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SVB Financial Group (NASDAQ:SIVB)

Q4 2008 Earnings Call Transcript

January 22, 2009 05:00 pm ET

Executives

Meghan O’Leary – Investor Relations

Ken Wilcox – President and Chief Executive Officer

Mike Descheneaux – Chief Financial Officer

Dave Jones – Chief Credit Officer

Greg Becker – President, Silicon Valley Bank

Analysts

Aaron Deer – Sandler O'Neill

John Pancari – JP Morgan

Erika Penala – Banc of America

Joe Morford – RBC Capital Markets

Fred Cannon – KBW

Operator

Good afternoon. My name is Abigail [ph] and I will be your conference operator today. At this time I would like to welcome everyone to the SVB Financial Group Fourth Quarter 2008 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions).

Thank you, Ms. O’Leary, you may begin your conference.

Meghan O’Leary

Thank you. Today, Ken Wilcox, our President and CEO, and Mike Descheneaux, our Chief Financial Officer will discuss SVB’s fourth quarter and year-end 2008 performance and financial results. Following this presentation, members of our management team will be available to take your questions.

I’d like to start the meeting by reading the Safe Harbor disclosure. This presentation contains forward-looking statements within the meaning of the Federal Securities laws including without limitation financial guidance for the full year 2009. Forward-looking statements are statements that are not historical facts. Such statements are just predictions, and actual events or results may differ materially.

The information about factors that could cause actual results to differ materially from those contained in our forward-looking statements is provided in our press release and our last filed Form 10-K and 10-Q. The forward-looking statements are made as of the date of broadcast, and the company undertakes no obligation to update such forward-looking statements. This presentation may also contain references to non-GAAP financial measures. A presentation of and reconciliation to the most directly comparable GAAP financial measures can be found in our press release.

Now I’d like to turn the call over to Ken Wilcox.

Ken Wilcox

Good afternoon and thank you for joining us. As you can imagine all of us here at SVB have mixed feelings about this quarter for obvious and understandable reasons. All told it was a very mixed quarter. In many regards, I’m very disappointed with our results. In many other regards I believe that we have a lot to be proud of and lot to be enthusiastic about.

I would like to start with my disappointment. Our earnings for the quarter leave a lot to be decided. Our first three quarters this past year were all record quarters and we were horning in on a record year. And then in the final quarter, we effectively lost our chance before what would have been a record year. Instead of the $0.60 to $0.70 we are all expecting, we barely broke even.

I should be clear from the press release we issued a week ago, the shortfall is almost 100% attributable to the provision. Instead of our usual 5 to $10 million, we took a $67 million provision in Q4. As a result we almost doubled our reserve, so I imagine you are all wondering why? The rise in the provision is partially due to approximately 24 million in net charge-offs in Q4.

And it’s partially due to $3 million to accommodate growth. But, primarily approximately $40 million is to build our reserve. So, what specifically happened? After what we have all been through in the past three months, I can imagine that the answer is fairly obvious.

The deterioration in the overall economy both domestically and globally has finally caught up with us here at SVB. I know that I don’t have to describe to you what has happened in the overall economy with that from a broader perspective and by that I mean from an overall perspective not necessarily ours we all entered into a new era in these past couple of months.

Beginning in October, markets flows as fear began to dominate emotions and the control behavior, by virtually every single measure of economic health and progress both the U.S. economy and most of the global economy continue to deteriorate and that deterioration after October was deeper, more dramatic and more pervasive than almost anybody had expected.

And as a result, this time even the world of venture back technology and life sciences companies has been affected as well. Just in these past couple of months a lot has happened almost all of it negative, on a average we believe the sales at our portfolio companies have dropped off somewhere between 5 and 15%. And in a few cases potentially even more.

Venture funding has dropped off significantly in these past couple of months both in terms of the amount of money that traditional LP's have been willing to commit a new funds and in terms of the amount of money that DCs have been willing to invest in new companies.

After rising every year since 2003, venture capital investment fell from 31 billion in 2007 to about 28 billion in 2008. During the same period fund raising dropped over 21% from above 35 billion in 2007 to 28 billion in 2008. Exits are few and far between. There are no IPOs and relatively few trade sales. And even those few trade sales are at valuations that are significantly lower that has been true for a number of years. LPs are struggling largely due to the so-called denominator effect. Because the values of the other parts of their portfolios have dropped dramatically, they are in effect overcommitted in so-called alternative assets, which include venture capital.

I would like to emphasize however that this has not at least not yet resulted in them not responding to capital calls. To the best of our knowledge and our knowledge is extensive, LPs have continued to respond to capital calls. But on the other hand because of the denominator effect they are reluctant to commit money to new funds and may be for sometime. Fortunately, there is enough dry powder in the system and by that I’m referring to money that limited partners have already committed and if not yet delivered. Enough money in the system to last for some considerable amount of time. The result for the world we live in has been as follows.

