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SVB Financial Group  (NASDAQ:SIVB)
Q3 2018 Earnings Conference Call
Oct. 25, 2018, 6:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the SVB Financial Group Third Quarter 2018 Earnings Call. My name is Ellen, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) Please note that this conference is being recorded.

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

Meghan O'Leary -- Head of IR

Thank you, Ellen, 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 third 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.

(Forward-Looking Cautionary Statements)

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'll turn the call over to Greg Becker.

Greg Becker -- President and CEO

Thank you, Meghan, and thanks everyone for joining us today. Our third quarter was an outstanding one with continued strong performance across the business. We delivered earnings per share of $5.10 and net income of $275 million. Our results were driven by robust client liquidity, healthy balance sheet growth, exceptional gains on warrants and VC-related investments, strong core fee income and stable credit quality.

A few highlights in the third quarter compared to the second. Average total client funds increased by 8% to $128.7 billion; average loans grew by 6% to $26.3 billion; net interest income increased by 6% to $496 million; core fee income increased by 7% to $132 million; and we had gains from equity warrants and venture capital related investments totaling $60 million.

We also delivered a return on equity of 22.5% and an efficiency ratio of 44%. It was truly an outstanding quarter and an outstanding year-to-date. Based on our outperformance, we're again raising our full year 2018 outlook for revenue and balance sheet growth. In addition, we're reducing our preliminary outlook for 2019, which shows healthy growth of an already strong year. The most significant trend of the year and a major contributor to our strong performance has been the high levels of liquidity available to our clients and in the markets overall. Venture capital and private equity investments are at near record levels, fundraising remain strong with a lot of dry powder on the sidelines and the exit environment is relatively healthy.

At $84.3 billion year-to-date, US venture capital investment has already exceeded 2017 levels and is approaching all-time highs. US VCs have raised $32 billion year-to-date, putting 2018 on pace to exceed 2017 and marks the fifth consecutive year of fundraising in excess of $30 billion. The expansion of global private industry has been dramatic and sustained. In Q3, there were more than 3,000 private equity funds raising capital, a 52% increase over a year ago and dry powder reached a record high of $1.1 trillion.

While tech IPOs have not regained their strength, the IPO market overall has shown some notable improvements over last year. The number of IPOs year-to-date has already surpassed 2017 and this is the best third quarter for IPOs since 2014. IPOs among the life science companies have been particularly strong, outnumbering tech IPOs 2:1 so far this year.

On the tech side, the number of IPOs has still increased, but is being impacted by liquidity available to later-stage private companies. This strong momentum in venture capital and strength in the broader private equity markets is evidenced across our business, as our ability to execute consistently. Our client win rate remains very strong with more than 1,200 new core commercial clients added in the third quarter. Private equity team delivered one of the strongest growth quarters ever and reached all-time highs for loans and deposits on both average and a period end basis. Our life sciences team has growing loans at 36% on an annualized rate and has generated $10 billion of client funds growth in the past 12 months.

Our private bank team is delivering loan growth at a 22% annualized rate and that rate has increased every quarter for the past year, thanks to investments in infrastructure, marketing and people.

Our international team is also growing its balance sheet and revenues at a rapid pace and we continue to expand that business. In May, we opened our Frankfurt office and has been generated denoting new business and have seen momentum there. And in September, our China joint venture opened a new office in Shenzhen, which is home to a booming innovation community in some of China's biggest tech companies.

Finally, despite the pressure from competition and liquidity in the markets, particularly on the technology lending, SVB continues to be a partner of choice for the innovation community, in part because we support our clients in ways that go far beyond lending. We believe our holistic focus on our client's success will continue to be a winning strategy in the long term.

Even with our thriving markets and prospering clients, the current market still holds challenges. From an industry perspective, competition from banks and non-banks continues to pressure balance sheet growth, product pricing and this extends to hiring and retaining the best people. We have demonstrated over the years that we'll do what it takes to succeed in our markets, but given our focus on our platform, values and culture, we will do it in a way that ensures SVB remains a place where people want to be for the long term.

The abundant liquidity in the market is another challenge as with so-called mega funding rounds for later stage companies continue to create headwinds to higher technology loan growth. Although our client liquidity is exceptional, we are nevertheless paying attention to our on-balance sheet deposits, but the levers and options we have for attracting clients to our balance sheet products and what it may cost to get them there. While we expect our cost of deposits to remain relatively low over the long term, it will increase as rates rise.

From a macro perspective, the ongoing tariff fight between the US and China, growing anxiety about rising interest rates, market volatility and potentially slowing global economies are all of concern. In addition to the broader potential impact of these developments on growth, a fear in the public market starts to affect exits of private funding in a meaningful way our late stage client would likely be the first to feel the negative impacts of that.

As we anticipate responding to these challenges and future challenges, we remain committed to building an organization that can scale and grow efficiently over the long term and to be the best partner to our clients, delivering critical solutions, insights and connections to fast growth innovation companies and their investors to accelerate their growth.

Our ongoing initiatives to enhance client experience, employee enablement and end-to-end process improvements are part of this. As we leveraged the current positive environment to make meaningful investments in this future growth, we expect this elevated level of investment in initiatives will continue as we move into 2019. Given our strong performance and profitability, plus the opportunities we see ahead, we believe there is no better time to invest.

And, now, I'd like to share our preliminary outlook for 2019. I'd like to stress this outlook is based on our assumptions about the market today, it does not include the impact of future rate changes and is subject to change. We are expecting healthy growth in 2019, including average loan growth in the mid-teens, average deposit growth in the high single digits, net interest income growth in the high-teens, and again that's without the benefit of future rate increases. If the rates were to rise consistent with their forward curve, we'd expect to see net interest income growth in the low-20s, core fee income growth in the mid-teens, net charge-offs consistent with 2018, and non-interest expense growth in the mid-teens.

