SVB Financial Group
Q3 2017 Earnings Call Transcript

Published: 28 Oct 2017

[Operator:]

Welcome to the SVB Financial Group Q3 2017 earnings call. My name is Nicole, 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 that this conference is being recorded. I would now like to turn the call over to Head of Investor Relations, Meghan O'Leary. Ms. O'Leary, you may begin.

[Meghan O’Leary:]

Thank you, Nicole, and thanks, everyone, for joining us today. Our President and CEO, Greg Becker, and our CFO, Dan Beck, are here to talk about our third quarter 2017 financial results and will 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 some 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 the call. In addition, some of our discussion may include references to non-GAAP financial measures. Information about those measures, including reconciliation to GAAP measures, may be 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.

[Gregory Becker:]

Thank you, Meghan, and thanks, everyone, for joining us today. We had an outstanding quarter, with record earnings per share of $2.79 and record net income of $148.6 million. This represents a 20% increase over the second quarter and a more than 30% increase over the same quarter last year. Our results reflect strong balance sheet growth, the continued impact of higher short-term rates on our earning assets, solid credit performance, good core fee income growth and healthy levels of activity among our clients. Highlights of our third quarter included net interest income growth of 9.2%, loan growth of 5.2%, total client funds growth of 6.7%, bringing us close to $100 billion of total client funds, core fee income growth of 17.7%, warrant gains of $25 million, primarily driven by Roku's successful IPO, and a return on equity of 14.6% and a return on assets of 118 basis points. Our clients continue to perform well overall despite mixed performance data from Venture Capital Markets. 2017 VC investment is still on track to be the highest in a decade, although both dollars and deals declined in the third quarter. Mega rounds in later stage start-ups continue to outpace investment in smaller, earlier stage companies. The IPO market remains soft as many later stage companies are staying private longer and taking advantage of readily available liquidity. With only 8 US VC-backed IPOs in the third quarter following two quarters of improvements, expectations for a robust VC-backed IPO recovery in 2017 have faded. However, we're on a somewhat better run rate than in 2016 and post-IPO performance is improving. Of the 5 largest US VC-backed IPOs during the quarter, all are trading above their initial IPO prices. New company formation remains healthy and there is ample capital available for good companies. VCs are sitting on some $93 billion of uninvested capital. And although investments in early stage companies declined, 1/3 of the $21 billion invested during the quarter went to early stage and seed-stage companies. Our client acquisition remained healthy as we added nearly 1,300 new core commercial clients for the second consecutive quarter. Overall, we are pleased with the continued momentum in our business. Our balance sheet is growing strongly due to healthy client acquisition as well as good business conditions overall and ready access to liquidity for our clients. We continue to benefit from recent rate increases consistent with our expectations for asset sensitivity. Fee income continues to grow driven by healthy transaction volume, in particular in FX and credit cards. And asset quality remains solid, a testament to our ongoing discipline and commitment to high quality growth despite the competitive environment. In many cases, the results we're seeing today are directly tied to investments we've been making in our growth which I spoke about last quarter. For example, we began investing to grow our market share of private equity firms 4 years ago. As part of this, we adopted a national team approach to allow us to better coordinate among ourselves and provide a higher level of service to our clients, and added valuable expertise in the form of new hires. Since that time, we have significantly increased our private equity client count and, as you know, private equity has become the primary driver of our loan growth, a major contributor to total client funds, and a significant driver of fee income. We're also applying these lessons learned through our experience to our technology and life sciences practices to help drive growth there. Our private bank is another area where we have made investments in the past 3 years that have nearly doubled our client count and more than doubled loan balances while also helping us cement key relationships through a high level of service. Notwithstanding this success, we believe we are only scratching the surface on the growth potential in private bank and we will continue to invest in its growth. Likewise, in foreign exchange we have seen positive outcomes from our investments in people, expertise and focused client engagement. Our foreign exchange team just had its strongest quarter ever with just under $30 million in revenue. Thanks to these outcomes and our solid performance overall, we expect to end 2017 on strong footing and the markets and our momentum suggest 2018 will be a strong year as well. As we move into 2018 and think about building and maintaining our unique position as the bank for the global innovation economy, we have numerous initiatives that we believe will help ensure our long-term growth. I would like to highlight 4 of them. First is raising the bar on client engagement and connecting with clients in a more meaningful way. Overall, we've done a really good job with client engagements, but we believe there is significant opportunity to strengthen and support our growth by making targeted improvements. For example, our early stage clients typically place a high priority on speed and efficiency of getting their accounts set up. We are looking at creating a frictionless onboarding experience through digitized client acquisition capabilities. On the other side of the client experience, we want to enhance our relationships with our private bank and wealth management clients. Our clients trust us and want to work with us more closely so we are adding expertise and looking at expanding our capabilities and offering unique or tailored alternative assets that reflect the access we have as a result of our position in the innovation economy. An important aspect of enhancing client engagement will also be allowing our employees to scale by making it easier for them to do their jobs by giving them access to information and analytics that will enable them to offer unique insights to clients and reducing and eliminating time consuming manual processes so they can spend more time supporting our clients. A second initiative will be continued investments in our global expansion. We are putting more resources behind our successful and growing UK Office which year-over-year has achieved 29% average loan growth, 62% average client funds growth, and just recently had its best quarter ever in foreign exchange. And we believe we have a lot more growth ahead. Obviously our Canadian and German applications will remain priorities and we hope to be up and running in both countries by mid-2018, regulatory approvals pending. We will also continue to support clients in Asia through our joint venture in China and SVB's direct efforts. Our business in Asia continues to expand in one of the fastest growing markets in the world. A third area of focus will be growing our fee income. We want to build on our long-term focus of starting with clients early in their lives to take a holistic approach, to improving product penetration across our clients, adding specialty teams to work on identifying and meeting the needs of specific client segments, and continuing to partner with and capitalize on the capabilities of our innovative FinTech clients. Finally, we'll take a more holistic approach to enhancing our risk management across the organization. This includes continuing our investment in enterprise wide risk management to meet the higher standards related to CCAR and Enhanced Prudential Standards, enhancing credit risk management so we continue our strong record of excellent credit quality, and investing in all regulatory areas of risk management including compliance in BSA and AML. Our focus on these areas combined with the execution of our long term strategic plan will enable us to drive deeper relationships with our clients, develop deeper engagement with our employees, and deliver strong financial results in both the short and long term. As we have done in prior years, I'd like to share our preliminary outlook for the upcoming year. For 2018 we expect average loan growth in the mid-teens. Average deposit growth in the low double digits; Net interest income growth from the high teens to the low 20s (This assumes a flat rate environment. If rates rise consistent with the forward curve, we would expect net interest income growth in the low to mid 20s.); Core fee income growth in the mid to high teens; Net charge offs consistent with 2017 of between 30 and 50 basis points; and noninterest expense growth in the high single digits. I'd like to stress this is a preliminary outlook, assumes the macro environment holds, and is subject to change. Based on what we know today, we expect a good 2018. In summary, I am incredibly proud of our Q3 quarterly results, strong engagement with our clients, and I am very optimistic about our outlook both in the short and long term. We are the centre of the innovation economy, one of the most robust in the world, have the most innovative and resilient client bases you could ask for, and incredibly talented employees. Finally, I want to say a word about the natural disasters that have devastated parts of the country recently

