SVB Financial Group (SIVB) 2018 Q2 法說會逐字稿

Welcome to the SVB Financial Group Q2 2018 Earnings Call. My name is Daryl, and I will be your operator for today's call. (Operator Instructions) Please note that this conference is being recorded. I will now turn the call over to Meghan O'Leary. Meghan, you may begin.

Thank you, Daryl, 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 second quarter 2018 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 second quarter with a continued strong performance across the business. We delivered earnings per share of $4.42 and net income of $238 million. These results were driven by sustained positive trends in our core business, including exceptional client liquidity, healthy balance sheet growth, higher interest rates, strong core fee income and stable credit quality.

A few highlights from the second quarter compared to the first quarter. Net interest income increased by 11% to $469 million; average loans grew by 4% to $24.9 billion; average total client funds grew by 8% to $119.3 billion; core fee income increased by 7% to $123 million; and we delivered a return on equity of 20.8%, along with an efficiency ratio of 46.4%.

Included in our results, a tax benefit tied to share-based compensation and a decrease in reserve related to the high quality of our capital call lines of credit and the write-off of previously capitalized assets related to CCAR reporting, which were no longer needed. Together, these 3 items equated to approximately $0.30 of EPS on a net basis.

Based on our quarterly performance and the current positive market environment, we are raising our full year 2018 outlook for revenues and balance sheet growth. I'd like to start with some comments on our markets, milestones and investments we're making, and then Dan will get into the details of our financial performance and in our improved outlook.

Starting with the markets. Record levels of liquidity continues to be a significant positive driver of our performance in almost every aspect, with the exception of loan growth. Venture capital funds invested $57.5 billion in the first half of 2018, which puts investing on pace to potentially exceed $100 billion for the first time since 2000. These investment levels reflect a continued trend of mega rounds for large later-stage companies, although median deal sizes for companies at all funding stages have been rising. While high company valuations are an area that many people, including SVB, are watching closely in general, the companies that are able to secure large funding rounds today have demonstrated significant revenue traction and the ability to scale rapidly.

The strong pace of VC investment continued to fuel new company formation, which contributed to our continued robust client acquisition, with 1,200 new core commercial clients added in the second quarter. On the exit front, we saw a relatively healthy 28 VC-backed tech and life science IPOs in the second quarter. That brings the total to 43 for the first half of the year, 67% of which were SVB clients.

All of this has been good for our business, and those effects have been amplified by the prevailing market tailwinds of regulatory relief, lower taxes and rising interest rates. We're taking advantage of these positive market conditions to invest in our growth.

On the people front, we continue to build out our management team, most notably by hiring Yvette Butler, who has deep expertise of private banking and wealth management and will lead our growth strategy on that front.

We saw continued momentum across nearly all markets and segments of our business. Our initiative to drive on-balance sheet deposit growth has gained traction. And since we launched in March, the number of related new positive account openings has more than doubled, while balances have grown to more than $1 billion.

Our overall client funds growth is not just a reflection of the liquidity environment but also of our deep client engagement and product capabilities. Year-to-date, more than 65% of our clients that have executed IPOs or follow-on transactions have chosen SVB as their asset manager.

On the loan side, we continue to see outsized growth in private equity, but that growth masked healthy activity in other segments. For instance, we logged a record quarter in life sciences loan growth, with annualized growth in that segment of 32%. And the pace of new underlying tech loan originations has been very strong, with 19% annualized growth and net new tech borrowers in the first half of 2018, even as immense liquidity in the market has suppressed actual loan outstandings.

In fee income, although client investment fee growth was a headline for the quarter, our foreign exchange income is up 31% year-over-year, which, in and of itself, is something to be proud of and reflects the success of our approach to client engagement. In addition, our FX team was ranked the #2 currency forecaster in the world by Bloomberg in the second quarter, the only U.S. bank in the rankings.

Finally, our continued investment in people and expansion of our national fintech practice has contributed to 80% growth in the number of fintech clients and more than 100% growth in fintech client funds year-over-year. In addition, it has opened up tangible opportunities to us in payments and new loan products, while giving us a unique strategic view on where disruption is occurring and how to leverage and embrace it.

In our international business, we achieved a major milestone, opening our German branch in June. There's a lot of opportunity there, and we hit the ground running, recently booking our first $20 million term loan. Overall, our international expansion continues to accelerate our already strong growth. International loan and deposit balances today are 10% and 23% respectively of total balances. And our international business continues to grow at a faster pace than the overall business.

These are just a few of the things that are driving our business forward, keeping our client engagement and amplifying the value we bring to them.

As positive as the current environment is, we continue to focus on some very real challenges. First, the pressure of competition for loans from banks, nonbanks and ample liquidity continues to pressure the pace of loan growth and utilization. Second, we continue to pay attention to valuations, in particular, the potential for a future market pullback that could trigger higher credit costs and possible warrant and investment securities losses. And finally, the escalating trade and tariff war between the U.S. and its biggest trading partners could potentially derail much of the positive market momentum we've all been enjoying.

For now, we remain focused on leveraging our current positive environment and market tailwinds to lay the groundwork for our future growth through 3 primary strategic objectives. First is employee enablement, making it easier for our employees to do their jobs. As part of this, we're rolling out new collaboration and mobility tools to help them work more efficiently and effectively. And we're also upgrading our CRM platform to one that's more integrated, scalable, mobile and secure.

Second is improving the client experience. The major focus here is improving our client-facing digital infrastructure and optimizing product and service delivery from our teams. These efforts will be supported by a central group responsible for orchestrating all client experience enhancements.

