Bank Analysis School eBook

Bank Analysis School

April 15-19, 2024 San Diego, CA

@ www.csbs.org ♦ @csbsnews

CONFERENCE OF STATE BANK SUPERVISORS 1300 I Street NW / Suite 700 / Washington, DC 20005 / (202) 296-2840

Bank Analysis School San Diego, CA April 15-19, 2024

DoubleTree by Hilton San Diego - Mission Valley Meeting Room: Shutters West II

Monday, April 15, 2024 7:30 am – 8:30 am

Registration & Breakfast South Foyer & The Deck

Introductions

8:30 am – 9:00 am

Interactive Market Simulation

9:00 am – 12:00 pm

12:00 pm – 1:15 pm

Lunch on your own

Interactive Market Simulation

1:15 pm – 4:30 pm

Networking Reception The Deck

5:30 pm – 7:30 pm

Tuesday, April 16, 2024 7:30 am – 8:30 am

Breakfast The Deck

Interactive Market Simulation

8:30 am – 10:00 am

10:00 am – 10:15 am

Break

Communication Amy Studer

10:15 am – 11:30 am

Regulatory and Examination Process Overview Adam Digmann & Amy Studer

11:30 am – 12:00 pm

12:00 pm – 1:15 pm

Lunch on your own

Earnings Adam Digmann & Chris Ward

1:15 pm – 2:45 pm

2:45 pm – 3:00 pm

Break

Earnings Case Study

3:00 pm – 4:30 pm

Adjourn

4:30 pm

Wednesday, April 17, 2024 7:30 am – 8:00 am

Breakfast The Deck

Prior Day Review (Reg Overview & Earnings)

8:00 am – 8:45 am

8:45 am – 10:00 am

Liquidity Carra Greyn

Break

10:00 am – 10:15 am

Liquidity Case Study

10:15 am – 11:45 am

11:45 am – 1:00 pm

Lunch on your own

Capital Carra Greyn & Amy Studer

1:00 pm – 2:15 pm

2:15 pm – 2:30 pm

Break

Capital Case Study & Comment Writing

2:30 pm – 4:30 pm

Adjourn

4:30 pm

Thursday, April 18, 2024 7:30 am – 8:30 am

Breakfast The Deck

Prior Day Review (Capital & Liquidity)

8:30 am – 9:30 am

Asset Quality and Investments Adam Digmann

9:30 am – 10:45 am

10:45 am – 11:00 am

Break

Interest Rate Risk Adam Digmann and Chris Ward

11:00 am – 11:45 am

11:45 am – 1:00 pm

Lunch on your own

IRR Case Bank Adam Digmann and Chris Ward

1:00 pm – 1:45 pm

Management Amy Studer

1:45 pm – 2:45 pm

2:45 pm – 3:00 pm

Break

Assign & Support Ratings for Case Bank

3:00 pm – 3:15 pm

Prepare Presentations

3:15 pm – 4:30 pm

Adjourn

4:30 pm

Friday, April 19, 2024 7:30 am – 8:00 am

Breakfast The Deck

Prepare Presentations

8:00 am – 8:30 am

Present Case Bank Ratings

8:30 am – 9:30 am

Review of the week

9:30 am – 10:30 am

Final Assessment and wrap up

10:30 am – 11:00 am

Adjourn

11:00 am

April 15-19, 2024 Bank Analysis School San Diego, CA

ATTENDEES California Department of Financial Protection and Innovation Carjuzaa, Christophe

christophe.carjuzaa@dfpi.ca.gov oscar.contreras@dfpi.ca.gov christian.fonseca@dfpi.ca.gov cytanil.fuerte@dfpi.ca.gov ashly.garcia@dfpi.ca.gov nhu.dao@dfpi.ca.gov

Contreras, Oscar

Dao, Nhu

Fonseca, Christian Fuerte, Cytanil

Garcia, Ashly Khong, Lee Lara, Jesse Singh, Henna

lee.khong@dfpi.ca.gov jesse.lara@dfpi.ca.gov henna.singh@dfpi.ca.gov

Delaware Office of the State Bank Commissioner Lewsader, Anna

anna.lewsader@delaware.gov erik.wellings@delaware.gov

Wellings, Erik

Iowa Division of Banking Baltimore, Danielle

danielle.baltimore@idob.state.ia.us nick.danielson@idob.state.ia.us

Danielson, Nicholas

Kansas Office of the State Bank Commissioner Myers, Jessica

jessica.myers@osbckansas.org michael.traffas@osbckansas.org

Traffas, Michael

Oklahoma State Banking Department Murray, Brandy

brandy.murray@banking.ok.gov

Texas Department of Banking Cain, Sara

sara.cain@dob.texas.gov lauryn.cash@dob.texas.gov lidia.coble@dob.texas.gov zach.evans@dob.texas.gov kiara.howard@dob.texas.gov kinley.kalbas@dob.texas.gov thomas.keele@dob.texas.gov bryce.lackey@dob.texas.gov charles.lange@dob.texas.gov ashlyn.mellette@dob.texas.gov michael.moreno@dob.texas.gov ray.pecero@dob.texas.gov tyren.willis@dob.texas.gov

