SVB Financial Group (SIVB) 2018 Q1 法說會逐字稿

Welcome to the SVB Financial Group Q1 2018 Earnings Call. My name is Adrienne, and I'll be your operator for today's call. (Operator Instructions) Please note this conference is being recorded. I'll now turn the call over to Meghan O’Leary. Meghan O’Leary, you may begin.

Thank you, Adrienne, and thank you, everyone, for joining us today. Our President and CEO, Greg Becker; and our CFO, Dan Beck, are here to talk about our first quarter and -- financial results and will 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'll 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, which 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 expect the call, including Q&A, to last approximately an hour. And with that, I will turn the call over to Greg Becker.

Thank you, Meghan and thanks, everyone, for joining us today. We had an excellent first quarter with exceptionally strong performance across the business. We delivered earnings per share of $3.63 and net income of $195 million. These results were driven by continuing trends of strong client liquidity, healthy balance sheet growth, higher rates, strong core fee income and stable credit quality. Our results also reflect the impact of approximately $16 million after tax of losses related to the sale of shares we held in Roku, which equates to an earnings impact of $0.30 per share.

A few highlights from the first quarter compared to Q4. Net interest income increased by 6.5% to $421 million. Average loans grew 6.1% to $23.8 billion. Average total client funds grew by 7.9% to $110.5 billion. Core fee income increased by 8.1% to $115 million. And we delivered a return on equity of 18.1%.

Our business is doing well across the board and performing better than expected on many fronts. We are seeing healthy activity among our clients, particularly private equity, life sciences and international, and our pipeline remains strong. Based on our performance in the first quarter and the dynamics we're seeing in the markets, we're making a number of positive revisions to our 2018 full year outlook for balance sheet and revenue growth, which Dan will get into in a few minutes. I'll preference his remarks with some commentary on our markets and the drivers behind our improved outlook, and I'll touch on a few business highlights as well.

The strong availability of capital has been a primary driver of our healthy client markets and our solid performance, and it appears to be getting even stronger. Venture capital investment topped $28 billion in the first quarter, marking the fourth successive quarter above $20 billion and the best quarter since the first quarter of 2000. With 16 U.S. venture-backed IPOs in the first quarter, the best quarter for innovation IPOs in 3 years, the IPO market has improved and the pipeline remains relatively healthy. Some industry watchers believe that recent strong IPO performance by high-profile companies and pent-up investor demand for stock in high-growth companies could lead to a wave of IPOs in 2018. Secondary offerings have also been exceptionally strong, particularly for our life science clients, who raised $2.4 billion in secondary offerings in the first quarter.

The primary weak spot in the markets is M&A-related exits, which have been sluggish overall. Nevertheless, our clients' liquidity, which was already robust, has continued to increase, supporting the growth and expansion of existing companies and encouraging new company formation. This environment also contributed to the strongest new client acquisition in our history, with more than 1,300 new core commercial clients in the first quarter.

We saw significant first quarter benefits from a number of market tailwinds. December's tax cuts resulted in a first quarter EPS benefit of $0.56 per share, which was significant, though generally in line with our expectations. In addition, the December increase in federal funds rates and the dramatic rise in LIBOR in the first quarter drove higher yields, strong net interest income growth and significant margin expansion, and we expect further benefit from the March Fed Funds rate increase.

So our markets are thriving, our clients are doing well and we're benefiting from market tailwinds. But just as important as these factors is our ability to execute on the changes, investments and enhancements to our business that will drive and support our continued growth. Here are a few highlights from the quarter.

We continued our international expansion. We realized a significant global milestone by receiving formal authorization from Canada's Minister of Finance to establish a lending branch in Canada, and are now awaiting final approval from the Superintendent of Financial Institutions. We also finished building out our team in Germany and believe our branch approval there is imminent. In general, we continue to build momentum in Europe on all fronts, most notably crossing the 2 billion threshold in loan balances in the first quarter.

We made investments to continue building out our products and capabilities. To that end, our recent enhancements to our treasury and asset management platform improved our retention of client funds following funding events in the first quarter, especially in our life sciences group. This contributed to higher off-balance sheet fund volumes, which in turn drove higher client investment fee income.

Our initiatives to drive stronger on-balance sheet deposit growth, while still very early, are already starting to having an impact. In the first 4 weeks, we saw 150% increase in the pace of new client deposit accounts related to these efforts. We expanded our energy and resource innovation practice, hiring our team of seasoned ERI bankers to help grow our project finance portfolio.

On a related execution note, I'm proud to say that as a result of our growing market cap and continued strong performance over time, on March 15, SIVB was added to the S&P 500.

While our outlook for the year ahead is notably improved, we continue to manage and monitor a number of challenges. As always, competition for loan from banks and nonbanks remains intense. And the high availability of equity provides an additional headwind to loan growth. And exit markets remain mixed, with strength in IPOs being offset by sluggish M&A. With so much available liquidity driving up private equity company valuations, the bar for a successful exit is high, which could further slow the exit markets and impact VC funding.

