SVB Financial Group
Q1 2016 Earnings Call Transcript

Published: 22 Apr 2016

[Operator:]

Welcome to the SVB Financial Group Q1 2016 Earnings Call. My name is Adrian and I will be your operator for today's call. [Operator Instructions]. I will now turn the call over to Director of Investor Relations Meghan O'Leary. Miss O'Leary, you may begin.

[Meghan O'Leary:]

Thank you Adrian and thanks everyone for joining us today. Our President and CEO, Greg Becker and CFO Mike Descheneaux are here to talk about our first quarter 2016financial 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 will 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, may be found in our SEC filings and in our earnings release. We will limit the call, including Q&A, to an hour. And with that, I will turn the call over to Greg Becker.

[Greg Becker:]

Thank you Meghan and thank you all for joining us today. We delivered a solid quarter in terms of our core business, with earnings per share of $1.52 and net income of $79.2 million. These results were marked by robust loan growth and healthy fee income. At the same time, downward pressure on valuations and investments resulted in lower securities and warrant gains which impacted EPS for the quarter. Mike will get into details of the quarter shortly. I'd like to talk primarily about the environment we're in and how we're thinking about it. In the simplest terms, we believe the VC markets are experiencing a healthy shift, one that comes with near term challenges for some companies but is positive overall. We have been talking about valuations and [indiscernible] for several quarters and we're not really surprised about what we're seeing. We believe there is still much to be optimistic about and we remain positive about our clients and our outlook. Let's start with the state of the markets. The economic landscape is unsettled. While concerns of a recession appear to have receded somewhat, market sentiment and the economic outlook seem to change day to day. The interest rate outlook is equally unclear and we're not counting on help from rates this year. The tech markets seem to have calmed somewhat following a volatile first quarter, sparked by a long buildup of fears over a possible unicorn bubble. While those fears may have been overstated, valuations have pulled back and capital is tightening, especially for early-stage companies. The IPO market was all but closed in the first quarter for tech companies which had zero IPOs compared to only six life science companies, making this the slowest quarter for IPOs since the third quarter of 2011. VC investment overall remained relatively robust, although the number and dollars of investments in seed and early-stage companies spell approximately 20%. So the VC and IP markets are somewhat challenging, but there are bright spots as well. First, entrepreneurs and investors are beginning to replace the growth at any cost mentality that led to high valuations of recent years with a focus on profitability and slower burn rates. This shift in focus, as well as more reasonable valuations, should make the private market healthier overall. Second, we're seeing our clients in general deliver on solid revenue growth, helped by strong demand for their innovative products and solutions. Third, after a long period of robust fundraising, VCs have substantial amounts of capital to invest, alongside many new sources of non-venture capital. This is the opposite of the situation VCs and entrepreneurs faced in 2008. This ample capital should ensure good companies will still be able to get funding. And fourth, while the IPO markets may remain weak for some time, lower valuations could drive an increase in M&A by corporates and private equity firms. This is a dynamic we saw emerge during the 2008 recession. In short, we see a healthy re-calibration and not the beginning of a material downturn. While the markets may slow for a few quarters as investors and entrepreneurs evaluate their next steps, we believe this is likely to be a beneficial period of adjustment. Nevertheless, we believe continued slow early-stage VC investment and a dormant IPO market could affect us in three potential ways. More investor dependent companies may fail and we could see more early-stage charge-offs as a result, although these are not unusual in any environment. If that happens, we believe these charge-offs would be manageable, because our early-stage loans tend to be small and make up only 6% of our loan portfolio. As you know, we have been mindful of overheating in the credit markets for several years now and have chosen to walk away from deals that do not fit our risk appetite. Slower VC and IPO markets could result in a slowdown or pullback in deposits. However, slower burn rates, increased focus on profitability at our client companies and a healthy new client growth may help to offset this risk. VC and warrant gains would probably be pressured as we saw in the first quarter, especially if the IPO market remains weak. These are potential challenges, but we believe our business environment remains healthy and we continue to see strength and momentum in key areas. For instance, we had excellent client growth during the quarter, adding roughly 1000 new company clients which is just below our average of 1100 per quarter in 2015. Demand for loans remains healthy, driven primarily by our highest credit quality segments, private equity and private bank and any tightenings of equity capital could lead to increased utilization on credit facilities of our other clients. Our fee business continues to grow due to our focus on expanding our client base, growing globally and cross-selling. These efforts have helped drive compound annual growth rates of more than 25% in both foreign-exchange and card revenue over the last three years. As we'll see in our forecast, we expect strong growth to continue. We continued to make progress in our payments platform. We marked a major milestone in the first quarter, partnering with Stripe to provide banking service for its new Stripe Atlas platform which allows entrepreneurs to start a global Internet business from anywhere in the world. This new program has gotten a tremendous global reception and we expect the Stripe Atlas relationship to be a fantastic new banking origination channel for SVB. We're very excited to be a strategic partner with Stripe. Globally, we announced plans to expand our fast-growing branch in London. SVB has become a vital partner to companies in that thriving ecosystem in a very short time and the branch just crossed $1 billion of funded loans. All of these things make us optimistic about 2016. We're thinking much bigger and longer term about our future and we're making significant changes to our business so that we can take advantage of the opportunities we see. To that end, as you know, we made a number of changes to our organization structure last year, specifically appointing Bruce Wallace as Chief Digital Officer, hiring Mike Dreyer as Chief Operations Officer and Roger Leone as Chief Information Officer. These changes are designed to support expansion of our payments and digital efforts and growth as a globally scalable business. And they are part of a conscious, long-standing commitment to investing in people and enhancing our processes and systems so that today, we're more sophisticated, adept and resilient organization than we ever have been. For now, we're keeping a close eye on our clients and the shifting conditions of early-stage companies, while maintaining our focus on effective execution regardless of the market environment. While the environment is more challenging as investors and companies adjust to new realities, our view is that this is a moderation rather than a material correction. We continue to believe whatever shifts the innovation space makes in the near term, it offers tremendous opportunities in the long term and is the best possible place for us to be. Thank you and now I'll turn the call over to our CFO, Mike Descheneaux.

