BlackRock’s consulting arm warned Silicon Valley Bank, the California-based lender that failed to stem the banking crisis, that its risk controls were “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 then added a mandate to review risk systems, processes and people in the treasury department, which manages these investments.
The January 2022 risk control report gave the bank a “gentleman’s C”, finding that SVB lagged behind similar banks in 11 out of 11 factors considered and was “below” in 10 out of 11, the people said. Consultants found that SVB was unable to generate real-time or even weekly updates on what was happening in its securities portfolio, the people said. SVB listened to the criticism but turned down an offer from BlackRock to do the work, he added.
SVB was taken over by the Federal Deposit Insurance Corporation on March 10 after announcing a loss of $1.8bn in the sale of securities, causing a collapse in stock and deposit prices. It accentuated fears over the larger paper losses the bank was nursing on long-dated securities that lost value as the Fed raised interest rates.
The FMA Group analyzes how SVB’s portfolio of securities and other possible investments will respond to various factors including rising interest rates and broader macroeconomic conditions, and how this affects the bank’s capital and liquidity. The scenario was chosen by the bank, two people familiar with the work said.
While BlackRock did not make financial recommendations for SVB in their review, this work was presented to the bank’s senior leadership, which “confirms the direction management is in” in building its securities portfolio, said one former executive of SVB. The executive added that “it was an opportunity to highlight the risks” missed by the bank’s management.
At the time the chief financial officer Daniel Beck and other top executives were looking for ways to increase the bank’s quarterly earnings by bolstering the yield of securities held on the balance sheet, said people briefed on the matter.
The review looks at scenarios including an interest rate hike of 100 to 200 basis points. But none of the models take into account what would happen to SVB’s balance sheet in the event of a sharper rate hike, such as the Federal Reserve’s rapid increase to its base rate of 4.5 percent last year. At that time, the interest rate was the highest and did not exceed 3 percent since 2008. The consultation ends in June 2021.
BlackRock declined to comment.
SVB has begun to absorb the risk of large interest rates to bolster profits before the BlackRock review began, said former employees. The consultation does not consider the deposit side of the bank, so it does not delve into the possibility that SVB will be forced to sell assets quickly to meet outflows, some 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 underway, tech companies and venture capital firms poured a flood of cash into SVB. The bank used BlackRock’s scenario analysis to validate its investment policy at a time when management is focused heavily on the bank’s monthly net interest income, a measure of earnings from interest-bearing assets on the balance sheet. Most of that money is in long-dated mortgage securities with low yields that have lost more than $15bn.
The Financial Times previously reported that in 2018, under the new financial leadership regime led by CFO Beck, SVB – which historically held assets in securities maturing under 12 months – moved to debt maturing 10 years or later to increase returns. This creates a $91bn portfolio with an average interest rate of just 1.64 per cent.
The maneuver boosted SVB’s earnings. Return on equity, a closely watched measure of profitability, rose from 12.4 percent in 2017 to more than 16 percent annually from 2018 to 2021.
But the decision failed to account for the risk that interest rate increases will both lower the value of the bond portfolio and lead to substantial deposit outflows, said insiders, exposing the bank to financial pressure that will later lead to collapse.
“And [Beck]’s focus is on net interest income, “said one person familiar with the matter, adding,” it can come out until not.