Silicon Valley Bank (SVB) was founded in 1983 by three entrepreneurs: Bill Biggerstaff, Ken Wilcox, and Rebeca Spencer. The three had worked together at another bank and saw an opportunity to provide specialized banking services to the technology industry in Silicon Valley. At the time, most banks were reluctant to lend to technology startups, and the founders believed that there was a significant need for a bank that understood the unique needs of this industry.
Initially, the bank was called Santa Clara Valley Bank and operated out of a small office in Santa Clara, California. In the early days, the founders had to work hard to convince potential customers that the bank was a safe place to deposit their money. Many startups were wary of using a new bank that had no track record and was not part of a larger banking institution.
Despite these initial challenges, the bank began to grow. In the early 1990s, it changed its name to Silicon Valley Bank to better reflect its focus on the technology industry. The bank’s reputation grew as it continued to provide specialized banking services to technology companies, including loans, lines of credit, and cash management services. Silicon Valley Bank was able to provide these services because it had a deep understanding of the technology industry and the needs of startups.
In the late 1990s, Silicon Valley Bank went public and began trading on the NASDAQ stock exchange. This move allowed the bank to raise capital and expand its operations. Over the years, Silicon Valley Bank continued to grow. The bank had a long history of working with companies in the technology industry, and some of its biggest clients have included companies like Google, Apple, Cisco, and Netflix.
For years, SVB has been investing in long term Treasury bonds, instead of lending. This was to try and keep a steady but secure return since the bank’s loans were concentrated in the startup industry. The bonds were purchased when interest rates were low but as the Fed started increasing rates, the yields on the bond decreased significantly. See Episode #XXX of our podcast for an explanation on bond yields
In addition to lower yields on their bonds, startups were raising less and less funds, so they had to draw on their existing accounts, which decreased the liquidity the bank had. The bank also had a large number of uninsured depositors. As the financial market started growing more volatile, the startups started withdrawing funds, the uninsured depositors started withdrawing funds and the treasury bonds had to be sold at lower yields. Last week, SVB failed to raise an additional $2.25 billion in new capital to cover all the losses from bond sales, causing a run on its deposits.
The FDIC has announced that the depositors will be made whole, but shareholders and bondholders will not. That’s also what they said when Lehman Brothers failed as the first of many dominos that caused the 2008 collapse.
This maybe the tip of the iceberg. Marketwatch has identified 9 other banks with negative capital and exposure to cryptocurrency. However, all of the banks are smaller local or regional banks and not of them are the larger national banks.
The rub behind all of this is not just a panic in the market, but accounting induced. In the midst of the financial crisis in 2007, the FASB (Financial Accounting Standards Board), the private body in charge of establishing Generally Accepted Accounting Principles (GAAP) in the US, fast-tracked a rule known as mark to market. This rule breaks up securities held by a firm into two general buckets: Available for Sale and Held to Maturity.
Available for Sale are securities that can be sold at any time. The value of these securities is required to be adjusted every quarter if they are losing money, regardless of whether they are actually sold or not.
Held to Maturity securities are ones that are intended to be held to maturity and are not required to be revalued every quarter.
In its December 31, 2022 financial statements, the bank recorded an unrealized loss on its treasuries in the amount of $1.8 billion. This was not an actual loss, it was unrealized if “all maturities were sold”. As a result of this perceived loss, there was a run on the bank. As more and more withdrawals occurred, SVB had to now actually sell these bonds at losses in order to meet the withdrawals. A snowball effect that ended in the bank being taken over by regulators.
Although the intention of mark to market accounting was to prevent fraud by companies such as Enron that would inflate money losing assets on their balance sheet in order to attract more investors, the flip side of the coin is that forcing companies to devalue their assets on their balance sheet just because the market is unfavorable can also cause chaos in the markets.