SVB, SIFI, Dodd-Frank, EGRRCPA, HQLA and LCR

One of the main questions that has come up with recent events is whether the problems that SVB has encountered have been discovered. EGRRKPA was not passed (which raised the threshold for what qualifies as SIFI). Bill Nelson of the Banking Policy Institute has a clarification post stating that the liquidity coverage ratio (LCR) that would apply to an SVB if it were classified as a SIFI would not be activated. people like former Senator Toomey (co-sponsor of the 2018 act) argued that the LCR would not have caught the SVB. Here is the logic that I think he and others rely on.

The LCR for the largest institutions is for 30 days of stress. For smaller and less complex entities, LCR stress assumptions are mitigated by multiplying projected net cash outflows by 70 percent. In the absence of S. 2155, the SVB would have been subject to this abbreviated LCR requirement. To evaluate the LCR SVB, two components must be evaluated: [High Quality Liquid Assets] HQLA and net cash outflow. All data for December. 31, 2022, and taken from 10-K SVB and call report. The results are summarized in Table 1.

High-quality liquid assets consist of reserve balances (deposits with the Federal Reserve Bank), Treasuries, agency debt and agency MBS, and a few other things. Securities are quoted on the market. Reserve balances, Treasuries, and Ginnie Maes (which are fully guaranteed by the US government) are included in HQLA level 1, which must be at least 60 percent of HQLA. Agency debt and agency MBS are included in Tier 2a and subject to a 15 percent discount. SVB had $7.8 billion in reserves, $16.2 billion in treasury securities at fair value, and $7.7 billion in Ginnie Maes at fair value, or $31.7 billion at HQLA Level 1. SVB had $61.7 billion in agency debt and agency MBS (excluding Jeannie Mays) at fair value; after a 15 percent haircut, that’s $52.4 billion in Tier 2 HQLA. Since Tier 1 HQLA must be at least 60 percent of HQLA, SVB’s Tier 2a HQLA assets are capped at $21.1 billion. In total, SVB would have $52.8 billion HQLA for LCR purposes.

Net cash outflows are even more difficult. They are calculated by applying predetermined ratios to various balance sheet and off-balance sheet items. The factors are chosen to replicate the situation during the global financial crisis, with significant market-wide idiosyncratic stress. In many cases, the exact factor applied depends on information that is not contained in the 10-K. An additional limitation of the LCR is that the projected inflow cannot exceed 75 percent of the projected outflow. As noted, for a bank the size of an SVB and other characteristics, the net cash outflow is multiplied by 70 percent.

First, outflows. SVB has $173.1 billion in deposits, of which $161.5 billion was domestic. Of domestic deposits, $151.6 billion was uninsured, meaning $9.9 billion was insured. Thus, according to our estimates, 163.2 billion US dollars of the total amount of deposits were not insured (total – insured domestically). The churn rate for uninsured deposits of retail and non-financial business customers ranges from 10 percent to 40 percent depending on the characteristics of the depositor and the deposit, with a lower churn rate applicable to retail customers, including those small businesses that are considered retail customers. The churn rate for uninsured deposits of financial business customers ranges from 25 percent for operating deposits to 100 percent for non-operating deposits. If we assume the churn rate is 30 percent, that’s a $49.0 billion churn.[1] The outflow rates for insured deposits are 3-40 percent, where 3 percent is for a stable retail deposit. Assuming a churn rate of 5 percent, you get a churn of $0.5 billion. SVB had $13.6 billion in short-term loans, which are almost entirely FHLB advances. The rollover rate on FHLB advances is 75 percent, so the outflow of short-term loans is $3.4 billion. SVB had $62.2 billion in lines of credit and letters of credit. The interest rate assumption for credit lines ranges from 0 to 30 percent, depending on the type and counterparty. If the drawdown rate is 20 percent, the outflow would be $12.5 billion. The total estimated outflow is $65.4 billion.

Secondly, tributaries. SVB had $5.3 billion in deposits with other financial institutions, all of which are assumed to be inflows. It had $73.6 billion in loans, of which $59.4 billion was due within three months. Half of the planned payments on most loans are treated as inflows. If we conservatively assume that one-third of loans maturing within three months are repaid within one month, the inflow would be $9.8 billion. The total estimated inflow is $15.1 billion.

The estimated net cash inflow is $50.3 billion, or $35.2 billion after multiplying by 70 percent.

So LCR SVB would have to be 150 percent ($52.8 billion / $35.2 billion) for December. 31, 2022. The requirement is that the LCR be equal to or greater than 100 percent.

Table 1 in article Explains simple math clearly.

Divide the total HQLA by the estimated net churn to get an LCR of 150% (circled in green below).

LCR = 150% depends on the outflow of 30% on uninsured deposits.

Given the rate at which SVB was losing uninsured deposits, I questioned the assumption of a 30 percent outflow of active and non-performing deposits. Taking into account all of Mr. Nelson’s other assumptions, I varied the churn rate by 30% to find what would give an LCR of less than 100%. The answer is 46%.

IN one day (Thursday of last week), depositors took out $42 billion according to journalistsso in one day 24% deposits left. I don’t know what the regulators would have assumed in their stress tests, but either way I’m not sure 30% would be the right number.

So, in my book (assuming I’m not a regulator and have no such experience) it’s not clear that having an SVB on the SIFI list wouldn’t at least cause regulators to look at SVB a little harder. Incidentally, having 76% of total debt held to maturity (i.e. 2.2% of available-for-sale securities) means that a typical LCR based on a calculation based on all high-quality liquid assets would need in a footnote.

Incidentally, none of this negates the fact that concentrating assets in Treasuries and agency debt without hedging interest rate risk seems like a dumb idea, given telegraphy of increasing speed.