Bank Failure Deja Vu All Over Again

It’s rarely a good sign when any major business fails, especially when that failure comes so suddenly and spectacularly, but there’s a particular trauma attached to the failure of banks that makes the events like those that started in Northern California back in March unwise if not difficult to ignore. 

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The failure of a second bank three days later and now a third bank failure last week - all within the span of less than 2 months -however, is impossible to ignore.  

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That said, while certainly alarming, it does still seem that we are probably not witnessing the beginnings of the 2008 financial crisis reboot given that there are a number of factors relatively specific to the recently failed banks' situations that make the problem unlikely to spread too deep into the larger economy. Further we appear to have a much healthier and better-capitalized banking system than last time -one that seems to be well-positioned to withstand significant financial disruption as a whole. 

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Then again, despite the relative health of the banking system as a whole, there are very likely a few other banks who may face similar exposure as SVB, Signature, and First Republic did, and with the Fed announcing another quarter point interest rate hike within days of the third federal regulator-imposed takeover of a major financial institution in as many fortnights, those exposures may well yet be tested still.

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In either case, when events of this magnitude occur with the potential to have such far-reaching effects - even if that potential is relatively remote - it tends to be wise to keep an eye on that ball, so we’ve prepared a quick breakdown to summarize what’s been happening, as well as what is likely to happen next.

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Who?

Prior to its failure, Silicon Valley Bank was the 16th largest bank in the US with about $210 billion in assets, catering to highly-capitalized tech startups/companies that would often deposit huge fundraising sums into SVB accounts that far exceed the $250k per account that is federally insured by the FDIC. 

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Signature Bank was heavily involved in real estate and legal fields and was about half the size of SVB.

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First Republic was slightly larger than SVB with almost $230 billion in assets. 

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Collectively, these three banks held more in assets (adjusted for inflation) than all the banks that failed during the 2008 financial crisis. 

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What?

SVB was taking the cash from large deposits and investing in US treasury bonds, but those lower interest bonds lost significant value as interest rates climbed and higher interest bonds became available. 

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After trying to raise some money to improve their cash position and failing to come up with what they needed, investors became concerned and started withdrawing their money, leading to a run on the bank and federal intervention that froze all activity as of Friday March 10, 2023. 

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The collapse of SVB in turn spooked depositors at Signature who began withdrawing assets and sparking another bank run which prompted regulators again to intervene.

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Following the collapse of Signature, regulators stepped in to guarantee deposits beyond the FDIC threshold of $250 thousand, but many depositors of regional banks have nonetheless continued shifting assets to larger institutions, thereby exacerbating the problem -especially for banks with large interest rate hike exposure, such as First Republic. 

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When?

‍SVB was shuttered by regulators on Friday March 10, 2023 after only a couple days of obvious distress. Signature Bank was seized on Sunday March 12 just a couple days after SVB, while First Republic was taken over and sold to JP Morgan on Monday May 1, 2023.

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Where?

‍SVB was headquartered in Santa Clara, California and had 17 branches across California and Massachusetts, while Signature Bank was headquartered in NYC and had 40 client offices across New York, Connecticut, California, Nevada, and North Carolina. First Republic was headquartered in San Francisco and had nearly 100 offices across 11 states.

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Why?

Executives at SVB seem to have made an overly aggressive bet on the presumption that interest rates were not going up any time soon, which put the bank in a very precarious position when those rates started climbing significantly.

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SVB’s position was worsened by the fact that the tech world had been having some of its own issues, in part reflected in the mass layoffs seen throughout the industry of late, so when SVB indicated it was in need of cash, it only took a couple days for its tech-heavy depositors to start worrying about satisfying their own obligations and pulling cash from the bank as quickly as they could.

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Signature also had outsized deposits related to real estate/investments and their own executive team had made a number of overly aggressive gambles in the crypto markets that had soured and made the bank ill-equipped to avoid going under. 

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First Republic ultimately lost half of its deposits by the time regulators had to step in, which depositors had been rapidly transferring to larger financial institutions.

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Ultimately, having a significant proportion of investments with high interest rate risk exposure and a large number of depositors with deposits in excess of the FDIC threshold were two of the primary characteristics linking these three failed financial entities. Perhaps even more importantly, all three of these banks look very similar on paper from a number of different vantage points, so the failure of one sparked a lot of additional scrutiny and fear surrounding the other two in part just because of appearances.

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What’s Next?

The hope is that the bank failures and depositor runs have largely been contained and should not extend beyond the handful of institutions that may have overextended their interest rate risk. That said, given that it can take a year or more for each interest rate hike to have fully rippled through the economy, and given that the interest rates have been increased more than 10 times now in just over a year, it’s possible that the number of financial institutions facing excessive interest rate exposure may not be limited to just a few institutions.

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Regardless, the risk tolerance exhibited and embraced by those institutions that may find their survival even near the gray area is likely to go down, which in turn will lead to reduced capital in circulation generally and less economic growth across the board as a result.

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