If we had 'SLEMAC' supervisors, they might have saved Silicon Valley Bank

Silicon Valley Bank was "well capitalized" when it failed, but certainly not well managed or well supervised.

SVB failed because it mismanaged Interest Rate Risk (IRR) and liquidity, resulting in a "virtual run" on a big bank where 94% of deposits were uninsured.

Our federal and state bank supervisors failed because of their traditional focus on "CAMELS" safety and soundness exams, which focus on Capital, Asset quality, Management, Liquidity and Sensitivity to risk. They put Capital first and Asset quality next, with Management and Earnings in the middle and Liquidity and Sensitivity to risk last. 

With all due respect, our myopic CAMELS regulators far too often have it backward. If we reversed this acronym and had "SLEMAC" supervisors at SVB, they would have demanded IRR management and increased liquidity with SVB's huge underwater government bond portfolio and uninsured depositor base.

SLEMAC examiners would have required SVB to hedge its huge bond portfolio against the record inflation and interest rate increases that should have been apparent in late 2021, but which became evident to everyone in early 2022.

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But how exactly would this have been done? I can tell you how, because I did something very similar.

Between 2021 and 2022 I oversaw a dramatic restructuring of my organization's $100 million bond portfolio, which held a mix of mortgage-backed securities and government bonds very similar to SVB's.

Rather than its normal 7- to 8-year bond duration, The Community Development Fund's duration was hedged down to 2.5 years at the end of 2021 and 2.0 years in early 2022 using Treasury futures. While no loss is acceptable for any portfolio, the resultant 6.4% decline was about half that suffered by peer funds and indexes in 2022, the worst year in the bond market's roughly 250-year history.

Ironically, I emailed SVB's CEO Greg Becker in October 2021 to introduce him to that fund after they opened their first office in my hometown of Miami. Unfortunately, he and his senior officers were not interested. They argued that since their Miami office was not a deposit-taking facility, they had no Community Reinvestment Act obligations.

While no one likes Monday morning coaches, I will unashamedly put on my basketball "Coach T" hat and argue that if SVB replicated our fund's IRR strategy, it likely would not have failed.  

With only a 6.4% hedging loss on its $120 billion bond portfolio instead of the 14.7% market value loss reported in its year-end 2022 financials, the more than 8% difference would have meant about $10 billion more of capital.

As opposed to that $17.6 billion bond loss wiping out its $16.3 billion of equity capital at that time, SVB, like many other banks, would have been undercapitalized instead of underground.  

Realistically, even if SVB's state and federal supervisors had required such an IRR hedging strategy, their board and officers might have been unwilling or unable to execute it.

The forensic autopsy on SVB will also reveal numerous secondary factors leading up to its death, like the significant portion of held-to-maturity securities not required to be marked to market, as well as the reliance on virtual rather than in-person board meetings and exams.

Friendly federal and state examiners will likely be an issue. The San Francisco Fed, where the Bank's CEO was a board member, was previously criticized for "mission creep."  The California Department of Financial Protection and Innovation, which recently changed its name to "cultivate financial innovation," could hardly be tough on SVB, the "bank of the innovation economy."

Another indication of supervisory failure is the fact that none of the very large recently failed or troubled banks including SVB, Signature or First Republic were among the 39 banks on the FDIC's year-end 2022 problem bank list.

The recent increase in deposit insurance coverage for uninsured depositors to stem the banking crisis will, unfortunately, reduce market discipline. One way to increase market discipline would be the disclosure of CAMELS ratings, as I recommended to the FDIC over 20 years ago. Regulatory discipline would also be increased with SLEMAC rather than CAMELS supervisors.