Philip Pacheco/Bloomberg
WASHINGTON — All the shiny promises of California’s gleaming tech world couldn’t save Silicon Valley Bank from the basic banking reality of a poor balance sheet.
The second-biggest failure in U.S. history by assets is raising concerns about whether other banks are inadequately managing interest rate risks, overexposed on uninsured deposits, or — as in the case of Silicon Valley Bank — both.
Its failure was, in large part, due to bond investments that left the bank too vulnerable when the Federal Reserve jacked up interest rates. “This is a really old-fashioned way of tanking a bank,” said Bert Ely, a bank consultant and principal of Ely & Co.
Silicon Valley Bank’s problematic reliance on uninsured deposits is another troubling aspect for regulators, who worry about how to unwind failed institutions with that profile. As of the fourth quarter of 2022, deposits that were under the $250,000 insurance limit accounted for just 2.7% of the bank’s total deposits, according to RBC Capital Markets analyst Gerard Cassidy. Together, these shortcomings — alongside a substantial push from the bank’s uneasy depositors who rushed en masse to pull money from their accounts — fueled a perfect storm that took down Silicon Valley Bank, experts say.
“This is quite a mess. I think it could snowball,” said Christopher Whalen, chairman of Whalen Global Advisors.
News reports circulated this weekend that the Federal Deposit Insurance Corp. is working quickly to auction pieces of Silicon Valley Bank to make some portion of uninsured deposits available to its depositors as early as Monday. Meanwhile, the Treasury Department and banking regulators are said to be contemplating creating a backstop for uninsured deposits at other banks that share some of the same problems as Silicon Valley Bank.
Former regulators and other policy watchers worry that the risks that drew the bank to this point remain for a handful of other institutions.
Simply put, Silicon Valley Bank experienced a classic run: A bunch of people with a lot of deposits using the same bank all starting fleeing at around the same time once the bank said it was experiencing problems. Investors and depositors reacted by initiating withdrawals of $42 billion of deposits on Thursday, causing a run on the bank, California regulators said Friday.
Because a large number of those deposits were uninsured, held by startup companies, venture capitalists and tech firms, the depositors now join a long, likely arduous process of ever seeing that money again.
“There is the risk that depositors get paid out up to the specified [Federal Deposit Insurance Corp.] deposit insurance limit, and then a haircut gets taken on the residual,” said John Popeo, a principal at The Gallatin Group and a former FDIC lawyer who led failure deals during the financial crisis. “Basically what happens is you’re subject to the FDIC claims process, which is analogous to the bankruptcy process. So whatever residual assets the receiver has post resolution, they will pay you out on that claim, no guarantees.”
Silicon Valley Bank’s problem goes back to 2021, when banks were struggling to make loans and some sought other ways to get some income.
For its part, the bank loaded up on mortgage-backed securities, a strategy that flopped as soon as the Fed started raising interest rates last year. The pace of those increases has been swift, hurting the value of Silicon Valley Bank’s and other banks’ bond investments as higher-paying options became available.
“It’s more about banking fundamentals. Overall you have to look at the asset quality and funding of the banks,” said Keith Noreika, former acting comptroller of the currency and current executive vice president and chairman of the banking supervision and regulation group at Patomak Global Partners. “As interest rates go up, the market value of assets on a banking balance sheet goes down and also the funding costs go up.”
Unrealized losses aren’t a problem if banks can hang onto the bonds, as bonds recoup their original value as they mature. But if banks are forced to sell underwater bonds, they are sold at a loss and the “unrealized” losses quickly become real.
Where Silicon Valley Bank ran into problems was that its tech customers, many of whom were dealing with costlier credit and other economic challenges, were burning through cash quickly.
Deposits have gradually been flowing out of the banking system in recent months, but its tech depositors’ heavy spending meant that outflows were far faster at Silicon Valley Bank.
In need of liquidity, it was forced to sell a big chunk of its bonds. What were previously on-paper losses turned into a $1.8 billion hit, and that’s when the panic started.
Its stock price sank 60% on Thursday, and some tech companies were told to pull their cash after the market closed. Trading was paused on Friday, and talks of a sale emerged. But ultimately, regulators announced they would take over the bank — and did so in the middle of the day, rather than waiting until the market closed.
As the day proceeded, analysts, investors, regulators and lawyers were wondering what other banks were running a similar risk.
