The Canadian Investor - The Reasons Behind SVB Collapsing

Episode Date: March 20, 2023

Silicon Valley Bank was the 2nd largest bank to collapse in US history. The largest bank to do so since the Great Financial Crisis. This entire episode is decade to what caused its collapse, the consequences and what may be coming in years down the line. Symbols of stocks discussed: SIVB, RY.TO, TD.TO, BMO.TO Check out our portfolio by going to Jointci.com Our Website Canadian Investor Podcast Network Twitter: @cdn_investing Simon’s twitter: @Fiat_Iceberg Braden’s twitter: @BradoCapital Want to learn more about Real Estate Investing? Check out the Canadian Real Estate Investor Podcast! Apple Podcast - The Canadian Real Estate Investor  Spotify - The Canadian Real Estate Investor  Sign up to Stratosphere for free 🚀 our platform for self-directed stock investing research. Register for EQ Bank, the seamless digital banking experience with better rates and no nonsense. Register for Shakepay List of Global Systemically Important BanksSee omnystudio.com/listener for privacy information.

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been waiting for us to have some commentary on the drama of the banking system in Silicon Valley Bank. We had to record a little differently our schedule to accommodate my uh my travels but um see what i'm actually kind of glad we did because the dust has settled and now we can have i think a more balanced view instead of just uh hysteria yeah yeah i mean i would say the the dust has somewhat settled but it's still settling as well it's it's yeah like there's like you know there's like still some sawdust kind of flying around like you know that's but i'm actually i was thinking about that throughout the week because there was news you know changes developments related to the collapses of svb that was happening throughout the week and i'm sure there's still

going to be stuff happening today um so i think it's good, like you just mentioned, we'll have a better overview where if we'd recorded as normally on Tuesday, there's a few things that happened in the past couple of days that we wouldn't have been able to touch on. That's right. And you know what? It always takes a little bit of time to digest the news and make good decisions. I think that that's a good way to run a portfolio. All right, let's do

this. We'll go back and forth. We each kind of have our explanations and hot takes about what we think is going on here. And we'll try to have it in a very digestible way. We're not going to assume anyone's a bank expert because frankly, I certainly am not. You are way more well-versed in banks. There's a reason that I steer clear from them as an investor generally, as a rule, because people underestimate how complicated it is to analyze their financial statements. But I will give the view of Silicon Valley Bank, aka SVB. It's a regional bank that primarily serves the startup and tech ecosystem there in the valley physically, but also across the country. They were publicly traded under ticker SIVB and even hit a market cap of $40 billion in the peak of the tech and

venture capital bubble of 2021. Now, SVB was used by about 50% of venture capital, aka VC-backed startups. I'm going to say VC a lot today. That just means venture capital. So companies that have been given money funded by venture capital, SVB was about 50% of their banks used in the US. So startups raised money from venture funds looking to scale fast and be the next big thing. But it also did serve more niche software startups. Think of Stratosphere. I personally did not bank there, but I know many of my peers that do. Our lead investor does. The companies that they fund do.

A lot of these companies and the investors had their funds tied up in Silicon Valley Bank. And regular people, not just tech billionairesaires do bank there for both their business and personal, but the ideal customer persona is a rich venture capitalist. And that's what makes the characters who have cried wolf in this story. So polarizing and polarizing for good reason. I think that there's good, uh good cases and good opinions on both sides. But let's get into our hot takes later. What were the kind of mechanics of this bank run? Yeah. So I think just having an overview of the basics, because I've been listening to tons of

podcasts, different experts, different kind of leaning podcasts, some that were trying to, you know, put the blame a bit more on one side than the other, and then others that were completely the opposite. I was trying to get as many point of views and also listening to experts that really know how this works. So this is what I came about, but clearly the basics are important. And I think that's where a lot of different publications or podcasts didn't do a great job as just explaining the basics to people. Well, first a bank run, it can really only happen in a fractional reserve banking system, which is what we have. So fractional banking just means that the bank is only required to have a

fraction of the deposits on hand. So when you deposit your money, the bank turns around and loans part of that to someone else. It could be a business or individual. Another thing the bank can do is use a portion of those deposits and put them in, and I'll use air quotes here, safe assets in order to get the returns on money they are holding. So in either case, the bank makes money by paying the depositor less interest than what it loans out or collects on those safe investments. And I'll talk about the safe investments a bit later here. Bank runs happen when there are large amounts of withdrawals that happen in a very short period of time. So it's usually because of a loss of depositor confidence in the bank and its ability to be solvent or liquid. I would say liquid is probably the better term here.

Because banks use that fractional reserve system, if the withdrawals are large and quick enough, it can lead to a bank being illiquid or insolvent. Yeah, good overview. And this bank run was so interesting because it was purely digital. It's what I'm calling the digital bank run. So in my view, this was a complete blunder by management. Really bad PR execution. Greg Becker, the CEO, revealed on Wednesday night, Thursday is when stuff really started to look bad. And then Friday it was, Oh, this is, this is over for them. That's how quickly this evolved. And Wednesday night, they said that they are going to raise 2.25 billion in capital via issuing stock, as well as a $21 billion asset sale to try to recoup some losses because they took losses on

bonds. And so they had to sell those at a loss and they marked those down on their balance sheet. Now, that news set off a wave of fear across Silicon Valley, where the bank serves as a key lender to these startups, many of them panicked. And they yanked $42 billion in withdrawals on just Thursday alone. That day, the bank stock crashed 60%. So 25% of the 16th largest bank in the US, 25% of their total deposits were yanked in just 24 hours. And then this idiot, Greg Becker, CEO, his message was, do not panic. That was his message out to depositors and the market. And you know what people do when you say don't panic? They panic. People panicked immediately. It was get your money out ASAP before it's gone. And if you're over the FDIC limit, get this stuff out immediately. If you

