SVB Financial Group Q2 2009 Earnings Call Transcript

| About: SVB Financial (SIVB)

SVB Financial Group (NASDAQ:SIVB)

Q2 2009 Earnings Call

July 23, 2009, 6:00 pm ET


Ken Wilcox - President and CEO

Michael Descheneaux - CFO

Dave Jones - Chief Credit Officer

Greg Becker - President, Silicon Valley Bank

Meghan O'Leary - Director of IR


Joe Morford - RBC Capital Markets

Aaron Deer - Sandler O'Neill & Partners

Christopher Nolan - Maxim Group

John Hecht - JMP Securities

John Pancari - Fox-Pitt Kelton

Fred Cannon - Keefe, Bruyette & Woods


Welcome everyone to SVB Financial Group’s second quarter 2009 Earnings Call. (Operator Instructions). Thank you. Its now my privilege to turn the conference over to our first speaker Ms. Meghan O'Leary. Please go ahead.

Meghan O'Leary

Thank you. Today Ken Wilcox, our President and CEO; and Mike Descheneaux our Chief Financial Officer will discuss SVB's second 2009 performance and financial results. Following this presentation, members of our management team will be available to take your questions.

I would 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 different materially from those contained in our forward-looking statements is provided in our press release and our last filed forms 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 the non-GAAP financial measures. A presentation of and reconciliation to the most directly comparable GAAP financial measures could be found in our press release.

Now, I would like to turn the call over to Ken Wilcox.

Ken Wilcox

Thanks Meghan and thanks to all of you for being here with us today. I am proud to announce that we earned $0.24 this quarter, considerably above what we believe to have been the street’s consensus. A large part of the difference is due to better performance than expected, higher deposit levels, better use of those deposits, better pricing on our loans than expected, fewer loan losses and so on.

Generally speaking we are, I believe, doing better than either we or for that matter you expected and we expect to be doing even better in the second half of this year. But let me be more specific, and in doing so let me distinguish between the business cycle on the one hand and some of the longer term changes we see taking place in our markets on the other.

Purely from the point of view of the business cycle, our belief is as follows: The worst is likely behind us or in a worst case, we are in the middle of it right now and it will be behind us by the time we hold this call again next quarter. That’s what we believe.

Further, we are anticipating gradual and continuous although certainly not dramatic improvement over the course of the next several quarters. That’s what we believe, based on what see happening around us and in the portfolio today.

Now that’s all very general and it relates pretty much exclusively to the business cycle itself. So this time, I would like to go one step further and talk a little bit about some of the major changes that we see taking place in our markets. What implications these changes have for us and what we are doing to address them.

These will all be developments that we have been observing for some number of years already and for which we have been preparing ourselves, piece by piece for the past several quarters.

In total, I would like to discuss five significant developments. Number one, the venture industry is evolving and at least initially this evolution seems to involve lower levels of investment than we have seen for some time now. Venture capitalists are experiencing fewer exits in either the form of IPOs or even M&A transactions. And the ones they are experiencing are at lower valuations than has been true for some time.

As a result, there returns to LPs are lower as well. Accordingly, many of them are less able to raise new funds. Consequently, many of these VCs are investing less money in their existing portfolio of companies and of course, founding fewer new companies as well. In general the venture-backed portion of our portfolio is shrinking, although our market share in that sector is increasing.

On the other hand, many of our later-stage larger and often publicly traded companies have continued to grow and in many cases, actually flourished, in these past few years, the mix in our portfolio has shifted a little from earlier stage companies to later stage, larger and publicly traded ones.

I want to be clear, we still focus on startups. And our market share, among startups is growing, but there are fewer of them today and many of them from prior years have grown into larger companies and are still with us. The result is interesting. Our market share amongst startups is now higher than ever, but our loan balances today are predominantly attributable to the mid-sized and larger companies’ end of the portfolio.

While the bulk of our profitability, when I first became CEO nine years ago, came from earlier stage companies. Today, as you might expect, the bulk of our profitability comes from later stage, larger, privately held companies and publicly traded ones.

