SVB Financial Group
SVB FINANCIAL GROUP (Form: 10-K, Received: 03/27/2006 06:15:47)

 

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, 2005

OR

o                Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                                to                               

Commission File Number: 000-15637

SVB FINANCIAL GROUP

(formerly Silicon Valley Bancshares)

(Exact name of registrant as specified in its charter)

Delaware

 

91-1962278

(State or other jurisdiction of incorporation or organization)

 

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

3003 Tasman Drive, Santa Clara, California 95054-1191

 

http://www.svb.com

(Address of principal executive offices including zip code)

 

(Registrant’s URL)

 

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:

Title of Class: Common Stock, par value $0.001 per share

Title of Class: Junior subordinated debentures issued by SVB Capital II and the guarantee with respect thereto

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes  x  No  o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes  o  No  x

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  o  No x

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2005, 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 $1,546,376,640.

At February 28, 2006, 35,454,171 shares of the registrant’s common stock ($0.001 par value) were outstanding.

Documents Incorporated by reference

 

Parts of Form 10-K
Into Which
Incorporated

Definitive proxy statement for the Company’s 2006 Annual Meeting of Stockholders to be filed within 120 days of the end of the fiscal year ended December 31, 2005

 

Part III

 

 




TABLE OF CONTENTS

 

 

 

 

 

Page

PART I

 

Item 1

 

Business

 

3

 

 

Item 1A

 

Risk Factors

 

15

 

 

Item 1B

 

Unresolved Staff Comments

 

23

 

 

Item 2

 

Properties

 

23

 

 

Item 3

 

Legal Proceedings

 

24

 

 

Item 4

 

Submission of Matters to a Vote of Security Holders

 

24

PART II

 

Item 5

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

25

 

 

Item 6

 

Selected Consolidated Financial Data

 

26

 

 

Item 7

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations       

 

29

 

 

Item 7A

 

Quantitative and Qualitative Disclosures About Market Risk

 

82

 

 

Item 8

 

Consolidated Financial Statements and Supplementary Data

 

89

 

 

Item 9

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      

 

156

 

 

Item 9A

 

Controls and Procedures

 

156

 

 

Item 9B

 

Other Information

 

159

PART III

 

Item 10

 

Directors and Executive Officers of the Registrant

 

159

 

 

Item 11

 

Executive Compensation

 

159

 

 

Item 12

 

Security Ownership of Certain Beneficial Owners and Management, and related Stockholder Matters

 

160

 

 

Item 13

 

Certain Relationships and Related Transactions

 

160

 

 

Item 14

 

Principal Accounting Fees and Services

 

160

PART IV

 

Item 15

 

Exhibits and Financial Statement Schedules

 

161

SIGNATURES

 

162

Index to Exhibits

 

164

 

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PART I.

ITEM 1.    BUSINESS

General

SVB Financial Group (formerly known as Silicon Valley Bancshares) is a bank holding company and a financial holding company that was incorporated in the state of Delaware in March 1999. 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 “SVB Financial Group,” the “Company,” or “we,” or use similar words, we intend to include SVB Financial Group and all of its subsidiaries collectively, including Silicon Valley Bank. When we refer to “SVB Financial” or the “Parent” we are referring only to the parent company, SVB Financial Group.

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

Income Sources

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, account for the major portion of our earnings.  That income, referred to as net interest income, was $299.3 million in 2005, $229.5 million in 2004, and $183.1 million in 2003. (For further information  see Item 8. Consolidated Financial Statements and Supplementary Data.)

Our deposits are largely obtained from commercial clients within our technology, life science, private equity, and premium wine industry sectors, and, to a lesser extent, from individuals served by our Private Client Services group. We do not obtain deposits from conventional retail sources and have no brokered deposits. As part of negotiated credit facilities and certain other services, we frequently obtain rights to acquire stock in the form of equity warrants in certain client companies.

Fee-based services also generate income for our business. We market our full range of financial services to all of our commercial and private equity firm clients. In addition to commercial banking and private client services, we offer fee-based merger and acquisition services, private placements, and investment and advisory services. Our ability to integrate and cross-sell our diverse financial services to our clients is a strength of our business model. Our non-interest income was $117.5 million in 2005, $107.8 million in 2004 and $81.4 million in 2003. (For further information  see Item 8. Consolidated Financial Statements and Supplementary Data.)

In addition, we seek to obtain equity returns through investments in direct equity and venture capital fund investments. We manage four limited partnerships: a venture capital fund that invests directly in privately-held companies and three funds that invest in other venture capital funds.

We are able to offer our clients financial products and services through five strategic business groups, as discussed in further detail below: Commercial Banking, SVB Capital, SVB Alliant, Global Financial Services and Private Client Services and Other. These operating groups are managed separately because they offer different services to our clients, may appeal to different markets and require different strategies. The Private Client Services and Global Financial Services groups did not meet the separate reporting

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thresholds for segment reporting purposes. For further information on our reportable business segments, see Item 8. Consolidated Financial Statements and Supplementary Data—Note 22 Segment Reporting.

Business Overview

SVB Financial Group is organized into strategic business groups that manage the diverse financial services we offer:

Commercial Banking

Through Silicon Valley Bank and its subsidiaries, we provide solutions to meet the needs of our commercial clients in the technology, life science, premium wine industry, and venture capital and private equity firm clients through lending, deposit account, cash management, and global banking and trade products and services.

Through our lending products and services, we extend loans and other credit facilities to our commercial clients, most often secured by the intellectual property or other assets of our clients. Lending products and services include traditional term loans, equipment loans, revolving lines of credit, accounts-receivable based lines of credit, asset-based loans, real estate loans, vineyard development loans, and financing of affordable housing projects. We may obtain warrants to purchase an equity position in a client company’s stock in consideration for providing credit facilities or other services.

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

Our global banking and trade products and services facilitate our clients’ global finance and business needs. These products and services include foreign exchange services that allow commercial clients to manage their foreign currency risks through the purchase and sale of currencies on the global inter-bank market. To facilitate our clients’ international trade, we offer a variety of loans and credit facilities guaranteed by the Export-Import Bank of the United States. We also offer letters of credit, including export, import, and standby letters of credit, to enable clients to ship and receive goods globally.

Silicon Valley Bank provides investment and advisory services to clients through our broker-dealer subsidiary, SVB Securities, Inc. (“SVB Securities”). SVB Securities is a broker-dealer registered with the U.S. Securities and Exchange Commission (“SEC”) and a member of the National Association of Securities Dealers, Inc. (“NASD”). Services offered by SVB Securities involve introducing mutual funds and fixed income securities on an agency or riskless principal basis. SVB Securities does not hold customer accounts. We also offer investment advisory services through SVB Asset Management, a registered investment advisor subsidiary of Silicon Valley Bank. SVB Asset Management specializes in outsourced treasury management, customized cash portfolio management and reporting and monitoring for corporations.

SVB Capital

SVB Capital (formerly referred to as our Merchant Banking group) focuses on the business needs of our venture capital and private equity clients, establishing and maintaining relationships with those firms

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domestically and internationally. Through this segment, we provide banking services and financial solutions, including traditional deposit and checking accounts, loans, letters of credit, and cash management services.

SVB Capital also makes investments in venture capital and other private equity firms and in companies in the niches we serve. The group also manages four venture funds that are consolidated into our financial statements: SVB Strategic Investors Fund, LP, SVB Strategic Investors Fund II, LP, SVB Strategic Investors Fund III, LP which are funds of funds that invest in other venture funds; and Silicon Valley BancVentures, LP, a direct-equity venture fund that invests in privately held technology and life-science companies. This segment also includes investments in Gold Hill Venture Lending Partners 03, LP, and its parallel funds (collectively known as Gold Hill Venture Lending Partners 03. LP), which provide secured debt to emerging-growth clients in their earliest stages; and Partners for Growth, LP, a special situation debt fund that provides secured debt to higher-risk, emerging-growth clients in their later stages.

During the first half of 2005 SVB Capital, through Private Equities Services (a division of SVB Securities), also assisted private equity firms, and the partners of such firms, with liquidating securities following initial public offerings and mergers and acquisitions, including in-kind stock transactions, restricted stock sales, block trading, and special situations trading such as liquidation of foreign securities. We exited this business during the third quarter of 2005 and ceased operations of the Private Equity Services division at that time.

SVB Alliant

Through SVB Alliant (formerly known as Alliant Partners), our investment banking subsidiary, we provide merger and acquisition advisory services (M&A), private placement advisory services through our Private Capital Group, strategic alliance services, and specialized financial studies such as valuations and fairness opinions. SVB Alliant is a broker-dealer registered with the SEC and a member of the NASD. In 2005, we established SVB Alliant Europe Limited, a subsidiary based in London, England, that will provide investment advisory services to companies in Europe when the subsidiary becomes licensed to do so by the Financial Services Authority in England.

Global Financial Services

Our Global Financial Services group, which we began referring to as “SVB Global” in 2006, facilitates our clients’ global expansion into major technology centers around the world by leveraging our worldwide network of contacts, including venture capitalists, corporate connections and service providers. Global Financial Services provides consulting and business services, referrals, and knowledge sharing, as well as identifying business opportunities for SVB Financial Group, through several global subsidiaries of SVB Financial Group including SVB Business Partners (Shanghai) Co., Ltd., SVB Europe Advisors Limited and SVB India Advisors Pvt. Ltd. In 2005 we established SVB Business Partners (Shanghai) Co., Ltd., a subsidiary based in Shanghai, China, that provides consulting and business services as well as serving as a hub for companies expanding business activities in China. In 2004, we established SVB Europe Advisors Limited, a subsidiary based in London, England, that provides consulting and business services, as well as access to financial services of Silicon Valley Bank to clients and prospects based in Europe in the niches we serve. In 2004, we also established SVB India Advisors Pvt. Ltd., a subsidiary based in Bangalore, India, that provides consulting and business services to facilitate technology companies and private equity firms pursuing international business in India. SVB India Advisors also provides services such as educational information, introductions to recommended service providers and networking events. Our Global Financial Group also provides banking services to international venture capital and private equity firms.

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Private Client Services and Other

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

Industry Niches

In each of the industry niches we serve, we provide 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. We define “emerging-growth” clients as companies in the start-up or early stages of their lifecycle; these companies tend to be privately held and backed by venture capital; they generally have few employees, are primarily engaged in research and development, have brought relatively few products or services to market, and have no or little revenue. By contrast, we define “established” or “corporate technology” clients as companies that tend to be more mature; these companies may be publicly traded, and more established in the markets in which they participate.

The emerging growth 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.

By expanding our suite of financial services, we have extended our business to more mature companies. Our corporate technology practice is a network of senior lenders focused primarily on the specific financial needs of more mature private and public clients. Today, we can comfortably address the financial needs of all companies in our niches, whether they are entrepreneurs testing new ideas or multinational corporations with established models and 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

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Private Equity

Since our founding, we have cultivated strong relationships with venture capital firms worldwide, many of which are also clients. SVB Capital provides financial services to a significant number of venture capital firms in the United States (more than 500) as well as to 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 Wine Group, which is part of Silicon Valley Bank, has become one of the leading providers 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. We will continue to service our existing real estate, media, and religious niche loans until they are paid-off.

For further information on our business segments, see Item 8, Consolidated Financial Statements and Supplementary Data—Note 22 Segment Reporting.