got millions of dollars, get it out. Next thing you know, we're watching a bank run unfold on the internet. And you have this digital bank run happening. But also, if you're not familiar with the Valley and the tech ecosystem, it's like a cult. It's like a cult. They speak to each other all day, every day, both the investors, the operators, the founders, the employees. It's a big cult. And many of them are saying, get out now. News spreads even faster in this group uh and then you have it amplified by the internet it is it's gasoline on a fire it's it was incredible to to see unfold on thursday and friday yeah it was it was pretty crazy and obviously it spread to the panic to other regional banks and we'll talk about that a little later on. And I will touch on what

Brayden mentioned. So I'll go into a bit more detail in terms of the mismatch in asset and the duration difference. So why they had to sell those assets as a loss. As do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense. And with them, you can buy all North American ETFs, not just a few select ones, all commission free so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award-winning customer service team with real people that are ready to help if you have questions

along the way. As a customer myself, I've been impressed with Questrade's customer service. Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit questrade.com for details. That is questrade.com. Calling all DIY, do-it-yourself investors. Blossom is an essential app for you. It has been blowing up with now more than 50,000 Canadians plus and growing who are using the app. Every time I go on there, I am shocked. The engagement is amazing. This is a really vibrant community that they're building and people share their portfolios, their trades,

their investment ideas in real time. And it's all built on the concept of transparency because brokerage accounts are linked. And then once you link your brokerage account, you can get in-depth portfolio insights, track your dividends, and there's other stuff like learning Duolingo style education lessons that are completely free. You can search up Blossom Social in the app store and join the community today. I'm on there. I encourage you go on there and follow me, search me up. Some of the YouTubers and influencers and podcasters that you might know, I bet you they're already on there. People are just on there talking, sharing their investment ideas and using the analytics tools. So go ahead,

blossom social in the app store and I'll see you there. Now, first thing, I think a little bit of historical context is important here. So in terms of regulation, so people may think, okay, isn't there regulation to make sure that a bank run doesn't happen or minimize the risk? Well, the reality is bank runs, if you're in a fractional system, no matter how much regulation, like technically a bank run could happen anytime, right? But there is regulation in place, but it varies depending on size of the bank in the US. So there's more strict requirements, the larger the banks are, because they're considered too big to fill. So in 2010, after the great financial crisis, the Dodd-Frank Act was passed setting stricter regulation for systemically important financial institution just a side note here we have two banks in canada that would be a global system

systemically important financial institution systemically yeah that one's a tough one we'll give you that one they're also called g sib so there's two there's royal bank and td in canada they're kind of at the bottom of a five tier list. We did an episode on that, which I'll try to maybe find and put in the show notes if people are a bit more interested because it is somewhat relevant here. They were required to have these more strict requirements if they had $50 billion or more in assets and they had to adhere to strict oversight by the Fed, higher capital requirements, periodic stress tests, and must have a plan to wind up operations without causing a financial crisis or bailout. Now, what ended up happening is in 2018, after some intense lobbying from smaller regional banks like an SVB, and apparently SVB was quite involved in that lobbying as well, they, under President Trump, there was a partial rollback of the Dodd-Frank Act. At first, it increased the threshold to $100 billion and then $250 billion. And then with the partial rollback, it allows smaller banks like an SVB to expand their asset base without having to meet the stricter set of rules imposed by the Dodd-Frank Act. It's also less costly and just provides them more flexibility.

Now, I pulled some data. I tweeted on it. I think you did as well um some data in terms of the rapid growth and to tweet i stole your data yeah you stole my tweet i did you have the tweet out already yeah i just fully like highway robber your tweet i didn't see your okay you're forgiven it's like forgiven hey you used my screenshot so there you go yeah so um the rapid growth in deposit and it was really concentrated like braden that is said in the you know highly volatile tech venture sector like that's just the

reality so in 2018 they had 48 billion in average deposits And then you'll see it increase with that change in legislation. 2019, $55 billion. 2020, $75 billion. 2021, $148 billion. And 2020, $185 billion. Obviously, 2020 fueled by easy money. Everyone was ready to invest in risky bets, whether it was crypto, whether it was venture-backed businesses. So they really, you know, they really benefit from that. And all these venture tech firms, essentially, you know, 50%, like you said, banking with SVB. So you saw this rapid growth, which, you know, was a mix of the change in legislation and then just the easing of the monetary policy. And since SVB is a fractional reserve bank, just like other banks, it used parts of those deposits to invest in long-dated US government bonds and mortgage-backed securities,

also known as MBS, and we're talking here 10 plus years in maturity now these like i said are considered safe from a credit perspective but credit risk just means that the risk that there will be a default on those bonds is low or i would say yeah just extremely low if you're talking about the u.s government anything you wanted to add before i continue? Look at the deposit growth from 2020 to 2021. You had a clean double during that period from $75 billion to $148 billion. So we'll call it a clean double. And then up to $185 billion in 2021, like another really strong, or sorry, in 2022, another strong year. And this was a time when VC startup world and, you know, anyone could raise

money from anyone, because there was so much capital flying, so much FOMO and so much herd mentality. And that herd mentality is very strong in the Valley. It's very, very strong in the Valley. And the herd mentality exists in public markets, like people piling into overpriced assets and private markets. You can't escape this human psychology no matter what market you're playing in. And so you saw the deposits explode. And what you also saw is every other tech company is using this bank.

