So much has been happening in the banking world it is a little hard to keep track of it. See recent articles here by fellow bloggers Mike Makowsky, Jeremy Horpedahl, and Joy Buchanan. Here is a quick guide to all the drama.
Credit Suisse Takeover by UBS
Perhaps the biggest, newest news is a shotgun wedding between the two biggest Swiss banks announced over the weekend. Credit Suisse is a huge, globally significant bank that has suffered from just awful management over the last decade. Its missteps are a tale in itself. Its collapse would be an enormous hit to the Swiss financial mystique, and would tend to destabilize the larger western financial system. So the Swiss government strong-armed a takeover of Credit Suisse by the other Swiss bank behemoth, UBS, in an all-stock transaction. The government is providing some funding, and some guarantees against losses and liability. An unusual aspect of this deal is that Credit Suisse shareholders will get some value for their stock, but a whole class of Credit Suisse bonds Is being written down to zero. Usually bond holders have strong priority over stockholders, so this may make it more difficult for banks to sell unsecured bonds hereafter.
Silicon Valley Bank Collapse: Depositors Protected
The Silicon Valley Bank (SVB) collapse is old news by now. The mismanagement there is another cautionary tale: despite having a flighty tech/venture capital deposit base, management greedily reached for an extra 0.5% or so yield by putting assets into longer-term bonds that were vulnerable to a rise in interest rates instead of into stable short-term securities.
A key step back from the brink here was the feds coming to the rescue of depositors, brushing aside the existing $250,000 limit on FDIC guarantees. That was an important step, otherwise large depositors would stampede out of all the regional banks and take their funds to the few large banks that are in the too-big-to-fail category. It is true that this new level of guarantee encourages more moral hazard, since depositors can now be more careless, but the alternative to guaranteeing these deposits (i.e. the collapse of regional banks) was just too awful. Bank shareholders and most bondholders were wiped out. Presumably that will send a message to the investing community of the importance of risk management at banks.
The actual disposition of the business parts of SVB are still being worked out. The feds originally tapped the big, well capitalized banks to see if one of them would take over SVB as a going concern. That would have been a nice, clean, thorough resolution. But the big banks all declined. I suspect the actual responses in private were unprintable. Here’s why: in the 2008 banking crisis, the Obama-Biden administration went to the big banks and encouraged them to take over failing institutions like Countrywide Mortgage, who among other things had made arguably predatory loans to subprime borrowers who had poor prospects to keep up with the mortgage payments. The Obama administration’s Department of Justice promptly turned around and very aggressively prosecuted these big banks for the sins of the prior institutions. J. P. Morgan ended up paying something like 13 billion and Bank of America paid 17 billion. So when today’s Biden administration reached out to these big banks this month to see about taking over SVB, they got no takers.
Now the assets of SVB (renamed Silicon Valley Bridge Bank) are getting auctioned off, perhaps piecemeal, but how exactly that happens does not seem so critical.
Signature Bank: Shut Down, But Sold Off Intact
Crypto-friendly Signature Bank was shuttered by New York State officials on Sunday, March 12, making this the third largest (SVB was the second largest) bank failure in U.S. history. Forbes gives the whole story. At the end of last year, Signature had over $110 billion in assets and $88 billion in deposits. Spooked by Signature’s similarities to failed banks SVB and Silvergate, customers rushed to withdraw deposits, which the bank could not honor without selling securities at huge losses. As with SVB, the feds had the FDIC insure all deposits of all sizes at Signature.
Unlike SVB, Signature has received a bid for the whole business, from New York Community Bancorp’s subsidiary Flagstar Bank. Flagstar will take over most deposits and loans and other assets, and operate Signature Bank’s 40 branches.
First Republic: Teetering on The Brink, Propped Up by Banking Consortium
First Republic is in a somewhat different class than these other troubled institutions. Its overall practices seem reasonable, in terms of equity and assets. However, it caters to a wealthy clientele in the Bay Area, with a lot of accounts over the $250,000 threshold. In the absence of a rapid and decisive move by Congress to extend FDIC protection to all deposits at all banks, somehow (I haven’t tracked what started the stampede) depositors got to withdrawing huge amounts (like $70 billion) last week. This was a classic “run on the bank.” That would stress any bank, despite decent risk management. Once confidence is lost, it’s game over, since there are always alternative places to park one’s money. Ratings agencies downgraded First Republic to junk status, and the stock has cratered.