[Michael Descheneaux:]

Thank you, Greg and good afternoon everyone. As Greg pointed out, we had a solid quarter despite a slower pace of early-stage funding, lower public market valuations and fewer exits. Specifically, we saw a significant decline in net gains from warrants and investments in private equity and venture capital which impacted EPS in the quarter. The items I will cover in detail include the following. First, loans which grew significantly. Second, a modest decline in total client fund balances. Third, higher net interest income and net interest margin. Fourth, healthy overall credit quality despite some stress in the early-stage portfolio. Fifth, lower warrant gains and modest investment securities losses. Sixth, higher core fee income. Seventh, lower expenses and finally, increased capital levels. Let us start with loans. Average loans grew by $1.3 billion or 8%, to a record high of $17 billion, driven by growth in private equity capital call lines during the first quarter and the impact of strong loan growth in the fourth quarter of 2015. Period end loans grew by $993 million, to $17.7 billion, as we saw those fourth quarter loan balances hold, although we could see some runoff of capital call lines in the second quarter. Now let us move to total client funds. That is combined on balance sheet deposits and off-balance-sheet client investment funds. Average total client funds decreased by $600 million or less than 1%, reflecting average deposit growth of $400 million or 1% and a decrease in off-balance-sheet client investment funds of $1 billion or 2.2%. Period end total client funds decreased by $2.1 billion or 2.6%, reflecting a decrease in period end deposits of $383 million or 1% and a decrease in off-balance-sheet investment funds of $1.7 billion or 3.9%. These decreases were the first we have seen since 2009 and reflect three primary drivers during the quarter. First, M&A activity by and of our growth and corporate finance stage clients were the primary drivers of the decreases in off-balance-sheet client investment funds. Second, inflows from our early-stage clients from equity funding rounds drove the increase in average deposit balances, although that impact was offset somewhat by a modest runoff in private equity balances, following a strong fourth quarter due to distributions by our clients. And third, efforts by our corporate finance clients to take advantage of higher-yielding off-balance-sheet investments were the primary driver of lower period end deposits balances. While we could see tempering in client fund flows if early-stage investment continues to slow and the IPO markets remain dormant, as Greg pointed out, slowing burn rates and strong new company acquisition could offset these impacts. In any case, it is too soon to declare a trend. Turning to net interest income and our net interest margin. Net interest income on a tax equivalent basis increased by $12.3 million or 4.6%, to $282 million in the first quarter, due to strong loan growth and the impact of the increase in the Fed funds rate in December. Interest income from loans increased by $12.5 million, due to higher average loan balances. Loan yields increased by one basis point, reflecting an increase of 8 basis points in gross loan yields due to the full quarter impact of the Fed funds rate increase which was offset by a decline in fees from early loan payoffs. Average fixed income securities decreased modestly, $184 million, to $23.4 billion, due to the sale of $1.9 billion of treasury securities to support our loan growth and cash balances. As a result, interest income from investment securities was essentially flat in the first quarter compared to the fourth quarter. Our net interest margin increased by 13 basis points to 2.67%, primarily due to growth in loans and the full quarter impact of the Fed funds rate increase in December. Now let us move to credit quality which remains healthy overall. Given the slower pace of early-stage funding, it was not surprising that we saw some stress in our early-stage portfolio. We also saw higher criticized loan balances from a handful of larger loans. However, these were not driven by any overarching trend. Overall, credit quality is performing as we expected. Total loan loss provision was $33.3 million in the first quarter, compared to $31.3 million in the prior quarter. This amount reflected approximately $9.5 million due to loan growth, $20.7 million related to net charge-offs and a $3.9 million increase in reserves. Net charge-offs were $20.7 million or 49 basis points, compared to $11.2 million or 28 basis points in the fourth quarter. This reflects $26.2 million in gross charge-offs, of which 60% came from early-stage loans, with most of the remainder from one loan to a later stage e-commerce company. Net charge-offs also reflect $5.5 million of recoveries, primarily related to the repayment of a loan that became impaired in the fourth quarter of 2014. Nonperforming loans decreased by $9.4 million, to $114 million or 64 basis points, compared to 73 basis points in the fourth quarter. This improvement was primarily driven by the resolution of two loans, the loan recovery I just mentioned and a sponsored buyout loan that became impaired in the third quarter of 2015. The sponsored buyout loan was repaid in full with no charge-offs and resulted in a reserve release of $7.2 million. These resolutions were offset by the addition of 10 nonperforming loans that were mostly in the early-stage portfolio. These loans tend to be quite granular and this level of new early-stage nonperforming loans is consistent with prior quarters. The two other sponsored buyout loans that became nonperforming in 2015 appear to be on a path to improved performance. Criticized loan balances increased to 6.1% of total gross loans, compared to 5.5% in the fourth quarter. This increase was driven by a handful of larger loans, each of which became criticized for reasons specific to the borrower. We do not expect significant migration of these loans to nonperforming or charge-offs. Our allowance for loan losses held steady at 1.29% of total gross loans. Our allowance for loan losses for performing loans increased 2 basis points, to 1.01%. And finally, the allowance for loan losses for nonperforming loans decreased by $1.4 million, to $50.4 million, reflecting $11 million of reserves for new nonperforming loans. Offset by the reserve release from repayment of the sponsored buyout loan noted earlier and $5.2 million of other reserve releases related to charge-offs and loan repayment. Now let us move to no-interest income which is largely composed of core fee income and net gains and losses from warrants and investment securities. I will discuss certain non-GAAP measures in my comments and we encourage you to refer to the non-GAAP reconciliations in our press release for further details. GAAP non-interest income was $86.1 million, compared to $114.5 million in the fourth quarter. Non-GAAP