4 Ways Law Firms Can Ensure Their Bank Is Sound
Written by Aebra Coe, Law360
Featuring Partner Jay L. Hack, Gallet Dreyer & Berkey, LLP
Following the high-profile collapses of Silicon Valley Bank on the West Coast and Signature Bank in New York, many law firms are taking a second look at their banking relationships with an eye to safeguarding not only their own funds but also those of clients.
Signature Bank counted a number of law firms in the New York area as its customers, and while the Federal Deposit Insurance Corp. stepped in to avert disaster after customer withdrawals created a crisis, many law firms have begun to think harder about whom they bank with following the tumultuous week in banking, according to Dickinson Wright financial institutions member Joseph E. Silvia.
While it appears the federal government is poised to insure banks going forward above the official $250,000 limit in order to avoid widespread panic, there is still the issue of the availability of funds in such a scenario, Silvia pointed out. Law firms are particularly interested in avoiding a scenario where client funds held in trust accounts are held up should such a disaster occur.
"Having a little more control over that relationship and that expectation of access may be where law firms and others focus their attention on working with new banks," Silvia said.
Some firms will simply move their accounts to the financial industry giants deemed "too big to fail" by the federal government. However, firms can also take a few simple steps to evaluate the financial health of their banks and tap into services offered by smaller community banks that can ensure their funds are as safe as possible.
Here, Silvia and others who specialize in banking offer their thoughts on what law firms need to know in order to evaluate their banks and avoid getting burned by one that's on shaky financial footing.
Look Out for Too Many Other Big Depositors
One factor that contributed to the woes of both SVB and Signature Bank is that the banks had a high percentage of customers who held large sums of money there, which means when those big depositors began to lose faith in the institutions and withdraw their money, the financial positions of the banks quickly spiraled.
Jeff Marsico, president of the bank consultancy The Kafafian Group, says one important way law firms can evaluate their banks is by checking to see what percentage of accounts in the bank hold over $250,000 and look for that number to be below 25% or so. That information can be found in the bank's federal Schedule RC-E call report, he explained.
Marsico co-led a webinar Wednesday on behalf of the New York State Bar Association that delved into what lawyers need to know about the recent banking failures.
"If it's over 25%, it creates a higher pool of nervous depositors if bad news occurs," Marsico said. "Signature and SVB's were both well over that amount."
Pay Close Attention to Liquidity
While capital is said to be king in banking, with strict regulatory definitions for banks' capital ratios, that capital is not always immediately available to banks if it is tied up in long-term investments, creating trouble if a large number of customers ask for their money at once, according to Jay Hack, a financial institutions partner at Gallet Dreyer & Berkey LLP, who co-led the New York Bar program with Marsico.
"The failures of Silicon Valley Bank and Signature Bank had nothing to do with capital," Hack said. "The problems were caused by liquidity issues. Did the bank have enough cash on hand to pay withdrawals as requested?"
An attorney or firm interested in figuring out the liquidity of their own bank can do so by looking at the top line of the balance sheet, Hack explained, which should be called something like "cash and due from banks." Cash and due should represent at least 5% of total deposits, he said, and ideally closer to 10%.
One factor that likely played a role in SVB's problems was the nature of the bank's investment portfolio, which led to decreased liquidity, according to Hack.
If a bank's investments are classified as available for sale, and especially if the term to maturity of the portfolio is relatively short, then that forms a second line of liquidity defense because it can be pledged or sold almost on a moment's notice, to generate additional cash if there is a run on the bank, he said.
"However, if an inordinately large percentage of the bank's investment securities portfolio is classified as held to maturity, and it has a long-term duration, that is a red flag to me," he said.
Consider How Deposits Are Insured
According to Marsico, law firms should also identify whether their bank has a reciprocal deposit program, in which deposits of more than $250,000 are split up and distributed into a network of other banks so that the full amount is insured by the FDIC.
"These programs essentially take a large deposit, say $1 million, and lay off $750,000 to other network banks so the full million is FDIC-insured. The originating bank gets $750,000 of other depositor money from network banks, so it still has the $1 million of deposits, just not concentrated with a large depositor," he said.
Another important factor for law firms to consider is the way their client escrow accounts are insured, according to Hack.
"A lawyer escrow account is not limited to only $250,000 of insurance for the entire account, so long as procedures are followed," he said. "If it is clear on the bank's records that the funds are held in a fiduciary capacity, and it is clear either on the bank's records or on the attorney's records what the separate ownership interests are in the fiduciary funds, then there is $250,000 of insurance for each beneficial ownership interest."
Look at Where the Bank's Expertise Lies
One final consideration for law firms is looking into their bank's level of experience and familiarity with providing services to law firms, including law firms of their size and focus, according to Silvia.
"A law firm that focuses heavily on litigation may have different interests in their banking provider than a law firm that does more on the trusts and estates side or underwriting side," Silvia said. "The questions law firms ask of their banks would be tailored by the kind of things they're using a bank for."
Large banks tend to have entire groups dedicated to law firms and serve firms of all sizes, which means they have expertise in handling the needs of a wide range of law firm customers.
However, for those considering a smaller community bank, it would be wise to look into what other types of law firms the bank serves and whether it has the products and services required by the firm, Silvia added.