The Collapse of Silicon Valley Bank

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What Happened?

The biggest event happened over the last two days is the sudden collapse of Silicon Valley Bank, which triggered a huge crisis in the American financial world. It is considered to be the second-largest failure of a financial institution in U.S. history. The stock of SVB Financial Group, the bank’s holding company, closed at $267.83 per share on Thursday, March 8. It went down to $106.04 by the market close on March 9, a 60.4% decline in value within a day. Then during the premarket trading on March 10, SVB’s stock spiraled down to as low as $37.50 per share, another 64.6% decline in value within a few hours. In order to protect the interest of investors and wait for the aftermath news, NASDAQ halted the trading of SVB Financial Group’s stock on early Friday morning.

The panic of SVB’s crash spread over to the entire financial sector in the U.S., wiping out hundreds of billion dollars in market value for all U.S. banks in two days. The four biggest U.S. banks, Citigroup, JP Morgan Chase, Wells Fargo, and Bank of America, lost $52 billion in market value on Thursday alone. KBW Bank Index of NASDAQ, which tracks the leading 24 major banks in the U.S., was down 11.4% in the last two days. This sharp selloff of banking stocks in the U.S. also spread to markets in Europe and Asia. Shares of banking giant HSBC were down 4.5% on Friday, Deutsche Bank 6.8%, Italy’s Unicredit 4%.

 So what happened? How could a major regional bank with assets totaled more than $200 billion just collapse in 48 hours? The whole event started on Wednesday when SVB announced that it recorded a loss of $1.8 billion by selling worth of $21 billion bond portfolio which mainly consists of U.S. Treasuries. The next morning, SVB announced that it would sell $2.25 billion in new shares to raise cash. That triggered a panic among some major venture capital firms, who advised their clients to withdraw money from the bank. Around $42 billion was withdrawn from the bank on Thursday alone. The fear of the bank’s financial health caused its stock value to drop by 60% within a day. This spooked investors who were willing to purchase the newly issued shares, and the effort for raising new capital failed later on Thursday. All of these add pressure on the stock price. During premarket trading on Friday, March 10, SVB’s stock was down by another 60%, which forced NASDAQ to suspend the the trading of its stock. Later that morning, Federal Deposit Insurance Corporation or FDIC, an independent agency created by the Congress to maintain stability and public confidence in the nation’s financial system, stepped in to take over the bank, announcing that Silicon Valley Bank was shut down and placed under its receivership. FDIC promised the public that the bank will reopen the following Monday, allowing the bank’s depositors to withdraw funds within $250,000 limit. FDIC also added that it would sell SVB’s assets and that future dividend payments may become available to uninsured depositors.           

Why Did It Fail?  

The stunning crash of Silicon Valley Bank shocked the world. The obvious question is to ask what caused SVB’s failure. There are a number of factors attributed to the collapse of the bank. I believe the most important one is Federal Reserve Bank’s endless effort to raise interest rate to combat inflation. Over the past year, the Federal Reserve has raised interest rate from near zero to 4.75% as of today. This rate hike puts a lot of pressure on the overall U.S. economy, especially the startup tech companies who happen to be the majority of SVB’s customer base. The higher interest rate caused the market for initial public offerings to become impossible and made private funding more costly. These startup companies needed cash to operate business, to pay their employees, and to fund their research and developments. So, they started to withdraw money out of SVB to meet their liquidity needs. As more and more of SVB’s clients withdrew money out of the bank, the bank’s cash balance began to shrink. To stay liquid, the bank must come up with ways to raise cash to meet its customers’ needs. Thus, the bank decided to sell a portion of its bond portfolio, mostly low-risk U.S. Treasury Bills, to get cash this week. These type of securities were usually held by the bank over a long period of time, 10 years or 20 years, yielding an average rate of return of 1.79% when interest rates were low. Because of the present higher interest rate, the current 10-year Treasury yield is around 3.9%. Therefore, SVB had to record a loss about $1.8 billion on the sale of securities, which triggered a series of unfortunate events in the next two days.

