SVB Financial Group (SIVB -17.15%)the parent company of Silicon Valley Bank, saw its shares fall more than 17% on Friday, making the stock the biggest loser in the market. S&P500 for the day. Investors sold the stock after the bank reported a major misfire in its second-quarter earnings report on Thursday and lowered its full-year guidance, following difficulties in the technology, startups, venture capital (VC) and private equity (PE), which the bank serves heavily. Should investors take advantage of the decline and buy the stock long term?
The reason behind the big puff
SVB reported earnings per share of $5.60 on revenue of $1.53 billion. While revenue only slightly missed the estimates, revenue fell short by $2.08.
This error is partly explained by the fact that the bank had to provision $196 million for possible future loan losses, much more than the provision of $11 million last quarter.
Recognized as the reference bank for startups, the SVB grants some of its loans to start-up and growth-stage companies. These companies must raise capital every year and a half to two years to continue to fund their growth, or somehow exit by getting bought out or going public. But we do know that IPO activity has been non-existent and technology valuations have fallen due to turbulence in this market sector. The larger provision this quarter accounted for deteriorating economic conditions, loan growth and expected loan losses of approximately $20 million.
SVB also saw its commission income fall by around 30% compared to the first quarter. Basic fee income was actually good, but the bank was hurt by gains on equity warrant assets and losses on investment securities. Since SVB will often bank risky start-ups, companies often give SVB stock warrants, which the bank can convert into stock if and when the company exits. But with virtually no IPO activity recently, equity warrant gains were tiny in the second quarter.
Bank stocks also posted a loss of $157 million on investment securities, which likely includes positions in public stocks held by the bank (as a result of warrants) which 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 well in 2022 year-over-year, but the outlook isn’t as rosy anymore.
The innovation economy remains promising in the long term
SVB’s loss of profits and slower business is linked to weaker seed funding activity and rapidly declining tech valuations in public markets, which have now trickled down to private markets.
During SVB’s earnings call on Thursday, CEO Greg Becker said venture capital flows had slowed, which had impacted deposit growth as well as capital call lending activity. -bank risk, which accounts for more than half of the bank’s loan portfolio. Startups are burning capital faster, and very low 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 seems to have a bright future. As Becker mentioned, the digital economy grew 350% between 2000 and 2020, more than doubling the growth of the US economy over the same period. Following the pandemic, the need for digitized technology and services has never been greater. Even though venture capital investment slowed in the second quarter, venture capital and private equity firms are currently sitting on a war chest of dry powder, about eight times the levels they held in 2000, according to SVB.
VCs and PEs can start putting this dry powder to work once valuations drop and stabilize. And Becker said the bank in the second quarter had one of its best quarters signing new term sheets with startups and signing other new businesses.
In addition, SVB has strongly developed its investment banking division and its private bank, which will continue to make a significant contribution in terms of income. Additionally, management’s lowered guidance does not include the impact of rising interest rates, which should greatly benefit net interest income – the profit the bank makes on loans, securities and liquidity after funding these assets. SVB also has a strong credit history, having been through many stressed scenarios including the dot-com bubble, the Great Recession and the pandemic.
Buy SVB shares on the decline?
SVB’s second quarter was undoubtedly a disappointment, and I wish management had been more forward-looking in the first quarter, in which they raised their guidance. But predicting what will happen to the economy and technology valuations in the near term is certainly not an 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 forecast does not include the very positive impact it is likely to see this year in because of higher interest rates. The tech and startup sectors need time to stabilize given market conditions and the Federal Reserve pulling cash out of the economy.
The innovation economy still seems very well positioned, as evidenced by the amount of dry powder that VCs and PEs sit on, so when that part of the economy rebounds, then SVB should follow suit. For investors with cash on the sidelines and a long time horizon, I would buy the dip and hold.