Silicon Valley Bank Failure: Extinction Level Event or Overreaction?

An unusual, dramatic series of events led to the failure of Silicon Valley Bank (SVB) on March 10, 2023.

News of SVB’s demise sent shockwaves through the tech industry and the financial markets. But what exactly happened? Though not a household name, SVB was the bank of choice for many early-stage technology companies and thus an important entity in the innovation industry ecosystem.

On Wednesday, 3/8/23, Silicon Valley Bank was a highly respected, well capitalized bank. Less than 48 hours later it was out of business. Its collapse represents the second largest bank failure in US history.

This certainly is big news and worthy of discussion. I do not pretend to be a banking or finance expert. So, I asked Carol Clark, MBA, CFA and managing partner of OnCenter Financial Advisors, a key resource, to help break things down for me via email. She did an amazing job so, with her permission, I’d love to share it with all of you!

The failure of Silicon Valley Bank

Many factors contributed to the bank’s death. But before delving into the details, it is important to note that the SVB event is believed to be a unique and idiosyncratic situation which should not lead to widespread contagion at other banks.

But what happened?!

Unfortunately, market conditions changed last year due to rising rates and market volatility. This made it difficult for companies to raise money through IPOs or private offerings.

Without access to new money, early-stage companies began withdrawing deposits from SVB to run their operations. But the volume of withdrawals exceeded SVB’s liquidity. So it had to sell Treasury bonds to generate enough cash to cover the withdrawals. This forced sale of bonds on short notice led to a $1.8BN loss for the bank.

SVB, working in conjunction with its adviser, Goldman Sachs, then announced that it needed to raise $2.25BN of new capital to shore up its balance sheet. This, pretty obviously, came as a surprise to investors. This unexpected announcement spooked the market causing SVB’s stock to fall 60% on Thursday.

Venture capital firms then began telling their portfolio companies to pull their money out of SVB. They worried in case this downturn ballooned into a full financial crisis. But this created panic which led to a mass exodus of money and a literal run on the bank resulting in a collapse of the institution.

And the end result…

On Friday morning, March 10, 2023, FDIC regulators shuttered the bank and seized all assets.

Ironically, the goal of this sale of Treasury bonds and SVB’s subsequent announcement of its intent to raise capital was to reassure investors. But it had the exact opposite effect.

Ryan Falvey of Restive Ventures summarizes the Silicon Valley Bank failure the situation as follows,

“This was an hysteria-induced bank-run caused by the venture capitalists and will go down as one of the ultimate examples of an industry cutting off its nose to spite its face.”

The spillover effect on the companies that banked at SVB and the companies that they do business with is not yet fully known. We do know that all assets at SVB are frozen. Thus, the early-stage companies with accounts at SVB cannot access their funds and many worry about being able to make payroll next week. There will be many high-level people working on this challenging situation throughout the weekend.

US Treasury Secretary Yellen met with regulators and expressed full confidence in their ability to respond to the situation. The FDIC insures deposit accounts holding up to $250,000 and authorities state that owners of those accounts will receive their money Monday morning. The FDIC does not cover deposits above $250,000. However, most expect that all depositors will ultimately get their money back, though this may take time.

SVB played too important a role in the vitality of the tech industry for the authorities not to take some type of protective action. Some are even using the term bailout to rescue the innovation hub of America. However, it appears that a federal bailout is not in the plans.

What does this mean for the overall health of U.S. finance?

As we await the post-mortem results, it is important to review the unique characteristics of this situation.

Most experts believe that an isolated set of circumstances at Silicon Valley Bank led to its failure. The overall feeling is that other mid-sized commercial banks are not at major risk.

There are three factors that separated SVB from its peers which created significant unique risk:

1. As the graph below illustrates, the deposit base had significant concentration risk because only 7% of deposits were from retail customers.

Possessing a small number of large deposit accounts makes it much easier to have a run on the bank.

Additionally, roughly 50% of total deposits across all US banks broadly are over the $250,000 FDIC insured limit. But greater than 90% of deposits were above the limit at SVB.

2. SVB used customer deposits to purchase 30 year bonds. There is an inverse relationship between the price of bonds and interest rates. When rates rise, the price of a bond goes down. And, the longer the maturity, the more price sensitivity there is to any change in rates.

Buying long-term 30 year bonds when rates were at historic lows set the bank up for oversized losses on the bond portfolio when rates began to rise.

3. Banks have discretion on what volume of bonds they place in the Hold-to-Maturity (HTM) category. The HTM category is significant because banks are not required to report the market value of bonds in this bucket until the bonds are sold.

SVB placed a large percentage of its bonds in the HTM bucket. Thus, they did not have to disclose the mounting losses on its bond portfolio as rates were rising over the past year.

SVB’s peer group took a much more conservative approach. The table below illustrates how misleading a bank’s capital ratios (a measure of the bank’s strength) become when they do not report bonds at market value. One can see that the Adjusted Tier 1 Capital ratio for SVB was an extreme outlier. You can also see that after accounting for the unrealized losses, SVB’s Tier 1 Capital Ratio was essentially zero.

Putting a bow on this analysis of the Silicon Valley Bank failure

In summary, the prevailing belief is that a unique set of circumstances and unusual client base led to SVB’s failure.

The markets will be watching closely next week to see how the authorities decide to resolve the issues. But at this time, it appears this was an idiosyncratic situation and that other banks are not at significant risk of a repeat of this unfortunate situation.

The implications to the broader economy will hinge on whether a sale of the bank or bailout of some sort occurs.

I think Carol does an amazing job here of analyzing and summarizing a very complex situation. I also think it is interesting, but not surprising, that the Silicon Valley Bank specialized in a lot of the tempting investments that I recommend we all avoid…

But regardless one question remains that I would like to address.

So, should this change our investing plan?

Nope!

Stick to your written investment plan. Blips like these are going to occur. Especially when we are in a recession like this.

But always remember, we are not investing for the short term. We are long term investors looking to capture the long term market gains passively using broadly diversified, low cost index funds.

I strongly believe this remains the best way to build long term wealth for doctors (and anyone else really). Here is some more evidence of why I feel this way:

What do you think? Did the failure of Silicon Valley Bank shock you? What do you think it holds for the near future of banking in the U.S.? Let me know in the comments below!