We wanted to let the dust settle a little before discussing what happened with the recent bank closures of Silvergate Capital, Silicon Valley Bank, and Signature bank, and the current turmoil with Credit Suisse. There are many rumors and opinions surrounding this situation and opportunists that are trying to spin these events into something that suits their own uses. These types of incidents have the potential to turn into major economic and market events, so the more we look at these situations with clarity and objectivity, the better.
Who are these banks?
The first bank to shutter its doors was Silvergate Capital. Silvergate catered to the crypto community by lending to crypto-centered businesses and being regarded as the crypto bank of choice. In the months leading up to its closure, it laid off about 40% of its employees and reported almost a $1 billion loss in the 4th quarter of last year. When the company saw that it would no longer be viable, it announced that it would close the bank down and give depositors back their funds in full. While Silvergate Capital was a newsworthy event, its closure would soon be overshadowed by the news of Silicon Valley Bank.
Silicon Valley Bank catered to the venture capital and startup community of the west coast. Its clientele was made up of companies like Etsy, Roku, Roblox, and others. Very few people knew SVB had issues until March 8th when it announced it would have to book a $1.8 billion loss after selling some of its investments to meet recent customer withdrawals. SVB planned to raise money by selling a mix of its stock, but it was too late as the run on SVB had already started.
Signature Bank was historically a New York regional bank that catered to real estate investors. Some years ago, it pivoted to a cryptocurrency strategy much like Silvergate Capital. Although it was recently the second leading “crypto bank” behind only Silvergate, it announced that it would steer away from its crypto pivot last year, as it thought it took on too much exposure to crypto assets. Apparently, it was too little too late. As fear spread about banks that had exposure to crypto and other high-growth sectors, the NY regulators stepped in over the weekend to shut down the bank before its bank run worsened.
Finally, Credit Suisse is a Swiss-based multinational bank. It has several business lines, such as Wealth Management, Investment Banking, Swiss Banking, and Asset Management. Credit Suisse has been marked by a very turbulent last several years. From net profit losses to large legal settlements due to corporate scandals. Late last year, the Saudi National Bank gave Credit Suisse a large cash infusion by adding a 9.9% investment into the bank. As fear in the banking sector spread through the weekend and earlier this week, bank customers questioned how stable their banks really were and started withdrawing funds from Credit Suisse. Additionally, the Saudi National Bank said it could not invest any more funds into Credit Suisse due to regulations. Thankfully, the Swiss National Bank has lent $54 million to Credit Suisse, and as of this writing, it is still operational. Furthermore, both Credit Suisse and the Saudi National Bank say that the bank is fine, and all of this is nothing more than “a little panic.”
Why did they all close?
Unlike the pre-2008 financial crisis, where banks were making risky investments into financial products no one understood (including the banks), these banks all had relatively safe investments and were well capitalized. In fact, most of their investments were U.S. Treasurys and U.S. agency mortgage-backed securities. This time, the risk was not getting paid back from investments the bank made, it was how long it was going to take to get paid back – duration risk.
The way banks traditionally work, is they take their customer deposits and make loans with some of the deposits, invest in relatively safe products like U.S. Treasury bonds, and keep a portion in cash or short-term investments to meet customer withdrawal demands. As these banks’ deposits grew exponentially in 2020-21 during the high-growth, and very low-interest rate environment, boom days, the banks felt they needed to put the high volume of deposits to work in longer duration U.S. Treasurys to earn a better yield than shorter-dated maturities.
In a normal economic environment, this would not have been a bad strategy; however, we all know that the last few years have been anything but normal. In hindsight, the banks should have foreseen that the low-rate environment and excess government stimulus were artificially speeding up the economy, and sooner or later the economy was bound to slow down. When the Federal Reserve began to raise rates last year, the high-growth areas of cryptocurrencies and Silicon Valley startups came to a screeching halt, as easy money policies stopped, and venture capital firms dramatically slowed investing new capital in these types of companies.
