EP 263 – David Gritz – co-Founder and Managing Director of InsurTech NY – The Run on Silicon Valley Bank: Hypocrisy, Fiduciary Responsibility, and Moral Hazard

Read the best-effort transcript below (This technology is still not as good as they say it is…):

Michael Waitze 0:18
This should be a fun one. Hi, this is Michael Waitze. And welcome to a special Silicon Valley Bank SVB edition of the Asia Tech Podcast. Today we have David Gritz back with us on the platform. David is a co-Founder and Managing Director of InsurTech New York. David, how are you?

David Gritz 0:37
I’m doing well, Michael, I think there’s a lot we have to digest. So I’m really excited that you’re able to put this impromptu topic on the table. So we can have it for discussion and hopefully, digest so your global audience can understand what’s going on.

Michael Waitze 0:55
Yeah. And same here. Look, I really appreciate it. You’re, in fact, boots on the ground, being in New York, being in United States watch watching this whole thing play out, right. I mean, I have probably a 12 or 14 hour delay from the news because some stuff happens when I’m sleeping. So it’s great to have you there. And to be fair, we were talking about this just before we started recording. It’s March 13. through March 14, for me, there was a whole bunch of Sturm and Drang at the end of last week, and over the weekend, people moaning and groaning and complaining at the end of the day now, I think we have some sort of resolution to this more than we had. So I’m glad we kind of waited until today to do this. Do you want to start at the beginning, from your perspective? What’s going on here? And then we can dig deeper as you start to hit like some of the biggest possible points? Yeah,

David Gritz 1:40
sure. So I think maybe the most logical place to start is for those that have heard about Silicon Valley Bank, but don’t really know about it, maybe to have a little bit perspective of what it means in the US and globally, a little bit of what happened. And then we can start to editorialize on what you can do what you should have done all those different things. So the fun stuff. Yeah, so I guess short background is Silicon Valley Bank, was a really well known institution. In the US, I mean, given its name. Now, obviously, a lot of the branches are in that San Francisco Bay area. So from up from, you know, Marina, cross the Golden Gate Bridge, all the way down to San Jose, they have a lot of branches, a lot of tech companies there. And I think to kind of give significance, so you understand, a lot of the startups would bank there, because they had built themselves as the VC back bank. So if you got VC money, there was a lot of great services and capabilities they had they understood tech companies, and if you got VC money, they understood what your needs were and designed products around you.

Michael Waitze 2:57
So what were the specifics here around that? If you know what some of these things were, right, I mean, I think from the outside, people are gonna look and just think it’s a bank. It has Silicon Valley in its name, but it might as well have just been called Marin County Bank. I mean, you could have called it anything. And I think at some level, the perception of what should have happened was, could have been driven by the name of the bank. But the other question I have is, what were the services that were so special that they offered? And were the startups compelled to bank there? Like if I wanted to just have an account at Bank of America instead of SVB? Was that problematic for my venture capitalists?

David Gritz 3:35
Sure. So I guess first starting point, what are some of those services? So I think the simplest services like if you think of a bank, right, there’s the core part of it, right deposits and custody, and then there’s how they make money, which is typically some version of lending or credit, right? So there’s not a lot of banks in the US that provide lending and credit to new companies. In fact, most traditional banks, you think, the JP Morgan’s the wells of the world, they want to see, you know, 2436 months of bank statements, and they’re gonna land on pretty logical things, like, what was your EBIT, da, and we’ll do a multiple of EBIT da, we’re usually like even some of the riskier ones. I say risky and air quotes, right, but ones that are willing to be up on the risk curve like Santander, they’ll say, What was your revenue for the past two years on the tax returns, and they’ll lend up to 20% of that revenue, because they figure like, you should probably have 20% margins. So that should work out but they’re also looking at traditional things like the owners credit, right. The difference is Silicon Valley, First Republic Square, one Signature Bank. They’re looking at it from the perspective of you know, we understand how startup works. Most startups are not profitable, but if they can attract Millions of venture capital money that’s going to sit in their account, they’re probably going to be good on the credit products we give them. As long as you know, the VCs that we know that are investing in them have really bad on them. And the other thing is, they were willing to do things that a normal bank would never do, which is to bridge. So if you had a check from a VC coming, you had a term sheet sign, those VCs might have to do a capital call, there may be other reasons why you have to wait. But they understood that because they knew most of the VCs, a lot of the VCs banked with them. So they could basically underwrite that bridge or credit products, they also got into some of the venture debt type of project. So if you’re raising 5 million neck today, maybe you pair that with 5 million in debt, and they’re okay accepting the fact that right now you don’t have the EBIT da to cover it, but they see your revenues growing, you know, 20% a month. So eventually it will be. So what

