The annual “snow summit”, hosted by Silicon Valley Bank (a vital financial institution for start ups), saw 40 chief financial officers representing various technology companies gather in Deer Valley, Utah, early March.
A week later, several finance chiefs exchanged frantic messages on Thursday morning about whether or not they should keep their cash in the bank.
To mitigate a sharp drop in deposits, SVB sold $20bn worth of securities. This had focused investors’ attention to the weaknesses in its balance sheet. They sold its stock, wiping out $10bn of its shares and dropping the bank’s market value to $7bn. It was worth $44bn 18 months prior.
“The prisoner’s dilemma was basically, I’m fine, if they don’t draw their money and they’re fine, if I draw my own,” stated one of the CFOs whose company had deposited around $200mn in SVB.
Some started to move. “I received a text message from a friend — he was moving his money to JPMorgan. The finance chief confirmed that it was happening. “The social contract we may have had collectively was too fragile,” he said. I called our CEO, and we wired 97 percent of our deposits to HSBC before noon on Thursday.”
The bank was insolvent by Friday morning. Customers had requested withdrawals of $42bn within a single day, which was 25% of total bank deposits. The bank couldn’t meet these requests. The Federal Deposit Insurance Corporation, the US bank regulator that guarantees deposits up to $250,000, entered the Santa Clara headquarters of the bank and declared it insolvent. The run was so quick that the bank’s coffers were empty and had a “negative cash balance” of almost $1bn.
SVB’s rapid collapse has shocked the start-up and venture capital community. Many are now uncertain about their bank accounts and business operations. SVB provided banking services for half of all venture-backed tech and life science companies in the US. It played a significant role in entrepreneurs’ lives, including managing personal finances and investing as a limited partner with venture funds, and underwriting company listing.A senior bank executive stated that catering to investors with herd mentalities was one of our biggest risks. “Isn’t that a bank run in the making?”
SVB was a spectacular failure in the bank run. However, its fate had already been sealed nearly two years ago.
SVB received an influx of money in 2021 during the peak of a private tech investment boom. Venture funds received ever greater investments from companies, so they poured the money into SVB, which saw its deposits rise from $102bn up to $189bn, leaving it in excess liquidity.
In search of yield in an era with low interest rates, it increased its investment in a $120bn portfolio high-rated government-backed securities. $91bn was invested in fixed-rate mortgage bonds, which have an average interest rate just 1.64 percent. Although the returns from short-term government bonds were slightly better than what it could get, these investments kept the cash in reserve for over a decade and made it vulnerable to rising interest rates.
The portfolio’s value fell by $15bn last year when rates rose sharply, which was almost as much as SVB’s capital. It would be technically insolvent if it had to sell any bonds.
These investments marked a major shift in strategy for SVB which, until 2018, had invested the majority of its excess cash into mortgage bonds that mature within one year. Securities filings indicated that this was a significant change in strategy.
One person involved directly in the bank’s finances said that the policy was due to a change in leadership in SVB’s key financial functions in 2017. The bank’s assets climbed towards $50bn in 2017, a threshold beyond which it would be considered a “systemically significant” lender and subject to more regulatory scrutiny.
The new financial leadership decided to shift an greater percentage of excess cash into fixed-rate long-term bonds. This was a move that would please shareholders and increase its overall profits.
It was blind to the fact that cash flowing in was a sign of low interest rates, which could be reversed if they rise. To curb investor overexuberance, central banks increase interest rates. This can lead to a decrease in investment in speculative businesses like technology start-ups. SVB’s bond portfolio was subject to rising rates, as were its deposits.
“There was enough risk in our business model. The bank’s ability sell assets to meet its liquidity requirements was not a risk that you needed, said the ex-executive. They completely missed that.”
Nate Koppikar (a partner at hedge fund Orso Partners) began studying SVB in order to place a bet against the entire industry as soon as the venture capital investment bubble burst in early 2021.
Koppikar stated that the problem with this business model was that capital evaporates and deposits disappear. It was one of the best ways short the tech bubble. This bank’s failure shows that the bubble burst.”
While SVB bankers entertained finance chiefs on Utah’s slopes in March, the pressure was quickly mounting on SVB’s executive team, headed by chief Greg Becker.
Despite the fact that SVB’s deposits were falling for four consecutive quarters due to tech valuations plummeting from their pandemic-era highs in the past, they fell faster than expected in February/March. Becker and his finance staff decided to liquidate nearly all of the bank’s securities portfolio that was “available for purchase” and to reinvest the proceeds into shorter-term assets which would yield higher interest rates and increase the pressure on the bank’s profitability.
Due to rising interest rates, the securities’ value had dropped since SVB bought them. The sale took a $1.8bn loss. Becker, who was a member of Goldman Sachs, arranged for the bank’s shares to be offered publicly. It also included a substantial investment by General Atlantic, which pledged to purchase $500mn stock.
Although the deal was announced Wednesday night, it looked like it would fail by Thursday morning. Investors were surprised by the decision of SVB to sell its securities. It indicated that it had exhausted all other options to raise capital. Goldman was making last-ditch attempts to get Silicon Valley financiers to join General Atlantic in raising capital.
Several large venture investors, such as Peter Thiel’s Founders Fund advised companies to withdraw their funds from SVB. Becker advised people to not panic in a series call with SVB’s investors and customers. He said, “If everyone tells each other SVB’s in trouble that is a challenge, that would be a problem.”
The risk that had been steadily building up on SVB’s balance sheets for over a year suddenly became a reality. SVB would have to sell its portfolio of held-to maturity bonds and recognize a $15 billion loss if deposits dropped further. This would bring it closer to bankruptcy.
Rival bankers claimed the plan was flawed right from the beginning. They disclosed a $1.8bn loss while simultaneously securing only $500mn from an anchor investor to fund the $2.25bn capital raising. One senior banker from a competitor stated, “You cannot build a book while there is a market open and you are telling people there’s $2bn in the hole.”
External pressure was also present. The deal was done with a difficult market backdrop. Goldman bankers who worked on the capital raise were aware of this fact. The company was faced with a time crunch after Moody’s downgrade to Baa1 on Wednesday. One person involved in capital raising said that the agency had forced their hand. Goldman Sachs declined comment.
The technology industry has been affected by the rapidity and scale of the destruction.
The bank’s approach to risk management has been under scrutiny as regulators try to save assets from SVB and restore customer funds.
It committed a grave financial sin. To boost short-term profits, it took on enormous risks and only received a small payoff.
A hedge fund short seller warned last year that SVB had unwittingly laid the foundation for what could be “the first large US banks to collapse in 15 years”.
The person, whose fund had placed a bet against SVB, stated that they wanted an additional [0.4% points] of yield. It is truly sad.