SVB Financial Group
Q1 2018 Earnings Call Transcript

Published: 27 Apr 2018

[Operator:]

Welcome to the SVB Financial Group Q1 2018 Earnings Call. My name is Adrian, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note this conference is being recorded. I will now turn the call over to Meghan O’Leary. Meghan O’Leary, you may begin.

[Meghan O’Leary:]

Thank you, Adrian, and thank you, everyone, for joining us today. Our President and CEO, Greg Becker, and our CFO, Dan Beck, are here to talk about our first quarter financial results, and we’ll be joined by other members of management for the Q&A. Our current earnings release is available on the Investor Relations section of our website at svb.com. We’ll be making forward-looking statements during this call, and actual results may differ materially. We encourage you to review the disclaimer in our earnings release dealing with forward-looking information, which applies equally to statements made in this call. In addition, some of our discussion may include references to non-GAAP financial measures. Information about those measures, including reconciliation to GAAP measures, maybe found in our SEC filings and in our earnings release. We expect the call, including Q&A, to last approximately an hour. And with that, I will turn the call over to Greg Becker.

[Greg Becker:]

Thank you, Meghan, and thanks, everyone, for joining us today. We had an excellent first quarter with exceptionally strong performance across the business. We delivered earnings per of $3.63 and net income of $195 million. These results were driven by continuing trends of the strong client liquidity, healthy balance sheet growth, higher rates, strong core fee income and stable credit quality. Our results also reflect the impact of approximately $16 million after-tax of losses related to sales of shares we held in Roku, which equates to an earnings impact of $0.30 per share. A few highlights from the first quarter compared to Q4. Net interest income increased by 6.5% to $421 million. Average loans grew 6.1% to $23.8 billion. Average total client funds grew by 7.9% to $110.5 billion. Core fee income increased by 8.1% to $115 million, and we delivered a return on equity of 18.1%. Our business is doing well across the board and performing better than expected on many fronts. We’re seeing healthy activity among our clients, particularly private equity, life sciences and international, and our pipeline remains strong. Based on our performance in the first quarter and the dynamics we’re seeing in the markets, we’re making a number of positive revisions to our 2018 full year outlook for balance sheet and revenue growth, which Dan will get into in a few minutes. I’ll preference his remarks with some commentary on our markets and the drivers behind our improved outlook, and I’ll touch up on a few business highlights as well. The strong availability of capital has been a primary driver of our healthy client markets and our solid performance, and it appears to be getting even stronger. Venture Capital Investment topped $28 billion in the first quarter, marking the fourth successive quarter above $20 billion and a best quarter since the first quarter of 2000. With 16 U.S. venture backed IPOs in the first quarter, the best quarter for innovation IPOs in three years, the IPO market has improved and the pipeline remains relatively healthy. Some industry watchers believe that recent strong IPO performance by high profile companies and pent up investor demand for stock in high growth companies could lead to a wave of IPO’s to 2018. Secondary offerings have also been exceptionally strong particularly for our life science client who raised $2.4 billion in secondary offerings in the first quarter. The primary weak spot in the market is M&A related exits, which had been sluggish overall. Nevertheless, our clients liquidity which was already robust has continued to increase supporting the growth and expansion of existing companies and encouraging new company formation. This environment also contributed to the strongest new client acquisition in our history with more than 1,300 new core commercial clients in the first quarter. We saw a significant first quarter benefits from a number of market tailwinds. December’s tax cuts resulted in our first quarter EPS benefit of $0.56 per share, which was significant though generally in line with our expectations. In addition the December increase in federal funds rates and the dramatic rise in LIBOR in the first quarter drove higher yields, strong net interest income growth and significant margin expansion. And we expect further benefit from the March Fed funds rate increase. So our markets are thriving our clients are doing well and we’re benefiting from market tailwinds. But just as important as these factors is our ability to execute on the changes investments and enhancements to our business that will drive and support our continued growth. Here are a few highlights from the quarter. We continued our international expansion, we realized a significant global milestone by receiving formal authorization from Canada’s Minister of Finance to establish a lending branch in Canada and are now waiting for final approval from the Superintendent of Financial Institutions. We also finished building out our team in Germany and believe our branch approval there is eminent. In general, we continue to build momentum in Europe on all fronts most notably crossing the 2 billion threshold in loan balances in the first quarter. We made investments to continue building out our products and capabilities to that end, our recent enhancements to our treasury and asset management platform improved our retention of client fund following funding events in the first quarter especially in our life sciences group. This contributed to higher off balance sheet fund volumes which in turn still higher client investment fee income. Our mission is to drive stronger on-balance sheet deposit growth, while still very early are already starting to have an impact. In the first four weeks, we saw 150% increased in the pace of new client deposit accounts related to these efforts. We expanded our energy and resource innovation practice hiring a team of seasoned ERI bankers to help grow our project finance portfolio. Under related execution note, I’m proud to say that as a result of our growing market cap and continued strong performance overtime on March 15 SIVB was added to the S&P 500. While our outlook for the year ahead is notably improved we continue to manage and monitor a number of challenges. As always, competition for loan from banks and non-banks remains intense. And high availability of equity provides an additional headwind to loan growth. And exit markets remain mixed with strength in IPO is being offset by sluggish M&A. With so much available liquidity driving up private equity company valuations the bar for a successful exit is high, which could further slow the exit markets and impact VC funding. These challenges notwithstanding our clients and the innovation economy continue to prosper overall and they’re expecting good things in 2018. And our annual start of outlook survey of more than 1000 entrepreneurs, which we released earlier this year 69% of respondents successfully raised capital this past year. And yearly a quarter says, it’s easy to raise funds in the current environment, double the number who said that last year. More than 80% plan to add employees a highest level in five years. 94% believe that business conditions in 2018 will be as good or better than 2017 and 91% believe M&A will be equal or better. Clearly the innovation community is optimistic, we are optimistic too about our markets, our clients, our ability to drive continued growth. To that end, as we’ve discussed in our prior quarters, we remain focused on a small group of internal investment priorities to expand our people, our systems and our processes around the world. These include raising the bar on client engagement, supporting long-term growth across the platform, growing fee income through stronger relationship management and expanding product set and broader partnerships, and enhancing risk management across the organization. We’re off to a strong start for the year and our 2018 outlook is much improved as a result of our performance to-date, the investments we’re making, and the substantial tailwinds we’re benefiting from. Our target market is creating lots of opportunities for us and we’re doing the right things to ensure we can continue to grow and maintain our leadership well into the future, solidifying our position as the Bank of choice for innovators and their investors around the globe. Thank you. And I’ll now turn the call over to our CFO, Dan Beck.

