SVB Financial Group (SIVB) 2014 Q3 法說會逐字稿

Good afternoon. My name is Kyle. I'll be your conference operator today.

At this time, I'd like to welcome everyone to the SVB Financial Group third quarter 2014 earnings conference call. (Operator Instructions)

I'd now like to turn the call over to Meghan O'Leary, Director of Investor Relations. Ms. O'Leary, you may begin your conference.

Thank you, Kyle. And thank you, everyone, for joining us today.

Our President and CEO, Greg Becker; and our CFO, Mike Descheneaux, are here to talk about our third quarter 2014 financial results. As usual, they'll be joined by other members of management for the Q&A. Our current earnings release is available on the Investor Relations section of our website, at svb.com.

We will be making forward-looking statements during this call, and actual results may differ materially. We encourage you to review the disclaimer in our earnings release dealing with forward-looking information. This disclaimer applies equally to statements made in this call.

In addition, some of our discussion may include references to non-GAAP financial measures. Information about those measures, including reconciliation to GAAP measures, may be found in our SEC filings and in our earnings release.

We'll limit the call, including Q&A, to an hour. And with that, I will turn the call over to Greg Becker.

Great. Thanks, Meghan. And thanks, everyone, for joining us today.

SVB delivered a good quarter, with net income of $63 million and earnings per share of $1.22, reflecting continued robust balance sheet growth, healthy loan and fee activity, and solid credit quality. Positive fundings, exit in business conditions for our clients, and our successful efforts at winning and keeping clients enabled us to deliver strong growth for the quarter, including average total client funds growth of 6%, to $60.7 billion; average loan growth of 3%, to $11.4 billion; and core fee income growth of 7%, to $53.3 million. We also posted solid credit quality of net charge-offs of just 28 basis points of total gross loans.

We continue to perform well as a result of our focus on the innovation ecosystem, more positive business conditions for our clients, an expanding market opportunity, and our work to cement client relationships are helping to drive our strong performance.

Exits of VC-backed companies remain strong. There were 21 US venture-backed IPOs in the third quarter, for a total of 86 so far in 2014. 64% of these were SVB clients.

Year to date, the number of IPOs has already surpassed 2013. And at this pace, 2014 is on track to be the best year for IPOs since 2007.

Merger and acquisition activity remains healthy. Year to date, the number of M&A transactions is up 15% year over year at 341, and the values of disclosed deals are up 86% at $8.8 billion.

Strong capital investment continues. Venture capital, corporate venture and angel investment are all up year over year and, at their current combined run rate, are on track to make 2014 the best year for early-stage investment since 2000.

Thanks in part to this ready funding for good companies, an expanding market, and our unique place in the innovation ecosystem, we've continued to win clients at a rapid pace, adding more than 1,300 new clients in the third quarter, primarily startups and early-stage companies.

As we've said in prior quarters, given the strength of these markets, we are paying close attention to today's valuations, which admittedly reflect very high expectations. While some companies and industries may be overheated based on what we're seeing, the business models overall are better. New types of businesses are disrupting and creating entirely new industries, and many of the companies generating the most interest are performing strongly against revenue and growth expectations.

As always, our primary goal with clients is to help increase their probability of success, which we do in a number of ways. One is through improving and expanding our product offerings and infrastructure. For instance, we recently began offering our clients 24-hour foreign exchange trading, placing FX traders in our different time zones around the globe to provide seamless coverage.

This move has helped improve our responsiveness with clients and has helped to drive a 13% increase in FX fees year to date. In the same vein, we recently expanded coverage for wire processing in Asia in order to be able to process same-day transactions for our clients there.

On the payments front, we launched the new Transmission platform that offers clients a secure, direct connection to our payment systems. And in the fourth quarter, we plan to launch our new Global Cards platform, offering credit cards to our UK and European union clients. Our commitment to developing a robust payment platform has helped to boost card payment volumes by 35% and transaction volumes by 46% year to date.

We're also very focused on supporting our clients' success by providing unique opportunities to enhance their business. For instance, working with MasterCard, we established Commerce Innovated, an accelerator dedicated to helping payment startups get to market faster. We have already graduated one class of companies from this program, and our second class is underway.

We're also a lead sponsor of the new FinTech Sandbox program designed to help early-stage financial technology companies put in place the infrastructure necessary to support and offer their services.

And we're a lead investor in the Startup Institute, which runs education programs for individuals two to 10 years out of college who want to transition from larger companies to startups. Think of it as a finishing school to give those individuals the soft skills they'll need to be successful in the startup. Startup Institute is one approach to providing qualified people to fill the large numbers of jobs openings our clients have available.

Activities like these are showing how our differentiated value, which is supporting continued growth and a healthy pipeline. We are pleased with our ongoing strong performance and encouraged by the opportunities we see in our domestic and international target markets.

Despite our good results, we face a number of ongoing challenges, including decreasing interest rates, which we didn't think was possible; increasing regulatory oversight and related costs, and an incredibly competitive market. Low interest rates have been a persistent challenge, of course. More recently, uncertainty in the markets cause long-term rates to decline even further, which impacts our new investment and reinvestment in our fixed income portfolio. And the timing of rate increases has been pushed out.

