EUR 850.00 For Business Accounts Only

Morningstar | Investors Mistake Peak Returns for Midcycle Profitability

Though 2017 was a great year for Silicon Valley Bank loan and deposit growth, we believe that Silicon Valley Bank is entering a period of lower returns from increasing competition and declining credit quality. Recently, management has said the company has benefited from sovereign wealth funds and SoftBank's aggressive investment campaign. We suspect these atypical investors represent the last of the few remaining pillars of funding supporting venture capital activity.One concerning trend of this tech cycle is the use of leverage by venture-capital-backed startups. Unlike in 2001, where equity was often the sole funding source, venture debt has played an increasing role at early-stage companies. Rather than dilute its equity stake, Uber has raised more than $3 billion in debt from major banks. WeWork, another unicorn with an unproven business model, has reportedly sought to obtain a $750 million credit line. Industrywide, we believe that as a result of rising competition, there has been a decline in underwriting quality by providing startups debt earlier in their life cycle. Too frequently, we have observed Silicon Valley Bank's public borrowers do not generate cash or have the asset coverage to take on significant debt. Yet, Silicon Valley Bank has been willing to provide them with loans.Given that Silicon Valley Bank grew loans at a 20% compound annual rate the past five years in a venture debt market that has become highly competitive, we believe a significant rise in charge-offs accompanied by slower growth is inevitable. We forecast charge-offs will increase to almost 2% in 2019 and 2020 and decline thereafter, though we’d warn this could be substantially higher. We don’t think the bank’s loans are as good as in previous cycles, given industrywide trends. We also believe the bank will see significant negative loan growth in a venture capital downturn. In past downturns, loans have contracted by as much as 18%. Silicon Valley Bank has experienced tremendous growth in capital call lines, which could lead to loan balances falling farther than they have in previous downturns. We expect to see loans contract by 20%-25% from peak levels over our forecast period.