svb asset management economic report q4 2015

Q4Quarterly Economic Report 2015

2

Table of contents Thoughts from the desk 03

Overview 04

Domestic economy 06

U.S. Federal Reserve & monetary policy 12

Markets & performance 19

Global economy 27

Portfolio management strategy 32

SVB Asset Management | Quarterly Economic Report Q4 2015

3

After a false start in September, the Federal Reserve finally provided a glimpse of monetary policy clarity at year-end as it deviated from other central banks and initiated its normalization process. Shaking off continued economic weakness in China, falling commodity prices and stubbornly low inflationary conditions, new Fed policies tilted towards improvements in economic fundamentals – specifically the diminishing of underutilization of labor resources. While further interest rate and quantitative easing policies will attempt to ignite the rest of the advanced economies, markets will focus on the Fed’s pace of future rate hikes which it signals as ‘gradual adjustments.’ We can only interpret that as non-mechanical and highly data dependent.

Benefiting from the Fed’s new policy were short term interest rates as they closed the year near its 52-week high. During the quarter, higher benchmark rates and widening of credit spreads led to drags in price performance of the fixed income sector but stellar returns of high quality credits from prior periods posted excess returns against treasuries with similar maturities. The high yield sector experienced a vastly different fate as it posted negative returns for the year. Other broader market indices squeezed out positive returns but commodities and energy investors were punished with double digit negative returns.

While the implementation of money market fund reform in October will likely have little significant impact to global capital markets it will nevertheless shape the future of short-end markets. After years of contentious battles between money managers and its regulators, approximately 60 percent of this $2.7T industry will convert from a stable net asset value methodology to a market pricing floating asset value, explicitly allowing fund managers to exercise redemption gates and imposed liquidity fees to mitigate fund outflows under a stressed environment. Corporate treasurers seeking daily liquidity with accounting ease will likely deemphasize the use of prime money market funds by shifting into exempt funds or direct investments.

There will be many factors for investors to consider during the year as the U.S. economy enters its ninth year of recovery while slack in the global economy continues to build. As markets shifts and drifts, we will continue to ferret investment opportunities for our clients to exceed their investment objectives.

Thoughts from the desk


4

Domestic economy U.S. Federal Reserve & monetary policy

Overview


ê  Q3 GDP expanded by a healthy 2 percent. The increase was driven by positive contributions from personal consumption, nonresidential fixed income investment, state and local government spending and residential fixed income spending. (p. 7)

ê  Strong consumer spending, fueled by improved labor conditions, supported the case for normalization of monetary policy. (p. 8)

ê  Personal consumption continues to benefit from an improved labor market, rising home prices and lower fuel costs. (p. 9)

ê  The holiday season kicked off on a good start. Retail sales in November were the strongest in four months. (p. 8)

ê  The low unemployment rate supported the rate hike in December, however the all-time low in the labor force participation rate will likely be one the reasons the Fed moves gradually with future rate increases. (p. 9)

ê  The low level of Core PCE will be another reason the Fed takes a gradual approach to raising rates. (p. 11)

ê  Wage growth is expected to pick up in 2016, translating into higher inflation. (p. 11)

ê  Short-term interest rates trended upwards during the quarter as markets refocused their attention on a December rate hike. Despite continued weakness in China and commodities, solid U.S. economic data prevailed and the Fed increased the target range by 0.25 percent. Accompanying the move was dovish forward guidance indicating a gradual path to normalization. (p. 13)

ê  In the latest FOMC statement, the Fed upgraded its overall assessment of the economy and said they will continue to take into account a wide range of information in future policy decisions, including readings on financial and international developments. Below-target inflation was highlighted with the Committee saying they will carefully monitor progress toward its goal. (p. 15)

ê  To accomplish their goal of raising interest rates, the Fed released implementation notes that detail the multilayered approach to policy normalization. (p. 18)

