SVB Financial Group
Q3 2016 Earnings Call Transcript

Published: 21 Oct 2016

[Operator:]

Welcome to the SVB Financial Group Q3 2016 Earnings Call. My name is Sherry [ph] and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I would now like to turn the call over to Meghan O'Leary. Meghan, you may begin.

[Meghan O'Leary:]

Thank you. Thanks everyone for joining us today. Our President and CEO, Greg Becker, and our CFO, Mike Descheneaux, are here to talk about our third quarter 2016 financial results. And they'll be joined by other members of management for the Q&A. Our current earnings release is available on the Investor Relations section of our website at svb.com. We will 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 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'll limit the call, including Q&A, to an hour. And with that, I will turn the call over to our CEO, Greg Becker.

[Greg Becker:]

Thanks, Meghan. Good afternoon and thanks everyone for joining us today. We had a strong third quarter, delivering our highest ever quarterly earnings per share of $2.12 and net income of $111 million. These results reflected solid performance across our business

[Mike Descheneaux:]

Thanks, Greg, and good afternoon everyone. Today I will highlight and focus on the following items. First, healthy loan growth driven by private equity capital call lines and private bank. Second, stabilization of total client funds. Third, higher net interest income and a higher net interest margin. Fourth, stable credit quality. Fifth, significant gains from warrants and PE and VC-related investment securities. Sixth, higher core fee income. Seventh, higher expenses driven by incentive compensation. And finally, increased capital ratios across the board. Let us start with loans. Average loans grew by $448 million or 2.5% to $18.6 billion, driven primarily by private equity capital call lines and the private bank. This reflects relatively healthy growth despite the headwinds from some loan repayments related to certain clients being acquired, as well as the impact of Brexit on exchange rates on our foreign currency denominated loan balances. While we could see some repayments of private equity capital call lines of credit given the significant growth we have had over the last four quarters, our pipeline remained strong. For the full year 2016, we expect to come in near the lower end of our recently increased outlook range of percentage growth in the mid 20s. Now let us move to total client funds, consisting of on-balance sheet deposits and off-balance sheet client investment funds. Average total client funds were flat in the third quarter at $81 billion, reflecting a much smaller decrease of $250 million in average deposits, compared to a decrease of $1.1 billion in the second quarter. This was largely offset by an increase of $222 million in average off-balance sheet client investment funds. The decrease in average deposits continue to be impacted by the recalibration of venture capital investment levels and activities from the first half of the year. Specifically, we saw a slower VC funding for certain early-stage clients, a higher proportion of new early-stage clients putting funds into off-balance sheet investments, and a relatively high pace of acquisitions of corporate finance clients. Foreign currency denominated deposit balances were also impacted by changes in exchange rates post-Brexit. Nevertheless, we believe we are starting to see a stabilization of deposits or possible shift back toward positive deposit growth as September average deposit balances were approximately $900 million greater than August balances. Additionally, period-end deposits increased by $593 million and period-end off-balance sheet client investment funds increased $272 million due to a solid pace of new client acquisition and robust inflows from private equity clients. For the full year 2016, we expect deposit growth to come in at the high end of our mid-single digits growth range. Turning to net interest income and our net interest margin. Net interest income increased by $5.8 million to $289.2 million in the third quarter, compared to growth of $1.9 million in the second quarter. This increase was primarily related to loan prepayment fees and one additional day in the quarter. For the full year 2016, we expect net interest income to come in at the low end of our mid-teens growth range. Interest income from loans increased by $8.9 million, of which approximately $4.4 million was related to higher average loan balances. Fees on two large loan prepayments and one extra day in the quarter accounted for the remainder of the increase. Gross loan yields decreased by 4 basis points, primarily due to growth in lower-yielding capital call lines and private bank loans. Interest income from investment securities declined by $3.2 million, primarily due to lower average balances. These lower balances reflect the effect of the second quarter sale of $1 billion of investment securities and use of portfolio cash flows in the third quarter to support loan growth and repay short-term borrowings. Overall, investment security yields remained at 1.62% in the quarter. Our net interest margin increased by 2 basis points to 2.75% due to the shifting mix of our average interest-earning assets toward higher-yielding loans versus investment securities. For the full year 2016, we expect our net interest margin to be in the middle of our range of between 2.6% and 2.8%. Now let us move to credit quality, which was stable in the quarter, with the early-stage portfolio showing fewer signs of stress than in the previous two quarters, and the rest of the portfolio performing well overall. As a reminder, it is important to note that our early-stage portfolio continues to be only about 6% of our total loans. Our allowance for loan losses was $240.6 million at the end of the third quarter of 1.25% of total gross loans, an overall decrease of $4.2 million compared to the second quarter. The decrease in the allowance is primarily driven by a decrease in specific reserves for non-performing loans, mainly due to charge-offs of non-performing loans that were previously reserved for. This was partially