With the sudden collapse of three regional banks in the past week, we understand that you may be worried about the solvency of other regional banks and what impact these events will have on your company and your portfolio. Therefore, we wanted to provide you with our thoughts.
- On Friday, March 10th, Silicon Valley Bank (SVB) ran into the perfect storm: Depositors were demanding their money at the same time the bank was selling long-term bonds (at a loss) to raise capital.
- It is important to note the SVB is very involved in the financing of start-up companies. This is a much riskier venture than making loans to well established companies with a long track record of stable margins and cash flow.
- The other two banks that collapsed in the past week, Silvergate and Signature Valley, were both involved in various aspects of the cryptocurrency market. Cryptocurrency can be very volatile and companies and investors in this industry, unlike well established businesses, do not have the same oversight nor do they have a track record of stable earnings.
- The biggest issue for consumers during most bank collapses is one of confidence. A “confidence spiral” happens when depositors become worried that they will not be able to get their money from a bank. If a few depositors start to worry, and their fears are broadcast through a medium such as social media (where headlines can quickly be disseminated to thousands of people), a problem at one regional bank can quickly become an issue for multiple financial institutions.
- The job of a bank is to match assets and liabilities. When you make a deposit, this is money the bank owes to you and is therefore a liability of the bank. When the bank makes a loan to a business or other consumer, this is money owed to the bank and is therefore an asset of the bank. A mismatch in this asset-liability matching can create problems because the bank may not be able to meet its liabilities with the assets it has on hand, which creates anxiety for depositors.
- To help ease these asset-liability mismatches, banks rely on borrowing money from other large banks or from the Federal Reserve. The rate banks charge each other for this short-term borrowing, usually done on an overnight basis, is called the federal funds rate. Banks rely on the federal funds rate to meet their short-term liquidity needs so when this rate increases, it can cause issues with the value of other assets the bank holds (e.g., long-term bonds) that were part of the bank’s asset-liability matching strategy.
- The mismatch at SVB was large enough that the bank needed to raise over $2 billion in capital to satisfy its liabilities. This created issues for the bank because:
- A bank that needs to raise a large amount of capital makes depositors nervous. Depositors can rightfully ask, “If the bank needs more capital, are my deposits safe?”
- Venture Capital (VC) firms who were aware of SVB’s capital needs told their portfolio companies to remove money from the bank as a safety precaution. By Thursday, March 9, over $40 billion had been withdrawn from SVB.
- Assets held for investment are not marked-to-market per accounting rules. With interest rates rising, SVB’s investment bond portfolio did not reflect the drop in market value. However, since the bank needed to sell bonds to raise capital, they were forced to sell LT bonds at a loss. Selling investments at a loss to raise capital spooks depositors because they rightfully worry that the bank is in financial trouble.
How Does This Get Resolved?
- Remember that the Federal Deposit Insurance Corporation (FDIC) insures up to $250,000 per depositor. Any individual or institution with $250,000 or less of money deposited at SVB, Silvergate, or Signature Valley will receive their money from the FDIC.
- However, many businesses likely have more than the FDIC limit and need that money to make payroll and pay bills. Confidence in the banking system can be fickle when there is news of a bank collapse. Liquidity issues, whether real or not, may cause business owners and other depositors to pull money and move that money to the largest banks that they perceive to be too big to fail. These transfers can create cash issues for regional banks that are not involved in riskier start-up or cryptocurrency lending (guilt by association). Therefore, with approval from the Treasury, the Federal Reserve has set up an emergency lending program to help ensure that eligible banks are able to meet their depositor’s needs.
- At this point, the government is actively looking for a private buyer for SVB. Officials have stated that taxpayers will not bear the burden of saving SVB, Silvergate, or Signature Valley, like they did during the collapse of Washington Mutual bank in 2008.
- Interestingly, the VC firms who helped create liquidity issues at SVB by encouraging their portfolio companies to withdraw funds have said that they will work with SVB under new ownership. This desire to continue working with SVB may help the government find a buyer for the bank.
What Should I Do?
- Take a deep breath and remember that in an economy as complex as ours, there are going to be issues that develop in the financial system. Being patient when others are panicking allows us to be more rational in our analysis and spot opportunities created by fears that are not based on facts.
- Remember that the goal of most news headlines is to play to your emotions. However, making critical decisions such as whether to sell a stock, take a loan, or pull your money out of a bank based on an emotional reaction to a news headline is not in your long-term interest.
- Keep in mind that there is a difference between short-term needs and long-term wealth creation. To help you differentiate between the two, we suggest the following:
- Review your current cash inflow to ensure you can meet your short-term business and personal needs (e.g., mortgage, utilities, payroll, etc.).
- Review your goals and the time horizons you have set for each goal. If the goal has a short-term time horizon, make sure you have cash to meet that goal. If the goal has a long-term time horizon, be patient and trust your strategic planning process.
We realize that headlines about the collapse, failure, or implosion of a bank are scary. What we encourage you to do is remember that hyperbole works well in the media but is not part of a solid strategic plan or wealth creation strategy.
We will continue to monitor the SVB situation and keep you updated on material changes. If you have any questions or would like to discuss your portfolio and planning needs in more detail, please let us know.