On Wednesday March 8th SVB Financial Group (SIVB), the holding company for Silicon Valley Bank, announced a recent sale of $21 billion from their bond portfolio as well as their intention to issue $2.25 billion in new stock to shore up their weakening financial position. Less than 48 hours later the bank was placed into receivership by the FDIC. While the end came swiftly for SIVB, the process started months ago.
From 2019 to the first quarter of 2022, customer deposits at SIVB more than tripled to a high of $198 billion. Coming out of the pandemic the commercial loan market was lethargic so banks like SIVB invested swelling deposits into U.S. government bonds and agency mortgage-backed securities. While these securities carry minimal credit risk their value declined as the Federal Reserve increased interest rates.
Accounting rules allow banks to place their bond holdings into two buckets. Those classified as “Available for Sale” are revalued at the end of every quarter on a bank’s balance sheet, but those labeled “Held to Maturity” escape this requirement. By the end of 2022 SIVB’s “Held to Maturity” bonds lost $15 billion in value that was not recorded on its financial statements. As long as SIVB did not sell these bonds, they were not required to recognize this paper loss. Unfortunately, accelerating customer withdrawals forced SIVB to sell securities at a loss, when recognized at the end of the quarter, would have wiped out almost all SIVB’s $16 billion equity capital.
To make matters worse 90% of SIVB’s deposits were uninsured by the FDIC. It was primarily a business bank focused on a concentrated customer base of technology startups and venture capital funds in the San Francisco area. These firms maintained large deposits well in excess of the $250,000 insurance limit. The proposed stock offering signaled financial weakness and spooked customers. The announcement caused an old-fashioned bank run and the collapse of the 15th largest depository bank in the United States.
While there will likely be some aftershocks from the SIVB collapse, swift action was taken to boost confidence in the U.S. banking system. Over the weekend the Treasury Department, the Federal Reserve, and the Federal Deposit Insurance Corp. (FDIC) collectively announced that all deposits at SIVB are guaranteed including those above the $250,000 FDIC threshold. Also, to backstop the banking sector further, the Federal Reserve created the Bank Term Funding Program (BTFP). This program will provide funding so banks in a pinch can meet their withdrawal needs. The program allows banks to post current bond holdings as collateral to the Fed, in return they will receive up to a one-year loan. The bank will not need to recognize any paper losses in exchange for these loans.
While the entire situation remains fluid, we want to address concerns about our primary custodian Charles Schwab & Co and its subsidiary Charles Schwab Bank. Schwab Bank, like many other banks, does have exposure to bonds with unrealized losses in their security portfolio, they are in a different position than SIVB. As outlined in a press release yesterday morning, more than 80% of Schwab’s bank deposits fall within the FDIC insurance limits, compared to only 10% for SIVB. This makes Schwab more resistant to a bank run like we witnessed last week with SIVB. Secondly, Schwab’s liquidity profile is more robust. As of year-end 2022 Schwab had 40% of total deposits in “Available for Sale” securities compared to only 15% for SIVB. They also have over $300 billion of backstop credit lines with the Federal Home Loan Bank (FHLB) and other short-term facilities – about equal to their total deposits. These factors, combined with Schwab’s adequate capital levels put them in a strong position to weather these turbulent times.
For some, the last few days may feel eerily similar to the Global Financial Crisis (GFC). However, there are major differences. This time government action was proactive and swift, reducing systematic risk across the banking system. The GFC was caused by poor credit risk and excessive leverage in the financial system. This time around asset quality on bank balance sheets is good, and the financial system is generally well capitalized. This gives us comfort that, while some weakened banks may fail, the events of last week were largely idiosyncratic. Financial market volatility will likely persist as investors digest recent dramatic events, but we believe your cash remains protected.