Customers scramble to find new lenders

Government intervention avoids a wider crisis, but banking system vulnerable after a sharp rise in interest rates

Colorado’s technology companies relied heavily on Silicon Valley Bank, and the federal government’s decision over the weekend to guarantee uninsured deposits after a takeover on Friday avoided a wider financial crisis by allowing the bank’s customers to access their money to meet payroll and other expenses.

Regulators, however, were unable to find another bank willing and able to take on SVB’S loan portfolio, leaving many borrowers scrambling to line up new creditors, who themselves are struggling with the rapid rise in interest rates that contributed to the failure of three banks this month.

“They need their credit facility in place and that is creating problems. The government will not be a lender. The FDIC can’t do that,” said George Singer, a partner in Denver with the law firm Holland & Hart while discussing the nonstop stream of calls he has been receiving from Colorado clients.

The most pressing worry initially was about paying bills after losing access to uninsured deposits. Every client calling held more than the $250,000 that the Federal Deposit Insurance Corp. covers against loss, Singer said. Some firms were holding tens of millions of dollars extended to them by private equity investors. About 87% of the $175.4 billion in deposits at SVB were not insured, leaving customers jittery about any signs of trouble.

“It was a super busy three or four days trying to help companies that were impacted try to understand what was going on, what our options were. And there was a lot of uncertainty for a time,” said Natty Zola, a partner with Matchstick Ventures, an earlystage technology investor based in Colorado. “Time will tell, but I think the main crisis has been averted with the FDIC and Fed stepping in, which is fantastic.”

Client calls are more focused now on existing loans made at interest rates below what the current market is charging and about credit lines that were shut down,

Singer said. Rather than waiting around for the FDIC to line up a buyer to take over loans, he is urging his clients to start forging new banking relationships.

Denver-based Soona, which runs a platform to create content through virtual photo and video shots, had millions of dollars tied up with SVB when an investor shared word on Thursday that the bank was in trouble. Soona management began planning an escape, but things moved too quickly.

“Over the course of the day, we worked with legal counsel and came up with a plan for the worst-case scenario,” said Liz Giorgi, Soona co-founder and CEO. By Friday, it was too late. Regulators stepped in and took over the bank, leaving Giorgi concerned about making payroll.

The FDIC’S decision to guarantee all deposits cleared the way to pay employees and now Giorgi said the company is talking to some of the larger banks about their services, which will include opening a line of credit.

How welcoming other more traditional banks will be to those escaping SVB, which had a reputation for understanding and working with startups and emerging technology companies, remains to be seen. Some banks are stepping forward to speed up the loan process, but transitioning

loans will take time.

“SVB was very comfortable working in the startup and early stage, with intellectual property serving as collateral rather than receivables. They were more comfortable in assessing risk,” Singer said, adding that private equity investors have also shut off the financing spigot until liquidity problems are resolved.

Of the 14 banks that worked with the companies in its portfolio, SVB, which maintained a commercial lending office at the Tabor Center in Denver, was by far the most popular, Zola said.

“I think a big loss for the community is what happens with SVB. We all used them, we relied on them. Their team here was fantastic. They were super helpful and key members of the startup ecosystem and we’re all going to have to try to figure out how do we replace them if SVB is not acquired,” he said.

On March 10, SVB became the country’s secondbiggest bank failure in U.S. history behind Washington Mutual, and its collapse in turn triggered a $10 billion run by depositors of Signature Bank, which focused on financing cryptocurrency firms and had $88.6 billion in deposits. Signature Bank became the third-largest U.S. bank failure on Sunday, March 12. On March 8, Silvergate Bank, a California lender to cryptocurrency firms, voluntarily liquidated after facing a run on its deposits following the failure of FTX.

“The Treasury, Federal Reserve, and FDIC took

swift action to protect our financial system and help small businesses that did nothing wrong continue to make payroll. It is important that banks — not taxpayers — cover any losses to the FDIC’S Deposit Insurance Fund,” said U.S. Senator Michael Bennet. “We need to work together to understand all of the pieces that contributed to the recent bank failures and restore confidence in our financial system.”

