March 22, 2023
Dear Partners,
We’ll skip the preamble as most of you have been tracking the ongoing banking crisis closely. Our goal for this letter is to share how we prepared for the possible (and eventual) closure of Silvergate Bank, how we navigated SVB’s collapse and the ensuing fallout, and finally, how the current banking environment affects the portfolio from here.
I. Deposits Exposure
At the FoF level - We have never held operating cash or dry powder as deposits at Silvergate, SVB, Signature, First Republic, Credit Suisse, or any of the other banks recently downgraded by Moody's. Our bank appears healthy and continues to operate without issue. That said, upon the SVB collapse, we nonetheless upgraded our Fund banking account to have over 2x the FDIC insurance that we expect to need at any point in 2023. We are fully covered with room to spare should we need it.
At the portfolio fund level - our portfolio funds began to fully exit any deposits with Silvergate Bank in December 2022 purely given that bank’s exposure to FTX. By the time Silvergate announced its closure on March 8, 2023, none of our portfolio funds had any remaining deposit exposure. Our portfolio funds did have modest exposure in deposits (less than 2-5% of total Fund AUM) at SVB and Signature collectively, but most managers successfully transferred those funds out prior to each bank’s closure last weekend. As most of you now know, following a joint statement by the Treasury, Federal Reserve, and FDIC guaranteeing deposits last week, all depositors regained full access to their deposits. Ironically this makes SVB, very temporarily, the safest place to be banking, but all affected portfolio funds are actively onboarding elsewhere. Where necessary, we’ve connected our portfolio funds with our primary banking partner as well.
At the portfolio company level - banking for domestic portfolio companies (ie: U.S.-based investments of our portfolio funds) has certainly become more difficult, but at the very least, these early stage startups can now access their deposits for payroll and general treasury management. Our fund managers are working around the clock to support their portfolios, helping to introduce new domestic banking partners, add foreign banking options where appropriate, and in some cases shifting operating cash to fully-collateralized stablecoin treasuries secured by gnosis safes or similarly battle-tested DeFi solutions.
II. Deep Dive - Our Banking Relationships
We use [redacted] for management company banking and [redacted] at the Fund level. [2 paragraphs redacted]
A Warning Shot: Silvergate’s December Demise
Silvergate didn’t announce its closure until March 8, 2023, but its unraveling began back in Q4 2022. In addition to banking many of the large American crypto investment firms, Silvergate was also the fiat-to-crypto banking rails for industry behemoths like Coinbase, Galaxy, Paxos, Circle, Bitstamp, Gemini and…FTX.
Following the collapse of FTX, confidence in Silvergate was quickly called into question, with its stock dropping nearly 50% overnight (not only due to the banking relationship but because, for a time, Silvergate had allowed FTX customers to unknowingly wire funds to Alameda Research). Rumors of DOJ investigations began to swirl, but even assuming Silvergate hadn’t facilitated FTX’s fraud, there was still an industry-wide shift towards removing all funds immediately from all exchanges. In the background, Silvergate was the banking solution for many of these exchanges, and saw deposits from digital assets customers plummet to $3.8B in Q4 2022 (down -68% from $11.9B in Q3 2022).
Over the next few months, Silvergate’s decline would take an eerily similar shape to the incoming collapse of SVB. Both banks overestimated the stickiness and growth of their deposit base, both invested heavily in long-dated securities, both were forced to sell those securities at a major loss when deposits eroded, and both had a very sector-specific mostly-uninsured customer base (Silvergate with crypto, SVB with Tech) with that came and left as a herd.
Drilling in on some of these qualities, as we monitor [redacted] health ahead of the upcoming Q1 2023 print, and as we evaluate other secondary banking relationship, we’re paying close attention to the following:
- Securities as % of Assets
- Net Loans and Leases as % of Assets
- Total Equity Capital
- Total FDIC Insured Deposits
- Crypto References & Exposure
At a high level, it’s helpful to remember that Bank Assets - Bank Liabilities = Bank Equity (sometimes called Bank Capital), so most of what we’re following maps to the relative health of those areas. Much of this information is publicly available on the FDIC’s BankFind platform. Using [our bank’s] Q4 2022 balance sheet as an example, let’s look at how they compare.
Securities as % of Assets
Total Securities (A) can include a lot of things, but we’ll focus on fixed-income securities like U.S. Treasuries (B) and Mortgage Backed Securities (C). The industry average for most banks is 24% of assets in fixed-income securities. At its most recent reporting, SVB had an aggressive 55% of assets in fixed-income instruments. That number for [our bank] was [redacted single digits]%, and its Total Securities as a % of Total Assets at year end was [redacted single digits]%.
