As of this writing the big story of today seems to be the closing of the Silicon Valley Bank, 16th largest in the nation. From David Hollerith, Myles Udland and Dan Fitzpatrick at Yahoo Finance:
Regulators closed troubled Silicon Valley Bank after deposit outflows and a failed capital raise plunged the country’s 16th largest bank into crisis, roiling the larger lending industry.
It became the largest bank to fail since Seattle’s Washington Mutual during the height of the 2008 financial crisis and, behind Washington Mutual, the second largest bank failure in U.S. history. It is also the first bank to fail since 2020. Treasury Secretary Janet Yellen acknowledged the industry turmoil Friday, saying there are “a few” banks the department is closely watching.
The observation of the editors of the Wall Street Journal is that the bank “fell victim of a classic banking strategy of borrowing short and lending long”.
I don’t think SVB will be the last substantial bank to fail in the present climate or even the last business and they will all have something in common: they’ve forgotten how to do business in an environment of high inflation and attendant high interest rates. It doesn’t help that all sorts of businesses have forgotten their core business. I don’t know that it’s the case in the instance of SVB but banks don’t understand the banking business any more, insurance companies don’t understand the insurance business, automobile manufacturers, aerospace companies, and on and on have lost touch with the basics of their own businesses.
As a colleague of mine quipped nearly 50 years ago artificial intelligence is what you use when you don’t have natural intelligence.
“…the bank “fell victim of a classic banking strategy of borrowing short and lending longâ€.
That phrase is usually used in observing a tenor mismatch in the loan portfolio. My understanding is that SVB actually had an extraordinarily large position in its investment portfolio: 30 year Treasuries. Interest rates rise, the bonds price down. Redemptions can’t be met. Bang. You’re dead.
The real question is where was the Risk Management Department. They look for this type of risk (among many others) all day long. It is inconceivable to me that they established a long duration position in the midst of an obvious tightening cycle. I told my wealth manager a good year and a half ago to keep durations short – like 1-2 years.
This is real basic stuff. Hard to believe that, ultimately, we won’t find that some guy over road policy in a riverboat gamble.
That’s sort of the point of this post. Is it possible that a generation-long period of low inflation and low interest rates has left the managers of the bank ignorant of the banking business?
Risk management failed on a much larger scale in 2008-2009. I dont think that term means what it is supposed to mean.
Also since you probably wont see it, Cochrane has issued a statement on its use of masks review saying pretty much what i said.
https://www.cochrane.org/news/statement-physical-interventions-interrupt-or-reduce-spread-respiratory-viruses-review
Steve
Dave –
I have to say I honestly doubt it. Any undergrad or MBA student, in their very first Investment class, learns/understands the inverse relationship between rates and bond prices. And further, the increasing volatility of that relationship as the bond’s term (duration) increases. And further, this is the freakin’ Risk Managment Department. Its their very job. They knew.
You don’t forget this stuff. But you might ignore it. As I said, I wonder if some senior exec decided to gamble on rates. Perhaps because they had gotten mispositioned at an earlier point in time in the investment portfolio, maybe due to a lack of quality loan opportunities. BofA supposedly has 25% in long Treasuries; I understand SVB had 50%. 50% of anything in a risk management environment is, by definition, way too much. Gross negligence.
Someone may hang for this.
Perhaps the “best is yet to come.” Volker had variable rate mortgages at 21% apr (or so) at one point. My wife and I had signed onto a 10% fixed rate mortgage a year before, and we were happy. Mortgage rates didn’t get below 7% or so until the late 80’s.
There have been some wild stories flying around that SVB’s risk management department had priorities other than risk management.
“There have been some wild stories flying around that SVB’s risk management department had priorities other than risk management.”
Nothing earth shattering here, but a summary:
https://www.zerohedge.com/markets/collapse-svb-portends-real-dangers
….except to point out that the Covid fiscal response was hysterical and with knock on effects everywhere.
