Breaking down the Banking Crisis with DLC CEO Adam Ifshin
Guest: Adam Ifshin
Topics: Banking crisis, DLC Management Corp.
Chris Ressa 0:00
This is Retail Retold, the story of how that store ended up in your neighborhood. I’m your host, Chris Ressa. And I invite you to join my conversation with some of the retail industry’s biggest influencers. This podcast is brought to you by DLC Management.
Welcome to Retail Retold, everyone. We have a special episode this week. I’m excited to be joined by Adam Ifshin, CEO, DLC, partner and friend. We have this special episode because given the turmoil in the financial markets, I thought it would be a good idea to bring Adam on who spends a lot of time dissecting, meeting with people and really analyzing what’s happening in the financial markets and with the SVB crisis and what’s going on in the banking system.
I think everyone will be able to learn a lot from this episode. So welcome to the show.
Adam Ifshin 0:40 Thanks, Chris. Thanks for having me back. Certainly wish it was to talk about some great new redevelopments Yeah, we’re dealing, but we are where we are. And I think I’m hopeful that I can provide people with a level of perspective, both as a real estate person and as an entrepreneur about what I think is going on in the banking system.
Ressa 1:31 Absolutely. Before we get there, you just had a whirlwind travel of real estate and basketball. Why don’t you tell everybody a little bit about that?
Sure. So I, a week ago today, at this time where we could go I was in Milan, Italy, at the tail end of my first overseas vacation since 2020. And I was dealing with a massive text and email storm about what was going on the banking industry, flew back, plane landed on the tarmac at John F. Kennedy Airport and the phone rang and it was one of one of our lead bankers, the plane had not yet gotten to the gate.
Spent a day and a half working around the clock on things related to banking and things related to the business, the typical things you do after the end of vacation and then I jetted off in a snowstorm to Scottsdale Arizona for a major investment sales investor conference in our industry.
And along the way in the middle of that, the University of Vermont made both the men’s and women’s March Madness basketball tournaments. And for those of you don’t know my dad, who co founded DLC with me, regrettably now passed six and a half years ago, was the star point guard at the University of Vermont in the mid 50s.
And post his passing, I’ve been a active guest lecturer and supporter and benefactor of the university. The family built my father’s memory, the expansion of the business school, and I’m very involved at the university. So both teams made the, both teams made the tournament, two 15 seeds, tough road. And then I got extremely lucky, depending on how you look at it, which is the men got slotted to play on a Friday and the women got slotted to play on a Saturday.
So it was at least theoretically possible that I might be able to go to see both teams play. And I like to support the team. So it was an opportunity. It was not easy to do.
I ended up flying the red eye out of Phoenix Thursday or at least Thursday night to Atlanta, switch planes went to Columbus Ohio, pick them rental car toward our asset in Columbus got some work in toward another asset that I think we’re going to be awarded to buy here and then very near future and then made my way to to a St. Patrick’s Day party on one hour asleep, that the Vermont Catamounts whose logo color is green.
We’re hosting at the entrance to the arena. When the band played it played more cat was a tremendous team. I actually think Marquette has an outside shot to win the whole thing. So other men play, including actually someone who’s coming to work on Team DLC as an intern here in a few weeks Nick Furillo.
And then from there, I went to my hotel room and passed out, took an early flight to JFK of car to my house, picked up my car and drove to Storrs, Connecticut where the women had the the real challenge of having to play one of the two dynasties in college basketball, which is the UConn women’s team and had an opportunity to see the women play. Obviously that was a particularly tough game.
I give them all the credit in the world for keeping their wits about them and hanging in a game where, during warm ups for different women from UConn dunked off a layup line which I think getting 13 Whose tallest player is six one but they I think they acquitted themselves pretty well.
I’m a huge basketball fan as you know I got it from my dad my little world when told tour of work and March Madness I did Chris I did my work yesterday on a Saturday I did go to see for existing DLC property up for existing DLC properties, and one that were under a letter of intent to acquire so i Yes, I was out playing around but I think I held my own as your partner the last couple for sure.
I spent some time watching the basketball NCAA Men’s wrestling was on so watch that and then i prepared we ordered to eat last week so prepared some elk that we’re going to eat tonight. So live life. Yeah, by the way, Chris, there’s a there’s a crew of real estate people who went to NCAA Division One Wrestling Championships in Tulsa, Oklahoma, including some folks we’ve done some business with. So remind me and I’ll hook you up.
So next year if you want to go. Some of the people I was with in Scottsdale, flew to Tulsa, and are there for the week. You know, they got there on Friday, and they’re there for the weekend to watch. Yeah, wrestling. It was it was it was pretty cool. One of the more exciting things, Cornell to the third, which I think one of the interesting things about wrestling is you can go to some some of the elite universities that academically and compete with some of the powerhouse public schools.
