How to Profit from the Collapse of Silicon Valley Bank

You think I would know better by now. But even after 40 years of stock market investing, something happens that catches me (and just about everyone else) by surprise.

Case in point: the collapse of Silicon Valley Bank (SVB) this month. Within a few days, the bank went from being the “go-to” financial institution for many privately held tech companies to non-existent.

Fortunately for the bank’s customers, the Federal Deposit Insurance Corp. (FDIC) stepped in immediately and made good on all their savings. If not, then as much as $150 billion in uninsured deposits might have been lost.

Unfortunately for those same customers, they just lost one of the few financial institutions that was willing to do business with them. Small tech companies don’t always grow into giants. More often than not, they fizzle out and disappear before you ever know who they are.

That’s why a lot of venture capitalists and small tech companies did business with SVB. The bank understood their unique requirements and was willing to accept the inherent risk of accommodating them.

But a lot of those small businesses do not have enough liquidity to operate long term without SVB. Merging them with a stronger partner may be the only way for them to survive.

Forced Liquidity

If I’m right about that, then the primary beneficiaries will be the venture capitalists and private equity funds that own most of the equity in those businesses. In this case, forced liquidity is better than no liquidity at all.

As for you and me, we will be relegated to the sidelines while billions of dollars change hands. There is no way for the average investor to acquire equity in a privately held tech company.

However, there is a way that you can indirectly participate in that process. Its call a Business Development Company (BDC), which makes loans to small businesses. As a regulated investment company, a BDC must pass distribute at least 90% of its taxable net income as dividends to avoid paying corporate tax on that income.

Most BDCs lend to a wide variety of businesses to mitigate sector risk. They also like to spread their money around different regions of the country to offset geographic risk.

However, there is one BDC that does just the opposite. Its name is Hercules Capital (NYSE: HTGC). Most of its loans are made to small tech companies based in California.

When I wrote about it three weeks ago, HTGC was on a roll. That day, it traded above $16 after ending last year below $13.

Now, its back below $13 thanks to the SVB fiasco. But if you bought it that day, don’t fret. I don’t think it will be long before it makes it back up to $16.

Deep Discount

I won’t repeat here what I said then. Suffice to say, if I liked HTGC at $16 then I love it at 20% less than that.

If you buy HTGC now, its most recent quarterly cash dividend of 39 cents a share equates to a forward annual dividend yield of 13%. That does not include any supplementary dividends paid out of the equity kickers that may be in peril as a result of the SVB failure.

Here’s another way to generate income from HGTC. Instead of buying the stock, sell a put option on it instead. Here’s how that works.

Last week while HTGC was trading at $12.25, the put option that expires on September 15 at the $12 strike price could be sold for $2. That money is yours to keep no matter what happens next.

If HTGC never falls below $12, then this option will expire with no value. At that point, you are off the hook.

If HTGC does fall below $12 before this option expires, then you may be forced to buy it at that price. But remember, you have already collected $2 per share to take that risk. In that regard, your net acquisition cost is only $10 per share.

At that price, the dividend yield would be closer to 15%. And when the stock eventually makes it back to $16, the gain on those shares would be 60%.

Of course, this trade comes with risk. If Hercules Capital suffers permanent damage due to the SVB collapse, then its share price (and dividend) may decrease substantially.

I don’t think that will happen. But as I said at the opening, the stock market never ceases to surprise me. This time, I think it’s going to surprise a lot of people on Wall Street.

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