Weekly Market Commentary
In the last 48 hours we’ve seen the 15th largest bank fail due to a lack of liquidity and then be bailed out by the Fed overnight. This crisis might stop the Fed from increasing rates next week. The Fed is caught between two tough decisions…….on the one hand wanting to tamper down inflation and on the other hand wanting to avoid additional bank failures. At the writing of this Special Commentary, the stock futures market is stable and the likelihood of a pause in interest rate hikes is overcoming the fear of bank insolvency. This morning there was an Op-Ed in the Wall Street Journal that does a great job of dissecting the events of the past few days as it relates to SVB (Silicon Valley Bank).
The following is taken from the Wall Street Journal Op-Ed, “Who Killed Silicon Valley Bank”, written by Andy Kessler on March 12, 2023.
That giant slurping sound on Friday was Silicon Valley Bank imploding. America’s 16th-largest bank had some $175 billion in deposits and disappeared by breakfast. It wouldn’t have happened if not for management mistakes. This was a 21st-century bank run—customers tried to withdraw about $42 billion, a quarter of all deposits. But what triggered the collapse?
Let’s go back. In January 2020, SVB had $55 billion in customer deposits on its balance sheet. By the end of 2022, that number exploded to $186 billion. Yes, SVB was a victim of its own success. These deposits were often from initial public offerings and SPAC deals—SVB banked almost half of all IPO proceeds in the last two years. Most startups had relationships with the bank.
That’s a lot of money to put to work. Some was lent out, but with soaring stock prices and near-zero interest rates, no one needed to take on excessive debt. There was no way SVB was going to initiate $131 billion in new loans. So the bank put some of this new capital into higher-yielding long-term government bonds and $80 billion into 10-year mortgage-backed securities paying 1.5% instead of short-term Treasurys paying 0.25%.
This was mistake No. 1. SVB reached for yield, just as Bear Stearns and Lehman Brothers did in the 2000s. With few loans, these investments were the bank’s profit center. SVB got caught with its pants down as interest rates went up.
Everyone, except SVB management it seems, knew interest rates were heading up. Federal Reserve Chairman Jerome Powell has been shouting this from the mountain tops. Yet SVB froze and kept business as usual, borrowing short-term from depositors and lending long-term, without any interest-rate hedging.
The bear market started in January 2022, 14 months ago. Surely it shouldn’t have taken more than a year for management at SVB to figure out that credit would tighten and the IPO market would dry up. Or that companies would need to spend money on salaries and cloud services. Nope, and that was mistake No. 2. SVB misread its customers’ cash needs. Risk management seemed to be an afterthought. The bank didn’t even have a chief risk officer for eight months last year. CEO Greg Becker sat on the risk committee.
The bear market started in January 2022, 14 months ago. Surely it shouldn’t have taken more than a year for management at SVB to figure out that credit would tighten and the IPO market would dry up. Or that companies would need to spend money on salaries and cloud services. Nope, and that was mistake No. 2. SVB misread its customers’ cash needs. Risk management seemed to be an afterthought. The bank didn’t even have a chief risk officer for eight months last year. CEO Greg Becker sat on the risk committee.
As customers asked for their money, SVB had to sell $21 billion in underwater longer-term assets, with an average interest rate around 1.8%. The bank lost $1.8 billion on the sale and tried to raise more than $2 billion to fill the hole.
The loss flagged that something was wrong. Venture capitalists, including Peter Thiel, suggested that companies in their portfolios should withdraw their money and put it somewhere safer. On Thursday the dam broke and there was no way to cover billions in withdrawal requests.
Mistake No. 3 was not quickly selling equity to cover losses. The first rule of survival is to keep selling equity until investors or depositors no longer fear bankruptcy. Private-equity firm General Atlantic apparently made an offer to buy $500 million of the bank’s common stock. Friday morning, I’d have offered $3 billion for half the company. Where was Warren Buffett? Or JPMorgan?
Before they could get a deal together, the Federal Deposit Insurance Corp. took over to protect up to $250,000 for each depositor. Larger, uninsured deposits are frozen. Since the bank took a 9% haircut on the $21 billion in bond sales, that could mean uninsured depositors might get 90 cents on the dollar, but it could take months or years. So venture capitalists are getting emergency funding requests.
Why did so many startups bank with SVB in the first place? Here’s a hint. Apparently, more than half of SVB’s loans went to venture and private-equity firms backed by the borrower’s limited-partner commitments, a legal but slippery way to goose venture funds’ all-important internal rate of return metric, IRR, by investing three to six months before calling investors for cash. VCs are very persuasive with startups.
Here’s an important lesson for companies in trouble: On Thursday, Mr. Becker told everyone to “stay calm.” That never works, ever since Kevin Bacon’s character in “Animal House” told everyone, “Remain calm. All is well,” as chaos ensued.
Was there regulatory failure? Perhaps. SVB was regulated like a bank but looked more like a money-market fund. Then there’s this: In its proxy statement, SVB notes that besides 91% of their board being independent and 45% women, they also have “1 Black,” “1 LGBTQ+” and “2 Veterans.” I’m not saying 12 white men would have avoided this mess, but the company may have been distracted by diversity demands.
Management screwed up interest rates, underestimated customer withdrawals, hired the wrong people, and failed to sell equity. You’re really only allowed one mistake; more proved fatal. Was management hubristic, delusional or incompetent? Sometimes there’s no difference.