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Silicon Valley Bank Collapse

Silicon Valley Bank Collapse

March 17, 2023

Many investors may be tempted to react in the wake of both the Silicon Valley Bank and Signature Bank's financial troubles. After all, the unprecedented events of last week would test the mettle of even the most seasoned investor.

The Federal Reserve and Treasury Department took the extraordinary step of designating SVB and Signature Bank as systemic risks to the financial system—even though we believe they're not big enough to take down the whole banking system—which gave the regulators flexibility to backstop the uninsured deposits. Regulators hoped that protecting these deposits would bolster confidence in the banking system. However, I want to reassure you that we will maintain a watchful eye as events unfold.

Here are a few facts about what happened—

After the market close last Wednesday, Silicon Valley Bank announced through the proper channels that they needed to raise additional capital by issuing debt and equity securities (i.e. bonds and stocks). We believe this was one of their big mistakes, they should have raised the capital through private placements and then announced they had already raised the money..but I digress. This announcement sparked concern among many. The institutional investors that owned their current bonds and stocks started to sell these securities on the open market Thursday morning. Then the hedge funds and trading algorithms kicked in and started to short (borrow their shares and sell them with the intent to buy them back at lower prices) their securities. 

Within an hour of the market mayhem in their tradable securities, a well-known entrepreneur, Peter Thiel, took to Twitter and told all his followers and portfolio companies to take their cash deposits from the bank and move it elsewhere. That's when the smoke turned into a full fledge fire and by the close of business Thursday, $42 billion of cash deposits had left the bank. On Friday morning, another $55 billion was queued to leave the bank minutes before it opened for business. This is when regulators stepped in to assess the situation and within a few hours, they shut the bank down. This was the first major bank run we have seen in our country since the Great Depression.

A few of the other problems that helped exasperate the situation were that approximately 97% of all Silicon Valley Bank cash deposits were over the FDIC-insured amounts of $250,000 per individual. This is why they all pulled their money at once, these individuals and companies that banked with Silicon Valley weren't playing by the rules.

But the big onerous fell on the risk managers of the bank. No, they weren't investing their customer deposits in mortgage-backed securities or other shady investments like the subprime meltdown of 2007-2009. These risk managers invested the majority of those deposits in long-dated Treasury bonds, some of the safest securities in the world. The problem with that strategy is they were not prepared for approximately 20% of their deposits to flee their bank within hours, with another 25% looking to depart the next morning.

Over the past year, the Federal Reserve has raised interest rates numerous times which has caused the longer-dated Treasury bonds to drop the most in value; which wouldn't be a major concern if they had minimal exposure to the 'long-end of the curve'. But since the bank would have had to sell all those securities on the open market in short order to give their customers deposits back, they would have realized those losses. And those losses would have been in the tens of billions, making the bank insolvent.

In short, Silicon Valley Bank was not diversified in any way, shape, or form. They had 'few' customers with large deposits and had all their 'eggs in one basket.' You can bet that more regulations will be coming down the pipe for small and mid-sized banks in the near future. And on the flip side of that same coin, we believe you can rest assured that the big banks (and most small and mid-sized banks) have great risk managers in place, truly diversified holdings, and a much smaller percentage of customers that have deposited cash above the FDIC-insured limits.

Remember, Wall Street and the media have a limited attention span regarding unusual economic events. That's why we craft our client's investment strategies to reflect their unique goals, time horizon, and risk tolerance, regardless of what the markets do on a daily basis.

Please reach out to us next week if you have any questions about what’s happening with the banking sector in light of these recent events. We'd be happy to give you our perspective on what’s happening.

Mike

The views stated in this email are not necessarily the opinion of LPL Financial LLC and should not be construed directly or indirectly as an offer to buy or sell any securities. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. A diversified portfolio does not assure a profit or protect against loss in a declining market.