Number two, the companies that we work with are going overseas earlier and doing a lot more and different things overseas than would been true just a decade ago. It is always been true that venture-backed technology companies have on average begun selling products overseas, much earlier in their life-cycles than most other kinds of companies. But in this past decade, with the sudden and unexpected emergence of both China and India, and as the technology industry, both on the producer and on the consumer side has spread itself out from the US to many other countries, two big things have happened.

First our companies are not just selling products overseas early in their life cycles, now they are also sourcing talent, raising capital, acquiring technology and establishing beachheads overseas as well in many different places and much earlier than its ever been true in the past. And as you would expect an even higher percentage of their sales are now overseas and much earlier than what have been true a decade ago.

Today most of the companies we work with have a global orientation. And accordingly we have become increasingly global in our orientation as well. We have in the course of these past few years not only established beachheads ourselves in a number of key countries, but we have overtime expanded our ability to deliver relevant products to those beachheads as well. In short, we are facilitating this trend that we are seeing in the market. To not do so would be a mistake and if we hadn’t done so we would be far less relevant to our target market today than we are.

Number three, the kinds of the companies that are attracting investment dollars today are different from the kinds of companies that we are doing so only a few years ago. We see more and more money flowing into alternative energy sources, natural resource management, genomics, broadband enhancements and applications and advance materials and proportionally less into some of the niches that were most prominent in years gone by. Accordingly, we have developed expertise in these new arenas and we will continue to do so as the market further evolves. Again, not to do so, would be a mistake and if we haven’t done so we would be far less relevant to our target market today than we are.

Number four, interest rates are low and in my opinion are likely to stay low for some considerable amount of time, as the Fed seems to be more worried about deflation than inflation and under any circumstances, does not want to dampen the flames of economic activity. As a result, we do not forecast any significant improvements in them for some period of time. There will of course be minor improvements as we continue to invest larger amounts of our excess cash in somewhat higher yielding instruments than Fed funds.

Under these circumstances, value pricing and expense control are more important than ever. Accordingly, we have been keenly focused on both of these for a number of quarters now and intend to continue to do so.

Number five; increasingly the companies that we work with are looking for advice in this increasingly complex, competitive and regulated world. Accordingly, we have devoted a good deal of time in these past few quarters to developing ways in which we can take the data that we generate in the course of banking, fully half of the venture back companies in the United States and a number outside the US and turning that data into information that our clients find useful.

This data involves things like evaluations as well as operating metrics and the companies that we work with are finding both of these useful. We believe that this aspect of our business will, over time, not only further distinguish us from our competition but could generate meaningful revenues as well.

Our responses to these trends coupled with our continued emphasis on helping our clients succeed have resulted in a measurable increase in our market share in these past several quarters.

Now, before turning the meeting over to Mike, I would like to mention a few things of a more tactical nature. One, we have closed HRJ. This is good for the shareholders. As we stated last quarter, we didn't expect any additional loan losses reserves and that is in fact the case, plus we have an opportunity now over time to actually recover some portion of the reserves or charge-offs we've already taken.

Number two. We've made meaningful progress towards raising the funds that we need to accommodate the allocations we've obtained through SVB Capital and believe that we have a clear path to a successful resolution of this issue.

Number three. In these passive quarters we've made progress on further improving our risk management systems in ways that we hope could make it easier for us to identify developing problems even earlier than we have in the past and thereby enable us to address such problems even more effectively.

Number four. Our capital base as well as our liquidity position remained strong. Further, we've taken steps to improve our utilization of excess liquidity, which should over time provide additional benefit to our shareholders.

Number five. Finally, we are continuing even in this very difficult environment to strengthen our systems and to include the very backbone of IT infrastructure. This too puts us in an even better position to compete in the future.

We are still building our organization for the long haul. Over the long haul, innovation will continue to play a pivotal role not only here in the United States, but we believe in the rest of the world as well. We are here to facilitate that development.

With that I would like to turn the meeting over to our CFO, Mike Descheneaux.

Michael Descheneaux

Thank you, Ken and thank you everyone for joining us today. As Ken said, in the second quarter 2009, we reported net income available to common stock holders of $7.8 million, equivalent of $0.24 per share.

