- Silicon Valley Bank made a bold call about where to invest cash. It backfired.
- An old-fashioned bank run got SVB rolling, but the seeds of its doom were planted months before.
- One of the smartest things I’ve read about all of this comes from Marc Rubinstein’s Substack Net Interest.
Wondering what the hell happened to Silicon Valley Bank?
The California bank was shut down by regulators on Friday and placed under the supervision of the Federal Deposit Insurance Corporation (FDIC). That followed a tumultuous few days, including a botched capital call and a flurry of depositors withdrawing their funds.
The speed of SVB’s collapse was particularly striking. On Tuesday, SVB CEO Greg Becker was at an investor conference answering questions about what he does to relax. A few days later, the bank he ran had collapsed.
So how did it come to this? SVB’s actions last week, where it surprised the market with a planned capital increase that later fell through, are partly to blame. Venture capitalists begging founders to pull money out of the bank certainly didn’t help.
But the seeds of SVB’s demise were planted months ago.
To explain, I want to recommend Marc Rubinstein’s explanation in his Substack Net Interest. Rubinstein is a former hedge fund partner and one of the world’s brightest minds when it comes to analyzing financial institutions.
I will highlight three sections from his note to SVB, but I would recommend you read the whole thing.
SVB deposits soar
SVB’s position as the key bank in the technology sector has made it a huge beneficiary of the Silicon Valley boom in recent years. As venture capitalists raised huge amounts of capital and then invested that money in start-ups banked with SVB, billions in deposits flowed into SVB.
“Driven by a boom in venture capital funding, many of Silicon Valley Bank’s clients were flush with cash in 2020 and 2021. Between the end of 2019 and the first quarter of 2022, the bank’s deposit balances more than tripled to $198 billion ( including a small acquisition of Boston Private Financial Holdings). This compares with industry deposit growth of ‘only’ 37% over the period.”
SVB made a bold call about where to invest that cash
A bank can normally convert these deposits into loans to customers. But partly because of the technology boom, there wasn’t much demand for loans among SVB’s technology clients.
Instead, SVB decided to park that cash in securities. When banks do this, they must decide whether they are going to hold these securities for the long term, in which case they will be considered held-to-maturity (HTM) assets or available for sale. at any time, in which case they would be ‘available for sale’ (AFS) assets.
Essentially, HTM assets do not need to be marked to market, meaning that the value of these assets does not move up and down with interest rates or the overall market. AFS assets, in contrast, are much more volatile, as their balance sheet value rises and falls with the market. As a result, AFS portfolios tend to be actively managed by the bank.
Here is Rubinstein again:
“The bank invested the bulk of these deposits in debt securities. It adopted a two-pronged strategy: to protect some of its liquidity in shorter-term available-for-sale debt securities, while seeking to achieve performance with a longer-dated held-to-maturity portfolio On a cost basis , the shorter-term AFS book grew from $13.9 billion at the end of 2019 to $27.3 billion at its peak in the first quarter of 2022. The longer-term HTM book grew much more: from $13.8 billion to 98, $7 billion.”
Most of those HTM assets were in things like bonds and mortgage bonds. As interest rates rose, the value of these assets fell. But as long as the assets were held to maturity, the paper losses were not recorded on SVB’s balance sheet. And over time, they would indeed mature, coming off the balance sheet altogether.
Then depositors started asking for their money back
The tech boom faded and SVB’s startup clients started asking for some of their deposits back.
Here is Rubinstein again:
“The problem at Silicon Valley Bank is exacerbated by its relatively concentrated customer base. Instead, its customers all know each other. And Silicon Valley Bank doesn’t have that many of them. At the end of 2022, it had 37,466 deposit customers, each of whom has more than $250,000 per account. Ideal for referrals when business is booming, such concentration can magnify a feedback loop when conditions reverse.”
Eventually, SVB reached a point where it had to sell some of the securities it had invested in to have enough cash to return that money to depositors. He could not sell HTM’s assets, as losses on them would completely wipe out the bank’s capital.
Instead, it sold $21 billion in bonds from its AFS portfolio last week, taking a $1.8 billion loss and seeking to raise money from investors to offset that loss. But the capital call fell through, leaving a hole in SVB’s balance sheet, and the rest is history.
And that’s why SVB failed
Banks are in what is sometimes called a maturity transformation business. They lend short-term (think of your deposits, which you can withdraw at any time) and lend long-term (think of a 30-year mortgage). The key is to manage their liquidity in the meantime so that they have enough cash to meet their short-term commitments if many of their depositors suddenly want their money back.
In the end, it was an old-fashioned bank run that had SVB spinning. But it was its decision to invest so much money in held-to-maturity securities during a period of record low interest rates that made it particularly vulnerable.