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On Banking

March 15, 2023

On Banking

While the seizure by Federal regulators of Silicon Valley Bank, Signature Bank, and the voluntary dissolution of Silvergate Bank is not ideal, we believe the actions of the Federal Reserve, Treasury Department and the Federal Deposit Insurance Corporation have largely mitigated the risk of bank contagion.  

What Happened? 

Over the last several years, liquidity has increased dramatically due to low interest rates and fiscal stimulus passed by Congress. That liquidity was then deposited into banks and banks that served the startup and venture capital (VC) communities experienced significant inflows over that time period. Banks can only invest those deposits through loans, cash, government bonds or mortgage-backed securities. Silicon Valley Bank and Signature invested a significant portion of their deposits into longer maturing government and mortgage-backed bonds at historically lower yields (interest rates). As rates increased, and liquidity decreased, their core client base (startups and VCs) became net withdrawers of funds as opposed to net depositors and this affected their capital ratios that they must maintain by law.  

As a result, SVB was compelled to sell a $21 billion bond portfolio and realize a $1.8 billion loss on the sale. Further, they still needed to raise capital to comply with Federal laws. At this point (last Thursday evening/Friday morning) word had spread in the startup and VC communities and withdrawals began to spiral out of control. This led to the bank being unable to comply with their capital requirements and Federal regulators seized the bank. 

A similar fate met Signature Bank which was seized by Federal regulators Sunday afteroon.

The Government’s Response 

Late afternoon, on Sunday, the Federal Reserve, Treasury Department and the Federal Deposit Insurance Corporation issued a joint statement guaranteeing all deposits of the two seized banks regardless of the normal $250,000 FDIC limit. They have not extended this limitless protection to the rest of the banking industry, but it seems unlikely that they would do so for the 16th and 29th largest banks in the country and not others if needed. 

At the same time, the Fed also announced a new bank lending facility, called the Bank Term Funding Program (BTFP). This program allows banks to present their bonds to the Fed window and the Fed will lend them 100 cents on the dollar regardless of the current mark to market value of said bonds. The default risk to the government is extremely low as these bonds are all government paper or mortgages and this allows banks to meet their liquidity needs without recognizing the losses on portfolios they intend to hold to maturity.  

These two actions are mutually reinforcing as the public should be reassured and not panic withdraw their deposits since the FDIC has now implied that all deposits are insured regardless of amount and to the extent that some banks do face a “bank run”, those affected can access the BTFP, to satisfy those demands without recognizing losses on their securities portfolios while staying in compliance with their Federally regulated capital requirements. 

What Makes this Different from 2008? 

The subprime mortgage crisis was a credit quality problem. That is to say that the securities in which the banks had invested were seriously overstated in terms of their credit quality (i.e. their ability to continue to make interest payments). As banks were forced to realize sales on these portfolios, it became obvious that these securities were incredibly overpriced which caused more sales, eventually causing many of them to be worth mere pennies on the dollar.  

What we are experiencing today is a mismatch in time horizons (duration gap). Banks own very high quality, mostly government backed bonds and mortgage-backed securities which are of a much higher quality than those that wrecked the markets in 2008. However, with the rapid increase in interest rates over the last year, the value of those investments has fallen. If they are held to maturity, they will be worth 100 cents on the dollar, but if banks were made to sell them, as SVB was forced to do, losses would be incurred which creates this capital requirement spiral. 

If you have any questions or concerns regarding the above or your portfolios, please contact us. 

Thank you for your trust and your business, 

Marin Wealth Advisors 

Category iconEducation Tag iconbanking,  duration gap,  silicon valley bank

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    San Rafael, CA 94903
    415-458-5880

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    925-374-4899

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