Across the board, venture capitalists are forcing their companies to tighten their belts and across the board, the CEOs and CFOs of our portfolio companies are worried about two things. Will their own customers continue to buy product and if they do will they themselves be able to find funding to support those sales, and the impact on us is in part I’m sure obvious. We are seeing some of our portfolio companies struggling to a greater extent and it has been true for years.

As we experienced in the fourth quarter things can change very dramatically and very fast. Our warehouse facility with HRJ Capital in the case in point. HRJ is a company that we worked with for ten full years with a proven track record, a talented team and access to some of the best venture capital funds in the world. We had never seen them struggle to raise money from limited partners. But that changed in 2008 and HRJ and by extension SVB, found ourselves in the unfortunate situation we have since discussed.

We have learned from this and we are refining our processes to help us avoid such instances in the future. Not only are we monitoring our larger credit more closely than we have in the past. But we are also modeling out for a broader set of future economic scenarios to better understand what extreme changes in the economy such as we saw in these past couple of months would mean to each individual credit.

While on the other hand, we are seeing some of our portfolio companies struggling on the other hand and I’m sure that this is not so obvious. We believe that our portfolio companies are still doing surprisingly well particularly in light of what is happening in the rest of the economy. In many cases, the products that they are developing or selling are actually even more necessary to their clients in a recession than they would be during a boom.

I would like to underscore even in a recession there is likely no better part of the economy to invest in than the world of venture backed technology and life sciences companies

I would also like to underscore that in 26 years of lending exclusively to this industry I have never seen it so affected by developments in the larger economy as we are seeing today.

So, let me now turn to the good news to the part of the quarter that I believe we deserve to be proud off and that continues to feed our enthusiasm. Our capital base is strong, and I would argue stronger than it has been for some time. Our liquidity has improved significantly. Our success in attracting deposits out of our broker dealer and onto our balance sheet has driven our loan to deposit ratio from 97% down to 74%.

And I would like to underscore, well loans have continued to grow in our fundamentals continues to be strong deposits of grown 62% in the last year. Loans have grown 33% in the past year and will continue to grow albeit at a smaller or slower phase in 2009. Commercial banking fee income has grown 15% in the past year, and would have grown more had it not been for the drop in rates. And our NIM while reflecting the continued drop in the said funds rate has held up I believe surprisingly well and the year when the FED funds rate drop 400 basis points, our NIM lost only a 151 basis points.

And we have continued to control our expenses even while investing in our future. Year-over-year non-interest expense dropped 9% inclusive of the fourth quarter Incentive Compensation and Employee Stock Ownership Plan reduction of 24 million.

Finally a few words on the outlook. Well I can’t tell you how long or how deep this recession will be, we will continue to focus on the long-term benefits or you the shareholder and for our other constituencies as well. And of course we continue to focus on the fundamentals growth and loans, growth and deposits, credit quality, growth in fee income, NIM, expense control and the strength of our balance sheet and we believe as importantly we continue to focus on the future in preparing ourselves to take maximum advantage of it on your behalf.

We believe that the economy will eventually turnaround and that our sector will turnaround with it. America has not given up on innovation nor will it in the future. Every year we see growth in the number of fundable ideas. Capital is still at least in theory available in abundance and the world continues to clamor for the kinds of products and services that the companies we work with produce.

And that’s where we see opportunity in this chaos, if we continue to support our clients and invest in our future I’m confident that we will emerge from this recession far stronger than our competition until then we are ready for whatever may come our way. In these economic times being ready begins with capital and liquidity. Throughout 2008 we worked hard to ensure that we had adequate levels both in terms of safety and soundness and to ensure we could fund our growth.

With that we’ve made refinements to products both in terms of loans and deposits some that produce greater flexibility for our clients. We are better prepared today to help them meet their financial needs no matter their size or location and most importantly as a result of these investments when this recession does come to an end we will better - see better positioned we think than our competition.

No matter how disappointed any of us are employees or investors, let’s not lose sight of an essential fact. this company earned $80 million this year. A year when most banks struggled to make a profit that’s something we can feel good about.

Finally, we are ready for that ever may come because we have over 1,200 dedicated employees to all of the SVB’s listening in on this call will perform so well and this very difficult year I want to recognize you and thank you for your valiant efforts in the phase of an increasingly challenging economy.

And now I would like to turn things over to our CFO, Mike Descheneaux.

Mike Descheneaux

Thank you, Ken and thank you everyone for joining us today. I want to start by addressing the obvious challenges we had during the quarter and some of their effects and then I will talk about some of their high points.

In the fourth quarter of 2008, we reported diluted earnings per share of $0.09 and net income available to common shareholders of 2.9 million compared to $0.80 and 27 million in the third quarter. For the full year 2008, EPS was $2.33 and net income available to common shareholders with 79.1 million.

Return on equity for 2008 was 11.2%, which is a respectable number for any year but, particularly for 2008.

