What Investors and Regulators Can Learn from Silicon Valley Bank’s Collapse

Silicon Valley Bank (SVB) was closed by the California Department of Financial Protection and Innovation (DFPI) citing inadequate liquidity and insolvency. DFPI determined that SVB was no longer able to operate safely and soundly and placed the bank under conservatorship or receivership. DFPI has turned over the receivership of SVB to the Federal Deposit Insurance Corporation (FDIC).

This news has sent shockwaves through the banking industry, as SVB was one of the most prominent and well-known banks in California, with total assets of approximately $209 billion and total deposits of approximately $175.4 billion as of Dec. 31, 2022. The collapse of this bank is significant not only for the banking industry but also for the tech industry and other businesses that relied on SVB’s financial services.

In this article, we will explore the events leading up to the collapse of Silicon Valley Bank, what happened, why it happened, and the potential impact on the banking industry and the US economy. We will also examine the regulatory framework surrounding banks and the role of regulatory agencies in ensuring the stability of the banking system.

Background of Silicon Valley Bank

Silicon Valley Bank (SVB) is a commercial bank headquartered in Santa Clara, California. It was established in 1983 and became known for providing financial services to technology and life science companies, venture capitalists, and private equity firms. SVB offered a range of financial products, including deposit accounts, loans, treasury management, foreign exchange, and investment services. They were also known for their significant presence in the founder and startup community, with SVB advertising that they did business with nearly half of all US venture capital-backed startups.

SVB experienced a rapid increase in deposits from 2019 to 2021, particularly from VC-backed companies. SVB invested a significant amount of these deposits in long-term bonds. This investment strategy presented issues when interest rates rose, ultimately contributing to the bank’s current situation.

As of December 31, 2022, SVB had total assets of approximately $209 billion and total deposits of approximately $175.4 billion. The bank’s assets were classified into three categories: mortgage-backed securities, direct loans, and liquid assets.

Despite being named one of America’s Best Banks by Forbes Magazine for the fifth straight year and being named to Forbes’ inaugural Financial All-Stars list, SVB has faced significant challenges. In a Q1’23 Mid-Quarter Update to Stakeholders released on March 8th, 2023, the bank revealed details that led to the current situation. These challenges ultimately led to the announcement on March 10th that the DFPI had taken possession of the bank citing inadequate liquidity and insolvency, with the FDIC appointed as the receiver of Silicon Valley Bank.

Regulatory oversight

SVB was subject to extensive regulation and supervision by both federal and state regulatory agencies, including the Federal Reserve, the California Department of Financial Protection and Innovation (DFPI), and the Federal Deposit Insurance Corporation (FDIC).

As a bank holding company with financial holding company status, SVB Financial Group was primarily regulated, supervised, and examined by the Federal Reserve under the Bank Holding Company Act of 1956 and subsequent amendments and subsequent amendments.

It is important to note that SVB was not subject to the full scope of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as changes were made to this act in the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018. The impact of these changes on the regulation and oversight of SVB is uncertain, and current political discussions are likely to address this topic.

SVB is a member of the Federal Reserve System and must comply with its regulations. The bank is also required to meet certain requirements of the FDIC since its deposits are insured by the FDIC.

Furthermore, as a California state-chartered bank, SVB is subject to state laws and regulations. California state-chartered banks must maintain sound operations and financial viability and comply with minimum capital and liquidity requirements. The DFPI is responsible for monitoring compliance and conducting audits. In cases where issues are discovered, the DFPI may act, such as in the closure of SVB.

The Order of Events and Timeline

On March 5th, 2023, Silicon Valley Bank (SVB) was named by Forbes Magazine as one of America’s Best Banks for the 5th straight year. On March 8th, SVB released a Q1’23 Mid-Quarter Update to Stakeholders, which included details that led to the current situation.

In the update, SVB announced “strategic actions” to strengthen its financial position and enhance profitability and financial flexibility. These actions include:

  • Repositioning SVB’s balance sheet to increase asset sensitivity for short-term interest rates
  • Selling substantially all of their Available for Sale (AFS) securities portfolio
  • Better protect net interest income (NII) and net interest margin (NIM)
  • Commenced an underwritten public offering to raise equity.

