You have probably seen the news that Silicon Valley Bank has been shut down by regulators after a run on the bank. We thought it may be helpful to provide some context to the situation, its impact on markets, and how our Research team is navigating the current environment.

To understand what happened at Silicon Valley Bank (SVB), it’s helpful to consider an analogy to the early days of the COVID pandemic. For a brief period, there was fear that we might run out of essential goods such as toilet paper. Out of fear, consumers stocked up, buying more than they required. As shelves started to empty, the panic grew. No one wanted to be the last one to show up to the store to buy toilet paper. Eventually, there was no toilet paper left on the shelf. This is similar in a lot of ways to what happened at Silicon Valley Bank.

In the case of Silicon Valley Bank, a series of unique circumstances sparked worry about the health of the bank. This created panic among customers. Like the toilet paper scenario, this fear cycle spun out of control. No one wanted to be the last one to show up at the bank to withdraw their deposits. Suddenly, SVB was receiving more electronic requests for deposit withdrawals than it had cash on hand to cover. There was no money left on the shelf. Once the panic cycle reached this point, regulators were forced to close the bank.

This incident was the result of a confluence of factors unique to Silicon Valley Bank. SVB caters mostly to start-up companies in (you guessed it) Silicon Valley. These businesses are mostly early-stage in nature and inherently burn through cash at a rapid pace. Over the past several years, venture capitalists poured billions into these start-ups, which more than offset their significant cash burn. Silicon Valley Bank’s deposits grew rapidly until recently when venture capital funding to these start-ups slowed significantly, causing a sharp decline in deposits. As deposits evaporated, SVB attempted to raise capital to fortify their balance sheet, but the capital raise was poorly timed and ultimately unsuccessful. Finally, as word spread and fear mounted, several influential Silicon Valley figures advised start-ups to pull their deposits, causing an unprecedented outflow in a short period of time which the bank couldn’t cover.

Ultimately, on March 10, regulators took control of the bank. As these events transpired, investors dumped regional bank shares into the market’s close on Friday out of fear that banks across the country would face similar issues. It was clear that the Fed would need to step in with further support.

On Sunday, the Treasury Department, Federal Deposit Insurance Corporation (FDIC), and the Federal Reserve announced substantial actions to calm financial markets. In a joint statement, they announced that all customers of Silicon Valley Bank would have access to their deposits in full starting Monday morning. In addition, the Federal Reserve announced the creation of the Bank Term Funding Program (BTFP) to give all banks another source of liquidity in the case of similar deposit outflows.

In effect, the FDIC is guaranteeing all deposits, a dramatic shift from the long-standing $250,000 per customer coverage. This action is meant to stop any further runs on deposits. If the additional insurance isn’t enough to calm depositors, the BTFP offers banks additional capital if needed.

While news of bank failures is unsettling and may remind you of the Global Financial Crisis, we think it is important to make some distinctions between the two events. The Global Financial Crisis was a credit issue – banks were acting irresponsibly and making bad loans. Credit quality is not an issue here. Today’s issue is one of liquidity.

The business model of a bank is to hold short-term deposits while writing longer-term loans to consumers and businesses. Generally, there are plenty of deposits available to satisfy the lending needs of banks while also holding cash on hand for customer withdrawals. Because banks use much of the capital from deposits to make longer term investments or loans, if there is a sudden rush to the exit from depositors, the demand for withdrawals can exceed cash on hand. The result of this phenomenon is a liquidity crisis like we saw at Silicon Valley Bank.

Bank runs are psychologically driven, and market participants can be irrational in the short term, so we expect further volatility in the markets as this all gets sorted out. We are confident that the Fed actions have sufficiently addressed practical concerns.

We’ve approached the current volatility like we always do – opportunistically looking for high-quality businesses to buy while also adding to current positions. Dislocations driven by fear and not business fundamentals are often the most attractive times to put money to work.

Best Regards,
The Sandhill Research Team

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