Insider Loans Surged Ahead of Turmoil at US Regional Banks

(Bloomberg) — Not long before the Federal Reserve began lifting interest rates to tamp down inflation, regional banks across the US reported a surge in lending to a group of well-connected people: their own directors, officers and major shareholders.

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The trend continued through all of last year, reaching almost $10 billion by the end of 2022, according to a Bloomberg News analysis of data submitted to federal regulators. That was 12% more than a year earlier and represented the largest annual jump in lending to insiders, along with their related interests, in at least a decade.

What’s more, some of the biggest increases were at firms that have recently failed, or are now struggling amid the worst banking crisis since 2008. Among the regional banks that said they more than doubled the amount of credit to insiders last year were Silicon Valley Bank, Western Alliance Bank and First Republic Bank.

None of the lenders or their officers, directors or major shareholders has been accused of wrongdoing. The banks have said they extended credit on similar terms to insiders as they did to other clients. And lending, more broadly, at regional banks was up during the period. Some of the reported increase in insider loans was new borrowing, while some was the result of changes on boards, in executive suites and among top shareholders.

Still, the recent industry turmoil has put a spotlight on stock trading and borrowing by people with power over banks because such transactions can be an indicator of questionable governance.

When a board member or executive borrows from the bank he or she oversees, “you have an inherent conflict of interest,” said William Black, an associate professor of economics and law at the University of Missouri – Kansas City and a former bank regulator who helped expose corruption in the savings-and-loan industry in the 1980s. “And, worse, if things get difficult, that conflict of interest becomes extremely acute.”

Such financing has featured in a number of decades-old financial scandals. Loans to officers, directors and major shareholders now require public disclosures and are regularly scrutinized as part of the Fed’s ongoing supervision of banks.

“If we find problems with these loans, we take enforcement or other remedial actions against the bank or refer the violations to other authorities,” a spokesperson for the Fed said.

Silicon Valley Bank collapsed into receivership on March 10 after a botched effort to raise capital forced it to sell securities at a loss and sparked a run on deposits. About a month before its failure, it reported in a regulatory filing that credit to insiders rose more than sixfold to $219 million in 2022, with the bulk of the jump coming in the fourth quarter, Bloomberg News first reported on March 21. That was the third-highest increase among banks that reported loans to insiders at the end of 2021 and finished last year with $10 billion to $250 billion in assets, data filed with the Federal Financial Institutions Examination Council show.

The 135 banks of that size include some of the fastest-growing in America in recent years. Collectively, these institutions had $9.6 billion in credit outstanding to insiders or their businesses at the end of last year, a sum that can include everything from mortgages to a line of credit.

Among the biggest increases were those at Fayetteville, Arkansas-based Arvest Bank, which has ties to the billionaire Walton family, where insider lending more than tripled to $186 million, and at Comerica Bank in Dallas. which extended $671 million in credit to insiders, more than twice as much as a year earlier. FirstBank in Nashville, Tennessee, which had $12.8 billion in assets at the end of last year, reported a 185% jump to $114 million.

The changing composition of bank boards, shareholders and executives can make the disclosures noisy — even if they reveal how entwined some insiders are with the financial institutions they oversee.

The biggest jump in insider loans among regional banks last year came at Western Alliance, which has seen its stock slip 46% this year as customers yanked deposits. The Phoenix-based lender reported that credit to insiders rose 67-fold to $476 million last year, an increase largely the result of the appointment of a new director, Patricia Arvielo, in June. That required the bank to disclose hundreds of millions of dollars in credit extended to Arvielo’s mortgage company, New American Funding.

Arvielo resigned from Western Alliance’s board on April 7, a day after receiving questions from Bloomberg about the relationship. The bank and New American said there was no connection between her departure and the credit Western Alliance extended to her business.

“She decided to leave the board due to her other personal and professional commitments,” a spokesperson for Western Alliance said, adding that the bank has “rigorous policies and procedures in place to avoid any potential favoritism” when it extends credit to insiders. “NAF is a longstanding, significant client of the bank, and our continued service to NAF has never been influenced in any way by Ms. Arvielo’s brief service on the board,” the spokesperson said. The bank wouldn’t comment on confidential interactions with regulators.

Western Alliance has been a critical partner for New American for several years, providing money to originate loans. By the end of March 2022, just before Arvielo joined Western Alliance’s board, the bank had $500 million in credit lines to New American, according to national data compiled by Massachusetts regulators. That was the biggest amount any bank had to her firm at the time and more than Western Alliance had underwritten for any other mortgage lender, the data show.

