Collapsing Banks and What It Means for Investors

by | Mar 28, 2023 | Real Estate Syndications

Unless you were vacationing off the grid over the last two weeks, you have no doubt heard the lightning strike…the collapse of Silicon Valley Bank (SVB), the 16th largest bank in America and the largest bank to fail since the 2008 financial crisis.  This bank failure was followed soon after by another one, Signature Bank.  These failures created a concern about the stability of community and regional banks, with those banks losing some deposits to large national banks (Bank of America, Citi, etc.)  Many regional bank stocks have also lost significant value as well. 

In this blog, we will outline the sequence of events that led to the SVB collapse and key implications for investors.

What Happened at SVB

SVB is a bank that catered to the venture-backed technology firms of Silicon Valley but also counted major tech companies like Roku.  Tech companies did very well financially in 2021, with the post-pandemic tech boom and government stimulus from the Pandemic.  According to Bloomberg, that led to a doubling of SVB deposits as tech firms stored their extra cash in this California bank.

The way banks make profit is to take our deposits and pay us a small interest rate, then they loan the money out or invest it in securities like treasury bills that pay them a substantially higher rate.  In SVB’s case, they could not grow their loans fast enough to put the capital influx to work, so they invested in longer-term debt instruments, mostly mortgage-backed securities and treasuries.

Then came the perfect storm.  The Fed started raising interest rates in 2022, in fact rates have increased nine times since March, 2022.  In part because of the rise in interest rates but also due to a slowdown in venture capital activity and tech growth, SVB depositors needed to draw down cash reserves to support their businesses. 

Problem is, SVB did not keep sufficient liquidity so they needed to liquidate $21 billion in those long-term debt instruments they bought in 2021.  Because interest rates had increased dramatically (when interest rates increase after we buy a fixed-interest investment, the value of our investment goes down), those $21 billion in securities had to be sold at a loss of $1.8 billion loss. 

When this loss was announced, depositors and investors panicked.  With news travelling almost immediately in this Twitter age, depositors rushed to the bank and withdrew billions in no time flat.  With no ability to redeem all these deposits, the FDIC needed to step in to assist SVB…and just like that, the bank was out of business. 

Today, it was reported that First Citizens is stepping in to buy SVB.  Of course, there will be continued ramifications to how the banking system – particularly regional and community banks – is impacted in the coming months as it deals with the regime of tighter credit and higher interest rates ushered in by the Federal Reserve.  But those ramifications will also impact us as investors.  Here are our observations regarding investors. (Note this is our view as business owners and investors ourselves, not as economists or financial advisers.  You will need to consult with your own financial professionals before acting on any comments below regarding stock market investing).

 Banking Outlook

  • Based on the rapid and fulsome response to the SVB/Signature Bank collapses by the Fed, the Treasury Department, and large multinational banks, it appears depositors will be protected even if they have deposits exceeding $250k in an account. This should keep further bank runs under wraps.  Having said that, out of an abundance of caution, our practice at GrowAbility Equity is to keep bank balances within FDIC limits.  Also, GrowAbility Equity and property accounts are all held at large multinational banks, namely Bank of America and Chase.
  • On the other hand, with the bailouts from 2008-2009 still being highly controversial, there seems to be no interest in protecting investors in smaller regional banks. Although failing banks are usually bought out by stronger banks, this purchase happens typically at a substantial discount.  The implication is that investors in banks like SVB and Signature are at risk of investment losses with no bailout protection like depositors.
  • On the other hand, with the bailouts from 2008-2009 still being highly controversial, there seems to be no interest in protecting investors in smaller regional banks. Although failing banks are usually bought out by stronger banks, this purchase happens typically at a substantial discount.  The implication is that investors in banks like SVB and Signature are at risk of investment losses with no bailout protection like depositors.

Look for this slowdown in lending to eventually lead to lower inflation as a result of lower economic activity in our communities and, unfortunately, an increase in unemployment.  This is actually the ultimate goal of the Federal Reserve’s interest rate increases as they look to bring inflation down to their long term target of 2% (the CPI is now 6%, was 9.1% back in June, 2022).  Investors are advised to be more vigilant around expense and debt management over the next year as our economy slows, banks lend less, and companies reduce hiring and payrolls.

