Silicon Valley Bank Collapses Following Run on Deposits

11th March 2023

Silicon Valley Bank Closed by Regulators, FDIC Takes Control

Some tech startups had been rushing to transfer money out

What happened at SVB Financial Group? i.e. Silicon Valley Bank Massive equity wipe out…

Technology-focused lender suffered loss on $21bn portfolio of Treasuries and mortgage-backed securities. It is the largest bank failure since 2008 rooted in bad bets on rates.

Based on the information available so far, SVB had $189B in deposits in 2021. SVB put $91B of those deposits into long term bonds.

2021, as we all know, was a year full of exuberance and peak bull market across most tech sectors, an industry that SVB heavily relies on. Post 2021, as interest rates began to rise and the bear market creeps in, tech market collapses. VC funding dwindles, startups start reducing costs and accordingly balances at SVB decrease drastically.

If SVB had managed duration risk better, it’d not be experiencing the bank run it is facing today. But now it has to figure out a way to make up for the capital inadequacy as $91B of the deposits are locked up in long term bonds. There is peak hysteria among its clients who want their funds safe and out of SVB as investors are cautioning their startups to diversify their deposits.

Silicon Valley Bank (SVB) has built its reputation lending to some of the world’s most innovate start-ups and investors. But now it has been hit by a bank run, with a large number of depositors withdrawing their funds at the same time, leading to a severe liquidity crisis for the bank.

Silicon Valley Bank: What did the Bank Do?

SVB’s commercial bank made a name for itself in California by catering to private equity and venture capital firms, with a specific focus on clients in the technology and healthcare industries. In 2022, the bank reported a profit of $3.4 billion, with approximately $172 billion in deposits. Its revenue of $5.23 billion accounted for roughly 84% of the firm’s total revenue for the year.

The majority of the company’s loans were directed towards private equity and venture capital funds, with a specific focus on capital call lines of credit. These credit lines provide VC firms with the option to access funds and invest in a startup immediately, with repayment taking place once the money is received from pension funds and other investors who have already committed to contributing to their funds.

During the past year, SVB Financial purchased tens of billions of dollars worth of assets that were perceived to be safe, primarily consisting of longer-term U.S. Treasuries and government-backed mortgage securities. As a result, the bank’s securities portfolio increased significantly, rising from approximately $27 billion in the first quarter of 2020 to approximately $128 billion by the end of 2021.

In 2020 and 2021, the fiscal stimulus provided to the people resulted in a significant increase in deposits received by banks. These deposits were utilized by banks to purchase securities that offered low yields at the time. However, as interest rates rose rapidly over the course of a year, the prices of these fixed income securities declined below the levels at which banks had acquired them.

To put it differently, let’s say that a bank purchased a 10-year Treasury note when the yield was at 1.5%. Now that the yield has risen to 4%, any potential buyers of the note would discount its price by around 15-20% in order to achieve an effective yield to maturity of 4%, which is the same as the yield on newer Treasuries.

As a result of purchasing a large number of securities at low interest rates, which are now heavily discounted if sold, banks are faced with a significant amount of unrealized losses. Usually, banks can retain these securities until maturity and recover their entire investment, which is why they are categorized as “hold to maturity” assets. Moreover, unlike the situation in 2008, the majority of these securities entail little or no credit default risk. Therefore, if banks can manage to hold on to them, they are likely to be in a stable position.

Why is That a Problem?

The securities that SVB Financial purchased are considered to have very low risk of default. However, they pay a fixed interest rate for an extended period of time. This wouldn’t pose a problem unless the bank suddenly found itself in need of selling the securities. Due to the significant increase in market interest rates, the value of these securities has dropped significantly in the open market compared to their valuation on the bank’s books. As a result, if the bank were to sell them, it would likely result in a loss.

At the end of 2022, SVB Financial’s unrealized losses on its securities portfolio, which is the difference between the cost of the investments and their current fair value, increased significantly to over $17 billion.

