SVB Financial Group (SIVB) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the SVB Financial Group second quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. (OPERATOR INSTRUCTIONS). Thank you. I would now like to turn the conference over to Ms. Meghan O'Leary, Director of Investor Relations. Please go ahead, ma'am.

Thank you. Today, Ken Wilcox, our President and CEO, and Mike Descheneaux, our Chief Financial Officer, will discuss SVB's second quarter 2008 performance and financial results. Following this presentation, members of our management team will be available to take your questions. I would 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 full year 2008. Forward-looking statements are statements that are not historical facts. Such statements are just predictions, and actual events or results may differ materially.

The information about factors that could cause actual results to differ materially from those contained in our forward-looking statements is provided in our press release and our last filed Form 10-K and 10-Q. The forward-looking statements are made as of the date of broadcast and the Company undertakes no obligation to update such forward-looking statements. This presentation may also contain references to non-GAAP financial measures. A presentation of and reconciliation to the most directly comparable GAAP financial measures can be found in our press release. Before I turn the call over to Ken Wilcox, I would like to note that the press release that went out over the wire was incorrectly formatted and did not contain the last several pages of tables. An addition is being made and you will see the full press release soon. Thank you. Ken?

Good afternoon. It is a pleasure to speak to all of you again at the close of another good quarter for SVB Financial. Mike will go into more detail in a moment, but let me start by sharing a few highlights. First, it was beyond a shadow of a doubt a great quarter. We earned over $21 million, if you include the negative impact of the Co-Co redemptions, which Mike will describe to you later. If you don't include the negative impact of the Co-Co redemptions, in order to get at what the business actually produced, we earned over $25 million. This was, I suspect, quite a bit more than the Street had anticipated, and I want to say that I'm proud of our accomplishment. When I compare this quarter to its counterpart a year ago, average loans were up by 26%, average deposits were up by 21%. Foreign exchange fees were up 37%. Client investment fees were up 8%.

In addition, our credit picture continues to hold up well. We have a strong capital base and our liquidity is strong. So it was another good quarter and we're happy to report it. So now, I'm sure you're all wondering, what about the future? Despite the turbulence in the economy, especially in the financial sector, we remain optimistic about our ability to continue the track record that we've built. There are two main reasons for this. First, our corporation is stronger and better positioned to create shareholder value, we think, than ever before. Second, our target markets are weathering the storm better than the target markets of most banks. Let me take a moment to elaborate on each of these points, beginning with the reasons I believe that we are stronger and better positioned to produce shareholder value than we have ever been in our now 25-year history. First, our product set is larger than ever. Fee-based income is higher than it has ever been before.

In certain key areas, such as foreign exchange, asset management, and SVB Analytics, our revenue growth in these past several quarters has been nothing short of remarkable. Along with a more diverse product set, we also have more diversity in our loan portfolio. Today, the proportion of our loan portfolio represented by loans to larger technology companies is bigger. The proportion represented by loans to venture capital and private equity firms is also bigger. And finally, the proportion represented by structured finance is bigger. Having said that, it is important to note that most new clients enter our portfolio as start-ups and our activity level there is higher than ever. But because of the facts that I just mentioned, the proportion that they represent is arguably smaller. Be it our product set, or our loan portfolio, there is strength in all of this diversity. In addition, our funds business, which focuses on top quality funds, is larger, growing, and we believe closer to the attractive part of the J curve than ever. Our infrastructure is also stronger. This includes both our systems and our people. Expense control is alive and well at SVB Financial.

If you normalize for interest rate changes, our operating leverage is greater than it has been for a number of years. This is the result of a number of factors -- better vendor management; our outsourcing programs in India; process improvement; and good old-fashioned thriftiness. Three final points on our positioning. First, we are more geographically diverse than ever before, which means that we have the potential to grow revenues in places that would have been out of reach only a few years ago. This affords us the opportunity for increased cash flows with, we believe, less volatility. We have a strong capital base and more than adequate liquidity. Which means that we're in a better position than many to weather a storm, if there is one -- which there isn't, at least not now -- either for us or for the markets on which we are focused.

