The Manila Times

Silicon Valley Bank: Mark to market and realized gains and losses

STEPHEN CUUNJIENG

AMONG the hand-wringing of the chattering class opposed to the Maharlika fund or whatever it is in the process of becoming have been histrionic claims about how even the bluest of blue-chip sovereign wealth funds, the Norway Oil Fund, lost $160 billion last year. Now Warren Buffet’s Berkshire Hathaway lost $22.8 billion last year as well (they “made” $89.795 billion the year before). Then came the collapse of Silicon Valley Bank, a specialized bank much used and appreciated by tech startups and not just in the US, thanks to having to sell securities not marked to market, but held to maturity in an emergency need for liquidity and realizing actual losses.

What then is the difference between the mark-to-market losses of Berkshire Hathaway and Norway Oil Fund and the actual losses of Silicon Valley Bank?

Actual losses

Let’s start with the complicated one which in this case is the simpler one — the mark-to-market losses. For over 20 years asset managers have been required to mark to market their portfolio positions in equities and in some cases debt, whether long-term or short-term even if not sold. What does that mean? Every year end you need to mark to market the value of those securities. If publicly traded stocks or bonds, one generally uses their closing price. That partly explains what is meant when you hear asset managers are “window-dressing” their portfolio close to year end. If you bought the security that year at $1,000 per bond and the bond is trading at year end at $1,010, then you have to book a mark to market gain of $10 per bond of 1 percent. If the next year you still held it and it is now trading at $1,009, then even though it’s still above your acquisition cost of $1,000, what is relevant is you now are mark to marking it from $1,010 to $1,009 so now you have to book a mark to market loss of 0.1 percent.

Can debt be held to maturity and not marked to market? If the debt instrument has a maturity of over one year it is intended to be held until maturity, it can be amortized rather than marked to market. Or placed in the trading book and marked to market. With long-term debt securities, you have the option to choose. It is different with equities. Common stock which has no maturity date is not eligible for hold to maturity and must be marked to market even if there is no plan to sell it. There is no hold to maturity as even if there may be a plan to hold, there is no maturity. So the other part of the equation in hold to maturity is missing.

Note in the year of the mark to market gain or the loss, the fund or asset manager did not realize the gain or the loss as it was not sold, but the carrying value is the mark to market value though there are no

cash flow implications. Bonds don’t normally trade at wide ranges in the short term unless there are unusual events (if this was a movie this line would be accompanied by ominous foreshadowing music at this point with double basses and cellos playing menacing tremolos) as we shall see later with Silicon Valley Bank. The small ranges given as an example are realistic. Equities are more volatile and double-digit swings for individual stocks are common, but for a broad portfolio the range of gains and losses are more commonly in the single digits or low teens. A third category would be unlisted or untraded securities and usually fund managers hire an independent adviser to do a valuation based on company performance, any other sales or capital raises that happened and comparable transactions whether private or public to arrive at a mark to market for these.

This is what happened with Berkshire Hathaway and Norway’s Oil Fund. Most of their multibillion losses like most of the prior multi-billion-dollar gains were not realized gains or losses but marked to market. So, there was no cash in or cash out, just updated valuations based on price movements on the underlying securities.

Bank run

On LinkedIn, Rich Falk-Wallace, the CEO of Arcana, wrote a very informative post of what happened with Silicon Valley Bank (SVB). Based on that analysis plus articles on Bloomberg, the New York Times and Financial Times, it seems to be a modern version of an old-style bank run. The catch which partly cost some pain and surprise leading to a panicked run on the bank was that SVB was a specialized bank that ably but nearly solely catered to tech start-ups and the ecosystem around it like venture capital firms and private equity funds and their limited partners, managers and investors. First, they announced in a footnote to their year-end results that in addition to their mark to market losses, they had $15 billion of unrealized losses in their hold to maturity book. This alarmed watchers as SVB had $212 billion of assets against $200 billion in liabilities and $12 billion in equity. That potential loss in their hold to maturity led to their entire equity cushion being wiped out and the bank being in a net deficit. Exacerbating this was last March 8 when they announced that they sold $21 billion of liquid assets at a loss of $1.8 billion from what was their hold to maturity book to cover those losses. That led the next day, March 9, to investors getting spooked by the greater than expected loss and poor net interest margin outlook. Depositors gave instructions to withdraw $42 billion of which $16 billion was successful. That left the bank with negative cash of minus $1 billion and the FDIC took over on Friday, March 10.

Please read the last paragraph again as it is the heart of the problem. Losses exceeding total equity led to a run on the bank as depositors wanted to withdraw en masse in one day! Why is this compressed and concentrated run on the bank? First, Silicon Valley Bank is a special and unique type of bank. It was set up and catered to tech companies and their specific needs and more so for tech startups backed by prestigious venture capital and private equity firms. Model worked very well and the bank was formed in 1983 by former Bank of America managers. It hit its stride in the mid-1990s with their internet book and continued doing very well until last year. It operated out of 13 countries and was much favored by the tech and start-up community. I actually feel sad as it did not have to end this way. Except for not reacting well to the fast pace of interest rate increases by the Federal Reserve last year (which was a reversal of prior guidance), it was a really well-run bank with a model worth emulating. The failure was not one of the strategy, fraud or bad loans, but of not ably managing the net interest rate margin between deposits and their loans and securities and anticipating the need for many of their depositors to run down their deposits given the hardship tech companies, especially their core clients — the early-stage ones — had starting last year.

Deposits

What was the problem? Ironically, not loans but its deposits. SVB was not a retail bank and most of its deposits were from the wholesale market or cash of early-stage firms funded by leading venture capital and private equity firms. SVB also gave modest credit lines backed by shares to these start-ups which were well-received and performed well. The problem was what they matched short-term deposit liabilities with, which were mostly treasuries, bonds and mortgage-backed securities of longer duration. With the steep increase in interest rates the margin shrank and as these firms ran down or withdrew their deposits they had to sell or unwind the longer-term assets (the treasuries and so on) at a loss.

That led to what I described earlier and the losses that wiped out its equity cushion. The FDIC and Federal Reserve has since announced that all depositors will be made whole as the asset book is fine if allowed to unwind at maturity just not a fire sale as they were forced to resort to before being shut down. SVB was not too big to fail, but its depositors were.

Pity as they really were invaluable to start-ups.

Another lesson was the Federal Reserve reopened its emergency loan window to allow orderly wind-downs of positions at maturity for SVB and similarly situated banks. So do we really want the BSP to contribute its profits to Maharlika as proposed by Congress or continue to plow back all of it as additional capital to support and enhance its ability to deal with contingencies and crises that may arise here? A rhetorical question if there ever was one. At least to me.

Opinion

en-ph

2023-03-17T07:00:00.0000000Z

2023-03-17T07:00:00.0000000Z

https://manilatimes.pressreader.com/article/281633899470536

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