So should I. My investor uses it. My investor says I should use it. I'm not going to do any research. And I'm not saying that it's fair to expect these startup founders to be analyzing the balance sheet of this 16th largest bank in the US. I'm not saying that that's reasonable. But you saw extreme herd mentality. And the herd mentality extends to this digital bank run, right? News spreads like wildfire and that much emotion and hysteria is heightened by these digital channels.

And this digital bank run is not only by the hysteria news spread by social media and Twitter and these channels, but you can actually remove your assets. You can withdraw cash from the bank in just a few clicks. It's not like, oh shit, Zimone, I got to go get, sorry, one sec, man. I know we're having lunch, but I got to go run to the bank because I got to get my money out and throw it under the mattress it's like no hold on just give me a second i'm gonna hop on my phone and transfer it all out right now that and that's so easy and so you just get this like out of control uh wildfire that can't be contained once it's out there and once he said don't panic that ship had already sailed yeah no exactly and it's out there. And once he said, don't panic, that ship had already sailed. Yeah, no, exactly. And it's kind of the first time we've seen that digital bank run where,

you know, it's not the first time there's been bank runs in the US. There's been hundreds of them in history. I mean, in the 1930s, I think there was several hundred every year. Just to give you an idea, obviously, that was a long time ago, there were some in 2008, 2009, as well. So it's not, you know, like we've ever seen that. And what SVB really did a really poor job was managing interest rate risk. So that's different from credit risk, like I just talked about. So the undervaluing, well, we've talked about, yeah. If someone's going to listen to one part, one section of this podcast on what happened, this is it. So, yes.

And we've talked and I've been hammering pretty much since we started the podcast how bonds are not as safe as people think they are. And this is one of the main reasons because the underlying value of an existing bond is inversely related to interest rates movement. If interest rates go up, the market value of the bond goes down. If interest rates go down, the market value of the bond goes up. That's because investors always have the alternative to buying newly issued bond over the existing one. So if they're going to buy existing ones, they're going to want to buy it at a price that gives them the same yield as if they bought it directly from the U.S. government, for example. So now the issue here is these were 10 plus years in duration. Deposits, on the other hand, are very short duration in nature. That's because your depositors,

like you just mentioned on that digital bank run, can go and withdraw their money at any given time. So there was a big mismatch in the deposit duration and the long-term debt duration. So with interest rates going up rapidly in the past year, the market value of those bonds or MBS, the mortgage-backed securities, had gone down. So this is fine if you hold them to maturity, but it's an issue if you need to sell them now. So why would SVB do this and not edge its interest rate risk?

That's a good question. I'm sure there's going to be some inquiries, but it's most likely a mix of greed or incompetence. That's a mix here because people may think, why greed? Well, because those longer duration bonds when they were purchased gave them a higher interest rates because typically the shorter term interest is lower than the longer term interest rates. Right now we're seeing the inverse because it's a bit of, you know, let's just say a strange and unusual situation. I'll just say that. So management took those risks because it went to the bottom line. If they can collect more interest, it pads up their profits and probably their incentive structure. There's also people that pointed out that they were selling stock like just a few days before the bank actually went under.

So that's the main reason is because those assets were sold at a loss to allow SVB to essentially, you know, get liquidity to meet those deposit withdrawal. And it got so high, like you mentioned, I think $42 billion in the span of a day or something, that they essentially just couldn't continue operating because the losses were too massive. This is it right here, right? It's a complete mismatch on their balance sheet. mismatch on their balance sheet. And you think, oh, all management team did was buy 10-year bonds. They bought T-bills, the safest asset known to man. How can that be a risky behavior?

And surface level, you can say, oh, it's not their fault. They're buying T-bills. It absolutely is because they were betting on interest rates being zero forever, essentially. And that goes the other way. And oh boy, you have a mismatch like no other. mismatched like no other like those those 10 year those 10 years were yielding like one third of what they yield today yeah maybe less right and so that's that's the mismatch right there they listen to carefully to tiff and his news conference about interest rates they listen to tiff mcclellan from canada say rates are going to be low for a long, long, long time, people. And clearly that was not the case. And, you know, this is what happens. Yeah. And this was kind of a slow bleed that happened to for SVB over, I would say, about the past year or so.

Just because you talked about it, right? These ventured companies, interest rate had gone up, capital dried up. So what they ended up having to do is actually use their cash more. So the deposits they had done at SVB, they had to start drawing on that even more because they couldn't go and do funding rounds. If they did, actually the funding rounds for the most part were coming at a lower valuation than just six months or a year before that so companies started withdrawing the capital um a lot quicker than svb had anticipated so it was kind of a slow bleed that already had started and then obviously the

quick kind of you know three days that we saw last week but it wasn't something that happened like the the underlying reason was not something that happened overnight it actually was happening you know in the background and i will talk about these assets and the reason why people didn't necessarily see this coming is because these they're called held to maturity assets they actually don't have to be marked to market. So they are just marked at the book value of the asset, not what the market will currently give you. So the only way you're obligated to mark it to market or the market value is if you mark these assets as I think it's available for sale assets, then you have to mark them to market or equities. We've seen this happen quite a bit with Berkshire,

where their earnings are just all over the place, depending on how their investments are doing. That's because they have to market to market. And this is one of the kind of things that I'm sure will come under scrutiny because it creates a false impression of the bank being liquid if they have a mismatch in duration and they are marking to market these these instruments or these long-term bonds yeah and and good point on you know it seemed like it blew up in two days because it did but they put themselves in a position for that to blow up in two days.

