Markets Rally in March Despite Bank Stress but Some Stocks Face New Challenges
The S&P 500 rallied 3.7% in March, bringing its year-to-date return to 7.4% despite the collapse of Silicon Valley Bank (SVB) and Signature Bank. These were America’s second and third largest bank failures on record.
As we shared in a note on March 15, both banks had a very high mix of uninsured deposits and outsized exposure to early-stage tech and venture-backed businesses, which boomed during the pandemic.
As venture funding slowed last year, many of these firms began drawing down cash deposits to finance their businesses. SVB didn’t have enough cash to meet these outflows after low interest rates led management to invest more in higher-yielding long-term bonds.
SVB was forced to sell some of these investment securities (primarily U.S. Treasuries) at a loss because the Fed’s aggressive rate hikes had reduced the value of long duration bonds.
Panic ensued since the unrealized losses of SVB's remaining bonds exceeded the firm's common equity (banks are highly leveraged by nature), creating a scenario that could wipe out the company if enough customers pulled their deposits to force additional sales.
The FDIC only insures up to $250,000 per depositor, per bank. No one wanted to be left holding the bag if SVB went under, resulting in a stampede of withdrawals that created a self-fulfilling prophecy.
Worries about the banking sector have simmered down the last couple of weeks after policy makers stepped in with emergency measures.
These included the guarantee of all uninsured deposits of SVB and Signature and allowing banks to take loans from the Fed using their debt investments valued at par as collateral, reducing the need to sell bonds at a loss.
Worries about the banking sector have simmered down the last couple of weeks after policy makers stepped in with emergency measures.
These included the guarantee of all uninsured deposits of SVB and Signature and allowing banks to take loans from the Fed using their debt investments valued at par as collateral, reducing the need to sell bonds at a loss.
But this shock highlights one of potentially many unintended consequences that the Fed’s aggressive tightening could have in the year ahead. Ripple effects from stress in the banking sector could build, too.
The biggest concern is a credit crunch. Deposits represented 90% of total liabilities across the 59 banks we analyzed in March. When deposits shrink, a bank has less capital it can use to make loans, reducing the amount of credit available for households and businesses.
Smaller U.S. regional and community banks lost $108 billion in deposits in the days after SVB collapsed as clients worried about the safety of their cash, according to Fed data cited by The Wall Street Journal. That marked the largest weekly decline on record.
Meanwhile, the nation’s 25 biggest banks gained $120 billion over the same period. Panicky customers viewed these too-big-to-fail institutions as safer places to park funds, especially for amounts above the FDIC’s insurance limit. As smaller banks work to retain deposits and preserve liquidity, lending activity could decline.
Firms with weaker credit profiles could especially face tighter lending standards as investor appetite for risk diminishes. After SVB failed, just one U.S. borrower with a junk credit rating has tapped the high-yield market, according to the Financial Times.
Firms with weaker credit profiles could especially face tighter lending standards as investor appetite for risk diminishes. After SVB failed, just one U.S. borrower with a junk credit rating has tapped the high-yield market, according to the Financial Times.
Many companies saddled with debt and facing challenging operating conditions have seen their stock prices hit hard following SVB’s failure. The market is worried these firms could struggle to access affordable funding as their debt matures and needs refinancing.
Assessing the economic impact of tighter credit standards will take time. But the odds of a recession have arguably increased, especially as the Fed insists on maintaining elevated interest rates in its ongoing battle to tame inflation.
We are keeping a close eye on these risk factors as we monitor Dividend Safety Scores across our coverage universe. For example, last month we combed through the 15 office REITs in our coverage to assess their:
- Mix of variable-rate debt (less than 10% on average)
- Debt maturities from 2023-25 (about 25% of total debt on average)
- Lease expirations from 2023-25 (close to 30% on average)
- Change in occupancy versus pre-pandemic (down 3% on average)
- Sensitivity to remote work trends (as assessed by mix of tenants and geographies)
These data points give us a better perspective on where a company’s payout ratio could head and any potential financing challenges that could emerge over the next few years if conditions worsen (due to even higher interest rates or restricted access to credit).
Our banking study in March took a similar industry-specific approach. Looking at payout ratios, dividend streaks, and capital ratios isn’t enough to understand a bank’s exposure to the issues that brought down SVB and Signature Bank.
We analyzed each bank’s mix of uninsured deposits, unrealized investment losses, adjusted capital ratios if these losses were included, and other factors to identify firms that could find themselves on shakier ground. You can grab the bank spreadsheet we assembled here.
Few small and midsize banks have disclosed recent deposit trends, so we are eager to comb through their first-quarter earnings results in a few weeks to reassess their risk profiles.
Most regional banks looked stable to us (outside of about a dozen that we highlighted here) but losing deposits and having to pay more for funding could significantly reduce earnings and lead to more conservative capital allocation decisions.
Most regional banks looked stable to us (outside of about a dozen that we highlighted here) but losing deposits and having to pay more for funding could significantly reduce earnings and lead to more conservative capital allocation decisions.
President Biden has also urged regulators to increase their supervision of large regional banks. Even if a bank’s deposits remain stable, the large unrealized bond losses on its balance sheet could potentially create a need to raise capital, depending on any regulations that emerge. We will keep monitoring these risks and provide updates as needed.
Our model portfolios have little direct exposure to these concerns. This is not a reflection of our skill in predicting the future (we have no idea where the economy will head) but the basic investment philosophy we follow: buy and hold high-quality dividend growth stocks that fit comfortably inside our limited circle of competence.
We do not own any bank stocks because their opaque balance sheets have historically led us to shy away from this complex industry. We prefer to own companies with simpler business drivers that are more within their control.
Similarly, our conservative bent has always made us prioritize owning firms with strong balance sheets. Around 70% of our Top 20 and Conservative Retirees portfolios are invested in businesses with at least A- credit ratings (or net cash positions).
This defensive positioning and underweight exposure to cyclical areas (financials, energy) helped our Top 20 and Conservative Retirees portfolios outperform their dividend ETF benchmarks (SCHD and SPHD) in March by 3.2% and 5.1%, respectively.
This defensive positioning and underweight exposure to cyclical areas (financials, energy) helped our Top 20 and Conservative Retirees portfolios outperform their dividend ETF benchmarks (SCHD and SPHD) in March by 3.2% and 5.1%, respectively.
Our strategy is not exciting, but it is reliable and requires minimal trading activity. Banking jitters, recession chatter, and credit crunch concerns have not changed our perspective on any of our holdings. As usual, we plan to stay the course.
Other companies may not be as fortunate if conditions tighten further. Businesses may become more protective of their credit ratings, especially if they are teetering on the brink of junk status.
With much higher debt costs in play, firms may be less willing to borrow to maintain their dividends through temporary rough patches, too.
We will continue doing our best to stay on top of these issues and help Simply Safe Dividends' members keep their dividend portfolio between the guardrails.
If you are looking for tools and research to help you manage your income portfolio, you are welcome to register for our free trial to see how your dividend stocks stack up in minutes.
With much higher debt costs in play, firms may be less willing to borrow to maintain their dividends through temporary rough patches, too.
We will continue doing our best to stay on top of these issues and help Simply Safe Dividends' members keep their dividend portfolio between the guardrails.
If you are looking for tools and research to help you manage your income portfolio, you are welcome to register for our free trial to see how your dividend stocks stack up in minutes.