Regulatory requirements also remain a challenge. We continue to build infrastructure and add people to support the increasingly intensive regulatory requirements related to BSA, stress testing, the Volcker rule compliance and our global activities. All of these regulatory requirements add to our complexity and cost base.

And competition remains intense. It's affecting our pricing and pace of loan growth. As we indicated last quarter, we're not willing to compromise the quality of loan growth for growth's sake. As a result, we're walking away from deals where we believe the risk and reward are out of balance. The good news -- the robust market and our competitive differentiation are still allowing us to expand, win and retain the majority of relationships we pursue.

Now, I'd like to share our initial outlook for our 2015 growth versus 2014. Our outlook is based on the assumptions that our market will remain strong, rates will remain a challenge, we will continue to invest in the business for long-term growth, and competition will remain intense. This outlook is based on our estimates to date, and it is preliminary.

We expect average loan growth in the low double digits. In the last few years, we have had better-than-expected growth in some categories, among them private equity services in the private bank. We think we could see some upside potential in these areas in 2015 as well, albeit at lower margins than other parts of the portfolio.

The market is there. But as we've discussed, the pace of growth will depend on the terms and pricing and the balance of risk and reward.

We expect average deposit growth in the high 20% range. Our clients' liquidity has grown well beyond our expectations, and our acquisition of new clients has been strong. Our 2015 outlook assumes continued strong liquidity growth but with a higher portion of off-balance sheet funds growth relative to deposit growth, as a result of our continued efforts to offer better and more compelling investment solutions to our clients.

We expect net interest income growth in the low double digits as a result of higher investment and loan balances, offset somewhat by lower yields. This forecast is based in part on the market outlook for rates. But as you know, the market outlook changes day to day, so it could be volatile.

We expect continued strength in credit quality, with net loan charge-offs between 30 and 50 basis points of total gross loans, which is comparable to 2014. This assumes the economy remains stable.

We expect core fee income growth in the mid-teens, driven primarily by foreign exchange, credit cards, and client investment fees as a result of new products, solutions and a growing client base.

And finally, we expect expense growth in the mid-single digits. Out outlook assumes we will continue to invest in our online delivery channels, infrastructure, new products and services, and people to support our growth. We also assume ongoing increases in compliance and regulatory costs.

We're feeling positive about the year ahead. Despite the challenges we face, we'll continue to take advantage of the opportunities in our market while maintaining our commitment to disciplined, reasonable growth. Our ongoing investment in our business and our long-term relationships with clients are helping us further solidify our unique position as the leading bank for the innovation economy.

We believe the investments we have made in supporting growth today, combined with the considerable talents of our SVB team, will help us deliver growth over the long term.

Thank you. Now, I'll turn the call over to our CFO, Mike Descheneaux.

Thank you, Greg.

It was a good quarter, even considering the impact of FireEye, which we estimate reduced earnings per share by $0.11 per share. Our results were driven by continued strong execution of our strategy and a positive operating environment for our clients. Nevertheless, we continue to see pressure from low rates, and competition remains intense.

I would like to highlight a few items, which I will cover in more detail shortly -- first, solid loan growth at a modestly stronger pace than we saw in Q2; second, outstanding growth in total client funds, which includes on-balance sheet deposits and off-balance sheet client investment funds; third, higher net interest income and a lower net interest margin; fourth, continued strong credit quality; fifth, higher noninterest income due to investment securities and warrant gains, notwithstanding the impact of FireEye, and solid fee income; and sixth, higher expenses, primarily due to professional services supporting our growth. Additionally, I will comment on capital and updates to our 2014 outlook.

Let me start with loan growth. Please note that these are quarter-over-quarter comparisons except where noted. Average loans group by $359 million, or 3.2%, to $11.4 billion during the third quarter. This growth was driven primarily by capital call lending. Period-end loan balances grew by $668 million, or 5.9%, to $12 billion, driven primarily by capital call lines and sponsored buyout lending.

We view this pace of loan growth as healthy. Nevertheless, competition and turnover of maturing loans in our sponsored buyout portfolio are impacting loan growth overall. As Greg mentioned, our commitment to disciplined, high-quality growth means we are being selective about new credits.

Despite these dynamics, we are seeing a robust pace of activity and continue to win deals based on competitive terms and on the strength of our client relationships. We are maintaining our full year 2014 outlook for average loan growth in the high teens to low 20s, and we expect to deliver results near the top of that range.

Moving to client funds -- we continue to see outstanding growth in total client funds in the third quarter, although at a relatively more moderate pace than in the second quarter. Average total client funds -- that is, average deposits and average off-balance-sheet client investment funds -- increased by $3.4 billion or 5.9%, to $60.7 billion during the third quarter. This compares to total client funds growth of $6.5 billion, or 12.8% in the second quarter.

Third quarter growth was driven by continued strong funding in exit markets for our clients and by our continued success at winning new clients. Average deposit balances grew by $2.6 billion, or 9.4%, to $29.7 billion, primarily driven by our early-stage clients. We are increasing our outlook for average deposit growth for the full year 2014 from the low 40s to the mid-40s and expect to be in the middle of that range. Average off-balance sheet client investment funds increased by $836 million, or 2.8%, to $31 billion, driven by the same strong funding and exit dynamics.

