Stockholm (NordSIP) – When an epidemic started in China and Russia invaded the Ukraine, investors were far from thinking that these events would ultimately conspire to bring down a household financial name in Silicon Valley. Yet, these events and their unintended consequences paved the road that led to the downfall of Silicon Valley Bank (SVB).
Even if sustainable investors were not better than the rest at seeing the writing on the wall, which they should perhaps have been, the fall of SVB is a fairly standard macro story, not the sustainable investing failure that “woke capitalism” detractors would have us believe. However, investors must do better. The issues were really not that complicated. It just seems no one was paying attention.
SVB Prioritised Returns Over Liquidity
At its heart, the fall of SVB appears to be a relatively simple, run-of-the-mill bank run. The bank was set up to cater to Silicon Valley startups in the 1980s, when the very idea of tech startups was only just started. It succeeded in this endeavour and flourished during the 1990s and early 2000s dot.com bubble. More importantly, it survived the end of that bubble and endured through the 2007-09 sub-prime crisis, although not without accessing some TARP assistance and while temporarily coming under the umbrella of the Dodd-Frank Act (but more on this later).
However, while the world was struggling in the face of COVID-19 uncertainty during 2020, tech companies boomed as the real world became exponentially more dependent on its digital counterpart. This was a boon for the bank that catered to 69% of silicon valley companies, leading to a rise in deposits. The figures from SVB Financial Group, SVB’s parent company, make the dynamics at play abundantly clear. Between 2019 and 2020, the bank’s deposits increased from US$61.76 billion to US$101.98 billion and continued to accelerate even further in 2021. However, this rise in deposits was not accompanied by a rise in cash or cash equivalent holdings. Instead, SVB chose to invest the money in the markets while actually decreasing its cash on hand. While in 2020 SVB had most of those assets in seemingly liquid “available-for-sale securities”, mostly Agency-issued MBS and Agency-issued collateralised MBSs, much of the US$87 billion in additional deposits made in 2021 were invested in less liquid, probably longer-term held-to-maturity Residential MBSs. All in all, the bank decided to look for returns at the cost of its liquidity.
The Macro Picture Changed
The issue came to a head once the macroeconomic winds started blowing in a different direction due to the end of COVID-19 and the inflationary effects of Russia’s invasion of the Ukraine started making global central banks hawkish. US Data suggest that a number of things started to take shape at the start of the second quarter of 2022, which would ultimately turn the macroeconomic environment on its head.
As the pandemic came under control, the Fed started increasing policy rates, increasing the cost of borrowing for everyone. As this happened, non-financial corporate debt issuance flattened. the 12-month moving average growth of the Nasdaq composite index (mostly dominated by tech stocks) turned negative, and bank deposits appear to peak. As financial conditions became tighter, it seems there was a shift from debt to cash.
All of this was concerning for SVB, which had little cash on hand to pay depositors, most of whom worked in the tech sector, which was taking a battering. Moreover, as interest rates rise, the price of debt falls, which was also bad for SVB, whom we saw had tied a lot of deposit cash into long-term Residential MBSs. According to the 2022 Annual report published at the end of February this year, SVB was facing US$15 billion worth of “Unrealised Losses from Held to Maturity Securities”.
The Chickens Come to Roost
The dominoes started falling at the start of March. Following the publication of SVB Financial Groups Annual Report and the announcement of those unrealised losses, Moody’s reportedly approached the bank to warn it about a potential double downgrade. Realising the implications of this problem, it appears that the management of SVB decided to take action by selling off some of its fixed-income investment portfolio. Unfortunately, not only did this not solve the problem it created a loss it now needed to cover.
According to the California Department of Financial Protection and Inovation (DFPI) description, “on March 8, 2023, the Bank announced a loss of approximately $1.8 billion from a sale of investments (U.S. treasuries and mortgage-backed securities). On March 8, 2023, the Bank’s holding company announced it was conducting a capital raise.”
Unwittingly, it seems that SVB caused a bank run.“Despite the bank being in sound financial condition prior to March 9, 2023, investors and depositors reacted by initiating withdrawals of $42 billion in deposits from the Bank on March 9, 2023, causing a run on the Bank.” Among others, Peter Thiel’s Venture Capital Founder’s Club, has emerged as a prominent voice advising depositors to run to collect their cash. The main issue at this stage seems to have been the fact that many of the deposits were owed to tech companies and wealthy tech entrepreneurs and workers with accounts higher than the US$250 thousand guarantee offered by the Federal government on bank deposits. To add insult to injury, the day ended with Moody’s announcing it had downgraded SVB from A3 to Baa1.
