RL45: Breaking my promise already, but SVB?!
RL45: Breaking my promise already, but SVB?!
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FWIW - This may be the article I am most proud of in our 45-edition journey.
Last week I promised to write about what it’s like to design a sales process from scratch.
I promise that I’ll get to it.
I had planned to write about identifying a customer persona, identifying their pain points, etc, BUT then…
I mean come ON - I have to write about some of the most consequential news in the startup ecosystem ever.
Enough equivocating - if you’re living under a rock, here’s what you need to know about a near meltdown of the financial system -
WTF happened with SVB?!
Mid-week last week, the CEO of Silicon Valley Bank (SVB) held a press conference and told everyone to chill out - there wasn’t a liquidity issue.
“DON’T WORRY ABOUT IT, THERE’S NO LIQUIDITY ISSUE IN THIS BANK RIGHT HERE TODAY. DO NOT PULL YOUR MONEY OUT ALL AT ONCE.”
-More or less what the SVB CEO said
By Friday, the bank had collapsed entirely.
The 16th largest bank in the United States. The bank of choice for half of the venture ecosystem COLLAPSED in 48 hours.
Wild stuff.
Here’s a summary of what led to the collapse -
The venture ecosystem between Q1 2020 and Q1 2022 was hot.
VCs were raising money at a record pace and deploying it to startups rapidly.
A lot of cash moved from Limited Partners (pension funds, sovereign wealth funds, etc) to Venture Capital Funds that banked with SVB.
These VCs deployed capital into startups.
SVB saw dramatic capital inflows between Q1, 2020, and Q1, 2022 - with deposits surging from $60bn to $200bn.
With me so far?
So SVB is sitting on a mountain of deposits as their primary clients, VC funds and startups, rake in dollars from LPs and VCs, respectively.
Next, we need to understand how banks make money -
How banks make money
Banks take customer deposits and promise a measly 0.1% interest rate for holding your cash.
They keep ~10% of that cash in reserves and turn around to loan out the remaining 90%.
They loan the remaining 90% to borrowers at a higher interest rate and make money on the spread.
There are other ways that banks make money, but let’s focus on the interest rate spread for the purposes of our story.
A ‘normal’ bank like Bank of America will loan consumer deposits in a number of ways -
Question: if your clients are startups and VCs who don’t really take on much debt, what do you do with all this cash?
Answer: Chase yield elsewhere.
SVB invested money into mortgage-backed securities and treasury bills with a longer duration.
How much?
From $27bn in 2020 to $128bn in 2022!
Interest rate risk
Let’s not dive too deep into how bonds are priced, let’s just say that price and interest rates are inversely correlated.
Interest rates go up, bond prices go down and vice versa.
The bond’s duration is also relevant - the longer term a bond, the more its price will move as interest rates move.
SO…
SVB purchases long-duration bonds in the form of mortgage-backed securities and treasury bills.
The federal reserve raises interest rates
Those long-duration bonds are sensitive to interest rate risk
Their price drops precipitously
SVB is now stuck holding bonds that are valuable, but less valuable than when they purchased them.
Then, in 2022… VC $ slows precipitously
As interest rates went up in 2022, stock prices dropped.
This caused a slowdown in the VC markets as well.
So
SVB’s assets drop in value
SVB sees its deposits shrink as VC funds are no longer able to raise giant funds
Startups spend more money than they raise
In the below graphic, look at the deposits from 2022 to 2023 - note that they lose about 1/8 of their total deposits.
Which brings us to Wednesday (3/8)…
On Wednesday (3/8/23), SVB needed liquidity (read: cash).
In an effort to create it, they decided to take two actions -
Sell $20bn of mortgage-backed securities
Raise $2.25bn by selling more of their stock to the public
They were able to sell their mortgage-backed securities, posting a $1.8bn loss on the transaction, but when it came time for the bank to sell additional shares of its own stock, the stock price fell.
And it fell.
And fell.
With the stock in free fall, the bank could not raise the additional capital needed, and depositors (VCs and startups) became spooked.
BANK RUN
Let me pose a hypothetical question to you - if I put you in a room with 10 strangers and said that everyone will keep their money if you all remain in the room, but if 3 people leave the room, the remaining 7 will lose all their money - would you stay or go?
That’s how bank runs work.
Even the most reputable banks in the world are subject to fear and panic.
If everyone with funds deposited at Bank of America demanded their money simultaneously, B of A would be F’d.
This is what happened with SVB.
Venture Capitalists started calling their portfolio companies saying, “pull your money out of SVB.”
And they did.
To the tune of $40bn - all in one day.
Fed Pulls the Plug
On Thursday, the FDIC stepped in and shut down SVB, locking in anyone who could not pull their cash out.
Over the weekend, the entire startup ecosystem panicked - for all we knew, any dollar above $250k was forfeited.
The ripple effects of this would have been catastrophic - the United States has a robust network of regional banks that are subject to this type of fear (side note: the United States is pretty much the only country on earth with thousands of banks, most other countries have 3-4 megabanks).
Fortunately, the Federal Government backstopped ALL deposits - guaranteeing any dollar above $250k would not be lost.
But was this the right move?
Abso-fucking-lutely.
In my honest opinion, the fed’s actions are the best of all possible outcomes.
Depositors do not lose their money (shame on them for not tracking their bank’s exposure to interest rate risk 🙄 /sarcasm - like any of us had any idea).
Shareholders of SVB lose their money. Sucks for them, but hopefully, this forces better corporate governance at other banks.
The government doesn’t lose a dollar.
Regional banks don’t need to worry as much about a run.
Nearly everyone wins with the notable exception of employees of SVB (my heart goes out to you), and shareholders.
Dishonorable mentions
There’s a LOT more to say about this incident, but here are some rapid-fire dishonorable mentions -
The CEO, CMO, and CFO all sold shares of SVB stock totaling $4.5m in the weeks leading up to the collapse. Assholes.
The Chief Admin Officer of SVB was apparently the CFO at Lehman Brothers?! He jumped ship in 2007 to SVB, but this dude is like the Jonah of financial services companies - yeesh.
Andy Kessler from the Wall Street Journal - this article basically insinuates that because SVB had a black, LGBTQ+, and Veteran board member, the bank was more preoccupied with diversity than doing their jobs. Jackass.
The VCs who turned their backs on SVB. Everyone seems to be shaking a finger at these VCs, but if I’m honest, I would have told my companies to do the same thing. Seriously, does your sense of loyalty to your bank exceed that of your loyalty to your investors, customers, employees, etc? What were they supposed to do? Let’s all fight game theory together! Come on.
I hope you enjoyed this week’s edition of Retained Learnings.
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Best,
Brendan