Profiting in Times of Crises: The Silicon Valley Bank Story

“I think I can effectually force you” and Monte Cristo drew another packet from his pocket. “Here are ten thousand more francs,” he said, “with the fifteen thousand already in your pocket, they will make twenty–five thousand. With five thousand you can buy a pretty little house with two acres of land; the remaining twenty thousand will bring you in a thousand francs a year.” 

In this excerpt from Alexandre Dumas' classic novel, Count Monte Cristo corrupts a humble operator of a government optical telegraph post to transmit a false message. That was part of Monte Cristo’s revenge plan against his long-time foe Baron Danglars, a bank tycoon, who used informal access to classified information to trade Spanish bonds.

A lot has changed since the first half of the 19th century, depicted in the novel. Well, sudden and fabulous fortunes are still around (maybe even more than ever). And so are corruption and insider trading. However, there is one important thing long gone over the past 200 years: stable interest rates. 

In fact, Monte Cristo tempted the bank operator not with mere money, but with a chance to live happily ever after. Let us do some simple maths: a capital of 20,000 francs, properly invested, would produce an annual rent of 1,000 francs, which makes an annualized rate of 5%. This figure had been a constant for several generations. It became so commonplace that it was clearly understood by any character of this novel (and of many other books of the time), be it a banker, young aristocrat, tavern owner, or sailor. In the early 19th century it was enough to say ‘he/she has a rent of 50,000 francs’ to describe a hefty fortune of 1 million francs.

In those days, the amount of money in the economy was basically limited to the amount of gold controlled by the government. But after the gold standard was abolished in the mid-20th century, interest rates became one of the major tools for the economy’s ‘thermal regulation’.

The monetary authorities lend money at a rate known as the prime credit rate to major banks, which in turn spread them across the entire economy. The lower the rate, the more money is available in the system, fueling business activity, consumption, and with it inflation.

In theory (and sometimes even in practice) moving interest rates is aimed at smoothening the ‘boom-bust’ economic cycles, making booms not so painful inflation-wise as rates should be hiked and busts not so destructive in terms of economic growth as rates get lower and more supportive. 

This rate play worked more or less until the subprime meltdown of 2008. The US Federal Reserve rates hit the bottom to support the disrupted financial system. Other central banks followed putting the world in a state of nearly zero rates for seven years.

The chart below may be outdated on the right side of the scale and quite debatable on the left side. But it is still a decent illustration of a basically ‘free money’ period, unprecedented in human history. For more recent and exact data across major countries starting in 1946, you can browse statistics aggregated by the Bank for International Settlements. 

Source: Robinson Sewell Partners  

Then, after a brief period of recovery and an attempt to return rates to the norm, COVID hit, sending rates to the bottom yet again. But as the economy rebounded in late 2021, inflation surged. Consumer demand, fuelled by cheap credit and direct government subsidies, recovered quicker than supply chains that still limped due to severe COVID restrictions in China.

Things got worse as Russia invaded Ukraine, as the consequences of the war disrupted commodity markets, primarily energy, food, fertilizer, and metals. World logistics and transportation were also severely affected. All this led to an inflation spike unseen for decades, forcing the Fed to hike its rates to levels last observed in 2007 within just 12 months. 

Being focused on the tech industry, which was one of the primary beneficiaries of the cheap money boom, Silicon Valley Bank (SVB) accumulated substantial deposits from tech companies in 2020-21, topping $130 billion by March 2023.

However, it failed to invest that money in a profitable way. Issuing loans in times of almost zero rates brought more risk than profit. So, the bank chose to invest in long-term sovereign bonds: the return was low, but the risks were even lower.

However, the Fed rate hikes were projected onto all rates throughout the economy, including government bonds. As the new debt was issued with higher interest rates, the old bond issues dropped in value. Selling them to get extra liquidity would shoot a cannonball through the bank’s balance sheet. And that is exactly what happened to SVB: it had to sell $21 billion in highly liquid assets to cover withdrawals, posting a loss of $1.8 billion.

The news spread like fire through social networks, causing even more clients to withdraw their money from the troubled SVB. In times of old, a classic bank run could take several days, as clients would have to come to the office to complete the necessary paperwork. But now transfers can be done online in just several clicks. So it took only 48 hours for SVB to collapse.

On March 9 alone clients withdrew deposits worth $42 billion. As a result, regulators seized SVB assets three days later. As the authorities decided not to bail out the bank itself, holders of SVB stocks and bonds were obviously hit hardest.

Below is an illustration of what happened to the SVB bonds. A slight rebound, often referred to as a ‘dead cat bounce’, was probably caused by the distressed debt funds that specialize in purchasing troubled securities. 

Source: Bloomberg

SVB stocks took a similar dive. Interestingly, many investment bank analysts, including those of Goldman Sachs, Wells Fargo, and others maintained strong ‘Buy’ recommendations on SVB stocks along with stratospheric target prices months, weeks, and even days before the collapse. Meanwhile, SVB’s problems and potential losses were obvious to JP Morgan as early as November 2022.

But the main question was whether the loss-takers’ list would include SVB clients that held deposits with the crushed bank. Depositors were warned, although on rather short notice.