The bank sold substantially all its Available for Sale (AFS) securities portfolio with the intention of reinvesting the proceeds, and commenced an underwritten public offering, seeking to raise approximately $2.25 billion between common equity and mandatory convertible preferred shares. General Atlantic, a leading global growth equity fund and longstanding client of SVB committed to investing $500 million on the same economic terms as the common offering.

These actions and disclosure caused concern among investors and customers. On March 9th, 2023, the bank experienced a bank run, and depositors attempted to withdraw $42B from the bank, of which it appears about $16 Billion was withdrawn. After which, transactions either were not successful or simply were not able to be input. After the run, the bank was left with a deficit of approximately $1 Billion when the FDIC took over on Friday.

SVB’s collapse began with a series of actions announced by the bank. On that same day, SVB sold $21 billion worth of investments, changed its target amount of cash reserves it holds at the Federal Reserve, and restructured its portfolio with short-term investments. It also used a financial tool called receive-floating swaps to protect its investments. These decisions ultimately contributed to the bank’s collapse.

The bank needed to make these actions in response due to

  • Expected continued higher interest rates (already up almost 10x in 12 months)
  • Pressured public and private markets from inflation, recession, & equity volatility.
  • Elevated cash burn levels from clients as they invest in their own businesses.

None of the actions prevented the bank run on March 9th, 2023. And their publication likely led to the collapse of SVB, its closure, and impending liquidation by the California DFPI.

What Happened

Silicon Valley Bank’s (SVB) collapse was due to a combination of factors, including its asset and liability structure, regulatory oversight, and market conditions.

SVB’s balance sheet was heavily weighted towards mortgage-backed securities and short-term loans to venture capitalists and private equity firms. The value of these assets declined when the Federal Reserve raised interest rates, leading to a decrease in SVB’s net interest margin (NIM) which is basically the amount of interest the bank earns from investments minus the interest paid to customers. Due to this and other issues the bank lost its equity cushion or the amount of capital the bank holds more than regulatory requirements.

To address this issue, SVB took the actions stated above to reposition its balance sheet. However, the announcement of the sale of liquid assets at a 9% loss and the need for a capital raise spooked depositors, leading to a bank run and ultimately the collapse of SVB.

The regulatory oversight of SVB was also called into question. SVB was considered a category IV organization and subject to less stringent requirements under the Economic Growth, Regulatory Relief, and Consumer Protection Act. However, concerns have been raised about the Federal Reserve’s supervision of SVB’s asset and liability management practices. Several factors may have contributed to this including SVB’s CEO as a member of the board of directors at the Federal Reserve Bank of San Francisco.

There has also been speculation about several executive members selling significant amounts of stock even before the March 8th release of information. What they know comes into question. Also, bonuses were paid out on March 9th, a day ahead of the closure. This also has resulted in speculation and will likely be reviewed as part of the investigations likely to occur as part of the collapse.

Why it Happened

The collapse of Silicon Valley Bank (SVB) was not an isolated event. It happened against the backdrop of broader economic and financial factors that created a perfect storm for the banking industry. One of the main drivers of the collapse was the sustained rise in interest rates that occurred over the past few years. This rise in rates caused the value of long-term debt to decline, which included the mortgage-backed securities (MBS) held by SVB.

The accounting rules allowed SVB to classify its MBS holdings as “held-to-maturity” (HTM) securities, which meant that the losses were not immediately reflected in the bank’s equity. In December, the bank disclosed that it had $15 billion in unrealized losses on its HTM portfolio. And at the time of disclosure, the losses had wiped out SVB’s $12 billion equity cushion.

SVB attempted to reposition its balance sheet to take advantage of potentially higher short-term rates by selling off its Available for Sale (AFS) securities portfolio and reinvesting the proceeds. The sales resulted in a $1.8 billion after-tax loss, further depleting SVB’s equity cushion. This caused concern among investors and contributed to the run-on deposits that led to the bank’s collapse.