[Daniel Beck:]

Good afternoon, everyone. As Greg outlined, we delivered an outstanding quarter with a strong increase in net income due to continued balance sheet growth, expansion in core fee income, stable credit performance and healthy warrant gains. Highlights of the quarter included the following. One, strong growth in net interest income due to robust balance sheet growth both from loans and deposits and the impact of recent rate increases. Two, good core fee income growth driven primarily by foreign exchange, client investment fees, lending related fees and credit cards. Three, notable warrant gains primarily from valuation gains related to Roku's successful IPO. Four, stable credit with solid, underlying trends. Fifth, somewhat higher expenses related to incentives reflecting our strong performance as well as some non-recurring items. And six, continued strong levels of capital and liquidity. We continue to see healthy growth across the business and solid momentum that we expect to continue through 2017 and into 2018 assuming the macro environment does not change. Now let me turn to the details. Starting with the balance sheet, where we saw very healthy growth, average loans increased by $1.1 billion or 5.2% to $21.6 billion, driven primarily by private equity capital call lines with strength in mortgage loans and technology lending. The pace of new lending remains solid across our businesses and we saw improved period end growth in our technology portfolio in the third quarter. New loan commitments are strong and our pipeline remains healthy. That said, the abundance of liquidity in the ecosystem continues to weigh on technology and life sciences loan growth for now. For the full year 2017, we expect to come in near the middle of our mid-teens outlook, assuming that clients' M&A activities remain near Q3 levels. Turning to client funds, average total client funds grew by $6.1 billion, or 6.7% to $97.3 billion. This increase reflected strong average deposit growth of $1.9 billion or 4.5% to $44 billion, driven by the continued trends of robust new client acquisition and healthy equity funding for our clients. These trends and the significant amounts of dry powder available for investment suggest deposit growth will remain on its strong trajectory. For the full year 2017 we expect deposit growth to come in at the high end of our outlook range of the high single digits, assuming current deposit growth trends continue. Average off-balance sheet client investment funds also grew an exceptional $4.2 billion, or 8.5%, also driven by strong equity funding for investor-backed clients helped by active secondary public offerings among our larger clients. Average assets increased $2.2 billion or 4.7% to $49.7 billion. Period end assets ended the quarter at $50.8 billion and we expect to reach the four-quarter average of $50 billion by the second or third quarter of 2018. Meaning we'd be subject to the Enhanced Prudential Standards compliance for $50 billion bank holding companies by mid-2019, and CCAR reporting in early 2020. Now I'd like to turn to the income statement. Net interest income grew strongly by $31.3 million or 9.1% to $374 million, due to higher loan balances, higher investment balances which grew $1.6 billion or 7.5% due to deposit growth, the impact of the June Fed Fund's increase, and one extra day in the quarter. This increase in net interest income was consistent with our expectations. Loan interest income increased $18.2 million or 7.3% and income from investments increased by $14.2 million or 14.7%. Average gross loan yields, excluding interest recoveries and loan fees, increased by 10 basis points, primarily due to the June rate increase. Approximately 55% to 65% of each rate increase translated to improvements in loan yields with the remainder absorbed by spread compression primarily on our private equity business. Overall loan yields increased 4 basis points due to lower fees in the third quarter and as a result of the impact of interest recoveries on nonperforming loans in the second quarter. Deposit betas remain low with less than a 10% change in deposit costs on a year-over-year basis. Our net interest margin increased by 10 basis points to 3.1% due to higher loan yields and higher investment yields as we purchased $2.8 billion of new investments in the third quarter at yields of 2.5%, replacing securities at 1.6%. Six maturities in the portfolio are roughly $700 million per quarter, not including prepayments. We are maintaining our full year 2017 outlook for net interest income growth. However, we are narrowing it to the top end of our percentage range. We expect full year net interest income growth at the low end of the low 20% range. Now I will move to credit quality, which remained stable in the third quarter. Our allowance for loan losses was $249 million at the end of the third quarter, an increase of $12.5 million over the prior quarter primarily due to increased reserves for loan growth but consistent at 112 basis points of total gross loans. Our provision for credit losses was $23.5 million, compared to $15.8 million in the second quarter. This consisted mostly of $13.8 million in net new specific reserves for nonaccrual loans, and $10.9 million for loan growth offset by $2.3 million related to overall improved credit quality in our performing loan portfolio. Net charge-offs decreased by $12 million to $10.5 million, or 19 basis points of total average loans. Non-accrual loans increased by $4.5 million to $124.7 million, or 56 basis points total loans. This increase reflects gross charge-offs of $11 million, repayments of $14.7 million, and new nonperforming loans of $30.2 million primarily from our technology portfolio. We are seeing good overall performance across the portfolio and solid trends in underlying credit metrics, although high valuation and soft exit markets still pose a risk for early stage credits. As all of you know, the natural disasters of the last few months have created some significant challenges for communities in coastal Texas, Florida and Northern California. As Greg mentioned, we are working to support our employees, clients and the communities that were affected. In terms of business exposure, the recent wild fires in Northern California are of most importance to us. We have been in touch with all of our clients in the affected areas and the