SVB Financial Group (SIVB) 2005 Q2 法說會逐字稿

Good afternoon and thank you for standing by. Welcome to the SVB Financial Group's second quarter conference call. This call is being recorded, and if anyone has any objections, you may disconnect at this time. And now I will turn the call over to your first speaker for today, Ms. Lisa Bertolet, Investor Relations Manager. Ma'am, you may begin.

Thank you. I'd like to start the meeting today by reading our Safe Harbor disclosure. This presentation may contain projections or other forward-looking statements regarding the future events, the future financial performance of the company, the impact of our proposed restatement, estimates of financial results for the second quarter that have not definitively determined and the timing of future filings by the company with the SEC. We wish to caution you that such statements are just predictions, and actual events or results may differ materially.

We refer you to the documents the company files from time to time with the Securities and Exchange Commission, specifically the company's last filed Form 10-Q, filed on May 10, 2005, which contains and identifies important risk factors that could cause the company's actual results to differ materially from those contained in our projections or other forward-looking statements. We further note that the completion of our results for the second quarter, and our proposed restatement, may be affected by factors not anticipated at the present time, and as such, are also subject to risks and uncertainties.

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

Thank you, Lisa. Good afternoon, and thank you for joining us. We have another strong quarter to tell you about today, one in which our continued focus on meeting our clients' needs at every stage resulted in strong performance and continued loan growth.

However, as you have seen by now, we have issued only highlights for the second quarter, and not a complete earnings release. This is due to the fact that we are in the process of implementing a different accounting treatment related to the valuation of our warrants. We intend to complete this process and issue our full quarterly earnings as soon as possible.

While this accounting change applies only to our warrants and does not affect our cash position or cash flow, it does affect our interest income and income from warrants, and will also have some impact on certain balance sheet items.

Although we are not providing the full P&L, we are still able to give you a very good idea of our results for the quarter. In an effort to be as transparent as possible, we have provided you with certain of the metrics that will not be affected by this accounting change and estimates, where we could, of those metrics that are affected.

I'm going to let Jack address some more of the detail on this change in accounting methodology. But let me emphasize that this is expected to increase retained earnings in the aggregate for the periods to be restated, resulting in an increase in total stockholders' equity.

Our results for this quarter are validation that SVB Financial Group continues to make the right decisions about where to focus and how to grow as a company. Our global financial services team is building momentum through a growing network of international subsidiaries and relationships. Our commercial bank is maintaining its position as the bank of choice among venture-backed companies, and is gradually building its roster of larger clients.

SVB Alliant, our investment bank, has firmly re-established its momentum and has enjoyed an upswing in the venture-backed M&A market. And SVB Capital, our funds management business, continues to cement its role as both banker and partner to the venture capital community.

In each of these arenas, by expanding and diversifying strategically where we see a need for financial services that complement our current offerings, we are giving our clients more reasons and opportunities to choose SVB and to stay with us.

Let me start with global financial services. As you all know, we recently opened subsidiaries in England and in India. We have seen a tremendous surge in interest from companies and venture capital firms looking for help in navigating these business landscapes, particularly in India, where we have worked with 180 companies since our opening last year.

The work we are doing in India and Europe has resulted in productive new client relationships, a stronger network of venture firms and business partners around the world, greater success in our cross-selling efforts and greater recognition of our leadership in the most important emerging economies. We are on track to open an office in China by year's end. And we remain very active in Israel.

Our commercial banking business remains strong with average quarterly gross loans at another record high of $2.3 billion for the second quarter, thanks to an ongoing demand for working capital. We are proud that we've been able to cement our relationships with clients by providing capital to lengthen their pre-revenue runways, regain their momentum or boost their revenue potential through acquisition.

The commercial bank has been at the center of many of the cross-selling successes I mentioned earlier, providing the entry point for clients seeking essential foreign exchange services, merger and acquisition advisory services and XM bank working capital facilities, just to mention a few.

We are also reaping the benefits of our relationship with Gold Hill Venture Lending, with whom we've closed a number of venture debt deals so far this year. I'm pleased to tell you that SVB Alliant continues to gain momentum. They had a solid quarter, closing 11 transactions and exceeding our expectations thanks, in part, to an improving M&A market.

Acquisitions of venture-backed companies in the U.S. are up by 14% over last year, and in the face of continued sluggishness in the IPO market, we are also seeing increased activity in our private placement practice. As part of our overall international push, we've been working to introduce SVB Alliant in the global markets in which we operate, laying the groundwork for their future efforts in Europe.

SVB Capital, our funds management business, is at the heart of our relationships with venture capital clients, who now number more than 500, and include nearly every top-performing firm in the country. Through SVB Capital and our venture services group, we have spent as much time learning about the needs of venture capital firms as we have working with entrepreneurial companies.

We are very good at providing venture firms with financial services tailored to the unique cycles of their business. We have applied that understanding with increasing success to our own funds management business for the past decade, and in the second quarter, we closed our second venture fund-to-funds, which we capped at $175 million following strong demand.

