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SVB Financial Group (NASDAQ:SIVB)

Q1 2008 Earnings Call

April 24, 2008 5:00 pm ET

Executives

Meghan O'Leary - Director of IR

Ken Wilcox - President and CEO

Michael Descheneaux - CFO

Greg Becker - President, Commercial Bank

Dave Jones - CCO

Analysts

Joe Morford - RBC Capital Markets

John Pancari - JPMorgan

Andrea Jao - Lehman Brothers

Aaron Deer - RBC Capital Markets

Fred Cannon - Keefe, Bruyette and Woods

Erika Penala - Merrill Lynch

Brent Christ - Fox-Pitt Kelton

James Abbott - Friedman, Billings, Ramsey & Co.

Operator

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

I'll now turn the call over to Ms. Meghan O'Leary, Director of Investor Relations.

Meghan O'Leary

Thank you. Today, Ken Wilcox, our President and CEO, and Michael Descheneaux, our Chief Financial Officer, will discuss SVB's first quarter 2008 performance and financial results. Following this presentation, members of our management team will be able to take your questions.

I'd like to start the meeting by reading the Safe Harbor disclosure. This presentation contains forward-looking statements within the meaning of the Federal Securities laws, including, without limitation, financial guidance for the first quarter and full year 2008. Forward-looking statements are just statements that are not historical facts. Such statements are just predictions and actual events or results may differ materially. The information about factors that could cause actual results to differ materially from those contained in our forward-looking statements is provided in our press release and our last filed Form 10-K. The forward-looking statements are made as of the date of broadcast, and the company undertakes no obligation to update such forward-looking statements.

This presentation may also contain references to non-GAAP financial measures. A presentation of and reconciliation to the most directly comparable GAAP financial measures can be found in our press release.

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

Ken Wilcox

Thank you, Meghan. I'm pleased to be here today to talk to you about another strong quarter, one in which we produced earnings per share of $0.81, ROE of 16.3% and net income of $27.9 million. We achieved strong loan and deposit growth, maintained our strong credit quality and met our expense control goals.

These results, particularly in this current economic environment, demonstrate the strength of our unique business model. That is, we focus on a single industry; we meet the needs of our clients from early-stage through maturity; and because of our focus and in-depth knowledge of our clients, I believe we are adept at distinguishing between real risk and perceived risk. We've maintained that focus in good times and in bad, and it drives the delivery of our products, our services and our thought leadership, all of which improve our clients' chances for success and help to ensure continued growth.

Although serving early-stage technology and life sciences companies remains the core of our business, and we continue to focus actively on those early-stage clients, much of our loan growth in recent quarters has been driven by our upstream initiative to expand our business with later stage, so-called corporate technology companies, and our continued focus on venture capital and private equity firms.

On the deposit side, we continue to introduce new products to meet clients' needs and to attract deposits to the balance sheet. To this end, we introduced two new products in the last year targeted at emerging companies and those doing business overseas. Through these products, we added over $200 million to our balance sheet in the first quarter. On the funds management side, we've expanded our funds management team to expand our activities into emerging industries and global markets. We provide our clients not only with products, but also with information. Sometimes, this takes the form of thought leadership.

In the first quarter, we issued a report that gave our early-stage and venture capital clients, the ability to benchmark valuations for private life sciences companies. This is the third time we've issued a report of this kind based on valuation data from thousands of companies, and we believe we're the only company with access to this kind of information.

Our good advice pays off for our clients. Over three years ago, we advised our asset management clients to stay away from auction-rate securities, and we've continued to advise them to stay away from auction-rate securities since then as well. As many of you know, the market for those securities recently came to a near standstill and the advice we gave is helping us win new clients into our asset management business. Our bucking of the auction-rate securities trend was the subject of a very positive Wall Street Journal article last month. These activities helped to drive our success in the first quarter and we believe they are positioning us for future success. Despite our strength, as you are all aware, we faced a number of challenges in the external environment in the first quarter, which we expect to be there throughout the year. The first of these is interest rate cuts. We maintained a net interest margin significantly higher than industry average, despite continued reductions in the Fed funds rate. Nevertheless, each 100 basis point cut reduces our NIM by about 50 basis points. And now, that's consistent with our expectations and our public statements for the last several months.

Turmoil in the global equity markets presented another challenge in the first quarter by suppressing company valuations and reducing the value of our funds management portfolio. The value of that portfolio includes unrealized gains and losses and varies according to market conditions. Accounting rules require us to record these changes in value on the income statement under gains on investment securities. These investment securities revenues, like those we receive from warrants, are highly variable and can be challenging to predict. We expect continued economic uncertainty in the year ahead to further increase the variability of these items.

We have built the impact of market cycles into our business model. In other words, we operate on the assumption that there will inevitably be bad times. This assumption, that we cannot depend on external market factors for our success, informs all aspects of our business planning. In April, it led us to further strengthen our liquidity position in order to support our growth by issuing 250 million in convertible notes. Mike, will talk about these in a few minutes, but I'd like to set the stage for that discussion by sharing our view that next to credit quality, sufficient capital and liquidity may prove to be the most critical success factor for banks across the country in the coming year.

