Banking & Financial Institutions
On April 28, 2023, the Board of Governors of the Federal Reserve System (“Federal Reserve”) and the Federal Deposit Insurance Corporation (“FDIC”) each released reports detailing the respective agency’s supervision history and analysis of the underlying causes of two of the more high-profile bank failures in U.S. history. In its report,1 the Federal Reserve analyzes the shortcomings, both in its own supervision and of bank management, that led to the failure on March 10, 2023, of Silicon Valley Bank (“SVB”). Similarly, in the FDIC report,2 the agency identifies the causes of the failure of Signature Bank on March 12, 2023, and assesses the FDIC’s supervision of the bank up until the date of failure. While each report squarely places responsibility for the failures at the feet of bank management, each report is also instructive for where it identifies supervisory shortcomings from the respective federal agency. In my view, this is a clear inflection point for the agencies, and I detail below some thoughts on “takeaways” that other financial institutions may be wise to consider in light of the changing regulatory winds.
Speed of Regulatory Response
In the SVB Report, the Federal Reserve’s Vice Chair for Supervision, Michael S. Barr, states bluntly:
SVB failed because of a textbook case of mismanagement by the bank. Its senior leadership failed to manage basic interest rate and liquidity risk. Its board of directors failed to oversee senior leadership and hold them accountable. And Federal Reserve supervisors failed to take forceful enough action, as detailed in the report.SVB Report, at pg. 1.
Vice Chair Barr goes on to highlight how Federal Reserve supervisors did not fully appreciate the extent of SVB’s vulnerabilities as it grew in size and complexity or, when supervisors did identify vulnerabilities, take sufficient steps to ensure that the bank fixed its problems quickly enough. The SVB Report states that “Overall, the supervisory approach at Silicon Valley Bank was too deliberative and focused on the continued accumulation of supporting evidence in a consensus-driven environment.”3
The Signature Report notes a similar conclusion with respect to the FDIC’s efforts to have Signature Bank address its deficiencies: “In retrospect, the FDIC could have acted sooner and more forcefully to compel the bank’s management and its board to address these deficiencies more quickly and more thoroughly.”4
In my view, each of the post-mortem reports is a real-time statement – from the top – to examination staff that they should be employing a “glass half empty” approach to future examinations. I would fully expect that the speed and frequency with which Matters Requiring Board Attention (“MRBAs”) are issued, CAMELS component scores are lowered, and informal and formal enforcement actions are sought, to increase in the coming months. Institutions should revisit their most recent exam for issues identified as supervisory issues or recommendations and correct them now (or again). Where an agency may have once accepted an explanation of how a perceived risk is being properly managed, do not expect to receive the same “benefit-of-the-doubt” response from the agencies going forward.
Concern Associated with Rapid Growth
In addition to abnormally high concentrations of uninsured deposits,5 SVB and Signature Bank also shared the common attribute of having experienced rapid growth. The Signature Report indicates:
[The Signature Bank] board and management pursued rapid, unrestrained growth without adequate risk management practices; funded growth through an overreliance on uninsured deposits without implementing fundamental liquidity risk management practices; and failed to understand the risk of its association with the crypto industry.Signature Report, at pg. 7.
Signature Bank’s total assets increased by 175 percent from the end of 2017 ($43.1 billion) to the end of 2021 ($118.4 billion), and the Signature Report notes that the bank grew significantly faster than its group of peer banks.6 Similarly, SVB grew from $71 billion to over $211 billion in assets from 2019 to 2021, nearly tripling in size.7 While it is not uncommon to see smaller institutions double in size given the smaller asset base, the growth at these institutions is particularly noteworthy given their pre-Pandemic size. In discussing the Federal Reserve’s supervisory approach, Vice Chair Barr noted:
We also need to be attentive to the particular risks that firms with rapid growth, concentrated business models, or other special factors might pose regardless of asset size. As I have previously announced, the Federal Reserve has begun to build a dedicated novel activity supervisory group to focus on the risks of novel activities (such as fintech or crypto activities) as a complement to existing supervisory teams. As we do so, we will identify whether there are other risk factors—such as high growth or concentration—that warrant additional supervisory attention.SVP Report, at pgs. 3-4.
