Silicon Valley Bank

On Friday, March 10, 2023, the federal government took over the 40-year-old bank, Silicon Valley Bank (SVB), as it was in the midst of collapsing. SVB had become known as a bank for tech startups and innovation. At the time of the failure, SVB was the 16th largest bank with approximately $200 billion in assets, of which approximately 95% of the assets were uninsured.¹

One of the biggest vulnerabilities of SVB was the concentrated client base. The client base was not very diversified in terms of industry, company maturity, or geography. Most clients were tech startups. In fact, SVB boasted that 44% of the companies backed by venture capitalists, which went public in 2022, were SVB clients.² The lack of diversification in banking clients can lead to amplified stress when an undiversified banking market is stressed, and the bank then becomes much more difficult to manage in terms of risks.

Several companies with high concentrations of their capital in SVB submitted regulatory filings, which specifically mentioned the failure of SVB and the possible impact on operations.³

Within two days, the federal government appointed the Federal Deposit Insurance Corporation (FDIC) as the receiver, and the FDIC created the Deposit Insurance National Bank of Santa Clara (DINB). The FDIC then immediately transferred all insured deposits of Silicon Valley Bank to the DINB.

To add to the complexity of the issues, as of March 14, 2023, the Department of Justice has announced an investigation into the bank collapse.⁴

Signature Bank

Signature Bank (Signature) in New York City, a 24-year-old bank, was also closed by the state regulatory authorities on Sunday, March 12, 2023. Signature was heavily invested in cryptocurrency and maintained a book of assets of approximately $88 billion. Signature catered to law firms and held many very large bank accounts. It was estimated that $79 billion of Signature’s $88 billion in assets were uninsured deposits because so many of the Bank’s deposit accounts were over the $250,000 insured by the FDIC.

The biggest issue for Signature, however, was that $16.5 billion was in crypto assets, which have not fared well since the demise of FTX. The large amount of capital invested in the crypto assets meant that Signature was also not very diversified.

The FDIC established the Signature Bridge Bank, N.A. as a successor to Signature to help depositors access
their money.⁵

Government Response

On Monday, March 13, 2023, the federal government announced a multi-part plan to secure the depositor’s money in the bank.⁶ President Biden announced that SVB depositors and Signature Bank depositors would be made whole.

The Federal Reserve has also created a new Bank Term Funding Program (BTFP), which will provide land to banks, credit unions, and other depository institutions to provide more liquidity for banks. By offering these short-term loans, the banks will not need to sell assets quickly at unfavorable terms. The BTFP will be able to borrow up to $25 billion from the Exchange Stabilization Fund as a backstop.⁷ The loans, though, are only available with the personal approval of Treasury Secretary Janet Yellen.

The Federal Reserve announced that the discount window will remain open to provide more liquidity to banks. The discount window applies the same margins as the BTFP to a wide array of assets as collateral for loans.

Finally, as a last measure, President Biden announced that none of the losses would be borne by taxpayers. The losses will instead be paid by the Deposit Insurance Fund, which is funded by assessments on banks to cover such losses.

A Tough Economy for Banks

The past three years have been particularly difficult for banks beginning with the pandemic that started in March 2020. This led to a national shutdown, large operating losses for businesses, payroll issues for restaurants and small businesses, the loss of employees to the so-called Great Resignation, and the seemingly always strained supply chain. And, as if the above reasons were not causing enough pressure on banks, the rising interest rates and inflation after years of quantitative easing have increased pressure on banks from all sides. The supply chain issue has been especially tough on Midwest banks, lending to farmers who themselves have been squeezed by the rising gas prices and the rising cost of fertilizer due to sanctions against Russia.

In addition to the business pressures, an economic slowdown inevitably leads to increased cases of fraud, investigations, and, ultimately, oversight. Warren Buffet once said that “Only when the tide goes out do you discover who’s been swimming naked.” We are now, unfortunately, seeing the results of a falling tide.

The Department of Justice is ramping up its investigation of PPP loan fraud or other incentives intended to help cash-strapped businesses during the pandemic.⁸ The FBI, through its Internet Crime Complaint Center (IC3),⁹ has published its annual report to announce another record year in losses — $10.3 billion in losses in 2022 compared to $6.9 billion in losses in 2021;¹⁰ and, recently, the DOJ revealed charges against 23 individuals for $61.5 million in Medicare fraud.¹¹

Even, Steady Steps in an Unsteady Banking Market

Considering the endless reports of economic issues, here are a few steps for uncertain times:

• Identifying Exposed Clients
  The fallout from bank failures will have far-reaching consequences. Many startups around the world are feeling the effects of the failures. One startup, which will feel this broad effect, is Etsy. Any company dependent on the craft site may experience delayed payments which will inevitably have a cascading effect. Several other companies include Roku, Circle, FarmboxRx, Nitro, and there could be many, many more. Identifying clients who may have direct or indirect exposure to bank failures may prevent an unpleasant surprise later.
• Communications with Clients
  Fear and chaos often provide a foothold for fraudsters. Clients may be receiving emails from fraudsters prompting them to click on a link for information about their bank or the status of their deposits or prompting them to apply for a loan from the BTFB. Regular communications with clients during times of uncertainty can avert further scams, issues, and frauds.
• Relationships with Companies
  Identifying key businesses with tight working capital accounts to discuss current and future working capital needs. Many potentially bad banking relationships will have red flags long before the accounts become liabilities. Those accounts may be identified with judicious monitoring and adjusting relevant thresholds for identification and reporting of the accounts.
• Relationships with Regulators
  Although regular communications with regulators are not something naturally sought or maintained by most banks, the regulators may have key information on forthcoming regulations, requirements, metrics, measures, cybersecurity, and industry knowledge. Regulators may have insight as to the cause and fallout of banking failures and information about financial indicators which may be of interest for future engagements.
• Relationships with Banking Partners
  The risks associated with larger loans may be shared with industry partners. Regular collaboration and communication with banking partners may lead to early intervention when necessary. Shared relationships can help distribute and share risk, but distributed communications may also result in red flags being obscured by the disparate knowledge base.
• Relationships with Individuals
  Identifying key accounts which may be near, at, or over the FDIC-insured amount of $250,000 and working with those clients to ensure they are aware of and understand the limits of federal insurance limitations may avoid uncomfortable conversations later.

Legal Fallout from SVB

Finally, working with counsel to identify and monitor key cases resulting from the failures may provide important information as to the direction and nature of the resulting litigation. While bank collapses have occurred in the past, the collapse of SVB and Signature were caused by previously unanticipated circumstances and may result in new legal analysis, new case law, or nuanced judicial opinions which should be studied and incorporated into banking procedures.

For more information, please contact Robert (Bob) Kardell at (402) 636-8313, bkardell@bairdholm.com, or visit www.bairdholm.com.