We feel that having the right people in the right leadership roles will also help to ensure our success. To that end, in the first quarter, we made a handful of management appointments that we believe will allow us to drive and support growth. We've promoted Greg Becker to President of the Commercial Bank. Greg will continue to oversee the bank's growth strategy, helping to ensure our continued market dominance among early-stage companies and growth in newer markets, such as later stage companies and private company valuations. To support this growth and that of our other business units, we named Dave Webb, who has been overseeing our performance improvement initiative, as Chief Operations Officer of SVB Financial Group. Dave will focus on creating an efficient and cost effective infrastructure to support our growth. In the first quarter, that mandate included moving forward on our plans to implement a new banking system backbone and identifying further opportunities for outsourcing certain operational functions.

We remain positive on our outlook for growth in loans and in deposits. Our target markets are performing solidly and venture capital investing is alive and well. According to early reports on first quarter activity, and I don't think the final reports will be out for another few days, venture firms invested $7.1 billion in 922 companies during the first quarter. While this number is 8.5% lower than the high levels, we saw in the fourth quarter of 2007, it still represents the fifth highest investment quarter since 2001. On the front lines of SVB, this translates into a strong pipeline of prospective clients. As you are all aware, the technology IPO market has disappeared for the time being, which is likely to increase the variability of our warrants and securities gains and losses. Nevertheless, we expect to see continued good M&A activity in the coming year.

We also see opportunities in the current economy, as currency volatility and the weak dollar have driven clients to increase their foreign exports, as well as their use of our foreign exchange services. While interest rate cuts will continue to drive our net interest margin downward, should they continue, we expect continued loan growth and our commitment to expense control to mitigate their EPS impact somewhat. We will maintain our underwriting discipline and focus on executing effectively in the present, while investing in future growth. Meanwhile, we are investing in our future through products, people and infrastructure. When the downturn in the global economy comes to an end, and it inevitably will, here at SVB, we will be well positioned to take advantage of it.

Thank you. And now, I'd like to turn the call over to our Chief Financial Officer, Mike Descheneaux, who will discuss our first quarter results.

Michael Descheneaux

Thank you, Ken, and thank you, everyone, for joining us today as we discuss our first quarter results. As Ken said, we delivered diluted earnings per share of $0.81 and net income of $27.9 million in the first quarter. Exceptional loan growth, solid deposit growth and contained expenses contributed to this strong performance, despite the impact of significant interest rate reductions and lower valuations on our investment fund portfolio.

Before I proceed, I would like to note that in general, my comments refer to the first quarter of 2008 in comparison to the fourth quarter of 2007, unless otherwise specified. There are five areas I would like to highlight with respect to our first quarter 2008 results. First, we grew average loans in Q1 by an impressive $340 million or 9.2%. Second, we delivered solid deposit growth of 5.4%, increasing average deposits to $4.4 billion from $4.2 billion. Third, our net interest margin was 6.36%. The decline is consistent with our expectations and reflects the impact of continued, dramatic interest rate cuts by the Federal Reserve, partially offset by exceptional loan volume. However, our net interest margin still remains well above industry averages.

Fourth, non-interest income was $41.6 million in Q1, which represents a decrease of $11.6 million. It was affected by lower company valuations and lower distributions in our investment securities portfolio related to our funds management business. In contrast, non-interest income from our core fee-based products, which includes client investment fees, foreign exchange fees, deposit service charges and letter of credit income, remained solid in the first quarter, with growth of 2.9%. Fifth, credit quality remained strong and in line with our expectations, with net charge-offs at 49 basis points of total gross loans annualized, compared to 28 basis points in the fourth quarter of 2007.

I would like to discuss some details regarding our Q1 performance. Loan growth was strong in the first quarter, reflecting activity across all of our client industry segments. Average loans reached a record $4.1 billion compared to $3.8 billion in the fourth quarter of 2007. End-of-period loan balances also increased to $4.3 billion compared to $4.2 billion in the prior quarter. Our efforts to meet client needs by offering new products and services allowed us to make meaningful progress in growing our deposits in the first quarter. We raised average deposits by 5.4% to $4.4 billion and we increased period-end deposits by 3.4% to $4.8 billion. Increased deposits from global venture capital clients drove the majority of first quarter period-end increases and activity among our traditional technology clients drove average increases. Although average non-interest bearing deposits declined 1.4% from the prior quarter, demand deposit balances in the fourth quarter were exceptionally strong, and stronger than we had expected, and we did not expect to maintain those levels heading into the first quarter.

As expected, net interest income decreased $5.2 million in the first quarter to $92.1 million owing to recent interest rate decreases. Our loan and deposit growth was able to offset a portion of the significant rate cuts in the first quarter. Nevertheless, the decline in net interest income and our net interest margin is consistent with our expectations.

With respect to non-interest income, there are three separate points I would like to note. First, we had good growth in income from our core fee-based products in the first quarter. Second, we recorded a net loss on investment securities before minority interest of $6.1 million versus a net gain of $6.1 million in the fourth quarter of 2007. The driver of the loss in Q1 relates to $8 million of losses from our sponsored debt funds, primarily from one investment whose share price decreased significantly during a lockup period. We also noted lower valuations, as well as lower distributions, from our SVB capital funds. As Ken pointed out, the vast majority of these changes are decreases in unrealized gains, rather than actual cash losses.

