Dear Prospective Investor,
By now, you are likely aware of Silicon Valley Bank's ("SVB") missteps in securing customer deposits, forcing regulators to scramble and thrusting Small Tech companies into a state of financial purgatory as their treasury funds were frozen. Thankfully, Cytonics has zero exposure to SVB, and will not be directly affected regardless of what regulators decide to do. On Sunday evening, the FederalReserve announced that all customer deposits (100%) will be available as of this (Monday) morning. What happens to the rest of SVB's assets while in the FDIC's receivership remains a mystery, but they will almost certainly be liquidated to make their customers whole.
While the dust settles, the financial services sector and the startup ecosystem must give serious thought to the confluence of factors that led to this disaster.
Since its founding in 1983, SVB has firmly entrenched itself in the startup ecosystem as the bank for burgeoning, venture-funded tech companies. This risk-seeking financial institution has played a significant role in providing Small Tech with both commercial and investment banking services. SVB also underwrote unsecured loans to startups with their "venture debt" product, and provided IPO underwriting and M&A advisory services to rapidly expanding companies . None of this is particularly alarming; most large financial institutions have their hands in multiple aspects of the financial services and capital markets ecosystem. But depository institutions (i.e. commercial banks, which offer interest bearing savings, checking, and money market accounts) have a strict fiduciary responsibility to guarantee the solvency of customer (i.e. depositors) funds.
This is where SVB failed to meet its legal and ethical obligations. Almost $200B worth of startup treasury funds were housed in SVB depository accounts. The bank invested these funds in 10-year Treasury bonds which were paying over 5% annual interest prior to the SVB collapse. This sounds like a great return for a passive, risk free investment, but not during a time of uncertain interest rate hikes. The core financial concept that decimated the value of SVB's balance sheet (where a significant portion of their assets were 10-year bonds and mortgage backed securities) is that the market price of bond are inversely correlated to prevailing interest rates. This is because bond buyers demand a commensurate interest rate (i.e. return on investment, a fixed payment determined at the time of bond issuance) for a bond issued yesterday as for one issued today. If the interest rates on bonds issued today rise, then the price of a bond issued yesterday must fall to mathematically produce a competitive interest rate in the open market. For example a 10x increase in interest rates decreases the market price of a bond by 90%.
Why is this relevant? The Federal Reserve has hiked interest rates eight times since March 2022, adding an additional 450 basis points(Federal Funds rate rose from ~0.25% to 4.75%) on to what what will (hopefully) be a cap on the central bank's aggressively hawkish approach to curbing inflation. During this time, SVB drastically grew its portfolio of securities and increased its exposure to Treasuries and (MBS), both of which are highly sensitive to interest rates. As the Federal Funds rate continued to rise, the book value(i.e. unrealized market value) of these fixed income assets fell precipitously, decimating SVB's stock by over 60% since last Tuesday. This triggered more scrutiny into SVB's balance sheet, and concerned founders began emptying their accounts in fear that SVB would not be able to meet their near-term financing obligations. Word in Silicon Valley spreads fast. A classic "run on the bank" was the result.
Silicon Valley Bank's overly aggressive (read: greedy) approach to investing customer deposits is not the only impetus for their collapse.The bank's risk seeking nature is illustrated by the "venture debt" financial product offered to startup tech companies. Venture debt is an unsecured loan with stock warrants issued by the borrowing company. This is not your typical commercial bank loan, which needs to be secured by some real asset that can be seized if the borrower defaults. SVB was banking on the value of the warrants in startup borrowers to make up for all of the defaults that would likely occur. Clearly, this is great for SVB's top line, but not so great for Founders who deposit their cash in the bank - a clear breach of fiduciary duty to keep customer deposits liquid and accessible.
The collapse of SVB is a tragic event in the startup world, but it is not a death knell and the sector will continue to be funded by the bold and propelled by those who dare to innovate. Increased scrutiny by regulators will have a positive impact on the private capital markets, as the financial maneuverings of the entire ecosystem is thrust into the spotlight and Founders will have to be more cautious about the allocation of investor funds. Cytonics is not directly exposed to SVB and has emerged completely unscathed, but we will heed this warning and continue to take the security of our investors' hard earned money seriously. We bank with PNC, and do not store funds in regional banks nor invest insecurities. Rest assured, (y)our money is safe. And it will stay that way.