The federal regulator rescue of Silicon Valley Bank (SVB) and insuring all deposits was a good outcome for business depositors. But for borrowers — many of whom are also SVB depositors — the outcome is in doubt. And contradictory messaging from the Federal Deposit Insurance Corporation (FDIC) last weekend, and the newly created Silicon Valley Bridge Bank on Monday and Tuesday, have finance executives wondering if their loan agreements will operate as usual.
Federal banking regulators used what they called the “systemic risk exception” to protect both the FDIC-insured and uninsured depositors of both SVB and Signature Bank. Still, on Monday, many SVB customers began to withdraw their money from SVB and put it into “systemically important” U.S. banks (SIBs) such as JP Morgan Chase and Bank of America.
The SVB loans are typically called “venture debt.” They made up about 24% of SVB’s $75 loan book. Few other commercial banks make loans to such companies due to the risk involved.
Because the FDIC is not a bank, it informs the borrowers that they are strongly encouraged to seek a new lender that will refinance their loan and serve as a replacement source of funding.
When a U.S. bank goes into receivership, as described on the FDIC website, “because the FDIC is not a bank, it informs the borrowers that they are strongly encouraged to seek a new lender that will refinance their loan and serve as a replacement source of funding.”
As noted in an initial client advisory by law firm Morgan Lewis, “for unfunded or partially funded lines of credit, the FDIC often repudiates funding obligations or otherwise curtails the lending operations of a failed bank.”
That led some advisers early on to tell CFOs that SVB lines of credit would be permanently frozen as of March 10 and they probably would not have access to undrawn amounts on lines of credit.
Then, on Monday, the FDIC transferred the deposits and the assets of SVB to a new “bridge bank” — a bank charged with holding the assets and liabilities of the failed bank until it is either sold or liquidated.
Tim Mayopoulos, Silicon Valley Bridge Bank
The new CEO of Silicon Valley Bridge Bank, as it is being called, Tim Mayopoulos, urged clients to bring their deposits back to SVB if they had withdrawn them, stating that the bank is “open for new business.” In a post on the SVB bridge bank website on Tuesday, Mayopoulos also said that the bank was “honoring existing credit lines,” and actively opening new accounts and “making loans.”
An FDIC spokesperson indicated that the SVB bridge bank is operating as a "full-service" bank.
Covenant Violations
Those statements from the CEO were a quick reversal from the FDIC's guidance. They also left worried SVB borrowers in a quandary. Loan covenants frequently require the borrower to keep some money deposited at the lending bank. As a result, finance executives have to decide whether to err on the side of caution and withdraw their deposits, despite the possibility it violates their loan agreement.
“Many earlier stage tech companies relied on these loans as a source of liquidity to grow and to fuel their development and marketing efforts as they [tried] to scale,” said John Pennett, a partner in the technology and life sciences group at EisnerAmper.
Within private online forums, finance executives shared that SVB sales reps were pushing them to return any deposit funds they withdrew to keep their loan facility — even customers that had not drawn down any portion of their lines. Some customers have withdrawn a portion of their deposit funds to meet payroll or other operating obligations, but are being careful not to break their covenants.
Among other issues, some vendors and customers are refusing to honor SVB accounts, forcing companies to find another bank for an operating account.
Whether or not banks go out of business, the bigger risk is just not knowing. — Zack Ellison, Applied Real Intelligence
Zack Ellison, the founder of Applied Real Intelligence, a venture debt investment firm, said he pulled some money out of one of its banks. Applied Real Intelligence is opening up credit lines and accounts for its funds with JP Morgan Chase and Bank of America.
“Whether banks go out of business, the bigger risk is just not knowing,” Ellison, who has experience as an investment banker and credit trader, told CFO. “There's also reputational risk. … [when] someone says ‘I would love to invest in your fund,’ [they ask] 'who do you bank with?'”
Ellison cautions that even though his company will not lose any money, "it takes weeks to set up these accounts."
Stay Put?
SVB’s CEO is touting SVB Bridge Bank as the safest place for businesses to have cash, since account holders are not subject to an FDIC deposit insurance cap.
As Pershing Square's Bill Ackman tweeted on Wednesday morning, "we now have three tiers of banks. SVB and Signature Bridge Banks — which are now the safest banks with explicit guarantees on all deposits; the [systemically important] banks -— which have implicit guarantees on all deposits; and all other banks."
If you have a good interest rate, especially in this rising interest-rate environment, maybe the company is better off keeping the loan because the loan is going to stay in place. — John Pennett
It may make sense for a borrower to choose to stay with SVB, but it is a highly individualized decision.
John Pennett, EisnerAmper
"If you have a good interest rate, especially in this rising interest-rate environment, maybe the company is better off keeping the loan because the loan is going to stay in place,” said Pennett. “It's now owned by the FDIC and they're going to sell it to another bank.”
According to a new client advisory from Morgan Lewis published on Tuesday, “If a loan has been transferred from SVB or Signature to a new bridge bank established by the FDIC, there is a greater chance that the bridge bank will fund the draw.” Even when a bridge bank has not taken over a failed bank, the FDIC sometimes advances funds in an emergency to ensure the short-term viability of a borrower.
In past U.S. bank failures, bridge banks did make loans but, according to FDIC’s Managing a Crisis whitepaper, bridge banks are also temporary, operating only up to two years, and are supposed to “operate in a conservative manner. The bridge accepts deposits and makes low-risk loans to regular customers. ... and honors the previous institution’s commitments."
The main purpose of a bridge bank is to preserve the franchise’s value and “lessen disruption to the local community,” the whitepaper reads, and the FDIC’s purpose in putting banks into receivership is to "maintain financial stability and maintain public confidence."
Need to Perform
Right now, the only certainty is that business borrowers need to comply with their loan agreements and continue to pay back their loans on the set schedule, according to attorneys. And SVB could indeed hold borrowers to their covenants.
“Unfortunately, the borrower is at a point where it needs to perform, but the receiver doesn’t necessarily need to perform,” according to Morgan Lewis.
William Hanlon, Seyfarth Shaw
However, a CFO whose company is banked at SVB has to be thinking about alternative financing arrangements, said William Hanlon, a partner in restructuring and bankruptcy at Seyfarth Shaw.
The FDIC does not want to be in the banking business, he said. It may operate the bridge banks [of SVB and Signature Bank] for a while, but ultimately it wants to sell the assets or liquidate. A purchaser may also make a bid for the bridge bank itself.
“In the best world, SVB bridge bank will find a purchaser with an entrepreneurial bent, and [they will] pick up where SVB left off. Honor the agreements, and be as flexible and warm and loving a lender as Silicon Valley Bank was to its customers,” he told CFO. “In the worst of all worlds, someone will buy the notes at a discount and go out to collect them.”
On Wednesday, the FDIC tapped investment bank Piper Sandler to relaunch the auction of Silicon Valley Bank, according to Reuters. Efforts to sell the bank whole or in pieces have not been successful to date.
