SILICON VALLEY BANK AND SOME CREDIT UNION SPILLOVER TO EXPECT

Assuming that the federal government is not going to let the FDIC’s takeover of Silicon Valley Bank (SVB) metastasize into a systemic risk that brings such a lack of American consumer confidence that all financial institutions begin to face liquidity issues, the SVB failure – coupled with the failure of Signature Bank in New York over this past weekend as well – is most going to be known mostly for the regulatory and supervisory spillover that will inevitably come.

While there is always a chance that consumer panic could replace calm in the financial service sector, that does not seem to be warranted in this case.  SVB is a large, but very unique bank that is primarily a depository with a balance sheet full of interest rate risk in long-term US Treasury paper and little lending other than to primarily start-up and almost exclusively fin-tech companies.

The SVB business model was built in a way that was almost certain to face a rocky coastline when interest rates go up as much and as fast as they have over the last eighteen months, when the two-year Treasury is paying more than the ten-year Treasury and when their lending is concentrated almost exclusively in one sector.

Signature Bank, while not as big, was a major player in cryptocurrency at the time SVB fell and crypto was at a very low ebb in regulatory agency favor following the FTX scandal.

In short, both banks were not in what most would consider to be the mainstream of financial institutions in the structure and management of their balance sheets.

This does not make their failure any less significant.  However, it does somewhat minimize the likelihood of a national consumer confidence crisis in the American financial services industry that topples hundreds of FIs of all types and sizes.

Admittedly, predicting what the American consumer will do when faced with unyielding media reports of bank failures of this size is not an exact science.  However, the Treasury Department, FDIC and Federal Reserve seem to have acted over the weekend to try to stem any potential depositor panic by guaranteeing that even uninsured deposits at SVB would be covered by FDIC insurance.

We’ll leave aside the moral hazard question involved when the $250,000 federal insurance coverage limitation can be obliterated over a two-day period with no congressional action.  That is a question for another day and, frankly, a question that will surely be asked in the aftermath of the current headlines.

But, it does appear from the lack of panic today that the emergency actions taken over the weekend have at least minimized the potential problems that a Monday morning run at SVB and Signature could have brought.

Now, the question presents itself – particularly for credit unions – as to what will be the spillover to other financial institutions in the aftermath of the SVB failure.  Unless something spins public confidence out of control in the next few days, it seems that the pertinent question moves to the “spillover” factor.

It is our view that there are three “spillover” issues that credit unions should be mindful of and prepare for.  One is a certain.   The second is very likely.  And the third should happen.

REGULATORS AND EXAMINERS WILL MOVE INTO “MAKE SURE IT NEVER HAPPENS AGAIN ON MY WATCH” MODE

As happened with Enron followed by Sarbanes-Oxley and Lehman Brothers followed by Dodd-Frank, Congress will get involved in trying to find a “fix” for what happened with SVB.

Legislation, as cited above, is always a possibility.  But the current split control of Congress makes another Dodd-Frank less likely – although Sarbanes-Oxley passed with the Democrats controlling the Senate and the Republicans controlling the House of Representatives.

But one thing that happened post-Enron and post-Lehman is certain to  happen again post-SVB.  That is, there will be series of hearings in which federal banking agency regulators are brought before congressional committees, blamed for being asleep at the switch and asked what their agencies are doing to “make sure this never happens again.”

Actually, the question is – what are you, Mr. Regulator, going to do to make sure this never happens again while I’m here in Congress to have to answer for it.

And how will the regulators respond?  They will begin citing all the new rules they are considering and the renewed focus of their examiners to “go deeper” and “be more demanding” of the institutions they regulate.

Federal banking regulators will move to doing what they know best and do on a daily basis – regulate and examine.

Even though the brunt of the inquiry by Congress will be on FDIC and the Federal Reserve if the failures remain limited to banks like SVB and Signature, NCUA will not escape scrutiny.

There are too many large credit unions today for these congressional committees to forget to invite NCUA leadership to the What Went Wrong Festival on Capitol Hill.

So, expect NCUA to face scrutiny – along with FDIC, the Fed and Treasury – as to what they are doing to “make sure this never happens to credit unions.”

