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Morningstar | Silicon Valley Bank's Loans Continue to Perform

Silicon Valley Bank continues to perform well ahead of our long-term expectations. Venture-capital-backed companies still enjoy abundant liquidity while repaying their loans. Total client funds grew 9.7% from the previous quarter. We believe deposit growth is a good indicator in funding available to VC-backed investments. So long as the client investment funds are growing by 5%-10% each quarter, VC investments will be able to attract funding and loans will continue to perform. Once funding slows, we still expect a substantial increase in credit losses while loans rapidly decrease. During the quarter, period-end loans grew at a sequential rate of 5.7% and are nearly 24% larger than the previous year. Though Silicon Valley Bank continues to perform and will most likely substantially beat our 2018 estimates, we still remain bearish on the company. We don't know exactly when Silicon Valley Bank's loan performance will decline, but still believe it eventually will. We’ll likely increase our fair value estimate by 5%-10% once we update our forecast model to reflect these results.

Beyond loan quality, Silicon Valley Bank will definitely benefit from the Regulatory Relief Bill and will not have to comply with CCAR since passing the $50 billion threshold for banks. In addition, a large bright spot for Silicon Valley Bank has been its foreign exchange fee income that has increased almost 30% year to date. It would appear that Silicon Valley Bank is definitely benefiting from its expanding geographic footprint.

During the second quarter, annualized credit provisions were only 0.42% of total loans. Loan growth remains strong. Loans to PE/VC firms grew by 9% or more than $1 billion from the previous quarter. The reason we continue to be bearish is it’s still easy to find Silicon Valley Bank borrowers generating little to no cash. For example, one publicly traded software company and SVB borrower, Tintri, filed for bankruptcy on July 10. As recently as January, this company had a market capitalization exceeding $150 million while being in default of its Silicon Valley Bank loans. Furthermore, during the call, management discussed its Chinese operations. Per management, Silicon Valley Bank has a 50-50 joint venture with Shanghai Pudong Development bank with $1 billion in assets. We can find one small loan to Secoo Holding Limited, a publicly traded Chinese borrower whose 2017 operating cash flow was a negative $27 million.

We’ll remind investors that combined these loans are immaterial in size and could have some asset to recover. However, competition for new loan opportunities remains intense and Silicon Valley Bank has grown its commercial loan portfolio by 36% from the previous year, so we struggle to understand why this bank should be valued at more than 3.5 times book value.