Transcription:
Penny Crosman (00:03):
Welcome to the American Banker Podcast. I'm Penny Crosman. What can be learned from the recent failures of Silver Gate Capital, Silicon Valley Bank and Signature Bank? We're here today with Brian Graham, partner and co-founder of Klaros, an advisory and investment firm. Welcome Brian.
Brian Graham (00:19):
Thanks for having Penny. It's great to be here.
Penny Crosman (00:21):
Thanks for coming. So I understand you were involved in some past banking crises. Can you tell us a little bit about that?
Brian Graham (00:30):
Sure. I think it's another way of saying I'm old, so I've seen my fair share of these. So beginning in the late eighties I was involved as an aid to then Congressman Chuck Schumer in the savings and loan crisis. And in the 1987 stock market collapsed, the Brady Commission that studied that. And then during the global financial crisis, I was involved by working with the F D I C in a publicly traded non-bank finance company to help a failing bank through a transaction that the F D I C facilitated. So been through a few of these wars.
Penny Crosman (01:10):
And are there any clear differences between what's happened over the last couple of weeks and what happened in those older crises?
Brian Graham (01:21):
So there are always differences. Every one of these things is triggered by a different confluence of events and has its own little spin. But the sad truth about it is that they're all kind of out of the same cloth. Something happens that triggers a liquidity crisis, but that liquidity crisis really only peels back the layers that were covering underlying problems in the global financial crisis. It was the credit quality of the underlying mortgage loans and the the fact that there were a bunch of really bad loans there in both the savings and long crisis. And to a large extent today, it was about the interest rate risk that was embedded there once you pulled back the curtain. And the fact that a lot of assets with long-term fixed rates were booked at a time when interest rates were lower, interest rates go up, they go down in value. And so even though it's not caused by credit risk, it's, it results in the same thing. So I wish I could tell you everyone's a new scenario, but there's a lot of paths that echoes here.
Penny Crosman (02:32):
Well, so to piggyback on that point, how widespread do you think that problem is of banks that have assets on their books that have lost value? It seems to me that would be fairly common.
Brian Graham (02:47):
It is very widespread, but it's not whether or not they have assets that have lost value because interest rates have gone up. The answer to that is yes, for every bank out there, what the more important questions are twofold. One is were those positions hedged? Did the value of your liabilities change as the assets change? So did you match fund them? Did you have explicit hedges interest rate derivatives and the like to protect yourself against that? And the second is how big were these exposures, these fixed rate exposures relative to your total balance sheet? The problems don't occur when somebody has assets that are a small proportion of their balance sheet that get impacted. It's really when it's large and they didn't hedge it, that things become very problematic.
Penny Crosman (03:44):
So if you were running a bank today or a CFO of a bank today, perhaps, would you be taking a hard look at the balance sheet and trying to perhaps make some changes if there were a lot of say long-term treasuries, et cetera?
Brian Graham (04:05):
Well, I would hope that if I were the c o of a bank, I would've done this long before any of this happened because that's kind of our job as CFOs in that context. We're supposed to manage these kinds of risks. We're supposed to monitor and measure them. And if you were monitoring and measuring the interest rate risk embedded in your balance sheet and doing it effectively consistent with the right asset liability management policies and everything else, you wouldn't find yourself in a position where you had to do something dramatic or severe. It's only when that isn't managed effectively that you really get that brutal wake up call.
Penny Crosman (04:50):
And so why do you think this was the case for so long, especially for Silicon Valley Bank, and why wouldn't their regulators have said something to them sooner to correct this issue?
Brian Graham (05:05):
Yeah, so Silicon Valley Bank is an outlier and we just have to acknowledge that if you look at their unrealized losses on their securities portfolios, whether those securities were held at available for sale, in which case they'd show up and that weird A O C I bucket on the accountant statements or in held with maturity, in which case they, they'd be disclosed as a foote. You can see what's happened to Silicon Valley banks assets over the last year and a half as the Fed has steadily raised interest rates. And as we speak here today, they just raised him again another 25 basis points and it's really not a surprise. What is different though at Silicon Valley Bank is first those fixed rate investments were a very large percentage of their balance sheet much larger than is the case of most other banks because Silicon Valley Bank did not really have a large loan portfolio.