initial news is positive. Only a handful of wineries sustained material property damage and we are not aware of any client whose availability to make and sell wine has been materially affected. We have minimal private bank exposure in the affected areas and at this point we anticipate no material impact on credit quality the near term. But a more prevalent issue is the anticipated drop in tourism during what is normally a busy season for the region which could affect their businesses in the coming months. We will continue to monitor the situation and provide updates as necessary. Taking all of this into consideration, we are maintaining our full year credit quality outlook for 2017. Our allowance outlook remains unchanged and we expect to come in near the low end of our net loan charge off range of 30 to 50 basis points. Now I'd like to turn to non-interest income, which is primarily composed of core fee income and gains from warrants and private equity and venture capital related investments. GAAP non-interest income was $158.8 million, an increase of $30.3 million or 23.5% over the prior quarter. Non-GAAP non-interest income net of non-controlling interest was $153.2 million, an increase of $34.2 million or 28.7% over the prior quarter. The increase was primarily driven by warrant gains and increases across most core fee income categories. Equity warrant gains were $24.9 million compared to $10.8 million in the second quarter. These included $18.2 million from valuation gains related to IPO activity -- the majority of that from Roku -- and $7.4 million from warrant exercises due to M&A activity. I would like to point out that there is typically a 180-day lockup period associated with our IPO related securities, so the value of those holdings may fluctuate depending upon the price of the stock. Net gains on investment securities net of non-controlling interest were $9.7 million compared to $8.2 million in the prior quarter. These gains were spread relatively evenly across our strategic investments, funds of funds, and debt funds. Approximately 2/3 were unrealized valuation improvements. Core fee income increased by $15.5 million or 17.7% to $102.7 million driven by growth in foreign exchange, credit cards, client investment fees, and lending related fees. Fees from foreign exchange transactions rose by $3.6 million or 13.8% to $29.7 million due to higher volumes. Credit card fee revenue increased by $2.2 million or 12% to $20.3 million due to higher interchange fee income, again, from higher volumes. Client investment fees increased by $2.6 million or 19.9% to $15.6 million as a result of higher client investment fund balances and the impact of higher spreads. Finally, lending related fees increased by $6.9 million or 81% to $15.4 million. $4.5 million of that was the result of an adjustment for unfunded commitment fees and $1.3 million was driven by higher syndication fees. We are raising our core fee income growth outlook for the full year 2017 from the mid-teens to the high teens and we expect to come in at the low end of that high teens range. Turning to expenses, non-interest expense was $257.8 million, an increase of $6.6 million or 2.6%. This increase was partly related to our continued strong performance in the third quarter and included $4.3 million of higher compensation, primarily performance related. Also included in the overall increase was $3.8 million related to the write-off of an internally developed software system. Minus these expenses, we would be within the range of our current expense outlook. Nevertheless, as a result of the higher than expected expense in the third quarter, we are revising our expense outlook for 2017 from the low teens to the mid-teens. We expect our efficiency ratio will trend down over time and we are committed to making that happen. We are focused on driving better scalability and efficiency in our back office and are looking at certain investments that could help improve our operating leverage in the coming years. Turning to taxes, our effective tax rate increased to 39.6% in the third quarter compared to 36.8% in the second quarter. The dollar increases of $25.7 million was primarily due to higher income before taxes, while the change in effective tax rate was due to a $5.7 million decrease in tax benefits related to share based compensation which lowered our effective tax rate notably in the first and second quarters. Looking to 2018 and 2019, we are looking at opportunities to optimize our tax rate as we continue to monitor the debate on tax reform in Washington. We expect this strategy to include, among other things, purchases of municipal bonds and other tax advantaged investments. Moving to capital, capital and liquidity remain very healthy although growth in risk-weighted assets due to positive loan and investment growth trends pressured risk based capital ratios slightly. The Tier 1 leverage ratio at the bank declined 7 basis points to 7.59% and was also affected by the dividend from the bank to the holding company, but remains well within our target range. To wrap up, we are very pleased with our outstanding performance this quarter. We delivered another quarter of record earnings, strong balance sheet growth, and solid credit quality. Our capital and liquidity remain strong to support our continued growth. Despite persistent competition and continued M&A activity among our clients, we see a healthy stream of new clients and continued momentum in our pipeline. We are benefiting from the recent rate increases and, should there be any future increases, we would expect to see upside to our current outlook. Loan growth, client fund growth and fee income are all strong and reflect the general good health of our clients as well as their access to funding and liquidity. Our positive revisions to our full year outlook more than offset the expense increase and we are well positioned for strong growth in 2018. We remain focused on expanding our business and our product offerings while improving our penetration among clients, delivering high quality growth and maintaining strong credit quality. And we continue to make the necessary investments in infrastructure, people, that will enable us to maintain our momentum while meeting the increasing regulatory requirements of being a $50 billion bank. Thank you, and now I'll ask the Operator to open the line for Q&A.

