Assessing Silicon Valley Bank’s stunning collapse

• Silicon Valley Bank (SIVB) was taken into receivership by the FDIC on Friday due to a run on deposits following a failed capital raise earlier in the week. Markets have been understandably jittery considering that this is the largest shutdown of a bank since 2008. Late Sunday, federal regulators stated that depositors will have access to their money starting Monday.
• We believe the situation is company-specific, resulting from SIVB’s business model, which includes significant customer concentration in small tech and biotech startups. The rest of the banking system remains healthy, and we do not expect broader lasting fallout to the banking system or financial markets.
• However, there are likely to be ripple effects for smaller VCbacked startups. We are analyzing the potential knock-on effects to technology companies with outsized deposit risk at SIVB. While we view potential losses to depositors as extremely low, access to deposits may take time, which could spark headlines and volatility in the coming days.
• We have zero exposure to SIVB securities in our US-registered actively managed equity and fixed income mutual funds.
• We continue to monitor our portfolios to ensure we do not have significant exposure to this riskier side of technology spending, and we are avoiding companies dependent on increased spending from new VC-funded entities.

Click for March 13 update on fixed income markets.

• How did we get here? On Wednesday, March 8, Silicon Valley Bank, the 18th largest bank in the US, announced it was restructuring its balance sheet and issuing new stock to raise capital due to management’s need to improve liquidity. The capital raise failed, and concerns about its ability to fulfill depositor withdrawals led some VC firms to recommend that portfolio companies move deposits out of SIVB immediately. The run on deposits led to the bank’s collapse by Friday, and the FDIC took it into receivership.
• How could such a large bank fail so fast? The plans that SIVB announced should not have led to this decline, but management action was poorly communicated, and SIVB’s deposit base is sourced primarily from its relationships with various VC funds. These deposits declined faster than the bank expected over that past few quarters due to VC-backed companies burning cash and withdrawing funds from the bank. Furthermore, the rapid, significant increase in short-term interest rates and quantitative tightening has put industrywide pressure on bank funding.
• The 2022 spike in rates was a contributing factor. Deposits are the raw material of the banking sector, and in a higher interest rate environment, the ability to retain deposits is one of the key factors that differentiates well-run banks from those that face potential challenges. What began with commercial depositors seeking out higher-yielding alternatives has spread more recently to retail customers moving money from low-cost deposits to higher-cost CDs and retail money market funds.
• What happens now? The government has said it will backstop depositors (but not lenders and shareholders), supported by new Fed lending facilities that bridge liquidity gaps.

• No signs of systemic stress: The current stress in the deposit market will likely lead to higher deposit rates, which could pressure bank margins in the near term. We would be much more concerned if current deposit stress were coupled with credit quality issues, which is not happening. Credit is weakening at the margin but at a much slower pace than what we’ve seen in prior economic downturns. Overall, the banking industry’s capitalization remains extremely strong, particularly among global systemically important banks (G-SIB).
• The US banking system remains healthy: Because the broad banking system is much better prepared for this funding challenge due to significantly higher levels of capital and liquidity today versus history, we believe the likelihood of contagion is low. And most banks (of any size) do not have the type of concentration among depositors that SIVB had. 
• What about smaller regional banks? Although we believe money centers are best positioned in this environment, most regional banks appear better able to manage deposit stress than SIVB, as their deposit bases/footprints are more diverse. A potential flight to quality among depositors (at the margin) could drive deposit growth at larger, more diversified banks.

• Credit likely to be remain available to tech startups, but at a higher cost. Other banks and non-bank lenders are likely to fill the void created by SIVB’s demise. However, it is possible there could be a temporary reduction in the availability of credit, or an increase in the cost of credit, to VC-backed tech companies.
• Some startups need help fast. Companies at greater risk include smaller startups that are dependent on an ongoing flow of funds to support growth and pay expenses, which could also have a trickle-down effect on their vendors’ revenue growth and stability.
• Expect increased capital discipline. We believe companies will initially tighten their belts to ensure adequate liquidity as the situation continues to develop. Longer term, we expect venture capital firms will continue to have significant funding resources available, but capital will likely be invested more judiciously.

