Financial R&R: Silicon Valley Bank Collapse - Immediate Takeaways and Next Steps
In light of the recent collapse of Silicon Valley Bank, Ron Borys and Ryan Farnsworth, Alliant Financial Institutions, sit down with Steve Shappell, Alliant Claims & Legal, to examine the implications of the second-largest bank failure in U.S. history. The team explores the actions taken by California banking regulators and the FDIC to mitigate its impact as well as the coverage provided by D&O or E&O policies.
Welcome to Financial R&R, a show dedicated to financial insurance and risk management solutions and trends shaping the market today. Here are your hosts, Ron Borys and Ryan Farnsworth.
Ron Borys (00:14):
Hi, everyone. Welcome to the latest edition of the Financial R&R. I'm Ron Borys. I'm here today with Ryan Farnsworth and Steve Shappell. Certainly, a ton to talk about right now. I was joking with somebody earlier, that It's March Madness; college basketball is usually the thing you think of when you think of March Madness. But unfortunately, the banking industry and certain banks, in particular, have taken and stolen the show this March. A very interesting last week or so with SVB being taken over and put into receivership by the FDIC. This is the first time a bank of this size has been put into FDIC receivership in quite some time. And Ryan and I and Steve thought it would be important to just get out there and try to start sharing some information because certainly we've been requested and approached by clients, by underwriters, by all sorts of folks, given our presence in the banking space. There are a lot of things to consider during this time when it comes to insurance, and who better to join me in a session like this than Ryan and Steve, so thanks for jumping on such short notice.
Steve Shappell (01:16):
Yeah, pleasure. I look forward to the conversation. There certainly was a lot of panic over the weekend, so I'm glad we can have this conversation and put some of this in context.
Ryan Farnsworth (01:26):
Nothing helps us be at greater ease than hearing Steve Shappell talk to us about people being sued and other claims and legal ramifications of it. We're happy to have you here, Steve.
Ron Borys (01:38):
Let's just start with the questions that have come up recently, which are, especially with when SVB failed, everybody was paranoid about their money, and we know that the federal government has opened the window and provided that backstop and has essentially guaranteed the deposits. And you're hearing a lot of scuttles out there about another round of bank bailouts. I wouldn't necessarily call this a bank bailout. I would call this a depositor bailout. I mean, different than in 2008 where the equity and debt holders really felt the relief of the government stepping in. It doesn't appear that's going to be the case here. So, let's just talk for a second, everybody was asking, "well, what's my coverage?" Most asset management firms, obviously this had a big impact on the private equity and VC industry, especially tech companies, and everybody's questioning, "What protection do I have for the money that I had in these banks?" So, Steve, I guess, a D&O or E&O policy is not necessarily going to help you get your money back, that's for sure.
Steve Shappell (02:35):
Yeah, that's right. So, whatever coverage SVB enjoys from an E&O or D&O perspective, that's third-party liability. And that's going to be a long, tedious process. For depositors, and thankfully the government stepped in to guarantee depositors because otherwise it was a long haul, right? And you're going to stand behind the FDIC and other creditors if that's the path. So thankfully, litigating as a depositor, it doesn't look like it's going to be something that's going to be required. FDIC is going to stand in those shoes and the FDIC is going to be very aggressive about pursuing it. I think you could read between the lines from regulators, including President Biden himself, talking about that the shareholders are not going to incur this loss. I think that's code for FDIC is going to recover this money, and there won't be a bailout, to your point.
Ron Borys (03:29):
So, we all know that in the banking segment and the FDIC insurance - which is not a private insurance - it's an insurance provided by the federal government, covers deposits up to $250,000 in a commercial banking setting. The concern being is that a lot of these tech firms and investment firms had millions, tens of millions, in some cases, hundreds of millions of dollars with SVB. Now, there are products out there that cover excess of what FDIC provides in the form of insurance. They had not been products that had been widely taken up. I would imagine, as a result of this crisis, this product will potentially rejuvenate and revitalize itself. But one of the things that I felt was interesting that people aren't really talking about, especially when it comes to individuals, is that when you think of the banking relationship that people have with some of the really big banks out there, especially high net worth individuals, they're not talking about the broker-dealer side of it, right?
