Silvergate Bank’s balance sheet problem is a warning

The implosion of Silvergate Bank has a lot to do with the fact that it was crypto's bank of choice. But it's also a prime example of the hidden insolvency that exists across much of the banking sector.

Why it matters: Silvergate had an unusually strong balance sheet — but that wasn't enough to save it because in today's high-rate environment, even strong balance sheets can tip into insolvency when they start to shrink.

How it works: A bank's deposits are its liabilities — it owes that money to its depositors on demand. On the other side of the balance sheet are assets, which are generally in the form of bonds and loans. When interest rates rise, the value of those bonds falls, eroding the value of the bank's assets.

What they're saying: "The financial world has been massively long bonds in a rising rate environment, a troubling scenario that has left many banks insolvent on a mark-to-market basis," writes bank analyst Chris Whalen.

• Under Generally Accepted Accounting Principles, or GAAP, banks don't need to mark their bond holdings to market so long as they're holding those bonds to maturity.
• Sometimes, however, as with Silvergate, an outflow of deposits means that a bank has to sell down its assets to meet withdrawals. The minute that happens, it has to start marking all such assets to market.

By the numbers: Silicon Valley Bank, reports the FT, was awash in deposits in 2021, when rates were low. It took $91 billion of that money and invested it in mortgage bonds — bonds that today are worth just $76 billion.

• "The unrealized $15bn loss disclosed by SVB," notes the FT, is "greater than the total profits reported by the bank over three decades."

The bottom line: The losses at banks aren't realized unless and until a forced sale occurs. But stock-market investors see them all the same and have been marking down many banks' share prices, including SVB's, accordingly.