The happy words of a doomed CEO portrayed extreme naïveté … or worse.
In his 2022 annual letter to stakeholders, written just weeks before the collapse of Silicon Valley Bank (SVB), CEO Glen Becker acknowledged danger. SVB’s “balance sheet growth,” he warned, “was more than offset by client cash burn.” But with the same confidence of Titanic Captain Edward Smith, a confident Becker assured shareholders that SVB had “flexible liquidity solutions” for the looming financial icebergs.
Even more astonishing, a year earlier, the now-former CEO said rising rates was an opportunity, not a threat. In his 2021 letter, he highlighted the “significant benefits” from the “potential impact of shorter-term interest rate increases,” bragging the bank’s balance sheet would generate up to $130 million in incremental income for each .25% increase in interest rates. “Regardless of market volatility,” Becker whistled in the dark, “we believe digital adaptation, healthcare activity, and the innovation economy overall will continue to drive strong investment and fundraising in 2022 and over the long term.”
California’s Valley Boys
Welcome to California’s new “valley talk.” Only this time, it was not teenagers babbling away but some of the world’s more sophisticated bankers and investors. Days after the spectacular collapse of SVB, Michael Moritz, a partner at one of SVB’s key clients, Sequoia Capital, waxed lyrically in the Financial Times that SVB, was Sequoia’s most important business partner because it was like your cherished “local market” where “people behind the counters know the names of their customers, and have a ready smile.”
Only SVB was not Schaub’s Meat, Fish and Poultry in Palo Alto. It was America’s 16th largest bank and a key financier of the critical “innovation economy.” Since its founding, Silicon Valley Bank had played an instrumental role in funding a generation of tech startups.
But SVB was more than naive. It used its cozy grocery store image to hide cutthroat corporate business practices.
Silicon Valley versus Goliath
SVB thrived because it was the anti-bank. It was David to the Goliath of “East Coast banks.” The bank developed a cult status in the valley because, Moritz says, “securing a relationship with a “large, established bank… was difficult, if not impossible. West Coast technology companies,” he said, “were “incomprehensible or insignificant to the large East Coast banks.”
This apparently does not include Amazon, Google, or Facebook.
But as Silicon Valley grew more successful, West Coast insecurity about their snobby Eastern counter parties turned to hubris. Community banking became reckless banking. Listen to Becker’s last words written weeks before frantic depositors pulled the bank version of a kill shot. “We remain confident,” he told his soon-to-be panicked customers, ”we are in the right market with the right strategy for the long term.”
Credit: i2 Capital
SVB was not your favorite butcher
But SVB was more than naive. It used its cozy grocery store image to hide cutthroat corporate business practices.
Modern banking and venture capital are about scale and performance – the opposite of a friendly neighborhood butcher. SVB wanted to be the Walmart, if not Fresh Direct, of bank deposits, not Schaub’s Meat, Fish, and Poultry market. Its venture capitalist clients flocked to the bank because they were angling for any competitive edge a friendly banker could offer in the brutally competitive world of VC fundraising.
So it is no surprise that this once-sleepy community bank became the leading bank in Silicon Valley. It offered more than smiles and wine in its lobbies. It deftly deployed a little-known and perfectly legal financial engineering trick to help boost the return of its performance-obsessed venture capital clients, reports Nathan Vardi in Market Watch.
The rise of “fund subscription lines”
They are called “fund subscription lines,” a short-term credit facility that a BlackRock report says reduces the administrative burden on managers and investors but can also be a “potential boost” to the IRR (internal rate of return)” of a fund. And every extra basis point of IRR helps.
With funds in hand, VCs then pressured their startups to deposit their capital at Silicon Valley Bank, which, in turn, offered yet more lines of credit to the VCs.
Key to the strategy was a breathtaking quid pro quo. With funds in hand, VCs then pressured their startups to deposit their capital at Silicon Valley Bank, which, in turn, offered yet more lines of credit to the VCs. Suddenly, deposits were surging through SVBKUS6S SWIFT Code to the tune of $175 billion in deposits, a vast majority from VC-funded tech startups.
Mutually assured ‘juicing’
For a brief and glorious moment, it was a win/win for everyone. The ultra-cheap SVB loans allowed VCs to modestly (the median increase was 0.2%) inflate the investment rate of return they reported to their investors, which, in turn, helped them raise new funds.
In return, SVB received deposits that juiced their earnings and stock prices. From 2018 to 2021, deposits jumped from $49 billion to $189 billion. At the same time, the stock went from $254 a share to $715 a share.
Putting the money to work
To make money on this crush of new money, SVB deployed a vast army of private bankers with a mission to lend that money in any way they could to tech founders and VC funders, further cementing their image as the cherished local market. Any loan was possible — too possible. Need a bridge loan for a child’s wedding, an African safari for 20 friends, a wine vineyard, a subscription to Yellowstone Ski Club, or a three-carat diamond ring from Bulgari? SVB had a loan for that.
The end of free money
But then rising interests rates caused the party to come to a crashing halt.
Despite helping smooth over the finances of the rich and famous tech titans, Silicon Valley Bank still needed many more ways to earn good money from its mountain of cash. And in a stunning display of outrageous risk-taking or naïveté, SVB fell into the oldest financial trap on Wall Street: it made higher-yielding long-term” illiquid” investments with short-term deposit money.
Last year, when interest rates started to rise, senior executives discovered the nightmare of bond “duration risk” as the bonds they had bought with all those deposits were rapidly losing value. Unlike a stock, as long as you hold a bond for a duration, you will get your initial investment back. But if you are forced to sell before the bond comes due, you may end up losing money on even the safest treasury bill, particularly in a rising rate environment.
Will SVB’s new owners (for now the U.S. government), will live up to its climate promises?
Populist blowback
All this portends to very rough days ahead for Silicon Valley’s and America’s vaunted innovation economy. Bailouts are not popular in Washington, DC. But now it turns out that hard-earned American middle-class retirement money was not only lent out to support the generous lifestyles of venture capitalists and to tweak their VC investment results, but that to do so required depositing unprecedented levels of money in a medium-sized bank with deeply flawed risk management practices, and apparently, alarming holes in regulatory supervision.
This, in turn, precipitated a bank run, triggering yet another federally-supervised bailout and possibly a new economic recession.
It is widely acknowledged that hubris, not the iceberg, was the main culprit for the Titanic’s sinking. History will probably say the same of SVB, who assured its wealthy patrons last year that “our strong financial performance speaks for itself.’
Like the Titanic, SVB was equipped with the finest luxuries and the latest technology. It, too, sold its gilded service to wealthy patrons. Flushed with unprecedented success, Captain Becker sailed into rising interest rates, with a mix of banking hubris and Silicon Valley exceptionalism that set ther stage for the end of magical thinking in Silicon Valley.
Committed to climate tech?
The collapse of SVB could not have come at a worse time for climate action. The bank was just waking up to climate change, publishing “Financing solutions for a healthier planet” shortly before it collapsed. The bank had committed itself to to provide at least $5 billion in loans, investments and other financing by 2027 to support companies advancing sustainability technologies. Internally, SVB has set a goal to be carbon neutral by 2025, which will include use of 100% renewable energy. Will SVB’s new owners (for now the U.S. government), live up to its promise?
