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Why did the Silicon Valley Bank Fail?

Are you scratching your head over the recent events at Silicon Valley Bank?

On Friday, authorities in California shut down the bank and transferred it to the Federal Deposit Insurance Corporation. After a chaotic few days that saw a failed capital call and a flood of depositor withdrawals, things finally calmed down.

It was shocking how quickly SVB collapsed. SVB CEO Greg Becker spent his Tuesday at an investment conference discussing his favorite ways to unwind. His bank failed not even a week later.

When did things get to this point? The market was caught off guard by SVB last week when the bank attempted a capital increase that ultimately failed. It didn’t help when the venture capitalists were urging the startup’s backers to withdraw cash.

But SVB’s downfall has been brewing for a while. 

To understand why, I suggest reading Marc Rubinstein’s explanation in his Net Interest newsletter for subscribers to the Substack platform. One of the best at assessing financial institutions, Rubinstein was a partner at a hedge fund in the past. 

I will summarize three points from his essay on SVB, but you should really check it out in its whole.

Deposits at SVB increase The bank’s reputation as the industry standard has made it a major winner throughout the recent tech boom in Silicon Valley. SVB received billions in deposits as venture capitalists raised large sums of money and put it in businesses that banked with the bank.

SVB’s investment decision was a bold one.

Typically, a bank would use customer deposits to fund lending products. However, the lack of interest in loans among SVB’s technological clientele can be attributed in part to the aforementioned IT boom.

The money was instead put into secure investments by SVB. For accounting purposes, a bank must decide whether a given security will be “held-to-maturity” (i.e., kept until maturity) or “available for sale” (sold at any time). 

Importantly, HTM assets are exempt from mark-to-market because their value is not affected by changes in interest rates or the market as a whole. In contrast, the value of AFS assets on the balance sheet fluctuates significantly more than the market. AFS portfolios are therefore typically monitored more closely by the financial institution.

The majority of these deposits were put into securities by the bank. It took a two-pronged approach, with its shorter-duration available-for-sale securities acting as a safe haven for its liquidity while its longer-duration held-to-maturity assets sought out yield. The HTM book with longer maturities increased from $13.8 billion to $98.7 billion, a much greater increase than the $13.9 billion growth in the AFS book with shorter maturities between the end of 2019 and the first quarter of 2022.Comparatively, the HTM book with longer maturities increased from $13.8 billion to $98.7 billion, while the AFS book with shorter maturities increased from $13.9 billion to $27.3 billion.

Treasury bills and mortgage-backed securities made up the bulk of these HTM assets. When interest rates increased, the value of these possessions plummeted. However, SVB’s financials did not reflect the paper losses because the assets were retained until maturity. With enough time passing, they would eventually be fully matured and eliminated from the books.

Depositors then began to demand their funds be returned.

As the dot-com bubble burst, SVB saw a rise in withdrawal requests from startup clients.

Silicon Valley Bank has a concentrated clientele, which exacerbates the bank’s problems. Its clientele are all familiar faces in their respective fields. And there aren’t a lot of them at Silicon Valley Bank. There were 37,466 depositors who had more than $250,000 in their accounts as of the end of 2022. While a concentrated effort is useful for referrals during prosperous times, it can amplify a feedback loop during downturns.

At some point, SVB ran out of time to repay depositors’ money without selling some of the securities it had purchased. It was unable to liquidate the HTM assets because doing so would destroy the bank’s financial standing.

Instead, it liquidated $21 billion in bonds from its AFS portfolio this week to try to raise money from investors to make up for a $1.8 billion loss. However, SVB’s financial sheet has a hole because the capital call failed. That’s ancient history now.

That’s why SVB didn’t succeed.

Financial institutions engage in what is sometimes referred to as the maturity transition business. They take out loans with lengthy terms (30 years for example) and short ones (your savings, which you can withdraw at any time). The trick is to manage their liquidity in the meantime so that they have enough cash to satisfy their short-term commitments even if a large number of their depositors want their money back all at once.

SVB was knocked for a loop by a good ol’ fashioned bank run. However, it was especially vulnerable because so much of its capital was invested in hold-to-maturity securities during a time of historically low interest rates.

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Wajahat Ali

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