As you've probably seen on the news by now, Silicon Valley Bank (which trades under SVB Financial (SIVB, Financial)) has recently collapsed in what has been dubbed as the biggest bank failure since Lehman Brothers in 2008. Now there are talks of possible "contagion,” which is a knock-on effect on other businesses which had deposits or exposure in some way to the business.
In this article, we will take a closer look at Silicon Valley Bank and why is it important before diving into what happened in this recent crash and what the fallout could mean for investors; let’s dive in.
Why is Silicon Valley Bank important?
Silicon Valley Bank is a mid-sized bank which was known as the go-to place for startups and scale-ups to store their raised funds from Venture Capital. In fact, over 50% of all venture-backed companies in the U.S. have funds or a relationship with Silicon Valley Bank, according to the company's website.
The bank also has a Venture Capital arm, which has relationships with over 760 unicorns (worth over $1 billion) and leading VC firms such as Sequoia, Accel and Kleiner Perkins. Its VC arm also invested into 75 different funding rounds for startups with mainly venture debt, equating to a staggering $5.7 billion.
Therefore, a failure in this bank would mean at least half of VC-backed technology companies could miss payroll, invoices, etc. This could have a huge impact on the innovation economy, which is already teetering on the edge of a recession.
What made it collapse?
Like any major financial collapse, the exact details are not straightforward, but here is what we do know so far. As of the first quarter of 2020, the company had ~$60 billion in total deposits. However, due to the boom in VC funding and the stimulated economy from quantitative easing measures and near-zero interest rates, its deposits skyrocketed to a staggering $342 billion by the fourth quarter of 2022.
A bank's job is to conservatively invest these deposits in order to generate profits for the business. In this case, the bank purchased over $100 billion of U.S treasurys and government-backed mortgage securities. These are often known to be “default free” or “risk free" as they are effectively backed by the U.S. Treasury.
However, as the Federal Reserve has raised interest rates to combat inflation, the bank's securities purchased (which pay a fixed/low interest rate) would effectively be worth substantially less should it have to sell them. By the fourth quarter of 2022, the gap between the cost of these investments and their fair value (if marked to market) was over $17 billion.
This delicate situation was like a barrel of dynamite, ready to explode if a spark lit the fuse. In this case, the macroeconomic environment around VC funding has dryed up, as have IPOs, which was the exit signal for many VC firms. These factors caused deposits to fall from $200 billion in March 2022 to $173 billion by December 2023.
Then, on Wednesday, March 8, the company sold a staggering $21 billion of its securities at a loss of $1.8 billion. The goal of this bold act was to help “reset” its balance sheet to be more aligned with the higher interest rates. In addition, the company wished to free up capital to fund new lending or any further outflows. The business also planned to issue new shares and raise ~$1.2 billion to cover its losses.
The sale of securites on the Wednesday caused the stock price to crater as investors panicked, plummeting by 68% in just a couple of days. Therefore, this would mean the cost of capital would be higher, and thus it had to put its share sale on ice.
It was at that point that alarm bells started to ring and many VC firms urged their portfolio companies to withdraw deposits from the bank. This caused a bank run as more and more customers panicked, fearing they would not be able to get their money out. This resulted in customers withdrawing a humongous $42 billion in deposits, which effectively meant the bank ran out of liquid cash, so as a result it was closed by California regulators.
Aren’t bank deposits insured?
Bank deposits are insured up to the FDIC limit of $250,000 per customer account. However, it is estimated approximately 95% of the deposits held at Silicon Valley Bank exceeded this threshold with over $151 billion uninsured, according to CNBC data.
Is the bank too big to fail?
Given how deeply embedded it is into the ecosystem of VC-backed technology companies, there is a chance that Silicon Valley Bank could be bailed out.
Billionaire investor Bill Ackman (Trades, Portfolio) took to Twitter to urge for the government to fix this “soon to be irreversible mistake” within “about 48 hours." Ackman believes without a bailout, this could cause a further run on mid-sized banks as company boards urge all deposits to be moved to the “big four” banks.
Notable VCs such as David Sacks (Craft Ventures) and Mark Suster (Upfront Ventures) also stated a similar opinion on Twitter.
What does this mean for investors?
If you're an investor directly into SVB Financial, you will of course be feeling the pain, but a bail out from the government could save the day.
There is also the risk of a "contagion” event, which is basically the spread of risk to the other half of VC-backed technology companies across the nation. If these companies can’t pay their bills or meet payroll, this could result in layoffs and further economic troubles.
Many mid-sized banks such as First Republic (FRC, Financial) and Signature Bank (SBNY, Financial) have also began to see huge stock sell-offs of over 40%. Silvergate Capital (SI, Financial) also saw its stock price plummet by over 52% in a single day.
Even the world of cryptocurrency has been affected, as Circle saw its USD coin break its peg to the U.S. dollar. This was after the company revealed it had close to 8% of its $40 billion of reserves in Silicon Valley Bank. Therefore, as more companies disclose deposits in Silicon Valley Bank, this could lead to a significant collapse in technology/growth stocks, as their balance sheets see devaluation. If these companies aren’t profitable, this could also impact payroll, expenses and investments and thus have a knock on effect in other areas.
According to SEC filings, companies such as Roku (ROKU, Financial), Roblox (RBLX, Financial), Rocket Lab (RKLB, Financial) and Vimeo (VMEO, Financial) have some exposure to SVB Financial, therefore I would expect a sell off in these stocks if financial trouble appears due to the bank's collapse. This collapse could also cause the Fed to reverse its policy on rising interest rates, and may actually cause them to lower interest rates to stimulate the economy, which would boost inflation to high levels again and make costs more expensive for these struggling companies, creating a vicious cycle.
Final thoughts
Silicon Valley Bank is an important institution and over half of VC-backed companies have exposure to its collapse. Without a bailout, we could see a repeat of the 2008 financial crisis, especially given that estimates by Statista already indicate a 58% chance of a recession in 2023. A bailout by the government could save the financial system and stop any contagion. I believe this would be the right thing to do, although it would raise polictical concerns.
Another option could be a buyout from a big four bank or even a big conglomerate like Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial), which has a vast cash position and a phone line setup ready for these events (similar to 2008). However, I believe Warren Buffett (Trades, Portfolio) would likely not be interested as the bank depositors are mainly VC-backed technology companies, which are out of Buffett’s area of expertise or interest.