[Operator:]

[Operator Instructions] And our first question comes from Ken Zerbe from Morgan Stanley. Your line is open.

[Kenneth Zerbe:]

I wanted to just ask the first question about expenses. I want to put you on the spot a little bit here. So, if we go back a year ago, your expense guidance for the year was high single digits. You came in, you're on track at least for call it mid-teens expense growth, while at the same time, your loan growth is a little bit lower than what you expected. Now fast forward to today, you're still calling for mid or high single digit expense growth in 2018. But what does that depend on? Because how do we get comfortable that you're going to stay in the high single digits versus see that creep up to the mid-teens again this year or next year?

[Daniel Beck:]

This is Dan. I'll answer and others might want to jump on. So again, as we look at 2018 in particular, and historically around our overall expenses, there are really two key drivers. One is paying for performance and the second is investing to support our growth. We've continued to see quite strong growth across all categories including loans as well as fee income. And at the same time, have continued to see a strong improvement in ROE, especially relative to our peers. So, the performance aspects are there, and as we talked about, as we start to think about 2018, the expectation is there for again strong performance in the year. At the same time, we know that we need to make some investments to support our growth on a long-term basis and that expense that we have incurred this year will helps in next year as well to support the overall expense levels.

[Gregory Becker:]

Ken, this is Greg. The only thing I would add to what Dan said is, when you look at the performance that we've had, and again, admittedly part of this is being helped by interest rates, we look at that performance and I would say there's probably some opportunistic things that we've done as we think about 2018 to say, look, given the performance, given the loan growth, given the deposit growth, total client funds and where we believe it's going to go, it's a good time to be putting some more money back into infrastructure to help, again, not just fuel the growth in 2018, but look at 2019 and 2020 and beyond. So, part of that does go into the fact that we're looking longer term for investments as well.

[Operator:]

And our next question comes from Ebrahim Poonawala from Bank of America Merrill Lynch. Your line is open.

[Ebrahim Poonawala:]

I guess first, I just want to touch upon, just to follow-up on Ken's question on expenses, I believe, Greg, you mentioned last quarter that based off of the ROE component of the incentive comp, that number should be about $30 million in 2017. Is it safe to assume that that $30 million is going to remain unchanged next year? Or is there some upside to that based on additional ROE improvement that you might see in 2018?

[Gregory Becker:]

Ebrahim, it's Greg. I'll start and Dan may want to add. So, there's two components as you comment. One is, there is 1/3 of our incentive compensation tied to ROE and it is relative, and the other 2/3 relates to our forecast, our internal budgeting purposes. And as you said, this year we kind of maxed out at as high as it can go. And again, assuming our outlook plays out, we would envision that would be at the high end of that range next year. So, the number, the percentage won't change very much. The only delta will be that as we add more people, you're going to see that $30 million grow a little bit more. But that's not going to be a meaningful delta. The other 2/3 will be based on performance and so there is a slight recalibration, but not as much, it's not like setting it back to a 1x the way we had in prior years because we're performing so well on a relative ROE basis.

[Ebrahim Poonawala:]

Understood. And I assume that's baked into your high single digit expense growth guidance given sort of you have a pretty positive growth outlook for next year, so that $30 million is already in the base and baked into how you're thinking about 2018 expenses right now?

[Gregory Becker:]

Correct. And so therefore, the areas that you could see, again, performance improvements, is on the 2/3 depending upon how we perform against our budget and our outlook.

[Ebrahim Poonawala:]

Understood. Switching to fees for a second, a very strong quarter. I think your guidance is very, very strong. It still feels like we had a relatively soft first half and you've seen some strength in 3Q. Is this all driven by stronger activity or has there been any changes you made at your end that has driven the sort of momentum you've see in 3Q?

[Gregory Becker:]

This is Greg again. There's a few things. The first half was a little bit softer. But we also had not just the volumes were a little bit softer, but we also had some compression in margins. We talked about it with credit card fees, we talked about it with FX in Q2 and actually even a little bit in, yeah Q2. So that created softness. So, what we had is increased volumes in the third quarter and we expect obviously that those will hold into the fourth quarter. So that's one part on volumes. The second part is that we saw stability in the margins on both FX and the credit cards. So that was the major lift was the stability in the margins combined with the volumes and that's kind of what we expect to happen for the balance of the year and into 2018.

[Operator:]

And our next question comes from Steven Alexopoulos from J.P. Morgan. Your line is open.

[Steven Alexopoulos:]

Greg, I appreciated the adjusted net interest income outlook you gave for 2018 if we get the forward curve right which is different than the guidance. If the forward curve played out, how would that impact your expense outlook for 2018?

[Gregory Becker:]

That's a good question. One thing about the expenses, specifically on comp, it would have very little impact on that or no impact because we don't build rate increases into our incentive comp program. We neutralize that. We did that this year and we'll do that again next year. So actually, I don't think it's really going to have any impact at all.

[Steven Alexopoulos:]

Wouldn't it impact the ROE component of the incentive dollars?

[Gregory Becker:]

We're already at the high end of that range, and so we're maxed out. So that actually wouldn't be able to go any higher.

[Steven Alexopoulos:]

At some point should we expect a more meaningful ramp in expenses though as you guys get ready to cross the SIFI threshold which Dan said would be mid-2019?

[Gregory Becker:]

Yeah, I'll start and my answer is no. Here's the one thing that you could see, and Dan and I have talked a lot about this, which is we believe, and I said in my comments, that there are opportunities to make improvements in our manual processes and procedures and I would say make some investments there, and what would be some meaningful investments, to help with the long-term trajectory of expense growth and improve the efficiency ratio. We may come back and say here's what it looks like, here's the program and this is why we would put that into place. We don't have that outlined right now. But right now, everything we've talked about is baked into the high single digits forecast.

