Even by the standards of the fast-paced world of finance and technology, the sudden collapse of Silicon Valley Bank1 is striking.
At close of trading on Wednesday, March 8, SVB had a market value of $16 billion and assets of over $200 billion,2 and by Friday, March 10, the bank was declared insolvent and seized by California’s Department of Financial Protection and Innovation.3 The equity holders were, essentially, wiped out.
As expected, shareholders have filed a federal securities class action against SVB and its senior executives, alleging securities fraud.4
Unlike most such class actions, the unique circumstances of this matter complicate the task of assigning responsibility for SVB’s downfall.
Plaintiffs Take Aim at SVB’s Management
A widespread, if not universal, consensus5 on SVB’s collapse is that the duration mismatch between the deposits and securities on its balance sheet exposed the bank to extraordinary risks and mark-to-market losses when the Federal Reserve began raising interest rates to combat inflation.
The plaintiffs contend that SVB’s management failed to disclose these risks to the market.
Specifically, the plaintiffs in Vanipenta v. SVB Financial Group, which is playing out in the U.S. District Court for the Northern District of California, allege that management failed to disclose to investors:
- The risks presented by rising interest rates;
- The risks associated with a depositor base composed largely of technology startups; and
- The risk that the bank was vulnerable to a bank run in a high interest rate environment.
These could be challenging arguments for the plaintiffs to prevail on since, at first glance, none of these facts appear to have been hidden from the market before March 8.
A fortnight before the bank’s collapse, on Feb. 24, SVB filed its Form 10-K for 2022 with the U.S. Securities and Exchange Commission, detailing its securities holdings and deposit base.
In the 10-K, SVB disclosed that its available-for-sale fixed income securities portfolio of $26 billion had an average duration of 3.6 years and an average yield of 1.56%, while the hold-to-maturity portfolio of $91 billion had an average duration of 6.2 years and an average yield of 1.66%. In comparison, five-year Treasury bonds offered a yield of 3.94% at the start of 2023.6
The $117 billion in fixed income securities were 68% of the total customer deposits of $173 billion held by SVB, of which $81 billion were noninterest-bearing demand deposits and $152 billion were uninsured deposits.
SVB also noted in the 10-K that its clients were “primarily in the technology and life science/healthcare industries as well as global private equity and venture capital clients.”
Further, the bank also disclosed that “[o]ur loan concentrations are derived from our borrowers engaging in similar activities that could cause those borrowers to be similarly impacted by economic or other conditions.”
The Impact of Rising Interest Rates on SVB’s Asset Values and Deposits
After holding down the federal funds target rate at 0.25% for two years during the COVID-19 pandemic, the Federal Reserve began aggressively raising the rate in March 2022 to combat inflation.7 The rate quickly rose from 0.25% to 4.50% within a nine-month period from March to December 2022.
Generally speaking, a high interest rate environment does not necessarily portend trouble for a bank, but SVB’s specific mix of assets, liabilities and customers left it vulnerable in the new interest rate regime.
Figure 1 illustrates the dramatic fall in the value of SVB as the interest rates were rising in 2022.
Once the Fed began raising interest rates, SVB’s customers withdrew almost $50 billion of their demand deposits in 2022, while the interest-bearing deposits continued to rise.
Table 1 tracks the growth of SVB’s customer deposits from 2020 through 2022. During the low interest rate regime from March 2020 through March 2022, both noninterest-bearing demand deposits and interest-bearing deposits grew sharply.
While the fair value of SVB’s portfolio was greater or equal to par value during the March 2020 to December 2021 period, by the end of 2022 the fair value of the held-to-maturity portfolio was $15 billion lower than the par value. This mark-to-market loss was, coincidentally, close to SVB’s market value of $16 billion.
Table 2 shows how the rising interest rates chipped away at the mark-to-market fair values of SVB’s held-to-maturity bonds.
The Role of Assets and Liabilities Duration Mismatch
At their peak in March 2022, demand deposits on SVB’s balance sheet were $128 billion, accounting for 65% of all deposits.
The legal duration of these demand deposits was less than seven days.8 In contrast, during the same quarter, SVB held $27 billion of available-for-sale securities with an average duration of 3.7 years and $99 billion of hold-to-maturity securities with an average duration of 5.2 years.
This mismatch between the durations of SVB’s assets and liabilities left the bank exposed to significant risk on three fronts.
First, as interest rates rose, the fair value of its portfolio of fixed income securities declined. SVB could, in theory, have weathered this mark-to-market loss had it been able to hold on to the securities till maturity for redemption at par value.
But second, the higher interest rates also negatively affected the technology and startup companies that were SVB’s primary customers.
As their valuations and fundraising took a hit, many of these companies likely needed to withdraw some of their deposits to ride through the technology downturn. SVB would have required liquidity to service these withdrawals and would not have been able to wait till maturity of its fixed income securities.
