An Overview on the Latest Banking Crisis

Markets and investors have long wondered what issues might arise when interest rates finally moved higher. Unfortunately, over the last week one such issue came to light rather quickly and dramatically with the failure of three separate small to midsize, regional banks.

Plenty has already been written about all three situations, but we thought it’d be helpful to provide a timeline of what transpired and answer some of the questions we’ve received from investors. However, before we do that it’s important to note that last night the U.S. Treasury, the Federal Reserve, and the FDIC issued a joint statement that depositors at two of the institutions, Silicon Valley Bank and Signature Bank, would be fully protected and have access to their funds.

Timeline of Events

Wednesday, March 8^th

• Silvergate Bank, a relatively small bank ($11B in assets) focused on the crypto industry, announced it will wind down operations and liquidate its bank. 
• Silicon Valley Bank (SVB), a midsized bank ($200B in assets) focused primarily on small, start-up companies, announced it had sold part of its bond holdings at a loss and aimed to raise $2.25 billion via a share offering to shore up its balance sheet.

Thursday, March 9^th

• The prior day announcement by SVB of their sale of assets and desire to raise equity capital triggered a panic among key venture capital firms who in turn began to withdraw their money from the bank. At the same time, fearing the start of another financial crisis, bank stocks took a hit.

Friday, March 10^th

• By Friday morning, trading in SVB shares was halted and the bank abandoned plans to raise capital through a stock sale. Regulators intervened, effectively shutting down the bank and placing it into receivership under the FDIC.

Sunday, March 12^th

• Signature Bank, another midsized bank ($110B in assets) focused on the crypto industry, was closed by regulators in New York and placed into receivership under the FDIC.

Common Questions

Is this the start of another financial crisis? It would be foolish on anyone’s part to definitively state one way or the other, but there are some clear differences compared to the ‘08-‘09 financial crisis that give us comfort. 

• The overall banking system is far better capitalized than it was leading up to the ‘08-‘09 financial crisis, particularly at the larger banks.
• While two of the institutions had asset bases in the billions, they were relatively small players within the larger banking industry.
• Two of these institutions, Silvergate and Signature Bank, failed in large part due to the struggles of the crypto industry after the FTX collapse. As the two main bankers to that industry, it is unlikely others will be similarly impacted.
• SVB had a different story than the other two, but what they all had in common was a unique and concentrated depositor base that is less than ideal when a “run on the bank” starts.

What were the issues with SVB and why did it fail?  Unlike most banks, SVB didn’t have a network of bank branches and smaller retail depositors. Instead, SVB had a very concentrated depositor base made up of small start-up companies. Those companies would receive funding from their investors and park large amounts of capital at SVB until it was needed. They developed a very nice niche in that area of the market and as a result experienced tremendous growth over the last several years.

Ironically, in their effort to be diligent about the loans they made with that money, most of the capital they received from their depositors was invested in longer maturity U.S. Treasuries, rather than being loaned out as banks would typically do. While that may seem prudent and safe from a credit standpoint, that approach exposed them to the negative impact that higher rates have on the market prices of those bonds. If held to maturity that isn’t necessarily an issue, but when depositors start to ask for their money back that can create serious issues and unfortunately have a snowball effect.

SVB can’t be the only bank impacted by higher rates, so what’s to stop the same thing from happening at other banks?  That’s the key question for investors and we do think there are several things here that should help investors gain some comfort.

• As we laid out in the prior answer, SVB, and really Silvergate and Signature Bank, were not your typical banks. SVB was focused on small start-up companies and the other two were heavily exposed to the crypto industry. Most banks will not be so concentrated in such volatile industries or market segments.
• Along those same lines, all three had a disproportionately high percentage of deposits that were above the FDIC’s $250,000 guarantee. SVB and Signature Bank were both well above 80% which is highly unusual and makes them more susceptible to a “run on the bank”.
• As part of their joint announcement on Sunday, the Fed, Treasury, and FDIC also announced a new lending facility that should alleviate a lot of the stress caused by the “mark-to-market” price impact to bonds that caused issues with all three banks.
• All three of the banks that have failed are notably below $250B in assets. That’s an important distinction due to the more stringent capital requirements and leverage limits placed on financial institutions above that threshold.

Is the announcement by the Treasury, the Fed, and the FDIC just another government bailout?  It probably depends on how you define bailout and who is getting “bailed out”. Are depositors being bailed out by being made whole? That’s clearly a “yes”, although I think when the term is used it’s directed more towards management, bond holders, and stockholders. In that case and with how things are structured this time, the answer is no. The only people being made whole in this case are the depositors. Management positions have lost their jobs, and bond and stockholders will get nothing unless there are miraculously assets leftover after liquidation. The debate about whether this creates a moral hazard going forward is a good one, but again there are some clear differences when we compare the government’s response today versus the ‘08-‘09 crisis response.

Are there any implications for the economy or market that we should be considering? There are a couple of things that come to mind. We don’t necessarily have the answers, but the recent developments could influence a few things.

• The Fed and rate hikes. Early last week, prior to Silvergate, there had been about a 70% probability of a 0.50% rate hike at the March meeting. Based on market pricing now that seems to be off the table and the debate is about whether there will be a 0.25% hike or none at all.
• While things in Washington seem to march to their own drumbeat, we’d hope that lawmakers better understand the impact that even the whiff of financial instability can have on markets. At the margin, we’d hope this would lead to a resolution on the U.S. debt ceiling sooner rather than later. 
• It probably won’t have an outsized impact, but it’s hard to imagine the events of the past week have been anything but negative for economic growth.

Are you making any portfolio changes as a result?  No, not at this time. As our investors know, we view volatility as opportunity, so we’ll continue to monitor markets and prices and follow up should things move enough to warrant a portfolio action.

There are many moving parts to the situations mentioned above. We welcome any questions or comments you may have. Please contact any member of our team to discuss any topic in more detail.

We value your continued support and your trusted relationship with Smith + Howard Wealth Management.

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