SVB Silicon Valley Bank Bankruptcy what went wrong

Silicon valley bank is around for almost 40 years, is the nation’s 16th-largest bank and started in 1983 as a bank lending to the silicon valley startups. Unlike other regional banks Silicon Valley banks client base is mostly technology workers and venture capital-backed companies.

SVB failure second biggest bank failure in U.S. history, behind Washington Mutual during the height of the financial crisis more than a decade ago.

In 2020 post pandemic world the silicon valley started to see the huge influx of deposits as the startup who raised capital at unicorn valuation parked the money at Silicon Valley Bank.

All this working capital that SVB collected was invested in treasury portfolio, mostly comprised of Agency MBS securities, corporate and Muni bonds with large duration and maturity profile, all fixed coupon securities with huge exposure to interest rate risk.

Given the Balance sheet size of less than 50 billion and being a small regional bank, SVB was not subjected to all the regulation that big banks are subjected to (like Stress testing, liquidity stress testing and CCAR/DFAST and everything related to Dodd-frank regulation.

SVB treasury portfolio mostly consisted of treasury, agency MBS(Mortgage back securities), corporate and Municipal bonds.

Within Agency MBS securities, a vast chunk of bonds are backed by mortgages that were originated in 2020 or later, including refinances. Think anyone with a 3% mortgage locked in is going to pre-pay, refinance or sell anytime soon?

AFS(Available for sale) and HTM(Held till Maturity) Accounting for Investment Portfolio

That is right HTM is only an accounting term Held-to-Maturity and usually should be a small portion of portfolio/balance sheet, where management based on prudent judgment have willingness and capability to “Hold” those securities till maturity.

This run shows failure on many fronts esp. the risk management and asset-liability management on SVB management part.

1. ALM(Asset-liability management) completely missing

2. Parking working capital to a 10 year Agency MBS at lowest interest rate in 5000 years of human history

3. And not doing anything to hedge the interest rate risk, duration risk and convexity risk and any form of stress testing

SVB issues are much more like Savings & Loans Crisis, and not like Global Financial Crisis(2008) when big money center banks like Lehman brother went bankrupt, and SVB issues are more related — extremely poor IRR(Interest rate risk)and liquidity management.

The biggest banks(SIFI and G-SIFIs) — those most likely to cause a systemic economic issue — have healthy balance sheets and plenty of capital.

Michael Cembalest, the brilliant market strategist at JP Morgan highlighted this showing how much of an outlier $SIVB was in charts below.

1. Highest risk, least sticky deposit base (Most of the deposit base was working capital and large amount of money (>250k FDIC insured limit) from tech startups. And all these CFOs/Tech startup are highly active and engaged on twitter, and other social media platform. $42 billion of $170+ billion of deposits was yanked in 1 day. Previous largest bank run in modern U.S. history took place at Washington Mutual bank in 2008, and totaled $16.7 billion over the course of 10 days. So this was almost 30 times faster compared to previous outflows.

2. Only 2.7% of Silicon Valley Bank deposits were less than $250,000, the maximum limit for FDIC insurance, and 97.3% aren’t FDIC insured.

Worst capital position

“Silicon Valley Bank senior management made a basic mistake. They invested short-term deposits in longer-term, fixed-rate assets” -Bill Ackman

Past Banking failure in US in last 30 years

Questions for Market Observers and Analysts are

And if interest rate stays like this just think of it how many ALM mismatch stories are out there. Pre-payment risk/negative Convexity and duration extension are not easy concepts, even for risk professional who are doing it for 15–20 years.

How Regulators should respond

1. FDIC guarantee all the deposits to stop bank run

2. Given that the FDIC is not fully capitalized to take all the losses in HTM books, it’s recapitalized with $600-$800 billion of additional capital

3. Fed continues to hike rate to combat inflation and make sure that genuine savers are rewarded

4. Make it mandatory that each and every bank needs to pay Fed fund Rates -25 bps to each saving account

5. This will wipeout the equity for most regional banks

6. Split the bigger banks, big 4 banks in 6–8 banks

7. Merge regional banks with zero equity in these 6–8 banks

8. That will ensure level playing field for consumer and not so much of power to big 4 wall st banks. I don’t think you have heart or mind to think along these lines.

Myths Debunked by SVB Collapse

Myth 1: Deposits are more sticky and stable source of funds (vs. wholesale funding)

Myth 2: Bank runs don’t happen in post GFC and regulation heavy era of Dodd-frank regulation.

Myth 3: Deposits are diverse not concentrated in one industrial sector, region and customer type and hence reliable source of funding.

Myth 4: Accounting treatment like putting a huge chunk in HTM books can solve problems or hide risk(i.e. MTM is too myopic)

Myth 5: Bank deposits are mostly FDIC insured, right now only deposists up to 250k are insured (only <6% in case of SVB!), though actions past this bankruptcy have made some changes.

Myth 6: Only systemically important financial institution (SIFI) matters for risk contagion and should be subjected to more strict regulation. Anything above $100 billion can cause a systematic risk.

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