SVB Financial Group (SIVB) 2006 Q4 法說會逐字稿

Good afternoon. My name is Matthew, and I'll be your conference operator today. At this time, I would like to welcome everyone to the SVB Financial Group's fourth quarter and year-end conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [OPERATOR INSTRUCTIONS] Thank you. I would now like to turn the call over to the Investor Relations Officer, Lisa Bertolet. Ma'am, you may begin.

Thank you. Today, Ken Wilcox, our President and CEO, and Jack Jenkins-Stark, our Chief Financial Officer, will discuss SVB's fourth quarter and year-end performance and financial results. Following this presentation, Ken and Jack, along with Marc Verissimo, our Chief Strategy Officer, and Dave Jones, our Chief Credit Officer, will be available to answer 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 2007. Forward-looking statements are just statements that are not historical facts. Such statements are just predictions and actual events or results may differ materially. 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-Q. Now I'd like to turn the call over to Ken Wilcox.

Thank you, Lisa. This has been a tremendously successful year for us. We've laid the foundation for future growth while delivering outstanding results. I'm immensely proud of what we've done this year in so many different regards. I'd like to tell you about our many accomplishments and investments in 2006, which can be organized into the following categories. Governance and control, systems and processes, people and organizational structure, new products and new businesses, clients and market share, financial results and strategic planning.

First, on the governance and control front, we enjoy the benefits of having an excellent and really world-class board. They are determined to remain on cutting edge of thought and practice in corporate governance. Under the guidance of this board, we've made significant advances in and enhancements to effective compliance risk management, compliance with the Bank Secrecy Act, and development of our internal audit function, and our enterprise-wide risk management framework. We've also made some notable improvements to our accounting processes and controls. Specifically, we created and filled a number of critical senior and expert positions on our accounting team, we established a dedicated derivatives team and developed key controls, policies and procedures for handling warrants, and finally, we developed new procedures for ongoing GAAP and SEC assessment of our accounting practices and formalized GAAP and SEC training for employees. We've made great strides in systems and infrastructure in 2006 and have taken significant steps toward greater integration of IT into our business planning and processes. We've automated many of our H.R. systems, including those for managing compensation, recruiting, and our contingent work force.

In the business units, we refined the workflow automation system we use to handle some aspects of credit authorization. We continued to add functionality and expand client access to our state-of-the-art online banking system, SVBeConnect. This system gives our clients efficient and secure access to our products and services via the web. We began implementation of our most advanced customer relationship management system to date to better monitor client service and support, and on the finance front, we implemented numerous systems and processes that offer better management, control, and documentation of our finances, including systems for financial certification, fee amortization, warrant management, profitability reporting, general ledger, and vendor management. In terms of IT backbone we've made significant -- we have significantly enhanced our systems for business continuity management and global network connectivity. And finally, in 2006, we built a duplicate data center in Salt Lake City, which will enable us to resume operations in the event of a business disruption. In particular, a natural disaster in Northern California. We also established an IT development resource in Bangalor which significantly enhances our capabilities.

With respect to people and organizational structure, we filled a number of very important positions this year. We have a new highly-skilled and experienced General Counsel, a new Head of Internal Audit, a new Head of Compliance and BSA, a new Director of Accounting and Financial Reporting, and several new senior commercial bankers, investment bankers and funds managers. Our reputation is a powerful tool for attracting such exceptional and accomplished employees, and I should mention that we were once again recognized as one of the best places to work in the Bay Area of Northern California. We conducted an employee opinion survey in 2006 to assess our status for ourselves, the first such survey in a number of years. We received very high marks from our employees, especially in the area of loyalty to the company, as well as respect for management and management's commitment to ethical behavior. We believe it's important to invest in our employees and to that end we introduced a variety of new training programs in 2006. These included sales and sales management, leadership, project management, accounting, and compliance risk management.

We also realigned our entire commercial banking organization in order to make it more effective and more efficient. As part of this effort, we established new teams devoted to sales origination in order to drive customer growth. We also reorganized our business development function to enhance cross-selling.

Moving on to new products and growing businesses, we built a brand-new business, SVB Analytics, to provide valuation services to private companies. We also acquired a majority interest in a complementary business, eProsper, which offers capitalization table management services primarily to earlier stage companies. We expanded our vendor exchange program through which we hope early stage companies find appropriate sources of capital. We grew our family of funds by over $300 million this year, and it is now in excess of $1 billion. And we began to build a team to address the unique needs of companies funded by private equity firms, in addition to the venture capital funds that had been our mainstay.

We have been successful at retaining our current clients and winning new ones. In the face of a growing market and increased competition, we maintained our market share in early stage companies, which of course have been our historical emphasis and our lifeblood. We also brought into our portfolio a number of new and larger client relationships with companies whose sales are in the hundreds of millions of dollars. And we added a number of new relationships in the venture and private equity communities, and expanded our limited partner base in the funds business. These efforts are all very significant to us, but of course they are only as good as the results they yield.

