Silicon Valley Bank: What Happened?
4min read
What happened with Silicon Valley Bank?
Silicon Valley Bank, as you might guess by the name, serves quite a few tech start-ups and Venture Capital Firms and experienced crazy growth over the last few years. According to the WSJ: "SVB ended the 1st quarter of 2020 with just over $60 billion in total deposits. That skyrocketed to just shy of $200 billion in the 1st quarter of 2022.”
Deposits on hand tripling in 2 years is not normal growth – and it's mainly due to the frothy Covid economic policies and near-zero interest rate environment. Here’s why - Venture Capital investment firms used all that easy money to their advantage, pumping funds into tech startups, many having yet to turn a profit.
As a quick reminder, a bank makes money on the spread between what it's charging folks to borrow and what it's paying on its deposits. For example - the difference between earning 6% on a mortgage and paying 2% on deposits would be called the net interest spread.
You want to squeeze out every cent you can when you have billions on your balance sheet in a low-interest rate environment (like the one two years ago). Accordingly, SVB took a big chunk of its deposits and placed them in “safe assets” such as longer-dated US Treasuries - keyword: longer-dated.
So what happens when interest rates skyrocket, all those profitless tech startups burn through cash to fund operations, and borrowing money is much more expensive? They go to their bank and make withdrawal requests to keep the lights on… well SVB needs to sell some of their treasuries on their balance sheet to cover these requests….
The problem is, as we’ve discussed in previous videos, there is an inverse relationship between rates and prices when it comes to bonds: when rates go up, prices go down. The longer dated the bond, the more drastic the relationship.
Most of the time, as a bondholder, you have a choice, you can hold the bond to maturity and get your money back, or sell it at a loss and reinvest at a higher rate.
However, SVB didn’t have a choice; they had to honor their depositor's request for withdrawal, meaning they had to sell at a loss. So, to make up for this loss, the bank announced plans to raise funds by selling additional shares to shore up its balance sheet; but when they announced this, the stock price collapsed, and they couldn’t raise the funds needed. Makes sense - who wants to buy stock in a bank when the bank’s balance sheet is upside down?
Making matters worse, with the viability of the bank in question, venture capital firms encouraged their clients to take their money out, which resulted in withdrawal requests of $42 billion on a single day, equivalent to 1/4 of its overall deposit base, effectively capsizing the bank itself.
Impact on other banks?
As the name suggests, Silicon Valley Bank serves a unique clientele. And although SVB is unique, as the 16th largest bank in the country and the biggest bank collapse since ’08, this has been causing a significant flare-up in consumer anxiety and could perpetuate the problem across the entire banking industry.
How has the government responded?
Restoring consumer confidence is priority number #1. So as a reminder: as long your cash savings at a bank are less than $250,000, or $500,000 for a joint account, you are covered by FDIC insurance in the event of a bank collapse.
On top of that, the FDIC has agreed to step in to guarantee ALL bank deposits for SVB, even those above the insurance limit. You may hear this being referred to as a bailout on the news, but it isn’t. All banks pay insurance premiums into the FDIC fund, and that’s where these funds come from.
What does this mean going forward?
As we advance, this event may set a near-term precedent for how the government will respond to additional bank failures, likely leading to additional bank regulations over time and possibly higher FDIC insurance premiums for banks. This is a small price to pay if it restores consumer faith and calms everyone’s worst fears.
On top of that, this might impact the near-term direction of interest rates. Given that the rapid increase in rates at least partially caused this collapse because the bank would’ve had to sell the bonds for such a significant loss, the anxiety seen may impact the Fed's plans for future rate hikes. Last week, a 50bips hike at the March meeting was squarely on the table, but now – not so much.
As you’ve heard me talk about before, this event illustrates the perils of short-term market forecasting. When something like this happens, it hits investor psychology hard and can move markets drastically. But the fact that the government has moved quickly and assuredly should be a sign of how they intend to deal with whatever comes next.
What about cash in a brokerage or investment account?
Cash held in a government money market fund at a brokerage firm is backed by the full faith and credit of the US government; in other words, you don’t need to worry about staying below FDIC limits unless you believe the US government is going out of business.
I hope this helps cut through every news channel's noise and fear-mongering. Please reach out if you have any specific questions.
As always - stay on point!
https://www.barnhartwealth.com/disclosures-disclaimers
Additional Reading/Watching:
A Silicon Valley Bank Postmortem
