As news unfolded last week regarding the collapse of Silicon Valley Bank (SVB), the banking sector was most concerned about contagion. Despite SVB operating as a mid-sized bank and falling beneath the threshold of what the US regulators considered a systemically important institution, its downfall raised concerns about the financial readiness of other similarly sized lenders. US onlookers did not have to wait long.
Following a downgrade in its credit rating due to what credit rating agencies cited as “a high proportion of uninsured deposits”, California-based private bank First Republic found itself the recipient of an unprecedented rescue package from 11 American banks including JPMorgan Chase, Bank of America, Wells Fargo, Citigroup and Truist Financial, which deposited $30bn with the bank.
According to reporting in the Financial Times, S&P Global downgraded the bank’s credit rating to B-plus from BB-plus this Sunday, saying the $30bn lifeline from large US banks “should ease near-term liquidity pressures, but it may not solve the substantial business, liquidity, funding and profitability challenges that we believe the bank is now likely facing.”
Despite a sharp drop in share price, First Republic’s shares rallied in premarket trading this week after news reports that the banking consortium, led by JPMorgan, announced it was formulating new plans to shore up the California lender.
Chris Aliotta, president and founder of fintech company Quantalytix and a former banker of 17 years, including almost six years at Regions Bank in Alabama, comments that the First Republic rescue was not unprecedented.
“American banks have been able to lend to each other for liquidity purposes for a long time. Typically, bank deposits held at the US Federal Reserve could be used to temporarily shore up balance liquidity,” he adds.
However, what makes this deal unprecedented, says Mr Aliotta, is that under normal circumstances JPMorgan and the other banks would probably not have lent money due to the size of the funding gap.
“The opportunistic bank would have allowed First Republic to have liquidity and capital issues and would have purchased the bank at distressed prices,” he says.
What was unique about First Republic’s liquidity issues was that they were not a result of bad credit, but unplanned and uninsured deposit outflows, “largely due to SVB fear” have put the bank in an unstable position, says Mr Aliotta. This is exacerbated by the losses in the investment security portfolio, used exactly for liquidity events like deposit outflows, due to failure to manage long-term interest rate risk, he adds.
“This move by the larger banks to shore up First Republic is an attempt to quell fears in the marketplace and placate an anxious Fed,” says Mr Aliotta. “We will likely see more of these deals; however, it will likely be implicitly supported by the US Federal Reserve.”
Good health at community banks
According to Jill Castilla, president and CEO of Citizens Bank of Edmond in Oklahoma, most community banks in America are in good health. “At Citizens, we are seeing deposits grow because people know we are safe and secure while accountable and accessible,” she says.
However, Ms Castilla is aware of the impact social media can have on customer trust in banking, especially considering the ongoing saga at SVB.
The speed of social media and the influence of non-experts caused a blaze of unprecedented actions
“The speed of social media and the influence of non-experts caused a blaze of unprecedented actions,” she says. “The public is smarter now. You can see the string of comments questioning bold, unsubstantiated statements taking root! I trust hardworking Americans to expect accessibility, accountability and transparency with their bank.”
Education around the Federal Deposit Insurance Corporation (FDIC), bank health and mission are part of customer conversations from this point forward and local banks are best positioned to authentically serve these more educated depositors, she adds.
Ms Castilla says she imagines many local community banks will see an influx of deposits because they have close connections to their communities, are able to develop relationships and have insights into the needs of businesses.
“The social capital of small banks is nearly as important to financial capital and we take both very seriously at Citizens,” she adds. “This is one of the key differences between local banks and your larger regional banks — the level of attention and accountability we have to our customers and community. For the regional banks, there are going to be winners and losers. One of our Oklahoma-based regional banks has proactively boosted liquidity, positioned themselves very well with their investments portfolio and built a highly diverse deposit base — they are poised for further success in this changing environment.”
Not an everyday occurrence
Both Mr Aliotta and Ms Castilla had seen the First Republic rescue as a ‘one off’. Mr Aliotta pointed to statements by US Treasury Secretary Janet Yellen that said uninsured deposits would be protected only at depository institutions that pose systemic risks to the financial system — leaving almost 70% of independent banks unable to expect help if they find themselves in a liquidity pinch.
However, Ms Yellen reversed that position this week by citing mounting evidence that panicked depositors are pulling savings out of regional banks, and guarantees offered to all depositors at the failed SVB could be replicated at other institutions if needed, according to the Financial Times.
“The good news is that most community banks of small size found themselves awash in deposits during the pandemic and typically cater to depositors that are well below the FDIC insured limits,” says Mr Aliotta. “This means that rapid deposit outflows are not as likely as they would be for larger institutional banks.”
Mr Aliotta feels that it is not a “surprise” a lot of banks were not prepared for rising interest rates and for the US Federal Reserve to be removing money from the money supply.
However, “banks should have expected liquidity to be a concern; banks also did not properly hedge their investment security portfolios for a rising rate scenario properly; and regulators failed to observe this issue, and little was done until it was too late,” he concludes.
