Silvergate's Use of Brokered Deposits
Plus, more on LevelField
Were (Formerly) Brokered Deposits a Problem at Silvergate?
This week Kyle Campbell at the American Banker had an article examining questions raised by policy advocates about the role brokered deposits, or deposits that would have been considered brokered absent Trump-era changes to the FDIC’s rules, may have played in Silvergate Bank’s liquidity issues last quarter.
One policy advocate described the concern this way:
"What seems to have happened with Silvergate is that a very large portion of its deposits were these formerly brokered, now not brokered, deposits from crypto," Todd Phillips, an independent consultant and former FDIC lawyer, said. "If those crypto firms' deposits were still considered brokered, Silvergate couldn't have as much as it did."
As explained below, based on call reports filed by Silvergate I do not think the data categorically rules out this argument. At the same time, however, there also is no smoking gun like what one would have expected to see if the brokered deposit rule changes a few years ago did indeed drive a significant change in Silvergate’s deposit strategies.
As relevant to this post, I think these are the key dates to keep in mind.
December 2019: the FDIC proposes revisions to its brokered deposits rule.
December 2020: the FDIC adopts a final rule, mostly similar to the proposal.
April 1, 2021: the final rule takes effect. Changes “will be reflected in Call Report Data due June 30, 2021.”
Looking Back at Silvergate’s Deposit Data from 2018 to Present
Intuitively, based on the above dates, you might expect to see a discontinuity in Silvergate’s reporting of brokered deposits before and after the June 30, 2021 call report date. Or, perhaps, you might even expect to start to see some changes beginning with the December 31, 2019 call report - for example, if Silvergate noticed something in the preamble to the proposed rule that affected its understanding of how the old (i.e., then-existing) rules were to be applied.
It is tough to see that in the data.
2018
Q1: $1.7 billion in total deposits, of which $0 are brokered
Q2: $1.6 billion in total deposits, of which $0 are brokered
Q3: $1.96 billion in total deposits, of which $0 are brokered
Q4: $1.8 billion in total deposits, of which $0 are brokered
2019
Q1: $1.6 billion in total deposits, of which $0 are brokered
Q2: $1.95 billion in total deposits, of which $248 million, or 13%, are brokered
Q3: $1.86 billion in total deposits, of which $323 million, or 17%, are brokered
[December 2019 proposed rule]
Q4: $1.8 billion in total deposits, of which $322 million, or 18%, are brokered
In its SEC filings over the course of 2019, Silvergate explained that these deposits were brokered CDs which the bank used to fund a hedging strategy.
In March 2019, we implemented a hedging strategy that includes purchases of interest rate floors and commercial mortgage-backed securities, primarily funded by callable brokered certificates of deposit. The implementation of this hedging strategy positively impacted interest income earned on securities which was partially offset by interest expense incurred on the callable brokered certificates of deposit.
As reflected in the 2020 data below, and as explained in its 10-Q, the company by the second quarter of 2020 had called all the outstanding brokered CDs.
2020
Q1 2020: $2 billion in total deposits, of which $141 million, or 7%, are brokered
Q2: $1.68 billion in total deposits, of which $0 are brokered
Q3: $2.3 billion in total deposits, of which $0 are brokered
Q4: $5.25 billion in total deposits, of which $0 are brokered
2021
Q1: $7 billion in total deposits, of which $0 are brokered
[Final rule takes effect]
Q2: $11.34 billion in total deposits, of which $0 are brokered
Q3: $11.7 billion in total deposits, of which $0 are brokered
Q4: $14.8 billion in total deposits, of which $0 are brokered
2022
Q1: $13.4 billion in total deposits, of which $0 are brokered
Q2: $13.5 billion in total deposits, of which $0 are brokered
Q3: $13.2 billion in total deposits, of which $1.2 billion, or 9%, are brokered
Q4: $6.3 billion in total deposits, of which $2.4 billion, or 38%, are brokered
The company has explained in its Q3 10-Q and in its Q4 earnings release that these brokered deposits are, as in 2019-20, brokered CDs.
