BANK STOCKS UNDER PRESSURE, GOVERNMENT TAKES ACTION
Bank stocks, specifically smaller regional banks, have come under tremendous pressure recently due to the collapse of Silicon Valley Bank (SVB), the second-largest bank failure in U.S. history. Concerns mounted quickly last week as markets learned that SVB was facing liquidity problems and had attempted to raise capital by selling assets and stock. The growing insolvency concerns triggered a “bank run” on SVB. A bank run occurs when a large number of customers of a bank withdraw their deposits at the same time, usually due to concerns about the bank’s financial stability, as was the case with SVB. SVB’s financial instability was due to several factors, including a concentrated deposit base (VC’s, start-ups) and very poor risk management policies related to their investments in fixed-rate bonds and loans which were made worse by the rising interest rate environment of the past year. Generally, a rapid and simultaneous withdrawal of funds can create a liquidity crisis for a bank, potentially leading to its insolvency and collapse.
The Federal Deposit Insurance Corporation (FDIC), a U.S. government agency that is responsible for protecting bank depositors and maintaining stability in the banking system, swiftly stepped in and took SVB into receivership. When a bank goes into receivership, the FDIC takes control of the bank’s assets and liabilities and appoints a receiver to manage the bank’s affairs. Once the FDIC took SVB into receivership, they created the Deposit Insurance National Bank of Santa Clara and immediately transferred all insured deposits of SVB to the DINB.
Paying off depositors: The FDIC’s primary role in receivership is to protect depositors and ensure that they are paid back. Typically, the FDIC will use the bank’s assets to pay off depositors up to the insured limit, which is currently $250,000 per depositor. In the case of SVB, approximately 90% of its bank deposits were not FDIC-insured because they were over the $250,000 limit. In an effort to restore faith in the banking system and quell concerns, the FDIC, Treasury Department, and Federal Reserve took additional measures and issued the following joint statement Sunday:
Today we are taking decisive actions to protect the U.S. economy by strengthening public confidence in our banking system. This step will ensure that the U.S. banking system continues to perform its vital roles of protecting deposits and providing access to credit to households and businesses in a manner that promotes strong and sustainable economic growth.
After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer…Shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law. Finally, the Federal Reserve Board on Sunday announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.
In the long run, there will be questions about what these actions by the federal government mean for the banking system and policy going forward, but for now, restoring faith in the system is imperative for a functioning economy.
In the coming days, the receiver will sell the SVB’s assets, such as loans, real estate, or other investments, to repay depositors and other creditors. The receiver will then work to resolve the bank’s affairs, which may involve merging it with another institution, selling it to another bank or investor, or liquidating its remaining assets.
WHAT IS NEXT FOR THE FED
The next question on the minds of investors is “what is next for the Fed?” and monetary policy in the wake of the recent bank failures, most notably SVB. After Fed President Powell’s recent address to Congress, and prior to the demise of SVB, he all but assured markets that the Federal Reserve would continue to raise interest rates in the face of consistently “sticky” inflation data. In fact, the probability of a potential 50 basis point hike at the Fed’s next meeting increased dramatically to almost 70%.
During his appearances on Capital Hill over two days, Powell stated, “the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated”…“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”
There is an old saying on Wall Street that “the Fed tightens until something breaks.” Well, something has broken, and all eyes now look to the Fed and their next policy decision. Many economists believe the lag effects of the aggressive interest rate policy cycle are starting to bite into economic activity, and the Fed should pause additional rate hikes at the next policy meeting. While the probability of a Fed rate pause has increased, inflation data will ultimately drive Fed policy. We think a 50 basis point hike is less likely, but an additional 25 basis point hike to the federal funds rate is still certainly a possibility.
Bond markets have rallied in recent days as investors made the “flight to safety,” sending bond prices higher. The 2-year U.S. Treasury, which was over 5% just last week, has now dropped a full percentage point over the span of just three trading days to yield about 4%. The 10-year U.S. Treasury having reached 4% has moved back down to 3.5%. As fears of a systematic banking collapse subside, treasury yields should again trend higher. See charts on the previous page.
UTILIZING TAX-LOSS HARVESTING
During periods of market volatility, some securities may experience declines in value. For long-term investors, it is important to utilize the concept of “tax-loss harvesting,” that involves strategically selling securities, realizing losses, and using them to offset future capital gains or reduce taxable income. When losses are realized, we can also reinvest the money in similar assets or securities without generating a wash sale. By utilizing tax-loss harvesting throughout the year, especially during periods of market volatility, we are able reduce tax liabilities and increase after-tax returns. See the example below as an illustration.
· Let’s say an investor purchased shares in a company for $10,000, but the shares declined in value to $6,000. The investor decides to sell the shares and realizes a $4,000 loss. The investor can use this loss to offset any capital gains they may have in the same tax year.
· If the investor has no capital gains to offset, they can use up to $3,000 of the loss to offset other types of income, such as wages or rental income. This will reduce their taxable income by $3,000, resulting in lower taxes owed.
· The remaining $1,000 of the loss can be carried forward to future tax years to offset capital gains or income. This is called a tax-loss carry forward.
As noted in the example, if an investor has any unused tax losses they can be carried forward to offset future capital gains or income. Capital gains are the profits that an investor realizes from selling an asset that has increased in value. These gains are subject to taxation, but the tax rate depends on whether the gain is classified as a long-term capital gain or a short-term capital gain.
A long-term capital gain is a gain on the sale of an asset that was held for more than one year. For example, in the United States, the tax rate for long-term capital gains can range from 0% to 20%, depending on the taxpayer’s income level, while the tax rate for short-term capital gains is taxed at the ordinary income tax rate, which can be as high as 37%. The lower tax rates for long-term capital gains has been meant to incentivize long-term investing.
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