The collapse of Silicon Valley Bank (SIVB) has caused all sorts of breathy talk the past few days. I would caution those thinking this is a “Lehman Brothers” moment all over again to switch to something decaffeinated.

As Former FDIC Chair Sheila Bair explained: “This is a $200B bank in a $23T banking industry. I think it’s going to be hard to say that this is systemic in any way.” Silicon Valley is about 8/10ths of 1% of the banking system.

In other words, this is not Lehman. It’s probably more a “Bear Stearns Lite” moment. That is, a harbinger of things that could come, if interest rates and quantitative tightening don’t run their course sooner than later from here. The new lending facility from the Fed offers a road map of what to expect:

• guarantees for depositors
• no bailouts for shareholders or executives.

It’s exactly what you asked for during the 2008-09 Financial Crisis.

Key takeaways

• The Federal Reserve and FDIC making SVB and Signature Bank depositors whole is the right move and does not cost taxpayers any money
• The nature of the new credit facilities to support bank depositors is another form of cover for the Fed to continue with higher for longer interest rates and Quantitative Tightening
• The Fed is doing what we all asked them to do in 2008-09, which is bailout the people, while letting the bank’s stockholders and executives absorb losses first
• Banks that need help are on notice to get their acts together quickly or face massive dilution down the road – there’s a few ways that could go, including dividend cuts again
• Don’t dismiss how smart the Federal Reserve is or that they only tell you half of what they are acting on

Why Silicon Valley Bank Went Down

Thinking through why Silicon Valley Bank went down I think is important. It’s not as simple as some would think.

This was not really a case of an overleveraged bank that got blown up with bad loans. Rather, it was a case of a bank that had a ton of cash come in and management invested it with an exceptional amount of hubris.

What do I mean by hubris? 

From day one with the Fed’s interest rate increase policy, people, mainly investors, have been saying the Federal Reserve would back off soon. The whole “Fed’s got our investing back” group think. 

Interestingly, many of those same people complained about the Fed causing inflation. So, while they insisted the Fed would keep rates low and back off on QT (quantitative tightening), they were at the same time saying low rates and QE (quantitative easing) caused inflation. 

A bit of an oxymoron. 

It turns out that the Fed decided to raise rates aggressively. I have argued for over a year now that they are fighting mainly imported inflation from OPEC, Russia and China, as well as, housing inflation, which likely was caused by the impact of Covid combined with cheap money. 

In the case of Silicon Valley, they invested their bond portfolio as if the Fed would back off quickly on rates and QT. They chose, they were not forced, to invest into bonds because there was a mismatch of loan opportunities as money flooded in during Covid. 

To put simply, SVB saw massive inflows of deposits…

SVB Inflows (10Q)
… and then invested poorly. According to S&P Capital, they invested 55% of their money into bonds, including around $80 billion in mortgaged-backed securities.

Remember, this was a bank with about $209 billion in assets, but only about $175 billion in deposits. A considerable mismatch. 

Also according to S&P, 47% of the bonds had durations over 5 years. 

Here we see how out of line SVB was with most other banks on duration: 

Bank Securities Maturities (S&P Global)

Why didn’t they just invest in short duration bonds of 90 days to 2 years? Like the number of licks to the center of a Tootsie Pop, the world may never know.

With interest rates shooting up, they took mark to market losses on that portfolio. This left them vulnerable to trader narratives and a run on the bank.

What happened next was classic.

Fear was fomented, particularly online, likely by those who were short the bank. It started small, as it usually does, planted by the shorts with the big idea. After a few weeks, deposits started to leave quickly.

Billions left in a matter of weeks.

Then it spiralled. 

And just a few months after insiders started selling stock, the bank failed. 

Oh, you might not have known that little nugget about insiders selling stock as the bank weakened. I’m sure there will be an investigation you can follow. 

Now, another interesting thing. The Federal Reserve has it in their power to lend directly to banks. Why didn’t they lend to SVB ahead of the collapse? 

There has to be a reason doesn’t there? 

