Many physicians are concerned and seeking advice on whether to move money from local banks to larger banks.
No matter how confident an investor feels about their current portfolios, it is impossible not to be shaken by certain headlines. Recently, concerned physician clients of our firm have been reaching out to me to ask if they should move their money out of local banks to larger ones. I explain to them how much of their funds are currently insured and advise them to deposit the additional funds in other insured banks within Federal Deposit Insurance Corporation (FDIC) limits. In mid-March, the news about Silicon Valley Bank (SVB) and the drama that erupted in a short amount of time was prominent in every news source, and it is important to understand what happened and what impact SVB’s collapse could have.
Although it was a favorite of tech company start-ups and venture capitalists, SVB operated like any other bank, with deposits and withdrawals being made daily. As the 16th largest bank in the United States, that amounts to a lot of money on the move.
To understand what happened, it is important to understand how banks operate. In simple terms, banks borrow money at low rates then lend it out at higher rates over a longer term. What this looks like is individuals and businesses making many small “loans” to a bank by making deposits, and those “loans” pay out to account holders at a very small interest rate. Meanwhile, the bank loans out greater sums of that money at a higher interest rate, such as loans for mortgages or auto purchases. Banks profit on the difference between the payout of account holders’ lower interest rates and those higher-rated loans.
This ordinarily works at a controllable pace, but it can happen (and has happened several times historically) that many bank account holders wish to withdraw all their money at once, generally because of a scare about the stability of the bank. This is known as a bank run and causes a problem for the bank, as all that money is not in-house at the same time. As discussed, it is likely to be held in long-term loans rather than being immediately accessible. This is essentially what happened to SVB.
Because SVB has a business model interwoven with the tech industry, most of its accounts are business accounts. Just like any other bank, SVB pays a low interest rate on those savings and checking accounts and then lends the money out for longer-term loans. In this case, they lent money to the US government, buying US treasuries at the 1.6% yield that was offered several years ago. It was not a small loan either—this was $80 billion, at a lower rate than the higher interest rate that the Federal Reserve System has now.
SVB sold $21 billion of securities to raise cash and lost about $1.8 billion on that deal. The bank planned to cover the loss by issuing common and preferred stock, which fell about 60% in premarket trading on Friday, March 10. Unrelated, but with incredibly bad timing, Silvergate Bank, a cryptocurrency bank, collapsed. This is not an unusual thing in and of itself for crypto banks, and it had nothing to do with SVB. However, the Silvergate failure coupled with SVB’s timing of their raising capital plan spooked the market. In the well-connected tech world, this spread like wildfire, and as word spread to investors, there was suddenly a bank run. On March 8, regulators shut down Silvergate Bank.
The potential effects were nerve-racking for businesses who suddenly did not know how they were going to pay their bills, move their product, or do payroll for the week. Of over 100,000 venture capital companies in the United States, more than half were banking with SVB. The failure of SVB is the second largest bank failure in the United States, so of course many people are concerned. People remember what happened back in 2008-2009, and it is almost impossible not to feel the shiver of worry at the back of your neck. However, although no one likes to see headlines about a bank failure, it is important to keep a level head.
The collapse of SVB does not signal a domino effect of bank failures across the country. Although a small ripple effect is perhaps inevitable, SVB does not have the deep interconnections that Washington Mutual did back in 2008, which led to those larger repercussions. SVB will not be allowed to fail without a plan. Already, the FDIC has transferred all deposits, insured and uninsured, to a newly created “bridge bank” that will act as a facility to allow all depositors to access their funds, which is a relief to businesses and individual investors alike while the debate over next steps continues.
The FDIC insures up to $250,000 per depositor, per insured bank for each account ownership category. All single accounts owned by the same person at the same bank are added together and insured up to $250,000, but other accounts have different limits. For example, a joint account is insured for up to $500,000 combined. A trust account with 4 beneficiaries will have a protected maximum insured amount of $1 million.
The current risk to the market is that other, smaller banks may face the same issue. However, in my opinion larger banks will benefit, as they had no trouble passing the federal stress test. With the smaller banks facing more scrutiny and instability, it is likely that many large account holders (whose accounts are higher than the FDIC-insured limits) will move to those larger banks. So although there may be a short-term drop in the value of bank stocks, in the long term they will come back stronger, as they are able to weather this storm.
Large tech companies will also be the beneficiaries of the current instability, as smaller tech companies will have a more difficult time accessing credit; this lack of capital will lower the competition from smaller companies. The lack of available credit for businesses may also have a slowdown effect on the economy in general, with a resulting lowering of inflation. Ultimately, the Federal Reserve will likely use this ongoing situation, and the already slowing inflation rate, as a reason to stop raising rates sooner than may have been expected.
Most importantly, while the SVB collapse does highlight some banking risks, the historical data give a clear indication that the financial sector recovers strongly from this sort of thing. Rather than giving in to the general panic, we can consider situations like this as times of opportunity. If you are interested in seeing how these opportunities may have a spot in your portfolio, or you are uneasy about some of the things you are seeing, contact your financial advisor to talk through your concerns. They will be happy to give you further explanations and guidance.
Johan Vako is assistant vice president of wealth management at Wall Street Alliance Group.