Sadly, Silicon Valley Bank (SVB, $SIVB), the 16th largest US bank at the end of 2022, experienced a bank run. Now the infection has spread to other regional banks such as First Republic Bank, Signature Bank, Zions Bancorp and Charles Schwab. Even the biggest banks were getting affected.
Ultimately, the Federal Deposit Insurance Corporation (FDIC) said on March 10, 2023, that it would take over the SVB and that its depositors would have access to their deposits as of Monday morning, March 13, 2023.
The bank had $209 billion in assets and $175.4 billion in deposits. Roughly 87% of deposits were uninsured as of December 2022, according to Silicon Valley Bank’s annual report.
Why did SVB Bank run?
First, the bear market happened in 2022. As the stock market declined, so did SVB’s share price by 66%. Its customers could not raise or deposit as much capital in SVB. SVB focuses on lending to technology companies, startups, biotech, venture capital and private equity firms.
Second, the Fed raised interest rates aggressively. The higher interest rates went, the more expensive SVB’s cost of capital became, which is its deposits. SVB had to pay high interest rates to attract and retain deposits in order to remain competitive. In general, this is fine because banks can then lend the deposits at a higher rate of return. This is called Net Interest Margin or NIM.
Third, in 2021, the SVB will invest nearly half of its deposits in 10-year Treasury bonds yielding an average of 1.63%. SVB plans to hold them till maturity (HTM). Unfortunately, buying 10-year Treasury bonds in 2021 was close to a market top. After the Fed raised rates aggressively, its HTM portfolio lost value.
You would think that it would be safe to hold a Treasury bond until maturity. And this is if you own all the money. However, SVB was reinvesting short-term customer deposits, which became increasingly expensive as they had to pay more than 4% in deposit interest rates. In such a scenario, the bank is losing money (negative net interest margin).
Then when SVB decided to raise $3 billion in equity to cover its shortfall, and couldn’t, the bank’s momentum accelerated.
a bank run is a crisis of confidence
Silicon Valley Bank customers began withdrawing money because they no longer believed their deposits would be accessible.
Imagine if you were a money-losing startup that just raised $20 million. Your cash runway is 18 months unless you need to raise a second round of financing. Through no fault of your own, the risk of losing all your capital in SVB is high. Therefore, the logical move would be to withdraw all of your deposits and transfer them to a larger bank like Chase.
Unfortunately, there is no upside to leaving your deposits in a bank that is experiencing a bank run. If the bank survives, it’s not like you’re going to get much better terms (higher deposit rates, lower fees). If the bank doesn’t survive, you risk losing everything.
Thankfully, the FDIC has stepped in to make sure depositors of SVBs are covered. Contagion is bad, especially as it negatively affects innocent parties.
Even the best capitalized banks are at risk of a bank run
The Tier 1 capital ratio measures a bank’s core equity capital against its total risk-weighted assets – which includes all of the bank’s assets that are systematically weighted for credit risk.
Think of the Tier 1 capital ratio as a capital buffer to absorb losses and remain liquid enough to withstand bank runs. The higher the Tier 1 capital ratio, the more protected you are.
The average Tier 1 capital ratio for the largest banks is around 14%, higher than during the 2008 global financial crisis. However, if more than 14% of a bank’s depositors decide to withdraw at any point in time, there is a possibility of the bank shutting down.
Banking is considered a low-risk business that can generate profits with leverage. The more money a bank can lend at a positive net interest margin, the more profit it makes. The only problem is when too many depositors decide they want their money back. SVB needed to sell its HTM securities at a loss to make its customers whole, which resulted in higher losses.
If you are a regional bank like SVB, even with a 25% Tier 1 capital ratio, it will be much easier for more of its customers to decide to withdraw their deposits. SVB was the largest bank in Silicon Valley with over 26% market share.
Will the Bank Run Transition Continue?
Sadly, the Silicon Valley bank run is likely to bring more bank runs. Lots of innocent individuals and companies will lose lots of money. After all, the FDIC only insures deposits up to $250,000 per depositor, per insured bank. And most of SVB’s clients were companies with more than $250,000.
I clearly remember when Bear Stern was under taken, then Washington Mutual was under taken, then Lehman Brothers went bankrupt. As financial institutions collapsed, so did the S&P 500 and the real estate market.
Leverage is great for making money along the way, but destroys investors along the way. And right now, regional banks are being decimated by funding mismatches and a crisis of confidence in SVBs.
First Republic Bank ($FRC), one of the best regional banks, is also suffering losses. Its client base is largely affluent retail as opposed to startups and venture capital firms.
If First Republic Bank Feels Like a Bank Run, Will the FDIC Step In Too? It would be in the best interest of the economy.
The Federal Reserve Wants People To Lose Money To Suppress Inflation
The sad part is that the Federal Reserve knew these types of bank runs would happen. It is inevitable that banks will experience mark-to-market losses in their bond holdings if the Fed hikes too quickly.
