With $212 billion in assets, as recently as Wednesday March 8th, Silicon Valley Bank (SVB) became the biggest bank failure since the 2008 global financial crisis when it was placed into receivership with the Federal Deposit Insurance Corporation (FDIC) on Friday.
SVB's problems began with the investment boom that followed the start of the coronavirus pandemic. As the go-to bank for California venture capitalists and start-ups, it was flooded with billions of deposits from young companies overloaded with investor cash. 2020 and 2021 saw $130 billion in new deposits that SVB could not adequately lend out. Instead, SVB invested much of the excess money in long-term US government-backed bonds. Thanks to the credit worthiness of the US government, the bonds had no "real" credit risk. Also, because of the near 0% interest rate SVB paid to depositors, the spread between the US bond interest earned and the bank account interest paid to customers produced a nice profit. (1)
The financial strategy appeared to be quite logical for the market at the time.
However, this balance sheet structure could only work while rates remained low. As the Federal Reserve battled inflation and steadily increased rates throughout 2022 – well beyond the pace that any of the so-called experts anticipated – the value of SVB's bond holdings declined (bond prices fall as yields rise) while demand for interest paid on deposits increased. A profit squeeze was looming.
SVB's client base was unique and their deposits were unusually sensitive to interest rates. A recent report from RBC Capital Markets ranked the 100 largest US banks in terms of various balance-sheet characteristics. SVB was 99th in the proportion of its deposits that were under $250,000, at less than 3%. (2)
The number of large accounts is important because large business depositors, such as SVB's, demand more interest on their deposits as soon as they see rates rise. Small retail depositors typically don't bother. This unique business mix resulted in immediate pressure on SVB's margins.
The bank planned to solve the problem by selling some long-term bonds at a loss (one recent $21 billion block of US treasury sales amounted to $1.8 billion in losses) and reinvesting the proceeds in shorter maturities at higher yields. The losses on these bond swaps would be repaired with new equity or new investors (SVB had outlined a plan to raise $2.25 billion of capital from private investors to shore up its finances). (3)
Unfortunately, depositors got wind of the plan and, as encouraged by their venture capital advisers such as Founders Fund, Coatue Management, Union Square Ventures and Founder Collective, did not wait to see if the plan would work. Depositors rushed to pull their money — to the tune of $42 billion in just 24 hours – and a run on the bank was underway.
Immediately after SVB's collapse into FDIC receivership on Friday, the Fed, the Treasury, the FDIC and the White House jointly announced a multi-billion dollar guarantee for all deposits held at SVB, in order to prevent SVB's collapse from causing any further instability to the U.S. banking system. Additionally, the Federal Reserve announced the establishment of a "Bank Term Funding Program" (BTFP) that will allow U.S. banks to borrow billions, at favorable market terms, if the loans are backed by Treasury bonds, high-quality agency debt or mortgage-backed securities, (4)
rather than selling them at a loss on the open market as SVB was forced to do.
The risk of wide-spread contagion within the banking system appears to be contained (although Signature Bank also collapsed into FDIC receivership over the weekend). Other banks' portfolios of long-term government bonds may be a drag on margins for years to come. That was largely understood by analysts and investors before SVB fell apart. After SVB's demise, depositors, their confidence shaken or their attention awakened, will likely begin to demand more interest on their deposits, squeezing banks' margins across the sector. But this is a profitability problem, rather than a threat to solvency in the style of the 2008 crisis.
The swift action by the U.S. government to inject capital into the failed banks to cover uninsured deposits may have restored enough confidence in the banking system to prevent further flight from other, more stable, institutions. Still, publicly traded bank stocks suffered over the past five trading days with the Dow Jones US Bank Index shedding nearly 18%.
At WT Wealth Management, we believe it is crucial to understand precisely what transpired in SVB's case, rather than equating their failure with the bad lending, inadequate capital and hidden interdependencies that was endemic during the financial crisis in 2008.
Our message to you: we do not view this as a systemic bank failure. Even where there was an isolated failure (in SVB's case), the government took decisive action to make depositors whole. From an investment perspective, panic creates disequilibrium and the WTWM Investment Committee is closely watching the developments in the banking sector for potential opportunities to take advantage of discounted stock prices on banks with solid balance sheets.
As always, your advisor stands available and well-informed to answer your questions and provide necessary guidance. Please reach out if you have questions.
- SVB's collapse is not a harbinger of another 2008
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- $42 billion in one day: SVB bank run biggest in more than a decade
- Fed Steps-In With Massive Bank Lending Plan To Stem Contagion From SVB Collapse