The full picture of why Silicon Valley Bank failed so spectacularly and so quickly has yet to be clarified. But unusual lending practices at the cutting-edge lender contributed to its woes and raised questions about risk management by its executives and board, analysts said. These lending practices may also explain why there hasn’t been a merger of the institution with a saner bank, as often happens when the Federal Deposit Insurance Corporation steps in as it did with Silicon Valley Bank last week.

For example, of the roughly $74 billion in total loans Silicon Valley Bank had on its books at the end of the year, nearly half, $34 billion, went to borrowers who used the money to buy or hold their own securities, as shown by regulatory data. Other lenders make such loans, but in much smaller amounts, the filings show.

For now, things have calmed down at the bank following an extraordinary move by the federal government to guarantee all its deposits, even those above the FDIC’s usual limit of $250,000. The institution continues to operate under new management and a new name: Silicon Valley Bridge Bank.

In the midst of its collapse, the bank is under investigation by federal prosecutors and the Securities and Exchange Commission, and investors are worried about the health of other US and global banks. On Thursday, Treasury Secretary Janet Yellen testified before Congress about the turmoil in the nation’s banking system and vowed to «take a hard look» at what happened at Silicon Valley Bank.

As 2022 drew to a close, Silicon Valley Bank had $175 billion in deposits and approximately $74 billion in loans. While the bank made loans to California homebuyers, commercial real estate borrowers and winemakers, the 40-year-old institution was fully dedicated to the booming technology sector and start-ups. Silicon Valley Bank was the first to create loan products for startups, according to their website.

This led to unusual securities-related loans dominating Silicon Valley’s portfolio, said Bill Moreland, chief executive of BankRegData, a provider of banking regulation statistics and analysis.

While the precise details surrounding these loans are not specified, it involves a large concentration of risk among a group of borrowers. Also, instead of having easily valued assets like a home or commercial building backing these loans, they are backed by unidentified securities that may also have lost value as interest rates rose and the tech sector fell.

It is noteworthy that these loans constitute such an important proportion of the bank’s portfolio, Moreland said, pointing to dubious risk management at the bank. The loans may also explain why Silicon Valley hasn’t been acquired or merged with a healthier institution, he said.

“Usually if you look at a bank with a $74 billion loan book, other banks would be interested in buying that,” he said in an interview. “But when 46% of your loan book is to buy and hold securities, a lot of banks have to ask, ‘What’s the value of those loans?’ ‘Is that an attractive asset?’”

Other banks do make such loans, but in much smaller doses, regulatory documents show. JP Morgan Chase, for example, had $14 billion of these loans on its books at the end of the year, the next largest amount held by a bank, according to BankRegData. But with JP Morgan Chase’s $1.1 trillion in total loans, securities-backed loans make up just 1.3% of its loans.

The loans are almost certainly part of what Silicon Valley called its «Bank of Global Funds» portfolio. According to the bank’s year-end financial statements, some 56% of its total loans fell into this category. Loans the bank made to private equity and venture capital firms were included for investors to repay in their funds when the firms ask for more capital.

Another type of loan favored by the bank was known as risky debt, according to a white paper on your site. In it, the bank described how it provided loans to start-ups of between 25% and 30% of the amount the companies had most recently raised in private transactions with investors. Unlike other business loans that are based on a company’s cash flow or assets, this type of risky debt relies on a company’s ability to raise additional capital from investors later to pay off the loans, he says. the website.

A problem with these types of loans arises when a start-up company is unable to raise fresh capital from investors to repay the loans or can do so only at a lower valuation from previous rounds of raising money. In the startup world, this situation is known as the dreaded «down round» of funding, which requires a full valuation of a company at the new bottom tier.

Since Silicon Valley Bank’s assets and deposits peaked in 2022, tech and startup valuations have fallen significantly; even mature and well-financed tech companies are laying off thousands of employees as a sign of their fortunes. This scenario suggests problems with the bank’s risky debt business.

A Silicon Valley spokeswoman declined to answer questions about the bank’s risk management, its concentrated loan portfolio or how its loans have been valued as operations by technology companies and startups have slowed in recent months.

One factor that contributed to the bank’s collapse affected other lenders as well: Rising interest rates led to paper losses on US Treasury debt and mortgage-backed securities these institutions held as investments. When interest rates rise, newly issued debt securities have higher yields than previously issued instruments, making older securities less valuable. In fact, the average return on Silicon Valley’s portfolio of debt securities was around 1.6% at the end of the year, the bank’s financial reports show. That’s about half the level that those values ​​now yield.

When customers rushed to withdraw their money from Silicon Valley Bank, it had to sell some of these securities, resulting in a $1.8 billion loss, it said.

Dealing with the onslaught of depositor withdrawals exposed another flaw in the bank’s operation, Moreland said. Silicon Valley Bank had an unusually small cash cushion: just $12 billion, or just 5% of its assets, regulatory filings show. Last Thursday alone, the bank made redemptions of more than $40 billion from depositors, California banking authorities said.

Other banks have much larger cash positions. At the end of the year, Citibank had almost 19% of its assets in cash.

During Silicon Valley Bank’s best days, its deposits skyrocketed, perhaps too fast to manage properly, analysts said. A year ago, deposits peaked at $183 billion, up from $57 billion in 2020. When the bank collapsed, just 5.7% of its deposits were insured, the documents show, compared with 40% in JP Morgan Chase.

Silicon Valley Bank’s securities filings tout its board’s oversight of risk in its operations, saying that «the board carefully considers risk management in its oversight of the company’s strategy and business, including financial implications.» reputation, regulatory, legal and compliance».

One member of the bank’s risk committee was Mary Miller, a former high-ranking Treasury Department official under Obama and a Silicon Valley Bank board member since 2015. Miller now heads a committee of bank directors that pitches potential offers for his loans and is considering a restructuring of his business.

The Silicon Valley Bank spokeswoman declined to make Miller available for an interview.

“It was a party and the music kept playing and the money kept flowing,” Moreland said of Silicon Valley Bank. Then suddenly he stopped.

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