SVB Financial Group
SILICON VALLEY BANCSHARES (Form: 10-Q, Received: 11/09/2004 18:04:24)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 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

 

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

incorporation or organization)

 

 

 

 

 

3003 Tasman Drive, Santa Clara, California

 

95054-1191

(Address of principal executive offices)

 

(Zip Code)

 

 

 

(408) 654-7400

Registrant’s telephone number, including area code:

 


 

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

Yes ý   No o

 

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

 

                At October 31, 2004, 35,986,648 shares of the registrant’s common stock ($0.001 par value) were outstanding.

 



 

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION

3

 

 

 

ITEM 1.

INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3

 

 

 

 

INTERIM CONSOLIDATED BALANCE SHEETS

3

 

 

 

 

INTERIM CONSOLIDATED STATEMENTS OF INCOME

4

 

 

 

 

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

5

 

 

 

 

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

6

 

 

 

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

7

 

 

 

ITEM 2.

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

22

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

56

 

 

 

ITEM 4.

CONTROLS AND PROCEDURES

57

 

 

 

 

 

 

PART II - OTHER INFORMATION

58

 

 

 

ITEM 1.

LEGAL PROCEEDINGS

58

 

 

 

ITEM 2.

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

58

 

 

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

59

 

 

 

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

59

 

 

 

ITEM 5.

OTHER INFORMATION

59

 

 

 

ITEM 6.

EXHIBITS

59

 

 

 

SIGNATURES

60

 

 

INDEX TO EXHIBITS

61

 

 

2



 

PART I - FINANCIAL INFORMATION

 

ITEM 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES
INTERIM CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands, except par value and share amounts)

 

2004

 

2003

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Cash and due from banks

 

$

231,656

 

$

252,521

 

Federal funds sold and securities purchased under agreement to resell

 

217,774

 

542,475

 

Investment securities

 

2,133,614

 

1,575,434

 

Loans, net of unearned income

 

2,230,414

 

1,989,229

 

Allowance for loan losses

 

(58,600

)

(64,500

)

Net loans

 

2,171,814

 

1,924,729

 

Premises and equipment, net

 

14,705

 

14,999

 

Goodwill

 

35,639

 

37,549

 

Accrued interest receivable and other assets

 

125,431

 

117,663

 

Total assets

 

$

4,930,633

 

$

4,465,370

 

 

 

 

 

 

 

Liabilities, Minority Interest, and Stockholders’ Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing demand

 

$

2,463,765

 

$

2,186,352

 

NOW

 

22,832

 

20,897

 

Money market

 

1,240,863

 

1,080,559

 

Time

 

310,155

 

379,068

 

Total deposits

 

4,037,615

 

3,666,876

 

Short-term borrowings

 

10,050

 

9,124

 

Other liabilities

 

100,072

 

87,335

 

Long-term debt

 

196,096

 

204,286

 

Total liabilities

 

4,343,833

 

3,967,621

 

 

 

 

 

 

 

Minority interest in capital of consolidated affiliates

 

74,739

 

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; 35,754,698 and 35,028,470 shares outstanding at September 30, 2004 and December 31, 2003, respectively

 

36

 

35

 

Additional paid-in capital

 

41,202

 

14,240

 

Retained earnings

 

467,954

 

422,131

 

Unearned compensation

 

(2,707

)

(1,232

)

Accumulated other comprehensive income:

 

 

 

 

 

Net unrealized gains on available-for-sale investments

 

5,576

 

11,831

 

Total stockholders’ equity

 

512,061

 

447,005

 

Total liabilities, minority interest, and stockholders’ equity

 

$

4,930,633

 

$

4,465,370

 

 

See accompanying notes to interim unaudited consolidated financial statements.

 

 

3



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

 INTERIM CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended September 30,

 

For the nine months ended September 30,

 

(Dollars in thousands, except per share amounts)

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

 

 

Loans

 

$

  41,639

 

$

  36,440

 

$

  115,551

 

$

  112,410

 

Investment securities

 

 

 

 

 

 

 

 

 

Taxable

 

19,763

 

10,532

 

51,775

 

29,466

 

Non-taxable

 

1,144

 

1,575

 

3,895

 

4,757

 

Federal funds sold and securities purchased under agreement to resell

 

1,347

 

1,204

 

4,097

 

3,163

 

Total interest income

 

63,893

 

49,751

 

175,318

 

149,796

 

Interest expense:

 

 

 

 

 

 

 

 

 

Deposits

 

2,138

 

2,196

 

6,276

 

7,036

 

Other borrowings

 

762

 

1,281

 

2,200

 

1,808

 

Total interest expense

 

2,900

 

3,477

 

8,476

 

8,844

 

Net interest income

 

60,993

 

46,274

 

166,842

 

140,952

 

Provision for loan losses

 

(3,251

)

(7,449

)

(5,993

)

(2,903

)

Net interest income after provision for loan losses

 

64,244

 

53,723

 

172,835

 

143,855

 

Noninterest income:

 

 

 

 

 

 

 

 

 

Client investment fees

 

6,955

 

5,793

 

19,622

 

18,159

 

Corporate finance fees

 

3,197

 

2,737

 

18,181

 

11,522

 

Letter of credit and foreign exchange income

 

3,874

 

3,419

 

11,408

 

10,050

 

Deposit service charges

 

3,187

 

3,567

 

10,595

 

9,688

 

Income from client warrants

 

1,152

 

1,518

 

7,370

 

4,531

 

Investment gains (losses)

 

133

 

1,317

 

1,933

 

(7,227

)

Other

 

3,304

 

2,989

 

9,087

 

9,568

 

Total noninterest income

 

21,802

 

21,340

 

78,196

 

56,291

 

Noninterest expense:

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

36,926

 

32,472

 

112,182

 

93,176

 

Net occupancy

 

4,512

 

4,614

 

13,622

 

13,119

 

Professional services

 

4,967

 

2,378

 

13,182

 

9,802

 

Furniture and equipment

 

3,067

 

2,654

 

9,426

 

7,558

 

Business development and travel

 

2,654

 

1,874

 

6,825

 

5,786

 

Correspondent bank fees

 

1,407

 

1,075

 

3,931

 

3,209

 

Data processing services

 

735

 

926

 

2,609

 

3,409

 

Telephone

 

856

 

707

 

2,540

 

2,342

 

Postage and supplies

 

808

 

590

 

2,452

 

1,806

 

Impairment of goodwill

 

1,910

 

 

1,910

 

17,000

 

Tax credit fund amortization

 

620

 

712

 

1,860

 

2,143

 

Advertising and promotion

 

647

 

374

 

1,827

 

905

 

Other

 

1,597

 

428

 

5,159

 

5,860

 

Total noninterest expense

 

60,706

 

48,804

 

177,525

 

166,115

 

Minority interest in net (gains) losses of consolidated affiliates

 

(2

)

7

 

(550

)

6,251

 

Income before income taxes

 

25,338

 

26,266

 

72,956

 

40,282

 

Income tax expense

 

9,235

 

8,837

 

27,135

 

13,011

 

Net income

 

$

  16,103

 

$

  17,429

 

$

  45,821

 

$

  27,271

 

Earnings per common share — basic

 

$

  0.46

 

$

  0.51

 

$

  1.31

 

$

  0.74

 

Earnings per common share — diluted

 

0.43

 

0.49

 

1.24

 

0.72

 

 

See accompanying notes to interim unaudited consolidated financial statements.

 

4



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

 

For the three months ended

 

For the nine months ended

 

(Dollars in thousands)

 

September 30,
2004

 

September 30,
2003

 

September 30,
2004

 

September 30,
2003

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

16,103

 

$

17,429

 

$

45,821

 

$

27,271

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Unrealized holding (losses) gains

 

16,591

 

2,425

 

(1,345

)

2,296

 

Reclassification adjustment for (gains) included in net income

 

(677

)

(1,007

)

(4,910

)

(3,067

)

Other comprehensive (loss) income, net of tax

 

15,914

 

1,418

 

(6,255

)

(771

)

Comprehensive income

 

$

32,017

 

$

18,847

 

$

39,566

 

$

26,500

 

 

See accompanying notes to interim unaudited consolidated financial statements.

