Welcome to the Superprime banking crisis

And the current emerging turmoil, so far, shows the opposite. Banks like Silicon Valley Bank and Signature Bank that cater to some of the wealthiest and most creditworthy clients — those with superior credit scores — are facing the biggest problems.

This is quite a transformation. After 2008, banking for the wealthy was often touted as a much better model. Even the largest banks have begun to target more consumer lending and wealth management to relatively well-off clients, and have scaled back their mortgage customer service. Wealthy clients rarely default, they bring in plenty of cash and business banking and pay big fees for investments and advice, the thinking went.

But when interest rates rose last year, it exposed weaknesses in the strategy. It is not that the wealthy default on loans in droves. But the most influx of depositors who had excess cash last year are starting to take their cash and look for higher returns in online banks, money boxes or the treasury. Moreover, startups and other private companies are starting to burn more money, which leads to deposit outflows.

When depositors began to panic about the safety of the banks this month and withdraw their money, the people most exposed were those with uninsured deposits that exceeded the Federal Deposit Insurance Corporation’s $250,000 limit. Uninsured deposits accounted for a large percentage of deposits at SVB, which encouraged customers to keep most of their cash in the bank. Wealthy clients came in for the perks, and then left with their money.

Doubling the risk of deposits is the problem of banks who have a lot of loans and securities that are now yielding well below market rates. Many of these could not be easily sold if needed to cover deposit outflows. One reason banks loaded up on securities is because they got a flood of deposits during the pandemic but didn’t see a corresponding increase in demand for loans. This may be particularly the case in banks that cater to the wealthy, as wealthy customers usually do not need a lot of bank borrowing to meet day-to-day needs.

One of the main ways well-off people borrow from banks is to buy homes, often in the form of what are known as mega-mortgages. Jumbos are for loan amounts over $726,200 in most places, and over $1,089,300 in high-cost cities like New York or San Francisco. Huge mortgages bring wealthy clients a lot of money. They are usually more difficult to sell in the market, in part because they are not guaranteed by government-sponsored companies like Fannie Mae or Freddie Mac..

So banks often sit on it. But the value of these mortgages, many of which are fixed at low rates for the foreseeable future, has fallen as interest rates have risen.

To be sure, not all banks that focus on wealthier retail customers are under severe pressure. Shares of Morgan Stanley and Goldman SachsAnd

The KBW Nasdaq Bank Index is down less than half of what it has been this month. But these banks are more diversified and focus more on the more stable, fee-generating parts of the wealth business, such as stock trading and asset management, than on mortgages or deposits.

Interest rate easing and liquidity support by the Federal Reserve may calm nerves for now. But the biggest pressures on banking for the super-rich may continue. Deposit movements may motivate clients to search for the best rates on cash. Some people would refinance if they had mortgages that reset at higher rates, but homeowners with a mortgage of less than 3% aren’t very motivated to move and create new loans.

Wealthy clients are not immune from economic troubles either. While they will still be better off, events such as layoffs along with market declines will be felt relatively more by white-collar workers than blue-collars, who may enjoy a much stronger labor market. This phenomenon has been called the “rich cast”.

Of course, a regular, deep recession and a wide jump in unemployment, accompanied by low interest rates, would drive out the pain. But for now, the problem starts at the top.

Write to Telis Demos at [email protected]