Like word got out of how messed up things were. And that's what really initiated the bank run. And things were seriously messed up. We just talked about how messed up their balance sheet was with that mismatch of long duration bonds. Like they missed 101 of duration in their finance classes. It's pretty embarrassing, honestly, for bank executives. But the other facet, which again, you've talked about is they had a lot of venture debt given to companies who times are not as good as they were in 21 when deposits are flying in, they're raising new money at inflated valuations, tons of cash on the balance sheet to, uh-oh,

down rounds, uh-oh, cash crunches, uh-oh, my customers are also in cash crunches. And so this just is a perfect storm in a way that was brewing in the background. It blows up in two days and it seems like it all happened so fast. But the writing had been on the wall for quite a while. If you kind of had that, I mean, hindsight 2020, hindsight 2020, it just goes that clearly the market's not efficient because this stuff is hard to uncover as an analyst. So as do-it-yourself investors, we want to keep our fees low. That's why Simone and I have been using

Questrade as our online broker for so many years now. Questrade is Canada's number one rated online broker by MoneySense, and with them, you can buy all North American ETFs, not just a few select ones, all commission-free, so that you can choose the ETFs that you want. And they charge no annual RRSP or TFSA account fees. They have an award-winning customer service team with real people that are ready to help if you have questions along the way. As a customer myself, I've been impressed with Questrade's customer service. Whenever I call or email, every support rep is very knowledgeable and they get exactly what I need done quickly. Switch for free today and keep more of your money. Visit questrade.com for details. That is questrade.com.

Calling all DIY do-it-yourself investors. Blossom is an essential app for you. It has been blowing up with now more than 50,000 Canadians plus and growing who are using the app. Every time I go on there, I am shocked. The engagement is amazing. This is a really vibrant community that they're building and people share their portfolios, their trades or investment ideas in real time. And it's all built on the concept of transparency because brokerage accounts are linked. And then once you link your brokerage account, you can get in-depth portfolio insights, track your dividends,

and there's other stuff like learning Duolingo style education lessons that are completely free. You can search up Blossom Social in the app store and join the community today. I'm on there. I encourage you go on there and follow me, search me up. Some of the YouTubers and influencers and podcasters that you might

know, I bet you they're already on there. People are just on there talking, sharing their investment ideas and using the analytics tools. So go ahead, Blossom Social in the app store and I'll see you there. I have many hot takes on what's next and what the Fed did. So should we get into that? Yeah. Well, go ahead and say the first part of what the Fed did, and then I'll talk about something else that they did earlier this week as well. Yeah. Okay. Sounds good. All right. So I'll kick us here on, on March 12th, which is last Sunday, uh, they released this press release and, you know, people were waiting, like, what's going to happen. Is this, are depositors screwed? Are they, you know, are all of these

companies not going to make payroll on Monday or, you know, is the fed going to come in here with the, with the bazooka and they released this press release already here. Today we are taking decisive actions to protect the US economy by strengthening public confidence in our banking system. This step will ensure that the US banking system continues to perform its vital roles of protecting deposits and providing access to credit to households and businesses in a manner that promotes strong and sustainable economic growth. After receiving a recommendation from

the boards of the FDIC and the Federal Reserve, consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank in a manner that fully protects all depositors. So this is the line that people are looking for. Depositors will have access to all of their money starting Monday, March 13th. No losses associated with the resolution of Silicon Valley Bank will be borne to the taxpayer. So the idea here is SVB management, you're punted, equity holders, bondholders, you're going to zero. It's not a quote unquote 08 bailout, but it is an FDIC insurer bailout of depositors. That's basically what the press release said. of depositors. That's basically what the press release said.

Yeah. And they also announced another program. I think it was on Sunday as well. So in order to try and help prevent bank runs on smaller regional banks, the US also did a new bank term funding program called the BTFP. This program is for a total of $ billion to support banks with this program the fed will allow banks to borrow from this facility using their long-term bonds or debt i mean it could be mortgage-backed securities for example as collateral at par value so even though there would be underwater like we just mentioned because interest rates have gone up, they'll actually allow them to borrow against that for a year to actually, you know, try and sort things, get things in order. And like I said, it's U.S. Treasury agency debt mortgage-backed securities. And this is only for existing long-term debts. So if you have banks that are trying to get into that for debt that was taken on like today

for example that would not be eligible and what this means is instead of having to sell those US treasuries at a loss like SVB did to get liquidity banks will be able to borrow at par against them this is big because like I mentioned earlier the biggest issues happened with SVB was that it was having big outflows and it had to sell those long duration debt to get liquidity and then incurred losses. Since the rates had gone up, those obviously were worth less. So with this facility, banks can borrow against the U.S. Treasury at par for a duration of up to one year. So that's the biggest difference because there are facilities open to banks in the US, but usually they are for a 90 day period, not a one year period. And I think there's already a decent amount of money that's

kind of been that has flown out from this fund. I think it's already in the tens of billions, mostly. And I don't know if we talked about that, but in the US, too, you have these like regional banks, right? And you have those larger banks banks so this will most likely be more for these smaller regional banks if you look at one thing that's interesting is you can look at the ticker kre which is the spdr snp regional banking etf it's just smashed um it's been I think it's down 30 percent in the last couple weeks so um they're doing this in in hope that this will help calm the markets and help those smaller banks dude banking is so much different in the U.S. compared to Canada. It's unbelievable. And I'm here down in Florida right now. And you drive down anywhere. And I will find in a 10 minute drive, I will find five banks that I've never heard of.