Finally, I believe we are better able to compete, as is evidenced by our recent sixth place ranking in both Bank Director Magazine and the ABA's Banking Journal's Best Performing Banks surveys. On to the second reason for my optimism, which is the environment we operate in. While not ideal, our market remains stronger than that of most other banks. Let me explain. First, a point that many of you know but one that continues to bear repeating is that we have no real real estate exposure, except for a small portfolio of CRA-related affordable housing loans, and a handful of residential mortgage loans, some for employees, and some for wealthy venture capitalists. Second, interest rates appear to have stabilized and I believe -- I believe -- are more likely to go up than down. As a reminder, Silicon Valley Bank always benefits from rising rates. Third, venture capitalists continue to raise money and invest money. The early returns are in for the quarter. Based on these early returns, venture capitalists invested as much in Q2 as they did in Q1, and they raised even more in Q2 than they did in Q1. As we all know, liquidity events, meaning IPOs and trade sales, are few and far between. But we believe that this situation is only temporary. Further, in the short run, it actually tends to help more than it hurts.

By that, I mean very simply it can be difficult to grow loans in a market with too many liquidity events, and we are definitely not suffering from a market with too many liquidity events. That's for sure. In addition, the companies we work with are holding their own. Default rates are consistent with prior quarters. And on average, companies are meeting their projections to the same extent that they ever did. While they are all concerned that problems in the larger economy could spill over and affect them, they are not experiencing it, at least not now. Finally, regardless of what your best friend in the venture capital community may have told you, the factors that drive the venture community are still there and functioning well. There is no shortage of innovation, and there is no shortage of capital to fund it. There is also no shortage of need for new and innovative solutions to some of life's most basic problems -- health, efficiency, energy, and so on. There is, to be sure, a shortage of IPOs in trade sales at the moment; but again, that is, we believe, only temporary.

So as you can see, I am, I think for good reason, optimistic about our ability to continue the track record that we have built. Part of that optimism is based on the good work and great attitude of the roughly 1,200 hard-working men and women who come here to work every day. I want to thank them right here and right now for another great quarter. And with that, I will turn it over to our CFO, Mike Descheneaux.

Thank you, Ken. And thank you, everyone, for joining us today as we discuss our second quarter results. As Ken said, we delivered diluted earnings per share of $0.62 and net income of $21.3 million in the second quarter, which was a strong quarter when you consider that our results include a $3.9 million nontax deductible charge related to the early settlement of a limited number of zero coupon convertible debt, which I will discuss later. Our earnings are even more impressive when you consider that we had no significant gains from M&A or IPO activity. We drove our Q2 results with the basics -- strong lending and deposit-taking activities, as well as solid fee income. Despite the impact of significant interest rate reductions, and the head wind of the current economy, we are performing well. Before I proceed, I would like to note that in general, my comments refer to the second quarter of 2008 in comparison to the first quarter of 2008, unless otherwise specified. There are four areas I would like to highlight with respect to our second quarter results, and they certainly look different from what you are seeing from most of the banking industry.

First, we grew average loans in Q2 by $207 million, or 5%. Second, we delivered impressive deposit growth of $214 million, or 4.8%. Third, our net interest margin of 5.69% in Q2 is still well above industry averages. Fourth, our credit quality remains strong, with net charge-offs at 44 basis points of total gross loans versus 49 basis points in the first quarter. Clearly, these highlights indicate strong fundamentals. Now, I would like to discuss some details regarding our Q2 performance. Loan growth was strong in Q2, reflecting activity across all client sectors. A good portion of this growth came from our lending for private equity buyouts, and we are on track for our forecasted eight to 10 deals for the year in this category. We grew our average loans from $4.1 billion in Q1 to $4.3 billion in Q2. Period end loan balances were $4.6 billion. This is a useful data point to consider when assessing the outlook for Q3, which indicates that we are starting Q3 on a positive note. Likewise, our focus on growing deposits is paying off.

For the first six months of 2008, we grew average deposits by $442 million, which is a significant change from our deposit picture a year ago. This growth is a direct result of our introduction of two new interest-bearing deposits -- deposit products, which in Q2 averaged $748 million. We ended the second quarter at $4.6 billion in average deposits, compared to $4.4 billion in the first quarter.

Moving on to our income statement, although our net interest income decreased $4.2 million in the second quarter to $87.9 million, this number is quite impressive in light of the significant interest rate cuts in 2008. As a result of our significant loan growth, we were able to partially offset the impact of recent interest rate cuts. As I said earlier, our net interest margin was 5.69% in the second quarter versus 6.36% in the first quarter. The majority of this decline stemmed from interest rate cuts in 2008, but it was also driven to a lesser extent by the interest impact of the $250 million of convertible debt we issued in April and our decision not to lower our deposit rates completely in sync with recent interest rate cuts.

