SVB Financial Group
Q4 2016 Earnings Call Transcript

Published: 27 Jan 2017

[Operator:]

Welcome to the SVB Financial Group Q4 2016 earnings call. My name is Adrian and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a looking at question-and-answer session. Please note this conference is being recorded. I’ll now turn the call over to Meghan O'Leary, Head of Investor Relations. Meghan O'Leary, please go ahead.

[Meghan O'Leary:]

Thank you, Adrian. And thanks everyone for joining us today Our President and CEO, Greg Becker, and our CFO, Mike Descheneaux, are here to talk about our fourth quarter 2016 and full year 2016 results, and they’ll be joined by other members of the management team for a Q&A. Our currently earnings release is available on the investor relations section of the 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. Our comments are a little bit longer today give that it’s end of year and we made our announcement about two hours ago. So, we still plan to limit the call including Q&A to an hour, so bear with us please. And with that, I will turn the call over to Greg Becker.

[Greg Becker:]

Great. Good afternoon and thank everyone for joining us today. Our fourth quarter was a strong finish to a very good year. We delivered earnings per share of $1.89 and net income of $99.5 million, with healthy loan growth, total funds growth and core fee income growth and stable credit quality. For the full year 2016, we delivered earnings per share of $7.31 versus $6.62 in 2015 and grew net income by 11% to $383 million. I’ll going into the details of the year and our expectations for 2017 in a moment. But I’d like to start by addressing the announcement we made earlier today. That is, our plans to appoint our CFO, Mike Descheneaux, as president of Silicon Valley Bank. I’m excited about this move because it's about growth. As many of you know, in the past decade, SVB has grown nearly every aspect of our business. Our balance sheet, client base, capabilities and global reach, not to mention our employee base. We have many more growth opportunities ahead, but we need to evolve our organization to better support that growth. In Mike's new role, he will be responsible for our global, commercial banking, private banking, funds management strategies, and for uniting our broader banking team around our shared vision and a clear set of priorities. Ultimately, I believe this move will enable us to better leverage the power of the SVB platform, including our insights and analytics, to help our clients succeed. As president CEO of SVB Financial Group, I will continue to oversee all aspects of our corporate strategy, vision, mission goals and objectives. I believe – and our Board believes – that Mike is the perfect choice for this role. In his almost ten years at SVB, he has proven to be an effective leader, a strong partner, a skilled communicator, and a valuable member of our executive team. He understands our business and our clients and he's passionate about what we do. Michael will take over his new role as president once we've identified and hired a new CFO. That search is currently underway. Until then, Mike will remain as our CFO. And now, I’d like to talk about our 2016 performance and milestones, our focus in the environment as we move into 2017. After that, Mike will go into the details of the quarter. I'm proud of our continued success in 2016. I’d like to touch on a few highlights. We grew average loans by 24% to $18.3 billion. We grew average total client funds by 9% to $82.1 billion. We increased net interest income by 14% to $1.2 billion. We grew core fee income by 19% to $316 million. We maintained good credit quality overall, consistent with our overall guidance. Our expenses increased by 12%. This was above our outlook range, but the excess was primarily due to higher incentive compensation related to our outperformance. And finally, we delivered a solid return on average equity of 10.9% despite low rates and continued investment in our business. The strong financial performance was underscored by numerous business milestones and incremental improvements, evidence of our consistent focus on effective execution. For instance, we continued to add new clients at a healthy pace. We expanded our net client count by 16%. This reflected growth across most of our client segments, particularly in private equity and the private bank, as well as 26% growth in the UK and Europe. We maintained our leading market share of early-stage companies and grew our early-stage client count by 13%. We expanded our US and global reach in various markets to support growth. This included expansion of our offices in San Francisco and London, as well as a number of smaller US markets. Establishment of a beachhead in Dublin, Ireland. And the first steps towards establishing a physical presence in Germany and Canada, pending regulatory approval. We saw continued growth and momentum from our payments initiatives. Fees from our foreign exchange and credit card lines grew by 20% in 2016 and FX revenues exceeded $100 million for the first time. We closed approximately 3,800 new cash management, card and merchant service deals in 2016. We also crossed the $3 billion threshold for client credit card spend and $5 billion threshold for total card volume. We continued to enhance our payment capabilities, platform and reach through partnerships. One of the most significant of these partnerships is with First Data, who’s industry-leading platform enables our clients to make and receive payments on any platform globally. And we reached a significant milestone in 2016, processing more than $1 trillion of payments. And that compares to $880 billion in 2015. Finally, we received a healthy amount of external recognition in 2016, but I’d like to call out two distinctions. Our strong performance put us on the Forbes’ best banks list for the eighth year running. And in one of the acknowledgements of which I'm most proud, we were included in Forbes’ first ever Just 100 list, one of only three banks on the list. This list is effectively a ranking of corporate integrity. I'm most proud of this recognition because it highlights our commitment to achieving success in a way that's consistent with our corporate values. As we look into 2017, we believe there are a lot of reasons to be positive. We are optimistic that 2017 will be a stronger year for VC investment and exits in 2016. If 2015 was the year of funding and 2016 was the year of recalibration, we believe 2017 has the potential to be the year of liquidity. While the VC market recalibration of 2016 created many challenges for early-stage companies, VC investing still remained near all-time highs, with $69 billion invested in more than 7,000 companies. We believe the recalibration was a healthy adjustment overall, signaling a return to a more normal pace of VC investment in 2017. Fundraising remained extremely strong in 2016 despite the investment pull back as VCs raised $41.6 billion, the highest amount in a decade. Clearly, VCs will have a lot of capital to deploy in 2017, although later stage startups may continue to attract the lion’s share of investment at the expense of early-stage companies. As we enter into 2017, the exit markets are looking promising. In addition to the 20 or so venture-backed companies that are formally registered for IPOs, we are aware of a growing pipeline of other companies that have file confidentially or are planning to file for an IPO. While the exit markets could remain somewhat challenging, especially for companies with high valuations, the mood has markedly improved over last year, helped by solid performance of companies that went public in the second half of 2016 and greater confidence since the US election. On the M&A front, we believe corporate tax reform could provide additional liquidity that could drive better M&A activity in 2017. Turning to the broader economic landscape, strengthening US economy and a steeping yield curve suggests an improving growth picture in 2017. Recent short-term increases in interest rates and higher interest rates implied by the forward curve will benefit asset-sensitive banks. And few banks are more asset sensitive than SVB. While it is too early to know what policies the new administration will enact, it is widely expected the corporate tax rates will fall and certain regulatory requirements impacting banks may be relaxed. And general activity since the election suggests the markets expect the new administration will be good for US businesses. For SVB specifically, our clients as a whole have tended to perform well through good and bad markets. We expect that trend to continue. We believe improving business conditions and exit markets will drive more new company formation and investment. In addition, the potential repatriation of an estimated $2.5 trillion that American companies are currently holding overseas could significantly increase liquidity for acquisitions and investments. With these conditions in mind, we see potential upside to our initial full year 2017 outlook. In addition, we’re increasing our outlook for net interest income and core fee income due to the expected impact of December’s rate increase. While we are optimistic about year ahead, we will face challenges. Global market volatility and uncertainty continue to affect our clients. In addition, it is unclear how the new administration's trade and tax policies will affect our clients that do business globally. Competition for us remains intense and we believe it's here to stay. And while we believe we have passed through the most significant impacts of last year's market recalibration, many of our early-stage clients are still feeling its effects on access to capital and valuations. In addition, elevated M&A activity among our clients continues to present a headwind to a higher rate of loan growth. We believe these challenges are manageable, however, and we remain optimistic about the resilience and the power of the innovation ecosystem. Our innovation clients continue to perform well overall and remain active regardless of short-term market bumps. Our unique place in the innovation ecosystem, our reputation, relationships, experience and insight gives us significant advantage in winning and keeping the best clients and helping them succeed. We see continued opportunities for growth and expansion in 2017 and remain focused on our long-term priorities of enhancing our client relationships and building our brand, expanding our platform capabilities and reach, and strengthening risk management to help support our growth. We have consistently demonstrated our ability to execute effectively under a variety of market conditions, aligning ourselves with the best companies and investors over the long-term. We have a long history of disciplined growth and now, more than ever, we remain focused on delivering high-quality growth and strong returns that we can sustain over the long-term. Our unique culture and place in the innovation economy remain key factors in our ability to attract and retain the very best employees, whose mission is to support our remarkable clients and increase their probability to success. Thank you. And now, I'll turn the call over to our CFO, Mike Descheneaux.

