BlackRock’s consulting arm warned Silicon Valley Bank, the California 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 impact of various risks on its securities portfolio. It later expanded the mandate to examine the risk systems, processes and people in its finance department who managed the investments.
The January 2022 risk control report gave the bank a “gentleman’s C” and found SVB lagged behind similar banks on 11 out of 11 factors considered and was “significantly below” them on 10 out of 11, the people said. The consultants found that SVB was unable to generate real-time or even weekly updates on what was happening to its 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. USD on the sale of securities, which triggered a stock price collapse and a deposit run. That added to fears of bigger paper losses, which the bank nurtured in long-dated securities that lost value when the Fed raised interest rates.
The 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 selected by the bank, said two people familiar with the work.
Although BlackRock did not make financial recommendations to SVB in that review, its work was presented to the bank’s senior management, which “confirmed the direction management was on” in building its securities portfolio, a former SVB executive said. The director 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 boosting yields from 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 considered what would happen to SVB’s balance sheet in the event of a sharper rate hike, such as the Federal Reserve’s rapid hikes 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 percent since 2008. That hearing ended in June 2021.
BlackRock declined to comment.
SVB had already begun absorbing large interest rate risks to shore up profits before the BlackRock review began, former employees said. The hearing did not consider the deposit side of the bank, so the possibility that SVB would be forced to sell assets quickly to accommodate the outflow was not delved into, multiple people confirmed.
The FDIC and California banking regulators declined to comment. A spokesman for the SVB Group did not respond to a request for comment.
While the BlackRock review was ongoing, technology companies and venture capital firms poured 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 its balance sheet. A large part of the money ended up in long-term mortgage securities with low returns, which have since lost over DKK 15 billion. USD in value.
The Financial Times previously reported that in 2018, under new financial leadership led by CFO Beck – 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 portfolio of DKK 91 billion. USD with an average interest rate of only 1.64 percent.
The maneuver strengthened SVB’s earnings. Its 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 failed to take into account the risk that rising interest rates would both lower the value of its bond portfolio and lead to significant deposit flows, insiders said, exposing the bank to financial pressures that would later lead to its downfall.
“Dan (Beck’s) focus was on net interest income,” said a person familiar with the matter, adding, “it worked until it didn’t”.