offset by additional reserves for loan growth as well as a shift in the mix of our performing loan portfolio. Our loan loss provision was $19 million, compared to $36.3 million in the second quarter. This amount reflects provisions of $8 million for performing loans, $5.5 million for charge-offs not previously reserved for, $4 million for non-performing loans, and $2.8 million for loan growth. The provision for non-performing loans is net of a $5.5 million partial reserve release for one of our non-performing sponsored buyout loans due to credit improvement. Net charge-offs were $22.5 million or 48 basis points in the third quarter, compared to $19.4 million or 43 basis points in the second quarter. This reflects $24.6 million of gross charge-offs. Non-performing loans decreased by $18.4 million to $106.2 million or 55 basis points in the third quarter. The decrease was driven largely by charge-offs of $19.1 million, of which $18 million was previously reserved for, and repayments of $15 million, partially offset by $15.9 million in new non-performing loans, primarily coming from a mix of early-stage companies and one late-stage company. We had no new additions to non-performing loans from our sponsored buyout portfolio during the quarter, and in fact, we resolved one of the three last week to a sell of the loan. The impact of the sale in the fourth quarter will be a charge-off of $7 million, a reduction in non-performing loans of $22.2 million, and a reserve release of $3.3 million. Regarding our credit quality outlook for the full year 2016, our allowance outlook remains unchanged. We expect to come in near the top of our net loan charge-off range of 30 to 50 basis points. Finally, we are decreasing our outlook for non-performing loans as a percentage of total gross loans to a range of 40 to 60 basis points. We now expect to come in at the middle of that range. Now let us move to non-interest income, which is primarily composed of core fee income and net gains from warrants and PE and VC-related 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 $144.1 million, compared to $112.8 million in the second quarter. Non-GAAP non-interest income net of non-controlling interest was $139.5 million, compared to $111.2 million in the second quarter. The increase was mainly related to warrant gains of $21.6 million, compared to $5.1 million in the second quarter. These gains were driven primarily by valuation gains on our warrant portfolio related to the improving IPO and M&A activities. In particular, we saw $10.3 million of unrealized gains related to the IPO of Acacia Communications in the third quarter. We also had non-GAAP net gains on investment securities net of non-controlling interest of $18.4 million, compared to $21.6 million in the prior quarter. This reflects unrealized gains of $7.2 million related primarily to our investment in one fund, which reflects a significant new funding realm at a higher valuation in one of the underlying investments; and $4.3 million in unrealized gains from our managed funds of funds reflective of M&A and IPO activity of the investments held by the funds. Additionally, we had $6.3 million of distributions from our PE and VC-related investments. On a related note, we also recognized $6.7 million in carried interest related to the fund that drove the $7.2 million of gains previously mentioned. This income is reflected in other non-interest income. Moving on to core fee income. Core fee income increased $6 million or 8.2% to $80.5 million in the third quarter. This increase was driven primarily by higher credit card, foreign exchange and letter of credit fee income. As a reminder, core fee income also includes deposit service charges, lending-related fees, and client investment fees. Credit card and payment fees increased by $2.9 million to $18.3 million, compared to $15.4 million in the second quarter. This increase reflects a one-time reclassification of $1.8 million in expenses related to certain merchant services client contracts to other non-interest expense, as well as an increase in interchange fee income due to higher volumes. In general, we continue to see lower spending on our business credit card by some clients as a result of the lingering impact of slower early-stage investment in the last few quarters and continuing client focus on expense management. While this appears to be easing somewhat, the impact is still noticeable, although long term we believe we will continue to see growth in this area. Foreign exchange income increased by $1.9 million to $25.9 million, an all-time high for the quarter, driven primarily by strong activity among our global clients. As a result of lower spending on our business credit cards and lower client investment fees due to the VC recalibration in the first half of the year, we are lowering our full-year 2016 core fee income outlook from the low 20s to the high teens and expect to end the year near the top of that range. To put that in perspective, the actual dollar difference we are talking about is being original -- or between the original and revised outlook is approximately $8 million. Moving on to expenses, non-interest expense increased by $21.4 million to $221.8 million. This increase was almost entirely due to high incident compensation and benefits related to our significant warrants and PE and VC-related investment gains in the third quarter. This included the following components

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And then we have our first question from Ken Zerbe of Morgan Stanley.

[Ken Zerbe:]

Great. Thank you. Good evening. I guess maybe just first question on credit, and this probably relates to the 2017 preliminary outlook that you gave of the 30 to 50 basis points. I get how this year, right, with the turmoil we had in the tech market earlier in the year, that it drove up higher credit losses and you ended up taking -- you're at the higher end of your range. But when you look at the 2017, the ultimate charge-offs guidance really doesn't change much, but I would have thought that the underlying environment would have actually been a better credit environment for SIVB. Why is -- am I thinking about that the wrong way?

