SVB Financial Group
SILICON VALLEY BANCSHARES (Form: 10-Q, Received: 08/14/2003 17:24:28)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

ý                                    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2003

 

OR

 

o                                    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

                                               

                                                For the transition period from           to            .

 

 

 

Commission File Number: 33-41102

 

 

SILICON VALLEY BANCSHARES

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

91-1962278

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

 

 

3003 Tasman Drive, Santa Clara, California

 

95054-1191

(Address of principal executive offices)

 

(Zip Code)

 

 

 

(408) 654-7400

Registrant’s telephone number, including area code: 

 


 

                Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

                Yes ý   No o

 

                Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)
                Yes
ý   No o

 

 

                At July 31, 2003, 34,512,616 shares of the registrant’s common stock ($0.001 par value) were outstanding.

 

 

 



 

 

                                                                                  TABLE OF CONTENTS

 

 

 

Page

PART I - FINANCIAL INFORMATION

 

 

 

 

ITEM 1.

INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

 

CONSOLIDATED BALANCE SHEETS

3

 

 

 

 

CONSOLIDATED STATEMENTS OF INCOME

4

 

 

 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

5

 

 

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

6

 

 

 

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

7

 

 

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

 

22

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

47

 

 

 

ITEM 4.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

49

 

 

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

ITEM 1.

LEGAL PROCEEDINGS

50

 

 

 

ITEM 2.

CHANGES IN SECURITIES AND USE OF PROCEEDS

50

 

 

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

50

 

 

 

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

50

 

 

 

ITEM 5.

OTHER INFORMATION

51

 

 

 

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

51

 

 

 

SIGNATURES

53

 

 

2



 

PART I - FINANCIAL INFORMATION

 

ITEM 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED BALANCE SHEETS

 

 

 

June 30,

 

December 31,

 

(Dollars in thousands, except par value)

 

2003

 

2002

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

Cash and due from banks

 

$

238,202

 

$

239,927

 

Federal funds sold and securities purchased under agreement to resell

 

305,609

 

202,662

 

Investment securities

 

1,663,920

 

1,535,694

 

Loans, net of unearned income

 

1,964,800

 

2,086,080

 

Allowance for loan losses

 

(69,500

)

(70,500

)

Net loans

 

1,895,300

 

2,015,580

 

Premises and equipment

 

15,585

 

17,886

 

Goodwill

 

83,548

 

100,549

 

Accrued interest receivable and other assets

 

92,426

 

70,883

 

Total assets

 

$

4,294,590

 

$

4,183,181

 

 

 

 

 

 

 

Liabilities, minority interest, and stockholders’ equity:

 

 

 

 

 

Liabilities:

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing demand

 

$

1,893,707

 

$

1,892,125

 

NOW

 

55,164

 

21,531

 

Money market

 

1,029,987

 

933,255

 

Time

 

509,526

 

589,216

 

Total deposits

 

3,488,384

 

3,436,127

 

Short-term borrowings

 

9,264

 

9,127

 

Other liabilities

 

115,551

 

47,550

 

Long-term debt

 

163,057

 

17,397

 

Total liabilities

 

3,776,256

 

3,510,201

 

 

 

 

 

 

 

Company obligated mandatorily redeemable trust preferred securities of subsidiary trust holding solely junior subordinated debentures (trust preferred securities)

 

38,718

 

39,472

 

Minority interest

 

47,481

 

43,158

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value, 20,000,000 shares authorized; none outstanding

 

 

 

Common stock, $0.001 par value, 150,000,000 shares authorized; 34,490,249 and 40,578,093 shares outstanding at June 30, 2003 and December 31, 2002, respectively

 

34

 

41

 

Additional paid-in capital

 

1,758

 

99,979

 

Retained earnings

 

419,999

 

476,610

 

Unearned compensation

 

(1,839

)

(652

)

Accumulated other comprehensive income:

 

 

 

 

 

Net unrealized gains on available-for-sale investments

 

12,183

 

14,372

 

Total stockholders’ equity

 

432,135

 

590,350

 

Total liabilities, minority interest, and stockholders’ equity

 

$

4,294,590

 

$

4,183,181

 

 

See notes to interim consolidated financial statements.

 

3



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

 INTERIM CONSOLIDATED STATEMENTS OF INCOME

 

 

 

For the three months ended June 30,

 

For the six months ended June 30,

 

(Dollars in thousands, except per share amounts)

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

 

 

Loans

 

$

38,134

 

$

39,652

 

$

75,970

 

$

77,977

 

Investment securities

 

10,143

 

13,468

 

22,116

 

29,283

 

Federal funds sold and securities purchased under agreement to resell

 

1,129

 

591

 

1,959

 

836

 

Total interest income

 

49,406

 

53,711

 

100,045

 

108,096

 

Interest expense:

 

 

 

 

 

 

 

 

 

Deposits

 

2,389

 

4,162

 

4,840

 

9,060

 

Other borrowings

 

317

 

476

 

527

 

961

 

Total interest expense

 

2,706

 

4,638

 

5,367

 

10,021

 

Net interest income

 

46,700

 

49,073

 

94,678

 

98,075

 

Provision for loan losses

 

1,162

 

(3,207

)

4,546

 

219

 

Net interest income after provision for loan losses

 

45,538

 

52,280

 

90,132

 

97,856

 

Noninterest income:

 

 

 

 

 

 

 

 

 

Client investment fees

 

6,034

 

7,774

 

12,366

 

16,412

 

Corporate finance fees

 

4,641

 

4,424

 

8,785

 

7,386

 

Letter of credit and foreign exchange income

 

3,128

 

3,575

 

6,631

 

7,352

 

Deposit service charges

 

3,245

 

2,294

 

6,121

 

4,530

 

Disposition of client warrants

 

1,051

 

681

 

3,013

 

807

 

Credit card fees

 

988

 

239

 

2,034

 

348

 

Investment losses

 

(3,839

)

(2,001

)

(8,544

)

(4,598

)

Other

 

2,257

 

1,868

 

4,545

 

3,518

 

Total noninterest income

 

17,505

 

18,854

 

34,951

 

35,755

 

Noninterest expense:

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

29,272

 

28,821

 

60,704

 

53,749

 

Impairment of goodwill

 

17,000

 

 

17,000

 

 

Net occupancy

 

4,103

 

6,433

 

8,505

 

10,951

 

Professional services

 

3,985

 

4,367

 

7,424

 

7,403

 

Furniture and equipment

 

2,710

 

1,571

 

4,904

 

3,667

 

Business development and travel

 

2,296

 

1,933

 

3,912

 

4,056

 

Data processing services

 

1,392

 

918

 

2,483

 

1,783

 

Correspondent bank fees

 

1,094

 

608

 

2,134

 

1,315

 

Telephone

 

857

 

701

 

1,635

 

1,602

 

Tax credit fund amortization

 

716

 

836

 

1,431

 

1,286

 

Postage and supplies

 

632

 

792

 

1,216

 

1,575

 

Trust preferred securities distributions

 

313

 

746

 

594

 

1,571

 

Other

 

2,833

 

1,292

 

5,369

 

3,378

 

Total noninterest expense

 

67,203

 

49,018

 

117,311

 

92,336

 

Minority interest

 

2,765

 

1,397

 

6,244

 

3,237

 

(Loss) income before income taxes

 

(1,395

)

23,513

 

14,016

 

44,512

 

Income tax (benefit) expense

 

(819

)

8,528

 

4,174

 

16,167

 

Net (loss) income

 

$

(576

)

$

14,985

 

$

9,842

 

$

28,345

 

Net (loss) income per common share - basic

 

$

(0.02

)

$

0.33

 

$

0.26

 

$

0.63

 

Net (loss) income per common share - diluted

 

$

(0.02

)

$

0.32

 

$

0.25

 

$

0.61

 

 

See notes to interim consolidated financial statements.

 

4



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

 

 

For the three months ended

 

For the six months ended

 

(Dollars in thousands)

 

June 30,

2003

 

June 30,

2002

 

June 30,

2003

 

June 30,

2002

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(576

)

$

14,985

 

$

9,842

 

$

28,345

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

Change in unrealized gains (losses) on available-for-sale investments:

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses)

 

949

 

5,546

 

(73

)

2,714

 

Reclassification adjustment for gains included in net income

 

(434

)

(434

)

(2,116

)

(514

)

Other comprehensive income (loss)

 

515

 

5,112

 

(2,189

)

2,200

 

Comprehensive (loss) income

 

$

(61

)

$

20,097

 

$

7,653

 

$

30,545

 

 

See notes to interim consolidated financial statements.

