We are not in 2008. Headlines reminiscent of the Financial Crisis, “Bank Collapse” or “Government Bailout,” may make it seem like déjà vu, however, Silicon Valley Bank’s (SVB) failure is quite different. Complex securities drove the Great Financial Crisis; no one, including the banks, had any concept of how great the losses could wind up. In contrast, SVB’s collapse resulted from irresponsible investing of its assets and not considering the risks if its deposits slowed.
The failure of SVB has been in the making since 2020. SVB had a niche client focus in the venture capital and technology industries, which had phenomenal runs during the pandemic leading to an influx of cash to deposit at the bank. Most banks want a diverse, low-risk customer base to make up most of their deposits; SVB took the opposite approach catering to narrow, higher-risk industries.
SVB invested customer deposits in safe, high-quality, longer-duration government securities. There was nothing wrong with this portfolio unless it faced a perfect storm of rising interest rates, slowing deposits, and increasing withdrawals, which brings us to today. SVB bought a large portion of its bond portfolio during a period of record-low interest rates. When interest rates rise, the value of bonds falls. This is only a paper loss if bonds are held to maturity, as SVB would have received the total amount at each bond’s maturity. Importantly, when SVB purchased these bonds, it did not consider having to sell the securities. These assets were “held to maturity” rather than “available for sale,” which would have limited the losses SVB had to realize.
Until recently, SVB could cover withdrawal requests with its liquid cash portfolio and customer deposits. Then, customer deposits went to outflows (remember its niche customer base in an industry that no longer deposits money daily) when those same companies needed their deposits back to meet basic business expenses. Last Wednesday, SVB sold $21 billion of its bond portfolio, realizing a $1.8 billion loss on its books. SVB aimed to reinvest some of its low-interest-rate bonds into the same government-backed bonds, now trading at higher interest rates. SVB also announced it would raise $2.25 billion of capital by issuing additional stock, which made customers realize how dire the situation had become.
After the announcement of the bond sale and capital raise, customers began a run on the bank, requesting $42 billion of the $179 billion deposits on March 9th alone. SVB had just over $20 billion of cash on hand, quickly leading to insolvency and forcing the Federal Deposit Insurance Corporate (FDIC) to take control of the bank last Friday, March 10th. Over the weekend, the FDIC, Federal Reserve, and U.S. Treasury stepped in to save investor deposits, both those insured by the FDIC and the uninsured. In the case of SVB, most (90%) of its deposits were uninsured, meaning accounts with a balance greater than $250,000.
While much of the focus is on SVB, Silvergate Capital and Signature Bank were also taken over by authorities in recent days. These banks also had a narrow focus, just on the cryptocurrency industry, with longer-duration bonds hurting the value of their portfolios. All three banks saw authorities step in to rescue depositors, not the investors or management teams.
It is important to remember that this is not 2008. Contagion is not spreading across the banking sector; it is focused on banks focusing on a niche industry while taking duration risk in their investments. Losses are known, and depositors have already been rescued. The stock market will experience volatility, credit conditions may tighten, and new regulations will most likely be enacted. This is another volatility-inducing crisis, but not a reason to change an investment portfolio. Allegheny believes in diversified portfolios to mitigate situations just like this. We are not overexposed to regional banks and fully expect portfolios to rebound and continue to meet their long-term objectives.
Author: Joe Clark, CFA | Research Team | Allegheny Financial Group | March 2023
The information included herein was obtained from sources which we believe reliable. This report is being provided for informational purposes only. It does not represent any specific investment and is not intended to be an offer of sale of any kind. Past performance is not a guarantee of future results.
Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered Broker/Dealer. Member FINRA/SIPC.