Silicon Valley Bank (SVB), a bank to some of the most infamous tech giants in the world, ran out of money this past Friday. And when a bank runs out of money in the U.S., it gets put under the control of the Federal Deposit Insurance Corporation (FDIC).
With around $178 billion in total deposits, SVB was a large bank, ranked 15th in the U.S. The U.S. has roughly 4,000 FDIC-insured banks, so ranking 15 is significant.
We’ve talked before about how rising interest rates have a nasty tendency to spark bankruptcies and jam up financing. And so we’re seeing that now.
How did this happen? Bank failures have been occurring for centuries, and like most bank failures, they tend to occur due to internal mismanagement or external macroeconomic factors. This seems to be a mix of both.
SVB first made a name for itself back in 1983 by offering looser lending standards to tech startups. It also offered higher interest rates on deposits to compete with larger banks like Citibank and PNCBank. SVB survived several boom-bust cycles in the tech sector, so it was always thought of as a strong, resilient bank.
But the tech boom that began around the 2010s was significant and gave it a huge influx of cash. And like any good bank, it poured this money into safe U.S. Treasury bonds and mortgages.
However, here SVB did something different. It invested in longer-dated Treasury and mortgage bonds, i.e. bonds with longer maturities like 10 to 30 years. These tend to be riskier and fluctuate with more volatility as interest rates shift quickly.
Why did it do this? Most banks invest in a mix of shorter and longer-dated Treasuries to reduce these risks. But, as we’re slowly learning, through most of 2022, it literally had no chief risk officer (CRO) after its previous officer stepped down in April 2022. It only appointed current CRO Kim Olson in January of 2023. This is a lot of time for the bank’s risk work to be done by its CEO, who tends to focus on profits.
And, as we all know, interest rates have risen precipitously over the last 12 months. And when interest rates rise, bond prices fall. This is because the that was yielding 1 percent before now has to compete with bonds offering 5 percent. The price of the 1 percent bond has to fall to make up the difference.
So a significant chunk of the bank’s portfolio declined. At the same time, higher rates caused its primary customer base - tech companies and their CEOs - to need more money. Tech companies and fund valuations have been highly sensitive to interest rate changes, so when rates rose, valuations plummeted, which in turn caused these tech companies and VCs to dig into their precious cash reserves to keep the lights on. Which, in turn, were all stored at SVB.
So all of the bank’s customers were needing money, while at the same time, it made bad cash management decisions and was running its bank without a chief risk officer.
And then, just last week, the bank’s customers panicked after SVB announced it needed to strengthen its financial position to make up for a loss of $2 billion in it’s portfolio. Depositors got spooked and ended up withdrawing $42 billion.
Which is huge. No bank could survive such an onslaught of demand all at once.
So on Friday, SVB looked for a buyer. But because its loan portfolio is heavily skewed toward VC funds - making up 56 percent of its portfolio - it couldn’t find one. So the FDIC was brought in by the California Department of Financial Protection and Innovation and appointed as the bank’s receiver.
Today, the FDIC is looking to find a buyer for the bank, with final bids due this afternoon (Sunday). A buyer would take over the assets and inject liquidity into the bank to smooth over the panic. But it’s possible it may not find one due to the bank’s concentrated portfolio, which would give any good conservative banker pause.
And while depositors with less than $250,000 in deposits are safe, the bigger question is, SVB had a huge list of very medium-sized tech companies such as Pinterest, Shopify, Crowdstrike, Zola, and Ziprecruiter whom likely had multi-million dollar accounts there. Without access to their accounts, their operations are in jeopardy.
Moreover, if the situation isn’t resolved, it could spook other account holders at medium-sized banks to withdraw their funds. After all, with rates rising so rapidly, customers are left wondering: will other banks fall into trouble?
Bank authorities will need to operate quickly. With bank failures, problems tend to escalate in unforeseen ways, the way Lehman Brothers failed back in 2008 and caused a chain reaction throughout the investment banking industry. And when they do, it’s hard to foresee where or when the next domino is going to drop. So the FDIC wants to resolve this quickly.
A few more details:
Tech-company customers with over $250,000 in deposits will receive “receivership certificates” for the time being. Meanwhile, the FDIC will then try to find a buyer for the SVC. It may successfully do so, thereby allowing most customers’ funds to be returned eventually. If it does not - and it’s possible it won’t - then the FDIC will enact a liquidation process of assets. If this happens, the dollar amount those assets fetch will be much less, which in turn could spark problems with other banks.
Other sectors sensitive to interest rates, such as the broader financial sector and commercial real estate, may also struggle in the weeks again to get new financing. In such a case, banks may tighten lending standards to prepare for large customer withdrawals.
Federal authorities will struggle - as they did in the 2008 financial crisis - to find the right balance to either a) backstop depositors and put taxpayer money at risk, or b) let this bank - and potentially others - fail due to mismanaging their portfolios. Whatever decision they make is likely to draw criticism from Congress, investors, and the general public.
In any case, we should prepare for a volatile week. And heightened attention on U.S. banking authorities. The FDIC and Federal Reserve learned a lot in 2008. And while this crisis is not yet as bad as 2008, they don’t want any hint of things getting there again.
Disclaimer: BubbleCatcher is published as an information service for subscribers, and it includes opinions as to forecasts on the global economy and its impact on securities linked to economic activity. The publishers of BubbleCatcher are not brokers or investment advisers, and they do not provide investment advice or recommendations directed to any particular subscriber or in view of the particular circumstances of any particular person. BubbleCatcher does NOT receive compensation from any of the companies featured in our articles. At various times, the publisher of BubbleCatcher may own, buy or sell the securities discussed for purposes of investment or trading. BubbleCatcher and its publishers, owners, and agents are not liable for any losses or damages, monetary or otherwise, that result from the content of BubbleCatcher. Past results are not necessarily indicative of future performance. The information contained on BubbleCatcher is provided for general informational purposes as a convenience to the subscribers of BubbleCatcher. The materials are not a substitute for obtaining professional advice from a qualified person, firm, or corporation. Consult the appropriate professional advisor for more complete and current information. BubbleCatcher makes no representations or warranties about the accuracy or completeness of the information contained on this website. Any links provided to other server sites are offered as a matter of convenience and in no way are meant to imply that BubbleCatcher endorses, sponsors, promotes, or is affiliated with the owners of or participants in those sites, or endorses any information contained on those sites unless expressly stated.