Panic set in this week when Silicon Valley Bank collapsed and the failure of a second bank followed. Is it 2008 all over again? Should we be worried about the financial system collapsing? First and foremost, take a deep breath. Second, let’s discuss. In this episode of The Agent of Wealth Podcast, host Marc Bautis discusses what happened, what could happen next, and actions you can take to protect yourself and your money.
In this episode, you will learn:
- What we know about the Silicon Valley Bank collapse.
- If you should be worried about more banks (or your bank) collapsing.
- The role the FDIC takes to protect your money.
- What SIPC Insurance is, and how it is different from FDIC.
- Actions you can take to protect yourself and your money.
- And more!
Resources:
FDIC Insurance Account Categories | FDIC Search for Institutions Tool | Schedule an Introductory Call | Bautis Financial: 7 N Mountain Ave Montclair, New Jersey 07042 (862) 205-5000
Welcome back to The Agent of Wealth Podcast, this is your host Marc Bautis. On today’s episode, we’re going to talk about the recent banking crisis that started when Silicon Valley Bank ceased operations on March 10th.
This has caused widespread fear, because you hear of a bank failure, account holders may not have access to their money, and that it may spread to other banks. So today we’ll talk about what happened, what could happen next, and things you can do to protect yourself.
What We Know About the Silicon Valley Bank Collapse
On Friday, March 10, Silicon Valley Bank, a lender to some of the biggest names in the technology world, became the largest bank to fail since the 2008 financial crisis, when bank regulators shut down the institution after it suffered a sudden, swift collapse.
Just two days prior, SVB signaled that it was facing a cash crunch. It first tried to raise money by selling shares. Then, the bank tried to sell itself. But all of the sudden movement spooked investors, so many companies and individuals with money in SVB moved to pull their funds out – also called a “bank run” – which contributed to the bank’s demise.
Let’s look at what happened in a little more detail
Silicon Valley Bank is in a unique niche in that its clientele mainly consists of start ups, specifically in the tech space. SVB wasn’t done in by lending to risky start ups or some crypto collapse. It was an old fashioned bank run. Similar to the bank run scene in the movie It’s a Wonderful Life
- In 20212 the stock market was booming, interest rates were close to zero and money flooded into the tech sector.
- A lot of start ups parked their cash at SVB and SVB did what many banks do and they took the cash and invested it in long term bonds.
Here’s a quick explanation of how bonds work and how their prices can be impacted by interest rates.
As an example, let’s say you have a 10 year bond that has a price of $100/bond and pays an interest rate of 2%.
If interest rates rise and the rate for that same 10 year bond that cost you $100/bond is now 5%, no one would pay $100 for your bond that pays 2%. So the market value of your bond drops from $100/bond to let’s say $90/bond. Now, if you didn’t have to sell your bond the price drop wouldn’t matter. At the end of 10 years your bond would mature and you would get your $100/bond principal back.
But this isn’t what happened to Silicon Valley Bank. In 2022, interest rates rose and the value of the bonds in SVB’s portfolio had steep losses. So now, on paper, they are sitting on a lot of paper losses. This would be like if customers deposits totaled $100 million, but after the loss of the bonds it was now only worth $75 million. The loss is on paper so it’s not necessarily a big problem. But recently, investment in the tech start up space dried up and tech companies had to start pulling out the cash they had parked at SVB to pay for things like expenses. To meet those obligations, SVB had to sell some of the bonds at a loss to cover the withdrawals. When SVB explained what had happened to customers it snowballed and other companies panicked and started pulling their funds out from SVB creating the bank run. Now they didn’t have enough money to cover their withdrawals.
Not everyone was able to get their cash out of the bank, and the FDIC only insures deposits up to $250,000, so customers who had more than that in the bank may be in trouble.
On Sunday, March 12, the federal government said it would step in to make sure that all of the bank’s depositors would have access to their funds by Monday, March 13. Regulators also shuttered another bank, Signature Bank of New York, which had gotten into crypto, and the federal government said its depositors’ money would be guaranteed as well.
What’s different about this financial crisis than the one in 2008 and 2009 is that in 2008 the bailouts came in to the banks, the executives, and to the shareholders. With this crisis the government is stepping in and making sure that FDIC and non-FDIC insured account holders will have access to their funds.
The incident on Friday sent shock waves across the tech sector and created a lot of doubt in the U.S. banking industry amid concerns that other banks could be in trouble.
Should You Be Worried About Your Bank?
At the end of 2022, SVB was the 16th-largest bank in the United States with $209 billion in assets. Unlike typical banks like Chase or Bank of America, SVB’s clients are venture capital companies and tech companies. Since SVB serves mostly businesses, FDIC limits of $250,000 often do not mean much. In December, nearly 95% of SVB’s deposits were over the limit and not uninsured, according to filings with the SEC.
The Fed’s rate hikes have hurt the investment portfolios of banks. Banks often invest their deposits in Treasurys since they are considered one of the safest assets. SVB invested in long-term Treasuries and mortgage-backed securities. Since interest rates have substantially increased, the securities that they bought were worth considerably less and could only be sold at a loss. During the pandemic, as deposits flowed in, buying short-term Treasurys would have insulated them from rising rates, but it also would have limited their income.
Also, SVB’s deposits turned into withdrawals as clients burned through cash as tech and startups have had a challenging start to the year. Deposits fell from $200 billion at the end of March 2022 to $173 billion at the end of 2022, and they forecasted that deposits would continue to decline in 2023.
