SVB Financial Group
SILICON VALLEY BANCSHARES (Form: 10-K, Received: 03/11/2004 14:36:09)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2003

OR

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

For the transition period from                  to                  

Commission File Number: 000-15637


SILICON VALLEY BANCSHARES

(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)

91-1962278
(I.R.S. Employer Identification No.)

3003 Tasman Drive
Santa Clara, California
(Address of principal executive offices)


95054-1191

(Zip Code)

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


Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock ($0.001 par value)
(Title of each class)

Nasdaq National Market
(Name of each exchange on which registered)

 

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  x   No  o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

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

The aggregate market value of the voting stock held by non-affiliates of the registrant, as of June 30, 2003, the last business day of the registrant’s most recently completed second fiscal quarter, based upon the closing price of its common stock on such date, on the Nasdaq National Market was $821,212,829.

At January 31, 2004, 35,136,142 shares of the registrant’s common stock ($0.001 par value) were outstanding.

Documents Incorporated by Reference

Documents Incorporated

 

Parts of Form 10-K
Into Which Incorporated

 

Definitive proxy statement for the Company’s 2004 Annual Meeting of Stockholders to be filed within 120 days of the end of the fiscal year ended December 31, 2003

 

 

Part III

 

 

 

 



 

TABLE OF CONTENTS

 

 

Page

PART I

 

 

ITEM 1.

BUSINESS

3

ITEM 2.

PROPERTIES

12

ITEM 3.

LEGAL PROCEEDINGS

12

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

12

PART II

 

 

ITEM 5.

MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

13

ITEM 6.

SELECTED CONSOLIDATED FINANCIAL DATA

14

ITEM 7.

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

15

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

46

ITEM 8.

CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

54

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

103

ITEM 9A.

CONTROL AND PROCEDURES

103

PART III

 

 

ITEM 10.

DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

103

ITEM 11.

EXECUTIVE COMPENSATION

103

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

103

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

104

ITEM 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

104

PART IV

 

 

ITEM 15.

EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

104

SIGNATURES

106

INDEX TO EXHIBITS

107

 

2



PART I

ITEM 1. BUSINESS

General

Silicon Valley Bancshares is a bank holding company and a financial holding company. Our principal subsidiary, Silicon Valley Bank, is a California state-chartered bank and a member of the Federal Reserve System. Silicon Valley Bank’s deposits are insured by the Federal Deposit Insurance Corporation. Our corporate headquarters is located at 3003 Tasman Drive, Santa Clara, California 95054 and our telephone number is 408.654.7400. When we refer to “Silicon Valley Bancshares,” or “we” or use 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 company, Silicon Valley Bancshares.

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. In 2003, we continued to diversify our services to support our clients throughout their life cycles, regardless of their age or size. We offer a range of financial services that generate three distinct sources of income.

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

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

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

We serve over 9,500 clients nationwide and have venture capital relationships in over 20 countries around the world. To deliver high quality, localized service we have 13 offices throughout California and operate 26 regional offices across the country in Arizona, Colorado, Georgia, Illinois, Massachusetts, Minnesota, New York, North Carolina, Oregon, Pennsylvania, Texas, Virginia, and Washington. Our focus on the technology, life sciences, and premium winery markets and our extensive knowledge of the people and business issues driving them, provide a level of service and partnership that contributes to our clients’ success.

Business Overview

Silicon Valley Bancshares is organized by groups, which manage the diverse financial services we offer:

Commercial Banking

We provide domestic and international cash management services including deposit services, collection services, disbursement services, electronic funds transfers, and online banking through SVBeConnect. Our lending services include traditional term loans, commercial finance lending, and structured finance lending. Global financial services that we provide include global treasury, global trade, foreign exchange and global finance.

3




Investment services are provided through our broker-dealer, SVB Securities, which offers mutual funds and fixed income securities. SVB Asset Management provides investment advisory services.

Merchant Banking

We provide banking services to private equity and venture capital firms, make direct private equity and venture capital fund investments, establish and maintain international alliances with venture capital firms, and manage two limited partnerships: a venture capital fund and a fund that invests in venture capital funds.

Investment Banking

We offer merger and acquisition, corporate partnering and advisory services through our subsidiary, Alliant Partners. In October 2003, Alliant launched a Private Capital Group and began offering advisory services for the private placement of securities.

Private Banking

Through the SVB Private Bank we provide a wide array of loans, personal asset management, mortgage services, and trust and estate planning tailored for high-net-worth individuals. We also provide investment advisory services to these clients through our subsidiary, Woodside Asset Management, Inc. In January 2004, our Private Banking division changed its name to “Private Client Services Group.”

Industry Niches

In each of the industry niches we serve, we have developed services to meet the needs of our clients throughout their life cycles, from early stage through maturity.

Technology and Life Science

We serve a variety of clients in the technology and life science industries. A key component of our technology and life science business strategy is to develop relationships with clients at an early stage and offer them banking services that will continue to meet their needs as they mature and expand.

Our early stage clients generally keep large cash balances in their deposit accounts and usually do not borrow large amounts under their credit facilities. The primary source of funding for most early stage clients is equity from venture capitalists and public markets. Lending to this market typically involves working capital lines of credit, equipment financing, asset acquisition loans, and bridge financing between funding rounds.

With an extended suite of financial services, we have successfully expanded our business to more mature companies. Our Corporate Technology practice is a network of senior lenders in every geographic region in which we operate, focused solely on the specific financial needs of mature private and public clients. Today, we can comfortably address the financial needs of all companies in our niches, whether they are entrepreneurs with innovative ideas or multinational corporations with hundreds of millions of dollars in sales.

Our technology and life science clients generally fall into the following industries:

·        Hardware: Semiconductors, Communications and Electronics

·        Software: Software and Services

·        Biotechnology

·        Drug Discovery

·        Medical Devices

·        Specialty Pharmaceuticals

Private Equity

Through our Merchant Banking division, we have cultivated strong relationships with venture capital firms worldwide, many of which are also clients. Our Private Equity Services group provides financial

4




services to over half of the venture capital firms in the U.S. as well as other private equity firms, facilitating deal flow to and from these private equity firms, and participating in direct investments in their portfolio companies.

Premium Wine

Our premium wineries practice has become the leading provider of financial services to the U.S. premium wine industry. We focus on vineyards and wineries that produce grapes and wines of the highest quality.

Industry Niches Exited

In keeping with our strategic focus on the technology, life science, private equity and premium wine industries, we exited three niches in late 2002: real estate, media, and religious lending. While we will continue to service our existing real estate, media and religious niche loans until they are paid-off, we expect our refined strategic focus on more profitable aspects of our core business will help improve overall profitability.

For further information on our business segments, see “Item 8. Consolidated Financial Statements and Supplementary Data—Note 14 to the Consolidated Financial Statements—Segment Reporting.”

Business Combinations

On October 1, 2002, we acquired substantially all of the assets of Woodside Asset Management, Inc., an investment advisor firm, which has approximately $200 million under management for 70 clients. We are offering Woodside Asset Management’s services as part of our private banking services. Additionally, as part of this acquisition, Silicon Valley Bancshares obtained the general partner interests in two limited partnerships, Taurus Growth Partners, L.P. and Libra Partners, L.P., with total assets aggregating $12.3 million as of December 31, 2003. We have less than a 1% ownership interest in each of these funds. The remaining ownership interest represents limited partners’ funds invested on their behalf by the general partner in certain fixed income and marketable equity securities. However, due to our ability to control the investing activities of these limited partnerships, we have consolidated the related results of operations and financial condition into our consolidated financial statements as of and for the year ended December 31, 2003. This acquisition did not have a material impact on goodwill and is not expected to materially impact our earnings in the short term.

On September 28, 2001, a subsidiary of Silicon Valley Bank, SVB Securities, Inc., completed the acquisition of Alliant Partners, an investment banking firm providing merger and acquisition and corporate partnering services. Our investment banking business continues to do business under the name “Alliant Partners.” See “Item 8. Consolidated Financial Statements and Supplementary Data—Note 2 to the Consolidated Financial Statements—Business Combinations.” On October 1, 2002, Alliant Partners was sold from our Silicon Valley Bank subsidiary to the Silicon Valley Bancshares parent company. This transfer allowed Alliant Partners to operate under less restrictive bank holding company regulations and increased our capital ratios at Silicon Valley Bank.

Competition

The banking and financial services industry is highly competitive, and evolves as a result of changes in regulation, technology, product delivery systems, and the general market and economic climate. Our current competitors include other banks and specialty and diversified financial services companies that offer lending, leasing, other financial products, and advisory services to our client base. The principal competitive factors in our markets include product offerings, service and pricing. Given our established market position with the client segments that we serve, we believe we compete favorably in all our markets in these areas.

Employees

As of December 31, 2003, we employed approximately 969 full-time equivalent employees. None of our employees are represented by a labor union. Competition for qualified personnel in our industry is significant, particularly for client relationship manager positions, officers, and employees with strong

5




relationships with the venture capital community. Our future success will depend in part on our continued ability to attract, hire, and retain qualified personnel.

Supervision and Regulation

General

Our operations are subject to extensive regulation by federal and state regulatory agencies. As a bank holding company, Silicon Valley Bancshares is subject to the Federal Reserve Board’s supervision, regulation, examination and reporting requirements under the Bank Holding Company Act of 1956 (“BHC Act”). Silicon Valley Bancshares has also qualified and elected to be treated as a financial holding company under the BHC Act. Silicon Valley Bank, as a California-chartered bank and a member of the Federal Reserve System, is subject to primary supervision and examination by the Federal Reserve Bank of San Francisco and the California Department of Financial Institutions. Both Silicon Valley Bancshares and Silicon Valley Bank are required to file periodic reports with these regulators and provide any additional information that they may require. The following summary describes some of the more significant laws, regulations and policies that affect our operations, and is not intended to be a complete listing of all laws that apply to us. Any change in the statutes, regulations, or policies that apply to our operations may have a material effect on our business.

Regulation of Holding Company

The Federal Reserve Board requires Silicon Valley Bancshares to maintain minimum capital ratios, as discussed below in “Regulatory Capital.” Under Federal Reserve Board policy, a bank holding company is also required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Board’s policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks or to observe established guidelines with respect to the payment of dividends by bank holding companies will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice, or a violation of the Federal Reserve Board’s regulations, or both.

Prior to becoming a financial holding company, Bancshares was required under the BHC Act to seek the prior approval of the Federal Reserve Board before acquiring direct or indirect ownership or control of more than 5% of the outstanding shares of any class of voting securities, or substantially all of the assets, of any bank, bank holding company or nonbank company. In addition, prior to becoming a financial holding company, Bancshares was generally limited under the BHC Act to engaging, directly or indirectly, only in the business of banking or managing or controlling banks and other activities that were deemed by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto.

The Gramm-Leach-Bliley Act of 1999 (“GLB Act”) amended the BHC Act to permit a qualifying bank holding company, called a financial holding company, to engage in a broader range of activities than those traditionally permissible for bank holding companies. A financial holding company may conduct activities that are “financial in nature,” including insurance, securities underwriting and dealing and market-making, and merchant banking activities, as well as additional activities that the Federal Reserve Board determines (in the case of incidental activities, in conjunction with the Treasury Department) are incidental or complementary to financial activities, without the prior approval of the Federal Reserve Board. The GLB Act also permits financial holding companies to acquire companies engaged in activities that are financial in nature or that are incidental or complementary to financial activities without the prior approval of the Federal Reserve Board. The GLB Act also repealed the provisions of the Glass-Steagall Act that restricted banks and securities firms from affiliating. On November 14, 2000, Silicon Valley Bancshares became a financial holding company. As a financial holding company, Silicon Valley Bancshares no longer requires the prior approval of the Federal Reserve Board to conduct, or to acquire ownership or control of entities engaged in, activities that are financial in nature or activities that are determined to be incidental or complementary to financial activities, although the requirement in the BHC

6




Act for prior Federal Reserve Board approval for the acquisition by a bank holding company of more than 5% of any class of the voting shares of a bank or savings association (or the holding company of either) is still applicable. Additionally, under the merchant banking authority added by the GLB Act, Bancshares may invest in companies that engage in activities that are not otherwise permissible, subject to certain limitations, including that Bancshares make the investment with the intention of limiting the investment in duration and does not manage the company on a day-to-day basis.

