Trading Desk: Not Every Bank Failure Necessarily Means Disaster

Last week I warned that it already felt like a recession in Silicon Valley, where Patagonia fleece vests are practically the corporate uniform for founders and venture capitalists alike. Now the chill in the California air is clear to everyone.

The questions now revolve around how long “tech winter” lasts and how far it spreads as contagion from the Silicon Valley Bank collapse becomes a real concern.  Will this be another Lehman Brothers meltdown threatening the entire system or just another of the long line of banks that hit a pain point and required regulators to intervene?

The Fed itself never considered Silicon Valley Bank to be too big to fail. We know this because despite being one of the biggest banking stocks, the operation itself never made the list of systemically important institutions that get stress tested every year.

And Silicon Valley Bank should have passed that test with flying colors. Whatever happened here looks more like bad communication than anything else . . . only a few weeks ago, management was doing investor events with the usual amount of confidence.

More information will come out as the regulators go over the books and figure out when it all went wrong. If I were guessing today, I’d suspect that customers who had watched crypto bank Silvergate (SI) wind down decided not to push their luck . . . but when they all made a run on their deposits at once, they crashed their own bank.

As a result, Silicon Valley Bank never even got a chance to show us whether its recapitalization plan would help it weather the kind of “Patagonia fleece vest recession” I’ve been talking about recently. But while times are tough in Silicon Valley, management seems as surprised by this as we were.

According to the fateful shareholder letter that went out a few days ago, the problem is actually with the entrepreneurs and venture capitalists that draw on lines of credit to fund unprofitable operations. SVB thought they’d cut costs to conserve cash, but that just didn’t happen.

Maybe those entrepreneurs are spending $5 billion more this quarter than their bankers initially expected . . . but the overall number showed no sign of going down this quarter until people started pulling their accounts. That’s the “elevated client cash burn” that scared shareholders.

We’ll just have to see. But ironically enough, the bank seemed resilient enough to survive an actual economic downturn. At worst management thought 0.35% of the loan portfolio would go bad this year.

Passing the stress tests required larger institutions to watch 6.4% of their loan books disintegrate. And that was a “severe” scenario that reflected unemployment shooting to 10% . . . no hint of that on the horizon yet.

All in all, Silicon Valley Bank’s failure may be only a blip. But we need the FDIC to move fast here to liquidate its assets and make uninsured depositors whole. Otherwise, $250,000 isn’t going to stretch far when it’s time to make payroll.