I haven’t heard those rumors, Dave. It would be interesting to know what they are. But as this article points out, given SVB’s client base that stimulus money couldn’t find its way into the loan portfolio in a useful way, and so went into the investment portfolio. It still doesn’t explain why they made the ultra rookie mistake of going long term in the face of a zero rate environment that could only go up.
Maybe they didn’t believe that pumping all that money into the economy, especially in light of supply chain issues, and a consumer building savings during the heat of the pandemic – and the associated money burning a hole in their pocket – would cause inflation. But then Joe, Nancy and Chuck lit a match. Maybe they just didn’t believe the Fed would raise rates.
Costly error in judgment.
PS –
I have heard that the head of Risk Management was all about LBGTQ and the like. Perhaps a woke hire. (an incompetent hire?) However, you can be gay etc and still understand risk management basics. The two are hardly mutually exclusive.
But banks, large corporate and government have been making lots of dumb decisions the last few years. M&M’s any one?
Or how about Kamala, Jean Pierre or Mayor Pete?
It’s not unfamiliarity with high interest rates that got SVB (4.5% isn’t high historically), but rising rates – rates have been rising for 2.5 years now.
The youngest bankers with working experience in a rising rate environment are 65+ — they would have needed to start work in 1978. i.e very few if any bankers today have experience.
The key question whether this is like 1994 (Orange County) or worse is how long rates keep increasing.
Watching what the response from the Federal Reserve, Treasury and Congress will be. The time is coming when the Federal Reserve will have to make hard choices.
Side note – the institution that is most exposed to interest risk is the Federal Reserve. Due to QE and operation twist they hold a trillions of long duration bonds while having to pay interest on 2 trillion in short term deposits to manage the Fed funds rate. Lucky a run on the Federal Reserve is impossible.
“It’s not unfamiliarity with high interest rates that got SVB (4.5% isn’t high historically), but rising rates – rates have been rising for 2.5 years now.”
My understanding is that (in round numbers) the decline in bond values was $2B. That’s how they sized their failed equity offering. And yes, quite a long time on rate rises. What were they doing?
Asleep at the wheel? Boneheaded dogma? Pure incompetence?
“The youngest bankers with working experience in a rising rate environment are 65+ — they would have needed to start work in 1978. i.e very few if any bankers today have experience.”
I just have a very hard time with this whole concept. Its a fundamental concept in any Finance 101 book. Its not experienced based. If I – a transactional and managerial steward type of guy; not risk management – could see it, surely they could. Its not a concept that comes only with apprenticeship.
In the 2000s we had major over investment in a single sector and there was a belief that prices could not go down. That was obviously mismanagement but on a larger scale. In the case of SVB from what I am reading it sounds like interest rate risk but also having so much of their risk in the tech sector. If tech went bad they would be in trouble.
It should be noted that the CEO was ultimately responsible for their decisions and he had a position on a Fed Board (SF?) and was an advocate for deregulation of regional banks, which he made some headway on. Deregulation of banks seems to frequently be followed by bank failures.
Steve
On the woke stuff the current risk officer didnt take her place until January this year and they had no risk officer the 9 months before that. Sounds to me like some indications of poor management issues. A lot, in some circles, has been made of the risk officer for their European branch being an LGB advocate but far as I can tell it was not the European assets causing their problems.
Steve
Sounds like they weren’t taking risk management particularly seriously. Too big to fail?
Maybe there are a few CEO/managment types who believe that but I think there are a lot more who believe they are too smart to fail. They are making lots of money and are convinced that their risks wont catch up with them.
Steve
Given the comments from the treasury secretary and leaked potential responses in the WSJ, Bloomberg, Washington Post — they are dealing like there is a systemic issue and not the idiosyncrasies of one bank.
Perhaps this a clue to what they are thinking.
From the chairmen of the FDIC 3 days before collapse of SVB.
