Monitoring Your Financial Institutions in Light of the SVB Failure

As most of us are all too aware, Silicon Valley Bank (SVB or Bank), a subsidiary of publicly traded parent company, SVB Financial Group, was shut down by federal regulators on March 10, 2023. At the time of its collapse, SVB was the 16^th largest bank in the U.S. with approximately $212 billion in assets.

The failure of SVB and other banks has generated many questions, including:

• “How could I have foreseen a bank collapse and moved my money?”
• “How do I monitor my key vendors to be sure they’re not impacted by a bank failure and unable to provide services to us?”
• “What can I do to mitigate risk in my current banking relationships?”
• “What risk factors should I monitor in current and potential banking relationships?”

It’s helpful to understand the specific factors that led to the collapse of SVB in thinking about actions you may want to take to monitor your banks and mitigate enterprise risk.

A Bank with a Unique Focus  

SVB was a state-chartered bank founded in 1983 and a member of the Federal Reserve System. Products offered were focused in the technology and life science/healthcare industries as well as global private equity and venture capital clients.

Between 2019 and 2022, during a period of significant growth, SVB used excess cash to buy U.S. Treasury Bonds (T-bonds). As interest rates rose and investors bought T-bonds at higher rates, the market value of SVB’s T-bonds declined.

In 2022, the technology sector hit a bumpy patch. With SVB’s higher loan concentration in venture capital, technology start-ups and cryptocurrency companies early in their lifecycle, cash-strapped customers in these sectors withdrew funds.

These deposit withdrawals, coupled with having to sell T-bonds at a loss to meet withdrawal demand, left SVB with insurmountable liquidity needs. These issues contributed to the bank’s closure by the California Department of Financial Protection and Innovations, which transferred control to the Federal Deposit Insurance Corporation.

Should I Monitor My Banks and Vendors Differently?

Recent failures of SVB and other banks highlight the need for prudent risk management and monitoring practices over your banking relationships.

To help mitigate the concentration risk in key banking relationships, incorporate bank monitoring into your risk management response process. The areas highlighted below are not all-inclusive, but they represent certain key risks that should be considered for monitoring in some form. Keep in mind that one indicator that is out of the safety zone may not tell the whole story, so having an understanding of how the information fits together is critical in determining the risk profile of your bank(s).

Capital Adequacy^.

There’s a difference between total equity based on Generally Accepted Accounting Principles (GAAP) and total capital for regulatory purposes. GAAP equity is what you’ll see reported as Total Stockholders’ Equity in a bank’s audited financial statements. The equity components typically include common stock, preferred stock, retained earnings, accumulated other comprehensive income/loss, less treasury stock.  Regulatory capital, on the other hand, uses the GAAP equity components and assigns risk weightings to stress the assets using certain market assumptions. Regulatory capital represents the amount of capital a bank has to meet the requirements stipulated by a bank’s regulator.

While GAAP equity can serve as a practical expedient for regulatory capital, be careful about relying on this measurement, as GAAP equity alone will not provide an adequate assessment of capital strength.

Regulatory capital and other key performance information can be found using a bank’s Call Report and Uniform Bank Performance Report (UPBR):

• The Call Report collects financial data and provides details on the Report of Condition, Report of Income and schedules detailing the composition of loan concentrations that support the reported balances.
• The Uniform Bank Performance Report is an analytical tool used for bank supervisory, examination, and management purposes. It shows the impact of management decisions and economic conditions on a bank’s performance and balance-sheet composition. The performance and composition data aid in evaluating the adequacy of earnings, liquidity, capital, asset and liability management, and growth management.

• The regulatory reports are available on the FDIC website

Using the Call Report or UPBR, you can compute a bank’s Capital Adequacy Ratio (CAR) by dividing a bank’s capital into risk-weighted assets. Generally, look for a ratio greater than 8% for a bank to be healthy. The CAR is an indicator of how much cushion there is for a bank to absorb losses before it becomes insolvent, and its depositors take their business elsewhere

Liquidity

Unlike capital adequacy, which is a measure of the resources a bank has to absorb losses, liquidity is a measure of the cash and other assets available to pay bills and meet other short-term financial obligations.

The UPBR has measurements and ratios that can be useful for evaluating the liquidity levels and risk components of your bank(s).  However, it’s important to note that SVB’s liquidity metrics looked adequate at the time it collapsed.  There are a lot of ratios in a bank’s UPBR. To help individuals and organizations in reviewing their bank’s UPBR, the Federal Financial Institutions Council has published a User’s Guide on what to key information should be reviewed. You can find the User’s Guide here.

