First, what happened this past Friday to Silicon Valley Bank is not what happened to banks during the subprime mortgage crisis during 2008-2009. The subprime mortgage crisis involved borrowers who could not pay their mortgages. They should not have qualified to obtain mortgages. They had no other assets or resources to pay their debt, and many foreclosed on properties and declared bankruptcy. Banks’ cash receipts dwindled, and they couldn’t pay their debts, and so on.
The current situation involves banks that perhaps made too many conservative investments with surplus deposits during the pandemic. By purchasing U.S. Treasury Bonds with longer maturities (duration) , the bank “locked in” a fixed coupon rate, averaging a 1.8% return on their bond portfolio ($121 billion at the end of Dec 2022. The bank’s deposits had increased from $60 billion in March 2000 to nearly $200 billion in March 2022.
Since last year, interest rates have risen dramatically due to the monetary policy actions by the Federal Reserve’s commitment to halt or slow inflation.
- The deposits from their main customers (startups and venture capital firms) began to slow down because of the rising interest rates and fewer public offerings. Deposits drooped 15% in 2022.
- The bank carried a book value of Treasury bonds and Mortgage-Backed Securities on Dec 31, 2022, of approximately $121 billion – 70% of their total deposits ($173B) were invested in longer-duration bonds. The bonds pay fixed interest payments at an average of only 1.8%. Similar bonds today are yielding over 5%, making SVB’s bonds worth less in the market. But if they plan to hold onto maturity and weather periods of high and low-interest rates, they need not worry about changing values because, at maturity, they get their principal back.
Just one last thing to do:
- SVB investors agreed the best way to create cash for operating capital, even though it would realize a loss, was to sell a portion of their bond portfolio, approximately $21 billion. The loss on the transaction was approximately $1.8 billion. The intent was to use $2.25 billion for capital and reinvest the balance ($18.8 billion) at today’s higher interest rates.
But the “Street” found out!
It wasn’t so much the transaction that got people talking since companies frequently may be forced to liquidate assets for various reasons (buybacks, acquisitions, etc.), but it was the bank’s disclosure that a portion was to be used for operating capital ($2.25 billion) is what spooked Silicon Valley on Friday – “You need to liquidate assets at a steep loss for ordinary expenses?” Silicon Valley is tightly knit, and when someone with influence says, “you should pull your money out of there,” it can be ugly. And it did as the requests for withdrawals exceeded the cash on hand. The bank would be forced to sell more of its low-yielding U.S. bonds at a loss.
What does it mean?
Silicon Valley’s involvement makes it a large issue that can entangle many companies and banks worldwide. But I don’t believe this is a big problem as it’s being made out to be. There are no risky asset purchases that will default. Their asset mix was the main problem, and the elapse of time may have fixed the issue (interest rates drop), but they are guilty of being too conservative, which turned out to be a major risk for them.
But the remedy here is to allow the normal cycle of interest rates to take its course, as the longer-duration bonds will rise in value just as quickly as they fell in value once rates begin to decrease. What improved regulation would have addressed is the bank from taking too conservative a position with lower yielding investments while the warnings of higher prices, and therefore higher interest rates, were visible.
Please consider meeting with me to discuss your financial goals and reexamine your financial situation to determine if your portfolio mix suits your situation and goals. Please don’t hesitate to contact us if you have a question or schedule a no-charge initial consultation.
Anthony B. Carr, CPA, CFP®, MBA