THOUGHTS FOR TODAY, MARCH 13, 2023: WHAT TO KNOW ABOUT THE SILICON VALLEY BANK COLLAPSE

On Thursday, the markets appeared to be performing well, until two events unfolded. The first was the introduction by the White House for a new budget. What spooked investors in the budget, even though it was likely not to become law, was the elimination of the lower tax rate on capital gains. While that took the air out of the markets what sent it reeling on the rest of Thursday’s session and into Friday’s market close was the collapse of the Silicon Valley Bank (symbol: SIVB).

So why did SIVB collapse? And will other banks follow in its footsteps such as was the case of bank contagion in 2008?

SIVB was in one respect a very non-traditional bank. It was the banker for private equity “unicorn” companies and large Silicon Valley technology firms. As startup tech companies raised capital through venture capitalists (VCs), which could amount to hundreds of millions of dollars or more, the VCs strongly suggested their startups to park their cash at SIVB. These startups tend to burn cash at high rates and require short-term liquidity. SIVB did not appear to model that into their investment portfolio.

Well managed banks will match their liabilities (deposits) with assets: loans and investment portfolio. SIVB did not do so. What they did was, buy longer dated bonds and mortgage securities to generate greater spreads between their assets and liabilities. The company did not factor in the impact on their investment portfolio of rising interest rates. Furthermore, it did not hedge its interest rate risk. As a result, the value of their assets fell and could not meet the demands of its depositors to withdraw cash. Put simply, SIBV was a poorly managed institution.

Bank deposits (not interest) up to $250,000 are guaranteed by the FDIC (Federal Deposit Insurance Company). Any deposits more than $250,000 are not guaranteed by the FDIC. Typical banks will have most client deposits below $250,000. That was not the case with SIBV who had extremely large and concentrated deposits.

Furthermore, in 2018 some bipartisan changes to the Dodd-Frank law were put into place which raised the threshold to define “systematically important financial institutions” from $50 to $250 billion while also limiting stress testing to banks with over $100 billion in assets. These regulatory changes favored SIBV.

SIBV loss on its investment portfolio forced the bank to try to raise more capital. That effort did not pan out. A run ensued on the bank and SIBV collapsed. California regulators stepped in on Friday to shut down the bank and was taken over by the FDIC.

There were several ways to cure the problems of uninsured deposits at SIBV. First was to find a buyer of the bank. Second was to have the FDIC, Treasury and Federal Reserve step up and protect the uninsured deposits. Over the weekend no buyer stepped up.

First Republic Bank (FRC) also ran into a similar problem and received additional funding by the Federal Reserve and JP Morgan Chase (JPM).

Roku (ROKU) reportedly had $425 million in cash at SIBV. Roblox (RBLX) had $150 million, and Juniper Networks (JNPR) had a sizeable cash deposit at SIBV. If you ask me, all of their CFOs and Treasuries should be shown the door.

So, what is likely to occur to solve these SIBV-like problems going forward?

1. The Federal Reserve Open Market Committee (FOMC) should be getting the message loud and clear that it raised rates too high too fast. Expect the FOMC to either halt its tightening cycle or signal a move to lower rates. Chairman Powell should make some market friendly comments today to comfort the financial markets.
2. FDIC insurance will have to be increased from $250,000 to a larger number, say $5,000,000.
3. Depositors will have to sign a waiver understanding that deposits over the new FDIC insurance limit will not be protected by FDIC.
4. Further consolidation in the banking industry.
5. Further tinkering with Dodd-Frank to tighten bank asset-liability mismatches.
6. Putting a watch dog over Venture Capital and Private Equity which are for the most part unregulated and fly below regulatory radar.
7. Don’t rule out small bank acquisitions by larger institutions, both domestic and international, as their stock prices get to fire-sale prices.

It appears that over the weekend, US Federal Regulators have stepped in to shore up SIBV’s financial condition. I expect stock market stability to occur this week, even today, to erase damage done on Thursday and Friday. In essence, in my opinion, this was not so much a bailout of SIBV as it was a bailout of the Silicon Valley venture capitalists and their investments.

It is the banks and credit markets which we need to be cautious of from a stock market perspective. Except for the tech bust in 1999 to 2000, all major stock market declines in the last fifty years or longer was due to banking problems or the credit markets.