To qualify as a financial holding company, a bank holding company’s subsidiary depository institutions must be well capitalized (as discussed below in “Regulatory Capital”) and have at least “satisfactory” composite, managerial and Community Reinvestment Act (CRA) examination ratings. A bank holding company that does not satisfy the criteria for financial holding company status is limited to activities that were permissible under the BHC Act prior to the enactment of the GLB Act. A financial holding company that does not continue to meet all of the requirements for financial holding company status will, depending upon which requirements it fails to meet, lose the ability to undertake new activities or acquisitions that are not generally permissible for bank holding companies or to continue such activities.

Silicon Valley Bancshares is also treated as a bank holding company under the California Financial Code. As such, Silicon Valley Bancshares and its subsidiaries are subject to periodic examination by, and may be required to file reports with, the California Department of Financial Institutions.

Regulatory Capital

The federal banking agencies have adopted minimum risk-based capital guidelines for bank holding companies and banks intended to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets and those recorded as off-balance sheet items. These include transactions such as commitments, letters of credit, and recourse arrangements. Under these guidelines, dollar amounts of assets and credit-equivalent amounts of off-balance sheet items are adjusted by one of several conversion factors and/or risk adjustment percentages. The Federal Reserve Board requires bank holding companies and state member banks generally to maintain a minimum ratio of qualifying total capital to risk-adjusted assets of 8% (10% to be well capitalized). At least half of total capital must consist of items such as common stock, retained earnings, noncumulative perpetual preferred stock, minority interests (including trust preferred securities) and, for bank holding companies, a limited amount of qualifying cumulative perpetual preferred stock, less most intangibles including goodwill (“Tier 1 capital”). The remainder (“Tier 2 capital”) may consist of other preferred stock, certain other instruments, and limited amounts of subordinated debt and the loan and lease allowance. Not more than 25% of qualifying Tier 1 capital may consist of trust preferred securities. In order to be well capitalized, a bank holding company must have a minimum ratio of Tier 1 capital to risk-adjusted assets of 6%. The Federal Reserve Board also requires Bancshares and Silicon Valley Bank to maintain a minimum amount of Tier 1 capital to total average assets, referred to as the Tier 1 leverage ratio. For a bank holding company or a bank that meets certain specified criteria, including those in the highest of the five categories used by regulators to rate banking organizations, the minimum Tier 1 leverage ratio is 3%. All other institutions are required to maintain a Tier 1 leverage ratio of at least 3% plus an additional cushion of 100 to 200 basis points (or at least 5% to be well capitalized). In addition to these requirements, the Federal Reserve Board may set individual minimum capital requirements for specific institutions at rates substantially above the minimum guidelines and ratios. Under certain circumstances, Silicon Valley Bancshares must file written notice with, and obtain approval from, the Federal Reserve Board prior to purchasing or redeeming its equity securities. See “Item 1. Business—Supervision and Regulation—Prompt Corrective Action and Other Enforcement Mechanisms” for additional discussion of capital ratios.

The ability of Silicon Valley Bancshares, like other bank holding companies, to continue to include its outstanding Trust Preferred Securities in Tier 1 capital has been made the subject of some doubt due to the issuance by the Financial Accounting Standards Board (FASB) in January 2003 of Interpretation No. 46 “Consolidation of Variable Interest Entities (VIE),” and in May 2003 of Statement of Financial Accounting Standards (SFAS) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” although the Federal Reserve Board announced in July 2003 that qualifying Trust Preferred Securities will continue to be treated as Tier 1 capital until notice is given to the contrary.

7




Silicon Valley Bancshares and Silicon Valley Bank are also subject to rules that govern the regulatory capital treatment of equity investments in nonfinancial companies made on or after March 13, 2000, and that are held under certain specified legal authorities by a bank or bank holding company. Silicon Valley Bank does not currently hold any such equity investments. Under the rules, these equity investments will be subject to a separate capital charge that will reduce a bank holding company’s Tier 1 capital and, correspondingly, will remove these assets from being taken into consideration in establishing a bank holding company’s required capital ratios discussed above.

The rules provide for the following incremental Tier 1 capital charges: 8% of the adjusted carrying value of the portion of such aggregate investments that are up to 15% of Tier 1 capital; 12% of the adjusted carrying value of the portion of such aggregate investments that are between 15% and 25% of Tier 1 capital; and 25% of the adjusted carrying value of the portion of such aggregate investments that exceed 25% of Tier 1 capital. The rules normally do not apply to unexercised warrants acquired by a bank as additional consideration for making a loan or to equity securities that are acquired in satisfaction of a debt previously contracted and that are held and divested in accordance with applicable law.

The federal banking agencies have also adopted a joint agency policy statement which provides that the adequacy and effectiveness of a bank’s interest rate risk management process and the level of its interest rate exposures are critical factors in the evaluation of the bank’s capital adequacy. A bank with material weaknesses in its interest rate risk management process or high levels of interest rate exposure relative to its capital will be directed by the federal banking agencies to take corrective actions. Financial institutions that have substantial amounts of their assets concentrated in high-risk loans or nontraditional banking activities and who fail to adequately manage these risks may be required to set aside capital in excess of the regulatory minimums.

The capital ratios of Silicon Valley Bancshares and Silicon Valley Bank, respectively, exceeded the well-capitalized requirements, as defined above, at December 31, 2003. See “Item 8. Consolidated Financial Statements and Supplementary Data—Note 23 to the Consolidated Financial Statements—Regulatory Matters” for the capital ratios of Silicon Valley Bancshares and Silicon Valley Bank as of December 31, 2003.

Regulation of Silicon Valley Bank

Silicon Valley Bank is a California-chartered bank and a member of the Federal Reserve System. Silicon Valley Bank is subject to primary supervision, periodic examination and regulation by the California Department of Financial Institutions and the Federal Reserve Board. If, as a result of an examination of Silicon Valley Bank, the Federal Reserve Board should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of Silicon Valley Bank’s operations are unsatisfactory or that Silicon Valley Bank or its management is violating or has violated any law or regulation, various remedies are available to the Federal Reserve Board. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of Silicon Valley Bank, to assess civil monetary penalties, to remove officers and directors and ultimately to terminate Silicon Valley Bank’s deposit insurance, which for a California-chartered bank would result in a revocation of Silicon Valley Bank’s charter. The California Department of Financial Institutions has many of the same remedial powers. Various requirements and restrictions under the laws of the State of California and the United States affect the operations of Silicon Valley Bank. State and federal statues and regulations relate to many aspects of Silicon Valley Bank’s operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, and capital requirements. Further, Silicon Valley Bank is required to maintain certain levels of capital. See “Regulatory Capital” above.

8



The GLB Act changed the powers of national banks and their subsidiaries, and made similar changes in the powers of state bank subsidiaries. The GLB Act permits a national bank to underwrite, deal in and purchase state and local revenue bonds. It also allows a subsidiary of a national bank to engage in financial activities that the bank cannot, except for general insurance underwriting and real estate development and investment. In order for a subsidiary to engage in new financial activities, the national bank and its depository institution affiliates must be well capitalized; have at least “satisfactory” general, managerial, and CRA examination ratings; and meet other qualification requirements relating to total assets, subordinated debt, capital, risk management, and affiliate transactions. Subsidiaries of state banks can exercise the same powers as national bank subsidiaries if they satisfy the same qualifying rules that apply to national banks. For state banks that are members of the Federal Reserve System like Silicon Valley Bank, prior approval of the Federal Reserve Board is required before a bank can create a subsidiary to capitalize on the additional financial activities empowered by the GLB Act.

Restrictions on Dividends

Bancshares’ ability to pay cash dividends is limited by generally applicable Delaware corporation law limits. In addition, Bancshares is a legal entity separate and distinct from Silicon Valley Bank, and there are statutory and regulatory limitations on the amount of dividends that may be paid to Bancshares by Silicon Valley Bank. During 2003, 2002, and 2001, Silicon Valley Bank paid dividends of $51.0 million, $80.0 million, and $140.0 million, respectively, to Bancshares. Consequently, under these regulatory restrictions, the remaining amount available for payment of dividends to Bancshares by Silicon Valley Bank totaled $2.8 million at December 31, 2003. The Federal Reserve Board and the California Commissioner of Financial Institutions (the “Commissioner”) have the authority to prohibit Silicon Valley Bank from engaging in activities that, in their opinion, constitute unsafe or unsound practices in conducting its business. Depending upon the financial condition of Silicon Valley Bank and other factors, the regulators could assert that the payment of dividends or other payments might, under some circumstances, be an unsafe or unsound practice. If Silicon Valley Bank fails to comply with its minimum capital requirements, its regulators could restrict its ability to pay dividends using prompt corrective action or other enforcement powers. The Commissioner may impose similar limitations on the conduct of California-chartered banks. See “Item 8. Consolidated Financial Statements and Supplementary Data—Note 23 to the Consolidated Financial Statements—Regulatory Matters” for further discussion on dividend restrictions.

Transactions with Affiliates

Transactions between Silicon Valley Bank and its operating subsidiaries, on the one hand, and their affiliates, on the other, are subject to restrictions imposed by federal and state law. These restrictions prevent Bancshares and other affiliates from borrowing from, or entering into other credit transactions with, Silicon Valley Bank or its operating subsidiaries unless the loans or other credit transactions are secured by specified amounts of collateral. All such loans and credit transactions and other “covered transactions” by Silicon Valley Bank and its operating subsidiaries with any one affiliate are limited, in the aggregate, to 10% of Silicon Valley Bank’s capital and surplus; and all such loans and credit transactions and other “covered transactions” by Silicon Valley Bank and its operating subsidiaries with all affiliates are limited, in the aggregate, to 20% of Silicon Valley Bank’s capital and surplus. For this purpose, “covered transaction” generally includes, among other things, a loan or extension of credit to an affiliate, a purchase of or investment in securities issued by an affiliate, a purchase of assets from an affiliate, the acceptance of a security issued by an affiliate as collateral for an extension of credit to any borrower, and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. A company that is a direct or indirect subsidiary of Silicon Valley Bank would not be considered to be an “affiliate” of Silicon Valley Bank or its operating subsidiaries unless it fell into one of certain categories, such as a “financial subsidiary” authorized under the GLB Act. In addition, Silicon Valley Bank and its operating subsidiaries generally may not purchase a low-quality asset from an affiliate, and covered transactions and other specified transactions by Silicon Valley Bank and its operating subsidiaries with an affiliate must be on terms and conditions that are consistent with safe and sound banking practices. Also, Silicon Valley Bank and its operating subsidiaries generally may engage in transactions with affiliates only on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable

9




to the Bank or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

Prompt Corrective Action and Other Enforcement Mechanisms

Federal banking agencies possess broad powers to take corrective and other supervisory action on an insured bank and its holding company. Federal laws require each federal banking agency to take prompt corrective action to resolve the problems of insured banks. Each federal banking agency has issued regulations defining five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized.

