While the general investing public is asking “where were the auditors?” in regards to the recent collapse of Silicon Valley Bank and Signature Bank, the banks’ auditors are insisting that, having exercised requisite due professional care, their unqualified opinions were based on the information available to them at the time and as such, the firm stands behind them. To any members of the general investing public reading this: “due professional care” means the independent auditor planned and performed the work required of them according to audit standards.
(Auditors and people who scored a 71 or above on AUD may ignore this next part, you know this already) An audit isn’t the financial equivalent of a doctor running every blood test available and feeling around in your butthole with a gloved finger to figure out everything wrong with you. It’s more like a trip to your general practitioner, checking vitals, getting a routine complete blood count and basic metabolic panel, giving the patient a thorough look over, and determining that the patient is not in immediate medical danger. (Anyone with a better analogy that doesn’t involve rooting around in butts is welcome to message the editor, thank you) Auditors don’t provide absolute assurance but reasonable; stated another way: audits are not perfect, they are good enough. This of course opens the floor for a discussion about why even bother with audits then, a topic best left to people who know better than we do (Francine McKenna and Jim Peterson are two such people I can think of off the top of my head).
Back to the auditors. KPMG Chair and CEO Paul Knopp talked about his firm’s work on the failed banks at an event at the NYU Stern Center for Sustainable Business on Tuesday and made it clear that the firm stands behind their opinions, per an article in Financial Times yesterday. “As we take into account everything we know today . . . we stand behind the reports we issued and we think we followed all professional standards,” he said.
“You have a responsibility until the day you issue the audit report to consider all facts that you know, so we absolutely did do that. But what you can’t know with certainty is what might happen after that audit report is issued.”
“There were actions taken in the month of March that set off another set of reactions that led to those two institutions being closed,” he said.
12 days after KPMG said it is their opinion that the consolidated financial statements present fairly, in all material respects, the financial position of the Company in conformity with U.S. generally accepted accounting principles, SVB parent company SVB Financial Group disclosed it sold $21 billion of bonds and booked an after-tax loss of $1.8 billion.
Former Federal Reserve bank examiner Mark T. Williams told Fortune‘s Sheryl Estrada he thought the actions taken by SVB Financial Group in March were a risk nightmare and “a colossal failure in asset-liability risk management.”
“To prevent a crisis of confidence, SVB’s CEO and CFO should have relied more on an old-fashioned banking approach of diversification of its lending and deposit customers,” says Williams, a master lecturer in the finance department at Boston University’s Questrom School of Business. “Venture capital is a highly risky business. So not only did the bank expose its asset side of the balance sheet but also its liability side.”
“The CFO and, I would argue, the board failed to adequately protect shareholder value,” Williams says. “The board-appointed risk management committee, which works closely with the CFO, should have done adequate scenario analysis to examine the deposit withdrawal risk. That, in fact, was the bank’s downfall.”
During this time, Y Combinator CEO Garry Tan warned his organization’s startups to be wary of the developing situation as it could mean life and death for them. “We have no specific knowledge of what’s happening at SVB,” he wrote in an internal message seen by Bloomberg News. “But anytime you hear problems of solvency in any bank, and it can be deemed credible, you should take it seriously and prioritize the interests of your startup by not exposing yourself to more than $250K of exposure there. As always, your startup dies when you run out of money for whatever reason.” Let’s be real, he wasn’t saying “be wary.” He was saying “GTFO while you can.”
Meanwhile, there was a storm brewing online from the time KPMG issued their opinion on February 24 and Silicon Valley Bank’s collapse two weeks later, an event that would require a kind of clairvoyance not currently required by PCAOB standards to foresee. A day before regulators seized the bank, investors and depositors attempted to pull $42 billion from SVB. Precipitating that, an influential person said some things and people who value this person’s opinion reacted in swift and extreme fashion.
First reported on Fortune, Evan Armstrong of Napkin Math pinned the whole thing (“potentially“) on Byrne Hobart and his newsletter The Diff so expect lawmakers to say we should regulate newsletters any day now. Armstrong tweeted:
Kinda insane that this entire debacle was potentially caused by @ByrneHobart‘s newsletter. Here’s how the butterfly effect happened.
1) Byrne posts this article/Tweet calling out SVB’s risk.
2) Pretty much every VC I know reads this newsletter
3) They all start to pay very,… https://t.co/zUSKF1ZW4J— Evan Armstrong 📧 (@itsurboyevan) March 11, 2023
Full text:
Kinda insane that this entire debacle was potentially caused by @ByrneHobart’s newsletter. Here’s how the butterfly effect happened.
1) Byrne posts this article/Tweet calling out SVB’s risk.
