The Silicon Valley Bank Collapse

On Friday, March 10, 2023, Silicon Valley Bank (SVB) became the second largest bank to fail in the United States. Silicon Valley Bank was uniquely positioned as a financial institution, as its client base was comprised of primarily tech companies and venture capital firms. According to Reuters, SVB was an important lender for companies in their early stage of development and was the banking partner for nearly half of U.S. venture-backed technology and healthcare companies that listed on stock markets in 2022.

On Wednesday, March 8, the downhill slide began for Silicon Valley Bank (SVB). SVB announced its intention to sell $1.75 billion of common and preferred stock to increase the strength of its balance sheet and offset bond investment losses. Earlier in the day, SVB completed the sale of substantially all of its available for sale securities portfolio, which was comprised primarily of U.S. Treasuries. Although U.S. Treasury bonds are generally viewed as a relatively safe investment, the market value of bonds will decrease if market interest rates increase. If the bonds are sold prior to maturity, the bonds would be sold at a loss. The market value of bonds decreases as buyers pay less so they can achieve the higher yield afforded by rising market interest rates. As interest rates increased in 2022 the bonds lost value. Increasing interest rates will have a greater negative impact on long-term bonds than short-term bonds.

The company’s CEO indicated that client “cash burn” had resulted in lower than forecasted deposits, as the company’s client base of tech companies had recently struggled which in turn reduced SVB deposits. As a result, SVB sold its bond portfolio to increase its cash and liquidity. SVB sold approximately $21 billion of securities, which would result in an after-tax loss of approximately $1.8 billion in the first quarter of 2023. The proceeds from the stock sale would offset the loss from the sale of bonds. However, the company’s proposed stock offering concerned investors about the financial strength of the company. The stock price tanked 60% on Thursday, March 9. According to a California regulatory filing, customers had withdrawn approximately $42 billion of deposits by the end of the day. The run on the bank was on, and Silicon Valley Bank was insolvent by Friday.

The U.S. banking system requires banks to hold a relatively small percentage of bank deposits in the form of cash reserves. The reason is simple. The goal is to have banks act as a conduit for economic growth. Banks keep a small percentage of deposits and make loans with the rest. Although banks do not have the cash on hand that matches the amount of deposits, the Federal Deposit Insurance Corporation (FDIC) insures up to $250,000 for each depositor. A significant demand by depositors for their money (as occurred with SVC) can result in the bank’s insolvency, as the bank will not have the necessary reserves.

Over the weekend, in an effort to prevent contagion, the Treasury Department stepped in and indicated it would “fully protect all depositors.” In other words, even SVC depositors with balances exceeding the normal FDIC insurance level of $250,000 would be protected. Depositors would be protected; investors (shareholders) would not be bailed out. Any losses to the Deposit Insurance Fund to make uninsured depositors whole will be recovered by a special assessment on banks. The Federal Reserve also announced a new Bank Term Funding Program, which will provide greater access to cash and needed reserves for financial institutions. In essence, banks can use financial securities as collateral for Federal Reserve funding rather than selling the securities in financial markets at a loss to raise needed cash.

Silicon Valley Bank was in a unique position with a primarily corporate client base that had a tech industry concentration. The tech industry concentration and providing loans to early-stage companies created a loan portfolio risk if the tech industry struggled. When the tech industry was booming, the bank invested excess deposits into longer term Treasury securities. However, the recent struggles of the tech industry reduced client deposits, resulting in the need to sell SVB’s bond portfolio to increase cash and liquidity. The focus on investing in longer term bonds created an investment risk if interest rates increased. Interest rates began increasing in 2022, resulting in a loss when the bonds were sold to increase necessary liquidity. The bank’s proposed stock offering was intended to offset the bond loss, but the stock offering raised investor concerns over the risk and liquidity of the bank. A run on the bank occurred, and within 48 hours insolvency resulted.

The causes of the failure of SVB differ from the causes of the 2008 financial crisis. The 2008 financial crisis resulted from a myriad of factors, including easy credit conditions in the housing market and increasing subprime loans, the transfer of risk from lenders to investors via mortgage-backed securities, the popularity of adjustable-rate mortgages, and reduced housing values resulting from rising mortgage rates. Several major banks made risky subprime loans and investments in mortgage-backed securities tied to subprime loans. When rising mortgage rates caused the defaults on adjustable-rate mortgages to significantly increase and home prices plummeted, many subprime loans and mortgage-backed securities were virtually worthless. A massive $700 billion bailout of the banking industry (including depositors and investors) was approved by Congress in 2008. The fear was that decreased liquidity in the mortgage market, caused by the write down of mortgage securities and consequently bank assets, would dry up funds available for banks to lend. This had the potential to have a significant, detrimental impact on the economy – and other financial institutions.  

As a result of the financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed by Congress in 2010 to increase government oversight and strengthen the financial system. However in 2018, Congress passed the Economic Growth, Regulatory Relief, and Consumer Protection Act, which rolled back significant portions of the Dodd-Frank Act. In particular, the new law eased the regulations for small and regional banks (like SVB at the time) by increasing the asset threshold for the application of certain standards, stress test requirements, and mandatory risk committees.

The failure of SVB is not like the 2008 financial crisis, but there are ramifications. In an effort to prevent contagion and decrease depositor concerns, the Treasury Department stepped in and indicated it would “fully protect all depositors” in the SVB failure. The focus was on depositors; however, investors would not be protected. The initial financial market fallout appeared to primarily focus on regional banks, as increased investor uncertainty led to several regional bank stocks declining significantly on the Monday (March 13) following the SVB failure.

The SVB failure also increased uncertainty over future Federal Reserve policy. Although the Federal Reserve was expected to increase the federal funds rate by at least 25 basis points in late March, there is growing uncertainty over another interest rate increase. Short-term interest rates are generally lower than long-term interest rates. Banks typically pay short-term market interest rates for deposits and earn long-term market interest rates on long-term loans. They profit from the spread between short-term and long-term interest rates. However, an “inverted” yield curve currently exists in financial markets – short-term interest rates are higher than long-term interest rates. An inverted yield curve typically increases pressure on bank profits. A growing concern is that further Federal Reserve increases could increase pressure on bank profits and liquidity.   

For further information:

1. From Reuters: Silicon Valley Stock Price
2. From the SEC: Preliminary Prospectus
3. From CNBC: Silicon Valley Bank Collapse – How it Happened
4. From the Motley Fool: Silicon Valley Bank – What Went Wrong
5. From Investopedia: Dodd-Frank Act: What It Does, Major Components, Criticisms