March 2023 Special Edition - Bank Failures
Making Sense of Bank Solvency
Aaron Kolkman, MSF, CFP®, CKA®
On Friday, March 10, we saw the failure of Silicon Valley Bank (SVB), the second-largest bank failure in U.S. history (with $212 billion in assets), followed by the failure of Signature Bank of New York on Sunday March 12, the third-largest bank failure in U.S. history ($110 billion in assets). The largest bank failure in U.S. history, was, of course, Washington Mutual, which failed in 2008, with approximately $300 billion in assets.
A “run on the bank” occurs when the bank experiences too many withdraws of its deposits at once, or the value of its capital drops too quickly (or both). Deposits are “demand” liabilities of a bank, meaning they are immediately owed to their respective owner(s). Assets of the bank, then, would include its own capital, and any loans owed to it. Although the FDIC insures deposits for up to $250,000 per titled account owner, deposits are usually unlimited. So, when SVB began experiencing large withdraws from its largest clients – mainly venture capital firms – last week (03/06-03/10/23), it’s loan-to-deposit ratio rose at a rapid rate. JP Morgan Asset Management said the failure was due to “a high level of loans plus securities as a percentage of deposits, and very low reliance on stickier retail deposits as a share of total deposits.”
Not dissimilar, Signature Bank was a 24-year real estate lending business with a recent play for cryptocurrency deposit. According to the New York Times:
“Regulatory filings show that more than $79 billion, or close to nine-tenths, of Signature Bank’s roughly $88 billion in deposits were uninsured at the end of last year. As of last week, Signature said more than 80 percent of its deposits were from law firms, accounting firms, health care companies, manufacturers and real estate management companies. The bank also said its digital asset-related client deposits stood at $16.52 billion. Signature was one of the few financial institutions that had opened its doors to taking deposits of crypto assets, a business it entered into in 2018.”
RATES AND BANKS
When the Fed acts to increase its short-term interest rate, as it has at a record pace over the past 15 months, the bond market responded wildly with downward pressure on prices. Those decreases in prices caused the capital base at Signature Bank of New York (Signature) to recede. What’s more, SVB and Signature both had the same increasing pressure on its deposit costs, with short-term interest rates rising so quickly. While it isn’t Fed actions that cause bank failures, its recent decisions have presented fresh risks to banks managed with high concentrations of large depositors, securities as a relatively high portion of their balance sheets, and/or exposure to certain areas of a slowing economy (venture capital, cryptocurrency, real estate, etc.).
WHAT TO EXPECT
Expect Washington’s actions on March 10 to now, to be sufficient at shoring-up both public concern about additional bank failures, and any future failures. Here are the details, according to Bloomberg:
The FDIC said it will resolve SVB in a way that “fully protects all depositors.” Similarly, “all depositors” at Signature will be made whole.
The Fed also announced a new “Bank Term Funding Program” that offers one-year loans to banks under easier terms than it typically provides. $25 billion is available.
The central bank relaxed terms for lending through its discount window, its main direct lending facility.
Expect regional banks to trade at an attractive valuation for the short-term – lower prices that could be enhanced by interest rate decreases. Expect institutional buying in this space at the same time. If you’re considering owning these firms, consider a long-term value investment approach to equity, possibly with conservative options to hedge potential downward price momentum.
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