As funding slowed for startups, startup founders began withdrawing funds from Silvergate Capital, Silicon Valley Bank, Signature bank, and others to meet their business operation demands. Eventually, the withdrawals became so great that the banks needed to raise additional funds to meet the demand. That’s when the fear started spreading.
If you recall, the banks all bought longer-duration U.S. Treasurys with the rush of deposits in 2020-21, when interest rates rise, those Treasurys reduce in value. So, the banks had to sell securities at a loss to raise the cash they needed for customer withdrawals. The fact that the banks were selling securities at a loss spooked some customers and the pace of withdrawals began to increase. If you add in modern technologies, like chat threads, Twitter, electronic bank transfer, and a very well-connected and techy group of people like startup founders, you have the fastest run on a bank we have ever witnessed. Quite frankly, if there wasn’t an ability to communicate so rapidly and have easy access to information due to modern technology, these bank runs probably would not have happened.
So, what is happening now?
Only about 12% of the deposits held at Silicon Valley Bank were insured by the FDIC; the rest of the deposits were larger than the $250,000 the FDIC insures. The FDIC, the Federal Reserve, and the Treasury Department decided to step in and guarantee all SVB’s uninsured deposits. To be clear, this is a bailout for bank depositors and not the bank itself or investors. Those that own SVB stock or bonds will most likely lose all their value, as the stock has been halted since Friday and the FDIC has taken charge of Silicon Valley Bank and placed it in receivership. If the guarantees had not been made to make depositors whole, many companies would not have access to their cash to pay payroll and other business expenses as early as Monday.
Silvergate Capital has already shut its own doors earlier this month and is making plans to send depositors back their funds. Signature Bank was taken over by New York bank regulators and those depositors will all be paid out as well. There are also discussions being held to see if regulators can auction off pieces of the banks to other banks and private entities to try and recover whatever business they can.
What don’t we know?
The banking system runs on public trust. If we as a society no longer trust our banks, it will make the banking system more vulnerable, especially smaller community banks. Customers may pull funds from smaller banks and add them to the bigger banks. Smaller community banks would have to close, and economic activity would slow dramatically. Community banks are the banks that have relationships with small local businesses; they are the ones that supply your local pizza shop or mechanic a line of credit to make sure they can make payroll when business is slow. Bigger banks do not have the same relationship with small businesses as local banks do. It’s imperative that the public does not lose trust in the banking system.
The more the government has to step in to shore up banks, the more likely they will add more regulation to the banking system. Whether that is right or wrong is to be determined, but one thing is for sure, added bank regulation will lead to a slower pace of money. It means less loan activity, tighter controls on investments, and possibly higher interest rates for borrowers. When the pace of money in the economy slows, so does the economy itself. We’ll see how that all plays out.
The Federal Reserve will most likely have to rethink its monetary policy. One of the major drivers of this banking debacle is the rapid pace the Fed has been raising interest rates. We don’t see how the Fed can keep raising rates. Currently, “the market” is pricing in one more interest rate hike of 0.25% during the next Fed meeting on March 22nd-23rd, and then a pause. Many talking heads have opined that the Fed should not hike anymore and start the pause now before something else breaks.
Rapidly raising interest rates, in the way the Fed has done, has real consequences for anyone that owns long-term debt instruments like U.S. Treasuries. This includes banks, insurance companies, pensions, endowment funds, etc. If the Fed continues to raise rates in the same manner, more banks will run into issues. They will more than likely pause the rate raise program very soon to allow the present higher rates to run its course without added pressure. There are some signs that the job market is finally starting to cool and inflation, although still high, is headed in the right direction.
All in all, the immediate threat seems to be contained for now. We will continue to monitor changes in the markets and economy and make adjustments as appropriate. We apologize for the longer than usual explanation, but we thought this topic needed a thorough run. We hope it has helped shed some light on what can be a complicated matter. As always, you are the reason we exist as a firm. If you have any questions, please reach out to us. Feel free to forward this to a friend that may find it useful.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that the strategies promoted will be successful.