Press "Enter" to skip to content

Let’s talk about Silicon Valley Bank and why IT services companies should care

The failure of Silicon Valley Bank has consumed tech news. You come here for analysis over breaking news, listener, and I will offer some of that shortly.     I will quote Ben Thompson, who summarizes what happened well.

Silicon Valley Bank’s depositors, many of whom were startups, deposited the cash they received from investors; the amount of deposits was particularly high over the last few years thanks to the ocean of money unleashed during COVID, much of which found its way to the tech sector.

Silicon Valley Bank effectively lent a large portion of that money to the federal government (in the form of U.S. Treasuries) and homeowners (in the form of agency mortgage-backed securities).

While Silicon Valley Bank used to primarily lend out money on shorter-term durations, in 2021, the bank shifted to longer-term securities in search of more yield; this, in retrospect, was the critical mistake — and to be clear, Silicon Valley Bank’s management bears ultimate culpability for the bank’s fate. 

When interest rates rose, (1) fewer deposits came in as venture capital funding dried up, and (2) the market value of those securities plummeted: who would want to buy a 10-year Treasury paying out 1% when you can buy one from the government for 3.5%?

In fact, Silicon Valley Bank has been technically insolvent for months: the company had more assets than liabilities, but a huge chunk of those assets could not be liquidated without taking a major loss; everything would be ok, though, because those securities would mature in time, paying back their value in full.

The big loser would be Silicon Valley Bank stockholders, who would forego all of the unrealized interest on the more attractive securities the bank could not buy in the meantime; small wonder the stock lost 66% of its value last year:

Still, Silicon Valley Bank was still a bank, albeit a less profitable one — unless there was a bank run.   End Quote

And that’s what happened last week.    The bank was working on converting long-term investments into higher yield short ones, and as the deal fell through on Thursday, some large venture investors advised companies to pull their money, and thus the bank run began.     The FDIC stepped in Friday, shut down the bank, and announced that all depositors would have access to their money beyond the $250K insured limit on Sunday night.     They cited the systemic risk of bank failure.   HSBC purchased the UK arm of the bank.. for 1 pound. 

Related, the Federal Reserve announced a new program to make it easier and more attractive for banks to borrow against assets like Treasury bonds if they find themselves under pressure to come up with cash.   That way, banks wouldn’t have to sell those bonds, many of which have declined in value as interest rates rose. 

Why do we care?

This story was breaking on Friday as I was working on that episode, and my initial take was that it wouldn’t impact IT services companies and MSPs directly – and so you know, why it wasn’t in Friday’s show.   I wanted to be an analyst, and there wasn’t enough yet to analyze.     

Why did I dismiss it Friday?  Because of the FDIC – if you’re a small business in the US, your banking up to $250,000 in cash is covered.    My dual assumptions – most small businesses don’t bank with SVB and that many have less than this amount in cash – were the lesser urgency.

One of the takeaways to be aware of is the idea of a Sweep Network – a system where your money is distributed across FDIC-insured banks, as the insurance is per bank per account.  Spread your money out; you’re insured.     Or a CDARS – Certificate of Deposit Account Registry Service, where it’s broken up across banks.      So here’s your tip of the day – this concern is preventable, particularly for companies in the SMB space.   Financial resilience means more than simply having cash in a bank.    Many should ask … what if the bank fails?   No single point of failure, right?  

I learned during my research that part of SVB’s model was loaning additional money to startups on the heels of VC investment, leveraging that due diligence, and to get that debt, the company would need to use SVB for all its banking.      That’s a key detail, especially when considering the significant investment dollars at play.     That’s a risk to know.     

Potentially vendors in the space are affected more – and of note, many are sending out new banking details… and be warned about the scammers preying on this possibility too.     Be warned about this potential ploy. 

I’ve seen some questions if the VCs were pushing their portfolio companies to withdraw their money in collusion.  That open question will be a key element – the bank’s customers made a bad decision far, far worse.  

If you’re unfamiliar with the Prisoner’s dilemma, this is an excellent time to consider it.   In a single instance, mutual betrayal is the only equilibrium: once both prisoners realize that betrayal is the optimal individual strategy, there is no gain to unilaterally changing it.   But, if played iteratively – where the players remember the outcomes – it’s been shown that playing for the long run, it’s better to be nice.   You make up for short-term losses with long-term gains.

Be First to Comment

Leave a Reply