When depositors started withdrawing money from Silvergate Capital Corp. after the collapse of the FTX cryptocurrency exchange, the bank of california bolstered its liquidity by turning to a quasi-government agency not normally known as a lender of last resort.
Silvergate received $4.3 billion from the Federal Home Loan Bank of San Francisco late last year, company files show. The billions in liquidity provided by the FHLB in the fourth quarter alone helped Silvergate, based in La Jolla, Calif., avoid one more run about deposits. The crypto-friendly bank now holds about $4.6 billion in cash — the bulk of which came from Home Loan Bank advances, according to select financial metrics Silvergate released last week.
The lifeline Silvergate obtained from the Home Loan Bank System shows one way in which the crypto industry has managed to find its way into the mainstream banking system. It also comes as the Federal Housing Finance Agency is reviewing the mission of home loan banks. critics have questioned the system’s hybrid public-private business model and whether banks are engaged in the core mission of supporting housing. Although banks were created during the Depression to support housing finance, some experts suggest that funding for Silvergate is an example of mission trespassing.
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“What the $4.3 billion for Silvergate was in terms of the mission is a very intriguing question,” said Karen Petrou, managing partner of Federal Financial Analytics. “The housing mission of Mortgage Banks is apparently long gone as it has nothing to do with housing. It has to do with supplementing wholesale funding sources for banks that cannot happen otherwise or at a higher cost.”
The Home Loan Bank System provides financing to members through secured loans known as advances. Each of the 11 regional home loan banks, which stretch from San Francisco to New York, make advances based on collateral offered by a bank. Silvergate pledged government-backed securities to secure the advances, according to the bank’s preliminary fourth-quarter financial metrics. General home loan bank advances come with few restrictions on how the funds are used on the bank’s balance sheet, experts say.
Mary Long, a spokeswoman for the San Francisco bank, said the system is privately funded and does not receive taxpayer assistance to operate.
“The advances that FHLBanks makes to members are backed by high-quality guarantees in line with statutory and regulatory requirements,” she said.
Silvergate declined to comment.
Home loan banks typically review a borrower’s financial condition to limit the risk of loss, balancing the need for a reliable source of finance. Each of the 11 banks continuously reviews the financial condition of borrowers and uses a methodology to evaluate borrowers based on financial, regulatory and other qualitative information.
Silvergate had an unusual business model, holding billions in interest-free deposits from cryptocurrency exchanges. It also operated the Silvergate Exchange Network cryptocurrency trading platform, which served as a closed-loop settlement system for cryptocurrency gamblers, said Todd H. Baker, senior fellow at the Richman Center for Business, Law and Public Policy at the Columbia Business School. and Columbia Law School. .
Silvergate’s liquidity problems were exacerbated by old-fashioned interest rate risk, not crypto-related credit losses, say Baker and other analysts. The rapid rise in interest rates over the past year has caused losses in its bond portfolio.
“Even they recognized that they had a significant liquidity risk because cryptocurrencies are so volatile,” Baker said. “But they had a plan that was reflected on their balance sheet that if depositors wanted to withdraw billions in deposits, they would just sell a bunch of bonds and they had a loan facility with the FHLB associated with their original historic mortgage deal. ”
Silvergate held $11.9 billion in deposits as of Sept. 30, but that number has dropped to $3.8 billion as of Dec. 31.
“This is where risk management is ridiculously bad,” Baker continued. “They weren’t thinking about the fact that all these bonds – which, when they bought them, had low interest rates – when rates go up, the value of the bonds goes down. At some point, they realized that when they sold the bonds, they would be a great loss.”
Silvergate sold $5.2 billion of debt in the fourth quarter, which resulted in a loss of $718 million, according to its recent financial metrics.
Given the loss of deposits at Silvergate and the high-profile challenges facing the cryptocurrency industry, some experts are questioning why the home loan bank has effectively become Silvergate’s lender of last resort. Some experts said the Federal Reserve should make decisions about whether funding an individual bank that is facing significant deposit outflows is in the public interest.
“They’re clearly not using that borrowed money for home loans, they’re using it to raise their capital levels,” said Todd Phillips, a Washington policy advocate and former attorney for the Federal Deposit Insurance Corp. the Federal Home Loan Bank lending them that money? It does not make sense. And that’s why the FHFA is reviewing the FHLBs now.
Another peculiarity of the Home Loan Banking System is that if a member bank fails, the Home Loan bank can claim legal priority of collateral over other assets – essentially putting the Home Loan bank ahead of all lenders. Because of this protection, no Home Loan bank has ever lost a penny on a down payment. Some critics suggest that the priority position of home loan banks, which are at the head of the FDIC’s deposit insurance fund, allows the banking system to ignore the risk of bankruptcy when pricing advances. Some critics suggest that the Home Loan Bank System creates moral hazard because the FDIC cannot charge fair premiums to offset the unpriced risk of bankruptcy, shifting downside risk to the FDIC.
“Home loan banks love to say they never lost a nickel and that’s because they have a back guarantee before the FDIC,” Petrou said. “The $4.3 billion is clearly at risk and leaves the FDIC holding the bag.”
The FDIC declined to comment.
The Home Loan Bank System, Petrou said, is forcing the FDIC “to bail out the irredeemable.”
Experts are already predicting what will happen in the worst case scenario for Silvergate and the regulators. The home loan bank is ahead of other lenders and the FDIC.
“If the FDIC came in and had to close the bank, the home loan bank would take the first $4.3 billion of whatever amount the bank had, leaving the rest to the FDIC,” Petrou said.
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