Although our performance improved in Q2, we continued to feel the effects of the economic downturn across our businesses, most particularly in lower loan balances and higher credit costs. However, there are some early signs that the economy maybe nearing a bottom, although it would not be surprising if we bump along the bottom for sometime before things improve.

I would like to highlight six items; one, credit quality; two, net interest income and net interest margin; three, loan balances; four, non-interest income; five, non-interest expense; and finally number six, capital. After that, I will also provide you with our updated 2009 outlook.

First off is, credit quality. Our credit quality in the second quarter was in line with expectations we said in April, the result of our continued diligent in proactively managing our portfolio. We recorded a provision for loan losses of $21.4 million in the second quarter, which is significantly lower than the $43.5 million provision recorded in the first quarter.

The second quarter provision reflects gross loan charge-offs of $21.9 million, primarily from our life sciences, software and private client services portfolios. We set in prior calls that we expected all segments of our portfolio to be challenged by the current economy in 2009 with particular stress among our early stage clients.

Our stance in the second quarter was consistent with that expectation with approximately $12 million in charge-offs coming from early stage borrowers. The ratio of net charge-offs to average gross loans improved significantly to 1.74% in the second quarter versus 3.21% in the first quarter. Year-to-date that ratio was 2.5%.

Our allowance for loan losses increased minimally by $500,000 in the second quarter to 2.26% of total gross loans up from 2.18% in the first quarter. However, we expect the allowance for loan losses to improve during the remainder of the year.

Non-performing loans did increase by $13.8 million in the second quarter to $111.5 million primarily from our software and private client services portfolios. Approximately $43 million of our non-performing loans relate to HRJ capital. As you will recall, in the first quarter of 2008 we recorded significant increases in net charge-offs and reserves related through loans to HRJ.

As noted earlier, an independent asset management firm announced it would assume management of HRJ's funds. This transaction is a significant step towards bringing that matter to a close. We will finalize the numbers as part of our Q3 reporting and we expect a significant decline in non-performing loans as a result. Furthermore, we do not believe the resolution will have a material impact on our net income or provision.

On the subject of credit, I want to mention one important item that we expect to close on in the third quarter. During the third quarter 2009, we expect to complete a transaction that will result in a recovery of approximately $11.5 million on a pre-tax basis from a hardware loan that we charged-off in the first quarter of 2009.

Next up is net interest income and our net interest margin. Although, our net interest margin declined from 3.97% to 3.71% in the second quarter, as expected, we were able to hold net interest income steady at $91.7 million; despite a significant decline in loan balances and higher deposit levels.

There are three reasons why we were able to achieve this. Number one, we increased our investment portfolio by $580 million, generating 1.9 billion in additional interest income.

Two, we decreased interest expense by $1.2 million as a result of lowering rates on deposits in the first quarter to be more in line with the market rates.

Three, we benefited from a decrease in interest expense of 900,000 on our long-term debt primarily as a result of lower LIBOR rates on the interest rates SWAP agreements we entered into in May 2007.

I would like to note that we do expect our net interest margin to improve in the second half of the year. Average deposits grew $505 million to $8.4 billion, owing to the full quarter effect of our discontinuation of a third party off balance sheet suite product and clients opting for the safety of FDIC insurance demand deposits.

In making investments, we continue to emphasize liquidity. Year-to-date, we have increased our investment portfolio by more than $1 billion and we expect to invest a further $500 million to $1 billion during the remainder of 2009. We still have significant levels of excess cash, owing to the influx of over $2 billion in deposits on to the balance sheet in the last two quarters, a significant portion of which flow to demand deposits because of the FDIC insurance.

However, we expect clients to begin moving a significant amount of these funds out of demand deposits into interest bank accounts or off balance sheet funds when the FDICs insurance of demand deposit expires or when interest rates begin to rise. In the meantime, they remain in highly liquid overnight deposits.

One interesting item I would like to highlight is that, despite a decline of 500 basis points in the Fed funds rate in the last 22 months, our net interest income in the second quarter, was up nearly 6% in comparison to the same quarter last year due mainly to growth in average interest earning assets.

Now, I'd like to move on to loans. Although, we remained very active in the market, we are facing challenges growing and even maintaining our loan balances. The two key headwinds have been deleveraging by our clients and standard term loan repayments.

