 Hello everyone, in this session I will explain the collapse of Silicon Valley Bank using the balance sheet and income statement using their actual numbers. Now as a viewer you don't have to understand the technical concepts. I am going to explain the items that are relevant to this process in simple terms so you can keep up. So don't worry about this balance sheet that's in front of you. I will show you this balance sheet later on and it will make sense at the end of the day. To illustrate the concepts I'm going to start from a bank that don't exist. It's going to take me two to three minutes. I'm going to create a balance sheet for the bank explaining the different accounts and therefore you understand the importance of each account then when I pull the actual balance sheet all will make sense for you. So let's assume I wanted to start a bank with a 10 million dollar of capital. I'm going to call this bank Adams Bank. So simply put on my balance sheet I invested 10 million. The bank will have 10 million in cash. Adams Bank as of January 1st 20x0. I have common stock of 10 million all fine and dandy. Next thing I'm going to do I'm going to take this 10 million and start to buy property asset equipment to open the bank. So I took I took this 10 million dollars that I have in cash and what I did during the year 20x0 which is I did not open yet I purchased land building and equipment to open the bank. Now I have still have 10 million in assets and 10 million in equity. So nothing really happened so far it just the bank existed and now they have land building and equipment now they can open their doors for business. So we open our doors for business in year x1 year 1 and we accepted for the first quarter 20 million in deposits. Deposits mean the people deposited the money at your bank. So these deposits are loans to the bank. So when you deposit your money at the bank yes the bank will have more cash but now they will have more liabilities they will have more debt. So notice at the end of year x0 we had 1 million dollar in cash. By the first quarter of year 1 we have 21 million in cash. How did we go from 1 million to 21 million? We have depositors. So notice here the deposits are a liability for the bank. The bank have more cash but they have deposits. Now what do bank do? What do banks do? Well banks need to make a profit. The banks need to invest these deposits to make a profit because they have to pay the depositors some sort of an interest rate so they need to invest this money. So here's what's going to happen. Adams Bank by the third quarter what they did they took this 21 million they lend out 2.5 million. First before they lend out any million we have to keep 10 percent. We're going to assume 10 percent you have to keep it a mandatory reserve at the central bank. So they use 2 million from this 21 million as mandatory reserve. Then they lend out 2.5 million to people who wants to purchase homes which is mortgage notes. They lend 3 million to personal as personal loans and they lend 5 million to business loans and this is what banks do. So notice they have loans now that's their assets. This is the bank's asset what I have in yellow. This is what's going to generate so if they're paying let's assume they're paying for the sake of simplicity 1% on their deposits they want to make maybe 8% on their investments therefore they will make a 7% difference as profit. That's why they can operate the bank and have some profit for the shareholders. So this is a simple banking system. Now here's what I want you to notice here as well. Notice the banks still have 8.5 million in cash and 2 million in mandatory reserve. So as of right now if all the depositors came and they want their money we can cover 52.5% of their deposit. Now the higher this ratio the better off the bank is because let's assume all the depositors came today you can you only have you can only give them 50% of their money but that's not what usually happens. That's not what the bank bank on right the bank you know the people don't come back for their money immediately but the point is you have to have this ratio covered. Before we proceed any further I have a public announcement about my company farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures multiple choice questions true false questions as well as exercises. Go ahead start your free trial today no obligation no credit card required. So let's assume further the bank accepted they were very popular accepted 25 million in additional deposit so notice from September year one till the end of year one in the next three quarters everybody likes this bank so what they did and you're going to see why I'm saying this in a moment we have 25 million in deposit so notice our deposit went from 20 million to 45 million and you're going to see how this all relate to SVB shortly. So what did we do with this 45 this additional 25 million well people are not buying homes people are not asking for personal loan there's no there's no need for business loans so what are we going to do with this additional money remember we had 8.5 as of September and now we have an additional 25 what did we do with this money we invested this money in US government bonds simply put we lend this money to the US government and we purchase bonds and let's assume we purchased three million offshore term bonds and 25 million in long term bonds which are called which we classify them from an accounting perspective I will explain this in a moment as held to maturity now these