Michael Waitze 6:01
are the implications of the mismatch of the balance sheet here? Right? Do you want to talk at all about how, you know, a lot of this lending takes place, short place, but a lot of the a lot of the investments that they made were long term, right? So you’re mismatching Short Term Liabilities with long term assets? Can you talk about that, and just the credit risk and the risk that they were taking in on that front as well?

David Gritz 6:24
Yeah, so for those who are not intimately familiar, essentially, what got them into trouble is last year when, you know, with rates banks could maybe make between 0%, and maybe 75 basis points. And most like short term investments, whether it’s T bills, or you know, overnight repos, or short term corporate notes, that wasn’t really where they wanted to be. And as a bank, they had grown essentially three times and their deposits over a couple year period, because of all the venture activity in 2021 2022. So they decide, you know, well, if we go longer term, we can get more yield. The challenge is, if you go, as many people know, if you go longer term on the yield curve, you’re locking in your rates for longer, but you’re also locking in your capital for longer. So if you’re going into an environment where rates are raising, and you can’t hold your bonds until maturity, now, they’re essentially depreciating assets, no different than, you know, the car when you drive it off of the lot, and you just bought it,

Michael Waitze 7:36
right? I mean, it’s a little bit more complicated than that, right? Because you’d have to talk about bond duration as well and bill duration. And the other thing is that the Fed path too, which is something that is really close to my heart, I was at Treasury, I was the US government bond trader. And one of the things that Tommy Dubois, who was the head of the government bond desk at the time used to tell us was you always have to understand what the Fed path is, back then. So in the in the early 90s, early to mid 90s, the Fed was way less transparent than they are today. And this is the thing that’s really curious for me, right, is that a bank like SVP, that’s super well connected, both to venture capitalists, but also to the rest of the banking system was at the 16th largest bank in the United States has some idea like what the Fed path is, right? And sure, the Fed raised from essentially 25 basis points, overnight rates, right. These are not long term rates that the Fed creates, or controls, but there is a yield curve over which the short term rates have impact. Because Are you have a flat yield curve. Do you have an inverted yield curve? Or do you have a typical yield curve? Right? That’s upward sloping? Why did it take them so long to react to this right, then what 20 Some 20 something billion dollars in relatively liquid assets. But during the time where the Fed went from 25 basis points up to what 5%? So 475 basis point increase in rates? They did? What? And why?

David Gritz 8:59
Yeah. So I mean, essentially, what they did is they bought these mortgage backed securities and long dated bonds that lock them into low rates. But I mean, yes, I agree with you, Michael, they absolutely should have had awareness of it, I believe one of their executives was one of the California or the San Francisco fed board members. So they’re directly tapped into those discussions. But I think when you look into a lot of the details, they didn’t have, you know, a head of risk management for more than six months. Right. And they were one of the original groups that lobbied the Trump administration to raise the limit in terms of being able to are required to do stress tests from 50 billion assets to 250 billion, right. So I think they had a general idea of what’s going on. And some of the interesting things I saw on LinkedIn was, you know, how many risk team meetings they had up over each year, and it was only increasing, I think it was more than 15 and 2022. So they knew all these problems were brewing, but they kind of more or less either had their head in the sand, or worse, if you look at some of the sales by some of the executives a couple of weeks before, right, had an idea that something wrong was going to happen.

