Monday, March 13, 2023
Silicon Valley Bank Failure - What Happened And Why?
Stock and bond market activity was materially shaken last week as Silicon Valley Bank (SVB), the California bank subsidiary of SVB Financial Group (SIVB), fell into FDIC receivership for inadequate liquidity and insolvency. SVB is the first FDIC-insured institution to fail since 2020 and the largest by assets since Washington Mutual failed in 2008.
Many market participants are focusing in on SVB’s losses in its securities portfolio as a key cause for its demise. Participants are also tying the bank’s fall to the Federal Reserve’s (Fed) rising rate policies. Additionally, SVB’s niche customer base in venture capital and lack of earning asset diversification (i.e. an unusually large portfolio of marketable securities relative to assets) also contributed to the bank’s failure.
Meanwhile, late Sunday, regulators closed Signature Bank (SBNY), an FDIC-insured New York state commercial bank with total assets of $110 billion. The institution fell victim to excess crypto-related deposits and was also experiencing material deposit outflows (-16.5% year-over-year).
At this time, we do not believe the SVB and SBNY bank failures are a deeper sign of things to come. However, we are paying close attention to ongoing developments in the banking sector and in other industries for hints of any widespread contagion. Indeed, more banks may come under distress (72 FDIC-insured banks have failed over the last 10 years). We are not expecting SVB and SBNY to be the first steps on the way to a systemic crisis.
Also on Sunday, regulators, including the U.S. Treasury Department, the Fed, and the Federal Deposit Insurance Corporation (FDIC) indicated that all depositors of SVB and SBNY will be made whole. Depositors with greater than the FDIC insured amount of $250,000 will receive a receivership certificate. As the FDIC sells the assets of Silicon Valley Bank, future dividend payments may be made. Meanwhile, we anticipate regulators will take emergency measures this week to help backstop the banking system and reinstall depositor confidence.
How Is This Different From The 2008 Financial Crisis?
SVB’s unique combination of bank depositors (individuals and institutions exposed to weakness in venture/start-up valuations) and degradation to its asset portfolio caused the institution to become troubled when faced with unusually large depositor withdrawals. While capital, wholesale funding and loan to deposit ratios improved for many US banks since 2008, there are exceptions. As shown in the chart below, SVB was in a league of its own: a high level of loans plus securities as a percentage of deposits, and very low reliance on stickier retail deposits as a share of total deposits. Bottom line: SVB carved out a distinct and riskier niche than other banks, setting itself up for large potential capital shortfalls in case of rising interest rates, deposit outflows and forced asset sales.
A further look at the pie chart below, show unusually high reliance on corporate/venture capital funding; only the small red private bank slice looks like traditional retail deposits to us. Out of SIVB’s $173 billion of customer deposits at the end of 2022, $152 billion were reportedly uninsured (i.e., over the $250,000 FDIC insurance threshold) and only $4.8 billion were fully insured. It’s fair to ask about the underwriting discipline of venture capital firms that put most of their liquidity in a single bank with this kind of risk profile1. At the end of 2022, SIVB only offered 0.60% more on deposits than its peers as compensation for the risks illustrated below; in 2021 this premium was 0.04%.
At the time of this writing, Fed officials are contemplating several measures to attempt to ensure stability in the banking system. Any such development will likely be viewed as a positive by the market. However, we are also anticipating that depositors at other California banks may become uneasy and may seek to withdraw funds. Reuters has reported of such an occurrence at a First Republic Bank in California (ticker: FRC).
We believe investors should react to the SVB and SBNY developments with some caution as sentiment around bank conditions remains fragile and depositors in other banking institutions could react irrationally to the recent failures. Meanwhile, overall conditions should improve with time based on regulator backstops.
Time-Horizon Is Key
It is important for investors not to get caught up in the noise and SVB headlines. When market volatility occurs, it is a natural response to want to sell and go away. Unfortunately that is a recipe for selling low and buying high.
The concept of buying low and selling high is ideal. However, it can also be difficult for investors as prices involve emotions and investor psychology. For investors with a long-term time horizon, now may be a good time to consider "buying the dip" as we expect to see some volatility.
"During times of volatility it's important to remember time horizon and to rely upon the planning that we've done together. As part of our planning with clients, we seek to align risk and time horizon for different portions of a client's portfolio," said Randy Eveland, CFP, RICP, CDFA, Wealth Advisor.
If you have specific questions or would like to discuss your own investment strategy or financial planning needs, we welcome you to call us at 302.234.5655 or email us at email@example.com to set up time to discuss further.
1.In an article on TechCrunch this week, Mark Suster from LA-based Upfront Ventures referred to the existence of deposit exclusivity arrangements required by SIVB for some of its customers that borrowed from it.
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