SVB Financial Group
SVB FINANCIAL GROUP (Form: 10-Q, Received: 05/10/2006 16:51:09)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

 

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

 

 

 

For the quarterly period ended March 31, 2006

 

 

 

OR

 

 

 

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

 

For the transition period from           to            .

 

Commission File Number: 000-15637

 

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)

 

(408) 654-7400

Registrant’s telephone number, including area code:

 

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

 

Yes  ý    No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes  ý    No o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes  o    No ý

 

At April 28, 2006, 35,534,315 shares of the registrant’s common stock ($0.001 par value) were outstanding.

 

 



 

TABLE OF CONTENTS

 

 

 

Page

PART I - FINANCIAL INFORMATION

3

 

 

 

ITEM 1.

INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3

 

 

 

 

INTERIM CONSOLIDATED BALANCE SHEETS

3

 

 

 

 

INTERIM CONSOLIDATED STATEMENTS OF INCOME

4

 

 

 

 

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

5

 

 

 

 

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

6

 

 

 

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

7

 

 

 

ITEM 2.

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

25

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

44

 

 

 

ITEM 4.

CONTROLS AND PROCEDURES

45

 

 

 

PART II - OTHER INFORMATION

48

 

 

 

ITEM 1.

LEGAL PROCEEDINGS

48

 

 

 

ITEM 1A.

RISK FACTORS

48

 

 

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

54

 

 

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

55

 

 

 

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

55

 

 

 

ITEM 5.

OTHER INFORMATION

55

 

 

 

ITEM 6.

EXHIBITS

55

 

 

 

SIGNATURES

56

 

 

 

INDEX TO EXHIBITS

57

 

2



 

PART I - FINANCIAL INFORMATION

 

ITEM 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS

 

SVB FINANCIAL GROUP AND SUBSIDIARIES

INTERIM CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Dollars in thousands, except par value)

 

March 31, 
2006

 

December 31, 
2005

 

Assets

 

 

 

 

 

Cash and due from banks

 

$

293,022

 

$

286,446

 

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

 

256,973

 

175,652

 

Investment securities

 

1,944,335

 

2,037,270

 

Loans, net of unearned income

 

2,757,980

 

2,843,353

 

Allowance for loan losses

 

(35,982

)

(36,785

)

Loans, net

 

2,721,998

 

2,806,568

 

Premises and equipment, net of accumulated depreciation and amortization

 

26,922

 

25,099

 

Goodwill

 

35,638

 

35,638

 

Accrued interest receivable and other assets

 

167,380

 

175,042

 

Total assets

 

$

5,446,268

 

$

5,541,715

 

 

 

 

 

 

 

Liabilities, Minority Interest, and Stockholders’ Equity

 

 

 

 

 

Liabilities:

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing demand

 

$

2,998,220

 

$

2,934,278

 

Negotiable order of withdrawal (NOW)

 

38,071

 

39,573

 

Money market

 

795,216

 

961,052

 

Time

 

316,999

 

317,827

 

Total deposits

 

4,148,506

 

4,252,730

 

Federal funds purchased and securities sold under agreement to repurchase

 

289,604

 

279,464

 

Contingently convertible debt

 

147,810

 

147,604

 

Junior subordinated debentures

 

49,560

 

48,228

 

Other borrowings

 

2,574

 

11

 

Other liabilities

 

83,731

 

124,921

 

Total liabilities

 

4,721,785

 

4,852,958

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Minority interest in capital of consolidated affiliates

 

138,365

 

119,456

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.001 par value, 20,000,000 shares authorized; no shares issued and outstanding

 

 

 

Common stock, $0.001 par value, 150,000,000 shares authorized; 35,446,037 and 35,103,145 shares outstanding at March 31, 2006 and December 31, 2005, respectively

 

35

 

35

 

Additional paid-in capital

 

7,812

 

8,439

 

Retained earnings

 

609,764

 

587,713

 

Unearned compensation

 

 

(5,792

)

Accumulated other comprehensive loss

 

(31,493

)

(21,094

)

Total stockholders’ equity

 

586,118

 

569,301

 

Total liabilities, minority interest, and stockholders’ equity

 

$

5,446,268

 

$

5,541,715

 

 

See accompanying notes to interim unaudited consolidated financial statements.

 

3



 

SVB FINANCIAL GROUP AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

 

For the three months ended

 

(Dollars in thousands, except per share amounts)

 

March 31, 
2006

 

March 31, 
2005

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

Loans

 

$

66,148

 

$

47,456

 

Investment securities:

 

 

 

 

 

Taxable

 

20,394

 

20,745

 

Non-taxable

 

823

 

1,023

 

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

 

2,040

 

2,959

 

Total interest income

 

89,405

 

72,183

 

Interest expense:

 

 

 

 

 

Deposits

 

2,325

 

2,262

 

Other borrowings

 

3,201

 

795

 

Total interest expense

 

5,526

 

3,057

 

Net interest income

 

83,879

 

69,126

 

Recovery of loan losses

 

(2,474

)

(3,814

)

Net interest income after recovery of provision for loan losses

 

86,353

 

72,940

 

 

 

 

 

 

 

Noninterest income:

 

 

 

 

 

Client investment fees

 

9,637

 

7,396

 

Corporate finance fees

 

2,438

 

4,814

 

Letter of credit and standby letter of credit income

 

2,350

 

2,370

 

Deposit service charges

 

2,178

 

2,504

 

Gains on derivative instruments, net

 

2,227

 

4,026

 

(Losses) gains on investment securities, net

 

(61

)

1,202

 

Other

 

4,632

 

3,057

 

Total noninterest income

 

23,401

 

25,369

 

 

 

 

 

 

 

Noninterest expense:

 

 

 

 

 

Compensation and benefits (including share-based compensation expense of $5.9 million and $1.2 million, respectively)

 

44,521

 

40,268

 

Professional services

 

8,355

 

5,070

 

Net occupancy

 

4,205

 

4,658

 

Furniture and equipment

 

3,704

 

2,719

 

Business development and travel

 

2,754

 

2,090

 

Correspondent bank fees

 

1,130

 

1,221

 

Data processing services

 

1,128

 

1,013

 

Telephone

 

907

 

889

 

Reduction of unfunded credit commitments

 

(496

)

(185

)

Other

 

4,480

 

3,072

 

Total noninterest expense

 

70,688

 

60,815

 

 

 

 

 

 

 

Income before minority interest in income of consolidated affiliates, income tax expense and cumulative effect of change in accounting principle

 

39,066

 

37,494

 

Minority interest in net (income) loss of consolidated affiliates

 

(244

)

441

 

Income before income tax expense

 

38,822

 

37,935

 

Income tax expense

 

16,743

 

14,999

 

Net income before cumulative effect of change in accounting principle

 

22,079

 

22,936

 

Cumulative effect of change in accounting principle, net of tax

 

192

 

 

Net income

 

$

22,271

 

$

22,936

 

 

 

 

 

 

 

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

 

$

0.63

 

$

0.64

 

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

 

$

0.57

 

$

0.59

 

Earnings per common share — basic

 

$

0.63

 

$

0.64

 

Earnings per common share — diluted

 

$

0.58

 

$

0.59

 

 

See accompanying notes to interim unaudited consolidated financial statements.

 

4



 

SVB FINANCIAL GROUP AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

 

For the three months ended

 

(Dollars in thousands)

 

March 31, 
2006

 

March 31,
2005

 

 

 

 

 

 

 

Net income

 

$

22,271

 

$

22,936

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

Cumulative translation gains (losses):

 

 

 

 

 

Translation gains (losses), net of tax

 

38

 

 

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

 

 

 

 

 

Unrealized holding (losses) gains, net of tax

 

(10,536

)

(14,051

)

Reclassification adjustment for gains (losses) included in net income, net of tax

 

99

 

(203

)

Other comprehensive (loss) income, net of tax

 

(10,399

)

(14,254

)

Comprehensive income

 

$

11,872

 

$

8,682

 

 

See accompanying notes to interim unaudited consolidated financial statements.

