skip navigation

Stay up to date on timely topics and market events. Subscribe to our Blog now.

March 15, 2023

Searching for Value in the Aftershock of Silicon Valley Bank

By Ryan K. Brist, CFA, Ivor Schucking, James J. So, CFA

Stay up to date on timely topics and market events. Subscribe to our Blog now.

What Happened

The second and third largest bank failures in US history, Silicon Valley Bank (SVB) and Signature Bank, respectively, occurred within 48 hours of each other due to classic bank runs, when the ability of the banks to return depositors' money was questioned. This crisis of confidence caused hasty deposit flight at these institutions and forced regulators to step in and ringfence operations. Bank regulators enacted emergency procedures to assuage depositor concerns, stating in their press release on the afternoon of Sunday, March 12 that “The Federal Reserve is prepared to address any liquidity pressures that may arise.” In the wake of these failures and their aftershocks, what’s likely to come next?

Western Asset believes the SVB situation will not cause pervasive contagion to the US banking system. There is no guarantee another bank won’t see a run on deposits, but the emergency measures implemented over the weekend should help to restore confidence and stem further sentiment contagion. Unlike the global financial crisis (GFC)—which was a credit crisis exposing all banks to similar deteriorating assets (residential mortgages and other sub-prime loans) along with high interconnectivity at the largest banks through counterparty risk—the overall banking system today is fundamentally strong.

Silicon Valley Bank Was a Unique Situation

We consider the SVB episode to be a unique, idiosyncratic situation based on this bank’s: (1) business strategy focused on rapid growth (fastest deposit growth in the US over the last three years) and highly concentrated on the technology sector in Silicon Valley; (2) investment strategy, which left the bank negatively exposed to rising rates as opposed to the typical asset mix at banks that benefit from rising rates, and (3) unique balance sheet structure (e.g., high percentage of corporate, as opposed to retail, deposits that were uninsured and with a concentration in the tech/VC sector).

The situation with Signature Bank was also unusual given: (1) its connection to the crypto currency markets, which led to it being the second fastest growing bank in the US over the last three years and (2) also having a high percentage of its deposit base being uninsured, making Signature Bank an outlier like SVB.

As mentioned earlier, banking regulators quickly announced emergency measures to mitigate liquidity concerns. The first measure, guaranteeing all deposits at these banks including amounts over the traditional FDIC-insured $250,000 threshold, intended to assuage fears of principal losses. It should also be noted that even during the GFC all depositors were eventually made whole. The second measure relieves liquidity concerns through a new Bank Term Funding Program, which allows banks to obtain advances for up to one year in exchange for eligible collateral (generally Treasuries and agency securities) at par rather than a mark-to-market discount. Both policies attempt to stem the risk of rapid deposit outflows.

The Largest Banks Remain Attractive

Since the GFC, Western Asset has regularly published on why we’ve favored investing in the best/largest banks. A quick summary of this reasoning includes: (1) banks’ strong balance sheets and the highly regulated banking environment; (2) their diversified asset base and liabilities structure; (3) near-record earnings in recent years—expected to rise further in 2023 given higher interest rates and margins; (4) benign future technicals—these large US banks issued much more debt than expected in 2021 and 2022; (5) conservative credit ratings—for the largest banks we expect positive ratings momentum with one-notch upside across the board, and (6) attractive valuations—after the GFC, banks traded wide of the overall credit sector in spite of the significant fundamental transformation the banking industry has been through. We continue to see value across the capital structure in the best and largest banks.

Our View on Regional Banks

Regional bank valuations, represented by both equity prices and credit spreads, have swiftly repriced to much lower levels. Regional bank spreads used to trade inside of the GSIBs (global systemically important banks), but in the wake of recent events they have gapped much wider. Part of this move reflects contagion fear and general selling pressure. Debt issuance for regional banks is likely heading much higher given the forthcoming higher-scrutiny regulatory environment and the larger capital cushions that will be required. Other earnings headwinds may include higher deposit costs, higher FDIC insurance fees, and increased staffing needed to comply with and manage to a much stricter regulatory framework. Valuations for new issuance are likely to come with attractive concessions to secondaries. The challenge now is to discern when attractive relative value is being offered.

The Bottom Line

The US banking industry is fundamentally strong. It will take time for confidence to completely return, but good bonds don’t trade at good prices when the news is positive. For those willing to get back in the water, we’d suggest starting with the largest non-GSIBs. These “super regionals” are more regulated than their smaller counterparts and have a stronger and more diversified asset base and balanced liability structure.

© Western Asset Management Company, LLC 2023. This publication is the property of Western Asset and is intended for the sole use of its clients, consultants, and other intended recipients. It should not be forwarded to any other person. Contents herein should be treated as confidential and proprietary information. This material may not be reproduced or used in any form or medium without express written permission.
Past results are not indicative of future investment results. This publication is for informational purposes only and reflects the current opinions of Western Asset. Information contained herein is believed to be accurate, but cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Western Asset may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of residence.
Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorized and regulated by Comissão de Valores Mobiliários and Brazilian Central Bank. Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services Licence 303160. Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services Licence for fund management and regulated by the Monetary Authority of Singapore. Western Asset Management Company Ltd is a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan. Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority (“FCA”) (FRN 145930). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK as defined by the FCA. This communication may also be intended for certain EEA countries where Western Asset has been granted permission to do so. For the current list of the approved EEA countries please contact Western Asset at +44 (0)20 7422 3000.