And third is an end-to-end process improvement, which will benefit both employee enablement and the client experience while improving overall operating leverage in our core business. This effort is currently focused on end-to-end transformations of both the client and loan onboarding processes and a quick-win program to address long-standing employee pain points that have led to manual workarounds in the past.

We are really pleased that our solid execution and strong performance enable us to make these investments. While the current market environment is ideal, we believe that our efforts now will also enable us to sustain this growth momentum in the future and maintain our unique role as the bank of the global innovation economy.

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 strength in our core business and included the following highlights: first, strong growth in net interest income due to healthy loan growth and higher yields from loans in fixed income investment securities; second, outstanding client funds balance growth both on- and off-balance sheet; third, higher core fee income, primarily due to higher client investment fees; fourth, continued stable credit quality, with solid underlying trends; fifth, strong gains on warrants and equity investment securities; and sixth, higher expenses related to higher incentive compensations from our strong performance, client investments and our write-off of capitalized CCAR costs. Due to our continued robust client liquidity and balance sheet growth as well as the June fed funds increase, we're again raising our full year outlook for balance sheet and revenue business drivers. And due to higher incentive compensation related to our outperformance in the CCAR write-off, we are raising our expense outlook. I'll get into those details as I discuss our operating results.

Starting with the balance sheet. Average loans increased by $1.1 billion or 4.4% to $24.9 billion, driven primarily by new private equity capital call lines as well as growth in life sciences and our private bank. In our technology lending segment, we saw healthy commitment origination, but that strength was offset by lower utilization as liquidity from a strong equity funding environment acted as a headwind to funded loan growth and by an increase in M&A in our corporate finance portfolio. We are holding our loan growth outlook steady but expect average loan growth for the full year to be at the high end of our current high-teens outlook range.

Average total client funds grew by $8.8 billion or 8% to $119.3 billion. This reflected average off-balance sheet client investment funds growth of 10.8%, particularly from healthy IPO and secondary offering activity among our clients. It also reflected the average deposit growth of $1.9 billion or 4%, driven primarily by new client acquisition and a healthy funding environment as well as the impact of our deposit initiative, which has generated more than $1 billion of new deposits year-to-date.

As a result of the strong funding environment and expectations of better growth from our deposit initiatives, we are raising our full year outlook for average deposit growth from the low double digits to the low teens. Average assets grew by 3.9% to $54.4 billion, and period-end assets were $55.9 billion. In addition, with the implementation of the Regulatory Relief bill, the threshold for compliance with certain Enhanced Prudential Standards for banks has been raised from $50 billion to $100 billion and will eventually be raised to $250 billion. And as a result, we will not be required to file a public CCAR report in the foreseeable future.

Now I'd like to turn to the income statement. Net interest income increased by 11.2% to $468.5 million due to loan growth, higher investment balances from deposit growth and the impact of higher rates on loan and investment unit yields. Higher loan and investment balances and higher interest rates drove an increase in interest income from loans of $33.2 million to $330.3 million in the second quarter. As a result of these rate increases, overall loan yields increased by 27 basis points to 5.33%. This includes an increase of 10 basis points or $7.9 million in low-fee yields related to prepayments.

In our fixed income investment portfolio, higher yields, mainly from reinvestment at higher market rates, drove an increase in interest income of $16 million to $146.9 million. We purchased approximately $2.2 billion in new investments in the second quarter, primarily mortgage-backed securities and municipal bonds, at an approximate tax-effective yield of 3.62%.

At the same time, interest-bearing deposit cost increased by only 11 basis points or $2.1 million. Total funding cost increased by only 1 basis point as a proportion of demand deposit accounts represented 83% of our total deposit balances at period end.

Our net interest margin increased by 21 basis points to 3.59%. As a result of the effect of higher rates on loan investment yields as well as our improved balance sheet outlook, we are increasing our full year 2018 outlook for net interest income from the low 30s to the mid-30s. We are also raising our full year outlook for net interest margin by 5 basis points to a range of 3.55% to 3.65%.

Now I'll move to credit quality, which remains stable with solid underlying trends. Our provision for credit losses was $29.1 million compared to $28 million in the second quarter. This was fairly evenly split between loan growth, net new specific reserves for nonaccrual loans and charge-offs. It was partially offset by a $16 million decrease in reserves related to methodology enhancement for large loans, which are primarily composed of private equity capital call lines of credit. Net charge-offs were $13.5 million or 22 basis points of total average loans compared to $8.8 million or 15 basis points in the first quarter. This reflected $8.7 million of charge-offs from one sponsored buyout loan not specifically reserved for, with remaining charge-offs coming primarily from early-stage loans.

Credit quality remains solid. We continue to monitor our client base and the markets for things we believe can affect future repayment activity. The trends in our portfolio, including the sponsored buyout portfolio, indicate continued stability.

With this in mind, we are improving our overall credit outlook for the year. We are reducing our full year outlook for net charge-offs to total gross loans by 10 basis points to between 20 and 40 basis points. We are likewise reducing our full year outlook for nonperforming loans as a percentage of total gross loans to between 40 and 60 basis points.

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 $192.7 million compared to $155.5 million in the prior quarter. Non-GAAP noninterest income, net of noncontrolling interests, was $183.2 million, an increase of $40.8 million from the prior quarter, which, as you will recall, included a $22.2 million of pretax losses on the sale of warrant-related Roku shares following expiration of the lock-up period. Net gains on investment securities net of noncontrolling interests were $26.4 million compared to losses of $3.8 million in the prior quarter. Second quarter gains were driven primarily by valuation increases from our VC-related investments.