 

5



 

SVB FINANCIAL GROUP AND SUBSIDIARIES

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

For the three months ended

 

(Dollars in thousands)

 

March 31, 
2006

 

March 31, 
2005

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

22,271

 

$

22,936

 

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

 

 

 

 

 

Recovery of provision for loan losses

 

(2,474

)

(3,814

)

Changes in fair values of derivatives, net

 

(359

)

462

 

Losses (gains) on investment securities, net

 

61

 

(1,202

)

Depreciation and amortization

 

1,872

 

2,136

 

Minority interest

 

244

 

(441

)

Tax benefits of share compensation and other

 

4,145

 

3,284

 

Share-based payment

 

5,938

 

1,245

 

Amortization of deferred warrant-related loan fees

 

1,507

 

(1,746

)

Deferred income tax expense

 

4,552

 

2,806

 

Changes in other assets and liabilities:

 

 

 

 

 

Decrease (increase) in accrued interest receivable

 

2,505

 

(1,117

)

Decrease in accounts receivable

 

1,325

 

396

 

(Increase) decrease in income tax receivable, net

 

(11,760

)

5,568

 

Decrease in accrued retention, incentive plans, other compensation benefits payable

 

(32,370

)

(25,169

)

Reduction of provision for unfunded credit commitments

 

(496

)

(185

)

Other, net

 

6,939

 

6,781

 

Net cash provided by operating activities

 

3,900

 

11,940

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of available-for-sale securities

 

(1,002

)

(172,537

)

Proceeds from sales of available-for-sale securities

 

644

 

1,829

 

Proceeds from maturities and pay-downs of available-for-sale securities

 

94,117

 

103,511

 

Purchases of nonmarketable securities (cost method accounting)

 

(5,976

)

(2,750

)

Proceeds from sales of nonmarketable securities (cost method accounting)

 

265

 

2,297

 

Proceeds from maturities and pay-downs of nonmarketable securities (cost method accounting)

 

1,443

 

1,210

 

Purchases of nonmarketable securities (investment fair value accounting)

 

(19,971

)

(11,705

)

Proceeds from sales of nonmarketable securities (investment fair value accounting)

 

3,580

 

927

 

Proceeds from maturities and pay-downs of nonmarketable securities (investment fair value accounting)

 

3,667

 

 

Net decrease (increase) in loans

 

85,256

 

(34,781

)

Proceeds from recoveries of charged-off loans

 

3,031

 

5,959

 

Purchases of premises and equipment

 

(3,694

)

(3,583

)

Net cash provided by (used for) investing activities

 

161,360

 

(109,623

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net decrease in deposits

 

(104,224

)

(63,239

)

Increase in other borrowings, net

 

12,703

 

2,095

 

Capital contributions from minority interest participants, net of distributions

 

18,665

 

14,866

 

Stock compensation related tax benefits

 

3,156

 

 

Proceeds from issuance of common stock

 

17,616

 

4,831

 

Repurchase of common stock

 

(25,279

)

(33,056

)

Net cash used for financing activities

 

(77,363

)

(74,503

)

Net increase (decrease) in cash and cash equivalents

 

87,897

 

(172,186

)

Cash and cash equivalents at beginning of year

 

462,098

 

627,218

 

Cash and cash equivalents at end of period

 

$

549,995

 

$

455,032

 

Supplemental disclosures:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest paid

 

$

5,261

 

$

3,035

 

Income taxes paid

 

$

16,636

 

$

3,673

 

 

See accompanying notes to interim unaudited consolidated financial statements.

 

6



 

SVB FINANCIAL GROUP AND SUBSIDIARIES

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.  Nature of Business

 

SVB Financial Group (formerly known as Silicon Valley Bancshares and individually referred to herein as “SVB Financial Group, the Parent”) and its subsidiaries (collectively referred to as the “Company” or “SVB Financial Group”) offer clients financial products and services through five strategic business groups:  Commercial Banking, SVB Capital,  SVB Alliant, SVB Global and Private Client Services. (see Note 10. Segment Reporting).

 

SVB Financial Group, the Parent is a bank holding company and a financial holding company whose principal subsidiary is Silicon Valley Bank (the “Bank”), a California-chartered bank, founded in 1983, and headquartered in Santa Clara, California. SVB Financial Group serves more than 11,000 clients across the country, through its 27 regional offices in the United States and three subsidiaries outside the United States. The Bank has 13 offices throughout California and operates regional offices across the country in Arizona, Colorado, Georgia, Illinois, Massachusetts, Minnesota, New York, North Carolina, Oregon, Pennsylvania, Texas, Virginia, and Washington. The three international offices are located in Bangalore, India; Shanghai, China; and London, England.

 

Through our Commercial Banking business group which includes Silicon Valley Bank and its subsidiaries, we serve clients in all stages of maturity ranging from emerging-growth companies to established, private and public companies in the technology, life science and premium wine industries. 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” and “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. In 2006, we began using “SVB Silicon Valley Bank” to refer to our Commercial Banking activities.

 

SVB Capital focuses on the business needs of our venture capital and private equity clients, establishing and maintaining relationships with those firms domestically and internationally. Through this segment, we provide banking services and financial solutions, including traditional deposit and checking accounts, loans, letters of credit, and cash management services. SVB Capital also makes investments in venture capital and other private equity firms and in companies in the niches we serve. The group manages four venture funds and oversees investments, including investments in several sponsored limited partnerships, such as Gold Hill Venture Lending Partners 03, LP, and its parallel funds, which primarily provide secured debt, typically to emerging-growth clients in their earliest stages; and the Partners for Growth funds, which are special situation debt funds that provide secured debt to, primarily, higher-risk, middle market clients in their later stages.

 

SVB Alliant, our investment banking subsidiary, provides 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 U.S. Securities and Exchange Commission (“SEC”) and a member of the National Association of Securities Dealers, Inc. (“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.

 

SVB Global (formerly referred to as our “Global Financial Services” group) , which we began referring to as “SVB Global” in 2006, includes our foreign subsidiaries which facilitate our clients’ global expansion into major technology centers around the world. The SVB Global group provides a variety of services, including consulting and business services, referrals, and knowledge sharing, as well as identifying business opportunities for SVB Financial Group.

 

Our Private Client Services and Other group is 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. The Private Client Services group helps 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.

 

2.  Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements contain all adjustments (of a normal and recurring nature) that are, in the opinion of management, necessary to fairly present our financial position results of operations

 

7



 

and cash flows in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Such interim financial statements have been prepared in accordance with the instructions to Form 10-Q pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of the results for any future periods. These interim consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2005 (“2005 Form 10-K”).

 

The consolidated balance sheet at December 31, 2005 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. The accompanying interim consolidated financial statements have been prepared on a consistent basis with the accounting policies described in Part II, Item 8. Consolidated Financial Statements and Supplementary Data -Note 2. Summary of Significant Accounting Policies presented in our Annual Report on Form 10-K for the year ended December 31, 2005.

 

The preparation of interim consolidated financial statements in conformity with GAAP in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Federal Funds Sold, Securities Purchased under Agreement to Resell and Other Short-Term Investments

 

Federal funds sold, securities purchased under agreement to resell and other short-term investment securities as reported in the interim consolidated balance sheets include interest-bearing deposits in other financial institutions of $26.3 million and $34.7 million at March 31, 2006 and December 31, 2005, respectively.

 

Share-Based Compensation
 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.123 (revised 2004), “Share-Based Payment” (“SFAS No. 123 (R)”), which requires the measurement and recognition of compensation expense based on estimated fair value for all share-based payment awards including stock options, employee stock purchases under employee stock purchase plans, non-vested share awards (restricted stock) and stock appreciation rights. SFAS No. 123 (R) supersedes our previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107, which provides the Staff’s views regarding implementation issues related to SFAS No. 123 (R).

 

We adopted the provisions of SFAS No. 123 (R) using the modified prospective transition method beginning January 1, 2006. See Note 4. Share-Based Compensation. In accordance with that transition method, we have not restated prior periods for the effect of compensation expense calculated under SFAS No. 123 (R). We have selected the Black-Scholes option-pricing model as the most appropriate method for determining the estimated fair value of all our awards.

 

Recent Accounting Pronouncements
 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”), which replaces APB No. 20 “Accounting Changes” and SFAS No. 3 “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 also changes the requirements for the accounting for and reporting of a change in accounting principle, and applies to all voluntary changes in accounting principles, as well as changes required by an accounting pronouncement in the unusual instance it does not include specific transition provisions. Specifically, SFAS No. 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine the period-specific effects or the cumulative effect of the change. SFAS No. 154 was effective for us beginning January 1, 2006. We do not expect the adoption of SFAS No. 154 to have a material impact on our results of operations or financial condition.

 

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140” (“SFAS 155”). Hybrid financial instruments are financial instruments that contain an embedded derivative within a single instrument. SFAS 155 permits entities an option to elect to record hybrid financial instruments at fair value as one financial instrument. Prior to this amendment, hybrid financial instruments were required to be separated into two instruments, a derivative and host, and generally only the derivative was recorded at fair value. SFAS 155 requires that beneficial interests in securitized assets be evaluated for derivatives, either freestanding or embedded. SFAS 155 is effective for all financial instruments acquired or issued after January 1, 2007. Additionally, SFAS 155 provides a one-time opportunity to apply the fair value election to hybrid financial instruments existing at the date of implementation at fair value as one financial instrument, with any difference between the carrying amount of the existing

 

8



 

hybrid financial instruments and the fair value of the single financial instrument being recorded as a cumulative effect adjustment to beginning retained earnings. We are currently assessing the impact of SFAS 155 on our consolidated financial position and results of operations.

