SVB Financial Group (SIVB) Management Discusses Q2 2013 Results - Earnings Call Transcript

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SVB Financial Group (NASDAQ:SIVB)

Q2 2013 Earnings Call

July 25, 2013 6:00 pm ET

Executives

Meghan O'Leary

Gregory W. Becker - Chief Executive Officer, President, Chief Executive Officer of Silicon Valley Bank, President of Silicon Valley Bank and Director

Michael R. Descheneaux - Chief Financial Officer

David A. Jones - Chief Credit Officer

Analysts

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Joe Morford - RBC Capital Markets, LLC, Research Division

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

Jennifer H. Demba - SunTrust Robinson Humphrey, Inc., Research Division

Ken A. Zerbe - Morgan Stanley, Research Division

John G. Pancari - Evercore Partners Inc., Research Division

Brett D. Rabatin - Sterne Agee & Leach Inc., Research Division

Herman Chan - Wells Fargo Securities, LLC, Research Division

Gaston F. Ceron - Morningstar Inc., Research Division

Gary P. Tenner - D.A. Davidson & Co., Research Division

Casey Haire - Jefferies LLC, Research Division

Operator

Good afternoon. My name is Dustin, and I will be your conference operator today. At this time, I would like to welcome everyone to the SVB Financial Group Second Quarter 2013 Earnings Conference Call. [Operator Instructions] Thank you. I'll now hand the call over to our host, Ms. Meghan O'Leary, Director of Investor Relations. Ma'am, you may begin.

Meghan O'Leary

Thank you, Dustin, and thanks, everyone, for joining us today for our second quarter 2013 earnings call. Our President and CEO, Greg Becker; and our CFO, Mike Descheneaux, are here to talk about our second quarter results. As usual, they'll be joined by other members of management for the Q&A. I'd like to remind everyone that our current earnings release is available on the Investor Relations section of our website at svb.com.

I will caution you that we will be making forward-looking statements during this call and that actual results may differ materially. As usual, we encourage you to review the disclaimer in our earnings release dealing with forward-looking information. This disclaimer applies equally to statements made in this call. In addition, some of our discussion may include references to non-GAAP financial measures. Information about those measures, including a reconciliation to GAAP measures can be found in our SEC filings and in our earnings release.

We plan to limit the length of the call, including Q&A, to 1 hour. [Operator Instructions] With that, I will turn the call over to our CEO, Greg Becker.

Gregory W. Becker

Thank you, Meghan, and thank all of you for joining us today. SVB had another strong quarter. We delivered net income of $48.6 million and earnings per share of $1.06 compared to consensus estimates of $0.94 per share. These results reflect solid performance across the business and strong activity among our clients.

A few highlights: We had outstanding loan growth, thanks to our success at winning larger corporate clients and our strong relationships with venture capital and private equity firms. Second quarter period-end loans grew by 9%, and average loans broke the $9 billion threshold. Average total client funds, which includes both deposits and off-balance sheet funds grew by $540 million or 1.3% for the quarter, which shows liquidity growth of our clients, as well as our success with new client acquisitions. Although average deposits were down for the second quarter in a row, off-balance sheet funds posted nice growth, led by our off-balance suite fund. We had healthy gains on VC investments and warrants, thanks to relatively robust exit markets and valuation increases, as well as our continued emphasis on working with the best and most promising innovation companies. And credit quality remained strong overall.

We are very pleased with our performance this quarter and with the year so far. The health of our client markets has been a key driver of our results and clients continued to do well. The VC-backed exit market appears to be enjoying a long-awaited pickup as well. There were more than twice as many of VC-backed IPOs in the second quarter as in the first with the strongest showing for biotech since 2000.

Of 21 venture-backed IPOs in the second quarter, 57% were SVB clients, another indication that we're banking the best and the brightest. The number of VC-backed M&A deals remain steady in the second quarter, while we saw an encouraging increase in average deal values. The level of venture capital invested picked up during the quarter as well. Although year-to-date, it's roughly on par with 2012.

The recent trend toward more capital-efficient business models and smaller investments has helped new company formation by creating opportunities for new kinds of investors. Innovation capital is becoming much more widely available from non-VC investors, including corporates, angels and specialized seed funds. And that's good for our business.

From our perspective, new company formation remains very healthy, and we are banking new startups at a record pace. We added 318 new early-stage clients in the second quarter, a 30% increase over the same period last year. And for the first half of the year, we're at 550 new early-stage clients, nearly double the number for all of 2010.

These early-stage client volumes are key component of our long-term pipeline. The pace of business for our more established clients remain strong as well, with activity among our larger corporate finance clients driving the bulk of average loan growth during the quarter. These clients contribute to healthy volumes in our core, fee-based products, which increased by 10% in the second quarter over the same quarter last year.

