Silicon Valley Bank, the 16th largest bank in the U.S. and a leading institution in the tech startup space, failed on Friday after a run on deposits led the Federal Deposit Insurance Corporation (FDIC) to take control of the bank’s assets, which include almost $175 billion in customer deposits. The failures sparked broader fears among other banks seen as having similarities to Silicon Valley Bank – notably First Republic Bank. Then, on Sunday, New York-based Signature Bank was also closed. Soon afterwards, federal regulators, in an effort to restore confidence, announced Sunday night that all depositors of both banks will have access to all of their money on Monday, March 13.

Our firm does not have a banking relationship with Silicon Valley Bank (SVB) or Signature Bank. In this update, we walk through what happened to SVB, address the investment implications including the potential for contagion to spread within the banking sector, review the ways in which this could impact clients, and provide a general review of how to keep your deposits safe.

How Silicon Valley Bank Went Bust

What happened to Silicon Valley Bank is that a boom in deposits in recent years amidst plentiful liquidity in the tech space left it with a challenge in earning an attractive return on those deposits. Lending opportunities among its tech customers were less than in other industries given that those customers had access to private capital and a tendency to be in an earlier stage of their lifecycle.

The bank chose to invest a large amount of the deposits in longer-maturity bonds with yields above what it was paying to depositors, including Treasury Bonds. While these investments had almost no credit risk, they had significant interest rate risk in that the market price of these bonds would drop in the event rates were to rise. And as we all know, rates rose sharply and swiftly last year, creating paper losses on those bonds.

Initially deposits were affected because its customer base tended to have large balances and were attuned to maximizing the interest they received. With higher rates becoming increasingly available at other institutions, some Silicon Valley Bank clients moved their money. As its financial position gradually weakened, fear took hold and ignited a classic feedback loop culminating in last week’s run on deposits that led to the bank’s failure.

The Broader Impact of Silicon Valley Bank’s Failure

The clear consensus among financial industry experts is that while shorter-term fears may roil some other regional banks, the Silicon Valley Bank failure is not a harbinger of another 2008-type financial crisis. There are some unique attributes of Silicon Valley Bank that are not common across the broader banking sector that contribute to this view, along with the generally healthy financial condition of most major banks.

While all banks are affected by rising rates, e.g. the need to pay more interest on deposits, Silicon Valley Bank was acutely exposed to rising rates. Rising rates decreased the value of the bonds it had purchased with depositor money while increasing the amount it had to pay to depositors – a double whammy. And SVB also apparently did not hedge its portfolio exposure to rising rates, unlike most other banks.

Its customer base is concentrated among tech-driven start-up firms, where higher rates and a general pullback in tech reduced the amount of capital flowing to the industry, reducing the supply of cheap deposits.

Finally, the demographics of Silicon Valley Bank’s customer base contributed to its failure. Their generally much larger depositors were both quicker to move their money to get higher rates (while the smaller depositors more characteristic of retail banks tend to leave their deposits alone) and because many corporate deposits were far in excess of FDIC insurance (which covers up to $250,000 per deposit account) the first whiff of trouble quickly escalated into herd behavior, with almost $42 billion pulled in the 24 hours leading up to the FDIC takeover.

We have looked at the potential impact on firms whose stock price was driven lower on Friday as a result of the Silicon Valley Bank failure. Most noteworthy is First Republic. We are not direct industry or company analysts, but we have looked at research and opinions of bank analysts who cover the stock and reviewed information provided by First Republic relating to its financial condition.

While fear is a powerful catalyst and can be difficult to predict, we note that First Republic has a significantly more diversified depositor base with low exposure to tech. The average consumer account size is below the FDIC insurance limit which in theory at least reduces any urgency to pull money (meanwhile all Silicon Valley Bank depositors are expected to have access to their money on Monday, March 13). First Republic also has access to significant liquidity. 

A second key financial institution is Charles Schwab & Company, which saw its stock price decline on Friday after the news broke on Silicon Valley Bank. Schwab is one of the largest custodians of client assets (along with Fidelity), but it’s important to understand that Schwab’s custody business is not affected by Schwab’s banking operation.

The investor reaction that pushed down Schwab’s stock price seems more a function of the realization (and pricing in) of earnings pressure than contagion fear. The troubles at Silicon Valley Bank are shining a light on the impact of higher rates on bank profit margins and earnings, including Schwab – which last year saw nearly half its revenue come from net interest revenue (the difference in what it earns on invested deposits and what it pays on bank deposits). Schwab issued a statement which gives more detail on their financials and perspective on recent events.

Finally, we use Charles Schwab Corporation for custody of our client’s investment assets. Your investment assets are not FDIC insured (with the exception of specific Schwab Bank assets), but instead are covered by SIPC coverage along with private insurance. Since custodians must keep client assets segregated, an SIPC claim would only arise if Charles Schwab, as the custodian, failed and client assets in brokerage accounts could not be located due to theft, misplacement or failure to maintain possession of the securities. Custody is significantly different than your assets being the bank's assets. Your assets are kept separate and distinct, and even if Schwab were to cease to exist, your assets would be moved to a different custodian and remain intact.

For more details check out this link to see how Charles Schwab Corporation protects custody assets.

Summary and Next Steps

The situation involving Silicon Valley Bank is very new and still developing. We have worked hard to ensure we fully understand any ramifications that could impact our clients and will continue to do so in the days and weeks ahead.

But for any clients who would like to review their bank deposits and the FDIC limit, we encourage you to contact your advisor. Your advisor can assess your individual banking situation and provide ideas on how to ensure all your deposits are insured.

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