Silicon Valley Bank

Silicon Valley Bank – An Autopsy of the Tech Industry’s Financial Services Partner

Nicholas Smith

MET AD 678: Financial Regulations and Ethics

25 April 2023

Silicon Valley Bank – An Autopsy of the Tech Industry’s Financial Services Partner

Abstract

Bank failures are not an entirely common phenomenon. So saying there have been 563 failures since 2001 might come as a striking antithesis to that statement. However, in 15 of the 23 years since 2001 cited by the FDIC in an analysis of bank failures, there were less than 10 bank failures a year. Thirteen of those years experienced 5 failures or less each year. The five-year period beginning with the financial crisis 2008 – 2013 brought the greatest concentration of failures accounting for 489 banks in the period to close. As of this writing, 2 banks have closed in 2023: Silicon Valley Bank and Signature Bank. While two bank failures do not sound significant, Silicon Valley Bank alone accounts for $209B, or 20.1% of total assets by banks that have failed since 2001. Only 2008 in aggregate saw larger failure by total assets, in a year which saw 25 banks fail at $373B, which notably included the Washington Mutual failure. With recent loosening of regulations, more financial institutions could be at risk without due diligence and corrective action. As such, the sheer size of the Silicon Valley Bank failure alone warrants deeper examination. By studying the characteristics of the bank, the relevant regulations and changes to those regulations, and the prevailing economic environment, we can better understand the profile of Silicon Valley Bank and how it ultimately failed in order to understand the forensic steps to mitigate risk of failure in the future. (FDIC, 2023)

Silicon Valley Bank – An Autopsy of the Tech Industry’s Financial Services Partner

Introduction – The Failure of Silicon Valley Bank

Wednesday March 8, 2023, Silicon Valley Bank was fresh off receiving a clean bill of health from auditor KMPG LLP. “KPMG signed the audit report for Silicon Valley Bank’s parent, SVB Financial Group, on Feb. 24.” (Weil, 2023). An 8-K was filed that Wednesday detailing Silicon Valley Bank’s intention to pursue an equity offering. Earlier that week, the bank had sold nearly all of its Available For Sale (AFS) Portfolio securities for $21 billion -- a $1.8 billion after-tax loss from book value. We would discover another 8-K filed the following week would reveal that Goldman Sachs was the purchaser of this portfolio. The company stated in the filing on March 8th that they were seeking $2.25 billion in equity capital. The deal for the offering breaks down as follows: $1.25 billion in common stock brokered with Goldman Sachs, $500 million in common stock issued in a private transaction with private equity firm General Atlantic, and $500 million in preferred stock also brokered through Goldman Sachs. At close of business on Wednesday, the bank was considered stable and solvent according regulator California Department of Financial Protection and Innovation. That night, Moody’s downgraded the credit rating for Silicon Valley Bank’s long-term local currency bank deposit and issuer ratings from Aa3 to A1 and A3 to Baa1 respectively. The outlook for Silicon Valley Bank was also changed from stable to negative.

Thursday March 9th held a litany of events for the bank following the release of this information. The price of the company’s stock fell over 60% during the course of the day on Thursday. Meanwhile, Silicon Valley Bank found itself in the midst of a bank run. Venture Capital firms were urging their companies to get their money out of the bank as quickly as possible. Customers attempted to withdraw $42 billion during the day on Thursday, totaling nearly 25% of the bank’s deposits. At the close of business, Silicon Valley Bank had a negative cash balance of approximately $1 billion and could not fulfill outgoing payments. Customers left behind in the bank were facing issues like fulfilling payroll and their own liquidity. By early morning Friday March 10th, the bank had scrapped its planned equity offering and was looking for a buyer. Regulators had run out of patience with the bank. Trading on Silicon Valley Bank’s stock (SIVB) was halted during pre-market trading on Friday March 10, 2023.

