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.
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:
- Diverse client base, not concentrated in any particular sector, across 34 million accounts
- Small loan to deposit ratio of 10% (Source: Morgan Stanley)
- Stronger position with a Tier 1 leverage ratio of 7.2%, above regulatory minimum of 4% (Source: Morgan Stanley)
- Only ~20% of deposits are uninsured, which is among the best of the largest 100 banks in the U.S. per S&P Global Market Intelligence.
- This makes a panic less likely than a bank like SVB where over 95% of deposits were uninsured
- Majority of portfolio invested in safe government/government-backed securities. Although this doesn’t preclude losses if Schwab was forced to sell to raise cash (that’s where the new BTFP lending facility comes into play).
- Diverse funding sources to satisfy withdrawal requests
- Organic cash generation of $90-$100 billion annually (Morgan Stanley)
- Cash and securities on hand
- Borrowing capacity
- Morgan Stanley estimates that $275 billion, or ~85% of Schwab’s securities portfolio could be eligible for the lending facility I mentioned above (BTFP) without having to sell those securities at a loss to honor withdrawal requests.
- $80 billion in borrowing capacity from FHLB
Note, SVB wasn’t subject to the same regulations and liquidity ratios as many other, larger/systemically important banks.
The firm commitment by authorities to backstop deposits and create this short-term lending facility, seems to have quelled fear and instill confidence for now.
None of this to say that Schwab Bank couldn’t have an issue. It’s certainly possible especially with a large, fixed-rate portfolio but there are important distinctions that make Schwab more resilient than SVB.
However, what does protection look like in the unlikely event of a brokerage failure?
Broker-dealers (such as Charles Schwab) are required to keep customer securities segregated from the firm’s securities so that in the unlikely event of insolvency of a broker-dealer, the segregated assets are not available to the general creditors and are protected against creditors’ claims. These entities are highly regulated with stringent reporting and auditing requirements to help ensure compliance with this rule. Here is a resource on what happens if a brokerage firm fails: https://www.finra.org/investors/alerts/if-brokerage-firm-closes-its-doors
Much like the FDIC offers $250,000 insurance on bank accounts, SIPC offers $500,000 protection on brokerage accounts in case assets are missing due to theft or fraud at the custodian.
This $500,000 limit can apply to each of multiple household accounts at the same firm as long as each account is titled under a separate capacity. For example, an account in husband’s name, an account in wife’s name and a joint account would each have $500,000 of coverage for $1.5 million of total coverage across the three accounts. Add an IRA and Roth IRA under each person’s name and now you’ve got seven accounts with $3.5 million of SIPC coverage. Duplicate accounts, however, are combined for purposes of determining coverage.
In addition to SIPC, Schwab also maintains additional protection through Lloyd’s of London.
Statement from Charles Schwab & Co, “Our Perspective on Recent Industry Events”: https://www.aboutschwab.com/perspective-on-recent-industry-events
SIPC, “Investors with Multiple Accounts”: https://www.sipc.org/for-investors/investors-with-multiple-accounts
FINRA, “If A Brokerage Firm Closes Its Doors”: https://www.finra.org/investors/alerts/if-brokerage-firm-closes-its-doors
JR Research, “Charles Schwab Stock: Undeserved Panic Selloff”: https://seekingalpha.com/article/4587068-charles-schwab-stock-undeserved-panic-selloff
Related Topic but applying it to households, “The Asset Must Match The Liability!” https://melottefa.com/the-asset-must-match-the-liability/
Risks of Fractional Reserve Banking addressed in this commentary: https://melottefa.com/inflation-or-deflation/
Past performance is no guarantee of future results. All investments maintain risk of loss in addition to gain.
Data from third-parties is believed to be reliable but accuracy is not guaranteed. Much of the data used to interpret the markets and forecast returns are often at odds with each other and can result in different conclusions. Many different factors impact prices including factors not mentioned here.
This is not investment advice but merely a general commentary. Individualized investment advice cannot be provided until a thorough review of your unique circumstances and financial goals is completed.
Views provided here are current only as of the moment of posting and are subject to change at any time without notification.