(06:08)
So they kind of used investment securities to bolster, I presume, to bolster their net interest income and had just a lot of these fixed rates securities. And the other thing is you can see how these unrealized losses accumulated with time and it's pretty clear, again, going back to the first quarter of 2022, and it's pretty clear that no action was taken in the first quarter of 2022 or the second quarter or the third quarter or in the fourth quarter or even the first quarter of this year until their hand was forced by a rating agency basically. And that's that, that's a shame. So if you add up all of the unrealized losses on their securities, they exceeded the total tangible book value of the bank. And it's one thing to argue if you've got some variation in your securities portfolio values and it moves things up or down 50 basis points or something like that, but if your exposure to interest rate risk is going to wipe out your entire capital, that's something that should have been handled with respect to the, I'm sorry, pe, go ahead.
Penny Crosman (07:24):
No, it's just curious that as you say, if no action was taken all of 2022 that no bank examiner pointed that out or there wasn't any attempt to rectify it.
Brian Graham (07:38):
So I don't think we know whether or not that was the case. I think that's to be determined as they look at what did and didn't happen. From a regulatory point of view, I would say it's pretty clear that the way in which the regulatory capital ratios are constructed for banks under 250 billion in size played a role here that if you are JP Morgan Chase, you can't kind of ignore these unrealized losses. They show up in various of your capital requirements and if had made bad interest rate decisions and put all of your book value at risk and used it up in these unrealized losses, the regulators would've been all over them because their capital ratios would've been in the tank. And that isn't true for smaller banks because they're allowed to ignore any and all of these unrealized losses. And unfortunate thing here is, again, if it were a difference of a half a percentage point on a capital ratio, that's okay, but when it takes a bank that the day before failure was had nearly 8% leverage capital as recorded by the rules and marks it to zero because essentially all of that 8% was chewed up with these unrealized losses, that's probably something for the policymakers to have a think about.
(09:15)
Whether that's the way we want those regulatory ratios to operate, they should have for, first of all, I would say even if the regulatory ratios aren't sending a warning signal management of the bank should have been, I think in my judgment, much more active in seizing the bull by the horns. But I hope and that the regulators were engaged in this well before the events of the last two weeks. But I don't know one way or the other,
Penny Crosman (09:46):
So correct me if I'm wrong here, but my sense of one aspect of these failures is that all these banks suffered a run on the bank, and that was partly because people became aware of the falling value of these assets on their books, the losses that Silicon Valley Bank suffered when they tried to sell off some of its assets and then people went and through email and through social media told others to pull all their money out of the bank at once. Is it fair to say that these banks could have survived if they hadn't had those kinds of runs?
Brian Graham (10:27):
I think they could have kicked the can down the road a bit more. I mean, as we were just discussing Silicon Valley encourag, its first unrealized losses in scale and 15 months ago, and it didn't kind of come to a head until recently, but I did it, the fact that you can kick can down the road a little bit doesn't mean you've solved the fundamental problem. And the fundamental problem here was there really two sets of capital standards at work. There's one that's run by the regulators and Silicon Valley Bank the day before it failed past that swimmingly. And there's one that operates within the mines and hearts of the counterparties to the bank, whether it be depositors or customers or loan customers or anybody else. And those customers spoke very, very loudly and very, very quickly and very collectively that they didn't believe that the institution was in good shape.
(11:32)
And candidly, they were right if this was just a liquidity crisis. The Fed and the federal home loan banks and everything else have a ton of tools to serve a pure liquidity crisis. But it was more than that. I think I started by commenting that what's old is new again, and that these crises kind of echo through the past here. There is one thing new about this one in a very real way, and that is Twitter and the ability of customers to grab their phone and initiate a wire or an ACH transfer or those kinds of things dramatically accelerated how fast the run happened. So it didn't occur over weeks or months. It occurred over minutes. And I think that really is something that we as a banking industry and probably the regulators as supervisors, weren't as prepared for as we probably in retrospect should be because things are going to happen much more quickly than they had in the past. The fact that it was a liquidity crisis that laid bare the underlying problem important, but the underlying problem stays true regardless.