Moving to net interest income and the net interest margin -- net interest income increased by $15.6 million, or 7.6%, to $220.6 million in the third quarter, driven primarily by a significant increase in average balances of our fixed income investment securities portfolio due to strong deposit growth and higher loan prepayment fees.

Average balances of fixed income securities, which include available-for-sale securities and held-to-maturity securities, increased by $3 billion or 20%, to $18.2 billion. These higher balances drove an increase of $10.1 million in interest income to $74.7 million in the third quarter. The increase in volume was partially offset by lower yields on new investments.

Period-end balances increased by $2.9 billion or 17%, to $20 billion, reflecting $3.5 billion in new purchases. New investments during the quarter consisted of $2 billion of fixed-rate US treasuries and $1.5 billion of agency-issued mortgage securities. The increase in the portfolio was offset by $555 million of maturities and mortgage pay-downs.

Average yields on new purchases during the quarter were 1.34%, and durations was 3.2 years. Overall, yields on our fixed income portfolio decreased by 8 basis points, to 1.63%, due to current market rates. Duration at the end of the third quarter was three years, compared to 3.1 years in the second quarter.

Interest income from loans increased by $5.6 million, to $153.3 million, driven primarily by higher fee income from early loan payoffs, one additional day in the quarter, and loan growth. The positive effect of these factors were partially offset by a 10-basis point drop in gross loan yields to 4.39%.

Our ability to grow loans has historically driven higher overall net interest income. But we expect loan mix, competition and a low-rate environment to continue to pressure loan yields moving forward. We are maintaining our outlook for net interest income in the low 20s for the full year 2014. We expect to deliver net interest income at the top of that range.

Moving to the net interest margin -- our net interest margin declined by 6 basis points, to 2.73%, compared to 2.79% in Q2. The decline was largely driven by the deployment of continued strong deposit flows into our investment securities portfolio, although it was tempered by higher fees from low prepayments.

Despite this decline, we are maintaining our current outlook for the full year 2014 and expect a net interest margin of between 2.75% and 2.85%. But we expect to end up near the bottom of that range.

Now, turning to credit quality -- it remained strong during the third quarter. We recorded a provision for loan losses of $16.6 million compared to an exceptionally low $1.9 million in the second quarter. The higher provision was due to net charge-offs and loan growth.

Net charge-offs were $8.3 million, or 28 basis points of total gross loans. This compares to $4.8 million or 17 basis points in the second quarter. Third quarter net charge-offs included $10.7 million of gross charge-offs, primarily related to early-stage software loans and recoveries of $2.4 million.

Our allowance for loan losses for performing loans increased by 3 basis points, to 1.05%, due to an increase in the level of criticized loans during the quarter. However, it is important to note that criticized loans as a percentage of gross loans were close to an all-time low in the second quarter and remain below our trailing three-year and five-year averages. The credit performance of our loan portfolio overall remains very strong.

Impaired loans decreased by $10.6 million, to $11.7 million in the third quarter, primarily due to repayments. At 10 basis points of total gross loans, our impaired loans remain near all-time low levels. We are maintaining our 2014 outlook for credit quality, as previously reported.

Now, let us move to noninterest income. Noninterest income was $80.2 million for the third quarter, compared to $14.2 million in the second quarter. Non-GAAP noninterest income net of non-controlling interest was $75.3 million in the third quarter, compared to $49.5 million in the second quarter. And we encourage you to refer to the non-GAAP reconciliations in our press release for further detail on those figures.

The increase in non-GAAP noninterest income net of non-controlling interests was primarily driven by lower private equity and venture capital-related investment losses of $1.1 million net of non-controlling interests. This compares to losses of $22.1 million net of non-controlling interests in the second quarter.

The decline in FireEye stock price during the third quarter was the primary contributor to these losses, accounting for $9.5 million of losses net of non-controlling interests during the quarter. Notwithstanding FireEye's impact in the third quarter, the positive overall investments [and] exit trends that have benefited our investment securities and warrant portfolios in prior quarters continued.

We saw gains of $8.4 million net of non-controlling interests on the remaining portion of our PE- and VC-related investment securities portfolio, compared to $11.6 million in the second quarter. These gains were primarily due to strong distributions and increases in valuations.

We also had gains of $13.2 million on equity warrants, compared to $12.3 million in the second quarter. Warrant gains were due equally to increases in private company valuations and warrant exercises.

Now, I will move on to core fee income, which remained healthy. Core fee income increased $3.3 million or 7%, to $53.3 million. Core fee income includes foreign exchange, credit cards, letters of credit, deposit service charges, lending related fees and client investment fees, and is a non-GAAP measure. Again, please refer to the non-GAAP disclosures in our press release for more information.

The increase in core fee income primarily reflects a $1.7 million increase in letter of credit revenue in the third quarter, primarily due to a nonrecurring item in Q2 and a $660,000 or 6.4% increase in credit card revenue, to $10.9 million, driven by higher interchange fee income due to increased volume, partially offset by higher reward expense.

