(Bloomberg) — When US banks fell like dominoes during the Great Depression, the cause was often a classic run: Depositors withdrew cash en masse amid fears that lenders were amassing huge losses on bad loans and investments.
The cryptocurrency era just put a new twist on that — with the depositors running into trouble first.
Silvergate Capital Corp., a California lender that offers digital-asset ventures a place to park their cash, jolted shareholders Thursday with the revelation that it had recently survived an $8.1 billion drawdown on deposits. That’s roughly 70%, even more severe than runs seen in the Depression. But in this case, the bad betting was done by the depositors themselves, a roster of crypto entities including parts of Sam Bankman-Fried’s doomed FTX empire.
“This is unprecedented, it’s very unusual,” said Karen Petrou, a managing partner at Federal Financial Analytics, a Washington-based research firm. “Because they were so dependent on crypto funding, they were vulnerable for a run. Given the crypto market has been unstable, they got it.”
Bank regulators, she said, will take a closer look at such situations.
Indeed, earlier this week the Federal Reserve, Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency issued an unusual joint warning to banks that deal with crypto firms, expressing concerns about business models that are too concentrated in crypto-related activities.
“It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system,” the regulators said.
Silvergate expressed confidence in its liquidity and ability to move on, a notion supported by several Wall Street analysts. But Silvergate’s disclosure — which included selling assets at a loss to raise cash — sent its stock tumbling, bringing its total slide to more than 90% since the end of 2021, the year Bitcoin reached a record high.
The shares slid again on Friday, dropping as much as 14%, as analysts warned that the deposit run might not be over. The balances could be headed back toward 2020 levels, prior to the bull run in crypto prices, JPMorgan analysts including Steven Alexopoulos wrote in a research note, adding that short sellers on Twitter may have made the run worse by spooking depositors.
Silvergate is still vulnerable because almost all the bank’s deposits are from crypto-centric institutions, and continued large outflows could hurt the bank’s financial condition, according to Moody’s Investors Service. The concern was reflected in the deeply distressed price of Silvergate’s preferred securities, which trade at about 40 cents on the dollar. Bloomberg Intelligence warned that the 5.375% interest payment may be in jeopardy.
In other modern bank crises, such as the 2008 credit crunch that claimed Bear Stearns Cos. and Lehman Brothers Holdings Inc., problems began as souring loans and other assets chewed holes in lenders’ balance sheets. As those losses mounted, funding sources panicked and pulled away.
Selling Assets
But in Silvergate’s case, the firm made relatively few loans. Regulatory filings show the vast majority of its $15.5 billion balance sheet at the end of September was comprised of securities issued or backed by the US government or municipalities — generally considered relatively safe and easy to unload.
Instead, the pressures started on the other side of Silvergate’s balance sheet. Almost 94% of the firm’s liabilities were deposits, with about $11.9 billion from digital-asset customers. That figure plunged to $3.8 billion by the end of the fourth quarter.
To keep up with outflows, Silvergate had to sell nearly half of its securities portfolio, liquidating $5.2 billion of debt securities for cash. In that rush, it incurred $718 million in losses. The firm said it anticipates more hits as it sells securities to reduce its $6.7 billion in wholesale borrowings.
Spurring customers’ retreat was the collapse of Bankman-Fried’s FTX exchange operator and his Alameda Research investment firm amid allegations that they had covered up billions of dollars in losses. That rattled the public’s confidence, sent prices of digital assets tumbling and cost FTX customers and crypto investors around the world. Bankman-Fried has pleaded not guilty to fraud charges.
Huge Pause
Amid the turmoil, some institutional clients pulled deposits from Silvergate accounts and switched to less risky positions, taking a “huge pause” from crypto, Silvergate Chief Executive Officer Alan Lane said on a call with analysts.
“We had clients that were proprietary traders, market makers that had been doing business with each other for sometimes six to eight years,” said the firm’s president, Ben Reynolds. “They just stopped doing business with each other and essentially pulled out all their deposits.”
Some clients desperately needed whatever cash they could muster to make ends meet. By year-end, about $150 million of Silvergate’s deposits came from clients in bankruptcy proceedings, the bank said.
FTX represented less than 10% of the bank’s deposits. The US government is seizing assets kept in Silvergate bank accounts tied to one of FTX’s units.
“No bank should be concentrated in one industry,” said Todd Baker, senior fellow at the Columbia Business School and Columbia Law School and a former chief strategy officer at three large banks. Silvergate will come under “significant regulatory pressure to diversity its business.”
–With assistance from Lydia Beyoud.
©2023 Bloomberg L.P.