And when so I thought that I thought that was interesting. Cornell had two NCAA champs Princeton had an NCAA champ. So it’s pretty cool. So it’s interesting. So Princeton, as you know, has pulled off not one but two massive upsets in March Madness and they’re young teen. And there is a p you can see it on social media online. The Princeton head men’s basketball coach happens to be a huge wrestling fan.
And the Princeton right after Princeton beat Missouri yesterday, they posted a picture of the entire coaching staff of Princeton, watching the final wrestling match on somebody’s phone, like in the runway of the arena where they had just beaten, I think they’d beat Missouri just beaten Missouri to go to the Sweet 16.
And they’re screaming their heads off for some Princeton wrestler who I guess become became the first Princeton wrestler in quite some time to win a national champ. Yes, for a long, long time. Yeah, it was. It’s a in the in the wrestler in high school, you know, the wrestlers have done bargain kid.
So high school, you know, you know, for a lot of us who competed in collegiate sports, as you did, and I did. You know, at the same time, I met all of these things. I have this app called Meet mobile open the whole time because my alma mater swim teams where I swam at Williams College, are at Division Three Nationals at the same time.
So it’s like, it’s, this is the time of year if you’re into if you’re into collegiate athletic competition to me, this is the best time of the year. Yeah, for sure. Okay, back to banking.
So, let’s start off with something simple, Adam, what makes you qualified to talk about the banking system and what’s going on? Well, I think I think that this is the most important question you could ask me today. Because otherwise, someone’s just gonna say, oh, Chris put his partner on to talk about this.
So I actually do have a background in banking. I spent eight and a half years on the board of directors of a publicly traded in New York Stock Exchange, bank holding company that owns a commercial bank here in Metro New York.
I served on that board all the way through until the we sold the bank to an acquirer who remains whose management team, I remain very, very close to. So it’s been only half years on a bank board. For those of you who think I’m smart, I’m not I accepted a position on that bank board in the spring of 2008. memo to file if you get invited on a bank board tried to do it not at the emergence of a global financial crisis.
And I knew a fair amount about banking before then I learned a ton. I had the opportunity in a front row seat in an eight and a half year period. I was on Word that got completely remade, turned over an entire C suite did not did a re IPO and a massive secondary, we raised over $100 million with capital in the fall of 2009, at the height of the crisis was on the team that recruited a chief risk officer.
And I actually the area of expertise that I had on the bank board was really around financial matters and human capital matters. So I was a member of compensation risk audit, and I chaired a committee call that every bank is required to have by bank charter called Alko, which stands for asset and liabilities.
And this is the committee of the board that is responsible for helping and overseeing management’s management of what of the other IRR in our industry IRR typically refers to internal rate of return in banking, it refers to interest rate risk. And as the chair of the Alko committee, in conjunction with learning from some really top people in the industry, I came to really understand how a bank balance sheet works.
And that’s really the heart of what these issues that have led to the failure of SVB. And the failure of Signature Bank as well as some stress in the system. So having spent eight years as the chair of an Alko. Committee, I think I can speak to some of that.
I agree. Okay, we’ve got the credentials and qualifiers out. So let’s start with the basics. And what I’d like to know is, what is happening, and why is it happening? And please explain this to me, like I’m a two year old.
Okay. So I had some practice at the conference, I was out last week someone, a group of people asked me this question. So hopefully, I can do this in a manner that that everybody can understand. I think the first thing to understand is that bank balance sheets to most people are hard to understand and very opaque, because they’re a little bit backwards.
Most most people, including Sophists, sophisticated business people, and we’ll get to this a little later about Silicon Valley Bank, think of deposits intuitively as an asset to a bank, they’re not their liability. And they’re the most dangerous liability you can have, right, which is that they are an instantly callable low deposits to a bank, right, or money that the bank effectively borrows from depositors.
That can be called at any moment. Now historically, in the old days, you know, certainly in the era of the Great Depression, which was the last time we saw bank runs, right, people have to line up with their passbook and wait to get led into the bank and talk to somebody etc. In this day and age, you can sit at your computer or pull up your phone, right and call your loan your deposits from the bank and transfer them out before anybody knows what’s happening.
So that’s the first side and the other side of the bank’s balance sheet. Its assets. Right are where it invests those deposits and where it invests its capital. Right, the liability side of the bank is essentially deposits, right and borrowings from other places, typically the Fed or the Federal Home Loan Bank Board of the relative region of the bank, right. Its assets are what it let what it does with that money, right.
And basically, banks, for the most part, do two things with that money. The first thing they do with that money is they make loans. And those loans can be any loan could qualify for car loans, one to four family residential mortgages, commercial mortgages to Pete to companies like DLC on individual properties or portfolios of properties.