These challenges notwithstanding, our clients in the innovation economy continue to prosper overall, and they're expecting good things in 2018. In our annual startup outlook, a survey of more than 1,000 entrepreneurs, which we released earlier this year, 69% of respondents successfully raised capital this past year. And nearly 1/4 say it's easy to raise funds in the current environment, double the number who said that last year.

More than 80% plan to add employees, the highest level in 5 years. 94% believe that business conditions in 2018 will be as good or better than 2017, and 91% believe M&A will be equal or better.

Clearly, the innovation community is optimistic. We are optimistic too, about our markets, our clients, our ability to drive continued growth. To that end, as we've discussed in our prior quarters, we remain focused on a small group of internal investment priorities that span our people, our systems and our processes around the world. These include: raising the bar on client engagement; supporting long-term growth across the platform; growing fee income through stronger relationship management and expanding product set and broader partnerships; and enhancing risk management across the organization.

We're off to a strong start for the year, and our 2018 outlook is much improved as a result of our performance to date, the investments we're making and the substantial tailwinds we're benefiting from. Our target market is creating lots of opportunities for us. And we're doing the right things to ensure we can continue to grow and maintain our leadership well into the future, solidifying our position as the Bank of Choice for innovators and their investors around the globe.

Thank you, and now I'll turn the call over to our CFO, Dan Beck.

Thank you, Greg, and good afternoon, everyone. Our excellent quarterly performance was the result of continued strong liquidity trends and a positive business environment for our clients, the impact of higher rates and lower taxes and solid execution on our growth initiatives. The quarter included the following highlights: one, strong growth in net interest income due to very healthy loan growth and higher yields from loans and fixed income investment securities; two, outstanding client funds balance growth, both on- and off-balance sheet; three, higher core fee income; four, continued stable credit quality with solid underlying trends; five, good gains on warrants and equity investment securities, excluding the impact of Roku; and six, controlled expense growth.

As Greg indicated, due to the impact so early in the year of better-than-expected client liquidity and balance sheet growth as well as higher Fed Funds and LIBOR rates, we are raising our full year outlook on all our balance sheet and revenue business drivers. I will get into those specifics in a moment.

Now let's turn to our operating results, starting with the balance sheet. Average loans increased by $1.4 billion or 6.1% to $23.8 billion, driven primarily by new loans and increased utilization in our private equity capital call lines and good growth in loans to our technology and life sciences clients. These drivers were further helped by lower M&A-related repayments by our clients. As a result of our strong loan growth and healthy pipeline, we are raising our full year 2018 outlook for average loan growth from the mid-teens to the high teens.

Average total client funds grew by $8.1 billion or 7.9% to $110.5 billion due to strong new client acquisition, a robust equity funding environment for our clients and the best quarter for IPOs in the last 3 years. Total client funds balances reflected average deposit growth of $1.3 billion or 3%, driven by our clients' strong liquidity and, to some extent, due to early results from our initiatives to drive stronger on-balance sheet deposit growth. We also saw average off-balance sheet client investment funds growth of $6.8 billion or 11.8%, particularly driven by robust secondary offering activity and healthy IPO activity among our life sciences clients as well as by improved fund retention by our asset management teams, following client liquidity events. Due to strong pace of on-balance sheet deposit growth in the first quarter and our forecasted balance growth from the recently implemented deposit initiatives, we are raising our full year 2018 average deposit outlook from the mid-single digits to the low double digits.

Average assets grew by $1.6 billion or 3.1% to $52.4 billion, and period-end assets were $53.5 billion. As predicted, we crossed the trailing 4-quarter average $50 billion SIFI threshold in the first quarter of 2018. And we are now subject to the Enhanced Prudential Standards applicable to banks over $50 billion. We would expect to file a public CCAR report in 2020, barring any changes from the Regulatory Relief bill in Congress.

Now I'd like to turn to the income statement. Net interest income increased by $25.59 million or 6.5% to $421.2 million due to loan growth and the impact of higher rates on loan portfolio yields and reinvestments at higher rates in our fixed income portfolio. Higher loan balances and higher Fed Funds and LIBOR rates drove an increase in interest income from loans of $17.3 million to $297.1 million in the first quarter. This increase reflects an offset of approximately $6 million from lower prepayment fees. As a result of these rate increases, average gross loan yields, excluding interest recoveries and loan fees, increased by 20 basis points to 4.52%.

In our fixed income investment portfolio, higher yields, mainly from reinvestment at higher market rates, drove an increase in interest income of $9 million to $131 million. We purchased approximately $2.4 billion in new investments in the first quarter at approximate yields of 3.5%. Our net interest margin increased by 18 basis points to 3.38%, due primarily to higher loan and investment yields, driven by higher interest rate and loan growth.

