The Silicon Valley ethos is winner takes all, driven by risk-taking and stepping away from any pesky regulations. The stories of Uber, Facebook owner Meta, Google’s parent Alphabet and others provide ample evidence to support the principle.
There is, then, some considerable irony that when Silicon Valley Bank (SVB) followed the same mantra and has now failed, the tech sector has been so astounded by the demise of its flagship financial partner.
SVB was founded in 1983 by two former Bank of America managers. By 2015, the bank asserted that over 65 per cent of all US start-ups, and myriad others worldwide, used its services. Until last week, while it was only the 16th-largest US bank, it was the clear winner in banking to the Silicon Valley community. SVB knew, and was known by, anyone in the Valley who matters.
It lobbied, with others, to reduce the Dodd-Frank banking regulations introduced under the Obama administration, and the Trump administration obliged by rowing back on solvency tests and liquidity obligations applicable to non first-tier banks. Meanwhile, SVB took a huge gamble with its investment strategy. And it has now failed.
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Why did companies, venture capitalists and private equity specialists bank with SVB, often exclusively? Because nearly everyone else did, and thus SVB knew everybody and could often facilitate introductions. The bank was a matchmaker, a connector, and a catalyst, but also a quality filter: a rising rookie company or founder could quickly and informally be vetted through the personal networks of SVB senior managers and executives.
The 11 non-executive directors on the SVB board included management consultants, experienced executives and venture capitalists spanning the tech sector. Just one came from the banking industry, and one from a US treasury background.
On Thursday, the rumour machine was rife, with many customers seeking to totally withdraw their funds despite the protestations of SVB leadership
The business model of most banks is to take deposits from those who have money to invest, to lend at a higher interest rate to those who need money, and to pocket the difference.
But by focusing on start-ups, venture capital and private equity funds, SVB had a majority of customers who had surplus money and often did not need loans. This was particularly the case throughout 2021, when interest rates were very low and almost all investors sought higher returns via riskier investments.
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Funds drenched the tech sector from venture capital, private equity, initial public and secondary offerings, and special purpose acquisitions (Spacs). Many tech sector customers, start-up or risk funds alike, parked their excess cash into SVB. SVB’s deposits grew by 86 per cent in 2021 alone, reaching $209 billion (€195 billion) by the end of 2022. About 37,000 customers accounted for 74 per cent of the bank’s assets, with an average account size of $4 million.
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Because few customers needed to borrow money – quite the opposite – SVB sought a low risk haven for its substantial deposits. But interest rates were low – which drove the inflows of underused capital into SVB in the first place – and so the bank purchased US government bonds with long maturity dates, which offered better interest yields. After all, US government bonds are a safe investment, or so the SVB board presumably judged.
The inevitable happened. In mid-2022, the US Federal Reserve started raising interest rates, concerned as inflation rates in the US economy surged after the pandemic downturn. US government bonds became available at higher yields, reversing the earlier investor flight from bonds into risk capital.
The tech sector started to stall, and public and secondary offerings diminished. Company valuations fell, and the start-up sector struggled to raise new funding rounds. Naturally, those with deposits at SVB began drawing down to cover routine costs such as payroll.
As the Valley well knows, innovation and disruption change entire sectors, economies and societies. The Valley celebrates the consolidation of power in new industry leaders.
SVB needed to meet its customers’ understandable withdrawals, yet much of its deposit capital was tied into long-term, low-yield, US government bonds purchased in previous years.
These bonds were perfectly safe but were not in themselves an immediate source of cash. The bonds could of course be sold but only at a loss, because they were low yield as compared to the higher yields available today from current US government bonds. SVB’s chief risk officer, responsible for managing the bank’s exposure and in particular balancing customer cash requirements against the bank’s assets, stepped down in April 2022. She was not replaced until January.
In December, there were some whispers by industry insiders that SVB had serious challenges. While the customer base was apparently diversified, in practice a relatively small number of risk investment firms strongly influenced the bulk of these customers. Neither SVB’s investment portfolio nor customer base were in reality diverse.
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SVB then sold $21 billion worth of its US government bonds, but at a loss of $1.8 billion. It hired Goldman Sachs to undertake a private sale last week of $2 billion of new SVB equity to plug the gap, planning to announce this publicly only after completion, so as not to spook its investors and customers.
On Wednesday, Moody’s notified the bank that it was about to downgrade its credit rating. SVB executives feared a credit downgrade would alarm its investors and customers, and sought to immediately anchor the private sale with a $500 million commitment from private equity firm General Atlantic.
On Thursday, the rumour machine was rife, with many customers seeking to totally withdraw their funds despite the protestations of SVB leadership, and others calmly advising that that they would stay with SVB: after all, it was just too important to the tech sector to be allowed to fail. SVB stock fell 60 per cent, and General Atlantic withdrew. On Friday, government regulators stepped in to take control to try to protect depositors.
[ Problems remain for Irish tech firms despite SVB rescueOpens in new window ]
As the Valley well knows, innovation and disruption change entire sectors, economies and societies. The Valley celebrates the consolidation of power in new industry leaders. But SVB clearly demonstrates how this culture creates obvious vulnerability.
Will the disruption now caused by the failure of SVB become a case of Silicon Valley having to – in a Valley phrase – eat its own dog food? And should we expect changes in Valley culture as a result?
