The Collapse of Silicon Valley Bank

SVB found itself unusually exposed to interest rate risk given the composition of their fixed rate asset holdings. When interest rates go up, most banks have to pay more interest on deposits, but also generate more interest income from the loans they issueThis typically results in profiting from rising interest rates with the spread captured as net interest margin or to put it more simply, revenue. SVB held a large quantity of fixed rate long-duration bonds, which on a mark-to-market basis were overvalued on their books in light of the Fed’s rate hikes focused on combating high inflation (for reference, when the Fed raises rates, fixed rate bonds typically experience a price decline and rise in yields).

Every bank optimizes their balance sheets for profits, capitalizing on rate differentials between their assets (issued loans) and their liabilities (sources of funding) — many banks borrow short to lend long, as that is what banking is — but many banks end up with a more balanced base than SVB. In the Financial Times, Robert Armstrong wrote: “Few other banks had as much of their assets locked up in fixed-rate securities as SVB, rather than in floating-rate loans. Securities were 56 percent of SVB’s assets. At Fifth Third, the figure is 25 percent; at Bank of America, it is 28 percent.” As Oppenheimer bank equity research analyst Chris Kotowski summarized, SVB was “a liability-sensitive outlier in a generally asset-sensitive world.”

When interest rates are higher, a dollar today is better than a dollar tomorrow, so investors want cash flows. While interest rates remained low for a long time, investment capital flowed easily to startups; once interest rates suddenly increased faster and to a much higher rate than anticipated, a large portion of new funding that was rushing to SVB customers was suddenly cut off. In SVB’s case, its startup customers kept taking money out of the bank to pay rent and salaries, but stopped depositing new money due to limited revenue and reduced VC funding. As startups began to hear rumors that SVB was in trouble, they immediately began to withdraw their deposits, forcing SVB to sell securities at a loss to return its customers’ deposits. SVB lost money and looked financially shaky, so customers got spooked and withdrew more money, soSVB sold more securities, and booked more losses…and the cycle continued to accelerate.

The combination of over-hiring in the tech sector over the last two years and slowing revenues led to a significant amount of SVB’s client base to experience accelerated cash burn in pursuit of growth, leading to a rapid decline in SVB’s deposit base as venture funding began to slow. On top of this, SVB was heavily exposed to longer duration fixed rate bonds, which declined in value as the overall interest rate environment marched upwards. So what happened? As SVB struggled to honor ongoing withdrawals, they needed to sell those declining fixed rate bonds at a loss to fund the requests. Given the bonds are worth less than they were at the time of purchase, SVB had to take realized losses. SVB decided to raise common and preferred equity (from General Atlantic) to fund the losses, which created the illusion of blood in the water for investors and started a cycle of panic perpetuated in part by VC funds’ direct outreach to their portfolio companies and on social media to move funds out of SVB. Once the run on the bank started, it could not be stopped.