To sum up, we're pleased to see our clients and our markets doing so well, and we're doing well as a result. We're incredibly proud of our results this quarter and year-to-date and you can see from our preliminary 2019 outlook we're optimistic about our future. I remain convinced that SVB's unique place at the center of the innovation economy, our talented and dedicated employees, and our innovative amazing clients together put us in a strong position for success now and in the long term.

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

Daniel Beck -- CFO

Thank you, Greg; and good afternoon, everyone. Our excellent quarterly performance was the result of continued strength in our core business and positive market conditions. The quarter included the following highlights: first, strong growth in net interest income due to healthy loan growth and higher yields from fixed income investment securities; second, outstanding client funds balance growth, mostly 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 venture capital-related investments; and sixth, higher expenses related to salaries and wages and incentive compensation from our strong performance.

Starting with the balance sheet, average loans increased by $1.5 billion or 5.9% to $26.3 billion, driven primarily by private equity capital call lines as well as growth in life sciences and our private bank. We are increasing our full year 2018 outlook for average loan growth from the high-teen to the low-20s. Due to our better-than-expected performance year-to-date, we expect to come in at the low-end of this range.

Average total client funds grew by $9.4 billion or 7.9% to $128.7 billion, reflecting growth across all portfolio segments. This was due to healthy funding environment and IPO activity Greg talked about, as well as secondary offering, particularly for our life science clients and our continued success with client acquisitions.

Total client funds growth was primarily driven by an increase of $8.3 billion or 11.6% in average off-balance sheet client investment funds. Average on-balance sheet deposits grew by $1.1 billion or 2.3%. On a period end basis, however, deposits declined slightly by $291 million. Our mix of DDA to total deposit accounts remain strong at 83%. In addition, we generated approximately $300 million of new deposit flows into interest-bearing accounts from our deposit strategy for the quarter. This deposit generation was offset somewhat by customers moving deposits off-balance-sheet based on the size of their accounts.

In terms of our full year 2018 deposit growth outlook of the low-teens, we expect to come in at the low end of our outlook range.

Turning to the income statement, net interest income increased by 5.9% to $496.1 million, due to loan growth and the impact of higher rates on loan and investment yields. For the full year 2018, we expect to come in toward the low-end of our outlook growth range from the mid-30s. Higher loan balances and higher interest rates drove an increase in loan interest income of $22.1 million to $352.4 million. Overall loan yield increased by 2 basis points to 5.31%. The decrease was primarily due to a $4.7 million decrease in loan prepayment fee. Excluding this, loan yields increased by 9 basis points, lower than prior quarters as we experienced the flat LIBOR environment and a continuation of higher pricing competition, in particular in our technology banking portfolio.

In our fixed income investment portfolio, higher yields from reinvestment at higher market rates and higher balances drove an increase in interest income of $8.8 million to $155.7 million. Interest expense increased by $5.2 million, primarily due to an increase in short-term borrowings to fund loan growth based on the timing of loan funding and deposit flows. Deposit betas remain low at 25% for interest-bearing accounts. Total funding cost increased by four basis points to a still very low 15 basis points. Our net interest margin increased by 3 basis points to 3.62%. This reflects a slower pace of margin growth than what we saw in prior quarters with a rate increase, primarily due to, one, lower loan prepayment fee income; two, increased funding cost due to short-term borrowings during the quarter; and, three, competitive pressure on loan pricing. We expect to end the year near the midpoint of our full year NIM outlook 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 $17.2 million compared to $29.1 million in the second quarter. This amount reflects reserve for period end loan growth of $1.5 billion, a portion of our net charge-offs that were not previously reserved for and specific reserves for new non-accrual loans. As an offset, we saw a $10.4 million decrease in reserves, primarily related to strong credit profile of our large loan portfolio due to continued growth in private equity capital call lines of credit, as well as a decrease in specific reserves related to the lower level of non-performing loan.

With regard to our credit outlook, we expect our full year net charge-off ratio to remain in the middle of our outlook range of 20 to 40 basis points. And we expect non-performing loan ratio to remain toward the bottom of our outlook range of 40 to 60 basis points.

Now, I'll turn to non-interest income, which is composed of core fee income, gains from venture capital related investments and gains from warrants. GAAP non-interest income was $210.1 million compared to $192.7 million in the prior quarter. Non-GAAP non-interest income net of non-controlling interests was $203.4 million, an increase of $20.2 million from the prior quarter. Market gains from our warrants and venture capital-related investments were a significant component of non-interest income during the quarter, thanks to positive funding and exit-related trends in our markets.

Net gains on investment securities net of non-controlling interests were $25.6 million, driven primarily by valuation increases from our venture capital related fund investments. Equity warrant gains were exceptionally strong at $34.1 million, driven by healthy IPO and acquisition activity as well as by round updates. I want to underscore that gains and losses from our warrants and venture capital related investments are primarily unrealized and subject to change. Valuations and actual realization are subject to a variety in factors, including market volatility, valuation fluctuations and sales restriction like lockups. This may be one of the best years for market-related gains in our history. Although we don't provide an annual outlook on this category revenue, it's important to say that we'd expect 2019 market-related gain to be more tempered than 2018.

Moving on to core fees. Core fee income increased by 7% to $131.7 million. This growth was driven primarily by an increase in client investment fees of $6.8 million related to higher rates and higher client investment fund balances due to the healthy funding and exit environments for our clients. As a result of this increase and our expectation of improved spread on the client investment funds, we are raising our full year outlook for core fee income growth from the low-30s to mid-30s, and expect to come in toward the bottom of that range for the full year.

Non-interest expense was $309.4 million compared to $305.7 million in the second quarter. This reflects an increase of $5.5 million related to performance-based incentive compensation and an $8.1 million increase in salaries and wages, primarily related to hiring for our ongoing investments and initiatives as well as retention incentives for key employees. These increases were offset by a $10.3 million decrease in professional services expense, primarily related to the write-off of $6 million of CCAR-related costs in the second quarter.

