From his base in Boston, Jesse Hurley cultivated the relationships that helped fuel Silicon Valley Bank’s stunning rise. He negotiated deals with thousands of venture capital and private equity firms that invested in everything from experimental medicines to artificial intelligence with checks ranging from $5 million to more than $30 million.
Hurley, however, was not in the business of lending to companies and operating businesses. He headed SVB’s global fund banking group that funded the venture capitalists themselves with a piece of financial engineering known as fund subscription lines. These loans were used to make initial equity investments in companies and served several purposes, including goosing a key metric that made venture capital fund returns look better than they would have otherwise.
“We are probably one of the largest fund finance practices in the world … to still fly under the radar has been surreal,” Hurley said in a 2021 podcast. “This organization is just so supportive of this business and is really all-in on fund financing.”
Hurley’s business wouldn’t fly under the radar too much longer. The run on the bank that led to the collapse of Silicon Valley Bank this week was sparked by venture capital firms, like Peter Thiel’s Founders Fund, that instructed the startups and businesses they backed to move their deposits out of SVB due to fears about the bank’s weakening balance sheet. The relationships that Hurley had helped cultivate for a decade soured and turned on the institution that largely existed to support the investor class in Silicon Valley. It was a business fraught with complexity and its growth created real challenges in the years leading to SVB’s demise. SVB declined to comment for this story
Silicon Valley Bank may have started out in the 1980s as a bank that mostly supported small businesses and tech startups, but that changed over the last decade as the bank rode the boom in venture capital and technology investing. Its chief business was making loans through fund subscription lines to venture capital firms that, in turn, used the rock-solid capital commitments of their investors as collateral.
A decade ago, SVB held $1.7 billion of fund subscription line loans, representing 19% of its total loan portfolio, Securities & Exchange Commission filings show. By the end of 2022, the bank was holding $41.3 billion of these loans on its books, making up 56% of its total book. SVB created a new business segment, global fund banking, to manage its subscription lines with Hurley in charge. By contrast, debt financing the bank extended directly to startups, tech companies and biotechs amounted to just $15.3 million, SEC filings show, only a fifth of SVB’s loans at the end of 2022.
The subscription lines were SVB’s main business, but the problem was it was not a lucrative one. The loans generated very low returns, even compared to commercial loans, which themselves were not yielding so much due to the low-interest-rate environment. What the subscription lines did do was bring new clients and deposits to the bank, chances to sell other products and services.
“We’ve had incredibly strong term sheets and new business sign-ups in the global funds banking,” SVB CEO Greg Becker told the bank’s investors last year. “That also creates opportunities.”
To understand the business SVB was really in, you need to understand the business of its main lending clients: venture capital and private equity firms, not the companies they backed. These investors raise money from pension funds, endowments and rich people to invest in companies for several years. The better the venture firms’ financial returns, the easier it is to entice investors to cough up more money the next time they go out to raise a new fund. And the most important metric that is used to assess financial performance is the internal rate of return, or IRR, of a venture capital or private equity fund.
An IRR is made up of several inputs and an important one is time. The shorter the period of time between when an investment is made and profitably exited, the higher the IRR. In recent years, private equity firms have increasingly tapped big Wall Street institutions like Citigroup
and Goldman Sachs
through fund subscription lines set up to lend money to make investments. The private equity firms initially use these borrowed funds and months later call capital from their investors, shortening the IRR clock on an investment. The maneuver also means the firms don’t have to quickly call investor capital for a specific deal, which can be helpful and reduce the administrative burden of making an investment.
“The use of credit in lieu of capital generally boosts net IRR, because it delays capital calls,” noted consultancy MJ Hudson in a report. “IRR is a popular metric to compare fund performance. All other things being equal, the higher the reported IRR, the better the manager’s quartile ranking.”
At big Wall Street banks, subscription lines are viewed as a loss leader, a way for banks to get their hooks into private equity firms that will later bring more lucrative business, like the big loans associated with leveraged buyouts.
SVB brought subscription lines to Silicon Valley. Venture and private equity firms would tap SVB fund subscription lines to make investments in startups and tech businesses, which would be encouraged to deposit those funds at SVB. The underlying decision to invest in the startups was not contingent on the SVB loans and eventually the venture firm would call capital from its investors to pay the loan back.
While all this activity helped boost SVB’s deposits from $62 billion at the end of 2019 to $189 billion at the end of 2021, the bank did not earn all that much income from it. Those more lucrative buyout loans? They only added up to $2 billion at the end of 2022, an SEC filing shows, a mere 2.6% of SVB’s loan book. Citigroup, one of the biggest fund subscription line lenders on Wall Street, is dramatically backing away from this business because it hasn’t generated enough other business in more profitable lending areas.
As deposits exploded at SVB, the bank decided to do something about this situation. It couldn’t find enough ways to earn good money by putting its deposits to work through its fund subscription line business or other lending activities. The bank, which had been plowing the excess money into its investment portfolio, started making changes to it. Until 2018, SVB mostly held mortgage bonds maturing within one year, the Financial Times reported, but as the global fund banking unit exploded the bank bought longer-dated mortgage bonds with fixed yields that were slightly higher to boost the bank’s income. When rates on bonds spiked last year, those longer-dated bonds SVB held were worth much less. Bond yields move opposite to prices.
By the start of this year, venture capital investment had dropped off and many venture-backed companies were drawing down cash on their bank accounts. When deposits fell, SVB sold a big chunk of its longer-dated bonds, realizing a $1.8 billion loss. With SVB’s balance sheet shaky, the bank’s venture capital clients started directing their portfolio companies to move their cash out of the bank, causing a run.
The same venture capital investors that the bank had supported for years ended up killing it. Hurley, the SVB executive who had been at the center of those relationships, once bragged, “we have a remarkably diverse set of clients.” It turned out those VC clients were not as different as Hurley thought and that SVB’s business wasn’t so great either. Another indication of that is that even with federal government support, no bank now seems interested in buying SVB.
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