 

3.  Earnings Per Share (EPS)

 

The following is a reconciliation of basic EPS to diluted EPS for the three months ended March 31, 2006 and March 31, 2005:

 

 

 

For the three months ended 
March 31,

 

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

 

Net 
Income

 

Weighted Average
Shares

 

Per Share
Amount

 

 

 

 

 

 

 

 

 

2006:

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

Income available to common stockholders

 

$

22,271

 

35,086

 

$

0.63

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Share-based compensation and convertible debt

 

 

3,361

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

Income available to common stockholders and assumed conversions

 

$

22,271

 

38,447

 

$

0.58

 

 

 

 

 

 

 

 

 

2005:

 

 

 

 

 

 

 

Basic EPS:

 

 

 

 

 

 

 

Income available to common stockholders

 

$

22,936

 

35,632

 

$

0.64

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Share-based compensation and convertible debt

 

 

3,134

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

Income available to common stockholders and assumed conversions

 

$

22,936

 

38,766

 

$

0.59

 

 

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 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 approximately 1.5 million shares and 1.0 million shares for the quarters ended March 31, 2006 and March 31, 2005, respectively. The assumed proceeds under the treasury stock method were calculated by subtracting the aggregate weighted average conversion price for the average market price of the shares related to the contingently convertible debt. 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 No. 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). However, the exposure draft of SFAS No. 128(R), 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 $0.04 per diluted common share, or 7.2 percent and by $0.05 per diluted common shares or 8.5 percent for the three months ended March 31, 2006 and 2005, respectively.

 

4.  Share-Based Compensation
 

Equity Incentive Plans

 

Our 1997 Equity Incentive Plan (the 1997 Plan), provides for the grant of incentive stock options to employees and nonstatutory stock options, stock appreciation rights, restricted stock purchase awards, stock bonuses, and restricted stock units (collectively Stock Awards) to employees, directors and non employees. The 1997 Plan provides a means by which selected employees, directors and non employees of the Company may be given an opportunity to purchase shares of our common stock

 

9



 

at a price not less than 100% of the fair market value of the common stock on the date the option is granted for incentive and nonstatutory stock or receive cash based on stock appreciation. Options may vest over various periods not in excess of five years from the date of grant and expire five to ten years from the date of grant.

 

The 1997 Plan provides for the granting of shares of our common stock to directors, employees, and non employees. Shares granted under this plan may be subject to certain vesting requirements and resale restrictions (“restricted stock”). For the quarters ended March 31, 2006 and 2005, we made restricted stock awards for 201 shares of restricted stock at a weighted-average fair value of 49.36 per share and 5,690 shares at a weighted-average fair value of 45.50 per share, respectively. We awarded 13,205 restricted stock units with an aggregate intrinsic value of $700,525 for the three month period ended March 31, 2006. At March 31, 2006, there were 250,862 shares of restricted stock outstanding, the vesting of these shares occurs on various dates through the years ending December 31, 2006, 2007, 2008 and 2009.

 

Employee Stock Purchase Plan

 

We maintain an employee stock purchase plan (ESPP) under which participating employees may annually contribute up to 10% of their gross compensation to purchase shares of our common stock at 85% of its fair market value at either the beginning or end of each six-month offering period, whichever price is less. All employees are eligible to participate in the ESPP. Eligible employees become Plan participants on the first day of hire. To be eligible, an employee must, among other requirements, be age 18 or above and complete at least one hour of service as an employee of us or any of our affiliates. Effective January 1, 2006, we began recognizing compensation expense in accordance with SFAS 123R. At March 31, 2006, a total of 986,613 shares of our common stock were reserved for future issuance under the ESPP. There were no shares issued under the ESPP during the three months ended March 31, 2006. The next purchase will be on June 30, 2006 at the end of the current six-month offering period

 

Pro forma Information for Periods Prior to the Adoption of SFAS No. 123(R)

 

Prior to the adoption of SFAS No. 123 (R), we provided the disclosures required under SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosures.” Previously reported amounts have not been restated.

 

If compensation cost related to our stock option awards to employees and directors and to the ESPP had been determined under the fair value method prescribed under SFAS No. 123, our net income, basic earnings per share, and diluted earnings per share would have been the pro forma amounts shown below for the three months ended March 31, 2005:

 

 

 

For the three
months ended

 

 

 

March 31,

 

(Dollars in thousands, except per share amounts)

 

2005

 

 

 

 

 

Net income, as reported

 

$

22,936

 

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

 

662

 

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

 

(5,318

)

Net income, pro forma

 

$

18,280

 

 

 

 

 

Earnings per common share – basic:

 

 

 

As reported

 

$

 0.64

 

Pro forma

 

0.51

 

Earnings per diluted share – diluted:

 

 

 

As reported

 

$

 0.59

 

Pro forma

 

0.48

 

 

10



 

Impact of the Adoption of SFAS No. 123 (R)

 

We adopted SFAS No. 123 (R) and related interpretations using the modified prospective transition method beginning January 1, 2006. Accordingly, during the three-month period ended March 31, 2006, we recorded share-based compensation expense for awards granted prior to but not yet vested as of January 1, 2006 as if the fair value method required for pro forma disclosure under SFAS No. 123 were in effect for expense recognition purposes adjusted for estimated forfeitures. For restricted stock grants, we continued to recognize compensation expense using the accelerated amortization method under FIN 28. For share-based awards granted after January 1, 2006 we have recognized compensation expense based on the estimated grant date fair value method required under SFAS No. 123 (R). For these awards we have recognized compensation expense using a straight-line amortization method. As SFAS No. 123 (R) requires that share-based compensation expense be based on awards that are ultimately expected to vest, estimated share-based compensation for the three-month period ended March 31, 2006 has been reduced for estimated forfeitures. Upon adoption, we recorded a cumulative effect of change in accounting principle net of tax to reflect the application of an assumed forfeiture rate to all restricted share awards which continued to vest subsequent to the implementation date. The impact on our results of continuing operations of recording share-based compensation for the three-month period ended March 31, 2006 was as follows:

 

Share-based Payment Expense

 

 

 

For the three
months ended

 

 

 

March 31,

 

(Dollars in thousands, except per share amounts)

 

2006

 

 

 

 

 

Total share-based compensation expense

 

$

5,938

 

Income tax benefit

 

1,275

 

Total share-based compensation expense, net of tax

 

$

4,663

 

 

 

 

 

Impact on earnings per common share:

 

 

 

Basic

 

$

0.13

 

Diluted

 

0.12

 

 

Unrecognized Compensation Expense

 

 

 

March 31, 2006

 

(Dollars in thousands)

 

Unrecognized
Expense

 

Average Expected
Recognition Period –
in Years

 

 

 

 

 

 

 

Stock option awards

 

$

21,025

 

1.11

 

Restricted stock awards

 

5,188

 

1.06

 

Employee stock purchase plan

 

350

 

0.25

 

Total unrecognized share-based compensation expense

 

$

26,563

 

 

 

 

11



 

Valuation Assumptions

 

As of March 31, 2006 and 2005, the fair value of share-based awards for employee stock option awards, restricted stock and employee stock purchases made under our ESPP was estimated using the Black-Scholes option pricing model. The following weighted average assumptions were used:

 

 

 

For the three months ended March 31,

 

 

 

2006

 

2005

 

Equity Incentive Plan Awards

 

 

 

 

 

Expected term of options in years

 

5.2

 

5.1

 

Expected volatility of the Company’s underlying common stock

 

30.4

%

39.5

%

Risk-free interest rate

 

4.48

%

3.89

%

Expected dividend yield

 

%

%

Weighted average fair values-stock options

 

$

18.28

 

$

18.19

 

Weighted average fair value-stock awards

 

$

49.36

 

$

45.50

 

 

 

 

 

 

 

ESPP

 

 

 

 

 

Expected term of options in years

 

0.5

 

0.5

 

Expected volatility of the Company’s underlying common stock

 

22.5

%

24.8

%

Risk-free interest rate

 

4.40

%

2.63

%

Expected dividend yield

 

%

%

Weighted average fair value

 

$

10.23

 

$

10.01

 

 

The expected term was based on the implied term of the stock options using a lattice option-pricing model with early exercise factors based on historic employee exercise behavior. The expected volatilities for the Equity Incentive Plan for the three months ended March 31, 2006 and 2005 were calculated using a blended rate consisting of equal measures of our historic volatility and our expected volatility over a five-year term. The expected volatilities for the ESPP for the three months ended March 31, 2006 and 2005 are equal to the historical volatility for the previous six month periods. The expected risk-free interest rates for all periods were based on the yields of Treasury Securities, as reported by the Federal Reserve Bank of New York, with maturities equal to the expected terms of the employee stock options.

 

Share-Based Payment Award Activity

 

The table below provides stock option information related to the 1989 Stock Option Plan and the 1997 Plan for the three-month periods ended March 31, 2006 and 2005:

 

 

 

March 31, 2006

 

 

 

Shares

 

Weighted-
Average
Exercise
Price

 

Outstanding at beginning of period

 

6,024,455

 

$

28.84

 

Granted

 

39,550

 

50.79

 

Exercised

 

(792,938

)

23.09

 

Forfeited

 

(120,436

)

34.05

 

Outstanding at March 31

 

5,150,631

 

29.81

 

Exercisable at March 31

 

3,007,828

 

$

26.12

 

 

12



 

Intrinsic Value

 

Shares

 

Weighted-
Average
Exercise
Price

 

Remaining
Contractual Life
in Years

 

Aggregate Intrinsic Value
of In-The-Money Options
($)

 

Outstanding at March 31, 2006

 

5,150,631

 

$

29.81

 

4.61

 

$

119,722,700

 

Exercisable at March 31, 2006

 

3,007,828

 

$

26.12

 

4.50

 

$

81,009,938

 

 

The aggregate intrinsic value of outstanding options shown in the table above represents the pretax intrinsic value as of March 31, 2006. This value is based on the Company’s closing stock price of $53.05 as of March 31, 2006. The total intrinsic value of options exercised during the three months ended March 31, 2006 and March 31, 2005, was $21.5 million and $4.7 million, respectively. Cash received from stock option exercises was $17.6 million and $4.8 million during the three months ended March 31, 2006 and 2005, respectively. The tax benefit of stock options exercised was $6.8 million and $2.5 million for the three months ended March 31, 2006 and 2005, respectively.