The continued expansion of our products and services is an important part of our long-term strategy to be the bank of choice for innovation companies of all sizes worldwide. Today, we have a complete set of solutions for high-performance companies.

On the loan side, these run the gamut from traditional working capital loans and acquisition financing to specialized and custom products, such as mezzanine debt, founder liquidity solutions and private banking.

On the noninterest income side, we're enhancing our payment systems to make it easier for our clients do business with us and with their vendors and customers. For example, we're helping our clients who still use paper checks to move to more efficient card-based accounts payable systems. Near term, we're in production with our transAct Gateway, a platform to allow U.S. clients to fully automate their accounts payable processing with SVB. And we plan to go into production in third quarter with a mobile deposit platform. Our goal with these enhancements, with new products and with our global expansion is to be the only bank VCs, PE firms and entrepreneurs will ever need anywhere in the world.

Our long-time commitment and focus in innovation space is a tremendous competitive advantage in this effort. We have global name recognition and a stellar track record in technology, life sciences and venture capital. Moreover, the knowledge, experience and relationships we built over 30 years are more meaningful differentiators in a market that is increasingly appealing to traditional bank competitors. That competition and its impact on pricing is a challenge. Interest rates are another challenge. And although we're pleased to see the markets drive up long-term rates and asset-sensitive stocks in June, our asset sensitivity is really tied to short-term rates. The good news is the market seems to think a short-term rate increase could happen sooner than originally expected. In the meantime, despite increased competition and pricing pressure, we are working hard to win and keep the best and most promising companies as clients.

Overall, I remain excited about our growth prospects. And our clients, by virtue of being in the innovation space, are creating new opportunities, new companies, products and industries everyday. We have built a very strong market position and are well positioned for continued strong performance, assuming the economy doesn't deteriorate. We believe we're on track with our long-term strategy of bringing clients in early and keeping them as they mature, providing one-stop shopping for VCs, PE firms and entrepreneurs, doing what we do globally and maintaining our focus on the client, which is the most important thing.

In closing, I'd like to share some recent feedback that I received from a spouse of a client of ours. Recently, we hosted a multi-day event with 75 venture capital and private equity financial executives. In one of the dinners, our clients husband came up to me and thanked me. He told me that after the firm switched to Silicon Valley Bank, her job became so much simpler, more streamlined and just easier that she's able to more -- spend more time with their family, and he attributed that to SVB.

One of our goals is making it easier for our clients to do business with us. And I can't think of a better example of what success looks like than that. Such success is really a testament to the dedication of our employees, who are the ones taking care of our clients and helping them reach their goals. Their commitment sets us apart and ensures we keep innovating to help our clients succeed.

Thank you, and now I'll turn it over to our CFO, Mike Descheneaux.

Michael R. Descheneaux

Thank you, Greg, and good afternoon, everyone. We are very pleased with our performance in the second quarter, which was marked by continued loan growth and higher net interest income, as well as strong gains on investment securities and warrants. There are 6 things I will highlight in my comments: first, outstanding loan growth and continued high credit quality; second, higher net interest income and an increased net interest margin; third, growth in total client funds despite a decline in deposits; fourth, strong gains from our VC-related investments and equity warrants; fifth, lower expenses as we expected; and sixth, continued strong capital ratios. Before moving on, I do want to point out that we are maintaining our overall 2013 outlook, although we have increased our net interest margin guidance and slightly decreased our expectations for core fee income.

Let us start with loan growth. Average loans reached another all-time high, increasing by $341 million or 3.9% to reach the $9 billion mark for the first time in our history. This increase reflects healthy demand among our growth stage and private equity clients. We also saw very strong runup at the end of the quarter in our private equity capital call loans, which helped drive up period-end loans by $777 million to $9.6 billion. Given the short-term nature of capital call loans, we would expect many of the capital call loans to be repaid quickly, which could result in relatively flat period-end balances in the third quarter. Nevertheless, we are on track to meet our full year average loan guidance, and our pipeline remains healthy.

Looking at the longer term, we expect our loan growth to outpace that of the broader industry, although as our portfolio increases in size, the percentage growth rate will likely trend lower.

Turning to credit quality. Credit quality remained strong, and our underlying metrics were solid. Our provision for loan losses was $18.6 million in the second quarter, of which approximately $9 million was due to strong period-end loan growth. This compares to a provision of $5.8 million in the first quarter. Net charge-offs in the second quarter were $11.2 million or 49 basis points annualized. This reflects gross charge-offs of $15.4 million. Net charge-offs also reflected exceptionally strong recoveries of $4.2 million, primarily from a single loan. Net charge-offs in the first quarter were $4.3 million or 20 basis points.

