There were several challenges that SVB was facing. For one, the bank’s clients were heavily concentrated in the tech industry, with approximately 52% of SVB’s deposits coming from private equity and venture capital-backed start-ups. As growth companies melted down in 2022, these start-ups burned through cash and thus began drawing down their deposits. As a result, deposit accounts at SVB had been falling sharply for nine months.
With rates rising over the last twelve months at the fastest pace in decades, SVB experienced rapid deterioration of its net interest margin (NIM). Net interest margin is a measurement comparing the net interest income a financial firm generates from credit products like loans and mortgages with the outgoing interest it pays holders of savings accounts and certificates of deposit (CDs). Higher rates meant SVB had to chase deposits by offering higher yields, but at the same time, the bank suffered significant losses in its bond portfolio due to rising interest rates. In other words, there was a large mismatch between their deposits (liabilities) and assets. As a result, the bank needed fresh capital to meet withdrawal demand but couldn’t find it quickly enough.
On March 12th, all SVB depositors were made whole, even if their deposits exceeded FDIC limits. The decision was made to do this to provide confidence for the entire banking system and prevent runs on other banks. However, according to the statement, bondholders of SVB wouldn’t be protected, so the move by regulators is not technically considered a bailout.
As a result of the recent turmoil, we will see a significant restructuring of FDIC insurance limits. While most of us think of keeping our cash reserve/emergency fund under the $250,000 FDIC limit per account title/depositor, think of all the large and small businesses that deposit and depend on banks for their payroll weekly. There is growing bi-partisan support from lawmakers for an upward adjustment for FDIC limits for business accounts.
What about the recent failures of Signature and Silvergate Bank?
Like SVB, Signature Bank and Silvergate bank were considered alternative banks with high exposure to venture capital, private equity, and Crypto exposure and high average balances relative to FDIC-insured limits. (most banks’ depositors – roughly 80% – are under the $250k FDIC coverage limit – SVB was the inverse – 80% of its depositors were over the per account FDIC limit.) In addition, they were considered two of the most crypto-friendly banks (per the Wall Street Journal, 27% of assets in Signature Bank in 2022 were from digital-asset clients). However, the recent struggles in crypto (e.g., the recent collapse of FTX, the crypto exchange from Sam Bankman-Fried) left both banks vulnerable to the runs on deposits that occurred.
As of this writing, First Republic Bank, which has a similar business model to SVB, has been rescued by eleven other larger banks with a total capital infusion of $30 billion. This is significant; what the banks and we, as long-term investors, are going through is not the echo of the Financial Crisis of 2008. Banks are much more capitalized than in 2007, before the Global Financial Crisis.
While it is always possible that more banks may fail, it is currently not expected that SVB, Silvergate, and Signature Banks issues will create systemic risks or that the banking industry as a whole is in immediate danger. The current banking turmoil is more of a lack of bank oversight and management, and not regulation issue.
The Fed’s current measures, including creating the new Bank Term Funding Program, are meant to provide support and confidence for the banking system. This is precisely why Congress created the Federal Reserve in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. In a nutshell, the system is working!
In addition, the current stress on the financial sector and the overall economic environment we find ourselves in will function as a tightening mechanism for the Fed and may alleviate their need to raise rates temporarily over the next few months. The Fed is currently fighting battles on three fronts:
- Taming inflation.
- Continued economic growth.
- Maintaining financial stability.
On the inflation front, we’re already seeing the prices of goods falling; however, it is wage inflation the Fed is trying to control, which is more complicated. In addition, while one of the Fed’s objectives is full employment, it is currently trying to cool the labor market. As a result, an uptick in the unemployment rate will be necessary for the Fed to achieve its objective.
With no clear silver bullet that will calm the markets in the near term, we will see heightened market volatility in the foreseeable future and likely higher and sustained interest rates for longer than we might’ve imagined just a few months ago. One way to manage the current environment is to allow inflation to run at 3- 4% versus the Fed’s stated inflation target of 2%. If this is the case, volatility will be here to stay for the next several quarters and well into 2024.
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