The demise of Silicone Valley Bank (SVB) the 15th largest US bank, with an important systemic role in the roll out of US Tech happened quickly. In less than 24 hours it was all over for shareholders as the regulators took over to prevent banking contagion. By offering insurance not only on the deposits of all denominations of SVB, but effectively on all deposits with US banks, should it be needed.
It was not a run on the banking system – depositors were not lining up to cash in their deposits- as they might have done in primitive times before. They were acting online, transferring their deposits as quickly as they could to their accounts with the banking behemoths JP Morgan, and their like. As the venture capitalists and their many subsidiary companies did with their deposits with SVB,
It was clear what caused the panic withdrawal of deposits from SVB. It was a sudden loss in the share market value of SVB to which the depositors acted as they did. They may not have known what was going on but they took fright. It is the market value of a company and its capital raising potential that protects creditors and this protection had fallen away. For reasons that had everything to do with decisions taken by SVB itself on surely very poor advice, that investors in SVB had recognized as destroying the market value of SVB.
The problem for SVB and other banks was that the fixed interest rate yield on their essentially sound assets had been rising steadily, causing their values to decline, even as the interest rates paid on deposits were edging higher in response to Fed tightening. Accordingly, the net interest income earned by the banks and their earnings per share were in decline. A trend clearly uncomfortable to earnings conscious and presumably earnings growth incentivized managers of SVB.
The advice was to mark the portfolio to market values, and recognize the capital losses on the balance sheet. To raise additional share capital in the market to restore required capital to asset ratios and to invest the capital in higher yielding government and other securities. By so doing improving net interest income and the earnings outlook and the share price.
There was no regulatory compulsion to recognize the losses on their portfolio. The alternative was to have let the assets run off as they became due and to accept the consequent decline in earnings for the next three years or so and the possibly negative reactions of the capital market to a well understood and unavoidable economic reality. There would then have been no need to raise additional capital.
The capital market would surely have been capable of seeing beyond the decline in earnings and focused on the inherent quality of the SVB balance sheet and its potentially durable business model. The problem for SVB was that the capital market clearly did not think that the proposed plans for the balance sheet made good sense and that two billion dollars of extra capital required could be raised on reasonable terms. Doubts that put pressure on the share price that undermined the possibility of raising the additional capital.
The protection in the form of market value for depositors and shareholders in SVB and beyond fell away dramatically and the bank went down. All because of a false belief in managing earnings per share and the failure to recognize how companies are properly appreciated and valued on the share market. Concerns that extend well beyond the short-term prospects for accounting earnings. Adjusting wisely to Covid 19 and its aftermaths has proved difficult enough for the great growth companies with the strong balance sheets. It is even more difficult for banks, with high degrees of leverage, to wisely adjust their balance sheets in such unpredictable circumstances. SVB clearly failed to do so.