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SVB Financial Group (NASDAQ:SIVB)

Q2 2010 Earnings Conference Call

July 22, 2010 6:00 PM ET

Executives

Meghan O'Leary – IR

Ken Wilcox – President and CEO

Mike Descheneaux – CFO

Dave Jones – Chief Credit Officer

Greg Becker – President, Silicon Valley Bank

Analysts

Joe Morford – RBC Capital Markets

Steven Alexopoulos – JP Morgan

Aaron Deer – Sandler O'Neill & Partners

John Hecht – JMP Securities

Bobby Bohlen – KBW

Casey (ph) – Bank of America

Michael Zaremski – Credit Suisse

Christopher Nolan – Maxim Group

Operator

Good afternoon. My name is Mason and I will be your conference operator today. At this time, I would like to welcome everyone to the SVB Financial Group Q2 2010 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. I'll now turn the call over to Ms. Meghan O'Leary, Director of Investor Relations. You may begin.

Meghan O'Leary

Thank you operator and thank you all for joining us. We welcome you to our second quarter 2010 earnings call. I would like to remind everyone that our second quarter earnings release is available on the Investor Relations section of our website at svb.com. I would also like to remind you that we will be making forward-looking statements during this call and actual results may different materially. We refer you to our reports filed with the SEC and ask you to review the disclaimer in our earnings release filling with forward-looking information.

This disclaimer applies equally to the statements made in this call. We will limit the length of the call to one hour which will include Q&A. During the Q&A section, we ask you to limit your question to one primary and one follow-up before getting back in the queue to enable other participants ask their questions.

And with that I will turn the call over Ken Wilcox. President and CEO.

Ken Wilcox

Thank you Meghan and thank you all for joining us. I'm pleased to report that we earned $21.1 million in the second quarter or $0.50 per share. We're proud of those numbers and encouraged by the fact that our performance in the second quarter was characterized by loan growth, high credit quality and increased net interest income. It appears that the positive momentums when we talked about in April is beginning to generate results.

First, there is growing evidence that despite the struggling economy our clients are moving now to pursue opportunities for growth. Period-end loans grew by $245 million, a 5.8% increase over last quarter. This was the first loan growth we've seen in six quarters and it was driven in large part by loans to our life sciences venture capital and private equity clients.

Activity in our pipeline also remains strong in the second quarter. An indication that this healthy demand maybe the beginning of a trend. Second, if our positive credit quality is any indicator, our clients are entering the recovery in a position of relative strength. Our net charge-offs dropped by 70% in the second quarter to less than $4 million. In addition, we saw a 15% decline in classified loans during the quarter and 38% decline from their peak one year ago.

While we have our underwriting expertise to think for the high quality of our loan book, we also believe the inherent resilience of our client base is a major factor. Third, our clients remains highly liquid. They added nearly $1.6 billion in total client funds during the quarter, one billion of which went to the balance sheet. These deposits allowed us to increase our average interest earning investment securities portfolio by another 30% to $5.2 billion. We have more than doubled our investment securities portfolio in the last year as a result of this solid deposit growth and our efforts have driven our net interest income to an all time high.

We are feeling encouraged by the resilience of our client base and by our solid loan momentum and good credit quality. In addition our capital and liquidity remained very strong, even after completing the repurchase of the warrant issued to the US treasury as part of our participation in the capital purchase program.

Overall SVB is well positioned to take advantage of the improvements we're seeing around us. The primary challenge we have right now is the slow pace of the broader economic recovery. While we believe we have the resources to operate effectively throughout this recovery period, we expect to realize our most significant growth potential only when the economy shows sustainable improvement and interest rates began to rise.

This recovery maybe complicated to some extent by the recent passage of the financial services reform bill. There are many questions still to be addressed by the regulators before we can say with any certainty what impact the new regulations will have on us. But I want to comment on two provisions of the bill that are of particular interest. First is the so called Volcker Rule, which puts limits on banks investments in hedge funds and private equity funds.

Clearly, this will have an impact on our funds management business SVB Capital, but it is too early to say exactly what that impact will be. We built SVB Capital as a way of delivering value to our clients and shareholders by providing clients with access to investments. They would otherwise be unable to access on their own. We do not believe the Volcker Rule is intended to restrict this kind of investment but ultimately the regulators will decided whether venture capital falls under the same umbrella as hedge funds and large private equity funds.

If the answer is yes, we could be required to reduce our investments overtime. Fortunately, the law would appear to provide ample time for exiting your liquid investments anywhere from four to nine years. That amount of run way would give us more flexibility to make the best decisions for shareholders in determining our next steps with SVB Capital.

