(Bloomberg) — When U.S. banks fell like dominoes during the Great Depression, it was often because of a classic run: depositors cashed out en masse amid fears that lenders were piling up huge losses on bad loans and investments.
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The cryptocurrency era has put a new twist on this – with depositors in trouble first.
Silvergate Capital Corp., a California lender that offers digital asset businesses a place to store their cash. shareholders recently disclosed that it survived an $8.1 billion reduction in deposits. That’s about 70%, even worse than the runs seen in the Depression. But in this case, the bad bet was made by depositors themselves, who had a list of cryptocurrencies, including parts of Sam Bankman-Fried’s doomed FTX empire.
“This is unprecedented, very unusual,” said Karen Petrou, managing partner at Washington-based Federal Financial Analytics. “They were vulnerable to a run because they depended heavily on crypto funding. Given the volatility of the cryptocurrency market, they got it.”
According to him, bank regulators will look more closely at such cases.
Indeed, earlier this week the Federal Reserve, the Federal Deposit Insurance Corporation, and the Comptroller of the Currency issued an unusual joint warning to banks dealing with crypto companies, expressing concern about business models that are too concentrated in crypto-related activities. .
“It is important that risks associated with the crypto-asset sector, which cannot be mitigated or controlled, are not transferred to the banking system,” the regulators said.
Silvergate expressed confidence in its liquidity and ability to move forward, a view echoed by several Wall Street analysts. But Silvergate’s disclosure — which included selling assets at a loss to raise cash — sent its shares tumbling, bringing Bitcoin’s total slide since late 2021, when it hit a record high, to more than 90%.
Shares fell as much as 14% again on Friday as analysts warned the deposit cycle would not end. JPMorgan analysts, including Stephen Alexopoulos, said in a research note that before the rally in cryptocurrency prices, balances could be heading toward 2020 levels, adding that short sellers on Twitter may have worsened the run by scaring off depositors.
Silvergate is still vulnerable because almost all of the bank’s deposits are from crypto-centric institutions, and sustained large outflows could hurt the bank’s finances, according to Moody’s Investors Service. The concern was reflected in the deeply depressed price of Silvergate’s preferred stock, which was trading at about 40 cents on the dollar. Bloomberg Intelligence warned that the 5.375% interest payment could be in jeopardy.
Bear Stearns Cos. and in other modern banking crises, such as the 2008 credit crisis that claimed Lehman Brothers Holdings Inc., problems began as loans and other assets chewed up lenders’ balance sheets. As these losses mounted, funding sources panicked and pulled away.
Sale of assets
But in Silvergate’s case, the firm made relatively few loans. The vast majority of its $15.5 billion balance sheet at the end of September consisted of securities issued or backed by the U.S. government or municipalities — generally considered relatively safe and easy to unload, regulatory filings show.
Instead, the pressure began on the other side of Silvergate’s balance sheet. Almost 94% of the firm’s liabilities were deposits from its digital asset clients, with approximately $11.9 billion. This number fell to $3.8 billion at the end of the fourth quarter.
To keep up with the outflows, Silvergate had to sell about half of its securities portfolio, liquidating $5.2 billion in debt securities for cash. This rush resulted in a loss of $718 million. The firm said it expects more hits as it sells securities to reduce $6.7 billion in wholesale debt.
The client retreat was prompted by the bankruptcy of Bankman-Fried’s FTX exchange operator and its investment firm Alameda Research amid allegations that they covered up billions of dollars in losses. This undermined public confidence, drove down digital asset prices, and cost FTX customers and cryptocurrency investors worldwide. Bankman-Fried pleaded not guilty to the fraud charge.
The Big Pause
Silvergate CEO Alan Lane said in a phone call with analysts that amid the turmoil, some institutional clients have withdrawn deposits from Silvergate accounts and shifted to less risky positions, taking a “big break” from cryptocurrency.
“We had clients who were private traders, sometimes market makers who had been doing business with each other for six or eight years,” said Ben Reynolds, the firm’s president. “They just stopped doing business with each other and took out all their savings.”
Some customers needed money. By the end of the year, about $150 million of Silvergate’s deposits came from customers in bankruptcy, the bank said.
FTX accounted for less than 10% of the bank’s deposits. The US government freezes assets held in Silvergate bank accounts linked to one of the FTX’s divisions.
“No bank should be concentrated in one industry,” said Todd Baker, a senior fellow at Columbia Business School and Columbia Law School and a former chief strategist at three big banks. Silvergate will face “significant regulatory pressure to diversify its business”.
–With assistance from Lydia Beyoud.
(At paragraph 11, Moody’s adds JPMorgan analyst commentary.)
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