A year ago today marks are dark day for one banking equity analyst at JPMorgan.
The topic was Silicon Valley Bank, the once high-flying bank that catered to tech startups. It often lent founders huge sums at rates as low as zero per cent so long as they parent company continued to do business with SVB. That obvious conflict of interest hasn’t yet resulted in shareholder lawsuits or IRS trouble (that I know of) but it wasn’t that kind of self-dealing that unwound the bank. Instead it was a reach for yield with bank capital that blew up as rates rose.
In any case, once questions began a run on the bank started. And as the old saying goes: “What do you do when there’s a lineup outside your bank? …Get in it.”
The bank was doomed but JPMorgan analyst Steven Alexopoulos didn’t know it. He lowered his target to $177 from $270 in this note.
Addressing Questions Including What to Do with SIVB Shares Post the Sell-Off and Industry Read-Through
SIVB shares declined 60% in response to the intra-quarter update as well as a number of strategic actions being announced. While the mid-quarter update from the company pointed to an incremental $5B of deposit outflows anticipated during 1Q23, on the surface this did not appear dramatic enough to warrant the company having also announced that it had sold $21B of AFS securities (which triggered a $1.8B loss being recognized). With the company also increasing its term borrowings by $15B (to $30B), these actions to dramatically boost liquidity we believe sends the message (from SVB management) that it’s a much more prudent strategy to have more robust liquidity levels on hand given a still uncertain environment ahead rather than adjusting to liquidity needs on a “just in time” basis. While we fully acknowledge that we did not see these aggressive actions coming to boost liquidity (as well as common raise), given that the cash burn from startup clients as well as pace of investments by VC firms each remain moving targets, on an overall basis we see this as a very prudent strategy from the company. Turning to the stock, while the mid-quarter fundamental update would have resulted in a -15% reduction to our 2023e EPS, very sharp selling pressure on the stock accelerated once the stock started trading below TBV. In fact, for those that were not around during GFC, when a bank completes a common equity raise below TBV, the lower the stock goes the more dilutive the raise is to TBV. The cure for this downward spiral is for the company to complete the raise and satisfy the market that enough capital is now in hand. With this fully being our expectation, with capital as well as liquidity positions bolstered we see the intense selling pressure abating. Although SIVB shares closed at $106, with the capital raise still pending, shares closed at $82.50 in the post-trading session. If we were to assume that the common equity raise was completed in the $80 range, our 2023e TBV is in the $177 range, which based on the $82.50 close in the post-trading session would imply a valuation of only 0.5x 2023e TBV. While it’s likely in our view that SVB stock opens much higher than the post-trading session close should the news emerge that the common equity raise was completed, we would be buyers of SIVB shares at this highly attractive valuation. SVB is a world class and highly valuable global franchise and the option to purchase the shares below TBV we believe more than adequately compensates investors for the risk being taken. To this end, we are revising our price target down from $270 to $177 which assumes the shares trade in line with 2023e TBV. With our revised price target implying considerable upside potential, we are maintaining our Overweight rating.
What happened next to the “highly attractive valuation”?
It fell apart almost instantly and the FDIC was forced to step in the next day — March 10, 2023 — leaving shareholders zeroed out.
How did it work out for Alexoploulus? Evidently not too badly as he remains an equity analyst covering mid and small-cap banks at JPM.
What now? Held-to-maturity bonds remain a big problem in the US banking sector but it’s been swept under the rub by account that doesn’t require marking to market. That’s all-and-good, until someone needs to raise money.