bonds are considered these bonds are USA bonds United States government those are safe bonds they are considered safe bonds so guess what from a coverage or liquidity perspective if we take our cash and mandatory reserve plus our bonds if anything our ratio of liquid asset to deposit we improved our ratio so so far so good nothing looks unusual the only thing that looks unusual is we have a large proportion of our asset 25 million out of 55 million of our assets are tied up in long term bonds classified as held to maturity again I'm going to explain what does that mean in a moment okay so so far everything looks good I'm just showing you how how we are looking at a balance sheet so once we call SVB balance sheet I don't have to explain it it's it's going to be simplified that's the whole purpose of it now why what is what is what is important why did they why did SVB or why did Adams Bank invested their money in those long term held to maturity well for one thing Silicon Valley did not have any other options to lend otherwise well why not because they did not have customers they they have a special type of customers you're gonna see SVB had a special type of customers they don't lend to regular in quote regular people you're gonna see why in a moment two why long term bonds long term bonds gives you a higher return the highest return high the high return why high return because if you lock your money with the government as for long term they will pay you more interest rate so the longer you are willing to lock your money to purchase long term bonds the higher is the yield the higher is the return so what H what SVB was doing just like what Adams doing is since they did not find the place to lend their money which is the bank is in the business of lending money to people to individual to businesses what they did they they what they did is they chase the yield and that yield was not really that high they were earning approximately 1.6% but the alternative is earning nothing because they did not know what to do with the money just like Adams Bank they just received that additional 25 million and they don't know what to do with it so what is held to maturity well held to maturity you don't have to record any unrealized gain or unrealized loss now we're going to go a little bit technical and explain the concept when you have an investment and that investment in bonds and that investment is classified as HTM held to maturity from an accounting perspective you don't have to show any gains or any losses that are unrealized why because bonds go up in value bonds go down in value well since you are not selling the bond don't worry about the fluctuation why because you're going to hold them to maturity what does that mean at maturity the US government will be there and pay you the face value so from an accounting perspective you don't have to worry about recording those gains and losses because they are unrealized and whether there's a fluctuation now at the end you're going to get your 25 million because the US government is considered a reliable creditor or at least we hope so or at least that's what we see in the near future you know if we think otherwise it's a problem for everyone so you would report those investments at amortized cost unless you need to sell them so here's where the problem comes with svb what happened with svb is this they had losses in those bonds which is fine we had losses it's not a big deal we don't have to report them like if they don't exist now why did we have losses i'm going to explain this in a moment shortly but unless you are forced and why were you forced to sell those bonds well if the depositors came back and they want their money look there's there's 45 million of 45 million in dollars right now you have 6.5 million in cash and mandatory reserve so of 10 million wants their money you have to liquidate you have to sell those bonds if you have to sell those bonds and they are experiencing losses now you have to report the losses now we're going to explain why did that happen in a moment now the question was the question is the first question was i just want to clarify this point why did the government did not intervene why did the government did not intervene earlier seeing this picture well here's why there's there's an act called dob frank and we studied this for the cpa exam dob frank used to cover any banks that's greater than 50 billion an asset an svb was lower than 50 billion so dob frank did not apply to svb at some point svb ink was higher than 50 billion but what happened is the dob frank act was adjusted to cover only banks above 250 billion so the government did not look at svb as closer as larger banks because the dob frank act was amended and the bank will have to be more than 250 billion so the bank was too small less than 250 billion now what i'm gonna do next i'm gonna explain to you the depositors who are the depositors who are the depositors that's important and why did those hdm lost value too important concept you need to understand in order to understand why svb collapse the first one is the customers of svb bank okay here we go only 2.7 percent of their deposits only two small percentage of the people who had deposit of svb were insured up to 250 000 let me explain this to you okay if you have money in a us bank the government they have this program called this corporation federal insurance deposit corporation they will guarantee your deposit up to quarter of a million so as long as you have quarter of a