One of the driving factors behind our fourth quarter numbers was an increase in our loan loss provision. Fourth quarter results were also affected by lower client investment fees, a result of the historically low rate environment. We had another solid quarter of loan growth, thanks to our hardware and software industry clients, although they are exciting headwinds to future growth. We delivered outstanding deposit growth, and we’re pleased to announce that our total assets reached a milestone of $10 billion in the fourth quarter. Finally, we refortified our already strong capital position to our participation in the Treasury’s Capital Purchase Program.

Now let me move into some specifics. Credit quality. Clearly credit quality had the largest impact on Q4 earnings, so I’d like to start with that. Our provision increased from 13.7 million to 67.3 million from Q3 to Q4, which reflects the impact of increasing our allowance for loan losses from 1.13% to 1.87% of total gross loans. This increase was primarily due to the impact of the deteriorating economic environment and its current estimated impact on loans as well as reserves related to HRJ.

Our net charge-offs increased from 47 basis points in the third quarter to 171 basis points in the fourth quarter. Non-performing loans also rose to 1.57% of total gross loans or 87 million versus 18 basis points in the third quarter or 9 million, due again primarily to HRJ and a Private Client Services loan.

I want to make a few points before I move on. First, we do not believe these elevated charge-offs are indicative of overall weakness in our underwriting. As you know larger loans of 10 to 20 million and above have been a key part of our growth in recent years and we have a history of strong underwriting and monitoring. Moreover, we have just concluded an additional review of all loans in our portfolio larger than 20 million and concluded that our underwriting standards are effective and appropriate for this type of lending.

We are disappointed with increase in provision. As we have said in the past if the economy continues its downturn, we would expect to see more of an impact on our loan portfolio in coming quarters. Given current economic conditions, we are increasing our vigilance and will continue to monitor our portfolio closely and to address matters in a timely manner.

This recession of the economic environment in relation to our portfolio along with horizon charge-offs cause it to significantly increase our level of allowance for loan losses as a percentage of total growth loans in the fourth quarter from 1.13% to 1.87% inclusive of specific reserves for impaired loans.

Excluding specific reserves for impaired loans, our allowance as a percentage of gross loans was 1.41% for Q4’08 versus 1.03% for Q3’08.

Loans. Moving on to loans, we finished the year the way we started it, with strong growth in the fourth quarter. Average loans grew 7.5% to 5.2 billion in the fourth quarter, primarily as a result of loans to our hardware and software clients. This growth was partially offset by decreases in loans to venture capital funds for capital calls. It’s worth noting that we continue to take in a considerable number of new warrants for early stage of lending especially given a tightness of the credit markets right now. In 2008, we took 556 new warrants compared to 374 in 2007.

Now let me move onto deposit, where our focus on a strong balance sheet continues to pay off. We grew average deposits in the fourth quarter by 18%, or 853 million to 5.7 billion. End of period deposits grew by an astounding 2 billion, or 38% to 7.5 billion. This increase was driven primarily by our decision to fully utilize our own balance sheet Sweep product, which we introduce in 2007 and to transition away from third party off-balance sheet product.

We also expect to see some additional increases on the balance sheet in January, as a result of that strategy. Our results demonstrates the success [Audio Dip] to growing deposits and funding loan growth by adjusting our strategy for on and off-balance sheets fund that meet our clients risk profile and needs. In 2008, average deposits grew 24% to 4.9 billion and period-end deposits at 7.5 billion to 62%. This is a dramatic turn around from two years ago when average deposits were down almost 6% year-over-year.

Now I would like to move on to net interest income and the margins. Our net interest margin held up relatively well at 5.42% in the fourth quarter compared to 5.73% in the third quarter. This decrease was driven primarily by certain reductions in our prime-lending rate in response to fed rates cut in the fourth quarter. It is important to note that as a part of our broader focus on pricing, we decreased our prime rates by only 100 basis points in the fourth quarter while the fed decrease rate by 175 basis points.

The tight credit markets and increased risks are allowing us to proactively increase our pricing. Lower interest rates on our short-term investment portfolio also contributed the decline in them, and we are offset somewhat by lower interest expense from reduced short-term borrowings.

Net interest income increased slightly by 1.9% to 96.9 million in the fourth quarter, going to a decrease in interest expense from short term borrowings, and strong average loan growth. Net interest income for 2008 was down only 2% to 372 million primarily as a result of fed rate cut during 2008 even though fed rate were down 123% or 400 basis points.

Moving on to capital management, due to our outstanding asset growth in the fourth quarter, our ratio of tangible common equity to tangible assets decreased to 7.5% from 9.2% albeit still remains at a strong level.

In December, we received 235 million in capital through the Treasury’s Capital Purchase Program. As we disclosed earlier, we intend to use these funds for continued growth particularly lending to the markets we serve. Moreover the additional capital will allow us to absorb potential credit or investment losses should they occur without interrupting our lending activities.

We've been asked why we had applied these funds given our strong capital levels. And the answer is that we felt the uncertainly of the current economic environment, and our growth plan called for maximum flexibility.

Moving onto non-interest income, non-interest income was sharply low in the fourth quarter at 28.9 million compared to 41.7 million in the third quarter, primarily due to net losses on investment securities from venture related investments of 9.8 million.