Our results in 2006 were really excellent. We experienced loan growth in excess of 20%. Total client funds and deposits grew nearly 20%, as a result of increases in our off-balance sheet investment funds associated with our broker dealer. Our net interest margin remained very high coming in at a healthy 7.38%. And we concluded our year with EPS at $2.38 and ROE at 15.2%. I'm very proud of these results.

Before I turn the call over to Jack for some details on those results, I want to address one more topic, and that is strategic planning. In 2006, we made a deeper dive into strategic planning than we normally do. And out of that effort came three primary directives and themes for 2007. The first is organizational performance improvement. We believe that we can become significantly more effective in the next few years by focusing on rationalization of our business processes, and other measures that can help us become more cost-efficient. The second theme is private equity. We are intensifying our focus on private equity firms, building relationships and capabilities that resemble our successful model with venture capital firms and their portfolio companies. We believe this intensification will provide us with significant opportunities for growth. Our third theme for 2007 is focus on our globalization efforts. We will continue to expand our activities globally in a consistent and thoughtful manner. To facilitate this process, we'll continue to leverage our network and the entire SVB Financial Group platform to offer our clients the global expertise and capabilities that they need to be successful in the global economy.

Let me wrap up by saying that I'm very pleased with our many accomplishments in this past year. I know the improvements and investments we've made have strengthened our foundation. I believe that they will improve our likelihood of success as we pursue our strategy in 2007 and beyond. Our financial success only adds to my confidence, and I have every reason to believe that 2007 will be the first of many more positive and exciting years for us. Thank you, and now I'd like to turn it over to our CFO, Jack Jenkins-Stark.

Thanks, Ken. Well, it was a terrific fourth quarter and a solid 2006. Before getting into the details, let's hit a few highlights. For the quarter, earnings per share at $0.77 were better than we had anticipated. Net interest income improved for the 13th quarter running. Loan growth was outstanding with quarterly average loans exceeding $3 billion for the first time in our history. Our net interest margin rose to 7.5%, an altitude requiring oxygen masks for many, and noninterest income grew to 45 -- nearly $46 million, reflecting the strength of our core businesses and the dynamic nature of the markets we serve. Looking at the year, earnings per share for 2006 were $2.38 down $0.02 from 2005. This number, as you know, reflects a net of tax charge of $10.4 million due to the impairment of goodwill which we recorded in the second quarter of 2006, as well as the impact of a full year of equity compensation expense. Net interest income was up almost 18% in 2006, versus 2005. We had terrific loan growth, as Ken, said with average loans growing in excess of 20% and our NIM averaged 7.38% for the full year. Noninterest income grew at a 20% clip as well.

Throughout the fourth quarter and the entire career we maintained strong credit quality. All in all, a solid 2006. Now, let's get into some of the details. In the fourth quarter, our period end assets exceeded $6 billion for the first time in our history, rising 2.9% from the third quarter and 9% from the same period in 2005. This increase is attributable primarily to our excellent loan growth. Quarterly average loan balances passed to $3 billion mark for the first time, totaling $3.15 billion during the fourth quarter of 2006 -- an increase of 6% over the third quarter of 2006. Our technology and life science clients were the primary drivers of that quarterly growth.

You may recall my statement in October that we appeared to be on track for a fourth consecutive year of loan growth in excess of 20% and we did indeed hit that mark. Average loans outstanding for the year grew 22% over 2005 to $2.9 billion. Average deposits were flat from the third to the fourth quarter of 2006 at $3.8 billion, although noninterest bearing deposits were unexpectedly higher owing to some new clients and an increase in year-end activity. For the year, average deposits were down from -- about 6% from 2005 levels. Higher loan volumes resulted in a rise in net interest income of nearly 4% to $93 million over the third quarter. For the year, net interest income rose 18% to $353 million. Income from the loan portfolio rose 7% to $84 million over the third quarter of 2006, reflecting a yield of 10.57%, comparable to that for the third quarter. For the year, income from our loan portfolio increased by 36%, or nearly $80 million over 2005 to almost $300 million -- a yield of 10.37%. That yearly rate reflects the impact of four 25 basis-point increases in the Fed Fund's target rate during 2006. Interest income was also impacted by lower income from our investment securities portfolio, owing to a Q4 decrease of $65 million in average investment securities. This decrease was due primarily to scheduled maturities and prepayments. For the year, average investment securities were $300 million lower as we increased our loan to deposit ratio.

You probably noticed another rise in our net interest margin in the fourth quarter of 2006, to 7.50%, compared to 7.45% in the third quarter. This increase is mainly due to a growth in our loan portfolio and an unexpectedly high level of noninterest bearing deposits in the fourth quarter as well as the recognition of additional loan fee income. Without this impact, the margin would have been slightly lower than in the third quarter.

