Breaking Down SVB
What the Hell Just Happened?
By now you’re aware that a number of banks have been taken over by the federal government following a run on those banks when depositors began to fret that their deposits were no longer safe.
Silicon Valley Bank is the largest bank to have failed since 2008, and it is the second largest bank failure in the US ever. The speed with which its shares plummeted and its insolvency became apparent was stunning, and even while it searched for a suitable buyer the government stepped in to ensure an orderly liquidation and quell the panic.
Two other banks have also collapsed, and given the Federal Reserve Bank’s precipitous rate hike schedule last year, more will likely follow.
Is the risk of contagion to the entirety of the banking system possible? Absolutely.
Am I panicking and pulling my cash from the bank and investments from the market? No way.
I will share with you why I’m not deeply concerned about a systemic risk here, but first let’s take a look at how it happened.
How Did It Happen?
2022 was a terrible year for bonds.
With a trough of around 16% in losses at its worst and given the bond indexes’ 2022 approximate losses of 13%, last year was one of the worst years on record for bond performance.
When a bond is issued at a fixed interest rate, say 4% for 30 years, and it is purchased directly from the issuer, traditionally for $1,000 a bond, the interest rate is guaranteed by the company or governmental entity issuing the bond.
Assuming that the issuing entity remains solvent, you are guaranteed to receive what you paid for the bond when it finally matures (in this instance $1,000 in 30 years). What isn’t guaranteed is whether or not you will be able to sell the bond for $1,000 to someone else before it matures.
Now imagine that the Federal Reserve decides to hike rates from near zero to 4.75% in one year. A company that issued a bond for 4% prior to the rate hikes will need to issue new 30 year bonds at a much higher rate, say 6%, only one year later.
If you want to sell the bond you purchased 12 months ago for $1,000, you will likely not find a buyer willing to pay you that. You might be able to unload it for $870, if you really needed to sell it, but selling at that kind of loss might not be preferable to just holding it to maturity. That bond should still mature at $1,000 in 29 years, so why rush?
This turns out to have been a weak spot for Silicon Valley Bank, and it was one of the reasons that the bank was unable to remain solvent.
Why Did It Happen?
Silicon Valley Bank presented a unique set of risks to investors and depositors that aren’t shared across much of the banking sector.
Primarily, SVB’s geographic location made it the institution of choice for venture capital firms and technology companies to park cash for payroll or other operational needs after they had received funding from investors.
This led to a hyperfocus in one sector- a considerable risk- and it also led to many savers placing far larger deposits with the bank than the FDIC insured $250,000.
Now consider the fact that banks are tasked with balancing, per banking regulations, lending against assets held at the bank.
When bonds are priced in the markets as if they are going to be sold at any minute, they represent considerable losses in value on paper that are only realized when sold.
If depositors suddenly decide to take their money out of the bank en masse, that money needs to come from somewhere. Although banking regulations are much stronger today than they were in 2008/2009 precisely because of this systemic risk, if a panic cannot be quelled and the bank is required to sell assets, they end up selling their bond holdings at a considerable loss.
Add to all of this the fact that the venture capital community is a tight knit one, and when a VC firm suggests that its partner companies would do well to liquidate their deposits in a bank those companies tend to comply. And this is exactly what happened. They literally communicated to their partner firms to take their money out of the bank, causing the panic that lead to SVB’s failure.
Why Not a Contagion?
One fundamental reason that SVB’s failure shouldn’t become another contagion to the financial system, a la 2008, is the fact that banking regulations have become more strict requiring far greater capitalization since then. Big banks are much healthier, on the whole, than they had been back then.
Additionally, the FDIC has now agreed to cover all deposits at SVB, even those above the $250,000 maximum previously insured. This should help to stave off some panicked liquidations at other banks.
Further, the government has set up a $25 billion fund to support banks should depositors request considerable distributions. Rather than selling off bonds at huge losses to meet their deposit liquidation requests, as in the case of SVB, banks can request a short term loan from this new fund to cover the requests. This measure will give banks quite a bit of time to raise additional funds and, again, to reduce the risk of a panicked run on another bank.
Now to You
Here at CWA, we work hard to ensure that we are investing in a diversified way for you. This means that we avoid undue concentration in any security from any one company or sector.
By continuing to remain calm and educate ourselves on the fast-moving world of finance and economics, we do our best to keep your portfolio stabilized and in the right risk category for you.
If you are concerned about the economy or the markets, don’t hesitate to reach out.
All the best,
Lena Rizkallah
These are the opinions of Lena Rizkallah and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Information gathered from CNBC, Yahoo Finance, Axios, and The New York Times.
Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker/dealer, member FINRA/SIPC. Advisory services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Conte Wealth Advisors, Any of the above mentioned companies and Cambridge are not affiliated.
Original post written by Tony Conte, CWA