UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K/A

(Amendment No. 1 to Form 10-K)

 

(Mark One)

ý

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the fiscal year ended December 31, 2004

 

 

 

OR

 

 

o

Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                                to                               

 

 

 

Commission File Number: 000-15637

 

SVB FINANCIAL GROUP

(formerly Silicon Valley Bancshares)

(Exact name of registrant as specified in its charter)

 

Delaware

 

91-1962278

(State or other jurisdiction of incorporation or organization)

 

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

 

 

 

3003 Tasman Drive, Santa Clara, California 95054-1191

 

http://www.svb.com/company/investor_fs.asp

(Address of principal executive offices including zip code)

 

(Registrant’s URL)

 

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

 

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

 

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

 

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

 

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

 

Indicate by check mark 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 o No ý

 

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

 

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

 

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2004, the last business day of the registrant’s most recently completed second fiscal quarter, based upon the closing price of its common stock on such date, on the NASDAQ National Market was $1,410,622,539.

 

At February 28, 2005, 35,901,144 shares of the registrant’s common stock ($0.001 par value) were outstanding.

 

Documents Incorporated

 

Parts of Form 10-K
Into Which
Incorporated

Definitive proxy statement for the Company’s 2005 Annual Meeting of Stockholders to be filed within 120 days of the end of the fiscal year ended December 31, 2004

 

Part III

 

 



 

TABLE OF CONTENTS

 

 

 

 

Page

 

 

 

 

EXPLANATORY NOTE

 

 

3

PART I

Item 1

Business

5

 

Item 2

Properties

15

 

Item 3

Legal Proceedings

15

 

Item 4

Submission of Matters to a Vote of Security Holders

15

 

 

 

 

PART II

Item 5

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

16

 

Item 6

Selected Consolidated Financial Data

17

 

Item 7

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

19

 

Item 7A

Quantitative and Qualitative Disclosures About Market Risk

73

 

Item 8

Consolidated Financial Statements and Supplementary Data

86

 

Item 9

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

155

 

Item 9A

Controls and Procedures

155

 

 

 

 

PART III

Item 10

Directors and Executive Officers of the Registrant

158

 

Item 11

Executive Compensation

158

 

Item 12

Security Ownership of Certain Beneficial Owners and Management

158

 

Item 13

Certain Relationships and Related Transactions

158

 

Item 14

Principal Accounting Fees and Services

158

 

 

 

 

PART IV

Item 15

Exhibits and Financial Statement Schedules

159

 

 

 

 

SIGNATURES

 

 

160

 

 

 

 

Index to Exhibits

 

 

161

 

2



 

Explanatory Note

 

SVB Financial Group (formerly known as Silicon Valley Bancshares) (the “Company”) has restated its interim consolidated financial statements as of and for the three-month period ended March 31, 2005, the consolidated annual financial statements for the years 2004, 2003 and 2002, interim consolidated financial information for each of the quarters within fiscal 2004 and 2003, and selected financial data for fiscal years 2004, 2003, 2002, 2001 and 2000 (the “Restatement”).  As previously disclosed, the Board of Directors decided on July 18, 2005 that the Company should restate these financial statements after concluding that the Company’s accounting for its warrant portfolio should conform to certain accounting pronouncements for derivative instruments interpreting Statement of Financial Accounting Standard No. 133, as amended.  The restated financial statements reflect changes in the Company’s derivative equity warrant accounting and other related changes.  Additionally, in connection with the Restatement process, the Company reviewed, corrected and modified, where appropriate, certain of its accounting policies and practices which were not in accordance with generally accepted accounting principles in the U.S. (“GAAP”).  Changes made as a result of such corrections are also included in the restated financial statements and the selected financial data as applicable.   For a description of the changes made in connection with the Restatement, see Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations --- Restatement of Financial Statements” below, and Note 3, “Restatement of Financial Statements,” to the accompanying consolidated financial statements contained in this report.

 

Additionally, effective as of May 31, 2005, the Company changed its name from Silicon Valley Bancshares to SVB Financial Group.  The Company’s new name is reflected in this document.

 

 This Amendment No. 1 on Form 10-K/A (the “Form 10-K/A”) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, initially filed with the Securities and Exchange Commission (the “SEC”) on March 16, 2005 (the “Original Form 10-K”), is being filed to reflect restatements of the Company’s Consolidated Balance Sheets as of December 31, 2004 and 2003, the related Consolidated Statements of Income, Comprehensive Income and Stockholders’ Equity and Cash Flows for each of the years in the three year period ended December 31, 2004, and the notes related thereto.  For a more detailed description of these restatements, see Note 3, “Restatement of Financial Statements,” to the accompanying consolidated financial statements, and the section entitled “Restatement of Financial Statements” under Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contained in this Form 10-K/A.

 

For the convenience of the reader, this Form 10-K/A sets forth the Original Form 10-K in its entirety.  However, this Form 10-K/A only amends and restates Items 6, 7, 7A, 8 and 9A of Part II, in each case as a result of, and to reflect, the Restatement.  No other information in the Original Form 10-K is amended hereby, except for the Company’s name change and certain updated risk factors and related party transactions in Items 7A and Item 8 of Part II, respectively.  The foregoing items have not been updated to reflect other events occurring after the filing of the Original Form 10-K or to modify or update those disclosures affected by subsequent events.  In addition, pursuant to the rules of the SEC, Item 15 of Part IV of the Original Form 10-K has been amended to contain the consent of the Company’s independent registered public accounting firm and currently dated certifications from the Company’s Chief Executive Officer and Chief Financial Officer, as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. Except for the foregoing amended information, this Form 10-K/A continues to speak as of the date of the Original Form 10-K and the Company has not updated the disclosure contained herein to reflect events that occurred at a later date.  Other events occurring after the filing of the original filing or other disclosures necessary to reflect subsequent events have been or will be addressed in the Company’s Amendment No. 1 on Form 10-Q/A to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, and/or the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, all of which will be filed after the filing of this Form 10-K/A, and any reports filed with the SEC subsequent to the date of this filing.

 

With the exception of this Form 10-K/A, the Company has not amended and does not intend to amend its previously filed Annual Reports on Form 10-K or its Quarterly Reports on Form 10-Q for the periods affected by the Restatement that ended prior to December 31, 2004.  For this reason, the consolidated financial statements, report of independent registered public accounting firm and related financial information for the affected periods contained in such reports should no longer be relied upon.

 

3



 

Primary Financial Impact of Restatement

 

The accounting changes primarily had the following financial impact on the Company’s consolidated results of operations for the following years:

 

 

 

Years Ended December 31,

 

(Dollars in thousands)

 

2004

 

2003

 

2002

 

2001

 

2000

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Income

 

$

(4,459

)

$

(5,184

)

$

(2,441

)

$

(6,725

)

$

(7,310

)

Non-Interest Income

 

929

 

5,771

 

3,568

 

10,197

 

8,845

 

Net Income

 

$

(1,510

)

$

1,065

 

$

1,142

 

$

9,829

 

$

1,195

 

 

 

 

Years Ended December 31,

 

 

 

2004

 

2003

 

2002

 

2001

 

2000

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share, after cumulative effect of change in accounting principle, net of tax

 

 

 

 

 

 

 

 

 

 

 

Earnings per Common Share -Basic, as reported

 

$

1.86

 

$

0.33

 

$

1.21

 

$

1.85

 

$

3.41

 

Adjustment

 

(0.05

)

0.03

 

0.03

 

0.20

 

0.02

 

Earnings per Common Share -Basic, as restated

 

$

1.81

 

$

0.36

 

$

1.24

 

$

2.05

 

$

3.43

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per Common Share -Diluted, as reported

 

$

1.74

 

$

0.32

 

$

1.18

 

$

1.79

 

$

3.23

 

Adjustment

 

(0.04

)

0.03

 

0.03

 

0.20

 

0.03

 

Earnings per Common Share -Diluted, as restated

 

$

1.70

 

$

0.35

 

$

1.21

 

$

1.99

 

$

3.26

 

 

4



 

PART I.

 

ITEM 1.   BUSINESS

 

General

 

SVB Financial Group (formerly known as Silicon Valley Bancshares) is a bank holding company and a financial holding company that was incorporated in the state of Delaware in March 1999. Our principal subsidiary, Silicon Valley Bank, is a California state-chartered bank and a member of the Federal Reserve System. Silicon Valley Bank’s deposits are insured by the Federal Deposit Insurance Corporation. Our corporate headquarters is located at 3003 Tasman Drive, Santa Clara, California 95054 and our telephone number is 408.654.7400. When we refer to “SVB Financial Group” or “we” or use similar words, we intend to include SVB Financial Group and all of its subsidiaries collectively, including Silicon Valley Bank. When we refer to “SVB Financial,” 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.

 

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

 

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

 

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

 

We are able to offer our clients financial products and services through four lines of banking and financial services, as discussed in further detail below: Commercial Banking, SVB Capital, SVB Alliant, and Private Client Services and Other Services. These operating segments are strategic units that offer different services to different clients. They are managed separately because each segment appeals to different markets and, accordingly, require different strategies.

 

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

 

5



 

to purchase an equity position in a client company’s stock in consideration for providing credit facilities 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.

 

In 2004, Silicon Valley Bank established SVB Europe Advisors, Limited, a subsidiary in the United Kingdom that provides consulting and business services and access to financial services of Silicon Valley Bank to Europe based clients and prospects in the niches Silicon Valley Bank serves. In 2004, Silicon Valley Bank also established SVB India Advisors Pvt. Ltd., a subsidiary in Bangalore, India that provides consulting and business services to facilitate U.S.-based and Indian technology companies and private equity firms pursuing international business. SVB India Advisors provides services such as educational information, introductions to recommended service providers (lawyers, accountants, real estate brokers, etc.), networking events, and technical and consulting services for commercial and venture fund clients visiting India.

 

The Commercial Banking group also provides investment and advisory services to our clients through our broker-dealer subsidiary, SVB Securities (formerly known as SVB Securities, Inc.). These services, which include mutual funds, fixed income securities and repurchase agreements enable our clients to better manage their assets. We also offer investment advisory services through SVB Asset Management, one of our registered investment advisor subsidiaries. SVB Asset Management specializes in outsourced treasury management, customized cash portfolio management and reporting and monitoring for corporations.

 

SVB Capital

 

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

 

SVB Capital also makes investments in venture capital and other private equity firms and in companies in the niches we serve. The segment also manages three venture funds that are consolidated into our financial statements: SVB Strategic Investors Fund, LP and SVB Strategic Investors Fund II, 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 to emerging growth clients in their earliest stages, and Partners for Growth, LP, a fund that provides secured debt to higher risk, emerging growth 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 companies” 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.

 

SVB Capital, through Private Equities Services (a division of SVB Securities), also assists private equity firms, and the partners of such firms, with liquidating securities following initial public offerings and mergers

 

6



 

and acquisitions, including in-kind stock transactions, restricted stock sales, block trading, and special situations trading such as liquidation of foreign securities.

