Silicon Valley Bank And the Modern Day Balance Sheet

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Bank Run? A quick thread about Silicon Valley Bank (SIVB), and how this could change the entire macro picture in the near term 🧵

First, banking 101: Banks make money by taking in deposits from folks like you and me, and lending it on to others at a slightly higher rate. It's not a risk free business since on the asset side, the loan can default, and on the liability side, the deposits can go away.

So in regular times, they make the net interest margin (NIM) between borrowing and lending, as well as fees from all sorts of other services.

When banks get into trouble, classically, it's been because the loans "soured". i.e. The loans on their books are unlikely to get their money back. This has to be marked down, and since the depositors are not on the hook for the losses, it's a hit to the bank's capital.

Here's an illustrated version of how an actual loan works in terms of bank balance sheet: pennyworks.com/article/how-banks-work-and-why-they-dont

But in essence, in the simple illustration below, if the $5 of loan goes belly up, the loss is taken by the equity holders, and the bank is left with just cash to pay back depositors

Now in today's environment, banks are required to hold a lot more equity and tighten lending. Because if this, banks have had a hard time finding suitable loans to invest in. So instead of lending, they resort to buying securities such as government bonds and other assets.

This pool of assets comprises the bank's portfolio, and is split into 2 parts. The Available For Sale (AFS), vs the Held to Maturity (HTM). It relates to accounting differences, but suffice to say banks are allowed to trade the AFS ones, and generally not the HTM.

However, in this current environment, the uniqueness is the speed with which the Fed has hiked. Many banks own huge AFS portfolios, and if they have a maturity of 3-5 years, a 4% increase in rate implies a 12-20% marked to market loss on their portfolios.

Now most of these investments are in high quality assets, so the likelihood of actual losses is low. However, bond prices have to adjust to market rates, and when rates go up a lot, prices have to come down. It eventually "pulls to par" but only at maturity.

This is essentially interest rate risk. This leads us to Silicon Valley Bank. According to the WSJ, they had an AFS portfolio that was worth ~$30B on the books, but with a $2.5B marked to market loss. They decided to sell all of it, take the hit, and raise $2.25B of equity

There's an even bigger HTM portfolio, that's worth $90B+. With an even larger $15B unrealized loss. But the way that book works is that as long as you don't sell it, you'll get your money back, it doesn't count towards earnings, and you don't take an equity hit.

So the main question is, will SIVB suffer a bank run? Definitely the press is bad, but having sold their AFS portfolio, it means they'll be able to meet $25B of withdrawals without any issues.

However, they do have $170B of deposits. So if the situation is that people lose confidence in them, there could be some issues in meeting withdrawals above ~$35B. If there is a lender of last resort that can provide liquidity until the HTM portfolio matures, they'll survive.

If there isn't, and they have to take extraordinary measures such as selling the HTM portfolio at a loss, that would wipe out all of SIVB's $16.3B of excess equity. So ironically, today's situation is less a classical solvency and bad loans problem, but more a rate hikes problem

This issue is directly caused by the Fed and is the collateral damage from their rate policies. We saw a mini version of this panic from the UK pensions a few months ago. If this translates to bank contagion in the US, we are in for much more pain and definitely a recession.

Unfortunately, since banks are essentially a closed system, the deposits don't really go anywhere other than other banks. This means that we could see a wave of consolidation where smaller banks suffer a deposit drain instead of a systemic bank run.

// These are definitely volatile times. What are your thoughts/questions on this issue? For more insights and weekly discussion of markets, check out and subscribe to our newsletter! pennyworks.com/articles