In preparation for that certainty, NCUA will begin looking at regulatory options.  But they will first, because it is easier and quicker to impact, look to strengthen their examination and supervisory scrutiny of credit union balance sheets.

Interest rate risk, to which they applied a reasonableness standard last year when interest rates began their significant upward movement and their NCUA IRR Supervisory Test needed revision, is going to return to top of mind for examiners.

For example, even though the Extreme Risk category for IRR has been removed, the corrective actions required for the High Risk category are about to become more demanding.

Credit unions should now begin putting together their responses for the examiners that come in and question whether the IRR management, liquidity and capital are sufficient now that a major bank has failed because of interest rate risk – even though its balance sheet was fundamentally different than almost every credit union.

In addition, there is going to be a much closer look given to the amount of and the liquidity impact of a credit union’s uninsured deposit base.

Since the precedent is apparently being established that in an emergency situation the FDIC is going to extend insurance coverage well above the statutory $250,000 limits, NCUA as an insurer is going to be watching closely the amount of uninsured deposits on credit union balance sheets because of fear that they might be required to do the same thing at some point in the future.

And, in general, exams – already outlined in the NCUA Supervisory Priorities for 2023-24 to be much more extensive – will become the focal point of NCUA’s efforts to demonstrate to Congress that they are decisively acting to “make sure this never happens to credit unions.”

Understand that the supervisory process, like regulation, always seems to ebb and flow over time as does any pendulum tied to a government fulcrum.  But, for the next year or two, exam teams are going to be bigger, exams are going to last longer and examiners are going to be more demanding.

This is how regulatory agencies answer the question of “what are you doing in response to SVB.”

Dread it, if you must.  Curse it, if you are so inclined.  Disagree with it, if it makes you feel better.  But get ready for it.

THE ODDS OF A 2024 NCUSIF PREMIUM FOR FEDERALLY INSURED CREDIT UNIONS JUST WENT UP DRAMATICALLY

If you study the agreement reached over the weekend to prevent a run at SVB and to make sure all depositors – regardless of amount – would be able to access their deposits this morning, the terms were that any losses from SVB and Signature would not be borne by the American taxpayer.

Call this the 2008 Financial Crisis backlash.  Because of the unpopularity of the large bank bailouts in 2009-13 following the 2008 financial crisis, everyone in a position of authority on the SVB issue has vowed and assured anyone who is listening that the plan to meet the needs of SVB’s depositors will “not cost the American people one red cent.”

Well, how will this happen?  The answer is simple.  The FDIC insurance fund will eat any losses.  They will not be passed on to the US Treasury as is historically the backstop for the FDIC fund that is backed by the “full faith and credit” of the US government.

For an institution the size of SVB with the amount of uninsured deposits they carried on their balance sheet, the increase of FDIC exposure is incredible.  A FDIC premium is going to have to be assessed on every bank in the country – large and small, national, region and community – to shore up the FDIC fund once the SVB exposure has been quantified.

Every time the FDIC fund has a premium and its equity level is increased, the pressure comes down on NCUA to look at the equity level of the NCUSIF fund.

While the risk on credit union balance sheets is historically much less than on bank balance sheets (and, particularly, those outside the mainstream banks like SVB and Signature), the push for more capital from credit unions and a higher equity level in the NCUSIF become stronger.

As mentioned earlier, examiners will lead the push for more capital retention at credit unions.  And they will use the new Risk-Based Capital regime to drive that push.

But the push for a NCUSIF premium will come from the NCUA Board level and not the examiners.

NCUA Chairman Todd Harper has stated multiple times his belief that that NCUSIF should have an equity level closer to 1.5% than the 1.2% to 1.3% range that NCUA currently operates within.

The reason Chairman Harper has not been able to get a premium increase to raise the equity level the last two NCUA budget cycles is solely because his two Republican NCUA Board colleagues, both holdovers from the Trump administration, have opposed such an increase.

Republican NCUA Board Member Rodney Hood’s term on the board expires in August 2023.  He is certain to be replaced by another Democrat appointed by President Biden, thus giving Chairman Harper a working 2-1 majority on the NCUA Board.