Foreign exchange fees remained flat for the quarter, primarily due to mix and following a record second quarter. Foreign exchange has been a strong performer in 2014, growing by 31% year-over-year. And transaction volumes remained strong. We remain on track to meet our full year 2014 outlook for core fee income, with growth in the high teens, and expect to deliver growth at the top of that range.

Now, turning to expenses -- noninterest expense increased by 5% or $8.5 million, to $182 million. This increase was primarily due to higher professional services expense related to increased activities to support our expansion of product offerings, as well as continued investment into ongoing business and IT infrastructure initiatives. As Greg mentioned, we continue to invest in the development of our systems, platforms and delivery channels, as well as additional FTE to support our growth.

Due to higher overall professional services expense associated with these efforts, as well as ongoing regulatory and compliance costs, we are moving our 2014 expense outlook up a notch, from the low double digits to the low teens. And we expect to end up in the lower part of that range.

Moving on to capital -- our capital position remains strong overall, although deposit growth has increased our average asset base and continues to push our regulatory Tier 1 leverage ratio lower. Our bank Tier 1 leverage ratio ended the third quarter at 7.05%, down from 7.51% at the end of the second quarter. Our risk-based capital ratios, Tier 1, and total capital ratios were lower by approximately 40 basis points compared to the second quarter, due primarily to an increase in period-end loans and unfunded loan commitments.

Given our outlook on deposit growth, we continue to closely monitor the trends in our bank Tier 1 leverage ratio to ensure we are positioned to support our future growth. We expect our earnings to support a meaningful amount of deposit growth and continue to target a bank level Tier 1 leverage ratio between 7% and 8%.

As Greg mentioned, we are continuing to focus on offering more off-balance sheet investment options to our clients. We will continue to evaluate the range of options available to us to support our growth and our Tier 1 leverage ratio, including downstreaming cash from the holding company to the bank, as well as turning to the markets to raise capital -- potentially debt securities.

So let me wrap up. We delivered good results in the third quarter, despite continuing intense competition and the historically low-rate environment. While the competitive environments and our commitment to high-quality growth have made it more challenging to replace some of the larger loans that are currently rolling off in the portfolio, our clients remain active, and our pipeline remains healthy.

We have exceeded our forecast for the year so far. And Greg outlined for you that we will continue to see opportunity for growth in 2015. We will continue to focus on delivering solid performance by adding new clients and deepening our relationships with existing clients, growing interest-earning assets and building core fee income.

Thank you. And now, I would like to ask the operator to open the line for Q&A.

(Operator Instructions) Joe Morford, RBC Capital Markets.

Good afternoon, everyone, and congratulations on a good quarter.

I guess, first question was -- looking at the $3.5 billion of inflows of average client funds -- can you give any color, and is that coming more from the record VC funding activity, or the increased number of IPOs? And what kind of impact, if any, do you see the recent market volatility having on that?

I guess the first question, Joe, is about where did it come from, and then kind of what's the outlook.

So when you look at where it came from is -- predominantly, we look at the client base that's driving that. It is more -- early-stage is the biggest driver of that. And obviously, it's driven by venture capital fundings, it's driven by corporate venturing -- even angel investing in that category, which, for the third quarter, was incredibly strong. And then you see additional dollars flowing in from later-stage companies as the [tier] prices in fidelities get more active in putting more money at the later stage. So it's not one area. It is truly across the board.

And we also saw growth in our Asia clients as well, putting in more deposits again as they raise capital. IPOs have some impact, but it is mainly the private companies that are really driving that total client funds growth.

Now, the outlook is -- as we said, and I referred to the 2015 view for deposits -- we still expect to see very strong growth in overall liquidity for our clients. We believe it's going to taper a little bit from where the growth was this year, which makes sense. And part of it is this year was so strong, the growth rate just can't, from my standpoint, keep at this level. But we're still looking for strong liquidity in 2015.

And you said in 2015 you're expecting more growth in the off-balance sheet accounts. How exactly do you see that playing out? Is it new products, is it change in pricing? More considered sales effort with incentives, or what have you?

The short answer is yes to all of the above.

When you think about it with our clients, got to start with what's the right thing for the clients. That's the most important thing. And you can look at our balance sheet right now. And how much of those deposits are sitting in non-interest-bearing accounts? And while the yields that they are getting off-balance sheet aren't substantial by any means, it's the right place for a lot of these funds to go. And right now, there really hasn't been an incentive for them. Because if you can only get 4 or 5 basis points off-balance sheet, is it really worth the hassle?

So what we're trying to do is make it as easy as possible for them to move the money to these off-balance sheet solutions. And so it's tempering that a little bit, moving it more towards the off-balance sheet. Is it going to be a dramatic change? We don't think so. But it really doesn't need to be a dramatic change to make sure that we're coming in within the Tier 1 capital levels that we want to be at.

That's helpful. Thanks, Greg.

Thanks, Joe.

Steven Alexopoulos, JP Morgan.

Maybe I'll start, just to follow up on that -- it looks like you had less success in the third quarter than the second quarter in directing clients into the off-balance sheet product. Is that because you just have more capital, so you didn't push as hard? Or has demand for that product just trailed off here?

Steve, this is Greg. I wouldn't read anything, quite honestly, into the third quarter. Because you can see in any quarter some pretty big swings. So I don't think it's a less emphasis on it. I don't think it was less compelling to move off-balance sheet. I would look at the trend and kind of the guidance that we're giving.

