Hello, and welcome to the Votes and Verdicts podcast, hosted by the litigation and Policy team of Bloomberg Intelligence, the investment research platform of Bloomberg LP. This podcast series examines the intersection of business policy and law.
I'm Elliott Stein.
I'm an analyst with Bloomberg Intelligence covering financials litigation.
And my name is Nathan Dean, and I'm an analyst with BI covering financials policy.
We're delighted today to be joined by Herman Chan, who is not just one of the foremost experts on regional banks, but also our colleague and friend here at BI. Herman has been covering the banking sector, including the regionals, for more than fifteen years. He's been on the cell side as a research analyst. He's been in investor relations at a leading regional bank for the.
Past four years.
He's led bi's regional bank coverage as a senior analyst. We're really excited to have Herman here today since there is really no one better to explain what we've seen these last few weeks with Silicon Valley Bank, Signature Bank, and more broadly, the most recent banking crisis. So Herman, Welcome to Votes and verdicts.
Great, Thanks Ellie, I really appreciate it and looking forward to the discussion.
So, you know, we'll jump into some substantive conversation in a minute about the banking crisis, but what we like to do with guests usually is to get a little more background about them first.
You know, you've been involved with.
Regional banks for about a decade and a half now, both as an analyst and also in investor relations, so you know, I thought it'd be good to get your take on how you got into research generally, how you got into regional banks specifically, and maybe as part of that, tell us you know what you like about covering the center.
Sure that'd be great, Elliott. Yeah, that's right.
I've been doing banks and regil bank specifically for a while now. What really got me interested was I knew I wanted to be in equity research. It sort of fits my personality and I'm a numbers person by trade, so it researching gives an individual really the opportunity to better understand the company, become an expert in it, and really focus on the performance and the potential performance of
the bank and the industry as a whole. I started out my career in equity research too many years ago to remember at this point, but it's been a great journey. Covered financial services my entire career, including life insurance, asset managers, large cat banks, small cat banks, and really cut my teeth during the Great Financial Crisis, which.
Was really a eye opening and learning.
Experience and have really shaped the way I think about banks and policy in general. And so I've been with BI for about four years. As you mentioned before, covering regionals, it was really an opportunity because I was covering the large cat banks as an associate at a prior institution and got the opportunity to cover regionals as a senior analyst on the cell side, and my career has really taken off ever since then.
So it's been great.
I got to imagine these last two maybe three weeks have been probably the craziest since the Great Financial Crisis for you, yeah, maybe.
COVID this many crisis of competence I would call it.
Has been.
Really interesting these last four years at BI and covering the current crisis at Bloomberg has really been interesting.
Because of the platform.
That we're on where we are able to connect with clients via research but also via media in radio and TV as well.
So I've been really.
Busy these last few weeks, but it's been really really been fun as well.
So yeah, so let's let's talk about this this most recent crisis. You know, I think most people have a general understanding of what happened, you know, in terms of you know, Silicon Valley Bank in particularly having a very non diversified customer base, and then also you know what it appears to be mismanagement of their interest rate risks. But you know, I'd love to get your explanation and you know, like the simplest explanation for what happened, like talk to talk to us.
Like we're five year olds.
Yeah, there's a lot of different issues that that really contributed to the failure of the bank.
I guess if you really break it down there.
There's one issue on the on the bank's asset side of the balance sheet and one issue on the bank's liability side of the balance sheet.
So on the asset side, uh SVB and said very.
Heavily in to investment securities, specifically held to maturity securities when interest rates were zero, So they built up their investment securities portfolio at a very large clip.
Subsequently, when interest rates rose.
Those the value of the securities fell and they were sitting on a fifteen billion dollar paper loss position in their health to maturity portfolio. Secondarily on the deposit side the liability side, SBB really was the premier bank that catered to the venture capital and startup communities.
So during the pandemic.
When reads for zero, startups were raising money left and right from venture capital firms, they were doing IPOs and garnering really astronomical evaluations. So all that money flowed into spb's balance sheet in the form of deposits, and SBB wasn't really growing their portfolio as fast as they were on the deposit side, so in effect they needed to park those funds somewhere else, hence the growth in the
securities portfolio. Now fast forward to early March, the bank was looking to raise capital and sell the AFS portfolio at a loss position because these were securities that they also bought during the height of the pandemic on rates for zero. That maneuvering from a capital standpoint really spooked the markets and contributed to the initial share price decline because management didn't.
Do a good job of.
