In 2011, I published an essay on the need for multiple banking relationships that hits the SVB coffin nail on the head.
By John E. McNellis, at real estate developer McNellis Partners, for WOLF STREET:
Silicon Valley Bank’s overnight collapse cold-plunged us into reality, a grim reminder that nothing is more constant than fear and greed, and it has us all scurrying to protect ourselves.
We hold an SVB letter of credit as rent security from a start-up tech tenant, and we have an operating line of credit with the bank. Whether we can draw a dime on either today is a coin toss.
Not that we’re ever wholly innocent, but this one isn’t on us—we were shanghaied into SVB.
Decades ago, we were happily ensconced with Borel Private Bank & Trust, a small Bay Area bank that understood real estate, was comfortable with California’s astronomic valuations and renowned for swift decisions. Too good to last. Boston Private Bank bought Borel in 2001 and lending decisions began wobbling, coming from the Back Bay rather than the Bay Area. SVB bought Boston in 2021.
In two chess moves, we went from cozy lenders to a tech bank that, as far as we could tell, had little interest in mundane shopping centers.
In 2011, I published an essay on the need for multiple banking relationships that hits the SVB coffin nail on the head.
It subsequently became chapter 18 of my primer, Making it in Real Estate. Here it is:
A picture of a developer and banker shaking hands could illustrate Wikipedia’s explanation of “symbiotic relationship.” Developers need to borrow and bankers need to lend, despite their occasional issues with regulators. We could almost end this chapter right there, but a few nuances in this often-happy relationship are worth touching on.
Unless the announcement of your birth appeared in the New York Times, you have to get started somewhere and, for successful deals at least, a banker’s money is always the cheapest in town—far cheaper, no matter the interest rate, than giving away half the deal. Yes, rookie developers must part with nearly everything regardless. But with a bit of luck, they may over time be able to decide for themselves how much to rely on banks versus equity partners.
Veteran developers usually argue in favor of partners, noting that you have to personally guarantee bank debt whereas you promise your equity partners nada (at least in the fine print).
However, if you are going to feel a moral obligation—forget the partnership agreement’s absolution—to repay your investors, you’re better off guaranteeing bank debt; your ethical and legal obligations are identical and you get to keep all the profits. Also, personal guaranties have the side benefit of focusing your attention on the moment at hand—in this case, your deal’s underwriting. Sooner or later, we all lose money, but perhaps a bit less often when it is our own money.
So, a banker is a successful developer’s best friend. But the first time you try to borrow more than a cup of sugar, your banker will want a committed, monogamous relationship. They will want all of your business. They will shake hands and promise to take care of all your needs; they will lend you every dollar you will ever need. And they will mean it. Your BFF with financial benefits. Here’s the problem—you can’t shake hands with a corporation.
Despite the best intentions in the world, your banker is only as good as the last loan they committed to you. Although your banker may truly become a close friend over time, likely as not they will quit, retire, be fishing, or be in the hospital the week you absolutely need a loan commitment. Or, their bank will be merged out of existence (this has happened to us four times), be taken over by the Feds (underline added 2023), or simply stop making real estate loans.
The solution? You need an open relationship with three bankers at three different banks. That way, the lights are always on somewhere. Will this be without its own sturm und drang? Of course not—for the same reasons an open relationship has never worked for any couple since Adam and Eve: your bankers will hate it. But they will begrudgingly accept it once they understand and accept your legitimate need for a financial backup plan.
Your role then is to nurture that understanding and acceptance. Bankers are sensitive souls. They don’t get out of their offices all that often; their joys are in the neat, the orderly, and the calm. Bankers are a lot like accountants, only with personality. They love nothing better than sipping herbal tea while poring over your spreadsheets, provided, of course, your numbers are handsomely positive. They savor reports showing solid leasing and construction progress; they embrace financial statements with even the merest hint of liquidity.
