Silicon Valley Bank and the Future of Regional Banking

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Stacie Jacobsen: [00:00:00] Hi, I'm Stacie Jacobsen. Welcome to a bonus edition of the Pulse. Today we are here to talk about the failure of Silicon Valley Bank and Signature Bank, [00:00:15] and the wider implications on the monetary policy and the banking system. As this is an evolving news cycle, I will add that we are recording this mid-morning on Tuesday, March 14th.

Now we are fortunate to have Todd Buechs back with us here. Todd is [00:00:30] the national director of our core and alternative fixed income efforts, and I have asked him to join us because of his deep background in the US banking sector. And you may remember that Todd joined us a few episodes back for the discussion on income and alternative.[00:00:45]

Hey Todd, thanks so much for joining us today. Happy to join. Good to see you. Todd, I wanna start with the why. Why did Silicon Valley Bank and Signature Bank

Todd Buechs: collapse? Let's just think what a bank does. What it does is it takes in a deposit and it then lends it out. [00:01:00] So your deposits are your cost of funds, what I'm paying you for your savings deposit, and then what I can earn is what I'm lending it out at.

And then profits are impacted by losses, right? So that's very simple. Silicon Valley Bank had a very unique [00:01:15] depositor base, so that's how you fund your balance sheet. , you use those deposits to make loans or to buy securities, whatever it is. They worked with the venture capital community, so lots of large deposits with very large firms, [00:01:30] but concentrated in one deposit base.

And the issue last year was that those venture capital funds weren't seeing inflows from their investors and they were drying down those funds. So, . If I'm a bank, let's say I had $1 [00:01:45] deposits and $1 in loans. If my deposits dropped to 50 cents, I have to replace that 50 cents. So they were faced with an issue.

They'd bought a bunch of securities using the deposits. When the deposits started being depleted, you have to replace that [00:02:00] funding. They could compete for more deposits. Pay up for things like certificates of deposit, et cetera, but that's not gonna react to large chunky outflows from those venture capital funds.

So their last chance was, or the last resort, was to go to the Federal Home Loan [00:02:15] Bank. Now, their major issue was that their securities they bought were returning 1.7% and the Federal home loan bank was lending it 5%. So if I, if I have that choice, Earn 1.7, paid [00:02:30] five, or rip the bandaid off, sell those securities and realize the losses and raise some equity.

They took the ladder. They said, okay, well we'll sell the securities. We'll realize that large loss raise some equity. It would be fine. [00:02:45] But the issue was that. They have a community venture capital that's very communicative, and there were two very prominent individuals. This is in the press, uh, that were out calling all of their venture capital friends and saying, pull your [00:03:00] deposits.

This. In other words, this didn't have to happen, but it shouldn't have happened. Both with them and with Signature, and then also with Silver Gate. All of them had a concentrated exposure to a certain type of deposit. [00:03:15] Silicon Valley was venture capital, silver gate, and signature. Both were cryptocurrencies, so they put themselves in a corner if those deposits were drawn down on, and all three of 'em saw that and were faced with a similar conundrum.

Stacie Jacobsen: The [00:03:30] fed, the FDIC and Treasury department rolled out emergency measures including a program to backs. All deposits in excess of the, uh, traditional $250,000, yet depositors are still looking for safety. And they were moving cash from [00:03:45] regional banks to larger, more, um, systematically important banks. You know, why was that? And do we think that's something that will continue?

Todd Buechs: I think because it's, it's so much panic. I see some parallels here in the great financial crisis. , it took a [00:04:00] long time to mobilize Congress, et cetera, for action. And if you think about the amount of Fed balance sheet that was used, it was very gradual over a period of years.

I think the Treasury, and I think the Fed has learned from that. So if you think back [00:04:15] to the pandemic, the Fed could only cut rates about a percent to zero, but they did it instantaneously and then they came out and said, we're gonna buy stuff and supported the markets. So they learned from that. And said, look, we've gotta act quickly and [00:04:30] decisively otherwise becomes an issue.

So I think. The Fed and Secretary of Treasury Yellen did, was said, look, we need to come out and be decisive and back this so that there's not a run on good banks. Now, part of what went around those venture capital [00:04:45] communities were a bunch of bank analyst reports, and one of those tables said, If all these banks took all these unrealized losses on their securities that are marked daily and the ones they would hold to maturity, which you don't have [00:05:00] to take marks on, what would that do to their capital?

So this is a, a worst case scenario, liquidating the bank type of scenario. But many of those banks that were caught up in this didn't have exposure to venture capital funds and didn't have deposits [00:05:15] from crypto. Funds, and I think people just reacted to that draconian scenario of worse, worse, worse case scenario.

And then kind of pulled deposits and ask questions later. There's names we, we won't mention that were [00:05:30] down dramatically that are at over 50% today. Today's the 14th. Uh, and I think that reflects the fact that people are now understanding. This was an isolated type of issue and not systemic.

Stacie Jacobsen: Todd, you mentioned the massive unrealized [00:05:45] losses of Silicon Valley Bank.

