Over the weekend you may have caught news of the Silicon Valley Bank failure. Now, a couple other banks seem to be following suit. However, these aren’t your average banks, and therefore the average person has no need to panic. Here’s my take on the Silicon Valley Bank failure, and what its repercussions are (and AREN’T) for the economy.
Silicon Valley Bank – What You Should Know
Silicon Valley Bank is a 40-year-old bank that catered to the venture capital and startup firms, not retail investors.
- It was the second bank in a week to fail and the second largest in history.
- Decisions made during the pandemic of mismatching assets and liabilities was the root of the collapse.
- Ultimately, panic brought the bank down completely.
Venture capital (VC) and start-up firms were already on edge after crypto-bank, Silvergate Capital, shut down earlier in the week before there could be a run on their assets. When word spread of Silicon Valley Bank (SVC) having trouble meeting requests from depositors who wanted to withdraw cash and SVB taking a loss on their bond portfolio, panic set in and everyone wanted their deposits back from SVB that were in excess of $250,000.
SVB’s client base was small businesses and startups, so most of them had over $250,000 in their bank accounts, and this money was crucial to their business. The government-run Federal Deposit Insurance Corp gets paid by banks to insure bank accounts up to $250,000. So, each customer will get back any amount in their account up to $250,000. For more retail focused banks, this might cover 75% of accounts, but banks with venture capital firms as their client base tend to have accounts well in excess of $250,000.
During the pandemic, the government had easy money policies that led to very low interest rates and an increase in the money supply. Cash was everywhere! SVB’s assets swelled to $198 billion by March 2022 from just $74 billion at the beginning of the pandemic. Banks take in deposits and then make loans or buy bonds and other forms of debt to earn interest. Interest rates were almost 0% during the pandemic, which led to SVB making the decision to invest in longer dated bonds and mortgages, up to 30 years, to earn a little more yield. Typically, as the bonds and loans matured, SVB would get their money back along with interest and reinvest at current rates or meet demands to return deposits. However, when depositors wanted money immediately, SVB was forced to sell these bonds and mortgages at a loss. This mismatch of assets and liabilities is what brought down the bank. The assets were long dated and illiquid, while the liabilities should be readily available and completely liquid.
As the Fed raised rates this year, it caused existing bonds and mortgages that have low interest rates to fall in price. Banks should be buying very short-term Treasury bills and notes that are less interest-rate-sensitive so if they need to raise money to meet demand from depositors, they can do it without significant loss. At the end of 2022, SVB’s balance sheet was showing that more than half their assets were in longer dated instruments of 10 years or more. For 2021, SVB showed a $1 billion loss on their bond portfolio. For year end 2022, they had a $15 billion loss on their portfolio. Cracks were showing at the end of the year. Deposits started trickling out during the second half of 2022 and fell from $198 billion to $173 billion by December 2022. Then, this week SVB announced they needed to sell some of the bonds to meet demands and shore up their balance sheet. They needed to raise just over $2 billion. In order to do this, they sold all their short-term bonds at a loss.
As with any on-going financial struggles, there are changes and actions constantly happening. The US Treasury and the Federal Reserve are stepping in to help depositors as a third bank is ready to collapse. Signature Bank closed yesterday (Sunday 3/12) as they felt the pressure of their balance sheet to meet withdrawals. This is an on-going story that we will continue to monitor.
Side Effects of SVB:
- Companies will likely spread their deposits around multiple banks to minimize exposure to any one bank.
- The government and other banks will examine liquidity levels and make sure assets and liabilities match. This might mean selling assets at a loss now to lock in more liquid short-term investments.
- The Fed is going to keep raising interest rates, which makes all existing bonds fall in value and hurts the banks’ balance sheets.
- Three banks failing is nothing compared to the financial crisis of 2008-2010.
- The entire publicly traded banking sector fell during trading the past three days. This could be a great opportunity to buy bank stocks that are well capitalized and managed.
- Expect companies to get more conservative and try to dial back risk, which could then push the economy into the much anticipated economic recession.
As the old saying goes, “Don’t Fight the Fed”. SVB fought the Fed by mismatching assets and liabilities while the Fed continued to raise rates. We need to accept that the money supply is constricting and the economy is cooling. As retail investors, look to dial back risk, watch your household budget and be ready to invest for the long-term when opportunities arise.