Weeks after the collapse of SVB Financial, the parent company of Silicon Valley Bank, I think it's safe to say that there are still lessons to be learned by stakeholders. Bankers will learn from this, regulators will learn from this, depositors will learn from this, and a lot of investors will learn from this.
One type of investor that can certainly learn from this is the growth investor, who invests in companies that can grow their earnings faster than the industry average.
After all, SVB catered to many growth companies and the stock itself really acted much more like a growth stock in recent years, surging from around $250 per share prior to the pandemic all the way to about $750 per share in November 2021 when the markets were raging. Here's one valuable lesson investors can take away from the demise of SVB.
If it grows like a weed...
The age-old saying is that if something grows like a weed then it probably is one. I think growth investors lost sight of this and I myself, while not exactly a growth investor, fell into this same trap on SVB, having been quite bullish on the stock.
Bank investors are always warned to watch for fast loan growth because if banks are originating loans quickly then there is a good chance they aren't underwriting prudently and that a surge in loan losses will follow that recent growth. But the same warning does not always go hand in hand with growth in deposits, which was ultimately the beginning of the end for SVB and also Silvergate Capital (SI 2.50%), another bank that found itself in a similar predicament and is now winding down its operations.
SI Total Deposits (Quarterly) data by YCharts
As you can see above, these banks experienced startling deposit growth between 2020 and 2022. SVB grew deposits from just under $62 billion to more than $198 billion, while Silvergate grew deposits from below $2 billion to more than $14 billion. This is largely because of quantitative easing (QE) in which the Federal Reserve pumped trillions of dollars into the economy, which then found its way into the coffers of SVB's main clients including start-ups, venture capital groups, and private equity companies. This excess liquidity also found its way into crypto companies, which Silvergate banked. In fact, QE injected the entire banking system with about $5 trillion of deposits in just a few years. The ultra low interest rate environment also had investors seeking out yield in more speculative and risky investments like crypto and venture capital.
But the big mistake investors like myself and arguably SVB's management team made was that they didn't look deep enough into who these customers were and what their deposit behavior might be like. They saw that they were non-interest-bearing deposits, which are those that the bank pays no interest on and are presumably stickier in a rising-rate environment, and assumed that these were somewhat sticky. They also were misguided in thinking how severe the rising interest rate environment might ultimately be, along with the possibility of quantitative tightening and its impact.
SVB banks half of all U.S. venture-backed start-ups. Start-ups raise a lot of money at once but then they spend that money, typically over the next 12 to 18 months, so the big dynamics powering SVB's deposit base are venture capital deployment and client cash burn. And this is where the music stopped: VCs stopped deploying capital after tech valuations came under pressure in 2022 and client cash burn accelerated. In the quarters leading up to SVB's demise, the bank lost tens of billions in deposits, which prompted Moody's to question its credit rating and a series of events that ultimately brought the bank down.
Challenge growth
Now, it's easy to look back in hindsight and realize what you should have done. And growth isn't the entire story. SVB could have avoided this if the company had managed its balance sheet better or perhaps made some different moves right before the demise like, say, raising capital prior to announcing a sale of its securities book.
But the overall lesson here is that if a company grows incredibly fast or is generating results that simply look too good to be true, you need to push back against the factors driving those results and question whether or not they are truly sustainable. In this case, if investors had dug beneath the surface of the non-interest-bearing deposits they might have noticed that these deposits were not the same as your traditional smaller-balance retail checking accounts and therefore would not act the same, especially under the challenging conditions that played out over the last year.
Nothing is simple and there will be companies that can grow fast and succeed but after the tech boom in 2021 and now the demise of SVB, a valuable lesson is to really challenge growth because if something goes up too quickly then it can fall just as fast.
