Commentary supplied from the linked article by Russian financial reporter Pavel Komarovsky
[DTFRULIFE] On Friday, there was a loud "pop" in the financial markets: the 16th largest US bank suddenly burst - and the bankruptcy itself became the second largest in history among American commercial banks. In this article, we take a look at what happened and how it could affect all of us.
Laura Izurieta, head of risk at Silicon Valley Bank, prudently resigned from the bank back in April 2022, and they couldn’t find a person for her position for almost a year (coincidence? I don’t think!)
HOW IT ALL BEGAN: A BANK FOR THE GEEKY ZUCKERBRINS
For 40 years back (in 1983) a bank appeared in California that made a bet on startups - it decided to serve mainly big-headed guys who created new promising businesses and raised a lot of money from venture investors.
Given that the business took place exactly in Silicon Valley, and the bank was called Silicon Valley Bank (SVB), this business model turned out to be extremely successful. After all, Silicon Valley has become a real cradle for fast-growing technology companies, which for the next few decades rowed money literally with a shovel (and some of it, of course, put it in the bank).
They say that Bob Medearis came up with the idea to drink Silicon Valley Bank while playing poker with another co-founder of the bank, Bill Biggerstaff. They had a good all-in, I must say!
In 2020-2021, the technology industry in the United States experienced another boom: under the slogan of combating covid, unprecedentedly huge amounts of money were thrown into the financial system, and a significant part of it went precisely to finance “fashionable” fast-growing tech companies. The Nasdaq-100 index has almost doubled in these two years, and startups raced to conduct initial public offerings (IPOs) and raise money directly from venture capital investors on an industrial scale.
Not surprisingly, the business of SVB, which serves all these tech start-ups, also grew by leaps and bounds. Its customer deposits more than tripled during this period (as did the bank's share price) to reach roughly $200 billion by early 2022, making Silicon Valley Bank the 16th largest bank in the US (and second in California).
As they say - nothing foreshadowed trouble ...
Any bank, of course, is happy when they bring a lot of money to it. But with big bucks comes a big responsibility: you have to decide where to invest them so that they earn a nice profit in the pocket of the owners of this bank. And this is where it gets interesting!
WHAT TO DO WITH THE MONEY, LEBOWSKI?
The classic business model of any bank is to collect more deposits at a lower rate, and distribute this money to reliable companies in the form of loans at a higher rate. In the case of Silicon Valley Bank, this turned out to be a little problematic: most of your startups from Silicon Valley do not look much like "safe businesses" (the guys there mostly have beautiful pictures with the promise of explosive revenue growth in the future - and not stable cash flows and strong collateral ). And they didn’t have much of a shortage of money: as I wrote above, in 2020–2021. except that investors didn’t line up in a queue to fill such startups with loot literally in bags.
Therefore, SVB decided that the money would be logical to invest in the stock market. No, of course, they did not go to buy Tesla shares with leverage - that would be too much. But to buy reliable bonds from the US government (US Treasuries), or mortgage-backed debt securities with suitable collateral in the form of real estate - why not?
And now let's remember what yield reliable dollar bonds gave during that period:
The yield of US government bonds as a percentage (vertical scale) depending on their maturity (horizontal scale) in 2020-2021 (source https://www.researchgate.net /figure/US-Treasury-Securities-Yield-Curve-Mar-2020-Jan-2021_fig1_348559338 )
The US Federal Reserve then drowned the interest rate to almost zero (in the name of saving the economy from covid horrors), so placing money in reliable US Treasuries on the horizon of a year or two brought about zero profitability.
So the bankers from Silicon Valley Bank thought that by investing at 0% you won’t earn much for bread and butter (and they still have to pay all current expenses: salaries to employees, office rent, and so on). The solution was simple - the bankers simply dumped the lion's share of available funds into longer bonds with a maturity of 5-10 years (mostly mortgages), which at that time had a yield slightly above 1.5% per annum. Despite the fact that they paid almost no profitability to their clients on attracted deposits - a good margin, right?
HOW RISING RATES KILLED BONDS
Any financier knows that when you buy long bonds, you take on the risk of rising interest rates. If you bought a long bond during a period of low rates, and then rates skyrocketed, then, in Tommy's terms from the movie Snatch, "You are PROPER HOSED."
Why is this happening? Invisible hand of the market, ept! Follow the logic: suppose a company issues a $100 par value bond with a 1% coupon (which was the market level at the time), maturing in 50 years, and you buy it. A year later, the market level of rates increased, and now it is customary to lend to such companies already at 2% per annum.
Can you sell your bond to someone for $100? Of course not - you will not find such fools (why would someone invest at 1% when the market already gives 2% with a similar reliability?). But for a conditional $50, such a bond will be bought from you without any problems: after all, then a coupon of $1 per year will just give a yield of 2% on the “current market value” of the paper at $50 (the exact numbers will not be exactly the same, but these are the details - you understand the logic.
In fact, this is exactly what happened in 2022: the head of the US Federal Reserve got a little crazy from the explosive growth of inflation, and at a record pace raised the interest rate from about zero to almost 5% (at the moment).