Cash, Lauryn Coble, Lidia Evans, Zach Howard, Kiara Kalbas, Kinley Keele, Thomas Lackey, Bryce Lange, Charles Mellette, Ashlyn Moreno, Michael

Pecero, Ray Willis, Tyren

INSTRUCTORS Georgia Department of Banking & Finance Ward, Chris

cward@dbf.state.ga.us

Iowa Division of Banking Digmann, Adam

adam.digmann@idob.state.ia.us

Montana Division of Banking & Financial Institutions Greyn, Carra

cgreyn@mt.gov

Ohio Division of Financial Institutions Studer, Amy

amy.studer@com.ohio.gov

CSBS STAFF Hoyle, Katie Lang, Julia

khoyle@csbs.org jlang@csbs.org

Richardson, Amy

arichardson@csbs.org

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Bank Analysis School April 15-19, 2024

Internal Use Only

Schedule • Breakfast will be available at 7:30 AM each day in The Deck. • Begin at 8:30 AM each day expect Wednesday & Friday starts at 8 AM. • Lunch on your own • Reception tonight at 5:30-7:30 PM in The Deck. Guests are welcome!

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Senior Examiner Iowa Division of Banking Adam Digmann

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Chief Analyst Montana Division of Banking & Financial Institutions Carra Greyn

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Regional Supervisor Ohio Division of Financial Institutions Amy Studer

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Supervisory Examiner Georgia Department of Banking and Finance Chris Ward

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Introductions

NAME

STATE

EXPERIENCE

FUN FACT ABOUT YOURSELF

WHAT DO YOU HOPE TO LEARN DURING THIS CLASS?

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Write down your favorite: C - Cuisine A – Animal

M – Movie/film genre E – Exercise/activity L – Location/travel destination S – Song/music genre

Do not write your name!

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Bank Analysis School Quick Reference Guide

Topic

Title/Description

Location / Link

CSBS UBPR Ratio Flow Chart for Earnings Analysis Intended to aid in navigating the UBPR, analyzing key ratios, and calculating “core” earnings. Municipal Bond Job Aid Resource to help understand and analyze municipal bonds. FDIC Municipal Bond Technical Assistance Videos Five videos (55 minutes total) discussing Municipal bonds. Supervisory Insights – Summer 2013 Contains an article covering securities pre-purchase analysis and ongoing monitoring expectations. FIL-51-2013: Uniform Agreement on the Classification and Appraisal of Securities Held by Financial Institutions Assists in determining if securities should be adversely classified. CSBS Capital Information Sheet Resource to understand components of capital, key ratios, etc. FIL-84-2008: Liquidity Risk Management Outlines content to be included in Contingency Funding Plans. FIL-13-2010: Funding and Liquidity Risk Management States that all banks need a Contingency Funding Plan and outlines expectations surrounding cash flow projections and stress-testing. FIL-2-2010: Joint Interagency Advisory on Interest Rate Risk Management Many exam recommendations are based on this guidance. FDIC Interest Rate Risk Technical Assistance Videos Eight short videos (6-12 minutes each) covering interest rate risk. Winter 2014 Supervisory Insights Entire issue is dedicated to interest rate risk. Page 25 is a step-by-step checklist for completing an in-house independent review. FDIC Supervisory Insights Newsletters covering relevant banking topics (can subscribe). Basics for Bank Directors Resource which explains basic banking and regulatory concepts. Sensitivity to Market Risk Analysis Guide Guide for analyzing this component. Community Bank Leverage Ratio Fact Sheet CSBS Liquidity Analysis Guide

Course binder

EARNINGS

Municipal Bond Job Aid (csbs.org) Technical Assistance Videos (fdic.gov) Supervisory Insights Summer 2013 (fdic.gov)

INVESTMENTS

FIL-51-2013 (fdic.gov)

Course binder

CAPITAL

CBLR Fact Sheet (csbs.org)

Course binder

FIL-84-2008 (fdic.gov)

LIQUIDITY

FIL-13-2010 (fdic.gov)

Course binder

FIL-2-2010 (fdic.gov)

SENSITIVITY TO MARKET RISK

Technical Assistance Videos (fdic.gov) Supervisory Insights-Winter 2014 (fdic.gov)

Supervisory Insights (fdic.gov)

OTHER/ GENERAL RESOURCES

Basics for Bank Directors (kansascityfed.org) Bank Accounting Advisory Series (occ.gov)

OCC Bank Accounting Advisory Series Addresses key accounting concepts in a Q&A format.

