In early March, news of financial stress for Silicon Valley Bank (SVB) gripped markets. Given the questions investors may have, we wanted to provide some comments regarding SVB.
Silicon Valley Bank is the 15th largest bank in the U.S., by deposits. Despite its size, SVB largely serves a niche market of business deposits of tech startups. This concentration would be the first instance of singularity in SVB’s business model amongst the country’s largest financial institutions. To further differentiate, SVB decided 2 decades ago to be a leader in catering to Chinese startups, when traditional banks shunned them. As China has grown to become the world’s second largest venture capital market after Silicon Valley, this has become big business (according to The Information).
So, what is going on with SVB?
SVB grabbed headlines on March 9th, as they announced significant losses related to bond holdings. This announcement resulted in an over 60% reduction in share price on March 9. Market open on March 10 brought more bleeding, eventually reaching a point of trades being halted. By noon on the 10th, largely driven by a run on deposits and an unsuccessful attempt by the bank to sell or attain capital, the Federal Deposit Insurance Corporation (FDIC) had stepped in to take over the bank. Working swiftly, the FDIC created the Deposit Insurance National Bank of Santa Clara and all the bank’s deposits have been transferred to the new bank. The WSJ has reported that, “insured depositors will have access to their funds by Monday morning,” and “depositors with funds exceeding insurance caps will get receivership certificates for their uninsured balances.” Wow, that was quick, and remarkably efficient. In addition, it was announced Sunday, March 11th that the FDIC will use funds from the Deposit Insurance Fund to ensure that all of its depositors are made whole. The
is part of the FDIC and funded by quarterly fees assessed on FDIC-insured financial institutions, as well as interest on funds invested in government bonds.
What caused this and what are the repercussions?
With the explosion of speculative financing during the pandemic, deposits with SVB skyrocketed. Venture capital firms invested in tech startups, which in turn deposited assets in SVB. SVB did not have a place to lend all those deposits, so they invested them overwhelmingly in long-term, fixed-rate, government-backed debt.
SVB’s managers made a huge mistake by not hedging its assets’ interest-rate risk. As we discussed earlier in this message, not exactly the smartest positioning. Their large deposits in longer term debt would assuredly be reduced in value as interest rates rose. On top of that, as rates rose, they could no longer take in cheap deposits from tech startups (who would have their own problems gathering capital at higher rates as well). SVB is not a systematically important bank that will, through counter-party risk, tear down the whole financial system. Instead, it’s symptomatically important, showing what happens when the Federal Reserve ignores the money supply and then claims inflation is transient when it isn’t.
Fortunately, the government has increased banking requirements significantly post Global Financial Crisis. With all its warts, Dodd-Frank regulation is likely to help reduce the overall damage of SVB’s poor fact pattern. According to the FDIC, as of December 31, 2022, Silicon Valley Bank had approximately $209.0 billion in total assets and about $175.4 billion in total deposits. At the time of closing, the FDIC reported the amount of deposits in excess of the insurance limits was undetermined. After the significant market losses on March 9 and 10, SVB’s market cap is now less than $6 Billion. However, we would hope the gap between total assets and deposits is as minimal as possible.
So, there are a few repercussions of this. Will the contagion of SVB spread to other bank stocks? As expected, there was some spread to prices of other banks in the short term. Some of the marginal losses for other large banks even exceeded the remaining market cap in SVB stock alone. Over the longer term, however, what happened to SVB is very unlikely to happen to JP Morgan (for example).
While the minimal risk always exists of a Great Depression style run on assets across banks globally, that did not occur even during the Global Financial Crisis. Most other banks do not have as high of a concentration of business deposits so their cost of borrowing is not rising as much. Likewise, most other major banks do not have as high of a percentage of exposure to fixed rate securities. For most banks higher rates are actually good news. They help the asset side more than they hurt the liability side. One Oppenheimer bank analyst summed it up well as “SVB is a liability-sensitive outlier in a generally asset-sensitive world”. Therefore, the level headed guess would be that 3 months from now this is relatively unrecognizable blip in the past 12 months for banks in the U.S. It was simply a case of a loser in a game of winners and losers.
The interest environment has changed significantly over the past year and we continue to monitor the Federal Reserve’s positioning and what implications it has on markets and your portfolio. If you have any immediate questions surrounding these events and the impact to your planning, please do not hesitate to give us a call. Thank you for your continued trust.
