Last week, Silicon Valley Bank (SVB) rapidly collapsed – going from normal operations to bankruptcy within days. With assets of approximately $209B, SVB was the 16th largest bank in the United States. The failure represents the second largest bank collapse in US history. As of Sunday, March 12, a second bank, Signature Bank, had been seized by regulators because of fears of bankruptcy. As of this writing, the government has stepped in with emergency measures aimed at preventing a full-blown financial crisis from occurring, but this story is still developing. In this article, I’ll explain what’s happened so far and what you should keep an eye on in the coming weeks.
how the banking system works
To understand what happened at SVB, we need a brief lesson on how banks work. If you’re unfamiliar, the basic idea is this: Banks take deposits from customers, which they then lend to other customers for profit. Your bank deposit does not just stay in the bank. For example, if you deposit $100,000 in a bank, a large portion of that money may be loaned out as part of a mortgage, HELOC, or the bank may even lend that money to the government in the form of Treasury bills. Could , Government regulators require banks to keep some portion of their deposits as “reserves” (usually around 10%) to ensure that banks are not too aggressive with deposit funds.
This system works well during normal times. Banks protect deposits and profit by lending money and paying interest. Problems arise when more depositors want their money out of the bank than the bank has in its reserves. This situation is called a “bank run,” and this is exactly what happened at Silicon Valley Bank.
What happened in SVB?
As the name suggests, Silicon Valley Bank focuses heavily on the tech industry, specifically targeting tech startups and the venture capital investors who fund them. The space boomed during the pandemic as deposits increased SVB up to 86% in 2021 alone, However, the tech industry has been hit hard as interest rates have risen over the past year. Tech stocks are down more than almost any other industry, and venture capital funding has slowed significantly. Due to this slowdown, deposits in SVBs have come down. Instead of keeping money in the bank as businesses usually do, startups need their own cash to operate and are pulling out a lot of money from SVB. This left the bank with very few reserves.
To raise money for the reserves, SVB wanted to sell some of its assets—particularly money it had loaned to the government in the form of treasury bills. The problem is that the bonds held by SVB have declined in value, and selling them will not be enough.
When an investor, like a bank, buys a bond, they invest a fixed amount of money and are assured of a specific yield – which is the interest rate the bond will pay. SVB bought a lot of bonds during the pandemic years when yields were very low, somewhere between 1-2%. As interest rates have risen, so have bond yields. As of this writing, the The yield on the 10-year US Treasury bill is around 3.6%, Due to current yields being higher than the yields on SVB’s bonds, there is little demand for SVB’s bonds at full price (as a potential buyer can buy a new, higher-yielding bond instead).
Thus, SVB has to redeem its bonds in order to sell them, which leads to a loss. Normally, these would be considered “unrealized losses” if a bank could hold the bonds to maturity, but since SVB was a forced seller, they were in fact forced to take these losses.
In a last-ditch effort to raise capital for the reserve, SVB sought an injection of capital from a private equity firm, but it was too late. Markets panicked, Moody’s Analytics downgraded SVB’s credit rating, and panic ensued.
The nature of SVB’s business seems to have caused the panic and bank run to turn out to be more dramatic than expected. Many of SVB’s clients have powerful venture capital investors whom they consult on many major decisions. On Thursday, March 9, several venture capital firms were panicking about SVB and emailed hundreds of portfolio companies asking them to withdraw their money. I’ve read some of these in person, and they are very clear.
Investors wanted their portfolio companies to cash out—and startups listened. Executives of tech firms, listening to their investors, jumped on their phones and tried to transfer money. On March 9 alone, $42 billion was withdrawn from SVB.
At this point, regulators from the Federal Deposit Insurance Corporation (FDIC) stepped in and took over the bank due to the threat of bankruptcy, preventing the bank from continuing to operate. During normal times, the FDIC insures all bank deposits up to $250,000. Depositing anything above this is risky. For most people, this isn’t an issue. Not many people have more than $250,000 in a single account. But it is very common for businesses, such as the depositors who make up the majority of SVB’s clients. It is estimated that around 86% of SVB’s deposits were uninsured. There were great fears over the weekend that the money would not be recovered and that the crisis would spread to other parts of the financial system.
Then, on Sunday, March 12, the government acted in an attempt to stabilize the banking system by doing three things:
- The FDIC closed another bank, Signature Bank, for fear of bankruptcy and another bank run. Signature Bank is heavily focused in the crypto industry and is roughly half the size of SVB with approximately $109B in assets.
- The FDIC said it would ensure 100% of the deposits at SVB and Signature Bank, and everyone would get their money. The FDIC will repay the deposits by selling the SVB properties and levying fines against the banks if necessary. He also said that the taxpayers will not foot the bill. He made a special note to say that SVB’s shareholders and bondholders would not receive a “bailout”. Only the customers will be protected.
- The Federal Reserve loosened access to its reserve funds, allowing other banks to avoid the issues faced by SVBs.
final thoughts
Whether or not these actions will be sufficient remains to be seen. The potential impact on the real estate industry is also unclear at the moment.
As of this writing, the issues are largely concentrated in the tech and crypto industries. I’ve read some fairly detailed analyzes of other banks’ balance sheets, and it seems that, for the most part, the other major banks in the US are in far better shape than SVB and Signature Bank. But, a bank run can be a product of fear and panic, not an underlying problem with the bank.
And we don’t know how people and businesses will behave going forward. The financial system is complex and heavily interconnected, and there is still a risk that the financial issues faced by these two banks will have a wider impact on the economy, including real estate.
I’ll be keeping a close eye on this industry and will provide updates as appropriate.
Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.