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Communication …it’s better than a root canal

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Objectives

Identify Techniques for Conducting Effective Management Meetings Identify Conflict Management Techniques Tips for Conducting Effective Meetings Common Mistakes

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Types of Management Meetings

Entrance or First Day Meetings

Loan Discussion Meetings

Operational Discussion Meetings

Exit or Wrap Up Meetings

Board of Directors Meetings

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Purpose of First Day Meeting

Introductions

Scope of Examination

Organization Structure

New Activities and Initiatives

Status of Previous Exam Findings

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Purpose of Loan Discussion

Credit Underwriting and Loan Administration

Loan Loss Reserve Provisions

Conformity to Loan Policy

Credit Quality Problem Loan Recognition

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Purpose of Exit Meeting Discuss Examination Findings •Report Worthy •Worthy of Management’s Attention

Verify Examination Findings

Document Management Responses

Disclose Tentative CAMELS’ Component and Composite Ratings

Provide Guidance and Recommendations

Discuss Next Steps

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Purpose of Board Meeting

Convey Examination Findings

Provide Guidance and Recommendations

Document Board Response

Disclose Tentative CAMELS’ Component and Composite Ratings

Advise on Any Potential Regulatory Actions

Discuss Next Steps

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Skills to Hone

Verbal Communication Skills

Grammar, Vocabulary, & Pronunciation Articulation – clarity of spoken sounds Volume – the loudness of your voice Inflection – emphasis on words Variety – rate and pace

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More skills Image and Personal Appearance

Always Look Neat and Professional For High Level Meetings Wear Your Best

Be Courteous and Friendly Maintain a Positive Attitude

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Even More skills Nonverbal Forms of Communication

Eye Contact Gestures and Facial Expressions Posture/Body Language

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Conflict Management

Be Prepared Keep Non-Verbal Communication in Check Be Assertive, Not Combative Focus on the Issues, Not the Person Understand the Other Person’s Viewpoint / Perspective Try to be Flexible- when appropriate

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Tips for Successful Meetings

Plan for the Worst But Hope for the Best.

Make sure communication goes both ways

Stick to factual comments

Avoid personal pronouns

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Tips for Successful Meetings (cont.)

If you want the audience’s attention to be on you, your attention should be on them.

Develop a system or routine.

Pace yourself

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More Tips … ad nauseum Use an Agenda and Outline Use Your Own Style and Words Try to Meet as Many People in Advance as Possible Understand Disagreements are Inevitable

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Common Mistakes

Unprepared

Making Comments That Are Unsupported or Inconsistent With Exam Findings

Conducting Meetings Alone

Avoid “We” When Referencing Management

Not Keeping Management Informed

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Report Writing

4 Dominant Communication Styles

Although there are many different personalities, communication styles can be broken into four major profiles. If you take into consideration the needs of each style when communicating with others, you have the greatest chance of establishing rapport and trust. Ignore the styles and you risk rubbing people the wrong way, possibly shutting down the possibility of gaining the results you want. In addition, when you acknowledge your own dominant style, you can build on your strengths and set goals to adapt or ask for help in areas you avoid.

The styles are based the most important needs when communicating, whether it be on achievement or on relationship, on idea creation or on action.

The two styles most focused on task:

DOERS Doers like to be in control. They like quick action and they like to see results. They like to get to the point with little formalities. They don’t care for details and love finding shortcuts. Otherwise, they get bored easily. They like autonomy, freedom and taking risks. They are self-starters, innovators and love to expend physical energy. They like public recognition, especially for putting what they most value into action and for creating results that make a difference in the world (or at least in world they see and act in every day). THINKERS Thinkers love to gather information. They enjoy reading and presenting their findings in detail. However, they need to mentally rehearse before they present, and take time to evaluate and wind down after the show. They take their time making decisions, but stand by what they decide once they do. They don’t care to talk about personal issues, but enjoy discussing hobbies and issues. They desire clear expectations, specific goals, deadlines and structure. They live by a sense of order, methodologies and personal responsibility. Thinkers love to win, and will compete with themselves if no one is available. They will jump into the game with no coaxing if they perceive they have a fighting chance. They are proud of their good work. They like acknowledgment but won’t ask for it.

The two styles most focused on relationship:

INFLUENCERS Influencers like to verbally process their thoughts so they welcome situations where they can “think out loud” with others. They like to interrupt others, especially when they are excited about the topic. They view this as conversation, not a disruption. They enjoy people, desire approval and tend to be friendly, creative and persuasive. However, they may need some help staying on track and following through on tasks. They desire social interaction, acknowledgment and chances to be creative and have fun. They often see the bright side and can be very amusing, dramatic and passionate about work. They help others get through difficult times and can build rapport and support. They genuinely like people. However, they might find themselves caught up in a lot of drama since they are quick to want to help fix things and people. Teasing is one of their favorite pastimes. CONNECTORS Connectors count on others to set the tone and determine direction. They are consistent and reliable once given their responsibilities. They like to work with others instead of alone but take their time trusting and allowing new people to join their established groups. They do not readily give opinions, but this does not mean they don’t have any. Because they are diligent and dependable, they often know the most about how work is getting done. They like to be asked what they know and they appreciate personal recognition (done privately, not in front of others). They desire consistency, social bonds and acknowledgment for effort as well as results. Although they may appear stubborn, they can be very flexible and adaptable if they understand why the changes are being made and how they will benefit themselves and others. They seek to reduce stress and promote harmony.