[Michael Descheneaux:]

Thanks, Greg, and good afternoon everyone. Let me get right into the quarter. I plan to highlight the following items in my comments. First, healthy loan growth across the portfolio with continued strength in private equity and the private bank; second, strong total client funds growth; third, higher net interest income despite a slightly lower net interest margin; fourth, stable credit quality; fifth, solid core fee income growth; and sixth, higher expenses. Additionally, I will comment on our capital ratios and provide details on our 2017 outlook, which has improved somewhat from our preliminary outlook in October. Starting with loans, average loans grew by $614 million or 3.3% to $19.3 billion, driven primarily by private equity capital call lines and the private bank. Strong period-end loan growth of $788 million or 4.1% was driven primarily by private equity, early-stage and sponsored buyout and points to healthy momentum as we enter 2017. Moving to total client funds – that is, combined on-balance sheet deposits and off-balance-sheet client investment funds – we saw a return to growth in the fourth quarter due to a combination of increased funding rounds and new client acquisition. Average total client funds grew $3.7 billion or 4.5% to $84.7 billion in the fourth quarter. This reflected strong average deposit growth of $1.8 billion or 4.7% due to cash inflows from growth stage clients tied to new funding and from our private equity and venture capital clients despite some seasonal outflows related to year-end distributions. It also reflected average client investment funds growth of $1.9 billion or 4.3%, primarily as a result of higher balances from our growth stage and corporate finance clients due to capital raising activity. Turning now to net interest income and our net interest margin. Net interest income increased by $7.4 million to $296.6 million in the fourth quarter. Higher average loan balances drove this increase, along with a benefit of $1.6 million from December's Fed fund increase, which was consistent with what we would have expected from the rate increase. Additionally, we saw an increase of $2.4 million in interest income from fixed income securities. The increase was primarily due to a $4.7 million change in premium amortization expense from Q3 to Q4 as a result of changes to prepayment estimates following the increase in market interest rates in the fourth quarter. Our net interest margin decreased by 2 basis points to 2.73% due to a higher average balances of cash and short-term investment securities, our lowest yielding asset. Now, let us move to credit quality, which remained stable overall. Our allowance for loan losses was $225.4 million at the end of the fourth quarter or 1.13% of total gross loans, an overall decrease of $15.2 million or 12 basis points compared to the third quarter. We recorded a loan loss provision of $7.1 million compared to $19 million in the third quarter. Our provision primary reflects $14.3 million in specific reserves for net new non-accrual loans and $6.5 million for loan growth. These additions were partially offset by a $5.8 million net reduction in reserves for performing loans. In addition, we also made certain enhancements during the quarter to our methodology for determining our allowance for loan losses and our reserve for unfunded loan commitments. The results were a $7.9 million decrease in the allowance for loan losses, which is reflected as part of our provision for loan losses, and an $8.1 million increase in our reserve for unfunded loan commitments, which is recorded in non-interest expense. The net impact of these two enhancements had a minimal impact on overall net income for the quarter. Given that our press release has a significant amount of detail in the various components of credit quality, I will limit my comments primarily to the quarter-to-quarter change in certain components and refer you to our press release for additional details. Net charge-offs were lower at $21.3 million or 44 basis points in the fourth quarter compared to $22.5 million or 48 basis points in the third quarter. I would note that the majority of our net charge-offs were previously reserved for and, therefore, had no significant impact on the provision for the quarter. Non-performing loans increased by $12.8 million to $119 million or 59 basis points compared to $106.2 million or 55 basis points in the third quarter. Now, I would turn 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 detail. GAAP non-interest income was $113.5 million compared to $144.1 million in the third quarter. Non-GAAP non-interest income, net of non-controlling interest, was $109.1 million compared to $139.5 million in the third quarter. The decrease was mainly related to lower net gains on investment securities and warrants relative to Q3, which was exceptional. These lower PE and VC-related gains were offset somewhat by higher core fee income. Let me review the components. First, non-GAAP net gains, net of non-controlling interests, on investment securities of $5.3 million compared to $18.4 million in the third quarter. These gains were driven primarily by distributions from our VC fund investments. Second, net gains of $4.6 million on equity warrant assets primarily related to valuation increases during the quarter. This compares to warrant gains of $21.6 million in the third quarter related to improving exit markets and Acacia’s IPO. Combined non-GAAP investment securities and warrant gains were $9.9 million. This number is net of two notable items, totaling $5.7 million, which includes a $2.8 million one-time write down on a strategic investment and a $2.9 million decline in the value of our Acacia holdings, which you will recall was the primary driver of third quarter's outstanding warrant gains. Moving on to core fee income, which includes fee from foreign exchange, credit cards, deposit service charges, lending-related activities, letters of credit and client investment