In the second quarter these activities resulted in lower average loan balances of $4.8 billion, a decline of 6.6% from the first quarter. The decline is coming primarily from our later states software and hardware clients as well as private client services. However, I believe some perspective is in order specifically that for the first six months of 2009, loan balances were 17.3% higher than for the same period last year.

While many companies are holding off on borrowing or do not need to borrow as much in this environment, we are still actively adding new clients and making new loans. In the second quarter we added 234 new borrowers who added $236 million in new loan balances. That compares to 157 new borrowers contributing $219 million in the first quarter. These borrowers were primarily from our private equity, venture capital and later stage hardware and software portfolios.

Now, let me turn to non-GAAP, non-interest income, net of non-controlling interests. While it was higher quarter-over-quarter at $34.4 million versus $25 million in the first quarter, it continues to be impacted by declining valuations in our private equity and venture capital investments, lower warrant income and lower fee revenues.

Much of the improvement in non-interest income in the second quarter, related to lower aggregate losses on our venture capital and private equity investments in the second quarter. Additionally, we were aided by realized net gain of $1.2 million on warrants due primarily to increases in valuations on warrants held in several public companies. However, private company warrant valuations were actually lower during the quarter.

Continued economic headwinds push fees on products and services down to $22.1 million, versus $23.4 million in the first quarter. These include client investment and letter of credit fees both of which were down in the quarter as well as FX fees and deposit service charges which remained flat. This number does not include credit card fees, which appears as a new category in our press release.

As you may recall, during the second quarter, we announced we would bring our credit card business in-house. These credit card fees offered a bright spot in the second quarter, growing from $1.5 million in Q1 to $3 million in Q2. With them fee based income was $25.1 million in the second quarter, versus $24.9 million in the first quarter.

A final note on non-interest income; during the second quarter of 2009 we determined that we had incorrectly recognized certain gains and losses on foreign exchange contracts in prior periods. As a result, we reversed $3.8 million in after-tax, FX gains and losses the equivalent of $0.11 per share from prior quarters. The specific periods impacted were the first quarter of 2009 and the full years 2008 and 2007. This area had no impact on the second quarter. We consider these reversals to be immaterial and have revised the financial results for those prior periods. You will find more details on these revisions in our press release.

Turning to expenses; we recorded non-interest expense of $89 million compared to $87.1 million in the first quarter. Our expenses included an increase in FDIC assessments of $5.9 million largely as a result of a $5.0 million special assessment fee as well as from higher average deposit balances.

Compensation expenses were down slightly in the second quarter primarily because of higher payroll taxes and seasonal accruals in the first quarter. We maintained total personnel at 1,260 compared to 1,262 in the first quarter. You may recall also that we had a $4.1 million non-tax deductible goodwill charge in the first quarter and the absence of a similar charge in the second quarter also helped our expenses.

Moving on to capital; our ratios remain strong with Tier 1 leverage at 9.88%. Our ratio of tangible common equity to tangible assets was slightly low in the second quarter at 6.94% owing to continue growth in assets driven by increases in deposits.

Our ratio of tangible common equity to risk-weighted assets increased to 10.54% primarily due to lower loan balances. Given the recent growth of our assets and their related composition, we pay particular attention to tangible common equity to risk-weighted assets, as we have a significant amount of assets in low risk-weighted asset classes. We feel tangible common equity to risk-weighted asset is a more reasonable reflection of our risk profile than other capital ratios.

We have been asked frequently whether we plan to repay the funds we received from the Treasury’s capital purchase program in the near future. Let me say that we continually evaluate this possibility. However, there are various factors that influence our thinking on this matter. First, is overall economic performance and outlook; second is the current performance and future outlook for our credit quality; and third is a ready availability of debts and equity to financial institutions like us.

We would like to see further improvements and stability in these factors before determining when we will repay the funds. For the time being, the additional equity enhances our flexibility and ability to do business comfortably in this challenging economic environment.

Now, I would like to comment on our revised outlook for 2009. Our outlook reflects our expectations for the full year 2009 versus the full year 2009. Although, we revisit and update our outlook each quarter, it is an annual outlook. Several aspects of our 2009 outlook have changed primarily because of lower venture capital on investment levels as well as the impact of the continued economic downturn.