Business Combinations

On October 1, 2002, we acquired substantially all of the assets of Woodside Asset Management, Inc., an investment advisory firm, which had approximately $200 million under management for 70 clients. We offer Woodside Asset Management’s services as part of our Private Client Services group, which is part of Silicon Valley Bank. Additionally, as part of this acquisition, SVB Financial Group obtained the general partner interests in two limited partnerships: Taurus Growth Partners, LP and Libra Partners, LP. Both of these funds were liquidated and funds were fully disbursed to the limited partners by December 31, 2004. We had less than a 1% ownership interest in each of these funds. The remaining ownership interest represented limited partners’ funds invested on their behalf by the general partner in certain fixed income and marketable equity securities.

On September 28, 2001, SVB Securities, a subsidiary of Silicon Valley Bank, completed the acquisition of SVB Alliant (at that time called “Alliant Partners”), an investment banking firm providing merger and acquisition and corporate partnering services. On October 1, 2002, SVB Alliant was sold from our Silicon Valley Bank subsidiary to the SVB Financial Group.

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 target 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, and our ability to integrate and cross-sell our diverse financial services to extend the length of our relationships with our clients, we believe we compete favorably in all our markets in these areas.

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Employees

As of December 31, 2005, we employed approximately 1,033 full-time equivalent employees. To our knowledge, 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 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, SVB Financial is subject to the Federal Reserve Board’s supervision, regulation, examination and reporting requirements under the Bank Holding Company Act of 1956 (BHC Act). SVB Financial 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 SVB Financial 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; it 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 SVB Financial 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, a violation of the Federal Reserve Board’s regulations, or both.

Prior to becoming a financial holding company, SVB Financial 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 non-bank company. In addition, prior to becoming a financial holding company, SVB Financial 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

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(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, SVB Financial became a financial holding company. As a financial holding company, SVB Financial 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 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, SVB Financial may invest in companies that engage in activities that are not otherwise permissible, subject to certain limitations, including that SVB Financial 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, loses the ability to undertake new activities or acquisitions that are not generally permissible for bank holding companies and may not continue such activities.

SVB Financial is also treated as a bank holding company under the California Financial Code. As such, SVB Financial 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 are expected 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 off-balance sheet items include transactions such as commitments, letters of credit, and recourse arrangements. Under these credit 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, non-cumulative 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, limited amounts of subordinated debt and the loan and lease loss 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 SVB Financial 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

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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, SVB Financial 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 SVB Financial, 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),” (FIN 46) 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.

SVB Financial and Silicon Valley Bank are also subject to rules that govern the regulatory capital treatment of equity investments in non-financial companies made on or after March 13, 2000 and 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 equity warrants acquired by a bank 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 non-traditional 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 SVB Financial and Silicon Valley Bank, respectively, exceeded the well-capitalized requirements, as defined above, at December 31, 2005. See Item 8. Consolidated Financial Statements and Supplementary Data—Note 20. Regulatory Matters for the capital ratios of SVB Financial and Silicon Valley Bank as of December 31, 2005.

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

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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.) 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 can not, 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, such as Silicon Valley Bank, that are members of the Federal Reserve System, prior approval of the Federal Reserve Board is required before they can create a subsidiary to capitalize on the additional financial activities empowered by the GLB Act.

Restrictions on Dividends

SVB Financial’s ability to pay cash dividends is limited by generally applicable Delaware corporation law limits. In addition, SVB Financial 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 SVB Financial by Silicon Valley Bank. During 2005, 2004, and 2003, Silicon Valley Bank paid dividends of $0.0 million, $25.0 million, and $51.0 million, respectively, to SVB Financial. However, a part of the dividends paid in 2003 and in 2004 were in excess of the amount permitted under the California State Department of Financial Institutions (“DFI”) guidelines. Therefore SVB Financial was required by the DFI to return to Silicon Valley Bank a portion the 2003 dividend and the 2004 dividend. The total amount returned in early 2005 totaled $28.4 million. At December 31, 2005, under these regulatory restrictions, the remaining amount available for payment of dividends to SVB Financial by Silicon Valley Bank totaled $95.0 million. 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

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Financial Statements and Supplementary Data—Note 20. Regulatory Matters for further discussion on dividend restrictions.

Transactions with Affiliates

Transactions between Silicon Valley Bank and its operating subsidiaries (including SVB Securities, Inc.; SVB Asset Management; Woodside Asset Management; SVB Europe Advisors Private Limited; and SVB India Advisors Pvt. Ltd.) and Silicon Valley Bank’s affiliates (including but not limited to, SVB Financial Group; SVB Alliant; and SVB Alliant Europe Limited) are subject to restrictions imposed by federal and state law. These restrictions prevent SVB Financial 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, a “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. Moreover, 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. 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 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 against 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 business, 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

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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 may assess premiums 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 examination 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, 2005, the FDIC’s semi-annual assessment for the insurance of BIF deposits ranged from zero (0) to twenty seven (27) cents per $100 of insured deposits. The FDIC may increase or decrease the premium rate on a semi-annual basis. As of December 31, 2005, Silicon Valley Bank’s assessment rate was zero.

Silicon Valley Bank is also required to pay an annual assessment of approximately six (6) cents per $100 of insured deposits toward the retirement of U.S. government-issued financing corporation bonds.

Community Reinvestment Act (CRA) 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 any violation of 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 customers’ non-public, personal information. 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 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 non-public, personal information with

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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 non-public, personal information to third parties. Third parties that receive such information are subject to the same restrictions as the financial company on the reuse 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 marketing through electronic mail. Financial companies were required to be in compliance with these consumer privacy requirements no later than July 1, 2001.

The California Financial Information Privacy Act (SB1) became effective on July 1, 2004, and applies to financial institutions doing business in the State of California. SB1 tightens existing federal restrictions on the sharing of consumers’ non-public personal information with affiliates and nonaffiliated third parties.

Silicon Valley Bank has written policies with regard to the sharing of consumers’ non-public, personal information. Our policies comply with both federal and California rules applicable to the security and confidentiality of consumers’ non-public, personal information.

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 U.S. Secretary of the Treasury has adopted several regulations to implement these provisions. Pursuant to certain of these regulations, Silicon Valley Bank may not establish, maintain, administer, or manage a correspondent account in the United States for, or on behalf of, a foreign shell bank. 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, SVB Alliant and SVB Securities, are registered as broker-dealers with the SEC and members of the NASD and as such are subject to regulation by the NASD and the SEC. 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. Under certain circumstances, this rule could limit the ability of SVB Financial to withdraw capital from SVB Alliant and of Silicon Valley Bank to withdraw capital from SVB Securities.

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As broker-dealers, SVB Alliant and SVB Securities are also subject to other regulations covering the operations of their respective businesses, including sales, and with respect to SVB Securities, trading practices and 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 NASD, in particular, emphasize the need for supervision and control by broker-dealers of their employees.

Available Information

We make available free of charge through our Internet website, http://www.svb.com, 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. The contents of the website are not incorporated herein by reference and the website address provided is intended to be an inactive textual reference only.

Item 1A.    Risk Factors

Our business faces significant risks, including credit, market/liquidity, operational, legal/regulatory, and strategic/reputation risks. The factors described below may not be the only risks we face, and are not intended to serve as a comprehensive listing or be applicable only to the category of risk under which they are disclosed. The risks described below are generally applicable to more than one of the following categories of risks. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations. If any of the events or circumstances described in the following factors actually occur, our business, financial condition and/or results of operations could suffer.

Credit Risks

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

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

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

Our loan portfolio has a credit profile different from that of most other banking companies. Many of our loans are made to companies in the early stages of development with negative cash flow and no established record of profitable operations. In many cases, repayment of the loan is dependent upon receipt of additional equity financing from venture capitalists or others. Collateral for many of the loans often includes intellectual property, which is difficult to value and may not be readily salable in the case of default. Because of the intense competition and rapid technological change that characterizes the

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companies in our technology and life science industry sectors, a borrower’s financial position can deteriorate rapidly. We also make loans that are larger, relative to the revenues of the borrower, than those made by traditional small business lenders, so the impact of any single borrower default may be more significant to us. Because of these characteristics, our level of nonperforming loans and loan charge-offs can be volatile and can vary materially from period to period. Changes in our level of nonperforming loans may require us to make material provisions for loan losses in any period, which could reduce our net income or cause net losses in that period.

Market/Liquidity Risks

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

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

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

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

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

We have historically obtained rights to acquire stock, in the form of equity warrants, in certain clients as part of negotiated credit facilities and for other services. In future periods we may not be able to ultimately realize gains from the sale of securities to third parties related to the exercise of warrants, or our realized gains may be materially less than the current level of fair value of derivative equity warrant assets and unrealized gains disclosed in this filing. We also have made investments in venture capital funds as well as direct equity investments in companies. The timing and amount of income, if any, from the disposition of client warrants, venture capital funds, and direct equity investments typically depend upon factors beyond our control, including the performance of the underlying portfolio companies, investor demand for initial public offerings, fluctuations in the market prices of the underlying common stock of these

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companies, levels of mergers and acquisitions activity, and legal and contractual restrictions on our ability to sell the underlying securities. In addition, our investments in venture capital funds and direct equity investments have lost value and could continue to lose value or become worthless, which would reduce our net income or could cause a net loss in any period. All of these factors are difficult to predict, particularly in the current economic environment. Additionally, due to the nature of investing in private equity venture-backed technology and life science companies, it is likely that additional investments within our existing portfolio will become impaired. However, we are not in a position to know at the present time which specific investments, if any, are likely to be impaired or the extent or timing of individual impairments. Therefore, we cannot predict future investment gains or losses with any degree of accuracy, and any gains or losses are likely to vary materially from period to period.

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

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

Operational Risks

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

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

Changes to our employee compensation structure could adversely affect our results of operations and cash flows, as well as our ability to attract, recruit, and retain certain key employees.

We account for our employee stock options in accordance with Accounting Principles Board Opinion No. 25 and related interpretations, which provide that any compensation expense relative to employee stock options be measured based on the intrinsic value of the stock options. As a result, when options are granted at fair market value of the underlying stock on the date of grant, as is our practice, we incur no compensation expense. In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which is a revision of SFAS No. 123 and supersedes APB No. 25. SFAS No. 123(R) requires us to record compensation expense for all employee share based payments. Such expense will have a material impact on our results of operations. In October 2004, in an effort to align our option grant rate to that of other financial institutions similar to us, we significantly decreased the number of shares subject to options granted to our employees on a prospective basis. We may in the future consider taking other actions to modify employee compensation structures, such as granting cash compensation or other forms of equity compensation. Our decision to reduce the number of option shares to be granted on a prospective basis, and any other future changes we may adopt in our employee compensation structures, could adversely affect our results of operations and cash flows, as well as our ability to attract, recruit, and retain certain key employees.

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

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

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

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

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

To mitigate these risks we have begun a phased business continuity program, with initial capabilities available in 2005 and additional capabilities to be implemented throughout 2006. Additionally, we announced in January 2006 that we expected to open a support and back-operations facility in Salt Lake City, Utah during the first half of 2006. The facility is part of our business continuity strategy to ensure the continuous availability of critical client operations in the event of an unforeseen disaster. We also have a back-up data center in Phoenix, Arizona. Nonetheless, there is no assurance that our business continuity program can adequately mitigate the risks of such business interruptions.

We rely on other companies to provide key components of our business infrastructure.

Third parties provide key components of our business infrastructure such as internet connections and network access. Any disruption in internet, network access or other voice or data communication services provided by these third parties or any failure of these third parties to handle current or higher volumes of use could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Technological or financial difficulties of a third party service provider could adversely affect our business to the extent those difficulties result in the interruption or discontinuation of services provided by that party.

We face risks associated with the ability of our information technology systems and our processes to effectively support our growth.