Our emphasis in all of these arenas is not just diversification and expansion, but growth and momentum-building as well. Our constant drive to innovate and to grow, to meet the demands of our clients, was at the heart of our recent holding company name change to SVB Financial Group, which we announced in May.

In our opinion, the name SVB Financial Group better reflects our current status and our future direction as an international diversified financial services company. Silicon Valley Bank, which is our primary and best-known subsidiary, representing roughly 70% of our business, will continue to operate under its current name.

If recent economic figures are any indication, the future looks promising for us. It appears the recovery in technology spending is finally here, which is good news for our clients. Output for equipment and software grew by 6.1% in the first quarter of 2005 and International Data Corp. expects global technology spending to grow at about 5.5% throughout 2009.

As companies replace computers and networking gear, and finally make those software purchases they've been delaying for the past four years, the market opportunities for products, services and new companies promise to grow at a healthy pace.

Venture capital investment in technology and life sciences companies appears to reflect this outlook, having risen 9.2% in 2004. In the first quarter of 2005, venture investing was up 13% over the first quarter of 2004 and first-time financing of companies hit a two-year high, accounting for 26% of all venture investing.

As I said earlier, the M&A market has been expanding and the quality of the deals is higher thanks to the recovery in technology and life sciences. As a result, the median amount paid for a venture-backed company in the first quarter of 2005 was $70 million, the highest median in nearly five years. All of these trends are good news for SVB Financial Group and for our clients. As we've said before, we're poised to take advantage of every market improvement as it comes. Our products, our infrastructure, our people, our networks and our competitive position are all strong and getting stronger.

As a result of the efforts of our employees, our reputation as a company with the dedication and the ability to help clients succeed has never been better. We will continue to leverage these strengths to our advantage and to the advantage of our shareholders. I want to thank you for joining us today. Now I'd like to turn the call over to Jack, who will take you through the numbers.

Thank you, Ken. Good afternoon. Well, the second quarter is one more illustration of why SVB Financial Group is a great place to be at this time. We continue to build on market successes and as a result, we have seen strong loan growth, continued growth in net interest margin, excellent loan quality and better-than-expected growth in both corporate finance fees and foreign exchange revenues.

Before I get into more specifics on the quarter, let me begin by discussing the accounting change that we announced today. This change is a result of a recent review of our accounting treatment for warrants. As Ken mentioned, it will have no impact on our cash flow, and it will tend to increase our equity in the aggregate for the periods being restated.

First, let me give you a little background on this issue. As you know, SVB has been taking warrants as part of its lending activities for over 15 years. Over that time frame, the bank has taken approximately 3,900 total warrants. Over the same period of time our accounting practice, as outlined in our SEC filings, has been to value these warrants at a nominal amount to be conservative in our accounting.

Our outside auditors, KPMG, agreed with this approach and as recently as March of this year completed our Sarbanes-Oxley 404 review without noting a single material weakness. However, late in the second quarter, it came to our attention that our historical practice for accounting for warrants should be reviewed and possibly revised. We immediately began working with several independent consulting firms on a review of our accounting for warrant valuations.

Subsequently, we concluded that our accounting treatment for our warrants should be revised and have started the process of implementing the revised accounting treatment. Let me outline the revised accounting treatment we will be adopting. We have concluded that SFAS 133, as clarified in one of more than 200 clarifications provided since its issuance in 1999, requires that our warrants be fair valued at inception and revalued at each reporting period.

We have also determined that the initial fair value should be amortized through an adjustment to our loan yield, much as we do with loan fees. Speaking to valuation, there is no agreed-upon methodology to value a warrant portfolio of this magnitude and granularity. Moreover, generally accepted accounting principles in the United States do not yet provide any meaningful guidance. Needless to say, the methodology currently under development by the company will conform to certain accepted accounting conventions, but it will also include significant management judgement and estimates.

With that said, our initial valuation approach will be to include very specific information about our warrant portfolio and its history, along with general industry information, into an options pricing framework. Once this approach is set, we are required to go back and assess the impact of this revised accounting treatment for our warrants beginning with the third quarter of 2001.

While we are still finalizing our assessment of any impact, it is our conclusion that we will have a material impact that will likely increase net income and stockholder's equity for that third quarter 2001. We have yet to analyze and determine the likely impact on our quarterly financial results since that date, but we continue our analytical efforts.

To put this in some perspective for you, we are required to replicate the accounting, using the new methodology, for every loan entered into beginning Q3 2001, and to make mark-to-market adjustments to the value of our warrant portfolio for the periods since then.

As you can appreciate, this is a significant and time-consuming undertaking. With that said, it is important to recognize that we expect it to result in a relatively small adjustment to our earnings, subsequent to the initial implementation in July 2001, as well as a relatively small adjustment to our balance sheet as we reflect the total value of previously issued warrants into our stockholders' equity.

We will alert you to these changes as soon as we complete them. What does this mean going forward? First, as you can imagine, over the next several weeks this means a tremendous amount of work.

