As you have likely read in the headlines Silicon Valley Bank (SVB) was closed Friday by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. Over the weekend, U.S. regulators subsequently announced that they would guarantee all deposits of SVB, both insured and uninsured, that they would use emergency-lending authorities to make more funds available to meet demands for bank withdrawals across the banking system. Both moves were designed to shore up wavering confidence in the banking system.
The failure of SVB is the second-biggest bank failure in US history trailing only the failure of Washington Mutual in 2008. The bank was the 16th largest in the US with $209 billion in assets as of the end of 2022, according the to the Federal Reserve. Total deposits stood at $175 billion, with $152 billion of those uninsured.
In light of the market reaction and general concerns about the health of the banking sector, we wanted to share two observations:
We believe SVB’s failure is likely to be a relatively unique situation that isn’t indicative of the health of the broader banking industry.
SVB was a tech-focused bank focused primarily on providing banking services to start ups and the funds that invest in them (i.e., venture capital and growth equity funds). The bank experienced rapid growth in recent years alongside the tech industry and deposits nearly doubled in 2021. In turn, SVB loaned these balances to other customers, and invested these balances in securities (e.g., U.S. Treasurys) to generate yield.
Under normal market conditions, deposits are relatively sticky and the returns from loans and marketable securities portfolio are relatively predictable. In the past year, however, there has been stress on the deposit side as investments into the tech sector slowed considerably at the same time as tech companies and VC funds have been burning cash at an elevated pace. That left the outflows from SVB much higher than the bank expected.
In order to meet the demand for withdrawals of these deposits, SVB had to sell assets from its securities portfolio. These assets had declined in value due to the rise in interest rates and were valued at less than they were purchased for. The bank was thus forced to sell these securities at a loss and the bank attempted to raise capital which clearly raised additional concerns amid investors and depositors. This led to a cascading effect of confidence and deposit withdrawals thus setting the stage for the bank’s ultimate demise.
We don’t believe this is a precursor to a wider issue in the banking sector.
Specialized banking industry fund managers and analysts we follow have pointed out that while other banks across the industry have unrealized losses in their securities portfolio due to rising interest rates, the vast majority are viewed as safe from the kind of losses that would leave them insufficiently capitalized, even if they were realized.
Critically, these unrealized losses don’t need to be realized unless a bank is faced with significant depositor withdrawals. The chance of this occurring at large, systemically important banks is greatly reduced given their much more diversified depositor bases and significantly lower percentage of deposits in excess of the FDIC insurance threshold. Analysts currently view the risk as primarily residing outside of the major banks (i.e., a limited number or smaller and mid-sized banks with deposit and/or loan books concentrated in stressed sectors or geographies).
Further, we believe that the emergency measures announced by regulators over the weekend that they would be guaranteeing all deposits of SVB and that they would use emergency-lending authorities to make more funds available to meet demands for bank withdrawals should be sufficient to stave off a potential widespread depositor panic.