Based upon its capital levels, a bank that is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment. At each successive lower-capital category, an insured bank is subject to more restrictions, including restrictions on the bank’s activities, operational practices or the ability to pay dividends. However, the federal banking agencies may not treat an institution as critically undercapitalized unless its capital ratios actually warrant such treatment.

In addition to measures taken under the prompt corrective action provisions, bank holding companies and insured banks may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses, or for violation of any law, rule, regulation, condition imposed in writing by the agency, or term of a written agreement with the agency. Enforcement actions may include the appointment of a conservator or receiver for the bank; the issuance of a cease and desist order that can be judicially enforced; the termination of the bank’s deposit insurance; the imposition of civil monetary penalties; the issuance of directives to increase capital; the issuance of formal and informal agreements; the issuance of removal and prohibition orders against officers, directors, and other institution-affiliated parties; and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.

Safety and Soundness Guidelines

The federal banking agencies have adopted guidelines to assist in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines establish operational and managerial standards relating to: (1) internal controls, information systems, and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest-rate exposure; (5) asset growth and asset quality; and (6) compensation, fees, and benefits. In addition, the federal banking agencies have adopted safety and soundness guidelines for asset quality and for evaluating and monitoring earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves.

Premiums for Deposit Insurance

Silicon Valley Bank’s deposit accounts are insured by the Bank Insurance Fund, as administered by the Federal Deposit Insurance Corporation, up to the maximum permitted by law. The FDIC assesses an annual premium to maintain a sufficient Fund balance. The amount charged is based on the capital level of an institution and on a supervisory assessment based upon the results of examinations findings by the institution’s primary federal regulator and other information deemed relevant by the FDIC to the institution’s financial condition and the risk posed to the Bank Insurance Fund. As of December 31, 2003, the FDIC’s assessment for the insurance of BIF deposits ranged from 0 to 27 basis points per $100 of insured deposits. The FDIC may increase or decrease the premium rate on a semi-annual basis. As of December 31, 2003, Silicon Valley Bank’s assessment rate was the statutory minimum.

Silicon Valley Bank is also required to pay an annual assessment of approximately 1.5 basis points per $100 of insured deposits toward the retirement of U.S. government-issued financing corporation bonds.

10




Community Reinvestment Act and Fair Lending

Silicon Valley Bank is subject to a variety of fair lending laws and reporting obligations, including the CRA. The CRA generally requires the federal banking agencies to evaluate the record of a bank in meeting the credit needs of its local communities, including low- to moderate-income neighborhoods. In November 2003, the Federal Reserve Board rated Silicon Valley Bank “satisfactory” in complying with its CRA obligations. A bank can become subject to substantial penalties and corrective measures for a violation of certain fair lending laws. When regulating and supervising other activities or assessing whether to approve certain applications, the federal banking agencies may consider a bank’s record of compliance with such laws and CRA obligations.

Privacy

The GLB Act imposed customer privacy requirements on any company engaged in financial activities. Under these requirements, a financial company is required to protect the security and confidentiality of customer nonpublic personal information. Also, for customers who obtain a financial product such as a loan for personal, family, or household purposes, a financial company is required to disclose its privacy policy to the customer at the time the relationship is established and annually thereafter. The financial company must also disclose its policies concerning the sharing of the customer’s nonpublic personal information with affiliates and third parties. If an exemption is not available, a financial company must provide consumers with a notice of its information-sharing practices that allows the consumer to reject the disclosure of its nonpublic personal information to third parties. Third parties that receive such information are subject to the same restrictions as the financial company on the re-use of the information. Finally, a financial company is prohibited from disclosing an account number or similar item to a third party for use in telemarketing, direct mail marketing, or other marketing through electronic mail. Financial companies were required to be in compliance with these consumer privacy requirements no later than July 1, 2001.

USA Patriot Act of 2001

As part of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”), Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (IMLAFATA). IMLAFATA amended the Bank Secrecy Act and adopted certain additional measures that established or increased already existing obligations of financial institutions, including Silicon Valley Bank, to identify their customers, watch for and report upon suspicious transactions, respond to requests for information by federal banking regulatory authorities and law enforcement agencies, and share information with other financial institutions. The Secretary of the Treasury has adopted several regulations to implement these provisions. Silicon Valley Bank is also barred from dealing with foreign “shell” banks. In addition, IMLAFATA expands the circumstances under which funds in a bank account may be forfeited. IMLAFATA also amended the BHC Act and the Bank Merger Act to require the federal banking regulatory authorities to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing an application to expand operations. Silicon Valley Bank has in place a Bank Secrecy Act compliance program.

Regulation of Certain Subsidiaries

Two of our subsidiaries, Alliant Partners and SVB Securities, are registered as broker-dealers with the Securities and Exchange Commission (“SEC”) and as such are subject to regulation by the SEC and by self-regulatory organizations, such as the National Association of Securities Dealers, Inc. Our investment advisory subsidiaries, Woodside Asset Management, Inc., and SVB Asset Management, are registered with the SEC under the Investment Advisers Act of 1940, as amended, and are subject to that act and the rules and regulations promulgated thereunder.

Our broker-dealer subsidiaries are subject to Rule 15c3-1 under the Securities Exchange Act of 1934 (the “Exchange Act”), which is designed to measure the general financial condition and liquidity of a broker-dealer. Under this rule, our broker-dealer subsidiaries are required to maintain the minimum net capital deemed necessary to meet broker-dealers’ continuing commitments to customers and others.

11




Under certain circumstances, this rule could limit the ability of Bancshares to withdraw capital from Alliant Partners and limit the ability of Silicon Valley Bank to withdraw capital from SVB Securities.

As broker-dealers, Alliant Partners and SVB Securities are also subject to other regulations covering the operations of their respective businesses, including sales and trading practices; use of client funds and securities; and conduct of directors, officers, and employees. Broker-dealers are also subject to regulation by state securities administrators in the states where they do business. Violations of the stringent regulations governing the actions of a broker-dealer can result in the revocation of broker-dealer licenses; the imposition of censures or fines; the issuance of cease and desist orders; and the suspension or expulsion from the securities business of a firm, its officers, or its employees. The SEC and the national securities exchanges, in particular, emphasize the need for supervision and control by broker-dealers of their employees.

Available Information

Our Internet address is http://www.svb.com. We make available free of charge through our Internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Bancshares was incorporated in Delaware in 1999.

ITEM 2. PROPERTIES

Our corporate headquarters are located at 3003 Tasman Drive, Santa Clara, California in three buildings, approximating 215,000 square feet in total. The leases related to our corporate headquarter facilities in Santa Clara expire in May 2005.

In 2002, we exited leased premises, located in Santa Clara, California, approximating 18,000 square feet. The lease on the building will expire in August 2005. Our management determined that the premises would have no future economic value to our operations, except for any potential future sub-lease arrangement. Therefore, during 2002, we incurred charge-offs of approximately $2.5 million related to the exit of these premises.

We currently operate 26 regional offices. We operate throughout the Silicon Valley with offices in Fremont, Santa Clara, Palo Alto, and on Sand Hill Road, which is the center of the venture capital community in California. Other regional offices in California include: Irvine, Los Angeles, Napa Valley, San Diego, San Francisco, Santa Barbara, and Sonoma. Office locations outside of California include: Phoenix, Arizona; Boulder, Colorado; Atlanta, Georgia; Chicago, Illinois; Boston, Massachusetts; Minneapolis, Minnesota; New York, New York; Durham, North Carolina; Portland, Oregon; Philadelphia, Pennsylvania; Austin, Texas; Dallas, Texas; Northern Virginia; and Seattle, Washington. All of our properties are occupied under leases, which expire at various dates through 2011, and in most instances include options to renew or extend at market rates and terms. We also own leasehold improvements, equipment, furniture, and fixtures at our offices, all of which are used in our business activities.

ITEM 3. LEGAL PROCEEDINGS

There were no legal proceedings requiring disclosure pursuant to this item pending at December 31, 2003, or at the date of this report.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote by the stockholders of Silicon Valley Bancshares’ common stock during the fourth quarter of 2003.

12



PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

Our common stock is traded over the counter on the National Association of Securities Dealers Automated Quotation (Nasdaq) national market under the symbol “SIVB.”

The following table shows the high and low sales prices for our common stock for each quarterly period during the last two years, based on the daily closing price as reported by the Nasdaq national market.

 

 

2003

 

2002

 

Quarter

 

 

 

Low

 

High

 

Low

 

High

 

First

 

$

15.71

 

$

19.63

 

$

21.17

 

$

31.25

 

Second

 

$

18.11

 

$

27.00

 

$

25.30

 

$

33.87

 

Third

 

$

22.66

 

$

31.00

 

$

16.75

 

$

27.01

 

Fourth

 

$

27.46

 

$

37.25

 

$

14.58

 

$

19.94

 

 

Stockholders

There were 705 registered holders of our stock as of December 31, 2003. Additionally, we believe there were approximately 8,194 beneficial holders of common stock whose shares are held in the name of brokerage firms or other financial institutions. We are not provided with the number or identities of all of these stockholders, but we have estimated the number of such stockholders from the number of stockholder documents requested by these brokerage firms for distribution to their customers.

Dividends

We have not paid cash dividends on our common stock since 1992. Currently, we have no plan to pay cash dividends on our common stock. Periodically, we evaluate the decision of paying cash dividends in the context of our performance, general economic performance, and relevant tax and financial parameters. Our ability to pay cash dividends is limited by generally applicable corporate and banking laws and regulations. See “Item 1. Business—Supervision and Regulation—Restrictions on Dividends,” and “Item 8. Consolidated Financial Statements and Supplementary Data—Note 23 to the Consolidated Financial Statements—Regulatory Matters” for additional discussion on restrictions and limitations on the payment of dividends imposed on us by government regulations.

The information required by this Item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 of this report.

13



ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and supplementary data as presented in Item 8 of this report. Certain reclassifications have been made to our prior years’ results to conform to 2003 presentations. Such reclassifications had no effect on the results of operations or stockholders’ equity. In addition, the common stock summary information has been restated to reflect a two-for-one stock split on May 15, 2000.