[Dan Beck:]

Thank you, Greg, and good afternoon, everyone. Our excellent quarterly performance was a result of continued strong liquidity trends and a positive business environment for our clients, the impact of higher rates and lower taxes and solid execution on our growth initiatives. The quarter included the following highlights. One, strong growth in net interest income due to very healthy loan growth and higher yield from loans and fixed income investments securities. Two, outstanding client fund balance growth both on and off balance sheet. Three, higher core fee income. Four, continued stable credit quality with solid underlying trends. Five, good gains on warrants and equity investment securities, excluding the impact of Roku. And six, controlled expense growth. As Greg indicated, due to the impact so early in the year, a better than expected client liquidity and balance sheet growth as well as higher Fed funds and LIBOR rates, we are raising our full year outlook on all our balance sheet and revenue business drivers. I will get into those specifics in a moment. Now let’s turn to our operating results. Starting with the balance sheet, average loans increased by $1.4 billion or 6.1% to $23.8 billion, driven primarily by new loans and increased utilization in our private equity capital call lines and good growth in loans through our technology and life sciences clients. These drivers were further helped by lower M&A related repayments by our clients. As a result of our strong loan growth and healthy pipeline we are raising our full year 2018 outlook for average loan growth from the mid-teens to the high-teens. Average total client funds grew by $8.1 billion or 7.9% to $110.5 billion, due to strong new client acquisition, a robust equity funding environment for our clients and the best quarter for IPOs in the last three years. Total client funds balances reflected average deposit growth of $1.3 billion or 3% driven by our clients strong liquidity and to some extent due to early results from our initiatives that drive stronger on balance sheet deposit growth. We also saw average off balance sheet client investment funds growth of $6.8 billion or 11.8%, particularly driven by robust secondary offering activity and healthy IPO activity among our life sciences clients, as well as by improved fund retention by our asset management teams, following client liquidity events. Due to strong pace of our balance sheet deposit growth in the first quarter and our forecasted balanced growth from the recently implemented deposit initiatives, we are raising our full year 2018 average deposit outlook from the mid-single digits to low-double digits. Average assets grew by $1.6 billion or 3.1% to $52.4 billion and period-end assets were $53.5 billion. As predicted, we’ve crossed the trailing four quarter average $50 billion SIVB threshold in the first quarter of 2018 and we are now subject to the enhanced potential standards applicable to banks over $50 billion. We would expect to file a public CRA report in 2020 borrowing any changes from the regulatory relief bill in Congress. Now I’d like to turn to the income statements. Net interest income increased by $25.59 million or 6.5% to $421.2 million, due to loan growth and the impact of higher rates on loan portfolio yields and reinvestments at higher rates in our fixed income portfolio. Higher loan balances and higher Fed funds and LIBOR rates drove an increase in interest income from loans about $17.3 million to $297.1 million in the first quarter. This increase reflects an offset of approximately $6 million from lower prepayment fees. As a result of these rate increases, average gross loan yield, excluding interest recoveries and loan fees increased by 20 basis points to 4.52%. In our fixed income investment portfolio higher yields mainly from reinvestment and higher market rates driven increase in interest income of $9 million to $131 million. We purchased approximately $2.4 billion in new investments in the first quarter at approximate yields of 3.5%. Our net interest margin increased by 18 basis points to 3.38% due primarily due to higher loan in investment yields driven by higher interest rate and loan growth. As a result of our improved full year balance sheet growth outlook as well as the impact of higher rates on our investment securities and loan portfolio yields we are increasing our full year 2018 outlook for net interest income from the high teens to the low 30’s. We are also raising our full year outlook range for net interest margin by 15 basis points to a range of 3.5% to 3.6%. Now I’ll move to credit quality, which remains stable with solid underlying trends. Our provision for credit losses was $28 million compared to $22.2 million in the fourth quarter. The majority of this increase $14 million was for loan growth with $11.3 million tied to net new specific reserves for non-accrual loans and $1 million for un-funded credit commitments. Net charge-offs were $8.8 million or 15 basis points of total average loans compared to $12.9 million or 23 basis points in the fourth quarter. Charge-offs came primarily from early stage loans. Credit quality has been a consistent bright spot for several quarters, while we continue to monitor a client base in the markets for anything we believe could affect the future repayment activity, the trends in our portfolio indicate continued stability for now. With that in mind, we’re maintaining our credit outlook for 2018 and at this rate, we would expect to come in at the low end of our outlook for net charge-offs. Now, I’ll turn to non-interest income which is composed of course fee income, gains from private equity and venture capital investments and gains for warrants. GAAP non-interest income was $156 million compared to $152 million in the prior quarter. Non-GAAP non-interest income net of