As we are sure you have seen, the FDIC stepped in to take over Silicon Valley Bank (SIVB) over the weekend. First and foremost, we want to assure that your assets at Charles Schwab are safe and secure.
To begin, we want to highlight a key difference between investment (brokerage accounts) and bank deposit accounts.
- Investment accounts are held in trust name for a client’s benefit. The assets are not comingled with the brokerage company’s assets. Because of this, if the brokerage company were ever to go into default as SIVB did over the weekend, the brokerage firm and its creditors would NOT have any access to client assets. Those assets could be transferred in full to another brokerage company at the client’s direction. There is NO risk of loss to clients’ assets because the brokerage company becomes insolvent.
- Bank Deposit Accounts are commingled with the bank’s assets. The bank receives deposits and then uses the deposit base to lend out capital to borrowers for things like mortgages, home equity lines of credit, business lines of credit, etc. Because of this, when a bank becomes insolvent, depositors’ assets MAY be at risk. FDIC insurance is the primary protection offered for bank deposits. The FDIC insures that up to $250,000 of deposits per depositor at a bank will be protected in the event of a bank’s failure. Beyond this, there are strict capital requirements for Banks to help ensure there is capital available to protect depositors beyond FDIC insurance limits. These deposits are not “guaranteed” through FDIC, so an analysis of the bank’s financial condition and its obligations must be completed before a determination can be made as to whether depositors with deposits above FDIC insured limits held at a bank may experience any loss of their deposits. This process was carried out for SIVB over the weekend, and on Sunday the Department of the Treasury, the Federal Reserve, and FDIC issued a joint statement. We have copied parts of that statement below.
Today we are taking decisive actions to protect the U.S. economy by strengthening public confidence in our banking system. This step will ensure that the U.S. banking system continues to perform its vital roles of protecting deposits and providing access to credit to households and businesses in a manner that promotes strong and sustainable economic growth.
After receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Yellen approved actions enabling the FDIC to complete its resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.
We are also announcing a similar systemic risk exception for Signature Bank, New York, New York, which was closed today by its state chartering authority. All depositors of this institution will be made whole. As with the resolution of Silicon Valley Bank, no losses will be borne by the taxpayer.
If you want to read the full text, you can access it through this link: https://www.fdic.gov/news/press-releases/2023/pr23017.html
Returning to the strength of Charles Schwab, Schwab releases a monthly activity report. Given the circumstances with SIVB, we wanted to share those comments with you now (we added the highlights).
- Client bank sweep cash outflows in February were about $5 billion lower than January and March month-to-date daily average outflows are tracking consistent with February. Importantly, these outflows reflect a continuation of client decisions to reallocate a portion of their cash into higher yielding cash alternatives within Schwab. Based on our ongoing analysis of these trends, we still believe client cash realignment decisions will largely abate during 2023.
- This activity reflects the collective behavior of our heterogenous client mix of individual retail investors and the advisors who serve them. More than 80% of our total bank deposits fall within the FDIC insurance limits, among the five highest ratios of the top 100 banks in the United States. As a reminder, our deposit base is primarily comprised of transactional cash balances swept to our banks from one of our 34 million brokerage accounts.
- We have access to significant liquidity, including an estimated $100 billion of cash flow from cash on hand, portfolio-related cash flows, and net new assets we anticipate realizing over the next twelve months. We believe we have upwards of $8 billion in potential retail CD issuances per month, plus over $300 billion of incremental capacity with the Federal Home Loan Bank (FHLB) and other short-term facilities – including the recently announced Bank Term Funding Program (BTFP).
- Our approach to managing our assets is quite different than traditional banks. So before closing, I wanted to provide some thoughts on recent comments by some pundits regarding unrealized losses within bank held-to-maturity (HTM) portfolios. As a reminder, our banks’ loan-to-deposit ratio is approximately 10% and nearly all the loans are over-collateralized by first-lien mortgages or securities. The remainder of our assets are invested in high-quality, liquid securities in either our available-for-sale (AFS) portfolio, working capital at the parent or broker-dealer subsidiaries, or in our HTM portfolio. Focusing attention on unrealized losses within HTM has two logical flaws. First, those securities will mature at par, and given our significant access to other sources of liquidity there is very little chance that we’d need to sell them prior to maturity (as the name implies). Second, by looking at unrealized losses among HTM securities, but not doing the same for traditional banks’ loan portfolios, the analysis penalizes firms like Schwab that in fact have a higher quality, more liquid, and more transparent balance sheet.
Since the Federal Reserve began tightening, weak spots in the economy and financial markets have begun to present themselves. We want to comment that they have been in HIGH RISK areas. Here is a summary of some of these recent failures:
- SVB – Significant lender to small startup ventures
- Signature Bank (NY) – Real estate lender who made significant crypto bets
- Silvergate Bank – Made large bets on cryptocurrency
- Genesis Crypto Lender
- Core Scientific Crypto Mining
- BlockFi Crypto Lender
- FTX Crypto Exchange
- Celsius Crypto Lender
- Voyager Digital Crypto Lender
- Three Arrows Capital Crypto Hedge Fund
These failures highlight the importance risk management with respect to investments. Although crypto currencies (like technology back in the late 1990s and early 2000s) probably have earned a permanent home in the financial markets, that does not mean that all are sound investments. The classic signs of too much risk are as true today as they have always been. Lending against volatile assets is risky, and if one is going to lend against volatile assets, the leverage ratios need to be VERY LOW. Some of the banks involved in crypto lending were more aggressive with the loan-to-value of their loan portfolio; it caused their insolvency. Others, like SVB did too much concentrated lending to small startup businesses and were too aggressive with the short-term investment portfolios. It cost them their business.
While we would prefer to see that failures like SVB didn’t happen, the ability to honor all of their depositor’s deposits without the tax-payer’s support (like in 2008) speaks to the strength in the banking sector as a result of the changes made in 2008. In a capitalistic economy, there is a fine line between too much and too little regulation. With too much regulation, growth and investment is stymied. With too little regulation, catastrophic failures could destabilize the economy very quickly. The current bout of financial failures (and their resolution) suggests the balance between too much and too little regulation may be just about right.
Please call or email us if you have any specific concerns you would like to discuss in more detail.