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SVB Financial Group (NASDAQ:SIVB)

Q1 2010 Earnings Call Transcript

April 22, 2009 6:00 pm ET

Executives

Meghan O'Leary – IR

Ken Wilcox – President and CEO

Mike Descheneaux – CFO

Greg Becker – President, Silicon Valley Bank

Dave Jones – Chief Credit Officer

Mark MacLennan – President, SVB Capital

Analysts

Dave Rochester – FBR Capital Markets

Ken Zerbe – Morgan Stanley

Steven Alexopoulos – J.P. Morgan

Christopher Nolan – Maxim Group

Aaron Deer – Sandler O'Neill & Partners

Ken Usdin – Banc of America

Fred Cannon – KBW

John Hecht – JMP Securities

Joe Morford – RBC Capital Markets

Operator

Good afternoon. My name is Deanne and I will be your conference operator today. At this time, I would like to welcome everyone attorney to the SVB Financial Group Q1 2010 earnings conference call. All lines have been placed on mute to call – I'm sorry, 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.

Meghan O'Leary

Thank you. Today, Ken Wilcox, our President and CEO and Mike Descheneaux, our Chief Financial Officer, will discuss SVB's First Quarter 2010 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 limitations financial guidance for future periods and the full year 2010. 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 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 non-GAAP financial measures. The presentation of the reconciliations to most directly comparable GAAP financial measures can be found in our press release and now I'd like to turn the call over to Ken Wilcox.

Ken Wilcox

Thank you, Meghan and thank you all for joining us today. SVB Financial Group reported a solid first quarter today, delivering earnings of $18.6 million or $0.44 per share and exceeding consensus estimates. These results were driven by our growing asset base fueled by deposits, better performance in our funds management business, a lower loan loss provision and improving credit quality. They were offset to some extent by lower loan balances and somewhat higher expenses.

Our first quarter results reflect improvements we're seeing in our markets and our business metrics. While they have not yet translated into net loan growth, we believe it is only a matter of time and we are greatly encouraged by several recent developments.

The first development is improving expectations for technology markets. Recent reports project that global information technology spending may increase as much as 8% in 2010. Some companies appear to be experiencing that growth already. IBM just announced a $2.6 billion profit in quarter-over-quarter growth. And Intel reported its best quarter ever, forecasting record profit margins for 2010. These companies demonstrate the resilience of the broader technology industry as up-to-date systems and software have long been a competitive necessity for many businesses.

An improving technology market will undoubtedly benefit many smaller emerging companies as well as the established leaders. And that leads me to the second development about which I'm optimistic, improving venture capital investment levels and greater activity in the exit markets for venture back companies.

Venture Investment in the first quarter was up 11% over a year ago at $4.71 billion, according to the most recent reports. That amount funded 597 rounds in the first quarter versus 522 rounds in the first quarter of 2009. In other words, a 14% increase. While Venture Capital Investment is still significantly lower than in many recent years, this modest improvement bodes well for our clients.

The exit markets improved more significantly in the first quarter with nine venture backed IPOs, the most in any quarter since 2007. These companies raised $936 million, more than double the amount raised in the fourth quarter of 2009. There were also 111 mergers or acquisitions of venture backed companies, the highest number in any quarter since 1975.

This increase in venture-backed exits has emerged after many successive quarters of anemic or non-existent exit activity. And it speaks to an improved outlook for fund raising as liquidity returns to the hands of limited partners. Of course, a single good quarter does not constitute a recovery but it's a good sign and we're encouraged by it.

Our clients' confidence appears to be improving as well. This is the third development that makes me optimistic. In a survey, we recently conducted of our early stage clients, more than two-thirds said things were already better than last year and three quarters expect things to improve even more in the next 12 months.

Indirectly, our lower charge-offs and .declining classified loan balances during the quarter suggest our clients are in better shape than they were a year ago. And our continuing deposit growth speaks to the fact that they have ample liquidity.

As I said, we are optimistic about all of these developments and although they did not result in loan growth during the first quarter, they contributed to significant growth in our pipeline which I would describe as extremely strong at this point. We have not seen activity like this in quite a while.

During the first quarter, we saw more traffic, had more definitive discussions and provided more term sheets to our current and prospective clients than we have in over a year and we continued to add new clients as we have throughout the downturn.

Our credit client count is the highest, it has ever been. We certainly expect these developments to generate loan growth in the near term. At that point, we will benefit from the additional earnings power of higher loan balances and the market share gains we've achieved throughout the downturn and of course, at some point, we will also benefit from higher interest rates as well, I'm sure.

In the meantime, we are doing everything we can to take advantage of the earnings potential offered by our excess liquidity even in this low rate environment. We increased our average interest earning investment securities by $715 million during the first quarter, after significantly increasing this portfolio in 2009 that in turn has helped our net interest income which has been significantly impacted by low interest rates.