As a result of our improved full year balance sheet growth outlook as well as the impact of higher rates on our investment securities and loan portfolio yields, we are increasing our full year 2018 outlook for net interest income from the high teens to the low 30s. We are also raising our full year outlook range for net interest margin by 15 basis points to a range of 3.5% to 3.6%.

Now I'll move to credit quality, which remains stable with solid underlying trends. Our provision for credit losses was $28 million compared to $22.2 million in the fourth quarter. The majority of this increase, $14 million, was for loan growth, with $11.3 million tied to net new specific reserves for nonaccrual loans and $1 million for unfunded credit commitments.

Net charge-offs were $8.8 million or 15 basis points of total average loans compared to $12.9 million or 23 basis points in the fourth quarter. Charge-offs came primarily from early-stage loans.

Credit quality has been a consistent bright spot for several quarters. While we continue to monitor our client base in the markets for anything we believe could affect the future repayment activity, the trends in our portfolio indicate continued stability for now. With that in mind, we're maintaining our credit outlook for 2018. And at this rate, we would expect to come in at the low end of our outlook for net charge-offs.

Now I'll turn to noninterest income, which is composed of core fee income, gains from private equity and venture capital investments and gains from warrants. GAAP noninterest income was $156 million compared to $152 million in the prior quarter. Non-GAAP noninterest income, net of noncontrolling interests, was $142 million, a decrease of $2 million from the prior quarter. This decrease was mostly due to $22.2 million of pretax losses on the sale of Roku public equity securities upon expiration of the lock-up period in late March. Although our sale price for these securities was lower than their value at December 31, 2017, it's important to keep in mind that net gains from our investment in Roku were nearly $46 million. Excluding the impact of losses on the final sale of our Roku shares, we had very strong noninterest income growth, with healthy gains from warrants and private equity venture capital-related investments, along with increases along all core fee income categories.

Core fee income increased $8.6 million or 8.1% to $115 million. This growth was driven primarily by: an increase in client investment fees of $4.3 million from higher fund balances and higher rates; an increase of $2 million in deposit service charges due to strong volumes, which is not typical of the first quarter; and better-than-expected FX revenue from our larger clients as a result of focused sales efforts on our part. As a result of these impacts as well as the expected impact from improved spread on our client investment funds related to a change in fund providers, we are raising our full year outlook for core fee income from the high teens to the high 20s.

Net losses on investment securities net of noncontrolling interests were $3.8 million compared to gains of $8 million in the prior quarter. Excluding the $22.2 million of losses on the first quarter sale of our warrant-related Roku securities, we had net investment gains of $18.4 million, primarily due to unrealized valuation increases from investments in our private equity and venture capital funds. Equity warrant gains were $19.2 million compared to $12.1 million in the fourth quarter, with the increase mainly coming from higher realized and fair value gains across the portfolio.

Now turning to expenses. Noninterest expense was $265.4 million compared to $264 million in the fourth quarter. This increase was primarily related to higher incentive compensation costs due to our strong first quarter performance, along with seasonal compensation expenses. These increases were mostly offset by lower professional services costs due to project timing. We expect professional services costs and expenses overall to be higher in the remaining quarters of the year as we continue our investments in growth, infrastructure and employees. We also anticipate higher levels of incentive compensation driven by our improved outlook. That said, we expect expenses to be at the higher end of our stated full year growth outlook of the low double digits.

Turning to taxes. We saw a tax benefit of more than $30 million in the first quarter as a result of tax cuts, with an effective tax rate of 27.5% compared to 53.5% in the fourth quarter of 2017. Normalized for the write-down of our deferred tax assets, our fourth quarter effective tax rate was 38.7%. Based on our first quarter implementation of the new tax rate, we anticipate being at the lower end of our target tax range of 27% to 30%.

Moving to capital. Capital and liquidity remained healthy with strong growth in regulatory capital during the quarter. While growth in risk-weighted assets from higher loan and investment balances reduced the bank's risk-based capital ratios somewhat, our bank Tier 1 leverage ratio increased by 13 basis points to 7.69% and remained well within our target range. Given our strong growth forecast for loan balances and the newly implemented deposit strategies, we expect that the majority of our earnings capital generation will be used to fund balance sheet growth for the remainder of 2018.

In closing, we had a tremendous quarter, and we have significantly improved our outlook for the full year 2018. Our improved outlook assumes our business and the markets continue on their current path. Upside could come from further rate increases or continued growth in our clients' liquidity. By the same token, a notable decrease in venture capital activity, higher loan repayments related to M&A, intensified competition or a significant market slowdown could all negatively impact our outlook. But for now, we are off to a strong start in 2018.

Our business and our balance sheet remain robust, reflecting our clients' access to ample funding and liquidity in a still strong economy. We are executing well, delivering solid growth and return while benefiting from higher rates and lower taxes. Our already positive outlook for 2018 has improved notably and we're well positioned for future growth, assuming the macro environment does not change materially. In the meantime, we remain focused on implementing our growth and operational initiatives, delivering high-quality growth with stable credit quality and maintaining optimal capital and liquidity to position ourselves for success in the long term.