 

5



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

 

For the six months ended

 

(Dollars in thousands)

 

June 30,

2003

 

June 30,

2002

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

9,842

 

$

28,345

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Impairment of goodwill

 

17,000

 

 

Provision for loan losses

 

4,546

 

219

 

Minority interest

 

(6,244

)

(3,237

)

Depreciation and amortization

 

3,927

 

3,512

 

Net loss on available for sale securities

 

8,544

 

4,598

 

Net gains on disposition of client warrants

 

(3,013

)

(807

)

Changes in other assets and liabilities:

 

 

 

 

 

Decrease in accrued interest receivable

 

989

 

4,752

 

Deferred income tax benefits

 

(7,615

)

(2,932

)

(Increase) decrease in taxes receivable

 

(6,393

)

12,578

 

Increase in accrued retention, warrant, and other incentive plans

 

4,403

 

4,081

 

Increase in investment payable

 

48,137

 

 

Other, net

 

8,173

 

5,731

 

Net cash provided by operating activities

 

82,296

 

56,840

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities and paydowns of investment securities

 

524,597

 

1,622,094

 

Proceeds from sales of investment securities

 

5,020,896

 

23,818

 

Purchases of investment securities

 

(5,685,395

)

(1,273,114

)

Net decrease (increase) in loans

 

107,552

 

(116,572

)

Proceeds from recoveries of charged-off loans

 

7,854

 

18,195

 

Purchases of premises and equipment

 

(1,626

)

(2,288

)

Net cash (used) provided by investing activities

 

(26,122

)

272,133

 

Cash flows from financing activities:

 

 

 

 

 

Net increase (decrease) in deposits

 

52,257

 

(387,798

)

Proceeds from issuance of convertible notes and warrants, net of issuance costs and convertible note hedge

 

123,493

 

 

Proceeds from issuance of common stock

 

4,426

 

7,172

 

Repurchase of common stock

 

(148,969

)

(8,281

)

Capital contributions from minority interest participants

 

13,841

 

5,518

 

Net cash provided (used) by financing activities

 

45,048

 

(383,389

)

Net increase (decrease) in cash and cash equivalents

 

101,222

 

(54,416

)

Cash and cash equivalents at January 1,

 

442,589

 

440,532

 

Cash and cash equivalents at June 30,

 

$

543,811

 

$

386,116

 

Supplemental disclosures:

 

 

 

 

 

Interest paid

 

$

5,509

 

$

10,441

 

Income taxes paid

 

$

14,327

 

$

1,304

 

 

See notes to interim consolidated financial statements.

 

6



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

1.  Summary of Significant Accounting Policies

 

The accounting and reporting policies of Silicon Valley Bancshares and its subsidiaries (the “Company”) conform with accounting principles generally accepted in the United States of America, rule 10-01 of regulation S-X.  Certain reclassifications have been made to the Company’s 2002 interim consolidated financial statements to conform to the 2003 presentations.  Such reclassifications had no effect on the results of operations or stockholders’ equity.

 

Descriptions of the significant accounting policies of the Company are included in Note 1 (Significant Accounting Policies) to the Consolidated Financial Statements in the Company’s 2002 Annual Report on Form 10-K.  As of June 30, 2003, there have been no significant changes to these policies.

 

Nature of Operations

 

Silicon Valley Bancshares is a bank holding company and a financial holding company whose principal subsidiary is Silicon Valley Bank (the “Bank”), a California-chartered bank, founded in 1983, and headquartered in Santa Clara, California.  The Bank serves more than 9,500 clients across the country, through its 27 regional offices.  The Bank has 11 offices throughout California and operates regional offices across the country, including Arizona, Colorado, Florida, Georgia, Illinois, Massachusetts, Minnesota, New York, North Carolina, Oregon, Pennsylvania, Texas, Virginia, and Washington.  The Bank serves emerging growth and mature companies in the technology and life sciences markets, as well as the premium wine industry.  Substantially all of the assets, liabilities, and earnings of the Company relate to its investment in the Bank.  The Company offers its clients financial products and services including commercial, investment, merchant and private banking.  Merger, acquisition, and corporate partnering services are provided through its wholly-owned investment banking subsidiary, Alliant Partners (“Alliant”).

 

Consolidation

 

The interim Consolidated Financial Statements include the accounts of Silicon Valley Bancshares and its subsidiaries.  Intercompany accounts and transactions have been eliminated in consolidation.  For a description of accounting policies related to consolidation, refer to Note 1 (Significant Accounting Policies — Consolidation) to the Consolidated Financial Statements in the Company’s 2002 Annual Report on Form 10-K.

 

Interim Consolidated Financial Statements

 

In the opinion of Management, the interim Consolidated Financial Statements contain all adjustments (consisting of only normal, recurring adjustments) necessary to present fairly the Company’s consolidated financial position at June 30, 2003, the interim results of its operations for the three and six months ended June 30, 2003 and June 30, 2002 and interim cash flow for the six months ended June 30, 2003 and June 30, 2002. The December 31, 2002, Consolidated Balance Sheet was derived from audited financial statements.  Certain information and footnote disclosures, normally presented therein, and prepared in accordance with accounting principles generally accepted in the United States of America, have been omitted from this report. The results of operations for the three and six months ended June 30, 2003, may not necessarily be indicative of the Company’s operating results for the full year.  The interim Consolidated

 

7



 

Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s 2002 Annual Report on Form 10-K.

 

Basis of Financial Statement Presentation

 

The preparation of interim consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets and liabilities as of the balance sheet date and the results of operations for the reported periods.  Actual results could differ from those estimates.  See “Part 1. Financial Information — Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies.”   An estimate of possible changes or a range of possible changes cannot be made.

 

Stock-Based Compensation

 

The Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and related interpretations, in accounting for its employee stock options rather than the alternative fair value accounting allowed by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” APB No. 25 provides that the compensation expense relative to the Company’s employee stock options is measured based on the intrinsic value of the stock option.  SFAS No. 123 as amended by SFAS No. 148 requires companies that continue to follow APB No. 25 to provide a pro-forma disclosure of the impact of applying the fair value method of SFAS No. 123.  The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and Financial Accounting Standards Board Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation.”

 

8



 

A comparison of reported and pro-forma net income, including effects of expensing stock options, follows.

 

 

 

For the three months ended

 

For the six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Dollars in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income, as reported

 

$

(576

)

$

14,985

 

$

9,842

 

$

28,345

 

Add:

Stock-based compensation expense included in reported net income, net of tax

 

253

 

211

 

391

 

399

 

Less:

Total stock-based employee compensation expense determined under fair value based method, net of tax

 

(4,836

)

(6,086

)

(8,548

)

(10,072

)

Net (loss) income, pro-forma

 

$

(5,159

)

$

9,110

 

$

1,685

 

$

18,672

 

 

 

 

 

 

 

 

 

 

 

Basic (loss) income per share:

 

 

 

 

 

 

 

 

 

As reported

 

$

(0.02

)

$

0.33

 

$

0.26

 

$

0.63

 

Pro-forma

 

(0.14

)

0.22

 

0.04

 

0.43

 

Diluted (loss) income per share:

 

 

 

 

 

 

 

 

 

As reported

 

(0.02

)

0.32

 

0.25

 

0.61

 

Pro-forma

 

(0.13

)

0.23

 

0.05

 

0.44

 

 

Obligation Under Guarantees

 

The Company provides guarantees related to financial and performance standby letters of credit.  The Company accounts for these guarantees in accordance with the provision of the Financial Accounting Standards Board (“FASB”) Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.”  The Company recognizes a liability with respect to its stand-ready obligation under the guarantee even if the probability of future payments under the guarantee is remote.  The Company recognizes a liability for the fair value of the guarantee at the inception of the contract.  See “Part 1. Financial Information — Item 1. Notes to the Interim Consolidated Financial Statements — Note 10 to the Interim Consolidated Financial Statements — Obligation Under Guarantees.”

 

Recent Accounting Pronouncements

 

In January 2003, FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities (VIE).”  It defined a VIE as a corporation, partnership, trust, or any other legal structure used for the business purpose that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities.  This interpretation will require a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities or entitled to receive a majority of the entity’s residual return.  The interpretation states that if a VIE was acquired before February 1, 2003, the Company is required to disclose the impact of the VIE in its interim and annual financial statements beginning after June 15, 2003.  However, if it is reasonably possible that the Company will consolidate or disclose information about a VIE when this

 

 

9



 

interpretation becomes effective, then the Company is required to disclose the nature, purpose, size, activities, and it’s maximum exposure to loss as a result of its investment with that VIE in its financial statements issued after January 31, 2003 regardless of the date on which the VIE was created.  As of June 30, 2003, the Company has identified one VIE which would require consolidation treatment if we continue to hold an ownership interest of greater than 50%.  This VIE is a real estate partnership, which invests in affordable housing projects and provides its investors federal and state income tax credits, and had $9.4 million in total assets and $4.6 million in total liabilities at June 30, 2003.  As of June 30, 2003, the Company committed approximately $5.1 million to this partnership of which $4.6 million had been funded.  This partnership was not consolidated in the Company’s financial statements at June 30, 2003.  The Company does not expect the consolidation of this partnership to have a significant impact on its results of operations or financial position.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” to amend and provide clarification on the accounting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities.”  SFAS No. 149 will be applied prospectively and is effective for contracts entered into or modified after June 30, 2003.  This statement will be applicable to existing contracts and new contracts entered into after June 30, 2003 if those contracts relate to forward purchases or sales of when-issued securities or other securities that do not yet exist.  The Company does not expect the adoption of SFAS No. 149 to have a material effect on the Company’s results of operations or financial condition.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” to establish standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within the Statement’s scope as a liability (or an asset in some circumstances).  Many of those instruments were previously classified as equity, or between the liabilities and equity sections of the statement of financial position.  SFAS No. 150 requires financial instruments issued in the form of shares that are mandatorily redeemable (or embodies an unconditional obligation requiring the issuer to redeem it by transferring its assets at a specified or determinable date or upon an event that is certain to occur) to be classified as liabilities.  The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  It is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance date of the Statement and still existing at the beginning of the interim period of adoption.  Restatement is not permitted.