Primarily as a result of the higher performance based incentive compensation related to the better-than-forecast performance and higher salaries and wages, we are raising our full year 2018 expense growth outlook from the low-teens to the mid-teens, and expect to end the year at the top of that range. As we said in prior quarters, given our strong current performance, we may look to further raise our growth outlook by accelerating other investments, which would result in higher project-related costs.

As Greg pointed out, our continued investments in people and our long-term growth are part of our strategy going forward. Given our current strong performance with a return on equity of 21% and an efficiency ratio of 45%, we believe there's no better time to commit to this level of investment.

Turning to taxes. We saw higher effective tax rate of 25.8%. This compares to 24.5% in the second quarter, which benefited from higher share-based compensation tax benefits. For the full year of 2018, we expect to be in the middle of our outlook range.

Moving to capital. Capital and liquidity remained very strong and our capital ratios increased across the board. Our bank 1 Tier 1 leverage ratio increased by 10 basis points to 7.82%.

In closing, we delivered another outstanding quarter and we're on our way to another very strong year. For now, our business continues to benefit from the ample availability of liquidity and exits for our clients and from the continued updraft of higher interest rates, lower taxes and a strong economy. As we move further into the final quarter of the year and look ahead to the 2019, we remain focused on delivering high quality growth with stable credit quality and maintaining optimal capital and liquidity to position ourselves for success in the long term. We continue to invest in our long-term growth through people and systems without losing sight of the need for scale and operating efficiency. As always, we prioritize strong execution, long-term planning, and adding value to our clients. Assuming there's no significant sustained negative change to the market environment overall, we believe our focus and consistent execution will position us for future healthy growth in 2019.

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

Questions and Answers:

Operator

(Operator Instructions) Ken Zerbe, Morgan Stanley.

Kenneth Zerbe -- Morgan Stanley -- Analyst

I wanted just to start off. There's a couple of mentions about increased short-term borrowings and that looks like they went up by, let's call, $2 billion on an end-of-period basis. Can you just walk us through how you use the short-term borrowings? Because I see the deposits on your balance sheet, I mean you have so much liquidity, how does short-term borrowings fit into sort of the 57% loan-to-deposit ratio? Thanks.

Daniel Beck -- CFO

Yeah. Ken, I'll take it. It's Dan. We use that for just short-term liquidity management. So in the quarter we had some deposit movement in higher loan growth, in particular toward the end of the quarter. And what we're doing there is just using that to close the funding gap on a short-term basis. And that will then roll off as we get additional deposits and pay down some investment securities. So, that's not a long-term feature by any matter. That's just a -- close to short-term funding expectations on a regular basis.

Kenneth Zerbe -- Morgan Stanley -- Analyst

Got you. And did that have any meaningful impact on your NIM or your funding costs in the quarter?

Daniel Beck -- CFO

Yeah. There was an impact that had, let's call it, about a 3 basis point impact on the NIM for the quarter, about $5 million in terms of P&L.

Kenneth Zerbe -- Morgan Stanley -- Analyst

Got it. Understood. Okay. And then, I guess, second question, we hear a lot about other midsized banks trying to get into the capital call lines business and it just does seem to be sort of growing area of interest. Are you seeing those competitors? Hopefully, can you just tell us a little bit about how competitive the landscape is? I mean, is it possible that those new entrants could take share or how does that affect your business?

Greg Becker -- President and CEO

Yeah. Ken this is Greg, and Mike may want to add to it as well. We've said this for quite a long time. It's -- the capital call lending business has been a good business for us. You know it's been a key part of our growth for a long period of time. We do it in the key markets across the US, but we also do it on the global basis in the UK and EMEA and in Asia as well. We have the biggest platform and more people than anybody else focus on this business and I think our platform is incredibly strong. But, clearly, given the credit quality, given the size of the loans and the growth potential, it isn't something new, we just see competitors in it and have for quite a while. So it's not a surprise to us. But, yeah, we do see competition in the market for this. And, again, because of the strength of our team and our platform, we feel exceptionally good about being able to be in that market.

Kenneth Zerbe -- Morgan Stanley -- Analyst

Got you. Okay. Perfect. And then just one last question, if I could. There has been a lot of discussion about you guys potentially bringing some of your off-balance sheet deposits onto the balance sheet, just given your growing capital position. Can you just talk about, like, has your thinking changed? Is that something we actually might see in the near term or would you approach it in a different way?

Daniel Beck -- CFO

Yeah. Ken, it's Dan. I'll start. So the strategy hasn't changed. We're continuing to look and this is more on how we're bringing new clients into the bank to the extent that the new clients meet a certain criteria. We're pricing to keep that money on the balance sheet. So on a year-to-date basis, and these are approximate numbers, we've been able to bring in through that strategy something close to about $1.5 billion of interest-bearing deposits. Now some of those clients, we call graduates, which means they have larger balances and ultimately then go to the off-balance-sheet offering. But the net number of what we've been able to bring in there is something closer to about $800 million on a basis and you saw for the quarter it's about $300 million. So that strategy continues to progress. And as -- and I think this is a unique feature and a good feature of the franchise as we proceed through this late environment. We have other options to the extent we want to bring and offer some of those off-balance sheet clients on-balance sheet options. So that's -- nothing's changed, at least in our strategy, and we're showing good progress.

Operator

Aaron Deer, Sandler O'Neill.

Aaron Deer -- Sandler O'Neill -- Analyst

I understand the lower prepayments weighed on the loan yields in the quarter. Is there any reason we shouldn't see, I guess, return to normalization would help give that a lift as we head into the fourth quarter here?

Daniel Beck -- CFO

Hey, Aaron, it's Dan. It's hard to predict what's going to happen with those prepayments fees. So, again, that's just based on the client activity. So hard to say what's going to happen. We did have a strong second quarter and I think that's something to take into consideration, but it's all about the client activity.