Noninterest income increased in the fourth quarter by 48% to 46 million, primarily due to warrant and security gains. The warrant component of this number reflects the dynamic nature of the industries we serve. Several companies in which we held warrants went public in the fourth quarter, resulting in a significant increase in the value of our warrant portfolio. The variability of this portfolio makes it challenging to predict its value from quarter to quarter, but our successful efforts to win new clients and the warrant activity that goes along with that lead us to expect warrants will remain a valuable and dependable source of nongood income. Noninterest expense rose about 11% from the third to fourth quarters of 2006, due primarily to increases in compensation and benefits related in part to increased headcount and a higher incentive compensation expense. For 2006, noninterest expense excluding the $18.4 million pre-tax charge for impairment of goodwill and excluding $21.3 million per share-based compensation, was about 9% higher than 2005. The big contributors to that number were increases in compensation and benefits and an increase of over $12 million in professional services fees, largely related to compliance activities.

Net income rose 13% during the fourth quarter of 2006 to $28.4 million. Net income was slightly lower for the year -- ended down about $3 million from 2005, to $89.4 million, although as you know our income stream -- that income reflected the $10.4 million post tax goodwill impairment charge we took in the second quarter. You will find a reconciliation of non-GAAP to GAAP net income in our press release.

Our credit equality remains strong. Although our provision increased to $5 million in the fourth quarter of 2006, this increase is largely a reflection of strong loan growth among our technology and life science clients. Nonperforming loans remain a very low .31% of total gross loans compared to .28% in the third quarter and .26% in the fourth quarter of 2005. Our allowance for loan and lease losses was about 1.22% of total gross loans outstanding.

Looking forward, SVB Financial Group currently expects first quarter 2007 diluted earnings per common share to be between $0.63 and $0.69. This outlook reflects an expectation of somewhat lower growth in average loans and comparable growth in total client funds compared to the fourth quarter of 2006. We expect the average yield on our loan portfolio and net interest margin to be comparable to the third quarter of 2006. Our outlook also reflects an expectation of lower noninterest income due to lower gains from investment securities and derivative instruments, a lower amount of provision for loan losses and unfunded credit commitments, and somewhat higher noninterest expense than we recorded in the fourth quarter of 2006, due to higher compensation costs. For the full year 2007, we expect average loans, total client funds, noninterest income and noninterest expense to grow and a somewhat higher provision for loan losses and unfunded commitments compared to 2006. We had an outstanding quarter and a solid year in which our core business lines delivered strong growth for the company. Thanks, and I'll turn it back to Lisa.

Thank you, Jack. We'd like to open it up for questions now.

[OPERATOR INSTRUCTIONS] Our first questions comes from John Pancari with J.P. Morgan.

Good evening. Just wanted to see if I can get some more color around your expectations for deposit growth. Obviously we saw an average deposits were essentially flattish in the quarter, which was good to see, and consistent, I guess with what we saw -- your expectations going in the quarter --just wanted to see what trends you're seeing in terms of balances being moved off balance sheet and what your expectations on that front will be going into '07?

I'll start it but I'm going to turn it quickly over to Greg Becker, who is our Chief Operating Officer for the commercial bank. We, from a deposit standpoint, we expect overall deposits to just be slightly lower than what we -- on average than what we saw in Q4. But we do expect our noninterest bearing to be about what we saw at Q4 while interest bearing declines a little bit. I'll let Greg speak to it generally, what he's seeing in the marketplace.

Yes, John, this is Greg Becker. And I guess from a deposit perspective looking at, I guess where we're headed, we've historically talked about DDA growth. And DDA growth, we've really looked at that being relatively close to what we see from new client growth so that our average DDA deposits will stay about the same and the growth will come from new client acquisition. On the on-balance sheet money market account, as I think everyone recalls, the issue is that what we pay for those deposits has been well under market, hence the reason for the decline. And our goal, obviously, is to come up with several strategies that we have in place and are putting in place to reverse that trend. Clearly, that's the hope that that's going to reverse over the course of 2007. And that's where we are right now to build that into the forecast.

Okay. And then I guess on the loan side, just want to see if you can give us an update on -- I know we had some expectations going into the first quarter, but what is -- maybe you can just characterize what you're seeing on that front for loan demand from your VC and private equity borrowers as well as the companies themselves?

And this is Dave Jones. Let me at least start and say that we have good momentum coming into 2007. We had good growth in the fourth quarter for our software/hardware and life sciences companies. I think that that will continue. We didn't see the same level of actual fundings in fourth quarter, at least at the end of the fourth quarter, from venture capital and private equity, but we are seeing opportunities in the first quarter to see a little more activity in first quarter than we saw in the fourth quarter. So I think there is great opportunity, and as I mentioned, there is good momentum coming into 2007.

