SVB "Who knew what when": 10b5-1, CROs, ALMCo, Duration gaps, VC Schism+

Unpopular Facts+ below:

Who Knew What When

“Who knew what when” will be the most infuriating and surprising revelation to folks who weren’t around during GFC and the aftermath.

I'd bet on CEO Greg Becker

• being advised 12+ months ago of the duration mismatch, risk factors, and available mitigation strategies;
• knowing 4+ months ago the duration gap was such that SVB would need to raise equity and sell AFS securities as an 11th hour last resort; and
• since both measures would drive bank equity value down, deciding to sell $3.6M of bank shares in his personal trust account before the public announcement.?

There will be shareholder lawsuits about fiduciary duty and self-dealing (not surprising); regulatory investigation by the the Federal Reserve, OCC, FDIC, SEC, and DOJ on managements actions, the Risk Committee, internal and external legal guidance on public disclosures, and the Asset/Liability Management Committee; and Congress will summon the CEO, CROs, and the banking regulators testify.

What & Who caused SVB's collapse?

CEO Greg Becker mismanaged SVB's asset/ liability duration mismatch. Period.

Not the Fed.

Not 99% of SVB's employees.

Not startup founders who banked with SVB.

Not on*/off-TV VCs who advised their startups to move cash from SVB this week.

Not Hedge Funds.

Not Short Sellers.

Not PE.

Not the Tailoring Rules of regulatory supervision.

*my very unpopular opinion: while VC Peter Thiel accelerated the bank run....i) the root cause was SVB Management's protracted duration mismatch ii) followed by poor communication of its revised guidance and a half-baked capital raise Wednesday (a surprise to the market given its public call weeks earlier); and iii) SVB account managers answering client questions on Thursday in a way that did not inspire confidence.

A bank's purpose is to be available for depositors. As a result, a bank's most fundamental investment objective is to manage liquidity and risk mismatches between the firm's assets and liabilities. The CEO should be focused on this objective and receive updates daily and multiple times daily in market stress. The bank CEO's risk mismanagement is inexcusable; locking in $80Bn of 10-year MBS at 1.56% rate in a rising rate environment is literally the absolute wrong answer. Where were the interest rate hedges? (surely someone at SVB understood Treasury and investment portfolio management; how the CEO and Board allowed such a moronic investment decision will surely come out in testimony and email discovery).

Banking 101: Balance Sheet & Liquidity Risk Management

Banks accept customer deposits, which are used to make customer loans.

Banks attempt to generate profit by creating a sustainable delta (called Net Interest Margin, "NIM") between the loan interest received and deposit interest paid.

When a bank's intent is to maximize long-term shareholder value, shareholder and depositor interests do not conflict. Why? because, risk in depositor safety creates risk in shareholder value, and vice-versa. So, a bank must constantly manage its liquidity and risk positions relative to its shareholder's equity, non-securities assets, and liabilities, to ensure i) depositor's have confidence in fund availability and ii) both depositors and shareholders have confidence in bank leadership's credibility (incl. transparency about risks to liquidity and equity value).

ALMCo.

A bank's most important committee is its Risk Committee, which has an Asset/ Liability Management Committee ("ALMCo") to provide oversight of the bank's liquidity management process and direction on its investment portfolio used to manage asset and liability flows.

A Bank's C-suite, senior control officers (incl. internal auditors), Board members, and external regulators have access to ALMCo. The ALMCo establishes a bank's Investment Policy Statement (IPS); continuously monitors performance; ensures the interest rate, FX, credit, liquidity, and solvency risk are within the bank's risk tolerances established by that IPS; and is authorized to mandate adjustments to the asset and liabilities for duration gap management. SVB's ALMCo used simulations to perform sensitivity analysis on NIM under various interest rate, balance sheet, and business strategy scenarios on a 12-month forward looking basis.

LCR, NSFR, Accounting, & Duration Gap Foresight

At $212Bn in Dec. 2022, SVB's assets were only slightly short of the $250Bn in assets that would subject it to the Fed's LCR (Liquidity Coverage Ratio) or NSFR (Net Stable Funding Ratio) requirements, which would subject the the bank to increased use of long-term debt, more specific liquidity reporting, and stricter calculation requirements for regulatory capital ratios. With assets tracking to $250Bn in 2023, it's likely the bank, research analysts, ratings agencies, and its regulators have been monitoring LCR and NSRF well before Jan. 2023 and tracking to anticipated requirements.

