About the Company
SVB Financial Group (SIVB) focuses mainly on commercial banking and venture capital services in technology, life sciences, and wineries. It also leverages these services to provide relationship banking to people mainly in the Bay Area.
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Over the years, SIVB has been able to create a competitive advantage by becoming a specialist in early-stage companies, which frequently depend on non-traditional ways of financing. With over 20 years of experience and local knowledge, SIVB now understands better than any other national bank how to manage risk in Silicon Valley, which is one of the few economically growing areas in the US. For a less specialized institution, these customers would probably imply higher provisioning costs commensurate with the amount of risk incurred. Its riskier client class enables SIVB to charge higher interest rates on its loans.
Moreover, after having grown out its product offerings over the past decade, its early-stage clients are now staying with the firm as they mature. Given the cyclical nature of its business, SIVB's business suffered in the last recession. Loan balances shrank almost 20% and Non-Performing Loans exceeded 2.5%. It operates through 27 offices in the United States, as well as offices internationally in China, India, Israel and the United Kingdom.
The healthy tech spending in the coming years leads us to believe that the current cycle for both (1) venture capital exits and (2) early-to-mid stage tech revenue growth will prove to be more profitable for SIVB than current investor expectations. However, we also note that at the current price SIVB is just too expensive.
Having disbanded its mortgage lending operations in 2001, SIVB bears essentially no direct exposure to the U.S. housing mess. Furthermore, in our opinion, those deep connections and a favorable future economic environment will lead the company to post impressive credit-quality metrics. We believe that there is solid evidence for growth in 2011:
a) An improving business environment
With strong economic growth, tech companies and industry analysts are raising their expectations for the future. Many claim that they are now seeing a wide array of businesses overcome their fear and reluctance to open their wallets and replace equipment that aged during the recession.
b) Growth will follow increase in expenses
Noninterest expenses are expected to increase in the low double-digit percent range. Target expense growth is 10%. One-third of the expense growth is expected to be from investment in global and private banking initiatives, 15-20% from investment in global banking systems and the remaining 50% related to normal operating expenses including growth of sales and support personnel and the full impact of hires added in 2010. In summary, we are seeing an increase in expansion spending in which we expect returns to follow.
c) Improving venture-backed exit markets and tech related M&A
SVB expects buyout financing to account for a meaningful component of loan growth in 2011, either via private equity ($15-25m deals) or capital call lines and follow through financing. The company recorded ~$1.0 billion of growth in this segment during 2010. On the flip side, loan growth looked impressive on the surface, but a large portion of the growth came from short-term bridge loans rather than stickier term debt. As a result, SIVB is unlikely to sustain the size of the loan portfolio.
d) Ample capital/liquidity to support growth
With strong deposit growth (+36.8% annual growth from FY 2009 to FY 2010), we expect SIVB to continue growing its loan book.
e) Results from ongoing investments in growth initiatives
The international portfolio approached $200 million in 2010, and management believes 100% growth during 2011 is not unreasonable. Private client services also have potential. SVB estimates line utilization was approximately 47% in 4Q10 vs. a trough of 42-43% and a historical norm of closer to 50%, but the company is not expecting much benefit from increased line utilization over the near-term without more meaningful help from the economy.
Rebound in the NIM could take time to materialize given deposit flows. That said, SIVB is unlikely to achieve its target of upper-tier, double-digit returns on equity at least until the Fed starts raising rates. Operating Margins have been compressed also given that the Bank has not seen any slowdown in deposit inflows. Our sense is that deposit flows are unlikely to stop without an increase in interest rates, which could prove a headwind to the company’s 2011 Net Interest Margin full year guidance of 3.30-3.40%.
SIVB also pointed out that the repricing of some older (i.e. higher yielding) credits in 2011 as well as heightened competition could place incremental pressure on loan yields. The company estimates that repayment of its convertible debt ($250 million matures in 2Q11) should provide 5-6bps of NIM benefit.
We continue to view “normalized earnings” as an appropriate valuation methodology for SIVB, as the current interest rate environment and excess liquidity (39% loan-to-deposit ratio at 4Q10) does not show the company’s long-term earnings power. Normalizing for these factors, we estimate SVB could earn closer to $6.00 in 2014-2015. Using a 15x multiple, we come up with a target price of $90 for 2014-2015. That translates into a ~12% annualized return. Given a beta of 1.39, this is NOT an attractive return (at this current price).
Is it a good short? No and here are my reasons:
- SIVB is in the top quartile of growing banks
- Strong operating leverage
- Crowded short (4.88m shares short, the highest absolute number of short interest in some time.)
The Financial Stability Oversight council issued its report and recommendations pertaining to the Volcker rule some time ago and the report validated SIVB's view that venture capital is different from private equity and hedge funds. Next steps will include regulatory agencies proposing and adopting final rules, but this will most likely be a long process.
More than half of SIVB’s loans are to the tech and life sciences sector, making the bank exposed to a significant downturn in the industry. A further drop-off in VC financing could weigh further on growth.
In addition, about 11% of SIVB’s loans are extended to early-stage companies with negative cash flow and no receivables as collateral, which could result in higher credit costs relative to peers.
Also, we assume that the company will benefit from an eventual rise in rates in the intermediate term. Should the currently very low rate environment be prolonged, this could pressure the company’s results and lead to the shares underperforming peers.
We believe this company is a very well run small bank/financial institution. Management is reasonable and the franchise is run appropriately. However, in terms of valuation, we believe that SIVB is just too expensive at the moment. We will monitor this company and at the right price we will take a position.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.