Stepping back a bit, since Q2 2007, the Fed has reduced interest rates by 325 basis points. In that same period, our net interest margin has held up relatively well, due in part to our success on growing deposits. Nevertheless, our net interest margin has declined by 170 basis points since Q2 2007, which equates to approximately 52 basis points for every 100 basis points decrease in rates by the Fed. Overall, the decline in our net interest income and net interest margin is consistent with our expectations, and we are hopeful that the Fed has come to the end of its easing cycle. As many of you know, we are asset sensitive and would benefit from interest rate increases.

Moving on to income from the rest of our operations, non-interest income rose 5.7% to $43.9 million in the second quarter, owing to better performance from our funds management business, SVB Capital. Fee income remained solid in Q2. I would like to remind everyone that in Q1, we earned corporate finance fees of $3.6 million from SVB Alliant, which helped our non-interest income in Q1. We had no such income in Q2 from SVB Alliant.

Let me start with net gains on investment securities. We recognized a $2 million net gain in Q2 compared to a net loss of $6.1 million in the first quarter. To put that difference in context, I would like to remind that you in the first quarter, we had a net loss of nearly $8 million on the valuation of one investment in one of our sponsored debt funds related to a drop in its public share price during a lock-up period, during which we were not able to sell the stock. We did not experience similar losses in the second quarter. As a result, net investment securities -- sorry, net investment securities gains looked quite good compared to the first quarter. Still, our funds management business and our warrant portfolio continued to be affected by a more discerning BC funding environment and a higher bar for valuation increases. However, we believe that good companies are still able to command good valuations and that there is meaningful activity in the portion of the M&A market that our clients rely on for exits. Other areas of fee income remain strong as well.

Outside of gains on investment securities and derivatives, corporate finance fees and so-called other income -- sorry, our fee income in the first half of 2008 grew 17% over the first half of 2007. Client investment fees remained strong in the second quarter at $13.6 million, compared to $13.6 million in the first quarter despite a 2.3% reduction in average balances to $21.4 billion. Our success in directing more of our client funds to on-balance sheet accounts contributed to the lower average balances, which were also affected by an absence of IPO activity in Q1 and Q2. Notably, purity in client balances rose 4.3% to $21.9 billion, ending the quarter on a high note.

Foreign exchange fees remained strong in the second quarter as well, totaling $8 million compared to $7.8 million in the first quarter. Thanks to our continued sales efforts, demand for this product remained solid in the second quarter, and we are pleased with its growth. It is interesting to note that foreign exchange fees in Q2 2008 have grown 37% in comparison to the same period one year ago.

Now, let us turn to non-interest expense. Including the $3.9 million charge related to early conversion of the zero coupon convertible debt, non-interest expense grew $3.8 million, or 4.5% in the second quarter.

Clearly, without the charge, we would have had a decrease in non-interest expense, which is evidence of our continued commitment to expense control. As disclosed in our 8-K filing dated June 26, 2008, we settled our zero coupon convertible notes in Q2. In the filing, we noted that we had two transactions arising from the early settlement of certain notes that offset each other on a cash basis. One was a $3.9 million non-tax deductible expense. The other was a $3.9 million increase in additional paid-in capital. As a result of this offset, the settlement had no net impact on total shareholders equity.

In other categories of non-interest expense, compensation expense was $3.7 million lower in the second quarter, owing to a number of seasonal items. This reduction was offset somewhat by higher incentive compensation expense in Q2, owing to our strong performance year to date, as well as an increase in number of employees and merit increases.

We recorded a provision of $1 million for unfunded credit commitments, which is due entirely to an increase in the balance of our total unfunded credit commitments, which grew from $4.9 billion to $5 billion at the end of Q2. Again, the increase was not due to any credit-related matters. Overall, we continue to maintain good credit quality, with net loan charge-offs declining to $5.1 million, or 44 basis points of total gross loans, compared to $5.4 million, or 49 basis points in the first quarter. Gross charge-off activity rose in the second quarter to $9.1 million, compared to $6.2 million in the first quarter. This rise was attributable to one non-venture backed loan which appears to be based on fraudulent client activity. We believe this is an isolated incident and not indicative of any trends. Gross recoveries were $4 million in the second quarter, due primarily to an unexpected recovery of $2 million from one client, which was charged off in Q1. We increased our total provision to $8.4 million, or 72 basis points in the second quarter, compared to $7.7 million, or 71 basis points in the first quarter. This increase was driven primarily by our continued strong loan growth. I would like to put this increase in context by noting that in the second quarter of 2007, our provision was $8.1 million, or 86 basis points.

