What happened to SVB?

On Friday, March 10, 2023, before 9:00 a.m., Pacific Time, SVB’s chartering authority, the California Department of Financial Protection and Innovation (DFPI), announced that the DFPI had taken control of SVB and appointed the Federal Deposit Insurance Corporation (FDIC) as SVB’s receiver. This is commonly known as a “bank failure.” SVB’s collapse was the second-largest bank failure in U.S. history behind that of Washington Mutual in 2008.

Why did SVB fail, and how did it happen so quickly?

The immediate cause of SVB’s failure was a lack of liquidity, or in layman’s terms a “bank run.” According to the DFPI, SVB customers withdrew $42 billion of deposits on March 9, 2023, leaving SVB will a negative cash balance of $958 million at the end of the day and forcing DFPI’s hand.

The pace at which investors and depositors lost confidence in SVB was staggering. On March 8, 2023, after the close of trading on Nasdaq, SVB Financial Group (Nasdaq: SIVB), the publicly traded entity that was then SVB’s parent company, made a filing with the SEC disclosing that SVB sold $21 billion of available for sale (AFS) securities, constituting substantially all of its AFS securities, and realized an estimated after-tax loss of $1.8 billion. (By comparison, SIVB’s total 2022 net income was $1.5 billion.)  SIVB also announced at the same time its plans to raise $2.25 billion of equity capital. The next day, March 9, SIVB’s stock declined precipitously in heavy trading, losing 63% of its value.  

Of course, bank runs are not a new phenomenon, but combination of factors arguably unique to SVB created the conditions for a perfect firestorm. According to reporting in the Wall Street Journal, Eric Rosengren, who served as president of the Federal Reserve Bank of Boston from 2007 to 2021, observed that SVB’s business was heavily weighted toward venture capital and the start-up companies in which they invest, known as “portfolio companies,” and venture-capital firms don’t want their deposits or those of their portfolio companies to be at risk. Rosengren argues that SVB should have anticipated that if venture-capital portfolio companies started pulling out funds, they would do so en masse.” Depositor anxiety ignited by the stock market sell off was exacerbated by social media comments about prominent venture capital firms urging their portfolio companies to withdraw their deposits.

However, unlike the bank runs of the early 20^th century, which, akin to the run seen on Bailey Savings & Loan in the iconic film It’s A Wonderful Life, required depositors to physically “run” to their respective banking institutions to get in line to withdraw funds in person before the bank ran out of cash, SVB’s failure was fueled in part by technology that allowed a staggering outflow of funds with very few customers setting foot in a branch office of SVB. Financial institutions have increasingly introduced mobile banking tools and other forms of technology to their platforms in recent years in order to make banking experiences faster and more user-friendly, and consequently, customers can make deposits, withdraw cash and transfer funds to separate accounts using technology at their fingertips within a matter of minutes, or even seconds. The combination of convenient online banking and frenzy of worrisome news, coupled with the SVB’s business concentration with venture capital firms and their portfolio companies, resulted in SVB’s failure in a single day.

What is the FDIC’s role as receiver?

When a bank fails, a receivership is established at the moment the bank is closed. Similar to bankruptcy proceedings for non-bank companies, a receivership is the legal process whereby the FDIC assumes responsibility for recovering the maximum amount possible from the disposition of the failed bank’s assets and the pursuit of claims, and then distributing funds collected from the sale of assets and the disposition of claims to the depositors and other creditors of the failed bank according to priorities set by law. The receivership does not end until all the bank’s assets are sold and all claims against the bank are addressed.

For SVB, the FDIC is using a relatively infrequent receivership strategy known as a “Deposit Insurance National Bank (DINB)” – in this case, the “Deposit Insurance National Bank of Santa Clara ,” a newly chartered temporary bank operated by the FDIC. Although a DINB is chartered as a bank, its operations are more limited, and its purpose is to ensure that insured depositors have continued access to their insured deposits as they transfer their deposit accounts to other financial institutions. A DINB, for example, cannot originate loans, and SVB’s loans will not be transferred into the DINB but instead are retained in receivership for disposition.

What happens to SVB’s customers?

