The collapse of Silicon Valley Bank led many pundits to blame rising interest rates, panicked depositors, bank regulators and credit rating agencies. Rising interest rates are inanimate agents and depositors, regulators and rating agencies do not run banks. SVB’s
Significant growth in asset size, reliance on largely homogenous depositors, as well as concentrations in investments and liabilities have signaled trouble at SVB since at least 2019. Banks are opaque institutions. Anyone analyzing a bank needs countless hours not only to analyze financial disclosures, but also Basel III disclosures, which focus on risk. And by the time any of us see their financials, that information is already out of date because the financials are usually released several weeks after the end of the quarter. However, even looking at aggregate data for SVB, a number of signs would have told investors, lenders and credit analysts that SVB was in trouble.
Asset Development and Quality
The first step in analyzing a bank’s financial health involves looking at its assets. This entails looking at data to inform us of asset growth, diversification, credit quality and measuring the sensitivity of assets to interest rate movements, both small and particularly large. From 2019 to the end of 2020, SVB’s assets, i.e. loans, credit facilities, securities and other investments, increased by 63%. And from 2020 to the end of 2021, the total assets of the banks increased by more than 83%. This significant increase in assets occurred during the years when Covid-19 caused death, disease and lockdowns. Loans alone grew nearly 114% from 2019 to 2020 and then nearly 30% from 2020 to 2021.
With increasing assets comes greater risk. What should also have raised eyebrows was when asset-weighted assets rose 13% in a period when asset size barely moved from 2021 to the end of 2022.
Significant growth at a bank should always cause risk managers, credit analysts, investors and regulators to question whether due diligence corners are being cut in their lending or investment decision-making processes. Growth is also always a good time to reassess whether a bank has highly skilled professionals who can manage the increased risk that comes with having more assets. Significantly higher asset growth is also a good time to consider whether a bank’s technology is up to the task of capturing significant amounts of data to price assets and measure their credit, market and liquidity risks.
From a credit perspective, SVB’s loans and bonds were of good credit quality. Their data showed a low probability of default. However, the problem with SVB’s assets was not credit, but market risk, namely their sensitivity to interest rate risk. Since the mid-2000s, market participants have been talking about the possibility that after more than a decade of lower interest rates, the Federal Reserve would have to raise interest rates. That moment definitely arrived last year. And it’s not the Federal Reserve that has raised interest rates, so have almost all major central banks around the world. What other signal does a bank need to conduct interest rate sensitivity and stress analysis on its bonds?
Blaming SVB’s woes on the Fed is simply absurd. Anyone who does not take interest rate risk sensitivity analysis and stress tests seriously as part of a Gap Analysis does not belong in banking. These interest resting exercises are essential for risk managers to analyze daily at what point a bank could have more assets or liabilities, or in the case of SVB more liabilities than assets.
By the fall of 2022, SVB had losses of nearly $100 million due to the decline in valuation as well as making a loss when it sold $1 billion in Available-for-Sale (AFS) securities.
Thanks to Barron’s, most of us learned just yesterday that on February 27th, SVB President and CEO Greg Becker sold 12,451 shares at an average price of $287.42 for $3.6 million. That day he also acquired the same number of shares using stock options priced at $105.18 each, a price well below the sale price. This was the first time Becker sold his company stake in a year. He had all of 2022 to see first-hand all the funding and liquidity problems his company had.
Funding and Liquidity
The next step would be to look at the bank’s funding risk. From 2020-2021, SVB deposits increased by 100%. Such a significant rise in deposits is logical, as individuals and companies received government-backed loans due to Covid-19. The increase in deposits also happened because market volatility made many investors want to park money in banks until they could figure out how to invest it. Such a rapid and large rise in deposits should always cause risk managers to test what would happen to the bank’s liquidity when depositors decided to leave as quickly as they entered.
Analyzing funding diversity can be difficult. This time, however, the SVB CEO and his team made it easier. We were repeatedly told that they were bankers at tech companies, startups, and venture capital firms. This immediately meant that SVB was too dependent on a highly interconnected part of the economy. High levels of deposits from traditionally riskier firms meant that if any had liquidity problems there was always the risk that they would come quickly en masse to withdraw their deposits. Since last year, data shows an increasing likelihood of defaults at tech companies and, unfortunately, they’ve laid people off. These two facts alone should have caused SVB to significantly increase its liquidity and capital, which it did not.
Was SVB anxious to see how liquid we would be in a time of stress? We do not know. Thanks to all those politicians and bank lobbyists who fought hard to reduce risk management requirements for banks under $250 billion, SVB didn’t have to disclose how much high-quality liquid assets it had to help it meet its net cash outflows in a period of stress. Part of the Basel III definition of stress of course includes the control of departing deposits.
Sure, SVB’s March 8th announcement The fact that it had sold all of its Available-for-Sale Securities caused depositors to rightfully panic. No one likes to be the last one in a room to turn off the light. On Thursday, depositors tried to withdraw $42 billion in deposits. A large part of the panic was also because many depositors had more than $250,000 in SVB accounts. these are not insured by the Federal Deposit Insurance Corporation (FDIC). According to SVB’s 10-K, “At December 31, 2022 and December 31, 2021, the amount of estimated uninsured deposits in US offices in excess of the FDIC insurance limit was $151.5 billion and $166.0 billion, respectively . As of December 31, 2022 and December 31, 2021, foreign deposits of $13.9 billion and $16.1 billion, respectively, were not subject to any U.S. federal or state deposit insurance regime. The amounts disclosed above are derived using the same methodologies and assumptions used for regulatory reporting requirements.”
Depositors walking out the door, accompanied by a drop in the share price, were the market’s strongest signs yet that SVB’s illiquidity would soon turn into insolvency. Trading in the shares was suspended yesterday after SVB shares fell more than 150%.
I realize that plowing through bank finances is not everyone’s cup of tea. However, there is no substitute for looking at a bank’s financials and market indicators such as stock prices and credit default swaps. together this information is the best hope we have for understanding a bank’s financial health. Until Wednesday, Moody’s and S&P Global had Silicon Valley Bank as an investment-grade issuer. This means that SVB had a fairly low default probability and loss severity. On Thursday, Moody’s and S&P Global changed their outlook on the bank from stable to negative.
On Friday, rating agencies downgraded SVB to junk, more politely known as a high-yield issuer.
All those politicians and banking lobbyists who succeeded in reducing the liquidity stress requirements for banks under $250 billion must be very proud now. I certainly hope they help all those depositors who cannot access their funds and those who will now be on the verge of unemployment, especially in California.