Silicon Valley Bank and the Most Recent Banking Crisis

Every few years there seems to be a new market crisis. We had the real estate meltdown of 2008-2009, the coronavirus pandemic, and now the Silicon Valley Bank collapse. Each situation had a different catalyst and required a new approach from the government. During times like this it’s normal to wonder what went wrong and how you as an investor can avoid these situations. For now, we want to share a bit about Silicon Valley Bank (SVB) and what happened over the past week, as well as our thoughts on the implications going forward. 

Silicon Valley Bank: Background

Silicon Valley Bank was a California-based bank known for its high tech and tech startup client base. Between 2019 and 2021, deposits tripled, loan losses were low, and there was an influx of deposits from venture capitalists. This is not a story of loans going bad like they did in the 2008-2009 recession. So, how could this seemingly stable bank go bankrupt in a matter of days?

In all cases, the same issue remains: banks are highly leveraged entities by design. Banks typically have $10 of assets for every $1 of equity. Consequently, it only takes 10% of asset losses to wipe out 100% of the equity of a bank.

When banks accept deposits from clients, those are liabilities to the bank because they must return the deposits at some future date, which comes at a cost. That cost includes interest expense, the costs of managing the deposits through branches, clearing checks, and other services.

To pay for those liabilities, the banks use deposits to earn money in the form of business and consumer loans. The banks then charge interest and fees to cover operating costs and generate profits from these loans. If they have more deposits than loans they want to make, banks often store the excess cash in U.S. Treasuries, agency notes, or mortgage-backed securities (MBS).

SVB brought in huge amounts of deposits in the last few years, and much of that cash came from the Venture Capital (VC) ecosystem. Instead of making loans to less credit-worthy borrowers, the bank used the excess cash to buy long-term U.S. Treasuries.

What Went Wrong: Culminating in Collapse

When venture capital funding started drying up early last year, companies increasingly pulled from their deposits to fund operating expenses. At the same time, the Fed was raising interest rates quickly and aggressively, which caused bond prices to drop. Most hard hit were the longer-term bonds, the majority of SVP’s bond portfolio. While clients were increasing cash withdrawals to cover expenses, the bank had to sell long-term bonds at a loss to cover the cash requirements.

Simultaneously, the bank’s costs were rapidly climbing, as interest expense on those deposits dramatically rose from $60 million in 2020 to $862 million in 2022.

Once the losses on the bond portfolio and SVB's unsuccessful efforts to raise new capital became public, a flood of withdrawal requests created a run on the bank. Within 48 hours, $42 billion of deposits had been withdrawn, and the bank collapsed.

Implications and Impact: Now What?

Was the response a bail-out, or not a bail-out? The Fed is effectively providing a bail-out for the depositors, but not the investors. The stockholders of SVB will lose their full investment. The depositors, who are considered innocent bystanders, have their full deposit balances restored, even above the official FDIC insurance limit of $250,000. 

As one outcome of this, the future of the $250,000 FDIC limit will likely become an open question. Why have a limit if we aren’t going to honor it in moments like this? On the flip side, if all SVB client companies lost their deposits, many would immediately go out of business and there would be resulting job losses and community economic costs that nobody wants to confront. 

As each economic or banking crisis is reviewed, often new regulations are proposed to prevent banks from making similar mistakes in the future. This situation is somewhat unique due to the nature of SVB's venture capital focus, the VC climate, and the bank's investment decisions, so most banks do not have the same risk factors.

For now, the hope is that U.S. government backstopping deposits will alleviate any contagion effect and give banks a chance to reassess their bond portfolios or shore up any equity shortfalls.

What does this event mean for the average investor? First, it's a reminder that only $250,000 of cash in the bank is FDIC-insured. If you have cash in excess of that amount in the bank, please get in touch and we can discuss your options and provide a recommendation. In regards to investment portfolios, it means ensuring your investments are liquid and properly diversified, which is always the case with how we invest. We also rely heavily on U.S. Treasuries for the bond allocations in our portfolios, which saw significant increases in price over the past week due to a "flight" to safe investments. Overall, our investment strategy takes into account that market disruptions and shocks will and do happen, and portfolios are performing and responding to this event as designed and expected.