Additionally, SVB Financial experienced a shift in its deposit inflows, which turned into outflows, as its clients began to use up their cash reserves and stopped receiving new funds from public offerings or fundraisings. Furthermore, attracting new deposits became more costly, as savers demanded higher rates in line with the Federal Reserve’s hikes. As a result, the bank’s deposits decreased from almost $200 billion at the end of March 2022 to $173 billion by the end of the year.

But what has caused the crisis at SVB?

Over the last 12 months, the start-up ecosystem that Silicon Valley Bank caters to has been greatly impacted by rising inflation and rate hikes. As a result, technology companies have seen significant drops in their valuations, and venture capitalists (VCs) have had to write off billions of dollars from their portfolios.

Against this unsettling backdrop, the bank recently announced the sale of a loss-making bond portfolio worth $21bn (£17.4) and a $1.75bn share sale to cover the $1.8bn deficit left by the sale.

Following the announcement, panic swept through the market, causing the firm’s share price to plummet by a staggering 69% since Wednesday. This has sparked concerns among the bank’s start-up clients about its stability.

In response, several prominent venture funds have advised their clients to withdraw their funds from the bank as soon as possible, further fueling fears of a potential bank run.

As AJ Bell investment director Russ Mould writes today, in a heavily interconnected banking industry “it’s not so easy to compartmentalise these sorts of events which often hint at vulnerabilities in the wider system”. “Lots of banks hold large portfolios of bonds and rising interest rates make these less valuable – the SVB situation is a reminder that many institutions are sitting on large unrealised losses on their fixed-income holdings,” he added.

My Opinion

I see echoes of the US savings and loan crisis here. Banks loading up on low/no credit risk long duration assets funded with ‘low cost deposits’ that don’t turn out to be so easy to source or low cost once inflation and Fed tightening starts to rear its ugly head. SI and SIVB aren’t the only banks to take on such positions during the extreme low yield era immediately post-Covid…

Greg Becker sat in a red armchair at an invite-only conference in Los Angeles last week, legs crossed, one hand cutting through air. “We pride ourselves on being the best financial partner in the most challenging times,” SVB Financial Group’s chief executive officer told the Upfront Summit on March 1 2023, a day before his firm was up for Bank of the Year honors at a London gala. Just a week later, it all fell apart.

The collapse of Silicon Valley Bank happened only one day after Silvergate Capital Corp, a bank that is friendly to cryptocurrency, announced that it would voluntarily wind down its operations and liquidate. This also resulted in significant gains for those who bet against the heavily-shorted stock, but unlike SVB, Silvergate Capital Corp’s shares are still being traded.

SVB Financial (NSQ:SIVB) aren’t alone in having used Bonds as a way of keeping “safe” reserves in their system. Apparently US banks have $630bn of paper losses in bonds at the moment which are off their balance sheets. So the major concern is a domino effect which then dries up capital in the market.

SVB is small, not a large bank. Yes, 18th largest. But there is a concentration of $$ at the top mega banks. So 18th doesn’t really mean much.
SVB problems are unique. It was undiversified in its short term “liabilities” (ie current/checking accounts). Didn’t build up a customer base across multiple industries, went all in on growth tech. The top banks don’t have this issue, they are well diversified in terms of industries and customer types (B2C, B2B).
The government is not intervening in SVB. Because it is small and not a systematic risk. But if one of the larger banks get in trouble, you can bet that the governments (both UK and US) will backstop. They will not allow a big bank to fail. Just like they have always done since 2008. The playbook is clear.

And it has played out like that this morning… SVB not seen as too big to fail, and allowed to collapse. Small enough for the usual FDIC process to take place for failed banks. Now the question comes whether this sparks larger contagion… mass withdrawals in cash by retail customers. Corporates taking money out of smaller, regional (more vulnerable) banks. I would be very surprised if the banking system couldn’t survive this. All the tighter regulations post-2008 was gamed on scenarios like this, to prevent this type of contagion happening.

