The full picture of why Silicon Valley banking failed so spectacularly and so rapidly has yet to come into focus. But the sophisticated lender’s unusual lending practices contributed to its woes and raised questions about risk management by its executives and board, analysts said. These lending practices may also explain why the company is not affiliated with a healthy bank when the Federal Deposit Insurance Corporation typically launches, as the Federal Deposit Insurance Corporation did with Silicon Valley Bank last week.
For example, of the roughly $74 billion in total loans a Silicon Valley bank had on its books at year-end, nearly half — $34 billion — went to borrowers who used cash. Other lenders offer such loans, but in very limited amounts, filings show.
For now, things have calmed down at the bank following an extraordinary move by the federal government to guarantee all of its deposits, even those above the usual FDIC limit of $250,000. The company continues to operate under new management – Silicon Valley Bridge Bank.
Amid its decline, the bank is under investigation by federal prosecutors and the Securities and Exchange Commission and investors are concerned about the health of other U.S. and global banks. On Thursday, Treasury Secretary Janet Yellen testified before Congress about the chaos in the nation’s banking system, promising to “take a hard look” at what happened at Silicon Valley Bank.
By the end of 2022, Silicon Valley Bank had $175 billion in deposits and approximately $74 billion in loans. While the bank made loans to homebuyers, commercial real estate borrowers and California winemakers, the 40-year-old company took it all in on the burgeoning tech and startup industry. Silicon Valley Bank was the first to create loan products for startups. According to its website.
That’s led to unusual bond-related loans dominating Silicon Valley’s portfolio, said Bill Moreland, chief executive of BankRegData, a provider of bank regulatory statistics and analytics.
Although the exact details surrounding these loans are not mentioned, it is a borrower group with a high level of risk. What’s more, instead of having an asset of easy value, such as a home or commercial building, that backs these loans, they are backed by unidentified bonds that may even depreciate as interest rates rise and the tech sector declines.
Notably, these loans form a very large proportion of the bank’s portfolio. Moreland said, pointing to questionable risk management at the bank. Debts may also explain why Silicon Valley hasn’t been acquired or merged with a healthy company, he said.
“Typically, if you look at a bank with a $74 billion loan book, other banks will be interested in buying it,” he said in an interview. “But when 46% of your loan book is buying and carrying securities, a lot of banks are asking ‘what are those loans worth?’ ‘Is that an attractive property?’
Other banks offer such loans, but in very limited amounts, regulatory filings show. JPMorgan Chase, for example, had $14 billion in debt on its books at the end of the year, the next largest amount for a single bank, according to BankRegData. But of JPMorgan Chase’s $1.1 trillion in total loans, bond-backed loans make up only 1.3% of its debt.
Loans are certainly part of Silicon Valley’s “global finance bank” portfolio. According to the bank’s year-end financial statements, 56% of its total loans fell into this bucket. Bank loans to private equity and venture capital firms are repaid by investors in their funds when the firms request more capital from them.
Another type of loan favored by the bank was known as a venture loan A white paper on its site. In it, the bank describes how companies have lent startups 25% to 30% of their recent raises in private transactions with investors. Unlike other business loans based on a company’s cash flow or assets, this type of venture loan depends on the company’s ability to raise additional capital from investors to repay the loan, the website says.
This type of lending problem arises when a startup cannot raise new capital from investors to repay loans, or can only do so with low valuations from previous fundraising rounds. In the startup world, this situation is known as the dreaded “down round” of financing, which requires a company’s total valuation at a new, low level.
Since Silicon Valley Bank’s assets and deposits peak in 2022, tech and startup valuations have fallen significantly; Even well-funded mature tech companies are laying off thousands of employees as their lucky flag. This situation suggests problems in the bank’s venture lending business.
A Silicon Valley spokeswoman declined to answer questions about the bank’s risk management, its concentrated loan portfolio or how its loans were rated as activity at technology and startup companies slumped in recent months.
A contributing factor to the bank’s collapse also affected other lenders: rising interest rates created losses on the paper these companies held as investments in U.S. Treasury debt and mortgage-backed securities. As interest rates rise, newly issued debt securities have a higher yield than previously issued instruments, while older securities are worth less. Indeed, the average yield on Silicon Valley’s portfolio of debt securities was 1.6% at the end of the year, the bank’s financial filings show. That’s about half of what such bonds now earn.
As customers scrambled to withdraw their money from the Silicon Valley bank, some of these bonds had to be sold, resulting in a loss of $1.8 billion.
Facing a flood of withdrawals from depositors brought to light another flaw in the bank’s operations, Moreland said. The Silicon Valley bank had an unusually small cash cushion — $12 billion, or just 5% of its assets, regulatory filings show. Last Thursday alone, California bank officials said the bank recovered more than $40 billion from depositors.
Other banks have much larger cash positions. At year-end, Citibank held nearly 19% of its assets in cash.
In the best days at the Silicon Valley bank, its deposits ballooned fast, perhaps too fast to be properly managed, analysts said. Deposits rose to $183 billion from a year ago and will be $57 billion in 2020. When the bank collapsed, only 5.7% of its deposits were insured, compared with 40% at JPMorgan Chase, filings show.
Silicon Valley Bank’s securities filings state that oversight risk in its operations is “carefully considered by the risk management board in the oversight of the company’s strategy and business, including financial, reputational, regulatory, legal and compliance implications.”
One member of the bank’s risk committee is Mary Miller, a former high-ranking Treasury Department official under President Obama and a member of Silicon Valley Bank’s board of directors since 2015. Miller is now leading the bank’s board of directors in restructuring its business.
A Silicon Valley Bank spokeswoman declined to make Miller available for an interview.
“It was a party and the music was going on. And then, all of a sudden, it stopped,” Moreland said of the Silicon Valley bank.