Dramatic headlines caused concern for many when Silicon Valley Bank (SIVB) failed last week. Now we have more clarity on what happened, how it happened, and the remedy. We explain it all below.

What Happened?

On Thursday March 9th, the stock of Silicon Valley Bank (SIVB) fell more than 60% following several announcements from Bank management. They made public that their estimated rate of customer withdrawal was too low. In reality, it was far above the published estimates and the company had been forced to liquidate assets at a significant loss in order to keep up with the withdrawals and that the bank was exploring ways to raise capital to help with its liquidity problems.

These admissions caused investors and depositors alike to doubt the banks solvency and confidence in the bank eroded quickly. Investors sold shares of SIVB and depositors raced to withdraw their funds in a high-tech replay of depression era bank runs. Fears of contagion became very real, as concerns rapidly spread to other bank stocks, the S&P 500 Bank Index dropped -6.56% while the Regional Bank Index fell -8.23%.

On Friday, March 10th the Federal Deposit Insurance Corporation (FDIC) put SIVB into receivership, meaning the bank had failed and they were stepping in to try to sort out the mess. They announced that depositors eligible for FDIC Insurance (covering up to $250,000) were to be paid in full on Monday, March 13th.

The issue was that less than 10% of SVB’s deposits were covered under FDIC insurance. This led to fears that the majority of depositors money, funds that companies rely on to pay their employees and keep their operations running, would be unavailable. Consequently, other banks in the area that had overlap started to see a spike in withdrawals as fears among depositors started to grow.

How did this Happen?

There were two main issues that caused SVIB to fail, its failure is seen by some as a symptom of the unique client base it served:

• High Industry Concentration – SVIB’s customer base was primarily made of up tech start-ups and the venture capital firms that fund them in their initial stages. As interest rates have increased and funding has been harder for these firms to secure, they have needed to draw on their deposits with SVIB at a much faster rate.
• Fixed Income Portfolio Losses – All banks take depositors’ money and either make loans or invest it in safe assets like U.S. Treasuries. SVIB invested much of its excess liquidity into fixed income securities at low interest rates in 2020 and early 2021. As interest rates increased rapidly, these securities lost value (interest rates up = bond prices down). Normally this is not an issue for banks, as they can hold the bonds to maturity and receive full par value back.

These two issues created a perfect storm. As SIVB’s base of tech startup clients found funding harder and harder to come by, they started withdrawing more and more of their deposits. SIVB, lacking a diversified client base, as well as an established loan portfolio to fall back on, needed to come up with funds to meet withdrawal requests from their investment portfolio. They were not able to wait for bonds to mature at par, but were forced to sell them on the open market at large losses.

As news broke on Thursday, the run on SIVB only exacerbated the problem. Several last ditch attempts to raise capital through issuing stock or finding a buyer for the entire bank fell through and by Friday the bank had failed.

FDIC and The Federal Reserve Respond

Monetary authorities acted quickly and scheduled emergency meetings over the weekend as it appeared a banking crisis could be forming. The Federal Reserve and FDIC announced a series of emergency measures on Sunday evening. The keystone of their actions is that they designated SIVB and a second bank Signature Bank in New York (SBNY), as systemic risks to the financial system.

This designation allowed them to use the deposit insurance fund to calm fears by announcing that all depositors at SIVB and SBNY will be made whole and access to their funds will be available starting Monday 3/13. The override of the $250,000 limit to FDIC insurance means that 100% of funds at SIVB and SBNY will be returned to depositors as soon as possible, eliminating the liquidity fears of those depositors.

The Federal Reserve then announced that it had created a facility called the Bank Term Funding Program (BTFP). This program will seek to help stabilize bank balance sheets by offering banks loans. These loans can be collateralized by fixed income securities (bonds) valued at par. The goal is to help banks avoid being forced to sell bonds at market prices, absorbing potentially massive losses.

It is important to note that this is not a taxpayer funded bailout, the money used to backstop the depositors is coming from the deposit insurance fund, which is funded by the fees the FDIC charges banks for its insurance. Stock and bond holders (investors), as well as the employees of the banks, are not protected in any way by the emergency measures announced over the weekend.

Our Commentary

• While no one predicted this exact set of events, these are the kind of stresses that occur when the Federal Reserve is hiking rates into an already slowing economy. We are watching developments related to the banking system and will take action to further reduce risk in client portfolios if we believe it is necessary.
• While the emergency measures taken by the Federal Reserve and FDIC are welcome, it is by no means an “all-clear” signal. Investors must remain vigilant, and it is worthwhile to remember that other financial crisis events have played out over time, not over a single week.
• There are continuing risks to banks, these risks are elevated for smaller regional banks, and banks that have large exposure to tech start up and cryptocurrency.

Our Recommendations

• Even though the FDIC can use the “systemic risk” designation to insure bank deposits over $250,000, it takes Congressional approval to formally change the $250,000 threshold. Investors should note that they have not done so, and at this point there has not been talk of Congress taking any action.
• It is important to know how much cash you have, and where it is.
• If you have more than $250,000 in cash per depositor, per insured bank, for each account ownership category, you should consider ways to mitigate your risk exposure. This includes opening additional accounts at the same bank in a different ownership category or opening an account at another FDIC insured bank.

Our Outlook: Bearish

The economy is starting to slow, but inflation remains stubbornly high. The Fed meeting on February 1 confirmed the roadmap of continuing to raise and keep rates high to curb demand pressures. Given low unemployment, this likely means they will push the economy into some type of recession, resulting in job losses to help kill demand and bring prices back down. Caution and patience are warranted.

How we Can Help

For more information on Schwab FDIC insurance check out this document, or if you would like to discuss safeguarding your assets further, please contact us.