The bulk of these losses were related to lower valuations of investments within our managed funds. As you may recall, we only own a small percentage of these funds so that net of minority interest is only about 1.1 million of the loss actually fell to our bottom-line.

As I mentioned earlier, client investment fee income in the fourth quarter was lower at 9.5 million compared to 13.6 million in the third quarter, primarily due to lower margins earned on certain off-balance sheet products owing to historically low rate in the short-term fixed income markets.

Average client investment balances, also known as off balance sheet funds increased by 1 billion to 21 billion, primarily due to our decision to fully utilize the on-balance sheet sweep products we introduced for clients in 2007, and transition away from the third party off-balance sheet sweep product we had previously offered clients.

End of period balances were 18.6 billion compared to 21.5 billion at September 30, 2008. Although we had great success in growing our off-balance sheet products in recent years, the extremely weak IPO market in 2008 has hampered those efforts. However, we have succeed in our efforts to provide clients with a range of on-balance sheet products that meet their needs and that has resulted in our tracking on to our balance sheet, some funds that would have previously gone off-balance sheet.

I would like to turn to non-interest expense now. Through the third quarter of 2008, we exceeded our targets for controlling expense growth. But while on the fourth quarter, non-interest expense was substantially lower at 62.9 million compared to 80.4 million in the third quarter, that drop was primarily due to lower incentive compensation expense as a result of below budget results for the quarter and for the year.

Now I would like to review our outlook for 2009. We are taking a slightly different approach this time in light current economic conditions, and are aiming to provide more insight on additional items. Having said that I’m sure you can all appreciate that it is difficult to forecast what will happen in the coming year given the uncertain and rapidly changing economic environment. We expect 2009 to be challenging in terms of suppressed evaluations for our client companies, a lack of exit opportunities, continued pressure on our net interest margin and the high probability that we will see rising credit costs.

Our outlook reflects our expectations for the full year 2009 versus the full year 2008. Although we will revisit and update our outlook each quarter, it is an annual outlook. Please refer to our press release for additional information. For 2009, we expect average loan growth at a percentage rate in the mid teens, with a significant amount of this increase relating to the full year effect of our 2008 loan growth on average balances.

We expect average deposit growth and a percentage rate in the high 30s again primarily related to the full year effect of 2008 deposit growth. Most of this growth will be in interest-bearing deposits. We expect net interest margin to range from 4.7 to 5%, assuming no changes in our own prime rate and market expectations for LIBOR and short-term treasury yields. We expect credit quality to be under continued pressure in 2009 as a result of their continued economic downturn, with our allowance for loan losses at approximately 1.4% of total gross loans exclusive specific reserves for impaired loans.

We expect net charge-offs to be approximately 1.3% of gross loans. We expect gross at a percentage rate in the mid single digit and fees for deposit services, letters of credit and foreign exchange in aggregate as a result of continued negative economic pressures. We expect client investment fees to decrease by roughly half compared to 2008 levels as a result of lower expected client investment fund balances and lower margins on certain products tied to the short-term fixed income markets.

Although deviating from our norm a little bit, we want to talk about our expectations for some of the more variable items that contribute to non-interest income specifically warrants and SVB capital venture related investments.

As I pointed out earlier, these items are challenging to predict in the best of times, but I would like to talk to you about our expectations at this point. We expect net gains on warrants to declines modestly compared to 2008, owing to a lack of IPOs and continued pressure on M&A and venture capital investments.

Owing to these same market forces, we expect net losses on investments in our venture capital related activities to SVB capital, net of minority interests to increase modestly.

Finally, we expect non-GAAP non-interest expense growth at a percentage rate in the low 20’s. And let me reiterate that while this expense growth number may seem high, our success in controlling expenses in 2008, and the exceptionally low compensation expense in the fourth quarter suppressed non-interest expense during 2008 to levels that are not sustainable, particularly, if we are to continue investing and building our business. If the 2008 non-GAAP, non-interest expense was normalized for the unusually low incentive compensation expense in Q4 2008, then our non-GAAP, non-interest expense growth for 2009 compared to the full year 2008 would be approximately or would be expected to be approximately 10%.

Before we move to Q&A, I would like to summarize briefly. Despite a truly terribly year for banks and the global economy, in 2008 we delivered a solid return on equity as well as outstanding loan and deposit growth, which are both the twin engines of our business. We have proven that we are able to execute on our strategy.

While the fourth quarter demonstrated that we are not immune to the problems plaguing the broader economy, we remain confident in our underwriting approach to our loan portfolio and we’ll maintain a high level of vigilance in underwriting and monitoring our loans.

We are making the decisions we think are necessary to continue to operate successfully and effectively in this environment. And we are focused on ensuring continued prudent credit monitoring as well as maintaining a strong balance sheet. While we work to navigate the current market environment successfully, we are also laying the groundwork for growth and efficiency beyond this market cycle. As always our employees are the key to our success not only weathering to the current storm, but in preparing for better days ahead.