It is in the interest of the broader banking industry to forestall yet another collapse. If folks start to generally mistrust banks and withdraw deposits en masse, our whole financial system will be in deep trouble. In the case of First Republic, the private sector is trying to prop up it up, without a government takeover. So far this has mainly taken the form of depositing some $30 billion into First Republic, as deposits (not loans or equity), by a consortium of eleven large U.S. banks led by J. P. Morgan. This is was a quick and fairly unheroic intervention, since in the event of liquidation, depositors (including this consortium) have the highest claim on assets. This intervention will probably prove insufficient. Two potential outcomes would be a big issuance of stock to raise capital (which would dilute existing shareholders), or some large bank buying First Republic. The stock rose today on reports that Morgan’s Jamie Dimon was talking with other big banks about taking an equity stake in First Republic, possibly by converting some of the $30 billion deposit into equity.
Old News: Silvergate Bank Liquidation
Overshadowed by recent, bigger collapses, the orderly shutdown of the crypto-focused Silvergate Bank is old news. It was two weeks ago (March 8) that Silvergate announced it would shut down and self-liquidate. The meltdown of the crypto financing world led to excessive loss of deposits at Silvergate. Unlike SVB and Signature, it held a lot of its assets in more liquid, short-term securities, so its losses have not been as devastating – – all depositors will be made whole, though shareholders are toast (stock is down from $150 a year ago to $1.68 at Monday’s close).
Warren Buffett To the Rescue?
Banks generally operate on the model of borrow short/lend long: they “borrow” from depositors and buy longer-term securities. Normally, short-term rates are lower than long-term rates, so banks can pay out much lower interest on their deposits than they receive on their bond/loan investments. With the Fed’s rapid increases in short-term rates this past year, however, the rate curve is heavily inverted, which is disastrous for borrow short/lend long. Fortunately for banks, many depositors are too lazy to do what I have done, which is to move most of my immediate-need money out of bank accounts (paying maybe 1%) and into T-bills and money market funds paying 4-5%.
All this churn goes to highlight an inherent fragility of banks: there is typically a maturity mismatch between a bank’s deposits/liabilities (which are short-term and can be withdrawn at any time) and its assets (longer-term bonds it purchases, and loans that it makes which can be difficult to quickly liquidate). Runs on banks, where if you were late to panic you lost all your deposited money, used to be a real feature of life, as dramatized in classic films Mary Poppins and It’s a Wonderful Life. Eliminating this danger was a key reason for setting up the Federal Reserve system, and in general that has worked pretty well in the past hundred years. Banks in general (see chart above) are now carrying enormous amounts of unrealized losses on their portfolios of bonds and mortgage-backed securities (MBS) due to the increase in market rates. In addition to the existing “discount window” at which banks can borrow, the Fed has set up a new lending facility to help tide banks over if they (as in the case of SVB and Signature) get stressed by having to sell marked-down securities to cover withdrawal of deposits. Also, new measures reminiscent of 2008 were announced to extend dollar liquidity to central banks of other nations.
But when Gotham really has a problem, the Commissioner calls in the Caped Crusader. Warren Buffett has been in touch with administration officials about the banking situation. We wrote two weeks ago about Warren Buffett’s gigantic cash hoard from the float of his Berkshire Hathaway insurance businesses which allows him to quickly make deals that most other institutions cannot. Buffett rode to the rescue of large banks like Bank of America and Goldman Sachs in the 2008-2009 financial crisis. A lot of corporate jets have been noted flying into Omaha from airports near the headquarters of various regional banks. Buffett’s typical playbook in these cases is to have the troubled institution issue a special class of high yielding (with today’s regional banks, think: 9%) preferred stock that he buys, perhaps with privileges to convert into the common stock. That stock would count as much needed equity in the banks’ books.