Silicon Valley Bank & Bonds – FDIC Coverage and the unfolding saga
This is likely a refresher for most, intended to inform and educate. As this story unfolds, sensational headlines and fear-mongering is undoubtedly on the horizon.
Ultimately, creating and managing a financial plan is the most effective way to avoid making hasty decisions in times of uncertainty. Cash management is one piece of a comprehensive financial plan, though it doesn’t often get addressed by traditional advisors.
WHAT IS THE FDIC?
The Federal Deposit Insurance Corporation insures deposits at over 4,000 participating institutions across the United States.
Deposits are insured for up to $250,000 per depositor, per insured bank, per ownership category.
Here are the deposit categories: 1
Single Account: Checking, Savings and Money Market accounts – all single account types up to $250,000.
Joint Account: A deposit account owned by two or more people, without named beneficiaries. To qualify for coverage, all owners must:
- Be living people
- Have equal rights to make withdrawals
- Self-directed Keogh plan accounts
- Sign the deposit account signature card (unless the account is a CD). Electronic signatures meet this requirement.
Revocable Trust Account:
A deposit account owned by one or more people that identifies one or more beneficiaries who will receive the deposits upon the death of the owner(s). This includes both formal “Living” Trusts and informal In Trust For (ITF)/ Payable on Death (POD) accounts.
- A revocable trust can be revoked, terminated, or changed at any time at the discretion of the owner(s). The account title must disclose the trust relationship with phrases such as Living/Family Trust, POD, or ITF.
- Beneficiaries must be people, charities, or non-profit organizations, and must either be named in the bank records or identified in the trust document.
Irrevocable Trust Account:
Irrevocable trusts typically have contingent interests which result in the trust being insured for a maximum of $250,000, regardless of the number of beneficiaries designated. However, the non-contingent interests of a beneficiary in all irrevocable trusts established by the same owner and held at the same bank are added together and insured up to $250,000.
Certain Retirement Accounts:
FDIC deposit insurance covers retirement accounts in which plan participants have the right to direct how the money is invested, including:
- Individual Retirement Accounts (IRAs)
- Self-directed defined contribution plans, such as a 401k or profit-sharing plan
- Self-directed Keogh plan accounts
- Section 457 deferred compensation plan accounts, whether self-directed or not
Corporation, Partnership Accounts:
Deposits owned by corporations, partnerships, and unincorporated associations, including for-profit and not-for-profit organizations. The corporation, partnership, or unincorporated association must be separately organized under state law and operate primarily for some purpose other than to increase deposit insurance coverage.
Employee Benefit Plan Account:
A deposit of a pension plan, defined benefit plan, or other employee benefit plan that is not self-directed. An employee benefit plan account is an account representing funds of a plan where investment decisions are made by a plan administrator (not by the participants).
How FDIC coverage works:
Q: What happens when a bank fails?
A: In the unlikely event of a bank failure, the FDIC responds in two capacities.
First, as the insurer of the bank’s deposits, the FDIC pays insurance to depositors up to the insurance limit. Historically, the FDIC pays insurance within a few days after a bank closing, usually the next business day, by either 1) providing each depositor with a new account at another insured bank in an amount equal to the insured balance of their account at the failed bank, or 2) issuing a check to each depositor for the insured balance of their account at the failed bank.
In some cases—for example, deposits that exceed $250,000 and are linked to trust documents or deposits established by a third-party broker—the FDIC may need additional time to determine the amount of deposit insurance coverage and may request supplemental information from the depositor in order to complete the insurance determination.
Second, as the receiver of the failed bank, the FDIC assumes the task of selling/collecting the assets of the failed bank and settling its debts, including claims for deposits in excess of the insured limit. If a depositor has uninsured funds (i.e., funds above the insured limit), they may recover some portion of their uninsured funds from the proceeds from the sale of failed bank assets. However, it can take several years to sell off the assets of a failed bank. As assets are sold, depositors who had uninsured funds usually receive periodic payments (on a pro-rata “cents on the dollar” basis) on their remaining claim.2
SILICON VALLEY BANK – A CAUTIONARY TALE OF RISK MANAGEMENT & BOND BASICS
Turning to Silicon Valley Bank, a 40+ year old institution catering largely to Venture Capital and Private Equity funds and their Startup/ Life Science companies.
The 18th3 Largest Bank by Deposits in the US collapsed virtually overnight as Moody’s downgraded SVB on March 8th. On March 9th, Customers withdrew $42B, leaving cash assets at just under $1B, causing share prices to drop 66% before trading was halted on March 10th.
On the morning of March 10th, the California Department of Financial Protection and Innovation took control of SVB and appointed the FDIC as Receiver.
Over the next few weeks and months more information will be released as to what happened, and the ripple effects will continue to unfold.
The pundits and financial news media will explain at length all of the reasons that this happened, with sophisticated jargon meant to make them look clever.
The liquidity crisis appears to be based on a lack of risk management, poor oversight and failure to implement the most basic bond investment strategy.
BOND INVESTING & INTEREST RATES
When investing in Bonds, it’s essential to match your time horizon (when you need to spend the money) with the Bond’s duration (similar to its maturity).
Why?
Interest rate risk is a fundamental yet overlooked challenge of investing in Bonds. Bonds are very sensitive to interest rates, the longer the duration of the bond, the more sensitive they are to interest rate hikes.
A basic rule of thumb is that for every percentage point of interest rate increase, a Bond’s value will decrease by its duration.
Example: 2% increase in interest rate, a bond with 7 years of duration can reasonably be expected to decrease in value by roughly 14%. Meaning, if you had to sell the Bond, for whatever reason, you’d be selling it for a loss.
The longer the duration of the Bond to maturity, the more sensitive to rising interest rates.
This is not a problem if you intend to own the Bond to Maturity, as the interest payments stay the same, and the principal is expected to be repaid at Maturity.
Simple, right?
The problem is, if you’re forced to sell a Bond before maturity.
That appears to be one of the things that happened with SVB.
We’re told they were over-invested in longer duration Bonds, got squeezed by interest rates, and didn’t have sufficient cash reserves to meet obligations – and therefore were forced to have a fire-sale.
WHAT IT MEANS FOR YOU
1. It’s a great time to be sure that your FDIC coverage is adequate, and that your accounts are titled correctly.
2. While you’re at it, be sure that you have beneficiary designations correctly filled out.
3. If you have created and maintain a comprehensive Financial Plan – stick to the plan or get a second opinion if you have concerns.
4. If you own Bonds, understand why you own them, and what you can expect to happen to that portion of the portfolio so that you don’t get caught having to sell them at a distressed price.
We’ve been in a period of rising interest rates for the past year and a half, and any money manager worth their salt is either:
- Using short duration Bonds
- Using Bond alternatives
If you’re paying someone to manage a portfolio, and there was no communication about Bond strategy over the past few years, it wouldn’t be unreasonable to get a second opinion.
Working with a Financial Planner is one way to avoid being scared into making mistakes by the financial news media. When you understand why you’re invested the way you are, and that uncertainty is inevitable, it’s much easier to stay the course and enjoy your retirement!
If you aren’t sure why you’re invested the way you are, it’s not a bad idea to get a second opinion.
– Ian
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1https://www.fdic.gov/resources/deposit-insurance/financial-products-insured/
2 https://www.fdic.gov/resources/deposit-insurance/faq/
3https://en.wikipedia.org/wiki/List_of_largest_banks_in_the_United_States
