Flush with cash from a booming tech industry, Silicon Valley Bank executives embarked on a strategy in 2020 to juice profits that quickly triggered an internal alarm.
In buying longer-term investments that paid more interest, SVB had fallen out of compliance with a key risk metric. An internal model showed that higher interest rates could have a devastating impact on the bank's future earnings, according to two former employees familiar with the modeling who spoke on the condition of anonymity to describe confidential deliberations.
Instead of heeding that warning - and over the concerns of some staffers - SVB executives simply changed the model's assumptions, according to the former employees and securities filings. The tweaks, which have not been previously reported, initially predicted that rising interest rates would have minimal impact.
The new assumptions validated SVB's profit-driven strategy, but they were profoundly misplaced. Over the past year, interest rates have climbed nearly five percentage points, the fastest pace since the 1980s. Meanwhile, the tech industry has entered a post-pandemic swoon, causing SVB's elite clientele to withdraw cash far faster than bank executives had expected.
On March 8, the bank was forced to raise additional cash by selling securities at a $1.8 billion loss. That touched off panic among SVB clients, who staged one of the biggest bank runs in U.S. history. Fanned by social media, depositors tried to withdraw $42 billion in a single day. The next morning, the bank collapsed and federal regulators took control.
The episode shows that executives knew early on that higher interest rates could jeopardize the bank's future earnings. Instead of shifting course to mitigate that risk, they doubled down on a strategy to deliver near-term profits, displaying an appetite for risk that set the stage for SVB's stunning meltdown.
"Management always wanted to tell a growth story," one former employee involved in the bank's risk management said. "Every quarter, there was always this pressure to deliver earnings."
The new revelations come as lawmakers and regulators review what a senior Federal Reserve official called a "textbook case of mismanagement" leading to the nation's second-largest bank failure. Much of their focus will turn to the arcane world of managing interest-rate risk.
SVB's new projections took effect last year and assumed that cash flow from deposits would stay consistent for longer, softening the projected bite of higher interest rates. Before changing the model, an interest-rate hike of two percentage points would drop a measure of future cash flows by more than 27 percent; afterward, the hit was less than 5 percent, according to the bank's securities filings.
Pushing for the change in assumptions was Dan Beck, SVB's chief financial officer, according to one former employee, and it was approved by the bank's Asset Liability Management Committee, which manages interest-rate risk, both former employees said. The change made several mid-level bank officials uncomfortable, one person said, though there was historical data on deposits to support it.
Efforts to contact Beck were unsuccessful, and lawyers representing him in a lawsuit didn't respond to requests for comment. Efforts to contact Michael Kruse, who headed the bank's Asset Liability Management Committee, according to the former employees, were also unsuccessful.
One of the former employees said changing assumptions about interest-rate risk were shared with federal and state regulators in late 2021 or 2022.
An official at the California Department of Financial Protection and Innovation said it could not comment on "confidential supervisory information."
Michael Barr, the Fed's vice chair for supervision, testified to a Senate committee Tuesday that its supervisory team cited the bank for "ineffective board oversight" and "risk management weaknesses" in May. A Federal Reserve spokesman declined to comment beyond those public statements.
SVB was a financial pillar of Silicon Valley start-ups, lending money to companies with untested business models but high potential for growth. As SVB prospered alongside the start-ups it aided, top executives increasingly thought of themselves as part of the industry they served and prioritized highflying returns, according to current and former employees. For a time, they succeeded: The stock price of SVB Financial Group, the bank's holding company, tripled in less than two years as deposits grew at breakneck speed.
Greg Becker, SVB's chief executive, was given to enthusiastic pronouncements on the prospects of start-ups and tech firms, even in recent downtimes. He saw himself as more venture capitalist than banker, according to some who know him.
"He thinks about taking some risks to make effective investments in companies, which is not how banks normally do them," a longtime venture capitalist who often dealt with Becker said, speaking on the condition of anonymity to preserve relationships in the Silicon Valley finance world. "It's fair to say he was more focused on the upside than risk management."
A spokesman for Becker declined to comment for this article.
