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First Quarter 2023 | Fixed Income Commentary

First Quarter 2023 | Fixed Income Commentary

Published on April 18th, 2023

The financial sector came under pressure in the first quarter following the failure of several U.S. banks.1 While the prices of many stocks and preferred equity issued by banks were negatively impacted as a result, at present, we do not believe the issuers of the securities held in our client portfolios exhibit the same risk factors which contributed to the recent bank failures. In our view, these factors included significant exposure to cryptocurrency deposits, concentration of deposits in too few firms or sectors, high percentage of uninsured deposits, and securities portfolios with material unrealized losses in excess of the bank’s tangible equity capital.


In simplified terms, when a bank takes in deposits, it can either make loans with those funds or invest them in fixed income securities, typically government or agency bonds. When a depositor withdraws cash from a bank, the bank can either sell a portion of its fixed income holdings or borrow from various sources to fund the withdrawal request. We believe several recent bank failures were characterized by very rapid and significant requests for withdrawals (a “run” on the bank) combined with the inability to quickly access cash to fund those withdrawals, without realizing substantial losses on banks’ securities portfolios.  


Silvergate developed the first digital currency payments network by an FDIC insured publicly traded bank in 2019.2 Companies that utilized its payments network included the major crypto currency exchanges, and the exchange’s clients kept large deposits of digital currencies at the bank. Moreover, the top ten depositor firms by market share made up roughly 50% of total deposits.3 Silvergate appeared to have been troubled with declining deposit balances ever since the failure of FTX (a cryptocurrency exchange), which filed for bankruptcy in November 2022.4 In total, $8.1B of deposits (68% of total deposits) left the bank during the fourth quarter 2022,5 and on March 8, 2023 the bank announced that a voluntary winddown of operations was “the best path forward”.6

Silicon Valley Bank

SVB was a leading bank to the technology and venture capital community in Silicon Valley whose strong relationship with these companies contributed to its substantial deposit growth over the last several years, in our view.  In recent months, however, it appears the bank’s deposits declined at a rapid pace due to the high cash burn rate of their clients combined with a lesser amount of new venture funding for startups coming into the bank as new deposits.7 As a result, the bank had to sell a portion of its securities portfolio at depressed market values and “realize” losses of $1.8 billion.8 SVB had engaged Goldman Sachs to sell additional equity to help repair the balance sheet damage incurred from the realized losses, but quickly deteriorating market conditions eliminated that possibility.8  We believe the combination of this news, along with Silvergate’s downfall just days earlier, caused many depositors to have serious concerns about the financial stability of the bank, and many of them withdrew their funds at the same time, triggering a run on the bank.

In terms of overall credit quality, SVB was very well capitalized.8 The bank’s tier 1 capital ratio was in excess of 15% (well above the required minimum), the average loan-to-value (LTV) on the mortgage portfolio was low, and loans only made up 35% of total assets.8 Moreover, although SVB was a lender to the technology and venture capital industry, its overall exposure to the riskiest elements of this ecosystem was not high.8

In hindsight, we believe what investors overlooked at SVB was the concentration of its deposit base in one industry, venture-funded technology companies, whose secular trends exposed the bank to volatile and ultimately skittish depositor flows. While this alone may not have been enough to cause the bank to fail, when coupled with the high proportion of uninsured deposits, significant unrealized losses in the securities portfolio (large enough to wipe out the bank’s tangible equity capital), and the securities portfolio comprising a substantial portion of the bank’s total assets; taken together we believe these factors contributed to the bank’s overall failure.

Credit Suisse

We believe its Swiss National Bank-brokered combination with UBS helped limit contagion. Because Credit Suisse counterparties Greensill and Archegos failed in 2021,9 U.S. banks had time to reduce their counterparty exposure to the Swiss bank, in our view. The Fed stress tests also incorporate counterparty failures and suggest to us that this potential issue will not cross the Atlantic. The failure of Credit Suisse’s AT1 securities caught some investors by surprise, and a subsequent move to redeem AT1 securities by Deutsche Bank sparked a widening in the German bank’s CDS spreads and a selloff in its equity.10 Our strategy does not hold any European bank securities. 

