[seanhunter]

The data is full detail. You know if you don't put the winning bid in that one of your competitors are holding those assets, and in certain cases even know who is holding it [1]. In this case it doesn't really matter that much because most of the assets that caused the problem are not the loans but the MBS that SBV bought because it had massively increased deposits and couldn't find enough eligable borrowers to lend out to.[2]

[1] For various reasons it's not just "the winning bidder holds all the stuff". There's a lot of horse trading where people buy chunks of it and the winning bidder gets the rest. This is important from a TBTF point of view because the bank had a problem (ldo that's why it failed) so the FDIC and regulators don't really want a single other bank to just inherit all the problems. They would prefer them to be spread about a bit so there isn't just one bank under massive stress.

[2] Yes yet another bank failure caused by mortgage backed securities although in this case it seems from the public information that it was actually the hedging strategy that caused SBV to go down, not the MBS. The reason MBS means it doesn't matter that much is all the information about individual MBS is public anyway and although you don't know who holds what on a line by line basis you know generally how much each bank on the street has and you know someone is holding all the pieces of a given bond.

[beezle]

The only factor MBS had in any of this, and it was relatively small, was compared to "normal" notes and bonds (govt or corp) the duration of mortgages extends in a risking rate environment due to fewer prepayments. So rather than say a 4% change for every 100bp move in interest rates, the MBS might change 4.5 or 5%.

[hd95489]

How much of a haircut do the assets take during the process. I’m assuming nobody is paying market rate so how much under is the bid? Like 80% or like 30-40%

[seanhunter]

Deciding that is exactly what the auction is and it will depend on market conditions, the quality of the assets etc. In the case I was familiar with the assets were "AAA but actually garbage" for the most part and there wasn't a liquid market price so we bid really where we were guestimating the true market price would be but it was a heavy discount to where the failed bank had been holding it.

I don't think I'm actually at liberty to say what our bid was but if you think about the gathering storm of the financial crisis in 2008 and "AAA but garbage" illiquid instruments were very hard to price and very expensive to fund so were trading in the 60s (cents in the dollar that is). So if you're on teh weekend and you get offered a massive parcel of that stuff marked in the 90s that you don't really want to hold in the first place you're going to bid significantly south of where the market closed given you know this news is going to really rock the market when it opens on Monday.

In this case I think the MBS they are holding is going to be more liquid and with a reasonably secure secondary market, and you're not going to be able to do a proper valuation on the SME loans they have in a single weekend and there isn't a liquid market given each loan is it's own special creature so you're going to have to put a bit of a finger in the air on those. So probably somewhat of a haircut but less extreme.

[chernevik]

In 2008 mortgage bonds were toxic waste looking for a bottom, today they're not nearly so bad. I doubt SVB had a team reading the tape on mortgages, so whatever they were buying must have been sufficiently standard as to be fairly liquid. (Unless they were COMPLETE idiots, which, I grant, is certainly does not seem impossible right now.) So I expect the question for most of it is interest rate risk rather than credit and pricing that isn't super complicated.

I would think SVB's book of startup/venture capital/commercial loans would be harder for most banks to value. They were a big player in that space and I doubt many have the expertise to do a fast read on that book.

Also, SVB's size is a real problem. There are only a few banks large enough to do this, and the regulators won't love the resulting consolidation.

They may sell it in pieces to deal with all that.

One big question is, does SVB have any franchise value? It really looks like their model depended on cozy relations with the VC community. You have to figure their whole board and C-suite will be replaced after this, how much of those relations remain after that? Nor am I sure players like JP Morgan can or want to play that game.

[yumraj]

> It really looks like their model depended on cozy relations with the VC community.

Which the VCs shat on, so not sure how much of coziness remains.

[chiph]

There may be coalitions of smaller banks being formed, where they agree to submit a single bid, and then internally split up the carcass into the parts they each want should they win.

I haven't seen the terms of the FDIC auction but I suspect it's winner take all, so any coalition will also need a plan how to split up or share the undesirable pieces.

[colechristensen]

What’s your perspective on the likelihood of a few more similar bank failures happening in the next couple of quarters?

[seanhunter]

I don’t have any inside scoop because I’m not in that world any more, so take this purely as my personal opinion, but I wouldn’t be at all surprised if that happens.

A lot of seemingly successful business models are hard to distinguish from the beneficial effect of ultra-low rates and a stable, growing economy[1] so the sudden raising of rates is going to hurt a lot. I also think the full effects are taking a while to filter through into the real economy so I personally don’t think we’ve seen the worst impacts yet. I see a lot of empty office and retail space and know that someone took out a loan to build or buy that building and now don’t have the rental income to pay back that loan. Like I say just one person’s opinion so take it with a pinch of salt.