And then the other thing that banks do with those funds is they invest them in securities, right, which is essentially buying a piece of some other loan that has been packaged up.
And by and large banks, particularly at the behest of their regulators, tend to focus their investments in on the security side in very safe securities, usually ones that are either government backed or implicitly government backed like Ginnie Mae’s Fannie Freddie, Sallie Mae, or in other types of triple A rated securities and certainly post the GFC.
By and large banks have constrained their investing in securities that aren’t either AAA or government backed largely because largely because the regulators have taken, you know, the lesson of the global financial crisis was the regulator’s became a lot more savvy about understanding what was on the asset side of a bank’s balance sheet in your security’s bunk.
So Hey, real quick, so just question. So on the, I think a lot of people who listen to this have an understanding on the lender side, right? We go, we applied for a loan, we’re negotiating loan docs, or we’re negotiating terms who go to committee, credit committee credit committee approves the loan, who’s the person at the bank who’s deciding, alright, I’m going to invest this leftover money or this part of our investable capital into the treasury. So we decide that
So by and large, they don’t buy treasuries. But who decides that is a really good is a really good question. So the answer is, and this is really important when we get to talking about Silicon Valley Bank, the answer is that depending on the size of the bank, and the level of sophistication of the bank, it’s generally a large bank with a large securities portfolio. The biggest example would be somebody like JP Morgan has an incredibly sophisticated group.
Right now, JP Morgan also has an investment bank, they can pull people from there. But by and large, large banks have very, very sophisticated, usually former Wall Street traders or current Wall Street traders, and portfolio managers with deep sophisticated experience in these areas, smaller banks, you know, in a very small community bank, in all probability is the Chief Financial Officer of the bank, uh, hopefully, operating with the, the help of a consultant.
And perhaps maybe more than one, as well as some type of risk manager, again, maybe an outsider who’s providing that service on a on a per diem or a contract basis. When I chaired Alko for the commercial bank that that was sort of right between a community bank and a small regional bank.
We had an outside consultant who overlooked and that consult reported to the Board to the committee that I chaired not to, not to management to help us understand, you know, what was the risk embedded in that securities portfolio? And what types of security should we be buying based on the mix of assets and liabilities on the bank’s balance sheet, but the big boys have a tremendous amount of acumen here, and as you can see, there’s very little exposure of the really big banks.
Only every has a meaningful Mark unrealized mark to mark exposure row relative to the others. The issue with Silicon Valley Bank, and we’ll get into Silicon Valley Bank A little later here has to do with the rate at which they grew and the lack of the lack of sophistication and controls that they had.
Guide. Okay, so let’s dive into that. That was helpful. What’s going on right now?
Okay, so here. So here’s what’s going on. And the reality is, is that to sophisticated players, there’s absolutely nothing that’s gone on here that should come as a surprise, none whatsoever. This is this is there’s nothing, nothing surprising here, right? Banks owned to varying degrees, some percentage of their assets. In securities highly graded, government backed usually government backed securities.
As we mentioned, the Fed has moved interest rates at a record pace, a record amount, right interest rates are up 450 basis to 500 basis points at the short end of the curve in about a year. This is no secret that if you were holding particularly longer duration fixed income securities, those securities are going to fall in value, in fact, quite dramatically. So the way that that banks work is their securities book can take one of can be in one of two buckets from an accounting perspective.
If the bank deems that they are going to hold those securities until they mature, what’s known as an htm book hold to maturity. They are not obligated to mark those securities to market every quarter. They are operating under the assumption that there’s a government backing on those securities and that at the end of the day, they will get paid 100 cents on the dollar on those two securities.
Now, those security may be due in a year, maybe doing two years, five years, 10 years. Or even longer conceptually, the flip side of it is, they also have typically a book that’s called AFS or available for sale. If you classify a security as available for sale, you must mark it to market.
So just because you may look at a bank balance sheet online and say, wow, they got a lot of securities relative to the size of their loans, their deposits, their overall balance sheet, however you want to measure, it doesn’t mean that that bank has any issue whatsoever. As it relates to a loss, because it depends on what percentage of their loans they’re having their AFS bucket versus their htm bucket.
So if you are if you are holding, let’s say you’re a bank with $10 billion, with the fixed income securities, well, if none of them are available for sale, and you’re holding all of them at par, in your hole to maturity bucket, then you have a big unrealized contingent liability.
Conversely, if you’re holding the same $10 billion, with securities exactly the same, but you’ve classified them as all available for sale, so two extreme examples, then there’s no issue because you’ve already marked down your earnings to account for the market value of the of the, of the securities, I’ll give you a crazy one.
