Headlines flooded the news on Friday with reports of Silicon Valley Bank (SVB) failing, the largest bank to fail since the 2008 financial crisis. The impact was swift, causing a bout of volatility across the market, and has left many investors wondering what their next steps should be. While SVB is not a holding of ours, the implications of its current situation deserve attention.
In this overview, the BerganKDV Wealth Management team shares the range of factors that led to the collapse and the potential broader implications. While SVB presents a unique situation that led to its failure, the issues highlight some of the realities within the current banking system.
What Happened?
SVB Deposits fell $16 billion from the previous year according to the most recent Securities and Exchange Commission (SEC) regulatory filing, equating to roughly 8.5% of SVB’s total deposits. Funds pulled from the bank were deposits concentrated within the technology and start-up/venture capital community, SVB’s core business focus. A reeling technology sector and tighter funding conditions in the venture capital space forced such depositors to tap cash reserves at a faster pace.
Additionally, the rapid and significant increase in the federal funds rate likely had a considerable effect. Bonds, such as Treasury bills, offering high short-term yields present an attractive alternative to those offered by bank deposits and create an incentive to remove them.
These developments added fuel to the fire as depositors accelerated withdrawals, which ballooned to $42 billion on Thursday, roughly 25% of total deposits. This led to a halt in trading the stock, after a more than 60% crash on both Thursday and Friday, and ultimately to the closure of the bank and takeover by the Federal Deposit Insurance Corporation (FDIC) on Friday.
To fund such outflows and attempt to stabilize the balance sheet, SVB was forced to raise capital. SVB initially accessed short-term funds from the FHLB (Federal Home Loan Bank) but was then forced to sell assets, consisting primarily of debt securities, beyond their basic cash balance. In a rising rate environment, such securities have experienced price declines and sit on the balance sheet at unrealized losses.
The run-on deposits has forced SVB to sell the entirety (more than $20 billion) of their “available-for-sale” assets, resulting in a $1.8 billion after-tax loss. Simply put, SVB was forced to fund short-term liabilities using assets susceptible to market risk.
Should Investors Be Concerned?
These developments highlight the realities of the current banking system. To take advantage of interest rate differentials, banks satisfy capitalization requirements by using longer maturity, higher duration assets (bonds) to offset short maturity, lower duration liabilities (cash deposits). Under normal circumstances, this borrow short/lend long model functions adequately. However, this asset/liability duration mismatch can create issues in periods such as now when a rapid exit from a period of secular low-interest rates is taking place.
To assess the likelihood that current circumstances may lead to broad contagion in the banking sector, it’s important to categorize the elements of Silicon Valley Bank’s situation as unique versus systemic. In our view, the nature of the clientele combined with a heavy reliance on available-for-sale and held-to-maturity assets by the bank seems to be a meaningful catalyst for the situation.
The combination of client/customer concentration, high reliance on deposits (see chart), and concentration of assets (see chart) put SVB at significant risk in an environment where customers faced liquidity needs and financial assets sit at depressed prices. These comparisons support the view that the situation is likely to be contained to SVB and possibly other smaller regional institutions as major national banks rely less on deposits and more on longer-dated funding sources.
That being written, confidence in the assertion depends upon the degree to which regulators will make depositors whole. In the absence of a government or private entity bailout, depositors in all but the largest institutions will question the rationale of holding deposits beyond FDIC insurance thresholds ($250,000).
Currently, however, the Treasury, Federal Reserve, and the FDIC have agreed upon a plan that will enable the FDIC to fully protect all depositors of SVB. Through the creation of a new Bank Term Funding Program (BTFP), they will have access to all their funds as of March 13th, where no losses will be carried by the taxpayer. However, the application of this solution to subsequent emergencies is still in question.
Even with the likely reprieve of the SVB situation, the fact remains that the current banking system causes depositors to in essence become unsecured creditors of the bank beyond the current FDIC insurance limits. This often-overlooked fact will likely face scrutiny in the days ahead, and if other areas of the economy become strapped for cash and simultaneously redeem deposits, significant ramifications affecting individuals, businesses, and the broad economy would result.
It seems probable that this event will catalyze the Federal Reserve to pivot to a looser monetary policy sooner rather than later. The general belief has been that the Fed would maintain its current interest rate trajectory until inflation sufficiently moderates, economic data meaningfully softens, or cracks emerge in the financial system. Recent data is consistent with the former two criteria (even if not at the magnitude desired), and large banks failing certainly satisfies the definition of major stress in our financial infrastructure.
SVB’s (and other banks’) situation speaks to the impact rising rates can have on the economy, specifically the financial system, and demonstrates the consequences of Fed actions. Regardless of the ultimate resolution of the circumstances regarding Silicon Valley Bank in the short term, the inherent mismatch in the maturity of assets and liabilities combined with elements of banking and regulatory mismanagement are issues that will remain front and center for the foreseeable future.
At BerganKDV, we help clients navigate volatility through a robust investment strategy and educational resources. If you have questions regarding market volatility and establishing an investment strategy that meets your needs, contact us today to learn more about our wealth solutions and what our advisors can do for you.
Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
The views expressed are those of BerganKDV Wealth Management. They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm.
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