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💵 The MILF at Silicon Valley Bank

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You've probably heard about Silicon Valley Bank and the good old-fashioned run on a very hipster sounding VC entity. But there's nothing new and innovative here, just another case of history repeating.

Here's the chart. Down by 62% this week alone, 86% drop from the November 2021 peak 👇

Across two days, they tried to raise capital, failed, tried to negotiate a sale, failed and then, just like that, it was all over...

Thanks for playing.

Although the bank was kinda unique as "the go-to financial institution for startups", the story of what went wrong is a tale as old as time.

Liquidity Management.

We're going to call it..

The Maturity, Ignorance, Liquidate, Fuuuuuuuuuuuc... Cycle. MILF for short.

It can happen to any business, but for banks, good liquidity management is particularly essential. That's literally their job.

SIVB failed, and they're probably not the only smaller bank under pressure.

This account (from January) lays out the issues brilliantly... 👇

 Silicon Valley Bank $SIVB reports earnings tomorrow

Investors have rightfully been fixated on $SIVB's large exposure to the stressed venture world, with the stock down a lot.

However, dig just a little deeper, and you will find a much bigger set of problems at $SIVB... 1/10— Raging Capital Ventures (@RagingVentures) January 18, 2023 

It's extraordinary how quickly the bank went from boom to bust. 👇

 $SIVB used these inflows to:

- Increase loans 100% to $66 b

- Go hog wild with its "held-to-maturity" (HTM) securities portfolio, ramping its mostly Agency mortgage holdings from $13.5 b at Q4 '19 to $99 b at Q4 '21.

 

3/10 pic.twitter.com/59Nn36t9S1— Raging Capital Ventures (@RagingVentures) January 18, 2023 

So, you're a bank taking in a shedload of deposits, paying next to nothing (interest rate) to attract (and keep) those inflows, and then you're lending out at slightly higher rates while investing in longer duration assets (agency mortgage holdings) to generate extra income.

Lovely little business model. Margins are a little thin but as long as nothing changes too drastically, everything will be just fine...

 $SIVB's HTM securities had mark-to-market losses as of Q3 of $15.9 b...compared to just $11.5 b of tangible common equity!!

Luckily, regulators do not force $SIVB to mark HTM securities to market. But the bank would be functionally underwater if it were liquidated today. 5/10 pic.twitter.com/WoM5789o4X— Raging Capital Ventures (@RagingVentures) January 18, 2023 

Ah shit. Things changed. FAST. The worst of all worlds. SVB's assets were long duration and intended to be held until maturity. The prospect of rapid interest rate hikes from the Fed devalued those assets just as rapidly.

They're not supposed to be a source of liquidity (clue's in the name), but they can be if really required. However, that would mean realising the loss. Still, as long as the bank doesn't suffer with outflows, everything should be just fine, no need to liquidate anything... 👇

 Basically, as its funding costs reset higher, $SIVB is facing a massive negative carry cost on its HTM, largely fixed-yield securities portfolio (which is not running off quickly, due to the nature of mortgage convexity). 7/10— Raging Capital Ventures (@RagingVentures) January 18, 2023 

AH COME ON!

Venture capitalists needed their cash, and the bank couldn't compete with more attractive offerings elsewhere. Money market funds were offering 4% when the thread was published, that jumped higher as t-bills broke above 5% recently.

What was the big risk? If outflows accelerate...

 $SIVB's clients also face a risk. With the bank's stretched balance sheet, will it tighten and/or pull back on credit lines? Worse, could customers become uncomfortable with $SIVB as a counter-party, due to unrealized balance sheet losses? 9/10— Raging Capital Ventures (@RagingVentures) January 18, 2023 

This thread was unbelievably explicit and prescient. That was exactly what happened. Selling the portfolio, and trying to raise equity capital were their last attempts to survive. But it was too late.

For all of the terminology above, the problem is simple liquidity management.

  • Step 1. The Maturity Mismatch created by lumping too much into long duration assets

  • Step 2. Ignorance of the changing market environment that led to large paper losses on those assets

  • Step 3.Liquidate 👇

SVB, which does business as Silicon Valley Bank, launched a $1.75 billion share sale on Wednesday to shore up its balance sheet. It said in an investor prospectus it needed the proceeds to plug a $1.8 billion hole caused by the sale of a $21 billion loss-making bond portfolio consisting mostly of U.S. Treasuries. The portfolio was yielding it an average 1.79% return, far below the current 10-year Treasury yield of around 3.9%.

  • Step 4.Fuuuuuuuuuuuc

MILF

MILF = Maturity Mismatch. Just like a young guy dating a much older woman, the maturity mismatch usually leads to problems down the line.

SVB made plenty of mistakes, but not being nimble enough with their portfolio management to ensure that the 'duration' of current assets (invested for the long term) could meet the 'duration' of current liabilities (give me my money now) was the big one.