Silicon Valley Bank: when your niche becomes your defensibility

SVB (Silicon Valley Bank) has been a stalwart in our business that many people take them for granted. But they’re actually a FDIC-insured commercial bank fully regulated by SEC, unlike many of their VC business partners including us. In this low interest environment most banks struggle to generate profit through interest spreads. I decided to take a look at SVB’s financial performances and see how much their niche helps them.

Turns out it helps them big time, to the point that SVB seems destined to be one of the very few banks going forward that would consistently beat the others.

First, some quick facts about SVB in 2018:

  • Total revenue = $2.55B

  • Operating profit = $1.4B = 55% of revenue

  • Net profit = $1B =38% of revenue

The current market cap is about $13B-ish. These numbers look great but how does it measure up to other regular banks?

Let’s take the largest commercial bank, Bank of America (BoA), for comparison. Here we’ll focus on the most common and core part of their businesses: interest-bearing businesses.

For 2018, here are the numbers of SVB:

  • Total interest income = $1.427B

  • Total interest expense = $47M = 3.3% of Total interest income

  • Net interest income = $1.38B

And here are the numbers of BoA for the same year:

  • Total interest income = $66.779B

  • Total interest expense = $19.337M = 29% of Total interest income

  • Net interest income = $47.432B

Here you see the big difference in profitability: BoA, as big and as powerful as it is, still needs 29% of interest expenses (paid to the savers) to generate its total interest income, whereas SVB only needs 3.3%! In fact the spread SVB was able to generate was so large that almost all their interest income was net income.

Why? The answer lies in defensibility.

BoA is a commercial bank with minimum differentiation from the other commercial banks such as JP Morgan Chase or Wells Fargo. The savers and loan clients have very little barrier to move to other banks. There’s no special interest to remain with BoA. As a result BoA competes mostly on pricing, in this case the terms of the loans they give out compared to the interest rates they give to savers. It’s a complete competition environment and the margin is of course much lower.

SVB, on the other hand, operates in a very special market: Silicon Valley and its startups & VC firms. They’ve been in this business for 35 years and built very strong relationships with all VCs and founders. They are able to build a comprehensive saver and loan portfolio that diversify dramatically the risks while retaining the upside. This is impossible for any competitor that’s trying to go after their market as they would not have the same reach and risk assessment know-hows.

In other words, SVB is in a unique banking business of its won: on the one hand it only needs to provide saving interest rates that are comparable to other commercial banks, but it has unique access and knowledges to the most lucrative startup businesses, where it’s term loans or revolving credit lines. This allows him to generate a lot more interest income per interest expense.

The market sees that clearly. SVB is currently trading at 9X its total interest income while BoA, with a market cap of $281B, is trading at 4.2X.

In other words, as a boring bank business SVB actually has built that monopoly in a growing niche market called startups that Peter Thiel has advocated over and over again. This is a good lesson for all entrepreneurs.

Book value (contd.) - Warren Buffet said the same thing in his annual letter

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