How worried should you be about what happened to Silicon Valley Bank (SVB)? Not much, but there are lessons to learn.
To start, there was a run on the bank. SBV’s depositors wanted their money back once the news was out that the bank’s tangible book values had declined. Deposits at a bank are a liability, so the bank purchases bonds to back those deposits, making money off the interest. However, for two full years through the pandemic, the fed funds rate was zero; consequently, U.S. Treasurys were yielding extremely low returns.
SVB bought higher duration bonds to get the best interest rate they could. However, when interest rates increase, the value of current bonds decreases. Thus, the bonds the bank held were valued much lower than what they paid for them. As more depositors insisted on getting their money out of the bank, SVB had to sell their bonds at market value, resulting in not having enough assets to back their deposits.
SVB tried to issue new equity, but with trouble brewing, investors did not buy quickly enough to allow them to avert collapse. Since the value of their bonds wasn’t enough to cover that liquidity need, the FDIC stepped in.
Unlike 2008 when banks were making speculative investments, this resulted from mismatching the duration of bonds to their liability; however, when they bought bonds, no one expected inflation to rise 6% or the Fed to raise interest rates eight times in 12 months.
Treasurys have a low risk of default as they are backed by the government; however, they do carry interest rate risk. When we recommend taking 10 years of expected withdrawals and holding them in a laddered bond portfolio, we are only trying to match your own need with an asset. When interest rates are low, we recommend keeping bond maturities short so you can reinvest at potentially higher rates in the future. We didn’t buy 10-year Treasury bonds yielding 0.52% because if investors had to access their money earlier, they could take a significant hit selling the bonds before maturity and potentially lose yield if rates increased.
This is what happened to SVB. They locked in low rates at long maturities and needed to cash in the bonds because of the run on the bank. Regulators allow banks to keep bonds on their books at cost to back deposits—what they paid for them. On paper, a bank can look well reserved, but if they had to write down their assets to book value or sell them unexpectedly, they may not be as well funded.
SVB is a significant banker for venture capitalists and startup companies. Many depositors were well over the FDIC limit of $250,000. Had the Fed not stepped in and provided unlimited insurance or loans to banks on their underwater bonds, many businesses would be unable to operate or make payroll. The FDIC bailed out the depositors—not the bank.
The lesson here is to ensure your deposits are within the FDIC limits. Should there be an issue, the bank has FDIC insurance to cover you.
If you have questions on the limits in any of your accounts managed by Henssler Financial or those held outside our management, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the March 18, 2023 “Henssler Money Talks” episode.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