What Exactly Happened?

In 2021, venture capital-supported companies in the US raised a remarkable $330 billion, which nearly doubled the prior record set just a year ago. The surge in investment coincided with a surge in popularity for Cathie Wood’s ETFs and a rise in retail traders on Reddit who were bullying hedge funds.

The Federal Reserve played a crucial role by keeping interest rates at historically low levels. Furthermore, it introduced a major shift in its framework, pledging to maintain low interest rates until it observed persistent inflation exceeding 2%, a possibility that no official projection anticipated.

In this environment, SVB amassed billions of dollars from its venture capital customers and subsequently invested that money in longer-term bonds with confidence that interest rates would remain stable.

By investing in longer-term bonds with the expectation of stable interest rates, SVB unknowingly created a trap for itself and subsequently fell right into it.

Becker and other executives in charge of the Santa Clara-based institution, which suffered the second-largest bank failure in US history after Washington Mutual in 2008, will need to address why they failed to shield the bank from the dangers of excessive exposure to deposits from young and unstable tech startups, as well as from rising interest rates affecting its assets.

Despite this, the steady decline of interest rates over the past few decades, beginning in the early 1980s when SVB was established over a game of poker, made it anathema for experts in the financial markets to propose the possibility of bond yields increasing without adversely affecting the economy. As it turns out, the US economy is doing well, with plenty of employment opportunities for American consumers.

The banks that are most vulnerable now are the ones, particularly smaller ones, that have not attracted the Federal Reserve’s attention. SVB serves as the most extreme case thus far of how Wall Street has been caught off guard by the impact of the global economy following the shock of the Covid-19 pandemic.

FDIC has announced that insured accounts will be fully covered by Monday afternoon. Uninsured accounts will get an IOU, like in Greece a few years ago. This could get ugly. Most of SVB customers are VCs and startups who had much bigger deposits. Startups typically go through their cash like drunken sailors. Now the cash is gone. This could get ugly real quick.

Silicon Valley Bank faced vulnerabilities due to weak risk management practices resulting from a combination of factors. Firstly, it received a significant influx of deposits from a concentrated industry. Secondly, it had an abnormally high number of large depositors whose accounts exceeded the FDIC coverage limit. Lastly, the bank’s portfolio had an unusual ratio of securities with unrealized losses compared to its total capital. Consequently, this made the bank uniquely susceptible to a “depositor rug-pull” where large depositors suddenly withdraw their funds, leading to the bank selling securities at significant losses. Other banks that focus on serving large depositors beyond the FDIC limit have also experienced similar vulnerabilities, leading to localized contagion among banks with comparable asset and deposit profiles as Silicon Valley Bank.

TIMELINE OF SILICON VALLEY BANK, $SIVB, COLLAPSE:

Bank run begins with $91 billion in bonds facing interest rate risk
$21 billion bond portfolio sale announced, $1.8 billion lost.
SVB announces $2.3 billion share sale to cover bond losses.
SVB fails to raise capital as investors panic.
Management attempts to sell the company.
FDIC seizes control of bank marking 2nd largest bank failure in US history.
Secretary Yellen says “not considering bail out”
FDIC begins auctioning SVB for immediate sale.
FDIC “unsure” if they will find a buyer.
10. Fed and FDIC start considering a bail out.

Failed management by SVB and regulators now puts largest bail out since 2008 on the table.

Why does retail always pay the price?

Silicon Valley Bank Failure

Silicon Valley Bank Was Flush with Cash in 2021

During March 2021, SVB faced what could be enviable issue for a bank: its customers had an abundance of cash at their disposal.

Bloomberg’s data shows that the bank’s total deposits surged to approximately $124 billion from $62 billion over the previous 12 months, marking a 100% increase. This growth rate greatly exceeded the 24% rise at JPMorgan Chase & Co. and the 36.5% jump at another California-based institution, First Republic Bank.

