What the Banking Confidence Crisis Exposed for Business Owners

On March 10^th the banking industry experienced the collapse of the 16th largest bank in the nation, Silicon Value Bank (SVB) and Signature Bank, a bank focused on business owners. SVB was the largest bank failure since Lehman Brothers in 2008. Shortly after Signature Bank announcement, First Republic Bank was next to follow. It looked as if the damage was contained to the three banks but this week it was reported that Credit Suisse Bank is being assisted by the banking industry’s largest bank in an effort to restore consumer confidence and secure liquidity. At the time of these announcements, First Republic had more than 67% of the bank’s domestic deposits unsecured. Shockingly, it showed in a SEC filing by SVB that 95% of its deposits were unsecured. Which begs the question, why weren’t banking clients with large cash balances instructed to seek other methods or strategies to protect their unsecured deposits? It was reported shortly before the collapse that Roku had over $500m in unsecured deposits with SVB. It is well known that businesses keep large amounts of cash on the balance sheet and banks are the benefactors. Large cash balances by business owners could have been a contributor to the larger than normal percentages of unsecured deposits at SVB, Signature Bank and First Republic, known as the banks for business owners. The impact of this disruptive event on the banking system has yet to be defined as there seems to be a willingness by the banking industry to support and backstop its’ community. But it is safe to say that the impact of faltering banks will continue to be felt by investors. As we watch consumers work through the short-term lack of confidence in the banking system, it has exposed a gap around business owners’ cash strategy.

What lead to last week’s disruption in the banking industry?

Banks are designed to take in deposits and reinvest those deposits in the economy via mortgage loans, car loans and additional services. Last week demonstrated that banks are not set up to handle large withdrawals of cash caused by a lack of consumer confidence. Though the outcome was similar for SVB and Lehman, it is important to understand the reasons were marginally different.  The 2008 crisis was caused by banks investing in sub-prime mortgages with values close to zero at the height of the crisis. It was an investment grade issue that contributed to that crisis. Last week’s banking crisis was essentially caused by duration risk on investment grade bonds. The effects of duration risk, lack of interest rate hedging, and the following three factors, created this fast developing crisis.

1. Rising interest rate environment and steep interest rate hikes: Many banks invest in a diversified portfolio of Treasuries (Short-term and Long-term treasuries). If interest rates continue to rise over a prolonged period, it impacts that value of the treasury bonds and other bond investments. At the end of 2023, it showed that banks were sitting on $620 billion in unrealized losses (assets that lost value but did not realize/book the loss by selling the asset).
2. Contraction in banks Net Interest Margins (NIM): A bank's net interest margin which is the spread between its average yield on loans and investments and its average cost for deposits and borrowing. SVBs’ NIM was 2% at the end of the fourth quarter which was showing signs of contraction throughout the 2022 fiscal year. Subsequently, there were ten other banks with lower contracting net interest margin percentages than Silicon Valley Bank. With SVB, Signature Bank and First Republic Bank following, there has been a question posed about the banking fallout reaching smaller banks and regional banks.
3. “Run on the bank”: Bank customers lacked confidence in the financial well-being of SVB and Signature Bank. That lack of confidence caused customers to rush to the bank to withdraw their cash from the bank. Today, with electronic banking and immediate access, that massive demand caused banks to liquidate bank investments made with the deposits that had unrealized losses. Those loses built quickly causing SVB and others to become insolvent.

How this crisis has added to business owner headwinds in 2023:

This recent addition in the lack of consumer confidence in banks, strengthens the headwinds for business owners in 2023 by causing concerns around cash flow and access to capital. Headwinds can be summarized as:

• Continued Negative Business Owner Sentiment: The NFIB Small Business Optimism Index remains below the 49-year average of 98 with continuing concerns. The economic pressure on small businesses has been one that is ongoing and has been felt across industries due to concerns of rising interest rates, increased COGS, hiring challenges, and the overall economic state of affairs.
• Stretching of Accounts Receivables and Cash Flow Constraints: In the last quarter of 2022, there are early signs that customers are starting to take more time to pay . Causing AR average to increase. This has begun to highlight a potential lending issue for small businesses as larger portions of their AR start to climb past 90 days.
• Another Event Potentially Impacting Vital Cash Flow: The announcement of SVB and other banks collapsing under the weight of weakening consumer confidence in the banking industry has only added to the concerns for business owners.

