In the Wake of the Demise of Silicon Valley Bank and Signature Bank: What Fintechs, Private Equity, and Banks Need To Know

On Friday, March 10, the California Department of Financial Protection and Innovation (DFPI) closed Silicon Valley Bank (SVB), the subsidiary of SVB Financial. The Federal Deposit Insurance Corporation (FDIC) was appointed the receiver of its over $250 billion in assets. This is the largest U.S. bank failure since the global financial crisis more than a decade ago.

SVB was the premier financial institution of choice for startups, fintechs, and their venture-capital/private equity (VC/PE) partners. SVB had over $200 billion in deposits in early 2022. Much of those deposits were in excess of the FDIC-insured limit of $250,000.00. To manage this excess liquidity, SVB Financial invested primarily in long-term U.S. Treasury and government-backed mortgage securities with fixed interest rates. This increased SVB’s securities portfolio threefold.

While these securities were safe bets because of the low risk of default, when they need to be liquidated prior to term, in a market of rising interest rates, the securities suddenly have a rapid decline in value. Couple this will a rapid cash outflow from depositors and SVB’s securities portfolio had a gap of $17 billion by the end of 2022.

SVB tried to cover this gap last week by selling $21 billion of their securities but for a loss of about $1.8 billion. Due to this loss, portfolio clients were then warned by VC/PE partners to withdraw deposits from SVB.

SVB was not alone in its liquidity strategy. Other similarly situated banks and mid-sized lenders whose portfolios contained long-term government-backed securities are seeing a similar fate in the need to sell quickly or raise capital.

What does this mean for banks?

The SVB implosion underscores the need for banks of all sizes to develop and maintain an effective risk management program, particularly with respect to assessing and managing interest rate and liquidity risks in the current rising interest rate environment. As the details of the debacle continue to unfold, we have also learned that SVB operated for much of 2022 without a chief risk officer. An effective risk management program should ensure that a competent and experienced professional is responsible for evaluating and mitigating risks enterprise-wide.

Banks should examine their exposure to rising interest rates and conduct stress testing of their cash management practices. SVB failed to effectively manage its unusually large exposure to interest rate risk: with less dependency on retail deposits than most banks, funding became more expensive at the same time that assets were not repricing higher. The rapid interest rate increases by the Federal Reserve have not provided banks with much time to shift their balance sheets and portfolios, but increased stress testing of various scenarios could help increase the swiftness of banks’ responses.

This crisis should also encourage banks to examine the concentration of their liabilities as well, and not simply the quality of their assets. Deposits at SVB were concentrated in a high-risk deposit base: start-up companies that were impacted by the downward trend in VC investments and operated in the same technology sector. Fear mongering by key players in the VC space led to a traditional bank run in which companies were advised to withdraw their cash due to the concern that nearly all of the SVB’s deposits were too large to be eligible for FDIC deposit insurance. The fact that such a dramatically low percentage of SVB’s deposits were insured made this bank unusually susceptible to a bank run, and we can expect that regulators will increase scrutiny of banks’ customer bases going forward.

What does this mean for Fintechs and Venture Capital/Private Equity Firms?

Investments in startups and fintechs were at an all-time high during and after the pandemic. Those investments significantly cooled in the first quarter of 2023. Many of the major VC/PE companies did business with SVB. Many will lose cash and their return on their investment in SVB stock. For these VC/PE portfolio clients, capital raises will be difficult or non-existent. However, this may result in opportunities for other non-SVB VC/PE companies to step in but expect a very conservative approach and smaller commitments of investment until the economic fallout becomes clearer. Finally, VC/PE companies will need guidance when establishing new banking relationships to ensure their deposits are adequately protected.

Clark Hill’s Regulatory Compliance Group of its Banking and Financial Services Practice is well-versed in liquidity and risk management issues for depository as well as non-depository institutions. Our members have worked closely with federal and state regulators like the FDIC, OCC, Federal Reserve, and the CFPB to assist our clients to meet regulatory expectations.

In addition, Clark Hill’s litigators have substantial experience in financial services litigation, complex insolvency matters, enforcement actions initiated by federal agencies, and claims determination and distribution processes that arise in these cases.

For more information or to discuss your needs, please contact our liquidity and risk management response team and attorneys Joann Needleman, Kevin Kent, and Stephanie Hager.