SVB Financial Group
SILICON VALLEY BANCSHARES (Form: 10-Q, Received: 11/14/2003 16:44:38)

 

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 September 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: 000-15637

 

SILICON VALLEY BANCSHARES

(Exact name of registrant as specified in its charter)

 

Delaware

 

91-1962278

(State or other jurisdiction of
incorporation or organization)

 

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

 

 

 

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 October 31, 2003, 34,729,225 shares of the registrant’s common stock ($0.001 par value) were outstanding.

 

 



 

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION

 

 

 

ITEM 1.

INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

 

CONSOLIDATED BALANCE SHEETS

 

 

 

 

 

CONSOLIDATED STATEMENTS OF INCOME

 

 

 

 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

 

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

 

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

 

 

 

ITEM 4.

CONTROLS AND PROCEDURES

 

 

 

PART II - OTHER INFORMATION

 

 

 

ITEM 1.

LEGAL PROCEEDINGS

 

 

 

 

ITEM 2.

CHANGES IN SECURITIES AND USE OF PROCEEDS

 

 

 

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

 

 

 

 

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

 

 

 

ITEM 5.

OTHER INFORMATION

 

 

 

 

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

 

 

 

 

SIGNATURES

 

 

2



 

PART I - FINANCIAL INFORMATION

 

ITEM 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED BALANCE SHEETS

 

(Dollars in thousands, except par value)

 

September 30,
2003

 

December 31,
2002

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

Cash and due from banks

 

$

229,001

 

$

239,927

 

Federal funds sold and securities purchased under agreement to resell

 

476,949

 

202,662

 

Investment securities

 

1,522,084

 

1,535,694

 

Loans, net of unearned income

 

1,911,932

 

2,086,080

 

Allowance for loan losses

 

(67,500

)

(70,500

)

Net loans

 

1,844,432

 

2,015,580

 

Premises and equipment

 

15,036

 

17,886

 

Goodwill

 

83,548

 

100,549

 

Accrued interest receivable and other assets

 

88,766

 

70,883

 

Total assets

 

$

4,259,816

 

$

4,183,181

 

 

 

 

 

 

 

Liabilities, minority interest, and stockholders’ equity:

 

 

 

 

 

Liabilities:

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing demand

 

$

1,875,684

 

$

1,892,125

 

NOW

 

21,586

 

21,531

 

Money market

 

1,113,983

 

933,255

 

Time

 

461,073

 

589,216

 

Total deposits

 

3,472,326

 

3,436,127

 

Short-term borrowings

 

9,054

 

9,127

 

Other liabilities

 

82,251

 

47,550

 

Long-term debt

 

154,377

 

17,397

 

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

 

38,731

 

 

Total liabilities

 

3,756,739

 

3,510,201

 

 

 

 

 

 

 

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

 

 

39,472

 

Minority interest

 

47,971

 

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; 34,595,541 and 40,578,093 shares outstanding at September 30, 2003 and December 31, 2002, respectively

 

35

 

41

 

Additional paid-in capital

 

5,453

 

99,979

 

Retained earnings

 

437,428

 

476,610

 

Unearned compensation

 

(1,411

)

(652

)

Accumulated other comprehensive income:

 

 

 

 

 

Net unrealized gains on available-for-sale investments

 

13,601

 

14,372

 

Total stockholders’ equity

 

455,106

 

590,350

 

Total liabilities, minority interest, and stockholders’ equity

 

$

4,259,816

 

$

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 September 30,

 

For the nine months ended September 30,

 

(Dollars in thousands, except per share amounts)

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

 

 

Loans

 

$

36,440

 

$

39,382

 

$

112,410

 

$

117,359

 

Investment securities

 

12,107

 

11,877

 

34,223

 

41,160

 

Federal funds sold and securities purchased under agreement to resell

 

1,204

 

1,251

 

3,163

 

2,087

 

Total interest income

 

49,751

 

52,510

 

149,796

 

160,606

 

Interest expense:

 

 

 

 

 

 

 

 

 

Deposits

 

2,196

 

3,848

 

7,036

 

12,908

 

Other borrowings

 

1,281

 

476

 

1,808

 

1,437

 

Total interest expense

 

3,477

 

4,324

 

8,844

 

14,345

 

Net interest income

 

46,274

 

48,186

 

140,952

 

146,261

 

Provision for loan losses

 

(7,449

)

2,630

 

(2,903

)

2,849

 

Net interest income after provision for loan losses

 

53,723

 

45,556

 

143,855

 

143,412

 

Noninterest income:

 

 

 

 

 

 

 

 

 

Client investment fees

 

5,793

 

7,416

 

18,159

 

23,828

 

Corporate finance fees

 

2,737

 

1,176

 

11,522

 

8,562

 

Letter of credit and foreign exchange income

 

3,419

 

4,354

 

10,050

 

11,706

 

Deposit service charges

 

3,567

 

2,253

 

9,688

 

6,783

 

Income from client warrants

 

1,518

 

443

 

4,531

 

1,250

 

Credit card fees

 

638

 

573

 

2,672

 

922

 

Investment gains (losses)

 

1,317

 