Third, we had a decrease in net gains from derivative instruments of $5.8 million, which was driven by a decrease in net gains on equity warrant assets of $2.8 million and a $2.9 million decrease in net gains on foreign exchange forward contracts, which are used to offset gains and losses from revaluation of our foreign currency denominated loans.

Net gains on equity warrant assets decreased due to the decline in equity markets and interest rates which led to a softening of valuations in the first quarter. I would like to point out that gains on derivative instruments in the fourth quarter were extraordinarily high. Such variability in this line item is within the norm and we advise caution in trying to extrapolate trends from these figures.

We actively continue to take new warrants and build the income potential of that portfolio. We obtained 117 new warrants in the first quarter compared to 105 in the fourth quarter, making this one of the highest quarters for new warrants in recent years. The decrease in net gains on foreign exchange, forward contracts largely results from a decline in the fair value of forward contracts used to mitigate foreign currency exposure risk on loans. As expected, the decline is offset by an unrealized gain resulting from revaluation of foreign currency denominated loans, which is recorded as other non-interest income.

Let's move to client investment fees. Client investment fees decreased slightly to $13.7 million in the first quarter of 2008, from $14 million in the fourth quarter of 2007. Although average client investment funds were up in Q1, tighter margins resulting from lower interest rates caused fees from client investment funds to decrease. Average client investment funds increased 1.7% in the first quarter to $21.9 billion, while period-end total client investment funds declined $1.2 billion to $21 billion. This lower balance was due to lower proceeds from IPOs and in part, to our success at directing more deposits onto the balance sheet. Quarter-to-quarter, these balances are affected by DC funding levels and IPO activity, both of which were down in the first quarter.

As I pointed out last quarter, an understanding of the impact to minority interest is relevant to understanding how much non-interest income falls to our bottom line. For details on this, please refer to the disclosures in our press release that present non-interest income, gains on investment securities and gains on derivative instruments, all net of minority interest and all non-GAAP measures.

A large part of the decline in non-interest income in the first quarter was due to one investment held by one of our sponsored debt funds. If you net out minority interest, non-GAAP non-interest income was $43.3 million in the first quarter compared to non-GAAP net interest income of $49 million in the fourth quarter. This represents a decline of $5.7 million or 12%, which is about half of the decline indicated by the GAAP non-interest income figure.

Now, let us turn to non-interest expense. As you can see from our first quarter numbers, we continued to manage expenses effectively. Non-interest expense was flat in the first quarter. It is important to note that we did have a net increase in compensation expense in Q1 due to an increase in headcount to support our growth, annual merit increases and other cyclical increases. We did benefit from a reduction in incentive compensation expenses in Q1.

We recorded a reduction of provision for unfunded credit commitments of $0.2 million owing to a slight decrease in the balance of our total unfunded credit commitments. This represents a swing of $1.8 million from the fourth quarter of 2007 when we had a provision for unfunded credit commitments of $1.6 million. As with non-interest income, an understanding of minority interest is important to assessing non-interest expense trends. With this in mind, non-interest expense, net of minority interest, remained relatively flat in the first quarter of 2008 at $80.7 million versus $81 million in the fourth quarter of 2007.

Moving forward, expense control and efficiency remains top of mind for us, as will managing our operating leverage. With that in mind, I want to comment on our efficiency ratio which rose to 59.5% in the first quarter of 2008 from 55.3%. This increase is primarily the result of the impact of Federal rate cuts on interest income and a decrease in income from investment securities gains and warrants. While our long-term objective is to move our efficiency ratio lower, we are comfortable with a sub 60% efficiency ratio, given the current economic environment.

Let's move on to credit quality. We continue to preserve our good credit quality with net charge-offs in the first quarter of 49 basis points of total gross loans annualized, compared to 28 basis points in the fourth quarter. Gross charge-offs rose a modest $1.5 million to $6.2 million compared to $4.7 million in the fourth quarter, but remained within our comfort zone.

Now, I'd like to move on to capital management and liquidity. We repurchased 980,000 shares of common stock in the first quarter of 2008, at an aggregate cost of $44.6 million, consistent with the pace of the previous two quarters. Additionally, we had a reduction of 248,000 shares from the dilutive impact of our contingently convertible debt as a result of a decrease in our average share price in the first quarter. I would like to point out that at the end of Q1, we had 1.2 million shares in our weighted average diluted share count related to our contingently convertible debt issued in 2003, which matures in June 2008. This represents 3.5% of our weighted average diluted share count at March 31st, 2008. If our share price remains below $51.34 prior to the bond's maturity, the dilutive effect of the contingently convertible debt will be removed when the bond matures in mid June. We expect that this will reduce our weighted average diluted share count in the second quarter. However, the bulk of the impact will not be seen until the third quarter of 2008.

We reduced our ratio of tangible common equity to tangible assets to 9.8% in the first quarter, compared to 10.1% in Q4, largely due to share repurchases and strong loan growth. Although we are still committed to reducing that ratio further in the long-term to 8.5%, we are constantly assessing that goal in light of the U.S. and world economies, taking into account the state of the capital markets, the needs of our business and the appropriate use of financial instruments at our disposal. We have used our capital in recent years to support loan growth, to develop new revenue lines and expand our key capabilities in key markets outside the U.S.

