Banking regulators closed Silicon Valley Bank (SVB) on Friday, March 10 and Signature Bank on Sunday, March 12, 2023 appointing the Federal Deposit Insurance Corporation (FDIC) as receiver to protect depositors. Through emergency government measures, the FDIC will now cover all deposits at the two banks, including those exceeding the standard $250,000 insurance threshold.

The failure of both banks—SVB, a startup-focused bank with deposits above the traditional $250,000 insured limit accounting for 85% of accounts, and Signature Bank, with nearly 25% of deposits from the crypto industry—raised concerns about runs on regional banks. Their collapse has also raised questions regarding liquidity management of community banks and credit unions.

How SVB’s Model Likely Differs from Yours

Unlike the Financial Crisis of 2007-08, the collapse of SVB is due to liquidity risk, not credit risk. Most banks and credit unions could not withstand the kind of rapid deposit redemptions SVB faced. Having said that, most banks and credit unions do not have the same type of deposit base as SVB. The majority of SVB’s depositors were tech companies that used the firm for payroll or investments—ROKU alone had $487 million in the bank, crypto lender BlockFi had $227 million, and RocketLab held $38 million.[1]

To further analyze SVB’s demise, let’s look at the numbers (year end 2022)[2]:

  • Total assets of $212 billion
  • Total deposits of $173 billion
  • CET1 capital of $13.7 billion
  • Tier 1 risk-based ratio of 15.4%
  • ROA of 0.71%
  • Book value per share of 208.85
  • Loan to deposit ratio of 42.8%
    • 56% to venture capital and private equity firms secured by their limited partner commitments
    • 14% in mortgages to wealthy individuals
    • 24% to various tech and health care companies, including 9% of all loans to early-stage startups
    • The bank claims it banks nearly half of all U.S. venture-backed tech and healthcare startups.

The remainder of their assets were held primarily in investments. As of year-end 2022, the unrealized loss on their Available for Sale (AFS) securities was $2.5 billion and the unrealized loss on the Held to Maturity (HTM) securities was $15 billion for a total of approximately $18 billion—much greater than the $12 billion of common equity and greater than its entire current equity base of $16.2 billion.[3]

This is one of the reasons the HTM designation exists. Banks and credit unions can “store” duration on their balance sheets in a way that many fixed income investors cannot, like a loan portfolio that’s held for investment. SVB was in the process of restructuring their government guaranteed investment portfolio, like many banks and credit unions are considering, but the overwhelming deposit/funding withdrawal was too much to overcome.

A Severe Negative Cash Balance Driven by a Rare Depositor Base

Regulators said investors and depositors tried to pull $42 billion or 24% of depositsduring the week of March 6, 2023, leaving the bank with a severe negative cash balance. To fund redemptions, SVB sold $21 billion of mostly Treasuries at a $1.8 billion loss (8.5% of book value). The bonds at the time were yielding 1.79%[4]—not that dissimilar to many bank and credit union portfolios that were built with the massive deposit influx at the beginning of the pandemic.

Most depositories with low-sensitivity non-maturity deposits and CDs will have unrealized gains in their liabilities as rates rise and deposits are locked into at lower rates, helping to offset the unrealized losses on assets. SVB is rare in that a vast majority of their deposits are from venture capital firms and startup companies that have high deposit amounts that can be moved in one single day. With the venture capital market funding drying up, they were starting to access these deposits at a faster rate, leading SVB to try to preemptively generate liquidity for future needs.

New Options to Help Protect All Banks & Credit Unions

Janet Yellen, Treasury Secretary, was interviewed by “Face the Nation” on the morning of March 12, 2023, in response to growing market concerns. She emphasized that the American banking system is safe and well-capitalized, and that it is resilient. New controls were put in place in 2008 so that Americans can have confidence in the soundness of the banking system. These controls include sound business practices such as ALM analyses and capital stress tests.