Credit Quality and the Texas Ratio

There are numerous approaches to evaluating a bank’s credit quality. They include evaluating loan concentrations by industry sector, past due loans by loan type, changes in the Allowance for Credit Losses (formerly known as the Allowance for Loan and Lease Losses), loan write-offs, and foreclosures, to name just a few elements.

• If a bank has high concentrations of loans in a particular geography or industry sector, it can represent a red flag and risk that should be monitored.
• The bank’s Call Report and UPBR can provide good monitoring information to help evaluate the financial strength of any U.S. chartered bank. Another way to identify deteriorating loan quality and a potential problem bank is computing what’s known as the Texas Ratio. The ratio, which can apply to any U.S. bank, was developed in the 1980s as a practical expedient to assess the strength of banks during the U.S. energy and real estate bubbles. The Texas ratio is computed by dividing non-performing assets by the sum of a bank’s tangible common equity and allowance for credit losses. The higher the ratio, the higher the bank’s exposure.

Management

Evaluating management is also key to understanding a bank’s overall risk. In the case of SVB, the Chief Risk Officer (CRO) stepped down in April 2022 and left the bank in October 2022. A new CRO was hired in January 2023.

To understand the current state of your bank, talking with your relationship officer or C-suite contacts may provide information not readily available through public information sources.

Board of Director Composition

For any organization, a key element for determining the strength of corporate governance is to understand who is on the board. Understanding the composition of the board and qualifications of board members could raise red flags that should be monitored more closely.

Other Ways to Mitigate Risks

Diversify Banking Relationships

Effectively mitigating risk may mean not keeping all deposit accounts at one bank. For example, it’s not as easy as one may think to simply transfer funds to another bank, especially if a relationship doesn’t currently exist. Payments to vendors and payroll processing can be difficult and time consuming to change. In fact, it may delay payments to vendors and prevent employees from getting paid timely. This exposes you to reputation risk with your vendors and trust issues with your employees.

It’s best to establish at least two banking relationships in addition to your primary one. Opening deposit and lending accounts can take time, as institutions must meet regulatory and internal credit requirements when establishing new relationships.

Know Who Your Vendors Bank With

While not obvious, it’s good to understand who your vendors bank with to help ensure they are able to continue business operations in light of possible delays in transacting business in the normal course of operations. A company can have significant operational and reputational risk if a key vendor is unable to provide a product or service.

If you use ACH to pay your vendors, you will have the vendor’s bank information. You can also make this a part of your vendor management process to assess whether your vendor is doing business with a strong financial institution.

Allocate Uninsured FDIC Deposits

FDIC currently insures deposits of up to $250,000 per depositor, per institution and per ownership category at FDIC member banks. Some companies spread risk by allocating account balances so there isn’t too much exposure at any one institution.

While you can open an account in a different ownership category, such as corporation, partnership or trust, you would still have exposure to a single institution.

If you’d like to protect your deposits over the $250,000 threshold, these are some options:

• The IntraFi Network Deposits program allows multi-million dollar FDIC protection through a network of banks without opening accounts at multiple banks. Rather, your deposits are maintained at one bank as long as that bank is a member of the IntraFi Network.  IntraFi uses products such as Insured Cash Sweep (ICS) and Certificate of Deposit Registry Service (CDARS) to help achieve this objective.
• MaxSafe Accounts maximize FDIC insurance by offering protection for balances of $250,000 up to $3.75 million. Wintrust, the company that offers MaxSafe accounts, provides this protection by distributing deposits across more than a dozen community bank charters, similar to the IntraFi Network. MaxSafe accounts include CDs, money market accounts and IRAs.
• The Depositors Private Insurance Fund insures deposits at member banks beyond what the FDIC covers — without a limit. About 70 banks offer this coverage and all are based in Massachusetts.

Look For Prior Regulatory Actions

To identify any prior regulatory actions against your current or prospective banks, you can search the Federal Reserve website for prior enforcement actions. Performing routine searches or having any changes in agency ratings reviewed would tip you off to higher risk trends.

Monitoring news releases on your banks can tip you off to trends or emerging risks that need to be monitored. Some companies place “at risk” institutions on a watch list and begin moving money when certain thresholds are met.

Key Takeaways

Monitoring your bank(s) should be part of your risk management process. While it may not be necessary to develop controls for each of the areas mentioned above, it is essential to mitigate the most impactful risks to your organization.

If you would like assistance in identifying and monitoring risks with your banking relationships, contact us. We would welcome the opportunity to discuss your needs with you.

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