non-controlling interest was $142 million, a decrease of $2 million from the prior quarter. This decrease was mostly due to $22.2 million pretax losses on the sale of Roku public equity securities upon expiration of the lock-up period in late March. Although, sale price for these securities was lower than their value at December 31, 2017. It’s important to keep in mind that net gains from our investment in Roku were nearly $46 million. Excluding the impact of losses on the final sale of our Roku shares, we had very strong non-interest income growth with healthy gains from warrants and private equity venture capital related investments along with increases along all core fee income categories. Core fee income increased $8.6 million or 8.1% to $115 million. This growth was driven primarily by an increase in client investment fees of $4.3 million from higher fund balances and higher rates. An increase of $2 million in deposit service charges due to strong volumes, which is not typical in the first quarter. And better than expected FX revenue from our larger clients as a result of focused sales efforts on our part. As a result of these impacts as well as the expected impact to improve spread on our client investment funds related to a change in fund providers we are raising our full year outlook for core fee income from the high teens to the high 20’s. Net losses on investment securities, net of non-controlling interest were $3.8 million compared to gains of $8 million in the prior quarter. Excluding the $22.2 million of losses on the first quarter sale of our warrant related Roku securities, we had net investment gains of $18.4 million primarily due to unrealized valuation increases from investments in our private equity and venture capital fund. Equity warrant gains were $19.2 million compared to $12.1 million in the fourth quarter with the increase mainly coming from higher realized and fair value gains across the portfolio. Now turning to expenses. Non-interest expense was $265.4 million compared to $264 million in the fourth quarter. This increase was primarily related to higher incentive compensation costs due to our strong first quarter performance along with seasonal compensation expenses. These increases were mostly offset by lower professional services costs due to project timing. We expect professional services cost and expenses overall to be higher in the remaining quarters of the year, as we continue our investments in growth, infrastructure and employees. We also anticipate higher levels in incentive compensation driven by our improved outlook. As said, we expect expenses to be at the higher and for our stated full year growth outlook of the low double digits. Turning to taxes. We saw tax benefit of more than $30 million in the first quarter as result of tax cuts with an effective tax rate of 27.5% compared to 53.5% in the fourth quarter of 2017. Normalized for the write-down of our deferred tax assets, our fourth quarter effective tax rate was 38.7%. Based on our first quarter implementations in new tax rates, we anticipate being at the lower end of our target tax range of 27% to 30%. Moving to capital, capital and liquidity remained healthy with strong growth in regulatory capital during the quarter, while growth in risk weighted assets from higher loan and investment balances reduced the bank’s risk-based capital ratio somewhat. Our bank Tier-1 leverage ratio increased by 13 basis points to 7.69% and remained well within our target range. Given our strong growth forecast for loan balances and the newly implemented deposit strategies, we expect that the majority of our earnings capital generation will be used to fund balance sheet growth for the remainder of 2018. In closing, we had a tremendous quarter and we have significantly improved our outlook for the full year 2018. Our improved outlook assumes our business and the markets continue on their current path, upside could come from further rate increases or continued growth in our client’s liquidity. By the same token a notable decrease in venture capital activity, higher loan repayments related to M&A, intensified competition or a significant market slowdown could all negatively impact our outlook. But for now, we are off to a strong start in 2018. Our business and our balance sheet remain robust requesting our clients’ access to ample funding and liquidity and there’s still strong economy. We are executing well, delivering solid growth in returns, while benefiting from higher rates and lower taxes. Our positive outlook for 2018 has improved notably and we’re well positioned for future growth assuming the macro environment does not change materially. In the meantime, we remain focused on implementing our growth in operational initiatives, delivering high quality growth with stable credit quality and maintaining optimal cast alone liquidity to position ourselves for success in the long-term. Thank you. And I will now ask the operator to open for Q&A.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Ebrahim Poonawala from Bank of America. Please go ahead.

[Ebrahim Poonawala:]

Hey, guys, good afternoon.

[Greg Becker:]

Hey, how you doing, Ebrahim?

[Ebrahim Poonawala:]

Good. So I guess the first question around the deposit growth outlook and the change there; one, would love to get your thoughts around the visibility that you have on the deposit growth outlook. We load the guidance in January relative with a preliminary outlook in October. I just want to understand in terms of how good we feel about that growth piece going forward. And then if you can just breakdown in terms of the outlook between non-interest bearing and interest bearing, it feels like we’ve started this strategy of bringing some of these off balance sheet or money markets, tight deposits on the balance sheet. So we’d love any color around that.