million dollar you don't have to worry about the bank svb they only had of their total customers it means 97.3 percent of their customers all had accounts greater than 250 000 so their customers they have a special type of customers high net worth customers versus a bank like welds fargo welds fargo 40 percent of their customers are covered by the fdic because they have deposits less than 250 look at us bank corp jp morgan but notice signature bank in silicon valley which is signature bank was brought down after silicon valley their customers are high net worth customers who are their customers that's very important the customers of svb bank that's the initial that's the initial when svb was created it was created to serve initial public offerings startup company venture capitalist those people they have a lot of money and they need to invest them their executives their CEOs their executives that's where they deposit their money in 2021 we're going to see in a moment in 2021 interest rate in year 2021 the fed rate was close to zero and what happened because the interest rate was low there was a lot of money there was a lot of quantitative easing people had money investors had money so what did they do they invested all this money there was a large inflow of deposits at svb bank and we're going to see this shortly on their balance sheet okay this is one picture of it so you need to understand why did they have suddenly a large amount of money two reasons interest rate was low and older customers were venture capitalist people with money that they need to invest that they invest in ipos ipos and their CEOs put their money in which bank silicon valley bank because you're going to see a huge spike under deposits now that's one port one picture of it the other picture that you need to understand is the increase in the fed fund rate in 2022 and 2023 interest rate started to go up now what does that mean well when you have a higher rate less and less people invest in ipos because they can go somewhere else and earn higher return one that's two ipos don't make any profit initial public offering don't make any profit so yes initially in 2021 they started to deposit their money because they got the money from the investors 22 23 ipos all what they do is they consume cash their initial public offering that initial public offering ipos at the beginning they don't make a profit they're based on the future and ipos don't need loans so ipos they're not going to ask the bank to give them loans that's why they got the money from the investors and technology stocks are inverse performance with interest rates so as interest rate goes up okay you have investors have alternative options to invest their money they're not going to invest in tech companies so those ipos were not doing well in addition to all of that in addition to all of that as interest rate goes up remember the htm bonds health to maturity bonds the value of these bonds go down let me explain so let's assume in year 2020 interest rate was just for the sake of illustration was one percent and you invested you had a million dollar to invest so you invested this one million dollar in government bond and you are earning one percent in 2022 the government is borrowing money at five percent now notice if you have a million dollar you can take your million dollar and invest the money at five percent notice the fed rate went from zero to five percent now what you do is when you invest your money at five percent you earn five percent so what happened to the old investor that invested their money at one percent they're only getting one percent the interest rate does not change so the value of this health to maturity will go down because if you want to sell this investment today it's worth way less because no one in the right mind will pay you a million dollar for something that's paying one percent you can go right now to the market and lend your money to the u.s government and earn five percent so as interest rates spiked so as interest rates spiked as you can see here in 2022 23 those investments in htm htm was happy earning 1.6 percent they were happy because they had no other alternative that what happened the value of those investments went down no big deal even if they went down remember we don't have to write there we don't have to show the losses because they're held to maturity unless we are forced to sell them unless we are forced to sell them in case we are forced to sell them we have a problem okay you know this is what we're gonna see what happened next but before we see what happened next i want to show you that if you look at svb annual report page 32 they clearly told us they told you the auditor told us svb told us that this is a risk notice here we have experienced a significant growth during 21 22 including deposit growth we're going to see this in numbers on the next slide again if we again experience the positive deposit growth at similar or greater rate then in the past we may need to raise additional equity to support our capital ratio remember if you have the positive if you invest the money you want to make sure that ratio is available in case the people wants to withdraw their money we have experienced significant balance sheet growth which we'll see on the next slide beginning in 2020 through the first half of 2022 follow with me failure to effectively manage our growth could lead us to over-invested or under-invested in our operation results in weakness in our internal control and give rise