KCS Quick Take – March 12, 2023
March 17, 2023
SVB: Canary in the Coal Mine or Just a Dead Duck?
Last week featured a surprising development. In the midst of a decent economy and no financial crisis in sight, a large bank suddenly went under: Silicon Valley Bank (SVB). Its stock cratered to essentially zero by Friday and other bank stocks were also hit hard by fears of contagion, with the Dow Jones Bank Index falling over 7% in 2 days. What happened and should we worry there’s more to come?
Who is Silicon Valley Bank?
SVB catered primarily to venture-backed technology companies. During the pandemic, many of these companies generated gobs of cash and deposited much of it with SVB. Between April 2020 and the end of last quarter, SVB’s deposits surged from $60 billion to almost $200 billion. The bank loaned out some of this cash and invested most of the rest in “safe” US government bonds. By the end of last year, it owned $128 billion of these securities.
What Went Wrong?
While government securities are immune to default, they are still subject to the effects of interest rates, which have been going up for over a year now. When rates rise, bond prices fall. Longer-term bonds do worse than short-term ones, and SVB had lots of the former. By the end of last year, it had unrealized losses of $17 billion on its bond portfolio.
Most other banks have similar issues to some degree, but SVB was an outlier in the size of these losses relative to its equity capital, which is what cushions banks from market and loan losses. To give you an idea of how much of an outlier SVB was, its unrealized securities losses represented 98% of its equity capital. Compare this with KCS’ largest US bank holding, JPMorgan Chase, whose unrealized losses total a mere 12% of equity.
What Else Went Wrong?
Unrealized losses on securities are not a problem for banks so long as they have ample cash to fund loans and provide cash to customers. Where do banks get this cash? From investors and depositors. SVB got into trouble because depositors were rapidly withdrawing their cash. At first, this was because those early-stage tech companies were continuing to burn through cash but unable to raise additional funds from venture capitalists. With interest rates so much higher than during the pandemic, venture funds became much stingier with their money. Withdrawing cash from SVB became these companies’ only option. During the last 9 months of 2022, depositors withdrew about $27 billion. And these withdrawals accelerated in 2023.
This meant that SVB needed more cash to continue to operate. Last Wednesday, they announced that they had sold $21 billion worth of government securities and took a $1.8 billion after-tax loss on the sale. SVB planned to replace these securities with bonds yielding today’s higher interest rates. At the same time, they wanted to raise another $2.25 billion in equity capital to replenish their cash.
In a normal market environment, investors would have taken this in stride. But with many already worried about the economy, this announcement did not sit well with the markets, causing SVB’s stock price to crater. This made it even harder for the bank to raise capital and they had to cancel their stock sale and start looking for a white knight to buy them. The bank was now in serious trouble.
What Was the Coup de Grace?
On Thursday things got really bad. Many venture capital firms started to advise their clients to withdraw their deposits, fearing the bank might collapse, and many clients dutifully complied. On that day alone, customers tried to withdraw $42 billion in deposits, 50% more than in all of 2022, creating a “run” on the bank. No bank can survive such a run (more like a sprint) and the FDIC stepped in on Friday to shut down SBV. The FDIC has stated that, by bank opening on Monday morning, all insured deposits (those under the $250,000 FDIC insurance limit) will be fully available to customers. But cash over those insured amounts will have to wait to be claimed until the FDIC works through the bank’s assets or arranges a sale.
Unfortunately for SVB, accounts under $250,000 represent only 2.7% of deposits, as nearly all their customers are businesses rather than individuals. Some of these tech company depositors may run into problems themselves if they can only withdraw $250,000 and don’t have access to the rest of their cash for a while.
Will the uninsured depositors eventually get all their money back? We’ll probably know the answer soon. In 2008, when Washington Mutual went under, no depositors lost money because JPMorgan Chase took over the bank. If the FDIC can find a buyer for SVB, then all depositors will likely be made whole.
What About Other Banks?
As mentioned above, prices of other bank stocks were also hit last week, though none so badly as SVB. The concern is that unrealized securities losses will reduce a bank’s equity capital if it, like SVB, needs to sell some of them to raise cash. But this only happens if there is a run on deposits, and SVB was unique in that most of its depositors were venture-controlled tech firms. So long as customers don’t withdraw money en masse, no other bank should get into trouble. We are, however, keeping our eyes out for the most vulnerable banks and are obviously avoiding their stocks.
Will There Be Ripple Effects from the SVB Failure?
Although other banks are in far better shape than was SVB, it’s possible there could be a couple of smaller bank failures. More likely, we’ll see some pain in companies with direct ties to SVB. One has already appeared: Circle, a cryptocurrency firm, revealed Saturday morning that it has $3.3 billion of its $40 billion in reserves at SVB. As a result, its stablecoin, USDC, fell below the $1 peg to 87 cents. Whether losses are actually realized depends a lot on whether the uninsured SVB depositors are made whole.
We’re sure the Fed is watching all this very closely, as it is the US’ main banking regulator. Given the sharp fall in interest rates on Thursday and Friday, it seems the market thinks the Fed will slow down its planned interest rate increases while it waits for the dust to settle. As we’ve said a few times, the Fed typically stops raising rates when something breaks. SVB’s failure might be the crisis that forces the Fed’s hand. We’ll have to wait and see.
Should You Do Anything Right Now?
There’s no reason to make any rash moves. We think the market’s and depositors’ reaction to the SVB failure was overdone because SVB truly is unique for the reasons cited above. Thus, we don’t believe that SVB is a canary signaling more pain to come, but just a dead duck. Your investments will recover and your bank should be just fine.
For anyone with less than $250,000 on deposit a bank, the FDIC will fully protect you and access to your funds should not be delayed at all, even if the bank were to fail. If you have more than $250,000 at any one bank, ask your advisor whether we think that this particular bank is at risk. The most likely answer will be “No.” However, if you want ultimate peace of mind, your advisor can discuss how to organize your cash holdings to maximize FDIC protection.
Dr. Ken Waltzer, MD, MPH, AIF®, CFA, CFP®
The KCS Investment Department
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