The State of Banking: How Concerned Should We Be?


Three banks have made headlines in recent days, Silvergate Bank and its holding company Silvergate Capital Corp (NYSE: SI), Signature Bank (Nasdaq: SBNY), and most notably Silicon Valley Bank and its holding company SVB Financial Group (Nasdaq: SIVB).  Silvergate Bank is a major bank of the cryptocurrency community and announced on March 8, 2023 that it would be winding down operations with plans to liquidate voluntarily.[1]  On Friday, March 10, 2023 California banking regulators announced that the FDIC would take over the liquidation of Silicon Valley Bank holding company SVB Financial Group.[2]  On Sunday night, March 12, New York banking regulators announced that Signature Bank would be placed into receivership of the FDIC.[3]

State of Banking
State of Banking

All three banks are FDIC insured and, as of the time of this writing, SVB Financial Group and Signature Bank were in receivership of the FDIC with Silvergate Bank in talks with the FDIC to attempt to avoid insolvency. The stock of each company has seen precipitous declines and trading was halted on SIVB on Friday, March 10 after a 60% intraday decline.  This sent ripples into the financial sector with concerns about contagion spreading out to the broader banking industry.

Considering these events, I want to take some time today to examine what happened with each of these banks, the likelihood of contagion in the banking industry, and provide a review of FDIC and SIPC coverage and what investors should know about each program.

As this is breaking news and it is likely that investors are concerned about their assets, it is important to state up front the Federal Reserve and the US Treasury have shown significant resolve since the Global Financial Crisis to back stop bank deposits and the money market to ensure liquidity and the operability of the American financial system.  Late Sunday the US Treasury announced that it would ensure the funds of depositors at SIVB and SBNY are available to them in full.  This means customers of these banks can access their funds on deposit without loss.  While the depositors at these institutions are covered, this is not a bail out of the banks’ investors and stock and bond holders of the banks are likely to see their securities become worthless.  The Federal Reserve further announced a liquidity measure in the form of the new Bank Term Funding Program (BTFP) that would allow banks to borrow against Treasury securities pledged as collateral.  These measures mean reduced risk to depositors and increased liquidity to banks which serves to reduce the probability of further bank runs.

What Happened With Silvergate Bank, Signature Bank, and Silicon Valley Bank?

To discuss the likelihood of contagion it is important to first understand how each of these banks came to be in the current position.  We will start by examining Silvergate Bank which has been a major player in banking for the crypto industry in recent years.  The significant decline in the value of Bitcoin (BTC) and Ethereum (ETH) over the last year certainly played a part, as well as the collapse of multiple crypto firms including Alameda Research and FTX, a client of Silvergate Bank according to Markets Insider.[4]  The reason the decline in crypto assets put pressure on Silvergate is that, as investors withdrew deposits from crypto exchanges, those exchanges banking at Silvergate had to withdraw deposits from Silvergate to satisfy those redemptions.  In addition to a run on deposits, Silvergate had risks in its investment portfolio.  One example of these risks is that it had taken on duration risk in the form of long-dated bonds which have lost significant value over the last year as interest rates have climbed rapidly.  So, an outflow of cash combined with a falling investment portfolio value put significant pressure on the balance sheet of Silvergate Bank.  

In the case of Silicon Valley Bank (hereafter SIVB), it was almost exclusively catering to Silicon Valley businesses.  These Silicon Valley tech firms received much of their operating capital in the form of cash infusions from venture capitalists, IPOs and SPACs in recent years.  In fact, SIVB received a substantial influx of deposits in a short period of time.  When banks have excess deposits, they will typically either loan out money or make investments to generate return on these deposits.  They don’t want idle cash.  SIVB did make some loans to private companies, but their client base was fast growing tech firms with massive cash infusions and little revenue.  In other words, their clients were not in need of loans.  So, SIVB decided to invest these excess deposits in Treasury securities which are generally considered a safe investment.  However, all of this cash came in at a time when yields on short-duration Treasuries were very low.  To lock in a higher yield, SIVB invested in longer-term Treasuries with long duration risk.  Then interest rates started climbing and the value of these bonds started falling, like the problem faced by Silvergate.  As you may have noticed by the lack of headlines about them, the pace of IPOs and SPACs has declined significantly since 2021.  As startup firms often do not have significant revenue, SIVB clients (tech firms) had to start tapping into the cash on deposit with SIVB to continue operations.  This led to a need for SIVB to raise cash for operations.  The way SIVB raised this cash was by selling bonds at a loss and then issuing new shares of stock to recover some of the losses from the investment portfolio (an approximate 10-15% increase in the number of outstanding shares).  One critical oversight was that they failed to make investors aware of the reason for, or even the fact of, this share issuance ahead of time.  This created a panic with their investors that led to a run on the bank and a crash in the stock price as investors pulled out.