 

The following table summarizes information regarding stock options outstanding as of March 31, 2006:

 

 

 

Outstanding Options

 

Vested Options

 

Ranges of Exercise Prices

 

Shares

 

Weighted-
Average
Remaining
Contractual
Life in Years

 

Weighted-
Average
Exercise
Price

 

Shares

 

Weighted-
Average
Exercise
Price

 

$8.25

-

$17.07

 

 

702,323

 

4.10

 

$

13.62

 

604,224

 

$

13.12

 

17.20

-

23.69

 

 

567,635

 

5.24

 

22.35

 

477,298

 

22.57

 

23.90

-

25.17

 

 

561,269

 

2.58

 

25.06

 

270,960

 

25.00

 

25.29

-

26.40

 

 

554,086

 

5.31

 

26.06

 

550,212

 

26.06

 

26.66

-

31.29

 

 

570,841

 

5.68

 

30.91

 

417,508

 

30.97

 

31.40

-

35.04

 

 

114,518

 

4.51

 

33.32

 

94,819

 

33.20

 

35.26

-

35.26

 

 

528,512

 

2.59

 

35.26

 

246,380

 

35.26

 

35.54

-

36.30

 

 

519,991

 

4.99

 

35.57

 

130,505

 

35.61

 

36.34

-

42.19

 

 

519,104

 

5.36

 

39.68

 

136,872

 

39.62

 

43.26

-

51.69

 

 

512,352

 

5.87

 

46.00

 

79,050

 

49.45

 

$8.25

-

$51.69

 

 

5,150,631

 

4.61

 

$

29.81

 

3,007,828

 

$

26.12

 

 

The Company expects to satisfy the exercise of stock options and future grants of restricted stock by issuing new shares registered under the Plan. At March 31, 2006, options for 1,553,149 shares were available for future grant under the 1997 Plan.

 

The table below provides restricted stock award information related to the 1989 Stock Option Plan and the 1997 Plan for the three-month periods ended March 31, 2006 and 2005:

 

 

 

March 31, 2006

 

March 31, 2005

 

 

 

Shares

 

Weighted-
 Average 
Fair Value

 

Shares

 

Weighted-
 Average 
Fair Value

 

Outstanding at beginning of period

 

253,848

 

$

42.12

 

251,113

 

$

29.56

 

Granted

 

201

 

49.36

 

5,690

 

45.50

 

Vested

 

(201

)

49.36

 

(92,382

)

17.39

 

Forfeited

 

(2,986

)

44.36

 

(643

)

17.09

 

Outstanding at March 31

 

250,862

 

$

42.10

 

163,778

 

$

37.03

 

 

The total fair value of restricted stock grants that vested during the three months ended March 31, 2006 and March 31, 2005 was $9.9 thousand and $1.6 million respectively.

 

13



 

5.  Investment Securities

 

The detailed composition of our investment securities is presented as follows:

 

(Dollars in thousands)

 

March 31, 
2006

 

December 31, 
2005

 

 

 

 

 

 

 

Available-for-sale securities, at fair value

 

$

1,740,288

 

$

1,850,655

 

Non-marketable securities (investment company fair value accounting):

 

 

 

 

 

Venture capital fund investments(1)

 

90,205

 

81,280

 

Other private equity investments(2)

 

27,505

 

26,782

 

Other investments(3)

 

28,301

 

25,300

 

Non-marketable securities (equity method accounting):

 

 

 

 

 

Other investments (4)

 

13,082

 

10,985

 

Low income housing tax credit funds

 

13,913

 

11,682

 

Non-marketable securities (cost method accounting):

 

 

 

 

 

Fund investments

 

27,514

 

26,924

 

Other private equity investments

 

3,527

 

3,662

 

Total investment securities

 

$

1,944,335

 

$

2,037,270

 

 


(1)

Includes $60.3 million and $58.7 million related to SVB Strategic Investors Fund, LP at March 31, 2006 and December 31, 2005, respectively. We have a controlling ownership interest of 12.6% in the fund. Also includes $28.8 million and $22.1 million related to SVB Strategic Investors Fund II, LP, at March 31, 2006 and December 31, 2005, respectively. We have a controlling interest of 8.6% in the fund. Additionally, it includes $1.1 million and $0.5 million related to SVB Strategic Investors Fund III, LP at March 31, 2006 and December 31, 2005, respectively. We have a controlling interest of 11.6% in the fund.

 

 

(2)

Includes $27.5 million and $26.8 million related to Silicon Valley BancVentures, LP at March 31, 2006 and December 31, 2005, respectively. We have a controlling ownership interest of 10.7% in the fund.

 

 

(3)

Includes $28.3 million and $25.3 million related to Partners for Growth, LP at March 31, 2006 and December 31, 2005, respectively. We have a majority ownership interest of 50.0% in the fund.

 

 

(4)

Includes $6.3 million and $5.6 million related to Gold Hill Venture Lending Partners 03, LLC, the general partners of Gold Hill Venture Lending 03, LP, as of March 31, 2006 and December 31, 2005, respectively. We have a majority interest of 90.7% in Gold Hill Venture Lending Partners 03, LLC. Gold Hill Venture Lending Partners 03, LLC has an ownership interest of 5.0% in the fund. It also includes $6.1 million and $5.4 million related to Gold Hill Venture Lending Partners 03, LP, as of March 31, 2006 and December 31, 2005, respectively. We have a direct ownership interest of 4.8% in the fund. Additionally, it includes $0.7 million to Partners for Growth II, LP as of March 31, 2006. We have an ownership interest of 24.2% in the fund.

 

14



 

The following table breaks out our unrealized losses on our available-for-sale investment securities portfolio into categories of less than 12 months or 12 months or longer as of March 31, 2006:

 

 

 

March 31, 2006

 

 

 

Less than twelve months

 

Twelve months or longer

 

Total

 

 

 

Fair Value
of
Investments

 

Unrealized
Losses
Investments

 

Fair Value of
Investments (1)

 

Unrealized
Losses(1)

 

Fair Value
of
Investments

 

Unrealized
Losses

 

 

 

(Dollars in thousands)

 

U.S. Treasury securities

 

$

9,850

 

$

(118

)

$

19,894

 

$

(105

)

$

29,744

 

$

(223

)

U.S. agencies and corporations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Collateralized mortgage obligations

 

394,818

 

(8,717

)

374,526

 

(15,155

)

769,344

 

(23,872

)

Mortgage-backed securities

 

296,873

 

(10,028

)

160,976

 

(8,185

)

457,849

 

(18,213

)

Discount notes and bonds

 

48,564

 

(1,401

)

189,047

 

(5,991

)

237,611

 

(7,392

)

Asset-backed securities

 

 

 

87,654

 

(1,511

)

87,654

 

(1,511

)

Commercial mortgage-backed securities

 

68,395

 

(2,779

)

 

 

68,395

 

(2,779

)

Total temporarily impaired securities

 

$

818,500

 

$

(23,043

)

$

832,097

 

$

(30,947

)

$

1,650,597

 

$

(53,990

)

 


(1)            As of March 31, 2006, we identified investments totaling $832.1 million with unrealized losses of $30.9 million whose fair value has been less than their adjusted cost for a period of time greater than twelve months. We had two U.S. Treasury securities totaling $19.9 million with unrealized losses of $0.1 million which were purchased in October 2003 and February 2005. We had 43 securities classified as collateralized mortgage obligations totaling $374.5 million with unrealized losses of $15.2 million which were originally purchased between July 1998 and February 2005 We had 16 securities classified as mortgage-backed securities totaling $161.0 million with unrealized losses of $8.2 million which were originally purchased between July 2001 and April 2004. We had 15 securities classified as discount notes and bonds totaled $189.0 million with unrealized losses of $6.0 million which were originally purchased between February 2003 and February 2005. We had 15 securities classified as asset-backed securities totaled $87.7 million with unrealized losses of $1.5 million which were originally purchased between October 2002 and February 2005. All investments with unrealized losses for a period of time greater than twelve months are either rated AAA by Moody’s and/or S&P or are issued by the US Treasury government or a government-sponsored enterprise. Because these securities are of superior credit quality, the unrealized losses are due solely to increases in market interest rates and we expect to recover the impairment prior to or at maturity, thus the Company deems these impairments to be temporary. We have the intent and ability to hold the securities until the market value recovers. Market valuations and impairment analysis on assets in the investment portfolio are reviewed and monitored on an ongoing basis.

