SVB - The king is dead, long live the king!

TLDR;

1. Startups bloomed & raised lots capital in a period of easy credit: 2019-2021.

2. SVB received massive deposits from startups and placed some as cash reserves in long-term bonds.?

3. Feds raised rates at the steepest ramp in history (2022).

4. SVB did not do an adequate risk analysis of holding long-term bonds in the face of rising rates.

5. Over 2022 and 2023, as Venture Capital deployment slowed startups began to withdraw more than they deposit. This caused SVB to reassess their balance sheet and decide to take a loss while converting some low interest long term bonds into higher interest shorter term bonds in March 2023.

6. March 9 2023: Despite solid fundamentals and asset holdings, a self fulfilling prophecy avalanche of a bank run was precipitated by disastrous PR communication by SVB and "celebrity VCs" tweeting to their Portcos about a possible bank run.

Now, let's talk about SVB for a moment

Or as a recent Bloomberg opinion piece from Matt Levine called it: "The Startup Bank that had a Startup Bank Run." The story serves as an important lesson that some industries are bad for banks. As context, for those of you not familiar with the matter, Silicon Valley Bank is not a Neobank or some sort of new fangled crypto bank. SVB has been a fundamental institution of the Venture Capital industry for over 40 years.

For a moment, imagine it is still 2021, and someone suggests, "Let's start the Bank of Venture-Backed Tech Startups?" Such a cool industry with so much money, right? As their bank, influencers on Twitter would tweet nice things about you, and you'd get invited to fancy parties. Also, as their bank, you'd probably find a way to get a cut of growing industries with lots of potential. You could provide banking services to tech startups, VCs, and rich founders, get warrants in those startups, and get rich when they go public. Maybe even provide banking services to large crypto exchanges and start some sort of blockchain-based payment network (get rich through the magic of saying "blockchain" a lot?).

So, basically, being the Bank of Startups was a bit shaky, especially after 2021. See, normal banks take deposits from people with money and lend to people who need it. But startups in 2021 had too much cash. If you were the Bank of Startups, all you did was take in money from investors and let the startups deposit it in your bank. Simple, right?

The problem was that the startups didn't need loans because investors kept giving them cash, and also because startups don't have much to put up as collateral. So what did the Bank of Startups do with all that cash? Well, they couldn't just leave it in the bank doing nothing because it wasn't earning any interest. So they invested it in longer-term, but safe, securities like Treasury bonds and agency mortgage-backed securities.

Normally, in banking, you make money by taking credit risk. You assess which customers are good at paying back loans and lend to them. But in the Bank of Startups, you couldn't do that because your customers didn't need that much credit. So instead, you had to take interest-rate risk. Instead of lending to risky customers, you bought long-term bonds backed by the US government. That's how the Bank of Startups made its money in 2021.

The result of this is that, as the Bank of Startups, you were unusually exposed to interest-rate risk. Most banks, when interest rates go up, have to pay more interest on deposits, but get paid more interest on their loans, and end up profiting from rising interest rates. But you, as the Bank of Startups, own a lot of long-duration bonds, and their market value goes down as rates go up. Every bank has some mix of this — every bank borrows short to lend long; that’s what banking is — but many banks end up a bit more balanced than the Bank of Startups.

Here's what Robert Armstrong wrote in the Financial Times:

• SVB has more of its assets invested in fixed-rate securities than most other banks.
• 56% of SVB's assets are in securities, compared to 25% at Fifth Third and 28% at Bank of America.
• Most banks like higher rates because they help the asset side of the balance sheet more than they hurt the liability side.
• But for SVB, higher rates hurt them more on the liability side than they help on the asset side.
• According to Oppenheimer bank analyst Chris Kotowski, SVB is "a liability-sensitive outlier in a generally asset-sensitive world".

As Matt Levine recently wrote in his Bloomberg article Startup Bank had a Startup Bank Run:

But there is another, subtler, more dangerous exposure to interest rates: You are the Bank of Startups, and startups are a low-interest-rate phenomenon. When interest rates are low everywhere, a dollar in 20 years is about as good as a dollar today, so a startup whose business model is 'we will lose money for a decade building artificial intelligence, and then rake in lots of money in the far future' sounds pretty good.

However, when interest rates are higher, investors prioritize cash flows over long-term potential. Levine explains, "When interest rates were low for a long time, and suddenly become high, all the money that was rushing to your customers is suddenly cut off. Your clients who were 'obtaining liquidity through liquidity events, such as IPOs, secondary offerings, SPAC fundraising, venture capital investments, acquisitions and other fundraising activities' stop doing that. Your customers keep taking money out of the bank to pay rent and salaries, but they stop depositing new money." This same phenomenon is even more pronounced in the crypto industry, as Levine notes, "I mean, the Fed raised rates once and the entire crypto industry vanished? This should not be true of startups." In other words, if you were the Bank of Startups in 2021 and a visionary tech founder came to you with a proposal to revolutionize the world, it may have seemed "unnatural to reply 'nah but what if the Fed raises rates by 0.25%?'" After all, startups are supposed to be about a radical vision for the future, not a bet on interest rates.

Turns out it was a bet on interest rates though.