[1] Hence the famous Buffett quote. https://www.goodreads.com/quotes/43237-it-s-only-when-the-ti...

[panarky]

Intuitively, a hundred billion dollar auction with only a few hours to research, analyze and horsetrade must necessarily result in a lower winning bid.

Given all the uncertainty about the assets and other regional bank dominoes that are yet to fall, it seems like even the winner will be a low-ball offer.

Doesn't that mean a bigger haircut for uninsured depositors than would be the case if assets were methodically liquidated over a few weeks or months instead of a fire sale on one Sunday?

[lmm]

> Intuitively, a hundred billion dollar auction with only a few hours to research, analyze and horsetrade must necessarily result in a lower winning bid.

Maybe. Or maybe the winner's curse will apply.

> Doesn't that mean a bigger haircut for uninsured depositors than would be the case if assets were methodically liquidated over a few weeks or months instead of a fire sale on one Sunday?

Maybe. Equally the longer depositors can't access their deposits, the worse things are. FDIC would rather get the depositors their 100% quickly than get maximum recovery for junior debt or equityholders. Now, if there's no offer coming in that covers 100% of deposits, then that gets more interesting; it's always possible that the FDIC will decide to keep running the bank and purse that kind of strategy.

[drdec]

It sounds like they are selling the bank, not the assets. If they are selling the bank then I think the depositors will be made whole by the buyer. This will factor into the bid.

This is just my understanding, I am very open to being wrong.

[Maven911]

Since you're on this thread..who normally runs the investment decisions inside of a bank, whether retail or investment. Is there a CIO office or is that the function of their Treasury department? Does it go by other names?

And in your experiences in 2008, what sort of strategy planning/what if scenarios were being played out since it was unprecedented and no one knew what was going to happen the next day

[hd95489]

At the end of the day did everyone walk out of the deal knowing they made a boat load of money or were folks wondering if they would be able to offload and hedge the garbage they bought fast enough.

[treis]

The most (in)famous example is Bank of America buying Countrywide in the early stages of the 2007 crash. They ended up losing like 40 billion on that deal.

[seanhunter]

We were not successful but the people who “won” lost a ton of money.

[twoodfin]

Given the constraints, the result of this auction is likely to be the closest measurement of “market rate” we’re going to get.

[hd95489]

Only a few chosen players get to bid so it’s going to come with some haircut off market

[Bluecobra]

On Friday’s thread someone posted that the average return SVB bought was ~1.5%. If the average 30 year rate today is ~7.0%, an ~80% discount sounds correct.

[fdasflkjvalkjlk]

You're off by around a factor of 10 because you're valuing MBS as if they're annuities without a terminal value. MBS are backed by the USG and you get the full principal back at by maturity.

[adriancr]

They bought 10 year bonds at 1.5% yearly. For every 100$ they will get 116$ at maturity.

Right now there are 10 year bonds at 4% that will pay 148$ at maturity.

To be able to sell your 1.5% bonds right now you need to discount them sufficiently so they have the same value as the new 4% 10 year bonds. (otherwise why would anyone buy them)

I'd guess you'd need to discount 148$ - 116$ = 32$.

This means selling your 100$ bonds at 68$ right now to have buyers... Otherwise money is stuck for 10 years which is unfortunate if you ran out of available cash.

Is this wrong?

[loeg]

I believe I read that the average maturity of their holdings are ~6 years out of the full ten. It looks like T-notes with similar maturity are yielding around 3.9-4.0%.

> Right now there are 10 year bonds at 4% that will pay 148$ at maturity.

How are you calculating that? My impression is:

> Notes and bonds are issued to pay a fixed rate of interest called the coupon rate. A $10,000 treasury note with a seven percent coupon rate pays an investor $700 per year interest in two semi-annual payments of $350 each. The interest from notes and bonds paid out to investors is simple and does not compound

Over a 10-year duration, I think that 4% bond would pay $140 on $100. 6-year to maturity notes at 3.9% would pay, I believe, $123 on $100 today; and at 1.56%, $109.

I think you'd value the 1.56% notes by something like the ratio of the two values at maturity? About 89% of what you'd pay for a 3.9% note. ($100 / 0.886 => $112.87; $112.87 * 1.0936 => about $123.)

(I don't work in this sector and I might be mathing it wrong.)

[skippyboxedhero]

They have also been marked down already, that is what the big unrealised losses are about.