Portfolio Review

In the wake of these recent bank failures, we have engaged in a detailed review of all the bank-issued securities we own in client accounts for similar risks: deposit concentration in too few sectors or firms, potential deposit flight from high levels of uninsured deposits, and potential unrealized losses embedded in securities portfolios that outweigh banks’ tangible equity capital. 

At present, we do not believe the banks to which we have exposure exhibit deposit concentration that could potentially be problematic; either via over-exposure to a single sector (like SVB) or via too few depositor firms (like Silvergate’s ten largest depositors). We believe the banks in which we have invested have a more diversified and stable deposit base.

We have also re-evaluated the portion of a bank’s deposits that are above the $250,000 FDIC guaranteed level. To us, this indicates the degree to which deposits could potentially be at risk of leaving the bank. Of the 25 largest U.S. Banks, SVB had the highest ratio of uninsured deposits to total deposits, at 88%. The bank with the second highest ratio of uninsured deposits to total deposits was First Republic, at 68%, which was a contributing factor towards our decision to sell the security. At present, we do not believe the other banks in which we are invested face a similar risk of losing deposits at a rapid pace. 11

Taking the analysis further, we assessed the potential impact on each bank’s tangible equity capital if all unrealized losses in “held to maturity” categories of securities portfolios, which record securities at book values as opposed to market values, had to be realized. An analysis of banks we own shows that all except for SVB and Schwab would have sufficient tangible equity capital (a tangible common equity to assets ratio > ~3%) remaining if all securities were sold, and all unrealized losses (after-tax) were realized. 11,12,13

For SVB and Schwab, tangible common equity ratios would fall to or slightly below zero in this situation.11,12,13 While this could have been a contributing factor to SVB’s failure, we don’t believe Schwab is at risk of facing similar pressures at this time. To be in a situation where the entire securities portfolio may need to be sold, deposits would also need to rapidly decline, and access to enough liquidity would also not be available, in our view. In Schwab’s case, uninsured deposits make up less than 20% over all deposits, which to us indicates that the bank is not at high risk of facing rapid deposit decline.12,13 We also believe Schwab has access to plenty of liquidity should the need arise. As Schwab’s CEO Walt Bettinger recently stated in the WSJ, “There would be a sufficient amount of liquidity… to cover if 100% of our bank’s deposits ran off,” “Without having to sell a single security.”14 Finally, unrealized losses in securities portfolios as of quarter-end 2022 have likely improved materially as Treasury yields have declined substantially since the crisis. 15

Subsequent to the bank failures in March, the Federal Reserve created a new liquidity facility (the Bank Term Funding Program or BTFP) which aims to help banks meet the needs of their depositors and help forestall any further bank liquidity problems.16 For the next 12 months, banks will be able to pledge their government bonds and agency mortgage-backed securities (regardless of the securities’ current market values) at the Federal Reserve and receive a loan back in return at the par-value amount of the securities.16 In other words, banks would not be forced to sell securities at depressed market values in times of stress, given the opportunity to borrow more than they are worth from the Fed. Banks also have access to additional liquidity sources such as the Federal Reserve’s discount window, as well as the Federal Home Loan Bank, where other types of collateral (besides treasuries and agency MBS) can be pledged.17


While we do not foresee another bank failure impacting the portfolio at this time, we do believe bank profitability could face potential headwinds in the future. To retain customer deposits, banks may have to pay higher rates on deposits to prevent them from leaving and seeking higher returns. Banks may also reduce lending activity to hold more liquidity on hand just in case deposits were to decline. Moreover, should banks have to utilize additional sources of liquidity, they would have to pay interest on the borrowed funds to do so. Each of these factors could potentially reduce banks’ net interest margin, which is the difference between what banks earn on their assets vs. what they pay on their liabilities, and this could negatively affect their overall profitability.