Silicon Valley Bank was closed by the California Department of Financial Protection and Innovation on March 10, 2023. The Federal Deposit Insurance Corporation (FDIC) was appointed as the receiver. At the time of closing, Silicon Valley Bank operated 17 branches located in California and Massachusetts. The FDIC created the Deposit Insurance National Bank of Santa Clara (DINB) for insured depositors. The DINB received all insured deposits from Silicon Valley Bank. (FDIC, 2023). On March 12, under recommendation from the FDIC, depositors at Silicon Valley Bank were made whole for balances above the FDIC insurance restrictions under the systemic risk exception clause of the Federal Deposit Insurance Act. The systemic risk exception allows the FDIC to intervene if a banking institution’s failure creates risk for the entire financial system’s stability. According to S&P Global, a high portion of Silicon Valley Bank’s deposits were uninsured. “Silicon Valley Bank ranked first among banks with more than $50 billion in assets, with 93.8% of its total deposits being uninsured…according to S&P Global Market Intelligence data as of year-end 2022.” (Hayes, 2023). Monday March 13, 2023, the FDIC transferred all deposits to a bridge bank named Silicon Valley Bridge Bank, N.A. The bridge bank serves as an intermediary institution where the FDIC can stabilize the situation between the bank failure and final resolution under the guidance of an FDIC appointed board.  On March 27, 2023, Silicon Valley Bridge Bank was acquired by First Citizens Bank, N.A.

Who was Silicon Valley Bank?

            At the time of the bank’s demise, Silicon Valley Bank was considered to be the second largest bank failure to date. Silicon Valley Bank was a state-chartered bank based in Santa Clara, CA. The Silicon Valley Bank 10-K filed for fiscal year ending December 31, 2022, shows that the bank held $211.79 billion in assets and $173.11 billion in total deposits. Additionally, the bank held $74.3 billion total loans and $120.1 billion total investment securities. It sits behind Washington Mutual as the largest bank failure to date in 2008. According to CNBC, Washingon Mutual held $307 billion in Assets and $188 total deposits at the time of its failure. As the FDIC announcement stated, there were 17 branches in operation located in California and Massachusetts. According to the Federal Reserve, Silicon Valley Bank was the 16th largest bank by Assets at the end of 2022. The bank catered heavily to startups and venture capitalists, especially in tech. “The California bank in 2022 banked almost half of U.S. venture-backed tech and life science firms, according to a 2022 investor relations presentation. It also banked 44% of venture-backed tech and health care IPOs.” (Cerullo, 2023). The bank recognizes four major client industries it serves: Technology and Life Science/Healthcare, Global Fund Banking, Premium Wine, and Private Banking/Wealth Management. According to the company’s Q4 2022 pitch deck, Silicon Valley Bank served between 35,000 and 40,000 commercial clients. The bank also placed limits on where some of its clients could take their money. “Silicon Valley Bank had exclusivity clauses with some of its clients, limiting their ability to tap banking services from other institutions, SEC filings show. The contracts, which made it impossible for those clients to safely diversify where they kept their money, varied in language and scope. CNBC has reviewed six agreements that companies signed with SVB regarding financing or credit solutions. All required the companies to open or maintain bank accounts with SVB and use the firm for all or most of their banking services.” (Goswami, 2023).

The bank has four operating segments: Silicon Valley Bank, SVB Private, SVB Capital, and SVB Securities. Silicon Valley Bank offers financial services primarily to clients in “the technology and life science/healthcare industries as well as global private equity and venture capital clients”. (Silicon Valley Bank, 2022). Services offered through this segment of the bank are a full range of credit solutions, global treasury management, foreign exchange, trade financial products, and investment services. SVB Private offers financial services for private clients. This includes “private banking, lending, brokerage and wealth management and investment advisory services”. (Silicon Valley Bank, 2022). The bank acquired many private banking customers from the acquisition of Boston Private in 2021 which offers private business, commercial real estate and non-profit commercial lending and banking.  SVB Capital is the funds management arm of the bank. It manages the venture capital and credit investment services offered. SVB Securities operates an investment banking arm of the bank. It offers products and services focusing on Capital Raising, M&A Advisory, Structured Finance, Equity Research and Sales and Trading.

The bank’s leadership listed on the FY2022 10-K were Greg W. Becker, President & CEO; Daniel J. Beck, CFO; and Karen Hon, Chief Accounting Officer.

The Laws at Issue

            The banking industry is one of the most regulated industries in the US. Many laws govern the requirements financial institutions have to abide by and standards to meet. While we could highlight an extensive breadth of regulations in the banking industry, it would be better served to focus on the depth of the specific and applicable laws and regulations at hand in the scope of Silicon Valley Bank.  In the case of Silicon Valley Bank, the scope of the laws and regulations to focus on encompass the time leading up to failure and the process of stabilizing and finding a disposition for the bank’s assets and deposits.

