This is Not 2008
The financial media is having a field day with the largest bank collapse since Washington Mutual failed in 2008. You may have heard that Silicon Valley Bank, the nation's 16th largest bank by assets ("SVB"), has been taken under FDIC receivership. Many pundits have claimed that this could be the beginning of a contagion. I believe the contagion call is inaccurate for a few reasons, mainly SVB-specific and the overall health of the banking system.
Let's start with SVB itself. SVB was founded in 1983 and has held itself out as the bank for startup tech entrepreneurs and venture capital backed firms. The bank focused on a narrow clientele and experienced a flood of deposits as these firms prospered during the Covid era. Deposits increased from $49 billion at the start of 2019 to $173 billion by December 2022. Given this flood of deposits, the bank was hard-pressed to find attractive lending opportunities to match. The bank ended up purchasing treasury bonds with various maturities throughout the period. Interest rates and bond prices have an inverse relationship, meaning when rates rise, bond values fall. Historically, treasuries have been seen as the "safe asset," However, with the aggressive rate increases experienced, the bank saw treasury prices decline, I have included the picture below that illustrates the price drawdown of the broader US Treasury market from 01/01/2022 to 03/10/2023.
Source: Kwanti. GOVT (iShares US Treasury Bond Index). Return 01/01/2022-03/10/2023: -11.81%
Rising rates became a double-edged sword for SVB as depositors demanded higher interest rates throughout 2022, causing the bank to lose money by merely holding client cash. Additionally, being so narrowly focused on the startup technology space, caused deposit drawdowns to hasten as money stopped flowing into the venture capital space and companies began drawing on reserves to fund operations. As the withdrawals continued, it sparked a bank run on SVB. According to Bloomberg, depositors pulled $42 billion out of SVB on Thursday. This was the final blow for SVB, and the FDIC placed the bank in receivership as of Friday around noon. SVB served a niche area of the market that was highly concentrated and whose success depended heavily on zero interest rate policy. The combination of over-concentration in one geographic area, sector, ill-timed investments, and overexposure to interest rate risk led SVB to fold.
The second, and more important reason I am not concerned about a contagion and banking crisis is due to the overall health of the banking system compared to the Global Financial Crisis ("GFC"). While we could get deep in the weeds here, I will illustrate a few statistics to convey my message. ("banks" refers to the aggregated data for all FDIC-insured banking institutions)
- In 2008, 25% of banking institutions were operating at a loss; As of 12/31/2022, 3.6% of banks are operating at a loss.
- In 2008, the banking system had 4x more troubled loans (2.94% vs. 0.74%) compared to 12/31/2022.
- In 2008, banks had a loan coverage ratio of 75% or $0.75 reserves/$1.00 of bad debt. Currently, the banking system has a coverage ratio of 217% or $2.17 reserves/$1 bad debt.
- In 2008 banks had $0.95 of deposits for every $1.00 in loans. Today, banks have $1.45 of deposits for every $1.00 of loans.
- In 2008, banks had 12% of assets in liquid assets; as of 12/31/2022, banks have 25% of assets in liquid assets.
The GFC came on the back of a long expansionary period where we saw unprecedented property price increases fueled by ever-decreasing lending standards and wild corporate speculation magnified by extreme leverage.
I take pride in staying current on the many levers that move markets. I also make it a point not to sugarcoat or see things through rose-colored glasses. I do think there will be more bank failures. You will likely see it localized in institutions with a narrow clientele, specifically technology and crypto-focused banks. I believe that the SVB failure will allow the Federal Reserve the opportunity to re-evaluate the current course it has taken in regard to rate hikes. I also believe the FDIC did the right thing by taking over SVB intra-day rather than close of business. I believe the GFC served as a big wake-up call for bankers and regulators, providing a painful and powerful blueprint to handle these situations.
While nothing is certain, I feel confident that the financial and broader media will drum up fear. You will see scary headlines and hear scary rhetoric. While our country may be facing a recession, we must remember to stay the course and avoid blowups (meaning permanent loss of capital). I am proud of our work in 2022 amid the worst stock and bond returns seen since the Great Depression.
As of Sunday evening (03/12/23), the FDIC provided more clarity on the situation, I have included an excerpt below:
After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.
We are also announcing a similar systemic risk exception for Signature Bank, New York, New York, which was closed today by its state chartering authority. All depositors of this institution will be made whole. As with the resolution of Silicon Valley Bank, no losses will be borne by the taxpayer.
Shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.
Finally, the Federal Reserve Board on Sunday announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.
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