Banking 101 And Silicon Valley Bank Crisis

Silicon Valley Bank comes down. Yes, the popular tech firm lender has revealed that it is in deep trouble, and within hours, the  share price tanked 60%, after announcing it needs to raise $2.25 billion to offset a $1.8 billion loss on some bond sales. Why is that happening? Blame the relatively high interest rates in the United States.

As I have noted here many times, many US banks would bleed valuation if the interest rates continue to stay high. At the beginning, they will look fine, since high interest rates mean more money from loans. Most of the loans like credit cards are not fixed rates; they are benchmarked to the prime rates which means as the prime rate changes, they change how much they charge customers. As I write, most banks are making more money from those loans.

Yet, there is an issue because before a high interest regime in a developed economy, there is always a moment of low interest rates. What do you do when interest rates go low? You load on bonds. Typically, bond prices inversely correlate with interest rates. 

Silicon Valley Bank was shut down by U.S. regulators Friday as the troubled lender struggled to stabilize its finances amid a rush of withdrawals. The Federal Deposit Insurance Corporation took over SVB and transferred the lender’s assets to a newly created bank, the Deposit Insurance National Bank of Santa Clara. Insured depositors will have access to their accounts from Monday morning. SVB — which lends heavily to venture-backed tech startups — spiraled rapidly after announcing Wednesday it had sold a chunk of its portfolio at a $1.8 billion loss and was trying to raise more capital.

Shares of SVB Financial, parent company of SVB, were suspended early Friday after dropping some 68% in pre-market trading.

VC firms had been advising portfolio companies to pull their money from the lender.

America’s four biggest banks — JPMorgan Chase, Citigroup, Wells Fargo and Bank of America — lost $52 billion in market value Thursday. (LinkedIn)

As interest rates rise, most fixed-rate bonds which are held as investments see lower yields. Banks are affected. About 2-3 years ago, with massive stimulus, citizens had surplus funds and they put those in banks as deposits. And with interest rates near zero, banks were not making much from loans, even as fewer citizens needed loans since the government was sending them cheques. What happened was banks loaded on bonds since lending was muted!

Unfortunately, right now, the values of those investments are now reduced and liabilities in the balance sheets of banks are rising. For small banks, that triggers liquidity issues and a need for more capital because you need liquidity to run a bank. That is the reality of most US banks, including SVB.

I predict that if the government does not arrest this, the projected recession will come via this path. This is possible since the government must still raise interest rates since inflation remains evident.

*Ndubuisi is an ex-Lagos banker.

Silicon Valley Bank, a major lender in the private market ecosystem, has sparked panic among venture capitalists and entrepreneurs by revealing plans to sell securities and raise billions in a public share sale to offset significant losses on its balance sheet. Following this announcement, the bank’s shares plummeted by approximately 60%, raising concerns of a bank run. Venture capitalists are advising their tech clients on where to move their money, with some recommending withdrawing deposits and relocating 6-12 months of cash burn to a more secure location. Despite the bank’s claims of being well-capitalized and possessing a high-quality, liquid balance sheet, signs of trouble are emerging, such as clients struggling to log into the bank’s website and wire transfers potentially being delayed (Fortune newsletter)

Update: SVB has collapsed, according to CNN. It was unable to raise capital

Silicon Valley Bank collapsed Friday morning after a stunning 48 hours in which its capital crisis set off fears of a meltdown across the banking industry.

Its failure marks the largest shutdown of a US bank since 2008, when Washington Mutual fell during the financial crisis.

California regulators closed down the tech lender and put it in control of the US Federal Deposit Insurance Corporation. The FDIC is acting as a receiver, which typically means it will liquidate the bank’s assets to pay back its customers, including depositors and creditors. The FDIC is an independent government agency that insures bank deposits and oversees financial institutions.

Comment: Ordinarily the bank didn’t manage their portfolio right. Huge funds with significant impact on their balance sheet if rate goes down were pushed to long term investment. If the tenor was right with good investment mix they wouldn’t have run into liquidity crisis. Or they didn’t foreseen this a year ago?

My Response: Profits corrupt in banking. To be a great banker, you need to know when to make the cut. If you have $2 billion that returns $200m yearly, it would be tough to call back that fund only for it to return $0. So seeing it is not enough as it is not physics. What if the government does another stimulus and prevents that problem? This explains why only the boring types build sustainable banking institutions, because one has to take the long game, and avoid chasing quarters.

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