Assorted Observations
To me, the biggest smoking gun that would lend support to the idea that the FDIC’s changes freed up Silvergate to take deposits that it previously had avoided would be if there was a sharp discontinuity or inflection point visible when comparing the pre-Q2 2021 brokered deposit numbers to those following that date. I do not see that. It is true that after the rule went into effect, Silvergate reported $0 in brokered deposits. But this is also what it reported in the year prior to the rule taking effect.
Of course, this does not prove that the people quoted in the American Banker article are wrong. As the data shows, Silvergate’s deposits jumped from $7 billion in the quarter before the FDIC’s rule changes became effective to nearly $15 billion shortly thereafter. It is possible that a portion of these new deposits were deposits that, under the old rules, would have been considered brokered.
What I struggle with re: the argument in #2 above, though, is that Silvergate also saw a sharp ramp up in total deposits from under $2 billion to $7 billion in the time period when the old rules were in effect. So, assuming Silvergate properly regarded its deposits as non-brokered during that time, then for the $7 billion to $15 billion ramp up to be evidence of a reliance on crypto-related deposits that previously counted as brokered, you would have to believe that Silvergate’s deposit-gathering strategies changed after April 2021. I cannot rule this out, but I am not aware of anything public from the company evidencing any change in its strategies from before April 2021. As I understand things, the bank had the same business model, the same type of clientele, and received the same types of crypto-related deposits for several years prior to 2021. The only difference in the characteristics of the deposits was their volume, not their nature.
It is also worth being clear about the counterfactual. Both before and after the FDIC’s rule change banks like Silvergate were not banned from taking brokered deposits. Under both the prior and the current rules, so long as a bank is well capitalized, which Silvergate is (but see #6 below), a bank could take brokered deposits without restriction. The only potential consequence is that, depending on the size of the bank and other factors, its FDIC deposit insurance assessments may be more expensive.1 So, in order to make the case that Silvergate post-FDIC rule change relied on deposits on which it would not have relied pre-FDIC rule change, you have to be able to argue that the pre-2021 rules would have deterred Silvergate from doing so. I am not sure that would be the case.2
The one type of brokered deposit that we know for sure Silvergate utilized, brokered CDs, were explicitly addressed in the preamble to the FDIC’s brokered deposits rule changes. But for all the talk, fair or otherwise, about the FDIC recklessly loosening things as part of the 2020 revisions, in this context the FDIC made no changes. Instead, the FDIC cited significant losses that brokered CDs have caused to the deposit insurance fund and affirmed that “without exception,” brokered CDs would remain within the definition of brokered deposits.3
Staying on the topic of brokered CDs, as shown above those deposits made up nearly 40% of Silvergate’s deposit base at the end of Q4 2022. One thing to keep an eye on here is that as of its latest call report Silvergate Bank’s Tier 1 leverage ratio was 5.12%, just 12 basis points above the 5% well-capitalized threshold. This matters because, although well-capitalized banks may accept brokered deposits without restriction, a bank that is not well capitalized may do so only if the FDIC finds that the bank’s acceptance of such deposits “does not constitute an unsafe or unsound practice.”4
Caveat to #6: On its most recent earnings call, Silvergate management argued that the bank's true leverage ratio was not quite so close to the well-capitalized threshold as it looks. Essentially, they remarked that the leverage ratio is calculated based on Tier 1 capital divided by average total assets over the course of the reporting period. Typically that is not a huge deal, but when you rapidly shed a bunch of assets, average total assets can be materially different from actual ending total assets. Based on Silvergate’s call report, that was the case at the end of Q4: total assets as reported on Schedule RC were $11.3 billion, but total assets for purposes of the leverage ratio (i.e.. the denominator of the ratio) as reported on schedule RC-R were $15.1 billion. So it may not be the case that Silvergate will ever need to seek an FDIC waiver to keep taking brokered deposits, although you never know what will happen next.