[Greg Becker:]

Yes. So, Ebrahim, I’ll start and then Dan will add. So, the quarter, obviously, it was a great quarter from liquidity perspective. We look at it from a total client funds perspective. And obviously it’s driven by what I talked about which is an incredibly strong venture capital funding quarter of $28 billion. What we’re seeing in the market and this is what’s driving it is that funding sources are coming from a whole variety of different areas, right. So venture capital reflects with cash, and private equity firms have a lot of cash. You have our global business continues to generate deposits in total client funds. So it’s not just in the U.S. the numbers that we’re driving are actually global total client funds. And you look at whether it’s the SoftBank Vision Fund, the sources are just greater and greater and we’re benefiting from that. So our outlook, we’d say that, a strong level of activity will continue. Will it be at $28 billion? Will it be at higher or lower? That’s hard to predict. But we certainly believe it’s going to remain robust. Now, I’ll let Dan to talk about how we think about the mix on and off and some of the initiatives that we have.

[Dan Beck:]

Yes. So, as we look at the mix what we ended the quarter was 82% of DDA to total deposits. We think with the implementation of the deposit strategy that that could be in a range of the high 70’s to the low 80’s, so not a material change. To answer your first question a little bit more, we think with the implementation of these new deposits strategies that we have a bit more confidence that we’ll be bringing some of that robust client growth on balance sheet versus off-balance. So I think with all those factors that give us a better view.

[Ebrahim Poonawala:]

That’s helpful. And just moving on to the investment fees again off-balance sheet growth also continues to remain strong. One, should we assume that growth will also look strong if the funding and the VC fund remain strong. And then, you are earning about 14 basis points, I know you had previously mentioned that it probably gets capped around 15. Are you still seeing that way or could we see 1 or 2 basis points increase with every Fed rate hike?

[Greg Becker:]

Yes. So this is Greg, I’ll start. So going back to – the question is pretty similar to the first one, which is that the overall market and again strong first quarter domestically and globally. And we think it’s going to remain healthy. Obviously it’s clients fund come on, then it’s a question about how does it get split on and off balance sheet. And Dan, I think answer the question about how we think about the on-balance sheet part and obviously the opposite of that is where else – we’re going to the off-balance number. So again, we feel good about that. As far as the fees themselves, right. We did say that and you are correct, we’re 14 basis points. We did believe back when we originally started this journey of higher rates that we are going to be capping out about 15 basis points but a few things. One is, now that we’re building up a larger portfolio off-balance sheet we’re able to negotiate better deals with our partners on the funds that we’re providing access for our clients too. And the fact that we believe there is some additional EPS. So whereas we thought we are going to be able to cap out at about 15 basis points, we now believe there’s the upside 17, 18 getting close to 19 or 20 basis points. So we do believe there’s more upside. And you’re right, it’s roughly about a basis point of increase per 25 basis point increase.

[Ebrahim Poonawala:]

Helpful. Thanks for taking my questions.

[Greg Becker:]

Absolutely.

[Operator:]

And our next question comes from Ken Zerbe from Morgan Stanley.

[Ken Zerbe:]

Great. Thanks. Good evening.

[Greg Becker:]

Hi, Ken.

[Ken Zerbe:]

I guess, I want to make sure I really understood that the outlook that you guys gave in terms of the guidance. Going from mid – I guess, high teens up to the low 30’s for NII like obviously a big part of that was driven by stronger loan growth, stronger deposit growth, so you should have a bigger balance sheet. But was there any change in terms of how you view your asset sensitivity within that. Because I guess I remember, I think on the prior call you mentioned that if you use Fed on futures curve like it’s up a 20% or in the low 20’s. It just seems that there’s almost like a disproportional benefit that you’re getting on the NII side that’s greater than what would normally be assumed from just the asset side.

[Dan Beck:]

Ken this is Dan, I’ll take it. So the key factors from the business perspective like we talked about one loan growth being so far ahead. And at the same time deposit balances being better and the deposit strategy that from a business perspective is a big driver. Secondly, rate wise obviously Fed funds increased coming through. Second, the LIBOR increase that we saw in the first quarter really helping the overall portfolio as 30%b of the loan book is LIBOR based. And then finally, the rates on the investment securities in the five year treasury which is generally where we’re investing is higher than when we started year. When we view all of that with the multiplier effect of having that happen so early in the year that’s where you see the increase in the guidance to that level.

[Ken Zerbe:]

Okay, that helps. And then I’m sure you guys have probably done the math yourselves. But if you did build in the Fed funds futures curve for the rest of this year do you have an estimated NII increase.

[Dan Beck:]

When we talk about it in the guidance, we were to get there from a margin perspective we’d be at the 3.5 to 3.6 rate.

[Ken Zerbe:]

Sorry. The 3.5 and 3.6 includes the additional rate hikes beyond the one we currently have.

[Dan Beck:]

3.6 to 3.7, sorry about that.

[Ken Zerbe:]

Okay. That’s perfect. No worries at all. And then just last question, is there any implication for crossing over the $50 billion trailing four quarter average, I mean, obviously, you’ve mention that you’re subject to enhance standards, but I guess, what is the actual implication of that, like from expense standpoint or anything else? Thanks.

[Greg Becker:]

Yes, I’ll start. It really starts to clock towards the implementation of certain standards around the capital for the CCAR preparation and the application of things with the modified LCRs. So these are things that we’ve been planning for quite some time and this is really just the indication that we’ve crossed over that threshold. So nothing happens the day after, but the planning for the first the CCAR filing for example which would happen in two years, it is now officially underway.

