Silicon Valley Bank Failed, Should I Be Worried?
Let’s begin with a couple of basics. Banks take deposits from individuals and businesses. Most of these deposits are known as “demand” deposits in that the customer can walk in the door at any time and “demand” their money back at any time. Other deposits are in the form of “certificates of deposit” that are supposed to stay on deposit for a fixed period of time but even these can be cashed in at any time with a penalty. Now comes the tricky part.
Banks need to invest the money at a higher return than they are paying to depositors to make a profit. Banks invest the deposits by making loans or buying investment products like bonds –which in effect are a type of loan.
Banks get into financial difficulty for two basic reasons. 1) Depositors take out their money leaving the bank with too little cash for banking operations. 2) Borrows are late with payments or worse yet, stop making paying payments, or even worse don’t repay the loan. This was the situation in 2008. Banks and mortgage lenders made bad loans (mostly on overpriced homes) to people who really could not afford the loans but were induced either through lack of knowledge, greed, over optimism, or deceitful business practices and who eventually defaulted on the loans.
Many banks in 2008 like Bear Stearns and Lehman Brothers bought many of these loans as investments for their investment portfolio. AIG sold the banks “insurance” for the loans in the case of default. As long as the borrowers paid the interest, it was good for the banks and AIG. But when the borrowers were late with payments or lost the loans to foreclosure, this was bad for the banks and AIG. This problem in 2008 was not isolated to a limited number of banks but was widespread throughout the banking and mortgage industry.
This was the big problem in 2008. It is not the problem now with Silicon Valley Bank or Signature Bank.
Both of these banks were “niche” banks whose customers were from two specific industries that many banks would not consider their “ideal customer.” Signature Bank had a disproportion of their customers from the crypto-currency industry. When these crypto-business raisied billions of investor dollars, much of the money was used to buy crypto-coins for customers but billions also had to be deposited to an ordinary bank for ordinary business purposes like paying rent for office space and payroll for employees (not to mention the extravagant life-styles of the founders). Long story short, as many of these crypto-companies began to fail in late 2022, these legitimate bank deposits evaporated. Signature Bank had a huge outflow of deposits (run on the bank) to the point they were no longer solvent and the FDIC closed their doors.
Silicon Valley Bank is an even more interesting story. It was founded over forty years ago in San Francisco. As the tech industry began to grow, many traditional banks avoided “start-up” companies. Over the past fifteen years as venture capital firms began to invest billions in new-idea, new-concept, untested, mainly technology companies, SVB sensed an opportunity and began to nurture these start-up companies who were funded with billions. In a very short period, SVB got billions in deposits they needed to then invest. They wanted something safe and what could be safer than Treasury Bonds. Interest rates have been at historically low levels so to get a higher yield, SVB invested the majority of their portfolio in longer-term Treasury Bonds.
As long as interest rates were low, the value of these long-term T-Bonds remained stable. Last year in 2021 interest rates went up a lot and the value of these went down a lot. Therefore, the financial stability of SVB began to come in question. This was when depositors with over the $250,000 FDIC insurance limit began to get worried.
This brings up the other problem with SVB. Rather than have a broad base of customers and depositors / savers from different backgrounds, industries, reasons for doing business with SVB, as mentioned before, most of the money on deposit came from start-up companies and the venture capital firms that finance them. Most banks have over 50% of their deposits under the $250,000 insurance level. SVB had less than 10% of their customer deposits insured.
During the first week or so of March 2023, as concerns about the solvency of SVB began to circulate, these start-up companies that had millions of un-insured deposits over the $250,000 limit became justifiably concerned. This was payroll money, rent money, money for research / development….these uninsured deposits are what these companies had to live on until they had a product they sell. These un-insured deposits are their lifeline.
On March 9 the dam broke for Silicon Valley Bank. Their investment portfolio of normally very safe Treasury Bonds is down in value due to interest rate risk. If held to maturity, the bonds will be worth face value. But today, in this market, the value is much lower.
On March 9, $42 billion or 25% of the money on deposit at Silicon Valley Bank was withdrawn. The bank was no longer solvent and the FDIC closed the bank.
Credit risk and mortgage defaults on the bad loans were the primary contagion in 2008 which led to the 2008 Financial Crisis. An overheated real estate market, un-qualified borrows and lenders greed to make the next loan led to the banking failures.
In 2023, two overly specialized banks with a laser focused customer base that took too much interest rate risk with their investments has led to the failure of these two regional banks. Will this spread broadly through-out the banking industry?
In my opinion, I think not. Banks are in much better financial condition today than in 2008. I am not forecasting the government needing to repeat the 2008 bail out of big banks or insurers like Bear Stearns or AIG. I do not see a bank failure similar to Lehman Brothers. That said, Credit Swiss Bank in Europe merged with UBS over this past weekend to prevent the unraveling of Credit Swiss’s banking, wealth management and brokerage operations.
Bank customers in the US with deposits over the $250,000 insurance level should be advised to research their banking relationships carefully and not assume that they will be bailed out if their bank fails. Most healthy banks have about 50% of their deposit accounts under the $250,000 insurance limit. Does yours? Healthier banks have seen their investment portfolios go down in value by about 10% while the less healthy banks have portfolios that dropped 20% or more. Do your homework….that is if you are fortunate enough to have over $250,000 in the bank. But if you don’t have that kind of balance, you probably have no need to worry, as you are insured.
Many firms such as ours offer “brokered CDs” with FDIC insurance from multiple banks. We make these both available in select situations for some of our clients. Call us if either of these are of interest.
Wollman Wealth Designs, Inc is a financial services firm in Escondido, CA partnering with families, friends and clients in San Diego County and around the country. Please visit our website, call the office or send us an email with your comments or questions.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
Regarding Brokered CDs, the Annual Percentage Yield (APY) represents the interest earned through maturity date. Rates are simple interest calculation over 365-day basis. Interest cannot remain on deposit. Early redemptions are subject to prevailing market conditions that could result in a loss of principal. Cetera Advisor Networks LLC does not guarantee the term of the CD. There are some unique differences between traditional bank CDs and brokered deposits: CDs purchased directly from the bank may face an interest penalty if redeemed prior to maturity. Brokered CDs cannot be redeemed back to the institution prior to maturity. Early redemption or liquidation prior to maturity may be an amount less than the original price.
Crypto-Currencies, Digital Assets and other Block-Chain related technology (such as Bitcoin, Ethereum, NFTs and others) are not securities, not regulated, and not approved products offered by Cetera Advisor Networks LLC. Crypto-currencies and other block-chain related non-securities products cannot be recommended, offered, or held by the firm.