non-interest income, net of non-controlling interest, was $88.8 million compared to $111.8 million in the fourth quarter. The decrease in non-interest income in the first quarter compared to the fourth quarter was driven by a modest net loss on investment securities and lower gains on warrants, primarily related to valuation pull-backs for public companies and a lack of VC-backed exits. This was the lowest level of combined net warrant and securities gains, excluding the volatility we saw in 2014 from one company, since the first quarter of 2012. Losses on investment securities, net of non-controlling interest, were $2 million compared to net gains of $9.6 million in the fourth quarter. This reflects $3.9 million of losses related to unrealized valuation decreases tied to a decrease in market prices of public positions held by certain of our funds of funds. This was partially offset by $2.4 million of realized gains in our strategic funds driven by distributions. Other components included $2.2 million of losses on sales of exercised warrant securities that were subject to lockup agreements during the first quarter's public market decline, offset somewhat by a $1.4 million gain from the sale of treasury securities which I noted earlier. We had warrant gains of $6.6 million, compared to $16.4 million in the fourth quarter. These were primarily realized gains from warrant exercises due to M&A among our clients. We had only $400,000 in valuation gains compared to $12 million in the fourth quarter, due to the pullback in valuations overall. Core fee income was $76.5 million, an increase of $3.8 million or 5.2% over Q4. As a reminder, core fee income includes foreign exchange, credit cards, letters of credit, deposit service charges, lending related fees and client investment fees. This increase was driven primarily by foreign exchange and client investment fees. FX income was solid at $27 million. While the increase compared to Q4 was primarily driven by a reclassification of fees on forward contracts previously reflected in gains and losses on derivative instruments, we were coming off a record quarter in Q4 in terms of volume and revenues. FX income is up 50% compared to the same quarter in 2015. We saw a 29% increase in client investment fees, to $8 million, due primarily to money fund rate increases in our client investment funds which were supported by an increase in short term rates. This represents a 78% increase over the same quarter in 2015. Credit card and payment income was $15.5 million in the first quarter, modestly below our fourth quarter income which was a record high. Nevertheless, first quarter 2016 credit card and payment income increased 28% over the same quarter in 2015, attesting to our continued momentum in implementing our credit card and payment strategy. Moving on to expenses. Non-interest expense decreased by $4.6 million or 2.1%, to $204.1 million. This decrease primarily relates to a decline in incentive compensation levels and seasonality in Q1 expenses. Incentive compensation was $10 million lower in comparison to higher than normal fourth quarter levels, driven by our strong 2015 performance. Professional service fees decreased by $5 million, reflective of changes due to timing of certain projects. These decreases were offset by an increase of $3.5 million in salaries and wages reflecting higher average FTE and $5.7 million of seasonal expense related to 401(k) matching and employer payroll taxes. Turning to capital, our capital position remains healthy due to solid earnings and we saw increases in all key capital ratios. Our bank level tier 1 leverage ratio increased by 10 basis points, to 7.19%, due to earnings and tempered average deposit growth in the first quarter. Our risk-based capital ratios, that is total risk-based capital and tier 1 risk-based capital, increased at the bank and the holding company levels by approximately 6 basis points. We continue to closely monitor the trend in our capital ratios and in particular our bank level tier 1 leverage ratio, for which our target range is between 7% and 8%. If deposit levels continue to temper, assuming no material changes in the economic environment or business conditions, we do not believe we would have to raise capital in 2016. If we were to see a return to deposit growth trends of past quarters or other changes in our capital position, we believe we have some options that we could pursue before raising capital. However, if we did raise capital to support our growth at some point, they we consider preferred equity as an option. Moving on to our outlook. We're making one improvement to our full-year 2016 outlook and that is the narrowing of our expectations for loan growth from our original range of the high teens to low 20s, to just the low 20s. Additionally, I would like to provide color on two of our outlook items, to give you a better idea of how we think they may trend during 2016. First, we believe deposit growth is likely to be near the bottom of our outlook range of the low double digits, due to a slower pace of early-stage funding and fewer exits. Second, continue pressure on valuations and a tough exit environment could mean more early-stage loan charge-offs and reserves, similar to what we saw in the first quarter. While these levels are not exceptional, they could mean that we could see full-year 2016 net charge-offs closer to the top of our outlook range of 50 basis points of average total gross loans. Furthermore, we could also expect to see loan loss provision levels for the rest of the year, on average, in line with the first quarter, although I am not suggesting that they would be identical from quarter to quarter. Finally, while we do not provide an outlook for net gains or losses from warrants and investment securities, I want to remind you that we expect lower early-stage investment levels, downward pressure on valuations and a slower pace of exits to put considerable pressure on gains from warrants and investment securities in 2016. In closing, we delivered a solid quarter in terms of our core business. We believe the slower pace of early-stage investment in Q1 and the ongoing re-calibration evaluations are healthy developments. While our early-stage clients may feel the impact of this shift more than others, our clients overall appear to be doing well. Nevertheless, we're paying close attention to the market shifts we saw in the first quarter and monitoring their potential impact. We expect our experience in the innovation industry, our multiple touch points with clients and investors, as well as our insight into our clients' businesses, will serve us well. In the meantime, we remain focused on delivering high quality growth and maintaining stable credit quality. While we're mindful of the challenges presented by the environment in which we operate, the economy and the regulatory landscape and we believe we're well positioned. Thank you and now I will ask the operator to open the line for Q&A.

