Losses caused by the rise in interest rates in 2022, coupled with inadequate interest rate risk management, appear to be the trigger for the collapse of Silicon Valley Bank. However, most of the losses on its fixed rate assets were not recognised in either the balance sheet or in profit and loss.
We discuss why investors may have thought the bank was better hedged against interest rate risk than turned out to be the case, and show how 2022 profit would have been very different when measured on a full fair value basis – we estimate a pre-tax loss of $14.4bn rather than a US GAAP reported profit of $2.2bn.
The recent collapse of Silicon Valley Bank raises interesting questions about interest rate risk disclosures and the measurement of financial instruments in bank financial statements. What assets and liabilities should be reported at fair value rather than amortised cost, and should more fair value changes be included in profit and loss? It also prompts us to consider how investors can use the fair value disclosures provided in the footnotes to derive an alternative, and potentially more relevant, measure of performance.
The underlying causes of business failures are generally complex but one factor for SVB seems to be a classic duration mismatch and a failure of interest rate risk management. Short-term and variable rate deposits financed longer-term fixed rate assets, including a large ‘held to maturity’ portfolio and significant ‘available for sale’ assets. The recent sharp rise in interest rates will increase interest expense to a greater extent, and more rapidly, than interest income, leading to a reduced net interest margin. In value terms, asset values fell sharply but with little change to the value of the liabilities.
Few obvious problems visible in the GAAP 2022 headline financials
However, in the 2022 financial statements of SVB there was little in the headline numbers to indicate any problems. Net interest income in 2022, the dominant component of profit and loss, was 41% up on 2021, hitting a record $4.1bn. The 2022 return on equity is stated to be a respectable 12.1%, with GAAP net income of $1.5bn.
Although 2022 net income was down on the prior year, the reduction was more than explained by reduced fair value gains on security holdings and the share warrants the bank holds in many of its customers. These fair value gains and losses are clearly a volatile component of performance and for SVB should be impacted by the general reduction in the value of equities, particularly tech stocks, in 2022.
Based on the data in the primary financial statements, the business appeared to be sound. Furthermore, a rising interest rate environment should be favourable for a commercial banking activity such as SVB. When rates are low, interest paid on deposits tends not to fall by as much as the interest charged for loans, which compresses interest margins. The increase in rates in 2022 should have had a positive effect on SVB, as it did for many banks.
So what went wrong? And could the problems be foreseen based on the reported data? To find the answers you need to go beyond the data in the primary statements and read the footnotes – in particular, explanations about interest rate risk management and fair value disclosures.
Read the footnotes – interest rate risk
SVB provides extensive disclosures about how they manage interest rate risk and how that risk management is overseen by the regulators. Their main risk exposure seems to relate to their largely fixed interest assets held as either available for sale (AFS) or held to maturity (HTM). SVB hedged at least some of this fair value risk through interest rate swaps, maybe because the fair value changes of AFS securities impact the balance sheet (although not profit and loss). However, the exposure related to the HTM assets is perhaps less clear due to the measurement at cost in the financial statements, although these fair values are disclosed on the face of the balance sheet.
Measurement of HTM assets at cost does not make interest rate risk go away. We estimate the unrecognised (pre-tax) fair value loss for these assets in 2022 to be $14.2bn (about 89% of their reported equity) due to the rise in interest rates.
This would not be a problem if SVB had fixed rate liabilities of a similar duration. There would appear to be no such liabilities in the SVB balance sheet because most of its banking liabilities are short-term or demand deposits. However, we think that SVB took a different view.
Interest rate risk management included a simulation of ‘sticky’ core demand deposits
SVB appears to have assumed that their demand deposits represent, in economic terms (even if not accounting terms), a longer-term fixed rate liability. Part of their interest rate risk management is focused on the “economic value of equity” (EVE) which they define as the “market value of assets less the market value of liabilities”. But it seems that the market value of liabilities includes an assumption that their zero and low interest deposits repayable on demand are ‘sticky’ and therefore economically of longer maturity and hence interest rate sensitive. As a result, these deposits would provide an offset in risk management terms for the fixed rate assets.
The following explanation is provided by SVB:
“Based on a historical deposit study of our clients, we make certain deposit balance decay rate assumptions on demand deposits and interest-bearing deposits, which are replenished to hold the level and mix of funding liabilities constant. These assumptions may change in future periods based on changes in client behavior and at management’s discretion.”
SVB risk interest rate risk management disclosures extract

