Many clients may have seen the news in regards to the SVB bank – Silicon Valley Bank.
This is a bank that is not well known and given there are over 4,800 banks in the US that is probably not a great surprise. SVB is actually a reasonably large bank with total assets of US $211.8 billion as at the 31st December 2022. Compare that to the NAB with total assets of $596.1 billion.
SVB grew very quickly, through venture capital firms pouring cash into it as they raised capital for potential start-ups, and in December 2019 it had total assets of just over US $71 billion. Incredibly, it grew by 62.68% to US $115.51 billion by December 2020 then US $211.3 billion by December 2021 (82.93%). December 2022 saw very little growth and its total assets at December 2022 was US $211.8 billion. Their cash flow issues started in December 2022.
The numbers look very positive, however it is this growth that may have been the cause of the problem and also why its situation may not be a reflection of the broader financials market.
Banks collect deposits from investors and then lend money to borrowers. The differential is their core business. If you pay a 1% deposit rate and lend at 3.00% it is a good margin business.
In Australia our major banks need more than our deposit base to meet all the lending demands. The ANZ funds about 75% of its lending from the deposit base and then borrows the balance from other suppliers such as offshore banks. You will often hear the term ‘cost of funds’ and that is what the banks have to pay to depositors and other suppliers to provide the money they lend.
If you look at the SVB it had an oversupply of depositors and couldn’t get the money out the door to borrowers fast enough. Instead of 100% of its deposits being lent out it actually lent only 43% of its deposit base and 57% they then invested in financial market securities such as US Treasuries earning around 1.66% interest and Mortgage Backed Securities earning around 1.56% interest.
Compared to most banks you would think this is a very low risk bank.
Unfortunately, you have a confluence of events that they didn’t foresee and arguably hadn’t managed appropriately.
- Their client base is very concentrated, mainly the tech sector and a lot of those clients were very substantial. The Tech sector had a very difficult 2022.
- The Federal Reserve rapidly increased the cash rate from 0.25% to 4.75% over the last 15 months which impacted negatively on the value of the securities and treasuries that SVB was holding. Why buy a bond with a 1.6% earning rate when you can buy one that now gives you over 4.0% for the same money. It is evident now that they were using historical cost accounting as opposed to ‘mark to market’ which means these treasury assets were sitting on their balance sheet at inflated values.
- Analysts are also reporting that they weren’t hedging their interest rate risk which most large/sophisticated banks normally manage. Hedging would have allowed them to liquidate their treasuries at book value.
This concentrated client base had its own problems and was withdrawing larger amounts of cash than anticipated.
SVB had to cash out a large portion of these financial securities at a loss – reported as close to a US $1.8 billion loss – ouch!
Nervous depositors got wind of the banks’ distress and as they say, the rest is history. A run on the remaining deposits led the Federal Deposit Insurance Corporation (FDIC) to step in.
The FDIC has now said it will pay out 100% of the insured deposits – think of the bank guarantee we have here -the first $250,000 of a depositors account is insured. That will equate to about US $21 billion and the uninsured depositors will also get some form of payout. Any SVB issued debt securities however are probably worthless.
So the headlines will blast ‘Second largest bank failure in US history’ – because they exclude investment banks like Lehman’s which had $639 billion in assets before its collapse in 2008.
This will definitely unsettle markets and no-one likes to see banks fail and destroy investor value.
Will there be contagion?
Most banks have nothing like this sort of growth and deposit and asset profile. Larger banks like Australia’s big four have risk measures in place that would mitigate this sort of risk and can manage through this interest rate cycle.
There may be other banks out there that have similar risks to SVB and the interest rate cycle will expose them if they do and that is not unusual in stressed markets. A well-used phrase is ‘a rising tide lifts all boats… only when the tide goes out, do you see who’s been swimming naked’. The first part is a John F Kennedy quote and Warren Buffet provided the addendum.
We should certainly pay attention to the demise of SVB. It is likely this interest rate cycle will expose other companies that have similar risks.
Will it be the start of something like the GFC? Very unlikely and we would be more focused on inflation and potential recession risk than a bank with questionable risk management practices.
SVB may just be an example of one of my favourite ‘demotivational quotes’. ‘It could be that the purpose of your life is only to serve as a warning to others’. I have added the link as you might enjoy these.
As always if you have any concerns, please do not hesitate to contact your adviser.
Regards,
Marshall Brentnall, and the AAN Investment Committee
