As many are well aware, Silicon Valley Bank (SVB) failed over the weekend. SVB was a critical investor throughout the entire lifecycle of both employees and companies across the technology ecosystem. The full scope of its demise on the broader market will likely come to light over the coming weeks and month. However, we want to make some observations regarding how this failure played out and the immediate implications for the technology companies.
Silicon Valley Bank's Grossly Mismanaged Debt Security Exposure
From the information we have at hand, we think it’s fair to say that SVB ran into these issues because of poor risk management. From 2019 to 2021, deposits increased from $61.8 billion to $189.2 billion, as capital flooded into the venture capital (VC) and startup ecosystem. (1)
Since SVB could not find enough loans to deploy this capital, they decided to invest a large part of excess funds into federal agency mortgage-backed securities (MBS), purchasing over $80 billion of MBS with these deposits for their hold-to-maturity portfolio. Approximately 97% of these MBS were 10+ year duration, with a weighted-average yield of less than 2%. (2)
These securities are low in credit risk but vulnerable to interest rate changes—a fact that was made very apparent when Fed rate hikes severely and negatively impacted the fair market value of SVB’s bond portfolio.
What started to accrue was a significant loss in their securities positions.
This alone would not be a long-term issue if the bank was able to hold these until maturity instead of having to fire sale them off. Now here’s what triggered the calamity—SVB shot themselves in the foot by alerting everyone of this issue.
Wednesday afternoon, SVB announced that they had sold $21 billion of their Available-For-Sale (AFS) securities at a $1.8 billion loss and were raising another $2.25 billion in equity and debt. (2) This came as a surprise to investors, who were under the impression that SVB had enough liquidity to avoid selling their AFS portfolio.
The equity raise failed as news got out just how offside they were caught. This was accelerated by the speed of information through social media as sentiment quickly soured. Depositors panicked and withdrew cash as soon as possible, as some VCs even ordered portfolio companies to withdraw everything.
Cue the bank run.
The fact that the bank did not properly hedge against the inherent risks associated with these securities shows an inexcusable lack of risk management. In many ways, SVB’s failure was reflective of the excess inherent in much of the tech industry, leading up to the beginning of 2022. SVB is a tech investor – not a fixed-income manager – and should not have made such an irresponsible active bet.
Direct Impact of SVB Collapse’s on Technology
The loss of SVB will cause significant ripples in the tech sector. They were a huge lender to companies across the entire lifecycle of investment (nearly 50% of venture-backed technology and life science companies) and also provided liquidity to VCs that ran into capital call problems. The company’s fall will severely impact the early-stage funding funnel for startups looking for capital.
In terms of cash account exposure from a public company-specific perspective, there are a few companies worth mentioning:
- Roku – by far the most exposed: $487M (26% of cash) at SVB
- Roblox – $150M (5% of cash)
- AcuityAds – $55M (90% of cash)
- Rocketlab – $38M (8% of cash)
- Sangamo Therapeutics – $34M (11% of cash)
- IRhythm – $55M (26% of cash) (3)
On the whole, as the numbers indicate, the impact is minimal on the public market front. Large public and well-capitalized technology companies are unaffected in daily operations, but one must consider the long-term knock-on effects. The removal of a critical early-stage non-dilutive lender like SVB will decrease the potential acquisition pool to expand megacap market opportunities in the future.
The serious issue is the complete removal of the preeminent player in the tech startup funding ecosystem.
Markets can’t function properly without a healthy banking system and the Fed is acutely aware of this fact.
The Treasury, Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC) issued a joint statement on Sunday evening with two planned actions:
- Insuring 100% of SVB deposits will be backstopped, with full access Monday morning
- Creation of a Bank Term Funding Program (BTFP)
To the US taxpayer, the message is “you are not paying for this” as losses will be recovered by a special FDIC assessment on banks. For equity and unsecured debt investors who got wiped out, the message is, “you are still on the hook for your investments.”
By insuring 100% of SVB’s deposits, tech billionaires, founders, and startups are saved – but debt and equity investors are not.
The goal here is to stop the contagion amongst other regional banks by protecting deposits.
Over the weekend, they also launched the Bank Term Funding Program (BTFP), which will allow qualifying depository institutions to pledge securities to tap liquidity and limit the need for banks to sell underwater securities to shore up liquidity if deposit declines materialize. (4)
The BTFP will offer, “…loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution's need to quickly sell those securities in times of stress.” (4)
Effectively, this program will act as a bailout for depositors in SVB and, as the above quote suggests, an insurance against further bank runs on smaller cap regional banks.
As the news of SVB’s fall is so recent, it is certain that this story will continue to evolve over the coming weeks and months. What we know right now is that the removal of SVB out of the tech startup funding funnel will, in the short term at least, have seismic implications for companies trying to secure financing.
However dire the situation unfolds at SVB, there is a silver lining here. We have seen 10-year Treasuries drop nearly 50bps and 2-year Treasuries drop around 100bps. Additionally, what was previous a debate on 25 vs 50bps for a hike in the upcoming FOMC is now becoming a question of whether to raise rates at all. A rise in rates has rapidly compressed technology multiples, sending stock prices down.
Will the concurrent drop in rates provide a tailwind? History suggests it will.
—Nick Mersch, Portfolio Manager of Purpose Global Innovators Fund
- “SVB Financial Group,” Wall Street Journal: https://www.wsj.com/market-data/quotes/SIVB/financials/annual/balance-sheet
- “How SVB Was Doomed By a Bad Bet on Mortgage Securities and the Fed’s Rate Hikes,” Barron’s: https://www.barrons.com/articles/svb-silicon-valley-bank-rates-securities-693c931c
- “Companies Whose Deposits in Silicon Valley Bank Were Just Freed,” Wall Street Journal: https://www.wsj.com/articles/companies-with-deposits-trapped-in-silicon-valley-bank-9034f33b
- “Federal Reserve Board announces it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors,” Board of Governors of the Federal Reserve System: https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312a.htm
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