Our allowance for loan losses as a percentage of total gross loans was 1.23% versus 1.26% in the first quarter. Second quarter nonperforming loans were $41.2 million, or 42 basis points of total gross loans, a decrease of $3.2 million from the first quarter. Classified loans remained consistent with Q1. As you can see, we continue to maintain high credit quality, and we remain confident in our credit outlook for 2013 assuming that the economy does not deteriorate.

Now let me turn to net interest income and net interest margin. Net interest income was $170.1 million, an increase of $6.9 million or 4.2% over the prior quarter. This increase was driven by strong average loan growth and higher overall loan fees, primarily prepayment fees. We were also helped by lower premium amortization expense in our available-for-sale securities portfolio. These increases were offset somewhat by lower interest income from our AFS portfolio due to declining average balances, which were impacted by our use of portfolio maturities to fund our loan growth.

Turning to net interest margin. Our net interest margin increased by 15 basis points to 3.4% in the second quarter. This increase was due to 3 factors: first, a favorable change in interest-earning asset mix, primarily as a result of loan growth; second, lower premium amortization on our available-for-sale securities portfolio due to a rise in long-term rates during the quarter; and finally, higher loan prepayment fees. VCs also drove the increase in overall yield on the loan portfolio by 8 basis points to 5.86% in spite of lower yields on loans before fees.

As a result of the second quarter improvements to our net interest margin, we have raised our 2013 net interest margin outlook range by 10 basis points. While keeping in mind that net interest margin will be affected by deposit growth and premium amortization, we now expect net interest margin for the full year to be between 3.25% and 3.35%.

Now let's look at total client funds. Average total client funds, that is the sum of our on-balance sheet deposits and our off-balance sheet client investment funds, increased by $540 million or 1.3% to $41.8 billion. This increase reflects higher average off-balance sheet funds offset by a decline in average deposit balances. Average client investment funds increased by $711 million to $23.2 billion. This change was largely driven by $573 million or a 14% increase in our off-balance sheet suite product.

Average deposit balances decreased by $171 million to $18.6 billion, primarily due to lower noninterest-bearing deposits. With respect to period-end balances, we saw an increase in off-balance sheet funds and a decrease in deposits. However, we have seen a rebound this month in deposit levels. And while it is still early in the quarter, we are off to a good start in Q3.

Now let us move on to noninterest income. Noninterest income net of noncontrolling interest was $67.4 million in the second quarter compared to $56.1 million in the first quarter. Please note that this is a non-GAAP number. The increase was driven by gains on investment securities and equity warrants. Gains on investment securities net of noncontrolling interest were $9.5 million compared to $5.1 million in the first quarter. These gains were primarily related to valuation increases in our fund of funds. Gains on equity warrants were $7.2 million, compared to $3.5 million in the first quarter. Most of these gains were due to increases in warrant valuations as a result of funding round-up dates.

Now let us turn to core fee income, that is fees and foreign exchange, deposit service charges, credit cards, client investments and letters of credit. As Greg indicated, although quarterly core fee income increased by $3.2 million or 10% year-over-year, it was flat in Q2 at $36.5 million compared to the prior quarter due to lower volumes from foreign exchange and a challenging fee environment for our client investment funds.

Accordingly, we are adjusting our full year outlook range for core fee income from the low teens to the low double digits. However, it is important to keep in mind that the dollar figures driving this change are relatively small, and we remain optimistic about the longer-term growth prospects of our core fee income.

Now I will move on to expenses. Noninterest expense was $143.3 million in the second quarter, a decrease of $5.7 million or 4% from the first quarter. This decrease was driven primarily by lower compensation and benefits expense following a seasonal spike in Q1. The decrease was offset somewhat by a high incentive compensation, which is a significant variable in our expenses since it is determined by our performance relative to that of our peer group and our internal goals.

Moving onto capital. Our capital position is strong and is further supported by our consistent earnings growth and solid credit performance. Our bank level Tier 1 leverage ratio increased by 31 basis points primarily due to earnings growth and to a lesser extent, to lower average assets.

Our bank level of tangible common equity to risk-weighted assets ratio decreased by 127 basis points to 11.18%. The key driver of the decrease was a significant increase in risk-weighted assets, driven by period-end loan growth. Additionally, decline was affected by a decrease in other comprehensive income from the impact of long-term market rates on our AFS portfolio. As a side note, the duration on our AFS investment portfolio was 2.7 years at the end of the second quarter compared to 2.4 years at the end of the first quarter. This increase reflects the impact of recent increases in market rates.

