-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PlIq/K7bHH4N8O+hvL5AhM9KTqEJcz4/b6GVsgfclYCQx2vl9xBK0QoD8VyjlxRT 7GcOzIEj0e3B/OhJQF42ZA== 0000912057-99-006015.txt : 19991117 0000912057-99-006015.hdr.sgml : 19991117 ACCESSION NUMBER: 0000912057-99-006015 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SILICON VALLEY BANCSHARES CENTRAL INDEX KEY: 0000719739 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 942856336 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-15637 FILM NUMBER: 99754534 BUSINESS ADDRESS: STREET 1: 3003 TASMAN DRIVE, M/S NC820 CITY: SANTA CLARA STATE: CA ZIP: 95054 BUSINESS PHONE: 4086547400 MAIL ADDRESS: STREET 1: 3003 TASMAN DRIVE, M/S NC820 CITY: SANTA CLARA STATE: CA ZIP: 95054 10-Q 1 10-Q As filed with the Securities and Exchange Commission on November 15, 1999 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------- FORM 10-Q (MARK ONE) [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from ________ to ________. Commission File Number: 33-41102 SILICON VALLEY BANCSHARES (Exact name of registrant as specified in its charter) Delaware 91-1962278 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 3003 Tasman Drive Santa Clara, California 95054-1191 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (408) 654-7282 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ At October 31, 1999, 20,885,366 shares of the registrant's common stock ($0.001 par value) were outstanding. - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ This report contains a total of 35 pages. TABLE OF CONTENTS
PAGE ---- PART I - FINANCIAL INFORMATION ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS 3 CONSOLIDATED STATEMENTS OF INCOME 4 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 5 CONSOLIDATED STATEMENTS OF CASH FLOWS 6 NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 12 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 34 ITEM 2. CHANGES IN SECURITIES 34 ITEM 3. DEFAULTS UPON SENIOR SECURITIES 34 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 34 ITEM 5. OTHER INFORMATION 34 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 34 SIGNATURES 35
2 PART I - FINANCIAL INFORMATION ITEM 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS SILICON VALLEY BANCSHARES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
September 30, December 31, 1999 1998 (Dollars in thousands, except par value) (Unaudited) - ------------------------------------------------------------------------------------------- Assets: Cash and due from banks $ 185,577 $ 123,001 Federal funds sold and securities purchased under agreement to resell 103,441 399,202 Investment securities, at fair value 1,745,262 1,397,502 Loans, net of unearned income 1,661,016 1,611,921 Allowance for loan losses (70,800) (46,000) - ------------------------------------------------------------------------------------------- Net loans 1,590,216 1,565,921 Premises and equipment 11,059 11,354 Other real estate owned - 664 Accrued interest receivable and other assets 86,200 47,808 - ------------------------------------------------------------------------------------------- Total assets $3,721,755 $3,545,452 =========================================================================================== Liabilities and Stockholders' Equity: Liabilities: Noninterest-bearing demand deposits $1,359,017 $ 921,790 NOW deposits 46,977 19,978 Money market deposits 1,760,790 2,185,359 Time deposits 238,017 142,626 - ------------------------------------------------------------------------------------------- Total deposits 3,404,801 3,269,753 Other liabilities 34,934 21,349 - ------------------------------------------------------------------------------------------- Total liabilities 3,439,735 3,291,102 - ------------------------------------------------------------------------------------------- Company obligated mandatorily redeemable trust preferred securities of subsidiary trust holding solely junior subordinated debentures (trust preferred securities) 38,524 38,485 Stockholders' Equity: Preferred stock, $0.001 par value, 20,000,000 shares authorized; none outstanding Common stock, $0.001 par value, 60,000,000 shares authorized; 20,877,388 and 20,711,915 shares outstanding at September 30, 1999 and December 31, 1998, respectively 21 21 Additional paid-in capital 96,024 94,108 Retained earnings 151,154 123,855 Unearned compensation (2,734) (4,191) Accumulated other comprehensive income: Net unrealized gain/(loss) on available-for-sale investments (969) 2,072 - ------------------------------------------------------------------------------------------- Total stockholders' equity 243,496 215,865 - ------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $3,721,755 $3,545,452 ===========================================================================================
See notes to interim consolidated financial statements. 3 SILICON VALLEY BANCSHARES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
For the three months ended For the nine months ended ------------------------------ ------------------------------ September 30, September 30, September 30, September 30, 1999 1998 1999 1998 (Dollars in thousands, except per share amounts) (Unaudited) (Unaudited) (Unaudited) (Unaudited) - --------------------------------------------------------------------------------------------------------------------- Interest income: Loans, including fees $41,813 $36,494 $118,872 $ 101,356 Investment securities 24,158 17,757 65,252 47,959 Federal funds sold and securities purchased under agreement to resell 9,415 5,941 22,340 15,149 - --------------------------------------------------------------------------------------------------------------------- Total interest income 75,386 60,192 206,464 164,464 - --------------------------------------------------------------------------------------------------------------------- Interest expense: Deposits 20,997 21,736 63,900 58,669 Other borrowings - - - 3 - --------------------------------------------------------------------------------------------------------------------- Total interest expense 20,997 21,736 63,900 58,672 - --------------------------------------------------------------------------------------------------------------------- Net interest income 54,389 38,456 142,564 105,792 Provision for loan losses 21,563 10,557 40,334 20,061 - --------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 32,826 27,899 102,230 85,731 - --------------------------------------------------------------------------------------------------------------------- Noninterest income: Letter of credit and foreign exchange income 4,304 1,795 10,448 5,137 Disposition of client warrants 6,177 705 8,687 4,979 Deposit service charges 729 432 2,073 1,277 Client investment fees 1,241 137 1,719 315 Investment gains/(losses) - 4,149 (243) 4,626 Other 963 498 2,441 1,208 - --------------------------------------------------------------------------------------------------------------------- Total noninterest income 13,414 7,716 25,125 17,542 - --------------------------------------------------------------------------------------------------------------------- Noninterest expense: Compensation and benefits 18,150 10,773 49,071 34,877 Professional services 2,531 2,361 8,426 6,390 Net occupancy expense 1,713 1,394 4,750 3,451 Business development and travel 1,500 1,460 4,356 4,422 Furniture and equipment 1,368 1,320 4,159 5,051 Trust preferred securities distributions 825 825 2,475 1,187 Postage and supplies 618 635 1,850 1,545 Advertising and promotion 474 643 1,808 1,553 Telephone 522 481 1,361 1,600 Cost of other real estate owned - 19 268 (1,229) Other 2,015 1,152 4,526 2,893 - --------------------------------------------------------------------------------------------------------------------- Total noninterest expense 29,716 21,063 83,050 61,740 - --------------------------------------------------------------------------------------------------------------------- Income before income tax expense 16,524 14,552 44,305 41,533 Income tax expense 6,015 6,002 17,006 17,202 - --------------------------------------------------------------------------------------------------------------------- Net income $10,509 $ 8,550 $ 27,299 $ 24,331 ===================================================================================================================== Basic earnings per share $ 0.51 $ 0.42 $ 1.33 $ 1.20 Diluted earnings per share $ 0.50 $ 0.41 $ 1.30 $ 1.16 =====================================================================================================================
See notes to interim consolidated financial statements. 4 SILICON VALLEY BANCSHARES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three months ended For the nine months ended ------------------------------ ------------------------------ September 30, September 30, September 30, September 30, 1999 1998 1999 1998 (Dollars in thousands) (Unaudited) (Unaudited) (Unaudited) (Unaudited) - ------------------------------------------------------------------------------------------------------------------- Net income $10,509 $ 8,550 $27,299 $24,331 Other comprehensive income/(loss), net of tax: Changes in unrealized gains/(losses) on available-for-sale investments: Unrealized holding gains arising during period 9,140 4,873 2,279 7,123 Less: Reclassification adjustment for gains included in net income (3,892) (2,815) (5,320) (5,571) - ------------------------------------------------------------------------------------------------------------------- Other comprehensive income 5,248 2,058 (3,041) 1,552 - ------------------------------------------------------------------------------------------------------------------- Comprehensive income $15,757 $10,608 $24,258 $25,883 ===================================================================================================================
