{"id":20411,"date":"2023-07-06T15:55:14","date_gmt":"2023-07-06T15:55:14","guid":{"rendered":"https:\/\/www.insurancejournal.com\/?p=728921"},"modified":"2023-07-06T15:55:14","modified_gmt":"2023-07-06T15:55:14","slug":"viewpoint-what-role-could-insurance-premium-finance-have-played-in-recent-bank-failures","status":"publish","type":"post","link":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/2023\/07\/06\/viewpoint-what-role-could-insurance-premium-finance-have-played-in-recent-bank-failures\/","title":{"rendered":"Viewpoint: What Role Could Insurance Premium Finance Have Played in Recent Bank Failures?"},"content":{"rendered":"<p><img decoding=\"async\" src=\"https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/04\/Banking-Collapse-Or-Bank-Run-bigstock-580x387.jpg\"><\/p>\n<ul class=\"nav nav-tabs tabs tabs-entry\">\n<li class=\"active\"><a href=\"https:\/\/www.insurancejournal.com\/news\/national\/2023\/07\/06\/728921.htm\">Article<\/a><\/li>\n<li><a href=\"https:\/\/www.insurancejournal.com\/news\/national\/2023\/07\/06\/728921.htm?comments\" rel=\"nofollow\">0 Comments<\/a><\/li>\n<\/ul>\n<div class=\"article-content clearfix\"> <span class=\"tts-notice\"><span>New<\/span> You can now listen to Insurance Journal articles!<\/span><\/p>\n<p>On March 10, 2023, while the majority of Americans were diligently toiling away in their jobs, very few people likely understood the silently ticking time-bomb sitting inside the balance sheets of many of our bank-brethren in our important banking industry. Few would have thought that over the second weekend in March, that the 11th largest banking company in the United States, with a 40-year history, roughly $215 billion in assets, a Loans to Deposits ratio of 43%, Tangible Common Equity of $11.8 billion and Tier -1 Regulatory Capital of 15.29%, an impressive CAGR (Compound Annual Growth Rate) of 39% and better than peer\u2019s earnings metrics for the past 10 years, would implode in 36 hours.<\/p>\n<p>That\u2019s what happened with Silicon Valley Bank (SVB) and is the pressure that several other banks were facing due to notional losses in their bond portfolio, high concentration of uninsured deposits and the corresponding run on their bank deposits.<\/p>\n<div class=\"bzn bzn-sized bzn-intext\">\n<ins data-revive-zoneid=\"79\" data-revive-block=\"1\" data-revive-id=\"36eb7c2bd3daa932a43cc2a8ffbed3a9\"><\/ins> <\/div>\n<p><em>The Scandinavians have an apropos saying that, \u201cDon\u2019t Wave Hello from Across the Bridge.\u201d<\/em><\/p>\n<div class=\"article-inline-sidebar article-inline-sidebar-left\"> <em><strong>This is the first in a two-part piece by Bill Villari, who has been in banking and premium finance for 34 years. Look for the second part tomorrow (July 7).<\/strong><\/em> <\/div>\n<p>What went wrong at SVB and the other banks that recently failed? It was a confluence of circumstances that dominoed, but in short, the electronification of banking led to their unexpectedly rapid demise.<\/p>\n<p>Deposits are the life blood of a bank. Deposit-withdrawal has become so efficient, that in an instant, crucially important bank deposits can be transferred out of a bank. When many depositors, who control a large amount and large percentage of the deposits withdraw, it can cripple the bank. It was a classic \u201crun-on deposits,\u201d through electronic withdrawals, that brought SVB to its knees in 24 hours.<\/p>\n<p>SVB financial ratios (metrics that indicate financial stability) were impressive. SVB\u2019s loan to deposit ratio was 43%, very low compared to its peers. A low loan to deposit ratio, as the term implies, means that the bank has fewer aggregate borrowers as a percentage of its cash and marketable securities. In bank parlance, the bank had balance sheet \u201cliquidity\u201d. SVB\u2019s liquidity would have been the envy of its peers. Having the additional cash liquidity gave the bank options. It gave them financial flexibility; thus, putting SVB on the offense to invest that liquidity in loans or other financial and investment opportunities. Prima facia, this was good. SVB\u2019s regulators likely would have considered them \u201csafe and sound\u201d and a low risk financial institution in Q4 of \u201921 and Q1, Q2, Q3 and even Q4 of 2022.<\/p>\n<p><strong>So what happened?