While easily pleased, bankers are not perfect. They can react badly when startled. The casual mention of a second lien holder’s pending foreclosure—especially one known for months—can be cause for surprising rancor. They can be oddly prickly about not having their calls returned (they have the money, after all) or about receiving a developer’s reply at 6 p.m. on Christmas Eve. And bankers may be at their least charming when confronted with bold-faced lies, displaying far less in the way of patience than, say, a mental health worker. Somewhere along the line, bankers lost their childlike joy in surprises.
Bankers are aware of their senseless, pathological aversion to risk, but, knowing how unhip it is to be wimpy, they hate being reminded of it. They especially hate it when a developer tosses aside their concerns with a chuckling dismissal: “Toxics? No problem, bro. That town already glows in the dark; no one will ever notice our little spill.”
The clever developer will make allowances for these personality quirks when maintaining the connection with their banker. But with a little care (under-promising is a time-honored strategy), your new best friend, your banker, will be your pal forever, or at least until they retire, get transferred, or go fishing. By John E. McNellis, author of Making it in Real Estate: Starting Out as a Developer.
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When you get into trouble your friendly local banker will be replaced with Hector the Collector before you can say, “oh my.”
And the bank will see to it that you lose your last dollar before the bank loses it’s first.
Many people thought that, while most investments have been losing money over last year, atleast cash in bank is safe.
Turn out that even that is wrong!
I feel many like me are getting screwed by this “very slow QT”. The best I can do is to buy TBills and rotate, and even then, I lose money to inflation, as more than 80% of my spending is services, where inflation is running pretty higher than TBill yield. Most other investments are losing money. Got lucky with some allocation to GLD 4 years ago.
Fed needs to speed up QT, else people will lose trust in fiat and the US monetary administration.
“Last dollar…first dollar”.
If more people really understood how banks structure (try to structure) loans in order to minimize their own risk (banks are playing with leverage too…if a small number of their loans go bad, the bk is finished too) then everybody might be happier (though fewer loans might occur).
1) The bank only wants to lend an amount (say 65 pct vs *theoretical* valuation of collateral) that will still be pretty much entirely intact if that theoretical (ZIRP deranged) valuation implodes. Like now. Bank (and taxpayer/USD saver) misery follows when banks swallow the ZIRP kool aid and use higher LTVs as collateral valuations go loopy. So developers have to try and cobble 35 pct equity against those loopy valuations. Not easy. But banks have been to this cyclical goat rodeo many many times before. Loose banks cease to exist. (We had 10,000 more banks in 1990).
2) If you want the banks’ 65 pct of the money, you have to accept that you are going off the gang plank first when the pirates attack (that’s the cost of getting a leveraged deal with just 35 pct of the necessary funds). As with CDOs, CLOs, etc. somebody has to always end up in the first loss position when the collateral valuation implodes…and that is the equity money. That is why it is called the equity money. You get higher returns if things go well…but are first against the wall when the interest rate revolution comes.
3) Don’t like the set-up? Use less wacked out collateral valuations, spend less money, come up with higher equity percentages, etc. There are multiple ways to lower risk for everybody…but if bankers are boring worryworts, developers are cowboys…never a valuation too crazy, a construction schedule too aggressive/optimistic/expensive, a flip too unlikely, an escape hatch too hidden, etc.
WeWork was just an extreme version of a common theme.
As a retired real estate lender (30+ years a construction loan specialist) this gave me a good chuckle. McNellis hits it right on the money.
I feel like my relationship with small companies that get bought out by a bigger company is never quite as good as it was with the small company.
Be it an Alarm Company, a Plumbing Company, a HVAC vendor or any other — small companies like small vendors. Lower pricing, easier to find the owner, and generally the small guys are smart enough.
It’s important to deal with someone your size — generally. Though that said, Wells Fargo Bank charges less on commercial loans than the small bank — and does seem to ask for higher quality supporting documentation on them.
and Chase bank was practically giving away commercial loans – low fees and interest rates – in Southern California, at least.
