When depositors began pulling money out of Silvergate Capital Corp. following the collapse of the cryptocurrency exchange FTX, the California bank shored up its liquidity by tapping a quasi-government agency not typically known as a lender of last resort.
Silvergate received $4.3 billion from the Federal Home Loan Bank of San Francisco late last year,
The lifeline that Silvergate got 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 the Home Loan banks. Critics
"What the $4.3 billion to Silvergate went to in terms of mission is a very intriguing question," said Karen Petrou, managing partner at Federal Financial Analytics. "The housing mission of the Home Loan banks is apparently long gone, since this has nothing to do with housing. It has to do with supplementing wholesale funding sources for banks that can't happen any other way or at greater cost."
The Home Loan Bank System provides funding to members through secured loans known as advances. Each of the 11 regional Home Loan banks, stretching from San Francisco to New York, makes advances based on collateral pledged by a bank. Silvergate pledged government-backed securities to obtain the advances, according to the bank's preliminary fourth quarter financial metrics. General advances from the Home Loan banks come with few restrictions on how the funds are used on a bank's balance sheet, experts said.
Mary Long, a spokeswoman for the San Francisco bank, said the system is privately capitalized and receives no taxpayer assistance to operate.
"The advances FHLBanks make to members are secured by high quality collateral in accordance with statute and regulatory requirements," she said.
Silvergate declined to comment.
The Home Loan banks typically review the financial condition of a borrower to limit the risk of loss while balancing a borrowers' need for a reliable source of funding. Each of the 11 banks reviews a borrowers' financial condition on an ongoing basis and uses a methodology to evaluate borrowers based on financial, regulatory and other qualitative information.
Silvergate had an unusual business model, holding billions in zero-interest deposits from crypto exchanges. It also operated the Silvergate Exchange Network cryptocurrency trading platform that served as a closed-loop settlement system for crypto players, said Todd H. Baker, senior fellow at the Richman Center for Business, Law and Public Policy at Columbia Business School and Columbia Law School.
Silvergate's liquidity issues were exacerbated by old-fashioned interest rate risk, not crypto-related credit losses, Baker and other analysts say. Rapidly rising interest rates over the past year drove losses in its securities portfolio.
"Even they recognized that they had significant liquidity risk because crypto is so volatile," Baker said. "But they had a plan that was reflected on their balance sheet that if depositors wanted to take out billions in deposits, they'd just sell a bunch of securities and they had a borrowing facility with the FHLB associated with their original, historic mortgage business."
Silvergate held $11.9 billion of deposits on Sept. 30, but that number had plummeted to $3.8 billion on Dec. 31.
"This is where risk management is ludicrously bad," Baker continued. "They weren't thinking about the fact that all these securities — which, when they bought them, interest rates were low — that when rates go up, the value of securities drops. At some point they realized that when they sold the securities, they'd take a huge loss."
Silvergate sold $5.2 billion of debt securities in the fourth quarter that resulted in a loss of $718 million, according to its recent financial metrics
Given the loss of deposits at Silvergate and high-profile challenges facing the crypto industry, some experts are questioning why the Home Loan bank effectively became Silvergate's lender of last resort. Some experts said the Federal Reserve should be making decisions as to whether funding an individual bank that is facing significant deposit outflows is in the public interest.
"They're clearly not using this borrowed money for home loans, they're using it to build up their capital levels," said Todd Phillips, a policy advocate in Washington and a former attorney at the Federal Deposit Insurance Corp. "Why is the Federal Home Loan Bank lending them this money? It doesn't make a lot of sense. And that's why the FHFA is doing its review of the FHLBs right now."
Another quirk of the Home Loan Bank System is that, if a member bank fails, the Home Loan bank can assert statutory lien priority on other assets — essentially putting the Home Loan bank ahead of all creditors. Because of this protection, no Home Loan bank has ever lost a penny on an advance. Some critics suggest that the priority position of the Home Loan banks, which stands ahead of the FDIC's deposit insurance fund, allows the bank system to ignore the risk of failure when pricing advances. Some critics suggest the Home Loan Bank System creates a moral hazard because the FDIC cannot charge fair premiums to offset the unpriced risk of failure, shifting the downside risk to the FDIC.
"The Home Loan banks love to say that they've never lost a nickel and that's because they have a prior lien ahead of the FDIC," Petrou said. "The $4.3 billion is clearly at risk and it leaves the FDIC holding the bag."
The FDIC declined to comment.
The Home Loan Bank System, Petrou said, is forcing the FDIC "to rescue the irredeemable."
Already experts are prognosticating what will happen in a worst-case scenario for Silvergate and for regulators. The Home Loan bank stands ahead of other creditors and the FDIC.
"If the FDIC walked in and had to close the bank, the Home Loan bank takes the first $4.3 billion of whatever the bank has that's worth taking, leaving the rest to the FDIC," Petrou said.