 

SVB Alliant

 

Through SVB Alliant (formerly known as Alliant Partners), our investment banking subsidiary, we provide merger and acquisition advisory services (M&A), strategic alliance services, and specialized financial studies such as valuations and fairness opinions. In October 2003, we enhanced our investment banking product set by launching a Private Capital Group that provides advisory services for the private placement of securities. SVB Alliant is a broker-dealer registered with the National Association of Securities Dealers, Inc. (NASD).

 

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

 

Industry Niches

 

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

 

Technology and Life Science

 

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

 

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

 

With an extended suite of financial services, we have expanded our business to more mature companies. Our corporate technology practice is a network of senior lenders focused primarily on the specific financial needs of more mature private and public clients. When we refer to “corporate technology,” we are referring to companies that tend to be more mature, better capitalized, possibly publicly traded and more established in the markets in which they participate. Today, we can comfortably address the financial needs of all companies in our niches, whether they are entrepreneurs with innovative ideas or multinational corporations with hundreds of millions of dollars in sales.

 

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

 

      Hardware: Semiconductors, Communications, and Electronics

 

      Software: Software and Services

 

      Biotechnology

 

      Drug Discovery

 

      Medical Devices

 

      Specialty Pharmaceuticals

 

7



 

Private Equity

 

Through our SVB Capital group, we have cultivated strong relationships with venture capital firms worldwide, many of which are also clients. SVB Capital provides financial services to a significant portion of the venture capital firms in the United States as well as to other private equity firms, facilitating deal flow to and from these private equity firms and participating in direct investments in their portfolio companies.

 

Premium Wine

 

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

 

Industry Niches Exited

 

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

 

For further information on our business segments, see Item 8. Consolidated Financial Statements and Supplementary Data—Note 25 Segment Reporting.

 

Business Combinations

 

On October 1, 2002, we acquired substantially all of the assets of Woodside Asset Management, Inc., an investment advisor firm, which had approximately $200 million under management for 70 clients. We offer Woodside Asset Management’s services as part of our Private Client Services. Additionally, as part of this acquisition, SVB Financial Group obtained the general partner interests in two limited partnerships: Taurus Growth Partners, LP and Libra Partners, LP. Both of these funds were liquidated and funds were fully disbursed to the limited partners by December 31, 2004. We had less than a 1% ownership interest in each of these funds. The remaining ownership interest represented limited partners’ funds invested on their behalf by the general partner in certain fixed income and marketable equity securities. However, due to our ability to control the investing activities of these limited partnerships, we were required to consolidate the related results of operations and financial condition into our consolidated financial statements for all periods presented.

 

On September 28, 2001, SVB Securities, a subsidiary of Silicon Valley Bank, completed the acquisition of SVB Alliant, an investment banking firm providing merger and acquisition and corporate partnering services. Our investment banking business continues to do business under the name “SVB Alliant.” See Item 8. Consolidated Financial Statements and Supplementary Data—Note 4 Business Combinations. On October 1, 2002, SVB Alliant was sold from our Silicon Valley Bank subsidiary to the SVB Financial Group.

 

Competition

 

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

 

Employees

 

As of December 31, 2004, we employed approximately 1,028 full-time equivalent employees. To our knowledge, none of our employees are represented by a labor union. Competition for qualified personnel in our industry is significant, particularly for client relationship manager positions, officers, and employees with strong relationships with the venture capital community. Our future success will depend in part on our continued ability to attract, hire, and retain qualified personnel.

 

8



 

Supervision and Regulation

 

General

 

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

 

Regulation of Holding Company

 

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

 

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

 

The Gramm-Leach-Bliley Act of 1999 (GLB Act) amended the BHC Act to permit a qualifying bank holding company, called a financial holding company, to engage in a broader range of activities than those traditionally permissible for bank holding companies. A financial holding company may conduct activities that are “financial in nature,” including insurance, securities underwriting and dealing and market-making, and merchant banking activities, as well as additional activities that the Federal Reserve Board determines (in the case of incidental activities, in conjunction with the Treasury Department) are incidental or complementary to financial activities, without the prior approval of the Federal Reserve Board. The GLB Act also permits financial holding companies to acquire companies engaged in activities that are financial in nature or that are incidental or complementary to financial activities without the prior approval of the Federal Reserve Board. The GLB Act also repealed the provisions of the Glass-Steagall Act that restricted banks and securities firms from affiliating. On November 14, 2000, SVB Financial became a financial holding company. As a financial holding company, SVB Financial no longer requires the prior approval of the Federal Reserve Board to conduct, or to acquire ownership or control of entities engaged in, activities that are financial in nature or activities that are determined to be incidental or complementary to financial activities, although the requirement in the BHC Act for prior Federal Reserve Board approval for the acquisition by a bank holding company of more than 5% of any class of the voting shares of a bank or savings association (or the holding company of either) is still applicable. Additionally, under the merchant banking authority added by the GLB Act, SVB Financial may invest in companies that engage in activities that are not otherwise permissible, subject to certain limitations, including that SVB Financial

 

9



 

make the investment with the intention of limiting the investment in duration and does not manage the company on a day-to-day basis.

 

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

 

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

 

Regulatory Capital

 

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

 

The ability of SVB Financial, like other bank holding companies, to continue to include its outstanding trust preferred securities in Tier 1 capital has been made the subject of some doubt due to the issuance by the Financial Accounting Standards Board (FASB) in January 2003 of Interpretation No. 46 “Consolidation of Variable Interest Entities (VIE),” (FIN 46) and in May 2003 of Statement of Financial Accounting Standards (SFAS) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” although the Federal Reserve Board announced in July 2003 that qualifying trust preferred securities will continue to be treated as Tier 1 capital until notice is given to the contrary.  See Item 8 Consolidated Financial Statements and Supplementary Data—Note 28.  Variable Interest Entities-Adoption of FIN 46R.

 

SVB Financial and Silicon Valley Bank are also subject to rules that govern the regulatory capital treatment of equity investments in nonfinancial companies made on or after March 13, 2000 and held under certain specified legal authorities by a bank or bank holding company. Silicon Valley Bank does not currently hold any

 

10



 

such equity investments. Under the rules, these equity investments will be subject to a separate capital charge that will reduce a bank holding company’s Tier 1 capital and, correspondingly, will remove these assets from being taken into consideration in establishing a bank holding company’s required capital ratios discussed above.

 

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

 

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

 

The capital ratios of SVB Financial and Silicon Valley Bank, respectively, exceeded the well-capitalized requirements, as defined above, at December 31, 2004. See Item 8. Consolidated Financial Statements and Supplementary Data—Note 23. Regulatory Matters for the capital ratios of SVB Financial and Silicon Valley Bank as of December 31, 2004.

 

Regulation of Silicon Valley Bank

 

Silicon Valley Bank is a California-chartered bank and a member of the Federal Reserve System. Silicon Valley Bank is subject to primary supervision, periodic examination and regulation by the California Department of Financial Institutions and the Federal Reserve Board. If, as a result of an examination of Silicon Valley Bank, the Federal Reserve Board should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of Silicon Valley Bank’s operations are unsatisfactory or that Silicon Valley Bank or its management is violating or has violated any law or regulation, various remedies are available to the Federal Reserve Board. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of Silicon Valley Bank, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate Silicon Valley Bank’s deposit insurance, which for a California-chartered bank would result in a revocation of Silicon Valley Bank’s charter. The California Department of Financial Institutions has many of the same remedial powers. Various requirements and restrictions under the laws of the State of California and the United States affect the operations of Silicon Valley Bank. State and federal statues and regulations relate to many aspects of Silicon Valley Bank’s operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, and capital requirements. Further, Silicon Valley Bank is required to maintain certain levels of capital. See Regulatory Capital above. The GLB Act changed the powers of national banks and their subsidiaries, and made similar changes in the powers of state bank subsidiaries. The GLB Act permits a national bank to underwrite, deal in, and purchase state and local revenue bonds. It also allows a subsidiary of a national bank to engage in financial activities that the bank cannot, except for general insurance underwriting and real estate development and investment. In order for a subsidiary to engage in new financial activities, the national bank and its depository institution affiliates must be well capitalized; have at least “satisfactory” general, managerial, and CRA examination ratings; and meet other qualification requirements relating to total assets, subordinated debt, capital, risk management, and affiliate transactions. Subsidiaries of state banks can exercise the same powers as national bank subsidiaries if they satisfy the same qualifying rules that apply to national banks. For state banks that are members of the Federal Reserve System like Silicon Valley Bank, prior approval of the Federal Reserve Board is required before a bank can create a subsidiary to capitalize on the additional financial activities empowered by the GLB Act.

 

11



 

Restrictions on Dividends

 

SVB Financial’s ability to pay cash dividends is limited by generally applicable Delaware corporation law limits. In addition, SVB Financial is a legal entity separate and distinct from Silicon Valley Bank, and there are statutory and regulatory limitations on the amount of dividends that may be paid to SVB Financial by Silicon Valley Bank. During 2004, 2003, and 2002, Silicon Valley Bank paid dividends of $25.0 million, $51.0 million, and $80.0 million, respectively, to SVB Financial. However, a part of the dividend paid in 2003 and the dividend paid in 2004 were in excess of the amount permitted under the California State Department of Financial Institutions (“DFI”) guidelines. Therefore SVB Financial has been required by the DFI to return to Silicon Valley Bank a portion the 2003 dividend and the 2004 dividend—the total amount returned totaled $28.4 million. At this time, Silicon Valley Bank must obtain prior approval from the DFI before paying any further dividends to SVB Financial. The Federal Reserve Board and the California Commissioner of Financial Institutions (the Commissioner) have the authority to prohibit Silicon Valley Bank from engaging in activities that, in their opinion, constitute unsafe or unsound practices in conducting its business. Depending upon the financial condition of Silicon Valley Bank and other factors, the regulators could assert that the payment of dividends or other payments might, under some circumstances, be an unsafe or unsound practice. If Silicon Valley Bank fails to comply with its minimum capital requirements, its regulators could restrict its ability to pay dividends using prompt corrective action or other enforcement powers. The Commissioner may impose similar limitations on the conduct of California-chartered banks. See Item 8. Consolidated Financial Statements and Supplementary Data—Note 23. Regulatory Matters for further discussion on dividend restrictions.

 

Transactions with Affiliates

 

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

 

Prompt Corrective Action and Other Enforcement Mechanisms

 

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

 

Based upon its capital levels, a bank that is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an

 

12



 

unsafe or unsound practice, warrants such treatment. At each successive lower-capital category, an insured bank is subject to more restrictions, including restrictions on the bank’s activities, operational practices or the ability to pay dividends. However, the federal banking agencies may not treat an institution as critically undercapitalized unless its capital ratios actually warrant such treatment.

