The market on Friday watched as regulators shut the doors at Silicon Valley Bank, capping off a speedy decline and marking the biggest bank failure since 2008.
According to a report from Yahoo, The bank’s collapse was a byproduct of the Federal Reserve’s hiking of interest rates by 1,700% in less than a year. Once risk-free Treasurys started generating more attractive returns than what SVB was offering, people started withdrawing their money, and the bank needed a quick way to pay them. They were ultimately forced to sell their loan portfolio at a huge loss.
The chaotic episode showed that the Fed’s aggressive interest rate hiking regime could upend institutions that were once thought to be relatively stable. It appears that any rate sensitivity is about to be laid bare, and past risk-taking behavior held accountable.
“When you raise interest rates quickly, after 15 years of overstimulating the economy with near-zero rates, to not imagine that there’s not leverage in every pocket of society that will be stressed is a naive imagining,” Lundy Wright, partner at Weiss Multi-Strategy Advisers, told my colleague Phil Rosen on Friday.
There are already two recent high-profile examples not specific to the banking system, but still indicative of the pressure being caused by higher rates.
The first has been the collapse of the cryptocurrency market. Since the Fed started raising interest rates in March 2021, bitcoin — formerly a highly touted inflation hedge — has plunged more than 65%. This asset-price pressure helped contribute to the demise of FTX, which is facing criminal proceedings, and crypto bank Silvergate, which just this week went into liquidation. There’s also been the double-digit decline in high-growth tech stocks over the same period.
The big questions now become what rate-sensitive areas will be next to feel the pain, and whether there’s any real risk of financial-system contagion. But before that, a bit of background.
SVB’s collapse is a perfect example of the kinds of dislocations that are exposed when rate cycles shift.
Back in 2020 and 2021, tech startups were buzzing with sky-high valuations, stock prices were soaring to record highs on an almost weekly basis, and everyone was flush with cash thanks to trillions of dollars of stimulus from the government.
In this environment, Silicon Valley Bank, which had became the go-to bank for start-ups, thrived. Its deposits more than tripled from $62 billion at the end of 2019 to $189 billion at the end of 2021. After receiving more than $120 billion in deposits in a relatively short period of time, SVB had to put that money to work, and it’s loan book wasn’t big enough to absorb the massive influx in cash.
So, SVB did a normal thing for a bank — just under terms that ended up working against it. It purchased US Treasury bonds and mortgage backed securities. Fast forward to March 16, 2022 when the Fed embarked on its first interest rate hike. Since then, interest rates have soared from 0.25% to 4.50% today.
Suddenly, SVB’s portfolio of long-term bonds, which yielded an average of just 1.6%, were a lot less attractive than a 2-year US Treasury Note that offered nearly triple that yield. Bond prices plunged, creating billions of dollars in paper losses for SVB.
Ongoing pressure on tech valuations and a closed IPO market led to falling deposits at the bank. That spurred SVB to sell $21 billion of bonds at a loss of $1.8 billion, all in an effort to shore up its liquidity but which essentially led to a run on the bank.
