Culling the Herd: SIVB, SI
Markets faced a new challenge last week – the specter of bank collapses, knocking the Fed off the top of the list in terms of market concerns.
Well, sort of.
Many would argue that the Fed’s actions exacerbated flaws that could have self-corrected if the pace of hikes hadn’t been so accelerated. For almost a year, they have been daring the markets and the economy to stumble as a sign that their unrelenting march against inflation was working. At least in part, they finally got their wish with the impact of dramatic changes in monetary policy claiming its first significant victims:
- Silvergate Capital (TKR: SI) – the logical and invariable end to a long saga in crypto that started with the demise (fraud) of FTX; and
- Silicon Valley Bank (TKR: SIVB) – “black swan” like in nature, seemed to come from nowhere and happen quickly, creating further challenges for a private equity industry that was already reeling.
Two bank failures in a week?!? While both events clearly matter, the speed of the collapse of SIVB, which unraveled in the span of a few hours, spooked the markets and rightly so – culminating in a traditional “bank run” straight out of “It’s a Wonderful Life” (version 3.0). According to the WSJ, it was the second-largest bank failure in US history with $209B of assets. For some perspective, Silvergate was 10% of the size.
The “Perfect Storm” of events and circumstances.
John Afrstrom of RBC Capital Markets calls it a “highly unusual situation without a roadmap.” We would agree. However, there are characteristics of SIVB that can be attributed to other financial institutions, namely, higher unrealized losses in held-to-maturity portfolios, perhaps waking the contagion and systemic beasts from their slumbers (ala 2008). According to Bloomberg, across all FDIC banks, there were about $620B of unrealized losses in securities portfolios as of 4Q22. All banks are dealing with the impacts of higher rates on some basis.
That said, we think it unlikely that a downward spiral will ensue, especially if regulatory authorities step up and intercede in an intelligent way. Why? For several reasons:
- SIVB misjudged the cost and lifespan of deposits and the yield and duration of their assets. That’s quite different from the widespread bad lending standards that led to the 2008 crisis. This was banking 101-type stuff.
- Few banks have an almost singular industry focus, in this case, private equity. Private equity itself was under tremendous stress and was undergoing a significant valuation and liquidity reset. And this resulted in a withdrawal of bloated deposits at an accelerating rate.
- Few banks with such a significant percentage of commercial customers with large deposits – supposedly 93% of deposits exceeded the $250k FDIC-insured limit.
- Not many banks bet the farm on long-term treasuries at the top of the market – bonds made up 56% of SVB’s assets, roughly double comparable to banks.
- Bi-partisan post-2008 rules help guarantee stability. Most systematically important banks have been rigorously tested. Although maybe we should revisit that definition?
- Regulators will likely move quickly to contain the risk. In our view, we are likely to see a sale, in whole or in part, engineered by the end of the weekend. Further, there is talk of implementing an industry-wide backstop to secure deposits above the FDIC limit.
- Hard to see a catalyst on the liability side (like with SI and SIVB) that would create a “run on banks” for general, diversified retail-focused banks.
Ultimately, what occurred – with some help from a short-sighted, possibly complacent management team – was a crisis of confidence brought on by the same folks who benefitted for years from the capabilities of two institutions that they brought down — “et tu, Brute?” The near-term effects will likely be contained to these realms of crypto and private equity. For instance, and somewhat ironically, stories abound about start-ups struggling to make payroll, even as many founders and VC partners have ample fortunes to fund any short-term dislocation.
There are already calls (from the likes of Mark Cuban, Larry Summers, and Bill Ackman) to backstop the depositors due to a failure of regulatory oversight and because it is generally in the interest of all Americans. Reluctantly, we must agree that limited government intervention is warranted. We are, however, frustrated that once again “all of us” must step in to save the few, many of whom will sail into the sunset having already made their fortunes by exploiting these fragile ecosystems to the point of potentially meaningfully impacting the broader economy over time.
Over the weekend, it was reported that SVB paid out employee bonuses on Thursday, even as depositors struggled to withdraw funds. Apparently, those error messages or “pending” status wire transfers only applied to some. “Moral hazard” has indeed returned.
Could there be broader longer-term implications?
The US has benefitted from a robust tech-driven innovation engine and start-up culture for which Silicon Valley is ground zero. SIVB has been the backbone of the start-up and VC ecosystem, growing up with the industry over the last 40 years. According to the company, it has provided services to nearly 50% of all VC-backed startups – services that such firms could not find elsewhere due to the higher risk associated with these activities. Silvergate provided the same services to another high-risk industry group, crypto. Who will step into these breaches now?
In the meantime, pockets of excess leverage will continue to be tested.
The markets remain hyper-vigilant in seeking its next victim – any signs like the need to raise additional capital by other smaller, regional banks will undoubtedly be met with swift justice, meaning some additional poorly diversified banks are likely to fail. In this suddenly unforgiving environment, the weak (of balance sheet and liquidity) will be culled from the herd by a loss of confidence from their once loyal customers. Even still, a broader overall loss of confidence in the system seems like a stretch at this point. Markets may even rally around the idea that the Fed may pause to let the economy and markets catch its collective breath and dial back its aggressiveness. Let’s hope they got the message.
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