By Haddon Libby
The recent failures of Silicon Valley Bank and Signature Bank have forced the Federal Reserve to step in to ensure depositors that all deposits at banks are money good. As the Fed have made this statement but not offered anything that ensures a government bailout, let’s take a minute to review how you can be certain that your money is insured.
If you have a personal account, you have up to $250,000 in cash insured by the FDIC or SIPC. The FDIC insures banks while the SIPC insures brokerage firms. The SIPC further insures non-cash balances to $500,000.
If you have a retirement account at the same bank or brokerage firm, that retirement account is also insured to $250,000/$500,000. If you have a joint account, you can add another $250,000 of insurance for each person on the account. Maybe you have a business account? Add another $250,000.
As you can see, insurance covers you in most situations.
Investment firms like Charles Schwab get additional insurance as well. In the case of Schwab, each relationship is insured by up to $600 million. The reason why a firm like Schwab can have so much insurance is because your funds are not commingled with the funds of the firm or other clients. The assets in an investment account are held in a segregated account with a third-party custodian like the Depositary Trust Company. In comparison, a bank commingles your money as your deposit helps finance loans and buy securities at that bank.
Banks are different than most companies in that they buy investments like US Treasuries and mortgage-backed securities (MBS) to earn income used to pay depositors and cover its costs. Accounting rules allow banks to hold these securities in two imaginary buckets on their balance sheet. One bucket is called ‘available for sale’ (AFS) while the other is called ‘held to maturity’ (HTM). AFS investments are valued each day like your 401k or investment account. From a profit and loss standpoint, this means that the bank must post the profit or loss on each investment as part of its financial statements.
HTM securities are valued differently than AFS securities in that the value of these investments do not change as the bank plans on holding the investments to maturity. Unlike the AFS bucket, these holdings are not revalued.
When a bank puts an investment in the HTM bucket, accounting rules do not allow it to be moved to the AFS bucket later. This caused a major problem for Silicon Valley when depositors began to leave. The bank could not sell the loans on their books, and it had sold all of its AFS securities. When they were forced to sell the HTM investments for as little as 50 cents on the dollar, the bank burned through more than $17 billion in capital in days.
If you want a simple way to judge the strength of your bank, look up its stock price. Most banks trade at book value or higher. When Silicon Valley and Signature Bank failed, each had a stock price that was 50% of book value. Logic suggests that a bank with a book value of lower than 50% is in trouble.
While your deposits are most likely to be safe, a bank with such a weak stock value has some problem that could force the bank to raise more in equity and dilute existing shareholders, make fewer loans or search for another firm to merge with.
If you want to have accounts that have more insurance, a brokerage account with a reputable firm may be a better option than your bank. These brokerage accounts typically earn much higher interest rates to boot!
Haddon Libby is the Founder and Chief Investment Officer of Winslow Drake Investment Management and uses TD Ameritrade Institutional and Charles Schwab & Co. As a reminder, this article should not be construed as accounting or financial advice. If you want investment or financial advice, please contact us at www.WinslowDrake.com.