FDIC-insured deposit balances

FDIC insurance covers up to $250,000 of deposits in

• Checking accounts,
• Negotiable Order of Withdrawal (NOW) accounts,
• Savings accounts,
• Money Market Deposit Accounts (MMDAs) (importantly, this is different than an investment in shares of a money market mutual fund, discussed below),
• Time deposits such as certificates of deposit (CDs), and
• Cashier’s checks, money orders, and other official items issued SVB.

It is possible to have deposits of more than $250,000 at one insured bank and still be fully insured if the deposits are maintained in different categories of legal ownership. (See below for important nuances about FDIC coverage.)

The FDIC has stated that customers should be able to withdraw their insured deposits beginning the morning of Monday, March 13, 2023.

Uninsured deposits

If, for example, a customer of SVB had a total of $400,000 in a single account with SVB when it was placed into receivership and the customer is paid $250,000 by the FDIC, what happens to the amount in excess of the FDIC’s deposit insurance limit – the remaining balance of $150,000?

The depositor would receive a claim against the liquidation proceeds of SVB (technically called the “estate of the closed bank”) for the remaining $150,000 which is not insured. The depositor would be given a Receiver's Certificate as proof of this claim and would receive payments as the assets of SVB are liquidated.

The FDIC has indicated that claims will be paid in the following order of priority (after administrative expenses have been paid):

1. Uninsured deposits;
2. General unsecured creditors;
3. Subordinated debt holders; and
4. Stockholders.

What about custodial accounts such an escrow account for which SVB was the escrow agent?

Escrow and other custodial accounts are fiduciary accounts in which a person or company (the fiduciary) serves as an agent on behalf of their client (the beneficiary) in placing funds into an account at a bank. The funds in a fiduciary account belong to the beneficiary(ies).

As such, when Individual A holds in Individual A’s name as custodian deposits of which Individual B is the beneficial owner, Individual B’s interests in those deposits will be insured up to $250,000 provided that the FDIC’s record-keeping requirements are satisfied. The FDIC will recognize a claim for insurance coverage based on a custodial relationship only if the relationship is expressly disclosed, by way of specific references, in the deposit account records of the insured depository institution. 

The express indication that the account is held in a custodial capacity will not be necessary, however, in instances where the FDIC determines, in its sole discretion, that the titling of the deposit account and the underlying deposit account records sufficiently indicate the existence of a custodial relationship. This exception may apply, for example, where the deposit account title or records indicate that the account is held by an escrow agent, title company or a company whose business is to hold deposits and securities for others.

In order to determine the amount of each beneficiary’s insured deposits in a fiduciary account, the FDIC may need to review the fiduciary’s records, which must list each of the beneficiaries of the account and the amount to which each beneficiary is entitled. If the bank acted as fiduciary, such as for an escrow account, then the FDIC should have access to the records necessary to determine the insured amount to which each beneficiary entitled.

Although the FDIC will provide pass-through deposit insurance coverage to the beneficiaries of a fiduciary account, the FDIC does not pay the beneficiaries directly. Instead, the FDIC will pay the total insured amount to the fiduciary, and the fiduciary will be responsible for distributing the funds to their customers.

What about account holders which are themselves pooled investment vehicles?

The FDIC deposit insurance regulations permit the FDIC to pay the participants in many pooled investment vehicles provided that the books and records of the failed bank indicate that the account is held by the investment vehicle on behalf of its participants. In general, “corporate” accounts are insured up to $250,000 and, in general, “any trust or other business arrangement” which is registered with the SEC or that would be required to register with the SEC but for certain sections of the Investment Company Act of 1940 (including Section 3(c)(1), which exempts from registration pooled investment vehicles with not more than 100 investors), is deemed to be a corporation for purposes of determining deposit insurance coverage. 

However, an exception provides that a deposit account of such a trust or business arrangement, including a limited partnership, will not be deemed to be the deposit of a corporation if the funds in the account can be traced to one or more specific investors or participants (based on the failed bank’s books and records including, presumably, its “know your customer,” or KYC, review) and the existence of the nature of the beneficial interest of the participants is disclosed in accordance with the requirements of the FDIC’s rules for fiduciary accounts. If the FDIC concurs that these conditions are satisfied, each participant’s pro rata share of funds will be insured up to $250,000 as a deposit account of the participant with the true beneficial interest in the funds.

