Yes, SVB’s (Silicon Valley Bank) failure at the end of last week is a big deal; but first things first—the immediate risk for your cash is not a concern.
SVB’s failure got so dire that the Federal Reserve Bank voted to shut it down. This morning, the Federal Reserve Bank also took over Signature Bank; there may be more to follow. However, the situation will likely be contained with the Federal Reserve Bank stepping in to guarantee depositors. As a result, the risks of a collapse in liquidity, which would undoubtedly lead directly to a very sharp and devastating decline in the stock market, have been significantly reduced.
While the issues are complex, we feel it essential to address some critical points related to why SVB and other banks got into trouble, why it likely does not directly affect you, and finally, why your investments at Schwab are not part of the problem.
Silicon Valley Bank
From a top-level view, SVB was trapped in a classic bank run. SVB grew to the 16th largest bank servicing the needs of many start-up companies, particularly in the technology sector. Funds raised from stock and bond offerings, private equity, and venture capital firms were deposited at SVB to pay operating expenses, including payrolls, for many firms. The balances were large and not FDIC-insured. There were also individuals with large uninsured balances, but the most significant funds were corporate. SVB’s increasing history of deposits led them to invest these funds in “safe” investments such as U.S. Government Securities. As a result, SVB earned more on these investments than they had to pay depositors.
But then, 2022’s dramatic rise in interest rates happened. We all know this story and have written about it over the last twelve months. The rising interest rates caused bond prices to fall. Not only fall but decline more than in any other 12-month period over the previous 100 years. In SVB’s case, their bond investments would likely be paid back in full at maturity, contributing to the bank’s earnings. And just as we have encouraged all of you, the forward returns for many fixed-income investments look very attractive, and if you do not panic and sell, the bonds will be redeemed at face value.
A small group of large institutional depositors started to get nervous and decided to pull funds from the bank, advising their client companies to do the same. So now SVB was forced to sell their “safe” positions at a loss. The news spread; some would claim it analogous to yelling “Fire!” in a crowded theater. As depositors lined up to take their money out of the bank ($42 billion before the shutdown), selling the remaining securities would cause a loss too significant to honor the redemption requests, leading to the Fed’s decision to shut down SVB.
The Federal Reserve stepped in and will guarantee depositors’ funds, allowing companies access to cash to fund their operations. In addition, a new fund facility was created to help institutions weather the storm if cash requests exceed liquid reserves so that the financial institutions are not forced to sell holdings at a loss. These actions will likely avoid panic. Of course, there will be collateral damage, but the likelihood of it spinning out of control is significantly less today than 24 hours ago.
We now see virtually no chance there will be a 50-basis increase in interest rates at the next Fed meeting. The past five days have shown us the real consequences of the rapid interest rate rise. Other investments are likely to start showing more pronounced signs of stress. For instance, high-yield bonds may be overpriced given that many weak or overleveraged companies relying on the junk bond market cannot afford to refinance their debt as it comes due.
Like many financial institutions, the news hit Schwab’s stock hard last week. Schwab is nowhere close to being the same type of institution as SVB. The asset structure is markedly different, and Schwab client assets are not owned by or directly held by Schwab. Schwab is a custodian. The investments are held directly by investors. Schwab does make a significant amount of money from clients holding their funds in low-yielding Schwab Bank or sweep money market accounts. But Schwab can handle withdrawals. We have made a concerted effort to move funds to higher-yielding money market funds as interest rates increased and feel your exposure is relatively limited anyway. Note the statement directly from Schwab, which we link here: Our Perspective on Recent Industry Events
Events over the past couple of days may change investing opportunities. If the Federal Reserve is successful, some asset classes will represent an opportunity for decent returns in 2023. Those will likely include more value-type investments that pay good and rising dividend income. On the other hand, growth stocks look pretty iffy, and it will be hard for the technology sector to continue to build on a good start in 2023. Higher quality fixed income is attractive.
We can help you not exceed the FDIC-insured limits if you hold large cash balances. For example, 6 to 9-month CDs can pay over 4.5%. In addition, money market funds can be purchased with yields over 4%. Some programs offer automated access to a pooled CD portfolio with insurance coverage of up to $20 million for sizeable institutional cash balances.
Setting up an account for safe and liquid cash separate from your investments at Schwab is easy, with links to your bill-paying account.
One thing is sure in this fast-moving situation; this is not the final word on this crisis. We will make adjustments as it evolves. In the meantime, please get in touch with us with questions or to discuss your situation and concerns.