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Edited Transcript of SIVB earnings conference call or presentation 25-Jul-19 10:00pm GMT

Q2 2019 SVB Financial Group Earnings Call

SANTA CLARA Aug 1, 2019 (Thomson StreetEvents) -- Edited Transcript of SVB Financial Group earnings conference call or presentation Thursday, July 25, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel J. Beck

SVB Financial Group - CFO

* Gregory W. Becker

SVB Financial Group - President, CEO & Director

* Meghan O'Leary

SVB Financial Group - Head of IR

* Michael R. Descheneaux

SVB Financial Group - President of Silicon Valley Bank

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Conference Call Participants

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* Aaron James Deer

Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst

* Brett D. Rabatin

Piper Jaffray Companies, Research Division - Senior Research Analyst

* Brian D. Foran

Autonomous Research LLP - Partner & US Regional Banks

* Brocker Clinton Vandervliet

UBS Investment Bank, Research Division - Executive Director & Senior Banks Analyst of Mid Cap

* Christopher Edward McGratty

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* David John Chiaverini

Wedbush Securities Inc., Research Division - Senior Analyst

* Ebrahim Huseini Poonawala

BofA Merrill Lynch, Research Division - Director

* Gary Peter Tenner

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Jared David Wesley Shaw

Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst

* Jennifer Haskew Demba

SunTrust Robinson Humphrey, Inc., Research Division - MD

* John G. Pancari

Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst

* Kenneth Allen Zerbe

Morgan Stanley, Research Division - Executive Director

* Steven A. Alexopoulos

JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks

* Tyler Stafford

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Welcome to the SVB Financial Group Q2 2019 Earnings Call. My name is Adrianne, and I'll be your operator for today's call. (Operator Instructions) Please note, this conference call is being recorded.

I'll now turn the call over to Meghan O'Leary, Head of Investor Relations. Meghan, you may begin.

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Meghan O'Leary, SVB Financial Group - Head of IR [2]

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Thank you, Adrianne, 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 2019 financial results and we'll be joined by other members of the management for the Q&A.

Our current earnings release as well as our quarterly earnings highlights slide and CEO letter are 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.

And now I will turn the call over to our President and CEO, Greg Becker.

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [3]

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Great. Thanks, Meghan. Good afternoon and thanks, everyone, for joining us. Before we get started, I just want to remind everyone that we're doing something different on this earnings call. We are not going to be reading scripts. Now I know that's going to really disappoint many of you, but we're just going to get to a couple comments at the beginning and then Q&A.

But you have that we filed today, you've got our full Q2 2019 earnings release that was filed, a short slide deck, and a summary letter highlighting the key drivers and themes of the quarter and providing some relevant color on our markets and strategy. The documents are available in the Investor Relations section of our website. By adding a short highlight deck and summary, we intend to focus on the most important aspect of each quarter's results and spend our time on the call answering your questions.

I'm going to add just a few comments about the quarter and then we'll dive into Q&A.

Bottom line, we had an outstanding quarter with record earnings and profitability driven by a strong client market, continued effective execution on our strategy. It's important to note that even with backing out the extraordinary warrant gains, we still exceeded expectations on pretty much across the board. Credit quality was excellent as well.

Our strong balance sheet growth generated healthy net interest income. And although we are seeing NIM headwinds, we are proactively managing the impact of declining rates on our business. The potential for declining rates aside, we see continued opportunities for growth near- and long-term and are continuing to invest in driving growth and creating operating leverage.

So with me to open up for questions, Dan Beck our CFO, as Meghan said, Mike Descheneaux, our Bank President and myself. Marc Cadieux is actually out on a family emergency, so any credit-related questions will be directed to Mike and myself, and that's the good news, good quarter to have that since credit quality is really solid.

So with that, operator, can you open up the line to questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Ken Zerbe from Morgan Stanley.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [2]

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Maybe shall we start off on expenses. Can you just talk about how much flexibility you have to limit the amount of expense growth, especially as we head into 2020? And again specifically, I'm just trying to understand. Is it possible to actually achieve positive operating leverage given the expectation that the Fed is going to cut rates a few times this year and probably a few times next year?

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [3]

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Yes, Ken. So this is Greg. I'll start and I'm sure Dan will want to add some commentary. So the answer is, do we have flexibility? Yes, we have flexibility to do that. We have a pretty big project spend, initiative spend that we have in place. That being said, if you just go to the forward curve and a couple rate decreases are built-in. To be honest, I don't expect that we're going to make any real changes to the expense guidance and for a lot of different reasons, right? One is a couple rate changes, to be honest, really shouldn't change the trajectory of our investment in the business whether it's projects initiative. We're investing for growth. So I just -- I wouldn't expect to see much of a change.

Now if we saw more headwinds, if there were other issues that came up, that's a little bit of a different story, but with the forward curve the way it is, I wouldn't expect to see a lot of change.

