Silicon Valley Bank was warned by BlackRock that risk controls were weak
BlackRock’s consulting arm warned Silicon Valley Bank, the California-based lender whose failure helped trigger a banking crisis, that its risk controls were “significantly below” its peers in early 2022, several people with direct knowledge of the assessment said.
SVB hired BlackRock’s Financial Markets Advisory Group in October 2020 to analyze the potential effect of various risks on the securities portfolio. It later expanded its mandate to examine the risk systems, processes and people in the finance department, which managed the investments.
The January 2022 risk control report gave the bank a “gentleman̵[ads1]7;s C”, finding that SVB lagged behind similar banks on 11 of 11 factors assessed and was “significantly below” them on 10 of 11, the people said. The consultants found that SVB was unable to generate real-time or even weekly updates on what was happening with the securities portfolio, the people said. SVB listened to the criticism, but rejected offers from BlackRock to do follow-up work, they added.
SVB was taken over by the Federal Deposit Insurance Corporation on March 10 after it announced a $1.8 billion loss on the sale of securities, leading to a stock price collapse and a deposit run. That accentuated fears of greater paper losses the bank nursed in long-dated securities that lost value when the Fed raised interest rates.
FMA Group analyzed how SVB’s securities portfolios and other potential investments would react to various factors, including rising interest rates and broader macroeconomic conditions, and how that would affect the bank’s capital and liquidity. The scenarios were chosen by the bank, two people familiar with the work said.
While BlackRock did not make financial recommendations to SVB in that review, the work was presented to the bank’s senior management, which “confirmed the direction management was on” in building the securities portfolio, a former SVB executive said. The manager added that it “was an opportunity to highlight risks” that the bank’s management missed.
At the time, CFO Daniel Beck and other top executives were looking for ways to boost the bank’s quarterly earnings by bolstering returns on securities it held on its balance sheet, people briefed on the matter said.
The review looked at scenarios including rate hikes of 100 to 200 basis points. But no models assessed what would happen to SVB’s balance sheet if there was a sharper interest rate increase, such as the Federal Reserve’s rapid increases to a base rate of 4.5 percent over the past year. At the time, the interest rate was at rock bottom and had not been above 3 per cent since 2008. That consultation ended in June 2021.
BlackRock declined to comment.
SVB had already begun absorbing large interest rate risks to bolster profits before the BlackRock review began, former employees said. The consultation did not take into account the deposit side of the bank, so it did not delve into the possibility that SVB would be forced to sell assets quickly to meet outflows, several confirmed.
The FDIC and California banking regulators declined to comment. A spokesperson for the SVB group has not responded to a request for comment.
While the BlackRock review was ongoing, technology companies and venture capital firms poured in a flood of cash into SVB. The bank used BlackRock’s scenario analysis to validate its investment policy at a time when management was closely focused on the bank’s quarterly net interest income, a measure of earnings from interest-bearing assets on the balance sheet. Much of the money ended up in long-term, low-yield debt securities that have since lost over $15 billion in value.
The Financial Times previously reported that in 2018, under new financial leadership led by CFO Beck, SVB – which historically held its assets in securities with maturities of less than 12 months – shifted to debt maturing in 10 years or later to boost returns. It built a $91 billion portfolio with an average interest rate of just 1.64 percent.
The maneuver strengthened SVB’s earnings. Return on equity, a closely watched measure of profitability, rose from 12.4 percent in 2017 to more than 16 percent each year from 2018 to 2021.
But the decision did not take into account the risk that rising interest rates would both reduce the value of the bond portfolio and lead to significant deposit outflows, insiders said, exposing the bank to financial pressures that would later lead to its downfall.
“And [Beck]the focus was on net interest income,” said a person familiar with the matter, adding, “it worked until it didn’t”.