Rate Your Dominant Communication Style

When under pressure, do you tend to be (circle the adjective that most fits you):

Write the item number here:

Humorous 3

Regimental 2

Concise 1 Excited 3

Concerned 4

______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______

Focused on outcome 1

Focused on steps 2

Apprehensive 4

Aggressive 1

Talkative 3

Disciplined 2 Resistant 2 Creative 3 Absorbed 2 Multi-tasking 1

Nurturing 4 Assertive 1 Productive 4

Non-confrontational 4

Schmoozer 3

Innovative 1

Talented 2

Driven 1

Enthusiastic 3

Seeking the peace 4

Scattered 3

Structured 2

Helpful 4

Analytical 2 Prophetic 1 Consistent 4 Competitive 2 Charismatic 3 Encouraging 4

Clear 1

Tolerant 4

Imaginative 2

Logical 2

Resourceful 3

Practical 4 Empathic 3

Heroic 1

Critical 2

Directing 1 Forceful 1

Enrolling 3 Friendly 4 Intellectual 2

Reliable 4

Technical 2

Independent 1

Light-hearted 3

Likes short -term goals 2

Socializer 3

Likes long-term goals 4

Risk-taker 1

Rule -breaker 1

Tests Rules 3

Abides by Rules 4

Upholds Rules 2

Explaining 2

Expecting 1

Supporting 4

Mediating 3

Leading teams 1

Avoiding teams 2

Motivating teams 3

Seeking teams 4

Leading by example 1 Overlooking others 1

Sharing leadership 3 Criticizing others 2

Avoiding leadership 4 Understanding Others 3

Leading by necessity 2

Promoting others 4

Shy from drama 4

Ignore drama 1

Hate drama 2 Questioning 2

Manage drama 3

Tough 1

Contained 4

Curious 3

Likes physical challenge 1 Avoids conflict 3

Likes mental challenge 2

Avoids stress 4

Avoids confrontation 4

Diffuses confrontation 3 Angered by confrontation 1 Energized by confrontation 2 ______

SCORING:

Count up how many 1s, 2s, 3s and 4s you had and put the total below:

Total 1s __________

Total 2s __________ Total 3s __________ Total 4s __________

SCORING INTERPRETATION

1 = Doer

2 = Thinker

3 = Influencer

4 = Connector

Your score:

_____ Doer

_____ Thinker

_____ Influencer

_____ Connector

Your high score demonstrates your strongest communication style, especially under pressure. Your secondary score indicates your fall-back or adaptive style or styles. There are strengths associated with each style as well as limitations.

Doers tend to be high achievers and leaders and drive necessary results. They also tend to be impatient and insensitive to others.

Thinkers tend to excel when they like their work and can think through all angles and contingencies. They can appear to be combative, critical and sarcastic.

Influencers can lighten up even the darkest of moments. They can be inspirational, understanding and encouraging. They can also be wishy-washy in their decision-making and seem impractical. They are often late on assignments they do not like. Connectors are reliable team players who look after everyone in their “tribe.” They are consistent and caring. They can also be stubborn and non-supportive of pushy people and what they judge to be impulsive ideas. If you scored below a five on any style, be aware of how you treat others who demonstrate this style. You may have little patience or tolerance for people who tend toward these styles. Yet these are people you need around you to support your efforts. Do not alienate them. Instead, find ways to collaborate with them. In the end, all the styles need to develop more tolerance for the other styles, and develop an appreciative point of view for what each style brings to the table. Diversity is the key to innovation and success.

COMMUNICATION TIPS When communicating with a DOER style:

~ Be clear, specific, brief and to the point. ~ Stick to business. ~ Be prepared to support your ideas and work.

Factors that will create tension or dissatisfaction: ~ Talking about things that are not relevant to the task or issue. ~ Being unprepared or incomplete. Avoiding or beating around the bush. ~ Appearing unsure or disorganized, but not asking for help.

When communicating with a THINKER style:

~ Prepare your “case” in advance. Be prepared for a debate. ~ Stick to business. ~ Be accurate and realistic.

Factors that will create tension or dissatisfaction: ~ Being giddy, casual, informal, emotional or loud. ~ Pushing too hard for results or being unrealistic with deadlines. ~ Being disorganized or messy.

When communicating with an INFLUENCER style:

~ Provide a warm and friendly environment. Do little things to show your care. ~ Don’t deal with a lot of details (put them in writing). ~ Ask “feeling” questions to draw their opinions or comments. Factors that will create tension or dissatisfaction: ~ Being curt or cold. Cutting them off if they have something to say. ~ Controlling the conversation. Not allowing them to talk and express. ~ Focusing on facts and figures.

When communicating with a CONNECTOR style:

~ Begin with a personal comment--break the ice. ~ Present your case smoothly, non-threateningly. ~ Ask “how?” questions to draw their opinions.

Factors that will create tension or dissatisfaction: ~ Rushing headlong into business. Creating tension. ~ Being domineering or demanding. ~ Forcing them to respond quickly to your ideas. Demanding change.

LIST YOUR COMMUNICATION STRENGTHS:

WRITE TWO COMMUNICATION GOALS FOR YOURSELF TO BETTER RELATE WITH OTHER STYLES:

Public Speaking Tips:

1) Visualize the space you will be speaking in. Walk through the room beforehand if possible and see how you will have to project your voice. 2) Be aware of the rate and depth of your breath, the volume of your voice, and the speed of your speech. 3) Know your audience and how to connect to them. 4) Be yourself. Trust yourself. 5) Think about how you’re going to say your message. 6) Deliver your message from a place of power. 7) Understand the different forms of body

language (over-gesturing, body movement). 8) Understand the impact of costume (how you dress). 9) Accept your nervousness. It’s normal. 10) Practice, practice, and practice.

