The First Republic Bank headquarters in San Francisco, California, US, on Saturday, April 29, 2023. First Republic Bank shares fell as much as 54% in extended New York trading Friday on speculation that it would be seized by regulators, as regional US lenders are pressured by deposit drains and weakening investments.
Jason Henry/Bloomberg
(Bloomberg) –The Securities and Exchange Commission is investigating the conduct of First Republic Bank executives before the government seizure and sale of the lender to JPMorgan Chase, according to two people familiar with the matter.
The SEC is looking into whether any members of the then-executive team of First Republic improperly traded on inside information, said one of the people, who asked not to be identified because the probe hasn’t been publicly disclosed.
It couldn’t immediately be determined which former executives are the focus of the inquiry. No one previously or currently at the bank has been accused of wrongdoing and the investigation could end without anyone being accused of misconduct.
Representatives for the SEC and JPMorgan declined to comment.
First Republic was seized by regulators and sold to JPMorgan on Monday in a government-led deal after a drama-filled weekend.
Separately, the SEC has been probing the trading activity of Silicon Valley Bank executives before its collapse in March, Bloomberg News has reported.
“That the SEC is looking into First Republic is no surprise,” said Richard Hong, a former SEC trial attorney who is now a partner at the firm Morrison Cohen in New York. “My expectation is that the SEC will be looking at a variety of issues regarding insider trading and disclosures.”
Martin Gruenberg, the FDIC’s chairman, has said he would give special consideration to the fee burden on smaller lenders.
Anna Rose Layden/Photographer: Anna Rose Layden/B
The U.S. is poised to exempt smaller lenders from kicking in extra money to replenish the government’s bedrock Deposit Insurance Fund, and instead saddle the biggest banks with much of the bill.
Smaller lenders with less than $10 billion of assets wouldn’t have to pay, said the people, who weren’t authorized to discuss the deliberations. There were more than 4,000 institutions under that threshold at the end of last year, FDIC data show.
Depending on the size of their deposit portfolio, some banks with as much as $50 billion of assets could also avoid the payments, which might be spread out over two years or paid at once, two of the people said.
Under the plan, bigger lenders would all face the same fee structure, but could end up having to kick in more money because of balance sheet size and number of depositors, the people said. The riskiness of deposits won’t be a factor.
A political battle has been raging over who should be on the hook for refilling the fund after it was depleted by billions of dollars when the government took the extraordinary step of making all SVB and Signature depositors — even uninsured ones — whole. Smaller banks have lobbied hard to avoid paying the so-called special assessment fees, in addition to the contributions that all lenders make to fund quarterly.
The FDIC declined to comment on its plans. Martin Gruenberg, the agency’s chairman, has said he would give special consideration to the fee burden on smaller lenders.
The DIF, as the fund is known, is a linchpin of the U.S. financial system as it’s used to insure most accounts for up to $250,000. It’s refilled by all insured banks paying quarterly fees known as assessments. The amount is based on formulas.
At Signature and SVB, many depositors had millions in their accounts — meaning they were uninsured — and were businesses that desperately needed the cash. The FDIC declared a “systemic risk exception” to use the fund to repay those depositors, in addition to those who would fall under the $250,000.
The FDIC has said that covering uninsured depositors will cost the DIF $19.2 billion and would be paid by special assessment fees. The agency may vote next week to introduce its plan for charging them and then take public comment on the proposal, before finalizing it months later.
The move to use the DIF to cover uninsured depositors has jump-started a long-simmering debate over whether the $250,000 cap needs to be raised. On Monday, the FDIC said it supported expanding coverage to business and laid out three options for overhauling the fund.
Beyond the special assessment that could be proposed next week and the broader overhaul considerations, the agency is also poised to announce changes to the regular quarterly fees that banks have to pay into the DIF. That plan will help blunt any impact from the First Republic to the DIF, the people said.
“Our products are undifferentiated, generally speaking. They’re good products, but they’re undifferentiated,” First Republic Founder James Herbert II said in a video for his induction into the Bay Area Business Hall of Fame. “What’s differentiated is the people and their passion, their caring for clients and the service they deliver,”
Jamey Stillings
James Herbert II spent four decades building one of the nation’s 20 largest banks. Then, in the span of just seven and a half weeks, the 78-year-old founder saw it all come crashing down.
First Republic Bank, which Herbert founded in 1985, collapsed on May 1 after being toppled by a deposit run. As the San Francisco bank’s executive chairman, Herbert was involved in desperate efforts to arrange a private-sector solution. But after those efforts failed, he was left to watch as the Federal Deposit Insurance Corp. seized the bank and sold it to JPMorgan Chase.
Herbert is taking the bank’s failure hard, according to his friend Frank Fahrenkopf Jr., a longtime First Republic board member. In recent days, Herbert has been staying with family members in Jackson Hole, Wyoming — sitting in the backyard, looking at the Grand Tetons and trying to forget what went wrong, Fahrenkopf said in an interview.
“The bank was his life. It’s a tragedy for him,” Fahrenkopf said. “I call him every day to make sure he’s doing all right.”
The story of First Republic’s demise has several elements. It’s about the impact of fast-rising interest rates on a large mortgage portfolio that quickly lost value, as well as about the fears sparked by the March 10 failure of Silicon Valley Bank.
But it’s also a deeply personal story. The son of a banker, Herbert built his own large banking franchise before agreeing to its $1.8 billion sale. He later regained control, then held on to the CEO job past age 75, all while collecting pay packages that rivaled the CEOs of larger banks. Finally, approximately a year after he ceded day-to-day control, he watched it all crumble.
Herbert declined to comment for this story. People who know him said that he built First Republic around a distinct business philosophy, which focused on providing exceptional service.
The bank’s branches were known for offering fresh-baked chocolate chip cookies and wood-handled umbrellas to its well-to-do clients. During the pandemic, when some big banks raised their hourly minimum wages above $20, First Republic hit $30 per hour.
“The bank reflected Jim’s view that customer service could play a central role in clients’ lives,” said Tim Coffey, an analyst at Janney Montgomery Scott. “And it worked until interest rates went parabolic.”
‘Exceptional service’
Herbert’s father, also named James, was a longtime banker in Ohio who eventually served as president of the Ohio Bankers Association. When his son graduated from college in the mid-1960s, he offered some career advice: Don’t become a banker.
The younger Herbert had other ideas, though. One of his earliest jobs was at Chase Manhattan Bank, a predecessor to the industry behemoth that swooped in this week to purchase First Republic.
During the early 1980s, Herbert and a partner, Roger Walther, bought two California-based thrifts and formed a holding company called San Francisco Bancorp. After selling that firm in 1984, they opened First Republic Thrift & Loan the following year.
First Republic took savings deposits and offered jumbo mortgages, largely to wealthy consumers. In 1986, when First Republic held an initial public offering, it had a total enterprise value of $23.3 million. But the bank was well positioned for growth.
There were lots of affluent households in the Bay Area, where First Republic was based, as the region rode the tech revolution. First Republic later expanded to other well-off coastal cities, including New York, Boston, Los Angeles, San Diego and Palm Beach, Florida, and grew its wealth management business.
“The real story of First Republic is exceptional service — exceptional service delivered by exceptional people, all the time, every day, to every client,” Herbert said in a video for his induction into the Bay Area Business Hall of Fame.
“We have products, but all banks have products. Our products are undifferentiated, generally speaking. They’re good products, but they’re undifferentiated. What’s differentiated is the people and their passion, their caring for clients and the service they deliver,” he added.
During the mortgage boom of the early 2000s, Herbert got an offer to sell First Republic to Merrill Lynch. He was initially reluctant. But the deal he struck with Merrill in 2007 allowed the bank to keep its brand, its management team, its offices, its employees and substantial authority to make decisions.
First Republic grew its assets from $22 billion in 2010 to $212.6 billion at the end of last year.
Eric Thayer/Bloomberg
Then came the 2008 financial crisis. Merrill Lynch, on the verge of failing, was acquired by Bank of America, which had a competing private bank and wasn’t a good fit for First Republic. In 2009, Herbert led a group that raised $2 billion to buy back the bank. And the following year, in late December, First Republic went public for the second time. The spinoff was lucrative for Herbert, whose compensation in 2010 totaled $36.3 million, most of it from stock option awards.
Growth continued at a rapid and steady pace, as a sustained period of low interest rates drove heavy mortgage volumes. First Republic went from $22 billion of assets three months prior to its second IPO to $55 billion of assets in the fall of 2015. And Herbert benefited handsomely.
His annual compensation fluctuated, but there were years where it rivaled the sums paid to the CEOs of very large banks. In 2012, Herbert’s total compensation was $15.2 million, mostly in stock awards.
And in 2021, Herbert was paid $17.8 million, again mostly in stock awards, according to the bank’s disclosures. Among U.S. commercial banks, only the CEOs of JPMorgan Chase, Bank of America, Citigroup, Wells Fargo and PNC Financial Services Group collected more money that year.
