Silicon Valley Bank (SVB)

What Happened to Silicon Valley Bank?

Up until a few days ago, most people had never heard of Silicon Valley Bank (SVB) in the San Francisco Bay area. It is now one of the leading topics in financial news, and you inevitably will soon know more than you ever wanted. SVB was the 16^th largest bank in the United States, mainly catering to technology companies, venture capitalists and wealthy tech individuals.

So, what happened with SVB and why is everyone talking about it? On Wednesday of last week, SVB announced they needed to raise additional capital to maintain their reserves. Pro tip: It’s not a good sign when a bank needs to raise capital to maintain reserves.

Let’s take a step back and look at why they needed to take this action. The primary way banks make money is by lending money to individuals and companies. The interest they collect from the loans they extend minus the interest they pay to depositors of the bank is effectively their profit. Banks are required to maintain a certain amount of money on hand. This is called the reserve requirement, or cash reserve ratio. Essentially, the reserve requirement is the amount it needs to hold onto versus lending it out or investing it.

For example, if a bank has $10,000 in deposits and is required to maintain 10% in reserves (that low of a percentage is not unusual), then the requirement is $1,000 in reserves. In the case of SVB, they invested the $1,000 required to be held in reserve into long-term U.S. treasuries. Normally, regulators don’t worry about that because these are government securities. However, as the Fed has been raising interest rates, the value of those treasuries has dropped (the value of bonds is inversely related to interest rates). Staying with the same example, what happens if the value of the $1,000 in U.S. treasuries went down to $800? That means the bank now only has 8% in reserves versus the 10% required, thus they are now required to raise 2% in capital.

Last Wednesday, the management of the bank announced they needed to raise capital, like in our example. One of the reasons they needed to raise capital is that many of the technology and venture capital firms were having a hard time getting additional rounds of funding and ended up withdrawing funds that they had previously deposited at SVB. This further confounded SVB’s problem creating an even bigger deficit of the required reserves. To make matters worse, announcing that they needed to raise even more capital spooked depositors and these venture capital and technology firms among other depositors began withdrawing additional funds. This started a classic run on the bank, which means depositors wanted their money back. As noted above, banks loan out most of the depositors’ money. With the drop in long-term treasuries, combined with a draw down by depositors, SVB simply did not have the cash on hand to satisfy the request to withdraw funds. Hence the insolvency.

The Federal Deposit Insurance Corporation, otherwise known as the FDIC, effectively took over the bank on Friday, which means deposits under $250,000 are guaranteed. However, 95% of the deposits in the bank were over $250,000, mainly owned by wealthy tech individuals, venture capital firms and technology startups. The government has a wide range of available options for rectifying the situation as the risk of contagion to other smaller regional banks is high. Depositors may start moving funds from those banks to larger institutions, thus creating a domino effect for these smaller banks.  One important piece to remember is that SVB had specific issues in addition to those caused by rising interest rates. The technology industry, especially in Silicon Valley, has been particularly hit in the last year. Just like portfolios, it is important for a bank to be diversified across industries and geographies.

On Sunday, Janet Yellen, Treasury Secretary, stated there will be no bailout of SVB and that this is vastly different from the financial crisis we experienced almost 15 years ago. Those bailouts were done for large financial institutions, the ones deemed “too big to fail.” The most recent rounds of “stress tests” by the Federal Reserve of the largest banks and financial organizations showed that 100% of them would survive a deep recession and a sizable rise in unemployment. However, the Fed/US Treasury/FDIC all stepped in to protect the depositors by allowing all deposits, not just under $250,000, to be fully accessible. This is not a bail out and consistent with what Janet Yellen said. Banks will pay an assessment into a special fund that will be used to help SVB depositors. The government interjecting into this will likely stop significant bank runs as confidence is restored into the banking system.

What does this mean to our portfolios? Unsurprisingly, we expect more volatility than usual in the short-term as this situation is navigated. However, we do not have any direct exposure to SVB as we simply do not invest in individual companies. Even within our mutual funds and ETFs, the exposure to SVB is insignificant. It’s the equivalent to a piece of lint on a ten-ton cotton ball! It’s times like this we are reminded that diversification is the best course of action. If you ever wonder why we consistently preach that it is not wise to put too many eggs in one basket, this is a prime example. Please know we are monitoring the situation and keeping abreast of new developments. We welcome any questions and concerns you have.