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Daniel J. Beck, SVB Financial Group - CFO [4]

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The only thing I'd add to that, Ken, is as we've talked about for next year, it's early, but we're still looking at expense guidance discussions in the high single digits. And there's really no change in expectations with that. The thought is with that, we will be able to continue to invest. And that's the focus.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [5]

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Okay. Great. I guess in the terms of the capital call lending, [as you --] that is now up to 50% of total loans. Can you just talk about your appetite or your willingness to increase your exposure to capital call lending above that 50% level?

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [6]

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Yes. This is Greg again. So we said on prior calls, we are comfortable going over the 50%. Our kind of soft guidance is kind of a 55%-range, and again, has some room to go up. And just maybe to think about -- share how we think about it, one is, remember when you look at our balance sheet, loans are only half of our overall balance sheet. So capital call lending is roughly then 25% of the balance sheet, roughly, number one.

Number two, the portfolio itself in private equity services is incredibly diversified. It's diversified from venture to private equity and in -- within private equity, which is still the preponderance. That is very diversified from fund-of-funds to small-cap buyout, mid-cap, large-cap buyouts. So geographically dispersed.

So there's -- it's very, very diversified. So yes, we're comfortable going above 50%. But we're also looking at it and saying, at some point, we do need to be more sensitive to it. So we're looking at different ways to syndicate those loans and other ways to create participations, so that we can still allow for the growth of the clients, but manage the overall exposure from a dollar amount perspective. Mike, you want to...

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Michael R. Descheneaux, SVB Financial Group - President of Silicon Valley Bank [7]

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No, I think that's absolutely right. I mean, Ken, the one thing that's very, very clear for us is to continue to be in the market for our clients, irrespective of this threshold or this number we're talking about. And there's other means in addition to what Greg said about syndications and partnerships, et cetera, but it's also to the use of some credit default swaps as well that we're looking at that would also help facilitate our runway -- extended runaway.

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Kenneth Allen Zerbe, Morgan Stanley, Research Division - Executive Director [8]

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Got you. Okay. And then just one last question, if I could. There was actually a sentence in the prepared remarks. It talks about for each 25 basis point cut, think it was like a $40 million to $50 million annualized number. There's one assumption you made in there, and I'm just trying to understand it. It says, "This estimate assumes deposit beta between 50% and 70%." I'm just trying to understand, your deposit costs are insanely low. How -- what am I missing here? Like how do you get a 50% to 70% deposit beta if the Fed cuts 100 basis points and you're only at 36 basis points currently?

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Daniel J. Beck, SVB Financial Group - CFO [9]

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Yes. Ken, when you look at that -- the 30 basis point number, that's total cost of deposits. The interest-bearing cost of deposits are right around 1.27%. So we do have flexibility to decrease from there.

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Operator [10]

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(Operator Instructions) And your next question comes from Jared Shaw from Wells Fargo.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [11]

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Maybe just starting on the loan side. We're seeing strong exit activity and strong deposit growth. When do you think that that's going to really start to flow-through into sort of stronger levels of loan growth away from the capital call lending? Should we expect to see at the life sciences and the software and hardware start to ramp up as categories as you go through the year and you start seeing more of that money reinvested on the part of the VCs and PEs?

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [12]

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Yes. So Jared, this is Greg. It's, I'd say, it's a little bit hard to predict, and here's why. There's 2 parts to the answer. One is, are we adding new lending relationships in technology, life sciences. Private bank is growing [outstandings] but just stick to technology and life sciences. The answer is yes, we are growing new relationships, new credit relationships.

The challenge is the headwinds that can be a positive or a positive of all the liquidity that exists. So we're seeing these very large rounds of financing get done. We're closing this working capital loans, but they're not wanting to borrow because they have $50 million, $60 million, $70 million, $100 million, $200 million of liquidity on their balance sheet. So from that standpoint, it is -- that is a headwind. When that balance comes out, that I don't know. We do expect to see some of it. But again, it's still a little bit of a headwind just given all the liquidity that we have in the market.

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Michael R. Descheneaux, SVB Financial Group - President of Silicon Valley Bank [13]

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The other thing I would add is, just the competitive environment in terms of pricing, size and structure and kind of when we reflect on where do we want to play for smart growth right? I mean growing loans is in a sense, you can absolutely grow loans, but can you grow the right kind of loans to get the right kind of returns given the risk profile as well? So that's something we're certainly keeping an eye on. But again, that's kind of natural when you have an environment like we have today where there's just so much liquidity available in the marketplace.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [14]

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Okay. And then looking at the cash balances, that continues to grow. As we look at a likely falling rate environment, how should we be thinking about that cash being deployed over the next, next few quarters?

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Daniel J. Beck, SVB Financial Group - CFO [15]

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Yes. Jared, we're focused on putting that money to work. So our anticipation is that we're going to put anywhere between $2 billion to $3 billion of that cash to work in the form of investment securities at least in the third quarter. So we're constantly looking at that and managing those balances and deploying them to investment securities.