5

Overview

Markets & performance Global economy


ê  Economic growth largely prevails across most developed and emerging economies, though they are below targets and sub-optimal. (p. 28)

ê  Major central banks are positioned to continue easing, even as the Federal Reserve increased interest rates to normalize policy. Extraordinary policies remain key tools for central banks. (p. 28)

ê  China lowers its growth target to 6.5% from 7% for 2016, as the economy transitions slowly away from manufacturing-driven to a service-oriented economy. The tech sector remains firm in China. (p. 29)

ê  Low interest rates have boosted home prices to historic levels across many developed economies, including Australia, Canada, and Sweden. (p. 30)

ê  The pace of growth in emerging economies is at risk from commodity prices, political strife, and security challenges, but these economies are mostly projected to be positive for 2016. (p. 31)

ê  Despite wider credit spreads at year-end, the fixed income sector posted positive returns in 2015 due to positive price performance earlier in the year. Higher quality credits materially outperformed their lower quality counterparts. (p. 20)

ê  Bonds still play an important role as a diversifier and source of income as they continue to insulate investors from rising interest rates. (p. 21-22)

ê  Credit fundamentals of U.S. corporations remain healthy, though profitability may have peaked. (p. 23)

ê  Sector-specific divergence in corporate fundamentals is a persistent trend. (p. 24)

ê  Credit conditions for the Financial sector are improving, as is the credit performance of the individual issuers. (p. 25-26)

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Domestic economy

-10.0%

-5.0%

0.0%

5.0%

10.0%

U.S. GDP Q-o-Q Trailing 4-quarter average

-3.0%

-1.0%

1.0%

3.0%

5.0%

Government Res Investment Inventories Net Exports Bus Fixed Investment Personal consumption exp GDP

GDP

GDP and components

7

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

GDP In good health


ê  Q3 GDP expanded by a healthy 2 percent. The increase was driven by positive contributions from personal consumption, nonresidential fixed income investment, state and local government spending and residential fixed income spending.

ê  Corporate profits have been negative in the three of the last four readings. The strong dollar, slow growth and weak energy sector are behind recent contractions.

ê  As predicted, inventory accumulation from the prior quarter was a drag in Q3.

ê  Strong consumer spending, fueled by improved labor conditions, supported the case for normalization of monetary policy.

40.0 50.0 60.0 70.0 80.0 90.0

100.0 110.0 120.0

Consumer sentiment (UofM) Average

$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 (m

illio

ns)

Ret

ail &

food

ser

vice

s sa

les

(bill

ions

)

Ex Autos Vehicle sales

0.0%

50.0%

100.0%

150.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

Personal consumption (LHS)

Personal savings (LHS)

Household debt to disposable income ratio (RHS)

Consumption overview

Retail & food service sales Consumer sentiment – University of Michigan

8

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

Consumption Firm footing


ê  Personal consumption continues to benefit from an improved labor market, rising home prices and lower fuel costs.

ê  The holiday season kicked off on a good start. Retail sales in November were the strongest in four months.

ê  Households were optimistic about the economy and finances. The majority of consumers in the Michigan survey expect higher borrowing costs in 2016, however that should not spur borrowing-in-advance behavior.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Job hire rate Job quit rate

-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

Thou

sand

s

Non-Farm Payroll (LHS) Unemployment Rate (RHS) U-6 (RHS)

Employment landscape Labor force participation rate

9

Hires and quits

Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U-6 defined as persons marginally attached to the labor force are 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.

Employment Steady state


ê  Average monthly job gains in 2015 were approximately 200k. ê  Unemployment rate is at a healthy level of 5.0 percent, the lowest

level since 2008. ê  The low unemployment rate supported the rate hike in December,

however the all-time low in the labor force participation rate will likely be one the reasons the Fed moves gradually with future rate increases.

ê  The hire and quit rates continue to be steady.