In closing, we feel good about our performance in the second quarter. In almost every respect, we are on track to meet our expectations and our outlook for 2013. Our clients continue to do well, and there are signs of modest improvements in the overall economy. The interest rate environment remains a challenge, and although we have seen a slight benefit from movements in long-term rates, increases in short-term rates will benefit us significantly. Irrespective of this and when rates improve, we continue to focus on things in our control. We have meaningful near-term growth opportunities. We remain well capitalized and highly liquid with outstanding asset quality. We have talented and motivated employees and the best, most dynamic clients of any bank. Together, these advantages enable us to deal with the current market challenges and drive our long-term growth.

Thank you, and now we'll be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Steven Alexopoulos with JPMorgan.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Maybe I'll start on the securities book. It doesn't look like you added to balances this quarter just given what loan and deposits did. I'm curious if those capital call balances come back in the quarter. Maybe for Mike, what's the reinvestment opportunity in terms of yield on your securities given what the curve has done?

Michael R. Descheneaux

So Steve, you are right. We didn't really add to our loan portfolio in the given quarter. And if we do happen to have surplus, at least, our view on the surplus deposits or cash to invest, I mean, we're essentially going to approach or take the same approach with our investment portfolio as we had in the past. But again, you're not going to really see anything significant of growth this year just even if we do get to reinvest it. But if we were reinvesting, it would probably be somewhere in around to 225 to 250 basis points is probably what we would end up reinvesting on. It just depends on what securities we choose.

Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division

Okay, that's helpful. And just -- could -- I wanted some color on the U.K. business, maybe the balance of the loans, how it changed versus 1Q. And can you talk about what's essentially that makeup of the loan portfolio at this stage? Is it capital call lines, software acquisition loans?

Gregory W. Becker

Sure, Steve. This is Greg, and I'll talk about that. We have about a little more than 300 corporate accounts opened up so far in the U.K. branch and about a little more than 1/3 of those are U.S. clients that are doing business in the U.K., and so we're setting up operations for them with the balance being local companies in the U.K.. I guess, first and foremost, we feel very good about where we are. It's ahead of our expectations. From a loan perspective, I think, the last quarter, we said it was around 400. It was a -- actually, a little bit less than 400, and right now, we're kind of a little bit higher than that, but it's in that range. It's made up of a combination of you take our portfolio in the United States, and you just mirror that against the U.K.. It's pretty close. When you look at growth stage company versus corporate finance, buyout and including capital call facilities, quite honestly, that's what excites us about it. We're not doing new things or different things there. We're consistently taking the profile of our clients in the United States and doing the same thing for them in the U.K.. So feel very good about where we are. We're optimistic about the outlook for the balance of this year and look forward to healthy growth that could be as much as 50% year-over-year.

Operator

Our next question comes from the line of Joe Morford with RBC Capital Markets.

Joe Morford - RBC Capital Markets, LLC, Research Division

I guess first question for Mike, if you could clarify the guidance on the margin a little bit? Seeing as if you just kind of held flat here at 3.40% through year end, we'd be slightly ahead of the full year range. Is that because some of the loan prepayment fees booked in the second quarter may not be repeated? Or is there some noise with premium amortization or price competition? What can you say about that?

Michael R. Descheneaux

Again, Joe, yes, you kind of answered your question yourself, but certainly, the loan prepayments, again, were a bit elevated in the quarter, so that was certainly affected and the same thing on the premium amortization. But other factor perhaps to consider as well, too, is where are we coming out on the deposit growth as well, too. If we're coming on the lower end of the range of the deposit guidance, then we'll certainly perhaps hold back or -- sorry, would help improve the net interest margin as well too. So there are those factors to consider.

Joe Morford - RBC Capital Markets, LLC, Research Division

Okay. And then, it's only because it may be the last chance I get to ask Dave a question. I wondered if he's there, if he could provide some...

Michael R. Descheneaux

He's here. He's here.

Joe Morford - RBC Capital Markets, LLC, Research Division

Okay, good. Maybe, David, you can provide some details on the increase in gross charge-offs this quarter and also just the outlook -- or the pipeline for additional recoveries.

David A. Jones

So thanks, Joe. I will take the last opportunity. The charge-offs in the quarter were the result of several bonds and the several cases of working through some lesser quality assets. You see that with the decrease in the nonperforming loans in the quarter. So -- still, mostly early-stage companies has been virtually a 15-year track record today. And on the recovery side, what we're very proud of what was accomplished in the second quarter with the $4.2 million of recoveries. I only wish that I can leave Marc with an opportunity to recover as much, but realistically, it's not there. So there are several small opportunities, and our recoveries for the foreseeable future probably will reflect what you had seen over 2012 and the first quarter of 2013 much more so than what you saw in second quarter of 2013.