What about investments or other assets acquired through SVB?

The following types of assets are not deposits, are not covered by FDIC insurance, and remain the property of SVB’s customer:

• Stock investments;
• Bond investments;
• Mutual funds (note that this is an investment in shares of a money market mutual fund (MMF), which is different than a money market rate deposit account);
• Life insurance policies;
• Annuities;
• Municipal securities;
• Safe deposit boxes or their contents; and
• U.S. Treasury bills, bonds or notes.

If an SVB customer used its funds on deposit with SVB to purchase shares of a MMF – and assuming the purchase of those MMF shares settled prior to the DFPI closing SVB, the FDIC should treat the MMF shares as assets owned by the customer, instead of a deposit.

What if a customer of SVB had a sweep account arrangement?

Reportedly SVB offered a sweep account product that automatically transferred amounts in excess of a specified level into a higher interest-earning investment option at the close of each business day. Commonly, the excess cash was swept into a money market mutual fund.

As noted above, if an SVB customer used its funds on deposit with SVB to purchase shares of a MMF – and assuming the purchase of those MMF shares settled prior to the DFPI closing SVB –the FDIC should treat the MMF shares as assets owned by the customer, instead of a deposit.

What if a customer of SVB had an overnight “repo” arrangement?

A repurchase agreement (repo) is a form of cash management. Reportedly, SVB sold government securities to customers investors, usually on an overnight basis, and then bought them back the following day at a slightly higher price.

The repo transactions typically are unwound before the opening of business, Eastern time, and cash proceeds are deposited into the customer’s account at SVB.

We anticipate that any SVB repo transaction that was unwound on Friday, March 10, 2023 before the opening of business, Eastern time, would have resulted in cash proceeds being deposited into the customer’s account at SVB, at which time any amount in excess $250,000 was an uninsured deposit.

If a customer of SVB had an undrawn line of credit as of time the DFPI closed SVB and appointed the FDIC as the receiver, may the customer still draw on that line of credit?

You should assume the line of credit will not be honored unless there is a very specific communication from the FDIC to the contrary. The DINB is not authorized to make loans, and the FDIC, in its capacity as receiver, has the right to repudiate certain types of contracts, include undrawn lines of credit. It’s possible, however, if the FDIC sells the SVB franchise in a P&A Transaction, the healthy acquirer bank may negotiate to assume the line of credit from the receiver. Note that the FDIC has indicated that borrowers of the former SVB should continue to make payments towards their loans as usual.

Is it still possible that the SVB franchise can be sold to another banking company or a new investor group?

Yes, although it would be slightly different from a conventional bank acquisition, and the shareholders of SVB’s parent corporation and publicly traded company SVB Financial Group may not receive any benefit.

One of the important lessons learned by the FDIC from the bank and thrift crises of the 1980s and early 1990s is the benefit of a resolution strategy that centers on selling assets back into the marketplace promptly, either at the time of failure or shortly thereafter.

When possible, the FDIC will attempt to find an acquirer for some or all of a failed bank’s assets or liabilities (including deposits) or both. The preferred and most common method – known as a Purchase and Assumption Transaction (or P&A) – involves a healthy bank assuming the insured deposits of the failed bank. Insured depositors of the failed bank immediately become depositors of the assuming bank and have access to their insured funds. The assuming bank may also purchase loans and other assets of the failed bank. Sometimes the P&A transaction will involve a loss sharing agreement between the FDIC and the healthy bank acquirer.

When there is no open bank acquirer for the deposits, or if all the bids are more costly for the FDIC than a payout, the FDIC will implement a payout strategy (also called a liquidation); in a payout, the FDIC will pay the depositors directly by check up to the insured balance in each account. Such payments usually begin within a few days after the bank closing. The FDIC then seeks to recoup those insurance payments with the funds the FDIC receives from asset sales over time.

What happens to direct deposits destined for SVB?