[Greg Becker:]

So, Ken, this is Greg. I'll start and then Marc will I'm sure want to add. I guess the first thing when you think about the range of 30 to 50 basis points, although it says only 30 to 50 basis points, on a percentage basis that's a pretty wide range. And so this year maybe at the higher end of the range. And clearly if things are better, things perform better, we could be at the mid range or even a lower part of that range. But you also have to look at there's still going to be a calibration that's going to happen with early stage, and it didn't stop in the third quarter, it just kind of diminished in the third quarter. So we still may see -- we expect to see more of that in 2017.

[Marc Cadieux:]

I have nothing to add.

[Ken Zerbe:]

Perfect. And then just the other question I had. Could you just help reconcile, in terms of the net interest income, I think it was low double-digits growth for 2017, do you expect high loan -- or high teens loan growth? Deposit growth, if I heard right, was actually getting better either late in the quarter, early this quarter, I forget which. What is the expectation for deposit growth in 2017? Because presumably you have to have some sort of either sharply lower margin or sizable deposit outflows to bring that NII lower than loan growth.

[Mike Descheneaux:]

Well, I'll start there. I mean, the one thing to remember, Ken, is that when we're adding on some of these loans here, a lot of our strength in our loan growth over the last couple of years has come from the capital call lines of credit and the private bank mortgages, which are at a lower yield than the overall portfolio. So I think that would be, at least when you do the math, that's going to be one of the largest drivers of that.

[Ken Zerbe:]

Got it. So, presumably, just we're going to see lower NIM all things equal?

[Mike Descheneaux:]

Well, you potentially could see higher -- a slightly higher NIM, right? Because some of those loans are presumably going to be issued above the current NIM levels, but what I was trying to say is that you're going to have some pressure to keep the NIM down or not moving as aggressively up because of these loans are just lower-yielding loans compared to the rest of the loan portfolio.

[Ken Zerbe:]

All right. Okay. Thank you very much.

[Greg Becker:]

Yup.

[Operator:]

And then our next question is from Steven Alexopoulos of JPMorgan.

[Steven Alexopoulos:]

Hey everybody.

[Greg Becker:]

Hey, Steve.

[Steven Alexopoulos:]

I wanted to start on the capital call business. I know the pace of VC investment trailed off a lot in the third quarter versus second quarter, and I would have thought the capital calls under $20 million would have actually declined, but they're up really nicely. Did you guys have smaller private equity capital calls hitting this quarter or did you just have VCs that remained very active?

[Greg Becker:]

Steve, this is Greg, I'll start, and Marc I'm sure will want to add. So the growth wasn't that different. Part of this is just utilization, so you had utilization dropped a few percentage points. When you have that large of a portfolio, a few percentage points makes a pretty big difference. So that was probably the main driver of it. And that, as you know, that's not something you can sit back and predict, because it does vary from quarter to quarter. I think looking at what you would say the growth rate in total borrowings has been for the first three quarters is what I would look at, and that has been robust throughout the first nine months.

[Marc Cadieux:]

The other thing I would add to that, Steve, it's Marc Cadieux, the correlation between the pace of venture investing and borrowings on our capital call portfolio is becoming less and less over time. Today, almost 80% of the total capital call line portfolio is private equity funds versus venture capital funds.

[Steven Alexopoulos:]

Okay. Got it. Okay. That's helpful. And then, when I think about the guidance, you know, obviously what happens in the exit markets are going to dictate what happens with the guidance. And this year was two different years, right? The first half was softer, the quarter was very strong. When we think about this, what's the general assumption for the exit markets you're making to hit this outlook? Do we need a better year than what we saw this year in 2016 or about the same?

[Unidentified Company Representative:]

So, from an exit perspective, right, so the drivers, when you think about, are the six drivers that we talked about, that really doesn't have that dramatic of an impact on the drivers, whether it's loans, deposits, core fee income. Most of that occurs within security gains and warrant income, and, Steve, you know that we don't give guidance on that. What I would say on that is, if you look at, you know, the year that we had, this year, we expect to have this year, you know, that's just a function of what are your expectations for next year. As I said in my comments, today, right, and it can change quickly, as we all know, we see more of our clients that are looking to -- they're preparing for an IPO, in the next, as we said, in the next 18 months. You know, if that plays out, that'll be positive. But again, it's such a -- it changes so quickly, which is why we don't give guidance on securities gains or warrants.

[Steven Alexopoulos:]

Fair enough. And if I could squeeze one more, Meghan, please. On the fee income guidance, in the third quarter you guys actually had a really nice improvement in card revenue, yet you're taking down the full-year guide on the fee income and then, you know, next year looks a lot like the reduced guidance for 2016. Can you help me reconcile what's changed from that original guidance?