And from what I can see and to my knowledge, SVB did have a broker-dealer arm. A lot of the major banks that serve customers have in many cases, some type of broker-dealer arm. And there's not a lot of discussion around that side of the banking relationship, right? So, the commercial bank is regulated by the Federal Reserve, and FDIC sort of falls within that oversight and purview. For the broker-dealer side, the deposits there are covered and regulated by a completely separate group of regulators. FINRA is the regulator of the broker-dealer industry, and SPIC is sort of the product that is provided by the government to backstop the broker-dealer industry. Most large broker dealers, and these include banks, have purchased a product called Excess SPIC, for many, many years to provide their high-net-worth customers with that protection, that added benefit.
And in many cases, the broker-dealers advertise this Excess SPIC limit. I know some of the largest wealth managers out there buy coverage in excess of a billion dollars, and that's exactly for this type of reason. Now, if you think about the last major crisis that the financial institutions industry had, and I know it feels like unfortunately they happen probably more often than we would like, but looking back at 2008 and the last big financial institution failure, Lehman Brothers, there was tons of litigation that emanated out of that. In that situation, the broker-dealer did also go insolvent with Lehman Brothers, the parent company. But, when you think about it from a SPIC perspective, and again, the protection under SPIC is really more for the theft or mysterious disappearance of securities or money. To my knowledge, there were no claims that came out of that, at least in the Excess SPIC portion of the insurance world. So, when you think about the losses that are going to emanate and Steve and Ryan, I think you both agree, this chapter of the financial institutions world is going to result in losses, and we'll talk about that in a few minutes. But at the end of the day, I just think it's really important that people understand kind of the insurance products that are out there and the protections that they have relative to the money that they're putting with these large institutions.
Ryan Farnsworth (06:36):
Yeah, and we talk all the time, Ron, about how we help our clients find that more rewarding way to manage risk, and risk management failures was really the root cause of why we're having this discussion so quickly after the initial run on the bank on March 9th. Having a robust risk management strategy, kind of keeping with your theme of March Madness, this is like the first half has gone completely haywire; that a college basketball team in this case is losing the game. Things have not gone their way. There's a lot of distress and everyone's now huddled up in the locker room figuring out how to attack the second half, because the interest rate environment is not changing, the risk management environment is not changing. There were some dynamics specific to Silicon Valley Bank that caused its failure, right? The second largest failure in American history.
But there's a lot of issues in the economy that are stressing regional banks, larger national and global banks, and those risk management issues are not going away. So, I'm sure, it's similar to when we're recording this podcast and talking through these issues, our clients are doing the same, and building in insurance products and other effective risk management strategies is critical to having a successful second half, as we churn through the financial distress that everyone's feeling in this economy. Together with the products that you're talking about, revisiting and talking about insurance structures with your board in terms of, do we have the right Side A limit? Do we have the right limit overall? And how are we best mitigating and transferring risk to the insurance companies as we go through the renewal process each and every year?
Ron Borys (08:12):
So, Steve, let's just talk about that for a minute, right? So, you had two banks, in a period of less than a week be taken over by the federal government for all intents and purposes, right? We know that from a D&O insurance perspective and other products, there are what we call "change in control provisions." And sometimes the change in control is anticipated, right? For example, in the past bankruptcy, we know bankruptcy in some cases can trigger a change in control, but when FDIC receivership happens, which again, it doesn't happen all that often, but when it does, it happens quickly, can you kind of just talk us through kind of what people should be thinking about? Because again, once that policy goes into runoff, assuming that some of these executives need to stay in place to work with the FDIC, to either wind down the operations of the bank or otherwise, theoretically, once that policy converts to change in control or runoff, unless they've done something to do otherwise, they have no coverage.
Steve Shappell (09:09):
Yeah. You're spot on, Ron. It's a big deal, and going into liquidation or receivership, is going to trigger this runoff. And what runoff does is basically convert that policy to runoff. So, if you purchase a policy on January 1st and you're going into receivership on January 2nd, that policy will convert to runoff. And so, it's not going to pick up any more wrongful acts for the rest of that policy period. So, for 363 days, all it will do is be available for us to notice claims that come in for acts before that date. And so, it's really important, on an event like this, that you immediately get engaged to get to the market to solve for this, right? Because while the policy will be automatic, there's ways to negotiate a different outcome and to continue coverage. And it's a big deal because while the bank might go into receivership, as Ron was talking about earlier, while broker-dealer relationships and activity and action that is an ongoing part of the business is covered by this policy in a master program, it's also in runoff, unless you take action, that policy's not going to cover ongoing acts, errors and emissions. So, it's a big deal to immediately roll your sleeves up and start talking with underwriters and find a solution. And if it's in runoff and there's nothing you can do about that, there are additional solutions. Go buy in new programs like you would in a traditional runoff situation. Inaction is not the answer, right? It requires some affirmative analysis and action.
