It’s been one week since the 2nd-largest bank failure in US history. Silicon Valley Bank (SVB) – which had $212B in assets at the end of 2022 and counted nearly half of all US venture-backed startups and nearly 1,100 investment firms as customers – is now under FDIC control after a bank run and collapse late last week.

What happened last week: Last Wednesday, SVB revealed it had sold $21B or substantially all of its most liquid available-for-sale securities to Goldman Sachs at a $1.8B loss, and was raising $2.25B in new equity. Behind the scenes, SVB had been informed by Moody’s the week prior that the bank’s bonds were at risk of being downgraded to junk by that Wednesday.

Investors were spooked, viewing SVB’s announcement as a sign it had exhausted all other options. On Thursday, SVB’s stock plummeted 60%. The news tore through the startup community via chat groups and Twitter, and many VCs advised their portfolio companies to pull their money out. Within 24 hours, startups pulled out $42B. By close of business, SVB had a negative cash balance of $958M. On Friday morning, SVB’s stock was down another 62% in premarket trading – it never reopened for trading. That day, the FDIC took control of SVB and transferred the assets to an FDIC-operated “bridge bank.”

What caused SVB’s insolvency: A key contributor was how it decided to invest the influx of deposits it received in 2021 from startups awash with venture funding. Deposits rose 86% to $189B in 2021, and peaked at $198B in Q1 2022. (By comparison, at the end of pre-pandemic 2019, SVB had just $62B in deposits.) SVB invested heavily in long-duration (10+ years) fixed-rate government bonds for a slightly better (but still very low) yield than shorter-duration bonds. $91B of its $120B portfolio was in mortgage-backed securities with an average interest rate of 1.64%. As they matured, the bonds provided enough cash for depositors’ withdrawals. However, much of SVB’s assets were illiquid.

SVB was doubly exposed to Fed rate hikes – on the deposits side and its bond portfolio. As Fed rate hikes ramped up starting in Mar 2022, funding dried up and startups began withdrawing more than they were depositing. At the same time, rising interest rates drove down the value of SVB’s long-duration bonds – which were classified as “held to maturity” and therefore didn’t have to be marked to market, masking its troubles.

By the end of 2022, the value of SVB’s bond portfolio was down $15.1B – nearly enough to wipe out its $16.3B in stockholders’ equity if the portfolio was marked to market. Industry observers began noting SVB’s blow-up risk (Dec 2022) and technical insolvency (Feb 2023). Still, SVB appeared to have enough assets to cover its deposit liabilities, though they were badly matched in duration – which is why it had to liquidate its available-for-sale securities at a loss. It was the bank run itself that turned SVB from an illiquid bank into an insolvent one unable to meet its obligations.

After the FDIC took over SVB last Friday, freezing the funds of all SVB’s startup customers, Y Combinator (YC) CEO Garry Tan called it an extinction-level event for startups. He had good reason – 30% of YC startups that banked with SVB would not have been able to make payroll within the next 30 days. 94% of SVB’s domestic deposits were uninsured (i.e. they exceeded the FDIC’s $250K insured limit), because of the nature of its customer base and SVB’s incentives for startups to put all their funds into one bank.

The state of current deposits: The FDIC, Federal Reserve, and US Treasury jointly came forward on Sunday night to announce that all SVB (and Signature Bank) depositors would be made fully whole by applying the systemic risk exception. The rescue relied upon the Deposit Insurance Fund, which is funded by premiums paid by insured banks. Any losses incurred by the insurance fund, which had $128B at the end of 2022, would be recovered by a special assessment on banks (i.e. not borne by taxpayers).

Regulators also announced a Bank Term Funding Program (BTFP) that could provide up to $25B total in one-year loans to backstop institutions, using banks’ qualifying assets valued at par as collateral. $11.9B had already been drawn upon as of this past Thursday.