funds. Core fee income increased $4.1 million or 5.1% to $84.6 million in the fourth quarter. This increase was driven primarily by higher foreign exchange and lending-related fee income. Income from foreign exchange fees increased by $1.2 million or 4.8% to $27.2 million. This increase was due to more clients actively managing their currency exposure as a result of volatility in global currency markets, something we have seen now for several quarters running. Lending-related fees increased $1.4 million or 17.7% to $9.6 million, primarily as a result of higher syndication fee income related to one particularly large deal. In general, we continue to see solid growth across most fee income lines. Moving on to expenses, non-interest expense increased by $22.8 million or 10% to $244.6 million in the fourth quarter. This increase consisted of several components. An increase in our provision for unfunded credit commitments of $8.3 million due to enhancements to our reserve for unfunded credit commitments, which I mentioned earlier, and $3.3 million in additional compensation and benefits expense. The most notable component of this increase was a $5.5 million increase related to compensation programs based on our stock price, which increased approximately 57% in the quarter. I would also like to call your attention to our effective tax rate in the fourth quarter, which was 35.5%, a decrease from the prior quarter and our usual rate of approximately 40%. This decrease was due to adjustments to our deferred tax balances. We expect our effective tax rate going forth to remain in the 40% range. Turning to capital. Our capital position remains healthy overall due to solid earnings. As you'll see in the press release, deposit and loan growth during the quarter drove average assets and risk-weighted assets higher. This had the effect of decreasing our bank level Tier 1 capital ratio by 7 basis points, although at 7.67% it still remains strong. We also saw a 12 basis point decline in our bank level risk-based capital ratios due to loan growth. Now, I’d like to discuss our 2017 outlook and provide some updates to the preliminary outlook we provided in October. This outlook is for the full year 2017 versus the full year 2016. Balance sheet growth rates are based on full-year averages, not quarterly averages. Additionally, our outlook reflects the impact of the 25 basis point Fed funds increase we saw in December, but assumes no further rate increases in 2017. If there are rate increases in 2017, we will adjust our outlook accordingly. As a reminder, this outlook is based on our current forecast and assumptions about market conditions and is subject to change. Starting with loans, consistent with our commentary in October, we expect average loan balances to grow at a percentage rate in the high teens, with the strongest growth expected to come from private equity and the private bank. We expect average deposit balances to grow at a percentage rate in the mid-to high single digits, which is consistent with our outlook in October. We expect net interest income to grow at a percentage rate in the low teens and increase over our preliminary outlook of low-double-digits growth. We expect our net interest margin to be between 2.8% and 3%, which has been helped with the recent increases in rates. We expect credit quality to remain stable and comparable to 2016 levels. Specifically, we expect net loan charge-offs to range between 30 and 50 basis points of average total gross loans. We expect non-performing loans to range between 50 and 70 basis points of total gross loans and we expect our allowance for loan losses for performing loans to be comparable to 2016 levels. It is important to know that although we expect continued good credit performance in 2017, we could see credit metrics trend toward the higher end of our outlook ranges if our investor-dependent clients continue to see an impact from the 2016 recalibration. We are improving our outlook for core fee income and now expect to grow at a percentage rate in the high teens. This primarily reflects the impact of December’s rate increase on our client investment fees. We expect non-interest expense to increase at a percentage rate in the high single digits, consistent with our preliminary outlook. Keep in mind that if we outperform on our financial metrics, we could see higher incentive compensation, which would drive a higher rate of expense growth. Finally, while we do not provide an outlook for warrant and investment gains, we believe venture investment levels, trends in funding rounds and the pace of M&A and IPOs in 2017 will all remain key factors to our overall earnings performance. In closing, we had a strong finish to a solid year. Our outlook for 2017 is positive and has improved somewhat since our preliminary outlook in October as a result of December’s very welcome increase in short-term rates. Our clients remain healthy overall and we are seeing higher confidence in exit market prospects for 2017. While competition, economic uncertainty and global market volatility persists, we remain focused on delivering the right kind of growth, maintaining stable credit quality and succeeding in the long-term. We see solid momentum across our business and we believe we are well-positioned for 2017. Finally, I want to comment on our announcement that I will be taking on the role of President of Silicon Valley Bank. We have a fantastic banking team and I am looking forward to working more closely with them to support our clients and grow our business. For now, I remain focused on my role as CFO, but I'm excited about the future, specifically about the opportunity to harness the power of our platform as we grow to become an even stronger partner to our clients and retain our position as the bank of choice for innovators and their investors. Thank you. And now, I will ask the operator to open the line for Q&A.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from Ken Zerbe from Morgan Stanley. Please go ahead.