Operator

Your next question comes from the line of Julianna Balicka with KBW.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

I have a couple of questions, one, to kind of follow up on the question began by Joe on the charge-offs. Dave, you said that the current -- the chart of this quarter kind of came from a pace of workouts that had been kind of building it seems like over several months to resolve NPAs. So kind of looking forward, is there more of -- I mean is that something that's finished out at this point? Or is this kind of an ongoing process and there may be a couple of more quarters of little bit higher charge-offs before the drop back down?

David A. Jones

So I am thinking that, in any given year, there could be one quarter that kind of stands out over the others. We had 1 quarter in 2012 and the second quarter of 2013 could well be that 1 quarter and appreciate also that in that 1 quarter, we're talking about a 50-basis-point annualized level of net charge-offs. So we have, otherwise, provided guidance that net charge-offs would range from 30 basis points to 50 basis points over an annual period. The idea that we could have net charge-offs at 20 basis points in the first quarter, as was the case, and 50 basis points annualized in the second quarter, feels fine. And I'm thinking that if the economy holds, that there's good reason to think that the foreseeable future would hold net charge-offs that might be bracketed by the first 2 quarters' performance.

Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, that makes sense. And then on the AOCI decline this quarter, any thoughts on -- any changes or any thoughts on the security portfolio margin going forward in terms of future AOCI decrease or in general? Can you elaborate a little bit more on that?

Michael R. Descheneaux

We've been gearing our securities portfolio to a relatively, what I would call, sensible shorter-term duration, right, in expectations of some of these rate moves. And our portfolio is fairly well seasoned, so if rates do continue to go up, we really don't see -- if you're getting into duration extension, we really don't see it extending out too much further. I mean, we are at 2.7 years here currently. And again, we see it perhaps -- probably we're quite comfortable to be going up in 3, 3.5 years as well, too. But we really don't see it extending out too much further.

Operator

Our next question comes from the line of Jennifer Demba with SunTrust Robinson Humphrey.

Jennifer H. Demba - SunTrust Robinson Humphrey, Inc., Research Division

My questions really have been covered, but I'm curious if you can give us just an overall data on the progress of your private banking effort over the last 6, 9 months and how it's going according to plan and where you see it going maybe the next couple of years?

Gregory W. Becker

Sure, Jennifer. This is Greg. And I will -- I'll give you my perspective. My insight to the private bank is, first of all, very focused. That's kind of the most important point. We're working with our venture capital, private equity firms and the individuals that are part of those firms, plus increasingly, the CEOs of our high-performing companies. And again, the strategy is to really be very targeted, and I think that's our value proposition, is when your whole product set is designed around very specific individuals, you can really hopefully add a lot more value and customize to them. So our view is progress is going well. We had -- saw nice growth this last quarter in the private banking loan portfolio. But again, it's going to pace itself at a pretty consistent level compared to the rest of the loan portfolio growth, so you shouldn't see it grow, quite honestly, a lot faster or a lot slower than the rest of the loan portfolio. But it's on track. We feel good about it. And the feedback we're getting from clients, most importantly, has been exceptionally positive.

Operator

Our next question comes from the line of Ken Zerbe with Morgan Stanley.

Ken A. Zerbe - Morgan Stanley, Research Division

I was hoping -- in terms of your growth in the larger client segment, can you just talk about how much of that came from acquisitions or buyout activity versus other type of, let's call it, more traditional C&I lending in the tech space?

David A. Jones

Yes, and this is Dave. So the majority of that growth would have come from acquisition financing, Ken, and it is simply because when we book $20 million, $25 million, $30 million for an acquisition financing, we're going to enjoy that, say, $25 million for the entire next 90 days versus when it's a working capital type financing, it could be out for 15 days or 45 days. So what we saw in the second quarter was the expansion of average loans primarily from acquisitions that were largely booked in the first quarter.

Operator

Our next question comes from the line of John Pancari with Evercore.

John G. Pancari - Evercore Partners Inc., Research Division

I wonder if you can give us a little more color on your loan growth outlook. Your low-20s range for the year-over-year seems a bit conservative, I guess, because it implies flat balances, obviously, for next quarter, which you've already mentioned but also for the fourth quarter, it implies flattish as well by my math. So just wanted to see if you can give a little bit more color there, if you think you could be on the conservative side?