 

As of June 30, 2003, the Company had $38.7 million in “Company Mandatorily Redeemable Trust Preferred Securities of Subsidiary Trust Holding Solely Junior Subordinated Debentures,” or Trust Preferred Securities (TPS) outstanding.  These securities are classified between the liability and equity sections of the Company’s Interim Consolidated Balance Sheets at June 30, 2003, and their related expense is classified as noninterest expense on the Company’s Interim Consolidated Statements of Income, under the heading “Trust preferred securities distributions,” for the three and six months ended June 30, 2003.  Adoption of SFAS No. 150 will result in a reclassification of TPS to the liabilities section of the Consolidated Balance Sheet and future

 

 

10



 

TPS distribution expense to be classified as interest expense on the Consolidated Statements of Income. Other than the aforementioned impact, SFAS No. 150 will not have a material impact on the Company’s results of operations or financial condition.

 

2.  Earnings Per Share (EPS)

 

The following is a reconciliation of basic EPS to diluted EPS for the three and six months ended June 30, 2003 and 2002.

 

 

 

For the

 

For the

 

 

 

Three months ended June 30

 

Six months ended June 30

 

(Dollars and shares in thousands,

 

Net

 

 

 

Per Share

 

Net

 

 

 

Per Share

 

except per share amounts)

 

Income

 

Shares

 

Amount

 

Income

 

Shares

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2003:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders

 

$

(576

)

36,735

 

$

(0.02

)

$

9,842

 

37,909

 

$

0.26

 

Effect of Dilutive Securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options and restricted stock

 

 

1,079

 

 

 

908

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders plus assumed conversions

 

$

(576

)

37,814

 

$

(0.02

)

$

9,842

 

38,817

 

$

0.25

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2002:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders

 

$

14,985

 

45,389

 

$

0.33

 

$

28,345

 

45,283

 

$

0.63

 

Effect of Dilutive Securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options and restricted stock

 

 

1,586

 

 

 

1,489

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders plus assumed conversions

 

$

14,985

 

46,975

 

$

0.32

 

$

28,345

 

46,772

 

$

0.61

 

 

 

11



 

3.  Investment Securities

 

The detailed composition of the Company’s available-for-sale and non-marketable investment securities is presented as follows:

 

 

 

June 30,

 

December 31,

 

(Dollars in thousands)

 

2003

 

2002

 

 

 

 

 

 

 

Available-for-sale securities, at fair value

 

$

1,571,529

 

$

1,444,231

 

Non-marketable investment securities:

 

 

 

 

 

Federal Reserve Bank stock and tax credit funds

 

25,241

 

25,649

 

Federal home loan bank stock

 

2,948

 

2,172

 

Venture capital fund investments (1)

 

47,842

 

46,822

 

Private equity investments (2)

 

16,360

 

16,820

 

Total investment securities

 

$

1,663,920

 

$

1,535,694

 


(1)           Non-marketable venture capital fund investments included $23.2 million and $22.1 million related to SVB Strategic Investors Fund, L.P., at June 30, 2003, and December 31, 2002, respectively.  The Company has a controlling ownership interest of 11.1% in the fund.  Excluding the minority interest owned portion of SVB Strategic Investors Fund, L.P., the Company had non-marketable venture capital fund investments of $27.2 million as of June 30, 2003, and December 31, 2002.

 

(2)        Non-marketable private equity investments included $10.3 million and $10.0 million related to Silicon Valley BancVentures, L.P., at June 30, 2003, and December 31, 2002, respectively.  The Company has a controlling ownership interest of 10.7% in the fund.  Excluding the minority interest owned portion of Silicon Valley BancVentures, L.P., the Company had non-marketable other private equity investments of $7.1 million and $7.9 million as of June 30, 2003, and December 31, 2002, respectively.

 

 

12



 

The following tables present the carrying value of our non-marketable venture capital and other private equity investments at and for the six months ended June 30, 2003.

 

 

 

(As consolidated)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wholly-Owned Equity Investments

 

Managed Funds

 Activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Venture Capital
Funds

 

Other
Private
Equity

 

Silicon Valley BancVentures, L.P.

 

SVB Strategic Investors Fund, L.P.

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Fund size

 

 

 

$

56,100

 

$

121,800*

 

$

177,900

 

Commitments

 

$

58,455

 

$

15,168

 

16,631

 

101,277

 

191,531

 

Capital investment

 

37,915

 

15,168

 

16,631

 

36,350

 

106,064

 

Carrying value

 

24,670

 

6,038

 

10,322

 

23,172

 

64,202

 

Year-to-date net investment losses

 

(1,608

)

(931

)

(1,963

)

(3,733

)

(8,235

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Net of minority interest ownership of managed funds)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wholly-Owned Equity Investments

 

Managed Funds

 Activites

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Venture Capital
Funds

 

Other
Private
Equity

 

Silicon Valley BancVentures, L.P.

 

SVB Strategic Investors Fund, L.P.

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments

 

$

58,455

 

$

15,168

 

$

6,000

 

$

13,500*

 

$

93,123

 

Capital investment

 

37,915

 

15,168

 

2,280

 

4,860

 

60,223

 

Carrying value

 

24,670

 

6,038

 

1,104

 

2,568

 

34,380

 

Year-to-date net investment losses

 

(1,608

)

(931

)

(210

)

(414

)

(3,163

)

Year-to-date management fee revenue

 

 

 

541

 

499

 

1,040

 


*      Effective January 1, 2003, SVB Strategic Investors Fund, L.P. reduced the total capital that can be called from $135.3 million to $121.8 million as a result of the reductions in the size of the underlying venture capital fund investments.  Our committed capital that can be called was reduced from $15.0 million to $13.5 million.

 

 

13



 

4.  Loans and Allowance for Loan Losses

 

The detailed composition of loans, net of unearned income of $12.6 million and $11.8 million, at June 30, 2003, and December 31, 2002, respectively, is presented in the following table:

 

 

 

June 30,

 

December 31,

 

(Dollars in thousands)

 

2003

 

2002

 

 

 

 

 

 

 

Commercial

 

$

1,674,702

 

$

1,756,182

 

Real estate construction

 

52,940

 

43,178

 

Real estate term

 

55,770

 

56,190

 

Consumer and other

 

181,388

 

230,530

 

Total Loans

 

$

1,964,800

 

$

2,086,080

 

 

The activity in the allowance for loan losses for the three and six months ended June 30, 2003 and 2002 was as follows:

 

 

Three months ended June 30,

 

Six months ended June 30,

 

(Dollars in thousands)

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

70,000

 

$

71,375

 

$

70,500

 

$

72,375

 

Provision for loan losses

 

1,162

 

(3,207

)

4,546

 

219

 

Loans charged off

 

(4,696

)

(8,157

)

(13,400

)

(14,789

)

Recoveries

 

3,034

 

15,989

 

7,854

 

18,195

 

Ending balance

 

$

69,500

 

$

76,000

 

$

69,500

 

$

76,000

 

 

The aggregate recorded investment in loans for which impairment has been determined in accordance with SFAS No. 114 totaled $16.7 million and $19.2 million at June 30, 2003, and June 30, 2002, respectively.  Allocations of the allowance for loan losses specific to impaired loans totaled $8.7 million at June 30, 2003, and $7.4 million at June 30, 2002.  Average impaired loans for the second quarter of 2003 and 2002 totaled $18.9 million and $21.2 million, respectively.

 

5.  Goodwill

 

The goodwill balance at June 30, 2003 and December 31, 2002 was $83.5 million and $100.5 million, respectively.  Substantially all of the Company’s goodwill pertains to the acquisition of Alliant Partners (Investment Banking Subsidiary).

 

During the three months ended June 30, 2003, the Company recognized an impairment expense of $17.0 million related to goodwill.

 

SFAS No. 142, “Goodwill and Other Intangible Assets,” is the authoritative standard on the accounting for the impairment of goodwill.  SFAS No. 142 requires that the Company evaluate on an annual basis (or whenever events occur which may indicate possible impairment) whether any portion of our recorded goodwill is impaired.  The Company performed this analysis at the “reporting unit” level as defined in SFAS No. 142.  As discussed in our Annual Report on

 

 

14



 

Form 10-K for the fiscal year ended December 31, 2002, this analysis requires management to make a series of critical assumptions to: (1) evaluate whether any impairment exists, and (2) measure the amount of impairment.  As part of this analysis, SFAS No. 142 requires that the Company estimate the fair value of its reporting units and compare it with their carrying value.  If the estimated fair value of a reporting unit is less than the carrying value, then impairment is deemed to have occurred.  In estimating the fair value of the Alliant Partners reporting unit, the Company primarily used the income approach (which utilizes forecasted discounted cash flows to estimate the fair value of the reporting unit) and the market approach (which estimates fair value based on market prices for comparable companies).

