This month's economic update from Rodney Johnson details the events of SVB and Signature Bank, how the Federal Reserve's rate hikes caused them trouble.
Warren Buffett once said (to paraphrase) that when the tide goes out, you find out who has been swimming without a bathing suit. Clearly, the bankers at the Silicon Valley Bank (SVB) and Signature Bank (SBNY) had been skinny dipping, although it wasn’t a falling tide that proved revealing, it was the Fed’s rate hikes.
To make money, banks borrow short, using our deposits, and lend long, either with loan extensions or investments, usually Treasuries, that mature years from now. This situation works out, as long as short-term interest rates are lower than long-term interest rates. The difference is called net interest margin. But when the yield curve inverts and short-term interest rates are higher than long-term rates, things can get weird. Banks can end up showing losses on their long-term bonds and the present value of their loans outstanding, even though the banks have no intention of selling their bonds or calling their loans.
This situation occurred during the Great Financial Crisis, when banks had to mark their bonds to a market price. With few buyers, bids fell, which meant banks showed big losses and had to sell their bonds to top up their capital. The situation led to many failed banks and a change in policy. After 2009, banks could deem some securities, those that they didn’t intend to sell, as held to maturity (HTM), and others, those that would be marked to market, as available for sale (AFS). That all sounds great, until a bank gets so many requests for withdrawals that it must sell all of its AFSs and some of its HTMs to come up with the cash. At that point, the losses on the HTM securities come into play and are part of the bank’s capital ratio calculation.
SVB catered to venture capital funds and startup companies, which burned through a lot of cash last year, while SBNY catered to the crypto crowd, which also burned through cash. This left their clients digging deep into their deposit base, which revealed that both banks were underwater.
But that’s not the entire story.
This isn’t the first time that the yield curve has inverted, with short-term rates rising above long-term rates. This isn’t the first time that a bank has had a concentration of clients that took an economic hit at one time, leading to excessive deposit withdrawals. And this wasn’t a surprise. Starting last March, the Fed told us in no uncertain terms that they were going to raise rates consistently and then hold them high for an extended period. Whether you agree with their position or not doesn’t matter. They control the interest-rate throttle.
To mitigate these issues, bankers hedge their bond portfolios or reconfigure them, swapping short-maturity bonds for long-maturity bonds. Both of these activities cut profits, as hedging has a cost and rolling down bond maturities means realizing losses to limit further losses, but that’s the business. Everyone knows it. The question is, why didn’t the officers at SVB and SBNY do it? In the case of SVB, there’s no reason that a bank with $200 billion in deposits should not be hedging as yields walk higher, and it certainly shouldn’t find itself $15 billion underwater. It’s unconscionable, and definitely breaches the fiduciary responsibility to clients and investors.
As for the Fed response, the latest and greatest bailout program, called the Bank Term Funding Program (BTFP), is the next step in unlimited bank deposit guarantees for everyone, and it goes on (almost) forever. The BTFP allows banks to borrow against their HTM investments at 100% of their purchase price, even if the investments have fallen dramatically in value, and to pay the money back up to a year later. If a year goes by and some of these entities still have loans against HTMs outstanding, expect the duration to be extended.
After taking over SVB on a Friday and not finding a buyer on Saturday, the Fed, Treasury, and FDIC dreamed up this backstop on Sunday and used it with SVB, because the bank is, in their eyes, systemically important, or “too big to fail.” They claimed it won’t cost taxpayers or consumers a dime. Any bailout funds will come from an insurance fund that banks pay into. Right. Where do they think that money comes from? Out of our interest payments and out of our investments.
For more information on SVB and how it impacts you, watch this video by CRA Founder Chris Cordoba
The market response to the BTFP was easy to predict. Anyone with more than $250,000 in a bank and a brain moved their cash to one of the big four—JPMorgan Chase, Wells Fargo, Bank of America, and Citibank—which are clearly too big to fail. This leaves smaller banks with nothing to do but watch their deposits drain out the door and potentially to suffer the same fate as SVB and SBNY.
Let’s hope other bank officials hedged… and have their bathing suits on.
Written by Rodney Johnson The Rodney Johnson Report
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