We have a complex set of information technology systems and processes to support our business. Our systems consist of multiple information systems that complicate our processing, reporting and analysis of our business transactions and business information. Although we have continuously improved our business systems and processes, as our business grows larger and more complex, our current systems and processes will likely not be able to support the growth effectively. In 2006 and forward, there will be a more significant focus towards improving our systems and processes in order to increase our efficiency, including

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upgrading and consolidating our information systems and improving and automating, where appropriate, our processes. There is no assurance that we can effectively and timely improve our systems and processes to meet all of our business needs efficiently.

We depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit, we may assume that a customer’s audited financial statements conform with accounting principles generally accepted in the United States (“GAAP”) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. We also may rely on the audit report covering those financial statements. Our financial condition and results of operations could be negatively affected by relying on financial statements that do not comply with GAAP or that are materially misleading.

Our accounting policies and methods are key to how we report our financial condition and results of operations. They may require management to make estimates about matters that are uncertain.

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with GAAP and reflect management’s judgment of the most appropriate manner to report our financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in our reporting materially different amounts than would have been reported under a different alternative.

Changes in accounting standards could materially impact our financial statements.

From time to time, the Financial Accounting Standards Board (FASB) changes the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements.

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results. As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.

Our management has determined that as of December 31, 2005, we did not maintain effective internal control over financial reporting based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control—Integrated Framework” as a result of identified material weaknesses in our internal control over financial reporting. Specifically, we did not have adequately designed internal controls in our financial reporting process related to the selection and application of generally accepted accounting principles in that (a) accounting policies, procedures and practices were not consistently developed, maintained or updated in a manner ensuring that financial statements were prepared in accordance with U.S. generally accepted accounting principles, (b) these policies and procedures were not designed to consistently ensure the preparation and retention of adequate documentation to support key judgments made in connection with the selection and application of significant accounting policies within our financial reporting process and (c) our policies and procedures

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did not consistently provide for effective analysis, implementation, and documentation of new accounting pronouncements. In addition, we did not maintain sufficient levels of appropriately qualified and trained personnel in our financial reporting processes resulting in our inability to establish internal control over financial reporting policies and procedures related to (1) the timely preparation of comprehensive documentation supporting management’s analysis of the appropriate accounting treatment for warrant derivatives or other non-routine or complex transactions, and (2) the review of such documentation by qualified internal staff, assisted by external advisors as deemed necessary, to determine our completeness and the propriety of our conclusions. For a detailed description of these material weaknesses and our remediation efforts and plans, see Part II, Items 9A and 9B. These control deficiencies resulted in material errors in our financial reporting which resulted in a restatement of our financial statements for the years 2002, 2003 and 2004. This restatement process took five months to complete, required substantial resources and personnel, and included a comprehensive review of our financial statements and accounting practices by our auditors. However, we have not yet fully remediated these material weaknesses.

In response to these material weaknesses in our internal control over financial reporting, we are implementing additional controls and procedures and are incurring additional related expenses. We cannot be certain that the measures we have taken to date and are planning to take will sufficiently and satisfactorily remediate the identified material weaknesses in full. Furthermore, we intend to continue improving our internal control over financial reporting and the implementation and testing of these efforts could result in increased cost and could divert management attention away from operating our business.

If we are unable to remediate the identified material weaknesses discussed above, or if additional material weaknesses are identified in our internal control over financial reporting, our management will be unable to report favorably as to the effectiveness of our internal control over financial reporting and/or our disclosure controls and procedures, and we could be required to further implement expensive and time-consuming remedial measures and potentially lose investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price and potentially subject us to litigation.

Legal/Regulatory Risks

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

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

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scrutiny or review may impact the conduct of our business and could have a material adverse effect on our business and profitability, since existing resources would be detracted from the current conduct of business and reprioritized to resolve any such review. For example, the scope and degree of regulatory scrutiny of Bank Secrecy Act (BSA)/anti-money laundering compliance have expanded significantly following the events of September 11, 2001 and as a result we have been focusing resources to understand our inherent BSA risk and to document our compliance. We could also receive regulatory sanctions or be subject to regulatory orders for any failure to comply with laws, regulations or policies, which may damage our reputation.

SVB Financial relies on dividends from its subsidiaries for most of its revenue.

SVB Financial is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from its subsidiaries. These dividends are the principal source of funds to pay dividends on SVB Financial’s common and preferred stock and interest and principal on its debt. Various federal and/or state laws and regulations limit the amount of dividends that our bank and certain of our nonbank subsidiaries may pay to SVB Financial. Also, SVB Financial’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors.

Strategic/Reputation Risks

Our business reputation is important and any damage to it can have a material adverse effect on our business.

Our reputation is very important to sustain our business, as we rely on our relationships with our current, former and potential clients and stockholders, the venture capital and private equity community and the industries in which we serve. Any damage to our reputation, such as regulatory enforcement actions, downgrade of ratings, loss of customers, late filings of SEC reports and potential delisting actions, could have a material adverse effect on our business.

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

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

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

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

21




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

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

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

We face risks in connection with completed or potential acquisitions.

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

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

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

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

We face risks associated with international operations.

A component of our strategy is to expand internationally on a limited basis, which requires management’s attention and resources. We already opened offices in the UK, India and China and plan to expand our operations in those locations and are exploring adding other locations. In addition to the uncertainty regarding our ability to generate revenues from foreign operations and to expand our

22




international presence, there are certain risks inherent in doing business on an international basis, including, among others, legal and regulatory requirements, legal uncertainty regarding liability, tariffs, and other trade barriers, difficulties in staffing and managing foreign operations, differing technology standards or customer requirements, requirements or restrictions relating to making foreign direct investments, difficulties associated with repatriating cash generated or held abroad in a tax-efficient manner, longer payment cycles, different accounting practices, problems in collecting loan or other types of payments, political and economic instability, seasonal reductions in business activity, changes in tax laws and potentially adverse tax consequences, any of which could adversely affect the success of our international operations. In addition, in many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by regulations applicable to us, such as the Foreign Corrupt Practices Act. Although we implement policies and procedures designed to ensure compliance with these laws, our employees and agents may take actions in violation of our policies. Any such violation, even if prohibited by our policies, could have a material adverse effect on our business. To the extent we continue to expand our international operations and have additional portions of our international revenues denominated in foreign currencies, we could become subject to increased risks relating to foreign currency exchange rate fluctuations. Since we have limited experience in globalizing our service, there can be no assurance that we will be successful in expanding into international markets or that one or more of the factors discussed above will not have a material adverse effect on our business, results of operations, and/or financial condition.

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

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

Item 1B.    Unresolved Staff Comments

None.

Item 2.    Properties

Our corporate headquarters facility consists of three buildings and is located at 3003 Tasman Drive, Santa Clara, California. On September 15, 2004, we renegotiated the lease related to our corporate headquarters facility, which replaced the original lease, dated March 8, 1995. The new lease covers two buildings, comprising approximately 157,000 square feet of space, which we occupied under the previous lease, as well as a third building, comprising approximately 56,500 square feet of space, within the same facility complex. The total square footage of the premises leased under the new lease arrangement is approximately 213,500 square feet, which is approximately the same square footage of our corporate headquarters under its previous leases. The term of the new corporate headquarters lease began retroactively on August 1, 2004, and will end on September 30, 2014, unless terminated earlier.

We currently operate 27 regional offices in the United States and three offices outside the United States. We operate throughout the Silicon Valley with an office in Fremont, two offices in Santa Clara, an office on Sand Hill Road in Menlo Park, and three offices in Palo Alto. Other regional offices in California include Irvine, Los Angeles, Napa Valley, San Diego, San Francisco, and Sonoma. Office locations outside of California within the United States include: Phoenix, Arizona; Boulder, Colorado; Atlanta, Georgia; Chicago, Illinois; Boston, Massachusetts; Minneapolis, Minnesota; New York, New York; Durham, North

23




Carolina; Portland, Oregon; Philadelphia, Pennsylvania; Austin, Texas; Dallas, Texas; Vienna, Northern Virginia; and Seattle, Washington. Our three foreign offices are located in:  Bangalore, India; Shanghai, China; and London, England. All of our properties are occupied under leases, which expire at various dates through 2014, 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.

Our Commercial Banking operations principally operate out of our corporate headquarters in Santa Clara, and the lending teams operate out of the various regional offices. SVB Capital principally operates out of our office in Menlo Park, and SVB Alliant out of one of the offices in Palo Alto. Our other businesses, including Global Financial Services and Private Client Services, principally operate out of our corporate headquarters in Santa Clara also.

Item 3.    Legal Proceedings

On May 24, 2001, Gateway Communications, Inc. (Gateway) filed a lawsuit in the United States Bankruptcy Court for the Southern District of Ohio (Western Division) naming the Bank as a defendant. Gateway (the debtor in the bankruptcy case) alleges that the Bank’s actions in connection with a loan resulted in Gateway’s bankruptcy, and seeks $20,000,000 in compensatory damages, punitive damages, interest and attorneys’ fees. On June 24, 2003, the Court dismissed four of the five counts in the complaint, including the claim for punitive damages, leaving one breach of contract claim. We believe that the sole remaining claim has no merit and intend to defend the lawsuit vigorously. Thus, we have not accrued any amount related to potential damages from this case as they are not considered probable and reasonably estimable. The action is scheduled for trial in July 2006.

From time to time, we are subject to legal claims and proceedings that arise in the normal course of our business. While the outcome of these matters is currently not determinable, based on information available to us, our review of such claims to date and consultation with our outside counsel, we do not currently expect that the ultimate costs to resolve these matters, if any, will have a material adverse effect on our liquidity, consolidated financial position or results of operations.

Item 4.    Submission of Matters to a Vote of Security Holders

None.

24




PART II

Item 5.    Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

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 per share range of high and low sale prices for our common stock as reported on the NASDAQ National Market, as applicable, for each full quarterly period over the years ended December 31, 2005 and 2004, are as follows:

 

 

2005

 

2004

 

 

 

Low

 

High

 

Low

 

High

 

Three Months Ended:

 

 

 

 

 

 

 

 

 

March 31

 

$

41.10

 

$

45.69

 

$

31.02

 

$

39.96

 

June 30

 

43.15

 

48.98

 

31.20

 

39.65

 

September 30

 

46.25

 

51.84

 

32.38

 

39.90

 

December 31

 

46.35

 

50.12

 

37.15

 

45.15

 

 

Stockholders

There were 698 registered holders of our stock as of December 31, 2005. Additionally, we believe there were approximately 8,167 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. The Company’s Board of Directors may, periodically, 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 20. Regulatory Matters for additional discussion on restrictions and limitations on the payment of dividends imposed on us by government regulations.

Securities Authorized for Issuance Under Equity Compensation Plans

The information required by this Item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 of this Annual Report on Form 10-K.