[Kenneth Zerbe:]

Great, thank you. Good evening.

[Greg Becker:]

Hi, Ken.

[Kenneth Zerbe:]

Question, in terms of – obviously, the deposit growth that you’re seeing, right, so it’s a bit stronger than what we were expecting, certainly increases the asset size faster. As you guys approach the SIFI buffer, right, and let's assume that the SIFI threshold is actually unchanged at $50 billion, does that accelerate your plans for getting ready for becoming SIFIite, specifically in terms of higher expenses? Because I think you mentioned a little bit about high regulatory expenses in this quarter’s results, I’m just trying to get a sense of the magnitude of change there.

[Greg Becker:]

Hey, Ken. This is Greg. I’ll start and I’m sure Mike will want to add. We did see nice deposit growth in the fourth quarter. We expect, as our outlook says, that deposit growth will continue, although not at the pace that we saw back in 2015. So, the timing, again, of hitting a higher threshold of $50 billion level is still a little bit in the distance. We’re not slowing anything down. We continue to invest as if that $50 billion hurdle will be there and unchanged. Obviously, we’re hopeful it changes. We’re hopeful there's more flexibility. But at this point, we are not definitely not banking on it.

[Kenneth Zerbe:]

Got you, okay. And then, if people have used the forward curve in their models, which we do, I think last quarter you mentioned what NII would be up if we applied the forward curve, has that changed? Can you just give – I don’t know – a potential range?

[Michael Descheneaux:]

So, Ken, we will come out with the updated sensitivity charts. But, generally, as you’ve seen over the last couple of quarters, for every one basis point increase in the rates, again across the board, what you will see is approximately a little bit more than $1 million benefit to net income. That’s after-tax. So, you can kind of gross it up a little bit to get to your net interest income number. So that’s generally the rule of thumb. And again, we will run the numbers in the model and publish it in our 10-Q here in the next couple of weeks – sorry, the 10-K.

[Kenneth Zerbe:]

Got it, okay. And then, really last question. Do you guys – in terms of the higher expenses, do you actually link incentive compensation to the benefit that you get in NII directly from interest rates?

[Michael Descheneaux:]

So, we have traditionally and historically been neutralizing that out of the equation for us. So, for example, in 2017 – sorry, 2018, as we go forward, if we have a lift in the interest rate, we would normalize that out and not necessarily drive a benefit from incentive compensation levels.

[Kenneth Zerbe:]

Okay, great. Thank you very much.

[Operator:]

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

[Ebrahim Poonawalla:]

Good afternoon, guys. Ebrahim here.

[Greg Becker:]

Hey, Ebrahim.

[Ebrahim Poonawalla:]

Greg, if you can start out in terms of thinking about asset growth, you talked about private equity, capital call lines and private bank are expected to drive growth, how should we think about the asset mix as we look into 1Q and 2017? Do you expect a considerable change between securities and loans and then within the loan portfolio or should it be more or less where we were in the fourth quarter?

[Greg Becker:]

Yeah. So, if you look at just in assets [indiscernible] deposits first, then we will convert that into assets. The deposit growth we had in the fourth quarter was very strong. It probably won't be that strong on a quarterly basis, but obviously we expect growth to occur. It’s going to be, I would say, pretty much in line in parity, when you look at the two together in general from growth perspective of loans matching the deposit growth. So, there probably won't be a big change in the investment securities portfolio overall. That being said, we do have investment securities that are maturing and cash flow coming and we’re able to reinvest that at higher rates, which obviously we are excited about. And if we get higher rates on the lending side through increasing Fed funds rates, we get a benefit there. So, it’s really on both sides of the asset side we hope to benefit. But from a growth perspective, I think, again, parity of deposit growth is going to match, generally speaking, the loan growth.

[Ebrahim Poonawalla:]

Understood. The thing to reconcile sort of when I think about your deposit guidance from mid to high single digits, with a spread revenue guidance for a low teens, so I’m assuming mid to high single digits is deposit growth and then the rest of that is the margin expansion, which is baked into your guidance of 3.20% to 3.4% – 2.80% to 3%, I mean.

[Michael Descheneaux:]

Yeah, that’s right. So, the net interest margin outlook we gave you, it does consider the Fed funds increase here in December. So, that's why you're seeing a bit of an increase going into 2017 here.

[Ebrahim Poonawalla:]

Okay, got it. And just in terms of – Greg, you mentioned tax reforms in your opening remarks, one, like if you can remind us the last time there was some foreign cash repatriation, sort of what impact that had on your business in terms of customer activity. And secondly, if we get any changes to interest expense, tax deductibility, like, does that impact how you think about the PE capital call line business or is it too soon to really think about that before we get any details on the tax reform bill?