Banks should expect to get additional supervisory scrutiny going forward if they have experienced rapid growth, whether on the asset or liability-side of the balance sheet. If you have concentrations, expect those to be highly scrutinized. Document how your institution has also grown its risk management structure commensurate with the size of the organization. Be prepared to highlight and demonstrate mitigating factors that may exist for any concentrations your institution may have, particularly as compared to your peer group. Such mitigating factors should be highlighted early, as it is extremely difficult to change a regulator’s conclusion after it has already been made.
Capital Remains Intertwined with Liquidity
In discussing issues exposed in the failure of SVB, Vice Chair Barr opined that “[T]his experience has emphasized why strong bank capital matters. While the proximate cause of SVB’s failure was a liquidity run, the underlying issue was concern about its solvency.”8 The SVB report touches in a number of places on the theme of how higher capital and liquidity requirements may have helped SVB stay solvent. Vice Chair Barr stated, “With respect to capital, we are going to evaluate how to improve our capital requirements in light of lessons learned from SVB. For instance, we should require a broader set of firms to take into account unrealized gains or losses on available-for-sale securities, so that a firm’s capital requirements are better aligned with its financial positions and risk.”9
Historically, it is not uncommon for memorandums of understanding, or MOUs, and Consent Orders to contain requirements that an institution subject to the enforcement action must retain a higher level of capital than may otherwise be required to be classified as “well capitalized” under applicable regulatory requirements. The additional capital serves as an additional “buffer” against losses, given the higher risk profile of the institution. Of course, the ability to raise capital can be negatively impacted by the existence of the enforcement action, which places the institution in a difficult position.
The SVB and Signature Bank failures certainly demonstrated the importance of proper interest rate risk management. Unlike the Great Recession, these banks did not fail due to credit losses associated with exposure to a collapsed real estate market. However, in both cases, the ability of an institution to “manage through” losses or a restructuring of the balance sheet would have been improved by a higher capital base. Bank boards of directors and management, unfortunately, have many stakeholders to which they must answer. The institutional investor may focus on return-on-equity performance, while the bank’s regulator would prefer to see excess capital. In the current environment, institutions should expect to receive additional regulatory focus on the sufficiency of the capital base. The valuations of bank stocks are down and the cost of subordinated debt or a similar security are very high in the current interest rate environment – not an ideal time to be raising capital. Being good stewards of your capital is going to be ever more important today. Institutions will need to weigh concerns about potentially dilutive capital raises against other strategies to preserve a strong capital base.
The SVP Report and Signature Report are recommended reads for anyone interested in understanding the current regulatory environment in which financial institutions are operating. Even if you feel your institution is nothing like SVB or Signature Bank (or First Republic Bank10), understanding the mindset of one of your most important stakeholders – your regulator – can be a worthwhile use of time.
1 Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank, Federal Reserve (April 28, 2023), available at, https://www.federalreserve.gov/publications/files/svb-review-20230428.pdf (the “SVB Report”).
2 FDIC’s Supervision of Signature Bank, FDIC (April 28, 2023), available at, https://www.fdic.gov/news/press-releases/2023/pr23033a.pdf (the “Signature Report”).
3 SVB Report, at pg. ii.
4 Signature Report, at pg. 16.
5 As of December 31, 2022, 94% of SVB’s deposits were uninsured. See, SVB Report, at pg. 21. As of December 31, 2022, 90% of Signature Bank’s deposits were uninsured. See, Signature Report, at pg. 6.
7 SVP Report, at pg. ii and 18.
8 SVB Report, at pg. 2.
9 SVB Report, at pg. 3. In SVB’s case, at year-end 2022, its common equity tier 1 capital ratio (12%) was actually 200 basis points higher than the large banking group (“LBO”) peer group average (10%). However, its securities portfolio as a share of total assets was double the LBO peer group, and SVB’s held-to-market portfolio was nearly double that of the average LBO. See, SVB Report, at pg. 22.
10 First Republic Bank failed on May 1, 2023, surpassing SVB as the second largest bank failure in U.S. history.
Stuart M. Rigot is co-leader of the Banking & Financial Institutions practice group at Wyrick Robbins. He regularly represents public and private companies in strategic combinations and financing transactions, with a particular emphasis on the financial services industry. Wyrick Robbins publishes Client Alerts periodically as a service to clients and friends. The purpose of this Client Alert is to provide general information, and it is not intended to provide, and should not be relied upon as, legal advice.