What happened
Shares of SVB Financial (SIVB.Q), the parent company of Silicon Valley Bank, tanked by more than 39% as of 10:45 a.m. ET today after the bank announced it was selling bonds for a loss and raising capital.
So what
SVB caters heavily to the start-up and tech industries. As liquidity funneled into the banking system during the early part of the pandemic and tech and growth valuations took off, deposits at SVB surged, ballooning SVB's balance sheet and leading management to invest excess deposits into bonds to boost profitability.
However, after the Federal Reserve aggressively hiked interest rates and began pulling liquidity out of the economy through quantitative tightening, tech valuations have come down, and VC activity has slowed. Meanwhile, start-ups and early-stage companies that SVB banks with have been burning cash at a high clip, resulting in large deposit outflows. Between the end of the second quarter of 2022 and the end of the year, SVB saw noninterest-bearing deposits, which it pays no interest on, fall by close to $34 billion.
These trends have continued in the current quarter, and to help cover these outflows, SVB has sold its entire available-for-sale bond portfolio, which resulted in a loss of roughly $1.8 billion. Bonds have been underwater as bond yields have soared.
Losses on bonds are only paper losses while a bank holds them, but once they are sold, the bank has permanently destroyed shareholder equity. Furthermore, Moody's Investor Service recently downgraded the credit ratings of SVB due to liquidity and funding issues.
Because of all this, SVB now wants to raise $2.25 billion of fresh capital, which includes $1.25 billion of common stock, a $500 million private placement from the private equity firm General Atlantic, and $500 million of mandatory convertible preferred stock.
Now what
While I have previously been bullish on SVB, I am incredibly disappointed by these actions today. On its first-quarter earnings call, SVB's management team said they had been seeing a lower level of cash burn. Although the environment is very difficult, management has clearly done a poor job of managing liquidity and went too heavily into bonds too early to try and reap additional earnings accretion.
Hopefully, things will stabilize, but in a worst-case scenario, management would need to dip into its held-to-maturity bond book to cover deposit outflows. Currently, losses in that portfolio exceed $15 billion, enough to wipe out almost all of SVB's equity.
While this is probably unlikely, SVB will face earnings challenges moving forward. I would recommend staying away from the stock until it is more certain that client cash burn and deposit balances have stabilized.