Aaron Deer -- Sandler O'Neill -- Analyst

Okay. And I absolutely support rewarding the employees for their hard work. But I guess looking at your guidance, notwithstanding the slight increase outlook for average loans and a little bit of fee income here, your other guidance items now have a qualifier that tends to be toward the lower end of the range. So I guess I'm not seeing materially better outlook here. So ex the warranted increase that you have for this past quarter, what's kind of behind the higher incentive comp generally in the higher expense guidance?

Greg Becker -- President and CEO

This is Greg. Aaron, I'll start. It's broad-based investment. So when I think about it, it's people. And from a people perspective, you've seen we've added a lot of new people this year. We have more people to add in the balance of the year and we have some additional ones. That's across the platform. That is both in the sales and relationship banking side, but it's also in the support side. And part of that is to support the growth and in some cases catch up with some of the growth that we actually have. The other part is to think about, again, building for the future.

So an example would be, we've added so far this year 50 people in our global operations. So when I mean global operations, I mean in EMEA and in China and in Germany. When you look at those three markets, we're hiring ahead of where the business is today, because we expect to build for the long-term growth and there's other businesses like that. So I understand your point that the growth isn't as strong as maybe it has been in the past, but the numbers from an absolute perspective are. Plus the fact we're building in the technology siding scale of the platform, such as more digitally enhancing our client onboarding, our loan process of looking at it from end-to-end. So, all those things are helping to really help to really build for long-term scalability and we think absolutely right now is the time to make those investments.

Operator

Steven Alexopoulos, JPMorgan.

Steven Alexopoulos -- JPMorgan -- Analyst

On the initial expense outlook for 2019, so if I look at this year, you're now assuming low 20% loan growth weight rate, 30% on the NII and core fee income and the outlook for expenses in mid-teens. Now I look at 2019, you're cutting the outlook which we would expect for loans, you're reducing it for both revenue components, but you still have the same mid-teens outlook on expenses, which is a bit surprising to me. I don't get it. What explains why you're looking for a mid-teens expense growth given the revenue outlook you're looking for next year?

Greg Becker -- President and CEO

Yeah. Steve, it's Greg. I'll start and in the middle I will let Dan pile on this next time. And so, again, as I've said, we are looking at making investments, I guess, take a step back. When you look at our overall performance right now, you look at ROE, you look at our EPS, you just look at the overall efficiency ratio et cetera. Now is the right time from our standpoint to actually and truly invest more money and it is across the platform.

And it is again as I've said, it's people that support our existing growth that we have right now, making sure that we got the right level of people to support our clients, but also building for that future. Again, the example, was that 50 people in global. So think about that. We have to -- as we add those people in 2018, we have a carryover effect that goes into 2019. So that's a big part of it, plus the other -- again the other investments in systems and technologies. So an example would be -- we have in our budget for our game plan for next year; in our projects and so forth we are around $35 million investments. We're going up to a much higher number in 2019. We really believe now is the critical time to invest across the infrastructure and across the platform.

And I'll just say one last thing. In addition to what I just said, there is one more factor. And I'd say, my guess is, a lot of other companies are seeing the same thing. There is a competition for talent. And so, as you add more people and you attract people in different roles, in different critical positions, both the market where the market demands and what you need to retain the top talent you have, both of those are actually going up. And so, you combine all those things together, that's what's creating the mid-teens expense growth.

Steven Alexopoulos -- JPMorgan -- Analyst

Sure. I don't know if Dan had anything to add to that. But when we think about, you said a couple of times, it's the right time. Are you saying like ROE is at a level now where you could basically afford to accelerate the pace of investment? Is that basically what you're saying?

Greg Becker -- President and CEO

I would say, it's all of the things. It's ROE, it is efficiency ratio, it is the level of income contribution. It is across all of the factors.

Steven Alexopoulos -- JPMorgan -- Analyst

Okay. Got you. And then to completely switch direction. So if we look at the $9.4 billion of growth in the quarter of total average client funds, I was surprised only $1.1 billion was on-balance sheet, I don't think we've ever seen $8.3 billion move off. Can you talk through that? Is the on-balance sheet product is not as competitive yet to attract more than funding, so you wouldn't need borrowings for example?

Daniel Beck -- CFO

So, Steve it's Dan. The dynamics that's at play is that, what we're seeing is that a lot of our clients that are coming onto the platform because of the larger-sized fundraising activities that's out there, they're bringing larger dollars initially to the bank. So, as larger dollar offerings come at a very high rate from a market interest perspective. Dollars don't necessarily make sense for us to bring on-balance sheet, considering the beta associated with those accounts. So as we see those high-dollar clients coming into the bank, they generally skew off-balance sheet. Like I said, through the on-balance sheet strategy we have been able to bring in $1.5 billion so far, $800 million net sitting at least on the balance sheet at a competitive price. So, we're making progress. I think it's the large size of those deposits that we're getting, because of the larger funding grounds that are driving a lot of that activity off-balance sheet.

Operator

Brett Rabatin, Piper Jaffray.

Brett Rabatin -- Piper Jaffray -- Analyst

I wanted to ask -- I guess, I just want to make sure I understood the commentary around, Greg, that pricing competition continues to be a factor. Do you feel like that's continue to increase relative to earlier in the year? Can you give us maybe a little color around just how you're seeing your loan yields act as rates keep moving up as competition is going higher? And then just specifically on LIBOR, was just curious it was late in the quarter when LIBOR finally started to move. I would guess that your end-of-period loan yield was quite a bit nicer than the average for the quarter?

Greg Becker -- President and CEO

Yeah. And there's about three questions underneath there.

Brett Rabatin -- Piper Jaffray -- Analyst

Sorry about that.

Greg Becker -- President and CEO

No, that's OK. So the first question is just on the overall competition. And so, I would say there was an increasing competition in the third quarter. And it kind of make sense, like, we've listened to other earnings calls out there from banks and there wasn't a lot of growth. And so, usually what you see happening is, people are struggling for growth, they start to be as aggressive as they possibly can be from a pricing perspective. That's the first thing that goes. We've seen that for the last obviously several years, but I would say there was a slight uptick in that competitive side on lowering pricing in the third quarter. And to be honest that's probably going to continue, right.

