Bank Failures Start with Human Failures

Bank Failures Start with Human Failures
April 19, 2023 Rob Artigo
In Podcasts

Silicon Valley Bank was not the only bank to fail in early 2023, but it shines as an example of mismanaging risk at enormous expense to depositors. In this Tough Things First podcast, Ray Zinn discusses the man made ingredients that have caused a banking crisis. (Click here for the Video Podcast.)


Rob Artigo: Welcome to the Tough Things First podcast, your indispensable source for business, leadership and life advice with the longest serving CEO in Silicon Valley. I’m your guest host, Rob Artigo, and he’s Ray Zinn. Hello again, Ray.

Ray Zinn: Hi, Rob. So good to be with you this morning.

Rob Artigo: Good to be back, Ray, and this is an interesting subject. I should let the listeners know that this is a video edition as well. So if you’re just listening to the podcast but you’d like to watch it, you can just click the link next to … you can go to toughthingsfirst.com and find the podcast, click the link that says video podcast and it’ll take you to Ray’s YouTube channel where we have the video posted, and you can watch it on video. I think it enhances what we do, and we don’t do it all the time, but we try to do it semi-regularly, and it’s fun to be on the same screen with you, Ray, and make videos.

Ray Zinn: Yep.

Rob Artigo: Well, today’s topic is something that’s been in the news a lot lately. I think people will understand this as being an important issue. I mean, people are always concerned about bank failures, and we had a big one. We had the largest … I think it’s gone down as the largest in history, the Silicon Valley Bank collapse.

Apparently, just recently, Ray, First Citizens BancShares, which is a family-run bank out of North Carolina that goes all the way back to the 1800s. I mean, it’s been around a long time. It has the track record. They purchased Silicon Valley Bank, and that was just fairly recently, and it was $72 billion in assets. That includes the loans and deposits and whatnot. They bought it for $16.5 million. Let’s just start with that first. That’s quite a discount, from 72 billion in assets to 16.5 billion in what it costs for them to acquire the bank. What do you think about that?

Ray Zinn: Well, given that UBS acquired Credit Suisse for 7 billion, I think they paid a lot more than UBS did for Credit Suisse. Of course, the Swiss government is really helping out UBS and the acquisition and guaranteeing certain aspects of the business, but again, the Swiss are known for banking and they didn’t want that to go down as a problem for banking in Switzerland to have Credit Suisse fail. So rather than letting Credit Suisse fail, they just let UBS acquire it. So, anyway.

Well, the banking mess, and, of course, I hope our listeners aren’t getting tired of hearing about this because it’s been on the news every single day. I hope that we can shed some light and get some credibility to what has been portrayed in the news. So first off, I know the folks at Silicon Valley Bank. Back in the early ’80s when they started, I had just started my company, Micrel, which is a semiconductor company in Silicon Valley, they wanted me to join the bank. Silicon Valley Bank has always been more or less a venture type bank. I call it a venture bank, always have. So what they should call it is Silicon Venture Bank, is what they should call it, and Sand Hill Road, that’s in Palo Alto, that’s where they have all those venture companies that are housed, as you would, in Palo Alto.

So, they really wanted a bank that could support these little startups, all these Silicon Valley technical, technology startups, and so they formed this company back, as I said, in the early ’80s to support the VCs, because the VCs were acquiring lots and lots of investment and they needed someplace to stick the money. So they thought they could have some degree of control for their clients, their companies, if they had their own bank. So, basically, is what the name implies, is it’s Silicon Valley, which got its name … Silicon Valley got its name back in the mid-60s or late ’60s, and so it really grew rapidly. The venture firms demanded almost that the companies that they founded, or that they funded, put their money into Silicon Valley Bank.

So, Silicon Valley Bank had a lot of deposits, massive, massive deposits, billions in deposits. Their loan book wasn’t all that much. I mean, if you look at their loan to deposit ratios, it’s not bad. I mean, so what they do is they use the deposits to make loans. All these banks do the same thing. They use their deposits to make loans or they find bonds. They use bonds to fund companies. So in the case of Silicon Valley Bank, it’s a high-flying group. In the beginning, these were run by very competent, very capable guys. Some of the best in the business were the ones that were running Silicon Valley Bank, but then Silicon Valley Bank, I guess because it’s just a very high profile bank, they started taking on more risks which weren’t all that good, and these mortgage-backed securities that they used to earn interest rate on their deposits really weren’t all that good.