As the housing market slowed last year because of rising interest rates, the line of credit was reduced by 30% to $350 million. Still, that was a smaller reduction than other banks’ lines to Arvielo’s firm. The mortgage company’s facility from JPMorgan Chase & Co. was reduced by 86% to $50 million from March to December, the Massachusetts data shows. JPMorgan declined to comment.

Ken Block, New American’s general counsel, said in a statement that Arvielo had no role in negotiating the company’s lines of credit and that any changes were tied to projections for loan originations. Arvielo began discussing leaving the Western Alliance board in January, he said, but she was asked by the bank to stay on until a replacement was found. She and the mortgage company have not received any regulatory inquiries related to business dealings with Western Alliance, according to the statement.

In general, loans to insiders tend to represent a small share of the overall credit that regional banks extend to customers. But regulators have long focused on the transactions because of their potential for abuse.

In the savings-and-loan crisis, more than 1,000 small and midsize lenders failed, and the government spent years scrutinizing the role that abuse and fraud by owners and executives played in encouraging risky lending practices. Taxpayers wound up on the hook for as much as $124 billion to resolve the industry’s troubled firms.

Under a federal rule known as Regulation O, lenders are allowed to extend credit to insiders, but only when it is on terms and interest rates similar to those provided to other borrowers. Banks must disclose the name of each executive officer or shareholder who has more than $500,000 of credit outstanding, including to related interests.

The Fed and the Securities and Exchange Commission have imposed fines and sanctioned executives for improperly extending credit to insiders and having inadequate oversight of conflicts of interest.

Regulation O is so strictly enforced that most banks and their officers and directors tend to be cautious, said Michele Alt, co-founder and partner at Klaros Group and a former legal official for the Office of the Comptroller of the Currency. Still, “any director should be cognizant of avoiding even the appearance of a conflict,” she said.

Despite rules around public disclosure, banks can keep many details of insider loans private. At First Republic, lending to directors, officers and major shareholders, along with their related interests, increased 166% during the year to nearly $47 million. Among the insiders the firm named when asked by Bloomberg were 11 executives, including James H. Herbert II, the founder and executive chairman of the bank. Herbert declined to comment, according to a spokesman.

First Republic said in an email that it reviews credit extended to insiders and limits activity largely to residential lending. The bank said it wouldn’t disclose the names of any directors with loans because the regulation doesn’t require it.

Arvest, the bank with ties to the heirs of Walmart Inc. founder Sam Walton, named two insiders, principal shareholders S. Robson Walton and Lukas T. Walton. Neither has total debt to the bank in excess of $1 million, it said. The Waltons didn’t respond to requests for comment.

Comerica said insider borrowers, or their related affiliates, included board members Robert Taubman, chief executive officer of shopping-mall owner Taubman Co., and Nina Vaca, CEO of Pinnacle Group, a firm handling payroll and human resources services. Taubman declined to comment. Vaca didn’t respond to requests for comment.

FirstBank said its board is “comprised of successful business people, entrepreneurs and community leaders working in the vibrant Southeastern economies” and that the increase in insider loans is primarily the result of growth in their businesses.

James Ayers, a principal shareholder and former director of FirstBank, was the only insider with more than $500,000 in credit from the bank at year-end. It didn’t specify how much of the $114 million in lending to insiders he or his interests represented.

“I’ve been doing business with FirstBank for more than 40 years and will continue to do so for my banking needs,” Ayers said in an emailed statement. “Any loans I have with FirstBank are fully collateralized with CDs, so the bank is not taking any credit risk.”

Even a month after its collapse, the details of the spike in insider lending at Silicon Valley Bank remain unclear.

The bank had a reputation as the go-to lender for tech companies and the venture capital firms that backed them. Just days before failing, its parent company, SVB Financial Group, said in a proxy statement that it lent to related parties including companies in which board members or affiliated venture funds had equity stakes. The filing didn’t provide amounts or names of recipients.

First Citizens BancShares Inc., the Raleigh, North Carolina-based lender that agreed to buy Silicon Valley Bank out of receivership in March, had no immediate response to questions about the status of the loans. Its own lending to insiders fell by 6% last year to about $100 million, prior to the purchase.

The Federal Deposit Insurance Corp., which has been working to sell $87 billion of SVB’s securities, refused to shed any light on the matter, either. “With regard to comment,” an FDIC spokesperson said in an email, “we’ll let the policies and practices in place speak for themselves.”

–With assistance from Annie Choi and Jason Grotto.