And, as both Ken and I have mentioned, we think that it is reasonable to conclude that, at the end of the process, we will have increased our stockholders' equity from where it is today. We can also conclude that, as our warrant portfolio grows, we will likely recognize income earlier, due to the valuation at issuance and the resulting amortization to our loan yield.

Now let me move on to review the results from the quarter that we announced today. As I said, we had another strong quarter. And, as my custom, I'll start with a few of the highlights. One, improved yield has had a significant positive impact on our net interest margin and on our net interest income.

Two, loan volume remains strong in the second quarter with quarterly average gross loans reaching another historic high. Our credit quality remains strong. Three, we saw continued positive trends across a number of business areas, including rising income from SVB Alliant, a letter of credit in foreign exchange business and client investments.

Four, expenses are up, primarily as a result of higher variable compensation due to better-than-expected performance and the implementation of a restricted stock program in lieu of options. While the accounting changes we mentioned earlier will impact our calculation of net interest income, we do not expect those changes to reduce our net interest margin below 6.5%. The change will likely increase that margin.

The continued improvement in both of these metrics reflects the benefit of higher loan balances and higher short-term interest rates during the quarter. Quarterly average gross loans at $2.3 billion in the second quarter of 2005 were 3.7% higher than in the first quarter of 2005 and represented another record high quarterly average for the company.

Quarterly average deposits were up over the same period last year, at $4.1 billion, but fell slightly for the quarter. As we stated during the call in January, we expect quarterly average deposit growth to be slower in 2005 than in 2004. On the plus side, too, our client asset management business is enjoying continued momentum with income from client investment fees rising to $7.8 million during the quarter, compared to $7.4 million in the first quarter and $6.4 million in the second quarter of 2004.

Client investment fund balances rose $1.3 billion to almost $13 billion in the second quarter, up from $11.7 billion at the end of the first quarter of 2005 and from $11 billion in the same quarter last year, a $2 billion or 18% increase.

While we can't give you a number for non-interest income, I can tell you that we had a 46% increase in corporate investment fees from SVB Alliant, $6.9 million, as well as the increases I mentioned earlier, in fees from client investment, letters of credit in foreign exchange services. These increases were partially offset by lower net gains from investment securities.

While the accounting change will impact our final calculation of warrant income reported on our financial statements, we can tell you that we did receive cash proceeds in the second quarter of $5.6 million.

Moving on to expenses. Non-interest expense rose $5.7 million in the second quarter to $66.3 million, owing primarily to increased compensation costs of $4.2 million related to a strong quarter at Silicon Valley Bank and SVB Alliant and incremental costs associated with the issuance of equity-based compensation. This increase reflects the transition of our equity-based compensation programs as we increase the use of restricted stock and restricted stock units in lieu of stock options as components of our employee compensation structure.

Additionally, we experienced higher professional services fees associated with the acceleration of completion of certain IT projects. Although cost control across the organization remains a focus, we anticipate that the costs associated with the earnings restatement and ongoing regulatory compliance work will likely result in higher expenses for outside services in the third quarter.

Moving onto one of the consistent highlights of our financial results, credit quality was again exemplary in the second quarter, with nonperforming loans or NPL's at $15.8 million, or just 0.65% of gross loan compared to $13.9 million or 0.59% in the first quarter of 2005 and $12.6 million or 0.59% in the second quarter of 2004.

The Company reported a provision for loan and lease losses of $932,000 in the second quarter of 2005 compared to a recovery provision for loan and lease losses of $3.8 million in the first quarter of 2005. We experienced net charge-offs of approximately $260,000 in the second quarter compared to $2 million in net recoveries in the first quarter.

And then finally one last reminder that we made a change in the first quarter of 2004 regarding the accounting disclosure of the way we segment our allowance for loan losses or our ALLL reserve. Previously, our ALLL balance included a reserve for probable losses in both our funded loan portfolio and our unfunded commitments. Beginning in the fourth quarter last year, we started to reflect our reserves in two places on the balance sheet -- our reserves related to funded loans, as reflected in the ALLL, and our reserves related to unfunded commitments is shown under allowance for unfunded credit commitments included in other liabilities.

This change is consistent with the treatment other banks have applied to this matter.

Going forward, to get a full measure of funds set aside for potential losses related to loans and unfunded commitments, one must look both at the asset side of the balance sheet and the liability side of the balance sheet. As indicated in our press release, this change in treatment of the ALLL had no impact on our results of operations or stockholders' equity.

SVB Financial Group repurchased approximately 831,000 shares of common stock in the second quarter of 2005 under the terms of our stock share repurchase program for a cost of about $39 million. We continue to have approximately $32.3 million available to repurchase stock under the current authority.

Moving forward, we will provide our usual guidance for the third quarter once we finish our review and restatement of warnings and issue our full second quarter results. Nevertheless, I can tell you that we are assuming another increase in the Fed funds rate of 25 basis points, in addition to the 25 basis-point increase announced on June 30, 2005 and a modest provision for loan and lease losses.

