Financial Planning Fridays #001: Special Episode: The Failure of SVB

Today we wanted to discuss the issue dominating the financial headlines over the past week and the impact it may have on banking going forward: the recent failure of Silicon Valley Bank.

Early last week, clients of SVB began hearing rumors that the bank may be in trouble and quickly many of them rushed to move their funds to other banks.

This was further fueled by e-mails and social media posts speculating on the bank’s potential ability to meet, or not meet, withdrawal requests. Ultimately, their clients requested withdrawals of $42 billion on Thursday and SVB was not able to meet demand. On Friday, Regulators closed the bank and took over operations.

And just like that, one of the top 20 largest US banks ceased to exist as we knew it.

At their core, banks are businesses like any others. To make money, they typically loan out their deposits to other customers or purchase government backed bonds with them to generate interest. SVB was no different.

They had about $173 billion in deposits and, in the extremely low interest rate environment of 2020 and 2021, they used the bulk of their deposits to purchase US government debt in the form of Treasuries and mortgage-backed securities issued by Freddie Mac and Fannie Mae. On the surface, all very safe.

Then the Federal Reserve began to raise rates, and they began to raise them at the fastest pace ever over the past year. This exposed SVB’s very large mistake.

In order to generate slightly more income for their bank, they purchased mortgage-backed securities that would mature in ten years or more, effectively locking up a large bulk of their money at a yield of roughly 1.6%. When the Federal Reserve began to raise rates at their very rapid pace, and investors could now purchase very similar bonds earning 5% instead, the value of SVB’s large position of mortgage-backed securities plummeted.

In the end, SVB would have been all right if they had the opportunity to hold these securities to
maturity. However, as rumors began to swirl, clients of the bank swooped in rapidly to remove
their deposits, creating a liquidity squeeze, ultimately leading the bank’s shutdown and the US
government’s actions.

So where do we go from here?

Moving forward, the Federal Reserve announced that they will provide one-year loans on the maturity value of these bonds if banks need to cover withdrawals. This should enable banks to meet withdrawal requests without having to sell their bond holdings at a loss, helping to avoid future runs on a bank for this reason.

Additionally, the FDIC, Treasury, and Federal Reserve issued a joint statement on Sunday, March 12th, that they will cover all deposits at SVB, even those that were above the FDIC limit of $250,000, seemingly setting a new precedent that all deposits at U.S. banks will be covered, which we think is the right thing to do. You need to have full confidence that the money you deposit into a bank is safe, secure, and will be available for you to use at any time.

However, for every action there is a reaction. The cost of this will likely be an increase to the insurance premiums that banks pay into the FDIC fund to cover potential future losses. In turn,
banks will likely lower the already small amount of interest that they typically pay customers on
their deposits.

This is yet another reason why clients should re-evaluate their bank relationship. According to a Wall Street Journal article in December 2022, the average amount paid on savings accounts in the U.S. at the five largest banks, where about half of all deposits are kept, is 0.4%. To put that into context, the rate as this publishing date (or March 17, 2023) on the Fidelity
Treasury Money Market is about 4.5%, more than ten times this amount.

This was another of the key reasons that we at Presilium Private Wealth have chosen Fidelity as a place to hold our client’s assets. We wanted clients to have a wide variety of money market options to get the best possible available rates while having the safety of an enormous institution, one that has about $4 trillion under management and serves more than 37 million accounts.

We will continue to closely monitor this situation and provide advice and guidance to our

Be on the lookout for our next Financial Planning Fridays episode. Subscribe to our Youtube Channel so you never miss an episode. Or contact us directly; schedule your 15-minute call with us today.