So what’s the deal with SVB?

By now, every major U.S. news outlet has published at least a handful of articles about SVB, every business/finance/startup podcast has produced a segment about it, and social media is full of commentary – some more accurate than others – about both what happened, why it happened, and speculation about what comes next.

I’m not going to pretend to add a new perspective here. What I will do is boil it all down, remove most of the financial jargon, and spell it out in plain English – and then pull back to 50,000 feet to put all this in context.

I’m not a trained economist (undergraduate studies don’t count IMHO), so I am admittedly a bit over my ski’s here – and should probably stick to my swim lane.

But I do understand business and basic economics, how the venture ecosystem works, and most importantly human psychology and how senior executives think, make decisions, and communicate externally. So that’s the perspective I’ll bring here.

Banking 101

To boil down what happened with SVB we must start with an overly simplistic understanding of how banks function:

Banks take money from people, corporations, and investors who want to store it somewhere (i.e., ‘depositors’). In exchange, they expect to receive interest on the money they’ve given the bank.
Banks also have to make money, so they can’t just keep the money they receive in a vault since they have to pay interest to depositors, and they have to pay their own bills (i.e., rent, software, salaries, benefits, etc.).
So banks are in the business of using the money other people have trusted them with to invest elsewhere and make more money.
Since bankers have learned some hard lessons over the years by getting stuck when they’ve invested too much of depositors’ money, the government has rules in place that require banks to keep a certain percentage of the total amount of money they’ve been given by depositors. They’re not allowed to invest this money.
The logic being some proportion of the total money they’ve been given needs to be immediately available in the event people come asking for their money back.

Venture Capital Ecosystem 101

We also have to start with a foundational understanding of what has occurred over the last 24 months across the venture capital landscape: an unprecedented amount of money has flowed both into Venture Capital / Private Equity Funds ($3.7 T to be precise) and subsequently into startups ($332B in 2021, US only).

Like any company, both funds and startups have to keep their cash somewhere, and most (nearly 50%) banked at Silicon Valley Bank (“SVB”).

This means that for a while, SVB was receiving an unprecedented amount of ‘deposits’. Going back to what I described earlier in ‘Banking 101’, this then means SVB was under tremendous pressure to turn around and invest more capital than they ever had needed to invest before – all during a time when interest rates were incredibly low, making it exceedingly hard to find the level of returns they’d need to operate at this far greater scale. Let’s pause on this for now and take a step back for a moment.

SVB

Silicon Valley Bank (“SVB”), though not a household name for the vast majority of Americans, was one of the 20 largest banks in the country with over $200B in assets and stewarding over $340B in client funds. Compare this to a known name like Lehman Brothers, which had ~$600B in assets at the time of its bankruptcy in 2008.

Established in 1983, SVB grew rapidly and went public in 1988 (NASDAQ: SIVB). Subsequently, they expanded globally and offered a range of services from corporate banking to private banking and wealth management, investment banking, and direct VC and credit investing. In the bank’s own words, “we are the financial partner of the innovation ecosystem.”

So while SVB didn’t do much business directly with the majority of Americans, they were a significant player, one which indirectly touched the lives of most of the 19.2% of Americans somehow involved in the startup ecosystem as of 2022.

As I started to explain above, while SVB’s deposits grew exponentially in 2021 it put greater pressure on them to turn around and invest that capital. The issue was the opportunities to invest were challenging: historically, low-risk investments (i.e., T-Bills, etc.) had a very low return profile, higher-risk investments, and public markets were still wildly overpriced, and inflation was beginning to pick up speed.

As a result, SVB decided to invest $21B into presumably low-risk bonds on a 10-year maturity date. Meaning they could not get this money back for 10 years without selling early. It’s also important to know that the going market value of bonds like this fluctuates depending on how the Fed has changed interest rates in subsequent time periods relative to what they were when the bond was initially purchased. In short, SVB bought bonds at a top of a bond market cycle.

As the Fed raised interest rates, the going market value (if they had to sell before the full 10 years they were supposed to hold them) would be materially less than what they paid for them.

Presuming you’re not going to sell the bonds, as I imagine SVB assumed, then it’s a fairly reasonable financial decision since the market value of the bonds should not – in theory – matter in the short term, given the intent is to hold it for the long term.

However, on Monday of last week, a credit rating agency of SVBs (one that determines how ‘safe’ they are for other banks to lend to) indicated that because of these theoretical losses, they were at risk of a credit rating downgrade. This is generally something every company, bank or otherwise, tries hard to avoid.

In simplest terms, imagine if you were given a notification that unless you did xyz, your personal credit would decline materially, which would increase the costs of your mortgage, car payment, etc.

