Compound248 💰

Compound248 💰

10-03-2023

08:14

The problem Silicon Valley Bank faces today is VERY different than the 2007-2009 banking crisis. $SIVB was thriving. Credit losses are fairly low. Its deposits TRIPLED from 2019 to ‘21. How’s that a problem? It sounds great, right? Well, it’s a Wonderful Life… 🧵👇

1. When banks accept deposits from clients, they OWE the client that money. So deposits are liabilities to the bank. Liabilities cost money… …”cost” both to serve those clients (branches, tellers, apps) and any interest the bank pays you on your checking account (deposit).

2. To pay for the cost of those liabs, banks turn them into assets: lending deposits as small business loans, mortgages, C&I, etc. If a bank can’t lend deposits responsibly, it often uses excess to BUY loans or “securities,” like US Treasuries & Mortgage Backed Securities (MBS).

3. As mentioned above, from 2019-2021, the deposits at $SIVB tripled! That’s a good, but tough, problem: banks need deposits but they COST banks $$. Banks need to lend deposits to cover the cost. Silicon Valley Bnk needed to take those funds & acquire “assets” to pay its costs.

4. $SIVB knew it couldn’t lend those responsibly - it was too much, too fast. Much of the $ was from VC-backed companies that needed a place to deposit the $ they raised. Those are big deposits. Keep in mind the FDIC (basically) only insures $250,000 per customer per bank.

5. Deposits were pouring in too fast to lend responsibly. $SIVB recognized that. Rather than make dumb loans, $SIVB bought assets guaranteed by the US government - Treasuries and MBS. BUT, it bought long duration. Often 10+ year bonds. Mistake!

6. When rates rise, fixed income prices fall. A general rule of thumb is for every one year of “duration,” each 1% interest rate move impacts the price of the bond by: 1% x Duration A 1% move on a 9 yr duration bond is ~9% +/- on the bond price. But banks are levered…

7. Remember: banks generally acquire assets by using deposits (liabilities) as the capital source. And banks like $SIVB are levered 10:1 or more: owing $10+ for every $1 of shareholder equity. If you’re levered 10x, a 10% loss on assets is a 100% wipeout. 😬

8. So $SIVB bought high quality assets, but it bought tons of them with LONG duration at LOW interest rates. When the Fed raised rates, those assets declined in value… …1% x Duration. Those losses, multiplied through the leverage at $SIVB, caused a big problem!

9. $SIVB now has a mark-to-market hole in its balance sheet. But it’s not taking loan losses like subprime defaults. It’s “just” mark-to-market: as long as its liabilities are sticky (ie, depositors leave their money @ $SIVB), it will ultimately be fine. But that’s a big “if.”

10. Technically, if all the depositors ask for their $ back at once, $SIVB needs to sell those bonds at the mark-to-market value, crystallizing what could have been a temporary loss. And if those losses are big enough, $SIVB may not have enough money to pay out all depositors.

11. But that situation rarely happens. The FDIC and FHLBs exist to limit this. However, once it starts, game theory kicks in: NOBODY wants to be the last depositor at a bank. We all can picture what happens… then.

12. Which brings us to today. $SIVB has large depositors. Large depositors aren’t fully insured by the FDIC - they have an incentive to find HIGHLY sound banks. Once a whiff of issue pops up, large depositors run… …one might say they, “bank run.”

13. As a bank’s deposits go in reverse, it has to sell assets. The bank raises money. The FHLB steps in to help turn its less liquid assets into more liquid. Reassuring utterances are made. But is it enough? Put yourself in a large depositor’s shoes: what would you do? -End

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