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Jared David Wesley Shaw, Wells Fargo Securities, LLC, Research Division - MD & Senior Analyst [16]

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Okay. And then maybe shifting over to the margin, just for a quick second. On the guidance that you have there, does that assume that the prepayment loan fees stay at sort of similar levels as you go through the rest of the year? Or could we see that pull back a little bit? I mean I think that added 4 basis points?

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Daniel J. Beck, SVB Financial Group - CFO [17]

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Yes. We expect them to pull back. So in our guidance, we factored that out for the remainder of the year to get to the base 3.60% to 3.70% range.

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Operator [18]

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And the next question comes from Ebrahim Poonawala from Bank of America.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [19]

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I just wanted to follow-up and clarify something to Ken's question earlier. When we look at the interest-bearing deposit cost, is it safe to assume then, based on what you said, that if we get a Fed cut next week, this should be the peak in terms of deposit costs for the bank?

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Daniel J. Beck, SVB Financial Group - CFO [20]

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So, the expectation is that, from a rate perspective, the cost will go down. But there is also an expectation that the mix is going to continue to shift towards interest-bearing. If we think about serving clients and keeping relationships with the clients, which -- that's the #1 objective for us. That's where -- that's the stickiest relationship, and that's where we get additional value as well. So we expect that interest-bearing deposit balance to continue to increase as we get through the rest of this year, which could drive, I would say, a more stable deposit cost from where we are today for the remainder of this year.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [21]

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Understood. So interest-bearing deposit cost would go down. Got it.

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Daniel J. Beck, SVB Financial Group - CFO [22]

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See, the rate would go down but the total cost of deposits should remain more stable in that environment.

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Michael R. Descheneaux, SVB Financial Group - President of Silicon Valley Bank [23]

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But that is a volume versus rate issue.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [24]

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Yes. Understood. So the rate will go down. I get the volume and I get the growth is coming from there. So the actual expense associated with those would go higher. And just more philosophically, Dan, if you could help us understand, like if these deposits are coming in at 1.25 to 1.50, you're buying securities at 2.30 to 2.40. Like what's the rationale of growing the securities book and use it -- as opposed to rechanneling some of these deposits back off balance sheet. And I mean and I recognize there's a good reason for that, but would love to hear sort of how you think about it?

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Daniel J. Beck, SVB Financial Group - CFO [25]

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Yes. So it's really 3 things: first is what I was just referring to before, that what we noticed when we had a less competitive product in the market in terms of rate is that our clients were moving some of that money to other financial institutions. And quite frankly, that doesn't make sense for us. We have the primary relationship with them and it makes sense for us to continue to be their primary depositor. So that's #1.

And with that comes the additional value of deepening with the client. Secondly, if we just look technically from a treasury perspective, to the extent that we're able to generate at this point of the cycle, 50, 75 basis points of excess spread, the fact of the matter is that we have excess capital. That makes sense for us with the ancillary benefit to the relationship to continue to put that money on the balance sheet, and that's a better situation than having that money off the balance sheet at this point.

So take those 2 factors into consideration, and that's why we think it continues to make sense. The third piece I will mention is, once it doesn't make sense, we've now proven that we have the ability with time, and it will take a quarter or so, to shift that dynamic. So these decisions aren't baked in stone and forever.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [26]

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Got it. And just a separate question around capital. So it looks like we're close to completing the buyback you had announced last year, about I think $493 million bought back. Just any updated thoughts around capital -- capital -- you're obviously, accreting tangible book value quite strongly despite the buybacks. I'm just wondering if, given where we are in terms of the buybacks that have already been used, could we see more than just the remaining $7 million in the next quarter.

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Daniel J. Beck, SVB Financial Group - CFO [27]

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So to be clear, we did complete the full buyback at this point, so that's been fully executed. And as we mentioned, we do continue to accrete capital. So that definitely gives us flexibility as we look ahead. We do have opportunities to continue to invest those dollars, but at the same time, are considering options for capital return. I think it's too soon right now to make those decisions, and we'll have more as we come back with the guidance for next quarter on what we're thinking.

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Operator [28]

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And our next question comes from Steven Alexopoulos from JPMorgan.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [29]

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I wanted to start for Dan. So you last disclosed in the 10-Q that you were 14% asset-sensitive, and if I look at the $40 million to $50 million reduction you're calling out today, that implies about 8%. How did asset sensitivity drop so much particularly in a quarter where most banks are saying it's not economical to add hedges?

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Daniel J. Beck, SVB Financial Group - CFO [30]

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Yes. So there are 2 aspects of the asset sensitivity and we try to outline this on one of the earnings [slides.] So one is the static balance sheet sensitivity and one is our forecast. The static balance sensitivity takes into consideration a 100 basis point parallel shift in overall yields. The big difference for us is with the redeployment of investment securities, on a regular basis, we invest anywhere between, let's call it between $1.5 billion to $3 billion. In the rate environment we're in, we wouldn't anticipate 100 basis point shift down in the yield curve associated with the investments where we're investing. So between that and the deployment of the cash that I mentioned earlier, we get to what we expect to happen in reality, which is the $40 million to $50 million of annualized impact for every 25 basis points.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [31]

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Okay. That's helpful. Dan, were you able to reduce that 14% at all for the quarter? Or is it still at that same level.