SVB 2022 10K (page 89)
The problem is that this risk management strategy only works as long as customers maintain their deposits. We wonder whether their simulations included the consequences of having to replace customer deposits with wholesale market funding, coupled with a rise in interest rates. That scenario would not have looked as good.
To be fair to SVB what they have done is nothing out of the ordinary in interest rate risk management. We believe the inclusion of assumptions about ‘core demand deposits’ is common practice.
We explain more about the accounting for core demand deposits below.
Read the footnotes – Fair values
SVB measures most of its financial instrument assets and liabilities using amortised cost. Had profit been measured on a full fair value basis, the headline numbers would have been very different. We derived the following from the SVB reported results and their footnote fair value disclosures.
Recognised amortised cost net interest income and unrecognised fair value changes – SVB

SVB quarterly reports and The Footnotes Analyst estimates
Net interest income reflects the amortised cost profit arising from holdings of securities and loans, financed by deposits and other funding obligations, including long-term debt. The rise is largely due to the increase in the volume of banking assets, but the net interest margin remained relatively stable and healthy throughout the last 2 years, with a modest reduction in Q4 2022.
Fair value accounting would have shown significant losses from Q1 2022
But what if these amortised cost assets and liabilities were measured at fair value? The results would be very different. The unrecognised fair value changes shown above are our estimate of the pre-tax1We did not try to calculate a post-tax effect of applying fair value accounting because of the difficulty of estimating the likely valuation allowance that would be necessary for the deferred tax adjustment. However, it is clear that, on a fair value basis, net income would have been significantly negative in each of Q1, Q2 and Q3 2022 – a very different picture from what is reported under US GAAP. gains and losses that would additionally be included in profit and loss, assuming all assets measured at amortised cost in the SVB financial statements were instead reported on a fair value basis. We also include further adjustments for assets measured at fair value, but for which fair value changes are excluded from profit and loss or reported in a different period – primarily available for sale securities and derivatives subject to cash flow hedge accounting.
Our figures are estimates since it is not possible to fully recreate fair value accounting from the available disclosures, but we believe them to be good estimates. We explain how to make these adjustments below.
SVB accounting is largely based on amortised cost
In common with most banks that largely derive their income from deposit taking and lending, SVB has very little fair value measurement in its financial statements. All of its loan portfolio plus most of the securities it holds in its investment portfolio are measured at cost in accordance with US GAAP.
Silicon Valley Bank balance sheet assets

SVB 10k 2022
The most significant category of assets measured at fair value in the balance sheet is ‘Available For Sale’ securities (AFS), which at $26.1bn represent about 12% of total assets. There are also some equity investments, including share warrants that are measured at fair value, and derivatives used for hedging purposes but, combined, these are only about 0.2% of total assets (although the volatility of such assets means that their value changes have greater significance than it might seem).
On the liability side there is even less fair value – just $556m of derivatives or 0.3% of total liabilities.
Fair value gains and losses are not fully reflected in performance metrics
In terms of the income statement the effect of fair values is even less pronounced than it is in the balance sheet due to how the accounting works and, in the case of SVB, the use of non-GAAP metrics. For all three categories measured at fair value the income statement impact of value changes is more muted.
Available for sale securities and OCI
Where a bank holds bonds and other securities (such as CDOs) for the purpose of investment, but where there is a potential for these to be sold, the investments are classified as available for sale (AFS). Although these assets are measured at fair value in the balance sheet, the fair value change in the period is not included in profit and loss but is instead part of other comprehensive income (OCI).
Interest income, calculated as it would be for amortised cost measurement, is included in profit and loss. If these assets are sold or deemed to be impaired a gain or loss is transferred (reclassified or recycled) from OCI to profit and loss. The result is that profit and loss includes gains and losses that are very similar to what would be reported if the assets were actually measured at cost (the difference is in the impairment calculation2The impairment of AFS securities under US GAAP is based on whether any decline in value is expected to be recovered, rather than the direct consideration of expected credit losses that applies to assets measured at amortised cost. IFRS has a similar category but called FVOCI rather than AFS. Confusingly, what is included in FVOCI is different from AFS. The IFRS FVOCI impairments are based on the same expected credit loss model as for amortised cost loans – although this is a different expected credit loss calculation compared with US GAAP. All very confusing for the poor investors! Ultimately just think of AFS and FVOCI as fair value in the balance sheet and amortised cost in the income statement with the difference reported in OCI.).
The effects of fair value changes and of recycling for AFS assets can easily be seen in the ‘other comprehensive income’ section of the statement of comprehensive income.
SVB statement of comprehensive income