Michael Waitze 10:22
So what is the moral hazard here? I mean, I want to go back a little bit, we can talk about moral hazard in a second. But I want to go back and talk about the repeal of Glass Steagall by the Clinton administration back in the early 90s. And also the relaxing of the Dodd Frank regulations that you were just talking about, right, because this is where the rubber really hits the road. You have banks like SVP, you know, that are doing great work that are building a very specific set of services, like you said, for specific clientele. So now you have this really, what’s the word highly concentrated risk, right, where no other bank would just lend to, like dog walkers? That’s it. It’s all you get special services for dog walkers, because there’s something happens in the dog walker market. You have problems, right. But the relaxation of Dodd Frank and the removal actually have Glass Steagall in this in the, in the 90s made it so that even a community bank, which is essentially what SVP was at scale, now can take superduper risk. I mean, we should have learned this back in 2007, and 2008. What was really going on? I mean, what is the chatter around this prior to it happening? And then what’s the culpability as well as some of the investors who like, don’t tell anybody, but just take your money out of the bank? Right? Because we think there could be a problem and then complaining later why the bank wasn’t then saved? Do you know what I mean?

David Gritz 11:43
Yeah, so I think a lot of points to hit on, I’ll start on the historical piece, because please, I mean, the Glass Steagall Act, being crushed, in my opinion, is one of the worst choices of regulators. In the last we’ll call it 5030 plus years, 50 years. Yeah. And if you think about it, this was created in depression era thinking, economists looked at what happened and what could happen. And they put this protection in place. And the protection makes a lot of sense. If you think about it, you shouldn’t as Goldman Sachs be able to leverage deposits in markets to be able to do more investment banking activity. Yeah, but

Michael Waitze 12:27
let’s be clear, right? Before 2007 and 2008, Goldman Sachs itself wasn’t a bank, what it was really meant to do, right was a bank, like any other bank, like Bank of America saying, we take all these deposits, and like you said, lending and credit, these are the these are the businesses of a bank. But the relaxation of Glass Steagall or the elimination of and said, you know, what, you can speculate on anything, just like an investment bank, you can become a trading house, this is where the moral hazard was right. And then SVB was kind of a hybrid in the middle, because they weren’t trading CDOs. And CDS is but they still were in mortgage backed securities. Right.

David Gritz 13:04
Right. No, I mean, I definitely agree with you, Michael, that, from that direction, that commercial banks and whether it’s just SVB, like, obviously, Signature Bank failed over the weekend, and, and they take the same type of risks. And like, if anything, they’re more like a community bank, than even SVB was. So I think that’s definitely the problem. But I guess what I was getting at with Marcus, is it goes both ways, right? Investment banks that want to get bigger by becoming commercial banks. Is it risk that, you know, in my mind, is a tail risk that we haven’t quite seen the impact?

Michael Waitze 13:41
Yeah, it’s so new. It’s so new, like a lot of the stuff that happened after the 2002 1008 Was that for the Fed, and for the Treasury to protect the investment banks after the global financial crisis, they said, to become under the regulatory authority, you have to become a bank and take deposits. And this was partially to help out what was happening in the financial system at the time, but also to help in inside of the regulatory environment as well. Can you comment about the run? Right? In other words, all those people that came out after the weekend or even before the weekend, we’re saying, like, we have to support SVP and all this other kind of stuff. And yet some of them were actually responsible for telling their firms, their investi companies excuse me to take the money out because they were nervous. Yeah.

