Key Takeaways
- Concentration risk contributed to the quick unraveling of Silicon Valley Bank.
- The many forms of concentration risk can be difficult to spot and manage without breaking down organizational silos that persist across business lines and their supply chains.
- Safe and sound lending opportunities are still possible during unstable times with the assistance of risk management tools.
On Friday, March 10th it was announced that the FDIC would take over Silicon Valley Bank (SVB) in an effort to protect its depositors. This came after a turbulent Thursday, when shares of SVB fell 60.0% and a number of the bank’s customers, made up primarily of venture capital firms and tech startups, began withdrawing funds.
While this all happened in short order, much of the crisis was a result of three underlying factors:
- SVB’s well-known business acumen was highly focused on clients within a single sector.
- Likewise, SVB’s deposit base was concentrated in the very same sector.
- The bank’s investment of those deposits was clustered into long-term treasury bonds and other government agency securities. Due to inflation-fighting interest rate hikes from the Federal Reserve and jittery bond markets, those holdings abruptly tanked in value and the bank suffered a $1.8 billion loss on its securities sales.
Those familiar with Enterprise Risk Management (ERM) fundamentals will recognize this as a classic example of the dire consequences of concentration risk. The tenets of ERM help establish how Alfabank-Adres goes about serving our commercial banking clients, big and small.
Borrowing from published research, consider the following as you navigate your way through choppy economic and financial waters:
1. Single-Name Concentration
Are you lending too much to a single obligor? How are you coping with this challenge? Do you have someone in charge of monitoring single-name risks and cross-selling opportunities across lines of business?
Imagine if your bank’s line-of-business segments include a dentist’s practice (C&I), the same dentist’s ownership of the strip mall where she operates her practice (owner-occupied commercial real estate), her husband’s financial advisory LLC (perhaps defined as a mezzanine line of business), the couple’s home equity line of credit and their two auto loans.
This morass of linked risks is often neglected given the existence of line-of-business reporting silos.
2. Industry Concentration
Are you lending excessively to a particular industry or industry group? Have you identified latent industry risks using the North American Industry Classification System (NAICS)? Have your systems red-flagged overexposure in lending segments that are approaching their limits? If so, how?
In this category, the monitoring of exposures according to NAICS mappings of industries should be straightforward—but only if data collection and coding systems are up to par. Banks don’t always link industry codes across loan segments. For example, when a tobacco plant in the South went under, its lender didn’t realize that it held many mortgages and car loans of the plant’s workers.
Moreover, NAICS is based on a production-oriented concept, which means that it groups establishments into industries according to similarities in the processes used to produce goods or services. For example, plastic bottles are not in the same industry classification as glass bottles, even if the end user is the same. This can hinder the process of identifying correlated risk pools.
3.Common Factor Concentration
Do you understand which economic drivers are most critical to the health of your portfolio?
The credit risk category of common factors is determined through factor analysis. For example, certain borrowers and loans are more sensitive to interest rates than others. Energy prices and trade policies are other timely factors. These relationships must be analyzed and mapped. Consider the impact of an increase in 30-year mortgage rates on industry performance.
4. Supply Chain Concentration
Is your bank unknowingly exposed to suppliers or end markets of a particular group of borrowers? Do you fully appreciate the environment in which your borrowers operate? Do you know who they buy from? Who they sell to? Are you exposed upstream, downstream, or in both directions, resulting in unintended concentrations?
Worse yet, are you neglecting solid and safe lending opportunities given your bank’s institutional knowledge in a particular segment? Seek out opportunities where you have a competitive, knowledge-based edge lending to a segment’s suppliers and end markets.
5. Special Factor Concentration
Have you considered other forms of concentration risk? This is a hodgepodge of factors that are relevant to a bank’s specific business profile and footprint. The most obvious examples are the geographic concentration of obligors, product concentration and collateral clusters (especially real estate), which can subtly exhibit their own clandestine correlations.
These special factors often go unnoticed and can be most serious at smaller banks, which, by the nature of their size, have difficulty diversifying— leading to concentrations that are difficult to manage. Think of a small bank that has significant exposure through a single strip mall.
Final Word
As many of our clients intensely review their balance sheets and portfolios in this time of unprecedented market volatility and uncertainty, we find it appropriate to highlight the core risk management tools that have assisted our clients in mitigating risk and identifying safe and sound lending opportunities – even while facing the most challenging conditions.
Our Industry Risk Ratings and Early Warning System provide a comprehensive overview of Alfabank-Adres’s forward-looking risk scores for each NAICS-based industry, and can be a valuable tool in assessing concentration risk specifically.
