Global banking failures were last heard of in 2008 with the last being Washington Mutual Bank’s collapse during the financial crisis. The recent Silicon Valley Bank (SVB) crash has caused shivers in the financial system with banking stocks in connected markets tumbling significantly as investors fret. Many even think the Lehman Brothers is back to haunt the global financial system after news that SVB’s Executives sold shares just before the collapse, that the Bank did not have a Chief Risk Officer for 8 months and also that the Banks Chief Administrative Officer (CAO) was once Chief Finance Officer at Lehman Brothers during its collapse. These are just but a few revelations so far.
READ ALSO: Silicon Valley Bank top bosses sold $4.5 million worth of shares before the collapse
Runs on banks are very common when financial institutions are exposed to homogenous classes of depositors that exhibit cow boy tendencies of being bound by social contracts. Only this time this class was technology investors. This article leverages off various articles done on various blogs that we do reference to analyze how risk fell through the cracks leading to SVB collapse.
Silicon Valley is the world’s technology hotspot and home to most inventions the world uses. This space is located in California which is dubbed the global center for high technology and innovation in the geographical area of Santa Clara Valley. To support the innovation economy and ecosystem comprising individuals, investors and the world’s most innovation companies Silicon Valley Bank was incorporated as a financial partner. SVB is the largest bank by deposit size in Silicon Valley, a subsidiary of the SVB Financial Group and has been operational since 1983. SVB was declared defunct on 10 March 2023 after perceived balance sheet vulnerabilities triggered by deposit flight, so excruciating that the Federal Deposit Insurance Scheme had to step in. In an article by the Financial Times titled Silicon Valley Bank: the spectacular unravelling of the tech industry’s banker, SVB’s decision to realize $20 billion of securities to curb sharp drop in deposits fueled investors’ attention on the bank’s balance sheet vulnerabilities. The asset sale crystalized $1.8 billion worth of mark-to-market losses given a tight monetary environment posed by a series of rate hikes as the US Fed sought to reign in on inflation. Rising yields do erode valuations for fixed-income portfolios such as bonds. Given that SVB was listed, asset (stock) sell-off was inevitable as investors raced into hedge against losses. The company’s stock was dumped to shave $10 billion off its market capitalization to 16% of what its valuation was a year and half ago to just shy of $7 billion.
The striking feature is that executives knew that they were dealing with a risky class of depositors with very similar characteristics which sounded like a bank run waiting to happen. Concentration risk to depositor classes is one aspect of banking that requires attention as usually, the client classes are the genesis points for any type of risk from a behavioural perspective. Risk always starts with booking clients on the book and along the value chain or with time decay threats actualize and translate to financial loss in the advent of adversity. The share price tumble over the last 18 – 24 months signals early warning indicators that were either ignored or concealed but if any action was to be taken it should have been then. Between 2021 and 2022 the banks risk weighted assets rose to 13% when the asset size marginally moved.
READ ALSO: Warning Signs At SVB May Have Been Missed Because Of Trump Era Stress Test Relaxations
The global environment has seen a metamorphosis of risks as the threat landscape evolved with the advent of COVID-19 which rippled through the financial markets. This resulted in supply chain disruptions and massive uncertainty with shrivelling of interest rates to help absorb pandemic-induced credit risks.
We establish that because technology as an enabler was the only resilient stock in the pandemic era, investments in the sector did boom in private technology companies. This period saw SVB surge on deposits to $189 billion from $102 billion. However, with these deposits, SVB took duration risk in longer-dated bonds for $120 billion exposed to interest rate risk in more recent times when the US Fed hiked rates aggressively to curb inflation. In a change of strategy, SVB asset liability management switched to shorter-dated duration assets from the previous longer-dated ones as global ambiguity thickened. Earlier management sought to appease shareholders by earning higher profitability. It may appear that the change in strategy was a little too late.
The trading posture does reveal risk appetite concerns and the absence of a chief risk officer to challenge the trading strategy. SVB did not have a Chief Risk Officer for 8 months from April 2022 when the last executive stepped down. It’s as though the financier took some excessive strategic risk that blew up in their face.
“We had enough risk in the business model. You didn’t need risk in the asset – liability management profile,” said a former executive, referring to the bank’s ability to sell assets to meet its liquidity needs. “They missed that entirely.”
