Sadly, Silicon Valley Bank (SVB, $SIVB), the 16th largest bank in America at the end of 2022, experienced a bank run. Now the contagion has spread to other regional banks such as First Republic Bank, Signature Bank, Zions Bancorp, PacWest, Comerica, and Charles Schwab. Even the largest banks were getting hit as well.
Ultimately, The Federal Deposit Insurance Corporation (FDIC) said on March 10, 2023, it would take over SVB and that its depositors with up to $250,000 will have access to their deposits no later than Monday morning, March 13, 2023. In the meantime, the FDIC will find a buyer so that depositors with over $250,000 will also be made whole.
The bank had $209 billion in assets and $175.4 billion in deposits. Roughly 87% of Silicon Valley Bank's deposits were uninsured as of December 2022, according to its annual report.
Thankfully, the Federal government decided to protect all SVB depositors on Sunday, March 13. The Feds also shut down New York’s Signature Bank and guaranteed all its depositors to help stop the contagion.
But will it be enough for the regional banks? Doubts are high as regional bank ETFs continue to tank.
Why Did The SVB Bank Run Happen?
First, the bear market happened in 2022. As the stock market declined, so did SVB's share price by 66%. Its clients couldn't raise as much capital or keep depositing as much capital at SVB. SVB focuses on lending to technology companies, startups, biotech, venture capital, and private equity firms.
Second, the Fed aggressively raised interest rates. The higher interest rates went, the more expensive SVB's cost of capital, which are its deposits. SVB had to pay higher interest rates to attract and retain deposits to stay competitive. In general, this is fine because banks can then lend out deposits at an even higher rate of return. This is called the Net Interest Margin, or NIM.
Third, in 2021, SVB supposedly invested about half of its deposits into 3-10-year Treasury bonds yielding 1.63% on average. SVB planned to hold them to maturity (HTM). Unfortunately, buying 3-10-year Treasury bonds in 2021 was close to the top of the market. After the Fed aggressively started raising rates, the value of its HTM portfolio tanked.
Borrowing Short And Lending TOO Long
You would think holding Treasury bonds until maturity would be safe. And it is if you own all the money. However, SVB was reinvesting short-term customer deposits, which became increasingly costly as the deposit interest rates they had to pay rose to over 4%. In such a scenario, the bank is losing money (negative Net Interest Margin). SVB borrowed short and lent too long, painful when the yield curve inverts.
Then when SVB decided to raise $3 billion in equity to cover its shortfall, and couldn't, the bank run accelerated.
A Bank Run Is A Crisis Of Confidence
Silicon Valley Bank's clients began withdrawing money because they no longer felt confident their deposits would be accessible.
Imagine if you were a money-losing startup that just raised $20 million. Your cash runway is 18 months until you need to raise another round of financing. The risk of losing all your capital at SVB, through no fault of your own, is immense. Hence, the rational move would be to withdraw all your deposits and move them to a larger bank like Chase.
Unfortunately, there's no upside in leaving your deposits at a bank that is experiencing a bank run. If the bank survives, it's not like you're going to get much better terms (high deposit rates, lower fees, etc). If the bank doesn't survive, you risk losing everything.
Thankfully, the FDIC stepped in to ensure SVB's depositors are made whole. Contagion is bad, especially given it negatively affects innocent parties.
Currently, thousands of startups are being negatively impacted because their money is stuck at SVB. They might not be able to pay vendors and make the next payroll.
Even The Best Capitalized Banks Are At Risk Of A Bank Run
The tier 1 capital ratio measures a bank’s core equity capital against its total risk-weighted assets—which include all the assets the bank holds that are systematically weighted for credit risk.
Think about the tier 1 capital ratio as a capital buffer to absorb losses and remain liquid enough to withstand a bank run. The higher the tier 1 capital ratio, the safer you are.
The average Tier 1 capital ratio for the biggest banks is around 14%, which is higher than it was during the 2008 global financial crisis. However, if more than 14% of a bank's depositors decide to withdraw funds at any given moment, the bank will likely shut down.
Banking is supposed to be a low-risk business that can generate profits with leverage. The more money a bank can lend out at a positive Net Interest Margin, the more profit it earns. The only problem is when too many depositors decide they want their money back. SVB needed to sell its HTM securities at a loss to make its customers whole, which ended up creating more losses.
If you're a regional bank like SVB, even with a 25% tier 1 capital ratio, it would be much easier for more of its clients to decide to withdraw their deposits. SVB was the largest bank in Silicon Valley with over 26% market share.
Will The Bank Run Contagion Continue?
Sadly, the Silicon Valley Bank bank run is likely the start of more bank runs to come. We already had the collapse of FTX, which looks more and more like fraud. Now the bank run contagion has spread to Europe with Credit Suisse succumbing to a takeover by archrival, UBS.
Plenty of innocent individuals and companies will lose lots of money. After all, the FDIC only insures deposits up to $250,000 per depositor, per insured bank. And most of SVB's customers were companies with way more than $250,000.
I recommend having three banking relationships to optimize terms and protect your assets. Even if you don't have over $750,000 in cash deposits, having multiple financial relationships helps make things easier.
Leverage is great for making money on the way up, but destroys investors on the way down. And right now, regional banks are getting destroyed thanks to a funding mismatch at SVB and a crisis of confidence.