Yes, Silicon Valley Bank made a mistake by buying too many 10-year Treasury bonds near the top of the market. Instead, it should have bought shorter-term Treasury bonds to better meet the maturity of its liabilities, despite the lower net interest margin.
But what happened is done. The Fed knew that banks like SVB and other regional banks would suffer from their actions, and they hiked aggressively and quickly anyway.
The Fed also knows that a recession will result in the loss of millions of jobs. But as I’ve written before, the Fed cares more about its legacy than the well-being of middle-class American citizens.
Yes, as more people lose money and their jobs, so will prices at grocery stores and gas stations. However, please be sure that you are not one of the millions who lose their livelihood in progress!
Innocent and good people in SVB who had nothing to do with management’s decisions and the Fed’s wishes are now suffering. it’s terrible.
Sometimes the medicine is worse than the cure.
I learned a lesson in 2008 not to depend on the government
I remember Monday, September 15, 2008, like it was yesterday. It was the day Lehman Brothers went bankrupt.
The Friday before, I bet my colleague, Will, $100 on the trading floor that the government would bail out Lehman Brothers over the weekend. How can the government allow the contagion to spread? I also bought 100 shares of LEH in solidarity. Oops.
It was then that I realized that I should not rely on the government for my financial well-being. Instead, it was best to rely only on yourself. The idea for the new three-legged stool for retirement was hatched, and I went on to start Financial Samurai the next year.
Please don’t trust the saviors. They will only disappoint you.
Feeling Pain Can Change You for the Better
The good thing about not getting bail is that you feel pain enough to change your ways.
After the global financial crisis, I decided to work harder, save more and invest more judiciously. My net worth became more diversified and I developed new income streams to supplement my day job income.
Without the global financial crisis of 2008, Financial Samurai would not have been born in 2009. Because till 2008 it was easy to make money. Why make contingency plans?
In the short term, the ecosystem around Silicon Valley Bank will have a major impact on Chin. The contagion would spread to other regional banks, who would experience running their own banks.
Big banks will grab more deposit dollars in order to make bigger profits. With more deposit dollars flowing in, deposit interest rates are likely to fall, giving the big banks even more money in the long run. That’s right, the big banks are the long-term beneficiaries when regional banks go bust.
If there is no trust in the banking system, our economy will suffer. So, the FDIC took over SVB and made innocent depositors whole. SVB shareholders get wiped out, but that is the cost of investing in riskier assets.
What does the bank-led transition mean for us?
If you have more than $250,000 per account at a regional bank, you may want to spread your money among other large banks like JPMorgan Chase, Citibank, Bank of America and Wells Fargo. Thanks to online banking it’s easy.
If you run a business, it’s easy to let your idle cash be less than what you earn in your business checking or savings account. I would contact the bank and invest some of that cash in high rate short term CDs of up to $250,000. Then I would take out the rest and leave just enough for working capital.
If you face a capital call with a venture capital, venture debt, or private equity firm that does banking with a Silicon Valley bank, I would not wire the money now. If you do, that’s how long your funds could be stuck, even after the FDIC has taken over and promised to make depositors whole. Instead take a wait and see approach.
If you have investments with a private fund that does banking with other regional banks, I would contact the general partners of the fund and ask for clarity. Again, unless you know that the money can be reinvested by the fund, it is not worth the capital transfer. The reality is that everyone is scrambling.
Lastly, please have enough liquidity to cover your living expenses in case you lose your main source of income. You don’t want to do a fire sale to raise money in a down market.
Now there is no need to be a hero and take extra risks
The current investment landscape is fraught with unknown risk, largely due to the overly aggressive Fed. Yes, we should also blame the investment committee of the bank which also made poor investment choices. Other banks and companies would inevitably close because of the contagion.
So, I think the best course of action is to continue to “T-Bill and chill”. My plan is to earn 5%+ in risk free treasuries while the carnage heals itself. Currently there is a huge unwinding of leveraged assets which will take time.
My main banker is u.s. There’s the Treasury Department, which isn’t going bankrupt because it can print an unlimited amount of money. If the Treasury Department fails, we will all have a problem of great concern.
Lastly, please review your net worth asset allocation and ensure it aligns with your risk tolerance and financial goals. The last thing you want is to lose all the financial progress you’ve made since the pandemic began.
Reader Questions and Suggestions
How are you preparing to run another bank? Do you think the contagion will spread to other regional banks and larger banks? Will the collapse of Silicon Valley Bank and potentially other regional banks slow down the Fed or change its rate hike decisions?
Pick up a copy of My Instant Wall Street Journal Bestseller By This, Not That. The book helps you make more optimal investment decisions so that you can live a better, more fulfilling life. You can pick up a copy for sale on Amazon today.
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