How SVB Lost Their Bank

Last Updated March 12, 2023
How SVB Lost Their Bank

Move Fast and Break Things

Last Wednesday, Silicon Valley Bank was fine. Thursday, the stock tanked. Friday morning March 10th, the bank belonged to the FDIC.

There will likely be a lot to say over the next few weeks about what happened here, but as of this weekend it seems pretty clear that SVB failed spectacularly for two key reasons:

Duration Mismatch

All banks are in the the business of duration mismatch. This means that they have short duration liabilities (deposits from customers which can be fully withdrawn at any time), which they offset with long duration assets (e.g., a mortgage loan that gets slowly repaid over 30 years). Banks do other things, too, but really this is the nut. They pay out very low interest on short term deposits, and they receive much higher interest on long term loans, and the spread between the two goes in their pocket.

The entire purpose of the leadership and management and board of directors at the bank is to not mess this up too badly. Because if you get too greedy and have too many assets that don't mature for a very long time, and you have a lot of depositors who can demand their money back at any moment, and then also you have just a little bit of bad luck.. well, you lose the bank.

That's what happened to SVB. They weren't investing in anything unusually risky, just super vanilla US Treasury bonds and mortgage backed securities. Unfortunately, they bought a lot of these bonds right before the Fed started raising interest rates, and as rates rose (and they have risen very quickly in the last 12 months), the market value of those bonds went deeply underwater. For a while this was fine, because no one needed to get their money from the bank. But depositors soon saw that SVB had these unrealized losses and began withdrawing some cash, which meant SVB had no choice but to sell assets at a loss, which made the problem even worse and before you knew it the market value of their liquid assets was less than the cash that SVB's customers wanted to withdraw and the FDIC had to take over the bank.

Even More Interest Rate Risk

SVB's deposit base increased greatly during Covid, because SVB has made a business out of serving the narrow niche market of silicon valley tech startups. When Covid spiked the tech-dominated startup industry boomed (particularly around software-as-a-service, remote/cloud solutions, etc). Part of the reason these startups had so much cash was because the Fed's zero interest rate policy for the preceding 15 years created easy credit. Money was essentially free to borrow, and cheap to invest in would-be unicorn startups. If interest rates ever rose, the free-money spigot would turn off, and SVB was almost certain to lose a lot of their deposits, disproportionately more than other banks.

In this way, SVB was particularly sensitive to interest rate changes. Established above, they made long term investments that would absolutely cripple their liquidity if interest rates ever rose. But on the other side, they were running a business where interest rates rising would obliterate their depository base and require that they have a lot of liquidity available.SVB bet both sides of their balance sheet that interest rates would never rise, and they did it during the lowest interest rate environment in modern history.

Concentration Risk

This one is even easier to explain. SVB was the 16th largest bank in the US, which sounds like they would probably have many, many individual depositors - probably tens of thousands, though that's just a guess. But SVB served a very particular submarket: silicon valley tech startups. One thing that these startups have in common is that they are predominantly funded and controlled by the same small handful of silicon valley venture capital firms. When these VC firms invest in startups they put their own people on the board in order to monitor the company and help steer it to profitability. This means that all these thousands of 'diversified' startups are under the control of a few dozen VC firm owners who can pick up the phone at any time and instruct all of their portfolio companies to withdraw their cash from the bank. So in truth SVB was the 16th largest bank in the US, but the people who controlled the vast majority of SVB's deposits could probably fit in a single conference room.

Doing it for the Memes

Lastly, and to their credit this item isn't entirely SVB's fault, but it's worth noting that this has been the first giant bank run in the age of ubiquitous social media. We now live in a world where "withdraw your cash" can be a trending topic that makes everyone's wristwatch vibrate in real time, and where said cash can be withdrawn from said watch, also in real time. It used to be that to take tens of billions dollars out of a bank you'd need at least need a few trucks - but today all you need is a hashtag. Worth noting that I do not entirely absolve SVB management here either, as their customer base skews much harder 'terminally online' than any other bank, the threat of a 'hashtag run' on their bank was arguably always disproportionately high.

Inevitable Conclusion

SVB was poorly managed. They bet the whole bank on a gamble that interest rates would never rise, during a period of historically low interest rates. They also had a bit of bad luck, and then a run, and now they're gone. Management lost their jobs, and the investors are totally wiped out.