[Operator:]

[Operator Instructions]. Your first question comes from Steven Alexopoulos from JPMorgan. Please go ahead.

[Steven Alexopoulos:]

I wanted to start on the capital calls, looking at the very strong growth in capital calls above $20 million which I assume were mostly private equity. Could you give more color on what drove that magnitude of growth this quarter? And was it funds investing outside of tech?

[Greg Becker:]

So Steve, it's Greg. I will start and then Mark is going to add some additional color. It was pretty broad based. It was private equity, I guess first and foremost, that was the main driver. It was both new clients. It was also utilization rates increased. And as you know, what we have been doing over the last three or four years is, it's been broadly going after private equity in technology but also in non-technology. And we just saw deal activity in the first quarter actually be stronger than even we expected.

[Michael Descheneaux:]

Yes, I think that covers it, Greg I have nothing to add.

[Steven Alexopoulos:]

Okay. And then in terms of customers adjusting cash burn which came up a couple of times, how widespread is that currently within your customer base?

[Greg Becker:]

So Steve, it's Greg again. I guess there's two ways to look at it. One is what we're hearing when we talk to the venture capitalist. And as you know, we spend -- we probably had more interactions with venture capitalists than anybody else. And obviously, in the first quarter, we talk to them a lot about, what is their outlook and what advice are they giving to their companies? And a lot of that advice came back that we're hearing, it is focused on lowering cash burn, get to profitability, try to raise capital so you really don't have to go to the market, if you have to, for 12 to 18 months and so we're hearing that pretty consistently. Now, some companies that are truly -- they're doing so well they really don't have to worry a whole lot about fundraising or valuations. We're not really seeing a major change. But then you look at our operations and our flows of dollars. We're starting to actually see it a little bit. I would expect that to continue to happen in Q2. So it is real and it is pretty broad based from the standpoint of what people are doing and how they are operating in this environment.

[Steven Alexopoulos:]

Okay. And Greg, related to that, when we think of inflows into deposits, we think of new clients. Right? And you mentioned 1000 new company clients this quarter which is really not that far off. Am I missing something? Or has the new company formation trends really have not declined by that much yet?

[Greg Becker:]

They haven't changed a whole lot, Steve. I'd say if you look back over the last three or four quarters, our high water mark, on a quarterly basis, was just under 1300. So from that high water mark, you've definitely seen a noticeable difference. But it was a little low in the first quarter, then it ramped up in the second quarter and then it trickled down. But I agree with you. When you look at the new client additions, it's really not that far off and my crystal ball would say it is going to be in that range for the next several quarters. And part of that is driven by the fact that you are seeing a decrease in that early-stage funding, number one and new Company investments. But it's also, on the positive side, driven by the fact that we now have a bigger footprint, right? We have a bigger footprint in the UK. We have a bigger footprint in the U.S.. We have more feet on the street and that helps us. So there's a positive side with our ability to bring in new clients despite the market, but it's also -- has a little bit of a headwind by the fact that there's less funding going into that early-stage, as well.

[Operator:]

And your next question comes from Jared Shaw from Wells Fargo. Please go ahead.

[Jared Shaw:]

When you look at the early-stage book can you tell us what done with the reserves on early-stage has that been increasing over the quarter as well and where do they stand now compared to the balances?

[Michael Descheneaux:]

Sure so this is Mark. So we have seen I think we alluded to at the distress in the early-stage we have seen an increase in criticized early-stage loan. And with the increase in criticized comes higher level of formula reserves.

[Jared Shaw:]

And when you look at the increase in the criticized, are you just saying since there's stress and the whole lifecycle we're going to make more of a methodological change to the evaluation of these loan services on a loan by month basis we're actually saying more of the migration criticized.

[Michael Descheneaux:]

So we have seen am I correct duration into criticized which is the first thing. As far as the methodology change, no. We continue to have the same loan methodology for early-stage we always had. Again the migration criticized comes higher level formula reserve.

[Greg Becker:]

Jared, what I would add on to that is what Mike tried to do in his opening comments is a couple things. One is we reiterated our expectations for net charge-offs in that 30 to 50 basis point range more toward the higher end of that and that will be driven by early-stage, that’s hoping to give a guy more context. And the second part is he also commented the fact that if you look at the first quarter from provision perspective and you then look at that number $33 million you could say that the next three quarters our view would be in that range although he was very clear to point out that obviously it wouldn't be that streamlined to each quarter it ends up being that but I think on average that's really what we expect to see and preponderance of that higher level of provision from what we've seen over the 2015 relates to early-stage.

[Jared Shaw:]

Okay. And then as you look at your markets and especially the international markets maybe outside of London are you seeing any greater weakness in those secondary tech markets? Or is it pretty similar throughout the footprint?