Our plans in 2008 and beyond call for continued investment in our business to support future growth. Given these priorities and the dislocation of the capital markets, we are strongly inclined to retain our capital. As a result, we are unlikely to repurchase any significant amount of shares in Q2. We will continue to evaluate this position as the year progresses. As noted in recent press releases this month, we issued 250 million of convertible senior notes due in 2011. The proceeds from this offering will be used to settle our existing 150 million due in June 2008, which has proven over time to be a low-cost source of funding for us.

A portion of the proceeds from our debt issuance was used to purchase a call spread, which while not affecting the rights of note holders, is intended to effectively raise the economic conversion price of the notes for SVB from $53.04 to $64.43 per share. The remaining proceeds will be used for general corporate purposes.

Now, let us turn to our outlook for 2008. Our outlook reflects our expectations for the full year 2008 versus the full year 2007. Although, we will revisit and update our outlook each quarter, it is an annual outlook. We had three changes to our outlook for the year ending December 31, 2008. First, we are improving our outlook for average loans. Average loan balances will increase at a percentage rate in the low 20s. Our strong loan growth in the first quarter caused us to raise our original expectations for loans.

Second, we have trimmed our outlook for growth in client investment fees to the high single-digit range due to lower VC investment in the first quarter and a lack of technology IPO activity, which we expect to persist into the second quarter. This also implies that balances would move in line with fees. However, we are increasing our outlook for certain fee-based income. We expect that fees for deposit services, letters of credit and foreign exchange, in aggregate, will grow at a percentage rate in the mid-20s. The rest of the outlook remains the same and I refer you to our press release for details on that.

Before moving to the question-and-answer session, I would like to touch on a few additional points. Our business remains healthy, thanks to the resilience of the industries we serve and our credit discipline. Although the rest of 2008, promises to be challenging for all businesses, we feel we are well positioned to focus on effective execution and strengthening our business. While interest rate cuts affect our margin and our income, we will remain focused on offsetting their impact by introducing new products and services and continue to grow loans, deposits and fee income. We believe we have already felt the most significant impact of interest rate cuts and we look forward to the coming end of this cycle of interest rate cuts.

We expect continued variability in our derivative and investment securities businesses. The turmoil in the equity markets will most likely suppress the value of our warrant and investment securities portfolios during 2008. While 2008 may be a challenging time for these investments, this is a long-term business, one which we expect to return along with a more positive market environment.

We have a strong management team, the best employees and strong liquidity and ample opportunity to continue building momentum. Notwithstanding these difficult economic times, we continue to retain our focus and to make the best of this opportunity in order to build and retain shareholder value.

This concludes the review of our first quarter 2008 results. With that, I would like to ask the Operator to open the call for questions.

Questions-and-Answers Session

Operator

Certainly, sir. (Operator Instructions).

Your first question comes from Joe Morford. Your line is open.

Joe Morford - RBC Capital Markets

Thanks. Good afternoon, everyone.

Ken Wilcox

Hello, Joe.

Joe Morford - RBC Capital Markets

Maybe a question for Ken or Dave Jones, listening to your comments about the latest venture capital investment activity being down and then comments, Mike, about you're looking to preserve capital and maybe hold off on buybacks in the near term, given the turmoil in the capital markets and the downturn in the economy, any implications of all this for credit quality? And are you at all beginning to see any signs of stress in some of the businesses that you serve at clients?

Ken Wilcox

I think we'll give that one to Dave.

Dave Jones

Thank you and this is Dave. In terms of signs of stress, the answer to that one is no. The conversations that we have with venture capitalists indicate that they are comfortable with the marketplace and then are very willing to invest in their existing portfolio companies and continue to grow with new companies that they're funding. One of the things that we are seeing is that the time that is required to close the next round of venture capital is extending out a little bit. We've had conversations with the venture capital community and I'm comfortable in saying that that is not because the venture capitalists are disinclined to invest but rather it's just the adjustment to the valuation issue. So we've been in this period for two or three years of increasing valuations, and now, the management teams, and maybe to a lesser extent, the investors, are dealing with next round valuations that are not going up.

And then it is taking a couple of extra weeks to close around while they get comfortable with the new valuation. But I think that given where we are in an economic cycle, that's completely to be expected, and I think that at least the near-term prospects for the marketplace is strong.

Joe Morford - RBC Capital Markets

Okay. And then in the charge-offs this quarter, Dave, anything of note there, any trends or is it fairly granular?

Dave Jones

It is fairly granular. There were several in that $6 million number, so, very small pieces of business. It tends to still be the early-stage company that is creating most of our loan loss experience.

Joe Morford - RBC Capital Markets

Okay. And then just lastly, any more color on just what drove just such strong loan growth in the quarter? It sounded like it was pretty broad-based, but even so this is the highest quarterly growth rate we've seen in years, really. And just anything in particular you can point to there?

Dave Jones

And this is Dave. At least I will begin the explanation. So I think there are two things to look at in that number. Joe, I think when you reference an above-average growth rate, I think you're probably looking at the average.

Joe Morford - RBC Capital Markets

Yes.

Dave Jones

Quarter-to-quarter, as opposed to end-of-period, end-of-period. End-of-period from 12/31 to March 31 was about $200 million and we've obviously seen a volatile number but numbers between 1 and 300 million in recent quarters. So end-of-period didn't stand out quite as much as the average.