SVB 10k 2022 (highlighting added by The Footnotes Analyst)
Included in OCI in 2022 is a loss of $2,503m or about 10% of the value of the AFS portfolio. The sales of AFS assets in the year produced a recycled amortised cost gain of $21m in profit and loss (the negative figure in the OCI statement is because OCI is reduced by $21m, with profit increased by the same amount).
Derivatives and cash flow hedge accounting
All derivatives that are assets or liabilities must be measured at fair value with value changes reported in net income. However, if these are subject to cash flow hedge accounting, gains and losses are initially reported in OCI and are recycled to profit and loss when the item being hedged itself affects profit and loss. The effective result is that profit and loss reflects a form of amortised cost measurement for these derivatives.
Cash flow hedging for banks often relates to mitigating interest income and expense fluctuations (the cash flows) for assets and liabilities that carry variable rates of interest. An interest rate swap is used to convert these into effective fixed rate instruments. Changes in the value of the swaps approximate the value changes for the synthetic fixed rate asset or liability. However, these fair values are omitted from profit and loss and only get reported in OCI. In a full fair value reporting model no derivative gains or losses would be reported in OCI (at least not for recognised financial instruments3Cash flow hedge accounting is also applied to certain forecast cash flows which relate to transactions that are yet to be recognised. Even if all financial instruments were fully reported at fair value, cash flow hedge accounting for these situations would remain – although not everyone thinks it should, but that is a topic for another blog post!).
SVB does not seem to be very active in hedging interest rate risks (which was perhaps part of their problem). The OCI statement above shows no cash flow hedges in the last 2 years with the only entry being the progressive reclassification of a hedge applied in 2020; in effect, the amortised cost recycling of the hedging instrument ‘flow’. But the net effect is that fair value changes for these derivatives are excluded from reported profit and loss.
Equity instruments and non-GAAP measures
Equity investments are measured at fair value under US GAAP4Under IFRS there is an option to include fair value changes for non-trading equity investments in OCI, but without recycling to profit and loss. In our article ‘Ignore this recycled profit – Ping An’ we explain why we think this use of OCI is bad for investors., with changes in value reported in net income. Although this represents full fair value accounting in both balance sheet and profit and loss, SVB mitigates the fair value effect by removing the fair value changes from its non-GAAP metrics.
SVB non-GAAP disclosures

SVB 10k 2022
The net effect of removing the changes in fair value is that the performance metrics presented by SVB to its investors largely omit the effects of fair value changes. We think that if investors only rely on this data important indicators will be missed.
Converting to full fair value accounting
To convert from amortised cost to fair value measures of performance you need to find the fair value disclosures for assets measured at amortised cost in the footnotes. Here it is for SVB:
SVB fair value disclosures


SVB 10k 2022
To adjust the balance sheet, simply replace the carrying value of each asset and liability with the fair value disclosed in this note. However, you also need to adjust deferred tax. A remeasurement at fair value creates a temporary difference and a deferred tax asset or liability, depending on whether the fair value adjustment reduces or increases equity respectively. To calculate the deferred tax just multiply the value difference by the marginal tax rate (about 27%, it seems, for SVB).
For SVB this would produce a significant deferred tax asset. But recovering this asset by offset against future profits could be uncertain, in which case it would not be recognised. Unfortunately, it is very difficult to allow for this lack of recoverability without further information.
To identify the unrecognised value change in the period you need to calculate the difference between the balance sheet amortised cost amount and fair value at the beginning and end of the relevant period. The value change that would be recognised under fair value accounting is the difference between these amounts. For example, the fair value of the SVB ‘held to maturity’ investments was lower than carrying value by $968m and $15,152m at the beginning and end of 2022 respectively. This means that the fair value loss for 2022 is $14,184m.
Here is a calculation for the year ending December 31, 2022. The data in the chart above has been derived in the same manner but using quarterly data.
Our calculation of SVB fair value accounting loss in 2022

