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The bank run by depositors on Silicon Valley Bank (“SIVB”) was shocking. After the bank announced an equity offering and the sale of a portfolio of mortgage-backed securities (“MBS”) on March 8th, depositors withdrew $40 billion in a single day on March 9th and made requests to withdraw another $100 billion on March 10th. Since SIVB did not have enough cash to meet these depositor requests, bank regulators shut down the bank the morning of March 10th. SIVB went from having a $16 billion stock market valuation on the afternoon of March 8th, to getting closed and placed into FDIC receivership by the morning of March 10th.
SIVB was primarily focused on the venture capital community. Venture capital investors and their portfolio companies comprised the majority of their customer base. As a result, the deposit base was much more concentrated than that of an average regional bank. An estimated 95% of SIVB’s deposits were not insured by the FDIC. When the venture capital firms decided to withdraw their deposits from SIVB, they strongly suggested to the management teams of their portfolio companies that they also withdraw their deposits. The combination of a concentrated depositor base, rapid spread of information over social media, and the easy accessibility of bank transfers on mobile phone apps led to a rapid drain on deposits from SIVB.
Other banks, such as Signature Bank, PacWest Bank, and Western Alliance, also focused on serving venture capital clients. Venture capital firms and their portfolio companies reduced their deposits at these banks as well, as they were worried about taking haircuts on their uninsured deposits if these banks failed. At Signature Bank, there were too many deposit withdrawal requests, which prompted the regulator to close the bank over the weekend of March 10th. Both PacWest and Western Alliance’s stocks declined by over 60% during this time period, but they were able to meet depositors withdrawal requests.
We are disappointed by the demise of SIVB. We had admired the bank’s franchise for a long time. You may remember that we published our bullish investment thesis on SIVB in our April 2019 letter. We sold SIVB during the onset of the pandemic in 2020 because we thought there were better investment opportunities. We continued to track SIVB’s progress and were amazed by the strong deposit growth at the bank. We never repurchased a position because we were worried about the red-hot venture capital environment. We were short SIVB during the Fall of 2022, but we were not short SIVB during 2023.
We are frustrated about SIVB’s management taking unnecessary risks that ended up destroying the franchise. Because SIVB had such a great deposit franchise, the bank only made loans for about 50% of its deposits. A typical regional bank is more balanced and lends out 90% to 100% of its deposits. Additionally, SIVB should have invested its excess deposits in short-term bonds. SIVB’s management instead invested almost the entire securities portfolio in long-term agency Mortgage Backed Securities (“MBS”). As interest rates troughed during 2020 and 2021, SIVB’s management continued to reinvest the bond portfolio in lower coupon MBS. They ended 2021 with a portfolio made up almost entirely of 1.5% and 2.0% yielding loans at a time when interest rates were at multi-generational lows. When interest rates rose in 2022, the value of these long-term MBS declined by 20%, which caused the bank to be technically insolvent as far back as last September. This was evident from the bank’s Q3 earnings release. However, bank regulators did not declare SIVB insolvent last Fall because of an arcane accounting rule which allowed SIVB (and other banks) to ignore the mark-to-market losses on the portion of its bond portfolio allocated to its “Held to Maturity” account when calculating its GAAP equity and regulatory capital. Due to the flexibility allowed by this accounting treatment of ignoring mark-to-market losses, SIVB and other banks took imprudent risks and bought long-term, low yielding bonds.
SIVB is not the only bank to damage their franchise by buying long-term MBS with low coupons. We think Bank of America, Charles Schwab, and Zions Bancorporation have all impaired their franchises by taking on too much interest rate risk in their bond portfolios. Specifically, these banks purchased a large amount of low-coupon MBS. With the increase in interest rates, the homeowners paying on the underlying mortgages have strong incentives to stay in their homes and keep their low mortgage rates, thus extending the duration of the MBS to 10+ years. These banks will therefore have to hold onto these underearning MBS for a considerable amount of time. At the same time, short-term interest rates have risen and made bank customers much more aware of the potential to earn higher returns on their cash balances. Unsurprisingly, there has been an acceleration of customers seeking higher short-term yields. These banks may earn a negative spread by funding these low-coupon MBS with high-cost deposits and borrowings for years.
Disclaimer: The discussion of any security is meant solely as an illustration of our investment and thought process and should NOT be considered as a recommendation or suggestion to buy or sell any securities. Before you make any investment, do your own research and talk to your own financial adviser. Information in this report is received from external sources. Therefore, we can make no guarantee as to the completeness or accuracy of the information provided.