 

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

 

Safety and Soundness Guidelines

 

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

 

Premiums for Deposit Insurance

 

Silicon Valley Bank’s deposit accounts are insured by the Bank Insurance Fund, as administered by the Federal Deposit Insurance Corporation, up to the maximum permitted by law. The FDIC may assess premiums to maintain a sufficient fund balance. The amount charged is based on the capital level of an institution and on a supervisory assessment based upon the results of examination findings by the institution’s primary federal regulator and other information deemed relevant by the FDIC to the institution’s financial condition and the risk posed to the Bank Insurance Fund. As of December 31, 2004, the FDIC’s semi-annual assessment for the insurance of BIF deposits ranged from zero (0) to twenty seven (27) cents per $100 of insured deposits. The FDIC may increase or decrease the premium rate on a semi-annual basis. As of December 31, 2004, Silicon Valley Bank’s assessment rate was zero.

 

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

 

Community Reinvestment Act and Fair Lending

 

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

 

Privacy

 

The GLB Act imposed customer privacy requirements on any company engaged in financial activities. Under these requirements, a financial company is required to protect the security and confidentiality of customer nonpublic personal information. Also, for customers who obtain a financial product such as a loan for personal, family, or household purposes, a financial company is required to disclose its privacy policy to the customer at

 

13



 

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

 

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

 

Silicon Valley Bank has written policies with regard to the sharing of consumer nonpublic personal information. Our policies comply with both federal and California rules applicable to the security and confidentiality of consumer nonpublic personal information.

 

USA Patriot Act of 2001

 

As part of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the USA Patriot Act), Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFATA”). IMLAFATA amended the Bank Secrecy Act and adopted certain additional measures that established or increased already existing obligations of financial institutions, including Silicon Valley Bank, to identify their customers, watch for and report upon suspicious transactions, respond to requests for information by federal banking regulatory authorities and law enforcement agencies, and share information with other financial institutions. The Secretary of the Treasury has adopted several regulations to implement these provisions. Pursuant to certain of these regulations, Silicon Valley Bank may not establish, maintain, administer, or manage a correspondent account in the United States for, or on behalf of, a foreign shell bank. In addition, IMLAFATA expands the circumstances under which funds in a bank account may be forfeited. IMLAFATA also amended the BHC Act and the Bank Merger Act to require the federal banking regulatory authorities to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing an application to expand operations. Silicon Valley Bank has in place a Bank Secrecy Act compliance program.

 

Regulation of Certain Subsidiaries

 

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

 

Our broker-dealer subsidiaries are subject to Rule 15c3-1 under the Securities Exchange Act of 1934 (the Exchange Act), which is designed to measure the general financial condition and liquidity of a broker-dealer. Under this rule, our broker-dealer subsidiaries are required to maintain the minimum net capital deemed necessary to meet broker-dealers’ continuing commitments to customers and others. Under certain circumstances, this rule could limit the ability of SVB Financial to withdraw capital from SVB Alliant and limit the ability of Silicon Valley Bank to withdraw capital from SVB Securities.

 

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

 

14



 

Available Information

 

We make available free of charge through our Internet website, http://www.svb.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. (Our website address is provided solely for informational purposes and is not intended to be part of this Annual Report.)

 

Item 2.   Properties

 

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

 

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

 

We currently operate 25 regional offices. We operate throughout the Silicon Valley with offices in Fremont, Santa Clara, Palo Alto and on Sand Hill Road in Menlo Park. Other regional offices in California include Irvine, Los Angeles, Napa Valley, San Diego, San Francisco, and Sonoma. Office locations outside of California include: Phoenix, Arizona; Boulder, Colorado; Atlanta, Georgia; Chicago, Illinois; Boston, Massachusetts; Minneapolis, Minnesota; New York, New York; Durham, North Carolina; Portland, Oregon; Philadelphia, Pennsylvania; Austin, Texas; Dallas, Texas; Vienna, Northern Virginia; and Seattle, Washington. All of our properties are occupied under leases, which expire at various dates through 2014, and in most instances include options to renew or extend at market rates and terms. We also own leasehold improvements, equipment, furniture, and fixtures at our offices, all of which are used in our business activities.

 

Item 3.   Legal Proceedings

 

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

 

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

 

None.

 

15



 

PART II

 

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

 

Market Information

 

Our common stock is traded over the counter on the National Association of Securities Dealers Automated Quotation (NASDAQ) national market under the symbol SIVB. The per share range of high and low sale prices for our common stock as reported on the NASDAQ national market, as applicable, for each three month period over the years ended December 31, 2004 and 2003, are as follows:

 

 

 

2004

 

2003

 

 

 

Low

 

High

 

Low

 

High

 

Three Months Ended:

 

 

 

 

 

 

 

 

 

March 31

 

$

31.02

 

$

39.96

 

$

15.71

 

$

19.63

 

June 30

 

31.20

 

39.65

 

18.11

 

27.00

 

September 30

 

32.38

 

39.90

 

22.66

 

31.00

 

December 31

 

37.15

 

45.15

 

27.46

 

37.25

 

 

Stockholders

 

There were 689 registered holders of our stock as of December 31, 2004. Additionally, we believe there were approximately 7,027 beneficial holders of common stock whose shares are held in the name of brokerage firms or other financial institutions. We are not provided with the number or identities of all of these stockholders, but we have estimated the number of such stockholders from the number of stockholder documents requested by these brokerage firms for distribution to their customers.

 

Dividends

 

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

 

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

 

Stock Repurchases

 

Period

 

(a)
Total Number
of Shares
Purchased

 

(b)
Average Price
Paid per
Share

 

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

 

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

 

January 1, 2004 – March 31, 2004

 

 

$

 

 

$

46,800,000

 

April 1, 2004 – June 30, 2004

 

 

 

 

46,800,000

 

July 1, 2004 – September 30, 2004

 

 

 

 

46,800,000

 

October 1, 2004 – December 31, 2004

 

300,000

 

41.93

 

300,000

 

34,200,000

 

2004 Total

 

300,000

 

$

41.93

 

300,000

 

$

34,200,000

 

 


(1)  On May 7, 2003, the Company announced that its Board of Directors authorized a stock repurchase program of up to $160.0 million, with no specified expiration date. This program became effective immediately and replaced previously announced stock repurchase programs. Stock repurchases under this program may be made from time to time. Under this program, the Company repurchased in aggregate 4.8 million

 

16



 

shares of common stock totaling $125.8 million as of 2004. The approximate dollar value of shares that may still be repurchased under this program totaled $34.2 million as of December 31, 2004.

 

Recent Sales of Unregistered Securities

 

None

 

Item 6.   Selected Consolidated Financial Data

 

The selected consolidated financial data set forth in this Item 6 has been restated to reflect adjustments to our consolidated financial statements and other financial information contained in our Annual Report on Form 10-K for the year ended December 31, 2004, originally filed with the U.S. Securities and Exchange Commission on March 16, 2005.  The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and supplementary data as presented in Item 8 of this amended Annual Report on Form 10-K/A (“Form 10-K/A”).  See Note 3 of the Notes to the Consolidated Financial Statements included in Part II Item 8 of this Form 10-K/A.  Certain reclassifications have been made to our prior years’ results to conform to 2004 presentations. Such reclassifications had no effect on the results of operations or stockholders’ equity. In addition, the common stock summary information has been restated to reflect a two-for-one stock split on May 15, 2000.  Information for the years ended December 31, 2004, 2003 and 2002 is derived from audited financial statements presented separately herein while information for the years ended December 31, 2001 and 2000 is derived from unaudited financial statements not presented separately herein, respectively.

 

17



 

 

 

(As Restated)

 

 

 

Years Ended December 31,

 

 

 

2004

 

2003

 

2002

 

2001

 

2000

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Income Statement Summary:

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

230,289

 

$

183,700

 

$

192,267

 

$

256,260

 

$

322,538

 

(Recovery of) provision for loan and lease losses

 

(10,289

)

(9,892

)

5,873

 

15,845

 

54,090

 

Noninterest income

 

106,962

 

80,831

 

71,426

 

81,030

 

198,475

 

Noninterest expense

 

241,830

 

264,896

 

183,326

 

182,551

 

198,383

 

Minority interest in net (income) losses of consolidated affiliates and income tax expense

 

(3,090

)

7,689

 

7,767

 

7,546

 

460

 

Income before income tax expense

 

102,620

 

17,216

 

82,261

 

146,440

 

269,000

 

Income tax expense

 

38,754

 

4,174

 

27,761

 

55,171

 

108,737

 

Net income before cumulative effect of change in accounting principle(1)

 

63,866

 

13,042

 

54,500

 

91,269

 

160,263

 

Cumulative effect of change in accounting principle, net of tax

 

 

 

 

6,714

 

 

Net income

 

$

63,866

 

$

13,042

 

$

54,500

 

$

97,983

 

$

160,263

 

Common Share Summary:

 

 

 

 

 

 

 

 

 

 

 

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

 

$

1.81

 

$

0.36

 

$

1.24

 

$

1.91

 

$

3.43

 

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

 

1.70

 

0.35

 

1.21

 

1.86

 

3.26

 

Earnings per common share-basic

 

1.81

 

0.36

 

1.24

 

2.05

 

3.43

 

Earnings per common share-diluted

 

1.70

 

0.35

 

1.21

 

1.99

 

3.26

 

Book value per share

 

$

15.07

 

$

13.07

 

$

14.83

 

$

14.03

 

$

12.58

 

Weighted average shares outstanding-basic

 

35,215

 

36,109

 

44,000

 

47,728

 

46,656

 

Weighted average shares outstanding-diluted

 

37,512

 

37,231

 

45,053

 

49,138

 

49,199

 

Year-End Balance Sheet Summary:

 

 

 

 

 

 

 

 

 

 

 

Investment securities

 

$

2,074,967

 

$

1,530,411

 

$

1,157,434

 

$

1,340,383

 

$

1,915,625

 

Loans, net of unearned income

 

2,308,588

 

1,987,146

 

2,084,099

 

1,765,706

 

1,723,005

 

Goodwill

 

35,639

 

37,549

 

100,549

 

96,380

 

 

Assets

 

5,145,679

 

4,468,410

 

4,212,031

 

4,202,484

 

5,650,890

 

Deposits

 

4,219,514

 

3,666,841

 

3,436,050

 

3,380,777

 

4,862,238

 

Contingently convertible debt

 

146,740

 

145,797

 

 

 

 

Junior subordinated debentures

 

49,470

 

49,118

 

 

 

 

Trust preferred securities(2)

 

 

 

39,472

 

38,641

 

38,589

 

Stockholders’ equity

 

$

541,948

 

$

457,953

 

$

601,938

 

$

637,048

 

$

616,001

 

Average Balance Sheet Summary:

 

 

 

 

 

 

 

 

 

 

 

Investment securities

 

$

1,771,779

 

$

1,135,195

 

$

1,064,416

 

$

1,468,509

 

$

1,752,796

 

Loans, net of unearned income

 

1,951,655

 

1,797,990

 

1,760,639

 

1,659,520

 

1,583,404

 

Goodwill

 

37,066

 

91,992

 

98,252

 