(this is second hand knowledge but from reliable sources)
Apropos of your comments, EVERYTHING is being rolled up by bean counters. Bob’s Barricades, Porta Potties, Bezos spent $100 million to put diapers.com out of business. I represent condo and homeowner associations. In the GFR, clients who suffered 700 days of non paying owners in first mortgage foreclosure called me to ask: “Can’t we call the bank?” I laughed in their face and said: “Potters not selling, he’s buying.” How quaint. Call a bank. And speak with whom, exactly? The monkey or the organ grinder? When you need to borrow they don’t want to hear from you; when you have “made it,” they pester you to.
Small is beautiful
You are the first commentator who exposed that their business was not dealing with SVB by choice, but by bank buyouts and mergers. That changes my perspective regarding the government’s protection of all deposits.
Thanks for writing this article.
Covering ALL deposits with ‘blanket protection’ and especially in combination with captive/incompetent regulators, is a sure way to encourage RISK-ON behavior with animal spirits. The current events confirm that.
The current capital at FDIC is around 145 Billions. How can it cover the 18 Trillion of bank deposits? How many small/Medium Banks cab afford to required pay exorbitant fees? Any kind of fee on the banks will be always passed on to consumers.
“The current capital at FDIC is around 145 Billions. How can it cover the 18 Trillion of bank deposits?”
This silly stuff needs to stop.
Banks have assets, and when the FDIC takes over a bank, it gets ALL the assets.
The FDIC sells those assets, and the FDIC fund only has to fund the shortage between assets and deposits plus secured liabilities.
The FDIC has made a deal to sell a lot of the assets of Signature bank. So the $90 billion in deposits are paid for with asset sales, except for the shortage which is $2.5 billion. So the FDIC only needed to fund 2.7% of the total deposits. The rest was covered by asset sales.
People need to get real about this.
Also not ALL banks are going to fail at the same time. That’s just silly. It’s like not all cars are going to hit each other in once gigantic accident where everyone dies, and all insurance companies go bankrupt.
Covering all deposits is adding more moral hazard. There is already enough.
Yes, it’s my opinion, but I’d be more than happy to place your wealth and anyone else’s at risk to make good on this guarantee if you are in favor of it.
Not a dime of mine.
“This BS needs to stop.”
Good luck with that Wolf! 🙈
“Also not ALL banks are going to fail at the same time.”
A battleship has multiple watertight compartments to prevent sinking by few hit as individual compartments flood, while others are isolated.
In US with bailouts, Fed Put, Govt Put, endless credit lending facilities of Fed and forebearance we have merged the balance sheets of all financial entities that are “too big to fail”, and today the printed dollar backed by tax payers is holding everything together and preventing individuals failures, losses and bankruptcies.
In battleship terms, we have opened all watertight compartments so that while no individual compartment floods, the whole ship keeps taking water and going lower.
When there is broad realization that US taxpayer cannot be enslaved to payback this debt, that was created to bailout billionaires and wallstreet without asking the taxpayer, everything can break together.
Leo, ultimately the dollar will collapse first. The billionaires’ assets won’t be worth anything without the claim on the U.S. taxpayer.
Very few people realize what you do, that all dollars out there are ultimately a claim on the productive capacity of the United States. As it declines, so does our total wealth.
Printing money and algorithms trading assets back and forth at higher valuations does not make us wealthier.
“not all the banks are going to fail at the same time”.
Wolf, I hear what you are saying but one of the toxins of long ZIRP is that more and more asset valuations (including the value of loans and loan collateral) become more and more *correlated to one another* because *they are all correlated to ZIRP deranged interest rates.*
In other words, ZIRP creates systemic overvaluation that all unwinds at nearly the same time as unZIRP starts (which it inevitably must).
ZIRP *created* toxic systemic correlation via the long repression of interest rates, falsely inflating many/all assets (and loan collateral) via the straightforward application of the discounted cash flow formula.
