In this article, we will look under the hood (or sub-cutaneous fat) of Silicon Valley Bank to understand those 48hrs between its seeking liquidity and declaring insolvency.
We are taking the view that SVB is a victim of its environment. In 2021, SVB gorged on a VC-backed economic boom of multi-million $ deposits piling up cash in the start-up community. Think IPOs, SPAC offerings, pre-seed funding for web3 and crypto and anything else that would ring alarm bells now, but rang jingle bells only two years ago. While a typical high street lender will match its deposit incomings with intensely diligenced lending (among other activities), SVB was flooded with cash and providing either stretched leverage lending based on its customers' ability to continue to raise VC funding or, where loans did not cover SVB's required outgoings, SVB bought (mostly) long-term fixed rate government bonds.
In a traditional banking model, as we are currently seeing, when interest rates increase there should be: an increase in the interest a bank pays on its deposits (although, this is a choice); and an increase in the interest a bank receives on its lending. Typically, and currently, commercial banks profit from the extra interest earned on lending until they are forced (by footfall) to offer better interest on deposits.
SVB does not benefit from this dynamic for two reasons: long-term government bonds’ market value decreases as interest rates increase (the economic outlook is particularly bleak at the moment); and periods of high-yielding short-term government bonds make far less attractive the risky web3 investments that might deliver a decent level of return in 10 years. Right now, you can get 5% yield on a 1-year T-bill for the first time in 15 years.
SVB found itself in an environment where its long-term bonds were losing value (c.$21bn of exposure). That’s fine, even if you suddenly required liquidity your asset base remained relatively diversified. Then, SVB’s start up customers simultaneously found themselves both: struggle to raise capital and facing the headwinds of inflation (mostly payroll). So, you have to liquidate your long-term bond exposure to cover an unexpected level of deposit withdrawals. Ok, tough but manageable. As long as it doesn’t make headline news that you lost $1.8bn on your bonds exposure. As long as you don’t then fail publicly to complete a capital raise, also making headline news. Thus, we have reached 36 hours.
Let’s take a breath to understand what a ‘bank run’ is. Where there is a mass concern over a bank’s solvency among its customer base, swathes of those customers simultaneously withdraw their deposits over fear their cash will be lost. This is fatal with the combination of two factors: truly all of a bank’s customers panic-withdraw (and not just, say, a 50% majority limited by having to queue at physical a bank to withdraw money as they did up to 2008), the bank does not have sufficient reserves to cover the withdrawals.
Let’s re-join hour 36, where SVB’s tech-enabled withdrawals are putting pressure on reserves as its venture capital hive-mind customer base all simultaneously (and I mean 80% of them) begin to panic that SVB is no longer solvent. This beast of glutton is placed firmly on the starting line, tasked with a run that parallels 800m Olympic finals. Spoiler alert: it lost.
SVB’s collapse was driven by a unique set of circumstances that put the bank under immense pressure over a short period. Sure, other lenders in the same position may start to sweat. Those lenders are unlikely to be systemically important, just as SVB wasn’t. You should have derived from this article that SVB served a particular market niche and was heavily concentrated to that niche. A set of relatively unique circumstances (see: Silvergate) culminated in a mass media-induced bank run within SVB’s particular ecosystem, a run not even driven by a genuine understanding of SVB’s balance sheet. Which, by the way, at the end of 2022 showed tangible assets of c.$200b and deposits of $173bn. SVB lost a relatively non-eye watering c.$1.8bn on its bonds portfolio. Judging by the Fed, treasury and FDIC all saying on Sunday afternoon that uninsured and insured deposits are both fully recoverable by customers, there is likely close to sufficient liquidity (with some support, but looking unlikely to be taxpayer). Shareholder value, however, is not recoverable.
So, is SVB the first sign of a storm? In the Silicon Valley tech ecosystem, the party is fast coming to an end; and more widely, FAANG is struggling to keep pace. The UK has made expressly clear that HSBC's government-approved rescue of SVB UK is to protect Britain's "most prominent and exciting businesses". This recession is intense and the causes are unprecedented. Systemically, though, and for the rest of us looking through the lens of a global economic crisis... let’s not squeeze into our lycras quite yet.
As an aside, the impact of the SVB shock on the Fed's rate hikes remains to be seen later this month, a balancing act to be had between recession indicators, inflation and, now, non-systemic bank liquidity. If SVB was a unique, overexposed (to interest rates) phenomenon and the Fed knows that, we really could see the rate hike go either way - sustained momentum or a dulling of the blade.
Source: Bloomberg Opinion.
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