 

 

Years Ended December 31,

 

 

 

2003

 

2002

 

2001

 

2000

 

1999

 

 

 

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

 

Income Statement Summary:

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

188,884

 

$

194,708

 

$

262,985

 

$

329,848

 

$

205,439

 

Provision for loan losses

 

(6,223

)

3,882

 

16,724

 

54,602

 

52,407

 

Noninterest income

 

75,060

 

67,858

 

70,833

 

189,630

 

58,855

 

Noninterest expense

 

262,687

 

186,374

 

183,488

 

198,361

 

125,659

 

Minority interest

 

7,689

 

7,767

 

7,546

 

460

 

 

Income before income tax expense

 

15,169

 

80,077

 

141,152

 

266,975

 

86,228

 

Income tax expense

 

3,192

 

26,719

 

52,998

 

107,907

 

34,030

 

Net income

 

$

11,977

 

$

53,358

 

$

88,154

 

$

159,068

 

$

52,198

 

Common Share Summary:

 

 

 

 

 

 

 

 

 

 

 

Earnings per share—basic

 

$

0.33

 

$

1.21

 

$

1.85

 

$

3.41

 

$

1.27

 

Earnings per share—diluted

 

0.32

 

1.18

 

1.79

 

3.23

 

1.23

 

Book value per share

 

12.76

 

14.55

 

13.82

 

12.54

 

8.23

 

Weighted average shares outstanding—basic

 

36,109

 

44,000

 

47,728

 

46,656

 

41,258

 

Weighted average shares outstanding—diluted

 

37,321

 

45,080

 

49,155

 

49,220

 

42,518

 

Year-End Balance Sheet Summary:

 

 

 

 

 

 

 

 

 

 

 

Investment securities

 

$

1,575,434

 

$

1,535,694

 

$

1,833,162

 

$

2,107,590

 

$

1,747,408

 

Loans, net of unearned income

 

1,989,229

 

2,086,080

 

1,767,038

 

1,716,549

 

1,623,005

 

Goodwill

 

37,549

 

100,549

 

96,380

 

 

 

Assets

 

4,465,370

 

4,183,181

 

4,172,077

 

5,626,775

 

4,596,398

 

Deposits

 

3,666,876

 

3,436,127

 

3,380,977

 

4,862,259

 

4,109,405

 

Long-term debt

 

204,286

 

17,397

 

25,685

 

 

 

Trust preferred securities(1)

 

 

39,472

 

38,641

 

38,589

 

38,537

 

Stockholders’ equity

 

447,005

 

590,350

 

627,515

 

614,121

 

368,850

 

Average Balance Sheet Summary:

 

 

 

 

 

 

 

 

 

 

 

Investment securities

 

$

1,440,517

 

$

1,554,035

 

$

1,817,379

 

$

1,932,461

 

$

1,576,630

 

Loans, net of unearned income

 

1,800,022

 

1,762,296

 

1,656,958

 

1,580,176

 

1,591,634

 

Goodwill

 

91,992

 

98,252

 

24,955

 

 

 

Assets

 

4,040,523

 

3,866,242

 

4,372,000

 

5,180,750

 

3,992,410

 

Deposits

 

3,277,594

 

3,063,516

 

3,581,725

 

4,572,457

 

3,681,598

 

Long-term debt

 

105,477

 

23,769

 

6,652

 

 

 

Trust preferred securities(1)

 

43,683

 

38,667

 

38,611

 

38,559

 

38,507

 

Stockholders’ equity

 

494,998

 

631,005

 

651,861

 

478,018

 

238,085

 

Capital Ratios:

 

 

 

 

 

 

 

 

 

 

 

Total risk-based capital ratio

 

16.6

%

16.0

%

17.2

%

17.7

%

15.5

%

Tier 1 risk-based capital ratio

 

12.0

%

14.8

%

15.9

%

16.5

%

14.3

%

Tier 1 leverage ratio

 

10.3

%

13.9

%

14.8

%

12.0

%

8.8

%

Average stockholders’ equity to average assets

 

12.3

%

16.3

%

14.9

%

9.2

%

6.0

%

Selected Financial Ratios:

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

0.3

%

1.4

%

2.0

%

3.1

%

1.3

%

Return on average stockholders’ equity

 

2.4

%

8.5

%

13.5

%

33.3

%

21.9

%

Net interest margin(1)

 

5.3

%

5.7

%

6.8

%

6.9

%

5.5

%

Other Data:

 

 

 

 

 

 

 

 

 

 

 

Private label client investments, sweep products, and assets under management

 

$

9,346,128

 

$

8,495,321

 

$

9,283,368

 

$

10,805,694

 

$

5,666,278

 


(1)              Adoption of FIN No. 46 and SFAS No. 150 in the latter half of 2003 resulted in a change of classification of trust preferred securities distribution expense from noninterest expense to interest expense on a prospective basis. Additionally, the adoption of FIN No. 46 and SFAS No. 150 resulted in a change of classification of Trust Preferred Securities from noninterest bearing funding sources to interest-bearing liabilities on a prospective basis. Prior to adoption of FIN No. 46 and SFAS No. 150, in accordance with accounting rules in effect at that time, the company recorded trust preferred securities distribution expense as noninterest expense. On October 30, 2003, $50.0 million in cumulative 7.0% Trust Preferred Securities were issued through a newly formed special purpose trust, SVB Capital II. The Company received $51.5 million in proceeds from the issuance of 7.0% Junior Subordinated Debentures to SVB Capital II. A portion of the net proceeds were used to redeem the existing $40.0 million of 8.25% Trust Preferred Securities. Approximately $1.3 million of deferred issuance costs related to redemption of the $40.0 million 8.25% Trust Preferred Securities were included in interest expense in the fourth quarter of 2003.

14



ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis contains statements that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in “Item 7A. Quantitative and Qualitative Disclosures About Market Risk—Factors That May Affect Future Results.”

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated financial statements and supplementary data as presented in Item 8 of this report. Certain reclassifications have been made to our prior years’ results to conform to 2003 presentations. Such reclassifications had no effect on our results of operations or stockholders’ equity.

Overview of Company Operations

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. In 2003, we continued to diversify our services to support our clients throughout their life cycles, regardless of their age or size. We offer a range of financial services that generate three distinct sources of income.

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

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

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

Critical Accounting Policies

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

We believe the accounting policies discussed below are the most critical to our financial statements because their application places the most significant demands on management’s judgments. Each estimate is discussed below. 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.

15




Executive management discussed the development, selection, and disclosure of these critical accounting policies with our audit committee on January 28, 2004.

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 “Item 1. Business—Business Combinations.”

Unrealized gains or losses on warrant and equity investment securities are recorded upon the establishment of a readily determinable fair value of the underlying security, as defined by 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. Gains or losses on these marketable equity instruments are recorded in our consolidated statements of income in the period the underlying securities are sold to a third party.

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

·         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 statements of income.

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

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

Non-Marketable Equity Securities

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

·         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

16




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

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

Unexercised warrant securities 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.

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. and SVB Strategic Investors Fund, L.P.

 

Investment company accounting, adjusted to fair value on a quarterly basis through the statement of 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% 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 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 company 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. Therefore, Silicon Valley BancVentures, L.P. is fully consolidated and any gains or losses resulting from changes in the estimated fair value of the investments are recorded as investment gains or losses in our consolidated statements of income. The portion of any gains or losses belonging to the limited partners is reflected in minority interest in net losses of consolidated affiliates and adjusts Bancshares’ income to its percentage ownership.

The SVB Strategic Investors Fund, L.P. portfolio 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 partner based on the percentage of SVB Strategic Investors Fund, L.P.’s interest in the total fair market value as provided by each venture capital fund investment. SVB Strategic Investors, LLC generally utilizes the fair values assigned to the underlying portfolio investments by the management of the venture capital funds. The estimated fair value of the investments is determined after giving consideration to the relevant market conditions, offering prices, operating results, financial conditions, exit strategy, and other pertinent information. The general partner, SVB Strategic Investors, LLC, is owned and controlled by Bancshares and has an ownership interest of 11.1% in SVB Strategic Investors Fund, L.P. Therefore, SVB Strategic Investors Fund, L.P. is fully consolidated and any gains or losses resulting from changes in the estimated fair value of the venture capital fund investments are recorded as investment gains or losses in our consolidated statements of income. The

17




limited partner’s share of any gains or losses is reflected in minority interest in net losses of consolidated affiliates and adjusts Bancshares’ 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 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

18




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 will be limited to twelve quarters beginning March 31, 2004 when our ten grade risk rating system will have 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

·         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. The majority of our goodwill resulted from the acquisition of Alliant Partners, a mergers and acquisitions

19




firm. The value of this goodwill is supported ultimately by revenue 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 statements of 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  “Item 8. Consolidated Financial Statements and Supplementary Data—Note 9 to the Consolidated Financial Statements—Goodwill” and “Item 7A. Quantitative and Qualitative Disclosures about Market Risk—Factors That May Affect Future Results.”

20



Results of Operations

Earnings Summary

We reported net income in 2003 of $12.0 million, as compared to net income of $53.4 million in 2002 and $88.2 million in 2001. Diluted earnings per common share totaled $0.32 in 2003, as compared to $1.18 in 2002, and $1.79 in 2001. Return on average equity in 2003 was 2.4%, as compared to 8.5% in 2002, and 13.5% in 2001. Return on average assets was 0.3% in 2003, as compared to 1.4% in 2002, and 2.0% in 2001.

The decrease in net income between 2002 and 2003, primarily resulted from an increase of $76.3 million in noninterest expense. The increase in noninterest expense was principally due to the following factors: (1) impairment of goodwill charges aggregating $63.0 million related to Alliant Partners, and (2) an increase in expense associated with our incentive compensation program, which we believe was necessary to retain our professional talent in an improving economic environment. Additionally, due to a decrease in the weighted-average prime rate from 4.7% in 2002 to 4.1% in 2003, we earned lower interest income from our investment securities and loan portfolios, which resulted in a decline in net interest income. However, our provision for loan and lease loss expense decreased by $10.1 million between 2002 and 2003, largely due to a significant loan loss recovery in the third quarter of 2003 and our improved credit quality.

The decrease in net income for 2002 as compared to 2001 was primarily attributable to a decline in both net interest income and noninterest income, partially offset by decreases in both provision for loan losses and income tax expense. The major components of net income and changes in these components are summarized in the following table for the years ended December 31, 2003, 2002, and 2001, and are discussed in more detail on the following pages.

 

 

Years Ended December 31,

 

 

 

2003

 

2002

 

2001

 

% Change
2003 / 2002

 

% Change
2002 / 2001

 

 

 

(Dollars in thousands)

 

Net interest income

 

$

188,884

 

$

194,708

 

$

262,985

 

 

(3.0

) %

 

 

(26.0

)%

 

Provision for loan losses

 

(6,223

)

3,882

 

16,724

 

 

(260.3

)

 

 

(76.8

)

 

Noninterest income

 

75,060

 

67,858

 

70,833

 

 

10.6

 

 

 

(4.2

)

 

Noninterest expense

 

262,687

 

186,374

 

183,488

 

 

40.9

 

 

 

1.6

 

 

Minority interest

 

7,689

 

7,767

 

7,546

 

 

(1.0

)

 

 

2.9

 

 

Income before income tax expense

 

15,169

 

80,077

 

141,152

 

 

(81.1

)

 

 

(43.3

)

 

Income tax expense

 

3,192

 

26,719

 

52,998

 

 

(88.1

)

 

 

(49.6

)

 

Net income

 

$

11,977

 

$

53,358

 

$

88,154

 

 

(77.6

)%

 

 

(39.5

)%

 

 

Net Interest Income and Margin

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

21




The following table sets forth average assets, liabilities, minority interest and stockholders’ equity, interest income and interest expense, average yields and rates, and the composition of our net interest margin for the years ended December 31, 2003, 2002, and 2001.

