Posted: Monday, March 13, 2023
On Friday, the FDIC announced their takeover of Silicon Valley Bank in the largest bank failure since 2008. On Sunday, regulators announced the shut down and takeover of a much smaller bank, Signature Bank. We believe these banks’ unique circumstances, enhanced bank regulation since 2008, and swift action from regulators will prevent their failures from spreading into contagion. We would like to put in context Silicon Valley Bank’s risky business model, what led to its failure, and what this means for your money.
Silicon Valley Bank was founded in 1983 and is headquartered in Santa Clara, California. As of Q4 2022, it was the 16th largest bank in the United States with approximately $210 billion in assets (1), making it nearly half the size of banks such as Capital One and Truist (formerly BB&T). The company has an extremely niche customer base serving businesses and venture capitalists predominately in Silicon Valley. Approximately 85% of the bank’s deposits were uninsured, meaning anything over $250,000 in a customer’s bank account was not covered by the FDIC.
During the early days of the COVID-19 pandemic, financial stimulus was pumped into small businesses and venture capitalists were able to borrow at 0% interest rates. Silicon Valley Bank experienced a windfall of customer deposits as a result. With excess cash at the bank, they decided to invest the proceeds in high-quality bonds. As interest rates rose rapidly in 2022, the value of those bond investments declined significantly. But this did not concern the bank, because they never planned to sell their bonds, and they believed they could wait for the value of their bond investments to recover.
As the economy slowed and interest rates rose, Silicon Valley Bank’s customers were burning through their cash and deposits began to decline. As this was taking place, informed business owners noticed the bank’s poor investment performance, and they became concerned that the bank would not have enough in deposits or liquid investments to meet customer withdraws. On Thursday, a run on the bank was underway, but instead of customers lining up outside, they were withdrawing deposits at an unprecedented rate from their phones. After two days the bank experienced $42 billion in outflows, and they could no longer meet customer withdrawals. As a result of their troubles, the FDIC took over, halted withdrawals, and backstopped all customer deposits. Stock owners and creditors in the bank will likely be wiped out completely.
The US government acted swiftly over the weekend to fully back deposit holders in excess of $250,000 and ensure this is a contained event. So all individuals with money at the bank can be reassured that the FDIC will back their deposits. The failure of Silicon Valley Bank was a result of their unusually high concentration of uninsured deposits and their inadequate risk management of interest rate risk as monetary policy evolved in 2022. Failure to support the depositors would have created a dangerous precedent as it is unrealistic to ask everyday Americans to underwrite their bank’s financial standing for the safekeeping of their money. In our quarterly market commentary, we noted that Federal Reserve interest rate hikes work with a lag and they can have unintended consequences. We believe this failure will give the Federal Reserve second thoughts on the pace and size of future interest rate hikes.
At Juno, we were proactively repositioning portfolios since last year to reduce risk as the Federal Reserve was raising interest rates. We will continue to monitor the situation closely.
Thank you for your continued trust in Juno Financial Group.