Misjudging the pace of Fed rate hikes, Silvergate and Silicon Valley banks are Mired in a liquidity crisis

原文标题：《 解密 Silvergate 与硅谷银行危机：一场美元加息周期下的豪赌 》

原文作者：0xmin，深潮 TechFlow

Small and medium-sized banks in the United States are thundering!

On March 8, Silvergate Bank, a famously crypto-friendly lender, announced it was liquidating and returning all deposits to customers.

On March 10, Silicon Valley Bank, which specializes in financial services for Silicon Valley technology companies, suffered a $1.8 billion loss on a sale of $21 billion in marketable securities and suspected liquidity problems. Shares plunged more than 60 percent on Thursday, wiping $9.4 billion off its market value in a day.

It has also spooked many of Silicon Valley's bigwigs.

"Godfather of Silicon Valley" Peter Thiel's venture capital Fund, Founders Fund, has directly advised companies to divest from Silicon Valley banks, and Y Combinator CEO Garry Tan has also issued a warning, advising companies to consider limiting their exposure to lenders to $250,000...

Even scarier, Silicon Valley Bank could be the first domino in the crisis, affecting not only other U.S. banks but also Silicon Valley tech startups.

What's going on?

Today, we tell the story of how a bank goes bust.

Interpreting the banking business model

First, we need to understand the banking business model.

To put it simply, a commercial bank is a company that deals in money. The business model of a bank is essentially the same as that of any other business -- buy low and sell high, except that the commodity becomes money.

Banks take money from depositors, or capital markets, and then lend it to borrowers, profiting from the interest margin.

For example, if a bank borrows money from deposits at an annual interest rate of 2% and then lends it to the borrower at an annual interest rate of 6%, the bank earns a 4% interest margin. This is net interest income. In addition, banks can also earn profits from basic fee-based services and other services, which is called non-interest income. Net interest income and non-interest income together make up the bank's net income.

Therefore, the best way for banks to make more profit is to run out of inventory, just like selling commodities. That is to say, they lend out all the deposits they have taken in at low cost. After all, deposits have a cost and they need to pay interest to depositors.

These also form two ends of a bank's balance sheet.

Owner's equity + liabilities: Owner's equity is equity. Deposits placed by customers in banks are essentially borrowed by banks from customers, which are liabilities. For banks, the more liabilities, or deposits, the better, and the lower the cost, the better. Crypto-friendly banks like Silvergate attract deposits from big companies in the crypto world by offering a unique service called SEN.

Assets: In contrast to deposits, loans made by banks to customers are claims of banks, which are assets, including all kinds of mortgage loans, credit loans to ordinary consumers, and all kinds of bonds, such as Treasury bonds, municipal bonds, mortgage-backed securities (MBS) or high-grade corporate bonds.

So how does a bank with such a simple business model go "bust"?

When a bank hits a crisis, which means its balance sheet is in trouble, there are usually two things: bad debts; Maturity mismatch.

Bad loans: In normal times, banks generate profits and need to call in loans, but if the loans they made or the bonds they bought turn out to be rubbish and default, they face real losses. Lehman Brothers went bust in the subprime crisis because it had so many bad loans that it lost more on its balance-sheet than on the bank's equity, meaning it was insolvent.

Maturity mismatch: the maturity of assets and liabilities does not match, mainly manifested as "short-term deposit and long-term loan", that is, the source of funds becomes short-term and the use of funds becomes long-term.

For example, if you are due to pay the rent on the 1st of this month, but your only cash flow income is the salary paid on the 10th of this month, your cash inflow and outflow do not match, there is a maturity mismatch, that is, a liquidity crisis. What do you do then? Either you sell your assets, such as stocks, funds, cryptocurrencies, etc., for cash, or you borrow some money from a friend to cope with the current crisis.

Return to   Silvergate and Silicon Valley Bank, the maturity mismatch is what got them into trouble.

Not only these two banks, but various crypto unicorns, Celsius, Codex, AEX, etc. have all failed due to liquidity crisis caused by maturity mismatch.

At the end of the day, it's all about the Fed raising rates. They're all dead bodies in the dollar cycle.

How did Silvergate go bankrupt?

Founded in 1986, Silvergate Capital Corp (ticker: SI) is a California based community retail bank that remained quiet for decades until Alan Lane decided to enter the crypto industry in 2013.

Silvergate Bank is billed as a crypto-friendly bank that not only accepts deposits from crypto trading platforms and traders, but also sets up its own crypto settlement payment Network, SEN (Silvergate Exchange Network), for cryptocurrency settlement. Help the trading platform and customers to better access money, and become an important bridge connecting legal currency and cryptocurrency, such as   FTX has been using SEN for fiat money.

As of December 2022, Silvergate had a total of 1,620 customers, including 104 trading platforms.

When the crypto bull market came, a lot of money entered, and customer deposits from the crypto industry increased sharply, especially because of the presence of SEN, resulting in a lot of trading platform funds had to precipitate in Silvergate.

From the third quarter of 2020 to the fourth quarter of 2021, Silvergate deposits soared from $2.3 billion to $14.3 billion, a nearly sevenfold increase.

Cryptocurrency-friendly and crypto-bull markets have allowed Silvergate's liabilities, or deposits, to expand dramatically, but this has forced the company to "buy assets" and lend money over a long period of time, which is not Silvergate's advantage. So he chose to buy billions of dollars of long-term municipal bonds and mortgage-backed securities over the course of 2021.