(2,063

)

(7,227

)

(6,661

)

Other

 

2,351

 

2,111

 

6,896

 

5,628

 

Total noninterest income

 

21,340

 

16,263

 

56,291

 

52,018

 

Noninterest expense:

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

32,472

 

27,246

 

93,176

 

80,995

 

Impairment of goodwill

 

 

 

17,000

 

 

Net occupancy

 

4,614

 

4,459

 

13,119

 

15,410

 

Professional services

 

2,378

 

4,613

 

9,802

 

12,016

 

Furniture and equipment

 

2,654

 

2,316

 

7,558

 

5,983

 

Business development and travel

 

1,874

 

1,872

 

5,786

 

5,928

 

Data processing services

 

926

 

1,199

 

3,409

 

2,982

 

Correspondent bank fees

 

1,075

 

754

 

3,209

 

2,068

 

Telephone

 

707

 

766

 

2,342

 

2,368

 

Tax credit fund amortization

 

712

 

835

 

2,143

 

2,121

 

Postage and supplies

 

590

 

678

 

1,806

 

2,253

 

Trust preferred securities distributions

 

 

334

 

594

 

1,905

 

Other

 

802

 

1,026

 

6,171

 

4,405

 

Total noninterest expense

 

48,804

 

46,098

 

166,115

 

138,434

 

Minority interest

 

7

 

2,300

 

6,251

 

5,537

 

Income before income taxes

 

26,266

 

18,021

 

40,282

 

62,533

 

Income tax expense

 

8,837

 

4,925

 

13,011

 

21,092

 

Net income

 

$

17,429

 

$

13,096

 

$

27,271

 

$

41,441

 

Net income per common share - basic

 

$

0.51

 

$

0.30

 

$

0.74

 

$

0.92

 

Net income per common share - diluted

 

$

0.49

 

$

0.29

 

$

0.72

 

$

0.90

 

 

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 nine months ended

 

(Dollars in thousands)

 

September 30,
2003

 

September 30,
2002

 

September 30,
2003

 

September 30,
2002

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

17,429

 

$

13,096

 

$

27,271

 

$

41,441

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

Change in unrealized gains on available-for-sale investments:

 

 

 

 

 

 

 

 

 

Unrealized holding gains

 

2,425

 

3,056

 

2,296

 

5,762

 

Reclassification adjustment for gains included in net income

 

(1,007

)

(322

)

(3,067

)

(828

)

Other comprehensive income (loss), net of tax

 

1,418

 

2,734

 

(771

)

4,934

 

Comprehensive income

 

$

18,847

 

$

15,830

 

$

26,500

 

$

46,375

 

 

See notes to interim consolidated financial statements.

 

5



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

For the nine months ended

 

(Dollars in thousands)

 

September 30,
2003

 

September 30,
2002

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

27,271

 

$

41,441

 

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

 

 

 

 

 

Impairment of goodwill

 

17,000

 

 

Provision for loan losses

 

(2,903

)

2,849

 

Minority interest

 

(6,251

)

(5,537

)

Depreciation and amortization

 

5,641

 

5,277

 

Net loss on available for sale securities

 

7,227

 

6,661

 

Net gains on disposition of client warrants

 

(4,531

)

(1,250

)

Changes in other assets and liabilities:

 

 

 

 

 

(Increase) decrease in accrued interest receivable

 

(1,044

)

4,615

 

Decrease in taxes receivable

 

 

12,856

 

Increase in taxes payable

 

3,007

 

 

Increase in accrued retention, warrant, and other incentive plans

 

7,512

 

3,491

 

Other, net

 

13,839

 

4,862

 

Net cash provided by operating activities

 

66,768

 

75,265

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities and paydowns of investment securities

 

1,580,656

 

2,523,476

 

Proceeds from sales of investment securities

 

11,248,631

 

24,406

 

Purchases of investment securities

 

(12,822,891

)

(2,034,120

)

Net decrease (increase) in loans

 

156,771

 

(141,745

)

Proceeds from recoveries of charged-off loans

 

16,734

 

21,079

 

Purchases of premises and equipment

 

(2,791

)

(2,938

)

Net cash provided by investing activities

 

177,110

 

390,158

 

Cash flows from financing activities:

 

 

 

 

 

Net increase (decrease) in deposits

 

36,199

 

(285,587

)

Decrease in short-term borrowings

 

 

(32,145

)

Decrease in long-term debt

 

(8,631

)

(8,429

)

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

 

123,493

 

 

Capital contributions from minority interest participants

 

10,012

 

9,730

 

Proceeds from issuance of common stock

 

6,502

 

8,169

 

Repurchases of common stock

 

(148,092

)

(63,661

)

Net cash provided (used) by financing activities

 

19,483

 

(371,923

)

Net increase in cash and cash equivalents

 

263,361

 

93,500

 

Cash and cash equivalents at January 1,

 

442,589

 

440,532

 

Cash and cash equivalents at September 30,

 

$

705,950

 

$

534,032

 

Supplemental disclosures:

 

 

 

 

 

Interest paid

 

$

9,049

 

$

14,716

 

Income taxes paid

 

$

14,626

 

$

6,799

 

 

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

 

Silicon Valley Bancshares and its subsidiaries (the “Company”) offers its clients financial products and services including commercial, investment, merchant and private banking, and private equity services, as well as value-added services using its knowledge and networks.  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 28 regional offices.  The Bank has 13 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.  Merger, acquisition, private placement and corporate partnering services are provided through its wholly-owned investment banking subsidiary, Alliant Partners (“Alliant”), whose offices are in Northern California and Boston.

