SVB Financial Group (SIVB) 2005 Q4 法說會逐字稿

Good day. All sites are now online in a listen-only mode. (OPERATOR INSTRUCTIONS) Please note today's call is being recorded. At this time I'd like turn it over to your speaker, Ms. Lisa Bertolet. Ms. Bertolet, you may begin.

Thank you, and welcome to the SVB Financial Group Fourth Quarter and Year-End 2005 Conference Call. Today, Ken Wilcox, our President and Chief Executive Officer, and Jack Jenkins-Stark, our Chief Financial Officer, will present prepared comments. Following their presentation, Ken and Jack, along with Marc Verissimo, our Chief Risk Management Officer, and Dave Jones, our Chief Credit Officer, will be available to answer your questions.

I'd like to start the meeting by reading a safe harbor disclosure. This presentation may contain projections and other forward-looking statements regarding the future events, the future financial performance of the Company, and impact of our prior restatement. 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 December 30, 2005, which contain and identify 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 -- I'm sorry. I will turn the call over to Ken now.

Thank you, Lisa, and thank all of you for joining us today. Last year at this time we outlined our efforts to build an innovative global financial services company, capable of helping entrepreneurial companies succeed at every stage of their life cycles. We also emphasized the steps we would take to leverage this organization to deliver revenues and results in the current market. As I look back on 2005, I am proud not only of the fact that we delivered the results we promised, but of the way in which we delivered them.

We've had another strong year with four successive quarters of record high loan balances, outstanding returns on our loan portfolio, stable deposits, strong credit quality, and accelerating growth in our non-banking businesses. We are making meaningful progress on the business initiatives behind our strategy from globalization to expanding our product set.

Our core businesses, Silicon Valley Bank, SVB Global, SVB Alliant, and SVB Capital are all performing according to our expectations, and our management team, many of whom were new to the Company at this time last year, have found its collective stride. We are executing according to plan in every facet of our business. We have achieved this level of performance and retained our positive momentum despite the time and resource consuming restatement process that has dominated any conversation about the Company in the last six months. I attribute our ability to deliver such outstanding results under such enormous pressure to three factors: First, our talented and dedicated team of employees. Their efforts and focus have allowed us to perform under circumstances that might have derailed or at least distracted other companies.

Second, the interest rate environment helped, too. After four years of declining interest rates, we have benefited, of course, from a 325 basis point increase in the federal funds rate since June 2004.

Finally, the third factor and perhaps the most important, with our persistent adherence to the strategy we have pursued for the past five years, this strategy, which I hope has become firmly cemented in your minds, is to focus on Technology, Life Science, Private Equity and Premium Line to expand our product set to meet the needs of companies at all stages, to be global, and to extend our reach to include smaller and larger companies. Through good times and bad, our results are proving that this strategy is a good one.

As part of this strategy in 2005, we strengthened our existing client relationships through cross-selling and the creation of new products, while targeting and winning new clients within our chosen niches. These efforts resulted in the loan growth I mentioned particularly among our clients in the Private Equity hardware and software spaces.

We enjoyed a rise in fees from our global products and services in part because of the growing activity in global markets. Through SVB Global, we broadened our international reach opening an office in Shanghai in December. SVB Global, which also includes subsidiaries in the London and Bangalore, India, continues to provide a gateway for our U.S. clients who want to establish business connections in global markets. Conversely, it provides a means for SVB Financial Group to connect with valuable business partners in these burgeoning markets.

As we strengthen our international networks, we are also looking for ways to bring our current products and services to global market. For instance, lending in the UK, which we accomplished through our Boston office. Together, these efforts allow us to further leverage our international networks to help our clients succeed.

Our strategy also led to a decision to change our name this past year. In April 2005, we became SVB Financial Group, a change intended, in part, to reflect our evolution as a company and increasingly the first set of offerings we've developed to meet our clients' needs. We're pleased with the momentum we've seen in the complementary business lines we've focused on building as part of our diversification. Our investment banking arm, SVB Alliant, has enjoyed increased volume and had a very strong fourth quarter as a result. SVB Alliant continues to meet our expectations and is proving to be a valuable complement to our commercial banking services.