SVB’s collapse highlights the risk many banks have in their investment portfolios. Most banks currently have enough capital to absorb these losses. However, one big question coming out of this will be which banks misjudged the match between the cost and lifespan of their deposits and the yield and duration of their assets.
What is FDIC Insurance, and How Does It Work?
Now, let’s talk about how the Federal Deposit Insurance Corporation, or FDIC, steps in after a bank failure.
Created in 1933, the primary purpose of the FDIC is to prevent “run on the bank” scenarios.
Here’s how the insurance works:
- The FDIC insures deposits – such as cash, money markets and CDs – of up to $250,000 (or $500,000 for joint accounts) per depositor, per federally insured institution, per account category.
The account category is where things can get complex. There are 14 account ownership categories. The most common ones include:
- Single Accounts
- Joint Accounts
- Revocable Trust Accounts
- Irrevocable Trust Accounts
- Certain Retirement Accounts
- Business Accounts
- Employee benefit plan accounts
Here’s are some coverage examples, using dollar amounts:
- Let’s say you have $200,000 in a savings account and $100,000 in a CD at a singular federally insured institution. Because the total amount is $300,000 and the FDIC only insures $250,000 per person, you have $50,000 of uninsured money.
- Now, let’s say you are married and as a couple you have $500,000 in a joint bank account and $250,000 in a retirement account… In this case, the entire $750,000 is insured, because each co-owners share of the joint account is covered (remember: The FDIC insures up to $500,000 for joint accounts) and retirement accounts are a different account category.
So, if you have more than $250,000 deposited in an account type with a single bank, you may need to spread your assets among multiple banks to ensure you are fully covered by the FDIC.
There are no limits to the number of accounts an individual can have covered, if they are held by different institutions. Customers could theoretically open 200 accounts at 200 different banks to get $50 million of coverage. Of course, managing relationships with many different banks would be a nightmare.
If you are a business with a high cash balance, there is a program called CDARS, an acronym for Certificate of Deposit Account Registry Service that you may find useful to obtain FDIC insurance. The concept is simple. Instead of manually opening savings accounts in different banks on your own, you can make one large deposit with your CDARS member-bank. After disclosing the financial institutions where you already have deposits, the CDARS network will divide your large sum into smaller amounts calculated not to exceed $250,000 over the lifespan of the CD. Those smaller sums then become CD accounts at other member institutions across the country.
It’s worth nothing here that FDIC insurance does not cover products such as mutual funds, annuities, life insurance policies, stocks or bonds. We’ll cover this when we talk about SIPC insurance next.
Now, when a bank fails, what happens?
The FDIC often becomes the receiver of its deposits and then arranges for another, healthy bank to take over management. Alternatively, the FDIC may cover the deposits directly and send out checks for the funds held at the now-defunct bank.
By law, once insured depositors are paid, uninsured depositors are paid next if there are additional funds available. Then, general creditors…. Then stockholders – which, in most cases, results in little or no recovery at all.
In the case of Silicon Valley and Signature banks, the FDIC decided that deposits would be guaranteed beyond the $250,000 cap to instill consumer confidence and prevent further bank runs.
Interestingly, more of the deposits at the two banks were uninsured:
- 95% at Silicon Valley were uninsured
- 90% at Signature were uninsured
But, the FDIC has said they will avoid relying on taxpayer funds to cover these losses by levying an additional fee on banks instead.
What is SIPC Insurance, and How is it Different from FDIC?
SIPC insurance is different. The Securities Investor Protection Corporation, or SIPC for short, is a nonprofit corporation created in 1970 by an act of Congress to protect the clients of brokerage firms that are forced into bankruptcy.
SIPC protection is not the same as protection for your cash at an FDIC-insured banking institution because SIPC does not protect the value of any security. The focus of the SIPC is getting assets returned from bankrupt or financially troubled firms.
While brokerage firm failures are rare, if it happens, SIPC provides brokerage customers up to $500,000 coverage for cash and securities held by the firm (although coverage of cash is limited to $250,000).
How to Protect Your Deposits
In light of these events, it will be hard to reverse the unlimited deposit guarantee, but it’s important to double-check a few items:
- Are you working with an FDIC-insured bank? Not all institutions are covered. You can look up your bank to confirm it is insured at banks.data.fdic.gov using the “Search For Institutions” tool. The link will be located in this episode’s show notes.
- Do you have deposits over the FDIC limit at a bank? You should avoid holding funds in excess of the FDIC insurance cap by spreading your funds across multiple institutions.
- If you are using a small bank, have you checked its solvency ratio? The solvency ratio – also known as the risk-based capital ratio – is calculated by taking the regulatory capital divided by the risk-weighted assets. This metric can be applied to any type of company, including banks, to assess how well it can cover both it’s short- and long-term outstanding financial obligations. Solvency ratios below 20% indicate an increased likelihood of default.
What’s Next For the Markets
We’re definitely seeing some volatility in the stock market especially in the financial services sector.
On Monday, the sector was down sharply. A company like First Republic who was thought next to be on the list to shut down saw their stock drop 60%.
On Tuesday, the sector rebounded and gained back a lot of what was lost on Monday.
On Wednesday, we’re seeing another drop as it’s back to worrying more about bank failures, specifically Credit Suisse.
Prior to this week, interest rates have been driving the markets. It was expected that we’d see another 25 basis point hike next week. Now, the prediction is that there will be a 75 basis point cut. SVB’s demise has put pressure on the Federal Reserve to rethink its economic tightening and the markets are pricing in a sharp pivot to rate cuts this year.
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