April 7, 2023

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- When the issues with Silicon Valley Bank emerged a couple of weeks ago, it instilled depositor and investor fear in banks for sure, but maybe the broader primal response was more like PTSD from 2008 to 2009.

I'm Chris William, and welcome again to the most widely watched and longest-running program on Carolina business policy and public affairs, seen every week across North and South Carolina.

We are going to unpack banking and financial services.

It's pretty important in the Carolinas, and we have insiders to wade in on it with us.

And we start right now.

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On this edition of Carolina Business Review, James Sills from M&F Bank, Peter Gwaltney of the North Carolina Banker's Association, Fred L. Green III, from the South Carolina Banker's Association, and Dr. Robert Hartwig of the Risk and Uncertainty Management Center, University of South Carolina.

(upbeat music) - And welcome back to our program, gentlemen.

Bob, welcome for the first time, hope you have a good experience.

But let's get into it.

Jim Sills, you are a sitting CEO at a bank.

Jim, would you describe what happened with not just SVB, but just everything since then as a banking crisis?

- Chris, I don't consider this a banking crisis.

Yes, there were a lot of headlines and a lot of media attention on the financial services industry, but it was really contained to two or three or a handful of banks.

And then it spread a little bit to some of the regional banks that were fairly large.

But generally speaking, the banking market is safe and sound.

Community banks are strong.

Medium-size banks are very strong.

So I think, in my view, it's not a banking crisis.

We did receive a lot of inquiries the first couple of days, but since then, everything has been very stable for most institutions all across North Carolina.

- Yeah, Dr. Hartwig, you've got... You're an expert in risk assessment management, maybe?

Certainly at USC and beyond, but I mean, how do you unpack this idea of what happened?

Is this a banking crisis or is this bank, some banks in crisis?

- Well, I agree with Jim here, but I kind of see this as a failure of risk management.

I mean, if you look at how SVB was managing its assets versus its liabilities, this was an accident waiting to happen.

And the rapidly rising interest rates we've seen over the past year were sort of the catalyst that ignited this.

But even then, I mean, SVB really should have seen the problems that were emerging on its balance sheet, should have essentially purchased very basic sort of derivative structures and instruments in order to manage this.

Most other banks in the United States did successfully manage this.

I work in the insurance world primarily and insurers seem to manage this as well.

So again, I agree with Jim that this was a problem with several banks.

And that I believe it was isolated, more or less, to those banks.

And that the contagion effect was relatively limited here, in part because of the actions of the federal government.

I think that those were important.

That's probably something that we'll get into.

But the good news here, and what I've been saying is that this is not a repeat of the financial crisis in 2008, right?

This was not a Lehman moment.

This was not a Bear Stearns moment.

And fortunately, and I think the markets have been bought into the narrative already, that this was an isolated issue.

- Peter, Fred, so is this a crisis in confidence, maybe the way that banks are set up about lending out money, about taking deposits, et cetera, et cetera?

Either one of you.

- Peter, let me jump in first, because these three banks, and if you go back to Silver Gate, which was a smaller one that started it all, they had very, very unique business models, unlike every other bank in the country.

So what they had was a very small number of very large depositors.

Every other bank in the country is based on small depositors, small... A large group of small customers.

And so they have diversity, where these banks had virtually no diversity.

The other thing that was unique about SVB is it happened pretty much overnight, through the, I guess, technology, through the ability to move money on a keystroke on your phone is exacerbated by a social media post, "Take your money out."

And basically they were gone in less than 24 hours.

- Yeah, Fred, great explanation.

And Chris, great question.

Confidence is everything in banking.

Banking is built on confidence that a business or a consumer can put their money in the bank and they'll be able to get it back.

And what the regulatory agencies did, and you referenced this earlier, the actions of the regulatory agencies on that Sunday evening, to guarantee all deposits of the two banks that failed, SVB and Signature, calmed the markets.

It steadied things so when banks opened that Monday morning, customers were nervous but there wasn't a widespread crisis.

There wasn't a widespread run.

And that was critical that they did that.

- So for anyone on this panel, is there an appropriate, is there a proportional response by the Fed and the regulators to this?

- And by proportional response, what do you mean?

- Well, so Senate hearings, of course.

And we always see that when there's a perceived crisis, Congress gets involved.

But maybe we'll start with the dialogue around insurance.

Is the FDIC enough insurance, at least on the general bank side for depositors?

Does there need to be more oversight?

Let me say this, and not to exacerbate and make this question even longer, but an insider said to me last week, "We don't need more regulation, we need to enforce what's already on the books."

So again, has there been a... Is there a good response from regulators?

Will this have a good outcome?