24,955

 

 

Assets

 

4,772,909

 

4,056,468

 

3,895,870

 

4,399, 262

 

5,200,483

 

Deposits

 

3,905,408

 

3,277,566

 

3,063,456

 

3,581,581

 

4,572,201

 

Contingently convertible debt

 

146,255

 

73,791

 

 

 

 

Junior subordinated debentures

 

49,366

 

23,823

 

 

 

 

Trust preferred securities(3)

 

 

19,193

 

38, 267

 

38,611

 

38,559

 

Stockholders’ equity

 

$

495,203

 

$

504,632

 

$

641,402

 

$

657,404

 

$

478,958

 

Capital Ratios:

 

 

 

 

 

 

 

 

 

 

 

Total risk-based capital ratio

 

16.09

%

16.83

%

16.31

%

17.34

%

17.15

%

Tier 1 risk-based capital ratio

 

12.75

%

12.23

%

15.00

%

16.08

%

15.90

%

Tier 1 leverage ratio

 

11.17

%

10.62

%

14.15

%

14.97

%

11.69

%

Average stockholders’ equity to average assets

 

10.38

%

12.44

%

16.46

%

14.94

%

9. 21

%

Selected Financial Ratios:

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

1.34

%

0.32

%

1.40

%

2.23

%

3.08

%

Return on average stockholders’ equity

 

12.90

%

2.58

%

8.50

%

14.90

%

33.46

%

Net interest margin(1)

 

5.38

%

5.16

%

5.64

%

6.57

%

6.76

%

Net recoveries (charge-offs) to average total loans

 

(0.10

)%

0.08

%

(0.25

)%

(1.02

)%

(3.32

)%

Nonperforming assets as a percentage of total assets

 

0.29

%

0.28

%

0.48

%

0.44

%

0.33

%

Allowances for loan and lease losses as a percent of total gross loans(2)

 

1.62

%

2.49

%

2.78

%

3.20

%

3.36

%

Other Data:

 

 

 

 

 

 

 

 

 

 

 

Client investment funds:

 

 

 

 

 

 

 

 

 

 

 

Private label client investment funds

 

$

7,260,320

 

$

7,615,307

 

$

7,642,090

 

$

8,572,910

 

$

10,069,607

 

Client investment assets under management

 

2,678,042

 

591,610

 

 

 

 

Sweep funds

 

1,351,244

 

1,139,211

 

853,231

 

710,458

 

736,087

 

Total client investment funds

 

$

11,289,606

 

$

9,346,128

 

$

8,495,321

 

$

9,283,368

 

$

10,805,694

 

 

18



 


(1)   Effective July 1, 2001, the Company changed its method of accounting for equity warrant assets in companies with net share settlement provisions.  Under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, these equity warrant assets are accounted for as derivative instruments. The restatement for initial accounting change for equity warrant assets pursuant to SFAS No. 133, as amended is reflected in the above table for fiscal year 2001 as a cumulative change in accounting principle net of tax. See Item 8. Consolidated Financial Statements and Supplementary Data—Note 3. Restatement of Financial Statements for further discussion.

 

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

 

(3)   Historically, we aggregated our allowance for loan losses and allowance for unfunded credit commitments and reflected the aggregate allowance in our allowance for loan and lease losses (ALLL) balance. Commencing in the fourth quarter of 2004, we reflected our allowance for loan and lease losses in our ALLL balance and allowance for unfunded credit commitments in other liabilities. These reclassifications were also made to prior periods’ balance sheets to conform to current period’s presentations. Additionally, we reclassified expense from the provision for loan losses related to changes in the allowance for unfunded credit commitments into noninterest expense for all periods presented. Such reclassifications had no effect on our results of operations or stockholders’ equity but have had the effect of lowering our ALLL to total gross loan ratios. See Credit Quality table included under Credit Quality and the Allowance for Loan and Lease Losses under Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition.

 

Item 7.    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 7A. Quantitative and Qualitative Disclosures about Market Risk—Factors That May Affect Future Results.

 

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated financial statements and supplementary data as presented in Item 8 of this amended Annual Report on Form 10-K/A. Certain reclassifications have been made to our prior years’ results to conform to 2004 presentations. Such reclassifications had no effect on our results of operations or stockholders’ equity.  All applicable disclosures in the following discussion in this Item 7 have been modified to reflect the Restatement as described below.

 

All of the numbers impacted by the Restatement in this section are as restated.

 

Restatement of Financial Statements

 

We have restated certain prior year amounts reported in our Annual Report on Form 10-K for the year ended December 31, 2004, originally filed with the Securities and Exchange Commission on March 16, 2005, for purposes of correcting misapplications of generally accepted accounting principles in the U.S. (GAAP). The cumulative adjustments increased our opening retained earnings by $11.7 million at January 1, 2002. Our net income for 2003, 2002 and 2001 increased by $1.1 million, $1.1 million and $9.8 million, respectively, and decreased in 2004 by $1.5 million.  The primary restatement adjustments recorded due to the misapplications of GAAP are described below.

 

Derivative equity warrant assets with net share settlement provisions were not reported as derivatives in accordance with the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (SFAS No. 133).

 

Derivative equity warrant assets with net share settlement provisions were not reported as derivatives in accordance with the provisions of SFAS No. 133.  This misapplication of GAAP resulted in a change to our interest income, provision for loan and lease losses, noninterest income and net income for the years ended December 31, 2004, 2003, 2002 and 2001 and for all quarterly periods during the years ended December 31, 2004 and 2003.  The total impact, including all adjustments, increased (decreased) income before income tax expense by $(1.2) million, $6.1 million, $5.0 million and $3.1 million for the years ended December 31, 2004, 2003, 2002 and 2001, respectively.

 

19



 

As described in Item 1 of Part I, “Business — Commercial Banking,” we often obtain derivative equity warrant assets to purchase an interest in a client company’s stock in connection with providing credit facilities and, less frequently, for providing other services.  In general, the derivative equity warrant assets that we hold entitle us to buy a specific number of shares of stock, at a specific price over a specific time period.  Certain warrants obtained by us include contingent provisions which set the underlying number of shares or strike price based upon certain future events.  For example, the number of shares exercisable for some warrants is contingent upon the related lending facility, such as the extent of utilization of the facility, including draw frequency or amount.  Or, in some cases, the underlying strike price of some warrants may be contingent upon the share price of a subsequent future round of equity financing of the issuer.

 

Previously, we recorded these equity warrant assets on our balance sheet at a nominal value until the date they became marketable, the date of expiration, or the date the issuer was acquired or completed an initial public offering.  However, we determined that our accounting treatment of equity warrant assets in our private and public client companies should conform to a 2001 interpretation of SFAS No. 133, as amended.  In April 2001, the FASB issued Statement 133 Derivative Implementation Group Issue No. A17, “Contracts That Provide for Net Share Settlement,” as revised (DIG A17), which was effective with the first financial quarter after the cleared guidance was posted to the FASB website and remains effective for all subsequent periods.

 

As a result, our accounting for equity warrant assets with net share settlement provisions has been revised beginning as of the third quarter of 2001. The net share settlement provision contained in each of our warrant agreements allow us to realize value without a capital investment.  Under such a provision, the client company delivers to us, upon our exercise of the warrant, the amount of shares with a current fair value equal to the net gain of the warrant agreement (sometimes described as a “cashless” exercise).  Because our warrant agreements contain such net share settlement provisions, our equity warrant assets are required to be accounted for as derivative instruments under SFAS No. 133, as amended.

 

Under the revised accounting treatment, equity warrant assets in our private and public client companies, which include net share settlement provisions are recorded at fair value and are classified as derivative assets, a component of other assets on our balance sheet at the time they are obtained. The grant date fair values of these equity warrant assets are deemed to be loan fees and, as such, are required to be recognized as an adjustment of loan yield through interest income, as prescribed by SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases” (SFAS No. 91).  Similar to other loan fees, the yield adjustment related to the grant date fair value of equity warrant assets, received directly in connection with the issuance of a credit facility, is recognized over the life of the related credit facility in interest income.  Any changes in value of the warrant derivative assets subsequent to the grant date fair value are recognized in gains (losses) on derivative instruments, net, in our consolidated statements of income.  If the warrant is in the money, we exercise these equity warrants for shares when a portfolio company completes an initial public offering on a publicly reported market or is acquired by a publicly traded company.  On the date a warrant is exercised and exchanged for equity securities, it is marked to market as a derivative asset with the resulting change in value recognized as gains (losses) on derivative instruments in noninterest income, a component of consolidated net income.  As of the exercise date, the basis or value in the equity securities is reclassified from Other Assets to the Investment Securities line item on the balance sheet.  The equity securities are classified as available-for-sale securities under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Instruments” (SFAS No. 115).  In accordance with the provisions of SFAS No. 115, changes in fair value of securities designated as available for sale are excluded from net income and reported in accumulated other comprehensive income after applicable taxes, which is a separate component of stockholders’ equity.

 

The initial implementation of the 2001 interpretation of SFAS No. 133, as amended, caused us to recognize the fair value of the equity warrant assets on our consolidated balance sheet as of the beginning of the third quarter of 2001.  We recorded as unearned loan fees the estimated grant date fair value of the equity warrant assets that, as of July 1, 2001, would not yet have been amortized to interest income had this accounting policy been in place since the warrants were first received. The unearned loan fees recorded as of July 1, 2001 were amortized, as a loan yield adjustment, over the remaining life of the related credit facilities.  In accordance with the implementation provisions of SFAS No. 133, as amended, the fair value of the warrant portfolio, less the amount recorded as unearned loan fees at December 31, 2001 is reported as a restatement adjustment to the balance at December 31, 2001. Refer to Note 3. Restatement of Financial Statements to the financial statements contained in this report.

 

20



 

The effect of the misapplication of GAAP related to derivative warrant equity assets for the years ended December 31, 2004, 2003, 2002 and 2001 is described below.

 

 

 

As Restated

 

 

 

Years Ended December 31,

 

(Dollars in thousands)

 

2004

 

2003

 

2002

 

2001

 

 

 

 

 

 

 

 

 

 

 

Effects on statements of income:

 

 

 

 

 

 

 

 

 

Interest income (1)

 

$

5,656

 

$

6,621

 

$

9,228

 

$

4,255

 

(Recovery of) provision for loan and lease losses (2)

 

104

 

108

 

75

 

82

 

Gains (losses) on derivative instruments, net (3)

 

2,749

 

8,208

 

(2,670

)

932

 

Gains (losses) on investment securities, net (4)

 

(535

)

(1,300

)

30

 

(148

)

Total impact on income statement

 

7,974

 

13,637

 

6,663

 

5,121

 

Less: Income previously recognized (5)

 

(9,191

)

(7,528

)

(1,661

)

(1,995

)

Net impact on pre-tax income statement

 

(1,217

)

6,109

 

5,002

 

3,126

 

 

 

 

 

 

 

 

 

 

 

Effects on balance sheets:

 

 

 

 

 

 

 

 

 

Other assets (6)

 

28,928

 

29,537

 

23,465

 

22,500

 

 

 

 

 

 

 

 

 

 

 

Unearned warrant fees (7)

 

$

5,351

 

$

4,612

 

$

6,360

 

 

8,543

 

 

 

 

 

 

 

 

 

 

 

Retained earnings - cumulative effect of change in accounting principle (8)

 

 

 

 

 

 

 

$

6,714

 

 


(1) Similar to other loan fees, amount represents the yield adjustment as prescribed by SFAS No. 91 related to equity warrant assets received directly in connection with the issuance of a credit facility.