This concludes the review of our 2008 fourth quarter and annual results. With that I would like to ask the operator to open the call for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Aaron Deer with Sandler O'Neill. Your line is open.

Aaron Deer – Sandler O'Neill

Hi. Good afternoon, everyone.

Mike Descheneaux

Hello Aaron.

Aaron Deer – Sandler O'Neill

I guess in my question, I would like to ask about the – the cashes on the balance sheet haven't brought in all these deposits on balance sheet, you’ve got a tremendous amount of cash there. And I guess it is the deployment of that cash, it’s going to help to drive some of this margin compression that that you expect to see. Can you talk a little bit about how you intend to invest that and how quickly and maybe specifically what kind of - I imagine some of it’s just going to be deployed into securities always near-term here and what kind of securities might be put in that and what kind of yield your are seeking?

Mike Descheneaux

Yeah, Aaron this is Mike Descheneaux here. In general, we will be continuing filing our investment policy, which is traditionally into fixed income securities. And I think you raised an important point about a distinction between here in the short-term as well more in the long-term. Our biggest priority here right now is maintaining security of those funds as well as liquidity. I mean those are two extremely important variables. So, right now, certainly we are very heavily focussed more on the short-term overnight investments. And as we’ve began to understand more clearly the behavior deposits, in other words will they end up sticking on our balance sheet, or how sticky will they be, that will begin to dictate more or less where we start to invest the monies in longer term securities, again following the premise for a safety and liquidity. As far as yields right now again I am not prepared to comment on this at this moment.

Aaron Deer - Sandler O'Neill

Okay. It sounds as though you are comfortable just letting the certain cash or cash lite products here for the time being?

Mike Descheneaux

You know until we see a little more clarity on that deposit behavior I think that is extremely the most sensible thing is environment. The last thing that we want to do is all of them get looked into a longer-term decision that we don’t have the clear vision on what’s going to happen with that deposit behavior. Again one other things to also remember why we were also after this - driving these assets on balance sheets, again is more focusing on our loan to deposit ratio to make sure we have the appropriate funds to be able to lend for the future.

Aaron Deer - Sandler O'Neill

Right, Okay. Thank you I’ll step back.

Operator

Your next question comes from John Pancari with JP Morgan. Your line is open.

John Pancari – JP Morgan

Good afternoon.

Mike Descheneaux

Hi, John.

Dave Jones

Hi, John.

John Pancari – JP Morgan

Can you give us some color on what drove the rest of the increase in non-performers in the quarter, I know we had obviously the portion of HRJ move on there. So, if you could just give us some detail what drove the rest of that increase?

Dave Jones

John, this is Dave Jones. And what we experienced was the HRJ as you mentioned and Mike referenced in his presentation one of our private clients services relationships moving into non-performing. And then after that there were a number of much smaller relationships consistent with what we’ve seen in past quarters.

John Pancari – JP Morgan

Okay, then no discernible trend on what’s moving into non-performer at this point, whether it’s any deterioration in your early stage DC backed, tech lendings or anything?

Dave Jones

And this is Dave. We are seeing a deterioration in the early stage, business to be expected and when that – here is a key part of our business in hand and in a environment like we have today, we will see some object in non-performings in that category and that uptick in our perspective of that segment of the portfolio for the foreseeable future is a part of the decision behind the reserve increase.

John Pancari - JPMorgan

Okay, now if you are just talking about how there may have been a change in and your expectations from last quarter for that specific portfolio I know you had described in the past that, it was that VC back to tech companies and comprised about 30% of your loans back in a – do in a .com bus and another about 10%. Losses on that portfolio peek that around 6% last during the downturn and so we extrapolate that out to the 10% contribution now and you could find an normalize loss ratio of around 60 basis points to set us so. Can you tell me how that compares what you are starting to see now?

Dave Jones

And again, this is Dave. We are not seeing loan losses at that level as yet, and what we are sensitive to is that we may experience over the balance of 2009 loan losses from the early stage portfolio rising to big somewhat comparable with what we saw and the 2000, 2001, 2002 timeframe.

John Pancari - JPMorgan

Okay, all right. All right I will step back. Thank you.

Dave Jones

Thanks John.

Operator

Your next question comes from Erika Penala with Banc of America. Your line is open.

Erika Penala – Banc of America

Good afternoon.

Dave Jones

Hello Erika.

Erika Penala – Banc of America

Hey, just I have a follow-up question, I guess on the back of what John I think was trying to ask, but either 130 basis points of the loss of guidance that was given for '09. Could you give with the sense in terms of what your expectation are for losses and dividing into your early stage portfolio your mid stage that portfolio and then your VC capital call line portfolio?

