The banking industry, government regulators, and investors alike are still processing the March 10 collapse of SVB Financial, the parent company of Silicon Valley Bank (SVB). It was the second-largest bank failure in U.S. history, with $175 billion in customer deposits on the line.
But this crisis had one unique (and worrying) feature: Just 6% of those deposits fell within the $250,000 deposit insurance limit mandated by the Federal Deposit Insurance Corporation (FDIC). Most of SVB's customers were technology companies, investors, and high-net-worth individuals, which meant the majority of them faced the prospect of a total loss.
Regulation saved the day
Thanks to prudent regulations that prevent banks like SVB from using customer funds to make risky investments, there actually wasn't an asset shortfall at all -- in other words, the bank was in a position to cover all deposits, it just had to liquidate its investment portfolios (it had an estimated $209 billion in assets at the time of failure).
Those portfolios consisted mostly of bonds and government Treasury bills, which are typically incredibly safe assets. But the rapid increase in interest rates over the last 18 months pushed the value of those bond portfolios lower (when a bond yields a higher interest rate, its value falls, and vice versa). At the same time, SVB's tech-sector customers were raising less money and burning through more cash, which was shrinking its deposit base.
Additionally, customers were moving money to higher-yielding accounts, money market funds, and Treasury bills themselves to earn more interest on their deposits. A combination of those factors forced SVB to liquidate $21 billion worth of bonds and Treasuries at a $1.8 billion loss so it could meet depositors' requests. The bank then attempted to raise money from investors to plug that hole, and when word began to circulate the institution might be in trouble, depositors began to flee en masse.
SVB expected to lose a whopping $100 billion in deposits on the Friday that it failed which it didn't have the liquidity to cover, but thanks to a lightning-fast intervention by the FDIC, the bank was shut down before that could happen. It allowed the federal government to step in and announce deposits of all sizes would be safe, and it also gave the Federal Reserve time to set up an "at-par" lending facility to banks, which meant they could temporarily plug any financial holes caused by the declining values of their bond portfolios. This measure shored up customers' confidence in the rest of the banking system.
But this crisis came with important lessons attached, even if you don't invest in banks or financial sector stocks. Here's one thing technology investors can take away from the SVB collapse.
Invest in companies with ultrastrong balance sheets
A company has a strong balance sheet if it has enough cash and short-term liquidity to comfortably service its liabilities, like loans and other costs. Fortunately, the technology sector is filled with great examples -- two of the best are fierce rivals Apple (AAPL -0.60%) and Microsoft (MSFT 1.44%).
Both have built their fortress balance sheets on the backs of their incredible cash-generating businesses. In fact, Apple brings in so much money it returned $104 billion to shareholders through dividends and share repurchases in fiscal 2022 (ended Sept. 24) alone. The company still has over $51 billion in cash, equivalents, and short-term marketable securities on its balance sheet, and since it spent only $9.5 billion servicing its debts in fiscal 2022, it still has plenty of runway.
Not to mention, Apple brought in $30 billion in net income (profit) in the recent first quarter of fiscal 2023 (ended Dec 31), so it's likely to continue piling up cash this year. Consumers love the company's portfolio of devices like the iPhone, iPad, and Mac computers, and its services including Apple Music, Apple Pay, and iCloud, so it's likely to remain a financial powerhouse for years to come.
Microsoft is in a similar position, though it has a different strategy from Apple in that it invests heavily in entering new industries to expand its footprint in the tech sector. Having started out in software with its Windows operating system, the company now operates one of the largest cloud services platforms in the world, it's a leader in the gaming industry, and it's becoming a front-runner in the artificial intelligence (AI) space. In fact, it recently committed to a multiyear investment deal with ChatGPT creator OpenAI, which is rumored to be worth $10 billion.
But Microsoft does have two things in common with Apple: Its cash position and its profitability. The company is sitting on $99.5 billion in cash, equivalents, and short-term investments, and in the recent fiscal 2023 second quarter (ended Dec. 31), it generated $16.4 billion in net income.
But a strong balance sheet alone won't always make for a great investment
During what can only be described as a frenzy in the stock market during 2020 and 2021, many technology companies took advantage of their sky-high valuations to raise piles of cash from investors. As a result, they're sitting in a great financial position today even if their businesses aren't exactly performing well.
Investment platform to Generation Z Robinhood Markets (HOOD 0.97%) is one example. It has over $6.3 billion in cash with no debt, yet investors have sent its stock price plunging 88% from its all-time high, valuing the company at just $8.4 billion as of this writing. That means they attribute only $2.1 billion of value to the business itself -- in other words, the cash on Robinhood's balance sheet is worth three times as much as the business it operates.
When the pandemic era of government stimulus and ultralow interest rates ended in late 2021, Robinhood's young user base became less active in the financial markets. At the end of 2022, its monthly active user base had declined 46% from its peak in the year prior, coming in at 11.4 million. Similarly, the value of the cash and assets customers are holding with Robinhood is down 39% from its peak, to $62 billion. As a result, the company's quarterly revenue remained well below peak 2021 levels throughout last year.
Investors typically don't want to own shares in a shrinking business. Therefore, Robinhood's incredibly strong balance sheet won't be enough to buoy its stock price in the long run, making it a difficult company to invest in.