We remain one of the best capitalized banks in the industry with ratios that in many cases are more than double the regulatory standards for well capitalized institutions. Nonetheless, the economy is still far from predictable and capital requirements for banks are likely to increase.

We believe we are well prepared to adapt to those requirements while continuing to lay the foundation for future growth. On that point, I want to touch on a topic we are frequently asked about these days which is portfolio acquisition.

We have said in the past that while we believe our growth will be primarily organic, we are prepared to acquire the right portfolio if it makes sense. There are a good number of high quality portfolios available in the market today which is another indicator of an improving economy. We have looked at a number of these portfolios in the past few months and will continue evaluating these potential acquisitions opportunistically.

Let me close by saying that although a broad based economic recovery is expected to come slowly, we think all signs point to growing positive momentum and we're optimistic, not just because there are better years ahead, but because SVB Financial Group stands to benefit tremendously from the many incremental improvements we will see along the way. And with that I'd like to turn the call over to our CFO, Mike Descheneaux.

Mike Descheneaux

Thank you, Ken, and thank you all for joining us today. As you heard from Ken, we had a solid quarter. We are seeing positive signs among our clients and strong momentum in the pipeline. There are five key topics I want to address today as I review our first quarter 2010 results. I will also update our outlook for 2010.

First is the timing of our return to loan growth. We are seeing strong signs of growing momentum despite the fact that loan balances were down during the first quarter and credit line utilization remained lower than normal.

Second is the increase in our interest earning assets. Clients continue to put deposits on the balance sheet in the first quarter and we further expanded our investment securities portfolio in order to put more of those funds to work.

Third is continued credit quality improvement marked by lower gross charge-offs and higher recoveries. This also marks the third successive quarter we've seen lower classified loans.

Forth is higher non-interest income driven primarily by gains in our venture capital and private equity related investments and fifth is expenses. As we predicted, they were higher in the first quarter due to our continued investment in people and projects. That said, they were still somewhat lower than we expected and we have slightly improved our expense outlook for the full year 2010.

Let me start with loan growth. Average loan balances declined by $252 million or 5.8% to $4.1 billion. This decrease came primarily from lower utilization of our capital call lines of credit by our venture capital clients related to the still relatively slow pace of Venture Capital Investment.

We believe these lines of credit will come back as venture capital funding activity increases. Let me explain why we are still optimistic about prospects for our loan growth. First, we expect the improving outlook for technology to translate into higher utilization rates as Ken outlined earlier.

Our efforts to refine our relationship management according to client size and stage of life should increase this impact as we deliver increased value to our clients. Second, our pipeline grew by 25% in the first quarter and is at its highest level since 2008. Third, we are building momentum among our larger corporate clients, especially in biofinancing, and fourth, our international lending is building. We saw a nice pick up during the first quarter and we expect that momentum to continue.

So we have a lot of reasons to feel positive about loan growth in the near term, but let me move on to the rest of our results. During the first quarter, we crossed a 14 billion threshold for period-end assets. We increased our average interest earning assets by adding 715 million of investment securities, an increase of 22%. These increases were fueled by average deposit growth of $1.1 billion or 11% during the quarter.

Since the first quarter of 2009, average deposits have grown by more than 38% and we have increased our average investment securities portfolio by $2.5 billion. We are committed to putting as many of these resources to work as the sensible in the light of the changing economic and regulatory environment.

Our strategy is to make investments that benefit income without compromising liquidity while positioning our balance sheet for rising rate environment.

Net interest income remained stable in the first quarter at $101.4 million compared to $102.7 million in the fourth quarter despite the fact that average loans declined and there were only 90 days in the quarter versus 92 in the fourth quarter. Compared to the first quarter of 2009, net interest income rose 10% despite a $1 billion decrease in average loan balances during the same period.

Loan yields were flat in the first quarter compared to the fourth, although they were higher than the first quarter 2009. Lower loans and continued deposit in flows contributed to a lower net interest margin of 3.3% compared to 3.5%, excuse me, 3.57% in the fourth quarter. Despite the impact of the deposit in flows on our net interest margin, our investment of these funds is accretive to net interest income.

Moving on to credit quality, which continues to improve each quarter. Net charge-offs were $14.9 million in the first quarter driven by lower gross charge-offs as well as higher recoveries. This compares to net charge-offs of $31.6 million in the fourth quarter and $40.9 million in the first quarter of 2009.

Our classified loan balances also declined for a third consecutive quarter. As a result of our improving credit picture and lower loan balances, our allowance for loan losses declined to 68.3 million or 1.61% of total gross loans compared to $72.5 million or 1.58% in the fourth quarter.

Our loan loss provision declined in the first quarter to $10.7 million compared to $17.3 million in the fourth quarter primarily due to lower loan balances and lower net charge-offs. Once loan growth resumes, the provision will most likely increase even if credit quality continues to improve.

