photo cred: Jordan Koons
Hello fellow Off-Grid Investors!
There has been a lot going on recently in our global financial system. I know it can all be confusing and hard to keep up. My job is to guide you through the noise and get you right to the point.
Today's post will start with a little lesson on the 2008 Global Financial Crisis. Then we will get into how to analyze a bank to see if it's safe.
Let’s begin…
The Global Financial Crisis was due to "credit risk." What happened with the regional banking crisis of 2023 (which is ongoing) is called "market risk."
What are credit risk?
Credit risk is the risk that someone won't pay back the money they borrowed, and lenders try to manage this risk by being careful about who they lend money to and setting terms that protect them from losses.
What is market risk?
Market risk is the risk of losing money because of changes in the value of financial things like stocks, bonds, and currencies. These changes can happen for lots of reasons like changes in the economy, politics, or monetary policy (interest rates, money supply).
Let me explain further...
In 2008, banks made a lot of bad loans that were never going to be repaid, causing these loans to start defaulting and leading to the collapse of the housing market.
Fast forward, the SVB debacle was market risk or the result of securities, such as high-yield corporate bonds, leveraged loans, and MBS (mortgage-back-securities) being bought during the pandemic.
As interest rates increased, bond values drop, which means they are worth less. When a bank has low deposits and has to hold longer-dated bonds(30 year bonds) until their maturity date, this can cause a financial problem.
Bank deposits were coming in slower to SVB due to the inability for startups to continue to raise money easily.
In the startup world, companies go through multiple funding rounds to fuel their growth. As an angel investor, we talk to multiple startup CEOs every month. We don’t just give them funding we learn about what their needs are and how we can add value.
SVB suffered losses that exceeded the capital they had in reserves, and they couldn't keep up with the pace at which their customers demanded their deposits back; and the bank ultimately failed.
There are more sides to this story that I am looking into. No situation is one-sided. And the truth will be revealed over time.
With that out of the way, let's move on to another lesson: how to judge banks.
How to Judge A Bank
Let’s start with a question. How do you know if your bank is safe enough to keep your deposits? And how do you measure them?
A bank is generally measured in 3 ways:
Solvency
Liquidity
Profitability
The Solvency Issue
Solvency is the ability of a bank to meet its financial obligations. This means that the bank's assets must be greater than its liabilities.
At times, assets can turn into liabilities (such as when Silicon Valley Bank purchased junk bonds in 2020) depending on a shift in the financial system or economy.
For most banks, this isn't a problem because there are government regulations and financial tools in place to keep the banking system intact (until it’s not).
However, if a bank's assets become too low, or if there is a run on the bank, the bank can become insolvent.
Liquid or Dried Up
The next question to ask is how liquid is the bank that holds your deposits?
To answer this question, we need to answer another question: what is liquidity?
Liquidity is the ease with which an asset can be converted into cash without affecting its market price.
Banks quickly convert assets to ensure that your deposits are safe.
Note: The inability to sell an investment easily is liquidity risk.
Next question is how do we measure if the bank is liquid or not?
Here are a few ways to measure Liquidity;
looking at the type of assets the bank holds
current ratio; can a bank meet short-term funding obligations?
acid test; can the bank sustain even though it can’t sell assets fast?
I have so much more to say about this i’ll save it for another newsletter!
To have or not to have profitability
Let’s ask the final question…what is profitability?
Profitability is the bank earning enough on its assets to pay its bills and keep deposits in. The more inflows the bank can lend and make more money.
The recent example of Credit Suisse is very interesting. There were several moves that destroyed their ability to be profitable.
Note: There issues started back as early as 2018.
Credit Suisse collapsed because of four things that were in their last annual report:
Bad investments
Fraud
Higher interest rates
Depositor exits
Here’s a timeline to follow the problem.
TIMELINE OF FAILURE
2018 Credit Suisse paid fines due to fraud claims
2020 a money laundering fraud settlement was reached
2021 they lost 5 billion because of bad investments in capital firms that failed
2021 another fraud settlement of $475 million in fines
2022 investor pulled out $125 billion over worries of a collapse
2022 overall they lost about $8 billion
In 2023, Credit Suisse tried to get money from the Saudi National Bank. The bank said no because of a rule that says if you own more than 10% of a company in the US or EU, you have to follow a lot of rules. This can be hard to do.
Because the Saudi bank said no, people started selling their Credit Suisse stock.
Credit Suisse also delayed releasing their financial report for 2022. This is a bad sign and made people lose confidence in the bank.
They released it late because they were trying to "adjust" the numbers because they have weaknesses in their profitability.
When they released it, investors got a chance to see how much money they had lost over the last 5 consecutive quarters.
What’s next?
We are in a period of time that more financial institutions will have issues or completely fail. And we won’t get a heads up unless we know the signs.
I have made it my mission to keep track of what I call “The Great Consolidation” via the Off-Grid premium subscription.
Subscribe below to stay ahead of the game. We will also discuss angel investing opportunities, private market deals, and deeper dives on the investing landscape.
Until next time…
Off-Grid Investor