At least, at least, like they're as common as gas stations like without a doubt in my mind and i've never heard of any of them um and it's just so much different uh it blows my mind um okay so looking looking at this like with the the 500 foot view oh we should also mention there was the uh silver gate was it so yeah yeah i was gonna talk about that but i can definitely talk about it now so silver gate is the and new york signature as well and new york signature that one is something else signature because a lot of people think um they shut it down to uh basically send a message to the crypto industry because they signature in silvage were the two primary bank like two banks in the u.s that had a lot of crypto customers so crypto related institution banking with them they also had some money transmission system for the crypto space

and what's extremely interesting is i believe his name is Bernie Frank anyways he's one of the guys whose name is on the Dodd-Frank legislation that I talked about who's actually a board member at Signature Bank and he's been out and basically saying like we would have been fine they did not have to shut us down and even saying that they believe they shut them down because they had a pretty substantial part of their business was crypto but you know aside from that um so their signature as well silver gate was actually quite similar in a lot of ways to silicon valley bank the similarities is first of, they primarily cater to crypto. And then obviously, as crypto winter took over, a lot of outflows came out with people wanting to withdraw their

money. So they had to, again, they had invested in long duration bonds. They had to sell those to meet deposits. They were also able to get a credit facility from a private banking institution down in California, but that was not renewed. I think it was a couple months ago. I'm just going on memory here. It wasn't in my notes. And then once that was not renewed, then the writing was on the wall that they would most likely have to wind down. So it was a wind down with Silver Gates. It wasn't necessarily like a bank run like SVP happened. And then they had to kind of stop everything and be taken over by the FDIC in the US. But very similar in the ways that it was highly concentrated in a volatile sector.

And then you also had a bit of a mismatch between the deposit that are short term versus the longer duration debt between the btfp program and the news that they had to release basically before monday morning at all costs they were busy they didn't they i'll tell you right now the people who work there did not get much sleep this past weekend. Add that to the long list of you couldn't pay me to work for the Federal Reserve. All right, moral hazard. Okay. This is a hot topic, a hot word right now, or two words, which is moral hazard. And there's two thoughts of opinion here. One is this bank completely mismanaged their balance sheet and blew up. And it sets a precedent for moral hazard of it doesn't matter how aggressive you run the balance sheet, your depositors are going to be bailed out. That's the message that it sends. The other

thought of opinion is, even if that's true, the Fed has to do something to prevent contagion. And I think that they're both right. And, you know, add this to the damned if you do damned if you don't list for for the Fed chair. And I don't care how much money they're going to offer me. I'm not doing that job. The overall take is like, the US has to do this. I mean, that's my opinion. I understand both sides of the aisle and school of thought here. I agree with takes from both schools of thought. My opinion is that the U.S. has to be a place and the place to build businesses with confidence. And if you can't have any confidence that your money is safe in a top 20 bank in the United States, then what, right? And it's the reason why they are a powerhouse. Look, building a business in

Argentina, for example, the currency defaults and it hyperinflates. The US is selling a product that this won't happen here. And that importance begins with the banking system. And they need to always be showing confidence globally and flexing their muscle to have that strong US dollar and be the de facto currency and de facto place to conduct business. So I guess i'll keep my money safe under the mattress is not an acceptable product of america and banking in in any developed nation but especially not there and so yes there is moral hazard but what is the other option i just let it fail have contagion like that's not what makes these powerhouse countries a good place to do business yeah yeah i mean i think and i'll touch about a few more things too as we wrap up here but i'll let you talk about your second point but i mean my view is that they probably didn't have a choice

but at the same time um they're probably kicking the can down the line for some even bigger problems i think that's what we're gonna see and i'll i'll mention a few figures i'm not pulling that straight off of my rear end like there are some pretty alarming numbers i don't want to spray a panic or anything but it's just what the numbers are feel free to interpret them how they may so i'll let you talk about your second point here that i think is interesting too. So there's another school of thought, I keep overusing that word, that these businesses that are banking with SVB should be doing their proper research. And in a true capitalism, you let this bank fail and you let the depositors fail too, because, you know, it's their duty to conduct counterparty risk. You know, that's the whole discussion.

And I think this is a ridiculous take. Like, the freezingest cold take that I've seen on the Twitter machine. I think it is completely unrealistic and stupid and idiotic to expect founders building the next big business to be doing proper research of counterparty risk when they're just trying to find their first customer and product market fit. Just trying to find even one person that will pay them when they're setting up their bank and their incorporation. And so to do some sort of level of forensic accounting to know something was up when the regulators are supposed to be reviewing every single bank and KPMG, their auditor gives the stamp of approval. It's like the victims of the Bernie Madoff scheme. It's like, well, they should have done their research. It's like the SEC did an investigation

in Bernie Madoff's office and came out with that he's legit. What on earth is the expectation that people are supposed to not take that for what it is? It is unrealistic to expect these startups to be thinking about that at day one or even day two, or to go open four bank accounts with 250K in each to be underneath the FDIC insurance limit in these regional banks when their investor says, yeah, use SVB. It's great. And we use it too. And so this take needs to be shut down immediately. I think it's outrageous. Yeah. So I'm going to nuance this a little more. I agree with the part on the startups where I think, you know, first of all, SVB, there's no indication that they did anything illegal with managing their assets.