Regardless of the outcome, regarding limits on venture capital investments, we do not expect that Volcker Rule to impact our core banking business in any significant way whatsoever. The second provision of the financial reform bill, particularly interest is the repeal of the regulation prohibiting banks from paying interest on business checking account. Again it is too soon to say exactly how this will affect SVB or any bank since all banks will be affected.

The provision will not be implemented for another year and its impact would depend on a variety of factors including market interest rates over time, client preferences, earnings credit rate policies and task considerations. From our perspective it becomes another consideration and striking a balance between our client's objectives and our own.

Despite the challenges ahead for the industry and the economy at large, we are feeling positive. The technology industry appears to be recovering ahead of the rest of the economy just as we expected. The second quarter brought another round of strong earnings reports from technology leaders such as Intel and IBM, who are seeing higher demand and increased opportunity. Such momentum among these larger companies is generally a positive sign for the broader technology industry.

Venture capital reports in the second quarter are positive as well. VC has invested $6.5 billion and 906 deals during the quarter, a 34% increase in dollars and 22% increase in the number of deals compared to the first quarter. Venture capital dollars invested year-to-date have increased by almost 50% over last year.

Exits for venture backed companies were also strong. Venture backed IPO volumes spiked to its highest quarterly level since 2007 with 17 offerings. The year is looking strong as well. There have been more IPOs in 2010 to-date than in all of 2008 and 2009 combined. There were fewer merger in the acquisitions of venture backed companies in the second quarter than in the first quarter, 92 compared to 119 but still a very strong number.

Still one of the strongest quarters we've seen in the past four years. We remain hopeful that his activity will tell a sustainable recovery in the technology markets overall. In the meantime, the opportunities for our clients are growing and that creates opportunities for us. Thanks to the hard work of our outstanding employees, we continue to see robust activity in our pipeline and solid credit quality.

We remain one of the best capitalized banks in the industry and are well positioned to take advantage of growth opportunities as they emerge. We continue to work hard to build momentum throughout the recovery that will provide significant earnings potential as the economy improves.

Thank you and now I will turn the call over to our CFO, Mike Descheneaux.

Mike Descheneaux

Thanks Ken and thank you all for joining us today. We are pleased to have delivered a strong second quarter marked by continued momentum in our core business and signs of improving business conditions for our clients. There are five highlights I think are worth mentioning at the offset. First is loan momentum. We are pleased that period-end loans grew by $245 million and average loan balances held steady after six quarters of decline.

Second, credit quality continued to improve as it has for the last five quarter, which is a great feeling. This improvement was led by lower net charge-offs. Third, we recorded our highest level of net interest income ever, $106.4 million, thanks to our investment portfolio which is being funded by our growing deposits. Fourth and finally, our non-GAAP non-interest income net off non-controlling interest rose by 5% to $37.2 million thanks to higher credit invest sorry, thanks to higher client investment fund balances.

Total clients investment fund balances increased overall. In aggregate, end of period deposits and off balance sheet funds increased by $1.6 billion or 6% during the second quarter to $28.1 billion, the second highest period-end balance in our history. Let's move into some details starting with loans. Average loan balances held steady at $4.1 billion, but we're trending up towards the end of Q2.

These improvements are a result of improvements in our clients markets as well as our success at winning their business. Our pipeline also remains stronger in the quarter which suggest that we may have reversed the trend of the last six quarter with a return to loan growth. We believe that the positive outlook for technology spending in the coming year will ultimately lead to higher utilization rates and increased commitments.

The environment continues to be very competitive but our ability to differentiate ourselves to win deals without sacrificing credit quality seems to be paying off. With respect to credit quality, we saw a continued positive trends in the second quarter. Our loans – allowance for loan losses remained flat at 1.6% which reflects loan growth and changes in the composition of our portfolio.

Even after provisioning for loan growth our loan provision decreased by $3.3 million to $7.4 million in the second quarter. That reduction was driven by improvements in our early stage portfolio which resulted in lower net charge-offs of $3.9 million compared to $14.9 million in the first quarter. This number reflects gross charge-offs of $7.1 million versus $21.2 million in the first quarter.

Impaired loan balances were flat at $50.9 million compared to $50.6 million in the first quarter. I am pleased to say that subsequent to the close of the quarter, we received payments totaling $5.8 million related to loans included in the impaired balance. As a result, we are entering Q3 on strong footing. Our overall credit trends reflect a high quality of our portfolio, our continued emphasis on strong portfolio management and what appears to be an improving business environment for our clients.