[Greg Becker:]

Yeah. So, two points, Ebrahim. One is, I can’t recall that far back when we actually got the change in the repatriation. So, I actually can’t off the top of my head remember exactly what the impact was. Do I believe it’s a big impact? The only place where it has a potential for an impact is from an M&A perspective. If a lot more cash comes back in, could you see more M&A from larger corporations as they now are flush with a lot of liquidity and now they’re going to be willing to put that for growth, that’s clearly a possibility. But bottom line, any of the performs quite honestly that we – that’s being talked about in the news, it's way too early to tell. My guess is there really won't be a lot of clarity on it for the next six to nine months at the earliest. We’re, obviously, paying attention to it. I know everyone else will be as well and we’re hopeful, but it's just too early to tell.

[Ebrahim Poonawalla:]

Thanks for taking my questions.

[Greg Becker:]

Yup, absolutely.

[Operator:]

And our next question comes from Steven Alexopoulos from J.P. Morgan. Please go ahead. Please go ahead.

[Steven Alexopoulos:]

Hi, everybody. First, congratulations, Mike, to you. That’s great news.

[Michael Descheneaux:]

Thank you.

[Steven Alexopoulos:]

First question on expenses. In 2016, expenses were up about 12%, right? So, that’s above the original high single digit guidance. For 2017, you're still looking at the same high single digit range, but from a higher base in 2016. So, effectively, you're raising the forecast for expenses for 2017. What's driving this? Is this infrastructure, regulatory compliance? Thanks.

[Michael Descheneaux:]

There’s a few things to think about, Steve. And we tried to highlight some of these notable items in Q4, but, clearly, you're right, we gave the outlook for our 2017. But let me just kind of remind us of some of these notable items in the expenses there. You may have heard in the remarks where we increased our provision for unfunded credit commitments and that amounted to around $8.3 million. And that in itself is like 1% of the total expenses for the entire year. So, that’s quite a sizable item. The other item we point out in expenses was $5.5 million incentive compensation increase related to our stock price increase. We do have incentive compensation for certain leaders in this organization that are tied to the stock price and you saw just the unusual, dramatic lift in stock prices, in particular our stock price here in the fourth quarter. So, when we look at those two items alone, those aren’t something that you would expect to see every single quarter, and so as you enter into 2017, we would not necessarily expect to see those in 2017. So, hence we get a little bit of – I would say, a little bit of a breather there. But those two items in itself drove a significant amount of expenses. Clearly, we are spending from the regulatory front, clearly, we’re expanding on the infrastructure front and for our clients and products. We are a rapidly growing bank. We’re expanding internationally. So, there's just a lot of things going on that you would expect from a growth company.

[Steven Alexopoulos:]

Okay, that’s fair. On the loan growth, you guys had really strong growth in the capital calls under $20 million, which were more typically VC. I was surprise to see that given VC investment was down in the quarter. Give some color there. Are you seeing more optimism out of VCs in terms of putting capital to work?

[Greg Becker:]

Steve, this is Greg. I will start. I wouldn't read anything into that as far as giving indication of how much venture capital, how much private equity. We still have some private equity firms that will make capital calls that are on the smaller side. Yes, some of them are larger, but it's also common to see some of them do some smaller draws at the end of the year. So, it's – I would say wouldn't read anything into it. On the venture capital side, in my comments, I talked about what we're hopeful for and kind of the outlook for 2017. And here’s kind of the storyline behind it, right? There is a lot of companies that are keyed up to go – either go public or be acquired. And a lot of times, that gives more validation to valuations, right? It’s the market clearing price. Then you start to see this big pool of money that’s a little bit sitting on the sidelines come into those other companies that they believe may be similar to have the exit potential. So, our belief is the exits that we’ll be seeing will help to create demand for more money to be deployed into these companies. So, that’s where our optimism comes from. And that’s – again, that’s just what our outlook shows into 2017.

[Steven Alexopoulos:]

Okay. Thanks. Maybe if I could squeeze one more in. On the client funds, you had really strong growth in the off-balance-sheet product this quarter. Is this tied to the rate opportunity improving there or you’re just seeing more demand for off-balance-sheet than on-balance-sheet?

[Greg Becker:]

Steve, this is Greg again. I would argue it's just – that’s a one quarter event and we haven't seen it be a trend yet. And so, I think it truly is just a – the mix that occurred in the quarter, nothing really being driven on our part or the clients’ part, it’s just – it’s where it ended up at the end of the day. As we’ve talked about in the past, our view is we would love to see a balance between when deposits or client funds come, but it’s roughly 50% off-balance-sheet, 50% on-balance-sheet, and that’s kind of what our goal remains. And so, quarter-to-quarter, you may see swings. But when you net things out, that’s kind of what we’re driving towards.

[Steven Alexopoulos:]

Okay. Thanks for all the color.

[Greg Becker:]

Yeah. You’re welcome, Steve.

[Operator:]

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

[John Pancari:]

Good afternoon.

[Greg Becker:]

Hey, John.

[John Pancari:]

And, Mike, congratulations on the change.

[Michael Descheneaux:]

Thank you, John.

[John Pancari:]

On the expense topic again, just – I hear you how you describe the expense trends going into next year and the investments that you’re still making, can you just give us how you’re thinking about the efficiency ratio and where do you think that could come in for the year, given that you’ve had the changes around the provisioning for the unfunded and I’m not sure how that impacts – how we should think about efficiency in the ratio of an annual basis. Thanks.