Regulation D

Regulation D (Reg. D) establishes reserve requirements for deposits within a bank and how different deposit accounts are classified in calculating requirements for reserves. Reserve requirements are the minimum amount of cash depository institutions are required to have on hand based on a percentage of the amount of deposits by the deposits in each account type. On March 26, 2020, the Federal Reserve set reserve requirements to 0% under jurisdiction of the Federal Reserve Act (1913). The Board of governors for the Federal Reserve explained the changes. “Prior to the change effective March 26, 2020, reserve requirement ratios on net transactions accounts differed based on the amount of net transactions accounts at the depository institution. A certain amount of net transaction accounts, known as the ‘reserve requirement exemption amount,’ was subject to a reserve requirement ratio of zero percent.  Net transaction account balances above the reserve requirement exemption amount and up to a specified amount, known as the ‘low reserve tranche,’ were subject to a reserve requirement ratio of 3 percent.  Net transaction account balances above the low reserve tranche were subject to a reserve requirement ratio of 10 percent. The reserve requirement exemption amount and the low reserve tranche are indexed each year pursuant to formulas specified in the Federal Reserve Act.” (Federal Reserve, 2020). The intended effects of this policy allowed banks greater flexibility with their capital and greater liquidity to serve depositors in the midst of the economic crisis related to COVID-19 at the time, helping to stabilize the broader financial industry. As of this writing, the reserve requirements remain at zero percent.

FDIC – Federal Deposit Insurance Corporation

The collapse of Silicon Valley Bank extends to a breadth of regulations that address business continuity and consumer protections. There are several governing and protective bodies to provide guidance in the event of a bank failure. Immediate risk mitigation begins with the FDIC. The Federal Deposit Insurance Corporation was founded in 1933. In a typical bank failure, the FDIC insures each depositor up to $250,000. “FDIC insurance covers deposits received at an insured bank. Types of deposit products include checking, NOW, and savings accounts, money market deposit accounts (MMDA), and time deposits such as certificates of deposit (CDs).” (FDIC, 2014). Additionally, the FDIC does not utilize taxpayer money. The FDIC is an independent federal agency that is funded through premiums paid by insured banks and through earnings in its investment portfolio. In the event of a bank failure, the FDIC fulfills two primary roles. It acts as the insurer of institution depositors and as the “Receiver” of failed banks, an institution tasked with collecting and selling the assets of failed banks and settling debts. Of note with the matter of Silicon Valley Bank, the FDIC, in conjunction with the Federal Reserve and Department of the Treasury, has the authority to declare a systemic risk exception. “The systemic risk exception is a recognition by Congress that financial stability concerns sometimes trump the desire to minimize potential costs to the taxpayer. Financial crises impose economic costs that can far exceed resolution costs to the FDIC. Because systemic risk is unpredictable and fast moving, emergency tools such as the systemic risk exception have been crafted to give policymakers broad, discretionary powers to respond quickly to a range of potential risks. This way, financial conditions can be stabilized before a crisis spirals out of control.” (Labonte, 2023)

Dodd-Frank

The Dodd-Frank Wall Street Reform and Consumer Protection Act was a sweeping bill addressing amendments and updates for financial legislation and regulations passed by Congress in 2010. The Dodd-Frank Act addressed a wide berth of financial issues and standards ranging from industry wide applications to individual consumer protections, including on-going standards of operations and disaster mitigation. It called for the development of prudential standards. The recommendations were “risk-based capital requirements, leverage limits, liquidity requirements, resolution plan and credit exposure report requirements, concentration limits, a contingent capital requirement, enhanced public disclosures, short-term debt limits, and overall risk management requirements”. (Dodd-Frank, 2010). In general, these standards were set to be applicable to banks with assets totaling $50 billion or greater. One of the specifics outside the scope of prudential standards of the Dodd-Frank Act expanded the requirements for stress tests to banks with assets totaling $10 billion or greater.

In 2018, many components of Dodd-Frank were rolled back with bipartisan support. The bill was titled the Economic Growth, Regulatory Relief, and Consumer Protection Act. “The measure eases restrictions on all but the largest banks. It raises the threshold to $250 billion from $50 billion under which banks are deemed too important to the financial system to fail. Those institutions also would not have to undergo stress tests or submit so-called living wills, both safety valves designed to plan for financial disaster. It eases mortgage loan data reporting requirements for the overwhelming majority of banks.” (Pramuk, 2018).  

How did this all come together?