The average was more a reflection of what occurred in the fourth quarter than what occurred in the first quarter. And as we were concluding [2008], a lot of our activities over the years with the later-stage companies came to fruition and several companies were closing on transactions with us. I'd like to say that that's because our message to the technology community is that you want to bank with Silicon Valley Bank because we are the market leader and we are the more reliable choice.

I think that that probably was the case in some instances. In other instances, I can't say exactly why it was that we were so successful in the fourth quarter, but I'm very pleased with the areas of our growth, the quality of our growth and would be happy to extend on that if the market is similar.

Joe Morford - RBC Capital Markets

Okay. Thanks so much.

Ken Wilcox

Thanks, Joe.

Operator

Your next question comes from John Pancari. Your line is open.

John Pancari - JPMorgan

Good afternoon.

Ken Wilcox

Hi, John.

John Pancari - JPMorgan

Can you give us a bit of color on your expectations for the margin? And I just want to get an idea of what are in your assumptions right now in terms of Fed actions at the upcoming meetings. And then, in terms of your expectations for the margin, how much compression, can we see another leg down of this size next quarter? Or is this notably a larger chunk that we'll see? And that could be smaller going forward, of compression, that is.

Michael Descheneaux

Sure. This is Mike Descheneaux. So with respect to how we look at the interest rates going forward, we basically use the forward curve for our rate outlook. And what we have been saying publicly, probably for the last three quarters, is we generally use a rule of thumb of about for every 100 basis point change in the Fed's rate that drops to our NIM by about 50 basis points. And so when you look at this quarter, that held true once again, and we'll be coming out with more updated numbers in our 10-Q, but it looks that it's holding fairly consistent in that range, about 50 basis points that will affect our NIM for every 100 basis point moves in the Fed.

John Pancari - JPMorgan

Okay. And then what are your expectations for the Fed at the upcoming.

Michael Descheneaux

Well, you're just looking at the forward curve where most people are expecting a 25-basis point decrease this month.

John Pancari - JPMorgan

Right.

Michael Descheneaux

So that's how we follow it.

John Pancari - JPMorgan

Okay. All right. And then, can you give us a little bit more detail on your loan growth, linked quarter, I guess using the averages, by type? I know your classifications, you provided us with foreign terms of technology, private equity, life sciences, private client.

Dave Jones

And this is Dave Jones. Let me touch on that. So end-of-period, loan growth was roughly about 40% for private equity and 40% for the hardware, software and life sciences in aggregate. And then our other business lines would account for the difference.

Ken Wilcox

Dave, maybe you should define those sectors though more specifically, so it's a little clear what you're referring to.

Dave Jones

In terms of the others?

Ken Wilcox

Well, no, the first, the private equity refers to.

Dave Jones

All right. So in terms of the private equity, these would be the capital call lines of credit that we are making to the venture capital firms. So, not to be confused with the private equity that gets the Wall Street Journal attention.

Ken Wilcox

Right.

Dave Jones

But capital calls is that we see.

John Pancari - JPMorgan

Okay. And then could you give us just an idea how has your loan mix changed in terms of the corporate tech versus Series A? I know you had provided it a little while ago. It was more like 80/20 corporate tech. How does that stand now?

Dave Jones

And that is continuing to weigh more heavily on the corporate tech side and it isn't because we are spending any less time with the early-stage; we're spending as much time as we ever have with the early-stage. But going back to my response to Joe, where we have loan losses in early-stage, it is that the early-stage is a relatively higher risk. And we manage that risk through the concept of granularity.

So we need to make sure that the size of the business for the Series A, as you describe it, is relatively small. To find the quality opportunity for a $10 million piece of corporate tech, obviously, will significantly overshadow the good growth opportunities that we would have for the early-stage. So if it was 80/20, it's now moving in the direction of 85/15.

John Pancari - JPMorgan

Okay. One last question, on the corporate finance fees. I'm assuming, it seems like their closure or exit aligned actually ended towards the end of March. So as we see this corporate financings go away, should we expect a similar decline on the expense side?

Michael Descheneaux

So, this is Mike Descheneaux, John. So this was basing, this is the last quarter of corporate finance fees and with respect to expenses, it's the same as well. So you won't see any of those going forward as well. But to be fair actually, we had a lot of the expenses were already cut out in Q3 and Q4 related to the normal operating infrastructure at aligned.

John Pancari - JPMorgan

Okay. Thank you.

Operator

Your next question comes from Andrea Jao. Your line is open.

Andrea Jao - Lehman Brothers

Good afternoon, everyone.

Ken Wilcox

Hello.

Meghan O'Leary

Hi, Andrea.

Michael Descheneaux

Good afternoon.

Dave Jones

Good afternoon.

Andrea Jao - Lehman Brothers

Hoping to get a bit more detail on the foreign currency denominated loans I was wondering why it was so noticeable this quarter and how much was the loan portfolio and how should we think about it going forward?

Michael Descheneaux

So, Andrea, this is Mike Descheneaux. I'll take a start-out and if anybody else can jump on, please do so. But our foreign denominated loan portfolio is approximately around $40 million and it's largely denominated in, let's say, British pounds for the most part. And so clearly, with the dollar not being so strong, we basically had, sorry, let me rephrase that. Because the foreign currency that we have the loans in were strong we reported a gain, which goes into our other non-interest income. The flip side of that, which is what you're talking about is the foreign currency exchange forward contracts, which we use to try to mitigate our exposure to fluctuations in currency movements.

