Silicon Valley Bank Collapse and Lessons Learned

Those in the financial services sector understand liquidity risks and have been keeping a close eye on liquidity ever since the federal reserve began raising interest rates in 2022. Since the COVID-19 pandemic and government programs began, financial institutions have seen a record run-up in savings amounts; however, deposits have decreased lately. On Friday, Silicon Valley Bank (SVB) became the first bank to fail in nearly three years and the largest to fail since the financial crisis of 2008-2009.

SVB was a strong bank

By many metrics, SVB was a strong bank and was the nation’s 18th-largest bank by asset size. Reviewing SVB’s December 31, 2022, audited financial statements:

• SVB had a low loan-to-deposit rate of 42.9%;
• SVB did not have risky investments, and deposits were about 80% of its assets;
• SVB had $13B in cash, $26B in Available for Sale (AFS) securities and $91B in HTM (Held to Maturity) securities; and
• SVB’s total assets were $211.8B, Regulatory Capital 13.7B, and CET1 capital of 12.05%.

SVB served a unique niche (which led to a bank run)

The uniqueness of Silicon Valley Bank is its role with tech start-ups, and the concentration of these businesses resulted in depositors with large deposits. Almost 90% of all deposits exceeded the federal insured limit of $250,000, meaning when the run began, withdrawals were of significant size. It also caused panic to ensue quickly, as customers knew each other from the industry, and information spread quickly – within hours, $42B in deposits was withdrawn on March 9, 2023, which was nearly a quarter of all customer deposits.

The run on the bank

The run on SVB caused SVB to overdraw its cash by nearly $1B. There were few options remaining for SVB. SVB previously liquidated $21B of AFS investment securities which had been classified as available for sale and resulted in SVB taking a $1.8B loss. SVB had a significant amount of securities classified as HTM, but liquidating these securities would mean taking an even larger loss. If any HTM investments were sold, the entire portfolio would be “marked to market,” and any unrealized loss would be recognized. As of December 31, 2022, these unrealized losses totaled $15B, which would have either completely depleted or nearly depleted all of SVB’s capital. This is likely why the California Department of Financial Protection and Innovation and the FDIC shut down the bank.

Impact on banking customers at SVB and other banks

While the news is alarming, there are a couple of things to note. First, while SVB became insolvent, they still have assets that represent more than the value of deposits, at least on a “book” value and the government will make sure all depositors receive their money.

Second, this is not like the bank failures of 2008 and 2009, which were due to underlying inherent flaws with granting credit and risky investments. Credit quality is still strong, as seen in extremely low delinquency and charge-off rates throughout the country.

Third, it seems that the concentration of tech start-ups and large deposits caused the bank to be vulnerable to a run on the bank. Rising interest rates have hurt these start-ups as it has been more difficult for them to raise capital, creating a need to burn through their deposits. When a run on the bank began, it accelerated due to the closeness of the community.

What can we learn from SVB’s failure?

Is this a classic “canary in the coal mine”? It’s not time to panic, but liquidity risk is real in this rising interest rate environment. The Federal Reserve showed some sign of slowing down rate hikes in February, but recent economic data released this week makes many think they will return to being aggressive on interest rate hikes. In other words, the economy is still heating up, and they have signaled they need to slow it down to keep inflation down. Rising interest rates are only one piece of the puzzle. Inflation is causing the public to go through cash quicker, which should result in deposits decreasing over time.

Financial Institutions need a liquidity plan. If liquidity is already tight, they may need to sell investments at a loss to increase liquidity. These losses could deteriorate capital quickly. Take a look at unrealized losses and evaluate what your capital will be if losses were realized. SVB should be a reason to review your concentrations – in geography, business sector, and by customer – if any group were to create a run on the bank, what would the impact be?

Other questions to ask your senior management team - How sticky are your deposits? Are your customers sensitive to the interest rates you are paying? Will rising costs and inflation cause your customers to deplete their savings accounts? What sources of liquidity do you have, and will they be available (lines of credit). What will a borrowing arrangement look like if you borrow against your HTM portfolio?

SVB is a cautionary tale of being concentrated in a unique market and being too thin in capital to weather the storm of a bank run. It is challenging to plan for the unknown or unexpected.

If you need additional resources or help, please don’t hesitate to contact our team.