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Daniel J. Beck, SVB Financial Group - CFO [32]

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It's sitting at 12% right now. So we have been making progress against it.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [33]

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Okay. And then looking at the Slide 12 where you're calling out the different levers in a changing rate environment, regarding the comment where it says on the bottom here, that you believe you could improve the efficiency ratio in a lower rate environment. Are you saying that you could improve that? Is that what you're saying in the backdrop of the Fed reducing short-term rates?

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Daniel J. Beck, SVB Financial Group - CFO [34]

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What we're saying there is that we don't believe that we can improve the operating efficiency ratio, but what we do have our levers to drive more scalable growth [for] the business. So the revenue side of the equation will clearly be impacted with Fed fund rate declines. But we do have options and have been investing to drive more scalable operations.

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [35]

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Yes, so it's more operating efficiency versus an operating efficiency ratio. So it's -- definitely improvements are going to be made, it's just the ratio itself may not change.

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Steven A. Alexopoulos, JP Morgan Chase & Co, Research Division - MD and Head of Mid-Cap & Small-Cap Banks [36]

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Okay. And just so we're clear, Greg. Do you guys plan to more aggressively manage expenses if the NIM starts coming down sustained if the Fed just keeps cutting rates? I know -- I heard what you said that you were going to continue investing. But what are the overall thoughts on the pace of expense growth?

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [37]

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You know -- so Steve, here's how I think about it. I think if you just -- as I said, if you just go look at the forward curve, it's got 2 baked in. If that's where it settles down, I don't think you're going to see a lot of change with our investment philosophy and how we approach. Once you start getting beyond that, if it goes to a third, if it goes to a fourth, we'll be sitting down and making decisions around that. At this point, I can't tell you that we will -- we'll slow down investing because it's going to be a function of whether we see the opportunities or not to invest in growth that will pay out over time. So it's just I don't have more information than that because we'll make a judgment call at that point. What's important though, as I said at the beginning, we do have the flexibility. We do have the flexibility. Whether we choose to use it or not, that's still undetermined at this point.

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Operator [38]

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And your next question comes from John Pancari from Evercore.

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John G. Pancari, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [39]

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Back to the expense question on 2020, I know you indicated that you're still confident in the high single-digit expense growth rate for 2020. Is that including Leerink or excluding Leerink?

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Daniel J. Beck, SVB Financial Group - CFO [40]

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That would include Leerink for this next year.

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John G. Pancari, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [41]

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Okay. All right. Got it. And then also on the Leerink topic sort of, last quarter you indicated that you lowered the expense growth outlook for the bank but maintained it for the company as a whole. Meaning, you essentially increased the expense outlook for Leerink. Is that -- were there any changes this quarter on that?

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Daniel J. Beck, SVB Financial Group - CFO [42]

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No. We didn't reduce the expense outlook for Leerink that was just specific to the bank. And at this point, based on where we stand, we believe that we're going to be at the lower end of the guidance range for the company as a whole including Leerink.

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John G. Pancari, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [43]

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Okay. That's helpful. And then on the bond portfolio, you did mention strategies to continue to extend the bond portfolio duration. And it looks like the duration right now is around 2.6 years and was 2.2 years last quarter. What's the outlook there? How much further are you willing to extend that portfolio?

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Daniel J. Beck, SVB Financial Group - CFO [44]

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So just to be clear, I think that you were looking very specifically at the available-for-sale. When we look at the combined portfolio, the duration is sitting out in the 3.4-year range. At the same time, as we look at it, we have been buying consistently. And this is, over the last 2-year period, and let's call that 4- to 6-year range. So we're going to continue to do that at this point to protect against the possibility for rates falling further. And to the extent that we're surprised that rates pick up quite quickly, that would be a good positive outcome for us. So we're really here right now just protecting against the risk of -- for further downside.

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Operator [45]

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And our next question comes from Chris McGratty from KBW.

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Christopher Edward McGratty, Keefe, Bruyette, & Woods, Inc., Research Division - MD [46]

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Dan maybe or Greg, question on CECL. Maybe updated thoughts now that we've got 4, 5 months implementation. Is -- are your prior comments about waiting until October to give an update on the capital return if there is more, predicated at all on CECL or maybe any initial assumptions?

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Daniel J. Beck, SVB Financial Group - CFO [47]

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The 2 are not related. We're refining our estimates of what we think CECL is going to look like and be ready for more of that in the third quarter. But as we're looking at our early estimates, we don't see a material change. But again, that's still early and we'll be able to come back with more details in the third quarter.

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Christopher Edward McGratty, Keefe, Bruyette, & Woods, Inc., Research Division - MD [48]

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Okay. Great. And if I could sneak one more in on the deposit mix that you continue to talk about. With the Fed kind of reversing course pretty quickly and now expectations are for cuts, does it make -- I'm maybe interested in your thoughts on growing noninterest-bearing deposits from here on a dollar basis? Or should we kind of be assuming a flat [-- a little bit of] growth this quarter?