25




Stock Repurchases

The following table presents stock repurchases by month for the fourth quarter of 2005:

Period

 

(a)
Total Number
of Shares
Purchased

 

(b)
Average Price
Paid per
Share

 

(c)
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs(1)

 

(d)
Maximum Approximate
Dollar Value of Shares that
May Yet Be Purchased
Under the Plans or
Programs(1)

 

October 1 – 31, 2005

 

 

 

 

 

 

 

 

 

 

 

31,500,000

 

 

November 1 – 30, 2005

 

 

 

 

 

 

 

 

 

 

 

31,500,000

 

 

December 1 – 31, 2005

 

 

 

 

 

 

 

 

 

 

 

31,500,000

 

 

Total

 

 

 

 

 

$

 

 

 

 

 

 

 

 

 


(1)           We currently have in place a program authorizing our repurchase of up to a total of $305.0 million of stock. The repurchase program was initially authorized by our Board of Directors and announced on May 7, 2003 for $160.0 million (with no expiration date), and was subsequently increased by $75.0 million (to be repurchased before June 30, 2006) and $70.0 million (to be repurchased before June 30, 2007) and announced on January 27, 2005 and January 26, 2006, respectively. Unless earlier terminated by the Board, the program will expire on June 30, 2007. As of December 31, 2005, we have repurchased 6.5 million shares totaling $203.5 million. At December 31, 2005, the approximate dollar value of shares that may still be repurchased under this program was $31.5 million, which does not include the additional $70.0 million announced on January 26, 2006.

Recent Sales of Unregistered Securities

None.

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 Annual Report on Form 10-K (“Form 10-K”). Certain reclassifications have been made to our prior years’ results to conform to 2005 presentations. Such reclassifications had no effect on the consolidated results of operations or stockholders’ equity. Information for the years ended December 31, 2005, 2004 and 2003 is derived from audited financial statements presented separately herein while information for the years ended December 31, 2002 and 2001 is derived from unaudited financial statements not presented separately herein.

26




 

 

 

Years Ended December 31

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

 

 

(Dollars in thousands. except per share amounts)

 

Income Statement Summary:

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

299,293

 

$

229,477

 

$

183,138

 

$

191,777

 

$

255,842

 

Provision for (recovery of) loan and lease losses

 

237

 

(10,289

)

(9,892

)

5,873

 

15,845

 

Noninterest income

 

117,495

 

107,774

 

81,393

 

71,916

 

81,448

 

Noninterest expense

 

259,860

 

241,830

 

264,896

 

183,326

 

182,551

 

Minority interest in net (income) losses of consolidated affiliates

 

(3,396

)

(3,090

)

7,689

 

7,767

 

7,546

 

Income before income tax expense

 

153,295

 

102,620

 

17,216

 

82,261

 

146,440

 

Income tax expense

 

60,758

 

38,754

 

4,174

 

27,761

 

55,171

 

Net income before cumulative effect of change in accounting principle

 

92,537

 

63,866

 

13,042

 

54,500

 

91,269

 

Cumulative effect of change in accounting principle, net of tax

 

 

 

 

 

6,714

 

Net income

 

$

92,537

 

$

63,866

 

$

13,042

 

$

54,500

 

$

97,983

 

Common Share Summary:

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share—basic before cumulative effect of change in accounting principle

 

$

2.64

 

$

1.81

 

$

0.36

 

$

1.24

 

$

1.91

 

Earnings per common share—diluted before cumulative effect of change in accounting principle  

 

2.40

 

1.70

 

0.35

 

1.21

 

1.86

 

Earnings per common share—basic

 

2.64

 

1.81

 

0.36

 

1.24

 

2.05

 

Earnings per common share—diluted

 

2.40

 

1.70

 

0.35

 

1.21

 

1.99

 

Book value per share

 

$

16.22

 

$

15.07

 

$

13.07

 

$

14.83

 

$

14.03

 

Weighted average shares outstanding—basic

 

35,115

 

35,215

 

36,109

 

44,000

 

47,728

 

Weighted average shares outstanding—diluted

 

38,489

 

37,512

 

37,231

 

45,053

 

49,138

 

Year-End Balance Sheet Summary:

 

 

 

 

 

 

 

 

 

 

 

Investment securities

 

$

2,037,270

 

$

2,054,202

 

$

1,519,935

 

$

1,147,868

 

$

1,333,235

 

Loans, net of unearned income

 

2,843,353

 

2,308,588

 

1,987,146

 

2,084,099

 

1,765,706

 

Goodwill

 

35,638

 

35,638

 

37,549

 

100,549

 

96,380

 

Total assets

 

5,541,715

 

5,145,679

 

4,468,410

 

4,212,031

 

4,202,484

 

Deposits

 

4,252,730

 

4,219,514

 

3,666,841

 

3,436,050

 

3,380,777

 

Contingently convertible debt

 

147,604

 

146,740

 

145,797

 

 

 

Junior subordinated debentures

 

48,228

 

49,470

 

49,118

 

 

 

Trust preferred securities(1)

 

 

 

 

 

39,472

 

38,641

 

Stockholders’ equity

 

$

569,301

 

$

541,948

 

$

457,953

 

$

601,938

 

$

637,048

 

Average Balance Sheet Summary:

 

 

 

 

 

 

 

 

 

 

 

Investment securities

 

1,984,178

 

$

1,753,920

 

$

1,125,039

 

$

1,055,447

 

$

1,461,533

 

Loans, net of unearned income

 

2,368, 362

 

1,951,655

 

1,797,990

 

1,760,639

 

1,659,520

 

Goodwill

 

35,638

 

37,066

 

91,992

 

98,252

 

24,955

 

Total assets

 

5,189,777

 

4,772,909

 

4,056,468

 

3,895,870

 

4,399, 262

 

Deposits

 

4,166,476

 

3,905,408

 

3,277,566

 

3,063,456

 

3,581,581

 

Contingently convertible debt

 

147,181

 

146,255

 

73,791

 

 

 

Junior subordinated debentures

 

49,309

 

49,366

 

23,823

 

 

 

Trust preferred securities(1)

 

 

 

19,193

 

38, 267

 

38,611

 

Stockholders’ equity

 

$

541,426

 

$

495,203

 

$

504,632

 

$

641,402

 

$

657,404

 

Capital Ratios:

 

 

 

 

 

 

 

 

 

 

 

Total risk-based capital ratio

 

14.74

%

16.09

%

16.83

%

16.31

%

17.34

%

Tier 1 risk-based capital ratio

 

12.39

%

12.75

%

12.23

%

15.00

%

16.08

%

Tier 1 leverage ratio

 

11.64

%

11.17

%

10.62

%

14.15

%

14.97

%

Average stockholders’ equity to average assets

 

10.43

%

10.38

%

12.44

%

16.46

%

14.94

%

Selected Financial Ratios:

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

1.78

%

1.34

%

0.32

%

1.40

%

2.23

%

Return on average stockholders’ equity

 

17.09

%

12.90

%

2.58

%

8.50

%

14.90

%

Net interest margin

 

6.46

%

5.39

%

5.16

%

5.64

%

6.57

%

Net recoveries (charge-offs) to average total loans

 

(0.04

)%

(0.10

)%

0.08

%

(0.25

)%

(1.02

)%

Nonperforming assets as a percentage of total assets

 

0.25

%

0.29

%

0.28

%

0.48

%

0.44

%

Allowances for loan and lease losses as a percent of total gross loans

 

1.28

%

1.62

%

2.49

%

2.78

%

3.20

%

27




 

Other Data (Dollars in millions) :

 

 

 

 

 

 

 

 

 

 

 

Client investment funds:

 

 

 

 

 

 

 

 

 

 

 

Private label client investment funds

 

$

8,863

 

$

7,208

 

$

7,615

 

$

7,642

 

$

8,573

 

Client investment assets under management

 

3,857

 

2,678

 

592

 

 

 

Sweep funds

 

2,247

 

1,351

 

1,139

 

853

 

710

 

Total client investment funds

 

$

14,967

 

$

11,237

 

$

9,346

 

$

8,495

 

$

9,283

 


(1)              Adoption of FIN 46R in December 2003 and SFAS No. 150 in May 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 46R 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 46R and SFAS No. 150, in accordance with accounting rules in effect at that time, we 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.

28




Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of Financial Condition and Results of Operations below contain forward-looking statements. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of various factors, including but not limited to those discussed in Item 1A. Risk Factors.

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 Annual Report on Form 10-K. Certain reclassifications have been made to our prior years’ results to conform to 2005 presentations. Such reclassifications had no effect on our results of operations or stockholders’ equity .

Overview of Company Operations

See Item I of Part I above, “Business—General” for an overview of Company operations.

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 GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, income, and expenses and related disclosure of contingent assets and liabilities. Management evaluates estimates on an ongoing basis. Management bases its estimates on historical experiences and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions. 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.

Our critical accounting policies are described below. Our senior management has discussed the development, selection, and disclosure of these critical accounting policies with our Audit Committee.

Non-Marketable Equity Securities

Our accounting for investments in non-marketable equity securities depends on several factors, including our level of ownership/control and the legal structure of our subsidiary making the investment. As further described below, we base our accounting for such securities on: (i) investment company fair value accounting, (ii) equity method accounting, or (iii) cost method accounting.

Investment Company Fair Value

Our non-marketable equity securities recorded pursuant to investment company fair value accounting consist of our investments in the following funds:

·        Direct equity venture fund, Silicon Valley BancVentures, LP, which makes equity investments in privately held companies;

·        Funds of funds, SVB Strategic Investors Fund, LP, SVB Strategic Investors Fund II, LP, and SVB Strategic Investors Fund III, LP, which make investments in venture capital funds; and

·        Special situation debt fund, Partners for Growth, LP, which provides financing to companies in the form of structured loans and equity investments.

29




A summary of our ownership interests in the investments held under investment company fair value accounting is presented in the following table:

Company Ownership
in General Partner

 

 

 

Company
Ownership %

 

Silicon Valley BancVentures Inc.(1)

 

 

100

%

 

SVB Strategic Investors, LLC(2)

 

 

100

%

 

SVB Strategic Investors II, LLC(2)

 

 

100

%

 

SVB Strategic Investors III, LLC(2)

 

 

100

%

 

Partners for Growth, LLC(3)

 

 

0

%

 

 

Company Ownership
in Limited Partner

 

 

 

Company
Ownership %

 

Silicon Valley BancVentures , LP(1)

 

 

10.7

%

 

SVB Strategic Investors Fund, LP(2)

 

 

12.6

%

 

SVB Strategic Investors Fund II, LP(2)

 

 

8.6

%

 

SVB Strategic Investors Fund III, LP(2)

 

 

100.0

%

 

Partners for Growth, LP(3)

 

 

50.0

%

 


Note—Entity’s results of operations and financial condition are included in the consolidated financial statements of SVB Financial Group net of minority interest.

(1)           The general partner, Silicon Valley BancVentures, Inc. is owned and controlled by SVB Financial Group and has an ownership interest of 10.7% in Silicon Valley BancVentures, LP. The limited partners do not have substantive participating or kick-out rights. Therefore, Silicon Valley BancVentures, LP is consolidated and any gains or losses resulting from changes in the estimated fair value of the investments are recorded as investment gains or losses in our consolidated net income.

(2)           The general partner of SVB Strategic Investors Fund, LP (SIF I), SVB Strategic Investors, LLC, is owned and controlled by SVB Financial Group and has an ownership interest of 12.6%. The general partner of SVB Strategic Investors Fund II, LP (SIF II), SVB Strategic Investors II, LLC, is owned and controlled by SVB Financial Group and has an ownership interest of 8.6%. The general partner of SVB Strategic Investors Fund III, LP (SIF III), SVB Strategic Investors III, LLC, is owned and controlled by SVB Financial Group and has an ownership interest of 100.0%. The limited partners of these funds do not have substantive participating or kick-out rights. Therefore, SIF I, II, and III are consolidated and any gains or losses resulting from changes in the estimated fair value of the venture capital fund investments are recorded as investment gains or losses in our consolidated net income.

