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Analysis by Jeff Liguori

Is Washington, D.C. broken?

The global rating agency, Fitch, certainly believes so. On Aug. 1, the company downgraded the credit of the United States one notch, from AAA to AA+. It is only the second time in history that our nation’s credit has been downgraded, the first in August 2011 by S&P. In its explanation, Fitch stated that the downgrade “reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to AA- and AAA-rated peers over the last two decades that has manifested in repeated debt-limit standoffs and last-minute resolutions.”

The move came as a surprise despite the agency hinting in May that the inability of Congress to effectively deal with the debt ceiling could lead to a downgrade. Once legislation was passed to raise the U.S. government debt limit, Fitch Ratings said the United States’ AAA credit rating would remain on negative watch. President Biden, Treasury Secretary Janet Yellen, and others in the administration have criticized the move as bizarre and arbitrary, careful to point out that the timing made no sense given the bipartisan effort to avoid a default in June.

The reaction by financial markets was somewhat mild considering the nearly unprecedented — and alarming — nature of the downgrade by Fitch. Bond prices went lower as yields continued higher, and the S&P 500 sold off about 1.3% — overall, a negative response. But 2023 has been a healthy year for investors thus far, with stocks up nearly 20% prior to the Fitch downgrade and a bond market about flat on the year, a stark contrast to 2022, when both markets were down double digits, an historical anomaly. So, what is the impact of a AA+ versus AAA rating for our government’s debt?

When S&P downgraded the U.S. government debt rating in 2011, global stock markets plunged and bonds rallied, driving interest rates lower. Typically, a downgrade in credit equates to higher — not lower — interest rates. But the uncertainty surrounding that downgrade pushed investors into safe-haven assets, namely U.S. treasuries, which illustrates that the move by S&P had no real implications for buyers of U.S. debt. It was a slap on the wrist, a consequence of massive accommodative fiscal measures intended to shore up a weak economy as the nation emerged from the greatest financial crisis since the Great Depression.

The rating agency was signaling that the U.S. had to get its fiscal house in order and Congress needed to come together to address the burgeoning debt. Like today, S&P had signaled to the Obama administration and U.S. Treasury that there was a risk of a downgrade about a month prior to the move. Stock markets lost roughly 10% of their value in the 30 days preceding the downgrade.

Fitch’s recent actions are consistent with its close competitor, S&P, in 2011. The U.S. debt, as a percent of gross domestic product (GDP), rose from 65% at the end of 2007 to 92% prior to the downgrade then. Before COVID locked down the economy, debt to GDP was just above 100%, ballooning to 135% by the middle of 2020. Currently, our debt is running at nearly 120% of GDP. And as interest rates rise, the situation worsens. (Growth in GDP can ameliorate this ratio, but the economy is not keeping pace with inflation presently.)

Similarities from the first downgrade to today are limited. Yes, the nation was emerging from crisis in 2011, the economy was flooded with stimulus spending, and Washington, D.C. was also unable to address our long-term fiscal issues. But the similarities end there.

Economically, global bond yields were falling prior to the downgrade in 2011, and central banks were still easing, dealing with the aftermath of the Great Recession. The unemployment rate was around 9%, high from a historical standpoint, but trending lower as the number of job openings were on the upswing. Debt to GDP was still under 100%, with most economists optimistic that further economic growth would remedy that dynamic. U.S. household debt had decreased about 8% and was also trending lower. The interest rate on a 30-year mortgage was about 4.5% and, again, trending lower.

Today, central bankers continue to fight persistent inflation, aggressively raising interest rates and tightening monetary conditions. The job picture remains sanguine, with the unemployment rate at 3.5%. Job openings, however, are now on the decline after sharply increasing from COVID lows. Household debt is on the rise, with total credit-card debt projected to hit $1 trillion for the first time ever. And housing affordability is at its worst level since the late 1980, according to the National Assoc. of Realtors, as the rate on a 30-year mortgage bumps up against 7%, an increase of 114% since the beginning of 2022.

