By Sari Zeineddine | Staff Writer
Non-Hedged Assets: Lessons from Lollar and SVB
The disastrous end of SVB, caused by poor risk management equally on the assets and liabilities side, is not to be compared to the Lebanese Banking Crisis. However, this article will draw some similarities associated with moral hazards and poor risk management. Note that the similarities are not structural, as the Lebanese Banking System was running on a Ponzi Scheme while SVB clearly wasn’t.
What happened with SVB?
Simply put, SVB had a large portfolio of bonds that wasn’t hedged with swaps: it mainly contained Mortgage-backed Securities and Treasury & Corporate Bonds. The issue with such a portfolio, beyond its portfolio being 57% of the assets (JPM only 30%), is that it was highly sensitive to interest rate risk and most importantly it was completely unhedged: An increase in interest rates would wipe out huge amount of the value of these securities, and that’s what happened.
On the other side of the balance sheet, the funding base of SVB was highly concentrated with deposits coming from Venture-related startups, crypto and tech fools. With the hawkish Fed, these companies were urged to start withdrawing in order to fund their operations. And note that deposits stopped coming in, which makes sense as such sectors are really sensitive to high interest rates and liquidity (Ironically, crypto seems to be more sensitive to interest rates than the typical US Money Holding formula).
In a nutshell, huge outflows pushed SVB to sell their Available-for-sale (AFS) securities at their fair value. If mark-to-market accounting was to be applied to the whole portfolio, AFS and Held-to-Maturity (HTM) securities, the mismatch between assets and liabilities would be disastrous. Obviously, SVB’s management wasn’t stupid but clear moral hazards were at play: SVB paid nearly 0% on deposits, and with no swaps, their spreads looked attractive.
Bonds v/s Swaps: Why banks play this game.
Banks hold bonds to get the coupon, and they are required to do so in terms of regulations. Regulations roughly require banks to hold 20% of their assets in High-Quality-Liquid Assets (HQLA). To contain the exposure of banks to interest rates risk, they usually enter a swap agreement to hedge this risk: Banks get the fixed coupon (holding Bonds) and pay a fixed one (Swap Agreement). They usually benefit from the spread between Bond Yields and Swap Yields.
SVB simply wasn’t involved in Swaps at all (approx.).Swaps are a type of derivatives and therefore they appear in the Income Statement so SVB tried to contain this volatility in the Income Statement by not entering much swap agreements.
Lollar vs SVB: the lessons traced
Lebanese banks kind of entered in the same position of SVB. The difference is ironically speaking with the high interest rates on deposits Lebanese Banks could never hedge their capital structure, what swap would ever pay you a 15%? SVB’s deposits didn’t grow faster than the economy, which prevents it from being a Ponzi like the Lebanese Banking Sector. The thing is that Lebanese Banks also willingly entered in similar operations: Portfolios hugely exposed to one instrument (government bonds) without assessing its risk at all. Lebanese banks cared not about risk management until deposit inflows couldn’t help them match the losses on the asset side (Eurobonds, T-Bills, and the par of the loans they made). Lebanese banks were completely involved in a Ponzi, but the similarities are to be found in the risk management that both SVB and Lebanese banks didn’t care much about as long as the moral hazards are satisfied.