(2) Reversal of provision for loan and lease losses previously recorded due to the effect of reducing the net carrying amount of impaired loans resulting from the higher balances of unearned fees due to the recognition of the initial grant date fair value of the derivative assets net of related amortization.

(3) Recognition of changes in value of warrant derivative assets subsequent to the grant date fair value.

(4) Represents recognition of gains (losses) from the sale of shares associated with exercised equity warrant assets. Upon exercise of an equity warrant asset, the fair value of the equity warrant asset plus the exercise price paid becomes the adjusted basis of the asset reclassified to investment securities. The investment security is then accounted for under SFAS No. 115.

(5) Represents reversal of income previously recognized by the Company in prior years under previous warrant income recognition methodology.

(6) Adjustment to recognize the fair value of equity warrant assets on the balance sheet in accordance with SFAS No. 133.

(7) Represents the unearned loan fees to be amortized over the remaining life of the credit facility associated with the respective warrants.

(8) In accordance with the implementation provisions of SFAS No. 133, the fair value of the warrant portfolio less the amount recorded as unearned loan fees at July 1, 2001, is reported as a cumulative effect of a change in accounting principle.

 

Initial non-refundable corporate finance fees were not reported in accordance with the provisions of Staff Accounting Bulletin No. 104, “Revenue Recognition” (SAB No. 104).

 

Initial non-refundable corporate finance fees were not reported in accordance with the provisions of SAB No. 104. This misapplication of GAAP resulted in a change to the Company’s consolidated noninterest income and net income for the years ended December 31, 2004, 2003, 2002 and 2001 and for all quarterly periods during the years ended December 31, 2004 and 2003.

 

The Company is engaged by clients to provide merger and acquisition advisory services. The income from these engagements is typically comprised of an initial non-refundable fee due upon execution of the engagement letter and a contingent fee due upon a merger or acquisition event, if any. The engagement letters generally do not include a termination date. Corporate finance fees on mergers and acquisitions advisory services, a component of noninterest income, have been restated to defer the recognition of the initial upfront non-refundable retainer until the completion of all contractual obligations pursuant to the terms of the engagement letters or upon receipt or notification of an engagement termination letter.  Therefore, the change in accounting resulted in a net increase (decrease) in corporate finance fees of $0.1 million, $(0.9) million, $(1.2) million and $(0.6) million for the years ended December 31, 2004, 2003, 2002 and 2001, respectively, and a corresponding increase in deferred revenue for the same periods which has been or will be recognized in future periods.

 

Non-refundable loan fees and costs associated with our lending products and fees associated with letters of credit were not reported in accordance with the provisions of SFAS No. 91 “Accounting for Non Refundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases” (SFAS No. 91).

 

21



 

Non-refundable loan fees and costs associated with our lending products and fees associated with letters of credit were not reported in accordance with the provisions of SFAS No. 91. This misapplication of GAAP resulted in a change to our interest income and net income for the years ended December 31, 2004, 2003, 2002, 2001 and 2000 and for all quarterly periods during the years ended December 31, 2004 and 2003.

 

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.  We often obtain loan fees and incur capitalizable costs in relation to the extension of these credit facilities to our clients. Net loan fee income, a component of interest income, has been restated to revise revenue recognition in accordance with the appropriate straight-line or interest method, as prescribed by SFAS No. 91.  In addition, the Company inappropriately recognized non-refundable loan fees it receives for factoring loans immediately rather than deferring and amortizing fees over the term of the facility granted.  In addition, we reclassified certain letters of credit fee income from loan interest income to noninterest income, as the probability of the commitment being exercised was deemed to be remote.  The Company did not properly defer direct loan origination costs associated with originating certain loan products.  Therefore, we restated our recognition of net loan fee income by increasing(decreasing) loan interest income by $(2.5) million, $(4.7) million, $(3.0) million, $1.2 million and $(0.2) million for the years ended December 31, 2004, 2003, 2002, 2001, and 2000 respectively.   These amounts were deferred and are recognized into income using the appropriate loan fee recognition methodology over the lives of the corresponding loans. In addition, we reclassified certain letters of credit fee income of $7.6 million, $7.0 million, $8.4 million, $11.9 million and $7.1 million for the years ended December 31, 2004, 2003, 2002, 2001 and 2000, respectively, from loan interest income to noninterest income, as the probability of the commitment being exercised was deemed to be remote.

 

Certain investment securities that were readily convertible to known amounts of cash and present insignificant risk of changes in

value with original or purchased maturity dates of 90 days or less, were not reported as cash equivalents in accordance with the provisions of SFAS No. 95, “Statement of Cash Flows”(SFAS No. 95).

 

Certain investment securities that were readily convertible to known amounts of cash and present insignificant risk of changes in value with original or purchased maturity dates of 90 days or less, were not reported as cash equivalents in accordance with the provisions of SFAS No. 95. This reclassification did not result in any change to our revenue or net income for the years ended December 31, 2004, 2003, 2002, 2001 and 2000 or for any quarterly period during the years ended December 31, 2004 and 2003.

 

A reclassification has been made to our consolidated balance sheets of money market mutual fund investments and commercial paper investments from the Investment securities line item to Federal funds sold, securities purchased under agreement to resell and other short-term investment securities line item. These investment securities were deemed to meet the definition of cash equivalents as they are readily convertible to known amounts of cash and present insignificant risk of changes in value with original or purchased maturity dates of 90 days or less. Cash equivalents are required to be reflected separately from Investment securities pursuant to SFAS No. 95.  Therefore, we reclassified these Investment securities to Federal funds, and securities purchased under agreement to resell and other short-term investment securities in the amounts of $181.3 million, $40.3 million, $381.8 million, $494.2 million and $195.2 million as of December 31, 2004, 2003, 2002, 2001 and 2000, respectively.

 

Current federal income taxes receivable and current federal income taxes payable were not reflected net on our balances sheets in accordance with the provisions of FASB Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts”(FIN No. 39).

 

Current federal income taxes receivable and current federal income taxes payable were not reflected net on our balance sheets. This misapplication of GAAP resulted in a change to our other assets and other liabilities as of December 31, 2004 and 2003. Current federal income taxes receivable and current federal income taxes payable should be netted as the Company has the legal right of offset, as defined by FIN No. 39. Therefore, other assets and other liabilities have been restated to reflect the net current federal income taxes receivable or net current federal income taxes payable at each of these period ends. This correction of accounting resulted in a decrease to both other assets and other liabilities of $22.5 million and $24.6 million as of December 31, 2004 and 2003, respectively.

 

 

 

We also recorded various other adjusting entries as part of the Restatement.

 

Overview of Company Operations

 

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

 

Critical Accounting Policies

 

The accompanying management’s discussion and analysis of results of operations and financial condition are based upon our consolidated financial statements, which have, as restated, been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, income, and expenses and related disclosure of contingent assets and liabilities. Management evaluates estimates on an ongoing basis. Management bases its estimates on

 

22



 

historical experiences and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions. The financial impact of each estimate, to the extent significant to financial results, is discussed in the applicable sections of the management’s discussion and analysis.

 

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

 

Non-Marketable Equity Securities

 

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

 

Investment Company Fair Value

 

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

 

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

 

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

 

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

 

23



 

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

 

Company Ownership
in General Partner

 

Company
Ownership %

 

Silicon Valley BancVentures Inc.(1)

 

100

%*

SVB Strategic Investors, LLC(2)

 

100

%*

SVB Strategic Investors II, LLC(2)

 

100

%*

Partners for Growth, LLC(3)

 

 

 

Company Ownership
in Limited Partner

 

Company
Ownership %

 

Silicon Valley BancVentures , LP(1)

 

10.7

%*

SVB Strategic Investors Fund, LP(2)

 

11.1

%*

SVB Strategic Investors Fund II, LP(2)

 

14.4

%*

Partners for Growth, LP(3)

 

53.2

%*

 


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

 

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

 

(2)  The general partner of SVB Strategic Investors Fund, LP (SIF I), SVB Strategic Investors, LLC, is owned and controlled by SVB Financial and has an ownership interest of 11.1%. The general partner of SVB Strategic Investors Fund II (SIF II), LP, SVB Strategic Investors II, LLC, is owned and controlled by SVB Financial and has an ownership interest of 14.4%. The limited partners of these funds do not have substantive participating or kick-out rights. Therefore, SIF I and II are consolidated and any gains or losses resulting from changes in the estimated fair value of the venture capital fund investments are recorded as investment gains or losses in the Company’s consolidated net income.

 

(3) The general partner of Partners for Growth, LP, Partners for Growth, LLC, is not owned or controlled by SVB Financial. The limited partners of this fund have substantive kick-out rights by which the general partner may be removed without cause by simple majority vote of the limited partners.  SVB Financial has an ownership interest of 53.2% in Partners for Growth, LP. Accordingly, the fund is consolidated and any gains or losses resulting from changes in the estimated fair value of the investments are recorded as investment gains or losses in the Company’s consolidated net income.

 

Under investment company accounting, the investments are carried at estimated fair value as determined by the fund’s respective general partner. The valuation generally remains at cost until such time that there is significant evidence of a change in value based upon consideration of the relevant market conditions, offering prices, operating results, financial conditions, exit strategies, and other pertinent information. Thus, any gains or losses resulting from changes in the estimated fair value of the investments are recorded as investment gains or losses in our consolidated net income. The portion of any gains or losses attributable to the limited partners is reflected as minority interest in net income (loss) of consolidated affiliates and adjusts SVB Financial Group’s consolidated net income to reflect its percentage ownership.

 

Equity Method

 

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

 

The venture debt fund investment is in Gold Hill Venture Lending 03, LP, which provides financing to privately-held companies in the form of loans and equity investments.  SVB Financial Group has a direct and indirect interests totaling 9.8% in Gold Hill Venture Lending 03, LP. Our total interest in Gold Hill Venture Lending 03, LP exceeds the 5% ownership interest threshold established by EITF Topic D-46 for cost method accounting.  Accordingly, this limited partnership investment is accounted for under the equity method.  Thus, the Company recognizes its proportionate share of the results of operations of each equity method investee in its results of operations.

 

We invest in several qualified affordable housing projects which provide benefits in the form of tax credits.   Our limited partnership investments in qualified affordable housing projects do not qualify for the effective yield method under EITF 94-1, “Accounting for Tax Benefits Resulting From Investments in Affordable Housing Projects” (EITF 94-1).  Accordingly, we account for such investments under the equity method in accordance with the provisions of the AICPA Statement of Position (SOP) 78-9, “Accounting for Investments in Real Estate Ventures.”

 

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

 

Cost Method

 

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

 

     In accordance with the provisions of Accounting Principles Board Opinion No. 18 (APB No. 18), equity securities, such as preferred or common stock in privately-held companies in which we hold an ownership interest of less than 20% and in which we do not have the ability to exercise significant influence over the investees’ operating and financial policies, are accounted for under the cost method. These non-marketable equity securities also include certain investments made for various other purposes, such as shares purchased pursuant to regulatory requirements (for example, Federal Reserve Bank and Federal Home Loan Bank stock).


 

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

 

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

 

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

 

Gains or losses on cost method investment securities that result from a portfolio company being acquired by a publicly traded company are marked to market when the acquisition occurs. The resulting gains or losses are recognized into consolidated net income on that date in accordance with EITF Issue No. 91-5, “Nonmonetary Exchange of Cost-Method Investments” (EITF 91-5).  Further fluctuations in the market value of these equity securities are excluded from consolidated net income and are reported in accumulated other comprehensive income net of applicable taxes, a component of stockholders’ equity.  Upon the sale of these equity securities to a third party, gains and losses, which are measured from the acquisition value, are recognized in the Company’s consolidated net income.

 

24



 

We consider our non-marketable equity securities accounting policies to be critical because the valuation of non-marketable equity securities is subject to management judgment. The inherent uncertainty in the process of valuing equity securities for which a ready market is unavailable may cause our estimated values of these securities to differ significantly from the values that would have been derived had a ready market for the securities existed, and those differences could be material. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s carrying value, thereby possibly requiring an impairment charge in the future. For further information related to non-marketable equity securities for the years ended December 31, 2004, 2003, and 2002, please refer to the table under Part II—Item 8. Consolidated Financial Statements and Supplementary Data—Note 7 - Investment Securities.

 

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

 

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

 

We implemented a 2001 interpretation of SFAS No. 133, as amended, as it applies to derivative equity warrant assets with net settlement terms in certain private and public client companies.  In general, derivative equity warrant assets that we hold entitle us to buy a specific number of shares of stock at a specific price over a specific time period.  Certain warrants obtained by us include contingent provisions which set the underlying number of shares or strike price

 

25



 

based upon certain future events.  For example, the number of shares exercisable for some warrants is contingent upon the related lending facility, such as the extent of utilization of the facility, including draw frequency or amount.  Or, in some cases, the underlying strike price of some warrants may be contingent upon the share price of a subsequent future round of equity financing of the issuer.  Our warrant agreements contain net share settlement provisions, which permit the issuing company to deliver to us, upon our exercise of the warrant, the amount of shares with a current fair value equal to the net gain of the warrant agreement (sometimes described as a “cashless” exercise).  Because our warrant agreements contain such net share settlement provisions, our equity warrant assets are required to be accounted for as derivative instruments under SFAS No. 133 as of the third quarter of 2001.

 

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

 

The grant date fair values of these equity warrant assets are deemed to be loan fees and are required to be recognized as an adjustment of loan yield through loan interest income, as prescribed by SFAS No. 91.  Similar to other loan fees, the yield adjustment related to grant date fair value of equity warrant assets, received directly in connection with the issuance of a credit facility, is recognized over the life of that credit facility.

 

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

 

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

 

The initial implementation of the 2001 interpretation SFAS No. 133, as amended, as of the beginning of the third quarter of 2001, as it applies to derivative equity warrant assets, caused SVB Financial Group to recognize the fair value of the equity warrant assets on the Company’s consolidated balance sheet. The Company recorded, as unearned loan fees, the estimated grant date fair value of the equity warrant assets that, as of July 1, 2001, would not yet have been amortized to interest income had this accounting policy been in place since the equity warrant assets were first received. The unearned loan fees recorded as of July 1, 2001 were amortized, as a loan yield adjustment, over the remaining life of the related credit facilities. In accordance with the implementation provisions of SFAS No. 133, the fair value of the warrant portfolio at July 1, 2001 less the amount recorded as unearned loan fees is reported as a cumulative effect of a change in accounting principle.

 

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

 

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

 

           Volatility, or the quantification of the risk associated with the warrants over time, was based on guideline publicly traded companies or indices similar in nature to the underlying client

 

26



 

companies issuing the warrant.  A total of ten such indices were used. The volatility assumption for each warrant was calculated based on the average of the annualized daily volatility of a basket of comparable public companies over each of the fiscal quarters from July 1, 2001 to December 31, 2004. The weighted average quarterly median volatility assumption used for the warrant valuation at December 31, 2004 was 50.6%.

 

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

 

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

 

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

 

At December 31, 2004, the fair value of our derivative equity warrant assets was recorded on our balance sheet at $28.9 million, which represents our best estimate of the fair value of these instruments within the framework of existing accounting standards and guidance provided by the Securities and Exchange Commission on fair value accounting. Changes in the above material assumptions will result in significantly different valuations. For example, the following table demonstrates the effect of changes in the expected life and volatility assumptions:

 

Valuation of Equity Warrant Assets Active at December 31, 2004

(dollars in millions)

 

 

 

Volatility Factor

 

 

 

10% Lower

 

Average – 50.6%

 

10% Higher

 

Expected Life in Years

 

 

 

 

 

 

 

Average minus approximately 9 months

 

$

16.9

 

$

18.9

 

$

20.9

 

 

 

 

 

 

 

 

 

Average – 3.0 years

 

$

25.1

 

$

28.9

 

$

32.6

 

 

 

 

 

 

 

 

 

Average plus approximately 10 months

 

$

29.0

 

$

33.5

 

$

37.8

 

 

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

 

27



 

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

 

Allowance for Loan and Lease Losses

 

We consider our accounting policy relating to the estimation of the allowance for loan and lease losses to be critical as estimation of the allowance involves material estimates by our management and is particularly susceptible to significant changes in the near term. Our loan and lease loss reserve methodology is applied to our funded and unfunded loan commitments. The reserve associated with the funded debt is recorded as a contra asset while the reserve associated with the unfunded loan commitments is recorded as Other Liabilities (collectively referred to as “Allowance for Loan and Lease Losses”). Except as described herein, the methodology for the determination of an appropriate reserve for funded and unfunded loan commitments is the same.  The allowance for loan and lease losses and reserve for unfunded credit commitments is management’s estimate of credit losses inherent in the loan portfolio at a balance sheet date.

 

We define credit risk as the probability of sustaining a loss because other parties to the financial instrument fail to perform in accordance with the terms of the contract. Through the administration of loan policies and monitoring of the loan portfolio, our management seeks to reduce such credit risk. While we follow underwriting and credit monitoring procedures, which we believe are appropriate in growing and managing the loan portfolio, in the event of nonperformance by these other parties, our potential exposure to credit losses could significantly affect our consolidated results of operations and financial condition.  The allowance for loan and lease losses is established through a provision for loan losses charged to expense to provide for credit risk. Our allowance for loan and lease losses is established for loan losses that are probable but not yet realized. The process of anticipating loan losses is imprecise. Our management applies an evaluation process, as described below, to our loan portfolio to estimate the required allowance for loan and lease losses:

 

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

 

Our evaluation process was designed to determine the adequacy of the allowance for loan and lease losses. We assess the risk of losses inherent in the loan portfolio by utilizing modeling techniques. For this purpose, we have developed a statistical model based on historical loan loss migration to estimate an appropriate allowance for outstanding loan balances. In addition, we apply a macro allocation to the results of the aforementioned model to ascertain the total allowance for loan and lease losses. While this evaluation process uses historical and other

 

28



 

objective information, the classification of loans and the establishment of the allowance for loan and lease losses relies, to a great extent, on the judgment and experience of our management.

 

Historical Loan Loss Migration Model

 

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

 

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

 

Macro Allocations

 

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

 

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

 

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

 

                  Changes in the nature of our loan portfolio.

 

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

 

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

 

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

 

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

 

Allowance for Unfunded Credit Commitments

 

We reserve for the possibility of an unfunded loan commitment being funded and subsequently being charged-off. Each quarter, every unfunded client credit commitment is allocated to a credit risk-rating category in accordance with each client’s credit risk rating. We use the historical loan loss factors described above to calculate the possible loan loss experience if unfunded credit commitments are funded. Separately, we use historical trends to calculate the probability of an unfunded credit commitment being funded by us. We apply the loan funding probability factor to risk-factor adjusted unfunded commitments by credit risk-rating to derive the reserve for unfunded loan commitments. The unfunded credit commitments reserve may also include certain macro allocations as deemed appropriate by our management.

 

29



 

Goodwill

 

Please see Note 2. Summary of Significant Accounting Policies, for a description of our process for evaluating goodwill. Goodwill, which arises from the purchase price exceeding the assigned value of the net assets of an acquired business, represents the value attributable to unidentifiable intangible elements being acquired. Our goodwill at December 31, 2004, related to the acquisition of SVB Alliant (Alliant Partners), a mergers and acquisitions firm. The value of this goodwill is supported by the free cash flows from the acquired businesses. A decline in earnings as a result of a decline in mergers and acquisitions transaction volume or a decline in the valuations of mergers and acquisitions clients could lead to impairment, which would be recorded as a write-down in our consolidated net income.

 

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

 

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

 

Events that may indicate goodwill impairment include significant or adverse changes in results of operations of the business, economic or political climate, an adverse action or assessment by a regulator, unanticipated competition, and a more-likely-than-not expectation that a reporting unit will be sold or disposed of. More information about goodwill is included in Item 8-Consolidated Financial Statements and Supplementary Data-Note 11. Goodwill and Item 7A. Quantitative and Qualitative Disclosures about Market Risk—Factors That May Affect Future Results.

 

Results of Operations

 

Earnings Summary

 

We reported consolidated net income of $63.9 million in 2004, as compared to consolidated net income of $13.0 million in 2003 and $54.5 million in 2002. Diluted earnings per common share totaled $1.70 for 2004, as compared to $0.35 for 2003 and $1.21 for 2002.

 

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

 

We included the dilutive effect of the $150.0 million zero-coupon, convertible subordinated notes due June 15, 2008 in our fully diluted earnings per share (EPS) calculation using the treasury stock method, in accordance with the provisions of EITF 90-19, “Convertible Bonds With Issuer Option to Settle in Cash Upon Conversion” (EITF 90-19) and SFAS No. 128, “Earnings Per Share” (SFAS No. 128).  The exposure draft of SFAS No. 128R, if adopted in its proposed form, will require us to change our accounting for the calculation of EPS on our contingently convertible debt to the “if converted” method. The “if converted” treatment of the contingently convertible debt would have decreased EPS by $0.17 per diluted common share, or 10.0 percent for 2004.