Moving on to the income statement. The headline is simply higher net interest income despite a lower net interest margin. Net interest income increased by 5% or $5.6 million in the second quarter to $106.4 million, its highest level in our history. This increase stand primarily from the significant growth of our average investment securities during the quarter from $4 billion to $5.2 billion, reflecting new investments in agency backed mortgage securities. Strong deposit inflows fueled our investment securities growth. Average deposits grew by almost a $1 billion to $11.9 billion in the second quarter.

This growth in the low interest rate environment impacted our net interest margin which was 3.20% in Q2 compared to 3.30% in the first quarter. And has also changed our 2010 outlook. Turning to non-interest income. Non-interest income, net of non-controlling interest increased in the second quarter to $37.2 million, a 5% increase over $35.4 million in the first quarter. As a remainder these are non-GAAP numbers. This increase was driven primarily by client investment piece as a result of higher client investment fund balances.

Average client investment funds increased by $435 million in the second quarter, to $15.5 billion. Owing to higher period-end balances in our SVB asset management business which grew by $1 billion. Income from our other core fee business lines which include deposit service charges, client investment fees, credit card fees and the letters of credit was higher in aggregate as a result of improving business conditions for our clients.

However fees on foreign exchange were down by $606 million, sorry, $606,000 although still at a nice lever, owing to lower national volumes especially in light of the exceptionally strong FX income we had in Q1. Gains in our investment securities portfolio net of non controlling interest were lower during the quarter, adding $1.2 million to our bottom line versus $3.2 million in the first quarter. Again those are non-GAAP numbers.

Net gains for the quarter primarily reflect the sale of all non agency mortgage securities held in our fixed income portfolio. I want to say a few words about total client funds before I move on. I mentioned earlier that we saw a significant increased in both deposits and off balance sheet client funds during the quarter. Average deposits grew by 8.6% to $11.9 billion during the quarter, while average client investment funds grew by nearly 3% to $15.5 billion.

We also reached a milestone in our SVB Asset Management business where we actively manage client funds. They exceeded period-end balances as $7 billion an all time high in early July. As I said we see this positive trend in total client funds as evidence that our clients liquidity is increasing driven by improving economic conditions particularly for technology industries.

Additionally it is a sign that we are engaging clients in the market and showing them what makes SVB different from other banks. Now we'll move onto our updated outlook for the full-year 2010. Let me start with a two areas that have changed, deposit growth and net interest margin. For 2010, we expect that average deposits will increase at a percentage rate in the high 20s. We raised our outlook for average deposits due to our clients focus on maintaining liquidity and the lack of compelling yields available in the current low rate interest rate environment.

We have said previously that we thought $1.5 billion to $2 billion deposits might move to off balance sheet funds, one we opted out of the FDIC's extended deposit insurance program. That opt out became effective June 30 and the deposit behavior we have seen since then suggests to us that lower interest rates are likely to influence our clients deposit behavior more than deposit insurance.

As a result, we think the likely flow of deposits off the balance sheet over time assuming a low interest rate environment will be in the range of $1 billion to $1.5 billion. As a result of our higher expectations for average deposits and the low interest rate environment we have decreased the outlook for our net-interest margin to a range of 3.2% to 3.4%. We previously said we expected a net interest margin between 3.5% and 3.8%.

As a result of the solid momentum on loan balances we saw towards the end of the second quarter, we continued to believe loan trends will improve in the second half of the year. We expect average loan balances to decrease at a percentage rate in the high single digits for the year which implies higher average quarterly balances in the coming quarters. Our pipeline remains strong and the strong loan growth we have seen in the last 45 days reinforces these expectations.

We feel we are starting at a strong point going into the second half of the year. In general we expect business conditions for our clients to continue to improve albeit slowly, with demand for technology recovering and an improving venture environment, we expect increasing demand for loans and fee-based services as well as better results in our venture related investments.

We expect credit quality to remain stable, assuming your gradual, economic recovery. Our clients are performing well on their credit commitments and the underlying trends in our portfolio are positive. I would like to close by saying that although the economic recovery appears to be a long-term proposition we are pleased with the momentum we have been seeing among our clients and the impact it is having on our business. We are encouraged by growth in our loan balances and the strong credit performance of our portfolio.

Despite what you are hearing regarding the level of economic uncertainty these days, our clients and the industries they serve are demonstrating their resilience. They appear pious to outperform the industry overall in the years ahead. Their prospects have generated some new competition given the game outlook for many banks in their traditional industries. Nevertheless, we believe we have a compelling value proposition as well as the resources to remain competitive and adaptive. Thank you and now I will ask the operator to open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). We'll pause for just a brief moment to compile the Q&A roster. Your first question comes from the line of Joe Morford from RBC Capital Markets. Your line is open.