So they did things that they were allowed to do in the current regulation. Whether, you know, there may be some illegality when they knew it was going under and they were selling stock like management. So we'll see. I'm sure that, you know, will come to light as the weeks and months. You can look it up, by the way, if you type in SIVB on Stratosphere. I think they sold like a decent chunk too. Yeah. Yes. as the weeks and months you can look it up by the way if you type in sivb on stratosphere i think they sold like a decent chunk too yeah yes you go to the investors tab and click on insiders click on the insiders secondary tab and it'll show you all of the insiders selling um over the basically

since their fourth quarter report yeah yeah and so, like, I'm not buying that they didn't know that, you know, was going very wrong. So that's that's a side note there. What I think there's a bit of blame to put on is these extremely wealthy VCs that did not do their due diligence on it. Like, I think Peter Thiel was one of them of them who like was telling people to is uh back startups to get the money out like that a peter teal doesn't have the resources to and the kind of at least prudence to do some due diligence on that that's where i'm like i i think there's a bit of a blame yeah to be uh to be given because I'm like, come on, dude. You should know better.

And he doesn't have to do it himself. He can just pay someone to do it for him. Yeah. Yeah. So that's probably my nuanced take there. I think that that's, I think that that's, I agree. I'm with you. So the startups, it's a ridiculous take.

that's i think that that's i agree i'm i'm with you uh so the startups it's a ridiculous take but that and also dude these guys that have been crying wolf oh no like you know the fed needs to come in and do something i agree but you guys are such nerds dude the the way that they have have done it and really through gas like through gasoline on the fire of the bank run like uh you know jason calacanis he has now said oh i don't have any affiliation with the bank i tweeted a tweet that went viral that showed a video of him admitting that he has his personal mortgage with them and that he recommends every founder use SVB. Like these guys are just lying out of their teeth. And I saw an interesting take that was like, you know, if this was a bunch of farmers in Oklahoma who banked at the regional bank of in Oklahoma, no one would give two shits.

regional bank of in Oklahoma, no one would give two shits. And so it's very hypocritical. I agree with that. Yeah. And I listened to the all in podcast. I mean, I enjoy most of their takes. And I listened to that one. I also listened to other ones that had completely different takes. And I have to agree to I was like, cringing at at times just hearing them talk because I back of my head, I'm like, clearly you're like very like, you know, very dependent on this resolution. Like, it's not like you have a lot of interest at stake. So I think but I like to get different points of view. So I like to form my own opinion. That's how I am. But I agree. Like I think for the for the startups, I think that would have been devastating for sure. And I think that was the right thing to do now. Between those guys and Chamath's SPACs, they are building up quite the

resume of grifts and scams at this point. I got to be honest. I think that I don't trust them as far as I can throw them. Anyways, I'll move on. Here's just another note. So in terms of some of the potential implications of what we've seen. So like I said, I'm a reference a bit of earlier is banks are not required to put the market value of securities that are held to maturity like i mentioned and according to the fdic as of december 31st 2022 unrealized losses in held to maturity securities total a whopping 620 billion and that there's a case to be made clearly because interest rates have gone up since that that number is even greater right now. And this is where the real problem currently lies and the potential implications more like medium, long term that it could have.

And we've seen that the Fed clearly has shifted. You know, they have not announced yet what they'll do for interest rate. But one other like the bazooka if you'd like in the fed's arsenal is quantitative easing so quantitative easing also known as qe so if you hear that that's what it is simply means that the fed or central banks are buying well the fed in this case is buying u.s treasuries from the market when central banks do this they expand the money supply or their balance sheet and it's often referred to as money printing it may not be balance sheet. And it's often referred to as money printing. It may not be physical money printing, but it's injecting money into the economy. So they're buying these bonds and providing liquidity and cash. So the Fed expanded

its balance sheet after several, almost a year, I think. Yeah, pretty much almost a full year of the balance sheet actually going down. It's still, you know, quite significant. It's still above $8 trillion in balance sheet, but they added $300 billion in the past week. And I have a graph here, and at least I know it'll be on the blog, but I'll put it on Twitter as well. It's really like evident where you see the balance sheet going down, going down, going down until pretty much last week or earlier this week. And then you see a massive spike in increase, that $300 billion. So this is one of the implications that unfortunately a lot of mainstream media are not talking about.

So the next domino to fall will have to be if they change their stance on interest rates. I don't know. I don't have a hot take. All I know is the market has been kind of flip flopping like 10 days ago. They were predicting a 50 basis point increase. Now I think it's either going to be, you know, keeping it the same or a 25 basis point increase. So we're seeing some of the impacts that it's having right now. Can you explain to me, I mean, I'm looking at the graph and I know what it is, but can you just kind of give people a visualization of what, what we're looking at here? Yeah. So the best way it's like, let's say it's a, it's a nice, smooth mountain. I'll just say that.

So in early... It's not like the Rocky Mountains of these sass stocks that have gotten obliterated. This is a nice Appalachian mountain. Yeah, Appalachian. If you go to Gatineau Park, kind of looks like that in the Ottawa region. So in 2020, 2021, you saw the balance sheet kind of increase. The chart here goes, starts in mid 2021. So you see it, it goes from 8.3 trillion

it goes up steadily up until uh april of 2022 and kind of levels out and then starts going down slowly again just kind of a smooth line almost a half circle i would say up until this week where there's a massive like straight up moonshot spike it looks like the graph is broken yeah it looks like the right looks like a cryptograph looks like you're like making an excel graph and you're like oh this looks nice and then you accidentally hit the wrong button and then the yeah no exactly so that's that's probably going to be uh you know something that we'll see which could have some implication without diving too much into it um you know there are some macro implications here are we going to see inflation potentially

