Shares of SVB Financial Got Crushed in 2022. Can They Rebound in the New Year?

It wasn't a pretty year in 2022 for SVB Financial Group (NASDAQ: SIVB), the parent company of Silicon Valley Bank, which saw its stock crater by more than 66%.

SVB caters heavily to the start-up, venture capital, and private equity communities, so naturally, as the tech sector took a beating last year, SVB followed suit.

The situation, however, has created some enormous risks for the bank, which have made investors very nervous, especially with so much recent uncertainty regarding the economy and markets. Can SVB rebound this year? Let's take a look.

How we got here

SVB is the original start-up bank and has been serving the sector since the 1980s. The bank's deposits come from early-stage start-ups across a variety of sectors, tech companies, venture capital and private equity firms, and some from high-net-worth individuals. At one point last year, SVB served roughly half of all U.S. venture-backed technology and life science companies.

Person looking at laptop.

Image source: Getty Images.

Following the early months of the pandemic, deposit growth took off at the bank. The Federal Reserve was pumping trillions of dollars of liquidity into the economy, start-ups were raising money and going public at meteoric valuations, and venture capital and private equity firms raised record levels of dry powder.

SVB had so much excess liquidity that it started investing deposits into bonds, which is a common thing for banks to do. Bonds like U.S. Treasury bills and mortgage-backed securities carry little risk and can help banks earn additional yield.

But SVB put the bulk of its loans in its held-to-maturity (HTM) portfolio, meaning it intends to hold these bonds to maturity and over a longer time frame. The upside of this is that HTM bonds are not marked to market and do not impact the bank's tangible common equity each quarter like they would if they were classified as available for sale (AFS), which means the bank intends to sell them before maturity. The downside is HTM loans are less liquid because they are supposed to be held to maturity.

Substantial risks

With tech valuations taking a hit, exit activity significantly down, slower fundraising, and heavy cash burn by start-ups, SVB has started to see deposits leave the bank, most of which are noninterest-bearing deposits that the bank doesn't pay any interest on. If deposits decline too much and the bank runs into liquidity issues, it would have to resort to first selling bonds in its AFS portfolio and then potentially bonds in its HTM portfolio.

The problem is bonds are underwater right now because interest rates have risen so fast and quickly boosted bond yields, which have an inverse relationship with bond values. At the end of the third quarter, SVB was sitting on unrealized losses in its HTM portfolio of close to $16 billion, which was more than the bank's total equity at the end of Q3.

Keep in mind that it's a highly unlikely scenario that SVB would need to sell any of the HTM book. First, SVB has off-balance-sheet funds that it can bring onto the balance sheet as deposits, albeit at a much more expensive rate and that will likely hurt its margin and earnings. The bank could also likely borrow against its securities holdings. SVB would also have to first sell its entire AFS securities book before it needed to reach into the HTM bucket.

Aside from liquidity risks and the need to sell chunks of the bond portfolio at heavy losses, investors may also be concerned about certain pockets of SVB's loan book. The bank said in its Q3 slide presentation that about 21% of the loan book is "more sensitive to a challenging fundraising environment." That includes certain commercial and industrial loans made to innovation companies, loans made to growth-stage companies that really need to exit for prepayment, and loans made to early-stage companies.

Can SVB rebound?

A lot of the rebound is going to depend on what happens to the tech sector and how the Federal Reserve acts. The struggles in the tech sector have led to outsize cash burn among SVB's clients, which has not yet adjusted to a more normalized fundraising environment. SVB's president and CEO, Greg Becker, said it can take several quarters for cash burn to be more in line with fundraising, which would shore up deposit outflows and maybe even lead to growth.

However, the Fed could certainly help if it can stop raising interest rates soon. A more stable environment could lead to a return in exit activity through initial public offerings, which would likely help with client inflows. Also, if rates stop rising, then bond yields may ease as well, which would lower unrealized losses in SVB's bond portfolio.

In terms of credit quality, SVB also has a strong history of managing credit well -- including through the dot-com crash and Great Recession -- and the company has also improved its loan mix over the years.

But bank investors are a conservative bunch, and the risks here are substantial if a severe scenario plays out. With rates having risen so rapidly, liquidity tightening, and the tech sector having gone through such intense volatility, we are in uncharted waters.

Ultimately, I like SVB's business model and do think the bank will be able to ride this out and perform well long term. But it's not unreasonable for investors to want to remain on the sidelines until there is better line of sight and some of these substantial downside risks are eliminated.

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SVB Financial provides credit and banking services to The Motley Fool. Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends SVB Financial. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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