With the exception of credit quality, I am going to talk only about the changes in our outlook from April 2009. Please refer to our press release for additional information.

One, we have lowered our expectations for loan balances based on market conditions as I discussed earlier. We now expect percentage increases in average loans to be in the mid-single digits, rather than the high-single digits. Two, we now expect the allowance for loan losses as a percent of loans to be in the range of 1.4% to 1.45%, excluding reserves for already impaired loans, primarily because we believe their credit quality for the remainder of 2009 will be more reflective of our second quarter results. Three, we have also lowered our outlook for aggregate fees on deposit services, lenders of credit and foreign exchange.

We now expect a percentage decrease in the low-single digit for those fees in 2009, rather than an increase owing to general economic conditions.

Finally, point number four, we have improved our outlook for non-interest expense growth once again pay percentage rate in the mid-teams.

Primarily owing to lower compensation and benefits expensed, reflecting the impact of the economy on our results and lower than expected fees on the special FDIC assessment.

Nevertheless, year-to-date FDIC fees were significantly higher than we expected.

We are maintaining our outlook on net charge-offs. We are still expecting net loan charge-off of between 1.75 to 1.8%, a figure that includes net charge-offs to June 30, but excludes potential charge-offs from already impaired loans.

Clearly, we see challenges in the remaining months of 2009, with headwinds from suppressed venture capital, valuations, a lack of exit opportunities for our clients, declining loan balances, pressure on the net interest margin from the low rate, environment and the continued need to aggressively monitor and manage credit quality. As we said last quarter, if the economy were to significantly deteriorate, it could change our expectations for the year.

Nevertheless we do see opportunities for growth as well. Companies will continue to borrow, and we believe we will see meaningful future activity among mid and later staged companies, venture capital and private equity funds, renewing their investment activities by our focused organizations in our international expansion. We also continue to build our business, creating new revenue opportunities through adding new products and services designed to help our clients succeed domestically and around the world.

In the meantime, we are focused on making the right decisions to help ensure our continued liability and strength in this challenging market. We have fortified our capital base and ensured we have ample liquidity.

We have a strong balance sheet and we remain vigilant with regard to credit. We will continue to support our clients and execute on our long-term strategy regardless of market cycles.

This concludes the review of our 2009 second quarter results.

With that, I would like to ask the operator to open the call for questions and then Ken will provide some closing comments. Thank you.

Question-and-Answer Session


(Operator Instructions). Our first question comes from the line of Mr. Joe Morford.

Joe Morford - RBC Capital Markets

Thanks. Nice quarter guys particularly on the credit front. Couple of questions. First, just really clarification on HRJ. I hear you that it doesn’t impact the net income of the provision, what are your current expectations for any recoveries on the $7.5 million or so that you charged off and how much of any specific reserves would be freed up in the allowance and what would be the timing of that? Would that be third quarter as well?

Dave Jones

Joe this is Dave Jones and as indicated in Mike's remarks the near-term expectations of anything in HRJ are nominal. So the extent to which there could be a modest reversal of specific reserve for HRJ it would be very modest. This is my belief based on present understanding and the recovery opportunities are likely to be over an extended period of time. So I wouldn’t anticipate anything in very near future.

Michael Descheneaux

Just one clarification, when we are saying nominal we are talking about the nominal impact of the provision or bottom line net income.

Dave Jones


Joe Morford - RBC Capital Markets

Okay. Can you talk a little bit more about the event that led to the large recovery coming through in the third quarter. Is that taken into account in the net charge-off guidance, which I think was 140 basis points for the second half of the year?

Dave Jones

This is Dave again. So we have a transaction that is presently in the works that would sell our debt position to another party and the information contained in the press release and in our comments today would reflect our confidence that the transaction is going to settle in the near-term.

In terms of it being reflected. So the $11.5 million would represent over 20 basis points relative to our gross loans and it is one of the factors. So we have the 20 plus basis points reflected in the anticipated recovery. We have another 90 basis points roughly in specific reserves for impaired accounts, those account most likely to incur loss and then over and above that, is our guidance for 142, possibly 145 basis points.