David Gritz 14:26
I mean, honestly, I feel like it’s super hypocritical. I mean, it’s not the only time that I will call VCs do hypocritical things. There’s probably half a dozen other examples, maybe right, like, you know, flying on their private jet to meet with startups and telling founders to reduce their travel. But I think

Michael Waitze 14:46
Going to COP27 on a private jet,

David Gritz 14:49
yeah. So I think in this situation, right. They had a fiduciary responsibility to protect their companies and to ask them to pull the money. out. But I think then over the weekend to all posts on Twitter and LinkedIn, you know, here’s the letter we have that we support SVB. And if SPV is bought, we’ll keep the deposits there. To me. Like, that’s the worst form of hypocrisy. If you said to take the money out, you should be in camp, you know, big for bank or whatever the alternative is, you can’t then turn around and say, Oh, we love all the employees of SVB. And we want to help them, even though you’re ultimately the ones that like, stabbed them behind the back. So I think you can’t have it both ways. On one side. Do I think that, you know, the investor is killed the bank? I mean, a lot of people say, you know, if the money didn’t flow out, is in, you know, billion dollar chunks and and our multibillion dollar chunks in an hour, they could have survived it. And, yes, that’s probably true, maybe. But I think the challenge is, it might have happened over a month, the fact that this happened, essentially on a Friday and could be resolved by the regulators on a weekend. I mean, I think partly what caused it to have to be solved on, you know, the weekend is most companies have payroll on the 15th. And if I’m Janet Yellen, I’m probably looking at this and saying, Well, you know, I really don’t want to use taxpayer money or have a perception of it. I don’t want to backstop a bank. But if I take you know, we’ll call it 5000 startups times 20 people, right, like that’s a big number. And that’s going to meaningfully affect the jobs report on the next month. Yeah. So it’s, I think that we can cause it to become political. And I think the government, in my opinion did the right thing, even though there’s probably a lot of people in this country that think, well, you know, why is the everyday man having the backstop, all the startups and all these VC people that knew what they were doing, they could have looked at the bank balance sheet, I think there is a certain sense that the regulators have to protect contagion, because if they didn’t backstop it, the same thing could have happened to 20. More banks, like on Monday, and from what I’m hearing, it is still happening to 20 more banks on Monday. But those banks may be able to survive. I mean, it sounds like Schwab’s being hit first republic pack last, there’s a bunch of others that, you know, may fail because of this, but it could have been a lot worse.

Michael Waitze 17:36
The equity trader and portfolio trader in me feels like a lot of the activity that happens on Twitter can get driven by people shorting stocks, and what we would call talking their own position. So going after some of the other smaller regional banks or smaller community banks means that maybe potentially they borrowed some stock at decent rates, shorted those stocks before the weekend, and then just again, went went after them in public. Cramer used to do this all the time, right. Just to try to make money. Do you feel like any of that’s going on as well?

David Gritz 18:15
No doubt, I think that’s absolutely going on. And then the thing that’s kind of upsetting to me a little bit is now every if that used to happen in the shadows, right now, it’s not just on Twitter and on LinkedIn, but you have YouTube influencers with millions of subscribers, as in, they have more views and Kramer does, right. And they’re sharing their opinions on what they should do, which, in theory, from my perspective, is functionally market manipulation. Yeah, but because they say, you know, this isn’t financial advice. This is Entertainment, maybe they get away with it.

Michael Waitze 18:53
This is just Gamestop all over again, right.

David Gritz 18:57
It’s in reverse a

Michael Waitze 19:00
little bit in reverse a little bit. Yeah. But I’m just saying like the same level of influence where people say it’s something bad’s happening, the only way to disintermediate. That is for us to get together and do it together, read the Reddit thread on it. And then Gamestop happens. Do you do get the sense as well, that some of the venture capitalists because they’ve been supporters, I’ll put that in quotes of SVB for the past 30 or 40 years, or for however long they’ve been investing, also had a lot of their own money, whether it’s personal money or their firm money in the bank to and this is one of the reasons why they were freaking out over the weekend. Because, you know, if you’re taking two and 20, on $2 billion, you’re talking about 40 million bucks a year in fees that that could potentially get deposited into a bank that may go bankrupt is was this part of the worry as well?