 

 

5



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

For the nine months ended

 

(Dollars in thousands)

 

September 30,
2004

 

September 30,
2003

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

 45,821

 

$

 27,271

 

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

 

 

 

 

 

Provision for loan losses

 

(5,993

)

(2,903

)

Net (gain) on disposition of client warrants

 

(7,370

)

(4,531

)

Net (gain) loss on available for sale securities

 

(1,933

)

7,227

 

Depreciation and amortization

 

6,229

 

5,641

 

Impairment of goodwill

 

1,910

 

17,000

 

Minority interest

 

550

 

(6,251

)

Changes in other assets and liabilities:

 

 

 

 

 

(Increase) in accrued interest receivable

 

(2,689

)

(1,044

)

(Increase) decrease in accounts receivable

 

(9,339

)

1,202

 

Increase in deferred rent liability

 

7,281

 

 

Increase in accrued retention, warrant, and other incentive plans

 

7,224

 

7,512

 

Other, net

 

9,638

 

15,644

 

Net cash provided by operating activities

 

51,329

 

66,768

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of investment securities

 

(8,937,125

)

(12,822,891

)

Proceeds from sales of investment securities

 

4,898,786

 

11,248,631

 

Proceeds from maturities and pay-downs of investment securities

 

3,479,857

 

1,580,656

 

Net (increase) decrease in loans

 

(253,793

)

156,771

 

Proceeds from recoveries of charged-off loans

 

10,414

 

16,734

 

Purchases of premises and equipment

 

(5,935

)

(2,791

)

Net cash (used by) provided by investing activities

 

(807,796

)

177,110

 

Cash flows from financing activities:

 

 

 

 

 

Net increase in deposits

 

370,739

 

36,199

 

Increase in short-term borrowings

 

1,000

 

 

(Decrease) in long-term debt

 

(8,190

)

(8,631

)

Capital contributions from minority interest participants

 

23,445

 

10,012

 

Proceeds net of issuance costs, from issuance of common stock including tax benefits of certain stock option exercises

 

23,907

 

6,502

 

Repurchase of common stock

 

 

(148,092

)

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

 

 

123,493

 

Net cash provided by financing activities

 

410,901

 

19,483

 

Net (decrease) increase in cash and cash equivalents

 

(345,566

)

263,361

 

Cash and cash equivalents at beginning of year

 

794,996

 

442,589

 

Cash and cash equivalents at end of period

 

$

 449,430

 

$

 705,950

 

Supplemental disclosures:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest paid

 

$

 5,517

 

$

 9,049

 

Income taxes paid

 

$

 19,973

 

$

 14,626

 

 

See accompanying notes to interim unaudited consolidated financial statements.

 

 

6



 

SILICON VALLEY BANCSHARES AND SUBSIDIARIES

NOTES TO INTERIM UNAUDITED 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 four lines of banking and financial services: our segments are described in Note 9 to the Interim Unaudited Consolidated Financial Statements on this Form 10-Q. 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 10,000 clients across the country, through its 26 regional offices in the United States and a subsidiary in each of the U.K. and India.  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 clients in all stages of growth from emerging-growth companies to corporate technology clients in the technology and life sciences markets, as well as the premium wine industry. The Company defines “emerging-growth” clients as companies in the start-up or early stages of their lifecycle; these companies tend to be privately held, thinly capitalized and backed by venture capital; they tend to have few employees, primarily engaged in research and development, have brought relatively few products or services to market, and have no or little revenue. By contrast, the Company defines “corporate technology” clients as companies that tend to be more mature; they may be relatively well capitalized, publicly traded and more established in the markets in which they participate. Additionally, merger, acquisition, private placement and corporate partnering services are provided through the Company’s wholly-owned investment banking subsidiary, SVB Alliant, whose offices are in California and Massachusetts.

 

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America. Certain reclassifications have been made to prior periods’ results to conform to current period presentations. Such reclassifications had no effect on the results of operations or stockholders’ equity.

 

Descriptions of the 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 September 30, 2004, there have been no significant changes to these policies, except as included herein.

 

Basis of Presentation and Preparation

 

Consolidation

The consolidated financial statements include the accounts of Silicon Valley Bancshares and those of its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. SVB Strategic Investors, L.L.C., SVB Strategic Investors II, L.L.C., and Silicon Valley BancVentures, Inc., as general partners, have significant influence over the operating and financing policies of non wholly-owned affiliates, SVB Strategic Investors Fund, L.P., SVB Strategic Investors Fund II, L.P., and Silicon Valley BancVentures, L.P., respectively. The limited partners of SVB Strategic Investors Fund, L.P., SVB Strategic Investors Fund II, L.P., and Silicon Valley BancVentures, L.P. hold no substantive participating rights, therefore, the assets, liabilities, partners’ capital, and results of operations are included in the Company’s interim unaudited consolidated financial statements. Minority interest in the capital of consolidated affiliates primarily represents the minority participants’ share of the equity of SVB Strategic Investors Fund, L.P., SVB Strategic Investors Fund II L.P., and Silicon Valley BancVentures, L.P.

Similar accounting is applied to SVB Woodside Financial, the general partner of Taurus Growth Partners, L.P. and Libra Partners, L.P., see the Company’s 2003 Annual Report on Form 10-K under “Item 8. Consolidated Financial Statements and Supplementary Data—Note 2 to the Consolidated Financial Statements—Business Combinations.”

 

The preparation of interim unaudited consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date, and the reported amounts of income, expenses, and the results of operations for the reported periods. Actual results could differ from those

 

 

7



 

 

estimates , and have a material effect on the Company’s financial position and operating results. 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 “Part 1, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates.”

 

In Management’s opinion, the interim unaudited consolidated financial statements contain all adjustments (of a normal, recurring nature) necessary to present fairly the Company’s interim unaudited consolidated financial position at September 30, 2004, the interim unaudited consolidated results of its operations for the third quarter and nine months ended September 30, 2004 and 2003, and the interim unaudited cash flows for the nine months ended September 30, 2004 and 2003. The consolidated balance sheet at December 31, 2003 was derived from audited financial statements. Certain information and footnote disclosures normally presented in audited financial statements have been omitted from this unaudited report. The results of operations for the third quarter and nine months ended September 30, 2004, are not necessarily indicative of the results for any future periods. The interim unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and its notes thereto included in the Company’s 2003 Annual Report on Form 10-K.

 

Income from Client Warrants

Unexercised warrant equity instruments in private companies are initially recorded at a nominal value on the Company’s interim consolidated balance sheets. They are carried at this value until they become marketable or expire.

Gains on warrant equity instruments that result from a portfolio company’s acquisition by a publicly-traded company are marked-to-market when the acquisition occurs. The resulting gains are recognized into consolidated net income on that date, in accordance with Emerging Issues Task Force (“EITF”), Issue No. 91-5, “Nonmonetary Exchange of Cost-Method Investments.”

Unrealized gains on warrant equity instruments are recorded upon the establishment of a readily determinable fair value of the underlying security, as defined by Statement of Financial Accounting Standard (“SFAS”) No.115, “Accounting for Certain Investments in Debt and Equity Instruments”, and are excluded from consolidated net income and are reported in accumulated other comprehensive income, which is a separate component of stockholders’ equity.

Further fluctuations in the market value of these marketable equity instruments, prior to eventual sale, are also excluded from consolidated net income and are reported in accumulated other comprehensive income, which is a separate component of stockholders’ equity. Gains or losses on warrant equity instruments are recorded in our consolidated net income in the period the underlying securities are sold to a third party.

 

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, to account for its employee stock options rather than the alternative fair value accounting allowed by SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” APB No. 25 provides that the compensation expense relative to the Company’s employee stock options be measured based on the intrinsic value of the stock option.  SFAS No. 123 as amended by SFAS No. 148 requires those companies that continue to follow APB No. 25 to provide 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.”

 

If compensation cost related to both the Company’s stock option awards to employees and directors and to the Employee Stock Purchase Plan had 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 shown below:

 

 

8



 

 

 

 

For the third quarter ended

 

For the nine months ended

 

 

 

September 30,

 

September 30,

 

(Dollars in thousands, except per share amounts)

 

2004

 

2003

 

2004

 

2003

 

Net income, as reported

 

$

16,103

 

$

17,429

 

$

45,821

 

$

27,271

 

 

 

 

 

 

 

 

 

 

 

 

 

Add:

 

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

 

396

 

103

 

813

 

494

 

Less:

 

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

 

(3,051

)

(3,134

)

(11,510

)

(11,682

)

Net income, pro-forma

 

$

13,448

 

$

14,398

 

$

35,124

 

$

16,083

 

 

 

 

 

 

 

 

 

 

 

Basic income per share:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.46

 

$

0.51

 

$

1.31

 

$

0.74

 

Pro-forma

 

0.38

 

0.40

 

1.00

 

0.44

 

Diluted income per share:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.43

 

$

0.49

 

$

1.24

 

$

0.72

 

Pro-forma

 

0.37

 

0.40

 

0.98

 

0.45

 

 

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.

