Image Credit: Andreas Prott – stock.adobe.com
Just over a month ago, on the 14th of February, Forbes magazine released an article entitled ‘America’s Best Banks’. In 20th place was Silicon Valley Bank (SVB), following 5 straight years on the list. Fast forward a few short weeks, and SVB collapsed, sending shockwaves through global markets. SVB was the 16th largest bank in the US, with total assets amounting to circa. $209 billion. Its failure is the biggest of its kind since the 2008/09 Global Financial Crisis, and the second biggest in history.
So, how does a bank go from being one of the best to bankrupt in a month? Below is an explanation:
SVB was the bank of choice for venture capitalists and tech start-ups. The bank’s business exploded during the COVID-19 pandemic, as low-interest rates prevailed, and trillions of US Dollars (‘printed’ by the Fed) were sloshing around the global financial system. Much of this cash found its way into tech stocks, causing the sector to explode. During this period, tech start-ups could access funding easily, due to cheap credit. This funding needed a home, and that’s where SVB entered the fray. SVB happily took in a lot of these deposits, and they took in a boatload. In 2019, they took in deposits of roughly $61 billion. By the end of 2021, this amount mushroomed to an eye-watering $189 billion. The question now became: How could SVB capitalise on all of this money? They decided on a strategy. And this is where it all went pear-shaped.
The management team at SVB decided that to boost company profit, they would purchase long-dated US treasuries and other securities (around $80 billion worth), as the yields were higher than short-term rates paid to depositors. In a low inflation/low-interest rate environment, this is a sound strategy. However, when it became obvious that inflation was no longer ‘transitory’, and rose sharply, the whole picture began to change.
Once the Fed realised that inflation was a much larger problem than previously anticipated, they began to raise rates rapidly. As the rates went up, so did bond yields, meaning that the prices of the bonds fell (given the inverse nature of bond prices and bond yields). So, if you’re a holder of these bonds (like SVB), you’ll see a rapid decline in the value of the bonds you’re holding. Now, it’s important to note that, even if the prices fall, you only lose money if you sell. So, any drop in value is termed an ‘unrealised loss’. If the bonds are held to maturity, you don’t lose anything.
By the end of 2022, SVB had unrealised losses of approx. $15 billion.
Because tech start-ups were struggling to get financing due to higher and higher interest rates, they were forced to start withdrawing cash from SVB to fund operations (you can probably see where this is going..). What this meant, was that SVB were forced to sell some of its bonds (at a loss) to provide liquidity and meet withdrawal orders. With start-ups being the main clients of SVB, this began to put enormous pressure on liquidity. Then, on March 8th, SVB dropped a bombshell by announcing that they would be selling their entire liquid bond portfolio, worth around $ 21 billion. Until then, their only losses were paper losses (‘unrealised’). Now, they were realised to the tune of $1.8 billion.
Another issue that exacerbated the problem was very unfortunate timing. Only a few days prior, a smaller crypto-focused bank Silvergate Capital had similar issues (underlying assets now worth a lot less than what they paid for them) and collapsed. Investors then assumed that SVP would go the same way, and a ‘bank run’ ensued. In a single day, SVP lost 60% of its share price, and withdrawals totalled around $41 billion.
On the 10th of March, SVB was shut down by the Federal Deposit Insurance Corporation (FDIC). The entire, and spectacular, crash took all of 2 days to happen…
Now, while both the FDIC and the Federal Reserve have stepped in to guarantee investors will be ‘made whole’ again, it still begs the questions: Why did this happen? Where were the checks and balances? Have we learned nothing from 2008/09?
Stewart Dando, Austen Morris Associates International: Chief Investment Officer