Silicon Valley Bank's demise began with a downgrade threat, here's how it all went crashing

Last week, SVB Financial Group, the parent company of Silicon Valley Bank, received a call from Moody's Investors Service Inc. The rating agency informed the bank that it was preparing to downgrade its credit rating, sending alarm bells ringing throughout the financial industry. The phone call was the beginning of the process that led to Friday's collapse of the startup-focused lender, which is now considered the biggest bank failure since the 2008 financial crisis.

The collapse of SVB sent shockwaves through global markets and had a profound impact on banking stocks. The collapse has raised concerns that the Federal Reserve's aggressive interest rate increases aimed at combating inflation have exposed vulnerabilities in the financial system.

The SVB collapse illustrates how quickly confidence in financial institutions can erode and how even the best-laid plans can backfire. The failure also sent shockwaves through California's startup economy, leaving many companies unsure about how much of their deposits they could recover and how they would pay their staff.

Moody's Call

Moody's call came after the value of the bonds in which SVB had invested its money fell due to higher interest rates. SVB's management team became concerned that the downgrade would undermine the confidence of investors and clients in the bank's financial health. To mitigate the damage, SVB's Chief Executive Greg Becker's team sought advice from Goldman Sachs Group Inc bankers and flew to New York for meetings with Moody's and other rating firms.

Over the weekend, SVB developed a plan to increase the worth of its assets. The plan involved selling more than $20 billion worth of low-yielding bonds and reinvesting the proceeds in assets that deliver higher returns. The transaction would generate a loss, but if SVB could fill the funding hole by selling shares, it would avoid a multi-notch downgrade.

Plan Unravelled

However, the plan backfired. News of the share sale spooked clients, primarily technology startups, who rushed to withdraw their deposits, upending the capital raising. On Friday, regulators intervened by closing the bank and placing it under receivership.

As SVB executives debated when to proceed with the fundraising, they received news from Moody's that the downgrade was imminent. The bank acted quickly to soften the blow, lining up private equity firm General Atlantic, which agreed to buy $500 million of the $2.25 billion stock sale. Meanwhile, a different investor stated that it was unable to reach an agreement within SVB's schedule.

By the middle of the week, SVB had offloaded the bond portfolio, incurring a loss of $1.8 billion. Moody's credit rating agency lowered the bank's rating, but only by one level, considering SVB's sale of the bond portfolio and its strategy to increase capital.

Ideally, the stock sale would have been completed before the market opened on Thursday to avoid the sale being jeopardized by any declines in SVB's shares once news of the sale got out. However, sources told Reuters that was not an option given the tight schedule.

“SVB had not done the preparatory work needed to sign confidentiality agreements with investors who would commit to a deal of such a size. Its lawyers advised the bank that investors would need at least 24 hours to digest new downbeat financial projections and complete the sale,” sources told Reuters.

The Finale

On Thursday, SVB's stock plunged on news of the share sale, ending the day down 60% at $106.04. Bankers at Goldman Sachs remained optimistic about finalizing the sale at $95. However, things took a turn when venture capital firms instructed startups they had funded to withdraw their funds from Silicon Valley Bank due to concerns of an impending bank run.

This quickly became a self-fulfilling prophecy: General Atlantic and other investors walked away, and the stock sale collapsed.

California banking regulators closed the bank on Friday and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver The FDIC will dispose of its assets.

(With Agency inputs)

Also Read

Silicon Valley Bank crisis: The rise and fall of CEO Greg Becker

Watch: Massive line forms outside Silicon Valley Bank as customers panic, over $200 billion in peril