SVB's rapid growth during the early years of the pandemic created several stresses. The bank had to invest a mountain of customer cash at a time of rock-bottom interest rates. To maximize its return, the company purchased longer-term mortgage and government-backed securities that pay higher interest than the bank passed on to its depositors, allowing it to show sparkling financial performance every quarter for two years.
In an apparent bet that interest rates would go down last fall, SVB sold for a profit the financial instruments it used to hedge against the risk of higher rates, according to a company presentation. Instead, the opposite happened: The Federal Reserve began to raise interest rates more aggressively over the summer to tamp down inflation. That reduced the value of SVB's securities portfolio, meaning the bank would take a loss if it had to sell.
"They thought they could never go wrong," said a former bank official who spoke on the condition of anonymity to discuss internal business practices, recalling an internal stress test in late 2018 or 2019 that showed SVB could lose at least a third of its deposits over two years. Executives directed that that model also be reworked. "If they see a model they don't like," the official said, "they scrap it."
Kate Mitchell, a venture capitalist and chair of the SVB board's risk committee, didn't respond to a request for comment.
The behavior of customers depositing money is a key variable that banks use in developing risk models. One metric, closely tracked by banks and their examiners, estimates future cash flows and how sensitive they are to changes in interest rates. It was this metric, called the economic value of equity, that triggered a warning in mid-2020, according to the former employees.
SVB hired a consultant, Curinos, to review its interest-rate risk model, according to the former employees. The bank first disclosed the review of its model in May and finalized the change in the second quarter of 2022. But by the end of the year, SVB left out the economic value of equity - which it had reported for a decade - from its public interest-rate analysis.
Curinos declined to comment on whether it did any work for SVB, adding in a statement that the company works with banks and "routinely analyzes customer behavior to assess the likelihood that their balances will change based on different stimuli, such as interest rates."
In catering to start-ups and tech companies, the bank had fewer customers than most banks its size. At the end of last year, 93.8 percent of SVB's deposits were above Federal Deposit Insurance Corp. limits and thus uninsured, the highest proportion among large U.S. banks, according to S&P Global. That made it more exposed to the risk of customers pulling their money, some felt.
In April 2022, SVB parted ways with its chief risk officer of nearly six years, Laura Izurieta. The bank said that it "initiated discussions with Ms. Izurieta about a transition" in early 2022 and that she stayed on to help with "transition-related duties" until October. SVB didn't disclose this until March 3, when a securities filing revealed it didn't hire a new chief risk officer until late December.
Izurieta didn't respond to requests for comment.
As late as July, Beck, the company's chief financial officer, said on an earnings call that "we're still well positioned to the upside for higher rates." But pressure was mounting on SVB as interest rates rose faster than the company had expected.
When the company filed its quarterly earnings report the following month, it revealed that its long-term securities - accounting for about 45 percent of its total assets - had an unrealized loss of $11.2 billion, up dramatically from a $1.3 billion unrealized loss just six months earlier. Three months later, unrealized losses totaled nearly $16 billion.
Compounding SVB's troubles, the bank was paying higher interest to keep customers from pulling their money while borrowing at higher rates.
By the end of 2022, SVB's deposits were costing the bank almost twice as much as the median among a group of peers, according to Moody's.
Some on Wall Street were also taking notice. Chris Kotowski, an analyst at Oppenheimer & Co., downgraded SVB's stock from buy to hold last September after the bank indicated its income from interest payments was under pressure.
"That just set the alarm bells off for me," Kotowski said.
With SVB's income squeezed by higher deposit and borrowing costs, investors soured on its stock, prompting executives to make their case to Wall street analysts.
JPMorgan Chase & Co. analysts hosted a webinar last November with Beck, SVB's chief financial officer, who addressed investor concerns over nearly two hours, according to a research note the bank sent to clients. The analysts concluded that the downturn in deposits was manageable and that SVB had ample liquidity without having to sell securities at a loss, "even if a worst case scenario plays out." As late as January, JPMorgan forecast a turnaround for SVB and recommended clients buy the stock.
A week before the bank failed, in its annual report to shareholders, SVB praised its top executives for an area of achievement: managing risk.
Becker, the CEO, had displayed "strong leadership of the continued evolution of risk management." Beck, the CFO, was credited for "promotion of a strong risk culture."