- Silicon Valley Bank has made a bold call on where to invest money. It turned against him.
- An old-fashioned bank run kept SVB running, but the seeds for its demise were planted months ago.
- One of the smartest things I’ve read about this comes from Marc Rubinstein’s Substack Net Interest.
Wondering what just happened at 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 rush of depositors withdrawing their funds.
The speed of SVB’s demise was particularly striking. On Tuesday, SVB CEO Greg Becker was at an investor conference to answer questions about what he does to unwind. A few days later, the bank he ran collapsed.
So how did we get here? Shares of SVB last week, where it surprised the market with a planned capital raise which then failed, are partly to blame. Venture capitalists pleading with the founders they back to get 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 on his Substack Net Interest. Rubinstein is a former hedge fund partner and one of the smartest minds in the analysis of financial institutions.
I will highlight three segments of his note on SVB, but I recommend that you go read the whole thing.
SVB deposits soar
SVB’s position as a benchmark tech bank has made it a huge beneficiary of the Silicon Valley boom in recent years. While venture capitalists have raised huge funds and then invested that money in startups that do business with SVB, billions in deposits have flowed into SVB.
“Thanks to the rise of venture capital funding, many Silicon Valley Bank customers have regained liquidity in 2020 and 2021. Between the end of 2019 and the first quarter of 2022, the deposit balances of the bank more than tripled to $198 billion (including a small acquisition of Boston Private Financial Holdings). This compares to industry deposit growth of “only” 37% over the period.”
SVB have made a bold call for where to invest that money
A bank could normally turn these deposits into loans to customers. But partly because of the tech boom, there wasn’t much demand for loans among SVB’s tech customers.
Instead, SVB decided to park that money in titles. When banks do this, they must decide whether they will hold these securities for the long term, in which case they would be considered “held-to-maturity” (HTM) assets, or whether they would be available for sale. at any time, in which case they would be “available for sale” (AFS) assets.
Importantly, HTM assets do not need to be marked to market, i.e. the value of these assets does not fluctuate with interest rates or the overall market. AFS assets, on the other hand, are much more volatile, as their balance sheet value rises and falls with the market. Therefore, AFS wallets are usually actively managed by the bank.
Here is Rubinstein again:
“The bank invested the bulk of these deposits in securities. It adopted a two-pronged strategy: sheltering part of its cash in available-for-sale securities of shorter duration, while seeking the yield with a longer duration held-to-maturity portfolio On a cost basis, the shorter duration AFS portfolio 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 duration HTM portfolio grew much more: from $13.8 billion to $98.7 billion.”
The bulk of these HTM assets were in things like Treasury bills and mortgage bonds. As rates rose, the value of these assets plunged. But as long as the assets were held to maturity, paper losses did not show up on SVB’s balance sheet. And over time, they would indeed gain in maturity, leaving the balance sheet completely.
Then the depositors started asking for their money
The tech boom waned and SVB client startups started asking for some of their deposits back.
Here is Rubinstein again:
“Silicon Valley Bank’s problem is compounded by its relatively concentrated customer base. In its niche, its customers all know each other. And Silicon Valley Bank doesn’t have that many. By the end of 2022, it had 37,466 deposit customers, each holding more than $250,000 per account Ideal for referrals when business is booming, such focus can amplify a feedback loop when conditions reverse.
Eventually, the 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 wipe out the bank’s capital entirely.
Instead, it sold $21 billion of bonds from its AFS portfolio last week, taking a loss of $1.8 billion and seeking to raise funds from investors to offset the loss. But the capital call failed, 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 the maturity transformation business. They borrow short-term (think your deposits, which you can withdraw at any time) and lend long-term (think a 30-year mortgage). The key is to manage their cash in the meantime, so 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 kept SVB running. But it was his decision to invest so much money in held-to-maturity securities in a period of record yields that made him particularly vulnerable.