Warning Signs At SVB May Have Been Missed Because Of Trump Era Stress Test Relaxations

The collapse of the Silicon Valley bank has prompted many pundits to blame rising interest rates, fearful depositors, bank regulators and rating agencies. Rising rates are inanimate actors, and depositors, regulators and rating agencies don’t drive banks. SVB’s
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chief executive officer Greg BakerHis team, and the bank’s board of directors, are responsible for this colossal failure, which now leaves not only many depositors without their money but significant layoffs at companies that hold their money at SVB.

Significant asset size growth, reliance on largely homogeneous depositors, as well as concentrations in investments and liabilities had been indicating trouble in SVBs since at least 2019. Banks are opaque institutions. Anyone analyzing a bank needs countless hours to analyze not only financial disclosures, but also Basel III disclosures, which focus on risk. And by the time any of us look at their financials, that information is already out of date because the financials are usually published several weeks after the quarter ends. Nevertheless, looking at the data collected about SVBs, several signs would have told investors, lenders, and credit analysts that SVBs were in trouble.

asset growth and quality

The first step in analyzing a bank’s financial position involves looking at its assets. It requires us to look at data to measure asset growth, diversification, credit quality, and the sensitivity of assets to both small and especially large interest rate movements. From the end of 2019 to 2020, SVB’s assets, Artha loans, credit facilities, securities and other investments grew by 63%. And from the end of 2020 to 2021, total bank assets grew by over 83%. This significant increase in wealth happened in the years when there was death, disease and lockdown due to Covid-19. Loans alone grew by nearly 114% from 2019 to 2020, and then by nearly 30% from 2020 to 2021.

With an increase in wealth comes greater risk. Eyebrows should have also been raised when risk-weighted assets soared 13%, at which point asset size barely moved from late 2021 to 2022.

Significant growth in a bank should always prompt risk managers, credit analysts, investors and regulators to question whether corners are being cut in due diligence in lending or investment decision-making processes. Growth is always a good time to re-evaluate whether the bank has highly skilled professionals who can manage the increased risk that comes with having more assets. Significant high growth in assets is also a good time to examine whether a bank’s technology is up to the task of taking in significant amounts of data to value assets and measure their credit, market and liquidity risks.

From a credit perspective, SVB’s loans and bonds were of good credit quality; Their data showed a low probability of default. The problem with SVB’s assets, however, was not credit, but rather their sensitivity to market risk, particularly interest rate risk. Since the mid-2000s, market participants have been talking about the possibility that after more than a decade of low interest rates, the Federal Reserve would have to raise rates. That moment definitely came last year. And it’s not just the Federal Reserve that’s raising rates, so is practically every major central bank around the world. What other signals does a bank need to perform interest rate sensitivity analysis and stress testing on its bond holdings?,

Blaming the Fed for SVB’s problems is absurd. Anyone who does not take interest rate risk sensitivity analysis and stress testing seriously as a part of gap analysis does not belong to banking. These interest comfort exercises are necessary for risk managers to analyze day in and day out at which point a bank may have more assets or liabilities than assets or in the case of SVB, more liabilities than assets.

By the fall of 2022, SVB had losses of nearly $100 million due to a decline in valuation as well as the sale of $1 billion in available-for-sale (AFS) securities.

thank you for Baron’sAs most of us only learned yesterday, on February 27, SVB President and CEO Greg Baker sold 12,451 shares at an average price of $287.42 for $3.6 million. That day he acquired the same number of shares by exercising stock options priced at $105.18 each, much less than the selling price. It was the first time Baker had sold shares of his company in more than a year. He had the whole of 2022 to see up close and personal all of his company’s funding and liquidity problems.

money and liquidity

The next step would be to look at the funding risk profile of the bank. From 2020-2021, SVB deposits increased by 100%. Such a significant increase in deposits is understandable as individuals and companies received government-backed loans due to Covid-19. The increase in deposits also occurred because market volatility caused many investors to want to keep money in banks until they could figure out how to invest it. Such a rapid and large increase in deposits should always lead risk managers to test what would happen to a bank’s liquidity when depositors decided to leave as quickly as they came in.

Analyzing funding diversity can be challenging. However, this time the CEO of SVB and his team made it easy. He repeatedly told us that he is a banker to technology, start-up companies and venture capital firms. This immediately meant that the SVB depended heavily on a largely interconnected segment of the economy. Its high level of deposits from traditionally riskier companies meant that if anyone had liquidity problems there was always the risk that they could come through swiftly. Very To get back their deposit. Over the last year, data has been showing an increasing likelihood of defaults at tech companies, and unfortunately, they are laying off people. These two data points alone should have significantly increased SVB’s liquidity and capital, which it did not.

Was SVB running under stress to see how liquid we would be in a period of stress? We do not know. Thanks to all the politicians and bank lobbyists who fought hard to ease risk management requirements for banks under $250 billion in assets, the SVB was not required to disclose net cash during periods of stress. How much did it have high quality liquid assets to help cover the outflow. , Part of the Basel III definition of stress certainly includes a deposit escape test. These regulatory changes were signed into law by President Trump in 2018 as part of the Economic Growth, Regulatory Relief, and Consumer Protection Act, which eased requirements under the Dodd-Frank and Consumer Protection Act following the 2008 financial crisis. Had done it.

Certainly, March 8 of SVB Announcement that it had sold all securities available for sale, causing panic among depositors. No one likes to be the last person in the room to turn off the lights. On Thursday, depositors attempted to withdraw $42 billion in deposits. A large part of the panic was also because many depositors had more than $250,000 in their SVB accounts; These are not insured by the Federal Deposit Insurance Corporation (FDIC). according to SVB 10-Kashmir, “As of December 31, 2022 and December 31, 2021, the amount of estimated uninsured deposits in US offices that exceeded the FDIC insurance limit was $151.5 billion and $166.0 billion, respectively. As of December 31, 2022 and December 31, 2021, $13.9 billion and $16.1 billion of foreign deposits, respectively, were not subject to any US federal or state deposit insurance regime. The amounts disclosed above are derived using the same methods and assumptions used for regulatory reporting requirements.

Depositors running out the door, along with a falling stock price, were the loudest signals from the market that SVB’s illiquidity would soon turn into bankruptcy. Share trading was suspended yesterday after SVB shares plunged more than 150%.

I realize that sorting out the financial condition of banks is not everyone’s cup of tea. Nevertheless, given the bank’s financial condition and market signals such as share prices and credit default swaps, nothing may be an option; Together this information is the best hope for understanding a bank’s financial condition. As of Wednesday, Moody’s and S&P Global had the Silicon Valley bank as an investment grade issuer. This means that the SVB had a significantly lower probability of default and the severity of the loss. On Thursday, Moody’s and S&P Global changed their outlook on the bank from stable to negative.

On Friday the ratings agencies downgraded SVB, which is more politely known as a high-yield issuer, to junk.

All those politicians and bank lobbyists who have been successful in relaxing the liquidity stress requirements for banks with less than $250 billion in assets are surely very…