🏦 Lessons from the Silicon Valley Bank collapse

I’m here with an out-of-the ordinary Friday newsletter. It’s been a wild few days in tech, the culmination being the sudden collapse of Silicon Valley Bank. It’s a shocking turn of events for the startup-friendly financial institution.

I started my career in risk management at Goldman Sachs and was there during the 2008 financial crisis when banks were failing left and right. Now that we’re seeing a bank failure that impacts many in the startup community, I wanted to add my thoughts on what’s happening.

Silicon Valley Bank has been a stalwart institution supporting the technology, startup and venture capital community for nearly 40 years. Nearly every major tech company or venture capital firm has worked with SVB at some point. A large number, if not a majority of startups also bank with SVB. There’s more to be written in the coming days and weeks, but it’s a sad day for all of us in the tech ecosystem.

So, what happened? What will happen? And what can we learn from it all?

Here’s my take.

What happened?

In short: A bank run. After releasing a “mid quarter update” where they announced large losses and a capital raise, SVB’s stock lost 60% of its value in one day. Depositors (VCs and startups) panicked and today the stock fell another 60% before being halted completely. This morning, the Federal Depository Insurance Corporation (FDIC) announced it was placing SVB into “receivership.” Essentially, they took control of the bank.

A bank’s fundamental business is “maturity transformation,” they borrow on a short-term basis (deposits) and lend on a longer-term basis (or buy bonds) and capture the spread between their cost of borrowing and the interest they earn on the loans or bonds. They make money by leveraging the deposits they receive from their customers to invest elsewhere. This of course is generally a good business model as long as the bank properly manages the risk on their longer-term investments. Their “mid quarter update” showed that it did not manage that risk well.

The depositors at SVB (Silicon Valley startups and investors) have been under stress for a while now. Cash has been hard to come by and the market has not been kind to unprofitable growth companies. Because SVB’s customers have been under stress, they’ve needed their cash, depleting deposits at SVB. Basically, little cash was coming in during this tough market environment but cash was definitely going out.

After the “mid quarter update,” and despite the troubles, the bank seemed to be in a fine liquidity position. But, the straw that broke the camel’s back was that as people got worried about SVB’s financial health, and many prominent venture capitalists advised their portfolio companies to withdraw their cash from SVB, causing panic. That only exacerbated the problem.

To fund the withdrawals, SVB had to sell assets. The assets it had on hand to sell were longer-dated bonds (a maturity mismatch). Bonds are loans, and loans typically have an interest rate and a maturity date. Upon maturity, the principal balance is due. Along the way to maturity the owner of the bond (the lender) receives interest payments. Bond prices move inversely with interest rates. When rates rise, the value of contractual fixed interest payments become relatively less attractive because now you can get higher interest elsewhere. Who would pay $100 for a bond that pays 2% interest when you can buy a bond that pays 3% interest for $100? When rates fall, the opposite is true. The longer the bond’s maturity, the more sensitive it is to interest rate changes. As interest rates rose, the bonds held by SVB decreased in value. The more depositors fled SVB, the more bonds they had to sell at a loss to meet the withdrawal demands. You can see where this is going. To borrow a term from recent crypto happenings, it was a bit of a “death spiral”.

What's going to happen?

The FDIC announced that depositors at SVB will have access to their money on Monday morning — up to the $250K FDIC insurance limit. Deposits beyond that level will receive a receivership certificate for the remaining amount of their uninsured funds. The receiver (the FDIC) will sell the assets of the bank over time to pay off depositors. If they get enough money from the sale of the assets, depositors will be paid in full.

As of December 31, 2022, SVB had assets of approximately $209 billion and $175.4 billion in total deposits. The value of those assets now is unknown as is the amount of deposits upon being placed in receivership. The hope is that there will be enough to go around so here’s to hoping there’s enough to go around that every depositor will be made whole.

Another possible scenario is a rescue. Nothing has been announced as of this writing, but these things tend to happen quickly. I would not be surprised if a larger, healthy financial institution swoops in, with or without some level of government backstop to losses, and takes over SVB this weekend.

The full extent of the ripple effects through the tech and banking ecosystem are still to be determined, though some immediate impacts are already happening. Namely that payroll for some startups could be delayed. Thankfully, this sounds like a short-term issue.

I also think a lot of startups and VCs are going to become much more familiar with banking and bank regulations. If a rescue occurs this weekend, then depositors will be fine and business as usual will resume next week.

If there is no rescue buyer, the FDIC will liquidate the assets on the balance sheet and it will become clearer what kind of recovery uninsured depositors can expect. It’s entirely possible that depositors will receive 100 cents on the dollar, eventually. It’s also possible that they’ll take a small haircut. If there’s a disorderly liquidation, then depositors almost assuredly will lose some of their money. However, the whole point of FDIC receivership is to prevent a disorderly wind down.

What do we learn from this?

We’ll likely learn more in the weeks and months ahead, but here are my initial takeaways. The reason SVB ended up here is because they took bad risks. They borrowed from a concentrated group of depositors (Silicon Valley startups and investors) that were all exposed to the same risks (a decline in valuations and drying up of VC funding).

At the same time, they didn’t manage the asset side of their balance sheet very well. They bought long-dated bonds while rates were near zero. The longer-dated bonds had slightly higher interest rates than the less risky short dated bonds. That meant more profits for SVB, as long as the bonds held their value. The bonds didn’t hold their value. Rates rose and SVB was not hedged appropriately. The value of their assets declined and here we are.

💸 Lesson 1: Diversify

I tell every single client that comes through our virtual door that they should diversify and offset the concentrated risks they are taking with their company stock. Here’s yet another case study of why you should diversify. Diversification makes you resilient and is a get-rich-slow approach. Concentration makes you vulnerable and is a get-rich-quick approach.

But, the slow approach is much more likely to succeed than trying to hit the winning lottery ticket. It’s times like these that remind us of the importance of resiliency.

📉 Lesson 2: Take calculated and complimentary risks

The second lesson is to take complimentary risks if you are necessarily concentrated. Silicon Valley Bank doubled up on startup risk. When rates rose their customers suffered and withdrew money. At the same time, their assets suffered and lost value. If most of your net worth is tied up in your company stock, you should not have similar exposures in the rest of your portfolio. You should take different risks with your liquid portfolio. Risks that are complementary to the ones you are taking in your employment and company stock.

🔈 Lesson 3: Clear communication

While SVB’s bad bets are what sunk them, it’s possible this could have been avoided if their communication was better. While they tried to quell panic, it only fueled more panic. Before long, it was a full-on bank run.

First, the press release they put out on Wednesday, ostensibly to announce they were raising money to cover their losses, did more harm than good. It caused more confusion than clarity.

Unfortunately, their CEO, Greg Becker, also made comments that did little to instill the trust that he was trying to get following their stock collapse. When someone tells you not to think about something…you’re probably only going to think about that thing. So, when he told customers “...so the last thing we need you to do is panic” that’s the first thing many did. It’s like telling someone who’s upset to “calm down.” It never works.

It’s not the cause of the collapse but it certainly didn’t help. And it’s a reminder that communication matters, especially from leaders and especially during times of crisis.

Ultimately, we’re hoping things get sorted out quickly. SVB has been integral in the startup and VC community for decades. We’re pulling for them and we’ll be back with any updates to keep you informed.