The U.S. government’s actions to minimize risk across the banking industry following the events of Silicon Valley Bank and Signature Bank have strong potential to prevent further bank runs and subsequent bank failures. But scrutiny of some regional banks will persist.
KEY TAKEAWAYS
- The U.S. government has announced significant, aggressive actions intended to stem the contagion of risks across the banking industry in the wake the closure of Silicon Valley Bank (SVB) and Signature Bank (Signature).
- We believe these steps have strong potential to prevent further bank runs and subsequent bank failures, but scrutiny has turned to regional banks that have a preponderance of large (and therefore uninsured) deposits.
- We are assessing the impact of the bank’s closure will have on client preferred securities holdings while managing risk across our holdings including identifying investments in firms that have any similarities to SVB or Signature.
What’s happening?
The U.S. government has announced significant, aggressive actions intended to stem the contagion of risks across the banking industry. The moves come in the wake of the recent closure of regional banks—Silicon Valley Bank (SVB) and Signature Bank (Signature)—that faced liquidity challenges amid greater- than-expected deposit outflows.
We believe these are important steps from the Federal Government that have strong potential to prevent further bank runs and subsequent bank failures. However, scrutiny is focused on regional banks that have a preponderance of large (and therefore uninsured) deposits and/or significant exposure to depositors who face significant cash flow challenges.
The most notable bank failure occurred at SVB, a commercial bank serving emerging and middle-market growth companies focused on technology and life sciences industries. Many technology start-up companies, which represent the bulk of SVB’s depositors, have been forced to spend their cash reserves faster than expected due to higher interest rates, volatile public and private markets, and uncertain and slowing macroeconomic conditions. It became harder for start-ups to raise new cash.
SVB, after initially indicating in January that deposit outflows had slowed, updated its 2023 guidance on March 8 to indicate deposit trends were weaker than expected. To offset the weaker trend in deposits, SVB announced it was taking steps to improve its liquidity, which included the sale of substantially all of its available for sale (AFS) securities portfolio (U.S. Treasuries and agency securities). It sold $21 billion of securities, which resulted in an after-tax loss of $1.8 billion in 1Q23 and the consequent need for a capital raise.
Its capital raising efforts failed, as depositors were encouraged to withdraw any funds they had at SVB, citing liquidity concerns. The bank’s stock (Nasdaq: SIVB) subsequently fell 65% on Thursday, March 9th and then fell another 65% in pre-market trading the next day before trading was halted. Financial regulators then announced they had closed SVB and taken control of its deposits.
In the wake of the issues at SVB, U.S. regulators, citing systemic risks, stepped in and on March 12 closed New York-based Signature Bank. That same day, the Federal Government announced a series of significant actions to address the market issues.
Steps from the Federal Government have strong potential to prevent further bank failures.
What actions has the U.S. government taken?
The U.S. government announced it would guarantee all deposits at both Signature and SVB, not just those below $250,000 that would have been guaranteed by the Federal Deposit Insurance Corporation (FDIC). Both banks had a significant amount of uninsured deposits.
The Federal Reserve is also establishing a new lending facility for banks and other financial institutions to help meet redemptions, while also valuing the collateral used to secure those loans at par rather than their current mark-to- market value.
Banks will be able to borrow from the Fed at par on their assets, which will help them to cover deposit outflows without recognizing losses, which was a primary contributor to the demise of SVB. However, the extent of potential depositor outflows remains uncertain. It is important that the actions also calm depositor fears, as outflows must be stemmed to break the cycle of deposit runs surpassing available bank liquidity.
What is our exposure and plan at Cohen & Steers?
Cohen & Steers investment portfolios held small to moderate positions in securities issued by SVB as a percent of assets under management as of Dec. 31, 2022, the last publicly available holding period. Some portfolios also hold a very small allocation in securities from Signature.
We are assessing the impact of the banks’ closure will have on client holdings. We are also actively managing the related risks, including identifying investments in firms that have any similarities to SVB or Signature. We continue to analyze portfolio holdings based on funding, capital, investment portfolio size, and loan-to-deposit ratios, among other factors. We are also monitoring commercial real estate loan books, though so far loan losses have not been an issue.
With potential economic fallout from tighter Federal Reserve policy possible, we continue to reduce credit risk, which is something we have been focused on the last several months.
