Silicon Valley Bank, a startup-focused lender based in California, was taken over by regulators late on Friday due to its poor capital conditions. Earlier in the day, its customers raced to withdraw nearly $42 billion according to the Financial Times, nearly a quarter of its deposits.
Such a scenario is called a 'run on the bank' and is a sign of trouble for any banking institution.
The newspaper says that Silicon Valley Bank is the 16th largest bank in the United States by assets, at $206 billion, and its failure is the second largest in history after fall of the Washington Mutual in 2008.
As a regional bank, Silicon Valley Bank was taken over by California's Department of Financial Protection and Innovation, which in turn cited three reasons for the move: the bank is insolvent, its business practices are unsafe and its liquidity positions are inadequate - it cannot reasonably pay its dues. The Federal Deposit Insurance Corporation (FDIC) - the US regulator that guarantees bank deposits up to a quarter of a million dollars - is the final receiver of the bank.
The release says that despite being financially stable till March 9, the bankrun had left the bank with a negative cash balance of $958 million.
On Friday morning, shares of the bank were halted by trading.
The turn of events eerily resembles that of 2008 - when the global financial crisis was sparked by the collapse of an investment bank. Further, Silicon Valley Bank's collapse comes at a time when the US is trying to fight its way out of recessionary predictions this year.
Why did the bank fail?
The bank caters to startups, tech companies and venture capitalist firms, and has invested a fraction of its deposits into US government bonds and treasuries on a long-term basis, which is considered to be a safe investment.
However, the rising interest rate environment by the Federal Reserve left these assets less valuable than when they purchased them. This alone led to these investments being $15 billion less valuable than they were at the time of purchase.
What made this bank fail is the unique problem faced by its clientele.
Rising tech layoffs and cooling startup job market meant that these firms were more reliant on their own funds, more often than not parked at Silicon Valley Bank. This implied that the bank now needed to meet the demand for more withdrawals.
In order to meet this added demand, the company had to sell good quality securities (US government debt and mortgage backed securities) at a loss of $1.8 billion, the Califronia regulator said. While this raised eyebrows, the bank also announced a share sale worth $1.75 billion to raise additional capital, prompting markets to raise concerns on its liquidity position.
The bankrun was a consequence of this uncertainty.
Further, regulatory filings show that Greg Becker, the CEO of the bank, who sold shares with $3.6 million through a trust owned by him. It also acquired options worth $1.3 million. While the trades took place on February 27, they were scheduled on January 26 under a rule that permitted insiders to schedule trades ahead of time to allay suspicions of insider trading. This can be found here.
What happens to the depositors?
The FDIC has said that all deposits that fall under the insurance limit of $250,000 would be paid out starting next week.
But, the problem is compounded by the fact that the bank is playing host to wealthy and rich clients. The Financial Times said that the bank estimated that nearly 96% of its clients were not eligible for FDIC cover in its entirety, or whose deposits exceeded the cover, citing filings with the Securities and Exchange Commission.
By contrast, a larger corporation like the Bank of America states that this number is only 39% on its $1.5 trillion asset sheet.
What is next for the bank?
Currently, regulators think that this will not have a deadly contagion effect and will be contained.
But this is provided the resolution for this issue is prompt.
For starters, US Treasury Secretary Janet Yellen, while expressing confidence in the regulators, has hinted that the government is looking for larger banks to merge it with. This was a tactic used during the 2008 financial crisis to absorb the bad sections of the bank into a larger competitor.
Marquee clients like Khosla Ventures, Accel Grelock and General Catalyst have all supported a resolution where the bank is purchased and "appropriately capitalised".
Second, as the deposit insurance coverage for the bank is so low, both regulators and industry feel like a liquidity crunch in the tech and startup sector is on the horizon, as they fear pay freezes and even furloughs till they get full access to their deposits.
In an unrelated tweet, Elon Musk - the owner of Twitter, Tesla and SpaceX - tweeted that he was open to the idea of buying the bank.
US banking stocks as indicated by the S&P500 banks declined - but only 0.5% on Friday. The difference in the decline by established players versus smaller players was stark though. Bank of America fell 0.9% and JP Morgan Chase actually rose 2.5%. But contrast, regional banks like Signature Bank dropped about 23%, while First Republic Bank fell 15%, according to Reuters. Western Alliance Bancorp is down 21% and PacWest Bancorp tumbled 38% after being halted in trade several times due to volatility.