[Daniel Beck:]

And specific to CCAR, we've talked about this in the past, we have in the number something close to $13 million to $15 million. Expect a small increase as we get into 2018. We've been investing in this over time so the cumulative investment I think puts us in a good place to be ready to cross over that threshold. So, I don't think you're going to see a major spike in those costs. We continue to monitor it and to the extent that it's necessary we'll come back, but at this point don't think it's necessary.

[Gregory Becker:]

The risk I would say gets less and less over time because we're getting more information, we're getting our arms around it more. And so, I think it's a more confident comment that we don't expect to see a spike.

[Steven Alexopoulos:]

I want to shift to the average client funds. You guys had a record quarter last quarter, it's even better this quarter. Greg, from a high level, I know you talked about the IPO market not being great, what is driving this? And is it sustainable here?

[Gregory Becker:]

There's two aspects of the growth in client funds. One is just the overall market liquidity and although there hasn't been as much, as we talked about, in the IPO market, but the private funding market is incredibly robust. And it's impacted by the Sovereign Wealth Funds coming in, it's impacted by the Vision Fund from SoftBank, it's impacted by a lot of money that's being invested by the Venture Capital community. And even through it was only, it was down slightly from Q2, it was still $21 billion, so it was still a very significant number. So, one is just the overall volumes that are coming in. The second component of it is our teams and how well they're doing. One is just bringing in new clients on a day to day basis, so new client acquisition. Again, I said that was strong. The other part that we started in a few quarters back is actually calling on larger companies and with our asset manager group going after some bigger pools of money from larger companies. So, it's not just one thing. It's the robust market, it's the opening the funnel at the beginning and adding a lot of new clients, and it's going after later stage clients. It's combination of those things. Now is it sustainable? Clearly as we said in our outlook for at least deposits, we expect still nice growth to occur next year which we assume the market is going to continue to hold. Obviously if we see a big decline in the client and venture capital, that could change. But we feel we have a really good handle on where we are and where we're going with the team we have, the client acquisition approach and the market being stable where it's at.

[Operator:]

And our next question comes from Jared Shaw from Wells Fargo. Your line is open.

[Jared Shaw:]

Looking at the strong growth this quarter I was surprised to see you pushed out the 4Q average to cross the $50 billion a quarter, or pushing out to the third quarter. Should we expect to see some incremental loan growth funded with securities or asset substitution on the balance sheet just given from the tone it sounds like still a robust loan pipeline?

[Daniel Beck:]

Not at this point. Though we continue to see strong growth in overall deposits, we're just taking a look at where we are from an overall ending balance perspective. Still expect to see strong growth and just by the calculation of the averages, don't think that it's possible for us to cross over that threshold in the first quarter. It would have taken much more or higher growth in the fourth quarter based on where we ended the third to get us there. So, we're starting to see again continued strong growth, but the expectation just based on the way the averages play out, is that will be in the second or the third quarter.

[Jared Shaw:]

How should we be thinking about growth in the noninterest bearing deposits as rates continue to grow? It's amazing that your overall costs of deposits were really unchanged. I mean could there really be a scenario where that could continue to be driven higher? Does it really matter at this point what other banks are paying given your relationship nature?

[Gregory Becker:]

This is Greg. There's a couple of different things to remember. First of all, I think when people look at our balance sheet and you look at the high level of noninterest bearing deposits, it feels like it is a very low cost to funds. But you really have to bring in the off-balance sheet to look at it holistically because you're looking at more than $50 billion of client funds that are over there and that's getting a market rate of return. So, you look at that combined with some money markets accounts on the balance sheet, and then you look at the total noninterest bearing deposits, and that total mix, it may shift a little bit, in fact it probably will shift a little bit as rates pick up. But we're still able to provide market rates for our clients in our off-balance sheet options. Do we expect it to change as rates pick up? Yeah, it's going to change a little bit. But we still expect the deposit beta to be pretty low. Right now, we're basically not seeing a whole lot of change and maybe it goes up to 20 or 30, but we don't expect it to be more than that. And that's under I'd say a scenario that is rates continue to pick up from where they are right now.

[Daniel Beck:]

Just to add to that, as we look ahead with additional rate increases, every 25 basis points giving us $53 million, we are modelling a slightly higher deposit beta in let's call it the 20% to 30% range versus where we are today in 10%. So, we are taking a little bit of that into consideration, we continue to monitor it, but at this point we're still less than 10% on the overall deposit beta.

[Jared Shaw:]

That $53 million per 25 basis points, that's increased costs of interest expense? A - Daniel Beck 0 No, that's the overall impact, improvement to net income of 25 basis points increase in short term rates.

[Jared Shaw:]

Great, thanks. And then just finally for me, looking at the FX going rate, I hear what you said how it's ramped up through the year. Was there any sort of a venture impact this quarter or was it really just good blocking and tackling in you said better margins and overall volumes?

[Gregory Becker:]

Yeah, I would say consistent margins. It wasn't better margins. And it was I would say blocking and tackling. We continue to invest in that area and will continue to invest in it on a go forward basis. We have both domestically and internationally the client base that utilizes foreign currency exchange spot and forwards and options. And we expect the volumes to be solid although obviously you could see variations on a quarter to quarter basis, but we still think it's going to be up and to the right based on our market and our team.

[Operator:]

And our next question comes from Brett Rabatin from Piper Jaffray. Your line is open.

[Brett Rabatin:]

Wanted to ask, you had substantial growth in the capital call lines of credit business, but you did have better growth in software this quarter. So, I'm just curious, thinking about the pipeline for the next year, do you anticipate the capital call line of business continuing to increase in terms of the overall percentage of the loan book? And I know the debt and equity markets are very competitive, but as you look out, is there anything that might change that dynamic where you can be more fruitful in your growth in your other core business lines?