 

15



 

The following table presents the components of gains and losses on investment securities, for the three months ended March 31, 2006 and March 31, 2005.

 

 

 

For the three months ended

 

(Dollars in thousands)

 

March 31,
2006

 

March 31, 
2005

 

 

 

 

 

 

 

Gross gains on investment securities:

 

 

 

 

 

Available-for-sale securities, at fair value

 

$

170

 

$

50

 

Non-marketable securities (investment company fair value accounting):

 

 

 

 

 

Venture capital fund investments

 

2,567

 

1,595

 

Other private equity investments

 

2

 

405

 

Other investments

 

3

 

 

Non-marketable securities (equity method accounting)

 

207

 

 

Non-marketable securities (cost method accounting):

 

 

 

 

 

Venture capital fund investments

 

76

 

2,051

 

Total gross gains on investment securities

 

3,025

 

4,101

 

 

 

 

 

 

 

Gross losses on investment securities:

 

 

 

 

 

Available-for-sale securities, at fair value

 

 

(397

)

Non-marketable securities (investment company fair value accounting):

 

 

 

 

 

Venture capital fund investments

 

(2,196

)

(1,205

)

Non-marketable securities (equity method accounting)

 

(552

)

(51

)

Non-marketable securities (cost method accounting):

 

 

 

 

 

Venture capital fund investments

 

(293

)

(846

)

Other private equity investments

 

(45

)

(400

)

Total gross losses on investment securities

 

(3,086

)

(2,899

)

Gains (losses) on investment securities, net

 

$

(61

)

$

1,202

 

 

6.   Loans and Allowance for Loan Losses

 

The detailed composition of loans, net of unearned income of $19.3 million and $20.6 million for the periods ended March 31, 2006 and December 31, 2005, respectively, is presented in the following table:

 

(Dollars in thousands)

 

March 31, 
2006

 

December 31, 
2005

 

 

 

 

 

 

 

Commercial loans

 

$

2,345,592

 

$

2,410,893

 

 

 

 

 

 

 

Vineyard development

 

102,418

 

104,881

 

Commercial real estate

 

18,723

 

20,657

 

Total real estate construction

 

121,141

 

125,538

 

 

 

 

 

 

 

Real estate term — consumer

 

42,724

 

39,906

 

Real estate term — commercial

 

7,827

 

10,694

 

Total real estate term

 

50,551

 

50,600

 

 

 

 

 

 

 

Consumer and other

 

240,696

 

256,322

 

Total loans, net of unearned income

 

$

2,757,980

 

$

2,843,353

 

 

The activity in the allowance for loan losses for the three months ended March 31, 2006 and March 31, 2005 was as follows:

 

16



 

 

Three months ended March 31,

 

(Dollars in thousands)

 

2006

 

2005

 

 

 

 

 

 

 

Beginning balance

 

$

36,785

 

$

37,613

 

Recovery of provision for loan losses

 

(2,474

)

(3,814

)

Loans charged off

 

(1,361

)

(4,060

)

Recoveries

 

3,032

 

5,959

 

Ending balance

 

$

35,982

 

$

35,698

 

 

The aggregate recorded investment in loans for which impairment has been determined in accordance with SFAS No. 114 totaled $3.9 million and $13.4 million at March 31, 2006 and March 31, 2005, respectively. Allocations of the allowance for loan losses specific to impaired loans totaled $0.3 million at March 31, 2006, and $3.8 million at March 31, 2005. Average impaired loans for the first quarter of 2006 and 2005 totaled $5.6 million and $13.8 million, respectively.

 

7.  Borrowings

 

The following table represents the outstanding borrowings at March 31, 2006 and December 31, 2005:

 

(Dollars in thousands)

 

Maturity

 

March 31,
2006

 

December 31,
2005

 

Other borrowings

 

Overdraft

 

$

79

 

$

11

 

Revolving line of credit – structured lending fund

 

Due on Demand

 

2,495

 

 

Total other borrowings

 

 

 

$

2,574

 

$

11

 

 

 

 

 

 

 

 

 

Federal funds purchased and securities sold under agreement to repurchase

 

Less than One Month

 

$

289,604

 

$

279,464

 

Contingently convertible debt

 

June 15, 2008

 

147,810

 

147,604

 

Junior subordinated debentures

 

October 15, 2033

 

49,560

 

48,228

 

 

Interest expense related to other borrowings was $6,000 and $75,000 for the three months ended March 31, 2006 and 2005, respectively. The weighted average interest rates associated with the our borrowings outstanding for the three months ended March 31, 2006 and the year ended December 31, 2005 was 3.33% and 2.27%, respectively.

 

Contingently Convertible Debt

 

The fair value of the convertible debt at March 31, 2006 was $238.4 million, based on quoted market prices. We intend to settle the principal amount of $150.0 million (accreted value) in cash. Based on the terms of the notes, if, at any time before June 15, 2007, the per share stock price on the last trading day of the immediately preceding fiscal quarter was 110% or more of the then current conversion price, the notes would become convertible. The per share closing price of $53.05 of our common stock on March 31, 2006, the last trading day of first quarter of 2006, was 57.8% or more than the then current conversion price of $33.6277. Accordingly, during the first quarter of 2006, our note holders held the right, at their option, to convert their notes, in whole or in part, subject to certain limitations, at the conversion price of $33.6277. We received conversion notice relating to the notes in an aggregate principal amount of $39,000 during the first quarter of 2006 and $103,000 cumulatively.

 

Concurrent with the issuance of the convertible notes, we entered into a convertible note hedge at a cost of $39.3 million and a warrant transaction providing proceeds of $17.4 million with respect to our common stock, with the objective of decreasing our exposure to potential dilution from conversion of the notes (see Note 8. Derivative Financial Instruments - Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock).

 

Available Lines of Credit
 

As of March 31, 2006, we have available $491.0 million in federal funds and lines of credit, $391.0 of which were unused. In addition to the available federal funds lines we have reverse repurchase agreement lines available with multiple securities dealers. Reverse repurchase lines allow us to finance short term borrowings using various fixed income securities as collateral. At March 31, 2006, we borrowed $189.6 million against our reverse repurchase lines.

 

8.  Derivative Financial Instruments

 

We designate a derivative as held for hedging purposes or non-hedging when we enter into a derivative contract. The designation may change based upon management’s reassessment or changing circumstances. Derivative instruments that we obtain or use include interest rate swaps, forward contracts, options and warrants. A swap agreement is a contract between two

 

17



 

parties to exchange cash flows based on specified underlying notional amounts, assets and/or indices. Forward settlement contracts are agreements to buy or sell a quantity of a financial instrument, index, currency or commodity at a predetermined future date, and rate or price. An option or warrant contract is an agreement that conveys to the purchaser the right, but not the obligation, to buy or sell a quantity of a financial instrument (including another derivative financial instrument), index, currency or commodity at a predetermined rate or price during a period or at a time in the future. Option or warrant agreements can be transacted on organized exchanges or directly between parties. The gross positive fair values of derivative assets are recorded as a component of the other assets line item on the balance sheets. The gross negative fair values of derivative liabilities are recorded as a component of the other liabilities line item on the balance sheets.

 

The total notional or contractual amounts, credit risk amount and estimated net fair value for derivatives as of March 31, 2006 and December 31, 2005 were as follows:

 

18



 

 

 

At March 31, 2006

 

 

 

Notional or
contractual
amount

 

Credit risk
Amount (1)

 

Estimated net
fair value

 

 

 

 

 

 

 

Asset (liability)

 

 

 

(Dollars in thousands)

 

Derivatives

 

 

 

 

 

 

 

Interest rate swap

 

$

50,000

 

$

 

$

(2,871

)

Foreign exchange spot and forwards

 

462,212

 

2,747

 

(124

)

Foreign currency options

 

7,284

 

55

 

 

Equity warrant assets

 

105,650

 

28,343

 

28,343

 

Equity conversion option

 

1,000

 

451

 

451

 

 

 

 

At December 31, 2005

 

 

 

(Dollars in thousands)

 

Fair Value Hedge

 

 

 

 

 

 

 

Interest rate swap

 

$

50,000

 

$

 

$

(1,314

)

 

 

 

 

 

 

 

 

Derivatives

 

 

 

 

 

 

 

Foreign exchange spot and forwards

 

432,733

 

5,701

 

766

 

Foreign currency options

 

18,772

 

101

 

 

Equity warrant assets

 

108,574

 

27,802

 

27,802

 

Equity conversion option

 

1,000

 

451

 

451

 

 


(1)            Credit risk amounts reflect the replacement cost for those contracts in a gain position in the event of nonperformance by all such counterparties.

 

Fair Value Hedges

 

Derivative instruments that we hold as part of our interest rate risk management may include interest rate swaps, caps and floors, and forward contracts. On October 30, 2003, we entered into an interest rate swap agreement with a notional amount of $50.0 million. This agreement economically hedges against the risk of changes in fair values associated with the majority of our 7.0% fixed rate, junior subordinated debentures. For information on our junior subordinated debentures, see Note 7. Borrowings.