While we expect our accounting issue and continued Sarbanes Oxley compliance costs to effect non-interest expense, overall, we expect it to be lower in the third quarter compared to Q2. We also expect somewhat stronger loan growth and deposit growth in Q3 compared to Q2 and non-interest income consistent with Q2.

As I said last quarter, in anticipation of the advent of options expensing, we revised our equity compensation late last year to reduce the total number of options granted and to include the use of both restricted stock units and other types of combinations of equity awards to supplement our use of more traditional options. As a result, the cost of RSUs granted in late 2004 and throughout 2005 will be reflected in our income statement this year, even though the cost of options will not.

To wrap up, our focus remains the same. We are working hard to deliver superior financial results. We continue to look for ways to improve our business processes in the name of higher revenues, greater efficiency, and better service to our clients. We continue to be encouraged by the positive trends we are seeing across all segments of our business and we look forward to continued momentum in the coming quarter. Thank you.

We'd like to open it up to questions now please.

Thank you.

(OPERATOR INSTRUCTIONS)

Our first question comes from Joe Morford, with RBC Capital Markets. Your line is open.

Thanks. Good afternoon, guys.

Hey Joe.

Hey Joe.

I guess as a start, just wondering if you could take a stab at giving us a better idea of what we should expect going forward, in terms of the accounting for the warrant. Is there going to be more volatility each quarter as you kind of mark to market this portfolio? And how would you go about valuing the portfolio, especially since so many of these companies are private companies? And when you actually cash in the warrants, is that still going to run through the income statement, though I guess maybe the actual gains may be less if they've been trued up every quarter.

Sure Joe, let me take a stab at it. Part of it is, of course, we simply don't know until we see the impact as it rolls through the quarter is between 2001 and 2005. But I think we can say a few things. One is I think a portion of warrant income is actually going to be more stable. Of course, that's the portion that we assigned to a given warrant or, excuse me, the corresponding loan and that will be amortized over the life of the loan. So that portion will be somewhat more stable than it has been in the past.

And the second item is we are going to be, by necessity I think, very, very conservative in the way we would mark these warrants. In other words, we are not going to create a situation where we are marking them up and then marking them down, and marking them up, and marking them down. That would just not make sense. So we haven't entirely worked out what that methodology will be yet and gotten it confirmed. But I can tell you it will have to be a fairly conservative methodology, given the uncertainties imbedded in the portfolio.

As far as the methodology goes, we do have a fairly significant history in the portfolio, and that history gives us a lot of insight into the performance of warrants over the time frames. Most of our warrants have a 10-year life, but we also know what the behavior of that warrant has been, or typical warrants have been. And so we know what -- in a sense we know what to expect and when we can expect it. So we'll be using that information combined with I'll call the general industry information, combined with information specific to the company, to value the warrants at their issuance, which will probably be a fairly -- I would think would be a fairly nominal value. And then to change that or modify that value as new information comes along. The exact treatment and our exact methodology will be documented fully in critical accounting policies when we file our 10-K/A.

The only other -- one other thing, Joe, is I think it's important to put it in some context here. Warrant income has rapidly become much less important to our bottom line than it was years ago. In fact, I think it's well under 10% and if current trends continue this year, it's likely to be well -- even further under 10%. So I don't anticipate it having -- increasing dramatically any volatility on the bottom line. But with that said, I think we have to wait and see what the methodology looks like and we'll be able to describe that much more fully in a few weeks.

And is there any way at this point to kind of ballpark the magnitude of the upward revision to your equity account at this point? You know, whether it's tens of millions or much bigger than that.

Yes, no, it's a good question. The answer is we wouldn't -- well, the answer is we don't know yet; we are still working on that. It will be in excess of some materiality threshold on our equity account, that's why we are announcing it to the investor community. But -- so I can't say yet what it will be, I just simply don't know. I do think we can say that it's likely to increase our -- it will increase on the aggregate for the period under review, our stockholders equity and as a result, give us an opportunity to -- frankly, to buy back more shares to reach our given target capital structure.

Okay. And then lastly, just real quick, you talked about the margin being up over 650 this quarter. Is there much restatement to the first quarter? I mean are we still looking at generally the magnitude -- this is an increase off of 615 in the first quarter?

Yes.

OK, great. Thanks, Jack.

Yes.

Our next question comes from Brian Conn with Sander O'Neill.

Good afternoon everyone.

Good afternoon, Brian.

Good afternoon.

I wanted to follow up on one margin question from Joe, and that was should we assume then that -- can you give us I guess a better breakout of where the margin ended in the quarter, even though we know it's going to move around on us before the restatement. We are just trying to get an idea on an apples-to-apples comparison, at least for what we have, what we should expect going forward.

I think I understand what you're saying, Brian. So what you're asking is the average for the quarter was 6 1/2%, you are sort of trying to get a sense of --

Where it measures --

-- where the margins --

Yes, -- in June.

Yes, actually I don't have that information with me. All I can tell you is that it averaged 615 in Q1, it averaged 6.5 in Q2 and to get that kind of average in second half, it had to be somewhat higher.