Ron Borys (10:46):
Steve, let's talk for a second about side A, because I know oftentimes people, they look over side A and they say, "well, side A is really expensive and it's never going to respond well." Well, now you have a situation where the balance sheets, the assets of these businesses have been absorbed or taken over. We've already heard in the SVB case, the securities class action litigation has already been filed. These folks are going to need to defend themselves and respond to the action. Again, we know in derivative litigation, which is often referred to as Side A type loss or claims, defense expenses are indemnifiable in most cases per Delaware law. But FDIC receiverships is a different story. So, is this going to be an uptick, now? Are banks going to reconsider their approach towards side A, non-indemnified loss insurance? Because this could be a big loss for those directors.
Steve Shappell (11:37):
Absolutely, Ron. We talk about, what are the Side A situations? Why do we buy Side A insurance? It is sleep insurance, right? It is for a very rare fact pattern to come down where the corporation cannot indemnify. But this scenario is a great reminder to every purchaser of insurance to sit and talk with their broker and their advisor as to what type of insurance we buy. A side insurance, while not cheap, is more affordable than ABC insurance and it’s broader coverage than ABC insurance. This is a great time and a reminder to really explore the benefits of buying A side insurance. It is true sleep insurance and here disaster response insurance; when you're in a receivership and the FDIC's going to have some serious issues with directors and officers using the proceeds of the D&O policies to indemnify directors and officers when that can and could be used for satisfying the obligations of the entity. So, it really presents another great example of the importance of A side insurance.
Ryan Farnsworth (12:50):
Yeah, and everyone's asking the question about going through and understanding the question of, do we have more bank failures to come? And how is that going to impact the market? And so having these types of discussions now, I expect this will be a topic of conversation on the Financial R&R for months to come. And we're going to look at it at a variety of different ways. Today we're looking at it more from a bank and a risk management perspective, but it impacted private equity and venture firms, continually now searching for other ways to finance their investments and work with their partners. Because SVB was such a core element of that process for so many years, how does this impact cyber risk and how banks are going to be impacted by cyber hackers that are going to prey upon this situation to try to expose additional vulnerabilities as people are looking for new banking relationships or reviewing their existing ones.
A lot to think about and a lot that as we look at the going forward, this is not going to harden the insurance market as of right now, but it will have absolutely an impact especially for regional banks and banking institutions that perhaps unnecessarily have been caught up in the crosshairs of the news of the last couple days to differentiate to underwriters how their risk is different and how they are managing their risk in this interest environment that is going to continue to persist in the coming months and years. And looking through that process and making sure that you attack those conversations with underwriters, well in advance of the renewal date will be key to success and driving the best possible result.
Ron Borys (14:23):
Yeah, as we know, May, June, July, big bank renewal season, I would imagine underwriters are getting tons of questions internally about their exposures to banks. Many banks’ stocks have had a rollercoaster ride this week. It's great to see that today a lot of them have rebounded and come back, but as you can imagine, there's going to be securities class action litigation brought, whether it's frivolous or not. This is just going to continue to sort of evolve and take on its own sort of shape and form. The Financial R&R is here to provide information, provide perspective, give people something to think about as they're battling these types of challenges and issues. It seems like just yesterday we were going through the challenges associated with COVID and now, to some degree, we are finally past that cycle and now a new cycle is upon us.
So, we're going to wrap it up for now. We appreciate everybody tuning in. As Ryan said, this will be the first of many topics and conversations that we plan on having in the coming days and weeks with regards to this. But we thought it was really important to get out there and start talking about it, trying to clear up some of the misconceptions, some of the panic that is ensuing. The most important thing is reach out to your broker, reach out to your insurance advisor as soon as you can. We realize insurance is not always the front of mind when executives are facing these types of challenges. But we're here, we work hard, we work around the clock, and we want to be helpful in any way that we can. So, with that, we thank you all for tuning in. For those of you who are interested in learning more about Alliant Financial Institutions, feel free to visit our website at www.alliant.com and we look forward to speaking to you again real soon.
Alliant note and disclaimer: This document is designed to provide general information and guidance. Please note that prior to implementation your legal counsel should review all details or policy information. Alliant Insurance Services does not provide legal advice or legal opinions. If a legal opinion is needed, please seek the services of your own legal advisor or ask Alliant Insurance Services for a referral. This document is provided on an “as is” basis without any warranty of any kind. Alliant Insurance Services disclaims any liability for any loss or damage from reliance on this document.
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