Truist Wealth| Webcast:
Timely insights – depositor safeguards a positive, but staying defensive
LAURA: Good afternoon, Welcome, and thanks for joining today's session. Laura here, to give you a few friendly reminders about today's session. This call is being recorded. All are in listen only mode, and muted upon entry. Now to get started, it's my pleasure to introduce Ralph Borrello, Head of Wealth Advisors. Ralph.
OK, thank you, Laura. Welcome, everyone. I am Ralph Borrello, and I head the wealth advisor line of business for Truist Wealth. And I want to thank you for joining our call today. We've assembled a great lineup of our thought leaders to discuss the recent federal takeover of Silicon Valley Bank.
And as I'm certain all of the listeners know, this is a really important and timely topic that speaks to the current state of the economy, and also the state of the banking industry. On today's call we'll be exploring the implications of this move, and what it means for the future of the banking sector. As always, our goal is to provide insight and clarity into these economic changes for our clients, and to help all of you make sound financial decisions.
Now before we get started however, I would like to just share a couple of data points about Truist. As the seventh largest bank in the country, Truist has a very strong balance sheet, with access to significant sources of liquidity and funding. We are a very well-capitalized bank, capitalized well above regulatory standards, and we of course, have a long history of safety and soundness.
We're blessed to have a very diverse deposit base, which allows us the privilege of supporting our purpose and to inspire and build better lives and communities, which is part of our mission and vision. Now, let's get started with the call, and let me turn the call over to our co-chief investment officer, Keith Lerner. Keith.
KEITH LERNER: Thanks so much, Ralph. Hello, everyone. Thanks so much for taking time out of your day to be with us. Today on the call I'll be leading a panel, along with Adam White. He's our Senior Equity Analyst following financials, along with Chip Hughey. He's the head of fixed income. So we can talk about the interest rate volatility that we're seeing. And then of course, Ravi Ugale, who heads our capital, private capital markets, to give us some insights of what he's seeing there as well.
But before I go into Silicon Valley and the implications, I think I want to just zoom out for a moment and kind of let you know what our thinking was heading into the year, and then bring you up to now. And more importantly, what do we think going forward.
But one of our key themes heading into this year, was to remain defensive. As we came into the year, and especially after that rally in January, our point of view was that the market was baking in a lot of good news with little margin for error.
The other thing that we've been focused on, is that over the last year, this is actually the one-year anniversary when the Fed started raising rates, we've seen the most aggressive rate tightening cycle in a generation.
And our point of view, is that when you raise rates from say 0% on the federal funds rate to 4.75% in less than a year, there's going to be some consequences. There's likely to be some financial strains. The question is, where does that come from, and when? And that was unknown. But I do think what we saw with Silicon Valley, as well as Signature Bank last week, was a byproduct of this aggressive move up in rates and some of the strains.So as we move forward, I will say, and Ralph mentioned this, I want to be clear. This, in our view, though is not 2008. This is not a credit crisis where there was a lot of bad mortgage loans and a lot of bad debt. This is more what we call an asset liability mismatch. And Adam is going to talk more about that.
But it's important to know what the Fed did by guaranteeing all the deposits of these two banks and also creating a facility to backstop other deposits, was very important, and in our view, greatly reduces any type of systemic risk in the overall system. That's not to say there's not risk out there, it's just really reduced. And again, this is a lot different than what some of us experienced in 2008, again, more detail.
But as we move more forward now, so what does this mean? You know, I think first thing, it's nice to see a little bit of green today. The market's traded overall pretty orderly outside of the financial sector yesterday, so I think that's fine. We're not seeing things that are really abnormal as far as the day-to-day trading on Monday and Tuesday. So that's good.
But as we move forward, we do think what's happened here will likely weigh on the economy, and probably corporate profits. And the reason being, is before this, what we start to see is bank lending standards were starting to get tighter before this.
And you go through something like this, bank lending standards are likely to only become tighter. And why is that important? Well, credit is the lifeline of the economy. And if that slows down, that typically will weigh down on the economy. And already, we thought the economy later this year would likely slow down, just because as the weight of all these interest rates work their way through the system, think about consumers, where, you know, where credit card rates are much higher than they were, or auto loans or what we've seen in the housing.
So again, we continue to think this will likely slow down the overall economy. So our position overall is still somewhat more on defense. I also want to be clear what that means. That doesn't mean run to the hills. That doesn't mean that this is the time to be an all cash. It means that we have long-term asset allocation plans, and relative to those plans, we want to be somewhat to the left of what neutral would be.