SVB Capital, which constitutes our funds management and private equity groups continues to provide valuable connections with the venture capital community that facilitate our client relationships and allow us to be the best at what we do. In 2005, SVB Capital extended its family of funds closing a second family of funds in the first Gold Hill Venture Debt Fund.

In short, we have more expertise and greater reach than we've ever had before. We're also getting better at understanding what complementary products will meet our clients' needs and providing those products to them.

Our goals for 2006 are focused on continuing to build our momentum and leverage what we've built to deliver value to our clients and shareholders. They include the development of new products and services to enhance our current offerings; the extension of our existing products and services to global markets; continued improvement of the processes and systems underlying our business in order to improve our effectiveness and to increase client satisfaction and retention, enhancement of our ability to recruit, train, develop and retain the best people; continued implementation of processes and systems required for our legal regulatory compliance and enterprise risk management efforts; and, of course, continued evaluation of potential avenues for new business development. Our success in achieving these goals will rely on the contributions of our talented employees for whose efforts this year I am tremendously grateful. The team we have here at SVB Financial Group today is the best that we have ever had. They've allowed us to perform well and consistently quarter after quarter regardless of booms, busts and restatements. I am certain their contributions will continue to be a defining factor in our success in 2006 and beyond.

Now, I'd like to turn the call over to our CFO, Jack Jenkins-Stark, who will give us some details on our performance for the quarter and for the year. Thank you very much.

Thank you Ken, and thank you all for joining us today. It has been a good quarter despite the prodigious efforts required to complete our restatement, which could have taken us off course in terms of execution. We have delivered outstanding results. And, too, to disappoint those who bet against us, and we know you are, we actually have numbers to report today, and for that I'm very proud.

Let me begin, as usual, with a few highlights. For the year and the quarter, we achieved outstanding loan growth and significant improvements in EPS, net income, debt interest margin, and net interest income. Second, we maintained our high credit quality once again in 2005. And, third, while the statement had a substantial impact on expenses, outside of restatement costs and costs associated with the increased use of restricted stock in lieu of options in 2005, we effectively met the target we set for ourselves early in last year. With that said, let me get into some specifics.

Earnings per share rose 11.7% in the fourth quarter to $0.67. That's an increase of over 24% from the same quarter last year. For the year, EPS rose over 41% to $2.40, compared to $1.70 a year ago. Net income rose by 10.8% in the fourth quarter to 25.6 million, a more than 23% increase over the same quarter last year. Net income for the year was up nearly 45% to $92.5 million. These numbers reflect $4 million of pre-tax restatement costs in the fourth quarter, and approximate 5 million for the year.

Net interest margin increased to 6.78% in the fourth quarter of 2005, from 6.54% in the third quarter. For the year, net interest margin increased to 6.46% from 5.38% in 2004. These improvements were primarily driven by an increasing yield on interest earning assets as a result of our continued strong loan growth and higher interest rates. Quarterly average loans reached a new record high of 2.6 billion in the fourth quarter of 2005, a rise of 5.8%, or almost 142 million over the third quarter.

For the year, average of loans were up to 2.4 billion, a rise of 20% from 2004. This growth in loans helped to increase net interest income by 3.3 million in the fourth quarter of 2005 to 81 million. This represents an increase of more than 20% from the same quarter last year. For the year, net interest income increased by almost 70 million, or 30%, to 299 million compared to 229 million in 2004.

Increases in short-term interest rates positively affected the yield on our loan portfolio in the fourth quarter bringing it to 9.6% from 9.36% in the third quarter. For the year, yield on our loan portfolio rose to 9.26% compared to 8.08% in 2004.

As you know, the way we report warrant income has fundamentally changed and it now shows up in several places on the income statement. A portion of our warrant income is reflected in loan yield, which included 1.3 million from warrant loan fees in the fourth quarter compared to 1.4 million in the third quarter of 2005.

