An old fashioned bank run – accelerated by rumours that spread at internet speed and massive withdrawals – hit Silicon Valley Bank (SVB) on Thursday. Depositors pulled a massive $48 billion out of SVB before US Financial Regulators seized the bank to prevent insolvency. SVB which had assets of $209 billion, will be the biggest US bank failure since Washington Mutual and Lehman Brothers in 2008.
Additionally Silvergate Corporation announced that it was liquidating its wholly owned subsidiary Signature Bank, and warned the public against relying on its own previously published financial accounts.
Silvergate and Signature were big cogs in the crypto ecosystem and many of their problems appear to stem from the FTX fraud.
Separately, Circle Internet Financial, the issuer of the popular USDC ‘stablecoin’ is in a world of hurt. The USDC stablecoin broke its $1.00 peg falling to $0.87 before recovering partially to $0.95. Part of the ‘reserves’ backing the stablecoin were parked with Signature Bank and SVB. While the detail of this may be only of passing interest to some of our readers, it serves to highlight how the interconnections in the financial world can quickly cause a contagion, spreading faster than COVID-19.
What went Wrong?
Leaving alone the moral hazard questions, the main cause of the collapse of SVB was a mismatch between the characteristics of its deposits (Liabilities) and a large portion of its investments (Assets)
The problem had been festering since long term bond rates started to rise. It seems that Silicon Valley Bank (SVB) held lot of deposits from Venture Capital (VC) and start up firms. Those deposits were mostly at call. SVB certainly had loans to VC as part of their Assets, but it was also quite convenient to use the deposits to buy long term bonds. Back when you only had to pay 0.25% you could simultaneously buy long term Treasury bonds yielding 1.5% and make a handy 1.25% margin. Now, many of our clients will know that when interest rates rise a long-term fixed interest bond falls in value. We would expect that financial geniuses at the banks would also know that.
However, the geniuses relied on the fact that a bank does not have to ‘mark to market’ the securities that it designates as Hold To Maturity (HTM). So, even though the bond rout over 2022 knocked about 12% off the value of a typical investor bond portfolio, the banks were able to ignore that yawning gap between present market value and their purchase price.
It’s all good fun till someone gets poked in the eye
Or in this case all good fun until depositors start asking for their money back. When that happens you have to move those HTM bonds to Available For Sale (AFS) category, and at that point you have to mark them to market. Bank depositors are not stupid. As interest rates have risen, depositors looked around for higher rates. When SVB could not match the higher rates (because they had already locked up a huge chunk of capital in bonds bought at lower rates) depositors started to withdraw. As they withdrew more of the bonds that were previously HTM had to be moved to AFS.
Then when SVB tried to do a capital raise to plug the gap in their regulatory capital investors smelled the smoke and the withdrawals accelerated. On Thursday March 9, depositors pulled $48 billion. No bank can survive that rate of withdrawal. By lunchtime Friday the 10th, the FDIC was appointed to take over the bank. No doubt there will be frantic negotiations going all weekend to come up with a resolution that can be announced by opening of business on Monday.
It is likely that a bank such as JP Morgan will come along and buy the SVB. Regulators tend to have cosy arrangements with the biggest of banks, and there is no small amount of mutual back scratching that happens behind closed doors.
The irony of all this is that it was the safest of financial instruments that brought down this large Silicon Valley institution. There was no default on the assets they had bought. US Treasuries are still considered the world’s safest asset. It was just a market movement in the value of those assets that was not fully hedged by SVB that led to its downfall.
What Lessons to Learn?
In the USA banks have Federal Deposit Insurance Corporation insurance for deposits up to $250,000.
This is designed to maintain confidence in the banking system in times of stress. The FDIC was created in 1933 as a response to Depression era bank runs.
So, most small depositors will be inconvenienced but generally made whole. We call it ‘money good’.
However, SVB was also the bank for many start-ups. Some would have had tens of millions deposited at SVB for payment of payrolls, inventory, tax etc. If those depositors are hung out to dry, it could create a crisis of confidence in other smaller regional banks, and specialist banks, of which America has thousands. First Republic Bank is at risk with reports of lines around the block at some of its branches.
If more than a few of those Venture Capital depositors start to falter if could shatter confidence in the whole VC community and the wider market for credit to smaller companies.
Australian Banks
We also have the benefit of a $250,000 government guarantee on deposits with Approved Deposit-Taking Institutions (ADI’s). These include banks and building societies that are regulated by APRA.
It applies per entity. So if you have a personal deposit with say Goldfields Money, and also an SMSF deposit with Goldfields Money, both deposits are guaranteed up to $250,000.
While the risk of contagion spilling over to Australian Banks is small, we do still need to think about it. The big four, ANZ, CBA, NAB & WBC are all too big to fail. Although deposits are only guaranteed up to $250,000 there is no way that the regulator or the Australian Government could stand by and see these banks fail to repay depositors (Shareholders are way down the priority list, just below the Hybrid Notes). At this stage we are still quite comfortable with deposits in the big four. However, if you were with a smaller bank or building society we would be cautious about exceeding the $250,000 guarantee limit. Not that we have reason to expect any failures, but it is easier sleeping through a bank run if you know the government has your back.
Wider Impacts
Could this contagion spread? Could this be like 2008? These are questions we have to consider. No two crises are ever exactly the same. As they say “history doesn’t repeat, but it does rhyme”.
In late 2007 the S&P peaked at 1562 points on a daily close basis. By 12 September 2008 it had fallen to 1251 points, down 19.9% in 11 months. Then over the weekend of 13/14 September the Lehman crisis exploded and on Monday the 15th Lehman was put into bankruptcy. That day the S&P 500 dropped another 4.7%. Tuesday was up. Wednesday was down 4.7%. Then on Thursday and Friday the market rallied back to just above the point on the Friday before the bankruptcy. It was a tricky week as the markets navigated a massive storm and lurched between rumours of hope and disaster.
From the end of the week after Lehman, the market would go on to fall another 46% to a final low six months later at 676 points. While that was happening, US Treasuries were up by 8.76%. And the US Dollar rose by 32% vs the Aussie dollar. Senior Investment Grade bonds held up OK, gaining 2.48% over the period. However, sub investment grade bonds did worse at -25.8%. Gold fared only slightly better than investment grade bonds, up 3.15% but you suffered higher volatility along the way.
Just for curiosity, I checked to see how Berkshire Hathaway shares went during that post Lehman period down to the final low in March 2009. Yes, the BRK.A shares were down 44.73% slightly worse than the S&P 500.
What actions should we take?
The ‘Fasten Seatbelts’ sign has been illuminated. I use the analogy of a pilot flying into a thermal turbulence. It will get very bumpy. We can’t even see the exact location of the next bumps on the radar. But it is best to know from the outset that this could get rough. If you have no stomach for this then it is best to act fast. In this analogy you don’t have to stay on the plane if you are not comfortable. But if you want to get off suddenly, you may not get to where you want to go.
We will provide more updates as needed to keep you informed.