David A. Jones

John, this is Dave. And -- so one of the things that you would say following us for as long as you have is that we have average loan growth that tends to be below the period ends. So it is not unusual for the average for the following quarter to be anywhere from, say, 3% to 5% below the period-end balance of the prior quarter. So when you think about average, we had a little over $9 billion of average in the second quarter. That average, if we were to continue it for third and fourth quarter, meaning that if we'd had had the last 3 quarters, for example, less $9 billion, we wouldn't get to that low 20s. We're going to need to see that we have a loan growth in the third quarter and fourth quarter, not as significant, obviously, as the second quarter, but we'll need to continue to see loan growth in the third and fourth quarter to get to that low 20s. So I would like to exceed the expectation knowing that there will be quality in the business generated. But I'd also acknowledge that given the competitive environments that it would be unwise for me to bestow on people that will follow me an expectation that it is conservative. I don't believe it is. I think that Marc and others are going to have to work hard to get to that low 20s.

John G. Pancari - Evercore Partners Inc., Research Division

That makes sense. On the deposit side, can you give us a little more detail on the decline in the deposits in the quarter? What you're seeing -- are you seeing any change in deposit behavior? Or is it just a shift towards the off-balance sheet? And then a little bit on the outlook on the deposit side as well.

Gregory W. Becker

Sure, John. This is Greg. I'll start with it, and Mike may want to add to it. We did see just really a modest decline in deposits during the quarter on an average basis. And again, we really try to stress that our focus is on total client funds, which grew about $575 million, $580 million during the quarter. And so from our standpoint, it kind of fits with what we've been talking about for a while, which is from a capital ratio perspective, we're fine with directing more of the balances, excess balances off the balance sheet. And that's what we saw this quarter. As far as the outlook goes, we've kind of described what the outlook is in our -- in the guidance. But how we see that playing out is we think deposits will stabilize where they are, possibly grow, but we expect to see total client funds see -- continue to see nice growth the balance of the year. And that's a function of both winning higher wallet share of our existing clients and new client acquisitions.

Operator

Our next question comes from the line of Brett Rabatin with Sterne Agee.

Brett D. Rabatin - Sterne Agee & Leach Inc., Research Division

Wanted to ask about just the loan portfolio. I noticed, thinking about the linked quarter perspective, the variable percentage increased and from a 10-Q disclosure perspective, you guys probably have the highest asset sensitivity to a 200-basis-point parallel shift in the yield curve. What if rates just don't quite do the parallel shift and do what we've been seeing, which is the short end takes longer than the longer end to move higher? Can you give us some thoughts on kind of both how your variable loan portfolio has changed and maybe thinking about NII, if the yield curve shift isn't parallel as you guys kind of use in your analysis?

Michael R. Descheneaux

So if I understand that question, I think what you're trying to drive at is where do we believe long-term -- or loan yields are going to head if the rates stay the same. Is that what you're trying to drive at?

Brett D. Rabatin - Sterne Agee & Leach Inc., Research Division

Well, just thinking about your loan portfolio yield. I guess, first, probably the easiest thing to do would just be to kind of break out the prime versus LIBOR based and then just kind of think about how you see your loan portfolio yields rising as rates do rise, whether it be the short end or the long end.

Michael R. Descheneaux

Well, I think I'll start off, and then Dave can chime in here. But the one thing to put in perspective is there is that tendency that most of the loans we're issuing today are variable-based loans. And particularly as we get to some of these larger corporate clients, most of the loans that we're doing with them are LIBOR-based type of loan. So again, we've continued to issue the variable-based loans here. Now additionally, a lot of our growth is also coming from the cap call lines of credit, which tend to be based on national prime rate as well, too. So a lot of it just depends on the mix on where we go from here. But again, I think you're going to continue see the growth areas come from those corporate finance and the private equity and the associated rates with that. So I mean, we'll start with that and then maybe you have the follow-up question on that.

Brett D. Rabatin - Sterne Agee & Leach Inc., Research Division

Well, I guess, I'm just trying to think about that you're pricing more of your loans off of LIBOR and if LIBOR is not moving quite as fast, and maybe prime is maybe at the longer end of the curve from a treasury perspective is -- I mean, as you think about your loan portfolio yield in the next year or so, I mean, I assume you're kind of thinking about that rate continuing to move and decline with competition. But I don't if you want to provide any additional thought on that.

Michael R. Descheneaux

So a lot of it will depend, again, on the mix and where we're going to come from. So if, for example, if we had some buyout loans, those would tend to hold the yields up and you have less deterioration in value. If the growth is going to continue to come from private equity cap call lines, when that's based on a national primary, that's certainly going to try to bring it down on the overall yield as well. So again, a lot of it, Brett, just depends on where that mix is going to come from. So I mean, you're going to continue to see a bit of pressure on the yields coming down in general, but again, going back to our strategy, our strategy about going to the larger corporate finance is not just about the loan interest income. It's also about the fee income that comes associated with it.