See notes to interim consolidated financial statements. 5 SILICON VALLEY BANCSHARES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended -------------------------------- September 30, September 30, 1999 1998 (Dollars in thousands) (Unaudited) (Unaudited) - ------------------------------------------------------------------------------------------------------------------ Cash flows from operating activities: Net income $ 27,299 $ 24,331 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 40,334 20,061 Depreciation and amortization 2,402 1,187 Net (gain)/loss on sales of investment securities 243 (4,626) Net gain on sales of other real estate owned - (1,298) (Increase) decrease in accrued interest receivable (8,286) 1,108 Increase in inventory (8,918) - Increase in prepaid expenses (456) (924) Increase (decrease) in unearned income (1,246) 662 Increase (decrease) in accrued liabilities 3,441 (489) Increase (decrease) in taxes payable (3,938) 3,926 Other, net (2,423) (1,539) - ------------------------------------------------------------------------------------------------------------------ Net cash provided by operating activities 48,452 42,399 - ------------------------------------------------------------------------------------------------------------------ Cash flows from investing activities: Proceeds from maturities and paydowns of investment securities 819,707 1,122,228 Proceeds from sales of investment securities 540,725 453,821 Purchases of investment securities (1,713,900) (1,489,814) Net increase in loans (70,340) (288,165) Proceeds from recoveries of charged off loans 6,958 2,055 Net proceeds from sales of other real estate owned 400 1,323 Purchases of premises and equipment (2,107) (6,251) - ------------------------------------------------------------------------------------------------------------------ Net cash used in investing activities (418,557) (204,803) - ------------------------------------------------------------------------------------------------------------------ Cash flows from financing activities: Net increase in deposits 135,047 511,463 Proceeds from issuance of trust preferred securities, net of issuance costs - 38,472 Proceeds from issuance of common stock, net of issuance costs 1,873 4,810 - ------------------------------------------------------------------------------------------------------------------ Net cash provided by financing activities 136,920 554,745 - ------------------------------------------------------------------------------------------------------------------ Net increase (decrease) in cash and cash equivalents (233,185) 392,341 Cash and cash equivalents at January 1, 522,203 426,832 - ------------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at September 30, $ 289,018 $ 819,173 ================================================================================================================== Supplemental disclosures: Interest paid $ 63,956 $ 58,528 Income taxes paid $ 29,310 $ 16,306 ==================================================================================================================
See notes to interim consolidated financial statements. 6 SILICON VALLEY BANCSHARES AND SUBSIDIARIES NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS 1. SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Silicon Valley Bancshares (the "Company") and its subsidiaries conform with generally accepted accounting principles and prevailing practices within the banking industry. Certain reclassifications have been made to the Company's 1998 consolidated financial statements to conform to the 1999 presentations. Such reclassifications had no effect on the results of operations or stockholders' equity. The following is a summary of the significant accounting and reporting policies used in preparing the interim consolidated financial statements. NATURE OF OPERATIONS The Company is a bank holding company whose principal subsidiary is Silicon Valley Bank (the "Bank"), a California-chartered bank with headquarters in Santa Clara, California. The Bank maintains regional banking offices in Northern and Southern California, and additionally has loan offices in Arizona, Colorado, Georgia, Illinois, Massachusetts, Minnesota, Oregon, Pennsylvania, Texas, Virginia, and Washington. The Bank serves emerging growth and middle-market companies in targeted niches, focusing on the technology and life sciences industries, while also identifying and capitalizing on opportunities to serve companies in other industries whose financial services needs are underserved. Substantially all of the assets, liabilities and earnings of the Company relate to its investment in the Bank. CONSOLIDATION The interim consolidated financial statements include the accounts of the Company and those of its wholly owned subsidiaries, the Bank, SVB Capital I and SVB Leasing Company (inactive). Intercompany accounts and transactions have been eliminated. INTERIM CONSOLIDATED FINANCIAL STATEMENTS In the opinion of Management, the interim consolidated financial statements contain all adjustments (consisting of only normal, recurring adjustments) necessary to present fairly the Company's consolidated financial position at September 30, 1999, the results of its operations and cash flows for the three and nine month periods ended September 30, 1999, and September 30, 1998. The December 31, 1998 consolidated financial statements were derived from audited financial statements, and certain information and footnote disclosures normally presented in annual financial statements prepared in accordance with generally accepted accounting principles have been omitted. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 1998 Annual Report on Form 10-K. The results of operations for the three and nine months ended September 30, 1999 may not necessarily be indicative of the Company's operating results for the full year. 7 BASIS OF FINANCIAL STATEMENT PRESENTATION The preparation of financial statements in conformity with generally accepted accounting principles requires Management to make estimates and judgments that affect the reported amounts of assets and liabilities as of the balance sheet date and the results of operations for the period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to possible change in the near term relates to the determination of the allowance for loan losses. An estimate of possible changes or range of possible changes cannot be made. CASH AND CASH EQUIVALENTS Cash and cash equivalents as reported in the consolidated statements of cash flows includes cash on hand, cash balances due from banks, federal funds sold, and securities purchased under agreement to resell. The cash equivalents are readily convertible to known amounts of cash and present an insignificant risk of changes in value due to maturity dates of 90 days or less. FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENT TO RESELL Federal funds sold and securities purchased under agreement to resell as reported in the consolidated balance sheets includes interest-bearing deposits in other financial institutions of $441,000 and $202,000 at September 30, 1999, and December 31, 1998, respectively. NONACCRUAL LOANS Loans are placed on nonaccrual status when they become 90 days past due as to principal or interest payments (unless the principal and interest are well secured and in the process of collection), when the Company has determined, based upon currently known information, that the timely collection of principal or interest is doubtful, or when the loans otherwise become impaired under the provisions of Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan." When a loan is placed on nonaccrual status, the accrued interest is reversed against interest income and the loan is accounted for on the cash or cost recovery method thereafter until qualifying for return to accrual status. Generally, a loan will be returned to accrual status when all delinquent principal and interest become current in accordance with the terms of the loan agreement and full collection of the principal appears probable. STOCK-BASED COMPENSATION The Company accounts for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and complies with the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the Company's stock and the exercise price. The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force ("EITF") Issue No. 96-18. 8 SEGMENT REPORTING The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," as of December 31, 1998. However, since Management views the Company as operating in only one segment, separate reporting of financial information under SFAS No. 131 is not considered necessary. Management approaches the Company's principal subsidiary, the Bank, as one business enterprise which operates in a single economic environment, since the products and services, types of customers and regulatory environment all have similar economic characteristics. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. In July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of SFAS No. 133," which delays the effective date of SFAS No. 133 to all fiscal quarters of fiscal years beginning after June 15, 2000. The Company expects to adopt this statement on January 1, 2001. The Company has not yet determined the impact of its adoption on the Company's consolidated financial statements. 2. EARNINGS PER SHARE The Company computes net income per share in accordance with SFAS No. 128, "Earnings per Share." Under the provisions of SFAS No. 128, basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if financial instruments or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. 9 The following is a reconciliation of basic earnings per share (EPS) to diluted EPS for the three and nine months ended September 30, 1999 and 1998.