As of March 2022, Herbert owned more than 800,000 shares of the company’s common stock, representing 0.4% of the total shares available, according to the bank’s proxy statement last year.
‘A silver platter’
During his final decade at the helm of First Republic, Herbert had a good deal of stature in the industry. In 2018, the Federal Reserve Bank of San Francisco appointed him to the Federal Advisory Council, which typically meets four times per year with the Fed’s Board of Governors to dismiss economic and banking issues.
At First Republic, questions were arising about who would succeed Herbert. Initially, the bank’s only CEO in its nearly 40 years of existence was set to remain chairman and chief executive through 2017, and to stick around as executive chairman through 2021.
But that deal was reworked, and then it was reworked at least three more times. In 2021, Herbert, then 77, was set to remain CEO through the end of last year, and Hafize Gaye Erkan, the bank’s then-president, was named co-CEO, setting her up as Herbert’s heir apparent.
But in an unexpected move, Erkan resigned from her post on Dec. 31, 2021, just two weeks after the company announced that Herbert would soon begin a medical leave of absence to address a coronary health issue. In March 2022, then-Chief Financial Officer Michael Roffler, who had been appointed interim CEO, was named to the post permanently and joined the bank’s board of directors.
Herbert, meanwhile, became the executive chairman, a role that allowed him to stay active “in the development of the bank’s overall strategy, preservation of its unique culture and maintenance of key relationships with clients and shareholders,” according to the bank’s 2022 proxy statement.
First Republic’s loan growth accelerated over the last three years, with total loans increasing by 48% between the end of 2020 and the end of 2022.
The bank was his life. It’s a tragedy for him.
Frank Fahrenkopf Jr., a longtime First Republic board member, on the bank’s founder, James Herbert II
Last year was an especially good year. The bank reported record-setting loan growth, loan-origination volume, revenue and earnings per share. Growth continued even as mortgage lending volumes fell industrywide, with the bank’s residential real estate book swelling by 28% between the first quarter and the fourth quarter.
At the end of 2022, First Republic’s assets were $212.6 billion — a nearly tenfold increase in the 12 years since Herbert bought back the bank.
In a January 2023 call with analysts, Herbert said the industry’s slowdown in mortgage lending presented “an extraordinary opportunity” for First Republic to take market share.
“Moments like this are very special,” Herbert said. “The volume of demand is down, we all know that … but the disruption that’s going on in the mortgage market … is just handing us [opportunity] on a silver platter.”
First Republic’s focus on mortgage lending, including its push for additional growth as the Federal Reserve began raising interest rates, ultimately contributed to its undoing, said David Chiaverini, a banking analyst at Wedbush Securities.
“The way that they were winning against the competition is by undercutting on price,” Chiaverini said this week in an interview. “They were offering what were essentially long-duration jumbo mortgages at an attractively low rate, which is great for customers and leads to fast growth.”
As other lenders scaled back their mortgage originations amid rising interest rates, First Republic faced questions about its ability to attract deposits while continuing to extend new loans. Herbert argued that First Republic’s reputation as an experienced and high-value lender would enable it to weather a potential downturn.
“Most of our business is with existing clients and their direct referrals,” he told an analyst during First Republic’s July 2022 earnings call. “When their friends are having trouble getting something done, they say, ‘You ought to try First Republic.’”
The bank’s push-forward mentality led to a liquidity crunch, Chiaverini said. After rates rose, the bank faced the prospect of having to sell mortgages at below par value to raise capital, since the market value of those loans had fallen, he said.
“That’s why it ended up failing. No investor wanted to recapitalize First Republic, just like they didn’t want to recapitalize Silicon Valley Bank,” Chiaverini said. “They viewed it as throwing good money after bad, given how deep of a hole their balance sheet was in.”
‘Demise can happen very quickly’
During the first three months of this year, Herbert was among a handful of First Republic executives who sold millions of dollars of First Republic stock, according to regulatory filings. The shares were priced on average in the $130-per-share range, and Herbert’s stock sales totaled $4.5 million, The Wall Street Journal reported in March.
The sales were in line with Herbert’s annual estate planning and philanthropic donations, a spokesperson for Herbert told The Wall Street Journal.
And they represented about 5% of Herbert’s holdings, according to a source familiar with the situation. “It’s important that people have that perspective,” this source said. “He held onto a vast majority of his shares.”
When Silicon Valley Bank failed, First Republic was particularly vulnerable to the fallout. Both banks were based in the Bay Area, and both had upscale clienteles.
“I’ve spent a lot of nights not sleeping thinking about this: What could we have done to have avoided this?” said Fahrenkopf, the longtime First Republic board member. “And I came to the conclusion: If our bank was headquartered in Reno, Nevada, rather than San Francisco, so close to Silicon Valley Bank, this probably wouldn’t have happened.”
One First Republic customer who withdrew funds from a branch in San Francisco on Saturday, March 11 — one day after Silicon Valley Bank was seized by the government — described an anxious scene, with many customers still waiting to be served at 2 p.m., after the branch was scheduled to close.
A First Republic employee climbed onto a file cabinet to tell the assembled customers that their requests would be fulfilled, but also expressed uncertainty about whether the bank would survive the weekend, according to the customer, who spoke on condition of anonymity.
The next day, another regional bank, Signature Bank in New York City, also failed, as fear spread.
By the end of March, First Republic’s deposits, which totaled $176.4 billion at the end of last year, had fallen by more than $100 billion, not counting the $30 billion that 11 big banks deposited at the bank on March 16 in an effort to stabilize the situation.
“Certainly the outflow of $100 billion in a three-week period is a major factor, and … before Silicon Valley, not something that anyone had really anticipated,” said the source who spoke about Herbert’s stock sales.
During First Republic’s final weeks, company executives mounted an all-hands-on-deck effort to find a private-sector solution that would keep the bank out of government receivership — and avoid wiping out shareholders.
As executive chairman, Herbert was no longer required to be involved in the bank’s day-to-day operations. But the crisis created an intense level of pressure that was hard for him to ignore, and his involvement increased. Still, the efforts failed, and First Republic became the second largest bank failure in U.S. history.
The level of complexity involved made a private-sector solution hard to achieve, said the source familiar with the bank’s situation.
The demise of three regional banks in the last two months is a reminder of how rapidly bank runs can happen. “As soon as an institution loses the confidence of its customers, demise can happen very quickly,” said Coffey of Janney Montgomery Scott.
But Fahrenkopf said that he’s advised Herbert not to dwell on the past. “It doesn’t do any good to look behind,” Fahrenkopf said. “We can look forward. Don’t fret too much.”
Businesses that want to safely stash sums of cash above Federal Deposit Insurance Corp. limits have options that don’t involve juggling multiple accounts at multiple banks.
They can invest directly in government money market funds or Treasury bills. They can inquire about programs within their bank, such as deposit networks and reciprocal arrangements engineered by IntraFi and the like, or automatic sweeps of amounts exceeding $250,000 into money market mutual funds.
Or they can turn to fintechs that offer a tech-forward version or combination of the above.
The disconnect between the size of accounts that enterprises typically maintain and deposit insurance levels has existed for a long time, said Brian Graham, a partner at Klaros Group. But the three days between Silicon Valley Bank’s failure and the FDIC’s assurance that it would cover uninsured deposits jolted people into action.
“There has been a lot of scurrying around in the last several weeks as these organizations figure out what they want to do,” said Graham in a March interview.
Fintechs such as Meow or Vesto, and business-oriented neobanks such as Brex and Mercury, have mechanisms that let business customers invest idle cash in Treasuries or money market funds. Some companies began turning to Meow and Vesto well before the recent bank collapses, particularly for easy investing in low-risk, high-yield instruments. As such, the reasons they have to stay are likely to persist even if the FDIC elevates levels of deposit insurance for businesses.
“The fintechs are moving faster” than banks, said Graham. “They are piecing things together to come up with solutions that they expect will appeal to customers, and they are not wed to a single set of tools.”
The safety of each investment product varies.
“There are lots of flavors of money market mutual funds and lots of flavors of government securities,” said Graham. “U.S. Treasury is a different credit risk than some local sewer authority in a muni bond.”
Mercantile, which partners with organizations to create custom branded cards, has been holding excess cash at Vesto the past six-plus months. Vesto defines itself as a cash management platform for venture capital-backed startups and mid-market businesses. It builds customized portfolios for its customers according to their risk tolerance, liquidity needs and more, typically investing in Treasury bills, money market funds, corporate bonds and certificates of deposit. The back-end custodian is BNY Mellon Pershing.
“With the market changing and Treasuries being a little more interesting, we wanted something that was very easy to use and exposes us to a high-yield Treasury option without endangering cash at hand,” said Samuel Poirier, CEO and founder of Mercantile. “Vesto understood the need to take cash out on a monthly basis to fund the company.”
He chose Vesto, which launched in 2022, because of its simplicity and its understanding that companies such as his will withdraw funds on a regular basis. He only invests in U.S. Treasuries through Vesto.