Overall, our continually improving credit quality reflects our emphasis on strong portfolio management as well as the improving business environment for our clients. The improving business environment also had an impact on non-interest income, which rose $8.6 million or 21% during the quarter to $49.3 million, compared to $40.7 million in the fourth quarter.

This increase was driven primarily by net gains of $16 million or $3.2 million net of non-controlling interest on investment securities related to our venture capital and private equity related investments. This compares to net gains of $6.7 million in the fourth quarter or 828,000 net of non-controlling interests.

Although our outlook for core non-interest income has not changed, I want to share some thoughts on foreign exchange and client investment fees. Foreign exchange fees rose slightly by $700,000 during the quarter owing to the improving economy and cross-border private equity activity.

We expect that trend to improve in coming quarters owing to improvements in the overall economy and renewed activity among our venture capital and private equity clients. Client investment fees were lower driven by lower client investment fund balances. We expect these fees will be somewhat lower in 2010 due to lower average client fund balances.

While the FDIC has decided to extend unlimited insurance for demand deposits, we expect to opt out of that insurance at this point owing to our strong capital and liquidity. As a result, we could see increasing period in client investment fund balances towards the second half of the year. Our outlook for 2010 includes our expectation to opt out of the FDIC extended plan.

Now I'd like to turn to non-interest expense, which as we expected increased by $10.7 million in the first quarter to $98.6 million, primarily due to higher compensation and benefits.

As we have said in prior calls, this increase reflects a return to targeted compensation levels following two years in which incentive compensation was at half of target levels. Further employees received no merit increases and SVB made no contributions to its employee stock ownership program in 2009. That is because despite being profitable in 2009, we did not meet our internal targets due to the continuing decline of the economy.

Going into 2010, one area of focus is to compensate our employees appropriately to reward their excellent work in the face of significant economic headwinds and to promote retention. This focus reflects an improving economic environment and the need to support our success in winning and retaining clients.

Our employees did an outstanding job of driving our growth prior to the recession. We intend to take the appropriate steps to insure we can resume that growth in the near future.

If we don't meet our performance goals, compensation expenses will likely trend lower, but if we do meet those goals, you will see the impact of merit increases, higher incentive compensation and some additional new senior staff who we expect will facilitate our future growth. Our view extends beyond the next quarter as we are developing and building our business for the long-term.

Now, I'd like to talk about our updated outlook for the full year 2010, specifically the items that have changed. In general, we are still assuming a gradual economic recovery with technology being a bright spot, improving IPO and M&A markets and somewhat increased VC investment.

We do not expect interest rates to rise until very late in the year. December is what the forward curve currently forecasts. As a result, we are unlikely to see a significant impact from higher interest rates in 2010.

Coming out of the first quarter, we have reduced our expectations for loan growth, net interest income and net interest margin somewhat. By the same token we have improved our outlook for expenses, deposits, gains and losses from VC related investments and equity warrant income. These changes haven't materially changed our overall expectations for the year.

For 2010, we expect that average loans will decrease at a percentage rate in the high single digits due to continued deleveraging by our clients in all industries and a somewhat slower return to quarterly loan growth than we expected.

Previously, we had said expected loans, sorry, previously, we expected loans to remain comparable to 2009 levels. Our revised outlook implies modest end of period growth toward the second half of the year of about 4%. The improving economy will be a key driver for this number.

We expect average deposits to increase at a percentage rate in the mid-teens due to our clients desire to maintain liquidity and the current low interest rate environment. We increased this outlook from the low double digits.

We expect net interest income to increase at a percentage rate in the low double digits. This outlook also decreased from the mid-teens due to continued client deleveraging. We have reduced our outlook on net interest margin owing to our high deposit outlook and our adjusted loan outlook. We now expect net interest margin of between 3.5% and 3.8%.

We have improved our outlook for net gains and losses on equity warrant assets. We now expect performance to improve slightly over 2009 levels due to upward market and valuation trends. Previously, we have said we expected no change from 2009.

We also improved our outlook for net gains and losses on investments related to private equity and venture capital. We now expect them to improve over 2009 levels owing to improving market trends. In 2009, we had a loss on these investments net of non-controlling interest of $4.6 million. Previously we said we expected no change from 2009.

Finally, we have slightly improved our expense outlook for 2010. We now expect expenses to increase a percentage rate in the high teens. We previously said expenses would increase at a rate in the high teens to low 20s. This change is related to a change in the timing of certain business initiatives and hiring plans.

I would like to close by saying that although no one knows exactly how the recovery will play out; it seems to be taking hold. The VCX end markets are showing signs of life. Technology markets seem to be coming back strongly. Our clients are doing better and feeling better, and our pipeline is extremely strong.

We have ample capital and liquidity and we expect that the improvements we have seen in the last quarter will enable us to continue capitalizing on opportunities for future growth.