Three Months Ended September 30, Nine Months Ended September 30, (Unaudited) (Unaudited) -------------------------------- --------------------------------- (Dollars and shares in thousands, Net Per Share Net Per Share except per share amounts) Income Shares Amount Income Shares Amount - ----------------------------------------------------------------------------------------------------------------- 1999: Basic EPS: Income available to common shareholders $10,509 20,602 $0.51 $27,299 20,535 $1.33 Effect of Dilutive Securities: Stock options and restricted stock - 625 - - 456 - - ------------------------------------------------------------------------------------------------------------------- Diluted EPS: Income available to common shareholders plus assumed conversions $10,509 21,227 $0.50 $27,229 20,991 $1.30 ================================================================================================================== 1998: Basic EPS: Income available to common shareholders $ 8,550 20,350 $0.42 $24,331 20,227 $1.20 Effect of Dilutive Securities: Stock options and restricted stock - 630 - - 721 - - ------------------------------------------------------------------------------------------------------------------- Diluted EPS: Income available to common shareholders plus assumed conversions $ 8,550 20,980 $0.41 $24,331 20,948 $1.16 ===================================================================================================================
3. LOANS The detailed composition of loans, net of unearned income of $8.8 million and $10.0 million at September 30, 1999, and December 31, 1998, respectively, is presented in the following table:
September 30, December 31, 1999 1998 (Dollars in thousands) (Unaudited) - ------------------------------------------------------------------------------------------------------------------ Commercial $1,443,667 $1,429,980 Real estate construction 80,533 74,023 Real estate term 71,465 60,841 Consumer and other 65,351 47,077 - ------------------------------------------------------------------------------------------------------------------ Total loans $1,661,016 $1,611,921 ==================================================================================================================
10 4. ALLOWANCE FOR LOAN LOSSES The activity in the allowance for loan losses for the three and nine months ended September 30, 1999 and 1998 was as follows:
Three Months Ended September 30, Nine Months Ended September 30, (Unaudited) (Unaudited) ------------------------------- --------------------------------- (Dollars in thousands) 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------------- Beginning balance $ 56,300 $ 42,300 $ 46,000 $ 37,700 Provision for loan losses 21,563 10,557 40,334 20,061 Loans charged off (10,253) (17,406) (22,491) (23,916) Recoveries 3,190 449 6,957 2,055 - ------------------------------------------------------------------------------------------------------------------- Balance at September 30, $ 70,800 $ 35,900 $ 70,800 $ 35,900 ===================================================================================================================
The aggregate recorded investment in loans for which impairment has been determined in accordance with SFAS No. 114 totaled $34.0 million and $23.2 million at September 30, 1999, and September 30, 1998, respectively. Allocations of the allowance for loan losses related to impaired loans totaled $13.3 million at September 30, 1999, and $5.9 million at September 30, 1998. Average impaired loans for the third quarters of 1999 and 1998 totaled $40.9 million and $30.2 million, respectively. 5. REINCORPORATION At the Annual Meeting of Shareholders, held on April 15, 1999, the shareholders of a majority of the Company's outstanding common stock approved a change in the Company's state of incorporation from California to Delaware. The reincorporation was effective April 23, 1999 and provided for 60,000,000 authorized shares of common stock with a $0.001 par value per share and for 20,000,000 authorized shares of preferred stock with a $0.001 par value per share. The accompanying consolidated financial statements have been retroactively restated to give effect to the reincorporation. Such reclassifications had no effect on the results of operations or stockholders' equity. 6. REGULATORY MATTERS In late September 1999, the Bank entered into an informal arrangement with the Federal Reserve Bank of San Francisco and the California Department of Financial Institutions, the Bank's primary banking regulators. Under the informal arrangement (pursuant to a memorandum of understanding), the Bank has committed to maintain a Tier 1 leverage ratio of at least 7.25%; obtain the regulators' consent prior to payment of dividends; further enhance its credit monitoring and review policies and submit reports to the regulators regarding credit quality. The Federal Reserve Bank of San Francisco has directed the Company to obtain its approval before incurring debt, paying dividends, repurchasing capital stock, or entering into agreements to acquire any entities or portfolios. The Company and the Bank believe compliance with this informal arrangement has not and will not have a material adverse impact on the business of the Bank, its clients or the Company. 11 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Company's interim consolidated financial statements as presented in Item 1 of this report. In addition to historical information, this discussion and analysis includes certain forward-looking statements regarding events and circumstances that may affect the Company's future results. Such forward-looking statements are subject to risks and uncertainties that could cause the Company's actual results to differ materially. These risks and uncertainties include, but are not limited to, those described in this discussion and analysis, as well as those described in the Company's 1998 Annual Report on Form 10-K. The Company wishes to caution readers not to place undue reliance on any forward-looking statements included herein, which speak only as of the date made. The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect unanticipated events and circumstances occurring after the date of such statements. Certain reclassifications have been made to the Company's 1998 consolidated financial statements to conform to the 1999 presentations. Such reclassifications had no effect on the results of operations or stockholders' equity. EARNINGS SUMMARY The Company reported net income of $10.5 million, or $0.50 per diluted share, for the third quarter of 1999, compared with net income of $8.6 million, or $0.41 per diluted share, for the third quarter of 1998. Net income totaled $27.3 million, or $1.30 per diluted share, for the nine months ended September 30, 1999, versus $24.3 million, or $1.16 per diluted share, for the comparable 1998 period. The annualized return on average assets (ROA) was 1.0% in the third quarter of 1999 versus 1.1% in the third quarter of 1998. The annualized return on average equity (ROE) for the third quarter of 1999 was 18.0%, compared to 16.6% in the 1998 third quarter. For the first nine months of 1999, ROA was 0.9% and ROE was 16.2% versus 1.1% and 16.9%, respectively, for the comparable 1998 period. The increase in net income during the three and nine month periods ended September 30, 1999, as compared with the prior year respective periods, was attributable to increases in net interest income and noninterest income, partially offset by an increase in both the provision for loan losses and noninterest expense. The major components of net income and changes in these components are summarized in the following table for the three and nine month periods ended September 30, 1999 and 1998, and are discussed in more detail below. 12
Three Months Ended September 30, Nine Months Ended September 30, (Unaudited) (Unaudited) -------------------------------- ------------------------------ (Dollars in thousands) 1999 1998 1999 1998 - -------------------------------------------------------------------------------------------------------------- Net interest income $54,389 $38,456 $142,564 $105,792 Provision for loan losses 21,563 10,557 40,334 20,061 Noninterest income 13,414 7,716 25,125 17,542 Noninterest expense 29,716 21,063 83,050 61,740 - --------------------------------------------------------------------------------------------------------------- Income before income taxes 16,524 14,552 44,305 41,533 Income tax expense 6,015 6,002 17,006 17,202 - --------------------------------------------------------------------------------------------------------------- Net income $10,509 $ 8,550 $ 27,299 $ 24,331 ===============================================================================================================
