Episode Transcript
Brenton: Every time you've looked on your phone this week or check the news, it's likely that somebody has been talking about the collapses of Silicon Valley Bank and Signature Bank, the second and third largest collapses in US history. But that doesn't mean that you actually understand what it means for a bank to collapse and why these two banks did so as well.
These few minutes may help you out.
Brenton: The first place we have to start in breaking down why SVB collapsed is with bonds and how they work in the first place. A bond is an instrument of debt. Think of it as something that a corporation, a city, even a country can use to borrow funds from investors to fund certain projects of their own.
And [00:01:00] when they issue these bonds, whether it be a city or a company, they do so in certain denominations. Those denominations may be a hundred dollars or they may be as high as a thousand dollars. And whatever that denomination is, is considered it's par value.
The par value of a bond is important because it helps dictate how much the investor is getting in interest payments every single year. You see, a bond can be given for a year, five years, 10 years, even 30 years. And if you're going to lock up a person's money for that long, they're going to want something in exchange. And what they get in exchange are called coupon payments. And these are payments of interest based on the par value of that bond.
As an example, let's say you have a bond with a par value of a thousand dollars that issues 5% coupon payments biannually. What this means is that 5% of a thousand dollars, which is $500 will be given to the bond holder and they're going to do that twice a year. So in this case, the bond holder would get a $250 coupon payment every [00:02:00] six months to total the 5% interest they're going to receive for the year.
But you also need to understand that you can sell bonds or buy them on bond marketplaces.
And you don't have to buy them for a thousand dollars, even if it's its par value. Instead the amount that you pay or sell your bond for has a lot to do with the other bonds that are available in the marketplace.
And this is what it means when people say that when interest rates go up, bond prices go down.
When new bonds are issued with higher interest rates than what's currently available in the marketplace. Everybody who's holding those old bonds has to scramble and lower the price of their bonds if they want to sell them.
How has this connected to banks? Well, when you look at Silicon valley bank and signature bank, they make money like all banks make money. If you have a bank that is.
Now, what does this have to do with Silicon valley bank and signature bank? Well, these two banks make money. Like all banks make money. The first way is by receiving deposits. These banks then take that money and they loan [00:03:00] it out to customers, and a significant portion of the income they receive is from the interest they collect on those loans that they're issuing to their customers. And they turn around and use a portion of those revenues to pay interest on their depositors.
another characteristic to know about these banks, is that they're not required to keep a hundred percent of your reserves actually at the bank. This is called fractional reserve banking, where they only have to keep a certain percentage of their deposits on hand and they can lend more than has been deposited out to their other customers.
Here's where these two banks ran into problems. During the pandemic when interest rates were really low, a lot of consumers and small business owners didn't use as many loans because they had more cash on hand. And they put that cash on hand in deposits through banks like SVB bank. As a matter of fact, Silicon valley bank's deposits went up over 300% in the pandemic.
If you have a threefold increase in deposit, these depositers want interest on the money they put into the bank. But if nobody's taking out loans, you've lost a crucial [00:04:00] source of revenue. So these banks had to find a way to get a spread on the money they were paying to their depositors and what they were earning in cash at the bank.
And they decided to go to another source of revenue by buying billions of dollars of treasury bonds. And treasury bonds are secure, but they pay a notoriously low interest rate. But the bonds that were available in the marketplace were paying an even lower rate at that time. So the value of those bonds was still higher and these banks were still making a profit on these investments.
Then comes the last 18 months where the federal reserve starts rapidly increasing interest rates. And remember when interest rates go up, the price of existing bonds goes down. And as a result, Silicon valley bank and signature bank are looking at billions of dollars of bonds that they're holding in their portfolio that are now essentially worthless because the interest rate they pay are so low that they can't sell them for a premium. They can't even sell them at a discount.
They have to take almost a total loss on these assets. [00:05:00] As a matter of fact, last week, SV Bank sold 21 billion worth of bonds, the majority of which were in US securities. And because of those low interest rates, the price they received was less than what they paid for them, and it led to an almost 2 billion loss. Simultaneously, they said they were gonna try to cover that loss by raising money from other investors. And when analysts heard this, they sounded the alarm that the finances of these banks might be shaky. And it led to an old fashioned bank run, where depositors nervously run to the bank and withdraw their funds as fast as possible.
But remember, these banks operate off of fractional reserve banking. They do not have a hundred percent of the deposits there. And the amount of money that was withdrawn from SV Bank exceeded the cash they had on hand, and it led to them being insolvent and eventually collapsing.
So that was the collapse of SV Bank and Signature Bank in a nutshell. And after the break, we'll tell you how this collapse could impact not only business owners, but [00:06:00] employees of these businesses who bank with Signature Bank, SV Bank, and similar banks.
And also the impact it could even have on you as an investor who might be in the banking industry without even knowing it.
[00:07:00]
Brenton: Before the break, we told you some of the things that led to the collapse of Signature Bank, Silicon Valley Bank, and similar institutions that are seeing some turmoil in that space.
