10 Ways to Decode Silicon Valley Bank Collapse

10 Ways to Decode Silicon Valley Bank Collapse
10 Ways to Decode Silicon Valley Bank Collapse

After analyzing coverage of the Silicon Valley Bank failure, and having familiarity with some of the stakeholders involved, here’s my take on the collapse. Needless to say there are many dimensions still to be uncovered and dissected. But below is a sample of what I call the Codebreaker Mindset on the Silicon Valley Bank collapse shared with you in the form of 10 questions to encourage probing further into what happened and how it could have been prevented.

  1. Where was the fundamental risk management? Where was the Chief Risk Officer (CRO), CFO, Treasurer, Head of Compliance & Regulatory?
    • These are interrelated functions that must work together to safeguard a bank and stakeholders.
    • In any bank there should be rigorous models, processes, governance around market risk, credit risk, operational risk. Risk management also includes asset & liability matching which is the responsibility of the Treasurer who reports to the CFO.
    • It was reported that SVB was without a CRO for 8 months. In January, the new CRO was appointed.
    • Who was responsible for risk management when there was no CRO? What happened when the CRO arrived in Jan. 2023?
  1. Did stakeholders read the SVB annual report and audit report issued by KPMG?
    • One red flag is SVB’s note disclosure on “Quantitative and Qualitative Disclosures about Market Risk”. In the audit report published in 2022, KPMG noted a “critical audit matter” pertaining to “Allowance for credit losses for loans and unfunded loan commitments for certain portfolio segments evaluated on a collective basis”.
    • Anyone with domain (understanding interest rate risk and the impact on deposits, loans, short and long term securities), reading these note disclosures would question the sufficiency of SVB’s approach, and transparency in reporting exposure (frequency and severity) to market risk and interest rate risk.
    • These financial statement note disclosures a filled with so much technical and legal language can exhaust and confuse the reader, but the street translation is “There are issues”
    • It was reported that some of the hedge funds and asset managers understood this, acted on it, and engaged in arbitrate trading. In other words, making money short selling SVB stock.
  1. Where was SVB’s auditor?
    • KPMG has been SVB’s auditor for 28 years since 1994. This means KPMG has the continuity of 28 years of understanding SVB’s people, processes, systems, internal controls, governance, risks, and living through all the market cycles with SVB
    • It would have conducted audit procedures for 28 years on: deposits, loans, NII (net interest income); valuations of assets, liabilities, short and long-term securities, along with mark-to-market adjustments, market risk, credit risk and operational risk models & pricing.
    • What dialogue was the auditor having with SVB management, including the CFO, CRO, and chief auditor?
  1. What was the role of the Board of Directors? What was the role of the Audit Committee, Finance Committee and Risk Committee of SVB?
    • The SVB Board appears to have qualified board members including a former EY Vice Chair and audit partner, former CEO of investment banking at Barclays, former Under Secretary for Domestic Finance, U.S. Department of Treasury, and former president of business process outsourcing at Accenture.
    • What do the Board minutes say when KPMG presented its 2022 audit report, including the “critical audit matter”, to the Board, and Audit, Finance and Risk Committees?
    • Was complete, transparent information being reported to the Board of Directors, and in ways they could decipher what was going on?
  1. What do SVB regulatory filings reveal? What was/is the role of federal and state regulators, such as the Federal Reserve, FDIC, OCC, during the past 12 months of dramatic increase in interest rates?
    • Was regulatory reporting accurate, transparent, with substance matching form?
    • If the regulatory reporting was accurate and complete, issues should have been identified much sooner by SVB, regulators and auditors. Regulatory filings are continuous and at least quarterly and yearly. Corrective action and risk mitigation could have occurred earlier.
    • The Federal Reserve raised interested rates 4.5% (to 4.75%) over the past 12 months. We have not seen such a dramatic increase in interest rates in decades. How were regulators monitoring the impact of this on banks real time? How were regulators monitoring if banks were effectively managing and calibrating all risk metrics timely such as capital adequacy, asset & liability matching, etc.?
    • The FDIC insurance limited was raised to $250,000 per depositor, per institution in 2008. How do regulators, such as the FDIC, continuously evaluate and modernize risk protection measures to address the dynamic needs of stakeholders?
  1. What issues and insights, if any, were reported by the 23 equity research analysts covering and analyzing SVB?
    • Equity research analysts should have deep domain on the companies they cover, know the management teams, understand the business and risk models, regulations impacting the company.
    • These 23 equity research analysts work for big publicly traded and private investment banks.
  1. What did the buy side know such as hedge funds? The asset management firms, such as mutual funds and sovereign wealth funds, who hold SVB stock?
    • This includes portfolio managers and their research teams.
    • Understand all of the stakeholders in an equation because in any transaction, even those involving crisis, there are those who gain and those who lose.
  1. Why would SVB customers, especially those backed by venture capital, pull money out and cause a bank run?
    • The Venture Capital (VC) and Private Equity (PE) community, especially the VCs, had their portfolio companies pull cash out of SVB and this significantly contributed to fear and chaos. Many assert this did not have to happen.
    • Are any of these stakeholders invested in hedge funds where they benefit from hedge funds making money doing arbitrage trading (i.e., short selling SVB stock)?
    • The stakeholders close to SVB would have known there were issues, especially if they also follow the impact of interest rate risk and market risk.
    • Some of these stakeholders, such as VCs and portfolio companies, recently suffered losses because they had to significantly write-down valuations of portfolio companies invested in over the past 2-3 years.
    • Investors in startups wait 5-10 years to make money. Those investing in hedge funds doing this arbitrage trading against SVB make money now.
  1. Did SVB management, including the CEO, thoroughly understand its main customer base? And the range of actions to expect when there is fear and crisis?
    • SVB’s key customer base is characterized as “the innovation economy”; an ecosystem of start-ups and investors, especially VCs. SVB has served this community for the past 40 years and the CEO has been at SVB for the past 30 years.
    • In capitalistic environments when there is risk, fear, chaos, stakeholders focus on self-preservation. This is even more so in high risk vs. reward business paradigms such as the innovation economy.
  1. Who benefits from SVB’s collapse today and over the medium and long term? What internal and external forces were influencing decisions and outcomes?
    • The questions in this article offer opportunities to probe the who, what, where, when and why.
    • Irrespective of form and function, who were making the substantive judgment calls and decisions?
    • Were there delays to take action?

In ecosystems where value is both created and at risk, the Codebreaker Mindset helps arrive at the root and defining causes, actions and outcomes. Perhaps it may be months and years before we uncover all the answers to the questions in this article. More questions will inevitably arise along the way.

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