NET INTEREST INCOME AND MARGIN Net interest income represents the difference between interest earned, primarily on loans and investments, and interest paid on funding sources, primarily deposits, and is the principal source of revenue for the Company. Net interest margin is 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 fully taxable-equivalent interest income expressed as a percentage of average interest-earning assets. The average rate paid on funding sources is defined as interest expense as a percentage of average interest-earning assets. The following tables set forth average assets, liabilities and stockholders' equity, interest income and interest expense, average yields and rates, and the composition of the Company's net interest margin for the three and nine months ended September 30, 1999 and 1998, respectively. 13 - ----------------------------------------------------------------------------- AVERAGE BALANCES, RATES AND YIELDS - -----------------------------------------------------------------------------
For the three months ended September 30, --------------------------------------------------------------------- 1999 1998 (Unaudited) (Unaudited) ------------------------------ ------------------------------ Average Average Average Yield Average Yield (Dollars in thousands) Balance Interest Rate Balance Interest Rate - ----------------------------------------------------------------------------------------------------------------- Interest-earning assets: Federal funds sold and securities purchased under agreement to resell (1) $ 730,271 $ 9,415 5.1% $ 423,316 $ 5,941 5.6% Investment securities: Taxable 1,589,229 22,798 5.7 1,135,695 16,835 5.9 Non-taxable (2) 136,994 2,092 6.1 79,872 1,418 7.0 Loans: Commercial 1,373,122 37,193 10.7 1,194,522 31,992 10.6 Real estate construction and term 132,975 3,310 9.9 124,789 3,394 10.8 Consumer and other 59,531 1,310 8.7 48,380 1,108 9.1 - -------------------------------------- --------------------------------- ---------------------------------- Total loans 1,565,628 41,813 10.6 1,367,691 36,494 10.6 - -------------------------------------- --------------------------------- ---------------------------------- Total interest-earning assets 4,022,122 76,118 7.5 3,006,574 60,688 8.0 - -------------------------------------- --------------------------------- ---------------------------------- Cash and due from banks 211,045 143,921 Allowance for loan losses (63,725) (43,295) Other real estate owned - 681 Other assets 71,735 57,447 - -------------------------------------- ------ -------- Total assets $4,241,177 $3,165,328 ====================================== ============ ========== Funding sources: Interest-bearing liabilities: NOW deposits $ 37,776 193 2.0 $ 21,742 101 1.8 Regular money market deposits 386,360 2,546 2.6 353,241 2,434 2.7 Bonus money market deposits 2,095,554 15,900 3.0 1,622,710 17,763 4.3 Time deposits 229,823 2,358 4.1 126,075 1,438 4.5 - -------------------------------------- --------------------------------- ---------------------------------- Total interest-bearing liabilities 2,749,513 20,997 3.0 2,123,768 21,736 4.1 Portion of noninterest-bearing funding sources 1,272,609 882,806 - -------------------------------------- --------------------------------- ---------------------------------- Total funding sources 4,022,122 20,997 2.1 3,006,574 21,736 2.9 - -------------------------------------- --------------------------------- ---------------------------------- Noninterest-bearing funding sources: Demand deposits 1,188,773 773,506 Other liabilities 32,694 25,644 Trust preferred securities (3) 38,513 38,460 Stockholders' equity 231,684 203,950 Portion used to fund interest-earning assets (1,272,609) (882,806) - ---------------------------------------- ------------ --------- Total liabilities and stockholders' equity $4,241,177 $3,165,328 ======================================== ========== ========== Net interest income and margin $55,121 5.4% $38,952 5.1% ======================================== ======= ==== ======= ==== Total deposits $3,938,286 $2,897,274 ======================================== ========== ==========
(1) Includes average interest-bearing deposits in other financial institutions of $227 and $232 for the three months ended September 30, 1999 and 1998, respectively. (2) Interest income on non-taxable investments is presented on a fully taxable-equivalent basis using the federal statutory rate of 35% in 1999 and 1998. The tax equivalent adjustments were $732 and $496 for the three months ended September 30, 1999 and 1998, respectively. (3) The 8.25% annual distributions are recorded as a component of noninterest expense. 14 - -------------------------------------------------------------------------------- AVERAGE BALANCES, RATES AND YIELDS - --------------------------------------------------------------------------------
For the nine months ended September 30, ---------------------------------------------------------------------- 1999 1998 (Unaudited) (Unaudited) ------------------------------ -------------------------------- Average Average Average Yield/ Average Yield/ (Dollars in thousands) Balance Interest Rate Balance Interest Rate - -------------------------------------------------------------------------------------------------------------------- Interest-earning assets: Federal funds sold and securities purchased under agreement to resell (1) $ 607,892 $ 22,340 4.9% $ 364,544 $ 15,149 5.6% Investment securities: Taxable 1,426,444 61,158 5.7 1,027,295 45,699 5.9 Non-taxable (2) 134,827 6,298 6.2 68,419 3,477 6.8 Loans: Commercial 1,382,358 104,738 10.1 1,113,177 89,257 10.7 Real estate construction and term 136,276 10,351 10.2 112,299 9,097 10.8 Consumer and other 58,004 3,783 8.7 43,943 3,002 9.1 - ---------------------------------------- ------------------------------------ ------------------------------- Total loans 1,576,638 118,872 10.1 1,269,419 101,356 10.7 - ---------------------------------------- ------------------------------------ ------------------------------- Total interest-earning assets 3,745,801 208,668 7.4 2,729,677 165,681 8.1 - ---------------------------------------- ------------------------------------ ------------------------------- Cash and due from banks 182,238 134,861 Allowance for loan losses (54,982) (41,364) Other real estate owned 242 686 Other assets 66,837 52,901 - ---------------------------------------- ----------- ----------- Total assets $3,940,136 $2,876,761 ======================================== ========== ========== Funding sources: Interest-bearing liabilities: NOW deposits $ 27,396 353 1.7 $ 19,463 283 1.9 Regular money market deposits 357,115 7,124 2.7 339,056 6,900 2.7 Bonus money market deposits 2,041,519 50,564 3.3 1,416,124 47,171 4.5 Time deposits 188,618 5,859 4.2 127,913 4,315 4.5 Other borrowings - - - 73 3 5.5 - ---------------------------------------- ------------------------------------ ------------------------------- Total interest-bearing liabilities 2,614,648 63,900 3.3 1,902,629 58,672 4.1 Portion of noninterest-bearing funding sources 1,131,153 827,050 - ---------------------------------------- ------------------------------------ ------------------------------- Total funding sources 3,745,801 63,900 2.3 2,729,679 58,672 2.9 - ---------------------------------------- ------------------------------------ ------------------------------- Noninterest-bearing funding sources: Demand deposits 1,034,637 741,798 Other liabilities 27,410 20,666 Trust preferred securities (3) 38,501 18,615 Stockholders' equity 224,940 193,051 Portion used to fund interest-earning assets (1,131,153) (827,048) - ---------------------------------------- ------------ --------- Total liabilities and stockholders' equity $3,940,136 $2,876,761 ======================================== ========== ========== Net interest income and margin $144,768 5.2% $ 107,009 5.2% ======================================== ======== ==== ========= ==== Total deposits $3,649,285 $2,644,355 ======================================== ========== ==========
(1) Includes average interest-bearing deposits in other financial institutions of $199 and $248 for the nine months ended September 30, 1999 and 1998, respectively. (2) Interest income on non-taxable investments is presented on a fully taxable-equivalent basis using the federal statutory rate of 35% in 1999 and 1998. The tax equivalent adjustments were $2,204 and $1,217 for the nine months ended September 30, 1999 and 1998, respectively. (3) The 8.25% annual distributions are recorded as a component of noninterest expense. 15 Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume change." Net interest income is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabilities, referred to as "rate change." The following table sets forth changes in interest income and interest expense for each major category of interest-earning assets and interest-bearing liabilities. The table also reflects the amount of change attributable to both volume and rate changes for the periods indicated. Changes relating to investments in non-taxable municipal securities are presented on a fully taxable-equivalent basis using the federal statutory rate of 35% in 1999 and 1998.
