SVB’s Fall Stunned Even the One Stock Analyst Who Said to Sell

(Bloomberg) — Morgan Stanley’s Manan Gosalia saw risks gathering over Silicon Valley Bank as tech startups burned through cash.

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So in early December, he issued a warning: It was time to cut exposure to shares of SVB Financial Group, the bank’s parent company. He would remain a lone bearish voice among Wall Street analysts.

Only days before a panic drove Silicon Valley Bank into a collapse in less than 48 hours, banking analysts remained widely optimistic about the company. Half of the two dozen who tracked it were still advising investors to buy the stock, according to data compiled by Bloomberg. One forecast the share price would nearly double to $500 in a year. Even some who saw the toxic mix that would later sink the bank stuck to their hold ratings — a neutral stance that amounts to sitting on the sidelines.

In short, just like regulators and investors, they were caught off-guard by a Twitter-age bank run that shook global markets, shining a spotlight on a thorny issue that Wall Street has wrestled with for decades: The almost unfailingly rosy analysis produced by many of its research divisions.

Yet even Gosalia was shocked by how quickly Silicon Valley Bank became biggest bank failure since 2008. “No one expected the pace at which this happened,” he said.

In retrospect, though, the warning signs seem clear. A deposit base concentrated in a boom-and-bust industry. Rising interest rates. And massive bond holdings hit by the worst losses in decades. All it took was a catalyst to rattle the faith of its fleet-footed customers.

Still, those risks weren’t enough to prompt calls to sell from Wall Street analysts, who saw a lucrative franchise in Silicon Valley Bank’s status as the tech industry’s go-to lender. Its share price more than doubled in the two years through 2021, tracking a rally in growth stocks as the Federal Reserve flooded the markets with cash.

In July, when the stock dropped on disappointing earnings, Michael Diana, an analyst with Maxim Group, told investors to buy the dip. “Here is the chance to buy the most unique/best-positioned bank for 2023 and the longer-term,” he wrote in a note to clients.

Diana remained Wall Street’s biggest bull, with a $500 price target on the stock right before the bank’s demise. He didn’t pull his buy rating until Silicon Valley Bank was taken over by the Federal Deposit Insurance Corp. on March 10. Diana declined to comment.

Chris Kotowski at Oppenheimer said he wishes he had cut SVB all the way to a sell, instead of just to hold. In a January note to clients, he said the bank’s securities holdings would “be like a stone anchor.” But, like nearly a dozen others, he kept a hold rating on the stock, stopping short of advising investors to get out. He said the debacle has been a lesson in the risk of investing in banks whose fates are tied too closely to a narrow base of clients.

“There’s all these venture-capital funded companies that have $5, $10, $20, $25, sometimes hundreds of millions of dollars parked with this little bank,” he said. “And you can move money with the click of a mouse now. And then they’re all talking to one another. So in retrospect, it’s like yeah, should have seen that one coming more easily.”

In early October, Morgan Stanley’s Gosalia downgraded SVB to equal-weight, the equivalent of a hold, anticipating that the downturn in venture-capital funding would linger. At the time, he said the bank had enough liquidity to cover deposit outflows and that venture-capital funding had the potential to “accelerate significantly” once the economic outlook turned.

Later that month, the stock slipped further after SVB dialed back its forecast for net-interest income — a key metric — while assuring that its underlying business was strong.

Gosalia had doubts. In early December, he and his colleagues said they expected SVB to remain under pressure as venture—capital companies burned through funds.

Those concerns finally prompted Gosalia to downgrade SVB to underweight, the equivalent of a sell. But he saw broader industry troubles from rising funding costs, too: He dropped Signature Bank to equal-weight and cut two others — Silvergate Capital Corp. and First Republic Bank — to underweight. The first two went on to fail; First Republic’s shares tumbled nearly 90% in March on worries about its solvency.

While SVB’s shares rallied earlier this year as the company’s guidance supported a more optimistic outlook, Gosalia held firm. The rating, he said by email, was based on anticipation that “ongoing pressure on VC deployment and cash burn would weigh on the bank’s net interest income, and that the pain was not over.”

The collapse began on the evening of March 8, when SVB said it planned to raise more than $2 billion of additional capital after unloading its available-for-sale securities at a loss. That snowballed into a meltdown in hours.

On March 10, the bank was taken over by the FDIC, and First Citizens BancShares Inc. has since agreed to buy Silicon Valley Bank. SVB was delisted from the Nasdaq stock exchange with a last closing price of $106. When it started trading on the over-the-counter market in late March, it hit as little as 1 cent.

The fears that undid Silicon Valley Bank have since shifted to other lenders, even with the pressures easing as US regulators take steps to restore faith in the industry. But Gosalia is mindful of what he said was a lesson of the last few weeks: “Things can change quickly in financial markets.”

Related Tickers:

SIVBQ US (SVB Financial)

FCNCA US (First Citizens BancShares)

–With assistance from Phil Kuntz.