On Friday, the FDIC took control of Silicon Valley Bank (SVB). On Thursday, the bank reported it was trying to raise new capital to help shore up its balance sheet. This caused a bank run as customers were trying to withdraw their deposits.
Silicon Valley Bank wasn’t a household name to a lot of people. That’s because they were largely focused on providing banking and lending services to technology companies and startups.
Why did this happen?
A simplified explanation is that SVB took in a lot of deposits in the last few years. They parked a lot of that money in low-yielding government and agency bonds. These are safe if held to maturity. But SVB had to sell $21 billion of bonds last week because clients were withdrawing funds and SVB needed cash to be available.
The problem is that interest rates are much higher now than they were when SVB purchased these bonds. This isn’t an issue if you plan on holding these bonds until maturity. However, if you try to sell these bonds prior to maturity, you will sell them at a loss because interest rates for newer bonds are much higher, making your lower-yielding bonds less desirable.
SVB realized a huge loss on these bonds and responded by announcing plans to sell additional stock in the company in order to replenish their cash.
How do you think clients with cash in SVB responded after hearing their bank was in trouble? You guessed it—they pulled their money. A reported $42 billion was pulled on Thursday, March 10. Venture Capital firms were telling their portfolio companies to pull out their money because SVB was in danger of failing.
Doesn’t FDIC insurance protect depositors? Absolutely! The FDIC has already taken control of SVB and immediately announced insured deposits would be made available on Monday, March 13 (over the weekend they announced even non-insured deposits would be safe).
Will this affect other banks?
Bank stocks have been down since last week on fears of “contagion”. Often in times like this, it’s “fire, ready, aim” when it comes to evaluating the ramifications. While some viewed SVB’s issues as idiosyncratic because of its concentrated client base in tech and VC-backed firms, other smaller “regional banks” are in the crosshairs (Signature Bank based out of New York was also taken over by the FDIC).
The FDIC, Federal Reserve, and Treasury announced a major plan to instill confidence in the banking system by offering funding to banks through a new Bank Term Funding Program (BTFP). Instead of these banks needing to sell bonds at a loss, they can pledge them as collateral in exchange for a short-term loan. These bonds would be valued “at par” instead of at a loss.
While we can debate whether these actions were warranted, I do not believe we will have a financial meltdown like we had in 2008-2009. Instead of toxic subprime mortgages, these banks were holding high-quality US Treasury and agency bonds. Did they mismanage their risks? Yes. Will it cause a financial catastrophe? Not likely.
