What to do if you are in danger of missing a bank covenant


In recent weeks, the swift failure of Silicon Valley Bank (SVB), an extremely popular bank for start-ups, has continued to make headlines. As federal regulators have continued to address the issues caused by SVB's failure, this ordeal brings up two critical questions:

  1. How does a large bank, with nearly $200 billion in deposits, fail in a matter of days?
  2. What can business owners, investors, and managers take away from this situation?


Prior to its failure, Silicon Valley Bank, headquartered in Santa Clara, CA, was one of the twenty largest commercial banks in the United States. It focused its efforts on start-ups and venture capital firms, often providing loans to start-ups, who in turn maintained their cash accounts at SVB.

In connection with a period of strong performance and fundraising amongst tech and life sciences start-ups, SVB saw its deposits from customers increase rapidly. This increase in deposits provided SVB with a large inflow of cash, much of which was used to purchase bonds, including treasury bonds and highly rated mortgage-backed securities, which are typically seen as safe, recession-proof investments. During 2021, SVB saw deposits increase from $102 billion to $189 billion, while its reported value of its investments increased from $49 billion to $128 billion.

Where Things Went Wrong

In response to high inflation, the federal reserve began ratcheting up interest rates in 2022. The goal of this action was to tamp down the economy so that inflation and economic activity returned to normal levels.

This had a two-fold effect for SVB, which ultimately led to its demise.

  1. Rapidly rising interest rates resulted in SVB's bond investments losing value quickly, as the price of bonds has an inverse relationship with interest rates. However, the vast majority of these investments were reported under an accounting principle which allowed unrealized gains and losses to be recognized when the investments are sold. As a result, SVB reported the investments at their purchase cost. Meanwhile, the unrealized losses on these investments skyrocketed from approximately $1 billion at the end of 2021 to approximately $18 billion by the end of 2022.
  2. Higher interest rates began to have the desired effect of "cooling down" the economy during 2022, which resulted in less investment money flowing into start-ups. Consequently, many businesses began withdrawing deposits from SVB to cover expenses, which forced SVB to begin selling its investments at a loss to cover withdrawals. By the end of December 2022, SVB's deposits totaled $173 billion, down from a high of $198 billion in March.

These issues came to a head on March 8, 2023. Facing a credit downgrade from Moody's Investors Service, SVB sold approximately $21 billion of its bond investments at a $1.8 billion loss and rushed to raise equity to help fill the gap created by these losses. However, SVB was unable to raise the desired equity, in part due to the appearance of desperation, which spooked investors and depositors alike.

On March 9, depositors, nervous about the solvency of SVB, pulled out their deposits en masse. Over $42 billion of SVB's deposits were withdrawn by customers in the span of a day. SVB, hampered by its poor bond investments, faced an immediate capital crisis, and had a negative cash balance of nearly $1 billion at the end of the day on March 9. On March 10, after failed attempts to obtain funding or be purchased outright, SVB was taken over by federal regulators, completing its swift collapse.

What Can Be Learned

1. The Risk of Uninsured Deposits. The failure of SVB served as a stark reminder to depositors and the public that only $250 thousand in deposits are insured by the FDIC. While the federal government did take action to ensure that all deposits, even those that are uninsured, were protected, it is not obligated to do so. In addition, even though companies were ultimately able to access cash deposited at SVB, the initial takeover of the bank by regulators resulted in short-term liquidity issues for many companies.

Companies and individuals should be sure to monitor the degree to which they are exposed to any one bank. While deposits beyond $250 thousand may be protected in the event of a bank failure, there is no guarantee that this would happen. Also, disruptions caused by a bank undergoing financial distress can lead to temporary liquidity problems that could impact a company’s ability to fund payroll and other operating costs in a timely manner.

2. Lack of Diversification. SVB's customer base was extremely concentrated, as a large percentage of its deposits came from venture capital funds and tech and life science start-ups. As a result, in 2020 and 2021, SVB prospered due to the strong operating performance and fundraising amongst start-ups. However, when operating and fundraising activity slowed down, SVB found itself wholly exposed to the notoriously volatile nature of the tech start-up market. Similarly, SVB's investments were not well-diversified, as its substantial investments in long-term bonds left it vulnerable to the negative effects of interest rate increases in 2022.

For business owners and managers, it is important to remember the value of diversification. When you put all your eggs in one basket, it can result in unusually strong performance, but it also leads to major downside risk. Therefore, it is important to evaluate whether your business is overly reliant on certain customers, suppliers, materials, geographic markets, or financing sources and to consider ways in which these risks can be mitigated.

It would be easy to conclude that SVB’s failure was an isolated occurrence, but bank failures are fairly common. In fact, there have been 563 bank failures in the U.S. since the turn of the century. Additionally, it would be nice to never have to ponder the potential impact of the loss of a major customer or vendor, but these are not rare events in business. Taking some time to evaluate and mitigate risks such as these will not only help you sleep better at night—they will also help you build a much more strong, resilient business.

If you have any questions or would like additional information, please contact a member of our Business Advisory Group.

Tyler Baum is an Associate in our Business Advisory Services Group. Contact him at Email.

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