Michael Sacher — former CFO of Xceed Financial FCU, principal of Sacher Consulting, and retired certified public accountant — has published an updated analysis and opinion piece on the recent failure of Silicon Valley Bank in CreditUnions.com.
Sacher originally presented his expert analysis and response to the collapse of the bank on a virtual meeting in late March with credit union CEOs, hosted by the California and Nevada Credit Union Leagues (10 Liquidity Questions for CUs in Aftermath of Silicon Valley Bank).
Today, he says the accounting standard concerning “intent and ability” was violated at Silicon Valley Bank, and those charged with governance and oversight of the bank failed in their roles. “All of these parties should be held accountable,” he states.
His article is as follows:
Silicon Valley Bank Failure: FASB And Auditor Implications
Silicon Valley Bank’s (SVB) recent failure has led to numerous postmortem analyses, yet one crucial issue remains unaddressed: Should the bonds in SVB’s investment portfolio have been allowed to remain in the held-to-maturity (HTM) classification, thereby eliminating any recognition of the massive losses that accumulated throughout 2022 and into 2023?
The answer is a resounding “NO.” The ultimate failure of the bank resulted from very poor financial management decisions, mostly surrounding basic asset/liability and interest rate risk management practices. Sadly, these poor financial management decisions were exacerbated by a complete breakdown in the application of basic accounting principles.
As of Dec. 31, 2022, SVB had unrecorded, unrealized losses on HTM securities totaling $15 billion. SVB’s total net worth was only $16 billion. Not one penny of losses was recognized either in net income or reflected in net worth. How was this possible? Under generally accepted accounting principles (GAAP), securities classified as HTM are measured at historical cost if “management has both the intent and ability to hold such securities to maturity” (more on GAAP below).
The ramifications of the HTM classification were profound. Once classified as HTM, the bank was significantly constrained from selling these securities to raise liquidity since any individual HTM security that was selected for sale would taint the intent and ability to hold the remaining portfolio to maturity and would therefore require an immediate write-down in value of the entire HTM portfolio.
Further, the continued reporting of these securities at historical cost — in spite of the incredibly significant decline in value — delayed recognition and understanding of the bank’s loss exposure and likely contributed to the delayed recognition of the severity of the situation. This ultimately lead to even higher levels of losses and stress on SVB and the U.S. banking system.
The accounting standard (ASC 320-10-25) that must be met to qualify for HTM status is pretty clear, albeit difficult to objectively measure. This standard states: “Investments in debt securities shall be classified as held-to-maturity only if the reporting entity has the positive intent and ability to hold those securities to maturity.”
Numerous financial aspects of the bank’s financial condition provide strong indication that SVB did not have the ability — intent is questionable — to hold these securities to maturity. Such aspects include SVB’s extraordinarily large concentration of uninsured deposits and the susceptibility of those deposits to withdrawal; its already tightening liquidity as of Dec. 31, 2022; and the lack of appropriate interest rate hedges to protect SVB in the event of rising rates. These matters were even more troublesome given that HTM securities represented nearly 80 percent of SVB’s investment portfolio.
The classification of nearly 80 percent of the investment portfolio as HTM should have been challenged by the bank’s management, by the audit committee, by the regulators, and, importantly, by the CPA firm that opined on the Dec. 31, 2022 financial statements. The accounting standard concerning intent and ability was violated, and those charged with governance and oversight of the bank failed in their roles. All of these parties should be held accountable.
The regulatory examination process failed, which should have identified the risks much sooner and forced the bank to take evasive action to avoid compounding losses. Importantly, the Financial Accounting Standards Board (FASB) should closely examine the current standard in recognition of the ambiguity of the “positive intent and ability” objectives.
At a minimum, disclosure requirements should be enhanced to provide the user of the financial statement appropriate levels of insight as to the intent and ability assertion made by management. Such additional disclosure for insured banking institutions should include amounts of deposits in excess of insurance limits, key liquidity stress testing results, and other pertinent factors that support the intent-and-ability assertions.