SVB Collapse: Timeline of events, outcome, and the importance of risk management

Since last week Wednesday, the financial industry and global markets have seen the effects of the recent collapse of Silicon Valley Bank. A business bank deemed the safe heaven and opportunity-maker for startups and venture capitalist (VC) firms suffered at the hands of rising interest rates and mismanagement, leading to a collapse within 48 hours of announcing their need for more funding. The question is..how did a bank with $209 billion in assets by the end of 2022 collapse this fast?

Who is SVB and what do they do?

SVB was the 16th largest commercial bank in the U.S. based out of Santa Clara, California. They held over $209 billion in assets and $174 billion in customer deposits before it collapsed last week Friday. Their primary customers were startups, venture capitalist firms and PE firms with businesses and investments in technology, healthcare, life sciences and private equity. Their main ways of operating were the collection deposits from startups that were being financed through VC firms, connecting VC firms to startups, and providing funding to VC firms overtime to invest in startups. They did this with the belief that they are one of the very few banks who best understood startups and their risk & growth potential, and could provide them with the most fitting services. Over 50% of SVB's loans were made to VC firms, with roughly 10% of their loans to startup companies. VC firms generally use loans received from SVB to fund startups, who then deposit said funding with SVB. Outside the US, they operate in countries such as the UK, China, Cayman Islands, Singapore, Sweden, Ireland to name a few.

SVB: 2019 to Last week Wednesday

The pandemic brought on lots of opportunity for startups and the tech industry. We witnessed an increased in the use of technology to maintain business productivity and operations. Many relied heavily on technology-friendly services such as Uber, Doordash, Zoom, apps to pay bills from the comfort of their home etc. This provided the gateway for VC firms to invest in startups that can provide services to people in this pandemic-driven era that would generate more revenue and grow with more funding. SVB began taking deposits from startups who receive such funding from VC firms. Their assets grew to record numbers, with them having over $200 billion in assets (loans) and about $174 billion in deposits by the end of 2022. Having all this excess deposit, they seek investments to generate large returns over time.

During the pandemic, interest rates were very low (around 1%) to help the economy maintain stability and grow. Low interest rates provided the opportunity for many to pursue investments in long terms "low risk" assets, such real estate and government-owned bonds. SVB decided to invest over $80 billion of their customers' deposit in government bonds with the goal to get a yearly return for 10+ years at a fixed interest rate of 1.56%, with the belief that interest rates will remain very low for a very long time.

However, there is an inverse relationship with bonds and interest rates. When interest rates increase, the value of existing bonds at their low interest rate goes down because new bonds being sold at the current (higher) rate would be of greater value to buyers, because the buyer will receive a higher annual interest payment for owning the new bond. This make existing bonds unattractive because lower interest rate means lower interest payment. The only way an investor would buy those bonds with lower interest payment is if they are sold at a much lower price than what they were initially bought for.

SVB anticipated that the interest rate will remain low or get lower as the economy was still somewhat in a "pandemic" phase. This was not the case. Global pressure, war and inflation in mid-2022 going into the 2023 forced the U.S. Treasury to raise the interest rate. A higher interest rate not only decrease the value of the bonds SVB had, but it affected VC firms' ability to continuously fund startups at the same level and it affected startups' ability to get new funding. Due to this, startups then had to look to their deposits from SVB to cover their operations, payroll, bills etc. The decrease in the value of the bonds SVB had resulted in a loss of over $17 billion on the value of all the bonds they had by December 2022 as reported. This report was recognized by Moody's who decided to lower the bank's credit ratings which is never a good sign for investors.

Last week Wednesday onwards...

Last week Wednesday, SVB announced that they sold an additional $21 billion dollars in bonds at a loss of $1.8 billion and now looked to investors for $2 billion in funding to cover that loss. This spook investors and created doubt about their financial security at SVB. Peter Theil, a major investor and leader of the VC firm Founder Fund, had doubts from early on this year and decided to withdraw his money and advise the startups he invested in to do the same. This created panic across the social media landscape and led to more VC firms and startups looking to pull their deposits i.e bank run. Unfortunately, the bank did not have enough deposits on hands to fulfill all these customers needs.

