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Silicon Valley Bank: What Happened and the Coming Fallout

March 11, 2023

Listen to a special audio message from President and CEO Peter Mallouk as he explains what happened with Silicon Valley Bank on Friday — and what the implications are for investors.


Hey, good evening everybody. It’s Peter Mallouk, the President of Creative Planning. We’ve gotten quite a few questions about Silicon Valley Bank. We wanted to share this message with you around our thoughts explaining what happened recently and what we think the implications and fallout are going to be in the coming weeks. And this is, in many ways, very simple, a classic bank run, but in many ways very complicated. And so we understand that some of our clients are extremely sophisticated hedge fund managers and private equity managers, but that we have thousands of clients where this is not their thing. They’re not in the business of analyzing banks. And so we’re going to start very basic and then get into the reality of what happened here.

So Silicon Valley Bank is just a bank. It’s got a name that sounds very venture capital related, and it is, but at the end of the day, it’s a bank. People go put their checking and their savings and their business accounts there. The issue is it’s the 16th largest bank in the United States in terms of deposits. There’s a lot of money sitting at that bank. And as of the close on Friday, it’s now the second-largest banking failure in the history of the United States. So to understand what happened, we have to start with how banks basically work. And basically, most banks make their money by borrowing money at low rates over the short term and lending it out at higher rates over the long term. So the practical way that most of us understand is we put money in a checking account at the bank that basically we’re lending the money, they pay us a very tiny interest rate, and then they go loan that money out in the form of a mortgage, for example, and collect a much higher rate. And the difference is how banks make a lot of their profits.

The issue with that is if everyone wants their money all at once, they can’t get it because it’s tied up in long-term investors. The few instances in history where everyone goes, “Well, I want all my money at once,” that’s called a bank run. And then the bank run collapses and that’s what we’re seeing here in real time.

So now let’s get to Silicon Valley Bank and what happened there. So a lot of people went and put their money in the bank. It happens to be a place, as its name suggests, that a lot of technology and venture capital funds put their money. So there’s a huge amount of business accounts at Silicon Valley Bank. So they’ve got all of these accounts, they’re paying these businesses very low, if anything, checking and savings rates. And then what do they do? They go lend the money out at higher rates. The issue is they lent a bunch of money to the federal government. They bought U.S. treasuries paying around 1.6%, which is where the yield was a few years ago. How much? About $80 billion. So they took about $80 billion and lent it to the federal government at 1.6%.

Now, if this was an individual investor and you just bought a U.S. treasury paying 1.6% and then interest rates went up, well, no big deal. You just hold your treasury until it matures and then you go buy a new higher yielding treasury. What happened to Silicon Valley Bank, we have to understand bond pricing. And I always like to explain bond pricing by starting with certificate of deposit or CD pricing at a bank because I just think it’s much easier to understand. If you go to a bank and you a couple years ago wanted a CD that paid out over the course of a year, they might pay you 1.5%, right? So you go buy your CD and at the end of the year you get your money, plus you’re 1.5%.

Now, let’s say you went a year ago and you bought that 1.5% CD. The next day they put a sign up that said, “Hey, there are new CDs paying 2.5%. Well, you don’t feel like you’re super lucky, you could have waited a little bit and got the 2.5% CD, but no big deal. You wait ’til your CD matures, then you go buy a new 2.5% CD.

Now, let’s say in the meantime, before the one-year maturity of your CD, you decide you want to sell your CD. Well, who wants to buy it? Well, no one wants to buy it because they’re higher yielding CDs that are out. So if you wanted to sell it before maturity, you’d have to sell it at a discount, and that’s how bonds work. So Silicon Valley Bank loaned $80 billion to the federal government at 1.6%. Well, as we all know, the Federal Reserve keeps raising interest rates. And today, if someone wants to loan money to the federal government, they’ll get 5%. So if Silicon Valley Bank felt like selling their $80 billion of treasuries that don’t mature for several years, no one’s going to want to buy them because they pay 1.6%. They can go get new treasuries that pay 5%.

So Silicon Valley Bank, if they wanted to sell them all at once or sell any of them early, would’ve to sell them at a discount. Now, Silicon Valley Bank didn’t want to sell them at a discount. That’s not the issue. The issue is a bank has a balance sheet that shows how strong they are and they have to put the fair market value of all of their investments on that balance sheet. And so they can’t say this 80 billion is worth a full 80 billion today. Because the reality is if they went to sell those bonds today, people would not pay that much for them because they could get higher yielding bonds. So they will look weaker on their balance sheet.