Surprise: the stock market has been bleeding non-stop for the whole of 2022 precisely because of the sharp increase in the Fed rate
It is clear that in this situation, the bond portfolio of Silicon Valley Bank “sad”: by the 4th quarter of 2022, it showed a drawdown from 9 to 17%, which already, as it were, exceeded the size of the bank’s own capital (that is, the difference between existing assets and liabilities to contributors).
Run on a bank: why it is sometimes important to be first in line, and not last netinterest.co/p/the-demise-of-silicon-valley-bank ). And there is even logic in this: because of the growth in rates, the bonds, as it were, sink not forever, but temporarily. If you hold them until maturity, then they will recover over time and everything will be ok.
But this logic only works if the bank has "the ability to wait." And here is the time to remember that most of the deposits in Silicon Valley Bank are the so-called “demand deposits”, which can be withdrawn at any time. Oops...
Bloomberg: By March 2022, SVB had accumulated almost $130 billion in demand deposits - and by the end of the year, $50 billion of them the smartest clients preferred to take. The systematic outflow of such deposits from the bank began in mid-2022. And there is no malicious intent on the part of Silicon Valley Bank customers: the tech industry began to decline, it was no longer easy to attract new investors' money, so many companies began to actively “eat up” the previously accumulated reserves.
But for SVB, this felt like a gradual activation of a time bomb: after all, deposits on demand had to be reimbursed from the most liquid assets, which meant that more and more strongly sagging long-term bonds remained on the balance sheet. And the faster the outflow of deposits became, the clearer it became that simply “sitting out to maturity” in these bonds would not work - sooner or later they would have to be sold at a loss in order to receive funds to return money to customers right now.
Actually, this is exactly what happened, and in 2023 the bank had to start selling these ill-fated long bonds at a loss - and then it suddenly became very clear to everyone that “the king is naked”, and in fact there will not be enough money for everyone. Venture start-ups from Silicon Valley began vying to call each other and advise urgently to remove all the loot from Silicon Valley Bank. But it was already too late ...
IN FINANCE, THIS PHENOMENON IS CALLED A "BANK RUN", AND IT LOOKS SOMETHING LIKE THIS, YES
It turns out that here the concentration of SVB in one sector played a cruel joke on the bank: if they had many small retail clients, they might have passed. But since IT startups in the Valley communicate very closely with each other, there was a full run on the bank, when everyone tries to get their money out early (because the last one in this line may not get anything).
Well, and a logical result - on March 10, banking regulators in the United States began, de facto, the bankruptcy procedure for SVB.
BANKRUPTCY OF THE LARGEST BANK IN CALIFORNIA: NOT PLEASANT
All operations with the bank were instantly suspended - for a huge number of start-ups from the Valley, this was a real shock (many of them used Silicon Valley Bank as the only place to store funds raised from investors).
Andrey Doronichev (former Google Product Director and one of the heroes of Dudya's special project about Silicon Valley) shares his feelings from the position of a startup The
American deposit insurance system FDIC promises to start paying out affected depositors next week - while the insured amount is $ 250 thousand per deposit. But this is only a part of the funds, in the region of 15% of the total amount of deposits. What will happen to the rest of the contributors is still unclear.
The worst case is if the case ends in a full-fledged bankruptcy, with the gradual sale of all assets and the division of the resulting pile of money among everyone to whom the bank owes. This process will most likely not be quick - but, nevertheless, investors should eventually receive the principal amount invested back (I think at least 80% - but it will be possible to say for sure only on the basis of detailed up-to-date financial statements).
A good scenario assumes that someone big will buy the whole bank and close the hole in the balance sheet with their own funds, getting a working business in return (which was estimated quite well by the market a year ago).
It is clear that US regulators will do their best to drown for a "good" scenario - so that all the people around them get what is due to them, calm down, and the negative effects on the mood prevailing among financiers are limited. But even in the worst-case scenario, so far it looks like the bankruptcy of a bank even of this size is unlikely to cause the beginning of the collapse of the entire financial system according to the domino principle (and this, of course, in such situations, everyone fears the most).
IT HURTS THE MOST, IT SEEMS, AS USUAL, HIT THE CRYPTANS
In Silicon Valley Bank, not only classic IT entrepreneurs kept money, but also cryptans. In particular, the company Circle, which manages one of the largest USDC stablecoins, also kept part of the reserves for this token there. So, in the wake of such news, USDC cheerfully depegged on the night from Friday to Saturday (disconnected from $1) and is currently being traded in different places for about 90% of the face value.
Why at the moment everyone in a panic gets rid of USDC and dropped the price a lot - this is understandable; but let's try to figure out what situation we are in in terms of the fundamental indicators of the security of this stablecoin. (Disclaimer: The author of this article has money in USDC, so I'm being a bit biased here - keep that in mind!)