 

The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America.  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 September 30, 2003, there have been no significant changes to these policies, except as included herein.

 

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 September 30, 2003, the interim results of its operations for the three and nine months ended September 30, 2003 and September 30, 2002 and interim cash flow for the nine months ended September 30, 2003 and September 30, 2002. The December 31, 2002, Consolidated Balance Sheet was derived from audited financial statements.  Certain information and footnote disclosures normally presented have been omitted from this report. The results of operations for the three and nine months ended September 30, 2003, may not necessarily be indicative of the Company’s operating results for the full year.  The interim Consolidated 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.

 

7



 

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.”

 

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

 

 

 

For the three months ended
September 30,

 

For the nine months ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Dollars in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

Net income, as reported

 

$

17,429

 

$

13,096

 

$

27,271

 

$

41,441

 

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

 

103

 

130

 

494

 

529

 

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

 

(3,134

)

(4,171

)

(11,682

)

(14,243

)

Net income, pro-forma

 

$

14,398

 

$

9,055

 

$

16,083

 

$

27,727

 

 

 

 

 

 

 

 

 

 

 

Basic income per share:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.51

 

$

0.30

 

$

0.74

 

$

0.92

 

Pro-forma

 

0.40

 

0.21

 

0.44

 

0.64

 

Diluted income per share:

 

 

 

 

 

 

 

 

 

As reported

 

0.49

 

0.29

 

0.72

 

0.90

 

Pro-forma

 

0.40

 

0.21

 

0.45

 

0.65

 

 

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 a 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 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.

 

8



 

In October 2003, FASB Staff Position FIN 46-6, “Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities , ” delayed the implementation date of Interpretation No. 46 for VIEs that existed prior to February 1, 2003, provided that the reporting entity has not issued financial statements reporting the variable interest entities in accordance with Interpretation No. 46.  The Company is required to complete its evaluation of VIEs and consolidate those VIEs where the Company is a primary beneficiary, in its financial statements issued for the interim and annual periods ending after December 15, 2003.  As of September 30, 2003, the Company has not consolidated any VIEs in its financial statements per FIN 46.  The Company does not expect implementation of FIN 46 to have a significant impact on its results of operations or financial condition.

 

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 adoption of SFAS No. 149 has had no material impact 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 September 30, 2003, the Company had $38.7 million in “Company Mandatorily Redeemable Trust Preferred Securities of Subsidiary Trust Holding Solely Junior Subordinated Debentures,” or 8.25% Trust Preferred Securities outstanding.  Beginning in the quarter ended September 30, 2003, under SFAS No. 150, the 8.25% Trust Preferred Securities were classified under the liabilities section of the Consolidated Balance Sheet and 8.25% Trust Preferred Securities distribution expense was classified under interest expense on the Consolidated Statements of Income.  Prior to adoption of SFAS No. 150, these securities were classified between the liability and equity sections of the Company’s Interim Consolidated Balance Sheets, and their related expense was classified as noninterest expense on the Company’s Interim Consolidated Statements of Income, under the heading “Trust preferred securities distributions.”  Other than the aforementioned reclassification, SFAS No. 150 did not have a material impact on the Company’s results of operations or financial condition.

 

9



 

2.  Earnings Per Share (EPS)

 

The following is a reconciliation of basic EPS to diluted EPS for the three and nine months ended September 30, 2003 and 2002:

 

 

 

For the three months ended
September 30,

 

For the nine months ended
September 30,

 

(Dollars and shares in thousands,
except per share amounts)

 

Net
Income

 

Shares

 

Per Share
Amount

 

Net
Income

 

Shares

 

Per Share
Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2003:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders

 

$

17,429

 

34,205

 

$

0.51

 

$

27,271

 

36,661

 

$

0.74

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options and restricted stock

 

 

1,143

 

 

 

970

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders plus assumed conversions

 

$

17,429

 

35,348

 

$

0.49

 

$

27,271

 

37,631

 

$

0.72

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2002:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders

 

$

13,096

 

43,993

 

$

0.30

 

$

41,441

 

44,849

 

$

0.92

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options and restricted stock

 

 

895

 

 

 

1,242

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders plus assumed conversions

 

$

13,096

 

44,888

 

$

0.29

 

$

41,441

 

46,091

 

$

0.90

 

 

3.  Investment Securities

 

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

 

(Dollars in thousands)

 

September 30,
2003

 

December 31,
2002

 

 

 

 

 

 

 

Available-for-sale securities, at fair value

 

$

1,428,800

 

$

1,444,231

 

Non-marketable investment securities:

 

 

 

 

 

Federal Reserve Bank stock and tax credit funds

 

24,579

 

25,649

 

Federal Home Loan Bank stock

 

2,979

 

2,172

 

Venture capital fund investments

 

50,961

 

46,822

 

Private equity investments

 

14,765

 

16,820

 

Total investment securities

 

$

1,522,084

 

$

1,535,694

 

 

10



 

The following tables present the carrying value of the Company’s non-marketable venture capital and other private equity investments at and for the nine months ended September 30, 2003.  For the carrying value of the Company’s non-marketable venture capital and other private equity investments at and for the year ended December 31, 2002, please refer to Item 7. Management’s Discussion and Analysis of Financial Condition (Critical Accounting Policies — Non-Marketable Equity Securities) in the Company’s 2002 Annual Report on Form 10-K.

