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Banking Crisis Update

Banking Crisis Update

| March 17, 2023

There are few words scarier to an investor than “banking crisis”.  Unfortunately, those are exactly the words being uttered by voices far and wide.  Our view is that the worrying is justified in some areas and completely overblown in other areas.  First, a quick background on what happened to Silicon Valley Bank (SVB).

Silicon Valley Bank was subject to a classic 1930’s bank run, where depositors get spooked and attempt to withdraw their money in droves.  On Thursday, March 9th there were $42 billion in investor withdrawals alone which caused the bank to be insolvent because at the end of the day they had a negative $1 billion cash balance. (1)  The run on the bank was started by a letter that SVB CEO Greg Becker sent to shareholders the day before where he said the bank suffered a $1.8 billion loss on the sale of US treasuries and mortgage-backed securities.  SVB also planned to raise $2.25 billion of capital to shore up its finances. (2)  This revelation was a surprise to many and spooked depositors because up to 97% of SVB’s depositor base was not covered by the $250,000 FDIC insurance coverage limit. (3) 

The issues started during an influx of cash spurred by quantitative easing causing venture capital firms to be flush with cash where they banked with SVB, causing their depositor base to triple since the fourth quarter of 2019. (4)  SVB then took this cash that they received from the deposits and invested them in long dated Treasury and Mortgage Backed Securities under the presumption they were low to no risk.  During normal times this would not be an issue, as a bank makes the spread from borrowing short and investing/lending long.  However, in an environment where interest rates have risen 450 bps in about 12 months by the Federal Reserve, this left SVB with huge unrealized losses on their balance sheet. 

The reason why this was not considered a concern was that the losses were obfuscated by accounting rules that treat held-to-maturity (HTM) and available-for-sale securities (AFS) different from each other on a bank’s balance sheet.  HTM securities do not show the unrealized gains or losses and AFS securities do show these losses.  Therefore, when SVB had to sell their HTM securities to cover redemptions, they had to realize massive losses that were previously not being shown on their financial statements, which caused the cataclysmic event.

The question everyone wants to know is, is this a systemic banking crisis or a case of a mismanaged bank?  Here at K2 Financial we are working under the assumption that this was a mismanaged bank with a unique depositor base that caused them to be uniquely vulnerable to the current environment.  They are not alone in this, but it is far from a systemic issue.  Other banks that deal with mainly large institutional clients that are not covered by FDIC insurance, that did not hedge their interest rate risk, and that had a large percentage of their asset base in long duration securities will most likely face similar issues.

Since we are not looking at this as a systemic issue but simply a few rotten apples in an otherwise healthy orchard, we will stick to the old Warren Buffett adage of “be greedy when others are fearful”.