SVB Financial Group (SIVB 1.98%), the holding company of Silicon Valley Bank, has been a top bank stock over the past decade. It's held up very well during the coronavirus pandemic, too, with its stock price now up for the year. And fast-growing digital trends resulting from the pandemic could bode very well for its continued success.
SVB is not your typical pure-play commercial bank. Rather, it focuses on the tech sector, banking lots of start-ups and making lots of loans to the private equity and venture capital community. Despite operating in what many consider to be a risky industry, the bank has exceptionally good credit quality. Here's why SVB is arguably the best bank stock right now.
Strong credit quality
We're in a recession. This is a bank. And there is lots of uncertainty, so the first thing you do is look at credit quality. Amazingly, its net loan charge-offs (debt unlikely to be collected) as a percentage of total average loans were only 12 basis points (0.12%) for the three months ending June 30, which is the lowest quarterly net charge-off level at SVB in the last year.
Now, the banking sector has not seen high charge-off levels yet because of all the government intervention, but to see charge-off levels decline year over year is still pretty amazing. Non-performing loans and assets (those that haven't received payment in 90 days or longer) as a percentage of total loans and assets are up from the first quarter, but still down on a year-over-year basis.
This dynamic really seems to come down to the composition of SVB's balance sheet. First of all, the bank only invests about 42% of its assets in loans, which is very small compared to most commercial banks. Roughly $46 billion of its assets are stashed away in cash and high-quality fixed-income securities.
Plus, about half of the loans the bank does make are in capital call lines of credit to venture capital and private equity firms. These are lines of credit to funds that have obtained commitments from limited partners, but which want the flexibility of a line of credit while they wait for the funding to come in -- sometimes they need to pull the trigger on an investment to a start-up or business quickly. But these are short-term loans, and SVB has a lot of different ways to get its money back if for some reason the funds don't pay it back. Overall, SVB has had zero net losses on capital call lines of credit since the product's inception in the 1990s.
The bank has currently set aside enough cash to cover losses on 1.61% of total loans. In 2009, during the peak of the Great Recession, its net charge-offs as a percentage of total loans reached 2.64%, but I still think SVB is in a great position from a credit perspective.
Lots of opportunity ahead
SVB is in a unique situation not only because of the sector it operates in, but also because of how much potential it has after the pandemic. Following downturns, when job prospects can be harder, more people turn to innovation and launch their own companies. There is and will continue to be lots of opportunity because the pandemic has fundamentally changed consumer behaviors from the increase in remote work to a heavier reliance on e-commerce, video conferencing, and digital payments. SVB brought in a record 1,500 new clients during the second quarter, most of which CEO Greg Becker said were early-stage companies.
"We've developed a broader product set to bring more clients," Becker said on SVB's most recent earnings call. "And I have to acknowledge ... that when you have an economic downturn that we've seen as pandemic, a lot of companies want to go where they view a trusted organization."
Also, federal regulators recently relaxed the Volcker Rule, a key part of the Dodd-Frank Act that prevented banks from taking any significant ownership stake in a covered fund such as a hedge fund, a private equity firm, and also many venture capital funds. SVB was one of the most vocal opponents of this law when it was being proposed, primarily because it was broad and included venture capital fund investments under the covered fund definition. SVB also had investments that were prevented under the Volcker Rule.
If the Volcker Rule had stayed in place as it was, the bank would have had to sell $211 million worth of investments made in certain venture capital and credit funds by 2022, or before those investments matured. Now, not only does the bank not have to sell these investments, but it could -- if it wanted to, although it has made no indication that it will -- make more venture capital investments with its own funds or even potentially sponsor a venture capital fund. These types of investments can be extremely profitable.
Plenty of upside
Trading at around $250 per share, SVB is not a cheap stock for the average investor, but it still has plenty of upside. It's one of the few banks out there heavily tied to the tech sector, which seems poised to explode, given the rapid acceleration of digital trends during the pandemic. It also has a good handle on credit and is seeing strong fundamentals behind its business segments. If you've been think about investing in banks during the sector's selloff this year, SVB is a good place to start.