Thu. Mar 28th, 2024

Why Silicon Valley Bank failed<!-- wp:html --><p>Police officers outside SVB's headquarters in Santa Clara, California on Friday.</p> <p class="copyright">Getty Images</p> <p>Silicon Valley Bank made a bold call on where to invest cash. It backfired.<br /> An old-fashioned bank run sent SVB spinning, but the seeds of its demise were planted months ago.<br /> One of the smartest things I've read about this all comes from Marc Rubinstein's Substack Net Interest.</p> <p>Wondering what the hell just happened at Silicon Valley Bank?</p> <p>The California bank was <a href="https://www.businessinsider.com/svb-failure-what-the-hell-happened-2023-3">closed by regulators</a> on Friday and put under the control of the Federal Deposit Insurance Corporation <a href="https://www.businessinsider.com/personal-finance/what-is-fdic-insurance">(FDIC)</a>. That followed a tumultuous few days, including a <a href="https://markets.businessinsider.com/news/stocks/silicon-valley-bank-sale-stock-price-bank-run-peter-thiel-2023-3?_gl=1*vs9hja*_ga*MTkxNzQzNjc2Mi4xNjYxNDU2MDU1*_ga_E21CV80ZCZ*MTY3ODQ2NzUzNC44MjIuMS4xNjc4NDY3NTUwLjAuMC4w&utm_medium=ingest&utm_source=markets">botched capital call</a> and a <a href="https://www.businessinsider.com/svb-silicon-valley-bank-startups-worry-run-pull-accounts-2023-3">rush of depositors</a> withdrawing their funds.</p> <p>The speed of SVB's demise <a href="https://www.businessinsider.com/silicon-valley-bank-svb-particularly-scary-bank-failure-why-2023-3">was especially striking</a>. On Tuesday, SVB CEO Greg Becker was at an investor conference answering questions about what he does to relax. A few days later, the bank he led had collapsed.</p> <p>So how did it come to this? SVB's actions in the last week, where it surprised the market with a planned capital raise which later failed, are partly to blame. Venture capitalists imploring the founders they back to <a href="https://www.businessinsider.com/vcs-blame-each-other-for-silicon-valley-bank-collapse-2023-3">pull money from the bank</a> certainly didn't help.</p> <p>But the <a href="https://www.businessinsider.com/silicon-valley-bank-svb-biggest-bank-failure-since-2008-crisis-2023-3">seeds of SVB's demise</a> were planted months ago. </p> <p>To explain, I want to recommend <a href="https://www.netinterest.co/p/the-demise-of-silicon-valley-bank" target="_blank" rel="noopener">Marc Rubinstein's explanation</a> over at his Substack Net Interest. Rubinstein is a former partner at a hedge fund, and one of the smartest minds around when it comes to analyzing financial institutions. </p> <p>I'm going to highlight three segments from his note on SVB, but I'd recommend you go <a href="https://www.netinterest.co/p/the-demise-of-silicon-valley-bank" target="_blank" rel="noopener">read the whole thing</a>.</p> <h3><strong>SVB deposits soar</strong></h3> <p>SVB's position as the <a href="https://www.businessinsider.com/startups-silicon-valley-bank-worried-wont-pay-employees-next-week-2023-3">go-to bank in tech</a> made it a huge beneficiary of the Silicon Valley boom through the last few years. As venture capitalists raised huge funds and then <a href="https://www.businessinsider.com/venture-capitalists-tech-founders-turned-on-silicon-valley-bank-2023-3">invested that money</a> into startups that bank with SVB, billions in deposits flowed to SVB.</p> <p>Rubinstein notes:</p> <p><em>"Driven by the boom in venture capital funding, many of Silicon Valley Bank's customers became flush with cash over 2020 and 2021. Between the end of 2019 and the first quarter of 2022, the bank's deposit balances more than tripled to $198 billion (including a small acquisition of Boston Private Financial Holdings). This compares with industry deposit growth of "only" 37% over the period." </em></p> <h3><strong>SVB made a bold call on where to invest that cash</strong></h3> <p>A bank might normally turn those deposits into loans to customers. But in part because of the tech boom, there wasn't a lot of demand for loans among SVB's tech customers.