The term bank sparks confidence or
is it? Is counterparty risk in a
bank for real?
Lets deep dive into the collapse of the 16th
largest US Bank. Its downfall is the
largest failure of a US-based financial institution since Washington Mutual
collapsed at the height of the financial crisis in 2008.
First Things First – What is Silicon
Valley Bank and why are we talking about it?
Silicon Valley
Bank or SVB was established in 1983 and has been in business since last 4 decades.
It is involved in providing financing for about half of all U.S. venture-backed
technology and healthcare companies. SVB was a preferred bank for the tech
sector because they supported those startup companies that not all banks would
accept due to higher risks.
As per
the website of SVB, it refers itself as “The financial partner of the
innovation economy.”
As per
the December 2022 financials, it has
- $ 212 Billion in Assets
- $ 74 Billion in Loans Provided
- $ 342 Total Client Funds
So Yes
it is important to know about it.
What is different about Silicon
Valley Bank - The Proof lies in the pudding
SVB typically is a banker for the
startups and startups by design are volatile.
The year 2020 was a dream year for
startups. Fed has started printing money coupled with ultra low interest rates.
Since SVB was the banker for startups, they were also a beneficiary with ultra
high deposits. Money Money all around!
Since there were limited
opportunities to lend these funds for SVB, they actually invested this funds
into US Treasury Bonds and other Government Sponsored enterprises.
All this was fine until the
attention goes to the duration of Deposits taken by SVB (Short Duration) vis-à-vis
the investment done (Long Duration). This is typically called the Asset
Liability Management (ALM) Mismatch. Ideally a bank should have invested the
funds with matching duration of deposits to counter any interest rate risks.
Once this merry making season came
to a standstill, it was time for the funding winter and layoffs. This was a
time for hard decisions. The startups took a look at their purse and began
withdrawing their deposits for business purpose.
Source: SVB Financial Presentation
Blame it on Inflation!
The interest rate curve made a
complete circle from the ultra loose monetary policy to support the business
and the citizens in the covid era to the current quantitative tightening with interest
rates hikes by Fed.
It is almost impossible to look back
to the fact that just a year back, the interest rate in US were virtually ZERO.
Today the same stands at 5.00%. Inflation is for real.
SVB invested these bonds in ultra
low interest rate environment. With such aggressive moves by the Fed, the losses
by the SVB in the bonds began increasing.
With an increase in interest rates,
the price of bonds decreases and vice versa.
Now there are two options of accounting
permitted for changes in prices of bonds.
Available for Trade (AFT) – Any
profits/losses on the bond portfolio have to be recognized on Mark to Market (MTM)
Basis immediately.
Hold till Maturity (HTM) - Any
profits/losses on the bond portfolio does not need to recognized immediately since
they don’t intend it to sell.
Now SVB classified majority of these
portfolio as HTM. Therefore giving the impression that losses are not for real
and there shall be time correction in the prices and all shall be good again.’
A Bank is supposed to be Boring No?
Banks typically are an extension of
the baniya dhanda, it takes deposits at a lower rate of interest and provides
loans at a higher rate of interest. The differential interest is the profit net
of expenses.
However, the lure of wall street
coupled with continuous pressure of quarter on quarter growth takes the toll on
the best of the minds. Sometimes the basic risk mitigation goes for a toss.
In this case, the business of SVB
was no longer boring. With increase in interest rates, they paid their
investors more than what they got in their investment in US treasuries which
was locked before the rate hikes. Therefore they started incurring a negative
interest income coupled with capital loss on the prices of the bonds.
Do you Remember the popular adage on
the highways– Speed thrills but kills!
Run on the Bank
All the above was fine, until
customers came to the doors of SVB asking for their deposits.
In this social media age, news spreads
like wild fire, more so any negative news in the financial domain because it is
inherently built on trust.
To provide the funds to the
investors, SVB has to sell their bond portfolios of $ 21 billion at a loss of $
1.8 billion and realize the losses which was not accounted till than.
They even tried to raise $1.75 billion share sale to shore up
finances. However investors began more and more tensed. Word spread quickly on Twitter
and WhatsApp inducing panic that the bank didn’t have enough funds. Customers
started to withdraw money. SVB's stock plummeted by 60% on March 7 after its
capital raising announcement.
It ultimately created a Run on the
Bank.
Conscience check from Fed?
Fed has loosened the requirement for
regulating regional banks in 2018.
Chair Jerome Powell said the central
bank would conduct a "thorough, transparent, and swift review."
Barr said: We need to have
humility, and conduct a careful and thorough review of how we supervised and
regulated this firm, and what we should learn from this experience.
President Joe Biden famously said - "Your
deposits will be there when you need them."
The government agreed to cover deposits, even those that
exceeded the federally insured limit of USD 250,000.
Takeover by First Citizens Bank
Silicon Valley Bank reported nearly
$167 billion in total assets and $199 billion in deposits As of March 10,.
First Citizens Bank shall purchase about $72 billion in assets at a discounted
rate of $16.5 billion. FDIC will remain in control of remaining $90 billion in
assets and securities in its receivership.
What Changes?
Whenever there is a Risk-on mode,
typically the ones who are big wins at the cost of small. When the dust
settles, the big shall be bigger and the small smaller.
It gives a thought to the basic principle of “Don’t put all your eggs in one basket”.
As Nithin Kamath says being
pessimistic is an underrated skill for running a business.
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