Is Your Money Safe? SVB Breakdown and Lessons Learned
Pretty quiet week for the markets…
On Friday (3/10) and over the weekend, Silicon Valley Bank (SVB) and Signature Bank were declared insolvent and seized by the Federal Deposit Insurance Corp (FDIC).
These were the second and third largest bank failures in history, and the first bank failures in 2-years.
When chaos strikes, we rush to make assumptions and cast blame when in reality it takes time to understand all of the facts.
Instead, start with asking good questions. Or, refer to people who do this for a living and can explain it in layman’s terms.
Matt Levine is one of my favorite finance/business writers. He is a former lawyer and investment banker so this situation was right up his alley.
His breakdowns on the situation have been extremely helpful.
Here is a very oversimplified analysis of what happened:
Banks borrow short and lend long. The deposits that you put into a bank is a liability for said bank. When you want your money back, they need to come up with the cash. In the meantime, the bank needs to make money. They primarily do this by giving out loans to their clients or they will purchase investments, mostly bonds, to earn interest.
SVB had a concentrated clientele group - mostly tech companies and venture capitalists (VCs), who flourished over the past few years. More than half of US tech and life sciences startups banked with SVB and, collectively, they raised billions and plowed those proceeds into SVB.
When interest rates were essentially 0%, these companies were in solid financial shape and didn’t necessarily need loans from SVB. So, SVB invested billions in US Treasury Bonds and agency mortgage-backed securities (MBS) — bonds with long durations. They needed to make money, clients didn’t need loans, and Treasuries/MBS are safe!
But then we experienced the fastest interest rate hike cycle in history (Rates up, value of bonds down). The market value of SVB’s bonds declined by around $15 billion. At the same time, VCs were bleeding cash (i.e. taking their cash out of SVB to pay bills) and funding to these companies came to screeching halt. SVB needed to raise equity to meet regulations and to be able to cover the deposits that clients were taking out.
SVB made an announcement explaining what they were doing. They also mentioned in the footnotes to its financial statements (yes some people read these), that they were borderline insolvent, and people freaked out.
Depositors tried to withdraw $42 billion(!!) on Thursday. Turns out, most of the start up companies that used SVB were backed by the same VCs. They may have had thousands of customers, but most of them were backed by the same VCs. One tweet or text from Peter Thiel recommending to move your money out of SVB, and you move fast and ask questions later.
Per Matt Levine:
SVB tried to pay them. It used its cash. It sold stuff that was easy to sell. It tried to borrow from the Fed, but “despite attempts from the Bank, with the assistance of regulators, to transfer collateral from various sources, the Bank did not meet its cash letter with the Federal Reserve.”
It was declared insolvent and seized by the Federal Deposit Insurance Corp. on Friday.
What can we learn from this?
Domino Effect
The banking system, and most of finance, is built on trust. Without trust, the US dollar would be worthless, banks pointless, and the stock market wouldn’t be what it is today.
These events shook people. It made many think for the first time, “are my bank accounts safe?”
Also, customers don’t need to actually show up to a bank anymore. We can do almost anything we want from our phones or computers.
Things happen fast. As soon as contagion starts to spread, it creates a domino effect.
Concentration Risk
On Wednesday, March 8th, SVB’s stock was trading around $267/share with a valuation of just under $20 billion.
As of today, you can presume those shares are now worthless. Shareholders and most bondholders completely wiped out.
Investing in individual stocks comes with risk. We live in a capitalist society, survival of the fittest.
Nick Maggiulli put out a great blog, “Because while concentration can lead to riches, it can also lead to ruin.”
SVB was also too concentrated on venture capital funded startups. Most of the accounts were well above the $250,000 insured level and this backfired immensely.
Ask yourself, are all of your eggs in one basket?
Risk Management
It’s clear that SVB made mistakes with their risk management, specifically the interest rate sensitivity on their balance sheet.
But when there is a bank run, and most depositors want to take their money out, that can be lethal to any institution.
Now, many customers are turning to the biggest banks (i.e. JP Morgan, Bank of America, Citigroup) as they trust these are truly ‘too big to fail’.
This may cause a major shift in how we bank. Smaller community banks can be a huge resource for smaller businesses and to help those in the local community. But brand recognition is everything right now.
It will be interesting to see how all of this plays out. The good news, SVB is open and operating and customers have access to their money.
I do find it somewhat ironic that the bank collapsed, FDIC and regulators step in, and then SVB sends this to clients:
That was a quick recovery…
Disclosure: This material is for general information only and is not intended to provide specific advice or recommendations for any individual.