Venture capital investors put a record amount of money to work in 2018, which proved to be a boon for their favorite banker, SVB Financial Group (NASDAQ:SIVB). The bank holding company, better known as Silicon Valley Bank, reported that it earned $266.3 million in the fourth quarter, up 127% over the year-ago period, helped by rising rates, lower taxes, and a growing balance sheet.

SVB Financial's fourth quarter: By the numbers

The table below shows some of SVB Financial's key metrics for the fourth quarter of 2018 and compares them to the year-ago period.

Metric

Q4 2018

Q4 2017

Year-Over-Year Change

Average net loans

$27.5 billion

$22.5 billion

22.4%

Average deposits

$49.1 billion

$44.8 billion

9.6%

Net income

$266.3 million

$117.2 million

127%

Diluted EPS

$4.96

$2.19

126%

Source: SVB Financial. EPS = earnings per share.

Note that outsize increases in net income were largely driven by a decline in tax rates from 2017 to 2018. On a pretax basis, which eliminates the impact of corporate tax reform, earnings increased about 46% year over year -- still a very impressive result.

Federal Reserve building.

SVB Financial's rate-sensitive balance sheet pays dividends in a rising-rate environment. Image source: Getty Images.

What happened this quarter

Banks like SVB Financial may be big and complicated, but their results in any given accounting period boil down to just a few metrics and events that really matter. Here are the notable items in SVB Financial's fourth-quarter earnings report:

  • Deposit growth moderated, as average deposits were unchanged from the sequential quarter and up roughly 9.6% year over year. Clients are taking their money off balance sheet in the pursuit of higher yields (more on that below), which has become a headwind for deposit growth.
  • Fund balances are soaring. In addition to traditional deposit accounts, SVB Financial also offers off-balance-sheet accounts, like money market products and other cash alternatives that offer higher yields than ordinary checking or savings accounts. Average client assets held off balance sheet increased 6.9% quarter over quarter and 47.7% year over year. Though these assets generate a steady stream of fee income, SVB Financial earns more from a dollar of deposits than it does a dollar held in investment funds.
  • Rising rates are padding earnings. The bank reported a net interest margin (NIM) of 3.69%, up from 3.62% sequentially and 3.20% during the year-ago period. A 7 basis point (0.07 percentage point) improvement over the sequential quarter was good to see, given that net interest margin expanded by 3 basis points (0.03 percentage points) sequentially in the third quarter.
  • Credit quality remains excellent. SVB Financial reported a net charge-off ratio of 0.20% of average loans, down from 0.30% in the sequential quarter and 0.23% in the year-ago period. Its allowance for loan losses stands at 0.99% of loans, down slightly from 1.03% last quarter and 1.10% in the year-ago period.
  • SVB Financial repurchased about $147 million of stock at an average price of approximately $206 per share in the fourth quarter, taking advantage of a late 2018 dip in bank stocks.
  • Shortly after the end of the fourth quarter, SVB Financial closed on a "bolt-on" acquisition, acquiring Leerink Partners for $340 million ($280 million in cash and a $60 million employee-retention pool). Leerink Partners is a small investment bank that specializes in healthcare and life-sciences companies. This acquisition will be most visible in the company's fee income line in 2019, which the bank expects to grow at a percentage rate "in the high sixties" this year compared to 2018.

What management had to say

In prepared remarks on the fourth-quarter conference call, management said that the performance of the venture-capital industry was a tailwind for the company in 2018. Given that so many start-ups bank with SVB Financial, a sizable portion of money deployed by venture-capital funds into smaller companies ultimately makes its way into an SVB Financial deposit account. According to management:

The health of our industry was a major factor in our performance. Venture Capital had a record year with $131 billion invested and $55 billion raised as well as record levels of dry powder still to be invested. While later stage companies received the majority of dollars invested, early stage Venture investing remained very strong, with aggregate values reaching all-time highs.

The IPO market improved significantly over the prior year with 85 Venture backed IPOs, the highest number since 2014 and the highest aggregate IPO value since 2012. SVB's clients represented 67% of these companies.

Management's guidance for 2019 suggests the year ahead could be rewarding for shareholders, driven by growth in the company's balance sheet, as well as growing net interest margin, as rates rise. One notable point of discussion on the conference call was how the bank plans to drive deposit growth in the year ahead. In response to an analyst's question, Mike Descheneaux, President of SVB Financial, gave more detail about where it sees opportunity to grow its balance sheet.

[T]o be clear, what we're expecting is the growth of deposits about 50% of that is going to be interest bearing. So when we take a look at overall expected average deposit cost for 2019, we're expecting that to be in the 11 basis points to 15 basis point range because of the level of those initiatives that we have confidence in.

SVB Financial arguably has the best deposit franchise in the banking industry, given that roughly 79% of its total deposits at the end of the fourth quarter were non-interest-bearing deposits on which it pays nothing in interest. That mix is naturally changing as some of its rate-sensitive clients move cash around to get higher yields. That said, if SVB Financial can meet its guidance for high-single-digit deposit growth and get half of those deposits from non-interest-bearing accounts, it's hard to see how that wouldn't be an excellent result for the bank's shareholders.

Looking ahead

When it comes to guidance and expectations, most banks give shareholders and analysts figures for just a few key metrics. SVB Financial issues guidance on just about every needle-moving metric in its business. Here's a reproduction of its guidance table for 2019.

 Metric

Growth Compared to 2018

Average loan balances

Increase at a percentage rate in the mid-teens

Average deposit balances

Increase at a percentage rate in the high single digits

Net interest income

Increase at a percentage rate in the high teens

Net interest margin

Between 3.80% and 3.90%

Allowance for loan losses

Comparable to 2018 levels

Net loan charge-offs

Between 0.20% and 0.40% of average total gross loans

Nonperforming loans as a percentage of total gross loans

Between 0.30% and 0.50% of total gross loans

Core fee income

Increase at a percentage rate in the high teens

Noninterest expense

Increase at a percentage rate in the mid-teens

Effective tax rate

Between 26% and 28%

Data source: SVB Financial.

There's a lot to unpack here, but the most important pieces are arguably loan balances, average deposit balances, and net interest margin, all of which management expects to continue moving in the right direction.

Notably, SVB Financial's guidance calls for its net interest margin to expand to 3.85% at the midpoint in 2019, which would be a meaningful improvement over the fourth quarter when it reported a net interest margin of 3.69%. Since management didn't incorporate any rate increases by the Federal Reserve in its outlook for 2019, any rate increases would be all upside for shareholders in 2019.

SVB Financial provides credit and banking services to The Motley Fool. Jordan Wathen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends SVB Financial Group. The Motley Fool has a disclosure policy.