 

The Company conducted its annual valuation analysis of the Alliant Partners reporting unit as of the end of the second quarter of 2003. The Company concluded at that time that it had an impairment of goodwill based on our market approach valuation and forecasted discounted cash flows for that reporting unit.  As required by SFAS No.142 in measuring the amount of goodwill impairment, the Company made a hypothetical allocation of the reporting unit’s estimated fair value to the tangible and intangible assets (other than goodwill) of the reporting unit. Based on this allocation, the Company concluded that $17.0 million of the related goodwill was impaired and was required to be expensed as a noncash charge to continuing operations during the second quarter of 2003. Thus the goodwill balance related to Alliant Partners was reduced from $98.6 million at December 31, 2002 to $81.6 million at June 30, 2003.

 

6.  Short-term Borrowings and Long-term Debt

 

The following table represents the outstanding short-term borrowings and long-term debt at June 30, 2003 and December 31, 2002:

 

 

 

 

June 30,

 

December 31,

 

(Dollars in thousands)

 

Maturity

 

2003

 

2002

 

 

 

 

 

 

 

 

 

Short-term borrowings (1)

 

September 28, 2003

 

$

9,264

 

$

9,127

 

Long-term debt:

 

 

 

 

 

 

 

Long-term note payable (1)

 

September 28, 2004

 

8,984

 

8,844

 

Long-term note payable (1)

 

September 28, 2005

 

8,695

 

8,553

 

Convertible subordinated notes

 

June 15, 2008

 

145,378

 

 

Total long-term debt

 

 

 

$

163,057

 

$

17,397

 


(1)                       Relates to the acquisition of Alliant Partners and are payable to the former owners, who are now employed by the Company. These notes were discounted over their respective terms, based on market interest rates as of September 28, 2001.   R efer to Note 2 (Business Combinations) to the Consolidated Financial Statements in the Company’s 2002 Annual Report on Form 10-K.

 

On May 20, 2003, the Company issued $150.0 million of zero-coupon, convertible subordinated notes at face value, due June 15, 2008, to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933 and outside the United States to non-US persons pursuant to Regulation S under the Securities Act.  The notes are convertible into the Company’s common stock at a conversion price of $33.6277 per share and are subordinated to all present and future senior debt of the Company.  Holders of the notes may convert their notes only if: (i) the price of the Company’s common stock issuable upon conversion of a note reaches a specified threshold, (ii) specified corporate transactions occur, or (iii) the trading price for the notes falls below certain thresholds.  At the initial conversion price, each $1,000 principal amount of notes will be

 

 

15



 

convertible into approximately 29.7374 shares of our common stock.  The Company has agreed to file a shelf registration statement with respect to the resale of the notes and the common stock issuable upon the conversion of the notes with the SEC within 90 days from the issuance of the notes.  The fair value of the convertible subordinated notes at June 30, 2003 was $141.4 million, based on quoted market prices.  The Company intends to repay the principal of the notes in cash.  Please see “ Part 2. Other Information — Item 2. Changes in Securities and Use of Proceeds” for additional discussion.

 

Concurrent with the issuance of the convertible notes, the Company entered into convertible note hedge and warrant transactions with respect to its common stock, with the objective of limiting its exposure to potential dilution from conversion of the notes.  The terms and conditions of the convertible note hedge are disclosed in  “Part 1. Financial Information — Item 1. Notes to the Interim Consolidated Financial Statements — Note 7 to the Interim Consolidated Financial Statements — Derivative Financial Instruments.”  The proceeds of the warrant transaction were included in stockholders’ equity in accordance with the guidance in Emerging Task Force Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”  Under the warrant agreement, Credit Suisse First Boston LLC (the Counterparty) may purchase up to approximately 4.4 million shares of the Company’s common stock at $52.34 per share, upon the occurrence of conversion events.  The warrant transaction will expire on June 15, 2008.

 

The Company currently has available federal funds and lines of credit facilities totaling $120.0 million, which were unused at June 30, 2003.

 

7.  Derivative Financial Instruments

 

On May 15, 2003, the Company entered into a convertible note hedge agreement (purchased call option) with Credit Suisse First Boston LLC (the Counterparty) with respect to its common stock to limit its exposure to potential dilution from conversion of the $150.0 million principal amount of zero coupon convertible notes.  For information on the Company’s $150.0 million principal amount of zero coupon convertible notes, please see “Part 1. Financial Information — Item 1. Notes to the Interim Consolidated Financial Statements — Note 6 to the Interim Consolidated Financial Statements — Short-term Borrowings and Long-term Debt.”  Upon the occurrence of conversion events, the Company has the right to purchase up to approximately 4.4 million of its common stock from the Counterparty at a price of $33.6277 per common share. The convertible note hedge agreement will expire on June 15, 2008.  The Company has the option to settle any amounts due under the convertible hedge either in cash or net shares of common stock.  At June 30, 2003, the cost of the convertible note hedge was included in stockholders’ equity in accordance with the guidance in Emerging Task Force Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”

 

Derivative instruments that the Company uses as a part of its interest rate risk management may include interest rate swaps, caps, and floors and forward contracts.  On June 3, 2002, the Company entered into a derivative agreement with a notional amount of $40.0 million.  The swap was called by the counterparty, Credit Suisse First Boston LLC, and accordingly was terminated effective June 23, 2003. The agreement hedged against the risk of changes in fair value associated with the Company’s $40.0 million, fixed rate, Trust Preferred Securities.  Changes in

 

 

16



 

the fair value of the derivative agreement and the Trust Preferred Securities are primarily dependent on changes in market interest rates.

 

Because the swap met the criteria for the short cut treatment, the benefit or expense was recorded in the period incurred.  This derivative agreement provided a benefit of $0.4 million, and $1.0 million for the three and six months ended June 30, 2003 over the comparable prior year periods.  The termination of the swap will increase related distribution expense to $0.8 million per quarter. The terms of the derivative agreement provided for quarterly receipt of a fixed-rate and payment of London Inter-Bank Offer Rate (LIBOR) plus a spread, based on the $40.0 million notional amount.  The derivative agreement mirrored the terms of the Trust Preferred Securities and, therefore, could be called and effectively terminated by the counter-party anytime after June 15, 2003, with a prior 40-day notification.  The Company assumed no ineffectiveness as the interest rate swap agreement met the short-cut method requirements under SFAS 133 for fair value hedges of debt instruments.  As a result, changes in the fair value of the derivative agreement were offset by changes in the fair value of the Trust Preferred Securities, and no net gain or loss was recognized in earnings.

 

For the Company’s Foreign Exchange Contracts and Foreign Currency Option Contracts, see the Company’s 2002 Annual Report on Form 10-K.

 

8.  Operating Segments

 

Prior to January 1, 2002, the Company operated as one segment.  On January 1, 2002, the Company reorganized into five lines of banking and financial services for management reporting: Commercial Banking, Merchant Banking, Investment Banking, Private Banking, and Other Business Services.  These operating segments are strategic units that offer different services to different clients.  They are managed separately because each segment appeals to different markets and, accordingly, requires different strategies.  The results of operating segments are based on the Company’s management reporting process, which assigns assets, liabilities, income, and expenses to the aforementioned operating segments.  This process is dynamic and, unlike financial accounting, there is no comprehensive, authoritative guidance for management reporting equivalent to generally accepted accounting principles.  The management reporting process measures the performance of operating segments based on the Company’s management structure and is not necessarily comparable with similar information for other financial services companies.  Changes in the management structure and/or the allocation process may (and have) result(ed) in changes in the Company’s allocation methodology as this process is under constant refinement.  In that case, results for prior periods would be (and have been) restated for comparability.  Results for the second quarter and first six months of 2002 have been restated to reflect changes in the Company’s allocation methodology.

 

As of June 30, 2003, based on the quantitative threshold for determining reportable segments as required by SFAS No. 131 “Disclosures About Segments of an Enterprise and Related Information,” the Company’s reportable segments are: Commercial Banking, which is the principal operating segment of the Company, Merchant Banking, Investment Banking, and the remaining segments.

 

Commercial Banking provides lending services, which include traditional term loans, commercial finance lending, and structured finance lending.  Commercial Banking’s cash

 

 

17



 

management services unit provides deposit services, collection services, disbursement services, electronic funds transfers, and online banking through SVBeConnect.  Commercial Banking’s International services unit provides trade services, foreign exchange services, export trade finance, and international cash management.  Also, Commercial Banking provides investment and advisory services through the Silicon Valley Bank’s broker-dealer subsidiary, SVB Securities, which includes mutual funds, fixed income securities, and investment reporting and monitoring.  The lending, deposit, cash management, International, and investment banking services to venture capital firms are included in the Merchant Banking segment.

