SVB Q2 2017 Economic Report

Q2Quarterly Economic Report 2017

0417-0062KHEXP083117 SVB Asset Management | Quarterly Economic Report Q2 2017

Table of Contents

2

Thoughts from the desk 3

Overview 4

Domestic economy 6

Central bank monetary policy 12

Markets and performance 17

Global economy 26

Portfolio management strategy 30


Thoughts from the desk

Major global economies, directionally similar to the U.S., continue to post positive growth — though political events may add fuel to the engine or choke off current momentum.

Across the pond, U.K. Prime Minister Theresa May invoked Article 50 to officially commence the EU divorce discussions, and key election outcomes in France, Italy and Germany threaten to possibly increase the call to exit from the Eurozone. Nonetheless, slowdown in quantitative easing programs by the European Central Bank, election uncertainties and early jockeying for favorable trade policies by member countries continue to weaken the British pound and euro.

In the states, the FOMC maintained its current path toward normalization of monetary policies with an additional 25-basis-point increase to the Federal Funds rate range in March — while signaling two additional hikes to follow by year-end. The Fed also cited further tightening in labor markets, inflation “moving close” to their 2 percent longer-run objectives and the increasing likelihood of discontinuing its policy of reinvesting principal payments from investment holdings. The Fed remains the only major central bank in a tightening mode, and it appears to stand alone for the foreseeable future.

Looking at Trump’s first 100 days in office, his administration has fallen short of his campaign promises — including the inability to reform the Affordable Care Act, decreasing odds of enacting his plan for personal and corporate tax cuts by year-end and infrastructure spending plans that are looking to be smaller than the original $1 trillion proposal. However, with elevated business and consumer sentiment — albeit a decline from post-election highs — markets will continue to test new highs if the President is able to roll back the Dodd-Frank Act on banking regulation, pass any form of infrastructure spending bill and work with Congress to pass a meaningful tax reform.

What’s ahead: with inertia for additional rate hikes, we continue to position duration for intermediate-to-long portfolios to be defensive. Investment-grade bonds offer better downside protection than government securities as compressing credit spreads and relatively attractive coupons counter price declines. As such, we favor allocations to this security type for our comprehensive portfolios.

3


Overview

Central bank monetary policy

  Economic activity has been healthy with Q4 GDP at 2.1 percent. The third revision saw consumer spending improve to 3.5 percent, which continues the solid readings over the past two quarters (4.3 percent in Q2 and 3 percent in Q3).   Although Q4 was expected to fall from the large Q3 reading, the 2.1

percent figure is still in line with the 2 percent trend we have seen over the past couple of years.   Consumer sentiment fell in the first quarter as Trump’s pro-growth

pre-election themes of tax reform, deregulation and infrastructure spending shifted to immigration and an unsuccessful attempt to repeal Obamacare.   The three-month average for nonfarm payrolls for Q1 is 178,000. January

and February had healthy gains of over 200,000, while March came in below expectations at 98,000.   The unemployment rate has been at or below 5 percent for the past 19

months, and the U-6 underemployment rate fell below 9 percent for the first time since 2007.   Core PCE continues to trend closer to the Fed’s 2 percent target,

supporting the March 2017 decision to raise the Federal Funds rate.   For the first time in nearly five years, the PCE price index rose above the

Fed’s 2 percent target to 2.1 percent for February.

Domestic economy

4

  After a decade of expansionary and accommodating monetary policy, normalization is under way as a result of a strong domestic economy and muted geopolitical concerns.   At the March FOMC meeting, the Federal Reserve raised the Federal

Funds rate at consecutive meetings, citing confidence in the robustness of the economy and its resilience to shocks. The rate increased by 25 basis points to a range between 0.75 and 1.00 percent.   Looking ahead, Fed members maintained a steeper path for interest rates

as inflation moved close to the Federal Reserve’s 2 percent target. Based on median projections, policymakers expect at least two more rate increases this year.   Compared to other major economies, the Federal Reserve remains the

only central bank in a tightening mode. Other central banks continue to weigh the effects of earlier stimulus measures on their economic indicators.


Overview

5

Markets and performance Global economy

  As most major economies continue to post positive growth, political events are primed to either accelerate the expansion or threaten to cause economic uncertainty.

  Large-scale policy changes across a broad swath of the economy have been discussed in the U.S. From rules on foreign workers to health care and taxes, any actual changes to laws and regulations could have the potential to boost economic growth and affect the views of the Federal Reserve. At this point, it is unclear what will transpire.

  The official notification of the United Kingdom’s exit from the European Union comes as the British economy has proved to be resilient. Economic conditions could change depending on the outcome of the divorce settlement. An adverse resolution would hurt both the British pound and the euro.

  Continental Europe continues to post economic gains, albeit at a slow pace. Upcoming elections in France, Italy and Germany have the potential to cloud financial conditions if parties advocating for exiting the euro currency are able to advance their agenda.

