The SVB Collapse: Read Between The Lines

The Silicon Valley Bank failure is bringing out all sorts of descriptive statements. I spoke to a well known national reporter today who said the word “contagion” is being widely bantered about. The truth it seems is far less about contagion and more about management. Let’s look under the hood of this one.

SVB had been rapidly growing. Deposit growth alone was up over 300% over the past 3 years. These depositors were largely Venture Capital investors (VC’s) and varied start ups from Silicon Valley. This is important as it relates to the liquidity shortfall that hit the bank and the hot money challenge that these depositors brought. As published in the economist on Sunday 3/12, “SVB was uniquely susceptible to a run because of its exceptionally close ties to tech firms” and thus this failure seems unique based on SVB’s operating model.

As shown in this graphic from Chris Whalen, SVB had invested close to 45% of their assets in MBS and likewise a large position in Treasuries. As Barrons reported, “As interest rates rose sharply and the bond market cratered in 2022 (bond prices move inversely to yields), SVB’s bond portfolio took a huge hit. At the end of 2022, SVB held $117 billion of securities, which accounted for the bulk of its $211 billion in assets. These bonds were showing big losses at the end of 2022, with some $91 billion of the bond portfolio, classified as “held-to-maturity” securities for accounting purposes, worth just $76 billion.”

To make matters a bit worse SVB had engaged in a bit of “gaming” of the system. While many of these securities and MBS were held as “AFS” (assets for sale) they reclassified many of them as “HTM” (held to maturity). This changed what would have been a forced mark to market to one where the losses could be taken over time. Some might say that this disguised the depth of their losses.

In addition, SVB made a couple of significant errors related to liquidity. This is big because short sided risk managers that fail to see the need for excessive liquidity in this type of uncertain market are the ones who will end up like SVB. But to make matters worse they timed it all wrong. Perhaps it was their financial advisors, but instead of doing a capital raise first, they waited. Instead they announced the $1.4 bb loss and the markets cringed and then announced the capital raise effort which by that time was a massive challenge. Had they raised capital first, enough to cover the loss, they would likely still be operating today.

Three other things:

1. The depositors were said to be VC firms and start ups. They likely demanded ever increasing yields on their deposits, almost demanding a 1:1 match to fed actions. With no other source of capital they quickly likely found themselves under water, paying depositors more than the coupon of their MBS and securities. They had little choice as they had not gone into the broader market to raise other forms of capital to support their liquidity needs.
2. The MBS and securities holding were a pretty big bet that were likely missing a more conservative hedging strategy. Make no mistake about it, these are government guaranteed instruments and high quality. When they go to market there will be plenty of buyers. But SVB literally got caught holding the bag in this inverted yield curve and QT climate.
3. And a final side note: If anything should highlight why Independent Mortgage Bankers are not the concern here, this collapse should. IMB’s are essentially pass through entities. They do not retain assets, they do not have depositors. Banks like SVB are risk retaining entities that hold assets on their balance sheets. And in a similar, but less impactful, manner to the S&L crisis in the 1980’s, asset holders with unhedged instruments and non diversified liquidity sources may find themselves submerged in a period of QT like we are experiencing. Non banks don’t retain interest rate risk, other than short term pre funded/pre sold pipelines. It’s a minor risk compared to how a string of errors, bad market timing, and management failures can take down a bank.

How this plays out with the broader banking system will depend on how FDIC and Treasury handle this one. But there is no doubt we have stepped into an even increasing period of market volatility.

One final thought. Powell and the Fed have created much of this mess. By going to unprecedented levels of QE prior to and then the aggressive QT we face today, they have thrust this volatility on the markets. It doesn’t excuse SVB, but it cannot be avoided as a focus point as we discuss current events.