 

 

Years Ended December 31,

 

 

 

2003

 

2002

 

2001

 

 

 

Average
Balance

 

Interest
Income/
Expense

 

Yield/
Rate

 

Average
Balance

 

Interest
Income/
Expense

 

Yield/
Rate

 

Average
Balance

 

Interest
Income/
Expense

 

Yield/
Rate

 

 

 

(Dollars in thousands)

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

385,169

 

$

4,530

 

 

1.2

%

 

$

153,185

 

$

2,865

 

 

1.9

%

 

$

509,965

 

$

25,421

 

 

5.0

%

 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

1,297,920

 

42,789

 

 

3.3

 

 

1,376,977

 

46,585

 

 

3.4

 

 

1,522,785

 

79,245

 

 

5.2

 

 

Non-taxable(2)

 

142,597

 

9,613

 

 

6.7

 

 

177,058

 

10,606

 

 

6.0

 

 

294,594

 

16,616

 

 

5.6

 

 

Loans:(3)(4)(5)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

1,508,961

 

134,589

 

 

8.9

 

 

1,508,204

 

141,697

 

 

9.4

 

 

1,459,748

 

167,850

 

 

11.5

 

 

Real estate construction and term  

 

98,720

 

5,989

 

 

6.1

 

 

102,479

 

7,245

 

 

7.1

 

 

83,389

 

8,819

 

 

10.6

 

 

Consumer and other

 

192,341

 

8,192

 

 

4.3

 

 

151,613

 

7,298

 

 

4.8

 

 

113,821

 

8,190

 

 

7.2

 

 

Total loans

 

1,800,022

 

148,770

 

 

8.3

 

 

1,762,296

 

156,240

 

 

8.9

 

 

1,656,958

 

184,859

 

 

11.2

 

 

Total interest-earning assets

 

3,625,708

 

205,702

 

 

5.7

 

 

3,469,516

 

216,296

 

 

6.2

 

 

3,984,302

 

306,141

 

 

7.7

 

 

Cash and due from banks

 

192,591

 

 

 

 

 

 

 

182,400

 

 

 

 

 

 

 

239,571

 

 

 

 

 

 

 

Allowance for loan losses

 

(72,044

)

 

 

 

 

 

 

(74,845

)

 

 

 

 

 

 

(76,287

)

 

 

 

 

 

 

Goodwill

 

91,992

 

 

 

 

 

 

 

98,252

 

 

 

 

 

 

 

24,955

 

 

 

 

 

 

 

Other assets

 

202,276

 

 

 

 

 

 

 

190,919

 

 

 

 

 

 

 

199,459

 

 

 

 

 

 

 

Total assets

 

$

4,040,523

 

 

 

 

 

 

 

$

3,866,242

 

 

 

 

 

 

 

$

4,372,000

 

 

 

 

 

 

 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

$

23,447

 

105

 

 

0.4

 

 

$

33,567

 

220

 

 

0.7

 

 

$

42,037

 

381

 

 

0.9

 

 

Regular money market deposits

 

332,632

 

1,824

 

 

0.5

 

 

288,238

 

2,751

 

 

1.0

 

 

269,886

 

3,034

 

 

1.1

 

 

Bonus money market deposits

 

673,982

 

3,686

 

 

0.5

 

 

614,378

 

5,855

 

 

1.0

 

 

733,412

 

8,580

 

 

1.2

 

 

Time deposits

 

485,199

 

3,468

 

 

0.7

 

 

610,996

 

7,403

 

 

1.2

 

 

792,031

 

24,871

 

 

3.1

 

 

Short-term borrowing

 

9,217

 

257

 

 

2.8

 

 

33,824

 

1,083

 

 

3.2

 

 

10,682

 

265

 

 

2.5

 

 

Long-term debt

 

105,477

 

1,087

 

 

1.0

 

 

23,769

 

564

 

 

2.4

 

 

6,652

 

210

 

 

3.2

 

 

Trust preferred securities(6)

 

24,490

 

3,026

 

 

12.4

 

 

 

 

 

 

 

 

 

 

 

 

Total interest-bearing liabilities

 

1,654,444

 

13,453

 

 

0.8

 

 

1,604,772

 

17,876

 

 

1.1

 

 

1,854,700

 

37,341

 

 

2.0

 

 

Portion of noninterest-bearing funding sources

 

1,971,264

 

 

 

 

 

 

 

1,864,744

 

 

 

 

 

 

 

2,129,602

 

 

 

 

 

 

 

Total funding sources

 

3,625,708

 

13,453

 

 

0.4

 

 

3,469,516

 

17,876

 

 

0.5

 

 

3,984,302

 

37,341

 

 

0.9

 

 

Noninterest-bearing funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

1,762,334

 

 

 

 

 

 

 

1,516,337

 

 

 

 

 

 

 

1,744,359

 

 

 

 

 

 

 

Other liabilities

 

72,073

 

 

 

 

 

 

 

44,316

 

 

 

 

 

 

 

52,023

 

 

 

 

 

 

 

Trust preferred securities(6)

 

19,193

 

 

 

 

 

 

 

38,667

 

 

 

 

 

 

 

38,611

 

 

 

 

 

 

 

Minority interest

 

37,481

 

 

 

 

 

 

 

31,145

 

 

 

 

 

 

 

30,446

 

 

 

 

 

 

 

Stockholders’ equity

 

494,998

 

 

 

 

 

 

 

631,005

 

 

 

 

 

 

 

651,861

 

 

 

 

 

 

 

Portion used to fund interest-earning assets

 

(1,971,264

)

 

 

 

 

 

 

(1,864,744

)

 

 

 

 

 

 

(2,129,602

)

 

 

 

 

 

 

Total liabilities, minority interest and stockholders’ equity

 

$

4,040,523

 

 

 

 

 

 

 

$

3,866,242

 

 

 

 

 

 

 

$

4,372,000

 

 

 

 

 

 

 

Net interest income and margin

 

 

 

$

192,249

 

 

5.3

%

 

 

 

$

198,420

 

 

5.7

%

 

 

 

$

268,800

 

 

6.8

%

 

Total deposits

 

$

3,277,594

 

 

 

 

 

 

 

$

3,063,516

 

 

 

 

 

 

 

$

3,581,725

 

 

 

 

 

 

 


(1)              Includes average interest-bearing deposits in other financial institutions of $783, $609, and $568 in 2003, 2002 and 2001, respectively.

(2)              Interest income on nontaxable investments is presented on a fully taxable-equivalent basis using the federal statutory tax rate of 35% for all years presented. These adjustments were $3,365, $3,712, and $5,815 for the years ended December 31, 2003, 2002, and 2001, respectively.

(3)              Average loans include average nonaccrual loans of $16,089, $19,602, and $21,565 in 2003, 2002, and 2001, respectively.

(4)              Average loans are net of average unearned income of $12,573, $11,651, and $7,669 in 2003, 2002, and 2001, respectively.

(5)              Loan interest income includes loan fees of $36,348, $36,701, and $37,407 in 2003, 2002 and 2001, respectively.

(6)              Adoption of FIN No. 46 and SFAS No. 150 in the latter half of 2003 resulted in a change of classification of trust preferred securities distribution expense from noninterest expense to interest expense on a prospective basis. Additionally, the adoption of FIN No. 46 and SFAS No. 150 resulted in a change of classification of Trust Preferred Securities from noninterest bearing funding sources to interest-bearing liabilities on a prospective basis. Prior to adoption of FIN No. 46 and SFAS No. 150, in accordance with accounting rules in effect at that time, the company recorded trust preferred securities distribution expense as noninterest expense. On October 30, 2003, $50.0 million in cumulative 7.0% Trust Preferred Securities were issued through a newly formed special purpose trust, SVB Capital II. We received $51.5 million in proceeds from the issuance of 7.0% Junior Subordinated Debentures to SVB Capital II. A portion of the net proceeds were used to redeem the existing $40.0 million of 8.25% Trust Preferred Securities. Approximately $1.3 million of deferred issuance costs related to redemption of the $40.0 million 8.25% Trust Preferred Securities were included in interest expense in the fourth quarter of 2003.

22



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

 

 

2003 Compared to 2002
Increase (Decrease)
Due to Changes in

 

2002 Compared to 2001
(Decrease) Increase
Due to Changes in

 

 

 

Volume

 

Rate

 

Total

 

Volume

 

Rate

 

Total

 

 

 

(Dollars in thousands)

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds sold and securities purchased under agreement to resell

 

$

3,102

 

$

(1,437

)

$

1,665

 

$

(11,905

)

$

(10,651

)

$

(22,556

)

Investment securities

 

(4,696

)

(93

)

(4,789

)

(14,099

)

(24,571

)

(38,670

)

Loans

 

3,442

 

(10,912

)

(7,470

)

11,391

 

(40,010

)

(28,619

)

Increase (decrease) in interest income

 

1,848

 

(12,442

)

(10,594

)

(14,613

)

(75,232

)

(89,845

)

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

(52

)

(63

)

(115

)

(69

)

(92

)

(161

)

Regular money market deposits

 

426

 

(1,353

)

(927

)

171

 

(454

)

(283

)

Bonus money market deposits

 

599

 

(2,768

)

(2,169

)

(1,201

)

(1,524

)

(2,725

)

Time deposits

 

(1,328

)

(2,607

)

(3,935

)

(4,766

)

(12,702

)

(17,468

)

Short-term borrowings

 

(701

)

(125

)

(826

)

724

 

94

 

818

 

Long-term debt

 

1,007

 

(484

)

523

 

422

 

(68

)

354

 

Trust preferred securities

 

3,026

 

 

3,026

 

 

 

 

Increase (decrease) in interest expense

 

2,977

 

(7,400

)

(4,423

)

(4,719

)

(14,746

)

(19,465

)

Decrease in net interest income

 

$

(1,129

)

$

(5,042

)

$

(6,171

)

$

(9,894

)

$

(60,486

)

$

(70,380

)

 

2003 Compared to 2002

Net Interest Income

Net interest income on a fully taxable-equivalent basis totaled $192.2 million in 2003, a decrease of $6.2 million, or 3.1%, from $198.4 million in 2002. The decrease in net interest income was due to a $10.6 million, or 4.9%, decline in interest income, offset by a $4.4 million, or 24.7%, decrease in interest expense over the comparable prior-year period. Interest expense in 2003 included $3.0 million relating to the SFAS No. 150 and Fin No. 46-mandated classification of trust preferred securities distribution expense as interest expense, for the latter half of 2003. For periods prior to June 30, 2003, trust preferred securities distribution expense was classified as noninterest expense, and therefore did not impact the net interest margin.

Impact of Declining Market Interest Rates on Interest-Earning Assets

Throughout the current decreasing market interest rate environment, we implemented numerous measures to minimize the impact to our net interest margin. These measures included diversifying the product mix in the investment portfolio to higher-yielding, high-quality assets and reducing rates paid on interest-bearing deposits. Additionally, we have increased the duration of our investment securities portfolio by replacing certain short-term, lower yielding securities with longer-term, higher-yielding securities such as collateralized mortgage obligations, thereby taking advantage of a steeper interest rate curve. Overall, the duration of our investment securities portfolio increased to approximately 1.7 years in 2003, from approximately 1.5 years in 2002.

23




The $10.6 million decrease in interest income for 2003, as compared to 2002, was the result of a $12.4 million unfavorable rate variance associated with each component of interest-earning assets, partially offset by a $1.8 million favorable volume variance. Market interest rates decreased slightly during 2003, which caused the weighted average prime rate to decline by 55 basis points from 4.7% in 2002. Consequently, the yield on loans decreased by 60 basis points in 2003 to 8.3% from 8.9% in 2002. In 2003, we incurred a $10.9 million unfavorable rate variance associated with our loan portfolio. Floating rate loans, which represent approximately 81.2% of our total loan portfolio, produced lower interest income due to a lower average prime rate in 2003 compared to 2002. The average yield on federal funds sold and securities purchased under agreement to resell also decreased due to the decline in market interest rates, from 1.9% in 2002 to 1.2% in 2003, which caused a $1.4 million unfavorable rate variance.

Net Increase in Interest-Earning Assets

Total average interest-earning assets in 2003 increased $156.2 million, or 4.5% as compared to the prior year. The increase in total average interest-earning assets was principally funded by an increase in average noninterest-bearing deposits of $246.0 million, or 16.2%, and an increase in average long-term debt of $81.7 million, or 343.8%, offset by a decrease in average stockholders’ equity of $136.0 million, or 21.6%. The increase in average long-term debt was principally due to the issuance of $150.0 million of zero coupon convertible debt in May 2003. The net proceeds from the issuance of the convertible debt were largely used to repurchase our common stock, which resulted in the aforementioned decrease in average stockholders’ equity.

