FDIC Enforcement Action Against Cross River Bank
In early February, I wrote about Affirm’s disclosure that it had “made the strategic decision to begin reducing the volume of loans originated by Cross River Bank.”
I am still not certain why Affirm made the decision it did or whether this had anything to with it, but according to a list of March enforcement actions released by the FDIC on Friday, Cross River Bank and the FDIC in early March 2023 entered into a 34 page consent order.
The consent order relates to what the FDIC has determined, and which Cross River neither admits nor denies, were “unsafe or unsound banking practices related to [Cross River’s] compliance with applicable fair lending laws and regulations by failing to establish and maintain internal controls, information systems, and prudent credit underwriting practices.”
The consent order requires various undertakings. For example, the bank must engage an independent third-party to conduct a study of fair lending resources and then produce a written report. This third-party review and report must consider or include, among other things:
the bank’s size and growth plans;
the current and anticipated number of Cross River Bank credit products and their respective volumes;
the current and anticipated number of third parties offering Cross River Bank credit products;
“the volume of decisions made by the bank or on behalf of the bank by a Third Party in connection with an Application, including credit underwriting practices, a CRB Credit Transaction and/or any decisions made in connection with marketing of a CRB Credit Product, including the terms and conditions described in the marketing of a CRB Credit Product”;
Cross River Bank’s use of non-staff resources, including software, automated systems, and/or other technology;
a review and analysis of non-staff resources, management, and other staffing necessary to ensure compliance with applicable fair lending laws and regulations for all CRB Credit Products offered, and CRB Credit Transactions;
the fair lending weaknesses and deficiencies identified in a 2021 report of examination.
After the report is submitted and receives a non-objection from the FDIC, Cross River Bank must develop a “written plan of action” to address the recommendations included in the report. Cross River must also develop or improve fair lending policies and procedures, fair lending training, and various other internal controls.
This is all significant enough on its own, but the biggest near-term impact for Cross River may be driven by Article 2 of the consent order.
Article 2 first requires the bank, within 15 days of the effective date of the order, to identify (1) each product through which credit was being offered by Cross River Bank and (2) any entity other than Cross River Bank offering a Cross River Bank credit product (i.e., third-party partnerships for the offering of such products).
Next, Article 2 requires the bank, within 30 days from the effective date of the order, to submit a list of all such credit products and third parties to the FDIC for its review.
Given the March 8 date of the order, presumably both of these requirements have now been completed.
But the point of putting together this list was that, again per Article 2 of the consent order, for any credit product not included on the list, or for any third party not included on the list, Cross River Bank must obtain FDIC non-objection before it may offer any new credit product, enter into a binding agreement with any new third party offering a Cross River Bank credit product, or allow a new third party to offer a credit product through or in conjunction with Cross River Bank.
A Bloomberg article yesterday reports that Cross River Bank believes these restrictions on launching new credit products or bringing on new partners for credit products will not materially restrict its growth:
Cross River expects the order will have no “meaningful impact” on growth, a spokesperson said in an emailed statement. “Many of the enhancements” required under the order “have been completed or will be completed in the coming months.”
Cross River Bank is privately held, but in a Q1 letter published by the bank a day or two before the enforcement action became public the bank’s founder and CEO wrote that, though he expects regulatory scrutiny to continue, he believes Cross River will be an industry leader in compliance.
Regulatory scrutiny on banks in general is increasing and the events with SVB will only expand those efforts with a specific focus on banks that support fintech. Cross River is the largest of these banking institutions and as such, we have regulatory examiners reviewing some elements of our business on a continuous basis. We view our compliance capability as a strategic advantage and are proud to lead our industry in maintaining the highest levels of compliance, transparency, and responsibility.
The New York Regional Office
One thing about the order that I typically would have skipped over without further thought is that the FDIC regional office responsible for supervising Cross River Bank, and the regional office that will be responsible for evaluating Cross River’s remediation work and any requests for non-objection, is the New York Regional Office.
In other words, this consent order will be overseen by the same regional office that the FDIC yesterday reported was badly under-resourced and understaffed, and that “could have been more forward-looking and forceful in its supervision.”
To be sure, Signature Bank was a much bigger bank that Cross River Bank, and to the extent that yesterday’s report was focused on large financial institution supervision, perhaps the NYRO is in a better place with respect to banks the size of Cross River.
But in light of the discussion in yesterday's report about the timeliness (or lack thereof) of examination work products, a paragraph in this WSJ article stood out to me as possibly hinting that there may be similar issues in play here:1
"This order is the result of a standard review pertaining to certain aspects of our lending processes conducted two years ago," the spokesperson said in a statement. Cross River has already made investment in technology and personnel to improve its compliance programs, the spokesperson added.