So you have to look at those two buckets tied together and then net-net, it's not overly significant numbers. But when you're looking on an individual basis, it can be kind of alarming or quite large fluctuations.

Andrea Jao - Lehman Brothers

Okay. So, on a net basis, roughly a couple of million dollars benefit, right?

Michael Descheneaux

I think it was a little bit over a million or so. It wasn't so significant.

Andrea Jao - Lehman Brothers

Okay. And then on the securities losses, given that distributions are probably going to be lower than past quarters and valuations also to be lower than past quarters, if I take out the $8 million in loss, it looks like securities gains were about $2 million. Is that right? Is that a good run rate to think about that line item going forward?

Michael Descheneaux

Well, I'm not going to comment about a run rate going forward, but I think your logic and how you're thinking about that, to take that interesting or one large item out of the picture, and then that kind of gives you a little bit better picture, at least for your side. So I think that is a fair way to look at it, but I won't comment on a run rate at this point.

Andrea Jao - Lehman Brothers

Fair enough. Thank you.

Michael Descheneaux

Thank you.

Operator

Your next question comes from Aaron Deer. Your line is open.

Aaron Deer - RBC Capital Markets

Hi. Many of my questions have been answered, but I'm curious with, given the strength that you are seeing and the relative strength of the markets in which you play, are you seeing increased competition at this point?

Greg Becker

Yes, Aaron, this is Greg Becker, I'll take that. I would describe it at stage of company. Early-stage is still, I would argue, pretty competitive and probably the simplest description around that is we compete in that area on the debt side with venture debt funds and other players like that. And they operate more like a venture fund where they have a longer-term investment horizon. So they're not as impacted by fluctuations of the existing market. So that market remains relatively competitive.

Where we are seeing the competitiveness change is mid-to-late-stage companies and just one indication is that when we look at this limited number of small buyout deals that we're doing, six months ago, nine months ago, you would see a handful, maybe two handfuls of people competing for those deals, and today, you may see literally a couple.

So clearly, the later the stage of the company, the fewer the companies that the competitors we're seeing in the market. And that is obviously creating demand.

Aaron Deer - RBC Capital Markets

Okay. And then secondly, is there anything we can derive from the lower level of unfunded commitments at period-end?

Dave Jones

This is Dave Jones. No, I don't think that there's necessarily anything. Maybe one factor to that is that at the end of December, we didn't see quite as much activity under the venture capital call lines as we did at the March 31 period. So those capital call commitments would have been in the unfunded commitments, whereas by the March 31 period, it would have moved differently.

Aaron Deer - RBC Capital Markets

Okay, great. Thank you, everyone.

Operator

Your next question comes from Fred Cannon. Your line is open.

Fred Cannon - Keefe, Bruyette and Woods

Hi, thanks, and good afternoon.

Ken Wilcox

Hello, Fred.

Dave Jones

Hi, Fred.

Fred Cannon - Keefe, Bruyette and Woods

Hi. I was wondering if you could provide a little color on the sponsored debt funds? You had the loss of $8 million on one investment and it looks like you only have three sponsored debt funds. I was wondering if you could kind of describe those debt funds and if these are kind of a core part of the overall fund business you have or kind of a peripheral type of activity.

Greg Becker

Yes, Fred, this is Greg. We do have, as you point out, three sponsored debt funds and so I guess, first point is they are core to our business. One of the sponsored debt funds relates mainly to earlier stage companies and the other two relate to middle-stage companies. And the way you basically do valuations, it's probably the challenging part, when you have write-ups.

In this case, a company went public. They were in a lockup period and the sponsored debt fund literally did everything that they could do to be a selling shareholder of the IPO. They were locked up. The stock price went down and we had already written up the valuation of the gain.

So they did everything right from our standpoint and that's just a fact of the market. So the good news is it was a big gain and now it's a gain, but maybe not quite as big. So we still feel good about the strategy around them.

Fred Cannon - Keefe, Bruyette and Woods

So the net effect was basically a small gain and I guess the question is when was the initial gain booked? Was that in the fourth quarter?

Michael Descheneaux

So what happens, Fred, is it's marked on a mark-to-mark basis. So for example, if the fair value of the shares of 12/31 is X, there's the corresponding value. And then so what we're recording in this quarter is the change in the share price value from December 31 to March 31. And so that's what you're seeing. So essentially it's unrealized losses is what we have.

Fred Cannon - Keefe, Bruyette and Woods

I guess that question would be what's the cash flow on the debt funds? Is there from it, is there cash flow consequences here we should think about?

Michael Descheneaux

On that particular item? No.

Fred Cannon - Keefe, Bruyette and Woods

Okay.

Ken Wilcox

Fred, this is Ken. I would also like to add to that. I don't know if this is what you were driving at with your question or not. But you were asking about the extent to which these debt funds were core to our funds business, I think was what you said specifically?

Fred Cannon - Keefe, Bruyette and Woods

Yes, exactly.

Ken Wilcox

And I would like to point out that they're really not core to the funds business. They're only nominally part of, or associated with the funds business. What they're core to would be the lending business. These are very strategic to the lending business because they extend our capabilities on the lending front, enabling us to offer a much broader spectrum of products and to our client base, and products at points in the risk-reward spectrum that would be much more difficult for a banking organization that was funding its loans through deposits to offer to its client base.