So I think, as I said to Joe, it's the product set that we have, it's making sure we're making it as easy for our clients to move it off-balance sheet, and also really targeting some of the really large depositors that have hundreds of millions of dollars sitting in an account, where it truly is the best for them to move it off-balance sheet. So we obviously expect to make progress on that over the coming quarters.

Okay.

What was the balance of the sponsor-led buyout loans at the end of the quarter? And can you talk about what pay-downs were? And are pay-downs in that bucket basically the key driver of your 2015 outlook, which is a bit more modest than it was at this stage last year?

This is Marc Cadieux. The sponsor-led buyout portfolio was actually up a bit in the third quarter. It's about 16% of our loan portfolio. Recognizing that to be a pretty good outcome, inasmuch as we did see some significant loan payoffs at the same time. So, encourage that, [had] been a slower part of the growth in the first half of the year, as its leverage kind of moved away from us and caused us to compete less frequently. But we saw some more strength there in the third quarter.

Steven, let me give perspective on next year. We still expect to see payoffs to occur in the buyout portfolio in 2015. And although we expect to see growth in that area, the market's a strong market. And so you're starting to see exits happen with the private equity firms as they try to sell these assets. So we're replacing and growing that portfolio.

The rest of the growth [is] really going to come from, I'd say, mainly a couple different areas, but then it's broad-based below that. The main areas are private equity services, the private bank; again, we'll see some in the buyout. And then, to a lesser extent, we're going to see global and the general technology market. So across the board, but predominantly private equity services, the private bank, is what we expect to see that.

And again, the temperate growth -- first of all, still feel good about the growth in the low double digits. But it is -- from a competitive standpoint, we expect the market to be very competitive. We're going to be very selective on where we want to play.

And as I said in my comments, there's upside there. And if we do see upside, I would expect that to be in the private equity services and the private bank.

Thanks, Greg.

Maybe just one final one -- the loan-to-deposit ratio pushed down below 40% again. And looking at the preliminary guidance, it's going to push down even further next year. Are you guys considering any other lending areas within your niche, or even options such as loan purchases, or anything like that? Thanks.

Yes, Steve, this is Greg. When I go back and look over the last 10 or 15 years, I would say where we have strayed from our focus, we probably have stumbled more than we've done a good job. And I think that really tight focus on our market, the markets that we serve, is really the right place for us to stick to.

When I think of expansion, I think of global. Global was a little bit flat this quarter, but mainly because of pay-downs. And as I've said in prior earnings calls, I look at global, and that's an area that should be growing 30%, 40%, 50% on an annual basis. I'd rather, again, stick to our target market, and in global, and in sponsor-led buyout, private banking and those areas. Because if we can still grow in the low double digits and maybe have some upside there, that feels right.

Your loan-to-deposit ratio question really is a function not of loan growth, which is a strong; it's actually more of a function of we have such a strong deposit franchise that that tends to swamp the growth we have in loans. I'll take that any day, because it really is a sign that we're really targeting a very robust market.

Okay. Thanks for all the color, appreciate it.

Yes.

Julianna Balicka, KBW.

I just wanted to follow up on a couple different areas. One, in terms of the competition that you highlighted as being more intense in your remarks, what about the competition changed linked-quarter and/or about the outlook on competition change that you have highlighted it so differently in this call? I mean, is it new entrants? Or is it pre-existing entrants becoming more competitive on pricing? Is it underwriting terms? I mean, what was the catalyst behind the change in tone?

Julianna, this is Greg. I'll start, and Marc may want to add to it.

When I think of the competitive landscape, and we compete on a debt basis -- you're looking at price, size and structure being the three components. And I've said in prior calls, you can look at all three of those components, and we're seeing very aggressiveness in all three of those areas.

And pricing is one thing. And we've seen that maybe start to really be impacted. A couple years ago, pricing is getting even more competitive. And the areas that we're being more sensitive about is really on the structure. And when structure starts to give, that's when we are starting to back away. So it's really the aggressiveness in structure that we're seeing that we're really making sure we're sharpening our pencil in being with the right companies.

Has anything changed dramatically? No. But the longer you see that intense competition at a certain level, it becomes more challenging to figure out where you want to play and where you don't want to play.

That being said, as I mentioned in my comments, we're still winning the majority of companies we want to pursue either by winning new business or retaining existing clients. And that's really because we offer a very differentiated both product solution and value add to our clients compared to our competitors.

So I wouldn't say it's new competition. I wouldn't say something's changed dramatically. It's just the continuation of that intensity.

Okay, that makes sense.

And then, another area in your remarks that struck my attention was how you had highlighted the regulatory and compliance costs, which of course many banks are encountering. However, in your outlook for 2015, your increase in expenses doesn't seem out of line with your previous outlooks, and beginning-of-the-year outlooks in previous times. So is it that you are investing less in certain growth areas and replacing that with compliance costs? Or how should we think about kind of what's going on in the mix of the expense growth?

Sure, Julianna, this is Mike here.