Notably, our strategies are diversified. By example, the Cohen & Steers Preferred Securities and Income Fund (the “Fund”) owned more than 300 securities from over 125 different issuers as of Dec. 31, 2022. More than 90% of the issuers in the Fund are investment grade rated at the issuer level. The Fund is also diversified across geographic regions (approximately half of its assets invested outside the United States) and sectors beyond banks, including insurance companies, utilities, telecommunications and real estate.
Concerns for broader banking sector?
As of March 13, it is estimated that U.S. banks have accumulated unrealized losses of $620 billion in AFS and held-to-maturity securities. We believe the Fed’s aggressive actions over the weekend mean that banks are unlikely to realize those losses. The confidence instilled in the system by the Fed’s actions will also likely stem bank runs.
While these steps have the potential to stop contagion from spreading, we also see additional regional banks facing deposit outflows stemming from concerns among depositors who may move their money to larger banks with better capitalization. Our investment team is actively managing our portfolios, though we are limited in what we can say about actions we are taking in real time.
We also believe it is important to distinguish between SVB and the broader U.S. banking industry. Other banks may face possible liquidity challenges and forced selling of their assets, but we believe SVB’s and Signature’s challenges were largely idiosyncratic.
SVB’s and Signature’s deposits were large, and therefore, predominantly uninsured. Further, SVB was concentrated across tech-related industries that experienced faster-than-expected cash burn rates as monetary policy tightened. The recent liquidation of Silvergate Bank, another bank focused on tech industries (notably the crypto market), further eroded market confidence in banks with significant tech exposure.
As SVB’s venture capital clients drew down deposits for liquidity, the company was forced to take losses on its large securities holdings to meet liquidity demands. Compounding the challenges for the bank, SVB had invested in term bonds, which were marked down as rates rose (marked down for rate reasons, not credit), forcing them to take losses and therefore require more equity. The Fed’s actions will likely minimize this as an issue going forward for other banks facing liquidity shortfalls.
Deposits and overall funding are also much more diversified across the broader U.S. banking industry. Smaller FDIC-insured retail deposits account for most deposits across the industry, in contrast to SVB’s deposit base. Retail deposits are stickier, and we believe this means there is more resilient funding across the banking industry. The largest U.S. banks are also heavily regulated and typically exceed capital minimums and liquidity coverage ratios. Larger U.S. banks have also benefited from more diversified business models.
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Important disclosures
Data quoted represents past performance, which is no guarantee of future results. The views and opinions presented in this document are as of the date of publication and are subject to change. There is no guarantee that any market forecast set forth in this document will be realized. This material represents an assessment of the market environment at a specific point in time and should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment.
This material is not being provided in a fiduciary capacity and is not intended to recommend any investment policy or investment strategy or to account for the specific objectives or circumstances of any investor. We consider the information to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for investment. Cohen & Steers does not provide investment, tax or legal advice. Please consult with your investment, tax or legal professional regarding your individual circumstances prior to investing. No representation or warranty is made as to the efficacy of any strategy or fund or the actual returns that may be achieved.
The mention of specific securities or sectors is not a recommendation or solicitation for any person to buy, sell or hold any particular security and should not be relied upon as investment advice. Holdings are subject to change without notice.
Before investing in any Cohen & Steers fund, please consider the investment objectives, risks, charges, expenses and other information contained in the summary prospectus and prospectus, which can be obtained by visiting cohenandsteers. com or by calling 800 330 7348. This commentary must be accompanied by the most recent Cohen & Steers fund factsheet(s) and summary prospectus if used in connection with the sale of mutual fund shares.
Risks of investing:
Preferred securities. Diversification does not ensure a profit or protect against loss. Investing in any market exposes investors to risks. In general, the risks of investing in preferred securities are like those of investing in bonds, including credit risk and interest-rate risk. As nearly all preferred securities have issuer call options, call risk and reinvestment risk are also important considerations. In addition, investors face equity-like risks, such as deferral or omission of distributions, subordination to bonds and other more senior debt, and higher corporate governance risks with limited voting rights. Preferred funds may invest in below-investment-grade securities and unrated securities judged to be below-investment-grade by the Advisor. Below-investment-grade securities or equivalent unrated securities generally involve greater volatility of price and risk of loss of income and principal and may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade securities.
Important disclosures
Data quoted represents past performance, which is no guarantee of future results. The views and opinions presented in this document are as of the date of publication and are subject to change. There is no guarantee that any market forecast set forth in this document will be realized. This material represents an assessment of the market environment at a specific point in time and should not be relied upon as investment advice, does not constitute a recommendation to buy or sell a security or other investment and is not intended to predict or depict performance of any investment.
