22 MARCH 2023
Dr. David Allen
The aftershocks of the Silicon Valley Bank debacle are still reverberating around the financial world. Should the venture capital firms that held their deposits with SVB and the regulators have known better? Using Plato’s proprietary 100+ Red Flags the resounding answer is yes.
Further to this, over the weekend UBS were forced into a shotgun wedding with their fiercest rival, Credit Suisse.
Again, Plato’s Red Flags indicate all the warning signs were there for all to see. Unfortunately, the discipline of digging through balance sheets and applying forensic accounting methods seems to have fallen by the wayside in the era of easy money.
Below, I highlight the red flags identified by Plato’s proprietary red flags modelling, for each of these publicly listed company. This modelling meant both SVB or Credit Suisse were screened out early in the Plato Global Alpha Fund’s investment process.
Silicon Valley Bank
Red Flag 1: Very high CHS bankruptcy probability
CFAs will remember Altman’s bankruptcy prediction model from 1968. In 2008, three Harvard, academics, Campbell, Hilscher, and Szilagy developed a more accurate model by incorporating market and financial data. Prior to the implosion, SVB’s bankruptcy probability was at extreme levels.
Red Flag 2: Significant vote against executive remuneration
Red Flag 3: Negative votes against directors
Red Flag 4: MSCI flagged concerns over the safety of SVB’s financial products
Red Flag 5: Very high downside volatility
Red Flag 6: SVB had cancelled their dividend
Red Flag 7: Miniscule savings deposits to total deposits
Just 0.9% of SVB’s deposits were savings deposits due to its corporate client base. The tightknit tech community acted almost in unison in withdrawing their deposits. Out of the 458 banks that we track globally, SVB had the 8thlowest percentage of savings deposits. SVB also had the 18th highest percentage of demand deposits making it particularly vulnerable to a bank run.
Red Flag 8: Very high unrecognised losses
Because SVB were intending to hold their long term treasuries to maturity, they did not have to mark them to market. All that changed when they were forced to liquidate their positions to meet deposit withdrawals. Fortunately, this was apparent in the FY22 financials with accumulated other comprehensive income accounting for some 11% of total equity.
Red Flag 9: Very high proportion of uninsured depositors
This is a Red Flag that we did not have as part of the Plato process that we are now looking to add. Some 93.8% of SVB’s deposits were over the $250,000 threshold and hence uninsured and prone to flight.
In Plato’s 10,000 stock investment universe, most companies have 0 or 1 red flags. So for a company to have over 9 red flags as with SVB really attracts our attention. Credit Suisse, had a frightening 16 red flags. Interestingly, there is a lot of overlap with the warning signs we saw for SVB. Because these flags are proprietary we do not list all of them here, so here is a subset.
Red Flag 1: Internal control weakness flagged by auditors
Red Flag 2: Very high CHS bankruptcy probability
Red Flag 3: Significant vote against executive remuneration
Red Flag 4: Financing difficulties
Red Flag 5: High impact governance events
Red Flag 6: Very poor audit quality score
Red Flag 7: Zero sell-side buy ratings
Sell side analysts are loath to place sell ratings on a company’s stock for obvious reasons. The fact there were zero buy ratings on Credit Suisse speaks volumes.
Red Flag 8: Credit default swap spikes
The CDS spread is the cost of insuring against default. For a long time, the CDS spread of Credit Suisse was similar to that of the major global banks, that is until June, 2022.
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About the Author
Dr David Allen is head of Long/Short Strategies at Plato. He holds a PhD from Cambridge and Bachelor of Business with First Class Honours.
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