While many outlets have reported on the failures of Silicon Valley Bank and more news will continue to trickle in, it is our understanding that these episodes do not reflect the systemic risks experienced during the financial crisis of ’08-’09. The Treasury and the Federal Reserve are providing full backing for customers’ deposits in banks of all sizes. Affected customers are being made whole from a pool of emergency cash that receives its funding from a 2010-era banking legislation (Dodd-Frank) that mandated special fees on banks.
Role of Crypto and Customer Concentration
The significant exposure and decline in cryptocurrencies led to both Signature Bank and Silvergate Capital’s demise over the weekend, with $118 billion and $11 billion in assets, respectively. Silicon Valley Bank, SVB, at twice the size of Signature Bank, was a victim of its own success in some regards.
The bank’s deposits were not tied to customers’ loan portfolio where it tends to be “sticky.” Instead, the deposits came from unallocated venture capital funds and other monies deposited by customer companies for payroll processing for a wide array of startups. The nature of these deposits makes them more susceptible to flight risks. The concentration of tech startups, where founders are more likely to know each other, adds to the herd mentality of decision-making and underpins the swift run on the bank that took place on March 10.
Silicon Valley Bank did not suffer loan losses or invest in risky assets. They made the tactical error of parking their substantial deposits in securities with high-interest rate sensitivity. They also failed to overcome the strategic concentration of its customer base. More than half of the bank’s $73.6 billion loan portfolio comprised fund financing, which takes the form of subscription credit lines that funds could draw on to ease capital calls. This form of financing is the lifeblood for private equity firms but can be severely cyclical. While most of its assets may eventually find better buyers/operators in the banking world, their bounty of errors will likely change the regional banking landscape in a few ways.
Dodd-Frank Redux?
Banks under $250 billion in assets have bypassed the strict capital cushion requirements of larger money-center banks since 2018. There will be intense scrutiny on whether mid-sized banking institutions should be held responsible for future failures. In addition, regional banks may have to get more competitive for customers’ deposits than the defensive pricing strategy banks have practiced for so long. This means lower margins for regional banks and an intermediate-term preference for large banks.
If Chairman Powell was looking to keep the “higher and longer” interest rate strategy in high gear, SVB just served up the first evidence that the monetary tightening engine is starting to redline. Approximately 30 percent of loans originated in smaller banks and those very banks will be on the defensive as they shore up capital over the next couple of quarters. This accomplishes a good portion of the Fed’s own goals. A more cautious Fed will be a welcome outcome as headline inflation continues to head lower on the money supply tightening already in motion.
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