Articulating to the street and investors their expectations for how to manage the securities portfolio, and it really caught investors by rise, contributing to the fact that the share price decline drove the spotlight to the AFS book with a fifteen billion dollar loss position, which in effect, if they would have had to realize that would have wiped out the book value. So the market was spooked. That in
turn spooked the depositors. And given the fact that depositors now have a very free hand in terms of extricating their deposits from from a bank, their phones and other electronic avenues, and given the fact that social media is a big influence as well, there was a herd mentality from its startups and vcs and really contributed to the deposit flight. And eventually regulators need to step in and close the bank.
So you know, Herman, I actually you bring up a great point here.
You listen to all the the you know, the the reasons why SVB failed and forth like that. You know, you and I have had some conversations this week about the congressional hearings and one of the big questions we hear in Washington is is this a regulatory problem or a regulator.
Problem, you know.
And so the question I have for you is as you dive, as you delved into SVB and the situation and so forth like that, you know, are what's your initial thoughts on the regulatory response we're regulators able to identify these items or where they slow to the game. I mean, I just I'm really curious on where do you think the response of the FED, in the San Francisco FED and the FDIC fall into this.
Yeah, I think it's a combination of management doing the wrong thing in terms of not managing the risk properly, especially interest rate risk, which is as as Michael Barr, the head of FED Supervision, has discussed earlier this week, it's a bread and butter core risks that banks in general manage, and it's one of its It's the same thing as banks managing credit risk and making sure their borrowers pay them back.
This is a.
Fundamental way and a fundamental thing that all banks manage and look at. And the fact that they blew it really speaks to the fact that they were they these
risks were unappreciated or underappreciated at the bank. I would also say that I think their regulators do need to take some blame because it's come out that the San Francisco FED did raise red flags on the bank as early as twenty twenty one, and if they were a bit more forceful with their enforcement and their duty as and role as regulators, maybe this whole situation wouldn't have unfolded.
The way it has.
And correct me if I'm wrong. But you know, SVB didn't have a chief risk officer for what nine months?
Right?
That's true that that's something that they probably should have done and filled that very important role a bit earlier. But you have a CFO that been in the business for a very long time, you have a treasury function that should be managing these risks on a day to day basis much more closely, and ultimately you have a CEO that should have taken more responsibility on looking into these matters.
So I think there there's really a lot of blame to go around. Yeah.
You know, when a FED Vice chair Bard testified earlier this week, he said, and I'm paraphrasing here, that the interest rate and risk models at SVB were not grounded in reality. You knew the regulators were going to have some issues with that, So just turning a little bit
more towards, you know, the response of the regulators. You know, so you know, Silicon Valley Bank was a small bank what two years ago, and it's balloomed up, and before it's collapsed, it was around two hundred and eleven billion in assets, so that would have put it in a
different category of regulations. But we've seen statements from Congress that they want to go back and revisit the CIFY threshold, whether it's fifty or two hundred fifty billion, And my analysis says that's not even gonna it's not even worth
really talking about. But the FED and the FDIC in the Office of the Comptrore or the Currency have said that they have the ability to go back and reapply enhance crudential standards to banks above one hundred billion in assets, so things like higher capital requirements, tough for liquidity cover ratio stress tests. If the FED were to do this,
what's your outlook on US regional banks. Is this a much more stringent environment for them or is this something that you think that they can manage in the long run.
It is something that they will have to manage in the wrong run. I'm not sure it really changes the trajectory of the bank, and I think these banks probably would welcome some of these enhance their regulatory standards given the fact that everything that we've been through.
One thing I would want to would want.
To ask, is everybody is talking about higher debt increases in the capital structure for these banks or making the capital ratio is a bit more conservative by taking out the unrealized losses and the available for sales securities book.
But really the issue with SBB was the liquidity and the liquidity of the balance sheet and the pace of deposits that really left the bank in such a ferocious fashion that I don't think anybody would have expected that, and I'm not sure if that scenario would have played out in any other regional or even larger bank that
that bank would still survive to this day. So I think the crux of the issue is the regulators need to focus on the liquidity and maybe change the way they look at liquidity based on the amount of uninsured deposits meeting chunkier commercial deposits that sit on banks balance sheets and really better understand the behavior of those deposits when we get the positive flight scenario that felled SVB.
So I'm going to put you on the spot a little bit. So again, we're recording this on March thirtieth, and anytime now in the next day or so, we're anticipating President Biden is going to put out a executive
order directing regulators to do tougher regulations. Now, I'm going to make you president of the United States, and I'm going to limit that, right, Yeah, I'm going to you know, So, I'm going to say that you have the ability to write this executive order and tell the FED and the OCC and the FDIIC what to do.