Equity warrant gains were strong at $19.1 million, driven by healthy IPO and M&A activity for our clients during the quarter. I want to underscore that a significant amount of gains from the investment securities and warrants is unrealized and is subject to future market volatility. With regard to our VC fund investments, many of these funds own positions in private and public companies and SVB does not control the timing of the sale of those positions.

Core fee income increased by 7.1% to $123.1 million. This growth is driven primarily by an increase in client investment fees of $6.6 million related to higher rates and higher client fund balances. As a result of this increase and our expectation of improved spread on our client investment funds, we are raising our full year outlook for core fee income growth from the high 20s to the low 30s, and we are tracking towards the higher end of this range.

Now turning to expenses. Noninterest expense was $305.7 million compared to $265.4 million in the first quarter. The quarter-over-quarter increase mainly reflects the following components: first, $16.2 million of higher compensation and benefits expense mostly related to incentive compensation from our outperformance and investments in people; second, $12 million for planned investments in projects and growth initiatives, along with accelerated investments mentioned last quarter, was an outcome of the tax reform benefit, these are largely investments in client experience, employee enablement and end-to-end process improvement efforts; and third, a $7 million write-off of previously capitalized costs related to CCAR preparation, these were investments in reporting systems we expected to use for regulatory compliance that will no longer be needed due to the implementation of the Regulatory Relief bill.

We are raising our full year 2018 expense growth outlook from the low double digits to the low teens. This increase, relative to our forecast, is driven by higher incentive compensation of our strong performance and improved outlook and by the write-off of capital costs related to CCAR. We believe we are likely to come in at the high end of this revised outlook. As we've said in prior quarters, if we continue to outperform and raise our growth outlook further in the second half of the year, we will see additional incentive compensation costs. And by the same token, we could decide to accelerate other investments in the second half of the year in light of our strong performance, which would result in higher project-related costs.

Turning to taxes, we saw a $9.4 million increase in tax benefit from share-based compensation related to our exceptional stock price performance and seasonally high activity surrounding the annual vesting of restricted stock units. This impact resulted in a lower effective tax rate of 24.5% compared to 27.5% in the first quarter. With additional excess tax benefits from share-based compensation expected for the remainder of 2018, along with the continued investments in tax-advantage municipal bonds, we expect our full year effective tax rate will be lower than originally forecast and are lowering our outlook range to between 26% and 28%.

Moving to capital. Capital and liquidity remained healthy, with strong growth in regulatory capital during the quarter. Growth in risk-weighted assets from higher loan and investment balances reduced the bank's risk-based capital ratios somewhat, and our bank Tier 1 leverage ratio increased by 3 basis points to 7.72%. We expect that the majority of these earnings' capital generation we see from strong loan and deposit growth will be used to fund balance sheet growth for the remainder of 2018.

In closing, we delivered another outstanding quarter and raised our full year growth outlook for the second time this year. Our business continues to benefit from the tremendous liquidity available to the market and to our clients and the generally high quality of businesses that are able to get funding and make a successful exit in these markets. As always, 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. We believe we remain well positioned for future growth, assuming no change in the macro environment, and regardless of the environment, we continue to prioritize strong execution, long-term planning and adding value to our clients.

Thank you. And I'll now ask the operator to open the Q&A.

(Operator Instructions) And we do have a question from Ken Zerbe from Morgan Stanley.

I guess maybe starting off with expenses. Just in -- obviously, a little bit higher than probably where we're thinking about this quarter. Is there a rule of thumb -- or maybe you could just help us understand like how much of the higher incentive-based comp is actually tied to noncore fee items, like the warrants or the investment security gains, if at all. I'm just trying to understand that relationship.

So there is incentive comps that is tied to the -- those non-core items, but that's at a lesser percentage than what we get from our core revenue drivers. So that's going to drive less of the increase in incentive compensation than what happens from the base net interest income and other core fee income drivers.

Got it. Okay. So it sounds like a fairly small percentage. I guess I'm just -- all right. No, that's fine. We can -- I'll follow up with that offline.

Ken, just to put in context the question on expenses for the quarter. If we take a look at this year, we've increased the overall revenue outlook just by 13% to 15%, just roughly, and expenses on a 3 to 4 percentage point basis. So we're driving strong operating leverage.

I guess I was going to say, like just given -- obviously, I did see the stronger revenue growth, which I think is great. But it almost -- the guidance for expenses almost implies that this is a 1-quarter boost in expenses and then it kind of reversed to something much lower, even though revenue stays higher. And that's what I was trying to figure out, like why this quarter was presumably higher expenses than it would seem like you would have on a go-forward basis from here.

Yes. So I'll take that. So if we look at the Q2 spend, there are 3 notable items to take into consideration. One was that CCAR impairment that we talked about for $7 million. Two was $5 million roughly of incentive compensation, which is really a catch-up from the first part of the year based on our strong performance. And third is about $5 million worth of professional services that are really driving these scalability and client experience initiatives that Greg referred to earlier. So when we look at that, those notable items, and we take that off of the base, that gives you a better picture of at least what the base case expense rate looks like.

Got you. Okay. That helps. And then maybe just a slightly different question on expenses. Regarding the strategic initiatives that you guys are doing, the way I understood your comments about the guidance for expenses, that you may accelerate some of those investments. I guess what is stopping you from just building that into your normal expense growth outlook?

So as we look at where we are from an internal capacity perspective, we have a substantial number of projects ready to support our strategic growth initiatives to support these scalability initiatives as well. So that's really a limiter for just how much we can get accomplished within a given year. So that, I think, is probably the biggest limiter for us on what would stop us from going further at this point.