(3)           The general partner of Partners for Growth, LP, Partners for Growth, LLC, is not owned or controlled by SVB Financial Group. The limited partners of this fund have substantive kick-out rights by which the general partner may be removed without cause by simple majority vote of the limited partners. SVB Financial has an ownership interest of 50.01% in Partners for Growth, LP. Accordingly, the fund is consolidated and any gains or losses resulting from changes in the estimated fair value of the investments are recorded as investment gains or losses in our consolidated net income.

Under investment company accounting, investments are carried at estimated fair value based on financial information obtained from the funds’ respective general partner. We utilize the most recent available financial information available from the investee’s general partner, for instance, September 30, for our December 31 consolidated financial statements, adjusted for any contributions paid or distributions received from the investment during the fourth quarter. The valuations generally remain at cost until such time that there is significant evidence of a change in value based upon consideration of the relevant market conditions, offering prices, operating results, financial conditions, exit strategies, and other pertinent information. Thus, any gains or losses resulting from changes in the estimated fair value of the investments

30




are recorded as investment gains or losses in our consolidated net income. The portion of any investment gains or losses attributable to the limited partners is reflected as minority interest in net income (loss) of consolidated affiliates and adjusts SVB Financial Group’s investment returns to reflect its percentage ownership.

Equity Method

Our equity method non-marketable equity securities consist of an investment in a venture debt fund and several qualified affordable housing tax credit funds.

The venture debt fund investment is in Gold Hill Venture Lending 03, LP, which provides financing to privately-held companies in the form of loans and equity investments. SVB Financial Group has direct and indirect interest totaling 9.3% in Gold Hill Venture Lending 03, LP. Our total interest in Gold Hill Venture Lending 03, LP exceeds the 3%-5% ownership interest threshold established by EITF Topic D-46 for cost method accounting. Accordingly, this limited partnership investment is accounted for under the equity method. Thus, we recognize our proportionate share of the results of operations of each equity method investee in its results of operations.

We invest in several qualified affordable housing projects, which provide us benefits in the form of tax credits. Under EITF 94-1, “Accounting for Tax Benefits Resulting From Investments in Affordable Housing Projects” we account for such investments under the equity method in accordance with the provisions of the AICPA Statement of Position (SOP) 78-9, “Accounting for Investments in Real Estate Ventures.”

We review these investments at least quarterly for possible other than temporary impairment. Our review typically includes an analysis of facts and circumstances for each investment, the expectations of the investment’s future cash flows and capital needs, variability of its business and the company’s exit strategy. We reduce our investment value when we consider declines in value to be other than temporary. We recognize the estimated loss as a loss on investment securities, a component of noninterest income.

Cost Method

Our cost method non-marketable equity securities and related accounting policies are described as follows:

·        In accordance with the provisions of Accounting Principles Board Opinion No. 18 “ The Equity Method of Accounting for Investments in Common Stock ” (APB No. 18), equity securities, such as preferred or common stock in privately-held companies in which we hold an ownership interest of less than 20% and in which we do not have the ability to exercise significant influence over the investees’ operating and financial policies, are accounted for under the cost method.

·        In accordance with the provisions of Emerging Issue Task Force (EITF) Topic D-46, “Accounting for Limited Partnership Investments” (EITF Topic D-46), investments in limited partnerships in which we hold an ownership interest of less than 5% and in which we do not have the ability to exercise significant influence over the investees’ operating and financial policies, are accounted for under the cost method. These non-marketable equity securities include investments in venture capital funds.

As stated above, we record these investments at cost and recognize as income, distributions or returns received from net accumulated earnings of the investee since the date of acquisition. Our share of net accumulated earnings of the investee after the date of investment are recognized in consolidated net income only to the extent distributed by the investee. Distributions or returns received in excess of accumulated earnings are considered a return of investment and are recorded as reductions in the cost basis of the investment.

31




We review these assets at least quarterly for possible other than temporary impairment. Our review typically includes an analysis of facts and circumstances of each investment, the expectations of the investment’s future cash flows and capital needs, variability of its business and the company’s exit strategy. We reduce the investment value when we consider declines in value to be other than temporary. We recognize the estimated loss as a loss on investment securities, a component of noninterest income.

Gains or losses on cost method 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 consolidated net income on that date in accordance with EITF No. 91-5, “Nonmonetary Exchange of Cost-Method Investments”. Further fluctuations in the market value of these equity securities, which are classified as available-for-sale securities, are excluded from consolidated net income and are reported in accumulated other comprehensive income, net of applicable taxes, (OCI), a component of stockholders’ equity. Upon the sale of these equity securities to a third party, gains and losses, which are measured from the acquisition value, are recognized in our consolidated net income.

We consider our non-marketable equity securities accounting policies to be critical because the valuation of non-marketable equity securities is subject to management judgment. The inherent uncertainty in the process of valuing equity securities for which a ready market is unavailable may cause our estimated values of these securities to differ significantly from the values that would have been derived had a ready market for the securities existed, and those 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. For further information related to non-marketable equity securities for the years ended December 31, 2005, 2004, and 2003, please refer to the table under Part II—Item 8. Consolidated Financial Statements and Supplementary Data—Note 6. Investment Securities.

Derivative Assets—Derivative Equity Warrants for Shares of Privately- and Publicly-held Companies

Derivative equity warrant assets for shares of private and public companies are recorded at fair value on the grant date and adjusted to fair value on a quarterly basis through consolidated net income.

In accordance with the provisions of SFAS No. 133 as amended, we account for equity warrant assets with net settlement terms in certain private and public client companies as derivatives. In general, derivative equity warrant assets that we hold entitle us to buy a specific number of shares of stock at a specific price over a specific time period. Certain warrants obtained by us include contingent provisions which set the underlying number of shares or strike price based upon certain future events. For example, the number of shares exercisable for some warrants is contingent upon the related lending facility, such as the extent of utilization of the facility, including draw frequency or amount. Or, in some cases, the underlying strike price of some warrants may be contingent upon the share price of a subsequent future round of equity financing of the issuer. Our warrant agreements contain net share settlement provisions, which permit the issuing company to deliver to us, upon our exercise of the warrant, the amount of shares with a current fair value equal to the net gain of the warrant agreement (sometimes described as a “cashless” exercise). Because our warrant agreements contain such net share settlement provisions, our equity warrant assets are required to be accounted for as derivative instruments.

Under the accounting treatment required by SFAS No. 133, equity warrant assets in private and public companies which include net share settlement provisions held by SVB Financial Group, are recorded at fair value and are classified as derivative assets, a component of Other assets, on SVB Financial Group’s balance sheet at the time they are obtained.

The grant date fair values of these equity warrant assets are deemed to be loan fees and are required to be recognized as an adjustment of loan yield through loan interest income, as prescribed by SFAS

32




No. 91. Similar to other loan fees, the yield adjustment related to grant date fair value of equity warrant assets, received directly in connection with the issuance of a credit facility, is recognized over the life of that credit facility.

Any changes from the grant date fair value of derivative equity warrant assets will be recognized as increases or decreases to other assets on our balance sheet and as net gains or losses on derivative investments, in noninterest income, a component of consolidated net income. When a portfolio company completes an initial public offering on a publicly reported market or is acquired by a publicly traded company, we may exercise these equity warrant assets for shares. On the date a warrant is exercised into equity securities, it is marked to market as a derivative asset with the resulting change in value recognized as a gain or loss on derivatives in noninterest income, a component of consolidated net income.

As of the exercise date, the basis or value in the equity securities is reclassified from Other assets to Investment securities on the balance sheet. The equity securities are classified as available-for-sale securities under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Instrument” (SFAS No. 115). In accordance with the provisions of SFAS No. 115, changes in fair value of securities designated as available for sale, after applicable taxes, are excluded from net income and reported in accumulated other comprehensive income, which is a separate component of stockholders’ equity.

The derivative equity warrant portfolio is comprised of warrants in companies from industries served by SVB Financial Group, as described in Item 1. Business. The fair value of the derivative equity warrant portfolio is reviewed quarterly. We value the equity warrant assets using an option pricing model approach, based on the standard Black-Scholes pricing model utilizing the following five material assumptions:

·        Underlying stock value was estimated based on information available, including any information regarding subsequent rounds of funding and a review of related customer credit files.

·        Volatility, or the quantification of the risk associated with the warrants over time, was based on guideline publicly traded companies or indices similar in nature to the underlying client companies issuing the warrant. A total of ten such indices were used. The volatility assumption for each warrant was calculated based on the average of the annualized daily volatility of a basket of comparable public companies over each of the fiscal quarters from January 1, 2002 to December 31, 2005. The weighted average quarterly median volatility assumption used for the warrant valuation at December 31, 2005 was 47.4%.

·        Actual data on cancellations, expirations and exercises of our warrants was utilized as the basis for determining the expected remaining life of the warrants in each financial reporting period. Warrants may be exercised in the event of acquisitions, mergers or initial public offerings (IPO), and cancelled due to events such as bankruptcies, restructuring activities or additional financings.

·        The risk-free interest rates were derived from the appropriate Treasury yield curve. Risk-free interest rates reflect the rates of return available on long-term high-quality fixed-income debt instruments.  Subsequent to issuance, the risk-free rate was calculated based on a weighted average of the risk-free rates that correspond closest to the expected remaining life of the warrant.

·        Other adjustments were estimated based on management’s judgment about the general industry environment combined with specific information about the issuing company, when available.

33




The fair value of our derivative equity warrant assets recorded on our balance sheets represents our best estimate of the fair value of these instruments within the framework of existing accounting standards and guidance provided by the Securities and Exchange Commission on fair value accounting. Changes in the above material assumptions will result in significantly different valuations. For example, the following table demonstrates the effect of changes in the expected life and volatility assumptions:

Valuation of Equity Warrant Assets Held(1) by Silicon Valley Bank Active at December 31, 2005

 

 

Volatility Factor

 

 

 

10% Lower

 

Average – 47.4%

 

10% Higher

 

 

 

(dollars in millions)

 

Expected Life in Years

 

 

 

 

 

 

 

 

 

 

 

 

 

Average minus approximately 1.5 years

 

 

$

14.1

 

 

 

$

15.9

 

 

 

$

17.7

 

 

Average – 2.4 years

 

 

$

22.3

 

 

 

$

25.7

 

 

 

$

29.1

 

 

Average plus approximately 1.6 years

 

 

$

27.9

 

 

 

$

32.2

 

 

 

$

36.4

 

 


(1)           In addition to Silicon Valley Bank’s warrant assets at December 31, 2005, warrants assets at Partners for Growth were valued at $2.1 million, using 39.5% volatility and 3.9 years expected life.

The timing and value realized from the disposition of warrant related equity securities to third parties, depend upon factors beyond our control, including the performance of the underlying portfolio companies, investor demand for initial public offerings, fluctuations in the market prices of the underlying common stock of these companies, levels of mergers and acquisitions activity, and legal and contractual restrictions on our ability to sell the underlying securities. In addition, our equity warrant assets could lose value or become worthless, which would impact our consolidated net income. All of these factors are difficult to predict. Due to the composition of our portfolio of equity warrant assets, it is likely that many of them will become impaired. However, we are not in a position to know at the present time which specific equity warrant assets, are likely to be impaired or the extent or timing of individual impairments. Therefore, we cannot predict future gains or losses with any degree of accuracy, and any gains or losses could vary materially from period to period.

We consider accounting policies related to derivative equity warrant assets to be critical because the valuation of these assets is complex and is subject to a certain degree of management judgment. Management has the ability to select from several valuation methodologies and has latitude in the calculation of material assumptions in the current methodology. The selection of an alternative valuation methodology or alternative approaches used to calculate material assumptions in the current methodology may cause our estimated values of these assets to differ significantly from the values recorded. Additionally, the inherent uncertainty in the process of valuing these assets for which a ready market is unavailable may cause our estimated values of these assets to differ significantly from the values that would have been derived had a ready market for the assets existed, and those differences could be material.