There may be no economic adjustment to the rating downgrade by financial markets. Stocks have been incredibly resilient this year. The message by the Fitch agency is more about the United States having the willingness to pass legislation to deal with our debt burden, and less about the ability to pay our borrowers.

It is not an issue solely for the U.S.; after the Federal Reserve and U.S. government accounts, the largest holders of our debt are Japan, China, and the UK (in that order). The snowball effect of a default would be catastrophic. Almost every analyst and economist voicing an opinion on the downgrade, however, knows that an actual default is such a remote possibility for the largest economy in the world that it isn’t worth mentioning. And there’s no new information that brought on the downgrade.

It is a warning, nonetheless, and emblematic of our long-term political issues, which continue to hamper constructive fiscal progress.

Jeff Liguori is the co-founder and chief Investment officer of Napatree Capital, an investment boutique with offices in Longmeadow as well as Providence and Westerly, R.I.

Daily News

Analysis by Jeff Liguori

Silicon Valley Bank (SVB), a California-based lender, was taken over by the FDIC due to fears of insolvency. The process was one of the swiftest in history.

Silicon Valley Bank was a niche banking franchise founded in 1983 to fill a growing need in the financial-services marketplace. The primary customers of the bank were private equity firms and their principals. Typically, private equity firms (or venture capital, which is a subset of private equity) invest in startup companies, help those companies grow, and eventually, if successful, have those companies go public or get sold in a liquidity event. Liquidity events — or lack thereof — are a critical piece in the demise of Silicon Valley Bank.

As a banking partner to these firms, SVB routinely made loans to its portfolio companies. The bank filled a very specific need: extending credit to companies that were often in growth mode, and not profitable — a distinct customer base that generally could not get credit from traditional commercial banks. As a result, when those private companies either went public or were sold, loans were paid off, and deposits at the bank (proceeds from liquidity events) rose, which created a loyal customer base. And not only was SVB extending credit to these firms, but the bank also held the operating accounts for those growing businesses as well as accounts for its private equity firms’ investors. Balances on such accounts regularly exceeded the FDIC insured level of $250,000. SVB generally held a larger number of uninsured deposits than most banks.

From its founding in 1983 to the end of 2022, with a very narrow customer base, Silicon Valley Bank’s assets grew nearly 25,000%, and its stock price appreciated 7,000%.

What Happened?

Deposits are considered a cheap source of funds for banks. A customer deposits money into his or her account and earns a nominal amount of interest while the bank makes loans against that deposit at a higher interest rate to a borrower. The spread between the two, called the net interest margin, is a major source of revenue for a bank. Deposits are generally invested in a portfolio of bonds by the bank treasurer. Depending on the interest rate environment and the loan liabilities of its customers, a bank generally creates a bond portfolio that allows for an appropriate level of liquidity to fund loans, with minimal volatility. It is crucial to understand that bond prices are inversely correlated to bond yields: as yields rise, bond prices go lower, and vice versa.

In the case of Silicon Valley Bank, the overall level of the bank’s deposits has been highly correlated to IPO activity. From 2015 to 2019, on average, almost 210 companies per year went public, slightly higher than the previous five-year average. In 2020, even with the pandemic, the number of IPOs rose to 480, and in 2021, 1,035 companies went public, the highest number ever recorded in the U.S. Consequently, SVB’s deposit base grew rapidly, from $60 billion at the beginning of 2020 to a peak of almost $190 billion by the first quarter of 2022, an increase of more than 200%. For context, Bank of America’s deposits grew by about 44% in that same time frame.

Not coincidentally, deposits at Silicon Valley Bank peaked in March 2022. As the bank was flooded with deposits, those had to be invested into bonds. But here’s where it got tricky: the rapid rise in short-term interest rates by the Federal Reserve was particularly damaging to SVB’s balance sheet. When banks invest deposits, there are two tranches: securities deemed ‘available for sale’ (AFS) and those ‘held to maturity’ (HTM). AFS are the most liquid and least volatile, with HTM having a longer maturity because the bank doesn’t project those securities will be needed to fund loans.