Thank you. And now, I'll ask the operator to open the call for Q&A. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Dave Rochester from FBR Capital Markets. Your line is open.

Dave Rochester – FBR Capital Markets

Hi, guys. Thanks for taking my questions. I know you mentioned loan growth of 4% in the back half of the year but given the increasing optimism we're hearing from you and the strong growth in the pipeline. Is it safe to say that you really expect to report loan growth next quarter?

Greg Becker

Dave, this is Greg Becker. And, I think from the loan growth perspective, what we try to do is give guidance that is more towards annual guidance and what we try to do is provide more clarity on what it's going to look like from towards the end of the year.

As you know our guidance, we don't give out quarterly guidance or guidelines, so we're trying to give some more information but not move away from our guidance of more annual numbers.

Dave Rochester – FBR Capital Markets

Got it. Okay. And how do you envision this playing out, when your clients decide to expand and spend. Do you generally expect them to perhaps cap their cash that first before drawing down on lines of credit or do you generally expect them to tap the lines first and hold off on spending the cash they've been saving in the near-term?

Greg Becker

Yeah, Dave. This is Greg again. So it is incredibly company dependent on answering that question. You'll see with some public companies, they may want to preserve a fair amount of cash and they would borrow, even though they do have ample cash depending upon their situation.

But clearly with most, what I'd say private companies, they are more geared toward working capital perspective to use cash first with the only exception being if they were doing equipment financing or something like that. So it is company dependent. But we don't expect to see any different trends than we have seen from historical periods.

Dave Jones

And this is Dave Jones. Let me just add and reinforce what Greg is saying that we are, we have been over recent weeks and months seeing folks put together the credit facility that maybe used for a small acquisition, maybe used for expanded working capital. And in the end, we might expect that they will both draw down on the credit facility and still maintain some pretty robust cash balances. That would be our historic norm.

Ken Wilcox

This is Ken. Let me just add one additional thing to think about and that is a lot of the companies and that we work with base their borrowing levels on business activity levels. Another way of putting it is if their credit facilities are geared towards their receivable levels and if their sales are not increasing then all other factors being equal, their receivables would also not be increasing and therefore the amount that they could borrow and the amount that they would probably borrow would not be increasing.

But right now, we're beginning to see revenues increase that is the revenues of our portfolio companies are beginning to rise. That means our average receivables are higher. Their borrowing potential is higher and all other factors being equal, they are likely to be borrowing in order to support the growth in the receivables.

Dave Rochester – FBR Capital Markets

That's great color. Thanks guys. Just one last one real quick on your international efforts you'd mentioned greater contributions from those. Can you just provide a little bit more color there as to what you're seeing?

Greg Becker

Yeah, Dave. This is Greg again. So from an international perspective, it's still relatively speaking small absolute numbers but it's more the incremental contribution, so we finished the first quarter with roughly $120, $125 million of loans from our kind of what we call our global international activities.

And, when we look at the pipeline and growth outlook for that, from a growth perspective, we could see growth of 70% on that, so hitting $200, $225 by the end of the year. So very good about that, very good quality companies and we're really just getting that ramped up right now.

Dave Rochester – FBR Capital Markets

Okay. Great. Thanks guys.

Operator

Your next question comes from the line of Ken Zerbe from Morgan Stanley. Your line is open.

Ken Zerbe – Morgan Stanley

Great. Thanks. And just a quick question on the portfolio acquisitions that you mentioned. Just to be clear on that. I think you said, you've looked at a few acquisitions and you've planned to continue looking at those. The ones that you've looked at have actually been sold and you didn't win or are these portfolios that you're still looking at that the process is just ongoing?

Ken Wilcox

Let me start out, I think both Greg and I would like to contribute to the answer here. This is Ken. They would really fit into about three different categories, I think. There are a lot of stuff out there and a lot of it is priced in a way that just doesn't make sense from our perspective.

So you could say that there are probably some things that we may still be looking at. You could probably say that there are some things that we weren't interested and may still be there and you could say there could be some things potentially although I'm not 100% sure; this is true that have actually gone to somebody who was willing to pay more.

Greg Becker

And only thing I would add, Ken, is that on the portfolio side. We've looked at this stuff and some of the stuff is in various stages of moving forward with other players and we'll see what happens, so we are definitely, Ken's main message is that, we have been looking and we're going to continue to look.

Ken Zerbe – Morgan Stanley

Okay. Great. And Ken, maybe just another follow-up on the loan growth question before, you see – I guess in your prepared comments, it just seems so optimistic in talking about all of the reasons why loan growth is picking up and the outlook is so bright.

But then the guidance is not that bright, it just seems that there's a disconnect to some extent between what you see happening versus what you say could happen. Are you just – are you intentionally being somewhat conservative in your guidance there?