</p> <p>Instead, SVB decided to park that cash in securities. When banks do this, they have to decide whether they're going to hold those securities for the long term, in which case they'd be considered "held-to-maturity" (HTM) assets, or have them be available to sell at any moment, in which case they would be "available for sale" (AFS) assets. </p> <p>Critically, HTM assets don't have to be marked-to-market, which is to say that the value of those assets don't move up and down with interest rates or the overall market. AFS assets, in contrast, are much more volatile, as their value on the balance sheet goes up and down with the market. As a result, AFS portfolios tend to be actively managed by the bank.</p> <p>Here's Rubinstein again:</p> <p><em>"The bank invested the bulk of these deposits in securities. It adopted a two-pronged strategy: to shelter some of its liquidity in shorter duration available-for-sale securities, while reaching for yield with a longer duration held-to-maturity book. On a cost basis, the shorter duration AFS book 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 book grew by much more: from $13.8 billion to $98.7 billion."</em></p> <p>The bulk of these HTM assets were in things like Treasuries and mortgage bonds. As rates went up, the value of these assets plunged. But as long as the assets were held to maturity, the paper losses didn't register on SVB's balance sheet. And over time, they would indeed mature, rolling off the balance sheet altogether.</p> <h3><strong>Then depositors started to ask for their money back</strong></h3> <p>The tech boom faded and <a href="https://www.businessinsider.com/silicon-valley-bank-panic-stock-dropping-vcs-startups-2023-3">SVB's startup customers</a> started to ask for some of their deposits back. </p> <p>Here's Rubinstein again:</p> <p><em>"The problem at Silicon Valley Bank 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 of them. As at the end of 2022, it had 37,466 deposit customers, each holding in excess of $250,000 per account. Great for referrals when business is booming, such concentration can magnify a feedback loop when conditions reverse."</em></p> <p>Eventually, 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. It couldn't sell the HTM assets, as the losses on those would wipe out the bank's capital entirely.</p> <p>Instead, it sold <a href="https://markets.businessinsider.com/news/stocks/silicon-valley-bank-svb-stock-price-bond-portfolio-firesale-treasury-2023-3">$21 billion in bonds</a> from its AFS portfolio last week, taking a $1.8 billion loss and seeking to raise money from investors to offset that loss. But the capital call failed, leaving a hole on SVB's balance sheet, and the rest is history.</p> <h3><strong>And that's why SVB failed</strong></h3> <p>Banks are in what's sometimes called the maturity transformation business. They borrow short term (think <a href="https://www.businessinsider.com/personal-finance/is-money-safe-in-bank-during-recession">your deposits</a>, which you can remove at any moment), and lend long (think a <a href="https://www.businessinsider.com/personal-finance/what-is-a-mortgage">30-year mortgage</a>). The key is to manage their liquidity in the meantime, so they have enough cash to meet their short term commitments should lots of their depositors suddenly want their money back.</p> <p>In the end, it was an <a href="https://www.businessinsider.com/silicon-valley-bank-deposits-how-much-will-you-get-back-2023-3">old-fashioned bank run</a> that sent SVB spinning. But it was its decision to invest so much money in hold-to-maturity securities in a period of record-low rates that made it especially vulnerable.</p> <div class="read-original">Read the original article on <a href="https://www.businessinsider.com/silicon-valley-bank-failure-what-happened-bank-run-explained-2023-3">Business Insider</a></div><!-- /wp:html -->

