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The data is full detail. You know if you don't put the winning bid in that one of your competitors are holding those assets, and in certain cases even know who

The data is full detail. You know if you don't put the winning bid in that one of your competitors are holding those assets, and in certain cases even know who is holding it [1]. In this case it doesn't really matter that much because most of the assets that caused the problem are not the loans but the MBS that SBV bought because it had massively increased deposits and couldn't find enough eligable borrowers to lend out to.[2] [1] For various reasons it's not just "the winning bidder holds all the stuff". There's a lot of horse trading where people buy chunks of it and the winning bidder gets the rest. This is important from a TBTF point of view because the bank had a problem (ldo that's why it failed) so the FDIC and regulators don't really want a single other bank to just inherit all the problems. They would prefer them to be spread about a bit so there isn't just one bank under massive stress. [2] Yes yet another bank failure caused by mortgage backed securities although in this case it seems from the public information that it was actually the hedging strategy that caused SBV to go down, not the MBS. The reason MBS means it doesn't matter that much is all the information about individual MBS is public anyway and although you don't know who holds what on a line by line basis you know generally how much each bank on the street has and you know someone is holding all the pieces of a given bond.

hd95489 4y ago
How much of a haircut do the assets take during the process. I’m assuming nobody is paying market rate so how much under is the bid? Like 80% or like 30-40%
- twoodfin 4y ago
  Given the constraints, the result of this auction is likely to be the closest measurement of “market rate” we’re going to get.
  - hd95489 4y ago
    Only a few chosen players get to bid so it’s going to come with some haircut off market
- seanhunter 4y ago
  Deciding that is exactly what the auction is and it will depend on market conditions, the quality of the assets etc. In the case I was familiar with the assets were "AAA but actually garbage" for the most part and there wasn't a liquid market price so we bid really where we were guestimating the true market price would be but it was a heavy discount to where the failed bank had been holding it. I don't think I'm actually at liberty to say what our bid was but if you think about the gathering storm of the financial crisis in 2008 and "AAA but garbage" illiquid instruments were very hard to price and very expensive to fund so were trading in the 60s (cents in the dollar that is). So if you're on teh weekend and you get offered a massive parcel of that stuff marked in the 90s that you don't really want to hold in the first place you're going to bid significantly south of where the market closed given you know this news is going to really rock the market when it opens on Monday. In this case I think the MBS they are holding is going to be more liquid and with a reasonably secure secondary market, and you're not going to be able to do a proper valuation on the SME loans they have in a single weekend and there isn't a liquid market given each loan is it's own special creature so you're going to have to put a bit of a finger in the air on those. So probably somewhat of a haircut but less extreme.
  - colechristensen 4y ago
    What’s your perspective on the likelihood of a few more similar bank failures happening in the next couple of quarters?
    - seanhunter 4y ago