First Republic Bank ($FRC), one of the best-run regional banks, is also getting hammered. Its customer base is more mass affluent retail as opposed to startups and venture capital companies. In First Republic Bank's 1Q 2023 earnings report, management took zero questions as the bank lost over $100 billion in deposits (half of total). First Republic Bank will be under new ownership as of May 2023. This is deposit an injection of $30 billion of deposits from larger banks.
The Federal Reserve Wants People To Lose Money To Suppress Inflation
The sad thing is the Federal Reserve knew these types of bank runs would happen. It is inevitable banks would experience mark-to-market losses in their bond holdings if the Fed raises too much too quickly.
Yes, Silicon Valley Bank made a mistake by buying too much long-duration Treasury bonds near the top of the market. Instead, it should have bought shorter-duration Treasury bonds to better match its liability duration, despite the lower Net Interest Margin.
But what's done is done. The middle-class is going to get crunched. The Fed knew banks like SVB and other regional banks would suffer from their actions, and they hiked aggressively and quickly anyway. The CEO of SVB was a Director at the SF Fed from 2019 until SVB went under.
The Fed also knows that causing a recession will lead to millions of jobs lost. But as I've written before, the Fed cares more about its legacy than for the well-being of middle-class American citizens. After all, the Fed governors are all powerful and rich.
Yes, as more people lose money and their jobs, the prices at grocery stores and gas stations will likely decline as demand wanes. However, please make sure you're not one of the millions of people who lose their livelihoods in the progress!
Innocent and good people at SVB and its depositors who had nothing to do with management’s decisions and the Fed’s desires are now suffering. This is terrible.
Hopefully, the downfall of First Republic Bank will result in the banking system healing. Everybody knows what's at stake and depositors and bank managers have had time to make adjustments to prevent contagion.
Learned My Lesson To Not Depend On The Government In 2008
I remember Monday, September 15, 2008, like it was yesterday. It was the day Lehman Brothers went bankrupt.
On the Friday before, I bet my colleague, Will, on the trading floor $100 the government would bail Lehman Brothers out over the weekend. How could the government let contagion spread? I even bought 100 shares of LEH in solidarity. Oops.
It was then that I realized not to rely on the government for my financial well-being. Instead, it was best to only rely on ourselves. The idea of the new three-legged stool for retirement was hatched, and away I went to start Financial Samurai the next year.
Please don't rely on saviors. They will only let you down.
Feeling Pain May Change You For The Better
The good thing about not getting bailed out is that you feel enough pain to change your ways.
After the global financial crisis, I decided to work harder, save more, and invest more prudently. My net worth became more diversified and I developed new income streams to buttress my day job income.
Without the 2008 global financial crisis, Financial Samurai would not have been born in 2009. Because up until 2008, making money was easy. Why create contingency plans?
In the short term, the ecosystem surrounding Silicon Valley Bank will take an uppercut to the chin. The contagion will spread to other regional banks, which will experience their own bank runs.
The big banks will gain more deposit dollars to make bigger profits. With the influx of more deposit dollars, deposit interest rates will likely decline, thereby making big banks even more money in the long run. That's right, the big banks are long-term beneficiaries when regional banks collapse.
If there is no trust in the banking system, our economy will suffer. Hence, the FDIC taking over SVB and making innocent depositors whole is a net positive. SVB shareholders get wiped out, but that's the cost of investing in risk assets.
What Does The Bank Run Contagion Mean For Us?
If you have more than $250,000 per account at one regional bank, you may want to spread out your money to other larger banks like JP Morgan Chase, Citibank, Bank of America, and Wells Fargo. It's easy to do thanks to online banking. All the biggest banks have seen an inflow of deposits at the expense of regional banks.
If you run a business, it's easy to let your idle cash sit in your business checking or savings account earning less than you could. I'd contact the bank and invest some of that cash into a short-term CD with a higher rate, up to $250,000. Then I'd extract the rest and leave enough only for working capital.
If you face a capital call with a venture capital, venture debt, or private equity firm that does banking with Silicon Valley Bank, I wouldn't wire the funds now. If you do, your funds could get stuck for who knows how long even though the FDIC has taken over and promises to make depositors whole. Take a wait-and-see approach instead.
If you have investments with a private fund that does banking with other regional banks, I would contact the funds' general partners and ask for clarity if they have yet to communicate their plans. Again, it's not worth transferring capital yet until you know the funds can be reinvested by the fund. The reality is, everybody is scrambling.
Finally, please have enough liquidity to cover your living expenses just in case you lose your main source of income. You don't want to have to conduct a fire sale to raise funds in a down market. The ideal number of banking relationships is three or more.
No Need To Be A Hero And Take Excess Risk Now
The current investing landscape is fraught with unknown risk, largely due to an overly aggressive Fed. Yes, we must also blame a bank's investment committee that made poor investment choices as well. Other banks and companies will inevitably collapse due to contagion.
Hence, I think the best move is to continue to “T-bill and chill.” Earning 5.3%+ in risk-free Treasuries is what I plan to do while the carnage sorts itself out. There is currently a great unwinding of leveraged assets that will take time.
My main banker is the U.S. Treasury Department, which isn't going bankrupt since it can print an unlimited amount of money. Although there is now a debt ceiling debacle to content with. If the Treasury Department does collapse, then we will all have bigger problems to worry about.
Finally, please review your net worth asset allocation and ensure it is aligned with your risk tolerance and financial goals. The last thing you want is to lose all the financial progress you've made since the pandemic began.
For people interested in how I'm investing in this market, see: How I'd Invest $250,000 Today.
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