Yes. And Ken, this is Greg. Just to add on to it. So as we look at that and Dan's right. You look at what your capacity is for change, capacity per project and all those things, and we're -- we've upped that capacity. But if we sit back and say during the course of the year that we believe we can actually keep doing them the right way and have more, that's what we may say, we may just continue to accelerate. Now again, our guidance doesn't have that expectation in there. We think we're on the right track and we have the right capacity for the balance of the year. But I think we just wanted to make sure we would have that kind of caveat in there, so we kind of look at what could cause it to go higher. It's really those 2 things. If we decided we had the capacity and the willingness to do it, number one and number two, if we actually continue to outperform our forecast. And so those are kind of the 2 things.

And our next question comes from Steven Alexopoulos from JPMorgan.

I wanted to start -- I thought Greg's remarks indicated that the newer interest-bearing deposit -- the interest-bearing account added $1 billion. But when we look at interest-bearing deposit, it's actually declined about $100 million quarter-over-quarter. Was that in the third quarter that you added that $1 billion?

So great clarification, Steve. So what -- I was specifically talking about the new product we introduced, which is -- and I'll make it really simple. So there's -- for early-stage clients, historically, we would have said, open up your checking account, and if the balance was high enough, we basically say then, take the excess balance and move it off-balance sheet. And that was kind of the standard. The change was the same client comes in, we say, open up your checking account, you have a lot of excess cash. We'll then open up an on-balance sheet money market account, right? So the point was, specifically to this product change, going from the opening of an off-balance sheet to opening up an interest-bearing on-balance sheet, that's where we doubled the run rate, and we effectively have, since we introduced this, $1 billion of deposits. Now obviously, what that means is there's other clients and other products that raised more money that moved then more off-balance sheet. So they had an interest-bearing account and then moved it off to higher levels of balances off-balance sheet. So that's -- it's very specific to the new product introduction.

Okay. And Greg, now that the SIFI threshold has lifted, does that change your appetite in terms of how much of that you'd like to bring on the balance sheet?

So that's probably a question before we hit $50 billion, Steve. So I kind of look at it and say, we have good amounts of capital. And so obviously, we're going to try to do what we can to appropriately balance the interest of our clients with the right product set. And so clearly, we would like to move more of that money onto the balance sheet, which is why we're paying attention to this new product introduction. And hopefully, it will accelerate and we'll see even more balances being driven by that. But I think we've got the right initiatives in place to see the deposit growth that we have in our outlook.

Okay. And then just one separate question on the capital calls. If we look at the capital call loans below $20 million, they decline modestly quarter-over-quarter. I assume most of those are VC. Give some color on that. Are volumes of VC peaking, or competition is getting tougher for that type of lending?

This is Greg. I'll start, and then Marc may want to add. That's just -- it's my view. It doesn't have anything to do with any change in behavior that we're seeing. That's just, I would say, coincidental that it happened as opposed to any trend that we're seeing. So we still see robust activity in our venture capital funds flow as well as private equity. So I don't see any change in that.

Yes. Nothing to add.

I think, the one thing to look at, Steve, is going through as your -- look over the year-over-year growth, probably with something around $700 million of growth in that area. So yes, there's no real pervasive or systemic trends that we've noted at this point.

And our next question comes from John Pancari from Evercore.

So yes, on the deposit balances, can you just tell us what are you paying on the new deposits that are redirected to -- or that are being directed into the money markets? What's that yielding now? And I know you had previously indicated, I think, in the ballpark, 90 to 100 basis points, on new money that you're putting onto the balance sheet. Where is that now?

Yes. So the range there is anywhere, call it, 50 to 90 basis points just based on the overall size of the deposit account, the deposit relationship.

Okay. All right. And then in terms of the off-balance sheet funds, obviously up more than expected as well, very solid growth there. Is that -- I mean, I guess what would be your outlook to that? So those flows, clearly, they seem to be coming in better and tied to the activity in the space. I mean, can you just give us a little bit of thought process on how we should think about that?

Yes, this is Greg. John, I'll start. So obviously, as we talked about where we are from this overall fund flow, venture capital financing is potentially trending towards an all-time high in volumes, right? So that's kind of one tailwind that we have. But there's other parts. As I mentioned, we have very strong market share of companies that are going public, and we're winning the majority of those funds in our off-balance sheet vehicles, right? And then there's just money flowing in from other sources, not just venture capital. And so our ability to have a product set that we're winning really well in the market, our team is exceptionally strong in our off-balance sheet solutions, so it's the market, it's the team and it's the share of the top companies that we have in our portfolio. And the combination of those 3 is really allowing us to really grow again another quarter of incredibly strong growth in total client funds, but especially, off-balance sheet. And as that part continues, we expect continuation of the trend based on our quality of companies and our execution. Obviously, the market will dictate how much money overall is flowing into the industry.

John, this is Mike. One thing you may want to think about, as Greg was saying, we brought in about, what, 20% on-balance sheet deposits this quarter in terms of total client funds. But you have to remember, in Q2, there's quite a strong IPO and FPO pipeline, particularly from some of the life sciences, so that's why a lot of those bulk of those dollars are going to go off the balance sheet as well. So it's just a really interesting quarter from that perspective.

Okay. Got it. Got it. All right. That's helpful. And then lastly, just back on the loan side of the PE and VC capital call lines. Where are you bringing them on to the balance sheet in terms of pricing right now? I think the last time we talked about it was prime minus 50, maybe prime minus 75 basis points?

Yes. It's Marc Cadieux. And that's still a pretty good range. Private equity tends to be in the, for interest-only yield, in the low 4s, and venture tends to be about 40 to 50 basis points better than that, so around the mid-4s.

And our next question comes from Aaron Deer from Sandler O'Neill.

