By: John V. Boardman, III
Friday morning started on a positive note. Markets rejoiced with a favorable labor report showing wage inflation falling below expectations signaling that the Federal Reserve’s efforts to contain inflation may be working. However, the New York Stock Exchange, before the market opened, announced that trading on Silicon Valley Bank (“SVB”) had been halted. Two days prior to this halting, SVB had announced that it needed to raise capital due to losses they experienced on bond sales to meet depositor demands. By Friday afternoon, the bank had shuttered, the bank had failed, and it was taken over by the FDIC.
Not known to many outside of Silicon Valley and the tech industry, SVB is/was the 15th largest bank in the US with over $195 Billion in deposits. This failure ranks as the second largest in US history, only second to Washington Mutual, which failed during the Great Financial Crisis. SVB is not categorized as a “Too Big to Fail” institution (this title is largely reserved for JP Morgan, Wells Fargo, Citi, and Bank of America), so why is there such concern over this one institution?
- SVB is the primary bank used by the venture capital industry with a very high and unique concentration in the technology industry. Interestingly, it is not a bank commonly used by Big Tech, but it is used by thousands of small tech and start-up firms. The FDIC protects deposits up to $250,000. Although many individuals custody their personal cash with SVB, the vast majority of account holders were businesses that utilize this cash for business operations, including employee payroll. It is estimated that 85% of SVB’s deposits were above the $250k account limit leaving over $150 Billion in potentially lost deposits.
- There is a lot of blame to go around for this collapse, but the failure comes down to a very simple issue, one of which is very likely shared among many other banks. Over the last several weeks and months, SVB saw substantial withdrawals from deposit accounts. Some of this is due to their concentration in start-up technology, where venture capital investment inflow has slowed, and cash burn outflow has continued. In addition, many venture capital firms advised their portfolio companies (out of an abundance of caution) to move their accounts to one of the larger US banks. This created a run on the bank (think It’s a Wonderful Life).
- If we break down how a bank works, it is easy to see why this is a problem. With $195 Billion in deposits, SVB does not keep all of this readily available to depositors. In fact, banks are only required to keep 10% of their deposit fully liquid for withdrawals. Although this number sounds low, it has traditionally not been an issue for banks to sell securities (typically US treasuries) to create liquidity if additional withdrawal demand exists. However, in the case of SVB, they held a large amount of Treasury Bonds with maturities approaching ten years. As the Federal Reserve has increased interest rates (as mentioned to battle inflation), this creates a meaningful negative impact on the value of those bonds. SVB announced it has sold $21 Billion on bonds, creating a $1.8 Billion loss to the bank and forcing the bank to seek additional capital to stay open. Their attempt failed and the FDIC took over the bank.
Below, I want to describe three scenarios that could have or may play out, highlighting the most ideal and investor ramifications for each.
Scenario #1: The bank is closed and uninsured deposits are lost.
If you spend any time on Twitter, there are a few uninformed opinions who favored this option. A pure failure with this level of lost deposits would create an issue for thousands of employers and employees in arguably the most critical innovative sector in our country and perhaps the world. As painful as this option would be for depositors, the contagion created would likely be far more impactful. If any bank outside of the top four is considered vulnerable to this issue, we would likely see a massive wave of deposits move to these already behemoth institutions, potentially placing devastating pressure on regional and community banks. This scenario is, in our opinion, the worst option by far.
Scenario #2: The Fed, the US Government, and/or the State of California bail out the bank.
A bailout could come in a number of forms, but some thought this would most likely resemble the TARP (Troubled Asset Repurchase Program) program from the Great Financial Crisis, where the Fed purchased assets from banks that could otherwise not be sold for a reasonable value. Interestingly, it is estimated that this program created a $15 Billion net profit for US taxpayers after the dust settled from the 2009 crisis. There are a couple of primary issues and hurdles with this path: 1) it very likely does not stave off contagion as described in Scenario #1, and 2) the Fed and Treasury have made it clear that bailouts are not on the table for bank failures (outside of the big 4). Doing so would be politically unpopular, as all governing bodies have reiterated that bailouts are not an option they want to present as a backstop to poor business and balance sheet management.
The other bailout form is one where the FDIC and Treasury provide a backstop to the failing bank to assure depositors that their accounts are fully protected. On Sunday afternoon, this is essentially what the Treasury, Fed, and FDIC announced. The basic provisions of the two backstops created are 1) SVB depositors are protected above the $250k limit and 2) the Fed announced a new program called the Bank Term Funding Program that will offer loans up to one year while allowing said banks to pledge bond holdings at par value (avoiding the issue created within SVB when they had to sell depreciated Treasury assets).\
Scenario #3: The FDIC auctions off the bank to a larger suitor and uses proceeds to make depositors whole.
As I started writing this on Sunday afternoon, the auction was occurring. As of this morning, HSBC, Europe’s largest bank, has agreed to buy the UK interest in SVB for the grand total of one pound! It is unclear who and how many potential suitors are interested in the US portion of the bank, but an eventual buyer appears to be the most likely and desirable scenario. In this situation, shareholders of SVB are likely to take a full loss. Although this scenario is likely to fully avoid contagion risk, it would show depositors that the FDIC has a formidable and efficient process to work through this scenario. The FDIC typically closes a bank on a Friday to deal with, and ideally sell, the bank to a new owner prior to the start of business Monday.
There will be a lot of posturing on this issue over the coming days. It is important that we all understand that the assets of SVB are largely sound (very dissimilar to the bank issues during the financial crisis). This situation vividly highlights how much faith we all have in the banking system, and I would not be surprised if we see some additional type of reform to the FDIC in the wake of this issue. Some pundits have suggested higher FDIC limits (as we moved from $100k to $250k during the financial crisis) or perhaps higher limits for business account holders with additional restrictions for banks on how the funds can be invested.
Advice for Depositors:
- If you have more than $250,000 in a bank, you should consider speaking with your banker about programs the bank has that can provide additional coverage. This can include CDARS, which is a program many banks utilize to allow their large depositors to access FDIC coverage from multiple banks.
- As treasury rates have increased on short-term bonds, you may also want to consider holding cash in US treasury bonds backed by the full faith and credit of the US government. This does require some commitment of time but may provide some additional yield on your cash.
- Don’t Panic! The run on the bank at SVB will likely be titled as the first “Twitter-inspired” bank run. As rumors spread over SVB’s stability, countless firms and individuals wired money from the bank with some estimates approaching $40+ Billion in the last two days of last week. It is entirely unclear how the FDIC, Fed, and Treasury will look to avoid this in the future, but it is very clear that they do not want to motivate behavior such as people running away with deposits from community and regional banks.
- Talk to us. We strive to be problem solvers in our client’s lives, and we are here to give you objective advice when you need it.
- 1 https://www.wsj.com/articles/the-silicon-valley-bank-bailout-chorus-yellen-treasury-fed-fdic-deposit-limit-dodd-frank-run-cc80761e?mod=hp_opin_pos_2
- 2 https://www.investopedia.com/terms/t/troubled-asset-relief-program-tarp.asp#:~:text=The%20Troubled%20Asset%20Relief%20Program%20(TARP)%20was%20instituted%20by%20the,recouped%20%24441.7%20billion%20in%20return.
- 3 https://www.cnbc.com/2023/03/13/hsbc-buys-silicon-valley-bank-uk-protecting-deposits-.html
- 4 https://www.bloomberg.com/news/articles/2023-03-09/svb-ceo-becker-asks-silicon-valley-bank-clients-to-stay-calm