Silicon Valley Bank Failure [pdf](am.jpmorgan.com) |
Silicon Valley Bank Failure [pdf](am.jpmorgan.com) |
We acknowledge most banks don’t want to touch startups and that startups will have a harder time banking in the future. Yet I don’t see much consideration for the fact that there is a good reason most banks see startups as risky. It’s just explained away as “they don’t understand .”
Also consider the past 10 years have probably been the friendliest 10 years to startups ever.
This isn’t even the fault of startups. It’s a complete risk management mistake on the side of the bank. Buying 10 year low yield securities and not hedging them against rising rates.
Plenty of banks would love to have the deposits of startups and VCs.
I bet a bank like Mercury or some other ones will grow to take SVB’s place.
Banks take deposits but also loan with a 10x or even more ratio. Not difficult to imagine a SV bank would have lended a lot of cash, with marginal interests that aren't covering the actual risk.
Only speculation on my part there but needs to see further unwinding to bring some clarity or where the hole mostly comes from.
Until then, the narrative sounds far better than pointing out a widespread bad credit issue that other banks are also going to face in the coming months.
Edit: typos
And those startups should have diversified their millions of VC cash to reduce their exposure and over-centralization on a single bank. In fact, they should not have been over-relying on VC cash in the first place. Now they will be getting $250k out of the millions of VC cash they chose to place in SVB.
The FDIC system working as intended once a bank goes under. No bailouts and no exceptions.
> I bet a bank like Mercury or some other ones will grow to take SVB’s place.
Mercury is not a bank. [0] It just works with other FDIC banks like Evolve Bank & Trust and CFG (Choice Financial Group).
I’m really glad ZeroTier used a boring old mainstream bank that didn’t specialize in any one sector. We looked at SVB. Bullet dodged.
It is now time for Bilious[0] to appear.
Yes, reality eventually back fires. It's not like the fed figured they should turn around because "inflation". It may simply be that they can't keep printing since it has become much harder to dump it anymore on (global) producers. See the geopolitics, Finance101 isn't enough to grasp the magnitude and seriousness of what's been going on lately.
Honest question: compared to what?
Did long duration assets (like bonds) comprise a greater proportion of SVB's assets compared to, say, JP Morgan?
Or is the case that JP Morgan is as insolvent as SVB, but JPM's depositors are less likely to withdraw their funds (because it's a big bank and it has primarily retail customers)?
These are honest questions; I'm not suggesting JPM is in the same situation. However, I'd like to see some numbers.
So, the big question for investors and depositors is this: how much duration risk
did each bank take in its investment portfolio during the deposit surge, and how
much was invested at the lows in Treasury and Agency yields? As a proxy for these
questions now that rates have risen, we can examine the impact on capital ratios
from an assumed immediate realization of unrealized securities losses (see next page
for a full explanation of our methodology). That’s what is shown in the first chart:
again, SIVB was in investment duration world of its own as of the end of 2022, which
is remarkable given its funding profile shown earlier.
Another key comment by Cembalest
As shown below, being flooded with deposits from fast-money VC firms and other
corporate accounts at a time of historically low interest rates might have been
more of a curse than a blessing.
Yes. JPMorgan is subject to the Fed’s stress tests and Basel III, both of which test duration. (SVB successfully lobbied to be exempt from both.)
It wasn’t because of “Startups”.
What they're saying is: "JPM is just as insolvent as SIVB. The only difference is that JPM's customers are less likely to withdraw their funds."
Everyone who have ever managed bond portfolio knows that he must hedge interest rate risk. And every bank is doing that. SVB didn't.
Since April 2022 till January 2023 SVB had vacant position of Credit Risk Officer.. And the explanation is simple - SVB's former head of risk, Laura Izurieta had left after 1Q2022 when looses from bond portfolio started to grow. She has probably already realized the final outcome as this is ABC of risk management (and in April 2022 the path of rate increases had been already set in motion by FED).
Now look at the timing of insiders selling shares of SVB...
I really don’t understand why these firms didn’t use at least two banks for their deposits. Surely these tech firms have heard of single points of failure being problematic?
