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Why 186 Other Banks Could Go The Way Of Silicon Valley Bank

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There were no new bank failures over the weekend. But the global banking system is not in the pink of health.

There are two reasons for continued concern:

  • A March 13 study by four economists reveals that 186 banks are at risk of “impairment” of $300 billion worth of insured deposits.
  • A March 19 New York Times report reveals that the Federal Reserve began warning Silicon Valley Bank (SVB) of financial risks in 2021 — over a year before it cratered — yet SVB management did nothing. What’s more Moody’s warned SVB’s management of an imminent downgrade about a month before it announced its emergency capital raise.

Shares of First Republic Bank FRC are trading well below where they were after it received $30 billion in deposits from other banks on March 16. It seems only a matter of time before more rot in the banking system comes to light.

(I have no financial interest in the securities mentioned in this post.)

Why Silicon Valley Bank Failed

Since March 10 when I first wrote about the FDIC takeover of SVB, every time I read an article about what happened, I learned something new about why SVB failed. Here is my latest Six Whys analysis:

  1. Why did the FDIC take over SVB? SVB could not find a private institution willing to acquire the bank in time.
  2. Why was SVB unable to find a buyer? A rapid outflow of deposits — totaling $42 billion on March 9 alone, about a quarter of the bank's total deposits — was complicating the sale process.
  3. What prompted the rapid outflow of deposits from SVB? SVB surprised investors on March 8 with an announcement that it took a $1.8 billion loss on its $21 billion portfolio of treasury securities and borrowed $15 billion. Since 94% of SVB's deposits exceeded $250,000, the FDIC did not insure them — thereby boosting incentives for depositors to flee.
  4. What prompted SVB to raise capital at such a high cost? In February 2023, Moody's told SVB that it was preparing to downgrade its credit rating.
  5. Why was Moody's poised to downgrade SVB's rating? SVB’s deposits and the value of its bond portfolio had fallen sharply.
  6. Why had SVB's deposits and the value of its bond portfolio dropped? As the Fed raised interest rates, technology stocks lost value, the IPO market dried up, venture capital firms stopped providing startups with more capital to fund their losses, startups began withdrawing their deposits to fund operations, and the higher interest rates cut into the value of SVB's lower yielding securities.

Why 186 Other Banks Could Go The Way Of Silicon Valley Bank

Four economists found 186 other banks share the characteristics that contributed to SVB’s failure.

In their paper, “Monetary Tightening and U.S. Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?,” the co-authors concluded that if a mere 50% of those uninsured depositors decided to withdraw their funds, 186 banks and “potentially $300 billion of insured deposits” would be at risk.

The key factors these banks share with SVB are:

  • A relatively high level of uninsured deposits — e.g., over $250,000; and
  • A significant drop in the value of government bonds and mortgage-backed securities due to interest rates that have risen from about 0% to nearly 5% in the last 12 months.

The interplay of these factors contributed to SVB’s failure in a way that could put other banks in financial trouble absent a capital infusion or other rescue. According to USA Today, SVB held mostly U.S. government bonds, which dropped in value because they paid a lower (below 2%) than current (more than 4%) interest rate.

At the same time, SVB customers — many money-losing startups — were withdrawing their deposits to cover payroll because the shutdown of the IPO market caused venture capitalists to stop funding the startups’ cash burning operations.

In addition, SVB’s high level of uninsured deposits made many depositors eager to withdraw their money at the slightest hint of trouble. “Only 1% of banks had higher uninsured leverage. Combined, losses and uninsured leverage provide incentives for an SVB uninsured depositor run,” according to the co-authors’ paper.

Why Our System Of Bank Regulation Lets Rot Fester

To paraphrase the Washington Post’s slogan, sick banks fester in darkness. More specifically, the Fed, ratings agencies, and even the four co-authors of that paper might know market-moving information that isn’t shared with the general public.

The failure to share that information puts depositors, investors, and bondholders at significant financial risk. First, I was frustrated to learn that the paper did not provide the names of the 186 banks that could go the way of SVB.

Instead, it includes an exhibit — Figure 5: Largest Insolvent Institutions if All Uninsured Depositors Run — that maps 10 banks and SVB — using colored dots accompanied by letters of the alphabet instead of their names — on three dimensions:

  • Their assets as of the first quarter of 2022 (the more the assets, the bigger the colored dot),
  • The percentage loss in value of those assets due to rising interest rates — using mark—to-market accounting, and
  • Their “runnable uninsured deposits” as a percentage of mark-to-market assets.

As a member of the general public, I would certainly like to know the names of each of those banks. More importantly, I would like to see the names of all 186 banks and their position on this map using fourth quarter 2022 data.

I was even more unhappy to discover on March 15, courtesy of the Wall Street Journal, that Moody’s had told SVB in February that it was preparing to downgrade its credit rating due to fleeing deposits and a drop in the value of the bank’s bond portfolio.

Why did so much time elapse between when Moody’s told SVB about the downgrade and March 8, the evening that the public learned about SVB’s money-losing sale of its $21 billion portfolio of government securities?

I am guessing Moody’s concluded that it would be better to give SVB time to raise capital before downgrading its credit rating — a delay that cost SVB shareholders plenty.

But the most troubling revelation came to me on March 19 when I learned that since 2021, the Federal Reserve has known about and warned SVB of its financial risks.

According to the New York Times, that’s when supervisors at the Federal Reserve Bank of San Francisco — on whose board SVB CEO Greg Becker served — issued six warnings to SVB including a lack of cash to repay a wave of depositors seeking to withdraw their money.

The highly-concerning report revealed that management ignored further communications by the Fed to fix what ailed SVB. “Last autumn, staff members from the San Francisco Fed met with senior leaders at [SVB] to talk about their ability to gain access to enough cash in a crisis and possible exposure to losses as interest rates rose,” reported the New York Times.

Why on earth did the SVB executives ignore the Fed’s warnings? Why did SVB’s board not act on behalf of shareholders and depositors and replace management with executives who would repair SVB?

How Markets Are Reacting To First Republic And Other Regional Banks

Shares of First Republic — which has suffered $70 billion in withdrawals, according to the New York Times — have lost about half their value since large banks deposited $30 billion there, reported CNBC.

On March 20, there was a glimmer of hope that First Republic’s woes were not spreading. “Despite First Republic’s decline, the SPDR S&P Regional Banking ETF gained 3.2% on Monday. PacWest Bancorp jumped 11%, while KeyCorp and Zions Bancorp were up about 2% for the day,” wrote CNBC.

Sadly, First Republic’s story is not over yet. The bank’s suspension of its dividend and other capital raising moves led S&P to write on March 19 that “the bank was likely under high liquidity stress with substantial deposit outflows over the past week.”

First Republic will struggle to attract an acquirer. As CNBC noted, First Republic has “a roughly $25 billion hole in [its] balance sheet caused by deposit outflows and the decline of long-term bonds and mortgages is a hurdle for the deal and no serious bidders have yet emerged.”

Until First Republic’s woes are cleaned up and those 186 SVB-adjacent banks are put right, the instability in our financial system could get worse.

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