[Michael Descheneaux:]

So, I think the best starting point for you is to start with the expense growth outlook that we say, which is the high single digits. And you can certainly work back into the efficiency ratio. You’ve seen here over the last couple of years – where do we finish the quarter? Something around 54%, 55%, somewhere in there. You can see that downward trend overall on our expense basis. So I think that’s probably your just best point, John, to really start with, is just the expense outlook, then work itself in. We continue to be focused on the efficiency ratio. But, again, we know we’ve got a fine balance between trying to maintain the growth. So, there’s definitely a lot of tension there and there’s certainly without a doubt pressure on expenses, but one that we’re very, very focused on. And, certainly, the things around continuing to spend on the regulatory front will just continue. It’s just a fact of life here for a while unless the government does something that kind of changes that trend.

[John Pancari:]

Okay. All right. Thanks, Mike. On the Fed hike topic, could you just quantify how much did the hike in December benefit your loan yield and your NIM in isolation?

[Michael Descheneaux:]

John, I haven't gone and worked out the math. I think the very simple rules – and you guys can actually work it out when you look at the disclosures in the 10-Q and 10-K. The simple rule of thumb is every basis point increase in those short-term rates will have a benefit after-tax of a little bit over $1 million. I think that’s probably the best way for you to look at that. It's been holding true for probably the last several quarters and that’s probably your best guide. As I’ve mentioned earlier, we’ll come out with kind of the updated sensitivities there, which does change quarter to quarter slightly, but for the most part it's been fairly consistent for the last several quarters.

[John Pancari:]

Okay, all right. And then lastly, on the loan growth outlook, can you just give us a little bit more color on the mix of the growth through 2017? Where do you think the bulk of that could come from?

[Greg Becker:]

Yeah, John. This is Greg. I’ll start and Marc may want to add something. If you break this down, right, so it’s a private equity venture capital, the capital call loans continue to be just such a great opportunity and I know we talked about this on, obviously, the last several quarters, but it just continues to be a great place for us to – with low risk, bring in some high-quality lending. That’s number one. Private bank will be the next area again. Even when rates start to pick back up, we believe we've only really scratched the surface with our client base, and so there's upside with the private bank there and that's in mortgages and also there are private loans. And then, if you take those two as the biggest drivers, the rest is really across the board, whether it’s life-sciences or global business, asset-based lending and our tech portfolio, sponsor-led buyout, you kind of see what we believe is consistent, albeit smaller growth across all those areas.

[John Pancari:]

Okay, great. All right, thank you.

[Greg Becker:]

Yup.

[Operator:]

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

[Aaron Deer:]

Hi. Good afternoon, everyone.

[Greg Becker:]

Hi, Aaron.

[Aaron Deer:]

A question on the growth outlook. In years past, you’ve had a certain amount of seasonality that comes in at the end of the year and sometimes it's paid off quickly and sometimes it's delayed. As you look at the mix of growth that you had in the back half of the year, how do you expect the paydowns of some of those to play out over the first couple of quarters here?

[Marc Cadieux:]

So, this is Marc Cadieux. It’s always a little challenging to predict, the borrowing and repayment outlook for our private equity borrowers. I think having said that, the sense is that there's going to be the potential at least for strong activity in 2017 and thus continued borrowings on capital call lines of credit.

[Greg Becker:]

But I think, Aaron, we didn't see the big run-up that we had in 2015. If you recall, we had, very late in the quarter, a very, very large run-up. We didn’t see that this year. So, it was a more of a steady growth, and so we don't expect a big decline right out of the gate in 2017. So, it should be a lot more smooth.

[Aaron Deer:]

Sure. Okay. And then, Mike, following up, I guess, on one of the earlier questions with respect to the expenses, you highlighted a couple of the more kind of non-recurring or one-time items in the fourth quarter that boosted the overall number for the year, but the guidance that you're giving is still off the – that total base, right?

[Michael Descheneaux:]

So, the guidance we’re giving is off the total expense base for the entire year 2016. That's correct.

[Aaron Deer:]

So, is it your expectation then that there could be other similar – we could continue to see any sort of outsized either provisions, unfunded commitments or additional compensation for stock-related comp or what are your thoughts there?

[Michael Descheneaux:]

No, I think those two were, I think, notable as we characterized them as well. So, again, unless you really expect our stock price to run up another 50% here in such short a period of time, it’s just unlikely you would have any real material amount that’s going to be driving that here in 2017. So, no, it got capped out quite a bit with this nice run. Similarly, on the provision front for unfunded commitments, we just made some refinement and enhancement to the methodologies. So, again, we have no real plans necessarily to have another change like that to drive that. So, I think, at this point, I would say, I don't see those types of things being recurring in 2017. Now, the one other thing to think about as we go into 2017 is we reset our incentive compensation level targets. So, because 2016 was such a strong year, the incentive compensation pool that we pay out was much higher than the initial target as we go into the year. So, that resets back to our 1x factor, so to speak. So, when you're going into almost like Q1 of this quarter, you could expenses potentially going down versus the Q4. Again, so things just reset and recalibrate. So, that might be where some people may be struggling with kind of – you’re at that run rate in Q4. I see you building off of that, but the reality is you’re going to have some benefits and takeaways going into Q1. We’re kind of starting at a lower base in Q1. So, hopefully, that helps.

[Aaron Deer:]

Okay. The first quarter usually does have, what, like $10 million or so in outsized comp related to FICA and such?

[Michael Descheneaux:]

Yes. So, those will be certainly seasonal expenses. I don’t know if it would be quite $10 million, but you’re somewhere, let’s say, between $5 million and $10 million. So, you will have maybe those type increase. But then, again, when we start to think about the unfunded, will you have that same $8.3 million unfunded in Q1? Probably not. Will you have that same $5.5 million increase in stock compensation in Q1? Probably not. So, that’s why you had a lot of the offsets. And again, coming back to where you reset the incentive compensation level to a 1X target versus the elevated levels that we had in 2016.

