Before Friday, Silicon Valley Bank (SVB) was a thriving U.S. bank where credit losses were fairly low while enjoying a tripling of deposits between 2019 and 2021.
So, what happened?
The bank's financial troubles have come as a surprise to many, given its reputation as a leading player in the tech industry, providing banking services to some of the most innovative and successful startups in Silicon Valley.
However, the cause of the bank's downfall is not entirely straightforward.
In this blog, I explain in plain English what happened to SVB and what lessons can be learned.
Hopefully this will help cut through the social media noise and alleviate general market fears.
Starting simply, banks accept deposits from clients.
Because they owe the money back on demand, this becomes a liability.
These liabilities carry a cost, whether that be in the form of interest paid to clients or through service costs, like ATM machines, branches, or paper statements.
Banks, of course, want to make a profit.
They look to make money by lending, charging the borrower interest.
If there are more deposits than borrowers, that becomes a negative return for the bank.
Between 2019 and 2022, SVB tripled their deposits.
To earn a return, they need to lend those deposits out (or do something else with the money).
If a bank can’t lend money out, they will buy loans (i.e.: bonds) like U.S. Treasuries and Mortgage-Backed Securities (MBS).
The majority of SVB's deposits were from companies backed by venture capitalists that required a secure location to hold significant sums of money.
The deposits were arriving much faster than SVB could responsibly lend them back out...
So, buying bonds is exactly what they did...
They bought “long duration bonds”, which matured at 10+ year mark.
When interest rates go up, the market value of those safe securities goes down...
Their portfolio of 10-year bonds went down much more, than if they had owned 1-year bonds.
But, SVB also used leverage... and owed around $10+ for every $1 of shareholder equity.
(So, if SVB was levered 10x and they experienced a 10% paper loss on bonds with the recent interest rate moves, that’s 10×10 = 100% loss.)
That's a loss on paper... for now.
Now, imagine a lot (or all) of the customers want their money back quickly.
SVB needs to sell those bonds.
This can turn a paper loss into a real loss…fast.
And when those losses are big enough, it doesn’t have enough money on hand to meet those customers withdraws.
Looking back, SVB had many red flags.
Perhaps these are the 5 most obvious:
- SVB's January earnings report showed mark-to-market losses of almost $16 billion in Q3 for its held-to-maturity securities, while its tangible common equity was only $11.5 billion. This means that if the bank had to sell all its assets, it would be in a negative equity position.
- The reason for the losses is straightforward. The bank used its customers' deposits, amounting to tens of billions, to invest heavily in bonds that carried significant interest-rate risk. Moreover, it invested heavily in long-duration bonds that would not mature for over 10 years, creating a mismatch between its assets and liabilities.
- SEC filings reveal that as of December, around 95% of the deposits exceeded the $250K insurance limit set by the Federal Deposit Insurance Corporation. It is evident that this was a high-risk gamble.
- For a period of nine months from April 2022 to January this year, SVB functioned without a Chief Risk Officer, meaning that there was no one in charge of risk management during that time.
- Bloomberg reported that Peter Thiel, the prominent tech venture capitalist with an infamous reputation, who is also known as an aspiring supervillain, withdrew his Founders Fund's multi-million-dollar account from the bank by at least Thursday. He also urged his portfolio companies to follow suit.
HSBC worked through the night Sunday to strike a deal with regulators to purchase SVB’s UK operation — less assets and liabilities — for £1.
Remember, between 2008-12, the US closed down 465 banks.
Between 1980-94, 1,617 banks failed.
There'll always be something to worry about.
Patience, consistency, and remaining calm, are well rewarded by the stock market.
Don't succumb to panic.
Stay true to your long-term plans.