John, you also asked a little bit about off-balance sheet -- neglected to hit on that -- and we do expect to see growth in the off-balance sheet. Probably on an average quarterly basis, probably a little stronger than we saw in Q4.

Okay, great.

Good, thank you.

Our next question is from Joe Morford with RBC Capital Markets.

Thanks. Good afternoon, everyone. And I guess congratulations on a great quarter of revenues. But unfortunately, it seems not enough of them found their way to the bottom line because expenses were up so much. And I recognize your investing in infrastructure and some of it, especially with the higher revenues at Alliant, but even without that, they're probably up almost 10% sequentially, and projected to go even higher in the first quarter. And I was just wondering, can you give us a little more color about what's going on here, and also are there some unusual items in the numbers at all? And can you give us some more specifics about the organizational performance improvement efforts that Ken mentioned and how that's going to help make you more efficient? Thanks.

All right, that's a lot of questions, Joe, so if you --

That's just the whole expense side, yes.

Yes, the whole expense side. So in the beginning, so part of what you saw in Q4 is a little bit of what I'll call exceptional or nontrending type of issues. We did revisit the -- our estimate for instead of compensation expense, and so that along with hiring drove the comp piece of the expense structure that you saw, which -- for Q4 -- which is the predominant increase, I think, in Q4, on the expense side. So there's a little bit of that. And -- or that element of it is a bit of out of trend, if you will. Looking forward in Q1, the part of what you see or part of what we're expecting there is related to the sort of traditional and expected costs associated with payroll tax, 401(k), etc., that tend to be front loaded. And so some of that is what I call a nonrecurrent -- nontrending type of expense as well. So you've got a couple of those lumpiness in both Q4 and -- and as we go into Q1. A catch-up on the ICP, or excuse me, our incentive compensation, and then the front loading of payroll taxes and 401(k) expense. As you look at the rest of the expense items for Q4, most of them were not all that different than Q3 or certainly within sort of the traditional variability or the expected variability of those numbers. I'll let Ken speak to some of the strategic initiatives, both in the organizational performance and others.

Joe, we are among other things focused now and will be focused in the course of the next year on a topic that we refer to as organization-wide performance improvement, which contains not only a focus on performance improvement but also on efficiency. And we're looking at that as having some considerable potential over time, probably consisting of three or four different aspects. One would be rationalizing some of our business processes. As we've grown over the years, and I think this is typical of growth companies, there's a tendency to layer processes on processes, and sometimes that results in a lack of efficiency. And that if you stop at any given point in time and look closely at your processes, you'll find out that your business processes -- you'll find out that you can take steps out, shorten processes, rationalize processes and ultimately that puts you in a position of being able to grow revenues without necessarily growing headcount. Because you become more efficient. That would be a dominant aspect.

A second aspect of this would be that as you know our -- one of our hallmarks over the years, certainly I would say throughout our entire history, I've been there for 17 years of that, and I think I can attest to that, but you've been associated with the company yourself, and I think you'd attest to it, too -- that high-touch has been an aspect of our delivery model. Having said that, we -- it's possible that we've been somewhat indiscriminate in our administration of high-touch, and that we should evolve more in the direction of what we think of as "right touch", meaning high-touch for those situations that warrant it, require it, and will pay for it, but correspondingly, lighter touch in those that don't. That also, we think, has potential to -- in terms of enabling us to become more efficient.

Those'd be, I think, two primary aspects of what we're looking to in that initiative that I could probably add to it two less significant aspects. One might be that, as is true in any organization, from time to time it's possible to take a close look at expenditures and become somewhat leaner in sort of an overall sense. And in a fourth avenue of potential here, in my view, would be that if we, as we move in the direction of becoming more sophisticated and have a more and more people in the corporation familiar with project management skills and outlooks, that we can do a better job of bringing our various systems projects in on time and at budget, and that, too provides -- offers some potential. So I think if we focus on this that there is some considerable potential to reduce the growth in the expense base over time.

And have you quantified any of these opportunities at all or is it just kind of at this point -- or the focus?

It's more the focus. We're working on benchmarks. We'll get there, of course, but there is nothing numerical to report to you at this juncture.

Okay. Thanks for the help.

Our next question is from Fred Cannon with KBW.

Yes, good afternoon and again, congrats on the revenue lines. I really wanted to focus on the guidance and kind of first for Ken -- as you discuss, Ken, the company seems to have very good momentum overall in terms of business flows, yet your guidance for the first quarter -- the midpoint is below your third quarter and far below your fourth quarter. I guess the question is, is why are your expectations so muted for the first quarter, and really why are you willing to accept this kind of backward step in the first quarter after the momentum that you have?

