The fall of major banks like Silicon Valley Bank, Signature Bank, and Credit Suisse have rightly spooked investors and raised questions about the relative health and sustainability of the banking sector as a whole. In the media, these failures have been aggregated and called a “Global Banking Crisis.” It is true that whenever a bank fails, it creates a level of uncertainty that makes depositors nervous and, on the margin, increases the probability of depositors at other banks withdrawing their funds and potentially triggering a run. However, the reasons these three banks failed are completely different and specific to the banks themselves, rather than to the industry.
WHAT HAPPENED WITH SILICON VALLEY BANK (SVB)?
SVB was a California-based bank focused on the start-up tech sector. Due to its niche, it remained widely unknown even as it grew to be the 16th-largest bank in the U.S. On March 10th, the Federal Deposit Insurance Corporation (FDIC) took control of SVB. It was the biggest bank collapse in America since the 2008 Financial Crisis. This takeover occurred on the heels of multibillion dollar losses incurred while selling bonds at a loss to raise money to cover withdrawals from depositors. The bond sales were followed by an unsuccessful bid to shore up finances by selling shares of the company. The resulting panic led to a run on the bank, culminating in the bank’s inability to return funds to depositors.
WHY DID SILICON VALLEY BANK COLLAPSE?
Investment Decisions:
A sizable portion of the bank’s customers were early-stage venture capital and private equity companies in the technology sector. As these firms are funded, they have large amounts of cash to be deposited that will be withdrawn over time. SVB deposits grew substantially over the last 5 years, with assets up 81% in 2022 versus 2021. Bank deposits can be used to fund lending, or they may be invested in financial assets. At SVB, a large portion of deposits were invested in high-quality financial assets, primarily U.S. Treasury, Agency, and MBS securities at a time when interest rates were near historic lows. As interest rates rose last year, the value of those assets declined. This decline negatively impacted all bank balance sheets, but the impact on SVB was particularly damaging. SVB had invested in higher-yield bonds with a longer maturity to fund their relatively high rates, leading to much greater losses in asset values.
The recent weakness in the technology sector led SVBs customers to pull money out faster than expected to support higher business expenses and future growth. This quickly drained the bank’s liquidity and forced them to sell their bond holdings at a loss. To make matters worse, the way that SVB classified the majority of its bond holdings meant that they had to realize a large portion of their losses at once when the bond was sold, rather than over time as the bond gradually lost value due to rising interest rates. After being forced to sell its $21B bond portfolio, resulting in a $1.75B loss, SVB announced its plan to raise capital. This announcement caused panic among their clients, and thus the run on the bank and the bank collapse.
Commercial Deposits:
To add fuel to the fire, over 90% of all deposits at SVB were commercial deposits rather than smaller and generally “stickier” retail deposits. The commercial deposits were concentrated in a small number of firms with 86% of the deposits being over $250,000. This level is important, as the FDIC insures deposits up to $250,000. Depositors with balances over $250,000 began to make withdrawals to protect their finances as confidence in the bank declined. These withdrawals contributed to the run on the bank, and untimately the bank collapse.
No single event led to the bank’s downfall. It was the confluence of these factors, along with the fact that the role of Chief Risk Officer at SVB was vacant for 8 months last year, that ultimately led to the run on the bank and the intervention by the U.S. Government.
WHAT IS NEXT?
As it stands now, the U.S. Government is investigating both the circumstances that led up to bank collapse as well as the apparent lack of sufficient oversight by regulators. In addition, the United States government has guaranteed all deposits at SVB, including those that were uninsured. Unfortunately, investors will likely receive little to no value for their shares.
The fallout from Silicon Valley Bank collapse and other banks will be felt in both the economy and in the markets for some time to come. While it is important to note that the issues were liquidity-related and not credit-related, the failure will likely increase volatility in stock prices as well as economic growth.
Author: Michael Gibb | President & CEO
Written: March 21, 2023