Ramping throughout the ...

Right.

Yes.

Right, and probably in excess of 6.6, but I don't have the number in front of me. The other thing is that of course we had another increase on June 30th, and probably another increase in Q3 coming. So it is ramped very quickly.

The second question goes back to the restatements. You made comments that it will increase earnings in the equity accounts in the periods under restatement. What impact we it have on forward earnings? Is it now you're taking what the warrant gains that would have happened in future periods and putting it back into historical periods, correct? So we should see -- all else being equal, we would see earnings be lower going forward?

Well, first let me answer the first part of the question or respond to the first part of the question in that I want to make it clear that when we refer to higher stockholders equity, we use the words in aggregate. We don't yet know what it might -- what the impact in any given year will be but in the aggregate, ending period sort of Q2 2005, compared to what we previously would have reported, we expect stockholders' equity to be higher. And of course, we expect it to be higher in 2001, 2002, 2003 and 2004 compared to what we previously reported. So in aggregate we do expect it to be higher.

Going forward is a good question, and that will in part depend on where we end up on a valuation methodology. It will in part depend on the speed with which we add warrants and it will in part depend on the marketplace in terms of how we can exercise warrants. I don't yet have a firm estimate of what we expect the value of the warrant portfolio to be at the end of Q2 to answer your question well.

Okay. And just lastly on the expense front. Can you breakout the portion of expenses that's due to be restricted stock from switching the program from giving options to the restricted stock?

Sure. We estimate that restricted stock added about $1 million in Q2 compared to prior quarter.

And then how much was the extra from the higher warrant gains? Is that another $1million, roughly 20% of the warrant gains?

Yes, it was about -- as I recall, just the warrant gains alone piece was about $700,000.

OK, thanks guys.

Our next question comes from Charlotte Chamberlain, with Jeffries & Company.

Hi, and I must confess to a certain amount of confusion by this Rubik's Cube of an earnings release, so I hope you'll bear with me as I try to --

Hey Charlotte?

Yes?

Could you talk louder? I can't hear you.

Okay. I was just mumbling about the Rubik's Cube presentation of the earnings. I'm trying to find my way through. Can you hear me better now?

Sure.

Yes.

Okay. First of all, unless I'm missing something, there's no fully diluted share count and I'm kind of wondering, one, what is it? And two, why couldn't you reveal the fully diluted share count? I don't understand why the warrants would impact fully diluted share count.

The calculation of our fully diluted shares includes -- uses a tax rate calculation that we have yet to get because that tax rate will be affected by the ultimate calculation of net income.

For the ones of us to have to estimate this, is it reasonable to assume kind of rationally the basic shares last quarter to fully diluted, that since you've given us basic shares this quarter, that we'll be within the ballpark using the ratio from last quarter?

I don't think you'd be out of the ballpark, but be sure and include the repurchases we did in Q2.

Well, presumably -- isn't that in the basic share count?

Yes, you're right.

Okay. All right. Okay. And the restricted stock -- you had some restricted stock in the first quarter, so that was reflected in the first quarter as well, right?

No it was not.

Okay. And the gentleman before me said the restricted stock would add about $1 million to expenses.

Yes.

Okay, and the --

Let me be clear, Charlotte. We had an equity grant, a normal scheduled equity grant in April of - in the second quarter of 2005. And the portion that I'm referring to is related to that equity grant. We've had prior equity grants and there were some reflected in Q1 related to those.

Okay and --

And the portion related to the most recent equity grant was an additional $1 million. As we converted, most employees who were eligible from all options to a split between options and restricted stock units.

Okay. In the $66 million 280 that you did give us in total earnings just expensed is that extra $1 million kind of in there somehow?

Yes --

Or going to be in there somehow --

--in compensation and benefits.

Pardon? Oh, Okay. That's what I wanted to know. You know, if I have to add it or if it's already there. Okay, fine.

Yes, it's there.

Oh, as I understand it, the reason why you and the bank that's now Comerica valued warrants at a de minimus amount was basically due to the bank regulators to the Federal Reserve and the Office of Controller of the Currency. And I was just wondering have they gone along with this valuation? Because I know there was something in bank regulation that would not allow an equity component to the interest rate charge (inaudible) and I was wondering -- the main thing is are they on board with what you're doing?

Charlotte, this is Ken speaking and the answer to your question would be first of all yes, they are on board. Having said that, I don't believe that they have a specific opinion on this particular issue. And secondly, to the best of our knowledge, and we've been doing this for a long time now, the reason that we valued warrants that a de minimus level was -- had little, if anything, at all to do with banking regulation. It was done in the interest of conservatism.

Okay. I'm going from experience with Imperial Bank, when it was still around. But okay, the main thing is the bank regulators are on board and not likely to turn it all around again --

That's correct --.

Just two more things. You said that the cash received on the warrants were $5.6 million. Absent all these changes, is it reasonable to assume that the amounts -- that under GAAP it would have been pretty close to $5.6 million?

