March Madness
Published on March, 13th, 2023
A series of events last week culminated in the United States Treasury announcing over the weekend that it would take steps to stabilize the banking industry. These actions included providing access to all depositor funds at two banks which were shut down by regulators, as well as a new funding vehicle to guarantee that all banks have access to liquid funds should the need arise in order to meet withdrawal requests by customers. The pace at which these events have unfolded is concerning, but we believe these actions by the Treasury should stabilize the banking system and prevent further panic by bank customers. However, there may be some additional issues which arise in the industry as the full implications of this episode become clearer in the coming days and weeks.
Last week, on March 8th, the holding company for Silvergate Bank announced that Silvergate would close down and liquidate its operations. Silvergate was a California-based bank unknown to most Americans that went public in late 2019.1 The bank described itself as the leading provider of innovative financial infrastructure solutions and services to participants in the nascent and expanding digital currency industry.2 Silvergate also built and operated a 24 x 7 currency exchange where cryptocurrency traders could buy and sell digital currency instantaneously.3 As a result, a large proportion of the bank’s depositors were cryptocurrency traders.4
The downfall of Silvergate may have been catalyzed in part by the November 11 collapse and bankruptcy of the FTX cryptocurrency exchange, the details of which are still being analyzed and uncovered. As a result of the FTX bankruptcy, cryptocurrency investors may have grown more cautious about the creditworthiness of the various entities operating in the crypto world.1 We believe that as Silvergate’s depositors began to withdraw more and more of their funds, this eventually began to put pressure on the bank’s balance sheet. (This is referred to as a “run” on the bank.)
In a simple model of a bank’s balance sheet, the bank takes in deposits from customers and uses those deposits to make loans as well as to invest in safe fixed income securities, usually government bonds. Typically, these bonds are divided into two categories, one of which is very short term and used for funding customer withdrawals, while the other can be thought of as longer term that might be held to maturity.5
If more withdrawals are requested of the bank than can be funded by the short-term category, the bank must then start to sell bonds from the long-term category. If those long-term bonds are priced at a loss because interest rates have increased, the bank must realize that loss by selling in order to provide funds back to the customers who are withdrawing their cash. However, if these realized losses are large enough relative to the net worth of the bank, the bank may end up in trouble.5 On March 8th, this situation appears to have developed at Silvergate Bank.
The very next day (Thursday), Silicon Valley Bank, whose parent is bank holding company SVB Financial Group, also suffered a run by depositors, and its stock price fell by 60%.6 That bank’s shares never reopened for trading on Friday and it was seized by the FDIC.6 SVB was a somewhat unique bank in that its deposits were largely from start-up companies, many of which had not yet done an IPO.7 SVB was also far larger than Silvergate, with total assets at year end of $212 billion compared to Silvergate’s $11 billion. According to company SEC filings, of SVB’s year-end deposits of $173 billion, just $74 billion were used to fund loans, while the remainder were largely invested in government bonds.
Just as was the case with Silvergate, SVB’s depositors apparently began to worry about the health of the bank, and many rushed to withdraw their funds. Ultimately SVB was in a situation where it began to realize losses on its bond portfolio which exceeded the bank’s equity,6 which seems to be why it was seized by the FDIC on Friday March 10. Another bank said to have exposure to crytpocurrency, Signature Bank, was closed down on Sunday by New York state regulators. Signature Bank had year-end total assets of $110 billion.
The unusual aspect as we see it to the seizures of SVB and Signature Bank is that both banks are apparently not facing problems with bad credit or delinquencies. Rather, they seemingly faced issues of liquidity and access to capital to shore up their balance sheets in the short term. We think that is what makes this episode so different, say, than the 2008 financial crisis where there were bad loans that ultimately destroyed the equity capital of many banks in the U.S.8 What we saw last week was not a credit problem. We believe that, in general, bank assets are creditworthy, and banks are well capitalized. Many rules promulgated since the 2008 financial crisis have required this, and the Fed conducts annual stress tests on the largest U.S. banks to ensure it.9 In our view, those tests were very tough in recent years, and all large U.S. banks passed them.
We believe that the bank seizures, as well as the winding down of Silvergate, can be at least in part tied to the Federal Reserve’s interest rate hikes which began in March 2022 as part of the Fed’s efforts to fight inflation, as well as the reversal of its quantitative easing program, called quantitative tightening. In past rate hiking cycles, we have often seen that “something breaks” and the Fed has to stop. Examples that we think about include Long-Term Capital Management (1998) and Continental Illinois (1984).
On Sunday March 12, the United States Treasury announced that all depositors of SVB and Signature would be able to access all their funds on Monday. This includes all deposits, even those exceeding the FDIC insured limit of $250,000 per depositor. The Federal Reserve also announced a new Bank Term Funding Program that will lend against Treasury and agency securities at par for up to one year, providing another resource for banks to meet depositor requests for funds should the need arise, in addition to the discount window. For now, we believe these actions are likely to limit further contagion and fears about the health of the U.S. banking industry. That said, it is possible that other factors like rising deposit costs that result from this episode could continue to weigh on at least some banks going forward.
Source
1https://en.wikipedia.org/wiki/Silvergate_Bank
2https://www.silvergate.com/about-us
6https://www.wsj.com/articles/silicon-valley-bank-svb-financial-what-is-happening-299e9b65
7https://s201.q4cdn.com/589201576/files/doc_financials/2022/q4/Q4_2022_IR_Presentation_vFINAL.pdf
8https://www.fdic.gov/bank/historical/crisis/overview.pdf
As of March 13, 2023
