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My trade during the fall of the SVB? An ‘insurance policy’ on BofA, I hope it doesn’t pay off

By Friday, Silicon Valley Bank had become something of a household name, even to many who had never heard of it or cared about it.

The Silicon Valley Bank, the California banking subsidiary of SVB Financial Group (SIVB), was closed. The move came from the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (FDIC) as the bank’s trustee.

This was the story that dominated the headlines late in the trading week and was the main cause of the market sell-off on Thursday and Friday, as well as a significant spike in volatility. Silicon Valley Bank went from being one of the country’s top 20 banks by deposits — worth just under $175 billion, of which just over $150 billion was uninsured — into receivership in the blink of an eye. SIVB ended fiscal 2022 with just over $200 per share in book value and started last year with a market cap of about $40 billion. As of December 31, the bank had approximately $209 billion in total assets and more than $175 billion in total deposits.

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This marks the largest bank failure in the country since the Great Recession.

The bank became just the latest victim of the most aggressive monetary policy in 40 years. After failing to act in 2021, the Federal Reserve, which thought inflation was “transient”, began its current trajectory of rate hikes in March last year. The Fed Funds rate is now at 4.50% to 4.75% with an additional increase of a quarter percentage point to half a percentage point when the Federal Open Market Committee meets on March 21 and 22. this moment remains unknown.

The blowout of Silicon Valley Bank certainly had a big impact on the whole market, hitting banks hard as well as high-beta parts of the market like biotech and small-caps. Both the Russell 2000 and SPDR S&P Biotech exchange-traded fund (XBI) are about to test their lows from last June.

Silicon Valley’s biggest problem was that it had nearly $60 billion in mortgage-backed securities (HTM) on its books, as well as about $10 billion in collateralised mortgage obligations, or CMOs, which represented a huge portion of its total assets. .

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As interest rates began to rise, the bank began taking significant unrealized losses on this portfolio. When management concluded this week that interest rates would remain high longer than previously assumed, the company sold just over $20 billion in available-for-sale securities that would be reinvested in shorter-term government bonds. This caused a loss of nearly $2 billion, which management attempted to fill with a large capital raise to bolster liquidity. When those and other attempts failed, the FDIC felt it had no choice but to close the bank on Friday, further shaking markets.

Unrealized losses on Silicon Valley Bank’s HTM bond portfolio dwarfed total equity. Other banks have not been as careless as the SVB. However, by the end of 2022, banks had about $250 billion in comparable unrealized losses on these types of bonds. Bank of America (BAC) accounted for just over 40% of this exposure, according to a piece this week in Zero hedge.

I don’t believe this is the start of the next financial crisis (and I pray not). However, I do think contagion fears could persist for a while, which could lead to further bank sell-offs. And if that theme plays out, I could easily see Bank of America moving significantly lower than the $30 level it’s currently trading at.

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Therefore, late Friday I bought a small amount of July $30 on the shares for $2. When the market closed on Friday, they were trading for about $2.20. As the contagion fears spread significantly, I saw the stock move to the low $20s, turning my trade into a tidy profit. If contagion fears prove unfounded, the rest of the market should see quite a rally and I’ll be happy with the loss on my little ‘insurance policy’.

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