The way to respond to that, Charlotte, is previously -- or in past quarters, we would have reported something that looked a lot like our cash proceeds --

Oh.

-- in the GAAP statements.

OK. And then the final thing, you went a little fast for me, in terms of the guidance -- the balance sheet guidance and if you gave any spread guidance for the upcoming quarter. I know you said something about slower loan growth and then you just got too fast and I couldn't keep up.

Sorry. I actually said we expect stronger loan growth.

Oh, well, that's good to get clarified. Stronger loan growth, that's good. Okay.

Yes, that's worth noting. The Q1 loan growth was actually -- or excuse me, Q2 growth was -- gross loans was about 3.7% quarter-over-quarter, which is a 16% annualized rate, so we were very happy with our loan growth in Q2 and we are currently estimating somewhat stronger loan growth in Q3.

And what about deposits?

And deposits, we are currently thinking they will be up in Q3, but at a slower -- much slower rate.

And how much were they again? Up in Q2? Because you don't have any liabilities in this release, I don't think.

Deposits were -- let me think. They were down slightly in Q2, very, very slightly and it's on page -- it's in the press release.

Okay. And you're expecting that you're not going to get any big bump in deposits in the September quarter?

We're expecting deposits to grow somewhat. We're just continuing the same guidance we gave at the beginning of the year, which is we expect loans to grow nicely and deposits to grow more slowly.

Okay. And the final, kind of $64,000 question, when we put all this stuff together and see $36 million fully diluted, we got to about $0.65. Does that sound reasonable, assuming $36 million?

Well, I can't comment on the calculations, Charlotte. I just don't know what else is in it that you're using. So --

Well, I mean, just using the numbers that you gave, the net interest income after provisions was 72.5, non-interest income, including $5.6 million of warrants would have been 32.3. Total non-interest expense, 66.3, $190 million of minority, pre-taxed income of $388.6, income taxes of $15.3 for net income of $23.4 and 36 million shares.

Let me try to respond this way because for a variety of reasons we're reluctant to comment on the exact question. But we did attempt to give you -- be as transparent as possible in what we were able to release so you could do your best to reconstruct what you think the quarter might have yielded. So we're trying to be as transparent with what we can be. I'd rather not respond directly to your question other than that way.

Okay. Well, then just let me ask one other thing. Is $36 million for fully diluted, is that a reasonable number?

I don't -- my recollection is that fully diluted in Q1 was higher than that.

Yeah. It was about $39 million.

Yeah. I'm not sure how you're getting to $36 so quickly.

Okay. So it's -- all right. Okay. Well, we'll play with that. Okay. Thanks very much.

Our next question comes from Gary Townsend with FBR. Your line is open.

Good afternoon, fellows.

Hello, Gary.

Nice quarter.

Thank you.

This question's been asked. If -- maybe it would be helpful though, Jack, if you could just review what has been your methodology with respect to recognition of warrants.

Sure, Gary. Our approach has been that typically we get a warrant attached to, as a piece of -- I shouldn't say a piece of. We get a warrant and we usually have an accompanying loan with a company. In other words, we don't get warrants without a loan. We do have loans from time to time without warrants. But in the preponderance of Series A or early-stage companies, warrants and loans go together. They are part of the package.

We have typically treated the valuation of that warrant as $1, held it -- and of course, it doesn't really -- when it's $1, it doesn't matter what you do with it after that. Then if that warrant is monetized in some fashion, we will recognize it into income at the time of a merger and acquisition or IPO. So that's been our traditional treatment.

So here you're going back to the beginning. You're taking that $1. You're evaluating it under a Black-Scholes or some similar methodology. Then on a quarterly basis you are re-valuating that warrant and adding them all up.

Yes. The only -- you're close. One is Black-Scholes is -- we're looking at a modified options pricing framework, but Black-Scholes is I think good shorthand, if you will.

But with that said, we don't re-value the $1, we actually look at the underlying shares that are in the warrant. So some of our warrants might be for 10,000 shares, some warrants might be for 100,000 shares. And so they could legitimately have a different payoff characteristic. So we'll be valuing each of those.

The value for an individual warrant, based on our experience -- again, using historical data, is likely to be relatively small, but still greater than $1. Substantially greater than $1.

Fair enough. I think that's prettily clear, actually. Thanks very much.

You bet.

Our next question comes from Todd Hagerman with Fox-Pitt Kelton.

Good afternoon everybody.

Hey, Todd.

A couple questions. Jack, I was wondering if you could reconcile the deposit flow trends in the quarter. It looks -- my calculations were-- the end-of-period numbers look to be up quite a bit. Then the average balances, as you mentioned, came down a little bit for the quarter. Could you just reconcile that for me?

Well, end-of-period for us is always a unique time. We have a fair amount of activity both on the loan and on the deposit front. That activity can range from, oh, software companies trying to reduce their DSO count and using loans and/or commercial relationships with us in some fashion to do that. Or it could be related to fundings for venture capitalists and their investments. There's a whole host of things. And so we've actually tended to -- both on these calls and in our own thinking, tended to discount the end-of-period numbers somewhat because they're not necessarily representative of trends, at least with regard to the nominal amount of loan or deposit activity.

