What seems to be glossed over in this account and many others is SVB’s motivation for wanting to pull forward losses on a large portfolio of Treasury and agency mortgage-backed securities (MBS). Yes, SVB bought some longer-term bonds, and those bonds were held at an unrealized loss, but why recognize the losses all at once?
The bank was apparently bleeding deposits, but there was no indication that the situation was unmanageable.
What seems to be missed in the reporting is that if SVB sold lower coupon Treasury bonds and bought higher coupon Treasury bonds, its returns would have been the same.
Take a hypothetical example of a 10-year Treasury bond with a 1% coupon rate purchased at par ($100) when 10-year rates were 1%. Let’s say Silicon Valley Bank purchased this bond one year ago. Assume further that today yields on newly issued nine and 10 year bonds have increased to 4% from 1% a year ago. The price of this hypothetical 1% coupon bond bought a year ago would be approximately $78. Why? Because the yield to maturity on the bond has to rise to 4% so investors will be willing to purchase it. If held until maturity in nine years, the bond would mature at par value of $100, and any investor purchasing it today would earn 4%. If Silicon Valley Bank holds the bond to maturity, its return from today would also be 4%.
So why would SVB sell one Treasury security with a 4% return if held until maturity to buy an almost identical Treasury security with the same return?
The difference between the hypothetical 1% coupon bond and a newly issued Treasury bond which would have a 4% coupon today, is not the return but the way in which the returns are generated. The lower priced bond earns its 4% return with small coupon payments and a large increase in price. The returns on the higher coupon Treasury bond issued today would come exclusively from interest income.
In terms of accounting, holding the lower coupon bonds until maturity would generate the same return, but those returns would not flow through SVB’s traditional income statement. Equity would rise as the bonds approach maturity, but interest income would not.
In other words, if SVB held the lower coupon bonds to maturity, it would have meant lower stated earnings per share, lower returns on equity, and probably lower share price appreciation than if it was able to pull off the swap.
Guess what the three primary factors are for determining executive bonuses at Silicon Valley Bank?
Maybe there were other motivations or factors at play that we don’t yet know about, but a more thorough explanation of why management decided to take a massive and seemingly unnecessary loss on a high quality bond portfolio that ultimately led to its downfall is warranted.
The Wall Street Journal’s AnaMaria Andriotis, Corrie Driebusch, and Miriam Gottfried report:
Silicon Valley Bank executives went to Goldman Sachs Group Inc. GS 0.20%increase; green up pointing triangle in late February looking for advice: They needed to raise money but weren’t exactly sure how to do it.
Soaring interest rates had taken a heavy toll on the bank. Deposits and the value of the bank’s bond portfolio had fallen sharply. Moody’s Investors Service was preparing for a downgrade. The bank had to reset its finances to avoid a funding squeeze that would badly dent profits.
The conversations—held over the course of about 10 days—culminated in a March 8 announcement of a nearly $2 billion loss and a planned stock sale that badly spooked investors. SVB Financial Group SIVB 0.00%increase; green up pointing triangle shares tanked the next morning. Startup and venture-capital customers with big uninsured balances panicked, attempting to pull $42 billion out of the bank in a single day.
While few could have predicted the market’s violent reaction to the SVB disclosures, Goldman’s plan for the bank had a fatal flaw. It underestimated the danger that a deluge of bad news could spark a crisis of confidence, a development that can quickly fell a bank.
Goldman is the go-to adviser to the rich and the powerful. It arranges mergers, helps companies raise money and devises creative solutions to sticky situations of the financial variety—a talent that has made the firm billions.
Yet, for SVB, Goldman’s gold-plated advice came at the steepest possible cost. SVB collapsed at warp speed in the second-largest bank failure in U.S. history, setting off a trans-Atlantic banking crisis that regulators are working furiously to contain.
This account of SVB’s last days is based on interviews with bankers, lawyers and investors who almost participated in the doomed deal.
SVB’s problem was mechanical: Banks make profits by earning more from putting money to work than they pay depositors to keep it with them. But SVB was paying up to stop depositors from leaving, and it was stuck earning a pittance on low-risk bonds bought in low-rate times.
Selling a slug of those bonds would ease the pressure: SVB would have extra cash on hand, and it could use at least some of that cash to buy new bonds that paid more. Yet the transaction came with a big asterisk: SVB would have to realize a big loss.
SVB executives came to Goldman with the rough outlines of a plan to raise capital. Two private-equity firms, General Atlantic and Warburg Pincus LLC, were on the bank’s list of possible investors.
Read more here.