So when all of this went on, as you saw, right, underlying interest rates fell like a stone, they collapsed 50 to 100 basis points, depending on where on the curve. perversely, if you’re a bank with a large AFS portfolio, you may have to book again on those securities at the end of this quarter. Because they may be worth more than they were worth on December 31, when we get around to march 31. So what happened, to answer your question,
Silicon Valley Bank, had an immense securities portfolio relative to the size of its balance sheet, in my professional opinion, their total balance sheet was about 200 $210 billion, up from about $70,000,000,000.03 years ago, that’s massive growth. And what let’s make sure we come back to that, because I think that growth is a critical component of why we ended up where Silicon Valley Bank is.
And they had acquired over the last two, two and a half years $80 billion dollars worth of long duration, typically 10 year term, fixed income securities, government backed that were all apparently classified in their whole to maturity bucket. So that’s the asset side of their book. Remember, when I told you about the liability side of their book, which are deposits which are like this instantaneously callable loan.
So to add to add to that, so there, there are banks all over, right? They all have deposits, that’s how they fund themselves. So Silicon Valley’s bank banks, funding of deposits, was highly unusual. relative to other banks. It was overwhelmingly from two sources, startups, and its custodial, its custodial business in managing crypto proceeds from cryptocurrency. And to be clear, they were not investing in crypto, I want to be super clear about that, nor was signature.
But what they did was they took large amounts of deposits from those two industries. And in the run up in valuation in venture capital and 21, and 22. They took in massive amounts of deposits. Silicon Valley Bank at the end of 2019, had $64 billion in deposits. At the end of 2022, they had over 180, almost $190 billion worth of deposits, growth in deposits. The issue is is that all of those deposits came from a very small number of customers.
So and by the way, Signature Bank, almost identical situation, except that it was not heavily involved in the venture capital tech world. But both of these banks had sought to make their deposit gathering machines hyper efficient. They have very few branches.
And the overwhelming majority of those deposits came from very large accounts, which is you imagine is much more efficient than Chase, Citigroup, Bank of America, Wells Fargo, US Bank excetera, right, who seemingly has a branch on every corner.
So these banks had, and both banks, I’m sure you read this, both banks had been written up as being among the most efficient banks in America, which meant that they had the lowest, some of the lowest expense ratios per billion dollars of deposits are billion dollars of loans. They were both elite deposit gathering institutions. So what happened was, they had an immense amount of deposit growth in a short period of time from a fairly small number of depositors.
So that leads to a couple of things. One is those depositors were essentially uninsured by the FDIC federal, Federal Deposit Insurance Corporation, which the which ensures each customer, not each account for $250,000. Right, so if Chris Ressa has four accounts, at Bank of America, with $240,000 apiece in it, those are not 100%. In short, you’re insured up to $250,000.
But if you have 250, in an account, and your wife, Victoria has 250, and account separate social security numbers on each account, those accounts are both in short. Make sense?
That makes sense. Okay,
But going out and collecting $200,000, at a clip in an account is, as you might imagine, expensive and inefficient. This is why banks have been closing branches, right, and pushing people to bank, on their phone, etc. Right, as they’re trying to lower the cost of that deposit gathered. For a lot for a lot of good reasons. It’s not that in of itself is not alone. The problem.
When I was when I was at a bank board, our consultants used to say, no, your depositor, how sticky are your deposits, how much service are you providing, what other things you provided to this customer, that’s going to encourage them to keep their money in your bank, given that they have the option to move it wherever they want. Now, this was a perfect storm of deposit gathering. Interest rates was zero for a long time.
So people weren’t shopping for the highest rate because no one was paying any no one was paying any interest on deposits. And people weren’t able to go by money market funds, through their broker were their wealth manager that paid any more either. So there was no motivation to move the money. Now, the most diversified deposit bases in America are typically by banks that have deep roots in communities.
So if you take a regional bank that came up from the community banking side, there are examples of these all over the country, right. But for example, if you take a Valley National Bank in New Jersey, a Webster bank in Connecticut, you know, it could give you more examples to draw Berkshire bank in Boston. These bags may have, you know, half of their deposits insured by the FDIC, which means they have lots of smaller accounts.
So you’ve spread that liability risk. Remember, deposits are liability and instantly callable loan, You’ve spread out across a huge number of customers. But those customers don’t really have any fear because maybe half or more of their deposits are insured by the FDIC. Right. Okay. Here’s the percentage of here’s the percentage of deposits that SVB two weeks ago that weren’t covered by FDIC insurance 7%.
Wow. Here’s the number. It’s at Signature 10%. And what happens is when you aggregate your deposits, in a smaller handful of depositors, very often it’s not that person’s own money. Right. Now, the person on the other side is likely to be highly sophisticated and have a fiduciary obligation.