[Greg Becker:]

This is Greg again. It is pretty similar. We have had very strong growth strong numbers in the UK as I mentioned in my comments. We have seen good new client acquisition in Asia. So it's pretty consistent across all the markets.

[Operator:]

And our next question comes from Ken Zerbe from Morgan Stanley. Please go ahead.

[Ken Zerbe:]

I guess probably a question for Mike. In terms of the NCO [ph] guidance they gave the 30 to 50 right, you're going to be at the high end of that range, but this quarter you were 49. I guess I'm just wondering what's the thought process because if you are already at the very high end of the range it kind of implies your losses on average around here maybe a little lower. But I guess the concern the market has this the loss continue to take higher. Can you just help us understand like why not raise the range or what are you seeing that may keep that sort of within that range? Thanks.

[Marc Cadieux:]

So it's Marc, I'll take this one. While at the 49 basis points for the first quarter important to point out two things that were true about the first quarter experience. The first is that we have one larger loan which unlike the fourth quarter which was entirely early-stage, this one large loan was almost a third of the charge-offs for the quarter. So that would be the first thing. And then the second thing is there was one larger early-stage loan in the population of early-stage charge-offs in the first quarter. Those two things together I think skew the first quarter relatively speaking from what normal or normal for 2016 might look like.

[Ken Zerbe:]

Okay. And then just the other question was in terms of -- I think you guys mentioned about deposit outflows was corporate finance clients taking advantage of higher grades elsewhere. Did that happen throughout the quarter? Was there any big lumpiness? I'm trying to figure out A, how meaningful was that particular case and are we done with that batch of outflows so to speak?

[Greg Becker:]

This is Greg. I will start and Mike may want to add if you look at the mix of total client funds we actually continued to see strong numbers at that kind of early mid-stage. When you got to the gross stage and later to include corporate finance and private equity services that’s actually where you saw the outflow of deposits. And it's for different reasons. The one reason you'd see in the later stage companies that were acquired that actually happened to have fairly sizable balances on the balance sheet, number one. Number two you had some of the corporate finance clients that we had that actually made acquisitions and took excess cash to actually make the acquisition and so it declined from that. The third one is you had distributions which means you had a lot of gains by some of the private equity firms and venture capital firms but then they paid out to limited partners as distribution. So it was a combination of those things that really drove the change in total client funds. Now your second question is which we think is going to happen? Again there's two parts to that. On the early-stage if the early-stage slows down more you could see some pressure or some slowness in that area again but we didn't see that in the first quarter. And we don't know yet on the corporate finance side if what the behavior I described either acquisitions going on and companies using up excess cash or companies getting acquired is going to make a meaningful dent. When I made that comment is there are some potential areas of headwinds but there's also positive signs in a sense of burn rates are coming down. Companies are focused more on profitability and again we have done a good job of new client acquisition. So that's kind of the whole context, whole picture when we think about the outlook for deposits in total clients funds.

[Operator:]

And your next question comes from Ebrahim Poonawalla from Bank of America. Please go ahead.

[Ebrahim Poonawalla:]

So I guess first question just in terms of if you can talk about the competitive landscape both from a lending and deposit side. I guess given what's happened in the last 6, 9 months, how has that impacted in terms of maybe increased opportunities on the lending side and likewise from a customer acquisition standpoint how you see some of the fringe players pull back, has created more opportunities?

[Greg Becker:]

When I think of the competitive landscape we have been saying for as you know the last several quarters that higher valuations and just activity levels we're paying more attention to where we want to lend, where we don't want to lend and what risk profile we want to take. We have seen over the last quarter or two that we have looked at certain business models, some in the consumer area and a few other ones that we’re just a little more cautious on because of the environment for fundraising and what's happening. What we have been surprised by I would say I have been surprised by that the competitive landscape I guess hasn't got a memo that things have changed a little bit. And from that standpoint we're still saying very aggressive terms and it's interesting not only aggressive terms and structure but aggressive terms on pricing. So we're still winning strong amount of new clients. But we’re also I would say probably losing more and it's not that there aren't opportunities it's more because we have chosen not to step up to the terms that others are willing to provide in the market.

[Michael Descheneaux:]

I think the only thing I would add there would Ebrahim, is that the demand is clearly there. But the demand sort of falls into maybe three broad buckets. It's refinancing debt taken on over the last couple years that we would look at say that's just too much debt in environment level on this one or it would be companies seeking debt in order to postpone their day of reckoning perhaps where it's a Company that's overvalued and those that might be facing a down route if they were to raise again. And then there's the last grouping of what I'll call quality opportunities and it's the quality opportunities that I think as Greg noted I too have been surprised at just how remarkably competitive it's been for that subset.

[Ebrahim Poonawalla:]

I guess on the second question and I appreciate you all not wanting to give a guidance on the warrant or securities gains. Is there action in the public market when we see sort of recovering the stock markets and sort of IPOs coming back recently, is that a good cross feed into what -- how the behavior of your warrant and securities gain might be or is it to detach from what's happening in the private markets and we shouldn't read into that signal of potential improvement for you?

[Michael Descheneaux:]

Obviously I think any improving public markets are actually very good for our clients, our warrant portfolios, our investment portfolios. I mean certainly in terms of valuation and certainly in terms of M&A exists or if the IPO markets return. So yes if you start to see a buying of that or improvement on that then we could intentionally see some improvements in the warrant gains and investment gains. And as you have clearly seen Q1 was just a dire quarter. It just was very limited M&A and certainly just no IPOs really to recognize but again things can change quickly. We all know that and we do have a lot of warrants. We have warrants in some 1600 companies so all it takes a handful of M&A activities, and then you're right back on to having some interesting gains and similarly on the investment side as well.

