Late last week, Silicon Valley Bank (ticker: SIVB), a California-based bank that caters to the technology venture capital sector, failed. Concerns over fallout to other banks caused a decline in the stock market, as the S&P 500 lost 4.5% and the Nasdaq lost 4.7% for the week.
While SIVB’s failure will go down as the second-largest bank failure in US history, its implications for the rest of the banking system may be limited, and its impact on markets may be short-lived.
Silicon Valley was a mismanaged bank that saw rapid deposit growth from technology employees, owners, and investors who monetized portions of their companies over the past 2-3 years through public offerings or venture capital cash infusions.
SIVB invested these deposits into long-term US Treasury and Agency bonds that lost value as the Fed hiked interest rates over the past 12 months. Long-term bonds always lose value as interest rates increase.
While other banks have done a similar thing, SIVB did it to a much larger degree on top of a non-sticky depositor base that was 85% uninsured (FDIC deposit insurance maxes out at $250,000 per account). As concerns over the health of SIVB rose, their customers withdrew $42 billion in two days. The bank failed due to an inability to meet these withdrawals since raising cash by selling its long-term bonds would have forced them to realize losses that would have wiped out all the bank’s equity.
The size of the unrealized losses on SIVB’s bond portfolio relative to its equity was unique among banks. The following chart shows the reduction in common equity (tan bars) from where it is currently (blue bars) should these longer-term “hold-to-maturity” bonds be sold among a sample of banks.
As you can see, given the size of SIVB’s bond portfolio, the losses would wipe out all its common equity. There is little to no risk in these US government and agency bonds if they can be held to maturity, as the holder will get their principal back. Unfortunately, SIVB owned too much of them on top of having a jumpy, niche depositor base that withdrew money at an alarming rate.
Source: J.P. Morgan
Our research suggests there is a strong possibility that SIVB may eventually be viewed as an isolated event rather another major credit crisis that leads to a severe bear market. We will likely not see continued fallout among other banks.
We did, however, see some modest deterioration in our models on Thursday & Friday and raised some extra cash and implemented a small hedge position in accordance with our discipline.
We should see markets stabilize in the days ahead as SIVB becomes viewed as idiosyncratic not systemic. That said, we will continue to monitor the many key risk metrics in our macro models that will either confirm that viewpoint or suggest that the risk of contagion is escalating. If the markets can’t stabilize soon, we see likely see further deterioration in our models and we will adjust our strategies accordingly.
-VGA Investment Team
Vineyard Global Advisors offers a range of investment strategies designed to allow participation in the market's growth within a dynamic, risk-managed framework that seeks to protect against significant market declines. Our goal is to give our clients greater peace of mind by generating steadier returns over time. Contact us to learn more.