Dave Jones

This is Dave and what we have to done as we have gone through exhaustedly in our portfolio and we have looked at our criticize book of business, we have looked at our early stage lending and, but we are anticipating trends within the venture capital investment activity that will make some of our early stage companies vulnerable. We have also evaluated the merger and acquisition activity, and that operates as a secondary source of repayment for the early stage companies. And we have seen a greatly diminished appetite for companies to offer and then to close on the M&A activity. We have concluded therefore that that best part of the portfolio is going to experience a difficult 2009 and a significant part of the loan loss forecast that we have is in that portfolio. And we cannot ignore the 90% of the business that is not in that portfolio and we recognize that given the economic climate that we are going to have some loss possibility, loss experiencing and that other 90% of the portfolio and if balance is out the loan loss broadcast.

Erika Penala – Banc of America

And how are you thinking about the portfolio that comprises the VC capital call lines, because in traditionally you have had really no losses and it’s, very shorten duration and so in terms of, when you look to formulate this guidance what were you thinking in there?

Dave Jones

Right, so there is an important distinction to be drawn between what we have historically done with our capital call lines of credit and they charge a relationship. And I am – I will remain very confident there the billion dollars of lending activity that we would do with the capital call lines of credit is still going to be a very high quality portfolio. Not expecting, they were going to have material changes to suggest we may not have any change in our loss experience for capital call facilities. Again the distinction there is HRJ was not a confirming capital call facility.

Erika Penala – Banc of America

And I guess with HRJ, could you just – you just remind us what is – what the remaining exposure is and if you could, is there - is any update in terms of the potential agreement that you are trying to forge with managing one other funds.

Dave Jones

And this is Dave. What we – what we shared with – with closing a relation in the mid December timeframe and was that we had $68.6 million of exposure, what we are updating as that we have experienced $10 million of collections against that facility and we also indicated that we have had a loss experienced in the fourth quarter for part of the relationship. So, I don’t wanted to be too detailed with an individual client experience, but I think you can see that right there. There is a pretty significant decline.

Erika Penala – Banc of America

Okay. Thank you.

Dave Jones

Thanks Erika.

Operator

Your next question comes from Joe Morford with RBC Capital Markets. Your line is open.

Joe Morford – RBC Capital Markets

Thanks, good afternoon everyone.

Dave Jones

Hi, Joe.

Mike Descheneaux

Hi, Joe.

Joe Morford – RBC Capital Markets

I guess also on the charge-off side Dave maybe you could talk a little bit more about the – it sound like maybe large software credit that was charged off and any other notable items in the fourth quarter there?

Dave Jones

Yes thanks Joe and relative to the almost $24 million of net charge-off referenced. I would just mention that that there was part of it that related to the HRJ relationship from, and Mike indicated that there was part slightly larger than HRJ in the one software company. And that experienced related to a piece of trimmed at that was underwritten to cash flow with that one borrower. And after those two loss experiences then we had loan losses that would reflect much of what Joe you would have seen in – in the third quarter, second quarter, first quarter before that.

Joe Morford – RBC Capital Markets

Okay. Turn after that I guess the other question I had was for Mike because you talked about the expense side of things and even normalizing for the ICP and stuff this maybe like a – the outlook is for like a 10% growth but it still strikes me it’s a little high given the - in the current environment and with revenues under pressure and I was just want a little bit more color on that if I could and also what can major growth and investments here your planning on making it drive that?

Ken Wilcox

Yeah Joe, this is Ken, let me start-off and then we will turn it over to Mike because you exclusively requested Mike. I’m or maybe a little bit more a numerical analysis but there are a couple of things that I think we need to consider here. One is that our volumes have grown considerably in this last year. I think you noticed the 60 plus percent increase in deposits and that are on the balance sheet and you noticed the 30% plus increase in loans and you also probably noticed in Mike’s guidance for 2009, that we are anticipating that there will be further increases in activity. There has been an increase. There have been increases in absolute number of clients. There have been increases in market share. There are increases in our fee-based income - it some, it’s a little bit difficult and you and I discussed this 10 years ago the last time the federal rates down to historical lows, it’s a little bit difficult to reduce expenses significantly given that most expenses are headcount just because rates have dropped and while volumes are increasing because the number of people that you need to do this job is a function of how many clients you have and how things are buying. It’s not really a function of where the fed funds rate has gone. The other thing I would say is that in an era of extreme economic deterioration such as we’re all experiencing right now and with anticipated increased credit costs reducing expenses, which is tantamount to reducing headcount is probably not something that would benefit the shareholders over the long haul. And of the third thing that I would say is that in many, many regards I think that we are gaining steam have for the last year and continued to in 2009 and I don’t think that it would be good for the shareholders at least the long-term shareholders to do anything that would reduce the potential for capitalizing on our increasing market share in the future.

Mike Descheneaux

And may I add a few comments Joe since you did call my name? Well, let me just assure you that we are extremely focused on expense and we have not loss side is the importance of that and the power of that that can bring to the bottom line. Just to recall a little bit of the things in 2008 is we had invested considerably in our people in 2008 particularly a new heads, a new FT, new employees that we added. In relation to loan portfolio management, so we saw - sometime ago that we know we needed to put more people on monitoring our loans, which we did. We are also building out our global practice you may recall that we got our license in India to lend in our non-banking financial corporations. We also opened up an office in Israel. Again all things that are certainly going to contribute in the long-term to our growth and finally as well we've been investing in our infrastructure systems, which in the long-term will help us be more efficient. So, those are certainly some of the areas that we have added and maybe one last thing is even in our analytics business, if you look at the traction that that’s starting to get in the revenue growth so those are some of the areas that we've been spending our money on.