[Gregory Becker:]

Let me start, I'll just briefly talk about the private equity part of our business, the capital call lines. Then I'm going to ask Mike Ducheneaux to add commentary on the tech and life sciences. So, we continue to see growth in the private equity capital call lines and just the one point to remember is that that is such a larger market than the venture capital market. We still have market share upside there that we believe has the opportunities to grow for years to come. We have an incredibly strong team, differentiated service and feel really good about that. The other part is, it's very diversified when you think about the target clients that we have in that. These are firms going after -- they're fund to funds, they're buyout firms doing small to midmarket stuff, they are oil and gas, they are other natural resources. So, it's very diversified in a very healthy and growing market. And with our low market share we again still feel we have upside, but I'll let Mike talk about where we saw kind of the Q3 software technology growth and the outlook.

[Michael Descheneaux:]

Sure, thanks, Greg. So, Brett, when we think about where we've come, if you remember 2016 was somewhat of a challenging year with the recalibration going on. Growth as you've seen amongst our technology portfolio has been challenged. It's essentially been flat year-over-year. So, as we go into 2018, we feel really good about our pipeline and what's happening. And coupled with the fact that we've been hit quite a bit lately with M&A transactions as well which has held back some of our growth in the tech portfolio. As we go into 2018, I think you can definitely see some of these pipelines coming into turning into some loans there as well. The other thing to think and keep in mind is we also have the plans for Germany and Canada start to potentially come online next year as well. The rest of the global operations in the UK continue to do really strong as well, so when you're coming back to your first question which was essentially as a percentage of the total loan portfolio in the PES, will that continue to be the same or grow? It looks like it won't necessarily grow as percentage so much in terms of proportion to the entire loan portfolio because this year, or going into 2018, we expect robust growth from the other areas such as the tech. And then you add in private bank as well which is doing quite well and will continue to grow. So, I think certainly the pace of PES as an annual year-over-year growth will continue to be strong. But again, I think the other areas will continue to pick up as we move into 2018.

[Brett Rabatin:]

Okay, that's great colour on that. Then I guess I want to make sure I understood the guidance around the fourth quarter fee income. It sounded like, if I heard correctly, you are going to come in on the lower end of the high teens growth for the year and so in 4Q that would sort of mean kind of flattish to maybe slightly lower fee income. I want to make sure that wasn't the case, and would there be any pressure on lending fees that were really strong in 3Q or maybe even a little more colour on the overall number.

[Daniel Beck:]

On an overall basis, it is slightly up Q3 to Q4. At least based on where we see things right now. And you were correct in terms of the overall guidance and where we expect things to be for the quarter.

[Operator:]

And our next question comes from Jennifer Demba from SunTrust Robinson. Your line is open.

[Jennifer Demba:]

Question on the private banking efforts. Sounds like you're still in the early innings there. What percentage of your customers are banking with you in this area?

[Gregory Becker:]

So, this is Greg. I'll start and Mike may want to add something. It is a small percentage still. The one area we do have I would say higher market share is in the venture capital partners. I don't have the percentage right off the top of my head, but that's probably I would guess probably 25%, 30% market share there. But in the rest of the area, whether it's private equity or if you see it in our commercial client base, the technology companies and life science companies, that actually is on the smaller side. As I go back and think about my comments, that's why I made a point to say that I believe we're only scratching the surface. We're getting really positive feedback from our clients when we do approach them with the private bank, so we need to build out our team, we need to build out our capabilities, we need to build our digital platform. And with all those things kind of on the docket to happen, that's why we believe there's just a lot of growth potential in that part of the business.

[Michael Descheneaux:]

Jennifer, I'd just add, we have about 2,000 clients in our private bank, somewhere around there. And as Greg alluded to, we've done exceptionally well as far as connecting with the venture capital community in terms of the private bank. Where we see the opportunity is to connect even more with I would say the C-level suites of our technology companies. Which as you know, we have a lot more technology companies as well so much that we can grow that portfolio. So those are some of the areas that we'll continue to focus on as we go onto 2018.

[Jennifer Demba:]

How long do too think it will be before you can get these capabilities built out to where you'd like them to be?

[Michael Descheneaux:]

Just from a private banking side, so for example the core of what we do currently is with mortgages, right? So, it really is about just enhancing the relationships between our private bank and our commercial bankers in order to get that referral pipeline coming into the private bank as well too. So, we believe we have the basic product set that we need to do, it's more just on executing on the sales side of the equation.

[Operator:]

And our next question comes from Chris McGratty from KBW. Your line is open.

[Chris McGratty:]

Greg, maybe a question -- it seems like a couple of quarters ago we were asking you about needing capital or coming to the market for capital. But with obviously the good underlying earnings momentum and obviously the potential for tax reform, how are you thinking about potentially returning capital to shareholders over time?

[Gregory Becker:]

I'll start, Chris, at a high level. It is interesting how fast things change where it was not that long ago when people were asking us questions about capital raise. So, I think we look at it and say we are in a position now that we are obviously in a better position than we maybe ever have been. Or at least starting that trend. As far as how we think about that, we're just starting the discussion and starting to think through that and what that would look like. You wouldn't from my standpoint see anything that is going to happen in the next few quarters. But when you get towards, again, some of these things continue to perform, you'll probably hear us talking about it more in I would say probably Q3 or Q4. Not that something is going to happen then, but that we're starting to describe what it will look like. So, I would say just hold tight for a few quarters and we'll be able to share kind of our outlook when we get there.