“I always tell people I’m confident I’ve got the best bank CEO job in the world, and maybe one of the best CEO jobs,” Becker said in a May 2021 Bloomberg TV interview.

When questioned about whether the bank’s recent trend of revenue growth was sustainable, Becker, who has been a part of SVB since 1993, smiled and used the lingo common among technology innovators.

“The innovation economy is the best place to be,” he said. “We’re very fortunate to be right in the middle of it.”

However, the Federal Deposit Insurance Corporation (FDIC) only provides insurance coverage for bank deposits up to $250,000, while SVB’s clients had much larger sums of money deposited. As a result, a significant portion of the funds held at SVB was not insured: based on a regulatory filing, over 93% of domestic deposits as of December 31 were not covered by insurance.

Initially, SVB’s exposure to uninsured deposits did not trigger any alarm bells, as the bank was able to pass regulatory assessments evaluating its financial condition without issue. However, unbeknownst to many, the bank was incurring substantial losses on longer-term bonds acquired during the period of rapid deposit growth, which had been mostly concealed from view due to accounting rules. By the end of 2022, the bank had accumulated mark-to-market losses of over $15 billion on securities held to maturity, nearly equal to its entire equity base of $16.2 billion.

Following the release of SVB’s fourth-quarter results in January, investors appeared optimistic, and a Bank of America Corp. analyst even wrote that the bank “may have passed the point of maximum pressure.” However, it quickly became apparent that this was not the case.

Difficult Situation

According to a source familiar with the matter, in a meeting towards the end of last week, Moody’s Investors Service delivered concerning news to SVB: due to its unrealized losses, the bank was at significant risk of experiencing a credit downgrade, which could potentially entail a drop of more than one level.

This left SVB in a difficult position. To bolster its balance sheet, the bank would need to sell a substantial portion of its bond investments at a loss to increase its liquidity, which could potentially alarm depositors. However, if it chose to remain idle and received a multi-notch downgrade, it could trigger a similar withdrawal of deposits.

Despite the difficult decision, SVB and its adviser, Goldman Sachs Group Inc., ultimately opted to sell the portfolio and announce a $2.25 billion equity deal, as per the anonymous source. However, the bank was still downgraded by Moody’s on Wednesday, regardless of its actions.

According to the source, when SVB made the announcement, significant mutual funds and hedge funds showed interest in taking large positions in the shares.

Investors’ interest in SVB’s equity deal changed when they noticed the bank was rapidly losing deposits. This situation worsened on Thursday, as a group of prominent venture capital firms, including Peter Thiel’s Founders Fund, recommended that their portfolio companies withdraw funds from SVB as a precautionary measure.

Stay Calm

On Thursday afternoon, SVB started to contact its largest clients and reassure them that the bank was well-capitalized, had a high-quality balance sheet, and had ample liquidity and flexibility. According to a memo seen by Bloomberg, Becker held a conference call where he urged people to “stay calm.”

Indeed, the sudden loss of deposits highlights the fragility of SVB’s business model and raises questions about its risk management practices. It also serves as a cautionary tale for other banks that rely heavily on a single industry or niche market. Banks need to be able to adapt to changing market conditions and potential risks in order to survive in the long term.

According to insiders, bankers from Goldman Sachs arranged for SVB Financial to sell shares at $95 each on Thursday afternoon. However, as the bank’s stock continued to decline, and more clients withdrew their deposits, the deal ultimately fell through.

Final Collapse

The sudden collapse of SVB happened on Friday and occurred within hours. After the bank’s shares had fallen more than 60% on Thursday, it abandoned the planned equity raise. Regulators had already arrived at the bank’s California offices by then. William Isaac, the former chairman of the FDIC, said that SVB “didn’t have nearly as much capital as an institution that risky should have had” and that “once it started, there was no stopping it.” He added that “that’s why they just had to shut it down.”