And third, the opportunity cost of leaving significant amounts of cash in zero-interest demand deposit accounts rose sharply with the interest rates.
Most firms would prefer their deposits earn the 3% to 4% going rate9 on short-term treasury bonds and savings accounts rather than zero interest in demand deposit accounts. This would have further increased SVB’s need for liquidity, which turned out to be an expensive proposition due to the long duration of its securities portfolio.
Significant Cash Withdrawals by SVB’s Customers
On March 8, after close of trading, SVB announced a sale of $21 billion of the fixed income securities in its portfolio, at a loss of approximately $1.8 billion.
In addition, the bank said it intended to raise $2.25 billion in new capital — which more than covered the loss on the fixed income securities sale — through sale of new common and preferred stock to investors.10
This news resulted in a steep decline in SVB’s stock price on the next trading day, March 9. The stock opened at $177, $91 below its previous close, and by end of trading the stock price had declined to $106, after which trading in the stock was halted. Trading reopened on March 29 three weeks later.11
The March 8 announcement and the subsequent stock decline was noted with alarm by the venture capital and technology startup community.12
On March 9, SVB’s customers withdrew $42 billion, more than half of all the demand deposits at the bank. As a result, SVB was left with a negative cash balance and was unable to meet its commitments to the Fed.13
On Friday, March 10, California’s Department of Financial Protection and Innovation declared SVB insolvent, took possession of the bank and placed it under receivership with the Federal Deposit Insurance Corporation.
It is noteworthy that the laws governing banks such as SVB were significantly changed in 2018 by the Trump administration.
The Economic Growth, Regulatory Relief and Consumer Protection Act, signed into law by former President Donald Trump in May 2018, increased the asset base from $50 billion to $250 billion for a bank to be considered systematically important and subject to a higher level of scrutiny.14
Under the regime before the passage of the 2018 law, SVB would have been subject to stronger capital and liquidity requirements and be required to conduct stress tests to determine weaknesses and risks on its balance sheet.
It is possible that, in a different timeline, SVB’s failure could have been prevented if it had been classified as a systematically important bank.
The failure of SVB was an abrupt, overdetermined event that followed two frenzied days during which customers withdrew their deposits from the lender in a classic run on the bank.
The roots of the failure stem from disruptions caused by higher interest rates, an asset-liability mismatch and substantial cash withdrawals within a short period of time by some of SVB’s customers.
As venture capital funds and their startup companies withdrew deposits to keep afloat in an unfriendly atmosphere for initial public offerings and private fundraising, SVB found itself short on liquidity and capital. The withdrawal of over $42 billion on a single day by SVB’s customers was unprecedented and contributed to a negative cash balance at the bank and its ultimate insolvency.
Given the facts leading up to SVB’s collapse on March 10, there does not appear to be a strong securities class action case, in the conventional sense.
For example, plaintiffs have not, as of yet, made any specific references to alleged false and misleading statements made by SVB to hide their financial condition. The issues facing SVB — and other similarly situated banks, it seems — were known to the market long before the fateful week.
SVB’s failure has spurred regulators and lawmakers to take a closer look at regional banks, and new requirements for these banks to comply with are likely to emerge. If there is any silver lining to be found in the demise of SVB, it could lead to stronger oversight of midsized banks and lower the likelihood of similar bank runs in the future.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of their employer, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
This article originally appeared in Law360, April 20, 2023.
1 SVB Financial Group is a diversified financial services company, as well as a bank holding company and a financial holding company. Silicon Valley Bank is by far the largest of the Group’s four reporting segments. In 2022, the Bank accounted for 81% of the Group’s total assets and 156% of the pre-tax income.
2 59.516 million diluted shares outstanding and a per share closing price of $267.83. Unless otherwise noted, all financial data is sourced from quarterly and annual reports filed by SVB with the SEC.
3 DFPI’s Order dated March 10, 2023 available at https://dfpi.ca.gov/wp-content/uploads/sites/337/2023/03/DFPI-Orders-Silicon-Valley-Bank-03102023.pdf?emrc=bedc09.
4 Vanipenta, et. al. v. SVB Financial Group, et. al., USDC Northern District of California, Case 5:23-cv-01097, filed on March 13, 2023.
5 For example, see “What Happened With Silicon Valley Bank?” in the Wall Street Journal, March 14, 2023, available at https://www.wsj.com/articles/silicon-valley-bank-svb-financial-what-is-happening-299e9b65.
6 5-Year Treasury Yield on January 3, 2023, available at https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value=2023.
7 The data is available at https://fred.stlouisfed.org/series/DFEDTARU.
11 Stock price data is from NASDAQ, available at https://www.nasdaq.com/market-activity/stocks/sivb.
13 Details from DFPI’s Order dated March 10, 2023 available at https://dfpi.ca.gov/wp-content/uploads/sites/337/2023/03/DFPI-Orders-Silicon-Valley-Bank-03102023.pdf?emrc=bedc09.