Another reason caused Silicon Valley Bank to fail is the high concentration of tech startup companies as being its customers. SVB founded in 1983, specializing in banking for tech startups. It provided financing for almost half of US venture-backed technology and health care firms. When startup companies were growing rapidly in early 90’s, so did the bank. It soon became the largest bank by deposits in Silicon Valley and the 16th largest bank in the nation at the time of its shut down. However, when the economy took a down turn due to the outbreak of corona virus and higher interest rate, the startup companies could not continuously raise cash to fund its operations. They began to withdraw fund out of the bank, which caused a bank run this week. If SVB’s customers were well diversified across all sectors of industry, it could have a better position to protect itself from this temporary event. It wouldn’t have caused a bank run. Similarly to manage a stock portfolio, it is always less risky to fully diversify the stocks rather than to concentrate only on a few individual stocks.    

Moreover, the poor management of Silicon Valley Bank when facing a crisis also caused the bank to fail. When the management noticed that the bank’s cash balance was declining because of the withdrawal of money by its customers, they should have taken a bridge loan from the Federal Reserve Bank or other big banks, like JP Morgan Chase or Bank of America to cover its cash deficit. By taking out a bridge loan, it would give SVB more time to find a prospective investor by issuing new shares to raise cash. Instead, the management decided to sell treasury bonds, which they knew for sure that they would have to record a loss and disclose it to the public. Then, the consequence of this action would drive down its stock price, which in turn would further make the situation worse. If the management were to raise cash in a more discrete way without sending an alarm to the public, the situation would not have gone out of hands, and the second largest banking failure could have been prevented.  

What Comes Next?

The aftermath of the collapse of Silicon Valley Bank is still ongoing. The immediate consequence to this event is that SVB’s depositors will lose a lot of money. The bank’s deposits are FDIC insured, so its customers would recover the loss up to the maximum of $250,000 only. However, Silicon Valley Bank is the largest regional bank in Silicon Valley. Most of its customers are high tech and health care companies, which have millions of dollars deposited there. For example, Roblox released a statement on Friday, claiming it had $150 million in cash deposited at SVB. Roku said $487 million of cash was held by the bank. iRhythm, a medical equipment maker, said in a statement that $54.5 million of cash was at the bank.

Because billions in funds were frozen or potentially lost when FDIC took over the bank, a lot of startup companies couldn’t even pay its employees and vendors on Friday. This would create a huge crisis in the tech industry’s financial system. Millions of families will be affected and go into a financial stress. If a quick resolution is not possible for the bank and the situation dragged on for months maybe years, startup companies would be forced to lay off employees or even go bankrupt, which would make the looming economy even worse. According to Garry Tan, chief executive of Y Combinator, one of the most important Silicon Valley start-up incubators, “this is an extinction-level event for start-ups and will set start-ups and innovation back by 10 years or more,” he said.

Nevertheless, the fear of the vulnerability of commercial banks could spread over to other banks in the financial industry. We’ve already seen the evaporation of significant market value of the entire banking sector in the stock market over the last two days. We are not sure how long this effect will last, but for sure it will raise the alarm for other banks to start thinking about how to capitalize their assets and make their cash balance adequate to stay solvent in case some catastrophic event happened.

On the other hand, many were arguing whether the federal government should step in to calm the situation. The answer to this question is that federal government is very unlikely to get involved. Treasury Secretary Janet Yellen said she was monitoring the situation on Friday, and Cecilia Rouse, chair of the White House Council of Economic Advisers, said the financial system was prepared to “withstand these kinds of shocks.” Deputy Treasury Secretary Wally Adeyemi made a comment on Friday, “Federal regulators are paying attention to this particular financial institution and when we think about the broader financial system, we’re very confident in the ability and the resilience of the system.” In other words, the regulators believed that the financial system in the U.S. is well capitalized and liquid. The banks that are now in trouble are much too small to be a meaningful threat to the broader system. Silicon Valley Bank is only a regional bank, which won’t set off a domino effect to other banks in the U.S. I guess we’ll just have to wait to see how this will play out.     

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