Our Thoughts on the Silicon Valley Bank Failure
Silicon Valley Bank, the 16th largest bank in the U.S. and a leading institution in the tech startup space, failed on Friday after a run on deposits led the Federal Deposit Insurance Corporation (FDIC) to take control of the bank’s assets, which include almost $175 billion in customer deposits. The failures sparked broader fears among other banks seen as having similarities to Silicon Valley Bank – notably First Republic Bank. Then, on Sunday, New York-based Signature Bank was also closed. Soon afterwards, federal regulators, in an effort to restore confidence, announced Sunday night that all depositors of both banks will have access to all of their money on Monday, March 13.
While our firm does not have a banking relationship with Silicon Valley Bank (SVB) or Signature Bank, we have worked quickly and diligently to assess any investment implications and to determine whether any Litman Gregory Wealth Management clients are directly or indirectly impacted by these events. In this update, we walk through what happened to SVB, address the investment implications including the potential for contagion to spread within the banking sector, review the ways in which this could impact clients, and provide a general review of how to keep your deposits safe.
How Silicon Valley Bank Went Bust
What happened to Silicon Valley Bank is that a boom in deposits in recent years amidst plentiful liquidity in the tech space left it with a challenge in earning an attractive return on those deposits. Lending opportunities among its tech customers were less than in other industries given that those customers had access to private capital and a tendency to be in an earlier stage of their lifecycle.
The bank chose to invest a large amount of the deposits in longer-maturity bonds with yields above what it was paying to depositors, including Treasury Bonds. While these investments had almost no credit risk, they had significant interest rate risk in that the market price of these bonds would drop in the event rates were to rise. And as we all know, rates rose sharply and swiftly last year, creating paper losses on those bonds.
Initially deposits were affected because its customer base tended to have large balances and were attuned to maximizing the interest they received. With higher rates becoming increasingly available at other institutions, some Silicon Valley Bank clients moved their money. As its financial position gradually weakened, fear took hold and ignited a classic feedback loop culminating in last week’s run on deposits that led to the bank’s failure.
The Broader Impact of Silicon Valley Bank’s Failure
The clear consensus among financial industry experts is that while shorter-term fears may roil some other regional banks, the Silicon Valley Bank failure is not a harbinger of another 2008-type financial crisis. There are some unique attributes of Silicon Valley Bank that are not common across the broader banking sector that contribute to this view, along with the generally healthy financial condition of most major banks.
While all banks are affected by rising rates, e.g. the need to pay more interest on deposits, Silicon Valley Bank was acutely exposed to rising rates. Rising rates decreased the value of the bonds it had purchased with depositor money while increasing the amount it had to pay to depositors – a double whammy. And SVB also apparently did not hedge its portfolio exposure to rising rates, unlike most other banks.
Its customer base is concentrated among tech-driven start-up firms, where higher rates and a general pullback in tech reduced the amount of capital flowing to the industry, reducing the supply of cheap deposits.
Finally, the demographics of Silicon Valley Bank’s customer base contributed to its failure. Their generally much larger depositors were both quicker to move their money to get higher rates (while the smaller depositors more characteristic of retail banks tend to leave their deposits alone) and because many corporate deposits were far in excess of FDIC insurance (which covers up to $250,000 per deposit account) the first whiff of trouble quickly escalated into herd behavior, with almost $42 billion pulled in the 24 hours leading up to the FDIC takeover.
We have looked at the potential impact on firms whose stock price was driven lower on Friday as a result of the Silicon Valley Bank failure. Most noteworthy is First Republic, which is popular in the Bay area and used by some of our clients. We are not direct industry or company analysts, but we have looked at research and opinions of bank analysts who cover the stock and reviewed information provided by First Republic relating to its financial condition.
While fear is a powerful catalyst and can be difficult to predict, we note that First Republic has a significantly more diversified depositor base with low exposure to tech. The average consumer account size is below the FDIC insurance limit which in theory at least reduces any urgency to pull money (meanwhile all Silicon Valley Bank depositors are expected to have access to their money on Monday, March 13). First Republic also has access to significant liquidity. These are reasons analysts we follow see the fears as overblown.
A key financial institution for Litman Gregory Wealth Management and our clients is Charles Schwab & Company, which saw its stock price decline on Friday after the news broke on Silicon Valley Bank. Most of our clients’ assets are custodied at Schwab (while some are custodied at Fidelity) and it’s important to understand that the investments that comprise our clients’ portfolios are not affected by Schwab’s banking operation.
The investor reaction that pushed down Schwab’s stock price seems more a function of the realization (and pricing in) of earnings pressure than contagion fear. The troubles at Silicon Valley Bank are shining a light on the impact of higher rates on bank profit margins and earnings, including Schwab – which last year saw nearly half its revenue come from net interest revenue (the difference in what it earns on invested deposits and what it pays on bank deposits). Earnings pressure aside, Schwab’s liquidity and overall financial condition are solid and we don’t have any concerns about their viability. Schwab issued a statement which gives more detail on their financials and perspective on recent events.
Impact on Our Clients Is Mostly Minimal
From an investment standpoint, as a member of the S&P 500 and other U.S. stock market indexes, Silicon Valley Bank was an extremely small position in client portfolios with investments in these indexes. In the case of the S&P 500, Silicon Valley Bank comprised just 0.04% of the index at the start of the year, which is about 4 cents per $100 invested in the S&P 500 (it’s even smaller in other indexes). For comparison, the largest company in the S&P 500 is Apple at more than a 6.00% weighting.
The exposure to Silicon Valley Bank or Signature Bank from actively managed mutual funds in client portfolios is similarly negligible based on a review of client holdings. In the case of private funds, some of which own a portfolio of underlying funds, we are in the process of assessing any direct or indirect look-through exposure to Silicon Valley Bank. We expect any exposure to be minimal.
Logistically there is some impact. Some of our clients bank with Silicon Valley Bank, and some of the private vehicles our clients hold have banking relationships with Silicon Valley Bank. Financial regulators said Sunday night that all depositors will have access to all their money on Monday, March 13 (including amounts above the FDIC limit) and normal banking operations like clearing checks, etc. are expected to continue normally. So any disruption should be minimal.
But for any clients who would like to review their bank deposits and the FDIC limit, we encourage you to contact your advisor. We can assess your individual banking situation and provide some ideas on how to ensure all your deposits are insured. For example, we have access to vehicles that parse savings to multiple banks with each being under the FDIC limit so that the larger total is insured. This is something clients can do on their own as well and we would support that strategy.
One of the steps our client service operations team has already taken is to identify any money movements (such as standing wire transfers, etc.) that involve Silicon Valley Bank or Signature Bank and to halt those. Any clients affected by this will be notified so that a solution can be reached.
Summary and Next Steps
The situation involving Silicon Valley Bank is very new and still developing. We have worked hard to ensure we fully understand any ramifications that could impact our clients and will continue to do so in the days and weeks ahead. We will report back with further information if necessary and work closely with individual clients related to any impacts to their situations. As always, we thank you for your trust and invite you to reach out with any questions.