take back up if it translates kind of level off, potentially cool down. I don't know. I'm just kind of, you know, putting it out there. There's a lot of different outcomes that could happen. But, you know, having that extra money in the economy, you could also make a case that, you know, you might start seeing kind of a risk on type of, you know, people start going on the risk curve. Again, I'm not saying that this will happen. I'm just saying there's a lot of things that are unknown, especially because you can also make a case that bank lending will be going down because banks now are a bit more concerned. I know I think there was Goldman Sachs that predicted that there's going to be a bit more

of a severe recession than originally planned, originally anticipated because banks are now, regional banks specifically, will be more reluctant to actually making loans, which is required to make the economy go. All right. So let's close this out by looking what's next and does this affect us here in Canada? In your mind, like quickly, what's next here for, let's start within the US, what's next for banks in the US? Well, even with the backstop of the Fed, like we mentioned, this 25 billion facility, first of all, I think that facility will be increased. I think that's inevitable. I think that was just a start and just to show that they're not bailing out this sector uh and whether you want to call it a bailout or not i think you can make an argument for both sides um you know whatever it doesn't matter it is a bailout it's

just not an of a 2008 bailout it's different it's different they're kind of doing it in a back end more if you want. So I think personally- But they're also leaving the equity holders and the management out of the bailout, which is the correct move. Yeah, it's the correct move. And I think maybe a double click on that, and we'll talk a little bit about Canadian banks here. talk a little bit about Canadian banks here, but when you invest in general, but especially in banks, I think it's important to know that, look, when you invest, you're the last on the list. You're in equity, you're entitled to the equity of the bank, but if it winds down or goes bankrupt or a business goes bankrupt, you are down on the totem pole in terms of getting some money back. And, you know,

we've talked about this before, but I think this is really, you know, it's important just to double click on that and just remind ourselves of that, especially for those who may be, you know, seeing the downturn in regional banks that ETF I just mentioned are like, oh, maybe it's a good opportunity. The Fed is backstopping them. Just be careful out there because, you know, equity holders or shareholders will be the first ones to be wiped out if there's something that's going wrong. And I personally think we're just going to see consolidation in the U.S. We're just going to see the big banks get bigger because people are flocking to safety.

Jamie Dimon is just licking his chops right now I know oh Jamie Diamond so several major news outlets actually reported that Bank of America saw an influx of 15.15 billion in deposits after the collapse of SVB so basically in the past week and the reports also say that other large u.s banks the too big to fail or the systemically important ones like i talked earlier have also received massive inflows in the billions of dollars and one last thing that we saw here is we saw the eight largest u.s banks send 30 billion dollars in deposit to first republic bank another regional bank that has come under trouble. That was after a round of financing led by JP Morgan last weekend that gave First Republic access to $70 billion

in U.S. funds as well. So you're really starting to see the big banks step up and also getting more of those deposits because they have stricter requirements. They're governed by the Dodd-Frank Act, like I mentioned. So they all are over that $250 billion in assets. So they have these stricter requirements. And I think you're just going to see more and more people and businesses saying like, screw this, I'm not risking these regional banks, even if i think the fed might step in like even if you think the fed steps in it's still while it may while it's happening it's a lot of stress it's a lot of pain to you know you know move the funds and all like and why not do it again if we don't have the rich the rich vc cry wolf so that's what are your thoughts on that are you thinking the same thing or yeah yeah i mean i

think that it you know banking in the u.s on a long duration like super super long duration starts to look more like banking in canada um on a long enough time horizon of course that's not going to start happening tomorrow there There are so many regional banks. The system is very different. But you saw a lot of inflows go from regional banks and the fallout of SVB and Signature and wherever else into the big dogs. So it's the Bank of America. It's the Citibank.

It's the JP Morgan. It's the it's the bank of america it's the city bank it's the jp morgan it's the wells fargo it those are those are the big dogs in town and you know like i said i think jp diamonds licking his chops here because i think that the big banks get bigger here and uh it's it's it's a it's tough sledding for this did you just Did you just call him JP Diamond? JP Diamond. Dude, that's amazing. I think I did. And that's what I'm calling him from now on. That's good. JP Diamond.

Dude, that's way better than Jamie Diamond. Yeah. Yeah. Well, in terms of Canadian banks, so like it's hard to say at this point. We do have different regulations in Canada. I think that's hard to say at this point. We do have different regulations in Canada. I think that's important to say. And Canadian banks, some Canadian banks don't have much exposure to SVB, if at all. I think for the most part, I haven't heard any of them having too much exposure to it.

But on the other hand, it's also a global financial system. And my assumption here is that Canadian banks that have larger U.S. operations, maybe we'll probably see a bit more volatility, I would think, in at least a short term compared to those who have little to no exposure. So here, I mean, the three that come to mind, and I may be missing one, but it's really RBC, TD, and BMO, the three that I think have the most exposure. I think CIBC does have a little bit, but not too much. RBC has a sizable business in the US, but a lot of it is tied to wealth management and capital markets. They have about 20% of their loans in the US, but the majority of it is actually wholesale clients. So that's essentially making loans with either other large institution,

whether it's other banks or other big companies or even government. So that's what the wholesale means. TD, on the other hand, is definitely the one that has the most of its profits coming from its U.S. operation. So last year, its U.S. operation represented about a third of their profits. TD did a lot of acquisitions in the U.S. following the great financial crisis. And BMO, the other bank that has a lot of exposure here in 2022, they had 20% of their net income coming from personal banking in the U.S., personal and commercial banking, sorry. banking in the U.S., personal and commercial banking, sorry. This is certainly higher now that they made the acquisition worth $16 billion of the Bank of the West. So BMO, I don't know exactly what percentage of their net income will come from the U.S. now after that acquisition,