[Dan Beck:]

And the only thing I would add to that, Ken, is that, so that’s true, we are preparing for it as if nothing is going to change with the law, but I would say that we are more optimistic that the bill will move in the house and be signed by the President. So, obviously there’s no guarantees, but we’re certainly hopeful that that is going to happen and obviously that would be a nice benefit to us and save some of the money we plan on spending.

[Ken Zerbe:]

Sounds good, thank you.

[Dan Beck:]

Yes.

[Operator:]

And our next question comes from Steven Alexopoulos from JPMorgan.

[Steven Alexopoulos:]

Hey, everybody.

[Greg Becker:]

Hey, Steve.

[Steven Alexopoulos:]

I want to start out with an industry question for you Greg. If we think about it, so IPO has been relatively strong, but historically M&A has been much more important for the VCs in terms of exits. Now with M&A being sluggish, how do you think about this increase in spent of $28 billion? What’s driving this?

[Greg Becker:]

Yes. Part of it is just the size of the market and size of the opportunity, right. Companies are still staying private longer. And so what’s interesting when you look at the numbers, you look at PitchBook, which is where we spend a lot of time, you have a lower number of companies that raised rounds of financing, right, then it has – what has been over the last couple of years, right, so kind of peaked out in 2015. And so I look at this, it’s not a flood of overfunding of companies, it’s actually companies are staying private longer, and the metrics they actually have are performing well. What we’re not seeing and hearing about as much is with some of these deals especially with the larger rounds, there is some liquidity or secondary transactions that are happening. And so it mass a little bit of the money that’s going back to shareholders. Now the notable one that everyone talked about was Uber as an example, where when SoftBank came in there were some maybe early shareholders that took some money off the table, that’s happening. Now it still doesn’t solve the issue that we’re paying attention to which is we do need more M&A, and it’s nice to see the IPO, but we do need that more to happen. So we’re paying attention to it, we certainly believe that the rest of the year is going to be stronger from an M&A perspective, but we’re paying attention to it.

[Steven Alexopoulos:]

Okay. It doesn’t sound like your VC customers are that concerned though, right, in terms of spending?

[Greg Becker:]

They’re looking at companies and they’re looking at the performance metrics and you obviously see what’s happening with some of the larger funds that are out there, later stage funds, they’re putting some very, very big rounds, we like to call them private IPOs. And those are rounds that are more than $100 million and there’s a significant amount of those rounds taking place. And again, a fair number of those are having some secondary transactions as part of those deals.

[Steven Alexopoulos:]

Okay. I wanted to follow-up on the deposit strategies that Dan referenced. Are you adding new products or you just changing the incentives?

[Dan Beck:]

Steve, we’re not adding new products – in effect looking at certain segments of our customers and driving them at market rates onto the balance sheet. So from a product perspective there’s really nothing new there.

[Greg Becker:]

Yes. So I would just clarify because I want to make sure it’s not misconstrued. So it’s just their interest bearing money market accounts on balance sheet and basically you’re taking these interest bearing deposit accounts and you’re just increasing it to a target clients, we’re not changing the incentives around; and so just to be clear on that.

[Steven Alexopoulos:]

Okay. And then one final one, this might sound like a crazy question, but from an infrastructure view can you handle more than like $8 billion or $9 billion of inflows what you took in this quarter or do you need to think about investing to improve the capacity?

[Greg Becker:]

Yes. So there’s a couple pieces to the question. One is as I said, the new clients that we had – we did have a record right and it was 1,300 core commercial clients that we added this quarter. But in perspective as you go back and look at the numbers that we put over the last couple of years they were around 1,100, 1,200 so it’s not as if the proportionate number of dollars that have come into the organization equates to the same proportionate number of new clients. So when you think about the infrastructure need it’s not quite as great as you would think what the dollars that are coming in. The infrastructure we have in our off-balance sheet, we continue to add what I would say, very sophisticated individuals who continue to up our game and what our capabilities are. But we feel really good about the systems and technology that we have there. And then the infrastructure internally, we continue to make investments there. We believe that’s a great place to invest. We upped faced with the tax law change and we said we would have some additional money, we upped our project spend in infrastructure in different projects to make sure that we’re building the right infrastructure. So I think we’re making the right investments for both our kind of on – bank infrastructure and our off-balance sheet as well.

[Steven Alexopoulos:]

Okay. Thanks for all the color. Appreciate it.

[Greg Becker:]

Yes. Absolutely.

[Operator:]

And your next question comes from John Pancari from Evercore ISI. Please go ahead.

[John Pancari:]

Afternoon.

[Greg Becker:]

Hey, John.

[John Pancari:]

On the competitive front, I know you flagged it a couple times that competitive pressures are intensifying. Just wanted to see what areas are you seeing the greatest competition as it in VC private equity capital call line area or any other areas on the lending front. Thanks.

[Greg Becker:]

Yes. This is Greg I’ll start and then Marc Cadieux would add something. As you’d expect right that the innovation market is a very target rich environment for other institutions to go after. And so we’ve seen that for years it is competitive, we’ve had to sharpen our pencil, add talent make sure we’re doing as much value added we can. We still believe we get a premium in the market but you still end up with competitors stuck with rising rates but there is maybe more margin give up. Now we’re paying attention to that. So it’s pretty much across the board to include private equity services but the teams are doing a phenomenal job of competing effectively in the market. And again, I would say from a value add perspective.

