Investors Wiped Out As Bank Run Causes Collapse Of Silicon Valley Bank

Key Takeaways

• Silicon Valley Bank (SVB) has collapsed, leaving many companies in the startup and tech sector worried about whether they’ll be able to make payroll this week
• It comes as a result of a run on the bank, with a liquidity crunch meaning SVB was unable to access cash to meet withdrawals
• Treasury Secretary Janet Yellen has ruled out a full bail out, saying that ‘We’re not going to do that again”

It’s been a crazy few days for the banking industry. Specifically, for Silicon Valley Bank and its shareholders, as it went from supposedly stable and solvent, to closed down by the regulators — in the space of just over 24 hours.

In a series of risk management oversights, macroeconomic factors and the good old fashioned rumor mill, Silicon Valley Bank (SVB) went through a liquidity crisis, causing a bank run on their deposits.

The stock crashed 60% through Thursday and was then halted Friday in pre marketing trading after falling another 69%. By midday Friday, the regulators had closed SVB down and they had officially collapsed.

So how did this whole situation happen, and how are investors likely to come out of it? Spoiler: Probably not great.

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Who was Silicon Valley Bank?

Before we can get into what happened, it’s important to have some context around how the bank operated and who their main clients were. SIlicon Valley Bank (as the name suggests) was a bank whose target clients were tech startups and their founders.

They’d been an important part of Silicon Valley for decades now, and helped provide banking services to companies and individuals who often found it difficult to get access to mainstream accounts.

New companies and founders attached to them are seen as (rightly) pretty risky from a banking point of view, which makes many big banks wary of offering them access to banking.

Silicon Valley Bank was created to fix this problem. It meant that their client base was very concentrated, and their cash deposits were less “sticky” than a traditional bank. That’s because startups receive funding in order to spend it.

A new company might receive $10 million from an angel investor or VC, this gets deposited into an account with SVB, and then it is withdrawn over the next year or two in order to fund the business growth.

This is compared to company and individual savings at other banks, whose deposits can stay broadly untouched for years. Even decades.

The circumstances leading up to the collapse

We’ll try to break this down as simply as possible, because like all matters to do with the complexities of the banking system, it’s not exactly straightforward.

It starts between 2019 and 2021. The level of venture capital funding exploded during this time, meaning startups were getting a ton of cash, and subsequently depositing this with SVB.

According to Morning Brew, SVB’s deposits went from roughly $60 billion in 2018 to $189 billion in 2022.

A common way for banks to make money is through what is known as ‘net interest margin.’ It’s when they offer you 0.2% on your savings account, and then take that money and place it in a different form of investment that gives them a return of 1% — keeping the 0.8%.

SVB had all of these deposits, and in order to generate a return (with interest rates still at almost 0% at this point) they placed reportedly $80 million of the $189 billion into long term mortgage backed securities.

These were reportedly paying a yield of around 1.5%, leaving SVB with a healthy net interest margin.

Unlike 2008, the viability of these mortgage securities wasn’t the problem. The issue was the fact that they were long term liabilities that were being used to secure short term deposits, purchased at a time when interest rates were at all time lows.

The risk of ‘safe’ mortgage bonds

So while there aren’t any problems with the mortgage bonds that were purchased, they are still sensitive to interest rates. The reason for that is that bond prices move inversely to interest rates.

If rates go up, bond prices fall and vice versa. It’s why we’ve seen ‘safe’ or ‘defensive’ ETFs fall so much in recent times. As rates have been hiked super quickly, the asset values of the bonds have been falling.

It’s important to understand how this works.

Say you purchase $1,000 worth of 20-year mortgage bonds at 1.5%, when the 10-year U.S. Treasury rate is 0.25%. That makes sense. High quality mortgage bonds are secure, they’re safe, but they’re not as safe as the U.S. Treasuries, which are considered as close to risk free as you can get.

Now say that the Fed hikes rates over the next 12 months, and now you can purchase a 10-year U.S. Treasury with a 1.5% yield.