Thank you, and I'll now ask the operator to open for Q&A.

(Operator Instructions) And our first question comes from Ebrahim Poonawala from Bank of America.

So I guess just first question around the deposit growth outlook and the change there. One, would love to get your thoughts around the visibility that you have on the deposit growth outlook. We lowered the guidance in Jan relative to the preliminary outlook in October. I just wanted to understand in terms of how good we feel about that growth piece going forward. And then if you can just break down in terms of the outlook between noninterest-bearing and interest-bearing, it feels like we've started the strategy of bringing some of these off-balance sheet or money -- type deposits on the balance sheet. I would love any color around that.

Yes. So Ebrahim, I'll start and then Dan will add. So the quarter obviously was a great quarter from a liquidity perspective. We look at it from a total client funds perspective. And obviously, it's driven by what I talked about, which is an incredibly strong venture capital funding quarter at $28 billion. What we're seeing in the market, and this is what's driving it, is that funding sources are coming from a whole variety of different areas, right, so venture capitalists are flushed with cash, you have private equity firms that have a lot of cash. You have -- our global business continues to generate deposits in total client funds. So it's not just in the U.S. The numbers that we're driving are actually global total client funds. And you look at whether it's the SoftBank Vision Fund, the sources are just greater and greater, and we're benefiting from that. So our outlook would say that a strong level of activity will continue. Will it be at $28 billion or would it be higher or lower? That's hard to predict, but we certainly believe it's going to remain robust. Now I'll ask Dan to talk about how we think about the mix on and off and some of the initiatives that we have.

Yes. So as we look at the mix, what we ended the quarter was 82% of DDA to total deposits. We think with the implementation of the deposit strategies that, that could be in a range of the high 70s to the low 80s. So not a material change, and I -- to answer your first question a little bit more, we think, with the implementation of these new deposit strategies, that we have a bit more confidence that we'll be bringing some of that robust client growth on-balance sheet versus off-balance sheet. So I think with all those factors, that gives us a better view.

That's helpful. And just moving on to the investment fees, again, off-balance sheet growth also continues to remain strong. One, should we assume that, that growth will also look strong if the funding and the VC investment fund remain strong? And then you're earning, what, 14 basis points? I know you had previously mentioned that it probably gets capped around 15. Do you still feel that way? Or could we see 1 or 2 basis points increase with every Fed rate hike?

Yes. So this is Greg. I'll start. So going back, the question is pretty similar to the first one, which is just the overall market. And again strong first quarter domestically and globally, and we think it's going to remain healthy. Obviously, as client funds come on, then it's a question about how does it get split on- and off-balance sheet. And Dan, I think, answered the question about how we think about the on-balance sheet part. And obviously, the opposite of that is where else it was going to go is the off-balance sheet number. So again, we feel good about that. The -- as far as the fees themselves, right, we did say that, and you are correct, we're at 14 basis points. We did believe, back when we originally started this journey of higher rates, that we were going to be capping at about 15 basis points. But a few things, one is now that we're building up a larger portfolio off-balance sheet, we're able to negotiate better deals with our partners on the funds that we're providing access for our clients to. And the fact that we believe there is some additional lift. So whereas we thought we were going to be able to cap out at about 15 basis points, we now believe there's going to be upside up in the 17, 18, getting close to 19 or 20 basis points. So we do believe there is more upside. And you're right, it's roughly about 1 basis point of increase per 25 basis point increase.

And our next question comes from Ken Zerbe from Morgan Stanley

I guess just want to make sure I really understood the outlook that you guys gave in terms of the guidance. The -- going from mid -- I guess high teens up to the low 30s for NII, like, obviously, a big part of that was driven by stronger loan growth, stronger deposit growth. So you just have a bigger balance sheet, but was there any change in terms of how you view your asset sensitivity within that? Because I guess I remember, I think, on a prior call, you mentioned that if you use the Fed Fund futures curve, like it's up, say, 20% or in the low 20s, it just seems that there's almost like a disproportional benefit that you're getting on the NII side that's greater than what would normally be assumed from just the asset side.

Ken, this is Dan. I'll take it. So the key factors just from the business perspective like we talked about, one, loan growth being so far ahead. And at the same time, deposit balances being better and the deposit strategy, that from a business perspective is a big driver. Secondly, rate-wise, obviously, Fed Funds increase coming through. Second, the LIBOR increase that we saw in the first quarter really helping the overall portfolio, as 30% of the loan book is LIBOR-based. And then finally, the rates on the investment securities and the 5-year treasury, which is generally where we're investing, is higher than when we started the year. When we do all that, with the multiplier effect of having that happen so early in the year, that's where you see the increase in the guidance to that level.

