Bank Stocks Got Wacked: Between a Rock and a Hard Place as Banks Run Out Free Money

Oh dearie, those bonds.

By Wolf Richter for WOLF STREET.

Bank stocks got whacked today by an item on the list of disclosures by SVB Financial, owner of Silicon Valley bank. These disclosures included a massive capital raise to shore up the balance sheet, and massive actions to shore up liquidity, including selling $21 billion in “available-for-sale” bonds at a whopper of a loss of $1.8 billion. SVB has lots more bonds it can sell at even bigger losses. SVB’s shares collapsed by 69% today, from $267 at the close on March 8 to $85 afterhours on March 9.

The Invesco KBW Bank ETF plunged by 7.6% today. Even the biggest commercial banks got whacked. The standout on this list is First Republic Bank, whose shares plunged 18.9% today.

Many mid-size banks got crushed today. Obviously, SVB, which had $210 billion in assets on December 31, takes the cake. Other winners today: PacWest Bancorp (-25.4%), Western Alliance Bancorp (-12.9%), Signature Bank (-12.6%), East West Bancorp (-8.4%).  You get the idea.

SVB has a host of problems associated with its specialty: The startup scene that is now facing a mass-extinction event. Other banks don’t have that kind of exposure to startups.

What rattled folks today was that SVB lost $1.8 billion on the sale of $21 billion of “available-for-sale” securities. It sold them because it needed to raise liquidity and to “reposition” its balance sheet. Its depositors are startups that once had a huge amount of cash on deposit at the bank that they’d obtained from venture capital investors. But those startups are burning cash like there is no tomorrow, and they aren’t getting new funding, and so they’re draining their deposits from the bank. And the bank has to fund those cash withdrawals.

Crypto bank Silvergate collapsed “in an orderly manner” on March 8 because of its losses on its bonds that it was forced to sell because it had a huge run on the bank from its depositors, which were crypto companies, including FTX, that suddenly withdrew combined billions of dollars of their dollar deposits because they needed every dollar they could get because they were themselves collapsing. And the losses on the sale of those bonds killed the bank’s capital.

Investors did the math today. Other banks are sitting on potentially the same problem: If they’re forced to sell bonds now, they’re going to lose a lot of money, even on perfectly good Treasury securities, because yields have risen and therefore bond prices have fallen.

If they don’t have to sell those bonds but can hold them to maturity, they will not lose anything, they will be paid face value for those bonds at maturity, and they collect interest along the way, and nothing happens.

But if they need to sell now to raise liquidity to fund the outflow of deposits, all heck breaks loose.

Banks run out of free money.

SVB depositors are pulling out their cash because they’re burning it. Silvergate depositor were collapsing crypto companies that yanked out their cash. These are somewhat unique circumstances. Other banks don’t face those issues; they face more mundane issues.

If banks don’t offer competitive interest rates on their deposits, retail and business depositors sooner or later figure it out and switch their cash from savings accounts that offer 0.2% or from transaction accounts and cash management accounts that offer 0%, to brokered CDs and Treasury bills that offer over 5%, and to money market funds that offer between 4.5% and 5%.

Banks can hang on to those deposits if they raise their rates to 4% or 4.5%, but that would squeeze their profit margins. So they don’t, and deposits are fleeing.

To fund the deposit outflow, banks can use the cash they have on hand, and they can use the cash they have on deposit at the Fed (what the Fed calls “reserves”). Banks have $3 trillion on deposit at the Fed. This is instant liquidity banks can use to fund deposit outflows. And they currently earn 4.65% on their cash on deposit at the Fed.

SVB mentioned putting some of the cash from the bond sales on deposit at the Fed to earn higher income going forward.

But some banks might not have a lot of cash on deposit at the Fed, or they might want to keep it there to earn 4.65%. So they can raise the interest rate they’re offering their current depositors to retain them, say to 3%.

But raising the rates they pay on all deposits is very expensive for banks. So they might instead try to attract some new deposits by offering CDs through brokers (“brokered CDs”).  But to be competitive, banks need to offer around 5%, which is expensive money, compared to 0.2% they’re paying on current deposits, but they’re losing those deposits.

Banks can also borrow short term from the Federal Home Loan Banks or at the Fed’s “Discount Window” at rates as low as 4.75%, which is also expensive money. And they can borrow at similar rates from other banks. And they can borrow by issuing bonds, but at higher rates.

Or they can fund the deposit outflow by selling bonds, and taking a loss each time they sell bonds, instead of squeezing their profit margins quarter after quarter by borrowing at higher rates.

Or they can do a combination, which is what they often do.

The issue is simple: the only free money left for banks is from depositors, and depositors have figured out that they’re getting screwed, and they’re fleeing. So Banks are facing higher funding costs – or they face big one-time losses if they raise cash by selling securities to reduce or avoid those higher funding costs. They’re between a rock and a hard place, and SVB explained this to investors today.

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