Brett D. Rabatin - Sterne Agee & Leach Inc., Research Division

Okay. That's good color. And maybe the other thing I was just hoping to get a little clarification on is just you were just talking about the client adds and the total deposits in the quarter. Could you talk about maybe, as rates do go higher, your thoughts on bringing some of the off-balance sheet back on-balance sheet or how you think about kind of funding growth as rates do move higher?

Gregory W. Becker

Yes, Brett. This is Greg. And as we're going through that process right now, and unfortunately, I guess, we haven't had to think about it a whole much -- a whole lot since the rates have been -- continue to be pushed out. But clearly, what our strategy is, is to build a product set that is going to allow us to continue to fund loan growth when rates start to pick back up, and one of the risks that we have is you start to see with our very low noninterest-bearing deposits is that more of that money starts to chase, either interest-bearing accounts are moving off-balance sheet to get yield, although we still think we're going to end up with a higher balance than a lot of our institutions with noninterest bearing, we're going to have to look at what we're going to be paying for our on-balance sheet money market accounts and make sure that we have the right, I'll you call it, toggles or switches to make sure that we can keep funding our loan growth. So we're looking at it, and clearly, the margin will pick up greater with the increase in rates. But we'll see some compression, but I guess, we'll just have to pay a little bit for the deposits that our on-balance sheet.

Michael R. Descheneaux

Perhaps the only thing I would add to it is just on the maturities on the investment securities portfolio, the capabilities of using the maturities to fund our loan growth. And currently right now, we have about a little bit over $600 million a quarter that's maturing from investment security portfolio, which is -- certainly has been adequate enough to fund the loan growth that we've because that's quite a large number on an annual basis as well, too. So even just with those maturities, that is quite healthy amount to help fund loan growth coupled with any -- even if it's a very modest growth in deposits on the balance sheet. So again, for the foreseeable future, we feel very good about the funding of the loan growth.

Operator

Our next question comes from the line of Herman Chan with Wells Fargo Securities.

Herman Chan - Wells Fargo Securities, LLC, Research Division

My question's on fee income. You've seen core fee income flattish for a couple of quarters now. Given the growth in the larger corporate finance clients, I would assume fee income would trend higher. Can you provide some color on the decline in your fee income outlook and what you're seeing specifically in foreign exchange activity?

Gregory W. Becker

So Herman, I will start, and Mike may want to add some color to it. So we have seen volumes last quarter were up. This is in Q1, and in Q2, they actually declined a little bit. And when you look at volumes and you look at margins, they were, quite honestly, just a little bit sluggish in both quarters. Now that being said, we still look at the outlook, and that is driven by the new client acquisition, the number of corporate finance clients and even with the competitive pressure, we still expect it to grow. So the last 2 quarters, it was a little flat, but I guess, right now, we're not worried about it. We're still optimistic about the outlook. That's one aspect. The second aspect is the card income and that's our overall credit card fees, and those volumes have continued to increase at a very rapid rate over the last 12 months, actually, the last couple of years. And the outlook that we have for that basically is the new products we're bringing in the market, with the up cycle or uptick we're going some more clients and these new products is actually very positive. So we're positive about the outlook, and I'd say, we should expect to see nice growth, especially in credit cards.

Herman Chan - Wells Fargo Securities, LLC, Research Division

Understood. And on the fund investment gains, are we at a stage in the investment cycle that we should expect an elevated level of fund gains going forward? How are you thinking about that particular item there?

Michael R. Descheneaux

That's a very, very tough question, and a lot of it, obviously, depends on the environment that we're operating in. If there's a healthy amount of M&A activity, that's very conducive to upside gain, if the IPO activity's very healthy or the valuations on the stock market. So again, it was a nice surprise this quarter. It's certainly, a little bit more than we anticipated, but we certainly do expect to have some decent gains going forward, again, as long as the economy holds true.

Operator

Our next question comes from the line of Gaston Ceron with Morningstar Equity.

Gaston F. Ceron - Morningstar Inc., Research Division

I just had a question about what we can improve from the bank's performance -- from the company's performance as hopefully, the economy continues to improve and your margin hopefully expands. What's the lever -- what's -- how should we be thinking about the level of operating leverage in the business model? I mean, what can we kind of expect, you think again as the economy improves, your margin expands and hopefully an increasing percentage of net revenue falls to the bottom line?

Michael R. Descheneaux

I'll start off here first. I mean, without a doubt, I mean, interest rate is going to be one of the key drivers to improve the leverage ratios. But as we said, we can't wait around for the interest rates to come back. I mean, we think they will come back, but nonetheless, it's starting focus on things within our control. And so when you start thinking about our operating structure and things that we're doing, we've talked about -- I mean, we recently set up an operation center in Tempe, Arizona, which, again, is very conducive to our model to help us scale and certainly, more attractive on a cost basis as well, too, again focusing more on the fee income as well to try and grow those as well to kind of offset any challenges that we may have on the interest rates. And some of those things that are -- -- we're looking at the way we do -- way we operate our model. So again, it's very -- top of mind for us is trying to manage that efficiency ratio.