What would you want them to do? I would focus more on the liquidity side.
We need to buff up the liquid coverage ratio, I think, and maybe have it in place for these banks that are fifty or one hundred billion dollars and above, and really tweak some of the assumptions within the LCR.
Right now, one of the.
Main components of the if we get on the beads weeds, one of the main components of the LCR is operational deposits versus non operational deposits. We probably need to factor in ensured deposits versus uninsured deposits as well, to really delineate the fact that these uninsured deposits cannot really be counted in times of stress and in times of need.
So you bring up deposits, and that's a perfect segue
for my next question. You know, there's currently the cap in especially if we have any non US listeners listening at the moment, you know, the cap for deposit insurance is two hundred and fifty thousand dollars per individual, and there's been a lot of talk about floating that up to one million or five million, but you know, just again in looking at SVB, it wasn't really the I mean, there were several firms there that had I think the FDIC chairman at one point even said that like something
like nineteen billion dollars worth of deposits were in the top ten accounts.
You know, is there a.
Is there a solution that Congress can do, because you know, changing FDIC insurance is a is a congressional matter, changing the assessment is an FDIC matter, But the actual is there a solution that Congress can come up with that would actually help a situation like SVB that doesn't just also inherently cover all the unsecured deposits across the across the country.
Yeah, that's really a good question.
I think that increasing the insurance limit the threshold maybe a way to calm fears.
But as you mentioned before, these are.
Very large deposits of multi million dollars deposits in certain accounts, and I don't think that increasing it to a million dollars really makes a big difference. I think the upshot is that banks really need to be more conservative with the way they manage the balance sheet, way they manage interest rate risks, everything. You don't want to give the
positors a reason to leave the bank. So all of this suggests to us that banks will be much more conservative with the way they manage their investment securities portfolio. They'll probably hedge their assets both on the loans and security sides a bit more to really protect themselves against
interest rate movements, and increase capital, increase liquidity standards. All of those things should create a more conservative bank and a more conservative banking system, so the powers would have less reason to leave to join a competitor.
And my last question before I turn it back to Elliott, you know the failure of Silicon Valley Bank is going to cost the FDIC insurance fund the diff if you will, twenty billion, and I saw that signature was around two point five billion, and that's got to be made up by the banks. So obviously the FDIC said that they're
going to put out a new assessment for this. You know, if the United States were to move forward and change deposit insurance, is it the big banks that are going to be paying the most for this just because they have the higher deposits or can we see this in your view across the bloard.
Yeah, it seems to me based on the commentary from the hearings that were in.
The past a couple of days, is that the.
Head of the fd I see seemed to suggest that that would be a bit more nuanced in terms of how they pushed the assessment to the industry. The fact that some of these community banks that have no connection to SBB or signature and don't operate in the same geography as don't operate in the same customer set, could
be relieved of a higher assessments. So the typical community bank is below ten billion in assets, so anything above that, probably the rest of the industry collectively would need to pay into recall that the diff is already below what they want in terms of the coverage. So there was already a two basis points increase in the assessment for twenty twenty three, and that's only going to go higher with a special assessment to really replenish the insurance fund.
So I have a question maybe for the two of you and Hermon, maybe you go first and and you chime in, but you know, you were just talking about the congressional hearings. I just wanted to get both your views on, you know, what you thought of them? Was it? You know, it felt like it was more policy actually than politics, although there was some politics, as they always is.
Yeah, a little bit of both.
We did see some humility from the regulators, specifically a Michael Barr, the head of the the FED in terms of regulating the banks. He says they're having.
An assessment in terms of what went wrong, and.
It seems like there is some blame to the regulators and the FED regulators themselves.
And then policy wise, there was talk about what.
Comes next in next steps, and the regulators had talked about May first with a report that will lay out their findings and recommendations. So things seem to be moving fairly quickly on that front. So we're really looking forward to what the policy makers think about what needs to happen next. And maybe Nathan, you can chime in in terms of what you expect.
Yeah, you know, you've seen a million of these, so they're very curious to hear your thoughts.
Yeah, and I watched all five hour or five hours and three minutes of the House Financial Services Committee. I mean these were working hearings. These were not political hearings. I mean, obviously there were you know, like Herman mentioned parts of political theater in there, but I think this also talks about the strength of the relationship between the chairman and ranking member of both the Senate Banking and the House Financial Services Committee, because this is a situation where it's easy.
