The recent collapse of Silicon Valley Bank is cause for concern about potential contagion risks in the industry, but GMO argues that high-quality banks are still safe bets.
First, the factors that led to the fall of SVB are unique and not present at every major bank, according to a recent GMO report. For example, over a half of SVB’s deposits were from start-up companies backed by private equity firms and venture capitalists. As these start-ups burned through cash in 2022, they drew down their deposits from SVB, which eventually led to the meltdown of the bank. SVB also had a large proportion of its investments in long-duration securities, which lost value amid consecutive rate hikes last year.
GMO recommends that investors avoid banks with similar traits as SVB, such as those with high exposure to PE and VC firms, high average balances above the limits provided by the Federal Deposit Insurance Corporation, and rapidly declining deposits over the past year.
“We look for high-quality banks with established track records of historical profitability and strong fundamentals, those with healthy financials that should be able to outgrow their peers with less risk,” Ty Cobb, portfolio manager on GMO’s quality strategies team, and Kim Mayer, research analyst on the firm’s focused equity team, wrote in the report.
Cobb and Mayer also proposed a new approach to valuing deposits at high-quality banks, which involves analyzing both gains and losses that are tied to rising interest rates. For example, Bank of America has lost $109 billion on its held-to-maturity securities, which aren’t factored into its book value. At the same time, the bank has $2 trillion in deposits, which are yielding about 1 percent as of the end of 2022. “Those deposits are probably worth a lot more than $109 billion and yet are not factored into tangible book,” according to the GMO report. “These are the types of considerations we analyze when evaluating high-quality banks.”
The authors also believe that the government’s backing of all deposits at SVB and Signature Bank will inspire confidence and slow the rate of deposit outflows. However, they think the government should do more to restore investors’ confidence, including issuing a statement from the central bank that says it will temporarily back all domestic deposits.
“In our view, the U.S. government should go further,” the authors wrote. “The Fed has blood on its hands. These banks were acting rationally by investing in long-duration assets at a time when the Fed was erroneously signaling that rates would stay low in the face of ‘transitory’ inflation.”