The aftermath for SVB startup customers: On Monday, while the customer portal was slow, customers were reportedly able to access their full account balances. Now, as the dust settles, startups are trying to determine what to do next. During this crisis, many scrambled to secure funding to keep their businesses afloat. Some founders took on high-interest lifeline loans or used personal credit cards, while others sold their deposits to Wall Street firms offering 70 cents on the dollar. Some startups offered steep discounts on purchases to customers, pulling sales forward. Many pulled their funds out of SVB, in some cases technically violating the terms of their lines of credit/venture debt.

Looking ahead, financing will become harder for startups since SVB was a major source of low-rate loans and lines of credit. 190+ companies are expected to be on the hunt for new lenders. Enterprise startups and others that need significant capital to reach scale will struggle in particular. The closures of crypto-friendly Signature Bank and Silvergate Bank, alongside SVB’s collapse, have effectively de-banked the crypto industry’s 24/7 fast payment rails. Paired with the tech downturn, there is serious concern that the SVB collapse could have a years-long impact on American startup innovation.

What will happen with Fed rate hikes: At the last Fed meeting in Feb 2023, the Fed decelerated to a 25-point hike, leaving the federal-funds target rate at 4.5-4.75%. However, just 3 days before the SVB collapse, Fed chair Jerome Powell issued a “surprisingly hawkish” speech suggesting the Fed could return to a 50-point hike given persistent inflation. In this week’s Consumer Price Index (CPI) report, the “all items” CPI rose 6% for the 12-month period ending Feb 2023 on a non-adjusted basis – still above the Federal Reserve’s target inflation of 2%. As of last Wednesday, interest-rate futures put the odds of a 50-point hike at about 80%.

In the wake of SVB’s collapse, which was in part triggered by rate hikes, sentiment appears to have changed dramatically. Interest futures as of this writing suggest that the odds of a 50-point hike are now effectively nil, with about a 70% chance of a 25-point hike and a 30% chance of no rate hike at all. Goldman Sachs analysts are expecting no rate hike at the next meeting, although they do expect the terminal rate to reach 5.25-5.5%. Among the Fed hawks, the counterargument is that monetary policy should be used to fight inflation, and other tools should be used to address financial instability.

The state of banking: The rapid collapse of SVB, the 16th-largest bank in the US, sent a shockwave throughout the banking system, as well as a loud message: Your bank may not be as secure as you think. There have already been significant outflows from smaller, less capitalized banks towards the systemically important banks that are implicitly insured by the government, such as JPMorgan Chase, Bank of America, and Citigroup.

One of the primary reasons why depositors of SVB and Signature Bank were made whole was fear of contagion. SVB and Signature Bank are not the only banks that are vulnerable to a bank run in the current climate. US banks were sitting on $620B in unrealized losses at the end of 2022. First Republic is the latest subject of a rescue, with big banks parking $30B in deposits for 120 days to support the bank. (This week also saw the Swiss National Bank offering Credit Suisse a $54B lifeline to keep the firm operating.) Moody’s has put 6 regional US banks on review for downgrade this week.

This past week, US banks borrowed a combined $165B from two Federal Reserve backstop facilities ($153B from the traditional Discount Window, plus the $11.9B from the new Bank Term Funding Program). This is the largest-ever usage of federal backstops – the previous high was $111B during the 2008 financial crisis.

This could be the beginning of what BlackRock CEO Larry Fink called a “slow rolling crisis…with more seizures and shutdowns coming.” Investors, watching how SVB and Signature Bank equity holders and unsecured bondholders were wiped out, are fleeing smaller banks. Commercial real estate – which is seeing rising defaults – could be the next domino to fall.

We are far from seeing the final fallout from SVB. The trust that streamlined the financial system and startup ecosystem has been damaged. Further regulation – especially of the smaller regional banks – is all but certain. Smaller banks are likely to start raising credit standards and restricting credit to limit their exposure to runs. Executives’ 10B5-1 plans – which allow insiders to sell company stock on a structured schedule – have been thrown into question.

If there is a silver lining to any of this, it is that the turmoil may help dampen inflation and allow the Fed to ease up on rate hikes. The crisis also serves as a reminder of the dangers of straying away from fundamentals – such as due diligence, lending standards, risk management, diversification, and keeping inflation under control.

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