FDIC’s pre-existing guidance indicates that all direct deposits, including Social Security payments, will automatically be re-directed to the deposit accounts at the DINB, which according to the FDIC’s March 10 press release, will reopen the main office and all branches of SVB on Monday, March 13, 2023. Specific information about any changes in the payment of direct deposits will be made available at the office locations of SVB.

In an acquisition scenario, what happens to checks drawn on SVB accounts and digital payments (such as ACH transfers) from SVB accounts that had not cleared before SVB was closed?

If the failed bank’s deposits are assumed by another bank, some or all of the failed bank’s offices typically reopen promptly (usually the next business day) and there usually is little or no interruption in the processing of checks drawn on the failed bank. (An exception to this procedure may include checks that were drawn against a deposit account that has been determined to be uninsured or an account for which the deposit insurance determination is pending.)

Deposit Payout Scenario

In a deposit payout scenario, however, any outstanding transactions or checks presented after the bank has closed cannot be paid or charged against the account.

The FDIC freezes all deposit accounts at the time the bank is closed to quickly pay the depositors for the insured deposit balances in their accounts.

Any outstanding checks or payment requests presented after the bank failure will be returned unpaid and will be marked to indicate that the bank is closed. This does not reflect on your credit standing. However, it is the customer’s responsibility to make other funds available to creditors who receive checks that were returned and did not clear your deposit account because of the bank closing.

How are FDIC coverage limits applied?

The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.

The FDIC provides separate coverage for deposits held in different account ownership categories. Depositors may qualify for coverage over $250,000 if they have funds in different ownership categories and all FDIC requirements are met.

All deposits that an accountholder has in the same ownership category at the same bank are added together and insured up to the standard insurance amount.

Below are certain ownership categories provided by the FDIC:

• Single accounts owned by one person ($250,000 per owner);
• Joint accounts owned by two or more persons ($250,000 per owner);
• Certain retirement accounts, including IRAs ($250,000 per owner);
• Revocable trust accounts (generally $250,000 per owner per unique beneficiary, but, if there are more than five different beneficiaries, special rules apply);
• Corporation, partnership and unincorporated association accounts ($250,000 per corporation, partnership or unincorporated association);
• Irrevocable trust accounts ($250,000 for the noncontingent interest of each unique beneficiary); and
• Employee benefit plan accounts ($250,000 for the noncontingent interest of each plan participant).

Are multi-tiered fiduciary relationships insured?

In the case of deposit accounts where there are multiple levels of fiduciary relationships (as described above), there are two ways to obtain insurance coverage for the interests of the true beneficial owners of a deposit account.

One method is to expressly indicate, in the deposit account records of the bank, the existence of each and every level of fiduciary relationships; and disclose, at each level, the name(s) and interest(s) of the person(s) on whose behalf the party at that level is acting.

An alternative method is to expressly indicate, in the deposit account records of the bank, that there are multiple levels of fiduciary relationships; disclose the existence of additional levels of fiduciary relationships in records, maintained in good faith and in the regular course of business, by parties at subsequent levels; and disclose, at each of the levels, the name(s) and interest(s) of the person(s) on whose behalf the party at that level is acting.

No person or entity in the chain of parties will be permitted to claim that they are acting in a fiduciary capacity for others unless the possible existence of such a relationship is revealed at some previous level in the chain.

Special rules apply to certificates of deposit (and certain other negotiable instruments) and to deposit obligations of the failed bank for payment of items forwarded for collection by another bank acting as agent.

What happens to commercial and other contracts and agreements individuals may have entered into with SVB?

By statute, when the FDIC is acting as receiver for a failed bank, the FDIC has the power to repudiate (i.e., terminate) any lease or contract (i) to which the failed bank was a party; (ii) the performance of which the FDIC deems, in its sole discretion, to be burdensome; and (iii) the repudiation of which the FDIC determines, in its sole discretion, will promote the orderly administration of the failed bank’s affairs.

If the FDIC repudiates a lease or other agreement formerly held by SVB, the counterparty to that lease or agreement other party would have the right to file a claim for actual direct compensatory damages. Parties filing claims for damages will be treated as “general unsecured creditors” in the levels of payment priority outlined above.