The DCF isn’t mysterious and it is very much garbage in, garbage out.
The garbage in was phony ZIRP interest/discount rates and the garbage out was economy wide overvaluations.
I really appreciate your analysis of FDIC and it’s obligation.
Not ALL banks are going to fail at the same time. Agreed
But the very notion of that FDIC is always there to back up will be an incentive to go risk-on, once this dust settled, regulators start waking up do their duties.
“…once this dust settled, regulators start waking up do their duties.”
Yes, agreed. And they should.
Before the pandemic, a handful of banks failed each year, and they were resolved routinely. When the Fed tightens, every time, a bunch of banks fail, just like a bunch of companies are going bankrupt. That’s how it is and how it should be. The government shouldn’t change FDIC rules every time a bank fails.
Just based on the normal rate of bank failures when interest rates rise, we’ll get another bank failure soon. This will be the rest for the government: can they stick to the FDIC rules of $250k (the FDIC would favor that), or are they going to do another blanket bailout.
What about the 700 Trillion in derivatives?? Who’s going to cover that?
1. Just like the Insurance Business, Derivatives are protected by Reserves or the FDIC….
2. The other side of the transaction always, always come through…
3. Let me show you the bridge….
Aren’t derivatives almost 50/50 winners/losers in the long run? one cancels the other.
1. that’s “notional value” — such as the notional value of your $1,000 in out-of-the-money Carvana options. Your max loss is $1,000, but the notional value could be $100,000. And your loss is someone else’s gain.
2. There are counterparties in derivatives. In the end, all combined, they sort of wash out.
3. What brought SVB down is that it did NOT have any interest-rate derivatives (interest rate hedges such as swaps).
Derivatives can be a big problem, but it’s not what you describe.
Eh…nobody held anybody at gunpoint, requiring anybody to *stay*.
And the interest rates of the last 20 years don’t exactly suggest a shortage of lendable funds (Thanks Mr. Fed!!) or lending outfits (Sharkskin Larry’s House of CMBS…)
Although not in real estate, I enjoyed your article and I think that it may well apply to what I am planning to do in the years ahead. Thank you.
@ McNellis who said: “far cheaper, no matter the interest rate, than giving away half the deal.”
“if you are going to feel a moral obligation”
1. Giving up half the deal, in exchange for no debt can be the less stress way to do deals. Debt is a killer …………… the continuous ticking of the $ clock, good times and bad, delays or not. With equity, interests are aligned, particularly if the developer has a bit of “skin in the game.”
2. There should be no moral obligation to repay equity investors unless you misled them or shirked your responsibilities.
an assertion: our society would be better off with much less debt and more equity. In many cases our debt based society, with special priveldges for banks to create money to lend, is just a wealth transfer system.
You misunderstand debt. Maybe you’re thinking of it in terms of credit cards.
In business, there are two types of “capital:”
— equity capital
— debt capital.
They’re different, but they are BOTH very important. I worked for a decade for a company that had two equal equity partners. I tell you, I learned this is absolutely the worst most stressful deal when the two start disagreeing in how to run the business. A nightmare. So this can be very risky if it goes wrong.
Also, you can pay off a debt pretty easily by borrowing from another bank to pay off the old debt. Buying out a 50% equity partner is much more complicated and costly, and you’ll end up with a lot more debt than you would have had if you had funded the operation with debt in the first place.
But of course, if you are doing a startup that is expected to burn cash for years, sometimes for years without revenues, then debt capital is not an option, and equity capital is the way to go.
Debt capital is only an option for businesses that generate decent cash flows. Real estate projects would do that.
Wolf – maybe you had a dud Shareholder Agreement between those two partners that led to that stressful situation.
A good Shareholder Agreement will have clear terms on:
(a) how to resolve disagreements and conflicts. An Independent Director on the board works best
(b) shareholder obligations should the business needs more capital
(c) the circumstances and mechanisms for how a shareholder may exit a business. These mechanisms can reduce the burden on the shareholder remaining in the business
Most people focus on the upside when entering a partnership. Its actually more important to focus on the potential downsides.
