March 2023 Bank Failures!

NEWSLETTER

?Article Title: March 2023 Bank Failures

Published Date: March 30, 2023

Bank regulators were in front of Congress on March 29, 2023, answering questions surrounding the strength of the banking system and "why" & "how" SVB & Signature Bank failures occurred. Regulators are currently doing their post-mortem analysis of both failures and will conclude their findings in a report on May 1, 2023.

It appears the banking crisis/contagion concerns that had been a serious concern the week or two following those closures have been subdued to some extent. I'm sure lawmakers will take everything into account and come to the conclusion on any changes to the banking system may be required moving forward, to hopefully avoid these types of events. With that said, I thought it might be helpful to share some thoughts on the recent events in the banking system.

1). Regulators - I've seen reports that SVB had been issued citations (MRA's & MRIA's) roughly 12 months prior to its failure. It will be interesting to learn whether the SVB management had taken the necessary steps to resolve those issues. Too early to call or point blame!?I’m sure the May 1, 2023 report will most likely answer these questions.?

2). SVB Management - A big part of banking, is constantly reviewing risks and taking proactive actions to minimize those risks. In the case of SVB, it should be worth pointing out that the bank's ALM, IRR, Stress Test, and Bond Portfolio Analysis should've identified issues with 100, 200, 400, 500 bps rate shifts (both increases and decreases) - even as crazy as those scenarios may be. So, why didn't SVB management heed those warning signs? As a reminder, bank regulators had issued citations on the bank's stress testing platform/system. SVB management had two or three different sources/indicators screaming at them to take action... ?Yet, they clearly didn’t take appropriate actions to better position/prepare their bank for the events that would unfold earlier this month.?SVB management knew that their bond portfolio was taking a hit on paper…

3). Franchise Value - Former FDIC Chair Sheila Bair was quoted during the 2008-2010 Great Recession saying, "the FDIC typically doesn't close down banks with Franchise Value". Why was SVB allowed to have 90%+ of their deposit base uninsured per the FDIC's $250,000 limit??I’m guessing there was a disagreement between regulators and bank management on the topic of Franchise Value.?For the record, the regulators were right!

4). Bank Compensation Plan(s) - should be “behavior-based” and in line with the FDIC's Franchise Value proposition. I would venture to guess that SVB's compensation plan was NOT in line with the FDIC's Franchise Value. I would like to know how SVB employees were rewarded for bringing in "large deposits" and keeping them on the bank's balance sheet versus off-balance sheet vehicles/solutions. ?Most banks have internal battles and challenges between leaving funds on-balance sheet versus off-balance sheet.?If you were to take a hard look, you’ll see that compensation is the underlining issue at play – bankers need to justify their existence to bank Management, and, they want to make as much money as possible.?Change the comp plan, you change behavior, and hopefully, if done correctly, you avoid these types of issues in the future.

5). Bank Branch System - relative to industry average comparisons. I've read that SVB had 17 branches when their regulator shut them down. As a reminder, SVB was $200B+ in assets, which would equate to roughly $12B in assets per branch. That, in and of itself is a red flag and something bank management and regulators should've identified. ?Normally, I’d go review industry statistics on the FDIC’s website to confirm this issue as a “red flag”.??However, I know that $12B is an insane asset amount for any bank branch.?As a reminder, Silvergate Bank, which announced earlier in the month that they are self-liquidating their bank had $11B in assets served by 5 locations.??You can also do this same analysis by the full-time employee (FTE’s) to asset – which is typical for banks to decide whether they need to hire more staff or reduce staff etc.???You can also look at the bank’s efficiency ratios.???SVB had roughly 8,500 FTE’s upon their closing.?Based on this figure, each employee at SVB would cover $23MM in assets.?However you want to slice and dice this stat, it screams “look at me”! ?

6). Customers – at SVB are at fault as well.?It is their money and they made a decision to leave their funds at the bank knowing they are uninsured, per the FDIC insurance limits.??They could’ve demanded an off-balance sheet solution due to the FDIC’s insured amount of $250,000 (or at least reciprocal deposits using third-party solutions to protect their client’s funds under the FDIC’s insurance limits).?If their SVB relationship manager required funds to be placed in the bank, per loan requirements, they should’ve demanded an off-balance sheet solution to safeguard their funds.?????

7). Greed – why did the SVB management feel compelled to artificially inflate their balance sheet by allowing large amounts of funds to be brought into their bank, and, why did they make the decision to purchase bonds/securities with those perceived volatile funds???The only reason I can conclude is due to “greed”.?They (SVB mgmt.) wanted to outperform their peers and the industry.?Well, they did, until they didn’t or couldn’t.?

8). Bank Liquidity – Every bank and bank department has policies and procedures with risk management parameters to help them make decisions, too simplify and help mitigate risks, perceived or real.??With respect to bank liquidity, every bank has primary, secondary, and contingency liquidity plans to ensure they can meet any future liquidity issues encountered.?The US banking system has two government agencies (FHLB & FRB) specifically charged with ensuring banks can access liquidity during the most severe circumstances/challenges faced on any given day or period in time.??Having worked in and with banks dating back to 1990, I understand there is a perceived negative connotation of utilizing the FRB discount window.?However, that doesn’t change the fact that you “should” test those sources on a quarterly basis to demonstrate that the resource(s) are working and functional.?For those that aren’t aware, the FHLB accepts bonds and loans as collateral from banks so they can borrow against them to ensure they meet daily liquidity shortcomings.?Furthermore, FHLBs might need to complete a loan review before accepting specific loans as collateral, common practice within the banking industry.?However, the FRB doesn’t require such stringent reviews prior to accepting loans as collateral.??What they may do, is lower the borrowing base (percentage) until a loan review can be conducted.?It is common knowledge within the industry that FRBs are the lender of last resort.?While that may create the “negative connotation” of utilizing them as a source of liquidity, it is a better option than allowing your bank to fail because you couldn’t meet the liquidity needs of your bank.

9). Technology – is clearly changing the way consumers utilize their banks and how those same banks serve their customer base.??It is being said that SVB is the first bank to fail by “tweeter”.?Furthermore, consumers with access to their cell phones can withdraw funds with the click of one button.?The speed at which SVB customers spread the word that their funds “weren’t safe” spread at lightning speed, and those same customers executed withdrawal requests from their phones, tablets, or computers at similar speeds.?SVB was “the technology” bank within the banking system and the clear leader in the technology ecosystem with a presence all over the globe.??I’m not sure how regulators can change, alter, or influence the importance “technology” plays in the economy, and, specifically the banking system.??This is a tough nut for regulators to crack…?

I’m looking forward to reading the regulatory body’s findings when they conclude and release their post-mortem report on May 1, 2023.??Based on Congress’s questioning of banking regulators this week, it is safe to say additional regulatory oversight is on the horizon.???????????

Best regards,

Michael A. Johnson, Founder & CEO

Eight Eleven Consulting, LLC. ?

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