The abrupt collapse of Silicon Valley Bank last week came as a surprise to nearly all the denizens of the venture-capital world.
Despite all the big brains who did business with the tech-industry stalwart, almost no one seemed to be aware that the bank would have been in deep trouble months earlier had it not been for an arcane accounting rule that allowed it to ignore the losses (then still on paper) in its investment portfolio.
But there were a few investors who did see the bank’s collapse coming. “Silicon Valley Bank’s failure is just what happens when a tech bubble bursts,” says Nate Koppikar, co-founder of San Francisco–based hedge fund Orso Partners, who was short (that is, betting against) the bank’s stock for more than a year before it failed. Not many others in the financial world had made the same bet: When Silicon Valley Bank was shuttered by the federal government, only 5.5 percent of its outstanding shares had been sold short, according to S3 Partners, which tracks short selling.
One big red flag for Koppikar was that both Silicon Valley Bank and Signature, the other tech-focused bank that federal authorities shut down in the past fews days, catered to “hot money” — deposits from businesses that are more likely to panic and move their money. (He was also short Signature.)
More than 95 percent of the deposits held by SVB and Signature were above the FDIC’s insured limit of $250,000. And they all had experienced sudden, explosive growth between 2020 and 2021 — the COVID era of nearly free money that led to a boom for Silicon Valley Bank’s venture and start-up clientele, which included the crypto concerns that banked at Signature.
“A substantial portion of money that went into venture capital somehow ended up at this bank,” says Koppikar. “I could tell their deposit franchise was much flightier than people actually believed, because it was a bunch of start-ups that burned money so that deposit accounts were constantly in a state of decline, and the only thing that could keep them going was more venture capital being invested.”
He adds, “The only way that would be sustainable was if venture capital continued to grow exponentially, and I knew that was not possible, because I knew this was a giant bubble.”
Both banks were outliers in a banking system that is, by and large, healthy. Silicon Valley Bank “was in a league of its own,” Michael Cembalest, chairman of market and investment strategy for J.P. Morgan Asset Management, said in a note to clients on Friday. It had “carved out a distinct and riskier niche,” he said, “setting itself up for large potential capital shortfalls in the event of rising interest rates, deposit outflows and forced asset sales.”
Another person who saw the light was short seller Bill Martin of Raging Capital Ventures. In January, he tweeted, “The bank would be functionally underwater if it were liquidated today.” The reason is that it had plowed a good portion of its ballooning client deposits during the 2021 bubble into conservative investments, including mortgage-backed securities (basically, bonds backed by mortgage payments), that ended up not matching the bank’s real-world financial needs. When interest rates rose rapidly last year, the prices of those investments (which were better suited to a low-interest-rate world) fell. In the third quarter of last year, Silicon Valley Bank’s losses on them would have been $15.9 billion — greater than the bank’s capital base of $11.5 billion. But until the banks sold those holdings, they didn’t have to account for the losses.
Silicon Valley Bank had, in recent years, gotten into the very risky business of lending to early-stage companies that traditionally wouldn’t be eligible for bank credit. “These companies actually never turned a profit,” says Koppikar. Since 2016, he says, “we engaged in this alchemy, where people put money into things that didn’t make money, then just kept putting more money into those things.” That game ended with last year’s market downturn: Fundraising fell, and valuations for private companies did too. But those uncollateralized loans to the start-ups were still on Silicon Valley Bank’s books.
Now it is obvious to everyone that the bank’s risk management was poor, and there was little regulatory oversight to address it. In 2018, a post-financial-crisis requirement that banks the size of Silicon Valley Bank had to undergo “stress tests” by the Fed was eliminated, and requirements on holding cash were lowered. According to the New York Times, Silicon Valley Bank CEO Greg Becker had lobbied for that change. (Becker is now being pilloried for selling $3.6 million in the bank’s stock days before the bank’s collapse.)
Regulators simply didn’t understand how venture capital operates, says Koppikar. “One of the things that bank regulators are supposed to look for is something called a ‘broker deposit’ and tell banks to break them up,” he explains. Such deposits, which have been an issue in prior bank runs dating back to the S&L crisis, create a lot of risk for a financial institution, because one actor can make decisions on behalf of many other account holders — think, for example, of a high-powered venture capitalist.
“You had a handful of VC firms that spoke on behalf of their companies,” Koppikar explains. “When they say ‘pull,’ they all pull at the same time. One VC firm can get maybe 100 or 200 of its portfolio companies to take their deposits out. That’s why this went so fast.”