Joe Morford - RBC Capital Markets

Okay, that’s helpful Dave and then lastly I guess on average loan growth, I see the guidance now is for mid-single digit growth for the full year but more specifically for the second half.

Do you see continued declines in balances given all the trends you talked about in the operating environment? Are we getting closer to seeing those balances flatten out at all?

Greg Becker

Joe, this is Greg Becker. I think the guidance would point you for the second half of the year that we expect flat to slightly improved loan balances and part of this is we talked about last quarter, that first quarter was just so challenged where there were so many reasons that held off any loan growth and people making decisions.

We see that changing modestly and really combining some additional capital, call borrowings, some corporate tech borrowings, some global growth, we think those are the things that will fuel a flattening, in fact a modest turnaround in net balance.


Our next question comes from the line of Mr. Aaron Deer.

Aaron Deer - Sandler O'Neill & Partners

A question on the, I guess a client deposits. The off-balance sheet funds, look like they were down about $1.7 billion well on-balance sheet deposits were up about $0.5 billion, the delta between those, I guess by $1.2 billion, is that, is that represent the cash burn of the VC backed companies or is there something also going on there?

Gregory Becker

Yeah Aaron. This is Greg Becker again. And that's what we're saying. Again our market share is growing or we are adding clients and our belief is that it's really just the cash burn that our clients are experiencing and the fact that it's not being replenished at the same pace by future venture capital around this financing.

Aaron Deer - Sandler O'Neill & Partners L.P

Okay. And then, I am impressed that the private client services loss in the quarter, what type of loan was that and was, or loans, I guess and how is the dollar amount related to that?

Dave Jones

Aaron, this is Dave Jones. And it was a collection of loan losses, there were four or five different borrowers, with whom we took loan losses and the aggregate of the loan loss between the four or five borrowers was roughly $5 million.

Aaron Deer - Sandler O'Neill & Partners L.P

What it was, can you say what the, what it was for, specifically was it for properties or was it for, I guess some securities or what, what those private client loans are?

Gregory Becker

I think probably it would be best to generalize it as investments…

Aaron Deer - Sandler O'Neill & Partners L.P


Gregory Becker

That the collective borrowers were making.

Aaron Deer - Sandler O'Neill & Partners L.P

Okay. Thanks guys. Appreciate the help


Our next question comes from the line of Mr. Christopher Nolan.

Christopher Nolan - Maxim Group

Thank you. Why the reservation of second quarter given that the charge-offs ratio have improved so much in the guidance is for there seems to be a improved credit quality and lower reserve coverage?

Dave Jones

This is Dave, Chris. And in a sense what we are talking about I think you are focused on here is the percent of the portfolio that increased. When you look at the dollars and the reserve there is very insignificant change in dollars.

So I think that the dollar level of the reserve reflects as we think that the second quarter performed to expectations. We think that we have a better sense of how a balance of the year and the foreseeable future will play out. So we are confident that we have an adequate reserve established.

Christopher Nolan - Maxim Group

Okay, and given the guidance for if I'm correct $1.45% loan loss reserve ratio for the second half of the year, is that correct Dave.

Dave Jones

No, I don’t think so. Because what we have is that 1.4 to 1.45 plus, specific reserves which are roughly 90 basis points on the present portfolio.

Christopher Nolan - Maxim Group

Great. Thanks for the clarification.


Okay. Our next question comes from the line of Mr. John Hecht..

John Hecht - JMP Securities

Thanks very much and congratulations on executing a good quarter. You talked about the margin contraction based on some of the factors that we saw on the quarter including low interest rates, but you did see your yields improve during the quarter on the loan side.

And then given the right vending that occurred during the quarter, I am wondering if you could give us some color about how you were able to re-price some of the assets during the quarter?

Greg Becker

Yes, John this is Greg Becker. The increase in improvement of loan pricing I would characterize is modest. Obviously it will take even modest increases in pricing in this environment and most of its really re-pricing for the increased risk profile that we see generally speaking with the client base.

So, I wouldn’t characterize it as a huge opportunity for us either this quarter or on a go forward basis but it did help to contribute to part of the lower decline that maybe was expected.