 It has exposed a gap in strategy from business owners around the management and well-being of cash reserves.

The vital relationship between a bank and business owner:

Banks are an intricate partner for business owners. In most cases the banking relationship has been around since the beginning of the business. Banks secure lending, payroll, and ancillary business services through the deposits made on behalf of the business, hence the reason why business owners have higher deposits that exceed the secured deposit limits by the FDIC. If you are a business owner that keeps large percentages of cash on the business balance sheet in a bank account, and it is above the $250,000 FDIC secured amount, you should review your cash management banking strategy.

 Business owners should be preparing for a potential cash flow crunch

One of the biggest issues facing business owners is a stress in cash flows due to longer delays in account receivable payments, reduced margins due to higher costs, and now dealing with the effects and fallout from the banking industry. 

What action steps should you be taking as a business owner?

Short-Term Action Steps:

1. Lean on Your Advisory Board: Speak with your advisory board about creating a cash strategy that protects your cash while offering lending capabilities. There should also be a contingency plan moving forward that identifies alternative lending sources.
2. Evaluate Current Banking Relationship: Set up a meeting with your banking relationship to gain a better understanding of the bank’s potential exposure to unrealized losses and what steps that bank is taking to mitigate risk for its clients and sure up its Net Interest Margin.
3. Create a Cash Management Strategy: If you have more than the FDIC insured $250,000, an option could be to open an investment account and invest in short term bonds or a cash management vehicle that provides liquidity and access to your cash when needed.
4. Understand The Account Structure Used by Your Bank: When setting up your investment account for excess cash, make sure your investment account is not commingled with other investor accounts. Most broker/dealers utilize accounts called omnibus accounts. In short, this means your investment account is commingled with other investor accounts to form a larger single account. The problem with this type of account is, if there is another market issue that impacts your banking provider, having an omnibus account creates complications around liquidating and access to your account. So you would escape the unsecured issue over $250,000 but would have issues getting access to your investments. A suggestion would be to use a custodian account from Charles Schwab or Fidelity as those accounts are not commingled.

Long-Term Action Steps:

1. Internal Communication Strategy: With any positive or negative event that could potentially impact your business, craft the right message to your team. Don’t let outside sources be the core source of information.
2. Use Your Data: Every minute, data comes from your company that tells you what and how the company is doing. This data can also alert you to potential issues that need to be addressed. Today’s economic and business environment is too complex to not utilize KPIs. As demonstrated by the banking collapse, issues that impact your business can happen in hours. Unlike a decade ago where there was time to assess and decide. It is important to utilize the tools needed to be proactive and not reactive. A data point you may want to create is 30-day AR trends, cash reserves and loan balance. If you analyze these three data points together, it will help better understand cash flow, lending needs, and if there are any dramatic changes to cash flow trends that you need to act on.  

Operational takeaways?

• Use this opportunity to create a comprehensive cash strategy. Utilize your advisory board and financial planner to create a customized strategy that fits the growing needs of your business.

• Use your company data to be prepared. Create KPIs that keep track of AR aging, cash balances, working capital, and loan levels. This will provide insights into your business. Not only to identify potential problems, but also use as GPS to help grow your business.
• Lean on a group of experts with experience that can help guide you through moments like this. I can share that when you are a business owner and you have someone to talk to about your vision, concerns, and has the depth of experience to help you and your company through these types of challenges, it is a real advantage.

Insulating your business from these types of disruptive events can be both challenging and daunting. Utilize this opportunity to implement a KPI strategy. Start the process of building an Advisory Board.  The benefits aren’t just in dealing with disruptors. The benefits extend to having the support and resources needed to successfully implement your long-term vision.

Written by:

Brett Dearing, CEPA, CM&AA