      I don’t have any inside scoop because I’m not in that world any more, so take this purely as my personal opinion, but I wouldn’t be at all surprised if that happens. A lot of seemingly successful business models are hard to distinguish from the beneficial effect of ultra-low rates and a stable, growing economy[1] so the sudden raising of rates is going to hurt a lot. I also think the full effects are taking a while to filter through into the real economy so I personally don’t think we’ve seen the worst impacts yet. I see a lot of empty office and retail space and know that someone took out a loan to build or buy that building and now don’t have the rental income to pay back that loan. Like I say just one person’s opinion so take it with a pinch of salt. [1] Hence the famous Buffett quote. https://www.goodreads.com/quotes/43237-it-s-only-when-the-tide-goes-out-that-you-learn https://www.goodreads.com/quotes/43237-it-s-only-when-the-ti...
- Bluecobra 4y ago
  On Friday’s thread someone posted that the average return SVB bought was ~1.5%. If the average 30 year rate today is ~7.0%, an ~80% discount sounds correct.
  - fdasflkjvalkjlk 4y ago
    You're off by around a factor of 10 because you're valuing MBS as if they're annuities without a terminal value. MBS are backed by the USG and you get the full principal back at by maturity.
    - hd95489 4y ago
      So you would expect 8% cuts? Or 2%. I could see 8%-10 being about right.
    - adriancr 4y ago
      They bought 10 year bonds at 1.5% yearly. For every 100$ they will get 116$ at maturity. Right now there are 10 year bonds at 4% that will pay 148$ at maturity. To be able to sell your 1.5% bonds right now you need to discount them sufficiently so they have the same value as the new 4% 10 year bonds. (otherwise why would anyone buy them) I'd guess you'd need to discount 148$ - 116$ = 32$. This means selling your 100$ bonds at 68$ right now to have buyers... Otherwise money is stuck for 10 years which is unfortunate if you ran out of available cash. Is this wrong?
      - panarky 4y ago
        The rule of thumb is every 100 bp increase in rates means a reduction in the market value of the security equal its years to maturity as a percentage. So if rates are up 250 bp and there are 9 years remaining to maturity, that would be a 2.5 * 9% = 22.5% reduction in market value. But I believe current yields on 10-year MBS are greater than 4%, the numbers I've seen put them at about 110 bp over 10-year Treasurys, which would make the reduction in market value even deeper.
        4y ago
SoftTalker 4y ago
So if they had a more diverse portfolio and laddered maturities they might have been OK? And would that have been hard to do? Not a finance guy.
- christophilus 4y ago
  Another thing that may have helped would be if they hedged their interest rate risk. That’s discussed on this podcast[0] by some folks who do that sort of thing for big banks. It’s pretty nuts that they didn’t have a hedge in place, given the pretty clear policy of the Fed. [0] https://pca.st/rq7eo75p https://pca.st/rq7eo75p
  - lordnacho 4y ago
    Hedge costs money, and the instruments in question were not going to default, given they were government backed, so if they could just hang on until maturity they would get the yield from the day they bought them.
    - kgwgk 4y ago
      Holding bonds in a rising rates environment also costs money. Hedging could have been a way to reduce the duration without selling - i.e. without realizing losses as the bonds could still be classified as hold-to-maturity - and avoid further losses. They chose not to.
      - lordnacho 4y ago
        Not disagreeing with you, it was basically a decision they had and they went with the wrong one.
  - astrange 4y ago
    You can't get insurance on something that's certain to happen. Can you really hedge this without paying 100% of the cost of just not owning it?
  - 4y ago
beezle 4y ago
The only factor MBS had in any of this, and it was relatively small, was compared to "normal" notes and bonds (govt or corp) the duration of mortgages extends in a risking rate environment due to fewer prepayments. So rather than say a 4% change for every 100bp move in interest rates, the MBS might change 4.5 or 5%.

