Silicon Valley Bank: What Happened and What Comes Next
Published: March 15, 2023
What Banks do with Deposits:
When a bank accepts deposits from a customer, they owe the customer that money. Deposits are considered liabilities to the bank. These deposits cost the bank money in the form of interest paid and service to their customers (branches, tellers, etc.). To pay for the cost of these liabilities (deposits), banks turn them into assets: lending them out as loans. If a bank can’t lend deposits responsibly, it often uses them to buy loans or securities like US Treasuries and Mortgage-Backed Securities (MBS).
Since SVB tripled its deposits in a short period of time, it knew that it couldn’t lend that new money out responsibly at the same rate. Rather than make risker loans, they bought assets guaranteed by the US Government (Treasuries) and Mortgage-Backed Securities. However, they bought these bonds with a long maturity rate to try to get a higher yield (interest rate).
Bonds have what is called “Interest Rate Risk.” When interest rates rise bond prices fall. The longer the maturity on the bonds, the more the interest rate movements impact the price of those bonds. A good rule is for every 1% movement on interest rates, a 10-year bond will decrease in value by 10%. If you hold on to bonds until maturity, these temporary declines are not as big of a risk if the bonds are high quality. At maturity you get paid back the par value of the bond (generally the dollar amount you paid to acquire it).
So, Silicon Valley Bank bought high quality bonds, but it bought many of them with a long maturity at low interest rates. Once the Federal Reserve raised rates, those assets declined in value. When a large number of SVB’s depositors asked for their money back, SVB had to sell these bonds at a loss to generate the large amount of cash needed for these withdrawals (over $42 Billion in 2 days). They did not have the luxury of waiting for the bonds to mature to avoid losses.
Why Silicon Valley Bank was Most Impacted:
Above, we have discussed the risk that even if bonds are of high quality, they can still have interest rate risk. Most banks have risk management in place to hedge against this risk. If you have a large amount of US Treasuries or similar risk bonds, you lock in a fixed interest rate on those investments. Rising rates represent a risk, but banks can hedge this risk. They can enter into an interest rate swap. An interest rate swap is essentially insurance against the increase of interest rates. A bank would buy these swaps and pay a premium to offset the risk of their bond portfolio declining in value, if interest rates increase. The downside is that it reduces the banks return on their bond portfolio because of the cost of the insurance.
Silicon Valley Bank (and there are a few others) are unique in the allocation of their deposits. 57% of their deposits are invested in bonds instead of loans to customers (the average US bank is 24%). But most importantly, they did not hedge interest rate risk at all. Looking at their balance sheet, they did not have any interest rate swaps in place to protect from the decline of their bond portfolio. In turn, this exposed their investors and most certainly their depositors to a huge amount of risk. This means that SVB was not applying basic risk management practices for a bank.
What Comes Next?
This is not a financial issue like we saw in 2008-2009. That was caused by a much more serious credit issue with banks and the overall US Economy. This is directly correlated to mismanagement of interest rate risk a few select banks.
The FDIC has stepped in to take control of these banks. Together with the Treasury Department and the Federal Reserve, the United States government has agreed to back all deposits of these banks and set up a new credit facility to provide liquidity to banks under stress. Stockholders of these banks will most likely have a complete loss, but depositors will not bear any of the burdens of the mismanagement of these banks.
The new program is the Bank Funding Term Program (BFTP). It will allow banks to liquidate their bond holdings when in need of raising liquidity to meet deposit outflows. Essentially, banks can sell high quality bonds to the Treasury Department for full value but are charged an interest rate to do this. This will hurt revenue for banks that have to access this program, but it is better than going belly up.
Raymond James Bank Enhanced Savings Program
The Raymond James Bank Enhanced Savings Program is a strategic savings program with a competitive interest rate that offers clients higher yields and FDIC insurance than standard savings or checking accounts. This program offers a competitive rate currently at 4.50% and offers FDIC coverage up to $50M per depositor. This coverage is provided through a network of 3,000 banks providing $250K of FDIC insurance coverage on New Money brought to Raymond James from external sources. A minimum initial deposit of $100K is needed to open an Enhanced Savings Program account. There are no bank account fees, and funds can be easily transferred with next-day availability.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Hall Financial Advisors and not necessarily those of Raymond James. APY as of 3/1/2023. Subject to availability. Terms and conditions apply. Interest rate may change after the account is opened. Cash on deposit at FDIC-insured institutions through the Enhanced Savings Program offered by Raymond James Bank is insured by the FDIC up to $250,000 per insurable capacity per depository institution (bank), subject to applicable FDIC rules and limitations. The minimum deposit required to open an Enhanced Savings Program account is $100,000.
The Enhanced Savings Program relies on the services of IntraFi Network, LLC for the placement of deposits at a network of third-party FDIC-insured depository institutions. The current list of FDIC-insured depository institutions in the network is shown at https://www.intrafinetworkdeposits.com/find-intrafi-network-deposits/. Raymond James is not affiliated with IntraFi Network, LLC.
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