Back in the … when they acquired them, they didn’t look bad at one and a half percent, or something like that, looked okay until the Biden administration came in, and, of course, inflation took off, and then the Feds came in and started raising interest rates, and now the interest rates are … as long as they stayed down below one and a half, 2%, then, of course, this is what we call the Fed rate, Silicon Valley Bank was perfectly okay, but as soon as they saw the interest rates go up, and they went up so fast, I guess they couldn’t unload those bonds fast enough.

So, all the bond prices have come down. I’m heavily involved in bonds myself, and the value of the bond is dropped significantly as the interest rates go up. So what happens is, is that at some point when the people started looking at the 10-Ks that were produced by Silicon Valley Bank, they could see that the bank was losing money like crazy, and so they started pulling their deposits out of the bank. That’s called a run on the bank, and that run on the bank, it resulted in, of course, what we’ve heard last week, which was the demise of Silicon Valley Bank, because soon as those deposits started leaving and they had all these loans out, then, of course, the Fed had to step in, the FDIC and guarantee the depositors the money they had in the bank.

So, it’s a matter of the bank putting all of its eggs in one basket, and the eggs in one basket, say the basket was the mortgage-backed securities, and so that’s the basket, of course, is the problem. They didn’t do any hedging. Hedging mean you find a way to offset the potential drop in something, whether it be the currency or whatever. You have to figure out some way to hedge your bet, as you would, they call it hedging your bet, and the bet they had was that the mortgage-backed securities would be a stable currency form and that turned out to be false.

So, I don’t put 100% of the blame on Silicon Valley Bank in the sense of the word that they got caught, as you would, in the wrong place at the wrong time using these really low rate securities to hedge their deposits. Unfortunately, with the interest rate going up, and now it’s in excess of 5%, five and a quarter percent, that damaged, significantly, the loaning capability of Silicon Valley Bank, and so customers say, “I don’t want my money sitting in a bank where the interest rate is only maybe a few percent when I can go out and go to money market or other places and earn two times that.” I think right now the interest rate’s somewhere, that money market’s paying, is four and a half percent, roughly, four to four and a half percent, and maybe even higher. Maybe it’s going to go over five.

Then, Silicon Valley Bank wasn’t the only one that had a problem. We had the First Republic, which is also a, quote-quote, a Silicon Valley bank. They were started in the Bay Area in Silicon Valley, and they were also in trouble, and so other banks have jumped in to help, Morgan Stanley. Banks, the big banks like that have jumped in to help First Republic. So it’s not just Silicon Valley Bank. As I said, I start out by saying Credit Suisse in Switzerland, First Republic Bank. So it’s not just Silicon Valley Bank.

There’s a lot of banks that … and we have somewhat of a banking crisis right now where, because these interest rates have gone up so quickly, and the Fed should have known this, the Fed should have known that by increasing interest rates as quick as they did, that that would significantly damage the bond market and hurt the banks. So we’ve ineffectively, because of inflation, because of the high interest rates, we have, in effect, have caused ourself a banking crisis. So that’s it in a nutshell, Rob, as to what happened. So just that Silicon Valley Bank had more eggs in her basket than others did, and so they weren’t diversified enough in their deposits.

Rob Artigo: You were, excuse me, a significant source of information on this because, like you said, you understand the players and the history that went around SVB and the other banks. You live in the area, this is right in your wheelhouse, you’ve done venture cap, you’ve had to deal with startups, and I think what’s significant about this is that there are a lot of people who got their loans from SVB and the other banks you mentioned to get their startups going and to keep them running, and suddenly they found themselves not able to get their deposits and not able to meet payroll and the other issues that occurred. If I’m a startup operator and I’m looking for a loan, am I in danger of making a bad decision in where I put my money for fear of being locked out somehow?

Ray Zinn: Well, not locked out. Let me correct something you said.

Rob Artigo: Okay.

Ray Zinn: I’ve never been involved in venture funding. So, I mean, I’m familiar with it.

Rob Artigo: Well, I think, Ray, I think you’re correct. Thank you for that, because I think what I mean is that you’ve been in the circles where people are … where you understand people that are in the startup arena.

