It has been a rollercoaster ride in the market in the last several days. It all started with California bank Silvergate announcing on March 8th that it intended to wind down operations and voluntarily liquidate. This would be done in an orderly manner in accordance with applicable regulatory process. The liquidation announcement came as a surprise but was not “shocker”. Silvergate catered to crypto clients and had been under pressure for months since the collapse of FTX. Silvergate’s market capitalization peaked at close to six billion in late 2021, falling to about $500 million by year end 2022. It had a market cap on March 1st of this year was about $400mm, and after the liquidation announcement it fell to $80 million. The market viewed this as an isolated event, very much linked to an overly exposed bank to a specific sector. A manageable default.

Immediately after Silvergate’s liquidation announcement the market started to question other banks undue concentration risk to certain sectors. Silicon Valley Bank client’s base was Venture Capital, Private Equity and Technology focused. They had less than 40 branches and were concentrated in Silicon Valley. During the tech boom in 2020 and 2021, SVB received a massive inflow of deposits as startup tech companies were flushed with cash from liquidity events like IPO’s, secondary offerings, SPAC fundraising and venture capital acquisitions. For example, nearly half of US technology and healthcare companies that went public last year after getting funding from venture capital firms were Silicon Valley Bank customers. Ruko, the internet TV provider had balances of over $475 million in the bank.

Most commercial banks take deposits and loan the monies to their clients and run a balanced asset / liability profile. SVB took in deposits but many of their clients did not need loans. This created a need for assets. Instead of depositing the monies at the Federal Reserve and earn very little, SVB went into the market and purchased Treasury Bond and mortgage-backed securities. These are safe assets that require very modest capital usage. As short-term rates were close to zero, many of these investments were longer dated to generate sufficient income. As we have spoken about in the past, long-term bonds have a much greater price impact per one basis point in yield change.

Silicon Valley Bank became collateral damage. It is concentration risk to a specific sector raised concerns in the market. Could this be another Silvergate situation? SVB was tested. Its stock dropped from $267 per share on March 8th to close at 106 on March 9th, its market cap dropping over ten billion to 6.2 billion. This drop led to a massive run on the bank. Unlike traditional banks, SVB’s client held large deposit balances, well over the 250K insured limit. Indeed over 95% of their deposit based held balances over the FDIC limit. A frightened deposit based lined up to withdrawal their monies. Approximately $40 billion of dollars left the bank. It also said that client cash burn rates had not slowed down as planned and deposits had been leaving the bank faster than expect this year.

The bank needed to raise the funds to meet the redemptions. There only choice was to sell their bonds and mortgage-backed securities. With the sharp increase in rate over the last year, the bank was forced to sell these assets at a significant loss. For example, a 30yr US Treasury Bond purchased in November of 2020 was worth about 65c on the dollar, purely based on an appreciably higher rate environment. The bank sold over $ 20 billion of assets at a loss of over two billion. This loss triggered the need to raise additional regulatory capital. SVB immediately announced a sale of $1.25 billion of common stock and $500 million of convertible debt. SVB was unsuccessful in raising the necessary capital and was shut down by regulators of Friday.

On Sunday night the Federal Reserve made an unprecedented announcement. All deposits over 250k at SVB will be backstopped by the government. Additionally, the created a facility where banks can pledge qualifying assets for cash at the Fed for full value, not market value.

We expected increased volatility in the markets in the near future, but the new facility established by the Federal Reserve is a positive step in the right direction as it allows banks to pledge assets for cash to meet excessive redemption requests.

As always if you have any questions feel free to call.

Best,
Bob

2023-152648 Exp 03/25
Source Bloomberg