EFFECTIVE WRITING TECHNIQUES

The Report of Examination (ROE) is intended to communicate the findings of an examination and support the assigned component ratings. The following suggestions may be helpful in increasing the effectiveness of written communication: • Understand the audience (primarily Board of Directors). • Comments supporting component ratings should relate to the UFIRS ratings definitions and evaluation factors. • The tone of component comments should match the assigned rating (for a 1 rated component the comments should be mostly positive; components rated 3 or worse should include very little or no favorable comments). • Consider developing an outline before you start. Coherent paragraphs include a topic sentence and supporting information. • Report of Examination comments should be fact-based, professional, and objective. • Use clear, concise, language appropriate to the subject and the intended audience. Simple language and short sentences and paragraphs are generally the most effective. • Examiners should not rely upon ratios alone to convey the ideas they wish to express. When ratios are cited, they should be in support of a conclusion, and their import should be made understandable to the reader. While ratios are meaningful to examiners, their significance is not always apparent to bankers and particularly bank directors. • Peer group comparisons are not a part of the UFIRS ratings definitions, so examiners should avoid over reliance on peer group comparisons in written commentary.

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Bank Analysis School Regulatory & Examination Process Overview

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Financial Crisis Kahoot

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Bank Failures are not Uncommon

157

140

Failed Banks

92

51

25

24 18

8 5 8

7 4 11 3 4 0 0 3

0 4 4 0 0 5

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23

59

39

88

70

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Commonalities of Failed Banks Summary Analysis of Failed Bank Reviews report from the Office of the Inspector General Aggressive growth Concentration in construction and land development loans Reliance on noncore funding Poor risk management Compensation incentives encouraging risk-taking 1 2 3 4 5

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How do Banks Fail?

Interest rate risk materializes

Asset quality issues

Fraud

or

or

Weak earnings

RISK MANAGEMENT PRACTICES

Capital

Liquidity

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Today’s Risks ( 2023 FDIC Risk Review) • Credit risk (CRE) • Low Net Interest Margins and interest rate risk • Liquidity and deposits • Cyber threats • Climate-Related Events

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Examination Process Examinations are the fact-finding function of bank supervision. Purpose of examination is to assess: •Adequacy of capital for the risk profile of the bank •Asset quality •Ability of management, and compliance with applicable laws and regulations •Earnings performance and future prospects •Ability to meet the demands of depositors and other creditors •Degree of exposure to interest rate risk

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Types of Examinations

Full-scope vs. Limited

Joint vs. Independent vs. Concurrent

Risk-focused: To effectively evaluate the safety and soundness of the bank by focusing resources on the highest risk areas

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Examination Key Roles

EXAMINER-IN-CHARGE (EIC)

LOAN-IN-CHARGE/ ASSET MANAGER (LIC/AM)

DETAIL-IN-CHARGE/ OPERATIONS MANAGER (DIC/OM)

TEAM MEMBER (TM)

REVIEWER

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Operations Manager

Responsibilities: • Pre-Planning Phase • On-Site Phase •Wrap-Up Phase

Get familiar with Examination Tools Suite (ETS)

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Course Objectives

• Lecture and real-world stories/examples • Case studies and exercises • Uniform Bank Performance Report (UBPR) – Locate and analyze key ratios

Analyze and assess risk

Assign and support ratings

• Uniform Financial Institution Rating System Definitions (UFIRs)

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Group Work / Case Study

The class is designed around Sunny State Bank, our case bank. Each day you will have independent study time and group time to discuss that day’s component assignment. On Thursday, your group will discuss and come to a consensus on the CAMELS and Composite rating for Sunny State Bank. Thereafter, each group will receive a component to present via a PowerPoint slide. Presentations will be on Friday. You will use all your class materials, including the Sunny State UPBR and UFIRS Rating Definitions. Detailed instructions for the presentations will be provided Thursday.

Risk Review 2023

TABLE OF CONTENTS

INTRODUCTION................................................................................................................................ 1 SECTION 1: Executive Summary....................................................................................................... 3 Key Risks to Banks................................................................................................................................... 4 SECTION 2: Overview of the Economy, Financial Markets, and Banking Industry.................................. 7 Economy.................................................................................................................................................. 7 Financial Markets. ................................................................................................................................. 12 Banking Industry................................................................................................................................... 16 SECTION 3: Credit Risks....................................................................................................................... 23 Agriculture . ........................................................................................................................................... 23 Commercial Real Estate........................................................................................................................ 28 Consumer Lending................................................................................................................................ 33 Energy.................................................................................................................................................... 37 Housing.................................................................................................................................................. 40 Leveraged Lending and Corporate Debt. ............................................................................................. 46 Nonbank Financial Institution Lending................................................................................................ 50 Small Business Lending........................................................................................................................ 53 SECTION 4: Market Risks ..................................................................................................................... 57 Liquidity and Deposits. ......................................................................................................................... 57 Net Interest Margins and Interest Rate Risk . ....................................................................................... 62 SECTION 5: Operational Risk . .........................................................................................................67 SECTION 6: Crypto-Asset Risk..........................................................................................................71 SECTION 7: Climate-Related Financial Risk......................................................................................73 ACRONYMS AND ABBREVIATIONS. ...................................................................................................79 GLOSSARY OF TERMS. .....................................................................................................................81