 

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 London Inter-Bank Offer Rate (LIBOR) plus a spread. This derivative agreement provided a benefit of $0.2 million and $0.4 million in the three months ended March 31, 2006 and 2005, respectively. The swap agreement largely mirrors the terms of the junior subordinated debentures and therefore is callable by the counterparty anytime on or after October 30, 2008. Changes in the fair value of the swap are recognized in net income as a gain or loss on derivative instruments. Changes in the fair value of the derivative agreement are primarily dependent on changes in market interest rates in relation to this interest swap agreement. We recorded a negative change in fair value of $2.9 million for the quarter ended March 31, 2006.

 

Derivatives

 

We enter into various derivative contracts primarily to provide derivative products or services to customers. These derivatives are not linked to specific assets and liabilities on the balance sheet or to forecasted transactions in an accounting hedge relationship and, therefore, do not qualify for hedge accounting. All of these contracts are carried at fair value with changes in fair value recorded on the line item gains (losses) on derivatives, net as part of our noninterest income, a component of consolidated net income.

 

We enter into foreign exchange forward contracts and non-deliverable foreign exchange forward contracts with clients involved in international trade finance activities, either as the purchaser or seller of foreign currency at a future date, depending upon the clients’ need. For each of the foreign exchange forward contracts and non-deliverable foreign exchange forward contracts entered into with our clients, we enter into an opposite way foreign exchange forward contract and non-deliverable foreign exchange forward contract with a correspondent bank, which mitigates the risk of fluctuations in foreign currency exchange rates. These contracts are short-term in nature, typically expiring within one year. We have not experienced

 

19



 

nonperformance by counterparties and therefore have not incurred related losses. Further, we anticipate performance by all counterparties to such agreements.

 

We enter into foreign exchange forward contracts with correspondent banks to economically hedge foreign exchange exposure risk related to certain foreign currency denominated loans. These contracts are short term in nature, typically expiring within one year. We have not experienced nonperformance by counterparties and therefore have not incurred related losses. Further, we anticipate performance by all counterparties to such foreign exchange forward contracts.

 

We enter into foreign currency option contracts with clients involved in international trade finance activities, either as the purchaser or seller of foreign currency options, depending upon the client’s need. For each of the currency option contracts entered into with our clients, we enter into an opposite way foreign currency option contract with a correspondent bank, which mitigates the risk of fluctuations in foreign currency exchange rates. These contracts typically expire in less than one year. We have not experienced nonperformance by counterparties and therefore have not incurred related losses. Further, we anticipate performance by all counterparties.

 

We obtain derivative equity warrant assets to purchase an equity position in a client company’s stock in consideration for providing credit facilities and less frequently for providing other services. The purpose of obtaining warrants from client companies is intended to increase future revenue. The change in fair value of equity warrant assets is recorded in noninterest income, a component of consolidated net income. The change in fair value of the warrants resulted in a net gain (loss) of $0.3 million and ($0.8) million for the three months ended March 31, 2006 and 2005, respectively.

 

Derivative Fair Value Instruments Indexed to and Potentially Settled in a Company’s Own Stock

 

On May 20, 2003, we issued $150.0 million of zero-coupon, convertible subordinated notes at face value, due June 15, 2008, (See Note 7. Borrowings). These notes include a conversion feature which is indexed to and could potentially be settled in our stock. The conversion option is an embedded derivative, which, pursuant to paragraphs 11(a) and 12(c) of SFAS No. 133, qualifies as an embedded derivative indexed to our stock. If it was a freestanding derivative, it would be classified in stockholders’ equity. Thus, the embedded derivative is not considered a derivative for purposes of SFAS No. 133 and is not recorded on our financial statements at fair value.

 

Concurrent with the issuance of the $150 million principal amount of contingently convertible notes, (See Note 7 Borrowings), we entered into a convertible note hedge (purchased call option) at a cost of $39.3 million and a warrant transaction providing proceeds of $17.4 million with respect to our common stock, with the objective of decreasing our exposure to potential dilution from conversion of the contingently convertible notes.

 

At issuance under the terms of the convertible note hedge, upon the occurrence of conversion events, we had the right to purchase up to approximately 4,460,610 shares of our common stock from the counterparty at a price of $33.6277 per common share. The convertible note hedge agreement will expire on June 15, 2008. We have the option to settle any amounts due under the convertible hedge either in cash or net shares of our common stock. The cost of the convertible note hedge is included in stockholders’ equity in accordance with the guidance in EITF 00-19.

 

At issuance under the warrant agreement, the counterparty could purchase up to approximately 4,460,608 shares of our common stock at $51.34 per share, upon the occurrence of conversion events defined above. The warrant transaction will expire on June 15, 2008. The proceeds of the warrant transaction were included in stockholders’ equity in accordance with the guidance in EITF 00-19. Due to conversion events in 2005 and 2006, the counterparty’s right to purchase our stock under warrant has been decreased by 3,063 shares. Also see Note 3. Earnings Per Share.

 

9. Common Stock Repurchase

 

We currently have in place a program authorizing our repurchase of up to $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 (announced on January 27, 2005 and to be repurchased before June 30, 2006) and $70.0 million (announced on January 26, 2006 and to be repurchased before June 30, 2007). Unless earlier terminated by the Board, the program will expire on June 30, 2007. The Company’s trading window closed at the close of business on March 3, 2006. To continue the repurchase program, the Company put into effect a 10b5-1 plan which allowed the Company to automatically repurchase a predetermined number shares per day at the market price on every trading day until the trading window re-opened on May 2, 2006. As of March 31, 2006, we had repurchased 7.0 million shares totaling $229.3 million. During the three months ended March 31, 2006, we repurchased 510,000 shares of our common stock. At March 31, 2006, the approximate dollar value of shares that may still be repurchased under this program was $75.7 million.

 

20



 

10.  Segment Reporting

 

In accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” we report segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing financial performance as our reportable segments. Please refer to the discussion of our segment organization in our 2005 Annual Report on Form 10-K, “Part I. Item 1. Business – Business Overview.”

 

We are organized into five lines of banking and financial services for management reporting:  Commercial Banking, SVB Capital, SVB Alliant, SVB Global (formerly referred to as “Global Financial Services”),  and Private Client Services and Other Business Services. These operating segments are strategic units that offer different services to different clients. The segments are managed separately because they appeal to different markets and, accordingly, require different strategies. The results of operating segments are based on our internal profitability reporting process. This process assigns each client relationship in its entirety, to a primary operating segment. The process assigns income and expenses to the operating segments according to the customer’s primary relationship designation. Additionally, working capital and its associated costs are allocated to the operating segments on an economic basis, treating each operating segment as if it were an independent entity. Unlike financial reporting, which benefits from the comprehensive structure provided by GAAP, the internal profitability reporting process is highly subjective, as there is no comprehensive, authoritative guidance for management reporting. The management reporting process measures the performance of operating segments based on our internal operating structure and is not necessarily comparable with similar information for other financial services companies. Changes in the management structure or the allocation process have resulted, and may in the future result in changes in our allocation methodology as this process is under constant refinement. In the event of such changes, results for prior periods have been, and may be, restated for comparability. Changes in an individual client’s primary relationship designation have resulted, and may in the future result in the inclusion of certain clients in different segments in different periods.

 

As of March 31, 2006, based on the quantitative threshold for determining reportable segments as required by SFAS No. 131, our reportable segments are Commercial Banking and SVB Capital. SVB Alliant, Private Client Services and SVB Global do not meet the separate reporting thresholds as defined by SFAS No. 131 and as such, have been aggregated in a column labeled Other Business Services for segment reporting purposes. For further information, please see our 2005 Form 10-K under “Part II. Item 8. Consolidated Financial Statements and Supplementary Data - Note 25. Segment Reporting.”

 

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

 

SVB Capital focuses on the business needs of our venture capital and private equity clients while establishing and maintaining relationships with those firms domestically and internationally. Through this segment, we provide banking services and financial solutions, including traditional deposit and checking accounts, loans, letters of credit, and cash management services. SVB Capital also makes investments in venture capital and other private equity firms and in companies in the niches we serve. The group manages four venture funds and oversees hundreds of investments, including investments in several sponsored limited partnerships, such as Gold Hill Venture Lending Partners 03, LP, and its parallel funds, which primarily provide secured debt, typically to emerging-growth clients in their earliest stages; and the Partners for Growth funds, which are special situation debt funds that provide secured debt to, primarily, higher-risk, middle market clients in their later stages.

 

The Other Business Services segment is principally comprised of Private Client Services, SVB Alliant, and SVB Global and other business service units that are not part of the Commercial Banking or SVB Capital segments. The Private Client Services group provides a wide range of credit services to high-net-worth individuals using both long-term secured and short-term unsecured lines of credit. Those products and services include home equity lines of credit, secured lines of credit, restricted stock purchase loans, airplane loans, and capital call lines of credit. SVB Alliant provides investment banking products and services including, merger and acquisition services, strategic alliances services, and specialized financial studies such as valuations and fairness opinions. SVB Global (formerly referred to as our “Global Financial Services” group) includes our foreign subsidiaries that facilitates our clients’ global expansion into major technology centers around the world SVB Global provides a variety of services, including consulting and business services, referrals, and knowledge sharing, as well as identifying business opportunities for SVB Financial Group.

