Too Big to Fail 2: a case study for students of the market.

March 13, 2023

I have always said that sell-side Financial Services companies will never teach how to invest. The buy-side must do that task; part of that education must come via case studies. The perpetrators of investor losses will never take responsibility for their actions. When these cases arise, it’s up to us to study and understand what happened so we can learn from those situations.

Brian Boyle of The Daily Upside has laid out the SVB collapse simply.

Silicon Valley Bank Imploded. Here Were the Biggest Red Flags

The Federal Government stepped in to backstop the deposits at failed Silicon Valley Bank on Sunday evening after unsuccessful attempts to sell off the troubled lender, and officials feared systemic contagion after the run on SVB last week. The FDIC began an auction process for SVB on Saturday, with final bids due Sunday afternoon, but nothing materialized, prompting Sunday evening’s backstop move.

The Federal Reserve and Treasury department also announced that Signature Bank had been closed by New York State regulators citing a similar systemic risk, making it clear that regulators had spent their weekend determined to prevent the contagion of SVB’s bank run, which caught them off guard at the end of last week. But should it have?

Too Big to Fail 2: 2 Big, 2 Furious

Hindsight is 20/20, and, looking back, SVB had more red flags than you’d see on a Carolina beach in October. Here were the biggest, brightest ones that everyone seemed to miss:

Red Flag No. 1: In its most recent earnings report in January, the bank revealed its held-to-maturity securities had mark-to-market losses of nearly $16 billion in Q3, against just $11.5 billion of tangible common equity. Essentially, the bank would be underwater if it was forced to liquidate all its assets.

Red Flag No. 2: The cause of the losses is simple — the bank took its tens of billions of customer deposits and invested heavily in bonds with sizable interest-rate risk. Worse, it was overloaded on long-duration bonds with more than 10 years to maturity, leading to a mismatch of assets and liability.

Red Flag No. 3: As of December, roughly 95% of deposits were above the Federal Deposit Insurance Corporation’s $250K insurance limit, according to SEC filings. Make no mistake, this was a high-stakes poker game.

Red Flag No. 4: Perhaps the risky maneuvering could have been avoided. But SVB operated without a Chief Risk Officer from April 2022 to January this year. That’s nine months… with no risk officer.

Red Flag No. 5: SVB did employ a Chief Administrative Officer, Joseph Gentile, who had been with the company since 2007. His previous employer? Lehman Brothers. Perhaps he just found himself in the wrong place at the wrong time. Twice… in a row.

Red Flag No. 6: CEO Greg Becker didn’t need a CRO. Just days before the bank disclosed the $1.8 billion loss that sparked the run, a trust owned by the big boss sold $3.6 million worth of SVB shares.

Red Flag No. 7: Peter Thiel, the influential tech venture capitalist/aspiring supervillain, withdrew his Founders Fund’s entire account worth millions from the bank by at least Thursday, Bloomberg reported, and encouraged its portfolio companies to do the same.

Red Flag No. 8: Where Thiel goes, well, so too do many tech leaders. The small, insular industry is practically by definition full of trend-chasers (these are many of the same folks who dropped everything to pursue Web 3.0, after all). In other words, it should’ve been a giant red flag that the bank’s entire clientele is hardwired to act in a way that perfectly facilitates bank runs.

Contagion containment: First Republic Bank, which has also been damaged by the fallout from SVB’s collapse, disclosed it had received a $70 billion liquidity infusion from The Fed and JPMorgan Chase, and meanwhile over in Britain, HSBC worked through the night Sunday to strike a deal with regulators to purchase SVB’s UK operation — less assets and liabilities — for £1.

The more that investors gain insights into the problems caused by others, the better they will invest in the future.

My book, Stock Market Literacy, teaches people how to invest.

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