Last week’s closure of Silicon Valley Bank (SVB) marked one of the largest bank failures in history and sparked fears over the health of the entire financial system. While the situation remains fluid, below you’ll find a high-level overview.
The situation with Silicon Valley Bank remains fluid and is certain to drive its fair share of volatility in the weeks to come. For now, we believe that what happened with Silicon Valley Bank is largely an isolated event, given its unique circumstances and unusual client base — it had very few typical retail customers.
The composition of Silicon Valley Bank’s balance sheet exposed the bank to larger shortfalls in the event of rising interest rates, deposit outflows, and forced asset sales. At this time, we view this as a unique or rare exposure within the current banking system, and the biggest ones, importantly, remain highly diversified with large balance sheets that are unlikely to be materially impacted by these events due to their hedging and risk management strategies.In the meantime, we believe the Federal Reserve will likely approach further interest rate hikes with more caution going forward.
Turmoil in the financial sector led to a sharp sell-off in stocks last week after the Federal Deposit Insurance Corporation (FDIC) announced the closure of Silicon Valley Bank on Friday, March 10.The closure of Silicon Valley Bank marked one of the largest bank failures in history and sparked fears over the health of the entire financial system. The S&P 500 tumbled nearly 5% last week, and the financial sector fell by more than 8%.
The U.S. Government’s Response
Following last week’s sell-off, the markets received some welcome clarity over the weekend regarding the fate of depositors and other institutions associated with the bank.On Sunday night, the U.S. Treasury, Federal Reserve, and FDIC released a joint statement designating Silicon Valley Bank as a systemic risk, giving the Treasury Department authority to unwind the bank in a way that will fully protect all depositors, both insured and uninsured.
The statement indicated that those with money at the bank will have full access to funds starting Monday morning. This is important since out of Silicon Valley Bank’s $173 billion of customer deposits at the end of 2022, $152 billion were uninsured (i.e., over the $250,000 FDIC insurance threshold) and only $4.8 billion were fully insured (JPMorgan).
Safeguarding Market Instability
In addition to back-stopping depositors, the Federal Reserve took decisive action to prevent this situation from spreading to other banks.
The Federal Reserve announced it is creating a new Bank Term Funding Program aimed at safeguarding institutions impacted by the market instability of the Silicon Valley Bank failure.The Fed facility will offer loans of up to one year to banks, saving associations, credit unions and other institutions. Markets initially reacted positively to the developments but fell in the pre-market trade Monday morning as markets were set to re-open for the week.
About the SVB Collapse
The collapse of Silicon Valley Bank happened swiftly. On Wednesday of last week, the bank reported that "client cash burn has remained elevated and increased further in February, resulting in lower deposits than forecasted." To shore up liquidity and reassure investors, the bank attempted to raise capital and liquidated approximately $21 billion of bonds at a significant loss. This had unintended consequences that spurred a run on the bank, leading toinadequate liquidity and insolvency due to the rush of withdrawals.
Silicon Valley Bank served a niche market focused on lending to and gathering deposits from venture capital firms.The problem didn’t stem from underlying credit risk issues but rather a severe duration mismatch between high-quality assets and deposit liabilities. In short, the bank had invested its deposits in low-interest rate bonds that it held on its books on a long-term “hold-to-maturity” basis.
That means that it did not have to mark-to-market those bonds until they were sold. If a bank does not need to sell “hold-to-maturity” assets to meet withdrawal requests, there is no problem. But if a bank is forced to sell these securities at a loss, that’s where the trouble starts.
In this case, many of the underlying bonds were purchased prior to the rapid spike in interest rates over the last year, meaning that they will have to be sold well-below par value (the amount the bonds would eventually be worth at maturity).
Many catalysts drive volatility in the markets, most of which are unknown until they occur. Working with Avantax can help smooth inevitable bumps in the road by taking a long-term tax and financial planning perspective.
If you have questions, please reach out to me.
Silicon Valley Bank Collapse – Is it An Isolated Event?
March 15, 2023