to operational risk financial losses loss of business opportunities and loss of client satisfaction invite increased laboratory scrutiny and result in loss of employee blah blah blah so they were aware as they're growing fast there's a risk in growing fast and they're telling you we are growing fast now they're gonna tell you where that money came from much of the recent deposit growth was driven by client across all segments obtaining liquidity through liquidity events such initial public offering secondary offering companies selling stocks under company and they're getting money and they're depositing their money as svb as SPAC fundraising now as SPAC fundraising had a lot of money and i know a personal individual that works in this industry he told me literally he had 300 million dollar he doesn't know what to do with he was asking me if i need money for my company i said right now i don't because i have no plan to grow i don't have a plan to grow but the point is they did not know what to do with money and matter of fact what this individual was doing i'm just gonna call him matt for the sake of illustration right so so matt what he did he was looking for businesses that need money take our money we need to invest this money because interest rate was zero so what he was looking for at the end he was looking for companies that build swimming pool because there's a lot of shortage during 2021 uh in swimming pool so if you want to build a swimming pool you would have to wait six month or a year so what he wanted to do to invest that money in these companies so they can grow so the point is there was a lot of money flowing around and i'm telling you i know for a fact from a personal experience because i was offered money i said i i can't use it i really can't use any money right now um venture capital improvement acquisition and other fundraising activities during 21 and early 2022 okay why because interest rate was low and the government was dumping money through co when covid was taking place though these liquidity events and our deposit abated over the course of 2022 they started to slow down 2022 we are unable to predict whether these liquidity event will return to elevated level so then i said we're not sure if this is gonna stay and whether our prior level of deposit growth will return and they're saying look we don't know if this growth will return it we're gonna see on the balance sheet next our level of deposit also depend on whether the client determined to keep proceeds from liquidity event and other fund and deposit product with us so they were aware of that risk they knew they knew they knew for a fact that at some point that some point these individuals may take their money out okay our level of deposit depend on whether the client determined to keep them okay although the client have historically retained the significant portion of their fund client began to move more funds of the balance sheet in the second half of 2022 so they knew exactly the second half of 2022 that clients are taking their money out and i told you why because ipos they consume money as interest rate goes up i ipos don't do well interest rate goes down so that's why they were aware of this okay and they were aware of this risk now let's look at now we can look at the numbers now we can look at the numbers and i'm gonna focus on two three accounts here one is there and by the way this is this is in billion but i had to superimpose 2019 and 2020 and they use a different format so i can show you the four year for the balance sheet so notice 2019 they had 6.7 billion in cash and cash equivalent 17 billion 14 billion 13 billion again again this is they're missing the zeros here because they changed the format of their balance sheet so notice i'm going to show you the numbers in a moment there was growth in their cash and cash equivalent now where did that money came from let's look at their deposits here under liabilities we can look at their deposits total deposits and i'm combining interest bearing and non-interest bearing because they're really interest bearing and non-interest bearing they paid basically minimal they don't they don't they were closed paying 0% on their deposit they had 61 billion and the 62 billion went up to 101 billion in 2020 189 billion in 2021 so notice what's happening to their deposits it's growing substantially and they went down to remember in 2022 companies were start uh people were starting to take their money out went down to 173 billion but if you compare 2021 to 2019 their deposit tripled and sometimes you don't know what to do with the money so what did they do with this money look what they did let's look at their htm securities health to maturity securities they had 13 billion invested in 2019 16 billion in 2020 that's fine they went from 16 billion to 98 billion so they took all this money that they got they did not know what to do with it and they deposit this money in health to maturities and what did we know about health to maturities bonds they are inversely related to to to interest rates so notice interest rate goes up the fed fund went up those funds started to go down and at the same time what's happening people are withdrawing are withdrawing their money so what would svb have to do to meet those withdrawals sell htm and what happened when you sell htm you are at a loss because those bonds lost value now are auditors responsible for this absolutely not the auditors are not responsible of how well you manage your investments auditors