Silicon Valley Bank, Signature Bank, First Republic, are just some of the banks in recent headlines. The large number of troubled banks represent risk evaluated institutions, since depositors don’t know where they stand in a bank run or bank failure. Many of our clients have asked how bank failures might affect their depository accounts with their current banking institution or any present or future municipal financing transactions. This article briefly reviews the effects of recent bank failures in the US on the municipal bond industry. We urge new and existing clients to schedule a complimentary one-on-one meeting with our team if you have specific questions or concerns regarding the recent market headwinds and their effect on your particular agency.
Source: New York Times
President Trump's 2018 Economic Growth, Regulatory Relief and Consumer Protection Act relaxed regulations put up by Dodd-Frank and exempted from certain regulations banks under a $250 billion asset threshold. In addition, the bill lowered the liquidity threshold (a measure of its ability to readily find the cash it may need to meet demands upon), and reclassified municipal bonds as high-quality liquid assets. Classifying municipal bonds as high-quality liquid assets allowed banks to use certain municipal debt obligations to help meet their liquidity requirements. Reclassifying an asset as a high-quality liquid asset could or already has changed a lot of behaviors including banks and the local government issuers.
In the specific case of Silicon Valley Bank, the bank was holding a lot of long-term fixed-rate assets, mostly treasury bonds, the value of which has fallen as interest rates have risen. Some may say it was a case of poor liquidity management. Some lawmakers blame the 2018 bipartisan law, stating the law allowed banks like SVB to take reckless risks and eased capital requirements.
However, there are many banks that purchase municipal bonds that have remained resilient in this time of widespread high-profile regional bank failures. These banks have been able to withstand the market headwinds by having a fully diversified portfolio of investments, with proper credit metrics.
Are your funds protected?
All governmental agency demand deposit accounts (DDAs) now, more than ever, require heightened due diligence. For our clients, we have taken steps to implement universal changes to our banking institution repository list. We continue to perform independent due diligence prior to placing a banking institution on any RFP list (whether for DDA's or private placement bond offerings). Coverage of deposits with some type of US government guarantee becomes more important. We use a variety of methods to ensure agency funds are protected.
Enhanced due diligence needs to be done prior to allowing a banking institution to bid on a bond transaction or DDA opportunity. In addition, Weist Law recommends that construction funds and reserves should not be deposited with the same bank purchasing the bonds, but rather placed with only the banks that have trust departments specializing in administering project funds and reserve funds, with proper credit metrics. This will help ensure that your reserves and deposits are being protected to every the extent possible.
When issuing bonds, many public agencies strongly prefer to borrow from banks, rather than issue bonds as a public offering, due to the flexibility and ease of borrowing and the ability to achieve lower all-in interest costs, especially for issuances under $10mm when the issue can be sold to a bank as a "Bank Qualified" transaction. Bank-qualified municipal bonds are bonds purchased by banks that gain a tax-advantaged status, presumably allowing banks to pass along lower interest rates to the government issuer. Weist Law can help you navigate your issuance while at the same time safeguarding your funds in a time of uncertainty.
Are taxpayers paying for the bank "bailout"?
It is important to understand how the federal government is assisting the banking industry at this time and how that assistance may be paid for by taxpayers. Most of the cost of the FDIC guarantee of all deposits within the failed banks will be covered by proceeds of the winding down of the banks.
In a joint statement by the Department of Treasury, Federal Reserve and FDIC it was stated that local taxpayers will not bear the responsibility of recent bank failures. All Signature Bank and Silicon Valley Bank depositors will be protected, including those above the $250,000 deposit insurance limit, and have access to their money. Money will instead come from the fees that banks pay into deposit insurance. However, when understanding standard bank lending structures it is correct to assume that ultimately consumers will see minor effects of the failures, either by earning a little less on deposits or paying a bit more for their loans.
To be clear there is no bank "bailout," all bank equity and bondholders are now taking the losses for their risk, however, taxpayers and depositors are indeed protected.
As of 3/20/23 the FDIC has assumed all Signature Bank deposits through a purchase and assumption agreement with Flagstar Bank, National Association a wholly owned subsidiary of New York Community Bancorp, Inc. guaranteeing that all customers should continue to use their local branch until further notice. (https://www.fdic.gov/news/press-releases/2023/pr23021.html) Standard FDIC insurance covers up to $250,000 per depositor, but that limit was bypassed with the recent failures of regional banks.
President Biden proposed on March 30, 2023 several reforms in the wake of the recent banking crisis with aim to "strengthen oversight and regulation of larger banks." Some of these reforms include ensuring that local community banks do not end up paying for losses of the FDIC Deposit Insurance Fund.
On the bright side
Recent bank failures suggest a turning point in the monetary cycle to squeeze demand and help the Federal Reserve to bring down inflation. Since the announcement of the Silicon Valley Bank failure, the Federal Reserve has opted to increase rates by 25 basis points twice, once in March and again on May 3rd rather than an expected increase of 50 basis points- marking the highest level since the Great Financial Crisis in 2008.
The Federal Reserve is also safeguarding deposits by making additional funding available through a new Bank Term Funding Program. This emergency program provides loans as an additional source of liquidity so that institutions are less likely to sell off high-quality securities to meet withdrawal needs. The ability to obtain loans through the Bank Term Funding Program will probably make it unnecessary to sell their municipal bond holdings to compensate for the loss of deposits.
According to New York Life Investments, while the municipal bond market provides investors with tax-free income potential across the nation, state-focused investment strategies currently present a compelling opportunity for residents of states with high tax rates, strong demand due to high concentrations of wealth, diverse issuance, and sound long-term credit fundamentals. California municipal bonds have benefited from strong relative performance compared to the overall municipal market over the ten-year period ending March 31, 2023.
Overall municipal bonds have provided resilience in times of uncertainty due to lower default rates than corporate bonds, little changes in ratings during recessions when compared to corporate bonds, and the fact that some muni bonds are backed by the financial strength of state and local governments. As mentioned in some of our other articles, during times of economic uncertainty it is time to create detailed financial strategies for the upcoming years to get ahead, rather than staying out of the market and losing opportunities. Low supply, stable and predictable cash flow from existing bond portfolios, and a steeper municipal yield curve all point to a strong future for returns. When the dust settles and investors become more comfortable that the Fed is done hiking, investments in the muni market will only strengthen.
We are currently offering a free consultation with current market outlooks, an overview of your financials and a discussion of some of our comprehensive financial management programs to help you maintain fiscally resilient during these times of market volatility. Please contact us here to schedule your free consultation.
For a FDIC press release on each bank failure please visit https://www.fdic.gov/bank/historical/bank/bfb2023.html.
The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact a designated Weist Law representative. This material may be considered advertising under certain rules of professional conduct.