To blame things and there is no one thing.
You know, you can either blame regulations, you can blame regulators, you can BLAMESVB. And with that touch of humility that came from the FED and the fdi C and so forth like that, there was more of a seriousness to
this issue. So, you know, I still don't think there's going to be a congressional solution to this, because I think the FED is going to use its own authority to move forward, and I think that may first report is going to just show about how the FED is going to do it, but certainly a lot less controversy in these hearings that I had originally thought there would be.
What do you think we're going to call this crisis like in five years right? I mean the AWAIT crisis with all the GFC now the Great Financial Crisis or global financial crisis. We had the SNL crisis in the early nineties. I guess, what is this the regional bank crisis?
Herman? Any thoughts?
Yeah, I think I think regional bank crisis. It's not super catchy, but it really gets to the crux of the matter than any thoughts.
You know. I was just thinking, I was trying to think of something fun. I saw somebody on Twitter say, you know, this was going to be the big hangover weekend, you know, just just because it all took place over over one weekend. But you know, I think the regional bank or you know, maybe the cify something, but it's going to be a blurb, you know, I think, is you.
Know in Herman correct me if you're wrong.
But it does feel like from the investor community that the contagion has been stopped for now, and I certainly have seen the White House starting to make statements about how they feel like contagent is stopped. So maybe this was just a blurb and not something much bigger. I mean, especially when it comes to like First Republic.
I was just gonna ask, you know, you're saying the contagion has stopped, but there's new there. You know, there have been concerns that there may be like a sort of a second wave of bank where I'm sort of more slow moving as people moved their money out of you know, the Positi accounts that are earning like nothing into money market funds or something else.
Does that wear you at all?
It worries me more as an earnings issue than a solvency issue or an ex extension issue. Banks will manage through it. With deposits continuing to decline. We've already seen deposits sort of drop last year in twenty twenty two, and this is a.
Continuation of that.
Given the fact that rates are much higher than they were, banks really are counting on some of the inertia from there from their depositors, and if the positive flight continues into money market funds, really what the banks will need to do is increase their deposit costs to entice these folks to remain at their banks. So it's and that also means that banks will need to increase their their lending rates to across their products set mortgages, credit cards,
commercial loans, commercial real estate loans. So that's going to affect the consumer, and that's going to affect businesses. So it's it will potentially lead to a slower economic growth scenario, which is something that we're really interested in monitoring and hearing more about. With earnings for the regionals a couple of weeks away, Yeah, that would.
Definitely be Earning season coming up is going to be really interesting. That's just for the regionals, but for so many different sectors, I think. All right, So, as we always do in our Votes and Verdicts podcast, we'd like to end with a couple you know, more fun type questions. That's about the substance of what we've been talking about. So Herman, you're no different. You get to answer these
as well. Great, So, okay, if you were expanded on a desert island, what three albums or you know, pieces of music or bands would you want to have with you.
Wow, that's interesting.
I guess if I would pick three, I would try to pick from different genres to spice it up, because if you're stuck in the desert potentially for a long time, you don't want to be listening to the same thing all the time. So I guess one would be something near and dear to my adolescence, never mind from Nirvana, so good.
Second maybe an R and B type album.
So mis Education of Lauren Hill is another one that's a classic in my view, and I still listen to this day and it's still relevant, So that's something. And I guess I'm not afraid to admit that I'm a bit of a swift feet, so I will say Taylor Swift's Red album Taylor's Version would be my third.
Were you able to get concert tickets under five of that.
I was hoping to surprise my wife with them, but alast no luck.
Well, Herman, I can offer that Lauren Hill is playing at Wolf Trapped in the Washington, DC area this summer, so if we can invite you down to Washington to work out of the DC Bureau.
Maybe we can go check that out. Make it happen.
So just one other fun question from my side is if you can invite any three individuals to dinner, you know, who would you do it and why would you pick me?
Wow?
Well, I've got.
Nathan, I've got Elliott and my wife.
So we make it happen.
We'll make it a bit of a dinner date in DC and then we'll go check out Lauren Hill.
That sounds like a good dinner where we're going to go to Botlet All right, I think we'll leave it there. Thank you for listening to this most recent episode of Boats and Verdicts. We're extremely grateful to Herman for taking time out of his day to appear on this episode and to really enlighten us with everything that's been going on.
Thank you to the listener for taking time to listen to this as well as a reminder you can read all of our Bloomberg intelligence research on the Bloomberg terminal at Big And with that, thank you again and have a great day.