 

The other business services units provide various products and services. The Other Business Services segment also reflects those adjustments necessary to reconcile the results of operating segments based on our internal profitability reporting process to the interim consolidated financial statements prepared in conformity with GAAP.

 

21



 

Our primary source of revenue is from net interest income. Accordingly, our segments are reported using net interest income. We also evaluate performance based on noninterest income and noninterest expense, which are presented as components of segment operating profit or loss. We do not allocate income taxes to our segments. Additionally, our management reporting model is predicated on average asset balances; therefore it is not possible to provide period-end asset balances for segment reporting purposes.

 

Our segment information at and for the three months ended March 31, 2006 and March 31, 2005 are as follows:

 

22



 

 

 

Commercial
Banking

 

SVB
Capital

 

Other Business
Services

 

Total

 

 

 

(Dollars in thousands)

 

Three months ended March 31, 2006

 

 

 

 

 

 

 

 

 

Net interest income

 

$

65,241

 

$

6,732

 

$

11,906

 

$

83,879

 

Provision for (recovery of) loan losses(1)

 

(570

)

 

(1,904

)

(2,474

)

Noninterest income (2)

 

20,215

 

1,725

 

1,461

 

23,401

 

Noninterest expense (3)

 

46,334

 

4,505

 

19,849

 

70,688

 

Minority interest in net (income) loss of consolidated affiliates

 

 

 

(244

)

(244

)

Income (loss) before income tax expense and cumulative effect of change in accounting principle

 

$

39,692

 

$

3,952

 

$

(4,822

)

$

38,822

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

$

2,248,183

 

$

61,228

 

$

354,037

 

$

2,663,448

 

Total average assets (4)

 

3,730,617

 

666,079

 

868,098

 

5,264,794

 

Total average deposits

 

3,239,528

 

625,062

 

196,961

 

4,061,551

 

Goodwill at March 31, 2006

 

 

 

35,638

 

35,638

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2005

 

 

 

 

 

 

 

 

 

Net interest income

 

$

50,721

 

$

4,327

 

$

14,078

 

$

69,126

 

Provision for (recovery of) loan losses(1)

 

(3,413

)

(401

)

(3,814

)

 

 

Noninterest income (2)

 

18,610

 

3,118

 

3,641

 

25,369

 

Noninterest expense (3)

 

42,207

 

4,696

 

13,912

 

60,815

 

Minority interest in net (income) losses of consolidated affiliates

 

 

 

441

 

441

 

Income (loss) before income tax expense

 

$

30,537

 

$

2,749

 

$

4,649

 

$

37,935

 

 

 

 

 

 

 

 

 

 

 

Total average loans

 

$

1,822,657

 

$

82,245

 

$

268,013

 

$

2,172,915

 

Total average assets

 

3,877,685

 

640,785

 

613,411

 

5,131,881

 

Total average deposits

 

3,439,873

 

601,928

 

155,343

 

4,197,144

 

Goodwill at March 31, 2005

 

 

 

35,638

 

35,638

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31, 2005

 

 

 

 

 

 

 

 

 

Total average loans

 

$

2,032,672

 

$

61,749

 

$

273,941

 

$

2,368,362

 

Total average assets (4)

 

3,807,150

 

680,626

 

702,001

 

5,189,777

 

Total average deposits

 

3,356,655

 

637,108

 

172,713

 

4,166,476

 

Goodwill at December 31, 2005

 

 

 

35,638

 

35,638

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31, 2004

 

 

 

 

 

 

 

 

 

Total average loans

 

$

1,630,961

 

$

76,522

 

$

244,172

 

$

1,951,655

 

Total average assets (4)

 

3,629,524

 

550,566

 

592,819

 

4,772,909

 

Total average deposits

 

3,231,625

 

518,066

 

155,717

 

3,905,408

 

Goodwill at December 31, 2004

 

 

 

35,638

 

35,638

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31, 2003

 

 

 

 

 

 

 

 

 

Total average loans

 

$

1,506,055

 

$

64,560

 

$

227,375

 

$

1,797,990

 

Total average assets (4)

 

3,021,016

 

517,940

 

517,512

 

4,056,468

 

Total average deposits

 

2,607,706

 

483,838

 

186,022

 

3,277,566

 

Goodwill at December 31, 2003

 

 

 

37,548

 

37,548

 

 


(1)                               For segment reporting purposes, we report net loan charge-offs as the provision for loan losses. Thus the Other Business Services segment includes $(0.8) million and $(1.9) million for the three-month periods ended March 31, 2006 and 2005, respectively,  which represents the difference between net charge-offs and the provision for loan losses.

 

(2)                               Commercial Banking segment includes direct depreciation and amortization of $0.8 million and $0.4 million for the three months ended March 31, 2006 and 2005, respectively. Due to the complexity of our cost allocation model, it is not feasible to determine the exact amount of the remaining depreciation and amortization expense allocated to the various business segments.

 

(3)                               The internal reporting model used by our management to assess segment performance does not calculate tax expense by segment. Our effective tax rate is a reasonable approximation of the segment rates.

 

(4)                               Total Average Assets have been corrected to reflect the current composition of particular segments and prior periods presented have been corrected accordingly. Specifically, certain assets previously reported in the other Business Services segment have been reclassified into the commercial Banking and SVB Capital segments.

 

11.   Obligations Under Guarantees

 

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

 

The credit risk involved in issuing letters of credit is essentially the same as that involved with extending loan commitments to clients, and accordingly, we use a credit evaluation process and collateral requirements similar to those for loan commitments. Our standby letters of credit are often cash-secured by our clients. The actual liquidity needs or the credit

 

23



 

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

 

The table below summarizes our standby letter of credits at March 31, 2006. The maximum potential amount of future payments represents the amount that could be remitted under the standby letters of credit if there were a total default by the guaranteed parties, without consideration of possible recoveries under recourse provisions or from the collateral held or pledged.

 

(Dollars in thousands as of
March 31, 2006)

 

Expires within one
year or less

 

Expires after
one year

 

Total amount
outstanding

 

Maximum amount
of future payments

 

Financial standby

 

$

565,491

 

$

64,147

 

$

629,638

 

$

629,638

 

Commercial standby

 

4,782

 

 

4,782

 

4,782

 

Performance standby

 

10,970

 

9,126

 

20,096

 

20,096

 

Total

 

$

581,243

 

$

73,273

 

$

654,516

 

$

654,516

 

 

At March 31, 2006, the carrying amount of the liabilities related to financial and performance standby letters of credit was approximately $3.9 million. At March 31, 2006, cash and investment securities collateral available to us to reimburse losses under financial and performance standby letters of credits was $271.6 million.

 

Additionally, the Bank, as a financial provider, routinely guarantees credit cards for some of our customers which have been provided by an unaffiliated financial institution. We have recourse against the customer for any amount it is required to pay to a third party in the event of default under these arrangements. These guarantees are subject to the same credit policies, underwriting standards and approval process as loans made by us. Certain of these amounts are secured by certificates of deposit and other assets which we have rights to in the event of nonperformance by the customers. The total amount of this guarantee was $59.2 million at March 31, 2006. It is not considered probable that material losses would be incurred by us as a result of these arrangements.

 

12. Related Party Transactions

 

The Bank increased its commitment under a revolving line of credit facility to an aggregate amount of $30.0 million to Gold Hill Venture Lending 03, LP, a venture debt fund (“Gold Hill”), and its affiliated funds. We have a 9.3% effective ownership interest in Gold Hill, as well as a 90.7% majority interest in its general partner, Gold Hill Venture Lending Partners 03, LLC. The line of credit expires in August 2006 and bears an interest rate of prime plus one percent. The highest aggregate balance outstanding during the quarter ended March 31, 2006 was approximately $30.0 million.

 

13. Legal Matters

 

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.

 

We are unable to predict at this time the final outcome of the above matter and the ultimate effect, if any, on our liquidity, consolidated financial position or results of operations.

 

Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against us or our affiliates. Based upon information available to us, our review of such claims to date and consultation with our outside legal counsel, management believes the liability relating to these actions, if any, will not have a material adverse effect on our liquidity, consolidated financial position, or results of operations. Where appropriate, as we determine, reserves have been established in accordance with SFAS No. 5, “Accounting for Contingencies.”  The outcome of litigation and other legal and regulatory matters is inherently uncertain, however, and it is possible that one or more of the legal or regulatory matters currently pending or threatened could have a material effect.

 

14. Income Taxes

 

Income Tax Rate Comparison

 

Tax rate for the quarter ended March 31, 2005

 

39.5

%

Add: Share-based compensation

 

3.6

 

Tax rate for the quarter ended March 31, 2006

 

43.1

%

 

Our effective tax rate was 43.1% for the first quarter ended March 31, 2006, compared with 39.5% for the first quarter ended March 31, 2005. The higher tax rate was primarily attributable to the 3.6% tax impact of certain categories of share-based payment expense recognized under SFAS 123(R) that are not deductible for tax purposes in the period the related expense was recognized.