<\/strong><\/p>\n<figure id=\"attachment_728930\" aria-describedby=\"caption-attachment-728930\" class=\"wp-caption alignright\"><a href=\"https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/07\/Bill-Villari.jpg\"><img decoding=\"async\" loading=\"lazy\" class=\"wp-image-728930 size-thumbnail\" src=\"https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/07\/Bill-Villari-150x150.jpg\" alt width=\"150\" height=\"150\" srcset=\"https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/07\/Bill-Villari-150x150.jpg 150w, https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/07\/Bill-Villari-300x300.jpg 300w, https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/07\/Bill-Villari.jpg 450w\" sizes=\"(max-width: 150px) 100vw, 150px\"><\/a><figcaption id=\"caption-attachment-728930\" class=\"wp-caption-text\"><em>Bill Villari<\/em><\/figcaption><\/figure>\n<p>SVB\u2019s liquidity and balance sheet strength was indirectly the source of theirtrouble and failure. The bank used its liquidity to buy, or invest in high-quality Mortgage-Backed Securities and Government Bonds, (\u201cUS Treasuries\u201d) backed by the United States Government. These types of investments are conservative and safe, correct? Yes, they are, normally! Unfortunately, the bank bought bonds with long(ish) dated maturities. For the past fourteen years since the Great Financial Crisis, the United States\u2019 central bank, called the Federal Reserve Bank, has guided the economy with low interest rates. What economists call \u201cloose monetary policy\u201d. In addition to low interest rates, the FED juiced monetary policy through Quantitative Easing (QE), which was a novel policy action whereby the FED purchased a predetermined amount of government bonds and other financial assets to stimulate the economy. The resultant effect was really low interest rates (short-, mid- and long-term rates). This was like rocket fuel for the economy.<\/p>\n<div class=\"bzn bzn-sized bzn-intext-2\">\n<ins data-revive-zoneid=\"162\" data-revive-block=\"1\" data-revive-id=\"36eb7c2bd3daa932a43cc2a8ffbed3a9\"><\/ins> <\/div>\n<p>When Silicon Valley invested the bank\u2019s liquidity in <u>long<\/u>(ish) maturing Government Bonds and Mortgage-Backed Securities it was in effect reaching for more yield, to wring out as much economic utility as it could from its large cash balances. These bank investments were extremely safe and conservative securities. Safe because the obligor on the bonds was the United States Government (for their US Treasuries). If these securities were held to their maturity date the bank would have received the full face-value of the bond. After all, what is the likelihood of the United States Government defaulting on its loans?<\/p>\n<p><em>[Note: The United States Government is about 248 years old and the last time it defaulted on it a government bond was NEVER. It is certainly reasonable to assume that the US Government Bond will continue to pay its bond obligations given the statistical data of over two centuries of no defaults.]<\/em><\/p>\n<p><a href=\"https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/03\/SVB-Bigstock-scaled.jpg\"><img decoding=\"async\" loading=\"lazy\" class=\"alignleft wp-image-712399 size-medium\" src=\"https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/03\/SVB-Bigstock-300x225.jpg\" alt width=\"300\" height=\"225\" srcset=\"https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/03\/SVB-Bigstock-300x225.jpg 300w, https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/03\/SVB-Bigstock-580x435.jpg 580w, https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/03\/SVB-Bigstock-768x576.jpg 768w, https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/03\/SVB-Bigstock-1536x1152.jpg 1536w, https:\/\/www.insurancejournal.com\/app\/uploads\/2023\/03\/SVB-Bigstock-2048x1536.jpg 2048w\" sizes=\"(max-width: 300px) 100vw, 300px\"><\/a><\/p>\n<p>In February 2022, the FED changed its monetary policy stance (to cool an overheated economy) and began raising the federal funds target interest rates for the financial system. The problem for SVB, and many other banks, was they invested in low yielding, long dated bonds; <em>with interest rate on the rise<\/em>, the low yielding bonds dropped in value as new bonds with the same duration were offered with higher coupons. SVB had billions of dollars of the bonds that dropped in value. As interest rates went higher throughout 2022, SVB\u2019s low yielding bonds continued to drop further in value.<\/p>\n<p>If one were not tuned into the economy and specifically bank balance sheets and more particularly the effects that rising interest rates have on US Treasury bonds and Mortgage-Backed Securities, there would have been no way to anticipate the wave. Heck, even if you were studying bank balance sheets the bank\u2019s Tier 1 Capital remained unchanged.<\/p>\n<p>So how would an investment in conservative government bonds trigger the demise of SVB? This is where it gets a little complicated.