Our Thoughts on Bank Failures
In the past week, two regional banks have failed. Signature Bank out of New York is the smaller of the two. They primarily catered to the cryptocurrency world. Silicon Valley Bank (SVB) is a much larger bank, but it too is a specialty bank that worked principally with start-ups and venture capital firms.
Federal Safeguards
Both banks are now under the control of the Federal Deposit Insurance Corporation or FDIC. The federal government announced that all depositor’s funds will be fully available – even those accounts which exceeded traditional insurance limits of $250,000. Quick action by the FDIC provides a backstop for individuals and companies that use those two banks for things like checking and savings accounts. This move is intended to thwart further bank failures. It is providing more stability and confidence in the banking industry through a variety of measures.
How Did We Get Here?
The simple answer is interest rates. Specifically interest rates and the speed at which they have risen over the past year. The Federal Reserve (the Fed for short) has a dual economic mandate: to maximize employment and keep inflation in check. Rising inflation has motivated the Fed to hike interest rates in a historically speedy manner to slow down the pace of the economy and in turn cool inflation down. Is it working? Yes, however, the status quo can be upended in situations like this. In this case, the banking industry has been under pressure because they often invest funds into government bonds. It’s a safe practice on the surface because the credit quality of government bonds safeguards against default….BUT, interest rate risk or duration risk is a different story. There is an inverse relationship between bond prices and bond yields. Consider this example: if a bank buys a 10-year bond with a rate of 2%, that bond is worth less money when a similar newly issued 10-year bond is yielding 4%. For the bank, holding that bond to maturity to guarantee face value (also know as par value or principal) is not always an option. When depositors are asking for money back from their bank in droves, these banks have to sell assets like the bonds. Sometimes at significant losses. This places the banks under more and more pressure until they ultimately topple.
The Fallout
Isolated turmoil can spill over. As a result, the banking issues associated with SVB can infect other banks and the financial sector at large. Are more banks at risk of failure? It’s possible. That said, it’s important to realize that not all banks and financial institutions are the same. There will be continued downward pressure on the entire publicly traded financial sector for the near term. These market risks are not company risks necessarily – although sometimes certain companies can get thrown into a boiling pot even when they don’t deserve the negative attention. This has happened with several banks. Charles Schwab is one of them. OnTrack Wealth Management utilizes Charles Schwab as the Custodian of our client’s investment portfolios. We have full faith in the ability of Charles Schwab to continue in that role as Custodian. Recent communications from Charles Schwab shed light on their financial strength and capabilities. What’s more, it’s important to note that any cash in the Custody of Schwab Bank is covered by the FDIC. Moreover, Charles Schwab as a broker-dealer is covered by the Securities Investor Protection Corporation (SIPC). The result is that your securities at Schwab for stocks and bonds are segregated in compliance with the U.S. Securities and Exchange Commission’s Customer Protection Rule making them fully protected against creditors’ claims in the unlikely event that a broker-dealer were to become insolvent.
What Does This Mean For Investors?
In the short term, we anticipate that market volatility will increase. Markets react to uncertainty in emotional ways that causes prices to rise and fall (again and again) in quick succession. It’s important to note that we maintain a long-term minded investor mindset. The turbulence of today and tomorrow will not last forever. The question we must ask is are we well diversified? Yes. OnTrack Wealth Management maintains diversified portfolios with assets allocated across different industries, company sizes, and countries. We do not go “all in” on one company or even one sector. And we continue to balance allocations between stocks and bonds. We are seeking yields in fixed income with a shorter duration to ameliorate interest rate risks. We maintain that stocks will continue to appreciate over the long term. In fact, the Fed may slow or even eliminate future interest rates hikes as a result of the current banking situation and this could enable more stock appreciation.
As always, if you have any questions or concerns, please let us know. Reach out anytime. We are here working for you as fiduciaries to achieve your goals.
Jim Burns, CFP®, CPA
Jeremy Whiddon, MSPFP, MA