Average loans increased $37.7 million, or 2.1%, in 2003, as compared to 2002, resulting in a $3.4 million favorable volume variance. In 2003, we grew our average loan portfolio to a record level by continuing to focus on attracting middle-market and mature corporate technology and life sciences clients, which we believe are under-served by our competitors. We experienced loan growth across most of the industry sectors we serve. Additionally, our new loans continue to be subject to our existing underwriting practices. We expect further growth in our loan balances to bolster our net interest margin since it will shift liquid interest-earning assets from our investment portfolio, which currently yields 3.6%, to loans with yields ranging from approximately 4.3% to 8.9%. We expect modest loan growth to continue throughout 2004.

Average investment securities for 2003 decreased $113.5 million, or 7.3%, as compared to 2002, resulting in a $4.7 million unfavorable volume variance. The decrease in average investment securities was primarily concentrated in short-term investments, partially offset by an increase in longer-term collateralized mortgage obligations.

Average federal funds sold and securities purchased under agreement to resell increased $232.0 million, or 151.4% in 2003, as compared to the prior year, resulting in a $3.1 million favorable volume variance. This increase was primarily due to a change in the investment portfolio mix. We expect to continue the trend of managing federal funds sold and overnight repurchase agreements at appropriate levels.

The yield on average interest-earning assets decreased 60 basis points in 2003 from the prior year. This decrease primarily resulted from a decline in short-term market interest rates; thus, we earned lower yields on each component of our interest-earning assets.

Decrease in Interest Expense

Total interest expense in 2003 decreased $4.4 million from 2002. This decrease was due to a favorable rate variance of $7.4 million, partially offset by an unfavorable volume variance of $3.0 million. The favorable rate variance between 2002 and 2003 primarily resulted from a reduction in the average rates paid on all of our interest-bearing deposits, particularly those rates paid on our time deposit and bonus money market deposit products.

The unfavorable volume variance was due in large part to the SFAS No. 150-mandated classification of trust preferred securities distribution expense of $3.0 million as interest expense, for the latter half of 2003. Trust preferred securities distribution expense was previously classified as noninterest expense. Of the $3.0 million in trust preferred securities distribution expense, approximately $1.3 million related to the

24




recognition of deferred issuance costs in the fourth quarter of 2003, due to the redemption of our 8.25% Trust Preferred Securities. In the fourth quarter of 2003, we entered into an interest rate swap agreement to swap our 7.0% fixed payment on Junior Subordinated Debentures for a variable rate based on the London Inter-Bank Offer rate (LIBOR) plus a spread. We expect this swap to have a positive impact on our cost of funds in 2004.

Additionally, we experienced an unfavorable volume variance related to long-term debt of $1.0 million. In the second quarter of 2003, we issued $150.0 million of zero-coupon, convertible subordinated notes, with a maturity of June 15, 2008. Although no interest is paid on the notes, we experienced an increase in interest expense due to amortization of the convertible debt issuance costs. The overall unfavorable volume variance caused primarily by long-term debt and Trust Preferred Securities was partially offset by average time deposits, which decreased from $611.0 million in 2002 to $485.1 million in 2003, causing a $1.3 million favorable volume variance.

The average cost of funds paid on average interest-bearing liabilities in 2003 was 0.8% down from 1.1% in 2002. This decrease in the average cost of funds was largely due to a decrease of 50 basis points on the average rates paid on both our money market deposit and time deposit products.

2002 Compared to 2001

Net interest income on a fully taxable-equivalent basis totaled $198.4 million in 2002, a decrease of $70.4 million, or 26.2%, from $268.8 million in 2001. The decrease in net interest income was due to an $89.8 million, or 29.3%, decline in interest income, offset by a $19.5 million, or 52.1%, decrease in interest expense over the comparable prior-year period.

In 2002, we implemented numerous measures to minimize the impact of the decline in market interest rates. These measures included diversifying the product mix in the investment portfolio to higher-yielding, high-quality assets, reducing rates paid on interest-bearing deposits, and embedding minimum interest rate “floors” into client loan agreements. We also increased the average expected life of investments in our portfolio by replacing some assets from lower-yielding short-term securities to higher-yielding longer-term securities, thereby taking advantage of the steeper interest rate curve. Overall, the expected average life of portfolio investments increased to approximately 1.5 years, as compared to less than 1 year in 2001.

Interest Income

The $89.8 million decrease in interest income for 2002, as compared to 2001, was the result of a $14.6 million unfavorable volume variance, combined with a $75.2 million unfavorable rate variance. The $14.6 million unfavorable volume variance resulted from a $514.8 million, or 12.9%, decrease in average interest-earning assets over the comparable prior-year period. The decrease in average interest-earning assets was primarily concentrated in highly-liquid federal funds sold, and securities purchased under agreement to resell, which decreased $356.8 million, and investment securities, which decreased $263.3 million. These decreases were partially offset by $105.3 million increase in loans.

Average loans increased $105.3 million, or 6.4%, in 2002, as compared to 2001, resulting in an $11.4 million favorable volume variance. At December 31, 2002, we grew our loan portfolio to a record level by refocusing on attracting middle-market and mature corporate technology and life sciences clients, which we believe are under-served by our competitors. In 2002, we experienced loan growth across most of the industry sectors we serve.

Average investment securities for 2002 decreased $263.3 million, or 14.5%, as compared to 2001, resulting in a $14.1 million unfavorable volume variance. The decrease in average investment securities was primarily centered in U.S. agency securities, which decreased $291.0 million. This decrease resulted from declines in our average deposit balances and our common stock repurchase programs. Deposit balances declined in 2001 as our clients continued to experience reduced liquidity due to the slowdown in the capital markets and lower levels of venture capital fund investment. However, quarterly average deposit balances stabilized during 2002.

25




Average federal funds sold and securities purchased under agreement to resell in 2002 decreased $356.8 million, or 70.0%, as compared to the prior year, resulting in an $11.9 million unfavorable volume variance. This decline was primarily due to a change in the investment portfolio mix, as funds were invested in longer-term, high quality securities while still maintaining high levels of liquidity.

Unfavorable rate variances associated with each component of interest-earning assets caused a $75.2 million decline in our interest income for 2002 as compared to 2001. Short-term market interest rates decreased rapidly throughout 2001, and we experienced additional, although less severe, market interest rate decreases in 2002. Thus, we earned lower yields in 2002 on federal funds sold and securities purchased under agreements to resell, as well as our investment securities, a significant portion of which were short-term in nature. The decrease in short-term market interest rates resulted in a combined $35.2 million unfavorable rate variance in 2002, as compared to 2001. In 2002, we incurred a $40.0 million unfavorable rate variance associated with our loan portfolio. The average yield on loans in 2002 decreased 230 basis points to 8.9% from 11.2% in the prior year. This was due to two factors. First, the lower average prime rate reduced yields on floating rate loans, which represent approximately 79.0% of our total loan portfolio. The weighted-average prime rate declined 224 basis points from 6.9% in 2001 to 4.7% in 2002. Second, our fixed-rate loans are priced by reference to U.S. Treasury securities. During 2002, the treasury yield curve moved lower and flattened. Thus, we earned lower yields on new, renewed, and refinanced fixed-rate loans.

The yield on average interest-earning assets decreased 150 basis points in 2002 from the prior year. This decrease primarily resulted from a decline in short-term market interest rates; thus, we earned lower yields on each component of our interest-earning assets.

Interest Expense

Total interest expense in 2002 decreased $19.5 million from 2001. This decrease was due to a favorable rate variance of $14.7 million, combined with a favorable volume variance of $4.7 million. The favorable rate variance largely resulted from a reduction between 2001 and 2002 in the average rate paid on our time-deposit product from 3.1% to 1.2%.

The average cost of funds paid on average interest-bearing liabilities in 2002 was 1.1% down from 2.0% in 2001. This decrease in the average cost of funds was largely due to a decrease of 190 basis points in the average rate paid on our time-deposit product.

Provision for Loan Losses

The provision for loan losses is based on our evaluation of the adequacy of the existing allowance for loan losses in relation to total loans and on our periodic assessment of the inherent and identified risk dynamics of the loan portfolio resulting from reviews of selected individual loans and loan commitments. For a more detailed discussion of credit quality and the allowance for loan losses, see “Item 7. Critical Accounting Policies” and “Item 7. Financial Condition—Credit Quality and the Allowance for Loan Losses.”

Our provision for loan losses totaled $(6.2) million in 2003, as compared to $3.9 million in 2002, and $16.7 million in 2001. We obtained net recoveries of $0.2 million in 2003, as compared to net charge-offs of $5.8 million in 2002, and $18.1 million in 2001. The decrease in provision for loan losses for 2003, as compared to 2002, primarily resulted from $20.4 million in recoveries in 2003 and improved credit quality. A large portion of the loan loss recoveries in 2003 related to the settlement of remaining film loan litigation. We expect lower gross loan loss recoveries in 2004. The decrease in provision for loan losses for 2002, as compared to 2001, resulted from $22.2 million in recoveries in 2002, relating in large part to loan loss recoveries from film loan litigation settlements.

26




Noninterest Income

The following table summarizes the components of noninterest income and the percent change from year to year:

 

 

Years Ended December 31,

 

% Change

 

 

 

2003

 

2002

 

2001

 

2003 / 2002

 

2002 / 2001

 

 

 

(Dollars in thousands)

 

Client investment fees

 

$

23,991

 

$

30,671

 

$

41,598

 

 

(21.8

)%

 

 

(26.3

)%

 

Deposit service charges

 

13,202

 

9,072

 

6,196

 

 

45.5

 

 

 

46.4

 

 

Corporate finance fees

 

13,149

 

12,110

 

2,911

 

 

8.6

 

 

 

316.0

 

 

Letter of credit and foreign exchange income

 

12,856

 

15,225

 

12,655

 

 

(15.6

)

 

 

20.3

 

 

Income from client warrants

 

7,528

 

1,661

 

8,500

 

 

353.2

 

 

 

(80.5

)

 

Credit card fees

 

3,431

 

955

 

625

 

 

259.3

 

 

 

52.8

 

 

Investment losses

 

(8,402

)

(9,825

)

(12,373

)

 

(14.5

)

 

 

(20.6

)

 

Other

 

9,305

 

7,989

 

10,721

 

 

16.5

 

 

 

(25.5

)

 

Total noninterest income

 

$

75,060

 

$

67,858

 

$

70,833

 

 

10.6

%

 

 

(4.2

)%

 

 

Client investment fees decreased in 2003 from 2002 and 2001. We offer private label investment, sweep products, and asset management services to clients on which we earn fees on clients’ average balances, ranging from 10 to 100 basis points in 2003, 12.5 to 107 basis points in 2002, and 11 to 107 basis points in 2001. At December 31, 2003, $9.3 billion in client funds were invested in these products, compared to $8.5 billion in 2002, and $9.3 billion in 2001. Of these funds, $6.4 billion, $8.5 billion, and $6.4 billion were invested in mutual fund products as of December 31, 2003, 2002, and 2001, respectively. Total invested client funds have increased between 2002 and 2003, however, the decrease in client investment fees from year to year was due to a shift in client investment mix. The sustained low interest rate environment has caused lower priced investment products to become a more attractive investment strategy for many of our clients.

In the first quarter of 2003, we established a registered investment advisor (SVB Asset Management) to meet the demand for active management of client investment portfolios. We expect this action will allow us to provide a more expansive and competitive array of investment products and service to our clients. While the fees earned per dollar managed has been reduced, our strategy is to make up for the lower fees through greater volume. At December 31, 2003, SVB Asset Management had $591.6 million of assets under management.

