The Main Causes of SVB’s Collapse: Trump’s Deregulation of Banks and Poor Balance Sheet Management by SVB

Part Two of a Special Off Schedule Blog Posting

You can find part one of this two-part blog posting here: Making Sense of the SVB Collapse.

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It’s easy to say that Silicon Valley Bank’s abrupt collapse last week was a “Black Swan Event,” an extremely rare occurrence whose existence is obvious in hindsight. The SVB case, though, is more like a perfect storm—unusually severe and due to a rare combination of meteorological phenomena.

In the aftermath of the run on SVB and insecurity related to regional bank balance sheets, it’s clear former President Donald Trump’s rollback of banking regulations in 2018 played a major role in the SVB collapse and the contagion it poses to regional banks. Those regulatory rollbacks weakened the ability of SVB and other regional banks with less than $250 billion in assets to manage risks associated with interest rates.

The perfect storm was born from a confluence of several “weather systems”:

• Accounting practices by SVB and other regional banks in the post-Trump era

• SVB’s delirious pursuits of VC-related profits

• Exorbitant spending by startups and VCs in late 2022 and into 2023

Not everyone was surprised. Seeking Alpha, for example, opined on Dec. 19, 2022, three months before SVB’s collapse, that the bank was in trouble, predicting “SVB Financial: Blow Up Risk” based on their deposit threshold and cash position. (Here)

The assets of Silicon Valley Bank are now up for sale. Specifically, SVB’s roughly $73 billion loan book, around 20 % of which is venture debt.

Moody’s Lit the Fuse: Last week, Moody’s—the ratings services firm that helped bring about the last recession—suggested it was preparing to downgrade the bank's credit rating. This downgrade was predicated on higher interest rates denting the value of the Treasury bonds on SVB’s books.

SVB’s planned response to this ratings warning was to sell over $20 billion worth of low-yielding bonds and reinvest the proceeds in assets that deliver higher returns. The bank planned to offset losses from that transaction by selling shares in Silicon Valley Bank Group (SIVB), but the planned sale backfired. News of the share sale spooked VCs and startup clients who rushed to withdraw their deposits, upending the capital raise.

The contagion effect became real on Friday: Investors dumped stocks of many regional banks which—like SVB—cater to startups, VC and service providers in the startup ecosystem. These regionals included First Republic, Signature Bank, PacWest, and Western Alliance, among others. At least five banks saw trading in their shares halted repeatedly throughout the day as steep price declines triggered stock exchange volatility tripwires.

According to UBS analyst Erika Najarian (here), SVB's average deposit balance is $1.1M and 92 % of the bank's deposit accounts have balances over $250K.

In contrast, First Republic’s average balance on consumer deposits is less than $200K. Its business deposit average account size is less than $500K, and business deposits are well diversified with no single sector over 9 %. She said technology-related deposits only account for 4 % of total deposits. For these customers, the fear of contagion may be greater than the actual impending default risk.

According to SVB filings, about 96 % of its deposits as of Dec. 31, 2022, were uninsured, far higher than a typical lender.

(NB: They aren’t alone—Bank of New York carries 98 % uninsured, while Northern Trust weighs in at 96%, followed by Signature Bank at 94%, Citigroup at 85% and JPMorgan at 68%. Source: S&P Global Market Intelligence)

So desperate for profits were SVB executives and risk and compliance overseers, they bought 10-year Treasury bonds. While Treasuries are a lower risk instrument, they can be called on a daily basis and their value, when properly recognized, varies.

Also, 10 % of SVB’s current assets came in the form of venture debt and played a major factor in its demise. Venture debt excels in bull markets, but bear markets demand it be cut and properly valued (i.e., marked to market, to let losses accrue).  When VCs slowed down or stopped funding startups, customer deposits at SVB dried-up and the venture debt became unsound from a balance sheet perspective.

VCs, founders, and startup CEOs and CFOs who did not have the guts to cut the burn in startups also hurt SVB’s position. This is a governance issue. Instead of encouraging pivots, a new sales strategy, or launching a new product, these board and ELT members should have downsized their burn. Trimming new initiatives, workforce, ELT salaries, and T&E are the easiest solutions to this problem, which many big tech companies have done.

Steps To Take This Coming Week:

Monday: If you are a startup and use First Republic Bank, PacWest, Signature, or other regional banks for checking and other services, consider transferring all your company’s capital above the $250,000 FDIC-insured limit into an ICS (InfraFi Cash Service) account to safeguard your money against further contagion. ICS accounts have overnight liquidity, provide FDIC insurance up to $150 million, and you can keep your hard-won cash with the same bank you’ve been using.

Early This Week: We will find out what’s next for SVB. Will the FDIC find a buyer or make plans to liquidate the bank’s assets?

Things to know:

• In the event of an acquisition, SVB's buyer will most likely be a big bank. Wall Street analysts see JP Morgan as the lead horse in the race, in no small part because it has been reportedly poaching SVB bankers since at least 2014. In an acquisition, though, SVB's uninsured depositors will take a hit if the bank’s liabilities exceed its assets (aka insolvency).

• If the buyer only purchases select portions of the portfolio, uninsured depositors may have to wait a long period of time for their funds.

• Either way, next week the FDIC will pay uninsured depositors an advance and continue to make dividend payments as it sells SVB's assets—no matter what that sale looks like.

• Depositors who are looking to get their money back will prefer an acquirer who buys SVB whole because this would simply move their capital into new bank accounts immediately after acquisition.

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