This morning regulators in California took control of First Republic Bank and put it into U.S. Federal Deposit Insurance Corp (FDIC) receivership. JPMorgan will pay $10.6 billion to the FDIC to acquire most of the assets of the San Francisco-based bank and to gain access to First Republic's customer base.
Coming on the heels of the Silicon Valley Bank (SVB) and Signature Bank collapses, First Republic is the third major bank failure in the US in two months and the biggest failure since Washington Mutual during the 2008 financial crisis. Many are questioning the solvency of other banks. Through April 28, the S&P 1500 Regional Banks Index was down 28% in 2023.[i] As investors pull their deposits, over $300 billion shifted into money market funds in the month of March according to the SEC.[ii]
The panic in the regional banking sector and the historic shift in capital has many households wondering what is a liquid, safe and stable place to store funds. We believe priorities should drive your capital allocation, not the headlines. So, let’s start with high level uses for cash below and the priorities each entails below.
Medium of Exchange – We use cash to pay expenses and execute transactions “on demand” with no need to wait for funds. The priority here is immediate access.
Store of Value – Cash also funds expected future outlay or unexpected disruptions in household income or other financial distress. We recommend every household maintains an adequate “Protective Reserve” to weather these emergencies. The priority here is preservation of principle.
Investment – Some investors use cash as part of their investment strategy. The priority here is current yield.
To meet these various needs, we group cash holding accounts into two distinct buckets.[iii]
- Demand Deposits are designed to ensure that funds can be readily accessed when needed. Without such an account, depositors would have to inform their banks about withdrawals prior to obtaining cash or paying for goods and services. Two common demand deposits are checking and savings accounts. An additional option is to lock up funds at a bank for a certain period of time via a Certificate of Deposit (CD) where the interest rate is typically higher. These deposits are covered by the FDIC, which insures up to $250,000 per individual per participating bank. (Be sure to check with your bank.)
We suggest households first determine their needs for on-demand accounts based upon their typical month-to-month spending. If necessary, these assets can be spread across multiple banking relationships to ensure FDIC insurance.
- Investment Accounts at brokerages or managed by registered investment advisors are not bank guaranteed. Although the funds are invested in highly liquid assets, it is still necessary for the account holder to alert their institution when they intend to withdraw funds.
Assets beyond Demand Deposits can be placed in investment accounts. Clearly, the range of options is large and needs to be combined with each household’s unique liquidity needs, available funds and risk tolerance. Here are some broad observations:
Money Market Funds are a mutual fund that invests primarily in short-term debt securities. Offered by financial institutions, they strive (but don’t guarantee) to maintain a stable value. Types of money market funds include government securities, tax-exempt municipal securities and corporate debt securities. Those that primarily invest in corporate debt are often called “prime funds.”
Prime funds can often carry higher yields but may, in times of severe economic distress, come under pressure to maintain their stable value. Indeed, two “broke the buck” in the Global Financial Crisis. But looking under the hood, the stress was much higher. From 2007 to 2011, 78 money market mutual funds had to rely on support from their sponsors in order to prevent their share prices from falling below one dollar, according to a report from the Boston Federal Reserve Bank.[iv] Accordingly, we typically emphasize money market funds that invest in government securities.
Treasury Bills are short-term obligations of the US Treasury. They can be purchased directly or owned in a fund structure like an exchange traded fund (ETF). For clients with smaller cash balances, we emphasize low-cost ETFs that own Treasury Bills. Larger balances can use a separately managed account.
Ultra-Short Term Bond Funds can have maturities of between 0.5 to 3 years. As a result, they seek the opportunity for potentially higher returns but do have price risk as they fluctuate each day. While they are susceptible to losses when interest rates rise (as in 2022), they historically have provided a higher long-term return and seek to do better in times of economic weakness relative to money markets.
Clearly the range of options is large. But so too are the stakes…according to Cap Gemini’s 2022 World Wealth Report, cash and equivalents comprise nearly a quarter of high net worth individuals' portfolios (24%). Big money figuratively and literally. So quoting Churchill, prudent investors may wish to use the current crisis to build a resilient Protective Reserve allocation aligned with your household’s unique spending, liquidity needs and risk tolerance.
Please contact Flatrock Wealth Partners if you have questions or would like further information. We can be reached at info@flatrockwealth.com.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor. The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
[i] Source: YCharts
[ii] https://www.sec.gov/files/mmf-statistics-2023-03.pdf
[iii] Some may note that we exclude crypto in this list. We do deliberately as crypto fails to adequately be a reliable store of value or medium of exchange on account of its substantial volatility.
[iv]https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3015986