Joe Morford – RBC Capital Markets

Thank you, good afternoon everyone.

Ken Wilcox

Hi Joe.

Mike Descheneaux

Hi Joe.

Joe Morford – RBC Capital Markets

I guess two questions, first related to the Volcker Rule maybe Mike could you just give us what the exact amount of VC and private equity investments that's subject to the role and is that number growing, are you continuing to make investments here in the near term or in a sense honoring calls and when do you expect to know more and about this and perhaps whether you'll be staying in the funds management business?

Mike Descheneaux

Let me Joe let me answer the first part of your question which is give you a rough ballpark of how much we have invested in the venture capital/ private equity world or (inaudible) investments related to that area and then (inaudible) little bit on the Volcker Rule and its impact for the rest of your questions.

But if you go back to Q1 in general we have approximately $210, let's say $220 million of investments in the private equity in venture capital space. We'll come up with a little bit more updated number here with the queue when it come out, but it's a little bit higher than that but to too much to in general when we think about investments at risk that's about let's just say $220 million here for the moment.

Joe Morford – RBC Capital Markets

Okay.

Mike Descheneaux

And then perhaps Ken will add, answer the second part of your question.

Ken Wilcox

So Joe, let me go to the second part and that's around when we will be making decisions concerning the ultimate, I suppose outcome which means when we be continued, will be continuing your invest or will we not be continuing to invest and if we're not continuing to invest what would be the doing with the investments that we've already made and the problem there is its really premature for to answer that question, I don't think there is a anybody on earth was in a position to answer that question right now and if they do answer for you, my name is there jumping the gun and they will have to change their answer to your question at some point in the next couple of year because it was just as you know signed in the law and the at we're going to grow and extensive period of time where law is somehow translated into regulation and that could at least a year and maybe two and who knows because sometimes that only take two years end up taking three or even four.

So I think tits going to be a long time been coming, second it's still not very clear based on what's called the (inaudible) which are the accompanying letter that are written by individual, senators and others. Around what they really met when they boarded, it's still not really clear whether they were intending to have this include venture capital or not and in fact they are.

There is ample evidence that the instigators weren't really intending to target venture capital to begin with. So we don't really know how that's going out and I would say there is not a person on earth how knows how we'll come out and one day we finally figured out I will almost guarantee at least a year or two would have gone by and potentially even more and once the final decisions are make the law provides several additional years for disposing of whatever assets are in your possession at the time. So ask me again, but wait a couple of years.

Joe Morford – RBC Capital Markets

Okay and then my other question was on jus the loan growth from the quarter. If I look at your table kind of outlining larger loans over $20 million that balance was up call it $183 million of the quarter which is roughly 75% of the overall growth and loans this quarter. It sounds like this is primarily due to a couple of life science credits and can you talk a bit about the nature of those credits, I don't think they've necessary capital call lines but are they participations and does this I guess given that how are you really feeling about demand going forward and how sustainable it?

Dave Jones

And Joe this is Dave Jones, let me tough on that. So your review is accurate. The larger share of the growth from a niche perspective did come from life sciences. There were a couple of pretty significant transactions in there, neither one or participated and Joe, not to get into more detail than it would appropriate but I can assure you that the loan structure is as good as realistically could be for the size of credits, meaning that it is very solid source of repayment for the credits.

Greg Becker

Yes it's Greg Becker. This is kind of second part of your question which is one kind of loan growth and outlook we as Mike had said we had this loan growth towards the end of the quarter, mainly driven by a couple of large but as we've said in previous calls the pipeline has been building, it's nice to say this pickup at the end of other quarter but outlook is positive and the growth is from where we've talked about the four which is across our gross segment, corporate finance, global and utilization rates improving as well.

And the combination of all those things is really what is composition of our pipeline and that what we derive our comfort from growth for the balance of the year.

Joe Morford – RBC Capital Markets

Okay, that's very helpful, thanks.

Operator

Your next question comes from one of Steven Alexopoulos from JP Morgan. Your line is open.

Steven Alexopoulos – JP Morgan

Hi everyone.

Ken Wilcox

Hi.

Steven Alexopoulos – JP Morgan

If we could start I know you said your client base I proving more resilient to the slowdown in the economy, just curious if you can pair last quarter's call to this one, did you see any mark caution in terms of the outlook from your clients that could impact the closing rate of what's in the pipeline?

Greg Becker

Yes Steve, this is Greg Becker again. And I would say that there is kind of contradicting messages one, you listen to lot of feedback from the overall general economy and its very muted, very uncertain or still uncertain. The word is unusually and certain I think we're even used. From our standpoint when we talked to our clients, companies are still, they're spending money on technologies, their demand is – they're feeling good about the demand. So they're still somewhat concerned about the overall market outlook but they continued to be optimistic about the demands for their business and their products and services.