are responsible for how well you report your numbers not how well you manage your investments so notice here there was a 161 increase under cash and cash equivalent in 2020 2017 went down from 2021 to 2022 cash and cash equivalent this is year to year this is not a trend this is year to year but notice cash their cash almost double over a two year period cash and cash equivalent so notice what happened the deposits went from 61 notice it grew by 66 percent then another 86 percent this is year over year then it started to dwindle 2022 but if we compare 2019 over 2022 or 2021 it tripled now what did they do with this deposit and that's the problem that's the problem held to maturities they went from 13 billion to 16 billion to 98 billion they did not know what to do with this money again they invested it in held to maturities what's the problem in held to maturities well the problem no the good news is it's safe the problem is at lost value why did it lose value because interest rate goes up those held to maturities bond went down so they made a lousy investments now let's look at the income statement again i'm going to look at few figures i'm going to highlight a few figures but this is their income statement loans income from loans well that's fine from between 2020 2021 their income from loans which is the business that they are in grew by 21 29 percent that's fine then it grew to 3.2 billion by 63 percent which is they doubled their income over the over two year period from loans that's fine and that's the business that banks are in let's look at investment investment income remember they invested that money that they have that they that they have in bonds it went from 635 million notice to 1.2 billion which is a growth of 89 percent then it went from 1.1 billion to 1.1 billion which is if you look at 600 million to 1 to 2.1 billion over a two-year period more than three times the growth why because they invested their money in htm bonds an htm bond pays interest and they have a lot of money invested there and that's why you see the growth in their investment income which is faster notice their investment income is faster than their business a bank is in the business of giving loans yes they make investments if they have extra money but most of their money most of the return they were chasing yields they were investing in bonds now what's interesting is this in 2021 gains and losses on investments this is investment sold actually sold they have 421 million in 2022 461 million in 2021 an 81 percent increase which is fine you sell investments and you make a profit notice what was happening in 2022 in 2022 they experienced 285 million in losses from actual sale and this is where those credit agencies started to look at them now why why did they experience this why would they sell why would they sell at a loss they needed the money to meet the depositors and as depositors are taking out money and their htm is going down in value they are getting hammered this is what happened to them and notice this number here 200 this is gains and losses this is a loss 285 million in 2023 this number is going to be huge and this is what led to the basically collapse because they had to sell those losses they had to sell those htm at a losses and let's take a look at one more number their interest expense their interest expense notice went from which is this is like their operating expense for a bank you want to look at this went from 60 million to 62 million which is a 3 increase which is fine that's fine your deposit went up your interest expense goes up notice what happened between 21 and 22 it went to 862 million why because they had an increase of 1290 percent they had a large increase in deposits which is good you have large amount of money coming but the problem is what did they do with this money they took this money and they deposited and held to maturities so what would what's the best way they should have have done just kept that money in cash so if the people want their money give them their money back so what they did they invested their money in health to maturity securities health to maturity securities went down in value people came to get their money they don't have the money they have to sell those investments health to maturities which they experience losses at and this is the problem with htm it's a liquidity crisis what do you mean by liquidity crisis i mean they did not have enough cash to meet their depositors versus a credit crisis what happened in 2007 2008 is is this let me show you the simplified balance sheet that just kind of illustrate the difference between the two crisis it's important in 2008 2009 these loans that they gave out specially mortgage notes and mortgage investments they were bad these these were hit people were not paying their loans and the bank was experiencing again losses and banks also invested in bonds that are related to those mortgage notes which is mortgage backed securities and as a result those bonds were losing value so the problem is liquidity with svb versus the traditional 20 27 2008 crisis was a credit crisis um if you if you know if i missed something if you'd like to add something please this is you know based on public information add in the add in the comment um like the recording if you're studying for the cpa exam if you're an accounting student studying for your um accounting professional certification please visit farhat lectures um subscribe to the channel good luck study hard and of course stay safe