 

Recent Accounting Pronouncements

 

On September 30, 2004, the Emerging Issues Task Force (“EITF”) concluded on Issue 04-8 that contingently convertible securities should be treated as convertible securities and included in the calculation of fully diluted earnings per share using the if-converted method. This requires that the Company include the weighted-average contingently issuable shares from the zero-coupon, convertible notes due June 15, 2008 as common stock equivalents for purposes of computing diluted earnings per share. This is required despite our stated intent to settle the principal amount of $150.0 million (accreted value) in cash. Although the economic substance of our financial performance is not impacted, the Company estimates that the impact of EITF 04-8 on our third quarter 2004 diluted earnings per share would have been a reduction of approximately 11.0%. EITF 04-8 is effective for reporting periods ending after December 15, 2004. The terms of the zero-coupon, convertible notes allow us to settle the security in cash or stock. During the fourth quarter of 2004, Management will continue to assess possible appropriate steps required to retain the treasury-method accounting for the outstanding contingently convertible securities.

 

2. Business Combinations

 

On September 28, 2001, the Company completed its acquisition of SVB Alliant and has included its results of operations in the Company’s consolidated results of operations since that date. This acquisition enabled the Company to strengthen its investment banking platform for its clients.

 

The Company agreed to purchase the assets of SVB Alliant for a total of $100.0 million, due in several installments of cash and/or common stock. These installments are payable over four years between September 30, 2001 and September 30, 2005. As of September 30, 2004, the first four installments, which aggregated $90.7 million have been paid in cash, and the remaining $9.3 million, which was discounted at prevailing forward market interest rates at the time of purchase of approximately 3.3%, are recorded as short-term debt.

 

In addition to the fixed purchase price, the founders of SVB Alliant received certain contingent purchase price payments including 75.0% of their pre-tax net income for the twelve-month period ended September 28, 2002, which totaled approximately $2.5 million.

 

Furthermore, the agreement provides for the Company to pay to the sellers an amount equal to fifteen times the amount by which SVB Alliant’s cumulative after-tax net income from October 1, 2002 to September 30, 2005

 

 

9



 

 

exceeds $26.5 million, provided, that the aggregate amount of any deferred earn-out payment payable shall not exceed $75.0 million. SVB Alliant’s cumulative after-tax net loss, from October 1, 2002 through September 30, 2004 was $37.3 million.

 

The Company also agreed to make retention payments aggregating $5.0 million in equal annual installments on September 28, 2003, 2004, and 2005, of which, one installment, due September 30, 2005, remains unpaid.

 

The purchase price was allocated to the assets acquired and liabilities assumed, based on the estimated net fair values at the date of acquisition of approximately $0.5 million. The excess of purchase price over the estimated fair values of the net assets acquired was recorded as goodwill. The business combinations were recorded in accordance with SFAS No. 141. See “Note 6 and Note 7 to the Interim Unaudited Consolidated Financial Statements — Goodwill, and Short-term Borrowings and Long-term Debt.”

 

On August 6, 2004, the Company and the founders of SVB Alliant agreed to release the Company (and its relevant affiliates) from any prospective earn-out payments associated with SVB Alliant’s after-tax net income, other than those associated with any change of control of the Company. In exchange for the release of the earn-out payments, the Company agreed to shorten the term of the non-compete agreements with certain founders of Alliant Partners.

 

3.  Earnings Per Share (EPS)

 

The following is a reconciliation of basic EPS to diluted EPS for the third quarter and nine months ended September 30, 2004 and 2003.

 

 

 

For the third quarter ended
September 30,

 

For the nine months ended
September 30,

 

(Dollars and shares in thousands,

 

Net

 

 

 

Per Share

 

Net

 

 

 

Per Share

 

except per share amounts)

 

Income

 

Shares

 

Amount

 

Income

 

Shares

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2004:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders

 

$

16,103

 

35,303

 

$

0.46

 

$

45,821

 

35,079

 

$

1.31

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options and restricted stock

 

 

1,910

 

 

 

1,866

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders plus common stock equivalents

 

$

16,103

 

37,213

 

$

0.43

 

$

45,821

 

36,945

 

$

1.24

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2003:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders

 

$

17,429

 

34,205

 

$

0.51

 

$

27,271

 

36,661

 

$

0.74

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options and restricted stock

 

 

1,143

 

 

 

970

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income available to common stockholders plus common stock equivalents

 

$

17,429

 

35,348

 

$

0.49

 

$

27,271

 

37,631

 

$

0.72

 

 

 

10



 

4.  Investment Securities

 

The detailed composition of the Company’s investment securities is presented as follows:

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2004

 

2003

 

 

 

 

 

 

 

Available-for-sale securities, at fair value

 

$

2,003,271

 

$

1,479,383

 

Marketable equity securities (investment company accounting)(1)

 

860

 

 

Non-marketable securities (investment company accounting)

 

 

 

 

 

Venture capital fund investments(2)

 

46,661

 

30,149

 

Other private equity investments(3)

 

12,455

 

10,097

 

Other investments(4)

 

7,047

 

 

Non-marketable securities (cost basis accounting)

 

 

 

 

 

Venture capital fund investments

 

25,719

 

25,196

 

Tax credit funds

 

14,690

 

16,551

 

Federal Home Loan Bank stock

 

12,681

 

3,009

 

Federal Reserve Bank stock

 

7,771

 

7,467

 

Other private equity investments

 

2,459

 

3,582

 

Total investment securities

 

$

2,133,614

 

$

1,575,434

 


(1)   Marketable equity securities (investment company accounting) included $0.9 million related to Silicon Valley BancVentures, L.P., at September 30, 2004. 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 marketable equity securities (investment company accounting) of $0.1 million as of September 30, 2004.

(2)    Non-marketable venture capital fund investments included $41.5 million and $30.1 million related to SVB Strategic Investors Fund, L.P., at September 30, 2004, and December 31, 2003, respectively. The Company has a controlling ownership interest of 11.1% in the fund. It also included $5.2 million and $0.0 million related to SVB Strategic Investors Fund II, L.P., at September 30, 2004 and December 31, 2003, respectively. The Company has a controlling interest of 14.4% in the fund. Excluding the minority interest-owned portion of these funds, the Company has non-marketable venture capital fund investments (investment company accounting) of $5.3 million and $3.3 million, as of September 30, 2004 and December 31, 2003, respectively.

(3)   Non-marketable other private equity investments included $12.5 million and $10.1 million related to Silicon Valley BancVentures, L.P., at September 30, 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 $1.3 million and $1.1 million as of September 30, 2004, and December 31, 2003, respectively.

(4)   Non-marketable other investments included $3.5 million related to Partners For Growth, L.P., at September 30, 2004. The Company has a majority ownership interest of 53.2% in the fund. It also included $0.9 million and $2.7 million related to Gold Hill Venture Lending Partners 03, L.L.C. and Gold Hill Venture Lending 03, L.P., respectively, as of September 30, 2004. The Company has a majority interest of 80.9% in Gold Hill Venture Lending Partners 03, L.L.C. Excluding the minority interest-owned portion of Partners For Growth, L.P. and Gold Hill Venture Lending Partners 03, L.L.C., the Company has non-marketable other investments of $5.3 million as of September 30, 2004.

 

The following tables present the total commitments, funded commitments, and carrying value of the Company’s venture capital and other private equity investments at September 30, 2004. The tables also present net investment gains (losses) for the nine months ended September 30, 2004. The carrying value of the Company’s venture capital and other private equity investments at and for the year ended December 31, 2003, are included in “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.

 

 

11



 

 

 

 

(As consolidated as of September 30, 2004)

 

 

 

Venture Capital Funds

 

Other Private Equity

 

 

 

(Dollars in thousands)

 

Wholly- owned Fund Investments

 

Funds of Funds

 

Wholly- owned Equity Investments

 

Co-Investment Fund

 

Venture Debt Fund

 

Total

 

Commitments by investors to consolidated funds

 

$

 

$

225,800

 

$

 

$

56,100

 

$

47,000

 

$

328,900

 

Commitments to investments

 

58,062

 

157,975

 

16,033

 

23,116

 

24,501

 

279,687

 

Commitments funded

 

43,999

 

64,228

 

16,033

 

23,116

 

7,291

 

154,667

 

Inception to date distributions

 

49,298

 

4,887

 

9,070

 

4,318

 

 

67,573

 

Current cost of investments

 

 

 

 

 

 

 

 

 

 

 

 

 

Marketable

 

8

 

 

 

1,189

 

1

 

1,198

 

Non-marketable

 

25,719

 

61,255

 

1,859

 

17,335

 

7,248

 

113,416

 

 

 

25,727

 

61,255

 

1,859

 

18,524

 

7,249

 

114,614

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Carrying value

 

 

 

 

 

 

 

 

 

 

 

 

 

Marketable

 

2

 

 

 

860

 

 

862

 

Non-marketable

 

25,719

 

46,661

 

1,859

 

12,455

 

7,047

 

93,741

 

 

 

25,721

 

46,661

 

1,859

 