John Heck - Deutsche Bank Americas

Okay. As, just sort of a related follow-up on that, when you guys are coming to refinance situation with that earlier-stage company, whether it’s a private equity or I guess this to be a venture capital kind of question, but even in the private equity segment when there is a refinance opportunity, how willing are the sponsors at this point that they need to add equity to help these organizations delever. Are you getting in sets that there is a greater willingness now or about where we were six months ago?

Dave Jones

And this is Dave, let me at least initiate the response on that. What we have seen here is a resurgence, modest I want to underscore but a resurgence and venture investment.

So in the fourth quarter the community seemed to be frozen stiff and few investments occurred, but in the first quarter and arguably slightly more still in the second quarter the venture capitalist established their willingness to fund a company.

Now, when you look at the venture capital activity, be mindful of the fact that the venture capitalists have encouraged their portfolio management teams to reduce their operating expenses, thus there is less money required for the operating company to get through another 10, 12, 18 months of operations.

So we’re seeing good activity. We clearly, in terms of our segment, of our portfolio, I saw over 60 different companies that closed on equity round during the second quarter and I’m sure that there were a lot more that were not necessarily on my radar strength.

John Heck - Deutsche Bank Americas

And that was up dramatically from Q1 or just it had one year improvement?

Dave Jones

It was improvement and given where we are in the economy, certainly all the improvement is welcome and preferred.

Greg Becker

John, this is Greg, may be just to add on to it. if you look at the data that’s come out although its preliminary from the different sources that attract venture fund inflow, it depends on which source you’re looking at, its anywhere from a 15% to as much as a 30% improvement in dollars over Q1 and if you take that data and you [matched] it up against, kind of we have experienced in our portfolio that feels about a right level from an improvement perspective.


Okay, our next question comes from the line of John Pancari.

John Pancari – Fox-Pitt Kelton

I’ll ask a question about a different portfolio for once here, can you talk a little bit about wine the premium wine portfolio, we’ve been insuring a little bit and seen some select journal articles discussing the wine business in difficulty up there in California. Can you just give us some color on what you're seeing in your portfolio.

Dave Jones

Again this is Dave. Let me offer a perspective. What we are seeing is that the overall volume of wine sales is trending down. And this is very reminiscent of what we saw after the last recession. So, post 9/11 of 2001, we saw a decline in wine sales.

What we are seeing is that clients with the higher dollar, the higher price point wine is generally more affected than their lower price point wines, so what they are loosing in revenue dollars also the high dollar wine, they are making up somewhat with the more moderate pricing wines.

So, our clients are being impacted, but the sense of it is that a trend line similar to what we saw through after, through and after the last recession could be a reasonable expectation of what we will see through and after this current recession.

John Pancari – Fox-Pitt Kelton

Can you give us a little bit of color in terms of the level non-accruals you may expect on portfolio or delinquencies or just given that as an idea of where that starting to trend. How that you said you are seeing that you are affected? Can you give us some color on that?

Dave Jones

Our level of non-accruals and past dues are very low, but historically in the wine portfolio, as with our technology portfolio, we do not see a large level of non-performing or past dues. What probably is more representative of the Company performance is our internal risk breakings. And certainly anybody with a one portfolio in these days should be expected to have a higher level of adversely rated credits and we have been seeing that.

I think that there will continue to be some degradation in that portfolio. It is not clear that the current trend line in terms of non-performing and charge-offs will be different than last time and last time non-performing and charge-offs were very low.

John Pancari – Fox-Pitt Kelton

All right, and then the secondly, can you talk about your participated loan portfolio. Just curious an update in terms of the current trends you are seeing there.

Dave Jones

Sure. So, we continue to spend a significant amount of time looking at those credits and there has been none of the credits in that segment of the portfolio. Move from a pass rating to a more adverse rating over the last 90 days and the general client activity that we are seeing is that generally the clients are experiencing more revenue which obviously is better for them. So, that part of the portfolio is fine in my opinion.


Okay. It looks like our last question in the queue comes from Mr. Fred Cannon.