And a lot of you might think that you're not impacted by it, but you'd be surprised and some people have already been surprised to find out that they are indeed subject to events like what happened last week. If you're an employee of a West Coast company, a venture capital company, a tech company, you might have already found out this week that your employer had funds with these two institutions, and you're wondering if your employment is on shaky ground because many businesses of various sizes [00:08:00] were wondering whether they'd be able to make payroll this coming week or meet expenses because they had significant funds with these institutions that were not insured. And here's what that means.
The FDIC insures accounts for banks up to $250,000. So if you have an account, and many businesses do, that has significantly more than $250,000 in it. Anything above those amounts are uninsured. Meaning if a bank collapses, there is not necessarily a federal entity that's going to come in and ensure that you can get your money out.
Now, thankfully, if you're one of these employees who unwittingly was a part of this disaster, there is already relief on the horizon. Because this past weekend, the government announced that they were going to save people who were exposed to the banks, failures via deposits, not actually saving the bank themselves.
What this means is that if you were a shareholder of the bank, if you were exposed to them, either knowingly or unknowingly through investments, [00:09:00] if you were management of the bank, if you're talking about the bank's assets themselves, they are still at risk and will fail without someone else coming in to save the day. But if you were a depositor who had your funds there, a small business who had payroll accounts there. If you are an employee of a small business or a large business who had deposits at these institutions, you should be okay. Because the FDIC is going to go above and beyond their $250,000 insurance limit to make sure that no one goes without when it comes to getting the funds back, that they initially deposited.
But as you can imagine, when you talk about coming in and seeing the government save a company's customers above and beyond insurance, they already provided, it led to a firestorm on both sides of the aisle about whether this is the government going too far in socializing the banking industry and protecting them from its own failures.
So this is something that while we've seen it with SB bank and [00:10:00] Signature bank, I would not say that it's an expectation that it should occur again and again, if we start to see more smaller or regional banks fail in the coming months.
So, if you feel like even though your company is not exposed to these two particular institutions, but if it's exposed to another regional bank that you might be in trouble or it's worth investigating, I would agree with you; it's probably worth investigating. Because the Fed has signaled that they plan to continue raising interest rates over the coming year. And this means that other banks who are exposed to things like treasury bills are going to be at risk of seeing these assets become worthless as well. And if you don't have a hawk's eye on the assets and the balance sheets of these banks, you could also have your funds or be employed by a company who has their funds with an institution who has a significant portion of their balance sheet held in essentially worthless assets.
So if you're an employee of a company that you feel might be impacted by not just these two banks, [00:11:00] but by putting money with smaller institutions, it is worth asking your superiors, upper management, what percentage of company dollars are insured with the FDIC, and what portion is not? And for the portion that's not, are they with stable banks, larger banks, or are they with regional banks that typically work with small businesses or venture capital firms?
Like what we saw with SVB.
I can tell you it's Tuesday and I've already heard from multiple people who were worried that they might have lost their job yesterday, because they found out after the fact that their company was invested or had funds with SV Bank or with Signature Bank.
So what do I mean by invested? Well, you might also be surprised to know that banks like Silicon Valley Bank and Signature Bank can have publicly traded stocks as well, and many mutual fund managers or exchange traded funds might have a portion of their portfolios invested in bank stocks.
So even if you don't work for a company that has their funds with these two banks or a similar [00:12:00] institution, you might still have exposure to these types of institutions through your retirement accounts or through even your non-qualified brokerage accounts without even knowing it.
And then lastly, if you're of the small slice of people who have more than $250,000 set aside in an account, then you could be worried yourself about a portion of your funds that is not insured by FDIC.
If you're in the first group and you're an employee who's worried, really the best you can do is, like I said, ask questions of your employer about the stability of the funds they've set aside as an organization. If you're worried about the exposure of your assets to banking, you can actually check the allocation of the funds in which you're invested.
Or you can look into the fund manager reports and even sit on quarterly calls in some cases and ask about the percentage of exposure you have to the financial industry or the banking industry. And once you know that exposure, ask them in which companies is it invested? And you'll likely find that it's often in larger [00:13:00] banks with less exposure to some of the things we saw last week, but at least you would know and not be worried.
And lastly, if you're a depositor, here is something to understand about the way that the FDIC insurance works. It insures you for not just $250,000, it's $250,000 per registration type at each bank. And that is basically having to do with ownership. So there's all different types of ownership you can have with accounts.
You could have an individually owned account, you could also have a joint account, and it's not $250,000. It's $250,000 per form of ownership.
So let's say that my wife and I are fortunate enough to be dealing with this problem and we have $250,000 in a jointly owned account, and maybe my wife has another account that has $250,000 in an individually owned account, and maybe I have $250,000 in an individually owned account, and maybe I also have [00:14:00] $250,000 in a retirement account that's held at that bank.
So even though that is collectively a million dollars worth of deposits, all 1 million could be insured by the FDIC because it's $250,000 increments across four different registration types.
So I would say for 99.9% of depositors out there who are worried about their bank, it's something that you should not be as concerned about as long as you know you're within those FDIC limits.
But just because you likely shouldn't be worried about it doesn't mean that you shouldn't be aware, and I hope that this episode shed some light as to what's going on and will at least spur you to check and make sure your account is FDIC insured. Check with your employer to see the stability of their finances.
Check to see your exposure and your investments and go forward with that knowledge and hopefully that comfort that the money that you set aside will be okay.
[00:15:00]