62.0%

63.0%

64.0%

65.0%

66.0%

67.0%

68.0%

90

140

190

240

290

Case Schiller 20 city FHFA purchase Median home price

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

0.0

50.0

100.0

150.0

200.0

250.0

Affo

rdab

ility

inde

x

Housing affordability 30-year fixed mortgage rates

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

Hom

e su

pply

(mon

ths)

Hom

e sa

les

(mill

ions

)

Total sales (new & existing) Existing home supply

Home sales & supply Home prices – indexed to 100

Housing affordability Household formation

10

Source: Bloomberg and SVB Asset Management.

U.S. Housing Stable


-3000

-2000

-1000

0

1000

2000

3000

4000

Thou

sand

s

$0.0

$1.0

$2.0

$3.0

$4.0

$5.0

$0.0

$50.0

$100.0

$150.0

Pric

e pe

r bar

rel

Crude oil Daily national average of gasoline prices (RHS)

Core PCE – % change from prior year Crude oil and gasoline prices

11

Univ. of Michigan Survey of inflation expectations

Source: U.S. Bureau of Labor and Statistics (BLS), SVB Asset Management, National Bureau of Economic Research (NBER). Note: The underemployment rate U-6 defined as persons marginally attached to the labor force are 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.

Inflation Below target


ê  Core PCE continues to hold at 1.3 percent. ê  Given the low level of Core PCE, the Fed can take a gradual

approach to raising rates. ê  Wage growth is expected to pick up in 2016, translating into

higher inflation. ê  Gas and oil prices fell significantly in 2015, contributing to the

lack of inflation.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Cha

nge

from

prio

r yea

r

1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5%

Core PCE Fed target Monetary policy threshold

1 year ahead 5-10 years ahead

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U.S. Federal Reserve & monetary policy

13

Historical interest rates We have liftoff


Q1 2015 Q2 2015 Q3 2015 Q4 2015

The ECB announces a bond purchase program, and central banks across the globe announce further easing measures.

U.S. economic data reveals some softness as Q1 GDP contracts 0.2 percent.

Anxieties over Greece dissipate early in the quarter, but then concerns over China’s growth and currency devaluation take the spotlight.

The Fed’s tone shifts at the October FOMC meeting and markets refocus their attention on a December rate hike.

U.S. job growth continues to be robust, although a strengthening dollar weighs on growth expectations.

Headlines center on a potential “Grexit” with a standoff between Greece and its creditors.

The U.S. economic landscape continues to improve: Unemployment drops to 5.1 percent, Q2 GDP expands 3.9 percent and inflation holds at 1.3 percent.

Employment and inflation readings head in the right direction. October’s report was the strongest of the year and the unemployment rate fell to 5 percent. Core CPI reaches the important 2 percent level. Core PCE stands at 1.3 percent.

Market consensus is for a Fed funds rate liftoff in September of this year.

Fed hints at rate hike this year, but a gradual path to normalization.

The Fed delayed rate liftoff, citing “recent global economic and financial developments.”

Continued weakness in China and depressed oil prices make headlines throughout the quarter.

Source: Bloomberg and SVB Asset Management. Data as of December 31, 2015.

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

2-year Treasury yield 1-year Treasury yield

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Hun

dred

s

14 SVB Asset Management | Quarterly Economic Report Q4 2015

Federal Reserve rate projections Gradual path ahead

December 2015 Median 0.375% 1.375% 2.375% 3.250% 3.50%

September 2015 Median 0.375% 1.375% 2.625% 3.375% 3.50%

June 2015 Median 0.625% 1.625% 2.875% 3.75%

Source: Bloomberg and Federal Reserve. Data as of December 16, 2015. Percentages below the chart reference the median forecasted rate at the end of each period.

