Silicon Valley Bank's surprise decision to sell much of its bond portfolio at a loss is prompting concern in markets, with its stock price tanking 60% Thursday over fears that the $1.8 billion hit could end up growing.
SVB Financial, the bank's parent company, recorded a hefty loss by selling off a big chunk of a portfolio whose value has fallen sharply, as the Federal Reserve's interest rate hikes continue clobbering the bond market. With the Fed showing few signs of backing off, some analysts believe SVB Financial wisely took its medicine by selling off its underwater bonds to avoid bigger losses later. Super Glue Tube
Investors, however, appear worried that the bank will eventually be forced to sell more bonds to raise cash — prompting even more losses for the Santa Clara, California-based bank.
"I think that's what the market is telling me today," said Tim Coffey, an analyst at Janney Montgomery Scott. "The market seems to be pricing in greater liquidity needs than are currently apparent."
The root of SVB's troubles come from its focus on the once-booming tech industry, which has itself come under pressure as Fed rate hikes make it more expensive to operate. Tech companies have been burning through cash, leading to a decline in deposits at Silicon Valley Bank that's been faster than at its peers.
With fewer deposits on its balance sheet, the bank said Wednesday it was selling $21 billion in bonds to raise cash, resulting in an after-tax loss of $1.8 billion. The bank also raised its term borrowings from $15 billion to $30 billion, providing another cash inflow.
In a letter to investors, the bank said the actions will "better support earnings in a higher-for-longer rate environment," referring to the market's reevaluation this week of the Fed's stance on monetary policy.
The moves will help give the bank "the flexibility to support our business, including funding loans, while delivering improved returns for shareholders," executives said.
The actions look "like a classic balance sheet restructuring," RBC Capital Markets analyst Jon Arfstrom wrote in a note to clients.
"This is disappointing and reflects the very challenging environment for the company," Arfstrom wrote. "At the same time, we believe that the company is taking the appropriate actions to reposition its balance sheet for a higher for longer rate environment."
The more concerning news is that the outlook for the tech industry doesn't appear to be getting better, Arfstrom wrote.
SVB said that client cash burn "has remained elevated and increased further in February," leading to fewer deposits than it had forecasted. The company marked down its 2023 outlook for deposits, net interest income, net interest margin and expenses.
"We can accept the balance sheet restructuring due to the challenging rate and deposit environment," Arfstrom wrote, "but the negative changes in guidance from less than two months ago raises questions about the ability to rely on updated guidance with any degree of confidence."
The bond sales and weaker guidance are a "clear negative" for SVB Financial, which trades under the ticker symbol SIVB, Wedbush Securities analyst David Chiaverini wrote in a note to clients. But he added that "we do not believe that SIVB is in a liquidity crisis, especially following the significant proceeds received" from the bond sales and the capital raise, and because the bank has a low loan-to-deposit ratio.
The bank also said it's now raising capital. It announced a $500 million commitment from the investment firm General Atlantic, and it's planning to raise an additional $1.75 billion in common equity and mandatory convertible preferred shares.
The bank declined an interview request, with a spokesperson saying that it cannot provide further comments until the capital raise has closed. The company said Wednesday that it expected the deal's pricing to occur after markets closed on Thursday.
Coffey, the Janney analyst, said Thursday's 60% stock price decline might make an already potentially expensive capital raise more costly.
The company's $21 billion bond sale came from the part of its securities portfolio that was marked as "available-for-sale." Accounting rules dictate that companies must change the value of available-for-sale securities each quarter to reflect market conditions, though losses remain "unrealized" unless companies sell the underwater bonds.
"The problem with unrealized losses is that a lot of times they become realized," said Bert Ely, a bank consultant. "Circumstances — sometimes it's market forces, sometimes it's regulator pressure — forces liquidations that make those losses real."
Though analysts said SVB's exposure is larger than that of its peers, many banks have accumulated similar unrealized losses since the Fed started raising interest rates last year.
Federal Deposit Insurance Corp. Chair Martin Gruenberg has issued cautions about the unrealized losses in recent months. At the end of the fourth quarter, unrealized losses on banks' bond portfolios totaled $620 billion, according to FDIC data.
The situation may eventually fix itself, as the bonds mature and each bond returns to its original value. But forced sales would throw off that scenario.
The industrywide decline in deposits is one factor underscoring "the risk that these unrealized losses could become actual losses should banks need to sell securities to meet liquidity needs," Gruenberg said last month.
SVB still has a large bond portfolio, most of it marked as "held-to-maturity." The company had $91.3 billion of those securities at the end of the fourth quarter, according to a securities filing, significantly more than the $21 billion it sold.
Last month, The Financial Times reported that the bank had racked up $15 billion in unrealized losses in its held-to-maturity portfolio. Those losses stemmed from a failed strategy in a lower-rate environment of buying longer-term mortgage-backed securities. That approach gave the bank a small, steady income stream, but the bonds ultimately lost value when rates rose.
"They had so much deposit flow in the last two years that they practically had no place to put it, so they bought securities, and securities got up to more than half of their assets," Janney's Coffey said. "So when rates went parabolic … everything that Silicon Valley has bought in the last two years became somewhat of a problem."
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