So, you are right, we are forecasting a decline for us in the growth rate of expenses for 2015. But just backing up a step -- as you know, one of the main reasons why 2014 expenses have increased from the initial guidance is because of outperformance, the incentive compensation that goes along with the outperformance. So as a result, the primary reason why we've gone from that initial forecast of mid-single digits to our new outlook for the rest of the year, for 2014, is almost entirely related to incentive compensation.

Having said that, we have continue to invest in systems, delivery channels. And as well, there's been some compliance and regulatory costs as well, too. But again, we have the outlook there for 2015. Because again, you go into the year, and you start anew with new targets. And again, if we over perform those initial targets, you'll see it go up. But again, it's that pay for performance.

So it sounds like the regulatory aspect of it is kind of as an outgrowth of your strategic investment initiatives as opposed to an input, like for banks that are, say, crossing $50 billion. You know what I mean?

That's right. I mean, we've been investing and dealing with regulatory challenges, like a lot of banks have, for quite some time. So it's nothing new for us; it's just a continued added expense.

Okay.

And then, finally, I found your comments about financial technology interesting. And I had a question about that, kind of speaking of competition. Do you think about nonbank lenders as a direct threat, such as Lending Club? Or how do they even interact in your space? And what's your view of nonbank lenders as you go on to support financial technology?

Sure, Julianna, this is Greg again. Actually, we view them as being great opportunities for us to partner with them. Most of the nonbank lenders that are out there are going after consumer finance in some form or fashion, which, as you know, we don't do, or just through our private bank. So we look at partnering with them and really figuring out how to leverage them -- having them leverage us in our infrastructure for payments and solutions. So we view it more as an opportunity as opposed to a challenge or a competitive threat.

And we have a whole payments team dedicated to not just these type of companies, but really payment companies or FinTech companies in general, again, so we view it as an opportunity.

This is Marc. The only thing I would add to that is -- I think Greg's remarks are about FinTech and payment companies, and I'll call it that category of nonbank lender. We do have competition from another category of nonbank lender both at the early stage and for sponsor-led buyout. These are (multiple speakers) venture debt funds, BDCs, those sort of things. So we're kind of bifurcating those two things.

I see, it makes sense. Thank you very much.

Yes, absolutely.

Aaron Deer, Sandler O'Neill & Partners.

I just want to, I guess, rehash a couple of points here that have been topics. One is on the expense line. Can you give any color behind the suddenness of this increase that you've had in the professional services? Was there something in particular this past quarter that drove that higher?

No, nothing in particular, Aaron. Again, you start initiatives, there's some timing challenges as well too, right? So you begin to think you're going to start some projects at the beginning of the year, where you'd have more smoothing or so of the expenses. But again, just some of the projects that did start in the Q3.

And so this is truly a run rate going forward off of this base level?

Well, I think probably the best thing for you to do is refer to our 2015 outlook, so kind of going back to that mid-single digits. And obviously, we give you the rest of the outlook for 2014. I think you can kind of back into what would be kind of a normal average. Again, as you know, we look at more the full year versus by quarter number.

Fair enough.

And then, in dealing with the deposit challenges -- you guys have had these extraordinary deposit inflows for quite some time. So it's not a new phenomenon. I got to think you guys been trying to work on and develop these alternative products to get some of this off-balance sheet for a while. So where does that stand in process? When might you expect to see something coming online that has a real incentive to bring some of this off the balance sheet?

Sure, Aaron, this is Greg. Let me take a step back first.

When I look at the growth in total client funds, we expected growth. We didn't expect growth anywhere to the degree that we have seen. So I think it would be hard for anyone to have predicted that. That's a function of two things, right? The market, number one; and our success of winning new clients. It's those two areas combined that have driven this growth.

And when we think about the answer to your question, which is how successful have we been, I would argue we've been very successful when you look at the amount of liquidity that has moved off-balance sheet. The challenge has been the entire growth has been massive. So we've done a really good job. But the growth has been even faster than that.

So when we talk about what else are we doing, those are the products and services, and making it simple for our clients to move that money off-balance sheet. So we're working more on that simplification to make it easy and compelling for our clients to move off-balance sheet, and just a renewed focus.

I would tell you that I expected two things to happen. One is the deposit growth to temper a little bit more from a volume perspective, just based on lower funding -- really hasn't happened -- number one. And number two, my hope as well was that interest rates were going to be heading up, growing in the second quarter of next year. And as that happens, it's easier to direct that money off-balance sheet as there's better opportunities for them.

And as I said in my comments, we didn't think rates could go lower. I guess we didn't think rates could continue to be extended. And that changed a couple weeks ago.

And so those two things are really causing us to have a renewed focus on making sure that simplicity of moving deposits off-balance sheet is the right thing for us and the right thing for our clients.

Okay. Thanks, Greg.

Yes.

Jared Shaw, Wells Fargo Securities.

Could you just let us know what the total prepayment penalty was for the quarter, and what your expectations are on that specifically going forward?

Roughly, the prepayment fees that we're referring to were roughly around $4.5 million is what we had talked about. And it varies quarter to quarter. I mean, I think that was a pretty good quarter on that one. I wouldn't necessarily say that that's the run rate. But again, you can look to the last couple of quarters in our disclosures and our press release if you want to kind of map it out and graph it out.

