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Well, it’s hard to hide from the news of the Fed and Treasury coming to the rescue of depositors of a failing bank. Silicon Valley Bank is the 20th largest bank in the United States of America and mainly serves the needs of startups and venture capital firms. And because of mismanaged risk and the inability to create liquidity when needed, the bank was taken over by regulators from the FDIC last Friday. This article covers the events that led to the failure of the bank and broader impacts as well as lessons learned from these series of events that can be applied to managing retirement.
So how did we get here specifically with Silicon Valley Bank? First, it is important to know that Silicon Valley Bank was a financially solvent bank. A key part of the financial operations in banks is its ability to attract new banking customers and increase deposits. The bank turns around and invests in assets with a slightly longer duration in loans and other financial products to earn a higher interest. The difference between what banks pay customers in yield and the interest they receive is called the net interest margin. If we look at SVB, their customer deposits were worth $173B of the bank’s $196B of total customer funds, and their investment portfolio was worth $208B. The $208B can be further broken down into 4 parts: $14B cash, $74B loan portfolio, $91B hold-to-maturity securities, and $26B Treasuries/MBS. When more than $14B of cash is needed to fund client withdrawals, something must be sold and now we have a problem. And that is effectively what caused the run on the bank because no one wants to be last holding the bag.
Specifically, for Silicon Valley Bank, there were two major problems:
- It did not have a diversified client base. Most of their clients were venture funds and startups. As soon as the economy started to slow down and the fundraising market tightened, those deposits became withdrawals.
- A large part of their portfolio was in long-duration bonds, and in a rapidly rising interest rate environment, those bonds were losing value. By holding long-term fixed interest rate securities when rates have continued to increase, it became difficult for SVB to create cash with assets that are not worth as much as they once were.
The failure of Silicon Valley Bank and other regional banks has two major impacts:
- There are thousands of small companies that bank at small and regional banks that may or may not have their operating capital at risk due to a run on regional/small banks. To solve this, the Fed has stepped in and created a new backstop to deposits. To stem the tide of withdrawals.
- The optics of the government bailing out venture capital and tech (both high-risk) is horrendous and a political talking point. To solve this, the Treasury will charge the bank a fee to hold the treasury bonds on its books until the banks can take on the risk of holding assets on its balance sheets. In our view, this accomplishes a few things, but mainly lets the government say that no taxpayer dollars were used in this intervention which creates the backstop that is needed and lets the Fed continue to fight inflation.
One day there will be many case studies done at universities on Silicon Valley Bank, but we can learn a few important and immediate lessons related to retirement planning.
Here are the top 3 lessons that one can take away from the chaos this weekend:
1. Liquidity- Having liquidity on hand is an essential factor to consider during retirement. The availability of cash or assets that can be quickly converted into cash without significant loss of value is critical in retirement. As retirees move away from a regular income stream, they rely heavily on their savings to cover their living expenses. Therefore, having liquidity in retirement is crucial to meet unexpected expenses, such as medical bills or emergencies. However, retirees must balance the need for liquidity with long-term income needs and protection against inflation. Maintaining an appropriate liquidity level based on a financial plan can provide peace of mind and financial security during retirement.
As we saw with SVB, the ability to create additional liquidity was very difficult. Public markets oftentimes offer more liquidity and transparency than non-publicly traded securities or annuities.
2. Cash Flow / Expenses- Managing cash flow and expenses becomes even more critical during retirement as retirees rely on their savings to cover their living expenses. The lack of a regular income stream means that managing expenses and cash flow become more challenging, and any unexpected expenses can significantly impact a retiree's financial situation. The stress on a portfolio during retirement can be significant and is defined by the percent of total annual withdrawals divided by the portfolio value (i.e. “withdrawal stress”). A higher level of withdrawal stress signals a lot more stress on a portfolio’s ability to meet that same level of withdrawal on a consistent basis. Therefore, it is crucial to have a solid understanding of cash flow and expenses to manage a portfolio effectively during retirement. Retirees need to stay flexible and may need to adjust their withdrawal rates to cover their expenses while ensuring that their portfolio remains sustainable over the long term. Overall, managing cash flow and expenses during retirement is crucial to minimize stress on a portfolio and ensure that retirees can maintain their financial security throughout their retirement years. It may be part of a process that is revisited frequently during retirement.
In SVB’s case, if they marked to market their bond holdings, maybe alarm bells would have gone off sooner, giving them a longer runway to create extra capital. Therefore, it is important to take inventory of your investments and ensure they have realistic valuations to meet your withdrawal needs.
3. Risk- Risk should not be static in retirement because retirees’ financial needs and goals change over time. While the preservation of capital and stability of income are critical objectives in retirement, it is important to strike a balance between these goals and the need to grow investments to keep up with inflation. A static approach to risk can leave retirees vulnerable to unexpected economic downturns, leading to a significant loss of wealth. Retirees should periodically review their risk tolerance, investment objectives, and financial situation to adjust their portfolio's risk accordingly. Having a framework on which funds have low risk and which funds have high risk and the balance between the two is important. Sometimes life events or economic events may shift the balance between the two. A dynamic approach to risk management can help retirees achieve their financial goals while minimizing the downward stress on their portfolios.
SVB tied its deposits and some of its loans to the same customer base, creating more risk in its business. There is a reason why regional banks were offering 3-5 percent interest and the top 4 banks were offering barely 1%. There are always risks in retirement, identifying and defining the risks you can live with is key.
Revisiting these three key components of your retirement plan is key to reducing overall risk to your plan. Making sure that you are in a safe place with liquidity, stress on your portfolio, and the amount of risk you are taking now, you will have covered 90% of the areas where retirees could potentially hurt themselves in having a successful retirement. If you have any questions about your individual scenario please feel free to reach out to us. We are here to help.