In 2022, because of weak financial markets, initial public offerings decreased sharply. There were 181 IPOs, the fewest since 2016 and an 80% decrease from 2021. Private companies shelved their exit strategies. That meant many private companies needed to take on additional debt. SVB management greatly underestimated this dynamic. To fund loans, the bank was forced to not only use AFS securities, but HTM as well, which, because of a sharp rise in rates, generated a loss and a hit to their required capital levels. It was a negative cycle, whereby bank management was caught between making decisions based on the adverse effect to its profit margin (selling securities at a loss) to actual solvency as a financial institution as the deposit base shrank — an exponential negative impact to the bank’s capital that quickly spiraled out of control.

After the stock market closed on Wednesday, March 8, Silicon Valley Bank announced an offering to sell additional shares of its own stock to raise capital. The amount targeted to be raised — $1.2 billion — was unusually large considering the market value of the entire company was about $16 billion at that time. After market hours, the price of the stock was lower, but only by about 10%. Investors did not seem terribly worried at that point. When the market opened on Thursday, the stock was already down about 30%, eventually losing 60% of its value that day, which ended up being the last day the stock would ever trade. Unbeknownst to many, the bank run by SVB’s customers had started earlier in the week.

Panic ensued for many customers who had large, uninsured balances at SVB. As one chief financial officer of a private equity firm told me, it was common for him to move substantial sums in and out of the bank. Meanwhile, his firm’s portfolio companies spent last weekend worried about whether they would make payroll in the coming weeks, among other concerns.

At some point, we will know exactly what transpired. Expect as many shareholder lawsuits and congressional hearings as there were for the fall of Lehman Brothers or Enron. But the Silicon Valley story, based on available information, does not seem to be one of corporate malfeasance. Rather, it was a timing issue. Bank management clearly did not anticipate the speed at which rates would rise or the sharp decline in deposits. That dynamic was exacerbated last week as customers heard insolvency rumors and withdrawals accelerated en masse. Interestingly, withdrawals were almost completely done online, an unforeseen consequence of a digital world. Having to wait for a bank teller to make a withdrawal is almost nonexistent, which probably would’ve helped the bank slow the run in this case.

On Sunday night, there was a joint announcement by the FDIC and Treasury that all balances would be insured. Also in that announcement was the news that another financial institution, Signature Bank, was put into receivership by the FDIC. The regulators are probably working overtime to avoid another failure.

Silicon Valley Bank — seen as critical to entrepreneurs and innovators in the economy — was unique. The irony is that past bank failures were due to poor credit decisions. SVB had a duration mismatch of assets and liabilities with a narrow customer base, all of which was adversely affected by higher interest rates and weak financial markets. Bank management should be held responsible, but the difference from a 2008 Lehman or Washington Mutual type of failure was that both those institutions held incredibly risky, or toxic, assets on their balance sheets.

Market Impact

While the issues seem clear today, almost no one anticipated the collapse of Silicon Valley Bank. Reputable analysts had maintained ‘buy’ ratings on the stock. Goldman Sachs, as recently as three weeks ago, upgraded the company with a $312 price target (it was trading around $275 at the time). The insolvency of this institution was a surprise to nearly the entire investment community.

Silicon Valley Bank was about one-fifth the size of PNC Bank, one of the largest super-regional banks, and about 1/20th the size of Bank of America. It was approximately the same size as Citizens Bank or First Republic Bank in terms of total assets prior to last week. The failure of this institution seems idiosyncratic in nature and not a huge threat to the banking system. The additional insurance measures by the federal government seem appropriate. And now, for very good reason, bank balance sheets are coming under extreme scrutiny in the wake of this historic event.

In an interesting twist, the bond market has rallied and interest rates have gone lower since last Wednesday. The collapse of a meaningful financial institution has actually helped improve the health of many bank balance sheets across the country.

Jeff Liguori is the co-founder and chief Investment officer of Napatree Capital, an investment boutique with offices in Longmeadow as well as Providence and Westerly, R.I.; (401) 437-4730.

Banking and Financial Services

Taking the Long View

By Mark Morris

Matt Landon and Jeff Liguori saw an opportunity for Napatree Capital to better serve Western Mass. out of its new location in Longmeadow.