 

 

 

(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

 

$

59,255

 

$

15,668

 

17,423

 

99,864

 

192,210

 

Capital investment

 

39,236

 

15,668

 

17,423

 

40,175

 

112,502

 

Carrying value (1)(2)

 

24,790

 

3,723

 

11,042

 

26,171

 

65,726

 

Net investment losses

 

(2,347

)

714

 

(1,716

)

(3,650

)

(6,999

)

 

 

 

(The Company’s ownership interest)

 

 

 

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

 

$

59,255

 

$

15,668

 

$

6,000

 

$

13,500

*

$

94,423

 

Capital investment

 

39,236

 

15,668

 

2,280

 

4,860

 

62,044

 

Carrying value (1)(2)

 

24,790

 

3,723

 

1,181

 

2,901

 

32,595

 

Net investment losses

 

(2,347

)

714

 

(183

)

(405

)

(2,221

)

Management fee revenue

 

 

 

812

 

741

 

1,553

 

 


(1)                     Non-marketable venture capital fund investments included $26.2 million and $22.1 million related to SVB Strategic Investors Fund, L.P., at September 30, 2003, and December 31, 2002, respectively.  The Company has a controlling ownership interest of 11.1% in the fund.  The Company’s ownership interest in non-marketable venture capital fund investments was $27.7 million and $27.2 million as of September 30, 2003 and December 31, 2002, respectively.

(2)                     Non-marketable private equity investments included $11.0 million and $10.0 million related to Silicon Valley BancVentures, L.P., at September 30, 2003, and December 31, 2002, respectively.  The Company has a controlling ownership interest of 10.7% in the fund.  The Company’s ownership interest in non-marketable other private equity investments was $4.9 million and $7.9 million as of September 30, 2003, and December 31, 2002, respectively.

 

*                            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.  Thus, the Company’s committed capital that can be called was reduced from $15.0 million to $13.5 million.

 

11



 

4.  Loans and Allowance for Loan Losses

 

The detailed composition of loans, net of unearned income of $12.3 million and $11.8 million, at September 30, 2003, and December 31, 2002, respectively, is presented in the following table:

 

(Dollars in thousands)

 

September 30,
2003

 

December 31,
2002

 

 

 

 

 

 

 

Commercial

 

$

1,640,237

 

$

1,756,182

 

Real estate construction

 

48,501

 

43,178

 

Real estate term

 

39,422

 

56,190

 

Consumer and other

 

183,772

 

230,530

 

Total loans

 

$

1,911,932

 

$

2,086,080

 

 

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

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

(Dollars in thousands)

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

69,500

 

$

76,000

 

$

70,500

 

$

72,375

 

Provision for loan losses

 

(7,449

)

2,630

 

(2,903

)

2,849

 

Loans charged off

 

(3,431

)

(7,713

)

(16,831

)

(22,502

)

Recoveries

 

8,880

 

2,883

 

16,734

 

21,078

 

Ending balance

 

$

67,500

 

$

73,800

 

$

67,500

 

$

73,800

 

 

The aggregate recorded investment in loans for which impairment has been determined in accordance with SFAS No. 114 totaled $12.6 million and $20.3 million at September 30, 2003, and September 30, 2002, respectively.  Allocations of the allowance for loan losses specific to impaired loans totaled $6.1 million at September 30, 2003, and $7.1 million at September 30, 2002.  Average impaired loans for the third quarter of 2003 and 2002 totaled $15.7 million and $18.2 million, respectively.

 

5.  Goodwill

 

The goodwill balance at September 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, and a minor portion relates to the acquisition of Woodside Asset Management, Inc.

 

In accordance with SFAS No. 142, the Company conducted its annual valuation analysis of the Woodside Asset Management, Inc. reporting unit during the third quarter of 2003.  Based on the results of this analysis, management concluded that the goodwill balance relating to Woodside Asset Management, Inc. was not impaired.

 

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 a market approach valuation and forecasted discounted cash flow analysis for that reporting unit.  As required by SFAS No.142 in measuring the goodwill impairment amount, 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 goodwill related to Alliant 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 $81.6 million at September 30, 2003, reduced from $98.6 million at December 31, 2002.

 

12



 

6.  Short-term Borrowings and Long-term Debt

 

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

 

(Dollars in thousands)

 

Maturity

 

September 30,
2003

 

December 31,
2002

 

 

 

 

 

 

 

 

 

Short-term borrowings (1)

 

September 28, 2003

 

$

 

$

9,127

 

Short-term borrowings (1)

 

September 28, 2004

 

9,054

 

 

Long-term debt:

 

 

 

 

 

 

 

Long-term note payable (1)

 

September 28, 2004

 

 

8,844

 

Long-term note payable (1)

 

September 28, 2005

 

8,766

 

8,553

 

Convertible subordinated notes

 

June 15, 2008

 

145,611

 

 

Total long-term debt

 

 

 

$

154,377

 

$

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 convertible into approximately 29.7374 shares of the Company’s common stock.  The Company filed 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 on August 14, 2003.  The fair value of the convertible subordinated notes at September 30, 2003 was $149.5 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 $51.34 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 September 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 September 30, 2003, the cost of the convertible

 

13



 

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

 

The swap met the criteria for the short cut treatment as defined in SFAS No. 133, thus, the benefit or expense was recorded in the period incurred.  This derivative agreement provided a benefit of $0.5 million for the nine months ended September 30, 2003, over the comparable prior year period.  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, upon a 40-day notification.  The Company assumed no ineffectiveness as the interest rate swap agreement met the short-cut method requirements under SFAS No. 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

 

The Company is organized 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 have resulted and may in the future result in changes in the Company’s allocation methodology as this process is under constant refinement.  In the event of such changes, results for prior periods have been and may be restated for comparability.  Results for the third quarter and first nine months of 2002 have been restated to reflect changes in the Company’s allocation methodology.

 

As of September 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 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.

 

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.

 

14



 

Segments included under Other 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.  Segments included under Other also contain necessary adjustments to reconcile segment data to Interim Consolidated Financial Statements.

 

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.

 

15



 

 

 

Commercial
Banking

 

Merchant
Banking

 

Investment
Banking

 

Other

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Third quarter of 2003

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

37,533

 

$

2,853

 

$

 

$

5,888

 

$

46,274

 

Provision for loan losses (1)

 

(5,448

)

 

 

(2,001

)

(7,449

)

Noninterest income (2)

 

14,056

 

3,716

 

2,737

 

831

 

21,340

 

Noninterest expense (3)

 

34,676

 

4,270

 

2,615

 

7,243

 

48,804

 

Minority interest

 

 

461

 

 

(454

)

7

 

Income before income taxes

 

22,361

 

2,760

 

122

 

1,023

 

26,266

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,460,829

 

54,289

 

 

222,669

 

1,737,787

 

Total average assets (4)

 

2,959,066

 

562,589

 

93,821

 

492,802

 

4,108,278

 

Total average deposits

 

2,661,014

 

538,970

 

 

157,998

 

3,357,982

 

 

 

 

 

 

 

 

 

 

 

 

 

Third quarter of 2002

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

37,534

 

$

2,622

 

$

 

$

8,030

 

$

48,186

 

Provision for loan losses (1)

 

4,801

 

 

 

(2,171

)

2,630

 

Noninterest income (loss) (2)

 

14,856

 

1,621

 

1,236

 

(1,450

)

16,263

 

Noninterest expense (3)

 

34,928

 

3,522

 

1,742

 

5,906

 

46,098

 

Minority interest

 

 

521

 

 

1,779

 

2,300

 

Income (loss) before income taxes

 

12,661

 

1,242

 

(506

)

4,624

 

18,021

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,550,618

 

65,577

 

 

192,067

 

1,808,262

 

Total average assets (4)

 

2,759,738

 

482,068

 

182,911

 

338,927

 

3,763,644

 

Total average deposits

 

2,358,128

 

443,574

 

 

130,874

 

2,932,576

 

 

 

 

 

 

 

 

 

 

 

 

 

First nine months of 2003

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

114,337

 

$

8,969

 

$

 

$

17,646

 

$

140,952

 

Provision for loan losses (1)

 

(93

)

 

 

(2,810

)

(2,903

)

Noninterest income (loss) (2)

 

41,754

 

5,894

 

11,522

 

(2,879

)

56,291

 

Noninterest expense (3)

 

105,491

 

13,028

 

25,840

 

21,756

 

166,115

 

Minority interest

 

 

1,519

 

 

4,732

 

6,251

 

Income (loss) before income taxes

 

50,693

 

3,354

 

(14,318

)

553

 

40,282

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,505,375

 

70,772

 

 

229,690

 

1,805,837

 

Total average assets (4)

 

2,861,878

 

527,081

 

102,508

 

473,784

 

3,965,251

 

Total average deposits

 

2,563,827

 

503,462

 

 

151,773

 

3,219,062

 

 

 

 

 

 

 

 

 

 

 

 

 

First nine months of 2002

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

115,803

 

$

7,992

 

$

 

$

22,466

 

$

146,261

 

Provision for loan losses (1)

 

1,206

 

 

 

1,643

 

2,849

 

Noninterest income (loss) (2)

 

46,966

 

2,421

 

8,622

 

(5,991

)

52,018

 

Noninterest expense (3)

 

103,426

 

9,993

 

7,267

 

17,748

 

138,434

 

Minority interest

 

 

1,557

 

 

3,980

 

5,537

 

Income before income taxes

 

58,137

 

1,977

 

1,355

 

1,064

 

62,533

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,500,790

 

60,173

 

 

175,385

 

1,736,348

 

Total average assets (4)

 

2,843,872

 

492,166

 

179,041

 

361,611

 

3,876,690

 

Total average deposits

 

2,442,262

 

453,672

 

 

160,570

 

3,056,504

 

 


(1)           For operating segment reporting purposes, the Company reports net charge-offs as the provision for loan losses.  Thus, the Other segment includes $(2.0) million and $(2.4) million for the three-month periods ended September 30, 2003 and September 30, 2002, respectively, and includes $(3.0) million and $1.4 million for the nine-month periods ended September 30, 2003 and September 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 segment included warrant income of $1.5 million and $0.4 million, for the three months ended September 30, 2003 and September 30, 2002, respectively and $4.5 million and $1.3 million, for the nine months ended September 30, 2003 and September 30, 2002, respectively.

(3)           Commercial Banking segment included depreciation and amortization of $0.3 million and $0.3 million for the three months ended September 30, 2003 and September 30, 2002, and $1.0 million and $0.9 million for the nine months ended September 30, 2003 and 2002.

(4)           Total average assets equals the greater of total average loans or the sum of total average deposits and total average stockholders’ equity for each segment.  Certain adjustments are included in the Other segment to reconcile segment assets to total average assets reported on a consolidated basis.  Total average assets presented in the Investment Banking segment included goodwill primarily related to the Alliant acquisition of $81.6 million and $98.6 million at September 30, 2003 and September 30, 2002, respectively.

 

16



 

9.  Common Stock Repurchase

 

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

 

From its 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.

 

$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 $113.2 million as of September 30, 2003.  The Company did not repurchase any shares during the third quarter of 2003.  On May 20, 2003, the Company purchased 1.3 million shares of common stock for approximately $33.4 million in conjunction with the convertible note offering.  Additionally, 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 $79.9 million.  The Company completed its settlement obligations under this ASR agreement in the third quarter of 2003.  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 the Company’s 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 standings 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 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 the Company’s standby letter of credits at September 30, 2003.  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
year or less

 

Expires after
one year

 

Total amount
outstanding

 

Maximum amount of
future payments

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Financial standby

 

$

519,460

 

$

55,036

 

$

574,496

 

$

574,496

 

Performance standby

 

5,130

 

1,127

 

6,257

 

6,257

 

Total

 

$

524,590

 

$

56,163

 

$

580,753

 

$

580,753

 

 

At September 30, 2003, the carrying amount of the liabilities related to financial and performance standby letters of credit was approximately $2.8 million.  At September 30, 2003, cash collateral available to the Company to reimburse losses under financial and performance standby letters of credits was $271.2 million.

 

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11. Subsequent Events

 

On October 30, 2003, the Company issued $50.0 million in cumulative Trust Preferred Securities through a newly formed special-purpose trust, SVB Capital II. The trust is a wholly-owned consolidated subsidiary of the Company and its sole assets are the junior subordinated deferrable interest debentures issued by the Company in connection with the issuance of Trust Preferred Securities.  Distributions are cumulative and are payable quarterly at a fixed rate of 7.0% per annum of the stated liquidation amount of $25 per preferred security.  The obligations of the trust are fully and unconditionally guaranteed, on a subordinated basis, by the Company.  The Trust Preferred Securities are mandatorily redeemable upon the maturity of the debentures on October 15, 2033, or to the extent of any earlier redemption of any debentures by the Company.  The Company may redeem the debentures prior to maturity in whole or in part, at its option, at any time on or after October 30, 2008.  In addition, the Company may redeem the debentures, in whole but not in part, prior to October 30, 2008 upon the occurrence of certain events.  Issuance costs of $2.1 million related to the trust preferred securities were deferred and are being amortized over the period until mandatory redemption of the securities in October 2033.  The Company intends to use the net proceeds to redeem approximately $40.0 million of its exiting 8.25% junior subordinated debentures, which are held by SVB Capital I.  The remaining net proceeds may also be used for general corporate purposes, which may include, investment in, or extension of credit to, its subsidiaries.

 

Please see the section under Recent Accounting Pronouncements , of  “Part 1. Financial Information — Item 1. Notes to the Interim Consolidated Financial Statements — Note 1 to the Interim Consolidated Financial Statements —Summary of Significant Accounting Policies,” for the impact of adoption of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.”

 

On October 30, 2003, the Company entered into an interest rate swap agreement with a notional amount of $50.0 million.  This agreement hedges against the risk of changes in fair values associated with the Company’s $50.0 million, fixed rate, Trust Preferred Securities.  The terms of this interest rate swap agreement provide for quarterly receipt of 7.0% fixed-rate and payment of London Inter-Bank Offer Rate (LIBOR) plus a spread, based on the $50.0 million notional amount.  The swap agreement mirrors the terms of the Trust Preferred Securities and therefore is callable by the counter-party anytime after October 30, 2008.  The Company assumes no ineffectiveness as the swap agreement meets the short-cut method requirements under SFAS No. 133 for fair value hedges of debt instruments. As a result, changes in the fair value of the swap are offset by changes in the fair value of the Trust Preferred Securities, and no net gain or loss is recognized in earnings.

 

On October 30, 2003, the Company’s wholly-owned subsidiary, SVB Capital I, called for redemption on December 1, 2003 all of its existing 8.25% Junior Subordinated Deferrable Interest Debentures (“Debentures”) due 2028.  SVB Capital I will use the proceeds from the redemption of the Debentures to redeem its Trust Preferred Securities and it will also redeem its common equity held by Silicon Valley Bancshares.  SVB Capital I had approximately $40.0 million in aggregate liquidation amount of 8.25% Trust Preferred Securities outstanding at September 30, 2003.

 

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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 has 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, without limitation:

 

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

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

                  Descriptions of products, services, and industry sectors;

                  Forecasts of future economic performance; and

                  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:

 

                  Liquidity and timing of liquidity of equity securities in our warrant, direct equity and venture capital fund portfolios;

                  Our ability to minimize the impact to our financial performance from changes in market interest rates;

                  The concentration of relatively higher-yielding, higher-quality securities in our investment portfolio;

                  Our ability to reduce the rates paid on interest-bearing deposits;

                  Our ability to embed minimum interest rate “floors” in loan agreements with our clients;

                  Level of average loan balances;

                  Development of our later-stage corporate technology efforts;

                  Future level of market interest rates;

                  Future net interest margin;

                  Impact to our earnings of future increases in market interest rates;

                  Expected increase in volume of investment advisory services;

                  Volatility and growth of future revenues of Alliant Partners;

                  Expected write-downs of equity investments;

                  Asset growth;

                  Credit risks;

                  Adequacy of capital leverage ratios;

                  Relative cost of funds raised through our real estate investment trust;

                  Significance of retained earnings as a source of capital and liquidity;

                  Future use of excess capital; and

                  Level of liquid assets as a percentage of total deposits.

 

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, we have based these expectations on our beliefs as well as our assumptions, and 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.

 

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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 page 11 through 16 of our registration statement on Form S-3/A, as filed with the Securities and Exchange Commission on October 21, 2003, and Item 7A of our 2002 Annual Report on Form 10-K for the fiscal year ended December 31, 2002, as filed with the Securities and Exchange Commission on March 5, 2003.  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

 

Our investments in marketable equity securities include:

 

                  Unexercised warrants for 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.

                  Investments in shares of publicly-traded companies

                  Taurus Growth Partners, L.P. and Libra Partners, L.P. — Marketable equity securities relating to these entities totaled approximately $8.0 million at September 30, 2003.  We have a controlling ownership interest of less than 1% in each of these funds.  Both entities are California limited partnerships, and 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.

 

Our merchant banking marketable warrant and equity securities totaled $6.1 million at September 30, 2003 and $0.8 million at December 31, 2002.  These instruments are classified as available-for-sale and are accounted for at fair value.  We recognized income from client warrants in our consolidated statements of income of $1.5 million and $4.5 million for the three and nine months ended September 30, 2003, and $0.4 million and $1.3 million for the respective periods ended September 30, 2002.

 

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.

 

3.                If we possess a warrant that can be net cash settled, then the warrant meets the definition of a derivative instrument.  Changes in fair value of such derivative instruments are recognized as securities gains or losses in our consolidated statements of income.

 

20



 

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 capital 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 $5.1 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 capital 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

                  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 $28.5 million at September 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 $11.0 million at September 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

 

21



 

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 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.  The investments in venture capital funds totaled $26.2 million at September 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 September 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 September 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.  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,

 

22



 

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.

 

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.

 

23



 

In addition to risk-rating every loan in our portfolio, our management concluded that our allowance for loan and lease losses at September 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

(3)           An increase of $43.5 million in our year-to-date average loan balances between December 31, 2002 and September 30, 2003.

(4)           Economic uncertainty.

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

 

We consider our allowance for loan losses at September 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.

 

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 related to Alliant Partners was reduced from $98.6 million at December 31, 2002 to $81.6 million at September 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 income of $17.4 million, or $0.49 per diluted common share, for the third quarter of 2003, compared with net income of $13.1 million, or $0.29 per diluted common share, for the third quarter of 2002.  Net income totaled $27.2 million, or $0.72 per diluted common share, for the nine months ended September 30, 2003, versus $41.4 million or $0.90 per diluted common share, for the respective 2002 period.  The annualized return on average assets (ROA) was 1.7% in the third quarter of 2003 compared with 1.4% in the third quarter of 2002.  The annualized return on average equity (ROE) for

 

24



 

the third quarter of 2003 was 16.0%, compared with 8.2% in the third quarter of 2002.  For the first nine months of 2003, ROA was 0.9% and ROE was 7.2% versus 1.4% and 8.6%, 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.

 

(Dollars in thousands)

 

For the three months ended
September 30,

 

%
Increase/
(Decrease)

 

For the nine months ended
September 30,

 

%
Increase/
(Decrease)

 

 

 

 

 

 

 

2003

 

2002

 

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

46,274

 

$

48,186

 

(4.0

)%

$

140,952

 

$

146,261

 

(3.6

)%

Provision for loan losses

 

(7,449

)

2,630

 

(383.2

)

(2,903

)

2,849

 

(201.9

)

Noninterest income

 

21,340

 

16,263

 

31.2

 

56,291

 

52,018

 

8.2

 

Noninterest expense

 

48,804

 

46,098

 

5.9

 

166,115

 

138,434

 

20.0

 

Minority interest

 

7

 

2,300

 

(99.7

)

6,251

 

5,537

 

12.9

 

Income before income taxes

 

26,266

 

18,021

 

45.8

 

40,282

 

62,533

 

(35.6

)

Income tax expense

 

8,837

 

4,925

 

79.4

 

13,011

 

21,092

 

(38.3

)

Net income

 

$

17,429

 

$

13,096

 

33.1

%

$

27,271

 

$

41,441

 

(34.2

)%

 

Net income totaled $17.4 million and $27.3 million for the three and nine months ended September 30, 2003.  In the third quarter of 2003, we settled our remaining film loan litigation, resulting in a significant loan loss and professional services expense recovery.  Additionally, we experienced an improvement in return from our equity securities that contributed to our improved net income.  The primary reason for the decrease in net income for the nine months ended September 30, 2003 compared to the comparable 2002 period was the $17.0 million impairment of goodwill charge 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.

 

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 nine months ended September 30, 2003 and 2002, respectively.

 

25



 

AVERAGE BALANCES, RATES AND YIELDS

 

 

 

For the three months ended September 30,

 

 

 

2003

 

2002

 

(Dollars in thousands)

 

Average
Balance

 

Interest
Income/
Expense

 

Yield/
Rate

 

Average
Balance

 

Interest
Income/
Expense

 

Yield/
Rate

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds sold and securities purchased under agreement to resell (1)

 

$

439,793

 

$

1,204

 

1.1

%

$

259,321

 

$

1,251

 

1.9

%

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

1,385,622

 

10,532

 

3.0

 

1,167,534

 

10,244

 

3.5

 

Non-taxable (2)

 

145,607

 

2,422

 

6.6

 

157,044

 

2,512

 

6.3

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

1,454,103

 

32,744

 

8.9

 

1,554,935

 

35,841

 

9.1

 

Real estate construction and term

 

98,312

 

1,709

 

6.9

 

100,137

 

1,688

 

6.7

 

Consumer and other

 

185,372

 

1,987

 

4.3

 

153,190

 

1,853

 

4.8

 

Total loans (3)

 

1,737,787

 

36,440

 

8.3

 

1,808,262

 

39,382

 

8.6

 

Total interest-earning assets

 

3,708,809

 

50,598

 

5.4

 

3,392,161

 

53,389

 

6.2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

190,769

 

 

 

 

 

150,160

 

 

 

 

 

Allowance for loan losses

 

(73,042

)

 

 

 

 

(76,895

)

 

 

 

 

Goodwill

 

83,548

 

 

 

 

 

98,628

 

 

 

 

 

Other assets

 

198,194

 

 

 

 

 

199,590

 

 

 

 

 

Total assets

 

$

4,108,278

 

 

 

 

 

$

3,763,644

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

$

22,047

 

25

 

0.4

 

$

25,259

 

40

 

0.6

 

Regular money market deposits

 

342,778

 

435

 

0.5

 

253,763

 

641

 

1.0

 

Bonus money market deposits

 

749,351

 

945

 

0.5

 

584,190

 

1,475

 

1.0

 

Time deposits

 

471,197

 

791

 

0.7

 

588,876

 

1,692

 

1.1

 

Short-term borrowings

 

9,185

 

69

 

3.0

 

41,475

 

266

 

2.5

 

Long-term debt

 

163,100

 

374

 

0.9

 

26,084

 

210

 

3.2

 

Trust preferred securities (4)

 

38,721

 

838

 

8.6

 

 

 

 

Total interest-bearing liabilities

 

1,796,379

 

3,477

 

0.8

 

1,519,647

 

4,324

 

1.1

 

Portion of noninterest-bearing funding sources

 

1,912,430

 

 

 

 

 

1,872,514

 

 

 

 

 

Total funding sources

 

3,708,809

 

3,477

 

0.4

 

3,392,161

 

4,324

 

0.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

1,772,609

 

 

 

 

 

1,480,488

 

 

 

 

 

Other liabilities

 

67,219

 

 

 

 

 

56,042

 

 

 

 

 

Trust preferred securities (4)

 

 

 

 

 

 

38,677

 

 

 

 

 

Minority interest

 

39,170

 

 

 

 

 

32,507

 

 

 

 

 

Stockholders’ equity

 

432,901

 

 

 

 

 

636,283

 

 

 

 

 

Portion used to fund interest-earning assets

 

(1,912,430

)

 

 

 

 

(1,872,514

)

 

 

 

 

Total liabilities, minority interest and stockholders’ equity

 

$

4,108,278

 

 

 

 

 

$

3,763,644

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income and margin

 

 

 

$

47,121

 

5.0

%

 

 

$

49,065

 

5.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total deposits

 

$

3,357,982

 

 

 

 

 

$

2,932,576