1999 Compared to 1998 ---------------------------------------------------------------------- Three Months Ended September 30, Nine Months Ended September 30, (Unaudited) (Unaudited) -------------------------------- ------------------------------- Increase (Decrease) Increase (Decrease) Due to Change in Due to Change in ------------------------------- -------------------------------- (Dollars in thousands) Volume Rate Total Volume Rate Total - ------------------------------------------------------------------------------------------------------------------- Interest income: Federal funds sold and securities purchased under agreement to resell $ 3,958 $ (484) $ 3,474 $ 8,943 $ (1,752) $ 7,191 Investment securities 7,364 (727) 6,637 20,115 (1,835) 18,280 Loans 5,286 33 5,319 23,164 (5,648) 17,516 - ------------------------------------------------------------------------------------------------------------------- Increase (decrease) in interest income 16,608 (1,178) 15,430 52,222 (9,235) 42,987 - ------------------------------------------------------------------------------------------------------------------- Interest expense: NOW deposits 83 9 92 101 (31) 70 Regular money market deposits 218 (106) 112 361 (137) 224 Bonus money market deposits 3,589 (5,452) (1,863) 15,491 (12,098) 3,393 Time deposits 1,064 (144) 920 1,886 (342) 1,544 Other borrowings - - - - (3) (3) - ------------------------------------------------------------------------------------------------------------------- Increase (decrease) in interest expense 4,954 (5,693) (739) 17,839 (12,611) 5,228 - ------------------------------------------------------------------------------------------------------------------- Increase in net interest income $11,654 $ 4,515 $16,169 $34,383 $ 3,376 $37,759 ===================================================================================================================
Net interest income, on a fully taxable-equivalent basis, totaled $55.1 million for the third quarter of 1999, an increase of $16.2 million, or 41.5%, from the $39.0 million total for the third quarter of 1998. The increase in net interest income was the result of a $15.4 million, or 25.4%, increase in interest income, combined with a $0.7 million, or 3.4%, decrease in interest expense over the comparable prior year period. The $15.4 million increase in interest income for the third quarter of 1999, as compared to the third quarter of 1998, was the result of a $16.6 million favorable volume variance partially offset by a $1.2 million unfavorable rate variance. The favorable volume variance resulted from a $1.0 billion, or 33.8%, increase in average interest-earning assets over the comparable prior year period. The increase in average interest-earning assets resulted from strong growth in the Company's deposits, which increased $1.0 billion, or 35.9%, compared to the third quarter of 1998. The increase in average interest-earning assets consisted of loans, which were up $197.9 million, plus a combination of highly liquid, lower-yielding federal funds sold, securities purchased under agreement to resell and investment securities, which collectively increased $817.6 million, accounting for 80.5% of the total increase in average interest-earning assets. Average loans increased $197.9 million, or 14.5%, in the third quarter of 1999 as compared to the 1998 third quarter, resulting in a $5.3 million favorable volume variance. This growth was widely distributed throughout the loan portfolio, as reflected by increased loan balances in most 16 of the Company's technology and life sciences and special industry niche practices, in specialized lending products, and throughout the Company's loan offices located across the nation. Average investment securities for the third quarter of 1999 increased $510.7 million, or 42.0%, as compared to the 1998 third quarter, resulting in a $7.4 million favorable volume variance. The aforementioned strong growth in average deposits exceeded the growth in average loans over the past year, and generated excess funds that were largely invested in U.S. agency securities, mortgage-backed securities and municipal securities. Average federal funds sold and securities purchased under agreement to resell in the third quarter of 1999 increased a combined $307.0 million, or 72.5%, over the prior year third quarter, resulting in a $4.0 million favorable volume variance. This increase was also a result of the aforementioned strong growth in average deposits during the past year. Unfavorable rate variances associated with federal funds sold, securities purchased under agreements to resell and investment securities in the third quarter of 1999 resulted in a decrease in interest income of $1.2 million as compared to the respective prior year period. Short-term market interest rates have declined on an overall basis during the past year. As a result of this decline, the Company has earned lower yields on federal funds sold, securities purchased under agreements to resell and its investment securities, a significant portion of which were short-term in nature, resulting in this unfavorable rate variance as compared to the third quarter of 1998 The yield on average interest-earning assets decreased 50 basis points in the third quarter of 1999 from the comparable prior year period. This decrease resulted from a shift in the composition of average interest-earning assets towards a higher percentage of highly liquid, lower-yielding federal funds sold, securities purchased under agreement to resell and investment securities. This shift in the composition of average interest-earning assets resulted from the aforementioned strong growth in deposits which continued to outpace the growth in loans. Total interest expense in the 1999 third quarter decreased $0.7 million from the third quarter of 1998. This decrease was due to a favorable rate variance of $5.7 million, partially offset by an unfavorable volume variance of $5.0 million. The unfavorable volume variance resulted from a $625.7 million, or 29.5%, increase in average interest-bearing liabilities in the third quarter of 1999 as compared with the third quarter of 1998. This increase was largely concentrated in the Company's bonus money market deposit product, which increased $472.8 million, or 29.1%, and was explained by high levels of client liquidity attributable to a strong inflow of investment capital into the venture capital community during the past year, and by growth in the number of clients served by the Company. Changes in the average rates paid on interest-bearing liabilities had a $5.0 million favorable impact on interest expense in the third quarter of 1999 as compared to the respective period in 1998. This decrease in interest expense largely resulted from a reduction in the average rate paid on the Company's bonus money market deposit product, from 4.3% in the third quarter of 1998 to 3.0% in the third quarter of 1999. The reduction during 1999, in the average rate paid on the Company's bonus money market deposit product, was largely attributable to a decline in short-term market interest rates during the second half of 1998, and to the Company lowering rates paid on the bonus money market deposit an additional 123 basis points during the third quarter of 1999. 17 The average cost of funds paid on average interest-bearing liabilities decreased 110 basis points in the third quarter of 1999 versus the comparable prior year period. This decrease in the average cost of funds was largely due to a decrease of 130 basis points in the average rate paid on the Company's bonus money market deposit product. Net interest income, on a fully taxable-equivalent basis, totaled $144.8 million for the first nine months of 1999, an increase of $37.8 million, or 35.3%, from the $107.0 million total for the first nine months of 1998. The increase in net interest income was the result of a $43.0 million, or 25.9%, increase in interest income, partially offset by a $5.2 million, or 8.9%, increase in interest expense over the comparable prior year period. The $43.0 million increase in interest income for the first nine months of 1999, as compared to the first nine months of 1998, was the result of a $52.2 million favorable volume variance partially offset by a $9.2 million unfavorable rate variance. The favorable volume variance was attributable to growth in average interest-earning assets, which increased $1.0 billion, or 37.2%, from the comparable prior year period. The increase in average interest-earning assets resulted from strong growth in the Company's deposits, which increased $1.0 billion, or 38.0%, compared to the first nine months of 1998, and consisted of increases in all components of interest-earning assets. The growth in average loans was widely distributed throughout the loan portfolio, as reflected