Silicon Valley Bank’s downward spiral began late on March 8, 2023, when it surprised investors with news that it needed to raise $2.25 billion to shore up its balance sheet. Customers then withdrew a staggering $42 billion of deposits by the end of March 9, according to a California regulatory filing.
The collapse of Silicon Valley Bank or SVB has sent shock waves through the markets, raising questions about whether this is reminiscent of the 2008 financial crisis. SVB was the 16th largest bank in the US with a 40-year history of service. Its collapse was the largest of a financial institution in the US since Washington Mutual went under in 2008. Out of a total of $175 billion in deposits, SVB lost $42 billion in less than 48 hours before the government intervened.
What actually led to SVB’s collapse? Here is a detailed account.
During January 2020, SVB had $55 billion in customer deposits on its balance sheet. By the end of 2022, that number exploded to $186 billion. These deposits were primarily from initial public offerings (IPOs) and SPAC deals. A special purpose acquisition company (SPAC) is a company without commercial operations and is formed strictly to raise capital through an IPO for the purpose of acquiring or merging with an existing company. SVB has taken care of more than half of all the IPO proceeds from startups in the valley going public over the last two years. This, not surprisingly, amounted to a lot of money. With the stock market still rising, appetite for credit was rather muted. Ramping up credit suddenly would not have been prudent either, so SVB decided to deploy its pile of cash—$ 131 billion—in government bonds and mortgage-backed securities.
To maximise yields, it chose to put about $80 billion into 10-year mortgage-based securities paying 1.5 percent. It also chose long-dated government bonds instead of short-term ones. This proved to be a costly mistake because of the rising interest rate scenario that set in with the US Federal Reserve’s aggressive rate hikes. When rates rise, the value of bonds with lower coupons fall so that their yields are aligned to the new prevailing interest rate in the market. Longer-dated bonds obviously see more erosion compared to short-maturity securities as the latter would get repriced faster. This caused erosion in the value of SVB’s holdings when it went on to sell these bonds in the market.
Secondly, SVB miscalculated the rate at which its customers would come calling for money. With the stock market in correction mode and IPOs not happening at the same pace, the rate of funds inflow could not keep up with withdrawals by clients.
The firm fell woefully short on risk management. It did not have a chief risk officer for nearly eight months in 2022. Greg Becker, the CEO of the bank, sat on the risk committee as well. As withdrawal requests were pouring in after SVB announced on Wednesday that it had sold a bunch of securities at a loss and that it would also dispose off $2.25 billion in new shares to boost its balance sheet. The core issue here is that SVB had to sell $21 billion in underwater longer-term assets with an average interest rate of around 1.8 percent. This resulted in the bank losing $1.8 billion. It then tried to raise around $2.2 billion to fill the shortfall. This triggered panic and even venture capitalists like Peter Thiel raised the alarm, which further escalated the selloff. It was also clarified by Thiel's Founders Fund, a venture capital firm, as per sources that it had pulled out cash from SVB by Thursday as the bank began to unravel, even as it advised investors to exit the lender.
This left the bank exposed and in no position to cover billions in withdrawal requests.The final nail in the coffin was the bank’s inability to sell down equity and bring in “confidence capital” which would have assuaged depositors’ worries and not push for withdrawals. Private-equity firm General Atlantic apparently made an offer to buy $500 million of the bank’s common stock but before any deal could materialise, the Federal Deposit Insurance Corporation (FDIC) intervened to protect up to $250,000 for each depositor.
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The management was thus wrong on three counts: investing in longer-dated securities instead of shorter-term treasuries; underestimating the demand for cash from its prime customers especially as fundraising hopes from the stocks market were fading away; and, of course, the cardinal mistake of not shoring up capital at the first perception of risk.SVB’s collapse is a consequence of the Fed’s aggressive rate hiking cycle, but equally it is the failure caused by lazy banking. While we will have to wait and watch if there are other banks in the same boat, the stock market may take solace in the fact that the Fed may be forced to go slow on rate hikes going forward.
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