[Chris McGratty:]

That's helpful, thanks. Maybe on taxes, you talked about the potential for a muni strategy in the investment portfolio. I would imagine you're going to wait until you get some clarity on taxes. And also, if you could, what should we be expecting for the tax rate notwithstanding any changes out of Washington?

[Daniel Beck:]

This is Dan. So obviously paying attention to what's happening in Washington and not going to execute on a large strategy until we have a view there. We have been investing already in municipal bonds as well as low income housing tax credits, so those things are there. And obviously that will be a thing that we would focus on should we get clarity of what's happening in Washington. In terms of overall effective tax rate on a go forward basis, the level that we're at, at least in the third quarter, is somewhat representative of what our run rate tax rate looks like. As we of course had in the first and second quarter, the overall equity compensation, impacts of the accounting change drove down that rate. So, you'll probably see a little bit more of that in the first and second quarter of next year, but the run rate effective tax rate is right now, absent that tax strategy, pretty similar to what we have in Q3.

[Chris McGratty:]

Great. And just to make sure I heard you, Dan, on the question about each 25-basis point, that $53 million, was that a net interest income or a net income pre-tax...

[Daniel Beck:]

That is pre-tax net income number.

[Chris McGratty:]

That doesn't factor into any kind of momentum that you're seeing in the CIF growth rate, right? That's in addition to that, is that right?

[Daniel Beck:]

That is a static view of the balance sheet.

[Operator:]

And our next question comes from Geoffrey Elliott from Autonomous Research. Your line is open.

[Geoffrey Elliott:]

There's been a few articles talking about capital call lending and private equity and specifically some concern that some funds have used capital call lines to enhance the IRR. Can you give us some thoughts around how long those lines are typically drawn for by you clients and whether you think there is any regulatory risk there or risk of changes in borrower behaviour?

[Marc Cadieux:]

This is Marc Cadieux, I'll take that. So, there's a couple of questions wrapped up there. First is that we are aware of that commentary from representatives of the LP community about private equity funds using capital call lines to improve the return of their funds. This isn't new phenomena. It's something that's been talked about before. As far as we can tell, it's not a concern or a commentary that's getting any traction in terms of a change in behaviour. That's the first thing. Second, on average, borrowings from private equity funds still remain relatively short. Advances tend to be out on average between 180 and 270 days. And while longer than what venture capitalists borrow, it's still relatively short-term borrowing. The last question, I think this is reflected in our guidance and some of the earlier comments, is we do not anticipate any meaningful noticeable behaviour change among private equity funds and how they utilize capital call lines of credit.

[Geoffrey Elliott:]

Thanks. Then just to clarify on one of the questions earlier, within loan growth, are you still expecting private equity and venture capital overall to grow faster than the rest of the portfolio but still expect it to gain share within total loans?

[Gregory Becker:]

This is Greg. As Mike described, we do believe that the other parts of the business, private banking, the core tech and life science part of the business in global, will pick up from where it's been a little bit slower, especially the tech side, so that it could be in balance with the percentage of the portfolio, it may stay in line. That being said, we have as you know, for the last several years seen stronger growth in private equity services, in the private equity part of the business. And that could continue and we're comfortable with that. So, we're comfortable if the 42% goes up to a higher number. In our plans we don't have it playing out that way, but if it does, because it could be very robust as it has been, if it goes higher, we'd be comfortable with that.

[Operator:]

And our next question comes from Tyler Stafford from Stephens Incorporate. Your line is open.

[Tyler Stafford:]

Just sticking with the capital call lines, do you have the percentage breakdown between PE and VC of the capital call book? And what the average new production yields out of which of those are?

[Marc Cadieux:]

Sure, it's Marc again. So, in terms of the funded balances, it's an 80/20, 80% private equity funds, 20% venture capital. And we think just relative to where the growth is coming from, that we'll continue to see it tilt towards private equity more so than venture capital. With regard to your question on the interest rate on those, for the portfolio overall, it's in the low to mid 3% range with roughly about a 40 to 50 basis point speared between private equity and venture capital, i.e., the private equity tends to be about 40 or 5 basis points lower on average than the venture capital funds.

[Tyler Stafford:]

Thanks for that, Marc. With the growth that you've seen out of that book, it's now I guess what 42% or so of the total, and given just the fact that you've had no losses virtually out of that portfolio the last decade, and then with the credit profile of the private bank loans, should your reserve methodology begin to loosen on the overall portfolio to where you could actually see a lower overall allowance for loan losses to growth performing loans?

[Marc Cadieux:]

So, in some respects you've already seen, not from a methodology standpoint, but in terms of the continued improvement in composition, from the growth coming from primarily our lower risk segments of the portfolio. You've seen that reflected in the loan loss reserve in terms of where it is now at that 112 basis points. Certainly, can't rule out the possibility that it could go lower if composition were to continue to improve, but having said that, there are, I think as recognized, we have pretty strong credit quality at present. So, while possible, it's certainly not an expectation that we would see it drift meaningfully lower.

[Michael Descheneaux:]

The only one thing I would just caution, obviously it depends on the economic environment as well. Whether it's with respect to credit quality and similar to our comments on the growth side as well too. But all things being equal, you should start to see some improvement if we continue to grow the private equity portfolio as Marc described.

[Tyler Stafford:]

Okay, thanks for that, Mike. And then just last one for me, if I'm doing the math correctly, the mid-teens expense guide for 2017 implies 4Q expenses are down sequentially from 3Q levels using that $860 million base for 2016. Am I thinking about that correctly?

[Daniel Beck:]

As we look at the overall expense guidance, as we said back in the second quarter, we thought that run rate levels, excluding some of the one-time items, would be in that $245 million to $250 million range. If you back out some of the nonrecurring items in the third quarter, we'd be in a similar spot. So, we'd expect the business as usual run rate to be a little bit lower assuming that market conditions remain the same in the fourth quarter.

