something that’s bursting at the seams, while having little legitimacy of its future potential not only puts investors at risk but other players as well.
Relying on one thing to carry you throughout your investing journey can leave you empty-handed, as we’ve seen with big-time investors and depositors that heavily invested their cash into the now-collapsed lender.
Seismic tremors of this economic proportion rattle the cage more than enough to give both novice and professional investors the wake-up call they need.
The significant failure of SVB and other smaller regional banks alongside it has given much-needed attention to not only reconsider where investors should be parking their cash amid volatility but rather how they can use this as a learning curb for the future.
How we got here
Following a series of misguided events, economic volatility, and poor risk management, the former Silicon Valley Bank’s clients became the household name among startups and venture capital firms in tech and healthcare within the greater Northern California region.
That was perhaps its first problem, the bank’s business was heavily concentrated in a single sector, and a single region. Although other regional lenders often follow a similar business model, it’s unusual for them to operate in sectors and regions that are both highly volatile and sensitive to broader economic impact.
Nonetheless, an annual report released by the bank at the start of May 2023, showed that the bank experienced a surge in client deposits before and during the pandemic. The banks’ deposits tripled from $60 billion in 2019, to more than $189 billion in 2022.
The free-flow cash era, where the government pumped nearly $5 trillion into the economy to keep things going, gave venture capital firms and startups little concern over borrowing money from other regional lenders.
This is where things start to become interesting. As part of their investment strategy, SVB invested $91 billion, roughly 43% of total assets in Treasury bonds and U.S. government agency mortgage-backed securities between 2020 and 2021.
These investment vehicles, which are often referred to as Held-To-Maturity (HTM) securities, pay a regular fixed coupon amount. In a low-return environment, SVB bought these securities, without the intention of ever needing to sell them off.
Consequently, things started to change at the starting point of last year, as the Federal Reserve embarked on its aggressive monetary tightening, to cool down core inflation.
With a series of interest rate hikes, the value of SVB’s bonds started to drop, leading the bank to a loss of $15 billion from its HTM products by the end of 2022. It was at this point that upper management realized they had run the bank into a liquidity crisis, making the loss public, and sourcing new investments from shareholders to increase its capital.
News of the bank trying to raise its liquidity didn’t take too long to spread, especially in the condensed and concentrated region the bank was operating.
Ultimately, by March 10, the majority of the bank’s clients, roughly 94% who had more than the $250,000 government-backed deposits sitting in the bank were yanking their cash from the bank, causing a $42 billion bank run, wiping out 20% of the bank’s assets and leaving it with a $1 billion negative balance.
Where we are now
“Truly sorry” is what the former CEO of Silicon Valley Bank, Greg Becker had to say when speaking at a Senate banking committee hearing on May 16, 2023.
Becker’s cold-handed apology however echoes a story that follows in the footsteps of similar banking failures we’ve experienced in the past, however this time, it comes with an added cautionary tale that even small-to-medium regional banks aren’t prepared to survive all types of economic headwinds.
The fall of SVB pulled along with its Signature Bank, followed by First Republic Bank shortly after. This marked the second largest bank failure in America since Washington Mutual collapsed in 2008 during the financial crisis.
The collapse of these three banks has already sparked concern regarding other regional banks, including PacWest Bancorp, which is currently mulling a sale, according to a Bloomberg report earlier in May this year.
However, these aren’t the only banks that have met their demise or nearing the end of the line. A study conducted on the fragility of the U.S. banking system raised alarms of 186 banks that are at risk of failure if government regulation is not considered to help protect depositors and the broader banking system.
All is not well, and that ends in the failure of nearly 190 regional banks. This comes at an even more crucial time against the backdrop of widespread economic uncertainty and market volatility.
Perhaps the fall of SVB, Signature Bank, and First Republic Bank is yet another testament that diversification, proper assets management, and increased liquidity requires investors, and other key players to become resilient and agile during turbulent conditions.
However, it is easier said than done. How do you prepare for something you can’t foresee, better yet, how do investors cushion their wealth against economic headwinds that affect nearly every corner of the market?
There’s a lot of this uncertainty that has placed investors, especially novice investors under scrutiny to reevaluate their current position, and how they can use the SVB and banking fiasco as a way to mount themselves against market ambiguity and the perplexity of current economic activity.
What novices learn from this
Considering the aforementioned, and the string of illegitimate asset management risks SVB took over several fruitful years, novice investors are reminded that nothing is always certain in the current economic climate.
However, this does create an opportunity for many of them to learn, albeit at the cost of putting the American banking system in a headlock. By looking at the story of the bank’s failure, many investors, even those with limited experience, have already seen several things they need to pay more attention to going forward.
