The story so far: The collapse of the California-headquartered Silicon Valley Bank (SVB) in 40 hours the previous week caused panic in the global tech-based start-up ecosystem.The California Department of Financial Protection (DFPI) closed the bank and took possession of the private lender — citing inadequate liquidity and insolvency. It appointed the Federal Deposit Insurance Corporation (FDIC) as its receiver.
The private bank has been particularly pivotal in lending support to the technology-based startup ecosystem. The development also categorises SVB as the largest bank to fail since the 2008 global economic crisis.
What was done in the immediate aftermath?
Treasury Secretary Jennet Yellen ruled out the possibility of a complete bailout of the bank.
The White House said that the Treasury Department is working with regulators on the next steps. Meanwhile, on Monday, the U.K. government along with the Bank of England facilitated the sale of the beleaguered bank’s U.K. arm to HSBC.
As previously noted, FDIC was appointed the ‘receiver’— in other words, a temporary guardian to take possession and facilitate the sale or liquidation of the assets to repay the entity’s outstanding debts. Insured depositors were given full access to their deposits Monday onwards, allaying concerns about the availability of deposits.
The management of the bank has been fired. Shareholders will also not be protected. “Investors in the banks will not be protected. They knowingly took a risk, and when risks don’t pay off, investors lose their money. That’s how capitalism works,” U.S President Joe Biden tweeted.
Further, as reiterated by Mr. Biden, “No losses would be borne by the taxpayer.”
In a joint statement with the U.S. Treasury Department, regulators announced that additional funding would be made available to eligible depository institutions for meeting the needs of their depositors.
Losses accruing to the Deposit Insurance Fund to support uninsured depositors would be recovered by a special assessment, as required by law. The Deposit Insurance System protects customers’ deposits— the standard insured amount is up to at least $250,000 per depositor per FDIC-insured bank— should an FDIC-insured bank or savings association fail. Any amount above this limit qualifies as uninsured.
Customers are not required to purchase deposit insurance separately; it functions by default. Money is accrued into the fund via payments made by banks.
In his address, President Biden assured that the banking system and deposits are safe. “Let me also assure you: We will not stop at this. We’ll do whatever is needed on top of all this,” he stated.
What led to the situation?
In an endeavour to fight inflation, the U.S Federal Reserve has been raising interest rates since last year. However, in a tight interest-rate regime, credit and capital towards the startup ecosystem become dearer Investor appetite to invest in startups and companies wanes, with broad investor unenthusiasm. This in turn results in a passive environment for IPOs and fund-raising for many startups as investors are unable to gauge how they would be able to exit their investments (or positions) in a company profitably.
SVB, which refers to itself as the “financial partner of the innovation economy”, is particularly exposed to the start-up ecosystem. It operates across four verticals: global commercial banking, private banking and wealth management, investment banking and venture capital and credit investing. Since it facilitates credit to startup companies, it is also exposed to greater risk. CEO Becker has, however, stated that early-stage loans, its highest risk segment, represented only 3% of its overall portfolio.
In January, the bank stated that it expected continued slow public markets, further declines in venture capital deployment and a continued elevated cash burn in the first half of 2023 with modest declines in second half. It had already observed four consecutive quarters of declining venture capital investment, albeit at a “slowing” pace.
In order to meet liquidity needs spurred by the inflationary regime and the slowing IPO market for startups, clients started pulling their deposits from SVB. This “cash burn” remained high and increased further in February. This resulted in lower deposits than forecasted, as companies rushed to withdraw deposits to keep their enterprises afloat.
Seeking to bolster this gap, the bank sold a $21 billion bond portfolio last week, consisting mostly of U.S. Treasuries. Its portfolio was yielding an average of 1.79%, much lower than the current 10-year Treasury yield of around 3.9%. This forced SVB to realise an approximately $1.8 billion loss.
How did the collapse take place?
What set in motion the subsequent chain of events was CEO Greg Becker’s letter to investors, informing them that the bank would realise this one-time, post-tax loss of approximately $1.8 billion.
The bank’s funding gap was to be cushioned through a capital raise using common equity and preferred convertible stocks – amounting to $2.25 billion. The intention behind the capital raise was to shore up their asset sensitivity, partially lock in funding costs and shield their net interest income (NII) and net interest margin (NIM)— the two most important metrics for assessing a bank’s financial health—from the impact of the higher interest rates regime, thereby enhancing profitability. This was to be done through reinvestment of the proceeds.
“We continue to see healthy technology borrowing as clients opt for debt over equity, but loan balances overall remain pressured by Global Fund Banking paydowns due to slower VC and PE investment,” the CEO’s letter read.
However, the announcement triggered a ‘bank run’— a large number of depositors withdrew their money fearing that the bank would become insolvent. In other words, clients were concerned due to the seeming incongruency between deposit safety and the bank’s need to raise more capital. Depositors withdrew $42 billion from the bank a day after the announcement. This resulted in the bank collapsing to a negative cash balance of $958 million. The regulators noted that “precipitous deposit withdrawal” had rendered the bank incapable of meeting its obligations as they came due. Thus, it was deemed to be insolvent and conducting business in an “unsafe manner” relative to its financial position.
Garry Tan, CEO & President of startup-accelerator Y-Combinator noted that the event triggered concerns about a “systemic contagion” with negative effects spreading to other domestic banks. Concerns also arose about the effects spreading to global participants.
Further, concernsemerged about 37,000 small businesses being unable to access their deposits— far greater than the FDIC limit of $250,000. According to the U.S.-based National Venture Capital Association (NVCA), this would have resulted in companies not being able to meet their payroll requirements. This in turn could cause furloughing of employees or even potential shutting down of the companies. These effects were also expected to ripple through the domestic ecosystem for startups with exposure to the bank.
For perspective on the aftermath, the S&P Regional Banks Select Industry Index <.SPSIRBK> closed 10.84% lower on March 13. Further, as reported by Reuters, major U.S. banks lost around $90 billion in stock market value on Monday, bringing their loss over the past three trading sessions to nearly $190 billion. In Europe, the STOXX banking Index <.SX7P> closed 5.7% lower.
Christopher Whalen, Chairman of the Whalen Global Advisors, blamed the bank’s failure on the fact that its management “naively invested half the bank’s assets in ‘risk free’ securities.” He observed that the bank had 43% of its total assets in mortgage-backed securities in comparison to an average of 12% for the 132 largest banks in the States. “Extension risk created by the Federal Open Market Committee (FOMC) killed Silicon Valley Bank. Shareholders of SVB have lost billions and other creditors are likely to also face losses,” he added. .
Some experts, however, offer a different viewpoint. “Given that FDIC has agreed to bail out all the depositors, it has very little financial impact,” said Puneet Purshkarna, Chairman Emeritus at The Indus Entrepreneurs (TiE)- Singapore chapter told The Hindu.
However, he adds, “It (SVB) was a great institution supporting entrepreneurs so its absence will impact the whole ecosystem, not just the Indian entrepreneurs.”
– With inputs from John Xavier