Okay.

And then, Greg, you had mentioned a little bit about some frothing is in the valuation in the IPL markets. Any particular industry that's giving you concern? And is that more -- you think we're at a plateau there, or that [things] should start pulling back from those valuations?

Yes, Jared. You're mainly seeing, I'd say, higher valuations in Software as a Service, cloud computing, security companies, market places, social -- so those general categories that probably all wouldn't surprise us.

Then you really see a big distinction, where companies that start to hit performance levels -- once they start to see good trends, that's when you start to see valuations pick up dramatically. And also the dollars that people are willing to invest in these companies pick up dramatically.

Again, the size of these rounds are massive. It's the largest sort of financings I've seen for private companies, where you're seeing consistently $50 million, $75 million; in some cases, even $100 million rounds being closed. And those are the areas where you're really seeing what I'll call price for perfection occurring with these high-performing companies.

Great. Thanks very much.

Yes.

Brett Rabatin, Sterne, Agee.

Wanted to just talk about, with this deposit obviously continuing to be faster growth, and that's the expectation as well on 2015 -- can you talk maybe a little bit about -- obvious disappointment with what's happened with rates, but any thoughts on [barbrall] strategy in the securities portfolio going forward; i.e., can the net yield improve in the taxable AFS portfolio? Or do you continue to be super conservative with what you're doing their very short-term, and so maybe it continues to be under pressure? Any thoughts around that?

Yes, no doubt there are pressures on the investment securities portfolio, for sure.

I would say we have to be sensible. Because when you start to look at the size of our investment portfolio in terms of proportion to your balance sheet, you've got to be really sensible, right? So we now are up to $20 billion of our -- we have $20 billion of investment securities versus the $36 billion balance sheet. So as you know, you've got to be very cautious. Because if interest rates move, and the rates [gap] up, that obviously can cause some challenges.

So for us, the primary area that we are going toward is liquidity. Obviously, in the low rate environment, much across the curve, rates are just low. And you just don't get paid to go out any longer duration. So I would say you would probably continue to see us by US treasuries, continue to see us kind of in that three-year duration. Yes, we might be able to go up a little bit as well. But again, you've just got to be conscious of that, and again just not go and chase yield.

Okay.

And then, I guess the other thing I was hoping to maybe get a little bit more color on was with the prior commentary around competition and that having an impact on the loan yields. I mean, they're still very robust. I guess I'm just curious if you guys have any thoughts on the magnitude of declines in the portfolio yield. Saw it obviously from the noise with loan fees. But does that pick up going forward? Or do you kind of feel like that is a manageable grind despite the environment?

This is Mike again. And I'll start, and some of my colleagues can jump in.

But yes, I think the bottom-line answer is you will continue to see pressure on loan yields. And it's for a variety of reasons, right? Part of it is actually the loan mix. So as we go into adding more private equity, capital call lines of credit; those tend to be in a lower rate, albeit very high credit quality.

So if you go back and look at kind of that declining glide path, or declining loan yields over the last two years or so, you're probably going to see continued declines of that nature in the loan yields. It's just the nature of the mix, coupled with the fact that what we talked about was the competitive environment is really, really fierce, right?

And so, when a loan actually goes up for renewal or rolls up on an annual basis, again, given the competition and tighter spreads, and just overall lower rates in the market, you're going to see those kind of compress.

So yes, it definitely continues to be under pressure. But again, it is just reflective of the market.

But it sounds like, Mike, you're basically saying that with the environment getting somewhat more competitive, you don't necessarily expect that pressure would increase on yields on a relative basis to past quarters, necessarily?

Brett, this is Greg. I'd probably say that, again, is you have a portfolio of loans. And as those loans come up for renewal, it's in some cases a very competitive process. And so you would see some yield deterioration, just based on the churn in the portfolio as new deals are added. That combined with, Mike said, the mix, you should continue to see some pressure downward on loan yields.

What I think is important to note, though -- and you mentioned this at the beginning of your comments about where our loan yields are, which are still actually good relative the market -- and it's mainly because we've spent so much time talking about the value add that we bring to the table, and companies want to work with us. Because again -- and it may sound somewhat trite that we can help our clients be more successful -- we really believe that, and we hear it from our clients.

And so that does give us a pricing premium in the market. And we don't take that lightly. We have to deliver on that. But it still is a very competitive market, and that trend downward in loan yields is what we'd expect to see.

Okay. That's actually very helpful, Greg. Thank you.

Yes.

Ebrahim Poonawalla, Bank of America.

All my questions have been asked. Thank you very much.

Yes.

Thank you.

David Long, Raymond James.

History has shown that you guys have been able to keep funding costs low, even in a rising-rate environment. I wanted to get your view here. And it's maybe a different -- times are different this time around. Looking out over the next couple years, if we do get that rate increase in the short term, how do you see that playing out with your deposits? And will you be able to keep your funding costs low like you have in the past? Thanks.

Very good observation. Our deposit franchise has been very strong and been known for very low-cost deposit base, primarily because we keep a significant amount of our clients' operating cash on the balance sheet. And for those clients who do want yield, we tend to get them in the off-balance sheet.