Benjamin Döpfner, founder and CEO at Vesto, says he has seen an influx of new customers since SVB collapsed.
“There has been a desire to diversify their holdings and cash,” he said. “We found a lot of companies have almost all their cash sitting in one bank account.” He says his customers choose Vesto to find a secure home for their cash and to earn high yields.
“Oftentimes founders and CEOs don’t have the capital markets experience to do this themselves,” said Döpfner.
Döpfner describes the company’s investment style as “incredibly conservative.”
“We take the viewpoint that safety and liquidity are priority number one and yield is priority thereafter when managing corporate cash,” he said. “We only work with highly liquid ‘ultra-low risk’ investment products like U.S. Treasuries.”
Stocktwits, a social network for traders, began investing in Treasury bills through Meow well before SVB and Signature Bank collapsed in March. Meow is a banking platform that lets businesses purchase Treasury bills using partner registered investment advisors and broker-dealers.
“As the Fed started to raise rates, we saw an inverse yield curve, so it made sense to put some of the firm’s capital to work in addition to diversifying credit risk,” said Philip Picariello, vice president of finance and operations at Stocktwits.
He considers the firm’s capital as being divided among three buckets: immediate liquidity for payroll and accounts payable, near term liquidity to fund product development and core capital. Like Poirier, he wanted to earn yield in a low-risk way.
“When I started digging into Meow I liked the team and the way they built it,” said Picariello. “I was sold on the fact that BNY Mellon Pershing is in the back end. It’s very seamless to move money over, allocate it, and ladder it out.” Stocktwits uses an insured deposit sweep program at its bank to protect funds that should stay liquid in the near term. He allocates the rest to Treasuries through Meow based on what the company needs in the next month, three months or six months.
As suggested by Stocktwits’ strategy, these accounts are not meant to hold operating cash.
“When you want to get your money, it takes some time,” said Graham. The success of this strategy “depends on your ability to look ahead and know when you need the cash.”
Picariello is not concerned.
“If a corporate treasurer or chief financial officer has a good handle on upcoming liabilities, you should never have to worry about it taking a day or two to get your money,” said Picariello.
Döpfner said almost all the investment products his company works with are highly liquid, and customers can usually access their cash within one to two business days. Brandon Arvanaghi, CEO of Meow, said in a March interview that it would take customers one to two business days to receive their funds after selling their T-bills.
Business-oriented neobanks have developed their own products they hope will entice customers to park large amounts there instead of at regular banks. Brex has increased its deposit insurance from $1 million to $6 million since SVB’s failure by using a sweep network. Customers can choose to store funds above that limit in a BNY Mellon money market fund. Mercury has increased the amount of cash it can protect per customer to $5 million in a product called Vault. Deposits exceeding $5 million are placed in a money market fund that is almost entirely invested in U.S. government-backed securities.
Brex and Mercury touted thousands of new customers since the bank failures in March, although it’s an open question as to how many they will keep over the long term. Döpfner of Vesto and Arvanaghi of Meow also report a wave of new customers in the wake of those disasters.
“These kinds of alternatives tend to be really effective if you know you won’t need the money for X period of time and you’ll get a heads up when you need it,” said Graham.
The Federal Deposit Insurance Corp. estimated that the sale of First Republic Bank to JPMorgan Chase could cost the Deposit Insurance Fund $13 billion, and there is a good chance that banks will have to pay those costs through higher premiums on deposit insurance.
Bloomberg News
WASHINGTON — The costly resolution anticipated for the failed First Republic Bank increases the odds that banks will have to pay higher deposit insurance premiums and a heavier special assessment — and diminishes the prospect that community banks will be off the hook, industry observers say.
The seizure and sale of the San Francisco-based bank is the latest in a string of failures this year, following the collapse of Silicon Valley Bank and Signature Bank in March. Unlike the prior two episodes, however, regulators were able to find a buyer for First Republic over the course of a weekend, allowing the bank to open as scheduled on Monday.
But the sale includes a cost-sharing agreement between JPMorgan and Federal Deposit Insurance Corp. on certain loans in First Republic’s former portfolio that the agency expects to contribute to a $13 billion hit to the Deposit Insurance Fund. Combined with the $22.5 billion of losses incurred on the failures of Silicon Valley and Signature banks, the DIF will be down roughly $35 billion on the year, and the FDIC will have to pass those costs on to banks one way or another.
“This is going to be an interesting circumstance going forward,” said Kathryn Judge, a law professor at Columbia University who specializes in financial regulation. “We have both a special assessment arising from the systemic risk exception and the need to replenish the DIF because it’s fallen below the minimum. I would expect the FDIC to look at each of those challenges in connection with the other in proposing a course forward.”
The Deposit Insurance Fund had been a topic of concern for the FDIC before any of this spring’s bank failures, with the agency approving increases to premiums banks pay for deposit insurance based on the influx of deposits banks took during the pandemic. The hit to the DIF from the First Republic deal likely means those heightened premiums are here to stay, according to Jaret Seiberg, Washington policy analyst at TD Cowen.
“This $13 billion loss likely eliminates any prospect that the agency would delay the 2-basis-point hike in deposit insurance premiums that is effective with the June 30 billing cycle,” Seiberg said in a policy note.
Former FDIC lawyer Todd Phillips said the First Republic deal could also affect the FDIC’s forthcoming special assessment to replenish the DIF after Silicon Valley Bank and Signature Bank’s failures. While the special assessment was meant to replenish the fund because of the March bank failures, the FDIC may try to tack on the First Republic losses in the same stroke.
“Because the FDIC didn’t use its systemic risk exception, it doesn’t need to do a new special assessment,” he noted, “That said, because it’s already doing one thanks to SVB’s and [Signature’s] failures, it may attempt to use that special assessment to backfill the hole left by FRB’s sale. But it’s really unclear what they’ll do.”
Small banks have already lobbied hard against paying into a special assessment to make up for the losses caused by Silicon Valley Bank and Signature Bank, arguing that because they would not have received a systemic risk exception they shouldn’t pay for the management mistakes of their larger peers.
Jenna Burke, senior vice president and regulatory counsel for the Independent Community Bankers of America, said that same principle applies to any potential increases in deposit insurance premiums in the wake of First Republic’s failure. She suggested that any increase to smaller bank premiums is unwarranted, and that any rule changes considered should focus on ensuring assessment fees correspond to the risk an institution poses.
“The bottom line is community banks should never have to pay for the failures or bailouts of the very largest banks — whether that is through increases to their base deposit insurance assessments or special assessments,” Burke said. “The FDIC needs to take a commonsense approach to deposit insurance premiums to ensure small banks are not forced to subsidize large bank risks — the FDIC should ensure its approach to assessments is consistent and proportionate to bank asset size and systemic risk.”
But other experts say that, given the variety of systemic benefits chartered institutions enjoy, all banks should pay to prop up a failed one. David Zaring, professor of legal studies and business ethics at the University of Pennsylvania’s Wharton School of Business, said that with great benefits comes great costs.
“I think it’s great when banks have to monitor one another. I think the banking industry gets a lot out of the guarantee of deposit insurance and the industry should ratably pay for the privilege,” Zaring said. “I’m not of the view that small banks shouldn’t participate in their insurance fund, too. I just don’t think it works that way with other private insurers. If they sustain losses in a hurricane, the policyholders all take a hit rather than just the wealthy policyholders.”
First Republic’s deposits plunged 40.8% between the end of last year and March 31 — and were down by more than $100 billion when excluding an effort by big banks to shore up its balance sheet.
Jeenah Moon/Bloomberg
U.S. regulators were reportedly pushing over the weekend to finalize a plan to seize First Republic Bank, with its deposits to be assumed by a larger bank in a last-minute deal that would solve the problem of how to handle the San Francisco company’s uninsured depositors.
Fears about First Republic’s health have deepened since Monday, when the bank disclosed a massive drop in deposits during the first quarter, spurring regulators and big banks to engage in talks about rescuing the troubled firm.
Its stock sank after the earnings report and fell further later in the week as a failure looked increasingly likely. The share price fell below $4 on Friday, a staggering drop from its highs of nearly $220 in 2021.
Regulators and banks spent the weekend discussing options, with the Federal Deposit Insurance Corp. asking banks to place bids for the company by Sunday, according to Bloomberg News. JPMorgan Chase, PNC Financial Services Group, U.S. Bancorp and Bank of America were weighing bids, the news outlet said. Reuters also reported that Citizens Financial Group was interested.
First Republic has been struggling since the March 10 failure of Silicon Valley Bank triggered large deposit outflows. At the end of the first quarter, the bank’s deposits had plunged 40.8% since the end of last year — and were down by more than $100 billion when excluding an effort from big banks to shore up its balance sheet.
