Silicon Valley Bank, SVB, and FDIC coverage.
Suddenly lots of questions arose this past week.
There is an old saying in the banking business: “Banks borrow short, and lend long.” This means banks borrow money from you (a depositor) which they have to be ready to return to you. And then banks make long-term loans or investments with the capital.
When a depositor places money in the bank (whether into a checking, or savings account) you are lending money to the bank. The bank owes you that money. Banks need to be ready to return those funds to you quickly. In fact, checking and savings accounts are technically deemed “demand deposit” accounts. Meaning, you (the depositor) can “demand” your funds back immediately, by making a withdrawal or writing a check. That truly is “borrowing short.”
And banks would usually pay you a little something for giving them the use of your money. That is called interest. Prior to 2008, you could earn a little interest on your money. The interest earned was not a competitive rate. And the rate of return was not above the rate of inflation(1).
With money deposited, the bank tries to “make the best use of” their capital. But that does not always work out.
Which brings us to Silicon Valley Bank (SVB). Something unique about SVB: their Board of Directors had little to no actual banking experience. The niche this bank served were start-up companies in the technology space and also venture capital firms.
This is a pretty spicy niche market. A few years ago (pre-Covid), the bank had $60 billion in total deposits. But by the end of 2022, Silicon Valley Bank had roughly $200 billion in deposits. That rate of growth is not seen often in banks. And their stock price skyrocketed.
The “plan” at Silicon Valley Bank was to earn a little more than what they paid out in interest to their depositors. The bank then placed a large amount of their deposits into ten year Treasury bonds and ten-year mortgage backed securities. And if interest rates had stayed near zero, this would have been a solid plan.
Except interest rates did not stay near zero.
There’s a little detail the bank overlooked. It’s kind of important. When interest rates rise, the price (the value) of your bond falls.
Now start-up technology companies often have little to no sales revenue. They need to raise a lot of cash to build their product. And since no one likes to work for free, they need to pay employees and vendors. Start-up companies “burn” through a lot of cash. And many start-ups do not make it.
We’re starting to hear stories that venture capital firms insisted their start-up companies not only do all their banking business with SVB, they also encouraged their “portfolio companies” to borrow from SVB as well. While we cannot verify how accurate this is, the point is that many small companies, employing many thousands of folks, were becoming embedded with the bank.
How Banks (not Silicon Valley Bank) Usually Invest
Early in my career (1984), I spent a year working at a small regional bank in New York. While I was not involved with the “Treasury” activity of the bank, my desk was placed in the middle of their “Investment” department. It was fascinating to see, on a ground-level, how the machinations worked:
When the “finance team” arrived at work in the morning, they had a printed report of their “money line.” This was the excess (net) deposits from the 50+ branch offices that had come in the previous day. Back in early 1984, the only person with a computer was the Senior VP for the Bank (Ed), who was responsible for all the investments for the entire bank.
The rest of the team had pens, pencils, graph paper and adding machines on their desk. Not very high-tech. Jay, who I sat next to, and reminded me of Dwight Schrute from The Office, was apparently a big shot. That’s because Jay had an electric pencil sharpener on his desk, too.
The team would spend each morning, calling around to their Wall Street contacts, gathering rates for overnight investments, for five and ten-day investments, and longer term, too. They would post these rates, by hand, on erasable white boards. The boards were hung on three walls, around the room. Carole spent much of her time writing, erasing and then re-writing updated rates on the boards.
Additionally, each day – usually after lunch, Ed, Bill, Jay and the rest of the group would calculate what they would need, in dollar terms, to hedge against their portfolio. This was needed in the event rates moved against them and the value of the holdings drop.
Usually somewhere between 2:30pm and 3 o’clock, Ed would stumble out of his office and announce how the funds were to be invested. Then each team member would begin sending the money transfer wire instructions to the Federal Reserve. The team would calculate what they might need for tomorrow at the branch level, and allocate the funds accordingly.
And the next day, they would start all over again.
It does not appear investments worked that same way at Silicon Valley Bank. The reports from SVB indicate a majority of their assets were invested in ten-year Treasury and Mortgage-backed bonds. They did not appear to hedge these investments against a change in rates. Over time, we are hopeful more details will emerge.
This is important because over the past year, since March 2022, the Federal Reserve has raised short term interest rates. Short term rates moved from near-zero to over four percent. This is an earth-shattering, massive move in short-term rates in less than twelve months.
So as rates moved up throughout 2022, and into 2023, the value of the bank investments dropped. And since the investments were un-hedged, there was no protection for the portfolio.