Fred maybe I should take a stab at the beginning of that question or at part of that question. If you -- as you take a look at our Q4 results, what you'll find is that our -- we had a very good quarter in the warrant area and in the securities gains and losses area, in many respects, and higher than expected and certainly higher than the guidance we provided to you. One of our challenges as we've discussed before is how do we estimate these going forward. And so right now I can't tell you I have the visibility into those same -- that same level of performance for Q4 and those two elements of our noninterest income. It's not to say it won't happen, it's not to say we don't expect it to be there for the year, but as we roll into Q1 it's tough to come out with a guidance stream that is based on warrant and investment gains that are not yet -- that we cannot yet see for certain. And there's at least $5 million in Q4, I think, that I just don't have visibility to -- into that same type of number for Q1.

The second item is, as I mentioned, some of the front loading, some of the compensation expenses. And you add those both up and you get pretty much a look at the difference that -- between Q4 and the guidance we're providing. Now, as the quarter goes on, we'll get additional insight into that Q1 warrant and gains and losses activity, and I have every expectation and hope that it'll be strong. But right now I just don't have that visibility. So it's -- all of it points to some of the comments about the difficulty of providing discrete quarterly guidance versus annual guidance on some of these interest -- noninterest income revenue streams.

Fred, I'd like to add just a couple of things to that, if I could. And to a certain extent, I may be repeating Jack, but that only serves to underscore the wisdom of what Jack's saying. First of all, I do think that we want to lean in the direction of being cautious around those aspects of revenue that have higher betas associated with them. So clearly in the investment gains and losses category we want to be -- we certainly don't want to raise your expectation level in a way that is hard to ensure that we'll meet. That's one factor.

A second factor is, I think sometimes we get caught up in the trees and it's hard to see the forest. In point of fact, a year ago in Q1 of '06, we had $0.58 in EPS and we're right now guiding to $0.63 to $0.69, and I think if you look at that and calculate the percentage increase, it's about a 14% growth in EPS. And 14% growth in EPS on an annualized basis really isn't too shabby, and probably deserves a little higher level of enthusiasm than your question might imply.

And then finally, I would add to this that last year or at the end of last year we, as you know, under duress, reintroduced a warrant -- a new method of warrant accounting which resulted in our putting somewhere over $20 million in additional net worth into the balance sheet. But obviously as of three or four years ago, for which we clearly would not have gotten any credit nor am I asserting that we should have. Having said that, that's got to get amortized. So we're taking 20-plus million dollars that you gave us no credit for and then amortizing it over the quarters which puts a little bit of a drag on what might otherwise be even a more interesting quarter from a revenue perspective. So I do think that there's more to this than meets the eye.

Thanks, Ken. If I could just ask the question a slightly different way. If I look at the third quarter where you didn't have the outsized warrant gains and, in fact, would I look at volatile income, it was actually below your kind of mean, you earned $0.68. And now your midpoint for your guidance in the first quarter is below that level. I guess is that kind of acceptable performance from a bottom line to you?

Is that acceptable performance --

I mean is that the kind of goal -- is that kind of reach your goals for what you think the company can produce, I guess?

In this environment?

Clearly not. Clearly not.

Let me follow up one other final question on that with Jack. Jack, in the -- when you gave guidance for the fourth quarter, you said that the net interest margin would fall back at the third quarter levels and yet we saw a nice margin increase. As we look towards the first quarter of next -- of this year, this quarter actually, you're again saying we'll fall back to that level. And I guess I'm wondering what kind of -- why was that off in the fourth quarter? I think you mentioned that, but why should we revert to that in the first quarter? And number two is specifically you said that the yield on the loan book would fall back to the third quarter levels, and I'm wondering why we should expect the yield on the loans to fall? And that's my last -- thanks.

Okay, let me -- if I keep saying it will fall back, I know I'll get it right one day, so that's one reason. The real reason, though, is we did have a surge in DDAs in the latter part of the quarter in Q4. And that really did alter the mix enough to just move that enough to -- well, move it up. And that was a bit of a surprise. We also, as I alluded to, had a bit stronger loan growth than we expected, and the amortizations that were a little stronger than expected. So all of those conspired, all of those good things for the most part conspired to produce a NIM that was slightly higher than what we had guided you to. As we roll forward into Q1 we're still guiding you back to sort of a Q3 level, and I still think that's reasonable unless again we have a surge in the DDA's which we don't currently expect. We expect DDAs to be relatively flat or just I think maybe up a couple of percent, maybe 1% in Q1.

On the loan yield, that's always a tough one in that it's -- it depends so much on the mix of loans and the relative sizes of those -- of that mix. And then on prepayments and recoveries of previously unamortized fees. So that's a tougher one in many respects to estimate. Currently we expect it to look a little bit more like Q3 than Q4, in part because we expect some of the loan growth, because we expect somewhat of a mixed change and in part because we expect some of the fee amortization to go back toward a more normalized level. So I don't think it's an indication of anything, I think Q4 was just a little bit stronger than we expected.