Overall, our charge-offs and provision levels are within our expectations and our comfort level. So far in this economic cycle, we are not seeing a trend of negative performance among our clients.

Now, I would like to move on to capital management. We reduced our ratio of tangible common equity to tangible assets to 9.5% in the second quarter, compared to 9.8% in the first quarter, largely due to strong loan growth and our desire to optimize our capital ratios. With respect to share count, the settlement of our zero coupon convertible debt in Q2 had a positive impact on our diluted share count. At the end of Q1, we had 1.2 million shares in our weighted average diluted share count related to those notes. When the notes matured on June 15, 2008, the dilutive effect of the contingently convertible debt was removed. This reduced our weighted average diluted share count in the second quarter by a nominal amount, approximately 134,000 shares. The bulk of the impact will be recognized in the third quarter of 2008.

The 250 million convertible senior notes we issued in April had no impact on diluted share count, since their conversion price was higher than our average stock price for the second quarter. We will begin to experience accounting dilution from those notes once our average share price for the quarter reaches $53.04 per share. However, through the purchase of a call spread, we effectively increased the economic conversion price of the shares to $64.43.

Now let me say a word about share repurchases. As we noted in the last quarter's call, we slowed our share repurchasing activity. In the second quarter, we repurchased only $1 million of our common stock. Given our priorities and the current state of the capital markets, we are strongly inclined to retain our capital. As a result, we are unlikely to repurchase any significant number of shares in Q3. We will continue to evaluate this position as the year progresses.

Now, let us turn to our outlook for 2008. Our outlook reflects our expectations for the full year 2008 versus the full year 2007. Although we will revisit and update our outlook each quarter, it is an annual outlook. We had three changes we would like to tell you about. One, we are raising our outlook for average loans. We expect average loan balances to increase at a percentage rate in the high 20s, due in a large part to strong loan growth in the first half, coupled with what we believe is a strong pipeline of loans. We increased our outlook for average deposits. We now expect average deposits to grow at a rate in the high teens due to the success of our recently-added deposit products. The third change is that we have reduced our outlook for growth in client investment fees to the mid-single digit range due to less IPO activity and our success in bringing funds on to the balance sheet from our off-balance sheet funds. The rest of the outlook remains the same as noted in our press release.

Before moving to the Q&A session, I would like to note that although we expect continued variability and valuation pressure in our warrants and funds businesses, we have a positive long-term outlook for these businesses. Even without a tail wind from the economy or help from gains from M&A or IPO activities, our business remains healthy. The earnings we are delivering are from our basic activities, and they show the fundamental strength of our business. Our success is due to our management team and employees, which continue to focus on growing our business despite the challenging economy. This concludes the review of our second quarter 2008 results. With that, I would like to ask the operator to open the call for questions. Thank you.

(OPERATOR INSTRUCTIONS). Joe Morford, RBC Capital Markets.

Hello everyone, and good work on a nice strong quarter.

Thanks, Joe.

I guess just a couple of questions. The call was pretty thorough. Recognizing that maybe there is still a little bit of a lag effect, as of quarter end, Mike, do you feel you have kind of played out most of the lingering effects of the Fed rate cuts on the margin?

Well, if you recall, the last interest rate cut was essentially at the beginning of May and that was what, the 25 basis points? So we do have about one more month of that impact, of the 25 basis points, which again is not that significant to play out.

Okay. And I was also curious about the investment portfolio and the increases there. It looks like it is the first time you've done that in a while. Was that primarily from a capital management position or excess liquidity or just good opportunities you saw?

As we talked about in the past, one of our target metrics is typically we like to keep our investment portfolio for treasury management purposes at around 20% of our balance sheet, so it is just, you know, with our growth in our assets -- particularly strong loan growth, we feel that it makes sense to move the size of our investment portfolio up a bit.

Okay. So but still targeting that kind of 20% level going forward?

That's correct.

Okay. All right. Thanks so much.