With a fellow Democrat serving with him Chairman Harper will almost certainly have his second vote to impose a NCUSIF premium in this fall’s budget for 2024.  Republican Vice-Chair Kyle Hauptman, very likely replaced as Vice-Chair by the new Harper-supporting Democrat board member, will be on the short end of that 2-1 vote.

Now add the impetus that the SVB aftermath will bring with higher FDIC premiums and countless congressional hearings on how depositors must be better protected at all federally insured institutions – including credit unions.

While I cited the increase in examiner scrutiny as an absolute spillover effect from the SVB failure, I feel pretty strongly that a 2024 NCUSIF premium is almost as much a certainty.

Not a sure thing.  But pretty close.  It’s a matter of NCUA Board politics.

The NCUA staff always wants the NCUSIF shored up with a higher equity level, almost as much as they consistently want more credit union net worth to protect the NCUSIF.

It’s the NCUA Board, led by Hood and Hauptman, that has resisted a NCUSIF premium the last several years when Chairman Harper has pushed it.  That NCUA Board dynamic will almost certainly change by the time the 2024 NCUA Budget is finalized later this year and a possible premium is voted upon.

Wise credit unions will begin to factor a 2024 NCUSIF premium into their budgets for next year.  Call it the SVB Premium – even though the B in SVB stands for bank, not credit union.

A NCUA ACTION THAT SHOULD HAPPEN FROM THE LESSONS OF SVB – WE WILL SEE

Banks have long been authorized by FDIC to structure depositor agreements for what they call “reciprocal deposits” or “deposit management” programs.

These programs are one of the reasons why the SVB failure potential is considerably less than it could be, even if it did become systemic.

Reciprocal deposits or deposit management programs give depositors with more than the $250,000 insurance limits the option to authorize the bank receiving the deposit to – with the depositor’s approval – split any amount of deposit above the insurance limits into deposits at $250k or less and distribute them to other banks in need of liquidity.

These programs, which allow the depositor to have access to his/her full deposit with 24 hour notice, are a popular option for bank depositors looking to maximize their FDIC insurance coverage without having to go to a half dozen banks themselves to spread it out.

Also, for the bank, such a program helps get uninsured deposits off of their balance sheets.  (I could argue that this is a win for the bank regulator as well since….well, see SVB and the problem billions in uninsured deposits is causing.)

In addition, these programs are a great liquidity management tool for the banks involved – some of which need more deposits for liquidity and others need to get deposits off balance sheet.

In short, these banking reciprocal agreement or deposit management programs have been around for decades.  Most banks, of all sizes, offer them in some shape or form in partnership with firms like Reich and Tang and several others who have bank clients on both sides of the deposit needs question.

Basically, FDIC has authorized this through regulatory interpretation and enabled banks to make these reciprocal deposit or deposit management programs work well for the industry as a whole.

It has been a win-win in the banking industry.

With the impetus of the SVB failure and the balance sheet issues involved in so many uninsured deposits and the liquidity challenges that rapid withdrawal of those funds could cause, NCUA would be wise to look at authorizing such a program for credit unions.

Instead of reciprocal deposits or deposit management, NCUA might could call such a program – as was described by a client of ours who strongly supports the need for this type of authorization industry wide – deposit “participations.”

In other words, deposit participations would be the liability side of the balance sheet’s version of loan participations on the asset side.

Whether it’s called participations, reciprocal deposits or deposit management, there has never been a more better time for NCUA to authorize programs that maximize member deposit insurance coverage, removes uninsured deposits from a credit union’s balance sheet and provides a liquidity management tool.

This would be a very prudent and progressive step that NCUA could take in response to the SVB failure because it addresses several of the underpinnings of that bank failure while providing credit unions a tool to use in parity with their banking brethren whose time has obviously come.

Will NCUA act on this?  Who knows.  The timing is right and the need is there.

Action on reciprocal deposits depends upon whether the SVB spillover is limited to the side of more restrictive actions (such as tougher exams and higher insurance premiums) or could it also be an igniter of long-overdue balance sheet management options for credit unions.   Time will tell.

Until next time.

Dennis Dollar