[Tyler Stafford:]

And just to be clear, you are using the $860 million base for 2016, correct?

[Daniel Beck:]

That is the base roughly.

[Operator:]

And our next question comes from John Pancari from Evercore. Your line is open.

[John Pancari:]

On the yields, the yield that you just gave for the PE and VC capital call portfolio, is that the average yield or the new money yield, that low to mid 3s?

[Marc Cadieux:]

That was the average yield and I should point out it's an interest only yield, not inclusive of fees.

[John Pancari:]

Okay. And the new money yield, is it near that rate?

[Marc Cadieux:]

Yeah, it's pretty close, yeah.

[John Pancari:]

Okay, then the same question for the other large portfolios if you could, particularly around the maybe early stage and later stage and then buyout portfolios for example?

[Gregory Becker:]

Sure. So early stage, and here I'll just broaden that a bit to be investor dependent, early stage and later but companies that are still burning cash, still dependent on raising capital. The interest only yields there tend to be higher. They can range from 5% to as high as 7% or 8% and then in some segments of our portfolio can get into low double-digit territory on occasion. Moving to sort of the I'll say larger end, larger corporate, there you see rates that are more reflective of prime. And on average a little bit under that. And then finally you asked about sponsor buy-out, and their yields then to be the interest yields tend to be LIBOR plus 400 give or take depending on the deal profile.

[John Pancari:]

Great, thanks. Then secondly, on the bond portfolio, just want to again get your plans for the bond book. You're looking to put more liquidity to work and at 40 -- what are you looking at, 47%, 48% of assets now, what's your longer-term target for the overall size of that book?

[Daniel Beck:]

It's obviously dependent upon the overall liquidity position, but we don't expect any major changes to the overall composition and size of the investment securities portfolio. The only thing could be, as we look at the tax strategy, potentially reallocating a portion of that investment portfolio to more tax advantaged investments. But generally speaking, we've talked about it in the past, the primary purpose of that portfolio is for liquidity purposes and we generally think it's going to look the same in the future.

[John Pancari:]

Okay. Then on that topic, what's the updated duration for that book and what's the updated monthly cash flow coming off it?

[Daniel Beck:]

The overall duration is 2.7 and the overall cash flow coming off of that is about $1.2 billion a quarter.

[Operator:]

And our next question comes from Chris York from JMP Securities. Your line is open.

[Chris York:]

LCD reported that you let a $102 million credit facility to Donuts to acquire Rightside Group in the third quarter. So, my question is twofold. First, what does the pipeline look like for those type of large transactions? And then two, maybe can you give us some colour on how to think about the trajectory for lending fees given the big increase in the quarter?

[Gregory Becker:]

I'll start and others may want to weigh in. First, as you would appreciate, not intending to comment on specific clients and specific transactions. Generally speaking though and thinking of the several-year journey we've been on to improve our syndications capabilities, you do see that reflected in terms of our ability to hang onto and serve clients longer. And of course, one of the ways that you do that is by being credible in the syndications market, able to agent deals and bring other lenders into it. And I feel that we've come quite a long way over the last several years in that regard.

[Daniel Beck:]

And I'll piggyback on that in terms of the overall lending fees. We mentioned in the earnings release as well as comments that we had an adjustment in the lending fee line item which was for the unfunded commitments. That, at least on a go-forward basis won't be there, at least in the size it was in the third quarter. So that was for about $4 million.

[Chris York:]

Got it, that colour is very helpful. That's it for me. Thank you.

[Operator:]

And our last question comes from David Chiaverini from Wedbush Securities. Your line is open.

[David Chiaverini:]

You mentioned the VC investment environment in the third quarter was mixed with the dollar in deals declining in the quarter. What type of VC investment and fundraising environment are you assuming that underpins your 2018 guidance?

[Gregory Becker:]

This is Greg. Just to clarify, it is true that the number of companies were down slightly. The dollars were down modestly. I think it was $22 billion down to $21 billion, so I would say very healthy markets in Q2 and Q3. I think if you look at that as a run rate basis, we would expect that things remain consistent with that as an outlook. So, it remains at that level, maybe a slight improvement. That's what our outlook is based on.

[David Chiaverini:]

Thanks. Then shifting gears, curious about the roughly $6 billion of money market deposits that you have on the balance sheet. How much of that is from your private bank and wealth management clients?

[Gregory Becker:]

This is Greg. Very little. When you think about it, the total deposits that we have from private bank clients is in the overall scheme of things, when you look at the full $100 billion of total client funds roughly, it's small overall. And obviously the money market would be a small subset of that.

[David Chiaverini:]

That makes sense. That's probably why the beta is staying so low. Thanks very much.

[Operator:]

That concludes our question and answer session. I would now like to turn the call back over to CEO Greg Becker for some brief closing comments.

[Gregory Becker:]

Great. Thanks. I just want to thank everyone for joining us today. I'm incredibly proud of the record results we were able to describe to you and share with all of you today. It's easy for us to sit in this room and to share our numbers with you, but at the end of the days, it's not us. It's the 2,500 employees that we have around the country and around the world who do such an amazing job every day for our clients. You just think about the results over the last few years, they truly have done an incredible job, so I just want to thank all of them for their efforts. I also, as I have in prior calls, want to thank our clients. As I get to spend more time out in the market, with Mike taking on the President role, it is truly thrilling and I've said this all the time, I do believe I've got the best Bank CEO job in the world because we've got great employees and we have the best clients. We don't take that lightly. We truly appreciate the trust they have in us and that's really what has fuelled not only our success over the last several years, but it's why we're optimistic about our outlook. So again, I just want to thank everyone for joining us, great to deliver the results, and have a great, great day. Thank you.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.