As of September 30, 2022, the company's balance sheet showed approximately $11.4 billion in bonds, in addition to only about $1.4 billion in loans. So, Silvergate is essentially an "investment company" arbitraging the crypto world and traditional financial markets: relying on its banking license and SEN to take deposits from crypto institutions at low or even zero interest, and then buy bonds to earn the intermediate yield.

Cheap deposits coexist with high-quality assets, and everything looks good until 2022, when the two black swans arrive.

In 2022, the Fed went into frenzied rate hike mode, with interest rates rising rapidly, causing bond prices to fall.

Financial products have an identity: today's price * interest rate = future cash flow. The characteristic of bonds is that the amount due to repay the principal and interest has been set, so the future cash flow will not change, so the higher the interest rate, the lower the price today.

As of the end of the third quarter of 2022, Silvergate had recorded an unrealized loss of more than $1 billion on the carrying value of its securities.

Additionally, during the crypto bull market, Silvergate, with its deep pocket, acquired FaceBook's failed Stablecoin project Diem in early 2022 for a total of nearly $200 million in stock and cash. By January 2023, Silvergate disclosed that it had taken an impairment charge of $196 million in the fourth quarter of 2022, taking down the value of intellectual property and technology acquired from Diem Group earlier in the year, which amounted to $200 million in lost value.

In a word,   Silvergate had bought too many overpriced assets at the top of the bubble, but in this case, it could have landed safely as long as the balance sheet wasn't in trouble, but Silvergate's big client, FTX, thundered.

When FTX went bankrupt in November 2022, Silvergate depositors began withdrawing money in a panic.

In the fourth quarter of 2022, Silvergate's deposits fell 68 percent and withdrawals exceeded $8 billion, a situation we often refer to as a bank run.

A liquidity crisis hit, and Silvergate had no choice but to borrow money or sell assets in order to meet depositors' redemptions.

First, Silvergate was forced to sell expensive securities it had bought in the fourth quarter of 2022 and in January of this year to gain liquidity. As a result, it incurred losses of about $900 million on securities, equivalent to 70% of its equity.

In addition, Silvergate obtained some cash by borrowing $4.3 billion from the Federal Home Loan Bank of San Francisco, a government-chartered agency whose main business is to provide short-term secured loans to cash-hungry banks.

On March 9th, Silvergate Bank, as you know, insisted on declaring a liquidation, stating that it would repay all deposits in full in an orderly wind-down and voluntary liquidation in accordance with applicable regulatory procedures.

Silicon Valley banking crisis

If you understand the crisis at Silvergate Bank, then the liquidity crisis at Silicon Valley Bank (SVB) is much the same, except that Silicon Valley Bank is bigger and more influential.

Silicon Valley Bank has always been one of the most popular financial institutions among Silicon Valley tech and life science startups. Once Silicon Valley Bank explodes, it will inevitably affect all kinds of startups, bringing a double crisis of technology and finance.

The trigger was a "fire sale" of $21bn in bonds that resulted in a $1.8bn loss. SVB said it would raise $2.3bn by selling shares to cover losses related to the bond sale.

This has scared the hell out of Silicon Valley VCS.

Founders Fund, the venture-capital fund of Peter Thiel, the godfather of Silicon Valley, has directly advised companies to divest from Silicon Valley banks; Union Square Ventures told portfolio companies to "keep only a minimal amount of money in SVB cash accounts";

Garry Tan, Y Combinator's CEO, warns his portfolio startups that the solvency risks of Silicon Valley banks are real and suggests they should consider limiting their exposure to lenders to $250,000.

Tribe Capital advises portfolio companies to withdraw some of their cash from Silicon Valley banks, if not entirely.

So, the bank run came, Silicon Valley bank into a deeper liquidity crisis.

Let's look at its assets and liabilities.

On the debt side, SVB attracted a lot of deposits with its 0.25% deposit rate due to low interest rates in the overall money market. In addition, in the last few years, the technology venture capital and IPO markets were good, so SVB's balance sheet also grew rapidly. From $61.76 billion in 2019 to $189.2 billion by the end of 2021.

However, the technology venture capital market has been sluggish, especially since the IPO market has been very quiet in the past year, SVBS deposits continue to decline, and direct purchase of Treasury bonds is a more cost-effective option for savers.

On the asset side, like Silvergate Bank, SVB also chooses to buy bonds such as MBS when it has a large amount of deposits and cannot release the funds through traditional lending methods. The problem is that it does not buy a little, but almost "soha".

When interest rates were low, America's big banks kept more of their deposits in government debt, accepting lower yields at a time of economic uncertainty. Assuming that interest rates would stay low for a long time, Silicon Valley banks invested most of their deposits in MBS in search of higher yields.

At the end of 2022, SVBS had $120 billion in investment securities, including a portfolio of $91 billion in mortgage-backed securities, far more than the $74 billion in total loans.

SVB sold a $21 billion bond portfolio with a yield of 1.79% and a duration of 3.6 years, according to public filings. For comparison, on March 10, the three-year Treasury yield was 4.4 per cent.

As interest rates soar, falling bond prices will cause losses for Silicon Valley banks.

Silicon Valley Bank holds a $91bn portfolio of bonds to maturity that now has a market value of just $76bn, equivalent to an unrealised loss of $15bn.

"We expected rates to rise, but not as much as they have," Greg Becker, CEO of SVB, said in an interview.

Overall, the woes of Silvergate and SVB are largely a result of misjudging the pace of Fed rate hikes, resulting in bad investment decisions, a temporary boom in soha bonds, and a difficult end to the dollar rate hike.

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