Bank Failures: This Time Is Different
By Cliff Aque, AIF®, CFA®
The past week has seen several large bank failures that we have not seen since 2008 during the Great Financial Crisis, but this time is different. While it does feel quite sudden, the problems at these banks have been brewing for the past several months, and stem primarily from their exposure to companies tied to the cryptocurrency markets (crypto) and venture capital (VC). As the Federal Reserve (the Fed) has tightened liquidity by raising rates and letting its balance sheet shrink, financial conditions have become tighter, especially in the frothier parts of the market.
In 2021, capital was flowing freely into both crypto and VC. These companies needed to hold their excess capital and deposited that money in their bank accounts. For crypto companies, their options for banking partners were few due to regulations. Several traditional banks stepped into these markets (including Silvergate Capital and Signature Bank) and saw their assets grow quickly. Silicon Valley Bank (SVB) was less exposed to crypto but very exposed to VC. SVB, which has been around for almost forty years, saw its deposits grow by 86% in 2021 alone 1. As their assets quickly grew, these banks could not lend the money out fast enough. Instead, they bought what they considered to be safe assets, including longer-dated Treasuries and agency mortgage-backed securities. While these bonds do not have credit risk, they do have interest-rate risk.
Unfortunately, this created a classic asset-liability mismatch for these banks as they held longer-dated assets but could potentially have to give money back to depositors at a moment’s notice. In 2022, the prices on those bonds fell as the Fed raised rates at the fastest pace in recent history. If the banks could have held these assets until maturity, they would have received all their money back. However, in late November, FTX, a crypto exchange that seemed to have a bright future was proven to be a house of cards and investors quickly pulled their capital from that platform. To meet outflows, FTX pulled its money from its banking partners which in turn were forced to sell assets at a loss to raise enough capital to cover those redemptions. FTX’s failure spread throughout the crypto ecosphere forcing other companies to pull their deposits from banks.
Silvergate was the first shoe to drop after it announced large losses in the fourth quarter due to selling assets at a loss, leading to its collapse, and putting investors on edge. SVB’s focus on startups made it uniquely exposed to a tight-knit, niche community. As VC money dried up in 2022, companies began burning through cash deposits and SVB found itself in a similar position to Silvergate, announcing last Wednesday that it had sold securities at a loss and would be selling stock to raise capital. Following Silvergate’s demise, VC depositors and their portfolio companies wasted no time in pulling capital from SVB and within 36 hours, the 39-year old bank was shuttered.
After SVB was seized last Friday, Signature Bank then faced a crisis of confidence. In early 2022, crypto clients accounted for 27% of its deposits but many of these were withdrawn after FTX’s demise. Even though the bank had announced that it would reduce its exposure to crypto, its shares were down 75% over the past year after declining 25% last Friday. Depositors took notice and began withdrawing from Signature Bank and by Sunday, the New York Department of Financial Services stepped in, forcing it into receivership with the Federal Deposit Insurance Corp (FDIC). This move may have been excessive but will hopefully be a good outcome for the remaining depositors at Signature. FDIC insurance only covers $250,000 per account ($500,000 for a joint account), and as of the end of December almost 90% of Signature’s $88.6 billion in deposits was not FDIC-insured. With $110 billion in assets at the end of the year, hopefully there are plenty of assets to cover its liabilities.2 Regardless, in a joint statement by Treasury, the Fed, and FDIC, it was announced that all depositors in SVB and Signature Bank would be fully protected.3
These closures are historic, but the contagion will hopefully be contained soon. Silvergate was well known for its ties to crypto and its closure was notable as a classic run on a bank. When SVB announced it had experienced a similar event of selling assets at a loss, the VC world panicked and SVB experienced its own run on the bank. When this started at Signature Bank, regulators stepped in quickly and hopefully in time to stop this run from going any further. As of this writing, some other regional banks are under pressure, including First Republic, Western Alliance, and PacWest Bancorp,4 but the banking sector as a whole is well-capitalized and healthy. While the three banks that failed appeared that way at the start of 2022, they were exposed to depositors that gave them money quickly and then withdrew it faster than the banks could handle. The Fed warned that there would be “some pain” as they tightened, and while they did not likely foresee these failures, this doesn’t appear to be anything like 2008.
3 https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312b.htm
4 https://finance.yahoo.com/news/us-regional-banks-remain-under-092829687.html