15

Yellen’s dashboard Heading in the right direction



Pre-recession level (2004-2007 average)

Worst level since 2008 Current level

Layoffs/discharges rate 1.4% 2.0% 1.2%

Job openings rate 3.0% 1.6% 3.5%

Nonfarm payrolls (3-month average) 161.8K -826.0K 284K

Unemployment rate 5.0% 10.0% 5.0%

Hires rate 3.8% 2.8% 3.6%

Quits rate 2.1% 1.3% 2.0%

U-6 underemployment rate 8.8% 17.2% 9.9%

Long-term unemployed share 19.1% 45.3% 25.7%

Labor force participation rate 66.1% 62.4% 62.6%

Target Threshold Current level

Inflation (core PCE) 2.0% 2.5% 1.3%

The Federal Reserve has a dual mandate to promote “maximum employment” and to keep prices stable. Below are the factors the Fed is considering to determine the path of monetary policy normalization.

The dollar & oil

The labor market

16



Tracking key indicators Concerns remain Inflation

Wage growth

0.0

20.0

40.0

60.0

80.0

100.0

120.0

70.0 75.0 80.0 85.0 90.0 95.0

100.0 105.0

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

60.0% 61.0% 62.0% 63.0% 64.0% 65.0% 66.0% 67.0%

-1,000.0 -800.0 -600.0 -400.0 -200.0

0.0 200.0 400.0 600.0

Thou

sand

s

0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0%

DXY index (LHS) Brent crude index (RHS) Fed target

Average hourly earnings YoY % change

Core PCE Yoy

Nonfarm payrolls(LHS) Labor force participation rate (RHS)

17

Central Bank economic projections Divergent policies


2015 2016 2017 2018 Longer run

Economic projections: United States

Change in real GDP 2.1% 2.4% 2.2% 2.0% 2.0%

Unemployment rate 5.0% 4.7% 4.7% 4.7% 4.9%

Core PCE inflation 1.3% 1.6% 1.9% 2.0%

Interest rate projections: United States

Federal funds target rate 0.4% 1.4% 2.4% 3.3% 3.5%

Economic projections: Eurozone

Change in real GDP 1.5% 1.7% 1.9%

CPI inflation 0.1% 1.0% 1.6%

Unemployment rate 11.0% 10.5% 10.1%

Economic projections: China

Change in real GDP 7.0%

CPI inflation 3.0%

Unemployment rate 4.5%

Economic projections: Japan

Change in real GDP 1.7% 1.5% 0.2%

CPI inflation 0.7% 1.9% 1.8%

Source: Federal Reserve, European Central Bank, National People’s Congress of China, Bank of Japan. Data as of December 31, 2015. Forecasts are not available for all periods.

18

Monetary policy implementation Multilayered approach


•  Interest on excess reserves (IOER): Interest rate raised to 0.50 percent •  Overnight reverse repurchase facility (ON RRP): Interest rate raised

to 0.25 percent and removed overall program cap with a counterparty limit of $30 billion per day.

•  Term deposit facility (TDF): No change •  Securities holdings: Continue rolling over Treasuries at maturity and

reinvesting principal payments on agency debt and agency MBS.

Target range raised to 0.25-0.50 percent

•  Open market operations: Undertake as necessary to maintain the target range. This includes approved overnight and term reverse repurchase operations.

•  Reserve requirements: No change •  Discount rate: Interest rate raised to 1.00 percent

Fed funds target range

Core policy tools

Supplemental tools

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Markets & performance

20

Fixed income returns Overview


Spread is based on Option Adjusted Spread. Duration is based on Modified Duration. Data as of December 31, 2015. 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 1.06 1.87 - - -0.44 0.54 - - 1-3yr Agencies 9.00 1.16 1.83 2.00 5.00 -0.37 0.69 0.03 0.08 0-3yr MBS 18.00 1.67 2.18 -30.00 -1.00 0.42 1.12 0.84 0.45 1-3yr ABS 84.00 1.72 1.30 12.00 31.00 -0.19 0.90 0.11 0.48 1-3yr IG corporates 108.00 2.17 1.90 -6.00 20.00 -0.13 1.01 0.35 0.38 3-5yr IG corporates 136.00 2.96 3.64 -4.00 25.00 -0.46 1.52 0.46 0.23 5-10yr IG corporates 185.00 3.96 6.29 -8.00 30.00 -0.44 0.78 0.86 -1.00 1-5yr High yield 850.00 10.08 2.83 59.00 272.00 -2.67 -5.23 -2.05 -6.12

