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  • Writer's pictureJeff Reynolds

Matlock Looks at SVB and ALCO

Now Is the Time to Do Our Homework on Deposits

I find it interesting how my teenage children dictate what we watch as a family on TV. I laugh now at how times have changed, and I live in fear of going to war with a 17-year-old young lady that I materially outweigh!

During my youth, it was what my father wanted to watch, or you could go read a book.

Not much of a reader, I learned to appreciate the investigative and murder mystery themed series that my dad loved to watch. Rockford Files, Magnum PI, Matlock, and Murder She Wrote among them.

Little did I know that the deductive reasoning I learned in the process would come in handy later in life as we unpack the death spiral of Silicon Valley Bank.

As I do this, I am looking for things that I can learn and therefore better assist my clients in managing their balance sheet risks.


From the Editor

The 2023 Boston Bruins had a historic season. By winning 65 out of 82 games, they set the NHL’s record for wins in a season and points percentage. Every single quantifiable metric pointed to the Bruins as the “odds-on” favorite to win the most coveted trophy in sports (i.e., the Stanley Cup).

However, in a shocking turn of events, the 8th seeded Florida Panthers knocked off the Bruins in an epic seven game series.

Inevitably, the local fanbase and media have taken to the airwaves/Twittersphere to point fingers. Coaching, goaltending, referees, you name it, and it’s likely ended up in someone’s crosshairs.

It’s hard to not draw an immediate parallel to another organization that had a similarly spectacular fall from grace that “no one saw coming.”

The demise of Silicon Valley Bank also brought out the best in Monday morning quarterbacks looking to shoot first and aim later.

In this month’s Bulletin, DCG Managing Director Jeff Reynolds channels his inner “Matlock” and presents a case for what really facilitated the swift closure of SVB. Instead of deferring to some of the “convenient” yet incomplete narratives bandied about, he deductively takes us through an autopsy of SVB and points out what really was at the core of this failure.

Jeff's main point is to be careful when looking at this failure in a silo; instead, it’s best to understand the “connective tissue” that binds together all of the issues. Because as we already know, it’s never just one thing that sabotages a season or a financial institution

Vin Clevenger, Managing Director


Did interest rate risk take down Silicon Valley Bank?

A lot has been made of the loss position in SVB’s bond portfolio. Per the year-end call report, losses in Held to Maturity (HTM) securities were $17 billion, which was roughly equal to Tier 1 capital. Tangible capital, which included an after-tax loss on Available for Sale (AFS) of $1.8 billion, stood at $15.2 billion. Surprised?

You shouldn’t be.

The numbers were even worse at the end of the prior quarter: HTM loss of $21.9 billion versus Tier 1 capital of $17 billion. Tangible was at $14.8 billion, reflecting an even larger than year-end AOCI mark of $2 billion.

The key point here is that this information on substantial bond losses has been public for some time, and even showed improvement in three months with longer-term interest rates declining and the value on the bonds increasing. By a lot. The Matlock in me is concluding that the bond losses attributed to interest rate risk were not solely the problem on March 9th when the bank hemorrhaged roughly $500k of deposits per second.

Was it really a balance sheet restructure or something else?

On March 8, SVB announced that it had completed the sale of essentially all of its AFS bond holdings ($21 billion in bonds with an after-tax loss of $1.8 billion). This loss trade was anticipated to be earned back over a reasonable time frame as the proceeds would be redistributed to new assets at much higher rates or extinguish a negative carry by paying down higher cost short-term wholesale funding.

I would be shocked if every bank of every size were not pitched the same idea by a bond advisor at some point in the 4th quarter of 2022. While understanding the optics of shifting current earnings into future periods for publicly traded companies, DCG was also actively pointing out to clients that any loss trade transaction has negative value unless the bank changes the risk profile of the balance sheet. Said differently: selling out of a bond and buying it right back requires paying two commissions and results in negative value.

