> The "I intend to hold it" is the relevant part of the valuation, though.
Yup, and definitely anticipate there will be major new regulations in this area. A huge part of SVB's book of bonds were categorized as "Hold to Maturity". And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category.
The fact that SVB had such a huge book of bonds at paltry rates with no/minimal hedging is just awful risk management.
> And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category.
This seems like an important point that I haven’t seen mentioned elsewhere. Lots of folks have been like “these people are morons they didn’t hedge their crappy bonds.” Can you write more about this?
But it's not just that they didn't hedge their interest rate risk, it's also that they assumed that their deposit base would continue to stay the same or grow. The problem is that their highly correlated deposit base of tech startups actually all needed to take their money out at the same time when they couldn't get additional funding.
Thus, it's important to understand that banks themselves make the choice of whether a bond goes into the "held to maturity" or "available for sale" bucket. I'm not a bank compliance officer so I don't know the rules about how much they're allowed to put in each bucket, but one problem was that SVB incorrectly estimated how much liquidity they would need because they didn't plan for the risk of their deposits all needing to be drawn down simultaneously.
They went overweight in long duration bonds to get a little more yield. Terrible timing when interest rates were at 1000-year lows, but it kept the bonuses flowing and the stock compensation in the green.
> Yup, and definitely anticipate there will be major new regulations in this area.
It already happened. The new regulation is that the Fed now has a liquidity backstop for banks holding this asset class, using cash loans with a set maximum term against the par value.
Apparently the Fed decided “if we treat it this way for capital adequacy, and we provide liquidity backstops for banks for other asset classes based on how they are valued for capital adequacy, maybe we should do the same thing here, since otherwise adequate capital can easily and suddenly become inadequate.”
This backstop only applies to existing holdings. Banks can't go out today and load up on hold-to-maturity assets and expect the Fed to backstop them tomorrow with loans at par value. Presumably the next step is to regulate HTM holdings so that this won't be necessary again, or else you're creating a moral hazard.
Yup, and definitely anticipate there will be major new regulations in this area. A huge part of SVB's book of bonds were categorized as "Hold to Maturity". And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category.
The fact that SVB had such a huge book of bonds at paltry rates with no/minimal hedging is just awful risk management.