[Marc Cadieux:]

And the only thing I would add to that is perhaps the biggest competitor of all is all of the equity that is so abundant out there. As crowded out would otherwise be a lot of loan demand which just makes the competition for what’s left that much more fierce.

[John Pancari:]

Thanks Marc. And then on that same note, are you seeing incremental spread compression as you move along here on new and renewed loans in your certain portfolios. And on that same, can you tell us what your new money loan yields are for new production this quarter. Thanks.

[Marc Cadieux:]

So perhaps we have a bright – minder bright spot is some stabilization in that margin compression in most segments of the portfolio. A couple of statistics there broad statistics in lending innovation companies. The interest only spread range from low 4’s to mid 6’s. PE or private equity venture capital has been more like low to mid 4’s and then our private bank has been more about mid 3’s.

[John Pancari:]

Got it. Thank you.

[Marc Cadieux:]

Yes.

[Operator:]

And the next question comes from Chris McGratty from KBW.

[Chris McGratty:]

[Question Inaudible]

[Greg Becker:]

Hey, Chris you are on a bad connection. But I think I got the message or the question you’re asking which is on capital ratios and deposit flows and what we think will happen with capital ratios. So our view is, we believe even with the deposit strategies that will probably end up maintaining where we are – still having some improvement in the capital ratios. So you shouldn’t see because of what our strategy is a whole lot of change in the reason. Obviously is that the profitability the net income has been so strong and obviously outlook is positive such that allows us a fairly sizable amount of deposit growth and still maintain flat or slightly increasing deposit ratios.

[Chris McGratty:]

[Question Inaudible]

[Dan Beck:]

That’s assuming two more hikes.

[Chris McGratty:]

[Question Inaudible]

[Dan Beck:]

Yes.

[Operator:]

And your next question comes from Brett Rabatin from Piper Jaffray. Please go ahead.

[Brett Rabatin:]

Hi, good afternoon.

[Greg Becker:]

Hi, Brett.

[Brett Rabatin:]

Wanted to ask just thinking about the expenses and I understand the guidance more towards the higher end of the range. I’m just curious just given the quarter that you just had, it would seem like your incentive comp accruals might have been even higher this quarter. Can you maybe give us a feel for how that might trend this year, and then just sort of what happened in 1Q versus the results you had?

[Dan Beck:]

Yes. So I’ll start. So as we take a look at what we think from a guidance perspective, again, in the script we’ve said that we would expect and we do expect higher incentive compensation because of the upgraded guidance and that did move us to the higher end of the range, that was offset to some degree by some slower project spend. So it offsets within the overall guidance range. That being said to the extent, that if we were to outperform this guidance there’s a potential for us to potentially move into the next range from an expense perspective, but we have to be what we just put out there.

[Greg Becker:]

And the only thing I would add on to it is that, remember, instead of compensation you have a two-thirds mix that’s tied to kind of our performance and kind of compared to what our budget is, one-thirds that’s compared to relative ROE against peers. And we had already in the budget plan that to be at the high-end max payout amount which is the 2x. And so you already have that factored in from a performance perspective, we can’t go higher than that. So the combination of what Dan said plus my comment is why we’re able to keep the guidance at the same level.

[Brett Rabatin:]

Okay, that makes sense, that’s helpful. And then wanted to understand or make sure I have clear this commentary around the products that and if we should be expecting some additional platform type things or what you’re exactly talking about when you say product side and some changes coming?

[Greg Becker:]

Yes. So I’ll start and Mike Descheneaux, our President may want to add something as well. So most of the CCAR capabilities, I guess, are around the people and the processes that we have. We are clearly looking at technology platforms, but I would say it’s too early to describe in detail what those will be, but we are looking at, again, what I would say infrastructure projects whether it’s digital banking, enhancing our card systems, and enhancing our FX capabilities. It’s not one area and it’s almost all what I would say enhancements. They will be a few new systems, but it’s almost all enhancements the majority of that is.

[Mike Descheneaux:]

That is – the heavy focus on the client experience and kind of the frictionless interaction with the bank, and so that’s been a really heavy focus for us, which again, coming back to Steve’s question about capacity, just going to enable us to better leverage and get more lift on processing and all these things.

[Brett Rabatin:]

Okay, great, thanks for the color.

[Greg Becker:]

Yes.

[Operator:]

And your next question comes from Tyler Stafford from Stephens Incorporated. Please go ahead.

[Tyler Stafford:]

Hey, good afternoon, guys.

[Greg Becker:]

Hey, Tyler.

[Tyler Stafford:]

I want to start on also the deposit strategy. How much of this initiative is pushing more new SVB depositors to stay on balance sheet versus off rather than moving the off balance sheet depositors back on the balance sheet? And then how do we think about the incremental cost these are coming onto the balance sheet?

[Mike Descheneaux:]

I’ll start, this is Mike Descheneaux. You’re going on the right track. So it’s a bit of product positioning, so making sure when the clients come onboard that they are taking advantage of our on balance sheet products. Now certainly there are opportunities where some already off the balance sheet, but really the primary focus is making sure that people take advantage of the product that we have on the on balance sheet. As far as the costs concerned, maybe Dan will take that question.

