The failure of Silicon Valley Bank (SVB) led to a broader concern over the stability of the financial sector. That has led to fears about client assets held at Charles Schwab, but those concerns are overblown.
As the head of financial and economic research at Buckingham Strategic Wealth, I've been getting lots of questions from clients concerned about the financial risks of having their assets custodied at Charles Schwab. The concerns arose because of the collapse of SVB and were likely elevated by a Bloomberg article that raised concerns about Schwab’s financial safety: Its holdings of longer-term Treasury securities have fallen in value, creating unrealized losses that reached almost $29 billion by the end of 2022. That compares to its current market capitalization of about $97 billion and book equity of about $27 billion.
To address the concerns, my colleague, Jake Fechter, director of compliance for Buckingham Strategic Wealth, explained how we manage the risk of assets at custodians and what level of protection investors have. It is hard to ignore the recent flurry of large bank failures. The downfall of SVB was the first domino in what has become one of the largest bank collapses in U.S. history. Recent attention has now turned to a Senate hearing where regulators are under intense scrutiny to determine how this type of failure happened and how to prevent it in the future.
A large spotlight has been put on Schwab, which has a unique position in all this turmoil. In a recent perspective shared with its clients, Charles Schwab’s founder and CEO stated that the company is “a different kind of financial firm, which can make us harder to understand.” It is the largest public broker-dealer in the U.S. and has expanded its financial services offerings to millions of clients. Part of that expansion is in banking, where it helps serve the needs of its financial services clients. While 90% of SVB’s deposits were uninsured, only 20% of Schwab are. Thus, there is significantly less liquidity risk for Schwab.
As the worlds of broker-dealers and banks collide, the regulatory framework becomes blurry. To help ease some of the confusion, here is an overview of some of the safeguards and protections for clients who custody their assets with Schwab. Multiple layers of protection safeguard investor assets at Schwab and all of the larger custodians and brokerage firms: (1) Brokerage firms must meet minimum net capital requirements to reduce the likelihood of insolvency; (2) Brokerage firms must keep customer securities and cash segregated from their own securities and cash (SEC Rule 15c3-3); and (3) Brokerage firms are required to be members of the Securities Investor Protection Corporation (SIPC), which insures customer securities accounts up to $500,000. Custodians also maintain a number of additional protections, including excess insurance coverage.
All bank deposits through Charles Schwab’s bank are protected under the Federal Deposit Insurance Corporation (FDIC). The FDIC is an independent agency that maintains the Deposit Insurance Fund, which is backed by the full faith and credit of the United States government. The FDIC insures accounts held at member banks up to $250,000 per depositor per insured bank. The Schwab Bank Sweep for Benefit Plans account has two underlying FDIC banks, so these holdings are protected up to $500,000 per depositor.
In the case of SVB, the company had approximately $175.4 billion in deposits, according to the FDIC, of which $151.5 billion exceeded the FDIC insurance limit of $250,000 (per SVB’s Q4 2022 10-K filing). In one prime example, the streaming service Roku maintained $487 million with SVB, leaving it extremely exposed and vulnerable to this type of bank run or collapse.
At Buckingham, we advise clients to think strategically about where they maintain cash positions. Splitting out assets across custodians or utilizing a service like Flourish Cash can ensure that all cash-related holdings maintain appropriate FDIC insurance. In addition, we monitor any brokered CDs and the corresponding FDIC coverage.
The Bloomberg article cited several “gambles” taken by Schwab over the years that are now being uncovered. These include a large bond portfolio with long maturities and higher loan costs that originate from cash that has led to clients moving cash positions. While it is highly likely that Schwab will find a way to weather this storm (given its highly profitable diversified businesses, with profit margins of about 35%), we are still faced with the questions and fears from clients about their own holdings.
Since one should not treat the unlikely as impossible, we will review the additional safeguards that are in place to secure client assets if Schwab became insolvent.
First and foremost, Schwab must become insolvent. That would likely be a situation in which it was violating an SEC rule of keeping customers’ assets segregated. As mentioned earlier, registered brokerage firms like Schwab must keep their customers’ securities and cash segregated from their own so that, even if a firm fails, its customers’ assets should still be safe. Securities “held” by a brokerage firm are still considered customer securities (rather than the broker’s own property) and are given priority distribution in an SIPC or bankruptcy code liquidation, meaning a customer would get their assets ahead of general creditors.
Assuming there was some issue with the segregated customer assets, the firm’s minimum net capital would have to be fully exhausted (again, customers ahead of creditors). If there were issues with the segregated customer assets and the net capital, SIPC coverage would have to be exhausted. Here is where the excess insurance coverage would kick in. Most custodians the size of Schwab maintain an aggregate limit well in excess of $1 billion. Thus, there are several “fail-safes” to ensure that customers still get their assets in the event of a company failure or bankruptcy.
If a custodian the size of Schwab were to become insolvent, there is also the possibility that the federal government would intervene. Looking through the history of the failure of broker-dealers, there are three likely scenarios that would result in customers being made whole:
- Self-liquidation, where no customers lost accounts (for example, Drexel Burnham Lambert in 1990).
- The finding of a buyer for the broker-dealer (for example, Bear Sterns was bought by JPMorgan in 2008).
- There is an orderly winding down of the broker dealer by SIPC (for example, U.S. broker-dealer for Lehman Brothers, where almost everyone was made whole, including creditors).
Unfortunately, bank failures are not uncommon. From 2008 to 2013, almost 500 banks went under. While we may see some short-term volatility and a continued increase in interest rates that lead to ongoing investor concerns, an institutional failure of Schwab (or Fidelity) is unlikely to lead to investors incurring losses due to the layers of protections and safeguards.
Larry Swedroe is head of financial and economic research for Buckingham Wealth Partners.
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The failure of Silicon Valley Bank (SVB) led to a broader concern over the stability of the financial sector. That has led to fears about client assets held at Charles Schwab, but those concerns are overblown.
