Investors certainly seem to like First Citizens BancShares' (FCNCA 9.80%) acquisition of SVB Financial's (SIVB.Q) former loans and deposits. Following the deal announcement on early Monday, share prices of First Citizens exploded higher by nearly 54%.
And for good reason. Because First Citizens is purchasing SVB's assets at a $16.5 billion discount, the deal is expected to significantly increase First Citizens' tangible book value (by potentially 50% to 100%), or net worth, which bank stocks trade relative to, as well as First Citizens' earnings power. After all, First Citizens is doubling its assets to $219 billion. It's not every day that a bank can do this practically overnight and at such an attractive price.
Any deal of this magnitude does not come without execution risk, and SVB did just collapse due to mismanagement. But if done properly, First Citizens may have just gotten the deal of a lifetime. Here's why.
Attractive new businesses
It may be hard to believe after seeing the bank collapse, but SVB was actually an extremely strong-performing bank stock and ran a very strong business for many years. The failure of the bank really boils down to incredibly poor asset-liability management that could have easily been avoided.
Image source: Getty Images.
But in acquiring SVB's assets, First Citizens is adding a very solid global fund banking business, which consists of capital lines of credit. These are short-term loans to venture capital and private equity firms, which use the funding to execute deals quickly and bridge the gap between the time a fund makes an investment and actually gets the funds from its limited partners. SVB has done this lending for decades, and since its inception has had practically zero losses. First Citizens can also leverage these relationships with venture capitalists (VCs) and private equities (PEs) and the high-net-worth people that run and work at these funds to serve them in other ways at the bank.
First Citizens also bought SVB Private, the company's wealth management division. Wealth management is a very valuable business these days because it is capital-light and can generate strong returns on equity. But wealth management is also a business that requires a lot of scale. The addition of SVB Private meaningfully grows First Citizens' wealth management division. At the end of 2022, First Citizens had roughly $34 billion in assets under management (AUM). The addition of SVB Private adds another $17.3 billion of AUM, growing total client assets by about 50%.
Much of SVB Private comes from SVB's acquisition of Boston Private in early 2021. Boston Private had supposedly built a next-generation digital wealth platform, and SVB believed the acquisition represented a $400 billion opportunity when combining wealth management and deposit and lending opportunities. I'm not sure if this would still be true today, but leveraging SVB's relationships with wealthy fund managers is still likely to be an attractive opportunity.
The other piece of SVB that First Citizens purchased is the bank's life science, tech, and healthcare loan portfolios. This portfolio is likely going to face some pressure in the near term because the ability of these companies to repay their loans is based on their ability to exit, which is difficult with private company valuations facing pressure and IPO activity still sluggish. But this portfolio has always been inherently riskier. SVB usually acquires warrants when lending to these companies to account for the risk, and over time these equity warrant gains that are realized when a company exits have widely outperformed loan losses.
Unfortunately, First Citizens didn't get these warrants, but it did set up a loss-sharing arrangement with the Federal Deposit Insurance Corp. (FDIC), which will essentially cover 50% of losses of commercial losses after the first $5 billion. And remember, First Citizens bought these assets at a significant discount -- so I think the risk is well accounted for when you consider these two factors.
Are SVB's deposits a flight risk?
A big question among analysts on the conference call following the deal was how sticky SVB's deposits are. On paper, they look great. Roughly 63% of deposits First Citizens acquired are non-interest-bearing, meaning the bank has to pay no interest on them. These are supposed to be the stickiest kind of deposits. But as we saw during the run on SVB when depositors pulled an astounding $42 billion of deposits from the bank in a single day, these may not be as sticky as initially perceived, especially with bonds and other types of bank account products paying 4% to 5% interest.
But keep in mind that SVB is really a leader when it comes to banking early-stage companies, and it had cash management products specifically for start-ups. Putting your money in numerous bank accounts makes perfect sense now after everything that just happened, but when you are a start-up you are trying to keep costs lean. Having multiple bank accounts and treasury management products likely creates more work for a CFO or requires additional hiring.
Following the demise of SVB, Pitchbook reported that early-stage companies were putting money back into SVB because they were having difficulties finding another bank that met their needs. Large VC firms like General Catalyst, Lightspeed Ventures, and Bessemer Venture Partners signed a joint statement the week after the SVB collapse "recommending our portfolio companies to keep or return 50% of their total capital with SVB."
So while start-ups may take steps to further diversify their banks and SVB may not have the same moat that it once did, I still think the bank will be the first choice for start-ups and VC/PE companies if First Citizens can maintain somewhat similar service.
When pressed on how they would handle SVB's deposits, First Citizens management said they would focus on operating accounts and also likely hold higher cash balances. The acquisition came with $35 billion of cash from SVB and access to a liquidity facility from the FDIC. First Citizens currently has enough liquidity to cover 175% of uninsured deposits. This will give First Citizens some time to adapt to liquidity flows at SVB and learn how to best manage liquidity on a regular basis.
The other thing to consider is that at the end of 2022, SVB reported that there was still record dry powder being held by PE and VC companies. SVB banked about half of all U.S. venture-backed start-ups. Furthermore, the digital economy has continued to make up an increasing amount of U.S. gross domestic product (GDP) over the years. Once the dust settles, I still expect the tech and start-up sector to be attractive clients for the bank.
A potentially transformational deal
The First Citizens-SVB deal certainly comes with a lot of execution risk. SVB did just collapse due to poor management, so there could always be other surprises lurking.
First Citizens is also very different from SVB, so integrating the two bank cultures could be difficult, and company culture is a bigger obstacle for large mergers than many people realize. First Citizens management is going to have to be very careful about managing deposits and the balance sheet in the near term.
But First Citizens is getting what has historically been a great franchise for practically nothing. The earnings and tangible book value accretion are far and away bigger than any bank could get in a normal acquisition. First Citizens didn't pay a premium for the deposits, and it has a loss-sharing agreement in place and access to liquidity from the FDIC.
This is also part of First Citizens' playbook. The bank has reportedly purchased 20 failed banks since 2009, so it has plenty of practice with this, though SVB will be its biggest challenge yet. Given the safeguards built into the deal, the new businesses it is getting, and the earnings and TBV accretion, First Citizens' purchase of SVB's loans and deposits could be the deal of a lifetime.
