Silicon Valley Bank (SVB), the nation’s 16th largest bank, failed and was closed by the California Department of Protection & Innovation and the FDIC on Friday. This is the second largest bank failure in U.S. history and the largest since that of Washington Mutual during the Great Recession. What happened and what are the implications for other U.S. banks?
SVB was founded almost 40 years ago and had become a centerpiece of finance in the technology and life sciences industries. The firm was often associated with early-stage startups, providing banking services before these ventures generated stable cash flow. SVB experienced phenomenal growth in the past several years. At the end of 2020 SVB Financial Group assets totaled $115B, a 63% increase over 2019. By 2022 this figure had almost doubled to $212B.
As a bank, SVB takes in customer deposits (liabilities to the bank). The bank then either loans the money or invests the money. In both instances the bank earns the “spread” – the difference between what the bank pays its depositors in interest and what the bank can charge for a loan or earn on its investments. Banks are also required to maintain certain levels of capital to avoid a bank failure. These are the bank’s assets. Regulators require specific risk thresholds be met for a portion of these assets. Banks meet this standard in the types of securities they purchase. Typically, banks maintain significant holdings of U.S. Treasury, mortgage-backed securities and like obligations. While not taking on credit risk, banks can earn a return or experience a loss on these securities.
Eagle Ridge does not own SVB on behalf of clients. However, the dynamics of what occurred in the past several days are instructive. SVB had a very concentrated client/depositor base. Since many of these businesses are start-ups and venture firms, they are subject to greater risks (as well as opportunities) and greater needs for cash than typical commercial customers. Importantly, only about 10% of depositors were fully insured, i.e. under $250,000.
The failure of SVB was caused both by a liquidity crisis, not having sufficient funds available for depositor withdrawals, and shortfalls in management’s risk assumptions. This latter point is borne out by the firm’s decision to invest depositor funds in longer term bonds. Keep in mind, when interest rates rise, bond prices fall. As SVB depositors looked to withdraw their money en masse, the bank was forced to liquidate bonds in their investment portfolio at significant losses. These losses had not been represented on their balance sheet previously due to generally accepted accounting principles. SVB classified about 75% of their investments as “Held to Maturity” and therefore did not recognize the losses on their balance sheet until sold. These losses effectively wiped out SVB’s equity and compelled regulators to close the bank.
What are the risks of contagion in the banking and financial industry? The Federal Reserve, the Treasury Department and the Federal Deposit Insurance Corporation announced that the bank’s troubles posed a systemic risk to the financial system, allowing regulators to take the unusual step of guaranteeing the deposits. This is an implicit nod to depositors at other banks that their assets are safe.
Nonetheless, as of this writing, Financial stocks remain under pressure. Prior to SVB, Silvergate Bank experienced a liquidity crisis as its digital crypto customers withdrew their money. The bank is still in operation, although the stock price is off more than 80% from the start of the year. On Sunday, Signature Bank was taken over by the New York Department of Banking Services. Signature lent to private equity and commercial businesses as well as having a payment platform for processing crypto transactions. Like SVB, a larger portion of its depositors were not fully insured. A combination of factors appears to have led to mass withdrawals and the bank’s closure.
Schwab, in particular, has been near the epicenter of selling. Although any bank may be subjected to overwhelming demand for depositor money, a “run on the bank”, Schwab appears adequately capitalized to withstand a worst-case scenario for the following reasons.
- Unlike SVB, Schwab has a broad base of customers across multiple lines of business and more than 80% of client cash held at Schwab Bank is insured dollar-for-dollar by the FDIC. As noted, about 90% of SVB’s deposits were uninsured.
- Schwab has capital well in excess of regulatory requirements, a high-quality and relatively small loan book, and a conservative investment portfolio that is 80% comprised of securities backed by the U.S. Treasury and various government agencies. Schwab also lists most of its investments at fair value, lowering the unrealized loss potential if forced to sell.
- As a further safeguard, Schwab has access to over $80 billion in borrowing capacity with the Federal Home Loan Bank (FHLB), which is an amount greater than all their uninsured deposits. That helps provide the firm significant access to liquidity, so money is there when clients need it.
- Investments at Schwab are held in investors’ names at the Broker Dealer. Those are separate and not commingled with assets at Schwab’s Bank.
- Schwab does not have any direct business relationship with Silicon Valley Bank or Signature Bank, so we do not have exposure to any direct credit risk from either.
While there is scar tissue, memories and the pain of the 2008-2009 financial crisis remain. We recognize the velocity of SVB’s collapse and recent market volatility are unsettling and encourage you to contact us to discuss these or any other matters.