In a co-working office space at the historic Brewer-Young mansion, Jeff Liguori and Matt Landon help people build their financial futures.

Liguori, founder and chief investment officer of Napatree Capital in Providence, R.I., relocated to Western Mass. in 2015 and began to sense increasing demand for his firm’s services in this area. In January, he hired longtime acquaintance and Western Mass. native Landon as a partner in the firm. Together, they discussed opening a local office, and on Feb. 1, Napatree Capital opened its five-person firm in the restored mansion in Longmeadow’s center.

While Napatree could have served clients here from Providence, Liguori and Landon both thought it was important to have a physical presence in Western Mass.

“It was serendipity that there was one opening left in the Brewer-Young mansion,” Landon said. “We felt this iconic and different building fit with our image, so we jumped on the opportunity to locate there.”

Liguori, who grew up in Westerly, R.I., named his firm after Napatree Point in Watch Hill.

“Our investment committee is skilled at finding temporarily undervalued, underloved, and underappreciated companies that are selling at a discount. But we feel they’ll get the recognition they deserve in the near- or medium-term horizon.”

“It’s a beautiful stretch of beach where I’ve spent many summers,” he said. “As the southwesternmost point of Rhode Island, it separates Block Island Sound from Long Island Sound, so it really splits Rhode Island from New York.”

Because he liked the symbolism of its location and the relative obscurity of the name, he sought copyrights for several variations of the Napatree name in anticipation of one day starting his own firm. “Very few people have heard of it; even many Rhode Islanders don’t know Napatree Point.”

Liguori explained that his firm specializes in two areas: working with private investors looking to reach long-term financial goals, and managing endowments for nonprofits, which he called a growing area of business.

The firm’s business philosophy starts with ‘value investments,’ which Liguori says has to do with how a stock measures up against its industry or sector. The firm has had success taking a contrarian approach by investing in companies that are currently under the radar and might be underpriced by the market.

“Our investment committee is skilled at finding temporarily undervalued, underloved, and underappreciated companies that are selling at a discount,” Landon explained. “But we feel they’ll get the recognition they deserve in the near- or medium-term horizon.”

Landon also made it clear that Napatree takes the long view toward investing. “We’re not traders; we are long-term owners of companies.”

All advisors at Napatree are fiduciaries, meaning they can only recommend investments that are in the client’s best interest. By contrast, financial advisors who are not fiduciaries are held to a much more lenient ‘suitability’ standard. For example, two index funds based on stocks listed in the Standard and Poor’s 500 may seem similar on the surface. If one fund charges high fees and the other low fees, they are technically both suitable investments. A fiduciary, however, is required to recommend the fund with the lower fee because it is better for the client. Landon pointed out that he enjoys sticking with a fiduciary approach.

“It makes doing business very simple when you operate from a fiduciary standard,” he explained. “If you do what’s in the client’s best interest all the time, it’s an easy path to follow, and everyone wins.”


Upward Projections

Liguori pointed out that growth in his business comes in two ways: investment performance and taking on new clients. When the world came to a halt last March, however, meeting with potential new clients became extremely difficult. As advisors and investors, Liguori and his colleagues listened to the concerns of panicked clients, while at the same time they continued to research and act on investment strategies.

“We are also business owners worried about our business,” Liguori said. “We saw assets evaporate, so that meant our fees went down 30%.” Digging in and working harder was a key to getting through the trying times, he added. “As the founder of the firm, and on a personal level, I couldn’t be more grateful for where we are now after what we went through last March.”

Landon added that the pandemic strengthened client relationships as communication became more important and frequent, especially for clients whose industries were hit hard by coronavirus. While there are clear challenges and roadblocks ahead, the market horizon looks further out and toward more recovery.

“We try to reinforce to our clients that better earnings and brighter days are ahead, along with being empathetic to where they are right now,” Landon said.

After a slowdown at the beginning of COVID, Napatree saw a big uptick in the fourth quarter of last year. Liguori said that set the table for projected 20% growth in 2021.