2023 Risk Review | i

INTRODUCTION

The FDIC was created in 1933 to maintain stability and public confidence in the nation’s financial system. A key part of accomplishing this mission is the FDIC’s work to identify and analyze risks that could affect banks. The Risk Review summarizes the FDIC’s assessment of risks related to conditions in the U.S. economy, financial markets, and the banking industry. The analysis of the banking industry pays particular attention to risks that may affect community banks. As the primary federal regulator for most community banks, the FDIC has a unique perspective on these institutions.1 The 2023 Risk Review provides an overview of banking conditions for 2022 through early 2023, including key developments that emerged from the stress in the banking sector in March 2023.2 The failure of three large banking institutions in March and May highlighted certain risks to the banking sector.3 The Risk Review presents key risks to banks in five broad categories—credit risk, market risk, operational risk, crypto-asset risk, and climate-related financial

risk. The credit risk areas discussed are agriculture, commercial real estate, consumer lending, energy, housing, leveraged lending and corporate debt, nonbank financial institution lending, and small business lending. The market risk areas discussed are liquidity and deposits, and net interest margins and interest rate risk. The discussion of operational risk examines the potential negative impact to banks from cyber threats and illicit activity. Crypto-asset risk, a new section in the 2023 Risk Review , discusses the FDIC’s approach to understanding and evaluating crypto-asset-related markets and activities. Monitoring these risks is among the FDIC’s top priorities. The discussion of climate-related financial risk focuses on the physical risk of severe weather and climate events to the banking system. Section 1 is an executive summary. Section 2 is an overview of economic, financial market, and banking industry conditions. Sections 3 through 7 include analysis of the key credit, market, operational, crypto asset, and climate-related financial risks facing banks.

1 Unless otherwise noted, “community banks” are FDIC-insured institutions that meet the criteria for community banks that was developed for the FDIC Community Banking Study, published in December 2012. Thresholds for certain criteria are adjusted upward quarterly and described in “Notes to Users” for the FDIC Quarterly Banking Profile. See, for example: page 35 of the FDIC Quarterly Banking Profile, First Quarter 2023. Noncommunity banks are banks that do not meet these criteria. 2 This report contains banking information available as of March 31, 2023. Unless otherwise noted, banking industry data are for FDIC-insured institutions from Consolidated Reports of Condition and Income (Call Reports), with data beginning in 1984. This report defines the pre-pandemic level as fourth quarter 2019, unless noted otherwise. 3 For more information on the three bank failures that occurred between March and May 2023, see “Remarks by Chairman Martin J. Gruenberg on “Oversight of Financial Regulators: Financial Stability, Supervision, and Consumer Protection in the Wake of Recent Bank Failures” Before the Committee on Banking, Housing, and Urban Affairs, United States Senate,” May 18, 2023.

2023 Risk Review | 1

SECTION 1 Executive Summary

The banking industry demonstrated resilience despite weaker economic conditions, sharply higher interest rates, high inflation, and financial market stress in early 2023. Stress in certain large banking institutions along with severe liquidity strains resulted in the failure of Silicon Valley Bank and Signature Bank in March and First Republic Bank in May. 4 The FDIC, Federal Reserve, and Treasury took swift and decisive action to restore public confidence in the banking system, but banking conditions remained stressed and vulnerable to additional adverse market developments. Weaker economic conditions and higher interest rates in 2022 continued through early 2023. The U.S. economy expanded at a markedly slower pace in 2022, with growth decelerating to less than half of the strong growth in 2021 and increased expectations for recession. Disruption to supply chains impeded economic growth in 2022. While these pressures abated and inflation moderated by early 2023, labor supply shortages remained. The economy has been supported by strong labor markets and continued growth in personal incomes, even as other sectors such as housing began to slow. Interest rates rose sharply in 2022 as the Federal Reserve raised short-term interest rates to combat sustained high inflation. Treasury yields rose across all maturities. Shorter-term interest rates rose more than longer-term interest rates, causing the yield curve to invert in 2022 and remain inverted at most tenors through first quarter 2023. An inverted yield curve makes lending conditions more challenging for banks.

