Articulating the Collapse of Silicon Valley Bank

SVB specialized in servicing venture capital fund-raising activities. Headquartered in Santa Clara, it became flushed with cash during 2020 and 2021 as technology and healthcare start-ups raised billions of dollars with the low cost of borrowing due to the Fed’s unprecedented QE program. This led the bank’s balance sheet to balloon from $70 billion to $200 billion as companies looked for a place to park their cash.

As any bank would do, it invested this excess cash. However, SVB chose to buy long-term treasuries and government-backed mortgages with the intention of holding them to maturity. With the benefit of hindsight, this was not a good idea because it increased their risk profile to interest rate, or duration risk. What this meant was the bank was extremely vulnerable to interest rate fluctuations, especially as interest rates rose. Thus, when the Fed implemented nine consecutive cycles of rate hikes starting from March of 2022, the coupon being paid to SVB for those securities did not keep up with the rising rates, causing $18 billion dollars of unrealized losses on the securities portfolio (more than the bank’s entire equity). If that doesn’t sound bad enough, start-ups naturally halted capital raising activities in 2022 as the cost of capital rose. They were also burning through their cash, drawing down the already slim deposits in SVB’s portfolio.

In response to the developing crisis, SVB decided to sell the long-term treasuries at a loss, with the intention to raise capital to offset those losses. However, the liquidity position of the bank deteriorated very rapidly as soon as news broke out of their financial health. In fact, it came to the point where there were $42 billion worth of outflows in one day. The FDIC eventually stepped in to protect $250,000 in each account to ease widespread panic.

Start of the Financial Contagion

However, SVB’s fall wasn’t an insular event. Soon, news broke of Signature Bank being unable to service withdrawal deposits due to its high number of uninsured deposits. Being the 19^th biggest bank in the United States, Signature happened to be New York’s state-chartered commercial bank that primarily worked with privately owned, middle market businesses. The death knell would soon come knocking on First Republic’s Door as well. Thus, from these examples, we can see the interconnectedness of the financial markets. SVB, with its west coast entrepreneurial roots, can almost instantly affect consumer confidence in banks all the way across the country in a completely different line of business. This example also highlights the role of the media that exponentially fueled investor panic, all of which questioned the stability of the American banking system.

In the end, JP Morgan had to negotiate a $30 billion deposit to restore investor confidence in First Republic. The Federal Reserve also created a new lending facility, called the Bank Term Funding Program, which banks can use to borrow cash in exchange for posting certain assets as collateral.

Lessons & Reflections

1. When any bank implodes, it usually is a symptom, not a cause, of something severely off-balance. In this case, it was a decade of ultra-loose monetary policy that enabled banks to take undue risk.
2. Don’t look to the past. Past mistakes can often tell us a lot about the future, but it isn’t the whole picture. Investors can get fixated upon one type of risk due to its memory (such as credit risk in 2008), and forget other risks exist. In this case, it was duration risk.
3. The bank run of 2023 also taught us to rethink the very definition of a safe asset. Take 2008 again. If you were to talk to anyone on the street at that time, the consensus would be that the housing market was indestructible. Now, I’m not saying that government treasuries will default tomorrow, but we need to be mindful of the risk we are taking because they can be hidden.  
4. The big just keeps getting bigger. With depositors taking money away from smaller, regional banks, they are parking their money into the JP Morgan’s of the world. First quarter 10-Ks just came out and JP Morgan saw an increase of $37 billion in deposits. In one quarter. Ridiculous.
5. Moral hazard is never a good fallback option. By reassuring ourselves the Fed will step in to back any failing bank will always backfire. Thus, seasoned risk management teams are worth the investment for any bank that wishes to stay afloat. With that being said, the Fed now must offload roughly $91 billion worth of MBS from SVB and Signature. Do you think the market is going to react well to that?