Joe Morford – RBC Capital Markets

Okay, so it sounds like you just with these costs building through the year, you got kind of a higher core run-rate in the fourth quarter adjusting for the incentive comp thing and that is just you are a kind of more normalized growth rate half of that higher level is that fair to say?

Mike Descheneaux

Exactly.

Joe Morford – RBC Capital Markets

Okay. All right, thanks a lot.

Mike Descheneaux

Thank you.

Operator:

Our next question comes from Fred Cannon with KBW. Your line is open.

Fred Cannon – KBW

All right thanks. A lot of my questions have been answered. Two quick ones, first your primarily I believe in the press release is at 4.0% in the industry, I believe the 3.25%. I was wondering if you're getting pushback apart from your clients as a result of holding your primary rate up high in the industry?

Greg Becker

Yes, Fred, this is a Greg Becker. I guess as we think about pricing of real, we’re really spending majority of our times thinking about pricing from a standpoint of risk for what balance and you can go look in the market and credit spreads overall including credits spreads are - I mean increasing pretty dramatically, so if you look at the total loan spreads that we have I would say number one, they are actually reasonable and there is actually we believe room for increases in that against the risk reward, its for not the overall credit exposure in the market, so we feel good about were are – our margins are and the upside that we have during course of the year.

Fred Cannon – KBW

Okay, thanks Greg. And then just one of Joe’s questions to can I guess kind of two things on the expense control end, I guess could you give us some confidence that is if we see continually weak quarters like we have the fourth that the comp won’t up until the budget is leveled, is there is some underlying expense control? Is there any concern that given that you have taken TARP that it will at least appear that you are paying a lot of the TARP preference in expenses?

Ken Wilcox

Yeah Joe, or Fred excuse me, your first one is very difficult to hear you because although we can hear everybody else or something wrong with your - with all the - that can actually between you and us right this minute, so I believe I know what you asked and answer what I thought you asked and you tell me if I give you the right answer but the – the bulk of our the vast majority of any expense growth that we are anticipating in 2009 is in infrastructure IT backbone and product that is not in headcount.

Fred Cannon – KBW

Okay and then in terms so but that would imply then Ken that if we do have a shortfall in revenue like you did in the fourth quarter, you wouldn’t have the ability to adjust expenses?

Ken Wilcox

No, on to the contrary, we have the ability because it’s – that’s what in either case whether you are talking about the investment in product and IT infrastructure or whether you are talking about headcount, you always have the option of making adjustments but I think that if we did run into the kinds of difficulties that you are implying that we always have the option and is probably much much easier if your growth and expenses on the project side as opposed to the people side is much - much easier I would I think to marginally back. So I think the answer is that we definitely are going to do our best on the expense side and if the picture evolves in a way that suggested it would be prudent and marginally fair you can be assured that we will do so.

Fred Cannon – KBW

Okay.

Ken Wilcox

Thanks Fred.

Operator

Your next question comes from James Abbott with FBR. Your line is open.

James Abbott – Friedman, Billings, Ramsey & Co

Yeah, hi good evening.

Ken Wilcox

Hello James.

James Abbott – Friedman, Billings, Ramsey & Co

Quick question on - you touched on this is a little bit earlier, I was wondering if you could give us some of the loss assumptions that helped you arrive at the 7, I believe the 7.4 or 7.4 million net charge-offs on HRJ? What sort of assumptions were you using on that discounted cash flow and so forth?

Dave Jones

James this is Dave and I am not sure that was the client confidentiality information that we’ve as an obligation that I want to need to get into that much detail.

James Abbott – Friedman, Billings, Ramsey & Co

Okay.

Greg Becker

James, this is Greg Becker. The other part is looking at the whole both charge-offs and reserves and looking at that on a combined basis that's really the best way to look at it so, between the two it’s roughly $30 million.

James Abbott – Friedman, Billings, Ramsey & Co

Okay. So you’ve collected chance so your are down to roughly $58 or $59 million, you charged-off 7, so 50 million and then the additional reserves and then you feel like you've got the losses covered through that announce, is that correct? So, we should expect that to run through the charge-offs than that – is that a fair way of seeing that

Dave Jones

And James this is Dave. The analysis that we have to do would required us to think about that cash flow stream collections down the road on a net present value basis and to be thinking about it from reasonable, sometimes on the conservative side. So, I would not want to suggest that the reserves are going to run through the charge-offs and we are going to do everything we can to as quickly as we can collect all of the monies that are due us, but there are risk inherent in that process and it is incumbent upon us to have a reserve for those risk and thus we do.

James Abbott – Friedman, Billings, Ramsey & Co.

Okay.