Allowance for Loan and Lease Losses

We consider our accounting policy relating to the estimation of the allowance for loan and lease 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. Our loan and lease loss reserve methodology is applied to our funded and unfunded loan commitments. The reserve associated with the funded debt is recorded as a contra asset while the reserve associated with the unfunded loan commitments is recorded as other liabilities. Except as described herein, the methodology for the determination of an appropriate reserve for funded and unfunded loan commitments is the same. The allowance for loan and lease losses and reserve for unfunded credit commitments is management’s estimate of credit losses inherent in the loan portfolio at a balance sheet date.

34




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 risk. 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 results of operations and financial condition. The allowance for loan and lease losses is established through a provision for loan losses charged to expense to provide for credit risk. Our allowance for loan and lease losses is established for loan losses that are probable but not yet realized. The process of anticipating loan losses is imprecise. Our management applies an evaluation process, as described below, to our loan portfolio to estimate the required allowance for loan and lease 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, at least quarterly, credit relationships that exceed specific dollar values. Our review process evaluates the appropriateness of the credit risk rating and allocation of the allowance for loan and lease losses, as well as other account management functions. Our Internal Audit department reviews a selection of credit relationships. In addition, our management receives and approves an analysis for all impaired loans, as defined by SFAS No. 114, “Accounting by Creditors for Impairment of a Loan” (SFAS No. 114). The allowance for loan and lease losses is allocated based on a formula allocation for similarly risk-rated loans by client industry sector and for individually impaired loans as determined by SFAS No. 114

Our evaluation process was designed to determine the adequacy of the allowance for loan and lease 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 a macro allocation to the results of the aforementioned model to ascertain the total allowance for loan and lease losses. While this evaluation process uses historical and other objective information, the classification of loans and the establishment of the allowance for loan and lease 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 and by client industry sector. 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 of a loan becoming charged-off based on its credit risk rating using historical loan performance 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 and by client industry sector. The percentages are averaged and aggregated to estimate our loan loss factors. The annual periods are reviewed and averaged to form the loan loss factors for several quarters of history. The current period-end client loan balances are aggregated

35




by risk-rating category and by client industry sector. Loan loss factors for each risk-rating category and client industry sector are ultimately applied to the respective period-end client loan balances for each corresponding risk-rating category by client industry sector to provide an estimation of the allowance for loan and lease losses.

Macro Allocations

A macro allocation is calculated each quarter based upon management’s assessment of the risks that may lead to a future loan loss experience different from our historical loan loss experience. These risks are aggregated to become our macro allocation. Based on management’s prediction or estimate 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, and charge-off and recovery practices.

·        Changes 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.

·        Other factors as determined by management from time to time

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. A committee comprised of senior management evaluate the adequacy of the allowance for loan and lease losses based on the results of our analysis.

Allowance for Unfunded Credit Commitments

We consider our accounting policy relating to the estimation of the allowance for unfunded credit commitments 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 record a liability for probable and estimable losses associated with our unfunded loan commitments. Each quarter, every unfunded client credit commitment is allocated to a credit risk-rating category in accordance with each client’s credit risk rating. We use the historical loan loss factors described above to calculate the possible loan loss experience if unfunded credit commitments are funded. Separately, we use historical trends to calculate the probability of an unfunded credit commitment being funded by us. We apply the loan funding probability factor to risk-factor adjusted unfunded commitments by credit risk-rating to derive the reserve for unfunded loan commitments. The allowance for unfunded credit commitments may also include certain macro allocations as deemed appropriate by our management. We reflect our allowance for unfunded credit commitments in other liabilities.

Goodwill

Goodwill, which arises from the purchase price exceeding the assigned value of the net assets of an acquired business, represents the value attributable to unidentifiable intangible elements being acquired. Our goodwill at December 31, 2005 related to the acquisition of SVB Alliant (Alliant Partners), a firm

36




which specializes in advisory services related to mergers and acquisitions. The value of this goodwill is supported by the free cash flows from SVB Alliant. 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 an impairment of the goodwill carrying amount, which would be recorded as a write-down in our consolidated net income.

On an annual basis or as circumstances dictate, our management reviews goodwill and evaluates events or other developments that may indicate impairment in the carrying amount. We consider our accounting policy on goodwill to be critical because 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 cash flow approach to value the reporting unit being evaluated for goodwill impairment. These estimates involve many assumptions, including expected results of operations and assumed discount rates. 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. Goodwill and Item 7A. Quantitative and Qualitative Disclosures about Market Risk—Factors That May Affect Future Results.

Results of Operations

Earnings Summary

We reported consolidated net income of $92.5 million in 2005, as compared to consolidated net income of $63.9 million in 2004 and $13.0 million in 2003. Diluted earnings per common share totaled $2.40 for 2005, as compared to $1.70 for 2004 and $0.35 for 2003.

Dilutive Effect of Contingently Convertible Debt on our Diluted Earnings per Share Calculation

We included the dilutive effect of the $150.0 million zero-coupon, convertible subordinated notes due June 15, 2008 in our fully diluted earnings per share (EPS) calculation using the treasury stock method, in accordance with the provisions of EITF 90-19, “Convertible Bonds With Issuer Option to Settle in Cash Upon Conversion” (EITF 90-19) and SFAS No. 128, “Earnings Per Share” (SFAS No. 128). The exposure draft of SFAS No. 128R, if adopted in its proposed form, will require us to change our accounting for the calculation of EPS on our contingently convertible debt to the “if converted” method. The “if converted” treatment of the contingently convertible debt would have decreased EPS by $0.18 per diluted common share, or 7.5 percent for 2005.

In September 2004, the EITF reached final consensus on EITF 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share” (EITF 04-8), that contingently convertible

37




securities should be treated as convertible securities and included in the calculation of diluted earnings per common share. The potential dilutive effect of the contingently convertible debt using the treasury stock method was considered anti-dilutive in 2003, whereby the average price of our stock during the periods were less than the conversion price. The potential dilutive effect of the contingently convertible debt using the treasury stock method was approximately 1.3 million shares and 0.4 million shares as of December 31, 2005 and December 31, 2004, respectively.

2005 Compared to 2004—Increase in consolidated net income, increase in net income/noninterest income.

Consolidated net income increased by $28.7 million between 2005 and 2004.

·        Net interest income increased by $69.8 million primarily due to an increase in average interest-earning assets, and also due to an increase in yield earned on those assets, particularly loans.

·        Noninterest income increased by $9.7 million. The increase was primarily due to increases in client investment fees and gains on foreign exchange derivatives, partially offset by a decrease in deposit service charges.

·        An increase in noninterest expense of $18.0 million was largely attributable to higher compensation and benefits expense of $9.7 million in 2005. In addition, we incurred higher professional services fees associated with the restatement of our financial statements and commitment of resources to adhere to the provisions of the Sarbanes-Oxley Act of 2002.

·        Finally, our effective tax rate increased by 1.8% to 39.6% in 2005.

2004 Compared to 2003

Increase in Consolidated Net Income —Increase in Net Interest Income, Decrease in Impairment of Goodwill Expense

Consolidated net income increased by $50.8 million between 2004 and 2003:

·        Impairment of goodwill expense decreased by $61.1 million. In 2003, we recorded an impairment charge related to goodwill associated with the SVB Alliant acquisition of $63.0 million;

·        Net interest income increased by $46.3 million, primarily due to increased interest income from both investment securities and loans; and

·        Noninterest income increased by $26.4 million, primarily due to an increase of $14.8 million in returns on investments securities. In addition, corporate finance fees increased $9.8 million, an increase in letter of credit and standby letter of credit income of $1.1 million and an increase in client investment fees of $2.9 million, offset by reduced gains on derivative instruments of $3.9 million.

These improvements to consolidated net income were partially offset by increases in certain noninterest expense categories, particularly compensation and benefits expense, which was higher in 2004 primarily due to variable compensation, attributable to our improved financial performance. Additionally, we experienced an increase in professional services expense primarily due to expenses associated with Sarbanes-Oxley compliance. Finally, our effective tax rate increased to 37.8% in 2004 from 24.2% in 2003.

38




The major components of net income and changes in these components are summarized in the following table for the years ended December 31, 2005, 2004 and 2003, and are discussed in more detail on the following pages.

 

 

Years Ended December 31,

 

 

 

 

 

 

 

% Change

 

 

 

% Change

 

 

 

2005

 

2004

 

2005/2004

 

2003

 

2004/2003

 

 

 

(Dollars in thousands)

 

Net interest income

 

$

299,293

 

$

229,477

 

 

30.4

%

 

$

183,138

 

 

25.4

%

 

Provision for (recovery of) loan and lease losses

 

237

 

(10,289

)

 

(102.30

)

 

(9,892

)

 

4.0

 

 

Noninterest income

 

117,495

 

107,774

 

 

9.0

 

 

81,393

 

 

32.4

 

 

Noninterest expense

 

259,860

 

241,830

 

 

7.5

 

 

264,896

 

 

(8.7

)

 

Minority interest in net (income) losses of consolidated affiliates

 

(3,396

)

(3,090

)

 

9.9

 

 

7,689

 

 

(140.2

)

 

Income before income tax expense

 

153,295

 

102,620

 

 

49.4

 

 

17,216

 

 

496.1

 

 

Income tax expense

 

60,758

 

38,754

 

 

56.8

 

 

4,174

 

 

828.5

 

 

Net income

 

$

92,537

 

$

63,866

 

 

44.9

 

 

$

13,042

 

 

389.7

 

 

Return on average assets

 

1.78

%

1.34

%

 

 

 

 

0.32

%

 

 

 

 

Return on average stockholders’ equity

 

17.09

%

12.90

%

 

 

 

 

2.58

%

 

 

 

 

Average stockholders’ equity to average assets

 

10.43

%

10.38

%

 

 

 

 

12.44

%

 

 

 

 

 

Net Interest Income and Margin

Net interest income is defined as the difference between interest earned (primarily on loans, investment securities and federal funds sold, securities purchased under agreement to resell and other short-term investments) 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 funding sources.

39




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, 2005, 2004, and 2003.