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Daniel J. Beck, SVB Financial Group - CFO [49]

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So our expectation is, as we continue to build client relationships and add clients, we had a really strong quarter in terms of client acquisition, 1,205 coming into the franchise. The expectation is that over time, we will continue to build noninterest-bearing deposits. But at the same time, we do have private equity fund distribution, things along those lines, that impact the deposit balances. So net-net, as we continue to grow clients, the expectation is that over time, we'll continue to grow noninterest-bearing. It's just going to be at a slower pace because of where we are in the rate environment. The customers and clients are still, because of what's in the rate environment, looking for yield on their deposits. And then I think it would take several reductions in Fed funds for that phenomenon to change.

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Operator [50]

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And your next question comes from Brock Vandervliet from UBS.

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Brocker Clinton Vandervliet, UBS Investment Bank, Research Division - Executive Director & Senior Banks Analyst of Mid Cap [51]

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Just turning to the Slide 9, I was doing some quick math in our model. Taking our NIM down based on these 2 Fed cuts to get into that range of 3.50% to 3.60%. That's -- I mean roughly, I'm coming up with a Q4 NIM of 3.34%. Is that reasonable to exit the year given 2 cuts in that -- around that level?

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Daniel J. Beck, SVB Financial Group - CFO [52]

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So just taking a look at the scenario where you'd expect 2 rate declines: one in July; one in September. Thinking about where you exit the quarter -- in the third quarter, you're in that, let's call it 3.20% to 3.30% range in terms of NIM. At the same time, that's also highly dependent upon the amount of noninterest-bearing to total deposits. And our expectation is that we'll be in the mid-60% range for those figures. So that's kind of the exit rate based on those assumptions.

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Brocker Clinton Vandervliet, UBS Investment Bank, Research Division - Executive Director & Senior Banks Analyst of Mid Cap [53]

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3.20% to 3.30% for the fourth quarter?

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Daniel J. Beck, SVB Financial Group - CFO [54]

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Yes.

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Brocker Clinton Vandervliet, UBS Investment Bank, Research Division - Executive Director & Senior Banks Analyst of Mid Cap [55]

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Okay. And relatedly, do you expect to hedge more aggressively going forward? Or do you feel like, given what's implied by the forward curve, you're going to fight near your foxhole from here?

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Daniel J. Beck, SVB Financial Group - CFO [56]

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The expectation is to continue to increase the hedge portfolio. As of now, we're sitting at $2 billion and our expectation is, depending on market conditions, to head up closer to the $3 billion to $4 billion range. Again, we view this as insurance over the long term, potential further rate declines and we think it's smart for where things are in the cycle to continue to put that insurance on. So that's what we're doing. And again, if rates spiked in the other direction, let's say, it grows positive for us.

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Operator [57]

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And our next question comes from Tyler Stafford from Stephens.

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Tyler Stafford, Stephens Inc., Research Division - MD [58]

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At the Investor Day in that slide deck, you guys laid out that you can generate 10% sustainable EPS growth with flat rates. So I'm just curious, what type of EPS growth do you think you can generate given where the Fed is implying rate cuts right now? Can you still generate positive EPS growth with down rates?

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [59]

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Yes, Tyler. This is Greg, I'll start. Boy that seems like a long time ago when we didn't even have rate cuts in the scenario. So I think the way to think about it is that we do believe -- and again, there's a lot of variables that obviously go into it. But that we do believe we'll be able to get a little bit ahead of breakeven when you got rate cuts built-in. So we're still shooting for a positive EPS with a couple rate cuts. When you see more than that, it depends upon how fast and all that stuff, then it starts to get more challenging. But with the couple that are built into the forward curve, we think we're going to be positive.

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Daniel J. Beck, SVB Financial Group - CFO [60]

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The only thing to add is, of course, the core -- the growth rate, excluding the rate cuts, the expectation is that we'll still able to grow in that strong 10% range. So the underlying growth is still strong.

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [61]

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Yes. The caveat I would add to it just to be clear, is that when we think about it, it's the -- excluding the extraordinary gains that we've got from warrants and securities. Obviously, those have been nice, really nice icing on the cake right now. And if that goes back to a very low number or goes to a low number, that would make them more challenging. So we're really looking at just the kind of the main part of the business, excluding those gains.

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Tyler Stafford, Stephens Inc., Research Division - MD [62]

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Yes. So ex those investment securities gains and warrant gains, with cuts flat to hopefully, slightly up EPS growth, assuming, Dan, to your point, that the business is not changing, you can still grow in that environment. Is that a fair summary?

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Daniel J. Beck, SVB Financial Group - CFO [63]

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Yes.

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [64]

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Fair summary.