 

Merchant Banking makes private equity and venture capital fund investments, international alliances and manages two limited partnerships: a venture capital fund and a fund of funds.  Merchant Banking also provides the lending, deposit, cash management, International, and investment banking services to venture capital firms.

 

Investment Banking provides merger and acquisition and corporate partnering services through the Company’s broker-dealer subsidiary, Alliant Partners.

 

Other segments include Private Banking and Other Business Services.  Private Banking provides a wide array of loan, personal asset management, mortgage services, trust and estate planning tailored for high-net-worth individuals.  It also provides investment advisory services to these clients through the Company’s Woodside Asset Management, Inc., subsidiary.  The Other Business Services unit provides Web-based business services and professional services.  Client Exchange™ is the Company’s online bulletin board, resume, and assets exchange service.

 

The Company’s primary source of revenue is from net interest income.  Thus, the Company’s segments are reported below using net interest income.  The Company also evaluates performance based on noninterest income and noninterest expense goals, which are also presented as measures of segment profit and loss.  The Company does not allocate income taxes to the segments.

 

 

 

18



 

 

 

Commercial

 

Merchant

 

Investment

 

 

 

 

 

 

 

Banking

 

Banking

 

Banking

 

Other

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Second quarter of 2003

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

38,055

 

$

2,895

 

$

14

 

$

5,736

 

$

46,700

 

Provision for loan losses (1)

 

1,469

 

 

 

(307

)

1,162

 

Noninterest income (loss) (2)

 

13,453

 

690

 

4,641

 

(1,279

)

17,505

 

Noninterest expense (3)

 

35,054

 

4,537

 

20,258

 

7,354

 

67,203

 

Minority interest

 

 

487

 

 

2,278

 

2,765

 

Income (loss) before income taxes

 

14,985

 

(465

)

(15,603

)

(312

)

(1,395

)

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,524,815

 

69,279

 

 

230,440

 

1,824,534

 

Total assets (4)

 

2,797,922

 

507,049

 

91,442

 

494,151

 

3,890,564

 

Total average deposits

 

2,499,871

 

483,430

 

 

154,027

 

3,137,328

 

 

 

 

 

 

 

 

 

 

 

 

 

Second quarter of 2002

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

38,726

 

$

2,710

 

$

 

$

7,637

 

$

49,073

 

Provision for loan losses (1)

 

(7,935

)

 

 

4,728

 

(3,207

)

Noninterest income (loss) (2)

 

16,604

 

691

 

4,424

 

(2,865

)

18,854

 

Noninterest expense (3)

 

36,050

 

3,270

 

2,954

 

6,744

 

49,018

 

Minority interest

 

 

528

 

 

869

 

1,397

 

Income (loss) before income taxes

 

27,215

 

659

 

1,470

 

(5,831

)

23,513

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,485,670

 

60,673

 

 

178,971

 

1,725,314

 

Total assets (4)

 

2,811,180

 

503,530

 

102,049

 

436,776

 

3,853,535

 

Total average deposits

 

2,409,569

 

465,036

 

 

156,235

 

3,030,840

 

 

 

 

 

 

 

 

 

 

 

 

 

First six months of 2003

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

76,805

 

$

6,115

 

$

27

 

$

11,731

 

$

94,678

 

Provision for loan losses (1)

 

5,355

 

 

 

(809

)

4,546

 

Noninterest income (loss) (2)

 

27,697

 

2,178

 

8,785

 

(3,709

)

34,951

 

Noninterest expense (3)

 

70,814

 

8,758

 

23,226

 

14,513

 

117,311

 

Minority interest

 

 

1,057

 

 

5,187

 

6,244

 

Income (loss) before income taxes

 

28,333

 

592

 

(14,414

)

(495

)

14,016

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,528,018

 

79,150

 

 

233,258

 

1,840,426

 

Total assets (4)

 

2,843,995

 

514,652

 

91,442

 

442,463

 

3,892,552

 

Total average deposits

 

2,514,429

 

485,413

 

 

148,608

 

3,148,450

 

 

 

 

 

 

 

 

 

 

 

 

 

First six months of 2002

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

78,268

 

$

5,370

 

$

 

$

14,437

 

$

98,075

 

Provision for loan losses (1)

 

(3,595

)

 

 

3,814

 

219

 

Noninterest income (loss) (2)

 

32,111

 

800

 

7,386

 

(4,542

)

35,755

 

Noninterest expense (3)

 

68,497

 

6,471

 

5,278

 

12,090

 

92,336

 

Minority interest

 

 

1,036

 

 

2,201

 

3,237

 

Income (loss) before income taxes

 

45,477

 

735

 

2,108

 

(3,808

)

44,512

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,475,462

 

57,426

 

 

166,906

 

1,699,794

 

Total assets (4)

 

2,882,524

 

495,186

 

102,049

 

454,391

 

3,934,150

 

Total average deposits

 

2,485,025

 

458,805

 

 

175,665

 

3,119,495

 


(1)           For operating segment reporting purposes, the Company reports net charge-offs as the provision for loan losses.  Thus, the Other column includes $(0.3) million and $(0.9) million for the three-month periods ended June 30, 2003 and June 30, 2002, respectively, and includes $(0.8) million and $3.8 million for the six-month periods ended June 30, 2003 and June 30, 2002, respectively, which represent the difference between net charge-offs and the provision for loan losses.

(2)           Noninterest income presented in the Merchant Banking column included warrant income of $1.1 million and $0.5  million, for the three months ended June 30, 2003 and June 30, 2002, respectively and $3.0 million and $0.6 million, for the six months ended June 30, 2003 and June 30, 2002, respectively.

(3)           Commercial Banking column included depreciation and amortization of $0.3 million and $0.3 million for the three months ended June 30, 2003 and June 30, 2002, and $0.7 million and $0.6 million for the six months ended June 30, 2003 and 2002.

(4)           Total assets for the Commercial Banking, Merchant Banking, and Other columns equals the greater of total loans or the sum of total deposits and total stockholders’ equity for each segment.  Total assets presented in the Investment Banking column included goodwill primarily related to the Alliant acquisition of $81.6 million and $98.6 million at June 30, 2003 and June 30, 2002, respectively.

 

19



 

9.  Common Stock Repurchase

 

$100.0 million share repurchase program authorized by the Board of Directors on September 16, 2002

 

From the inception through its termination on May 7, 2003, the Company repurchased 5.2 million shares of common stock totaling $94.3 million in conjunction with the $100.0 million share repurchase program.  In the second quarter of 2003, under this program, the Company purchased 0.1 million shares of common stock for $2.3 million.

 

$160.0 million share repurchase program authorized by the Board of Directors on May 7, 2003

 

On May 7, 2003, the Company’s board of directors authorized an additional stock repurchase program of up to $160.0 million.  This program became effective immediately and replaced previously announced stock repurchase programs. Under this program, the Company repurchased in aggregate 4.5 million shares of common stock totaling $113.4 million during the second quarter of 2003.  The Company purchased 1.3 million shares of common stock for approximately $33.4 million in conjunction with the convertible note offering.  During the second quarter of 2003, the Company entered into an accelerated stock repurchase agreement (ASR) for approximately 3.2 million shares at an initial price of $80.0 million.  The terms of this ASR are substantially the same as ASR agreements entered into in January 2003 and November 2002.  (See “Item 8. Consolidated Financial Statements and Supplementary Data — Note 15 to the Consolidated Financial Statements — Common Stock Repurchases” in our 2002 Annual Report on Form 10-K, for terms of the ASR.)

 

10. Obligations Under Guarantees

 

The Company provides guarantees related to financial and performance standby letters of credit issued to its clients to enhance their credit standing and enable them to complete a wide variety of business transactions.  Financial standby letters of credit are conditional commitments issued by the Company to guarantee the payment by a client to a third party (beneficiary).  Financial standby letters of credit are primarily used to support many types of domestic and international payments.  Performance standby letters of credit are issued to guarantee the performance of a client to a third party when certain specified future events have occurred.  Performance standby letters of credit are primarily used to support performance instruments such as bid bonds, performance bonds, lease obligations, repayment of loans, and past due notices.  These standby letters of credit have fixed expiration dates and generally require a fee paid by a client at the time

 

20



 

the Company issues the commitment.  Fees generated from these standby letters of credit are recognized in noninterest income over the commitment period.

 

The credit risk involved in issuing letters of credit is essentially the same as that involved with extending loan commitments to clients, and accordingly, we use a credit evaluation process and collateral requirements similar to those for loan commitments.  The Company’s standby letters of credit often are cash-secured by its clients.  The actual liquidity needs or the credit risk that the Company has experienced historically have been lower than the contractual amount of letters of credit issued because a significant portion of these conditional commitments expire without being drawn upon.

 

The table below summarizes at June 30, 2003 our standby letter of credits at the inception of the contract.  The maximum potential amount of future payments represents the amount that could be lost under the standby letter of credits if there were a total default by the guaranteed parties, without consideration of possible recoveries under recourse provisions or from the collateral held or pledged.