 

 

Years Ended December 31,

 

 

 

2005

 

2004

 

2003

 

 

 

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, securities purchased under agreement to resell and other short-term investments(1)

 

$

313,266

 

$

9,531

 

 

3.04

%

 

$

607,460

 

$

8,421

 

 

1.39

%

 

$

689,899

 

$

8,024

 

 

1.16

%

 

Investment securities(2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

1,900,027

 

83,950

 

 

4.42

 

 

1,630,677

 

69,839

 

 

4.28

 

 

982,442

 

38,733

 

 

3.94

 

 

Non-taxable(3)

 

84,151

 

5,685

 

 

6.76

 

 

123,243

 

7,698

 

 

6.25

 

 

142,597

 

9,613

 

 

6.74

 

 

Loans(4)(5)(6):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

1,969,204

 

194,018

 

 

9.85

 

 

1,613,689

 

141,179

 

 

8.75

 

 

1,506,929

 

129,405

 

 

8.59

 

 

Real estate construction and term

 

159,123

 

10,032

 

 

6.30

 

 

120,568

 

6,511

 

 

5.40

 

 

98,720

 

5,989

 

 

6.07

 

 

Consumer and other

 

240,035

 

15,233

 

 

6.35

 

 

217,398

 

9,914

 

 

4.56

 

 

192,341

 

8,192

 

 

4.26

 

 

Total loans

 

2,368,362

 

219,283

 

 

9.26

 

 

1,951,655

 

157,604

 

 

8.08

 

 

1,797,990

 

143,586

 

 

7.99

 

 

Total interest-earning assets

 

4,665,806

 

318,449

 

 

6.83

 

 

4,313,035

 

243,562

 

 

5.65

 

 

3,612,928

 

199,956

 

 

5.53

 

 

Cash and due from banks

 

227,869

 

 

 

 

 

 

 

213,213

 

 

 

 

 

 

 

192,591

 

 

 

 

 

 

 

Allowance for loan and lease losses

 

(37,144

)

 

 

 

 

 

 

(48,249

)

 

 

 

 

 

 

(58,658

)

 

 

 

 

 

 

Goodwill

 

35,638

 

 

 

 

 

 

 

37,066

 

 

 

 

 

 

 

91,992

 

 

 

 

 

 

 

Other assets(2)

 

297,608

 

 

 

 

 

 

 

257,844

 

 

 

 

 

 

 

217,615

 

 

 

 

 

 

 

Total assets

 

$

5,189,777

 

 

 

 

 

 

 

$

4,772,909

 

 

 

 

 

 

 

$

4,056,468

 

 

 

 

 

 

 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

$

33,196

 

135

 

 

0.41

 

 

$

25,986

 

114

 

 

0.44

 

 

$

23,447

 

105

 

 

0.45

 

 

Regular money market deposits

 

406,843

 

2,834

 

 

0.70

 

 

513,699

 

2,587

 

 

0.50

 

 

332,632

 

1,824

 

 

0.55

 

 

Bonus money market deposits

 

792,123

 

6,057

 

 

0.76

 

 

739,976

 

3,721

 

 

0.50

 

 

673,982

 

3,686

 

 

0.55

 

 

Time deposits

 

297,286

 

1,908

 

 

0.64

 

 

329,336

 

2,001

 

 

0.61

 

 

485,199

 

3,468

 

 

0.71

 

 

Federal funds purchased and securities sold under agreements to repurchase

 

69,499

 

2,698

 

 

3.88

 

 

 

 

 

 

 

 

 

 

 

 

Contingently convertible debt

 

147,181

 

941

 

 

0.64

 

 

146,255

 

943

 

 

0.64

 

 

73,791

 

572

 

 

0.78

 

 

Junior subordinated debentures

 

49,309

 

2,330

 

 

4.73

 

 

49,366

 

1,505

 

 

3.05

 

 

23,823

 

3,026

 

 

12.70

 

 

Other borrowings

 

8,035

 

263

 

 

3.27

 

 

16,605

 

520

 

 

3.13

 

 

40,903

 

772

 

 

1.89

 

 

Total interest-bearing liabilities

 

1,803,472

 

17,166

 

 

0.95

 

 

1,821,223

 

11,391

 

 

0.63

 

 

1,653,777

 

13,453

 

 

0.81

 

 

Portion of noninterest-bearing funding sources

 

2,862,334

 

 

 

 

 

 

 

2,491,812

 

 

 

 

 

 

 

1,959,151

 

 

 

 

 

 

 

Total funding sources

 

4,665,806

 

17,166

 

 

0.37

 

 

4,313,035

 

11,391

 

 

0.26

 

 

3,612,928

 

13,453

 

 

0.37

 

 

Noninterest-bearing funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

2,637,028

 

 

 

 

 

 

 

2,296,411

 

 

 

 

 

 

 

1,762,306

 

 

 

 

 

 

 

Other liabilities

 

114,012

 

 

 

 

 

 

 

100,920

 

 

 

 

 

 

 

79,079

 

 

 

 

 

 

 

Trust preferred securities(7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

19,193

 

 

 

 

 

 

 

Minority interest

 

93,839

 

 

 

 

 

 

 

59,152

 

 

 

 

 

 

 

37,481

 

 

 

 

 

 

 

Stockholders’ equity

 

541,426

 

 

 

 

 

 

 

495,203

 

 

 

 

 

 

 

504,632

 

 

 

 

 

 

 

Portion used to fund interest-earning assets

 

(2,862,334

)

 

 

 

 

 

 

(2,491,812

)

 

 

 

 

 

 

(1,959,151

)

 

 

 

 

 

 

Total liabilities, minority interest and stockholders’ equity

 

$

5,189,777

 

 

 

 

 

 

 

$

4,772,909

 

 

 

 

 

 

 

$

4,056,468

 

 

 

 

 

 

 

Net interest income and margin

 

 

 

$

301,283

 

 

6.46

%

 

 

 

$

232,171

 

 

5.39

%

 

 

 

$

186,503

 

 

5.16

%

 

Total deposits

 

$

4,166,476

 

 

 

 

 

 

 

$

3,905,408

 

 

 

 

 

 

 

$

3,277,566

 

 

 

 

 

 

 


(1)                 Includes average interest-yielding deposits in other financial institutions of $20.4 million, $10.6 million, and $0.8 million, in 2005, 2004 and 2003, respectively.

(2)                 Average noninterest-earning investment securities, primarily marketable and non-marketable equity securities, are excluded from the totals of investment securities and are included in other assets. Average noninterest-earning investment securities amounted to $157.1 million, $107.6 million and $85.9 million for the years ended December 31, 2005, 2004 and 2003, respectively. The calculation of yield on available-for-sale securities is based on average historical cost and does not give effect to changes in fair value that are reflected in stockholders’ equity.

(3)                 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 $2.0 million, $2.7 million and $3.4 million for the years ended December 31, 2005, 2004 and 2003, respectively.

(4)                 Average loans include average nonaccrual loans of $13.0 million, $14.5 million  and $16.1 million in 2005, 2004 and 2003, respectively.

(5)                 Average loans are net of average unearned income of $19.5 million, $16.4 million and $14.2 million in 2005, 2004 and 2003, respectively.

40




(6)                 Loan interest income includes loan fees of $39.1 million, $31.9 million and $31.2 million in 2005, 2004 and 2003, respectively.

(7)                 Adoption of FIN 46R in December 2003 and SFAS No. 150 in May 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 46R 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 46R and SFAS No. 150, in accordance with accounting rules in effect at that time, we 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 unamortized 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.

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 for each major category of interest-earning assets and interest expense for each major category of interest-bearing liabilities. The table also reflects the amount of simultaneous changes attributable to both volume and rate changes 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.

 

 

2005 Compared to 2004
Increase (Decrease)
Due to Changes in

 

2004 Compared to 2003
Increase (Decrease)
Due to Changes in

 

 

 

Volume

 

Rate

 

Total

 

Volume

 

Rate

 

Total

 

 

 

(Dollars in thousands)

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Federal funds sold, securities purchased under agreement to resell and other short-term investments

 

$

(5,484

)

$

6,594

 

$

1,110

 

$

(1,029

)

$

1,426

 

$

397

 

Investment securities

 

9,242

 

2,856

 

12,098

 

26,265

 

2,926

 

29,191

 

Loans

 

36,575

 

25,104

 

61,679

 

12,393

 

1,625

 

14,018

 

Increase in interest income

 

40,333

 

34,554

 

74,887

 

37,629

 

5,977

 

43,606

 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

30

 

(9

)

21

 

11

 

(2

)

9

 

Regular money market deposits

 

(611

)

858

 

247

 

922

 

(159

)

763

 

Bonus money market deposits

 

279

 

2,057

 

2,336

 

345

 

(310

)

35

 

Time deposits

 

(202

)

109

 

(93

)

(1,000

)

(467

)

(1,467

)

Federal funds purchased and securities sold under agreements to resale

 

2,698

 

 

2,698

 

 

 

 

Contingently convertible debt

 

6

 

(8

)

(2

)

481

 

(110

)

371

 

Junior subordinated debentures

 

(2

)

827

 

825

 

1,802

 

(3,323

)

(1,521

)

Other borrowings

 

(280

)

23

 

(257

)

(602

)

350

 

(252

)

Increase (decrease) in interest expense

 

1,918

 

3,857

 

5,775

 

1,959

 

(4,021

)

(2,062

)

Increase in net interest income

 

$

38,415

 

$

30,697

 

$

69,112

 

$

35,670

 

$

9,998

 

$

45,668

 

 

2005 Compared to 2004

Net Interest Income

Net interest income, on a fully taxable-equivalent basis, totaled $301.3 million for 2005, an increase of $69.1 million, or 29.8% from 2004. The increase in net interest income was the result of a $74.9 million increase in interest income and offset by a $5.8 million increase in interest expense.

41




Interest Income—Net Increase in Interest-Earning Assets (Volume Variance)

The $74.9 million increase in interest income, on a fully taxable-equivalent basis, was partially due to the result of a $40.3 million favorable volume variance. The favorable volume variance resulted from a $352.8 million, or 8.2% increase, in average interest-earning assets. Increases in our sources of funding, largely non-interest bearing funding sources, were the main contributors to the increase in average interest-earning assets. Average deposits increased $261.1 million due to a continued improved venture capital funding environment and a general improvement in business conditions for many of our clients. In addition, a decrease in federal funds sold, securities purchased under agreement to resell and other short-term investments of $294.2 million was used to fund investments in loans and taxable securities. Loans and taxable investment securities collectively increased $686.1 million.

Average investment securities increased by $230.3 million, resulting in a $9.2 million favorable volume variance. We estimated the duration of the total investment portfolio at December 31, 2005 to be 2.9 years, compared to 2.1 years at December 31, 2004.

In addition, average loans increased by $416.7 million resulting in a $36.6 million favorable volume variance. The volume variance is largely driven by growth in our commercial loan category, which represented $355.5 million of the increase, followed by smaller increases in the real estate and consumer loan categories. In particular, the average balances of higher-yielding loan products such as asset-based loans and accounts receivable factoring increased by $51.0 million and $73.0 million, respectively. The increase in average loans reflects an improvement in economic activity and in the markets served by us. Our loan yield in 2005 included $6.1 million from accretion of gross warrant loan fees as compared to $5.7 million in 2004.

Interest Income—Change in Market Interest Rates and Shift in Investment Portfolio Mix (Rate Variance)

Favorable rate variances associated with each component of interest earning assets caused a $34.6 million increase in interest income. The yield on average interest-earning assets increased 118 basis points overall, largely driven by higher yields generated by average loans and taxable investment securities. The increase in yields on interest-earning assets was primarily caused by:

·        an increase in our prime lending rate,

·        an increase in short-term market interest rates,

·        a shift in the loan portfolio mix, and

·        a shift in the average investment portfolio mix.

The average yield on federal funds sold, securities purchased under agreement to resell and other short-term investments for 2005 increased by 165 basis points to 3.04% from 1.39% resulting in a favorable rate variance of $6.6 million. The aforementioned increases in short-term market interest rates were largely responsible for this favorable rate variance.

The average yield on taxable investment securities for 2005 increased 14 basis points to 4.42% from 4.28% in the comparable prior year period, causing a $2.9 million favorable rate variance associated with our average investment securities. This was primarily due to a shift in the composition of a portion of the investment portfolio to a slightly higher concentration of higher-yielding, mortgage-backed securities and collateralized mortgage obligations.

We realized a $25.1 million favorable rate variance associated with our loan portfolio, largely driven by a shift in loan product mix and increases in short-term market interest rates. On eight occasions during 2005 we increased our prime lending rate, each time by 25 basis points, bringing our prime rate to 7.25%, in response to increases in short-term market interest rates. Our weighted-average prime lending rate

42




increased to 6.18% in 2005 from 4.34% in 2004. As of December 31, 2005, approximately 73.8%, or $2.1 billion of our total loan portfolio, were variable rate loans and would reprice with an increase in our prime lending rate. The increase in loan yields was also partially attributable to a shift in the composition of the loan portfolio to higher-yielding, asset-based lending and accounts receivable factoring products.