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Tyler Stafford, Stephens Inc., Research Division - MD [65]

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And on -- I know the prepared comments mentioned, the lower end of the expense growth range for 2019 and I believe you have rate hikes embedded in to your internally budgeted ROE. So I'm just wondering what the expense growth range might look like for 2019 if we do indeed get 2 cuts rather than hikes?

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Daniel J. Beck, SVB Financial Group - CFO [66]

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We're looking right now at the lower end of the range and that's with our forecasted set of assumptions. To the extent that we get rate cuts out from here, it's going to provide a little bit of benefit but it won't be that significant for 2019. It'll still be within that lower end of the range.

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Tyler Stafford, Stephens Inc., Research Division - MD [67]

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Okay. And then just lastly from me. Just in the prior question, you mentioned adding a couple more billion dollars of swaps. How do we think about the expense associated with that? I'm just curious if the cost of those swaps is included in your NII guidance that you gave?

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Daniel J. Beck, SVB Financial Group - CFO [68]

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Yes. The cost of the swaps are included in the NII guidance to the extent that we went, look, let's say up to the 4 -- $4 billion range, it would add another couple million dollars' worth of expenses. So it's not that material for the year.

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Operator [69]

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

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [70]

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A question about the deposits. I think when you guys first started [pushing] this new on-balance sheet product that they're -- if I'm not mistaken, please correct me if I am, but I felt like there was a -- like a 1-year period of where the rate was set, is that -- am I remembering that correctly?

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Daniel J. Beck, SVB Financial Group - CFO [71]

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At this point, what we have -- we don't have any set rates within the first year. One of the new products that we're looking at implementing is something that will have a year rate associated with it. But as of right now, no.

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [72]

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Yes. We didn't -- This is Greg, Aaron. There wasn't a 1-year requirement for flat rates, no.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [73]

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Okay. So you have full flexibility to bring down the offered rates?

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [74]

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We do.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [75]

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Okay. And then just, I guess looking at the other side of that, has -- with the prospect of potential higher fund -- your funding cost still coming up, how does that make -- obviously, you're working with the bond portfolio to try to maximize your yields. What about on a loan book [inspires] your price now? Obviously, that's a market pricing decision, but has your higher deposit cost or funding cost caused you to rethink where you're pricing your loan book and is there options there to maybe get some better yield?

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Daniel J. Beck, SVB Financial Group - CFO [76]

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No. At this point, we're comfortable with the origination yield. What we've seen in the markets and we've made mention of that, is strong competition in particular on the private equity services book. So there's been some pricing margin compression there. But all in, when we look at the overall yields and our very low cost of funding, you're still looking at 37 basis points worth of all-in average cost to funding. That really doesn't impact our pricing or competitiveness in the market. We still have a quite strong pricing power.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [77]

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And how effective has your efforts to put floors in place on the new production been?

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Daniel J. Beck, SVB Financial Group - CFO [78]

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We've been doing fine with it. It just has a much smaller impact to the overall NII sensitivity than what we can get with the investment securities portfolio as well as what we can do on the swap portfolio. So it's been effective, but at the same time, it's not going to provide as much protection until you get past 50, 75 basis points worth of reductions. And even then, it's on a smaller part of the book.

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Operator [79]

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

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Gary Peter Tenner, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [80]

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Lots to talk about on balance sheet deposits. Obviously, your off-balance sheet client funds also increased this quarter. And I was just curious really, just have you kind of comment on the impact of the client investment fees line item in a down-rate environment? If that does [something] to the rate that you're [occasionally] getting through the fee line?

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Daniel J. Beck, SVB Financial Group - CFO [81]

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Yes. So that rate remain constant in this quarter. And what we're looking at is to the extent that we do see a July Fed funds decrease, largely think that the rate, overall on a blended basis, would remain about the same. We think it would be probably with the second rate decrease that we would see about a basis point worth of compression in that fee margin for every 25 basis points. So we've got at least this first 25 basis points without that much compression. It -- after that, the expectation is for every 25 basis points, it would come back down by about a basis point.

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Michael R. Descheneaux, SVB Financial Group - President of Silicon Valley Bank [82]

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And the only thing I would add there is just clearly, it's market-driven like what other people aren't doing in the market. So we'll certainly keep a close eye on that because if the overall market starts then certainly, we may be obligated to try to bring that down as well.

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Operator [83]

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And our next question comes from Brian Foran from Autonomous.

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Brian D. Foran, Autonomous Research LLP - Partner & US Regional Banks [84]

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Just to make sure I'm working off the right base and also understanding the NIM exit. So I guess when you say you can grow EPS a little bit even with falling rates but it's excluding the extraordinary gains, I mean, it sounds like $20, plus or minus the EPS base, that you're kind of thinking of in your head that you can grow slightly off of. Or I guess is $20 a nice round number that you're thinking that you can grow slightly off of?

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [85]

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Brian, it's Greg. We don't give EPS guidance. I think when you do the models out there as we've described it, we just try to make it as simple as possible. It's like -- as you put that together and look -- build the model, again, if we get 2 rate increases, it's going to be a slight increase -- I'm sorry, rate decreases. I keep thinking rate increases. Rate decreases, you'd see a little bit of a growth in EPS kind of on a core business perspective.

