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Lessons for CUs as Industry Touts Secure Financial Position

As credit unions assure their members that their financial cooperatives are safe and sound, leaders across the industry are taking stock of the U.S. banking environment after the failure of Silicon Valley Bank last week (now Silicon Valley Bridge Bank)…

‘Credit Union Lessons’ After SVB Fallout
Mike Sacher, former executive vice president and CFO at Xceed Financial FCU (El Segundo, CA), contributed the following piece at CreditUnions.com: “5 Lessons for Credit Unions from Silicon Valley Bank’s Collapse.” As industry leaders carefully consider appropriate risk-mitigation measures, he outlines five issues — and “credit union lessons” for each issue — related to the Silicon Valley Bank (SVB) failure:

  • Regulatory net worth versus an expanded net-worth ratio.
  • Basic asset/liability management (ALM) issues.
  • Deposit retention and growth.
  • Curtailing loan growth.
  • A word about regulators.

Credit Unions vs. Silicon Valley Bank
According to publicly filed data and analysis by the Credit Union National Association (CUNA), the vast majority of credit unions across the United States have much more modest “unrealized losses” within financial market investments compared to banks like Silicon Valley Bank, as reflected in the credit union industry’s equity capital-to-asset ratios (which account for unrealized losses). About 90 percent of the nation’s 4,800 federally-insured credit unions reflect equity capital-to-asset ratios of 6.5 percent or higher (the median is 10.2 percent).

In addition, the overwhelming majority of U.S. credit unions reflect a very high percentage of total deposits that are federally insured by the National Credit Union Share Insurance Fund (NCUSIF), with 90 percent of all federally-insured credit unions reflecting an insured deposit-to-total deposit ratio of about 90 percent or higher. For comparison, the minimum federally insured deposit-to-total deposit ratio across all 4,800 credit unions is 78 percent, which is much different than Silicon Valley Bank’s 5 percent ratio.

Reasons for the failure of Silicon Valley Bank (now Silicon Valley Bridge Bank) include:

  • An extreme percentage of uninsured deposits. Overall, only 5 percent of the bank’s deposits were federally-insured — which means 95 percent were not. Naturally, many of these uninsured depositors pulled funds out of the bank at the first hint of trouble.
  • Extreme concentration within uniquely structured loans overwhelmingly made to venture capital firms that mostly focus on the technology sector.
  • A low and fast-deteriorating liquidity position. The bank’s investment portfolio was highly concentrated in longer-term bonds in the financial markets (albeit conservative investments) that had significant “unrealized losses” arising from the Federal Reserve’s 2022 historic interest rate-hiking plan to keep U.S. inflation in check.

‘Drag’ on Small Bank Lending Going Forward
In “Stress Among Small Banks is Likely to Slow the U.S. Economy,” Goldman Sachs researchers indicate the following:

  • When assessing the economic impact of tighter lending standards, our economists assumed that small banks with a low share of FDIC-covered deposits will reduce new lending by 40 percent and other small banks will reduce new lending by 15 percent.
  • Our economists expect lending standards will tighten more — to a degree that’s greater than during the dot-com crisis, but less than during the financial crisis of 2008 or the height of the COVID-19 pandemic.
  • To the extent the banking stress that started with the resolution of Silicon Valley Bank has an impact in lending, it’s likely to be concentrated in a subset of small- and medium-sized banks. 

How Many Other Banks are ‘Run Prone’?
In “Monetary Tightening and U.S. Bank Fragility in 2023,” run-prone deposits (in aggregate) at banks with above-average uninsured deposits across the U.S. banking system is explored (a working paper published by Social Science Research Network—SSRN):

  • Combined, losses and uninsured leverage provide incentives for an SVB uninsured depositor run. We compute similar incentives for the sample of all U.S. banks. Even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to insured depositors, with potentially $300 billion of insured deposits at risk.
  • If uninsured deposit withdrawals cause even small fire-sales, substantially more banks are at risk. Overall, these calculations suggest that recent declines in bank asset values very significantly increased the fragility of the U.S. banking system to uninsured depositor runs. 

‘Dash for Cash’ Under San Francisco FHLB
In “SVB Collapse Exposes Fed’s Massive Failure to See Bank’s Warning Signs,” researchers spotlight Silicon Valley Bank’s explosive asset growth, hyper reliance on uninsured deposits, and huge interest rate risk. However, they also note the bank’s “dash for cash” was made possible by the Federal Home Loan Bank (FHLB) system:

  • As SVB needed cash, they used the arcane Federal Home Loan Bank (FHLB) system to borrow heavily, becoming the San Francisco FHLB’s top borrower with $20 billion. The FHLB is called the lender of next-to-last resort, and when a bank fails, the FHLB is the only entity that gets paid out ahead of the FDIC. Thus, the more in-debt a bank is to the FHLB, the greater the losses born by the taxpayer if the bank fails. 

A ’Misleading Risk-Weighted Capital Measure’?
In “SVB: The Blame Game Begins,” former Federal Reserve Bank of Kansas City president (and Federal Open Market Committee member) Thomas Hoenig discusses his opinion on the Silicon Valley Bank failure using only public data:

  • Had the regulator not relied on the bank’s misleading risk-weighted capital measure/standard, it might have taken actions sooner. A simple capital-to-assets ratio tells the regulator and public in simple, realistic terms how much a money a bank can lose before becoming insolvent. The regulatory authorities need to stop pretending that their complex and confusing capital models work; they don’t.
  • Also, regulators know that rapidly growing banks are inherently more risky and require more capital to absorb the lending and investing mistakes that come with exceptionally fast growth. In this instance, the regulator should have insisted that such growth be funded with substantially more capital to allow for the risk. 

CUs Have Strong Liquidity, Reserves, & Insured Deposits
In “Credit Unions: Strong and Robust Liquidity, Reserves, & Insured Deposits,” the California and Nevada Credit Union Leagues point out that:

  • California credit unions are among the most well-capitalized financial institutions, maintaining equity reserves and liquid investments that prioritize safety and soundness for their members. They currently have more than $29.9 billion in equity reserves, according to publicly filed data. Combined with $51.4 billion of available liquidity, credit unions in California have the reserves to protect their members and weather shocks to the financial services market. In addition, more than 90 percent of total deposits (approximately $240 billion) at California’s 267 locally headquartered credit unions are insured by the National Credit Union Share Insurance Fund (NCUSIF).
  • Nevada credit unions have more than $815 million in equity reserves. Combined with $1.6 billion of available liquidity, credit unions in Nevada also have the reserves to protect their members and weather shocks to the financial services market. 

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