Again, the outlook that you saw from other institutions was very, I'd say, generally anemic growth. And how do you try to solve that? You -- again, you go after whether it's growth and you lower the pricing. So that's probably something what we're going to continue to see. What I would tell you though, through cycles over the many years I've been here, that's the way it does play out. But, again, we have historically -- and I believe we'll continue to get a premium, because of the platform we have and how we approach our clients and our focus is on figuring out how we can add value to them. And I do believe that is a very unique approach compared to what other institutions bring to the table and they think especially high-growth companies value that more than anybody else. So, I see it's a marker. Dan or Mike, anything else to add on that?

Mike Descheneaux -- President

And I think the only thing I would add is that, there continues to be a significant amount of liquidities in the bank that they need to deploy. And so there has really been no let up on that. And additionally what we see out there is, a lot of pressures from the non-banks as well to that are deploying. There has been a lot of large funds have been raised on the debt fund side, so they have a lot of dry powder that they're trying to deploy, so that all that adds up to continued pressure on some of the loan yields.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay. And then maybe the second part, just around LIBOR moved late in the quarter. I would assume your loan yields toward the end of quarter were quite a bit nicer than the average, even if competition is stronger?

Daniel Beck -- CFO

Yeah. We're still waiting for the impact of those resets to come through, because that obviously takes a little bit of time. But to get to your point on the flattening LIBOR, if I look at the LIBOR rates in the second quarter versus third quarter that cost us, let's call it about 3 basis points worth of margin expansion on the loan side in the third quarter. So to the extent that that's starts to pick up, that'll at least help in the fourth quarter.

Operator

Ebrahim Poonawala, Bank of America.

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Analyst

This was a question on expenses, but more to do with -- can you talk about how quickly you could dial down expenses, Greg? You talked about the environment and given what you've seen in the equity markets over the last few weeks, it's hard to know what the environment will be, we see investment wise six months out, like, can you just talk to in terms how much flexibility you have to the downside if the macro backdrop gets worse?

Greg Becker -- President and CEO

Yeah. So there's a couple of things in there. Part of the investments that we're making when I think about it are really related to -- at some point in the future where rates are and the tailwinds that we have at our back probably will change to some extent. And our goal is to, again, as I said to Steve's question is, to invest right now, so that we create a scalable operations and we have still today too many manual operations. We still have too many things that are done inefficiently. And we certainly believe that by investing in it now, that we really are preparing for a more scalable operation in the future. That's the biggest thing.

How fast that could scale down? Certainly, we could scale it down. But we certainly believe that it makes sense to continue to put the paddle on it for the next 12 to 18 months to make sure that we're going to see the benefits beyond that. So that to me -- that's the biggest overarching comment when I think about expenses.

Now the other part is, again, if we did see a deterioration, a lot of what we've seen and we still expect in 2019 is headcount growth. We believe that's because the opportunities are ahead of us. Obviously that's -- we could slow that if we wanted to, but again even if we see some slowdowns, I think the debate we're going to have here is, how is that temporary, how long, and do we need to continue to invest through even what could be a downturn, because again we're not thinking about what's going to happen in 12, 18, 24 months, we're thinking about 36 month and beyond. And that's why we really think now is the time to make those investments.

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Analyst

That's helpful. And just switching to your deposit growth or let's call it asset growth guidance for next year, high single digits with a 20% ROE implies a fair amount of capital build. If I'm not sure Greg or Dan, if you can talk to around how you think about capital build over the next year or 18 months, if your balance sheet growth outlook is -- comes out to be correct and what other options of that sort of will lead to in terms of deploying that capital?

Mike Descheneaux -- President

Ebrahim, we've been talking about it. At least the way we're looking at it is through the expenses that we can continue to grow capital at a strong ROE, organic growth and to continue to utilize that capital for organic growth is obviously the first thing that we want to do. Based on our capital position and the view that we could have a capital surplus, obviously, we would have options from either of buyback or dividend perspective. But at this point with the returns that we have, we're still generating a strong ROE and we think that use of that capital from an organic perspective makes sense, but we do have options.

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Analyst

Understood. And one last one, if I can. Rate sensitivity, the 100 basis points $195 million in NII upside, is that still hold true at the end of third quarter?

Daniel Beck -- CFO

Yeah. On a -- it's important to note that's on the static balance sheet, so that just takes the look the position as of today, but it's roughly the same math, 25 basis points is roughly $50 million to pre-tax -- around $50 million with a pre-tax net interest income. So that asset sensitivity is holding up.

Operator

Jared Shaw, Wells Fargo.

Jared Shaw -- Wells Fargo -- Analyst

Just circling back on the NIM discussion guidance, does that assume that the blend of liquidity in terms of on-balance sheet cash and securities in borrowing sort of stay stable here or that it reverts back to maybe where we were earlier?

Daniel Beck -- CFO

It's largely assuming that the mix of deposits, EDAs, the money markets remains relatively stable. We've talked about that from a DDA to total deposits percentage being in the high-70s to the low-80s is kind of the range of where we think that will play out. That's how we've built those expectations.

Jared Shaw -- Wells Fargo -- Analyst

Okay. And then when we look at the period end borrowings, so what is that -- any of those already been paid off or they still on-balance sheet?

Daniel Beck -- CFO

Yeah. They have started to pay down and we're -- yes, we're paying those down. There's still some outstanding though.

Jared Shaw -- Wells Fargo -- Analyst

Okay. Thanks. And then just finally just looking at the expenses on the incentive accrual, so are the -- is the run rate for the incentive accruals fully baked in at this point? Or could there still be upside from performance for the rest of the year?

Daniel Beck -- CFO

There can always be upside for better performance, but our expectations are where things stand in the guidance that's baked into the numbers. The other thing I think is just important to mention, on the incentive compensation for this quarter we have about $5 million roughly of additional incentive compensation related to the warrant gain. So, I'd just think that's something to take into consideration.