So on the loan front, I think you see the average gross loans growing 16% annualized. That, to us, represents a trend. What they did at the last day of the quarter absolutely could be an anomaly.

Similarly, average deposits were essentially flat for the quarter. What they do at the quarter end, I don't think is yet indicative for us to give you a good sense of other growth in Q3. But I can say that loans were definitely ahead of what we thought they would be for Q2.

No, I was speaking more in terms of the deposit flows and just wondering if maybe there was any unusual deposit activity at the end of the quarter that was skewing those numbers. Anything unusual that came through?

I can't -- We can't think of anything that might have done something on the last day that stands out from the normal activity that we see.

Okay. Thanks. And then just in terms of the restatement itself, you had mentioned that you had gone through with KPMG your SOX Compliance review in the early part of the year. That was a clean review. Any idea or potential that this restatement may trigger some sort of issue with the SEC as it relates to the restatement and your prior certification?

We don't think so because we believe it's a technical accounting issue and it's relatively small in its overall impact. But I -- Derek, would you like to speak to that?

Sure. This is Derek Witte. I'm the General Counsel here. We have talked about this with outside counsel because this is a technical accounting issue and, if anything, it increases our past stockholders' equity. We wouldn't expect this to draw any kind of attention from the SEC. Having said that, of course, one never knows.

And similarly, you wouldn't think it would have any impact on, for example, your treatment of the codes and how you interpret those accounting statements and so forth?

Codes?

I'm sorry. The treatment of the codes?

Right.

Oh, the cocos (ph)?

Yeah, the cocos, excuse me.

Oh.

Oh. No.

No.

It has no relationship.

Okay. That's helpful, thank you.

Our next question comes from Andrea Jao with Lehman Brothers.

Good afternoon, all.

Good afternoon.

First question, the income line items showed really good trends, but if my calculations are correct, operating revenues still grew a little slower than expenses. I know this has been the focus. Could you remind us what you're doing about this and over the next couple of quarters what we could expect in terms of operating leverage?

I'm sorry, Andrea, I might have misunderstood the question. What I heard was "the" income grew.

I was referring to positive operating leverage. Looks like operating revenues were -- grew about 7% link quarter while expenses grew 9.3%. I know this has been a focus for you. Could you remind us, again --

Sure.

-- and then what could we expect in coming quarters?

Sure. No, that's a good question. So a couple of things that I think are worth noting. When we went into the year, we had anticipated and given guidance on expenses -- well, we had anticipated the stock option expensing would be in effect the second half of the year. We also anticipated or gave guidance that said -- on expenses that did not reflect options expensing.

So one of the things that you're seeing happen here is that in April, still expecting that options expensing would be in place and because we thought it was the right thing to do in any event from a competition strategy standpoint, we implemented a broad-based restricted stock unit for option-eligible employees, knowing that that would start to hit our expenses in Q2 and Q3 and Q4 related to that RSU program. So we have about $1 million that are impacting our bottom line in Q2, and we'll also do that in Q3 and Q4, that we hadn't really anticipated or had -- and our guidance had not reflected that for good reason. We had given you guidance that was separate from equity-based compensation expense. So that's one item.

Number 2 item is we also indicated last quarter that we expected outside services, particularly in the professional services area, to be somewhat higher this year than we had originally thought due to responsiveness to the Sarbanes-Oxley filings in the IT arena. And so some of what you're seeing is exactly related to that, consistent with what we said last quarter.

Lastly, what you're seeing in the expense line is that the underlying performance of the bank is well ahead of expectations that we went into at the beginning -- well, in last late year. And I think that's even demonstrated by the financial community and the changes they've made in their target EPS for this year. And some of that better-than-expected performance is going back through performance-based programs in the -- performance-based variable compensation programs.

Lastly, and related, is that Aliant had a much better than expected quarter and, as you know, that's a fairly direct relationship between compensation expense and revenues at SVB Aliant. So you're seeing a lot of that. I think one way to think about it is in a sense we're easing into options expensing, where other companies may have to adopt a whole bunch of stuff all of a sudden through the -- we're easing into it a bit through the use of the restricted stock program this year.

Okay. How about this restatement? Will it add expenses materially? Can you tell at this point?

No, we can't tell at this point, but obviously there'll be some expenses related to the restatement. Now, we don't envision it being in the -- trying to put a ballpark on it, it's difficult for me to envision it being in excess -- having a seven-digit kind of number on it. It's going to have, I think a low, six-digit kind of number, but we'll see. We'll give you better information on that as we get closer to it.

But it's going to take a lot of work. We're going to do a fair amount of it internally. We'll do some of it with external help, but I don't have a good estimate at this time. In fact, we're having a little meeting tomorrow to help flesh that out.

Okay. If I may follow up with a question and kind of play devil's advocate. I know you mentioned earlier you need to look at each loan going back and you need to decide on the methodology. What are the other steps you need to take to make sure that you can complete the restatement by the August 9 deadline? And kind of what's your confidence that you can complete the restatement by the August 9 deadline?