You know, it seems that maybe the system was a little bit fragile, right? Should the fact that they decided to go the route of taking the unrealized losses have caused this run on the bank and the ultimate failure?

Todd Buechs: You know, I'm [00:06:00] not Silicon Valley's management team, although they're not the management team either, right?

So they're not, they're out. From a balance sheet management perspective, you need to diversify your funding base. That was a big part of the issue. And investing [00:06:15] at the end of 2021 when rates were so low, probably wasn't smart either. We've talked about with our, with our banks team, you know, they could have hedged and hedged means you offset your risk.

So if you're earning 1.7% from your [00:06:30] AAA rated mortgage portfolio, right? That's. Government backed really safe, but that's prone to being marked to market based on where rates are. If you would hedge that into floating rate, we wouldn't be having this [00:06:45] conversation because they would've made more and more and they wouldn't have to worry about funding that.

So should it have happened? No. Should they have been more diversified? Yes. Now, the run on the bank that was caused, I mean, you've gotta know your client [00:07:00] base and at some point they should have said, Now's the time to rip off the band. And they just waited too long.

Stacie Jacobsen: Okay, Todd, the Fed is meeting again on March 22nd.

With the recent labor market data and inflation data showing persistent [00:07:15] strength, it was expected that the Fed would raise rates by another 50 basis points in that meeting. How does the turbulence in the banking sector change that expectation?

Todd Buechs: They've said we will be data dependen. The employment report was [00:07:30] stronger than expected.

Last month's employment report was off the charts at over 500,000 jobs. Created the inflation report. Today, the 14th of March was also stronger than expected, so if you're in the camp that they would cut, and there is [00:07:45] one competitor that says that. I don't think that's gonna happen. I think it's less of probability.

That they would not do anything, although they could cite that. I mean, there's precedent. They raised 50 basis points when they were gonna raise 25 back when we got a really difficult number [00:08:00] out of Michigan consumer inflation expectations back at the beginning of the hiking. But, you know, I, I look at this and I, it's probably gonna be a quarter point.

Does this mean that they may not raise three more times? Potentially. You know, we've had people writing on, you know, competitors that [00:08:15] kind of talk about the Fed will raise until something breaks. I don't think that's their intention. They wanted to raise until their Fed funds rate was above neutral, which means it would impact growth, it would restrict growth, and I think [00:08:30] we're already there, so I don't know if they had to go much further.

It's just hard when the data reports come in and they're so strong. To say, Hey, we should stop now. I think they would much rather get to a point that hurts a little bit. Maybe not puts banks outta business. Now, although I say I [00:08:45] think those three banks are definitely complicit in what happened they, they brought that upon themselves, but I think they stay longer and higher because the market's now starting to price in cuts.

I think that's a little aggressive.

Stacie Jacobsen: So where do we go from here? What do you think the longer term impact on regional banks wil be.

Todd Buechs: [00:09:00] So when we say regional, we're not talking about the banks of America, of the world. We're talking about banks like Silicon Valley that size and before they ran into their issues and uh, obviously were taken over, they were probably a 16, 17 billion bank.

[00:09:15] So very large what we've seen with our data checks, Is that a lot of the big banks, bank of America, et cetera, it was a flight to quality. They were termed significant financial institutions or cis during the great financial crisis. Why? Because people [00:09:30] flight to what they perceive as strength in large banks.

We saw from the great financial crisis. That's not always necessarily the case. But that's why bank regulators have increased the amount of capital that they have to hold. We've also seen small community banks, and we've talked to a lot of [00:09:45] small community banks, CEOs talking about really small ones, a billion to 2 billion assets.

They have not had deposits pulled. They're gaining deposits. So where's the larger regional banks that may have concentrated deposits? Whatever it. Maybe losing deposits. [00:10:00] Smaller, well run banks, which is what bank regulators want because there's consolidation going on. They want smaller, more capable banks.

They were the ones that gave out the PPP loans, which shows a confidence in them. I think what you shouldn't do is panic. The bank system [00:10:15] has doubled the capital it did prior to the great financial crisis. There's always gonna be a team or a company or a bank that pushes the limits. as these three banks did, being very concentrated in one depositor base.

That's not [00:10:30] the system, and that's why Janet Yellen and the Fed acted decisively to say, this is not systemic, but we don't want it to become systemic because it's a self-fulfilling prophecy. Okay, who's next? Who's the next one? There isn't another venture capital bank like [00:10:45] that. And there. Other banks with massive concentrations of deposits from crypto firm funds.

So I think it's not to panic, but if you are, keep your deposits below the $250,000 F D I C limit.

Stacie Jacobsen: That's great advice. Todd, thanks so much for being with us today.

Todd Buechs: [00:11:00] It was a pleasure. As always.

Stacie Jacobsen: We wanted to bring you this special update this week in between our regularly scheduled episodes. Don't forget to subscribe wherever you get your podcast to ensure you never miss a beat.

I'm your host, Stacie Jacobsen.