  U.S. investment-grade and high-yield spreads continued their tightening trend this quarter. At the sector level, financials outperformed as markets embraced the possibility of a regulatory-lite environment for the banking sector.   Solid gains continued in U.S. equities, lifted by an improving economic outlook,

rising consumer confidence and steady corporate earnings.   After finishing 2016 as the best performing sector, crude oil lagged in the first

quarter of 2017. Diminishing optimism surrounding OPEC production cuts and rising domestic inventories put downward pressure on prices.   Corporate credit fundamentals remain solid overall, particularly among larger

and higher-quality companies. Credit metrics remained little changed from the previous quarter across all sectors.   The asset quality and capital levels of U.S. financial institutions remained solid

as evidenced by the FDIC Quarterly Banking Profile result. Notably, community bank revenue and loan growth continue to outpace the banking industry.   The Dodd-Frank Act was featured as a target in President Trump’s campaign

statements. While it is unclear whether a sweeping wholesale or partial repeal could pass, the process will be complex and global systemically important banks (G-SIBs) will remain subject to high international standards.

Domestic economy


  Economic activity has been healthy with Q4 GDP at 2.1 percent. The third revision saw consumer spending improving to 3.5 percent, which continues the solid readings over the past two quarters (4.3 percent in Q2 and 3 percent in Q3).   The latest GDP figure supports the Federal Reserve’s case for raising the Federal Funds rate at their March 2017 meeting.   Although Q4 was expected to fall from the large Q3 reading, the 2.1 percent figure is still in line with the 2 percent trend we have seen over the past couple of

years.   In addition to the solid consumer spending figure, business equipment spending rose 1.9 percent — the first gain in five quarters.

GDP: Solid consumer and business spending

GDP and components

Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Data as of 12/31/2016. Note: GDP values shown in legend are % change vs. prior quarter, on an annualized basis.

7

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Per

cent

Personal consumption Gross private domestic investment Net exports Government GDP

Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Data as of 3/30/17. Note: GDP values shown in legend are % change vs. prior quarter, on an annualized basis.


Consumption: Optimism tapers Consumption overview

Consumer sentiment Retail and food service sales

  Q4 data showed a 3.5 percent increase in consumer spending quarter-over-quarter — an improvement over the prior quarter.   Personal savings continued to creep down slightly. The recent downward

trend supports the view that consumers are feeling more confident in the U.S. economy.   Retail sales in the first quarter mostly were in line with expectations at 0.6

and 0.1 for January and February respectively. The lower figure shows a slight slowdown in recent consumer spending compared to prior months.   Consumer sentiment fell in the first quarter as Trump’s pro-growth

pre-election themes of tax reform, deregulation and infrastructure spending shifted to immigration and a unsuccessful attempt to repeal Obamacare.

Source: Bloomberg and SVB Asset Management. Data as of 3/31/2017.

8

0.0

50.0

100.0

150.0

-10.0 -5.0 0.0 5.0

10.0

Per

cent

Per

cent

Personal consumption (LHS)

Personal savings (LHS)

Household debt to disposable income ratio (RHS)

5.0

10.0

15.0

20.0

25.0

250.0

300.0

350.0

400.0

450.0

500.0

Vehi

cle

sale

s ($

mill

ions

)

Ret

ail &

food

ser

vice

s sa

les

($

bill

ions

)

Ex autos (LHS) Vehicle sales (RHS) 40.0

50.0

60.0

70.0

80.0

90.0

100.0

110.0

120.0

Uni

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ity o

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onsu

mer

S

entim

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ndex

Average


Employment: Unemployment fell — for good reasons Labor force participation rate Employment landscape

Employment to population ratio   The three-month average for nonfarm payrolls for Q1 was 178,000.

January and February had healthy gains of over 200,000, while March came in below expectations at 98,000.   The unemployment rate has been at or below 5 percent for the past 19

months.   The unemployment rate fell for good reasons since it was in conjunction

with the labor force participation rate rising to 63 percent — the highest since last March.   The U-6 underemployment rate fell below 9 percent for the first time since

2007.

Source: U.S. Bureau of Labor and Statistics (BLS), Bloomberg and SVB Asset Management. Data as of 3/31/2017. Note: The underemployment rate U-6, defined as persons marginally attached to the labor force, counts those who currently are neither working nor looking for work, but indicate they want and are available for a job and have looked for work in the past 12 months.

9

0.0

2.0

4.0

6.0

8.0

10.0

12.0

62

63

64

65

66

67

68

Per

cent

Per

cent

Labor force participation rate (LHS) Unemployment rate (RHS)

55 56 57 58 59 60 61 62 63 64

Employment Population Ratio

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

-1,000.0

-500.0

0.0

500.0

1,000.0

Per

cent

Thou

sand

s

Non-farm payroll (LHS) Unemployment rate (RHS) U-6 (RHS)


U.S. housing: Firm footing Home prices — indexed to 100 Home sales and supply

Household formation Housing affordability


10

0

50

100

150

200

250

300

Thou

sand

s

Median home price FHFA purchase Case-Schiller 20 city

0.0

2.0

4.0

6.0

8.0

10.0

12.0

0.0

50.0

100.0

150.0

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250.0

Per

cent

Affo

rdab

ility

inde

x

Housing affordability 30 -year fixed mortgage rates

-3000

-2000

-1000

0

1000

2000

3000

4000

Thou

sand

s

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

3.0

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8.0

9.0

Hom

e su

pply

(mon

ths)

Hom

e sa

les

(mill

ions

)

Total sales (new & existing) Existing home supply


Inflation: Higher expectations Crude oil and gasoline prices Core PCE — % change from prior year

Wage growth   Core PCE continues to trend closer to the Fed’s 2 percent target,

supporting the March 2017 decision to raise the Federal Funds rate.   For the first time in nearly five years, the PCE price index rose above the

Fed’s 2 percent target to 2.1 percent for February.   OPEC’s extension of their November decision to reduce output by 1.2

million barrels a day to 32.5 million for possibly another six months helped stabilize oil prices and should apply some inflationary pressure.   Wage growth continued the increase we saw in 2016, with the most recent

reading rising to 2.8 percent. If the trend continues, it will add to future inflationary pressures and support the case for further rate hikes by the Federal Reserve.


