The headlines of the past two weeks covering the failure of two mid-sized banks, Silicon Valley Bank (SVB) on March 10th and Signature Bank on March 12th, sent a surge of worry through depositors and investors alike.
How did these banks fail?
While inadequate liquid collateral played a role, these banks failed mainly due to a combination of large amounts of uninsured deposits (or deposits that exceed the FDIC limit of $250,000 per depositor, per institution) combined with massive withdrawals. This is a reemergence of the classic “bank run”. When customers withdraw their deposits all at once and the bank does not have liquid capital to cover withdraws (due to outstanding loans, illiquid collateral, etc.) the result is a bank failure.
Regulatory filings show that more than $79 billion, or close to nine-tenths, of Signature Bank’s roughly $88 billion in deposits were uninsured at the end of last year.
Around 97% of SVB’s deposits (by value) were uninsured. This is because the bank catered primarily to the tech community, with many of these companies and nonprofits (perhaps up to 37,000 of them) parking their operating cash there.
SVB also had most of its excess capital in long-dated treasury bonds, which are very interest rate sensitive. After the rapid rate hikes seen in 2022, SVB’s collateral had taken a large loss and added to liquidity constraints to satisfy withdrawals. Long dated treasury bonds as measured by TLT, the iShares 20+ year Treasury Bond ETF, lost 31.24% of their value in 2022.
On top of this, SVB’s primary customers were technology companies, a sector that is also very interest rate sensitive and (alongside communications) led poor performers in U.S. equities in 2022. Once these companies began making needed withdraws, the bank's risk exposure became apparent.
What happened to SVB and Signature Bank depositors?
Federal regulators stepped in promising to make depositors whole, even for amounts not subject to FDIC insurance without using taxpayer dollars. The Federal Reserve also announced the creation of a new lending facility for the nation’s banks, large enough to cover trillions of dollars, to buttress banks against financial risks caused by the collapse of SVB.
Are other banks in danger?
San Francisco based First Republic Bank, another mid-sized bank, shared similarities with SVB and Signature Bank. First Republic’s customers are mostly wealthy clientele with large deposits and about two-thirds of deposits were uninsured. Further, it’s loan to deposit ratio was 111%, meaning it had lent more than it held in deposits. The risk of another bank run led to a group of 11 U.S. banks lending First Republic $30 billion to bolster liquidity.
In addition, over the weekend the Swiss National Bank (SNB) coordinated a takeover of Credit Suisse by UBS. Credit Suisse had been struggling for years to turnaround operations and become profitable while continuing to lose deposits from its privately wealthy clientele. When Credit Suisse’s largest shareholder, Saudi National Bank, declined to provide fresh funding, confidence was lost in the bank’s ability to maintain profitable operations. The crisis in confidence in the bank’s ability to recover, in addition to its size and complexity, ultimately led to its takeover.
What do we make of all of this?
The combination of the actions of Federal regulators and the U.S. financial system internally supporting itself are two very important moves to calm depositors and financial markets. The Swiss National Bank brokering the takeover of Credit Suisse instead of allowing it to experience a Lehman style collapse was also crucial. Stemming massive withdraws by underpinning banking institutions with liquidity is the primary objective of these actions. The message being sent is clear: depositors will be protected.
Further, larger money center banks like Bank of America, JP Morgan, Citi and Wells Fargo (among others) primarily borrow and lend to governments, large corporations, and regular banks. As a result, these banking institutions do not have the concentrated risks, nor the client profile, that created a perfect storm for SVB, Signature Bank and First Republic.
We believe the failure risk in the banking sector to be relatively narrow with exposure to a specific profile of banks with large amounts of uninsured deposits. Further, banks are substantially better capitalized than they were in the 2008 crisis, with capital ratios (representing the first line of capital available to absorb losses) at multi-decade highs.
What actions should you take?
We recommend clients and business owners consider limiting their bank balances to $250,000 per depositor, per bank at FDIC insured institutions. This affords you government backed insurance in the event of a bank failure. We also recommend considering your options if you tend to hold large amounts of savings in money market funds. While risk to these investments is currently not of concern, understand that money market funds are considered securities and are therefore not FDIC insured. With compelling yields on short dated government bonds, we think U.S. treasury bonds and high quality general obligation municipal bonds offer a good alternative for excess savings beyond operational reserves and FDIC insurance limits. Plus, in the event interest rates decline, you're in a position where you've locked in your yields for longer.