What are the other steps? Let me answer that question first. We literally will have to match up every loan that we previously processed that had a warrant. We'll have to value that warrant. We'll have to calculate whether that -- how much life is still left in the loan and then amortize a portion of that warrant's value through that remaining life. These are fairly granular transactions, so each warrant's value is actually fairly -- in the big picture of things, is not a high-dollar number. But there's obviously lots of them. They all have to be processed.

We have to figure out, then, whether we have cancelled -- for those warrants that expire without value, we want to make sure that we've cancelled or allowed them to expire in the right quarters. While we think we've got that information, we have to go back and check and make sure that that information is absolutely audit-proof and accurate. And then we have to value new warrants as they come on each year that we added a new loan and the new warrant associated with it and, of course, amortize that over the loan period.

So those are just sort of a flavor for what has to be done. Again, each of these warrants is relatively small, but -- and some of them are up and some are down and there's a whole bunch of stuff that needs to sort itself through. But those are the calculations that we would be making.

Then we have to go back -- then we also have to go and basically walk through our 10-K and make sure that in every element of the 10-K or every section of the 10-K we properly incorporated this change. So that will take some time.

And then lastly, we have to have KPMG audit this whole process and that'll take some time. We're going to work really hard. We are going to throw a lot of bodies at it, both internally and externally, to get it done in time. But it's -- at this point, it's a bit of a toss-up whether we'll make that date. But we are going to work pretty hard to do our best to get there.

Great. Thank you.

Our next question comes from John Pancari with JP Morgan.

Good afternoon, guys.

Good afternoon.

Just a question around the restatement. Could the change in the treatment here on the accounting basis for the warrants, could that really influence your use of warrants here and your decision to take these as part of the relationships with your clients? I mean, could you possibly pare down these warrants as a result of this if volatility picks up or anything?

Absolutely not.

Okay. Could it possibly influence you to put on some type of -- any type of market hedge against them or any other way to minimize any kind of volatility that could come through?

This is Ken again, speaking. I would not anticipate that that would be the case.

Okay. All right. And one other question aside from the restatement, actually - actually, no, I do have one more question on the restatement. Could the disclosure requirements around the warrants change as a result of this? In other words, would you be required to break out the warrants that you have in the fair market value? And if so, could that impact the competitiveness of the bank, just kind of disclosing some of the relationships you have?

No, we don't see that. We're going to be looking at our financial presentation, trying to determine what -- I'll say combination -- of financial presentation provides the most transparency for investors to make good decisions but does not jeopardize some sort of competitive side of these. But I don't see -- we just -- it's difficult to see anything like you're suggesting happening.

Okay. All right. And then one last question aside from that. Do you have the amount of non-dollar denominated loans on the books, I guess -- or the dollar equivalent or so at the end of the quarter, just point to the Euro and British pound loans that you've pointed out in the press release?

That's a great question for Dave Jones. He's here.

All right. John, this is Dave Jones. In terms of loans valued in other than dollars, it's something less than $10 million today.

Okay. How does that differ from -- how did that change from last quarter? Or from March 31st?

I think it is roughly flat with March 31st.

Okay. Great. Thank you.

Our last question comes from Fred Cannon with KBW. Your line is open, sir.

Thanks and good afternoon. Sorry to belabor the point on your restatement. Jack, just a quick question. You said it was due to FAS 133, which I always view as a hedge accounting issue and I was curious why FAS 133 would be applied to warrants.

Well, it's a good question, Fred, and I encourage you to take a look at Dig A17 (ph) and you'll see it.

Okay. Lucky me.

Yes.

Secondly, you laid out well how you're revaluing the warrants going back. Could you tell us how this affects interest income?

Yes. It will likely increase interest income -- no, almost -- it will increase income, I shouldn't say likely. It will increase interest income. The accounting that we are -- the accounting approach will be to flow through interest income as a loan fee amortization, the original issuance value that we calculate for a warrant. Any subsequent changes to the warrant's value will be flowed through non-interest income.

Okay. So it'll affect both. Then on -- you stated earlier on that this would increase your capital levels. Will it positively affect regulatory capital as well as stated capital levels?

Yes.

Okay. That's why, in part, you would be able to repurchase more shares in light of that?

Correct.

Oh, and then finally, I noticed you did take a credit reserve this quarter, but you also had a recovery of the unfunded credit commitment. So should I think of that as -- if historically, before you split those out, that you were basically kind of a wash for the quarter in terms of provision for credit losses as part of the regular loan loss provision and then a backing out of the provision for unfunded credit?

The appropriate approach to achieve what you're trying to achieve would be to net both of them and you'll find that it was a slight negative.

Okay. Great. Great trends in the quarter, so congratulations on the business trends.

Thanks.

Thanks, Fred.

There are no further questions at this time.

Thank you for joining us today. We'll talk to you next quarter.

Thank you for joining today's conference call. We will now conclude.