Many of you have seen the headlines this week about Silicon Valley Bank’s collapse and that some other banks (namely First Republic and Credit Suisse) are in trouble. I thought it would be helpful to give you a brief overview of why SVB failed and if it has an impact on your portfolio. Without further ado, here’s how a bank fails:
- A bank makes money by taking deposits from customers, and then lending or investing that money. The spread the bank makes between what they pay depositors and what they earn on their loans/investments is the profit. Regulations require a certain amount of the deposits to be available in cash/cash-like securities. What is not held as cash can either be invested (usually in government bonds) or lent out to other customers via loans. As long as everyone pays their loans and the bonds don’t default, everything is good.
- SVB got into trouble because they had a homogeneous customer base (a bunch of tech companies). If you don’t have a diversity of customers, then your entire bank can dramatically be impacted based on one sector (ie technology). The last 12 months have been rough on tech firms and many were burning through their cash (ie needing to withdrawal their deposits). As the same time, SVB made investments in government bonds that go down in value as interest rates go up. A huge failure of SVB is that they did not hedge much of their interest rate risk. So tech firms were withdrawing money and the bank was having to sell investments at a loss. Eventually, this brought them to a precarious financial situation. Others noticed the financial weakness and sounded the alarm. Then, customers in mass tried to withdraw their money…only exacerbating the problem. In reality, if everyone had stayed calm, the bank could have likely worked through the problem (or gotten some equity raised) to solve the short term issues.
The takeaways from SVB’s failure:
- Any and every bank will fail (including the largest banks in America) if everyone tries to withdraw all their money on the same day. The money isn’t there – it’s loaned out and cannot be immediately available.
- You can protect yourself by knowing the FDIC limits and rules. The FDIC protects up to $250k per depositor per bank per ownership category. The key to maximizing FDIC coverage if you have more than $250k cash is to open accounts at different banks or have accounts in different categories (ie a business account is treated differently than a joint account with your spouse…each would get $250k coverage). https://www.fdic.gov/resources/deposit-insurance/diguidebankers/general-principles/index.html
- While interest rates have put pressure on all kinds of businesses, I think banks have been more impacted than your average business (because of the impact on their investment portfolios). That said, in my opinion, SVB seems to be an isolated event of bad management decisions coupled with a rising interest rate environment that we haven’t seen in 40 years.
Your portfolio: I do not foresee that SVB’s collapse is indicative of the entire financial system collapsing (I could be wrong!). Although rising interest rates have created a challenging environment in the past year, investors who have a long term plan and allocation should not be phased by a difficult one or two years in the market. Take a long term perspective and focus on what your can control. From the SVB turmoil, use this as a reminder to do the little things in life that can make a big difference. Check your bank accounts and make sure you have FDIC coverage. And, to reassure you, you can rest knowing that your brokerage account(s) are covered by a separate type of insurance (SIPC) that insures brokerage accounts up to $500k in the event that a brokerage company gets into trouble. Get to know your bank and ask them about their customer diversity (ie are they only serving one type of customer?). Ask them about their loans: Do they have a diverse loan portfolio? Seemingly small details in your finances can have a huge impact on your life goals and plans. Let us know if you have questions about your bank, FDIC, or SIPC coverage – we are happy to answer any of your questions!