Ken Wilcox

Yeah. Well I think, we are, first of all, I'm the CEO and Mike is the CFO, and the other thing I'd say is that, we both have a good reason for looking at things the way we do. I think that I'm basing my views which are optimistic. There can be no doubt about it, on the fact that we're seeing the revenues of the companies and the portfolio pick up, and we're also seeing a much stronger pipeline.

We were as good as anybody if not better at pipeline analysis and the pipeline is beyond the shadow of a doubt much stronger than it was a quarter ago and so all the other factors being equal that it would be shocking to me, if that didn't translate into loan growth, having said that you can't say with absolute certainty that it will.

Greg Becker

The only think I would add is I would actually say that there's two ways to look at it. One is average and clear the guidance is down on average basis. And it's name Greg. The only thing I would add-on to it is I would actually say that there's two ways to look at it. One is average and clearly the guidance is down on the average basis, and it's mainly because of the continued decline we did have in the First Quarter but the additional color we tried to provide was taking period end, the end of 2009 compared to the period end of 2010 and that's a 4% growth is what we had just stated in the revised guidance. That's going to give you a lot more color and if you look at that period end at 4% growth compared to where we are today, it is actually pretty robust growth from here to the end of the period.

Ken Zerbe – Morgan Stanley

Okay. All right. Thank you.

Greg Becker

Yeah.

Operator

Your next question comes from the line of Steven Alexopoulos from J.P. Morgan. Your line is open.

Steven Alexopoulos – J.P. Morgan

Hi, everyone.

Greg Becker

Good afternoon.

Steven Alexopoulos – J.P. Morgan

Could we start, could you give a little more color what's driving the deposit growth here particularly the non-interest bearing? Is it just a case that your customer sales are up and they just have more cash to hold?

Greg Becker

This is Greg. I'll start and others may want to add. So there's a couple things to look at. One is just the overall total client funds and if you look towards the middle of last year, we kind of reached another low point, 24-25 billion. We've been growing nicely since then and at a pretty steady path since that time period. So one is just both the new companies we're adding, liquidity in the market which is increasing is helping to contribute to overall total client funds. So that's the first thing. Second thing what you said I believe is true which is as sales pick up, as activity levels pick up, more cash flowing to transactional business comes into their checking account or their DDA balance and because there really isn't a alternative that's going to get a decent yield. It's just easier to keep it in your transactional or your DDA account. And so that is the main reason why you've seen a growth in DDA, but I'd look at both things that happening, improving economy and overall total client funds picking up.

Steven Alexopoulos – J.P. Morgan

To follow-up on the portfolio acquisition questions, can you give us a sense as to the size of the portfolios you've actually done, due diligence on and who are the sellers here? Are these other banks that are selling these portfolios?

Greg Becker

We really can't comment on that kind of thing and I think you can understand why.

Steven Alexopoulos – J.P. Morgan

Okay. We'll follow-up off line. Just one for Mike.

Mike Descheneaux

I won't talk offline.

Steven Alexopoulos – J.P. Morgan

Okay, can you give –

Mike Descheneaux

Nor will Mike. Okay, go ahead with your question, sorry, Steve.

Steven Alexopoulos – J.P. Morgan

That's okay. I'm looking at the expense guidance which changed just from the Investor Day. We spent a lot of time that day talking about why everybody was too low on their expense expectations. Could you give a little more color on what's changed since then now that you're taking the guidance down?

Mike Descheneaux

So we're taking it down slightly as I alluded in my prepared comments there and again, part of our expense outlook in growth was related to investing in certain project, be it systems projects or a global expansion as well as even hiring additional people to help us with our growth going forward. So when we're sitting here trying to continue with the project as well as the hiring there sometimes becomes a little bit more challenging to hire people. So for example, when we may have expected to hire something in Q1 and perhaps that's not happening and maybe sliding into Q2 or Q3, so again, I wouldn't, it's a slight adjustment but nonetheless it is an adjustment from an improved outlook.

Steven Alexopoulos – J.P. Morgan

Got you. Okay, thanks.

Operator

Your next question comes from the line of Christopher Nolan from Maxim Group. Your line is open.

Christopher Nolan – Maxim Group

Good afternoon guys.

Mike Descheneaux

Hi, Chris.

Christopher Nolan – Maxim Group

A quick question, Mike. On the securities gains, those appear to be mostly from SVB Capital, is that correct?

Mike Descheneaux

It's between our investment and managed fund to funds as well as some of our sponsored debt funds as well.

Christopher Nolan – Maxim Group

And I guess a key question here is has these funds entered any investment harvest phase which was spoken about a couple years ago where once they start reaching a certain maturity in terms of time, the harvest in terms of carry and so forth started coming on a more regular basis. So we should start seeing these security gains from this unit be a more regular occurrence?