but I'm going to assume it's more than 20%. and they're probably kicking themselves for not waiting to do that acquisition right now because I'm gonna assume that they would have been able to get it at a much cheaper price than 16 billion after the whole SVB fallout. I've gotten questions about EQ Bank as well and it's funny because you look at the banks in Canada and you look at EQ Bank and the CET1 ratios are just so high. And EQ Bank is actually a leader in that scenario too. So of course, it is a global financial system. I'm not going to say there's no risk. There's risk to everything and there's risk to every security um but right now i don't see it as a concern personally no i don't think so and if you want to be safe right um you know

most like i would personally only bank with banks that are cdic insured and which eq bank is and all the large banks um those who are, they're usually under provincial kind of legislation. So I think they also have some kind of insurance, but it's not CDIC. And, you know, if you have a lot of cash, what you can do is just you have more than one account. So you have different accounts at different banks and you're covered up to $100,000. So that's something you can do if, you know if you have that much cash. Good for you. It's a good problem to have, I guess.

But that's something you can do if you're feeling like your deposit may be at risk. I don't think they are, like you just said. But the biggest domino, and we can dig into that in a later episode because that would probably be a half episode as well, but it's what's happening with krisis swiss in europe credit swiss yeah yeah so kids swiss is definitely their balance sheet has looked like swiss cheese no pun intended for a while yeah and then things gotten so bad that the uh swiss central banks actually injected i believe it was 54 54 billion US into the bank. I think it was yesterday.

And Crédit Suisse is a globally systematized, G-SIB, I'll just say G-SIB. I just butchered it. Systemic. It's a tough one for you. Systemically important bank. And so that one would have major repercussions worldwide if it were to go under. So this is a bank that's classified similar ways to Royal Bank and TD, like I mentioned earlier. So I'm sure there's going to be more developments on that. But I don't think we've seen the end of the potential ripple effects. But also, at the end of the day, look, I think this is a common take, but I think it's a pretty good one. In terms of the rising interest rates, a lot of people were

saying, and experts in the field, they thought the Fed would continue raising rates until something broke and something broke. So, I don't know what they're going to do. Checking back. Sir, something broke. Oh, he's like, okay, good. I don't know what they'll do. I mean, they're really in a tough spot because we talked in the past what the Fed's mandate is. It's, you know, keeping employment high, inflation low. But the mandate that's never really talked about as much it's probably the most important mandate is financial stability. So now they're trying to juggle all three.

Dude, rock in a hard place. That's their job description. Because if they stop raising rates, what will that do to inflation? Maybe it's already controlled and it won't have any impact. I don't know, but there's just so many layers to whichever move they decide to make. So I don't know. I guess we just take a backseat and watch. There's not much more you can do.

Get the popcorn out. I wanted to highlight here before we sign off. Last night there was a hearing with, I guess, Yellen was up doing a hearing. And Senator James Lankford, who represents Oklahoma, he asked, will every community bank here in my state of Oklahoma get the same treatment as SVB? And Yellen responded, banks only get the treatment if the failure to protect uninsured deposits would create systemic risk. So it's basically reinforcing what you and I have been talking about, which is the smaller regional banks just got a lot riskier, even though they just bailed one out in a way. They're saying, if it's not systemically important enough, if there's not enough contagion, then it'll be screwed. SVB was important enough, big enough, and have enough ties to a very important sector, which is technology and innovation in the US, if that contagion risk is not assessed to the same level, they'll let it

fail, is basically what the response was. And the response I honestly expected. So that tells you pretty much everything you need to know. No, exactly. I mean, I don't think you need more than that. And maybe I'll finish off with those G-SIB banks. I was able to pull it here. So like I said, there's five tiers. The fifth tier is the most kind of critical. The only bank that is in the second most important tier is JP Morgan Chase. And then you have two American banks in that third tier, Bank of America, Citigroup. HSBC is the third one there. And then in the second to bottom tier, I guess the second least important tier, you have some pretty large bank again. I think it's a Chinese bank, PNB, Paribas, Deutsche Bank, some banks over there. And then the first year, which is where the Canadian banks are founded, and Crise Suisse as well. So this is how it's kind of laid out.

And what I'll do is I'll just add it to the show notes. It's just a PDF if people want to have a look at it, see what the banks are there. But there are a total, I think about 25 banks, I would say, just looking at it. They're not numbered, but just to give people an idea there. This is a good call out too, if you put that PDF in there, go to thecanadianinvestorpodcast.com, thecanadianinvestorpodcast.com. In the top navigation, you see show notes. Show notes is money. We're adding all of our notes here for topics that we're actively making notes and writing or taking screenshots so that later, you know, you're talking about the Appalachian mountain graph and say, I want to check that out, go to the show notes and it'll be there.

We're posting all of it on the Canadian investor podcast.com now. And I am noticing lots of traffic. So producer Mel, good work. Lots of traffic going there. So check that out. That is at the Canadian investor podcastorpodcast.com. There you will also find links to Stratosphere and our Patreon, joinTCI.com, where we disclose our monthly portfolio updates for our own portfolios. Oh man, deep breaths, Simone, deep breaths.

There we go. Back to the normal programming next week and uh i'm excited lots of lots more news and uh lots of interesting topics we have up on uh up on our document here so check that out we are here mondays and thursdays we'll see you in a few days take care bye-bye the canadian investor podcast should not be taken as investment or financial advice. Brayden and Simone may own securities or assets mentioned on this podcast. Always make sure to do your own research and due diligence before making investment or financial decisions.