I am not 100% sure what the accounting rules for htm vs afs are anymore. I believe htm allows you to amortize losses over the term of the loan (which is, of course, still as controversial as it was in 2008). But SVB has already taken fairly substantial markdowns already on securities that were transferred into htm after they dropped significantly.

And the purpose of receivership is to preserve value for depositors. So the problem is that the losses have absorbed the firm's capital, not that other sources of funding have taken losses. A book of MBS is not going to be trading at a 30% discount to the mark a few weeks ago when their financial period ended. All of this stuff is liquid, unless their corporate lending was awful (unlikely) then there won't be a massive discount.

Btw, this did happen last year in the UK. The BoE essentially left the market to sort out problems caused by higher rates/falling bond prices, and hedge funds absolutely rinsed pension funds. Some made hundreds of millions in a few hours. This won't happen in this case because FDIC has stepped in and is running a proper auction.

[panarky]

The rule of thumb is every 100 bp increase in rates means a reduction in the market value of the security equal its years to maturity as a percentage.

So if rates are up 250 bp and there are 9 years remaining to maturity, that would be a 2.5 * 9% = 22.5% reduction in market value.

But I believe current yields on 10-year MBS are greater than 4%, the numbers I've seen put them at about 110 bp over 10-year Treasurys, which would make the reduction in market value even deeper.

[kgwgk]

> But I believe current yields on 10-year MBS are greater than 4%, the numbers I've seen put them at about 110 bp over 10-year Treasurys, which would make the reduction in market value even deeper.

Presumably they were yielding more than treasuries when they bought them as well. The relevant thing is whether the spread has narrowed or widened (too lazy to check and too coward to guess...).

[loeg]

I don't think 10-year T-notes are up 250 bps from 1.56% (might be mistaken -- looks like 235 bps to me), though 10-year MBS might be, and my impression is that SVB's average maturity is more like 6 years than 9. Those would both soften the impact on market value.

[hd95489]

So you would expect 8% cuts? Or 2%. I could see 8%-10 being about right.

[SoftTalker]

So if they had a more diverse portfolio and laddered maturities they might have been OK? And would that have been hard to do? Not a finance guy.

[christophilus]

Another thing that may have helped would be if they hedged their interest rate risk. That’s discussed on this podcast[0] by some folks who do that sort of thing for big banks.

It’s pretty nuts that they didn’t have a hedge in place, given the pretty clear policy of the Fed.

[0] https://pca.st/rq7eo75p

[seanhunter]

The stuff I read is that it was the hedge implementation that lost them all the money. It's very hard to know for sure how that happened without being inside the situation.

Long answer: Hedging rate risk in general is a very deep topic. Investment banks have massive swaps desks that are built on the back of this and there are numerous examples of people losing a ton on hedges and in certain cases the dealer banks have been fined for miss-selling etc. Not saying that's the case here but it is at least possible. For example in the UK there was this[1] and in the US from memory there were numerous munis who settled and received payouts after losing a ton on rates hedges.

On top of that, hedging rate risk on an MBS is slightly more complex than for a regular bond because it amortizes and as the underlying loans prepay or default this affects future cashflows from the bond. So you can only hedge the forward rate risk given certain assumptions about prepayment/default and if those assumptions turn out to be off you will be imperfectly hedged. Normally that isn't that big of a deal if you have a big portfolio as you can roll swaps on or off to fix the problem [2] but the cost of that adjustment is going to be a factor of how "wrong" you are about the default profile of the collateral and how much rates have moved.

[1] https://www.theguardian.com/business/2013/oct/23/interest-ra... [2] There is also the problem of default correlation skew here meaning you have so called "wrong way risk" where if your assumptions are wrong on one bond they're highly likely to be wrong across your portfolio. This is as opposed to normal portfolio thinking where a diversified portfolio helps.

[lordnacho]

Hedge costs money, and the instruments in question were not going to default, given they were government backed, so if they could just hang on until maturity they would get the yield from the day they bought them.

[kgwgk]

Holding bonds in a rising rates environment also costs money.

Hedging could have been a way to reduce the duration without selling - i.e. without realizing losses as the bonds could still be classified as hold-to-maturity - and avoid further losses.

They chose not to.

[lordnacho]

Not disagreeing with you, it was basically a decision they had and they went with the wrong one.

[astrange]

You can't get insurance on something that's certain to happen. Can you really hedge this without paying 100% of the cost of just not owning it?

[lmm]

Maybe. Essentially anything they could've bought would've had a similar kind of interest rate exposure. Laddering maturities would definitely have helped, but they expanded their portfolio quickly, and off-the-run issues are much less deeply traded, especially if you're a newcomer that doesn't have connections with the rest of the market.