Interest Rate, Inflation, Recession and Market Outlook

  • As mentioned, the Fed has increased interest rates 9 times since March, 2022, in its fight against inflation. Some Fed watchers believe that due to the banking system’s potential ongoing credit issues and with an impending economic slowdown, the Fed will be forced to pause and then lower rates over the summer.  The Fed is saying that they will not pause and ease interest rates until 2024.  Only time will tell.  Needless to say, as we all look to buy homes or other major purchases that need to be financed, we need to realize interest rates could continue higher into 2024, but the silver lining in the bank crisis is that it may force the Fed to lower interest rates much sooner than they are planning.
  • Historically, equity markets move inversely to interest rates. The S&P500 is down over 10% since the Fed began to hike rates in March, 2022.  Ultimately, the increased interest rates will likely result in a fairly significant economic slowdown, maybe even a recession, and perhaps even lower stock market prices.  The other factor in upcoming stock market performance is when will the higher interest costs and business slowdown be fully reflected in Wall Street earnings.  There is usually a lag effect so some market watchers are looking for a potential lower leg to the market once companies start to miss their profit projections later in the year.  But no one knows for sure, the market often moves to surprise the most number of people and inflict the most amount of pain!

Needless to say, these market experts are advising investors who need to use stock market funds in the next few years to be mindful about this downside risk for current funds in the market or new monies being considered for investing.  For longer-term market investors, these experts think lower prices and an eventual market bottoming will be a good buying opportunity later in the year or next year for those with the interest, nerves and discipline to invest in the market.  For long-term retirement investors who stay fully invested, at least you now have a sense of what market observers expect in the coming months.

Outlook for Commercial Real Estate Connected to Housing (Our Sweet Spot of Focus)

Not all commercial real estate (CRE) does well in times of financial turmoil.  Some CRE is very cyclical, like office space or industrial.  Office space is particularly out of favor as many employers never went back full time after the Pandemic.  Currently, with layoffs occurring, office vacancies are rising even further.  Now is not the time to put money to work in office investments.  The exception to this would be investing in offices which are being converted to multifamily due to the great shortage of housing units nationwide (4 million unit shortage) and continued strong fundamentals in the multifamily space (more below).

CRE that stands out as a resilient and reliable alternative to traditional investing (bank or market investments) is housing-related real assets like mobile home communities, self-storage communities and apartment buildings.  Housing is a core need that exists in good times and bad.   Investing in real assets like apartment buildings offers several advantages over traditional investments:

  • Inflation-Resistant: Because wage inflation is typically a key component of overall market inflation and because housing is a core need, multifamily historically has pricing power to increase rents to keep up with market inflation.  Inflation negatively impacts the returns of many traditional investments, especially fixed interest investments and stocks of companies without pricing power.
  • Recession-Resistant: In tough times, the need for rental housing increases as home affordability declines, bolstering the performance of multifamily.  On the other hand, recessions typically reduce corporate earnings and the performance of traditional stock market investments.
  • Higher cash-on-cash returns: Real estate investments typically provide higher cash-on-cash returns of 5% to 8%, higher than the typical stock dividend or the interest on bank products like CD’s.
  • Tax Benefits: CRE offers tax-savings, especially due to depreciation deductions, while traditional investments offer tax-deferral (IRAs and 401Ks) instead of tax reduction.
  • Tangible assets: Unlike financial institutions, real estate investments are tangible assets that can’t disappear overnight, that have an intrinsic value. The value is not determined by the supply and demand of a (stock and bond) market, but by the actual income generated by a given property.
  • Immunity to investor runs: Real estate is not subject to investor runs and panic withdrawals, making it a more stable investment option.

In summary, the recent bank turmoil has given us an opportunity to step back and take a look at our game plans as investors.  One of the lessons that can’t reiterated enough is the importance of diversifying our investment portfolios.  But there is a finer point here to start to diversify into alternative assets that don’t move in lock-step with banking and market investments.

Most of us have bank investments, most of us have market investments, but most of us don’t own investments in apartment buildings or other housing-related CRE investments that don’t correlate with traditional investments and offer different benefits, as laid out above.  Importantly, housing-related CRE investments offer a reliable and resilient alternative in the face of financial turmoil.  They provide a safer haven that has benefited the wealthy for years.  But now you have access to invest just like them through apartment syndications we offer that enable you to be a part-owner of a multi-million dollar apartment community.  And even better, you can invest passively…no hammer, no side-hustle required!

Interested in learning more?  Schedule a wealth acceleration call with us at Growability, and don’t forget to join the GrowAbility Equity Club to stay updated on the latest investment opportunities.

Thanks for being a part of our community. Until next time, keep growing your ability to accelerate your wealth and legacy building….glad to be a part of this journey!