13,315

 

7,047

 

94,603

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year-to-date net investment (losses) gains

 

(1,687

)

1,467

 

414

 

409

 

(66

)

537

 

 

 

 

 

(The Company’s ownership interest as of September 30, 2004)

 

 

 

Venture Capital Funds

 

Other Private Equity

 

 

 

(Dollars in thousands)

 

Wholly- owned Fund Investments

 

Managed Funds of Funds

 

Wholly- owned Equity Investments

 

Managed Venture Capital Fund

 

Venture Debt Funds

 

Total

 

Commitments to investments

 

$

58,062

 

$

28,500

 

$

16,033

 

$

6,000

 

$

45,000

 

$

153,595

 

Current cost of investments

 

25,727

 

6,966

 

1,859

 

1,981

 

5,450

 

41,983

 

Carrying value

 

25,720

 

5,344

 

1,859

 

1,424

 

5,257

 

39,604

 

Year-to-date net investment (losses) gains

 

(1,687

)

158

 

414

 

44

 

(120

)

(1, 191

)

 

5.  Loans and Allowance for Loan Losses

 

The detailed composition of loans, net of unearned income of $14.6 million and $12.3 million, at September 30, 2004, and December 31, 2003, respectively, is presented in the following table:

 

12



 

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

2004

 

2003

 

 

 

 

 

 

 

Commercial loans:

 

 

 

 

 

 

 

 

 

 

 

Core commercial

 

$

1,339,379

 

$

1,340,745

 

Asset-based lending

 

306,045

 

198,056

 

Accounts receivable factoring

 

210,827

 

165,185

 

Total commercial loans

 

1,856,251

 

1,703,986

 

 

 

 

 

 

 

Vineyard development

 

85,065

 

50,118

 

Commercial real estate

 

15,351

 

12,204

 

Total real estate construction

 

100,416

 

62,322

 

 

 

 

 

 

 

Real estate term — consumer

 

27,290

 

19,213

 

Real estate term — commercial

 

14,005

 

12,902

 

Total real estate term

 

41,295

 

32,115

 

Consumer and other

 

232,452

 

190,806

 

Total loans, net of unearned income

 

$

2,230,414

 

$

1,989,229

 

 

The activity in the allowance for loan losses for the three and nine months ended September 30, 2004 and 2003 was as follows:

 

 

 

Third quarter ended September 30,

 

Nine months ended September 30,

 

(Dollars in thousands)

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

61,900

 

$

69,500

 

$

64,500

 

$

70,500

 

Provision for loan losses

 

(3,251

)

(7,449

)

(5,993

)

(2,903

)

Loans charged off

 

(3,200

)

(3,431

)

(10,321

)

(16,831

)

Recoveries

 

3,151

 

8,880

 

10,414

 

16,734

 

Ending balance

 

$

58,600

 

$

67,500

 

$

58,600

 

$

67,500

 

 

The aggregate recorded investment in loans for which impairment have been determined in accordance with SFAS No. 114 totaled $15.0 million and $12.6 million at September 30, 2004, and September 30, 2003, respectively. Allocations of the allowance for loan losses specific to impaired loans totaled $4.5 million at September 30, 2004, and $6.1 million at September 30, 2003. Average impaired loans for the third quarter of 2004 and 2003 totaled $13.6 million and $15.7 million, respectively.

 

6.  Goodwill

 

The Company adopted the provisions of Statement of Financial Accounting Standard No. 142 (“SFAS No. 142”), “Goodwill and Other Intangible Assets” effective November 1, 2002, which requires that the Company allocate its goodwill to its various reporting units, determine the carrying value of those businesses, and estimate the fair value of the reporting units so that a two-step goodwill impairment test can be performed.  SFAS No. 142 requires impairment testing to be performed initially upon adoption annually, and whenever events and changes in circumstances indicate there may be a potential impairment. If the fair value exceeds the carrying value, goodwill is not impaired and no further testing is performed. If the carrying value exceeds the fair value, then the second step must be performed, and the implied fair value of the reporting unit’s goodwill must be determined and compared to the carrying value of the goodwill for the reporting unit. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then an impairment loss equal to the difference is recorded.

 

Goodwill totaled $35.6 million at September 30, 2004 compared to $37.5 million at December 31, 2003. All of the Company’s goodwill at September 30, 2004 pertains to the acquisition of SVB Alliant.

 

13



 

SVB Alliant

During the second quarter of 2004, the Company conducted its annual impairment review of SVB Alliant in accordance with the provisions of SFAS No. 142, based primarily on forecasted discounted cash flow analyses. The valuation analysis of SVB Alliant indicated no further impairment beyond that already identified and recorded.

 

During the second quarter of 2003, the Company conducted its annual impairment review of SVB Alliant, which elicited an indication of possible impairment. Despite an increase in revenues during the second quarter of 2003 compared to the first quarter of 2003, SVB Alliant failed to achieve the revenues projected by the financial model used to value SVB Alliant in connection with its original acquisition by the Company. In response to these indications, the Company engaged an internationally reputable business consulting firm to assist the Company in consulting a valuation of SVB Alliant, in compliance with the requirements of SFAS No. 142. Based on this valuation, the Company recorded an impairment charge of $17.0 million during the second quarter of 2003.

 

During the fourth quarter of 2003, it became apparent that the operating results of SVB Alliant during the second half of 2003 were substantially below the performance forecasted in connection with the second quarter analysis, primarily due to decreased fees associated with weak initial public offering (“IPO”) and mergers and acquisitions environments. The Company engaged the same business-consulting firm that assisted the Company with its annual impairment review during the second quarter of 2003 to assist the Company in conducting a valuation of SVB Alliant, in compliance with the requirements of SFAS No. 142. Based on this valuation, the Company recorded an impairment charge of $46.0 million during the fourth quarter of 2003. The total impairment charge for 2003 was $63.0 million.

 

Woodside Asset Management, Inc.

During the third quarter of 2004, the Company conducted its annual impairment review of Woodside Asset Management, Inc., which indicated possible impairment. Based primarily on an internal analysis of forecasted discounted cash flows, the Company recorded an impairment charge for the entire goodwill amount of $1.9 million during the third quarter of 2004. Woodside Asset Management, Inc. failed to achieve or exceed the projected operating results used as the basis of its valuation in connection with its original acquisition by the Company.

 

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.”

 

7.  Short-term Borrowings and Long-term Debt

 

The following table represents the outstanding short-term borrowings and long-term debt at September 30, 2004 and December 31, 2003:

 

 

 

 

 

September 30,

 

December 31,

 

(Dollars in thousands)

 

Maturity

 

2004

 

2003

 

 

 

 

 

 

 

 

 

Short-term borrowings:

 

 

 

 

 

 

 

Short-term note payable(1)

 

September 28, 2005

 

$

9,050

 

$

9,124

 

Revolving Line of Credit - Partners For Growth

 

Due on demand

 

1,000

 

 

Total short-term borrowings

 

 

 

$

10,050

 

$

9,124

 

 

 

 

 

 

 

 

 

Long-term debt:

 

 

 

 

 

 

 

Long-term note payable(1)

 

 

 

$

 

$

8,837

 

Convertible subordinated notes

 

June 15, 2008

 

146,504

 

145,797

 

Junior subordinated debentures

 

October 30, 2033

 

49,592

 

49,652

 

Total long-term debt

 

 

 

$

196,096

 

$

204,286

 


(1)       Relates to the acquisition of SVB Alliant, and are payable to the former owners, who were employed by the Company.  R efer to the Interim Unaudited Consolidated Financial Statements Note 2. Business Combinations.

 

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

 

14



 

subordinated to all present and future senior debt of the Company. Holders of the notes may convert their notes only if: (i) the price of the Company’s common stock issuable upon conversion of a note reaches a specified threshold, (ii) specified corporate transactions occur, or (iii) the trading price for the notes falls below certain thresholds. At the initial conversion price, each $1,000 principal amount of notes will be convertible into approximately 29.7374 shares of the Company’s common stock. This represents 4,460,410 shares of the Company’s common stock. The Company filed a shelf registration statement with respect to the resale of the notes and the common stock issuable upon the conversion of the notes with the SEC on August 14, 2003. The fair value of the convertible subordinated notes at September 30, 2004 was $181.6 million, based on quoted market prices. The Company intends to settle the principal amount of $150.0 million (accreted value) in cash. Please refer to the 2003 Annual Report on Form 10-K, under “Item 8. Consolidated Financial Statements and Supplementary Data — Note 11 to the Consolidated Financial Statements — Short-term Borrowings and Long-term Debt.” During the third quarter of 2004, our zero-coupon convertible debt notes were convertible due to the share price of $39.65 on June 30, 2004, exceeding their conversion price. The notes will also be convertible during the fourth quarter of 2004 due to the share price of $37.17 on September 30, 2004, exceeding their conversion price. We are unaware of any note holders exercising their conversion option. The potential dilutive effect of this contingently convertible debt as of September 30, 2004 was excluded from the calculation of earnings per share in 2004 and 2003 in accordance with the provisions of SFAS No. 128 and EITF 90-19. See “Note 1 to the Interim Unaudited Consolidated Financial Statements, Recent Accounting Pronouncements under Summary of Significant Accounting Policies.”