Greg, obviously, you guys have a lot of tailwinds working for you and the outlook seems to be improving. But you've expressed concern over the potential for market pullback and maybe some of the trade and tariff issues. Is there anything specific that you see currently that gives you pause, or is there anything that you're watching for that would cause you to become more cautious, I guess, especially on the lending side?

So this is Greg. I'll start, and then Marc may want to add. My view is, right now, we don't see anything on the horizon. But kind of given where we are, both in this length of the cycle, given where we are enough fund flow of capital into the industry and just what's happening around, I think anyone that doesn't have a little bit of a caution to say that things are moving really well, I would say, is probably not being that thoughtful about the real risk in their business. And so there is nothing that, as we see in our crystal ball, that would point to that happening in the near term other than just, again, the market is doing really well and the fund flows are strong. And you do have the issues out in the market, the geopolitical issues, and trade is one of them, and none of us know how that is going to shake out at the end of the day and implications there are, I would say, a little bit less for the technology and innovation space, but it's more for the broad economy. And if that, all of a sudden, takes a -- there's an economic shock there, that's obviously what could kind of cause the whole market to settle down.

Okay. And then maybe as a follow-up related to credit. The -- any details you can provide on the $9 million sponsor-led buyout loan in terms of industry that, that was in or circumstances that might have led to that default?

Sure. It's -- so it's Marc Cadieux. So the company, broadly speaking, is in the software space. It had been, candidly, a company that had struggled for the last couple of years. And while this doesn't happen with any frequency in this segment of the portfolio, it can happen where things can deteriorate very quickly as was the case with this particular credit. It got worse in a hurry in the space in the second quarter. And so while, again, rare event, it can happen, it did happen, this instance, I think, the key things to take away from this is, first, it's not indicative, we think, of any broader systemic issue, deteriorating trend, et cetera, in this segment of the portfolio. And I would also point out that we've been in this business, the sponsor-financed business for almost 12 years now. This is only our second loan loss in that entire 12-year period, which we think is reflective of the thoughtful and prudent approach we have taken to lending in that segment, particularly, and following on Greg's comments, given where we are in a long period of economic expansion, we think we continue to manage the portfolio in a way that should keep that -- hopefully keep that loss record clean.

And our next question comes from Ebrahim Poonawala from BofA Merrill Lynch.

Just on one question, like if you take a step back, given your balance sheet size today, the global expansion that we are doing, just on one, if you can touch upon, has it improved your ability in terms of the clients you're acquiring, in terms of when you look at the software or tech clients in the mid- to higher end of the spectrum, which usually may have not banked with you? I'm just wondering, just given your sort of evolution of your franchise, has that improved? And does that lead to -- as we look forward in terms of the kind of deposit growth and loan growth, that we may get, not next quarter, but over the next few years.

Yes. This is Greg. I'll start, and Mike may want to add to it. Clearly, the balance sheet helps, right? So when you're working with larger companies, their ideal situation would be is they love to work with fewer institutions than more. And so if you can step up with either a larger loan commitment or a larger syndication capability, which we obviously can do both of, that's really effective, right? So those 2 things are drivers. But I would say, on top of that, there's other things. One is we've talked about the product and services and the core fee income growth that we've had. And I just would say, whether it's FX, whether it's cards, our off-balance sheet, cash management, each one of those areas, both in capability from a technology perspective as well as the people that we have, we're doing incredibly well and we get really positive feedback. Again, just one example. I mentioned in my prepared comments about our FX team being ranked by Bloomberg the second-best forecaster, not just in the U.S., but actually around the world. We do believe we have incredibly strong teams. And so it's not just one thing, it's really a combination of both our balance sheet capability, syndications, deal sizes as well as our product capabilities that really allows us to compete. Now your question was what will that do then in the future to drive loan growth or to drive deposits. I would say client acquisition, clearly, it helps with that. Or as important, and maybe even in some cases, more important, keeping our clients with us longer. We're certainly optimistic about that. How that translates into outstandings, the challenge still is there, as I said. In technology especially, there's so much liquidity out there that it's still a challenge to find outstandings to the way we would see in maybe a more normal environment. But for new client acquisition and retention, it's clearly a positive thing.

That's helpful. And just switching gears to the off-balance sheet funds and the investment fees. So we were about at 16.5 basis points in the second quarter. I know you want to be conservative there, but outlook on that? I mean, I know precrisis, this used be in the 20, 25 basis points range. So how much more room is there for those -- the investment fees you charge on those funds to go higher with future fed rate hikes and just over the next year?

Yes. This is Greg. And yes, we -- if you go back a few quarters ago, maybe even several quarters, we said we thought we'd cap out kind of at that 15 basis points. And by virtue of the size of the assets that we have right now, it actually allows us to negotiate better deals with our partners. So that's helped with a few basis points. And then on top of that, just the rate pickup and how fast it's been, that actually allows us to help too. So that's how we've gotten to 17 basis points. As we look at our crystal ball, we could see, with kind of each additional rate increase that we see, a basis point per increase and maybe capping out around 20 basis points. So clearly, 3 basis points doesn't seem like a whole lot. But when you multiply that across $70-plus billion, it ends up being real money. And so that's kind of how we look at the future.

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

I wanted to, I guess, first ask about the guidance around loan growth and if we just think about this quarter and the guidance, I realize you indicated to the upper end of that range. But it would seem like you might have a little bit more upside than that. Are there things in the back half of the year either competitively or that you see in the market that are indicating some slower growth? Or what additional color can you give us on the back half guide being a little slower?

Yes. This is Dan. When we looked at what happened in 2017, we certainly started to see higher levels of M&A than what we've seen as a headwind to loan growth. And we haven't seen as much of that in the early stages of 2018. But just to be prudent, the expectation is that we'd get to a much more normal level of M&A as we got through the second half of the year. So that's why you're seeing us be a little bit more conservative in the forecast in the second part of the year.