What you have there, are the components coupled with technology that enables them to move the money without having to speak to their friendly banker. You have a 20 year had the components of a 21st century bank run?
So what? So that’s the risk component? What really drove people to want to withdraw? Because at the end of the day, you know, what was what what’s interesting, right is, you know, I wonder if these if banks, if some of these banks weren’t public entities, that you would have this amount of what I would call a bank run issue, because, you know, I think the, when they…
When they report earnings, and they give their business plan of what they’re going to do, investors in the stock get concerned, there’s a dump of the stock. And now that’s forcing a, you know, a one on the bank is, is that part of what happened?
It is not at all what happened, okay. It doesn’t matter whether the bank was public or private at all. And it would be my contention, that the investors in the stock of the bank, the equity holders, the shareholders, they were the tail wagging the dog. On Friday night, a week ago, Friday, signature stock closed at $70 a share. Now, the stock had fallen from a year ago being at $300 a share, but $70, a share signature was a multibillion dollar entity.
In fact, on the Friday before the bank failed, the co founder of the bank owns $160 million with the stock at $70 a share. So the reality is, is that it had nothing to do with the shareholders, a bank run, let’s let’s make sure everyone understands what a bank run is. A bank run is depositors for whatever reason, real or imagined, no longer feel comfortable making that on demand loan to that particular bank.
So they take their money out. That’s what a bank run is bankrupt has nothing to do with loans going there has nothing to do with the price of the stock. It has to do with a crisis of confidence. Right? So let’s look at what created that crisis of confidence Aragon Valley Bank, because I described to you a that Silicon Valley Bank had grown very quickly on the deposit side. And I described to you the nature of how quickly and easy it is to take your money out. Right.
So what led investors to say, Ah, I can’t leave my money there. So let’s talk about that. So the week prior to them failing on that Friday, Silicon Valley Bank, having having spent apparently weeks or months looking at this came to the conclusion that they had a significant problem and their securities book, I would submit to you that they were months late, and billions dollars short, they should have been selling this book down.
They never should have bought this book, and we’ll talk about that. But they certainly should have been selling it down once they had it. Probably starting in late summer of last year. They didn’t. So they crafted a plan to sell a huge block of the book roughly 25 28% of the book $21.8 billion in a block trade to Goldman Sachs, who was also advising them. And at the same time, they move to file to issue secondary stock and raise capital.
And they were trying to match the loss with the amount of capital they were going to raise. And they even secured an anchor investor for the capital, a large P firm called general Atlantic for $500 million. There was a colossally bad plan and it was communicated terribly and on top of it all because they moved to do them simultaneously.
They entered it immediately entered into a quiet period and could not explain their actions cogently because they were simultaneously trying to do an overnight and raise another billions five to 1,000,000,007 in a variety of different stocks, scale, stocks, IP sales, convertible preferred, preferred, etc. Complicated deal, and it failed completely. When it bailed. And you know, the tide went out and the emperor had no clothes.
Suddenly everybody goes, Well wait a minute, what’s their securities book really look like. And their securities book was like, wow, that 21 point 8 billion is like the tip of the iceberg $80 billion of long term, fixed rate securities and an average at an average yield of 1.56%.
They’re paying out more on their deposits way more on their deposits at this point than that they’re losing money every month holding those securities. And, of course, the Fed is still signaling that they got more more to go. So then a series of events happened. So please, back up.
So let’s back up. So I think this is an important point. They, they they took in deposits, they invested $80 billion more, that was yielding about 1.6% interest, and their depositors could get, you know, now that interest rates have risen, you know, more than that, or they can take their money and go somewhere else and get more interest in that. So that’s a negative spread. And they’re in a bind.
I mean, Chris, I bought short term treasuries, I bought two month treasuries, three month, four month treasuries, in my own personal account this week in the mid to high force. I mean, it’s not that complicated. So here’s, so here’s what happens at the point of attack. Then, now everybody wakes up, right, and everyone and remember what I told you about their deposit base. It’s 92 or 93% uninsured.
And it’s in the hands of a relatively small group of depositors, relative to the number of depositors that say, a US Bank, a PNC a truest would have to have $180 billion in deposits. And their Silicon Valley Bank, they have a super efficient online banking system for their customers. And their customers are overwhelmingly operating companies that sophisticated venture capital and PE firms have invested it.
So basically, and then, just to add a little bit to it. Peter Thiel, Founders Fund, right legendary investor. Look now meta Pay Pal etcetera. Peter Thiel goes on this social media platform called Twitter, right? And effectively at lightspeed yells fire in a crowded theater. And now you have a backbone. You have a 21st century, walk chain tech enabled bank room.