11

0.0

1.0

2.0

3.0

4.0

5.0

% C

hang

e fro

m p

rior y

ear

Core PCE Fed target Monetary policy threshold

-

1.0

2.0

3.0

4.0

5.0

0.0 20.0 40.0 60.0 80.0

100.0 120.0 140.0 160.0

Pric

e pe

r bar

rel (

$)

Crude oil (LHS) Daily national average of gasoline prices (RHS)

1.5

2.0

2.5

3.0

3.5

4.0

Ann

ual p

erce

ntag

e ch

ange

Wages

Central bank monetary policy


Q2 2016 Q3 2016 Q4 2016 Q1 2017

A recovery in oil and hawkish Fedspeak earlier in the quarter drive interest rates temporarily higher. The yield on the 2-year Treasury note hits 92 basis points in May.

Following Brexit, Treasury yields experience a period of low volatility for much of the summer. We also saw a flatter yield curve as evidenced by the tighter spread.

Following a period of low volatility, interest rates break out of trading ranges and head higher on the heels of the presidential election ⎯ given prospects for greater fiscal spending.

Treasuries have remained range-bound throughout most of the quarter, as investors weighed the normalization of monetary policy and inflation growth against geopolitical concerns.

A confluence of factors in June brings rates back down to H1 2015 levels. At center stage is Brexit, which sent investors towards safe havens such as U.S. Treasuries. A disappointing employment report and a dovish tilt from the FOMC meeting also lowers probabilities for future rate hikes.

Solid employment reports and inflation readings drive hawkish comments from Fed members and temporarily increase probabilities for a rate hike. At the September FOMC meeting, they announce a stronger case for a rate hike, but decide to wait for further evidence of continued progress towards their objectives.

Continued strength in economic data ⎯ specifically, the decline in the unemployment rate to a nine-year low, inflation hovering around the Fed’s 2 percent target and expectations for greater inflationary pressures — prompts the Fed to raise the target range for the Federal Funds rate at year-end.

The economy continued to grow at a moderate pace with solid job gains, while the unemployment rate has been little changed. Inflation has increased in recent months and is moving close to the FOMC’s 2 percent goal, which has resulted in consecutive Federal Funds rate increases.

Markets are focused on the broader implications of Brexit, while central banks such as the ECB and Fed stand ready to provide liquidity if needed.

Looking ahead, the Fed continues to stress a gradual approach to raising interest rates. The Fed’s median forecast projects one interest rate increase for the remainder of 2016.

OPEC agrees to cut production, sending oil prices higher and creating more inflationary pressure.

The Federal Reserve’s dot plot shows that policymakers expect at least two more rate increases in 2017 as economic conditions evolve and warrant gradual increases.

Historical interest rates: Upward trajectory


13

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4

Per

cent

2-year Treasury yield 1-year Treasury yield


Central bank economic projections: Brighter outlook

14

2015 2016 2017 2018

Economic projections: United States

Change in real GDP 2.6% 1.6% 2.1% 2.1%

Unemployment rate 5.3% 4.8% 4.5% 4.5%

Core PCE inflation 1.4% 1.7% 1.9% 2.0%

Economic projections: Eurozone


CPI inflation 0.0% 0.2% 1.6% 1.7%

Unemployment rate 10.9% 10.0% 9.4% 8.9%

Economic projections: China

Change in real GDP 6.9% 6.7%

CPI inflation 1.4% 2.0%

Unemployment rate 4.1% 4.0%

Economic projects: Japan


CPI inflation 0.8% -0.1% 1.7% 1.9%

Source: Federal Reserve, European Central Bank, National People’s Congress of China, Bank of Japan. Data as of 3/31/2017. Forecasts are not available for all periods.


-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Per

cent

Federal Reserve rate projections: Expectations accelerate

Source: Bloomberg and Federal Reserve. Data as of 3/15/17. Percentages below the chart reference the median forecasted rate at the end of each period.

FOMC Dots Median 1.375 2.125 3.00 3

OIS – As of Meeting Date 1.276 10629 1.823

OIS – Latest Value 1.27 1.577 1.747

15


Japan Eurozone United Kingdom China United States

Central bank Bank of Japan European Central Bank Bank of England People's Bank of China Federal Reserve

Benchmark rate -0.10 percent 0.0 percent 0.25 percent 4.35 percent 0.75-1.00 percent

Current policy

Maintaining current easing program, which includes 10-year rates near zero and commitment to push inflation above 2 percent.

Keeping previous cuts on refinancing rate and deposit rate with no change to its expanded QE program.

After an August rate cut in response to the EU referendum outcome, no further action has been taken.

While the benchmark rate has been steady since February 2016’s rate cut, the PBOC hiked other borrowing rates in March 2017.

Considering additional rate hikes after increasing rates by 25 basis points in March.