I think given the common “Fed is stupid” narrative perpetually out there, most will attribute it to some sort of disfunction at the Fed. And again, we won’t know until some of the Fed Presidents retire and write books. 
I would submit this though. Silicon Valley Bank had largely monopolized lending in venture capital and tech start-ups. They controlled over 80% of the market. That’s like big tech’s control over tech stuff. Pretty obnoxious. 

I think the Fed let them go down because they wanted more competitive lending in the VC and start-up space. Diversifying the lending sources to innovative technology and new businesses is good for the economy long term.

In short, I think the logic was: If a monopoly can’t protect itself, why should the Fed? Now we’ll see dozens of new banking players in lending to entrepreneurs and holding deposits. (That’s good folks.)

Systemic Risk And Moral Hazard

Janet Yellen initially declared that she didn’t seen an systemic risk with Silicon Valley Bank.

Former FDIC Chair Sheila Bair exclaimed: “This is a $200B bank in a $23T banking industry. I think it’s going to be hard to say that this is systemic in any way.” Silicon Valley is about 8/10ths of 1% of the banking system.
And, then, within a day or two, there were cures used for systemic problems. 

Go figure.

Here’s what I said to members of Margin of Safety Investing a few hours before the SVB and Signature Bank depositors were bailed out: 

“… Uninsured depositors, at first glance, will recover at a minimum 80% of their funds, but 100% is fairly likely…”

I went on to discuss how bailing out the depositors was a good idea since most of the money is corporate and used to support businesses, which, in turn, support employment. 

Bill Ackman tweeted something similar regarding most uninsured money is corporate and supports businesses that employ people. I think that’s a super important point.  

Here’s what Bob Elliott, CIO of Unlimited, said: “The big question is whether the FDIC and Fed make the uninsured depositors whole—or at least close to whole… If the resolution of SVB Financial isn’t handled well, there’s a systemic risk that uninsured depositors will flee small banks.”  

Make Depositors Whole (Bob Elliott)

Several libertarian slanted investors have taken the opposite side of the argument suggesting moral hazard is being introduced by supporting depositors. I’d point out a lot of those people make money in financial markets, including being short and using technology tools to skim, errr, front run, ummm, ahhh, get their beak wet, I mean, beat markets. 

I would suggest that whatever is being introduced as moral hazard is more than offset by holding financial people accountable for their decisions. 

By letting bank stock go to zero, bond holders taking haircuts and executives being under the ax, as well as, potential criminal penalty, the moral hazard that people like Ken Griffin (ironically of all people) point to, is largely solved.  

I expect that the $250,000 guarantee for individual depositors to remain the same. However, a new corporate guarantee is likely coming. In my investment webinar this week, which discussed the SVB fallout,  I suggested a tiered system. We’ll see how that shakes out, but corporate deposits need some sort of backing to prevent business and employment disruptions. 

The Fed and FDIC to the rescue!

The $23 Trillion Banking Industry

There is no doubt that there are problems with the banking industry. The rise in interest rates has left some banks with bond heavy portfolios with massive mark to market losses.

The Fed’s new loan facility is designed to help fill the gap in bank balance sheets caused by mark to market, as well as, other issues. 

The new Bank Term Funding Program [BTFP] will allow banks with short-term liquidity issues to borrow from the Fed using the par value of their investments vs mark to market today values. 

So, rather than having to sell assets at a discount if depositors withdraw funds, the bank can borrow from the Fed at the long-term par value of their Treasuries and MBS. This closed the gap on securities pricing issues. 

The loans have one year limits. That means banks get about a year to solve their issues. In many cases they will not be able to do so on their own.

Expect a lot of changes in banking, including a new wave of mergers and acquisitions. In the meantime, a lot of dividends are at risk. 

This new facility won’t solve all the problems. 

Truly troubled banks, those with bad loans, still at risk. I would submit that in the next year or two we will see plenty of banks ask for help due to bad real estate loans on office properties in particular.

We’ll see what that episode brings. I suspect a massive repricing of office buildings at a minimum. In the banking sector, get ready to forget some names and learn new ones.

Author

Kirk Spano 

CEO/CIO — Fundamental Trends

Kirk is an Accredited Investment Advisor and founder of Fundamental Trends and Bluemound Asset Management LLC. Kirk has been highly successful in helping DIY investors make sense of the investment world, and profit in stocks, ETFs and crypto.