Silicon Valley Bank Collapse Explained

4/6/2023 - By Chris Stennett, CFP

Silicon Valley Bank (SVB) was founded in 1983 in Northern California with the specific purpose of banking the up-and-coming technology sector. Over the next few decades, it grew into one of the 15 largest banks in the nation. In March 2023, financial regulators stepped in to remove management and control deposits, as the bank experienced a run on deposits. Though the dust has yet to settle, it’s important to understand the problems that lead to the bank’s downfall.

Problem #1 - Lack of Diversity Amongst Depositors

As mentioned above, the purpose of creating SVB was to offer bank services to an up-and-coming market that was underserved and not well understood by the larger national banks. Clients of the bank who needed to access capital for funding (loans, lines of credit, etc.) were incentivized to hold large balances within the Bank, often well more than the FDIC’s $250,000 insurance limit. This means that businesses banking with SVB were exposed to significant uninsured losses, should the bank fail. Generally, banks have several ways to manage their risk and avoid failure, but in SVB’s case, not all risks were managed appropriately. This bank’s clientele, both the business and the individuals, were heavily involved in the technology space. 2022 was a particularly challenging year for Tech, as new deposits started to dry up and accounts began to see greater withdrawals.

Problem #2 - Poor Investment Risk Management Strategy

The 2020 COVID Crisis brought about nationally low interest rates as the nation began to recover. Silicon Valley Bank was a big benefactor of those low rates as the bank saw an influx of new depositors. These new depositors were often businesses who were able to start their own ventures at historically low financing costs. The bank’s growth ballooned in 2020 and 2021 with deposits growing by 65% and 85%, respectively. As the bank grew, so too did its investment portfolio, as deposits were used to purchase U.S. Treasuries and Mortgage-Backed Securities. While these funds are traditionally “safe” investments, they have very long-term maturities, often 20 years or longer, and more are sensitive to interest rate changes than short-term maturities. Should interest rates begin to increase, these investments would not only lose value, but they would also be unattractive to buyers as they have lower yields than newly issued bonds.

Problem #3 - Inflation

In 2022, The Fed began rapidly raising interest rates to combat inflation. As interest rates rose, the value of existing bonds (such as the U.S. Treasuries and MBS’ purchased by SVB the prior two years) plummeted in historic fashion. Banks hold their securities in 2 different portfolio buckets: Available For Sale (AFS) and Held To Maturity (HTM). Losses or gains to securities in the AFS portfolio reduce (or increase) a bank’s capital base. Losses or gains in the HTM portfolio do NOT impact a bank’s capital base.

In late September of 2022, Silicon Valley Bank said the losses on its HTM portfolio exceeded the total value of the bank itself, but CFO Dan Beck stressed that “There are no implications for SVB because, as we said in our Q3 earnings call, we do not intend to sell our Held To Maturity securities.” Translation, there would be a loss if we sold them today, but we don’t have to sell them today. And furthermore, there won’t be a loss, because we will hold them to maturity. This would all be true if SVB always had enough cash on hand to cover withdrawals.

Problem #4 - Bank Run

On March 8, 2023, Silicon Valley Bank announced it was raising money, by selling some equity and by selling these recently purchased, Available For Sale (AFS) bond assets at a significant loss. The reason the bank did this is believed to be because of the capital needs of the underlying clients of SVB. As the bank’s clients navigated a tighter economy, deposits declined and outflows increased, forcing SVB to raise cash to cover the withdrawals. The announcement to raise capital seemed to have scared its clients and problems began to compound. The following week, the bank faced a record $42 billion of account withdrawals as the bank’s clients pulled all their exposed and uninsured assets from the bank. SVB was unable to raise the cash it needed to cover the requests, forcing regulators to step in and shut down operations.

The good news is depositors with the bank have been backstopped, meaning they will still have access to their money even if SVB doesn’t have any. The more concerning part is how many more institutions this will impact, as now Signature Bank and Credit Suisse have faced similar challenges. Unfortunately, smaller, regional banks will likely take a hit for this as depositors move to large national banks and safe, U.S. Treasury-backed, money market mutual funds, reducing competition and lending. There’s an important lesson to be learned from the demise of Silicon Valley Bank: risk and reward are inseparable. Ensure you understand how your money is invested.

Questions?
Reach out to our Saltmarsh Financial Advisors to invest your money properly.

About the Author | Chris Stennett, CFP

Chris is a senior financial advisor and Certified Financial Planner® practitioner for Saltmarsh Financial Advisors, LLC, an affiliate of Saltmarsh, Cleaveland & Gund. He serves individuals and organizations as a comprehensive financial planner and coordinator of investment activities. His areas of expertise include investment management, income planning, tax and estate planning and risk management. Chris has over a decade of experience as a wealth manager working with teachers, federal and state employees, retired Armed Forces and private-sector employees.