- Hey Chris, let me try to attack that problem, that question.

I think the regulators need to examine SVB very closely to prevent that type of risky business model and the after effects of it happening again.

Versus just widespread new regulation that impacts all banks.

Most banks are extremely strong, have strong capital positions.

So I think it's important to just to examine SVB and the other failures, just to make sure that it doesn't happen again.

- I agree with Jim.

The regulatory agencies had plenty of authority to supervise SVB and Signature Bank.

And so there are a lot of questions about how management failed at the bank to manage risk, how regulatory oversight missed things.

And we had a flash failure of two banks that we weren't talking about the week before.

And so there will be a lot of questions.

And we're very fortunate in North Carolina, we have Patrick McHenry chairing the House Financial Services Committee.

Senator Tillis is on the Senate Banking Committee, and Tim Scott, Senator Scott from South Carolina, is the ranking member of the Senate Banking Committee.

They're asking a lot of questions of the regulatory agencies.

How did this happen?

What did the regulatory agencies miss?

How did the bank mismanage risk so terribly?

And how can we avoid this again?

What changes need to be made or what changes don't need to be made?

These are all very important questions.

And the right people are asking all the right questions.

- And Fred, I wanna get to you in a second, Fred, on smaller banks in South Carolina particularly.

But before we do that, Bob, I wanna go to you on this idea that there's a lot of talk that supervision on the Fed side missed and it was a big miss, et cetera, et cetera, and they're unwinding that.

But is there something else that's part of this dialogue?

Again, the question, do we need to enforce what's on the books or does there need to be another idea about what additional regulatory oversight needs to be considered?

- Right, so kind of lost in the whole SVB debate, and there was it a lot of finger pointing in the immediate aftermath of this, was it the failure of management in SVB?

Was it the lack of appropriate and sufficient oversight on the part of regulators?

Which regulators?

Was it the Federal Reserve?

Was it the FDIC?

Was it Congress?

Whose fault was it?

Who was asleep at the switch there, potentially?

And then even beyond that, we heard a lot of recriminations going beyond not only was SVB potentially asleep at the switch but they were so enamored with being woke, for instance, is one narrative that you hear, that they weren't paying attention to the fundamentals of what it takes to actually run a bank.

And this was in part driven by the fact that they were in Silicon Valley where people are enamored with this kind of a thing and they were blinded by it.

But to get back to your question, and I'm gonna agree with Fred and others here, that we need to examine what happened at Silicon Valley specifically.

Quite frankly, if you look at what happened at Silicon Valley Bank is you had a 21st-century version of what happened in "It's a Wonderful Life."

If you were to bring Jimmy Stewart back here today for that movie, he would recognize, the character he played would recognize exactly what happened, except now that we have Twitter and means of moving cash around very quickly in a digital sense.

It was a classic run on a bank.

Why in the year 2023, given everything we know from the experience, not just from the financial crisis of 2008, but going all the way back to the Great Depression?

We've done a lot to try to prevent those kinds of things.

And the FDIC was one great innovation to help prevent those bank runs from occurring.

So to me, that suggests that the general framework of regulation has actually functioned relatively well.

If you look at...

It was actually 867 days from the date that Signature Valley went down the drain.

I'm sorry Signature.

(laughs) Conflating two different banks here.

Silicon Valley went down the drain to the most recent bank failure before that.

That was the longest interval between bank failures since the 1930s, so basically 90 years ago.

So something is largely going right, in terms of preventing these kind of classic bank runs.

And so what that means is likely an idiosyncratic issue at Silicon Valley.

What went wrong?

We need to figure that out.

And if there needs to be some tweaking of existing regulation, that's what should happen.

- So Fred, let me come to you, and notwithstanding Bedford Falls would hold hearings on whether the Bailey Loan and Trust is gonna be...

If they're gonna bail them out or not.

But that does bring up the idea of smaller banks.

Fred, what's the implication for all of the dialogue now that are going on for Carolina Banks?

'Cause we have a lot of small banks in North and South Carolina, the community banks.

You know they're at the center of a lot of these communities.

So what happens with them going forward?

- So probably just like Peter did, and our colleagues from around the country, that Monday morning after the two banks failed, I created a conference call.

We had over 500 bankers throughout the state.

Part of that was for us to keep our fingers on the pulse, know what was happening within the banking industry in the South Carolina, talk about the uniqueness of the two bank failures, that we don't have a model that even approaches that.

And to suggest any media contact, pretty much promote that, which we did.

And as a result, we had zero negative media coverage on the South Carolina banking industry.

Meaning that there was no story there, or if there was a story, it was a positive story that the banks in South Carolina are healthy, they're not having runs on deposits, they're well capitalized and pretty good earnings, given the environment we're in.