Interest Expense

Total interest expense for 2005 increased by $5.8 million due to unfavorable rate variance of $3.9 million from an increase in interest expense related to money market deposits and an unfavorable volume variance of $1.9 million largely attributable to federal funds purchased and securities sold under agreement to repurchase.

The unfavorable rate variance was also attributable to an increase in the average rates paid on our money market deposits, from 0.50% in 2004 to 0.70% in 2005 and on our bonus money market deposits, from 0.50% in 2004 to 0.76% in 2005. The increase in interest rates on these products was in response to increases in short-term market interest rates which became effective in the same period.

During 2005 the average balance of federal funds purchased and securities sold under agreement to repurchase was $69.5 million and the average interest rate during the period was 3.88%.

In 2003, we entered into an interest rate swap agreement with a notional amount of $50.0 million. This interest rate swap agreement hedges against the risk of changes in fair value associated with our 7.0% junior subordinated debentures. The terms of this fair value hedge agreement provide for a swap of our 7.0% fixed rate payment for a variable rate based on LIBOR plus a spread. For 2005, we paid interest expense of $3.5 million on the 7.0% junior subordinated debentures. However, the fair value hedge agreement provided a benefit of $1.2 million, resulting in net interest expense of $2.3 million for 2005, compared to $1.3 million for 2004.

The average cost of funds paid increased 11 basis points in 2005 to 0.37%, changed from 0.26% for 2004. The increase in deposit rates resulted from our decision to increase rates for interest-bearing deposit accounts in response to recent increases in short-term market interest rates.

2004 Compared to 2003

Net Interest Income

Net interest income, on a fully taxable-equivalent basis, totaled $232.2 million for 2004, an increase of $45.7 million, or 24.5%, from 2003. The increase in net interest income was the result of a $43.6 million increase in interest income and a $2.1 million decrease in interest expense.

Interest Income—Net Increase in Interest-Earning Assets (Volume Variance)

The $43.6 million increase in interest income for 2004, as compared to 2003, was primarily the result of a $37.6 million favorable volume variance. The favorable volume variance resulted from a $700.1 million, or 19.4% increase, in average interest-earning assets. We believe increases in our sources of funding, largely deposits, were the main contributors to the increase in average interest-earning assets. We believe deposits increased due to an improved venture capital funding environment and general improvements in business conditions for many of our clients. This increase in average interest-earning assets was primarily centered in investment securities, which increased $628.9 million, and loans, which increased $153.7 million.

Average investment securities increased by $628.9 million, resulting in a $26.3 million favorable volume variance. Throughout 2004, we continued our investment strategy of changing the investment portfolio mix by increasing the portion of the portfolio invested in relatively higher-yielding mortgage-

43




backed securities and collateralized mortgage obligations. Our average investments in mortgage-backed securities and collateralized mortgage obligations collectively increased by $564.8 million for 2004 as compared to 2003, largely funded by increases in client deposits. We estimated the duration of our investment portfolio increased to 2.1 years at December 31, 2004, from 1.7 years at December 31, 2003. The increase in duration was primarily due to the increase in mortgage-backed securities and collateralized mortgage obligations whose average duration is typically in the 2 to 5 year range.

In addition, average loans increased by $153.7 million, or 8.5% in 2004 as compared to 2003, resulting in a $12.4 million favorable volume variance. The volume variance is largely driven by growth in our commercial loan category, which increased by $106.8 million. In particular, the average balances of higher-yielding loan products such as asset-based loans and accounts receivable factoring increased by $39.4 million and $68.6 million, respectively. In addition, we also grew our average real estate and consumer loan portfolios. The increase in average loans reflects an improvement in economic activity and in the markets served by us. These new loans continue to be subject to our existing underwriting practices. Our strategy is to grow average loans modestly during 2005 as our corporate technology efforts continue to develop. Our loan yield in 2004 included $5.7 million from accretion of gross warrant loan fees as compared to $6.6 million in 2003.

Average federal funds sold, securities purchased under agreement to resell and other short-term investments for 2004 decreased by $82.4 million, or 11.9%, resulting in a $1.0 million unfavorable volume variance.

Interest Income—Shift in the Composition of Average Interest-Earning Assets (Rate Variance)

Favorable rate variances associated with each component of interest-earning assets caused a $6.0 million increase in interest income in 2004 as compared to 2003. Although the yields on federal funds sold, securities purchased under agreement to resell and other short-term investment securities increased and the yield on loans remained unchanged, the yield on total average interest-earning assets remained relatively unchanged. The overall yield remained unchanged due to a change in the mix of our total average interest-earning assets. In 2004, investment securities represented 40.7% of our total average interest-earning assets and loans represented 45.3% of our total average interest-earning assets. In 2003, investment securities represented 31.1% of our total average interest-earning assets, and loans represented 49.8% of our total average interest-earning assets. Thus, the increase in yields on federal funds sold, securities purchased under agreement to resell and other short-term investment securities in 2004 as compared to 2003 was offset by the change in overall composition of our interest-earning assets.

We increased our prime lending rate by 25 basis points on each of five occasions in the latter half of 2004, increasing it from 4.00% to 5.25%. As of December 31, 2004, approximately 81.3%, or $1.9 billion, of our outstanding loans were variable rate loans, which would re-price with any further increase or any decrease in our prime lending rate, unless restricted by the terms of any such loans.

The yield on investment securities increased by 12 basis points to 4.42% in 2004 from 4.30% for 2003, causing a $2.9 million favorable rate variance. This was primarily due to a shift in the composition of a portion of the investment portfolio to relatively higher-yielding mortgage-backed securities and collateralized mortgage obligations.

We also realized a $1.4 million favorable rate variance associated with our federal funds sold, securities purchased under agreement to resell and other short-term investments, which is largely driven by higher short-term market interest rates in 2004 as compared to 2003. We expect to continue the trend of managing federal funds sold, securities purchased under agreement to resell and other short-term investments at appropriate levels for our liquidity needs.

44




Interest Expense

Total interest expense for 2004 decreased by $2.1 million from 2003, despite a $167.4 million, or 10.1% increase in our interest-bearing liabilities. The decrease in interest expense was primarily the result of a $4.0 million favorable rate variance, partially offset by a $1.9 million unfavorable volume variance.

We experienced a favorable rate variance of $4.0 million primarily due to lower interest expense related to borrowing. In the fourth quarter of 2003, we recognized $1.3 million in unamortized issuance costs associated with the early redemption of the $40.0 million, 8.25% trust preferred securities.

Also, in the fourth quarter of 2003, we issued $51.5 million in 7.0% junior subordinated debentures and simultaneously entered into an interest rate swap agreement with a notional amount of $50.0 million. This interest rate swap agreement hedges against the risk of changes in fair value associated with our 7.0% junior subordinated debentures. The terms of this fair value hedge agreement provide for a swap of our 7.0% fixed rate payment for a variable rate based on LIBOR plus a spread. For 2004, we paid interest expense of $3.5 million on the 7.0% junior subordinated debentures. However, the fair value hedge agreement provided income of $2.2 million, resulting in net interest expense of $1.3 million for 2004.

There were significant fluctuations in several line items of the total interest expense volume variance, which largely offset each other. In particular, the implementation SFAS No. 150 and FIN 46 in mid-2003 required us to reclassify our trust preferred securities to the long-term debt category during 2003. Additionally, these accounting pronouncements also required us to classify the trust preferred securities distribution expense as interest expense, on a prospective basis. The trust preferred distribution expense had previously been classified as noninterest expense.

Increases in regular money market and bonus money market deposits contributed a $1.3 million unfavorable variance to the total interest expense volume variance. This unfavorable volume variance was largely offset by lower time deposits, which provided a $1.0 million favorable volume variance. Due to the general improvement in the venture capital funding environment, highly-liquid money market deposits increased by $247.1 million, while longer-term time deposits have decreased by $155.9 million. Our clients may use time deposits as collateral for letters of credit issued by Silicon Valley Bank on their behalf, to certain third parties such as real estate lessors. We believe time deposits have decreased partly because of a softer real estate market, which generally reduces the frequency of these types of arrangements. Moreover, due to the general improvement in the economic environment, borrowings secured by time deposits have decreased.

A shift of client funds from time deposits to more liquid money market deposits also contributed to the favorable rate variance.

The average cost of funds of 0.26% for 2004 represented a decrease from 0.37% in 2003. The decrease was largely attributable to a decrease in the cost of borrowings and to a relative increase in noninterest-bearing funding sources as a percentage of total funding sources.

Provision for Loan Losses

The provision for loan losses is based on our evaluation of the adequacy of the existing allowance for loan and lease 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 and lease losses, see Item 7. Critical Accounting Policies and Item 7. Financial Condition—Credit Quality and the Allowance for Loan and Lease Losses.

45




2005 Compared to 2004

We recorded a provision for loan and lease losses of $0.2 million for 2005, compared to a recovery of $10.3 million for 2004.

We incurred net charge offs of approximately $1.1 million for 2005 compared to net charge-offs of $2.0 million for 2004, respectively. Credit quality remained strong with nonperforming loans at 0.26% of total gross loans. See “Financial Condition - Credit Quality and the Allowance for Loan and Lease Losses” for additional related discussion.

2004 Compared to 2003—Continued Improved Credit Quality Prompts Further Recovery of Provision for Loan Losses

We realized a recovery of provision for loan losses of $10.3 million in 2004 compared to a recovery of provision for loan losses of $9.9 million in 2003. In 2003, our loan loss recoveries exceeded loan charge offs by $1.4 million. We incurred net charge-offs of approximately $2.0 million in 2004 and credit quality remained strong with nonperforming loans at 0.64% of gross loans. We believe the improvement in the recovery of loan losses was primarily attributable to our improved credit risk management and to improved economic conditions.

Noninterest Income

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

 

 

Years Ended December 31,

 

 

 

 

 

 

 

%Change

 

 

 

%Change

 

 

 

2005

 

2004

 

2005/2004

 

2003

 

2004/2003

 

 

 

(Dollars in thousands)

 

Client investment fees

 

$

33,255

 

$

26,919

 

 

23.5

%

 

$

23,991

 

 

12.2

%

 

Gains on derivative instruments, net

 

24,656

 

16,325

 

 

51.0

 

 

20,200

 

 

(19.2

)

 

Corporate finance fees

 

22,063

 

22,024

 

 

0.2

 

 

12,204

 

 

80.5

 

 

Letter of credit and standby letter of credit income

 

10,007

 

9,994

 

 

0.1

 

 

8,912

 

 

12.1

 

 

Deposit service charges

 

9,805

 

13,538

 

 

(27.6

)

 

13,202

 

 

2.5

 

 

Gains (losses) on investment securities, net

 

4,307

 

5,198

 

 

(17.1

)

 

(9,614

)

 

(154.1

)

 

Credit card fees

 

3,691

 

2,817

 

 

31.0

 

 

3,431

 

 

(17.9

)

 

Other

 

9,711

 

10,959

 

 

(11.4

)

 

9,067

 

 

20.9

%

 

Total noninterest income

 

$

117,495

 

$

107,774

 

 

9.0

%

 

$

81,393

 

 

32.4

%

 

 

 

 

At
December 31,
2005

 

At
December 31,
2004

 

At
December 31,
2003