The failure of SVB Financial Group (NASDAQ:SIVB) was the second largest in US history after Washington Mutual Bank (WAMU) back in September of 2008. During the financial crisis, I was a bank analyst working for a long/short fund and successfully shorted WAMU down to zero.
I only bring this up to validate my experience covering the banking sector given the surprisingly large number of banking experts that have sprouted up on Twitter and Linkedin overnight. The current scenario with SIVB is unique and distinct from the environment during the financial crisis.
During the financial crisis, banks failed because of credit issues in their loan portfolios. Banks had made poor lending decisions to unqualified subprime borrowers and the losses from their lending eventually destroyed their balance sheets. SIVB is in my experience the first major bank that has failed due to a fund mismatch between its high-quality assets, and low-quality deposits.
Q4 2022 hedge fund letters, conferences and more
The basic business model of a bank is to borrow short (take in deposits) and lend long (purchase assets). In normal credit environments, short-term interest rates are lower than longer-term rates.
Thus, the bank profits from the spread between short-term and long-term rates. The steeper the yield curve the bigger the profit the bank generates. Most banks rely on funding from retail deposits or in other words the general public. These deposits are considered "sticky" and are of higher quality than commercial deposits.
Retail deposits are considered high-quality because people rarely change their bank accounts when interest rates change. The vast majority of us have set up automatic bill pay or have direct deposits for our salaries so we're rarely inclined to change banks because a competing bank is paying 25 bps higher on their deposits. It's just not worth the hassle.
JPMorgan Chase & Co (NYSE:JPM), widely considered the highest quality bank in the US, has approximately 50% of its deposit funding sourced from retail depositors. Less than 10% of SIVB's deposits were from retail.
SIVB catered to technology start-ups and the venture capital community. Funding from businesses as opposed to individuals is classified as commercial deposits and is definitely not sticky. Commercial deposits can leave a bank for any number of reasons ranging from a small differential in deposit rates to rumors of liquidity concerns.
The IPO boom from 2020 to 2022 left SIVB with the influx of deposits which reached a peak of $198 b at the end of Q1 2022. By the end of Q4 2022, total deposits had declined to $173 b as losses mounted in their Held-to-Maturity portfolio.
Given the large influx of deposits, the bank had to do something with the money. Thus, SIVB management decided to put the majority into US treasuries and federal agency mortgage-backed securities. These securities have minimal credit risk but significant interest-rate risk.
We can see in the table below from SIVB's latest 10-K the bank had $91 b in its bond portfolio categorized as held-to-maturity. This classification allows a bank to hold the securities to maturity without needing to recognize mark-to-market losses. At the end of 2022, SIVB's $91 b portfolio was worth just $76 b.
The $15 b notional loss was enough to nearly wipe out the bank's $16 b in equity capital. A few depositors probably decided at the margin that situation was untenable and withdrew funds. As deposits declined the bank would be forced to sell securities on its balance sheet to pay back depositors.
Even if a security is classified as held-to-maturity, the bank must recognize a loss if it ends up selling the security. SIVB was forced to sell its bonds at a loss which eventually sparked a full-blown panic.
The Bank Term Funding Program (BTFP), was one of a number of measures the Fed introduced over the weekend to prevent a crisis. The facility is a brilliant move as it allows banks to borrow from the Fed for up to a year by pledging Treasuries, mortgage-backed bonds, and other types of debt as collateral.
The key point is that the Fed will allow banks to borrow an amount equal to the par value of the security. Without the need to mark-to-market, there is no need to recognize unrealized losses. Thus, a bank can meet its customer withdrawal needs without resorting to selling securities at a loss. This facility will allow banks to keep lending and ultimately new lending drives GDP growth.
Article by Ankur Shah via LinkedIn
