Silicon Valley Bank 🏦

While spring approaches, markets have grown turbulent on news of potential problems in the banking sector after the rapid closure of Silicon Valley Bank. Nearly every year, the FIDC puts a few banks into receivership. As a result of the Global Financial Crisis (2008-2009), 157 banks failed by 2011. The total assets affected during that time was roughly $600 billion. By comparison, there was $200 billion of assets in Silicon Valley Bank. 

Additionally, Silicon Valley Bank was the second largest bank failure in United States history. At the time of failure, SVB was the 16th largest bank in the US.

Silicon Valley Bank Summary

• Specialty bank that primarily focused on tech and start-up companies.
• During COVID-19, they had a huge surge of deposits from the government’s stimulus funds.
• Yields at the time were low, so they bought longer dated Treasury securities. Unlike the 2008 Great Financial Crisis, which was caused by “junk bonds” that were mis-rated as “high quality”, the SVB crisis is more about an asset vs. liability mis-match of time. The duration of the high quality treasury portfolio was simply too long, given the need of the tech sector for their funds.
  • NOTE: If investors or institutions buy and hold US Government bonds until they mature, they receive their principal back. However, if they are forced to sell during a period of rising interest rates, losses occur. 
• As the FED rates rose during 2022, the bond prices fell at the same time tech companies needed their cash back, SVB was forced to sell bonds at a loss, many customers demanded their funds and the bank became insolvent within hours.

How Did SVB Fail

• There were a number of influences that together spelled the downfall of the bank. From 2020 through 2021, Silicon Valley Bank took in incredibly high deposits through PPP loans and through clients that were taking their companies public through a Special Purpose Acquisition Vehicle (SPAC). The bank took those deposits and decided to invest in long-term bonds, such as mortgages and treasuries, while interest rates were low.
• 2022 was a very different year. Not only did Silicon Valley Bank’s unique customer base of private companies start to need cash and, as a result, pull their deposits, but interest rates also increased. This impacted the mark-to-market value of their longer-term bonds.  
• In an effort to appropriately deal with the impact of mark-to-market losses, the bank used a valid accounting change to consider those bonds “held to maturity.” (Any bonds that are held to maturity do not need to be updated with the market value but can be held on the books at cost.)
• Unfortunately, you cannot hedge interest rate risk for bonds that are in the “held to maturity” category, meaning the bank could not appropriately hedge interest rate risk for these longer-term bonds (of which they had many).
• The combination of reducing deposits, too few assets that were marked at the market (or consistent with the current market value), and growing withdrawals forced the bank to sell their held-to-maturity bonds. When they did so, they were forced to realize the losses, and those losses effectively overwhelmed the bank’s equity, causing the bank to fail.
• This all happened over the course of a week and really over two days. The stock was worth $267.90 as of the close of business Wednesday and worthless by the close of business Friday.

Did Silicon Valley Bank do anything wrong?

• This is yet to be determined. The bank did not break any rules as they are written according to current reporting, but they also did not effectively hedge their interest rate risk. Their poor risk management ultimately spelled their doom. It would have been easy enough to reduce purchases of so many long-term bonds back in 2021, but the appeal for the bank to make a little bit more money on their deposits was likely too strong. Also, how many market participants expected the Federal Reserve to raise interest rates so much so quickly? They were caught offside.

Was this a “bank run”?

• Yes, there are really three reasons why depositors pulled their money out. Some depositors wanted higher interest rates they could achieve with a money market fund (4.5% vs. 1% at many banks). Many depositors needed money because their startup businesses were not as successful due to the market environment. And importantly, when depositors realized that the bank’s tangible equity was falling, those who had more than the FDIC-insured limit of $250,000 (per account) decided to take their additional savings out to be safe.

Is this a risk for the big banks (over $250B in assets)?

• Big banks are stress-tested regularly and are required to hedge their interest rate risk. As a result, those banks are not at risk of the same problems as Silicon Valley Bank.

Impact to the market?

• No one knows how this will impact the overall market, other than introducing more volatility. Some think the Federal Reserve must stop raising interest rates immediately to stem the losses of these poorly performing long-term bonds on bank balance sheets, while others think the Fed needs to continue to raise rates to combat inflation.
• One thing is certain – bond market volatility as measured by the MOVE index is likely to be heading higher. Last year, when the MOVE index went higher, financial conditions tightened, the stock market declined, and the economy slowed. That could be the case again in 2023.
• Depositors will end up being okay, while equity holders of the banks may not.

What investor protections do you have?

• FDIC
  • For banking products, FDIC provides protections up to certain limits. Many of SVB’s clients were large tech companies that most likely exceeded the limits, but the latest news does indicate that the U.S. government will come to the rescue.
  • While the collapse of SVB may feel jarring, and large companies or venture capitalists may be impacted, most individuals will not feel the shock waves of this event. First and foremost, the vast majority of individuals and families have less than the $250,000 FDIC insurance cap deposited in traditional checking and savings accounts.
• SIPC
  • The traditional investor is also covered by Securities Investor Protection Corporation or SIPC. SIPC covers up to $500,000 in investments, with a $250,000 cash coverage limit, should anything happen to an investor’s broker.
  • It is a good time to mention that while FDIC covers banking products, it is SIPC that protects investors of securities held at clearing firms.

Other Resources

• Timeline: The Shocking Collapse of Silicon Valley Bank
• Calculate insurance coverage: Use the FDIC’s online Electronic Deposit Insurance Estimator (EDIE)
• Can the Government Contain a Banking Crisis? – WSJ

Disclaimer:

This information does not constitute an offer to sell or a solicitation of an offer to buy any securities or investment strategy and is intended for informational purposes only. Investments are subject to market risk, including the loss of principal, and the investment strategies described may not be suitable for all investors. Equities are subject to market risk meaning that stock prices, in general, may decline over short or extended periods. The information contained does not take into account any investor’s specific individual investment objectives, particular needs, or financial situation. Nothing in this material constitutes investment, legal, accounting, or tax advice, or a representation that any investment or strategy is suitable or appropriate.