According to the latest data from the Circle website, as of March 9, total reserves were an impressive $43.5 billion, of which 75% ( $ 32.4 billion) accounted for a short public debt of the United States - about these funds, pah-pah, you don’t seem to worry about it. But $ 11 billion lay in bank accounts, and according to Circle on Twitter, $ 3.3 billion managed to end up in Silicon Valley Bank.
If you count it "on the forehead", the funds blocked in SVB accounts make up 7.5% of reserves - which is a lot. But at the same time, as we discussed above, it is hardly worth considering this money as “completely missing”. If we assume that at least 80% of the bank's liabilities are adequately backed by assets, then the real "hole" in Circle's balance sheet can be only ~1.5%, which already does not look so threatening. Taking into account the fact that now reliable short US Treasuries bring 5% per annum, it is possible to recoup this amount purely from interest income in four months.
True, if everyone rushes en masse to exchange their USDC for real cash directly in Circle, then this “little hole” may begin to grow ... And the last one who comes for such an exchange will already get a donut hole - in fact, because the outcome and these same raids on banks take place (and Circle in this case acts as a kind of crypto-bank).
Is it likely? I am not here to give advice and predictions - but I can share my personal opinion: it seems to me that with the beginning of the next working week (when interbank transfers and other things start working again), arbitrageurs should quickly return the USDC peg to $1 (albeit not ideally, but a deviation should be reduced from 10% to at least 1-2%). At the same time, we should expect a significant reduction in USDC capitalization due to the work of arbitrageurs (who will buy tokens at $0.9 and exchange them in Circle for a real crunchy dollar).
So one of the main questions here is whether Circle will have enough patience and infrastructural capabilities to sit out the first wave of outflow of funds, and how much they will be able to draw a clear and transparent picture for cryptans regarding “what is with the reserves now and what is the plan for the future.”
Worst case scenario for USDC crypto holders here could look something like this: Circle says “sorry, there’s a hole in the balance, so we are suspending the USDC to dollar exchange – until we figure out how to fairly share the rest of the reserves among everyone. Based on our calculations above, this in itself will not mean that all the money in USDC is lost (Circle has a lot of real assets), but all arbitrage mechanisms will break down at the moment - and USDC quotes will go even much lower than $0.9.
In general, we'll see. It is not an investment recommendation, but personally I still bet on a moderately positive scenario for USDC - and I’m getting ready on Monday-Tuesday, if quotes again approach $1, to slowly diversify my “crypto pillow” away from USDC. But, of course, I could be wrong.
PS: I foresee a lot of gloating in the comments on the topic that “Tether was branded for unreliability, but USDC ended up well!” Well, here we must also take into account that we now know about the problems of USDC precisely because of the greater transparency of this token. If Tether got into the same situation, we would most likely simply not even know about it now (and, accordingly, it’s not a fact that the situation inside the reserves is now much better).
UPD: As they say, “our shooter has ripened everywhere”: Elon Musk writes that he is open to the idea of buying Silicon Valley Bank.
From regnum.ru:
The IMF is closely monitoring the situation with the bankruptcy of Silicon Valley Bank
The situation with the bankruptcy of the American bank Silicon Valley Bank (SVB) is being closely monitored by specialists from the International Monetary Fund (IMF). Bloomberg writes about this on March 12.
As the representative of the international organization clarified to the publication, the development of the situation with SVB is being closely monitored, potential financial risks from the collapse of the bank are being assessed.
In addition, the IMF representative indicated that the organization retained absolute confidence in the representatives of the US authorities, as well as in the appropriate steps that Washington, without any doubt, will take to resolve the situation.
Earlier , REGNUM reported that the US Congress hopes to receive a statement from the White House administration regarding the situation with the bankrupt Silicon Valley Bank (SVB) before the opening of trading on Monday morning, March 13.
More from RIA Novosti
US Treasury won't bail out bankrupt Silicon Valley Bank
The American authorities are not considering the possibility of buying out the bankrupt Silicon Valley Bank, by analogy with the practice of the financial crisis of 2008, US Treasury Secretary Janet Yellen said in an interview with CBS News.
"During the financial crisis, some investors and owners of large systemic banks were saved <...> government reforms do not suggest that we will do it again <...> At the same time, we are worried about depositors and are focused on trying to satisfy them needs," the minister said.
According to her, now the task of the authorities is to prevent a chain reaction due to the collapse of the Californian company.
“The American economy relies on a sound and strong banking system that can meet the credit needs of households and organizations. So when a bank, especially one like Silicon Valley Bank, with billions of dollars in deposits, collapses, it is a concern,” she stressed.
Yesterday, the Federal Deposit Insurance Corporation (FDIC) reported that regulators in the state of California closed Silicon Valley Bank, the largest bank to collapse in the US since the last financial crisis. The FDIC transferred all insured deposits from the SVB to a separate entity it created, the Deposit Insurance National Bank of Santa Clara.
SVB specialized in working with Silicon Valley startups. On March 8, the bank announced the sale of virtually all of its securities and suffered an after-tax loss of $1.8 billion.
On Sunday afternoon, the American online publication Axios reported that the Joe Biden administration is facing a banking crisis if it does not work out a plan to rescue SVB depositors by Monday.