By now I am sure a good number, if not all of you, have heard about the rapid fall of Silicon Valley Bank (SIVB). SIVB was the 16th largest bank in the United States prior to its failure late Friday afternoon, March 10th, 2023. Below you will find some high-level details of SIVB and its ultimate failure.
SIVB had been in business for over 40 years, serving as the “go-to” bank for the venture capital, private equity, and technology communities.
SIVB can count every significant company incubated out of Silicon Valley as a client at one time or another: everything from Apple to Google, Kleiner Perkins to Sequoia (the premier and longest standing venture capital firms in America).
While it wasn’t the largest bank in the U.S. by deposit base or services provided, it was the most trusted financial institution in the technology/venture capital ecosystem.
A combination of a high-quality fixed income portfolio losing value as interest rates rose AND significant cash burn (e.g. cash withdrawals) by venture capital companies led to a deterioration in SIVB’s capital position.
A risk management failure to hedge the interest rate exposure would ultimately prove negligent by SIVB management.
The final nail in SIVB’s coffin was a failed capital raise that gave many venture capital companies and funds no choice but to request their money out of SIVB and into other banks. As these withdrawal request outstripped the cash on hand, the FDIC took the bank over.
Late Sunday evening, prior to the opening of Asian equity markets, the FDIC and the U.S. Federal Reserve announced a program that would guarantee all deposits at SIVB. While the plan is still being rolled out, it appears that SIVB stock and some junior debt holders will likely lose all of their value.
Bottom Line Up Front: SIVB was taken over by the FDIC and California state banking regulators in the early afternoon on Friday amid a “run” on the bank. For those that are not familiar with what a “run” on the bank is, it boils down to a significant number of depositors losing faith in their banking institution and withdrawing (or attempting to withdraw) all of their deposits at the same time. Understandably you might be asking how this happens in 2023, and it is entirely reasonable question to ask. The answer to how the 16th largest bank in the U.S. failed is that almost all U.S. banks/credit unions operate as fractional reserve banks. In a fractional reserve banking system, which most of the world operates under, a bank does not keep, nor are they required to keep, 100% of depositors’ cash on hand for withdrawal. There is a reserve requirement in place, tiered out by size; a bank that size of SIVB would be required to keep at least 10% of deposits on hand. While the particulars are not fully understood (some are known and others will no doubt be revealed over the next several days/weeks/months), in terms of the broad mechanics, SIVB experienced a rather traditional “run” on the bank of the course of 48 hours culminating with the bank being taken over by regulators.
How did the Silicon Valley Bank collapse happen?
As stated in the introduction, SIVB was Silicon Valley’s go-to financial institution for over four decades. While it no doubt had modest amounts of traditional banking clients, the majority of its depositor base were directly ingrained in the Venture Capital/Technology ecosystem. This concentration of their client base would ultimately prove to be their undoing. During 2020 and 2021, the venture capital community raised record amounts of capital as investors flocked to the promise of high growth companies in a 0% interest rate environment that, they thought, would be forever changed by the COVID pandemic. The vast amount of capital raised by venture capitalists mostly found its way to SIVB. SIVB saw its deposit base grow from approximately $60 billion in 2019 to almost $200 billion by the end of the first quarter of 2022. SIVB had to do something with the deposits, as they had to pay interest on checking and savings accounts. In other words, SIVB had to do the traditional blocking and tackling that bank(s) across the country do. However, SIVB received the large influx of cash just at the moment the Federal Reserve would begin the most restrictive and quickest tightening of interest rates since 1981-1982. SIVB invested the cash in a series of high-quality investment grade bonds like US treasuries and mortgage-backed securities. The bonds that were purchased by SIVB were classified as “Available for Sale” and thus had to be marked to market. The fixed income portfolio was not hedged for its interest rate exposure – a decision that would contribute significantly to SIVB’s demise.
As interest rates went up rapidly in 2022, the value of fixed income instruments went down. While the bonds in the “available for sale” portfolio of SIVB were going down in value, the deposit base remained strong for most of 2022 as many venture capital-backed portfolio companies raised significant fresh capital in the last few months of 2021. What changed in late 2022 and early 2023 was the deposit base at SIVB was falling, as VC backed companies were unable to raise new capital and were burning cash at ever higher rates. The strong deposit base that cushioned much of the mark to market losses in the available for sale portfolio at SIVB had deteriorated and SIVB needed to pursue a different strategy. The executive team at SIVB decided to sell approximately $21 billion of high-quality bonds last week, hoping to take the proceeds and reinvest them at much higher interest rates (yields on 6-month U.S. treasuries are over 5%). In selling the $21B in bonds, the bank recognized an almost ~$2 billion loss, which eroded most of the capital cushion required by regulators. SIVB would be forced to raise fresh capital to plug the hole, which it attempted to do earlier last week. Unfortunately for SIVB, the message by the CEO of the bank was not well received by the investment community and the bank failed to raise capital. By this point, after a failed capital raise and an ill-timed (if not ill-conceived) bond sale, many depositors had started requesting money be wired to other financial institutions. The requests of SIVB grew through the day Thursday and into Friday morning, until the regulators declared SIVB insolvent and took over the bank.
How does it all play out?
The FDIC, U.S. Federal Reserve, and the U.S. Treasury announced early Sunday evening that all deposits at SIVB were guaranteed. The program outlined by the FDIC on its website was light on details; however, the announcement made clear that taxpayers would not be bailing out SIVB. Instead, the FDIC stated that shareholders and certain unsecured debtholders would not be protected, senior management at SIVB had been removed, and that any “losses” to depositors would be covered by a special assessment tax on banks. Reading through the release, there appeared to be concern that there were potential systemic issues, and regulators and policy makers felt compelled to make a strong move to reinforce faith in consumers of banks that their deposits were safe.
This is why Schneider Downs Wealth Management embraces diversification, owning stocks (U.S. and Non-U.S.), bonds, and diversifiers (real assets and real estate). We will never have 100% of the best performer nor will we have 100% of the worst performer. That diversification is valuable in volatile markets, especially down markets, where over concentration in certain areas of the market can create significant risks, as SIVB unfortunately found out the hard way.
Schneider Downs Wealth Management has been providing investment and retirement services since 2000. Although our service platforms continue to evolve, commitment to our clients remains our first priority. Our service is tailored to your individualized goals but built on the fundamental principles of our practice: fiduciary guidance, fee transparency and goal-based decision making. To learn more, visit our dedicated Wealth Management page.
You’ve heard our thoughts… We’d like to hear yours
The Schneider Downs Our Thoughts On blog exists to create a dialogue on issues that are important to organizations and individuals. While we enjoy sharing our ideas and insights, we’re especially interested in what you may have to say. If you have a question or a comment about this article – or any article from the Our Thoughts On blog – we hope you’ll share it with us. After all, a dialogue is an exchange of ideas, and we’d like to hear from you. Email us at [email protected].
Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.