Everybody's talking about Silicon Valley Bank, so we will too. As a financial advisor, I know many of you have concerns, even if you're not directly tied to the tech and start up space. What actually happened? Will it spread to other banks? And critically, how will it affect your financial plan? Here's a microcosm of what happened with Silicon Valley Bank.
What Happened to Silicon Valley Bank?
Silicon Valley Bank is just like every other bank. They're highly dependent on two things:
- Steady, predictable deposits
- The valuation of their loan portfolio
The Unique, Challenging Start-Up Sector
In this case, Silicon Valley Bank has a particularly challenging business model because they are a bank for Silicon Valley companies, not mom-and-pop small businesses. These start ups and VC firms often go out and get a billion dollars in financing. Where do they take it? Silicon Valley Bank.
Those companies then immediately start paying people out of that and spending money like drunken sailors, as startups do. Many of their customers don't aim to keep a stable balance like you or I might. They're spending down that capital.
That means that Silicon Valley Bank's deposits, which have tripled in the last four years, are very not sticky. So their business model requires them to look for new companies to come in, deposit a lot of money, and then continue to spend it down over time. Their deposits are particularly volatile.
The Declining Value of Their Loan Portfolio
On the other side is the valuation of their loan portfolio, which is dependent upon long-term interest rates. Many banks loan out ten times their deposits. While this is common, it leaves them vulnerable to a certain scenario... like say, if interest rates suddenly went up by 4 or 5% on a bunch of 30-year mortgages. If something like that were to hit a bank's loan portfolio, all of the equity in the bank could be gone in a moment.
What Triggered the Bank Run?
A year and a half ago, SVB put a lot of money in 10-year government bonds, which were paying 1.5%. They bought a bunch of assets in the form of their loan portfolio that were yielding one and a half percent. They were not anticipating that interest rates would go up by four or five percentage points on that portfolio over the course of the last year, which caused a significant drop in the valuation of those bonds.
It left them vulnerable because of a volatile deposit portfolio and an extremely volatile loan portfolio.
(The guy who is their chief risk person was involved in Lehman Brothers before they crashed. I'm not sure who put that guy in charge again of a $200 billion-plus organization, but he's in charge again. So maybe this time he'll retire. Anyway, I digress.)
An Almost $2B Loss Selling Bonds
In the midst of their VC and start-up clients burning through cash, they did was they decided to sell off some of their bonds at a loss and issue more stock to improve their capital situation. As a sign of urgency, they sold over $20B in bonds at a nearly $2B loss to have access to cash. A bank accepting that kind of loss to access capital was seen as a red flag to many of their clients.
When that move was made, a bunch of their depositors came out and said, "The FDIC only ensures up to $250,000. We've got something like $900 million in deposits with this company. Maybe we should diversify how many banks we have our cash in."
As a result, a bunch of their depositors showed up in a really short period of time and said, "Hey, we've decided we want to work with six banks, not one. So we want 90% of our money out." Well, that's a run on the bank. In the midst of this chaos with a declining value on their loan portfolio and already unsticky deposits, a bunch of their deposits went away really fast.
That's what caused the cash crunch. That's what caused the regulators to come in and close down Silicon Valley Bank and all bondholders and all stockholders of the Silicon Valley Bank are going to be completely wiped out.
What to Learn From This Collapse
There are a lot of rules and lessons here. At a high level:
- Diversification is a wise principle.
- How banks manage their risk is really important.
- And the big question: is this a Lehman Brothers moment?
Even though there's that one guy who's probably going to lose his job again, but seriously, is this a Lehman Brothers moment?
The short answer? We don't know.
We think that there will be other banks that get whipsawed like this. We think that many of those banks and their boards are taking a lot of notes right now to try to study this and figure out how not to be next week's SVB. Nobody wants to have their acronym up next to the word contagion in a headline. Everybody's trying to avoid that.
Time will be the best predictor of how far this splash reaches. If you're a client of Vizionary, rest assured we are watching closely for how this will unfold – not just as a headline, but as a part of your financial world. Here at Vizionary Wealth Management, we're always here with perspective for the decisions ahead. Call anytime. Have a great day.