I would take equity – established with a thoughtful Shareholder Agreement – over debt most times.
Unfortunately, the downside of crafting a Shareholder Agreement is the requirement to work with f&*king lawyers.
I am with Wolf on this one. “Partnerships” have a nasty habit of blowing up in the real world. And when they do… it doesn’t matter how many smart lawyers drafted the initial agreements because there always smart lawyers willing to work overtime on the other end to undo them.
Or even worse… the partners STAY together… with results like the 1980s movie the War of the Roses.
If you are going to have equity “partners” then your best bet is to have LOTS of them. If someone becomes unhappy, it is a lot easier to buy out a 5% partner than a 50% partner.
Regarding development, I agree that debt is the way to go if you can swing it. I doubt that many deals pencil today. Probably better to be on the sidelines and wait for blood in the streets to pick up an option on land. By the time you get entitlements (which in CA could take years), hopefully the market will be better.
Thanks for posting this… interesting, enlightening and humorous. A VERY well written piece (might even entice me to look for his book)
1) Small businessman will never get a dime either from one bank or several banks, unless they have a senior partner, or a wealthy aunt to cosign. If they don’t, they use c/c loans or teaser loans to get by.
2) SVB bank is high tech bank. They don’t care about shopping centers guys.
3) Good relationship with suppliers and large customers, the ability to adopt and change is a recipe for survival. Don’t aim high, aim at survival.
4) When things are bad suppliers will not drop u if u are late. Your large customers will keep u busy during downturns. Begging is cheaper and quicker than collection agencies or lawsuits.
5) When business is good try new things as an option. Don’t expand too fast or spend money to showoff.
6) Small businesses don’t die within days. There are always stupid mistakes to remember, but with a little luck and few good moves small businesses can survive for decades.
Your #1: The bank of the Wolf Street media mogul empire has been urging me for years to open a $100k credit line with them for the corporation. I got the most recent offer a couple of days ago, at “Prime” +1.5%. “Prime” at that bank was raised by 25 basis points to 8%, the day after the rate hike, so the credit line would come with a variable rate, currently 9.5%.
Wolf Street Corp also has a credit card with a huge credit limit from the same bank, that it never borrows against. The rate is in the double digits. So 9.5% would be a deal, LOL.
Nearly all owners of small businesses will have to personally guarantee business loans. Personal guarantees for corporate debt suck, but that’s part of the deal.
If you get a working capital line of credit that is secured by inventories and receivables, and your small company is big enough, you might be able to avoid a personal guarantee.
The Wolf Empire is a member of the privileged elite with connections all over the world. A guy from the street will get nothing from the banks. The banks like mid level loans between 3M/10M to established customers. 25K/50K loans to cover payroll, rent, A/P, during the Xmas season, are teaser loans. Most small businesses are not big enough for the banks. Banks sometimes have cookies for the little people. Repo businesses. There are many empty stores and restaurants in NYC, good to go. The banks will try to match them with people who know how to run a chain stores, but if they can’t they will try a cook to open them. They will not open a new branch in vacant spaces as they did in 2010/2011.
Griswold is that you?… The little people. Lol
What happens if you were a founder of a private Silicon Valley tech company and you wanted a loan . You went to SVB and received a loan with your completely illiquid stock as collateral
Yes, a lot of high-end homes were bought that way. First Republic was big into this.
I find most of your comments salient but difficult to parse.
This one clear, relevant, insightful and top notch. Kudos. Thanks
I think his code was updated by ChatGPT.
Thank u for enlightening me
I always say “banks are always willing to loan you money when you don’t need it”. Those people who have not had a setback and found that all sources of credit dry up, think that I’m mumbling gibberish. We run a small business and have relationships with 3 banks and we pay money on short term loans so we can have 3 month’s worth of funds in cash.
“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.”