 

30



 

2004 Compared to 2003

 

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

 

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

 

                  Impairment of goodwill expense decreased by $61.1 million. In 2003, we incurred charges aggregating $63.0 million related to our investment banking business unit, SVB Alliant;

 

                  Net interest income increased by $46.6 million, primarily due to increased interest income from both investment securities and loans; and

 

                  Noninterest income increased by $26.1 million, primarily due to an increase of $14.8 million in returns on investments securities. In addition, corporate finance fees increased $9.8 million, an increase in letter of credit  and standby letter of credit income of $1.1 million and an increase in client investment fees of $2.9 million, offset by reduced gains on derivative instruments of $3.5 million.

 

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

 

2003 Compared to 2002

 

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

 

Consolidated net income decreased by $41.5 million between 2003 and 2002.

 

The decrease in consolidated net income between 2003 and 2002 primarily resulted from an increase of $81.6 million in noninterest expense. The increase in noninterest expense was principally due to the following factors:

 

                  Impairment of goodwill charges aggregating $63.0 million related to SVB Alliant, and

 

                  Increase in expense associated with our incentive compensation program, which we believe was necessary to retain our professional talent in an improving economic environment.

 

Additionally, due to a decrease in the weighted-average prime rate of 4.1% for the year ended December 31, 2003, from 4.7% for the year ended December 31, 2002, we earned lower interest income from our loan portfolios, which resulted in a decline in net interest income. However, our provision for loan loss expense decreased by $15.8 million for 2003, as compared to 2002, largely due to a significant loan loss recovery, and our improved credit quality.

 

31



 

The major components of net income and changes in these components are summarized in the following table for the years ended December 31, 2004, 2003 and 2002, and are discussed in more detail on the following pages.

 

 

 

(As Restated)

 

 

 

Years Ended December 31,

 

 

 

 

 

 

 

%Change

 

 

 

%Change

 

(Dollars in thousands)

 

2004

 

2003

 

2004/2003

 

2002

 

2003/2002

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

230,289

 

$

183,700

 

25.4

%

$

192,267

 

(4.5

)%

(Recovery of) provision for loan and lease losses

 

(10,289

)

(9,892

)

4.0

 

5,873

 

(268.4

)

Noninterest income

 

106,962

 

80,831

 

32.3

 

71,426

 

13.2

 

Noninterest expense

 

241,830

 

264,896

 

(8.7

)

183,326

 

44.5

 

Minority interest in net (income) losses of consolidated affiliates

 

(3,090

)

7,689

 

(140.2

)

7,767

 

(1.0

)

Income before income tax expense

 

102,620

 

17,216

 

496.1

 

82,261

 

(79.1

)

Income tax expense

 

38,754

 

4,174

 

828.5

 

27,761

 

(85.0

)

Net income

 

$

63,866

 

$

13,042

 

389.7

 

$

54,500

 

(76.1

)

Return on average assets

 

1.34

%

0.32

%

 

 

1.40

%

 

 

Return on average stockholders’ equity

 

12.90

 

2.58

 

 

 

8.50

 

 

 

Average stockholders’ equity to average assets

 

10.38

 

12.44

 

 

 

16.46

 

 

 

 

Net Interest Income and Margin

 

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

 

32



 

The following table sets forth average assets, liabilities, minority interest and stockholders’ equity, interest income and interest expense, average yields and rates, and the composition of our net interest margin for the years ended December 31, 2004, 2003, and 2002.

 

 

 

(As Restated)

 

 

 

Years Ended December 31,

 

 

 

2004

 

2003

 

2002

 

(Dollars in thousands)

 

Average
Balance

 

Interest
Income/
Expense

 

Yield/
Rate

 

Average
Balance

 

Interest
Income/
Expense

 

Yield/
Rate

 

Average
Balance

 

Interest
Income/
Expense

 

Yield/
Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

607,460

 

$

8,421

 

1.39

%

$

689,899

 

$

8,024

 

1.16

%

$

645,290

 

$

11,517

 

1.78

%

Investment securities(2):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

1,648,536

 

70,651

 

4.29

 

992,598

 

39,295

 

3.96

 

887,358

 

37,933

 

4.27

 

Non-taxable(3)

 

123,243

 

7,698

 

6.25

 

142,597

 

9,613

 

6.74

 

177,058

 

10,606

 

5.99

 

Loans(4)(5)(6):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

1,613,689

 

141,179

 

8.75

 

1,506,929

 

129,405

 

8.59

 

1,506,547

 

139,256

 

9.24

 

Real estate construction and term

 

120,568

 

6,511

 

5.40

 

98,720

 

5,989

 

6.07

 

102,479

 

7,245

 

7.07

 

Consumer and other

 

217,398

 

9,914

 

4.56

 

192,341

 

8,192

 

4.26

 

151,613

 

7,298

 

4.81

 

Total loans

 

1,951,655

 

157,604

 

8.08

 

1,797,990

 

143,586

 

7.99

 

1,760,639

 

153,799

 

8.74

 

Total interest-earning assets

 

4,330,894

 

244,374

 

5.64

 

3,623,084

 

200,518

 

5.53

 

3,470,345

 

213,855

 

6.16

 

Cash and due from banks

 

213,213

 

 

 

 

 

192,591

 

 

 

 

 

182,400

 

 

 

 

 

Allowance for loan and lease losses

 

(48,249

)

 

 

 

 

(58,658

)

 

 

 

 

(61,042

)

 

 

 

 

Goodwill

 

37,066

 

 

 

 

 

91,992

 

 

 

 

 

98,252

 

 

 

 

 

Other assets(2)

 

239,985

 

 

 

 

 

207,459

 

 

 

 

 

205,915

 

 

 

 

 

Total assets

 

$

4,772,909

 

 

 

 

 

$

4,056,468

 

 

 

 

 

$

3,895,870

 

 

 

 

 

Funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

$

25,986

 

114

 

0.44

 

$

23,447

 

105

 

0.45

 

$

33,567

 

220

 

0.66

 

Regular money market deposits

 

513,699

 

2,587

 

0.50

 

332,632

 

1,824

 

0.55

 

288,238

 

2,751

 

0.95

 

Bonus money market deposits

 

739,976

 

3,721

 

0.50

 

673,982

 

3,686

 

0.55

 

614,378

 

5,855

 

0.95

 

Time deposits

 

329,336

 

2,001

 

0.61

 

485,199

 

3,468

 

0.71

 

610,996

 

7,403

 

1.21

 

Contingently convertible debt

 

146,255

 

943

 

0.64

 

73,791

 

572

 

0.78

 

 

 

0.00

 

Junior subordinated debentures

 

49,366

 

1,505

 

3.05

 

23,823

 

3,026

 

12.70

 

 

 

0.00

 

Other borrowings

 

16,605

 

520

 

3.13

 

40,903

 

772

 

1.89

 

57,593

 

1,647

 

2.86

 

Total interest-bearing liabilities

 

1,821,223

 

11,391

 

0.63

 

1,653,777

 

13,453

 

0.81

 

1,604,772

 

17,876

 

1.11

 

Portion of noninterest-bearing funding sources

 

2,509,671

 

 

 

 

 

1,969,307

 

 

 

 

 

1,865,573

 

 

 

 

 

Total funding sources

 

4,330,894

 

11,391

 

0.26

 

3,623,084

 

13,453

 

0.37

 

3,470,345

 

17,876

 

0.52

 

Noninterest-bearing funding sources:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand deposits

 

2,296,411

 

 

 

 

 

1,762,306

 

 

 

 

 

1,516,277

 

 

 

 

 

Other liabilities

 

100,920

 

 

 

 

 

79,079

 

 

 

 

 

64,007

 

 

 

 

 

Trust preferred securities(7)

 

 

 

 

 

 

19,193

 

 

 

 

 

38,267

 

 

 

 

 

Minority interest

 

59,152

 

 

 

 

 

37,481

 

 

 

 

 

31,145

 

 

 

 

 

Stockholders’ equity

 

495,203

 

 

 

 

 

504,632

 

 

 

 

 

641,402

 

 

 

 

 

Portion used to fund interest-earning assets

 

(2,509,671

)

 

 

 

 

(1,969,307

)

 

 

 

 

(1,865,573

)

 

 

 

 

Total liabilities, minority interest and stockholders’ equity

 

$

4,772,909

 

 

 

 

 

$

4,056,468

 

 

 

 

 

$

3,895,870

 

 

 

 

 

Net interest income and margin

 

 

 

$

232,983

 

5.38

%

 

 

$

187,065

 

5.16

%

 

 

$

195,979

 

5.64

%

Total deposits

 

$

3,905,408

 

 

 

 

 

$

3,277,566

 

 

 

 

 

$

3,063,456

 

 

 

 

 

 


(1)           Includes average interest-yielding deposits in other financial institutions of $10,559, $783, and $609 in 2004, 2003 and 2002, respectively.

(2)           Average noninterest-earning investment securities, primarily marketable and non-marketable equity securities, are excluded from the totals of investment securities and are included in other assets. Average noninterest-earning investment securities amounted to $137,475, $130,030 and $120,126 for the years ended December 31, 2004, 2003 and 2002, respectively. The calculation of yield on available-for-sale securities is based on average historical cost and does not give effect to changes in fair value that are reflected in stockholders’ equity.

(3)           Interest income on nontaxable investments is presented on a fully taxable-equivalent basis using the federal statutory tax rate of 35% for all years presented. These adjustments were $2,694, $3,365, and $3,712 for the years ended December 31, 2004, 2003, and 2002, respectively.

(4)           Average loans include average nonaccrual loans of $14,533, $16,089, and $19,602 in 2004, 2003, and 2002, respectively.

(5)           Average loans are net of average unearned income of $10,407, $10,541 and $9,994 in 2004, 2003, and 2002, respectively.

(6)           Loan interest income includes loan fees of $31,940, $31,164, and $34,260 in 2004, 2003 and 2002, respectively.

 

33



 

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

 

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

 

 

 

(As Restated)

 

(As Restated)

 

 

 

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

 

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

 

(Dollars in thousands)

 

Volume

 

Rate

 

Total

 

Volume

 

Rate

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

(1,029

)

$

1,426

 

$

397

 

$

750

 

$

(4,243

)

$

(3,493

)

Investment securities

 

26,631

 

2,810

 

29,441

 

2,072

 

(1,703

)

369

 

Loans

 

12,393

 

1,625

 

14,018

 

3,207

 

(13,420

)

(10,213

)

Increase (decrease) in interest income

 

37,995

 

5,861

 

43,856

 

6,029

 

(19,366

)

(13,337

)

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

NOW deposits

 

11

 

(2

)

9

 

(56

)

(59

)

(115

)

Regular money market deposits

 

922

 

(159

)

763

 

376

 

(1,303

)

(927

)

Bonus money market deposits

 

345

 

(310

)

35

 

523

 

(2,692

)

(2,169

)

Time deposits

 

(1,000

)

(467

)

(1,467

)

(1,315

)

(2,620

)

(3,935

)

Contingently convertible debt

 

481

 

(110

)

371

 

572

 

 

572

 

Junior subordinated debentures

 

1,802

 

(3,323

)

(1,521

)

3,026

 

 

3,026

 

Other borrowings

 

(602

)

350

 

(252

)

(403

)

(472

)

(875

)

Increase (decrease) in interest expense

 

1,959

 

(4,021

)

(2,062

)

2,723

 

(7,146

)

(4,423

)

Increase (decrease) in net interest income

 

$

36,036

 

$

9,882

 

$

45,918

 

$

3,306

 

$

(12,220

)

$

(8,914

)

 

2004 Compared to 2003

 

Net Interest Income

 

Net interest income, on a fully taxable-equivalent basis, totaled $233.0 million for 2004, an increase of $45.9 million, or 24.5%, from 2003. The increase in net interest income was the result of a $43.9 million increase in interest income and a $2.1 million decrease in interest expense.

