Could Silicon Valley Bank trigger the next Enron moment?

Shares of a little known Californian lender to tech companies – Silicon Valley Bank – were suspended today after revealing big bond losses, triggering billions of dollars to be wiped off the value of global banking stocks on fears that they too face huge losses on their bond portfolios.

The rout – which saw $50 billion knocked off the value of US giants such as JP Morgan as well Europe’s biggest banks such as HSBC and Deutsche – inevitably raised questions over whether SVB is the catalyst to a 2008 style contagion throughout the financial system. One analyst suggested SVB could be the canary in the coal mine for mainstream banks while another asked whether SVB’s collapse could trigger the next Enron. 

The trouble started on Wednesday after SVB’s boss informed investors the bank needed to raise $2.3 billion of new capital through a share sale to cover a massive loss of $1.8 billion on the sale of $21 billion of securities, raising questions over the value of its assets. In its letter, SVB Greg Becker said it sold “substantially all” of its available-for-sale securities made up of mostly US Treasurys.

Instead of calming investors, SVB’s capital-raising prompted its venture capital clients to start withdrawing funds, sparking a bank run and prompting shares in the Nasdaq-listed bank to crash by over 60% on Thursday. News that clients were withdrawing funds only intensified the chaos, causing the shares to fall again overnight until they were halted this morning. Last week SVB was worth $16.8 billion, and today it’s value has more than halved to $6 billion. 

The Santa Clara based bank is a highly specialist lender – taking deposits from venture capitalist funds and other clients – and then lending them on to Silicon Valley tech start-ups. And a strategically important one – it’s estimated that SVB lent 44% of all venture capital-backed tech and healthcare companies that publicly listed last year. 

It’s too early to say to what extent SVB’s turmoil will flow into the wider financial markets because as a specialist lender to tech companies, it holds around half of its assets in Treasuries, and is therefore more exposed than mainstream banks to fluctuating interest rate changes and bond prices.

And while SVB’s collapse is spectacular it’s not perhaps surprising considering the aggression and hawkishness with which the Federal Reserve has been putting up interest rates in its attempt to flatten inflation. There are two reasons for this.

First, when interest rates rise, the price of Treasuries fall, and they have fallen about a quarter in value over the last few months thus leaving banks and other financial institutions with potential losses. 

Second, when interest rates rise, it becomes more difficult for start-ups of any sort and of course raising money becomes more expensive. 

Investors have been worried for months that the Fed’s race to crush inflation by jacking up interest rates so fast would lead to trouble in the bond markets, and therefore in the banking system. It’s estimated that the value of high-rated bond holdings – mainly mortgage-backed securities and Treasuries – represent about 25% of all US bank-sector assets.And as rates go higher, the value of bonds falls. For example, the iShares 20+ Treasury Bond ETF, which is made up of longer maturity Treasuries, is down 24% in the last 12 months.

Those fears have intensified as the Fed’s chair, Jay Powell, has reiterated his desire to see rates climb higher still, a move which many believe is dangerous as it might tip the economy into recession.

 According to TheStreet, Carl White, a senior vice president for supervision at the St. Louis Fed, warned in a blogpost last month that “while rising rates could support margins on bank loan books, they also could increase the cost of liabilities and decrease the value of investment securities held as assets.”

White went on to say that: “Even unrealised losses in investment portfolios can have negative effects on liquidity and present funding challenges, earnings pressures and, in some cases, issues with capital.” He added that other possible consequences of significant “unrealized losses include reductions in or restrictions on borrowing capacity and declining market valuations of the affected institutions, which could have a negative impact on banks looking to engage in merger and acquisition activities.”

Usually, higher interest rates would be positive for banks and other financial institutions which hold big chunks of US treasuries and mortgage-backed securities. But not this time around because most of the big institutions bought bonds at rock bottom prices and at low interest rates. 

Which is why bank share prices around the world fell on the collapse of SVB – which is now trying to find a buyer – because of worries over banks’ capital levels. However, not everyone is convinced that SVB’s plight will have wider ramifications. 

Morgan Stanley analysts, Manan Gosalia and Betsy Graseck, have pointed out that the “Falling VC funding activity and elevated cash burn are idiosyncratic pressures for SIVB’s clients, driving a decline in total client funds and on-balance-sheet deposits for SIVB. “That said, we have always believed that SIVB has more than enough liquidity to fund deposit outflows related to venture capital client cash burn.”

 But they also said the current pressures facing SIVB should not be viewed as a read-across to other banks.” 

We shall see. But there will be fall-out, if not through the wider banking system but certainly for new tech start-ups. It’s already difficult enough to raise money but SVB’s fall will make it much tougher. 

As billionaire hedge fund investor Bill Ackman tweeted, if private investors can’t help shore up confidence in the California lender, then the government needs to step in. 

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