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Collapse of Silicon Valley Bank: What pushed this 40-year old bank to doomsday?

A pile of money. (Government Accountability Office)

Founded in 1983, California-based Silicon Valley Bank went on to become the largest bank by deposits for the home to many startups and the biggest names in the tech sector, Silicon Valley. But last week, this bank met its doomsday when the California department shut down its business. Now, approximately 175 billion dollars of deposits are at stake! The reason behind SVB’s collapse would be the shortage of cash. SVB now holds the title of the largest bank failure since the 2008 financial crisis. So where could this four-decade-old bank go wrong?

Currently, billions of dollars of wealth are trapped in SVB. Federal Deposit Insurance Corporation (FDIC) which is appointed as the receiver for SVB has created a Deposit Insurance National Bank of Santa Clara (DINB) which is expected to protect both insured and uninsured depositors of SVB. The bank will reopen on Monday which will be maintained by DINB and deposits will be released to the companies accordingly.

But the real question is will the uninsured depositors recover their full amount from SVB? Everyone is uncertain and there is a sense of panic among companies especially startups who need funds to carry out their operations.

It makes you wonder really where did things go so mind-bogglingly wrong with Silicon Valley Bank?

SVB is a subsidiary of SVB Financial Group. And at the time of failure, SVB was the 16th largest bank in the United States.

The issue with SVB is still being evaluated by experts. However, certain cracks are founded in the bank’s liability. Simply put, SVB had higher reliance on institutional/VC funding rather than traditional retail deposits. Also, US Fed’s policy rate has also played a key role in the downfall of SVB.

Michael Cembalest, Chairman of Market and Investment Strategy for J.P. Morgan Asset Management, in a note, said, SIVB’s $209 bn in assets are roughly 2/3 of Washington Mutual (not adjusted for inflation), which failed in 2008. The mid-day closure of the bank was unusual and is something we are still evaluating.

Cembalest report dated March 10th, explains that while capital, wholesale funding, and loan-to-deposit ratios improved for many US banks since 2008, there are exceptions. Adding he said, “SIVB was in a league of its own: a high level of loans plus securities as a percentage of deposits and very low reliance on stickier retail deposits as a share of total deposits.”

The bottom line as per Cembalest is that SIVB carved out a distinct and riskier niche than other banks, setting itself up for large potential capital shortfalls in case of rising interest rates, deposit outflows, and forced asset sales.

After a brief look at SVB’s funding, Cembalest pointed out that the bank has “unusually high reliance on corporate/VC funding; only the small red private bank slice looks like traditional retail deposits to us.”

Of the total deposits at SVB by end of December 2022, about $152 billion are reportedly uninsured — which is over the $250,000 FDIC insurance threshold. And only y $4.8 billion were fully insured.

“It’s fair to ask about the underwriting discipline of VC firms that put most of their liquidity in a single bank with this kind of risk profile. At the end of 2022, SIVB only offered 0.60% more on deposits than its peers as compensation for the risks illustrated below; in 2021 this premium was 0.04%,” his note added.

JP Morgan expert highlighted in regards to past banks’ failures and their losses imposed on uninsured depositors. He cited FDIC Resolution Tasks and Approaches data for this, and gave a glance at the failures of banks during crisis years.

Here’s how losses are passed when banks fail, Cembalest cited: — 1980-1987: losses imposed at 24% of resolutions — 1988-1991: losses imposed at 14% of resolutions — 1992-2007: losses imposed at 65% of resolutions — 2008: despite deposit insurance limit increase from — $100,000 to $250,000 and a temporary guarantee program for uninsured noninterest-bearing transaction accounts, losses still imposed at 28% of resolutions — 2009-2013: losses imposed at 6% of resolutions

From the data, it can be seen that in recent times the quantum of losses that are passed on to uninsured depositors when a bank fails has reduced, however, a certain degree of losses were passed still.

By end of the December 2022 quarter, in SVB’s deposit funding — early-stage technology accounted for the most weight at 29%, followed by the technology sector at 20%, while international at 18%, US global fund banking at 14%, early-stage life science/healthcare at 8%, and private banks at 7%.

According to Cembalest, between Q4 2019 and the first quarter of 2022, deposits at US banks rose by $5.4 trillion and due to weak loan demand, only ~15% was lent out; the rest was invested in securities portfolios or kept as cash. Banks can designate these securities as being “available-for-sale” (AFS) or in “hold-to-maturity” (HTM) portfolios instead.

His note added, “SIVB was one of the banks that relied extensively on HTM treatment for its growing securities portfolio: since 2019, its AFS book grew from $14 to $27 bn while its HTM book grew from $14 to $99 bn. Selling HTM securities is complicated since it results in larger parts of the portfolio being suddenly marked to market, which can in turn then result in the need for a capital raise.”

So, hence, his note said, “the big question for investors and depositors is this: how much duration risk did each bank take in its investment portfolio during the deposit surge, and how much was invested at the lows in Treasury and Agency yields?”

He added, “The irony of SIVB is that most banks have historically failed due to credit risk issues. This is the first major one I recall where the primary issue was a duration mismatch between high-quality assets and deposit liabilities.”

“Being flooded with deposits from fast-money VC firms and other corporate accounts at a time of historically low-interest rates might have been more of a curse than a blessing,” Cembalest concluded.


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