[Mike Descheneaux:]

So, Steve, this is Mike here. I mean, first and foremost, I mean, when you look at the longer-term picture of core fee income, we believe that's going to go at a strong pace as you see in 2017. And it's certainly going to be driven by the card fee income and the payments fee income, and as well as the FX income. What happened in, I'd say, during 2016, we obviously had some slowdown in the spend on that as well too, and when you get more pointed to Q3 of this year, we had, as I mentioned in my prepared remarks, we did have a reclassification of some expenses, and that [inaudible] line item, which made it look a little bit healthier than what it really was. But nonetheless, the fundamentals are still strong, at least for us in the long term. So that I think is just the one delta, is what -- just that one anomaly here in the Q3, coupled with this -- definitely a slowdown in spending. The other thing to think about as well too is, you know, with the recalibration in the VC markets here this year, we did have a, I would say, a lower-than-expected amount of earnings from our client investment fees, the fees from the off-balance-sheet instruments, and that certainly held back some of the core fee income growth as well too. So, yeah.

[Steven Alexopoulos:]

Okay. Thanks for all the color.

[Greg Becker:]

And Steve, just to give you a little more perspective on the card stuff, if you look at the growth for the year, it's been actually healthy for the year, but it really is at the average spend for business credit cards has grown [inaudible] it's dropped. So that growth collectively during the course of the year, even though we're adding a lot of clients, is only up about 4%. So the cards as a platform, that business has actually been healthy. And so we expect it'll get back to a little bit more normal level in 2017.

[Steven Alexopoulos:]

Okay. I appreciate all the color. Thanks.

[Greg Becker:]

Thanks, Steve.

[Operator:]

And then our next question is from Jared Shaw of Wells Fargo Securities.

[Jared Shaw:]

Hi, good afternoon.

[Greg Becker:]

Hey, Jared.

[Jared Shaw:]

I guess on the salaries, if we're looking at fourth quarter, should we be looking at excluding most of that $16 million from the warrants, or is that going to -- is that more of a catch-up or is that going to be dependent upon what we see for warrant gains next quarter?

[Mike Descheneaux:]

Yeah. Good point and good observation. I mean, exactly what you say, in Q3, because our outlook for the full year was that we're going to come in higher on the net income line, it actually drove a higher accrual for the incident compensation. So, to your point, we did have to go back and make that catch-up for the Q1 and Q2. So that's why you have an elevated expense in Q3. So, you know, all things being equal, we would not expect that same level of incentive compensation in Q4.

[Jared Shaw:]

Okay. So this is three quarters worth of accrual there. Okay.

[Mike Descheneaux:]

Yeah. If you look at the math or kind of compare it to the, you know, it's -- the prior quarter, it's probably up anywhere around between $10 million and $14 million versus the last quarter, so that just kind of gives you a little bit of ballpark. Now there was some adjustments in Q2, kind of a similar thing, to try to true up or be consistent with the outlook for the full year, but that's generally what you're going to come out with that range.

[Jared Shaw:]

Okay. On the securities portfolio, should we expect to continue to see around that $800 million per quarter cash flow range?

[Mike Descheneaux:]

Yeah, currently at the moment that's right. I mean, as you know, we haven't really -- we haven't been adding to the investment securities portfolio. In fact, we've had some of the run-off in the investments ,we've been putting it back in to support our loan growth.

[Jared Shaw:]

Right. Okay. And then finally for me, on the sponsor-led loan that improved, is that improved enough to move off of NPAs? Is that the one that you were speaking about that is -- has worked out? Or is this -- is there a potential for additional improvement in those handful of loans that are non-performing?

[Marc Cadieux:]

Sure. So it's Marc. The one for which we had a reserve release, the way to think about this I think is there's day one of the turnaround and you don't know what's going to happen. And on the other end of the spectrum would be a loan that's just like any of the other good loans in our buyout portfolio where leverage levels are reasonable and they're able to service and full repay their debt within a reasonable period of time. We are on that journey. And for the one that we saw reserve release, we saw sufficient performance to their turnaround plan to support a partial reserve release. I'd still believe that there is at least another quarter or two that we would want to see of that continued progress before we would be in a place where we could say that restoring it to accrual and releasing the rest of the reserve, the specific reserve, is the appropriate thing to do.

[Jared Shaw:]

Okay. Thank you very much.

[Operator:]

And then our next question comes from Aaron Deer of Sandler O'Neill.

[Aaron Deer:]

Hi, good afternoon everyone.

[Greg Becker:]

Hi, Aaron.

[Aaron Deer:]

Wanted to ask I guess going back to the guidance. The alternative guidance that you gave, Greg, with respect to net interest income under a higher rate scenario, you said mid-teens increase with rates up. What does that assume in rate hikes? Is that one hike, two hikes?

[Greg Becker:]

So I'm going to go to Mike for the forward curve estimate, but it's 25 basis points assumed in December, and I'll have to ask him for what is assumed in the --

[Mike Descheneaux:]

It's pretty much the assumption would be that there was a rate hike in December. That's the heavier lift. So the way to look at it, Aaron, is the number, when you think about it is, for every 25 basis points, roughly, using a static balance sheet as of the point in time, gives you about $28 million -- $25 million to $28 million of net income, bottom-line net income. That's kind of basic rule of thumb currently right now based on the profile of our balance sheet.

