Silicon Valley Bank Events & Insights

Folks...lots of rumblings on the Silicon Valley Bank (SVB) failure ranging from the sky is falling to nothing to see here.  Everyone is sifting through the ashes and data is still emerging, but we thought it would be appropriate to do a quick post on what we know and our interpretation of the events thus far.  This may change as things emerge, but these are our thoughts currently. 

SVB was the 16th largest bank in the US by assets.  As its name probably suggests, it catered to Silicon Valley technology firms.  In particular, start-up companies backed by venture capital funding were their primary depositors.  To be clear, SVB was not investing in these companies, rather many of these tech startups had their operating accounts (i.e. checking) at the bank. Nothing particularly risky about that.  

Now, most commercial banks make money on loans.  SVB's clientele didn't require that service, as they derived their funds from public and private markets (i.e. venture capital funding and the IPO market).  Therefore, SVB had a larger than normal investment portfolio; 57% of total assets as compared to 24% (source: The Macro Compass) .  This is typically invested in very safe securities like US Treasury bonds, but therein lies the problem.   

Their liabilities, the deposits that can be withdrawn, are short term.  You can literally make a withdrawal on your phone.  The treasury portfolio is something longer, if even a few years.  The spread is how this bank profits, receiving higher interest rates than they pay out.  But it is also the source of their risk.  Longer-term securities decline by more than short-dated securities as rates rise, just as they have over the past year.  Banks typically hedge this risk via interest rate swaps.  This essentially trades their fixed payment treasury portfolio receipts for a variable rate, but eliminates their risk of principal in the process. Here's where it gets a little murky.  It appears as though SVB did a poor job of this as the portfolio realized meaningful losses when the bank was recently forced to sell assets to meet deposit requests. 

Now, the hedge and portfolio losses only really matter when everyone wants their money at once, i.e. a bank run.  Why would everyone at this bank want money?  It started fairly innocuously.  With the economy facing the strain of higher rates and a potential economic downturn, VCs are less willing to provide funds to risky tech startups than they were previously. As a result, many depositors are drawing down their deposits with SVB to pay expenses (e.g. payroll, daily operating expenses, etc.).  The panic occurs when depositors realize that there may not be enough to cover everything.  The FDIC insures bank deposits, but only up to $250k per bank.  Therefore, if you think your bank is in jeopardy, and you have more on deposit than $250k, what do you do?  Withdraw it.  This saves you, but makes the problem worse for the bank, inevitably resulting in a failure.  In fact, SVB is the 2nd largest failure in US history, exceeded only by Washington Mutual.  

So where does this leave us?  Actually, at an interesting crossroad.  The issues with SVB are very specific.  They have a specialized clientele and a unique set of circumstances that really doesn't apply to most other banks.  Problem solved.  Not so fast.  If you have money at another small bank, above the FDIC insurance limit, how safe do you feel?  Maybe that can happen to you too? Therefore, you withdraw your money above the limit.  Better safe than sorry.  If that were to happen in droves, perhaps other banks come under pressure.   

The other implication is what happens to the companies and their employees who are SVB depositors.  Take Roku for example that has nearly $500mm dollars on deposit at SVB.  Do they now default on their obligations?  Maybe they miss payroll?  Do those missing a paycheck miss a mortgage payment or several? The risk is that this spirals.  Our initial reaction is that FDIC limits will likely be extended and the depositors at SVB will be paid in full.  This stops the crisis of confidence.   

Now, I know, everyone hates bailouts.   To be clear, this would not be a bailout.  The stock will go to zero and investors will lose everything.  However, the depositors will remain whole in this scenario. This is about saving the depositors and preventing others from fearing the same fate, not bailing out the shareholders or management.  

There may be more to come on this as it unfolds, but this is what we know at the moment.