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The Story Behind the SVB Collapse and  an Outlook on the Future of Small Banks

The Story Behind the SVB Collapse and an Outlook on the Future of Small Banks

April 07, 2023

For good reason, it has been a widely discussed topic over the past few weeks. How did a bank thought to be a growing giant in the Venture Capital world collapse so quickly? The answer is twofold: poor risk management and even worse investment timing during a rising interest rate environment.

I’ll start first by discussing the poor risk management. SVB (Silicon Valley Bank) did not have an active Chief Risk Officer from April 2022 until December 2022. Their former CRO, Laura Izurieta, stopped performing her role in April but didn’t leave the company until October. Analysts and industry experts believe that the bank was neglecting many duties owed to customers and shareholders alike, so the exit of Izuriata is under investigation1

SVB also benefited from the decade-long low interest rate environment. Many banks did the same. Billions of dollars poured into the bank from tech companies and venture capital. The bank then invested many of these deposits into long-term US treasury bonds. As interest rates sharply rose in 2022, investors demanded higher returns, and the bank was forced to sell its long-term bonds at a loss. News of these sales hit social media, which sparked a bank run that took only 36 hours to materialize, the 2nd largest bank failure in US history.

At least for now, it seems as though small and mid-sized banks have negated further trouble. However, that doesn’t mean that they are out of the woods yet. Over the past two decades, small banks increased their share of the loan market in commercial real estate. Many carry significant loans on their books in this area, as small banks grew their lending in commercial real estate by 20% from March 2022-2023. “Lenders with less than $250 billion in assets account for roughly 50% of U.S. commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending and 45% of consumer lending, according to a report by Goldman Sachs economists Manuel Abecasis and David Mericle.”2 The increased popularity of hybrid and remote work is a worry as tenants won’t require as much office space as they did in the past.

According to the Wall Street Journal, tenants typically try and reduce size in their office space by 30% when leases expire.3 In the past, landlords have been able to stay current on their mortgages because office leases run for 10 years or more, in most cases, and lenders have been willing to extend expiring mortgages. The delinquency rate for office loans is still low but saw an increase of 0.25% last month with major cities bearing the brunt of the increase. “The growing number of distressed office buildings reflects a recognition by owners and lenders that the robust return to the office they had hoped for isn’t likely ever to materialize. The number of employees returning to the office rate has plateaued at around half the level it was before the pandemic, reflecting the popularity of remote and hybrid work policies.”4

With the growing default rate on office loans, a less than robust return-to-office movement, and an expected tightening of lending standards in this space, we are likely to see a drag on the performance in the banking sector and overall 2023 GDP growth4. The path that the Fed takes through the remainder of 2023 and into 2024 will have a significant impact on the outlook for banks and lending practices moving forward. This is something we will continue to monitor.