Silicon Valley Bank

I wanted to take some time to discuss all the craziness that’s been going on. I’m sure you’ve heard about Silicon Valley Bank and everything happening in the banking community.

Most importantly, let’s give you a plain English explanation of what we’re seeing going on and how it affects you. The three big things we’ll hit on are what happened with Silicon Valley Bank, what might happen next, and of course, what we should do.

How does it affect us?

The first thing we want to say is we think that you will be okay. If you’re a client of ours, we are in great shape. We want to first hit on the most important thing because we all want to know how does this affect me?

We’re still gathering updates from every single company we work with. I’m going to give this as a spoiler for the rest of the blog. Still, the bottom line is the people that are going to be at risk with Silicon Valley Bank are people who own stock in the bank or who owned bonds with the bank, and it appears that would be the same for any other bank problems that we have going forward.

As long as you aren’t directly investing in those stocks or bonds, it appears that we should be in great shape. So that’s where we believe we stand right now.

Let’s take you back through a little bit of the background. How do banks make money? So a bank accepts deposits from us in checking accounts, savings accounts, and CDs. Most of the time, what they’re trying to do is they’re trying to lend that money out.

I actually worked very closely with some smaller to midsize banks earlier in my career and got to know the bank presidents. In my understanding, having the proper amount of deposits and loans was ideal for them. 

Now, what happens if they get extra deposits? Either they can’t or shouldn’t make those additional loans, so in that case, they will reinvest those funds, typically into bonds, and then hopefully earn more interest on those bonds than what they’re paying out. So what happened is Silicon Valley Bank failed, and there are several steps to how this happened.

First of all, it’s a very unusual circumstance. Most banks are going to have customers of all different types. Silicon Valley Bank, as you can tell from the name, is a little different than us here in the Columbia, South Carolina, area. Their clientele is primarily venture capital – companies that are startups. Or it might be people that were investing in these small startup companies. In those cases, they are often generating a lot of value but not a lot of revenue.

What’s happened over the last few years?

The Fed flooded the economy with cash after COVID, and the deposits at the bank more than tripled in just three years, which is a crazy amount. What the bank did was they either couldn’t, or they shouldn’t have lent that money out. So all those extra deposits they invested into long term-bonds.

The Fed flooding the economy with extra cash helped create these additional deposits. Well, then, guess what the Fed did? The Fed started increasing interest rates because we started having so much inflation. When interest rates go up, the value of bonds goes down, and the longer term the bond is, the more it’s affected.

In a very short period, the value of the bonds the bank invested in dropped by 18%. Now, if they were able to hold those bonds to maturity, it’s our understanding they would have gotten the full value back; but of course, that’s not what happened.

As interest rates have been rising, the economy has been slowing down. This caused those venture capital firms to start spending more money than they were taking in. Instead of being flooded with cash, they actually needed to spend some of that money. They were starting to use some of the excess deposits at the bank.

It appears that the interest rate risk was poorly managed. First, it seems like the bank had very long-term bonds, which is the worst possible scenario when interest rates are rising.

The second is it appears they didn’t hedge those risks at all, which a bank can certainly do. What happened is they needed to raise money to improve their finances. They went out and announced that, and it created a run on the bank. We have all probably seen pictures of the Great Depression and the line of people going around a bank. Of course, that’s not what happened this time. It’s able to be done with the click of a button. Incredibly, the bank had about 200 billion in deposits. And within a couple of days, 42 billion was withdrawn, which is just an eye-popping number. That caused the bank to fail. It was the 16th largest bank in America at the time.

Now, this was happening late last week. Officials worked very quickly, which I’m very impressed with. The bottom line is that the US Treasury has agreed to serve as a backstop. Some of the phrasings we’ve seen are they’re essentially guaranteeing every bank deposit in the country, which is remarkable. This is being paid for by a fund that is funded by fees collected from banks. And also they’ve created a new program to lend money to banks if necessary.

If you’re like me, I’m thinking, are my tax dollars paying for this thing? As of right now, every single person has said taxpayers will not be funding this. So kudos to the officials if they’re able to pull that off. That’s always our biggest concern. Anytime government is getting bigger and bigger and if we have to foot the bill. So if that’s not the case, we’ll be very impressed. We’ll certainly be watching that and hope that that will continue to be the case.

The other thing that is important to know is so who loses out. Well, if you owned stock in Silicon Valley Bank or if you had a bond with the bank, the bank doesn’t exist anymore, and you are not being bailed out like some of the companies in 2008. So those funds would be lost.

If you were an employee of the bank, that’s a problem for you as well because the bank doesn’t exist anymore. So there are people that are still going to be harmed in this scenario.

But for so many of us, of course, the first thing we’re wondering is if enormous banks are failing, is my money safe? Am I going to be okay? And right now, it seems like that is going to be the case for the vast majority of us. So how does that affect us? What should we be doing? The first thing, of course, and we cannot know the answer to this, what people are wondering is, will other banks be affected?

We’ll be watching this. We’ll continue to monitor the markets and the news and see what’s happening. We certainly do not expect all the banks to fail or anything like that. The backstop that the treasury provides should provide a lot of stability, which we commend them for. So we’ll see if that holds up.

One thing I would still say, though, is that even though we’re being told deposits above $250,000 will be protected. I don’t know if I would be comfortable with that. We’ve always advised our clients probably as smart not to have more than $250,000 in any one bank, certainly per tax ID.

So if you’re married, you can have up to 250,000 in each person’s tax ID. Keep in mind, though, if there is a lack of cash in some of these entities, FDIC does not have to provide that within a day or two or something like that.

Now, we’re seeing and hearing that that’s the plan right now. But it’s one thing, if that’s theoretical, for people out in California that we don’t know; it’s another thing when it’s your own money. So just keep that in mind as far as how much you have exposed to things like that.

The main thing I want to say is to prepare for volatility and a lot of noise. The markets are definitely going to be shaken by this. We have a lot of people that are predicting a recession in the next year. Typically, that means the stock market is shaky or has a drawdown prior to that. So it’s going to be fascinating to see if this helps trigger something like that.

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