Silicon Valley Bank Failure, March 10, 2023

 

Silicon Valley Bank (SIVB) has been shut down by regulators who cited both inadequate liquidity and insolvency. According to the FDIC, insured SIVB depositors will have access to their funds no later than Monday morning.

SIVB’s $209 bn in assets are roughly 2/3 of Washington Mutual (not adjusted for inflation), which failed in 2008. The mid-day closure of the bank was unusual, and is something we are still evaluating.

While US bank Tier 1 capital ratios, wholesale funding ratios and loan to deposit ratios improved substantially for many US banks since 2008, there are exceptions… SIVB was in a league of its own: a high level of loans plus securities as a percentage of deposits, and very low reliance on stickier retail deposits as a share of its total deposit base.

Bottom line: SIVB carved out a distinct and riskier niche than other banks, setting itself up for large potential capital shortfalls in case of rising interest rates, deposit outflows and forced asset sales… A further look at SIVB funding… shows unusually high reliance on corporate/VC funding; only the small red private bank slice looks like traditional retail deposits to us.

Out of SIVB’s $173 billion of customer deposits at the end of 2022, $152 billion were reportedly uninsured (i.e., over the $250,000 FDIC insurance threshold) and only $4.8 billion were fully insured.

It’s fair to ask about the underwriting discipline of VC firms that put most of their liquidity in a single bank with this kind of risk profile1 . At the end of 2022, SIVB only offered 0.60% more on deposits than its peers as compensation for the risks illustrated below; in 2021 this premium was 0.04%.

The core issue: forced asset sales and securities losses Between Q4 2019 and the first quarter of 2022, deposits at US banks rose by $5.4 trillion and due to weak loan demand, only ~15% was lent out; the rest was invested in securities portfolios or kept as cash.

Banks can designate these securities as being “available-for-sale” (AFS) or in “hold-to-maturity” (HTM) portfolios instead. SIVB was one of the banks that relied extensively on HTM treatment for its growing securities portfolio: since 2019, its AFS book grew from $14 to $27 bn while its HTM book grew from $14 to $99 bn.

Selling HTM securities is complicated, since it results in larger parts of the portfolio being suddenly marked to market, which can in turn then result in the need for a capital raise. So, the big question for investors and depositors is this: how much duration risk did each bank take in its investment portfolio during the deposit surge, and how much was invested at the lows in Treasury and Agency yields?

As a proxy for these questions now that rates have risen, we can examine the impact on Common Equity Tier 1 Capital ratios from an assumed immediate realization of unrealized securities losses...

From Eye on the Market, Michael Cembalist, J.P. Morgan