1-3yr Corporates by rating AAA 22.00 1.36 2.11 -16.00 0.00 -0.10 1.03 0.39 0.33 AA 56.00 1.63 1.90 -8.00 14.00 -0.14 1.05 0.34 0.42 A 81.00 1.90 1.90 -12.00 17.00 -0.03 1.19 0.46 0.55 BBB 172.00 2.83 1.90 2.00 28.00 -0.26 0.74 0.21 0.11

1-3yr Corporates by sector Financial 96.00 2.03 1.86 -14.00 8.00 0.04 1.33 0.52 0.72 Industrials 116.00 2.25 1.92 -1.00 28.00 -0.23 0.83 0.25 0.18 Utility/energy 118.00 2.28 1.97 0.00 36.00 -0.41 0.25 0.09 -0.41

Total return comparisons Stability in bonds

21

All returns above are on Total Return basis. YTD 2015 returns are on an annualized basis up to December 31, 2015. FI Credit refers to Barclays 1-3 year US Investment Grade Fixed Income portfolio; Treasury refers to Barclays 1-3 year US Treasury portfolio; Gold refers to S&P GSCI Gold Spot; WTI 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 and SVB Asset Management.

Ass

et c

lass

retu

rns

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

WTI 40.82%

REIT 34.18%

WTI 57.68%

US Treasury 6.67%

WTI 78.00%

Gold 29.67%

Gold 10.23%

REIT 16.47%

Wilshire 33.06%

REIT 28.24%

S&P 500 1.40%

Gold 18.36%

Gold 22.95%

Gold 31.35%

Gold 5.53%

Wilshire 28.29%

REIT 26.97%

WTI 8.15%

Wilshire 16.05%

S&P 500 32.39%

S&P 500 13.69%

REIT 1.30%

Wilshire 6.38%

S&P 500 15.79%

US Treasury 7.31%

FI Credit 0.30%

S&P 500 26.46%

Wilshire 17.18%

REIT 7.48%

S&P 500 16.00%

WTI 7.32%

Wilshire 12.70%

FI Credit 0.85%

S&P 500 4.91%

Wilshire 15.78%

FI Credit 5.96%

S&P 500 -37.00%

REIT 26.27%

WTI 15.10%

S&P 500 2.11%

Gold 6.96%

FI Credit 1.45%

FI Credit 1.12%

Wilshire 0.70%

FI Credit 1.89%

FI Credit 4.66%

Wilshire 5.61%

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%

US Treasury 1.62%

US Treasury 3.93%

S&P 500 5.49%

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%

WTI -0.34%

REIT -17.84%

WTI -53.52%

US Treasury 0.80%

US Treasury 2.40%

Wilshire 0.98%

WTI -7.08%

Gold -28.26%

WTI -45.76%

WTI -30.50%


Source: Bloomberg, BofA Merrill Lynch and SVB Asset Management. Data as of December 31, 2015.

22

Sector returns Primary source of returns


-‐2.23

-‐1.12

-‐1.50

-‐1.03

-‐1.55

-‐2.24

-‐1.33

-‐0.61

-‐3.41

-‐3.14

-‐2.05

-‐1.44

-‐0.99

-‐1.42

-‐2.72

-‐1.51

-‐3.51

-‐1.66

-‐1.77

-‐1.82

2.70

1.66

2.14

1.73

2.28

3.06

2.20

1.52

4.38

4.14

3.09

2.54

2.11

2.55

3.88

2.71

4.83

3.03

3.18

3.28

0.47

0.54

0.64

0.70

0.73

0.82

0.87

0.90

0.98

1.00

1.05

1.10

1.12

1.12

1.17

1.20

1.32

1.37

1.41

1.46

-‐4.00 -‐3.50 -‐3.00 -‐2.50 -‐2.00 -‐1.50 -‐1.00 -‐0.50 0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 5.50