The fate of depositors with funds exceeding the $250,000 insurance cap is currently uncertain. The amount of deposits above the insurance limit is unknown. Insured depositors will have access to their funds no later than Monday morning, according to the FDIC. Startup founders are concerned about whether they will be able to pay their employees. Meanwhile, SVB’s goal is to find a buyer and complete a deal, even if it means selling the company’s assets in pieces, according to an anonymous source familiar with the matter.

SVB Financial is ranked as the 16th largest bank in the United States, with assets totaling around $209 billion as of December 31, according to the Federal Reserve. Its recent failure is by far the largest of any bank since the near-collapse of the financial system in 2008, with the exception of the crisis-era collapse of Washington Mutual Inc.

What Have we Learned?

A significant question arising from these developments will be which banks miscalculated the match between the cost and lifespan of their deposits and the yield and duration of their assets. This differs significantly from the issues surrounding bad lending that plagued the 2008 financial crisis.

During the pandemic, as money flowed into banks, they could have insulated themselves from the risk of rising interest rates by purchasing the shortest-term Treasuries or keeping the money in cash. However, this would have also limited their income. Banks’ pursuit of “safe” yields may now be what causes them problems in this current situation.

Ted Kucklick

Some serious pudding has hit the fan. SVB has weathered many a downturn, including the 1987 tech recession, the bursting of the internet bubble, the 2008 recession, but it took Biden and Powell and their foolish policies of driving up inflation by runaway government spending and foolish rate hikes to finally bring them to total collapse.

Elections have consequences. In this case really, really bad ones. Some of the people that will get hurt by this the most are those who have most heavily invested in the Democrat Party, especially tech moguls in California and New York. I hope they seriously consider deploying their donation capital elsewhere.

Connor Smith

Difference is SVB bought AAA high quality insured mortgages where the default rate was close to 0. Lehman did not buy safe assets. The mistake SVB made was going ultra long in duration. They felt like it was ok because the assets they were buying were indeed so safe. Idiotic management to take that much duration risk. If there was no run on the bank SVB would have been fine if they could have held to maturtity then no-one would have lost a dollar but they couldnt. This is all a liquidity and duration problem isolated to SVB.

Rosemary Samulski

There is a picture of Rachel Maddow on the Silicon Valley Bank website. That does not seem like a business type of person you would want your bank associated with.

What is challenging to understand is it’s not bad loans or tech companies going under or their base clients suffering. It’s the lack of these banks ability to have liquidity competing against government money market funds. I don’t know that Powell thought he would be squeezing banks out of business by raising interest rates on the deposits that their clients could get.

Carol Perry

More FTX fallout? Regulators weaponizing banks to avoid crypto exposure. Add in bank capital requirements to hold bonds and bonds having the worst down turn in a century. If all had to mark these assets to market , banks of all sizes would be facing huge losses. The Fed is starting to break things. And destroying crypto is kind of a bonus. Best be careful here Jerome, bank runs can get out of control quickly and cause a lot of damage outside the ponzi tech and crypto space. They were asleep in 2008, but now we should trust in their ability to control the very inflation they helped create. Uh, no. Fool me once….

Gary Fitzimmons

So Jerome Powell and his buddies at the Fed are getting exactly what they want – a financial sector crash and a deep economic recession, the destruction of middle class retirement portfolios, and a real-estate downturn. All to ‘tame’ a fairly middling inflation rate brought about by Biden’s idiotic energy policies and doling-out dollars for the last two years to individuals and local government to address an overblown national emergency that was mostly the result of bad Covid policy.

William Markley

I think we should look at bank management here before we blame the fed. They obviously didn’t balance their financial position well if they piled money from deposits into long term treasuries. They could have let some of those deposits go if they were so deposit heavy by paying lower rates and investing in shorter term paper that wouldn’t generate this kind of loss. This was a gamble to try and make a higher profit margin assuming these deposits would stick for a long time. That obviously didn’t happen.