• We do not own SIVB securities in any of our actively managed equity and fixed income US-registered mutual funds.
• Our multi-asset mutual funds and variable portfolios that invest a portion of their assets in passively managed vehicles have minimal exposure to SIVB within their allocations to US large-cap and mid-cap equity index vehicles. Furthermore, some Voya multi-asset variable portfolios have a small allocation to an external, actively managed US mid-cap equity portfolio that has minimal exposure to SIVB securities. In aggregate, exposures to SIVB within these strategies are less than 0.02%. 

• Assessing ripple effects. We are analyzing the potential knock-on effects to technology companies with outsized deposit risk at SIVB. While we view potential losses to depositors as extremely low, do not be surprised if cash flow issues spark headlines and volatility in the coming days. We continue to monitor our exposure to VC startups, as we did throughout 2022, to ensure our holdings do not have significant exposure to this riskier side of technology spending.
• Staying away from certain businesses. We are avoiding exposure to companies that are dependent on increased spending from new VC funded entities, or whose growth is driven primarily by usage and not long-term contracts or recurring revenue.
• Watching for signs of economic fallout. While we don’t believe there will be significant impact to the overall economy, we will continue to monitor the banking sector for contagion effects and any broad impact on consumers or the broad economy.

Comments post market close:

US interest rates: Treasury markets rallied aggressively on Monday amid continued concerns of further fallout despite regulators’ announcement backstopping depositors at Silicon Valley Bank and Signature Bank. Beyond the events surrounding these banks, the rapid bull steepening over the past week has reflected a) an unwind of extended positioning driven by Powell’s Humphrey-Hawkins testimony, b) deeper growth concerns resulting from tighter lending conditions, and c) consequently, lower terminal rates for the current cycle. Although the Fed is expected to continue to move rates higher, the prior expectation of a 50 bp rate hike at the March meeting now looks much less likely.

Money markets: The funding markets are showing limited signs of stress. Commercial paper is trading normally but with a lighter volume. Bank/financial issuer volumes are down as buyer demand has shrunk. Not surprisingly, asset-backed commercial paper is holding up better. General collateral repo and tri-party repo are trading normally. One place we are seeing stress reflected is in the usage of FHLB overnight discount notes, which this morning was 4–5x the volume of recent weeks. T-Bill demand has increased, reflecting a flight to quality trade as would be expected under current conditions.

Corporate credit: Spreads widened Monday, but no panic selling, including in high yield. Money center banks were 10–15 bp wider; the better regional and super-regional banks were about 50 bp wider; while third-tier regionals were around 100 wider but trading. The focus will be individual names with idiosyncratic stories, from Credit Suisse to Charles Schwab. While the FDIC’s actions to safeguard uninsured depositors of a troubled financial institution are within their charter, a former FDIC Vice Chair has noted legislation would be needed to extend a full guarantee of uninsured deposits at all banks.

Securitized credit: Trading was but orderly and functioning, albeit with wider spreads and lower volumes. We have not seen any evidence of forced selling across account types, including banks, although we remain on high alert.

• The most beta is where we would expect it: credit risk transfers (CRTs) 30–60 bp wider, and “down-the-stack” collateralized loan obligations (CLOs) 30–50 bp wider. Almost nothing is trading in CRTs, and Fannie pulled their current deal, although some volumes in AAA tranches are coming through in CLOs.
• Agency MBS trailed US Treasuries, primarily reflecting elevated rate volatility. Liquidity is deep and trading volumes are fine. In non-agency RMBS, the broker dealer community is framing markets 20–30 bp wider, but there is little trading. Some issuers were looking to announce deals today despite the volatility, which should give the market better transparency into levels and depth.

• Moves in asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS) were more modest, although we sense materially deeper liquidity in ABS than CMBS.