Santa Clara, California-based Silicon Valley Bank (SVB) has collapsed. This is the second largest bank failure in US history and the largest bank failure since the global financial crisis.
The US government has boarded protect savers. The government is not going to save SVB. Shareholders are not protected. The deposit protection is financed by a special tax on banks rather than by taxpayers themselves.
There are some echoes of the 1930s, which also saw bank runs and bank failures, while the Federal Reserve (the Fed) raised interest rates.
But why did the US bank fail? Should we expect the Great Depression and increased volatility for the financial system again? Or are there more company-specific factors involved in the collapse of the SVB?
Let’s see how the banking industry disaster unfolded, leading US regulators to intervene in the collapse of Silicon Valley Bank.
1: A base of bad deposits
“Don’t put all your eggs in one basket.” That’s the cliche. But this adage contains a grain of truth.
Indeed, Silicon Valley Bank put all the eggs in one basket. As the name suggests, the financial institution focused on startups, venture capital funds, and the wider Silicon Valley ecosystem. The deposit base was highly concentrated. This is a bad foundation for a bank.
The problem is that those customers have similar economic risks. If one customer needs to withdraw their money, it is very likely that countless other customers will have to. This is analogous to the mortgage-backed security crisis in 2008: When one borrower defaults, there are likely to be many more.
Silicon Valley Bank had a steady increase in withdrawals. It’s been a tough year for startups and the tech industry. Since the pandemic, venture capital funds have tightened their belts. Enterprise sales take longer. So-called ‘down rounds’ are more common. And so tech startups — and VC funds — needed more and more money, leading to more and more withdrawals and fewer bank deposits.
This increased Silicon Valley Bank’s cost of capital. With money disappearing from deposit accounts, Silicon Valley Bank now has to pay depositors higher rates to keep them, or rely on more expensive external sources of funding.
2: An asset problem
Suppose you buy a house in the US. You take out a 30-year mortgage and you get a covid-era loan with an ultra-low rate. But now less overtime has been done, you need cash while house prices have fallen. What are you doing? Your wealth has plummeted, your need for money has increased. If only you could hold out until you pay off the house.
Silicon Valley Bank had a similar problem: it now needed cash, its assets had fallen in value, and its cash flow was shrinking in proportion to its need for cash.
Let’s dig into this a little bit.
Silicon Valley Bank’s main assets — which enabled it to meet depositors — consisted of several major components: (1) assets for sale, (2) assets held to maturity, (3) other non-marketable securities, (4) cash and (5) Loans. Of these, only assets for sale and cash are designed to be liquid.
Here we see an immediate liquidity problem: if a bank run comes, Silicon Valley Bank would simply not be able to meet all of its withdrawals because it simply does not store the deposits as cash.
Silicon Valley Bank assets have also fallen in value. Most of Silicon Valley Bank’s assets are loans and bonds. A bond is a loan. When you buy a bond (or a loan), you buy the right to the future cash flow underlying that loan. Banks — such as Silicon Valley Bank — don’t need to record the current market value of those bonds if they plan to hold the bond until the loan is fully repaid.
As interest rates rise, so does the required yield on a recently issued bond. Think about how mortgage rates have changed for household loans. The same goes for corporate debt.
But the old bonds that had locked in low interest rates are now worth significantly less because they pay less than what investors could get on new loans.
This is a problem. Silicon Valley Bank owned a lot of US government bonds and mortgage-backed securities. These have returns below 2 percent. Meanwhile, the Fed Funds rate rose to well above 4 percent. For example, SVB sold its ‘available-for-sale’ bonds, making a loss of $1.8 billion. SVB’s ‘held-to-maturity’ assets have also fallen in value.
The asset base can also create a cash flow problem. Silicon Valley Bank’s borrowing costs rose. As indicated, this was due to higher interest rates. However, many of Silicon Valley Bank’s assets are locked into low interest rates. This created an ongoing cash flow concern.
3: A capital increase that shocked the market
Due to this situation, Silicon Valley Bank decided to raise capital to support its balance sheet and provide sufficient liquidity. At this increase, it disclosed that it had sold bonds. It asked for about $2.25 billion. The market reacted badly. This was likely on the news that Silicon Valley Bank had sold all of its “available-for-sale” securities and was in a dire liquidity and solvency position.
A classic bank run followed. Within a day, $42 billion was withdrawn. This largely followed venture capital funds collecting their deposits and instructing their portfolio companies to do so. This created an immediate liquidity and potential solvency problem for Silicon Valley Bank.
Banking regulators stepped in and took control of Silicon Valley Bank. Silicon Valley Bank collapsed.
How bad is the damage? Will Silicon Valley Bank be bailed out?
The SVB Financial Group may attract a buyer. It has real assets. And these assets could be a way to cover most of his deposits. The government has indicated that this will happen not redeem However, SVB will protect depositors. The distinction is important.
In a bailout, shareholders and lenders often receive at least some government support. However, with SVB, the US government has indicated that “shareholders and certain unsecured debt holders will not be protected”. SVB is not saved. On the contrary, depositors will be protected and this will be financed by a “special assessment”. [levy] on banks”.
Another bank maybe acquire what’s left of Silicon Valley Bank. This investment thesis would be to obtain the banking and finance licenses from the SVB, the branch network and the number of depositors from the SVB.
Being seen to support the startup industry can also create goodwill among a valuable customer base.