The Fed’s fight against inflation through tightening and interest rate hikes since last year has claimed its first few victims in banking. The recent Silicon Valley Bank (NASDAQ:SIVB) collapse was the second largest bank failure in US history after Washington Mutual (WaMu) in 2008.
This was the 2008 moment for many in the Valley, and in the entire startup ecosystem. Before this there was Silvergate the day before, then SVB. Then there was Signature Bank in New York, then this was followed in Europe by a sudden drop in Credit Suisse’s stock price.
The move of the FDIC to ensure the entire amount held by SVB may be good news to their depositors, but it opens up a Pandora’s box and moral hazard concerns for those who fail to do proper risk management.
Fortunately there hadn’t been too many bank failures these past few years as most are properly capitalized, and so the FDIC funds are mostly intact. But that won’t necessarily be true if they need to bailout more banks.
Uncertainty Surrounding The Banking System
Before we would see long lines in front of banks with people shouting for their money to be returned to them, but these days bank runs are done quietly 24x7 with the speed of the Internet. Depositors can easily move their money elsewhere in a matter of seconds.
Although our banking and financial leaders are saying the banking system is strong, one cannot help but feel the uncertainty moving forward. Banking is after all a trust business, given that banks do not hold a 1:1 ratio of cash to deposits since they rehypothecate it by lending a lot of it out to make money.
Unfortunately for them, their spreads are low since there are very few takers for 9-10% loan rates to the public if the Fed lending rate reaches 6-7%
As for the startup community, SVB was a pillar of support for many thousands of startups not just in the Valley but in different global innovation ecosystems where they had a presence. SVB had a forty year legacy (since 1983) of supporting tech startups. Many of Silicon Valley’s leading tech companies were helped by them in one way or another in the past, some even up to the day they closed.
I founded a startup many years ago. My previous startup was only down to a few months of cash when SVB saved us by giving a $500K bridge loan in 2012. That bridge loan kept us afloat and allowed us to raise another $25M in VC money. SVB had my back. Eventually the Company grew and sold for $780M.
That type of loan isn’t really feasible if someone like SVB isn’t around to help startups. It’s next to impossible to get traditional banks to give loans to startups when all you have are your illiquid pre-IPO (pre-listing) shares of stock. That’s where SVB came in. They were like a friendly uncle to many tech startups over the years.
They’d take care of their startup clients, treat them to concerts of artists like Lady Gaga. They had a nice box at the San Francisco Golden State Warriors stadium. They understood how startups think.
I feel bad for those new founders who won’t be getting that support moving forward, and also for those who have money in other banks that may go belly up just in case.
SVB's Risk Management Practice
To raise liquidity, SVB had to sell their long term treasuries and mortgage backed securities before full maturity, which meant they needed to declare that as a mark-to-market $1.8B loss on their books. No one wants these older treasuries that yield lower than current short term ones.
SVB clients withdrew around $42B leaving a negative cash balance of $958M. Their share price dropped 70% before trading was halted. Their ratio of assets to liabilities plus equity on their balance sheet was totally screwed.
Their treasury and risk management practices could have been better. Because of rapid growth and expansion in the past, they put a lot of that cash into long term treasuries and mortgage backed securities.
Unfortunately the recent Fed interest rate hikes resulted in a yield curve inversion that saw newly issued short term bonds yield higher than long term ones. Plus with the Fed no longer buying bonds with their tightening, there were very few buyers for these older long term treasuries and mortgage securities.
They could only get cents on the dollar by selling these prematurely. Long term it would not have been a problem if held to maturity but they needed the cash immediately to pay their depositors who were withdrawing.
Most SVB clients had deposits above the $250K guaranteed by FDIC insurance. Fortunately the Fed, the Treasury and the FDIC stepped in to guarantee the depositor’s money. Personally some of my portfolio companies were in this predicament.
Founders didn’t know how to make payroll. Some M&As were in pause mode. Term sheets were being withdrawn during the early hours of this bank run. If this hadn’t been fixed, the US could have lost its innovation lead with the loss of this vital cog.
Moving forward, who is now going to lend money to new founders and VCs now? I really believe this could have been avoided with better timing and communication and smarter risk management.
Unfortunately if new management steps in to resurrect SVB, most likely they will raise their capitalization ratio and thus be more tightfisted and restrictive on issuing loans. Pre IPO shares will even be worth less as collateral given current high interest rates.
Higher interest means that the discounted value of future cash flows will even be less. Plus the immediate business outlook is not good, meaning the immediate years of a startup is expected to have lower earnings. Mass tech layoffs are likely to follow.
The Fed still needs to stomp out inflation. But it needs to do so at a pace that also avoids wrecking the entire economy and the lives of ordinary Americans. A balance needs to be struck between crushing inflation and protecting our banks like SVB that are a vital piece of our economy.