ECONOMICS ETHICS AND THE LAW – IS THE LEHMANS GHOST ALIVE
Drawing lessons from past failures on Wallstreet we focus our analysis on ethics, the law and economics. Greg Becker the Chief Executive Officer of SVB sold his $3.6 million worth of shares 11 days before the Bank collapsed. Other top executives such as Chief Finance Officer Daniel Beck and Chief Marketing Officer Michelle Draper collectively sold shares worth $4.5 million. While it can be argued that they followed regulatory procedure, the run on the bank just coincides with this action which continues to raise corporate governance concerns very similar to behaviour once seen during the financial crises of the past.
The lender had no official Head of Risk Assessment for 8 months while the UK-based CRO is accused of prioritizing other non-bank-related activities over her actual role. The absence of a Head of Risk Assessment arguably raises concerns around who would have been available to inform the Risk Committee of the risk posture of the organization. It has also been reported that SVBs Chief Administrative Officer Joseph Gentile was Lehman Brothers’ Chief Finance Officer at the time of its collapse raising concern about how an experienced executive would have allowed the governance gaps to crystallise risk.
READ ALSO: Who Is Joseph Gentile? Silicon Valley Bank Exec Scrutinized After Collapse
The economics of the business is to craft a strategy that grows shareholder value but this however must be within the confines of ethical activity and must pass the legal test.
Whether the bank passed the strategy goodness of fit test in a rising interest rate environment could arguably be a lesson for traders to exit longer-dated fixed-income positions in bearish interest rate seasons. It is vivid the SVB took duration risk in longer-dated assets in a period of uncertainty because the yields were higher in an ultra-thin interest rate era. In times of uncertainty risk skew is safer placed in shorter-dated higher yielding tenors to manage duration. However, what is unclear about the strategy is the intent around concentrating risk in longer-dated assets to appease shareholders but exposing the bank to excessive risk. Further is vague as to why SVB management did not exit the longer-dated bond positions earlier to hedge against bleeding equity reserves.
Food for thought is whether the actions of the SVB executives will pass all three tests – ethics, economics and legality – when scrutinized by the US regulatory authorities.
IS THE SVB COLLAPSE A US BANKING CRISIS
What is clear is that SVB services venture capital-funded silicon valley technology companies. In the 2019 and 2021 period, the low-interest rates governed by the US Fed led technology firms to benefit from huge capital injections translating into a surge in cash deposits from Silicon Valley companies. To offset the increased deposit liabilities, SVB purchased longer-dated US treasuries paying decent returns at a time interest rate were ultra-thin. This tripled asset their base from $70 billion to $220 billion, between the period of 2019 to 2021. However, with the US Fed, a rate hike streak as pandemic-induced inflation spiralled out of control asset valuation erosion impacted SVBs portfolio. One issue to bear in mind is that technology companies’ money is hot and interest rate sensitive.
While most US banks hold 60% of their deposits from small depositors (<$250,000) for SVB, that is less than 2%. When rates climb, technology clients are more prone to trigger deposit flights for safety purposes in safer haven assets and in this case for the US, they would be eyeing 2-year paper priced at 4.6%. Capital raising has become difficult in a monetary tightening environment and as such technology firms are cash-strapped.
The odds of a US banking crisis a very thin however we are of the view that this meltdown is more of a ‘credit risk’ threat to the technology sector and to be specific, the venture capital funds operating in the US. Other risks pertinent are to smaller banks in the US. This exposure, however, is to the extent that the US Fed, does not protect the investors which is highly likely. The contagion is likely going to be limited to a few regional banks and not the globe.
READ ALSO: SA banks bleed after US lender slumps 60%
Reacting to the news on Friday, March 09, Deutsche Bank led the loss race with its shares plummeting almost 10% in Frankfurt while on the Johannesburg Stock Exchange, Standard Bank and Absa were 3% lower. Capitec sagged 2.5% while FirstRand and Nedbank were 1.5% weaker. In London, Barclays, Lloyds and NatWest traded close to 5.2% lower before they clawed back earlier losses. Other markets such as France, Hong Kong and Japan panicked as much but by close of business last week were calmer as markets priced clarity around the extent of the contagion.
READ ALSO: Yellen seeking solution for Silicon Valley Bank as industry frets about fallout
US Treasury Secretary Janet Yellen said she was working with regulators to respond to the SVB collapse and has ruled out bailout, as fears of a broader fallout across the banking sector deepened.
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