<\/p>\n<p>Bonds pay an imputed interest rate (\u201ccoupon\u201d) based purchasing the bond at a discounted. F<em>or example<\/em>, a $100 face or terminal value of a one-year bond bought at inception at $98 will pay roughly a 2% yield (2\/100s). While the concept is a little wonky to think about, its becomes understandable when put in more familiar terms like when your local grocery store discounts tomatoes. Tomatoes normally priced at $5.00 a bushel buton sale (or discounted) for $4.50 this week, indicates you\u2019re buying $5.00 worth of tomatoes at $4.50. That\u2019s an intrinsic benefit, or discount, of $.50. That same intrinsic benefit, or discount, is realized by a bondholder when the full face-value of the bond is paid to the investor in cash at maturity.<\/p>\n<p><strong>What seemed like a safe, conservative investment in government bonds by a bank with a ton of excess cash, became the silver bullet that triggered their ultimate demise.<\/strong><\/p>\n<p>To understand more specifically what happened with SVB\u2019s bond portfolio, and the corresponding domino effect that killed the bank one has to understand another counter intuitive fact about bonds. \u201cA bond\u2019s <u>yield<\/u> moves <em>inversely<\/em> to its price.\u201d Meaning when a <u>bond<\/u> goes <u>up<\/u> in price, its <u>yield<\/u> goes <u>down<\/u>, and when a <u>bond<\/u> goes <u>down<\/u> in price, its <u>yield<\/u> goes <u>up<\/u>. By way of example, remember the 2% bond described above ($100 of face, buyable at $98, leaving 2% in yield) \u2026 what if that same $100 in terminal-value bond, could be purchased at $96 because the price of the bond decreased (but the bond\u2019s yield goes up). The bond\u2019s yield would go up to 4% ($100 face, bought at $96 = 4% yield)? What\u2019s a better yield, 4% or 2%? 4%, right? Herein lies the problem at SVB. With all their extra cash they purchased those long duration bonds with low coupons. As we said above, when the Federal Reserve Bank raise interest rates, the value of the SVB\u2019s bonds dropped. As the FED continued to <strong><em>raise<\/em><\/strong> interest <strong><em>rates<\/em><\/strong> to fight inflation, the price of SVB\u2019s <u>bonds<\/u> fell even further.<\/p>\n<p>Using the hypothetical scenario above, if SVB owned a bond priced at $98, and, when rates went from 2% to 4%, the price of the bond dropped to $96 (as rates were pushed up by the FED), that produced an imputed (or notional) loss of two dollars ($2.00). The loss is \u201cnotional\u201d because the bondholder only realizes the loss if they sell before the maturity date. Remember, if the bond is held to maturity, it pay out at face value. A $2 loss doesn\u2019t seem like much, but two dollars multiplied by billions of dollars in bonds, and the number adds up fast. Since banks may hold only 8-10% of equity capital against their assets, losses of this magnitude impact on equity rapidly becomes material. <em>SVB had billions of dollars of notional losses in their securities portfolio.<\/em><\/p>\n<\/p><\/div>\n<div class=\"article-poll\" data-post=\"728921\">\n<div class=\"article-poll-vote\">\n<p>Was this article valuable?<\/p>\n<\/p><\/div>\n<div class=\"article-poll-feedback voted-no\">\n<form class=\"feedback-form\">\n<p>Thank you! Please tell us what we can do to improve this article.<\/p>\n<p> <textarea placeholder=\"Enter your feedback...\"><\/textarea> <button type=\"submit\" class=\"submit\" disabled>Submit<\/button> <button class=\"cancel\">No Thanks<\/button> <\/form>\n<\/p><\/div>\n<div class=\"article-poll-feedback voted-yes\">\n<form class=\"feedback-form\">\n<p>Thank you! <span class=\"percent\"><\/span>% of people found this article valuable. Please tell us what you liked about it.<\/p>\n<p> <textarea placeholder=\"Enter your feedback...\"><\/textarea> <button type=\"submit\" class=\"submit\" disabled>Submit<\/button> <button class=\"cancel\">No Thanks<\/button> <\/form>\n<\/p><\/div>\n<div class=\"article-poll-more-articles\">\n<p class=\"thank-you-text\">Here are more articles you may enjoy.<\/p>\n<\/p><\/div>\n<\/p><\/div>\n<div class=\"author-byline clearfix\">\n<div class=\"author-byline-content\">\n<h4 class=\"author-byline-name\"> <small>Written By<\/small> Bill Villari <\/h4>\n<p class=\"author-byline-bio\"> Bill Villari is president of P1 Finance, a 36-year-old premium finance company with clients in all 50 states. Villari has been in banking and premium finance for 34 years. His offices are in Norcross, GA. Prior to P1 Finance, Villari was CEO and founder of US Premium Finance. He began his banking career in 1989 at First Union National Bank in Charlotte, NC, followed by Stern Stewart and Co. in New York, NY, as a Financial Analyst. <\/p>\n<\/p><\/div>\n<\/p><\/div>\n<div class=\"subscribe-banner subscribe-banner-in-content-2\">\n<div class=\"content\">\n<h4>The most important insurance news,in your inbox every business day.<\/h4>\n<p>Get the insurance industry&#8217;s trusted newsletter<\/p>\n<\/p><\/div>\n<\/p><\/div>\n","protected":false},"excerpt":{"rendered":"<p>Article 0 Comments New You can now listen to Insurance Journal articles! 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