[Greg Becker:]

The only thing I would add on to it is the added upside is that in the investment portfolio we have certain amount of investments that are held at cost from an accounting perspective and obviously the market value is still even if it pulls back a little bit is still roughly $100 million of valuation difference and so it's those companies sell as those companies or those funds become liquid even more depressed market there's still more upside. But when are those going to happen and what's the timing, as you know that's why we don't give guidance on a quarterly basis because it's really too difficult to predict.

[Operator:]

And the next question comes from Joe Morford from RBC Capital. Please go ahead.

[Joe Morford:]

I guess my first question was just a follow-up to that last one. Marc, did you say you are saying more companies turn to the bank for financing their growth as opposed to say doing a down round and so you suggest that's kind of business that you are leery of taking on it at this point?

[Marc Cadieux:]

So I'm going to break that question into two pieces, Joe. I think there is potentially demand for assistance with financing growth, right. Working capital financing but that would probably be in the bucket that has been more in the hypercompetitive. And then there's the second category were I'd say it's not necessarily to finance growth it's debt to avoid equity. And it's that second category where again they are looking for a large leg of debt to replace the equity financing that probably is the right answer for the Company but they don't want to go there because of valuation or other reasons that we're particularly leery of.

[Joe Morford:]

And then I guess Mike you mentioned the payments and credit card fees were up 26% year over year. What's been the biggest driver to that activity and how do you see that growth rate kind of going forward?

[Michael Descheneaux:]

So I will go ahead start and Greg will probably add on to it. I mean certainly the credit card aspect of it has been a key driver and as we've talked before there as in terms of developing a broader payment strategy just taking advantage of payments from Point A to Point B. So again we continue to implement that strategy and in terms of growth we do provide the guidance on the core fee income outlook and so you do have our outlook for that as well to. Those are primarily driven by FX and credit card fees as well.

[Greg Becker:]

This is Greg I would just add on to it. It starts with just additional penetration of the product on the credit cards, that's one area that's driving growth. But as you know we’ve talked about this a lot, the business we're trying to connect more with our clients and be a value added payment partner in the pay site so we’re using virtual cards B2B payments where more companies can use virtual cards to pay not just travel and entertainment but actually to make their payments on their vendor payments and when you are running that through the volumes are obviously much, much bigger than travel and entertainment. So those things can drive very nice growth and we expect that to be a key driver of our growth on a go forward basis which is why our outlook remains where it is in the mid-20s.

[Joe Morford:]

And then lastly Mike do you anticipate doing additional sales of securities to help support the loan growth and liquidity?

[Michael Descheneaux:]

Joe, obviously if we need to we certainly well, right? It's all about matching your maturity from your investment securities portfolio. So for example, each quarter we have maturities about $800 million per quarter in terms of investment securities portfolio and you saw obviously this past quarter we grew loans over a $1 billion around a $1 billion at least in the period numbers. So just really depends on the inflows and deposits and the loan growth and so that just dictates whether or not we need to sell. But again healthy liquidity, healthy amount of maturities which generally would hopefully we wouldn't have to sell.

[Operator:]

And the next question comes from Aaron Deer from Sandler O'Neill. Please go ahead.

[Aaron Deer:]

Following up on Joe's question with the credit card business. Given the growth that you're seeing and projecting in the payments and that API, would it make sense to break that out in the individual line item because it would be nice for us to get a better sense of just how that's performing independently?

[Greg Becker:]

This is Greg, I'll start. So you know right now as you know we lump it together. That is something that we may want to do in the future. It's not big enough yet to really justify because you're going to see potentially some fluctuations on a quarterly basis. So you really want to get to -- it becomes more meaningful. Do I think that will happen in the next 12 months, 18 months? Yes I could see it happening maybe as we consider it looking at the volumes and what numbers it would be and what the forecast is possibly in 2017 or 2018

[Aaron Deer:]

And then going back to the reserve and credit. I'm curious on new loan fundings what kind of reserves do you establish on the various loan types. For example, what's the reserve on a new loan for early-stage companies versus those for capital call lines?

[Marc Cadieux:]

Generally the reserve that's assigned in our model will be a function of the category. So as you mentioned private equity services versus early stage and the credit risk ratings and so considering that our loans are originated at a risk rating of pass meaning expectation that everything is going to be great, you would have reserves that would be plus or minus 1% of the funded balance might be lower for private equity services where the probability of migrating to criticize are nonperforming or charge-off is far, far less, might be higher for the early-stage. But generally they are plus or minus 1% at the pass rating and then depending on the category moving up as they migrate or if they migrate into criticized or worse risk rating.

[Operator:]

Next question comes from Matthew Keating from Barclays. Please go ahead.

[Matthew Keating:]

I was hoping you could review obviously venture capital fundraising activity was pretty healthy in the first quarter, I think around $13 billion was raised relative to about $28 billion in all of the last year. Could you comment maybe the historical relationship between VC fundraising activity and then venture capital actual financing activity and then maybe related exits, is there any relationship there or is that more of a lagging indicator on the fundraising side. Thanks.