Thanks.

You bet.

Our next question is from Brent Christ with Fox-Pitt.

Good afternoon. A couple of follow-ups on the expense base. One, you mentioned somewhere that the sequential increase was related to hiring efforts. Could you talk a little bit about where you're seeing those hires concentrated?

Yep. Do you want to do it?

Do you want to start and I'll finish?

All right. So I would say it's across the board. It's in both the revenue generation area, so we've got, we're hiring in the funds as we grow our funds business. And this isn't hundreds and hundreds of people, but it's a meaningful number. We're hiring -- we've hired people in the operations area to deal with the level of activity that we're seeing. Recall, now, and keep in mind that we're seeing activity levels that are extremely strong and one of the things that probably isn't as obvious to you as you looked at the numbers, but when we grow loans by 20%, that's on a net basis. Given the nature of our clientele, it means the activity level is probably 1.5 times that number or one and a third times that number. So that's been very strong and higher than expected.

You layer then on of course the things that we've mentioned before and that you're hearing from every other financial institution in the country, which is just the overall level of compliance that's required. And that is causing us to hire both people into the compliance area but also into the operations area to ensure we know each and every one of our customers and all their relatives and all their ancestors and whether they came over on the Mayflower or not. So there's a lot of activity on the compliance front that is also driving the hiring. But we're -- we think we are doing it relatively smartly. Now we also, as Ken alluded to with the organizational-wide improvement, we believe that there are ways to go at this business that's a little different than we have gone at it in the past and going at it differently will yield a lower rate of increase, a substantially lower rate of increase in costs than you've seen in '06.

So and then lastly, it's -- I don't know what it's like in your business, but I would say, too, that the -- the wage pressure is pretty strong in the economy right now. And so it's not just here in the Bay Area, but it's also elsewhere in the country. And so the kinds of people that we're going after right now are in demand, whether they're revenue -- top of the -- best of class revenue producers in the bank, whether they're funds developers, managers, and marketers in the funds business, or whether they're compliance people. They are all in high demand right now. So those would be some of the factors that are driving what I see. But I would say the hiring includes revenue-producing but also the operations and compliance to support that.

Okay. In terms of some of the efficiency initiatives that you guys are kind of contemplating right now, would you expect to kind of come out with somewhat of a formal program to the investment community or is that strictly going to be an internal focus?

I think the formality will express itself in the terms of results, but I doubt that we will be describing in great detail formalized programs to the investment community, nor do I think that would necessarily be appropriate.

Okay. And then last question on the expenses, you indicated part of the reason for the expected uptick in the first quarter is some of the seasonal costs. Does that imply that you would expect some relief later on in the year from first quarter levels?

On the compensation costs, yes.

Okay. And then last question, just in terms of Alliant, and it looks like you had a nice quarter there on the revenue perspective, do you feel like you're back on track on relative to where you were prior to some of the departures?

I would say yes.

Okay. Thanks a lot.

Our next question's from Erika Panala with Merrill Lynch.

Good afternoon. My first question is more for clarification. Jack, you mention that DDA growth was unexpectedly higher. Now was, if I understand correctly, due to greater than expected client coming on board rather than structural, something structural you put in place to prevent deposit attrition off-balance sheet?

Yes, you're right, Erika, I did say that but I probably was remiss in not mentioning too the -- some of the programs that we have put in place that we've talked about earlier in 2006 -- or in the latter half of 2006. Changing our earnings credit rate, for example, and just some elements of a go-to-market strategy such that we think -- while we can't quantify it exactly, we do believe that an element of that higher DDA growth that we saw in Q4, particularly in December was, in fact, due to that. But I think -- Greg, anything you want to add?

Yes, Erika, probably the only thing I would add is that as we looked at the new clients we added in the third and the fourth quarter, the average DDA balance from those clients was actually higher than the average overall. And I think it's a reflection of our going over later stage clients, private equity firms, venture capital firms, and so when you see an average -- and these could have in the venture capital and private equity size -- very tremendous swings in DDA balances. So it's kind of the aggregation of all those things, what Jack said and what I described from a new client acquisition.

Okay. And Ken, if I could ask you, how do you see on -- from a relative credit quality standpoint the landscape unfolding for '07?

Our monitoring systems, I believe, are really as good as they get, meaning that we're able to see as far into the future as people can possibly see. And based on our monitoring systems, credit quality is every bit as good today as it was a year ago. So obviously I'm not in a position to tell the future anymore than anybody else is, but I think that we here at SVB are in a better position to tell the future than most lenders are, and based on our abilities, everything is as good as it was a year ago.