“First Republic was like the person waiting at the crosswalk when a drive-by shooting occurs on the corner,” said Todd Baker, a senior fellow at the Richman Center for Business, Law & Public Policy at Columbia University. “They essentially would not have had anywhere near the kind of problems they had if Silicon Valley Bank had not failed because there was significant crossover in the types of customers, and it all happened in the Bay Area.”
Eleven big banks — including JPMorgan, Citigroup, Bank of America, Wells Fargo and several large regional banks — deposited $30 billion at First Republic last month in a show of confidence. Those funds comprised roughly 60% of the uninsured deposits at the bank as of March 31.
The bank’s position became dire early on Friday, after efforts to negotiate a deal that would avoid the need for government intervention failed and regulators realized the bank’s options were limited, according to The New York Times.
The last-minute talks were complicated by a provision in federal law that prohibits regulators from approving mergers of banks from different states that would result in the acquiring bank controlling more than 10% of all insured U.S. deposits. The law provides an exception for deals involving banks that are “in default or in danger of default,” but the deposit cap was still seen as an obstacle to either JPMorgan or Bank of America acquiring First Republic.
The worries over First Republic came only weeks after similar concerns emerged over the now-failed Silicon Valley Bank. Regulators stepped in and deployed a systemic risk exception for Silicon Valley and Signature Bank, a crypto-friendly bank that also collapsed in March, in the hopes that covering their uninsured deposits would curb contagion throughout the banking system.
An agreement by a larger bank to assume First Republic’s deposits would ensure that uninsured depositors will be covered. If First Republic failed through the FDIC’s normal process, without a buyer lined up for the bank’s deposits, there would be no way to ensure that uninsured depositors would be made whole without again invoking the systemic risk exception.
Such a designation would be politically fraught in the case of First Republic, since the 11 large banks that had $30 billion of uninsured deposits at the bank would be major beneficiaries. Critics would likely frame such a move as a bailout for some of the nation’s biggest banks.
First Republic, long known for catering to wealthy clients, was caught off guard last year by the rapid rise in interest rates.
As the housing market thrived during the pandemic, the bank’s business had boomed, as wealthy customers took out mortgages at ultralow interest rates. Once rates rose, those mortgages proved to be the bank’s undoing, since it was saddled with long-term assets whose value had fallen.
“There’s a lesson in that for all finance that what seems like a darling and a wonderful winner at one moment seems like the opposite only a little while later,” said Alex Pollock, a former Treasury Department official.
In addition to its large mortgage portfolio, the value of which cratered once rates started rising, First Republic also held long-term municipal bonds that faced similar woes.
The losses on First Republic’s balance sheet have made a rescue difficult, since potential buyers would have been forced to reckon with the bank’s massively underwater assets. The bank’s $137 billion of mortgages were worth $19 billion less at the end of last year, according to its annual report. Those losses would have materialized if the mortgages were sold.
“Obviously there’s a very generalized problem of people making the most classic financial mistake, which is investing in long-term fixed-rate assets and funding them with floating-rate money,” Pollock said. “They were lulled into it by the actions of the central banks — by keeping interest rates both long and short-term very low for very long periods of time, and convincing people that it was going to continue.”
The large sums of money that First Republic’s wealthy clientele stuck at the bank also made it more vulnerable to a depositor panic. Nearly 68% of its deposits at the end of last year weren’t covered by the FDIC. Many customers fled when they realized their money was at risk.
“Throughout its run, First Republic filled a niche,” said Gene Ludwig, a former comptroller of the currency and current managing partner of Canapi Ventures.. “It was a private banking business for comfortable but not the wealthiest Americans. Yes, other banks do this, but the loss of competition in the marketplace and the disruption to clients is unfortunate.”
In recent weeks, the bank’s prized wealth management business has also been bleeding staff as advisors have defected to competitors.
During the bank’s quarterly earnings call on Monday, First Republic President and CEO Mike Roffler laid out plans to slash 25% of its staff, cut executive pay and reduce its corporate office space. First Republic also said that it was “pursuing strategic options.” But Roffler did not take questions from analysts, underlining the bank’s troubled status.
Earlier this year, Roffler had told the Federal Reserve and the FDIC that he expected the bank could be resolved without extra oversight or government requirements. Those comments came in response to an advance notice of public rulemaking on the possibility of extending resolvability measures like total loss-absorbing capacity or long-term debt requirements to midsize banks.
“In the event of failure, it is expected that the bank could be resolved in an orderly fashion in accordance with its resolution plan,” Roffler wrote in a January letter to regulators.
Federal Reserve Vice Chair for Supervision Michael Barr released his report on the failure of Silicon Valley Bank on Friday.
Bloomberg
As the dust settles on a pair of reports about last month’s failure of Silicon Valley Bank, parties on both sides of the issue are walking away wanting more.
Both the Federal Reserve and the Government Accountability Office released their findings on the matter on Friday, though it was Fed Vice Chair for Supervision Michael Barr’s report that garnered the most attention.
Backers and detractors alike commended Barr for putting together a comprehensive review that addressed the Fed’s own supervisory failings that contributed to the demise of the $200 billion bank last month, despite having just six weeks to do so. But bank groups argue the policy recommendations included in the 114-page report are misguided, particularly those relating to regulatory changes.
Kevin Fromer, president and CEO of the Financial Services Forum, a trade group that represents the eight largest banks in the country, took issue with Barr’s calls for heightened capital requirements for all large banks in the wake of the failure.
He argued that Barr is using the unique circumstances surrounding Silicon Valley Bank — a fast-growing bank with a distinct business model and distinctively poor risk management capabilities — to justify industrywide changes.
“One should not conflate a liquidity-driven event marked by management failures and supervisory shortcomings with capital adequacy at the largest U.S. banks,” Fromer said in a written statement. “The assertion in the introduction that the Fed should focus on large bank capital requirements is disconnected from the report’s conclusions.”
Similarly, Greg Baer, president and CEO of the lobbying group Bank Policy Institute, pushed back against Barr’s assessment that regulatory changes ushered in by the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018, also known as S. 2155, played a role in the bank’s failure.
Instead, Baer said, the issue was that Fed supervisors — from both the Board of Governors in Washington and the Federal Reserve Bank of San Francisco — failed to act on clear signs that the bank was in trouble, including the fact that it failed its own internal stress tests and that it had insufficient hedges on its interest rate risk exposures.
“Put simply, there is no provision of S. 2155 that requires examiners to misjudge interest rate risk,” Baer said in a written statement, “the examination materials make clear that nothing in S. 2155 prevented them from properly examining it.”
Meanwhile, Baer took a positive view of the congressionally requested GAO report, which hung more blame on the San Francisco Fed’s “lack of urgency” around addressing issues at Silicon Valley Bank. He called it “accurate and objective.”
Rob Nichols, president and CEO of the American Bankers Association, took a less hard-lined stance against the Fed. He applauded the focus of both the GAO report and the Barr report on the failure of bank supervisors to use the tools at their disposal, as well as the acknowledgment of both assessments that Silicon Valley Bank itself was a unique circumstance.
Yet, Nichols also cautioned against using either report to justify sweeping changes.
“We take any bank failure seriously, and we will review the findings and proposed policy changes in these reports carefully, including where the conclusions may differ,” he said in a written statement. “At the same time, we urge policymakers to refrain from pushing forward new and unrelated regulatory requirements that could limit the availability of credit and the ability of banks of all sizes to meet the needs of their customers and communities when these reports suggest that existing rules were sufficient.”
Dennis Kelleher, head of the consumer advocacy group Better Markets, took issue with the assertion by the banking organizations that certain policy changes enacted by Congress and the Fed in 2018 and 2019 played no role in Silicon Valley Bank’s failure. While no one change would have staved off the unprecedented deposit run that toppled the bank, he said the totality of the policy shifts would have resulted in less risk-taking by the bank.
Kelleher commended Barr for holding the Fed accountable for its supervisory failings, but said the vice chair could have done more. Specifically, Kelleher said he would have liked Barr to have hung the blame on individuals at the Fed who oversaw the shift toward lighter touch regulation and supervision in 2019, namely Fed Chair Jerome Powell and then-vice chair for supervision Randal Quarles.
“Chairman Jay Powell was not a bystander to Randy Quarles’s deregulation, he was a cheerleader of Randy Quarles’s deregulation and, in fact, Chair Powell proposed deregulation before Randy Quarles even got to the Fed,” Kelleher said. “The public would have been served and it would have enabled greater accountability if the report more appropriately identified, in detail, the actions taken by Chair Powell and others in the years of deregulation and under supervision during the Trump years.”
Kelleher was not the only regulation advocate to say Quarles should have been called out by name.
Alexa Philo, a senior policy analyst for banking at American for Financial Reform and a former examiner for the Federal Reserve Bank of New York, said Barr’s report was “notably light” on the role changes by current and past Fed leaders contributed to the situation at Silicon Valley Bank.
“Powell supported a light-touch approach to banking regulation and supervision before he even became chair, and Quarles handled these matters directly,” Philo said. “Yet the report gives us only vague impressions of lower-level officials about leadership, not concrete evidence.”
