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Silicon Valley Bank Fails

March 13, 2023

                Banks regulators shut down SVB Financial Group on Friday after portfolio losses led to a run on the bank. The Federal Deposit Insurance Corp. was named as the receiver. Silicon Valley Bank (“SVB”) was headquartered in California and specialized in serving the startup ecosystem. A combination of factors led to its demise. Some issues were idiosyncratic, while others can be found at other banks on a more modest level.

                SVB was the largest and one of the few banks focusing on the start-up ecosystem. As such, weakness at SVB’s clients is not indicative of the backdrop for larger diversified banks, nor does it ensure that other smaller banks are rife with problems. SVB lent to and serviced cash-hungry startups and their founders. Last year’s steep rise in interest rates and decline in equity markets caused venture capital funding to dry up, and that created problems at SVB. As the capital markets shut down, early-stage businesses started burning through cash. That cash was previously on the books as deposits at Silicon Valley Bank. Additionally, SIVB had a large investment portfolio compared to other banks. According to Bloomberg, the bank’s investment portfolio was 57% of total assets, 15% more than any other of the top seventy-four banks. SVB had large unrealized losses in its portfolio due to rapidly rising interest rates. Unfortunately, SVB had to realize losses on the securities as customer cash needs intensified. It was unable to raise equity to plug the hole on its balance sheet. This led to an old-fashioned run on the bank. 

                SIVB’s downfall shines a spotlight on banks and financial companies that were borrowing short and lending long. The inverted yield curve is causing interest expense to rise faster than interest income at many banks. The issue of rising deposit costs applies to all banks. For example, Keycorp warned on Monday, March 6th that interest income would be up 1-4% versus the prior estimate of 6-9% due to rising funding costs as loans grew while deposits shrank. Keycorp’s stock fell on the news, but profitability or solvency was never in doubt. The reason being is that its diversified loan book and revenues should allow it to weather the current issue of rising costs. It should be noted that many banks are asset-sensitive, meaning the yields on their loans reprice faster than their funding costs. Rising interest rates are a help to their income statements unless rising rates lead to more write-offs. 

                The Federal Reserve announced on Sunday, March 12th that all depositors will have access to their money Monday morning even if they are uninsured. The same measures were put in place for Signature Bank of New York which was seized by regulators over the weekend. The Federal Reserve created a Bank Term Funding Program to reduce the possibility of other bank runs occurring. This allows lending institutions to pledge high quality collateral at face value, not fair market value, for one year. These measures will give time to financial companies that have a duration mismatch between their assets and liabilities to address their problems. 

                The Federal Reserve has been trying to slow the economy. Rising funding costs and compressed interest margins will almost surely lead to tightening lending standards. The sudden seizure of SVB will cause all banks to look more closely at their balance sheets and liquidity. As such, SVB’s issues may cause banks to slow loan growth and lead to belt-tightening throughout the economy. It is not a stretch to say that it may precipitate the recession that so many people have been forecasting. This will likely put a halt to future increases in interest rates by the Federal Reserve Board. Just last week, expectations were for the federal funds rate to rise another 75 to 100 basis points over the course of the next several meetings. This should help contain a further decline in equity markets. The market is a leading indicator, and it will see falling interest rates as a support not a hindrance to future growth. In addition, investors should be helped by the fixed income portion of their portfolios when and if rates decline further. NPP does not think contagion is likely. If it was, J.P. Morgan’s stock would not have risen on Friday.  

                For clients whose investments are held at Schwab, they should keep in mind that their securities are not part of Schwab Bank and therefore not affected by what happens on the banking side of the business. The uninvested cash in their accounts held as bank deposits is part of Schwab Bank. However, it's extremely rare that clients have more than the FDIC's, federally insured limit of $250,000 in cash. While the current turmoil will affect Schwab earnings in the short run, we do not feel that the stability of the company is in doubt. As always, please reach out to us if you are concerned. We are available to talk if you have any questions.