Inflation

Unemployment 2.8% 9.5% 4.7% 4.0% 4.7%

Analysis

No material policy changes expected for 2017 given recent yen weakness.

No additional easing action projected despite improving conditions.

With a recent rise in inflation and stronger-than-expected macroeconomic conditions, the next BOE move will be a rate hike.

The economy has posted steady results, though financial conditions remain cloudy. Some rates skewed higher after increases in PBOC repo and lending rates.

Anticipating additional interest rate increases in 2017.

Easing Stable Tightening

Central banks: Poised higher

Source: Federal Reserve, European Central Bank, Bank of England, The People’s Bank of China, Bank of Japan, Bloomberg, SVB Asset Management

16

0.20%

0.0% 1.0% 2.0%

0.70%

0.0% 1.0% 2.0%

2.3%

0.0% 1.0% 2.0%

0.8%

0.0% 1.0% 2.0% 3.0%

2.1%

0.0% 1.0% 2.0%

Markets and performance


Fixed income returns: Overview

18

Spread is based on option adjusted spread. Duration is based on modified duration. Data as of 3/31/2017. Source: Bloomberg, BofA Merrill Lynch and SVB Asset Management.

Basic statistics Spread change Total return % Excess return %

Spread Yield Duration QTD YTD QTD YTD QTD YTD

1-3yr Treasuries 0.00 1.27 1.89 0.00 0.00 0.26 0.26 0.00 0.00 1-3yr agencies 10.00 1.38 1.81 -2.00 -2.00 0.31 0.31 0.11 0.11 0-3yr MBS 62.00 2.43 1.96 24.00 24.00 0.02 0.02 -0.25 -0.25 1-3yr ABS 58.00 1.74 1.28 -10.00 -10.00 0.47 0.47 0.32 0.32 1-3yr IG corporates 75.00 2.05 1.92 -13.00 -13.00 0.70 0.70 0.50 0.50 3-5yr IG corporates 94.00 2.70 3.71 -10.00 -10.00 1.21 1.21 0.73 0.73 5-10yr IG corporates 128.00 3.50 6.44 -4.00 -4.00 1.63 1.63 0.74 0.74 1-5yr high yield 455.00 6.16 2.40 -55.00 -55.00 2.54 2.54 2.24 2.24

1-3yr corporates by rating

AAA 28.00 1.59 2.03 -6.00 -6.00 0.48 0.48 0.26 0.26 AA 52.00 1.81 1.92 -10.00 -10.00 0.57 0.57 0.36 0.36 A 68.00 1.97 1.92 -10.00 -10.00 0.62 0.62 0.41 0.41 BBB 96.00 2.27 1.92 -19.00 -19.00 0.88 0.88 0.67 0.67

1-3yr corporates by sector

Financial 78.00 2.09 1.94 -15.00 -15.00 0.74 0.74 0.53 0.53 Industrials 71.00 2.00 1.92 -13.00 -13.00 0.69 0.69 0.48 0.48 Utility/energy 84.00 2.10 1.81 -9.00 -9.00 0.65 0.65 0.45 0.45


Total return comparisons

19

All returns above are on Total Return basis. 2017 returns are on an periodic basis up to 3/31/17. FI Credit refers to BofA/ML US Corporate Bonds 1-3 year Index; Treasury refers to BofA/ML US Treasuries 1-3 year Index; Gold refers to S&P GSCI Gold Spot; Crude Oil refers to Spot West Texas Intermediate Crude Oil; Wilshire refers to Wilshire 5000 Total Market Index; REIT refers to MSCI US REIT Index; S&P 500 refers to S&P 500 Index. Source: Thomson Reuters, Barclays Live, BofA Merrill Lynch and SVB Asset Management.

Ass

et c

lass

retu

rns

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD

US Treasury 6.67%

Crude Oil 78.00%

Gold 29.67%

Gold 10.23%

REIT 16.47%

Wilshire 33.06%

REIT 28.24%

S&P 500 1.40%

Crude Oil 44.80%

Gold 8.60%

Gold 5.53%

Wilshire 28.29%

REIT 26.97%

Crude Oil 8.15%

Wilshire 16.05%

S&P 500 32.39%

S&P 500 13.69%

REIT 1.30%

Wilshire 13.40%

Wilshire 6.20%

FI Credit 0.30%

S&P 500 26.46%

Wilshire 17.18%

REIT 7.48%

S&P 500 16.00%

Crude Oil 7.32%

Wilshire 12.70%

FI Credit 0.85%

S&P 500 12.00%

S&P 500 6.10%

S&P 500 -37.00%

REIT 26.27%

Crude Oil 15.10%

S&P 500 2.11%

Gold 6.96%

FI Credit 1.45%

FI Credit 1.12%

Wilshire 0.70%

Gold 8.60%

REIT 0.70%

Wilshire -37.23%

Gold 23.96%

S&P 500 15.06%

FI Credit 1.75%

FI Credit 3.69%

REIT 1.26%

US Treasury 0.63%

US Treasury 0.56%

REIT 7.10%

FI Credit 0.70%

REIT -39.05%

FI Credit 11.59%

FI Credit 4.15%

US Treasury 1.55%

US Treasury 0.43%

US Treasury 0.36%

Gold -1.51%

Gold -10.50%

FI Credit 2.38%

US Treasury 0.26%

Crude Oil -53.52%

US Treasury 0.80%

US Treasury 2.40%

Wilshire 0.98%

Crude Oil -7.08%

Gold -28.26%

Crude Oil -45.76%

Crude Oil -30.50%

US Treasury 0.89%

Crude Oil -6.00%


Core principles

On February 3, 2017, President Trump signed the Presidential Executive Order on Core Principles for Regulating the United States Financial System. The core principles listed in the order are:   Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement and build