Financial market conditions tightened considerably starting in 2022 on rising interest rates, high inflation, and concerns over a potential recession. Bond markets faced several challenges as rising interest rates and bond market volatility weighed on both new issuances and performance. Stocks generally performed worse in 2022 than in any year since 2008. Although corporate earnings largely surpassed expectations in 2022, financial market conditions worsened throughout the year due to strong inflationary pressures and a tight labor market. The failure of three large banks, two in first quarter 2023 and one in the second quarter, introduced a renewed bout of stress primarily in the banking sector. Financial market conditions stabilized to some degree by the end of first quarter, but interest rates and funding costs remained elevated. Despite these challenges and the market stress in early 2023, the banking industry demonstrated resilience, but industry performance moderated from 2022. Bank net income was roughly unchanged in first quarter 2023 after excluding accounting gains associated with the acquisition of two failed banks. Banking sector profitability moderated in 2022 after strong gains in 2021 as increased provision and noninterest expenses offset higher net interest income. Net interest margins (NIMs) improved in 2022 as interest rates rose, but NIMs began to decline in first quarter 2023 as higher funding costs offset increased asset yields on an aggregate basis. Deposit outflow from the banking industry, which started in mid-2022, continued at a faster rate in first quarter 2023. However, asset quality metrics for the banking industry overall remained favorable through first quarter 2023, and the industry remained well capitalized. After surging in 2022, the volume of unrealized securities losses moderated in first quarter 2023 but remained elevated.

4 The banking failures included Silicon Valley Bank of Santa Clara, CA on March 10, 2023; Signature Bank of New York, NY on March 12, 2023; and First Republic Bank of San Francisco, CA on May 1, 2023.

2023 Risk Review | 3

Key Risks to Banks Credit Risks: Asset quality remained generally favorable as of first quarter 2023 despite modest deterioration. Weaker economic conditions and higher interest rates may challenge bank loan portfolios, including credit card, commercial and industrial, residential real estate, and commercial real estate (CRE) loans. • Agriculture: The agricultural sector had another strong year with record profits despite widespread drought conditions. Loan growth and higher loan yields boosted farm bank earnings in first quarter 2023 following a down year in 2022. Stronger farm sector financial conditions led to improved farm bank asset quality through first quarter 2023, but higher interest rates and production costs pose challenges in 2023. • Commercial Real Estate: Banks have substantial exposure to CRE lending as CRE loans comprised a quarter of total loans held by the banking industry as of first quarter 2023. CRE loans as a share of total industry assets have grown and approached their 2009 peak. Most CRE property types performed well in 2022, but some challenges continued into 2023, particularly among office properties. With a structural decline in office demand and weak rent growth, some borrowers may have difficulty refinancing. Longer-term leases, which are prevalent in the office sector, helped to insulate office properties from reduced occupancy earlier in the pandemic, but more office leases are scheduled to expire over the next three years in some large markets. While aggregate banking industry CRE asset quality metrics remained favorable in first quarter 2023, challenges to loan performance include higher interest rates, difficulty refinancing particularly for loans secured by some office properties, and economic uncertainty. • Consumer Lending: Consumer debt increased, owing primarily to strong growth in credit card balances. While a strong labor market supported consumer incomes, consumers faced higher inflation that constrained budgets. Consumer savings declined, and declines in equity prices pressured some consumer balance sheets.

Potential signs of consumer loan problems emerged at banks, as the total past-due rate on credit cards and auto loans rose. While asset quality remained generally favorable, trends in consumer loan performance could deteriorate in 2023 if the labor market or economic growth weakens. Auto loans in particular showed concerning asset quality trends that may worsen if auto prices normalize from high levels. • Energy: Energy prices softened during the second half of 2022 as oil prices receded from earlier highs and were more stable through early 2023. Despite the decline in prices, the energy industry remained profitable, supporting employment in energy-concentrated states. Bank loan exposure to oil and gas firms continued to decline in 2022 from 2021 levels. Community bank asset quality in energy-concentrated states continued to improve through first quarter 2023. Despite strength in 2022, the outlook for conditions in the energy sector weakened by year-end and remained uncertain in early 2023. • Housing: The housing market began to slow in mid-2022 as mortgage rates rose sharply. Through early 2023, home price appreciation declined from 2022 highs. But home prices nationally remained elevated and above the pre-pandemic level, aided by strong demand and a limited supply of homes for sale. High home prices and increased mortgage rates continued to reduce the affordability of homes, particularly for first-time home buyers. With the sharp rise in long-termmortgage rates, mortgage originations declined last year and through first quarter 2023, but banks reported higher residential mortgage loan balances and increased residential construction and development lending. Asset quality metrics for residential mortgage loans remained favorable, but early signs of potential credit deterioration have emerged.

4 | 2023 Risk Review

Market Risks: Market risks were primarily related to the effects of higher interest rates. Deposit outflows along with high levels of unrealized losses could pressure liquidity for some banks in 2023. The banking industry benefited from strong loan growth and higher NIMs in 2022, but higher funding costs reduced NIMs in early 2023. • Liquidity and Deposits: Higher unrealized losses made securities portfolios a less effective liquidity source. Deposit levels continued to grow among community banks in 2022 through first quarter 2023 despite the overall decline in deposits for the banking industry. Community bank loan growth remained strong and outpaced deposit growth, causing liquid assets to contract and wholesale funding to increase. High interest rates remain a significant source of liquidity risk for banks. • Net Interest Margins and Interest Rate Risk: Higher interest rates initially supported higher NIMs, particularly as loan growth strengthened. These trends began to reverse in first quarter 2023, as funding pressures rose and loan growth slowed. The sharp rise in interest rates in 2022 caused widespread depreciation in securities portfolios, and banks with a higher share of long-term assets reported higher depreciation in investment portfolios and lower growth in NIMs than other institutions. Operational Risk: Operational risks, including cybersecurity risks and risks related to illicit financial activity, remained elevated across the banking industry. • Operational risk remains one of the most critical risks to banks. Geopolitical events continue to increase the likelihood of cyber attacks on banks. The banking industry’s software infrastructure remains vulnerable to cyber attacks including ransomware attacks and threats against third-party service providers. Robust customer due diligence policies and anti-money laundering