It’s a pretty old complaint.
We just lived this over the past three years of turmoil at work. Finally ended up with a new bank because the old one got acquired enough times that we became little more than a line item.
They lost a 40-year banking relationship by tugging at the umbrella at the first sprinkle.
It seemed to me all along very straightforward and obvious risk management not to place one’s bank deposits or banking relationships on too narrow a base, if reasonably possible. Key contacts and other dynamics can always shift in a moment. A counter-party can be merged, for example.
And I was shocked to see businesses just dumped all their deposits over the insurance limits into one institution.
They probably had to deposit above the $250,000 limit because of some deals they made to get certain kinds of loans. I don’t like to think they were simply idiots, but that is a possibility.
Nobody has a right to bank funding. If a business endeavor is too risky, banks should simply decline to take part in that risk, and loans shouldn’t be extended. If it’s a good enough idea, the entrepreneur should try to raise equity capital instead.
Lately, banks have funded too many speculative loans and speculative investments, implicitly relying on government guarantees and other subsidies to generate earnings.
The banking industry needs to be completely revamped from the outside.
Banks should only place their shareholder’s capital and that of anyone who agrees to be their explicit creditor.
Depositors should be given the choice of being a creditor, or not. Currently, they do not have that choice.
Taxpayers should not be bailing out any bank. Anyone who chooses to be a creditor (“depositor”) deserves to be “bailed in”. They made a loan to a bank, not a deposit.
I’m okay with that as long as the inflation target is lowered to 0%.
I have to agree with Einhal. If the FED and .gov stopped increasing the money supply, our dollars sitting in the bank would gain value due to deflationary pressures. I would be happy to pay a bank to keep my dollars secure in that environment. Dream on…
People who have experience working in SV and are honest and sober understand 80 / 20. Only about twenty percent of SV start ups have:
* The ability to offer quantifiable value
* A management team that has the ability to grow a team that can deliver profit at scale
* Have a second source to deliver profit
* Know what their organization’s valuation is
These companies can exit. Only a few exits are profitable for investors although.
The fractured banking system in the US is both a blessing and a curse. The shear number of small banks in the US is mind boggling:
The cursed part of it is coming to roost. Both due to small size and the ease in which one can switch and due to lack of regulation.
The blessing part is highlighted by this comment:
“They will shake hands and promise to take care of all your needs; they will lend you every dollar you will ever need.”
“Here’s the problem—you can’t shake hands with a corporation.”
The bigger the corporation the less you can build relationships. Unless you are a big corporation
What is the reason why SVB had probably the highest % of deposits over 250,000 of any bank in the country. Sounds like they made some very questionable loans in exchange for requiring that their deposits remain at SVB
Thanks for the great read, John McNellis!
Has there been much talk about the volatility in the treasury market lately? NYT did a piece, said it looks rough.
I read a really “funny” article this weekend written by an SVB employee, talking about how they were working tirelessly these last couple of weeks, to the pont of not sleeping and only eating a bagel a day, in order to keep things running for their loyal clients, lol.
They went on about how they cared more about their customers’ money than their own and how they had no advance notice of what happened.
Now here’s the funny part. He/she/they (SVB is very gender proper) went on to say how he personally lost a million dollars in stock acumulated during several several years of employment at SVB. Tell me this. How the hell does a bank employee accumulate $1.0 million in stock in a few short years f work?
This explains a big part of the SVB illness – a corporation operating primarily to pump up stock prices and then doling out overpriced stock and options to itself. I guess they learned some lessons from their VC clients… pump and dump. Except they missed the dump part of the class.
No alligatot tears from me.
Noticed the IRS didn’t bother to send the estimated tax payment vouchers like they usually do every year. I have to send in one before April 18th. They are getting lazier every year. I went on-line to get my recent voucher.
They took 8 months last year to process my simple return. Filed it in Feb and got my refund in November. They IRS wants more funding, to conduct more audits. I say give them nothing.