individual wealth   Prevent taxpayer-funded bailouts   Foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk

and market failures, such as moral hazard and information asymmetry   Enable American companies to be competitive with foreign firms in domestic and foreign markets   Advance American interests in international financial regulatory negotiations and meetings   Make regulation efficient, effective and appropriately tailored   Restore public accountability within federal financial regulatory agencies, and rationalize the Federal financial regulatory framework

Review process

  Empower The Secretary of the Treasury will review and consult with the heads of member agencies of the Financial Stability Oversight Council (FSOC)

  The review will focus on the degree to which the existing laws and regulations promote the Core Principles and identify the ones that contradict the Core Principles

  The review process is to be completed and submitted to the President within 120 days of the date of the executive order (February 3, 2017) and repeated periodically thereafter

No immediate impact

  Executive orders do not have any immediate actual impact, nor do they alter the existing Dodd-Frank Act. Executive orders must first be reviewed and require legislation to substantially change the law

  Currently, the future impact is unknown as no changes have been released   While some aspects of regulations may be loosened, any changes would take time through the slow political and regulatory rulemaking

process. As a result, minimal impact is expected in 2017   Many of the regulatory reforms have translated positively after years of enhancing infrastructures and increase barriers to entry   Rumors include: the possible extension of CCAR stress testing to every two years rather than annually, not finalizing currently proposed rules,

and potentially loosening regulation limiting regulatory authority and diminishing fines issued   The Fed’s recent adoption of a less-onerous CCAR process for banks under the $250 billion threshold suggests that higher standards

for G-SIBs remain

U.S. banks regulations: Trump’s executive order

Source: Whitehouse.gov, SVB Asset Management

20


Key objectives

The Financial CHOICE Act (FCA) was introduced by Representative Jeb Hensarling in 2016, and may serve as the blueprint for financial reform. Its key objectives are to: 1.  Provide for the election to be a strongly capitalized, well-managed financial institution 2.  End ‘too big to fail’ and bank bailouts 3.  Empower Americans to achieve financial independence by fundamentally reforming the Consumer Financial Protection Bureau (CFPB) and

protecting investors 4.  Demand accountability from financial regulators and devolve power away from Washington 5.  Demand accountability from Wall Street through enhanced penalties for fraud and deception 6.  Unleash opportunities for small businesses, innovators and job creators by facilitating capital formation 7.  Provide regulatory relief for Main Street and community financial institutions

Key proposal highlights

  Banks could exempt themselves from most federal prudential financial regulations if they maintain a leverage ratio greater than or equal to 10 percent

  Eliminate stress testing for all banks with less than $50 billion in total assets or that qualify as a traditional banking organization

  Repeal Orderly Liquidity Authority and change to bankruptcy code   Repeal restrictions on: the Volker Rule, the Durbin Amendment, and

the Department Of Labor Fiduciary Rule

  Modify existing regulatory agencies: remove FSOC, replace CFPB, expand Securities and Exchange Commission (SEC) framework, ensure congressional oversights of appropriations on financial regulators, ensure congressional review of federal financial agency rulemaking

  Conduct an annual study on ending Fannie Mae/Freddie Mac conservatorship

  Implement Federal Reserve oversight reform and modernization: changes to Federal Open Market Committee (FOMC) and amendment to Federal Reserve powers

  Eliminate financial market utility designation

No immediate impact

  Regulatory change process is complex and will require significant legal review.

  The impact of individual banks’ credit profiles will be determined by the response to any implemented changes.

  As global financial institutions, GSIBs would remain subject to international regulatory standard such as Basel III — so drastic changes to local regulation may be offset.

  Banks will continue to require strong Nationally Recognized Statistical Rating Organization (NRSRO) ratings. NRSROs are likely to require banks to maintain strong financial metrics, including those created as requirements following the financial crisis — so it is in a bank’s best interest to ensure that these strong financial level metrics are maintained.

U.S. banks financial regulation: Financial CHOICE Act proposal

Source: Congress.gov, SVB Asset Management.

21


U.S. banks performance: Healthy assets and solid capital Loss provisions % net charge-offs Noncurrent loans & leases as % Tier 1 capital plus reserves

Total loans and leases growth   Solid 2016 industry results indicate healthy asset quality and solid capital.   Bank loan growth continues to be healthy with all major loan categories

reporting positive growth in 2016, particularly for community banks.   Community banks, which accounted for 43 percent of the industry’s small

loans to businesses, grew at a faster pace — led by growth in commercial real estate loans, commercial and industrial loans and residential mortgages.   Declining non-current loans and stable loan loss reserves led to

improvement in the industry’s ability to absorb credit losses.   2016 marked the lowest percentage of unprofitable banks for any year

since 1995.

Source: FDIC. Data as of 12/31/16.

