1/ What happened?
a) A story of shadow banking exposure and depositor concentration
The US banking system is made up of more than 4,000 credit institutions, the overwhelming majority of which holds less than $10bn of assets. Regulatory oversight obviously differs whether you are JPMorgan Chase (more than $3,600bn of assets as at the end of 2022) or a small regional bank. Capital requirements are set at lower levels for smaller banks and they do not have to fulfill several liquidity constraints. Yet, this story is not about regulatory failure.
This is a story about fast growth and depositor concentration that ends badly for three banks:
- Silvergate Bank (SI): assets grew from $2bn to $16bn between 2019 and 2021, then dwindled back to $11bn as at the end of 2022. This crypto-centric bank announced on Thursday that it was winding down its operations and liquidating the bank, which has been in financial turmoil since the collapse of crypto exchange FTX. Following a bank run in the fourth quarter, Silvergate leaned on the Federal Home Loan Bank of San Francisco for a $4.3 billion cash injection, which by the end of the quarter made up nearly all of its total assets.
- Signature Bank (SBNY): its assets went from $50bn to $118bn between 2019 and 2021 and was much bigger than now-defunct Silvergate Bank. In the wake of the demise of SVB and SI, Signature Bank, the bank was closed on Sunday by its chartering authority. All depositors of this institution will be made whole. As with the resolution of Silicon Valley Bank, no losses will be borne by the taxpayer.
- Silicon Valley Bank (SIVB): assets went from $71bn to $211bn between 2019 and 2021 and were stable until the end of 2022. As its name suggests, SVB was lending to companies mostly based in the Silicon Valley, with a focus on lending to technology companies, providing services to venture capital and private equity firms. It rapidly grew to become the 18th largest bank holding company in the US. During the 2019-2021 phase, SVB received significant inflows of deposits from venture capital firms that it needed to cover from an asset standpoint. As such, management sought to chase yield by buying long-duration bonds (Treasuries, MBS…). The bank started to lose deposits as VCs pulled cash through operating capital, which pressured management to sell some of its long-term assets. It seems like these assets were not really properly hedged, but we lack sufficient information thus far.
On March 9, 2023, shares of SVB Financial plunged more than 62% after the company proposed a share sale to shore up its balance sheet which had suffered fleeing deposits and a $1.8bn realized loss on the securities sale. According to a regulatory filing published on Friday, investors and depositors tried to pull $42bn from SVB on Thursday… A good old fashioned “bank run”. Despite being in sound financial condition prior to Thursday, the California watchdog said the run “caused the bank to be incapable of paying its obligations as they come due,” and it was now insolvent. The bank was then closed by the California Department of Financial Protection & Innovation and placed into FDIC receivership, marking the biggest failure of a US bank since the financial crisis.
On Sunday evening, a joint statement by the US Treasury, the Fed and the FDIC announced that “no losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer”. In other words, all deposits (even those that are uninsured by the FDIC above $250k) will be guaranteed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks. Subordinated debtholders and equity holders will very likely be wiped out, while senior unsecured creditors may recover part of their holdings (bonds were trading at c. 40 cents on the dollar at Friday close, but this is not a trustworthy indication of their final recovery).
In order to contain the fallout from these bank failures, the Fed said it would create a new lending program for banks: the Bank Term Funding Program, or BTFP. The facility will allow banks to take advances from the Fed for up to a year by pledging Treasuries, MBSs and other debt as collateral. By allowing banks to pledge their bonds, they can meet customer withdrawals without having to sell their bonds at a loss, which is what SVB did last week. Banks can borrow funds equal to the par value of the collateral they pledge, which means that the Fed will not be looking at the potential unrealized losses on the bonds.
This mechanism, along with the guarantee that all depositors will be made whole, are very significant steps to ensure the safety of the US banking system.
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