For those of us that have lived through the 2008 recession and the banking/housing crash, Thursday and Friday of last week was nothing new. Of course, the magnitude and speed that it happened is always a bit of a shock.
As you know I like to take my shots at the FED, but I can’t lay this whole issue at the feet of the FED. Did the FED leave interest rates at zero for too long? Yes! Prior to the SVB (Silicon Valley Bank) collapse, was the FED likely to raise rates too high? Yes!
You know I’m a fan of saying the FED drives the economic car from one ditch to the next, and this time is no different. But they are not the only entity to blame for this. As Warren Buffett likes to say, ‘You never know who’s swimming naked until the tide goes out’. We know the tide has been going out the last year or so and it was bound to affect something, you just didn’t know where.
You can see that SVB stock had been going down since late 2021. Much of that was related to tightening monetary conditions and a slowing tech world. But compared to more diversified banks, it dramatically underperformed its peers. So that was the Macro economic environment.
Now that the FDIC has taken SVB into receivership, it deserves reviewing who else was to blame and how it got to this point.
First and most importantly, SVB did a terrible job matching their liabilities and assets. Because of the ultra-low treasury yields over the last few years (prior to 2022) the bankers at SVB invested much of their assets in long-term Treasuries and Mortgage-backed Securities. We know (I won’t go through the math) that as interest rates rise, prices of bonds go down.
We know that rates were basically at zero a year ago and now are around 4.5%. Again, without doing the math behind it, we would expect bond prices to go down during that time. Here’s the loss on the SVB bond sales.
I don’t know about anyone else, but that looks like just shy of a 10% loss on their bonds. But they’re a bank, shouldn’t they know what they’re doing? I would say yes. But check this out.
Oops! As it turns out, SVB had removed nearly all of their interest rate hedges, leaving their bond portfolio almost totally exposed to the rate increases the FED was pushing through.
So here you have the startup ecosystem collapsing, interest rates rising and nothing to hedge the risk that your balance sheet was taking, never mind nobody overseeing that risk. Sounds like the perfect storm for a bank to go under.
But wait, that’s not all. Actually, the hole that SVB was trying to fill wasn’t all that big to begin with, as SVB had hired Goldman Sachs to raise $2.25 billion in securities. That was not able to be accomplished because of the speed at which it collapsed. At the same time Goldman was trying to raise capital, a very influential VC in Silicon Valley, Peter Thiel and his Venture Capital fund (Founders Fund) held a call with many of his portfolio companies. According to the Washington Examiner, here’s what happened:
The total withdrawals on Thursday was $42 billion (that’s a busy ATM! 😊, which is what caused SVB to sell their $21B worth of Bonds referenced above.
So, while Peter Thiel may have said there was ‘no downside to moving their money,’ clearly there was a downside, that being putting an otherwise “good” bank into receivership.
Finally, we come to all the people, companies, and venture funds that held money at SVB. If you remember back in 2008, the FDIC coverage limit was $100,000. Subsequent to the banking crisis, the FDIC raised its coverage limit to $250,000 (per account, so you can get creative to significantly expand this coverage across all of your banked assets). That’s where it is today. Now maybe some people don’t know the limits of the coverage, but companies and VC firms certainly should and likely do.
87% of deposits at SVB were over the limit of FDIC insurance. We can also assume that many of the small companies that are raising rounds of funding probably don’t have a treasury department or may not even have a CFO to oversee their cash. While many of those companies were pre-revenue and were burning money on a monthly basis, they still had an obligation to prudently manage (or at least safeguard) the cash that investors entrusted them with. Many of those companies were obligated to leave their cash at SVB because of covenants of loan or lines of credit. They were trapped between a rock and a hard place.
So now we come to the rescue part of the story. If you have been following it, the FED and Treasury came in Sunday and said they would back all deposits and make those entities whole. Which I would agree is probably the right thing to do. But it does beg one question.
WHAT’S THE POINT OF FDIC INSURANCE IF THE GOVERNMENT BACKS ALL DEPOSITORS?
Or will this be a one off and they will institute different rules for the next bank that becomes insolvent? As of right now, there is no reason to move your money from any bank if you assume the explicit guarantee of the US government is backing it.
In 2008 we had TBTF (Too Big to Fail). Today is it TITF (Too Interrelated To Fail)?
So, what lessons have we learned?
- Banks need to do a better job of matching assets with liabilities
- A good risk manager is apparently nice to have
- Bank runs happen extremely fast
- Beware of having too much cash in a single bank
As near as we can tell, Madison Park is nowhere near SVB or any other affected bank in any material way. Things seem to be business as usual. We haven’t noticed anything out of the ordinary. If you are interested in owning a bank, I hear there are a couple for sale really cheap 😊.
It will be interesting to see how this plays out over the next couple weeks. The FED is meeting on Wednesday next week to discuss monetary policy. It should be interesting. This latest news certainly adds a wrinkle to their considerations. Have a good week and as usual, if something doesn’t make sense or you want clarification, let’s talk.