Got you. Okay, that helps. And then I'm sure you guys have probably done the math yourselves, but if you did build in the Fed Fund futures curve for the rest of this year, do you have an estimated NII increase?

Yes. What we talked about in the guidance is we were to get there, from a margin perspective, we'd be at the 3.5 to 3.6 range.

Sorry, the 3.5 to 3.6 includes the additional rate hikes beyond the one we currently have?

3.55, sorry, 3.55 to -- 3.6 to 3.7. Sorry about that.

Okay. That's perfect. No worries at all. And then just last question, is there any implication for crossing over the $50 billion trailing 4-quarter average? I mean, obviously you mentioned that you're subject to enhanced standards. But I guess, what is the actual implication of that, like, from an expense standpoint or anything else?

Yes, I'll start. It really starts the clock towards the implementation of certain standards around the capital for CCAR preparation and the application of things like the modified LCR. So these are the things that we've been planning for, for quite some time. And this is really just the indication that we've crossed over that threshold. So nothing happens the day after. But the planning for the first CCAR filing for example, which would happen in 2 years, is now officially underway.

And the only thing I would add to that, Ken, is that -- so that's true. We are preparing for it as if nothing is going to change with the law. But I would say that we are more optimistic that the bill will move in the house and be signed by the President. So obviously there's no guarantees, but we're certainly hopeful that, that is going to happen. And obviously, that would be a nice benefit to us and save some of the money we plan on spending.

And our next question comes from Steven Alexopoulos from JPMorgan.

I wanted to start out with an industry question for you, Greg. When we think about it, so IPOs have been relatively strong but historically, M&A has been much more important for VCs in terms of exits. And with the M&A being sluggish, how do you think about this increase in spend to $28 billion? What's driving this?

Yes. Part of it is just the size of -- the money, size of the market and size of the opportunity, right. Companies are still -- they're just staying private longer. And what's interesting when you look at the numbers, you look at PitchBook, which is where we spend a lot of time, you have a lower number of companies that raised rounds of financing, right, than it has -- what it had been over the couple of years, right. So it kind of peaked out in 2015. And so I look at this, it's not a flood of -- or an overfunding of companies. It's actually companies are staying private longer, and the metrics they actually have are performing well. What we're not seeing and hearing about as much is with some of these deals, especially the larger rounds, there is some liquidity or secondary transactions that are happening. And so it's -- it masks a little bit of the money that's going back to shareholders. The notable one that everyone talked about was Uber as an example where when SoftBank came in, that there was some early shareholders, who took some money off the table. That's happening. Now it still doesn't solve the issue that we're paying attention to, which is we do need more M&A. And it's nice to see the IPOs but we do need that more to happen. So we're paying attention to it. We certainly believe that the rest of the year is going to be stronger from an M&A perspective, but we're paying attention to it.

Okay. It doesn't sound like your VC customers are that concerned, though, right? In terms of their spending?

They are looking at the companies and they're looking at the performance metrics. And you obviously see what's happening with some of the larger funds that are out there, later-stage funds, they're putting some very, very big rounds. We like to call them private IPOs, and those are rounds that are more than $100 million. And there's a significant amount of those rounds taking place. And again, a fair number of those are having some secondary transactions as part of those deals.

Okay. I wanted to follow up on the deposit strategies that Dan referenced. Are you adding new products? Or are you just changing the incentives?

Steve, we're not adding new products. It's in effect looking at certain segments of our customers and driving them at market rates onto the balance sheet. So from a product perspective, there's really nothing new there.

Yes. So just -- I would just clarify because I want to make sure it's not misconstrued. So it's just they're interest-bearing money market accounts on-balance sheet, and basically, you're taking these interest-bearing deposits accounts and you're just increasing it to a target client. We are not changing the incentives around -- and so just to be clear on that.

Okay. And then one final one. This might sound like a crazy question, but from an infrastructure view, can you handle more than, like, $8 billion or $9 billion of inflows, what you took in this quarter? Or do you need to think about investing to improve the capacity?

Yes, so there's a couple of pieces to the question. One is as I've said, the new clients that we had, we did have a record, right, and it was 1,300 core commercial clients that were added this quarter. But to put it in perspective, as you go back in and look at the numbers that we've quoted over the last couple of years, they were around 1,100, 1,200. So it's not as if the proportionate number of dollars that have come into the organization equates to the same proportionate number of new clients. So when you think about the infrastructure need, it's not quite as great as you would think with the dollars that are coming in. The infrastructure we have in our off-balance sheet, we've continued to add, what I would say, very sophisticated individuals, who continue to up our game and what our capabilities are. But we feel really good about the systems and technology we have there. And on the infrastructure internally, we continue to make investments there. We believe that's a great place to invest. We upped based with the tax law change and we said we'd have some additional money. We upped our project spend in infrastructure in different projects to make sure that we're building the right infrastructure. So I think we're making the right investments for both our, kind, of on bank infrastructure and our off-balance sheet as well.