As Bloomberg's Katie Greifeld puts it, "Both crypto and venture capital booms were children of the ultra-low rates of the past decade and a half. Now, rising rates and the shrinking of the Federal Reserve’s balance sheet have burst those industry bubbles and increased the competition among banks for funding." So, if you were the Bank of Startups or the Bank of Crypto, you had made a huge concentrated bet on interest rates. According to Greifeld, "Your customers were flush with cash, so they gave you all that cash, but they didn’t need loans so you invested all that cash in longer-dated fixed-income securities, which lost value when rates went up. But also, when rates went up, your customers all got smoked, because it turned out that they were creatures of low interest rates, and in a higher-interest-rate environment they didn’t have money anymore. So they withdrew their deposits, so you had to sell those securities at a loss to pay them back. Now you have lost money and look financially shaky, so customers get spooked and withdraw more money, so you sell more securities, so you book more losses, oops oops oops." As Greifeld explains, this vicious cycle has left banks like SVB with "a double sensitivity to higher interest rates. On the asset side of the balance sheet, higher rates decrease the value of those long-term debt securities. On the liability side, higher rates mean less money shoved at tech, and as such, a lower supply of cheap deposit funding."

According to Levine, There is another reason that it is maybe not great to be the Bank of Startups, which is that"

nobody on Earth is more of a herd animal than Silicon Valley venture capitalists.

As we all know by now, some of the most prominent venture capitalists in Silicon Valley, including Peter Thiel’s Founders Fund, recently advised startups to withdraw their deposits from Silicon Valley Bank (SVB) because of concerns about its stability. The bank's collapse on Friday came after its long-established customer base of tech startups withdrew deposits, leaving it insolvent.

While it's not uncommon for people to follow the herd mentality, a bank should not rely on a single group of depositors. The reason being, if all your depositors are startups with the same handful of venture capitalists on their boards, and all those venture capitalists are competing with each other to "Add Value" and "Be Influencers" and "Do The Current Thing", then all of your depositors will take their money out at the same time. This puts the bank at significant risk.

The California Department of Financial Protection and Innovation cited "inadequate liquidity and insolvency" when it put SVB into FDIC receivership, suggesting that the assets are worth less than the liabilities. The FDIC’s job, in receivership, is "efficiently recovering the maximum amount possible from the disposition of assets" to distribute to creditors.

One obvious question that Levine pointed out is:

If you are "another, healthy bank" working through this weekend to buy SVB and assume its deposits, how much would you pay for the assets, which were worth $212 billion in December?

"I am pretty sure the answer is higher than $8 billion," commented Levine, which is the amount of insured deposits. The $15 billion of Federal Home Loan Bank advances are also quite senior and will presumably be no problem to pay back. However, the answer is also likely lower than $188 billion, the total amount of deposits plus FHLB advances. It seems bad for the FDIC to wind up a big high-profile bank in a way that causes significant losses for depositors, including uninsured depositors.

The collapse of SVB highlights the importance of diversifying a bank's deposit base to mitigate the risk of deposit flight. It also underscores the need for regulators to consider deposit concentration when evaluating a bank's stability. It is essential for banks to manage their risk effectively and avoid relying on a single group of depositors. In doing so, banks can better weather storms and remain stable in challenging times.

Let's not ignore SVB's Communications and PR catastrophe

Chief Communicator at Activision Blizzard, Lulu Cheng Meservey in a recent interview highlighted that SVB's financial press release was “all numbers, no narrative,” allowing SVB’s vast community of VCs and startups to misinterpret what should have been a routine capital adjustment by the bank to respond to rate hikes. Other blunders included…

• Never say “stay calm”:?While SVB may not have had a choice on the bad timing of the announcement, as the public had a heightened sense of uncertainty in the face of a separate banking?collapse of crypto lender Silvergate, Lulu highlights that SVB’s CEO blundered corporate messaging by repeating to concerned customers to “stay calm,” a message which adds on to public fears rather than allay them.?
• Cross-channel oversight:?Lulu points to an oversight in message alignment across channels. Important context for SVB’s liquidity strategy and its explanation for raising capital was laid out clearly in the company’s 8-K filings and should have been understood by its investor audiences. Crucially, Lulu says SVB should have made sure this financial context made its way to customers.

Top VCs doomsday self-fulfilling prophecy?

Corporate Flack on Substack also hit the nail on the head when they wrote:

SVB’s communications missteps weren’t helped by VCs. Influential venture investors such as Sequoia and Peter Thiel’s Founders Fund sounded the alarm early on Thursday night, urging startups to pull deposits from SVB, activating a flood of outflows which obliterated SVB’s financial position (Axios).

• Corporate stakeholders?in the crisis took to LinkedIn to express their concerns about the bank run and its many effects. SVB’s?Head of Product, Sanjay Gosalinashared his thoughts by reposting a quote from?an article from?fintech VC Partner Jeremy Solomon?which asked why “select venture funds” were bailing on SVB all at once, implying that VCs needed to trust SVB as a banking partner and avoid a panic over a minor issue.

This sets a tragic scene, where VCs told a self-fulfilling prophecy. Because they thought SVB would implode, they told others, which caused it to implode.?

The reputational loss of credibility amongst SVB’s most important constituency of venture capital investors was all it took to collapse the 40-year old mid-size bank. In other words, as social media finance influencer Deepak Shenoy put it, “In banking, perception is reality.”

Ultimately, there was in fact a run on SVB in part because there hasn’t been a big bank run in a while, and people — venture capitalists, startups — were naturally worried that they might lose their deposits if their bank failed. Then as has happened with almost every single run on the bank in history — the bank failed.

Silicon Valley Bank is dead, long live Silicon Valley Bank!