“Everybody’s kind of looking around. I think everybody’s a little nervous,” said John Toohig, head of whole loan trading at Raymond James. “The world’s maybe a little bit more scary, but it certainly does bring into focus liquidity and deposits.”
A few banks that focus more on tech customers took a hit on Friday, but investors appeared to take a more nuanced view after evaluating the industry’s exposures as a whole. Shares in JPMorgan Chase rose 2.5%, while Wells Fargo’s eked out a 0.56% gain.
“I think it’s a good sign. It’s a vote of confidence,” said Todd Lowenstein, chief equity strategist at HighMark Capital Management, though he noted the market remains in “the fog of war” and on the lookout for more damage.
But the dynamic of investments in long-term bonds with short-term deposits as the Fed raises interest rates isn’t unique to Silicon Valley Bank. FDIC Chairman Martin Gruenberg warned about interest rate risk in a speech just four days before Friday’s failure.
“Unrealized losses weaken a bank’s future ability to meet unexpected liquidity needs,” Gruenberg said. “That is because the securities will generate less cash when sold than was originally anticipated, and because the sale often causes a reduction of regulatory capital.”
Because banks are in a generally strong financial condition, they haven’t had to realize these losses by selling depreciated securities, Gruenberg said. But now, in the case of Silicon Valley Bank, that liquidity need came back around, and that institution was caught out.
The banking industry as a whole is sitting on some $620 billion in unrealized losses on its securities portfolios, as of the end of 2022, according to the FDIC.
That figure is substantially higher than it’s been historically. Unrealized losses on securities began skyrocketing in 2022, around the same time the Federal Reserve began raising interest rates. It dropped slightly from the third quarter of 2022 to the fourth but remained significantly higher than any period going back to 2008.
“I think every bank is going to need to look at its balance sheet and its capital liquidity position and its asset quality and how it’s managed interest rate risk and troubled asset quality,” Noreika said. “I think the market is going to be looking very closely at bank balance sheets and asset quality and funding. We could see different manifestations of that depending on what the market finds.”
Gruenberg warned, too, of reliance on uninsured deposits, particularly as it relates to banks of about Silicon Valley Bank’s size, in a speech at the Brookings Institution a few years ago.
“The heavy reliance of these institutions on uninsured deposits would pose a significant resolution challenge,” he said at the time. “In a resolution where there is no acquiring institution, and possibly little or no unsecured debt to absorb losses, it is likely that the least-cost test would require that uninsured depositors take losses. Given the heavy reliance of regional banks on uninsured deposits, uninsured depositors’ taking losses at a failed regional bank could have knock-on consequences for other regional banks, particularly in a stressed economic environment.”
The share of uninsured deposits has risen in recent years, according to FDIC data, which shows the share of insured deposits ticking down from 59% in 2019 to 55.3% in 2022.
Regulators have circled around some kind of capital requirements for large regional banks in the event they need to wind them down in an orderly fashion — and the Silicon Valley Bank incident would seem to prove at least one use case.
The threat of losing uninsured deposits can also exacerbate a bank run. In Silicon Valley Bank’s case, the FDIC wasn’t able to immediately find a buyer, and had to forgo a deal that would keep those deposits intact.
Some experts worry that the FDIC’s deal will trigger other uninsured depositors to pull their deposits from similarly structured banks.
“The FDIC is only giving non-insured depositors an ‘advance dividend’ of unknown amount within the next week and ‘receivership certificates’ for their balances, which likely means they have to get in line with all the bank’s other creditors and hope that at some point in the future they might get some of their money back,” said Dennis Kelleher, co founder and CEO of Better Markets, in a statement.
“While the FDIC said that future dividend payments ‘may be made,’ it is unknown and will not help with the many uninsured depositors of SVB that have to make payroll and pay other bills today and long before that money, if any, becomes available,” he said. “That immediately signals all other uninsured depositors in any bank to immediately run to withdraw their money from their bank.”
Popeo said that runs on large, complicated banks like Silicon Valley Bank often precipitate trouble at related institutions.
“What I’ve seen based on my own experience having resolved large, complex institutions, you see a trickle-down effect either among respondent banks vis-à-vis the correspondent banking network that they maintain,” he said. “Or you trigger conversations regarding the exposure to particular industries, and that triggers runs on similar institutions.”