by increased loan balances in most of the Company's technology, life sciences and special industry niche practices, in specialized lending products, and throughout the Company's loan offices located across the nation. The growth in average federal funds sold, securities purchased under agreements to resell and investment securities resulted from the aforementioned strong growth in average deposits, which exceeded the growth in average loans over the past year. The $52.2 million favorable volume variance associated with interest-earning assets was partially offset by a $9.2 million unfavorable rate variance in the first nine months of 1999 as compared to the respective prior year period. This unfavorable rate variance was largely attributable to a decline in short-term market interest rates and a corresponding drop in the prime rate of 75 basis points during the second half of 1998, partially offset by increases in short-term market interest rates and the prime rate of 50 basis points in the third quarter of 1999. The yield on average interest-earning assets decreased 70 basis points in the first nine months of 1999 as compared to the respective prior year period. This decrease resulted from a decline in the average yield on loans, largely due to a reduction in the Company's prime rate during late 1998, as well as to a shift in the composition of average interest-earning assets towards a higher percentage of highly liquid, lower-yielding federal funds sold, securities purchased under agreements to resell and investment securities. This shift in the composition of average interest-earning assets resulted from the aforementioned strong growth in deposits, which continued to outpace the growth in loans. Total interest expense in the first nine months of 1999 increased $5.2 million from the first nine months of 1998 due to a $17.8 million unfavorable volume variance partially offset by a $12.6 million favorable rate variance. The unfavorable volume variance resulted from a $712.0 million, or 37.4%, increase in average interest-bearing liabilities in the first nine months of 1999 as compared with the first nine months of 1998. This increase was largely concentrated in the Company's bonus money market deposit product, which increased $625.4 million, or 44.2%, and was explained by high levels of client liquidity attributable to a strong inflow of investment 18 capital into the venture capital community during the past year, and by growth in the number of clients served by the Company. The $12.6 million favorable rate variance was largely attributable to a 120 basis points decrease in the average rate paid on the Company's bonus money market deposit product, due to a decline in short-term market interest rates during the second half of 1998 combined with the Company lowering the rates paid on the bonus money market deposit product an additional 123 basis points during the third quarter of 1999. The average cost of funds paid on interest-bearing liabilities decreased 80 basis points in the first nine months of 1999 versus the first nine months of the prior year. The decrease in the average cost of funds was largely due to a decrease of 120 basis points in the average rate paid on the Company's bonus money market deposit product. In an informal arrangement with the Bank's primary banking regulators (the Federal Reserve Bank of San Francisco and the California Department of Financial Institutions) pursuant to a memorandum of understanding entered into in late September 1999, the Bank has agreed to maintain a Tier 1 leverage ratio of at least 7.25% (see "Regulatory Matters" for further discussion). By maintaining fourth quarter 1999 average assets that approximate total assets as of September 30, 1999, combined with increasing Tier 1 capital through internally generated capital (e.g., net income), the Bank's Tier 1 leverage ratio is expected to exceed 7.25% at December 31, 1999. In recent periods, the Company's deposit growth has driven the growth of interest-earning assets. However, as part of the Company's plans to address the regulatory concerns described above, the rate paid on the Company's bonus money market deposit product was lowered by 100 basis points and higher yielding off-balance sheet private label mutual fund products were emphasized to clients. As a result, deposit balances decreased approximately $700 million during the last two weeks of September 1999 and average interest-earning assets (primarily federal funds sold) in the fourth quarter of 1999 are expected to be less than the previous quarter's total. Interest-earning assets totaled $3.5 billion at September 30, 1999, a decrease of $512.4 million, compared to $4.0 billion in average interest-earning assets for the third quarter of 1999. The Company's net interest margin for the fourth quarter of 1999 is expected to increase over the prior quarter's percentage due to an increase in the yield on interest-earning assets (resulting from a shift in the composition of interest-earning assets due to the anticipated decline in lower-yielding federal funds sold) as well as to a decrease in the cost of funds paid on interest-bearing liabilities (due to the lowering of deposit rates in late September 1999). PROVISION FOR LOAN LOSSES The provision for loan losses is based on Management's evaluation of the adequacy of the existing allowance for loan losses in relation to total loans, and on Management's periodic assessment of the inherent and identified risk dynamics of the loan portfolio resulting from reviews of selected individual loans and loan commitments. The Company's provision for loan losses totaled $21.6 million for the third quarter of 1999, an $11.0 million, or 104.3%, increase compared to the $10.6 million provision for the third quarter of 1998. The provision for loan losses increased $20.3 million, or 101.1%, to a total of $40.3 million for the first nine months of 1999, versus $20.1 million for the comparable 1998 period. 19 See "Financial Condition - Credit Quality and the Allowance for Loan Losses" for additional related discussion. NONINTEREST INCOME The following table summarizes the components of noninterest income for the three and nine month periods ended September 30, 1999 and 1998:
Three Months Ended Nine Months Ended September 30, September 30, (Unaudited) (Unaudited) ------------------------- ---------------------- (Dollars in thousands) 1999 1998 1999 1998 - ---------------------------------------------------------------------------------------------------------------- Letter of credit and foreign exchange income $ 4,304 $1,795 $10,448 $5,137 Disposition of client warrants 6,177 705 8,687 4,979 Deposit service charges 729 432 2,073 1,277 Client investment fees 1,241 137 1,719 315 Investment gains (losses) - 4,149 (243) 4,626 Other 963 498 2,441 1,208 - ------------------------------------------------------------------------------------------------------------------- Total noninterest income $13,414 $7,716 $25,125 $17,542 ===================================================================================================================
Noninterest income increased $5.7 million, or 73.8%, to a total of $13.4 million in the third quarter of 1999 versus $7.7 million in the prior year third quarter. Noninterest income totaled $25.1 million for the first nine months of 1999, an increase of $7.6 million, or 43.2%, from the $17.5 million recorded in the comparable 1998 period. The increase in noninterest income was largely due to increases in income from the disposition of client warrants, letter of credit fees, foreign exchange fees and other trade finance income, and client investment fees, partially offset by a decline in gains on sales of investment securities. Letter of credit fees, foreign exchange fees and other trade finance income totaled $4.3 million in the third quarter of 1999, an increase of $2.5 million, or 139.8%, from the $1.8 million reported in the third quarter of 1998. For the first nine months of 1999, letter of credit fees, foreign exchange fees and other trade finance income totaled $10.5 million, an increase of $5.3 million, or 103.4%, compared to the $5.1 million in the first nine months of 1998. The growth in this category of noninterest income reflects a concerted effort by Management to expand the penetration of trade finance-related products and services among the Company's growing client base, a large percentage of which provide products and services in international markets. The Company has historically obtained rights to acquire stock (in the form of warrants) in certain clients as part of negotiated credit facilities. The receipt of warrants does not change the loan covenants or other collateral control techniques employed by the Company to mitigate the risk of a loan becoming nonperforming, and collateral requirements on