Here’s The Big Reason Why SVB Financial Faces Some Tough Times Ahead

After an outstanding 2021, SVB Financial (NASDAQ: SIVB) entered 2022 with solid business momentum. And after the company released its first-quarter 2022 results, management, increasingly confident in riding the tailwinds of rising rates, further raised investors’ expectations for great results over the year.

However, now that the U.S. economy has shrunk for its second consecutive quarter, and with the deterioration in SVB’s recent second-quarter results, investors are wondering whether SVB’s bull thesis is running out of gas. Here’s why SVB could face a tough time over the next year.

Image source: Getty Images.

SVB’s management downplays the canary in the coal mine

Many of its banking clients consist of private companies, and as private market valuations for its clients go, so goes SVB’s business results. Consequently, you should carefully watch the health of private markets to gain insights into SVB’s business.

In 2021, the health of private markets was excellent. Venture capital (VC) and private equity (PE) funding of private businesses soared to new heights — a significant driver of SVB’s 76% stock appreciation during the year. SVB’s management started 2022 with similarly high expectations for a favorable growth environment for private companies. However, it didn’t take long for problems to show up. Signs of trouble arrived in the first quarter in the form of later-stage VC activity and initial public offerings declining — a canary in the coal mine for bad times ahead.

Management played down the trouble with later-stage funding because the first-quarter 2022 results otherwise showed a company firing on all cylinders. Additionally, early stage start-up fundraising was still healthy, and SVB thought it was unlikely that public market turbulence would soon impact early-stage private start-ups.

Unfortunately for management, the company’s second-quarter results showed private markets deteriorating further. During the company’s earnings call, Chief Executive Officer Gregory Becker said that economic uncertainty nearly closed the IPO market, meaningfully slowed the pace of PE and VC investment at all stages, and negatively revalued private companies. Sadly, management had seriously misjudged how bad the macro environment had become.

Image source: SVB Financial

Investors were disappointed in second-quarter results

SVB missed its second-quarter 2022 consensus revenue and earning estimates because of the private market collapse. Its net revenues came in at $1.53 billion, missing Zacks consensus analyst estimate of $1.63 billion. On the bottom line, the company only produced earnings per share (EPS) of $5.60 — a decline of 38.4% from the prior-year quarter. Additionally, these earnings lagged Zacks consensus analyst EPS estimate of $7.68. 

SIVB Net Income (Quarterly) data by YCharts

Investors were also disappointed in management ratcheting back guidance for loan balances and net interest income (profits from loans). As a result, the stock dropped 17% after the company released earnings.

Prior full year 2022 outlook
compared to 2021 results (January 20, 2022)
Prior full year 2022 outlook
compared to 2021 results (as of
April 21, 2022)
Current full year 2022 outlook
compared to 2021 results (as of
July 21, 2022)
Average loan balances
Low thirties growth
Mid-thirties growth
High twenties growth
Net interest income (NII)
High thirties growth
Low fifties growth
Mid-forties growth
Net interest margin (NIM)
 1.90% — 2.00%
2.10% — 2.20%
2.15% — 2.25%
Net charge-offs
0.15% — 0.35% of average loans
0.15% — 0.35% of average loans
0.15% — 0.35% of average loans

Source: SVB Financial. 

Moving forward, investors should monitor net charge-off (NCO) ratios, the debt a bank owns that will unlikely remain unpaid. While SVB maintained its 2022 full-year guidance for NCOs, it expects the number to rise in the second half of 2022. If NCOs rise substantially, the stock could drop much further.

The possibility of a quick rebound 

However, despite things looking bleak in the short term, SVB’s fortunes could quickly turn favorable.

First, VC and PE firms have record levels of reserve cash to invest (eight times higher than 2000) — rapid investment is likely to happen once private company valuations stabilize. Many investment firms regret missing out on opportunities during the last global financial crisis, so the market for private companies could quickly return to health once the all-clear signal sounds — a favorable scenario for SVB’s loan business.

Second, according to an article written by Morgan Stanley (NYSE: MS) Chief Investment Officer Lisa Shalett, inflation-driven recessions are shallower and less damaging to corporate earnings than credit-driven recessions like the Great Recession. And this potential 2022 recession falls in the inflation-driven category. As a result, a shallow economic slowdown would likely result in a quick bounce back in SVB’s revenues and earnings.

If you choose to invest in this company long-term, however, you should remain aware that its road could be rocky until the private markets return to health. Unfortunately, SVB is not immune to the effects of a recession, and everything could become worse over the next six months to a year before beginning to improve.

SVB Financial provides credit and banking services to The Motley Fool. Rob Starks Jr has positions in SVB Financial Group. The Motley Fool has positions in and recommends SVB Financial Group. The Motley Fool has a disclosure policy.

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