And what that means for you specifically, is really more of a conversation for your advisor, who knows you best, your time frame, and most importantly, your risk tolerance, as well. But from a broad asset allocation view, we do, as I mentioned, think the economy will likely slow down. And we still think there's some downward pressure on corporate profits.
When we look at the overall market today, even with some of this uncertainty, markets are trading around average valuations. We would argue that if you have above average risk, that markets should be traded somewhat below average valuations for us to feel like there was more of a compelling opportunity.
We still think we're somewhat in choppy waters in more of a trading range right now. From an asset allocation perspective, what this means is, again, big picture view is, if you, let's say there was a split between stocks and bonds, like a target was like a 50/50 portfolio, we would have more of a tilt towards fixed income, somewhat of a lower tilt to equities. Again, we will still have an exposure, but just less than where we would be at other points of the cycle.
And then the other thing is, within equities, we would focus on large caps, companies that have strong balance sheets. We still like the US better than other parts of the globe. And then what Chip will talk about later on is, we're really keeping it simple with fixed income and focusing on things of high quality, and trying to stay away from things that have a lot of credit risk or leverage to the economic cycle as well.
So that's the big picture backdrop as far as how we're thinking about things. Our position really hasn't changed because of this, because already, we were already somewhat more defensively positioned heading into this. So that's big picture. Let's move into, let's go ahead and bring in Adam White into the conversation.
Adam, as I mentioned, is a senior analyst. He follows the financials for us. And Adam, when the headlines hit on Sunday night from the Federal Reserve, I think a lot of people on Monday morning thought that would have been very beneficial for some of the financial stocks. And what we saw initially, is some of these stocks were still under pressure, rebounding today. Just give us a sense of what you're seeing and what to make of the latest news.
ADAM WHITE: Thank you, Keith. You know, um, Silicon Valley really was a unique situation, and, you know, we really did expect a relief rally on Monday morning, at least a lot of people did, as this took care of the liquidity problems. But it seemed investors were kind of in a shoot now and ask questions later kind of mode.
It did feel as though that the muscle memory from the great financial crisis was awakened. You know, Silicon Valley really was unique. It was just a confluence of some events, including mismatch assets and liabilities, poor management communication, and an unexpected depositor reaction.
Almost all the banks grew deposits during the pandemic, as savings rates rose, and also stimulus. Banks invested these deposits to earn income. Most of them invest in high quality securities, like treasuries and agency-backed securities.
Interest rates were still low when all the deposits came in, and then Silicon Valley Bank reached for more yield by investing and longer dated fixed income securities. And they did it near the top of the bond market. So inflation soared, as we all know. The Fed raised interest rates, which lowered the prices of these bonds, created unrealized losses in Silicon Valley Bank's securities portfolio.
So almost all the banks have been experiencing a decrease in deposit as stimulus has worn off, and also, because investors with higher interest rates have more opportunities to earn higher interest elsewhere. And so Silicon Valley Bank had a very concentrated deposit base consisting of tech-oriented companies and venture capital.
And as interest rates rose, these deposits were drawn down faster and to a greater magnitude than most other banks. And we've all read about the tech layoff. The sector was hit particularly hard due to higher interest rates. So they were burning through cash much faster, and they also didn't have the same access to external capital.
So in order to alleviate these investor concerns about these unrealized losses, you know, Silicon Valley's management sold some of these securities. And by doing so, had to realize these losses. And this was totally voluntary. These securities were already marked down according to GAAP rules. By doing so, management planned to capital raise to increase the bank's capital ratios.
And simply, capital ratios are a measure of a bank's available capital as a percentage of the risk-weighted assets, and simply, it's just a measure of bank strength. And so everyone heard capital raise and freaked out. The stock plummeted. The capital raise could not be executed. And the firm advised their clients to take the deposits out, resulting in $42 billion of deposit outflows in one day.
And then the FDC (sic) stepped in. And as you alluded to, we thought everything was going to be OK after that. And then on Monday, banks were down big again. You know, so I think what investors were thinking yesterday, is they didn't have a good understanding of what was unique about Silicon Valley. And again, just shoot now, ask questions later.
And so, you know, what's going to happen? We do think there's going to be tighter regulation, especially in regards to liquidity, and especially for banks down the market cap spectrum. You know, it certainly seems like a lot more banks are now systemically important than previously thought.
