Silicon Valley Bank: the spectacular unraveling of the tech industry banker

In early March, 40 chief financial officers from various tech companies gathered in Utah’s Deer Valley ski resort for an annual “Snow Summit” hosted by Silicon Valley Bank, a major financial institution for startups.

Barely a week later, on Thursday morning, several CFOs were frantically exchanging messages about whether to keep their cash in the bank.

A $20 billion sale of securities by the SVB to mitigate a sharp drop in deposits had drawn investor attention to weaknesses in its balance sheet. They divested their shares, taking $10 billion off their stock and dropping the bank’s market value – which was worth $44 billion just 18 months earlier – to below $7 billion.

“Basically, the prisoner’s dilemma was: I’ll be fine if they don’t withdraw their money and they’ll be fine if I don’t withdraw mine,” said one of the CFOs, whose company had invested around $200 million in SVB.

But then some started to move. “I got a text from another friend – he definitely wanted to transfer his money to JPMorgan. It happened,” said the chief financial officer. “The social contract that we might have had collectively was too fragile. I called our CEO and we had 97 per cent of our deposits transferred to HSBC by Thursday noon.”

On Friday morning the bank was broke. Customers had initiated $42 billion in withdrawals in a single day – a quarter of the bank’s total deposits – and it was unable to fulfill the requests. The Federal Deposit Insurance Corporation — the US banking 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 its coffers were completely drained, showing a “negative treasury balance” of nearly $1 billion.

The rapid collapse of the SVB has stunned the venture capital and start-up community, many of whom now face uncertainty over the fate of their bank accounts and business operations. Banking half of all technology and life science venture capitalized companies in the United States, SVB has played a prominent role in the lives of entrepreneurs and their lenders, managing personal finances, investing as a limited partner in venture funds and underwriting company public listings.

“It turned out that one of the biggest risks to our business model was serving a very tight-knit group of investors who have a herd-like mentality,” said an executive at the bank. “I mean doesn’t that sound like a bank run waiting to happen?”

The SVB failed spectacularly in this 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 was inundated with cash. Firms, which received larger and larger investments from venture funds, put the money in the bank, whose deposits of 102 billion

Seeking yield in an era of extremely low interest rates, it has increased investments in a $120 billion portfolio of highly rated government-backed securities, including $91 billion in fixed-rate mortgage bonds with an average interest rate of just 1.64 percent. Although the investments were slightly higher than the meager returns they could earn on short-term government debt, they locked up the money for more than a decade, exposing it to losses when interest rates rose rapidly.

When interest rates rose sharply last year, the value of the portfolio fell by $15 billion, an amount nearly equal to SVB’s total assets. If it were 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 held the vast majority of its excess cash in one-year mortgage bonds, according to securities filings.

One person directly involved in the bank’s finances attributed the policy to a leadership change in SVB’s key finance functions in 2017, when its assets rose to €50bn.

The new financial leadership began reallocating an ever-increasing percentage of excess cash into long-term fixed-rate bonds, a maneuver that would placate public shareholders by bolstering their overall profits, albeit marginally.

But it seemed blind to the risk that the flow of cash was a symptom of low interest rates that could reverse if they went up. Central banks often raise interest rates to curb investor exuberance, decisions that generally result in a slowdown in investment in speculative companies like tech start-ups. The SVB bond portfolio was exposed to rising interest rates, as were deposits.

“We had enough risk in the business model. They didn’t need risk in the asset/liability management profile,” the former manager said, citing the bank’s ability to sell assets to meet its liquidity needs. “They completely overlooked that.”

As a venture capital investment bubble began to inflate in early 2021, Nate Koppikar, partner at hedge fund Orso Partners, began investigating SVB to bet against the industry at large.

“The problem with the business model is that when capital dries up, 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.”

While SVB bankers were entertaining CFOs on the Utah slopes in early March, the pressure on SVB’s leadership team, led by CEO Greg Becker, mounted rapidly.

Although SVB’s deposits fell for four straight quarters as tech company valuations plunged from their pandemic-era highs, they plunged 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 reinvest the proceeds into shorter-term assets that would earn higher interest rates and ease the pressure on profitability.

The sale represented a $1.8 billion loss as the value of the securities had fallen due to rising interest rates since the SVB bought it. To compensate, Becker arranged for a public offering of the bank’s stock, led by Goldman Sachs. It involved a large investment from General Atlantic, which committed to buying $500 million worth of stock.

The deal was announced Wednesday night but looked like a flop Thursday morning. The SVB’s decision to sell the securities surprised some investors and signaled that it had exhausted other avenues to raise funds. At lunchtime, Silicon Valley financiers received final calls from Goldman, which was briefly attempting to rally a larger group of investors alongside General Atlantic to raise capital as SVB’s share price plummeted.

At the same time, some big venture investors, including Peter Thiel’s Founders Fund, advised companies to withdraw their money from the SVB. In a series of conversations with SVB customers and investors, Becker urged people not to panic. “If everyone is saying SVB is in trouble, that would be a challenge,” he said.

Suddenly, the risk that had weighed on SVB’s balance sheet for more than a year became a reality. If deposits fell further, SVB would be forced to sell its held-to-maturity bond portfolio and post a $15 billion loss, moving closer to bankruptcy.

Competing bankers argued the plan was flawed from the start – posting a $1.8 billion loss while securing just $500 million of the $2.25 billion capital raise from an anchor investor. “You can’t build a book as long as the market is open and you tell people there’s a $2 billion hole,” said a senior banker at a competitor.

There was also pressure from outside. Goldman bankers, raising capital, knew the deal was being completed in a way that was difficult to pull off in an unhelpful market. However, the company was pressed for time due to Moody’s downgrade from A3 to Baa1 on Wednesday. “Your hand was forced by the rating agency,” said a person involved in raising the capital. Goldman Sachs declined to comment.

The magnitude and speed of the ensuing destruction impacted the technology industry worldwide.

As regulators seek to salvage SVB’s assets and restore client funds, possibly through a sale of some or all of the bank’s operations this weekend, the collapse has prompted a review of its approach to risk management.

Ultimately, it committed a cardinal sin in the financial arena. It has taken huge risks with only a modest potential payoff to bolster short-term gains.

A hedge fund short seller who detailed the bank’s risks last year warned that SVB almost unknowingly laid the groundwork for what could become “the first major US bank failure in 15 years.”

“They went for an extra [0.4 percentage points] of yield and blew up the bank,” said the person whose fund had bet against SVB. “It’s really sad.”