Bud, it was greed:
In 2020 and 2021 when rates were “zero”, the excess cash in banks were kept (deposited) at the Fed and were only earning .15% yield. Banks were paying depositors, not much, but it was about .20% to .30% , so with the cost of FDIC insurance, about 5 or 6 bp, the “all in cost” of interest bearing deposits was ..25% to .35%, which created a NEGATIVE spread for banks on all its excess cash. Banks had two choices:
Suffer through the negative spread until rates normalized. Naturally, no one knew how to plan this timing; or
Invest the excess cash in longer term securities, i.e. MBS (mortgage backs) or other bonds , i.e. UST.
Many banks could not stand the loss of profitability by keeping the funds at the Fed at .15%, so they bought longer term securities, such as:
· MBS. Expected average life of 5 to 6 years, yield avg. of about 2.25% to 2.5%. (remember the mortgages in those days were 2.75% to 3%);
· UST, 5yr to 6 yr maturity. Yielding probably 1.2%;
These investments of excess cash provide a positive (modest) POSITIVE margin or profit.
· Then March 2022 comes around and rates skyrocketed, and this was the impact to the above securities:
· The average life of their MBS investments moved from 5 or 6 years to 8 to 9 years. No refis and borrowers with low mortgage rates would not sell their home. The market value of those securities plummeted as much a 30% to 40%, creating huge unrealized losses.
· While the maturity shrank 1 year, the market value on the USTs plummeted, as much as 20% depending on the maturity.
So, these banks now find themselves with low yielding bonds, relative to the rate the Fed pays (4.60%) and are now having to pay premium rates for interest bearing deposits.
· Net net, the unrealized losses in some cases (Silicon and others) amounted to as much as 50% to 60% of their capital account; therefore, it was difficult to justify, economically or accounting, selling the bonds and realizing the losses. Yet, SBV HAD to, whereas most other banks with these large securities portfolios won’t face this same problem as they’re not weighted in VC / tech.