Silvergate Bank Files One of Its Last Call Reports
On March 8, Silvergate Capital Corporation announced that it intended to wind down operations and voluntarily liquidate its bank subsidiary, Silvergate Bank. That liquidation continues to proceed, but because Silvergate Bank still exists for now, it like all other banks must file a quarterly call report.
The bank did so late yesterday. In a note accompanying the call report, Silvergate explains:
On March 8th, 2023, Silvergate Capital Corporation, the bank's holding company, announced its intent to wind down operations and voluntarily liquidate its wholly-owned subsidiary Silvergate Bank. Based on U.S. GAAP guidance, the bank has adopted the liquidation basis of accounting for the March close. The transition from a going concern basis of accounting to a liquidation basis of accounting has resulted in the recognition of $8.6 million of net interest income, $10.9 million of additional impairments of securities, and $69.8 million of non-interest expenses. This has resulted in a reduction in equity of $72.1 million. On a going concern basis, the bank's tier 1 leverage capital ratio would have been 4.76.
For that and other reasons, the following numbers should not be taken too seriously or as anything more than a curiosity, but if you are indeed curious, here are some notable line items from the call report that give a sense as to how the liquidation is proceeding.2
Total assets of $1.89 billion, down from $11.35 billion at 12/31/22.
Total deposits of $1.5 billion, down from $6.34 billion at 12/31/22.
Nearly all of these remaining deposits, $1.43 billion, are brokered deposits.
First quarter net income of negative $537.9 million, driven in part by a realized loss of $269.9 million on AFS securities and a $115.7 million loss on the sale of other assets.
Other notable items contributing to the loss included $37.7 million in legal fees and expenses, as well as $8.3 million in consulting and advisory expenses.
A CET 1 risk-based capital ratio of 99.02% and a total risk-based capital ratio of 99.18%. (congratulations)
A Tier 1 leverage ratio of 3.63%.3
This is below the 4% regulatory minimum requirement, but I have to confess I am not sure what happens (if anything) when this occurs at a bank that is in the process of liquidation.
ECB Macroprudential Bulletin endorsing a positive neutral rate for the CCyB
Finally, just quickly, I thought this publication by the European Central Bank this week was interesting for its conclusion that a positive neutral rate for the CCyB —that is, setting the CCyB above zero in “normal” times — is necessary “to enhance the effectiveness of the current macroprudential framework.”
This article discusses the possible implementation of a positive neutral rate for the countercyclical capital buffer (CCyB) as a means of increasing macroprudential policy space in the European banking union. Drawing on experience from the coronavirus (COVID-19) pandemic, it explains why a positive neutral rate is needed to enhance the effectiveness of the current macroprudential framework. It also describes recent progress on the application of this tool around the globe and concludes with some remarks on the calibration and potential future application of the tool in the banking union.
This is not currently the approach taken in the United States, but the idea has been floated by various U.S. policymakers,4 and we’ll see if Vice Chair for Supervision Barr’s holistic review of capital requirements heads in that direction.
Thanks for reading! Thoughts, challenges, criticisms are always welcome at bankregblog@gmail.com.
The Bloomberg article linked above refers to what I am assuming is the same statement from the spokesperson.
The order was a result of a “standard review” related to lending conducted in 2021, and was unrelated to the crypto or payments businesses, a spokesperson said.
This all is consistent with the consent order’s references to a 2021 ROE.
Silvergate Capital Corporation is still a public company, but it has been late in filing its 10-K for 2022 and has also not released anything in the way of Q1 results, so the call report is really all we have for now.
But see the quote above re: liquidation basis of accounting and how the going-concern ratio would have been higher for what that is worth.
For example, former Vice Chair for Supervision Quarles has spoken favorably of a variant of this approach.
[S]ystems similar to the United Kingdom's, where the CCyB is positive during normal times, may allow policymakers to react more quickly to economic, financial, or even geopolitical shocks that occur amid otherwise normal conditions, without relying on the slow-moving credit aggregates contemplated in the original Basel proposal. Moreover, this setting of the CCyB permits more gradual adjustments in the CCyB, especially in periods with a high degree of uncertainty about the level of financial vulnerabilities. Another possible benefit of a system that has additional flexibility is the ability to coordinate the setting of the CCyB with the setting of monetary policy in situations where such coordination is valuable.
Current Under Secretary for Domestic Finance Nellie Liang has also said that a positive neutral rate could be an improvement compared to the existing U.S. approach:
Based on this evidence, some changes could be considered to improve the use of the CcyB and offset an apparent reluctance by banks to use buffers to support lending. There could be better communication to banks about the goals of the CcyB and the simplicity of using it, and seek to assuage banks’ concerns about possible negative reactions from supervisors. In addition, authorities may be slow to activate the CcyB because of uncertainty about when financial stability risks are sufficiently elevated – until imminent and obvious. The UK (and some other countries) set a positive CcyB as the default in normal times, perhaps offset by other regulatory adjustments, to ensure a usable buffer when risks are realized.