We are writing to provide you with an update on the disappointing news about the failure of three banks over the last several days, including Silicon Valley Bank. We’ll also provide you with some recommended steps you can take to make sure you are never subject to losing a dime if another bank implodes like SVB did.
First and foremost, rest assured that we are NOT heading into Armageddon. The failure of these banks was sparked by the age-old human problems of greed, avarice, and failure to manage risk, with plenty of stupidity mixed in. Most importantly, the failures of these banks is not a “canary in the mineshaft” situation that portends some deep and previously hidden systemic failure in the banking system.
Let’s take the bank failures one at a time.
The first bank to close was Silvergate, which voluntarily chose to close its doors on Wednesday night. Silvergate was a big lender to companies operating in the cryptocurrency business (Bitcoin is one such cryptocurrency). There have been some spectacular Crypto company failures in recent months, after the most recent spasm of crypto speculation burst. This has put Silvergate in a severe cashflow bind because their primarily crypto business depositors needed liquidity. So Silvergate made the decision to close operations while they still had enough money on hand to pay all their depositors in full. Even though the bank’s failure was not unexpected, it still created a shockwave in the tech industry, where many of the companies’ leaders seem to have forgotten that banks can actually fail.
Silicon Valley Bank
The most spectacular failure of the three was Silicon Valley Bank. Founded 40 years ago with the primary goal of becoming the banker of choice to the venture capital markets, it was wildly successful. In 2021, the bank’s deposits leaped by 86% from the prior year. The bank was awash in billions of dollars in funds needing a place to be invested. This is where the bank went off the rails.
Smart money management for banks requires a matching of assets and liabilities. If you are a bank and have $100 Billion in checking, savings and short-term CDs, you need to have a high percentage of those customer deposits invested in short-term investments that can be easily and profitably liquidated if a sudden unexpected need arises. SVB foolishly failed to follow the playbook, and instead invested these funds in long-term treasuries and 30-year mortgages that paid a much higher yield. As a result, the bank raked in huge profits…in the short run.
But then the unexpected happened, at least from SVB’s point of view. Inflation came roaring back in the US economy and to fight it, the U.S. Federal Reserve began a series of aggressive interest rate hikes that drove long-term interest rates higher. When interest rates rise, the value of longer-term bonds and mortgages decline significantly.
This was a massive failure by the bank’s management and one also has to wonder where the banking regulators were while this was going on. As a case in point, for several years we have been anticipating that rates had nowhere to go but up, which is why we have avoided any exposure to longer-term bonds. There was just no excuse for what SVB’s management did.
Now, SVB was in a world of hurt, because they had a large imbalance between what they owed their depositors and the collateral they had in long bonds. Even though long-term Treasury bonds are 100% guaranteed to pay off, the payoff is not until 10-30 years from now. Bank depositors want their money now, not in 30 years, so the bank got caught in a cash flow squeeze of epic proportions. They filed a “Form 8-K” informational SEC filing on Wednesday saying it was hoping to raise $2.25 Billion in additional capital by selling more company stock.
On the back of the Silvergate collapse the very same day, SVB’s 8-K filing set off a panic among the bank’s 37,000 depositors who held $157 Billion in deposits at SVB. A whopping 93% of these deposits were not insured by the Federal Deposit Insurance Corporation (FDIC). More on the FDIC in a moment.
When the word got out, in the ensuing panic, depositors tried to withdraw a staggering $42 Billion on Thursday alone. That signaled the end. The next day, the FDIC seized the bank and closed its doors. Silicon Valley firms were reported to be scrambling over the weekend to find cash to make payrolls, and the hunt was on for other weak banks who might be close to failure.
Concerns grew over the weekend that customers at other small regional banks might start pulling cash out from those banks also, causing the contagion to spill over.
Late this afternoon, Signature Bank, another crypto-associated bank was also closed by regulators. They had too little in short-term assets to cover a depositor run on their $89 Billion in deposits.
