Why did Silicon Valley Bank collapse within just 48 hours?

SVB Financial Group, the parent company of Silicon Valley Bank (SVB), has recently made headlines for its unexpected collapse. Despite owning one of the safest assets in the financial world, the bank went under in just two days. This has left many wondering how such a reputable institution could crumble so quickly.

To shed some light on the matter, the Wall Street Journal has provided a series of questions and answers to explain what has just occurred.

Why did this happen?

SVB Financial is the parent company of Silicon Valley Bank, which serves many startups and venture capital firms in the Silicon Valley area. Since its establishment in 1983, SVB has specialized in providing financial services to technology startups.

During the pandemic, these customers saw a surge in cash inflow, leading to a boom in deposits at SVB. By the end of Q1 2020, the bank had a total of just over $60 billion in deposits. However, by the end of Q1 2022, this number had skyrocketed to $200 billion.

Over the past five years, SVB has grown four-fold. As of the end of last year, the bank had a market capitalization of over $40 billion.

What did SVB Financial do with all that money?

SVB Financial spent tens of billions of dollars to purchase two of the safest assets available: long-term U.S. government bonds and asset-backed securities guaranteed by the government. The bank’s securities portfolio grew from $27 billion in Q1 2020 to approximately $128 billion by the end of 2021.

Why is this a big problem?

These securities have virtually no default risk. However, they pay a fixed interest rate over a very long period of time, sometimes several years. This is not a big issue unless the bank suddenly has to sell those securities. But that’s exactly what happened.

Due to a sharp increase in interest rates on the market, the value of these bonds plummeted on the open market compared to the value recorded on the bank’s books. As a result, the bank had to sell them off as quickly as possible to avoid a ballooning loss.

By the end of 2022, SVB’s unrealized losses on its securities portfolio – the difference between the amount of money invested and their fair value – had reached over $17 billion.

Are there any other issues?

At the same time, cash inflow to SVB reversed as customers began running out of money. We all know that many tech companies struggled to stay afloat during the pandemic, leading to a cash crunch. It became increasingly difficult for these firms to raise funds, whether through stock offerings or venture capital investments.

Furthermore, the cost of borrowing also increased sharply with each Fed interest rate hike, making it increasingly expensive for SVB to attract deposits. Deposits at the bank plummeted from nearly $200 billion at the height of the pandemic to less than $170 billion by the end of 2022.

As we step into 2023, the situation worsens. On January 19th, SVB predicted a deposit decline of about 5% in 2023. However, on March 8th, they had to adjust their prediction to a two-digit figure.

What was SVB’s original plan?

On March 8th, the bank announced that it had sold a large amount of bonds worth $21 billion, and incurred a loss of around $1.8 billion (after taxes) in order to “reset” the interest rate yield in the context of rising bond interest rates, while also strengthening the accounting balance sheet to meet deposit withdrawals and funding new loans.

In addition, SVB also raised $2.25 billion in new capital.

Why did the plan fail?

After the announcement on the evening of March 8th, SVB’s stock plummeted, making it even more difficult to raise new capital and ultimately forcing the bank to postpone its stock issuance plan. Some speculative investment companies started advising firms in their portfolio to withdraw their deposits from SVB.

What happened to customers’ deposits?

Many deposits were too large to be insured by the Federal Deposit Insurance Corporation (FDIC). According to SVB’s announcement, as of the end of 2022, a total of $151.5 billion in deposits were in accounts that exceeded the FDIC insurance limit.

On March 10th, the FDIC announced that by next Monday, SVB customers will have full access to insured deposits. The agency has not yet determined how much of the deposits are not insured. However, uninsured depositors will receive an upfront payment next week, and the remaining depositors will receive a claim for their share after the FDIC liquidates SVB’s assets.

Why did investors heavily sell bank stocks?

Previously, investor confidence in bank stocks was severely shaken after the collapse of Sivergate Capital. The troubles of this bank were linked to digital currencies but also reflected losses on the bond investment portfolio due to rising interest rate pressure.

In yesterday’s session, stocks of mid-sized banks such as First Republic Bank and Signature Bank were temporarily halted due to excessive price declines.

The impact of rising interest rates on the securities investment portfolio of banks is not limited to SVB. Across all banks insured by the FDIC, as of Q4 of last year, total unrealized losses on the securities investment portfolio amounted to $620 billion.

What is the lesson to be learned here?

One of the biggest questions raised after this event is which banks have made similar mistakes, meaning misjudging the relationship between one side being the cost and “life expectancy” of the deposits they mobilize, and the other side being the interest rates and maturity of the assets they hold. This is a core difference from the questions about bad debt mountains that fueled the 2008 financial crisis.

When money poured into banks during the pandemic, buying short-term bonds or holding cash helped them better defend against risks from rising interest rates. However, this also means a decrease in the banks’ income. This time, the search for “safe returns” has caused them significant trouble.

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