Understanding Recent Bank Failures: Context and Perspective
Why the Government Took Over SVB and SBNY and What it MeansJay Pluimer, AIF® CIMA® Wednesday, 15 March 2023
Banks have been in the headlines recently after several significant developments. News broke on Friday, March 10 that Silicon Valley Bank (SVB) was being taken over by the government after failing to have enough resources to meet customer requests for withdrawals. A similar (and related) scenario played out on Sunday, March 12 when Signature Bank New York (SBNY) was no longer able to meet liquidity requirements. Although these are separate events, there are important similarities that led up to each bank failure. We want to provide context for the bank failures, share an update on the most current news, and add some perspective for what we expect to happen next.
A Brief Introduction to SVB and SBNY
Both SVB and SBNY were in the business of making large, long-term loans to high-profile clients. SVB is a mid-sized regional bank with around $215 billion in assets and SBNY is a mid-sized regional bank with around $110 billion in assets. After the Great Recession in 2008, bank regulations were designed to prevent failures like this through the Dodd-Frank Act, which established strict guidelines about how much cash banks needed to have on hand relative to deposits and loans. The Dodd-Frank Act initially applied to banks over $50 billion, which would have included both SVB and SBNY, but the regulations were rolled back in 2018 and now only apply to banks with over $250 billion of assets.
Why Did These Failures Happen?
SVB is the second-largest bank failure in U.S. history, behind Washington Mutual in 2008, and SBNY is the third-largest failure. The Federal Deposit Insurance Corporation (FDIC) will protect up to $250,000 for each customer at both SVB and SBNY, but most clients at each bank had significantly larger balances.
The loan-to-value ratio is the main reason for each failure because the banks invested in long-term bonds that have lost value over the past year due to rising interest rates. The falling value of those investments meant the banks no longer had enough cash on hand or assets to sell that would meet withdrawal requests from customers. Each bank has relationships with cryptocurrencies, venture capital, and other high-risk loans. Many of the news headlines about SVB and SBNY reflect concerns that the impact from the failures could have broad impact on other parts of the economy.
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The Federal Government’s Response
As announced on the morning of March 13, the U.S. Government has stepped in to support both banks. The government has created a pool of over $100 billion to support SVB, SBNY, and any other financial institution that’s in trouble. That’s good news for a lot of companies across the country who were in danger of not being able to make payroll without this government support. For example, there is a publicly traded technology company in Minnesota that had over $2 million in deposits at SVB and only $250,000 would have been protected without government intervention. SVB and SBNY aren’t the only banks that have lost money on their investments over the past year, but neither of these banks had a safety net in place to support a significant increase in withdrawal requests.
Should We Be Worried About a Domino Effect?
Although this will be an evolving situation over the next few weeks, there are no signs of widespread concerns about the stability of the U.S. financial system. The biggest banks are regulated by the Dodd-Frank Act and have much lower loan-to-value ratios, meaning they are in a good position to meet withdrawal requests from customers. The proactive steps by the U.S. Government to intervene at the early stages of the crisis should limit the impact of these bank failures. In fact, both banks are up for sale and could be purchased by companies that will have the financial resources to get through the short-term crisis. It is also worth noting that neither bank would have failed without a significant increase in customer withdrawal requests which were initiated due to concerns about the stability of each bank.
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What Does it All Mean for Flourish Clients?
SVB and SBNY are both publicly traded companies and are very small holdings in the S&P 500 Index and the Russell 1000 Index (both less than 0.05%). We use strategies that replicate both of these indexes and own some CDs issued by SBNY that will be supported by the FDIC, but we do not have direct ownership in either stock. It is helpful to know that there are limited direct effects on client portfolios from these events. In addition, we expect the broad impact on the stock market to be relatively mild and short-lived now that the U.S. Government is involved. There will most likely be government oversight meetings about how banks like SVB and SBNY are regulated, but those conversations will stretch out over many months with minimal (if any) impact on the stock market.
Final Thoughts on SVB, SBNY and Broader Impact
In summary, two regional banks failed after being unable to meet short-term cash demands due in large part to making investments that lost money. The FDIC is supporting clients with up to $250,000, and the large clients at each bank will receive support from the U.S. Government – a combination that will, hopefully, limit broader impact from these failures. This is a rapidly evolving situation with expectations for short-term market disruption but minimal longer-term impact.
Client portfolios at Flourish have minuscule exposure to these developments, we are comfortable with how client accounts are currently invested, and we don’t plan to make any immediate changes or adjustments based on events at SVB and SBNY. An important and consistent lesson from historical crises is that maintaining a long-term perspective with a patient investment approach is difficult in the moment but has proven to be the most effective response.
About the Author
Jay Pluimer, AIF® CIMA®
Jay Pluimer brings over 25 years of experience working with Investment Committees and individual investors to Flourish Wealth Management. He has built a career focused on investment research, client conversations about investments, and building diversified portfolios to help clients accomplish their goals. As Director of Investments, Jay is passionate about the opportunity to deliver individualized investment solutions for our clients that help align their resources and goals.