Deposit service charges have increased steadily from year to year, primarily due to increased client usage of our expanded and enhanced suite of fee-based cash management services. Additionally, clients compensate us for depository services, either through earnings credits computed on their demand deposit balances, or through explicit payments recognized by us as deposit service charges income. Earnings credits are calculated using client average daily deposit balances, less a reserve requirement and a discounted U.S. Treasury bill interest rate. Clients received lower earnings credits in 2003, as compared to the prior years due to lower market interest rates. As such, our clients had fewer credits to offset deposit service charges. Thus, we earned higher recognizable deposit service charges year over year.

Corporate finance fees increased slightly in 2003 from 2002. Corporate finance fees totaled $12.1 million in 2002, a substantial increase from 2001. In 2002, Alliant Partners, our investment-banking subsidiary, generated the entire balance of $12.1 million. SVB Securities, Inc., generated $1.1 million in corporate finance fees in 2001. The increase in corporate finance fees from 2001 to 2002 was primarily due to the acquisition of Alliant on September 28, 2001, which increased our mergers and acquisitions advisory activity. See “Item 8. Consolidated Financial Statements and Supplementary Data—Note 2 to the Consolidated Financial Statements—Business Combinations.” Alliant’s revenues are typically a function of the valuation of their clients’ mergers and acquisitions transactions. In recent years, economic events have depressed valuations of high technology and life sciences corporations. Thus, Alliant has not achieved its merger and acquisition revenue goals. Consequently, we have incurred aggregate impairment of goodwill charges of $63.0 million in 2003, see the discussion under the heading “Noninterest Expense” contained later in this “Management Discussion and Analysis of Financial Condition and Results of Operations” section.

27




Letter of credit fees, foreign exchange fees, and other trade finance income decreased between 2002 and 2003, as a result of increased competition and increased availability of these product types from other financial institutions. The increase in income between 2001 and 2002 reflects an increase in the number of products offered by us and an increase in the volume of client foreign exchange transactions during 2002 as compared to 2001.

Due to an increase in client initial public offering and mergers and acquisition activities, the income from client warrants increased between 2002 and 2003. Conversely, we experienced a decrease in warrant income between 2001 and 2002, due to a slowdown of those activities in 2002 from 2001. The timing and amount of income from client warrants typically depends upon factors beyond our control, including the general condition of the public equity markets as well as the merger and acquisition environment. We have historically obtained rights to acquire stock, in the form of warrants, in certain clients, primarily as part of negotiated credit facilities. The receipt of warrants does not change the loan covenants or other collateral control techniques we employ to mitigate the risk of a loan becoming nonperforming. The collateral requirements on loans with warrants are similar to lending arrangements where warrants are not obtained. Due to the uncertainty of factors beyond our control, we cannot predict the timing and amount of income from client warrants with any degree of accuracy, and this income is likely to vary materially from period to period.

Credit card fees have continued to increase year over year as a result of our increased efforts to market a full range of fee-based financial services to our clients. In 2003, client usage of this product has increased, as well has fees charged for this line of service.

We experienced improvements in investment securities losses from year to year. The 2003 and 2002 losses primarily related to the write-down of certain venture capital fund and direct equity investments. Excluding the impact of minority interest, the net write-downs of our equity securities totaled approximately $2.8 million in 2003, $4.1 million in 2002, and $6.6 million in 2001. In 2004, we expect continued volatility in equity securities losses, with general improvement in a lower range in the near term.

Other noninterest income largely consisted of service-based fee income associated with our deposit and loan services, as well as fund management fees. It totaled $9.3 million in 2003, $8.0 million in 2002, and $10.7 million in 2001. The decrease in 2002, as compared to 2001, was primarily due to the elimination of supply chain service operations in late 2001.

Noninterest Expense

Noninterest expense in 2003 totaled $262.7 million, compared to $186.4 million in 2002, and $183.5 million in 2001.

The following table presents the detail of noninterest expense and the percent change, year over year:

 

 

Years Ended December 31,

 

% Change

 

 

 

2003

 

2002

 

2001

 

2003 / 2002

 

2002 / 2001

 

 

 

(Dollars in thousands)

 

Compensation and benefits

 

$

122,093

 

$

105,168

 

$

89,060

 

 

16.1

%

 

 

18.1

%

 

Impairment of goodwill

 

63,000

 

 

 

 

 

 

 

 

 

Net occupancy

 

17,638

 

20,391

 

16,181

 

 

(13.5

)

 

 

26.0

 

 

Professional services

 

13,677

 

18,385

 

24,543

 

 

(25.6

)

 

 

(25.1

)

 

Furniture and equipment

 

11,289

 

9,562

 

13,916

 

 

18.1

 

 

 

(31.3

)

 

Business development and travel

 

8,692

 

8,426

 

10,159

 

 

3.2

 

 

 

(17.1

)

 

Correspondent bank fees

 

4,343

 

2,835

 

479

 

 

53.2

 

 

 

491.9

 

 

Data processing services

 

4,288

 

4,360

 

3,785

 

 

(1.7

)

 

 

15.2

 

 

Telephone

 

3,187

 

3,123

 

4,317

 

 

2.0

 

 

 

(27.7

)

 

Tax credit funds amortization

 

2,704

 

2,963

 

2,756

 

 

(8.7

)

 

 

7.5

 

 

Postage and supplies

 

2,601

 

3,190

 

3,995

 

 

(18.5

)

 

 

(20.2

)

 

Trust preferred securities distributions

 

594

 

2,230

 

3,300

 

 

(73.4

)

 

 

(32.4

)

 

Other

 

8,581

 

5,741

 

10,997

 

 

49.5

 

 

 

(47.8

)

 

Total noninterest expense

 

$

262,687

 

$

186,374

 

$

183,488

 

 

40.9

%

 

 

1.6

%

 

 

28




Compensation and benefits expenses increased in 2003 from 2002, primarily due to increased incentive compensation expense. We believe this was necessary to retain our professional talent in an improving economic environment. Average full-time equivalent (FTE) personnel decreased from 1,000 in 2002 to 994 in 2003, and was 970 in 2001. Compensation and benefits expenses increased by $16.1 million between 2001 and 2002. We experienced an increase in compensation and benefits during 2002 for the following reasons. First, we completed a strategic realignment of some of our business activities, which resulted in severance expense of $1.1 million in 2002. Second, we incurred $6.1 million in incentive compensation expense related to our target earnings levels being achieved in 2002, as compared to $0 in 2001. The increase in FTE personnel from 2001 to 2002 was primarily due to conversion of certain consultants to permanent employees status, the acquisition of Alliant Partners and Woodside Asset Management, Inc., and our efforts to build an infrastructure sufficient to support our business activities and regulatory requirements. We are continuing our specific measures to control the number of FTE personnel during 2004.

We incurred aggregate impairment of goodwill charges related to the Alliant Partners reporting unit of $63.0 million ($38.7 million net of tax, or $1.04 per diluted common share in 2003). Alliant Partners was acquired by us on September 28, 2001. In recent years, economic events have depressed valuations of technology and life sciences corporations. Thus, Alliant has not achieved its originally forecasted results of operations. Consequently, we have incurred these aggregate impairment charges, see “Item 8. Consolidated Financial Statements and Supplementary Data—Note 9 to the Consolidated Financial Statements—Goodwill” for further information. For a discussion of our goodwill accounting policies, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Goodwill.”

Occupancy expense decreased by $2.8 million between 2002 and 2003. In 2002, we exited leased premises in Santa Clara, California, approximating 18,000 square feet. The lease on the building expires in August 2005. Our management determined that the premises would have no future economic value to our operations, except for any potential future sub-lease arrangement. Therefore, during 2002, we incurred charge-offs of approximately $2.5 million related to the exit of these premises. We incurred no such charge-offs in 2003 or 2001.

Professional services expenses, which consist of costs associated with corporate legal services, litigation settlements, accounting and auditing services, consulting, and our board of directors, has decreased year to year. In 2003, we settled the remaining aspects of certain film loan litigation and were able to recover related legal expenses. Additionally, over the past few years, we have implemented stringent measures to control the use of external consulting services. In 2002 as compared to 2001, the decrease in professional services expenses was primarily related to a reduction in the number of business initiatives supported by consultants.

Furniture and equipment expenses increased in 2003 compared to 2002, mainly due to an increase in information technology maintenance costs related to new business initiatives. The decrease in furniture and equipment expenses in 2002 as compared to 2001, was primarily due to a $1.2 million charge-off of software related to an abandoned project in the third quarter of 2001.

Correspondent bank fees increased from year to year. Many of our correspondent banks provide earnings credits to offset bank fees we incur when using their services. Earnings credits are generally calculated using average daily deposit balances, less a reserve requirement and a short-term market interest rate. We received lower earnings credits in 2003 as compared to 2002 and 2001, due to our maintaining lower average balances with our correspondent banks and lower market interest rates. As such, we had fewer earnings credits to offset bank fees charges incurred by us. Thus, we incurred higher recognizable bank fees in 2003 as compared to 2002 and 2001. Management made the decision to lower the average balances with correspondent banks because we were able to earn more on our funds by investing them than we would have saved by leaving these funds with the correspondent banks.

29



Beginning July 1, 2003, trust preferred securities distribution expense was required to be classified as interest expense on a prospective basis, pursuant to adoption of SFAS No. 150. Therefore, noninterest expense does not reflect trust preferred securities distribution expense for the latter half of 2003. The 8.25% Trust Preferred Securities, originally issued during the second quarter of 1998, paid a fixed-rate quarterly distribution and had a maximum maturity of 30 years. We redeemed the $40.0 million of 8.25% Trust Preferred Securities in the fourth quarter of 2003.

On June 3, 2002, we entered into a derivative agreement with a notional amount of $40.0 million. The agreement hedged against the risk of changes in fair value associated with our $40.0 million of 8.25% Trust Preferred Securities. The derivative agreement provided a $1.0 million and $1.1 million decrease in trust preferred security distribution expense for 2003 and 2002, respectively. This interest rate swap was terminated effective June 23, 2003.

Other noninterest expenses totaled $8.6 million in 2003, $5.7 million in 2002, and $11.0 million in 2001. Other noninterest expense is comprised of miscellaneous loan and deposit related client service expenses, as well as insurance expense and other assessments.

Minority Interest in Net Losses of Consolidated Affiliates

The minority interest limited partner’s share of losses were $7.7 million, $7.8 million, and $7.5 million in 2003, 2002 and 2001, respectively. The minority interest limited partner losses were primarily due to management fees and write-downs of minority interest-owned investments associated with SVB Strategic Investors Fund, L.P. and Silicon Valley BancVentures, L.P. of $5.5 million, $5.7 million, and $5.8 million in 2003, 2002 and 2001, respectively.

Income Taxes

Our effective income tax rate was 21.0% in 2003, compared to 33.4% in 2002 and 37.5% in 2001. The decrease in our effective tax rate from 2002 to 2003 was primarily due to a higher impact of our tax-advantaged investments on our lower overall earnings, partially offset by the exclusion of REIT tax benefits.

In the third quarter of 2002, we implemented a real estate investment trust (REIT) to serve as a future-funding vehicle. In 2002 we obtained $0.8 million in tax benefits from the REIT structure. In 2003, we did not take REIT tax benefits of $1.7 million in response to a California Franchise Tax Board (FTB) announcement on December 31, 2003, which related to new tax shelter regulations. We believe we are appropriately reserved for prior year benefits that were previously recognized. We will not reflect REIT tax benefits in our future financial statements until this matter has been resolved with the FTB. Based on information provided by our financial advisors, we believe that our position with regard to the REIT has merit and we plan to pursue our tax claims and defend our use of this entity. For further information on our effective tax rate, see “Item 8. Consolidated Financial Statements and Supplementary Data—Note 16 to the Consolidated Financial Statements—Income Taxes.”

