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Silicon Valley Bank notes
There has been a lot happening in the financial world these past few days. I’m writing to give you a quick summary about what happened at Silicon Valley Bank (SVB) and to remind you about the FDIC coverage.
Interest rate risk
Interest rate risk always impacts banks’ balance sheets, however, the banking industry has ways to manage it. When banks purchase securities, they are forced to decide whether they intend to hold the securities as “held-to-maturity” (HTM) assets or as “available-for-sale” (AFS) assets.
- HTM assets are not marked to market, therefore, banks don’t worry too much when bonds lose value (due to interest rate increases). These HTM assets stay on the banks’ balance sheets at amortized cost regardless.
- AFS are marked-to-market, which means volatility. AFS securities that are marked down have to be reflected on the balance sheet with the offsetting unrealized loss. And regulators watch the balance sheets of big banks to ensure they have enough capital on hand to cover deposits and debt service.
AFS assets were favored by banks as giving them flexibility because they could be sold anytime. Prior to 2021 mark-to-market unrealized gains were approx. $39 billion across US banks’ AFS portfolios - but as interest rates increased and bond prices began to slide, these unrealized gains shifted to unrealized losses of $31 billion by the end of 2021.
To deal with this shift, JP Morgan, transferred 30% of AFS to HTM securities. Other banks also made these type transfers, which meant that they took a loss, but reinvested in higher yielding securities in the non-marked to market HTM securities. Previous interest rate tightening occurred in 2017/18, but the bank managers never had to deal with as sharp a rates move as occurred in 2022.
Now, let’s think about what happened at SVB.
First you need to know that SVB has depositors that are unlike most banks – there are few depositors (at the end of 2022, it had 37,466 deposit customers), many depositors are venture capital companies who all know each other, and 97% of the deposits exceeded $4 million dollars (only 3% of depositors had balances below the $250k FDIC threshold).
By the end of Q1 2022, the bank’s deposit balances more than tripled to $198 billion (that’s approx. 37% growth in less than a 6 month period).
SVB invested these deposits using a two-pronged strategy – short duration AFS assets, and longer 6.2-year average duration/higher yielding HTM assets. These assets were mortgaged back securities. And as rates started to go up, the mortgage assets got hit hard.
Here is a summary of the two-part punch to SVB.
The HTM unrealized losses went from nothing in June 2021, to $16 billion by September 2022, which was a 17% mark-to-market hit. The smaller AFS holdings, held 9% mark-to-market losses by the end of September 2022. Silicon Valley Bank was technically insolvent at the end of September.
Just as the deposits from the venture capital companies grew so fast in early 2022, the deposits fell from $198 billion at the end of March 2022 to $165 billion by the end of February 2023. In order to reposition its balance sheet to accommodate the outflows, SVB last week sold $21 billion of AFS securities to raise cash, with a $1.8 billion after tax loss.
The announcement of the balance sheet restructuring, and other treasury challenges that banks are facing, caused fear among their depositors, and the SVB deposit outflows turned into a run on the bank.
Last weekend regulators took action to protect all insured and uninsured depositors affected by the collapse of SVB and Signature Bank (SBNY), a New York-based bank. Meanwhile, First Republic Bank (FRC) announced that that it has obtained additional liquidity from the Federal Reserve and JP Morgan. Also, new bank regulations have been implemented.
FDIC Coverage Limits
For the industry overall, the episode is likely to cast a long shadow. It’s been 870 days since a bank last failed in the US, close to the longest stretch on record.
It’s a good time to review your uninsured deposits and remember that there are risks and that’s why FDIC was created to insure American’s bank deposits up to $250k.
The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.
The FDIC provides separate coverage for deposits held in different account ownership categories. Depositors may qualify for coverage over $250,000 if they have funds in different ownership categories and all FDIC requirements are met.
All deposits that an account holder has in the same ownership category at the same bank are added together and insured up to the standard insurance amount of $250,000.
FDIC ownership categories:
• Single Accounts
• Certain Retirement Accounts
• Joint Accounts
Note: If all of these requirements are met, each co-owner’s shares of every joint account that he or she owns at the same insured bank are added together and the total is insured up to $250,000.
• Revocable Trust Accounts
• Irrevocable Trust Accounts
• Employee Benefit Plan Accounts
• Corporation/Partnership / Unincorporated Association Accounts
I hope the above was a refresher on interest rate risk, which you have seen in your own portfolios, and a reminder that although the stock market has been calm these past few days, stock market volatility is likely from this SVB shake out and from others such as Signature Bank and1st Republic Bank.
Thank you for your time and have a good week.
My best to you and your family,
Control your Money... Live, Give, Owe, Grow
Managing your money is not always an easy or a fun thing to do. We sometimes put it off until it is too late. If you start early with small amounts over time and you spend less than you earn, you can take real control over your money and be a financial success. It is a simple concept money comes in and goes out, and we should control our money, and not let our money control us. If you are conscientious about managing money, you can work with a CPA, CFP, or Financial Planner, together you can get your money working as hard as you do!
Your Money has only four potential uses in your life:
1. You live on it.
2. You give it away.
3. You pay what you owe in debt or taxes.
4. You make it grow through saving and investing.
Since we control our money and not the other way around,
Which of these uses is most important to you to attain? Which do you want to see become a smaller portion of your plan?
Living is often the largest portion of money spent at least at the start of your career. Living expenses are housing, food, utilities, transportation etc... We often think that higher income increases the standard of living. Wise managers of money will ask themselves if increasing their standard of living is necessary. Often, they will set limitations on their living expenses. Increasing income does not mean it should all be spent maintaining a certain lifestyle.
It is helpful to me when doing this exercise, to separate “productive” uses of money and “consumptive” uses. What has lasting value and what is just “consumed”? Giving, to me, is the ultimate productive use because of its eternal impact. Serving people and furthering God’s truth have eternal value. (Many people see giving as a guilt offering of sorts — that would equate to a consumptive perspective.)
Managing your finances successfully means avoiding taking on too much debt. Paying interest is not wrong, especially if you consider what you can earn with your money in comparison, or what you can do with the liquidity. Debt may increase your risk because of the obligation it creates that your future circumstances may not be able to meet. When borrowing takes place, it should include a reasonable way to pay it back. We are to pay our fair share of taxes, which means not cheating the system, nor paying more than what we are prescribed.
To meet long-term goals of retirement, you need to save! How we save and invest for the future should be charted out based on short-term and long-term priorities. In order to grow your money, you need to set up a comprehensive financial plan, which can provide a structure for sound decisions today based on an uncertain future that will achieve your goal of growing your money. You can set up the plan yourself or get assistance from a financial planner.
“Growing” should be an essential habit to get the best use of your hard-earned money. The reason growing your money is important is that it will make your future more flexibility. Conversely, as you reach your savings goals it may make sense to consider reducing your growth allocation as savings become reasonably adequate.
You must ask yourself several questions:
- How much is enough?
- How do I reach that goal?
- Do I need advice of a Financial
Advisor to reach my goal?
Please be careful because simple to do is also simple not to do. The meaningful impact to your family plan is in the doing of simple things repeatedly and long enough to ignite the miracle of the Compound Effect.
Financial decisions can be complex, but the all-encompassing uses of money are not. Take the time to put together actionable steps toward creating a “Live, Give, Owe, Grow” plan you want to pursue….