0x Finance | How Powell Killed Silicon Valley Bank

Text/James Early, Chief Investment Officer of BBAE; Translated/Jinse Finance 0x25

what happened to silicon valley bank

A simple sequence of events is:

1. Deposits at Silicon Valley Bank grew from $61 billion at the end of 2019 to $181 billion at the end of 2021 as its start-up clients raised sufficient venture capital funding.

2. This is great. Silicon Valley Bank couldn’t lend out those deposits fast enough, so it started looking for other uses for the money.

3. Unfortunately, a large portion of this “other stuff” happens to be very long-dated (i.e. over 10 years) mortgage-backed securities (MBS). Silicon Valley Bank has 56% of its assets in fixed-rate securities, a far higher percentage than most banks.

4. Whether fully intentional or half-intentional, Silicon Valley Bank is betting that rates won’t rise.

5. As interest rates rise—for example, the yield on one-year Treasury bonds rose from around 0.05% (May 31, 2021) to over 5% today—the value of these MBS plummets.

6. Moody’s lowered Silicon Valley Bank’s rating.

7. People worry about Silicon Valley Bank. Peter Thiel and other venture capital firms advise portfolio companies to divest. With funding slowing, tech startup account holders are already withdrawing deposits in 2022, so it won’t be hard to convince them to withdraw more.

8. To provide the money, Silicon Valley Bank had to sell depreciated assets at low prices.

9. (Silicon Valley Bank also tells people “we’re ok” when they’re terribly ok, which could fuel panic.)

10. Silicon Valley Bank, with $209 billion in assets, became the second largest bank to fail in US history. FDIC insurance covers deposits of $250,000, but since Silicon Valley Bank is a commercial bank, less than 3% of deposits are covered.

11. By the way, bank stocks fell overall as other US banks had $620 billion in unrealized losses and fears that other small, monolithic lenders would suffer a similar fate.

So the Silicon Valley Bank story is really a story about interest rates. Powell didn’t actually kill the banks, at least not intentionally. In fact, he was right to raise rates — Silicon Valley Bank just got itself into trouble. As Matt Levine said, Silicon Valley Bank’s assets and customers are very sensitive to rising interest rates.

In this era of rising interest rates, your portfolio may be more exposed than you think, so now is a good time to talk about interest rates – how they are set and how they affect asset prices.

How and why does the Fed adjust interest rates?

Interest rates are the “price” of money. It is a direct price to the individual, company or government that borrows the money. For companies raising equity, it’s an indirect price that’s included in expected returns.

Like a gas pedal and a brake pedal, central banks such as the Federal Reserve stimulate or slow the economy by lowering and raising interest rates.

The easiest way for the Fed to adjust interest rates is to buy and sell U.S. government bonds in the open market. As Silicon Valley Bank discovered, bonds pay fixed fees, so if a big investor (say, the one nicknamed “JPow”) jacks up the bond’s price, those fixed fees now equate to a lower yield, and vice versa .

Technically, JPow’s deal affects the interest rate on any government bond the Fed buys, but US Treasuries (notes if maturing in a year or less, though I don’t know why they can’t call them both bonds ) are the world benchmark risk-free rates, so the way they affect the interest rate environment is the way they change Wisconsin municipal bond yields.

More in the news is the federal funds rate, which increasingly appears to be labeled the “Fed funds rate.”

The Fed influences but doesn’t actually set the federal funds rate; it’s the rate on overnight lending between member banks to help replenish balances to meet minimum reserve deposit thresholds.

The fed funds rate is even less linked to the broader economy than U.S. Treasuries, but the Fed assumes that banks will use it as a floor for their own lending.

How do interest rates affect stock prices?

In theory, higher interest rates reduce the present value of future expected cash flows, and vice versa. The effect is more pronounced for companies whose major cash flows are expected to occur over an extended period of time, as is the case with many SVB clients.

One might debate whether it is more appropriate to be sad that the party is over or happy that it lasted so long: years of low interest rates have largely created SVB’s customers and made the investors who funded them rich (Also driving tech and biotech stocks higher).

Why Tech Stocks (and Silicon Valley Bank Clients) Are Hurt

Big money — at least traditionally determined by stock prices — values ​​companies at the present value of their future cash flows. But as the table below shows, these values ​​drop precipitously over time and with higher discount rates.

The major cash flows of unprofitable early-stage companies, which likely include many of Silicon Valley Bank’s clients, but also biotech and cryptocurrency companies, have been projected far into the future. Now they have a higher discount rate.

Time and high interest rates are the enemies of diversifying cash flow.

Take a look at the rightmost column. A dollar that a company expects to earn in 20 years is worth 55 cents today at a discount rate of 3%, but only 3 cents if the discount rate rises to 20%—almost 95% less.

This boring chart, and the chart below, not only tell the story of the rise and fall of biotech, not only the rise and fall of tech stocks, but to some extent, the rise and fall of Silicon Valley Bank.


Interest rates skyrocketed with consequences.st louis fed

Will there be more bank failures?

The future is hard to know. Bank failures are like ghosts in the room, if you are scared enough they will appear – if everyone thinks they will happen they will happen, if not they will not. This is the “social” part of the social sciences of economics.

The broader lesson is that we’ve been used to the whole “growth” ecosystem for 13 years – VCs, biotechs, startups, unprofitable tech companies, crypto companies, lenders to all of them Banks – whose foundations are shaken by changes in interest rates.

Those who don’t understand interest rates now will soon.

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