Written by: Ken Burke, CPA/PFS CBEC®
As more information becomes available about the SVB failure, there are important lessons for all of us to understand and apply to our personal finances.
In my opinion, there are a few Universal Laws that apply equally to business and personal finance:
- Cash is King
- Understand and Manage Risk
- Don’t Stretch
Let’s Talk About SVB: The BIG Issue
- SVB sold $21 Billion of Treasuries and agency bonds realizing a $1.8 billion loss. This was a big deal, and depositors agreed as they rushed to pull deposits from the bank when the news broke.
Executives Sell Stock and Pay Bonuses—What? According to CNBC:
- Gregory Becker, SVB President and CEO, sold $3.6 million of SVB stock about two weeks before the bank failed.
- SVB executives sold $84 million of SVB stock over the past two years.
- SVB paid out employee bonuses on Friday of last week just hours before Regulators seized the bank.
Universal Law #1: Cash is King
In other words, cash flow planning is King. SVB was focused on the Technology sector which is evident in the name of the bank. This concentration accelerated the growth of the bank, and also led to its demise. The tide of capital into the bank began to go out. The customers needed to draw on their cash reserves to pay bills.
Challenge #1: The tide was going out, increasing the current liability for cash withdrawals. When the news broke about the $1.8 billion loss on bond sales, it must have looked like the scene from “It’s a Wonderful Life.” Unfortunately, SVB’s CEO was Gregory Becker and not George Bailey.
SVB had bonds (Treasuries), not cash. A Bond is not King, Cash is King.
Universal Law #2: Understand and Manage Risk
I thought treasuries were a safe investment. All bonds—corporate, municipal, agency and government—are subject to market fluctuation due to interest rate risk. The longer the duration of the bond, the higher the risk. Let’s look at a 1-year chart of TLT, ISHARES 20 YEAR TREASURY BOND ETF:
As of February 28, 2023, the annual return was -25.64%. The primary driver of this loss is the rising interest rate environment. According to the FDIC, banks had approximately $600 billion in unrealized losses on Treasuries and mortgage-backed securities at the end of 2022. The key term is “unrealized.” If the banks hold the bonds to maturity, the unrealized loss goes away. If you happen to sell, as SVB did, the unrealized loss becomes realized and the run on the bank begins.
Challenge #2: Selling a long-term investment for a short-term need. As you can see, long-term bonds are subject to interest rate risk. I’m sure the bank executives knew this, but they didn’t manage it.
Identifying and managing this risk is a process of matching the maturity of investments and obligations. A long duration investment, a 20-year bond, that is needed for short-term cash flow is a mismatch in maturities.
Universal Law #3 Don’t Stretch
If I was a personal trainer, I would recommend you stretch, but I’m not. As you know, I’m referring to investment management. What is stretching when it comes to investments?
- Feeling like you must invest more aggressively to make up for previous losses.
- A lack of investment diversification in your portfolio.
- No consideration of your cash flow-time horizon.
SVB overinvested their capital by banking standards, hoping they could increase their return on invested capital. It appears they didn’t consider or chose to ignore the time-horizon of customer withdrawals. They obviously didn’t maintain enough cash to cover short-term needs.
SVB’s 52 week high was $597.16. I imagine SVB shareholders wished they knew what the executives knew two years ago and decided to sell at the top.
Challenge #3: The modernization of hope and greed. Hope and greed are not core values of investing or running a business. You might need a small measure of each to take on the risk of investing or owning a business, but they are not the guiding principles.
- Maintain adequate levels of cash to meet your current obligations. We often refer to this as liquidity planning and it is central to our retirement planning approach.
- Identify, understand, and manage risk. It is fun to run financial projections when everything is going well. We love helping clients plan for a happy and successful retirement, but planning isn’t complete until we look at unfortunate life events. There are plenty of risk beyond investing in the stock market:
- Health issues
- Death or disability
- Large unplanned expenses
- Aggressive tax policy
We are here to help and provide perspective when events like SVB’s failure happen. We don’t believe this is the beginning of the end. Our advice is to stay the course and update your plan with your High Falls Advisor. Your advisor can help you view these recent events through your plan to determine if any adjustments need to be made.
I wonder if George Bailey’s guardian angel, Clarence, could have intervened on behalf of SVB shareholders and earned another set of wings?