Okay. And then I wanted to ask, just thinking about the whole on-balance sheet, off-balance sheet topic and your capital levels and your high level of profitability now. Can you just give us maybe some thoughts on just will you lose some more of the off-balance sheet, on-balance sheet to kind of keep the capital levels fairly consistent? I know you bought some municipal securities this quarter. Are there things that you're going to do to kind of manage capital from growing given your new higher level of profitability?

Yes. So as we look at where we are from a capital accretion perspective, it certainly does provide us opportunity with deposits. And as Greg was mentioning, the deposit strategy that we put in place starts with the new clients to drive, for the right rate for the client, those balances on-balance sheet. So we think that program has continued room to grow, and that will consume some of the additional capital that we have. So between that and the loan growth opportunities we have, we think can use that capital organically. And we'll see, based on where things are at the end of the year, where we stand from a capital perspective.

Okay. Are there -- is there any targeted capital ratio that you might be thinking about?

We manage -- our constraining ratio's historically been the Tier 1 leverage ratio with the bank, and the expectations, we've managed between 7% and 8%. So we're still in the 7.7-ish range at this point. So we still are in between that range at this point. So we're managing between it.

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

As your comments on the tariffs, and there's a potential headwind, do you see that potentially driving more of your -- more business to the international branches? And if so, I guess where do you see the international loans as a percentage of the book going as we look out over the next year or so?

Yes, Jared. So it's Greg, I'll start. Right now, we're not seeing, I would say, any real change in behavior or things that are causing loans to be directed in a different way or demand in a certain jurisdiction domestically or in international markets. So I think it's too early to tell what will happen with that. The good news, to your point, is our strategy of actually having international offices could be beneficial because if that does happen, we have offices in these international jurisdictions that could benefit from it. But we're not, again, we're not seeing it yet. What I said in my prepared comments holds true though that the domestic business is growing really well, but our international business, loans and deposits, is actually growing at a faster pace, right? So 10% of our loan portfolio or 23% of our deposits are international in nature, and they're growing at a faster pace. So not dramatically so. So do you see that going 11%, 12%, 15% and a little bit higher in deposits? Yes, you could see that. But as far as your specific question, really not seeing any behavior changes.

And in the past, you'd mentioned that when international loans, it was either a percentage or a dollar price, you sort of loss of the benefits from Crapo. Where are we in terms of progress there? And do you think that there could be additional regulatory reform that would give you some relief on those additional burdens?

Oh, is that question specifically about the foreign exposure question?

Yes. Yes.

Yes. So that foreign exposure limit would not be cleared up with the Crapo bill. But I think it's important to note that as we said we were going to do -- just look at what we can do to move things around and I guess optimize the number, and so really, it hasn't changed a whole lot. It still around $6 billion, $6.5 billion. Our view is that it really doesn't become an issue until 2000 -- late 2019 and 2020, maybe even late 2020. And so from that standpoint, what we certainly believe is that there is the potential probability that the regulators are continue to look at all facets of the laws and regulations to say how do we make sure we're tailoring it the right way. And we certainly hope that the $10 billion will be part of that tailoring, which is why we continue to spend time in Washington, D.C. to make sure that our voice is known.

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

Dan, just to start with you, do you still think the impact to NII from each rate hike is going to be roughly around $50 million?

Yes. On an annualized basis, $50 million worth of pretax net interest income, yes.

Okay. So when you weigh the strong loan growth you had in the second quarter in the June rate hike, how much did the deposit strategy success you've had so far contribute to that NII guidance to the low 30s -- or excuse me, to the mid-30s? Is there a way to think about the magnitude of each of those, the growth -- the loan growth, the hike and the deposit strategy?

Yes. My opinion, I think, it's too complicated to look at it like that. I think if we take a look at the overall growth in deposits, the fact that we added $1 billion year-to-date through that strategy just helps us continue to reinforce the deposit guide that we put out there, which is obviously a generator to the uplift in net interest income. So I'd just think about it that way versus trying to parse the 2 out.

Okay. And then just lastly for me do you have what the reinvestment rate on the new securities that you're purchasing right now is?

It's right around 3 50 right now.

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

Forgive me if I've missed this, but what was the period-end balance in PE/VC loans and then maybe the utilization on the lines there?

So period end was about $12.2 billion. Utilization, I believe, was somewhere in the mid-50s, I think. I don't actually have that stat handy but around there.

Okay, helpful. And then maybe a follow-up Greg or Marc. Is the growth net loan subtype maybe today driven more by increasing utilization or maybe clients raising funds or new clients recognizing the value proposition to GPs themselves and then LPs by the liquidity in the facility?

Yes. This is Greg. I think it's really -- there is new clients clearly, but it's also existing clients raising new funds. And those are the 2 main drivers. Utilization, it changes a little bit on the quarter-to-quarter basis, but it's not changing materially in a trend line basis. It really is those first 2.

Great. And then any changes in the competitive environment in that product?

I guess I would just say it's one of the most competitive of all. And for the reasons that we know, right? It's a big space. It's a place to get outstandings, and the credit quality is very sound. So as we think about it, it's like we have to continue to differentiate based on client service expertise, based on speed, based on our ability to add value, meaning the fact that we, in our private equity, we have offices in Hong Kong, in New York and in the U.K., London. And those are the kind of the big centers. And we can bring people together to talk about what's happening in the industry, what are the best practices and things like that. We really have to focus on how to add value because it is a competitive space. And obviously you can tell based on the growth that we've done an effective job of competing there.