At the same time, remember, they’ve got a lot of venture capital firms, a lot of tech firms that had their deposits there. That’s kind of what they were known for. A very big percentage of their accounts or businesses in the tech industry that are backed by venture capital investors, private equity investors. Now we all know that tech is not doing great. So technology companies, they can’t go out and raise money the way they could a year or two ago. The market’s much tighter, it’s almost impossible to borrow money. So what are they doing? They’re spending the money they have at the bank, which also makes the bank look weaker.

So Silicon Valley Bank, they all get together and go, “Hey, look, our bonds don’t look as good on paper and we’ve got people spending their money. We need to shore up our balance sheet. We need to get more money in here so we look stronger.” So they said, “Okay, let’s get $500 million from a private equity fund. Let’s go to the public markets. Let’s issue some stock, get over a billion dollars in stock, share some stock to the public.” That was the plan. Unfortunately for Silicon Valley Bank and everyone related to it, that same week, a crypto bank called Silvergate went out of business. So totally unrelated to anything, it’s a bank that handles cryptocurrencies. These banks fail. I have no confidence in any bank involved with cryptocurrency. Totally unrelated to Silicon Valley Bank, but nonetheless, no one likes to see anything with the word bank collapse. And that’s what happened to Silvergate.

Silicon Valley then sent out a letter, “Hey, we’re raising money.” It wasn’t the most eloquent letter in the world and it raised some eyebrows. Next thing you know, Peter Thiel, who’s one of the most famous venture capitalist investors who runs a fund called Founders Fund, he told all of the companies in that fund that they should move their money away from Silicon Valley Bank. So that word spreads like wildfire. This is a community where everybody’s talking to each other and following each other, and the next thing you have is what we call sequential risk.

So if you are worried a bank is going to collapse and you’re the first one that goes to the bank and takes your money out, well, you have all your money. But the reality is most people who knew kind of looked at it and said, “Hey, Silicon Valley Bank has plenty of money to get through this. They’re pretty strong, but some of these things aren’t going perfectly. Their balance sheet doesn’t look great. Peter told his people to move people away. Maybe I should take my money out.” And then the next thing you know, you have people saying, “Hey, my friend, my friend’s taking money out of the bank and if I wait, I’ll be the last one standing.” And you get the bank rush. This is the classic textbook bank run.

Now what happens when there’s a bank run is the bank collapses because they don’t have enough to meet all of these short-term needs. The shareholders lose all their money so the people that invested in Silicon Valley Bank are going to get zero. The lenders, the companies that lent money to Silicon Valley Bank almost certainly are going to get zero. And now we’re left with the depositors, all these people that had their money at the bank.

Now we all are all pretty familiar with FDIC insurance, which is a insurance up to $250,000 per deposit. So hey, no problem. Most banks, half their money is FDIC insured. This is why you don’t see a lot of bank runs. People don’t worry too much about it because 50% of the money is insured. Now here, and I mean this is an unbelievable stat, is 7% of the deposits at Silicon Valley Bank were insured. And the reason is there’s a lot of businesses there. So you have a lot of small biotech technology companies. They have their business accounts there. And to run a business, you might have a million dollars or several million dollars because you’re making payroll, you’re buying equipment and technology and things like that to run your business. You’re not dividing up your account into five different banks. It’s not practical, right? So they have their money at the bank and they’re not insured. So 93% uninsured or about $150 billion of uninsured deposits.

Now, to give you a perspective of how much this impacts the venture capital technology community, a venture capital is just a fund that invests in companies that are really small usually and starting out. Once they get a little bigger, they might get bought by private equity companies. When they get a little bigger, they might go public and you can buy them on a stock market exchange. So a venture capital’s pretty early stage investments. There’s about 120,000 venture capital funded companies in the United States. About half of them were at Silicon Valley Bank. So these is just a stunning percentage of them. These people have products and they have employees and they have payroll. And unless something happens here in the next couple days, by Monday we’re going to have some payroll issues.

So it’s incredible what’s happened with this kind of classic bank run. So we look at this and we go, “Okay, well what are the implications? What should we expect from here? Is this going to be like 2008, 2009?” So let’s look at the options that the FDIC and that the government have here. So number one, they could do nothing. They could go, “Hey, look, Silicon Valley Bank collapsed. People shouldn’t have more than $250,000 in an account. They should know better. We’re just going to let the bank collapse.” Okay, that’s option number one. Now, if they do that, which I would be stunned if they do that, if they do that, what’s going to happen is everybody in America that’s not at one of the few largest banks in the United States is going to take their money out of their banks and you will have this cascading bank run all across the United States. Local banks, regional banks, even national banks that aren’t so big that they would pose with a failure by themselves, what we call systemic risk, right? So I don’t think we’re going to see them do nothing.