Penny Crosman (12:56):
Yeah, I was talking to one banker who felt that if this had happened 20 years ago and we were talking about Gate capital specifically at this point, if this had happened 20 years ago, the bank would've had more time to kind of regroup. And I'm sorry, we were talking about Silicon Valley Bank because Silicon Valley Bank happened so quickly after Silver Gate announced some of its problems that between the speed and the coinciding of those two banks kind of falling into difficulties at the same time that, and then everybody talking about this on Twitter and venture capital firms telling their portfolio companies to pull all their money out, that all of that kind of just brought Silicon Valley Bank down in a way that 20 years ago maybe might not have happened, maybe 20 years ago. The bank could have quietly gotten some more funding, fixed some of the issues that it had, and before everybody knew about it and started talking about it and initiated Iran on the bank. Do you think that has merit?
Brian Graham (14:15):
I don't think it would've changed the ultimate outcome. The ultimate outcome could have been wildly less painful. So the ultimate outcome is the bank incurred a bunch of losses, unrealized or not, those were losses and it was going to need to fill the resulting hole on balance sheet with incremental equity. If in my judgment, if the bank had started to do that earlier, if they'd started to do that a year ago, they'd be in fine shape. They could have raised a significant amount of equity on a very orderly basis at probably very attractive evaluations. But if they'd even started a week or two or three or four earlier than that than the panic at the end, I think they could have managed the situation to a much better outcome. They still would've needed to fill the hole in the balance sheet. But that speed that you talk about Penny is really important because so many of the tools that supervisors have at their hands are they take time, they take time to figure out, they take time to implement.
(15:28)
There was a Wall Street Journal story today about the TikTok of what happened at Silicon Valley Bank and talking about how they needed to send a test file from the Fed over to from the Federal Home loan banks over to the Fed, and it took 'em too long and they just passed the 4:00 PM mark and all those kinds of things. And it goes to show that what Twitter and everything else has done is reduce the time in which decision makers and policy makers have the freedom to act. And that really means that puts the onus on all of us to do a lot more planning in advance because you can't wing it when you've got an hour to figure this stuff out and to make sure we're kind of ahead of that curve because we're not going to have time in the midst of any crisis, whether it be institution specific or more to kind of figure that out.
Penny Crosman (16:25):
Now in the case of Signature Bank, Barney Frank, who was on the bank's board has said the bank was not insolvent, but that regulators kind of rushed in to seize control because it was a crypto friendly bank. Do you think that point has any merit?
Brian Graham (16:44):
It's really hard to tell from the outside. There are a couple things that are consistent between Silicon Valley and Signature that are probably important to notice. And the most important is that they both had very large balances of uninsured deposits and logically uninsured deposits are the ones that are most likely to leave the soonest if there are hints of concern about the solvent saving institution. And so I think they were both kind of in that circumstance. Interestingly, the reason they were in that circumstance was because they were serving commercial customers by and large, we'll get to the crypto in a second, but they were serving commercial customers and deposit insurance and the deposit insurance cap of $250,000. That makes sense if you think about it from the perspective of a household $250,000. So it's a lot of money to have in a checking account for a household, but you're a company and you have any material number of employees, $250,000 doesn't cover payroll, it doesn't cover the healthcare insurance premiums you got to pay, et cetera.