Ken Wilcox

Sure, if I could just add to this James, this is Ken, that the reserves are there in the case that we are fail to achieve but, we hope to achieve not because we anticipate that we will fail to achieve but we hope to achieve.

James Abbott – Friedman, Billings, Ramsey & Co.

Understood. Okay, thank you and then on a – another questions on the asset side of venture capital firms because they are weaker companies, what are you hearing in that regard obviously, the early stage companies have been weaker as this has been earlier - discussed earlier on the call but are you hearing that the venture capital firms are trying their best to keep the commitments going or are they now making the decision that we got to cut a couple of companies loose from the portfolio and so what are you hearing there.

Greg Becker

So, James this is Greg again. Clearly the venture capitalists are looking at their portfolio and making decisions about which ones are going to be good performers and survivors in this market. So we are seeing some of that I think, it won’t be as dramatic as what you read in the press and the magazines out there, venture capital is half capital, there has been a fair amount of money that’s been raised. Even the numbers that Ken quoted when you look to how much money was raised from venture capitalists last year, that’s still a substantial amount of money, now they are going to be slower to deploy that. They are increasing their reserves on a company-by-company basis to keep them – to support them longer. All those things are going to our analysis of the risk of the early stage portfolio. So, yes we’re seeing some of that on one hand and the other hand there is still a fair amount of money out there to invest in early stage companies.

James Abbott – Friedman, Billings, Ramsey & Co.

And that’s a little bit of a change from maybe three months ago though I think as I ask this kind of question over few times over a period of time but, is that correct is that maybe three months ago they were still trying to hold down and neither cutting back or is that my mistaken in that.

Greg Becker

Yeah this is Greg, again James and I would absolutely agree with you that there was a three significant change in attitude and perspective over the last 90-days. And we have saw that across, all our markets both domestically and even internationally. So, yeah it did change pretty roughly.

James Abbott – Friedman, Billings, Ramsey & Co.

Okay.

Mike Descheneaux

If I can just add to that I would like to underscore that because in the same way and I know all of you look at all sorts different things and you are familiar with the much wider variety of industries and aspects of the markets probably than we are, but in the same way that you know noticed I think I find it across the board basis a sudden and more dramatic change in people to attitudes in October and November and has been drew prior to that – that has on – that has reached into our market as well, and it was I am just as sudden and unexpected for us as it was for yield. When I say – when I say that I obviously everybody who pay any attention to the economy has note a shifts, but I think everybody notice that function shift in October and November.

James Abbott – Friedman, Billings, Ramsey & Co.

Okay, well good luck with those of the deposit balances that should be an nice offset to some of the credit, so good luck with that.

Ken Wilcox

Thank you

Mike Descheneaux

Thanks a lot James.

Greg Becker

Thanks James

Operator

Your next question comes from John Pancari with JP Morgan. Your line is open.

John Pancari – JP Morgan

Hi just I have a quick follow-up. And you deserve a couple of housekeeping things, what was the amount of the IC comp reversal in the fourth quarter?

Mike Descheneaux

John this is Mike Descheneaux, we will have that more in our MD&A section when we release the 10-K but, it was approximately around that 24 or $25 million mark, pretax of course.

John Pancari – JP Morgan

Okay.

Mike Descheneaux

So we will give you in our SEC upcoming, SEC filings.

John Pancari – JP Morgan

All right, and then in other housekeeping one. How much was that existing specific reserve for entire bounds. What is the amount you are using for that just for makes rather right calculation?

Mike Descheneaux

On the specific reserves amount.

John Pancari – JP Morgan

Yeah in terms of your – yeah just looking at your outlook on credit, you give the outlook for the – for loan loss reserve and in that you said exclusive of specific reserves for impaired loans.

Dave Jones

Hello and this is Dave Jones, and the reserve for impaired loans is approximately $23 million.

John Pancari – JP Morgan

I am sorry you will tell the amount again.

Dave Jones

23.

John Pancari – JP Morgan

Okay. All right, good. And then lastly I know this one will probably more challenging to help me always but, and I am just trying to look at what type of run-rate going into next year on a core basis given in your guidance in terms of EPS and just looking at a more normalized level here giving your guidance on I guess some comment with EPS and 30 to 40 set range on the quarterly basis. But, I don’t know if there is any way you can give us any type of expectation on a EPS level here you given all the moving parts is there way you can help us on a moment.

Mike Descheneaux

John, this is Mike Descheneaux. As you know we don’t provide the guidance on EPS and, again what we try to do this quarter is really help you guys out a lot by giving a lot more inside on this, but, again this at this point we would – we are not going comment on that.

John Pancari – JP Morgan

All right. Good try, thanks.

Mike Descheneaux

Al right thanks John. Nice try though.

Operator

This concludes the question-and-answer portion of today’s call. I will now turn the call back to the speaker for any additional or closing remark.

Meghan O'Leary

And there are no closing remarks. Thank you very much.

Operator

This concludes your SVB Financial Group conference call for today, you may now disconnect.

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Source: SVB Financial Group Q4 2008 Earnings Call Transcript
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