Another part of warrant income shows up in derivative equity warrant assets in which we realized a net gain of 2.7 million in the fourth quarter compared to 1.8 million loss in the third quarter.

The final portion of warrant income is recorded in investment securities related to the sale of equity securities from the exercise of warrants. We realized a small gain on these investment securities in the fourth quarter of about $100,000. As an aside, proceeds from warrants in the fourth quarter and for the year ended 2005 totaled 1.6 million and 11 million, respectively. And from a proceeds standpoint, 2005 represented the third highest year ever.

As we predicted, there was a little change in quarterly average deposits, which were 4.1 billion in the fourth quarter of 2005, compared to 4.2 billion in the third quarter, and 4.1 billion in the fourth quarter of 2004. For the year ended December 31, 2005, average deposits were up 6.7% to 4.2 billion.

We achieved very strong growth in client investment fees, which were 9.4 million in the fourth quarter, an 8% increase from the third quarter, and a 28% increase over the fourth quarter of 2004. For the year, fee revenues were up 24% to over $33 million compared to just under 27 million in 2004. Total client investment funds and deposits reached another record high of 19.2 billion in the fourth quarter of 2005, up from 18.1 billion in the third quarter, and up from 15.5 billion in the fourth quarter of 2004.

Corporate finance fees from our investment bank, SVB Alliant, were on track with our expectations in the fourth quarter 2005 at 7.3 million. That's an increase of 4.3 million over the third quarter, and thanks to a higher number of completed transactions.

The 2005 corporate finance fees of 22.1 million were also consistent with our expectations and with what we achieved in 2004.

Credit quality continues to be a strong area for the Company. Nonperforming loans for the fourth quarter of 2005 were 0.26% of total gross loans, down from 0.51% in the third quarter , and down from 0.64% for the fourth quarter of 2004. We experienced nominal net recoveries in the fourth quarter, up 0.1 million, reflecting gross recoveries of 2 million, and gross charge-offs of 1.9 million. This is an improvement from the third quarter of 2005, in which we experienced debt charge-offs of 3 million, and from the fourth quarter of 2004, in which net charge-offs were 2.4 million.

Owing to higher loan balances, the Company recorded a provision for loan losses of 1.8 million in the fourth quarter of 2005, compared to 1.4 million in the third quarter of 2005.

Moving on to expenses. Cost for professional services associated with the restatement total 4 million in the fourth quarter of 2005, and approximate 5 million for the year. Costs associated with the increased use of restricted stock in lieu of stock options were approximate 2.5 million. As I mentioned earlier, excluding those two items, non-interest expense rose less than 5% for the year, thanks to our ongoing focus on reducing discretionary spending.

Looking ahead to the first quarter of 2006, we expect earnings to be between $0.57 and $0.63 per diluted common share. This outlook assumes an increase of 25 basis points in the federal funds rate during the quarter. A provision for loan loss is somewhat lower than in the fourth quarter, and higher non-interest expenses due to higher compensation costs associated with the implementation of options expensing in 2006 offset somewhat by lower professional services and compliance costs compared to the fourth quarter. We also expect lower loan growth in the first quarter than in the fourth quarter, and lower non-interest income related to corporate finance fees and derivative gain.

For 2006, we expect average loans to grow somewhat more slowly, deposits to be relatively flat, non-interest income to increase faster, a higher provision for loan losses, and non-interest expenses to be higher than in 2005, with a significant portion of that increase due to stock options expensing.

In closing, we feel very good about the quarter and the year we've had. We've shown meaningful improvement on all fronts, and our strategic and operational efforts appear to be paying off. We are enormously proud of what we achieved this year, especially given the amount of time and attention required by the restatement. We continue to focus and deliver and our results speak for themselves. With that said, I know I'm not the only one who is relieved to be facing a new year, one in which we'll be able to focus 100% on achieving our business goals. Thank you.

Now we'd like to open it up for questions, please.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from Fred Cannon of KBW. Go ahead, please.

