Silicon Valley Bank (ticker SVB) has been in the news this week due to its recent troubles. Prior to Friday, I had never heard of this bank. However, on Thursday, I noticed several of my bank holdings were down greater than 5%. It seemed odd for the entire banking sector to be down suddenly. As it turns out, something big was happening, and we found out on Friday what that was.
On Friday, SVB went into receivership, which means the bank in question is insolvent, and the FDIC takes over the bank and guarantees all depositors with $250,000 or less in deposits with the bank, which are FDIC insured. For depositors with more than this amount, there is no saying when they will have access to their deposited funds. In layman’s terms, there is a run on the bank.
The last time this happened was during the GFC crisis with Bear Sterns going into receivership and was bailed out by the Fed, which was then followed by the global meltdown of the financial sector. However, I don’t think we’re looking at a similar situation unfolding in the near future.
In my opinion, SVB’s troubles are the result of extremely poor risk management. They were drowning in startup deposits at a time when interest rates were close to zero and made the mistake of taking these short-duration assets and invested in long-duration mortgage-backed securities, which at the time were yielding ~1.5%. The temptation to make some returns on the horde of cash in hands seemed almost irresistible at the time.
And then the world changed. The Fed began raising interest rates at an unprecedented pace, and long-duration bond assets suffered their worst loss in decades. With money becoming tight, all the startups who were drowning in venture capital suddenly found themselves in a situation when capital raise started becoming substantially harder, and they started to draw down on their deposits in SVB.
SVB then made a gross mistake of selling some of their bond holdings at a loss of $1.8B in an attempt to beef up their liquidity, which spooked the markets and depositors en masse. This led to a 60% drop in their stock price on Thursday, and depositors tried to withdraw upwards of $42 billion in what turned out to be one of the biggest bank runs on a US bank since the GFC crisis.
In the near term, I expect that the Fed will make sure all depositors are made whole. Either one of the SIB (systematically important bank) takes over SVB or the Fed rescues SVB with taxpayer dollars. It’s just impossible to fathom the repercussions of letting depositors lose their bank deposits.
There will be more dominoes to fall, but I do not think this incident poses a systemic risk to the entire financial sector. I also do not foresee another GFC playing out. However, investors and depositors will become more cautious about banking with regional banks in general, with funds flowing into SIBs, making these even more important and leading to a more fragile financial system.
Market overreactions may produce some bargains to be had. Folks with cash may benefit from lapping up SIBs on sale. I hope to be one of those to take advantage of this unfortunate turn of events!