Jared Shaw -- Wells Fargo -- Analyst

Okay. Thanks. And then finally just looking at the change in allowance levels and the capital call lines, is that a methodology change or is that just applying the existing methodology to the performance that you've seen through the portfolio?

Marc Cadieux -- Chief Credit Officer

Hi. This is Marc Cadieux. And it is the latter. It's -- no change in methodology, it's the continued application of the methodology and what you see is really a function of our growth continuing to be driven by both the lower risk capital call lending.

Operator

Chris McGratty, KBW.

Christopher McGratty -- KBW -- Analyst

Just wanted to come back on the expenses, I apologize. Last year you started the year with high single digits, I believe, you're making your way to mid-teens. Given the mid-teens started, is there anything to suggest that correlation if you outperform on the revenues won't -- that 15 (ph) won't drift to maybe 20 or are there any other considerations that I might think about next year?

Greg Becker -- President and CEO

Let me start and I'm sure Dan will add on to this. Just take you back when we talked about at the beginning of their kind of starting at high single digits. You remember that was -- we've said we have some baked in for performance, but we could outperform, which we did. And the part we also said is that, we may take this opportunity to make more investments in the overall business. And so, that's really what you saw. When we saw all other things play out, right, when rates again started to play out, when the tax reform started to play out, when reg reform started to play out, we saw these tailwinds and we said, we really made a constant position in 2018 to take up the guidance on expenses and part of it is driven by performance. Going into 2019, effectively think about it -- we started out wind at our back or we believe we will, which is why we believe that level of investment in expenses and investing overall still makes sense. So that's the -- that's the biggest delta when I think about the two periods starting about with high single digits earlier this year versus thinking about the beginning of 2019 and beyond.

Christopher McGratty -- KBW -- Analyst

Okay. Just to make sure I'm clear, so that's 15 that we're starting with today, again, if you outperform on the top line relative to the guide, I presume there's an upward bias to that number but perhaps if may hearing you right not as much as the delta was this year from the high-teens (multiple speakers)

Greg Becker -- President and CEO

Yeah. Definitely not as much bias. We talked about this on prior calls about how our incentive compensation is structured, it's one-third relative to peers and we're at the top of the peer group on an ROE basis. So, that's again maxed out. And the other two-thirds based on performance. But, again, some of that is expected in there. So, yeah, if we outperform the guidance you gave in a meaningful way, you would see some uptick, but a lot of it is baked in already.

Christopher McGratty -- KBW -- Analyst

Okay. That's clear, Greg. Thank you. And just one more if I could sneak in. The client investment fee rate, I think last quarter Greg you talked about kind of tapping out of that 20 basis point range, is that still how we should be thinking about it given the rate curve?

Daniel Beck -- CFO

Well, it's Dan. We're up to 19 this quarter and I think we have continued opportunities with additional rate hikes we talked about for every 25 basis points getting about another one basis point and we'd probably get into the low-20s from that perspective. So I think we have continued room to grow there.

Christopher McGratty -- KBW -- Analyst

And that would -- Dan, that's not in the guide, because you don't guide with rates, right?

Daniel Beck -- CFO

Yeah. That is not.

Operator

Christopher York, JMP Securities.

Christopher York -- JMP Securities -- Analyst

So we focus focused on non-interest expense a lot this year, so I'm curious if you could quantify how much non-interest expense is in testament maybe in this quarter and then also this year?

Greg Becker -- President and CEO

Yeah. This is Greg. I'll start at a high level and then Dan will be going to go into more detail. What I think about it, some of the systems in technology people -- first of all, it's hard to break it down in the buckets perfectly, but I look at it and say when I think about what we're doing is part of our looking at on-boarding and looking about what we're doing employee enablement and all of those things, you're probably looking at high-level numbers, I would say, and this is -- I'm looking at it for the year, less so for any given quarter. But for the year, you're probably looking at anywhere $30 million to $50 million in that range. And, again, it's partially because you can't exactly isolate it perfectly. But it is, from our standpoint, a sizable investment and next year it's similar if not actually a little bit higher.

Christopher York -- JMP Securities -- Analyst

Yeah. I know it's difficult to kind of, I guess, provide precise numbers. So the $30 million to $50 million is helpful. I'm just kind of framing it. And then just question on competition for talent that was touched on, but I wanted to look at it may be another way, so with client engagement and reduced ability to make connection to the client is a significant advantage and very hard to replicate. But I'm curious to learn how you think about that actual risk to client attrition when competitors hire a group head or maybe a key employee to try to replicate your business. Is the client evaluating -- how does the client evaluate the platform maybe to -- versus the relationship?

Greg Becker -- President and CEO

Yeah. We -- look, I spent a lot of time with clients visiting them and here's what they enjoy about our platform. They enjoy, number one, the client experience and how it's a broad-based across the entire platform, the relationship manager and our client service teams, number one. Number two, they look at the service levels that we have for lending the money, how responsive, how competitive we are and how we operate when times get tough. Now there hasn't been a lot of tough times, so the memory isn't quite as good as it was back. But people still appreciated -- starting to appreciate it more in the sense that because they do realize the market is at higher levels and they really need to know who they are going to be partnering with over the long run.

And the last part is they want to make sure that the platform the part of the institution actually understands their business from the top to the bottom of the organization and that technology or whatever life science isn't just a side business for them. Because they know when things get to sideways that could change that platform and they may not be part of the same institution over time. So that's what clients really enjoy working with us, because we cover all those bases. And our goal is, it's a platform, individuals are clearly important, our individuals are incredibly strong, but it's the whole platform that has to deliver what I just described to you. That's what they really want to be part of.

Christopher York -- JMP Securities -- Analyst

Yup. That's great color. And then last one, given your partnership with Stripe, I thought it maybe conceivable that you have participated in previous funding rounds in some area of the business. So do you have equity or warrants in the company that would have been contributing in this quarter's results as a result of the Stripe's last funding round?

