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Welcome to Lookzy. Now that the dust is settling, we interrupt your regularly-scheduled programming with a special edition breaking down this past weekend’s banking crisis. Let’s dive in.

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WHAT HAPPENED?

After depositors withdrew over $42 billion in deposits from Silicon Valley Bank on Thursday, March 9th, regulators stepped in and closed the bank on March 10th.

Specifically, Silicon Valley Bank was put into receivership by regulators when the FDIC created the Deposit Insurance National Bank of Santa Clara which was transferred all insured deposits of SVB.

What contributed to this collapse?

• Duration mismatch: SVB was borrowing money with a short term duration (i.e., taking in deposits from customers) and lending that money out at a long term duration (investing in long term treasuries). This is, in essence, modern fractional reserve banking: take deposits in, lend them out and/or invest them. When the Federal Reserve dramatically increased interest rates over the last year, however, the value of those long term holdings dropped dramatically. If and when depositors become spooked and pull funds (exactly what happened), SVB is left with a potential shortfall. While SVB could have likely managed its portfolio better given its depositor base, unrealized losses at banks following the rapid rise in interest rates are a systemic issue (see below chart).

• Mismanagement: SVB's depositor base was somewhat unusual. Approximately 97% of the bank's deposits were uninsured (i.e., were greater than the $250,000 FDIC limit) as of December 31, 2022, higher than most of its peers. This reflects the business-focused customer base, including many startups and small businesses. Given the depositor base and general market activity, SVB could likely have moved faster in protecting the bank.

What is Silicon Valley Bank?

• Silicon Valley Bank was the 18th largest bank in the country before the collapse. Although named "Silicon Valley Bank" due to its location (and marketing focus), SVB is a normal, FDIC-insured bank.

How does the receivership process typically work?

• Typically, the FDIC receiver bank allows all FDIC-insured deposits (e.g., those accounts with $250,000 or less) to be withdrawn virtually immediately.

• All uninsured deposits receive a "certificate". Prior to the Fed's announcement, it was expected that all certificate holders would receive half of their uninsured amount immediately and receive the remainder over the following six months.

What's different about this process?

• The US Treasury, Federal Reserve and FDIC jointly announced that all assets - both insured and uninsured deposits - would be transferred to a bridge bank, Silicon Valley Bridge Bank, N.A., allowing all normal banking activity and protecting all customers.

• This action was taken pursuant to a "systemic risk exception".

• Shareholders and certain unsecured debtholders will not be protected. Senior management was terminated.

• The government noted that taxpayers would not be paying for the bailout; instead, this is being paid for out of the FDIC's Deposit Insurance Fund, and any costs exceeding that fund would be recovered by a special assessment on banks.

Why didn't another bank just acquire SVB?

• Early in the crisis, SVB announced it was working with Sullivan & Cromwell and Centerview Partners to sell itself.

• Rumors emerged that the government was blocking potential takeovers by "GSIBs", global systemically important banks (e.g., JP Morgan), due to concentration concerns in those banks.

• Following the government's announcements, however, interest in a takeover reportedly cooled.

• SVB's separate UK entity was acquired by HSBC for one single pound.

Was there any contagion?

• Countless startups and small businesses feared they would not be able to make payroll or pay expenses with their funds locked up in SVB, and many sought out separate short term loans as a fix. This problem was resolved following the government's announcements.

• A few large companies had hundreds of millions or even billions of dollars sitting with SVB, including Roku and Circle, the issuer of the USDC stablecoin. Following Circle's announcement that it had $3.3 billion with SVB on Friday night, the stablecoin USDC depegged, though it has now returned to par.

• Almost every other regional bank faced dramatic falls in share price and almost all were halted from trading. Many, like First Republic, took actions with other banks (e.g., JPM) to shore up liquidity.

What about Signature Bank?

• Signature Bank was also closed by regulators pursuant to the systemic risk exception. Former Congressman Barney Frank, who helped create the Dodd-Frank legislation regulating bank activity, was a director of Signature Bank.

• Frank noted that, "By Sunday, we had stabilized the situation ... But I believe the regulators, especially the New York state regulators, wanted to send the message that crypto is toxic." (Signature Bank was used by several prominent crypto companies).

What does this mean going forward?

• The Federal Reserve's announcement with the treatment of uninsured depositors is very noteworthy. In effect, the US government has now pledged to backstop all bank depositors going forward, even those above the FDIC limit. The Fed is now acting as the direct insurer of most bank deposits.

• Additionally, the Fed announced a change in how it treats collateral. The Fed created the Bank Term Funding Program (BTFP), which offers loans of up to one year to lenders that pledge collateral including US Treasuries and other "qualifying assets". Surprising, the Fed will value such other assets at par, rather than marking to market. This in effect juices the value of any collateral.

• The two above points raise important questions. Will the Fed serving as a backstop actually serve to increase moral hazard, as banks learn they can continue to take risks since the government will ultimately serve to make depositors whole? Will the Fed, instead of stopping interest rate increases or even cutting rates (as was done in the GFC), continue to raise rates due to its new treatment of collateral? Time will tell.

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