Dissecting Goldman’s gory $2.25bn SVB equity issue
Well that escalated quickly
Bankocalypse postponed? While equity and unsecured creditors will lose their money and top management will lose their jobs, Silicon Valley Bank’s demise shows that the authorities still don’t feel confident winding down a medium-sized bank without protecting uninsured depositors.
The question remains why the government had to intervene in the first place. Couldn’t SVB have saved itself?
After all, SVB had put together a rescue plan with a powerhouse investment bank and a powerhouse investment firm. On the evening of March 8 SVB launched a $2.25bn combined common and preferred stock offering led by Goldman Sachs, with General Atlantic agreeing to purchase $500mn of the common stock at the offer price.
Better yet, SVB was raising more money than the $1.8bn it said it had lost from the sale of nearly all of its “available for sale” (AfS) bond portfolio. What could go wrong?
Everything.
By the next day it was obvious the offering had failed spectacularly: depositors were pulling their money, the stock price was crashing, and investors weren’t buying at any price. SVB was doomed to FDIC receivership.
It’s too early to say whether SVB was insolvent or could have been saved from collapse. But this equity offering seemed to have ignored key lessons from the recapitalisations of the banking sector in 2008-09.
I worked on several financial crisis-era banking recapitalisations in Europe. Whether by luck or by design, I avoided the unsuccessful capital-raises. In volatile capital markets — as Spinal Tap teaches us — “it’s such a fine line between stupid and, uh, clever.” During that febrile period we had a couple of guiding principles as we groped for ways to raise equity for stricken, overleveraged banks.
First, go big. Really big. Bazooka-big. Raise a lot more equity than you need and a lot more equity than regulators tell you to raise. Don’t just fill in the capital hole.
Second, the stock offering has to be underwritten. Hard-underwritten. Or already subscribed-for. Investors must assess the equity offering on the basis of a repaired balance sheet. They must know you don’t actually need them.
On both counts — especially the second count — the offering of SVB stock failed. Maybe it was a lost cause anyway, but the stock offering had no chance.
As mentioned before, SVB was raising $2.25bn in common and mandatory convertible preferred stock as it was announcing a $1.8bn loss from selling much of its AfS bond portfolio. But investors learned in the financial crisis that problems at banks are rarely isolated or contained. They know there is almost always another shoe to drop, and that shoe will have a sharp stiletto.
Raising just 20 per cent more than the realised loss assumed that management had more credibility than it in fact had with the market. The equity size had to be comprehensive, even overwhelming, and SVB and Goldman Sachs tried to cut it too close.
But the (much) bigger issue is that the offering was not underwritten or already subscribed-for. Ideally, Goldman Sachs would have spoken with a small group of investors before the equity offering by “wall-crossing” them. This is a well-established (and, for any cynical readers, well-policed) process for disclosing material nonpublic information to investors and confidentially sounding them out on their interest in buying into a deal.
And ideally, SVB’s press release would have said that the entire offering was subscribed for or guaranteed by a series of reputable investors, subject either to a clawback or to an increase in offer size if public investors wanted to buy into the deal.
Was this feasible? A global investment bank like Goldman Sachs has touchpoints into any sizeable pool of capital you can imagine: hedge funds, private equity funds, public equity funds, sovereign wealth funds, family offices, endowments, pensions and so on. In fact, the reason a company hires investment banks for distribution is to tap into their network.
But the best Goldman Sachs could come up with was a $500mn cornerstone order from General Atlantic. Maybe there wasn’t enough time or maybe other wall-crossed investors didn’t like the deal. Or maybe SVB and/or Goldman Sachs thought they didn’t need to, and assumed the General Atlantic order was a strong enough vote of confidence to assuage the market.
If it’s the last reason, that was a misjudgment of General Custer proportions.
The General Atlantic commitment was more semi-skimmed milk than full-fat dairy. Crucially, it was neither irrevocable nor unconditional. It was “contingent on the closing of the offering of common stock”. Moreover, the purchase price wasn’t fixed but rather to be set at whatever the public offering price would be. General Atlantic was in effect getting a guaranteed allocation on an offering that Goldman Sachs is pricing with the goal and expectation (not guarantee, to be very clear) that it will trade well.
Ironically, if SVB had been a European bank, there would have been a better chance of saving it from collapse. In a rights issue the investment banks underwrite — on a firm or “hard” basis — the subscription of new shares, usually at a 30-40 per cent discount to the dilution-adjusted share price. Importantly, proceeds are guaranteed, come hell or high water. Rights issues enabled most European banks to recapitalise in the last financial crisis.
A rights issue for SVB would admittedly have been difficult, if not impossible, to execute. US investors are mostly unfamiliar with the mechanism, and when panic sets in, it is hard to gain mindshare around a novel structure.
But this only serves to highlight that nobody had enough skin in the game to reassure nervous public investors that SVB could survive the crisis. Goldman Sachs was underwriting only on a “best efforts” basis (which does not entail real financial risk), and General Atlantic’s commitment depended on the support of the broader market.
It was naive under the circumstances to launch an equity deal that was not fully “spoken for”, to use investment banker lingo.
Is this criticism easy to say after the fact? Yes. But there’s a reason why South Park’s Captain Hindsight has been described as “the hero of the modern age”. Because we should recognise mistakes we make and learn from them. And maybe also remember what we learned from the last crisis.