[Aaron Deer:]

Right, okay. And then, on the -- going to the fee income. Client investment fees were flattish with the prior quarter, I guess that makes sense given that those balances really didn't move much. How sensitive are those fees to rate? So if we do get another 25 basis point hike in rates, is there going to be any benefit to the fees there?

[Greg Becker:]

So this is Greg. I will start. So there'll be some benefit clearly, but it won't be much as a pickup as there with the first 25 basis points, partially because we basically were going from such a low number that it was in the 3, 4 basis points. So if you're growing up to 5, 6, 7 basis points on a percentage basis, that's a very big jump. If there's another 25 basis points that occurs or 50 basis points, it won't be the same percentage sharing, so maybe it's, you know, 1, 2 or 3 basis points. So, you know, clearly it will help, it'll help if there's more rate increases, but the big driver, once we get that first lift of a few basis points is going to come from growth in the off-balance-sheet.

[Aaron Deer:]

Okay, great. Thanks for taking my questions.

[Greg Becker:]

Yes.

[Operator:]

Our next question is from Ebrahim Poonawala of Bank of America.

[Ebrahim Poonawala:]

Good afternoon guys.

[Greg Becker:]

Hi, Ebrahim.

[Ebrahim Poonawala:]

Just had one question in terms of deposits. I wanted to get a sense, I think when I think about deposit growth, I guess one side is VC funding, which would give more clients more deposit growth, and the other is just sort of balancing -- sort of channeling deposits on balance sheet versus off-balance-sheet. When we think about sort of diverting deposits to the balance sheet, can you talk about just in terms of customer preference today? Are you seeing your early-stage clients having a bit more sensitivity to pick up that extra yield and stay off-balance-sheet, or should we see that then move as we look into fourth quarter into 2017?

[Greg Becker:]

Yeah, Ebrahim, this is Greg. I'll start and Mike may want to add to it. So, deposits clearly are impacted by venture capital; that's one of the drivers. It's also, as you said, where the preference or the direction of the products that we actually have to offer. So at the early stage, right now we're looking at more of an on-balance-sheet, both checking account, money market account. And even though rates increased 25 basis points last December, there still is very little, I guess, desire to focus on what the yield actually is. The other part is you have to look at the whole relationship. It's not just what you're charging on the overall money market account but it is what services you're giving, what are you charging for those services. And from our standpoint, at the early stage, we have a very, very competitive bundle package. So it's not just one thing, you have to look at the whole thing overall. From a deposit perspective, again, as Mike articulated in his comments, we feel better about here we are. We think the decline is either stopped or definitely reduced, and that's what we're giving an outlook into 2017 that has some modest growth.

[Ebrahim Poonawala:]

Got it. And I guess just a separate question, in terms of when we think about the sort of competitive environment and sort of the covenant structures in terms of lending to these early-stage companies, has it gotten better over the last 12 months in terms of sort of the warrants that you're getting as part of these relationships, or has it not really changed?

[Greg Becker:]

This is Greg. I will -- I'll start. When I think about the competitive landscape, Ebrahim, it has been extremely competitive for the last several years and we expect it will continue to be competitive, as other markets, other industries clearly don't have the growth rate that technology market has. And that's part of our expectation. We've had that. We believe we get premium pricing in general because of the whole platform and what we provide and how we provide it. But it is competitive. When you think about warrant coverage or just pricing in general, I would say that it continues to be under pressure, and I would expect that it will continue to be that way for the foreseeable future.

[Ebrahim Poonawala:]

That's helpful. Thanks for taking my questions.

[Greg Becker:]

Yeah.

[Operator:]

Our next question is from John Pancari of Evercore ISI.

[John Pancari:]

Good afternoon.

[Greg Becker:]

Hey, John.

[John Pancari:]

On -- just a question back on credit. The on-the-spots or buyout portfolio, now that you're seeing some improvement in some of the credits that had surfaced in that portfolio, is your view there that that was still one-off type of issues that you were seeing and somewhat idiosyncratic, or was there a commonality at all that you can say at this point, now that you're seeing some of the issues abate, you know, that drove some of the problems you had in that portfolio?

[Greg Becker:]

Yeah, it is -- it's very much the first one. These were company-specific issues that resulted in each of them becoming non-performing, and by extension are not indicative of any broader or systemic trend in that segment of our portfolio.

[John Pancari:]

Okay. All right, thanks. And then on the same topic there on credit, are there portfolios that you would say you're watching closely, I guess? I just, you know, I would assume early-stage just given some of the color you gave in your prepared comments given the flows from the venture capital and private equity community into early stage, so that will clearly be one. But any other areas of the portfolio that you're watching closely in terms of credit?

[Greg Becker:]

Sure. So I'd say first that we rigorously monitor the entirety of our loan portfolio. The ones that I think, to your point, that have gotten the most attention as they should and as they historically always have is the early stage segment. Certainly buyout continues to be an area of focus just because they are larger loans and we've seen some stress there in the form of the handful of non-performing loans. But having said that, continue to believe that credit quality of that segment of the portfolio is stable overall and don't see any signs of challenges elsewhere in the portfolio, hence, the reaffirmation of our guidance for 2017.