Thanks, and congratulations both on a very strong result, and also on having a full press release. I wanted to talk about the funding and deposit mix, particularly, Jack, in terms of what's going on in terms of the balance sheet on funding. While you mentioned that deposit growth has been relatively slow overall, I note that the funds that you are managing, I think, were up about 8% linked quarter, off balance sheet, and also your demand deposits were up about 4% linked quarter, non-interest bearing, while the interest bearing accounts were basically down. So, it looks like there's a positive mix shift that is going on in terms of your deposit funding base. Also, I noted that the cost of the yield on all the deposit -- the interest-bearing deposits I don't think even really increased linked quarter despite higher rates. So, I was wondering as you talk both -- is there an ongoing focus of that mix shift? In other words, are you guys focused on allowing some of the non-interest -- I mean, the interest-bearing numbers to run off, at the same time continuing to improve the mix with non-interest bearing? Also, when you talk about flat deposits in 2006, can we expect this positive mix shift to continue to occur?

Well, you've captured it well, and I think the answer is yes and yes, if I remember the questions correctly. We do expect that mix shift to continue, i.e., loans to grow more quickly than deposits, and clearly interest-bearing deposits are going to be a much -- are going to continue to be a much smaller fraction of our total deposit base. We do expect that interest rate sensitive customers will continue to see our off balance sheet option as an attractive one going forward as we add customers and we add funds under management.

The only place where the positive mix shift is a little mixed, I guess, in it's impact is that we are using short-term borrowings to fund some of that very significant loan growth we had in 2005 and, as a result, as you probably notice, we had other borrowings that averaged a higher number than in Q4 than they did in Q3, as we continue to do that.

That was the repos, right?

Yes.

Okay. Now, so you're okay doing that and just keeping those deposit rates low, even if the deposits run off a bit in the interest bearing, things like --

Yes.

Okay. One other quick question. The 4 million in expenses, did those go through a couple of different -- in terms of the restatement, did those go through a couple different line items, and do you expect more expense in the first quarter from these?

The bulk of them would have gone through Professional Services. Obviously, the bulk of the restatement costs, or a substantial portion of the restatement costs are related to external audit services, and then the other major element is internal consulting or contractors that we hired. Some higher compensation expense due to overtime or contractors that were included in our compensation expense line, but the bulk of it would have gone through professional services.

Great. Thanks.

You're welcome.

Thank you. Our next question comes from Joe Morford at RBC Capital Markets. Go ahead, please.

Thanks. Good afternoon, everyone. I guess first as a follow-up to a couple of Fred's questions. On the deposit mix shift, at least on an end of period basis, the money market funds in particular were down quite a bit, I think maybe 25%, or 300 million. Was there something specific that happened that triggered that movement, and I guess, were you encouraging some of that money to go off balance sheet, or why a more dramatic move than we've seen in the last several quarters?

I guess the answer is, it wasn't unexpected from a period end. I think we had more -- we might have had more quarterly window dressing going on in Q3 than we had in Q4. That might have caused some of that major trail off, Joe. Beyond that, I don't have really a ready explanation.

Okay, that's fine. And then in the comp line, Jack, how much in there would be associated with the higher Alliant revenues this quarter? What would the commission thing there be?

A good rule of thumb would be to sort of take the change in revenue and take half of that.

Okay.

That's a good approximation.

Okay, fair enough. And then, I guess, any comments on the Alliant pipeline at this point?

Nothing -- I would just say what we've said before, which is that the market for this -- that Alliant targets, the M&A activity in that market was very strong in 2005, and we don't see that changing in 2006.

Okay. And then I guess last thing, maybe a question for Dave, if he's there. Just the last couple of quarters we have seen some acceleration in loan growth, particularly strong rates. Any color as to what's driving that, and any color on the mix that's happening whether by niches or by product?