“ First, as a result of the higher interest rates, longer term maturity assets acquired by banks when interest rates were lower are now worth less than their face values. The result is that most banks have some amount of unrealized losses on securities. The total of these unrealized losses, including securities that are available for sale or held to maturity, was about $620 billion at yearend 2022. Unrealized losses on securities have meaningfully reduced the reported equity capital of the banking industry.
The good news about this issue is that banks are generally in a strong financial condition, and have not been forced to realize losses by selling depreciated securities.â€
https://www.fdic.gov/news/speeches/2023/spmar0623.html?source=govdelivery&utm_medium=email&utm_source=govdelivery
The problem has only gotten worse since Dec 2022. High interest rates on short term treasuries is attracting savers to withdraw their money earning 0% in savings accounts to 1 year treasuries earning 5%. The leak of deposits that can force a bank to sell those long duration bonds and enter a spiral of doom…
As an FYI; there’s 30 trillion dollars of Federal Debt; excluding 5 trillion held by the Federal Reserve; and the average maturity is 5 years. That’s 25 trillion debt is 25 trillion worth of assets somewhere — these “assets†has an average maturity of 5 years. Given the interest has gone from 1% to 3% in 2 years — how much losses is that….?
steve-
I think its correct that SVB was too industry concentrated. But there is more to the story. The political environment and anti-PE sentiment caused many banks to decline PE banking relationships. We were kicked out of a prominent bank for that reason. SVB was a bank that capitalized on this. They specialized in tech, venture and later stage PE. An outgrowth of political correctness.
That doesn’t excuse the poor risk management issues, and their management should have understood one of the most fundamental principles in all investment: diversification.
And one has to ask: where were the regulators? No need to answer that.
I still say. This was gross negligence and should be dealt with as such.
I should finish the thought. A natural consequence. I’m sure they had Treasuries as a “less risky” counterbalance to their relatively risky client loan/investment positions.
But Treasuries are not necessarily “safe.” 30 years are not, in a rising rate environment. Maybe they believed Uncle Joe, or Janet Yellen that inflation was “transitory.” Heh. Bad move. But when was the last time Joe told the truth?
” where were the regulators? No need to answer that.”
But we should answer that. The SVB CEO was the one pushing for less regulatory effort for regional banks and it sounds like he achieved that. So it sounds like the regulators were not there, by design.
Its politically correct to deal with late stage PE but not other PE? Who knew?
Steve
Steve – You are showing your ignorance.
Most industry players argue for regulations in their favor. Like,say, Saint Buffet and his arguments that perpetuate rail and monopoly for his beloved rail company. And are you saying regulation is that malleable? Super. (See below). And I happen to know what the key regulatory argument is. I bet you don’t have a clue.
In the case of banking, regulators argue for “safe†government securities to balance a risky loan portfolio. Heh. What tenor risk? We just cleared an SEC audit. As one of our guys quipped. It’s like dealing with the Post Office and DMV at the same time.
Apparently the VC vs late stage issue went right over your head. Stick to gall bladders.
Sorry, just found it funny that the bank that was holding Thiel’s money supposedly didnt approve of VC.
Lots of other people writing on this. From what they are saying due to the regulatory changes SVB did not have a stress test last year, while also not having a risk officer. In this case it seems unlikely that regulators would have insisted they buy even more treasuries to offset the interest risk.
Steve
“Safe” treasuries is the long standing position of regulators as a counterbalance a risky loan portfolio. But all treasuries are not alike in a rising rate environment. The longer the remaining term, the more they decline. There is no excuse for going long.
Uncommented on in the thread. And I’ve just been waiting. Does no one know, or ask, what the hell was SVB doing making “loans” to relative start ups, and venture vs late stage PE? The very nature of the former is that they are not loan-worthy. Volatile cash flow. That’s why they are funded mostly by equity, and a collateralized working capital line of credit. WTF?
Lastly, a lot of the regulatory lobbying concerned classifying PE loans and deposits in the banks capital base. That’s a separate issue from going long treasuries and making high risk “loans.”