Thanks, Joe.

Andrea Jao, Lehman Brothers.

Good afternoon, everyone.

Hi, Andrea.

Congrats on a good quarter.

Thank you.

Wanted to check in on the investment portfolio first and foremost. Could you remind us the mix of securities that you're holding? Do you have any, you know, Fannie or Freddie securities, do you have any slice of the portfolio that are more volatile in value against the market?

Our portfolio mix has not really changed significantly over the past few quarters. I mean, what I will say is from the Fannie and Freddie, are you talking about a direct investment or common stock for the Fannie and Freddie?

Yes.

No, we don't hold any of that. So our portfolio has not been that volatile. It is pretty well seasoned. And we look at that quarter to quarter. So so far, we're feeling pretty comfortable with where we're at.

Thank you. And then with respect to interest rate risk management, as you anticipate rising rates, should we see the amount -- some of the borrowings, and should we see, you know, kind of grow borrowings similar to lock in lower rates?

I don't quite follow your question, Andrea. I'm sorry.

With respect to the balance sheet, should we expect some lengthening in the maturities on the funding side and growth in borrowings as you try to lengthen maturities of your liabilities?

I think that is possible. We still evaluate that every day, Andrea. Obviously, it is a very -- it is a moving target. But we are looking forward to the rates rising, that's for sure.

Okay. Perfect. Thank you very much.

James Abbott, FBR.

James?

The mid stage investment, which was a little larger, I was trying to see if I could normalize the gross charge-offs. I know that in the past, you've said if gross charge-offs start ticking up, that that might be an indication that there is some weakening, so I wonder if we can just back that out and see what the -- what would be comparable with the prior quarter's gross charge-offs?

And this is Dave Jones. Let me touch that. Absent the one event, we would have been talking about approximately $6 million of gross charge-offs. So very comparable with what we have seen in recent quarters.

Okay. Wonderful. Thanks. And can you give us a sense on the -- just looking on the margin -- the net interest margin on the incremental business that you're getting, is it -- is there any way for you to give us some sense as you go forward what the mix of the pipeline is, and whether we can expect -- since -- let's assume the Fed doesn't do anything for another six or 9 nine or 12 months, would you expect the margin to expand gradually, under that scenario or contract somewhat? Just trying to understand the mix of growth that you're seeing on the horizon.

You know, James, this is Mike, let's start off a little bit, again, a lot of that just depends on the types of loans that we're driving. If we are driving some loans in the bio-financing, those loans are quite -- had large interest rates and of course naturally that would be very helpful to the net interest margin, but if you get into some other areas such as capital call lines which are a bit tighter on the spread, then obviously that could affect the mix. So it just really depends on what type of mix is going forward.

This is -- James, this is Greg Becker. And I think what you would see is if you look out over, you know, future quarters, the majority of the loan growth is going to come from more mature companies. Loan growth will occur across the portfolio, we believe, but if the majority of it comes from later stage companies, that will have a reduced margin than the average just based on them being more sophisticated and higher quality.

Okay. Fair enough. Not substantially dilutive -- nothing in the 2% or 3% range, but maybe something in the 4% to 5% range then, Greg?

From a spread perspective? You know, I'm just thinking of what -- based on what the average is, I would say it would be, you know, modestly off, so you shouldn't see a significant change.

Okay. And the types of loan growth that you've seen, or that you see in the pipeline, or the stuff that grew in the quarter, I guess the question I have is related to window dressing that you've sometimes seen in the past and I think the key here is term loans versus lines of credit. Can you give us a sense as to whether the growth was mostly term or mostly line of credit or an even balance?

This is Dave. The majority of the growth that we saw in the quarter was term, which will be good for future quarters in terms of the contribution to the average house.

Thanks again for your time, and nice job.

Thanks, James.

Brent Christ, Fox-Pitt.

A question on expenses. You guys have done a good job of keeping the expenses pretty stable in kind of this 83 to $84 million range over the past three or four quarters. And I guess if I look at your full-year outlook, kind of calling for mid single digit growth, that would imply a little bit of a step-up in the expenses in the back half of the year, and I'm just wondering if there is any specific investment spend or anything that would be driving it toward that mid-single digit level, or if that is just a conservative assumption at this point?

We stand by our forecast for that growth rate. I mean, there certainly are some back half of the year expenses and we would continue to invest in our business, in our funds business; we are also obviously investing in systems as well, which we've talked about in the past as well.