loans with warrants are similar to lending arrangements where warrants are not obtained. The timing and amount of income from the disposition of client warrants typically depend upon factors beyond the control of the Company, including the general condition of the public equity markets as well as the merger and acquisition environment, and therefore cannot be predicted with any degree of accuracy and are likely to vary materially from period to period. During the first nine months of 1999, as well as throughout 1998, a significant portion of the income realized by the Company from the disposition of client warrants was offset by expenses related to the Company's efforts to build an infrastructure sufficient to support present and prospective business activities, as well as evaluate and pursue new business opportunities, and was also offset by increases to the provision for loan 20 losses during those periods. The Company realized pre-tax income of $14.5 million from the disposition of client warrants in October 1999. Based on October 31, 1999 market valuations, the Company had additional potential pre-tax warrant gains totaling over $29.2 million, of which over $22.9 million related to four clients. The Company is restricted from exercising many of these warrants until the fourth quarter of 1999 and first quarter of 2000. Further, based on October 31, 1999 market valuations, the Company had a potential pre-tax gain on a venture capital fund investment of over $14.3 million. The Company is restricted from selling this equity instrument until the first quarter of the year 2000. Additionally, the Company is precluded from using any type of derivative instrument to secure the current unrealized gains associated with these equity instruments. Hence, the amount of income realized by the Company from these equity instruments in future periods may vary materially from the current unrealized amount due to fluctuations in the market prices of the underlying common stock of these companies. Furthermore, the Company may reinvest some or all of the income realized from the disposition of these equity instruments in pursuing its business strategies. Deposit service charges totaled $0.7 million for the three months ended September 30, 1999, an increase of $0.3 million, or 68.8%, from the $0.4 million reported in the third quarter of 1998. For the first nine months of 1999 and 1998 deposit service charges totaled $2.1 million and $1.3 million, respectively. Clients compensate the Company for depository services either through earnings credits computed on their demand deposit balances, or via explicit payments recognized as deposit service charges income. The increase in deposit service charges income was due to both a reduction in earnings credits resulting from a decrease in short-term money market rates during the second half of 1998 and growth in the Company's client base. Client investment fees totaled $1.2 million in the third quarter of 1999 compared to $0.1 million in the 1998 third quarter. For the nine months ended September 30, 1999, client investment fees totaled $1.7 million versus $0.3 million in the comparable 1998 period. Prior to June 1999, the Company only earned client investment fees on off-balance sheet funds that were invested by clients in investment securities such as U.S. Treasuries, U.S. agencies and commercial paper. Off-balance sheet client funds totaled $1.1 billion at December 31, 1998. Beginning in June 1999, the Company began offering off-balance sheet private label mutual fund products to clients. The Company earns approximately 35 basis points on the average balance in these products. At September 30, 1999, $3.8 billion in client funds were invested off-balance sheet, including $1.9 billion in the mutual fund products. The significant growth in the amount of off-balance sheet client funds was explained by high levels of client liquidity attributable to a strong inflow of investment capital into the venture capital community during the past year, and by growth in the number of clients served by the Company. The Company realized a $0.2 million loss on investment securities during the first nine months of 1999, versus a $4.6 million gain on sales of investment securities during the comparable prior year period. All investment securities sold were classified as available-for-sale, and all sales were conducted as a normal component of the Company's asset/liability and liquidity management activities. For additional related discussion, see the Item 2 section entitled "Liquidity." Other noninterest income largely consists of service-based fee income, and increased $0.5 million, or 93.4%, to $1.0 million in the third quarter of 1999 from $0.5 million in the third quarter of 1998. For the nine month period ended September 30, 1999, other noninterest income increased $1.2 million, or 102.1%, to $2.4 million from $1.2 million in the comparable 1998 21 period. The increase during 1999 was primarily due to a higher volume of cash management and loan documentation services related to the Company's growing client base. NONINTEREST EXPENSE Noninterest expense in the third quarter of 1999 totaled $29.7 million, an $8.7 million, or 41.1%, increase from the $21.1 million incurred in the comparable 1998 period. Noninterest expense totaled $83.1 million for the first nine months of 1999, an increase of $21.3 million, or 34.5%, over the $61.7 million total for the comparable 1998 period. Management closely monitors the level of noninterest expense using a variety of financial ratios, including the efficiency ratio. The efficiency ratio is calculated by dividing the amount of noninterest expense, excluding costs associated with other real estate owned, by adjusted revenues, defined as the total of net interest income and noninterest income, excluding income from the disposition of client warrants and gains or losses related to sales of investment securities. This ratio reflects the level of operating expense required to generate $1 of operating revenue. The Company's efficiency ratio for the 1999 third quarter was 48.2% versus 50.9% for the third quarter of 1998. The Company's efficiency ratio for the first nine months of 1999 was 52.0% versus 55.4% for the comparable 1998 period. The following tables present the detail of noninterest expense and the incremental contribution of each line item to the Company's efficiency ratio:
Three Months Ended September 30, (Unaudited) ---------------------------------------------------------------- 1999 1998 ------------------------- ----------------------------- Percent of Percent of Adjusted Adjusted (Dollars in thousands) Amount Revenues Amount Revenues - ------------------------------------------------------------------------------------------------------------------- Compensation and benefits $18,150 29.5% $10,773 26.1% Professional services 2,531 4.1 2,361 5.7 Net occupancy expense 1,713 2.8 1,394 3.4 Business development and travel 1,500 2.4 1,460 3.5 Furniture and equipment 1,368 2.2 1,320 3.2 Trust preferred securities distributions 825 1.3 825 2.0 Postage and supplies 618 1.0 635 1.5 Telephone 522 0.8 481 1.2 Advertising and promotion 474 0.8 643 1.6 Other 2,015 3.3 1,152 2.8 - ------------------------------------------------------------------------------------------------------------------ Total excluding cost of other real estate owned 29,716 48.2% 21,044 50.9% Cost of other real estate owned - 19 - ------------------------------------------------------------------------------------------------------------------ Total noninterest expense $29,716 $21,063 ==================================================================================================================
22
Nine Months Ended September 30, (Unaudited) ---------------------------------------------------------------- 1999 1998 ------------------------- ----------------------------- Percent of Percent of Adjusted Adjusted (Dollars in thousands) Amount Revenues Amount Revenues - ------------------------------------------------------------------------------------------------------------------- Compensation and benefits $49,071 30.8% $34,877 30.7% Professional services 8,426 5.3 6,390 5.6 Net occupancy expense 4,750 3.0 3,451 3.0 Business development and travel 4,356 2.7 4,422 3.9 Furniture and equipment 4,159 2.6 5,051 4.4 Trust preferred securities distributions 2,475 1.6 1,187 1.0 Postage and supplies 1,850 1.2 1,545 1.4 Advertising and promotion 1,808 1.1 1,553 1.4 Telephone 1,361 0.9 1,600 1.4 Other 4,526 2.8 2,893 2.5 - ------------------------------------------------------------------------------------------------------------------ Total excluding cost of other real estate owned 82,782 52.0% 62,969 55.4% Cost of other real estate owned 268 (1,229) - ------------------------------------------------------------------------------------------------------------------ Total noninterest expense $83,050 $61,740 ==================================================================================================================