“The last 12 months have been similar to a full market cycle, something that usually takes place over a five-year time period,” he said. “Clients who were full-on panicked in the beginning and were able to stay invested are now reaping the rewards of their patience.”

He admitted that even clients who have stayed invested are still anxious about the future. Most concerns are ones that existed long before COVID-19. In addition to parents who worry about saving enough for their children’s college education, the number-one concern Landon hears involves retirement.

“About 80% to 90% of the people we talk to have not been trained in investing; they would rather be gardening or hiking. So, if we can help put them at ease and feel good about the path they are on, it’s enormously rewarding.”

“People often ask if they will have enough to retire comfortably and live with dignity,” he said, noting that, because people are living longer, financial planning for retirement now involves making sure people have money for up to three decades after they retire.

Recent findings prove the point. Data from the CDC shows the average life expectancy for everyone born in the U.S. to be 78.9 years, but when calculating life expectancy after reaching age 65, it’s a different story. According to 2018 findings from the Society of Actuaries, there’s a 50% chance that a 65-year-old male lives to age 87, and that a 65-year-old female lives to age 89. For couples at age 65, there is a 50% chance at least one of them will live to age 93, and a 25% chance one will live to 98.

Disruptive events, like pandemics, can create the kind of fear and anxiety in people that lead to bad decision making in their efforts to reach long-term savings goals such as college and retirement.

Liguori said behavioral investing, whether it’s driven by fear or greed, usually leads to dangerous outcomes. His firm looks to avoid the herd mentality that can happen during volatile markets and instead focus on the client’s long-term objectives. He noted the GameStop stock bubble as an example that may look good in the near term, but the usual outcome for a small investor in events like this is disaster. Napatree’s philosophy, Landon added, is the exact opposite of chasing bubbles.

“We want to buy compelling long-term businesses that are selling at a discount right now because we’ve researched the likelihood they will be going up, not down,” he explained, adding that, when Napatree recommends a company to a client, the firm also own it.

“When we believe in an investment, it’s where we are putting our own money as well,” he said. “We think it’s important to show that we invest in the same companies as our clients.”

Another part of Napatree’s business involves helping small and medium-sized companies manage their employee 401(k) programs. Landon said the firm works with a couple dozen businesses to make sure programs are designed well and priced fairly, and that employees feel confident about participating in the plan.

“About 80% to 90% of the people we talk to have not been trained in investing; they would rather be gardening or hiking,” he added. “So, if we can help put them at ease and feel good about the path they are on, it’s enormously rewarding.”


Bottom Line

Landon said he and his colleagues love to meet with people to dissect their financial situations, and if it leads to someone being a client, that’s even better.

“We’re excited to be here in Western Mass. to expand the Napatree footprint,” he told BusinessWest. “We look forward to helping a lot of people and doing good things in the community.”

Daily News

LONGMEADOW — Jeff Liguori, co-founder and chief investment officer at Napatree Capital, announced the addition of Matt Landon as a partner.

With more than 26 years of broad investment experience, Landon began his investment career at MassMutual Financial Group, rising to the role of managing director after a series of promotions. He was later recruited to senior positions at investment-industry leaders Fidelity Investments and T. Rowe Price. He also founded Intelligent Portfolio Services, an early mover in the robo advisor space. Most recently, he held senior advisor roles at Commonwealth Financial Network and LPL Financial, helping families and business owners pursue their financial goals.

Landon has earned a reputation as a skilled investment practitioner and trusted advisor to his clients. As a dedicated student of the financial markets and lifelong learner, he has been awarded the prestigious chartered financial analyst (CFA) designation.

Locally, he serves as a trustee at Veritas Prep Charter School and is a member of its finance and investment committees. As a lacrosse fan and enthusiast, he also serves on the board of the Longmeadow Boys’ Lacrosse Assoc. and still suits up for an occasional over-40 lacrosse game.

Napatree Capital, with flagship locations in Providence and Westerly, R.I. and now at the Brewer-Young Mansion in Longmeadow, is an independent, client-centric investment-management boutique with a depth of experience in wealth advisory and investing.