[John Pancari:]

And do you have non-performing ratios for -- by portfolio? Like, do you have what the non-performing ratio is for your early-stage book and then for the buyout book?

[Greg Becker:]

We do not.

[John Pancari:]

Okay. All right. And then lastly, if I could ask one more, on the -- back to the margin benefit question, the 25-basis-point hike, I heard you say it in terms of the net income benefit. What would that be in terms of your margin, if we did see a hike in December of 25 basis points, what would the margin be?

[Mike Descheneaux:]

John, I don't have that right in front of me, but you can work out the math pretty easily. If I had one or two minutes I could probably do it, but it's baked into it, yeah.

[John Pancari:]

Okay, that's fine. So we can use our typical math there, nothing else that impact that.

[Mike Descheneaux:]

Yup, exactly, yeah. There's not a whole lot of rocket science there.

[John Pancari:]

Yup. Okay. Good. Thanks, Mike.

[Operator:]

And our next question comes from Chris McGratty of CBW.

[Chris McGratty:]

Close. Afternoon guys.

[Mike Descheneaux:]

KBW.

[Greg Becker:]

We know who you are, Chris.

[Chris McGratty:]

Okay. Question on the VC book. It's about 40, you know, the capital call is pushing 40%. Obviously very low risk. What's the internal cap that we should be thinking about in terms of how large it'll be?

[Greg Becker:]

Yeah, Chris, this is Greg. There's a couple of ways to think about it. One is, as you said, it's roughly 40%, 39% of the overall loan portfolio, and it is incredibly high quality, which is why we're comfortable with it, clearly at this level, and comfortable with it going to a higher level. Another way to think about it is just the overall size of that relative to the assets of the overall bank, which gets you down to kind of that 17% to 19% range. Another way too look at it. And so, where could we end up watching this go to before we want to pay even more attention to it? To me, that number is kind of in the high 40s, maybe even approaching 50%. But at the same time, we're looking for growth in the other parts of the portfolio to include the private bank. And so that still allows for ample growth, from our standpoint, in the overall private equity services portfolio.

[Chris McGratty:]

Okay. Great. Maybe a follow-up. Assuming the range and charge-offs next year, and based on kind of what you put in in the portfolio in terms of risk, you had been providing call it a 75, 90-basis-point range over the past few quarters because of the stress. Is there any reason why that proportion of provisioning shouldn't abate or converge closer to the charge-off rate next year?

[Greg Becker:]

So this is Greg, Chris. When you think about the 30 to 50 basis points, that's for charge-offs. The overall loan provision is a function of that, reserves against loan, and also loan growth. And so if you go back and look at the provision part of the reason the number is higher, is because the loan growth has been so strong. And so I would extract from our guidance, the 30 to 50 basis points, that is again similar to this year and, depending upon what loan growth does, that would provide the higher level of what the provision would look like.

[Chris McGratty:]

Okay. Thanks.

[Greg Becker:]

Yup.

[Operator:]

Our next question is from David Long of Raymond James.

[David Long:]

Hey guys.

[Greg Becker:]

Hey, Dave.

[David Long:]

The one question I have remaining is regarding sponsor abandonments. You guys had given a number on that the last couple of quarters on your calls. Do you have a number for the third quarter the amount of sponsor abandonments that happened?

[Unidentified Company Representative:]

By sponsor abandonment, do you mean --

[Mike Descheneaux:]

VC abandonment, early stage?

[Unidentified Company Representative:]

Right, but it's more of a --

[David Long:]

Exactly.

[Unidentified Company Representative:]

In the form of charge-offs or non-performing, is -- just maybe getting specific on what is [inaudible]?

[David Long:]

Yeah, just, you know, Mike had talked about, in the past, about I think the first quarter the number was 15 basis points -- or not -- 15 companies, and then I want to say it was around 11 last quarter. I just wanted to see if that's still coming down here at this point.

[Unidentified Company Representative:]

Right. So, okay, that's -- thanks for that. So, yes, 15 companies in the first quarter. So here, just talking about charge-offs, it was 15 companies in the first quarter, 11 in the second quarter. It was 11 again in the third quarter, but to give you a little more color on that, there was, yeah, 9 of the 11 were in the very, very, very, very granular category. And so the early-stage charge-offs was about $6.3 million in third quarter versus $13.9 million in the second. Going to non-performing loans, which would be another, I'll say, you know, related to your abandonment question, the number of companies, the pace has been very steady over the course of this year, with the higher stress we saw in the first quarter being a function of a higher incident of NPLs, early-stage NPLs in the fourth quarter of 2015.

[David Long:]

Got it. That's what I was looking for. Thank you.

[Unidentified Company Representative:]

Great.

[Operator:]

Thank you. And our next question comes from Brett Rabatin of Piper Jaffray.