Despite not being cited in the report by name, the repeated reference to changes orchestrated on his watch were enough to elicit a response from Quarles, who left the Board of Governors in December 2021.
In a statement released Friday, Quarles questioned how the report could conclude that a “shift in the stance of supervisory policy” inhibited the Fed’s supervision of Silicon Valley Bank while also acknowledging that “no policy” led to the change. Instead, the report cites a perceived shift in expectations, which Quarles said fails to support the report’s ultimate verdict.
“I have the highest respect for the staff of the Fed– they are the cream of the federal civil service. Much of today’s report reflects that tradition,” he wrote. “I am disappointed that the conclusion on supervisory policy does not meet that high standard.”
Several banking experts picked out one specific sentence in the cover letter of Barr’s report that seemed to stand out, striking precisely the wrong chord.
Barr wrote: “Today, for example, the Federal Reserve generally does not require additional capital or liquidity beyond regulatory requirements for a firm with inadequate capital planning, liquidity risk management, or governance and controls.”
“That’s an amazing statement because that’s exactly what they’re supposed to be doing,” said Joe Lynyak, a partner at the law firm Dorsey & Whitney, who called the report “surprisingly candid.”
“What they are admitting is they just didn’t do their jobs with the authority they have,” he added. “It’s almost as if everybody failed bank supervision 101.”
Lynyak and others said that in past cycles, excessive growth has always been a warning sign that the Fed would monitor closely.
He also faulted the 90-page report for using the words “due process,” four times, in referring to the shift in supervision during the Trump administration. The report said that under Quarles, “supervisory policy placed a greater emphasis on reducing burden on firms, increasing the burden of proof on supervisors, and ensuring that supervisory actions provided firms with appropriate due process.”
Lynyak said he was astonished that the Fed said they were concerned about giving due process to the banks.
“Are you guys kidding me? There is no due process to the banks,” he said. “You toe the line and you do an enforcement order against [SVB] to make them do it.”
Ken Thomas, founder and CEO of Community Development Fund Advisors in Miami, faulted the Fed’s internal review, calling oversight of Silicon Valley Bank “a textbook case of mismanagement — not by the bank — but by the Fed.”
He also faulted Barr’s report for not addressing the fact that the Fed gave Silicon Valley Bank a “stamp of approval,” on its risk management procedures in 2021 when it bought Boston Private Financial Holdings. Silicon Valley Bank’s risk mismanagement issues should have been apparent to the Fed two years ago when deposits ballooned to $148 billion in the first half of 2021, from $103 billion at year-end 2020. Deposits continued to skyrocket in the second half of 2021 to $191 billion, he said.
“I put this whole thing on Jay Powell, because he gave Silicon Valley Bank a glowing stamp of approval on risk management in June 2021, so why should SVB’s board think management wasn’t doing a good job?” said Thomas. “If I was on the board of SVB and I knew nothing about banking, as most of them did not, why would I be concerned? Because Jay Powell said it was all right. That is the most important thing that is not mentioned in the report.”
Crypto companies “have chosen to be noncompliant and not provide investors with confidence and protections, and it undermines the $100 trillion capital markets,” SEC Chairman Gary Gensler told the House Financial Services Committee on Tuesday.
Al Drago/Photographer: Al Drago/Bloomberg
WASHINGTON — Securities and Exchange Commission Chairman Gary Gensler tied together cryptocurrencies and the recent banking crisis as he asked Congress for more resources to police the crypto market.
“Silvergate and Signature [banks] were engaged in the crypto business — I mean some would say that they were crypto-backed,” Gensler testified at a House Financial Services Committee hearing Tuesday.
The loss of deposits linked to cryptocurrency clients are widely believed to have contributed to Silvergate’s decision to close and the failure of Signature. Federal regulators took unusual steps to try to prevent a loss of public confidence in the banking system after the collapse of those two banks and Silicon Valley Bank last month.
Gensler emphasized that the crisis showed that the regulated banking sector and the less-regulated crypto market have mutual exposures that have to be addressed.
“Silicon Valley Bank, actually when it failed, you saw the country’s — the world’s — second-leading stablecoin had $3 billion dollars involved there, depegged, so it’s interesting just how this was all part of this crypto narrative as well.”
The stablecoin company Circle has confirmed that it held $3.3 billion of its $40 billion USD Coin reserves at Silicon Valley Bank, which failed on March 10.
While the SEC has the authority it needs to police crypto market, Gensler says, the agency “could use more resources.”
“The dedicated staff of this agency has done remarkable work with limited resources,” Gensler said in his prepared remarks. “In the face of significant growth in registrants, more individual investor involvement in our markets, and increased complexity, the SEC’s headcount actually shrunk from 2016 through last year. With Congress’s help, our headcount this year now is approximately 3% larger than in 2016. I support the President’s FY 2024 request of $2.436 billion, to put us on a better track for the future.”
In its budget request, the SEC asked for funding for 5,475 new positions, some of which would increase the agency’s oversight of crypto assets, including policing the market for noncompliant and fraudulent activity.
“I think this is a field that, in the main, is built up around noncompliance, and that’s their business model,” Gensler said at the hearing. “They have chosen to be noncompliant and not provide investors with confidence and protections, and it undermines the $100 trillion capital markets.”
Gensler’s appearance was his first before the committee since Republicans took control of the House in January. They had little to say on Gensler’s call for more resources.
But Rep. Patrick McHenry, R-N.C., the chairman of the panel, has said that he intends to scrutinize the SEC and Gensler’s leadership of the agency as part of an aggressive oversight agenda.
“As you can see, we’re under new management and a new Congress,” McHenry said. “So please get comfortable.”
McHenry suggested he would use the committee’s subpoena power or other methods to get information that Republicans say the SEC has withheld from Congress.
“If you continue to thwart this institution by ignoring our requests and providing incomplete responses, we will be left with no choice but to pursue all avenues to compel the information or documents we need,” he said.
“I’m committed to getting this done,” Gensler said.
Rep. Andy Barr, R-Ky., the chairman of the subcommittee on financial institutions, questioned Gensler on an SEC staff bulletin that he said prevents banks from serving as custodians for crypto assets. Gensler defended the bulletin.
“I’m actually quite proud of the staff that put out that staff accounting bulletin, because what they said was public companies, not just banks, needed to put on their balance sheet their customers’ crypto, because what we found in bankruptcy court, Celsius bankruptcy and others, in bankruptcy investors just stand in line,” Gensler said.
When Barr asked if bank regulators were consulted beforehand, Gensler said that the agency discussed the issue with them “subsequently.”
“There was significant dialogue beforehand with the accounting profession and the big four [accounting firms] and others, because this question kept coming up, but there has been consultation about this with the bank regulators subsequently,” he said.
HSBC has hired more than 40 former Silicon Valley Bank employees to create its own practice focused on health care startups and venture capital funds in the U.S., hitting the gas on its entrance to a sector that experts say is challenging for banks.
The formation of the new line of business marks London-based HSBC’s second successful grab at Silicon Valley Bank offerings, following its acquisition of the failed bank’s United Kingdom subsidiary for one British pound last month. The Santa Clara, California-based bank was a stalwart financial institution for the high-risk world of technology startups and venture capital firms, even amid a tough market for fundraising, until its collapse in March.
Michael Roberts, CEO of HSBC USA and Americas, said in a prepared statement that the new team, which includes four former practice leaders at SVB, will be able to support companies at each phase of their growth, from early stage to multinational.
“We know that companies are scaling globally earlier in their life cycle and we want to bring the full breadth of our domestic and international capabilities to be the bank for entrepreneurs,” said Roberts in the statement. “This effort demonstrates our commitment to serving the innovation economy.”
Dozens of former Silicon Valley Bank employees in the San Francisco Bay Area, Boston and New York City will offer banking products for startups in the health care and life science space, as well as provide connectivity to HSBC’s resources across the pond.
First Citizens Bank, which announced it would acquire SVB in late March, has similar ambitions. The Raleigh, North Carolina, company said in investor presentations that one of the draws of the deal was its ability to expand offerings in the private equity, venture capital and technology sectors, specifically citing life science and health care.
Although HSBC picked off 40 bankers, First Citizens is still “confident that Silicon Valley Bank will continue playing a leading role in supporting the innovation economy,” said spokesperson John Moran in an email to American Banker shortly after the news broke that HSBC had hired 40 employees from SVB.
“First Citizens acquired Silicon Valley Bank knowing it had the deepest bench of experts serving the innovation economy and that remains unchanged,” Moran said in the email. “This strong team, with decades of experience, is focused on what has always set SVB apart — providing the best client service in the industry.”
The HSBC team will be led by David Sabow, former head of technology and health care for SVB in North America. Sabow had been tapped in December as CEO of Silicon Valley Bank U.K., pending regulatory approval, but hadn’t officially stepped into the role before the failure.
Sabow said in a prepared statement that HSBC will channel “the full strength of their platform toward the innovation economy.”
