This edition of The Blind Spot Wrap was interrupted by the collapse of Silicon Valley Bank. It’s now a two-parter, compiled by Izabella Kaminska.
We will be back with the full wrap within 24 hours… because this week’s blind spots undoubtedly lie in the news being buried by Silicon Valley events.
(And if you found this edition useful, feel free to forward or recommend.)
End of the valley for SIVB:
- On Friday afternoon UK time, the US FDIC moved to close Silicon Valley’s eponymously-named bank, Silicon Valley Bank.
The shock is really in how quickly the collapse of SVB has come.
I first got wind of trouble at SVB when Reuters published this story about its failed stock sale late Thursday (as I pixelate, that’s less than 24 hours ago). The next morning I woke up to discover that Peter Thiel was recommending that his companies withdraw funds from the lender sharpish. The news triggered Fidelity Fiduciary Bank tunes in my head, which of course I felt compelled to share on Twitter.
The night before I had attended an OSINT-themed book signing at a UK govtech VC venue. The experience reminded me of the insane volumes of government cash that have been pumped into the start-up scene during the most recent low-interest rate cycle. Just how many dodgy fintechs have been inadvertently gobbled up by the UK government balance sheet (and those of other governments and sovereign wealth funds)? And how much co-investment had occurred alongside SVB? How different might that make this crash to the dotcom collaspe of the 2000s?
I decided to reach out to some SV-connected VCs. Was this Silicon Valley’s Northern Rock moment? Or something else?
The replies were yes and no. No, in that SVB seemed better capitalised. Yes, in that the bank had exposed itself to exactly the same sort of mismatched duration/yield trades at the top of market, and in size. “Nuts” was the overall view.
Another VC confirmed he had spent most of the day moving his companies’ funds out of SVB. By the time we spoke during the afternoon his portfolio had been weatherproofed against further SVB shock. But it had been a big upheaval for him. He seemed stressed. SVB had been his personal banker and wealth manager too. One of the main reasons for his panic: no-one in government was coming to the rescue of the tech bro sector. Bailouts were not an option. The community would be on its own: unmade by its own distrust in government. Just how they always wanted it.
Moments earlier I had been on a call with a former US cbanker (albeit on an unrelated topic). We reminded ourselves that the last time we had crossed paths was on the day of Terra Luna’s crash. “We have to stop meeting like this,” we mused.
What we did conclude: tech bros had spent most of the last decade reinventing old financial concepts and passing them off as something new simply by giving them new names. Case in point: Circle USDC, which some people call a stablecoin, is by all conventional identifiers a money market fund. And where does it hold the bulk of its investments? Here’s a clue:
Update 0850 GMT: USDC has since firmly broken the buck.
But of course, if any sector was going to experience a Twitter amplified doom-loop frictionless bank-run, it was always going to be the tech sector. Because that, dear readers, is precisely what fintech has enabled. Extreme frictionless banking that won’t wait for anyone.
So what actually happened at SVB?
The official narrative is that the bank, having benefited from massive deposit inflows over the course of the Covid stimulus era, found little opportunity to invest them anywhere decent. The funds instead were parked in a two-tiered strategy, partly in low-yielding (but short-term and highly liquid) Treasury bonds and partly in longer duration mortgage-backed securities in the hope of delivering a little extra yield.
When the Fed started to hike rates last summer most of these securities began to suffer mark-to-market losses. To avoid taking a hit on the bank’s income statement, SVB decided to reclassify the assets as held-to-maturity rather than available-for-sale — the intention being to ride out the interest-rate storm until the point of maturity.
This would have been fine had a crypto collapse alongside a general malaise in tech financing not triggered an accompanying outflow of deposits. Holding assets to maturity is all very logical, but in practice — as in the case of SVB — sometimes a lender has no choice but to engage in a fire-sale. And when SVB assets hit the market this past week, as they eventually had to, they generated a $1.8bn loss, forcing the bank to launch an emergency capital raise. This failed. The rest is history.
As the official statement from the commissioner of financial protection and innovation dealing with its closure read on Friday:
“Despite the bank being in sound financial condition prior to March 9, 2023, investors and depositors reacted by initiating withdrawals of $42bn in deposits from the Bank on March 9, 2023, causing a run on the Bank. As of the close of business on March 9, the bank had a negative cash balance of approximately $958 million. Despite attempts from the Bank, with the assistance of regulators, to transfer collateral from various sources, the Bank did not meet its cash letter with the Federal Reserve. The precipitious deposit withdrawal has caused the Bank to be incapable of paying its obligations as they come due, and the bank in now insolvent.”
I’m still not entirely sure how SVB became exposed to crypto-lender Silvergate, but the death of Silvergate on March 7 eventually sealed SVB’s fate. Frances Coppola was early to see the connection. I recommend her write up from March 9.
Some people are now asking why, if SVB was illiquid but solvent, did it not repo its securities for funding instead? Well, it turns out, despite boasting a relatively strong tangible common equity number ($16bn) as recently as its last annual report on Feb 24, its assets weren’t sufficient to cover its outflows. Such a move would also have eviscerated its net interest margin (NIM) — since taking in ever more expensive cash to fund long-term assets that will never recover your costs is a death spiral business model.
But what about post-GFC regulation and Dodd-Frank?
JP Koning cites the annoyingly knowledgable Dan Davies on the fact that “the Basel rules that protect against these sorts of banking flameouts were not applied in the the US, or at least, they were only applied to very large banks. Silicon Valley Bank was exempt”. In other words, it didn’t have to be this way. SVB voluntarily chose to go for lighter touch regulation — because being from Silicon Valley, of course it did — and it got the liquidity conditions it deserved.