[Dan Beck:]

Yes. From a pricing perspective they’re being priced at near market rates what they could get off balance sheet.

[Tyler Stafford:]

Dan, would you quantify that for us?

[Dan Beck:]

We typically don’t talk exactly on the pricing side, so rather not.

[Greg Becker:]

When we think about these things and we think about our outlook in financial outlook, we are contemplating these things in our outlook. At this point I wouldn’t anticipate any material changes over above and what we have in our outlook.

[Tyler Stafford:]

Okay. And then I want to go back to the expenses. And I think Dan said that you have to beat what the guidance is that you just put out there for 2018. So in terms of the two-thirds instead of comp did you build in this deposit strategy in terms of the impacts on ROE into your internal budget?

[Dan Beck:]

So we built it into the guidance expectations that we have now, it wasn’t built into the original budget. And I think if we take a step back and think about the reasons that there could be additional expenses for incentive compensation in and above what we have now their paper performance related it would be better performance than the guidance at the same time it could be higher at warrant incentive gains. These are all things that would just drop additional income to the bottom line and would be performance related.

[Tyler Stafford:]

Okay.

[Greg Becker:]

The only thing I would add to what Dan said is that there – entirely right on the incentive compensation what Dan said. I would say just given the overall performance there may be opportunistic things that we do during the course of the year that again it wouldn’t materially change the number but it could push us slightly over that low double digit number from a standpoint of hiring certain positions and things like that. We already have a lot build in the forecast but again we’re still early in the year. And we maybe opportunistic, no plans right now. But I would say, it’s something like that it does happen, it would be for good reason.

[Tyler Stafford:]

Okay. Got it. And then I just want to make sure I understood lastly for me. When did you first implement this deposit strategy? I think, I heard you say just a few weeks ago and does that mean once you had no impacts from the strategy.

[Greg Becker:]

Yes. The impact in the first quarter was quite small only four weeks ago.

[Tyler Stafford:]

Okay. Got it. Thanks guys. Congrats on a very nice quarter.

[Greg Becker:]

Thanks.

[Operator:]

Your next question comes from Geoffrey Elliott from Autonomous Research.

[Geoffrey Elliott:]

Hello. Thanks for taking the question. In terms of this strategy of getting deposits on to the balance sheet it sounds from what you’re saying like most of the effort is going to be around new business rather than getting sums that are currently off balance sheet on to balance sheet. Could you just explain why that’s the case and maybe give us a sense of out of the existing off-balance sheet sums how much you think would be a candidate for bringing on to the balance sheet.

[Mike Descheneaux:]

I’ll start off. This is Mike Descheneaux. If you go back and reflect on our – fasten our history right. If you went back a couple years ago about a rapid deposit growth and the pressure put on the capital ratios, right. We started focusing more on moving some of these clients to our off-balance sheet products for making those products available. Clearly time to change interest rates have gone up and the value of the deposit coming our balance sheet is significantly better. So what we’re doing is we’re making the on-balance sheet products more available to this new forming companies that is early state companies. So that’s really their principal strategy there. Again, as I mentioned earlier certainly if we can try to move some of those that are already in the off-balance sheet on we certainly will given again the strong capital position we have that we can certainly use and absorb that excess capital we have.

[Geoffrey Elliott:]

Thanks. And then just one of the quick one. The private equity in venture capital component of the loan book, I think it’s now up to about 45% of total loans. How much that are you comfortable in moving.

[Greg Becker:]

Yes. This is Greg, I’ll start. You’re right, it is at 45%. And obviously that’s been a driver of growth for many, many quarters. So we’ve been doing a lot of work internally looking at credit quality making sure that we’re bringing in outside consultants to come in to make sure we’re not missing anything. I’m going to let Marc talk about credit quality from his perspective. But when we think about it we feel very good about how we’re managing these companies the quality of the companies, the quality of the firms. In fact they have more upside and it’s a scalable business as well. And so we look at it I guess my point of view would be originally I was looking at it kind of around that 50% but the more we talked about it internally, I’m certainly comfortable, the team is comfortable moving out to the kind of low 50’s. So we certainly believe we have headroom. In addition, we believe a lot of the things that we’re putting in place which are adding new people and structures and different approaches on the lending side and other areas of the business, life sciences, technology, private banking, and in international. A lot of other areas are going to continue to provide growth, which would mitigate that moving up to a dramatic degree. So I’ll turn it over to Marc on the credit quality question.

[Marc Cadieux:]

Yes. The only thing I would add on the topic of credit quality is it is historically been excellent for the over 20 years that we’ve been doing this business. There’s a number of reasons for that and I think as the mix in that portfolio continues to tilt towards private equity, which in the main continues to or generally has more institutional limited partners behind it, the likelihood of a defaulter continues to go down, said in another way, already very low probability of a defaulter loss event gets lower still. And so don’t see anything in the near-term horizon or on the horizon period that would be likely to impact that.

[Geoffrey Elliott:]

Great, thank you very much.

[Greg Becker:]

Yes.

[Operator:]

And our next question comes from Christopher York from JMP Securities.