Ray Zinn: Yeah. So are you in danger? Your loan, you’re not in danger on your loan. I mean, your loan’s at a certain interest rate. Where you’re in trouble is if you’re a depositor in the bank, because that’s the asset. Your loan is not an asset. Your loan’s a liability. So you’re not in trouble on your loan at all. You’re in trouble on your asset, which is your deposit. That’s the problem, and that’s what caused the demise of Credit Suisse, Silicon Valley Bank and First Republic, is the run. The customers were pulling their deposits out and putting them where they could earn more interest. Silicon Valley Bank just could not, or nor First Republic or Credit Suisse, could not compete on the interest rate because they’re getting only one and a half percent, let’s say, on the money that they got from mortgage-backed securities.

As you know, bonds, they go down when the interest rate goes up. So if you wait until a bond terms out, then, of course, you get all your money back, but unless the bond terms … if you have to unload the bond before it terms out, that’s a loss. You’re going to lose money, and they lost billions of dollars because they were having to sell those bonds at a 25, 30% discount, and that’s billions of dollars that they lost. That’s what you could see on the 10-K and should have alarmed or alerted you, if you were a manager, a risk manager at the bank, you should’ve seen that.

Of course, what do you do? Keep it a secret? You can’t because you got to report it in your 10-K, which is a reporting form that you use every quarter to report your financial results. So the fit was going to hit the shan any day. There’s no question about it, and, of course, it did, and, of course, we see the result of that. So I think that they’re … when they do the investigation, I think they got to look at what kind of hedging did they do, what kind of protection did they provide their depositors?

Now it is, as it turns out, the FDIC came in and bailed everybody out. Because your deposit was only guaranteed at $250,000, and they’re guaranteeing deposit, like Roku. They had $539 million that they had sitting at Silicon Valley Bank. So they bailed out this big company called Roku, which is that entertainment streaming service.

Rob Artigo: Yeah. Right.

Ray Zinn: They bailed them out, but that wasn’t … I was surprised. I thought that, for sure, anybody that had deposits in there over $250,000 was not going to get their money back, or not in excess of 250,000, but FDIC came in and bailed them out. That shocked me.

Rob Artigo: Yeah. It was crazy.

Ray Zinn: I think the total FDIC book is about 100 billion. So, I mean, FDIC’s not going to have any money left pretty soon. Now, they’ve been selling off some of the assets of Silicon Valley Bank, so they’ll get that back, but, I mean, there’s a limit to how much the FDIC can really fund these deposits in excess of $250,000.

Rob Artigo: Yeah, and we have to wrap this up real quick here shortly, but let me, on that concern, is the FDIC ensures up to $250,000 of your deposit, and then it comes out and says, “Oh, we’re going to bail that bank out completely.” Does it set up a dangerous precedent that the FDIC is saying, “No matter how big your investment is, we’ll back that,” so they would raise from 250 to infinity, basically?

Ray Zinn: Well, I think the government’s going to have to take a look at that. I mean, there’s not an unlimited amount of money that the FDIC can cover, so I don’t know where they’re going to go with that. I know that Congress is going to investigate this whole banking issue. So here we go again, 2008, here we go. I mean, it seems like we can’t learn from the past. So I have a saying, he who repeats the past fails in the future, and so that’s what we’ve seen. We’re repeating the past and we’re going to fail if we don’t get our act together and be a little smarter about the way we manage the assets of this country.

Rob Artigo: As this goes forward, there’ll be that investigation. There’ll be more information to be gained and hopefully a lesson for anyone about how the banking system works and about how protected their funds are and proper decision making. It just seems like it’s a time to learn so that you don’t make those same mistakes in the future, right?

Ray Zinn: Well, we haven’t learned everything yet. We don’t know any skullduggery, what they were doing with managing the bank, banks, and now that we got three of them. So there’ll be investigations that we’re going to have to get to the bottom of what … because these controls that we want to put in on the bank have to be based on some logic, and so they’re going to have to investigate what happened, why did it happen, what can we do to prevent it in the future? So we got to quit making these stupid mistakes that are really harming this country. So we got to make sure we elect the right people, I guess, is up for me.

Rob Artigo: I guess so, yeah. It’s one of those things where we have to be diligent, and if you want to think about the future, it doesn’t hurt to look into who’s on the board of a bank too, just to find out if you’re safe.

Ray Zinn: Yeah.

Rob Artigo: As always, you can reach out to Ray Zinn with your questions at toughthingsfirst.com, continue, excuse me, your education and conversation with all the podcasts, blogs and links to information about Ray’s books. Tough Things First, you want to get that, it’s essential, and then the other books are The Zen of Zinn. There’s one, two and three, and all three of them will be of benefit to you, so please check them out. Great conversation, Ray.

Ray Zinn: Thanks, Rob.

 

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