 

 

 

Expires in one

 

Expires after

 

Total amount

 

Maximum amount of

 

 

 

year or less

 

one year

 

outstanding

 

future payments

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Financial standby

 

$

529,236

 

$

69,493

 

$

598,729

 

$

598,729

 

Performance standby

 

4,697

 

729

 

5,426

 

5,426

 

Total

 

$

533,933

 

$

70,222

 

$

604,155

 

$

604,155

 

 

At June 30, 2003, the carrying amount of the liabilities related to financial and performance standby letters of credit was approximately $2.2 million.  At June 30, 2003, cash collateral available to us to reimburse losses under financial and performance standby letters of credits was $293.4 million.

 

21



 

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

Results of Operations

 

Throughout the following management discussion and analysis when we refer to “Silicon Valley Bancshares,” or “we” or similar words, we intend to include Silicon Valley Bancshares and all of its subsidiaries collectively, including Silicon Valley Bank.  When we refer to “Silicon,” we are referring only to Silicon Valley Bancshares

 

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our interim consolidated financial statements and supplementary data as presented in Part I - Item 1 of this report and in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2002.

 

This discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Our senior management have in the past and might in the future make forward-looking statements orally to analysts, investors, the media, and others.  Forward-looking statements are statements that are not historical facts.  Broadly speaking, forward-looking statements include:

 

(1)                       Projections of our revenues, income, earnings per share, cash flows, balance sheet, capital expenditures, capital structure or other financial items

(2)                       Descriptions of strategic initiatives, plans or objectives of our management for future operations, including pending acquisitions

(3)                       Descriptions of products, services, and industry sectors

(4)                       Forecasts of future economic performance

(5)                       Descriptions of assumptions underlying or relating to any of the foregoing

 

In this report, we make forward-looking statements discussing our management’s expectations about:

 

(1)                       Future gains or losses from private equity and venture capital fund investments

(2)                       Future market conditions and impairment charges on investments

(3)                       Future credit losses due to nonperformance of other parties

(4)                       Future changes in allowance for loan losses balance

(5)                       Future revenues of Alliant Partners

(6)                       Future impairment of goodwill

(7)                       Future changes in our average loan balances and their impact on our net interest margin

(8)                       Future net interest margin

(9)                       Future changes in private label investment product balances due to transferring of private label investment operations from Silicon Valley Bank to its wholly-owned broker-dealer subsidiary

(10)                 Future nonperforming loans

(11)                 Future Full Time Equivalent Employees

(12)                 Future funds generated through earnings and their impact on our liquidity

(13)                 Future common stock repurchases

(14)                 Future changes in trust preferred securities distribution expense

(15)                 Future expansiveness and competitiveness of array of investment products and services

(16)                 Future write-downs of equity investments

 

 

 

22



 

 

(17)                 Future growth of private label investment products and international services

(18)                 Future growth of our client-lending relationships

(19)                 Future tax benefits from our real estate investment trust

(20)                 Future adequacy of our capital leverage ratios

 

You can identify these and other forward-looking statements by the use of words such as “becoming,” “may,” “will,” “should,” “predicts,” “potential,” “continue,” “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends,” or the negative of such words, or comparable terminology.  Although we believe that the expectations reflected in these forward-looking statements are reasonable, and we have based these expectations on our beliefs, as well as our assumptions, such expectations may prove to be incorrect.  Our actual results of operations and financial performance could differ significantly from those expressed in or implied by our management’s forward-looking statements.

 

For information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see the text under the caption “Risk Factors” included in Item 7A of our 2002 Annual Report on Form 10-K as filed with the Securities and Exchange Commission.  We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this discussion and analysis.  All subsequent written or oral forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements.  The forward-looking statements included in this filing are made only as of the date of this filing.  We do not intend, and undertake no obligation, to update these forward-looking statements.

 

Certain reclassifications have been made to prior years results to conform with 2003 presentations. Such reclassifications had no effect on our results of operations or stockholders’ equity.

 

Critical Accounting Policies

 

Marketable Equity Securities

 

Investments in marketable equity securities include warrants for shares of publicly-traded companies and investments in shares of publicly-traded companies.  Equity securities in our warrant, direct equity, and venture capital fund portfolios generally become marketable when a portfolio company completes an initial public offering on a publicly-reported market, or is acquired by a publicly-traded company.  Our merchant banking marketable warrant and equity securities totaled $1.8 million at June 30, 2003 and $0.8 million at December 31, 2002.  Marketable equity securities relating to Taurus Growth Partners, L.P. and Libra Partners, L.P. totaled approximately $7.3 million.  Both Taurus Growth Partners, L.P. and Libra Partners, L.P., California limited partnerships, were formed to acquire, purchase, invest in, hold for investment, own, exchange, assign, sell or otherwise dispose of, trade in, lend, lease, mortgage, pledge and otherwise deal in securities and other investment vehicles, including without limitation, various equity and fixed income security instruments.  We have a controlling ownership interest of less than 1% in each of these funds.  These instruments are classified as available-for-sale and are accounted for at fair value.  We recognized gains from the disposition of client warrants in our consolidated statements of income of $1.1 million and $3.0 million for the three and six months ended June 30, 2003, and $0.7 million and $0.8 million for the respective periods ended June 30, 2002.

 

 

23



 

 

Unrealized gains or losses on warrant and equity investment securities are recorded upon the establishment of a readily determinable fair value of the underlying security, as defined by Statement of Financial Accounting Standard (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Instruments.”

 

1.          Unrealized gains or losses after applicable taxes on available-for-sale marketable equity securities that result from initial public offerings are excluded from earnings and are reported in accumulated other comprehensive income, which is a separate component of stockholders’ equity.  We are often contractually restricted from selling equity securities subsequent to a portfolio company’s initial public offering.  Gains or losses on these marketable equity instruments are recorded in our consolidated statements of income in the period the underlying securities are sold to a third party.

 

2.          Gains or losses on marketable warrant and equity investment securities that result from a portfolio company being acquired by a publicly-traded company are marked to market when the acquisition occurs.  The resulting gains or losses are recognized into income on that date, in accordance with Emerging Issues Task Force, Issue No. 91-5, “Nonmonetary Exchange of Cost-Method Investments.”  Further temporary fluctuations in the market value of these marketable equity instruments, prior to eventual sale, are excluded from earnings and are reported in accumulated other comprehensive income, which is a separate component of stockholders’ equity.  Upon the sale of these equity securities to a third party, gains and losses, which are measured from the acquisition price, are recognized in our consolidated statements of income.

 

Notwithstanding the foregoing, a decline in the fair value of any of these securities that is considered other than temporary is recorded in our consolidated statements of income in the period the impairment occurs.  The cost basis of the underlying security is written down to fair value as a new cost basis.

 

We consider our marketable equity securities accounting policies to be critical, as the timing and amount of income, if any, from these instruments typically depend upon factors beyond our control.  These factors include the general condition of the public equity markets, levels of mergers and acquisitions activity, fluctuations in the market prices of the underlying common stock of these companies, and legal and contractual restrictions on our ability to sell the underlying securities.  We are typically contractually precluded from taking steps to secure the current unrealized gains of $1.8 million associated with our warrant portfolio.  Hence, the amount of income we realize from these equity instruments in future periods may vary materially from the current unrealized amount due to fluctuations in the market prices of the underlying common stock of these companies.

 

Non-Marketable Equity Securities

 

We invest in non-marketable equity securities in several ways:

 

                  Through the exercise of warrants obtained in the normal course of lending

                  By direct purchases of preferred or common stock in privately held companies

 

 

24



 

                  By capital contributions to venture capital funds, which in turn, make investments in preferred or common stock of privately held companies

                  Through our venture capital fund, Silicon Valley BancVentures, L.P., which makes investments in preferred or common stock of privately held companies

                  Through our fund of funds, SVB Strategic Investors Fund, L.P., which makes investments in venture capital funds, which in turn invest in privately held companies

 

Unexercised warrant securities are recorded at a nominal value on our consolidated balance sheets.  They are carried at this value until they become marketable or expire.

 

A summary of our accounting policies for other non-marketable equity securities is presented in the following table.  A complete description of the accounting policies follows the table.

 

 

 

Private Equity and Venture

Capital Fund Investments

 

 

 

 

 

Wholly-Owned by Silicon

 

Cost Basis Less Identified Impairment, If Any

 

 

 

 

 

Owned by Silicon Valley BancVentures, L.P. and SVB Strategic Investors Fund, L.P.

 

Investment Accounting, Adjust To Fair Value On A Quarterly Basis Through The Statement Of Income

 

 

Non-marketable venture capital fund investments and other direct private equity investments wholly-owned by Silicon totaled $30.7 million at June 30, 2003 and $31.6 million at December 31, 2002 (excluding our ownership interest in our managed funds, SVB Strategic Investors Fund, L.P. and Silicon Valley BancVentures, L.P., which are described below.)  We record these investments on a cost basis as our interests are considered minor because we own less than 5% of the company and have no influence over the companys’ operating and financial policies.  Our cost basis in each investment is reduced by returns until the cost basis of the individual investment is fully recovered.  Returns in excess of the cost basis are recorded as investment gains in noninterest income.

