For top tech industry lender, Silicon Valley Bank (NASDAQ: SIVB), cheap money is the engine driving its high profitability. It gets this funding by serving as a one-stop shop for the tech start-ups that require its services. In this segment, we discuss how this strategy is reaping a windfall for the bank.

A full transcript follows the video.

 

This podcast was recorded on Dec. 7, 2015.

John Maxfield: Silicon Valley Bank is another ... One of the things that Gaby and I have talked about a lot on this show is that, when you're looking at not only just a company, but a bank, in particular -- and this comes from our favorite investor, Warren Buffett -- really, the things that you're looking for are either a bank that is in a particular niche -- and a company that we've talked a lot about is in a particular niche over the last few months is New York Community Bancorp. But another bank that falls into that niche is Silicon Valley Bank.

And so when you're in a niche like that, what it allows you to do is, it allows you to earn excess profits over your competitors. Because you can have wider margins, because either you're specializing in a thing, or somehow you've differentiated your product. What Silicon Valley Bank does, is it provides banking services to, guess where? Silicon Valley, right? So all your new start-ups. So a new start-up will come in, it will need, you know, treasury management services, it will need deposit accounts, it will need checking accounts, it will need loans -- all these different things. Where do they go? They go to Silicon Valley Bank.

And there are a number of really, really interesting things that come from this. The first is that, if you look at Silicon Valley Bank, so most banks what they do is they borrow money really inexpensively from depositors, and then they invest that money into much higher interest-earning assets, namely loans. Well, what Silicon Valley Bank does is it has so much free money in terms of deposits, let me make sure my numbers are right here. Out of roughly $40 billion worth of liabilities, get this... $31 billion worth are interest-free deposits.

Gaby Lapera: That's insane.

Maxfield: Think about that for a second. This is a bank that 78% of its financing is free. I mean, it's unbelievable, and the reason its financing is free is because all of these Silicon Valley Banks put all of their excess deposits in there, and they get all those excess deposits from your venture capitalists. So then, what Silicon Valley Bank can do with this, is because their funds are so inexpensive, they don't have to make as many loans as many of their competitors do to earn as much money.

So what that means is that it can then go and invest a lot of those cheap deposits into extremely safe securities, like government securities are AAA rated, right? I can't remember if our government is AAA rated anymore or not. Or AAA-, or AA+. But it's basically as safe as you can get. And it can still earn all this money, reduce credit risk, and serve this particular niche market. And it's just been a great thing for Silicon Valley Bank's investors over the years. It's been able to compound at a faster rate than many of its competitors.

Gaby Lapera has no position in any stocks mentioned. John Maxfield has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.