The Downfall of Silicone Valley Bank

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Abstract

ity. When interest rates increase, bond prices tend to decrease. This is because new bonds being issued offer higher yields, which makes existing bonds with lower yields less attractive to investors.To understand this relationship, consider that bonds are essentially loans made by investors to the issuer of the bond, such as a corporation or government entity. The bond issuer pays interest to the bondholder over the life of the bond, and at maturity, the bondholder receives their original investment back.When interest rates rise, new bonds being issued will offer higher yields to investors, which means that they will pay a higher interest rate than existing bonds. As a result, investors who are looking for yield will tend to sell their existing bonds, which have lower yields, in order to buy the new, higher-yielding bonds. This increased selling pressure will cause the price of existing bonds to fall.Conversely, when interest rates fall, the yield on new bonds will be lower than the yield on existing bonds, which makes existing bonds more attractive to investors. This increased buying pressure will cause the price of existing bonds to rise.As a result, SVB was stuck with the difficult choice of keeping their bundle of mortgage backed securities returning a dismal ~1.7% or sell at a loss to retain liquidity to find better returns elsewhere.SVB chose to sell and start moving their assets around which is typically a warning sign for large banks. Due to this, a lot of venture capitalist firms started warning their founders to take their money out of Silicon Valley Bank as quickly as possible before it was too late. This caused a classic bank run situation that is what led to Silicon Valley Bank’s stock price to drop over 60% in a single day.<p id="1

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34b">Another reason why this is such a terrifying event for startup founders and venture capitalists is that most of the assets held by SVB are not FDIC insured. According to Bloomberg Business, over 93% of SVB’s $161 billion in deposits were not covered under FDIC insurance.Silicon Valley Bank positioned themselves in the startup scene as the where you go when you’re a founder who just got a big check from a venture capitalist. This matters because typically when you get a big check from a venture capitalist it’s worth like millions of dollars. FDIC insurance is really only focused on protecting everyday people like you and me. Retail customers are normally only depositing a few thousand dollars for maybe an emergency fund or putting money away for a rainy day. This is why FDIC insurance only covers up to$ 250,000 per depositor and was created after the Great Depression when there was a run on the banks. Banks are surprisingly fragile institutions that rely quite a lot on widespread trust. Most people will not leave their money to others without full confidence in them. This is no different for financial institutions. FDIC insurance essentially provides an additional guardrail and provides more confidence for consumers to store their money in banks.This ended up being quite the scary situation as SVB had taken a massive loss on their recent sale of the mortgage backed securities at the same time that valuations in the tech industry were falling. As startups were struggling to raise funding as easily, less and less deposits where falling to Silicon Valley Bank. In response, SVB preemptively sold some more securities in order to free up extra cash only to spook investors and causing their market cap to get destroyed within a single day and get closed down Friday March 10 in 2023.</article></body>

The Downfall of Silicone Valley Bank

Banks are failing. Over the last couple decades, Silicon Valley Bank has become the tried and true bank for startup founders. Whenever a new founder secured funding for a new seed or series A, they would head on over to SVB and deposit those funds.

In recent years, especially so during the pandemic, Silicon Valley Bank has seen immense growth as interest rates were low, venture capitalist firms were flush with cash and startups were being built almost every day. Prior to the pandemic in 2019, SVB managed roughly $60 billion which grew to over $189 billion in 2022.

Growing that quickly, Silicon Valley Bank had to figure out what to do with all that newly deposited cash. They ended up deciding to buy $80 billion dollars in mortgage backed securities which returned roughly 1.7%. Keep in mind this was during the years of interest rates being close to zero and cash being super cheap to borrow. Investing quite a large portion of their assets into mortgage backed securities was was a solid, reliable strategy when money was cheap but quite the opposite when rates started increasing with no sign of tapering. This meant that the price of those mortgage backed securities fell off a cliff as interest rates increased.

The reason being that mortgage-backed securities (MBS) are a type of bond that is created by pooling together a large number of individual residential mortgages into a single security. When interest rates increase, bond prices tend to decrease. This is because new bonds being issued offer higher yields, which makes existing bonds with lower yields less attractive to investors.

To understand this relationship, consider that bonds are essentially loans made by investors to the issuer of the bond, such as a corporation or government entity. The bond issuer pays interest to the bondholder over the life of the bond, and at maturity, the bondholder receives their original investment back.

When interest rates rise, new bonds being issued will offer higher yields to investors, which means that they will pay a higher interest rate than existing bonds. As a result, investors who are looking for yield will tend to sell their existing bonds, which have lower yields, in order to buy the new, higher-yielding bonds. This increased selling pressure will cause the price of existing bonds to fall.

Conversely, when interest rates fall, the yield on new bonds will be lower than the yield on existing bonds, which makes existing bonds more attractive to investors. This increased buying pressure will cause the price of existing bonds to rise.

As a result, SVB was stuck with the difficult choice of keeping their bundle of mortgage backed securities returning a dismal ~1.7% or sell at a loss to retain liquidity to find better returns elsewhere.

SVB chose to sell and start moving their assets around which is typically a warning sign for large banks. Due to this, a lot of venture capitalist firms started warning their founders to take their money out of Silicon Valley Bank as quickly as possible before it was too late. This caused a classic bank run situation that is what led to Silicon Valley Bank’s stock price to drop over 60% in a single day.

Another reason why this is such a terrifying event for startup founders and venture capitalists is that most of the assets held by SVB are not FDIC insured. According to Bloomberg Business, over 93% of SVB’s $161 billion in deposits were not covered under FDIC insurance.

Silicon Valley Bank positioned themselves in the startup scene as the where you go when you’re a founder who just got a big check from a venture capitalist. This matters because typically when you get a big check from a venture capitalist it’s worth like millions of dollars. FDIC insurance is really only focused on protecting everyday people like you and me. Retail customers are normally only depositing a few thousand dollars for maybe an emergency fund or putting money away for a rainy day. This is why FDIC insurance only covers up to $250,000 per depositor and was created after the Great Depression when there was a run on the banks. Banks are surprisingly fragile institutions that rely quite a lot on widespread trust. Most people will not leave their money to others without full confidence in them. This is no different for financial institutions. FDIC insurance essentially provides an additional guardrail and provides more confidence for consumers to store their money in banks.

This ended up being quite the scary situation as SVB had taken a massive loss on their recent sale of the mortgage backed securities at the same time that valuations in the tech industry were falling. As startups were struggling to raise funding as easily, less and less deposits where falling to Silicon Valley Bank. In response, SVB preemptively sold some more securities in order to free up extra cash only to spook investors and causing their market cap to get destroyed within a single day and get closed down Friday March 10 in 2023.