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1. Bank buys lots of mortgages (well, assets backed by mortgages) at 0 interest rates. Let's say those mortgages are $100 each. 2. Fed raises interest rates. N

1. Bank buys lots of mortgages (well, assets backed by mortgages) at 0 interest rates. Let's say those mortgages are $100 each. 2. Fed raises interest rates. Now new mortgages are shiny (they return more money) and those old mortgages are shitty, so now they are worth $75 ea. Normally not a problem as they can wait for those mortgages to mature and get $105. 3. Tech sector experiences a crunch. All the sudden more and more companies are taking money out of their bank account. 4. In order to process withdrawals, SVB is now forced to sell the mortgages it bought for $100 for $75. If this continues SVB won't be able to find enough money to pay depositors.

topicseed 4y ago
thank you, this was helpful
randlet 4y ago
Great summary, thanks (assuming it's accurate!).
toast0 4y ago
> 2. Fed raises interest rates. Now new mortgages are shiny (they return more money) and those old mortgages are shitty, so now they are worth $75 ea. Normally not a problem as they can wait for those mortgages to mature and get $105. It's not that new mortgages are shiny and old mortgages aren't; it's that $100 in 5 years (or whatever) is now worth less. It's easier with zero coupon bonds, because there's only the maturity, so a $100 zero coupon bond that matures on date X is worth $Y, regardless of when it was issued; and $100 mortgage that completes on date X needs to have each payment adjusted for current value. Clearly, a smaller series of payments is worth less than a larger series of payments, even though the principal amount is the same.
- lamontcg 4y ago
  Yeah really its based on long-term t-bills and the risk premium. Because safe interest rates went up, people can get a better deal on long term debt unless they get a discount on the bonds from SVB so that in the end the SVB bonds work out to a the current interest rates, if held to maturity. This is how bond prices move opposite to the external interest rate environment. There is also a risk premium since t-bills are considered perfectly safe, while these mortgage backed securities are likely now carrying a risk premium so buyers want an even higher effective interest rate out of them. It isn't really new-vs-old, it is just the interest rate environment. If there was zero new issuance of debt people would still be trading the old debt at the same interest rates and the value of the bonds held by SVB still would have been underwater. Of course if there wasn't enough debt to satisfy the appetite for buying debt then the prices would rise and get bid up, but we'd see this as a lowering of interest rates in these markets (which isn't happening).
mypalmike 4y ago
> SVB is now forced to sell the mortgages it bought for $100 for $75. Not quite. The article addresses this in detail. They bought mostly hold-to-maturity (HTM) bonds which could not be sold. (Technically such bonds could be sold, but selling would trigger a portfolio revaluation of all their HTM bonds, which would have made them immediately insolvent.)
- zby 4y ago
  Here is a quote I found in the article: "The decision dictates whether the securities are designated as “held-to-maturity” (HTM) assets " - HTM was an internal designation - an accounting convention. It does not have anything to do with the bond terms.
  - mypalmike 4y ago
    I'm not an expert. But it appears to be an accounting designation that shows up in filings, so it's not purely internal. You are correct that they are not part of the bond terms, which I was unclear on before. "HTM assets are not marked to market... they remain glued to balance sheets at amortised cost regardless. By contrast, AFS assets are marked-to-market... Sell even a single bond out of an HTM portfolio, however, and the entire portfolio would need to be re-marked accordingly." There's a bit more detail here, but it doesn't get into the re-marking aspect. https://www.investopedia.com/terms/h/held-to-maturity-security.asp https://www.investopedia.com/terms/h/held-to-maturity-securi...

topicseed 4y ago

thank you, this was helpful

randlet 4y ago

Great summary, thanks (assuming it's accurate!).

toast0 4y ago

> 2. Fed raises interest rates. Now new mortgages are shiny (they return more money) and those old mortgages are shitty, so now they are worth $75 ea. Normally not a problem as they can wait for those mortgages to mature and get $105. It's not that new mortgages are shiny and old mortgages aren't; it's that $100 in 5 years (or whatever) is now worth less. It's easier with zero coupon bonds, because there's only the maturity, so a $100 zero coupon bond that matures on date X is worth $Y, regardless of when it was issued; and $100 mortgage that completes on date X needs to have each payment adjusted for current value. Clearly, a smaller series of payments is worth less than a larger series of payments, even though the principal amount is the same.

lamontcg 4y ago
Yeah really its based on long-term t-bills and the risk premium. Because safe interest rates went up, people can get a better deal on long term debt unless they get a discount on the bonds from SVB so that in the end the SVB bonds work out to a the current interest rates, if held to maturity. This is how bond prices move opposite to the external interest rate environment. There is also a risk premium since t-bills are considered perfectly safe, while these mortgage backed securities are likely now carrying a risk premium so buyers want an even higher effective interest rate out of them. It isn't really new-vs-old, it is just the interest rate environment. If there was zero new issuance of debt people would still be trading the old debt at the same interest rates and the value of the bonds held by SVB still would have been underwater. Of course if there wasn't enough debt to satisfy the appetite for buying debt then the prices would rise and get bid up, but we'd see this as a lowering of interest rates in these markets (which isn't happening).

mypalmike 4y ago

> SVB is now forced to sell the mortgages it bought for $100 for $75. Not quite. The article addresses this in detail. They bought mostly hold-to-maturity (HTM) bonds which could not be sold. (Technically such bonds could be sold, but selling would trigger a portfolio revaluation of all their HTM bonds, which would have made them immediately insolvent.)

zby 4y ago
Here is a quote I found in the article: "The decision dictates whether the securities are designated as “held-to-maturity” (HTM) assets " - HTM was an internal designation - an accounting convention. It does not have anything to do with the bond terms.
- mypalmike 4y ago
  I'm not an expert. But it appears to be an accounting designation that shows up in filings, so it's not purely internal. You are correct that they are not part of the bond terms, which I was unclear on before. "HTM assets are not marked to market... they remain glued to balance sheets at amortised cost regardless. By contrast, AFS assets are marked-to-market... Sell even a single bond out of an HTM portfolio, however, and the entire portfolio would need to be re-marked accordingly." There's a bit more detail here, but it doesn't get into the re-marking aspect. https://www.investopedia.com/terms/h/held-to-maturity-security.asp https://www.investopedia.com/terms/h/held-to-maturity-securi...