U.S. Banks (should) concurrently monitor their balance sheet under 3 accounting systems: i) GAAP, ii) statutory accounting required by banking regulation iii) economic accounting (mark-to-market). Thus, even without the Fed's LCR and NCR requirements or GAAP requiring AFS and HTM securities to be marked-to-market, management and the ALMCo. should have been aware of deteriorating liquidity and interest rate exposure (as well as balance sheet optics in the event that they had to sell AFS securities at some time in the future).

The Fed has raised interest rates 8 times over the last 12 months. We've been talking about rates rising for the past 3 years <(edit: 8 years), a natural outcome of the long zero rates environments and politicized Fed under Trump and Biden.

As a result, no one should be surprised by the need to manage interest rate risk, duration mismatches, convexity, the leverage multiplier, asset & liability composition, and correlation (!), particularly not the most critical and empowered group for a publicly listed U.S. bank watching repeated interest rate hikes and their (supposed) models.

Before resorting to this week's surprise equity raise and AFS sales, ALMCo, Becker, and the Board had months to

• put on interest rate hedges
• increase term deposits and reduce demand deposits, for better outflow matching
• for larger depositors ($500M+), negotiate preferred interest accumulation in return for shifting demand deposits to 6 month+ term deposits for predictable outflows
• diversify their assets, liabilities, and customer base
• better match asset/liability exposure to borrower and claimant options
• raise equity -- common, preferred, convertible, etc. -- communicated in scheduled quarterly management calls rather than a surprise 8-K

To understand the bank's internal decision-making, I'll be interested in hearing from former CRO Laura Izurieta, newer CRO Kim Olson, and the ALMCo. as well as reviewing Board materials and minutes about position management, simulations and recommendations to the CEO, implementation decisions, and disclosures.

FDIC Receivership -- the best option; let the Market, Banking Reforms, and Auction system do what they're supposed to for an Orderly Liquidation

In my view, FDIC receivership was the right and best option for customers, in terms of maximizing near term liquidity and recovery rates on uninsured deposits as well as reducing panic and uncertainty. And a better solution than direct acquisition by another bank or private equity for a number of reasons, including that

• i) bank integration isn't a panacea or easy (been there; VCs who've never worked at a bank or through merger integration seem to view it as a light switch to next day BAU)
• ii) after JPM stepped in to buy Bear Sterns, the government hounded the firm and mischaracterized its actions as predatory, self-interested, and propped up by tax dollars
• iii) a 2021 Biden Executive Order directed the DOJ and Prudential regulators to enhance scrutiny of bank M&A; in July 2022, FTC Chairwoman Lina Khan underscored her views on enhancing bank acquisition scrutiny.

No bank CEO wants to step into any of that. Purchasing select SVB assets, liabilities, and equity out of an FDIC auction process better insulates bank CEO's, their shareholders, and SVB depositors from these protracted risks and operating uncertainty.

VC Schism, Free Speech, "Defamation", the true Alarmists, Short Sellers are not the Villains

A coalition of decorated VCs alleges other VCs caused the bank run that led to SVB's failure. Again, I agree Theil accelerated the bank run, however the run was underway as a result of SVB surprising the market by revising its guidance and attempting to raise capital mid-quarter.

Outside of that coalition, Bill Ackman and Jason Calacanis -- investors who frequently talk their books in emotional television pleas -- contributed to fear rather than solutions. Many wonder whether that's so the FDIC or Treasury guarantees [their personal or their portcos'] uninsured SVB deposits? Their arguments have gotten creative and hyperbolic: e.g. if SVB isn't bailed out, China will takeover the U.S. as a world power.

Despite being venture capital investor with portfolio company exposure to SVB, I will not drink or serve the kool-aid that SVB's collapse and disruption to business requires a specialized government intervention or rescue.

