SVB Financial Group
SILICON VALLEY BANCSHARES (Form: 10-Q, Received: 05/07/2004 16:23:39)

 

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, 2004

 

 

 

OR

 

 

 

o

 

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

 

 

 

For the transition period from               to           .

 

Commission File Number: 000-15637

 

SILICON VALLEY BANCSHARES

(Exact name of registrant as specified in its charter)

 

Delaware

 

91-1962278

(State or other jurisdiction of
incorporation or organization)

 

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

 

 

 

3003 Tasman Drive, Santa Clara, California

 

95054-1191

(Address of principal executive offices)

 

(Zip Code)

 

 

 

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, 2004, 35,318,047 shares of the registrant’s common stock ($0.001 par value) were outstanding.

 

 



 

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION

 

 

 

 

ITEM 1.

INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

 

CONSOLIDATED BALANCE SHEETS

 

 

 

 

 

CONSOLIDATED STATEMENTS OF INCOME

 

 

 

 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

 

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

 

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

ITEM 2.

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

 

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

 

 

 

ITEM 4.

CONTROLS AND PROCEDURES

 

 

 

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

ITEM 1.

LEGAL PROCEEDINGS

 

 

 

 

ITEM 2.

CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

 

 

 

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

 

 

 

 

INDEX TO EXHIBITS

 

 

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)

 

2004

 

2003

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Cash and due from banks

 

$

200,966

 

$

252,521

 

Federal funds sold and securities purchased under agreement to resell

 

489,453

 

542,475

 

Investment securities

 

1,709,180

 

1,575,434

 

Loans, net of unearned income

 

1,992,707

 

1,989,229

 

Allowance for loan losses

 

(63,300

)

(64,500

)

Net loans

 

1,929,407

 

1,924,729

 

Premises and equipment

 

14,316

 

14,999

 

Goodwill

 

37,549

 

37,549

 

Accrued interest receivable and other assets

 

111,384

 

117,663

 

Total assets

 

$

 4,492,255

 

$

 4,465,370

 

 

 

 

 

 

 

Liabilities, minority interest, and stockholders’ equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing demand

 

$

2,161,633

 

$

2,186,352

 

NOW

 

27,521

 

20,897

 

Money market

 

1,150,791

 

1,080,559

 

Time

 

336,348

 

379,068

 

Total deposits

 

3,676,293

 

3,666,876

 

Short-term borrowings

 

9,761

 

9,124

 

Other liabilities

 

71,070

 

87,335

 

Long-term debt

 

202,763

 

204,286

 

Total liabilities

 

3,959,887

 

3,967,621

 

 

 

 

 

 

 

Minority interest in capital of consolidated affiliates

 

55,935

 

50,744

 

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; 35,236,779 and 35,028,470 shares outstanding at March 31, 2004 and December 31, 2003, respectively

 

35

 

35

 

Additional paid-in capital

 

23,586

 

14,240

 

Retained earnings

 

436,144

 

422,131

 

Unearned compensation

 

(925

)

(1,232

)

Accumulated other comprehensive income:

 

 

 

 

 

Net unrealized gains on available-for-sale investments

 

17,593

 

11,831

 

Total stockholders’ equity

 

476,433

 

447,005

 

Total liabilities, minority interest, and stockholders’ equity

 

$

 4,492,255

 

$

 4,465,370

 

 

See accompanying notes to interim consolidated financial statements.

 

3



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

 INTERIM CONSOLIDATED STATEMENTS OF INCOME

 

 

 

For the three months ended March 31,

 

(Dollars in thousands, except per share amounts)

 

2004

 

2003

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

Loans

 

$

36,632

 

$

37,836

 

Investment securities:

 

 

 

 

 

Taxable

 

14,023

 

10,377

 

Non-taxable

 

1,461

 

1,596

 

Federal funds sold and securities purchased under agreement to resell

 

1,444

 

830

 

Total interest income

 

53,560

 

50,639

 

Interest expense:

 

 

 

 

 

Deposits

 

2,014

 

2,451

 

Other borrowings

 

726

 

210

 

Total interest expense

 

2,740

 

2,661

 

Net interest income

 

50,820

 

47,978

 

Provision for loan losses

 

17

 

3,384

 

Net interest income after provision for loan losses

 

50,803

 

44,594

 

Noninterest income:

 

 

 

 

 

Client investment fees

 

6,268

 

6,332

 

Corporate finance fees

 

4,087

 

4,144

 

Letter of credit and foreign exchange income

 

3,729

 

3,503

 

Deposit service charges

 

3,713

 

2,876

 

Income from client warrants

 

2,908

 

1,962

 

Investment gains (losses)

 

1,322

 

(4,705

)

Credit card fees

 

777

 

1,046

 

Other

 

2,082

 

2,288

 

Total noninterest income

 

24,886

 

17,446

 

Noninterest expense:

 

 

 

 

 

Compensation and benefits

 

34,103

 

31,690

 

Net occupancy

 

4,523

 

4,402

 

Professional services

 

3,339

 

3,439

 

Furniture and equipment

 

2,909

 

2,194

 

Business development and travel

 

1,991

 

1,616

 

Correspondent bank fees

 

1,281

 

1,040

 

Data processing services

 

1,085

 

1,091

 

Telephone

 

782

 

778

 

Postage and supplies

 

772

 

584

 

Tax credit fund amortization

 

620

 

715

 

Trust preferred securities distributions

 

 

281

 

Other

 

1,764

 

2,278

 

Total noninterest expense

 

53,169

 

50,108

 

Minority interest in net (gains) losses of consolidated affiliates

 

(481

)

3,479

 

Income before income tax expense

 

22,039

 

15,411

 

Income tax expense

 

8,029

 

4,993

 

Net income

 

$

14,010

 

$

10,418

 

Earnings per common share - basic

 

$

0.40

 

$

0.27

 

Earnings per common share - diluted

 

$

0.38

 

$

0.26

 

 

See accompanying notes to interim consolidated financial statements.

 

4



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

 

For the three months ended

 

(Dollars in thousands)

 

March 31,
2004

 

March 31,
2003

 

 

 

 

 

 

 

Net income

 

$

14,010

 

$

10,418

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

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

 

 

 

 

 

Unrealized holding gains (losses)

 

8,025

 

(1,378

)

Reclassification adjustment for gains included in net income

 

(2,263

)

(1,326

)

Other comprehensive income (loss), net of tax

 

5,762

 

(2,704

)

Comprehensive income

 

$

19,772

 

$

7,714

 

 

See accompanying notes to interim consolidated financial statements.

 

5



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

For the three months ended

 

(Dollars in thousands)

 

March 31,
2004

 

March 31,
2003

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

14,010

 

$

10,418

 

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

 

 

 

 

 

Provision for loan losses

 

17

 

3,384

 

Minority interest

 

481

 

(3,479

)

Depreciation and amortization

 

1,959

 

1,973

 

Net (gains) losses on available-for-sale securities

 

(1,322

)

4,705

 

Net gains on disposition of client warrants

 

(2,908

)

(1,962

)

Changes in other assets and liabilities:

 

 

 

 

 

Deferred income tax expense (benefits)

 

2,201

 

(1,393

)

Increase in income tax receivable

 

(5,003

)

(553

)

Decrease in unearned income

 

367

 

1,184

 

(Decrease) increase in accrued retention, warrant, and other incentive plans

 

(10,869

)

2,025

 

Other, net

 

3,979

 

2,163

 

Net cash provided by operating activities

 

2,912

 

18,465

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities and paydowns of investment securities

 

600,446

 

224,825

 

Proceeds from sales of investment securities

 

2,090,295

 

2,909,648

 

Purchases of investment securities

 

(2,811,393

)

(2,897,229

)

Net (increase) decrease in loans

 

(7,900

)

6,129

 

Proceeds from recoveries of charged-off loans

 

2,838

 

4,820

 

Purchases of premises and equipment

 

(1,276

)

(310

)

Net cash (used) provided by investing activities

 

(126,990

)

247,883

 

Cash flows from financing activities:

 

 

 

 

 

Net increase (decrease) in deposits

 

9,417

 

(185,033

)

Increase in short-term borrowings

 

567

 

 

Capital contributions from minority interest participants

 

4,710

 

7,075

 

Proceeds from issuance of common stock

 

4,807

 

553

 

Repurchases of common stock

 

 

(32,545

)

Net cash provided (used) by financing activities

 

19,501

 

(209,950

)

Net (decrease) increase in cash and cash equivalents

 

(104,577

)

56,398

 

Cash and cash equivalents at January 1,

 

794,996

 

442,589

 

Cash and cash equivalents at March 31,

 

$

690,419

 

$

498,987

 

Supplemental disclosures:

 

 

 

 

 

Interest paid

 

$

2,599

 

$

2,743

 

Income taxes paid

 

$

7,548

 

$

4,748

 

 

See accompanying notes to interim consolidated financial statements.

 

6



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

1.  Summary of Significant Accounting Policies

 

Silicon Valley Bancshares and its subsidiaries (the “Company”) offer its clients financial products and services through its five lines of banking and financial services: Commercial Banking, Merchant Banking, Investment Banking, Private Client Services (formerly Private Banking), and Other Business Services. These operating segments are strategic units that offer different services to different clients, and are managed separately because each segment appeals to different markets and, accordingly, require different strategies.  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 26 regional offices.  The Bank has 12 offices throughout California and operates regional offices across the country, including Arizona, Colorado, Georgia, Illinois, Massachusetts, Minnesota, New York, North Carolina, Oregon, Pennsylvania, Texas, Virginia, and Washington.  The Bank serves emerging growth and mature companies in the technology and life sciences markets, as well as the premium wine industry.  Merger, acquisition, private placement and corporate partnering services are provided through the Company’s wholly-owned investment banking subsidiary, SVB Alliant, formerly Alliant Partners, whose offices are in Northern California and Boston.

 

The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America.  Certain reclassifications have been made to the Company’s 2003 interim consolidated financial statements to conform to the 2004 presentations.  Such reclassifications had no effect on the results of operations or stockholders’ equity.

 

Descriptions of the Company’s significant accounting policies are included in the Company’s 2003 Annual Report on Form 10-K under “Item 8. Consolidated Financial Statements and Supplementary Data — Note 1 to the Consolidated Financial Statements – Summary of Significant Accounting Policies .”   As of March 31, 2004, there have been no significant changes to these policies, except as included herein.

 

Basis of Presentation and Preparation

 

The interim consolidated financial statements include the accounts of Silicon Valley Bancshares and its subsidiaries.  Intercompany accounts and transactions have been eliminated in consolidation.  For a description of accounting policies related to consolidation, refer to the Company’s 2003 Annual Report on Form 10-K.

