Key Lessons from Silicon Valley Bank

Key Learnings – Silicon Valley Bank

“Yikes!!  The Silicon Valley Bank just went under and who knows what lies ahead for the financial sector/economy now!  I'm praying this isn't a replay of 2007-08!!!!!  Should I make changes to my portfolio?”

This was a recent comment that I received from a client; and I figured it might be a good time to address some of the worry. In addition, we can learn from the Silicon Valley Bank (SVB) failure. Therefore, in this article, you will learn about why SVB failed and key considerations for you as an individual investor.

Granted, I recognize that there have been other bank failures beyond SVB. Though the causes may be different, many of the same principles apply.

Who Is SVB?

SVB bank, ranked 16th in the nation in terms of market-cap at the start of March, has been very good at getting business from technology firms in, you guessed it, Silicon Valley. Over the past decade, SVB benefited from the long boom in the technology industry, financing deals and holding the money for start-up businesses. These start-up businesses often received funding from venture capitalists; and thus, in the recent past, SVB banking clients were often in the position of adding money to their accounts or at least not having large withdrawal needs.

Banks traditionally earn money by making a “spread” on the difference between the interest they pay to depositors and the interest they earn on loans like mortgages. Since banking is a highly regulated industry, there are rules about how much banks can lend so that there should always be enough cash available to customers who need to make a withdrawal. Normally, banks do not have every dollar on hand if every customer decides to withdraw their money on the same day. 

Over recent years, SVB had much larger deposits than loans in which they could make a spread; so, they had to look for other ways to keep their deposits working.  What they could not lend out, they invested in “safe” long term U.S. Treasury bonds. The problem is the rapid increase in interest rates in 2022, from 0% to 4.4%, caused the value of these seemingly safe securities to plunge.

A characteristic of bonds is that when yields or interest rates go up, bond valuations go down, and vice versa. If you hold a long-term treasury bond over the entire hold period of 10-30 years, an investor should expect to receive the level of return equal to the interest paid. It’s when you must sell long bonds in less than the hold period, that the bond valuations themselves can become a problem.

What Went Wrong

In recent months, interest rates increased rapidly, technology stock values dropped, and venture capital dried up. This created a cash flow crisis for SVB, and it escalated quickly:

·     Tech firms (SVB’s core customers) had not been getting much new investment and had instead been spending down their cash in the bank.

·     The long-term U.S Treasury bonds lost 20-30% in value (meaning current saleable value) due to higher interest rates.

·     To provide cash to their customers, SVB had to start selling their bond portfolio at a loss. 

·     Realizing this wasn’t sustainable, they announced they were looking to raise capital.

·     Coming from a bank holding many billions of dollars this sounds Very Bad, so customers started withdrawing funds via wire transfer as fast as they could. Panic spread via text, Twitter, and Slack! About ¼ of the money held at SVB was pulled in five business days!

·     Their stock price dropped so fast that trading was shut down mid-morning on Friday, March 10th.

These are not the same mistakes made as those of the banks in 2008ish with the Global Financial Crisis. While the banks in 2008 primarily did not properly manage risk related to mortgages, SVB’s cashflow problems of today seems to be a combination of different factors.

In hindsight, it seems obvious that SVB could have prevented their failure if they would have diversified their types of banking clients further (beyond the tech sector and beyond business accounts) and if they would have invested less of their bank deposits in long-term Treasury bonds that are super sensitive to interest rate risk.

The whole story reminds me of one of my favorite quotes by Warren Buffett: “Only when the tide goes out do you discover who's been swimming naked.”

What Happened to SVB Account Holders

The FDIC (Federal Deposit Insurance Corporation) announced that the bank was shut down and depositors would have access to funds on Monday, March 13th. The FDIC is set up to handle this situation (banks close almost every year), and had already created a new bank, Deposit Insurance National Bank of Santa Clara (DINB) to allow depositors access to their insured deposits and time to open accounts at other insured institutions. Thus, all depositors with $250,000 or less were guaranteed to have their account values restored.

