We are writing this update in response to the events that have shaken the banking world over the last number of days which began with the failure and FDIC takeover of SVB Financial (parent company of Silicon Valley Bank) and has grown to impact other banks including Signature Bank and most recently First Republic Bank.
The crisis started with an announced bond restructuring at SVB which caused the realization of a $1.8 billion loss and an intent to raise $2.25 billion additional in equity capital. This caused prominent VC fund managers to encourage technology firms, large and small, to pull their deposits from SVB. The ensuing withdrawal of customer funds was staggering with $42 billion in withdrawals on March 9th alone. Despite the bank being in sound financial condition prior to March 9 this massive amount of immediate withdrawal triggered the near immediate failure of the 16th largest bank in the country.
Banks are not really equipped to withstand such a large percentage of deposits being withdrawn over a short period of time. To compound depositor anxiety, historically only deposits of $250,000 and below were protected by the FDIC which wasn’t of much comfort to corporate clients with significantly more on deposit at these banks (sometimes in the tens or hundreds of millions).
On Sunday, March 14th a joint statement was made by the FDIC, Federal Reserve, and Treasury Department aimed at reducing the run on the bank risk:
“After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer. … Finally, the Federal Reserve Board on Sunday announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.”
They also extended this uninsured depositor coverage to Signature Bank and will potentially do the same with other impacted banks.
One of the issues with the rapid withdrawal of funds from the banking system is that banks only hold a portion of the deposited funds in cash and a large percentage of the funds are invested in bonds and used to make loans. As a result, no bank is really equipped to have all of their deposits suddenly walk out the door and maintain liquidity. Compounding the impact for banks is that any bonds they bought within the last few years are likely sitting on unrealized losses due to the upward move in interest rates. The banks intend to hold these bond investments to maturity and get their principal back but higher levels of withdrawals can force selling at a loss. The Fed’s additional funding line is designed to mitigate this risk for banks.
We want to emphasize that this crisis has been driven by a lack of confidence and the fear sparked by the run on these banks, not by credit losses. Unlike prior bank failures, these events have not been related to investments that have gone under or making loans that have defaulted. We believe it is important for the FDIC, Fed, and Treasury to take actions to help mitigate the run on the bank risk to avoid it moving from bank to bank and creating wider contagion. We believe the banking system is fundamentally sound but requires depositors having confidence that their funds are safe. We believe the actions taken over the weekend will help reduce some anxiety but it is possible there will need to be broader regulatory adjustments to assure depositors and avoid broader economic spillover. We are also mindful of the long-term investment opportunities that panic-induced selling can produce and are in the process of evaluating these opportunities and risks carefully.
The following provides more detail on what happened specifically with SVB:
We are providing an update on SVB Financial (holding company of Silicon Valley Bank) – given the sudden and unexpected developments with Silicon Valley Bank we wanted to provide an update on what happened and why things unwound so quickly.
It was announced on Friday that SVB was being taken into receivership by the FDIC. The stock didn’t trade on Friday and the announcement by the FDIC creates a grim outlook for equity holders. When a bank goes into receivership, a new bank is formed by the FDIC that takes over the assets of the bank. This is done to protect depositors who are insured to the FDIC insurance limit, amounts above the FDIC insurance are given certificates for their uninsured funds and are amongst the first in line to get paid back.
SVB marks the second largest bank failure in history. SVB had made moves to raise additional capital or explore a potential sale but the run on the bank effect essentially created the liquidity issue that required the FDIC to step in. SVB had been for decades the leading bank for technology firms and has the tagline “The Financial Partner of the Innovation Economy”. SVB was founded in 1983 and was a well-established, profitable bank. As of the last reported data, the bank had $212 billion in assets, and $74 billion in total loans. On February 16th, less than a month ago from failing, SVB was ranked #15 on Forbes list of the 100 largest publicly traded banks based on growth, profitability, and credit quality. The company had a 43% loan to deposit ratio, significantly lower (meaning more stable) than the peer median ratio of 75%. In addition, SVB had a book value per share of $208.85 as of the most recently reported financial data.
What happened this week?
Due to increasing customer withdrawals from technology firms, on Wednesday SVB announced that it was restructuring its bond portfolio, taking a write-off in the process as the portfolio had declined in value due to higher interest rates versus when the bonds were purchased. Note this was a decline in value in the investments the bank had made into high quality bonds, not from defaults on loans made. SVB essentially decided to sell their existing bond portfolio at a loss and reinvest into shorter maturity bonds which carry a higher interest rate. On Wednesday, they provided an update to investors which instead of reassuring investors, sparked the ultimate liquidation of the bank. From the letter to investors as of Wednesday, March 8, 2023 (less than 48 hours before the FDIC takeover):“While we will realize a one-time, post-tax earnings loss of approximately $1.8 billion in connection with the sale, we expect the reinvestment of the proceeds to be immediately accretive to net interest income (NII) and net interest margin (NIM), resulting in a short payback period of approximately three years. As a result of these actions, we expect an approximately $450 million post-tax improvement in annualized NII. Taken together, these actions will further strengthen our capital position. We expect them to be immediately accretive to EPS (excluding the realized loss) and improve our return on common equity going forward. We are confident that these are the right decisions for our profitability and financial flexibility, both now and for the long term.“
“Our financial position enables us to take these strategic actions. SVB is well-capitalized, with a high quality, liquid balance sheet and peer-leading capital ratios. Even before today, we had ample liquidity and flexibility to manage our liquidity position, with one of the lowest loan-to-deposit ratios of any bank of our size, income from progressive securities paydowns, levers to manage our off-balance sheet client funds, and substantial borrowing capacity. The improved cash liquidity, profitability and financial flexibility resulting from the actions we announced today will bolster our financial position and our ability to support clients through sustained market pressures. The vast majority of our assets are in high-quality, government and agency securities and low-credit- loss lending activities. We’ve demonstrated strong credit performance throughout cycles, and the risk profile of our loan portfolio has significantly improved over time, with strong expansion of the lowest- risk categories. Early-stage loans, our highest risk segment, today makes up only 3% of the portfolio.”
Why did things change so quickly?
We understood the moves the bank took with regard to investment portfolio repositioning. We feel the $1.8 billion realized loss on the bond portfolio repositioning, coupled with the announced capital raise of $2.25 billion startled depositors, including some of the largest technology VC firms who encouraged their portfolio companies to start pulling all their corporate deposits from the bank. This was essentially like yelling “FIRE” in a crowded theater and can have a cascading effect whereas as more depositors pull capital the word spreads and more start to make withdrawals. No banks have the liquidity to meet all of their depositors simultaneously asking for their money back. Banks don’t hold all of the deposits in cash, they make loans with the money, and invest it and can’t readily make it all available for immediate withdrawal. Unfortunately, this run-on-the-bank risk while rare is incredibly difficult to halt once it starts, hence the FDIC stepping in.
SVB played an important role in financing innovation and had a 40 year history of supporting many dynamic growth industries. We also think this outcome was unnecessary and driven by the panic and fear that spread through the depositor base. If enough people start talking about and believing in a bank failure, it can become a self-fulfilling outcome.
We are available to jump on any calls to discuss this issue in more detail with investors should there be more specific questions.