The failure of Silicon Valley Bank: The song remains the same
All successful banks are the same; each bank fails in its own way and SIVB, as well as the spate of additional failures that followed, are no different.
This is a guest post from David Glaymon, a former partner of Kynikos Associates, where he worked identifying financial fads and frauds and had a front-row seat to the Global Financial Crisis. Prior to that, working as sell-side analyst in both equity and corporate bond research, he was an eyewitness to the telecom bubble.
“All happy families are alike; each unhappy family is unhappy in its own way.” Leo Tolstoy, Anna Karenina
The failure of SVB Financial Group (SIVB), led by the collapse of its subsidiary Silicon Valley Bank, seems different than crisis-era collapses but also, in many ways, the same. In the wake of any corporate collapse predictable patterns emerge. Investors and customers appear stunned, but finger-pointing begins immediately. The truth emerges slowly but steadily, and management greed and corporate governance failure repeatedly drive stories that were hiding in plain sight.
There have been no shortage of explanations for the failure of SIVB from pundits and experts. They run the gamut. A simple take is that it was a bet gone bad on higher yield, longer duration US government bonds. A political one is that oversight was hampered by the 2018 bipartisan rollback of Dodd-Frank Act regulatory requirements for banks under $250 billion in assets. Opportunistic ridiculous takes include that the collapse was a function of the board's focus on diversity and inclusion rather than risk, given key departures from the board of directors and risk management team in 2022.
These theories miss the point. SIVB reflected its Silicon Valley environment. SIVB’s management was incentivized to focus on rewards while paying scant attention to risk, reflecting the attitudes of its venture capitalist customer base. Its senior executives were incentivized to drive share price with no motivation to balance share price appreciation with prudent risk management.
Riding the Upside
Silicon Valley Bank was founded in 1983 by a group of former Bank of America executives. It immediately positioned itself as a "broker connecting start-up companies with venture capitalists and professional services advisors. Numerous news stories have now documented how it cemented that spot, including by providing a range of services extending far beyond those of a conventional bank.
From NBC News’ Gretchen Morgenson:
While the bank made loans to homebuyers, commercial real estate borrowers and California winemakers, the 40-year old institution went all in on the burgeoning tech and startup company sector. Silicon Valley Bank was the first to create loan products for startup companies, according to its website. This led to the unusual securities-related loans dominating Silicon Valley’s portfolio, said Bill Moreland, chief executive of BankRegData, a provider of bank regulatory statistics and analysis.
Given its Silicon Valley roots, the bank acted like its venture capitalist customers, always focused on the upside. SIVB bankers believed they were putting these companies into business, so they should also get a piece of the action. Acquiring warrants as part of providing credit facilities and other services was just part of the game.
According to its most recent 10-K, at December 31, 2022, SIVB held warrants in 3,234 companies, compared to 2,831 companies at December 31, 2021 and 1,320 companies ten years ago. The total fair value of the warrant portfolio was $383 million at December 31, 2022 and $277 million at December 31, 2021. Warrants in 65 companies each had fair values greater than $1 million and collectively represented $199 million, or 51.9 percent, of the fair value of the total warrant portfolio at December 31, 2022.
That largesse extended to the crypto economy, one that many of Silicon Valley Bank’s most important customers such as Andreessen Horowitz's 16z and Peter Thiel's Founders Fund heavily support. In Feb 2021, Coindesk reported that banking services were so hard for cryptocurrency businesses to come by in the early days that pre-IPO Coinbase gave Silicon Valley Bank (SVB) stock warrants in 2014. This was part of an agreement allowing Coinbase to send and receive U.S. dollars through the banking system.
The disclosure in Coinbase's S-1 filing describes a warrant that gave Silicon Valley Bank the right to buy more than 400,000 class B shares of common stock at a little over $1 per share.
Management’s Key Incentive
SIVB’s management was paid for making its stock go up. There were three stated metrics in named executive officer (NEO) compensation:
1) Return on equity (ROE);
2) Stock price appreciation; and
3) Total shareholder return (TSR).
In 2009, SIVB reported a return on average common equity of 2.68%, with deposits at $10.3 billion and total assets at $12.8 billion. Micheala K. Rodeno, chair of the bank’s Compensation Committee and a longtime vintner who was also a director of the US wine industry trade group, Wine Market Council, led the adoption of the new metrics in 2010. With ROE now a key compensation metric, SIVB’s ROE jumped to 7.72% as assets grew to $17.8 billion.
Dan Beck, SIVB’s Chief Financial Officer, joined the company on June 5, 2017. In the six years under his management, SIVB’s ROE was consistently higher than the seven years before his arrival.