David Gritz 19:48
Absolutely. I think there’s two pieces of that. So the first order worry is many of them had their money sitting. Even like what if you did a cat Apple, I’ll call that week you have a lot of your money sitting in the account. So I think there was a legitimate concern that they would be losing money for their LPs directly. But then there’s the indirect impact, which is their portfolio companies that the money they just gave them is now all evaporated. And they either have to put more money in to dilute them or they’re going out. And now, you know, if you have to get, you know, let’s call it two and 100. Now, you need to get four and 100 to make up for the ones that just died. Right?

Michael Waitze 20:34
So But again, there, here’s the part of the moral hazard. I also think some of their personal money was there, too, right? In other words, watch this flow. I invest in a company like Airbnb, let’s say, or Uber, right? And I deposit and I deposit the money that I gained from that back into SCP. And then I use that to make some of my capital calls if I build my own venture capital company based on the winnings that I’ve had from some of these unicorn companies that got built in Silicon Valley. And it all seems fine. until it’s not. So it’s not just meaning my firm’s money, but my personal money is there as well. And I think I saw some of that in public freaking out on Twitter. How do you protect against this happening going forward? Is there any way to do that?

David Gritz 21:18
Yeah, no, I think there’s definitely one I agree with you, they probably had some of their personal money, as well. But I think, you know, a number of people have come out on LinkedIn that come from more of a traditional finance background, like one guy I’ve been following a lot, Howard Katzenberg, he runs a startup called Gleann, and used to be the CFO of ondeck. Capital. I mean, he’s been having like, really good posts. And if you think about it, this all comes down to fundamentals, treasury management, right? So if you know, your insurance limit in the US is 250,000. Why would you ever exceed that? Right? It’s pretty simple. There is money market accounts now. And in fact, it’s actually kind of stupid, right? Like, if you’re a startup, you got $10 million, then you can make 4% on it in a money market, that you’re probably same bank, maybe even SBB had, because it’s supposedly bad sweep accounts. You know, you’re you’re one not giving your company, the capital that it could have because of the return. But the other thing is just poor treasury management, right? Like, you should ultimately have your capital protected, and it should be invested properly. So I think a lot of this is there are too many tech people without any finance background, without any training on what to do with the capital, just making moves in the way that they would think is normal. But anyone who is trained in finance that’s been in large corporation would say that that’s crazy, right? Yes.

Michael Waitze 22:51
Yeah. I mean, when you when somebody with my background comes out and reads all the stuff that’s been going on here, you just look at it. And just, again, it reminds me if you’re a movie buff at all, it reminds me of the one of the scenes in Casa Blanca, where the chief prefect of police comes in and finally shuts down Rick’s American cafe. And he says, There’s gambling going on in here. And then on the way out of the building, one of the guys goes, yeah, here your winnings, by the way. If you’ve never seen Casa Blanca, go back and watch the movie. But the point is that it all seems very sort of incestuous as well. And I think this is part of the perception problem that they have, you know, there were a lot of people saying, What if this was just called the Kansas City farmers bank? And I guess my response to that is, what if it was just called the balance sheet mismanaged bank, right? We don’t want anyone to lose their jobs. And you’re right, if it’s 5000 companies and 200 employees, or whatever it is, you’re talking something that’s material to employment, particularly on a month to month basis. But on the other hand, if in the risk reward calculation, there is no risk, and it’s just rewards. If you remove risk, then this is just going to keep happening at scale. And because information is available in a way that’s frictionless and almost instantaneous, this is just going to keep happening, I think, unless some other things change. And we go back to Glass Steagall, and also re strengthen the Dodd Frank stuff. Right. Does that make sense?

