The rapid collapse of Silicon Valley Bank may well be the biggest story in the world right now. With a total asset base of $209 billion, the bank's failure is the largest since the global financial crisis. We wanted to talk about what's happening now and what it means for portfolios.
First of all, why did the bank collapse?
SVB was the most popular bank for start-ups and tech. The past few years saw a huge boom for tech companies and SVB's deposits grew. These funds had to go somewhere. The bank chose 10-year US Treasuries, which were yielding a measly 1.5% p.a.
The one-two punch hit SVB in the form of higher interest rates and the start-up/tech industry drying up. Last year brought sharp interest rate rises and bond prices fell. The longer the bond, the bigger the price cut. On the other hand, SVB's chosen clients tend to run at losses. They were withdrawing their deposits to cover their costs. Usually the cash to run these businesses came from venture capital (VC) firms.
The bank ended up having more money going out than coming in. It became necessary to sell bonds at a loss to cover the shortfall. They decided to try raise capital to keep some liquidity and calm their clients. Instead, their VC clients withdrew funds in a panic, precipitating a bank run which led to SVB's demise.
We should put the size of this collapse in better context. As we mentioned above, this is the largest collapse since the GFC.
A few things about this chart. You may notice the text below stating "does not include investment banks". This omits Lehman Brothers, an investment bank with the prize for largest bankruptcy in history. They had a $600 billion asset base. Also, this chart doesn't address inflation of about 40% in the time between the GFC and now.
SVB is a big bank, but they are dwarfed by the big four US banks, who manage a collective $9.11 trillion between them.
These other banks have much more diversified business models and customer bases. The risks they face are very different to SVB, with their focus on smaller start-ups.
Following the GFC, additional regulations were placed on large US banks, requiring stringent capital requirements and stipulations for diversification. SVB faced less regulatory oversight due to the smaller size of the bank.
Interestingly, these oversights were reduced in 2018, with the change strongly supported by SVB's cheif Executive, Greg Becker. One change was a reduction in the required cash on hand required by regional banks to weather storms like these.
We don't want to dismiss SVB as a drop in the bucket. It's failure will have flow on effects throughout the industry. We do want to contextualise the failure historically and against their peers.
In order to shore up confidence, we received a joint statement by US Treasury Secretary Janet Yellen, Chairman of the Federal Reserve Jerome Powell and Federal Deposit Insurance Corporation (FDIC) Chairman Martin J. Gruenberg yesterday. They announced the FDIC will guarantee all deposits including uninsured deposits. The bank will not be bailed out, so shareholders will not be covered.
The response should ease fears of further bank runs and ensure those companies banking with SVB will have liquidity needs met. These businesses already have access to their deposits. This rapid response shows the efficiency with which the FDIC fulfills their role.
But how does all of this affect our portfolios?
The direct impact is negligible. SVB is included in Dimensional's Global Core Equity Trust, which is an important part of our portfolios. Before the share price collapsed, it represented about 0.03% of the fund, or 3 cents for each $100. The Global Core fund includes shares of about 2,000 US companies. This shows the importance of wide diversification.
The indirect impact is difficult to predict. The shares of other banks will be affected, both due to the interconnected nature of the financial services industry and the risk estimated by investors. This impact is clear for regional banks, which are more comparable to SVB. The SPDR S&P Regional Bank ETF has fallen 20%. It is important to remember, this information has already been priced in.
The wider implications for the market are hard to foresee. Clearly this is not a positive development. But stock markets are incredibly complex and this is only one factor. We are also experiencing a period of rising interest rates, slowing inflation, strong employment and a myriad of other factors. Trying to make predictions around a single event is not beneficial for long-term investors, especially when this information is already priced in.
We may continue to see volatility in markets as investors wrestle with these factors. With diversification and a long-term strategy, even a surprise bank collapse needn't derail our plans.