And you probably heard and people posted stories of this online of there were so many people trying to outbound wire money out of Silicon Valley Bank, that effectively their wire system collapsed. And it was purely a matter if you got lucky and you were in the queue or not. This is this.
This is the 21st century equivalent of your my grandparents, your great grandparents lining up outside of a bank in 1929, with their passbook trying to get their life savings out of that bank by getting led in the door by a security guard to get their money out. That’s what this is at on Thursday. A week ago, Thursday, over $40 billion was transferred out of Silicon Valley Bank. Now banks are obligated to keep cash on hand, right?
Okay, someone comes calling says give me my money. Remember those automatically instantaneously callable loans called deposits. But they had 80 billion in securities, they had sold 21 billion of it. They have a loan book. They had other securities, there was no way that they could come up with the money fast enough. Banks in America are typically regulated by more than one group. They have a primary regulator mode for most banks.
That’s the Office of the Comptroller of the Currency, which is a division of the Department of the Department of the Treasury. working in concert with the FRB the Federal Reserve Bank And then of course, the FDIC has regulatory oversight because they’re providing the insurance. But most banks are also subject to state regulation.
On Friday morning, the California state banking regulator convened a meeting of their board and called the San Francisco fed and said, You have to take the bank now they cannot meet their obligations at the window, i.e. they did not have cash to pay out to the people who were trying to get their cash out of the bank. And that led to what what banking experts will call a messy
So given their druthers, the Fed likes to take a bank if they have to take a failing bank at the close of business Friday. And they like to have a pre arranged transaction, either arm’s length, or assisted, where they have sold the deposits to a successor institution. And that successor institution will open up on Monday morning. And notwithstanding the insurance, everybody has access to all of their deposits.
So even at the height of the financial crisis, with the exception of Washington Mutual, I believe in every instance, that’s what happened. Right, I don’t believe that there had been a major payout against FDIC insurance without someone picking up the deposits in 30, plus years. And they’ve only been a handful since they can since the Great Depression. They had to take this bank in the middle of the day on Friday, with no successor bank or receiver bank.
So the Fed actually had to go out and hire somebody to one Silicon Valley Bank Monday morning. This is exceedingly rare. And this This is that is all the result of the speed at which this occurred. Normally, regulators know well not well in advance, but have some reasonable amount of warning and opportunity to plan for this type of situation. They did not have that here, because of the speed at which the technology enabled a small group of depositors to move. So now,
we understand what happened to SVB. Why is there this what I call potential contagion? You have first republic and Credit Suisse and all these other bank challenges. What’s happening now? And where do you think Cisco?
Okay, so it’s a great question. So before before I answer that, I think the first thing is, people need to recognize that anybody who goes and answers that question and says, Well, based on what happened in the global financial crisis in the GFC, were in the third inning, don’t listen to those people. This is completely different than the global financial crisis in the global financial crisis.
What led to that, and the massive contagion of it was what was on the other side of banks balance sheets, what was their assets. And if you go all the way back to the savings and loan crisis, when I started DLC in 1990 9192, it was all about asset quality, ie they made loans that were crappy that they weren’t gonna get repaid, or they bought securities, like in the global financial crisis that everyone said were triple A when they were really crack. That is not the case here, right?
Silicon Valley Bank, absent a bank run, we’re holding high quality, secure government insured assets, by and large, plus some loans, Signature Bank, by and large, the securities book, and a large multifamily cre bond with very few no defaults for all intents purposes. So this is completely the other side of bank’s balance sheet. This is not like the global financial crisis. I can’t stress it enough. So is there a potential contagion? There is a potential contagion only because this is a bank run.
So this is a crisis of confidence. And you need to go back and look at something like 1929 versus 1990 or 2008 2009. So I think the so what, what happens next, where are we what happens next? I think it’s important to know the following things. First of all, signatures follow up, follow up or follow on to SVB is entirely predictable.
They were the bank with the second largest percentage of uninsured depositors signature for years, you can go back and look at their annual reports regularly touted how many billions of deposits they had per branch. Typical bank branch in America has less than $100 million in deposits. Typical signature branch has over a billion dollars in deposits.
So they were regularly written up, and I was client, not our primary bank, but a client as being one of the most efficient deposit gathering banks in the history of the world. So they were clearly faced the same risk. And then they had a unique, additional challenge, which is that they had gotten very heavily, they had invested very heavily into developing blockchain technology to bank the crypto industry.
And again, to be clear, they didn’t only crypto and invest in crypto, they didn’t trade crypto, but they had a group of, of, of crypto investors who kept their US dollars, because they built the system that helped those people invest in crypto at Signature Bank. So one of the things that the regulator’s teach you, if you’re on a bank board, or you’re in banks, senior management is to be leery of what they call hot money.