HSBC also brought on: Sunita Patel, formerly chief business development officer at SVB, to oversee investor coverage and business development of the practice; Katherine Andersen, who was SVB’s head of U.S. life science and health care relationship and corporate banking, to lead the same sector; and Melissa Stepanis, who was head of technology credit solutions at SVB, to oversee technology.
The London bank’s domestic arm primarily offers wealth management and commercial banking. The new practice will sit in the commercial banking business.
“HSBC USA’s mission is to support the growth ambitions of our international client base and serve as an anchor point for the global HSBC network with our integrated wholesale banking and wealth platform,” said Matt Ward, head of communications for HSBC USA, in an email to American Banker. “The U.S. startup market is weighted to sectors aligned to our areas of focus, notably technology and life sciences, that are naturally oriented to international banking needs in the future.”
Silicon Valley Bank’s failure has posed a potential hole in the volatile startup industry. The bank provided crucial services to the industry, like venture debt, a vast network of contacts and industry-specific expertise. While SVB clients were initially looking for a safe place to park their deposits, the tighter capital-raising environment also leaves startups needing other banking services, like lending.
The startup ecosystem that SVB built isn’t easily replicable, said Neil Hartman, a senior partner at consulting firm West Monroe. He said that startup portfolios are often less profitable, due to lower revenue generation.
“There aren’t very many banks that can offer what SVB can offer, or could offer, today,” Hartman said in an interview shortly after the collapse of the bank in mid-March. “Everyone’s going to have to build into that. It’s not something that’s going to happen overnight.”
Ronak Doshi, a partner focused on digital transformation and banking at research firm The Everest Group, said in a mid-March interview that startups want to bank with institutions that have specific verticals focused on their sectors, like life sciences and health care.
HSBC’s acquisition of SVB’s United Kingdom business last month included the failed bank’s staff, assets and liabilities, expanding the company’s offerings for the startup and technology sector abroad.
“This acquisition makes excellent strategic sense for our business in the U.K.,” said CEO Noel Quinn in a prepared statement at the time. “It strengthens our commercial banking franchise and enhances our ability to serve innovative and fast-growing firms, including in the technology and life science sectors, in the U.K. and internationally.”
HSBC isn’t the only financial institution to recently pick up SVB executives. In late March, Stifel Financial hired three former SVB banking leaders as managing directors to expand its startup and venture practice, providing commercial banking and lending, along with sponsor finance, treasury and other services.
Stifel hired Jake Moseley, former head of relationship management technology banking at SVB; Matt Trotter, former head of frontier technologies and climate technology and sustainability at SVB; and Ted Wilson, former head of enterprise software at SVB.
“We believe that Stifel is the best place for us to continue our mission of providing best-in-class financial services to entrepreneurs and their investors,” said Moseley, Trotter and Wilson, in a joint statement last month.
Since the fall of SVB, startups are also re-evaluating their priorities in a banking partner. New items on the banking checklist include deposit protection and a banks’ technology infrastructure, which were previously nonfactors.
The unfinished Dodd-Frank rule would give the Federal Deposit Insurance Corp. more ability to claw back the compensation of failed-bank executives.
Andrew Harrer/Bloomberg
WASHINGTON — Finalizing the Dodd-Frank Act’s unfinished executive compensation rule might be a straightforward path to more easily punish the executives of failed banks in the wake of the Silicon Valley Bank and Signature Bank failures, but the regulatory process could be fraught with legal issues.
To avoid at least some of those, several progressive groups are urging financial regulators to finish the Dodd-Frank executive compensation rule, which would give the Federal Deposit Insurance Corp. the ability to claw back the compensation of some failed-bank executives — a growing priority for the Biden administration. Congress required the agencies to finalize the rule by May 2011, but while a rule was proposed in 2016, it remains incomplete.
The groups — which include Americans for Financial Reform Education Fund, Public Citizen, the Revolving Door Project, Governing for Impact, and the Center for LGBTQ Advancement & Research — asked financial regulators in a letter to be sent Tuesday to finish that 2016 plan rather than restart the rulemaking process. Beginning that process over again could leave the Biden administration vulnerable to more legal challenges than if the executive branch finalized a rule out of the one proposed in 2016, the groups argue.
Six agencies are involved in the rulemaking, including the Office of the Comptroller of the Currency, the Federal Reserve, the FDIC, the National Credit Union Administration, the Securities and Exchange Commission and the Federal Housing Finance Agency.
“More than a decade after the [Dodd-Frank Act’s] 2011 deadline, and after several failed starts — the most recent of which was the 2016 proposal — your agencies have yet to finalize a rule under section 956, leaving the financial system at risk,” the groups say in the letter. “Without it, covered institutions are subject to different requirements depending on their primary regulator, leading to regulatory arbitrage. And without having finalized a regulation, your agencies have potentially opened themselves up to litigation.”
Specifically, the agencies should finalize the rule before the middle of 2024 to avoid a Congressional Review Act challenge, the letter says, should Democrats do poorly in the 2024 elections.
“The 2024 election could usher in a new President, Senate, and House, allowing them to overturn rules finalized by the Biden regulatory agencies within 60 legislative days of Congress’s adjournment in December,” the groups said in the letter. “This special look-back period has traditionally begun running somewhere between May and September.”
Revisiting the 2016 rule should also not pose a risk under the Administrative Procedure Act, especially if the agencies introduce a brief comment period before finalizing the rule, the progressive groups argue. However, courts have in the past decided that an additional comment period is unnecessary if the original record is “still fresh.”
“There is an argument that the 2016 rulemaking record is still fresh, even after seven years; after all, the basic dynamics of inappropriate financial incentives do not change,” the groups said.
Instead, the agencies could face litigation should they fail to finalize a rule, according to the Administrative Procedure Act, the groups argue.
“Competitors to institutions who would be subject to the rule have standing to sue; and those competitors would be likely to prevail,” according to the letter.
In fact, policy watchers say the unfinished state of the executive compensation rule is one of the outstanding legal questions about the rulemaking going forward. Under Republican and Democratic administrations, regulators have prioritized other elements of Dodd-Frank, such as the Fed’s focus on “tailoring” capital requirements under former Vice Chair for Supervision Randal Quarles.
But while the executive compensation rule has lingered at the agencies due to a combination of attrition and turnover, experts said, the recent bank failures have made it more likely that regulators will complete it.
Karen Petrou, managing partner at Federal Financial Analytics, said that the wide range of financial regulators required to approve the final rule, from banking agencies to market cops, has historically made it difficult for the rule to be finalized. Currently the Biden administration has control of all of the agencies except for the NCUA, which still has two of three board seats allocated to Republican members.
“Sec. 956 required all the financial regulators to write a single rule,” Petrou said in an email. “That proved impossible not only due to the difficulty of doing so in general, but also the very different missions of each agency subsequently complicated by Trump appointees after the election.”
Ian Katz, managing director of Capital Alpha Partners, said that regulators nominated by both parties have simply had issues that have seemed more urgent compared with the executive compensation rule, but that the recent bank failures have made it more of a priority.
“It’s hard to explain how it’s taken this long except to say it clearly hasn’t been a very high priority for the regulators,” he said in an email. “I think there’s more interest in this issue now than there has been in many years. So I believe the chances for action on this have improved significantly and there’s a good chance this finally gets done.”
The Federal Reserve’s overnight repo facility has been utilized by money market funds to a large extent, and may be contributing to dramatic outflows of deposits from banks since the failure of Silicon Valley Bank and Signature Bank last month.
Bloomberg News
Deposit flows after a pair of high-profile bank failures last month have renewed a debate about the Federal Reserve’s support of money market funds and whether that support harms banks.
Between March 8 and March 22, total commercial bank deposits declined by $300 billion, according to Fed data. During that same period, money market funds ticked up $238 billion.
It is unclear how many of those deposits went directly from banks to money market funds, but some in and around the banking sector worry that the Fed’s Overnight Reverse Repurchase Program has made it easier for funds to move in that direction.
Also known as the ON RRP, the facility allows money market funds and other entities to purchase securities from the Fed and sell them back the next day at a fixed, higher price. Between March 8 and March 22, total ON RRP usage — which includes activity by government-sponsored entities and some banks — only increased by $47 billion. But since March 2021, the facility has swollen from zero to roughly $2.2 trillion per day, and has remained at that level since last June.
Some of the sharpest criticism of the facilities growth has come from the Bank Policy Institute, a bank lobbying organization, which accused the Fed last week of “abetting a draining of deposits from banks.”
Policy experts outside the banking industry also say the Fed’s engagement with money market funds, through both its ON RRP facility and other actions, have given those funds advantages over banks, ones that do not always benefit the broader economy.
“The whole [ON RRP] facility should be unwound,” Karen Petrou, managing partner of Federal Financial Analytics, said. “Similarly, the Fed should stop sitting on trillions in bank deposits. It’s a huge distortion.”
