The most popular example of Innocence The thing about Silicon Valley Bank is that it foolishly amassed a $124bn bond portfolio and then – more maddeningly – didn’t hedge against swelling interest rate exposure.
But is it right? FT Alphaville dug into the balance sheets of SVB and Credit Suisse for one Very sad Geeky compare-and-contrast. tl;dr maybe not as stupid as many people assume, but pretty dumb. Be warned, the following is acronym-heavy.
The first thing to remember is that SVB’s bond portfolio was basically in two different accounting buckets. At the end of 2022 it held $91.3bn in “held-to-maturity” portfolios – bonds that you plan to hold until maturity – and $26.1bn in “available-for-sale” portfolios, which are Marked to market.
Here is a snapshot of SVB’s end of 2022 Financial accounts.
Let’s take the chunkier HTM portfolio first. Securities in the HTM basket can be carried at their nominal par value, as the assumption is that they are held until they are paid in full.
As the table below shows, most of SVB’s $91.3bn HTM portfolio consists of very long-term, agency-guaranteed, mortgage-backed securities maturing in 10 years or more ($56.6bn to be exact).
The creditworthiness of this material is extremely high, but it is also very sensitive to interest rates (for bond nerds, the average duration of the HTM portfolio was 6.2 years).
Due to rising rates real The market value of the HTM portfolio at the end of 2022 was about $76bn, according to someone who has looked at the portfolio details and shared it with FTAV – an unrealized loss of $15.1bn.
Yes, SVB has no hedge on this beat. But to do so would arguably be absurd. Remember, the entire HTM portfolio is held equally, but the value of the hedge will obviously fluctuate with the market.
So the bank makes money on the hedge if rates rise, but the bond stays the same. If rates fall they lose money on the hedge, but they can shift the bonds from HTM to AfS and sell them at a higher price. That means it basically becomes a directional bet on interest rates that flows directly to the income statement, something most banks hate.
For example, Credit Suisse’s HTM portfolio of Treasuries maturing 1-5 years stood at a bare minimum of $992mn at the end of 2022. The market value was around $949mn, but there still doesn’t seem to be a hedge here. Unrealized loss.
Some large commercial banks collect FTAV frequently to do Do some hedging of interest rate risk anyway, just in case. But generally they try to hold mostly short term bonds to reduce interest rate sensitivity.
That’s something SVB definitely didn’t do — from 2018 they actually added a a lot Period by piling into 30-year MBS. But in practice, not hedging the interest rate risk on HTM was probably not Silicon Valley Bank’s biggest mistake.
However, let’s turn to the AfS side. Unfortunately, there are dragons here.
This is what SVB’s AfS portfolio looked like at the end of 2022. As you can see, it was mostly Treasuries. Remember, this is carried at a fair price, i.e. marked to market.
It is very big. For comparison, Credit Suisse had “trading assets” with a market value of $70.5bn at the end of 2022 – it constantly buys and sells all kinds of securities on behalf of clients – but had a real AfS portfolio (mostly of corporate debt). $860mn.
The AfS bucket is precisely where most self-respecting banks live around a large portfolio of bonds to hedge their interest rate risk. Otherwise, the income statement will bounce around depending on what the market does from one quarter to the next.
SVB seems to be aware of the risk. Here’s what CFO Daniel Beck told analysts in early 2021:
. . . We are certainly positioned at this point for the potential for higher rates. So in the quarter, we put about $10 billion worth of swaps on that available-for-sale portfolio. And we will continue to do more to hedge against that, to mitigate the impact of potential further rate movements.
And at the end of 2021, SVB’s financial accounts indicate that on the AfS side it held $15.26bn of interest rate swaps to hedge against the impact of rising rates on its large bond portfolio. So what happened?
Well it looks like profitability is weakening in 2022 because the tech world has really made a fool of SVB. In the first quarter, it unwound a $5bn AFS hedge to book a $204mn gain, and in the second quarter it dumped another $6bn of hedges to lock in a $313mn gain.
Or as the bank put it in a July 2022 presentation to investors, it was “focusing on managing downrate sensitivity”. (H/T to FT’s Antoine Gara for the slide below):
You can see the shift in SVB’s 2022 annual report here. As of the end of last year it had only $563mn worth of hedges outstanding on its books. For comparison, the notional value of Credit Suisse’s interest rate swap hedge at the end of 2022 was $135.7bn.
Essentially, to interest its P&L in the short term, SVB is almost completely unhedged in 2023 – in effect, a huge multibillion-dollar bet that interest rates are reaching their peak.
Ironically, it was type Right! The 10-year Treasury yield peaked at around 4.29 percent in October last year, and after a sharp decline in January it was as high as just 4 percent in early March (and has since fallen below 3.5 percent as the turmoil unfolds. via SVB ).
However, the Achilles heel of SVB’s balance sheet was not the asset side, it was its liabilities. Specifically this:
Innocently, SVB amassed a spectacular pile of uninsured deposits, almost entirely only in an industry that was burning through its deposits as VC funding dried up.
Deposits are generally considered very stable, sticky funding, but in SVB’s case they proved to be anything but. With the money gone by last Friday and no way to sell the unhedged HMT securities without realizing a bigger loss than the $1.8bn it incurred when it dumped most of the AfS portfolio on March 8, the FDIC had to step in.
Bank balance sheets are a messy business, and FTAV hopes we haven’t messed anything up here. But if we have, let us know in the comments.
Credit Suisse’s main problem clearly appears to be its stumbling business, and it has minimal exposure to higher rates. Conversely, SVB could be briefly forgiven for not hedging more of its HTM book, but locking in low rates and leaving its AfS portfolio almost bare for profit maximization – despite a clearly volatile deposit base – looks like an asset-liability snafu. is A cautionary tale for bank treasurers and regulators.