So what it really does is it gives us a much broader and deeper product set and ultimately, brings higher returns to the shareholders than a bank could normally achieve with the kinds of loan products that a bank is able to offer.

Fred Cannon - Keefe, Bruyette and Woods

Oh, okay. Thanks, Ken. So is it fair to think of these more then as part of the lending function, but kind of a mark-to-market part of a lending function?

Ken Wilcox

I think that would be fair. I think you need to think of it conceptually as being part of our lending business and I think we only nominally associate them with the funds business because of a structural perspective.

They obviously fit under the rubric of the funds business. But from a strategic and operational and practical everyday perspective, they're very clearly a part of our lending business. And really and truly give us a much greater impact in our market than we would have otherwise if we were operating purely as a commercial bank.

Fred Cannon - Keefe, Bruyette and Woods

Okay. Thanks very much.

Ken Wilcox

Thanks, Fred.

Operator

Your next question comes from Erika Penala. Your line is open.

Erika Penala - Merrill Lynch

Good afternoon.

Ken Wilcox

Hello.

Meghan O'Leary

Hi, Erika.

Erika Penala - Merrill Lynch

I just wanted to follow-up on one of the questions that was asked. You mentioned the competition has tempered for mid-to-later stage companies. Do you compete with mainstream banks in this sector? And if so, do you sense that real-estate-related troubles that have impacted the mainstream banks have pulled back their appetite to compete?

Greg Becker

Yes, Erika, this is Greg Becker, again. So, the mid-and-later stage companies, we do see more traditional banks competing in that area, and I would say absolutely, we're seeing an impact by the turmoil in the credit markets related to real estate impact their willingness and ability to lend. Yes, absolutely, it's later stage.

They're mainly focused on working with existing clients. We're not seeing a great interest in going out and adding new clients and clearly, lending money to those new clients.

Ken Wilcox

And Erika, I would just add to that the credit crunch that we all read about in the Wall Street Journal and the New York Times, it clearly involves banks. It doesn't involve hedge funds and the very early-stage mark is, in some sense, driven, at least in part, by the activity of hedge funds which, and obviously, hedge funds come in a wide variety of shapes and sizes.

And some of them may not be doing as well as they'd like to, but others of them seem to have unlimited capital to deploy; whereas, the mid-stage and late-stage and corporate tech part of the market is served largely by commercial banks which are hampered now by some of the things that have happened in these past several months and are all part of what the Wall Street Journal thinks of as a credit crunch.

Erika Penala - Merrill Lynch

And my second question is your lowered outlook for a client investment fund growth, is that due to a more pessimistic outlook for venture capital fundraising or is it because you're really trying to direct more of this money on balance sheet?

Greg Becker

Erika, this is Greg again. I'd say there's several things in there. The first thing is the outlook driven by IPO activity and I guess as we look at 2008, I don't see a big turnaround or a big improvement, at least in the near term, of IPO activity. And when our clients go public, the majority of those clients will keep that money in our off-balance sheet fund. So that's one of the drivers that’s causing us to be a little more cautious on that guidance.

The second point you mentioned was are we driving more of that on balance sheet and the answer is yes, and that is related to early-stage companies and other types of clients that clearly, we are focused on moving that onto our balance sheet.

The third question relates to venture capital activity and I'd say your question was specifically about venture capital fundraising and although fundraising was down in first quarter, when we're out in the market, we clearly get the sense, in talking to investors that are looking to come into venture funds, that there's still a lot of money looking to come into venture capital firms. And so that is a good sign for the longer term outlook.

Now, over the course of this year, the amount of money that's actually invested in companies, I think, as we experienced in the first quarter, may be a little softer than last year. And so that will have an impact if that impact plays out that way. So it's the combination of all those things that really causes us to be a little more cautious.

Erika Penala - Merrill Lynch

Okay. Thank you.

Operator

Your next question comes from Brent Christ. Your line is open.

Brent Christ - Fox-Pitt Kelton

Good afternoon.

Ken Wilcox

Hi, Brent.

Brent Christ - Fox-Pitt Kelton

It looked like you guys got a nice lift in the deposit service charges this quarter with rates coming down. I was just wondering to what extent we could kind of see that continue into the second quarter, just given the timing of the rate cuts and you lowering earnings credit rates?

Greg Becker

Yes, this is Greg again. And as Mike alluded to on the revised outlook guidance on some of the key drivers, we do believe that this core fee category of which deposit servicing fees is part of it, will continue to show nice growth for the year and that's obviously driven by the lower interest rate or lower earnings credit rate that clients get on those balances. So, yes, we do believe it will continue.

Brent Christ - Fox-Pitt Kelton

Got you. And the second question, with respect to the specific losses within the one investment in the sponsored debt funds. Can you give any specifics in terms of what security that one loss was tied to?

Michael Descheneaux

No, Brent. This is Mike Descheneaux. We actually don't provide that information. It's just, it was a publicly held company.

Brent Christ - Fox-Pitt Kelton

Okay. And then the last question is just in terms of the convert itself, can you talk a little bit about the rationale behind issuing the new convert and potentially what other options you considered, whether it was just calling the existing convert and why you decided to replace it with a new one?

