Fintech Horror Stories - Silicon Valley Bank!

The ultimate horror story, a bank run?

Mar 10, 2023

This week, we had it all planned out, to focus on a story regarding an old friend of ours from a previous horror story, in an unexpected follow up due to some news regarding its financials that arose last week (can you guess who we’re talking about??). But then an even more unexpected story broke within the last 24-48 hours, and we had to throw out our original plans. Yep, you guessed it - this week, we’re going to spend time on the Fintech Horror Story of the moment right now, SVB aka Silicon Valley Bank.

Who or what is SVB?

It’s a bank that has been around since the early ‘80s, and from their early beginnings it served as a place for VC-backed businesses to park their cash, and then eventually provided financing to VCs themselves. This almost 40 years of experience is what has given the bank its edge. They have been through multiple crises (the ‘92 real estate crisis, the dot-com bust in ‘01, the financial crisis in ‘08) with each crisis significantly impacting the bank’s assets, stock price, and/or its outstanding debt. But as of 2016, they were the source of deposits and/or funding for well over 50% of all startups. When you hear SVB, it’s likely that your favorite early stage or late stage startup is operating on funds that have passed through their accounts.

So what exactly happened over the last week or two?

Good to know that the bank has seen a lot of crises over the years, because this may be their most desperate hour. On March 8, they announced and filedwith the SEC a “mid-quarter update” with “strategic actions,” complete with a zoom call later in the day. The details, you will have no doubt heard about, but essentially the bank announced a share sale of “substantially all” of its securities (a good analogy to a share sale is a second IPO) in order to boost its capital and get more cash.

Share sales by banks in and of themselves are not the end of the world - and there are recent examples to provide it. In November 2022 in India, the government, which was a major investor in Axis Bank, one of the well-known depository institutions in the country, sold about half of its shares and Axis continues to operate without any issues (most recent example, them buying Citibank’s Indian Consumer Banking Business). Then in December 2022 in Canada, BMO needed to get its hands on more capital to complete an acquisition so it announced a sale of $2.3 billion in stock - and that acquisition has since been completed with their purchase of Bank of the West. And finally, just last week, one of Japan’s largest banks, Post, offered a stock saleof about 20% of one of its subsidiaries (of which it held 89% before the sale). None of these examples resulted in any panic or sell-offs, but that’s because a) none of these companies had to sell all of their securities b) none of these companies indicated that concerns about their customers’ liquidity was the reason why and c) none of these companies had just indicated unrealized losses on the bulk of their investment securities on their earnings call a week before. Unfortunately, SVB has just done all of these things (or signaled its intent to).

In its presentation, SVB stated that one of the main reasons they had to do this raise was because “Client cash burn remains ~2x higher than pre-2021 levels and has not adjusted to the slower fundraising environment.” Read between the lines, this means inflation and/or the rise in interest rates are contributing to the ability of their clients - aka startups - to spend money efficiently. This is absolutely not stating that those startups are spending their funds unwisely (although certainly in some cases, that could very well be true) - on the contrary, without saying it directly, it means that for these startups, money is running out quicker than they expected because everything has become much more expensive including things like talent, marketing, operations, and so much more.

But banks are expected to have a ton more cash laying around right? I mean, they’re a bank. Well, this is where it gets fun (or not so much fun). In 2021, with the economy booming, they decided it wouldn’t hurt to put some of that idle cash into a bond portfolio consisting of US treasury and mortgage bonds - $91 billion to be precise. In essence they locked up money for the long-term that wouldn’t be available to pull from. All good from the vantage point of 2021 - except now, the value of that portfolio has dropped to $76 billion. - for a good piece of why this was already raising the alarm bells a few weeks ago, check out this great piece by the Financial Times. And now, to make matters worse, they’ve realized startups are burning cash and they could have really used these assets. Thus, the need to do a share sale.

And this isn’t even mentioning the recent crypto bank failure of Silvergate.

Why did the stock tank yesterday (and why was trading halted)?

It’s worth noting that after the revelation of the bond portfolio taking a hit (noted at the end of February) there was little to no meaningful impact to the stock. While this wasn’t great news, it seems like investors bought into Becker’s reassurances (as noted in the FT article). After all, the company continued to announce rounds of debt financing (per Crunchbase, check out this list of their most recent investments). However, upon yesterday’s disclosure/filing/presentation, the stock proceeded to tank hard - it has dropped over 60% in one day to return to levels it has not seen since 2016, and because it was tanking so hard overnight, trading was halted. This in spite of CEO Becker arranging that zoom call and pleading with investors to “calm down” - however, because the bank has pretty much admitted that on top of locking up the $91 billion (which wasn’t a great decision on its own given high interest rates have contributed to the loss in value) their startup clients are burning cash, investors are panicking and selling off. It’s a combination of hatred for tech and evaluation of the bank’s poor decision making.

