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March 23, 2023
The sudden failure of Silicon Valley Bank (SVB) – the sixteenth largest bank in the country – has created a lot of concern about the safety and soundness of the banking industry.
So, how does a bank that was touted by Forbes on 2023 America’s Best Banks list last month fall so fast?
Well, it probably started by growing too fast.
Between 2019-21, the bank’s deposit base more than tripled.
Fast deposit growth creates excess liquidity for a bank, and liquidity needs to be deployed or a bank’s cash position increases and creates margin compression.
This is significant when talking about this level of deposit growth.
To achieve acceptable margin, banks deploy the excess liquidity into higher yielding assets, preferably quality loans.
If the bank cannot lend responsibly, investments, such as government-backed securities, are also an option, though at a lower yield and longer duration than loans.
Much of the deposit growth came from venture capital-backed technology companies that needed a place to deposit the money they raised.
Just as a bank can have concentration risk in the loan portfolio, the SVB failure has put a spotlight on recognizing the need to monitor concentration risk on the other side of the balance sheet.
Without the ability to safely grow loans fast enough, SVB purchased a lot of bonds, which created a large exposure on their balance sheet.
When interest rates rise, the prices of fixed-income securities decline – which creates an unrealized-loss position in the bank’s investment portfolio.
This is basically a “mark-to-market” hole in the balance sheet – it only becomes real if you sell the investments.
If the deposits are sticky, there shouldn’t be any issues.
Downward spiral
Now we are back to the source of the deposits – the technology industry.
A downward spiral took place in the tech space and deposits began to run off due to the heavy cash burn in the industry.
SVB sold a large position in their investment portfolio to create liquidity to compensate for the runoff of deposits.
The sale crystallized the “mark to market” loss position to the tune of nearly $2 billion.
Not a death penalty for a bank this size, but a hit to regulatory capital that the market and regulators certainly took notice of.
SVB had large depositors, which were not fully insured by the Federal Deposit Insurance Corporation (FDIC).
Once the venture capitalists got a sense of some issues at SVB and advised their technology companies to find a highly sound bank to move to, the run was on.
Institution specific issue
The failure of SVB is more institutional than an indictment of the entire banking industry.
Most banks do not have deposit concentrations within cyclical industries, nor do they have excessive amounts of uninsured deposits, which can be prone to flight.
SVB’s level of uninsured deposits are said to have been at least 90%.
Community banks that I have spoken to have stated their figure at closer to 20-30%.
As FDIC chairman Martin Gruenberg noted in the agency’s most recent assessment of the nation’s banks just days ago, “the industry remains well-capitalized and highly liquid.”
Recent events do not change those facts.
I feel it is important that folks do not lose faith in the banking industry.
Importance of community banking
While the story of SVB continues to be told, I’d focus on the story of community banking – which has been supporting small businesses for more than 100 years.
They have helped clients through the Great Depression, two world wars, the Great Recession and a global pandemic.
Community banks were some of the first to get out in front of their clients and communities and offer them assistance during the pandemic – providing 30% of all Paycheck Protection Program loans.
Wisconsin’s community banks are a safe and sound alternative to trendy digital or niche banks.
Deposits at community banks stay in the community supporting local businesses.
According to the Independent Community Bankers of America, community banks make 60% of all small-business loans and more than 80% of farm loans.
Community banks really are the champions of small business.
Successful companies were once startups – an entrepreneur with a dream.
Local banks provide the fuel for these opportunities.
The staff of local banks are typically heavily engaged in their communities, often serving on the boards of nonprofit organizations, raising money for worthy causes and donating time at local food banks and homeless shelters.
When you support a local bank, the money stays in the community and allows the bank to support small business, create home ownership and contribute to the overall well-being of the community.
Your friends and neighbors work at the local bank and are part of the fabric of that community.
Every year on Small Business Saturday, the public is asked to eat local and shop local.
I would also encourage everyone that now, more than ever, is a great time to bank local.
Paul Northway, the president and CEO of American National Bank Fox Cities.