Contained or contagion?

The swift action by federal regulators over the weekend to restore access to uninsured deposits resolved the most pressing problem and restored confidence. But it doesn’t address more fundamental issues within the system that much higher interest rates are causing. The bonds and other debt instruments banks bought when they were flooded with deposits during the pandemic are now worth much less, and realizing those losses will trigger huge writeoffs at banks. Losing deposits to competitors offering higher interest rates is a key reason why banks might be forced to sell.

“SVB is one cancerous cell in your body and it is going to spread. I don’t think people quite understand what effect the spread will have and the vastness of it. There is serious contagion here,” warned James King, who is launching Contrarian RE Fund 1, a distressed real estate fund based in

Colorado.

The most important engine of economic growth in the U.S., tech, has essentially seized up, or at least the financing for it has. Real estate values, after getting stretched, are starting to come down and that could be an even bigger problem for banks. Zillow estimates metro Denver home values are down about 10% from the peak.

And the failure of SVB carries global reverberations. King said an Australian tech startup he invested in had 50% of its cash tied up with SVB, something he didn’t expect. Billions of dollars in bank valuations have been wiped out, and that is weighing on equity investors. Closer to home, King said he knows of a local developer who had a good chunk of his net worth evaporate on Thursday with the collapse of SVB, leaving him unsure about finishing a project under construction.

Before its dramatic failure, SVB passed all of the government’s stress tests on banks and had made the Forbes’ annual list of the best banks in the U.S. for the fifth consecutive year. Regulators will need to look more carefully under the hood of banks to understand the exposure they face and to get ahead of future failures so they are handled in a more controlled way, said Jim Swanson, a principal at Bank Strategies, a Denver firm that advises banks.

Swanson argues that both SVB and Signature were special cases — rapidly

growing banks in very concentrated niches with a very high share of uninsured deposits. Risks to the wider system can be managed.

And Sanjai Bhagat, a finance professor at the University of Colorado-boulder, was part of a group that advocated banks keep a 20% capital cushion, a recommendation resulting from the 2008 financial crisis. SVB only had 5.8%, forcing it to seek an equity offering to cover $1.8 billion in bond portfolio losses that spooked its customers.

And yet the core problem that SVB and Signature faced is common throughout the entire banking system, holding “conservative” debt instruments that are worth much less than they used to be as deposits become more expensive to retain. An early warning sign that a bank is under pressure is a drop in its stock market value, and investors were in a selling mood on Monday.

Wells Fargo, which holds a fifth of the bank deposits in the state as of June 30, was down 7.1% on Monday and is down 29% from its recent peak. Shares of JP Morgan Chase & Co., the state’s second-largest bank with 12.7% of deposits, dropped only 1.8% on the day. U.S. Bank, the fourth largest bank operating in the state with 10.8% of deposits, lost a tenth of its market value.

Keycorp, the parent to the state’s sixth largest bank, suffered a 27.3% loss in value on Monday and its shares are down by more than half from its 52-week high. Shares of Zions Bancorporaton, the parent of

Vectra Bank, lost more than a quarter of their value on Monday.

“Zions Bancorporation has access to tens of billions of dollars of readily available liquidity, without having to sell securities. The credit quality of our loan and securities portfolios has been outstanding in recent years, and our capital remains strong,” Vectra Bank president and CEO Bruce Alexander wrote in a letter to reassure customers.

Swanson said most banks have the capital reserves to handle losses in their bond holdings if they are forced to sell. Where he would begin to worry more is if they start taking losses in their loan portfolios, which historically has been how most banks get into trouble and eventually fail.

A recession could hurt the ability of borrowers to pay back their loans by reducing income, while also undercutting the value of the collateral backing those loans. Handling big losses in both their bond and loan portfolios could challenge the solvency of a lot of banks.

But that is not the scenario Swanson expects. Banks will need to do better about attracting deposits, a skill many have lost with hyper-low interest rates, and they will need to ride out the depressed bond market until they can roll their money into higher-yielding investments.

“I don’t view this as a systemic issue for the banking industry,” he said.” If asset quality remains sound, it gives me hope this too will pass.”