I’m a firm believer that a strong economy needs a healthy banking industry foundation to build upon. If the banking industry is in peril, then it is near impossible for companies to thrive. I am sure I hold a biased view. Maybe I drank the banking cool-aid after working way too many long nights and weekends in Bank of America’s investment bank in 2009, just after the banking crisis, helping banks in the United States and Latin America raise capital, find merger partners and execute bank acquisitions. We affectionately and arrogantly called ourselves the banker’s banker. How’s that for formulating a biased view of the banking industry?
The problem Silicon Valley Bank (SVB) faced wasn’t the same that Lehman Brothers, Wachovia or Washington Mutual faced of holding complex mortgage securities that were not accurately priced. SVB had a liquidity and confidence issue.
SVB has made its name offering banking products to the technology industry. Many of its account holders run losses and require regular capital injections to continue to grow and scale their operations to hopefully attain a sustainable, cash flowing level.
With the recent decline in technology valuations (see chart #1) and the now less frequent capital raises at lower valuations (see chart #2), I believe these technology bank account balances continued to decline without replenishment. SVB managers didn’t expect that and as such, SVB had to sell some of its investment holdings (U.S. government bonds) to meet the liquidity needs of its customers. Unfortunately, because of the recent increase in interest rates, SVB sold those bonds at losses as bond values and interest rates move in opposite directions. That spooked some account holders and some technology investors so much that they decided to move their banking business to other institutions. Private and some public proclamations asserted that SVB was in trouble which wasn’t completely true at the time. They could have been fine without the run on the bank. But between the existing nerves, horrible execution, messaging around the capital raise, and frantic public statements from notable VCs on Twitter and in private forums, the run was on and SVB’s fate was sealed.
Thankfully, state and federal banking regulators stepped in to limit the issues to SVB and a few others while instilling confidence in the U.S. national banking system. When I say “thankfully” that’s at least for now. It remains to be seen what the long-term implications of effectively nationalizing all bank risk will be. For now total disaster was averted and we’ll see over time at what cost.
While I do believe the U.S. banking industry is stronger now than during prior banking scares… it’s far from perfect. The issues that SVB faced exist for other banks. Private company equity valuations will continue to face downward pressure so long as interest rates continue to increase to combat inflation (see Chart 3). How high rates will go is anybody’s guess. Where, when and if public company and private company valuations will return to pre-pandemic levels is anybody’s guess. Venture capital investment deal values may continue to remain muted. As such, banking customers will continue to need access to their cash. Banks will continue to fail for a variety of reasons.
In the meantime, I would advise entrepreneurs and company executives to preserve cash in this low valuation environment, develop relationships with multiple banks to ensure you have sufficient access to your funds, judiciously manage your debt obligations as more interest rate increases are in the forecast. Whether you agree or disagree with the federal decision to intervene in the SVB failure, I sincerely hope we will not see additional failures.
Chart #1
Over the last 10 years, company valuations climbed relatively steadily, followed by a very rapid increase during and shortly after COVID. Then, company valuations fell very quickly, which coincides with interest rate increases.
Chart #2
Q4 total deal value is the lowest it has been since 2018. After years of increasing deal values, 2022 saw consistent declines quarter over quarter.
Chart #3
As interest rates have risen, public company valuations have declined.