And our next question comes from John Pancari from Evercore ISI.

On the competitive front, I know you flagged it a couple of times that the competitive pressures are intensifying. Just want to see what areas are you seeing the greatest competition? Is it in the VC, private equity, capital call line area or any other areas on the lending front?

Yes. This is Greg, I'll start. And then Marc Cadieux, Chief Credit Officer, may want to add something. As you would expect, right, that the innovation market is a very target-rich environment for other institutions to go after. And so we've seen that for years. It is competitive. We've had to sharpen our pencil, add talent, make sure we're doing as much value-add as we can. We still believe we get a premium in the market. But you still end up with competitors, especially with the rising rates, where there's maybe more margin to give up, that we're paying attention to that. So it's pretty much across the board to include private equity services. But the teams are doing a phenomenal job of competing effectively in the market, and again, I would say, from a value-add perspective.

And the only thing that I would add to that is perhaps the biggest competitor of all is all of the equity that is so abundant out there, has crowded out what would otherwise be a lot of loan demand, which just makes the competition for what's left that much more fierce.

And then on that same note, are you seeing incremental spread compression as you move along here on new and renewed loans in your certain portfolios? And on that same tone, can you tell us what your new money loan yields are for new production this quarter?

So perhaps a bright spot, minor bright spot is some stabilization in that margin compression in most segments of the portfolio. A couple of statistics there, broad statistics, in lending to innovation companies, the interest-only spread has ranged from low 4s to mid-6s. PE or private equity venture capital has been more like low to mid-4s. And then our private bank has been more about mid-3s.

And our next question comes from Chris McGratty from KBW.

Greg, a capital question for you, do you believe the strategy of moving the deposits back on will accomplish the capital ratio from swelling further keeping a flat I think the [debt] number? I'm just trying to frame the outlook over the next couple of years and how the magnitude of the strategy can go?

Chris, you're on a bad connection, but I think I got the message or the question you're asking which is on capital ratios and deposit flows and what do we think will happen with capital ratios. So our view is we believe, even with the deposit strategies, that we'll probably end up maintaining where we are and possibly even still having some improvement in the capital ratios. So you shouldn't see, because of what our strategy is, a whole lot of change. And the reason obviously is that the profitability, the net income has been so strong, and obviously the outlook is positive, such as that, that allows us a fairly sizable amount of deposit growth and still maintain flat or slightly increasing deposit ratios.

Okay, great. Sorry about the connection. And if I could sneak one in on the 3.60 to 3.70. Dan, that was assuming how many more rate hikes for the rest of the year?

That's assuming 2 more hikes.

And our next question comes from Brett Rabatin from Piper Jaffray.

Wanted to ask just thinking about the expenses, and I understand the guidance more towards the higher end of the range, I'm just curious, just given the quarter that you just had, it would seem like your incentive comp accruals might have been even higher this quarter. Can you maybe give us a feel for how that might trend this year and then just sort of what happened in 1Q versus the results you had?

Yes, so I'll start. So as we take a look at what we think from a guidance perspective, again, in the script, we said that we would expect, and we do expect, higher incentive compensation because of the upgraded guidance. And that did move us to the higher end of the range. That was offset, to some degree, by some slower project spend. So it all fits within the overall guidance range. That being said, to the extent that we -- if we were to outperform this guidance, there's the potential for us to potentially move into the next range from an expense perspective, but we'd have to beat what we just put out there.

And the only thing I would add on to it is that remember with our incentive compensation, you have a 2/3 mix that's tied to kind of our performance and kind of compared to what our budget is. And you have 1/3 that's compared to relative ROE against peers. And we had already, in the budget, planned that to be at the high end of max payout amount, which is the 2x. And so you already have that factored in from a performance perspective. We can't go higher than that. So the combination of what Dan said, plus my comment is why we're able to keep the guidance at the same level.

Okay. That makes sense. That's helpful. And then I wanted to understand or make sure I have clear this commentary around the product set, and if we should be expecting some additional platform-type things or what you're exactly talking about when you say product side and some changes coming.

So I'll start, and Mike Descheneaux, our President, may want to add something as well. So most of the, I'll call it, capabilities in, I guess -- are around the people and the processes that we have. We are clearly looking at technology platforms, but I would say it's too early to describe in detail what those will be. But we are looking at, again, what I would say, infrastructure projects, whether it's digital banking, enhancing our card systems, enhancing our FX capabilities. It's not one area, and it's almost all, what I would say, enhancements. There'll be a few new systems, but it's almost all enhancements, the majority of that is.

The only thing I would add is the heavy focus on the client experience and kind of the frictionless interaction with the bank, and so that's been a really heavy focus for us, which, again, going back to Steve's question about capacity, is just going to enable us to better leverage and get more lift on processing all these things.

And our next question comes from Tyler Stafford from Stephens Inc.

