Just Wing It!
It is a best practice for bank treasury teams to hedge interest rate risk and diversify across the yield curve. Or you could just wing it!
Ultimately, the leadership at SIVB was comically stupid in managing the bank’s risk.
Founders and partners in Venture Capital firms were incentivized to hold all corporate deposits, personal deposits, and even encourage their subordinates (read acquired startups/companies they invest in) to do the same.
For this, SVB provided favorable lending terms not only in the form of mortgages and personal loans, but also risk-inappropriate lending terms reducing the cost of capital for the startups, venture capital, and private equity firms that consolidated their banking needs with them.
Since everything was so interconnected, a bank run was predictable if there was ever a hint of liquidity concerns. Unfortunately for SVB, startups and VC funds are lighting money on fire at an ever-increasing pace, and new deposits were not even close to keeping up with the cash burn.
Last week, large depositers wanted more money than SVB had readily available. Not ideal for a bank. As such, they were forced to liquidate a portion of their treasury portfolio. On the surface, this doesn’t seem awful; however, the liquidation resulted in a roughly $2 billion loss.
SVB’s balance sheet all of a sudden looked pretty shaky, and the company filed to issue stock to raise capital. That doesn’t work for banks.
Enter the bank run. Everyone tried to pull cash at the same time, and there was no cash because the assets were tied up in treasuries, mortgage backed securities, and deployed in the form of the sketchy loans to the folks who knew they shouldn’t be getting the terms they’re getting on their capital infusions.
All pretty bleak.
The good news is that the issues that plagued SVB are moderately concentrated in a handful of other specialty banks and a few regional banks. Also good news, the receivership process has already been modified to backstop deposits above the traditional FDIC limit of $250k. Stockholders and bond holders are going to get torched, but that is the cost of not executing due diligence (ie listening to Cramer).
What happens now?
Well, another bank (Signature Bank) has already fallen into receivership, which is just a fancy way of saying it failed. We are currently sitting on a list of other banks which are reasonably likely to suffer the same fate. Whether you agree with them or not, the Fed is supporting folks who make deposits and letting the investors suffer the consequences.
This is NOT a taxpayer bailout of the financial sector in the traditional sense. FDIC covered deposits are backed by the insurance system funded by member banks. The additional funding will come from two places. First, the FDIC will assess member banks above and beyond their normal contributions. Second, assuming SVB and Signature Bank are purchased, the acquiring institution(s) will liquidate remaining assets to support the capital needs of the depositers. If there is a need in the interim, prime lenders fill in the gaps. These are banks like JP Morgan and Bank of America.
In my opinion, the Fed acted decisively to stem further runs on the banking sector writ large. This also shows other banks that the Fed does not intend to stop raising rates anytime soon. Given the volume of swaps trading right now, I wouldn’t be surprised if most of the small banks at least reasonably hedged for the next round of interest rate hikes. That is assuming they have the capital to employ such hedges, which is a whole other can of worms.
The bottom line:
C-suite leadership went full send on their business model of catering to the rich and highly leveraged. The trickle down was exposure to high cash burn, unproven business models. After all, you can’t be a successful startup without having a new and often unproven idea. The mistake, aside from the obvious, was simply being lazy on protecting reserves and managing the most basic of banking risks – interest rate risk. That and of course paying no interest on your customers’ deposit balances. Whoops.
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