Got you. And then, a question on the minority interest, I guess for a while it had been, you know, a drag on your earnings I guess when the -- you know, the gains were more outsized in the fee lines, and the past couple of quarters it has been actually been the reverse and been a positive contributor. And just how are you guys kind of thinking about that minority interest line, or how should we be thinking about it relative to some of the fees?

Well, the minority interest area is purely driven where your gains or losses come from. So for example if we have a gain from a fund where we have, let's say, 10% ownership, that is going to have, you know, less of an impact than say a fund where we have 50% ownership. So it really just depends on where that is coming from. The blend-- I mean, you've seen the historical blend and so, you know, you probably have been applying that, but you've just got to keep an eye on where those gains are coming from and that will essentially determine how that number is going to look.

Okay. I guess just because I look at it and both the gains and the minority interest are swung in your favor in this quarter, and I guess you're saying it is just depending on, you know, the relative contribution of you know, what percentage of the funds you're owning?

That's correct.

Okay.

Brent, this is Ken Wilcox. I just want to add one thing to what Mike has said, and that is we are sticking by our forecast around expenses, but to the extent that the expenses are -- would tick up a few percentage points on a year to year basis, it would be, I think, in some considerable measure headcount, because we are growing, obviously, and that growth needs support in terms of head count additions.

Got you. Okay. Thanks a lot.

Thanks, Brent

Fred Cannon, KBW.

Thanks. I wanted to just ask the deposit product development you guys have. Specifically, I see this Eurodollar sweep deposit product seemed to have jumped considerably linked quarter. I was wondering if that was one of the new products you've developed and if we can continue to see that kind of growth in that and some of the other new products that you have?

Yes, Fred, this is Greg Becker. On the new deposit product, you saw a jump in this quarter mainly attributable to our global clients. And that was an opportunity we have with private equity firms, even clients that are mainly domiciled internationally but have a Cayman Island, I guess, kind of parent, if you will, and so those opportunities are for bringing those deposits into our Cayman sweep account. We saw a nice pop there and much like we saw with the early stage product. Once you release them, there is typically a rapid growth and then a leveling off. And so while we still expect growth in those products, our goal is to release new products over the course of the next six months, and in future quarters beyond that to make sure we can continue to build that momentum of deposit growth.

Great. Thanks. And on the international issue, I noticed that there has been some volatility in the FX line regarding the value of loans driven by kind of the -- the value of the dollar movement and I was wondering if there is any effort to perhaps hedge out some of that volatility?

Actually, we do that, Fred. If you look at -- there's two places that I think the changes come from. So we use FX forward contracts to essentially try to economically hedge that, so you're seeing that number come though the derivatives line item. And then the offset, the one that we value a loan, that actually goes to the other non-interest income pieces. So in reality you need to look at those two pieces in conjunction. So net-net, the effect is typically in a given quarter, plus or minus $800,000. So it is not that significant on a ore-tax basis.

So it's the geography rather than really not?

That's correct.

Okay, great. Thanks very much.

Erika Penala, Merrill Lynch.

Good afternoon.

Hi, Erika.

I guess most of my questions have been answered, but the one follow-up I had on the deposit side is, you know, are you seeing any material opportunities to poach deposit market share from more traditional banks that are perhaps having a bit of an issue? Or are you really successful in bringing on funds that were off-balance sheet on the balance sheet?

This is Greg Becker. And I guess on the deposit side, most of it has been bringing it on to the balance sheet. And the biggest growth has been from early stage companies, so companies that are very early in their formation. That's where the most new client growth is coming from. As far as specifically targeting institutions that maybe are having challenges, there really isn't a concentration of anywhere our target clients would be resident at that we would go after. So yes, that would make it a lot easier but we're not finding that to be the case.

And one more question. It was mentioned during opening remarks that the percentage of earlier stage clients of your portfolio has now -- has shrunk a little bit. Does that mean that your average loan size has changed significantly over the past, let's say, 12 months?

This is Dave. And the average size of the loans have not changed so dramatically over the last 12 months, but if you were to go back to 2000 and 2001, and compare us to a time when the early stage client was relatively significant in the portfolios, to today, where a strong effort for early stage, but as Ken was describing, a diminished percentage of the portfolio -- the average size -- the change in the average size of our clients has increased roughly $500,000.

From what to what?

