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  • Writer's pictureEng Guan

Will The SVB Saga Lead To Another Great Financial Crisis?

We expected last week to be a potentially turbulent week with Jerome Powell testifying before the US economic committee and the release of key February US labor data on Friday. And it didn’t disappoint. It was indeed a chaotic week with the S&P 500 dropping more than 4.5%. But what took center stage this time, however, was not the expected Fed and interest rates stuff, but the sudden collapse of a US bank – Silicon Valley Bank (SVB). The fear of a broader contagion was in the air and this prompted a flight to safety with US Treasuries rallying strongly in contrast to the stock market.

How Did Silicon Valley Bank Collapse?

Most of us would not have dealings or even heard of SVB until this saga. Because it is a commercial bank that specializes in providing banking services for tech startups. But, nonetheless, it is still a fairly large bank that holds $175 billion as of the end of 2022 in clients’ deposits. So what led to its downfall?

Higher rates made the operating environment tougher for startups spurring a drop in deposits and a rise in withdrawals. This pushes SVB to sell the US Treasuries it holds at a loss to meet the withdrawal demands. And it subsequently plans to issue new shares to raise funds to plug the gap. Now, under normal operating conditions, SVB could have held these Treasuries to maturity and these losses would not have been realized. But, unfortunately, as a bank, it has to satisfy its client’s withdrawal requests.

What SVB did spook their clients and the market. Because a bank that shows even the slightest hint of liquidity problems triggers one of the worst nightmares for anyone who has funds with them. As a result, SVB Financial Group's share price plummeted more than 60% derailing their plans for the sale of new shares.

SVB shares fell more than 60%
SVB Financial Group shares fell more than 60%

Many Venture Capital (VC) firms added fuel to fire by advising their portfolio companies to pull money out from SVB and that led to an avalanche of withdrawal requests coming up to USD 42 billion. Unable to raise cash in time, SVB collapsed and the Federal Deposit Insurance Corporation (FDIC) took over. Ironically, the VC community which is instrumental in causing this bank run is now frantically asking the government to bail them out.

What is going to happen next?

The most important thing now is to restore confidence in the system to prevent any contagion which can get out of hand if not managed properly. And to do that, they have to make sure that SVB’s clients can get most, if not all, of their money back or be assured that they can and they have to do it fast before it causes excessive disruptions to business operations.

Each depositor with SVB is insured by FDIC up to $250,000 of their deposits. FDIC already assured all SVB’s clients that they will have access to the insured portion of their deposits on Monday. But since SVB’s customers are mostly companies, their deposits are way above this amount. About 89% of their $175 billion deposits are uninsured. This is unusual for most banks but not surprising for SVB given their clients' profiles.

Those with uninsured deposits can expect to get an advance dividend (based on historical patterns of FDIC - est. 20%-60%) on the uninsured portion within the next week. As for the remaining amount, they will get future dividends as FDIC disposes of the assets of SVB. At the same time, regulators are also looking out for another lender that is willing to merge with SVB to safeguard deposits. If they are able to do that over the weekend, that would be the best outcome.

Will This Lead To Another Great Financial Crisis?

These are my personal opinions. It will definitely lead to some short-term heightened volatility, but a broader contagion leading to a systemic failure of that magnitude is unlikely. Why?

1. The deposits in SVB we are talking about are small relative to the entire US banking system.

The total US bank deposits as of the end of Q3 2022 stood at USD 19.36 trillion. Even though SVB is the 16th largest bank in the US, its deposit of USD 175 billion in absolute terms represents just 0.9% of the US banking system and much less if considered globally.

2. SVB runs a concentrated business.

SVB is a specialized bank whose clients are concentrated largely in a single space - tech startups. Those that are directly impacted at the moment are constrained mostly to these companies. Their larger counterparts or other industries in the broader economy are not yet in the line of fire. And unless you work for companies that use SVB's services or invested in their stock, you or any other average man on the street is unlikely to be affected in any significant way by its fallout short of a more serious contagion.

3. The current US banking system is stronger than they were before the Great Financial Crisis.

Since the Great Financial Crisis in 2008, banks are put under increased scrutiny and subject to heavier regulations. This is to ensure that they are well-capitalized and capable of weathering adverse crises. In 2018, the US government eased some of these regulations for smaller banks which are perceived to have smaller risks. And under the revised framework, banks are categorized into 4 groups with top-tier banks such as JP Morgan and Bank of America in Category I. Banks in this category are considered as having the potential to cause global systemic risk if they fail. SVB falls into Category IV.

5. We are not talking about pervasive toxic assets this time.

During the Great Financial Crisis in 2008, toxic financially engineered assets, many based on subprime mortgage loans were packaged and sold pervasively across both the institutional and retail space. As the real estate market collapsed in the face of rising rates and defaults rose across nations then, these products crash to the point where it becomes worthless. No one even dared to make a bid and those holding on to these toxic assets are unable to get rid of them. The entire market was gripped with uncertainty and fear as no one knows the extent of the damage and its repercussions then. In the end, the government has to step in to bail them out to contain the fallout. But this time, at least, I don't see any toxic assets in the picture.

6. They hold USD 212 billion in assets vs USD 175 billion in deposits.

SVB holds USD 212 billion worth of assets. This is more than its deposit liabilities of USD 175 billion. And out of these liabilities, 11% are insured by the FDIC. This means the uninsured portion is around USD 156 billion. On the asset side, SVB holds $120 billion in invested securities out of which $91 billion are long-term investments marked as "Held to Maturity" securities. The bulk of these are bonds and mortgage-backed securities and they are allowed to carry these securities at costs on their books. But given how bonds and fixed-income instruments have been beaten down since interest rates started rising, these securities are now worth only USD 76 billion. But even with this and considering all the other liabilities they have, they should still be able to cover at least a good bulk of the deposits they owe.

7. There are buyers waiting to buy the assets of SVB.

Since we are not talking about toxic assets here, the Wolves of Wall Street never miss the opportunity in a firesale. As far as the capital world is concerned, it is all about profits. The best time to buy anything from anyone is to buy it when they are in distress. Because that is where you can potentially acquire assets at a good discount. So if it comes to that, FDIC should have no issue disposing of SVB's assets. On top of that, FDIC is also on the lookout for candidates that have the ability to take over. If such a white knight comes along, that would be the ideal scenario.

But of course, there is still a real risk of this episode impacting the smaller banks in an adverse manner. Being more lightly regulated and less well-capitalized than larger banks, means they are more vulnerable to a bank run. The larger customers might pull some of their funds out and diversify them across other banks. Or they may simply opt for the larger ones. To retain customers, smaller banks may have to increase the interest they pay. That will eat into their margin. So we might see a greater dispersion in the performance of the larger banks vs the smaller ones.

In any case, we will have a better picture next week as this saga evolves.

Update: After this post was written, the US regulators created a new Bank Term Funding Program which will offer loans up to one year to depository institutions using their assets such as Treasuries, agency, and mortgaged-backed securities as collaterals. This will provide a backstop for deposits for banks that runs into problems and guarantee depositors access to their deposits. While this should relieve SVB's depositors of their fear, this also probably means that they did not manage to find buyers for SVB over the weekend. It is also worth noting that at the same time another bank, Signature Bank, was closed by the New York regulators. If we try to infer what happened, it can also mean the regulators may be anticipating more such bank failures in light of an increasingly hostile interest rate environment.


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