Greg Becker -- President and CEO

Yes, this is Greg. We don't comment on -- about where our market positions (ph) or investments are in unless whoever that is would actually put that in one of their filings or something, they're the ones that notified part of this, because we have warrants in so many different companies and so clearly if we had something it would be in our numbers but we don't comment on individual companies.

Operator

Gary Tenner, D.A. Davidson.

Gary Tenner -- D.A. Davidson -- Analyst

I just wanted to ask a question regarding the private equity and venture capital lines. Has this continue to grow in balances? Are you finding that it's -- what's the balance between continuing to add new customers to that line of business versus just growing it, because the funding rounds have been so large and there's a lot of dry powder on the key balance sheets and venture capital balance sheets?

Marc Cadieux -- Chief Credit Officer

So, it's Marc, I'll start, others may want to add. It's a been combination of both. We're seeing greater utilization from existing clients. We're bringing on new clients. And as reflected in the investment activity, utilization of those credit facilities is a function of that pace of investment continues to be relatively strong. So it's a combination of several different things.

Operator

Tyler Stafford, Stephens.

Tyler Stafford -- Stephens Inc -- Analyst

I want to just go back to the expenses one more time. I think I'm clear on the expense pressure that would be there for next year relative to the mid-teens expense growth if the revenue comes in better than expected, but can you just remind us how the revenue pick up solely from future rate hikes might impact that mid-teens expense growth?

Daniel Beck -- CFO

Yeah. Tyler, so part of that rate increase, especially on the go-forward basis considering that pressure on deposits and liquidity is going to be out there. It makes sense for us to include some of the benefit of rate increases in our compensation on that basis. So we do as a part of our plans to, obviously, have for loan balances, interest income performance as well as what folks do for fee income that as part of their overall plan. So future rate increases could drive higher incentive compensation.

Tyler Stafford -- Stephens Inc -- Analyst

Okay. Okay. Thanks, Dan. Just going to the deposit-level strategy again, so looking at the guidance next year, obviously, the net dollar of deposit growth implied by the high single-digit guidance is still clearly robust. But I guess -- a little surprised it wasn't a little bit stronger given the -- I guess the early stance on the deposit leverage strategy. So, I'm just wondering if there's any kind of significant, I guess, deterioration or slowdown in the overall capital raising environment that you're assuming or that's underpinning that outlook that would pressure that lower or is the outlook just kind of steady as she goes on the capital raising environment?

Daniel Beck -- CFO

Yeah. It's Dan. The outlook is steady as things go on the capital raising environment and what we're doing is, taking into consideration what those current conditions are and looking what's happening from an on-balance sheet deposit generation perspective. So that's really consistent with our strategies today. And we are making good progress with the deposit initiative as I talked about earlier.

Mike Descheneaux -- President

This is Mike Descheneaux. As you see, the overall client funds continue to be extremely strong. You saw that here in Q3 where we had almost what $10 billion in growth there. Obviously, a lot of it was on the off-balance sheet. So it really comes down to how can we direct and put the clients into the appropriate product on-balance sheet. So, it's not a question of a sourcing. It's kind of a mixed challenge, which is what goes on and what goes off. So if we had seen a deterioration in some of the overall client funds growth then maybe we might start talking a little bit different outlook, but nonetheless it is about a mix.

Tyler Stafford -- Stephens Inc -- Analyst

Does the high single digits on-balance sheet deposit growth not assume a net dollar decline of growth '19 versus what you've seen in '18?

Daniel Beck -- CFO

No. It assumes growth in deposits in 2019.

Tyler Stafford -- Stephens Inc -- Analyst

Yes. And I guess just the absolute dollar deposit growth of high single digits would be down from the net deposit growth you've seen in 2018, if I'm thinking about that right. Is that right?

Daniel Beck -- CFO

Yes. On a year-over-year basis, yes.

Tyler Stafford -- Stephens Inc -- Analyst

Yeah. Okay. And then just last one for me, if I can. Just going back to the leverage here. Can you guys actually leverage the capital base with the pace of balance sheet growth you're expecting given just the profitability outlook? Or would actual capital leverage deployment come through dividends or buybacks or other means?

Daniel Beck -- CFO

Yeah. Like, we were saying again, our measure is what can we generate from an organic capital perspective and to the extent that we can continue to do that at a strong ROE. We're going to continue with that to the extent that the capital build to a point that we can't deploy it at a strong rate, that's when we'll start to consider our options as we do have surplus capital for a dividend or a buyback in no particular order.

Operator

John Pancari, Evercore.

John Pancari -- Evercore -- Analyst

On the -- back to the deposits, I hear you in terms of the larger balances graduating to the off-balance sheet and then some of them just were going to carry a higher beta than you wanted to meet. How do you view that trade off cost-wise between that versus the strategies that you're looking at now that you said to bring some of that off-balance sheet on to the balance sheet, like, what's the pricing differential there that it makes it worth going after some of those off-balance sheet funds versus letting the other ones go?

Daniel Beck -- CFO

Yeah. There are some clients that as we look at overall size of balances and, again, this is doing the right thing for the clients where we still have rates in the, let's call it, 60 to 100 basis point rate range just depending upon the size of those relationships. So, those that -- at that rate it makes a lot of economic sense, especially in this rate environment for us to keep those on-balance sheet. As rates increase, so we'll continue to expand and look at higher rates that are sitting in our off-balance sheet accounts or additional opportunities.

And depending upon where the fed funds go and where we can invest that from a treasury perspective, that's a good way to understand what we're willing to do from an investment perspective. So, today, again based on size and balance of some of the clients, it makes a ton of sense to bring them on-balance sheet and, again, we've added about $1.5 billion of those on a net basis $800 million sitting in money market. In the future as rates increase that will continue to open an aperture for us as to what we can bring on from the off-balance sheet side.

John Pancari -- Evercore -- Analyst

Okay. And then separately, the expenses on -- what is your flexibility on the expense side if the revenue picture doesn't play out as you expect?