 

Concurrent with the issuance of the convertible notes, the Company entered into a convertible note hedge at a cost of $39.0 million and a warrant transaction providing proceeds of $18.0 million with respect to its common stock, with the objective of decreasing 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 Unaudited Consolidated Financial Statements—Note 8 to the Interim Unaudited Consolidated Financial Statements—Derivative Financial Instruments.”  The cost of the convertible note hedge and 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 L.L.C. 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.

 

7.0% Junior Subordinated Debentures

 

On October 30, 2003, the Company issued $51.5 million in 7.0% Junior Subordinated Debentures to a 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 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.  Also see “Note 8. Derivative Financial Instruments” below. The fair value of the 7.0% Junior Subordinated Debentures was estimated to be $48.5 million as of September 30, 2004.

 

Available Lines of Credit.

The Company currently has available federal funds and lines of credit facilities totaling $304.0 million all of which were unused at September 30, 2004.

 

8.  Derivative Financial Instruments

 

Derivative instruments that the Company uses as a part of its interest rate risk management may include interest rate swaps, caps and floors, and forward contracts.

 

On 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

 

15



 

 

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 $0.5 million and $1.7 million for the third quarter and nine months ended September 30, 2004. The swap agreement mirrors the terms of the Junior Subordinated Debentures and therefore is callable by 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. Consequently, 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 $0.2 million, which was recorded in other assets at September 30, 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 shares 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 of 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 “Item 8. Consolidated Financial Statements and Supplementary Data — Note 1 to the Consolidated Financial Statements — Summary of Significant Accounting Policies” in the Company’s 2003 Annual Report on Form 10-K.

 

9.  Operating Segments

 

The Company is organized into four lines of banking and financial services for management reporting: Commercial Banking, SVB Capital, SVB Alliant, and Private Client Services and Other. 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 internal profitability reporting process. This process assigns each client relationship in its entirety, to a primary operating segment. The process assigns income and expenses to the operating segments according to the customer’s primary relationship designation. Additionally, working capital and its associated costs are allocated to the operating segments on an economic basis, treating each operating segment as if it were an independent entity. Unlike financial reporting, which benefits from the comprehensive structure provided by U.S. generally accepted accounting standards (“GAAP”), the internal profitability reporting process is highly subjective, as there is no comprehensive, authoritative guidance for management reporting. The management reporting process measures the performance of operating segments based on the Company’s internal operating 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, to reflect changes in the Company’s allocation methodology. Changes in an individual client’s primary relationship designation have resulted, and may in the future result, in certain client’s inclusion in different segments in different periods.

 

As of September 30, 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, SVB Capital, and SVB Alliant. Private Client Services does not meet the separate reporting thresholds as defined by SFAS No. 131 and as such, has been combined with Other Business Services for segment reporting purposes.

 

Commercial Banking provides solutions to the needs of our commercial clients in the technology, life science, and premium wine industry niches, through our lending, cash and deposit management, and global banking and trade products and services.

 

 

16



 

 

Lending products and services provide our commercial clients with loans and other credit facilities, most often secured by our clients’ assets. Lending products and services include, traditional term loans, equipment loans, revolving lines of credit, accounts-receivable based lines of credit, asset-based loans, real estate loans, vineyard development loans, and financing of affordable housing projects. We often obtain warrants to purchase an equity position in a client company’s stock in consideration for making loans, and for the provision of certain other associated lending services to these clients.

 

Within the Commercial Banking segment, the cash management services unit provides deposit account and cash management products and services, providing our commercial clients with short and long-term cash management solutions. Deposit account products and services include traditional deposit and checking accounts, certificates of deposit, and money market accounts. In connection with deposit accounts, the Company also provides lockbox and merchant services that facilitate quicker depositing of checks and other payments to clients’ accounts. Cash management products and services include wire transfer and Automatic Clearing House (“ACH”) services to enable clients to transfer funds quickly from their deposit accounts. Additionally, cash management products and services include collection services, disbursement services, electronic funds transfers (including ACH services), and online banking through SVBeConnect.

 

Within the Commercial Banking segment, the international services unit provides global trade products and services, to facilitate our clients’ global finance and business needs. Global banking and trade products and services include, foreign exchange services that empower commercial clients to manage their foreign currency risks through purchases and sales of currencies on the global inter-bank market. Also included are export trade finance services and products, including a variety of loans and credit facilities guaranteed by the Export-Import Bank of the United States to facilitate our clients’ international trade, as well as a variety of letters of credit, including export import, and standby letters of credit to enable clients to ship and receive goods globally. Additionally, included are products and services in international cash management.

 

Within the Commercial Banking Segment, Silicon Valley Bank provides investment and advisory services through it’s broker-dealer subsidiary SVB Securities. These services’ which enable our clients to better manage their assets, include mutual funds, fixed income securities, and investment reporting and monitoring.

 

Within the Commercial Banking segment, Silicon Valley Bank actively manages commercial client investment portfolios through SVB Asset Management, one of its registered investment advisor subsidiaries, by providing our commercial clients with customized cash and investment portfolio management.

 

SVB Capital focuses on the business needs of our venture capital and private equity clients while establishing and maintaining relationships with those firms domestically and internationally. Through this segment, Silicon Valley Bank provides banking services and financial solutions, including traditional deposit and checking accounts, loans, letters of credit, and cash management services.

 

SVB Capital also makes investments in venture capital and other private equity firms, and in companies in the niches the Company serves. The segment also manages three venture funds that are consolidated into our financial statements: SVB Strategic Investors Fund, L.P. and SVB Strategic Investors Fund II, L.P., which are funds of funds that invest in other venture funds, and Silicon Valley BancVentures, L.P., a direct equity venture fund that invests in privately held technology and life-sciences companies. This segment also includes the interest in Partners For Growth, L.L.F. a fund that provides secured debt to “emerging-growth” clients, and the interests in Gold Hill Venture Lending Partners 03, L.P.

 

SVB Capital, through the Special Equities Group (a division of SVB Securities), also assists private equity firms with liquidating restricted securities following initial public offerings and mergers and acquisitions, including in-kind stock transactions, restricted stock sales, block trading, and special situations trading such as liquidation of foreign securities.

 

SVB Alliant provides investment banking products and services including, merger and acquisition services (“M&A”), strategic alliances services, and specialized financial studies such as valuations and fairness opinions. In October 2003, the Company enhanced the investment banking product set by launching a Private Capital Group that provides advisory services for the private placement of securities.

 

 

17



 

The Private Client Services and Other segment, principally comprises of the Private Client Services group, and other business service units, that are not part of the Commercial Bank, SVB Capital, or SVB Alliant segments. The Private Client Services group provides a wide range of credit services to high-net-worth individuals using both long-term secured and short-term unsecured lines of credit. Those products and services include home equity lines of credit, secured lines of credit, restricted stock purchase loans, airplane loans, and capital call lines of credit. We also provide our clients with deposit account products and services to meet cash management needs, including checking accounts, deposit accounts, money market accounts, and certificates of deposit. Through our subsidiary, Woodside Asset Management, Inc., we provide individual clients with personal investment advisory services, assisting clients in establishing and implementing investment strategies to meet their individual needs and goals. The Private Client Services Group was known as the Private Banking Group until its name change in January 2004.

 

The other business services units provide various products and services. The Private Client Services and Other segment also reflects those adjustments necessary, to reconcile the results of operating segments based on the Company’s internal profitability reporting process to the interim unaudited consolidated financial statements prepared in conformity with U.S generally accepted accounting principles applicable to interim financial statements.