 

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 materially from those estimates.  An estimate of possible changes or a range of possible changes cannot be made.  For more information on the Company’s critical accounting policies and estimates, refer to the Company’s 2003 Annual Report on Form 10-K under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies.”

 

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, 2004, and the interim results of its operations and interim cash flows for the three months ended March 31, 2004 and 2003. The December 31, 2003 Consolidated Balance Sheet was derived from audited financial statements.  Certain information and footnote disclosures normally presented have been omitted from this report. The results of operations for the three months ended March 31, 2004, 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 2003 Annual Report on Form 10-K.

 

7



 

Stock-Based Compensation

 

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

 

Had compensation cost related to both the Company’s stock option awards to employees and directors and to the Employee Stock Purchase Plan been determined under the fair value method prescribed under SFAS No. 123, the Company’s net income, basic earnings per share, and diluted earnings per share would have been the pro-forma amounts below:

 

 

 

For the three months ended

 

 

 

March 31,

 

(Dollars in thousands, except per share amounts)

 

2004

 

2003

 

 

 

 

 

 

 

Net income, as reported

 

$

14,010

 

$

10,418

 

Add:

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

 

132

 

138

 

Less:

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

 

(4,280

)

(3,712

)

Net income, pro-forma

 

$

9,862

 

$

6,844

 

 

 

 

 

 

 

Earnings per common share—basic:

 

 

 

 

 

As reported

 

$

0.40

 

$

0.27

 

Pro-forma

 

0.28

 

0.18

 

Earnings per common share—diluted:

 

 

 

 

 

As reported

 

0.38

 

0.26

 

Pro-forma

 

0.28

 

0.18

 

 

Refer to the Company’s 2003 Annual Report on Form 10-K under “Item 8. Consolidated Financial Statements and Supplementary Data — Note 18 to the Consolidated Financial Statements – Employee Benefit Plans” for assumptions used in calculating the pro-forma amounts above.

 

8



 

2.  Earnings Per Share (EPS)

 

The following is a reconciliation of basic EPS to diluted EPS for the three months ended March 31, 2004 and 2003:

 

 

 

For the three months ended

 

 

 

March 31,

 

 

 

Net

 

 

 

Per Share

 

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

 

Income

 

Shares

 

Amount

 

 

 

 

 

 

 

 

 

2004:

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

Income available to common stockholders

 

$

14,010

 

34,881

 

$

0.40

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options and restricted stock

 

 

1,841

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

Income available to common stockholders plus assumed conversions

 

$

14,010

 

36,722

 

$

0.38

 

 

 

 

 

 

 

 

 

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

 

 

3.  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)

 

2004

 

2003

 

 

 

 

 

 

 

Available-for-sale securities, at fair value

 

$

1,607,180

 

$

1,479,383

 

Non-marketable securities at cost:

 

 

 

 

 

Venture capital fund investments (1)

 

59,396

 

55,345

 

Other private equity investments (2)

 

16,166

 

13,679

 

Tax credit funds

 

15,931

 

16,551

 

Federal Reserve Bank stock

 

7,468

 

7,467

 

Federal Home Loan Bank stock

 

3,039

 

3,009

 

Total non-marketable securities

 

102,000

 

96,051

 

Total investment securities

 

$

1,709,180

 

$

1,575,434

 

 


(1)    Non-marketable venture capital fund investments included $33.1 million and $30.1 million related to SVB Strategic Investors Fund, L.P., at March 31, 2004, and December 31, 2003, 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 $30.0 million and $28.5 million as of March 31, 2004 and December 31, 2003, respectively.

(2)    Non-marketable other private equity investments included $13.5 million and $10.0 million related to Silicon Valley BancVentures, L.P., at March 31, 2004, and December 31, 2003, 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 $4.1 million and $4.7 million as of March 31, 2004, and December 31, 2003, respectively.

 

9



 

The following tables present the carrying value of the Company’s non-marketable venture capital and other private equity investments at and for the three months ended March 31, 2004.  For the carrying value of the Company’s non-marketable venture capital and other private equity investments at and for the year ended December 31, 2003, please refer to “Item 8. Consolidated Financial Statements and Supplementary Data — Note 6 to the Consolidated Financial Statements – Investment Securities” in the Company’s 2003 Annual Report on Form 10-K.

 

 

 

(As consolidated)

 

 

Venture Capital Funds

 

Other Private Equity

 

 

 

 

 

Wholly-
owned

 

SVB Strategic
Investors
Fund, L.P. (1)

 

Wholly-
owned

 

Silicon Valley
BancVentures,
L.P. (1)

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments by investors to managed funds

 

 

$

121,800

 

$

 

$

56,100

 

$

177,900

 

Commitments to investments

 

$

84,133

 

101,763

 

15,946

 

21,426

 

223,268

 

Commitments yet to be funded

 

41,676

 

52,430

 

 

 

94,106

 

Carrying value

 

26,331

 

33,065

 

2,617

 

13,549

 

75,562

 

Net investment (losses) gains

 

(577

)

529

 

(8

)

145

 

89

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(The Company’s ownership interest)

 

 

 

Venture Capital Funds

 

Other Private Equity

 

 

 

 

 

Wholly-
owned

 

SVB Strategic
Investors
Fund, L.P. (1)

 

Wholly-
owned

 

Silicon Valley
BancVentures,
L.P. (1)

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Commitments to investments

 

$

84,133

 

$

13,500

 

$

15,946

 

$

6,000

 

$

119,579

 

Commitments yet to be funded

 

41,676

 

7,560

 

 

3,180

 

52,416

 

Carrying value

 

26,331

 

3,665

 

2,617

 

1,449

 

34,062

 

Net investment (losses) gains

 

(577

)

59

 

(8

)

15

 

(511

)

Management fee revenue

 

 

249

 

 

271

 

520

 

 


(1)   Funds managed by affiliates of Silicon Valley Bancshares.

 

10



 

4.  Loans and Allowance for Loan Losses

 

The detailed composition of loans, net of unearned income of $12.6 million and $12.3 million, at March 31, 2004, and December 31, 2003, respectively, is presented in the following table:

 

 

 

March 31,

 

December 31,

 

(Dollars in thousands)

 

2004

 

2003

 

 

 

 

 

 

 

Commercial

 

$

1,685,762

 

$

1,703,986

 

 

 

 

 

 

 

Vineyard development

 

60,359

 

50,118

 

Commercial real estate

 

11,578

 

12,204

 

Total real estate construction

 

71,937

 

62,322

 

 

 

 

 

 

 

Real estate term — consumer

 

16,524

 

19,213

 

Real estate term — commercial

 

14,370

 

12,902

 

Total real estate term

 

30,894

 

32,115

 

Consumer and other

 

204,114

 

190,806

 

Total loans, net of unearned income

 

$

1,992,707

 

$

1,989,229

 

 

The activity in the allowance for loan losses for the three months ended March 31, 2004 and 2003 was as follows:

 

 

 

Three months ended March 31,

 

(Dollars in thousands)

 

2004

 

2003

 

 

 

 

 

 

 

Beginning balance

 

$

64,500

 

$

70,500

 

Provision for loan losses

 

17

 

3,384

 

Loans charged off

 

(4,055

)

(8,704

)

Recoveries

 

2,838

 

4,820

 

Ending balance

 

$

63,300

 

$

70,000

 

 

The aggregate recorded investment in loans for which impairment has been determined in accordance with SFAS No. 114 totaled $14.0 million and $19.1 million at March 31, 2004, and March 31, 2003, respectively.  Allocations of the allowance for loan losses specific to impaired loans totaled $4.7 million at March 31, 2004, and $6.0 million at March 31, 2003.  Average impaired loans for the first quarter of 2004 and 2003 totaled $14.4 million and $17.6 million, respectively.

 

5.  Goodwill

 

The Company’s total goodwill balance was $37.5 million at March 31, 2004 and December 31, 2003.  Substantially all of the Company’s goodwill pertains to the acquisition of SVB Alliant (formerly Alliant Partners) and a minor portion relates to the acquisition of Woodside Asset Management, Inc.

 

During 2003, the Company conducted its annual valuation analyses of these reporting units in accordance with SFAS No. 142, primarily based on forecasted discounted cash flow analyses. The valuation analysis of Woodside Asset Management, Inc. reporting unit indicated no impairment.

 

However, SVB Alliant’s results of operations in 2003 were substantially below forecasted performance. Therefore, as required by SFAS No.142 in measuring the goodwill impairment amount, the Company made a hypothetical allocation of the reporting unit’s estimated fair value to the tangible and intangible assets (other than goodwill). The valuation analyses performed on this reporting unit, as of June 30, 2003, and again as of December 31, 2003, indicated impairment of goodwill of $17.0 million and $46.0 million, respectively. The Company expensed these amounts as impairment charges to continuing operations during the second and fourth quarters of 2003, respectively.  For a description of the Company’s accounting policies relating to goodwill, refer to the 2003 Annual Report on Form 10-K, under “Item 8. Consolidated Financial Statements and Supplementary Data — Note 1 to the Consolidated Financial Statements – Summary of Significant Accounting Policies.”

 

11



 

6.  Short-term Borrowings and Long-term Debt

 

The following table represents the outstanding short-term borrowings and long-term debt at March 31, 2004 and December 31, 2003:

 

 

 

 

 

March 31,

 

December 31,

 

(Dollars in thousands)

 

Maturity

 

2004

 

2003

 

 

 

 

 

 

 

 

 

Short-term borrowings:

 

 

 

 

 

 

 

Short-term note payable (1)

 

September 28, 2004

 

$

9,194

 

$

9,124

 

Other

 

May 11, 2004

 

567

 

 

Total short-term borrowings

 

 

 

$

9,761

 

$

9,124

 

 

 

 

 

 

 

 

 

Long-term debt:

 

 

 

 

 

 

 

Long-term note payable (1)

 

September 28, 2005

 

$

8,908

 

$

8,837

 

Convertible subordinated notes

 

June 15, 2008

 

146,032

 

145,797

 

Junior subordinated debentures

 

October 30, 2033

 

47,823

 

49,652

 

Total long-term debt

 

 

 

$

202,763

 

$

204,286

 

 


(1)        Relates to the acquisition of SVB Alliant, formerly Alliant Partners, and are payable to the former owners, who were employed by the Company.  These notes were discounted over their respective terms, based on market interest rates as of September 28, 2001.  R efer to Note 2 (Business Combinations) to the Consolidated Financial Statements in the Company’s 2003 Annual Report on Form 10-K.

 

On May 20, 2003, the Company issued $150.0 million of zero-coupon, convertible subordinated notes at face value, due June 15, 2008, to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933 and outside the United States to non-US persons pursuant to Regulation S under the Securities Act. The notes are convertible into the Company’s common stock at a conversion price of $33.6277 per share and are subordinated to all present and future senior debt of the Company. Holders of the notes may convert their notes only if: (i) the price of the Company’s common stock issuable upon conversion of a note reaches a specified threshold, (ii) specified corporate transactions occur, or (iii) the trading price for the notes falls below certain thresholds, which have not yet been reached. At the initial conversion price, each $1,000 principal amount of notes will be convertible into approximately 29.7374 shares of the Company’s common stock. The Company filed a shelf registration statement with respect to the resale of the notes and the common stock issuable upon the conversion of the notes with the SEC on August 14, 2003. The fair value of the convertible subordinated notes at March 31, 2004 was $168.1 million, based on quoted market prices. The Company intends to repay the principal of the notes in cash.

 

Concurrent with the issuance of the convertible notes, the Company entered into convertible note hedge and warrant transactions with respect to its common stock, with the objective of limiting its exposure to potential dilution from conversion of the notes. The terms and conditions of the convertible note hedge are disclosed in  “Part I. Financial Information—Item 1. Notes to the Interim Consolidated Financial Statements—Note 7 to the Interim Consolidated Financial Statements—Derivative Financial Instruments.”  The proceeds of the warrant transaction were included in stockholders’ equity in accordance with the guidance in Emerging Task Force Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”  Under the warrant agreement, Credit Suisse First Boston LLC may purchase up to approximately 4.4 million shares of the Company’s common stock at $51.34 per share, upon the occurrence of conversion events defined above. The warrant transaction will expire on June 15, 2008.

 

The Company currently has available federal funds and lines of credit facilities totaling $140.0 million, which were unused at March 31, 2004.

 

7.0% Junior Subordinated Debentures

 

On October 30, 2003, the Company issued $51.5 million in 7.0% Junior Subordinated Debentures to a newly formed special-purpose trust, SVB Capital II.  Distributions to SVB Capital II are cumulative and are payable quarterly at a fixed rate of 7.0% per annum of the face value of the Junior Subordinated Debentures. The Junior Subordinated Debentures are mandatorily redeemable upon the maturity of the debentures on October 15, 2033, or to the extent that there are any earlier redemptions of any debentures by the Company. The Company may redeem the debentures prior to maturity in whole or in part, at its option, at any time on or after October 30, 2008. In addition, the Company may redeem the debentures, in whole but not in part, prior to October 30, 2008 upon the

 

12



 

occurrence of certain events. Issuance costs of $2.2 million related to the Junior Subordinated Debentures were deferred and are being amortized over the period until mandatory redemption of the debentures in October 2033.  On October 30, 2003, the Company entered into an interest rate swap with a notional amount of $50.0 million, which hedges against the risk of changes in fair values associated with the Company’s Junior Subordinated Debentures. This derivative agreement provided a $0.6 million decrease in interest expense for the first quarter of 2004. For further information, see “Part I. Financial Information—Item 1. Notes to the Interim Consolidated Financial Statements—Note 7 to the Interim Consolidated Financial Statements—Derivative Financial Instruments.”

 

The fair value of the 7.0% Junior Subordinated Debentures was estimated to be $51.8 million as of March 31, 2004.

 

7.  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 October 30, 2003, the Company entered into an interest rate swap agreement with a notional amount of $50.0 million. This agreement hedges against the risk of changes in fair value associated with the Company’s Junior Subordinated Debentures.

 

The terms of this interest rate hedge agreement provide for a swap of the Company’s 7.0% fixed rate payment for a variable rate based on London Inter-Bank Offer Rate (LIBOR) plus a spread. Because the swap meets the criteria for the “short cut” treatment under SFAS No. 133, the benefit or expense is recorded in the period incurred. This derivative agreement provided a benefit of $0.6 million in the first quarter of 2004. The swap agreement mirrors the terms of the Junior Subordinated Debentures and therefore is callable by the counterparty anytime after October 30, 2008. The Company assumes no ineffectiveness as the swap agreement meets the short-cut method requirements under SFAS No. 133 for fair value hedges of debt instruments. As a result, changes in the fair value of the swap are offset by changes in the fair value of the Junior Subordinated Debentures, and no net gain or loss is recognized in earnings. Changes in the fair value of the derivative agreement and the Junior Subordinated Debentures are primarily dependent on changes in market interest rates. The derivative instrument had a fair value of ($1.5) million, which was recorded in other liabilities at March 31, 2004.

 

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

 

For the Company’s Foreign Exchange Contracts and Foreign Currency Option Contracts, see the Company’s 2003 Annual Report on Form 10-K.

 

13



 

8.  Operating Segments

 

The Company is organized into five lines of banking and financial services for management reporting: Commercial Banking, Merchant Banking, Investment Banking, Private Client Services (formerly Private Banking), and Other Business Services. These operating segments are strategic units that offer different services to different clients. They are managed separately because each segment appeals to different markets and, accordingly, requires different strategies. The results of operating segments are based on the Company’s management reporting process, which assigns assets, liabilities, income, and expenses to the aforementioned operating segments. This process is dynamic and there is no comprehensive, authoritative guidance for management reporting. The management reporting process measures the performance of operating segments based on the Company’s management structure and is not necessarily comparable with similar information for other financial services companies. Changes in the management structure and/or the allocation process have resulted, and may in the future result in, changes in the Company’s allocation methodology as this process is under constant refinement. In the event of such changes, results for prior periods have been, and may be, restated for comparability, and to reflect changes in the Company’s allocation methodology.

 

As of March 31, 2004, based on the quantitative threshold for determining reportable segments as required by SFAS No. 131 “Disclosures About Segments of an Enterprise and Related Information,” the Company’s reportable segments are: Commercial Banking, which is the principal operating segment of the Company, Merchant Banking, Investment Banking, and the remaining segments.

 

Commercial Banking provides lending services, which include traditional term loans, commercial finance lending, and structured finance lending. The segment’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. Investment and advisory services are provided through Silicon Valley Bank’s broker-dealer subsidiary, SVB Securities, which includes mutual funds, fixed income securities, and investment reporting and monitoring.  Also under the Commercial Bank is SVB Asset Management, one of the Bank’s registered investment advisor subsidiaries, which actively manages client investment portfolios.

 

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

 

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

 

Other segments include Private Client Services and Other Business Services. Private Client Services provides a wide array of loan, personal asset management, mortgage services, and trust and estate planning tailored for high-net-worth individuals. It also provides investment advisory services to these clients through the Company’s subsidiary, Woodside Asset Management, Inc. The Other Business Services unit provides Web-based business services and professional services. Other segments also include necessary adjustments to reconcile segment data to the interim consolidated financial statements.

 

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

 

14



 

 

 

Commercial

 

Merchant

 

Investment

 

 

 

 

 

 

 

Banking

 

Banking

 

Banking

 

Other

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First quarter of 2004

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

38,083

 

$

2,567

 

$

 

$

10,170

 

$

50,820

 

Provision for loan losses (1)

 

1,218

 

4

 

 

(1,205

)

17

 

Noninterest income (2)

 

15,727

 

3,834

 

4,087

 

1,238

 

24,886

 

Noninterest expense (3)

 

36,754

 

4,754

 

4,121

 

7,540

 

53,169

 

Minority interest

 

 

471

 

 

(952

)

(481

)

Income (loss) before income taxes

 

15,838

 

2,114

 

(34

)

4,121

 

22,039

 

 

 

 

 

 

 

 

 

 

 

 

 

Average loans

 

1,522,342

 

64,260

 

 

220,490

 

1,807,092

 

Average assets (4)

 

3,383,622

 

540,830

 

65,555

 

431,638

 

4,421,645

 

Average deposits

 

3,003,583

 

504,043

 

 

112,563

 

3,620,189

 

 

 

 

 

 

 

 

 

 

 

 

 

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 (loss) (2)

 

14,244

 

1,488

 

4,144

 

(2,430

)

17,446

 

Noninterest expense (3)

 

35,760

 

4,258

 

2,967

 

7,123

 

50,108

 

Minority interest

 

 

570

 

 

2,909

 

3,479

 

Income (loss) before income taxes

 

13,347

 

1,020

 

1,177

 

(133

)

15,411

 

 

 

 

 

 

 

 

 

 

 

 

 

Average loans

 

1,531,256

 

89,131

 

 

236,108

 

1,856,495

 

Average assets (4)

 

2,890,577

 

522,340

 

106,864

 

374,780

 

3,894,561

 

Average deposits

 

2,529,146

 

487,419

 

 

143,129

 

3,159,694

 

 


(1)    For segment reporting purposes, the Company reports net charge-offs as the provision for loan losses.  Thus, the Other segment includes $(1.2) million and $(0.5) million for the three-month periods ended March 31, 2004 and 2003, respectively, which represent the difference between net charge-offs and the provision for loan losses.

(2)    Noninterest income presented in the Merchant Banking segment includes warrant income of $2.9 million and $2.0 million, for the three months ended March 31, 2004 and 2003, respectively.

(3)    Commercial Banking segment includes direct depreciation and amortization expense of $0.3 million for the three months ended March 31, 2004 and 2003.  Due to the complexity of the Company’s cost allocation model, it is not feasible to determine the exact amount of the remaining depreciation and amortization expense allocated to the various business segments (totaling approximately $1.7 million for the three months ended March 31, 2004 and 2003.)

 (4)   Average assets equals the greater of average loans or the sum of average deposits and average stockholders’ equity for each segment.  Certain adjustments are included in the Other segment to reconcile segment assets to total average assets reported on a consolidated basis.  Average assets presented in the Investment Banking segment included goodwill primarily related to the SVB Alliant acquisition of $35.6 million and $98.6 million at March 31, 2004 and 2003, respectively.

 

15



 

9.  Common Stock Repurchase

 

$160.0 million share repurchase program authorized by the board of directors, effective May 7, 2003

 

On May 7, 2003, the Company announced that its board of directors authorized a stock repurchase program of up to $160.0 million. This program became effective immediately and replaced previously announced stock repurchase programs.  The Company did not repurchase any shares under this program in the first quarter of 2004.  Under this program, the Company repurchased in aggregate 4.5 million shares of common stock totaling $113.2 million in 2003.

 

10. Obligations Under Guarantees

 

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

 

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

 

The table below summarizes the Company’s standby letter of credits at March 31, 2004.  The maximum potential amount of future payments represents the amount that could be lost under the standby letters of credit if there were a total default by the guaranteed parties, without consideration of possible recoveries under recourse provisions or from the collateral held or pledged.

 

 

 

Expires in one

 

Expires after

 

Total amount

 

Maximum amount of

 

 

 

year or less

 

one year

 

outstanding

 

future payments

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Financial standby

 

$

487,506

 

$

56,892

 

$

544,398

 

$

544,398

 

Performance standby

 

3,843

 

2,653

 

6,496

 

6,496

 

Total

 

$

491,349

 

$

59,545

 

$

550,894

 

$

550,894

 

 

At March 31, 2004 and 2003, the carrying amount of the liabilities related to financial and performance standby letters of credit was approximately $3.7 million and $0, respectively.  At March 31, 2004, cash collateral available to the Company to reimburse losses under financial and performance standby letters of credits was $236.6 million.

 

16



 

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND 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 “Bancshares,” 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 notes as presented in Part I - Item 1 of this report and in conjunction with our 2003 Annual Report on Form 10-K as filed with the Securities and Exchange Commission (SEC).  Certain reclassifications have been made to prior years’ results to conform with 2004 presentations. Such reclassifications had no effect on our results of operations or stockholders’ equity.

 

Executive Overview

 

For over 20 years, we have been dedicated to helping entrepreneurs succeed, specifically focusing on industries where we have deep knowledge and relationships. Our focus remains on the technology, life science, private equity, and premium wine niches. We continue to diversify our services to support our clients throughout their life cycles, regardless of their age or size. We offer a range of financial services that generate three distinct sources of income.

 

In part, our income is generated from interest rate differentials. The difference between the interest rates paid by us on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received on interest-earning assets, such as loans extended to clients and securities held in our investment portfolio, accounts for the major portion of our earnings. Our deposits are largely obtained from clients within our technology, life science, and premium winery industry sectors, and, to a lesser extent, from individuals served by our private client services group. We do not obtain deposits from conventional retail sources and have no brokered deposits. As part of negotiated credit facilities, we frequently obtain rights to acquire stock in the form of warrants in certain client companies.

 

Fee-based services also generate income for our business. We market our full range of financial services to clients and private equity firms including venture capitalists. In addition to our commercial banking and private client services, we offer fee-based merger and acquisition services, private placements, and investment and advisory services. Our ability to integrate and cross-sell our diverse financial services to our clients is a strength of our business model.

 

In addition, we seek to obtain equity returns through investments in direct private equity and venture capital fund investments. We also manage two limited partnerships: a venture capital fund and a fund that invests in venture capital funds.

 

Critical Accounting Policies and Estimates

 

The accompanying management’s discussion and analysis of results of operations and financial condition are based upon our interim consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Management evaluates estimates on an ongoing basis, including those related to the marketable and non-marketable equity securities, allowance for loan losses, and goodwill. Management bases its estimates on historical experiences and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions.

 

We believe the accounting policies relating to marketable and non-marketable equity securities, allowance for loan losses, and goodwill are the most critical to our financial statements because their application places the most significant demands on management’s judgments. Additional information about these critical accounting polices may be found in the our 2003 Annual Report on Form 10-K under “Item 7. Management’s Discussion and

 

17



 

Analysis of Financial Condition and Results of Operations—Critical Accounting Policies.”  As of March 31, 2004, there have been no material changes to these policies.

 

Results of Operations

 

Earnings Summary

 

We reported net income of $14.0 million, or $0.38 per diluted common share, for the first quarter of 2004, compared with net income of $10.4 million, or $0.26 per diluted common share, for the first quarter of 2003.  The annualized return on average assets (ROA) was 1.3% in the first quarter of 2004 compared with 1.1% in the first quarter of 2003.  The annualized return on average equity (ROE) for the first quarter of 2004 was 12.1%, compared with 7.3% in the first quarter of 2003.

 

The increase in net income for the three months ended March 31, 2004, compared to the three months ended March 31, 2003, was due to a combination of the following factors: (1) an increase of noninterest income, (2) a decrease in the provision for loan losses, and (3) increased net interest income, primarily due to an increase in interest-earning assets.  These improvements were partially offset by an increase in noninterest expense and income tax expense.  The major components of net income and changes in these components are summarized in the following table, and are discussed in more detail below.

 

 

 

For the three months ended

 

%

 

 

 

March 31,

 

Increase/

 

(Dollars in thousands)

 

2004

 

2003

 

(Decrease)

 

 

 

 

 

 

 

 

 

Net interest income

 

$

50,820

 

$

47,978

 

5.9

%

Provision for loan losses

 

17

 

3,384

 

(99.5

)

Noninterest income

 

24,886

 

17,446

 

42.6

 

Noninterest expense

 

53,169

 

50,108

 

6.1

 

Minority interest in net (gains) losses of consolidated affiliates

 

(481

)

3,479

 

(113.8

)

Income before income taxes

 

22,039

 

15,411

 

43.0

 

Income tax expense

 

8,029

 

4,993

 

60.8

 

Net income

 

$

14,010

 

$

10,418

 

34.5

%

 

Net Interest Income and Margin

 

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

 

The following table sets forth average assets, liabilities, minority interest, stockholders’ equity, interest income, interest expense, annualized yields and rates, and the composition of our annualized net interest margin for the three months ended March 31, 2004 and 2003, respectively.

 

18



 

AVERAGE BALANCES, RATES AND YIELDS

 

 

 

For the three months ended March 31,

 

 

 

2004

 

 

2003

 

 

 

 

 

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)

 

$

541,819

 

$

1,444

 

1.1

%

 

$

248,384

 

$

830

 

1.4

%

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

1,515,957

 

14,023

 

3.7

 

 

1,233,457

 

10,377

 

3.4

 

Non-taxable (2)

 

144,413

 

2,247

 

6.3

 

 

144,727

 

2,455

 

6.9

 

Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

1,514,123

 

33,303

 

8.9

 

 

1,547,717

 

34,241

 

9.0

 

Real estate construction and term

 

96,310

 

1,236

 

5.2

 

 

100,879

 

1,437

 

5.8

 

Consumer and other

 

196,659

 

2,093

 

4.3

 

 

207,899

 

2,158

 

4.2

 

Total loans (3)

 

1,807,092

 

36,632

 

8.2

 

 

1,856,495

 

37,836

 

8.3

 

Total interest-earning assets

 

4,009,281

 

54,346

 

5.5

 

 

3,483,063

 

51,498

 

6.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

212,335

 

 

 

 

 

 

185,405

 

 

 

 

 

Allowance for loan losses

 

(66,103

)

 

 

 

 

 

(73,094

)

 

 

 

 

Goodwill

 

37,551

 

 

 

 

 

 

100,571

 

 

 

 

 

Other assets

 

228,581

 

 

 

 

 

 

198,616

 

 

 

 

 

Total assets

 

$

 4,421,645

 

 

 

 

 

 

$

3,894,561

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

$

23,475

 

25

 

0.4

 

 

$

22,214

 

25

 

0.5

 

Regular money market deposits

 

427,993

 

537

 

0.5

 

 

306,882

 

456

 

0.6

 

Bonus money market deposits

 

704,511

 

891

 

0.5

 

 

609,104

 

903

 

0.6

 

Time deposits

 

370,177

 

560

 

0.6

 

 

558,558

 

1,067

 

0.8

 

Short-term borrowings

 

9,375

 

70

 

3.0

 

 

9,153

 

69

 

3.1

 

Long-term debt (4)

 

204,067

 

657

 

1.3

 

 

17,451

 

141

 

3.3

 

Total interest-bearing liabilities

 

1,739,598

 

2,740

 

0.6

 

 

1,523,362

 

2,661

 

0.7

 

Portion of noninterest-bearing
funding sources

 

2,269,683

 

 

 

 

 

 

1,959,701

 

 

 

 

 

Total funding sources

 

4,009,281

 

2,740

 

0.3

 

 

3,483,063

 

2,661

 

0.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

2,094,033

 

 

 

 

 

 

1,662,936

 

 

 

 

 

Other liabilities

 

77,239

 

 

 

 

 

 

57,767

 

 

 

 

 

Trust preferred securities (4)

 

 

 

 

 

 

 

38,701

 

 

 

 

 

Minority interest

 

46,968

 

 

 

 

 

 

36,516

 

 

 

 

 

Stockholders’ equity

 

463,807

 

 

 

 

 

 

575,279

 

 

 

 

 

Portion used to fund interest-earning assets

 

(2,269,683

)

 

 

 

 

 

(1,959,701

)

 

 

 

 

Total liabilities, minority interest and stockholders’ equity

 

$

4,421,645

 

 

 

 

 

 

$

3,894,561

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income and margin (4)

 

 

 

$

51,606

 

5.2

    %

 

 

 

$

48,837

 

5.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total deposits

 

$

3,620,189

 

 

 

 

 

 

$

3,159,694

 

 

 

 

 

 


(1)

 

Includes average interest-bearing deposits in other financial institutions of $4,536 and $1,311 for the three months ended March 31, 2004 and 2003, respectively.

(2)

 

Interest income on non-taxable investments is presented on a fully taxable-equivalent basis using the federal statutory rate of 35% in 2004 and 2003.  The tax equivalent adjustments were $786 and $859 for the three months ended March 31, 2004 and 2003, respectively.

(3)

 

Nonaccrual loans and related income are included in their respective loan categories.

(4)

 

Adoption of FIN No. 46 and SFAS No. 150 in the latter half of 2003 resulted in a change of classification of trust preferred securities distribution expense from noninterest expense to interest expense on a prospective basis. Additionally, the adoption of FIN No. 46 and SFAS No. 150 resulted in a change of classification of Trust Preferred Securities from noninterest bearing funding sources to interest-bearing liabilities on a prospective basis. Prior to adoption of FIN No. 46 and SFAS No. 150, in accordance with accounting rules in effect at that time, the company recorded trust preferred securities distribution expense as noninterest expense. On October 30, 2003, $50.0 million in cumulative 7.0% Trust Preferred Securities were issued through a newly formed special purpose trust, SVB Capital II. We received $51.5 million in proceeds from the issuance of 7.0% Junior Subordinated Debentures to SVB Capital II.  A portion of the net proceeds were used to redeem the existing $40.0 million of 8.25% Trust Preferred Securities.

 

 

19



 

Net interest income is affected by changes in the amount and mix of interest-earning 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 2004 and 2003.

 

 

 

2004 Compared to 2003

 

 

 

Three months ended March 31,

 

 

 

Increase (decrease)

 

 

 

due to change in

 

(Dollars in thousands)

 

Volume

 

Rate

 

Total

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

Federal funds sold and securities purchased under agreement to resell

 

$

819

 

$

(205

)

$

614

 

Investment securities

 

2,609

 

829

 

3,438

 

Loans

 

(797

)

(407

)

(1,204

)

Increase in interest income

 

2,631

 

217

 

2,848

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

NOW deposits

 

1

 

(1

)

 

Regular money market deposits

 

163

 

(82

)

81

 

Bonus money market deposits

 

135

 

(147

)

(12

)

Time deposits

 

(310

)

(197

)

(507

)

Short-term borrowings

 

2

 

(1

)

1

 

Long-term debt

 

697

 

(181

)

516

 

Increase (decrease) in interest expense

 

688

 

(609

)

79

 

Increase in net interest income

 

$

1,943

 

$

826

 

$

2,769

 

 

Quarter ended March 31, 2004 compared to Quarter ended March 31, 2003

 

Net Interest Income

 

Net interest income, on a fully taxable-equivalent basis, totaled $51.6 million for the quarter ended March 31, 2004, an increase of $2.8 million or 5.7% from the comparable 2003 period.  The increase in net interest income was the result of a $2.8 million increase in interest income, offset slightly by a small increase in interest expense.

 

Interest Income - Net Increase in Interest-Earning Assets

 

The $2.8 million increase in interest income for the first quarter of 2004, as compared to the first quarter of 2003, was primarily the result of a $2.6 million favorable volume variance.  The favorable volume variance resulted from a $526.2 million, or 15.1%, increase in average interest-earning assets.  Increases in certain sources of funding, largely deposits, were the main contributors to the increase in average interest-earning assets, which was primarily centered in highly liquid federal funds sold and securities purchased under agreements to resell, and taxable investment securities, which collectively increased $575.9 million.

 

Average federal funds sold and securities purchased under agreement to resell in the first quarter of 2004 increased, resulting in a $ 0.8 million favorable volume variance.  The increase was mainly due to the aforementioned growth in funding sources, mainly deposits.  However, the favorable volume variance was partially offset by an unfavorable rate variance of $0.2 million, as average yields decreased from 1.4% in the first quarter of 2003 to 1.1% in the first quarter of 2004.

 

We also experienced an increase in average investment securities, resulting in a $2.6 million favorable volume variance.  Collectively, average investments increased by $282.2 million, and in particular, relatively higher-yielding mortgage-backed securities increased by $381.8 million.

 

20



 

The $0.8 million favorable volume variance associated with federal funds sold and securities under agreement to resell and $2.6 million favorable volume variance associated with investment securities was partially offset by a $0.8 million unfavorable volume variance for loans.  The unfavorable volume variance of $0.8 million was caused by a decrease in average loans by $49.4 million, concentrated in commercial loans.  The decrease in commercial loans reflects the Company’s decision to refine its strategic focus on the technology, life sciences, and premium winery industry sectors by exiting the real estate, religious lending, and media niches in late 2002.  However, our strategy is to grow average loans modestly throughout 2004, as our corporate technology efforts continue to develop.

 

Interest Income - Declining Market Interest Rates and Shift in Investment Portfolio Mix

 

The average yield on taxable investment securities in the first quarter 2004 increased 30 basis points to 3.7% from 3.4% in the prior year first quarter, causing a $0.8 million favorable rate variance associated with our investment securities.  This was primarily due to a shift in the composition of a portion of the investment portfolio to relatively higher yielding securities.

 

We incurred a $0.4 million unfavorable rate variance associated with our loan portfolio, and a $0.2 million unfavorable rate variance associated with federal funds sold and securities under agreement to resell.  This was largely due to a decline in the weighted-average prime rate of 25 basis points from 4.3% in the first quarter of 2003 to 4.0% in the first quarter of 2004.  This decrease in prime rate reduced yields on floating rate loans, which represented approximately 82.4% of our total loan portfolio as of March 31, 2004.

 

The yield on average interest-earning assets declined 50 basis points in the first quarter of 2004 from the first quarter of 2003.  The decrease in yield on interest-earning assets was primarily caused by the drop in the weighted average prime rate and a decrease in short-term market rates, which resulted in decreased yields on loans and federal funds sold and securities purchased under agreement to resell.  Many elements of our interest-earning assets are extremely interest rate sensitive, thus we expect that any future increase in market interest rates will be incremental to our earnings.

 

Interest Expense

 

Total interest expense in the first quarter of 2004 increased only slightly from the first quarter of 2003, despite a $216.2 million, or 14.2% increase in our interest-bearing liabilities.  The unfavorable volume variance of $0.7 million was due in large part to FASB Interpretation No. 46 and SFAS No. 150-mandated classification of our 7.0% Junior Subordinated Debentures (and formerly, our Trust Preferred Securities) as interest-bearing liabilities beginning in the second quarter of 2003.  In the fourth quarter of 2003, we entered into an interest rate swap agreement to swap our 7.0% fixed payment on the Debentures for a variable rate based on LIBOR plus a spread.  The swap provided a $0.6 million benefit in the first quarter of 2004.  Additionally, in the second quarter of 2003, we issued $150 million of zero-coupon, zero-yield, convertible subordinated notes, with a maturity date of June 15, 2008.  See “Part 1. Financial Information — Item 1. Notes to the Interim Consolidated Financial Statements — Note 6 to the Consolidated Financial Statements — Short-term Borrowings and Long-term Debt,” for further discussion of the convertible subordinated notes.  Although no interest is paid on the convertible notes, the amortization of convertible debt issuance costs is reflected as interest expense.

 

Time deposits decreased by $188.4 million from the first quarter of 2003 to the first quarter of 2004, causing a $0.3 million favorable volume variance.  Our clients may use time deposits as collateral for letters of credit issued by Silicon Valley Bank on their behalf, to certain third parties such as real estate lessors.  We believe time deposits have decreased partly because of a softer real estate market, which generally reduces the frequency of these types of arrangements.  M oreover, due to general improvement in the economic environment, borrowings secured by time deposits have decreased .

 

We experienced a favorable rate variance of $0.6 million due to decreased market interest rates.  The favorable rate variance primarily resulted from reductions in the average rates paid on our time deposit product and bonus money market deposit products.

 

21



 

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.

 

We recorded a negligible provision for loan losses in the first quarter of 2004, resulting in a decrease of $3.4 million from the first quarter of 2003.  We experienced $1.2 million of net charge-offs in the first quarter of 2004, due in part to recovery of a portion of a non-technology niche loan, which was charged off in 1999.  This compares to net charge-offs of $3.9 million in the first quarter of 2003.  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, 2004 and 2003, and the percent changes from the 2003 period to the 2004 period:

 

 

 

For the three months ended

 

%

 

 

 

March 31

 

Increase/

 

(Dollars in thousands)

 

2004

 

2003

 

(Decrease)

 

 

 

 

 

 

 

 

 

Client investment fees

 

$

6,268

 

$

6,332

 

(1.0

)%

Corporate finance fees

 

4,087

 

4,144

 

(1.4

)

Letter of credit and foreign exchange income

 

3,729

 

3,503

 

6.5

 

Deposit service charges

 

3,713

 

2,876

 

29.1

 

Income from client warrants

 

2,908

 

1,962

 

48.2

 

Investment gains (losses)

 

1,322

 

(4,705

)

(128.1

)

Credit card fees

 

777

 

1,046

 

(25.7

)

Other

 

2,082

 

2,288

 

(9.0

)

Total noninterest income

 

$

24,886

 

$

17,446

 

42.6

%

 

Client investment fees decreased slightly for the three months ended March 31, 2004 over the comparable prior year period.  We offer private label investments, sweep products, and asset management services to clients on which we earn fees on clients’ average balances, ranging from 12 to 61 basis points for the first quarter of 2004.  Client funds invested in private label investment, sweep products, and assets under management totaled $10.0 billion at March 31, 2004, including $6.7 billion in mutual fund products and $1.1 billion in assets under management.  This compares to $8.1 billion in client funds invested in private label investment and sweep products for the first quarter of 2003, including $6.2 billion in mutual fund products.  In the first quarter of 2003, we did not have any assets under management.  Total invested client funds have increased between the periods, however, the decrease in client investment fees was due to a shift in client investment mix.  The sustained low interest rate environment has caused lower priced investment products to become a more attractive investment strategy for many of our clients.

 

Deposit service charges increased for the three months ended March 31, 2004 over the respective prior year period.  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 that we recognize 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 three months ended March 31, 2004 compared to the respective prior year period due to lower market interest rates.  As such, our clients had fewer credits to offset deposit service charges.  Thus, we earned higher recognizable deposit service changes.

 

Primarily due to an increase in client initial public offering and merger and acquisition activity, income from client warrants increased for the three months ended March 31, 2004 over the respective prior year period.  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

 

22



 

amount of income from the disposition of client warrants typically depends on 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.

 

We recognized investment gains for the three months ended March 31, 2004, an improvement from the investment losses recognized for the same period in 2003.  Securities gains in the first quarter of 2004 were primarily due to sales of fixed income securities in the normal course of investment portfolio management.  Excluding the impact of minority interest, the net write-downs of our equity securities was $0.5 million for the first quarter of 2004, compared to $1.7 million in the first quarter of 2003.  We expect continued volatility in the performance of our equity portfolio.

 

Noninterest Expense

 

Noninterest expense in the first quarter of 2004 was $53.2 million, an increase of $3.1 million from the $50.1 million incurred in the 2003 first quarter.  The following table presents the detail of noninterest expense, as well as the percent change in noninterest expense for the current year period compared to the prior year period:

 

 

 

For the three months ended

 

%

 

 

 

March 31,

 

Increase/

 

(Dollars in thousands)

 

2004

 

2003

 

(Decrease)

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

$

34,103

 

$

31,690

 

7.6

%

Net occupancy

 

4,523

 

4,402

 

2.7

 

Professional services

 

3,339

 

3,439

 

(2.9

)

Furniture and equipment

 

2,909

 

2,194

 

32.6

 

Business development and travel

 

1,991

 

1,616

 

23.2

 

Correspondent bank fees

 

1,281

 

1,040

 

23.2

 

Data processing services

 

1,085

 

1,091

 

(0.5

)

Telephone

 

782

 

778

 

0.5

 

Postage and supplies

 

772

 

584

 

32.2

 

Tax credit funds amortization

 

620

 

715

 

(13.3

)

Trust preferred securities distributions

 

 

281

 

(100.0

)

Other

 

1,764

 

2,278

 

(22.6

)

Total noninterest expense

 

$

53,169

 

$

50,108

 

6.1

%

 

Compensation and benefits expenses increased for the three months ended March 31, 2004 from the three months ended March 31, 2003, partially due to increased incentive compensation expense.  Full-time equivalent (FTE) personnel were 969 at March 31, 2004, down slightly from 985 FTE personnel at March 31, 2003.

 

Furniture and equipment expenses increased for the three months ended March 31, 2004 over the comparable prior year period, primarily due to new business initiatives and the expansion of certain regional offices.

 

Business development and travel increased for the three months ended March 31, 2004 over the comparable prior year period, due in part to increased travel expenses as we continue efforts to expand our business globally.