Basic industry US Treasury US Agency

AutomoAve Technology Insurance

Energy ABS

CMBS UAlity

Capital goods Healthcare

MBS TelecommunicaAons

Media Consumer goods

Services Banking

Financial services Real estate

Total return % YTD Income return % YTD Price return % YTD

During the quarter, higher benchmark rates and widening of credit spreads led to drags in price performance of the fixed income sector but stellar returns of high quality credits from prior periods posted excess returns against treasuries with similar maturities.

U.S. U.S.

YTD 1-3 year sector returns %


S&P 500 Index fundamentals

Credit cycle: Corporate credit health remains resilient While operating margins may have peaked, it remains well elevated and leverage is still near historic lows.

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

13.0%

14.0%

15.0%

Source: Standard & Poor’s and Bloomberg

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

S&P 500 sector-level fundamentals ê  Energy continues to be the weakest, with the highest

leverage and negative margins. ê  Information technology remains the strongest

with the lowest leverage and the highest margins of all sectors.

ê  Financials are the most profitable, followed by Information technology and Utilities.

ê  Trend of diverging fundamentals is expected to continue as credit cycle matures.


Credit focus: Corporate sectors divergent in fundamentals

Sources: Eurostat, Bloomberg and SVB Asset Management.

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

Debt to EBITDA Operating margin

Moody’s ratings – SAM actively traded approved issuer list S&P ratings – SAM actively traded approved issuer list

25

Actively traded approved issuer list

Source: Bloomberg & SVB Asset Management. Note: Active issuers are currently traded issuers. Identical list of issuers have been used for both 2006/07 as in 2015.

Credit cycle Strengthening of the financial institutions sector


ê  In SVB Asset Management’s view, it is comfortable recommending selected Financial Institution names due to improved credit fundamentals and relatively higher spreads.

ê  Various downgrade activities in the sector have largely occurred due to the methodology changes as NRSROs reassess government support assumptions as a result of various new regulations and establishment of resolution regimes.

ê  More stringent regulatory requirements on higher and better quality of capital, lower leverage, higher quality liquid assets and less participation in riskier lines of business are credit positive for the banks.

ê  Due to capital adequacy requirements, banks are unlikely to distribute high dividends as they must build capital to provide improved stability in stress situations.

0

5

10

15

Baa3 Baa2 Baa1 A3 A2 A1 Aa3 Aa2 Aa1 Aaa

2006/07 2015

0 2 4 6 8

10 12

BBB- BBB BBB+ A- A A+ AA- AA AA+ AAA

2006/07 2015

Pre-recession level average

2004-2007

Worst level since 2008

Current level

2014/15*

Loan/deposits (%) 117.75 333.56 97.42

T1 RBC ratio (%) 9.33 7.35 12.86

Leverage ratio (%) 32.99 61.93 24.53

Total assets (USD million) $603,671 NM $869,387

Nonperforming loans (%) 0.99 9.09 1.03

A+/A/A- Issuers yield curve

Source: Bloomberg and SVB Asset Management.

AA+/AA/AA- Issuers yield curve

26

Credit cycle Banks vs industrials – December 31, 2015


ê  These graphs represent the 3-year yield curve for the entire U.S. banks and U.S. industrials universe captured in Bloomberg.

ê  U.S. bank issuers provide more value on a relative basis than U.S. Industrials. Issuer selection continues to be important to mitigate risk in the sector while still taking advantage of these relatively attractive yields.