Greg Becker -- President and CEO

This is Greg, John. So there is a fair amount of flexibility. You've got incentive compensation, you have headcount growth, you have the investments we're making in projects, there's a whole laundry of list of things. So the answer is, yes, we have flexibility, but that's only -- that's one part of the equation. The other part of the equation is going to be -- is -- what do we want to pull back on? What do we want to slow down? And part of that depends upon what the crystal ball looks like at that point in time. What does it look like in the future, but I would say just right now sitting in this chair that we believe, right now, with the performance levels that we're at and that we expect to be at that, that we will continue to invest, because we believe now is the time to make those investments to create the scalability and future growth that we believe is the right way to invest. So, that's the main thought process.

John Pancari -- Evercore -- Analyst

All right. Thanks, Greg. And then one last thing on the loan yield side. Can you remind us of where the capital call lines are coming on the books? I believe you said for PE it was in the low-4s and VCs maybe around the mid-4s. And then separately on the loan yield side, I know you indicated in the press release that your loan yield would have been 9 basis points ex the fees and recoveries. Is that the amount of loan yield increase you would expect out of the next 25 basis point hike, or would it be higher than that?

Greg Becker -- President and CEO

So, I'll take the first part and Dan may want to chime in with the second part. So, for private equity services, it has come up a little bit as rates have come up. And so, mid-4s would be the average and the spread between VC and PE has narrowed a bit from the historical 50 basis points to closer to 25 to 30.

Daniel Beck -- CFO

And then to add to your question, John, as we take a look at the 9 basis points this quarter, that's with a flat LIBOR environment. So to the extent that we have an increasing LIBOR environment we would -- in this quarter that cost us 3 basis points. So you can kind of look at that to the extent that we got back to a LIBOR environment that looks like Q2, at least because of steepening LIBOR environment like Q2 that we would add a couple of basis points there. So, again, we've talked about it in the past that being for every 25 basis points what do we expect to come through in terms of overall loan yield, we've been talking about that in the 50% to 60% range. It's probably closer to the 50% range on a go-forward basis just because of where we are in the cycle, but we still feel like that's the right level and that's what we're seeing.

John Pancari -- Evercore -- Analyst

Okay. That 10 percentage point disparity that's more around the competition of the impact?

Daniel Beck -- CFO

Yes.

Operator

David Chiaverini, Wedbush Securities.

David Chiaverini -- Wedbush -- Analyst

So, I have a question on market share. So growth has been outstanding, that's clear. But I'm curious, based on all the investment in the business you're doing, do you still believe you're still winning the same level of market share that you've enjoyed in the past?

Greg Becker -- President and CEO

Yeah, this is Greg. The answer I guess Mike tempered (ph) is absolutely. And how I think about it is that, there's the market share and there is two questions. One is, are they client or are they not a client, right, that's number one to look at market share. And the second way is, what percentage of the wallet do we have in the sense of what do we have in credit cards? What do we have in FX? What do we have of other fee-based products and services? And so, we're increasing that share and our market share is strong and the overall market is growing. So you have all three of those things that are driving the growth and then we expect to continue to drive the growth.

David Chiaverini -- Wedbush -- Analyst

Great. Thanks for that. And my next question is just on the off-balance sheet client investment funds. Maybe I missed it earlier, but did you state what rate or yield they're receiving on the off-balance sheet, you mentioned the on-balance sheet is 60 to 100.

Greg Becker -- President and CEO

Yeah. So the off-balance sheet, there are several product sitting there, but that was much closer to all-in market rates.

Daniel Beck -- CFO

Yeah. As we said, the average on that is 19 basis points. And so, you can look at across all the products and say whatever market is on average subject take -- subtract -- 19 basis points from that, that's the yield. So it's actually a very attractive market rate.

Operator

And that was our final question. I'd like to turn the call back to Greg Becker for closing comments.

Greg Becker -- President and CEO

Great. Thanks. So before I close, I just want to remind everyone that we're going to be hosting an Investor Day on December 4th. The event is going to be live webcast and we'll get more information out to everyone from Meghan and the team. So -- but you -- we hope people can tune into that. The last time we did that was actually over 6.5 years ago. So we thought it was time to go a little bit of a deeper dive and not just the business where we are, but more importantly where we're headed as a company. So tune in for that, if you can.

So just kind of wrap up, obviously, we're really excited and pleased about the quarter and not just the quarter but the results so far in 2018 until we have a strong outlook for the balance of the year. Obviously, there's a lot of caution and concern out in the market, but as I have said many, many times in this call, there is -- if you could be in one spot, if you could pick one market to be part of with the long run it's the innovation economy, right. It's the one market that I certainly believe is going to be up into the right for the long term even if you do see volatility in the quarterly bases or even on in annual basis. And that's what we're all about.

So, I just want to thank our great team of employees who do such a phenomenal job on -- and our clients who again are doing amazing things in innovating and ways that are just so incredible and so proud of them, and to our investors also who put their trust in us and what we do. So, thanks everybody. Have a great day and take care.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.

Duration: 66 minutes

Call participants:

Meghan O'Leary -- Head of IR

Greg Becker -- President and CEO

Daniel Beck -- CFO

Kenneth Zerbe -- Morgan Stanley -- Analyst

Aaron Deer -- Sandler O'Neill -- Analyst

Steven Alexopoulos -- JPMorgan -- Analyst

Brett Rabatin -- Piper Jaffray -- Analyst

Mike Descheneaux -- President

Ebrahim Poonawala -- Bank of America Merrill Lynch -- Analyst

Jared Shaw -- Wells Fargo -- Analyst

Marc Cadieux -- Chief Credit Officer

Christopher McGratty -- KBW -- Analyst

Christopher York -- JMP Securities -- Analyst

Gary Tenner -- D.A. Davidson -- Analyst

Tyler Stafford -- Stephens Inc -- Analyst

John Pancari -- Evercore -- Analyst

David Chiaverini -- Wedbush -- Analyst

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