SV BANK - V.2

15 March 2023

SIilicon Valley Bank bought long-dated US treasuries with its customers deposits. This is recommended practise, it should a safe,no-risk investment, no one would expect the US government to default. It bought when interest rates were at historic lows. But the Fed has increased interest rates since then, in order to combat inflation, and the price of these bonds has fallen, taking SVB with it.

1. The trouble is the banks' customers were tech startups with big loans and small revenues.

Then rising loan int charges and many of these still-low-revenue startups had trouble repaying their loans.

So some had to draw cash out of their current account.

The bank didn't have enough current assets to reimburse and so it had to sell some of its bonds ... very safe but long-term government bonds 

But because interest rates have been rising, these Bonds were worth less than par value ie the balance sheet was potentially having liabilities exceed assets.

Once other customers got a whiff of trouble at the bank, that their deposits may not be safe, they wanted to withdraw their money as well.

If so many customers turn up at the bank asking for their money and the bank can't give it to them because it doesn't have it, well then this is called a bank run !!!

I do not understand why SVB hadn't hedged against this risk of default with a Credit Default Swap. 

Normally, when you own a bond, issued by govt or corporate, you can expect to receive regular interest payments - the "coupon" - but there is always the risk the borrower can't make repayments ie defaults. 

A corporate treasurer or anyone owning bonds should insure against this risk - "hedge" against the risk of default - by swapping the risk of default on the expected fixed income stream with another investor, who agrees to reimburse them if the borrower defaults.

These CDS, Credit Default Swaps, contracts would commonly be maintained by regular payments of a premium - much like the regular premiums due on an insurance policy. 

Why wasn't SVB worried about the borrowers who issued the bond (the loan) defaulting? Why didn't SVB buy CDS to offset or swap that risk? They borrowed short, in effect, from their depositors; and invested long in government treasuries; but didn't take out a hedge against a fall in the value of their assets, presumably because they are expected to hold the asset to maturity and thus the par value would be returned.

What they didn't expect was to have to sell these treasuries before maturity in a market where are rising interest rates had reduced the value you of the asset and thus they were forced to crystallise a loss on their balance sheet.

Now, liabilities exceeded assets and SVB became insolvent. There would be a run on the bank because depositors couldn't get their money out and the fed had to take over to reassure markets even though this was only a medium-sized bank.

2. To avoid a bank run and the contagion to other banks, the US Fed (the BFTP) decided to guarantee the value of those government bonds *at Par*, even if the bank had to sell them at below par they would still get full par value from this govt top-up (bailout) 

And this stemmed the tide of customers and prevented a bank run ... in any case, the bank has shut its doors, taken over by the Fed ... it's the shareholders and unsecured Bond holders who will pay pay this time and not the taxpayer like in 2008.

3. Of course, the worry now is there are many companies with government and corporate bonds on their balance sheets 

And because of this problem that risk is being repriced, we can see it in the share price 

For example legal and general LGEN.L is down to 230 GBp. Where its value before was around 260 maybe even 300.

Many big companies have seen their share price fall by five percent today and more.

4. My question is : will the Fed step in to protect the value of corporate bonds as well as government bonds? and will the Bank of England follow suit ?

In which case legal and general for example is an absolute bargain at the moment at 230 GBp.

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SILICON VALLEY BANK - ANOTHER LEHMAN MOMENT? OR BUY THIS DIP?

14 March 2023

No. Not another Lehman moment. The system is safe though you wouldn't think so from the world reaction to the collapse of a relatively small bank. The Fed had to step in to save a run on the bank. Here's the story.

It seems that the bank was lending money to the Startup VC tech industry (... and also to the California wine industry curiously, the vineyards) 

and one of the conditions for a start-up fledgling company being granted a loan was that it must also choose SVB for its bank account 

So in other words SVB had a whole load of tech industry commercial account customers and almost no retail customer

 in fact 90% of the money flushing through the bank came from commercial tech, it seems, which is most unusual and highly unbalanced. That is a risk that regulators should have spotted especially as the CEO of the bank also sits on the regional Fed board (hmmmmm...).

The money its customers placed with it, SVB very wisely invested in American government bonds. Nothing safer, you would think -  these were long dated American government bonds meaning you are totally guaranteed to get back full par value at the end....if you hold it to the end, to maturity.

But like the LDI affair in the UK, interest rates started to go up up up some months ago, as we know, and this made it more and more difficult for some of its highly-indebted customers to repay their loan from their low startup revenues.

Some well-known celebrity (I forget his name) announced a few days ago that SVB was getting into difficulty - some customers were wanting to withdraw from their cash account to make loan repayments.

And so of course as soon as the word got around from that Bay area dinner table, many of the bank's customers started to get anxious and wanted to withdraw their money.

The money you remember had been put into safe long dated government bonds ... which now SVB had to sell, at whatever prices it could get.

It would have been ok if only the customers could have waited till the bonds could be sold at face (par) value ... the bank could have matched liabilities to assets according to the redemption dates of the bonds.

But they couldn't, the customers wanted their money now. So the bank was forced to sell off some of these bonds before maturity. But as we know, interest rates had risen since the bank had bought the bond, so the value of the bonds had fallen below par. The bank had to sell them off cheap, take a hit to its balance sheet. The bank had to mark the bonds to market prices ("mark to market" means you reconcile the value of your assets to market prices every three months, but this does not apply to long-dated bonds ... unless you sell them of course) and this is where the the assets were no longer able to cover the liabilities and why the Fed and FDIC had to step in, saving depositors but unlike 2008 this time the shareholders and unsecured Bond holders will pay and not the tax payers as in 2008. TO SAVE A RUN ON THE BANK.

Sad story. It is only a medium-sized bank with 210 billion dollars of assets, ie no risk to the banking system, and yet look at the, albeit temporary, damage to a fragile nervous world financial system from the uncertainty caused by this bank's collapse!

EPILOGUE 15 MARCH

1. BFTP will accept government bonds and similar at par value (most unusual) as collateral against insurance in the case of a bank needing to restructure, making bankruns a near impossibility.

2. They say the Fed will carry on raising rates until something breaks and it looks like something has just broken. So instead of 50 basis points at the next meeting it's more likely to be 25.

3. But the fight against inflation is ever more important - it is runni g at 10% now and that is on conventional measures - and this means the pause in Fed rate hikes can only be temporary.

4. HSBC UK has bought the bank for £1 which is a good deal for the UK albeit the HSBC share price fell 9% on the news.

5. Since the new BFTP guarantee referred to above does not cover uninsured loans, this is likely to reprice risk, raising the cost of capital for banks and thus lowering their margins and their share prices.

6. Yes this is a good moment to buy the dips and in particular tactical trades on regional US banks, or there is an ETF, $KRE, that specialises in regional US banks. It has fallen considerably and it's a good moment to buy and resell once price has reverted to the mean, given that there is now very little risk in future of similar bank runs.

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