Another contributing factor is the reaction from VCs. As we said before, many of their firms have either received or plan to receive financing from SVB. Many others have also parked massive amounts of deposits that they were no doubt planning to invest in their portfolio companies (or future ones). With news like this, they too are now panicking, mainly because their firms may not be able to get the financing they expected, or worse they may not have confidence that they can access their deposits (from which they fund startups) beyond $250K (the minimum amount guaranteed by the FDIC). In essence, this chatter from VCs legitimately indicates they believe the bank is going to fail.

Okay, we’re clear on why SVB’s stock is taking a hit. But why are other bank stocks going down?

SVB has invested in startups itself via debt financing, and would theoretically expect to have these loans paid back. Based on the deposit situation noted above, we can do the math about why this is terrifying for other banks and their investors:

1) SVB biggest bank for startups ->

2) Startups’ cash running out ->

3) Same (or similarly profiled) clients using cash also in debt to said bank with declining amounts of cash to pay bank back ->

4) Cause of client cash woes due to rising costs of everything ->

5) Bank running out of cash, additional cash that would have been lying around locked into bond that got hurt by interest rate hikes ->

6) Realization that your bank may also be facing the same liquidity issue ->

7) SELL SELL SELL

But how valid is the concern that other banks may be in the same dire straits as SVB? After all, SVB’s whole game is startups, and it seems like they made a bad investment decision in 2021. Other banks, i.e. the JP Morgans, Bank of Americas, etc, couldn’t possibly be in that dire of straits as SVB, right? Right?

This is actually a good point. There are a few things that differentiate SVB from these other banks:

(All numbers in billions). One of these things is not like the other. Specifically, SVB’s exposure (aka investments vs loans) compared to any of these other banks (including First Republic, which is the closest thing it has to a rival).

However, at this point, perception is reality. The truth is, this comes down to how much investors in other banks believe them when they say that their loans (and deposits) are in good shape. This is where contagion risk comes in, and is already beginning to show up in play - as of this morning, First Republic, was down about 30% itself at one point and has essentially been dragged into the controversy (even as other big bank stocks are doing okay (so far)).

Right now, investors (and customers) likely don’t know what to believe anymore, particularly since one bank run can lead to another, can lead to another, and before you know it you have a full on financial system meltdown.

Are there additional dominoes that could fall?

One domino (as of just a few moments ago while i was finalizing this article) has already fallen. SVB has already scrapped its plans to raise capital and is now going to look for a buyer. So the share sale that was mentioned earlier in the article is a moot point now. Early speculation on buyers range from JP Morgan to Elon Musk to the government.

And now CNBC is reporting that attempts to find a buyer are failing as customers continue to pull deposits out of the bank.

In a more meta sense, this is devastating for the fintech space (and the startup world in general). A bank like SVB going down that knew the landscape, had experience working with founders, and was a trusted partner to so many new businesses means fewer options, potentially less competence, and more stinginess in lending from banks and investors alike (as if the situation wasn’t already worrisome enough).

This isn’t good news.

I’m just a consumer or a small business owner, I’m not a finance person, how does this affect me?

Your stock portfolio and your 401(K) is likely already down, so that’s one thing to be concerned about. Another is that this has impacts on the health of the economy since the US government having to bail out this bank (potentially) signals the deeper impacts of interest rate increases than was expected and that the Fed’s philosophy of needing the economy to go into a recession for inflation to subside may be showing up in a sinister way. Furthermore, this has global effects since Chinese startups, to give one example, used SVB as a bridge bank to receive funding from US investors. This comes back to their reputation as being a trusted partner in the startup community for decades. And finally, a reason you should be concerned is that a run on the banks may likely lead to a market crash. That will affect everyone.

To conclude this article, we’ll link to a few examples of what has happened in the past in similar situations and scenarios:

Washington Mutual

Bear Stearns - Lehman Brothers - AIG

1930 Bank Run

And here are a few good resources to read further written by people who are way smarter than/more well-versed on this than I am: