SVB Financial Group
SILICON VALLEY BANCSHARES (Form: 10-Q, Received: 05/13/2003 12:18:30)

 

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 March 31, 2003

 

OR

 

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

                                               

For the transition period from                  to                     .

 

Commission File Number: 33-41102

                                                                                                                               

SILICON VALLEY BANCSHARES

(Exact name of registrant as specified in its charter)

 

 

 

 

Delaware

 

91-1962278

(State or other jurisdiction of

 

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

incorporation or organization)

 

 

 

 

 

 

 

 

3003 Tasman Drive, Santa Clara, California

 

95054-1191

(Address of principal executive offices)

 

(Zip Code)

 

 

 

 

Registrant’s telephone number, including area code: (408) 654-7400

 

 

                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 April 30, 2003, 38,798,283 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.

EVALUATION OF DISCLOSURE 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

 

 

 

 

CERTIFICATIONS

 

 

2



 

PART I - FINANCIAL INFORMATION

 

ITEM 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED BALANCE SHEETS

 

 

March 31,

 

December 31,

 

(Dollars in thousands, except par value)

 

2003

 

2002

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

Cash and due from banks

 

$

145,805

 

$

239,927

 

Federal funds sold and securities purchased under agreement to resell

 

353,182

 

202,662

 

Investment securities

 

1,291,551

 

1,535,694

 

Loans, net of unearned income

 

2,070,063

 

2,086,080

 

Allowance for loan losses

 

(70,000

)

(70,500

)

Net loans

 

2,000,063

 

2,015,580

 

Premises and equipment

 

16,223

 

17,886

 

Goodwill

 

100,567

 

100,549

 

Accrued interest receivable and other assets

 

80,697

 

70,883

 

Total assets

 

$

3,988,088

 

$

4,183,181

 

 

 

 

 

 

 

Liabilities, Minority Interest, and Stockholders’ Equity:

 

 

 

 

 

Liabilities:

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing demand

 

$

1,769,916

 

$

1,892,125

 

NOW

 

38,854

 

21,531

 

Money market

 

892,138

 

933,255

 

Time

 

550,186

 

589,216

 

Total deposits

 

3,251,094

 

3,436,127

 

Short-term borrowings

 

9,196

 

9,127

 

Other liabilities

 

61,020

 

47,550

 

Long-term debt

 

17,538

 

17,397

 

Total liabilities

 

3,338,848

 

3,510,201

 

 

 

 

 

 

 

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

 

39,247

 

39,472

 

Minority interest

 

43,857

 

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; 38,874,487 and 40,578,093 shares outstanding at March 31, 2003 and December 31, 2002, respectively

 

39

 

41

 

Additional paid-in capital

 

69,649

 

99,979

 

Retained earnings

 

487,028

 

476,610

 

Unearned compensation

 

(2,248

)

(652

)

Accumulated other comprehensive income:

 

 

 

 

 

Net unrealized gains on available-for-sale investments

 

11,668

 

14,372

 

Total stockholders’ equity

 

566,136

 

590,350

 

Total liabilities, minority interest, and stockholders’ equity

 

$

3,988,088

 

$

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

 

 

 

March 31,

 

March 31,

 

(Dollars in thousands, except per share amounts)

 

2003

 

2002

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

Loans

 

$

37,836

 

$

38,325

 

Investment securities

 

11,973

 

15,815

 

Federal funds sold and securities purchased under agreement to resell

 

830

 

245

 

Total interest income

 

50,639

 

54,385

 

Interest expense:

 

 

 

 

 

Deposits

 

2,451

 

4,898

 

Other borrowings

 

210

 

485

 

Total interest expense

 

2,661

 

5,383

 

 

 

 

 

 

 

Net interest income

 

47,978

 

49,002

 

Provision for loan losses

 

3,384

 

3,426

 

Net interest income after provision for loan losses

 

44,594

 

45,576

 

Noninterest income:

 

 

 

 

 

Client investment fees

 

6,332

 

8,638

 

Corporate finance fees

 

4,144

 

2,962

 

Letter of credit and foreign exchange income

 

3,503

 

3,777

 

Deposit service charges

 

2,876

 

2,236

 

Disposition of client warrants

 

1,962

 

126

 

Investment losses

 

(4,705

)

(2,597

)

Other

 

3,334

 

1,759

 

Total noninterest income

 

17,446

 

16,901

 

Noninterest expense:

 

 

 

 

 

Compensation and benefits

 

31,432

 

24,928

 

Net occupancy

 

4,402

 

4,518

 

Professional services

 

3,439

 

3,036

 

Furniture and equipment

 

2,194

 

2,096

 

Business development and travel

 

1,616

 

2,123

 

Correspondent bank fees

 

1,040

 

707

 

Telephone

 

778

 

901

 

Tax credit fund amortization

 

715

 

449

 

Postage and supplies

 

584

 

783

 

Trust preferred securities distributions

 

281

 

825

 

Other

 

3,627

 

2,952

 

Total noninterest expense

 

50,108

 

43,318

 

Minority interest

 

3,479

 

1,840

 

Income before income tax expense

 

15,411

 

20,999

 

Income tax expense

 

4,993

 

7,639

 

Net income

 

$

10,418

 

$

13,360

 

Basic earnings per share

 

$

0.27

 

$

0.30

 

Diluted earnings per share

 

$

0.26

 

$

0.29

 

 

See notes to interim consolidated financial statements.

 

4



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

 

 

For the three months ended

 

 

 

March 31,

 

March 31,

 

(Dollars in thousands)

 

2003

 

2002

 

 

 

 

 

 

 

Net income

 

$

10,418

 

$

13,360

 

 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

Change in unrealized losses on available-for-sale investments

 

(1,378

)

(2,832

)

Reclassification adjustment for gains included in net income

 

(1,326

)

(80

)

Other comprehensive loss

 

(2,704

)

(2,912

)

Comprehensive income

 

$

7,714

 

$

10,448

 

 

See notes to interim consolidated financial statements.

 

5



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

For the three months ended March 31,

 

(Dollars in thousands)

 

2003

 

2002

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

10,418

 

$

13,360

 

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

 

 

 

 

 

Provision for loan losses

 

3,384

 

3,426

 

Minority interest

 

(3,479

)

(1,840

)

Depreciation and amortization

 

1,973

 

1,766

 

Net loss on sales of investment securities

 

4,705

 

2,597

 

Net gains on disposition of client warrants

 

(1,962

)

(126

)

(Increase) decrease in accrued interest receivable

 

(617

)

3,036

 

Deferred income tax benefits

 

(1,393

)

(945

)

(Increase) decrease in income tax receivable

 

(553

)

8,363

 

Decrease (increase) in unearned income

 

1,184

 

(87

)

Increase (decrease) in retention, warrant, and other incentive plan payable

 

2,025

 

(201

)

Other, net

 

2,570

 

2,841

 

Net cash provided by operating activities

 

18,255

 

32,190

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities and paydowns of investment securities

 

224,825

 

630,453

 

Proceeds from sales of investment securities

 

2,909,648

 

22,993

 

Purchases of investment securities

 

(2,897,229

)

(604,970

)

Net increase in loans

 

6,129

 

14,506

 

Proceeds from recoveries of charged-off loans

 

4,820

 

2,206

 

Purchases of premises and equipment

 

(310

)

(1,431

)

Net cash provided by investing activities

 

247,883

 

63,757

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net decrease in deposits

 

(185,033

)

(199,465

)

Increase in short-term borrowings

 

69

 

266

 

Increase in long-term debt

 

141

 

210

 

Proceeds from issuance of common stock, net of issuance costs

 

553

 

2,036

 

Repurchase of common stock

 

(32,545

)

 

Capital contributions from minority interest participants

 

7,075

 

 

Net cash used by financing activities

 

(209,740

)

(196,953

)

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

56,398

 

(101,006

)

Cash and cash equivalents at January 1,

 

442,589

 

440,532

 

Cash and cash equivalents at March 31,

 

$

498,987

 

$

339,526

 

 

 

 

 

 

 

Supplemental disclosures:

 

 

 

 

 

Interest paid

 

$

2,743

 

$

5,580

 

Income taxes paid

 

$

4,748

 

$

242

 

 

See notes to interim consolidated financial statements.

 

6



SILICON VALLEY BANCSHARES AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

1.  Summary of Significant Accounting Policies

 

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

 

Nature of Operations

 

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

 

Consolidation

 

The interim Consolidated Financial Statements include the accounts of Silicon Valley Bancshares and its subsidiaries.  Intercompany accounts and transactions have been eliminated in consolidation.  Wholly-owned merchant banking subsidiaries, SVB Strategic Investors, LLC and Silicon Valley BancVentures, Inc., are general partners of SVB Strategic Investors Fund, L.P. and Silicon Valley BancVentures, L.P., respectively, and are considered to have significant influence over the operating and financing policies.  In addition, a wholly-owned private banking subsidiary, Woodside Financial is general partner of Taurus, L.P. and Libra, L.P., and is considered to have significant influence over the operating and financing policies.  Therefore, SVB Strategic Investors Fund, L.P., Silicon Valley BancVentures, L.P., Taurus, L.P., and Libra, L.P. are included in the Company’s interim consolidated financial statements.  Minority interest represents the minority participants’ share of the equity of SVB Strategic Investors Fund, L.P., Silicon Valley BancVentures, L.P., Taurus, L.P., and Libra, L.P.

 

For further discussion, see “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Note 2 to the interim Consolidated Financial Statements — Business Combinations.”

 

7



SILICON VALLEY BANCSHARES AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continuted)

 

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 March 31, 2003, the interim results of its operations for the three months ended March 31, 2003 and March 31, 2002, and interim cash flow for the three months ended March 31, 2003 and March 31, 2002.  The December 31, 2002 consolidated balance sheet was derived from audited financial statements.  Certain information and footnote disclosures, normally presented therein, were prepared in accordance with accounting principles generally accepted in the United States of America, have been omitted from this report.  The results of operations for the three months ended March 31, 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 filed with the SEC on March 5, 2003.

 

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.

 

Revenue Recognition

 

Revenues earned on mergers and acquisitions advisory services are recognized when Alliant has fully completed its contractual and regulatory obligations related to its client service engagements.

 

The Bank’s wholly-owned, registered, broker-dealer subsidiary, SVB Securities, manages client funds invested in private label mutual funds and sweep products.  SVB Securities generally earns client investment fees based upon the average daily balances of clients’ investment funds.

 

Cash and Cash Equivalents

 

Cash and cash equivalents as reported in the interim consolidated statements of cash flows include cash on hand, cash balances due from banks, federal funds sold, and securities purchased under agreement to resell.  The cash equivalents are readily convertible to known amounts of cash and present insignificant risk of changes in value due to maturity dates of 90 days or less.

 

8



 

Federal Funds Sold and Securities Purchased Under Agreement to Resell

 

Federal funds sold and securities purchased under agreement to resell as reported in the consolidated balance sheets include interest-bearing deposits in other financial institutions of $2.0 million and $0 million at March 31, 2003 and December 31, 2002, respectively.

 

Investment Securities

 

Fixed Income Securities

 

Fixed income investment securities are classified as held-to-maturity, available-for-sale, trading, or non-marketable upon purchase or acquisition.

 

Securities purchased with the ability and positive intent to hold to maturity are classified as held-to-maturity and are accounted for at historical cost, adjusted for the amortization of premiums or the accretion of discounts to maturity, where appropriate.  The Company did not have any investments in the held-to-maturity portfolio as of March 31, 2003 or as of December 31, 2002.  Unrealized losses on held-to-maturity securities become realized and are charged against earnings when it is determined that an other-than-temporary decline in value has occurred.

 

Securities that are held to meet investment objectives such as interest rate risk and liquidity management, and which may be sold by the Company as needed to implement management strategies, are classified as available-for-sale and are accounted for at fair value.  Unrealized gains and losses on available-for-sale securities, after applicable taxes, are reported in accumulated other comprehensive income, which is a separate component of stockholders’ equity, until realized.  Unrealized losses on available-for-sale securities become realized and are charged against earnings when it is determined that an other than temporary decline in value has occurred.  Further, the cost basis of the individual security is written down to fair value as a new cost basis.

 

Amortization of premiums and accretion of discounts on debt securities are included in interest income over the contractual terms of the underlying investment securities using the straight-line method, which approximates the effective interest method.

 

Securities acquired and held principally for the purpose of sale in the near term are classified as trading and are accounted for at fair value.  Unrealized gains and losses resulting from fair value adjustments on trading securities, as well as gains and losses realized upon the sale of investment securities, are included in noninterest income.  The Company did not have a trading portfolio as of March 31, 2003 and December 31, 2002.

 

Non-marketable securities include Federal Reserve Bank stock, Federal Home Loan Bank stock and tax credit funds.

 

Marketable Equity Securities

 

Investments in marketable equity securities include warrants for shares of publicly-traded companies and investments in shares of publicly-traded companies.  Equity securities in the

 

9



 

Company’s 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.

 

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.  The Company is 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 the 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 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, gains and losses, which are measured from the acquisition price, are realized in the Company’s consolidated statements of income.

 

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

 

Summary financial data related to the Company’s marketable equity securities at March 31, 2003 are presented in “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Note 4 to the interim Consolidated Financial Statements — Investment Securities.”

 

Non-Marketable Equity Securities

 

The Company invests 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 its venture capital fund, Silicon Valley BancVentures, L.P., which makes investments in preferred or common stock of privately held companies

 

10



 

                  Through its 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 the Company’s consolidated balance sheets.  They are carried at this value until they become marketable or expire.

 

The Company records non-marketable venture capital fund investments and other direct private equity investments on a cost basis as the Company’s interests are considered minor, as it owns less than 5% of the company and has no influence over the companys’ operating and financial policies.  The Company’s 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.  The Company’s review of these 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 the Company’s consolidated statement 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. are recorded at fair value using investment accounting rules.  The investments consist of stock in private companies that are not traded on a public market and are subject to restrictions on resale.  These investments are carried at estimated fair value as determined by the general partner, Silicon Valley BancVentures, Inc.  The valuation generally remains at cost until such time that there is significant evidence of a change in values based upon consideration of the relevant market conditions, offering prices, operating results, financial conditions, exit strategy, and other pertinent information.  Silicon Valley BancVentures, Inc., is owned and controlled by the Company and has an ownership interest of 10.7% in Silicon Valley BancVentures, L.P.  As such, 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 limited partners’ share of any gains or losses is reflected in minority interest and adjusts the Company’s income to its percentage ownership.

 

The SVB Strategic Investors Fund, L.P. portfolio consists primarily of investments in venture capital funds.  These funds 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 the Company and has an ownership interest of 11.1% in SVB Strategic Investors Fund, L.P.  As such, SVB Strategic Investors, LLC 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 the Company’s consolidated statements of income.  The

 

11



 

 

limited partners’ share of any gains or losses is reflected in minority interest and adjusts the Company’s income to its percentage ownership.

 

Summary financial data related to the Company’s non-marketable equity securities at March 31, 2003 are presented in “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Note 4 to the interim Consolidated Financial Statements — Investment Securities.”

 

Loans

 

Loans are reported at the principal amount outstanding, net of unearned income.  Unearned income includes both deferred loan origination and commitment fees and costs.  The net amount of unearned income is amortized into loan interest income over the contractual terms of the underlying loans and commitments using the interest method or the straight-line method, if not materially different, adjusted for actual loan prepayment experience.

 

Allowance for Loan Losses

 

The allowance for loan losses is established through a provision for loan losses charged to expense to provide for credit risk.  The Company applies the following evaluation process to its loan portfolio to estimate the required allowance for loan losses.

 

The Company maintains 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 its portfolio is assigned a credit risk-rating.  Credit risk-ratings are assigned on a scale of 1 to 10, 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, such factors as payment status, the financial condition of the borrower, borrower’s compliance with loan covenants, underlying collateral values, potential loan concentrations, and general economic conditions.  The Company’s policies require a committee of senior management to review credit relationships that exceed specific dollar values, at least quarterly.  The Company’s 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, the Company’s 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.

 

The Company’s evaluation process is designed to determine the adequacy of the allowance for loan losses.  The Company assesses the risk of losses inherent in the loan portfolio by utilizing modeling techniques.  For this purpose, the Company has developed a statistical model based on historical loan loss migration to estimate an appropriate allowance for outstanding loan balances.  In addition, the Company applies 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,

 

12



 

 

the classification of loans and the establishment of the allowance for loan losses relies, to a great extent, on the judgment and experience of the Company’s management.

 

The Company’s allowance for loan losses is established for loan losses not yet realized.  The process of anticipating loan losses is imprecise.  The Company’s allowance for loan losses is its best estimate using the historical loan loss experience and its perception of variables potentially leading to deviation from the historical loss experience.

 

Nonaccrual Loans

 

SFAS No. 114, “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures” requires the Company to measure impairment of a loan based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on the loan’s observable market price or the fair value of the collateral if the loan is collateral-dependent.  A loan is considered impaired when, based upon currently known information, it is deemed probable that the Company will be unable to collect all amounts due according to the contractual terms of the agreement.

 

Loans are placed on nonaccrual status when they become 90 days past due as to principal or interest payments (unless the principal and interest are well secured and in the process of collection), when the Company has determined, based upon currently known information, that the timely collection of principal or interest is doubtful, or when the loans otherwise become impaired under the provisions of SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.”

 

When a loan is placed on nonaccrual status, the accrued interest is reversed against interest income and the loan is accounted for on the cash or cost recovery method thereafter until qualifying for return to accrual status.  Generally, a loan will be returned to accrual status when all delinquent principal and interest become current in accordance with the terms of the loan agreement and full collection of the principal and interest appears probable.

 

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 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.”

 

13



 

 

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

 

 

 

Three Months Ended March 31,

 

 

 

2003

 

2002

 

 

 

(Dollars in thousands,

 

 

 

except per share amounts)

 

 

 

 

 

 

 

Net income, as reported

 

$

10,418

 

$

13,360

 

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

 

138

 

188

 

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

 

(3,712

)

(3,986

)

Net income, pro-forma

 

$

6,844

 

$

9,562

 

 

 

 

 

 

 

Basic earnings per share:

 

 

 

 

 

As reported

 

$

0.27

 

$

0.30

 

Pro-forma

 

0.18

 

0.21

 

Diluted earnings per share:

 

 

 

 

 

As reported

 

0.26

 

0.29

 

Pro-forma

 

0.18

 

0.21

 

 

Derivative Financial Instruments

 

The Company accounts for derivative instruments in accordance with the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities.”  SFAS No. 133, as amended, establishes accounting and reporting standards for derivative instruments, and requires that all derivative instruments be recorded on the balance sheet at fair value.  Additionally, the accounting for changes in fair value depends on whether the derivative instrument is designated and qualifies as part of a hedging relationship and, if so, the nature of the hedging activity.  Changes in the fair value of derivatives that do not qualify for hedge treatment, as well as the ineffective portion of a particular hedge, must be recognized currently in earnings.  For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in earnings in the current period, unless the derivative instrument meets the definition of the short-cut treatment, as defined by SFAS No. 133.  For derivative instruments that are designated and qualify as a cash flow hedge, changes in the fair value of the effective portion of the derivative instrument are recognized in Other Comprehensive Income (OCI).  These amounts are reclassified from OCI and recognized in earnings when either the forecasted transaction occurs or it becomes probable that the forecasted transaction will not occur.  See “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Note 8 to the interim Consolidated Financial Statements —Derivative Financial Instruments.”

 

14



 

 

Foreign Exchange Contracts

 

The Company enters into foreign exchange contracts with clients involved in international trade finance activities.  The Company also enters into an opposite-way foreign exchange contract with a correspondent bank, which completely mitigates the risk of fluctuations in foreign currency exchange rates, for each of the contracts entered into with its clients.  However, settlement, credit, and operational risks remain.  The Company does not enter into foreign exchange contracts for any other purposes.  These contracts are not designated as hedging instruments and are recorded at fair value in the Company’s consolidated balance sheets.  Changes in the fair value of these contracts are recognized immediately in non-interest income.

 

Business Combinations

 

The Company accounts for business combinations in accordance with the provisions of SFAS No. 141, “Business Combinations,” which requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001.  SFAS No. 141 also specifies the criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately.  See “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Note 2 to the interim Consolidated Financial Statements — Business Combinations.”

 

Goodwill and Other Intangibles

 

The Company accounts for intangible assets in accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets.”  Under these provisions, the Company is required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations.  In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company is required to test the intangible asset for impairment in accordance with the provisions of SFAS No. 142 each year.  SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually.  The Company adopted the provisions of SFAS No. 142 on January 1, 2002.

 

In testing for a potential impairment of goodwill, SFAS 142 requires the Company to: (1) allocate goodwill to the reporting units to which the acquired goodwill relates; (2) estimate the fair value of those reporting units to which goodwill relates; and (3) determine the carrying value (book value) of those reporting units.  Furthermore, if the estimated fair value is less than the carrying value for a particular reporting unit, then the Company is required to estimate the fair value of all identifiable assets and liabilities of the reporting unit, in a manner similar to a purchase price allocation for an acquired business.  Only after this process is completed is the amount of goodwill impairment determined.  Accordingly, the process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment at many points during the analysis.

 

Substantially all of the Company’s goodwill pertains to the acquisition of Alliant, discussed in “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Note 2 to the interim Consolidated Financial Statements — Business Combinations.”  In

 

15



 

 

accordance with the provisions of SFAS No. 142, the goodwill balance was determined to be unamortizable.  The Company completed its initial test for goodwill impairment in July 2002.  Based on the Company’s best estimates, it concluded that there was no impairment of its goodwill.  However, changes in these estimates could cause the businesses to be valued differently.  If Alliant does not meet projected operating results, subsequent analyses could result in a non-cash goodwill impairment charge, depending on the estimated value of the Alliant business unit and the value of the other assets and liabilities attributed to the business.  The Company will perform the test of impairment in July 2003, and does not anticipate an impairment of goodwill.  At March 31, 2003, the Company’s goodwill totaled $100.6 million.

 

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 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 11 to the interim Consolidated Financial Statements — Obligation Under Guarantees.”

 

Recent Accounting Pronouncements

 

In January 2003, FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities (VIE).”  It defined a VIE as a corporation, partnership, trust, or any other legal structure used for the business purpose that either a) does not have equity investors with voting rights or b) has equity investors that do not provide sufficient financial resources for the entity to support its activities.  This interpretation will require a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities or entitled to receive a majority of the entity’s residual return.  The interpretation states that if a VIE was acquired before February 1, 2003, the Company is required to disclose the impact of the VIE in its interim and annual financial statements beginning after June 15, 2003.  However, if it is reasonably possible that the Company will consolidate or disclose information about a VIE when this interpretation becomes effective, then the Company is required to disclose the nature, purpose, size, activities, and it’s maximum exposure to loss as a result of its investment with that VIE in its financial statements issued after January 31, 2003 regardless of the date on which the VIE was created.  As of March 31, 2003, the Company has identified one VIE which would require consolidation treatment if we continue to hold an ownership interest of greater than 50%.  This VIE is a real estate partnership, which invests in affordable housing projects and provide its investors federal and state income tax credits.  As of March 31, 2003, the Company committed approximately $5.1 million to this partnership of which $4.6 million has been funded.  This partnership was not consolidated in the Company’s financial statements at March 31, 2003.  The Company does not expect to have a significant impact from the consolidation of this partnership on its consolidated financial statements.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”, to provide clarification on the meaning of an underlying,

 

16



 

 

the characteristics of a derivative that contains financing components and the meaning of an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors. SFAS No. 149 will be applied prospectively and is effective for contracts entered into or modified after June 30, 2003. This statement will be applicable to existing contracts and new contracts entered into after June 30, 2003 if those contracts relate to forward purchases or sales of when-issued securities or other securities that do not yet exist.  The Company does not expect the adoption of SFAS No. 149 to have a material effect on the Company’s results of operations or financial condition.

 

2.  Business Combinations

 

On October 1, 2002, the Company acquired substantially all of the assets of Woodside Asset Management, Inc., an investment advisor firm.  Woodside Asset Management, Inc. is expected to enable the Company to expand its product offerings in the private banking.  Additionally, as part of this acquisition, Silicon Valley Bancshares obtained the general partner interests in two limited partnerships, Taurus, L.P., and Libra, L.P., with total assets aggregating $11.4 million.  The Company has less than a 1% ownership interest in each of these funds.  The remaining ownership interest represents limited partners’ funds invested on their behalf, by the general partner, in certain fixed income and marketable equity securities.  However, due to the Company’s ability to control the investing activities of these limited partnerships, we have consolidated the related results of operations and financial condition into our interim consolidated financial statements, since the date of acquisition.  This acquisition did not have a material impact on goodwill and is not expected to materially impact the Company’s earnings in the short-term.

 

On September 28, 2001, the Company completed its acquisition of Alliant and has included its results of operations in the Company’s consolidated results of operations since that date.  The acquisition has allowed the Company to strengthen its investment banking platform for its clients.  The Company agreed to purchase the assets of Alliant for a total of $100.0 million, due in several installments of cash and common stock.  These installments are payable over four years between September 30, 2001 and September 30, 2005.  The first two installments aggregating $72.0 million have been paid in cash.  The remaining $28.0 million was discounted at prevailing forward market interest rates ranging between 2.9% and 3.3% and was recorded as short-term and long-term debt.  In addition to the fixed purchase price, the sellers received certain contingent purchase price payments including 75% of the pre-tax income of Alliant for the twelve-month period ended September 28, 2002.  Furthermore, the Company shall pay to the sellers an amount equal to fifteen times the amount by which Alliant’s cumulative after-tax net income from October 1, 2002 to September 30, 2005 exceeds $26.5 million, provided, however, that the aggregate amount of any deferred earnout payment shall not exceed $75.0 million.  The Company shall also make retention payments aggregating $5.0 million in equal annual installments on September 28, 2003, 2004, and 2005.  The purchase price was allocated to the assets acquired and liabilities assumed, based on the estimated net fair values at the date of acquisition of approximately $0.5 million.  The excess of purchase price over the estimated fair values of the net assets acquired was recorded as goodwill.  The business combinations were recorded in accordance with SFAS No. 141.  See “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Notes 1 and 7 to the interim Consolidated Financial Statements — Significant Accounting Policies and Borrowings.”

 

17



 

 

3.  Earnings Per Share (EPS)

 

The following is a reconciliation of basic EPS to diluted EPS for the three months ended March 31, 2003 and 2002.

 

 

 

Three Months Ended March 31

 

(Dollars and shares in thousands,

 

Net

 

 

 

Per Share

 

except per share amounts)

 

Income

 

Shares

 

Amount

 

 

 

 

 

 

 

 

 

2003:

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

Income available to common stockholders

 

$10,418

 

39,092

 

$0.27

 

Effect of Dilutive Securities:

 

 

 

 

 

 

 

Stock options and restricted stock

 

 

691

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

Income available to common stockholders plus assumed conversions

 

$10,418

 

39,783

 

$0.26

 

 

 

 

 

 

 

 

 

2002:

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

Income available to common stockholders

 

$13,360

 

45,179

 

$0.30

 

Effect of Dilutive Securities:

 

 

 

 

 

 

 

Stock options and restricted stock

 

 

1,346

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

Income available to common stockholders plus assumed conversions

 

$13,360

 

46,525

 

$0.29

 

 

18



 

 

4.  Investment Securities

 

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

 

 

 

March 31,

 

December 31,

 

(Dollars in thousands)

 

2003

 

2002

 

 

 

 

 

 

 

Available-for-sale securities, at fair value

 

$

1,201,415

 

$

1,444,231

 

Non-marketable investment securities:

 

 

 

 

 

Federal Reserve Bank stock and tax credit funds

 

25,934

 

25,649

 

Federal home loan bank stock

 

2,171

 

2,172

 

Venture capital fund investments (1)

 

45,898

 

46,822

 

Private equity investments (2)

 

16,133

 

16,820

 

Total investment securities

 

$

1,291,551

 

$

1,535,694

 


(1)           Non-marketable venture capital fund investments included $20.9 million and $22.1 million related to SVB Strategic Investors Fund, L.P., at March 31, 2003, and December 31, 2002, respectively.  The Company has a controlling ownership interest of 11.1% in the fund.  Excluding the minority interest owned portion of SVB Strategic Investors Fund, L.P., the Company has non-marketable venture capital fund investments of $27.4 million and $27.2 million as of March 31, 2003, and December 31, 2002, respectively.

 

(2)        Non-marketable private equity investments included $9.8 million and $10.0 million related to Silicon Valley BancVentures, L.P., at March 31, 2003, and December 31, 2002, respectively.  The Company has a controlling ownership interest of 10.7% in the fund.  Excluding the minority interest owned portion of Silicon Valley BancVentures, L.P., the Company has non-marketable other private equity investments of $7.3 million and $7.9 million as of March 31, 2003, and December 31, 2002, respectively.

 

The following tables present the carrying value of our non-marketable venture capital and other private equity investments at and for the three months ended March 31, 2003.

 

 

 

 

(As consolidated)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wholly-Owned Equity

 

Managed Funds

 

 

 

 

 

Investments

 

Activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Venture

 

Other

 

Silicon Valley

 

SVB Strategic

 

 

 

 

 

Capital

 

Private

 

BancVentures,

 

Investors

 

 

 

 

 

Funds

 

Equity

 

L.P.

 

Fund, L.P.

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Fund size

 

 

 

$

56,100

 

$

121,800

*

$

177,900

 

Commitments

 

$

54,583

 

$

15,168

 

14,677

 

101,382

 

185,810

 

Capital investment

 

37,029

 

15,168

 

14,677

 

32,943

 

99,817

 

Carrying value

 

25,040

 

6,279

 

9,854

 

20,858

 

62,031

 

Net investment losses

 

(560

)

(730

)

(632

)

(2,852

)

(4,774

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Net of minority interest ownership of managed funds)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Wholly-Owned Equity

 

Managed Funds

 

 

 

 

 

Investments

 

Activities

 

 

 

 

 

 

 

 

 

 

 

 

 

Venture

 

Other

 

Silicon Valley

 

SVB Strategic

 

 

 

 

 

Capital

 

Private

 

BancVentures,

 

Investors

 

 

 

 

 

Funds

 

Equity

 

L.P.

 

Fund, L.P.

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments

 

$

54,583

 

$

15,168

 

$

6,000

 

$

13,500*

 

$

89,251

 

Capital investment

 

37,029

 

15,168

 

1,980

 

4,320

 

58,497

 

Carrying value

 

25,040

 

6,279

 

1,054

 

2,312

 

34,685

 

Net investment losses

 

(560

)

(730

)

(68

)

(316

)

(1,674

)

Management fee revenue

 

 

 

271

 

251

 

522

 


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

 

19



 

 

5.  Loans and Allowance for Loan Losses

 

The detailed composition of loans, net of unearned income of $13.0 million and $11.8 million, at March 31, 2003, and December 31, 2002, respectively, is presented in the following table:

 

 

 

March 31,

 

December 31,

 

(Dollars in thousands)

 

2003

 

2002

 

 

 

 

 

 

 

Commercial

 

$

1,772,166

 

$

1,756,182

 

Real estate construction

 

46,895

 

43,178

 

Real estate term

 

55,922

 

56,190

 

Consumer and other

 

195,080

 

230,530

 

Total loans

 

$

2,070,063

 

$

2,086,080

 

 

The activity in the allowance for loan losses for the three months ended March 31, 2003 and 2002 was as follows:

 

 

 

Three months ended March 31,

 

(Dollars in thousands)

 

2003

 

2002

 

 

 

 

 

 

 

Beginning balance

 

$

70,500

 

$

72,375

 

Provision for loan losses

 

3,384

 

3,426

 

Loans charged off

 

(8,704

)

(6,632

)

Recoveries

 

4,820

 

2,206

 

Balance at March 31,

 

$

70,000

 

$

71,375

 

 

The aggregate recorded investment in loans for which impairment has been determined in accordance with SFAS No. 114 totaled $19.1 million and $19.0 million at March 31, 2003, and March 31, 2002, respectively.  Allocations of the allowance for loan losses specific to impaired

 

20



 

 

loans totaled $6.0 million at March 31, 2003, and $7.3 million at March 31, 2002.  Average impaired loans for the first quarter of 2003 and 2002 totaled $17.6 million and $19.6 million, respectively.

 

6.  Goodwill

 

The goodwill balance at March 31, 2003 and December 31, 2002 was $100.6 million and $100.5 million, respectively.  In accordance with the provisions of SFAS 142, the goodwill balance was determined to be unamortizable.  The Company completed its initial test for goodwill impairment in July 2002, the results of which concluded that the goodwill balance was not impaired.

 

7.  Borrowings

 

As of March 31, 2003, the Company had $9.2 million and $17.5 million in short-term borrowings and long-term debt, respectively.  These borrowings were recorded in relation to the acquisition of Alliant and are payable to the former owners, who are now employed by the Company.  The short-term note payable, due September 30, 2003, has a face value of $9.3 million.  The long-term note payable, due in two equal annual installments commencing September 28, 2004, has a face value of $18.7 million.  These notes were discounted over their respective terms, based on market interest rates as of September 28, 2001.  See “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Note 2 to the interim Consolidated Financial Statements — Business Combinations.”  The Company currently has available federal funds and lines of credit facilities totaling $120.0 million, which were unused at March 31, 2003.

 

8.  Derivative Financial Instruments

 

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 agreement hedges 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 are primarily dependent on changes in market interest rates.  The derivative instrument has a fair value of $0.5 million that was recorded in other assets at March 31, 2003.

 

Because the swap meets the criteria for the short cut treatment, the benefit or expense is recorded in the period incurred.  This derivative agreement provided a benefit of $0.5 million in the first three months of 2003, compared to the first three months of 2002.  The terms of the derivative agreement provide 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 mirrors the terms of the Trust Preferred Securities and, therefore, is callable by the counter-party anytime after June 15, 2003.  The Company assumes no ineffectiveness as the interest rate swap agreement meets the short-cut method requirements under SFAS 133 for fair value hedges of debt instruments.  As a result, changes in the fair value of the derivative agreement are offset by changes in the fair value of the Trust Preferred Securities, and no net gain or loss is recognized in earnings.

 

21



 

 

For the Company’s Foreign Exchange Contracts and Foreign Currency Option Contracts, see the Company’s 2002 Annual Report on Form 10-K filed with the SEC on March 5, 2003.

 

9.  Operating Segments

 

Prior to January 1, 2002, the Company operated as one segment.  On January 1, 2002, the Company reorganized into five lines of banking and financial services for management reporting: Commercial Banking, Investment Banking, Private Banking, Merchant 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 the management reporting equivalent to generally accepted accounting principles.  The management reporting process measures the process of operating segments based on the Company’s management structure and is not necessarily comparable with similar information for other financial services companies.  Changes in the management structure and/or the allocation process may (and have) result(ed) in changes in the Company’s allocation methodology as this process is under constant refinement.  In that case, results for prior periods would be (and have been) restated for comparability.  Results for the first quarter of 2002 have been restated to reflect changes in the Company’s allocation methodology.

 

As of March 31, 2003, based on the quantitative threshold for determining reportable segments as required by SFAS 131 “Disclosures About Segments of an Enterprise and Related Information,” the Company’s reportable segments are: Commerical Banking, which is the principal operating segment of the Company, Merchant 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.  The lending, deposit, cash management, International, and investment banking services to venture capital firms are included in the Merchant Banking.

 

Merchant Banking makes private equity and venture capital fund investments, international alliances and manage 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.

 

Other segments include Investment Banking, Private Banking, and Other Business Services.  Investment Banking provides merger and acquisition and corporate partnering services through the Company’s broker-dealer subsidiary, Alliant Partners.  Private Banking provides a wide array of loan, personal asset management, mortgage services, trust and estate planning tailored for

 

22



 

 

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, professional services, and executive placement services.  Client Exchange™ is the Company’s online bulletin board, resume, and assets exchange service, and BenchmarkPro gives the Company’s clients the opportunity to see the financial performance of companies relative to their industry.

 

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.

 

 

 

Commercial

 

Merchant

 

 

 

 

 

 

 

Banking

 

Banking

 

Other

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

First quarter of 2003

 

 

 

 

 

 

 

 

 

Net interest income

 

$

38,749

 

$

3,220

 

$

6,009

 

$

47,978

 

Provision for loan losses (1)

 

3,886

 

 

(502

)

3,384

 

Noninterest income (2)

 

14,244

 

1,488

 

1,714

 

17,446

 

Noninterest expense (3)

 

35,760

 

4,221

 

10,127

 

50,108

 

Minority interest

 

 

570

 

2,909

 

3,479

 

Income before income tax expense

 

13,347

 

1,057

 

1,007

 

15,411

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,531,256

 

89,131

 

236,108

 

1,856,495

 

Total estimated assets (4)

 

2,890,577

 

522,340

 

481,643

 

3,894,561

 

Total average deposits

 

2,529,146

 

487,419

 

143,129

 

3,159,694

 

 

 

 

 

 

 

 

 

 

 

First quarter of 2002

 

 

 

 

 

 

 

 

 

Net interest income

 

$

39,542

 

$

2,660

 

$

6,800

 

$

49,002

 

Provision for loan losses (1)

 

4,341

 

 

(915

)

3,426

 

Noninterest income (2)

 

15,507

 

109

 

1,285

 

16,901

 

Noninterest expense (3)

 

32,448

 

3,201

 

7,669

 

43,318

 

Minority interest

 

 

508

 

1,332

 

1,840

 

Income before income tax expense

 

18,260

 

76

 

2,663

 

20,999

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,465,142

 

54,142

 

154,708

 

1,673,992

 

Total estimated assets (4)

 

2,954,661

 

486,749

 

574,251

 

4,015,661

 

Total average deposits

 

2,561,321

 

452,504

 

195,309

 

3,209,134

 


(1)           For operating segment reporting purposes, the Company reports net charge-offs as the provision for loan losses.  Thus, the Other column includes $(0.5) million and $(0.9) million for the three-month periods ended March 31, 2003 and March 31, 2002, respectively, which represent the difference between net charge-offs and the provision for loan losses.

(2)           Noninterest income presented in the Merchant Banking column included warrant income of $2.0 million and $0.1 million, for the periods ended March 31, 2003 and March 31, 2002, respectively.

(3)           Commercial Banking column included depreciation and amortization of $0.3 million for the periods ended March 31, 2003 and March 31, 2002.

(4)           Total estimated assets presented in the Other column included investments held by Silicon Valley Bancshares, the parent company, and goodwill primarily related to the Alliant acquisition of $100.6 million and $98.4 million as of March 31, 2003 and March 31, 2002, respectively.

 

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10.  Common Stock Repurchase

 

The Company repurchased 1.9 million shares of common stock totaling $32.5 million during the first quarter of 2003, in conjunction with the $100.0 million share repurchase program authorized by the Board of Directors on September 16, 2002.

 

In January 2003, the Company entered into an accelerated stock repurchase (ASR) agreement for 1.7 million shares of common stock for $29.9 million.  The terms of this second ASR arrangement are substantially the same as those in the ASR agreement entered into in November 2002 with the exception of the size.  See “Item 8. Consolidated Financial Statements and Supplementary Data — Note 15 to the Consolidated Financial Statements — Common Stock Repurchases” in our 2002 Annual Report on Form 10-K, as filed with the SEC, for terms of the ASR agreement.  As of March 31, 2003, the Company completed all obligations under the ASR.

 

In November 2002, the Company entered into an ASR agreement to facilitate the repurchase of its shares of common stock.  Pursuant to the agreement, the Company purchased approximately 2.3 million shares from the counterparty for approximately $40.0 million.  As of March 31, 2003, the Company completed all obligations under the ASR.  See “Item 8. Consolidated Financial Statements and Supplementary Data — Note 15 to the Consolidated Financial Statements — Common Stock Repurchases” in our 2002 Annual Report on Form 10-K, as filed with the SEC, for terms of the ASR agreement.

 

Additionally, during 2002, prior to the ASR agreement, the Company also repurchased 2.3 million shares of common stock, at an average price of $21.83 per share, for a total purchase price of $50.2 million in conjunction with the $50.0 million shares repurchase program authorized by the Board of Directors on March 21, 2002.

 

11. Obligations Under Guarantees

 

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

 

24



 

 

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 have experienced historically have been lower than the contractual amount of letters of credit issued because a significant portion of these conditional commitments expire without being drawn upon.

 

The table below summarizes at March 31, 2003 our standby letter of credits at the inception of the contract.  The maximum potential amount of future payments represents the amount that could be lost under the standby letter of credits if there were a total default by the guaranteed parties, without consideration of possible recoveries under recourse provisions or from the collateral held or pledged.

 

 

 

Expires within

 

Expires after

 

Total amount

 

Maximum amount of

 

 

 

one year

 

one year

 

outstanding

 

future payments

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Financial standby

 

$

510,852

 

$

90,435

 

$

601,287

 

$

601,287

 

Performance standby

 

4,091

 

599

 

4,690

 

4,690

 

Total

 

$

514,943

 

$

91,034

 

$

605,977

 

$

605,977

 

 

At March 31, 2003, the carrying amount of the liabilities related to financial and performance standby letters of credit was zero.  At March 31, 2003, cash collateral available to us to reimburse losses under financial and performance standby letters of credits was $319.6 million.

 

12. Subsequent Event

 

On April 17, 2003, the Company’s Board of Directors authorized a share repurchase program of up to $160.0 million.  As of the filing date of this document, the Company has not purchased common stock under this program.

 

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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 have in the past and might in the future make forward-looking statements orally to analysts, investors, the media, and others.  Forward-looking statements are statements that are not historical facts.  Broadly speaking, forward-looking statements include:

(1)

 

Projections of our revenues, income, earnings per share, capital expenditures, capital structure or other financial items

(2)

 

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

(3)

 

Descriptions of products, services, and  industry sectors

(4)

 

Forecasts of future economic performance

(5)

 

Descriptions of assumptions underlying or relating to any of the foregoing

 

 

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

(1)

 

Future investment gains or losses from private equity and venture capital fund investments

(2)

 

Future market conditions and impairment charges on investments

(3)

 

Future credit losses due to nonperformance of other parties

(4)

 

Future changes in allowance for loan losses balance

(5)

 

Future revenues of Alliant Partners

(6)

 

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

(7)

 

Future changes in short-term interest rates and their impact on our earnings

(8)

 

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

(9)

 

Future nonperforming loans

(10)

 

Future funds generated through earnings and their impact on liquidity

(11)

 

Future common stock repurchases; and

(12)

 

Future changes in trust preferred securities distributions expense due to changes in hedging interest rates

 

 

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

 

26



 

comparable terminology.  Although we believe that the expectations reflected in these forward-looking statements are reasonable, and we have based these expectations on our beliefs, as well as our assumptions, such expectations may prove to be incorrect.  Our actual results of operations and financial performance could differ significantly from those expressed in or implied by our management’s forward-looking statements.

 

For information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see the text under the caption “Risk Factors” included in Item 7A of our annual report on Form 10-K as filed with the Securities and Exchange Commission (SEC) 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

 

Investments in marketable equity securities include warrants for shares of publicly-traded companies and investments in shares of publicly-traded companies.  Equity securities in our warrant, direct equity, and venture capital fund portfolios generally become marketable when a portfolio company completes an initial public offering on a publicly-reported market, or is acquired by a publicly-traded company.  Our merchant banking marketable warrant and equity securities totaled $0.1 million at March 31, 2003 and $0.8 million at December 31, 2002.  Marketable equity securities related to Taurus, L.P. and Libra, L.P. totaled approximately $6.8 million, see “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Note 2 to the interim Consolidated Financial Statements — Business Combinations.”  These instruments are classified as available-for-sale and are accounted for at fair value.  We recognized gains from the disposition of client warrants in our consolidated statements of income of $2.0 million for the three months ended March 31, 2003, and $0.1 million for the three months ended March 31, 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

 

27



 

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 fluctuations in the market value of these marketable equity instruments, prior to eventual sale, are excluded from earnings and are reported in accumulated other comprehensive income, which is a separate component of stockholders’ equity.  Upon the sale of these equity securities to a third party, gains and losses, which are measured from the acquisition price, are recognized in our consolidated statements of income.

 

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

 

We consider our marketable equity securities accounting policies to be critical, as the timing and amount of income, if any, from these instruments typically depend upon factors beyond our control.  These factors include the general condition of the public equity markets, levels of mergers and acquisitions activity, fluctuations in the market prices of the underlying common stock of these companies, and legal and contractual restrictions on our ability to sell the underlying securities.  Hence, the amount of income we realize from these equity instruments in future periods may vary materially from the current unrealized amount of $0.1 million and are likely to vary materially from period to period.

 

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.

 

28



 

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.

 

Investment Accounting, Adjust To Fair Value

and SVB Strategic Investors Fund, L.P.

 

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 $31.3 million at March 31, 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 $9.9 million at March 31, 2003 and $10.0 million at December 31, 2002 and are recorded at fair value using investment accounting rules.  The investments consist of stock in private companies that are not traded on a public market and are subject to restrictions on resale.  These investments are carried at estimated fair value as determined by the general partner, Silicon Valley BancVentures, Inc.  The valuation generally remains at cost until such time that there is significant evidence of a change in values based upon consideration of the relevant market conditions, offering prices, operating results, financial conditions, exit strategies, and other pertinent information.  Silicon Valley BancVentures, Inc. is owned and controlled by Silicon and has an ownership interest of 10.7% in Silicon Valley BancVentures, L.P.  Therefore, Silicon Valley BancVentures, L.P. is fully consolidated and any gains or losses resulting from changes in the estimated fair value of the investments are recorded as investment gains or losses in our consolidated statements of income.  The portion of any gains or losses belonging to the limited partners is reflected in minority interest and adjusts Silicon’s income to its percentage ownership.

 

The SVB Strategic Investors Fund, L.P. portfolio consists primarily of investments in venture capital funds.  These funds totaled $20.9 million at March 31, 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,

 

29



 

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 4 to the Consolidated Financial Statements — Investments,” for the carrying value of our non-marketable venture capital and other private equity investments for the three months ended March 31, 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 March 31, 2003 represents our best interpretation of the underlying equity securities performance at this 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

 

30



 

yet realized.  The process of anticipating loan losses is imprecise.  Our management applies the following evaluation process to our loan portfolio to estimate the required allowance for loan losses.

 

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

 

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

 

Historical Loan Loss Migration Model

 

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

 

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.

 

31



 

Macro Allocations

 

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

 

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

 

(1)

 

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

(2)

 

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

(3)

 

Changes in the nature of our loan portfolio

(4)

 

Changes in experience, ability and depth of lending management and staff

(5)

 

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

(6)

 

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

 

 

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

 

In addition to risk-rating every loan in our portfolio, our management concluded that our allowance for loan and lease losses at March 31, 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 $17.2 million in our average loan balance between December 31, 2002 and March 31, 2003

(4)

 

A continued weakness in the U.S. economy

(5)

 

A declining venture capital fund investment into our clients in our core industry sectors

 

 

We consider our allowance for loan losses at March 31, 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

 

32



 

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 “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Note 1 to the Consolidated Financial Statements — Significant Accounting Policies,” we adopted the provisions of Statement of Financial Accounting Standard No. 142 (“SFAS No.142”), “Goodwill and Other Intangible Assets” on January 1, 2002.  Under this standard, we are required to test intangible assets identified as having an indefinite useful life for impairment in accordance with the provisions of SFAS No. 142 each year.

 

In testing for a potential impairment of goodwill, SFAS 142 requires us to: (1) allocate goodwill to the reporting units to which the acquired goodwill relates, (2) estimate the fair value of those reporting units to which goodwill relates, and (3) determine the carrying value (book value) of those reporting units.  Furthermore, if the estimated fair value is less than the carrying value for a particular reporting unit, then we are required to estimate the fair value of all identifiable assets and liabilities of the reporting unit in a manner similar to a purchase price allocation for an acquired business.  Only after this process is completed is the amount of goodwill impairment determined.  Accordingly, the process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment at many points during the analysis.

 

Substantially all of our goodwill pertains to the acquisition of Alliant, discussed in “Part 1. Financial Information — Item 1. Notes to the interim Consolidated Financial Statements — Note 2 to the Consolidated Financial Statements — Business Combinations.”  In accordance with the provisions of SFAS No. 142, the goodwill balance was determined to be unamortizable.  We completed our initial test for goodwill impairment in July 2002.  Based on our best estimates, we have concluded that there is no impairment of our goodwill.  However, changes in these estimates could cause the businesses to be valued differently.  If Alliant does not meet projected operating results, then this analysis could potentially result in a non-cash goodwill impairment charge, depending on the estimated value of the Alliant business unit and the value of the other assets and liabilities attributed to the business.  We will perform the test of impairment in July 2003, and do not anticipate an impairment of goodwill.  At March 31, 2003, our goodwill totaled $100.6 million.

 

Earnings Summary

 

We reported net income of $10.4 million, or $0.26 per diluted share, for the first quarter of 2003, compared with net income of $13.4 million, or $0.29 per diluted share, for the first quarter of 2002.  The annualized return on average assets (ROA) was 1.1% in the first quarter of 2003 compared with 1.3% in the first quarter of 2002.  The annualized return on average equity (ROE) for the first quarter of 2003 was 7.3%, compared with 8.5% in the first quarter of 2002.

 

The decrease in net income for the first quarter of 2003, as compared with the first quarter of 2002, primarily resulted from a decline in net interest income combined with an increase in noninterest expense, partially offset by an increase in noninterest income and a decline in income

 

33



 

tax expense.  The decrease in net interest income was primarily due to a 50 basis point decline in the average prime rate.  The major components of net income and changes in these components are summarized in the following table for the three months ended March 31, 2003 and 2002, and are discussed in more detail below.

 

 

 

For the Three Months Ended March 31,

 

 

 

 

 

 

 

2002 to 2003

 

(Dollars in thousands)

 

2003

 

2002

 

Increase (Decrease)

 

 

 

 

 

 

 

 

 

Net interest income

 

$

47,978

 

$

49,002

 

$

(1,024

)

Provision for loan losses

 

3,384

 

3,426

 

(42

)

Noninterest income

 

17,446

 

16,901

 

545

 

Noninterest expense

 

50,108

 

43,318

 

6,790

 

Minority interest

 

3,479

 

1,840

 

1,639

 

Income before income taxes

 

15,411

 

20,999

 

(5,588

)

Income tax expense

 

4,993

 

7,639

 

(2,646

)

Net income

 

$

10,418

 

$

13,360

 

$

(2,942

)

 

Net Interest Income and Margin

 

Net interest income is defined as the difference between interest earned, primarily on loans, investment securities, federal funds sold, 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, average yields and rates, and the composition of our net interest margin for the three months ended March 31, 2003 and 2002, respectively.

 

34



 

 

 

 

AVERAGE BALANCES, RATES AND YIELDS

 

 

 

For the three months ended March 31,

 

 

 

2003

 

2002

 

 

 

 

 

Interest

 

 

 

 

 

Interest

 

 

 

 

 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

(Dollars in thousands)

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

248,384

 

$

830

 

1.4

%

$

55,709

 

$

245

 

1.8

%

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

1,233,457

 

10,377

 

3.4

 

1,631,706

 

13,850

 

3.4

 

Non-taxable (2)

 

144,727

 

2,455

 

6.9

 

234,865

 

3,023

 

5.2

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

1,547,717

 

34,241

 

9.0

 

1,435,717

 

34,699

 

9.8

 

Real estate construction and term

 

100,879

 

1,437

 

5.8

 

102,720

 

1,913

 

7.6

 

Consumer and other

 

207,899

 

2,158

 

4.2

 

135,555

 

1,713

 

5.1

 

Total loans

 

1,856,495

 

37,836

 

8.3

 

1,673,992

 

38,325

 

9.3

 

Total interest-earning assets

 

3,483,063

 

51,498

 

6.0

 

3,596,272

 

55,443

 

6.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

185,405

 

 

 

 

 

210,467

 

 

 

 

 

Allowance for loan losses

 

(73,094

)

 

 

 

 

(74,393

)

 

 

 

 

Goodwill

 

100,571

 

 

 

 

 

96,399

 

 

 

 

 

Other assets

 

198,616

 

 

 

 

 

186,916

 

 

 

 

 

Total assets

 

$

3,894,561

 

 

 

 

 

$

4,015,661

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

$

22,214

 

25

 

0.5

 

$

45,449

 

84

 

0.7

 

Regular money market deposits

 

306,882

 

456

 

0.6

 

341,150

 

834

 

1.0

 

Bonus money market deposits

 

609,104

 

903

 

0.6

 

641,365

 

1,576

 

1.0

 

Time deposits

 

558,558

 

1,067

 

0.8

 

673,730

 

2,404

 

1.4

 

Short-term borrowings

 

9,153

 

69

 

3.1

 

43,453

 

275

 

2.6

 

Long-term debt

 

17,451

 

141

 

3.3

 

25,762

 

210

 

3.3

 

Total interest-bearing liabilities

 

1,523,362

 

2,661

 

0.7

 

1,770,909

 

5,383

 

1.2

 

Portion of noninterest-bearing funding sources

 

1,959,701

 

 

 

 

 

1,825,363

 

 

 

 

 

Total funding sources

 

3,483,063

 

2,661

 

0.3

 

3,596,272

 

5,383

 

0.6

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

1,662,936

 

 

 

 

 

1,507,440

 

 

 

 

 

Other liabilities

 

57,767

 

 

 

 

 

34,712

 

 

 

 

 

Trust preferred securities (3)

 

38,701

 

 

 

 

 

38,643

 

 

 

 

 

Minority interest

 

36,516

 

 

 

 

 

27,910

 

 

 

 

 

Stockholders’ equity

 

575,279

 

 

 

 

 

636,047

 

 

 

 

 

Portion used to fund interest-earning assets

 

(1,959,701

)

 

 

 

 

(1,825,363

)

 

 

 

 

Total liabilities, minority interest, and stockholders’ equity

 

$

3,894,561

 

 

 

 

 

$

4,015,661

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income and margin

 

 

 

$

48,837

 

5.7

%

 

 

$

50,060

 

5.6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total deposits

 

$

3,159,694

 

 

 

 

 

$

3,209,134

 

 

 

 

 


(1)     Includes average interest-bearing deposits in other financial institutions of $1,311 and $2,463 for the three months ended March 31, 2003 and 2002, respectively.

(2)     Interest income on non-taxable investments is presented on a fully taxable-equivalent basis using the federal statutory rate of 35% in 2003 and 2002.  The tax equivalent adjustments were $859 and $1,058 for the three months ended March 31, 2003 and 2002, respectively.

(3)     The 8.25% annual distribution to SVB Capital I, which is a special-purpose trust formed for the purpose of issuing the trust preferred securities, is recorded as a component of noninterest expense.

 

35



 

Net interest income is affected by changes in the amount and mix of interest-earnings assets and interest-bearing liabilities, referred to as “volume change.”  Net interest income is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabilities, referred to as “rate change.”  The following table sets forth changes in interest income and interest expense for each major category of interest-earning assets and interest-bearing liabilities.  The table also reflects the amount of simultaneous change attributable to both volumes and rates for the periods indicated.  For this table, changes that are not solely due to either volume or rate are allocated in proportion to the percentage changes in average volume and average rate.  Changes relating to investments in non-taxable municipal securities are presented on a fully taxable-equivalent basis using the federal statutory rate of 35% in 2003 and 2002.

 

 

 

2003 Compared to 2002

 

 

 

Three Months Ended March 31,

 

 

 

(Decrease) Increase

 

 

 

Due to Change in

 

(Dollars in thousands)

 

Volume

 

Rate

 

Total

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

Federal funds sold and securitiespurchased under agreement to resell

 

$

657

 

$

(72

)

$

585

 

Investment securities

 

(4,713

)

672

 

(4,041

)

Loans

 

3,950

 

(4,439

)

(489

)

Decrease in interest income

 

(106

)

(3,839

)

(3,945

)

Interest expense:

 

 

 

 

 

 

 

NOW deposits

 

(33

)

(26

)

(59

)

Regular money market deposits

 

(77

)

(301

)

(378

)

Bonus money market deposits

 

(76

)

(597

)

(673

)

Time deposits

 

(360

)

(977

)

(1,337

)

Short-term borrowings

 

(250

)

44

 

(206

)

Long-term debt

 

(67

)

(2

)

(69

)

Decrease in interest expense

 

(863

)

(1,859

)

(2,722

)

Increase (decrease) in net interest income

 

$

757

 

$

(1,980

)

$

(1,223

)

 

Net interest income, on a fully taxable-equivalent basis, totaled $48.8 million for the first quarter of 2003, a decrease of $1.2 million, or 2.4%, from the $50.1 million total for the first quarter of 2002.  The decrease in net interest income for the first quarter of 2003 was due to a $3.9 million, or 7.1%, decrease in interest income, offset by a $2.7 million, or 50.6%, decrease in interest expense over the first quarter of 2002.

 

We have implemented numerous measures to minimize the impact of the decline in market interest rates.  These measures included diversifying the product mix in the investment portfolio to higher-yielding, high-quality assets, reducing rates paid on interest-bearing deposits, and embedding minimum interest rate “floors” into client loan agreements.  We also increased the average expected life of investments in our portfolio by replacing some assets from lower-yielding short-term securities to higher-yielding longer-term securities, thereby taking advantage of the steeper interest rate curve.  Overall, the expected average life of portfolio investments was approximately 1.7 years at March 31, 2003.

 

The $3.9 million decrease in interest income for the first quarter of 2003, as compared to the first quarter of 2002, was primarily the result of a $3.8 million unfavorable rate variance.

 

36



 

Average loans increased $182.5 million, or 10.9%, in the 2003 first quarter as compared to the 2002 first quarter, resulting in a $4.0 million favorable volume variance.  We grew our total average loan portfolio to a record level for the fourth consecutive quarter, in part by refocusing on attracting middle-market and mature technology and life sciences clients, which we believe are currently under-served by competitors exiting these industry sectors.  We experienced loan growth across most of the industry sectors we served.  Nevertheless, new loans continue to be subject to our sound underwriting practices.  We expect loan growth to continue in the latter half of 2003, although at a slower pace than we experienced in 2002.  We expect further growth in our loan balances to bolster our net interest margin since it will shift lower yielding short-term, highly-liquid interest-earning assets, to loans with yields ranging from approximately 4.2% to 9.0%.

 

Average investment securities for the first quarter of 2003 decreased $488.4 million, or 26.2%, as compared to the 2002 first quarter, resulting in a $4.7 million unfavorable volume variance.  The decrease in average investment securities was primarily centered in U.S. agency securities, obligations of states and political subdivisions, and money market mutual funds, which collectively decreased $700.1 million.  These decreases were partially offset by a $300.4 million increase in mortgage-backed securities.  The decrease in average investment securities resulted from a shift in interest-earning assets to loans and federal funds sold.  Additionally, we repurchased approximately 7.5 million shares of common stock for approximately $142.3 million from the second quarter of 2002 through the first quarter of 2003, thus reducing our investable funds.

 

Average federal funds sold and securities purchased under agreement to resell in the first quarter of 2003 increased $192.7 million, or 345.9%, from the first quarter of 2002, resulting in a $0.7 million favorable volume variance.  We shifted funds from money market mutual funds to federal funds sold and securities purchased under agreement to resell, which provided comparatively higher yields in the 2003 first quarter.

 

Unfavorable rate variances associated with federal funds sold and securities purchased under agreement to resell and loans caused a $4.5 million decline in our interest income for the first quarter of 2003 as compared to the first quarter of 2002.  Short-term market interest rates decreased 50 basis points in November 2002.  Thus, we earned lower yields in the first quarter of 2003 on federal funds sold and securities purchased under agreements to resell.

 

In the first quarter of 2003, we incurred a $4.4 million unfavorable rate variance associated with our loan portfolio.  The average yield on loans in first quarter 2003 decreased 100 basis points to 8.3% from 9.3% in the prior year first quarter.  This was primarily due to two related factors.  First, the lower average prime rate reduced yields on floating rate loans, which represent approximately 81% of our total loan portfolio.  The weighted-average prime rate declined 50 basis points from 4.8% in the first quarter of 2002 to 4.3% in the first quarter of 2003. Second, our fixed-rate loans are priced by reference to U.S. Treasury securities.  During 2002, the treasury yield curve moved lower and flattened.  Thus, we earned lower yields in new, renewed, and refinanced fixed rate loans.  Active management of the investment portfolio assets resulted in a higher yield in investment securities primarily due to a shift in investments to mortgage-backed securities.  Many elements of our interest-earning assets are extremely interest rate sensitive, thus we expect that any increase in interest rates will be incremental to our earnings.

 

The yield on average interest-earning assets decreased 30 basis points in the first quarter of 2003 from the first quarter of 2002.  This decrease primarily resulted from a decline in market interest rates.

 

37



 

Total interest expense in the 2003 first quarter decreased $2.7 million from the first quarter of 2002.  This decrease was due to a favorable volume variance of $0.9 million combined with a favorable rate variance of $1.9 million.  The favorable rate variance primarily resulted from a reduction in the average rate paid on our time deposit product, from 1.4% in the first quarter 2002 to 0.8% in the first quarter of 2003.

 

The average cost of funds paid in the first quarter of 2003 was 0.3%, down from 0.6% paid in the first quarter of 2002.  The decrease in the average cost of funds was largely due to a decrease of 60 basis points in the average rate paid on our time deposit product.

 

Provision For Loan Losses

 

The provision for loan losses is based on our evaluation of the adequacy of the existing allowance for loan losses in relation to total loans, and on our periodic assessment of the inherent and identified risk dynamics of the loan portfolio resulting from reviews of selected individual loans and loan commitments.

 

Our provision for loan losses totaled $3.4 million for the first quarter of 2003, relatively unchanged from the first quarter of 2002. We incurred net charge-off of $3.9 million in the first quarter of 2003, as compared to $4.4 million in the first quarter of 2002.  See “Financial Condition - Credit Quality and the Allowance for Loan Losses” for additional related discussion.

 

Noninterest Income

 

The following table summarizes the components of noninterest income for the three months ended March 31, 2003 and 2002:

 

 

 

For the Three Months Ended March 31,

 

(Dollars in thousands)

 

2003

 

2002

 

 

 

 

 

 

 

Client investment fees

 

$

6,332

 

$

8,638

 

Corporate finance fees

 

4,144

 

2,962

 

Letter of credit and foreign exchange income

 

3,503

 

3,777

 

Deposit service charges

 

2,876

 

2,236

 

Disposition of client warrants

 

1,962

 

126

 

Investment losses

 

(4,705

)

(2,597

)

Other

 

3,334

 

1,759

 

Total noninterest income

 

$

17,446

 

$

16,901

 

 

Noninterest income increased $0.5 million to a total of $17.4 million in the first quarter of 2003, as compared to $16.9 million in the first quarter of 2002.  This increase was primarily due to an increase of $1.8 million in the disposition of client warrants and a $1.2 million increase in corporate finance fees, partially offset by a decrease of $2.3 million in client investment fees.  Client investment fees totaled $6.3 million for the three months ended March 31, 2003, a decrease of $2.3 million, or 26.7%, from $8.6 million in the first quarter of 2002.  We offer private label investment and sweep products to clients on which we earn fees ranging from 14 to 95 basis points on the average balance of these products.  At March 31, 2003, $8.1 billion in client funds were invested in private label investments and sweep products, including $6.2 billion in the mutual fund products compared to $8.9 billion and $7.1 billion for the first quarter of 2002, respectively.  The decrease in client investment fees was due to a shift of client funds from more profitable products to less profitable ones combined with a decline in our clients’ balances.

 

38



 

             In the third quarter of 2002, we completed a short-term initiative of transferring the private label investment operations from Silicon Valley Bank into a wholly-owned registered, broker-dealer subsidiary of Silicon Valley Bank.  In the first quarter of 2003, we formed a registered investment advisor unit to attract larger private-label client investment balances.  These actions will allow us to provide a more expansive and competitive array of investment products and service to our clients.  While the fees earned per dollar managed has been reduced, we expect to make up for the lower fees though greater volume.  We expect average client investment balances in the second quarter of 2003 to be slightly below the first quarter of 2003.  However, as we continue to re-align our sales effort, we expect private-label client investment balances to increase later this year.

 

Corporate finance fees generated by Alliant, our mergers and acquisitions subsidiary, totaled $4.1 million in the first quarter of 2003, an increase of $1.2 million, or 39.9%, from the $3.0 million earned in the 2002 first quarter.  The increased pace of merger and acquisition deal closings caused first quarter revenues to be the second highest since we acquired Alliant.  Due to the nature of the mergers and acquisitions industry, we expect Alliant revenues to continue to be volatile, but to exhibit a general upward trend over the long run.

 

Letter of credit fees, foreign exchange fees, and other trade finance income totaled $3.5 million in the first quarter of 2003, a decrease of $0.3 million, or 7.3%, from the $3.8 million earned in the first quarter of 2002.  The decrease in the first quarter of 2003 as compared to the 2002 first quarter was primarily due to lower volume of client exchange transactions, which resulted from the impact of recent global political events.

 

Deposit service charges totaled $2.9 million for the first quarter of 2003, an increase of $0.6 million, or 28.6% from the first quarter of 2002.  As we have expanded and enhanced our suite of fee-based financial (depository) services and client usage has increased, overall service fees have increased quarter over quarter.  Additionally, clients compensate us for depository services, either through earnings credits computed on their demand deposit balances, or via explicit payments we recognized as deposit service charges income.  Earnings credits are calculated using client average daily deposit balances, less a reserve requirement and a discounted U.S. Treasury bill interest rate.  Clients received lower earnings credits in the first quarter of 2003 as compared with the first quarter of 2002 due to lower average client deposit balances and lower market interest rates.  As such, our clients had fewer credits to offset explicit deposit service charges.  Thus, we earned higher explicit deposit service charges in the three months ended March 31, 2003, as compared to the three months ended March 31, 2002.

 

Income from disposition of client warrants totaled $2.0 million in the first quarter of 2003, an increase of $1.8 million, or 1,457.1%, from the $0.1 million in the first quarter of 2002.  We have historically obtained rights to acquire stock, in the form of warrants, in certain clients, primarily as part of negotiated credit facilities.  The receipt of warrants does not change the loan pricing, covenants or other collateral control techniques we employ to mitigate the risk of a loan becoming nonperforming.  The collateral requirements on loans with warrants are similar to lending arrangements where warrants are not obtained.  The timing and amount of income from the disposition of client warrants typically depends upon factors beyond our control, including the general condition of the public equity markets as well as the merger and acquisition environment.  We therefore cannot predict the timing and amount of warrant related income with any degree of accuracy and it is likely to vary materially from period to period.

 

39



 

Investment losses totaled $4.7 million in the first quarter of 2003, an increase of $2.1 million, or 81.2%, as compared to the first quarter of 2002.  This increase was primarily related to the write-down of certain venture capital fund and direct equity investments.  Excluding the impact of minority interest, the net write-downs of our equity securities totaled $1.7 million in the first quarter of 2003 compared to $1.3 million in the first quarter of 2002.  The increase in investment losses primarily related to our share of losses recorded by venture capital funds in which we invested either directly or through our managed funds.  During the first quarter of 2003, venture capital funds recorded write-downs in connection with year-end procedures and we recorded our share of those write-downs.  We expect future equity write-downs to be of a smaller magnitude than those we experienced in the 2003 first quarter.

 

Other noninterest income largely consists of service-based fee income, which increased $1.6 million, or 89.5%, to $3.3 million in the first quarter of 2003 from $1.8 million in the first quarter of 2002.  The increase in other noninterest income was primarily due to an increase in merchant and corporate card fees.

 

Noninterest Expense

 

Noninterest expense in the first quarter of 2003 totaled $50.1 million, a $6.8 million, or 15.7%, increase from the $43.3 million incurred in the 2002 first quarter. We closely monitor our level of noninterest expense using a variety of financial ratios, including the efficiency ratio.  The efficiency ratio is calculated by dividing adjusted noninterest expense by adjusted revenues.  Noninterest expense is adjusted to exclude costs associated with investments in tax credit funds, minority interest, and retention and warrant incentive plans.  Revenues are adjusted to exclude income associated with minority interest, the disposition of client warrants, and gains or losses related to investment securities.  This ratio reflects the level of operating expense required to generate $1 of operating revenue.  Our efficiency ratio was 71.4% for the first quarter of 2003, compared to 62.0% for the first quarter of 2002.  The following table presents the detail of noninterest expense and the incremental contribution of each expense line item to our efficiency ratio:

 

40



 

 

 

Three Months Ended March 31,

 

 

 

2003

 

2002

 

 

 

 

 

Percent of

 

 

 

Percent of

 

 

 

 

 

Adjusted

 

 

 

Adjusted

 

(Dollars in thousands)

 

Amount

 

Revenues

 

Amount

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

$

31,432

 

46.2

%

$

24,928

 

36.5

%

Net occupancy

 

4,402

 

6.5

 

4,518

 

6.6

 

Professional services

 

3,439

 

5.1

 

3,036

 

4.4

 

Furniture and equipment

 

2,194

 

3.2

 

2,096

 

3.1

 

Business development and travel

 

1,616

 

2.4

 

2,123

 

3.1

 

Correspondent bank fees

 

1,040

 

1.5

 

707

 

1.0

 

Telephone

 

778

 

1.1

 

901

 

1.3

 

Postage and supplies

 

584

 

0.9

 

783

 

1.1

 

Trust preferred securities distributions

 

281

 

0.4

 

825

 

1.2

 

Other

 

3,369

 

4.9

 

2,952

 

4.5

 

Expenses incurred by minority interests

 

(532

)

(0.8

)

(537

)

(0.8

)

Total, excluding cost of, tax credit funds amortization, minority interest, and retention and warrant incentive plans

 

48,603

 

71.4

%

42,332

 

62.0

%

Tax credit funds amortization