The Fall of Silicon Valley Bank: What You Need to Know

By now many of you have heard about the collapse of three regional banks, including Silicon Valley Bank (SVB), in the past week. We would like to address what the implications are for the wider banking system, and what this means for the safety of your portfolios.

All three banks, which have been taken over by the FDIC (Federal Deposit Insurance Corporation), are considered regional banks which means they are smaller than national banks and operate in a particular region.  Given their size they are also usually focused on a niche market, and therefore have somewhat undiversified customer bases. The largest, SVB, specialized in venture capital funded start-ups in the tech industry. The venture capital market has slowed down significantly in the past year after a long runup fueled in part by a low interest rate environment. That low interest rate environment is a large part of the reason we have experienced high inflation over the past two years, and why the Federal Reserve has been sharply raising interest rates to rein in rising prices.

Banks tend to invest some of their deposits into government bonds, which are very liquid. Due to the extended period of low interest rates, some banks such as SVB “chased yields” by buying longer-term bonds that yielded a little more interest but with a commensurate additional sensitivity to interest rate movements. When interest rates finally started rising, the value of those bonds dropped as interest rates and bond prices have an inverse relationship. When the venture capital market began to slow down, resulting in a slowdown in customer deposits, SVB had to start selling some of those bonds at a loss to cover withdrawal requests from its customers. Eventually, the value of their liquid assets was not enough to cover withdrawals, causing a classic run on the bank, and the FDIC had to step in.

It is reasonable to expect more trouble amongst regional banks. However, in a big relief to many in the banking industry and the markets at large, the FDIC announced in a joint statement with the Treasury Department and the Federal Reserve that “depositors will have access to all of their money starting Monday, March 13.” In addition, the Federal Reserve has established an emergency lending program called the Bank Term Funding Program that would provide liquidity to eligible banks and help ensure that they are able to “meet the needs of all their depositors.”

In terms of our client portfolios, it is important to understand the relationship (or lack thereof) between banking and brokerage services. Your portfolios are held in the brokerage arms of TD Ameritrade and Charles Schwab which are completely separate legal entities from their banking businesses. Since the merger of the two firms is far enough along at this point (to be finalized in September this year), we should focus on Charles Schwab.

Schwab Bank is the eighth largest bank in the United States. In a very helpful announcement today on their website, they point out that more than 80% of client cash is insured dollar-for-dollar by the FDIC, compared to only 2% to 20% at the banks recently in the news. Furthermore, “Schwab Bank has a broad base of high-quality customers across multiple lines of business, capital well in excess of regulatory requirements, a high-quality and relatively small loan book, and a conservative [bank] investment portfolio that is 80% comprised of securities backed by the U.S. Treasury and various government agencies.”

Perhaps just as important is the fact that assets in your portfolio are held in the brokerage arm of Charles Schwab, which is a massive, highly successful business fully independent of the banking arm with over $7 trillion in assets while Schwab Bank has total assets of $577 billion. And the two arms of the business are entirely separated in the sense that Schwab could never use your portfolio assets to help pay off depositors on the banking side. In other words, your money is never lent out like that of depositor money at a bank. Therefore, if you want your money, it is there for you, subject only to investment fluctuations, as there is no such thing as a “run on the brokerage” as in the case with banks.

We do keep small allocations of our client money in cash, typically for upcoming fees or withdrawal requests. While the cash is unused, Schwab will sweep it to Schwab Bank (or an affiliate) in order to earn interest. That cash is protected by FDIC insurance.

Finally, our portfolio exposure to regional banks is very small. Our main US stock funds had a less than 0.1% exposure to SVB. Some have been following news on First Republic Bank, for which our funds have a 0.1% exposure. Still, when unexpected bad news comes out, stocks will drop. But these drops are always temporary for ultra-diversified long term focused investors like us. As we work our way through the broader inflation challenge, there could be more temporary declines. However, our financial plans and portfolios are designed to weather times like these, and our advisors would welcome the opportunity to discuss this with you further and answer any questions you may have.

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