Thursday, March 30, 2023

Silicon Valley Bank crisis: Decoding the biggest US banking failure since 2008

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By Koustav Das: Global banking and financial stocks took a massive hit on Friday after US-based commercial lender SVB Financial Group was shuttered by US regulators, following an aggressive decline in its stock that led to a market loss of over $80 billion.

With this, Silicon Valley Bank became the largest US bank to fail since the 2008 financial crisis and its sudden collapse stranded billions of dollars belonging to companies, investors and depositors.

The SVB crisis unfolded in just 48 hours, following the bank’s announcement that it was planning to raise funds worth more than $2 billion to plug gaps in its balance sheet. This led to widespread panic among its clients and depositors and also triggered a massive selloff.

As panic grew among its investors and depositors, SVB was forced to shelve its fundraising plan, but the damage was already done.

How SVB crisis unfolded

The embattled tech and startups-focused lender was closed by California regulators on Friday, and it has been put under the control of the US Federal Deposit Insurance Corporation (FDIC).

The overnight shock came after SVB’s stock experienced another sharp 60 per cent decline in premarket trade, after panicked depositors rushed to withdraw funds.

The sudden collapse of Silicon Valley Bank has created a bloodbath in the startup industry and banking stocks in the US and other major markets in the world.

The SVB Financial Group was also looking to sell itself after its failed fundraising attempt, but to no avail as deposits moved out “very quickly”. As the crisis unfolded, the group even told its employees to work from home till further notice.

Shortly after, the FDIC confirmed that SVB was closed by the California Department of Financial Protection and Innovation, and that it was appointed as the receiver. It may be noted that SVB is the first FDIC-insured bank to fail in more than two years.

Also Read | Silicon Valley Bank shut down by regulator, 2nd biggest US lender failure in history

Decoding the SVB collapse

SVB Financial Group’s collapse and takeover by the FDIC may have unfolded in just a couple of days, but analysts said the bank became a victim of sustained high interest rates, and fears of more rate hikes in 2023.

After a period of record low interest rates during the pandemic, central banks around the world, led by the US Federal Reserve, started raising key rates aggressively to tackle inflation. This has dampened investor sentiments and also hit the businesses of tech and start-up focused lenders like SVB.

This is because investors do not like to take risk when the money available to them becomes expensive due to higher interest rates. As a result of the higher interest rates, investors in technology start-ups – that are the primary clients of SVB – became reluctant to take risks.

As higher interest rates led to a funding winter for technology start-ups, SVB’s clients started pulling out their money to meet their liquidity needs. This sent SVB scrambling to look for ways to meet its customers’ withdrawals.

A locked door to a Silicon Valley Bank (SVB) location after it was shut down by regulators in the US.

What happened next was the beginning of the end for Silicon Valley Bank. Under pressure to meet withdrawals, SVB sold a $21 billion portfolio consisting mostly of US Treasuries last week at a huge loss of $1.8 billion. The portfolio was yielding an average of 1.79 per cent, much lower than the current 10-year Treasury Yield of around 3.7 per cent as of March 10.

To fill this $1.8 billion gap, it announced it would sell $2.25 billion in common equity and preferred convertible stock to fill its funding hole. This sudden announcement on Thursday triggered concerns about its balance sheet and its shares plummeted 60 per cent.

The fact that SVB’s fundraising announcement came right after the closure of Silvergate Capital, a crypto-focused bank, aggravated fears among investors and led to more panic.

Investors immediately pulled their money from the bank after being advised by venture capital firms. This spooked other major investors of the bank as well, and led to the scrapping of the stock sale plan.

SVB desperately tried to find alternative funding sources and even considered selling the company on Friday. But its last ditch efforts were unsuccessful and it ended up being shut down by regulators, following which it was handed over to the FDIC.

The FDIC has added that it would seek to sell SVB’s assets, adding that future dividend payments may be made to uninsured depositors.

Christopher Whalen, Chairman, Whalen Global Advisors, said :”I think the Fed badly miscalculated the impact of rising interest rates and so these are self-inflicted wounds and if we see more banks fail, then the Fed is faced with a very tough situation which may force them to drop interest rates.”

“There could be a bloodbath next week as banks are in trouble, the short sellers are out there and they are going to attack every single bank, especially the smaller ones. I think Silvergate started it. That one was the first pebble to go off the mountain and now we have a boulder and more are likely to follow,” he told news agency Reuters.

Biggest US bank to fail since 2008

The Silicon Valley Bank episode marks the second-biggest US commercial bank failure since Washington Mutual, which collapsed at the peak of the 2008 financial crisis.