So I would say my gage would be its slightly better than last quarter and which is slightly better in the quarter so that's what a continuation of the positive trend that we've seen.

Steven Alexopoulos – JP Morgan

Okay, thanks. Maybe just one follow-up from Mike. How should we be thinking about the yield on the $5 billion of taxable securities going forward, there is 290 pretty close to a bottom here?

Mike Descheneaux

As far where we're trending where it's going to go.

Steven Alexopoulos – JP Morgan

Well it's been trending down quite a bit each quarter for the last two quarters, just wondering if that 290s a reasonable run rate here, or does it keep going down because you're trimming duration in that book.

Mike Descheneaux

Yes, I think if you could down a little bit some, we do have some of the investments securities that are maturing each quarter as well and obviously the reinvestment rate that's available out there, particularly considering when you think of it the treasury is right around 50 basis points or so. So yes there is the certainly pressure on that going forward a little bit.

Steven Alexopoulos – JP Morgan

Do you have a bottom before you think a bottom is out approximately?

Mike Descheneaux

No again lot of it just depends on how we reinvested, I mean rates have been coming down quite a lot lately, I mean we're certainly trying to balance what's available out there in the rate with I'm trying to keep it very sensible duration but right now again its jus going to be driven by the rates here.

Steven Alexopoulos – JP Morgan

Okay, fair enough. Thanks.

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

Hey good afternoon guys.

Ken Wilcox

Hi Aaron.

Aaron Deer – Sandler O'Neill & Partners

Mike maybe just following up on Steven's question. Can you just maybe give a little bit more color on how you're managing duration risk and interest rate risk and the securities book, it's just I guess with it now being larger than the new loan book, it's a big piece of the balance sheet and seems like there is could be some growing risk there.

Mike Descheneaux

We're trying to manage to is making sure that we're investing sensibly and maintaining liquidity, I mean the one of the things you have to be conscious of is the fact of not going too far or getting too far on duration particularly with the fixed rate portfolio, and again unfortunately here right now in this rate environment the rates are so low. But again our first and primary objective is protecting the portfolio and just being sensible of obtaining some yield.

So we're still targeting that kind of a two, 2.5 year duration. And as we probably point out at the end of last quarter, we did add bit over a $1 billion in some variable rate securities on LIBOR base with a relatively short duration say one to 1.5 year. So we're primarily going to keep that objective of maintaining strong liquidity. Because again there is just not a whole lot of yield after the chase to get any kind of yield you really need to go five, six, seven years to get anything decent so again primary objective is keeping strong liquidity.

Aaron Deer – Sandler O'Neill & Partners

Well with that I guess you also have more than $4 billion in cash on the balance sheet, what's the right number for that and are you still looking to deploy more of the cash.

Mike Descheneaux

Yes, Aaron since we did opt out of the FDIC's insurance program. We are going to start to see some of that tail off towards end of the year. We are seeing it moving essentially from our balance sheet to our off balance sheet investment funds business or so we have started to see that already if they're onset of Q3. So you will certainly see those balances go down quite a fair amount here, as you know I updated here on the call, we expect anywhere from $1 billion to $1.5 billion probably to come off between now and the end of the year on those deposits and it would certainly come out of those cash balance levels.

Aaron Deer – Sandler O'Neill & Partners

Okay, that's helpful. Thank you.

Operator

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

John Hecht – JMP Securities

First question is more about the venture capital environment. You guys were discussing that deployment in Q2 increased from Q1. IPO activity was also part of solid VC environment. But if I read something actually recently, it suggested that the venture capital fundraising was down relatively significantly from early part of the year. I am just wondering what's your perspective on this and what do we make of this in terms of the consistency potential for a loan demand.

Greg Becker

Obviously we feel good about the growth in venture capital in the second quarter, maybe a follow-up to your question, is it sustainable at that level, I think the second quarter was a strong quarter. I can see by declining or flattening out for the balance of the year mainly based on what you said which is the fundraising that is taking place. It's hard to raise money out there and I think that's going to continue for a while. So although we feel good about the second quarter, again it's probably going to be slightly down to flat on a go-forward basis. The other point I would make is given that the M&A volume and the IPO volume the venture firms that we are talking to are feeling clearly a lot more optimistic than they were last year and it's consistent maybe even a little bit improved from Q1.

So those are the positive things that are going on in the market. But I wouldn't extrapolate the second quarter number and roll that out and say we are going to be seeing a $25 billion or $26 billion investment here.