Another area we are watching is the commercial real estate sector, specifically banks’ and life insurers’ loan exposure to office and retail properties. Higher interest rates and a shift to work-from-home trends that may permanently increase office vacancy levels could continue to pressure valuations of some commercial real estate. While this could have an impact on banks’ earnings or capital ratios in the future, for the US banks we own, we do not expect the impact to be material. In a stressed scenario that assumes a 21% default rate and 41% loss severity on office property loans and a 15% default rate and 42% loss severity on retail property loans, the annualized after-tax impact to banks’ capital ratios would be less than < 1%.18 For insurance companies, we believe the impact from deteriorating commercial real estate and CMBS fundamentals would also be manageable. Life Insurance companies’ commercial real estate loans are characterized by low LTV’s with long duration fixed rates and debt service coverage, on stabilized properties with very low overdue/default rates, and their CMBS exposure exists to highest rated CMBS tranches.18 In a draconian scenario that assumes office occupancy declines of 30% and default rates that reach 35%, investors in investment grade tranches of CMBS would generally be protected.18

We also continue to monitor the overall level of deposits in U.S. banks. Each week, the Federal Reserve releases reports which show the aggregate deposit levels for large and small/mid-sized banks have declined $411 billion since the first week of March.19 While this may seem like a large amount, it represents just ~2% of all U.S. banks’ deposits. Further, the largest banks may have been beneficiaries of the crisis because depositors believe they are too big to fail. The weekly Fed data shows a market share gain by the largest banks since the crisis even as total systemwide deposits have declined.19 In fact, Bloomberg reported that Bank of America collected $15 billion of deposits in the first week following the SVB and Signature failures.20 Additionally, the $30 billion rescue of First Republic by the private sector suggests the cohort of large depositor banks have more than sufficient liquidity.21 We hold many securities of this cohort whose credit may have improved in the last month.  Weekly regional Federal Reserve data also confirms that the abundance of short-term borrowings have been concentrated in the New York and San Francisco Federal Reserve Banks.22 To us, this indicates that the crisis has not spread far beyond those areas where Silvergate, Silicon Valley and Signature Banks are located.

In terms of the overall economy, we expect the Federal Reserve to rely on incoming data to determine appropriate monetary policy moving forward. On one hand, consumer spending is still growing at an annual rate in the high single digits23, the labor market is still strong22, corporate balance sheet fundamentals are solid24, supply chains are recovering and credit losses at banks are still very low, implying that the economy is still in good shape.25 On the other hand, we believe given the recent banking crisis, expectations for lending standards to tighten, and what appears to us to be a slew of recent weaker macroeconomic data that have missed expectations, the outlook for the economy and the Federal Reserve’s future actions may become more uncertain.

At present, we believe the portfolio is well positioned to withstand potential volatility from macro-economic uncertainties and any additional impacts from the crisis in the banking system. We will be scrutinizing first quarter earnings reports for uninsured deposit flows, the value of securities holdings, and any borrowings from emergency liquidity facilities. We will also be focused on the quality of CRE portfolios including delinquencies and credit reserves. We do not expect the banks we own to experience similar rapid deposit declines, and we believe the situation for any bank that needs quick access to liquidity has improved due to recent actions taken by the Federal Reserve in creating the BTFP. We continue to monitor the portfolio’s credit quality and interest rate sensitivity, as well as US banks’ deposit levels, exposure to commercial real estate and other metrics that could potentially impact any of our positions.








7 Q1-2023-Investor-Letter.FINAL-030823.pdf

8 Q1-2023-Mid-Quarter-Update-vFINAL3-030823 (1)

9 Credit Suisse, Burned By Archegos And Greensill Scandals, Shifts Focus To Wealth Management In Overhaul.pdf

10 Deutsche Bank shares slide after sudden spike in the cost of insuring against its default.pdf

11 Barclays: “State of the Industry Spring 2023” Slides

12 schwab_annual_report_2022.pdf

13 Calculations based on data from Schwab’s Consolidated Financial Statements as of 12/31/22


15 Bloomberg USGG10YR Index.docx

16 Federal Reserve Board – Federal Reserve Board announces it will make available additional funding.pdf


18 JPM_Commercial_Real_Esta_2023-03-23_4367489.pdf

19 (For the weeks ending March 08, 2023 – March 29, 2023)






25 Global Supply Chain Pressure Index_ March 2022 Update – Liberty Street Economics.pdf

As of March 31, 2023


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