Imagine now that you want to sell your mortgage bonds. Why would someone buy them from you for $1,000 for a 1.5% yield, when they could buy a safer investment (U.S. Treasuries) with the same yield?

The answer is, they wouldn’t.

So in order to sell your bonds, you would need to sell them at a price that keeps margin above the U.S. Treasury rate. Keeping the same 1.25% margin as before, it means your mortgage bonds would have a market value of $545.50 in order to give the investor a yield of 2.75%.

If you need to sell your bonds right now, that’s a big loss.

The thing to remember with bonds though, is that at the end of the term, if the bondholders don’t default, you get your money back. So if you didn’t need to sell right now, you could hold your mortgage bonds for the entire 20 year term, pick up your yield and then get your $1,000 back at the end.

So as long as the underlying debt hasn’t defaulted, the fall (or rise) in a bond’s price is temporary.

Last point on this. The longer the duration on a bond, the more sensitive it is to interest rate changes. And SVB bought a lot of long duration bonds.

Why did Silicon Valley Bank collapse?

This was simply an old-school liquidity crisis. SVB’s underlying investments haven’t failed. They’re prices have just gone down. Because of the uncertain economic conditions, SVB has seen a lot of their clients looking to get their hands on their money.

Facing $80 billion of their assets being held in securities which have fallen in value, they’ve been looking to raise cash.

This made markets a little nervous, but it went into overdrive when they announced a sale of stock at a loss of $1.8 billion. This came just days after crypto-focused bank Silvergate failed, and the announcement was made with little attempt at calming investors.

The stock began to tank.

A trickle of deposit holders turned into a tidal wave, as prominent VC’s called their portfolio companies and told them to get out as fast as they could.

This type of bank run would be a problem for any bank. They don’t have enough liquid cash at hand at any given time for every account holder to redeem at once. Just like your local gym doesn’t have enough barbells to allow every member to get on the bench press at the same time.

But it was an especially big problem for SVB, with their liquidity profile as it was.

What happens to Silicon Valley Bank depositors?

That remains to be seen. Only around 15% of the accounts are reported to be under the FDIC limit, meaning 85% of the accounts are at risk. In reality though, there are believed to be sufficient assets to cover all of these accounts.

It’s just a matter of timing.

That’s not much comfort for companies who are unsure if they’re going to make payroll this week, and we may see a larger bank step in to take over the remnants of SVB, or we may see some form of short term government intervention.

This is an incredibly fast moving story, and we’re likely to see further information released into Sunday even and Monday morning.

What happens to Silicon Valley Bank investors?

They’re wiped out. The asset value of the bank itself is zero, and there’s essentially no chance of a government bailout for shareholders.

Treasury Secretary Janet Yellen has gone so far as to come out and officially confirm this, referencing the 2008 banking crisis and stating, “We’re not going to do that again.”

If you’re not clear on the difference, imagine you held an account with a (made up) bank called Green Bank with $5,000 in it. You also like banking with them so you decide to buy $1,000 worth of stock in the company on your trading app.

If the bank was to fail, you’d lose your $1,000 in stock, because it would be worth $0.

However, your $5,000 would be safe, because it would be protected by the Federal Deposit Insurance Corporation (FDIC) as it’s less than $250,000.

The bottom line

It’s the first time in a long time that we’ve seen a bank run like this, and it highlights the importance of understanding counterparty risk. Even organizations that appear stable and secure can be undone, in a matter of hours, given how fast information travels in 2023.

As always, diversification is the best way to limit your risk, whether you’re talking about investments or savings accounts.

As well as ensuring you’re properly diversified, hedging can be a powerful tool to protect against volatility. But it’s not easy to do.

However Q.ai’s Portfolio Protection uses the power of AI to do it for you. Every week, our AI predicts your portfolio’s sensitivity to various forms of risk, and then automatically implements hedging strategies to protect against them.

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