The change in our effective income tax rate from 2001 to 2002 was primarily due to an increase in items giving rise to permanent tax benefits. In particular, on September 11, 2002, California enacted a law requiring large banks (those with average assets in excess of $500 million) to conform to federal law with respect to accounting for bad debts. Prior to the law change, all banks, regardless of size, were eligible to use the reserve method of accounting for bad debts which enabled them to take deductions for anticipated bad debt losses prior to the losses being incurred for California tax purposes. With the change, large banks may now only deduct actual charge-offs net of recoveries in determining their California taxable income. Banks that are required to conform to the new law must include in taxable income 50 percent of their existing bad debt reserves as of the end of the prior tax year. As a concession for requiring large banks to comply with the new law, recapture of the remaining 50 percent of the reserve is waived thereby creating a permanent tax benefit. Our one-time tax benefit resulting from the law change was $0.8 million and was reflected in our income tax expense for 2002. This change, while reducing income tax expense, also results in accelerated tax payments.

30




Operating Segment Results

Commercial banking’s pre-tax income for the year ending 2003 was $66.4 million compared to $70.8 million for the same period in 2002. This decrease was caused by declines in net interest income and noninterest income, partially offset by a decline in net charge-offs. The commercial bank benefited from net recoveries of loan losses in 2003. Our segment reporting includes net charge-offs in lieu of provision expense to determine segment financial performance.

For the years ended December 31, 2003 and 2002, merchant banking’s pre-tax income was $6.1 million and $1.6 million, respectively. In 2003, noninterest income increased by $7.0 million, primarily related to warrant income of $7.5 million compared to $1.7 million for the same period in 2002.

Investment banking’s pre-tax (loss) income for the years ended December 31, 2003 and 2002, was $(62.6) million and $2.4 million, respectively. The 2003 pre-tax net loss was primarily due to aggregate impairment of goodwill charges of $63.0 million, for further information, see “Item 8. Consolidated Financial Statements and Supplementary Data—Note 9 to the Consolidated Financial Statements—Goodwill.”

All other segments include private banking and other business services. Other segments also include necessary adjustments to reconcile segment data to the consolidated financial statements. Our segment reporting is under continuous refinement. As a result, the other segments will be subject to large amounts of variability from period to period as our management reporting and cost allocation process evolves. Other segments’ pre-tax income remained consistent at $5.3 million for the years ended December 31, 2003 and 2002. For operating segment results, see “Item 8. Consolidated Financial Statements and Supplementary Data—Note 14 to the Consolidated Financial Statements—Segment Reporting.”

Financial Condition

Total assets at December 31, 2003 were $4.5 billion, an increase of $282.2 million from December 31, 2002. Federal funds sold and securities purchased under agreement to resell increased by $339.8 million, and investment securities increased by $39.7 million while loans, net of unearned income, decreased by $96.9 million. The increase in total assets was primarily funded by a $230.7 increase in client deposits. Between December 31, 2002 and December 31, 2003, long-term debt increased by $186.9 million primarily due to the issuance of $150.0 million of zero coupon convertible debt in May 2003. The net proceeds from the issuance of the convertible debt were largely used to repurchase our common stock, which resulted in a decrease of stockholders’ equity. The remaining increase in long-term debt was the result of a change in accounting rules, which mandated the classification of Trust Preferred Securities as long-term debt, on a prospective basis.

Federal Funds Sold and Securities Purchased under Agreement to Resell

Federal funds sold and securities purchased under agreement to resell totaled a combined $542.5 million at December 31, 2003, an increase of $339.8 million, or 167.7% as compared to $202.7 million outstanding at the prior year-end. We actively manage overnight funds between federal funds sold and securities purchased under agreement to resell and money market mutual funds, based on current interest rates. The increase in federal funds sold and securities purchased under agreement to resell was primarily funded by an increase in client deposits of $230.7 million and a slight shift of funds from short-term investments, due to higher yields.

Investment Securities

For a description of the accounting policies related to Investment Securities, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” and “Item 8. Consolidated Financial Statements and Supplementary Data—Note 1 to the Consolidated Financial Statements—Significant Accounting Policies—Investment Securities.”

The following table details the composition of investment securities, which were classified as available-for-sale and reported at fair value, with the exception of non-marketable securities that include Federal Reserve Bank and Federal Home Loan Bank stock, tax credit funds, venture capital fund

31




investments, and other private equity investments, which were reported on a cost basis less any identified impairment or reported at fair value using investment company accounting rules at December 31, 2003, 2002, and 2001.

 

 

December 31,

 

 

 

2003

 

2002

 

2001

 

 

 

(Dollars in thousands)

 

Available-for-sale securities:

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

31,153

 

$

20,578

 

$

85,148

 

U.S. agencies and corporations:

 

 

 

 

 

 

 

Collateralized mortgage obligations

 

611,385

 

420,161

 

154,314

 

Mortgage-backed securities

 

296,494

 

158,936

 

142,493

 

Discount notes and bonds

 

285,429

 

197,545

 

425,843

 

Asset-backed securities

 

37,695

 

38,508

 

 

Obligations of states and political subdivisions

 

150,871

 

210,517

 

421,634

 

Commercial paper and other debt securities

 

26,991

 

11,148

 

34,800

 

Money market mutual funds

 

23,079

 

378,933

 

494,230

 

Warrant securities

 

7,676

 

839

 

2,406

 

Venture capital fund investments

 

8

 

11

 

69

 

Other equity investments(1)

 

8,602

 

7,055

 

5

 

Total available-for-sale securities

 

1,479,383

 

1,444,231

 

1,760,942

 

Non-marketable securities:

 

 

 

 

 

 

 

Venture capital fund investments(2)

 

$

55,345

 

$

46,822

 

$

38,647

 

Tax credit funds

 

16,551

 

18,255

 

12,719

 

Other private equity investments(3)

 

13,679

 

16,820

 

13,706

 

Federal Reserve Bank stock

 

7,467

 

7,394

 

7,148

 

Federal Home Loan Bank stock

 

3,009

 

2,172

 

 

Total non-marketable securities

 

96,051

 

91,463

 

72,220

 

Total investment securities

 

$

1,575,434

 

$

1,535,694

 

$

1,833,162

 


(1)              Available-for-sale other equity investments included $8.6 and $7.1 million related to investments owned by two consolidated limited partnerships, Taurus Growth Partners, L.P. and Libra Partners, L.P. as of December 31, 2003 and December 31, 2002, respectively.

(2)              Non-marketable venture capital fund investments included $30.1 million, $22.1million, and $16.5 million related to SVB Strategic Investors Fund, L.P., as of December 31, 2003, 2002, and 2001, respectively.

(3)              Non-marketable other private equity investments included $10.1 million, $10.0 million, and $5.1 million related to Silicon Valley BancVentures, L.P., as of December 31, 2003, 2002, and 2001, respectively.

Available-for-sale investment securities totaled $1.5 billion at December 31, 2003, an increase of $35.2 million, or 2.4%, from the December 31, 2002 balance of $1.4 billion. The increase in available-for-sale securities resulted from growth in average client deposits in excess of loan growth. The change in the composition of investments was the result of our continuing efforts to diversify the product mix in our investment portfolio to higher yielding, high quality assets. Short-term money market mutual funds were reallocated to higher yielding mortgage-backed securities and collateralized mortgage obligations. We continue to add some duration to the portfolio due to active interest rate risk management, and have increased the average life to 1.7 years in 2003 from 1.5 years in 2002. Other notable changes include the reduction of short-term municipal bonds and an increase in agency discount notes and debentures.

The increase in nonmarketable securities relates to an increase in venture capital fund investments of $8.5 million between 2002 and 2003, primarily due to additional investments made by our managed fund, SVB Strategic Investors, L.P. during the year.

Investment securities totaled $1.5 billion at December 31, 2002, a decrease of $297.5 million, or 16.2%, from the December 31, 2001 balance of $1.8 billion. This decrease resulted from a reallocation of funds to loans and our common stock repurchase programs during 2002. The decrease in investment securities was primarily in U.S. Treasury and agency securities, short-term obligations of states and political subdivisions, and money market mutual funds. This was partially offset by an increase in

32




collateralized mortgage obligations. This shift represents a change in investment portfolio management as we become more active in measuring and managing our interest rate risk. We have increased the expected average life of investments in our portfolio to approximately 1.5 years in 2002 from under 1 year in 2001 by adding higher yielding, highly liquid agency mortgage-backed securities and other triple A rated securities. The increase in venture capital fund investments of $8.1 million between 2001 and 2002 was primarily due to additional investments made by our managed fund, SVB Strategic Investors, L.P. during the year. The change in the composition of investments was the result of interest rate conditions.

Based on December 31, 2003 market valuations, we had potential unrealized pre-tax warrant gains totaling $7.5 million. We are restricted from exercising many of these warrants. As of December 31, 2003, we held 1,842 warrants in 1,329 companies, had made investments in 254 venture capital funds, and had direct equity investments in 19 companies, many of which are private. We also had investments in 20 venture capital funds through our fund of funds, SVB Strategic Investors, L.P. and had direct equity investments in 25 companies through our venture capital fund, Silicon Valley BancVentures, L.P. We are typically contractually precluded from taking steps to secure the current unrealized gains associated with many of these equity instruments. Hence, the amount of income we realize from these equity instruments in future periods may vary materially from the current unrealized amount due to fluctuations in the market prices of the underlying common stock of these companies.

At December 31, 2003, we held no investment securities that were issued by a single party, excluding securities issued by the U.S. Government or by U.S. government agencies and corporations, which exceeded 10.0% of our stockholders’ equity.

33




The following table provides the remaining contractual principal maturities and fully taxable-equivalent yields on investment securities as of December 31, 2003, except for auction rate securities that use the next reset date as the maturity date. The weighted-average yield is computed using the amortized cost of available-for-sale securities, which are reported at fair value. Expected remaining maturities of callable U.S. agency securities, mortgage-backed securities, and collateralized mortgage obligations may differ significantly from their contractual maturities because borrowers may have the right to prepay obligations with or without penalties. This is most apparent in mortgage backed securities and collateralized mortgage obligations as contractual maturities are typically 15 to 30 years whereby expected average lives of these securities are between two and five years. Warrant securities, venture capital fund investments, other private equity investments, Federal Reserve Bank stock, Federal Home Loan Bank stock, and tax credit funds were included in the table below as maturing after 10 years.

 

 

December 31, 2003

 

 

 

Total

 

One Year
or Less

 

After One
Year to
Five Years

 

After Five
Years to
Ten Years

 

After
Ten Years

 

 

 

Carrying
Value

 

Weighted-
Average
Yield

 

Carrying
Value

 

Weighted-
Average
Yield

 

Carrying
Value

 

Weighted-
Average
Yield

 

Carrying
Value

 

Weighted-
Average
Yield

 

Carrying
Value

 

Weighted-
Average
Yield

 

 

 

(Dollars in thousands)

 

U.S. Treasury securities

 

$

31,153

 

 

1.81

%

 

 

 

 

 

$

30,913

 

 

1.81

%

 

$

240

 

 

1.81

%

 

 

 

 

 

U.S. agencies and corporations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collateralized mortgage obligations

 

611,385

 

 

4.24

 

 

 

 

 

 

3,723

 

 

1.13

 

 

854

 

 

3.84

 

 

$

606,808

 

 

4.28

%

 

Mortgage-backed securities

 

296,494

 

 

4.51

 

 

 

 

 

 

 

 

1,105

 

 

3.75

 

 

27,343

 

 

3.35

 

 

268,046