ê  Industrials are susceptible to economic and event risk and tend to perform relatively weaker than financial institutions in a rising rate environment.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Global banks A+/A/A- U.S. industrials A+/A/A-

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Global banks AA+/AA/AA- U.S. industrials AA+/AA/AA-

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Global economy

United States United Kingdom Eurozone China Japan

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

Benchmark Rate 0.25-0.50% 0.5% 0.05% 4.35% 0.1%

Current Policy

Additional hikes to occur in 2016 if inflation nears 2% target with stable employment

Weak cost pressure, falling energy prices preventing a 25 bps rate hike

Cut deposit rate, extended QE, reiterated additional easing to reach 2% inflation

Interest rate and reserve ratio were cut 5 and 4 times, respectively, in 2015

Reinforced Quantitative & Qualitative program to hit 2% inflation target in 2017

Inflation

Unemployment 5.0% 5.2% 10.7% 4.0% 3.3%

Analysis

Expect 2 additional rate hikes during 2016, as Fed normalizes monetary policy

Rate hike delayed until mid-year by uncertain inflation path

Bias for further easing due to falling oil prices hindering inflation

Further rate cuts ahead to support 6.5% annual growth target

Further easing in 2016 if fiscal stimulus fails to generate faster inflation

1.5%

0.0% 0.5% 1.0% 1.5% 2.0%

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


1.3%

0.0% 0.5% 1.0% 1.5% 2.0%

1.2%

0.0% 0.5% 1.0% 1.5% 2.0%

0.20%

0.0% 0.5% 1.0% 1.5% 2.0%

0.90%

0.0% 0.5% 1.0% 1.5% 2.0%

Rising Stable

Easing

Easing

Easing

Central banks Diverging views

$0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0

2009 2010 2011 2012 2013 2014 2015*

Bill

ions

Annual foreign direct investment: information transmission, computer services, software

46

48

50

52

54

56

PMI i

ndex

, >50

= e

xpan

sion

Manufacturing Non-manufacturing

-10%

0%

10%

20%

30%

40%

50%

Cha

nge,

yea

r ove

r yea

r

Fixed asset investment: information transmission, computer services, software

Economic activity Tech still attracting outside investors

29

Tech spending remains strong

Source: National Bureau of Statistics of China, the People’s Bank of China, Bloomberg, SVB Asset Management. * Through November 2015

China The big bang theory


ê  Manufacturing has been weak, but services continue to grow at a steady pace, indicating a maturing and transitioning economy.

ê  The technology sector continues to fuel the transition to a service-driven economy.

ê  While slowing growth has sparked overall capital outflows, technology continues to attract foreign investment.

0.0

0.5

1.0

1.5

102

107

112

Per

cent

age

Inde

x, 2

007

= 10

0

Nonperforming loans (RHS) New housing price index (LHS)

Overnight rate (RHS)

-1.0

0.0

1.0

2.0

3.0

1.7

1.9

2.1

2.3

2.5

2.7

Per

cent

age

Aver

age

pric

e, m

illio

ns S

EK

Nonperforming loans (RHS) Sweden home sales price (LHS)

Overnight repo rate (RHS)

0.0

1.0

2.0

3.0

4.0

5.0

98

108

118

128

138

Per

cent

age

Inde

x, 2

011-

2012

= 1

00

Nonperforming loans (RHS) Established home price index

Overnight rate (RHS)

Australia Canada

30

Sweden

Source: Australian Bureau of Statistics, Statistics Canada, Statistics Sweden, the World Bank, Bloomberg, SVB Asset Management.

Developed economies Uncertainty continues


ê  Low interest rates have pushed housing prices to historic highs across many developed economies.

ê  Housing prices are vulnerable in commodity-sensitive economies, such as Australia and Canada, where foreign buyers have also contributed to rising prices.

ê  Swedish housing prices have been supported by supply constraints. ê  Overall nonperforming loans have been stable, as home prices remain

largely aloft, in part, due to low loan-to-values.

