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Reflections on the Collapse of Silicon Valley Bank Thumbnail

Reflections on the Collapse of Silicon Valley Bank

Dear friends and clients,

You’ve probably been reading about the collapse last week of Silicon Valley Bank (SVB) in California. As a result of SVB’s demise, the stock market fell sharply on Friday, with bank stocks losing more in one day than at any time since the financial crisis of 2008. Two other institutions–Silvergate Bank and Signature Bank–were caught up in their own meltdowns.

Hopefully, the following commentary will answer questions that may have come up for you, and give you a sense of where things stand now. 

A Decisive Response from Regulators

Regulators acted quickly to quell fears that spreading panic could cause other bank failures following the closure of SVB. Sunday evening the Fed, Treasury, and FDIC issued a joint statement guaranteeing that depositors at both SVB and Signature will get all their money back (including those with unsecured deposits above the FDIC insurance limit of $250,000.) This is possible under rules that allow the government to rescue depositors at systemically critical institutions whose insolvency puts the whole banking system at risk. Depositors at the much smaller Silvergate are not so lucky.

The Fed also announced an emergency lending facility to shore up US banks. The “Bank Term Funding Program” will offer loans of up to a year to any qualified lender who pledges US government bonds and mortgage-backed securities as collateral, while valuing those bonds at their original price. This eliminates the need for banks to sell their portfolios at a loss to meet withdrawals. Additional steps were announced to increase liquidity in the banking system.

These actions should a) limit the economic impact among depositors at the two closed banks, which, in the case of SVB, represented a large percentage of US startup companies, and b) reassure investors that other banks will not be forced to close.

Sunday night, US stock futures were already rising ahead of the market opening as investors absorbed the news of Federal support and revised their expectations upward.

How did SVB get into such trouble and how did things unravel so fast?

A Niche Market Banker

Silicon Valley Bank was a key lender to the startup industry, providing banking services to half of all venture capital-backed tech and life science companies in the US, as well as many of the entrepreneurs, executives, and investors in these companies. At the time of its collapse, it had $209 billion in assets.

The cause of its insolvency was a classic case of poor risk management. SVB broke the cardinal banking rule of having an appropriate mix of short and long term investments to balance out its obligations to depositors. Its rapid collapse stunned the venture capital and startup communities, as well as investors who began questioning whether similar missteps might affect other institutions. For all the speed of its downfall, the seeds of SVB’s implosion were planted over two years ago.

Money Floods In

In 2021, at the height of the investment boom in private tech companies, SVB received a wave of cash from startups. Deposits surged from $102 billion to $189 billion in a year. The bank added this money to its portfolio of government-backed bonds, but it did so at a time of historically low interest rates. To eke out a fractionally higher yield, it locked up over $91 billion of its total $120 billion portfolio in government agency mortgage-backed securities with maturities of over ten years. Despite committing its funds for such a long period of time, it received an interest rate of only 1.6% on these investments.

The Tide Goes Out

In 2022, as consumer prices soared over 9%, the Fed began an aggressive campaign of interest rate hikes to quash inflation. The bond market experienced its worst year in history. Long-maturity, low-interest bonds like those purchased by SVB, were amongst the hardest hit.

The value of the bank’s portfolio fell by $15 billion. 

Simultaneously, high interest rates and an uncertain economic environment were causing venture capital funding to startup companies to dwindle. Without this source of cash, companies began withdrawing their deposits at SVB to fund operations. Deposits fell for four straight quarters, dropping even faster than expected in February and March of 2023.

To meet these withdrawals, and to improve its profitability, management decided to liquidate most of its $20 billion investments in shorter maturity bonds, and invest the proceeds in newer bonds that, because of the general rise in interest rates, yielded three to four times as much as the securities being sold.

The sale, however, meant taking an almost $2 billion loss on the bonds. To make up for this, SVB announced a $2.35 billion public stock offering led by Goldman Sachs.

What was intended to reassure had the opposite effect. Investors, surprised by the announcement, took it as a signal the bank was making a desperate effort to raise cash.

Worried depositors in the closely-knit community of startup entrepreneurs and funds began pulling out their money, especially large, uninsured deposits. 