Yes, I was going to say the same thing there. Switching gears, just 2 housekeeping items. So I wrote down 2 different numbers for investment spend within noninterest expenses in the quarter. So could you clarify again how much was allocated to investment?

So not sure what you mean by investment. Are you talking about investments on some of the key initiatives that we were mentioning that were in the Q2 expense base?

Yes. I think that was maybe a $12 million? Is that right?

Yes. So we said, yes, $12 million for planned investments in the second quarter. And that's an increase over the expenses from the first quarter.

Got it, okay. That's very helpful. And then the last one, what would your NIM outlook in '18 include subject to the forward curve?

So as we look at the NIM outlook, we'd probably be towards the higher end of the range that we put out there considering how late in the year we'd be with rate increases.

And our next question comes from Chris McGratty from KBW.

Dan, your -- the durations moved up a bit. Just interested in kind of target duration and timing.

Yes. So we continue to extend duration with the purchases in the investment securities portfolio. So you've seen us continue to extend out. In terms of the target, we haven't set that at least at this point. But just considering how late we are with the overall economic expansion, it makes sense for us to continue to extend out. So you'll see us progressively continue to extend out on the investment securities portfolio at about the same pace that we've been doing over the last year or so.

Okay. And Greg, on capital return, I think, you addressed the balance sheet strategy. I'm not sure if you touched on the dividend that you talked about in the past. Any update on the dividend prospects?

Yes. Chris, we've talked about this in the past. We said it's like -- it's something we'll consider when we hit or exceed the threshold targets that we talked about. And what we looked at, and it's part of the reason we focused on the deposit question last quarter, is given where rates are, we do believe there is an ability for us to attract more deposits on-balance sheet with the type of product that we just mentioned earlier. And that, that is the best place to use capital to -- you get a better -- a really strong return. And so right now, as Dan talked about, we're in that range in the Tier 1 leverage ratio on the 7% to 8% and feel good about that. So as we -- if deposit strategy changes, if something doesn't work or if capital again continues to be brought on board at the rate it is with earnings, at some point, we may have to make a decision about it. But I guess, in some ways, we're just not in a rush to think about the dividend strategy. It's best to invest it in the core business.

And our next question comes from Gary Tenner from D.A. Davidson.

I just wanted to ask a follow-up question in terms of the PE and venture capital lending business. It's about 80% of your sequential quarter growth this quarter. It's starting to get pretty close to 50% of total loans outstanding. I know the experience has been great historically and, of course, the momentum is very strong right now. But how do you think about it from a risk perspective, maybe not as much credit, although I'd love to hear your thoughts there, but earnings risk perspective, if there were to be a slowdown or any sort of disruption in the fund raising market?

Yes. This is Greg. I'll start at a high level. And you're right, it's roughly 47% right now. And as we've said, we're comfortable going up to a higher number, and I think the last quarter I talked about maybe in the mid-50s. And so you're right. We feel very good about the credit quality. We've done a lot of sensitivity around what I'll call stress-testing of the portfolio, what could happen with private equity and venture capital. Of the 2 buckets, though, I think it's really important to look at venture capital versus private equity. Venture capital tends to be more volatile and more tied to the economy. So if the economy starts to slow, if there's an issue in the funding side, we've seen that historically where it actually slows down more quickly. But the private equity portfolio, private equity not venture capital, is incredibly diversified. And so you can look at it both domestically and globally. And so from a sensitivity perspective, based on industry and based on geography, it's very broad based. And so we don't believe that it actually has the level of sensitivity that people may think. It doesn't certainly act and we don't believe it will act like venture capital as we look at it. So that's how we think about it on a volatility perspective. I don't know, Marc or Dan, if you guys have anything else to add.

So I think, just to echo something Greg said, first we think the credit quality in that segment of the portfolio is -- has been excellent historically. We think it will remain so. And so that wouldn't be a concern for us as it approaches that 50% of loan balances. I think the other thing to note, and Greg touched on this a little bit in his comments, is that we continue to see good borrower count growth in other segments of our portfolio, and then growth in other segments like private bank and in life sciences, for example. It certainly is the hope that at some point, the liquidity -- the massive liquidity out there notwithstanding, that we'll see those new borrowers we're adding start to borrow more and take some pressure off of that growing concentration of private equity and venture capital.

And maybe I would add one more thing which is, as a percentage of the loan portfolio, we're spending a lot of time on that, but I think it's really the percentage of the overall what I'll call earnings of the company, you have look at that. And what I mean by that is tech banking, as an example, the headwinds of deposits and liquidity. But if you look at the amount of both core fee income that's being driven by that team as well as the deposits and total client funds, it has been incredible growth. And so we have to look at it holistically and look at the drivers of the business. And remember, even on the loan side with private equity, it's been a key part of our loan growth, but it's also one of the lowest margins as well. And so we look at it holistically, and the revenue part is the best way that we look at it. And so it's much more broad-based revenue growth than you would look by just focusing on the lending.

Okay, that's great color. I appreciate it. And just one other question related to that topic. Mechanically, are the lines for the private equity firms or venture capital firms, are they -- do most of them have multiple lines, to where they have a primary line and secondary line? And if that's the case, how would you kind of view yourselves as positioned there?

This is Greg. Almost all the capital call lines, in fact, Marc may say none are excluding this, is that there's 1 credit facility. So there isn't -- you don't have in these capital call loans a senior and a junior strip. They typically only have 1 lender. If it's multiple lenders, it's under 1 agreement, and so you're kind of all -- you're pari-passu.

