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Reality Check: SVB's Collapse Was A Full Year In The Making
The Collapse Was Foreseeable And Should Have Been Foreseen
Shout out to one of my readers for asking an important question on my thread posting about Roku putting a quarter of its cash in an uninsured account with Silicon Valley Bank.
To which “taxpayer” asked:
So if your company needs to hold hundreds of millions of dollars for immediate use, what is the safer practical alternative to a bank? Do you buy TBills and hold them directly in an account with US Treasury? Do you trust a brokerage and SIPC insurance? Do you disperse among hundreds of banks so insurance covers you?
Due diligence is an investigation, audit, or review performed to confirm facts or details of a matter under consideration. In the financial world, due diligence requires an examination of financial records before entering into a proposed transaction with another party.
Before Roku, or any potential depositor, deposits any money in any account in any bank, they owe it to themselves to scrutinize the bank, its history, its financials, and its management, to ensure that their funds are properly handled.
When one scrutinizes the financials of Silicon Valley Bank, it becomes abundantly clear that the collapse should have been anticipated far earlier than it was—and most especially should have been anticipated by SVB’s own management.
The signs were there, as far back as the bank’s 2021 Annual Report. The warning signs that were visible in the bank’s balance sheet and income statement then only got progressively worse throughout 2022, until by last Wednesday, March 8, the stage was set for mass panic among the depositors, triggering a bank run which drained the bank and forced regulators to step in on Friday (March 10).
Could the collapse have been avoided? We will never know for certain, but we can know that the bank failed to act early on to avoid the events which led to the collapse. SVB’s financials tell the tale the corporate media declines to explore.
In the corporate media narrative, SVB’s troubles hit the markets seemingly out of nowhere, catching everyone completely off guard when the bank announced a major stock offering to shore up its capital base on March 8.
SANTA CLARA, Calif., March 8, 2023 /PRNewswire/ -- SVB Financial Group ("SVB") (NASDAQ: SIVB), announced today that it intends to offer $1.25 billion of its common stock and $500 million of depositary shares, consisting of 10 million depositary shares each representing a 1/20th interest in a share of its Series F Mandatory Convertible Preferred Stock ("Preferred Stock"), liquidation preference $1,000 per share (equivalent to a liquidation preference of $50 per depositary share), in separate underwritten registered public offerings.
The surprise offering was shock enough, but the announcement also contained this small bit of disclosure that caught everyone’s eye:
Additionally, earlier today, SVB completed the sale of substantially of its available for sale securities portfolio. SVB sold approximately $21 billion of securities, which will result in an after tax loss of approximately $1.8 billion in the first quarter of 2023.
Wall Street did the obvious math ($1.25 billion in common stock + $500 million in preferred stock == $1.75 Billion in fresh capital) and realized SVB was shoring up its capital position by, in effect, replacing the $1.8 Billion lost on the sale of the securities portfolio.
$13 Billion in short-term borrowing from the Federal Home Loan Bank.
$2 Billion in long-term FHLB loans.
By Thursday, the panic had set in.
Panic swept through the start-up industry on Thursday as investors at some venture capital firms urged portfolio companies to move their money from Silicon Valley Bank over concerns about the tech industry stalwart’s financial stability.
Silicon Valley Bank’s spiral was set off by its surprise announcement Wednesday that it would take extraordinary and immediate steps to shore up its finances amid a dimming economic environment for the start-ups and other technology companies that dominate its client base. The bank disclosed that it had sold off $21 billion of its most liquid, or easily tradable, investments; borrowed $15 billion; and organized an emergency sale of its stock to raise cash.
Compounding the bank’s woes was a 60% drop in its stock price—triggered by the same events.
Silicon Valley Bank shares plunged as much as 62 per cent on Thursday, a day after launching a $2.25bn stock sale to shore up its balance sheet as it grapples with declining deposits from technology start-ups.
The shares of SVB Financial Group, Silicon Valley Bank’s parent company, were set for their biggest decline on record, wiping $9.4bn from its market capitalisation, after the banking group admitted large losses on the sale of securities as it attempted to raise cash.
By Friday, it was all over, as banking regulators moved to take over SVB.
Silicon Valley Bank has been seized by financial regulators after a run on deposits tipped the bank into collapse, in the largest US bank failure since the Great Recession in 2008.
California state regulators shuttered the bank on Friday, and the Federal Deposit Insurance Corporation (FDIC) immediately took control of the bank's $209 billion in assets and $175.4 billion in deposits.
The bank based in Santa Clara, California had been the 18th largest bank in the US, and primarily catered to the tech startups and wealthy entrepreneurs of Silicon Valley.
If one follows the corporate media timeline laid out above, one might easily conclude that Silicon Valley Bank’s problems erupted out of nowhere last week, without warning and without any indication the bank was in any difficulty.
However, the reality is the warnings were there—but no one was paying attention, until it was too late.
The seeds of SVB’s liquidity crisis can be seen in their 10-K Annual Report for FY2021, which shows they held some $15 Billion in US Treasuries at the end of 2021.
$11 Billion of those Treasuries had been purchased in 2021.