Federal regulators announced this afternoon that all depositors at SVB and Signature Bank—even those with uninsured deposit balances, would be able to withdraw their entire account balances without limit. They relied on their authority to designate both banks as “systemic risks to the banking system” to backstop 100% of client accounts at these banks. Regulators also provided additional cash to the banking system to guarantee smooth operations and reassure depositors that their funds are safe.
San Francisco-based First Republic Bank was also in investors’ crosshairs on Friday, over concerns about the bank’s solvency. FRB filed its own Form 8-K on Friday saying its average consumer account balance is less than $200,000 and its average business account is less than $500,000, which implies customers have little reason to make panic withdrawals like what SVB experienced on Thursday. In addition, the bank noted it has a “strong liquidity position” and today announced they have access to more than $70 Billion in available and unused borrowing capacity with the Federal Home Loan Bank and the Federal Reserve Bank. After the filing, investors seemed satisfied and the bank’s stock more than doubled in value. Time will tell if they are out of the woods.
What to Expect This Week
Early indications this evening are the markets like Federal Government’s response to these developments. Dow, S&P 500 and NASDAQ futures are all up 1% or more in futures trading. However, it would not be surprising at all to see small investors reacting in fear and selling tomorrow, and of course, we are already seeing TV shows with the title, “Banking Crisis,” so we could be in for a bit of volatility this week based on a heightened level of investor anxiety.
That said, there is no reason to believe the financial system is at great risk. While the actions of the three banks were extremely dumb, not to mention entirely preventable, there are plenty of previous examples of spectacular flameouts that also did not lead to Armageddon, including Orange County’s 1994 bankruptcy and bond default, and Long-Term Capital Management’s failure in 1998.
How You Can Protect Yourself from Bank Failures
Nobody needs to lose a cent when a bank fails. You simply need to make sure without fail that your total account balances in each and EVERY bank, even the biggest ones, are below the FDIC’s deposit insurance limit. For individual investors, this limit is $250,000. Joint account owners get $250,000 of coverage each. Living Trust accounts can qualify for additional coverage if there are more family members who are trust beneficiaries. You can see how much FDIC coverage you currently have by using the FDIC’s Insurance Calculator at https://edie.fdic.gov/calculator.html
Safe and Safer Alternatives to Banks
When your bank balance exceeds FDIC insurance limits, you have great alternatives. In fact, the alternatives can be much better than most banks! For example, brokers like Schwab, Fidelity, and Vanguard have money market funds which are paying more than 4%. While these are all very safe, if you desire the highest level of safety in a money market fund, you can buy one that invests only in U.S. Treasury securities. The yields are a tad lower than general money market funds, but they are still generally above 4%.
Last but certainly not least, you can buy U.S. Treasury bills notes, or bonds themselves directly from the government via treasurydirect.gov or through Schwab, Fidelity, or Vanguard. They can be purchased in $1,000 increments and you can get maturities ranging from one week to 30 years, but stick with three years or less, all of which are currently yielding 5% or more, and the interest is free of state income taxes!
We recently did a podcast episode on cash management if you want to go deeper on this topic.
Please do not stress yourself out about these unsettling developments. Nobody likes uncertainty, and that is especially true this year when we are already trying to shake inflation and adjust to higher interest rates. The news outlets will likely show you lines around the block at banks to get your attention. Remember they are selling ad space.
We are very optimistic about the changes that have occurred with interest rates over the last year. While they may seem “high,” to some, in truth they have pretty much returned to what was considered “normal” for decades prior to the Fed’s artificially low rates that followed the Great Recession. For the last decade it was hard to generate decent returns in fixed income investments, but conditions have now changed from famine to feast with today’s higher yields. This makes it much easier to generate higher returns for savers, diversified investors and retirees alike.
Please do not hesitate to contact us if you’d like to discuss current events or your portfolio. We are here for you as always.
Richard and Angela