Joe, this is Dave. I will at least start to answer that question. The growth that we experienced both for 2005 and also in the fourth quarter of 2005 was largely an expansion of business in the software niche followed by growth, across-the-board hardware, private equity, a little bit of growth in premium [inaudible] in the fourth quarter. What I think is behind the general growth would be two things: One, we're seeing good volumes in the early stage, so the first round [inaudible] Company from the VC market is increasing their appetite for data increasing. They're drawing down on the facilities. Additionally consistent with Jack's comments about the M&A market, and our initiatives in support of our client companies and private equity market is the opportunity to fund both on the private equity side, where we are seeing larger draws on the capital call facilities, and second, where we're seeing some opportunity with middle and later stage companies that are in an M&A environment and borrowing modestly to support the acquisitions.

Okay, great. Appreciate the color.

Thank you. Our next question comes from John Pancari from JP Morgan. Go ahead, please.

Hi, guys, good quarter. I just wanted to see if I can get a little bit more color just on the year outlook and I guess your current assessment of the VC environment right now in terms of the private equity flows and I guess just your assessment of the health of the flows, if they continue to remain, you know, pretty stable, and what your outlook will be going into '06?

This is Marc Verissimo. Both the amount of money raised by the venture capital firms and also the money put to work or invested in companies in 2005 were four-year highs, so we hadn't seen numbers like that since 2001. And you saw them right in a fairly stable manner, so you're not seeing it go up like a rocket ship, like you did during 1999 and 2000, which the industry views as positive, so the money is being metered in at an appropriate rate. If you look forward to 2006, you see some indication -- you saw it during 2005 and hopefully to continue in 2006, that investments in early stage companies will continue to go up, so the number of companies getting money. There have been a lot of new funds raised during the year, because we did have a record year, and so that money needs to be put to work. They do see -- unless the IPO market improves substantially, that you'll continue to see a fair amount of money go into the later stage companies. So, basically, these companies are being funded longer by the venture investors than before. So all in all, it still seems like there is more demand than supply, meaning more money wants to get into the venture capital sector than there are funds and ability to be put to work, so that's good. But on the other side, you're seeing venture capital funds be more disciplined than they have been in the past at putting the money out and the size of funds they raised. They're going to get very disciplined by keeping their fund sizes where they want them to be rather than just taking all the money that comes in. Right now we see a healthy market and we would, you know, look to say maybe we see anywhere from a 10 to 15 increase in 2006.

Great. That's helpful. Thank you. And on a separate topic, just on the margin. Jack, do you have the quarterly -- or, I'm sorry, the monthly margin numbers for the fourth quarter?

No, I don't have them with me, but clearly it's higher than it was for the average for the quarter. In fact, I would say, you know, we're getting to that mythical 7% number shortly, in the near future.

Okay. Great. Thank you.

Thank you. Our next question comes from [Kathy Steinberger] from [Lesley Securities]. Go ahead, please.

Good morning -- sorry, good afternoon. Can you talk a little bit about the global franchise, the potential office opening in Israel. You had mentioned the income, letters of credit was doing pretty well. Can you expand on that a little bit more?

Can you say that last part a little louder, please, Kathy? I couldn't hear you.

I asked if you could expand on the global franchise, the letter of credit fee income. I think it was mentioned on the call, that that was up nicely. Can you provide additional details in that area?

Sure. Let me answer both questions, because those are actually in some sense two separate questions. It's entirely possible that the increased level of letter of credit activity would have been there possibly, at least, even without our attempts to build a global franchise simply because, as you know, we're dealing with -- primarily with technology companies. Ninety percent of our business falls into that category, and technology companies export from the get-go. As soon as they begin shipping product, they're shipping product overseas, and there has been, as you well know, a fairly sizable increase in the level of exports at least in technology in these past few years. So that might have taken place even without our attempt to build a more significant global franchise.