[Brett Rabatin:]

Hey, good afternoon. Wanted to ask, capital call lines of credit PE growth, you mentioned earlier in the call there could be some payoff activity there. Could you give us an idea of the magnitude of what you think might be potentially paying in that portfolio over the next year versus the pipeline?

[Marc Cadieux:]

So I'll start. Greg or Mike might want to add. It is difficult to predict what the -- what payoff or, you know, utilization activity will be. Having said that, loan growth in the first half 2016 was assisted by some borrowings in the fourth quarter of 2015 that stayed outstanding, and we actually saw some significant repayment of the third quarter, which is one of the factors in the more muted loan growth. At the same time, in the third quarter, unfunded commitments increased by roundabout $800 million, the vast majority of which were capital call lines of credit. What we tend to see, when we book a new capital call line of credit is utilization within a one to two-quarter period. And so that would be, you know, an indicator, if you will, of why we would have some confidence in the loan growth outlook.

[Brett Rabatin:]

Okay. That's good color. And then the other thing I was just curious about was the expansion in San Francisco, can you maybe give us any color or thoughts around just how much of an initiative that will be and how much that adds to growth as you think about that for the next year or two?

[Greg Becker:]

So, Brett, this is Greg. You know, we've been growing our presence up in San Francisco just based on the number of employees, because there's a lot more activity up there. There's also not just our client-facing teams but parts of our employee base in different areas that are also located up there. And so we've been very tight on our quarters up in San Francisco. So we're looking at the relocation just to provide future growth for the next, you know, many, many years. That's one point. Second point is, just taking an approach that we've done in more and more offices, which is a very open environment. So, actually, although the footprint is bigger, it effectively pretty much doubles our capacity for growth up in San Francisco. So that's a great market for us, not just from a client perspective but it's a great market for us to retain and attract employees, and we are kind of excited about the move coming up next year.

[Brett Rabatin:]

Okay, great. Thanks for the color.

[Greg Becker:]

Yup.

[Operator:]

Our next question is from Jennifer Demba of SunTrust.

[Jennifer Demba:]

Thank you. Good evening.

[Greg Becker:]

Hi, Jennifer.

[Jennifer Demba:]

Just wondering if you can give us some color on possibly going in Germany and Canada, if you could just give us whatever color you can on that.

[Greg Becker:]

Yeah. It's Greg. Very early days in both markets, and as I said, obviously this is more or less just to give it a highlight at something we're pursuing, but it's early and obviously subject to regulatory approval both domestically and in those local markets. But, you know, so the question is really, why are we looking at those markets? Well, if you look at venture capital activity, then Germany, as an example, Germany is one of the strongest European economies from the venture capital activity. The other part we look at is not just how much -- how many early-stage companies or startups are there, but how many mid and later-stage companies are there, and again Germany ranks very high, nearly the highest in Europe. And we've had some request to lend money for a few buyouts and things like that in Germany based on sponsors that we know and trust and have worked with for a long period of time. So the market is attractive. And because of our success in the U.K., this allows us to look at that market as well. So we're just working on that right now. Canada is very, very similar. We've been pulled into Canada by again clients, innovation companies, for years, and quite honestly it's going to reach the critical mass that we believe it's something we need to consider opening up. Both of those offices, just to clarify, would more than likely be lending-only offices to allow us to have a very light footprint in both markets. But we're right now again in the exploratory stage and, if something were to happen, it really would be late 2017, into 2018, where you would really hear a lot more about it.

[Jennifer Demba:]

Thanks so much.

[Greg Becker:]

Yes.

[Operator:]

Thank you. And then our next question is from Chris York of JMP Securities.

[Chris York:]

Good evening guys and thanks for squeezing me in here.

[Greg Becker:]

Yes.

[Chris York:]

Just one question. Just wanted to talk a little bit maybe about investment, as Greg talked again about strengthening the brand and investing in the platform. So, clearly, historically, PE has been a source of that investment, but maybe where else is that showing up? Is that in premises and equipment? And then, could you quantify how much you think the investment is in the non-interest expense and maybe how much that might be and your high single digit guidance in 2017?

[Greg Becker:]

So, Chris, it's -- I wouldn't say that we're doing anything new. We continue to invest in both infrastructure, in client-facing roles, in geographic expansion, as I just outlined. So on a global basis, we continue to invest in the U.K. as that continues to expand, investing in Asia, investing potentially in Germany and Canada. So geographic is one area. The second area is just overall infrastructure. We need to continue to put money into our digital platform, our systems, infrastructure, the regulatory compliance, all those areas. So it is very difficult, I would say nearly impossible, to say, how much of that is investment for where we are today versus keeping up for growth. But clearly, the high single-digit growth and expense levels that we're forecasting for 2017 is not just for today, it is very much building for the future.

[Chris York:]

Yeah, makes sense, and that's fair enough. That's for me. Thank you.

[Greg Becker:]

Great. Thanks, Chris.

[Operator:]

Our next question is from Jeffrey Elliott [ph].

