Silicon Valley Bank’s demise has led many pundits to blame rising interest rates, panicked depositors, bank regulators, and rating agencies. Rising rates are inanimate actors, and depositors, regulators, and rating agencies do not run banks. SVB’s
Significant asset size growth, reliance on largely homogeneous depositors, as well as concentrations in investments and in liabilities were signaling 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 are focused on risk. And by the time any of us see their financials, that information is already old because financials are usually published several weeks after the quarter ends. Yet, even looking at aggregated data about SVB, a number of signs would have told investors, lenders, and credit analysts that SVB had problems.
Asset Growth and Quality
The first step in analyzing a bank’s financial health involves looking at its assets. This entails looking at data to tell us about asset growth, diversification, credit quality, and measuring assets’ sensitivity to interest rate movements, both small and especially large. From 2019 to the end of 2020, SVB’s assets, meaning loans, credit facilities, securities, and other investments grew 63%. And from 2020 to the end of 2021, total bank assets grew over 83%. This significant asset growth happened in years when Covid-19 caused death, illness, and lockdowns. Loans alone grew almost 114% from 2019 to 2020 and then almost 30% from 2020 to 2021.
With a rise in assets comes more risk. What should have also caused eyebrows to raise was when risk weighted assets went up 13% at a time that asset size barely moved from 2021 to the end of 2022.
Significant growth at a bank should always make risk managers, credit analysts, investors, and regulators question whether corners in due diligence are being cut in lending or investments decision making processes. Growth is also always a good time to reevaluate whether a bank has highly skilled professionals who can manage the rising risk that accompanies having more assets. Significant higher growth in assets is also a good time to examine whether a bank’s technology is up to the task of taking in significant amounts of data to price assets and to measure their credit, market, and liquidity risks.
From a credit perspective, SVB’s loans and bonds were of a good credit quality; their data showed a low probability of default. The problem with SVB’s assets however was not credit, but rather market risk, specifically their sensitivity to interest rate risk. Since the mid-2000s, market participants have been talking about the likelihood that after over a decade of lower interest rates, the Federal Reserve would have to raise rates. That moment certainly arrived last year. And it is not the Federal Reserve that has been raising rates, so has practically every key central bank around the globe. What more of a signal does a bank need to conduct interest rate sensitivity analysis and stress tests on their bond holdings?
To blame 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 rest exercises are essential for risk managers to analyze day in and day out at what point could a bank have more assets or liabilities or is in the case of SVB more liabilities than assets.
By the fall of 2022, SVB had almost $100 million in losses due to valuation declines as well as realized losses when it sold $1 billion in Available for Sale (AFS) securities.
Thanks to Barron’s, most of us learned only yesterday that on February 27, SVB’s 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 much lower than the sale price. This was the first time that Becker had sold his company’s share in over a year. He had all of 2022 to see up close and personal all the funding and liquidity problems that his company was having.
Funding and Liquidity
Next step would be to look at how the bank’s funding risk. From 2020-2021, the SVB’s deposits grew by 100%. Such a significant rise in deposits makes sense since individuals and companies received government-backed loans due to Covid-19. The rise in deposits also happened because market volatility made many investors want to park money at banks until they could figure out how to invest it. Such a rapid and large rise in deposits should always make risk managers test what would happen to the bank’s liquidity when depositors decided to leave as quickly as they came in.
Analyzing funding diversity can be challenging. This time, however, SVB’s CEO and his team made it easier. They repeatedly told us that they were bankers to technology, start-up companies, and venture capital firms. That immediately meant that SVB was too reliant on a largely interconnected segment of the economy. Its high levels of deposits from traditionally riskier companies meant that if any had liquidity problems there was always the risk that they could come rapidly en masse to withdraw their deposits. Since last year, data has been showing rising probability of defaults at tech companies, and most unfortunately, they have been laying off people. These two data points alone should have made SVB increase its liquidity and capital significantly, which it did not.
Was SVB running a stress to see how liquid we would be in a period of stress? We do not know. Thanks to all those politicians and bank lobbyists who fought hard to lower risk management requirements for banks under $250 billion assets, SVB was not required to disclose how much it had in high quality liquid assets to help it cover net cash outflows in a period of stress. Part of the Basel III definition of stress certainly includes testing fleeing deposits. These regulatory changes were signed into law by President Trump in 2018 as part of the Economic Growth, Regulatory Relief and Consumer Protection Act, which eased requirements put in place in the aftermath of the 2008 Financial Crisis under Dodd-Frank and the Consumer Protection Act.
Certainly, SVB’s March 8th announcement that it had sold all its Available for Sale Securities understandably caused depositors to panic. No one likes to be the last one in a room turning off the light. On Thursday, depositors tried to withdraw $42 billion in deposits. A big 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, “As of December 31, 2022, and December 31, 2021, the amount of estimated uninsured deposits in U.S. oﬃces that exceed the FDIC insurance limit were $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 stampeding out the door, accompanied by a plunging stock price, were the loudest market signals that SVB’s illiquidity would soon turn to insolvency. Share trading was suspended yesterday after SVB shares plummeted by over 150% .
I realize that it is not everyone’s cup of tea to plow through banks’ financials. Yet, nothing can substitute looking at a bank’s financials and market signals such as share prices and credit defaults swaps; together this information is the best hope we have to understand 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 reasonably low probability of default and loss severity. On Thursday, Moody’s and S&P Global changed their outlook on the bank from stable to negative.
On Friday, the rating agencies downgraded SVB to junk, more politely known as a high yield issuer.
All those politicians and bank lobbyists who were successful at lowering liquidity stress requirements for banks under $250 billion assets must be very proud now. I sure hope that they go help all those depositors who cannot access their funds and those who will now be in the unemployment line, especially in California.
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original source: Warning Signals About Silicon Valley Bank Were All Around US