Three banks have failed, one of whom was the 16th largest in the U.S., Silicon Valley Bank (SVB). This created widespread concern over other financial institutions leading to swift action from the Treasury, Federal Reserve and FDIC over the weekend to instill confidence and prevent a panic.
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Note: This is not intended to be a commentary on the ideological views of bailouts or the moral hazards they create. My goal here is to break down recent events, why it happened and address what I anticipate people’s main concerns may be. We can certainly discuss the short and long-term impacts of bailouts another time.
I’m sure there are a lot of questions and concerns, with one of the most important being, “are my assets safe?”
In order to answer that question we first need to understand what happened at SVB.
It’s important to note, this is not like 2008. This is a very different situation. In 2008, financial institutions were loaded up with low quality, high-risk securities that ended up being worth far less than they were being carried on balance sheets, or completely worthless altogether.
Banks, today, are, generally speaking, far better capitalized than they were going into 2008 and many of the assets on their balance sheets are high-quality, low-to-no-default risk government bonds and government-backed securities.
The problem with SVB (and banking in general) is that a large portion of their assets are long-term, fixed-rate loans and securities. These types of assets lose value when interest rates rise. After all, who wants a 2% bond when they can get the same bond at 4%? So, prices of the lower yielding bonds from previous years must fall to compensate.
Given how aggressively interest rates have risen the last year, many of these assets on banks’ balance sheets are worth much less in the market today than they were upon purchase. Depending on the bank size and how these securities are categorized, the bank may not have to mark those asset values to market but can carry them at amortized cost, which, in the current environment, is higher than market value.
SVB, specifically, was not as well capitalized as many other banks and had too much allocated to longer-term, fixed-rate securities. So, as withdrawals were accelerating they were liquidating securities and having to suddenly take those losses thereby eroding their equity.
Additionally, SVB had a very finnicky, unstable deposit base (1) because it was highly concentrated in the tech sector, which has been having its own problems as of late and (2) because over 95% of its deposits were uninsured (by virtue of exceeding the FDIC $250,000 insurance limit)!
Any whiff of problems would obviously send these depositors scrambling for cash given the lack of protection assumed, which is exactly what happened.
So, is this possible at other banks? Yes, it’s always possible…a bank run is even possible for the best managed, most conservative banks. However, authorities took decisive action yesterday to backstop deposits…even the uninsured balances above the FDIC thresholds. So, I believe all SVB’s depositors had access to their funds this morning.
The authorities created a new lending facility – Bank Term Funding Program (BTFP). Whereas SVB had to sell a lot of assets at a loss to satisfy withdrawals ultimately leading to their insolvency, the newly-created one-year lending facility will accept those high-quality government bonds and other securities as collateral at their full value (not the reduced market value) and simply lend cash against those preventing the need to sell those securities and realize losses.
So, it appears depositors have been bailed out (or, put another way, deposits backstopped) and will continue to be if any other bank failures follow.
What About Client Assets At Charles Schwab?
The market appears to be concerned about Charles Schwab (more specifically, its banking subsidiary, Schwab Bank) given recent stock price action. After all, it appears Schwab also has a sizeable longer-term, fixed-rate securities portfolio weakened by rising rates, much like SVB.
So, below I’m going to share some information from various sources (including Schwab itself) about how Schwab’s situation is different from an SVB: Continue reading “Silicon Valley Bank: The Asset Must Match The Liability!”