- Peter, what are you seeing?

Same thing.

- Well, the same experience.

And as I made calls around the state doing house calls with all of our banks by phone, they were just telling me it was business as usual.

An occasional phone call from a concerned customer.

Because if the customers were sitting at home watching any of the business news channels, they would get tied into a pretzel.

It was very concerning and it was being couched as a crisis.

But really, in the banks, there was a net inflow of deposits was the report that I was getting.

- And if I could just add to that, I mean, and what nobody expected to see in the immediate aftermath of Silicon Valley, that was in fact that it would be a North Carolina bank that would actually wind up acquiring most of Silicon Valley's operations.

And so I think that really says something for the state of the banking industry in the Carolinas.

That of anywhere in the country, the bank that wound up assuming the operations of Silicon Valley was based in Raleigh, North Carolina.

- Good point, Bob.

And Peter, I'm gonna bring you back in on your observation around the First Citizen's acquisition of those assets from Silicon Valley Bank.

Before we do that, though, Jim, I wanna...

Same question for you.

What are the implications now forward for smaller banks?

And there were many reports that the funds moved from smaller, mid-size banks to large banks out of just an abundance of caution.

Have you seen that?

- Yeah, we have not experienced that at M&F Bank.

We did receive phone calls, but all of our deposits are really...

It's the same inflows and outflows that we've maintained for months.

But the long-term implications is always gonna be that big versus small.

But we're relationship bankers.

Our business model is a safe and sound model.

We're well capitalized.

And community banks specifically provides 60% of all the small business loans in the United States.

So we're an important clog in the wheel, so to speak, for our financial services industry.

And I think community banking is still gonna be strong.

I just don't want more regulation 'cause we have so much of it now.

- Peter, what's your observation about First Citizen's quick move to acquire the bank, and in fact got the approval and the thumbs-up from the Fed to do it?

- I was pleased to see that they were successful in their bid to acquire SVB assets and loans and deposits, and the bank in general.

The bank has a long history of these FDIC-assisted transactions through the banking crisis.

(Chris murmuring) For citizens, yes.

Through the banking crisis of 2008, they purchased a number of failed banks around the country and developed a practice around that.

And they're very disciplined, very conservative, highly capitalized.

And they have a team who understand how to do this.

And so I knew that if they were successful in their bid, it would be because they have a good relationship with the FDIC.

The FDIC has confidence in their ability to execute on this.

And it's good for the venture capital world and the startup world.

They're not just all in California.

We have them here in the Carolinas, specifically here in Charlotte and Raleigh and across North Carolina.

And in Atlanta.

It's important to have a thriving venture capital marketplace and startup marketplace.

And so now, First Citizens, as we see it, will be bringing a different kind of discipline, a different kind of banking approach to that sector.

And that's important to the health of our nation.

- Sorry to interrupt you.

For anyone here, are there other opportunities here, not just First Citizens seeing the opportunity to strategically acquire the assets of what was Silicon Valley Bank, but are there other opportunities?

Are we missing something because of some PTSD that we have?

Anyone?

- I don't know of any specific opportunities, but maybe on an earlier comment, there were, in a number of our banks, deposits that came in from SVB.

And it was unusual to find folks in Charleston, South Carolina that add a very large deposit account there.

So I think that might be the opportunity.

Let's do banking business with folks that you know and the communities you're in.

- Yeah, and as an economist, I'll say this.

If you look at the demographics of the Southeast and the Carolinas in particular, they are very, very favorable to the banking community, in the sense that the demand for credit, the inflow of deposits from around the country.

As people move to this part of the country, they form businesses, they grow businesses.

If you look at the corridor in South Carolina, up towards the Greenville, Spartanburg area, down towards the Charleston area, with the enormous investments that are being made in infrastructure, and again, companies from literally around the world investing in these areas.

And I'm sure it's the same in North Carolina.

I mean, I think it's a great place to be in the banking community.

And there's a lot of opportunities for organic growth, in addition to potentially some additional acquisitions along the lines of what we saw in First Citizens.

Not necessarily occurring sort of in an overnight type of emergency context.

What kinda organic kinds of growth where there are economies of scale and scope that regional banks in this region could realize?

- Jim, let me bring in again, as the CEO of a bank, a couple of things that came out of the observations around SVB and some of the other banks that got in trouble the last couple of weeks, few weeks, has been the idea of loans and lending.

And the assets that they held, obviously treasuries that had gone down in their market value, but also loans.

And as rates rise, the loan that you made that you booked now has a lower value.