John Hecht – JMP Securities

Mike, if I heard you, you referred to a post quarter approximately $5 million payment on an impaired loan or was it a payment on a $5 million of impaired loan? I just want to make sure I heard that right.

Mike Descheneaux

Let me touch on that. We had a couple of accounts that received significant collections of the book balance in the first part of July. So they were impaired as of June 30 and that $5.8 million was collected in the very first part of July.

Ken Wilcox

I would like to add just a couple of points to what the answer that Greg was giving around projected loan growth. And those would be that, what we are really seeing out there in the market right now in terms of the relationship between the level of money that's being invested on the one hand, which clearly has gone up and the level of money that's being raised or a new funds which is clearly not going up. It's less a question of the venture industry moving in a bad direction and more a question of the venture industry actually at least in my opinion moving in a good direction, meaning we are seeing a significant calling (ph) going on in the venture industry. People who were unsuccessful in their venture investing in these past several years are falling by the wayside, they are either exiting funds that are substantially successful and will be continuing but individual partners may not have – had that much of a positive impact or the entire funds at the lower end of the pyramid are falling by the wayside. And but the best funds in the industry at the top of the pyramid are continuing to flourish, they largely flush with dry powder and are continuing to invest.

Ultimately although it makes for choppy waters in the short run, ultimately in the long run, this can only be good for the industry and we see it as a positive development even though in the short run it may be a little choppy and has been a little choppy. No question about that.

The other thing that I think we need to add to our answer is that a substantial merchants not only are lending but also of our pipeline and the pipeline that gives us some considerable kinds (ph), things are moving in a good direction comes from companies that have already graduated from the venture capital cycle and are no longer dependant on venture capital infusions in the quarter to grow because they either are past the need for that type of equity infusion or in many cases already public.

Operator

Your next question comes from the line of Bobby Bohlen from KBW.

Bobby Bohlen – KBW

First, I think Mike, this was your very last time you said the business was beginning to attract competition. I was wondering if you could, if I heard that right and if you could I guess elaborate on that.

Greg Becker

Let me check that, then Mike can add on. As Mike had said, we are not surprised that there is additional competition or increased competition mainly when you think about the prospects the other executions have, much of the opportunities for their growth historically has been in real estate and real estate related lending. And as we all know, that has been challenged and the outlook for that is it to be – continue to be challenged for the foreseeable future. With that in mind, everyone has growth goals and the market that we service obviously one that is we clearly enjoy, we enjoy being part of, and so it's not surprising that we are seeing more competition in that space.

Bobby Bohlen – KBW

Is it competition that's been there that's increasing their, I guess happed into (ph) into it or is it new stuff coming in, new participants coming in?

Greg Becker

It's mainly the ones that have been out there in the space that kind of around the edges. And we have talked about this increased competitive landscape and the probably for it for quite frankly the last couple of years and as the market turned down, this is one of the things we had talked about. And we have been, again planning for increased competition because of the appeal of the market for a long time. So our goal has been and will continue to be to leverage our strengths, the high touch client service, the people that we have, our ability on the lending and structuring side but also what I would say are the long-term differentiators and probably the two biggest ones from my standpoint are the knowledge and information that we have that is unique that no other institution has and that's part of the knowledge bank or business services area that we continue to develop, although it's early.

Secondly and probably more importantly, mainly because our clients are going global more early on in their lifecycle is the global capabilities that we have. And those two from my standpoint are the biggest differentiators and those are the ones that are we relying on along with our people to really deal with the increased competition that we are having. So yes, there is more competition. We expected it and we are taking a long-term look on how we are differentiating ourselves.

Mike Descheneaux

I think I would add just one sentence to that and that is that it's yet another wave in a string of waves over an extended period of time meaning the last time we had no competition was I think 1992. And since then we have had waves of competition, they come and they go. A very few competitors actually sustain themselves through multiple waves. For the most part they disappear after a wave or two. And so it goes, certainly we are seeing a resurgence of competitive activity. But if the future is anything like the past, it will subside and then we will see more again later. So I think it's something to be concerned about and I would characterize, that's just hyper vigilant in this regard, but it's not, we shouldn't characterize it as a new phenomenon because it's in truth always been there, at least for the past 18 years.

Bobby Bohlen – KBW

Okay, and then second question if you could, you talked about line utilization, I was wondering if you could give kind of the linked quarter where we are in the line utilization for some of your borrowers. Is that across the board or is it in a particular sector?

Dave Jones

Overall, the line utilization was up, but very, very little from first quarter. What we saw was that our factoring clients picked up a little bit, our asset base lending dropped off a little bit, our venture capital clients reasonably have significant unfunded commitments at any point in time, drew up on their facilities in the second quarter, but up ever so slightly overall.

