SVB Collapse Simply Explained

The short story is: The bank failed due to a bank run. All depositors will be fine, but shareholders and debt holders may not be so lucky.

Here's the long story.

Let's start at the beginning.

Who is SVB?

SVB is a specialized commercial bank that primarily serves tech companies, Venture Capital (VC) and Private Equity (PE) firms.

How did the collapse start?

This started on Wednesday when SVB CEO wrote a letter to shareholders saying that the bank was rebalancing its balance sheet, had sold $21bn of securities at nearly $2 billion loss, and they plan to sell $2.25bn worth of shares to raise extra cash.

Shareholders don't generally like when companies sell new shares because it reduces the power and value of their shares.

E.g. if you own 1 out of 10 of all the apples in the world, you own and control 10%, but tomorrow if someone creates 2 more apples, you now own 1 of 12 i.e. 8%. So you lost 2% control without doing anything.

SVB's market cap was about $11bn before this announcement. So a $2.25bn raise is almost 20% dilution. So this announcement sent SVB shares down.

What happened next?

This sale of securities at a loss and the announcement of a capital raise to plug a hole in SVB's balance sheet worried some depositors. This worry led them to withdraw their funds and tell their friends to do the same.

If you warn people that a run on the bank is going to happen, you are basically causing a run on the bank.

What's a bank run?

A bank run is when too many depositors ask for their money at once. See the 1946 movie It's a Wonderful Life.

Why's that a problem? Shouldn't banks be able to pay depositors at all times?

Commercial banks, at their core, are dealers in trust.

They get deposits from you and me because, to an extent, we trust that if we call our bank any day, we can get our money back in full. These banks, in turn, make money from lending deposits to others they trust in the form of mortgages, business loans etc., after doing credit checks and sometimes getting collateral.

E.g. if I deposit $100, and the bank pays me a 1% interest, the bank can lend $80 to someone else at a 5% interest rate to profit on the difference, known as net interest income. Banks don't lend all deposits because they are legally required to keep some of that money in cash, and very liquid assets they can easily convert to cash to meet deposit withdrawals.

Banks typically agree to hold cash in the short term and lend for the long term to make a profit.

This system works unless

1. Too many depositors ask for their money at once because they no longer trust the bank
2. Too many debtors can't pay their loans, breaking the bank's trust

Scenario 1 is a bank run

Scenario 2 is the 2008 financial crisis

Why wasn't SVB able to handle the bank run?

2 key reasons

1. Deposit decline: SVB primarily serves tech companies. Tech companies have been severely affected since the US Federal Reserve started raising interest rates and quantitative tightening. Case in point the many tech layoffs. While this happened, some startups continued burning more money than SVB expected, while VCs were not depositing more money. So overall, more money was going out than was coming in
2. Assets were also declining in value: The bonds they bought with customer deposits lost value as the Fed raised interest rates. A 3% change in interest rates caused the value of the 10-year bonds they owned to go down 25%. As a result, their bond portfolio got devalued.

But banks are not required to disclose the fair value of assets on the balance sheet. Hence, while everything looked okay on paper, it wasn't in reality and all it took for the dominos to come crashing down if for enough depositors to demand their money back. There is also a question on the value of their other assets in their portfolio, e.g. venture debt they held

Why didn't anyone see this coming?

Looking at SVB's balance sheet, they should have been able to cover customers' deposits if less than 25% of total deposits were withdrawn. More than 25% of deposits were called, and their assets weren't sufficient to cover the withdrawals.

To be fair, some analysts at Seeking Alpha wrote articles about this in December 2022

What's happening now?

US regulators have guaranteed that all depositors will get their money back, but shareholders and debt holders will likely be wiped out.

The Federal Reserve has also stepped in to guarantee deposits of other banks to prevent future bank runs.

HSBC UK has acquired SVB for ￡1. As of 10 March 2023, SVB UK had loans of around ￡5.5bn and deposits of around ￡6.7bn, and they made ￡88m in profits in 2022.

Summary:

SVB benefited from the rise of tech, tripling assets from 2019 and 2022 and doubling deposits in the same period

They rose with the tech boom and collapsed with the tech bust

What can beginner investors do from here

Check that your deposits don't exceed the amount that is insured. In the US, the FDIC insures up to $250,000, the UK's FSCS insures up to ￡85,000 ($100,000), and Nigeria insures up to ?500,000 ($800).

This also means the Federal Reserve might not raise interest rates as high as some expected last week to prevent a banking collapse. Paul Volcker, known for his rate tightening, had to pause tightening when Continental Illinois bank failed. Also, the Bank of England recently showed that Central Banks will pause their fight against inflation to ensure financial stability.

Is this a time to be greedy when others are fearful?

Maybe or maybe not. There is still scope for stock prices to go down further from here, but maybe in the future, we could see some good buying opportunities at this time.