I never heard of Silicon Valley Bank until they became a top news story. I certainly have opinions about the bank being closed, its equity wiped out and then its takeover in an FDIC-engineered maneuver.
Right from the beginning, my students had many questions, and I was pretty much forced to figure out what happened so I could make it a learning experience. I was also asked by CPA Academy if I would be able to put together a webinar about SVB within a very short period. I worked hard on this, reviewed SVB's 10-Ks for the last three years and other data that was easily available, and tried to look at how all of this interacted with GAAP so the webinar would qualify for accounting CPE credits. I think I came up with an explanation.
GAAP treatment
GAAP provides for three categories of investment reporting. One category is for securities that are available for sale (AFS), i.e., to be traded pretty much whenever cash is needed from their sale or for whatever reasons the company has (but not necessarily for active trading); another is for securities intended to be held to maturity (HTM), i.e., to be owned for a long period with no intention of the securities being sold precipitously. The third category does not apply here.
GAAP requires the AFS securities to be valued on the balance sheet at fair value, which is the market value of those securities. Any adjustments to arrive at fair value will create either a gain or loss that would be reported on the company's other comprehensive income statement. The cost is shown parenthetically.
GAAP requires the HTM securities to be valued at their cost, with the fair value amount shown parenthetically. The difference between the cost and fair value will not cause either a gain or loss to be reflected anywhere until the securities are sold. The underlying rationalization for this treatment is that the company should not benefit or be penalized for "temporary" market changes since these securities are intended to be held for a long period. HTM securities are where the investor has the "positive intent and ability" to hold those investments to maturity.
I have no issue with either of these GAAP treatments. The issue I have is with the underlying assumptions of the intentions and ability of SVB to hold its HTM long-term Treasury bonds to maturity.
Explanation of bond investing
Here is a short "lesson" I give to my financial planning clients on long-term bond ownership. I tell them they should not buy long-term bonds unless they are willing to lock in and settle for the current interest rate until maturity, and they should only buy bonds that they fully intend to hold to maturity and have the wherewithal to hold to maturity. This means their current and likely future situation will make it very unlikely they would have to sell the bonds before maturity.
If they can hold the bonds until maturity, assuming there is no default, the bonds would be redeemed at their face amount, and for their period of ownership, they will get exactly what they intended to receive from that bond ownership. By the way, SVB's investment in the long-term treasuries had no risk of default.
SVB balance sheet data
SVB's Dec. 31, 2022, balance sheet shows the cost of its HTM securities at $91.321 (these amounts are in billions) while parenthetically its fair value was $76.169. This represents an "unrecognized loss" of $15.152. Its stockholders' equity was $16.295. If for some reason the HTM securities were valued at fair value, its equity would pretty much be wiped out (brought down to $1 billion). However, GAAP does not provide for this.
Tying in GAAP and bond investing
My opinion (based on the limited information I accessed) is that SVB overinvested in long-term bonds, and that placed the bank in a position where there was a high likelihood that those bonds would have to be sold prior to their maturity and much sooner than the HTM threshold calls for. This is borne out by SVB not meeting my two tests for owning long-term bonds: the ability and wherewithal to hold the bonds to maturity, and the desire to lock themselves into the long-term income rate as of the date of acquisition of the bonds.
The company and its auditors should have considered that as a bank, a sale of the HTM bonds might be necessary or be forced on it to raise cash quickly irrespective that it was outside of the realm of GAAP. I also feel that as a bank it wasn't possible for SVB to be fully satisfied during the bond terms with the long-term income rate it locked itself into. The precariousness of its level of deposits (there was a 35% drop in noninterest-bearing deposits in 2022), the upward push on interest rates from the Fed's many actions in 2022, the potential for the possible need for quick cash to cover reserve requirements, and the extremely high investments in HTM securities put them in a perilous situation, which unfortunately occurred. The sale of any of those HTM securities would result in an immediate loss that would be recognized on the income statement and drop to the equity.
Takeaway
As auditors we are required to follow the rules provided by GAAP. It's true that many judgments are called for when doing this; it's also true that the financial statements are the client's and our role is to audit them. However, sometimes we might need to step outside the box and question some of the assumptions that can swing some amounts into multiple reporting categories.
The SVB situation makes everyone an expert with 20/20 hindsight. But in future situations, perhaps a few minutes of focused reflection might yield a result different than the client's. This technique can also be used separately from auditing when providing consulting or advisory services to clients. I suggest thinking about the full consequences if something should unexpectedly go wrong.
Other issues
There are other issues also, but for this column I wanted to discuss the GAAP treatment. If you want further information from me, I am presenting a webinar on this at
My opinions
This column solely represents my personal opinions based on the limited information I've reviewed and based on the time constraints placed on me. I am in no way suggesting there were any errors or misjudgments by SVB's management or auditors.
Do not hesitate to contact me at