            Many factors contributed to Silicon Valley Bank’s failure. The banking system is a very complexly interwoven, highly integrated network. The failure of one bank compromises the stability and integrity of the greater system. The situation with Silicon Valley Bank represents a series of systemic and firm specific events that culminated in the bank’s failure.

            Many of the problem’s Silicon Valley Bank encountered revolved around the securities the bank held. These are assets that are classified in two major categories: Available-for-Sale (AFS) & Held-to-Maturity (HTM). We can trace some of the origins of the bank’s issues back to 2019. At the time, Silicon Valley Bank closed its fiscal year 2019 with $71 billion in assets with $14 billion AFS and $13.8 billion HTM securities.  The balance sheet grew substantially from FY2019 to FY2022, but there are some peculiarities to point out. Below is an exhibit pointing out key points of information from Silicon Valley Bank’s balance sheet.

See Exhibit A

Most strikingly, Silicon Valley Bank’s Total Assets grew considerably from 2019 to 2022, but its growth in cash balances did not quite follow that trend after 2020 in what seems to be reactionary take to the Reg D. requirements for deposit reserves being dropped to zero that year. In FY2021, Silicon Valley Bank increased its position in HTM securities consisting largely of mortgage-backed securities (MBS) and boosted its position in US Treasuries as well as transferring almost $9 billion of AFS securities to HTM. However, in 2022, market interest rates rose. Silicon Valley Bank was stuck holding a significant portion of near zero, low interest fixed income securities. The byproduct of increasing interest rates is fixed income securities like MBS and US Treasury bonds lose face value in the market. It did not appear that Silicon Valley Bank hedged its position. Compounding the problem, the bank lost $16 billion in deposits that same year. Silicon Valley Bank catered heavily to a wealthy clientele, and the bank’s clients were generally not traditional retail banking customers. As we discovered earlier, the bank required an exclusivity agreement with some of its clients. This all or nothing clientele approach had a contributing factor to aspects of the bank’s failure, including risks attributable to customer retention and deposit burn as well as the decision invoke the systemic risk exception because of the high volume of deposits over the FDIC’s $250,000 insured limit. Lower numbers of clients with higher concentrated net worth meant that the impact of departure from the bank was significant. To combat its liquidity problems, Silicon Valley Bank took a $13 billion short term cash advance from the Federal Home Loan Bank, FHLB, of San Francisco. However, this sank Silicon Valley Bank’s liquidity ratios. With liquidity ratio issues looming from deposit burn, devalued securities, and economic uncertainty, Moody’s issued the downgrade for Silicon Valley Bank’s credit rating, prompting the ensuing bank run and failure.

Conclusion

            The failure of Silicon Valley Bank serves as a cautionary tale for the financial industry as we enter a more uncertain economic prospectus. While the failure of the bank was fairly limited, without the support and stability of the US regulatory bodies, the impact of the event could have spread very precipitously. Leverage from governing tools like the systemic risk exception helped prevent that from happening. However, rollbacks in regulation facilitated the environment for the bank’s demise. At the time of the FY2022 10-K, the bank held approximately 7.97% ($13,803B/173,109B) cash relative to total deposits. While not overtly egregious, Silicon Valley Bank still did not have much of a cash safety net in place. Additionally, the 2018 Dodd-Frank rollbacks raised the threshold for mandated stress tests and application of prudential standards. While Silicon Valley Bank is responsible for its own misactions and financial mismanagement, it is plausible this could have been detected and avoided under the original Dodd-Frank standards, if not mitigated at the very least.

            So while it is easy to point a finger at a catchall topic like poor risk management and the absence of a risk management executive, as is one of the more popular sentiments at hand, many of Silicon Valley Bank’s misfortunes were the byproduct of simple financial mismanagement that should have been in the purview of any basically competent financial team. Compounded by regulatory rollbacks, the bank’s client profile, and unfavorable economic circumstances for the bank’s investment portfolio, Silicon Valley Bank found itself in an untenable situation that signals a need for peer banks to observe prudence and self-examination in the financial industry to avoid a similar fate.

References

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Dodd-Frank Wall Street Reform and Consumer Protection Act. H.R.4173, 111th Congress (2009-2010). https://www.congress.gov/bill/111th-congress/house-bill/4173/text

Economic Growth, Regulatory Relief, and Consumer Protection Act. S.2155, 115th Congress (2017-2018). https://www.congress.gov/bill/115th-congress/senate-bill/2155

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