SVB financial statements and The Footnotes Analyst estimates
The above calculation is not perfect, but we think it is the best we can do from the disclosures provided. Only if the disclosures included a full roll forward of each asset and liability, and if there were additional disaggregation of cash flow hedges, could we be confident in our adjustments and allow for complicating factors, including foreign currency effects, asset transfers between categories, and business disposals.
Fair value accounting and core demand deposits
In the above SVB fair value note, the fair value of the ‘non-maturity deposit’ liability is the same as the balance sheet carrying value. This liability, sometimes referred to as ‘core demand deposits’, is customer checking (current) and savings accounts that are repayable on demand. The demand feature means that, under financial reporting, the fair value must be the same as the face value of the liability that is reported in the balance sheet.
However, core demand deposits tend have a zero or very low rate of interest and hence are more advantageous to a bank than funds raised from other sources. This advantage may be recognised by valuing the core demand deposit liability below face value by assuming an ‘effective’ maturity and treating the liability similarly to a term-deposit. This hypothetical (lower) fair value may be presented as a customer intangible asset alongside the face value of the demand deposit liability.
In practice, the only times the fair value effect of core demand deposits is recognised is in the context of business combinations and potentially in managing the exposure to interest margin risk. SVB’s explanations about how they manage interest rate risk includes discussion about the ‘economic value of equity’ (EVE). We think that this includes consideration of the value effects of their demand deposits.
Our full fair value profit ignores so-called fair value ‘gains’ from core demand deposits
It could be argued that our full fair value accounting measures of financial position and performance are incomplete without some consideration of the value effects of core demand deposits. However, the value gain is only present if customers maintain their low or zero interest deposits. The demand feature means that these can disappear without warning and the value lost, which is exactly what SVB has discovered.
We think fair value profit should not include any assumptions about gains from core demand deposits. The feature is relevant when valuing banking businesses but tends to simply be a factor in determining the net interest margin and not separately considered.
How reliable are fair value disclosures?
Fair value can be subjective and complicated to calculate, which reduces the reliability of data available to investors. Additional disclosures about the methodology and assumptions used to calculate fair values help including the related level 1,2 and 3 classifications), but do not entirely solve the problem.
Loans to customers
In the above fair value disclosure note, SVB states that the fair value of its portfolio of loans is higher than the amortised cost carrying value. One explanation could be the conservative nature of loan loss provisioning under US GAAP, which would reduce the amortised cost amount. Another could be that the accounting for the share warrant received as part of the loan deal reduces the amortised cost balance to below face value, although it is not clear why this would not also be reflected in the fair value.
The fair value of the loan book would certainly be an area of focus for us in evaluating the fair value based performance of SVB.
Equity warrants
The valuation of the equity warrants is also challenging. In this case values affect the reported GAAP performance as well as our adjusted full fair value measures. SVB provides details about the valuation inputs to their Black-Scholes based measures of fair value. This in itself deserves scrutiny, but a further uncertainty, mentioned only in the table footnote, is the fair value of the underlying equity to the warrant, which must be estimated because most of the companies involved are not listed.
SVB fair value measurement disclosures for equity warrants

SVB 2022 10k
A fair value increase for share warrants in each of the last 8 quarters deserves closer scrutiny
What causes us to focus on this measurement issue is that a material portion of the SVB GAAP pre-tax profit has come from fair value gains on its portfolio of share warrants – 21% and 7% in 2021 and 2022 respectively. How these warrants are valued (and how the equity instruments received when warrants are exercised are also valued) has a significant impact on profitability.
SVB has reported a share warrant fair value gain in each of the last 8 quarters, this seems surprising considering what has happened to tech stock prices over that same period.
The fair value accounting debate
How financial instruments should be measured in financial statements has long been debated in financial reporting. Both IFRS and US GAAP apply a similar (although not identical) mixed measurement model, with some assets reported at fair value and others measured using amortised cost, with a similar but confusingly different mix for the income statement.
Some have argued that measuring all financial instruments at fair value for both balance sheet and performance reporting purposes would improve the transparency and understandability of financial statements. At one stage both the FASB and IASB flirted with a ‘full fair value’ approach. Indeed, before the 2007 financial crisis when the IASB was debating how to improve IAS 39 (the IFRS standard pre-IFRS 9), Sir David Tweedie, the chair of the IASB, suggested that all 350+ pages of IAS 39 and supporting guidance could be replaced by a standard of just two paragraphs …
The Sir David Tweedie solution to accounting for financial instruments
Paragraph 1. Measure all financial instruments at fair value.
Paragraph 2. See paragraph 1.
With apologies to our friend Sir David for highlighting one light-hearted remark from a distinguished career in accounting standard setting. But then David always did like a joke.
Of course, the comment was not entirely serious (and probably mis-remembered by Steve who was present at the time). Nevertheless, full fair value would certainly simplify financial reporting; there would be no need for many of the existing complex rules, such as those for classification and impairment testing.
Very soon after David’s comment the financial crisis hit and banks faced multiple problems, including rising credit losses, falling security values and illiquid markets. Fair values became difficult to measure and it was argued that fair value losses (to the extent they were required) threatened financial stability. The IASB and FASB came under pressure to mitigate the impact and in the end the IASB reduced rather than increased the use of fair value.
Maybe a full fair value model, or greater scrutiny of fair values, would have saved SVB
Today a switch to full fair value for financial instruments, or even an increased use of fair value in a mixed measurement model, seems highly unlikely. Nevertheless, we think investors should consider fair values and fair value based performance metrics, particularly when analysing banks. Had more done so for SVB then maybe the large interest rate bet would have been unwound before disaster struck.
Insights for investors
- Most assets and liabilities of banks tend to be measured at amortised cost in the balance sheet. But additional fair value disclosures can always be found in the footnotes.
- A duration mismatch creates interest rate risk. In amortised cost accounting, the gains and losses that result from a change in interest rates affect net interest margin over several periods, but the unrecognised value effect is immediate.
- Including core demand deposits as interest sensitive fixed rate liabilities in interest rate risk management only works as long as customers do not demand them back.
- Using the fair value disclosures to recalculate profit on a full fair value basis can help give further insight into financial performance.
- Remember that fair value is subjective. Try to identify and then question the critical measures that affect GAAP and your adjusted measures of performance.