SVB Financial's Third-Quarter Earnings: Rising Rates, Gains, Oh My!

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SVB Financial (NASDAQ: SIVB) put up another record quarter, generating $148.6 million in net income for common shareholders, or $2.79 per diluted share, in the third quarter. The holding company for Silicon Valley Bank saw its earnings rise due to rising rates, growing loan balances, and a jump in non-interest income due to warrant and investment gains.

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SVB Financial's third quarter: The raw numbers

Metric  Q3 2017 Q3 2016 Year-Over-Year Change
Net loans $22 billion $18.9 billion 16%
Deposits $44.8 billion $38.2 billion 17%
Net income $148.6 million $111.1 million 34%
Diluted EPS $2.79 $2.12 32%

What happened this quarter?

  • Total on-balance-sheet assets crossed the $50 billion mark for the first time, ending at $50.8 billion in the third quarter. It had another $54.2 billion of client funds under management in the form of investments, the majority of which is tucked away in money market and fixed-income funds on which it earns fee income.
  • Loans to private equity and venture capital funds remain the primary driver of loan growth. These loans now compromise $9.6 billion (43%) of total gross loans. This portfolio grew 8.2% from the second quarter, and 29.1% year over year.
  • Gains on the company's vast portfolio of warrants (SVB Financial holds warrants in more than 1,800 Silicon Valley-type companies) were a standout star, contributing $24.9 million of net gains. It booked another $15.2 million in gains on other investment securities. This income is particularly volatile, but together, they were a very notable contributor to its earnings this quarter.
  • Lending related fees jumped to $15.4 million, partially due to a $4.5 million prior-period adjustment. It's likely SVB Financial collected some syndication fees on a large $110 million loan it led in the third quarter to domain registrar Donuts. Syndication fees are something to watch going forward, as they could be a good source of incremental income that SVB Financial can extract from its deep connections in the Silicon Valley ecosystem.
  • Credit quality is exceptional. SVB Financial reported net charge-offs of 0.19% of total gross loans on an annualized basis compared to 0.44% last quarter, and 0.48% a year ago.
  • Net interest margin (NIM), or the spread between what it pays on its liabilities and earns on its assets, expanded to 3.1% this quarter from 3% last quarter and 2.75% a year ago. SVB Financial is one of the most rate-sensitive banks, as approximately 83% of its on-balance-sheet deposits are non-interest-bearing. Thus, rate increases have resulted in more interest income, while its cost of deposits has changed very little.

What management had to say

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In the press release, Greg Becker, president and CEO of SVB Financial Group, summed up the quarter by saying that the company "had an outstanding quarter marked by record earnings, robust loan and deposit growth, healthy increases in both net interest income and fee income, and continued stable credit quality." 

The conference call yielded some interesting commentary around SVB Financial's loans to private equity and venture capital funds. Management noted that the portfolio is roughly split 80% private equity, 20% venture capital, and suggested that the loan portfolio generates interest in the "low-to-mid 3%" range, before any lending fees are considered. These loans have attracted some media scrutiny recently, but the proof is in the pudding: Charge-offs in this corner of its loan book have, in most years, been nonexistent.

Looking ahead

SVB Financial will soon earn the label of a systemically important financial institution, colloquially known as a "SIFI" bank, or "too big to fail" bank. That will bring increased regulatory scrutiny and compliance. That happens when banks cross the $50 billion threshold, which the bank expects to cross in 2019 under the official measurement. SVB Financial has been prepping for this change for a while, which can be observed from a consistent increase in professional fee expenses and employee headcount.

Looking ahead, SVB Financial pointed toward loans to private equity and venture capital funds as its main bread and butter business, but it noted that loans to Silicon Valley-type businesses are expected to pick up over the next few quarters, according to conference call commentary.

Credit quality is the name of the game. With no change in loan performance, SVB Financial is poised to ride rising rates to a better top and bottom line, helped by its rate-sensitive balance sheet that benefits as rates move higher.

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SVB Financial provides credit and banking services to The Motley Fool. Jordan Wathen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends SVB Financial Group. The Motley Fool has a disclosure policy.