 

15. Subsequent Event

 

From April 1, 2006 through May 3, 2006, the Company repurchased 192,000 shares of its common stock totaling $10.0 million under the stock repurchase program leaving $65.7 million that still may be repurchased under the program. To continue the repurchase program, the Company put into effect a 10b5-1 plan which allowed the Company to automatically repurchase a predetermined number shares per day at the market price on every trading day until the trading window re-opened on May 2, 2006.

 

In April 2006, the Bank issued a letter of credit in the amount of $200 thousand on behalf of SurgRx, Inc. The initial maturity date of the letter of credit is April 4, 2007, but the letter of credit will be automatically renewed unless affirmatively terminated by SurgRx until its final expiry on May 10, 2010. The letter of credit is secured by a certificate of deposit pledged by SurgRx, Inc. which certificate of deposit is held by the Bank. David Clapper, one of our directors, is the Chief Executive Officer of SurgRx, Inc.

 

In April 2006, two of the managing directors of the SVB Alliant business unit resigned from the Company. The Company is actively conducting a search for their successors.

 

24



 

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

 

Management’s discussion and analysis 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 factors discussed in “Item 3. Quantitative and Qualitative Disclosures about Market Risk—Factors That May Affect Future Results.”

 

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our interim unaudited consolidated financial statements and notes as presented in Part I - Item 1 of this report and in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2005 (“2005 Form 10-K”) as filed with the Securities and Exchange Commission (“SEC”). Certain reclassifications have been made to prior years’ results to conform to the current period’s presentations. Such reclassifications had no effect on our results of operations or stockholders’ equity.

 

Overview of Company Operations

 

SVB Financial Group is a bank holding company and a financial holding company that was incorporated in the state of Delaware in March 1999. In May 31, 2005, we changed our name from Silicon Valley Bancshares to SVB Financial Group. 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. SVB Financial Group’s corporate headquarters is located at 3003 Tasman Drive, Santa Clara, California 95054, and our telephone number is 408.654.7400. When we refer to “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 Group, the Parent” or “the parent company” we are referring only to the parent company, SVB Financial Group.

 

For over 20 years, we have been dedicated to helping entrepreneurs succeed, specifically focusing on industries where we have deep knowledge and relationships. Our focus 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 their age or size. We offer a range of financial services that generate three distinct sources of income interest rate differentials, fee-based services and investments in private equity and venture capital funds.

 

In part, our income is generated from interest rate differentials. The difference between the interest rates received on interest-earning assets, such as loans extended to clients and securities held in our investment portfolio, and the interest rates paid by us on interest-bearing liabilities, such as deposits and other borrowings, accounts for the major portion of our earnings. Our deposits are largely obtained from commercial clients within our technology, life science, private equity, and premium 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 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.

 

In addition, we seek to obtain returns through investments in private 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.

 

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Business Overview

 

SVB Financial Group is organized into groups, which manage the diverse financial services we offer:

 

Commercial Banking

 

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

 

Through our lending products and services, we extend loans and other credit facilities to our commercial clients, most often secured by the 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 often obtain warrants to purchase an equity position in a client company’s stock in consideration for making loans, or for providing 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.

 

We offer a variety of investment services and solutions to our Commercial Banking clients and others which enable companies to better manage their assets. SVB Silicon Valley Bank’s Repurchase Agreement Program (Repo) is designed for our Venture Capital and Private Equity clients. Through our broker-dealer subsidiary, SVB Securities, we offer money market mutual funds and fixed income securities. SVB Securities is registered with the SEC and a member of the National Association of Securities Dealers, Inc. (NASD). We also offer investment advisory services through SVB Asset Management, our registered investment advisory subsidiary. SVB Asset Management specializes in outsourced treasury management, customized cash portfolio management and reporting and monitoring for corporations.

 

SVB Capital

 

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

 

SVB Capital makes investments in venture capital and other private equity firms and in companies in the niches we serve. The segment also manages four venture funds that are consolidated into our financial statements; SVB Strategic Investors Fund, LP, SVB Strategic Investors Fund II, LP, and 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 2004 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, primarily to emerging growth clients in their earliest stages, and the Partners for Growth funds that provide secured debt to, primarily, higher risk, middle market clients in their later stages. 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, have brought relatively few products or services to market, and have no or little revenue. By contrast, “middle market” clients tend to be more mature; they may be publicly-traded and more established in the markets in which they participate, although not necessarily the leading players in their industries.

 

Other Business Services

 

The Other Business Services segment is principally comprised of SVB Alliant, SVB Global and Private Client Services, and other business service units that are not part of the Commercial Banking or SVB Capital segments. SVB Alliant, SVB Global and Private Client Services do not meet the separate reporting thresholds as defined by SFAS No. 131 and as such,

 

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have been aggregated as Other Business Services for segment reporting purposes.

 

SVB Alliant

 

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

 

SVB Global

 

SVB Global (formerly referred to as our “Global Financial Services” group) includes our foreign subsidiaries that facilitates our clients’ global expansion into major technology centers around the world SVB Global provides a variety of services, including consulting and business services, referrals, and knowledge sharing, as well as identifying business opportunities for SVB Financial Group.

 

Private Client Services and Other

 

Our Private Client Services and Other group is principally comprised of our Private Client Services group and other business services units. Private Client Services provides a wide range of credit services to high-net-worth individuals using both long-term secured and short-term unsecured lines of credit. Those products and services include home equity lines of credit, secured lines of credit, restricted stock purchase loans, airplane loans, and capital call lines of credit. We also 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. As a result of the Private Client Services group’s recent decision to focus on its core banking and credit products, we sold Woodside Asset Management during the quarter ended March 31, 2006. The impact of the sale had an immaterial impact on our financial condition and results of operations.

 

Critical Accounting Policies and Estimates
 

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

 

A summary of significant accounting policies and a description of accounting policies that are considered critical are described in “Part II. Item 8. Consolidated Financial Statements and Supplementary Data—Note 2. Significant Accounting Policies” and in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” in our 2005 Form 10-K.

 

Recent Accounting Pronouncements
 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS No. 154”), which replaces APB No. 20 “Accounting Changes” and SFAS No. 3 “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 also changes the requirements for the accounting for and reporting of a change in accounting principle, and applies to all voluntary changes in accounting principles, as well as changes required by an accounting pronouncement in the unusual instance it does not include specific transition provisions. Specifically, SFAS No. 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine the period-specific effects or the cumulative effect of the change. SFAS No. 154 was effective for us beginning January 1, 2006. We do not expect the adoption of SFAS No. 154 to have a material impact on our results of operations or financial condition.

 

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140”. SFAS No. 155 permits fair value measurement of any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. We are currently assessing the impact of SFAS No.155 on our consolidated financial position and results of operations.

 

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Results of Operations

 

Earnings Summary

 

We reported net income of $22.3 million for the three months ended March 31, 2006, $0.7 million, or 2.9% lower than net income of $22.9 million for the three months ended March 31, 2005. Earnings per diluted common share were $0.58 for the three months ended March 31, 2006, as compared to $0.59 for the comparable prior year period.

 

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 diluted earnings per share (EPS) calculation using the treasury stock method, in accordance with the provisions of Emerging Issue Task Force (EITF) issue No. 90-19, “Convertible Bonds With Issuer Option to Settle in Cash Upon Conversion” and Statement of Financial Accounting Standard (SFAS) No. 128, “Earnings Per Share”. The exposure draft of SFAS No. 128(R), 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 $0.04 per diluted common share, or 7.2% for the three months ended March 31, 2006, and by $0.05 per diluted common share, or 8.5% for the three months ended March 31, 2005, respectively.

 

Three Months ended March 31, 2006 Compared to Three Months ended March 31, 2005

 

Consolidated net income decreased by $0.7 million for the three months ended March 31, 2006 versus the three months ended March 31, 2005.

 

                    Net interest income increased by $14.8 million due to an increase in average loans, and due to an improvement in yields generated from these loans.

 

                    The increase in noninterest expense of $9.9 million was largely attributable to an increase of $4.3 million in compensation expense, an increase of $3.3 million in professional services fees and an aggregate increase of $1.7 million in furniture and equipment and business development expenses.

 

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

 

 

 

For the three months
ended March 31,

 

%

 

(Dollars in thousands)

 

2006

 

2005

 

Change

 

 

 

 

 

 

 

 

 

Net interest income

 

$

83,879

 

$

69,126

 

21.3

%

Recovery of provision for loan losses

 

(2,474

)

(3,814

)

(35.1

)

Noninterest income

 

23,401

 

25,369

 

(7.8

)

Noninterest expense

 

70,688

 

60,815

 

16.2

 

Minority interest in net income of consolidated affiliates

 

(244

)

441

 

(155.3

)

Income before income tax expense

 

38,822

 

37,935

 

2.3

 

Income tax expense

 

16,743

 

14,999

 

11.6

 

Cumulative effect of change in accounting principle, net of tax