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BirdsEye View

 The events of the past six weeks have been a stunning shock for many of us.  The lightening-speed unraveling of some of the industry’s most respected and analysts’ favorite banks has jarred us all.  Much has been written about the root causes, but no one described the situation more succinctly than my good friend Rodger Levenson, CEO of WSFS Bank.

As a backdrop for this liquidity crisis, consider the following:

Very low interest rates dating back to December 2008.  9 out of the next 13 years (up until Dec. 2021) rates were effectively zero.

In response to COVID, rates dropped to zero in March 2020 and over $6 trillion of stimulus was pumped into the economy.

This $ went looking for yield and fueled growth in higher risk assets such as crypto, early-stage technology, venture capital, etc….

Much of this money made its way into bank deposits especially at banks that had these industries as customer segments.

As rates increased during 2022, these deposits started to reduce.

Then the crypto meltdown including FTX incurred in late 2022…

Rodger identified three elements which, together, brought down SVB and Signature.

O Rapid growth

O Customer and balance sheet Concentrations

O ineffective internal and external risk oversight

The trigger for the meltdown started with the gigantic crypto fraud at FTX.  That event wiped out an entire market, and, with it, confidence in certain parts of the financial services industry.

Shortly thereafter, on March 8, Silvergate, a crypto currency based bank, liquidated itself.  This event contributed to the rapidly eroding investor confidence in banks with unique business models which, by definition, were associated with significant concentrations in a single industry or customer base.

One more unprecedented change which contributed to the incredible speed of SVB’s demise was the advent of digital banking.  For the first time customers could take their money and run, and no one was the wiser. This is how $42B left the bank in one afternoon (March 9th), with another $100B requested for the next day and remaining in a withdrawal queue.  Social media poured gasoline on the fire and fanned the flames to such an extent that Signature was taken over at 11am, a most unusual move (typically Friday afternoon at 4pm is the witching hour). 

While the entire industry is slowly bleeding the deposit overhang from the COVID era, these banks experienced incredibly fast and alarming withdrawals to such an extent that they could not stem the tide.  Signature, for example, was working hard in shoring up their liquidity, but with 20% of their deposits in crypto-related businesses, they ran out of time.

The impact of these bank failures is industry-wide and profound.  Despite the uniqueness of these banks’ business models and extraordinary concentrations, the entire industry will pay the price.

A. Customers awakened to the higher deposit rates overnight.  This was inevitable, but the sudden shift caused deposit rates to rise and firm up within weeks, not months.

B. The utilization of Alternative core deposit products such as CDars is increasing rapidly.

C. Margin pressure intensified markedly as a result of these developments.

D. Deposit outflows intensified, reducing liquidity in the system and contributing to the recession predictions.

E. As recession takes hold, whether shallow or deep, credit costs and volatility will increase, further depressing bank earnings.

F. Accounting renewed pressures on AOCI, available for sale and held to maturity classifications will increase as well.

H. Risk management best practices will broaden to include liquidity  invent ration considerations we have not visited for years, as well as new ratios of uninsured deposits to everything from total deposits to AFS securities portfolios.  Further, social media risk will be added to the numerous risks we already monitor, given the important role social media played in the collapse of the two banks and the rapid deterioration of others such as First Republic, other West Coast banks etc.

I. Bank ratings will also suffer, and Moody’s has been quick to put five banks including Comerica, Zions and others on a watch list.  Bank borrowing costs inevitably will also rise as a result.

J. It remains to be seen how the FDIC will handle the increased expenses it incurred in handling these failures.  A special deposit insurance premium assessment is likely to hit the bank, with more to come. The FDIC will also need to address, through congressional action, how to shore up consumer confidence in the smaller banks in the system.  The obvious solution - insuring all deposits of banks under a certain size - will further increase deposit insurance assessments.

Among the takeaways already identified are:

1. Develop a communication preparedness plan for unexpected developments, especially considering the speed we witnessed recently.

2. Expand multi-dimensional tress testing.

3. Meaningfully improve the management and monitoring of social media risk.

4. Never forget - CONCENTRATIONS KILL - both deposits and loans.

During this time, opportunities also emerge.  For one, focusing only on what we can control will help rebuild a sense of control and yield action plans. The proliferation of projects we have experienced in recent years will give way to renewed sharpened focus, fewer projects and a commitment to optimize recent investments.

Finding the silver lining is management’s challenge these days.  You can turn these lemons into lemonade through actions and forward movement.  These are the times when leadership and management make a great difference, galvanize and inspire the troops to get the job done and be successful despite adversity outside their control.