-6% -4% -2% 0% 2% 4% 6% 8%

10% 12%

2010 2011 2012 2013 2014 2015 2016 2017 2018

Cha

nge,

yea

r ove

r yea

r

Brazil Argentina Chile Peru

0%

2%

4%

6%

8%

10%

2010 2011 2012 2013 2014 2015 2016 2017 2018

Cha

nge,

yea

r ove

r yea

r

Nigeria South Africa Egypt Kenya

-8% -6% -4% -2% 0% 2% 4% 6% 8%

10% 12%

2010 2011 2012 2013 2014 2015 2016 2017 2018

Cha

nge,

yea

r ove

r yea

r

Iran Israel Saudi Arabia UAE

South America Middle East

31

Africa

Source: International Monetary Fund, Bloomberg, SVB Asset Management.


ê  The International Monetary Fund projects positive Gross Domestic Product expansion across many emerging economies.

ê  Low commodity prices, political strife, and security challenges represent primary risks to the pace of growth.

ê  Technology, consumer goods, infrastructure, and financial services are sectors positioned for increased investment.

ê  Idiosyncratic events will keep the pace of near-term growth erratic in some emerging economies, though they remain the foundation for global growth over the long term.

Emerging economies Growing pains

Aria

l 201

5 4:

3

Portfolio management strategy

33

Portfolio strategy Macro overview

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.


Economy

Rates

Duration

Sector

Solid economic data

•  Q3 GDP +2 percent. 2015 average at +2.2 percent

•  Labor market averaged 200,000 new jobs per month

Short end rates higher

•  6-month T-bills rose from single-digit yields to over 0.50 percent before December FOMC meeting.

•  2-Year Treasury rose above 1 percent for the first time in 5 years.

Defensive on duration

•  Short & 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

Overweight spread product

•  Prefer finance sector in corporate bonds and credit card & auto asset-backed securities

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

34

Portfolio strategy Relative value curve analysis

Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.


Source: SVB Asset Management and Bloomberg. Data as of 12/31/2015.

Where is the current value? ê  Although rates have been trending higher, we analyze where the current value is on the curve. ê  In the 4th quarter we saw short-end rates rise ahead of the December FOMC meeting. ê  6- and 9-month part of the curve is relatively flat with 9-month yields only 3 basis points higher. ê  We see similar flat yield pick up around the 2-year part of the Treasury curve. ê  From a relative value standpoint, in the short end we prefer the 6-month part of the curve and prefer 18-months vs 2-years.

Bond

Yield

Yield pick up from shorter

tenure

3-‐month T-‐bill 0.16% -‐-‐-‐-‐

6-‐month T-‐bill 0.47% +0.31

9-‐month T-‐bill 0.51% +0.03

1-‐year Tsy 0.74% +0.24

1.5-‐year Tsy 0.94% +0.20

2-‐year Tsy 1.05% +0.11

2.5-‐year Tsy 1.18% +0.13

3-‐year Tsy 1.31% +0.13

Flat

Flat

Flat

35

Portfolio strategy Duration and sector overview

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.


Strategy

Duration Target

Short duration benchmark 3-month

Intermediate duration benchmark 6-month

Intermediate plus duration

benchmark 9-month

Long duration benchmark

1- and 2+ years

-30% Neutral +30%

-30% Neutral +30%

-30% Neutral +30%

Neutral -30% +30%

Sector

Overview

Governments

•  Favor Treasuries over Agencies for liquidity

purposes and the reduced spread pick of Agencies over Treasuries.

•  12- to 18-month Treasuries offer better relative value yield pick up than extending further out the curve. 18- to 24-months is relatively flat vs. shorter end of yield curve.

Corporate bonds

•  Bank and broker-dealer corporate bonds offer better liquidity and value as both regulation and performance have increased credit fundamentals.

•  Industrials continue to have strong balance sheets and positive earnings. We favor consumer cyclical and non-cyclical on improving fundamentals in consumer spending.

Asset-backed

Securities •  Strong consumer credit fundamentals and stable

spreads in auto and credit card receivables make this a sought-after sector.

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

SVB Asset Management | Quarterly Economic Report Q4 2015 36

Our team

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.

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