Signature Bank was seized by banking regulators rather abruptly and this may have had to do with the fact that it had some striking similarities to Silvergate and Silicon Valley Bank.  Signature Bank catered primarily to commercial depositors with a significant majority of deposits above the FDIC insured limits.  It also catered to the crypto community.  While the news is still coming out regarding the reason for the seizure, it is likely that banking regulators were trying to get ahead of another SIVB-like scenario.

Are There Risks of Contagion in the Broader Banking Industry?

The failure of three banks in rapid succession inevitably leads to questions of whether this is an illness that is catching and will spread through the banking industry.  All three of these banks had several things in common.  In the case of SIVB and SBNY, they catered to primarily commercial clients with deposits well in excess of typical consumer bank deposits.  This increases the risk of a bank run as large liquid deposits from a small number of depositors means that even just a few of their customers running into cash squeezes could cause the bank to burn through their cash reserves quickly and need to sell securities to raise reserves.  In the case of Silvergate and SBNY, they both catered to the crypto community which has seen significant declines in value and other stresses from failures over the last year as described above.  These banks also had long duration risk in their investment portfolios.

The announcements by the US Treasury and Federal Reserve each decrease the likelihood of contagion in different ways.  The US Treasury has provided assurance to depositors that deposits will be secured by the government, even those deposits exceeding the FDIC insurance limits.  While the FDIC has only explicitly guaranteed the deposits at SBNY and SIVB, this action leaves the door open for the FDIC to take similar measures in the event of another bank failure in the near term.  This reduces the risk that depositors will rush to pull their money out of banks which reduces the risk of a bank run and a subsequent liquidity crisis.  The Federal Reserve announcement reduces the risk that banks will run into the liquidity issue faced by Silvergate and SIVB since they can borrow from the Federal Reserve an amount equal to the face value of Treasury securities in their portfolio rather than selling at a loss in the secondary markets.  The flight to safety in response to these bank failures has also pushed up the price of bonds which means any Treasuries on bank balance sheets have appreciated in recent days.  Further, the structure of banks catering to crypto and commercial clients is different than that of many regional and national banks serving retail clients.  Let’s examine some other banks to understand the differences.

How Do Other Banks Compare?

Banks in the financial sector fall into several industries.  Among those industries are diversified banks like Bank of America Corp (NYSE: BAC) and JPMorgan Chase & Co. (NYSE: JPM), and regional banks like US Bancorp (NYSE: USB).  These banks are different from SIVB, SI, and SBNY in a few important ways and do not share the unique risks faced by SBNY and SIVB.  First, these banks cater more to retail investors which means a much larger pool of customers with smaller average balances.  For reference, 93% of SIVB clients and 100% of SBNY clients were commercial depositors compared to a 34% category median.  This translates to a comparatively smaller risk of a bank run as retail depositors do not have the unique large cash needs of commercial depositors (e.g., meeting payroll and other operational cash needs) and the risk of a single client having large cash needs is spread out across a much wider client base.  Another unique risk is the percent of deposits above FDIC insured limits at the failed banks with over 80% of deposits at SIVB and 90% of deposits at SBNY exceeding FDIC limits compared to a median of 54% more broadly. While there are certainly still risks in the industry in the form of long-duration portfolio risk and significant exposure to commercial real estate, we believe the actions of the FDIC, US Treasury, and Federal Reserve should be sufficient to stabilize the banking industry.

Outside of diversified and regional banks, there was also some concern about Charles Schwab (NYSE: SCHW), a national financial services firm with a banking arm which warrants examination.  In response, Charles Schwab released a report regarding the firm’s financial position.[5]  SCHW is down on concerns that it may have troubles resembling SIVB; however, we believe the cash needs of Charles Schwab are significantly different from those of SIVB.  Whereas SIVB had a run on deposits resulting from the operational cash needs of their commercial depositors, the primary reason for cash needs at Charles Schwab are related to clients moving from cash deposits to money market funds and bonds that provide higher returns than cash deposits.  This could mean that Charles Schwab will need to raise cash to cover these money movements and there are concerns that the firm may need to sell securities at a loss to cover these cash needs.  However, Charles Schwab has many options for raising cash or even reducing the incentive to move cash to bonds and money market funds and stem the cash outflow related to these moves.  For one, it can borrow from the Federal Reserve or Federal Home Loan Bank, or even take advantage of the new BTFP described above.  It can also offer higher rates on bank products such as CDs and savings accounts to make leaving cash on deposit a more attractive option for their customers.  