Okay. And now, is there anything in your portfolio in terms of maybe an industry that you're keeping a more watchful eye on for '07?

This is Dave Jones. Let me, as I try to scan, I am really not keeping an eye on necessarily anything. I try to keep a pretty careful eye on everything, but software, hardware, life sciences all are performing well. Private equity venture capital is performing well. Premium wine has performed much better in the last couple, three years. So I am pleased across the board and not concerned at any part of our credit horizon.

Okay. And if I could ask, when formulating your budget for '07 what were your assumptions in terms of Fed moves for the duration of the year?

Good question, should have mentioned it. At least for Q1 we're not expecting any change in the Fed funds rate as we formulated our assessment for the year. We are expecting a couple of rate changes toward the latter part of the -- weighted towards the second half the year.

Rate cuts toward the second half of the year?

Yes.

Okay. And one more question, if I may. Ken, you spoke about globalization being one of your big priorities for '07. Now does this mean an extension of your advisory capacity overseas or perhaps more of an extension of credit in -- to an international capacity?

That all depends on a number of different factors, and I would say at this juncture it's impossible to predict. I will tell you, though, that the vast majority of our clients, and particularly those who are more successful, are increasingly involved in activities on other continents, most particularly India and China. But to a lesser extent, Israel and Europe as well, and in particular the U.K.

And when I talk to our clients, which I do on a regular basis, about their hiring plans, it's amazing to me the percentage of our clients who are intending to do a significant portion, if not the majority of their hiring, in either India or China in the course of this next year because engineering talent costs appreciably less, A. And B, there are many CEOs of technology companies who also are of the belief that not only is the talent less expensive but in many cases it's actually superior. The result is that virtually all of our companies are doing something and many, if not most of them, actually have a portion of their company now located on another continent. And these facts obviously necessitate our involvement to one degree or another in other technology centers around the world.

I would also add to that that many of our domestic clients, I believe today, are with us at least in part because of our capabilities in other countries -- meaning that our ability to assist them in one form or another in India or in China has ended up being the tipping point in terms of our winning a deal where we might have been competing with another organization, in some cases, that might have been considerably larger than ours. In addition to that, as you know, we provide banking services to an astoundingly high percentage of all the venture capital funds and increasingly of the private equity firms in the United States and even around the world. And the very best of those venture capital funds and private equity firms are increasingly investing their dollars in foreign markets, in technology centers in India and in China, and to an extent in Europe and in Israel as well. And there is increasingly an opportunity for us to assist them, that is, the same venture funds and the same private equity firms, with which we've been -- worked very closely over the years to assist them as they invest in ever -- in higher proportion of their own investment dollars in other markets.

All right. That's it for my questions. Thank you for the time.

Due to time restraints, our final question will be from James Abbott with FBR.

Well, thank you, I'm glad I got in under the radar there. I'm not sure what that says about the quality of education in the United States. But in any case, I wanted to see if you could touch on the -- we did the expenses so many times but I wanted to come back to the incentive compensation accrual and could you give us a sense as to how much the increase was on a linked quarter basis in dollar amounts and then also tell us what that is tied to? Is it revenue, gross revenue, is it a certain type of revenue, is it balance sheet driven? And probably I'm sure it's driven by all of that, but maybe the 80/20 rule here, what is the majority of that incentive compensation driven by and why did it go up so much in the fourth quarter?

Sure, the linked quarter -- well, number one, incentive comp at the bank for most, if not all employees, and here I'm thinking outside of Alliant, which is more revenue driven, but is fundamentally based on pre-tax operating income relative to budget. So it's -- it can be a tough pool. The linked performance was up, was we accrued about $2.5 million, maybe close to $3 million more incentive comp in Q4 than we had in Q3, and that's --

Okay.

-- that's really sort of reflects our best estimate of what we thought we'd do as we look forward in Q3 compared to our best at what we actually were able to do.

Okay. And then with pre-tax operating income going down, presumably in the first quarter of '07, is there some unwinding of that or do we start off at a new level?

The way our program is, we -- it's a calendar year program, so we rebenchmark based on our best estimate for the quarters going forward.

It's safe to say that $3 million doesn't go away in the first quarter, it stays?

Unless it's for those whose program is only generated by revenue, that's right.

Okay. Okay. And then is it -- have you considered tying some of that to deposit growth? I think that's obviously where a lot of the value of the franchise comes from?

Sure. The way our -- by the way, this -- what I was referring to is just one -- well, the largest component, but a large component of our incentive comp plan here at SVB. For those relationship managers who deal directly with customers, their program is split between generalized corporate performance and how they do relative to the individual customers and they are heavily incented to bring on deposits.