Eventually, the bank run caused SVB to run out of cash with which to settle transactions with the Fed. “As of the close of business on March 9, the bank had a negative cash balance of approximately $958 million. Despite attempts from the Bank, with the assistance of regulators, to transfer collateral from various sources, the Bank did not meet its cash letter with the Federal Reserve. The precipitous deposit withdrawal has caused the Bank to be incapable of paying its obligations as they come due, and the bank is now insolvent,” the DFPI explained. By the end of the day Moody’s had further downgraded SVB from Baa1 to C, and announced it was withdrawing its rating.
As the facts illustrate, unfortunate though it might be, the bankruptcy of SVB is, in a sense, very banal. A bank mismanaged its liquidity, tried to cash its assets at a bad time, couldn’t get the price it needed to meet its liabilities, and so it went bankrupt.
At no time throughout this tale was sustainability a factor. No evidence has emerged to suggest that any investments made by SVB, be they described as “ESG”, “sustainable”, “woke”, or “impact” played any role in the crisis that befell the bank. Indeed, the issue was not that it invested in a particular type of asset but rather that it invested in assets rather than keep more cash on hand. Although none of the respondents were directly exposed to SVB, when NordSIP reached out to Swedish funds classified as Article 9 Sustainable Finance Disclosures Regulations (SFDR) to hear their view on the matter, the portfolio managers shared this view.
Eric Penser Bank’s Jonas Thulin argued that “greed, lack of oversight and very aggressive balance sheet management” was at the source of what went wrong with SVB.” CB Fonder’s Marcus Grimfors echoed the above mentioned overview. “As we understand it they got problems with liquidity when customers began to withdraw money. An attempt to raise money from investors failed and the intensity of withdrawals increased to a bank run, which even a very well capitalised bank would have problems with.”
Mirella Zetoun, portfolio manager of SEB, and Andreas Johansson Head of Quantitative Equity Team at SEB added a bit more detail. “From our perspective there were two big mistakes that were made by SVB. a) They had a very concentrated deposit base and many of the depository companies held cash above the FDIC-insured level. This increased the likelihood of rapidly shrinking deposit base if any worries about the bank’s liquidity situation would arise. b) there was a maturity mismatch between the deposits and the investments in the fixed-income portfolio. It seems like they were playing a carry strategy trying to fund themselves short-term and investing further out on the curve to pick up yield. The risk, in this case, was a move higher in bond yields creating paper losses on the investment portfolio that were huge. In combination with the mistake above this proved fatal as the withdrawal of the deposits meant the bank had to realize its losses.”
Nevertheless, SVB’s bankruptcy was immediately and opportunistically picked up by conservatives in the USA who hope to use ESG as a distraction. Ron De Santis, Florida’s Governor and the presumptive Republican presidential candidate in 2024, argued that SVB was “so concerned with DEI and politics and all kinds of stuff. I think that really diverted from them focusing on their core mission.” Since then, and as the details of the bankruptcy became clearer, the rhetoric seems to have calmed down.
Nevertheless, a the glove was thrown down and in so doing, the question is raised. What was the role of ESG integration and sustainable investors in this bankruptcy. For good or bad, the truth seems to be a resounding “nothing”.
Clearly, sustainability played no role in bringing down SVB. But sadly it also failed to keep it afloat. There appear to have been a number of moments when sustainable factors, particularly on the governance side, could have played a role but sadly did not. The onus is not exclusively on investors. If we are to take this more encompassing view of this issue, regulators may also share in the blame.
As for sustainable investors, apparently, they missed a somewhat suspicious US$ 3.6 million share sale by SVB CEO, Greg Becker at the end of February. The issue seems to have come back to haunt Alecta, but also Norges Bank Investment Management (NBIM) as well as the 263 Article 8 and 29 Article 9 SFDR funds who were also shareholders. None of them appear to have caught the share sale nor SVB’s poor liquidity decisions. They also seem to have completely missed the fact that SVB didn’t have a chief risk officer for most of 2022, which may have been a contributing factor to the bad decisions taken by the bank.
Last but not least, it seems that SVB might be one of the first victims of the pull-back from the Dodd-Frank Act regulatory requirements introduced in the aftermath of the 2007-09 financial crisis. The original 2010 rule book required banks with over US$50 billion in assets to have to abide by stringent capital requirements, stress-test balance sheets and prepare resolution plans in case of failure. However, the threshold was raised to US$250 billion in 2018, during the Trump presidency, leaving SVB outside its remit and exposed to the dangers that befell it.
The Way Foward
SVB was only one of the local American banks that struggled at the start of March 2023. In Europe, Credit Suisse is facing owes of its own. Financial markets are still reeling from all this disruption and the Dow Jones US Banks Index had lost 14% since March 8th.
This crisis was clearly not the fault of sustainable investors. But those involved could have done better. As my colleague argues, “the curious case of SVB goes to show that no truly responsible investor can afford to be distracted by glossy headlines, neatly packaged ESG ratings and labels. Sustainable investing should be about paying more attention to fundamentals, not using ESG as an excuse to disregard them.”