Welcome, folks, to another episode of the Hypergrowth Investing podcast!

This week, we’ll be discussing the elephant in the room – the recent collapse of Silicon Valley Bank (SVB) and its implications for the markets.

So what happened?

SVB’s failure was caused by a classic bank run, but this alone is not enough to bring down a bank, especially one as prestigious in technology as SVB. 

Rather, the run on SVB was a symptom of deeper issues – namely, two unique problems that arose from SVB’s very niche, exclusive focus on the startup tech sector. We’ll delve into these issues and explore what they mean for the future of the markets.

What Happened to Silicon Valley Bank?

The bank saw rapid growth in deposits amid the tech boom of 2020 and ‘21. And due to regulations put in place after 2008, SVB had to back up all those deposits with high-quality assets, which mostly comprise U.S. Treasuries. So, in 2020 and ‘21, SVB bought a bunch of U.S. Treasuries with its customers’ deposits. 

Given the Fed’s rapid rate-hiking cycle, U.S. Treasuries have since lost significant value. Consequently, SVB has been sitting on massive unrealized losses in its bond portfolio. Under typical operating circumstances, those unrealized losses are manageable because SVB can just hold the Treasuries to maturity and cash out without recognizing any real loss. 

However, in stressed operating circumstances wherein customer deposits dwindle and SVB needs to raise cash, the bank is forced to sell those bonds, and the unrealized loss becomes a realized loss. 

That’s exactly what happened. Over the past 12 months, venture funding for tech startups dried up. SVB’s customers were no longer seeing lots of cash inflow. In fact, very little cash was coming in the door. But those startups were still running businesses that required funds to keep the lights on, so cash flow going out of SVB accounts was still very high. 

Very little cash in, lots of cash out – obviously, that is an unsustainable situation, so SVB was forced to sell its bond portfolio to raise the funds necessary to keep up. 

The result? The company suffered a multi-billion-dollar loss on that bond portfolio. In order to recoup those losses, SVB tried to raise outside capital via share offerings. That didn’t work. No capital came to the rescue. So, the federal government swooped in and took over.

What Comes Next?

But remember: SVB was forced to cash out early because of its unique and exclusive focus on the most rate-sensitive part of the economy – early-stage tech startups. Since essentially all of its customers saw their funds dry up over the past 12 months, SVB saw its deposits start to dwindle quite rapidly. Yet, cash needs of those customers were not dwindling, leaving the company with a massive imbalance that it needed to fill. 

So, this appears to be a problem unique to SVB. This is idiosyncratic – not systemic.

SVB’s collapse is a big warning shot to the Fed. Fed rate-hike cycles are like bulls running through china shops – they both keep going until something breaks. And something significant has broken.

And what broke SVB could potentially break other banks – bigger banks – if the Fed keeps its foot on the rate-hike pedal. But we’re confident the central bank will heed that warning. 

A pause is coming – and that means a major market rally likely is, too.

On the date of publication, Seth Kuczinski did not have (either directly or indirectly) any positions in the securities mentioned in this article.