WHY DID SILICON VALLEY BANK FAIL?
The failure of Silicon Valley Bank sent shockwaves through the financial industry, leaving many wondering how a bank that had once been so successful could collapse so suddenly. At the heart of the matter was a run on the bank, sparked by a loss of confidence from the bank's clients. But while the immediate cause of the bank's failure may have been a lack of confidence, the underlying issues were much more complex.
The bank had invested heavily in low-interest rate bonds, which it held on its books on a long-term "hold-to-maturity" basis. This allowed the bank to avoid marking-to-market those bonds until they were sold, creating a distorted view of its balance sheet. So long as the bank did not need to sell those assets to meet withdrawal requests, there was no problem. But if the bank had to sell those assets at a loss, things would quickly become complicated.
Compounding this issue was the fact that the bank had recently sold $21 billion of bonds at a $1.8 billion loss. This move was made in part because many of those bonds were yielding an average of only 1.79 percent at a time when interest rates had risen drastically, making the bank appear to be an underperformer relative to its peers. Moody's was considering downgrading its rating, and the bank's management, with the help of Goldman Sachs, decided to raise new equity from General Atlantic and sell a convertible bond to the public.
Initially, the sale was meant to reassure investors, but it had the opposite effect. The sudden sale surprised the market, leading the bank's smart client base of venture capitalists to direct their portfolio clients to withdraw their deposits en masse. The bank's management may have also made a tactical mistake by selling convertible preferred stock, which could not be sold until the next day. This left time for investors and clients to start questioning the firm, leading to an exodus of deposits.
While the bank's collapse may have been avoidable, it ultimately came down to a failure of management to effectively communicate with its customers and the public. The bank's collapse has also raised concerns about other small and regional banks, and we can expect to hear more about bank regulation from Washington in the coming weeks and months.
In the immediate term, the fallout from Silicon Valley Bank's collapse is already being felt. Venture capital firms that used the bank may struggle to gain access to their money, and this may make it difficult to fund current and new investments or rescue other companies inside and outside their portfolios. We may also see secondary sales of private shares to fund businesses and individuals.
Silicon Valley Bank may be finished, but its legacy will live on for some time. As the financial industry grapples with the fallout from its collapse, it will be important to learn from its mistakes and take steps to prevent similar failures in the future.
