SVB Financial Group (SIVB +0.00%), a bank that caters to its namesake Silicon Valley customers, released its third-quarter 2022 earnings on Oct. 20. Although investors were highly disappointed with the report, there was good news in the results.
Here is the one big reason the stock dropped after earnings and one reason you should remain optimistic over the long term.
OTC: SIVB
Key Data Points
1. The bad news: Lowered guidance
SVB generates most of its revenue through loans. The bank measures its profits from lending activities based on net interest income (NII), the difference between the interest rate it pays depositors and the interest rate on the loans it makes.
SVB maintains a relatively high percentage of deposits on which it pays no interest, formally called non-interest-bearing deposits. When start-ups or private companies raise money from a venture capitalist (VC) or private equity (PE) investor, they often deposit those funds into an SVB non-interest-bearing account.
These deposits also benefit the bank, especially in a rising interest rate environment. When the Federal Reserve raises interest rates, the bank will also increase the interest rate on its loans. And the higher its percentage of non-interest-bearing deposits, the more significant the boost will be to NII when it raises its loan rates.
For instance, in the first quarter of 2022, the company had 65% of its deposits in non-interest-bearing accounts, a relatively high percentage compared to the average bank. Because of this high percentage, the bank projected a $100 million to $130 million increase in annualized pretax NII for each 25 basis-point rate increase by the Fed.
However, when economic growth began faltering, the bank ran into trouble; private and public company valuations began dropping. And VC and PE investments slowed.
As a result, SVB's depositor base of start-ups and young high-growth companies began making fewer no-interest deposits and more withdrawals. And the bank's average non-interest-bearing deposits fell from $120.67 billion in the second quarter to about $106 billion in the third quarter.
To compensate for the loss of non-interest-bearing deposits, SVB brought interest-bearing funds onto the balance sheet, resulting in higher loan-funding costs and reduced sensitivity to rising interest rates than it forecast in the first quarter. Consequently, SVB lowered its fiscal 2022 deposit and NII estimates in its third-quarter 2022 earnings report. The company also said its NII has peaked for this rising-rate cycle. So any investors who bought SVB using a thesis that included an extra boost to NII from rising interest rates just got the rug yanked out from underneath them. As a result, disappointed investors sold the stock, and it declined 24% after the company released its earnings.
You should expect the company's results and stock price to remain depressed as long as private and public fund-raising activity for tech and startups continues to decline, which results in lower non-interest-bearing deposits. Unfortunately, the timing for when things might improve is unknown, a reason SVB failed to give a 2023 forecast.
2. The good news: The bank remains positioned for growth once conditions improve
There are four indicators of future business growth.
First, the long-term outlook for tech remains promising.
Image source: SVB Financial.
Second, average loan growth remained solid in the third quarter, up 20% year over year to $71.1 billion, driven by technology, healthcare, and private bank lending.
Third, PE loan term sheets are at record levels. A loan term sheet signals an intention by a borrower to consummate a loan. And PE and VC cash levels remained at all-time highs. Once it is safe to get back into the water, SVB believes PE and VC firms will resume investing in young, high-growth companies. And the bank thinks those companies will deposit their funds in SVB non-interest-bearing accounts.
Lastly, the bank continues to expand its global client base rapidly. New client acquisition reached a record of nearly 1,800 commercial clients in the third quarter.
Should you buy this bank?
SVB currently has a price-to-book (P/B) ratio of 1.14, slightly below 1.27, where the average regional bank trades today. And during a better market, SVB trades substantially higher. Consequently, its median P/B ratio is 2.15, and its maximum is 3.86 over the past 10 years.
SVB's return on equity (ROE), a measure of profitability, is 13.62% compared to an average ROE of 12.97% for banks in a similar category -- justifying SVB's current valuation for long-term investors who believe the business will significantly improve once the economy rebounds.
If you are willing to withstand some downside over the short term, it might be worth investing part of your nest egg in the stock at current prices.