In this case, it did not seem like there was anything that implied the change in risk profile that could result in a payback period would have added significant risk. Was a $1.8 billion after tax hit the death knell for SVB? It may have contributed but it was not a deal breaker. They still had a Tangible Equity ratio of 7.27%, which would be near their new post transaction Leverage ratio. Their risk weighted capital ratios remained healthy enough.

Was it something I said? Or didn’t say?

SVB Financial Group was trading at $225 a share at the beginning of 2023. Despite the well-known bond losses and weakening outlook for the tech industry that SVB served, it traded up to $334 a share in early February. The day it announced the balance sheet restructuring, it was trading at $268 a share. But shares tumbled because it was also announced that it intended to raise $2 billion (give or take a quarter billion depending on the news release you read) in capital. This was very dilutive to existing shareholders and the share value landed at $106 before trading was suspended.

That capital raise announcement in tandem with the balance sheet restructure was probably not a wise decision. But was it the sole reason for what came next?

The enemy is at the gate…wait, they look kind of familiar!

As we understand it, SVB’s business model was built around a symbiotic relationship with private equity investors that encouraged (or demanded) their portfolio companies to bank with SVB. While I am speculating here, these PE investors knew that the tech industry was slowing, saw the SVB loss trade announcement and determined that the bank is going to attempt to recapitalize.

One might ignore the economic merits of the balance sheet restructure and feel that (perhaps) SVB had to sell their AFS portfolio for liquidity purposes. If that were the case, the next pool of assets was the HTM bonds with massive losses that would wipe out capital.

In practical terms, it’s hard to keep a trade this large under wraps. Rumors spread. There are stories that in the week leading up to March 9th many of those PE investors had a change of heart. They now demanded those companies withdraw their deposits immediately.

There is some tragic irony in this when you think about it.

From corporate cheerleader to hitman, the unrest of the PE investors was likely the death knell of SVB.

Peaceful Endings

An orderly liquidation of a bank is ideal and requires time. Having lead time to allow the bank to work to improve its situation is fair, as is knowing that failure to do so in a specified timeframe will ultimately lead to receivership. This time also allows the receiver to approach potential bidders, for the bidders to perform some due diligence, and with rare exceptions (at least in recent history), the winning bid acquires all deposit liabilities at par or even a slight premium. This negates the messy nature of the discussion about dealing with deposits above the FDIC insurance cap.

Having the lead time to get this done is imperative to prevent panic in the street and spread of contagion. This obviously was not the case with SVB and the swift and severe outflow of deposits, the lifeblood of a bank.

Darwin Award goes to…

There is a social media page dedicated to people making bad decisions and suffering severe harm. The name of the award is a nod to Darwinism and the concept of survival of the fittest. It is hard to read a story and say see a picture of the lead up and not conclude, “There is no way that guy is coming back from that.” That was March 9th for SVB.

$45 billion or so in deposit outflows in one day. $100 billion rumored in the on-deck circle for the next day. Approximately 75% of assets in about 36 hours. Nobody comes back from that. There would not be enough morphine, blood plasma, defibrillators, or ER staff to keep this patient alive.

The key take-away here is that there is talk about how this event will change expectations for liquidity management and on-balance sheet liquidity requirements.

I feel that a broad-brush mandate that requires all banks to cover a 75% of asset outflow of deposits is simply unreasonable.

The Blame Game

In the month and a half following March 10th and the takeover of SVB, the finger pointing is unsurprising.

But who or what is to blame?

Many, especially politicians, are upset about the government’s need to effectively guarantee all deposits. But that was necessary because of the unique circumstances outlined above and public panic that can spread quickly.

The roll back of Dodd-Frank regulation on banks under $250 billion in assets? I feel that is more of a credit risk management issue and less about what was at play at SVB. But credit stress testing should in fact be an expectation and key component of the quality of capital assessment for the regulators. Furthermore, the argument that these larger regional banking entities are not “systemically important” has also lost much of its credibility.