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Brian D. Foran, Autonomous Research LLP - Partner & US Regional Banks [86]

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Okay. And then on NIM, the 3.20% to 3.40% in 4Q, I mean, obviously who knows what's going to happen to rates in 2020, but is that like fully where the dust settles? Or all else equal, is there like a little bit of deposit pricing lag and catch up that would happen in first half 2020 and give it a lift? I guess what I'm really asking is, that 3.25% midpoint of that range, like where the NIM settles out with the 2 cuts? Or is that just 4Q and then there's still some lag effects happening in the first half of 2020 that maybe lift it back up?

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Daniel J. Beck, SVB Financial Group - CFO [87]

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Yes. It's hard to predict with certainty. Where -- what we see heading into the end of the year with 2 cuts and expectations for further growth in interest-bearing is in that 3.20% to 3.30% range. We would expect -- assuming we stop at 2 cuts, that you would still see some momentum and increase in interest-bearing deposits as a percentage of the total deposit base. So that could be a driver of some additional cost on deposits as we get into the 2020. But we have to see how the rate environment plays out, and it's really too early to speculate and to lock-in on a margin for 2020.

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [88]

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There's so many different variables that come into play, that's why it's hard to give an answer, because you can look at reinvestment rates, what those look like, what your deposit rates are going to look like. And if that blend becomes way too compressed, that it becomes uneconomical to bring it on-balance sheet, we may again change products around to direct more of it off-balance sheet, and that could have an impact on the NIM as well. So there's just -- there's so many variables that will be coming into play here over the next 3, 4 or 5 months, it's hard to give you a real clear picture on 2020 at this point.

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Daniel J. Beck, SVB Financial Group - CFO [89]

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And Brian, we'll be coming back the next quarter's earnings with a preview into next year. So that will be when we really set our view on what we think is going to happen in 2020.

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Brian D. Foran, Autonomous Research LLP - Partner & US Regional Banks [90]

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And if you could just clarify very quickly, a reminder, the minimum capital you're comfortable on, what's the metric and the level?

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Daniel J. Beck, SVB Financial Group - CFO [91]

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Yes. We focus on Tier 1 leverage at the bank level. And we feel comfortable between the 7% and 8% range. We're currently over that range, and that was one of the main reasons that we were comfortable with the share buyback that we just completed. But we're over that at this point.

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Operator [92]

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

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Brett D. Rabatin, Piper Jaffray Companies, Research Division - Senior Research Analyst [93]

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Wanted to ask about Slide 6, and just talking about VC/PE investment. And looking at that slide, it says, at this stage, is set for continued growth. Can you just talk about your expectations for PE deal values, VC exit values, if they -- you think they continue to move up, and then how you kind of see liquidity? I know you talked about this a little bit, but just if that continues to be as strong as it has? Or if you think that might dip a little bit?

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [94]

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Yes. There's a lot of different parts to your question. One is -- let's just talk about exit values, right? So obviously, first half of the year from an exit value perspective, the IPO market for biolife science and technology companies have been -- has been exceptional. That being said, there's a number of companies that are lined up behind it, given how the companies have gone public, how the stock prices have held up or increased, in some cases, pretty dramatically. So that again, assuming the market has some stability, the exits for the balance of the year in venture capital we [certainly] believe will continue to be robust. So that's one category.

Talk about exits in private equity. Private equity actually in the first half of the year were slower, pretty dampened. And our crystal ball and talking to the market would say that, again, market holding, that's going to actually be a little more robust in the second half of the year. So I would say exits, again, assuming the market doesn't change dramatically, looks positive.

And then on the fundraising side, if these markets, again, stay where they are, there's more money that wants to come and access this -- the alternative assets, and that's venture capital and private equity, so our expectations are that you're going to continue to see nice momentum there from a funding perspective.

And the last point is, that's just VC/PE. But there's a whole another source, as we described in the letter, of capital flowing in from sovereign wealth funds, from family offices, high-net-worth individuals, corporate venture capital, all those that's also fueling liquidity in the market. So it's not just VC/PE, it's also these other areas. And that's kind of causing us to have that positive outlook for the second half of the year as well.

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Operator [95]

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And our next question comes from David Chiaverini from Wedbush Securities.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [96]

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Just one left from me. So the interest-bearing deposit growth was roughly equal to the off-balance-sheet growth. But just curious, are the rates that you're offering on-balance sheet still roughly equal to what you're offering off-balance sheet?

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Daniel J. Beck, SVB Financial Group - CFO [97]

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Yes. They're pretty close to one another. They're within probably about 5 basis points, something along those lines right now. So roughly equivalent at this point.

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David John Chiaverini, Wedbush Securities Inc., Research Division - Senior Analyst [98]

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And as you approach that target range of Tier 1 leverage, 7% to 8%, is that when you start with toggle-down and reduce that rate on-balance sheet to slow it?