Operator

Your next question comes from the line of Ken Usdin from Bank of America. Your line is now open.

Casey – Bank of America

It's Casey (ph) here, filling in for Ken. Good evening. I have a question on the margin guidance of 3 2 to 3 4. We're currently on the year, we're averaging 3 25. I'm implying that there's not much room to go below. But if I heard you right, you expect to more deposit growth coming in the latter half of the year. I'm just trying to figure out what am I missing regarding – does the loan growth have to outpace that deposit growth for the margin to sort of quit from eroding?

Ken Wilcox

I think there's two things Casey. One is actually, did deposit balance as we expect to start declining between now and the end of the year? Then we talked about $1 billion to $1.5 billion are going to come off. So that will certainly, you know, if you're taking that out of cash, which is only 25 basis points here today, they will obviously have a positive effect on the net interest margin. But perhaps, one of the stronger things that will help net interest margin is long growth. So if you bring on loans which you look at our average yields for loans in the neighborhood of over 7%, when you start adding the loans at 7% versus the overall net interest margin of between 3.2 and 3.3, it's going to be accretive overall. So that's where it's going to come from.

Casey – Bank of America

Okay, so you see deposits down 1.5 billion period to period end, between now and year end?

Ken Wilcox

It's somewhere between 1 billion and 1.5 billion that we expect to move off.

Casey – Bank of America

Okay, alright. I misheard that. And then finally, so the variable rate agency CMOs, what is the yield that you guys get on new investments there?

Ken Wilcox

Well, what we've done doing is at the beginning of Q2, it's somewhere in the neighborhood yielding around 80 basis points or so. And they do have like say 1 year to 1.5 year duration or so. And they're indexed to LIBOR.

Casey – Bank of America

And that's primarily going to be the investment strategy going forward?

Ken Wilcox

Well we can obviously continue to value where we can get the best yield out there. Again, keeping in mind liquidity. But as you look out at the yield curve and that the investment alternative is just not a whole lot of compelling investments out there.

Operator

Your next question comes from Mike Zaremski from Credit Suisse.

Michael Zaremski – Credit Suisse

Hi guys. Thinking about capital. Lease the way I measure it, you seem to have a decent amount of access. Should I be thinking about any ways you guys can deploy it? And I guess sure, a buyback, would that even be an option?

Ken Wilcox

You know we're always exploring what's the best use of capital but I would say first and foremost, mean we certainly expect that we can put it to good use here overtime. So you know, I wouldn't necessarily any share repurchases or buybacks yet at this time. And we have a lot of growth opportunities and our balance sheet has been growing considerably, so I wouldn't expect that in the near term.

Michael Zaremski – Credit Suisse

And Ken, I know this is a tough question for all of us in terms of the ability to pay interest on commercial deposits eventually. Should maybe we think about this as a way that cool competitors can use that could increase competition? And maybe that causes banks to hold higher cash balances? I'm just trying to see if you had a more solid opinion on how this could play out.

Ken Wilcox

Could you – not repeat the whole question, but I wasn't quite sure that I got the line of thought?

Michael Zaremski – Credit Suisse

Sure. So if banks can say you know, start paying on commercial deposits now and effectively, I think you know, you pay implicitly by credits already but, you make it explicitly. I guess if there's a way that you know, could increase competition of federal banks wanting to start paying higher rates right? Which could mean a little over deposits. I guess would that cause people to maybe keep higher liquidity or cash balances? I'm just trying to think of how this plays out?

Ken Wilcox

We are trying to think of how it's going to play out too. And the truth is that it's a very complex set of issues. Fortunately, we have I think, a year or two to figure it out. And we've got lots of people that are doing a lot of modeling and we're testing out various scenarios. I'd like to say that it's a good thing but I have a hard time doing that with a straight face. At the same time, I don't honestly think that it's a necessarily a horrible thing. For the simple reason that we're all in the same boat and I will say that – I guess I'd rather be SVB that some banks. Because first of all, we certainly have enough deposits to fund our loans, and are probably going to be disinclined to take advantage of (repeal of red cue) to pay up in order to get deposits on to our balance sheet so.

There are going to be people out there, there are banks that I'm sure you know about that have trouble funding their loan growth, and are going to be paying up now that they have the opportunity in another year. They're going to be paying up in order to get deposits to fund that loan growth and that's going to squeeze their margins. I think that there could be scenarios, in fact, I have envisioned scenarios. And they don't necessarily pertain to the day. But if I look at our, the 20 years I've been here at SVB, there have been times when the ability to pay (R&DDA) would've been a big help to us. And so I think that this is really a multi-faceted question. We obviously have to deal with it. We are concerned but we're confident that we'll figure out ways of using this, potentially even to our advantage overtime.