I think it was entirely reasonable for Series B and earlier startups to keep all their money in SVB. It was wrong, in hindsight, but reasonable. Bank failure is not the thing that's going to kill most startups. SVB just failed spectacularly, and it sure seems like it's not going to put anyone out of business.
Really? How would this be enforceable or even discoverable?
JPM says neither of these were the case:
> “At the end of 2022, SIVB only offered 0.60% more on deposits than its peers as compensation for the risks illustrated below; in 2021 this premium was 0.04%.”
> “The irony of SIVB is that most banks have historically failed due to credit risk issues. This is the first major one I recall where the primary issue was a duration mismatch between high quality assets and deposit liabilities.”
Unsurprising how the bank failed due to the VC driven mania and now that the pyramid scheme collapsed right in front of everyone; taking the majority of startups in the tech industry with it.
Now we will see how unprofitable these startups really are and have been fully dependent of constant VC cash. A very big lesson to learn about risk.
The VCs aren't happy because they and the startup both expected that the money-equity exchange meant that the startup would have working capital, so potentially the value of the equity that they got has fallen. This is a problem for both parties.
No cash? Then sell your assets. Creditors/depositors ain't gonna wait. Realised loss? That's your balance going down in true accounting terms now. Accountings get disclosed? Those quarterly release are mandatory for all publicly trading company: that could cause worry among investors, and in the case of a bank a panic a bank run.
What a market valuation made at each quarter could achieve is give a momentarily evaluation of what a fund's assets is made of if they were to liquidate right then, or that day. But it isn't how it works*
It does work for goods though, amortization is accounted for and a well oiled exercise. Futures, bonds, stocks? Good luck with that. If we could predict the future the game would be a whole lot different.
I'm guessing the answer is: something something make more profit...
E.g. my businesses are required to carry liability insurance. I have to do that because we have big company customers who made it a condition of doing business with them. So why do big companies hand $nB over to another company for safe keeping but not require insurance?
What good is private insurance from an insurance company if they go insolvent because of massive numbers of bank failures
So, now the answer to your question is a political one: are we willing as a society and government to potentially put that much taxpayer money at risk. I think it's a perfectly valid discussion to have, but it's one we haven't had yet, and one we refuse to have until the shit has hit the fan
Otherwise, it’s weakness will soon be recognized by some billionaires, Thiel in this case, and they will take advantage of this weakness to become even richer.
It just adds that SVB's situation was exacerbated by the fact that the health and size of the deposit base they had cultivated was also inversely correlated with interest rates (ie VC and startup activity declines with rising rates), which made their situation even more precarious than at other banks.
Just a thought: the UK gilt crisis in December was related to pension funds holding long term gilts. And these pension funds all properly hedge the interest rate risk, they normally don't care how rates evolve.
However, the market value of the gilts was changing too fast for the hedging to work. My understanding is that money couldn't be moved around fast enough to meet margin calls. Which then caused a bad feedback loop of forced liquidations of gilts, and the Bank of England had to step in to handle the crisis.
So with this new story of duration risk at SVB, I'm wondering now whether other banks are in danger. They may have hedged their duration risk, but what if the hedging mechanism turns out to be broken?
No, you got it wrong.. UK pension funds didn't have much gilts. UK pension funds had swaps on gilts and mostly assets equal to long term gilts (AAA rated). Like for example ownership of a parking lots in Germany, apartments in Norway - safe, steady cash flows. This is what chasing yields at zero interest rates does.
Penions funds needed a window of few days to make a fire sale of these assets to meet their margin calls. It takes about two weeks from some junior analyst from BlackRock visiting said parking lot in Germany, checking books to BlackRock depositing money at UK Pension fund bank account. So Bank of England opened unlimited discount window for UK Pension funds for about two weeks. And then it closed.
This is what happend.
zirp has caused some pretty astounding fuckups and i'm sure there are many more to come.
https://www.reuters.com/markets/europe/why-are-britains-pens...
How are other banks hedging interest rate risk?
And how is the opposite end of this hedge hedging their position?
Plenty of financial functions create natural short interest rate exposure. Like SVB, they have no business speculating on rates, so they hedge it away. (The Fed is also involved in the repo market.)