To avoid this credit rating downgrade, SVB leaders needed more cash quickly (a so-called ‘liquidity crisis’, not a ‘solvency crisis’). Leadership made the challenging decision to sell a large portion of the bond portfolio early (the same bonds it had bought last year and was supposed to hold for 10 years) at a steep financial loss. They knew doing this could spook investors and depositors, but also knew not doing it and receiving a credit rating downgrade could equally scare stakeholders. They were in a tough position and made a highly calculated gamble. The decision was then also made to not only sell assets to raise cash but also to issue additional equity in the form of new shares.

The combined result was investors got concerned and started selling shares, driving down the stock price ~60% in 24 hours. At the same time, depositors started getting worried, and all tried to pull their money out at the same time. The combined result was an outflow of $42B in value in one day, leaving SVB with a negative cash balance of ~$1B. The sheer speed at which all this happened was only feasible because of modern online banking infrastructure, which facilitates near same-day transfers, combined with new public and private social media (i.e., Twitter and Telegram, for example), which rapidly disseminated fear, uncertainty, and misunderstanding of the situation: specifically, the perception that the bank was no longer solvent (meaning liabilities>assets), and not that they just had some short-term liquidity challenges (i.e., assets still > liabilities, but cash on hand not sufficient). Financially speaking, there is a HUGE difference between the two. But here we are.

So where does this leave us?

So-called ‘experts’ remain split on the depth of impact SVB itself will have on the broader economy.

Most have suggested that it does not present an economy-wide ‘systemic risk’ (aka a 2008-type financial system meltdown) (e.g., Jaret Seiberg of TD Cowen, CNN, Moody’s) for a number of reasons I won’t get into here. Many do acknowledge, however, that there is likely to be some impact on other regional banks (e.g., Dennis Kelleher of Better Markets, Fortune, CNN, Reuters, MSN).

While no one knows for certain what comes next, we can still put SVB in a broader context: this is not an isolated incident, things are breaking, and while our leaders are doing their best to steer the ship, we need to acknowledge that they are in fact making calculated guesses.

Our economy has never before experienced what we are experiencing right now, and SVB is just the latest in a likely string of cracks that are beginning to emerge.

To use an American football analogy: there is no ‘playbook’ to pull out and run. While our leaders are incredibly smart and capable, the reality is they’re being forced to call audible after audible, hoping to somehow find the endzone.

What then do we know with certainty?

The economy is teetering on the edge, and a truly ‘soft landing’ is highly unlikely (8 interest rate hikes in last twelve months, the most in history; inflation remains high; unemployment remains historically low despite recent increases; etc.). The key questions weren’t if so much as when and where, and to what extent. All of those questions still remain. This last week’s events, of which SVB is only one, have heightened their importance and increased the probability that the timeline for a material event is sooner rather than later.
The economy, Silicon Valley, the banking and tech sectors WILL make it through this period of material uncertainty. However, not everyone will make it through the same: some will profit from it, some will protect themselves and remain mostly neutral, and some will be hurt –bad.
We should never take news headlines at face value. Especially in times of greater market exuberance or distress and when material money is on the line. Nearly everyone, if not everyone, speaking to the media about SVB and the entire economy have skin in the game somehow. I’m not saying they’re being intentionally deceptive with their communications, though some may be. I can say definitively that if their livelihood is tied to continued economic prosperity, as is the case for most CEOs and bankers, they are inherently psychologically biased towards positive exuberance and framing.

What does this mean for me?

I don’t like to think of myself as a “bear”, but I’ve been saying for months now that it's going to get rough – really rough (see here, here, and here). On multiple occasions, I’ve shared my perspective that we would all be wise to hope for the best while planning for the worst (i.e., be ‘cautiously optimistic’).

This means cutting organizational and personal/household spending down to a bare minimum, shoring up cash reserves as much as possible, minimizing additional investment allocations – and dollar cost averaging into high-conviction positions when we do invest. This is what my family has been doing, and it's what the fund I work for has been doing and has been advising founders to do.

It's easy to say this; it’s a different thing to actually do it. While we’re psychologically programmed to be risk-averse, it is hard for us to process unknown future risks and tradeoffs against decisions that are right in front of us.

For business leaders, this shows up in places like not making difficult staffing decisions fast enough, or deep enough, or not cutting back on marketing spend to intentionally grow slower but more profitably.

For us individually, it shows up in continuing to spend on new clothes, cars and vacations, going out to eat, etc. In short, it's much harder psychologically for humans to scale back than it is to scale up.

So we should all take SVB as a wake-up call. If we haven’t already, it’s time to take action, and quickly. I hope as much as anyone that SVB is an entirely isolated incident, but I try to avoid basing significant decisions on hope and given the broader macroeconomic indicators that are continuing to flash red, its highly likely that this is NOT the end, and that we are in for additional pain.

If you’re interested in more technical discussions on some of these topics, below are several resources I can recommend:

SVB & The Economy’s Path Forward

So what’s the deal with SVB?

So where does this leave us?

What does this mean for me?