You likely heard about Silicon Valley Bank (“SVB”) this past weekend, and by now, you’ve probably also heard that the government took actions to quell fears that SVB’s failure might lead to a broader “contagion” effect. It seems as though the bank will, in fact, “fail” in the sense that its debt and equity will suffer or be wiped out…but customers will not lose their deposits, even temporarily.

What follows is a brief recap of what happened, and what it means for investors who don’t bank with SVB, but who are concerned about the downstream effects of its failure on their portfolios.

What Happened

Last Wednesday, a press release from SVB surprised investors with news that it needed to raise over $2 billion to shore up its balance sheet. This raised concerns about the bank’s liquidity levels, which in turn led its customers, many of which are startups backed by venture capital or private equity firms, to move cash from SVB to other banks. In total, customers withdrew $42 billion by the end of the day Thursday.

In essence, the liquidity crunch stemmed from SVB’s decision to invest a large part of its deposits in long-dated bonds.  Generally, bondholders receive greater yields when purchasing bonds with longer terms to maturity, all else being equal.  But this decision tied up SVB’s liquidity for a long time, in bonds that were paying historically low yields. For simplicity’s sake, let’s use a round number of 2% as the average yield of these bonds, though that figure is not exact.

As everyone has seen over the past year, interest rates have increased at unprecedented levels. If SVB was able to hold the bonds they purchased until maturity, the bonds would likely have matured, and all principal would have been returned, plus whatever interest was earned along the way. However, when SVB made the decision to sell some of these bonds to generate more liquidity, the bonds had to be sold at a substantial loss. After all, no one would pay full price for a bond paying 2% when that same bond now yields closer to 5%.

These losses, coupled with the massive withdrawals by its customer base, led to SVB being declared insolvent on Friday.

Why Was SVB Unique?

SVB is known for catering to the venture capital and startup community, a very tight-knit community where the key players know and talk to each other frequently. Its business was highly concentrated in the technology sector, which in and of itself has been hit hard over the past 18-24 months. By communicating its otherwise responsible decision to shore up its balance sheet through bond sales and issuing new stock, SVB left venture capitalists and thousands of companies with a dilemma – remain loyal to SVB, a key part of the startup ecosystem, or risk being unable to pull their cash from SVB in the event that things got ugly. Most recognized that remaining loyal came with very little upside, but tremendous downside, and chose to pull their money. It was a classic run on the bank, compounded by some poor risk-management decisions made by the bank itself.

FDIC Insurance

A central reason for customers pulling their funds from SVB has to do with FDIC insurance, which protects depositors from a bank failure, but only up to $250,000. SVB, like many banks, required that it maintain cash accounts for many companies with whom it did business. Many of these customers’ account balances far exceeded the $250,000 insured limit.

As someone who closely follows the news through various outlets, I saw debates rage over the weekend as to whether depositors should be bailed out by the government. Few (if any) seemed to argue that the bank itself should be bailed out. Still, most seemed to agree that customers who simply used SVB to maintain cash accounts should not suffer losses on those deposits due to poor risk management by the bank, even to the extent that those deposits exceeded the FDIC insurance limit of $250,000. Many of these companies who banked at SVB were planning for the worst – not being able to continue operations, pay vendors, or even make payroll. Absent a government intervention or a private transaction that guaranteed deposits, customers were told that they’d need to wait potentially a long time to get back (likely) less than 100% of their deposits that exceeded the FDIC limit. Even if they were eventually made whole, the delay alone could have crippled or killed many businesses.

Had this situation spilled into this week, it is likely that many more local and regional banks would have experienced a similar fate in short order. Although it’s too early to tell what, if any, downstream effects there may be, the government has said that depositors will be made whole for 100% of their deposits, without delay. Some other banks have either been forced to shut down, or are facing tremendous pressures to avoid a similar fate, but it appears the government is intent on protecting depositors.

Unlike other banking crises in years past, where it became evident that certain large banks were often working in direct opposition to their client base, there is no evidence of that here. Mistakes were clearly made but, from what we’ve gathered, not of the sinister kind. It appears that many good people at SVB did their best to avoid this situation and do right by the bank’s customers, and perhaps its biggest failure was one of communication. I have some good friends in the venture capital world, and they are angry at the industry itself for the panic that it caused, viewing this as a potentially avoidable situation. 

I Don’t Bank With SVB – What Does This Mean For Me?

Our clients’ brokerage accounts are custodied primarily at Fidelity and Charles Schwab, and their assets are not commingled with these custodians’ balance sheets. Furthermore, these accounts have coverage up to $500,000 under the Securities Investor Protection Corporation (SIPC). Both custodians have also purchased Excess of SIPC Coverage, which provides added insurance should one of the custodians fail financially. Importantly, this coverage only guarantees that the securities are there…it does not protect their value.

Unlike SVB, Fidelity and Schwab are not overly concentrated in one industry. Frankly, they are different businesses entirely. For what it’s worth, all of our firm’s Principals personally have money at Schwab and/or Fidelity. I have money at both, and haven’t thought for one second that the funds might be at risk, aside from the inherent market risk of the securities themselves. Firms that rightly segregated client assets from their own balance sheet survived 2008, which in my opinion was a far bigger banking crisis than what we saw this weekend and what we’re likely to see in the days, weeks, and months ahead.

With that said, it is still too early to tell if there will be additional fallout from this bank failure. Will the stock market temporarily fall as fear increases? Perhaps. Will the backstopping of deposits give investors confidence that this was a one-off problem with no significant broader market impact? Perhaps. The reality is that no one knows. Just one week ago, Forbes Magazine listed SVB as one of “America’s Best Banks.” Consensus among stock analysts who cover the financial sector (and SVB specifically) was that the stock was either a hold or a buy!

There is an endless supply of examples that prove that, in the short run, no one knows anything. But focusing on risk management and downside protection, be it from diversification or simply being mindful of FDIC limits, is always paramount. Also, note that programs exist whereby FDIC insurance can be provided for amounts substantially greater than $250,000. Alternatively, certain government-backed securities may be used to effectively accomplish the same for larger balances.

If you have any questions about your specific situation, we invite you to connect with our team.

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