[Greg Becker:]

There is a correlation between the two but as far as how long that, what it takes to deploy that capital is very different. It's kind of venture capital fund, it is -- what their investment horizon is and it's what they see from opportunities perspective. So you could see venture funds that deploy their funds in 24 months but you can also see funds that really they are raising large funds and the whole point is to create diversification for that fund and then maybe over three, four, or even five years and then they keep a certain level of reserve so this Company needs funds over even a six, seven, eight year period they have capacity to support those companies. So it's a great indication of how limited partners look at the venture capital market that $13 billion has raised in the first quarter but you can't extrapolate that and say then if you raise that in the first quarter that means, second, third, and fourth quarter are going to be very, very strong. In addition to that you have to look at what's changed over the last two, three, four, five years which that is that it's venture capital, it's as important as it is and it's very important. There are other sources of capital in the market and so watching how that behaves is going to be what we’re paying attention. And just kind of a separate note to that we spent some time with some of the larger visual mutual funds out there that have gotten into the market and kind of gotten their perspective and wondering if they're going to pull back and how far they will pull back if they are. And what we have heard directly from them is that yes they don't like written down some of the investments they have made over the last couple of years but they believe because of these companies state private longer they have to play in the late stage private market. So we believe they are going to continue to invest in this market over the coming years and that is a good sign for us and a good sign for our clients.

[Matthew Keating:]

I guess more on the later stage aspect of the market. What percentage of your business is related to these unicorns, these billion dollars private market valuation companies. Is that a major factor in your business or not so much in your opinion?

[Greg Becker:]

It's not a major part of our business. Clearly we have some unicorns in the portfolio but we don't actually lend that much to them in fact I would argue very little part of that it's because as we said in prior calls a lot of times we have competed over the last few years with equity so when you've raised hundreds and hundreds of millions of dollars does it really make sense even if it's an attractive rate to basically borrow money and the answer has been for the most part no. We do have some deposits and some total client funds but I would argue from my standpoint it's not a material number.

[Matthew Keating:]

And then -- so [indiscernible] capital call lending this quarter, the rest of the portfolio's loan growth was a little bit more moderate. What can be done -- is there anything that can be done to accelerate that growth? Do you’ve any strategic initiatives at play to drive more early-stage lending growth or is that really just a function of the market right not being as vibrant as it has been over the past couple of years.

[Greg Becker:]

As you look at the loan growth excluding equity services was exceptionally strong and the private bank which is also very strong. There were some growth in other parts of the portfolio. Life sciences for example had some growth. What we saw in the first quarter again is you're seeing some companies that have come to the realization that their business models don't work and some of those loans are actually getting repaid when they say we have got excess cash, it doesn't make sense, it's going to be hard for us to raise that next round of financing let's pay down that loan. You have other companies that could raise money. They really -- a lot of people try to get those fund replenished as quickly as possible and they still have 12 to 18 months' worth of capital. That being said at least there is an opportunity is still in that mid and later stage as competitive as it is, we clearly believe we have a competitive differentiation and we believe that we're going to be able to grow the book of business over the course of the year although again it's very competitive.

[Operator:]

[Microphone Inaccessible].

[Unidentified Analyst:]

The remaining question I have is regarding the net interest margin. Maybe Mike you can answer this. You talked about the loan yield and it had an eight basis point benefit from the fed rate hike in December but then there was an offset from a decline in loan fees of seven basis points. My question is what is the absolute impact of the loan fees and then how does the first quarter compared to what you think may happen for the rest of 2016?

[Michael Descheneaux:]

So the loan fees affect the loan yields from the prepayments does vary quarter to quarter. So just depends on if certain loans are pre-paying early and then we can accelerate the re-collection of the fees. So again admittedly it's up and down every single quarter by anywhere from $2 million to $4 million on average in a given quarter. So there's no really way to predict that it's just behavior in terms of growth in loans and when somebody decides to repay a loan early. So but again like I said generally it moves up and down around between $2 million and $4 million a quarter.

[Unidentified Analyst:]

And did you disclose what the absolute dollar amount was here in the first quarter?

[Michael Descheneaux:]

No but you can keep an eye on, so if you actually go to the press release there's a disclosure about -- in the footnotes back there on the income statement that talk about the loan fees that we're recognizing each quarter so you can actually pull that out from there.

[Operator:]

And the next question comes from [indiscernible]. Please go ahead.

[Unidentified Analyst:]

Just one more from me. I believe the question was asked earlier but I think I missed the answer if you gave it. Can you tell us what the current reserve on the early stage portfolio is at this point?

[Greg Becker:]

Yes we didn't actually we didn't in the earlier question and will now breakout the portion of the loan loss reserve that's allocated to early stage. But would repeat the answer to the early question that it has trended up at the level of criticized early-stage loans have trended up.

[Operator:]

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

[Brett Rabatin:]

Just wanted to ask you gave range guidance towards higher low-end for some of the line items but not on the margin and was just curious kind of given where the margin is and what's going on with the balance sheet any thoughts on why you wouldn't talk about the margin guidance being at the higher end of the range or maybe changing that this quarter?

[Greg Becker:]

Obviously we feel comfortable with the margin in that. I mean certainly the rate increase that we had in December's it's very helpful. The things you've got to think about is what could change that going forward and you know certainly loan mix or as we continue to grow loans that's going to have a positive impact on them because by and large the loans we’re issuing are larger than our net interest margin. So that's why we feel comfortable with our range that we have outlook. With respect to deposits, whether those are coming in lower or faster pace certainly does affect it but again not a significant amount at least at this stage.

[Brett Rabatin:]

Okay it just seems like you might be at the high end or maybe higher potentially at some point this year.

[Greg Becker:]

Well let's hope so. We are always hopeful for an increase in net interest margin.

[Operator:]

And our next question comes from Juliana Balicka from KBW. Please go ahead.