22

0%

50%

100%

150%

200%

250%

Per

cent

Assets > $250 billion Assets $10 billion - $250 billion Assets $1 billion - $10 billion Assets $100 million - $1 billion Assets < $100 million

0.00

0.10

0.20

0.30

0.40

0.50

Per

cent

Assets > $250 billion Assets $10 billion - $250 billion Assets $1 billion - $10 billion Assets $100 million - $1 billion Assets < $100 million

-40

-20

0

20

40

60

80

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Per

cent

Total loans and leases growth YoY

50

40

30

20

10 0

250

200

150

100

50 0


Credit cycle: Corporate credit health remains resilient   Leverage remains near historic lows.

  Though operating margin has been on a decline since peaking in late 2014, it stabilized in 2016.

23

S&P 100 S&P 500

Source: Bloomberg. Data as of 3/20/17.

20.0

25.0

30.0

35.0

40.0

45.0

7.0

9.0

11.0

13.0

15.0

17.0

Per

cent

Per

cent

Operating margin (LHS) Total debt to total asset (RHS)

20.0

25.0

30.0

35.0

40.0

45.0

7.0

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11.0

13.0

15.0

Per

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Per

cent

Operating margin (LHS) Total debt to total asset (RHS)


Credit cycle: Corporate credit fundamentals hold steady   Across all corporate sectors, credit metrics showed little change sequentially from the previous quarter — with energy showing meaningful improvement in margin.

S&P 500 debt to assets by sector

S&P 500 operating margin by sector

Source: Bloomberg, operating margin trailing 12 months data.

24

0

10

20

30

40

50

Energy Materials Industrials Consumer discretionary

Consumer staples Health care Financials Information technology

Telecom services Utilities

December 2016 March 2017

-15

-5

5

15

25

Energy Materials Industrials Consumer discretionary

Consumer staples Health care Financials Information technology

Telecom services Utilities

December 2016 March 2017

Source: Bloomberg. Data as of 3/20/17.


Cut top rate   Reduce top corporate tax rate from 35 percent to 20 percent

(or as low as 15 percent)   Improve profit margins, encourage investments

Minimal impact on bond issuance

Immediate deduction of capital spending

  Reduce cash tax cost of capital projects   Encourage investments

Increase bond issuance in capital-intensive industries

Eliminate interest deduction

  Increase cost of borrowing   Make equity (particularly preferred) financing relatively

more attractive

Reduce high-yield bond issuance for non-financials

Foreign tax repatriation   Special tax holiday (10 percent or 8.5 percent) on repatriation of

overseas cash   No tax on future foreign income

Reduce investment-grade bond issuance in cash-rich sectors (technology and pharmaceuticals)

Border adjustment   No income tax on exports, tariff on imports   Encourage domestic manufacturing, discourage imports Minimal impact on bond issuance

Corporate tax reform: What proposals mean for bond issuance

Source: SVB Asset Management. https://waysandmeans.house.gov/taxreform/, https://assets.donaldjtrump.com/trump-tax-reform.pdf

25

Global economy


United States: Policy divergence propelling the dollar 10 year yields Dollar index

  The U.S. dollar (USD) retreated after the FOMC maintained their forecast of the dot plot in March with three projected rate hikes per year from 2017 to 2019. While the tightening cycle should continue at a moderate pace, it was a little less aggressive than some had predicted. This transpired into long USD liquidation with the dollar index shedding -2.5 percent from its highs in early March.   Over the medium term, policy divergence and yield differential are still in favor of USD assets with the USD benefitting from capital inflows. Recent comments

from Janet Yellen and other Fed officials have been quite hawkish and they were successful in guiding expectations for further tightening in just a short period of time.   There is still a lot of uncertainty around Trump’s fiscal reforms, trade and immigration policies. But, so far the market has given the President the benefit of

doubt as equities stayed elevated near record highs despite the recent pull back. Of course, how much of Trump’s fiscal agenda is passed into legislation, the timing for implementation and its impact on the market will be revealed in due course. With more clarity on the fiscal front and additional economic data, the Federal Reserve will have more ammunition to reshape the rate path if necessary.

Sources: Bloomberg, Silicon Valley Bank, SVB Asset Management. Data as of 3/31/17

27

92

94

96

98

100

102

104

U.S

. dol

lar i

ndex

(DX

Y)

0

0.5

1

1.5

2

2.5

10 y

ear y

ield

s, %

U.S. Germany Japan U.K.


Great Britain: Economically sound, politically driven FTSE 100 Index British pound

  The U.K. referendum on June 23, 2016 sent GBPUSD down 15% in a day and the pound has stayed under pressure ever since with the uncertainty of the Brexit negotiation looming.   U.K. Prime Minister Theresa May invoked Article 50 on March 29 to officially commence an exit from the EU. While her government has outlined 12 high-level

priorities that include controlling U.K. law and immigration, free trade with European markets and establishing new unilateral trade agreements with other countries — the government’s desire for an orderly Brexit over a two-year time horizon is quite ambitious. May cautioned that they are prepared to walk away if the U.K. doesn’t get the right deal, and their European adversaries have equipped themselves with plan B if negotiations breaks down, which suggests we’ll be in for a bumpy ride.   Recent economic data from the U.K. has been robust as the weaker GBP injected fresh stimulus to trade and the economy, helping to propel the FTSE 100

up 26 percent since the referendum. However, the real game of brinksmanship begins when the Europeans come to the table to negotiate the divorce settlement. The direction of the UK and European economies, as well as currency volatility, will be driven by politics. A hard Brexit outcome could see the GBP and euro get punished and test new lows.