 

The Company’s primary source of revenue is from net interest income. Accordingly, the Company’s segments are reported using net interest income. The Company also evaluates performance based on noninterest income and noninterest expense, which are presented as components of segment operating profit or loss. The Company does not allocate income taxes to its segments. Additionally, the Company’s management reporting model is predicated on average asset balances therefore, it is not possible to provide period end asset balances for segment reporting purposes. Our operating segments are categorized as follows:

 

18



 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands at September 30, 2004)

 

Commercial Banking

 

SVB Capital

 

SVB Alliant

 

Private Client Services and Other

 

Total

 

Third quarter of 2004

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

43,281

 

$

3,166

 

$

 

$

14,546

 

$

60,993

 

Provision for loan losses(1)

 

48

 

 

 

(3,299

)

(3,251

)

Noninterest income (loss)(2)

 

16,305

 

2,355

 

3,197

 

(55

)

21,802

 

Noninterest expense(3)

 

41,071

 

6,005

 

4,828

 

8,802

 

60,706

 

Minority interest in net (gains) losses of consolidated affiliates

 

 

701

 

 

(703

)

(2

)

Income (loss) before income taxes

 

18,467

 

217

 

(1,631

)

8,285

 

25,338

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,688,585

 

74,957

 

 

254,959

 

2,018,501

 

Total average assets(4)

 

1,691,292

 

185,034

 

77,805

 

2,853,979

 

4,808,110

 

Total average deposits

 

3,266,102

 

575,841

 

 

109,803

 

3,951,746

 

Period-end goodwill

 

 

 

35,639

 

 

35,639

 

 

 

 

 

 

 

 

 

 

 

 

 

Third quarter of 2003

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

37,533

 

$

2,853

 

$

 

$

5,888

 

$

46,274

 

Provision for loan losses(1)

 

(5,449

)

 

 

(2,000

)

(7,449

)

Noninterest income(2)

 

14,056

 

3,716

 

2,737

 

831

 

21,340

 

Noninterest expense(3)

 

34,676

 

4,270

 

2,615

 

7,243

 

48,804

 

Minority interest in net (gains) losses of consolidated affiliates

 

 

461

 

 

(454

)

7

 

Income before income taxes

 

22,362

 

2,760

 

122

 

1,022

 

26,266

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,460,829

 

54,289

 

 

222,669

 

1,737,787

 

Total average assets(4)

 

2,959,066

 

562,589

 

93,821

 

492,802

 

4,108,278

 

Total average deposits

 

2,661,014

 

538,970

 

 

157,998

 

3,357,982

 

Period-end goodwill

 

 

 

81,638

 

1,910

 

83,548

 

 

 

 

 

 

 

 

 

 

 

 

 

First nine months of 2004

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

121,044

 

$

8,535

 

$

 

$

37,263

 

$

166,842

 

Provision for loan losses(1)

 

(93

)

 

 

(5,900

)

(5,993

)

Noninterest income(2)

 

48,885

 

10,552

 

18,181

 

578

 

78,196

 

Noninterest expense(3)

 

120,112

 

16,093

 

19,450

 

21,870

 

177,525

 

Minority interest in net (gains) losses of consolidated affiliates

 

 

1,824

 

 

(2,374

)

(550

)

Income (loss) before income taxes

 

49,910

 

4,818

 

(1,269

)

19,497

 

72,956

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,593,190

 

74,396

 

 

235,029

 

1,902,615

 

Total average assets(4)

 

1,591,386

 

174,089

 

70,702

 

2,812,638

 

4,648,815

 

Total average deposits

 

3,169,023

 

541,802

 

 

113,119

 

3,823,944

 

 

 

 

 

 

 

 

 

 

 

 

 

First nine months of 2003

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

114,337

 

$

8,969

 

$

 

$

17,646

 

$

140,952

 

Provision for loan losses(1)

 

(93

)

 

 

(2,810

)

(2,903

)

Noninterest income (loss)(2)

 

41,754

 

5,894

 

11,522

 

(2,879

)

56,291

 

Noninterest expense(3)

 

105,491

 

13,028

 

25,840

 

21,756

 

166,115

 

Minority interest in net (gains) losses of consolidated affiliates

 

 

1,519

 

 

4,732

 

6,251

 

Income (loss) before income taxes

 

50,693

 

3,354

 

(14,318

)

553

 

40,282

 

 

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

1,505,375

 

70,772

 

 

229,690

 

1,805,837

 

Total average assets(4)

 

2,861,878

 

527,081

 

102,508

 

473,784

 

3,965,251

 

Total average deposits

 

2,563,827

 

503,462

 

 

151,773

 

3,219,062

 


(1)   For segment reporting purposes, the Company reports net charge-offs as provision for loan losses. Thus, the Private Client Service and Other segment includes $(3.3) million and $(2.0) million for the three month ended September 30, 2004 and 2003, respectively, and includes $(5.9) million and $(2.8) million for the nine month ended September 30, 2004 and 2003, respectively, which represent the difference between net charge-offs and the provision for loan losses.

(2)   Noninterest income presented in the SVB Capital segment included warrant income of $1.2 million and $1.5 million, for the third quarter ended September 30, 2004 and 2003, respectively and $7.4 million and $4.5 million, for the nine months ended September 30, 2004 and 2003, respectively.

(3)   Commercial Banking segment included direct depreciation and amortization of $0.4 million and $0.3 million for the third quarter ended September 30, 2004 and 2003, respectively, and $1.3 million and $1.0 million for the nine months ended September 30, 2004 and 2003,

 

 

19



 

 

respectively . 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 and $1.6 million for the third quarter ended September 30, 2004 and 2003, respectively, and approximately $4.9 million and $4.6 million for the nine months ended September 30, 2004 and 2003, respectively.

(4)   Total average assets for the Commercial Banking and SVB Capital segments equal the greater of total loans or the sum of total deposits and total stockholders’ equity for each segment. Total assets presented in the SVB Alliant column included goodwill primarily related to the Alliant acquisition of $35.6 million and $81.6 million at September 30, 2004 and 2003, respectively.

 

10.  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 during the nine months ended September 30, 2004. Under this program, the Company repurchased in aggregate 4.5 million shares of common stock totaling $113.2 million in 2003. The approximate value of shares that may still be repurchased under this program totaled $46.8 million as of September 30, 2004. On May 20, 2003, the Company purchased 1.3 million shares of common stock for approximately $33.4 million in conjunction with the Company’s convertible note offering. Additionally, during the second quarter of 2003, the Company entered into an accelerated stock repurchase agreement (“ASR”) for 3.2 million shares at an initial price of $79.9 million. The Company completed its settlement obligations under this ASR agreement in the third quarter of 2003.

 

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

From its inception through its termination on May 7, 2003, the Company repurchased 5.2 million shares of common stock totaling $94.3 million in conjunction with the $100.0 million share repurchase program. Under this program, the Company had repurchased 3.3 million shares of common stock totaling $59.7 million during 2002. A portion of the shares repurchased under this program was completed under an ASR agreement.

 

Accelerated Stock Repurchase Agreements

In May 2003, January 2003, and November 2002, the Company entered into ASR agreements to facilitate the repurchase of shares of its common stock. As of December 31, 2003, the Company had completed all of its settlement obligations under these ASRs. The Company repurchased 3.2 million, 1.7 million, and 2.3 million shares of its common stock from the counterparties for $79.9 million, $29.9 million, and $40.0 million under the ASR agreements of May 2003, January 2003, and November 2002, respectively. These agreements had a five-year term. During the term of the agreements, the Company had an obligation to sell shares to the Counterparty equal to the number of shares the Company purchased from them at the outset of the agreement. The Company had the option to fulfill its obligation either by buying shares in the open market and selling those shares to the Counterparty at forward prices specified in the agreement or by issuing new shares and remitting them to the Counterparty in exchange for the forward price. The forward price was based on a formula that began with the price of the initial purchase and was adjusted for fees and commissions and the length of time from the initial purchase to when shares were sold or delivered to the Counterparty. The Company had complete discretion as to the timing and number of shares that the Company sold to the Counterparty subject to a cumulative minimum of 20.0% by the end of each year of the agreement. Under the ASRs, if the Company were required to pay the Counterparty and elected to settle its obligation in shares, the number of shares to be issued by the Company was capped.

 

The Company accounted for initial payment under the ASR agreements as a purchase of treasury stock, and the Company subsequently retired those shares. Prior to June 15, 2003, the effective date of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” the Company accounted for ASRs under the Emerging Issues Task Force (“EITF”) No. 99-7, “Accounting for an Accelerated Share Repurchase Program.”  EITF No. 99-7 provided that an entity should account for an accelerated stock repurchase program as two separate transactions: (a) as shares of common stock acquired in a treasury stock transaction recorded on the acquisition date and (b) as a forward contract indexed to its own common stock. The forward contract was to be accounted for in accordance with the provisions of EITF No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”  As of December 31, 2003, the Company had fulfilled all its obligations under the ASR agreements in accordance with the provisions of SFAS No. 150.

 

 

20



 

 

11. Obligations Under Guarantees

 

The Company provides guarantees related to financial and performance standby letters of credit issued to its clients to enhance their credit 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, the Company uses a credit evaluation process and collateral requirements similar to those for loan commitments. The Company’s standby letters of credit are often cash-secured by its clients. The actual liquidity needs or the credit risk that the Company has experienced historically have been lower than the contractual amount of letters of credit issued because a significant portion of these conditional commitments expire without being drawn upon.

 

The table below summarizes the Company’s standby letter of credits at September 30, 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.

 

(Dollars in thousands as of

 

Expires within one

 

Expires after

 

Total amount

 

Maximum amount

 

September 30, 2004)

 

year or less

 

one year

 

outstanding

 

of future payments

 

Financial standby

 

$

516,191

 

$

71,645

 

$

587,836

 

$

587,836

 

Performance standby

 

4,001

 

6,180

 

10,181

 

10,181

 

Total

 

$

520,192

 

$

77,825

 

$

598,017

 

$

598,017

 

 

At September 30, 2004 and 2003, the carrying amount of the liabilities related to financial and performance standby letters of credit was approximately $3.3 million and $2.8 million, respectively. At September 30, 2004 and 2003, cash collateral available to the Company to reimburse losses under financial and performance standby letters of credits was $228.6 million and $271.2 million, respectively.

 

 

21



 

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

Throughout the following management’s 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 the parent entity, Silicon Valley Bancshares.

 

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our interim unaudited 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 to current period’s 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 commercial clients within our technology, life science, private equity, 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 and certain other services, 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 all of our clients who include private equity firms and venture capitalists. In addition to 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 three limited partnerships: a venture capital fund and two funds that invest in venture capital funds.

 

We are able to offer our clients financial products and services through four lines of banking and financial services, as discussed in further detail below: Commercial Banking, SVB Capital, SVB Alliant, Private Client Services and Other 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.

Commercial Banking

We provide solutions to the needs of our commercial clients in the technology, life science, and premium wine industry niches through our lending, deposit account and cash management, and global banking and trade products and services.

Through our lending products and services, we extend loans and other credit facilities to our commercial clients, most often secured by our clients’ assets. Lending products and services include traditional term loans, equipment loans, revolving lines of credit, accounts-receivable based lines of credit, asset- based loans, real

 

 

22



 

estate loans, vineyard development loans, and financing of affordable housing projects. We often obtain warrants to purchase an equity position in a client company’s stock in consideration for making loans, and for the provision of certain other services to these clients.

Deposit account and cash management products and services, provide commercial clients with short and long-term cash management solutions. Deposit account products and services include traditional deposit and checking accounts, certificates of deposit, and money market accounts. In connection with deposit accounts, we also provide lockbox and merchant services that facilitate quicker depositing of checks and other payments to clients’ accounts. Cash management products and services include wire transfer and Automatic Clearing House (“ACH”) services to enable clients to transfer funds quickly from their deposit accounts. Additionally, the segment’s cash management services unit provides collection services, disbursement services, electronic funds transfers (including ACH services), and online banking through SVBeConnect.

Global banking and trade products and services, facilitate our clients’ global finance and business needs.  Global banking and trade products and services include, foreign exchange services that empower commercial clients to manage their foreign currency risks through the purchase and sale of currencies on the global inter-bank market. Also included are export trade finance services and products, including a variety of loans and credit facilities guaranteed by the Export-Import Bank of the United States to facilitate our clients’ international trade, as well as a variety of letters of credit, including export, import, and standby letters of credit, to enable clients to ship and receive goods globally. Additionally included are products and services in international cash management.

Within the Commercial Banking segment, we provide investment and advisory services through it’s broker-dealer subsidiary SVB Securities. These services enable our clients to better manage their assets, include mutual funds, fixed income securities, and investment reporting and monitoring.

Within the Commercial Banking segment, we actively manage commercial client investment portfolios through SVB Asset Management, one of it’s registered investment advisor subsidiaries, by providing our commercial clients with customized cash and investment portfolio management.

SVB Capital

SVB Capital focuses on the business needs of our venture capital and private equity clients while establishing and maintaining relationships with those firms domestically and internationally. Through this segment, we  provide banking services and financial solutions, including traditional deposit and checking accounts, loans, letters of credit, and cash management services.

SVB Capital also makes investments in venture capital and other private equity firms, and in companies in the niches we serve. The segment also manages three venture funds that are consolidated into our financial statements: SVB Strategic Investors Fund, L.P. and SVB Strategic Investors Fund II, L.P., which are funds of funds that invest in other venture funds, and Silicon Valley BancVentures, L.P., a direct equity venture fund that invests in privately held technology and life-sciences companies. This segment also includes the interest in Partners For Growth, L.P., a fund that provides secured debt to “emerging-growth” clients, and the interests in Gold Hill Venture Lending Partners 03, L.P.

SVB Capital, through the Special Equities Group (a division of SVB Securities), also assists private equity firms with liquidating restricted securities following initial public offerings and mergers and acquisitions, including in-kind stock transactions, restricted stock sales, block trading, and special situations trading such as liquidation of foreign securities.

SVB Alliant

Through a broker-dealer subsidiary, we provide merger and acquisition (“M&A”), strategic alliance services, and specialized financial studies such as valuations and fairness opinions. In October 2003, we enhanced our investment banking product set by launching a Private Capital Group that provides advisory services for the private placement of securities.

 

 

23



 

Private Client Services and Other

 

Private Client Services and Other principally comprises of our Private Client Services group and other business services units. Private Client Services provides a wide range of credit services to high-net-worth individuals using both long-term secured and short-term unsecured lines of credit. Those products and services include home equity lines of credit, secured lines of credit, restricted stock purchase loans, airplane loans, and capital call lines of credit. We also provide our clients with deposit account products and services to meet cash management needs, including checking accounts, deposit accounts, money market accounts, and certificates of deposit. Through our subsidiary, Woodside Asset Management, Inc., we provide individual clients with personal investment advisory services, assisting clients in establishing and implementing investment strategies to meet their individual needs and goals. In January 2004, our Private Banking group changed its name to “Private Client Services Group.”

 

 

24



 

Critical Accounting Policies and Estimates

 

The accompanying management’s discussion and analysis of results of operations and financial condition are based upon our interim unaudited 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. 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 and estimates discussed below are the most critical to our interim unaudited consolidated financial statements because their application places the most significant demands on management regarding matters that are inherently uncertain. The financial impact of each estimate, to the extent significant to financial results, is discussed in the applicable sections of the management’s discussion and analysis. As of September 30, 2004, there have been no material changes to these policies since the last reporting period.

Marketable Equity Securities

Our investments in marketable equity securities include:

  Unexercised warrants for shares of publicly-traded companies.

  Investments in shares of publicly-traded companies. Equity securities in our warrant, direct equity, and venture capital fund portfolios generally become marketable when a portfolio company completes an initial public offering on a publicly-reported market, or is acquired by a publicly-traded company.

  Marketable equity securities related to Taurus Growth Partners, L.P. and Libra Partners, L.P. For   information on these entities, see our 2003 Annual Report on Form 10-K under “Item 8. Consolidated Financial Statements and Supplementary Data—Note 2 to the Consolidated Financial Statements—Business Combinations.”

 

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

  Unrealized gains or losses after applicable taxes, on available-for-sale marketable equity securities that result from initial public offerings are excluded from earnings and are reported in accumulated other comprehensive income, which is a separate component of stockholders’ equity. We are often contractually restricted from selling equity securities, for a certain period of time, subsequent to the portfolio company’s initial public offering. Often, equity securities held by us for sale, are not registered under the Securities Act of 1933.  In such an event, we often seek exemption from the registration requirements of the Securities Act by effecting sales of equity securities of the portfolio company in compliance with the current public information, holding period, volume limitation and manner of sale requirements of Rule 144 under the Securities Act.  In addition, as an inducement to the underwriter(s) to underwrite such an offering, security holders, including us, typically enter into an agreement with the underwriter(s) and/or the portfolio company, pursuant to which the security holder agrees to refrain from selling the securities held by such holder for a period of time, often 180 days, after the initial public offering. As a result of such regulatory and contractual requirements, we are frequently restricted for some period of time in its ability to liquidate portfolio securities even after a portfolio company has completed an initial public offering. Gains or losses on these marketable equity instruments are recorded in our consolidated net income in the period the underlying securities are sold to a third party.

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

Marketable equity securities are recorded at fair value, which initially is the purchase cost of the securities. However, a decline in the fair value of any of these securities that is considered other-than-temporary is recorded

 

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in our consolidated net income in the period the impairment occurs. The cost basis of the underlying security is written down to fair value as a new cost basis.

We consider our marketable equity securities accounting policies to be critical, as the timing and amount of income, if any, from these instruments typically depend upon factors beyond our control. These factors include the general condition of the public equity markets, levels of mergers and acquisitions activity, fluctuations in the market prices of the underlying common stock of these companies, and legal and contractual restrictions on our ability to sell the underlying securities.

Non-Marketable Equity Securities

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

  Unexercised warrants for shares of privately-held companies.

