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Banking Boondoggle

Banking stocks and ETFs had a wild ride this week

The SPDR S&P Bank ETF (ticker: KBE), a popular banking sector, ETF had a volatile week. Ditto for the SPDR S&P Regional Banking ETF (KRE).

It was an interesting week in bank stocks, to put it mildly. When equity markets opened on Monday, traders were reacting to the news that federal regulators had shut down and taken over two banks they deemed to have excessive systemic risk. Silicon Valley Bank (SVB) and Signature Bank (SB) were both put into receivership and now operated by the Federal Deposit Insurance Corporation (FDIC).

This, of course, caused a panic and a sell-of in bank stocks and related ETFs that track the banking sector. Regional banks, and those with similar client demographics as SVB were hit the hardest. First Republic Bank (FRC), in particular, experienced severe collateral damage (pun intended).

Five Day Price Return for select banking ETFs and First Republic Bank (FRC)
Daily price returns from Friday March 10, 2023 to Thursday March 16, 2023 for the KBE and KRE ETFs and First Republic Bank (FRC) stock

Source: Koyfin, Jackson Creek Investment Advisors

Also, during the week, Credit Suisse (CS), a major global investment bank, which had already been under regulatory pressure for misconduct and internal control weaknesses, was in dire shape. After the U.S. markets closed on Wednesday (3/15), it was announced the Swiss National Bank (SNB) would loan Credit Suisse up to fifty billion francs to help strengthen its financial position. Swiss regulators did not want the country’s reputation as a financial center to be tarnished. Read more about the Credit Suisse situation here.

This situation is still evolving. After the close on Thursday (3/16) it was announced that 11 financial institutions are depositing a combined $30B at FRC. They include major money center banks, investment banks, and major regional banks. However, FRC still appears to be searching for a buyer.

Five day chart for SPDR S&P Bank ETF (KBE)
SPDR S&P Bank ETF (KBE) five day chart

Source: Koyfin

So why did SVB fail/get taken over?

Silicon Valley Bank appears to have suffered from mismanaging its investment portfolio in light of rising interest rates, combined with withdrawals from a concentrated client base. They cater to the venture capital community, growing rapidly in the recent past. The bank provides loans and financial services to start up companies, venture funds, and the employees and founders of those firms. When the tech industry is healthy, everyone does well. When the tech industry suffers, well, there is a run on the bank.

Banks normally borrow short-term money and lend for longer periods. In normal times, this process works well. Short-term interest rates tend to be lower than long-term interest rates. SVB purchased large amounts of longer-dated treasuries when yields were extremely low, and they were flush with customer deposits. The Federal Reserve’s rate hikes to combat inflation caused the yield curve to invert, meaning short-term rates are higher than long-term rates. Long-term rates still increased causing those securities to decrease in value. SVB was left holding low-yielding, lower-valued securities with rising borrowing costs (higher short-term rates and paying depositors more to keep money in the bank). The addition of customer outflows worsened the situation.

U.S. Treasury Yield Curve
U.S. Treasury yield curve - March 15, 2023

Source: S&P Global Capital IQ

The bank attempted to raise more capital via public stock sale, but that plan was abandoned when the severity of the situation became known. Tech industry executives and SVB clients began withdrawing funds en masse fearing the bank would soon not able to meet client withdrawals – a run on the bank. A bank run occurs when depositors fear they will not be able to get their money back. This causes a mass exodus of withdrawal activity. The bank struggles to meet every immediate demand. The bank was shut down on Friday.

Signature Bank’s dealings with cryptocurrency was too risky for regulators.

The banks were taken over to circumvent further damage to the banking industry. The banks were not saved – shareholders were wiped out. The actions were designed to save depositors and prevent the damage from spreading further among the banking system.

Here is a good summary of SVB’s final days from the WSJ.

Isn’t a bank run something that happens in times like the Great Depression?

I must admit, when I hear ‘bank run’, my mind conjures up images of long lines of men in 1929 waiting outside bank branches. Bank failures are not that uncommon, even in more recent times. This graphic shows bank failures in the U.S. since 2001. The majority are clustered around the 2008-9 Financial Crisis and its aftermath, but others occurred during more “normal” times.

The historical imagery of long lines is antiquated because mobile banking probably exacerbated the problem. People and businesses with accounts at SVB were able to pull out their money and deposit it at another institution right from their phones.

Is SIVB & SBNY getting bailed out like investment banks during the Financial Crisis? Am I (as a taxpayer) going to be on the hook for this?

This may get different answers from different people, depending on their definition of “bailout”. The banks themselves are not getting saved. The shareholders are going to lose their investments and bond holders become creditors. The agencies running the banks are going to look for buyers or sell the assets off in pieces.

The government guaranteed that all clients would have full access to all deposits, even above the $250,000 insured limit. This means that the banks clients are getting a lifeline. Without that government backstop, clients would have been given receivership certificates for the amounts exceeding $250,000, making them creditors too. Opponents of the guarantee claim depositors should have been aware of the $250,000 insurance limit when they made deposits. Depositing anything over that is taking a risk on the bank’s financial health and its ability to meet withdrawal requests.

The government, and those that support its stance, claim this is not a bailout and no taxpayer dollars will be used to fund the account guarantees. The plan is to use fees charged to banks to cover the cost of the program. How those fees get recovered is yet to be seen. A former Chairman of the FDIC believes this is a bailout (video).

In addition to insuring full deposit amounts, the evasive action taken by regulators and the Federal Reserve over the weekend will help surviving banks. The Federal Reserve instituted a program where banks can borrow money against the par value of assets that have been devalued. Meaning, a bank can borrow $100 using an asset that may be worth $95 as collateral.

Definitional semantics aside, special measures were enacted through the coordination of several government agencies, including the Federal Reserve, to protect uninsured depositors and help surviving banks borrow money easier.

How will this end?

Good question.



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