 

The values of the non-marketable venture capital fund investments and other direct private equity investments are reviewed at least quarterly, giving consideration to the facts and circumstances of each individual investment.  Management’s review of these equity investments typically includes the relevant market conditions, offering prices, operating results, financial conditions, and exit strategies.  A decline in the fair value that is considered other than temporary is recorded in our consolidated statements of income in the period the impairment occurs.  Any estimated loss is recorded in noninterest income as investment losses.

 

Investments held by Silicon Valley BancVentures, L.P. totaled $10.3 million at June 30, 2003 and $10.0 million at December 31, 2002 and are recorded at fair value using investment accounting rules.  The investments consist of stock in private companies that are not traded on a public market and are subject to restrictions on resale.  These investments are carried at estimated fair value as determined by the general partner, Silicon Valley BancVentures, Inc.  The valuation generally remains at cost until such time that there is significant evidence of a change in values based upon consideration of the relevant market conditions, offering prices, operating results, financial conditions, exit strategies, and other pertinent information. Silicon Valley BancVentures, Inc. is owned and controlled by Silicon and has an ownership interest of 10.7% in

 

 

25



 

 

Silicon Valley BancVentures, L.P.  Therefore, Silicon Valley BancVentures, L.P. is fully consolidated and any gains or losses resulting from changes in the estimated fair value of the investments are recorded as investment gains or losses in our consolidated statements of income.  The portion of any gains or losses belonging to the limited partners is reflected in minority interest and adjusts Silicon’s income to its percentage ownership.

 

The SVB Strategic Investors Fund, L.P. portfolio consists primarily of investments in venture capital funds.  These funds totaled $23.2 million at June 30, 2003 and $22.1 million at December 31, 2002, and are recorded at fair value using investment accounting rules.  The carrying value of the investments is determined by the general partner, SVB Strategic Investors, LLC, based on the percentage of SVB Strategic Investors Fund, L.P.’s interest in the total fair market value as provided by each venture capital fund investment.  SVB Strategic Investors, LLC generally utilizes the fair values assigned to the underlying portfolio investments by the management of the venture capital funds.  The estimated fair value of the investments is determined after giving consideration to the relevant market conditions, offering prices, operating results, financial conditions, exit strategy, and other pertinent information.  SVB Strategic Investors, LLC, is owned and controlled by Silicon and has an ownership interest of 11.1% in SVB Strategic Investors Fund, L.P.  Therefore, SVB Strategic Investors Fund, L.P. is fully consolidated and any gains or losses resulting from changes in the estimated fair value of the venture capital fund investments are recorded as investment gains or losses in our consolidated statements of income.  The limited partner’s share of any gains or losses is reflected in minority interest and adjusts Silicon’s income to its percentage ownership.

 

Please refer to “Part 1. Financial Information — Item 1. Notes to the Interim Consolidated Financial Statements — Note 3 to the Consolidated Financial Statements — Investments,” for the carrying value of our non-marketable venture capital and other private equity investments at June 30, 2003.

 

We consider our non-marketable equity securities accounting policies to be critical, as the timing and amount of gain or losses, if any, from these instruments depend upon factors beyond our control.  These factors include the general condition of the public equity markets, levels of mergers and acquisitions activity, and legal and contractual restrictions on our ability to sell the underlying securities.  Therefore, we cannot predict future gains or losses with any degree of accuracy and any gains or losses are likely to vary materially from period to period.  In addition, the valuation of non-marketable equity securities included in our financial statements at June 30, 2003 represents our best interpretation of the underlying equity securities performance at that time.  Because of the inherent uncertainty of valuations, the estimated values of these securities may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material.  Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s carrying value, thereby possibly requiring an impairment charge in the future.

 

Allowance for Loan Losses

 

We consider our accounting policy relating to the estimation of the allowance for loan losses to be critical as it involves material estimates by our management and is particularly susceptible to significant changes in the near term.

 

 

26



 

 

We define credit risk as the probability of sustaining a loss because other parties to the financial instrument fail to perform in accordance with the terms of the contract.  Through the administration of loan policies and monitoring of the loan portfolio, our management seeks to reduce such credit risks.  While we follow underwriting and credit monitoring procedures, which we believe are appropriate in growing and managing the loan portfolio, in the event of nonperformance by these other parties, our potential exposure to credit losses could significantly affect our consolidated financial position and earnings.

 

The allowance for loan losses is established through a provision for loan losses charged to expense to provide for credit risk.  Our allowance for loan losses is established for loan losses not yet realized.  The process of anticipating loan losses is imprecise.  Our management applies the following evaluation process to our loan portfolio to estimate the required allowance for loan losses.

 

We maintain a systematic process for the evaluation of individual loans and pools of loans for inherent risk of loan losses.  On a quarterly basis, each loan in our portfolio is assigned a credit risk-rating.  Credit risk-ratings are assigned on a scale of 1 to 10, with 1 representing loans with a low risk of nonpayment, 9 representing loans with the highest risk of nonpayment, and 10 representing loans which have been charged-off.  This credit risk-rating evaluation process includes, but is not limited to, consideration of factors such as payment status, the financial condition of the borrower, borrower compliance with loan covenants, underlying collateral values, potential loan concentrations, and general economic conditions.  Our policies require a committee of senior management to review credit relationships that exceed specific dollar values, at least quarterly.  Our review process evaluates the appropriateness of the credit risk rating and allocation of allowance for loan losses, as well as other account management functions.  In addition, our management receives and approves an analysis for all impaired loans, as defined by the Statement of Financial Accounting Standards (“SFAS”) No. 114 “Accounting by Creditors for Impairment of a Loan.”  The allowance for loan losses is calculated based on a formula allocation for similarly risk-rated loans, or for specific risk issues, which suggest a probable loss factor exceeding the formula allocation for a specific loan, or for individual impaired loans as determined by SFAS No. 114.

 

Our evaluation process was designed to determine the adequacy of the allowance for loan losses.  We assess the risk of losses inherent in the loan portfolio by utilizing modeling techniques.  For this purpose, we have developed a statistical model based on historical loan loss migration to estimate an appropriate allowance for outstanding loan balances.  In addition, we apply macro allocations to the results of the aforementioned model to ascertain the total allowance for loan losses.  While this evaluation process uses historical and other objective information, the classification of loans and the establishment of the allowance for loan losses, relies, to a great extent, on the judgment and experience of our management.

 

Historical Loan Loss Migration Model

 

We use the historical loan loss migration model as a basis for determining expected loan loss factors by credit risk-rating category.  The effectiveness of the historical loan loss migration model is predicated on the theory that historical trends are predictive of future experience.  Specifically, the model calculates the likelihood and rate of a loan in one risk-rating category moving one category lower using loan data from our portfolio.

 

 

27



 

 

We analyze the historical loan loss migration trend by compiling gross loan loss data and by credit risk rating for the four-quarter period preceding the current period end.  Each of the loans charged-off over the four-quarter period is assigned a credit risk rating at the end of each of the preceding quarters.  On a quarter-by-quarter basis, the model calculates charged-off loans as a percentage of current period-end loans by credit risk rating category.  These percentages are weighted, based on the age of the data, and are aggregated to estimate our loan loss factors.  These expected loan loss factors are ultimately applied to the current period end aggregate outstanding loan balances to provide an estimation of the allowance for loan losses.

 

Macro Allocations

 

Additionally, we apply a contingent allocation to the results of this model.  Our contingent allocation acknowledges that unfunded credit obligations can result in future losses.  Unfunded credit obligations at each quarter end are allocated to credit risk rating categories in accordance with the client’s credit risk-rating.  We provide for the risk of loss on unfunded credit obligations by allocating fixed credit risk-rating factors to our unfunded credit obligations.

 

A macro allocation is calculated each quarter based upon an assessment of the risks that may lead to a loan loss experience different from our historical results.  These risks are aggregated to become our macro allocation.  Based on management’s prediction or estimates of changing risks in the lending environment, the macro allocation may vary significantly from period to period and includes but is not limited to consideration of the following factors:

 

(1)                       Changes in lending policies and procedures, including underwriting standards and collections, charge-off and recovery practices

(2)                       Changes and development in national and local economic business conditions, including the market and economic condition of our clients’ industry sectors

(3)                       Changes in the nature of our loan portfolio

(4)                       Changes in experience, ability and depth of lending management and staff

(5)                       Changes in the trend of the volume and severity of past due and classified loans

(6)                       Changes in the trend of the volume of nonaccrual loans, troubled debt restructurings and other loan modifications

 

Finally, we compute several modified versions of the model, which provide additional assurance that the statistical results of the historical loan loss migration model are reasonable.  Our Chief Credit Officer and Chief Financial Officer evaluate the adequacy of the allowance for loan losses based on the results of the historical loan loss migration model.

 

In addition to risk-rating every loan in our portfolio, our management concluded that our allowance for loan and lease losses at June 30, 2003 was appropriate in consideration of the following factors:

 

(1)           The past due and nonaccrual loans are performing at satisfactory levels

(2)           A decreased risk of loan losses resulting from client instigated corporate fraud, due to the enforcement of recent government corporate governance regulations

 

 

28



 

(3)           An increase of $78.1 million in our year-to-date average loan balances between December 31, 2002 and June 30, 2003.