I want to start on also the deposit strategy. How much of this initiative is pushing more new SVB depositors to stay on-balance sheet versus off, rather than moving the off-balance sheet depositors back on the balance sheet? And then how do we think about the incremental cost these are coming on to the balance sheet at?

I'll start. This is Mike Descheneaux. But you are going down the right track. So it's a bit of product positioning. So making sure when the clients come on board that they are taking advantage of our on-balance sheet product. Now certainly, there are opportunities where some are already off the balance sheet, but really the primary focus is making sure people take advantage of the product that we have on the on-balance sheet. As far as the cost is concerned, maybe Dan will take that question.

Yes, from a pricing perspective, they're being priced at near market rates what they could get off-balance sheet.

Dan, any way to quantify that for us?

We typically don't talk exactly on the pricing side, so I'd rather not.

When we think about these things and we think about our outlook and the financial outlook, we are contemplating these things in our outlook. So at this point I wouldn't anticipate any material changes over and above from what we have in our outlook.

Okay. And then I want to go back to the expense. And I think, Dan, you said that you have to beat what the guidance is that you just put out there for 2018. So in terms of the 2/3 incentive comp, did you build in this deposit strategy in terms of the impact on ROE into your internal budget?

So we built it into the guidance expectations that we have now. It wasn't built into the original budget. And I think if we take a step back and think about the reasons that there could be additional expenses for incentive compensation in and above what we have now, they're pay for performance-related. It would be better performance than the guidance, at the same time, it could be higher warrant incentive gains. These are all things that would just drop additional income to the bottom line, and it would be performance-related.

Yes. And the only other thing I would add to what Dan said is that they're -- that's entirely right on the incentive compensation, what Dan said. I would say just given the overall performance, there may be opportunistic things we do during the course of the year that, again, it wouldn't materially change the number but could push us slightly over that low double-digit number from a standpoint of hiring certain positions and things like that. We already have a lot built in the forecast, but again we're still early in the year and we may be opportunistic. No plans right now, but I would say if something like that does happen, it would be for a good reason.

Okay, got it. And then I just want to make sure I understood, lastly for me. When did you first implement this deposit strategy? I think I heard you say just a few weeks ago. And does that mean 1Q had no impacts from the strategy?

Yes, the impact in the first quarter was quite small. It was only 4 weeks ago.

And our next question comes from Geoffrey Elliott from Autonomous Research.

In terms of the strategy of getting deposits onto the balance sheet, it sounds from what you're saying like most of the effort is going to be around new business rather than getting funds that are currently off-balance sheet onto balance sheet. Could you just explain why that's the case, and maybe give us a sense of out of the existing off-balance sheet funds, how much do you think would be a candidate for bringing onto the balance sheet?

I'll start off, this is Mike Descheneaux. I mean, if you go back and reflect on our past and our history, right, if you went back a couple of years ago about the rapid deposit growth and the pressure it put on the capital ratios, right, we started focusing more on moving some of these clients to our off-balance sheet products and making those products available. Clearly, times have changed. Interest rates have gone up. And the value of the deposit coming on our balance sheet is significantly better. So what we're doing is we're making the on-balance sheet products more available to these new forming countries -- companies, so these early-stage companies. So that's really the principal strategy there. Again, as I've mentioned earlier, certainly if we can try to move some of those that are already in the off-balance sheet on, we certainly will, given, again, the strong capital position we have that we can certainly use and absorb that excess capital we have.

And then just one other quick one. The private equity and venture capital component of the loan book, I think it's now up to about 45% of total loans. How much further are you comfortable moving that?

Yes, this is Greg, I'll start. You're right, it is at 45%. And obviously, that's been a key driver of growth for many, many quarters. And so we've been doing a lot of work internally and looking at, I'll call it, the credit quality, making sure that we're bringing in outside consultants to come in and to make sure we're not missing anything. I'm going to let Marc talk about credit quality from his perspective. But when we think about it, we feel very good about how we are managing these companies, the quality of the companies, the quality of the firms, the fact they have more upside, and it's a scalable business as well. And so we look at it. I guess my point of view would be, originally, I was looking at it kind of around that 50%, but the more we talked about it internally, I'm certainly comfortable about it -- comfortable with it. Our team's comfortable moving up to the kind of low 50s. So we certainly believe we have headroom. In addition, we believe a lot of the things that we're putting in place which are adding new people and structures and different approaches on the lending side and other areas of the business, life sciences, technology, private banking, international, a lot of other areas are going to continue to provide growth, which would mitigate that moving up to a dramatic degree. So I'll turn it over to Marc on the credit quality. Marc?

Yes. And the only thing I would add on the topic of credit quality is that it has historically been excellent for the over 20 years that we've been doing this business. There's a number of reasons for that. And I think as the mix in that portfolio continues to tilt towards private equity, which, in the main continues to -- or generally has more institutional limited partners behind it, the likelihood of a default there continues to go down. Said another way, already a very low probability of a default or a loss event gets lower still. And so don't see anything in the near-term horizon or on the horizon period that would be likely to impact that.