hd95489 4y ago

How much of a haircut do the assets take during the process. I’m assuming nobody is paying market rate so how much under is the bid? Like 80% or like 30-40%

twoodfin 4y ago
Given the constraints, the result of this auction is likely to be the closest measurement of “market rate” we’re going to get.
- hd95489 4y ago
  Only a few chosen players get to bid so it’s going to come with some haircut off market
seanhunter 4y ago
Deciding that is exactly what the auction is and it will depend on market conditions, the quality of the assets etc. In the case I was familiar with the assets were "AAA but actually garbage" for the most part and there wasn't a liquid market price so we bid really where we were guestimating the true market price would be but it was a heavy discount to where the failed bank had been holding it. I don't think I'm actually at liberty to say what our bid was but if you think about the gathering storm of the financial crisis in 2008 and "AAA but garbage" illiquid instruments were very hard to price and very expensive to fund so were trading in the 60s (cents in the dollar that is). So if you're on teh weekend and you get offered a massive parcel of that stuff marked in the 90s that you don't really want to hold in the first place you're going to bid significantly south of where the market closed given you know this news is going to really rock the market when it opens on Monday. In this case I think the MBS they are holding is going to be more liquid and with a reasonably secure secondary market, and you're not going to be able to do a proper valuation on the SME loans they have in a single weekend and there isn't a liquid market given each loan is it's own special creature so you're going to have to put a bit of a finger in the air on those. So probably somewhat of a haircut but less extreme.
- colechristensen 4y ago
  What’s your perspective on the likelihood of a few more similar bank failures happening in the next couple of quarters?
  - seanhunter 4y ago
    I don’t have any inside scoop because I’m not in that world any more, so take this purely as my personal opinion, but I wouldn’t be at all surprised if that happens. A lot of seemingly successful business models are hard to distinguish from the beneficial effect of ultra-low rates and a stable, growing economy[1] so the sudden raising of rates is going to hurt a lot. I also think the full effects are taking a while to filter through into the real economy so I personally don’t think we’ve seen the worst impacts yet. I see a lot of empty office and retail space and know that someone took out a loan to build or buy that building and now don’t have the rental income to pay back that loan. Like I say just one person’s opinion so take it with a pinch of salt. [1] Hence the famous Buffett quote. https://www.goodreads.com/quotes/43237-it-s-only-when-the-tide-goes-out-that-you-learn https://www.goodreads.com/quotes/43237-it-s-only-when-the-ti...
Bluecobra 4y ago
On Friday’s thread someone posted that the average return SVB bought was ~1.5%. If the average 30 year rate today is ~7.0%, an ~80% discount sounds correct.
- fdasflkjvalkjlk 4y ago
  You're off by around a factor of 10 because you're valuing MBS as if they're annuities without a terminal value. MBS are backed by the USG and you get the full principal back at by maturity.
  - hd95489 4y ago
    So you would expect 8% cuts? Or 2%. I could see 8%-10 being about right.
  - adriancr 4y ago
    They bought 10 year bonds at 1.5% yearly. For every 100$ they will get 116$ at maturity. Right now there are 10 year bonds at 4% that will pay 148$ at maturity. To be able to sell your 1.5% bonds right now you need to discount them sufficiently so they have the same value as the new 4% 10 year bonds. (otherwise why would anyone buy them) I'd guess you'd need to discount 148$ - 116$ = 32$. This means selling your 100$ bonds at 68$ right now to have buyers... Otherwise money is stuck for 10 years which is unfortunate if you ran out of available cash. Is this wrong?
    - panarky 4y ago
      The rule of thumb is every 100 bp increase in rates means a reduction in the market value of the security equal its years to maturity as a percentage. So if rates are up 250 bp and there are 9 years remaining to maturity, that would be a 2.5 * 9% = 22.5% reduction in market value. But I believe current yields on 10-year MBS are greater than 4%, the numbers I've seen put them at about 110 bp over 10-year Treasurys, which would make the reduction in market value even deeper.
      - 4y ago

SoftTalker 4y ago

So if they had a more diverse portfolio and laddered maturities they might have been OK? And would that have been hard to do? Not a finance guy.

christophilus 4y ago
Another thing that may have helped would be if they hedged their interest rate risk. That’s discussed on this podcast[0] by some folks who do that sort of thing for big banks. It’s pretty nuts that they didn’t have a hedge in place, given the pretty clear policy of the Fed. [0] https://pca.st/rq7eo75p https://pca.st/rq7eo75p
- lordnacho 4y ago
  Hedge costs money, and the instruments in question were not going to default, given they were government backed, so if they could just hang on until maturity they would get the yield from the day they bought them.
  - kgwgk 4y ago
    Holding bonds in a rising rates environment also costs money. Hedging could have been a way to reduce the duration without selling - i.e. without realizing losses as the bonds could still be classified as hold-to-maturity - and avoid further losses. They chose not to.
    - lordnacho 4y ago
      Not disagreeing with you, it was basically a decision they had and they went with the wrong one.
- astrange 4y ago
  You can't get insurance on something that's certain to happen. Can you really hedge this without paying 100% of the cost of just not owning it?
- 4y ago

beezle 4y ago

The only factor MBS had in any of this, and it was relatively small, was compared to "normal" notes and bonds (govt or corp) the duration of mortgages extends in a risking rate environment due to fewer prepayments. So rather than say a 4% change for every 100bp move in interest rates, the MBS might change 4.5 or 5%.