A stunning announcement from SVB Financial Group, the parent company of Silicon Valley Bank, on Thursday, March 9, 2023, sent shock waves through the banking industry. SVB fell 60% after announcing it would book a steep loss on its securities portfolio, leading it to raise fresh capital at its now-depressed share price. But on March 10, 2023, the bank failed after a run on its deposits. The California Department of Financial Protection and Innovation (DFPI), SVB's regulator, seized the bank and placed it into the receivership of the Federal Deposit Insurance Corporation (FDIC) in the second-largest bank failure in U.S. history.
In sympathy, shares of many banks also declined in price, especially those that hold large securities portfolios backed by customer deposits. Some deposits have left these banks in search of higher yields, requiring them to either sell securities at losses or to borrow from the Federal Reserve Board or Federal Home Loan Bank (FHLB) system.
Then, on March 12, 2023, regulators in New York State closed Signature Bank after nervous customers withdrew more than $10 billion in deposits. Signature's closing was the third largest bank failure in U.S. history.
Shares of many banks have plummeted amidst the turmoil, including the three banks covered in the Investor Advisory Service.
Two important questions are why, and why now? SVB expected “elevated cash burn levels from our clients as they invest in their businesses,” in addition to the potential that interest rates remain high and some business customers might have greatly reduced access to affordable capital. The comments about cash burn levels and reduced access to capital seem more acute among the tech companies found in SVB’s backyard in tech-heavy Silicon Valley and likely would apply less to more diversified banks. As to “why now,” regulators have become concerned about the potential that deposit runoffs could lead banks to sell assets at a loss, transforming unrealized losses to realized losses. While this might seem like a logical concern, one of the major purposes of the Fed and FHLB is to serve as backup sources of liquidity; without backup liquidity, banks would be faced with the choice of locking in deposits for the long term, issuing loans that could be called instantly, or risking periodic insolvency.
In recent days, the three banks covered in IAS have issued statements defending their businesses, but one subsequently needed a public-private rescue from the Federal Reserve and JP Morgan Chase. The Fed also announced the Bank Term Funding Program to lend to banks experiencing liquidity problems. Such banks likely already had access to the Fed Discount Window or Federal Home Loan Bank borrowing capacity. The new facility runs longer than the other two, which are intended to be temporary.
The common link between the three banks covered in the Investor Advisory Service and the two large banks that have gone under (Silicon Valley Bank and Signature Bank) is that they all have large securities portfolios. However, two of the banks share another characteristic with Silicon Valley, Signature, and many other major banks: customer concentration risk. In the case of Silicon Valley and Signature, 90% or more of their deposits were uninsured, meaning that they exceeded the FDIC insurance cap of $250,000 per depositor. The thought of losing access to their money caused large depositors to flee Silicon Valley and Signature so quickly that it left both banks insolvent, and the government had little option but to close them down. By comparison, of the three banks covered in IAS, the amount of deposits that exceed FDIC insurance limits were 68%, 55%, and 16%. Levels at the first two banks are concerning, although several other major banks report similar levels.
The longer the crisis goes on, the greater the risk to shareholders of other banks with these problematic concentration risks. However, a spreading contagion would also increase the pressure on bank regulators and the Federal Reserve to raise the tiny $25 billion Bank Term Funding Program.
Investments in many banks have become much riskier than they appeared a week ago, and investors need to decide whether they can stomach the risk.
More complete versions of the above updates were sent to Investor Advisory Service subscribers with specific recommendations about the banks covered in the newsletter
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