In early March, 40 CFOs from various technology groups gathered in the Utah ski resort of Deer Valley for an annual “snow summit” hosted by Silicon Valley Bank, a major financial institution for startups.
Barely a week later, on Thursday morning, several of the CFOs exchanged frantic messages about whether they should continue to keep their cash in the bank.
A sale by SVB of securities of $20 billion. to mitigate a steep decline in deposits had focused investors’ attention on vulnerabilities in their balance sheets. They dumped his stock, wiped 10 billion. dollar of its shares and crashed the bank’s market value – to a value of 44 billion. dollars just 18 months earlier – to under 7 billion. dollar.
“The prisoner’s dilemma was basically: I’m fine if they don’t withdraw their money, and they’re fine if I don’t withdraw mine,” said one of the CFOs, whose company had banked about $200 million. at SVB.
But then some began to move. “I got a text from another friend—he was definitely moving his money to JPMorgan. It was about to happen,” the CFO said. “The social contract that we might have had together was too fragile. I called our executive director and we transferred 97 percent of our deposits to HSBC by noon on Thursday.”
By Friday morning, the bank had come to a standstill. Customers had initiated withdrawals of $42 billion in a single day – a quarter of the bank’s total deposits – and it was unable to meet the requests. The Federal Deposit Insurance Corporation – the US bank regulator that guarantees deposits of up to $250,000 – moved into the bank’s headquarters in Santa Clara, California, declared it insolvent and took control. The run was so fast that the coffers were fully drained and had a “negative cash balance” of nearly $1 billion.
SVB’s rapid collapse has stunned the venture capital and startup communities, many of which now face uncertainty about the fate of their bank accounts and business operations. SVB provided banking services to half of all venture-backed technology and life sciences companies in the United States and played a central role in the lives of entrepreneurs and their backers, managed personal finances, invested as a limited partner in venture funds, and underwrote corporate IPOs.
“It turned out that one of the biggest risks to our business model was catering to a very tight-knit group of investors who exhibit herd-like mentalities,” said a senior executive at the bank. “I mean, doesn’t that sound like a bank run waiting to happen?”
SVB unraveled spectacularly in that bank run, but its fate had been sealed almost two years earlier.
In 2021, at the height of an investment boom in private technology companies, SVB received a flood of money. Companies receiving ever-larger investments from venture funds plowed the money into the bank, which saw its deposits rise from $102bn. to $189bn, leaving it awash in “excess liquidity”.
In search of returns in an era of ultra-low interest rates, it increased investment in a portfolio of 120 billion. USD of highly valued state-backed securities, of which 91 billion USD in fixed-rate mortgage bonds with an average interest rate of only 1.64 per cent. . While that was slightly higher than the meager returns it could earn on short-term government debt, the investments locked up the cash for more than a decade and exposed it to losses if interest rates rose quickly.
When interest rates rose sharply last year, the value of the portfolio fell by $15 billion, an amount almost equal to SVB’s total capital. If it was forced to sell any of the bonds, it would risk becoming technically insolvent.
The investments represented a huge shift in strategy for SVB, which until 2018 had kept the vast majority of its excess cash in mortgage bonds maturing within a year, according to securities filings.
A person directly involved in the bank’s finances attributed the policy to a leadership change within SVB’s key finance functions in 2017 as its assets marched towards 50bn. USD, a threshold at which it would be labeled a “systemically important” lender subject to greater regulatory scrutiny.
The new financial management began moving an ever-larger percentage of excess cash into long-term fixed-income bonds, a maneuver that would appease public shareholders by boosting its overall profits, if only slightly.
But it appeared to be blind to the risk that the influx of cash was a symptom of low interest rates that could reverse if they rose. Central banks often raise rates to quell investor euphoria, decisions that generally lead to a slowdown in investment in speculative businesses such as technology start-ups. SVB’s bond portfolio was exposed to rising interest rates, as were its deposits.
“We had enough risk in the business model. You didn’t need risk in the asset/liability management profile,” said the former executive, referring to the bank’s ability to sell assets to meet its liquidity needs. “They completely missed that.”
As a venture capital investment bubble began to inflate in early 2021, Nate Koppikar, a partner at hedge fund Orso Partners, began studying SVB as a way to bet against the industry as a whole.
“The problem with the business model is that when the capital dries up, the deposits flee,” Koppikar said. “It was one of the best ways to short the tech bubble. The fact that this bank failed shows that the bubble has burst.”
As SVB bankers entertained finance executives on Utah’s slopes in early March, pressure quickly mounted on SVB’s management, led by boss Greg Becker.
Although SVB’s deposits had fallen for four straight quarters as technology valuations tumbled from their pandemic-era highs, they fell faster than expected in February and March. Becker and his finance team decided to liquidate almost all of the bank’s “available-for-sale” securities portfolio and to reinvest the proceeds in short-term assets that would earn higher interest rates and relieve pressure on its profitability.
The sale took a $1.8bn hit as the value of the securities had fallen since SVB had bought them due to rising interest rates. To compensate for this, Becker arranged for a public offering of the bank’s shares, led by Goldman Sachs. That included a major investment from General Atlantic, which committed to buy $500 million of stock.
The deal was announced on Wednesday night, but by Thursday morning it appeared to have flopped. SVB’s decision to sell the securities had surprised some investors and signaled to them that it had exhausted other options for raising cash. By lunchtime, the Silicon Valley financiers received the last call from Goldman, who briefly tried to assemble a larger group of investors alongside General Atlantic to raise capital as SVB’s share price was falling.
At the same time, some large venture investors, including Peter Thiel’s Founders Fund, advised companies to withdraw their money from SVB. In a series of calls with SVB’s customers and investors, Becker asked people not to panic. “If everyone tells each other that SVB is in trouble, it would be a challenge,” he said.
Suddenly the risk that had been building on SVB’s balance sheet for more than a year became a reality. If deposits fell further, SVB would be forced to sell its hold-to-maturity bond portfolio and recognize a loss of DKK 15bn. USD, moving closer to insolvency.
Rival bankers claimed the plan was flawed from the start – revealing a £1.8bn loss. USD at the same time that they secured only 500 million USD of the capital raising of 2.25 billion. “You can’t build a book while the market is open and you’re telling people there’s a $2 billion gap,” said a senior banker at a competitor.
There was also external pressure. Goldman bankers on the capital raise knew the deal was being done in a way that was difficult to pull off with an unhelpful market backdrop. But the company faced a time crunch due to Moody’s downgrade to Baa1 from A3 on Wednesday. “Their hand was forced by the rating agency,” said a person involved in the capital increase. Goldman Sachs declined to comment.
The scale and speed of the subsequent destruction has had a ripple effect on the technology industry globally.
As regulators try to salvage SVB’s assets and restore customer funds, potentially through a sale of some or all of the bank’s operations this weekend, the collapse has sparked an investigation into its approach to risk management.
In the end, it committed a cardinal sin in the financial sector. It absorbed huge risks with only a modest potential return to bolster short-term profits.
A hedge fund short seller who described the bank’s risks last year warned that SVB had almost unwittingly built the foundations for what could be “the first major US bank collapse in 15 years”.
“They went for an extra (0.4 percentage point) return and blew up the bank,” said the person, whose fund had a bet against SVB. “It’s really sad.”