On December 31, 2021, yields on US Treasuries varied from 0.4% for the 1-Year Treasury to 1.94% for the 20-year Treasury.
On March 16, 2022, the Federal Reserve raised the Federal Funds rate 25bps. By March 31, Treasury yields were well above 1% across the entire yield curve.
The rise in Treasury yields after that first Fed Funds rate hike in March of 2022 meant that SVB’s portfolio of Treasuries had dropped in value—and would continue to drop as interest rates went higher.
On SVB’s 10-Q filing for that first quarter of 2022, their portfolio of US Treasuries was already showing an unrealized loss of over $500 million, up from an unrealized loss of $70 million at the end of FY2021.
One full year before SVB’s collapse, and two weeks after Powell raised rates for the first time, SVB’s investment bet on US Treasuries had produced $500 million in potential losses.
An investment that generates a $500 million loss in three months is an astoundingly bad investment for anyone. It would only get worse from there.
By the end of the second quarter, that loss was up over $700 million.
Yields by that time were up over 2.5%.
By the end of the third quarter, SVB was sitting on a loss of over $1 Billion from its Treasury bet.
Treasury yields at that time were up over 3%.
Nor was the carnage confined to just US Treasuries. All of SVB’s Available-For-Sale securities were losing value in 2022, so that by the 3rd quarter the combined losses of all the AFS securities was over $2.7 Billion.
Even without looking at the 4th Quarter, we can clearly see that SVB’s fixed-income investment portfolio was losing money.
Nor is there any mystery as to why the investments were performing so atrociously. This is what happens when interest rates rise. Lower yield investments lose value compared to higher yield investments. The management of SVB knew this back in March of 2022, when the Fed first started raising interest rates, and it knew all along that a portfolio of low-yield Treasuries was only going to decline in value as the Fed pushed interest rates higher—and Jay Powell has been saying all along that he means to raise rates to beat inflation no matter what.
The quality of SVB’s investment portfolio was never going to do anything but decline in value, as a direct result of Jay Powell’s interest rate hikes.
There were also clear warning signs that Silicon Valley Bank was facing a growing challenge in maintaining liquidity. Consider this notation from their first quarter 10-Q filing with the SEC from March of last year (emphasis mine):
We have certain facilities in place to enable us to access short-term borrowings on a secured and unsecured basis. Our secured facilities include collateral pledged to the FHLB of San Francisco and the discount window at the FRB (using both fixed income securities and loans as collateral). Our unsecured facility consists of our uncommitted federal funds lines. As of March 31, 2022, collateral pledged to the FHLB of San Francisco was comprised primarily of fixed income investment securities and loans and had a carrying value of $8.4 billion, of which $7.0 billion was available to support additional borrowings. As of March 31, 2022, collateral pledged to the discount window at the FRB was comprised of fixed income investment securities and had a carrying value of $515 million, all of which was unused and available to support additional borrowings. Our total unused and available borrowing capacity for our uncommitted federal funds lines totaled $2.0 billion at March 31, 2022. Our total unused and available secured borrowing capacity under our master repurchase agreements with various financial institutions totaled $8.0 billion at March 31, 2022.
A similar notation was also found in the second quarter 10-Q filing (again, emphasis mine).
We have certain facilities in place to enable us to access short-term borrowings on a secured and unsecured basis. Our secured facilities include collateral pledged to the FHLB of San Francisco and the discount window at the FRB (using both fixed income securities and loans as collateral). Our unsecured facility consists of our uncommitted federal funds lines. As of June 30, 2022, collateral pledged to the FHLB of San Francisco was comprised primarily of fixed income investment securities and loans and had a carrying value of $8.5 billion, of which $3.5 billion was available to support borrowings. As of June 30, 2022, collateral pledged to the discount window at the FRB was comprised of fixed income investment securities and had a carrying value of $5.6 billion, all of which was unused and available to support additional borrowings. Our total unused and available borrowing capacity for our uncommitted federal funds lines totaled $3.0 billion at June 30, 2022. Our total unused and available secured borrowing capacity under our master repurchase agreements with various financial institutions totaled $29.0 billion at June 30, 2022.
In just three months, SVB had tapped its credit with the FHLB of San Francisco for some $3.5 billion.
In the third quarter 10-Q we find this note about the FHLB borrowings (again, emphasis mine):
We have certain facilities in place to enable us to access short-term borrowings on a secured and unsecured basis. Our secured facilities include collateral pledged to the FHLB of San Francisco and the discount window at the FRB (using both fixed income securities and loans as collateral). Our unsecured facility consists of our uncommitted federal funds lines. As of September 30, 2022, collateral pledged to the FHLB of San Francisco was comprised primarily of fixed income investment securities and loans and had a carrying value of $18.7 billion, of which $2.9 billion was available to support borrowings. As of September 30, 2022, collateral pledged to the discount window at the FRB was comprised of fixed income investment securities and had a carrying value of $4.9 billion, all of which was unused and available to support additional borrowings. Our total unused and available borrowing capacity for our uncommitted federal funds lines totaled $3.2 billion at September 30, 2022. Our total unused and available secured borrowing capacity under our master repurchase agreements with various financial institutions totaled $30.5 billion at September 30, 2022.