What’s hot money, money is deposits that don’t have any loyalty to stick around in your bank. Right? Historically, this meant banks that bought brokered CDs off the street, because they needed more deposits, and they had to pay off to get those deposits. Now it means money that could just run out the door for whatever reason cryptos down, you know better than I want to strip down down 70 80% On average, maybe even more. So those deposits have obviously fallen precipitously.
Well, on Friday, the day after the 40 billion ran out of SVB, a whole bunch of people, many of whom, you know, Chris, who were longtime signature, depositors went, Oh, Blanc, I better do something here. Because I don’t want to be the one caught holding that. signatures, bread and butter core depositors are a who’s who of the New York real estate industry. That is historically a very sticky, non hot money deposit base.
And signature was very good at providing them with lots of service. They were also banking, many of those people on the loan side. You know, lots of it was in multifamily. So you’re talking about things like security deposit accounts, things that are not as easy to move. But that crew got up Friday morning and said, I gotta get my money out. And $40 billion, ran out of signature in a day. Now they were holding about $100 billion worth of deposits plus or minus.
And the Feds had no choice but to take them that Sunday while I was on that plane coming back from my vacation Nemo file, if you want to bank in crisis send out I’m on vacation. So the regulator’s that had a problem. So here’s how you control a contagion. You’re saying control contagion. Bless you, you take a global regulators, you have to take massive, massive action fast.
So what the regulator’s did, to stop money running out of these two banks that they were taking was to guarantee all of those deposits. Now coupled with the fact that the top, you know, the four or five, you know, whatever they’re called, you know, significantly, whatever financial institutions too big to fail institutions colloquially have an implicit but not an explicit guarantee of their deposits. Right.
Now, what you’ve done inadvertently by not explicitly guaranteeing all bank deposits, is you’ve created this situation where you think you’ve controlled the contagion, but you’re actually creating a perverse incentive now for people to move money into signature. So if we took $20 million and moved into the signature now be 100% Guaranteed.
Whereas any other bank, it’s not explicitly guaranteed. Now, most people seem to be operating off of the assumption that well, if the government guaranteed the signature deposits, and yes, we’d be deposits, they would have to be prepared to guarantee the deposits of the rest of the, you know, the banking industry. There’s only one problem
posed by Dodd
Frank and the 2018 partial rollback of Dodd Frank under the Trump administration. You can’t, without an act of Congress. So you could stop the contagion tomorrow, if you want, if you could get Congress to pass a law, which I assume President Biden would sign that said that the FDIC is authorized to insure deposits to an unlimited amount, which has happened, by the way, twice before. Right? The government did this at the start of COVID.
And the government did this at the height of the GFC. So it’s not without precedent, but the government can’t just go do it by executive order. They now need an act of Congress to do it. And you know, I’m not quite sure that the Speaker of the House at the moment could Rustle up the votes so easily. Let’s put it that way. You mentioned Credit Suisse. I think it’s important that we talk about Credit Suisse. There’s news about Credit Suisse.
This morning, were recording this Sunday morning, March 19. So here’s the thing about credit scores, Credit Suisse, a completely different situation. Credit Suisse. So UBS has made an offer by Credit Suisse this morning, for a billion euro, which is kind of like the cheap, low rent version of JP Morgan offering to buy Bear Stearns for $2. A share in 2008.
But here’s the thing about here’s the thing about Credit Suisse, I think it’s important for people to understand this totally different situation. Credit Suisse. And this is just not me talking. I think this is the generally the view of the financial community has been the worst run. Financially significant financial institution on the globe for over a decade. It’s been through multiple management teams, it’s been bailed out multiple times. It is a poorly run.
Business they have they have had more scandals, mouthpieces than anybody else. And for big numbers, right archipelagos are Archer goes for over 10 billion euro a couple of years ago. And this isn’t. So what happens is, you know, once the world wakes up, they laser focus on the weak. And that is what’s happened here. Now, people are pulling their deposits in their accounts, their their investment accounts out.
So there’s definitely been a run on Credit Suisse. But the problems at Credit Suisse go far further, then on the asset side, than either Silicon Valley Bank or signature. First Republic, you know, I kind of feel very almost feel bad. That is great back, it has historically been a great bank. If you asked 10 Really well respected bankers in America six months ago, they would all have them in their top quartile of management teams.
They are, however, the bank with the third highest percentage of their money uninsured. Again, very efficient deposit gathering operation from this uber high net worth individuals and family offices, sophisticated, fiduciary same kind of scenario. And they do have a fairly high percentage of their book in fixed rate securities that they have not marked, not as severe as SVB. But more than signature, and I think they’re, I think that franchise is highly desirable to a lot of people.