• Leveraged Lending and Corporate Debt: Corporate borrowing conditions deteriorated in 2022 and through first quarter 2023 as high inflation, rising interest rates, and an economic slowdown challenged corporate borrowers. Corporate debt issuance slowed sharply. Issuance of leveraged loans, a subset of the corporate debt market, declined normalizing from the record issuance in 2021. Slowing economic growth and continued high interest rates could weigh on corporate debt markets and pose credit risk for the banking industry, while limited near-term corporate debt maturities should mitigate some risks. Rising corporate defaults would affect holders of corporate debt securities, including banks. • Nonbank Financial Institution Lending: Bank lending to nonbank financial institutions (NBFIs) continued to increase, led by growth in the larger banks. Community bank exposure to nonbank entities, primarily in the form of line of credit facilities to nonbank mortgage lenders, remained limited and declined through first quarter 2023, according to supervisory observations. The banking industry is increasingly exposed to the broad and varied risks from nonbank business activities. Asset quality of NBFI loans remained favorable in first quarter 2023, but banks remain vulnerable to adverse developments in nonbank institutions. • Small Business Lending: Small business conditions weakened from high inflation and labor market shortages. Conditions varied across industries as consumer spending patterns shifted toward services. Small business loans declined in 2022, primarily reflecting the winding down of lending under the Paycheck Protection Program. While asset quality remained sound, small businesses reported concerns about the weaker outlook, which may be a source of risk for banks during 2023.

and countering the financing of terrorism programs reduce the U.S. financial system’s susceptibility to illicit financial activity risks.

2023 Risk Review | 5

Crypto-Asset Risk: Crypto-assets present novel and complex risks that are difficult to fully assess.

Climate-Related Financial Risk: Climate-related financial risk includes physical risk and transition risk. The Risk Review is a retrospective look at risks, and the discussion in this section focuses on physical risk from severe weather and climate events. • In 2022, severe weather and climate-related events included three hurricanes, an extensive wildfire, and a prolonged drought in the West. Estimated damages from severe weather and climate events in 2022 were among the most costly. The FDIC is expanding efforts to understand climate-related financial risk in a thoughtful and measured manner that emphasizes a risk based approach and collaboration with other supervisors and the industry. The FDIC recognizes that risk management practices in this area are evolving and will continue to encourage banks to consider climate-related financial risk in a manner that allows them to prudently meet the financial services needs of their communities.

• The crypto-asset sector experienced significant market volatility in 2022. Growth in the crypto asset industry corresponded with an increasing interest by some banks to engage in crypto-asset activities. The FDIC has been generally aware of the rising interest in crypto-asset-related activities through its normal supervision process. However, as this interest has accelerated, the FDIC determined that more information was needed to better understand the risks associated with these activities. The FDIC, in coordination with the other federal banking agencies, continues to closely monitor crypto-asset-related activities of banking organizations. As warranted, the FDIC will issue additional statements related to engagement by banking organizations in crypto-asset-related activities. The FDIC also has developed processes to engage in robust supervisory discussions with banking organizations regarding proposed and existing crypto-asset-related activities and provide case-specific supervisory feedback.

6 | 2023 Risk Review

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Bank Analysis School Earnings

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Why is earnings performance important?

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3 From a bank regulator’s standpoint, the essential purpose of bank earnings, both current and accumulated, is to absorb losses and augment capital . ” - FDIC Risk Management Manual

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Learning Objectives 1 – How Banks Make Money

2 – Income Statement 3 – UBPR Ratio Analysis 4 – Budget 5 – Impact on Capital 6 – Risk vs. Return

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Banks are the “Middleman” Connecting Depositors and Loan Customers

BANK

Funding (savers)

Assets (borrowers)

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Net Interest Income is the “Bread and Butter” for Most Community Banks

Interest income (assets) - Interest expense (liabilities) = Net interest income

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What percentage of Sunny State Bank’s total income (Adjusted Operating Income) is from Net Interest Income?

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Net Interest Margin is the “Profit Margin”

Net Interest Income Average Earning Assets =

NET INTEREST MARGIN

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Learning Objectives

1 – How Banks Make Money 2 – Income Statement 3 – UBPR Ratio Analysis 4 – Budget 5 – Impact on Capital 6 – Risk vs. Return

Internal Use Only

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Income Statement (Broad Categories) Interest Income (loans & investments) Interest Expenses (deposits & borrowings) - Net Interest Income = Noninterest Income (service charges, many other types) + Noninterest Expenses (personnel, occupancy, other) - Provision Expenses “X” Factor - Other Items (securities gains/losses, taxes) + or - Net Income =

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Some Banks Focus More on Noninterest Income than Others

Sunny State Bank

Another Bank