VC firms and Silicon Valley Bank
Venture capitalists and hedge fund managers spend a lot of time reading and talking. At the same time, publicly traded companies (like SVB) need to disclose how their assets are invested. Their “assets” were loans to start-up companies (a significant risk on their own) along with an un-hedged portfolio of bonds. Here is (likely) what these titans of industry were reading:
In these reports are details concerning the billions of dollars in losses from the bank’s investment portfolios. Average fixed income investment securities saw a decrease of $1.5 billion. And period-end fixed income investment securities (again, bonds) saw a decrease of $2.6 billion. Additionally, the bank saw total client funds decrease $12.2 billion, which includes a decrease in period-end on-balance sheet deposits of $3.7 billion.
Money was going out.
To fortify the asset base, SVB began discussing a secondary offering of stock. SVB’s share price began falling as the news broke. This made selling more shares nearly impossible. All it took was a few phone calls regarding what was happening, to start massive withdrawals from the bank. Prior to the last few weeks, SVB had been the 16th largest bank in the country.
But within a single day, the bank received withdrawal requests of $42 billion. This was the equivalent of a quarter of its overall deposit base of the bank itself. By Friday, March 10, the bank collapsed. No bank can withstand a run like that. The process feeds on itself. Which is one reason why FDIC coverage exists (to help reduce the chance of a run on the bank).
As Ben Carlson, in his post over on “A Wealth of Common Sense” described:
There is a lot to this story but it really boils down to an old-fashioned bank run. A flood of withdrawals from depositors destroyed the bank.
If everyone with a Planet Fitness membership showed up at the gym at the exact same time there would be chaos at the squat racks. It would be impossible for anyone to work out and the gym model wouldn’t work.
The same thing applies to banks. If everyone goes to get their money out on the same day, it’s going to be hard for a bank to survive.
The Treasury and the FDIC has stepped in this past week to announce that all deposits at SVB will be secure. This includes balances at Silicon Valley Bank in excess of the $250,000 FDIC threshold. We have been told “this is not a bailout” and “no taxpayer funds are at risk” in securing these deposits. However, the fees each bank pays to contribute to the FDIC pool comes from their banking activity. Essentially, the fees we all pay.
On Friday, March 17, 2023, Silicon Valley Bank officially filed for bankruptcy. The bank reported a net position of just $2.2 billion in equity at the time of the filing. And while the deposits of these start-up companies has been secured, what about the lines of credit nearly all of these start-ups have been counting on – or even using? It is possible these borrowers may be able to secure new lines of credit elsewhere, at what kind of terms will they be facing?
FDIC and Silicon Valley Bank
It may be hard to remember, but up until banks started collapsing left and right in 2008, the coverage from the Federal Deposit Insurance Corporation (FDIC), had been $100,000. One of the better outcomes from the financial mess of 2008 was how FDIC coverage was raised form $100,000 up to $250,000 per person, per bank. in fact, FDIC coverage was up to $10,000 in the 1950’s, then up to $15,000 in 1966. The coverage was raised to $20,000 in 1969, and again raised to $40,000 by 1974. In 1980, the FDIC threshold was raised to $100,000.
For individual investors and savers, it’s a good idea to stay alert when a balance reaches $250,000 at a bank. Technically, a married couple will have a combined amount of $500,000 in FDIC coverage. And you should know your accounts are insured up to a grand total of $250,000, spread over multiple accounts. For example, if you have $150,000 in a checking account and $200,000 in a savings account in your name only; you have $350,000 at a bank in your name only. You are over the FDIC threshold by $100,000.
This level tends to work well for many individuals. But what should a business do? There could be huge balances in business accounts right before payroll. There could be huge reserve balances for a future need sitting in the bank. These are questions lots of folks suddenly had to begin thinking about last week. It might make sense for some businesses to have multiple bank accounts, and consider use of money market accounts, treasury securities and other investments.
Incidentally, we received an email from of our own vendors (a data/technology company), informing us they were seeing “business as usual” this week, and were continuing to work with Silicon Valley Bank. This surprised us, we had no idea this vendor was even working with the bank. We’re happy to report this has zero impact on us in any way.
We discussed where should you keep your cash in a recent podcast with the team. If you have questions regarding the ins and outs of FDIC coverage, feel free to contact us.
- There was a brief period of time in the late 1970’s-early 1980’s where it was possible to out-earn the rate of inflation. This period was very short. Additionally, in the late 1960’s the fixed rate on savings accounts was five percent. Depending on the prevailing rate of inflation it was possible a saver could temporarily earn more than the inflation rate.