Diversification
It’s perhaps something that can’t be reiterated enough, however following recent events, it’s important to bring this back into the spotlight. Diversification remains one of the key elements that can help investors spread their cash and portfolios across different investment vehicles.
This might seem like the opening paragraph of ‘Investing 101’ but even regional banks such as SVB had a hard time appropriately diversifying their billion-dollar assets.
Diversification is more than keeping tight spreads across different asset classes such as stocks, bonds, exchange-traded funds (ETFs), and real estate, among other vehicles. It includes investment into different industries and geographic regions.
Instead of concentrating your portfolio on just one or two specific assets, continue to look at a mirage of different options that can deliver long-term success and growth, even against the backdrop of wider economic volatility.
Cash flow
Novice investors are often trigger-happy, investing in exciting new companies that promote exponential growth within the coming decade, without properly considering the company’s past and present balance sheet.
This is where investors, especially younger and newer investors need to learn how to properly research a company’s balance sheet to see what the company’s cash flow situation is. Yes, cash flow isn’t the only thing to consider, there’s debt, loans, profits after tax, and market share that also adds to the equation of things to consider.
However, with positive cash flow, the company signals that it’s able to generate enough money to sustain its operations and invest in further growth. There’s also the idea that companies hold enough positive net cash flows to pay dividends to shareholders, or even increase their annual dividend yield.
If the company is struggling to pay its bills, or having a hard time keeping the lights on, then it might be time to reconsider your interests.
Trust the data
It might be easier to invest based on feeling, rather than looking into the facts of something. What’s more, for something that seems too good to be true, it might be a good idea to push back against this feeling and consolidate actual data to show you the true face of something.
Consider how valuable the data you have on a company can be for your long-term investment strategy. It’s at times better to stay away from things you’re not well clued up with, or have had on your radar for long enough to be thoroughly researched.
What it boils down to, is do your homework, even if it means putting aside a trade or investment due to a lack of fundamental data or information. The more clued up you are, the better.
Redirecting portfolio performance
Simply throwing cash into something, and never considering its performance over several terms is a dangerous game novice investors need to avoid at any cost. This is even more true considering the ongoing economic climate that has left markets overshadowed in uncertainty.
It’s well worth your time knowing that asset values change over time, and this causes a shift in how your portfolio is exposed to different levels of risk. Having your portfolio weighted in one investment vehicle could require you to intervene and rebalance it, helping you to minimize the risk of continuous exposure to volatile assets.
Consider the risk and return of your portfolio, and how much are you willing to expose over the long or short term. Ensure that there is enough diversification, across different asset spreads to help you balance growth, even in times where market conditions may be slowing due to economic conditions.
Increase portfolio liquidity
Following the collapse of SVB and other regional banks, threats of ill-liquid performance are now appearing in a growing number of portfolios. Instead of holding onto assets that don’t necessarily help provide liquidity, investors need to understand the ramifications these actions can have on their growth and performance.
With this in mind, creating a liquid portfolio isn’t easy and it takes time to consider how conditions will change over the coming years. However, as we’ve now established that difficult economic conditions will continue for the next several months, investors need to capitalize on opportunities that allow them to manage the risks more effectively.
More so, providing more liquidity to your portfolio ensures that even in the case of declining growth or returns, there will be enough weight in your portfolio that can help you capitalize on different investment opportunities until conditions have stabilized again.
Building a strategy
Novice investors need to keep in mind that having an entry and exit strategy can become a lifeline for them, especially if they have a portfolio that’s weighted in only a few asset classes.
Each entry point can be different, but investors need to consider how their end goal and risk tolerance align with their overall investment strategy. In a similar vein, we see this with investors that have considered their exit strategy.
Investors need to maximize their exit, and staying around, even well beyond the initial release could affect portfolio growth in both near and long-term performance. The more it’s possible to minimize losses, the better, it’s part of investing. However, this only comes at times when investors are geared to exit at the right time, without tipping scales too much.
The bottom line
Going back to how we got here, we are once again reminded that poor management and risky investments are a combination of efforts that should not be reckoned with.
For novice investors, there’s a lesson here, even in the midst of a possible banking crisis and a looming recession. Having an investment goal allows you to build an investment strategy that suits your portfolio and risk tolerance.
Not only does it highlight the importance of making adjustments every often, or doing additional research before parking your cash in several different investment vehicles. Instead, it shows that even the biggest and most established enterprises can run themselves into the ground, even after decades of experience and building trust among their shareholders.
Regardless of where you may be in your investment journey, never underestimate the importance of taking the backseat now and again, and letting other contenders right out risks you’re not prepared to undertake. But more so, it’s better to make sure you have a decisive plan of execution, instead of casting your line in a dried-up pond.