I think that's right. And I am hard-pressed to think of any instances where there is 1 -- more than 1 loan to a fund borrower. The only thing I would add is that there's firms and funds, and so it's very typical to have a given firm have multiple funds under management and then, of course, multiple credit lines -- or a credit line for each of those funds, if that helps.

And our next question comes from Matthew Keating from Barclays.

I have a follow-up question on the international business. If I think back several years ago, SVB invested a lot of time, effort and energy in Asia, in particular in China. More recently, we hear a lot more about the U.K., Germany and Canada. And so maybe you could just provide an update on, obviously the banks' already gotten out of India, but what's going on in China at this point? And what is the recent trade issues had on your level of investment there?

Yes. So a couple of things. One is there's 2 parts to the -- our business in Asia. There is the SVB Asia, which is taking deposits and having clients from offshore Chinese firms usually funded by U.S. venture capital. So they have a parent company, deposits get put into a Cayman account. And then it gets downstreamed in-country to a local account in mostly China. That business is doing really well. We also have capital call lending to Asian venture capital and private equity firms that we do out of Hong Kong. That is also doing exceptionally well. So the deposits and loans from that business mostly deposit-heavy, so those deposits are very strong, I want to say $7 billion -- $6 billion to $7 billion. And then on the lending side, you're anywhere -- it varies but you're kind of at that $500 million to $650 million in that range. Now that's that business, so that's doing really well. The joint venture, I'll start with the comment that when we highlighted this at the beginning, and we said we're going to be in that business, we said we're taking a very long-term approach, long-term view of that, and we think that's the only way to do it. That being said, the joint venture is doing really, really well. We have roughly $1 billion of assets in that joint venture. For the last couple of years, it's grown 75% to 100% per year from a growth perspective in loans and deposits, right? The reason we're not spending much time talking about it is because again we're a 50-50 joint venture, number one. Number two, on the bottom line basis, it's kind of at that kind of breakeven or modest loss perspective so the contribution to our numbers isn't that great. Now that being said, do we believe we're adding value there? Do we believe we're on the right track, the right plan that we put in place several years back? And the answer is yes. We're actually ahead of that plan that we put in place. We believe we're headed to what we want to get to, which is to build out a bank like Silicon Valley Bank in China. Your last question was do we see the impact of what's going on? And the answer is, from a trade perspective, the answer is no, not at this point.

Great. And then just following up, Greg, on your comments about trying to keep your clients longer. Just curious if you have any milestones around those initiatives in terms of progress, whether it's the number of Corporate Finance type clients or the number of clients that were growth clients and now are transitioning to that next bucket. How can you kind of monitor or assess the bank's progress on that front?

I think maybe something you might want to look at Matt is on the loan concentrations for example maybe one data point you can point to. So loans greater than $20 million is typically an indication of, say, larger clients that we may have you'll hold onto. And so you can kind of see that growth year-over-year where we've gone from about $9 billion or so to $12 billion of loans, but you might want to focus more on the software and hardware clients. So you'll definitely see some growth, use that as a data point to kind of show that we have been making progress on holding onto our clients longer and then also attracting some larger clients.

And our next question comes from David Chiaverini from Wedbush.

You mentioned that you're building out the private banking capability with a key strategic hire and leadership hire. Is the team fully in place? Or is some additional spending and hiring required in that segment?

Yes. This is Greg. I'll start. So we -- as you know, we've talked about, for a few years, that we believe we have such a great opportunity in the private bank and in emerging, I would say, in the wealth management space as well. We have, I would say, done a really good job of executing on the strategy that we had in place, which is if you look at the loan growth we have in the private bank, we can look at the deposits from the private bank and new client acquisition to private banks. It actually has been very, very good. But I would also say that we look at it and say we're still only scratching the surface on the potential. And so we said is let's take a look, as good as our team is, let's go out in the market and try to find somebody that has just a lot of different experiences. And so what Yvette has is she's worked at many different firms to include the last one being Capital One. And so she's got a broad background. She also is rooted in technology. So if you look at her background, she actually came from a development background and then had spent the last kind of 15, 20 years more in the -- running these type of businesses. We believe, that combination, along with the team we have in place, is going to allow us to grow that business. Now the question specifically, do we believe we're going to be making investments in that space, and the answer is yes. Is it going to be noticeable that we would have to come out and say, "Look, there's something specific in this quarter or the next few quarters," I don't believe so. I think it will be in the run rates that we're going to be able to provide you over the coming years. It's not something that's going to happen tomorrow. So the answer is yes to investment. It will be our view is enough to make sure we capitalize on opportunity, but it won't be so significant that I would say that investors or analysts are going to be paying a lot of attention to it.

And that concludes our question-and-answer session. I would like to turn the call back to CEO Greg Becker for closing comments.

Great. Thanks, Daryl. Just to wrap up. Obviously, we had another great quarter really across the board, raised our outlook for the second time this year. Really pleased with the results. And obviously our clients are doing well, the markets are doing well. And I think the team is executing really effectively on our strategy. As always, the success that we're having is really a function of 2 things: one is our clients. And I get the opportunity to spend an incredible amount of time with our clients, meeting with them face-to-face and hearing what they're doing. And I have absolutely no doubt in my mind that our clients are doing things that are just -- no other bank gets the exposure and gets to work with clients the way we do. And that is truly inspiring. It inspires me, it inspires our employees, and so clients are number one. Number two is our employees because whether it's the feedback I get directly about our employees and how they engage our clients or their commitment to our clients and what I see firsthand, I think we have the best employees, and they're incredibly dedicated to clients and dedicated to SVB. So a combination of those 2 things allow us to be a successful as we are and we certainly feel good about the outlook. So with that, I just want to thank everyone for joining us, and just wish everyone a great day. Thanks.

And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.