by Bryan Perry
March 14, 2023
The failure of SVB Financial Group (SIVB) is epic – in the size of deposits lost to so many fledgling companies, the payrolls they won’t be able to meet, the mismanagement of the balance sheet, the job losses it will likely trigger, and the damage to investor sentiment that was evident when the 15th largest bank in the U.S. went up in flames late last week.
Forget Friday’s bullish jobs report that showed a silver lining in wage inflation. When SVB never re-opened for trading for lack of being able to raise capital amid too many unanswered questions, the path of least resistance was sharply lower prices. The age-old investor reflex of “sell first, ask questions later” took complete control of price action. Being this banking bombshell took place on a Friday only made things worse, heading into a weekend of unknown consequences and wild speculation of perceived outcomes.
One chart that was widely circulated at the Federal Reserve and the Treasury Department last week was that of the banking sector (below). After eight months building a base in the face of the most aggressive rate hike cycle in history, seeing shares of the purest bank ETF, the Invesco KBW Bank ETF (KBWB), slice through its low (far right) like a hot knife through butter, surely sounded alarm bells. How could “the bank where all the smart money banks” get it so wrong? This was a full breach of investor confidence.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The problem we writers have is that by the time this column hits your inbox, we’ll all have a pretty good idea of whether there is a buyer or set of buyers for some or all of SVB, or a pre-packaged bankruptcy deal, or some other outcome that is a new form of government sponsored hybrid bailout. Let’s not forget that SVB is home to some of the most powerful people in the world, where “losing “is not an option.”
So, don’t be shocked if somehow the government prevents another Washington Mutual, Bear Stearns, or Lehman Brothers fire sale. This meltdown happened on Jerome Powell and Janet Yellen’s watch, and their legacies will be defined by whether this hole in Santa Clara is plugged, and is featured as a one off, or becomes something that gets very messy for several “who’s who” companies in Silicon Valley.
For those wondering what the heck happened, there are some glaring outliers in the SVB situation, such as: Roughly 87% of SVB’s deposits were above $250,000, thereby uninsured, whereas the typical regional bank has roughly 40% of deposits above the FDIC insured level. Why didn’t regulators raise this red flag? This helps to explain the panic regarding the run on the bank. Last Friday, the bank failed following a bank run that saw investors and depositors trying to withdraw $42 billion on Thursday alone.
The core of the story was clearly put forth by Marc Rubenstein over the weekend:
“Driven by the boom in venture capital funding, many of Silicon Valley’s customers became flush with cash over 2020 and 2021. Between the end of 2019 and the first quarter of 2022, the bank’s deposit balances more than tripled to $198 billion. The bank invested the bulk of these deposits in securities. It adopted a two-pronged strategy: to shelter some of its liquidity in shorter duration available-for-sale securities, while reaching for yield with a longer duration held-to-maturity book. On a cost basis, the shorter duration AFS book grew from $13.9 billion at the end of 2019 to $27.3 billion at its peak in the first quarter of 2022; the longer duration HTM book grew by much more: from $13.8 billion to $98.7 billion. Part of the increase reflects a transfer of $8.8 billion of securities from AFS to HTM, but most reflected market purchases. ‘Based on the current environment, we’d probably be putting money to work in the 1.65%, 1.75% range,’ said the bank’s CFO at the beginning of 2022, referring to the yields he wanted to achieve. ‘The vast majority of that…being agency mortgage backed, mortgage collateral, things along those lines.’”
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
“The trouble is that when rates started to go up, mortgage assets got hit hard. The duration of Silicon Valley’s HTM portfolio extended to 6.2 years, as at the end of 2022, and unrealized losses snowballed, from nothing in June 2021, to $16 billion by September 2022. That’s a 17% mark-to-market hit. The smaller AFS book was also impacted, but not as badly. Mark-to-market losses there amounted to 9% by the end of September. So big was this drawdown that on a marked-to-market basis, Silicon Valley Bank was technically insolvent at the end of September. Its $15.9 billion of HTM mark-to-market losses completely subsumed the $11.8 billion of tangible common equity that supported the bank’s balance sheet.
(source: netinterest.co/p/the-demise-of-silicon-valley-bank)
This “technical insolvency” is right out of the movie “Margin Call,” in which market forces push that firm’s leverage in CMBS beyond the equity of the firm. Considering this took place back in September, that should have sounded alarm bells far sooner. While SVB held bonds with an average duration of 6.2 years, which would ultimately be redeemed at par, they ran out of time. They did not anticipate the VC market to dry up completely in 2021, and the rate of deposits to fall by some $33 billion over the past year. The bank struggled to contain bond losses at a time of accelerating deposit outflows.
And then there is the issue of SVB operating without a chief risk officer for nine months leading up to the current collapse. SVB’s former head of risk, Laura Izurieta, who formerly performed a similar role for Capital One, left the bank in April 2022. She wasn’t replaced until January 2023 when the bank hired Kim Olson, formerly of Japanese bank Sumitomo Mitsui. This is bad. Who was overseeing risk in between?
With several big-name corporate, banking, and celebrity VIPs having funds at SVB, the Fed may take whatever inflation data they formerly feared in stride and put any further rate hikes on hold.
The fact is that the banking community has also suffered hundreds of billions in mark-to-market losses on their securities portfolio. According to a recent speech by FDIC Chairman Martin Gruenberg, banks under his purview have accumulated $620 billion in unrealized losses on investment securities as of the fourth quarter due to elevated market interest rates. The elevated level of unrealized losses is at risk of becoming realized if the banks need to sell securities to meet liquidity needs.
Navellier & Associates Inc. does not own Silicon Valley Bank (SVB), in managed accounts. Bryan Perry does not personally own Silicon Valley Bank (SVB).
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
This chart is probably the second most circulated chart going around the Fed this past weekend.
Here too, SVB might be the canary in the coal mine, if further stress is added to the system.
If the charts don’t lie, I would venture to say we have seen the last of the rate hikes for this cycle.
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
Also In This Issue
A Look Ahead by Louis Navellier
What Friday’s Jobs Figures Really Mean
Income Mail by Bryan Perry
Will California’s Big Bank Failure Halt Further Rate Hikes?
Growth Mail by Gary Alexander
Should We “Beware the Ides of March”? (Again)
Global Mail by Ivan Martchev
The Fed is on the Cusp of a Gargantuan Mistake
Sector Spotlight by Jason Bodner
“Numbers Don’t Lie” – Or Do They?
View Full Archive
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Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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