Martin Gruenberg could not have picked a more prescient time to flag risks in the U.S. banking industry.
On Monday, the chairman of the Federal Deposit Insurance Corporation (FDIC)the agency that backstops depositorsaddressed risks U.S. lenders faced three years after the outbreak of the pandemic. Chief among them was the potential of a bank run.
The industry had become vulnerable after the 4.5% interest rate hike the Federal Reserve began this time last year blew open a potential $620 billion hole in the sectors collective balance sheet, as the value of banks bond holdings tumbled, according to the FDIC.
Gruenberg warned these unrealized losses weaken a banks ability to meet unexpected liquidity needs, and cautioned that mapping out a strategy to fund themselves profitably would prove a complex and challenging task in an environment where interest rates changed so radically over the past 12 months.
Meaningful deposit outflows have not yet materialized, but banks will need to watch these trends carefully as the interest rate environment evolves, he told a financial lobby group.
Courtesy of FDIC
Just two days later, the lender of choice for nearly half of the U.S. venture capitalists blindsided markets with a cash crunch brought on by a steady stream of deposit outflows. By the end of the week, Gruenbergs FDIC shut it down.
SVB Financial, the 16th largest U.S. bank with some $209 billion in assets, became the second largest commercial lender in the countrys history to fail after the collapse of Washington Mutual in 2008.
SVB Financial had downplayed risks from its underwater bond portfolio
It all started when SVB, suffering from depositor flight, attempted to raise cash by dumping $21 billion worth of bonds. In so doing it crystallized $1.8 billion in previously unrealized losses on its balance sheet. Simultaneously SVB Financial announced plans to raises $2.25 billion in fresh equity, mainly via a dilutive share offering, to plug the hole and rebuild regulatory buffers.
Investors in the Silicon Valley Bank parent company were left stunned on Thursday. Only a few weeks earlier CEO Greg Becker attested to a strong balance sheet.
We continue to see strength in our underlying business, he said in January. While tech startups were withdrawing cash at elevated levels, he predicted this would subside amid a renewed sense of fiscal discipline leading them to stretch every last dollar to its furthest.
Its true that investors had been aware at the latest since its 10-Q filing on Nov. 7 that it had sustained unrealized losses among its Held-to-Maturity portfolio large enough to wipe out its entire $15.8 billion in shareholder equity. While this would theoretically render it insolvent were they to materialize in full, SVB Financial was dismissive of the risks.
It told the Wall Street Journal in a Nov. 11 article this risk bore no implications for SVB because, as we said in our Q3 earnings call, we do not intend to sell our HTM securities.
After speaking to SVB finance chief Dan Beck days later, analysts at J.P. Morgan reaffirmed their overweight recommendation and $375 price target, arguing deposit outflows appeared quite manageable.
Even if a worst case scenario plays out, SVB has multiple liquidity sources available before even thinking about selling underwater securities, the investment bank wrote in a Nov. 15 research note.
In February, CNBCs Mad Money host Jim Cramer recommended SVB to his viewers on live television when it was still trading at $320 a share.
Long term private equity and venture capital are not going away, Cramer said. Being a banker to these immense pools of capital has always been a very good business. The stocks still cheap.
Depositor flight in February surpassed its worst expectations
Unfortunately for the banks shareholders, SVBs clients in the tech startup scene quickly proved more profligate than Becker anticipated, rendering his January guidance for 2023 moot within a matter of weeks.
As customers drained its reserves, SVB found itself in a classic liquidity mismatchshort term liabilities like deposits were covered by illiquid long-duration assets like mortgage-backed securities that had taken on water.
Timeline of Silicon Valley Bank, $SVIB, Collapse:
1. Rumors emerge that SBV faces interest rate risk on $91 billion in bonds
2. SVB announces firesale of $21 billion bond portfolio
3. Bond portfolio sale takes a massive $1.8 billion loss
4. SVB announces $2.3 billion share https://t.co/1jEPrkrrSx
The Kobeissi Letter (@KobeissiLetter) March 10, 2023
To de-risk its balance sheet, it sold the bulk of its Available-for-Sale (AFS) securities and reinvested the remaining proceeds in more attractive shorter duration bonds that wouldnt be pummeled by a historic high yield curve inversion.
Client cash burn [] increased further in February, resulting in lower deposits than forecasted, SVB admitted on Wednesday.
But coming immediately on the heels of crypto bank Silvergate winding down its operations, the response from panicking investors was swift and brutal: shares plummeted 60% on Thursday.
It sparked a sector wide sell-off with the KBW Bank Index falling as much as 7.7% on Thursday, its biggest one-day drop since June 2020. Venture capitalists like Founders Funds Peter Thiel reportedly even advised companies that havent done so to pull their money out of SVB.
Because if there is one lesson the collapse of supposedly strong crypto companies like Voyager Digital, Celsius and FTX taught investors, its better to be safe than sorry.
Trading in SVB stock has were halted on Friday amid reports that management might be exploring a sale. Meanwhile Pershing Square hedge fund boss Bill Ackman even called for a taxpayer bailout, implying SVB somehow provided a systemic risk to the U.S. economy were it not rescued.
His calls fell on deaf ears. Despite Beckers attempt to salvage his bank, the FDIC shut it down on Friday and will liquidate its assets.
Fortunes CFO Daily newsletter is the must-read analysis every finance professional needs to get ahead. Sign up today.