Fred Cannon - Keefe, Bruyette & Woods

Well, thanks. Most of my questions have been answered. But I just wanted to ask a more, perhaps my or kind of philosophical question on the balance sheet. We’ve seen a huge transformation in the last year in the balance sheet with the loan to deposit ratio I think a year ago was 94% and currently its 52% in the current balance sheet, certainly from a liquidity and capital standpoint looks like a fortress balance sheet.

As we go forward and I mean it sounded to me that a couple of things, number one is that, loans deposit ratio may well slip further and go below 50%. Number two is, at least in the main time until you can kind of get an all clear signal on the economy, you are probably going to maintain these strong levels of liquidity and capital.

With that said, the question is kind of strategically, when would you guys like to see the balance sheet evolve to? Is it back to the future, kind of like the 1990 Silicon Valley balance sheet with a 50% loan deposit ratio and a bunch of securities or is it something more like we saw just a couple of years ago?

Michael Descheneaux

Alright, I think I know what your preference would be. So let me just answer that in three different ways. One is, the good news is that we have been, I would say amazingly successful at deposit raising and we may have overshot the mark. And so I think we would be interested in correcting that. But I think we are trying to look on the good side because not every organization has been quite that successful at raising deposits and I would like to at least feel good about the positive side of that development.

But I do not recognize exactly what you mean and I can assure you that we are not targeting a loan to deposit ratio of 50 or lower or even 60. But we are aiming for something that is a little bit more optimal. Having said that, things are situational, meaning we are in the midst of a recession here and I think that when you are in the midst of a recession, responsible bankers seek to have fortress like balance sheets.

This balance sheet is in part a function of having been successful at raising deposits than we intended to be but its also in part an expression of our deliberate attempt to create a balance sheet that I think is appropriate to a recession of the magnitude of the one we’re experiencing.

So to certain extent, I think this makes perfect sense given where we are but your question really goes to normalization and under normal circumstances and in an economy that was more robust than the one we are in right now, we would hope to have a loan to deposit ratio that was more in the optimal range and the optimal range to my way of thinking is, 75 to 80 somewhere in there, maybe even, on some days 90.

We don’t want to sound like too nervous by going too much above that but on the other hand we don’t want to make you too unhappy by being too much below it. We also under normal circumstances and in a more robust economy would try to optimize our capital as opposed to stock piling. But for the moment I don’t think, I think it’s good and responsible to have some more capital than you might not want to have in better times.

Finally I will say that, we have come a long way over the years in terms of perfecting the tools that we can use to either bring deposits onto the balance sheet or move them more into the broker-dealer and you know that we don’t have complete discretion in that regard, but we I think are getting better and better at achieving what we are hoping to achieve in terms of where the preponderance of the deposits are located and I think that in the coming quarters and coming years, we’ll come up with tools that are even more effective at accomplishing what we are open to accomplish.

So I think we’ll do a better job of creating the optimal balance sheet, but once again I think its really relative to the state of the economy. So, I hope that helps, Fred.

Fred Cannon - Keefe, Bruyette & Woods

Yeah. That's very helpful Ken. Regarding to your last comments then as we, when we do normalize hopefully sooner rather than later, you will continue to pursue the kind of off-balance sheet management of the deposits that you tend to pull in at a rapid rate during the growing economy just as you did earlier in this decade?

Ken Wilcox

Well, absolutely Fred. I will say that we, a few years back discovered that our balance sheet could be source of profitability to and we have not lost interest in that concept.

Fred Cannon - Keefe, Bruyette & Woods

Okay thanks very much Ken.

Ken Wilcox

Yeah. I think we are at the end of our line here, so I think I will just round-off by giving you a summary comment or do I want to reiterate that we are confident that we are moving in a good direction. I'd also like to repeat that we are in this for the long haul and over the long haul, we are convinced that the economy will improve and that the innovation space will continue to play a pivotal role not only here in the United States, but in the rest of the world as well.

We are focused on responsible growth, risk mitigation, expense control and good balance sheet management and I'd like to conclude by thanking the 1,260 SVBers all of whom contributed each in their own way to our progress this quarter. Thank you very much.


Okay. This concludes today's SVB Financial Group's second quarter 2009 earnings conference call. You may now disconnect your lines.

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