The rise and fall of Silicon Valley Bank

Author: JOSEP SABATÉ TOMÀS

Abstract

This article analyzes the collapse of Silicon Valley Bank from a multidimensional perspective. Firstly, it examines the fundamental characteristics of the bank, including its failed investments in securities and lack of diversification. Additionally, it explores external events that significantly impacted the bank, such as the rise in interest rates. The article considers new aspects of this banking crisis, including the influence of social media and digitalization, which have become increasingly relevant. It concludes by suggesting a discussion on topics such as banking regulation and moral hazard, presenting both sides of the issue and weighing the pros and cons of each aspect.

1 Introduction

Silicon Valley Bank was founded in 1983 in California with the main objective of becoming the trusted bank for startups. Traditional banks at that time did not fully understand the needs of emerging business and the Venture Capital community. Finding a niche to fill, SVB grew exponentially to become the 16th largest bank in America. However, in March 2023, the bank failed and had to be bailed out.

The collapse was the second largest bank failure in the United States since 2001 in terms of total deposits lost. SVB was ranked as the 20th Best Bank in America by Forbes magazine just a month before its bankruptcy. In its last ten years of operation, SVB achieved an extraordinary 700% increase in its deposit accounts and total assets.

Therefore, in this article I examine the rise and fall of SVB from two different perspectives. On the one hand, the financial and endogenous factors, by analyzing its annual financial statements. On the other hand, the macroeconomic and exogenous causes, exploring the impact of global events such as Covid-19 pandemic, rising inflation and interest rate hikes.

2 Financial analysis

This section of the article focuses on the evolution of the bank’s economic-financial structure in order to understand where the bank’s boom came from and how it affected the other parts of its business structure.
So the ultimate goal is to be able to understand how macroeconomic variables affected the bank. For that reason, an in-depth study of the most important financial variables, as deposits and, above all, assets, their diversification, yields, maturity and losses, is required.

2.1 Assets, deposits and net earnings

The data shows a small but steady growth in deposits and assets during the first three years, with a significant increase occurring in 2020 due to the pandemic. In 2021, with minimal interest rates, there was a second large increase, almost doubling the value of these two variables. Then, in 2022, due to rising inflation and interest rates, the value of assets stagnated and deposits even contracted, marking the first decline in six years of analysis. In 2023, with many losses and people withdrawing their deposits, the bank ultimately failed.

Figure 1. SVB total deposits, total assets and net earnings. Source: Call Report

The net profit shows a significant nuance compared to assets and deposits. In 2018, the net profit doubled from 500 million dollars to one billion in American terms. The increase cannot be justified solely by the other two variables, as they do not experience significant growth. However, in the following two years, the increase in profits decelerates a bit compared to that of deposits and assets. In 2021, growth rebounds and the enormous figure of 2 billion in net profit is reached.
It is noteworthy that the net earnings declined by -22% over the course of 2022. The total deposits column also shows a decline, but assets remain at the same level. Thus, the discrepancy in this 2022 annual report could be one of the first clues pointing to some kind of internal crisis or weak management.

2.2 Composition of deposits

Figure 2 illustrates the divergent paths of interest-bearing and non-interest-bearing deposits. First, non-interest deposits start from a relatively high level and thus account for the bulk of the total. Although the first years may appear stagnant, there is significant growth in 2020 and 2021, followed by a contraction of one-third in the last year. In contrast, interest-bearing deposits start small but grow exponentially, reaching more than 50% of the total in 2022 and ending the dominance of traditional current accounts.

Figure 2. Composition of SVB total deposits. Source: Call Report

The initial deposit distribution was optimal for the bank, with a majority of non-interest bearing deposits. This allowed the institution to invest in assets that earned more interest than was paid to depositors, resulting in profits. Over time, even though the proportion of interest-bearing deposits increased, the bank could continue to increase its profits through new investments and appropriate diversification. However, net profits only increased until 2021, as we have seen.
From 2022 onwards, it can be stated that net profits decreased due to the increase in interest-bearing deposits, which became a significant burden. Additionally, the bank faced a significant imbalance between its assets, which continued to grow, and its deposits, which decreased for the first time in many years. In the consolidated income statement, the total interest expense increased by 1000%, supporting the theory that the decrease in profits was primarily due to interest-bearing deposits.

2.3 Equity and its ratio to assets

After conducting an initial analysis of assets, deposits, and net income, it is important to examine the group’s equity before delving further into asset investments. Figure 3 illustrates a steady growth in the equity item, which doubled in 2021, in line with the significant increase in assets and deposits.
The analysis of the equity to assets ratio is the most remarkable aspect of this section. Despite the total increase in equity, this ratio decreased considerably in 2020. It averaged 9% and was on the rise in the first three years, but decreased considerably to an average of 7.6% in the following triennium. The decline in the ratio indicates that recent investments were driven by deposit growth rather than equity. It was therefore essential to have a profitable deposit base, which was not the case in the last few years.

Figure 3. SVB equity and equity-to-assets ratio. Source: Call Report

2.4 Assets: investment securities

Having seen the relationship between deposits and the fall in both net earnings and the equity to assets ratio, it is now necessary to determine what caused the unexpected increase in total assets during the pandemic. Therefore, I analyze the group’s investment securities, focusing on Available-for-sale (AFS) and Held-to-maturity (HTM) assets.
It is worth recalling the definitions of AFS and HTM securities to refresh your memory or provide context for those unfamiliar with the subject. AFS securities are debt or equity securities purchased with the intention of selling them before maturity to generate liquidity. HTMs, on the other hand, are securities bought to be held until maturity, providing secure returns over the long-term.
By using an appropriate combination of both types of asset, you could achieve consistent returns over time, with the ability to generate liquidity when needed. It is important to note that only these two assets have been considered, firstly, because they represent an average of 50% of total assets, and secondly, because they were the most impacted by global events and interest rate increases, which will be discussed later.

2.4.1 Evolution

In 2021, the sum of the two types of investment securities tripled, as shown in Figure 4. This growth was driven by HTMs, which increased by 500%. It is well known that these investment strategies were adopted mainly due to the low interest rates prevailing in the economy at the time. Moreover, it is important to take into account the aforementioned analysis of deposits, since it provided financial support for the large investment in securities.

Figure 4. SVB HTM and AFS securities. Source: Call Report

Furthermore, not all of these new HTM securities in 2021 were purchased, but some came from transfers from AFS to HTM. As the company states in the following note to the financial statements: “During the year ended December 31, 2021, we re-designated certain securities from the classification of AFS to HTM. The securities re-designated consisted of agency-issued CMO’s, CMBS’, MBS’ and U.S. agency debentures”.[1] The strategy was based on its “ability and intent to hold these securities to maturity”, so we can see that the company opted for a long-term mega-investment.

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