 

Correspondent bank fees increased for the three months ended March 31, 2004 over the comparable prior year period.  Many of our correspondent banks provide earnings credits to offset the bank fees we incur when using their services.  Earnings credits are generally calculated using average daily deposit balances, less a reserve requirement and a short-term market interest rate.  We received lower earnings credits in the first quarter of 2004 as compared with the first quarter of 2003, due to lower market interest rates.  As a result, we had fewer earnings credits to offset bank fees we incurred.  Thus, we incurred higher recognizable bank fees in the first quarter of 2004 as compared with the first quarter of 2003.  Also, our management made the decision to lower the average balances with correspondent banks because our investment alternatives yielded a higher return than our earnings credit rate.

 

In the latter half of 2003, trust preferred securities distribution expense was reclassified from noninterest expense to interest expense, pursuant to adoption of SFAS No. 150 and Fin No. 46.  Thus, first quarter 2004 noninterest

 

23



 

expense does not reflect trust preferred securities distribution expense.  For the three months ended March 31, 2003, the 8.25% Trust Preferred Securities distribution expense was not reclassified.  The 8.25% Trust Preferred Securities, with an aggregate par value of $40.0 million, paid a fixed rate quarterly distribution of 8.25% and had a maximum maturity of 30 years.  The 8.25% Trust Preferred Securities were redeemed effective December 1, 2003.  On June 3, 2002, we entered into a derivative agreement with a notional amount of $40.0 million.  The swap was terminated effective June 23, 2003.  The agreement hedged against the risk of changes in fair value associated with our $40.0 million, fixed rate, 8.25% Trust Preferred Securities.  The terms of the agreement provide for quarterly receipt of 8.25% fixed-rate and payment of London Inter-Bank Offer Rate (LIBOR) plus a spread, based on the $40.0 million notional amount.

 

Other noninterest expense decreased primarily due to non-recurring miscellaneous charges incurred in the first quarter of 2003 that were not present in the first quarter of 2004.

 

Minority Interest in Net (Gains) Losses of Consolidated Affiliates

 

Investment gains or losses related to our managed funds, SVB Strategic Investors Fund, L.P. and Silicon Valley BancVentures, L.P., are included in noninterest income.  Minority interest primarily represents net investment gains or losses and management fees attributable to the minority interest holders in these managed funds.

 

The minority interest share of net (gains) and losses, primarily relating to our managed funds, totaled $(0.5) million and $3.5 million for the three months ended March 31, 2004 and 2003, respectively.  This decrease in minority interest losses was mainly due to gains on investment securities held by these limited partnerships.

 

Income Taxes

 

We realized tax expense of $8.0 million in the first quarter of 2004.  Our effective tax rate was 36.4% for the first quarter of 2004, compared with 32.4% for the first quarter of 2003.  The increase in our effective tax rate was primarily due to our higher overall earnings, and the exclusion of real estate investment trust (REIT) tax benefits.  The first quarter of 2003 benefited from an increase in items giving rise to permanent tax differences, and also includes $0.5 million in REIT tax benefits, discussed below, which were subsequently reversed in the fourth quarter of 2003.

 

In the third quarter of 2002, we implemented a REIT to serve as a future-funding vehicle. In 2002 we obtained $0.8 million in tax benefits from the REIT structure. In 2003, we did not take REIT tax benefits of $1.7 million in response to a California Franchise Tax Board (FTB) announcement on December 31, 2003, which related to new tax shelter regulations.  We will not reflect REIT tax benefits in our future financial statements until this matter has been resolved with the FTB.  Based on information provided by our financial advisors, we believe that our position with regard to the REIT has merit and we plan to pursue our tax claims and defend our use of this entity.

 

Operating Segment Results

 

The commercial bank’s first quarter of 2004 pretax income of $15.8 million represents a $2.5 million increase compared to $13.3 million for the same quarter in 2003, primarily caused by a decline in net charge-offs of $2.7 million, and an increase of $1.5 million in non-interest income, partially offset by a $1.0 million increase in noninterest expense.  The increase in non-interest income was primarily related to deposit service charges, while the increase in noninterest expense was primarily related to compensation expense.  Our segment reporting includes net charge-offs in lieu of provision expense to determine segment financial performance.

 

The commercial bank, and the merchant bank to a lesser extent, experienced an increase in average assets and average deposits when comparing the first quarter of 2004 with the first quarter of 2003.  The growth in deposits was due to various market factors, as well as the company’s initiatives to serve clients at all stages of growth.  Increases in certain sources of funding, such as deposits and long-term debt, were the main contributors to the increase in average assets.

 

The merchant bank’s first quarter of 2004 pretax income increased  $1.1 million from the first quarter of 2003 to $2.1 million. The merchant bank experienced an increase in noninterest income of $2.3 million primarily related to increased warrant income.

 

24



 

The investment bank’s pretax income decreased by $1.2 million from the first quarter of 2003 to the first quarter of 2004. Investment banking revenues remained relatively unchanged, while expenses increased $1.2 million over the first quarter of 2003, due in part to higher compensation expense.  The investment bank experienced a decrease in average assets from the first quarter of 2003 to the first quarter of 2004, primarily due to a decrease in goodwill relating to SVB Alliant.

 

The Other segment includes the private client services group and all other activities not allocated to clients.  Our segment reporting is based on client data and is under continuous refinement.  As a result, the ‘Other’ segment will be subject to large amounts of variability from period to period as our management reporting and cost allocation process evolves. Pretax profit for the first quarter of 2004 increased from the prior period, primarily due to increases in net interest income due to an increase in the overall yield on the investment portfolio.

 

Financial Condition

 

Total assets at March 31, 2004, were relatively unchanged at $4.5 billion, from December 31, 2003.

 

Federal Funds Sold and Securities Purchased Under Agreement to Resell

 

Federal funds sold and securities purchased under agreement to resell totaled $489.5 million at March 31, 2004, a decrease of $53.0 million, or 9.8%, compared to the $542.5 million outstanding at December 31, 2003.  Generally, we shifted funds into longer-term investment securities.  Our plan is to continue the trend of managing federal funds sold and overnight repurchase agreements at appropriate levels.

 

Investment Securities

 

Investment securities totaled $1.7 billion at March 31, 2004, an increase of $133.7 million, or 8.5% from December 31, 2003.  The increase in securities was centered in mortgage-backed securities and asset-backed securities, which collectively increased $143.4 million.

 

Based on March 31, 2004 market valuations, we had potential pre-tax warrant gains totaling $4.6 million related to 27 companies.  We are restricted from exercising many of these warrants until later in 2004.  As of March 31, 2004, we directly held 1,845 warrants in 1,334 companies, and had made investments in 263 venture capital funds, and direct equity investments in 19 companies, many of which are private.  Additionally, we have made investments in 20 venture capital funds through our fund of funds, SVB Strategic Investors Fund, L.P., and made direct equity investments in 25 companies through our venture capital fund, Silicon Valley BancVentures, L.P.  Refer to our Annual Report on Form 10-K under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” for our accounting policies related to investment securities.

 

Loans

 

Loans, net of unearned income, at March 31, 2004, totaled $2.0 billion, up slightly from December 31, 2003.  Our strategy is to grow loan balances modestly throughout 2004, as our later stage corporate technology efforts continue to develop.

 

Credit Quality and the Allowance for Loan Losses

 

For a description of the accounting policies related to the allowance for loan losses, see our 2003 Annual Report on Form 10-K, under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies.”

 

We incurred $4.1 million and $2.8 million in gross loan charge-offs and recoveries, respectively, during the three months ended March 31, 2004.  Gross charge-offs for the first quarter 2004 included 3 commercial credits totaling $2.5 million.  We experienced gross recoveries of $2.8 million for the first quarter 2004, $1.1 million of which was due to the recovery of a portion of a non-technology niche loan, which was originally charged off in 1999.

 

Nonperforming assets consist of well-secured loans that are past due 90 days or more but are still accruing interest and loans on nonaccrual status. The table below sets forth certain relationships between nonperforming

 

25



 

assets and the allowance for loan losses.  For the periods presented, nonperforming loans equaled nonperforming assets.

 

 

 

March 31,

 

December 31,

 

(Dollars in thousands)

 

2004

 

2003

 

Nonperforming assets:

 

 

 

 

 

Nonaccrual loans

 

$

13,968

 

$

12,350

 

Total nonperforming assets

 

$

13,968

 

$

12,350

 

 

 

 

 

 

 

Nonperforming loans as a percentage of total gross loans

 

0.7

%

0.6

%

Nonperforming assets as a percentage of total assets

 

0.3

%

0.3

%

 

 

 

 

 

 

Allowance for loan losses:

 

$

63,300

 

$

64,500

 

As a percentage of total gross loans

 

3.2

%

3.2

%

As a percentage of nonperforming loans

 

453.2

%

522.3

%

 

We continued our recent trend of good credit quality, with non-performing loans at $14.0 million, or 0.7 percent of total gross loans, at March 31, 2004.

 

In addition to the loans disclosed in the foregoing analysis, we have identified three loans totaling $5.2 million, that, on the basis of information known to us, were judged to have a higher than normal risk of becoming nonperforming.  We are not aware of any other loans where known information about possible problems of the borrower casts serious doubts about the ability of the borrower to comply with the loan repayment terms.

 

Liabilities

 

Other liabilities at March 31, 2004 decreased from December 31, 2003, due to decreases in taxes payable and accrued expenses.  Specifically, accruals relating to incentive compensation and our employee stock ownership program decreased.

 

Capital Resources

 

Our management seeks to maintain adequate capital to support anticipated asset growth and credit risks, and to ensure that Silicon Valley Bancshares and Silicon Valley Bank are in compliance with all regulatory capital guidelines.  Our primary sources of new capital include the issuance of common stock, as well as retained earnings.

 

We did not repurchase any common stock in the first quarter of 2004.  See “Part 1. Financial Information — Item 1. Notes to the Interim Consolidated Financial Statements — Note 9 to the Consolidated Financial Statements — Common Stock Repurchase,” for amounts of common stock repurchased in 2003.

 

Stockholders’ equity totaled $476.4 million at March 31, 2004, an increase of $29.4 million, or 6.6%, from the $447.0 million balance at December 31, 2003.  This increase was primarily due to our earnings and the exercise of employee stock options, and an increase in net unrealized gains on available-for-sale investments.  We have not paid a cash dividend on our common stock since 1992, and we do not have any material commitments for capital expenditures as of March 31, 2004.

 

Over time, funds generated through retained earnings are a significant source of capital and liquidity, and are currently expected to continue to be so in the future.  Our management engages in a periodic capital planning process in an effort to make effective use of the capital available to us.  The capital plan considers capital needs for the foreseeable future and allocates capital to both existing business activities and expected future business activities.  Expected future activities for which capital is set aside include potential product expansions and acquisitions of new business lines.  Once capital is allocated to both existing and future business needs, management determines if any excess capital is available and recommends to the board of directors appropriate steps to utilize the excess capital.  In the future, excess capital may be used for common share repurchases or to pay dividends.  However, as of March 31, 2004, there are no plans for payment of dividends.

 

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Both Silicon Valley Bancshares and Silicon Valley Bank are subject to capital adequacy guidelines issued by the Federal Reserve Board. Under these capital guidelines, the minimum total risk-based capital ratio and Tier 1 risk-based capital ratio requirements are 10.0% and 6.0%, respectively.

 

The Federal Reserve Board has also established minimum capital leverage ratio guidelines for state member banks.  The ratio is determined using Tier 1 capital divided by quarterly average total assets.  The guidelines require a minimum of 5.0% for a well capitalized depository institution.  For further information on risk-based capital and leverage ratios as defined by the Federal Reserve Board, see our 2003 Annual Report on Form 10-K, under “Item 1. Business—Supervision and Regulation—Regulatory Capital.”

 

Both Silicon Valley Bancshares’ and Silicon Valley Bank’s capital ratios were in excess of regulatory guidelines for a well-capitalized depository institution as of March 31, 2004, and December 31, 2003.  Capital ratios for Silicon Valley Bancshares are set forth below:

 

 

 

March 31,

 

December 31,

 

 

 

2004

 

2003

 

Silicon Valley Bancshares:

 

 

 

 

 

Total risk-based capital ratio

 

17.6

%

16.6

%

Tier 1 risk-based capital ratio

 

13.0

%

12.0

%

Tier 1 leverage ratio

 

10.8

%

10.3

%

 

The increase in the Total and Tier 1 risk-based capital ratios from December 31, 2003 to March 31, 2004 was primarily attributable to an increase in Tier 1 capital from increases to additional paid in capital and retained earnings.  This positive impact to the Tier 1 leverage ratio was partially offset by an increase in quarterly average assets.

 

Liquidity

 

An important objective of asset/liability management is to manage liquidity.  The objective of liquidity management is to ensure that funds are available in a timely manner to meet loan demand, to meet depositors’ needs, and to service other liabilities as they become due without causing an undue amount of cost or risk and without causing a disruption to normal operating conditions.

 

We regularly assess the amount and likelihood of projected funding requirements through a review of factors such as historical deposit volatility and funding patterns, present and forecasted market and economic conditions, individual client funding needs, and existing and planned business activities.  Our Asset/Liability Committee provides oversight to the liquidity management process and recommends policy guidelines, subject to our board of directors’ approval, and courses of action to address our actual and projected liquidity needs.

 

The ability to attract a stable, low-cost deposit base is our primary source of liquidity.  We continue to expand on opportunities to increase our liquidity and take steps to carefully manage our liquidity.  In the third quarter of 2002, we became a member of the Federal Home Loan Bank of San Francisco, thereby adding to our liquidity channels.  Other sources of liquidity available to us include federal funds purchased, reverse repurchase agreements, and other short-term borrowing arrangements.  Our liquidity requirements can also be met through the use of our portfolio of liquid assets.  Our definition of liquid assets includes cash and cash equivalents in excess of the minimum levels necessary to carry out normal business operations, federal funds sold, securities purchased under resale agreements, investment securities maturing within six months, investment securities eligible and available for financing or pledging purposes with a maturity in excess of six months, and anticipated near-term cash flows from investments.

 

Our policy guidelines provide that liquid assets as a percentage of total deposits should not fall below 20.0%.  At March 31, 2004, the Bank’s ratio of liquid assets to total deposits was 50.8%.  This ratio is well in excess of our minimum policy guidelines and was higher than the ratio of 48.6% as of December 31, 2003.  In addition to monitoring the level of liquid assets relative to total deposits, we also utilize other policy measures in liquidity management activities.  As of March 31, 2004, we were in compliance with all of these policy measures.

 

In analyzing our liquidity during for the three months ended March 31, 2004, reference is made to our consolidated statement of cash flows for the three months ended March 31, 2004; see “Item 1. Interim Consolidated Financial Statements.” The statement of cash flows includes separate categories for operating,

 

27



 

investing, and financing activities. Operating activities included net income of $14.0 million for the quarter, which was adjusted for certain non-cash items including the provision for loan losses, depreciation, deferred tax assets, and an assortment of other miscellaneous items resulting in positive cash generated from operations.  Investing activities consisted of transactions in investment securities resulting in a net cash outflow of $120.7 million and the net change in total loans, which resulted in a net cash outflow of $7.9 million during the first quarter of 2004. The net cash outflow related to loans relate to loan originations offset by principal collections. The net cash outflow from securities transactions were the net result of purchases of investment securities, offset by securities maturities and sales.  Financing activities reflected cash inflows of $19.5 million primarily resulting from a slight increase in deposits, issuances of common stock, and capital contributions from minority interest holders.  In the first quarter of 2004, we did not repurchase any common stock.  In total, the transactions noted above resulted in a net cash outflow of $104.6 million for the three months ended March 31, 2004 and total cash and cash equivalents, as defined in our consolidated statement of cash flows, of $690.4 million at March 31, 2004.

 

On a stand-alone basis, Bancshares’ primary liquidity channels include dividends from Silicon Valley Bank, its investment portfolio assets, and its ability to raise debt and capital.  The ability of Silicon Valley Bank to pay dividends is subject to certain regulations described in “Item 1. Business—Supervision and Regulation—Restriction on Dividends” of our 2003 Annual Report on Form 10-K.

 

Forward-Looking Statements

 

This discussion and analysis contained forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Our senior management has in the past and might in the future make forward-looking statements orally to analysts, investors, the media, and others.  Forward-looking statements are statements that are not historical facts.  Broadly speaking, forward-looking statements include, without limitation:

 

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

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

      Forecasts of future economic performance

      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:

 

       Average loan balances

       Sensitivity of our interest-earning assets to interest rates, and impact to earnings from an increase in interest rates

       Realization, timing and performance of investments in equity securities

       Merit of our position with regard to the tax benefits provided by our real estate investment trust

      Management of federal funds sold and overnight repurchase agreements at appropriate levels

      Development of our later-stage corporate technology lending efforts

      Growth in loan balances

      Credit quality of our loan portfolio

      Levels of nonperforming loans

      Liquidity provided by funds generated through retained earnings

      Activities for which capital will be required

      Ability to meet our liquidity requirements through our portfolio of liquid assets

      Ability to expand on opportunities to increase our liquidity

      Use of excess capital

 

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

 

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For information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see the subsection below “Factors that May Affect Future Results.”  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.

 

Factors That May Affect Future Results

 

Our business faces significant risks. The factors described below may not be the only risks we face, and is not intended to serve as a comprehensive listing. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations. If any of the events or circumstances described in the following factors actually occur, our business, financial condition and/or results of operations could suffer.

 

If a significant number of clients fail to perform under their loans, our business, profitability, and financial condition would be adversely affected.

 

As a lender, the largest risk we face is the possibility that a significant number of our client borrowers will fail to pay their loans when due. If borrower defaults cause losses in excess of our allowance for loan losses, it could have an adverse effect on our business, profitability, and financial condition. We have established an evaluation process designed to determine the adequacy of the allowance for loan losses. While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses are dependent to a great extent on our experience and judgment. We cannot assure you that our allowance for loan losses will be sufficient to absorb future loan losses or prevent a material adverse effect on our business, profitability or financial condition.

 

Because of the credit profile of our loan portfolio, our levels of nonperforming assets and charge-offs can be volatile, and we may need to make material provisions for loan losses in any period, which could cause reduced net income or increased net losses in that period.

 

Our loan portfolio has a credit profile different from that of most other banking companies. Many of our loans are made to companies in the early stages of development with negative cash flow and no established record of profitable operations. In many cases, repayment of the loan is dependent upon receipt of additional equity financing from venture capitalists or others. Collateral for many of the loans often includes intellectual property, which is difficult to value and may not be readily salable in the case of default. Because of the intense competition and rapid technological change that characterizes the companies in our technology and life science industry sectors, a borrower’s financial position can deteriorate rapidly. We also make loans that are larger, relative to the revenues of the borrower, than those made by traditional small business lenders, so the impact of any single borrower default may be more significant to us. Because of these characteristics, our level of nonperforming loans and loan charge-offs can be volatile and can vary materially from period to period. Changes in our level of nonperforming loans may require us to make material provisions for loan losses in any period, which could reduce our net income or cause net losses in that period.

 

Our current level of interest rate spread may decline in the future. Any material reduction in our interest spread could have a material impact on our business and profitability.

 

A major portion of our net income comes from our interest rate spread, which is the difference between the interest rates paid by us on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates we receive on interest-earning assets, such as loans extended to our clients and securities held in our investment portfolio. Interest rates are highly sensitive to many factors beyond our control, such as inflation, recession, global economic disruptions, and unemployment. In addition, legislative changes could affect the manner in which we pay interest on deposits or other liabilities. For example, Congress has for many years debated repealing a law that prohibits banks from paying interest rates on checking accounts. If this law were to be repealed, we would be subject to competitive pressure to pay interest on our clients’ checking accounts, which would negatively affect our interest rate spread. Any material decline in our interest rate spread would have a material adverse effect on our business and profitability.

 

29



 

Decreases in the amount of equity capital available to start-up and emerging growth companies could adversely affect our business, profitability, and growth prospects.

 

Our strategy has focused on providing banking products and services to emerging growth and middle-market companies receiving financial support from sophisticated investors, including venture capitalists, “angels,” and corporate investors. In some cases, our lending credit decision is based on our analysis of the likelihood that our venture capital or angel-backed client will receive a second or third round of equity infusion from investors. If the amount of capital available to such companies decreases, it is likely that the number of new clients and investor financial support to our existing borrowers could decrease, having an adverse effect on our business, profitability and growth prospects.

 

Among the factors that have and could in the future affect the amount of capital available to startup and emerging growth companies are the receptivity of the capital markets to initial public offerings or mergers and acquisitions of companies within our technology and life science industry sectors, the availability and return on alternative investments, and general economic conditions in the technology and life sciences industries. Reduced capital markets valuations could reduce the amount of capital available to startup and emerging growth companies, including companies within our technology and life science industry sectors.

 

Our business is dependent upon access to funds on attractive terms.

 

We derive our net interest income through lending or investing capital on terms that provide returns in excess of our costs for obtaining that capital. As a result, our credit ratings are extremely important to our business. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs (or trigger obligations under certain existing borrowings and other contracts), or increase the interest rates we pay our depositors. Further, our credit ratings and the terms upon which we have access to capital may be influenced by circumstances beyond our control, such as overall trends in the general market environment, perceptions about our creditworthiness or market conditions in the industries in which we focus.

 

In the event that we change our method of accounting for stock compensation expense, our cash flows and results of operations, as well as our ability to retain certain key employees, could be adversely affected.

 

We account for our employee stock options in accordance with Accounting Principles Board Opinion No. 25 and related interpretations, which provide that any compensation expense relative to employee stock options be measured based on the intrinsic value of the stock options.  As a result, when options are priced at the fair market value of the underlying stock on the date of grant, as is our practice, we incur no compensation expense.  However, the Financial Accounting Standards Board has proposed in its exposure draft entitled “Proposed Statement of Financial Accounting Standards” new accounting requirements that, if adopted, would cause us to record compensation expense for all employee stock option grants.  Any such expense, although it would not affect our cash flows, could have a material impact on our results of operations.  Accordingly, if such accounting requirements are adopted, we may implement alternative employee compensation structures including, for example, the reduced use of equity compensation and increased employee cash compensation.  We continue to evaluate different approaches in employee compensation.  Any such changes in approach could adversely affect our cash flows and results of operations, and our ability to retain certain key employees.

 

We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business.

 

Silicon Valley Bancshares, Silicon Valley Bank, and their subsidiaries are extensively regulated under federal and state law. These regulations are intended primarily for the protection of depositors, other clients, and the deposit insurance fund—not for the benefit of stockholders or security holders. Federal and state laws and regulations limit or otherwise affect the activities in which Silicon Valley Bancshares, Silicon Valley Bank, and their subsidiaries may engage. A change in the applicable statutes, regulations, or regulatory policy may have a material effect on our business and that of our subsidiaries. In addition, Silicon Valley Bancshares, Silicon Valley Bank and their subsidiaries are required to maintain certain minimum levels of capital. Federal and state banking regulators possess broad powers to take supervisory action, as they deem appropriate, with respect to Silicon Valley Bancshares and Silicon Valley Bank. SVB Alliant (formerly Alliant Partners) and SVB Securities, both broker-dealer subsidiaries, are regulated by the SEC and the National Association of Securities Dealers, Inc. (NASD). Violations of the stringent regulations governing the actions of a broker-dealer can result in the revocation of broker-dealer licenses, the imposition of censures or fines, the issuance of cease and desist orders, and the suspension or expulsion from the securities business of a firm, its officers or employees. Supervisory

 

30



 

actions can result in higher capital requirements, higher insurance premiums, and limitations on the activities of Silicon Valley Bancshares, Silicon Valley Bank or their subsidiaries. These supervisory actions could have a material adverse effect on our business and profitability.

 

Warrant, venture capital fund, and direct equity investment portfolio gains or losses depend upon the performance of the portfolio investments and the general condition of the public equity markets, which is uncertain.

 

We have historically obtained rights to acquire stock, in the form of warrants, in certain clients as part of negotiated credit facilities. We may not be able to realize gains from warrants in future periods, or our realized gains may be materially less than the current level of unrealized gains disclosed in this filing. We also have made investments in venture capital funds as well as direct equity investments in companies. The timing and amount of income, if any, from the disposition of client warrants, venture capital funds and direct equity investments typically depend upon factors beyond our control, including the performance of the underlying portfolio companies, investor demand for initial public offerings, fluctuations in the market prices of the underlying common stock of these companies, levels of mergers and acquisitions activity, and legal and contractual restrictions on our ability to sell the underlying securities. In addition, our investments in venture capital funds and direct equity investments have lost value and could continue to lose value or become worthless, which would reduce our net income or could cause a net loss in any period. All of these factors are difficult to predict, particularly in the current economic environment. Additionally, it is likely that additional investments within our existing portfolio will become impaired. However, we are not in a position to know at the present time which specific investments, if any, are likely to be impaired or the extent or timing of individual impairments. Therefore, we cannot predict future investment gains or losses with any degree of accuracy, and any gains or losses are likely to vary materially from period to period.

 

Public offerings and mergers and acquisitions involving our clients can cause loans to be paid off early, which could adversely affect our business and profitability.

 

While an active market for public equity offerings and mergers and acquisitions generally has positive implications for our business, one negative consequence is that our clients may pay off or reduce their loans with us if they complete a public equity offering or are acquired or merge with another company. Any significant reduction in our outstanding loans could have a material adverse effect on our business and profitability.

 

Adverse changes in domestic or global economic conditions, especially in the technology sector and particularly in California, could have a material adverse effect on our business, growth, and profitability.

 

If conditions worsen in the domestic or global economy, especially in the technology sector, our business, growth and profitability are likely to be materially adversely affected. Many of our technology clients would be harmed by a worsening of the global or U.S. economic slowdown. Our clients may be particularly sensitive to disruptions in the growth of the technology sector of the U.S. economy. In addition, a substantial number of our clients are geographically concentrated in California, and adverse economic conditions in California could harm the businesses of a disproportionate number of our clients. To the extent that our clients’ underlying businesses are harmed, they are more likely to default on their loans.

 

If we fail to retain our key employees, our growth and profitability could be adversely affected.

 

We rely on experienced client relationship managers and on officers and employees with strong relationships with the venture capital community to generate new business. If a significant number of these employees were to leave us, our growth and profitability could be adversely affected. We believe that our employees frequently have opportunities for alternative employment with competing financial institutions and with our clients.

 

We cannot assure you that we will be able to maintain our historical levels of profitability in the face of sustained competitive pressures.

 

Other banks and specialty and diversified financial services companies, many of which are larger and have more capital than we do, offer lending, leasing, other financial products and advisory services to our client base. In some cases, our competitors focus their marketing on our industry sectors and seek to increase their lending and other financial relationships with technology companies, early stage growth companies or special industries such as wineries. In other cases, our competitors may offer a broader range of financial products to our clients. When new competitors seek to enter one of our markets, or when existing market participants seek to increase their market share, they sometimes undercut the pricing and/or credit terms prevalent in that market. Our pricing and credit terms could deteriorate if we act to meet these competitive challenges.

 

31



 

We face risks in connection with completed or potential acquisitions.

 

We completed one acquisition in each of 2002 and 2001 and, if appropriate opportunities present themselves, we intend to acquire businesses, technologies, services or products that we believe are strategic. There can be no assurance that we will be able to identify, negotiate or finance future acquisitions successfully, or to integrate such acquisitions with our current business.

 

Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, and/or contingent liabilities, which could have a material adverse effect on our business, results of operations, and/or financial condition. Any such future acquisitions of other businesses, technologies, services or products might require us to obtain additional equity or debt financing, which might not be available on terms favorable to us, or at all; and such financing, if available, might be dilutive.

 

Upon completion of an acquisition, we are faced with the challenges of integrating the operations, services, products, personnel, and systems of acquired companies into our business, which may divert management’s attention from ongoing business operations. In addition, acquisitions of new businesses may subject us to regulatory scrutiny. We cannot assure you that we will be successful in integrating any acquired business effectively into the operations of our business. Moreover, there can be no assurance that the anticipated benefits of any acquisition will be realized.

 

The success of our acquisitions is dependent on the continued employment of several key employees. If acquired businesses do not meet projected revenue targets, or if certain key employees were to leave the businesses, we could conclude that the value of the businesses has decreased and that the related goodwill has been impaired. If we were to conclude that goodwill has been impaired that conclusion would result in an impairment of goodwill charge to us, which would adversely affect our results of operations.

 

We could be liable for breaches of security in our online banking services. Fear of security breaches could limit the growth of our online services.

 

We offer various internet-based services to our clients, including online banking services. The secure transmission of confidential information over the internet is essential to maintain our clients’ confidence in our online services. Advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology we use to protect client transaction data. Although we have developed systems and processes that are designed to prevent security breaches and periodically test our security, failure to mitigate breaches of security could adversely affect our ability to offer and grow our online services and could harm our business.

 

People generally are concerned with security and privacy on the Internet and any publicized security problems could inhibit the growth of the internet as a means of conducting commercial transactions. Our ability to provide financial services over the internet would be severely impeded if clients became unwilling to transmit confidential information online. As a result, our operations and financial condition could be adversely affected.

 

We face risks associated with international operations.

 

A component of our strategy is to expand internationally on a limited basis. Expansion into international markets, albeit on a limited basis, will require management attention and resources. We have limited experience in internationalizing our service, and we believe that many of our competitors are also undertaking expansion into foreign markets. There can be no assurance that we will be successful in expanding into international markets. In addition to the uncertainty regarding our ability to generate revenues from foreign operations and to expand our international presence, there are certain risks inherent in doing business on an international basis, including, among others, regulatory requirements, legal uncertainty regarding liability, tariffs, and other trade barriers, difficulties in staffing and managing foreign operations, longer payment cycles, different accounting practices, problems in collecting loan payments, political instability, seasonal reductions in business activity, and potentially adverse tax consequences, any of which could adversely affect the success of our international operations. To the extent we expand into international operations and have additional portions of our international revenues denominated in foreign currencies, we could become subject to increased risks relating to foreign currency exchange rate fluctuations. There can be no assurance that one or more of the factors discussed above will not have a material adverse effect on our business, results of operations, and/or financial condition.

 

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Maintaining or increasing our market share depends on market acceptance and regulatory approval of new products and services.

 

Our success depends, in part, upon our ability to adapt our products and services to evolving industry standards and client demands. There is increasing pressure on financial services companies to provide products and services at lower prices. In addition, the widespread adoption of new technologies, including internet-based services, could require us to make substantial expenditures to modify or adapt our existing products or services. A failure to achieve market acceptance of any new products we introduce, or a failure to introduce products that the market may demand, could have an adverse effect on our business, profitability, or growth prospects.

 

Business interruptions due to natural disasters and other events beyond our control can adversely affect our business.

 

Our operations can be subject to natural disasters and other events beyond our control, such as earthquakes, fires, power failures, telecommunication loss, terrorist attacks, and acts of war.  Our corporate headquarters and a portion of our critical business offices are located in California, near major earthquake faults.  Such events of disaster, whether natural or manmade, could cause severe destruction or interruption to our operations and as a result, our business could suffer serious harm.

 

33



 

ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

 

Interest Rate Risk Management

 

A key objective of asset/liability management is to manage interest rate risk associated with changing asset and liability cash flows and market interest rate movements.  Interest rate risk occurs when interest rate sensitive assets and liabilities do not re-price simultaneously both in timing and volume.  Our Asset/Liability Committee provides oversight to our interest rate risk management process and recommends policy guidelines regarding exposure to interest rates for approval by our board of directors.  Adherence to these policies is monitored on an ongoing basis, and decisions related to the management of interest rate exposure are made when appropriate.

 

We manage interest rate risk principally through strategies involving our investment securities portfolio.  Our policies permit the use of off-balance-sheet derivative instruments in managing interest rate risk.