This column is part of the Sixth Annual Heard on the Street stock-picking contest.
Bank stocks aren’t often where investors turn to find growth. Yet there might be a potential bargain lurking among them.
parent of Silicon Valley Bank, has been at the heart of the venture-capital industry for many years. A lot of young technology and life-science companies deposit the venture money they raise into the bank, and venture-capital firms borrow from the bank before drawing down on their limited partners’ commitments. This has been a lucrative and fast-growing flywheel for many years, extending into private banking and capital markets, helping its stock often sharply outperform banks overall.
SVB Financial Group
- Recommendation: Buy
- Price: $435.39
But after beating the KBW Nasdaq Bank Index every year since the end of 2012, SVB shares have dropped alongside the initial public offering and fundraising markets in 2022.
The shares are down over a third so far, well behind the KBW index’s 15% decline.
Investors’ worries about SVB are in the sweet spot of concerns about banks in general right now: weakening deposit growth and rising credit risk. As young companies raise less money and burn it faster, that is felt in SVB’s deposit growth. Deposits declined 5% from the end of the first quarter to the end of the second.
The bank lowered its outlook for 2022 year-over-year average deposit growth from the low-40% range to the high-20% range. Also, the bank took a nearly $200 million provision for credit losses in the second quarter, partly related to loan growth but also to “increased recession risk” and “emerging pressure from market volatility.” Recessions can be tough for younger, less-established firms.
Reflecting these challenges, the bank’s stock is trading around 11 times expected 2023 earnings, according to FactSet figures. That is about a third below its 10-year average ratio. It is still trading at a premium of around 20% to banks overall in the S&P 500, but that compares with an average premium of 50% over the past decade.
That will likely prove to be too much of a discount. The last time SVB shares underperformed the KBW index for more than a year was after the dot-com bubble’s burst, from 2000 to 2002. But this isn’t likely to resemble that era. Venture-capital firms globally still have over $500 billion of undeployed funds they have raised, or “dry powder,” as of August, according to Preqin—almost seven times as much as they did at the end of 2000. That is a lot of potential spring-loaded growth for SVB.
Meanwhile, the bank’s credit exposure might be relatively limited, even if risks are rising. More than half of SVB’s overall loans are capital-call lines that venture funds can draw on before they get the cash from their limited partners. The bank has reported one net loss on capital-call lending in the three decades it has been in that lending business. By contrast, just 2% of SVB’s total loans are now to early-stage companies that the bank says have historically been “the most vulnerable loan class with the most losses.” Even as SVB expects its loss rate to tick higher in the second half of the year, its overall 2022 net charge-off outlook has remained in the range of 0.15% to 0.35% of its average loan portfolio.
As for deposits, SVB has sources of funding to draw on to sustain asset growth. Over $190 billion of client money as of the end of June was held off balance sheet in vehicles such as money-market funds. Clients might expect to be compensated with higher rates to move it back into deposits—but that is still better than the alternative of needing to slow balance-sheet growth, which some banks might face.
Investors have been rightly worried about growth companies. But SVB has hardly lost its place at the heart of the venture business, adding some 1,700 commercial clients in the second quarter. It would be shortsighted to count it out after a down round.
Write to Telis Demos at Telis.Demos@wsj.com
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Appeared in the August 22, 2022, print edition as ‘Dry Powder Key to Silicon Valley Bank.’