[Unidentified Participant:]

Hello. Thank you for taking the question. You've mentioned a few times the capital call loans being lower yield than the rest of the portfolio. Can you put numbers around that differential?

[Greg Becker:]

Yeah. This is Greg, I'll start. You know, when you look at capital call loans for private equity firms, you're looking at prime minus, I would say, half to maybe in that general range, with, you know, 25 to 50 basis points on either side of that range. So clearly it's lower-yielding than our overall loan portfolio, which is why the average loan yield is coming down mainly. But another point I just want to make sure, this is really important, is that when you look at it, the reason that we're comfortable doing that from a return on capital perspective is the fact that the overall credit quality of that portfolio has been exceptional, and we certainly expect that we needed to be exceptional for the foreseeable future. It's a big market, we have a, you know, very strong competitive advantage, and so we still expect that to see nice growth.

[Unidentified Participant:]

And then just to follow up, you sound pretty positive on the growth outlook there. What sort of environment would it take for the capital call loans to (stop) growing?

[Greg Becker:]

It's an interesting question because you have to look at it in two different ways, and Marc Cadieux would say that again the vast majority of that portfolio now is in broad-based private equity, so it's a little bit less depending upon what I would say is the innovation economy or the tech industry overall. That being said, it is susceptible to the market overall and activities around the globe, but it's kind of funny in the sense of, in one way, it can be impacted negatively to existing companies, but their willingness to put more money to work actually is a function of the price of what they're going into. And so if the economy starts to slow, some of them actually look at the market as being a great time to be in the market. A great example of that is what you see in the U.K. So over the last six months you can look at what's happened with the pound to dollar ratio. So we're seeing a lot of --

[Unidentified Participant:]

I know it well.

[Greg Becker:]

-- private equity firms coming in and actually looking at that as a good opportunity, roughly 20%, 25% discount.

[Unidentified Participant:]

Thank you.

[Greg Becker:]

Yup.

[Operator:]

Our next question is from Gary Tenner of D.A. Davidson.

[Gary Tenner:]

Thanks. Just a quick question regarding your loan portfolio, kind of rate orientation towards LIBOR phase [ph] loans. Was there any impact this quarter? Is there any lag of the move in LIBOR that would impact the fourth quarter and beyond?

[Marc Cadieux:]

So, maybe just to give you a little bit of color, first, the answer would be it's very modest. The second answer, so, about 88% of our portfolio is floating rate versus fixed rate and it's about 60% tied to prime versus 40% LIBOR.

[Gary Tenner:]

Okay. And would there be any just a lag in terms of the impact to where there wouldn't have been much 3Q, maybe more in 4Q?

[Mike Descheneaux:]

So maybe one other thing to add on there is, certain parts of our portfolios do have floors, roughly around 100 basis points of LIBOR, you know, partake [ph] in the sponsor buyout portfolio, which is roughly about $2 billion of our loan portfolio. So that'll put some hesitation. And then you've got the 30, 60, 90, one-year type LIBOR [inaudible] reset. So that's why, as Marc described it, it's actually quite a modest thing. But once we do break through a floor of 100, then we would start to see more of that impact.

[Gary Tenner:]

Okay. Thank you.

[Operator:]

Our next question is from Tyler Stafford of Stephens, Inc.

[Tyler Stafford:]

Hey. Good afternoon guys. Just one last one for me. Meghan, apologize for taking this over the hour.

[Greg Becker:]

That's quite all right, Tyler.

[Tyler Stafford:]

Do you have the global loan and deposit balances at quarter-end, and any change in those and either of those call it from pre-Brexit?

[Greg Becker:]

Yeah, this is Greg. So when you look at it in dollar terms, actually has changed a little bit, but not much, which is interesting, because the -- if you looked at it on constant dollar terms, you would have seen roughly a 15% growth rate. And so, flatness [ph] may appear not to be a great number. We look at it as a positive and clearly hope that the pound to dollar has stabilized.

[Tyler Stafford:]

Okay. Thanks.

[Greg Becker:]

Yup.

[Operator:]

And that is all the time we have for our questions today. I'll turn the call back to Greg Becker for closing remarks.

[Greg Becker:]

Great. Thanks. I just want to thank everyone for joining us today. We had a great quarter that we are extremely proud of and an outlook that we expect to continue to drive solid growth into 2017. I want to thank all our employees again for doing such a great job in taking care of our clients, and for our clients, again, as always, putting their trust in us. We don't take that trust lightly. And I also have a special thanks, this is my close. Today I just want to do a special shout-out to Joe Morford. Joe has been an analyst that's covered Silicon Valley Bank for the last 24 years, pretty much my entire tenure at Silicon Valley Bank. He recently stepped down from RBS. And I just wanted to say, Joe -- RBC -- sorry, Joe, I just wanted to say, thanks, Joe, for all the great work over the years, and best wishes for whatever your next step in your career is.

[Mike Descheneaux:]

Hear, hear.

[Greg Becker:]

Thanks and have a great day.

[Operator:]

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