SVB Financial Group (SIVB -0.64%), the holding company of Silicon Valley Bank, is a $71-billion-asset niche bank that caters to the start-up and tech sectors. The company has four main divisions: a global commercial bank, a venture capital investment arm, a private banking practice, and an investment bank operation focused on life science and healthcare.
Is it one of the best bank stocks? Quite possibly. Before the coronavirus pandemic, it was one of the highest-performing bank stocks of the last decade, with its stock climbing nearly 470% between early 2010 and the end of 2019. Despite the impact of the coronavirus pandemic on banks, it appears that SVB has a good handle on credit quality, avoids risky industries by the very nature of its business model, and is well-positioned for a post-coronavirus market.
Conservative thinking in risky industries
After a turbulent end to the first quarter, SVB reported first-quarter profits of roughly $132 million, a 54% drop from the first quarter of 2019. That was mainly because the bank took a quarterly credit provision of more than $243 million to cover potential future loan losses, up from a credit provision of just $24 million in the first quarter of 2019. All in all, I think this was a very conservative provision, which is never a bad thing to do during an event like a pandemic. CEO Greg Becker said in the company's first-quarter earnings call that the bank modeled for its provision by using very "severe" economic assumptions because of the uncertainty.
This is a good sign because, without a doubt, there is risk in SVB's portfolio, which is heavily based on lending to the private markets. Some 5 percent of the company's loan book is made to early-stage start-ups. Ever heard it said that 90% of start-ups fail? That's not even factoring in the pandemic.
And despite the inherent risk that comes with making loans in the tech and start-up sectors, over half of SVB's $36 billion loan portfolio consists of loans to private equity and venture capital firms. Most of these loans are capital call lines of credit that provide bridge financing for clients that need to quickly execute on investments. The loans are paid back in short order once the firms obtain the capital committed to them from limited partners. Because private equity and venture capital firms slowed their investment activity in March and April, this loan segment likely experienced less volume. But from a credit perspective, these loans are very safe. In fact, SVB has had zero losses on capital call lines of credit since it began making the loans in the 1990s. Yet the company still set aside 0.30% of its total allowance for loan losses to cover potential losses in this segment, showing it is thinking conservatively.
Start-up funding in the U.S. has begun to rebound, reaching $6.3 billion in May, down more than 15% from May of 2019, but up close to 32% from March, according to AlleyWatch. Additionally, SVB is a very liquid bank. Loans only make up about half of the bank's total assets, with the rest invested in cash and fixed-income securities. At the end of the first quarter, SVB had a common equity tier 1 capital ratio (a measure of a bank's core capital against its risk-weighted assets) of 12.36%, well above regulatory minimums for a bank of this size.
A promising future
If you look at the earnings materials of other regional banks, you will notice that many broke down the industries they had exposure to that were heavily impacted by the coronavirus. These industries likely included travel, entertainment, retail, and several others. But SVB has very little exposure to such industries. Sure, the bank has 5% of its loans tied up in early-stage start-ups, but otherwise it has very limited direct exposure to retail, restaurants, travel, and hotels, and no direct exposure to energy. The bank's loans skew heavily toward technology, life sciences, and healthcare. These sectors have been impacted as well, but have a much brighter future than, say, the office and retail industries, which could see a fundamental shift once the coronavirus subsides.
Additionally, start-ups and new companies tend to flourish following a significant economic downturn. This is in part because the job market may less healthy than before, so launching a company could be more practical. Citing data from Pitchbook, SVB said that following the Great Recession in 2008, company formation increased by 105%, while 41% of current unicorns and 9% of current Nasdaq companies were also founded during this period. Uber Technologies launched following the Great Recession, and given the rapid acceleration of digital and remote trends, I think there could be a flurry of new start-ups, as well as further adoption of existing start-ups founded before the pandemic. Being the bank of start-ups and tech, SVB is well-positioned to take advantage of this trend.
SVB has operated in the tech and start-up sectors for three decades now, where many banks are weary to lend. Not only has SVB shown that it can survive a downturn like the Great Recession, but it has also shown that its business model can produce higher returns than its peers. With the stock trading around $221 per share on Thursday, down only 12% this year, I fully expect SVB to return to its previous highs and see further success once the coronavirus subsides.