[Aaron Deer:]

That’s great. Thanks for the clarification. And congrats on the new gig, Mike.

[Michael Descheneaux:]

Thank you very much.

[Operator:]

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

[Jared Shaw:]

All right, thank you. Just looking at that provision for unfunded commitments, the $8.3 million, how much of the $8.3 million was a one-time readjustment versus how we should be looking at the distribution between provision and traditional line and provision and the expense line for normal growth going forward?

[Michael Descheneaux:]

For all practical purposes, the majority, if not all of it, was more or less related to that. As you’ve seen, kind of in a given quarter anyway, it's in plus or minus kind of $1 million. So, it’s usually a pretty small number overall. So, the vast majority of that number would be just this enhancement.

[Jared Shaw:]

Okay, okay. And then, maybe just a little bigger picture – I appreciate the commentary on potential tax reform. But as you look at – if the domestic tax situation got significantly better, does that change your views in terms of opportunity for international growth? Would you expect to see more of those customers actually just coming into the US and trying to develop domestically or would there still be the same opportunity for future foreign growth?

[Greg Becker:]

Hi, Jared. This is Greg. Almost back to my earlier comments, it’s just too early to start speculating on what would happen because there is a lot of positive potential things that happen. There's other things that made – people have asked us about, how does it impact your clients in a negative basis, the ones that operate globally. Really, the great thing about our client base is that it is very nimble and flexible and they’re used to just being able to change very quickly. And that's one of the most positive things about our client base. And so, it’s just too early for us to start thinking about what I'll call strategic change or anything related to that until there is a lot more clarity.

[Jared Shaw:]

Great, thank you.

[Greg Becker:]

Yup.

[Operator:]

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

[Brett Rabatin:]

Hey, good afternoon. Congrats, Mike.

[Michael Descheneaux:]

Thank you, Brett.

[Brett Rabatin:]

I wanted to just go back on the tax rate. If we do have reform, just thinking about the effect it would have on your earnings, would all of that fall to the bottom line? Just thinking about the DTA adjustment you made in the fourth quarter, how should we think about the implications if the tax rate is lowered on your actual earnings?

[Michael Descheneaux:]

I think the implication is we would all be ecstatic, first and foremost. Clearly, as you’ve seen, generally, for our banks, we have one of the higher effective tax rates in the industry. And part is, because we operate in some of the most expensive, high tax rate states such as California and Massachusetts. But, clearly, we would stand to benefit significantly if they lower the federal rate down to 20% or 15%, whatever the number they're talking about. And for us, we tend to get a bigger lift in other banks because we have less composition of tax advantage investment security. So, said another way, we have less municipal investment securities than other banks may have. We don't have bank owned life insurance. We don’t have a few of these other products or as many of the other things. So, we will definitely benefit a lot more for that. So, one can only hope that it will drop, but, as Greg said, it’s just too early to tell to even start to count anything.

[Brett Rabatin:]

Okay. So, nothing really to offset the decrease. And then the other question I had was, the last time you…

[Greg Becker:]

If I just may clarify, because you were just talking about something to offset the decrease, I didn’t quite understand what you meant by that.

[Brett Rabatin:]

Just if there was anything you would – in terms of – if the tax rate was lowered, if there was anything that you were going to have – like, would it all drop to the bottom line essentially? And it sounds like that’s the case.

[Michael Descheneaux:]

Yeah, I think that’s a fair way to look. At this point – again, there’s been talk about what’s deductible, what’s not deductible. Again, we can’t go into that because it’s just – who knows right now. But just, all things being equal, if you drop the federal tax rate, you're right, for the most part, at this point, we would see most of it drop into the bottom line and benefiting shareholders.

[Brett Rabatin:]

Okay. And then, the other question I had was just around credit. The last time, you guys talked about the higher end of the range on charge-offs. I think people got a little antsy about the early stage. Can you maybe just talk about the recalibration and what may have fallen out in the fourth quarter in terms of early stage and just any thoughts around what you're seeing in terms of the early-stage portfolio?

[Marc Cadieux:]

So, it’s Marc Cadieux. Early stage was interesting in the fourth quarter, in that we saw charge-off levels in the early-stage segment that were reminiscent of 2015 best of times, but then we also saw an increase in new early-stage non-performers, indicative of that continued stress in that segment, going on from the recalibration that started last year. And given the diminished rate of investment in early-stage companies throughout 2016, it’s our conclusion that we’ll continue to see some stress in that segment. Having said that, I think as our guidance reflects, we expect that stress overall to be manageable and, by extension, to be able to live within the charge-off guidance for 2017.

[Brett Rabatin:]

Okay, great. Thanks for the color.

[Greg Becker:]

Thanks, Brett.

[Operator:]

And our next question comes from Chris McGratty from KBW. Please go ahead.

[Christopher McGratty:]

Hey, good afternoon. Congrats, Mike.

[Michael Descheneaux:]

Thank you, Chris.

[Christopher McGratty:]

If we’re thinking about the next rate hike, your off-balance-sheet, your client investment fee rate, I think, last time, were up about 2 basis points. Is that about the rate of assumption we should assume for each subsequent raise or is there any kind of upward or downward adjustment?

[Greg Becker:]

Hi, Chris. It’s Greg. That is a good job benchmark to take into consideration. You’re right. It was roughly 2 basis points. And if we saw another 25 or 50 basis points, you could assume it would be in that range.

[Christopher McGratty:]

Okay, great. Maybe a second question on capital. Obviously, capital levels have increased nicely over the past six to nine months. Any change in the way you’re approaching capital planning for 2017, given the growth aspirations in your stock price?