Before its collapse, Washington Mutual was the largest savings and loan association bank in the US. It was also placed into receivership under the FDIC and was ultimately sold to JP Morgan Chase.

The failure of Washington Mutual, along with other major investment banks such as Lehman Brothers and Bear Stearns, led to a systemwide banking crisis, and many other small and mid-sized regional banks failed as a result.

Washington Mutual is the largest ever US banking failure. (Photo: Reuters)

The crisis at SVB Group, which conducts business as the Silicon Valley Bank, has already raised concerns around the globe, having triggered a small contagion that has impacted banking and financial stocks around the world.

Some of the major banks and financial institutions around the world have faced massive losses ever since SVB announced its move to raise funds, especially those in the US and Europe. European banks slid after JPMorgan and BofA shares fell over 5 per cent on Thursday.

The impact of the closure could have a significant impact on stock markets around the world, including the US, the UK, the Eurozone and others, as shares of major banks and financial institutions are likely to feel the aftereffects of SVB’s collapse. There are fears among many that the failure of SVB could even trigger a situation similar to the financial crisis in 2008.

Will it trigger a financial crisis?

It is still unclear whether it will have an impact on broader industries in the US and around the world. This is because US banking regulations have become a lot stricter after the 2008 financial crisis, especially in the case of bigger banks like JP Morgan Chase, Bank of America, Citi Bank, Wells Fargo and more.

For instance, one of the most important regulations that was introduced was related to capital requirements, meaning a bank must have a certain amount of reserves to weather emergencies. Regulations around diversification also became important for banks after the crisis.

With $209 billion worth of assets as of last year, SVB was the 16th largest bank in America. As it is much smaller compared to the biggest banks in the US, the regulations that apply to SVB are unfortunately not as stringent.

The meltdown of Silicon Valley Bank is unlikely to trigger a global financial crisis, according to analysts. (Photo: Reuters)

The regulatory oversight allowed SVB to invest aggressively when interest rates were low, without maintaining adequate reserves to tackle the kind of crisis it faced before it was shut down. After its collapse, several other mid-sized institutions began to feel the heat and their shares tumbled too.

However, some of the top US banks like JP Morgan, Wells Fargo and CitiGroup saw their shares rise, indicating that bigger banking institutions may not feel the impact of the collapse after all.

While US stock indices fell due to the contagion fueled by the SVB crisis, most analysts feel that it will not have a cascading impact and that it is company-specific. Though it may not have a broader impact on banking and financial institutions in the US, it does come as a wake-up call for banks sitting on unrealised losses.

David Trainer, CEO, New Constructs, Investment Research Firm said the SVB issue shows that companies, including banks, need to be much more discerning about whom they do business with. “The market has been punishing companies that have no business models since the bear market began in January 2022 and SVB’s woes are the latest frontier in the market’s reckoning. The market is tired of companies that do business with unprofitable companies or that are unprofitable themselves.”

“We do not believe there is contagion risk for the rest of the banking sector on the heels of SVB’s struggles. The deposit base of the major banks is much more diversified than SVB and the big banks are in good financial health,” he added.

Analysts at JP Morgan also agree with Trainer, and believe that the sell-off was “overdone” as large banks have a lot more liquidity than smaller banks. Larger banks are more diversified with broader business models, have a lot of capital and also have a lot of oversight from regulators.

“We don’t expect a fire sale of securities from our banks, unlike at some smaller banks due to their liquidity positions and large, diversified deposit funding,” JP Morgan analysts said. However, most analysts feel that banking and financial stocks in global markets could experience strong volatility in the near-term.

So, who will be hurt most by the SVB crisis?

There is a growing sense of tension among SVB’s uninsured investors, who have parked substantial amounts in the bank. These depositors, which include many start-ups, venture capitalists and tech companies among others, will now have to wait and watch as the situation evolves.

The FDIC said the amount of uninsured deposits at the bank is yet to be determined, seemingly a result of the rush of bank customers to remove uninsured funds when the crisis was unfolding over the past 48 hours. However, the data handed over by the bank to the FDIC showed that 89 per cent of its $175 billion in deposits were uninsured.

For insured depositors, the funds will be accessible by Monday morning, but the process could be long and complicated for uninsured depositors, who will get a “receivership certificate”. The FDIC also said future dividend payments “may be made” to pay off uninsured funds as the bank’s assets are sold.

This could spark major concerns for thousands of uninsured depositors, who are typically not individuals but companies that need cash on hand for payroll and other expenses. So, even if the SVB crisis does not trigger a full-blown financial crisis, it has definitely put the livelihoods of many at risk.

Quearn – Do QnA

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