Gaston F. Ceron - Morningstar Inc., Research Division

And then lastly on a different kind of leverage question, I mean, again, kind of looking at longer term, I mean, what's a good way to kind of think about how you approach just overall leverage? Whether it's TA to -- TE to TA or assets to equity or what not? I mean what -- Or TCE to TA? What sort of a good way that kind of we're thinking about what the bank wants to be sort of over the longer term?

Michael R. Descheneaux

We haven't come out with any guidance on that. One of the things we have and if you're talking about leverage ratio, the Tier 1 leverage ratio, again, that is something we've been trying to drive up. And if we're talking about the bank level, that's certainly something we've -- say, look, we'd like to see it go above 7%. And in fact, we're actually already there, and you saw a nice improvement in that ratio this quarter as well, too. So given the quality of our equity stack and given the market environments around it, we feel very, very comfortable with where we're at, above that 7%.

Operator

Our next question comes from the line of Gary Tenner with D.A. Davidson.

Gary P. Tenner - D.A. Davidson & Co., Research Division

I think my questions have largely been answered. Just curious on the provision build in the quarter. Can you talk about the amount of reserve that you sort of allocate to new capital call line drawdowns as opposed to other parts of the portfolio? Is it a lower provision build, relative to those lines?

David A. Jones

Yes. This is Dave. The answer is yes. Our allowance methodology does take the individual niches and the loss experience we have recognized from the niches in determination of our ultimate recommendation. I don't want to get too far end to weeds to describe that, but specifically, for private equity and venture capital call facilities, the required reserve is a little bit less than the 113 basis points. That is, the generic allocation for performing loans.

Gary P. Tenner - D.A. Davidson & Co., Research Division

Okay, so presuming that period-end balances in the third quarter are flat as you suggested could happen, but the mix is a little bit different. There would still be some amount of reserve build out less so than what was driven by the growth this quarter. Is that fair?

David A. Jones

So if loan balances were flat across the board, then all other things equal, we could expect to have an allocation of 113 basis points again, and presumably then the recommendation for the provision would largely be associated with the net charge-off.

Operator

Our next question comes from the line of Casey Haire with Jefferies.

Casey Haire - Jefferies LLC, Research Division

A question on SVB prime, just how much of the loan book is still go on SVB prime? How much of a drag was it on the margin? And at what point is SVB prime sort of fully migrated to national prime?

Michael R. Descheneaux

We're pretty much eliminating most of that in our portfolio. It's come down significantly over the last several quarters, and I can't really think off the top of my head, but I think it's probably somewhere around 10% is what I'm thinking, 10% to 15%, but it continues to come down as we migrate over the national prime rate.

Casey Haire - Jefferies LLC, Research Division

Okay. And then just thinking longer term, I know you guys have a deeper penetration of the later-stage client base, which obviously comes with a lower loan yield. I'm just curious how -- what's the mix -- what's the composition of that later-stage client base today versus, say, 2006 when last time that, that was at a higher rate policy?

David A. Jones

So this is Dave. The later-stage business would be in the ballpark of, say, $2.25 billion. So it is, call it, about 25% of our business. And if you wanted to go back as far as 2006, then I would obviously have to be working off the top of my head in saying that, but I would say comfortably, it was substantially lower as a percent of our business in 2006 than it is today.

Operator

And we seem to have no further questions at this time, I'll now hand the call back over to management for closing remarks.

Gregory W. Becker

Great. Thanks, so just to summarize, we had a great quarter. We had strong loan growth and great client acquisition. The gains on securities and warrants were a nice positive uptick as well. So overall, good. I guess, what I'm more excited about is the outlook, and not only what we're building from new products and solution set but what we're doing globally and how we're supporting our later-stage clients. So we feel good about the outlook and are looking forward to many years to come.

So -- and I also want to thank our clients for their trust in us and our employees for their commitment. And I guess, most importantly, right now, when I give a big shoutout to Dave Jones for 16 years of doing a fantastic job as our Chief Credit Officer, and during that time period, we've been through a couple of big ups and downs, and Dave has been a great supporter of strong loan credit quality, as well as great loan growth over that time period. I know Marc's going to do a fantastic job, but I just want to thank Dave and thank everyone on the phone. So have a great day.

Operator

Ladies and gentlemen, this concludes today's conference call. We thank you for your participation. You may all disconnect.

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