With respect to your question about the global franchise, in these past five years or so, in our estimation, the world of venture-backed technology in life sciences companies has become a global market as opposed to one which was arguably up until the end of the 1990s, concentrated primarily in the United States. So, today -- and when I say global, what I mean is that there are now significant pockets of ventured capital activity springing up in a multitude of markets around the world, most notably in the UK, in the so-called Thames Valley market, in Bangalore, but in other places in India as well; in Shanghai, but in many other places in China as well; and certainly throughout Israel, to name the most significant ones, and then others in other places in the world, as well. And increasingly venture-backed companies are, themselves, in terms of their very makeup international from not just first product shipment, but from inception, meaning increasingly we're seeing companies that have capital from one continent, management teams from another, technology from a third, and possibly themselves are located in a fourth. The result of that is that to become global would be to become irrelevant over time. Having said that, we're proceeding, I think, very cautiously, step-by-step. We're, I think, determined and we'll continue relentlessly, but always incrementally, and that's what you're seeing take place here now. Our office in Shanghai was opened, as we said before, in December, completing the initial set of four: London, Shanghai, -- completing an initial set of three, I should say -- London, Shanghai, and Bangalore. And you can expect us to continue to expand our global franchise in small steps over time.

Thanks. That's a very thorough answer. Thank you very much. The second question on a different topic. I think it was mentioned, also, earlier that the rising interest rate environment has helped your financials. I'm wondering what your thoughts would be in the second half of '06, if interest rates were to stop increasing, what impact that would have?

Well, as we look forward in the guidance that will be provided both for Q1 and for the general guidance we provided for 2006, we really expect only one interest rate increase to occur, one additional 25 basis point increase to occur in first quarter of the year. Beyond that, we're not planning on additional rate increases. We are planning, of course, to grow loan volumes, fee incomes, and all the other things. Clearly, since approximately 75% of our lending activity is prime-based lending activity, as the fed funds rate stabilizes, that loan yield will tend to stabilize as well.

My last question, if you have this number, for fourth quarter earnings, if you included options expense, what would the earnings per share have been?

Actually, we have not made that calculation yet. It will be in our 10-K, but I think for Q4, it would not be unreasonable to use a number that's close to the number that we showed on Q3 in our 10-Q.

Great. Thank you.

And that includes both options expense, I believe, and ESPP.

Okay. Thank you very much.

Employee stock purchase plan.

Thank you. Our next question comes from Andrea Jao of Lehman Brothers. Go ahead, please.

Asked and answered, thank you.

I like that question, Andrea.

Thank you. Our next question comes from Gary Townsend of FBR. Go ahead, please.

Good afternoon. My question has also been answered. Thanks very much.

Thank you. We have a follow-up question at this time from Fred Cannon of KBW. Go ahead, please.

Well, I do have a question, follow-up. On the capital management, you announced a fairly significant increase in the authorizations. Kind of two-fold: One is, do you have any further thoughts in terms of capital ratios where you think, you know, might be trending? I know, Jack, you said on the conference call when you restated, that prior to the restatement you felt you had excess capital and that would even increase down, so I was wondering if you had any more guidance in terms of capital ratios, number one. And number two, as I wonder within this authorization, would there be any way to affect the CoCo in the related warrant in terms of a potential repurchase or reduction in that capital structure?

Speaking to the first question, everything I said at December 30 was it, is still in place today, that we thought we had excess capital, or more capital than we needed to support the business going forward, and I think that's obviously still the case. And we did request additional authorization from the board.

As far as a target goes, our target -- while we recognize the substantial differences in many respects of our business model, our target is for -- capital ratios will tend toward a broad-based peer group, and so we'll let you choose your own broad-based peer group. We have ours, but we'll tend toward that broad-based peer group over time.

The third had to do with using any sort of additional repurchase authority on the warrants or the CoCos. At this point, we don't anticipate that, but, of course, we'll always evaluate what makes most economic sense, but at this point we haven't -- we don't really have any plans to deal with the CoCos or the warrants, for that matter.

Great. Thanks.

Thank you. At this time we have an opportunity for one more question. (OPERATOR INSTRUCTIONS) At this time it appears we have no further questions. We'd like to thank you for joining us on our call today. If you would like to listen to a replay of today's 4th quarter earnings, you may simply call 888-566-0884. Again, we thank you for joining. This concludes today's conference. You may disconnect your lines at any time.