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Understanding Recent Banking Failures
Well, I suppose I have no choice but to talk about the bank failures we saw last week. Actually, I’m happy to do this to help bring some clarity and understanding to what may seem complicated. I thought about doing a special edition podcast as the news broke about the FDIC closing Silicon Valley Bank – but decided that I would let the dust settle a bit so I could present a well-informed account. I’ll start by making a summary about the failures of Silicon Valley Bank and Signature Bank, and then I’ll go on to unpack it in more detail and share some implications for you and your money. Here’s the summary: The dramatic rise in interest rates over the last year has exposed companies (including banks) that either have a high degree of risk or a high degree of industry concentration. This is causing a shift of resources within the banking industry. This is not a collapse of the banking system, but a recalibration of where assets are held in the banking system. Now let me unpack this.
First of all, when interest rates go up in dramatic fashion, businesses, regardless of the industry, with high degrees of debt are affected. The tech industry was one impacted most by rising rates. These companies saw record earnings during the pandemic. Some of those companies adjusted their business model, assuming those record levels of revenue were the new normal. When we began to emerge from the fog of Covid and people began to spend money on services again instead of goods and technology, revenue for these tech companies went down. At the same time they saw revenue coming down, costs were going up, especially in the area of their interest cost. Tech start-ups in particular with lots of debt would have been the most vulnerable – and that was one of the primary customers of Silicon Valley Bank. These tech companies began drawing down deposits to keep their businesses afloat. Other companies that specialized in helping start-ups (known as venture capital companies) also began needing more cash to operate because of the stress on the system of higher interest rates. To meet these withdrawal requests, Silicon Valley bank had to sell investments they owned at a loss. This became public knowledge, those withdrawals accelerated, and they reached a point where there was an all-out run on the bank. A run on the bank is like what you saw with George Bailey in “It’s a Wonderful Life”: everyone trying to get their money out at the same time. So, Silicon Valley’s demise appears to have been primarily driven by its concentration in a sub-industry that fell on hard times all at once.
Not long after, Signature Bank was closed. This bank in New York appears to have had a high concentration of customers with money over the $250,000 FDIC deposit limit which was also the case for Silicon Valley Bank, so it immediately came into the crosshairs as the market surveyed the landscape. Not only that, but there also appears to have been exposure in some shape or form to crypto currencies. New York Community Bank stepped in over the weekend and bought Signature Bank.
I’ll say it again, because it is a truth that I think is so important – high interest rates, especially those that rise rapidaly, expose risk taking. Those risks may have been profitable when interest rates were low, but now may have become unsustainable with interest rates that are high. The banking industry and tech industry are not the only ones that will have surprises like we’ve seen in the last week and a half. There is certain to be more fallout in other places in the economy as companies with lots of debt may have seen their variable rate loan costs more than double. It’s the natural unfortunate consequence of this part of the economic cycle.
I mentioned in my summary statement that we are seeing a shift of resources within the banking industry. Companies are now starting to underwrite their banks much like their banks have underwritten them for loans. In other words, businesses are checking on the financial health of their banks to help give them some measure of assurance that any money held over FDIC Insured limits will be safe. Now as an overall industry, banks have rarely been in better shape. The sector generally speaking is very strong. Capital Ratios are high. Loan losses have been minimal. Earnings have been strong for years. But certain players in the system may be singled out by the market (maybe even unfairly), perhaps because they made high risk bets, or perhaps they were overly concentrated with a particular client base, or perhaps they were thrown in with similar banks.
I closed my summary statement by saying this is not a collapse of the banking system, but a recalibration. Every night, individuals must decide the safest place to keep their money. We could call this a “store of value.” So where are you going to store your value? Some decide to hold it in US Treasuries. Others have it in a bank account. Still others have cash under their mattress while some decide to put it in a host of other alternatives. Every form of money has risks. There is no such thing as a risk-free place to put your money. You simply have to decide what risks you are willing to accept. If you withdraw your money from a bank and take a bunch of cash home, you’re taking on a whole new set of risks that you don’t have to worry about when your money is in the bank. The banking system has been one of the safest and most effective ways throughout history to not only store, but also move, your money efficiently. Although people may take a fresh look at where they put their money, the banking system will survive. And it is in everyone’s best interest that it not only survives but thrive. Banks are the circulatory system of the economy. Banks take resources from certain players in the economy and put them to work on other parts of the economy. They connect sources of money with uses for that money. The banking system has always been critical to the financial health of communities, and it will continue to be so.
Let me mention briefly the important distinction of community banks from regional and large banks. Community banks know their customers and their customers know them. Community banks have a very different business model than large banks, typically being very diversified in their client base. Many community banks are owned by people in those communities, so those banks are not under the pressure of publicly traded stock prices and investor expectations that could drive aggressive risk taking to meet the next quarter’s earnings estimates. These distinctions are likely to become even more clear as pundits debrief on the actions of public policy makers during the last few weeks.
So, what kind of decisions should you make in light of this:
Utilize FDIC insurance as best as you can. The FDIC insures up to $250,000 per deposit category. In other words, one person can have a few different kinds of accounts and be insured for more than $250,000. If this is important to you, consult with your banker to structure your accounts in such a way that you can maximize the FDIC guarantees available.
Know your bank and your banker. In a world where technology can make things easier, it can also make knowledge of those we are doing business with harder. It really does matter who is on the other end of your transactions. If you have more than the FDIC insured limit in your bank, know their risk appetite. Understand their long terms goals and ownership structure. A bank should be a partner – not just a logo on your banking app.
Be ready for opportunities. In this high interest rate environment, and with the very real possibility that rates go even higher to fight inflation, there are going to be companies in multiple industries that close their doors. There may be opportunities to buy things on sale. Raise your reserves. Have cash on hand. Keep your eyes open. Every environment, even the tough ones, contains opportunities for those with the resources to seize them.
At MBC and Foundation Bank we’ve been serving West TN Communities for almost 90 years. All along the way we’ve tried to make decisions that will allow us to continue serving this area for decades to come. If you want to learn more about us, explore our website or stop by your local branch. If you’ve found this podcast helpful, we hope you’ll subscribe to it in your favorite podcast app and share it on social media. Please remember that this does not constitute a recommendation specific to your own unique circumstances, so please consult your own advisor, particular when it comes to FDIC insurance. And until our next episode, God bless you.
-President Chad P. Wilson, CFP
Today’s episode of “Money Matters” was written and recorded by President Chad P. Wilson of McKenzie Banking Company / Foundation Bank on March 21, 2023. This episode does not constitute financial advice. Please consult a financial professional to discuss your specific needs. MBC/Foundation Bank is an Equal Housing Lender, Member FDIC.