You know, deposit insurance premiums should increase. And, uh, you know, banks are going to have to pay more to depositors to retain or grow deposits. And so I think the freak-out on Monday was these forces, these factors are going to pressure returns and earnings for banks in the long term. Now, I'll keep going.
LAURA: Keith, you're on mute.
KEITH LERNER: Sorry. Yeah, I got it, thanks. Adam, thanks so much. So I just wanted to, I just want to hit on something so everyone understands, part of what you just said with Silicon Valley, there was some things that were really unique to them. Over 90% of the depositors were uninsured. That was an outlier in the industry. And when you don't have insured, that's what caused this run.
But what the Fed has done, is with this backstop, should alleviate that concern. But the other point I think Adam, you said is true, is like, after you go through this, what you saw with the stocks, and again, they're rebounding today, is they're just, there's just some uncertainty around the future earnings stream and that being repriced.
So that process, that digestion process, will likely take time. But the health of the overall banking system still seems relatively sound. OK, well, I appreciate that, that color, Adam. Let me kind of turn it over now to Chip. Chip, the fixed income world has been extremely volatile. We're used to the stock market being volatile, but the fixed income market has been very volatile.
You know, last week it was interesting. Right before this came out, we've been advocating an overweight to fixed income. So we like bonds, high quality bonds. And we've been also saying, as bonds got close to, or the 10-year got close to 4% last week, that was an opportunity.
But what we just saw over the last couple of days, is yields moved from 4% to 3.40% on the 10-year. That's a dramatic move, before bouncing back. So just provide us some color about what you're seeing at this point, and how you're thinking about the fixed income markets today.
CHIP HUGHEY: Yeah, sure. Thanks, Keith. The yield curve, no doubt, has experienced a wild ride over the last week. I think some points for context might help. So, over the past three days, the two-year US Treasury yield dropped at the fastest rate that we've seen since the late 1980s. The two-year fell by 109 basis points in just three days. So 1.09% lower in yields.
It is worth noting that we actually are seeing yields rise here today by about 40 basis points, as well. The 10- year, which you know, highly associated with consumer lending rates, like mortgage rates, car loans, credit card rates, that fell by almost 50 basis points, half a percent. That also is rising a little bit today.
But as a result of all this, we saw the highest interest rate volatility that we have seen since 2009. So the question is, why is all of this happening in fixed income? So for one, the challenges at Silicon Valley Bank and Signature, it did fuel a global flight to quality.
And questions arose over whether or not this is the first crack exposed, and is there more to come. Those concerns pushed longer yields down as investors flocked into safe haven assets, like treasuries. Today, we are seeing cooler heads prevail a bit. We're seeing a bit of a reversal of the past few days' market trends.
But the primary reason, and Keith, you alluded to it, you know, behind our growing kind of economic concerns, our stay defensive bias, and also, our more favorable view of high quality fixed income this year, has been the aggressive tightening taken by really central banks around the world.
So secondly, and you know, this is why short-dated yields absolutely plummeted through yesterday. We saw a major recalibration in what the market expects the Fed to do with respect to rate hikes going forward. So you know, after seeing the stress emerge in the banking sector, specifically in those two banks, and also the FDIC and Fed's swift response, the market dramatically lowered its expectations for the Fed's terminal rate.
And also, conviction grew that the Fed will actually cut rates multiple times before the year is over. So this fueled one of the sharpest drops in short yields that we've seen on record. I will say, and then I'll pause, but we do think that the Fed is likely not going as high with interest rates as expected maybe even a week ago. But we still think that the idea of really swift rate cuts shortly after reaching that point, betting on that's probably a little premature.
KEITH LERNER: Yeah, it's interesting. If we had this call a week ago, Chip, last Tuesday, Chairman Powell was testifying before Congress. And the concern was about how high rates would go, would it be 25 basis points or 50 basis points they're going to raise. And now the conversation now is, are they going to do nothing or 25. Our leaning is towards 25, but there's actually a decent amount of data between now and then.
Are you are you seeing anything systemic within the fixed income market? If you think back to the 2008 crisis, I mean, you saw in your markets, the fixed income markets, really, things come undone. Are you seeing any stress points within the markets you're following?
CHIP HUGHEY: Yeah, I think that one of the key places that we would look is what are known as credit spreads. So basically, the incremental yield that is available in high yield and investment grade corporate bonds, right, relative to US treasuries.
And so we did see those spreads widen over the past, over the past three to four days, pretty dramatically. In high yield, about a percent in the increase in spread there, only about 30 basis points in investment grade corporates. But that's actually not an insignificant move.