Michael Descheneaux

Well, I think the first point you need to understand is there is a difference between capital and liquidity, as we all know and whilst we're very well capitalized and strongly capitalized at the bank holding company, you always do need the liquidity to pay off the debt, of course. Now, what the bank holding company does, it relies primarily on the bank to provide liquidity and when you start looking about all the growth opportunities we have at the bank and the strong loan growth, you always need to look for alternative liquidity channels for the bank holding company.

So when we started thinking about that and we're looking at what's available in the financial markets that we could use to refinance, and you've seen all the dislocation in the credit markets. There's not a whole lot of available credit for the banks. The big banks still can tap the financial markets, but some of the smaller and medium-sized banks, it's a little bit different.

So some of the alternatives we considered were certainly the just plain vanilla debt because most of the debt is not really readily available in the very short term. Of course, tenure debt is potentially available, but it's at extremely high coupon rate. So that was kind of the sweet spot for us is looking at it from an interest rate perspective and that convertible debt, offer that cost of funds at a low level.

Brent Christ - Fox-Pitt Kelton

Got you. And then the last question, just a follow-up with respect to the unfunded commitments coming down this quarter, could you give us a sense in terms of the sequential loan growth, how much of that was due to new business versus draw-downs on existing lines?

Dave Jones

This is Dave Jones. And I really don't have that level of detail to be able to answer that question. We did have good client acquisition though, but I just can't parse up all of the loan funds to that level.

Brent Christ - Fox-Pitt Kelton

Okay, no problem. Thanks a lot.

Operator

And your next question comes from James Abbott. Your line is open.

James Abbott - Friedman, Billings, Ramsey & Co.

Hi, good evening.

Ken Wilcox

Yes.

James Abbott - Friedman, Billings, Ramsey & Co.

I have a question for you on a couple of things on the margin. Number one is, was there any prepayment penalty income in there? Last quarter, I think there was and maybe I missed it in the press release, but I was skimming really quick.

Michael Descheneaux

The answer, as you point out, we did have a large fee recognition last quarter related to some of these prepayments. It certainly was not as large this quarter. So that obviously hurt our margin a little bit, but our margin held up very strongly this quarter as well. Of course, every quarter, we have some prepayment fees that go in there. It's just a question of whether it's larger or smaller than the previous quarter, whether they're called down or not.

James Abbott - Friedman, Billings, Ramsey & Co.

Yes, I'm sorry. But from just kind of looking at it qualitatively, would you say it's kind of back into a normal range here, Mike, or is it still elevated? Should we think about that coming down a little bit further?

Michael Descheneaux

No. I think I wouldn't say that it characterizes it at elevated levels. I would say we've got back more within normal, a more normal level.

James Abbott - Friedman, Billings, Ramsey & Co.

Okay. And then also, do you have a sense or what the margin was in the month of March, just trying to kind of give us a sense for what the run rate might be? I understand there's some math that you've given guidance on based on what the Fed's done, but if you have the March margin, that might also help.

Michael Descheneaux

Yes, we don't give out, obviously, the March run rates, but again, as we said about the rule of thumb, the 50 basis points rule of thumb, we think that's pretty fair going forward. However, I will caveat that by saying we will come up with updated interest rate sensitivity numbers in our 10-Q. And so we're going to retest that and we back test that to make sure that's still consistent going forward. But it looks like that's going to hold true for a bit.

James Abbott - Friedman, Billings, Ramsey & Co.

Okay. Well, I thought I'd try.

Michael Descheneaux

That's okay.

James Abbott - Friedman, Billings, Ramsey & Co.

Now, we have seen, I just wanted to touch base on, this might be something for Dave, I guess, is I know that you've mentioned in the past that some of the losses tend to come from the early-stage. And then also what you tend to do is as things sort of deteriorate for these early-stage companies is you tend to move them into asset-based lending and also factoring. Can you give us some color around the migration trends there in the quarter or over the last six months? Just trying to see if you're seeing any movement there?

Dave Jones

And this is Dave. I will at least start the response and the answer is not a significant amount of movement from traditional products into the more monitored lines of credit, but I would caution that with regard to the economy as a whole, we're what, six, nine months into the decline? And for our client base in particular, we're not that far into the decline. So I think that our prospects for growth and to more structured and better compensated products is still ahead of us, not something that we would have expected to see by this point in the cycle.

James Abbott - Friedman, Billings, Ramsey & Co.

And Dave, were the losses that came from this quarter still skewed towards the factoring? I know you mentioned it was early-stage companies, but specifically, was it coming out of the factoring that where the losses were?

Dave Jones

No, it wasn't. Actually, by early-stage, I would tend to characterize that as a company with no revenue or diminimus amounts of revenue versus a mid or a later-stage company with a healthy amount of revenue and a better prospect for factoring.

James Abbott - Friedman, Billings, Ramsey & Co.

Okay. So this quarter was still into the early-stage, low-revenue companies that was where the problem was.

Dave Jones

Okay, thank you.

Operator

There are no more questions in queue.

Ken Wilcox

Thank you very much.

Meghan O'Leary

Thanks very much for listening to the call.

Operator

Thank you so much. You have a wonderful evening. This concludes your conference call for today. You may now disconnect your lines.

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