How far can Silicon Valley Bank shares go?

If you follow the banking industry then I don’t need to tell you that SVB Financial Group (NASDAQ: SIVB), the parent company of Silicon Valley Bank, has been in tears for over a year. Before the pandemic, the bank was trading at around $ 246 per share, a price it had won after a long string of phenomenal performances. But the pandemic has taken startup banking technology and power to the next level, and now SVB is trading around $ 573. This is more than 350% of the tangible book value (equity less goodwill and intangible assets), which is a high valuation in the banking sector.

At this type of valuation, many investors might already be taking gains, or at least thinking about it. But I actually think the opposite – I wonder how high this stock can go, with a significant rise in mind.

An enlightened neighborhood

While much of the industry has faced high credit costs during the pandemic and still struggles to find loan growth, SVB has been another story. Niche banking pioneered startup banking in the 1990s and has been reaching out to startup, venture capital and private equity communities ever since.

SVB provides short term loans to private equity and venture capital firms so that they can execute investments quickly. It finances start-ups and is often able to secure equity warrants at attractive valuations. It owns an investment bank specializing in the health and life sciences sectors, invests in private capital on behalf of its clients and has a private bank and a wealth management service for clients. high net worth individuals.

Image source: Getty Images.

These activities reached their full potential in the first quarter of the year as the bank followed a series of superb quarters with the best in its history. SVB generated net income of over $ 532 million, or diluted earnings per share (EPS) of $ 10.03, on total revenue of over $ 1.4 billion. The bank’s net interest margin, the difference between what it does on interest-bearing assets such as loans and repayments on interest-bearing liabilities, fell to 2.29%, down from 0 , 83% year over year. However, over the same period, net interest income has grown from around $ 524 million to almost $ 660 million. This is pretty incredible, because it means that even though the bank’s assets were earning a lower interest rate (the fall in the federal funds benchmark rate lowered lending rates), SVB still found a ton of loan volume to bring lower rates under control and significantly increase net interest income.

This lending activity is the result of oversized venture capital and private equity investments during the pandemic, with investors pouring their money into private markets. The bank also brought in tons of fees from its investment banking division due to the continued strength of public markets, while continuing to capitalize on initial public offerings from start-ups.

Share subscription warrants

Often times SVB will provide services to start-ups that are too risky for more traditional banks. In exchange for the risk, start-ups will often throw away sweeteners such as stock warrants, which essentially give the bank the right to buy a large sum of shares cheaply if the start-up enters. in stock exchange. So big risk, big reward.

SVB has made a lot of noise about these warrants in recent quarters, as several of its top-tier start-ups have gone public. In the first quarter, the bank took gains of more than $ 115 million related to the exercise of warrants it held in the cryptocurrency exchange. Coinbase Global. In total, SVB recorded earnings of nearly $ 222 million related to warrants during the quarter, compared to just $ 13.4 million in the first quarter of 2020. This type of income is volatile and difficult. to be expected, but it has become more and more common in recent quarters.

SVB also capitalized on its strong quarter while taking on a pre-tax charge of $ 80 million related to a customer the bank said committed potentially fraudulent behavior. This is one of the few slippages the bank has had in credit quality in its venture capital and private equity lending operations since the 1990s – and it hasn’t stopped the bank from producing. its best quarter of profitability.

Tons of additional growth to come

The knockout quarter and improved outlook led SVB to significantly raise its full year forecast. The bank now expects average loan balances to increase at a percentage rate in the mid-1930s, well above what I have heard any other bank predict for loan growth. Net interest income is expected to increase at a percentage rate in the mid-1930s. Average deposit balances are expected to increase at a percentage rate in the 1960s, which is again incredible considering the amount of deposit entries that SVB saw in 2020.

SVB is also well positioned to enter a rising rate environment when the Federal Reserve begins to think about raising the federal funds rate. More than half of the bank’s total loan portfolio is associated with venture capital and private equity lending activities, which are tied to short-term rates. The bank revealed in its earnings documents that it will realize $ 100 million in net interest income for every 0.25% increase in the federal funds rate. With the huge surge in deposits, around 66% of the bank’s average deposits in the first quarter were unpaid, which costs the bank nothing and tends to be stickier in a rising rate environment.

The other big news is that earlier this year SVB announced its intention to acquire Boston Private Financial Holdings, a major player in wealth management. As long as the deal goes through, it could present another huge growth path for SVB. This acquisition not only strengthens the bank’s presence in Boston, one of the world’s largest start-up ecosystems, but significantly increases SVB’s private banking and wealth management operations. Boston Private has $ 16.3 billion in assets under management and $ 7.2 billion in loans. It also improves SVB’s private banking and wealth management products and technologies, and puts the bank in an even better position to cross-sell to its high net worth clients.

SVB President and CEO Greg Becker said the addition of Boston Private enabled the bank to develop mortgage lending, specialist lending opportunities for high net worth individuals in the innovation economy and fee income from asset management. Overall, SVB previously characterized the acquisition as a $ 400 billion opportunity among its current customers.

Keep growing

As you can see, although the bank has thrived over the past year or so, it doesn’t even look close to being exploited. SVB is very asset sensitive and well positioned for rate hikes; the innovation economy appears to be flourishing with the acceleration of digital trends during the pandemic, and the impending acquisition of Boston Private will allow the bank to further penetrate its existing customer base. SVB’s investment bank is also set to experience an even bigger year than last year, and big gains on stock warrants – though they may not support the kind of business it is doing. ‘experienced the bank in the last quarter – are becoming more and more common.

SVB has raised $ 2.4 billion in debt and equity to continue to support its growth. The bank has increased its tangible book value per share by 165% since 2015, which contributes to the growth of the stock. On average, analysts already expect the bank to generate $ 27.89 in profit in 2021. If that kind of earning power holds up, or just stays within reach, I think the stock still has plenty. of tracks.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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