Mike Descheneaux

So what happened in Q1 was more some of the valuation metrics improved. You had some better valuation comps. Now, as far as into that harvesting we're hopeful that that is going to begin to start to happen. We should start to hopefully expect to see some exits and actual distributions from those portfolios. So yeah, you could say that we are looking out to seeing those this year.

Christopher Nolan – Maxim Group

Sorry, Chris, we actually have Mark here.

Mark MacLennan

As Mike said, it's our expectation or at least we hope to see continued modest recovery in the whole M & A and IPO market and that's really where the distributions will come from so certainly far more optimistic in 2010 than we have the last 15 months on that level of activity.

Christopher Nolan – Maxim Group

Great. Thank you very much.

Operator

Your next question comes from the line of Aaron Deer from Sandler O'Neill & Partners. Your line is open.

Aaron Deer – Sandler O'Neill & Partners

Hi, good afternoon everyone.

Mike Descheneaux

Hello, Aaron.

Aaron Deer – Sandler O'Neill & Partners

A question with respect to the liquidity that continues to build and the securities that you've been purchasing. Can you give some additional detail on the securities and in particular, kind of where things are in terms of fixed versus floating? You suggested that you're preparing the balance sheet for rising rates but I imagine that's got to be tough with big securities book.

Mike Descheneaux

Yeah. And that's right. I mean as you know historically we've only bought fixed income instruments. And so in those events typically two and a half to three and a half years or so in duration, so as we enter into Q2 we're beginning to purchase variable rates agency CMOs as well too which have a slightly lower duration, perhaps one to two years in duration, so when rates do pick up that portfolio will benefit so essentially one way you could look at it is we're moving some of our cash that's only earning 25 basis points into some of these variable rate securities. So that's kind of what we've been doing.

Aaron Deer – Sandler O'Neill & Partners

And have you done models to see, I'm sure you have but I'm just curious what or how are you managing that so that you aren't put into a bad valuation position on that book if we do start seeing rates hike towards end of this year or early next year?

Mike Descheneaux

Valuation perspective from what's the concern?

Aaron Deer – Sandler O'Neill & Partners

Well, if rates start rising and the value of the securities book starts falling, what are you doing to prevent that kind of scenario?

Mike Descheneaux

Again, by us taking down the duration what's going to be helpful is adding these variable rate securities. So if we continue to pile on that and if rates started going up you'd have that so-called unrealized loss position as the rates rise. So part of the investment going into the variable rate securities is to try to help alleviate them.

Aaron Deer – Sandler O'Neill & Partners

What are the cash flows currently coming out of the portfolio?

Mike Descheneaux

I don't have that off the top of my head, Aaron.

Aaron Deer – Sandler O'Neill & Partners

Okay. Thank you.

Ken Wilcox

And before we go on to the next question, this is Ken; I would just like to interject something. I'd like to go back to the earlier discussion that we were having around portfolio acquisition and add one final point that I hope will be helpful in terms of understanding what we're trying to accomplish. And that is that the reason that I mentioned it may not have been the reason that some of you were inferring and I apologize for that. I just want to underscore that we're very pleased that our balance sheet is such that we're in a position now to look at anything that's out there. And to make an evaluation and if we were to come to the conclusion that it was being offered at a sensible price or that we could acquire it for a sensible price, we're in a position to take advantage of those kinds of opportunities and they are out there.

There could be no doubt about it. For a whole host of different reasons, they are out there. Having said that though, first of all we aren't going to overpay if we can possibly help it and we probably are in a pretty good position to evaluate most of these portfolios because we know most of the companies that are in them. And the other thing I wanted to say though is that we are still focused first and foremost on organic growth. That has virtually always been our approach and continues to be our approach and we expect that most of the good things that you'll see in the coming years will emanate from organic growth, not from portfolio acquisition. This just happens to be an unusual point in the business cycle where there are probably obvious reasons a number of portfolios out there that are either in the market for sale might be soon.

Meghan O'Leary

Operator, can we have the next question?

Operator

Certainly, your next question comes from the line of Ken Usdin from the Banc of America. Your line is open.

Ken Usdin – Banc of America

Thanks, good afternoon. My question is about the net interest margin, so just understanding you have all of this excess liquidity on the deposit side and the margin came down to 330. I'm just wondering as far as getting back to the 353.85 for the full year that implies a very steep ramp for the rest of the year, so I'm wondering if you can just help us differentiate between what's your expectation of rate hikes like how many and when and versus how much of that benefit would come through the improvement kind of on the loan side, the rate versus volume question.

Greg Becker

Let me just start with the rate outlook. As far as the rate outlook, look, in this year, we aren't expecting any significant upside at all. If you look at the forward curve, it's just not going to add anything to this year here. And again, our margin is basically strictly down because of those large volumes of deposits so if you were to take out some of the deposits you'd still be within the guidance on the net interest margin. As far as the loans, certainly loans, when our loan yields are somewhere in the neighborhood of a little bit north of 7%. If you start bringing those loans on it has a very powerful effect to help us get back to the net NIM range.