Going forward, it's anybody's guess. But I guess when I step back and look about it -- if rates go up, then clearly there could be a [need] that's we might have to pay more for deposits to keep them on the balance sheet. Which is okay, it's not necessarily a bad thing. Because what that means is rates are likely up. Because then, on the asset side and the loan side, you'd actually be making more interest income as well, too, which allow you to pay up for the deposits if you actually need them. Right?

So we've been very, very fortunate, very, very liquid, and had significant amount of deposits under loan growth. So I think we're in a really good position. But time will tell whether or not we will actually have to pay up.

But again, if you look at history, history shows that we have a large amount of demand deposits, and we don't really have to pay up for them.

Dave, this is Greg. Let me just add on to that.

The one thing I think it's important to keep in mind is looking at the total client funds number, and the amount of money that companies would typically keep in an operating account even if rates start to pick up. So let's just use the simple math here. $60 billion of total client funds -- if you were to keep 20%, 25% in operating cash, you can look at -- just in a DDA account or checking account, you can look at $12 billion to $15 billion sitting in that operating account, even as rates pick up.

And so when you think about that being the main part of your funding cost, keeping that at a very low level, zero -- obviously, that has a big impact on what your total cost of funds actually is.

So I think going back and looking at that in a historical basis and a higher-rate environment, I don't see the mix of operating cash to total cash being that different.

Got it. Thanks for the color, guys.

Yes.

John Pancari, Evercore.

On the competitive topic again -- can you give us a little more detail? What loan types are you seeing the greatest amount of competitive pressure right now? And if you can, can you give us an idea of where your new production yields are coming in it? Thanks.

Sure, John, this is Greg. And then I'll have Marc add even more color to my comments.

We're seeing competition across the board. And you can look at it at the early stage, you can look at mid-stage in the buyout financing. You're seeing refinances come. So you're seeing it from a variety of different areas. It's interesting, you're seeing competition also from the amount of liquidity in the market. Right? When you see these companies that are raising massive rounds of equity financing, you sit back and you say -- even though you may have availability of a term loan, or even acquisition financing in some cases, you sit back and say -- why would I even spend, even if rates are low, money to borrow, if you have this excess liquidity that isn't earning a whole lot?

So our utilization rates have dropped down a little bit. But we are seeing again competition pretty consistent across the board. I'll have Marc add some color both on where we are seeing it more, but also on where the yields are.

Yes.

Well, as Greg mentioned, the competition is broad-based. It's pretty much in every segment of our business.

To give you a sense for where yields are in the current environment, and maybe focusing on those areas where our growth has been the greatest -- capital call lending -- the range there tends to be in the high 2s to low 3%. The same for our private bank -- has been in the low 3% of late.

Going to some of the higher margin, which maybe we wish were growing a little more, a sponsor-led buyout would still be in the low 5% range. Again, we're talking interest-only yields and net of fees. And then finally, our early-stage lending tends to similarly be in that low to mid 5% range.

Okay. And the later stage is just similar to traditional C&I, I guess, that the other banks are seeing?

Yes, later stage would be in that high 3% to -- maybe mid-3% to low 4% range.

Okay.

And then, separately, can you give us just an update on the size of the global loan book, and then also the growth rate that you're seeing there? Thanks.

Sure, John. It's Greg.

If you look at the total loan portfolio, the global loan portfolio, which includes London global private equity service [biz], so private equity firms, capital call loans that are international -- what we're seeing in those kind of two areas mainly -- you're looking at about $800 million of total loans.

This past quarter, we saw some pretty significant pay-downs with a couple credits that were on the more substantive side. That being said, the pipeline and outlook is very strong. And so that's an area again, as I mentioned in my earlier comments, that you could see substantial year-over-year growth, just because we're still coming into the market, especially UK. And we're delivering our full product set from a lending perspective, from early-stage loans to buyouts to private equity services. And it's a small base to grow from, so the percentages actually tend to be higher.

So that, we feel very good, is an opportunity for growth for the next several years.

All right.

And then lastly, on your comments about spending on risk and compliance through this year and in your expectations for next year, are you pretty much implying that the spending you're doing now you feel is starting to factor in the infrastructure here going to need as you approach and surpass $50 billion?

John, this is Greg.

It's not as if you hit a switch, and one thing -- and all of a sudden, everything changes. It's something you build into. And the regulators are looking at this. And although they don't say you have to comply of the $50 billion today, they are asking for greater -- just increasing the bar on a regular basis. So yes, it's being built-in. Is part of it heading towards the $50 billion? Yes, sure, part of its heading towards the $50 billion. But it's kind of a steady increase that we see on a quarterly basis.

Okay. Thank you.

Absolutely.

There are no further questions at this time. I'd turn the call back over to Greg Becker for closing comments.

Great.

Well, thanks, everyone, for joining us today. We delivered another real good quarter of growth in deposits, in core fee income. So feel very good about that. And it's really because we're in the right market. And we believe we have the right strategy not just for 2014 or 2015, but we have the right strategy for many years to come. And we're so [fortunate] to have such great clients that support us, and great employees that help us support those clients.

So, feel really good about where we are, really good about where were going. And hope everyone has a great day. Thanks.

This concludes today's conference call. You may now disconnect.