And our next question comes from Christopher York from JMP Securities.

Most of them have been asked, but maybe I'll ask a question on credit, so for Marc. Credit is clearly solid, but I did notice some skew towards early-stage charge-offs that prompted the question, are you seeing any regulators taking a harder line on these types of loans today, given the tendency for the repayment to be investor-dependent?

So there are a couple of questions wrapped up in there. So the first -- or maybe I'll go in reverse order. With regard to regulators, you would appreciate why we don't comment on discussions that we have with our regulators on an ongoing basis about early stage or any other part of the portfolio. Having said that, the charge-off experienced in the first quarter was fairly typical in terms of early stage. Almost 2/3 came from early stage. Obviously, it was a relatively no -- low number, and so a relatively low number of charge-off events in there and fairly granular. And so that is fairly typical and the kind of thing that we expect in our business to continue to see at any point in the cycle. Unfortunately not everything venture capitalists try works out. But in the main, it's been a great business for us and one we continue to focus on.

I just want to maybe reflect on as well, too, is extraordinarily low net charge-offs in the quarter of 15 basis points.

And our next question comes from David Chiaverini from Wedbush.

So I had a follow-up on the deposit strategy. I was just curious, do you fear any migration from noninterest-bearing deposits into the money market product that you're offering the higher rate on?

So this is Dan. We -- the way that we structured the product and the way that we're looking at it and what we talked about of being noninterest-bearing around the high 70s to low 80s is really a reflection of how we think things are going to move from noninterest-bearing to interest-bearing. So we don't think there is going to be a significant amount of migration and haven't experienced any of that. And it's mostly because of the fact that our noninterest-bearing are operating accounts of the clients and customers that we have. That's been the general practice, and we don't expect that to change very much.

Got it. And it sounds as if the gating factor in terms of how much could come on balance sheet is your capital ratios. And I was curious, what is your comfort level on either the Common Equity Tier 1 or the leverage ratio that you're thinking about?

Yes. On the leverage ratio, I think we've talked about that. Historically, we're comfortable in that 7% to 8% range. Obviously, we're in the middle of that right now. So we continue to see net income growth based on the guidance that we just put out there. And we have to see how these deposit strategies go into place, and we'll see how well that takes and how much capital it consumes.

This is Greg. The only thing I would add is we're -- we have cushion in there. We have room, but that's not the game plan. The game plan is to maintain the ratios where they are. But again, as far as the gating item, we're looking to make sure that our clients have the right product. That is critically important to us. And we believe, as Dan pointed out, the mix of interest-bearing versus noninterest-bearing, and kind of simple math at $110 billion of total client funds, you have roughly $70 billion that is interest-bearing in some form or fashion, either on our balance sheet or off. You have $40 billion that is noninterest-bearing. So that mix has stayed very consistent through multiple cycles. And so we feel very good about it, both from a client -- how clients perceive it and what products we're offering them. So we think we're in very good shape.

And the next question comes from Jared Shaw from Wells Fargo.

This is actually Timur Braziler filling in for Jared. Just one question for me. Just looking at the securities book, trying to gauge what the expectations are there as far as mix between AFS and held-to-maturity, are those -- is the runoff or the cash flow from AFS just being put into the held-to-maturity bucket and that duration extended a little bit this quarter? Just would love to hear your thoughts on where that could go in the incoming quarters.

Yes, so first on the duration point, we did see extension this quarter. We did have the sales at the end of the fourth quarter of the AFS securities. That, plus the increase in rates, really led to the duration extension. If you look at the mix of AFS versus HTM, I mean, we're going to keep that relatively constant from here. So you won't see a major shift in that from a percentage basis.

And that concludes the question-and-answer session. I'll now turn the call over to Greg Becker for final remarks

Great. Thanks. So just to wrap up, so we had a great quarter and obviously, a very improved outlook which we feel really good about. Our clients and our markets are doing exceptionally well. And we believe we still have opportunities to, quite honestly, to do even better. This wouldn't be the case without our amazing employees, roughly 2,500 of them. They do such a phenomenal job with our clients, helping them, as we like to say, increase their probability of success. And that's one of the key parts that sets us apart from other institutions. So really, we can't thank them enough.

As important, obviously, is our clients. The fact they are working with us, they put their trust in us, we don't forget that. And we know that's part of the reason we talked about making more investments in our business. And Mike talked about client experience, we believe that is so critically important, and adding value to them. So we want to thank to them. And the last part I'm going to say thanks is to a couple of board members. We have 2 board members that are going to be rolling off after many years: Lata Krishnan has been on the board for 10 years, and she had decided to step down; and Dave Clapper, who has been on the board for 14 years. And 2 amazing people that have been key contributors to SVB's success over their tenure, and I just want to say thanks to them. Finally, I want to thank everyone for joining us and have a great evening. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for your participation, and you may now disconnect.