Historically, money market funds have increased the availability of credit by purchasing short term corporate loans — known as commercial paper — and Treasury bills, which are government bonds with maturities of less than one year. Funds still engage in this activity, but their ability to earn interest simply by engaging in these purchase agreements with the Fed diminishes their economic impact, Petrou said.
“The Fed is supporting funds flowing out of the banking system, where they support macroeconomic activities, into the funds sector, then looping them back into the Fed where they support the Fed’s portfolio and government borrowing,” she said. “That’s a really altered state that nobody’s quite focused on.”
Fed officials, including Gov. Christopher Waller, have described increased use of the ON RRP facility — which has primarily been driven by money market funds — as excess liquidity in the financial system. Because of this, he said, the $2 trillion regularly tied up in that facility could be shed from the Fed’s balance sheet with little consequence.
However, some economists worry what the growth of that facility will mean for bank funding, especially if economic conditions worsen. To this, Waller has said it will be up to the banks to attract depositors back from funds by paying higher interest rates.
“At some point, as reserves are draining out, it’ll come out of the banks and then the banks, if they need reserves, it’s sitting over there on this ON RRP being handed over by money market mutual funds,” he said during a public appearance in January. “You’re going to have to go compete to get those funds back.”
But doing so may be easier said than done, given how many bank balance sheets are weighed down by long-duration legacy assets — loans and securities — that are paying low fixed rates. If banks start paying more to depositors, they diminish the net interest margins that support their profitability.
This could be especially problematic for banks that see outflows of current depositors who are being paid minimal interest on their deposits, said Michael Redmond, an economist with Medley Advisors who previously worked at Federal Reserve Bank of Kansas City and the U.S. Treasury.
“There’s a limit on how much banks can adjust their deposit rates higher if their existing deposit base does turnover, and that’s why a lot of economists think there is going to be credit contraction,” Redmond said. “Rather than only adjusting on the liability side of their balance sheet, banks might also try to curtail some of the activity on the asset side of their balance sheets as well.”
Money market funds tend to pay significantly higher interest rates than banks. This happens for a few key reasons.
The fund model is simpler than that of a bank. Funds profit off fees charged to investors who, in turn, are paid using proceeds from the fund’s investments. Banks, meanwhile, largely profit from the difference between the interest they collected from their assets and the amount paid out to depositors, also known as their net interest margin.
Instead of conducting maturity transformation — using short-term deposits to create long-term loans — money market funds use investor money to buy public or private debt. Because these funds invest in short-term instruments, investors are generally able to redeem their deposits at any time.
However, that redemption is not technically guaranteed. Money market funds are less tightly regulated than banks and they do not have to carry insurance for their deposits. This results in lower operating costs for funds relative to banks, but also increases the risk associated with their model. Investors, in theory, are paid a premium for taking on that additional risk.
But whether investments in money market funds are actually at risk is debatable, said Aaron Klein, a senior fellow at the Brookings Institution and a Treasury official during the Obama administration.
“For an institution run by economists, the Fed seems to struggle with the concept that greater return implies greater risk,” Klein said.
Following the collapse of the investment bank Lehman Brothers in 2008 and the onset of the COVID-19 pandemic in 2020, the Fed and the Treasury Department guaranteed money market investors that they would be made whole. The actions were taken under systemic risk declarations by the agencies to prevent a run by depositors.
Klein said these actions have signaled to market participants that money market funds will have the implicit backing of the federal government in times of distress. For uninsured depositors — such as those who fled Silicon Valley Bank last month — that not only made funds a more lucrative option, but also a potentially safer one, he said.
“Ask yourself today what is more implicitly guaranteed by the Federal Reserve: money market mutual funds or uninsured bank deposits? If you can’t find a difference in the level of implicit guarantee, that’s quite telling,” Klein said. “The Federal Reserve’s repeated bailouts of money market mutual funds, which are owned by the wealthy, makes our financial system less stable and, in the long run, our economy more unequal.”
The Fed created the ON RRP facility in 2013. The idea behind it was to create a channel through which the central bank could convey its monetary policy to market participants other than banks. It was conceived as the Fed was preparing to raise interest rates from their lower bound, where they had been since 2008.
Money market funds were not the intended beneficiary of the program, but they have taken advantage of it more than almost any other type of counterparty.
As a tool for implementing monetary policy, the facility has been effective, said Bill English, a finance professor at the Yale School of Management and a former monetary official at the Fed. But the program looks quite a bit different than when it was initially introduced.
Instead of setting the rate for the facility a quarter percentage point below the federal funds rate, the Fed now pays about 10 basis points less for its repurchases, English said. It also lifted the $300 billion cap that the program first featured and now offers unlimited use.
Like others, English says the facility could benefit from some revisions, such as a reducing the rate paid to counterparties. Doing so, he added, could be beneficial to the Fed’s monetary goals by allowing it to shrink its balance sheet more swiftly.
Ultimately, he said, banks should not count on changes to the Fed’s ON RRP facility changing the competitive landscape for deposits.
“Banks may have to get used to the idea that the safe, stable, low-cost funding that they get from their retail deposit franchise is just less than was the case 20 years ago,”English said. “And this interest rate cycle is showing that.”
The collapse of Silicon Valley Bank left a lot of fintech and insurtech companies wondering where their operating capital would come from not just in the near term. At a time when VC funding is already slowing down, funders are likely to be even more careful and deliberate in supporting new companies. What does that mean for how new entrants should approach their businesses, strategically? Digital Insurance editor in chief Nathan Golia is joined by American Banker executive editor for technology Penny Crosman to talk about what’s to come for startups in financial services.
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.
First Citizens BancShares is in advanced talks to acquire Silicon Valley Bank after its collapse earlier this month, according to people familiar with the matter.
First Citizens could reach a deal as soon as Sunday to acquire Silicon Valley Bank from the Federal Deposit Insurance Corp., said the people, who asked to not be identified because the matter isn’t public. No final decision has been made and talks could fall through, the people added.
A representative for the FDIC declined to comment. First Citizens didn’t immediately respond to requests for comment.
Silicon Valley Bank became the biggest U.S. lender to fail in more than a decade, unraveling in less than 48 hours after abandoning a plan to shore up capital. The bank took a huge loss on sales of its securities as interest rates climbed, unnerving investors and depositors who rapidly began pulling their money.
As of Friday, Raleigh, North Carolina-based First Citizens had a market value of $8.4 billion.
The Federal Reserve and five other central banks announced coordinated action on Sunday to boost liquidity in US dollar swap arrangements, the latest effort by policymakers to ease growing strains in the global financial system.
Central banks involved in the dollar swaps will “increase the frequency of 7-day maturity operations from weekly to daily,” the Fed said in a statement coordinated with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank.
The US central bank has typically provided access to such arrangements at times when there’s a squeeze on the availability of dollars. That can arise because banks outside the US typically have obligations that are denominated in greenbacks, and in times of financial strain have less access to dollar funding.
The liquidity injection is “very much needed” especially for the Swiss and European central banks right now, said Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis. “We learned that the hard way during the global financial crisis in 2008 when it took too long to set them up. The Fed was much faster in March 2020 and this time around.”
The move comes amid heightened tension that began with the collapse of three US lenders a week ago. Earlier Sunday, UBS agreed to buy Credit Suisse in a government-brokered deal aimed at containing a crisis of confidence that threatened to spread across global financial markets.
The boost to swap lines will “enhance the provision of liquidity,” the central banks said, describing the arrangements as “an important liquidity backstop to ease strains in global funding markets” and mitigate the impact on the supply of loans to households and businesses.
The Fed said daily operations will begin on Monday, March 20 and will continue at least through the end of April.
In a joint statement earlier Sunday, the Fed and the US Treasury joined other central banks in welcoming the Credit Suisse rescue. Treasury Secretary Janet Yellen and Fed Chair Jerome Powell stressed that the capital and liquidity of US banks is strong.
Last week, banks rushed to borrow cash from the Fed as they sought to shore up liquidity amid concern about a flight of deposits. Lenders borrowed some $165 billion in total under two backstop facilities. Altogether, the emergency lending reversed several months’ worth of the Fed’s campaign to shrink its balance sheet.
—With assistance from Michelle Jamrisko and Malcolm Scott.
A coalition of midsize US banks asked federal regulators to extend FDIC insurance to all deposits for the next two years, arguing the guarantee is needed to avoid a wider run on the banks.
“Doing so will immediately halt the exodus of deposits from smaller banks, stabilize the banking sector and greatly reduce chances of more bank failures,” the Mid-Size Bank Coalition of America said in a letter to regulators seen by Bloomberg News.
The collapse this month of Silicon Valley Bank and Signature Bank prompted a flood of deposits out of regional lenders and into the nation’s largest banks, including JPMorgan Chase and Bank of America. Customers spooked by the bank failures were taking refuge in firms seen as too big to fail.
