Many of you may have seen the headlines over the weekend regarding Silicon Valley Bank (“SVB”) and two other bank failures. We understand this can bring up memories of 2008, so we wanted to provide further insight into what occurred and how it might affect you.
To better understand SVB’s fallout, we should take a step back and understand the bank itself. SVB started in October 1987 in San Jose, California. Due to its location, it became the go-to bank for venture capital and startup firms. Fast forward to 2020 and 2021, when tech startups were all the rage and cash was plentiful due to trillions of dollars of stimulus by the government and Federal Reserve, SVB’s deposits grew from $62 million at the end of 2019 to $189 billion at the end of 2021, well above the average of the banking sector. That is a lot of money to put to work, especially in an environment of near-zero interest rates. As a result, SVB put some of the new deposits into higher-yielding, long-term government bonds and approximately $80 billion into 10-year mortgage-backed securities, which were yielding 1.5% interest versus short-term treasuries 0.25% interest. This was SVB’s first mistake by reaching for yield.
SVB’s second mistake was not foreseeing the risks involved with tighter monetary policy and the possible shrinkage of the IPO market. It seemed SVB wasn’t prepared to monitor these risks as they were without a chief risk officer for most of 2022. As interest rates increased and startup funding dried up, many of their clients’ cash needs increased and they began withdrawing their deposits. To cover those withdrawals, SVB eventually had to sell bonds they previously purchased, and this is where the risks came to fruition. To raise $21 billion from their balance sheet, SVB realized $1.8 billion of losses. These losses stemmed from the large increase in interest rates, which caused their bonds to reprice to the current market’s interest rates. As a reminder, bond prices and yields have an inverse relationship, so when bond rates of today increase, the value of yesterday’s bonds decrease. SVB then attempted to raise liquidity by offering shares of their stock and this is when their clients took notice.
To make matters worse, 95% of SVB’s deposits were not insured by the Federal Deposit Insurance Corporation (“FDIC”), meaning client accounts were well above the $250,000 FDIC insured threshold. This is an industry extreme as the FDIC states around 50% of an average bank’s deposits are FDIC-insured. Couple this with the fact that the client base was heavily concentrated in venture and startup firms, which are more sensitive to their bank’s liquidity concerns. Naturally, if the majority of deposits are not FDIC-insured, any inkling of liquidity issues would ignite withdrawals. All this unfolded last week and, by Friday, SVB was taken into receivership by the FDIC. As of today, the Treasury announced that it would guarantee all deposits at SVB, not just those up to the $250,000 FDIC-insured amount.
Needless to say, the failure of SVB spooked investors and markets. Immense doubt has been cast on banks across the country—smaller, regional banks sharing the majority of concern. Then, came worries of contagion in U.S. financial markets. To alleviate these concerns, the Fed announced a new lending facility for the nation’s banks, designed to bolster them against financials risks posed by SVB’s collapse. Although we expect further fragility in the short-term, we believe the weakness specifically in the shares of the higher-quality banking sector is overdone.