No Systemic Risk + High Recovery Rates

• SVB does not present systemic risk to the U.S. or global financial systems (and it need not).
• SVB's uninsured deposits can have a high, healthy recovery rate and fast liquidation.
• This situation is not analogous to 2008, where we had attempted fire-sales of esoteric illiquid assets, individual asset-backed loans, and bulge bracket bank buyers (and PE firms requiring cheap credit) suffering themselves from balance sheet stress, counterparty credit, and contagion, so unable to due diligence, finance, and structure asset sales.
• VC Jason Calacanis and investor Bill Ackman, like others in VC, have been fanning the fire, instead of letting the orderly liquidation process run without dramatic hypotheticals for main street. They have also be generating fear among younger, greener VCs and emerging managers, contributing to bank run rumors. Every bank would show a significant negative GAAP impact from marking ATS and HTM to market, but that does not mean they cannot meet depositor demand.

Moral Hazard

• FDIC funds available cannot guarantee every uninsured deposit. And Treasury's purpose is not to guarantee every deposited dollar. That would only further pervert bank managements' incentives, encouraging more management ineptitude and risk taking to maximize equity while having the federal government serve as the capital source of last resort.
• I empathize with founders, employees, and impacted users, however a guarantee (aka assurance, "bail out") here only creates more risk to the U.S. financial system and economy.

What Should/ Can be Done? Government Conundrum

1. Should individuals or companies get 100 cents on the dollar back for amounts over $250K? The average American bank balance is <$10K, so Americans understandably perceive that as a bail out for rich individuals and startups, which makes a bailout politically unpopular.
2. To reduce duration mismatches, the perception that regional bank's AFS portfolios will need to be sold, and thus the likelihood of bank runs, regional and community banks should reassure depositors and/or privately raise additional preferred equity now from investors with higher risk appetites, higher risk capacities, or vested interest. They may want to time the equity announcement with their standard quarterly earnings call to underscore that the measure is being done in the normal course of business, not out of management panic.
3. Biden can issue an Executive Order directing Treasury to backstop uninsured deposits. Similar to Biden's executive order on student loan cancelations, the narrative and immediate perception that deposits are secure may be sufficient to stem outflows from other banks.
4. The government's support focus should be on SVB's non-VC-backed small businesses with real cash flow, assets, and collateral, who should be assisted to get banking services elsewhere.
5. The federal government and private markets should prioritize the private companies with a payroll shortfall risk for Monday/ Tuesday. That does not include a focus on individuals with $1M+ in private accounts.
6. Undoubtedly, all equity and creditors should get 0 cents on the dollar.
7. Most importantly, let the market, FDIC orderly auction process, and private capital markets work as they're supposed to; it's the rational and best solution:

• With PE's $3 trillion in dry powder & VC's $500 Billion, private funds can make depositors whole or near-whole without government support
• The ultimate stakeholders of VC-backed private companies are the VC investors and founders who provided risk capital, and they have the power, incentive, and knowledge to make decisions around new capital infusions.
• For example, if portcos suddenly lose a portion of deposits.... the equity capital holders (VCs and founders) are put at risk; thus, they have incentive to inject more capital to fortify portco cash reserves if they believe in the long term value of the company. Here, VCs can and should send more cash to those companies via new equity and/or debt investments. The market works because incentives are properly re-aligned: the new investment decision and additional risk capital are provided by the future beneficiaries of the company's economic upside (#unpopularopinion )
• Again, as the primary risk capital, current equity holders of VC-backed private companies are the primary long-term beneficiaries of these companies' going concern, so VCs should be the source of additional capital, not a taxpayer funded federal backstop.

What's Next?

• Will average Americans fear their deposits aren't safe and line up outside of regional banks on Monday? Unlikely. Because the average American doesn't have an excess of $250K in a deposit account.
• Will rich people pull out their money out of banks? Unlikely. Where would they store an excess $250K? In crypto wallets, Switzerland, lawless SF? No.
• Tech companies issuing 8-Ks this coming week to show payroll shortfall risk and operating impact. I believe the Treasury, FDIC, and Congress should pay more attention to these than individual VCs on TV
• CFOs reassessing their credit relationships and their banking partners' balance sheets

*Notes

1. The purpose of this article is to inform on root cause for people wondering what happened and what the debates and options are
2. I empathize with and am supporting real time depositors, employees, founders, investors, and communities.
3. One can empathize with those affected, while also believing the CEO, Management team, and Board completely failed at their most critical management function
4. We're all in this together :)