(18:01)
And by their nature, those kinds of customers tend to hold balances that are much larger than that. And so these two banks, because they were serving companies, which is obviously an important part of the whole economy here, were susceptible to that dynamic. If you throw in the crypto thing, I think it is it not unreasonable to speculate a solids, but it is speculation, which is Silicon Valley Bank had a small amount, relatively small amount, I think it was like 3 billion that my memory serves of reserves that back a stablecoin. The stablecoin are the ones that are designed to always be a dollar and supposedly are fully backed. And those reserves, since it's 3 billion, is greater than $250,000 not fully insured. And over the course of the weekend, you could see by tracking the market price of these stable coins, that there was a great deal of concern until the government came in and dealt with the uninsured deposits issue about whether or not stable coins would kind of blow up.
(19:20)
It turns out signature had orders of magnitude, more stablecoin reserves in deposits on their balance sheet than Silicon Valley. It wouldn't surprise me if that dynamic contributed to the speed at which the government decided to act with respect to signature. And I wouldn't at all take a different opinion than former banking committee chairman of Marty Frank with respect to the outlook of regulators towards crypto, which has become quite negative over the past six to 12 months. I'm not sure that's really what caused either the underlying problem or the actions that were taken. Again, I wasn't in the room. I don't know for sure.
Penny Crosman (20:07):
So if you were running a bank right now, that's not one of these three, but any other, say mid-size or smaller bank in the us, what would be some of the things that you might be trying to do right now? You talked about looking at the balance sheet very carefully, maybe doing some hedging, maybe making sure you're adequately capitalize. What are some of those specific things that you think banks ought to be pretty wary of right now?
Brian Graham (20:42):
I think obviously interest rate risk management is got to be top of the list list for almost a generation. Interest rates have been close to zero or going down, and as a consequence, a lot of the people who are running these banks and operating in the treasury departments just haven't had personal real life experience with rates going up. And I think we probably have lost some of that muscle tone of interest rate risk management because we didn't have to do it for 20 plus years or put differently. We should have been doing it, but it didn't have an impact. This rates always moved in a way that was net favorable. So stretching out those muscles and working out our interest rate risk management, I think has got to be a critical priority. And the sets further move today to increase interest rates in other 25 basis points, underscores that it's going to continue to be important regardless of what happens.
(21:48)
So that's number one. And that means making sure you understand the sensitivity of your assets and your liabilities to rates, and it means matching both sides of your balance sheet as best you can. And it means making sure you don't have outsized exposure on either of your asset or your acid reliability side to your balance sheet to significant swings and interest rates. So I think that's number one. Number two is liquidity is really important right now. And if I were a banker, even if I had plenty of liquidity right now, I'd be making sure I had the right collateral, federal Home Loan bank to ensure I could access funding there. If God forbid it became necessary, I'd make sure I'd already tested my files with the Federal Reserve to make sure I could access the discount window as opposed to waiting until the middle of a crisis.
(22:45)
I would figure out what my Fed funds lines were with correspondent and other banks to ensure I had access to that kind of funding. And I'd be thinking about the structure of my deposit offerings, pricing and terms and everything else to maximize my ability to manage my liquidity risks. God forbid such should something happen. So I think that's really, really important. The third thing I do is we talked a minute ago, penny, about how time scales have just been compressed dramatically by technology. I think you got to do some scenario planning here. I think you've got to do something that's analogous to what we do in the systems world of business continuity planning and phone trees and who calls who and can work from home and access their accounts and all that kind of stuff that we've done for years. On the system side of things, I think we need to do some of that on the liquidity and asset liability management side of things to more this when it's not a crisis so that we are prepared and we know who's supposed to do what in order, who's supposed to call home when God forbid a crisis does emerge if it does.
Penny Crosman (24:08):
Yeah, and in conversations I've had with fintechs, I've gotten the sense that any FinTech that didn't have a CFO is now getting one and really trying to make sure they've got the basic accounting principles all covered, so, well this has been really helpful. So Brian Graham, thanks so much for joining us today for all of us. Thank you for listening to the American Banker Podcast. I produced this episode with audio production by Kevin Parise. Special thanks this week to Brian Graham at Klaris Group. Rate us, review us and subscribe to our content at www.americanbanker.com/subscribe. For American Banker, I'm Penny Crosman and thanks for listening.