[image redacted]
As has been written about at length elsewhere, when SVB leaned into long-dated fixed-income securities (purchasing ~$90B of MBS with an average yield of 1.56% and 10 year term), they exposed themselves to tremendous interest rate risk: as Fed interest rates rose, SVB’s fixed-income portfolio if marked-to-market (or forced to sell) would represent a massive loss.
Net Loans & Leases as % of Assets
Loans and leases are the most traditional (ie: least exotic) way for banks to make money from customer deposits. These tend to be small business loans, commercial real estate loans, residential real estate loans, etc…For most conservative banks, this number represents over 50% of assets. For SVB this number was only ~35% since, as mentioned above, it was overwhelmingly leaning into U.S. Government Securities like MBS. To make matters worse, much of SVB’s loan book was venture debt, which was becoming both more difficult to originate and more likely to default as cash-burning startups failed to raise more capital. Compared to SVB’s 35%, [our bank] ended 2022 with Net Loans and Leases representing roughly [redacted well over 50%]% of assets, some of which are loans to small businesses and none of which is being used for venture debt.
Total Equity Capital
Healthy equity capital for most banks is at least 8%. This provides a buffer in the Assets - Liabilities = Equity equation, protecting against losses when needed. If this buffer gets too small, a bank like SVB will try to raise additional equity. On March 8, 2023 when SVB recognized a $1.8B loss from its fixed-income portfolio (see above), they attempted to make up this hole by raising additional equity capital. Unfortunately, by announcing the $$ value it intended to raise before having a finalized deal, SVB signaled weakness and incoming dilution to existing shareholders, prompting more selling and depressing its level of equity capital even further.
[Our bank’s] equity capital to assets ratio at year-end 2022 was nearly [north of 8.5]%. For context, that number for JP Morgan was 9.5% and 8.2% for First Republic. We’ll continue to track bank equity closely. On the month, [our bank] was down more than majors like Citi (down -11.5%) or JPM (down -9%) but nowhere near First Republic (down -90%), PacWest (down - 60%), or others.
Total FDIC Insured Deposits
It’s fairly common for federally insured deposits to be surprisingly low, often less than 50%, because so many individuals and small business accounts are above the $250k FDIC insurance threshold. In normal times, this is rarely cause for alarm. JP Morgan, for example, ended 2022 with 39.39% of its domestic deposits FDIC insured. That number for [our bank] was 46% and drilling down further we see that the overwhelming majority of accounts by number are within the $250k threshold (A). Not pictured here, [our bank] also offers an upgraded account for high net worth individuals or businesses to get up to $3.5M of FDIC insurance.
[image redacted]
[paragraph redacted]
Again, we will continue to monitor all of the above as Q1 2023 prints come online.
III. Outlook
Yesterday, Treasury Secretary Yellen announced that the U.S. would protect customer deposits at additional banks if necessary. She reiterated the rationale behind the Bank Term Funding Program (BTFP), an emergency loan program providing liquidity to banks, and stressed that it will protect depositors and the banking system at large. Fed Chair Jerome Powell echoed her in his address this morning stating “depositors should assume that their deposits are safe”. Still, markets remain on edge as it's not yet clear whether the current liquidity injection differs meaningfully from an outright return to QE or whether the BTFP solves duration mismatches at the expense of obscuring deeper systemic problems.
For our part, we’re keeping in close contact with our portfolio funds and supporting them however we can. As always, we’re also taking a step back to understand what the current environment means for crypto and the Fund. Somewhat surprisingly, the banking turmoil of the last 2 weeks hasn’t been so bad for the industry: BTC surged +40%, ETH nearly 30%, and – more meaningful than price action – the reliability of banks, money, and the traditional financial system at large was called into question for the first time since 2008. No longer is the idea of a frozen bank account considered an impossibility for the crypto skeptic. No longer is this dismissed as a theoretical headache experienced only by faraway authoritarian countries or underdeveloped economies.
Does this shakeup mean everyone transitions to crypto overnight? Unfortunately, the SEC is doing everything in its power to make sure that’s not the case. Meanwhile, in this week’s highly-anticipated Economic Report of the President, the White House went so far as to write that crypto assets do not “offer any fundamental value, nor do they act as an effective alternative to fiat money”, this while teasing explorations of a central bank digital currency (CBDC) in the same breath.
We’re optimistic that our crypto allies in Congress (yes, they exist) will push for legislation that strikes down a CBDC and protects crypto innovation domestically, but the Fund is positioned globally and ready for the disappointing case in which the U.S. chooses continued antagonism. Whether we want to see it or not, the U.S. seems to be losing its grip on the global financial controls. The rest of the world is taking note, some by embracing innovation and others by embracing alternative global powers. In that context, we’re proud to be supporting the former: open innovation, permissionless building, and a more forward-thinking financial substrate for a globally connected world.