Just ahead of the collapse, JP Morgan offered SVB customers a safe haven. Peter Tiel through his Founders Fund urged portfolio companies to flee from SVB. And as the panic reached its peak, Founders Fund was already safe. Also, Union Square Ventures and Coatue Management called on portfolio companies to withdraw from the SVB. However, it was too late for many.

Under US law, all bank deposits under $250,000 are insured by the Federal Deposit Insurance Corporation (FDIC). According to the regulators’ estimates, 85% of all deposits held with the SVB fell outside this category. It would be logical to assume that holders of all deposits above that sum would have to wait until the bank’s assets are liquidated and proceeds distributed between the clients. In practice that would mean that a lot of clients would lose a lot of money. But it took the US government just a few days to announce that all SVB clients would get their money regardless of the deposit size. 

This decision may sound controversial from a market fundamentalist's point of view. But apparently, the authorities were choosing between the bad and the terrible. SVB specialised in banking for tech and startup companies. According to the SVB website, 50% of US venture-backed tech and life sciences companies bank with SVB.

Reuters compiled a comprehensive list of companies that held deposits with SVB: from Roblox online gaming platform with about $150 million to the cryptocurrency firm Circle with an astonishing $3.3 billion. This list should have definitely sent shivers up the regulators’ spines. Should these companies lose their money, the potential fallout could spread across the entire tech sector.

Big tech companies, these Monte Cristos of today, have seen better days even without SVB failure. With money becoming dearer and people mostly returning to their normal offline lives after COVID restrictions were lifted, many top tech companies have to cut their headcount by anything between 5% and 50%. Considering that tech now composes over 20% of the S&P 500 backbone stock market index, SVB's demise could trigger consequences that could have shadowed the dotcom bust of the early 2000s, the 2008 financial crisis, and possibly even the economic outcome of COVID.

Odd as it may sound, the most immediate winners were SVB's top managers. It turned out that SVB CEO Greg Becker sold the bank stock worth almost $30 million at prices ranging between $287 and $598 per share over the past two years. That included a sale of $3.6 million worth of shares made on February 27, just days before the bank collapsed. All in all, SVB executives sold shares worth a total of $84 million over two years, CNBC reported. It remains to be seen if regulators pursue any investigation over what might look like insider trading. 

The major winners are the usual suspects: big players. Top US banks embraced clients from SVB and other (not necessarily troubled) banks. For instance, Bank of America alone attracted more than $15 billion in deposits in only a few days of the SVB drama.

Salvaging SVB wrecks also produced some very lucrative deals. HSBC announced it was buying SVB’s UK arm for £1 (yes, one pound sterling). According to the statement, SVB UK had loans of around £5.5 billion and deposits of around £6.7 billion, with £88 million of full-year profit before tax in 2022.

Finding buyers for the main chunk of SVB assets took more time and toil. At first, majors like JPMorgan Chase & Co, PNC Financial Services Group, Apollo Management, Morgan Stanley, and Royal Bank of Canada were mentioned among the bidders. But finally, it was announced that First Citizens Bank agreed to buy about $72 billion of Silicon Valley Bank’s assets at a discount of $16.5 billion. Another $90 billion in assets remain in FDIC’s receivership. The FDIC is also entitled to the First Citizens Bank shares that could be worth up to $500 million. 

Summing things up, SVB fell prey as it got into the crosshair of several major trends. First, dirt cheap money is a highly addictive substance, especially when prescribed for a long period of time. Its removal, especially in a swift and harsh way performed by the Fed, cannot come without a severe hangover. Troubled banks and signs of decay in the tech sector may be just the beginning.

Second, everything related to tech had become a major concern. Economy and finance leveraging easily available credit and technology have become phenomenally agile and effective. However, any leverage is a two-way road. The economic system has become an infant prodigy, exceptionally talented, but hysterical and unpredictable, making its regulator ‘parents’ violate their own rules of free markets and investor responsibility principles. Protecting the tech sector and, with it, the financial markets was the most probable reason the authorities took an unprecedented step of effectively waiving the limit for deposit insurance. 

The third major trend we have been witnessing is the consolidation of the banking sector. Banks in the US and elsewhere are getting fewer and bigger. Over the past two decades, the number of FDIC-insured and FDIC-supervised banks halved, while total assets of those banks combined nearly tripled. This is happening at the expense of two categories: smaller banks and niche banks with their clientele limited to a certain geographical area or industry.

Up until now, it was a silent massacre, mostly happening through M&A activity. Loud bangs were scarce: SVB failure was the biggest one since 2008. However, things may not be that quiet anymore: as panic continued, two banks followed a similar faith: Signature Bank and First Republic, both focused on real estate and mortgages.

The death row may well continue in the coming months: in one week of March alone, smaller US banks lost a record $119 billion in deposits. Meanwhile, large institutions like Bank of America, Wells Fargo, and Citigroup benefit not just from a customer influx but from acquiring assets of failing banks at a discounted price.

Well, Count Monte Cristo may be an entertaining read, but in real life, it is the Danglars that prevail and make profits.