David Gritz 24:16
Yeah, no, I think the challenge is what just happened with the regulators is we basically celebrated risk taking, and basically, no one even got a slap on the wrist. I mean, obviously, all the people as freebie are likely going to lose their job. But all these other players, the VCs that were hypocritical about it, the founders that didn’t have the proper treasury management practices, and frankly, like the individuals that didn’t have proper treasury management practices aren’t going to go back. They’re gonna go to sleep and they’re going to forget all about it the next day, and we’re going to lose this opportunity to collectively get better as an organization or as a globe in terms of Thinking about how to properly manage money.

Michael Waitze 25:04
So a couple more things, and I’ll let you go it just be C comes in in the United in the United Kingdom and says we’re going to buy all of the assets, essentially. And all of the liabilities of Silicon Valley Bank, UK, they come in and essentially save this business. And it’s probably just going to be business as usual going forward. Right. HSBC has trillions of dollars of deposits and assets under management. Has there been an announcement of what’s going to happen in the United States? Because it feels to me and I said this on Thursday and Friday of last week, just watch the bank that actually acquires them. And they’re the ones with like, the closest relationship to the fed to the FDIC. And also the Treasury. Yeah.

David Gritz 25:43
Yeah. So there hasn’t been an announcement yet. There’s an acquisition. I know, on Sunday, there was a lot of news about, you know, in auctions opening up, and like, there were some people saying, you know, PNC was going to put a bid in and then they pulled the bid out. So there is likely going to be an acquisition at some point. But my understanding of what’s happened is like they’ve opened their doors, but it’s essentially, you know, government and conservatorship for the moment until they figure out if there’s an ultimate home.

Michael Waitze 26:15
Got it. Is there anything else that we missed that you wanted to point out? We’ve been at this already, I think for about 30 minutes. Is there anything else you want to mention? Or should we just let you go?

David Gritz 26:23
So I think the one thing that I want to mention is like, what’s next and some of the long consequences and go for it? You know, since we’re InsurTech, New York, the insurance angle? So I think the long term consequences of this is yes, I think there’s going to be some contagion. It’s going to affect other banks beyond first republic, Schwab and Signature Bank, there could be, you know, a dozen others that are impacted. But I think the ultimate long term consequences, my hope is that there is now awareness that no matter where you’re putting your money, right, when you put your money into a stock, when you put your money into a bond, you typically do your diligence. I think everyone should know now, if you’re putting your money into a bank, you should do your diligence, right. And I mean, myself, I am to fault like, I have some money in a community bank. And this prompted me to look at their, their balance sheet. And you I know it was great. I looked at their balance sheet, and they have no like $0 in assets held to maturity, right? They have roughly 900 million that’s in assets, like across like, a bunch of different things. I have a strong loan portfolio, and there’s only 100 million in deposits. So they’re extremely healthy. And this is just some random bank that’s in Delaware bank of Delmarva. So I think, you know, community banks could definitely be good. But you should do your due diligence. And I think that’s what I hope the long term is that everyone’s aware of this now. And then the second thing is, is my concept on the insurance perspective, which is kind of a funny thing, which is, it seems like it’s always the insurance people that save the banks, right? It’s it’s FDIC, that’s that taking over to save a thing. So I just hope people realize it’s the insurance that they all done out. It wasn’t the taxpayer money. So hopefully, people will be a little bit more proud to be in the insurance industry and we can look at as a noble profession because we’re here to help.

Michael Waitze 28:32
Yeah, I mean, the I in the FDIC stands for insurance. People should know this. Most people have no idea. Okay. David, that was great. I really appreciate your time. Anytime you want to come on to anywhere on the platform, to just to talk about stuff that’s happening. Emergency podcasts are the best kind of podcasts. I really appreciate it. David Gritz a co-Founder and Managing Director of InsurTech New York. That was awesome. Let’s do more of that.

David Gritz 28:58
Yeah.