Sources: Bloomberg, Silicon Valley Bank, SVB Asset Management. Data as of 3/31/17.

28

5700 5900 6100 6300 6500 6700 6900 7100 7300 7500

FTS

E 1

00 In

dex

1.2

1.25

1.3

1.35

1.4

1.45

1.5

1.55

Gre

at B

ritis

h po

und

per U

.S. d

olla

r (G

BP

/US

D)


Europe: Elections loom large French election polls Euro currency

  Upcoming elections in France, Italy and Germany will be important. France’s Marine Le Pen, a right-wing presidential candidate, warned that if she wins, she will lead France out of the Eurozone. However, with her rival Emmanuel Macron gaining meaningful ground at the polls, the risk of ‘Frexit’ has been reduced significantly. Together with more certainty from the Fed, FX option volatilities generally have skidded lower, with three-month EURUSD volumes (9 percent) near the November 2016 low —despite the election risks ahead.

Sources: Bloomberg, Oddschecker, Silicon Valley Bank, SVB Asset Management. Data as of 3/31/17.

29

  The euro/dollar currency pair (EURUSD) continues to weaken, shedding nearly 9 percent from its highs in May 2016. Even though the European Central Bank (ECB) announced in December 2016 that it would pare down its quantitative easing program from €80 billion to €60 billion beginning in April, the ECB extended the bond buying program by an additional nine months. As a result, there will be a significant amount of monetary accommodation through December 2017. ECB President Mario Draghi could remove the easing bias as economic conditions improve. But, given the current rate path between the ECB and the Fed, EURUSD could challenge the psychological parity level.

1.02

1.04

1.06

1.08

1.1

1.12

1.14

1.16

Eur

o pe

r US

dol

lar (

EU

R/U

SD

)

0

10

20

30

40

50

60

70

% C

hanc

e of

win

ing

Marine Le Pen Emmanuel Macron Francois Fillon

Portfolio management strategy


Portfolio strategy: Macro overview

Source: SVB Asset Management and Bloomberg. Data as of 3/31/17. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.

Economy

Rates

Duration

Sector

Stable data   Q3 2016 GDP: +3.5 percent (two-year high), Q4 2016 GDP: +2.1 percent   Unemployment Rate: +4.5 percent (at or below 5 percent since September 2015)   Weekly jobless claims average (YoY): 257,000, below 300,000 since March 2015   PCE rose above Fed’s 2 percent target for the first time in five years

Directionally Higher

  The rate outlook is for yields to move directionally higher, largely based on solid economic data and inflationary fiscal policies

  Our focus will be to balance more attractive current income from the short end of the yield curve with anticipated interest rate volatility

Defensive

  Short and intermediate benchmarks: long duration vs. benchmark as coupon income should offset price volatility

  Intermediate-plus benchmarks: stay neutral to benchmark   Long benchmarks: shorter to manage price fluctuations and maximize reinvestment

opportunities

Overweight spread product

  Favor corporate bond, commercial paper and asset-backed securities. Diversify by security type, sector and issuer concentration

  As rates rise spread product will help protect bond prices due to higher income accruals

31


Institutional fund flows Year-to-date as of 3/31/17

Money markets: prime +12 billion

Money markets: government -63 billion

Investment grade credit fund flows (Lipper) +56 billion

Portfolio strategy: Prime vs. government money market funds Our ongoing discussion is whether prime money market funds make sense from an investment standpoint — taking into consideration yield advantage over government funds, as well as the floating NAV and potential fees and gates.   Both government and prime money market fund yields have increased since mid-December.   The spread between prime and government funds is averaging 35 to 40 bps, which is up from the pre-reform spread of 10 to 15 bps. This is due to the lack of demand for prime fund securities relative to the increased demand for government bonds.   Although yields have risen for both money fund types, our recommendation is still to allocate operating cash holdings to government money market funds due to the potential of NAV changes.

32

Example of prime fund NAV fluctuations Examples of prime and government yields

Source: SVB Asset Management, Bloomberg, Crane, Lipper. Data as of 3/31/17. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.

Money market fund flows show investors shifting allocations from government funds, with the majority of allocation going to investment-grade corporate funds.

0

0.2

0.4

0.6

0.8

1

1.2

Government fund Prime fund

0.9998 0.9999

1 1.0001 1.0002 1.0003 1.0004 1.0005

NAV


0.50 0.38

0.25 0.13 0.00

-0.13 -0.25 -0.38

-0.50 -0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

Per

cent

-100 -75 -50 -25 Base case +25 +50 +75 +100

% in market value

Short duration 3 month T-bill

Short duration 3-6 month T-bill

Intermediate duration 6 month T-bill

Intermediate-plus duration

9 month T-bill

Long duration 1 year Treasury

Benchmark duration

0.25

0.375

0.50

0.75

1.0

Portfolio duration target

Portfolio strategy: Duration and interest rate risk management

Source: SVB Asset Management and Bloomberg. Data as of 3/31/17. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio as individual portfolio durations will vary.

Duration (price sensitivity) analysis

  We exercise a disciplined benchmarking approach to manage portfolio duration where we position duration in a +/- 30 percent band around the appropriate benchmark.