2) Pretty much every VC I know reads this newsletter
3) They all start to pay very, very close attention to SVB earnings
4) Absolutely massive earnings miss by SVB
5) Peter Thiel, USV, and Coatue are first to send out messages/mass emails to portfolio co’s to pull out funds
6) Tech Twitter catches word of this
7) Bank Run
8) Collapse
9) If FDIC/Buyer doesn’t come in, in the next 7 days, potential 20%+ collapse of entire startup industry.All started by one overly prolific dude in Austin. Amazing.
He then links to the one overly prolific dude in Austin who tweeted this on February 23:
Also in today’s newsletter: Silicon Valley Bank was, based on the market value of their assets, technically insolvent last quarter and is now levered 185:1.
One thing to add—there was viral thread that talked about it earlier. I’ve also heard reports of 1 or 2 firms warning their portcos late last year. But my estimation is that this tweet/newsletter was the one that truly entered the vc hive consciousness https://t.co/ZXnUZmMLM8
— Evan Armstrong 📧 (@itsurboyevan) March 11, 2023
“I think Byrne helped tipped the industry into a frenzy, but the speed and ferocity of this was beyond anything I thought possible,” wrote Armstrong.
House Financial Services Committee Chairman Patrick McHenry (R-NC) called the events of the past few days “the first Twitter fueled bank run” and The Atlantic said earlier this week that the world’s first online-inspired bank run doesn’t bode well for the next major crisis. Finger-pointing at the internet aside, these incidents have once again put audit front and center as a checkbox exercise that even when performed perfectly is anything but perfect. And that’s when audits are done right, which they so often are not. So again the public has to ask: what is the point then? And who do we blame for this?
Of these questions, ex-Freddie Mac CFO, former PwC partner, and former PCAOB chief auditor Marty Baumann said: “I suspect that may cause some people to question the value of an audit, but I believe the audit is incredibly valuable to investors. But I do question whether accounting disclosures of asset and liability duration mismatch is adequate.” Expect the PCAOB to start digging around in the SVB workpapers post haste.
A KPMG spokesperson provided the following statement to Going Concern regarding the SVB and Signature Bank audits: “Due to client confidentiality, we have no specific comment. We conduct our audits in accordance with professional standards. Any unanticipated events or actions taken by management after the date of an opinion could not be contemplated as part of the audit. It’s important to recognize that audit opinions, which only address the financial statements and internal controls of the business, are based on audit evidence available up to and at the date of the opinion.”
Whatever happened and how much of it should have been called out by auditors, I think we all agree that this is a bad look for a profession already struggling with optics.
What about the absence of a going concern qualification in the audit findings? What is in whistleblower reports the audit committee or audit team received? If no whistleblower reports were received, then why not? What about exit interviews with departing employees? What about the vacant CRO position? What is in the risk committee minutes from all THIRTEEN(!) meetings in 2022? What about insider stock sales? What about possible disagreements within the audit team? “we stand behind the reports we issued and we think we followed all professional standards” clearly lacks credibility. If KPMG followed all professional standards, then the standards are inadequate!
To answer your question, all amounts in millions:
SVB Form 10-K page 95, 12/31/22 total assets 211,793; equity 16,295.
SVB Form 10-K page 125, 12/31/22 difference between amortized cost and fair value of assets, 15,160.
16,295 – 15,160 = 1,135.
211,793 / 1,135 = 187, the asset / equity ratio.
If KPMG didn’t see SVB was virtually insolvent, it is full of fools. Of course KPMG saw this. So did the: Fed, OCC and FDIC.
They all failed as SVB did not “match maturities”.
Much of the fault for the SVB failure lies with GAAP which permits recording bonds at amortized cost. The distinction between trading and other securities is phony.
Plenty of other persons have seen this.
It interesting that if any credentialed business valuator had done a business valuation of SVB, the bonds would have been stated at fair market value exposing a far different equity amount.
Our valuation standards do not differentiate between industries. The problem is not with KPMG but with the banking industry allowed balance sheet presentation that shows bond at amortized costs and not at fair market values.
I realize that the value of bonds can be a moving target, and that their sale can be far into the future, but the investor / customer needs to know what the value is as of the audit or valuation date. With valuations they do.
That all sounds good, but there’s a significant problem. ALL banks in the US have loans. Under your thesis of “fair market value” accounting, all banks would have to audit all loans every quarter to determine their fair market value. The cost of auditing 10,000,000’s of loans would wipe out many consumers and small businesses because that’s a pass through cost. Poof, instant collapse of the economy, IF there was an honest attempt to do as you suggest. Almost no bank in America can withstand a bank run of that magnitude in 12 working hours of operation. Don’t forget, the boys that pushed for the bank run would be arrested in many other countries. In China, well, it’s considered treason and they spool up a 6 cylinder diesel wood chipper.