Silicon Valley Bank faced a situation where many of its customers suddenly withdrew their money, causing a loss of confidence from other customers. The bank was not in financial trouble before this happened.
Taking Too Big of a Risk
The bank's management decided to sell bonds at a lower price, resulting in the bank losing money. This decision was influenced by low bond yields and rising interest rates, making the bank look underperforming compared to its competitors. Moody's was considering lowering the bank's rating.
To reassure investors, the bank's management sought to raise new equity by partnering with the venture capital firm General Atlantic and selling a convertible bond to the public. However, this move surprised the market and led to the bank's client base, mainly consisting of venture capitalists, advising their portfolio clients to withdraw their deposits en masse.
Moreover, the bank made a tactical error by not completing an equity investment quickly and instead selling convertible preferred stock, which could not be sold until the following day. This left investors and customers with time to doubt the bank's ability to manage its financial situation, causing more people to withdraw their deposits.
In the coming weeks and months, there will be a detailed examination of the bank's failure. The collapse could have been prevented, as it was caused by the management's mishandling of communication with customers and the public, leading to a loss of confidence.
However, the underlying issue was a demonstrable problem that other banks should be aware of. The bank had invested its deposits in low-interest rate bonds, which were held on its books as long-term “hold-to-maturity” assets. This meant that the bank did not have to update the value of those bonds until they were sold, giving investors an inaccurate view of the bank's financial standing.
As long as the bank did not need to sell these assets to meet withdrawal requests, there was no issue. But if the bank had to sell at a loss, it would create complications. Therefore, banks must be cautious when investing in “hold-to-maturity” assets.
Washington is likely to discuss bank regulation further, following reports that the bank's management lobbied regulators in 2015 to ease rules that could have prevented them from taking risky moves. Testimony from the bank's president was reportedly given to the Senate, seeking to weaken some regulations.
While Silicon Valley Bank seems unique with its unusual client base, which had very few retail customers, there is already concern about some other small and regional banks.
In the short term, this presents the most significant challenge for Silicon Valley Bank itself. Venture capital firms that used the bank may find it challenging to access their funds, along with their limited partners, including pension funds that had invested money.
This could make it difficult to fund existing and new investments or to rescue other companies in their portfolios. DealBook is already hearing about secondary sales of private shares to fund both businesses and individuals.
This article was produced and syndicated by Wealth of Geeks.