And now SVB’s regulatory arbitrage loss is the core banking system’s gain.
The tech bros gathered in Mario Nawfal’s Twitter Spaces on Friday afternoon failed to grasp this. The conversation flowed instead to whether this would be Bitcoin’s moment to shine and endless speculation about whether the Fed would soon be forced to cut rates and if the FDIC might go bust. (Nothing we haven’t heard before or continuously survived.)
There’s no doubt that what’s happening is bad, and there will certainly be contagion — most likely in the regional bank sector — but this isn’t GFC 2.0. This is something hugely significant but, in the end, something focused on taking out zero-sum activity in the economy. A killer for the tech sector, but not necessarily for main street or core productivity. Larger systemic banks still remain well capitalised. And I’m actually of the opinion main street might do quite well from all this in the long run.
Not that this will stop VCs from speculating that the whole debacle is a strategic act of Nord Stream-style sabotage by Elizabeth Warren. It was she, they pointed out during the chat, who had launched a political attack on the crypto and tech world in December 2022 by calling for Silvergate to face drastic consequences for having been the banker to failed crypto exchange FTX. The political scrutiny, they noted, contributed to the lender losing access to essential last resort Federal Home Loan Bank funding, which saw to its collapse this Wednesday.
The Wednesday date may be significant in its own right. As Felix Salmon at Axios noted banks usually collapse on Fridays so that authorities have time to make arrangements over the weekend. The Wednesday shutdown, in hindsight, does look like a planned prelude to this Friday’s SVB collapse. Anecdotal reports from Blind Spotters on our Discord server suggest emails were flying around Silicon Valley warning about SVB risk as early as this Tuesday. So who knows how managed the collapse has been behind the scenes or for how long?
Many unanswered questions linger. For example, what exactly were SVB’s off-balance sheet client fund relationships? What role did they play in the collapse if any? And how come nobody noticed they were even a thing?
According to SVB’s annual report: “In the normal course of business, we use financial instruments with off-balance sheet risk to meet the financing needs of our clients. These financial instruments include commitments to extend credit, commercial and standby letters of credit and commitments to invest in venture capital and private equity fund investments. Some of these instruments involve, to varying degrees, elements of credit risk. Credit risk is defined as the possibility of sustaining a loss because other parties to the financial instrument fail to perform in accordance with the terms of the contract.”
And here’s some additional detail about its off-balance sheet derivatives:
“Interest rate risk is managed primarily through strategies involving our fixed income securities portfolio, available funding channels and capital market activities. In addition, our policies permit the use of off-balance sheet derivatives, such as interest rate swaps, to assist with managing interest rate risk.”
Who is on the other side of these interest rate swaps? And how do they connect to the wider financial system? Nobody seems to know the answer.
Other questions to ponder beyond that: What happens to all the Silicon Valley payrolls that SVB supports? Will another player come in and buy the bank on Monday, and if so who? What about its equity stakes in a plethora of pre-revenue or profitless start-ups? Will these be sold off to make depositors good? And if so, is there a risk this pummels tech valuations further?
And finally what about SVB’s international subsidiaries?
Over in the UK, the about turn from the UK division was like nothing I had ever seen before. What started as the following release from SVB UK at 4pm GMT (no longer available outside of cache):
… had by 11.30pm turned into an FT story that the Bank of England was putting the division into resolution following a £1.8bn liquidity request. So much for trusting bank comms, eh?
As to what happens next, the story continues…
The best of the internet on SVB (as of midnight UK time):
- Silvergate had fully repaid Home Loan Bank advances by March 2.
- Dan Davies explained how “when the Fed implemented Basel III in October 2020, they took advantage of the fact that strictly speaking, the Basel Accords are only internationally agreed to apply to “large, internationally active” banks.”
- Marc Rubenstein offered one of the sharpest accounts of SVB’s history and how things soured so quickly, adding that a highly concentrated client base that all knew each other certainly didn’t help.
- Chris Whalen, chairman of Whalen Global Advisors, blamed the Fed and warned of a broader banking crisis.
- David Sacks changed his tune on government intervention.
- BlockFi’s crypto bankruptcy had $227 million at Silicon Valley Bank.
- Startups, among them human resources startup Rippling,worried about paying employees.
- Wayne in our Discord chat calculated that VCs must have been burning circa $160bn per year in the US, which, assuming a salary or cost per employee of $250k, implies VCs have been charitably supporting about 640k people, or, if you account for them having some revenues, a number closer to 1-2 million people.
- Wells Fargo was having some tech problems.
- Streaming service Roku said in an SEC filing on Friday that 26 per cent of its cash reserves were held at Silicon Valley Bank.
- Michael Burry warned “today we found our Enron”, and then deleted his tweet.
- There were 20 other banks with potentially similar exposures to unrealised losses on securities.
- Brad Setser asked who else in the global economy holds a lot of underwater bonds? — hinting there’s a few of them on Asian insurer and policy bank balance sheets. ( But shhh, don’t say central banks.)
- The Fed announced a closed board Meeting would take place on March 13 at 11.30am under expedited procedures.
- If you happen to be in Paris on March 23, why not come and see me MC the Politico finance summit. The conference is free to attend, you need only sign up on the website. The guest list includes European Commissioners Paolo Gentiloni and Mairead McGuinness, the governor of the Bank of Greece Yannis Stournaras, UK economy secretary Andrew Griffith and Circle’s chief strategy officer and head of global policy, Dante Disparte. If you can’t make it in person, you can watch online.
Hubris Research LLC:
- This stonker from JP Morgan’s Us Mid and Small Cap Banks team in November 2022: