Thread by @jonwu_

The 20th largest bank in the US was just closed by California state regulators.

Silicon Valley Bank was rumored to be in a sale process to protect its depositors.

Now, it's the second biggest banking failure in US history.

All because of a secular bet against rising rates:

Yesterday, there were whispers of a bank run at SVB triggering a massive bond sale.

That bond sale of $21 billion in assets represented a realized $1.8 billion paper loss--an effort to reposition the bank's assets to better meet the duration of their liabilities.

Now SVB is in receivership with the FDIC, who is custodying all assets.

Insured depositors can withdraw in an orderly manner.

Uninsured depositors--anyone with more than $250,000 at the bank--will receive a "receivership certificate." fdic.gov/news/press-rel…

Unfortunately, more than 93% of SVB's $161 billion in deposits are uninsured.

Meaning a huge swath of America's startup ecosystem has their money locked in a giant paper IOU with the Federal government.

https://twitter.com/markets/status/1634211637774233600?s=20

This could represent one of the biggest cash crunches for Silicon Valley and its companies ever, as large depositors' funds are frozen for an indeterminate amount of time.

So what is Silicon Valley Bank, and how did this happen?

SVB's core product is "venture debt," which isn't something special--after all, debt is debt.

What's special and weird about it is the customer:

Startups.

Businesses that don't make money for a long time, whose primary source of cash is raising equity from venture capital.

The SVB venture debt deal was straightforward for founders:

You raise money from a top Silicon Valley VC, and we'll chuck in 20-30% of the round in "non-dilutive" capital at prime + 50.

And we'll get a few basis points in equity warrants in exchange.

In my last startup (RIP food trucks-as-a-service, we barely knew ya) we raised $5.8 million on a deck and were immediately offered more than a million dollars from SVB at extremely favorable terms.

What were those terms?

SVB goes to founders right after they raise a very, very expensive venture round from top venture firms offering:

- 10-30% of the round in debt
- 12-24 month term
- interest only with a balloon payment
- at a rate just above prime

Nothing short of amazing, really.

We found ourselves asking, "What's the catch?"

No catch! And SVB weren't the only kids on the block.

Slews of "venture banks" have sprung up to compete in this prestigious, high-growth startup market.

For investors, it also seems like a no-downside scenario for your portfolio:

Give up 10-25 bps in dilution for a gigantic credit facility at functionally zero interest rate.

If your PortCo doesn't need it, the cash just sits.

If they do, it might save them in a crunch.

The deals typically have deposit covenants attached.

Meaning: you borrow from us, you bank with us.

And everyone is broadly okay with that deal.

It's a pretty easy sell!

"You need somewhere to put your money. Why not put it with us and get cheap capital too?"

The thing is, those deposit covenants were often the *only* covenants attached to the loans ("cov-lite").

No coverage or collateral requirements, since, well, startups typically don't have earnings or assets other than the cash on their balance sheet.

To sweeten the deal for everyone, SVB was incredible at business development.

Not only did they have a stellar reputation for service, it's a well-known fact that they gave sweetheart mortgage deals to venture capitalists and founders, backed by company and fund equity.

Say you're a founder (or VC) with a bunch of illiquid but sure-to-be-worth-something-someday startup equity or fund carry, and you need a house.

Typical mortgage lenders won't help you.

But SVB will, at the same insanely good terms they're known for in the venture debt world.

That's why everyone in tech loved SVB:
- they're nice people who take you to nice dinners
- they'll help you buy a house
- they provide structurally underpriced capital at comically friendly terms ("just bank with us")

It's that last part--"just bank with us"--that the entire startup ecosystem fled from in the last 48 hours.

After all the golf trips and homes and underpriced capital, folks whispered to each other to get money out of SVB!

Ungrateful doesn't begin to describe it.

And why?

Well with all those deposit covenants, SVB accrued $190B (with a B) in deposits in 2021.

That rapidly growing capital base was a key part of the business. Maybe break even on the loan book, but squeeze ANY sort of yield on deposits, and this is a good bank.

So it goes.

The business model is therefore:

1) make cheap loans to elite startups and convince yourself they're definitely going to raise money again to pay you back
2) grow the capital base massively via deposit requirements connected to those loans
3) get some yield on those deposits

What was done with those deposits is the source of SVB's troubles.

In an effort to chase yield and provide a decent return on equity, SVB bought billions of dollars of long-dated mortgage-backed securities paying ~1.6%.

https://twitter.com/jamiequint/status/1633956163565002752

Now, a couple very bad things are happening all at once, all because of the end of the Fed's 15-year long streak of zero-rate policies:

- startups are burning cash faster
- deposit growth is slowing
- they can't raise

So SVB has a bunch of long-dated illiquid assets and a bunch of short-term liabilities.

Because remember: to banks, deposits are liabilities.

https://twitter.com/jonwu_/status/1540162617167163392?s=20

Remember what happened to Celsius, that disgusting crypto bank?

Well it's kind of the same deal here:
- collect lots of deposits
- lock them away for a long time to get some yield
- people ask for their money back today
- big oopsie

https://twitter.com/jonwu_/status/1536769262928465927?s=20

SVB tried over the last few days to raise debt + equity in order to shore up its balance sheet.

As a result, depositors got even more freaked out:

"If they had sufficient liquidity, why would they have to raise?"

VC's were caught in an impossible decision:

- tell portfolio companies to keep deposits in SVB and shore up a key capital provider in the VC ecosystem

- tell them to withdraw, ensuring that same bank failure

The confusion and desperation triggered a classic bank run.

SVB's long-dated assets couldn't be fire-saled fast enough to cover immediate depositor withdrawals.

"Stay calm"
- every deposit institution when clients start running on the bank

latimes.com/business/story…

SVB was finally in talks late last night to find a buyer in order to protect its depositors--with eerily similar echoes of crypto sector failures from the last year.

https://twitter.com/SBF_FTX/status/1590012124864348160?s=20

In the final calculus, skyrocketing rates caused valuations for all long-dated cashflows to plummet.

That included all of SVB's exposure:
- VC-backed companies, who comprised both their clients and investments
- their MBS portfolio

Even the sweetheart mortgages were worth less!

SVB made an all-in bet on rates:

1) targeting an extremely interest-rate sensitive asset class (high-growth startups), then

2) doubling down on low-rate, long-dated securities (10+ year duration MBS).

cnbc.com/2023/03/10/sil…

And now, Uncle Sam is banker to most of the startups in this country.

And all because SVB:
- had a core business lending to unprofitable companies
- made a ridiculously long bet on bonds and MBS
- triggered its own run by announcing a fire sale and capital raise

Thread continues here:

https://twitter.com/jonwu_/status/1634250780965478400?s=20

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I cover the most interesting things happening in blockchain, finance, and tech.

May God have mercy on American startups.

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