Hamilton Capital Partners | Atlanta, GA — Hamilton Capital Partners

Opinion – FDIC is Worthless

By Kelvin Lee, Alonso Munoz

It’s been 15 years since the Great Financial crisis, and history has repeated itself. U.S. Banks failed, the government stepped in, and everyone is scrambling to assess risk. The last 72 hours have been remarkable, and the fallout is likely far from over. Yet again, it is the American people that suffer most from the failures of the banking system, regulators, pompous bankers, and financial elites.

Aside from all the headline news and drama, one of the most interesting developments is the concept of FDIC insurance. Most of us have a general understanding that our money is “safe” at the banks, up to $250,000. In the case of Silicon Valley Bank’s depositors, the government stepped in and backed all deposits, regardless of amount. Although this was likely the right short-term move, it potentially sets the precedent for the action governments are forced to take when banks fail.

So, what’s the lesson learned from all this? Don’t put all your money in one place? Yeah, try splitting your $5M between 20 different banks. What is the alternative? We know that banks are currently paying little on savings accounts. Even banks that are paying higher yields are likely benefiting from paying you less that what you could achieve on your own. So why not cut the middleman out? Or at least implement a backup plan for your excess cash.

Enter U.S. treasury bills. You can very easily buy treasury bills yourself, or through your investment managers, and make every penny of the current yields (assuming no management fee). The treasury bill is a better solution than any FDIC insured checking or savings account. There are few limits, no credit risk, and no liquidity concerns. Treasury bills are issued by the U.S. Treasury, with durations under 12 months.

Maybe you sold property, a business, or have funds for a future investment or development. Considering this alternative, while yields are still attractive, makes sense especially as banks are on the verge of a full-blown crisis.

What’s the investment or repayment risk? Well, only if the U.S. government collapses, and at that point, FDIC protection wouldn’t matter anyway. For true cash management, rolling the 4-week Treasury Bill ensures that you have a short time horizon to get your funds back, without being exposed to rapid changes in yields.

The true winners of money market funds, CD’s, or bank deposits are the banks and sponsors of those products.

As will all things money, make sure you have a good understanding of the basics, risk, and cost, but taking control of your cash makes more sense than hoping that your bank doesn’t fail.

What kicked all of this off? Here’s a quick rundown on why the Silicon Valley Bank (SVB) collapsed last Friday:

The bank used deposits to buy “safe” long duration treasuries and mortgage-backed securities.

That’s normal practice among banks, borrowing short and lending long. However, banks also use loans to generate income on deposits, and SVB didn’t have much of a loan book. Most of SVB’s clientele are tech startups flush with cash from venture capital, IPOs, and other liquidity events. Those clients don’t have a need to borrow money, but rather, an institution to store it.

Interest rates went up, lowering the market value of SVB’s bonds by approximately $15 billion.

SVB turned out to be extremely interest rate sensitive as it brought bonds on a much greater scale than peers, with over 56% of SVB’s assets locked in fixed rate securities. As interest rates increased, the market value of these securities fell hard.

These losses depreciated to a degree that SVB’s assets at market value were about equal or less than its liabilities, i.e., insolvency.

Remember, banks earn money by making more interest on your money than they give you, aka net interest income. If a bank gives you 1% on your deposits while they lend or buy a bond yielding 3%, they capture the 2% spread. However, what if interest rates go to 4%? The bank needs to increase the interest they give you to keep deposits but, as in SVB’s case, if they are locked into a 3% yield then they lose money.

SVB’s clients noticed this and started withdrawing money, fast.

Depositors attempted more than $42 billion in withdrawals just last week. The concentrated tech startup clientele of SVB caused the urgency. Small growing tech companies and venture capitalists talk with each other and when news that their bank is insolvent comes out, withdrawal requests came in all at once.

SVB used all its cash and was forced to liquidate its bonds at a loss to fund the withdrawals.

The unfortunate news is that SVB would have likely survived if the withdrawals didn’t happen so rapidly. If depositors didn’t spark a bank run, SVB wouldn’t have had to lock in losses on their securities and as they matured or interest rates fell, SVB could have rolled the funds into higher yielding securities at better market values. SVB had positive net interest incomes this quarter, so the bank did make money, just not enough to cover immediate losses on its whole portfolio. That’s the problem of being forced to sell anything.

The bank was declared insolvent and seized by the Federal Deposit Insurance Corp (FDIC)

SVB was unable to borrow the capital or raise enough of it to cover its deposits and was insolvent by Friday. About $165 billion of the $173 billion in deposits were over the $250k FDIC limit and thus uninsured. However, FDIC has promised to make whole to all depositors, even the uninsured ones. The Federal Reserve also established a Bank Term Funding Program that provides loans where collateral will be valued at par rather than market value. Banks can get bigger loans for securities that are worth less due to higher interest rates, which is another backstop (or get out of jail free card) for banks.



To contact the author of this story:
Kelvin Lee at kelvin@hamiltoncapllc.com

To contact the editor responsible for this story:
Alonso Munoz at alonso@hamiltoncapllc.com

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