Meanwhile, investors for the public offering proved hard to find. SVB’s stock market valuation continued its downward spiral. The industry’s most respected bond ratings provider downgraded the bank’s credit rating from investment grade to junk. To meet withdrawals, the bank was forced to liquidate its entire portfolio (including its long-dated bonds intended to be held to maturity) at a $15 billion loss, wiping out most of the bank’s capital. Customer withdrawals snowballed into a full-blown run on the bank. In one day last week, $42 billion was wired out, representing ¼ of SVB’s total deposits. 

With the bank unable to meet further requests, regulators stepped in and on Friday declared the bank insolvent and under state control. Efforts, thus far unsuccessful, began over the weekend to find a larger buyer willing to rescue the stricken institution. None of the major US banks have yet stepped up.

During the same week, Silvergate Bank in San Diego and Signature Bank in New York, institutions that had in the past few years evolved into major lenders to the beleaguered crypto industry, both faced a similar crisis of confidence, with depositors fleeing and their stock prices plunging. On Wednesday, Silvergate announced its voluntary closure and on Sunday, the New York State bank regulator took control of Signature.

Implications for Your Portfolio

The rapid steps taken by the Federal Reserve, Treasury, and FDIC should help to reassure investors about risks to the broader financial system. Longer term, questions are likely to center on whether the deregulation of small and regional banks enacted by Congress in 2018 removed institutions like SVB and Signature from regulatory scrutiny that might have strengthened their risk management practices.

SVB’s situation was unusual–in that it was the dominant lender to a niche market and fell victim to a combination of market forces and poor risk controls. The same may be said of Silvergate and Signature banks. Nevertheless many financial institutions were forced to invest deposits in low-yielding securities during the pandemic as interest rates bottomed. It remains to be seen how many of these could find themselves challenged if withdrawals begin to rise.

The Fed’s “Bank Term funding Program,” announced Sunday, should go a long way towards ensuring that other banks in this position will not find themselves forced to sell bond portfolios at a loss to meet withdrawals. The Fed is now offering to exchange bonds for cash at their original face value, and not at the reduced market values caused by rising interest rates.

Market volatility is likely to be higher in the coming months as the reverberations of SVB play out, and investors’ appetite for risk could well diminish. Bank runs are unpredictable and some smaller regional banks could still be vulnerable. 

The political aspects of a broader rescue could become tricky in a divided congress, if taxpayer money is required for a bailout. 

A wider banking crisis, even if it is concentrated within smaller regional banks, could further tighten financial conditions (i.e. make it harder for businesses and consumers to borrow) and cause the current economic slowdown to deepen.

Nevertheless, we do not expect this situation to balloon into anything like the scale of the 2008 financial crisis. The banking system generally is better capitalized and stronger now, and widespread excesses such as the reckless lending practices seen in the mortgage industry prior to 2007 are hard to find. Stock markets have already fallen significantly since the peak of 2021 and investors are no longer overconfident.

Clients who have deposits in local banks may want to consider not keeping more than the FDIC insured limit of $250,000 per customer in a single institution. Larger deposits at the giant money center banks like Citi, JP Morgan Chase, Wells Fargo and Bank of America are arguably safe. These institutions face more stringent regulatory controls and in addition, they fall into the “too big to fail” category that would be rescued by the government.

LongView’s base investment case has been for the economy to slow due to higher interest rates, and inflation to fall commensurately. We expect the Fed to end its rate hikes sometime this year, followed by a recovery in the broad economy and in financial markets. With a crisis in the banking system, this timeline could be accelerated, and the likelihood of recession increases, but our fundamental outlook remains intact. 

Like any market dislocation, this one may offer opportunities to attentive investors. We are watching the situation closely and are available if you want to discuss your questions or concerns.



The information contained herein is intended to be used for educational purposes only and is not exhaustive.  Diversification and/or any strategy that may be discussed does not guarantee against investment losses but is intended to help manage risk and return.  If applicable, historical discussions and/or opinions are not predictive of future events.  The content is presented in good faith and has been drawn from sources believed to be reliable.  The content is not intended to be legal, tax, or financial advice.  Please consult a legal, tax, or financial professional for information specific to your individual situation.

This content not reviewed by FINRA. Photo by Mariia Shalabaieva on Unsplash.