Ken Usdin – Banc of America

And so basically you can comfortably get inside even the bottom half of that range without if the Fed doesn't move?

Greg Becker

That's right. So when we did do our forecast. We basically are looking at the forward curve so the forward curve is roughly around a rate hike in December. But as you know, first 25 basis points is not going to be overly helpful on loans. But again, it would only be like one month for the year. So it's not going to have a major impact on the NIM.

Ken Usdin – Banc of America

Okay. So then you're basically going to exiting the year on NIM a lot higher than – even to get to the bottom end to 350 you're going to have to be exiting the year at a much higher NIM than you are at right? That's just the math of it?

Mike Descheneaux

Yeah. I'm sure that's how it works mathematically. Again, for the year our guidance is 3.5 to 3.8 range.

Ken Usdin – Banc of America

Okay. Great. Thanks very much.

Operator

Your next question comes from the line of Fred Cannon from KBW. Your line is open.

Fred Cannon – KBW

Thanks. Just this may be repetitive. Mike, so the position is very large cash position $4.5 billion of cash, maybe just a little more on your current strategy. It looks like your hesitant to invest it because of giving up rate sensitivity and you want to remain liquid for opportunities for both organic growth and portfolio purchases. Is that the best way to think about it?

Mike Descheneaux

You're right, Fred. Those are certainly some of the aspects. The other aspect is we've talked about opting out of this FDIC insurance program. And we've been talking for some time now that look, we could have some movement in $1.5 to $2 billion possibly a bit more in our deposits is well too. So when I'm thinking about it looking out or we all think about it we do bear that in mind and say look what happens if that does move to interest bearing or to our off balance sheet funds as well.

So that's part of the playing out and again like you correctly said you don't want to go too long in duration. And the yields out there are just not overly impressive and so that's why we're just being very sensible not to get caught up too much on duration.

Fred Cannon – KBW

I guess from a capital liquidity standpoint, maybe general question. Do you guys want the balance sheet to be bigger than $14 billion or do you feel like this is kind of as big as you'd like it to be strategically or do you follow what deposits come in?

Mike Descheneaux

Fred, as long as we can still be accretive and it's not a drag on return equity yeah, I think it definitely makes sense to keep the deposits on balance sheet. Because either perhaps in the short-term we aren't able to put it to work but again if you take our long-term view and the things we're trying to do with some of our larger corporate clients.

And we are going to need those deposits long-term down the road. And so the last thing is you want to deposit to leave your bank and then you try to struggle to go get it back. So our view is you know what, let's keep those deposits on our balance sheet as long as we can put it to work effectively.

Ken Wilcox

Hey, Fred. I'd like to add one thing to that, because I really don't want you to walk away with a wrong impression. We are fixated on optimizing the value of the balance sheet. This isn't about balance sheet size or anything of that sort. This is about optimizing the value of the balance sheet. And I wouldn't – I also don't believe that it would be fair to characterize our behavior as simply going with the flow of the deposits. We also in our effort to optimize value of the balance sheet do everything that we reasonably can to influence the direction of the flow of deposits.

Having said that, I think you are probably coming from your observation that there's an awful lot of capital and an awful lot of liquidity on this balance sheet and hard to disagree with you on that. But I think you are also going to keep in mind that we're coming out of a pretty deep recession and although things appear to be getting better. I don't think any reasonable person can claim that they can predict the future with absolute certainty. So I think prudent bankers right now have stronger balance sheets, not in terms of size but in terms of strength.

Fred Cannon – KBW

Which may be a tad less efficient than you ideally like. Is that a point?

Ken Wilcox

Well, yeah. We would hope to be more efficient and it's our intention to be more efficient. Because again our goal is to optimize or maximize the value of the balance sheet and so I completely understand what you're driving at and I am incomplete agreement with you. If your view is that we could have a more efficient balance sheet and should target that and we will indeed. But I think there's a time and a place and at this point in the business cycle, I'm comfortable that we're doing the right thing for our shareholders.

Fred Cannon – KBW

Okay. And then just one more, in terms of the expenses, you did say that basically the growth in expenses is related to achieving internal targets in your performance goals. And I guess it would appear that given the expenses that we saw this quarter that you are hitting your current performance goals. I was wondering, Ken, if you could give us any insight into what those kind of the performance goals you're looking at are to continue to keep that expenses in line with your guidance?

Ken Wilcox

Yeah. I'm going to leave specific numbers up to Mike. But I will tell you that we are doing a pretty good job although I would not, I do not believe that we are knocking the cover off the ball just yet. Having said that, I can assure you that that is everybody is intention here at SVB. I think there are at least 1200 people here who are maybe its 1200 and change, who are intent on knocking the cover off the ball and every one of them intends to earn their variable compensation to the fullest extent in the course of the year.