Later that day, following a statement by the New York State Department of Financial Services announcing the takeover of Signature Bank (approximately $110.36 billion in total assets and $88.59 billion in deposits)[5], regulators unveiled a plan to backstop all of the depositors of both SVB and Signature Bank[6]. The Federal Reserve also said it is creating a new Bank Term Funding Program aimed at safeguarding deposits. The facility will offer loans of up to one year to banks, savings associations, credit unions and other institutions[7].

The Importance of Liquidity Management

As markets and depositories continue to digest the impact of the SVB and Signature Bank failures and subsequent government emergency measures, we continue to stress the importance of liquidity management as a cornerstone of financial stability. Modernized approaches to liquidity measurement, cash flow simulations designed to test the adequacy of on-balance sheet and secondary liquidity sources in stress scenarios, and thoroughly constructed contingency funding plans with targeted responses to varying levels of liquidity crisis are all key elements of a strong liquidity management framework.

In addition, diversification of liquidity sources is critical both in times of stress and for daily cash management, affording financial institutions agility in their funding strategy and margin control. Beyond the investment portfolio, alternative funding options including loan sales, borrowing lines, wholesale funding strategies and other options should be continually assessed and tested to ensure peak responsiveness when a stress scenario arises.

The Role of Your Investment Portfolio

The name ALM First was derived from the fact that depositories should lead with asset-liability management (ALM). Prior to developing an investment strategy, a financial institution should have a thorough understanding of asset and liability effective durations and sensitivity mismatches.

Our philosophy has always centered around the idea that the investment portfolio is the rudder of the balance sheet, designed to complement the overall asset-liability profile including its exposure to credit, liquidity, and interest rate risk. Investment strategies should be set with a thorough understanding of the true franchise value of the deposits and liquidity of the remaining assets. Constant monitoring of the portfolio’s risk profile within the context of the balance sheet is essential to continued refinement of the portfolio strategy and the portfolio’s contribution to the overall financial health of the institution.

Planning for the Unforeseen

While a prudent ALM process is at the heart of daily depository balance sheet and portfolio management, inevitably the unforeseen will happen. Layering enterprise risk management (ERM) with the ALM process can help identify the financial, operational, and idiosyncratic risks unique to an institution and forecast the potential impacts on performance.

While both SVB and Signature Bank had more unique depositor bases and balance sheet considerations, their collapses highlight the importance of the ALM process, robust liquidity management framework, and deeper understanding of embedded risks driven by the business model and customer base. Achieving an ideal state of preparedness is an active process rooted in a thorough risk management framework, dependent upon robust analytics and a customized approach to risk identification, measurement, and mitigation.

[1] CNN Business, March 11, 2023

[2] J.P. Morgan North America Equity Research, March 10, 2023

[3] NY Times: DealBook/Business & Policy, Newsletter, March 11, 2023

[4] SVB, March 8, 2023; SVB Financial Group – Q1’23 Mid-Quarter Update

[5] New York State Department of Financial Services, March 12, 2023; Press Release- March 12, 2023: Superintendent Adrienne A. Harris Announces New York Department of Financial Services Takes Possession of Signature Bank

[6] Federal Reserve Board, March 12, 2023; Federal Reserve Board – Joint Statement by Treasury, Federal Reserve, and FDIC

[7] Federal Reserve Board, March 12, 2023; Federal Reserve Board – Federal Reserve Board announces it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors

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The content in this article is provided for informational purposes and should not be relied upon as recommendations or financial planning advice. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues. While such information is believed to be reliable, no representation or warranty is made concerning the accuracy of any information presented. Statements herein that reflect projections or expectations of future financial or economic performance are forward-looking statements. Such “forward-looking” statements are based on various assumptions, which assumptions may not prove to be correct. Accordingly, there can be no assurance that such assumptions and statements will accurately predict future events or actual performance. No representation or warranty can be given that the estimates, opinions or assumptions made herein will prove to be accurate. Actual results for any period may or may not approximate such forward-looking statements. No representations or warranties whatsoever are made by ALM First Financial Advisors as to the future profitability of investments recommended by ALM First Financial Advisors.

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