From approximately $500,000 to now $1 million, approximately.

So it is still a comparatively low average loan size, Erika. And Erika, I would like to add one thing to what Dave said to be 1,000% clear, and that is, in absolute numbers, the number of early stage companies has definitely continued to rise. It's in terms of proportions of loan outstandings that the early stage portfolio would be smaller, simply because of the growth in the larger Company portfolio.

Okay. Thank you so much for taking my call.

Thank you.

John Pancari, J.P. Morgan.

Good afternoon.

Hi, John.

Hey, John.

Just have one question on -- actually around credit. Just wanted to see, what are the areas of concern that you would have at this point? Or what are you watching closely at all on the credit front, given that obviously you've side-stepped a lot of these issues right now the other banks are facing, it gives you time to really sit back and I guess really evaluate the portfolio before the pressure is on top of you, which hopefully it won't be, but what are you seeing on that front? What areas of concern do you have, if at all?

And this is Dave. Let me at least start the response to that. And let me do so with this understanding, that we have indicated that our portfolio quality is strong. We are quite proud of it. So I have the good fortune then of being concerned about credit in an environment that might otherwise suggest that I shouldn't be overly concerned about it. But the things that I would be watching for would include the activities in the early stage, and what is going on with venture capital funding. So Ken indicated that there is a lot of money. There is a lot of money. Ken indicated that a lot of that money is being invested, and it is quite clear that it is being invested. But obviously, if that ever changes, then we need to be monitoring it and being on top of it. So the one thing that I always want to worry about is to make sure that we have the right staffing, the right training, and the right level of attention in terms of monitoring the portfolio that we have today. So always something good times and bad that I will be focused on.

Okay. And does your relationships with the financial sponsors themselves help you be proactive on that front in terms of identifying potential problems?

This is Dave. The answer to that is absolutely. So if you have a relationship with somebody -- in this case the venture capitalist -- then we can have open and direct conversations, and we can have open and direct conversations on both sides of it. We can make the appropriate inquiries of them, and they can give us a sense of their feelings and convictions to the companies that they have funded.

Okay. All right. And then one just housekeeping question. Can you just give us an idea of your outlook for the tax rate for the remainder of the year?

We don't put out the outlook, but I mean you've seen it has been fairly consistent. I mean, one thing you do have to remember this quarter is that Co-Co charge of $3.9 million was non-tax deductible so that is what has affected our book tax rate. But you know, if you think about it without that, that is more or less fairly consistent with last quarter's.

Okay. Great. Thank you.

Aaron Deer, Sandler O'Neill

Under the wire. Mike, I've got a question about the -- with the maturity of the Co-Cos and now the convertible notes, I was just wondering if you could indicate, I guess all else being equal, what kind of additional drop might we see in the average fully diluted share count in the third quarter? And then similarly, what will be the impact on the margin in the third quarter, all else being equal?

Well, start with the first one, the Co-Co. I mean, as I mentioned, the fact the maturity -- what we call the old co as you know it, we probably got a benefit of a little bit over 100,000, 150,000 shares, right around that number; and if you looked at our share count at March 31, we had about 1.2 million in our diluted share count. So you're going to see a benefit of approximately a little bit over 1 million shares that is going to come out of the diluted share count. So that is the first question. Does that answer your question, Aaron?

Yes, it does.

So as far as the second question, with respect to the NIM, or the impact going forward, again, the last interest rate cut that we had was essentially at the beginning of May, which was very modest. So we did have one full month of that that still needed to go through. So for example, there was not that rate cut in April, so that rate cut was only in effect for two out of the three months of the quarter. So we had the one full month effect of that to come through in Q3. But again, that is not that significant in terms of our net interest margin, so I don't really anticipate anything significantly changing a as a result of those rate cuts. The rest would just be the normal play depending on deposit mix and loan mix on how that's going to affect us going forward on the NIM.

But with the -- how about the convertible notes though? Is there an effect there that we will see come through on the margin?

Oh, certainly, yes, I apologize for that. So the coupon on that is what, 3.875%; so that certainly will have an effect. But the thing to remember, that was outstanding for the entire quarter. We essentially brought that in around the beginning of April, so you really are not going to see any incremental additional impact on the NIM from that -- nothing significant.

All right, perfect. Thank you.

Okay. Thanks a lot, Aaron.

All right. This concludes our call. Thanks very much.

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