SVB Financial Group (SIVB.Q -40.00%), the parent company of Silicon Valley Bank, saw its shares plummet more than 17% on Friday, making the stock the biggest loser in the S&P 500 for the day. Investors sold the stock after the bank reported a big miss on its second-quarter earnings report Thursday and lowered its full-year guidance, following difficulties in the tech, startup, venture capital (VC) and private equity (PE) sectors, which the bank heavily serves. Should investors take advantage of the dip and buy the stock for the long-term?
The reason behind the big whiff
SVB reported earnings per share of $5.60 on revenue of $1.53 billion. While revenue only missed estimates slightly, earnings missed by a whopping $2.08.
Part of the reason for the miss is that the bank had to provision $196 million for potential future loan losses -- much higher than last quarter's $11 million provision.
Known as the go-to bank for startups, SVB makes some of its loans to early-stage and growth-stage companies. These businesses need to be raising capital every year and a half to two years to continue to fund growth, or exit in some way by getting acquired or going public. But we know IPO activity has been nonexistent and tech valuations have dropped due to turmoil in this market sector. The larger provision this quarter accounted for deteriorating economic conditions, loan growth, and expected loan losses of about $20 million.
SVB also saw fee income drop by about 30% from the first quarter. Core fee income actually came in fine, but the bank got hit by gains on equity warrant assets and on investment securities losses. Because SVB will often bank risky early-stage startups, the companies often give SVB equity warrants, which the bank can convert into equity if and when the company exits. But with practically no IPO activity recently, equity warrant gains were minuscule in Q2.
The bank stock also reported a $157 million loss on investment securities, which likely include public equity positions the bank has (as a result of warrants) that declined significantly in the second quarter.
Finally, management lowered its full-year guidance for average loan growth, average deposit growth, and net interest income. The bank is still going to grow all of these items nicely in 2022 on a year-over-year basis, but the outlook is no longer as optimistic.
The innovation economy is still promising in the long-term
The earnings miss and slowdown in SVB's business are related to weaker startup funding activity and rapidly declining tech valuations in the public markets, which have now trickled over to the private markets.
On SVB's earnings call Thursday, CEO Greg Becker said VC flows have slowed, which has impacted deposit growth and also the bank's venture capital call lending business, which makes up more than half of the bank's loan portfolio. Startups are burning through capital more quickly, and very little IPO activity has also hurt SVB's investment banking business.
But an investment in SVB is really a bet on the innovation economy, which still looks to have a bright future. As Becker mentioned, the digital economy has grown 350% between 2000 and 2020, more than doubling the growth of the U.S. economy in the same time frame. Following the pandemic, the need for technology and digitized services has never been greater. Even though VC investment slowed in Q2, VC and PE firms are currently sitting on a war chest of dry powder, roughly eight times the levels they held in 2000, according to SVB.
VCs and PEs may begin putting that dry powder to work once valuations come down and stabilize. And Becker said the bank in Q2 had one of its best quarters in signing new term sheets with startups and signing up other new businesses.
Furthermore, SVB has greatly built out its investment banking division and its private bank, which will keep contributing meaningfully from a revenue standpoint. Also, management's lowered guidance does not include the impact of higher interest rates, which are expected to greatly benefit net interest income -- the profit the bank makes on loans, securities, and cash after funding those assets. SVB also has a strong track record when it comes to credit, having been through numerous stressed scenarios including the dot-com bubble, the Great Recession, and the pandemic.
Buy SVB stock on the dip?
SVB's second quarter was no doubt disappointing, and I do wish management had greater foresight in the first quarter, during which it raised guidance. But predicting what will happen with the economy and tech valuations in the near term is certainly no easy task.
The bank is still much stronger than it has been, SVB has an impressive track record of good credit performance, and its lower guidance does not include the very positive impact it's likely to see this year from higher interest rates. The tech and startup sectors need time to stabilize given market conditions and the Federal Reserve pulling liquidity out of the economy.
The innovation economy still looks very well positioned, as evidenced by the amount of dry powder VCs and PEs are sitting on, so when this part of the economy bounces back, then SVB should follow suit. For investors with cash on the sidelines and a long-term horizon, I would buy the dip and hold.