Compensation and benefits expenses totaled $18.2 million in the third quarter of 1999, a $7.4 million, or 68.5%, increase over the $10.8 million incurred in the third quarter of 1998. For the first nine months of 1999, compensation and benefits expenses totaled $49.1 million, an increase of $14.2 million, or 40.7%, compared to $34.9 million for the comparable 1998 period. The increase in compensation and benefits expenses was largely the result of an increase in the number of average full-time equivalent (FTE) personnel employed by the Company combined with the Company lowering its performance-based compensation in the third quarter of 1998 in response to an increase in charge-offs during that quarter. Average FTE were 641 and 623 for the three and nine month periods ended September 30, 1999, versus 537 and 504 for the respective prior year periods. The increase in FTE was primarily due to a combination of the Company's efforts to develop and support new markets through geographic expansion, to develop and expand products, services and niches, and to build an infrastructure sufficient to support present and prospective business activities. Further growth in the Company's FTE is likely to occur during future years as a result of the continued expansion of the Company's business activities. Professional services expenses, which consist of costs associated with corporate legal services, litigation settlements, accounting and auditing services, consulting, and the Company's Board of Directors, totaled $2.5 million and $8.4 million for the three and nine months ended September 30, 1999, an increase of $0.2 million, or 7.2%, and $2.0 million, or 31.9%, compared to $2.4 million and $6.4 million in the comparable 1998 periods. The increase in professional services expenses primarily related to an increase in consulting fees associated with several business initiatives, including the Year 2000 remediation project. The level of professional services expenses during 1999 and 1998 reflects the extensive efforts undertaken by the Company to continue to build and support its infrastructure, as well as evaluate and pursue new business opportunities. It also reflects the Company's efforts in outsourcing several corporate functions, 23 such as internal audit, facilities management and credit review, where the Company believes it can achieve a combination of cost savings and increased quality of service. Occupancy, furniture and equipment expenses totaled $3.1 million and $8.9 million for the three and nine months ended September 30, 1999, an increase of $0.4 million, or 13.5%, and $0.4 million, or 4.8%, from the $2.7 million and $8.5 million for the three and nine months ended September 30, 1998, respectively. The increase in occupancy, furniture and equipment expenses in 1999 as compared to 1998, was primarily the result of the Company's continued geographic expansion to develop and support new markets. Trust preferred securities distributions totaled $0.8 million for the three months ended September 30, 1999 and 1998. For the first nine months of 1999, trust preferred securities distributions totaled $2.5 million, an increase of $1.3 million, or 108.5%, compared to $1.2 million for the comparable 1998 period. These distributions resulted from the issuance of $40.0 million in cumulative trust preferred securities during the second quarter of 1998. The trust preferred securities pay a fixed rate quarterly distribution of 8.25% and have a maximum maturity of 30 years. During the second quarter of 1998, the Company realized a net gain of $1.3 million in connection with a sale of an OREO property that consisted of multiple undeveloped lots. Other noninterest expense totaled $2.0 million and $4.5 million for the three and nine months ended September 30, 1999, an increase of $0.9 million, or 74.9%, and $1.6 million, or 56.5%, compared to $1.2 million and $2.9 million for the respective 1998 periods. This increase was primarily attributable to increased data processing services related to both the overall growth in the Company's business and several new business initiatives. Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against the Company and/or the Bank. Based upon information available to the Company, its review of such claims to date and consultation with its legal counsel, Management believes the liability relating to these actions, if any, will not have a material adverse effect on the Company's liquidity, consolidated financial position or results of operations. INCOME TAXES The Company's effective tax rate was 36.4% and 38.4% for the third quarter and first nine months of 1999, compared to 41.3% and 41.4% in the three and nine month prior year periods, respectively. The decrease in the Company's effective income tax rate was principally attributable to an increase in the amount of the tax exempt interest income received by the Company, as well as to a change in the Company's multi-state income tax rate. FINANCIAL CONDITION The Company's total assets were $3.7 billion at September 30, 1999, an increase of $176.3 million, or 5.0%, compared to $3.5 billion at December 31, 1998. 24 FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENT TO RESELL Federal funds sold and securities purchased under agreement to resell totaled a combined $103.4 million at September 30, 1999, a decrease of $295.8 million, or 74.1%, compared to the $399.2 million outstanding at the prior year end. This decrease was attributable to a decrease in the Company's deposits of approximately $700.0 million during the last two weeks of September 1999. See "Financial Condition - Deposits" for further discussion. INVESTMENT SECURITIES Investment securities totaled $1.7 billion at September 30, 1999, an increase of $347.8 million, or 24.9%, from the December 31, 1998 balance of $1.4 billion. This increase resulted from excess funds that were generated by growth in the Company's deposits outpacing the growth in loans during the first nine months of 1999, and primarily consisted of U.S. agency securities and mortgage-backed securities. The increase in short-term market interest rates during the first nine months of 1999 resulted in a pre-tax unrealized loss on the Company's available-for-sale fixed income securities investment portfolio of $31.5 million as of September 30, 1999. This unrealized loss was offset by a pre-tax unrealized gain of $30.5 million associated with equity securities, which includes the Company's warrant portfolio and venture capital fund investments. Because of the level of liquidity maintained by the Company, the Company does not anticipate having to sell fixed income investment securities and incurring material losses on sales in future periods for liquidity purposes. Additionally, the Company is restricted from exercising many of the warrants until the fourth quarter of 1999 and first quarter of 2000. The Company is also precluded from using any type of derivative instrument to secure the current unrealized gains associated with these equity instruments. Hence, the amount of income recognized in future periods by the Company from the disposition of these equity instruments may vary materially from the current unrealized amount due to fluctuations in the market prices of the underlying common stock of these companies. LOANS Total loans, net of unearned income, at September 30, 1999, were $1.7 billion, a $49.1 million, or 3.0%, increase compared to the $1.6 billion total at December 31, 1998. While the Company continues to generate new loans in most of the Company's technology, life sciences and special industry niche practices, as well as in specialized lending products, the Company's clients, primarily in the technology niche practices, have experienced high levels of liquidity attributable to the capital markets and venture capital community. Consequently, the Company has experienced higher than normal loan paydowns and payoffs, which has caused total loans to remain relatively unchanged between September 30, 1999 and the prior year end. CREDIT QUALITY AND THE ALLOWANCE FOR LOAN LOSSES Credit risk is defined as the possibility of sustaining a loss because other parties to the financial instrument fail to perform in accordance with the terms of the contract. While the Bank follows underwriting and credit monitoring procedures which it believes are appropriate in growing and managing the loan portfolio, in the event of nonperformance by these other parties, the Bank's 25 potential exposure to credit losses could significantly affect the Company's consolidated financial position and earnings. Lending money involves an inherent risk of nonpayment. