The Collapse and collateral damage of Silicon Valley Bank

How SVB (Silicon Valley Bank) which was amongst Forbes America’s 50 best banks for five consecutive years collapsed in just 48 hours?

 

 

 

What happens to the startups that have direct or indirect exposure to SVB?

 

How does the collapse of SVB benefit or hinder Bharat?

 

 

There is a very powerful shloka in Sanskrit, “वज्रं वज्रेण भिन्यते”.

It simply means, “A diamond only cuts a diamond”.

 

This is true in life, and in relationships and stands true in the case of SVB.

SVB's biggest strength of being the apple of an eye for the startup world became its biggest weakness, which led to its downfall.

 

  

The Silicon Valley bank was founded by former Bank of America employees Bill Biggerstaff and Robert Medearis in 1983 to cater to the needs of startup companies. SVB started its operations on Oct 17, 1983, as a wholly-owned subsidiary of Silicon Valley Bancshares with mere 100 initial equity investors with its first branch in San Jose City, in the State of California.

 

The underlying assumption, thesis, conjecture of setting up the bank was that - traditional banks didn’t understand the banking and loan needs of start-ups and venture funds, that have a business model of not making revenues or profits quickly. SVB positioned itself as the Bank for the Innovative World.

 

The thesis worked and this specialized banking entity catering to VCs, PEs, and Startups grew rapidly both in fee and interest income.

 

In the next five years, SVB IPOed itself on NASDAQ. Post-listing, there was no looking back. It expanded its reach in other states of the United States as well as in other European countries including Denmark, Germany, Sweden etc. It moved further towards the East by setting up its branches in China, Israel and India.

 

As the bank grew, SVB became a one-stop-shop connecting Startups with Venture capital firms (VC), connecting Venture-Capital firms with law firms, and accounting firms, helping startup founders avail quick loans pledging their un-listed equity and any and every other value-added services, the founders or the funders of the entrepreneurial ecosystem would need.

  

 

 

In one of the interesting lending transactions undertaken a couple of decades back, SVB lent to Kleiner Perkins (one of the biggest VC firms in Silicon Valley), a loan of over half a million dollars to build a bridge between its two office buildings. The collateral provided for the loan was the fee that will accrue to the VC from its VC funds in the future. SVB did what it can to tailor-make and customize solutions as its clients would seek.

 

At one point in time in the past VCs made it a mandatory condition putting it as a part of the Term sheet to set up a banking relationship for its investee company with SVB.

 

SVB thus catered to the VCs, law firms, accounting firms, startups, founders, incubators, their partners, investors, in a nutshell to the entire ecosystem both on the asset side and liabilities side.

 

Over four decades, the bank moved, modified and pivoted as per the preferences of its patriarchs from a High-risk real estate lending business to providing loans for a winery building business to healthcare, life sciences, to deep tech businesses.

 

 

As of 31st December 2022, SVB relatively unknown name to the outside world had client funds of USD 342 billion USD (~ equivalent to the size of Hong Kong's economy, just a little shy of the size of South Africa and Israel’s economy), 212 billion USD in Assets and 74 billion USD in Outstanding Loans.

 

The SVB was rated amongst the best 50 banks in the United States by American Magazine Forbes for five consecutive years in a row. Newsweek, an American Weekly news magazine labelled SVB among the top 500 American Most Responsible companies in 2021.

 

SVB is the largest banking failure in the American financial system since 2008. Second largest in the history of America after the collapse of Washington Mutual in 2008 which had assets of ~ 300 billion USD.

 

 

SVB lent to startups, start-up employees with home loans, personal loans, advanced acquisition financing to VCs and many other products as its clients sought on both sides of the balance sheet.

The challenge started when the asset book had longer-dated loans & advances whilst the liability book had short-term money to finance such assets. The money raised in the form of bank balances and deposits came from the Startups funded by VCs and the VCs themselves, thus the tenure of these deposits was short and it was dependent on the cash burned by the startup.

SVB’s deposit base fell from 200 billion USD at the beginning of 2022 to 175 billion USD by end of 2022. But the bank didn’t take enough measures to shore up its deposits or diversify its deposit base from other sources.

 

On account of Covid, the US Fed reduced the interest rates to near Zero (0.00 – 0.25%). During this period of the Pandemic, Startup funding saw a mammoth jump, with the availability of cheap money pushing VCs and Startups to park money with SVB.

 

Whereas the deposit base of the other banks in the US grew by 37%, the SVB deposit base grew in 2020 and 2021 by over 200%.

 

With huge liquidity and no means to enhance returns, SVB invested a large quantum of these deposits in Mortgage-backed securities (MBS) @ an average yield of 1.56% p.a.

The quantum of such securities that stood on the balance sheet of SVB before the collapse stood at 80 billion USD with 97% of the MBS having a maturity of 10 years or more and to make things worse 56% being invested in fixed-rate MBS (not adjusting to increased interest rates).

 

To curb the US inflation, which hit a 9.1% mark (last decade’s US inflation stood at 1.90% to 2.30%), the fed swiftly hiked the interest rates from 0.25% to 4.75% pushing SVB’s MBS investments to have a huge marked to market losses.

To cover those losses and shore up the deposit base, SVB went to the market to sell equity, but that didn’t go through, hence was forced to exit MBS and its bond portfolio at a discount. This led to panic within the VC community, which ultimately led to the collapse of the bank.

 

 

Despite four decades in operations, SVB didn’t diversify its asset base or liability base. The VCs and the Startup ecosystem were supporting the bank on both sides of the balance sheet making it vulnerable to market ups & downs.

One is aware that financial markets are cyclical in nature and even more cyclical is the start-up or unlisted ecosystem. There can be funding winters for long periods of time especially when there is global uncertainty like covid or war or any other global or regional catastrophe.

When there is funding winter, more borrowers come to the bank with limited startups available to put in excess cash. During such times, even VCs have limited fundraises, thus creating a challenge for financing the assets or the loan book or the advances already given. This was the conundrum with SVB.

 

 

Most of the banking hustle and regulators' interest is on the West Coast around Manhattan (New York City). SVB folks grew silently in a niche market on the east coast and thus the type of loans and liability book created by SVB never came under the radar or questioning from the Fed and the other US regulators, creating a froth in terms of lending norms, investing norms as well as underwriting norms.

 

 

To top this all, the bank didn’t even have a Chief Risk officer during the toughest period for the bank when their investments were getting diminished in value (due to rising interest rates) and their deposits were being lost. The bank didn’t have a chief risk officer from March 2022 to Jan 2023.

 

Y Combinator is an American Startup technology accelerator that enabled companies like Airbnb, Coinbase, Reddit, Dropbox, Quora etc that provide mentorship, funding assistance, HR capabilities and other linkages to succeed in the startup ecosystem. It has financed and assisted over 217 startups in India including some of Unicorns like Razorpay, Meesho, Groww, and others like Zepto, Khatabook etc.

 

Nearly 60% of Y Combinator Indian startups have exposure to SVB. The norm set to get funding was simple. To get the backing from Y Combinator, the Indian Startups had to shift their corporate ownership entity from India to the US.

  

Once the Indian startup owner entity becomes the US entity, the Y Combinator get the startup to open the bank account with SVB as the default bank to ensure the tracking and the end utilization of funds. Thus all the funding and surplus of startups stayed with the SVB.

 

With the collapse of SVB, the funds that VCs have provided to the startups have been stuck at SVB creating a challenge for the Indian startup ecosystem.

 

 

Post-SVB Crisis, the First Republic Bank met with the same fate as SVB. It also failed to honour its deposit holders when its depositors took out 40 billion USD in deposits from the bank post the SVB implosion. Thankfully 11 big banks in the US and the Fed provided emergency funding support to prevent the meltdown contagion.

 

From this episode one can clearly see and say that tightness and prudence from the Indian Banking regulator to curb and discourage Crypto, taking judicious measures of not freely distributing cash during Covid and Sane regulations (checks and measures) towards banks has made India, an Island of Hope and Safety amidst global chaos.

 

This brings back the thought of the famous Scottish Philosopher - Thomas Reid who once said, “The chain is only as strong as its weakest link, for if that fails the chain fails and the object that it has been holding up falls to the ground.”

 

The banking and financial system in any economy is exactly like that chain, where every part of the chain needs to strengthen for the system to work seamlessly, else in the zeal to support one specific segment, the jitters can be felt everywhere.