 

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

 

The $43.9 million increase in interest income for 2004, as compared to 2003, was primarily the result of a $38.0 million favorable volume variance. The favorable volume variance resulted from a $707.8 million, or 19.5% increase, in average interest-earning assets. We believe increases in our sources of funding, largely deposits, were the main contributors to the increase in average interest-earning assets. We believe deposits increased due to an improved venture capital funding environment and general improvements in business conditions for many of our clients. This increase in average interest-earning assets was primarily centered in investment securities, which increased $636.6 million, and loans, which increased $153.7 million.

 

34



 

Average investment securities increased by $636.6 million, resulting in a $26.6 million favorable volume variance. Throughout 2004, we continued our investment strategy of changing the investment portfolio mix by increasing the portion of the portfolio invested in relatively higher-yielding mortgage-backed securities and collateralized mortgage obligations. Our average investments in mortgage-backed securities and collateralized mortgage obligations collectively increased by $564.8 million for 2004 as compared to 2003, largely funded by increases in client deposits. We estimated the duration of our investment portfolio increased to 2.1 years at December 31, 2004, from 1.7 years at December 31, 2003. The increase in duration was primarily due to the increase in mortgage-backed securities and collateralized mortgage obligations whose average duration is typically in the 2 to 5 year range.

 

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

 

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

 

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

 

Favorable rate variances associated with each component of interest-earning assets caused a $5.9 million increase in interest income in 2004 as compared to 2003. Although the yields on federal funds sold, securities purchased under agreement to resell and other short-term investment securities increased and the yield on loans remained unchanged, the yield on total average interest-earning assets remained relatively unchanged. The overall yield remained unchanged due to a change in the mix of our total average interest-earning assets. In 2004, investment securities represented 40.9% of our total average interest-earning assets and loans represented 45.1% of our total average interest-earning assets. In 2003, investment securities represented 31.3% of our total average interest-earning assets, and loans represented 49.6% of our total average interest-earning assets. Thus, the increase in yields on federal funds sold, securities purchased under agreement to resell and other short-term investment securities in 2004 as compared to 2003 was offset by the change in overall composition of our interest-earning assets.

 

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

 

The yield on investment securities increased by 11 basis points to 4.42% in 2004 from 4.31% for 2003, causing a $2.8 million favorable rate variance. This was primarily due to a shift in the composition of a portion of the investment portfolio to relatively higher-yielding mortgage-backed securities and collateralized mortgage obligations.

 

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

 

Interest Expense

 

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

 

35



 

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

 

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

 

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

 

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

 

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

 

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

 

2003 Compared to 2002

 

Net Interest Income

 

Net interest income on a fully taxable-equivalent basis totaled $187.1 million in 2003, a decrease of $8.9 million, or 4.5%, from $196.0 million in 2002. The decrease in net interest income was due to a $13.3 million, or 6.2%, decline in interest income, offset by a $4.4 million, or 24.7%, decrease in interest expense over the comparable prior-year period. Interest expense in 2003 included $3.0 million related to the SFAS No. 150 and FIN 46 mandated classification of trust preferred securities distribution expense as interest expense for the latter half of 2003. For periods prior to June 30, 2003, trust preferred securities distribution expense was classified as noninterest expense and therefore did not impact the net interest margin.

 

Interest Income—Impact of Declining Market Interest Rates on Interest-Earning Assets (Rate Variance)

 

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

 

36



 

The $13.3 million decrease in interest income for 2003, as compared to 2002, was the result of a $19.4 million unfavorable rate variance associated with each component of interest-earning assets, partially offset by a $6.0 million favorable volume variance. Market interest rates decreased slightly during 2003, which caused the weighted average prime rate to decline by 56 basis points to 4.12% from 4.68% in 2002. Consequently, the yield on loans decreased by 75 basis points in 2003 to 7.99% from 8.74% in 2002. In 2003, we incurred a $13.4 million unfavorable rate variance associated with our loan portfolio. Floating rate loans, which represent approximately 81.2% of our total loan portfolio, produced lower interest income due to a lower average prime rate in 2003 compared to 2002. The average yield on federal funds sold, securities purchased under agreement to resell and other short-term investments also decreased due to the decline in market interest rates from 1.78% in 2002 to 1.16% in 2003, which caused a $4.2 million unfavorable rate variance.

 

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

 

Total average interest-earning assets in 2003 increased $152.7 million, or 4.4% as compared to the prior year. The increase in total average interest-earning assets was principally funded by an increase in average noninterest-bearing deposits of $246.0 million, or 16.2%, and an increase in average long-term debt of $80.9 million, or 140.5%, offset by a decrease in average stockholders’ equity of $136.8 million, or 21.3%. The increase in average long-term debt was principally due to the issuance of $150.0 million of zero coupon convertible debt in May 2003. The net proceeds from the issuance of the convertible debt were largely used to repurchase our common stock, which resulted in the aforementioned decrease in average stockholders’ equity.

 

Average loans increased $37.4 million, or 2.1%, in 2003, as compared to 2002, resulting in a $3.2 million favorable volume variance. Our loan yield in 2003 included $6.6 million from accretion of warrant loan fees as compared to $9.0 million in 2002.  In 2003, we grew our average loan portfolio to a record level by continuing to focus on attracting corporate technology clients, which we believed were under-served by our competitors. We experienced loan growth across most of the industry sectors we serve.

 

Average investment securities for 2003 increased $70.8 million, or 6.6%, as compared to 2002, resulting in a $2.1 million favorable volume variance. The increase in average investment securities was primarily an increase in longer-term collateralized mortgage obligations.

 

Average federal funds sold, securities purchased under agreement to resell and other short-term investments increased $44.6 million, or 6.9%, in 2003, as compared to the prior year, resulting in a $0.8 million favorable volume variance. This increase was primarily due to a change in the investment portfolio mix.

 

The yield on average interest-earning assets decreased 63 basis points in 2003 from the prior year. This decrease primarily resulted from a decline in short-term market interest rates; thus, we earned lower yields on each component of our interest-earning assets.

 

Interest Expense

 

Total interest expense in 2003 decreased $4.4 million from 2002. This decrease was due to a favorable rate variance of $7.1 million, partially offset by an unfavorable volume variance of $2.7 million. The favorable rate variance between 2003 and 2002 primarily resulted from a reduction in the average rates paid on all of our interest-bearing deposits, particularly those rates paid on our time deposit and bonus money market deposit products.

 

The unfavorable volume variance was due in large part to the SFAS No. 150 mandated classification of trust preferred securities distribution expense of $3.0 million as interest expense for the latter half of 2003. Trust preferred securities distribution expense was previously classified as noninterest expense. Of the $3.0 million in trust preferred securities distribution expense, approximately $1.3 million related to the recognition of deferred issuance costs in the fourth quarter of 2003, due to the early redemption of our 8.25% trust preferred securities. We entered into an interest rate swap agreement to swap our 7.0% fixed payment on junior subordinated debentures for a variable rate based on the London Inter-Bank Offer Rate (LIBOR) plus a spread.

 

Additionally, we experienced an unfavorable volume variance of $3.2 million related to borrowings. In the second quarter of 2003, we issued $150.0 million of zero-coupon, convertible subordinated notes, with a maturity of June 15, 2008. Although no interest was paid on the notes, we experienced an increase in interest expense due

 

37



 

to amortization of the contingently convertible debt issuance costs. The overall unfavorable volume variance caused primarily by long-term debt and trust preferred securities was partially offset by average time deposits, which decreased from $611.0 million in 2002 to $485.2 million in 2003, causing a $1.3 million favorable volume variance.

 

The average cost of funds paid on average interest-bearing liabilities in 2003 was 0.81% down from 1.11% in 2002. This decrease in the average cost of funds was largely due to a decrease of 50 basis points on the average rates paid on both our money market deposit and time deposit products.

 

Provision for Loan Losses

 

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

 

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

 

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

 

2003 Compared to 2002—Improved Credit Quality Leads to Recovery of Provision for Loan Losses

 

We realized a recovery of provision for loan losses of $9.9 million in 2003, as compared to provision for loan losses of $5.9 million in 2002. We realized a slight net recovery of loan losses in 2003, compared to net charge-offs of $4.4 million in 2002. The change in provision for loan losses for 2003, as compared to 2002, resulted from the improvement in our loan portfolio’s credit quality position.

 

A large part of the loan recoveries in 2003 related to a settlement in August 2003 of litigation commenced by us relating to a charged-off film loan. This was reflected in the provision for loan losses for both the third quarter and nine months ended September 30, 2003. In October 2000, we filed a civil lawsuit for approximately $8.3 million (plus attorneys’ fees and interest) in the United States District Court for the Central District of California, against certain insurance companies for various causes of action, including breach of contract, breach of the duty of good faith, and fair dealing and fraud. The lawsuit concerned our claim for insurance coverage under an insurance policy issued to us by these insurance companies related to a loan made by us to finance production of a film. In the third quarter of 2003, the parties entered into a confidential and mutually agreeable settlement agreement, after which we dismissed the lawsuit. As a result of the settlement, we recorded significant recovery related to a previously charged-off film loan.

 

38



 

Noninterest Income

 

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

 

 

 

(As Restated)

 

 

 

Years Ended December 31,

 

 

 

 

 

 

 

%Change

 

 

 

%Change

 

(Dollars in thousands)

 

2004

 

2003

 

2004/2003

 

2002

 

2003/2002

 

 

 

 

 

 

 

 

 

 

 

 

 

Client investment fees

 

$

26,919

 

$

23,991

 

12.2

%

$

30,344

 

(20.9

)%

Corporate finance fees

 

22,024

 

12,204

 

80.5

 

10,872

 

12.3

 

Letter of credit and standby letter of credit income

 

9,994

 

8,912

 

12.1

 

10,258

 

(13.1

)

Deposit service charges

 

13,538

 

13,202

 

2.5

 

9,072

 

45.5

 

Gains (losses) on investment, securities net

 

5,198

 

(9,614

)

(154.1

)

(10,679

)

(10.0

)

Credit card fees

 

2,817

 

3,431

 

(17.9

)

955

 

259.3

 

Gains (losses) on derivative instruments, net