[Michael Descheneaux:]

So, right, now all of our capital is going to continue to support our growth both here in the US and abroad as well too. You’re right, capital levels have gotten stronger. They've improved for the first time at levels where we can actually consider different options. We’re not advocating anything, whether it’s buybacks or dividends or further growth options, but at least now, in our planning, we can start to consider about whether or not – or evaluate the different options we may or may not have. So, yes, different discussions, more discussion starting to happen here in 2017 than in the past. But nothing on the agenda right now to do anything radically different than what we've done over the last several years.

[Christopher McGratty:]

Great. And maybe if I could ask one more, Greg, the comments in your opening remarks were markedly more optimistic than you were six months ago and your comments about exit markets being pretty active and healthy for 2017 was encouraging. Tough question, but third quarter was a big exit quarter for the bank. This quarter was a little bit less. Should we interpret kind of the near-term exit potential for the [indiscernible] to kind of get back to the third quarter level or is that a bit of a stretch? Thanks.

[Greg Becker:]

Chris, as we have said in the past, it’s the most difficult thing to predict because the window for IPO is going to open and close very quickly. M&A activity can – all of a sudden, you see a whole slew of companies. So it depends upon the extent, the size of these exits, number one, and also it depends upon the concentration. Our point is just that the outlook that we see, in talking to our clients and talking to investment banks and talking to clients and talking to strategic partners is very positive relative to what we saw in 2016. And if you look at the number of both publicly filed IPOs and what we know about our existing clients and just discussions about the private filings, it’s really healthy. And that's good. And as we have said in the past, the exit market last year was very slow. But what you have happening in that time period is these companies – a lot of them continue to perform well. They’re getting stronger. They’re delivering better revenue. They’re delivering either bottom line profits or they’re narrowing their losses. All those things are good indications for what we hope is going to be a good exit year.

[Christopher McGratty:]

Very helpful. Thanks a lot.

[Greg Becker:]

Yup.

[Operator:]

And our next question comes from Geoffrey Elliott from Autonomous Research. Please go ahead.

[Geoffrey Elliott:]

Thank you for taking the question. When you’re thinking about all of the regulator reforms that could happen, raising the $50 billion threshold, Volcker being changed, which one thing could regulators do that you think would make the biggest difference for your bank?

[Greg Becker:]

I’ll start. Those are all tempting things to think about. And, again, it’s just too early to spend a whole lot of time on it. But, if you we can look at Volcker, I don't believe – assuming that we get an extension on our time to comply with Volcker, I don't think that’s going to really have a dramatic impact on our business. So, if it changed, yeah, it’d be nice, but I don’t think you’re going to see a dramatic impact on our business, which means that really the regulatory reform and the hurdles of the requirements for SIFI are the biggest things. From my standpoint, I think about the regulations – I think just like the DFAST and everything else we went through, there's a lot of positive things, benefits we got out of it as an institution that I would argue did lower our risk, which is good. On the SIFI side, there are things that I think fall into that camp and there’s things that fall into the camp that from our standpoint aren’t as important to lowering the risk. And so, even if you had a designation of SIFI going up to a higher level CCAR, you are still going to have to invest in the regulatory side of the house. We’re still getting big. It’s just the trajectory of growth that is going to actually be lowered and that's that we’re looking for. So, it’s mainly in that area that we would see benefit.

[Geoffrey Elliott:]

And then just one quick further question. The split in the president role, I guess having one president of Silicon Valley Bank and another president of SVB Financial, what’s the kind of thought process there?

[Greg Becker:]

So, this role, it may seem like a new role. It’s actually the role I had before I became CEO. And the one benefit of that really is really aligning all the banking activities together. Today, in addition to the banking activities, more the client-facing, market-facing role that I have in my existing role, I do have the regulatory side, I’ve got the risk, I have operations working with the team. Obviously, this is all done by our team. But as I look at the next five-plus years, the next ten years, being even more tightly coordinated, so that we can make decisions faster, jump on opportunities more quickly, those things I'm really excited about. It’s going to allow me to focus more. And having Mike in the banking team, which has done a phenomenal job, even be more focused and take advantage of the opportunities is, to me, what I'm most excited about. And as we’ve talk about it internally, I'm only getting more excited about the opportunity and what I think it will mean in 2018, 2019 and 2020 and beyond.

[Geoffrey Elliott:]

Great, thank you.

[Greg Becker:]

Yup.

[Operator:]

That concludes the question-and-answer session. I’ll now turn the call back over to Greg Becker for closing comments.

[Greg Becker:]

Great, thanks. So, first, I want to thank everyone for joining us today. We described a strong quarter and really good momentum going into 2017. We increased a couple of areas of our outlook. So, healthy growth in 2017. We also think there's potential upside. As we described, our outlook doesn't include any additional rate increases other than what we saw in December. So, if the rates rise, there should be some additional benefit there. And that’s even before we get into anything talking about tax reform or regulatory reform, which, as we said, is too early, but clearly we’re hopeful we'll get some benefits from that. And that will turn out too in a positive way. As I close every call, I just want to really thank our employees for doing such a great job of taking care of our clients and really living and breathing SVB’s mission. I want to thank Mike for all the things he’s done as the CFO, and I know he is not going anywhere. So, he’s going to be in the CFO role until we find a replacement. But I am excited about Mike and his new role. And we work exceptionally well together and I'm looking forward to that on a go-forward basis. And I also want to thank all our clients for putting the trust in us. Every quarter that goes by, I get an opportunity to spend time with our clients in a variety of different ways and I can tell you that we have, without a doubt, the most dynamic, interesting engaging clients of any institution in the world. And that's what motivates all of us every day. So, looking for a great year and progress next quarter. And just hope everyone has a great day. Thank you.