A Brief Q&A
OJM partners and advisors received several questions related to the failure of Silicon Valley Bank (SVB) last week. Our team has put together a Q&A in an attempt to answer these questions about the SVB failure and provide additional information about assets held in other U.S. banks.
Who is Silicon Valley Bank?
Silicon Valley Bank is a traditional bank. Individuals have savings and checking accounts with the bank. SVB is the 16th largest bank in the U.S. (based on deposits) and the second largest bank in the U.S. to fail. The bank had been known to be very friendly to technology, venture capital, and start-up businesses. Relative to their peers, a disproportionate number of their business deposits were concentrated among a few industries.
Was there a failure in risk management?
Information continues to be released at a rapid pace. As of Friday, March 10, it appears SVB extended the average maturity of its portfolio of bonds to achieve a higher yield. The company invested in longer-term treasuries. While treasuries are very safe and liquid, they can lose value if sold before maturity in a rising interest rate environment. A bank the size of Silicon Valley lends out billions of dollars and has a need to manage cash flow.
An individual investor with a prudent risk management process would not take the cash they intend to use for a home purchase within six months and purchase individual stocks. If the stock market drops 15-20% and a down payment is due, the home buyer has a liquidity problem.
A bank needs to maintain liquidity to meet the cash needs of its clients. The problems started for SVB when they took a bet on longer-term Treasury Bonds. Last year, the bond market experienced unprecedented losses. The losses were not due to Treasuries defaulting, they were paper losses resulting from rising interest rates.
Example: If you purchase a 2-year bond paying 1% and a year later interest rates are 5%, the value of your bond has declined. In this scenario, you effectively own a 1-year bond paying 1%. If you hold onto the bond, you will receive your entire investment. However, if you were forced to sell the bond a year early, it is not worth as much as a 5% bond, therefore you would take a loss when selling early.
Early reports suggest SVB purchased $80 billion of longer-term bonds. The bonds were no longer worth $80 billion, and the time was not optimal to sell. Silicon Valley Bank announced they intended to raise $500 million from a Private Equity Fund.
What other factors created the cash crunch?
A lack of regional and sector diversification hurt Silicon Valley Bank. Last year, many publicly traded tech/growth stocks were down nearly 30%. Many venture capital (VC) and startup companies were struggling financially too. When these companies needed cash, it created an additional strain on SVB’s balance sheet. SVB carved out a distinct niche and set itself up for future capital shortfalls should rates continue rising and depositors face net outflows. (These outflows would cause forced asset sales at discount prices.) As JPM wrote, “being flooded with deposits from fast-money VC firms and other corporate accounts at a time of historically low interest rates might have been more of a curse than a blessing.” Another red flag took place back in April 2022 when the Chief Risk Officer left the bank. That position went unfilled for 8 months.
What created the bank run on Silicon Valley Bank?
A well-known venture capitalist encouraged the companies in his fund that they should pull their money from Silicon Valley Bank. His comments were made shortly after the letter from SVB was sent, requesting a cash raise.
Do I need to be concerned about additional bank failures?
Bank failures do occur regularly, more frequently than most realize. While there could be additional fallout from the SVB failure, at this time we do not anticipate widespread contagion throughout the banking sector. Caution should be warranted if you are considering investing in the stocks of regional banks on the west coast.
What happened when the largest bank collapse occurred?
The biggest collapse in history occurred in 2008. Washington Mutual failed and 100% of depositors did receive their money.
Should I be concerned about the cash I have with my bank?
As previously mentioned, a broad run on banks is unlikely. Risk-averse investors can take additional precautions.
FDIC insurance covers up to $250,000 per account registration. An individual account, joint account, and entity would each be eligible for $250,000 in FDIC coverage. Investors who are concerned can limit deposits in a single account to the FDIC coverage limit.
We believe the failure of Silicon Valley Bank was a unique occurrence. The environment today does not resemble the financial crisis of 2008 when banks were over-leveraged, and the financial system was filled with excessive speculation. If you have further questions, please contact an OJM advisor.