A Basic Primer on How This Massive Failure Exploded and How We Can Respond
Last week, the banking world was rocked by the spectacular failures of two major players: Silicon Valley Bank (SVB) and Signature Bank. With SVB being the second largest bank failure in US history, eclipsed only by Washington Mutual, it's no wonder the financial world is in turmoil. But amidst the chaos, there are some fascinating insights to be gleaned.
First, is the reason for SVB’s failure. They took their deposits and put them in long-term bonds, back when bonds were paying very low rates. To illustrate, let’s say they bought a 10-Year Treasury Bond for $100 at 1.5% interest one year ago. When they bought the bond, 1.5% was the prevailing interest rate. So, in this example their bond was worth exactly what they paid for it - $100.
Granted, today 1.5% may not sound like a great return. However, when you are paying your investors 0% for business accounts, and .25% for personal accounts, the bank creates what is called arbitrage. They collect between 1.25% - 1.5% on their $209B in assets, earning approximately $2.9 billion per year on that spread. So, that small percentage yields a very big number for the bank.
Enter The Year-Long Fed Reconning!
On March 17, 2022, The Fed approved a .25% rate increase, their first increase in more than three years. Fast forward to today, and The Fed has now increased the Federal Funds rate by 4.5%.
Back to our example, let’s say the same $100 10-Year Treasury Bond can be bought at a rate of 4% today. What would you pay SVB for their 1.5% $100 Bond? Well, you wouldn’t pay $100, when you could take your $100 and buy the same note at 4%, right?
To illustrate further, let’s do the math on these 10-Year Treasury Bills.
- Paying 1.5% the first T-Bill will be worth $116.17 at maturity in ten years.
- Paying 4% the second T-Bill will be worth $149.08 upon maturity in ten years.
So, there is no way to buy SVB’s 10-year bond at 1.5% and make it worth $149.08. However, you could buy SVB’s 10-year bond for less than $100 to generate the same 4% yield, in its remaining nine years, until maturity.
By buying SVB’s 10-year bond for $81.10 today.
Doing that would generate a 4% return – or $116.17 over nine years.
So...what is SVB's $100 bond worth?
In this simple example - $81.10.
It's Happening In All Banking
The looming issue is that this math is occurring throughout the entire banking system. According to an article on CNN, The Fed reports that American Banks are sitting on $630B of unrealized losses.
So, we’re at the beginning of what could become a significant crisis, that all started to unfold when SVB sold $21B of their assets. They were unloading stock to remain solvent, when rumors of losses started to get out.
Instantly, fear gripped SVB depositors and it created a “run on the bank”.
The same thing happened with Washington Mutual in 2008. At the peak of the run on Washington Mutual, account holders withdrew $16.7B over a nine-day stretch. That was a lot of money leaving during that nine-day period – but it pales in comparison to the run on SVB.
At the peak of the run on SVB, depositors were pulling out over $500,000 per second! In total, they withdrew over $42B in a single day!
Then, last week, First Republic Bank looked as if it might get into a similar situation. However, they received a $30B backstop from 11 other large US banks.
Over the weekend, UBS agreed to take over its rival Credit Suisse to stave off a potential failure at Credit Suisse. Why? It doesn’t benefit any banks to see another bank fail, because it calls into question the solvency of all banks.
In this picture, regional bank stocks are getting hit the hardest since they are the most susceptible to the contagion.
In Steps The Fed Again!
All that said, The Fed is doing a great job to still the fears of the market. They stepped up to the plate and told account holders at both SVB and Signature Bank that they would insure 100% of their deposits, even if they were in excess of the $250,000 FDIC maximum.
This was extremely important as most of the Silicon Valley Tech and Biomedical startups had large deposits at SVB. In fact, a friend who was staying with us this past weekend works for a medical device company partially funded by SVB. As a result, they did a large portion of their banking with SVB. When SVB collapsed, they had over $60MM on deposit in SVB. Without The Fed guaranteeing all deposits, regardless of size, we would have seen a tremendous number of company failures.
So, why did I tell you all of this, besides my innate curiosity for all things financial?
There are three things I think that are important for us:
- Despite all the banking turmoil, we are in a great position to help builders with quality projects.
- Treasury rates are falling signaling a potential Fed easing, which should have a positive sales impact for our clients.
- Regional banks are now more hesitant than ever to lend, especially on ground up construction loans – we can fill that need.
So, if you have a quality project, please reach out. We’re happy to look and see if there is anything we can do to help you.
Robb Kenyon, Chief Credit Officer
PS The current Fed policies have put many into a tailspin. So, if you're a midsized builder with quality projects, let's partner to take advantage of the opportunities and gain quality market share together.
Hope to talk with you soon!
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