One potential problem was that SVB account holders are … very rich? The FDIC limits their insurance coverage on bank deposits to $250,000 per account title. Apparently 86% of SVB accounts (mostly business accounts) were over the FDIC insurance limit.

On Sunday, March 12th, in the afternoon, the federal regulators announced that even account holders beyond $250,000 in an account would be made whole starting Monday.

Did this mean business as usual on Monday? Well, not exactly. SVB account holders were still having challenges with account access and cashflow in the early part of the week which was exacerbated by having to make payroll on Wednesday the 15th. It will probably still be weeks before these companies feel like they are back on solid ground with their banking needs.

Up until now, it does appear that regulators are doing all they can to restore confidence at SVB. No one wants Americans to lose faith in the banking system, and up until very recently, SVB had a good business which could be attractive as an acquisition.

The overall effect on the banking system and the stock market remains to be seen. As of this article writing, it seems as if bank stocks have declined about 25% while the broad S&P 500 stocks have declined about 2%. In addition, there are ripple effects of other large banks having severe problems including First Republic (in the process of being rescued by the big U.S. banks) and Credit Suisse (in process of acquisition by UBS). A positive outcome of the cracks in the banking sector could be that it might force the US Federal Reserve to end or at least slow its rate hike cycle.

What you as an individual investor should know:

There is a reason why we generally avoid long-term bonds in investment portfolios at Wealthrise. They are known to be VERY interest rate sensitive. During Covid, the Federal Reserve dropped rates to 0% increasing the likelihood of a future rate hike cycle. With the onslaught of inflation coming out of Covid lockdown, the need for rate hikes became pretty clear. The sensible investor avoided long-term bonds in the first place; and definitely, gave them a wary eye when inflation started to heat up.

In addition, most clients hold stocks and bonds which typically are non-correlating in their performance. Obviously, this past year was an exception as rapid interest rate hikes proved to punish bonds, down 13%, and stocks, down 18%. Yet, over time, we should still aim to keep some exposure to stocks and bonds in portfolios where clients have near term withdrawal needs. The discipline of holding both core asset classes as well as various investment categories should lend to an ability to draw money out of investments without compromising the long-term return to a great extent.

It pays to stay diversified. During certain periods, it is tempting to focus investments on certain sectors like tech. This approach eventually comes back to bite. We saw that in the late 90’s, and we are getting a taste of that again. The prudent investor will stay broadly diversified across all the sectors and across other countries. 

Investors should pay attention to account balances. If you are ensured up to $250,000 at a bank or in a CD and have more money to add; you may want to start a new account. Each account is insured up to $250,000; and you may hold more than one account at a bank.

In brokerage accounts like the one’s at Schwab, SIPC insurance applies which insures each account to a balance of at least $500,000. SIPC coverage is used to make investors whole if there is a shortage after all customer assets held at the brokerage firm have been recovered. These limits do not mean that the account will only receive up to $500,000 of their invested securities. Rather, in a SIPC customer proceeding, the account will receive a pro-rata share of all client assets recovered in liquidation then will receive up to $500,000 from SIPC to make up any difference that exists.

No one knows for sure where this banking crisis will land. There are simply too many factors in play. Therefore, a reasonable investor drawing money from accounts should consider holding up to two years of their withdrawal needs in cash equivalent accounts (CDS, money markets, high yield savings) and then set up a balanced portfolio that incorporates stocks, bonds, and broad diversification that is in line with the investor’s risk tolerance.

So, after all this, where are nervous investors putting their money? One of the interesting fall outs of these past couple of weeks is the rush to invest even more money into U.S. Treasury bonds. Demand has spiked for the “riskless” asset.

Have questions or concerns? We are here to help. Schedule a time to meet with us.

This article is for educational purposes only and should not be considered investment advice. Speak to a financial advisor for advice on your personal situation.

Shelley Murasko, MBA, CFP®, is founder of Wealthrise Financial Planning, a Registered Investment Adviser in California.