The impact of rising interest rates on the banking industry is not unique to SVB. Banks across the industry are facing similar challenges, which could lead to further collapses. There may be systemic risks within the industry that have yet to be fully recognized. The collapse of SVB serves as a reminder of the importance of effective risk management practices and regulatory oversight. The Federal Reserve and other state and federal regulatory agencies have a critical role to play in ensuring the stability and safety of the banking industry.

Significance and Implications

The collapse of Silicon Valley Bank (SVB) has significant implications for not only the banking industry but also the wider economy. SVB served as a crucial partner for many startups and venture capital firms, and its failure is likely to have a ripple effect throughout the industry. More than 100 venture capital and investing firms have expressed support for SVB, calling for the institution to be purchased by another entity to maintain business continuity for SVB’s customers.

Others, such as Investors Mark Cuban and Bill Ackman are calling for government intervention to save SVB. They are looking for a federal bailout like what Systemically Important Financial Institutions (SIFI) have received. You may know these institutions as the Too Big To Fail institutions of the past. As of today, SVB is not treated as a SIFI.

The potential impact of SVB’s collapse on other banks and industries cannot be overstated. Nearly half of all US venture-backed companies were SVB customers, and the failure of the bank has put many startups and their investors at risk. This includes individual investors, not just VCs or institutions. While the FDIC will make some funds available on March 13th, many companies have already missed payroll or payment to significant vendors. There is the potential of a domino effect in which other banks could also be affected.

The risks to the US economy and financial system are significant. As SVB was a key lender to startups and venture capital firms, its collapse could have a major impact on the overall funding landscape. This could result in reduced innovation and startup activity, which could in turn harm economic growth and job creation. The situation highlights the need for greater oversight and regulation of the banking industry to prevent such collapses from occurring in the future.

The policy implications and regulatory response to the SVB collapse remain to be seen. The California Department of Financial Protection and Innovation has already announced the liquidation of SVB, but questions remain about how this will impact the wider banking industry and what steps regulators will take to prevent similar situations in the future. The collapse of SVB should serve as a wake-up call for regulators to re-examine the banking industry’s risk management practices and ensure greater transparency and oversight to prevent similar failures in the future.

Conclusion

The collapse of Silicon Valley Bank (SVB) will have significant implications for the startup ecosystem, leaving many startups, founders, and tech firms at risk of losing deposits exceeding the FDIC-insured amount. While uninsured depositors may recover 90% or more of their deposits, the situation remains uncertain for companies like Stripe or Roku, which reportedly held $487 million at SVB.

Moody’s rating agency attributed SVB’s failure to significant interest rate and asset liability management risks, weak governance, and high risk in its financial strategy and risk management. Close to half of all US venture-backed startups used SVB’s services, which saw deposits soar in recent years.

The sharp rise in interest rates and the failed attempt at a $2.3 billion stock sale to offset losses on bonds led to a collapse in its shares and the move by major customers such as Peter Thiel’s Founders Fund to withdraw their funds. The FDIC took control of the bank and is seeking a buyer before markets reopen on Monday. The potential consequences for SVB startups and VC borrowers could be dire. The collapse of SVB highlights the importance of selecting financial institutions as part of general investing rules of diversity.

The rise in interest rates and the effect on the bonds SVB held led to a mark-to-market hole in the balance sheet causing the value of these assets to decline.

The broader policy implications and regulatory response to prevent similar incidents from happening in the future should be considered. The collapse of Silicon Valley Bank is a reminder of the importance of risk management and diversification in the financial or any industry. As we move forward, it is crucial to learn from this event and take the necessary steps to ensure the stability and resilience of the US financial system.

Customers and investors should keep in mind the general investing rules of diversification and not put all their assets in one financial institution. While it is expected that customers of SVB may eventually recover most or all their deposits, it may take time and still have a significant impact on those SVB customers and their customers, vendors, and employees.

The collapse of Silicon Valley Bank serves as a cautionary tale of the importance of risk management and diversification in the financial industry. As the industry moves forward, it is crucial to learn from this event and take the necessary steps to ensure the stability and resilience of the US financial system.

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