The following Thursday afternoon, SVB's stock price fell from $283 to $172. To prevent a potential ripple effect across the industry, SVB halted trading of their stock at $106 on Friday and decided to no longer seek that $2 billion in funding. With no further action to take while still experiencing a bank run of over $40 billion been withdrawn, the bank collapsed, resulting in the Federal Deposit Insurance Company (FDIC) stepping in and taking immediate full control of the bank and all its assets to prevent another 2008 situation.

What's next for SVB's customers and investors...

For all U.S. banks with FDIC insurance, the FDIC has a policy which states that up to $250k per bank account owner is insured, meaning that any owner having $250k or less in their account can recover the full amount in the case of a bank's collapse. However, with SVB, over 90% of their customers had over $250K in their accounts, specifically millions and billions of dollars being that they are startups and VC firms.. not individual everyday customers. The FDIC will cover all insured deposits of SVB using money from the $100 billion fund that banks pay into, that was set up as a safe haven for future bank collapse. Customers with $250k or less will receive their money immediately. Deposits over that amount will be recovered overtime, as the FDIC plans to use all proceeds from selling SVB to repay those customers. Unfortunately, the FDIC will not help shareholders and investors.

What's next for SVB?

Even though c-suite management has been fired, the U.S. Federal Reserve has made an exception for SVB to continue to operate under FDIC's guidance with a new CEO. They will still be able to do business as usual but with much more oversight and direction going forward. The U.S. Treasury will look into the actions that management took prior to the bank's collapse. e.g. the bonus payout to management last Friday. At the same time, regulators may seek out other financial institutions to buy some assets of SVB, possibly through various M&A strategies. HSBC has already acquired the UK branch of SVB for £1. The goal of many banks, if they acquire branches of SVB, would be to leverage SVB's customer base and help them grow their businesses with a new bank rather than be stranded and further impact the startup business landscape globally.

Key Takeaways and the Importance of Risk Management

The major reasons for SVB collapse are said to be ineffective leadership, poor decision-making and lack of proper risk management & oversight strategies.

Key Facts:

• The Chief Administration Officer was the CFO of Lehman Brothers when it collapsed in 2008 causing the financial crisis

• The bank did not institute a Chief Risk Officer for 8 months; during this period there were rising interest rates, startups were tapping into their deposits and VC firms were pulling back on funding startups

• Over 10% of SVB's deposits were placed in some of the riskiest investments

• Startups' deposits were also being used as loans to other startups in the form of venture debt. This is very risky because if all startups are affected by the market, the one's needing their deposit will be unable to get that from the bank because the banks cannot recover the loan lent to other startups

• It's very ineffective for a bank that specializes in banking for startups to take risks with billions of dollars in deposits, knowing their customers require constant funding. If they're not getting that funding, they will turn to their deposits in the bank

• Executives were paid high bonuses on the Friday before the eventual collapse of the bank, which signal to many the lack of timing and proper leadership in the bank

From this, it's clear that a lot of risks were being taken across the board with very little prediction of where the market will be. SVB bet on the idea that the interest rate would remain low for a very long period of time. However, global macroeconomic issues impacted inflation, leading to rising interest rates. Even so, many argued that SVB could have made key decisions to fix the issues when the interest rate was around 2.5-3.5%. When operating financial institutions where customers rely on your trust, expertise and guidance with their money, it's imperative to have a strong, effective and well-run risk management and governance team.

The power of social media and access to investing is far greater than what it was in 2008. It's very easy for fear-mongering to takeover leading to uncertainty and bank runs if there is any whiff of poor risk management and ineffective leadership. Financial institutions should note that customers and investors are paying more attention than ever before. A financial report may be 100 pages long but the details of monetary figures, specifically losses, matter greatly to those investing millions of dollars and to customers with millions in the bank. Major losses and risky investments raise questions so early and effective communication can makes a difference.