[Christopher York:]

Good afternoon, guys, and thanks for taking my questions. Most of them have been asked, but maybe a question on credit. So for Marc, credits are clearly solid, but I did notice some skew towards early stage charge-offs that prompted the question. Are you seeing any regulators taking a harder line on these types of loans today given the tendency for the repayment to be investor dependent?

[Marc Cadieux:]

So there are a couple of questions wrapped up in there. So the first or maybe I’ll go in reverse order. With regard to regulators you would appreciate why we don’t comment on discussions that we have with our regulators in an ongoing basis about early stage or any other part of the portfolio. Having said that, the charge-off experience in the first quarter was fairly typical in terms of early stage, almost two-thirds came from early stage obviously was a relatively low number and so a relatively low number of charge-off events in there and fairly granular. So that is fairly typical and the kind of thing that we expect in our business to continue to see at any point in the cycle, unfortunately not everything venture capital try works out, but in the main it’s been a great business for us and one we continue to focus on.

[Greg Becker:]

I just want to maybe reflect on as well too, it’s extraordinarily low net charge-off in the quarter of 15 basis points.

[Christopher York:]

Yes, exactly, I was just going to ask that, prompt the question on that part. So that’s it for me. Helpful color, thanks, guys.

[Greg Becker:]

Yes.

[Operator:]

And our next question comes from David Chiaverini from Wedbush. Please go ahead.

[David Chiaverini:]

Hi, thanks. So I had a follow-up on the deposit strategy. I was just curious do you fear any migration from non-interest bearing deposits into the money market product that you are offering the higher rate on?

[Dan Beck:]

So this is Dan, the way that we structure the product and the way that we’re looking at it and what we talked about of being non-interest bearing around the high 70%s to low 80%s is really a reflection of how we think. Things are going to move from non-interest bearing to interest bearing. So we don’t think there’s going to be a significant amount of migration, and haven’t experienced any of that. And it’s mostly because of the fact that our non-interest bearing are operating accounts of the clients and customers that we have, and that’s been the general practice and we don’t expect that to change very much.

[David Chiaverini:]

Got it. And it sounds as if the gating factor in terms of how much could come on balance sheet is your capital ratios and I was curious what is your comfort level; on either the common equity Tier-1 or the leverage ratio that you are thinking about?

[Dan Beck:]

Yes. On the leverage ratio I think we’ve talked about that, historically, we’re comfortable in that 7% to 8% range, obviously, we’re in the middle of that right now. So we will continue to see net income growth based on the guidance that we just put out there, and we have to see how these deposit strategies go into place and we’ll see how well that takes and how much capital it consumes.

[Greg Becker:]

And this is Greg, I would like to add is we have positioned there, we have room, but that’s not the game plan. The game plan is to maintain the ratios where they are, but again, as far as the gating items, we’re looking to make sure that our clients have the right product that is critically important to us, and we believe as Dan pointed out, the mix of interest bearing versus non-interest bearing in kind of simple math $110 billion of total client funds you have roughly $70 billion that is interest bearing in some form or fashion on our balance sheet or off and you have $40 billion that is non-interest bearing. So that mix has stayed very consistent through multiple cycles. So we feel very good about it both from a client – help clients to perceive it and what products we’re offering them. So we think we’re in very good shape.

[David Chiaverini:]

Thanks very much.

[Greg Becker:]

Absolutely.

[Operator:]

And our next question comes from Jared Shaw from Wells Fargo.

[Timur Braziler:]

Hi. Good afternoon. This is actually Timur Braziler filling in for Jared. Just one question for me, just looking at the securities book trying to gauge what the expectations are there as far as mix AFS and held-to-maturity. Are those the run off or the cash flow from AFS being put into the held-to-maturity bucket? And that’s a ration expanded a little bit this quarter. Just love to hear your thoughts on where that could go in coming quarters.

[Dan Beck:]

Yes. So first on the duration point we did see extension this quarter, we did have the sales at the end of the fourth quarter of the AFS securities that plus the increase in rates really lead to the duration extension. If you look at the mix in AFS versus HTM we’re going to keep that relatively constant from here. So you won’t see a major shift in that from a percentage basis.

[Timur Braziler:]

Okay. Thank you.

[Operator:]

And that concludes our question-and-answer session. I’ll now turn the call over to Greg Becker for final remarks.

[Greg Becker:]

Great. Thanks. So to wrap up, so we had a great quarter and obviously a very improved outlook. So we feel really good about our clients and our markets are doing exceptionally well. And we believe we still have opportunities quite honestly to get even better. This wouldn’t be the case that our amazing employees roughly 2,500 of them, they do such a phenomenal job with our clients helping them as we like to say increase their probability of success. And that’s one of the key parts of success apart from other institution. So we really can’t thank them enough. As important obviously their clients the fact they are working with us, they put their trust in us we don’t forget that and we know that part of the reason we talk about making more investment in our business. And Mike talked about client experience, we believe that is so critically important and adding value to them. So we want to thank them. The last part I’m going to say, thanks is to a couple of board members. We have two board members that are going to be rolling off after many years Lata Krishnan has been on the board for 10 years and she decided to step down and Dave Clapper, who has been on the board for 14 years. And two amazing people that have been key contributors to at SVB success over their 10 year and I just want to say thanks to them. Finally, I want to thank everyone for joining us and have a great evening. Thank you.

[Operator:]

Thank you ladies and gentlemen. This concludes today’s conference call. Thank for your participation. And you may now disconnect.