Here’s the big reason SVB Financial faces tough times ahead

After an exceptional year 2021, SVB Financial (SIVB -1.38%) started 2022 with solid commercial momentum. And after the company released its first quarter 2022 results, management, growing confident that it could take advantage of the tailwinds of rising rates, further raised investors’ expectations for strong results over the course of the year. ‘year.

However, now that the US economy has contracted for its second consecutive quarter and with SVB’s recent Q2 results deteriorating, investors are wondering if SVB’s bullish thesis is running out of steam. Here’s why SVB could face a tough time over the next year.

Image source: Getty Images.

SVB management downplays importance of canary in coal mine

Many of its banking customers are private companies, and as the private market valuations of its customers evolve, so does SVB’s business results. Therefore, you need to carefully monitor the health of private markets to gain insight into SVB’s business.

In 2021, the health of private markets has been excellent. Venture capital (VC) and private equity (PE) funding from private companies hit new highs – a major driver of SVB’s 76% share appreciation during the year. SVB management started 2022 with equally high expectations for a favorable growth environment for private companies. However, it didn’t take long for problems to appear. Signs of trouble emerged in the first quarter in the form of later-stage venture capital activity and declining initial public offerings – a canary in the coal mine for bad times to come.

Management played down the issue with subsequent funding, as Q1 2022 results otherwise showed a company firing on all cylinders. Additionally, fundraising for early-stage start-ups was still healthy, and SVB believed that public market turmoil was unlikely to impact private early-stage start-ups anytime soon.

Unfortunately for management, the company’s second quarter results showed private markets deteriorating further. During the company’s earnings call, chief executive Gregory Becker said economic uncertainty had nearly shut down the IPO market, significantly slowed the pace of private equity and venture capital investment at all stages and negatively reassessed private companies. Unfortunately, management had seriously misjudged just how bad the macro environment had become.

Four graphs show the decline in venture capital investments since the second quarter of 2021.

Image source: SVB Financial

Investors were disappointed with the second quarter results

SVB missed its consensus second-quarter 2022 revenue and profit estimates due to the private market crash. Its net income was $1.53 billion, missing the Zacks consensus analyst estimate of $1.63 billion. In the end, the company only produced earnings per share (EPS) of $5.60, down 38.4% from the year-ago quarter. Additionally, those earnings were below Zacks consensus analyst EPS estimate of $7.68.

SIVB net income table (quarterly)

SIVB Net Income Data (Quarterly) by YCharts

Investors were also disappointed by management’s downward revision to forecasts for loan balances and net interest income (earnings on loans). As a result, the stock fell 17% after the company’s earnings release.

Previous outlook for the year 2022
compared to 2021 results (January 20, 2022)
Previous outlook for the year 2022
compared to 2021 results (at
April 21, 2022)
Current outlook for 2022
compared to 2021 results (at
July 21, 2022)
Average loan balances Low thirties growth Growth in mid-thirties twenties growth
Net interest income (NII) Growth of high thirtysomethings Slow growth of the 1950s Growth in the mid-40s
Net interest margin (NIM) 1.90% — 2.00% 2.10% — 2.20% 2.15% — 2.25%
Net allocations 0.15% — 0.35% of average loans 0.15% — 0.35% of average loans 0.15% — 0.35% of average loans

Source: SVB Financial.

Going forward, investors should watch net charge ratios (NCOs), debt held by a bank that is unlikely to stay repaid. While SVB has maintained its full year 2022 forecast for NCOs, it expects the number to increase in the second half of 2022. If NCOs increase significantly, 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, venture capital and private equity firms have record levels of reserve cash to invest (eight times more than in 2000) – rapid investments are likely to occur once private company valuations rise. stabilize. Many investment firms regret missing opportunities during the last global financial crisis, so the private company market could quickly return to health once the clear signal sounds – a favorable scenario for lending business from SVB.

Second, according to an article written by Morgan Stanley (MRS -0.25%) According to Lisa Shalett, Chief Investment Officer, inflation-related recessions are shallower and less damaging to corporate earnings than credit-related recessions like the Great Recession. And this potential 2022 recession falls into the inflation-related category. Therefore, a mild economic downturn would likely lead to a rapid rebound in SVB’s revenues and profits.

If you choose to invest in this company for the long term, however, you should keep in mind that its road could be rocky until the private markets recover their health. Unfortunately, SVB is not immune to the effects of a recession and everything could get worse over the next six months to a year before it starts to improve.

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

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