Greg Becker

Hey Mike, this is Greg. Let me just add on a couple of things. One is the institutions that compete with us today. If they wanted to use that today as a way to get deposits from our clients, they could clearly pay up on their money market account balances today and pay much higher rates than we could to try to attract them. So it is slightly different but if they wanted to do that, they have that option, that's number one. Number two, institutions, if they're going to reprice their demand deposits, there's a lot better demand deposits on other bank's balance sheet as well, but they would have to look at repricing. So it's too early to tell how it will shake out. But my feeling is that it won't be as big of an impact as it potentially could be for the reasons that we've already talked about. So it's still too early to tell.

Ken Wilcox

Let me add one thing to that, and that is – it doesn't directly answer your question, but I think it's advantageous to be a bank like ours with a substantial broker dealer. That in most quarters, actually ends up having more client funds than we do on our balance sheet. And that affords us an additional lever in terms of enticing funds in one direction or another. And the way we've structured, that the broker dealer obviously, we end up doing reasonably well no matter where the funds go. So I think that, again facing the (repeal of red cue) I'd rather be us, than some other banks.

Michael Zaremski – Credit Suisse

Okay, those are good points. And last real quick, increased competitions, the existing or the loan yields have been creeping up. Should I think about them not creeping up any more then, if there's increased competition? In terms of the loans in place? Or new loans to go on the book?

Ken Wilcox

That's also a tough one to answer because obviously, the best lenders are going to get the best pricing. And it's not always the case that competition results in reduced margins. Maybe Greg would like to add some of the details of that.

Greg Becker

Yes, Mike. It's also a question of what the mix is. From a standpoint, obviously we have a very diverse loan product set from factoring to commercial finance to traditional loans. And they have a wide range of yield associated with them. And depending upon the mix of that, that can also have an impact on the a quarter-to-quarter basis. Do I expect to see, all things being equal, the mix doesn't change. Do we expect to see a significant change in loan yield? Probably not until interest rates pick back up. So it's mainly, the changes that you've seen have mainly been driven by mix.

Operator

Your last question comes from the line of Christopher Nolan from Maxim Group.

Christopher Nolan – Maxim Group

Thanks for taking my call. Is there any geographic classification or change in terms of the loan growth? Are you seeing more from overseas? Or is it just a real change there?

Dave Jones

Chris this is Dave. So loan growth on the non-U.S. side. As a percent of that portfolio, is very nice starting from a very small base. But the loan growth that we are seeing is in the U.S. And geography really isn't an issue. Software, hardware, lifescience companies sell globally. They don't sell locally. So the perspective really is the niche. And where we're seeing growth is indicated, largely, lifesciences, some from the venture capital, capital called lines of credits that we provide. So it really is a geographic issue.

Christopher Nolan – Maxim Group

Do you have any update on your comments from the last quarter? Talking about possibly talking about loan portfolios?

Greg Becker

Yes Chris, this is Greg. You know I would say the update is the message is the same it was last quarter which is we're always on the lookout and that hasn't change. So there are levels of interest in trying to pick up something that hasn't changed. But as of last quarter, there was nothing eminent that they're looking at that we wouldn't want to comment on the call.

Christopher Nolan – Maxim Group

So purchasing on a loan portfolio is not a factor in terms of your loan-growth guidance for 2010, correct?

Greg Becker

No. It is absolutely not going to be our outlook.

Ken Wilcox

Which isn't to say we're not constantly looking. So let me then wind up here by stating unequivocally that we are feeling positive. Now I know I say that almost every quarter because we are pretty positive people. But I will, to a point of comparison say that we are feeling, I would say more positive this quarter that we were three months ago. So it's a good trend line in terms of our mood. And there are good reasons why. Think about it, venture capitalists are investing, I would say significantly more actually than they were last year. There are portfolio companies, they're doing better. And I would say significantly better than they were last year.

Credit quality is improving and is considerably better than it was last year. Loan balances are up and it was a hard time saying significantly up over last year but after all this waiting, it's nice to see them going up. Deposits are growing like topsy and fortunately, we have the broker dealer to encourage some of them into. And there are significantly more and better access right now than there were a year ago.

So in short, pretty much everything is looking up to one degree or another, and accordingly, our outlook on the future is looking up as well. And that's it.

Operator

Thank you, ladies and gentlemen for joining this conference call, and it does conclude. You may now disconnect.

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Source: SVB Financial Group Q2 2010 Earnings Call Transcript
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