  In a rising rate environment where a portfolio is more susceptible to unrealized losses, we mitigate this risk by managing average duration relative to the benchmark, and by limiting exposure to longer-dated investments. This allows for greater reinvestment opportunity to take advantage of higher anticipated rates.

*Sample portfolio with duration of 0.5 years

33

-30% Neutral +30% -30% Neutral +30% -30% Neutral +30% -30% Neutral +30% Neutral -30% +30%


Portfolio strategy: Credit risk management

Key criteria for approved issuers

1.  Strong franchise value

2.  Diversified business lines

3.  Strong balance sheet

4.  Healthy cash flow generation

5.  Strong liquidity profile

6.  Robust capital to absorb downturns

7.  Management with solid track record

8.  Prudent financial policy

9.  Quality and timeliness of the disclosure

10.  Strong collateral performance and sponsor’s interest alignment for asset backed securities

  We are highly selective in our security selection process, and look to diversify by sector, sub-sector and issuer concentration.

  Our dedicated credit research team performs a rigorous examination of every issuer, as well as ongoing credit monitoring of all investments.

  The credit analysis incorporates a proprietary scoring system to analyze issuers, and also takes into account trading factors such as market liquidity, market depth and headline risk.

34

S&P

Moody's Fitch Rating description

AAA Aaa AAA Highest credit quality

AA+ Aa1 AA+

High credit quality AA Aa2 AA

AA– Aa3 AA–

A+ A1 A+

Upper-medium grade A A2 A

A– A3 A–

BBB+ Baa1 BBB+

Medium grade BBB Baa2 BBB

BBB- Baa3 BBB-

Investment grade

Source: SVB Asset Management and Bloomberg. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.


Portfolio strategy: Relative value curve analysis Front-end Treasury yield curve

Source: SVB Asset Management and Bloomberg. Data as of 3/31/2017. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.

Flat

Flat

35

Treasury CP ABS AA Ind A- Ind AA Fin A- Fin

90D 0.72 0.87 1.00 1.14 0.86 0.96 0.94

180D 0.88 1.05 1.08 1.25 1 1.11 1.12

270D 0.99 1.16 1.17 1.33 1.16 1.18 1.34

1Y 1.07 1.28 1.44 1.2 1.32 1.36

1.5Y 1.17 1.47 1.61 1.33 1.47 1.53

2Y 1.25 1.65 1.7 1.49 1.7 1.68

2.5Y 1.38 1.81 1.8 1.72 1.83 1.88

3Y 1.49 1.97 1.9 1.78 2.03 1.97

Commercial paper

Asset-backed securities

  In Q1, Treasury yields rose across the curve led by the front end.

  3-9 month Treasury yields rose on average 20 basis points from year-end levels.

  Commercial paper and ABS yields are primarily unchanged since the end of 2016.

  During same period, all Treasury yields have risen approximately 20 basis points.

  In a rising rate environment, spread product typically outperforms due to spreads tightening.

Treasury   Due to our rate outlook, we are focusing on front end Treasuries and agencies.

0.50% 0.62% 0.80% 0.91% 1.03% 1.19% 1.30% 1.45%

0.72% 0.88%

0.99% 1.07%

1.17% 1.25%

1.38% 1.49%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

3 mo 6 mo 9 mo 1 yr 1.5 yr 2 yr 2.5 yr 3 yr

3/31/17

12/30/16


Our team Portfolio Management Team

Eric Souza [email protected] Paula Solanes [email protected] Renuka Kumar, CFA [email protected] Jose Sevilla [email protected] Hiroshi Ikemoto [email protected] Jason Graveley [email protected]

President, SVB Asset Management

Lauri Moss [email protected]

Head of Investment Strategy and Portfolio Management

Ninh Chung [email protected]

Head of Credit Research

Melina Hadiwono, CFA [email protected]

Credit and Risk

Tim Lee, CFA [email protected] Daeyoung Choi, CFA [email protected] Nilani Murthy [email protected]

Silicon Valley Bank Partners

Teresa Quizon [email protected]

36

Guest Contributors

Peter Ng, Senior FX Trader [email protected]@svb.com Minh Trang, Senior FX Trader [email protected]@svb.com


This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice, nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.

All material presented, unless specifically indicated otherwise, is under copyright to SVB Asset Management and its affiliates and is for informational purposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party without the prior express written permission of SVB Asset Management. All trademarks, service marks and logos used in this material are trademarks or service marks or registered trademarks of SVB Financial Group or one of its affiliates or other entities. ©2017 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of the FDIC and the Federal Reserve System. Silicon Valley Bank is the California bank subsidiary of SVB Financial Group (Nasdaq: SIVB). SVB, SVB FINANCIAL GROUP, SILICON VALLEY BANK, MAKE NEXT HAPPEN NOW and the chevron device are trademarks of SVB Financial Group, used under license. B_SAM-17-15329 Rev 05-08-17.

SVB Asset Management, a registered investment advisor, is a non-bank affiliate of Silicon Valley Bank and member of SVB Financial Group. Investment products offered by SVB Asset Management:

Are not insured by the FDIC or any other federal government

agency

Are not deposits of or guaranteed by a bank

May lose value

37

Documents

SVB Q2 2017 Economic Report