I would be surprised at this point. If first republic is not acquired by another institution, I would think that there’s probably intense dealmaking going on at the moment around that. Unlike SVB, unlike signature, FRC is being in is being advised by the absolute dean of the crisis banking bar Rajan cone at Sullivan and Cromwell, he is the best, hands down, everybody knows it. He is the he is the man behind more solving more bank crises than almost anybody else in America.
And I would just I would be surprised at this point. If there wasn’t a transaction for first republic. By and large, by the way, I want to be clear about this. The banking system in America is rock solid. The government needs to take action to stop a bank run. In my view, that’s the government’s responsibility.
I don’t have a lot of sympathy, by the way, for you know, billionaire tech guys saying, you know, the government’s got to do something, government’s got to do something, well, you know. We’re all pretty anti regulation. And you’re pretty much not interested in the government being in your businesses until you need a bailout. So I don’t have a lot of sympathy there. But if you want to know technically how to stop a bank run, you stop a bank run with government action, at least historically.
And I was, I don’t perceive that this is going to get much further. My sense of it is there’s a lot of liquidity in the system. Still, it shouldn’t most bank management teams did not make the mistakes that these bank management teams made. And I think that’s, I think, you know, we’ll talk a little bit about the end of the day, who’s responsible and where the liability sits.
But, you know, I think a lot of I think a lot of bank management teams have, you know, have both the balance sheet and the acumen to weather the storm.
Okay, so we’ve been going for a while and over an hour here, let’s, why don’t we do this? Why don’t we can you wrap this up in a nice pretty bow for us or not? So pretty bow? And, you know, you mentioned where the liability sits and maybe start there and, you know,
Okay, so, at the end of the day, here are the takeaways. The overall banking system in America is incredibly healthy. Banks have a ton of capital, they’ve generally have very clean, you know, assets out of their books, cleaner than ever, especially given the size, especially given the amount of capital they have. I think we have a fairly limited situation here, where you have this confluence of deposit concentration, and lack of mark to market and a handful of bank securities books.
So I think it’s limited, I think it’s contained. This is not the global financial crisis, I think the single most important thing of is not the global financial crisis, the overwhelming majority of assets on banks, books are high quality. So I think there are two things that people should know on the way out the door of this conversation. Number one, I don’t want to hear anybody blaming the regulator’s is not the regulator’s fault. Okay.
This is the fault of management and a handful of banks that took in deposits without a place to invest them. So they park them in perceived safe securities. And they set up a colossal, classic mismatch, they borrow short and lend long. And that’s called interest rate risk. That’s the other IRR.
And I will tell you now, and I’m not talking my own game, there is no way when I chaired Alcoa of a small bank that we would have allowed management to do what SPPs management did no chance, and guess what management never would have suggested. And we had an outside consultant who warned us about precisely this every quarter in every committee meeting. This was a failure, a colossal failure on the part of SVPs management team.
In my personal opinion, they grew super fast, they did not have a chief risk officer for nine of the 12 months of 2022. And they made just some very, very rudimentary mistakes at scale. That’s number one. Number two, clients need to know their banks, you are lending a bank money when you put a deposit in a bank. I have no understanding of why ro coos CFO had over $400 million in Silicon Valley Bank.
It makes absolutely no, it’s suicidal risk, makes absolutely no sense. So that’s number two, you have to know your counterparty at all times. And you need to understand their balance sheet, and you need to understand the risk. And to me, those are probably the two biggest takeaways. There’s one more I mentioned this in 2018. Congress at the behest of the executive branch, and there was bipartisan support for this.
There was uniform Republican support, and there were a handful of moderate Democrats, particularly the Senate who supported a partial rollback of Dodd Frank. That roll back in retrospect is very unfortunate for what happened here, because it lowered the stress testing bar for regional banks between 50 and $250 billion in assets. Those banks prior to 20 eighteens. Rollback would have been subject to very similar stress testing, as Wells Fargo Bank of America, JP Morgan, etc.
By rolling that back the regulator’s lost a powerful weapon in having the ability to have been more proactive at places like say Michurin SVB SVB in particular. So in retrospect, that rollback has some level of partial responsibility. But at the end of the day, it’s bank management and their boards. I think that the bank management and the boards of those two banks are going to sit for a lot of depositions, Chris, and they’re gonna get sued a whole bunch.
They may even be criminally investigated. I’m not qualified to say if they’ve have they have criminal culpability or not, but they are absolutely. They did to me anyway. And having sat in that seat, the responsibility sits with those individuals in mind, in my view.
All right. Well, there you have it, everybody. That’s what’s going on. I hope you’ve enjoyed. Adam, thank you for shedding some light on a situation that for many Americans, I think is pretty opaque. And you made it a little more, gave a little more clarity to something that a lot of people aren’t visibility to. So really appreciate that. Thanks so much.
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