2023-03-11 07:46:29 ET
Summary
- On Friday, due to a sudden increase in deposit outflows and a failed attempt to raise equity, Silicon Valley Bank was shut down by US regulators.
- I would love to quickly explain as simple as possible what I believe caused the collapse of SVB Financial.
- Silicon Valley Bank's collapse was caused by an idiosyncratic balance sheet composition that is not matched by major diversified banking giants.
- In my opinion, major banks are fine - for now. In fact, I continue to believe that major diversified banks such as JPM, C and BAC are a 'Buy'.
What a week for the equity markets, and banks in particular! On Friday, due to a sudden increase in deposit outflows and a failed attempt to raise equity, Silicon Valley Bank (SIVB) was shut down by US regulators -- marking the largest bank failure since the financial crisis (by far).
As a consequence, I have received quite a few messages from concerned readers about their investments in bank stocks. Thus, I would love to quickly explain as simple as possible what I believe caused the collapse of SVB Financial. And similarly, why I agree with Janet Yellen's assessment that the banking system is fine - for now.
The SIVB Collapse Explained
So what happened to SIVB? To find the answer we must go back to early 2020, when the COVID-crisis prompted an unprecedented liquidity flood. This liquidity flood, which has been seen as a Fed put, provoked a boom in venture capital activity.
On the backdrop of a risk-on mentality, which flushed start-ups and founders with cash, Silicon Valley Bank, which has positioned itself as the bank for the venture capital market, enjoyed an inflow of deposits. In fact, from 2019 to late 2022 , SIVB total deposits more than tripled, growing from $61.7 billion in 2019 to $173 billion as of December 2022.
Now, what should SVIB do with these deposits? With a compressed NIM spread (which was another consequence of QE), writing loans was not very attractive. So, SVIB decided to park the excess liquidity in U.S treasury securities and similar low-yield risk-free notes. Although these securities have been considered 'risk free', with the end of QE and start of QT these securities depreciated sharply in lock-step with rising interest rates. (Remember that the value/ price of a bond is inversely related to the interest rate level).
For reference, below is the 10 year chart of the iShares 20+ Year Treasury Bond ETF (TLT). Evidently, bonds repriced sharply as inflation concerns prompted central banks around the world, including the Fed, to rapidly raise rates.
SIVB suddenly needed to struggle with falling prices of its holdings of fixed income securities. Meanwhile, concerns about a depreciating asset base were compounded by an outflow of deposits, as savers were seeking higher yield opportunities than parking cash at a bank. A balance sheet crunch was looming. And after the market woke up to SIVB's struggles, the meltdown materialized quickly.
Large Banks Are Fine - For Now
Silicon Valley Bank's collapse was caused by an idiosyncratic balance sheet composition that is not matched by major diversified banking giants such as JPMorgan (JPM), Bank of America ( BAC ), or Citigroup ( C ). For reference, below is a snapshot of J.P. Morgan's deposit growth from Dec 2019 to Dec 2022: As compared to a more than 200% increase for SIVB, JPM's deposit base only jumped by approximately 50%, growing from $1.56 trillion to $2.3 trillion.
Moreover, larger banks didn't go all-in on 'overvalued' U.S treasury securities. With that frame of reference, in late 2021 Jamie Dimon even commented that [he] ...
wouldn't touch Treasurys with a 10-foot pole at these rates
And while SIVB ended 2022 with a $13 billion net debt position (stretched financial liquidity), JPM, BAC, C ended the year with net cash of $688 billion , $440 billion and $164 billion respectively!
A Final Thought On Systematic Risks
In my opinion, major banks are fine - for now. In fact, I continue to believe that major diversified banks such as JPM, C and BAC are a 'Buy'. But still, investors should consider that a banking crisis may quickly spiral out of control. In the end, banking is a business of confidence. And confidence is built on believes that may be shaky - sometimes influenced more by moods than by facts.
Moreover, the second-level impacts of SVB's fallout could be far-reaching, given the bank being a partner for nearly 50% of venture-backed tech and life sciences companies.
At this point, the SIVB collapse looks like a warning slap only. I hope the government, as well as the Fed, take note. Please let us not stretch this game [financial tightening] too far.
For further details see:
SVB Financial Collapse - Simply Explained