But then you kind of zoom out and say, OK, well, how did how did these things look in previous periods of stress, or even in recessionary levels? And they're just not at those levels at this point. They're not flashing this systemic warning by any means. And in fact, we don't think that they actually are really compensating investors for the kind of economic risks that we see.
So, to your point earlier, this is a time, in our opinion, to keep fixed income simple, to take advantage of the highly productive yields in really high quality fixed income. And we do think that there will be opportunities to take advantage of these riskier areas, perhaps later this year or beyond. But for now, we would really focus on an up and quality bias.
KEITH LERNER: Yeah, great, Chip. And you just reminded me of something else. You know, I told you coming into the year on our look, one of our themes was the stay defensive, but the other one is to be tactical. And also, be open-minded.
Things are very fluid right now.
So on the team, we're going to be looking for opportunities. And in January, after the run-up, you know, when our guidance back then was that the run-up in the equity market was overdone. But I think, Chip, what you're saying right now, is for investors with cash or even with the yield volatility, we still find value in high quality fixed income. Think about government agency type of bonds, both on the short end and the longer end of the curve, where there's still opportunity even today. Is that fair?
CHIP HUGHEY: Yeah, absolutely.
KEITH LERNER: OK. Great. All right, Chip. Let's turn it over to, let's turn next to Ravi Ugale, again, head of our private capital.
Really, Ravi, the main purpose for you being on the call, I mean, I know you're tracking a lot of our managers in the private capital space. And just, what's your assessment of where things are right now on that side?
RAVI UGALE: Yeah, no, thanks, Keith, and good afternoon, everyone. So with respect to private capital strategies, our initial assessment is minimal exposure to Silicon Valley Bank developments across the private capital platform. And this is based on information gathered from communicating with approximately 25 fund managers on the platform.
It's also important to point out that as an investment philosophy, the IAG Private Capital team has stayed away from single manager venture capital funds that typically have more risk and volatility. And have instead, utilized diversified venture capital fund of funds, or the more diversified private equity funds that have minimal venture capital exposure.
And finally, I think the major concern for these private capital fund managers, and most specifically, the venture funds and their portfolio companies, was whether they had a banking relationship with SVB and the risk to those uninsured deposits that they had with SVB.
But as mentioned, given the announcement on Sunday evening by the regulators that depositors would have full access to their funds since yesterday, the risk to venture managers and their portfolio companies has decreased significantly.
KEITH LERNER: OK, great, great. Well, good deal. Let me, um, I think, let me just take a moment to summarize where we stand a little bit. First, again, big picture. Again, this is a liquidity situation. We don't think is a credit crisis. We are still a bit more defensive in our overall position, because we just think this will take time to work out, and we think, we think the trends in the economy and earnings are likely to weaken somewhat.
But I also want to say, a lot of folks are not on the line, our clients, you're not investing just for this next six months. You're investing for the next three, five, 10 years. And we still have an enormous amount of confidence, not only in the US economy, but in US corporations, as well.
So as you think about financial plans, I mean, we actually, our long-term investment returns from last year relative to this year, have gone up, because prices are lower. We just think more in a shorter period that we still have some challenges, where, where we see in our work, economy that's likely going to slow somewhat.
And from a portfolio position standpoint, we want to be reflect that. And as the data changes and as we get more information, we'll be ready to adjust. But we had a lot of questions come in. If we didn't answer your question today, please reach out to you advisor. We want to get all the questions answered. And with that, Ralph, let me turn it back to you to help close us out today.
OK, great. Thank you, Keith. Well, let me say first, let me thank Adam White, Chip Hughey, Keith Lerner, and Ravi Ugale for their analysis and comments this afternoon. And, and, and just share with our clients that our experts will continue to carefully monitor this developing situation, as well as the overall economy.
And also, let me add that I want to close by really thanking our clients for the confidence ... they've expressed in Truist Wealth. And, and we very much look forward to our continued discussions and analysis going forward. So with that, I believe we can conclude our call. Keith, is there anything final you'd like to say before we wrap up?
LAURA: You're on mute.
RALPH BORRELLO: I think you're on mute.
KEITH LERNER: OK. Yeah, I would just say, thanks, everyone, for taking time out of their day to spend with us. And as you said, Ralph, as things evolve, expect us to write more about this. And if it makes sense to do more of these calls, depending on the information that comes out. So thanks again, and we can close the call. Thank you.
Ralph Borrello: Thank you, everybody. Bye bye.