SVB Financial's Fourth Quarter: Deposit Growth Slows as Clients Seek Higher Yields on Cash

SVB Financial (SIVB.Q -1.96%) reported that it earned $117.2 million, or $2.19 per diluted share, in the fourth quarter. Without one-time impacts from the Tax Cuts and Jobs Act, the company would have earned approximately $154.8 million, or $2.89 per diluted share, based on my estimate.

SVB Financial's fourth quarter: By the numbers

Data source: SVB Financial. Adjusted diluted EPS calculated by author by adding back $37.6 million impact of adjustments related to the Tax Cut and Jobs Act to net income.

What happened this quarter

• Let's get the tax ramifications out of the way first: Financial companies, including SVB Financial, have deferred tax assets (DTAs) on their balance sheet that primarily result from temporary differences between tax and GAAP accounting for loan losses. Because the corporate tax rate dropped from 35% to 21%, these DTAs have to be remeasured to reflect the drop in taxes. SVB Financial took $37.6 million in accounting charges related to the Tax Cut and Jobs Act this quarter, though it's really just a one-time accounting nuance. What really matters from a shareholder perspective is that the company expects its tax rate to be between 27% and 30% in 2018, down from a GAAP rate of roughly 36% in the first nine months of 2017.
• Average total deposits grew to $44.8 billion in the fourth quarter, up 1.7% sequentially, and 12.8% from the year-ago period. These deposits can be used to fund loans and investments in low-risk securities to generate regular interest income. Approximately 83% of SVB Financial's average deposits are non-interest-bearing, allowing it to capture most of the impact of rising interest rates for its own benefit.
• Average loans grew to $22.4 billion in the fourth quarter, up 4% sequentially, and 16.5% from the year-ago period. Commercial loans remain its bread and butter, with roughly 50% of its commercial loan portfolio put to work in loans to private equity and venture capital funds. The remainder of its commercial portfolio is split between software and internet (31%), life science and healthcare companies (9%), hardware (6%), and other loans (3%).
• SVB Financial's average total client funds held off-balance-sheet (money markets and short-term bonds, primarily) grew much faster than bank deposits, growing to $57.6 billion, up 8.1% from the sequential quarter and 28.1% from the year-ago period. The growth helped power a 19% sequential increase in investment fees earned on client assets. On the conference call, management suggested that fast off-balance-sheet growth was primarily driven by clients seeking higher yields on their cash, though it's exploring ways to bring that cash onto the bank's balance sheet, where it could be put to work more profitably.
• The company's portfolio of investments (warrants and other securities) generated net gains of $27.9 million this quarter. SVB Financial pointed out that its gains included a large gain from exercising Roku warrants it held, in addition to subsequent gains from the stock's rise thereafter. 
• Credit quality remains pristine. Net charge-offs tallied to 0.23% of total gross loans on an annualized basis in the fourth quarter, up about 4 basis points compared to the previous quarter, but still very low on an absolute basis. Nonperforming assets stood at 0.23% of total assets.
• Net interest margin (NIM), or the spread between what SVB Financial pays on its liabilities and what it earns on its assets, widened to 3.2%, up from 3.1% in the previous quarter. The increase was driven by rising rates and a slight shift in its balance-sheet composition from lower-yielding securities to higher-yielding loans.

What management had to say

In its earnings release, Greg Becker, the company's president and CEO, said, "As we enter 2018, our outlook remains positive; this is due to the health and vibrancy of our client base and our expectation that we will see results from our continued investment in growth and client engagement; as well as tailwinds from lower corporate taxes, higher interest rates and the potential for some regulatory relief."

Since taxes are the topic of the day in earnings releases this quarter, it may be helpful to refer to prepared remarks on the conference call, in which the company explained how it expected lower taxes to impact its profitability:

[W]e plan to use some of our tax savings for investments and growth, infrastructure and employees. As a result, we are raising our outlook for non-interest expense from the high single-digits to the low double-digits. That said, we still expect 75% to 80% of the tax reform benefit to translate to earnings.

Image source: Getty Images.

Looking ahead

In every quarterly report, management updates its expectations on various financial metrics for the year ahead. The guidance table for the full year 2018 is reproduced below.

Source: SVB Financial.

There are a few things to note here, namely the improvement in net interest margin, which management sees improving to 3.4% at the midpoint this year, up from 3.2% in the fourth quarter, as rising interest rates fuel larger margin, thanks to a treasure trove of non-interest-bearing deposits.

Just as important, however, is that SVB Financial sees its noninterest expenses rising in the "low double digits," offsetting some of the benefit from tax savings and rising net interest margin. It also moderated its view on deposit growth in 2018, believing that its clients will seek out higher yields for their cash, and direct funds to SVB Financial's off-balance-sheet cash-management products rather than keep cash in on-balance-sheet accounts.

Of course, credit quality is the single most important driver of any bank's profitability. SVB Financial's credit record is excellent, helped by the fact that the venture capital community is awash with cash, and venture-backed companies have been able to find buyers, either privately or by going public with an initial public offering (IPO).

Management is point-blank with shareholders about the inherently cyclical nature of the business, saying in prepared remarks that if there were a "significant decline in VC funding, or a growing trend of exits below the last private round, it would likely affect the broader universe of venture-backed companies, which could mean higher credit costs for us." 

That's a boilerplate warning, but one that's important for investors to keep in mind as they think about the drivers that underlie SVB Financial's earnings power in the year ahead.