So give us an idea that you see loans that you booked as of the end of last year have lost some value, but also the possibility as we maybe head into a recession, most likely some kind of slowdown, that there may be some more non-performing loans.

What are you keeping your eye on in that area?

- We're always looking at asset quality.

We have excellent asset quality at our institution.

But as interest rates increase, it does make it more difficult for the borrower to keep up with the payments if the payments are variable, if they're increasing with the increase in prime.

And so we are looking at that very closely.

We also stress test our loan portfolio from time to time.

But generally speaking, as the economy slows, there will be less loan demand.

But I think the other thing that we need to also consider, interest rates on deposits are actually rising very, very rapidly.

So when you see both of those things occurring at the same time, it will slow up banks from providing access to capital because they're paying so much for the deposit and there's only so much that they can make on the loan that they have to really make a a very good credit decision to make sure that that loan does not come back to haunt them.

- So do you see a difference between what you just described in this cycle versus past cycles with interest rates rising and slowdowns?

- When the interest rates were a lot lower, it was a lot easier to actually approve the credit.

When they're higher, you actually have to stress test the borrower to see can he make the payments in the event rates continue to rise?

Especially if the small business loan is tied to prime.

- Peter, thoughts?

- And I think all of this is very intentional.

From a monetary policy at the Federal Reserve, they wanted to see a tightening of the economy.

They want to bring inflation down.

And so what we're seeing happening in the banking industry, it's not that banks are changing their lending practices or policies, it's that interest rates are increasing.

Some new deals don't cash flow and existing borrowers are kind of tightening their belts and watching for the future.

So all of this is very intentional, from the Fed's perspective.

- Fred, from your colleagues and your association members, do you see a concern around the commercial real estate asset and the lending on that?

- I would've thought that we would've seen that long before now.

And in continuing to talk to our bankers, they still haven't seen any significant risk bubbling up out of that.

Kind of I will tag on a little bit to what Peter and Jim said, the rate and the magnitude of the Fed increases created, will create, I do think, a slowdown in the economy.

And that's what we're talking about.

I think it was an all time historic rate and magnitude of Fed increases.

- Yeah, and I would say that if there is an achilles heel here, it would be in commercial real estate lending.

If you look at what's happening to pricing of commercial mortgage backed securities, for instance, they are trading at pretty steep discounts relative to say triple B corporate bonds.

And the margin above treasuries is very, very high.

So that suggests that at least the markets are very concerned about that segment.

So to the extent that certain banks potentially have exposure or other institutional investors, which may not be banks, exposure to that particular sector, I think that's one area to keep an eye on.

- So Bob, in just about 30 seconds here for you, is that the securitization of the corporate bond- - That's, yes.

That's the securitized instrument that comprised of a portfolio of commercial mortgages and so that trade out in the marketplace.

- So we've got a couple minutes left.

And I do wanna at least float the idea of shadow banking.

So for anyone, Jim, let me start with you.

Does shadow banking again come back into the dialogue?

And for the benefit of viewers, shadow banking would be PayPal, Venmo, lenders that aren't regulated.

Is there going to be more scrutiny and more discussion about, well, maybe we need to bring them back, maybe we need to bring them into the fold about having some oversight?

- I think the last thing we need is more oversight of community and regional banks and even large banks.

But specifically to your question, yes, they will be even more regulated and reviewed than they are today because of this entire, I don't want to call it a crisis, but this entire episode.

Yes, I do see that happening more.

I think the one thing that we haven't really touched on is I think we all have to remember SVB had 93% of their deposits were uninsured.

That's a very risky business model.

That's very unusual for any bank in the United States to have a percentage that high.

- Fred, Peter, same question.

Do you expect that there would be more scrutiny now, not on the banking system, but maybe the shadow banking system?

Is that gonna be part of the dialogue?

And we've got about a minute.

- Go ahead, Peter.

- Yeah.

Peter, I'll jump in first.

I do, and if you go back to what I said earlier about the unique business model of SVB and Signature, high concentrations of deposits from a relatively small base.

That's similar to what you have in the shadow banking world.

And their funding probably isn't as robust and as diversified as what you see in a community bank.

- Peter, last 20 seconds.

- Well, and all we ever seek, and bankers are not afraid of competition.

And we've been asking for years, a level playing field.

If you're in financial services, you need the oversight that banks of all kinds have.

And what's interesting about the silver lining, I guess, of this episode is we've been not talked about FDIC insurance for years.

Customers didn't seem to care.

They do now, and they're seeing the value that the banking industry brings because of that confidence they can have.

- Peter, last word, and it's a good one to end on.

Gentlemen, thank you and have a good weekend.

Until next week, good night.

(upbeat music)