That being said, I don't think it's possible for all banks to hedge interest rate risk. The risk, to the system as a whole, doesn't go away just because it's transferred to someone else.
It should be noted that JPMorgan participated in the bailout in 2008, with the resulting headaches that that entailed, and Dimon has explicitly stated that he wouldn't participate in a current bailout. So JPMorgan may not be entirely objective. However, to my eyes, this appears rather clear.
Depositors can and should assume that regulations prevent banks from assuming outsize risk like this.
This is a policy failure of the regulators that oversee banks. Banks should not be allowed to have so little cash on hand, especially when we knew with high likelihood the fed would raise rates.
Small depositors, yes. Institutional depositors, no.
Not all banks are equal. SVB was borderline investment grade before it collapsed. Treasury advice strikes me as low-hanging fruit VCs could have guided their companies on. Instead, most universally recommended SVB because the priority was reducing friction, not risk.
But given https://techcrunch.com/2021/02/19/brex-applies-for-bank-char... and the fact that https://www.brex.com/svb-emergency-line emerged literally overnight... it's unclear to me whether these strategies are truly robust, or whether much of this is hype driven by Thiel and other Brex etc. investors - who are, at the very least, incentivized to capitalize on this situation.
We use their Treasury account type for most of our cash. It's split between Morgan Stanley and Vanguard funds.
Now, if Mercury fails it's going to be a pain in the ass to get at the money in these backer accounts. So we keep what we need for 2 months of operations with another bank. We were using SVB for this, now we have to find a new emergency backup bank.
Brex and Ramp are similar to Mercury.
"Mercury checking and savings deposits are FDIC-insured up to $1M. As a broader effort, we are working on expanding all coverage up to $4M."
A lot of people want to blame depositor panic, but I don’t think that is really fair. In a properly managed bank, the assets exceed the liabilities, which means that if people want their money out, the bank can liquidate their assets to pay them and still have money left over. SVB’s assets are worth far less than their liabilities (to the tune of nearly $100B dollars by some estimates). Panicking depositors didn’t cause that.
That that can cause or accelerate collapse makes me question the entire bank model.
What other model leads to instant death, damage to their entire customer base, and collateral damage to the broader system, when a certain number of customers decide to go elsewhere?
Customers also want to earn easy, high interest, that's the main issue. You're taking a risk (albeit a small one) with your deposits; your money is being lent by the bank and they pay you interest in return.
If you only want your cash to be held safely, put it in a safety deposit box.
The proximate cause is short-term funding from risky depositors, i.e. start-ups. The ultimate cause was insolvency. (Yes, not illiquidity, simple illiquidity is solved by the Fed’s discount window.)
>For systemically important banks, no adjustment for AFS is needed because all AFS unrealized gains and losses are already reflected in their reported capital ratios. As a result, only gains and losses in the HTM portfolio need to be included in our adjustment. For these four banks ...
So, regulations turn a blind eye to HTM losses for any bank under $1T in assets:
https://banks.data.fdic.gov/bankfind-suite/financialreportin...
Ow the irony
It's kind of like the terms of service on a home mortgage loan.
* It's easily and quickly available
* The number only goes smaller when the account owner authorizes it for stuff the account owner wants to spend money on
* The account owner does not have to think about any of the actual logistics of making the above
Naturally, these are in tension - it costs money to make all of this happen. And since people want the number in the account to not go down (through fees or whatever), then 'naturally' the bank needs to make $$$ somehow.
The flip side of your original question about "business model" validity is that the business model is heavily subsidized by the state and overall society because this particular business model generates a lot of liquidity, which is generally believed to be net beneficial for governments, societies and countries.
In effect, this entire business model and all the regulation and laws and structures put in place are attempting to systemically will into being a high-trust environment. The possible downsides of this system more or less scale with the size of the gap between the actual underlying society, and the degree of trust implied by the system.
> What other model leads to instant death, damage to their entire customer base, and collateral damage to the broader system, when a certain number of customers decide to go elsewhere?
None of these things happened because some customers decided to go elsewhere. They were going to happen anyway. SVB was in really terrible shape and was already in the process of collapsing.