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Daniel J. Beck, SVB Financial Group - CFO [99]

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That would be one of the things that we pay attention to. The other things that we mentioned was just the overall net spread that we could get on the overall investments. And again, the focus is on meeting client expectations and needs. And there is a desire for on-balance sheet money market account at this point. So kind of measuring all those things together, paying attention to the capital forecast or levers that we are looking at to make the decision of moving on- versus off-balance sheet.

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Operator [100]

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And the next question comes from Ebrahim Poonawala from Bank of America.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [101]

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Just had a follow-up, Dan. I'm just doing the math in terms of your 2% guidance for NII drop for 25 basis points hit, implies about 8 basis points of margin compression. So 3.60%, give or take, with the prepay income going back lower, still gets you to something like 3.40%. I'm just trying to understand what the discrepancies between the 3.20% to 3.30% you talked about versus somewhere around 3.40% implied by that 2% hit from each 25 basis points cut?

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Daniel J. Beck, SVB Financial Group - CFO [102]

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Yes. It's a good question. If you think about the deposit composition, our expectation is that we'll continue to see continued growth in interest-bearing. One of the points that we make in the slides is the expectation between here and the rest of the year is that the growth will come primarily from interest-bearing. So as that mix continues to shift, that's the other element that's generating some of the margin compression.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [103]

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Got it. So the 2% is off of a static balance sheet?

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Daniel J. Beck, SVB Financial Group - CFO [104]

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The 2% is in -- off of a static balance sheet, but also takes into consideration the shift in mix that we expect between now and the end of the year. So balance is the same, but mix different.

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Ebrahim Huseini Poonawala, BofA Merrill Lynch, Research Division - Director [105]

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Understood. And just one follow-up question. Wondering if there was any update on Canada? I mean -- so you had a change in leadership there, Greg. Just any color. I know it's early days in terms of -- since you guys have been on the ground with the loan office, like, if there's any update you could provide?

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Michael R. Descheneaux, SVB Financial Group - President of Silicon Valley Bank [106]

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Ebrahim, it's Mike Descheneaux here. I mean we definitely had some good prospects and it's such an exciting opportunity in Canada. And look, I think we'll probably tell you in a couple of months, but that business is doing well. It's going to thrive, and we're very excited about doing things in Canada.

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Operator [107]

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And the next question comes from Jennifer Demba from SunTrust.

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Jennifer Haskew Demba, SunTrust Robinson Humphrey, Inc., Research Division - MD [108]

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Questions on Leerink. Just wondering if you could give us some color on the Leerink quarter? It looks like the fees were kind of flattish sequentially?

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [109]

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Yes. This is Greg. I will start. So I guess let me just talk about SVB Leerink overall, and how we're feeling about it. I would say feeling very, very good. When I think about, again, the leadership team over there, the team that are doing the execution, their connection to their clients, it is I would say everything we expected and more given the level of engagement. Their numbers are a function of the market, and we had built in a pretty healthy market into the forecast. And they're on track with their numbers for the year. Obviously, you see a little bit of a quarter-to-quarter variability, but overall, as far as our expectations, what we have built into the plan, the forecast, our outlook that we communicate, things are on track with that. So I don't know if there's much more to add on that than it's on track and we feel very good about it.

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Operator [110]

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And this concludes our question-and-answer session. I'll now turn the call back over to the President and CEO, Greg Becker.

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Gregory W. Becker, SVB Financial Group - President, CEO & Director [111]

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Great. Thanks. I want to just thank everyone for joining us today. I feel obviously great about the quarter. Record quarter, record net income EPS-wise and net income. And you can look at the client funds' growth, the new client growth, just overall incredibly strong. And on top of, again, a strong, robust kind of core business, you have on top of that these gains from both warrants and securities that we feel really, again, as I described it, it's kind of icing on the cake. So really hitting on all cylinders from that standpoint.

Yes, we've got headwinds potentially with rates. But as we articulated, if we even, if we have a couple of rate declines, we expect to be able to generate positive EPS from kind of the core side of the business.

But one of the things when I reflect on the questions in the Q&A, we spent a lot of time talking about the numbers and what's going to change quarter-to-quarter. What I think it's missed a lot in this is our strategy and what we're doing and why we're doing it and where we're positioned in the market. And quite honestly, that's what excites me more than anything else.

It's great talking about what happens on a quarter-to-quarter basis. But I sit back and still believe that, number one, we are in the best market that anyone could hope for; that number two, we've got the best clients that you could ever ask for; and three, we got the best employees executing on this. And it's really those 3 things that gives me a lot of confidence on where we're going over the long run. So I want to say thanks to our clients, thanks to our employees and look forward to talking to you guys next quarter.

And then last part, as I said at the beginning and you guys have obviously experienced, this is a very different format than we've had. Would love feedback, so please pass it along to Meghan, and let us know what we can do to provide even more clarity to all of you.

And with that, thanks a lot, and have a great day.

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Operator [112]

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