[Juliana Balicka:]

I wanted to ask a little more about your investment fundings. You’ve been in some of these funds for coming up on a decade now. So shouldn't some of these fund be in kind of harvesting stage, for example your managed funds which are still holding onto public securities. Is there any kind of [indiscernible] when you're going to sell this securities and get you out of strategic another investments conservative positively to gains [indiscernible] warrants contributed positively. So is there any way to think about a kind of a curve of when you will start to exit?

[Michael Descheneaux:]

Obviously I think over time they will begin to exit but they will look to markets that are more calm, as we all know in Q1 it was very anxious market. If the markets do come then perhaps you would start to see them beginning to exit out of some of these positions. Now you also have to think about some of these public companies that they are holding positions in are subject to lock-ups, right, that also can delay. But at the end of the day as you know the partners of those funds will decide when is the opportune time to exit out of those markets. But yes overtime over the next couple years since some of these funds have been around for a long time, we should start to be seeing exits as long as there's M&A activity and the economy market holds and as Greg pointed out a fair amount of these investments we have are held at the cost basis and so we certainly look to the, when they do exit because that would certainly potentially generate some nice gains for us.

[Juliana Balicka:]

Okay and then maybe switching to the early-stage credit cycle as you talked about that being within expectations. In terms of thinking about how long a credit cycle might last early-stage loans, it seems to me that these companies are going to fail, they are going to fail, they are going to fail very quickly. So what else I would say more established industries like oil rates can drag on for seemingly forever. It would seem that credit situation [indiscernible] should come fairly quickly and by let's say I don’t mid-2017, you would almost be resetting or how do we can think about the duration of potential credit stress?

[Greg Becker:]

You are right it actually is -- it happens in the near term. The only caveat I would here is that companies have longer funding maybe 12 months 18 months with a cash as opposed to the companies we’re running on nine months of cash collective on average and all of a sudden then you've got to make a decision very quickly or you'll find very quickly where the stress actually is. So we kind of see that over the course of 2016 a lot of this is going to play out and it could actually be even earlier than that. So as Mike described in his comments that we expect the first quarter provision to repeat itself. Q2, Q3, Q4 again on an average but it may be volatile from quarter to quarter. That's kind of our best view of what we would expect to play out early-stage and then decrease and start to improve once the market settles down and as you said some of these companies will have played out already.

[Operator:]

And our next question comes from John Pancari from Evercore.

[John Pancari:]

I just want to ask about the loan yield impact from the fed hike. You indicated that you saw about an eight basis point benefit to loan yields from the 25 basis point fed hike in December, that feels light especially given your 88% variable loan composition. So can you give me a little more color on -- is there anything that impacted that 8 basis points where possibly it could the greater in future hikes.

[Michael Descheneaux:]

Roughly about 80% of our loans are tied to variable rates. There a few things to consider when you think about the number whether it's light or not, first off is part of the increase of the loan yields actually happened affect in December. There was a little bit of that -- perhaps one of the larger things to consider would be the fact that we have LIBOR based loans as well too. So if you look at the LIBOR rates, one month LIBOR is around 43, 44 basis points, so not quite up to the 50 basis points. So there's a little bit of not quite the full impact of that plus you also saw in December that LIBOR rates are starting to increase even before the feds started increase. So there was some of that pickup as well too and perhaps the final point is look it still takes some time for some of these loans to reset whether it's on a 30 day LIBOR or 90 day LIBOR as well, so that would I think account for the difference. But by and large when you see a 25 basis point rise assuming LIBOR is going to move in conjunction, you’re going to see approximately 75% to 80% of us kind of that falling to the loan yields.

[John Pancari:]

Okay. So you think that 8 basis points is relatively representative of the move you'll get if you get another 25 base point hike later on this year?

[Michael Descheneaux:]

No. I think what I am saying is just in the core of the 8 basis point is reflective of again some of the yield increases we saw in December, some of the pre-run up with respect to LIBOR, some of the things related to LIBOR and some of our clients are still resetting over the time here and the fact that right now there still is the different LIBOR again one month LIBOR is only at 43 basis points, so not quite the full 50.

[John Pancari:]

And then separately on the lower loan fees I guess you answered it earlier they tend to be volatile. Do you have any visibility into the next quarter about how that's trending?

[Michael Descheneaux:]

No again when you look at the low fee income we had in Q1, it was $25 million. If you compare that to Q4 it was $27 million, so there was a decline of $2 million by and large it's primarily driven by the prepayment fees from early loan repayments. And again if you go back and map it out and do some of that benchmark and look at it you’re going to see movement anywhere $2 million, $3 million, $4 million in a given quarter run-rate but again it's very difficult to predict because I just can't predict when somebody is going to repay a loan.

[Operator:]

This concludes the Q&A session. I'll now turn the call back over to CEO, Greg Becker for closing remarks.

[Greg Becker:]

Thank you. Thank you everyone for joining us today. We look at the first quarter we delivered a solid quarter in terms of the core numbers. Clearly as you heard on the call we spent a lot of time talking about where we saw some stress and expect to see a little pressure in the early-stage loan portfolio and some headwinds in our investment, security portfolio and warrants. That being said, we did spend a lot of time and I hope that came through that we're comfortable with the outlook, comfortable with our ability to manage it and maybe as important or more important we're still looking at the long term and what we can do to invest for the long term to grow our business and support our clients. So with that I want to thank our clients for their support of us, our ability to support them and all our employees and our investors and the analysts for joining us today. Thanks and have a great day.

[Operator:]

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