In this case, depositors lost access to their money in the middle of Friday morning and will have access to their insurances deposits Monday morning.
So a very brief outage in the typical case. And about five or so extra hours in the SVB case. An FDIC takeover is efficient and well oiled.
I guess the gist of the point I was trying to make still stands though. SVB was not the first fallout from rising yields on long duration assets. There is probably more improper hedging of duration risk out there.
Of course it does..
It has evolved, a lot over the years. And with it, the prevalent valuation of companies has changed, likewise by a LOT (generally going up, by a lot).
So you'll have to be more precise? There are many valuation philosophies, from Nprofit, to value of the physical assets of a company, Nrevenue, Discounted cash flow analysis, Growth stock ... which "reality", exactly, do you mean?
Some people even see the "in the end, we're all dead", as the "reality" at the end of the stock market. Eventually, they're probably right.
By reality here I meant that SVB caught itself having to liquidate positions to get, what I suppose is, enough liquidity to operate. Realised a significant loss, and the cashflow got aggravated when investors and depositors reacted to that information.
Reality that some (chief?) executive, based on perhaps unrelared reasons, sold a big bag of shares, and that information spread and caused further market pressure, followed later on by more run on the bank.
Reality that entering 2023 the fed continued to raise the interest rate and the tech sector saw further negative prospects, at least from the point of view of investors, aggravating SVB's situation. In particular when Moody was about to downgrade the bank rating.
I don't have a crystal ball, neither did SVB, and its CFO surely is many folds better at strategic/tactical financing than I, but this series of events is although summarised the way it unfolded for them and I refer to reality calling back because, it doesn't matter how the books looked like or what philosophy was used in 2021, in September last year, or at the latest financial disclosure. Wires couldn't be honored and.. reality call happens. Not my reality. The reality, which i would call accountinglessly obvious.
About "the end" I don't see it that way at all. We certainly aren't dead. Death though already owns most of life and keeps growing relatively to the living. It doesn't imply we will necessarily all end up dead.
Lastly, back to the market and the demise of some major bank, or all of them if needs be, it matters very little to life. Not all that serious if you want my take on it.
Let's see what Monday morning got to say, reality is what it is.
I guess I made you give some examples, which is already a big improvement.
* Those with cash in SVB, or another regional bank, and want to find a 'safer' bank.
* The relatively uniformed that are nervous about banking.
"This document is an analysis by person X, based on his opinion. That opinion may change at any time."
That's a lovely, if corporatey way of paraphrasing the well-known quip "When facts change, I change my mind. What do you do?"
There's no doubt the document was prepared in a huge rush. Like any large bank, JPM would have had to get it out well before end of business on Friday. Wouldn't be surprised if they had to get it out before lunch! But that rush also means there would have had been far less time to polish it up, and indeed, the author points out that at least some of the industry figures were lifted as-is from an earlier report they had produced.
I was answering why startups need a bank, and it isn't just for loans. The most basic needs for an account is so that you can 1) store the money you get from VCs, 2) pay your employees, 3) receive payments from customers.
Do you see why a company needs a bank account?
Without a bank you need to operate in cash and have a room somewhere full of physical cash with guards, ect.
I do not think I said a company does not need a bank? My comment was in response to the statements trying to imply SVB, was the only option for Startups or that other banks would not accept Startups as clients.
Then again, you have people like Mark Cuban who clearly don’t know about basic cash management (https://twitter.com/mcuban/status/1634413306948603905), so maybe American lack of financial literacy has truly trickled all the way up.
if one or more of those tiny regional banks fail in the same way SVB did I don’t see why there wouldn’t be an issue as a customer of Mercury
it’s also unknown what percentage of these banks’ total deposits are Mercury deposits now. if it’s a lot then you have the same risk of a bank run on the Mercury side disproportionately impacting the solvency of the underlying bank
Regarding the first, I am not expert. Many commenters in the various threads have highlighted problems they have had at other banks, such as banks rejecting VC wires or stupid profitability requirements for lines of credit. It mostly sounds like banking SOPs which are incompatible with startups.