This material is not being provided in a fiduciary capacity and is not intended to recommend any investment policy or investment strategy or to account for the specific objectives or circumstances of any investor. We consider the information to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of appropriateness for investment. Cohen & Steers does not provide investment, tax or legal advice. Please consult with your investment, tax or legal professional regarding your individual circumstances prior to investing. No representation or warranty is made as to the efficacy of any strategy or fund or the actual returns that may be achieved.
The mention of specific securities or sectors is not a recommendation or solicitation for any person to buy, sell or hold any particular security and should not be relied upon as investment advice. Holdings are subject to change without notice.
Before investing in any Cohen & Steers fund, please consider the investment objectives, risks, charges, expenses and other information contained in the summary prospectus and prospectus, which can be obtained by visiting cohenandsteers. com or by calling 800 330 7348. This commentary must be accompanied by the most recent Cohen & Steers fund factsheet(s) and summary prospectus if used in connection with the sale of mutual fund shares.
Risks of investing:
Preferred securities. Diversification does not ensure a profit or protect against loss. Investing in any market exposes investors to risks. In general, the risks of investing in preferred securities are like those of investing in bonds, including credit risk and interest-rate risk. As nearly all preferred securities have issuer call options, call risk and reinvestment risk are also important considerations. In addition, investors face equity-like risks, such as deferral or omission of distributions, subordination to bonds and other more senior debt, and higher corporate governance risks with limited voting rights. Preferred funds may invest in below-investment-grade securities and unrated securities judged to be below-investment-grade by the Advisor. Below-investment-grade securities or equivalent unrated securities generally involve greater volatility of price and risk of loss of income and principal and may be more susceptible to real or perceived adverse economic and competitive industry conditions than higher-grade securities.
Risks of preferred securities differ from those of other investments. In the event of bankruptcy, a company’s preferred securities are senior to common stock but subordinated to all other types of corporate debt. Corporate bonds sit higher in the capital structure than preferred securities and therefore, in the event of bankruptcy, will be senior to preferred securities. Municipal bonds are issued and backed by state and local governments and their agencies; the interest from municipal securities is often exempt from state and local income taxes. Treasury securities are issued by the U.S. government and are generally considered the safest of all bonds since they are backed by the full faith and credit of the U.S. government as to timely payment of principal and interest; U.S. Treasury interest is generally exempt from state and local income taxes.
Contingent capital securities (CoCos). CoCos are debt or preferred securities with loss absorption characteristics built into the terms of the security, for example a mandatory conversion into common stock of the issuer under certain circumstances, such as the issuer’s capital ratio falling below a certain level. Since the common stock of the issuer may not pay a dividend, investors in these instruments could experience a reduced income rate, potentially to zero, and conversion would deepen the subordination of the investor, hence worsening the investor’s standing in a bankruptcy. Some CoCos provide for a reduction in the value or principal amount of the security under such circumstances. In addition, most CoCos are considered to be high yield securities and are therefore subject to the risks of investing in below-investment-grade securities.
Cohen & Steers Capital Management, Inc. (Cohen & Steers) is a registered investment advisory firm that provides investment management services to corporate retirement, public and union retirement plans, endowments, foundations and mutual funds.
Cohen & Steers U.S. registered open-end funds are distributed by Cohen & Steers Securities, LLC and are only available to U.S. residents.
Contingent capital securities (CoCos). CoCos are debt or preferred securities with loss absorption characteristics built into the terms of the security, for example a mandatory conversion into common stock of the issuer under certain circumstances, such as the issuer’s capital ratio falling below a certain level. Since the common stock of the issuer may not pay a dividend, investors in these instruments could experience a reduced income rate, potentially to zero, and conversion would deepen the subordination of the investor, hence worsening the investor’s standing in a bankruptcy. Some CoCos provide for a reduction in the value or principal amount of the security under such circumstances. In addition, most CoCos are considered to be high yield securities and are therefore subject to the risks of investing in below-investment-grade securities.
Cohen & Steers Capital Management, Inc. (Cohen & Steers) is a registered investment advisory firm that provides investment management services to corporate retirement, public and union retirement plans, endowments, foundations and mutual funds.
Cohen & Steers U.S. registered open-end funds are distributed by Cohen & Steers Securities, LLC and are only available to U.S. residents.