(4)           A continued weakness in the U.S. economy

(5)           Weakness in venture capital fund investment into our clients in our core industry sectors

 

We consider our allowance for loan losses at June 30, 2003 to be adequate but not excessive and to be our best estimate using the historical loan loss experience and our perception of variables potentially leading to deviation from the historical loss experience.  However, future changes in circumstances, economic conditions or other factors could cause us to increase or decrease the allowance for loan losses as deemed necessary. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses.  Such agencies may require us to make adjustments to the allowance for loan losses based on their judgment of information available to them at the time of their examination.

 

Goodwill

 

As discussed in Note 1 (Significant Accounting Policies) to the Consolidated Financial Statements in the Company’s 2002 Annual Report on Form 10-K, we account for intangibles in accordance with the provisions of Statement of Financial Accounting Standard No. 142 (“SFAS No.142”), “Goodwill and Other Intangible Assets.”  Under this standard, we are required to test intangible assets identified as having an indefinite useful life for impairment on an annual basis. During the three months ended June 30, 2003, we recognized an impairment expense of $17.0 million related to goodwill.

 

SFAS No. 142, “Goodwill and Other Intangible Assets,” is the authoritative standard on the accounting for the impairment of goodwill.  SFAS No. 142 requires that we evaluate on an annual basis (or whenever events occur which may indicate possible impairment) whether any portion of our recorded goodwill is impaired. We performed this analysis at the “reporting unit” level as defined in SFAS No. 142. As discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2002, this analysis requires management to make a series of critical assumptions to: (1) evaluate whether any impairment exists, and (2) measure the amount of impairment.  As part of this analysis, SFAS No. 142 requires that we estimate the fair value of our reporting units and compare it with their carrying value. If the estimated fair value of a reporting unit is less than the carrying value, then impairment is deemed to have occurred. In estimating the fair value of our reporting units, we primarily used the income approach (which utilizes forecasted discounted cash flows to estimate the fair value of the reporting unit) and the market approach (which estimates fair value based on market prices for comparable companies).

 

We conducted our annual valuation analysis of the Alliant Partners reporting unit as of the end of the second quarter of 2003. We concluded at that time that we had an impairment of goodwill based on our market approach valuation and forecasted discounted cash flows for that reporting unit.  As required by SFAS No. 142, in measuring the amount of goodwill impairment, we made a hypothetical allocation of the reporting unit’s estimated fair value to the tangible and intangible assets (other than goodwill) of the reporting units. Based on this allocation, we concluded that $17.0 million of the related goodwill was impaired and was required to be expensed as a noncash charge to continuing operations during the second quarter of 2003. Thus the goodwill balance

 

 

29



 

 

 related to Alliant Partners was reduced from $98.6 million at December 31, 2002 to $81.6 million at June 30, 2003.

 

If Alliant Partners does not meet the most recent projected revenues targets, or if certain key employees were to leave Alliant Partners, we could conclude that the value of the business has decreased and that goodwill relating to Alliant Partners has been further impaired. If we were to conclude that goodwill has been further impaired, that conclusion could result in a non-cash goodwill impairment charge to us, which would adversely affect our results of operations.

 

Earnings Summary

 

We reported net losses of $0.6 million, or $(0.02) per diluted common share, for the second quarter of 2003, compared with net income of $15.0 million, or $0.32 per diluted common share, for the second quarter of 2002.  Net income totaled $9.8 million, or $0.25 per diluted common share, for the six months ended June 30, 2003, versus $28.3 million or $0.61 per diluted common share, for the respective 2002 period.  The annualized return on average assets (ROA) was (0.1)% in the second quarter of 2003 compared with 1.6% in the second quarter of 2002.  The annualized return on average equity (ROE) for the second quarter of 2003 was (0.4)%, compared with 9.3% in the second quarter of 2002.  For the first six months of 2003, ROA was 0.5% and ROE was 3.6% versus 1.5% and 8.9%, respectively for the comparable prior year period.

 

The major components of net income and changes in these components are summarized in the following table, and are discussed in more detail below.

 

 

 

For the Three Months

 

%

 

For the Six Months

 

%

 

 

 

Ended June 30

 

Increase/

 

Ended June 30

 

Increase/

 

(Dollars in thousands)

 

2003

 

2002

 

(Decrease)

 

2003

 

2002

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

46,700

 

$

49,073

 

(4.8%

)

$

94,678

 

$

98,075

 

(3.5%

)

Provision for loan losses

 

1,162

 

(3,207

)

136.2

 

4,546

 

219

 

1,975.8

 

Noninterest income

 

17,505

 

18,854

 

(7.2

)

34,951

 

35,755

 

(2.2

)

Noninterest expense

 

67,203

 

49,018

 

37.1

 

117,311

 

92,336

 

27.0

 

Minority interest

 

2,765

 

1,397

 

97.9

 

6,244

 

3,237

 

92.9

 

(Loss) income before income taxes

 

(1,395

)

23,513

 

(105.9

)

14,016

 

44,512

 

(68.5

)

Income tax (benefit) expense

 

(819

)

8,528

 

(109.6

)

4,174

 

16,167

 

(74.2

)

Net (loss) income

 

$

(576

)

$

14,985

 

(103.8%

)

$

9,842

 

$

28,345

 

(65.3%

)

 

 

30



 

 

A major reason for the decrease in net income for the second quarter and six months ended June 30, 2003 compared to the comparable 2002 periods was the $17.0 million impairment of goodwill recognized in the second quarter of 2003.  Please see “Part 1. Financial Information — Item 1. Notes to the Interim Consolidated Financial Statements — Note 5 to the Consolidated Financial Statements — Goodwill” for further discussion.  Additionally, the decrease in net income for the second quarter of 2003 as compared with the second quarter of 2002, resulted from a decline in net interest income and an increase in provision for loan losses.  The decrease in net income for the six months ended June 30, 3003, as compared to the six months ended June 30, 2002, resulted primarily from the same factors, as well as an increase in other components of noninterest expense.

 

Net Interest Income and Margin

 

Net interest income is defined as the difference between interest earned, primarily on loans, investment securities, federal funds sold, and securities purchased under agreement to resell, and interest paid on funding sources, primarily deposits.  Net interest income is our principal source of revenue.  Net interest margin is defined as the amount of annualized net interest income, on a fully taxable-equivalent basis, expressed as a percentage of average interest-earning assets.  The average yield earned on interest-earning assets is the amount of annualized taxable-equivalent interest income expressed as a percentage of average interest-earning assets.  The average rate paid on funding sources is defined as annualized interest expense as a percentage of average interest-earning assets.

 

The following table sets forth average assets, liabilities, minority interest, stockholders’ equity, interest income, interest expense, annualized yields and rates, and the composition of our annualized net interest margin for the three and six months ended June 30, 2003 and 2002, respectively.

 

 

31



 

AVERAGE BALANCES, RATES AND YIELDS

 

 

 

For the three months ended June 30,

 

 

 

2003

 

2002

 

 

 

 

 

Interest

 

 

 

 

 

Interest

 

 

 

 

 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

(Dollars in thousands)

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds sold andsecurities purchased underagreement to resell (1)

 

$

345,163

 

$

1,129

 

1.3

%

$

122,718

 

$

591

 

1.9

%

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

1,151,524

 

8,557

 

3.0

 

1,438,209

 

11,752

 

3.3

 

Non-taxable (2)

 

143,506

 

2,440

 

6.8

 

172,165

 

2,640

 

6.2

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

1,528,983

 

34,557

 

9.1

 

1,477,767

 

35,983

 

9.8

 

Real estate construction and term

 

104,887

 

1,520

 

5.8

 

104,657

 

1,931

 

7.4

 

Consumer and other

 

190,664

 

2,057

 

4.3

 

142,890

 

1,738

 

4.9

 

Total loans

 

1,824,534

 

38,134

 

8.4

 

1,725,314

 

39,652

 

9.2

 

Total interest-earning assets

 

3,464,727

 

50,260

 

5.8

 

3,458,406

 

54,635

 

6.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

193,709

 

 

 

 

 

185,545

 

 

 

 

 

Allowance for loan losses

 

(72,436

)

 

 

 

 

(73,641

)

 

 

 

 

Goodwill

 

100,386

 

 

 

 

 

97,365

 

 

 

 

 

Other assets

 

203,991

 

 

 

 

 

185,860

 

 

 

 

 

Total assets

 

$

3,890,377

 

 

 

 

 

$

3,853,535

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

$

26,897

 

31

 

0.5

 

$

40,836

 

60

 

0.6

 

Regular money market deposits

 

277,872

 

424

 

0.6

 

289,130

 

713

 

1.0

 

Bonus money market deposits

 

634,365

 

946

 

0.6

 

611,219

 

1,528

 

1.0

 

Time deposits

 

522,807

 

989

 

0.8

 

608,726

 

1,861

 

1.2

 

Short-term borrowings

 

9,450