Okay. I appreciate that. The other question I had was with -- related to the guidance on higher credit costs. It sounds like you're suggesting that the credit is fairly under control, you're suggesting that loan growth is slower in 2007 but the credit or provision expense anyway is higher in 2007 than it was in 2006. I'm having a hard time reconciling that. It sounds to me like you're saying that credit will deteriorate, and that's why you're having to provision more expenses for it, because with slower loan growth I would expect normally slower provision growth. Do you follow what the question is?

Sure, I think I understand it, I'm going to let Dave speak to it.

And again this is Dave Jones. The one thing that is going to be different in 2007 than we have experienced in recent periods is the level of recoveries. So in 2006 for the annual period we had $14 million in gross charge-offs, approximately. And we had also approximately $10 million of recoveries. It is my belief that we do not have the level of recoverable loans in our existing charge-off pool to have the same level of recoveries in 2007. So if the gross charge-off level were to be flat with 2006, the net charge-off level would rise and that will inevitably be reflected in out loan loss provisioning.

Perfect. That's a great answer. And then last question -- it's kind of a housekeeping question -- you have the total number of clients from in the third quarter and then also in the fourth quarter and then the growth rate there. If-- I don't know if you don't -- you used to disclose some stuff in the press release that helped us sort of back into the number of clients the company had and I used to track that.

Greg may be able to give you an estimate.

Yes, James, let me -- I'm going to focus on kind of year over year as opposed to really getting into the quarter because part of this is we do see a lot of quarterly fluctuations as we talked about with a lot of our numbers. What we've really experienced this year is very consistent with last year from a growth rate perspective. And, you know, our growth rate is kind of in the 9% annualized net client growth, which is from our vantage point very good. And so that's what it's been.

Did you say nine?

Nine.

Nine, okay. And on a linked quarter basis, just out of curiosity because I do have the older data so I can look for seasonality in it, but was it down on a sequential quarter basis? It sounds like it should have been up but --

The quarter-over-quarter, we had for the year, and the numbers I'm looking at -- I can't put together the math together that quickly but it looks like the highest growth rate we had in new client growth was in July through October, that time frame. And again, I think you also saw a pop in the DDAs in the fourth quarter because once you get an account opened up, it takes a little white to get active and funded. So as I mentioned in the last call, we had again high growth in the third quarter, and so once those get funded again, that translates to higher deposits. So clearly that's part of the reason for the growth in the fourth quarter as well.

Okay. And maybe I will take just one other second here.

You're up to five.

I'm sorry?

You're up to five questions.

The question is related to the deposits. I got the sense in last quarter's conference call that you'd be able to sort of flip a switch and bring some deposits back on balance sheet with changing the earnings credits. Could you maybe touch base on what our expectations should be for that to materialize? You said a little bit in December maybe.

So there's several things. This is Greg Becker again. There's several things that we have done and are planning to do over the course of '07, and I would love to tell you there's a magic switch that we hold back here that we can switch on and the deposits will grow, the noninterest or the interest bearing deposits, but that's obviously not the case. Part of it is what Jack alluded to, we have modified our earnings credit rate, we've looked at our product pricing and obviously that will help from a deposit perspective. But that's really, I'd say, relatively speaking, a nominal help -- and that's something we've already done. As we look at '07 we have a lot of things that we're working on that we believe and hope that over the course of the year will have a more meaningful impact on the interest bearing deposits. And again, the point that I think it's great to make is when you look at the amount of new client funds that we pull on as an organization each year, this year was around $4 billion, it doesn't take much of that money to pull on balance sheet to have a meaningful impact for our on-balance sheet deposits. And so we are very focused, extremely focused on turning that tide of the downward trend of the interest bearing deposits. And so it's one of my number one priorities in the commercial bank as well.

Okay. Thank you. I will not ask a 6th question.

I would like to just add with one final -- end with one final comment here which is a point that we made earlier, but I think it bears repeating. And that is clearly there's a lot of emphasis on expense in today's discussion. You can be absolutely sure that we are focused on that issue as well. Having said that, Jack's guiding to $0.63 to $0.69, and I think it's -- it bears noting that reported earnings in Q1 of '06 were $0.58, and if we hit the midpoint of that guidance range, that would still be 14% growth in EPS. And it strikes me that 14% should be something that a company could be proud of.

Okay, thank you, Ken. I'd also like to apologize for anyone that is left in the queue that we didn't get questions from, we do have a time schedule for some of our executives on -- following this call. So if you do have questions, please forward them to me and we will try to answer as best we can at a later date. Thank you very much.

Thank you for participating in today's SVB Financial Group fourth quarter and year-end conference call. This call will be available for replay beginning at 8:00 P.M. Eastern Time today, through 11:59 P.M. Eastern time on Sunday, February 25, 2007. The conference ID number for the replay is 6014657. Again, that conference ID number for the replay is 6014657. The number to dial for the replay is 1(800)642-1687, or international (706)645-9291. Thank you, you may now disconnect.