Fred Cannon – KBW

Thanks, Ken.

Ken Wilcox

Do you have a further comment on that or is that good enough?

Fred Cannon – KBW

I think that's fair. Okay. Thanks.

Ken Wilcox

Yeah.

Operator

Your next question comes from the line of John Hecht from JMP Securities. Your line is open.

John Hecht – JMP Securities

Good afternoon, guys. Thanks for taking my questions. I just have one question actually that hasn't been answered at this point and it's related, intends to model the poor get a sense for the relationship between the equity gains and the composition of the minority interest. You had a $16 million net gains and a $10 million minority interest expense this quarter. I mean is given the composition of your investments and your outlook for gains going forward, is that relationship a fair one that we should think about going forward or is there some volatility there we should be accounting for?

Mark MacLennan

John, this is Mark MacLennan. I think the portions are still rough proportions. Our investment depending on whether it's a fund investment or possibly a strategic investment can range from a 5% investment to in some cases we've had deal north of 15%. So on a quarterly basis, it will vary depending upon where the returns come from in that minority interest to the gross level of gains, but I think if you look at what happened this past quarter because it was a good mixture of results coming from both SVB Capital as well as our strategic investment. That's probably about as good a ratio as I can give you.

John Hecht – JMP Securities

And then given than the pipeline of maybe IPSs within your portfolios and things of that nature. Is this a spike or is this a fair number to think about on a quarterly basis or is this just going to be so volatile that it's not even worth forecasting at that level?

Mark MacLennan

By I'd love to have you give me the answer to that one.

John Hecht – JMP Securities

Okay.

Mark MacLennan

It's an extraordinarily tough number to figure out. I would say moderate improvement certainly in the first quarter than what we saw, the numbers that, Ken, gave you in his introductory comments. So I'm more optimistic than I've been in a long-time about the M&A and a resurgence of the IPO market. But that can come and go at any point in time. So it's hard to, I believe it will continue, I believe it will be a full continuation which on average will certainly benefit us to the positive.

John Hecht – JMP Securities

Great. Thank you for the color. Thanks very much.

Mike Descheneaux

You're welcome.

Operator

(Operator Instructions) Your next question comes from the line of Joe Morford from RBC Capital Markets. Your line is open.

Joe Morford – RBC Capital Markets

Thanks. Good afternoon, everyone.

Ken Wilcox

Hi, Joe.

Mike Descheneaux

Hi, Joe.

Joe Morford – RBC Capital Markets

Circling back again on this portfolio acquisition, I was just curious for the ones being marketed are they any particular part of the lifecycle or industry niche and as you think about that opportunity where would be your greatest interest?

Ken Wilcox

Well, we work with companies everywhere from pre-venture capital Roth [ph] start up to I think the largest companies in the portfolio are in the $1 billion in sales range. So that's quite a range and I don't know, personally of any portfolios that include companies that are in the hundreds of millions of dollars in sales range.

So that would leave us with earlier stage and growth stage companies and our interest would be anywhere where that the companies themselves fit into our target market. In other words, there are portfolios of things out there that we would have absolutely no interest in whatsoever because we are intending to stick to what we do, which is we work as you know, with venture backed companies in the innovation space and then our companies that were venture backed and have now out grown venture capital support.

So it's anything in our target market on the opportunities would be earlier stage and growth stage and in addition to that, I'm underscoring here, we are not as – I would say our opinion of the value of some of the things that we've looked at is not as high as the opinion of the sellers.

Joe Morford – RBC Capital Markets

Right. Okay. I guess secondly not to let Dave feel left out, non-performing assets were being flat.

Ken Wilcox

He looks much happier?

Mike Descheneaux

Were there any kind of major inflows or outflows or anything of note in some of the credit trends? It sounds like the overall pool of potential problems continues to kind of with sometime.

Ken Wilcox

Yes. And thank you, Joe. So our performance in the first quarter was as we would expect. And we continue to see some issues stemming from the early stage portfolio, but as you can see by the numbers, that is declining. Obviously, there wasn't anything large in the first quarter experience. So that also is a very positive and contributes to the information that Mike shared in our forecast for the balance of the year.

Joe Morford – RBC Capital Markets

Okay. Thanks so much.

Operator

There are no further questions at this time. I'd now turn the call back over to the presenters.

Ken Wilcox

All right. Well, let me just wind up by reiterating my optimism and it's based not just on everything I see and hear out there in the market, but it's based on what we're seeing in our pipeline. And we're feeling good about the accomplishments this quarter. Again, we didn't knock the cover off the ball but we did pretty well and we intend to knock the cover off the ball in the coming quarter. So that's I think the best summary I can possibly give. Thank you all for being part of the call today. We hope it was helpful. Have a good day.

Operator

This concludes today’s conference. You may now disconnect.

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Source: SVB Financial Group Q1 2010 Earnings Call Transcript
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