How SVB was ruined by a bad bet on mortgage securities and the Fed’s rate hike

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The collapse of was driven not by credit problems but by the age-old mismatch of assets and liabilities that doomed many thrifts in the 1970s.

California regulators seize Silicon Valley bank, whose parent is Santa Clara-based


Financials (ticker: SIVB), on Friday following a deposit run. It was the biggest bank failure since

Washington Mutual

in 2008.

Silicon Valley Bank, which caters to the technology start-up and venture capital community, saw a huge inflow of deposits from 2020 to early 2022. Deposits increased from $74 billion in June 2020 to $198 billion as on March 31, 2022.

Banks needed to do something with customer deposits and the SVB decided to put large amounts of money into bonds, mostly federal agency mortgage-backed securities. They carry the least credit risk but can carry high interest rate risk.

SVB’s mistake was to invest in long-term mortgage securities with maturities of more than 10 years, rather than short-maturity Treasury or mortgage issues maturing in less than five years. This resulted in an asset/liability mismatch.

As interest rates rose sharply and the bond market declined in 2022 (bond prices move inversely to yields), SVB’s bond portfolio took a severe blow. At the end of 2022, SVB held $117 billion in securities, which accounted for the bulk of its $211 billion in assets.

These bonds were showing large losses at the end of 2022, with some $91 billion of the bond portfolio, classified as “held-to-maturity” securities for purposes, worth only $76 billion.

A loss of $15 billion compared to a loss of just $1 billion at the end of 2021 before the fall in bond prices. The yield on that portfolio averaged just 1.6%, compared to current mortgage-securities yields of about 5%.

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While that loss was real, SVB was not required to recognize it because rules allow time-to-maturity securities to be effectively carried at their cost. Losses on those bonds would have nearly wiped out the bank’s $16 billion equity capital base at the end of 2022.

While SVB was sitting on huge economic losses, investors and analysts paid little attention to it—until late last week. It looked as though the bank would out the storm and the bond portfolio would slowly mature and losses would subside.

In fact, SVB CEO Greg Baker appeared on a Morgan Stanley conference call on March 7 and did not take any questions about the bank’s balance sheet, deposits or securities portfolio. He was asked about crypto, venture capital, the IPO market, and the “innovation economy,” among other things. The final question was how he “de-stressed”.

His response: Bicycling. “So cycling is my advice, of course, living in Northern California and living on the peninsula. That’s it — I think this is the best bike-riding cycling in the world, period. And so many colleagues, staff and teams And it’s great to work with venture capitalists, et cetera.

The bank shuddered—much as austerity did in the 1970s—as the effective maturities of its mortgage-securities portfolio lengthened as rates rose. Portfolio duration, a measure of risk, rose to six years from about four years during 2022.

SVB compounded the problem by relying on institutional deposits, with the vast bulk of its deposit base having accounts in excess of $250,000. This made it more vulnerable to a single run.

Even before this, it experienced a drop in deposits from $198 billion in March 2022 to $173 billion at the end of the year.

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“SIVB was in a of its own: high levels of and securities as a percentage of deposits, and much less reliance on stickier retail deposits as a share of its total deposit base,” wrote Michael Cembalist, president of market strategy. In JP Morgan Asset Management.

Things quickly unraveled for SVB. On Wednesday, it announced the sale of some $21 billion of Treasury and agency bonds classified as available for sale for purposes; Realize a loss of $1.8 billion, and raise $2.25 billion in capital.

The plan did not work as depositors rushed to withdraw their money. SVB shares fell 60% to $106.04 on Thursday and did not open for trading on Friday. There may not be much recovery value for shareholders.

With only 0.15% losses on the $74 billion portfolio in the fourth quarter, SVB’s loan book appears to be in good shape.

SVB was unusual due to the extent of its bond losses relative to its capital base compared to the largest banks and regional ones.

The bank’s demise could prompt regulators to take a look at the for bank bond portfolios that allow banks to effectively hide losses by classifying them as maturities. The other category of bondholdings available for sale needs to be carried at market value.

“This way of classifying securities, and the different treatment of each category, has always been a bit problematic and can certainly be manipulated to the bank’s advantage when it feels the need to do so,” said Robert. Willens, a New York tax expert, wrote in an email to Baron’s,

Indeed, there was a rush by banks to reclassify their bonds as “held to maturity” in 2022, so much so that the FDIC has estimated losses of $600 billion across the industry.

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The large capital hole in SVB’s balance sheet could complicate the sale of the bank as the buyer would likely have to recapitalize it. There is speculation that private-equity buyers are eyeing the bank.

One potential buyer is JPMorgan Chase (JPM), the country’s top bank, but that doesn’t seem likely.

For starters, JPMorgan and the other largest banks do not require deposits and may be reluctant to take on loan portfolios that they did not underwrite. For example, JP Morgan can handpick some of the most productive teams in SVB. The regional bank may be more attracted to its presence in Silicon Valley and ties to the tech community.

In addition, Jamie Dimon, CEO of JPMorgan, took over a failing institution after buying Bear Stearns during the 2008 financial crisis and taking over Washington Mutual, mostly legal liability for mortgage-related activities by the bank. Taking has vowed not to help regulators.

Write to Andrew Barry at [email protected]