The second thing that could happen is we get a quick sale. Like in the next 24 hours or 72 hours, you see a Goldman Sachs or JP Morgan or Bank of America comes in and buys Silicon Valley Bank that gets an incredible customer base. They’ve got a balance sheet that’s good enough. This is a steal for somebody. I’m sure what is happening in the background now is trying to create some sort of organized sale before Monday opens up. The third thing is FDIC or the federal government could come in and say, “Everyone’s going to be made whole.” Now you could say, “Well, look, that’s not fair. We don’t want to government bail out of the bank.” Well, remember the shareholders of the bank are now wiped out. They have nothing. So we’re talking about the companies that have the deposits to the bank, the people that work for those companies. What happens to other banks if this people aren’t made whole?

And so I could very likely see some sort of announcement that, “Hey, everyone is going to be made whole here.” Because if you see that kind of announcement, you won’t see people go make a run at other banks and go, “Hey, I’m not going to sit here at another bank with tech exposure like a First Republic or a regional bank that may not be strong enough to withstand this. I’m going to make sure all my money is sitting in these enormous institutions, not just even banks, but like Schwab or Fidelity or JP Morgan or places like that where I feel like there’s really, really big money and that the government would never let them fail.”

So if you look at the options available, it’s, Let them fail. Not going to happen. I’d be stunned if it would happen; there would be huge repercussions if it happened. Second, organized sale. I’m sure this is the number one thing that they want to happen, is somebody to pay full price for it, make all the depositors whole, and the financial markets stay a little shaky for a while and we all move on. Or third, if they can’t get that sale done, I expect that there will be a full bailout of those investors because the repercussions to everybody else who has nothing to do with this would be very significant if they didn’t do that.

Now, just to point out, the biggest collapse in history was Washington Mutual in 2008. 100% Of people got their money back then. And this is not 2008. If you look at what started 2008, Lehman Brothers, at that point, all of these institutions were very, very connected. A lot of money going back and forth. That’s not the case here. Silicon Valley Bank, of course, there’s going to be a ripple effect. There’s a lot of companies that are dependent there, but it’s not the same as Lehman Brothers.

Now for individual investors, what can you do from a practical sense with your accounts? Well, for those of you, no matter what bank you’re at, make sure, number one, you’re in an FDIC insured bank. And number two, make sure your account has less than $250,000 unless you have an account that has even greater protection. So, for example, if you have a revocable living trust, that makes you the grantor — you’re the one who put the money in the trust — and you have three beneficiaries, then your FDIC insurance is not $250,000, it’s $1,000,000. You get $250,000 for you as the grantor and you get $250,000 for each of the beneficiaries. If you’re married, put one account in your name, one account in your spouse’s name. So try to do things to expand that protection.

If you’re looking at your portfolio and you’re thinking, “Well, what’s going to happen to my stocks and what’s going to happen to my bonds?” Things like this happen all the time. This isn’t the first bank failure in the United States. It’s not going to be the last. During those periods of uncertainty, you see a lot of short term movement that’s completely unpredictable and usually to the downside because a lot of speculators see their positions get blown up or they try to move money to protect certain positions.

If you’re a long-term investor, this is not something to spend time on. If you’ve got bonds to cover you for five years, if you’ve got stocks that are going five years now, we’re going to have, between now and five years now, five or 10 more mini crisis or big crises that are going to happen. It doesn’t matter if it’s a bank failure or a pandemic or a terrorist event or a tech bubble or whatever. There’s always going to be something and you really have to step back and look at it from 50,000 feet, 40,000 feet and go, “Hey, look, are people not going to be going to McDonald’s in five years over this? Are they not going to be going to Disney World in five years over this?” The answer is of course not. One way or another, we’re going to get through this and the markets are going to move on.

Make sure your investments match your goals and you don’t have to worry about these things day to day. But be aware that this could have some ripple effects and a lot of that will be dependent on how this is handled over the next 48 hours. No predictions there, but I’ve walked you through the three scenarios. I would be stunned if we saw what we’re seeing right now, which is the actual failure of the bank without everyone being made whole. I think we’re going to see an announcement at some point in the next 48 hours, one way or another, to avoid the contagion.

Thanks for listening to me over the weekend. Hope you have a good rest of your weekend and we’ll be following up with more information as we have it. Thank you.

Disclosure: This show is designed to be informational in nature and does not constitute investment advice. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels.

This commentary is provided for general information purposes only, should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.


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