Silicon Valley Bank collapse explained (5 reasons the bank went bust)
Silicon Valley Bank, a bank previously the 18th largest in the United States, is today the most talked about bank in the world, for all the wrong reasons.
On Friday it was placed into receivership and is now being controlled the Federal Deposit Insurance Corporation (FDIC). The shares of it’s NASDAQ-listed parent company SVB Financial Group have been halted and shareholders are very unlikely to see any return.
Meanwhile, there’s a bank run on, with depositors scrambling to withdraw funds – however, the FDIC has reassured depositors all insured and uninsured deposits will be paid out, totalling around $173 billion.
So how did this happen?
Prominent bond market trader and respect macroeconomic analyst, Christopher Joye has outlined 5 key reasons why the bank went bust.
1) A concentrated business model
Silicon Valley Bank was “unusually concentrated” in both industry and geography says Joye.
By this he means the tech sector in California.
“Tech provided almost all SIVB’s deposit funding. And the vast bulk of SIVB’s loans also went to tech. As the US Federal Reserve’s hiking cycle smashed the tech industry, SIVB started losing deposits at a very rapid rate.”
Over 2022, it’s understood SIVB lost ~$25 billion in deposits. By March 2023, that accelerated to more than ~$30 billion in deposit outflows. Then on Thursday last week, depositors reportedly tried to pull ~$42 billion on that day alone.
“While this industry and geographic concentration was extreme, it is also an attribute of smaller US regional banks, which commonly collapse: since 2012, around 7 regional banks in the US have died, on average, each year.
2) No interest rate risk hedging
Christopher Joye notes this is another unusual aspect of the Silicon Valley Bank business model.
“SIVB unusually appeared not to hedge any interest rate risk at all, which meant that it was not equalizing the very long-term interest rate risk on its ~$212 billion asset book with the very short-term interest rate risk on its ~$173 billion deposit (or liability) book,” he says.
“All large/sophisticated banks normally manage this interest rate risk (and are required to do so by regulators). Every bank on the planet runs a big asset-liability mismatch insofar as they borrow via issuing short-term (mostly at-call) deposits and lend this money out via 30 year home loans.
“Sophisticated banks hedge their asset (or loan) books back to a typically very short-term, effectively floating, interest rate to match the interest rate profile of their deposits, which are also short-term. SIVB did not do this.”
3) The bank lent out only a limited amount of its total deposits
Only 43% of SIVB’s $173 billion in deposits was used to fund normal loans. The remaining 57% was invested in financial market securities.
“The problem is that almost all these assets carried huge interest rate risks, which SIVB chose not to hedge to floating,” says Joye.
“Most bank assets are accounted for on a hold-to-maturity basis, which means they are not revalued daily: instead, they are held at their cost price. SIVB was not unusual in accounting for its assets this way. But it did mean that if it ever was subject to a run on its deposits, its assets might not be worth the original cost price that it was reporting – they might be worth materially less.”
4) Fed rate hikes
In 2022 the Fed dramatically hiked its overnight policy rate from 0.25% to 4.75%, which lifted long-term government bond yields in the US from ~1% to ~4%.
“If you did not hedge your interest rate risk, this materially reduced the value of your assets,” explains Joye.
“It is not a problem if you hold these assets until their maturity when you get repaid 100% of what you invested. But if you have to sell them at current, marked-to-market prices, it could be a big problem, as SIVB discovered.“
5) SIVB exploited a Trump regulatory change
All large US banks have to deduct any unrealised losses on their hold-to-maturity assets from their reported equity capital base.
This provides investors with a clear picture of how much of an equity buffer they really hold. The cut-off to be considered a large bank that is captured by this rule is $50 billion. This would have caught SIVB, which as at December 2022 had more than $200 billion in assets.
But in 2018 when SIVB only had $50 billion in assets, Trump lifted the cut-off to $200 billion.
“This meant that SIVB’s equity capital base could be artificially inflated if interest rates spiked or there was ever a run on its deposits. If SIVB had to sell assets to meet these outflows, it would incur losses, and its equity capital base would be reduced materially.
“This is precisely what happened in March 2023. SIVB announced a $2.25 billion equity raising to cover $1.8 billion in realised losses on a sale of a $21 billion fixed-rate debt portfolio. Investors then extrapolated that if there were more deposit outflows, there would be more realised losses. And the rest is history.”
Further Silicon Valley Bank demise reading
Greg Becker, the chief executive officer of Silicon Valley Bank, made a personal profit of $3.37 million in January, after converting SIVB options and selling stock.
The trades were made just weeks before The California Department of Financial Protection and Innovation closed the bank and appointed the Federal Deposit Insurance Corporation (FDIC) as its receiver.
Just hours before it was revealed Silicon Valley Bank – the 18th largest bank in the U.S. – is on the brink of bankruptcy, one options trader executed a trade that would turn $4000 into just over $1.2 million.