The $97 billion asset Silicon Valley Bank is on a run that it will not forget. The stock price of its parent company, SVB Financial Group (SIVB.Q -1.96%), has surged from a low around $130 in March to more than $350 at Wednesday's close. The stock is setting new all-time highs during a period when the banking sector has faced no shortage of challenges.
Silicon Valley Bank, which caters heavily to the start-up, venture capital, and private equity communities, has a lot going for it. But I believe it has one attribute that really sets it apart from the industry right now.
Image source: Silicon Valley Bank.
Capital call lines of credit
One of banks' main challenges right now has to do with revenue. Ultra-low interest rates have dropped the amount of interest that banks receive on many of their loans, which is known as net interest income. Additionally, unlike in most low-rate environments, banks are not experiencing heavy loan demand on the commercial side because the coronavirus has significantly hurt a lot of commercial sectors, such as hotels, retail, office space, and more. Many businesses are still also worried about the uncertain economic outlook and are therefore not investing in themselves. Most banks saw their total net interest income continue to decline in the third quarter, and the profit margin on loans is now at its lowest levels since the Great Recession, according to the data company Trepp.
Silicon Valley Bank also saw its net interest margin drop significantly in the third quarter, but the bank was rare in the sense that it managed to increase its net interest income from the second quarter and on a year-over-year basis. That's because unlike most of the industry, Silicon Valley Bank originated enough loans in its niche lending segments to offset the smaller margins.
And this is where we get to the attribute that I think sets this bank apart right now.
Silicon Valley Bank lends heavily to the venture capitalist community through loans called capital call lines of credit, which make up nearly half of its total loan book. Capital call lines are short-term loans to venture capital and private equity companies that are trying to execute quickly on investments they are making in start-ups or businesses. So, Silicon Valley Bank provides a line of credit until the venture capital or private equity company can secure the funding it has already been promised from its own investors. This product carries an interest rate of around 3%, and Silicon Valley Bank has had net zero losses in this lending segment since it started originating the loans in the 1990s.
This is a big deal because, as I mentioned earlier, most traditional banks are finding it very difficult to drum up commercial loans, which typically have higher interest rates. While there are other banks that do capital call lending, it is not common in your traditional commercial bank, and Silicon Valley Bank has been doing this kind of lending longer than just about anyone else. Banks have also been flooded with deposits this year but have nowhere to deploy that capital. The low-rate environment has hurt yields in the bond market, and investing in commercial real estate is also not super attractive right now. When banks get stuck with too much cash on their books not generating any meaningful returns, it can hurt their return metrics. Although net interest income and margins may soon begin to bottom, it's unclear if banks will be able to get net interest income back to levels seen before the pandemic.
Meanwhile, Silicon Valley Bank is in a much different position. Silicon Valley Bank President Michael Descheneaux said on the company's third-quarter earnings call that there are "record levels of dry powder for VC." Not only are the private markets one of the few places for investors to find meaningful yield right now, but entrepreneurship and start-ups tend to surge following a recession. With the acceleration of digital adoption, I think entrepreneurship activity could break out once again.
This will provide good lending activity for Silicon Valley Bank, and at attractive rates. It's perhaps one reason why Silicon Valley Bank is projecting high-single-digit-percentage net interest income growth in 2021, and remember this is after continuing to grow net interest income in the third quarter despite the low-rate environment.
Great prospects for 2021
Silicon Valley Bank has never allocated a huge portion of its assets to loans. It has a ton of excess liquidity to deal with, and it's trading way above tangible book value. But even with all of this in mind, I still see this bank producing better and more consistent earnings than most of the banking industry in 2021. The bank also has so much going for it, including a top-notch efficiency ratio and a strong and growing investment banking division. But with net interest income such a struggle right now for the banking sector and Silicon Valley Bank in such a strong position with its capital call lending product and experience, this is one attribute that in my opinion really separates it from the rest of the industry.