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

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

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

  Through our funds of funds, SVB Strategic Investors Fund, L.P. and SVB Strategic Investors Fund II, L.P., which make investments in venture capital funds, which in turn, invest in privately-held companies.

   Through our investments in Partners For Growth, L.P., Gold Hill Venture Lending Partners 03 L.L.C., and Gold Hill Venture Lending 03, L.P., which makes investments in privately-held companies including equity and loans.

Unexercised warrant securities in private companies are initially recorded at a nominal value on our consolidated balance sheets. They are carried at this value until they become marketable or expire, except in the following circumstance:

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

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

Private Equity and Venture Capital Fund Investments

 

Wholly-Owned by Bancshares

 

Cost basis less identified impairment, if any

 

Owned by Silicon Valley BancVentures, L.P., Partners For Growth, L.P., SVB Strategic Investors Fund, L.P., and SVB Strategic Investors Fund II, L.P.

 

Investment company accounting, adjusted to fair value on a quarterly basis through net income

 

 

Bancshares’ wholly-owned non-marketable venture capital fund investments and other direct equity investments are recorded on a cost basis as our interests are considered minor because we own less than 5.0 percent of the company and have no influence over the company’s operating and financial policies. Our cost basis in each investment is reduced by returns until the cost basis of the individual investment is fully recovered. Returns in excess of the cost basis are recorded as investment gains in noninterest income.

The values of the investments are reviewed at least quarterly, giving consideration to the facts and circumstances of each individual investment. Management’s review of private equity investments typically includes the relevant market conditions, offering prices, operating results, financial conditions, and exit strategies. A decline in the fair

 

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value that is considered other than temporary is recorded in our consolidated statements of income in the period the impairment occurs. Any estimated loss is recorded in noninterest income as investment losses.

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

The SVB Strategic Investors Fund, L.P. and SVB Strategic Investors Fund II, L.P. (“SIF I & II”) portfolios consists primarily of investments in venture capital funds, which are recorded at fair value using investment company accounting rules. The carrying value of the investments is determined by the general partners based on the percentage of SIF I & II’s interest in the total fair market value as provided by each venture capital fund Investment. SVB Strategic Investors, L.L.C. and SVB Strategic Investors II, L.L.C. generally utilize the fair values assigned to the underlying respective portfolio investments by the management of the venture capital funds. The estimated fair value of the investments is determined after giving consideration to the relevant market conditions, offering prices, operating results, financial conditions, exit strategy, and other pertinent information. The general partner of SVB Strategic Investors Fund, L.P., SVB Strategic Investors, L.L.C., is owned and controlled by Bancshares and has an ownership interest of 11.1%. The general partner of SVB Strategic Investors Fund II, L.P., SVB Strategic Investors II, L.L.C., is owned and controlled by Bancshares and has an ownership interest of 14.4%. The limited partners of these funds do not have substantive participating rights. Therefore, SIF I & II are fully consolidated and any gains or losses resulting from changes in the estimated fair value of the venture capital fund investments are recorded as investment gains or losses in our consolidated net income. The limited partner’s share of any gains or losses is reflected in minority interest in net losses of consolidated affiliates and adjusts Bancshares’ consolidated net income to its percentage ownership.

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

Allowance for Loan Losses

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

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

The allowance for loan losses is established through a provision for loan losses charged to expense to provide for credit risk. Our allowance for loan losses is established for loan losses that are probable but not yet realized. The

 

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

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

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

Historical Loan Loss Migration Model

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

We analyze the historical loan loss migration trend by compiling gross loan loss data and by credit risk-rating for the rolling twelve-month periods as of the end of each quarter. Each of the loans charged-off over the twelve-month period is assigned a credit risk rating at the period end of each of the preceding four quarters. On an annual basis, the model calculates charged-off loans as a percentage of current period end loans by credit risk-rating category. The percentages are averaged and are aggregated to estimate our loan loss factors. The annual periods reviewed and averaged to form the loan loss factors for twelve quarters of history. The current period end client loan balances are aggregated by risk-rating category. Loan loss factors for each risk-rating category are ultimately applied to the respective period end client loan balances for each corresponding risk-rating category, to provide an estimation of the allowance for loan losses.

Contingent and Macro Allocations

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

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

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

 

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

   Changes in the nature of our loan portfolio.

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

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

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

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

Goodwill

Goodwill, which arises from the purchase price exceeding the assigned value of the net assets of an acquired business, represents the value attributable to unidentifiable intangible elements being acquired. Our goodwill at September 30, 2004 related to the acquisition of SVB Alliant, a mergers and acquisitions firm. The value of this goodwill is supported ultimately by the free cash flows from the acquired businesses. A decline in earnings as a result of a decline in mergers and acquisitions transaction volume or a decline in the valuations of mergers and acquisitions clients could lead to impairment, which would be recorded as a write-down in our consolidated net income.

On an annual basis or as circumstances dictate, management reviews goodwill and evaluates events or other developments that may indicate impairment in the carrying amount. The evaluation methodology for potential impairments is inherently complex, and involves significant management judgment in the use of estimates and assumptions. We evaluate impairment using a two-step process. First, we compare the aggregate fair value of the reporting unit to its carrying amount, including goodwill. If the fair value exceeds the carrying amount, no impairment exists. If the carrying amount of the reporting unit exceeds the fair value, then we compare the “implied” fair value, defined below, of the reporting unit’s goodwill with its carrying amount. If the carrying amount of the goodwill exceeds the implied fair value, then goodwill impairment is recognized by writing goodwill down to the implied fair value.

We primarily use a discounted future cash flows approach to value the reporting unit being evaluated for goodwill impairment. These estimates involve many assumptions, including expected results of operations, assumed discounts rates, and assumed growth rates for the reporting units. The discount rate used is based on standard industry practice, taking into account the expected equity risk premium, the size of the business, and the probability of the reporting unit achieving its financial forecasts. The implied fair value is determined by allocating the fair value of the reporting unit to all of the assets and liabilities of that unit, as if the unit had been acquired in a business combination and the fair value of the unit was the purchase price.

Events that may indicate goodwill impairment include significant or adverse changes in results of operations of the business, economic or political climate, an adverse action or assessment by a regulator, unanticipated competition, and a more likely-than-not expectation that a reporting unit will be sold or disposed of. More information about goodwill is included in “ Part 1, Item 1 - Interim Unaudited Consolidated Financial Statements, Note 6. Goodwill” and in our 2003 Annual Report on Form 10-K, “Item 8. Consolidated Financial Statements and Supplementary Data” and “Item 7A. Quantitative and Qualitative Disclosures about Market Risk—Factors That May Affect Future Results.”

 

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Results of Operations

 

Earnings Summary

 

We reported net income of $16.1 million, or $0.43 per diluted common share, for the third quarter ended September 30, 2004. This was $1.3 million, or 7.6%, lower than net income of $17.4 million, or $0.49 per diluted common share, for the third quarter ended September 30, 2003, however, there were significant fluctuations in various components within net income. The lower net income is in part attributable to higher noninterest expenses of $11.9 million, which were largely attributable to higher compensation and benefits expenses of $4.5 million, higher professional services expenses of $2.6 million, and an impairment of goodwill expense related to Woodside Asset Management of $1.9 million. Additionally, the recovery of provision for loan losses was $4.2 million lower in 2004 than in 2003, primarily due to the recovery of a significant loan loss in the third quarter of 2003. However, net interest income was $10.5 million higher in 2004 than in 2003. A detailed analysis of the underlying reasons for the higher net interest income and lower provision for loan losses is provided following the table summarizing the components and changes of net income.

 

We also reported net income of $45.8 million, or $1.24 per diluted common share, for the nine months ended September 30, 2004. This was $18.5 million, or 68.0%, higher than net income of $27.3 million, or $0.72 per diluted common share, for the corresponding nine months ended September 30, 2003. Net income for the nine months ended September 30, 2003 was lower than the comparable nine months ended September 30, 2004, primarily due to incremental net interest income from improved yields on investment securities and loans and increases of noninterest income, offset by increases of noninterest expense, particularly in compensation benefits and professional fees. Additionally, we recognized an impairment of goodwill charge of $17.0 million during the second quarter of 2003.

 

The major components and changes of net income are summarized in the following table:

 

 

 

For the Third Quarter

 

 

 

For the Nine Months

 

 

 

 

 

Ended September 30,

 

%

 

Ended September 30,

 

%

 

(Dollars in thousands)

 

2004

 

2003

 

Change

 

2004

 

2003

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

60,993

 

$

46,274

 

31.8

 

$

166,842

 

$

140,952

 

18.4

 

Provision for loan losses

 

(3,251

)

(7,449

)

(56.4

)

(5,993

)

(2,903

)

106.4

 

Noninterest income

 

21,802

 

21,340

 

2.2

 

78,196

 

56,291

 

38.9

 

Noninterest expense