If SVB was not so highly concentrated in uninsured deposits (estimated at 85% or more) would there not have been such a rush of cash toward the exit door? Fair enough. As is criticizing management for taking too much duration risk in in the investment portfolio.

For me, the lack of awareness of how the market would perceive wiping out a couple billion in equity and announcing a capital raise was a key item here. That certainly did not help and the drop in share price grabbed a lot of unwanted attention. Was that considered (at all) in the context of the contingency liquidity management process? Should have been if it was not.

When you say the above out loud, it appears to be that the demise of SVB centers on what appears to be a fundamental lack of understanding about the deposit base and who the gate keeper of the deposit relationship truly was.

Savvy PE investors understand how financial statements work and are therefore much more decisive than the average depositor in mitigating their exposure to a potential bank failure.

That was likely the eye in the middle of a perfect storm.

Those that fail to learn from history are doomed to repeat it.

Over time, regulation has evolved to better ensure that history does not repeat itself. A recent example of the regulatory evolution process was on display during the Federal Reserve’s recent self-reflection and congressional testimony on April 28. The Fed acknowledged they weren’t forceful enough in requiring SVB to address risk warnings that bank’s governance process apparently did not feel was mission critical.

So, we know that changes lie ahead.

What are some of the rumors floating in the banking circles about what that evolution looks like?

Will regulatory capital now be based on inclusion of AFS bond losses in Tier 1 capital, as it is for banks above $250 billion? I sure hope not. There are so many negative unintended consequences when fair value accounting is mixed with accrual accounting.

Former FDIC Chair William Isaacs explains it in detail in his book Senseless Panic about the 2008 banking crisis. However, I would not be surprised to see an increase in tangible in assessing the quality of capital during exams. How would rising rates impact that ratio and would it hinder a bank’s ability to access different funding channels? Those are valid inquiries.

Another area of attention will likely be limits on uninsured deposit concentrations. It might surprise some, but funding concentrations are already highlighted in examination manuals, and large uninsured deposits are already in place for scoping liquidity risks. I would simply expect increased attention to those concentration risks.

Disclosure about bond portfolio risks? Please. SEC and call reporting requirements already cover this. If someone is arguing a lack of adequate disclosure on bond portfolio values, they should not be investing in banks and/or should just make sure they keep less than a quarter million in each institution.

What would Matlock say?

There were myriad issues that led to the failure of SVB. In isolation, the issues were manageable. But the unique nature of a deposit base, weak assessments of that risk, and poor contingency liquidity planning practices were at fault.

Make no mistake, when it comes to managing balance sheet risks, “good enough” will not pass muster after March 10 of 2023. I think that Matlock would be making the argument that this is where bankers should be looking for change and tighter regulation.

It is convenient to look at balance sheet risks in silos. Those that truly care about managing them care deeply about the connective tissues between those silos.

Caring about those connective tissues is no longer elective, but will be a requirement. As will be having the evidence to prove that out, in the form of robust analyses, backed by quality data and assumptions, and well communicated among management and the board of directors. At this point, Matlock would state that his case rests.


Contact DCG today to speak with one of our balance sheet experts, schedule a credit stress testing demo, or discuss your institution’s needs and goals. We look forward to hearing from you.



Jeff Reynolds is a Managing Director at Darling Consulting Group. After serving as an auditor in the insurance and banking industries, Jeff joined DCG in 1996. In this capacity, Jeff’s primary responsibility is advising clients on ways to enhance earnings while more effectively managing their risk positions. He regularly assists clients with strategic and capital planning projects and has also served on numerous due diligence teams for client acquisitions. Jeff is a frequent author and speaker on a variety of balance sheet management topics and has served as a guest faculty member for the ABA’s Stonier Graduate School of Banking.

An Eagle Scout, Jeff volunteers in his community as a Boy Scout leader and assists with leadership development programs. He received a B.S. degree in business administration from Salem State University in Massachusetts.


© 2023 Darling Consulting Group, Inc.


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