Police officers outside SVB’s headquarters in Santa Clara, California on Friday.

Silicon Valley Bank made a bold call on where to invest cash. It backfired.
An old-fashioned bank run sent SVB spinning, but the seeds of its demise were planted months ago.
One of the smartest things I’ve read about this all comes from Marc Rubinstein’s Substack Net Interest.

Wondering what the hell just happened at Silicon Valley Bank?

The California bank was closed by regulators on Friday and put under the control 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 especially striking. On Tuesday, SVB CEO Greg Becker was at an investor conference answering questions about what he does to relax. A few days later, the bank he led had collapsed.

So how did it come to this? SVB’s actions in the last week, where it surprised the market with a planned capital raise which later failed, are partly to blame. Venture capitalists imploring the founders they back to pull money from 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 over at his Substack Net Interest. Rubinstein is a former partner at a hedge fund, and one of the smartest minds around when it comes to analyzing financial institutions. 

I’m going to highlight three segments from his note on SVB, but I’d recommend you go read the whole thing.

SVB deposits soar

SVB’s position as the go-to bank in tech made it a huge beneficiary of the Silicon Valley boom through the last few years. As venture capitalists raised huge funds and then invested that money into startups that bank with SVB, billions in deposits flowed to SVB.

Rubinstein notes:

“Driven by the boom in venture capital funding, many of Silicon Valley Bank’s customers became flush with cash over 2020 and 2021. Between the end of 2019 and the first quarter of 2022, the bank’s deposit balances more than tripled to $198 billion (including a small acquisition of Boston Private Financial Holdings). This compares with industry deposit growth of “only” 37% over the period.” 

SVB made a bold call on where to invest that cash

A bank might normally turn those deposits into loans to customers. But in part because of the tech boom, there wasn’t a lot of demand for loans among SVB’s tech customers.

Instead, SVB decided to park that cash in securities. When banks do this, they have to decide whether they’re going to hold those securities for the long term, in which case they’d be considered “held-to-maturity” (HTM) assets, or have them be available to sell at any moment, in which case they would be “available for sale” (AFS) assets. 

Critically, HTM assets don’t have to be marked-to-market, which is to say that the value of those assets don’t move up and down with interest rates or the overall market. AFS assets, in contrast, are much more volatile, as their value on the balance sheet goes up and down with the market. As a result, AFS portfolios tend to be actively managed by the bank.

Here’s Rubinstein again:

“The bank invested the bulk of these deposits in securities. It adopted a two-pronged strategy: to shelter some of its liquidity in shorter duration available-for-sale securities, while reaching for yield with a longer duration held-to-maturity book. On a cost basis, the shorter duration AFS book 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 book grew by much more: from $13.8 billion to $98.7 billion.”

The bulk of these HTM assets were in things like Treasuries and mortgage bonds. As rates went up, the value of these assets plunged. But as long as the assets were held to maturity, the paper losses didn’t register on SVB’s balance sheet. And over time, they would indeed mature, rolling off the balance sheet altogether.

Then depositors started to ask for their money back

The tech boom faded and SVB’s startup customers started to ask for some of their deposits back. 

Here’s Rubinstein again:

“The problem at Silicon Valley Bank 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 of them. As at the end of 2022, it had 37,466 deposit customers, each holding in excess of $250,000 per account. Great for referrals when business is booming, such concentration can magnify a feedback loop when conditions reverse.”

Eventually, 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. It couldn’t sell the HTM assets, as the losses on those would wipe out the bank’s capital entirely.

Instead, it sold $21 billion in bonds from its AFS portfolio last week, taking a $1.8 billion loss and seeking to raise money from investors to offset that loss. But the capital call failed, leaving a hole on SVB’s balance sheet, and the rest is history.

And that’s why SVB failed

Banks are in what’s sometimes called the maturity transformation business. They borrow short term (think your deposits, which you can remove at any moment), and lend long (think a 30-year mortgage). The key is to manage their liquidity in the meantime, so they have enough cash to meet their short term commitments should lots of their depositors suddenly want their money back.

In the end, it was an old-fashioned bank run that sent SVB spinning. But it was its decision to invest so much money in hold-to-maturity securities in a period of record-low rates that made it especially vulnerable.

Read the original article on Business Insider

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