Silicon Valley Bank’s failure: Is it the start of another financial turmoil?

The news of the run on Silicon Valley Bank (SVB) and its failure may have brought back bitter memories of the global financial crisis (2008) to many stakeholders in the banking system. As the most preferred bank of venture capitalists, start-ups and tech companies in the US, and more specifically in the Silicon Valley, SVB – founded in 1983 – enjoyed a great run over the decades.

SVB reported $212 billion in assets and $175 billion in deposits as of the fourth quarter of 2022. These amounts are higher than the size of most large Indian public and private sector banks. It had a meteoric rise in deposits during the COVID pandemic when record low rates allowed a funding boom for start-ups.

But was SVB’s failure the result of bad lending or was it due to poor investment decisions? What led to its shuttering? What are the implications for depositors and is this likely to start a bank contagion?

Here’s more on how to make sense of the news flows around the event, and understand if it is indeed a Lehman moment or more a hyperbole.

What happened with Silicon Valley Bank?

SVB specialized in lending to start-ups and technology firms. It was therefore a preferred choice for the entire start-up ecosystem, including venture capitalists, private equity companies and the like.

Silicon Valley Bank has long been a proponent of the start-up ecosystem and not surprisingly, it lent to and also took deposits from these start-up tech companies and investment firms. In the immediate aftermath of the COVID-19 pandemic, interest rates were at the rock bottom (near-zero levels).

SVB invested the funds received from start-up and venture capital clients in long-dated treasury and 10 year Mortgage-backed securities (MBS) for ~1.5%, when the long term Treasury bonds were yielding close to zero. The SVB treasury chose an immediate better alternative, a decision that seemed rational at that point in time.

For the better part of two years from March 2020, the world witnessed a technology and start-up boom, fuelled by easy funding from venture capital money post monetary easing by Central Banks.

From about $60 billion in early 2020, deposits nearly tripled to $175 billion by late 2022.

Source: Financial times

 

But the twist started from early and mid-2022, when the high inflation pushed the Federal Reserve to increase interest rates sharply. Rates were hiked by around 450 basis points in short span of under one year.

Source: Statista.com

The sharp interest rate hikes meant that yields on government securities and even mortgage-backed securities soared, resulting in heavy declines in bond prices, thus causing losses to investors. Yields and bond prices have an inverse relationship – they move in opposite directions.

Impact of Fed hikes and the fallout

SVB’s investments in long-dated securities suffered serious erosion in value. In fact, as late as in December 2022, it had mark-to market losses of $15 billion in its held-to-maturity bond portfolio, precariously close to its equity base of 16.2 billion, according to a Bloomberg report.

Meanwhile, as interest rates rose, funding for start-ups and tech companies dried up sharply. But most of them continued to burn cash despite the global slowdown.

Many start-ups started withdrawing their deposits to fund their operations. With an investment book that was already deep in losses and depositors yanking off their money, there was a disaster in the making.

Amidst huge unrealized losses and deposit erosion, rating agency Moody’s warned of a credit downgrade of more than one level. It went ahead and did indeed downgrade SVB.

Given that another Cryptocurrency focused bank, Silvergate, had just collapsed, private equity and venture capital players started pulling out money from SVB as well.

SVB was then forced to sell $21 billion worth of available-for-sale bonds for a loss of nearly $1.8 billion. This led to further panic among depositors.

By last Thursday, depositors had withdrawn more than $42 billion of money from SVB. The efforts of CEO to calm investors and depositors went in vain. It had negative cash balance of $958 million by the end of that business day and did not have any sufficient collateral.

SVB planned to raise $2.25 billion in equity capital to bail itself out of the current situation, but had to call it off.

SVB’s parent company, SVB Financial, saw its share price crashed more than 60% in trade and had to be halted.

As relentless run on the bank continued, the regulator had to step in to stem the rot. SVB collapsed and was taken under the FDIC (Federal Deposit Insurance Corporation).

What happens to depositors?

The FDIC insures deposits of up to $250,000. Depositors will start receiving this maximum amount from Monday itself. But given the high-profile standing of SVB, most depositors had much more parked in the bank. As much as 93% of the deposits were uninsured as of December 2022.

For those with more than $250,000 held in SVB, a receiver certificate for the amount in excess of $250,000 would be issued. The amount may be settled fully or partially based on whether SVB’s assets could be sold in an organised manner or if a suiter to buy the bank emerges. As and when assets are disposed, depositors would get ‘dividend’ payments.

Is this a Lehman moment?

Most of us like dramatic news flows and hyperboles connecting a present difficult situation with a catastrophic event of the past. In Silicon Valley Bank’s case, it was purely bad investment decision and non-raising of capital much earlier than the alarm signals went off were the reasons.

It was not any bad lending decision or defaults by borrowers or some cascading effect of mass delinquency of mortgage-backed securities or large systemically important banks going under.

SVB was a specialized bank and it suffered more due to the troubles around the start-up world and mistakes of its own, and not because of a systemic failure.

The surge in interest rates in the US and the offshoot of falling bond prices played a part. Therefore, it may be far-fetched to call this the Lehman moment.

Also, banks around the world and more so in the US have regular stress tests conducted by central banks. Most banks easily pass the stringent requirements. So, any concerns on the financial health of large banks may be misplaced.

It is also pertinent to note that consumer confidence is still buoyant in the US. Unemployment was at just 3.6%, the lowest in decades and the job market still had more opening for seekers. Retail sales have actually improved.

In the short term, of course, there would be a dampening of sentiments and a risk-averse attitude among depositors and investors.

The start-up ecosystem could find the going tough and the funding winter is likely to last for a bit more, hurting valuations, disrupting operations, thus leading to possible layoffs.

Another offshoot could be that depositors and investors would be more discerning while choosing the right bank. They would prefer the larger, stronger and trusted names rather than going to weak ones just because better rates are being offered.