Some Thoughts on Silicon Valley Bank

Over the last 48 hours, I’ve had several clients reach out to ask about the potential impact to their portfolios from the Silicon Valley Bank (SVB) collapse.

What happened?

It’s important to start by pointing out that SVB is unique relative to typical banks, in that it works mostly with venture-backed companies. In fact, on its website SVB said 44% of U.S. venture-backed tech and healthcare IPOs banked there in 2022.

Generally speaking, traditional banks are in the business of collecting deposits from customers, and using those deposits to make loans to other customers after assessing their credit risk. Most banks charge their customers higher interest rates on their loans than what they pay out on their deposits. Therefore, banks make money on the “spread” between the interest collected from borrowers and the interest paid out to depositors. Banks then invest any excess deposits in interest-bearing securities such as government bonds.

Silicon Valley Bank is different from traditional banks in that it wasn’t making many loans to its customers because most of its customers are venture-backed companies that are inherently more risky and instead raise money from venture capital funds. Rather than lend them out to borrowers, SVB invested most of its deposits in fixed-rate government bonds. In fact, fixed-rate securities accounted for roughly 56% of SVB's total assets compared to 28% at Bank of America and 25% at Fifth Third Bancorp.

As interest rates increased, the value of the bonds SVB was holding decreased. Because it had far fewer customer loans compared to traditional banks, SVB did not have the benefit of offsetting these losses and the higher interest it had to pay on its deposits with higher rates on its loans to customers.

So SVB aimed to restructure its balance sheet, by selling $21 billion of its fixed-income portfolio at a $1.8 billion loss. SVB intended to use the proceeds of its bond portfolio sale to buy short-duration government bonds with meaningfully higher interest rates to better match the interest rate on its assets and liabilities.

Once the news of this bond sale hit, several large venture capital funds reached out to their portfolio companies and advised them to withdraw their deposits from Silicon Valley Bank. This action sparked a bank run which ultimately led to the collapse of Silicon Valley Bank.

What Are the Implications?

I do not see any major risk to the financial system resulting from SVB’s collapse. As I indicated above, I believe that SVB was unique in that its customers were mostly early-stage, private companies, and that it had an outsized percentage of its deposits held in fixed-rate securities. Most banks have more balanced investment portfolios and larger lending businesses which should enable them to offset investment losses resulting from higher rates.

However, there are contagion risks. The most concerning risk in my view is that most of SVB’s remaining customers – presumably hundreds of early-stage companies – are unable to recover their deposits, of which 93% were uninsured according to a recent regulatory filing. In this case, there could be a loss of funding for a meaningful percentage of the innovation economy. While this would be painful for a sector of the economy, it does not present a systemic risk in my view.

How We’re Positioned

Evolve Investing’s public equity portfolios have exposure to the Financial Sector primarily across larger, well-diversified banks. None of our managed portfolios have exposure to regional banks or banks that are focused on servicing one industry or sector. I’m comfortable that relative to smaller banks such as SVB, the banks I’ve selected have more liquidity, broader business models, more than sufficient capital, and greater oversight from regulators.

Additionally, certain of Evolve Investing’s public portfolios have exposure ranging from 1-4% to a closed-end investment fund that offers private loans to late- and growth-stage companies. This investment fund does not bank with SVB, underwrites its loans at a loan-to-value ratio of 30%, and 99% of its underlying investments are in first lien senior secured loans. Given these factors, I remain comfortable with this exposure, and more broadly, I do not recommend any changes to my clients’ portfolios at this time.

For clients with private early-stage investments, we are monitoring on a case-by-case basis. Most of the private companies in which we are invested should have FDIC-insured deposits of $250k available on Monday, and we are following the FDIC auction process over the weekend.

If you have any questions about your portfolio or positioning, you're welcome to email me directly or schedule a call via this link.