There are a few other points of interest from the press release.  For one, Schwab notes that over “80% of our total bank deposits fall within the FDIC insurance limits, among the five highest ratios of the top 100 banks in the United States.”  This is in comparison to the exact opposite with SIVB and SBNY.  Recalling from above the size of commercial versus retail deposit sizes, Charles Schwab Bank average cash balances are around $23,000 compared to SIVB average cash balances exceeding $1 million.  This means that SIVB had much higher risk of a run on deposits from a small handful of commercial clients.  The press release also contained comments about liquidity:

We have access to significant liquidity, including an estimated $100 billion of cash flow from cash on hand, portfolio-related cash flows, and net new assets we anticipate realizing over the next twelve months.  We believe we have upwards of $8 billion in potential retail CD issuances per month, plus over $300 billion of incremental capacity with the Federal Home Loan Bank (FHLB) and other short-term facilities – including the recently announced Bank Term Funding Program (BTFP).

Notes on FDIC and SIPC Coverage

In the event of worst-case scenarios there are programs in place to provide insurance on investor portfolios and bank deposits.  These are the Federal Deposit Insurance Corporation (FDIC) which insures bank deposits in the event of bank failures and the Securities Investor Protection Corporation (SIPC) which insures certain brokerage assets in the event of the failure of brokerage firms.  We will examine each one in turn and provide an overview of the important facts you should know.

Beginning with the FDIC, this insurance covers deposit accounts such as checking, savings, and certificates of deposit (CDs) up to certain limits based on account registration.  The insurance goes into effect when, like with SIVB and SBNY, the FDIC takes a bank into receivership; in other words, when a bank has failed.  The simplest explanation of the coverage is that the FDIC provides insurance on up to $250,000 per depositor, per bank, per ownership category.  We will break that down.  Depositor for the purposes of this explanation would simply mean person.  So, an individual account has one person associated with it and receives $250,000 in coverage.  A joint account with two owners has two people associated with it and receives $500,000 in coverage ($250,000 per person).  Since this coverage is per bank if a single person has an individual account with Bank A and another individual account with Bank B, they have $250,000 of coverage at each bank for a total of $500,000 so long as they split that $500,000 evenly across the two banks.  Ownership category means account type (also commonly referred to as account registration) and can include individual accounts, joint accounts, IRAs, trust accounts, and so on.  If a couple each has an individual account and share a joint account at one bank, they effectively have $1,000,000 in FDIC coverage ($250,000 for individual account 1, $250,000 for individual account 2, and $500,000 for the joint account).  It is important to note that one person owning two individual accounts at the same bank does not increase coverage as they are aggregated as one account type at one bank, while that same individual having an individual account at two different banks does increase coverage.  Being aware of your account types and the amount deposited in each can help you ensure that your deposits are covered or take action to bring balances under coverage if any amount is currently outside of coverage limits.  Should you want to calculate the amount of insurance on your deposits you can use the Electronic Deposit Insurance Estimator (EDIE) provided by the FDIC.[6]  For assets held in credit unions there is a similar, but separate, program called the National Credit Union Administration (NCUA).[7]

The SIPC is separate and different from FDIC as it covers brokerage assets.  Stocks, bonds, mutual funds (including money market funds), Treasury securities and certificates of deposit are all covered under the SIPC.  Some investments such as currency, commodity futures, fixed annuity contracts and unregistered investments are not covered.[8]  Further, SIPC does not cover investment losses incurred by the change in market value of the covered securities.  The insurance goes into effect when a brokerage firm goes bankrupt or becomes insolvent and this does cover assets lost due to unauthorized trading.  To be clear, SIPC is designed to protect investors from the failure of, or unauthorized trading by, their brokerage firm and not to back stop losses from risky investments.  The coverage limit is $500,000 per brokerage firm, per ownership category (called “separate capacity”) with up to $250,000 allocable to uninvested cash balances.  This is similar to FDIC coverage where the $500,000 limit is applied per account type.  However, there is an important distinction where a joint account has the same $500,000 limit as an individual account regardless of the number of owners on the joint account.  More information about separate capacities can be found on the SIPC website.[9]  It is also worth noting that both of our custodians provide coverage in excess of that provided by SIPC.[10, 11]  With Charles Schwab the combined coverage (SIPC and excess) per client is $150 million with $1,150,000 allocable to cash.  With Fidelity the combined coverage (SIPC and excess) there is no per customer dollar limit on coverage of securities, but the limit on cash is $1.9 million.  

We hope that this has helped shed light on the events in the markets in recent days while also providing some reassurance to our readers regarding the state of the banking industry.












Michael Carrico

Michael Carrico is a Wealth Manager at Howe & Rusling.


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