Thus by the end of the third quarter Silicon Valley Bank had tapped the FHLB of San Francisco for over $15 billion.
These notes, embedded in the quarterly filings with the SEC, show SVB making increasing use of an “emergency” funding facility of the FHLB long before the decision to dump the toxic securities portfolio and seek a fresh capital injection in March, 2023. SVB was a leaky boat taking on water for most of 2022, and anyone reading the 10-Q statements during 2022 would be able to easily see that.
Nor was the FHLB the only short-term debt SVB was using to bolster its liquidity.
In their first quarter 10-Q, in the breakdown of their interest-earning assets and the accompanying funding sources, they disclosed $3.1 Billion in “short-term borrowings”, as compared to $12 million in the first three months of 2021.
During the second quarter, that short-term borrowing amount had risen to $3.607 Billion, with long term debt coming close, at $3.122 Billion.
In the third quarter, the short-term borrowing amount had risen to $7.655 Billion, with the long-term debt now at $3.367 Billion.
These increases in both short-term and long-term debt in order to bolster liquidity are red flags that SVB was not nearly as healthy as many wanted to believe. From a regulatory perspective everything might have been fine, but these debt increases all beg the question: “Why?” Anyone depositing millions and hundreds of millions in cash in an SVB uninsured account should have been asking that question of SVB’s management, and SVB’s management should have been forthcoming with the ugly truth of their interest-bearing investments.
It has not been reported whether or not Roku did these due diligence exercises before depositing money with Silicon Valley Bank, or if they did them periodically as a matter of prudent cash management. Given that Roku was caught off guard by SVB’s collapse, however, we may safely presume that either the due diligence was not done or the significance of the items detailed here (and no doubt other items besides) was not recognized.
Yet there is no substitute for due diligence when it comes to handling financial assets of any kind, and cash in particular. There is no substitute for asking of a prospective bank to defend their banking and cash management practices prior to depositing hundreds of millions of dollars in an uninsured account with that bank, nor is there any substitute for asking those questions periodically to make sure the bank is still on the right path.
SVB ran into liquidity problems because it took depositor funds and invested them bigly in US Treasuries and other interest bearing assets, and all of those assets began to lose value the moment the Federal Reserve began hiking rates. SVB tried to cover its liquidity problems with a variety of short-term “emergency” loans, even as the Available-For-Sale portfolio of interest-bearing assets continued to lose money.
Only at the very last minute did SVB attempt to raise capital to shore up its liquidity position while selling off the permanently underperforming interest-bearing assets.
This is exactly the behavior I said would happen five months ago—that Wall Street (i.e., bankers) would not take steps to unwind the investments they already knew were going to tank because of rising interest rates, and would just let the markets “break”.
The persistent insistence on Wall Street that things will break if the Fed continues to push rates up tells us one more very dangerous and very tragic thing: Wall Street won’t take the hint and act now to get ahead of the crisis.
Wall Street needs to unwind its derivative investment transactions, and it needs to do so starting yesterday. The urgency is immediate and real. Wall Street’s fear of a breakdown in US Treasury bond markets indicates they already know that this needs to be done.
Wall Street’s blaming a breakdown in US Treasury bond markets tells us that they will not take proactive steps to avoid the crisis, but will ride their derivative investments right into the inevitable crash. They won’t unwind those transactions until it is too late. The addiction to the “cheap” money of a low interest rate environment is overwhelming common sense and logic, which apparently are telling all but the most somnambulent of investors that their investment strategies are about to go south in a major way, and that it is time to switch strategies.
From the moment Jay Powell began raising interest rates, Wall Street has stubbornly refused to adjust its thinking about interest rates and interest-bearing assets. It has deflected and rationalized and kicked the can down the road at every turn, and Silicon Valley Bank finally ran out of road.
That low-yield Treasuries would lose value as the Fed raised rates is an Econ 101 level of thinking. SVB’s management ought to have understood that when the talk turned to the Fed’s rasing interest rates. Regardless of their justifications and rationalizations, the bottom line reality is that SVB’s management opted to ignore the warning signals that were accumulating on their books, until it was too late.
Similarly, Roku and other SVB customers with large deposits in uninsured accounts ought to have realized that the rising interest rate environment was a structural change in how financial assets would perform going forward, and they should have asked more and harder questions of SVB to ensure the bank was adapting to the new environment appropriately (which, as it turns out, it wasn’t). Regardless of their justifications and rationalizations, the bottom line reality is that Roku and the other uninsured depositors did not perform the due diligence that was incumbent upon them to perform regularly just to protect their own cash.
While Silicon Valley Bank did not cause the interest rate increases that eroded the value of their investments in interest-bearing assets, Silicon Valley Bank alone is responsible for what the bank did in response to those rate increases. Unfortunately for SVB depositors, what the bank decided to do can be summed up as “too little, too late.”
The same can be said for SVB’s uninsured depositors.
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Chen, J. “Due Diligence”, Investopedia. 28 Sept. 2022, https://www.investopedia.com/terms/d/duediligence.asp.