In the preamble to the proposed rule, the FDIC suggested that it was considering requiring banks to provide information on their call reports about deposits that would have been brokered deposits but that were now excluded from the definition based on the primary purpose exception included in the revised rule. In the end, the call report forms were amended by the agencies more narrowly to elicit information on sweep deposits that are not brokered deposits. (Silvergate reports $0 of these.)
Toward the end of the article, the American Banker includes quotes from the policy advocates saying that, even if brokered deposits were not a culprit in Silvergate’s rapid deposit withdrawals, it is still worth taking another look at, and then walking back, the FDIC’s rule changes.
Phillips said even if Silvergate's deposit outflows were not driven by third-party deposit collectors, the fact that those types of groups could be treated the same as individual bank customers raises concerns that warrant another look by the FDIC. […]
"Too many regulators, especially in the Trump years, fell in love with the cryptocurrency industry far too fast, perhaps because they had dollar signs — or maybe bitcoin signs — in their eyes," said Carter Dougherty, a spokesman for the advocacy group Americans for Financial Reform. "Regardless of their motivation, the crypto crash has underscored the need to protect the integrity of our banking system, not allow a pretend financial system into the real one."
Maybe so, but a poster child other than Silvergate may need to be found.
LevelField
Earlier this week I wrote about the digital asset firm LevelField and its plans to acquire Burling Bank and thereby become a bank holding company. I expressed uncertainty about how this was going to work, given what I understood about the company’s currently existing activities and the future plans described on its website.
I also acknowledged, though, that maybe it will all work out fine. In this regard I noted statements that LevelField management gave to the media after the deal was announced saying that it now intended to stick to a business plan devoid of anything “novel” or that might give regulators pause.
How is the plan to avoid giving regulators pause going so far? The most fair thing to say is we do not know for sure. It is not clear what has happened with the regulators behind the scenes (either pre- or post-announcement) or what the formally filed application will say.
On the other hand, to be a little less fair, if I were at one of the agencies reviewing this proposal, I would be given at least a tiny bit of pause based on events in the latter half of this week.
First, on Wednesday, the company’s head of business development tweeted at Bitcoin Magazine “Thank you for the love” after the publication wrote an article titled, “LevelField Financial to Become First FDIC-Insured Bank to Offer Traditional Banking and Bitcoin Services.”
Then, on Friday, LevelField’s CEO did an interview with CoinDesk.tv’s First Mover. The interview included several exchanges that were largely standard, but also a few that, as a person who according to some of my friends in the crypto industry is overly cautious about these things, made me cringe.
On the goals of the acquisition:
[Around 0:25]
CoinDesk: What is the significance of this acquisition and what it would mean for the crypto industry?
Gene Grant II: We think that when we combine the world of crypto with banking, we can really push forward adoption here in the United States. One of the biggest areas of contention we hear from everybody who participates in the digital asset industry are the problems associated with moving fiat to crypto and back and forth. One of the great things about having an FDIC-insured vehicle is that we can combine both the traditional checking accounts, along with all the traditional banking products and services, with the ability for customers to buy and sell certain selected digital assets and have them all held in the same custody within that highly regulated vehicle. We think that is going to be a gamechanger for adoption here in the United States.
On uninsured vs. insured products
[Around 03:00]
CoinDesk: In Gemini’s case, the deposits they said were FDIC insured, those were deposits to outside banks. Those were insured, but not [Gemini’s] own products. In terms of LevelField, if it becomes an FDIC-insured bank, you know, cryptocurrency transactions, will those be protected? … Crypto is an asset class that remains uninsured, so until that changes, how will you make sure customers understand the difference?
Gene Grant II: That’s very important for any financial firm getting involved in this space, to clearly differentiate between insured products and uninsured products. Banks have long offered uninsured products, whether it is foreign exchange or, through an affiliate, securities. And in every case the bank must make extraordinary efforts to differentiate between your insured and uninsured products. That’s something we are going to be very careful to do to make sure our customers are not mistakenly led to believe that their digital assets - which are being held in safe custody - are covered by FDIC insurance. Those assets will be covered by supplemental private insurance, as they are in many cases with digital asset firms today, but not FDIC.
