When the Federal Deposit Insurance Corporation (FDIC) took over the March 10, 2023, collapse of Silicon Valley Bank (SVB), it marked the second biggest bank failure in U.S. history. What led to this historic collapse? The short answer is a run on deposits that hampered the bank’s plans to raise fresh capital.
But how could a financial institution — the 16th largest in the U.S. with almost $210 billion in assets on December 31, 2022 — and which was financially sound on March 8 find itself in such dire straits a day later? We could blame it on the interest rates, as well as the bank’s leaders’ failure to address the concerns flagged over many months.
Soaring Interest Rates
In 2020, SVB had bought many “safe” assets including government-backed mortgage bonds and U.S. Treasurys. But as rates rose quickly in 2022, fixed interest payments failed to keep pace. Assets declined in value, leaving SVB with more than $17 billion in potential losses on those assets by January 1, 2023.
During the week of March 6, 2023, the bank became deluged with $42 billion in deposit withdrawal requests, and it wasn’t able to raise the cash necessary to cover the outflows. Regulators stepped in to close the bank.
But why the run? Why then? Many financial experts hypothesize that the bank’s announcement of a capital raise — and sale at a loss of a tremendous amount of securities — triggered the panic. Among the bank’s main customers? Venture capitalists and technology startups, and because these were corporate deposits, they exceeded the FDIC’s $250K insurance limit. In fact, at the end of 2022, SVB held over $150 billion in uninsured deposits.
Theoretically, the bank could have possibly soldiered on, allowing the securities to mature and eventually get its money back. But that approach wasn’t an option once it faced the tidal wave of withdrawal requests.
Seeds of Demise Planted Months Ago
Mark Rubinstein, a former hedge fund partner, shared his analysis of the factors leading to SVB’s implosion.
The financial institution’s role as a go-to bank for technology meant it was a giant beneficiary of the Silicon Valley tech boom, with VCs raising (and investing) incredible amounts of capital in startups that banked with SVB. Rubinstein says, “Driven by the boom in VC funding, many of SVB’s customers became flush with cash over 2020 and 2021. Between the end of 2019 and the first quarter of 2022, the bank’s deposit balances more than tripled to $198 billion. This amount compares with industry deposit growth of “only” 37% over the period.”
The bank, recognizing a low demand for loans among its tech customers, opted to purchase securities instead. There are two options: “held-to-maturity” (HTM) assets or “available for sale” (AFS) assets. One of the biggest differences between the two? The value of HTM assets doesn’t adjust with interest rates or the overall market but stays fairly consistent. AFS assets, however, are more volatile. Their value increases or decreases according to the market. Usually, a bank will more actively manage its AFS portfolios.
Rubinstein said, “The bank invested the bulk of these deposits in securities. It adopted a two-pronged strategy: to shelter some of its liquidity in shorter duration AFS securities, while reaching for yield with a longer duration HTM book. On a cost basis, the shorter duration AFS book grew from $13.9 billion at the end of 2019 to $27.3 billion at its peak in the first quarter of 2022; the longer duration HTM book grew by much more: from $13.8 billion to $98.7 billion.”
Much of the HTM assets included Treasurys and mortgage bonds and while rates went up and these assets’ values plummeted, as long as the assets were held to maturity, SVB’s balance sheet didn’t reflect the paper losses. Eventually, they’d mature anyway and roll off the balance sheet completely.
However, the tech boom petered out and the bank’s startup customers wanted to withdraw their deposits, creating a cash flow problem for the bank. Rubinstein said, “The problem at SVB is compounded by its relatively concentrated customer base. In its niche, its customers all know each other. And SVB doesn’t have that many of them. As of the end of 2022, it had 37.466 deposit customers, each holding in excess of $250K per account. Great for referrals when business is booming, such concentration can magnify a feedback look when conditions reverse.”
Because selling HTM assets would come at a loss and completely wipe out its capital, SVB instead opted to sell $21 billion in bonds from its AFS portfolio. But the sale of those securities resulted in a $1.8 billion loss. The capital call failed, and a gaping hole appeared on the bank’s balance sheet. The rest, as they say, is history.
Now What?
The Fed remains steadfast in its desire to lower inflation, via a cooling economy. Since Q4 2022, some in the market have worried about tightening financial conditions should lenders pull back and lending liquidity become constrained, which is exactly what happened with the SVB failure.
Other concerns have swirled around crypto losses and the technology (including start-up tech companies) challenges finding capital could cause credit worries in the financial sector. Until Silicon Valley Bank failed, credit concerns hadn’t materialized. But 2008 proved that financial sector credit issues can generate the contagion effect — that is, disturbances or shocks in each sector (like the financial sector) create a chain reaction spreading across other sectors, increasing volatility and risk across the wider economy.
Where might it lead in the CREA industry? It’s hard to say. SVB had over $2 billion of CRE loans on its books, including an investment securities portfolio including $1.3 billion in qualified affordable housing projects and another $14.4 billion in commercial mortgage-backed securities. The bank’s failure may affect the Massachusetts market, where commercial landlords have many tech and life science tenants and there’s a plethora of affordable housing projects reliant on financing.
According to Susan Wachter, a professor of real estate and finance at The Wharton School at the University of Pennsylvania, “Unlike the 2008 global financial crisis, real estate wasn’t the cause of this meltdown, but it’s still going to bear the brunt of this fallout. That’s because regional and super-regional banks — the ones facing the most scrutiny right now — disproportionately lend into commercial real estate.
“Banks weakened by the current crisis will see their growth hindered,” said Wachter,” including their ability to lend real estate. Banks will also be reexamining real estate deals they’ve been negotiating — something that had already been happening for several months thanks to inflation and higher interest rates.”
Credit spends will potentially increase and lending liquidity will decrease, at least in the short term, even if the FDIC or Fed intervenes because it takes time for the market to pivot and stop the fallout from contagion-type events like SVB’s collapse.
There is, however, a silver lining. When risk increases, investors opt for safer investments like treasury bonds. They push down the yield, increase their price, and generally result in lower losses on bond sales. Questions do, however, remain. Will lending remain liquid or dry up? How will lending spreads react? How long will the fallout last? Right now, only time will tell.
Are you a commercial real estate investor or looking for a specific property to meet your company’s needs? We invite you to talk to the professionals at CREA United: an organization of CRE professionals from 92 firms representing all disciplines within the CRE industry, from brokers to subcontractors, financial services to security systems, interior designers to architects, movers to IT, and more.