“Notwithstanding the overall health and safety of the banking industry, confidence has been eroded in all but the largest banks,” the group said in the letter. “Confidence in our banking system as a whole must be immediately restored,” it said, adding that the deposit flight would accelerate should another bank fail.
The group cited remarks by Treasury Secretary Janet Yellen that the backstops put in place so far will protect uninsured deposits only if regulators found it “necessary to protect the financial system.” That’s a category unlikely to include the smaller banks represented by the MBCA.
The expanded insurance program should be paid for by the banks themselves by increasing the deposit-insurance assessment on lenders that choose to participate in increased coverage, the group proposed.
The letter was sent to Yellen, the Federal Deposit Insurance Corp., the Comptroller of the Currency and the Federal Reserve.
Treasury spokesman Michael Gwin declined to comment, as did representatives for the FDIC, Fed and OCC.
‘Modestly reverse’
Deputy US Treasury Secretary Wally Adeyemo said Friday that, based on discussions regulators have had with banking executives, deposits at small- and medium-sized banks across the country had begun to stabilize and in some cases “modestly reverse.”
Brent Tjarks, a representative for MBCA, declined to comment on the letter. His group includes banks with assets of as much as $100 billion, and there are at least 110 members of the coalition. The organization was one of the groups that lobbied in favor of reducing some of the burdens the Dodd-Frank Act imposed on smaller lenders.
“It is imperative we restore confidence among depositors before another bank fails, avoiding panic and a further crisis,” MBCA wrote in the letter. “While the cost of deposit insurance is not insignificant, the likelihood of it being needed is much, much smaller should all deposits be temporarily insured.”
—With assistance from Christopher Condon and Max Reyes.
Rep. Maxine Waters, a California Democrat who is ranking member of the House Financial Services Committee, left, speaks with Rep. Patrick McHenry, a North Carolina Republican who chairs the committee, during a Feb. 7, 2023, hearing.
Ting Shen/Bloomberg
Representatives from the Federal Reserve and Federal Deposit Insurance Corporation are set to testify before Congress later this month at a hearing about the failures of Silicon Valley Bank and Signature Bank.
FDIC Chairman Martin Gruenberg and Federal Reserve Vice Chair for Supervision Michael Barr are scheduled to attend the March 29 hearing as witnesses and answer questions about the banks’ collapses.
The bipartisan hearing is expected to be the first of multiple hearings on the issue, according to House Financial Service Committee Chairman Patrick McHenry, R-N.C., and California Rep. Maxine Waters, the committee’s top Democrat.
“This hearing will allow us to begin to get to the bottom of why these banks failed,” McHenry and Waters said Friday in a joint statement.
Additional witnesses may be added as the hearing date approaches, McHenry and Waters said.
The Federal Reserve and FDIC did not immediately respond to requests for comment Friday afternoon.
The Fed said Monday that Barr will lead a review of Silicon Valley’s failure. The findings of that report are expected to be publicly available by May 1, the agency said.
The Senate Banking Committee has yet to schedule a hearing into the matter. Chairman Sherrod Brown, D-Ohio, this week urged regulators to review the circumstances around the failures of both Silicon Valley and Signature.
On Thursday, Treasury Secretary Janet Yellen became the first high-level administration official to testify before Congress after the failures set off a maelstrom across the banking industry. Yellen defended the federal government’s decision to step in and provide systemic-risk exceptions to both Silicon Valley and Signature, and maintained that not all deposits at other banks are guaranteed.
After what felt on Wednesday like relative calm in the banking industry compared with the chaos of the five previous days, uncertainty returned early Thursday amid concerns about the stability of Swiss lender Credit Suisse and the future of First Republic Bank in San Francisco.
But by midafternoon, 11 of the nation’s largest banks rode to the rescue with a pledge of $30 billion of deposits to stabilize First Republic’s balance sheet after a depositor exodus. The move was also a bid to instill confidence in an industry that has endured two bank failures, a mountain of liquidity concerns and a whole lot of jitters in the past week.
Now the question is: Will it work?
“Our expectation is that calmer heads will prevail,” Michael Driscoll, head of North American financial institutions at DBRS Morningstar said in an interview just as the First Republic deal was announced. “Regulators are doing their jobs, and things will stabilize.”
The tactic — in which big banks band together to prop up another bank by injecting deposits — is an unusual strategy, experts said. The cash infusion is being made in the form of interest-bearing deposits from participating banks. The funds are the banks’ own and not those of their customers or of First Republic customers who have withdrawn money from their First Republic accounts in recent days and parked those deposits at the larger banks, sources said Thursday.
JPMorgan Chase, Bank of America, Citigroup and Wells Fargo — the nation’s Big Four banks by assets — have each committed $5 billion of uninsured deposits to First Republic, while Goldman Sachs and Morgan Stanley have committed $2.5 billion, according to a joint statement released by the banks on Thursday afternoon.
U.S. Bancorp, PNC Financial Services Group, Truist Financial, Bank of New York Mellon and State Street are each placing $1 billion of deposits, the statement said.
The additional liquidity comes five days after the $212.6 billion-asset First Republic, which specializes in private banking and wealth management, touted its financial position after announcing in a press release that it received more borrowing capacity from the Federal Reserve and the “ability to access additional financing through JPMorgan Chase.”
On Sunday night, around the same time the federal government said it would cover uninsured deposits at both Silicon Valley Bank in Santa Clara, California, and New York-based Signature Bank — which had failed within two days of each other — First Republic issued a statement saying that it had more than $70 billion of unused liquidity. The $70 billion figure excluded any additional liquidity that the company could receive under the Bank Term Funding Program, or BTFP, also announced Sunday night.
By the end of Wednesday, First Republic reported a $34 billion cash position in a regulatory filing.
“I personally thought [those measures] would fix some of the issues with First Republic, but obviously they continued to have significant pressure this week,” Driscoll said.
Regulators lauded the cash infusion Thursday afternoon. In a joint statement, Federal Reserve Chair Jerome Powell, Treasury Secretary Janet Yellen, Federal Deposit Insurance Corp. Chair Martin Gruenberg and acting Comptroller of the Currency Michael Hsu called it a sign of strength for the banking sector as a whole.
“Today, 11 banks announced $30 billion in deposits into First Republic Bank,” the regulators said in a written statement. “This show of support by a group of large banks is most welcome, and demonstrates the resilience of the banking system.”
The Fed issued a separate statement encouraging any banks in need of liquidity to turn to the BTFP, which allows banks, credit unions and other depositories to pledge assets as collateral for penalty-rate loans. Through Wednesday, the central bank disclosed that banks had taken nearly $12 billion of advances from the emergency liquidity vehicle and had pledged nearly $15.9 billion of government-backed bonds — including Treasury securities, U.S. agency mortgage-backed securities and U.S. agency debt securities.
At least one analyst expressed some skepticism about whether the deposit injection at First Republic will make a difference as more problems might lurk under its hood.
In a research note, Autonomous Research analyst David Smith said First Republic’s stock has “been on a roller coaster over the past week” following the demise of Silicon Valley Bank and Signature Bank, both of which experienced significant deposit withdrawals after customers became spooked about their financial well-being.
First Republic “was also seeing rapid deposit outflows,” so much so that S&P Global on Wednesday downgraded the company’s credit to below investment grade, Smith noted.
Two other credit ratings agencies, Moody’s Investors Service and Fitch Ratings, also made changes to the company’s ratings. Fitch downgraded the company’s ratings, while Moody’s placed the ratings under review for a downgrade.
“It remains to be seen what will happen to core client deposit flows at [First Republic Bank] from here and indeed what has happened to date this quarter, which will ultimately drive the company’s fate,” Smith wrote.
Earnings could suffer if many of the deposits drained from the bank were lower-cost and the big banks’ market-rate deposits are costlier, according to Smith. A need to steeply mark down liabilities could scare off a potential buyer, too.
“First Republic’s situation remains challenged, in our view, although today’s actions seem to have bought the company time at the least,” Smith wrote.
Big banks — often criticized for receiving government bailouts, as they did in the 2008 financial crisis — positioned themselves Thursday as being part of the solution to the crisis that has hit regional banks in the past week.
The plan is an “unprecedented private sector collaboration … to bolster liquidity and reflects our confidence in the critical role of regional banks in our economy,” Truist CEO Bill Rogers said in a statement.
The markets seemed to like it. The Dow Jones Industrial Average, which at one point in the day was off more than 250 points from its open, finished at 32,246.55, up 1.17% from a day earlier. First Republic rose more than 10% by day’s end, though it began losing ground in after-hours trading Thursday night.
Most regional stocks that had drawn scrutiny lately finished in the green, though some closed stronger than others.
What’s unclear is whether Thursday was a turning point in a crisis that has taken down Silicon Valley, Signature and Silvergate banks or was another positive blip in a more protracted period of volatility.
The condition of other regionals will be watched closely. For instance, Reuters reported Thursday that PacWest Corp. in Los Angeles was in talks with Atlas SP Partners and other investment firms about a liquidity boost.