And this is not new to the banking industry. This is something they are very much used to, and something we will be doing with Burling Bank when we combine the two, to ensure that our customers clearly understand that safety and security comes from dealing with the bank, it comes from dealing with a highly regulated entity that has layers of supervision, both internally and externally, it comes with good governance, which includes a very engaged board of directors. And, on top of that, the supervision of the FDIC, which is not just an insurance company, it’s actually a sophisticated regulator that ensures banks operate within safety and soundness principles.
On top of that, the bank does have FDIC insurance for its US-dollar deposits. But that whole comprehensive mixture is what provides safety and security to customers in U.S. chartered banks.
On whether the Custodia situation gives them any pause:
[Around 06:20]
CoinDesk: This is a different situation [from Custodia], but do you worry that your association with crypto could have an impact on your approval process?
Gene Grant II: … Key to [the Board’s denial of Custodia’s application] is that Custodia was asking permission to have principal positions, to actually take positions in cryptocurrency. LevelField Bank, post-acquisition, will never hold any digital assets as principal, which means the bank will not have risk to underlying crypto margins. That’s something that the regulators have made very clear is not in accordance with safety and soundness.
So, [we take] no principal positions, we facilitate customer activity, [and] we hold assets in safe custody. [That is] definitely an activity in the banking space that has been approved, and the Federal Reserve in their announcement re-affirmed that custody is an approved service. It’s just holding assets as principal that is problematic…
Grant concluded the interview by saying (07:49) that he hoped LevelField and Burling Bank would be able to “speed toward approval.”
Thanks for reading! Thoughts, challenges, criticisms are always welcome at bankregblog@gmail.com
Certain kinds of brokered deposits are also treated less favorably in some cases under the Liquidity Coverage Ratio and Net Stable Funding Ratio rules, but these rules apply only to very large banks and thus are not relevant to Silvergate.
A potential counterpoint: in December 2006, the FDIC brought an enforcement action against Silvergate Bank, then a state nonmember bank, relating to certain unsafe and unsound practices. Among other things, the order required the bank, within 10 days of signing the order, to submit “a written plan for reducing its reliance on brokered deposits,” and to provide monthly reports to the FDIC thereafter on its progress. The 2006 consent order was terminated in December 2008, but nonetheless you could hypothesize that Silvergate Bank still institutionally bore the historical scars of that experience, and absent the FDIC’s 2021 changes, would have been deterred from taking a significant amount of brokered deposits for that reason.
That is a reasonable point, and credit to the person who pointed it out to me. (I am happy to edit this to credit them by name, if desired.)
See page 6748 of the release accompanying the final rule.
The FDIC acknowledges that the brokered CD market has evolved, in part, to ensure that its underlying depositors receive pass-through deposit insurance and to allow the beneficial owners of the deposits to trade their accounts in a secondary market maintained by the broker. Nevertheless, under the final rule, without exception, and as further explained below in the section discussing the primary purpose exception, brokered CDs continue to be classified as brokered. Brokered CDs, which were offered well before Section 29 of the FDI Act was enacted, were specifically intended to be included as part of the statute. Moreover, and as provided in the ANPR, brokered CDs have caused significant losses to the DIF. Regardless of any future innovations and re-structuring in the brokered CD market, the FDIC intends that third parties that assist in the placement of brokered CDs, or any similar deposit placement arrangement with a similar purpose, will continue to be considered deposit brokers under this part of the deposit broker definition.
The discussion of the possibility of a waiver in the text above describes the rule for banks that are not well capitalized (the highest threshold) but that are nonetheless adequately capitalized. Banks that are undercapitalized, i.e., below the adequately capitalized threshold, may not accept brokered deposits, period.