It sounds stupid but I have run into similar problems working at large companies trying to partner or buy startups. We want some IP from some small startup and begin financial disclosures. Some idiot in finance runs the numbers and sees the startup is losing $X per year and puts up a red flag on the deal. Like, no shit it is unprofitable, it is a startup and we want their IP.
Edit: I just saw this relevant thread:https://twitter.com/mattyglesias/status/1634735012955279360
Seems like SVB wasn't willing to pay the premium, though.
My amateur understanding is that this counterparty would need to be short long bonds, ie. be a bond issuer. And they would need to be interested in exchanging their fixed interest rate for a variable one.
If the above is correctly understood I don't see how banks can find issuers of trillions of dollars worth of bonds that want a variable interest rate in a rising interest rate environment.
If I’m taking the variable end of a swap and expecting interest rate hikes, I can use the spread I’m gaining to offset the damage to a portfolio I already have of shorter duration (thus: less interest rate sensitive) bonds.
Overall, the USG issuing trillions of dollars of low interest bonds and then raising rates is going to cause losses for bond holders throughout the system, but as long as those bonds are held, in aggregate, in portfolios and entities which won’t face liquidity crises until they mature, the loss can be borne.
There may also be more sophisticated ways of offsetting bond exposure, but I’m not familiar. I’m appealing more to the idea that this impact by the Fed is easy to predict, indeed exactly the point. Bond valuations drying up will reduce the multiplier and take money out of circulation. The system is supposed to remain capitalized (and/or hedged) to survive the stress and the Fed would be watching. Apparently some parts of the system weren’t. And there are calls for the Fed to slow down. And probably more evidence that banking regs need to remain strong.
For example, pension funds often benefit from rising rates because they plan on paying out future liabilities with current assets and landlords are negatively exposed to rising rates because they own a stream of income in the future. The trade of interest rate exposure between these parties helps both achieve more stability.
A real world example would be taxi drivers trading weather risk with ice cream vans. One party benefits from wet weather that stops people walking outside and the other benefits, so they can trade exposure in a way that makes the system more stable.
The difference between the 10 year and 3 month bonds - https://ycharts.com/indicators/10_year_3_month_treasury_spre...
You'll note that you can get more money buy buying a 3 month bond rather than a 10 year bond.
So, now if you want to sell a 10 year $100 bond, you'll need to sell it for less than what a 3 month $100 bond costs to buy... which is $100.
https://ycharts.com/indicators/3_month_t_bill (look at 3 year chart range) and https://ycharts.com/indicators/10_year_treasury_rate (again, look at 3 year range).
The 10 year $100 bond is still going to pay out at a profit... in 10 years. But there's more valuable things that one can do with $100 in the shorter term so any sales of that before it pays out will be done at a loss.
For example, a 10-year bond that pays $2 per year costs $100 today. That is, a piece of paper that pays $2 to the holder every year for 10 years, after which the holder gets its $100 back.
Now, some time passes and the market thinks the above bond is too expensive. Instead, the market will only pay $50 for the above bond, ie. $50 to get $2 per year.
This means that the price of another bond: the bond that pays $4 per year will now cost $100. This is the case because holding two bonds that cost $50 each and pay $2 per year is exactly equivalent to holding a single bond that pays $4 per year and costs $100.
If the market price of a 10-year bond that pays $4 per year costs $100 then we say that the current rate of interest for the 10-year bond is 4%. If this rate of interest falls to 2%, it simply means that the market is now willing to pay $200 per year for a bond that pays $4 per year — or, equivalently, $100 for a bond that pays $2 per year.
Probably better to say "face value". The initial price paid for the bond may well not be its face value.
and the problem is you know nothing about the financial health of the small banks that are white label providers so how can you say you’re confident in the management of these individual banks that Mercury is contracting with? you don’t know anything about them.
so, if mercury has a 1M FDIC guaranteed, then you can move 1M per day through their systems with 100% guarantee, but the risk that a bank fails on one particular day is very small, so maybe you can move 10M a day through them, with effectively no risk.
10M a day is 3.5B a year. very few companies are doing transactions on that level, so mercury scales up very well.