SVB, Largest Bank Failure Since 2008 - What Happened?
A story of Covid, zero-rate envrionment, VCs, Fed rate policy and duration risk...
A few days ago, I heard about the failure of Silvergate Bank who had concentrated exposure to many of the largest crypto companies & exchanges. But this bank (with about $14B of customer deposits in Q3’22) is small compared to SVB (with about $173B in deposits in Q4’22). The failure of SVB is reminiscent of the beginning of 2008 when Bear Stearns collapsed (followed by several others later that year).
In 2008, I worked in the investment analytics space and we served many financial institutions who were directly impacted by those events. After the Lehman bankruptcy, the financial crisis ensued and many of our clients didn’t make it. It also impacted our company but somehow, we made it through. While I believe and hope that this is an isolated event and don’t have too much reason to believe any other Top 20 bank could fail, there potentially is still some contagion risk, particularly to the tech sector.
Some background:
Silicon Valley Bank (SVB) was founded 40 years ago and quickly rose to become one of the primary banks involved with startups as well as established tech companies like Cisco Systems. It has been reported that they are now one of the primary banks used by over 50% of VC-backed tech startups.
Here is a summary of my understanding of what developed at SVB other the past few years:
1) In the zero-rate environment of the pandemic, private company valuations peaked and we saw an enormous amount of funding being raised, especially in 2021. Much of this cash was deposited at SVB. Deposits more than doubled from 2019-2021 (ending 2021 with about $189B).
2) Similar to any bank, SVB looked to earn a yield that exceeded any (small) amount they may have paid their individual and corporate depositors.
3) To earn the yield and make money for the bank, SVB invested much of the cash into longer duration securities (i.e. 10+ year US treasuries or mortgage-backed securities) in 2020 and 2021 while rates were still very low.
4) With the tightening conditions of 2022, VC money started to dry up, tech startups continued to draw down on their cash balances, and SVB started to see declining deposits.
5) It appears that the SVB bank ratios were fine throughout 2022. But as deposits were declining, SVB needed to shore up their balance sheet. But to do so, they had to sell off some of their longer duration securities (about $21B worth) at a loss of $1.8B. This is because the Fed had raised interest rates so quickly in 2022 in response to inflation which meant that any longer duration bonds purchased a couple years ago had come down significantly (the inverse relationship between bond prices and rates is especially pronounced for longer duration securities).
6) The CEO was trying to be transparent when this was communicated in a letter to shareholders on Thursday and it was also reported that the company was looking to raise additional capital.
7) This communication (along with several VCs telling their portfolio companies to get their cash out of SVB) led to a crisis of confidence and the run on the bank which resulted in the bank failure on Friday.
As I mentioned before, I do not think this is a “Lehman” moment. But there are some major concerns for people that still have their cash tied up at SVB.
Individual customers are insured by the FDIC ($250,000 per individual) and they should be able to get their deposits out at some point (maybe as early as Monday?). But what about deposits beyond that? What happens to all of the tech startups and other companies that have millions or tens of millions at SVB?
While I don’t think the situation is likely to affect other banks, I’m more concerned about all of the companies who have most (or all?) of their cash at SVB. Ideally, these companies would have diversified their banking services across several banks. But if they didn’t, they could have trouble making payroll or paying their bills. If the situation drags on, these companies (and the people that work for them), could get in trouble.
For now, it seems likely that depositors will get a substantial portion of their money back. Based on their balance sheet on 12/31/2022, they have a lot more assets than liabilities (customer deposits). But this is the primary concern - the value of the bonds purchased have not been marked down to current values. If held to maturity, the values are accurate. But if sold today, they will be sold for much less (just like the $21B that they just sold).
Also, a significant portion of their assets (a little over $70B) is their loan portfolio of which some % is to those same tech startups that may be experiencing a cash crunch. So some portion of this loan portfolio is likely at risk.
The quickest way to resolve this situation is likely to have larger bank (like JPM or BoA) come in and acquire SVB (similar to the Bears Stearns acquisition by JPM in ’08). But valuing the SVB assets could prove to be difficult since it would be hard to estimate how much would have to be sold off to satisfy depositors that want to get out.
Maybe SVB should have done a better job of rebalancing their portfolio towards the shorter end as they saw the Fed continuing to raise rates. Maybe VCs shouldn’t have told their portfolio companies to get all of their money out as quickly as possible. But now here we are and it is important that a solution is found as quickly as possible.
If you’ve made it down this far, thank you for reading. I hope you and your company are not impacted by these events but given the significant impact SVB has in the VC / tech-startup ecosystem, I’m worried that many of my friends and colleagues are (or will soon be) impacted. Good luck to you all and I hope there is a resolution soon.