A note to start: In today’s special edition of DD, we want to help you understand why Silicon Valley Bank suddenly went bust, what it means, what comes next and how it could change financial and private markets.
Welcome to Due Diligence, your briefing paper on Dealmaking, Private Equity and Corporate Finance. This article is the on-site version of the newsletter. Sign up Here To get the newsletter delivered to your inbox every Tuesday through Friday. Contact us anytime: [email protected]
DD breaks down SVB’s downfall
on Friday, Silicon Valley Bank was shut down by US regulators.
The collapse of the $209bn-in-asset lender is the second biggest bank failure in US history after its 2008 shuttering. Washington Mutual, SVB tried and failed to raise $2.25 billion in new funding to cover losses on its bond portfolio and began looking for a buyer to rescue it, according to people with knowledge of the efforts.
The bank’s failure sent shockwaves through Silicon Valley, where it is a major lender to many of the largest venture capital firms and their portfolio companies.
Let’s back up for a second. , , What is SVB?
Founded 40 Years Ago as a Small California Lender, SVB Carves a Mighty Place During the Tech Boom, Beats Wall Street Giants JPMorgan Chase And Goldman Sachs, in financing tech companies’ growing affinity for debt as they sought to stay private longer and avoid diluting equity positions. It was also an important lender to venture capital and private equity firms that increasingly used leverage at the fund level.
But its codependent relationship with start-ups backfired as the tech world was hit by rising interest rates, which increased SVB’s funding costs, as well as the biggest drop in tech valuations since the dotcom era. SVB also found itself exposed: its market capitalization has plummeted from a peak of more than $44bn two years ago to just $6.3bn at the end of trading on Thursday.
How did we get here?
As the Financial Times reported in detail last month, the lender’s troubles stem from a wrong bet on interest rates made at the height of the tech boom. Our colleague Rob Armstrong explains the crux of the issue at Unhedged: SVB’s tech start-up clients, flush with money from venture capitalists during the speculative coronavirus tech boom, are flooding the bank with cash (dark blue line) Were.
Unable to lend at the same pace (light blue line), the SVB decided to deposit a staggering $91bn elsewhere: long-term securities such as mortgage bonds and US Treasuries (red line).
Here’s why it’s bad, Unhaged explains: “This gave the SVB a double sensitivity to higher interest rates. On the asset side of the balance sheet, higher rates reduce the value of those long-term debt securities. On the liability side, higher rates mean less money invested in tech, and thus, less supply of cheap deposit funding.
When federal Reserve Aggressively raising interest rates, this asset/liability mismatch meant that the bank faced a margin squeeze.
In addition, the value of SVB’s bond portfolio fell by $15 billion. , , Almost as much as the bank’s Tier 1 common equity.
Making things worse, the subsequent share sale blew the bank’s balance sheet to the brim.
SVB expected to sell $1.25 billion of its common stock to investors and an additional $500 million of mandatory convertible preferred shares. It has received a commitment to invest $500 million from its longtime client General Atlantic which was subject to the completion of the share sale.
But as its bankers at Goldman built up the book on share sales, SVB’s stock was in the midst of its biggest drop on Thursday, slashing $9.6 billion from its market capitalization. Goldman was able to meet sufficient demand for a $1.75 billion share sale, according to people with knowledge of the matter, but the rapid decline in SVB’s business made the deal untenable.
SVB’s tech customers were already pulling cash — or burning it — as venture capital funding dried up. When its fragility was exposed, clients, including companies advised by venture capitalists Peter Thiel, pulled their cash, as has Bloomberg informed of,
SVB’s customers were impatient and quickly tore a large hole. they had large deposits that were beyond Federal Deposit Insurance Corporationguarantees, and were prone to drop at signs of distress – $151bn of the bank’s $173bn deposits was uninsured. SVB could do nothing to stop the bleeding.
That day, as bankers worked their phones, SVB customers attempted to withdraw $42bn. The amount was so large that Goldman bankers knew they could not proceed with the offering without first informing investors again.
By Friday morning, SVB and Goldman had abandoned the effort as they began looking for an emergency buyer.
Bondholders are also bracing for huge losses: SVB’s senior debt was trading at about 45 cents on the dollar on Friday, and its junior debt dropped as low as 12.5 cents.
what happens next?
The collapse has left Silicon Valley start-ups scrambling To pay employees and identify sources of back-up funding following the intervention of US regulators at the FDIC.
The FDIC only guarantees bank deposits up to $250,000, which is well under the account balances of its early-stage tech and venture capital clients.
Several SVB depositors FT spoke to are hopeful that the bank will be bought out of receivership and its new owner will reopen the accounts and start lending.
The collapse could also have major ramifications for investment firms on the other side of the pond. People in the know told DD that many European private equity and credit firms turned to SVB for fund-level leverage facilities, which helped juice their returns.
FT also revealed that bank of england SVB plans to bring its UK branch into resolution after it applied for £1.8bn of emergency liquidity on Friday.
We don’t want to get too ahead of ourselves when it comes to the potential consequences for the rest of the banking industry. SVB was an outlier both in its exposure to the tech industry and its disinclination to the Fed’s steep hikes in interest rates over the past 12 months.
Another big difference between SVB and its peers is that most of its clients are businesses, not retail investors – meaning that if yields fail to impress, or simply burn through their accounts with cash, They’re more likely to pull their cash.
Panic is in the air for many in Silicon Valley. “This is an *extinction level event* for start-ups,” Gary TanStart-up Accelerator President Y Combinator, wrote on twitter on Friday.
And a smart read to end: The FT’s Tom Braithwaite offers a glimpse into the chaos of an FDIC takeover in 2011. Spoiler alert: It was a mess.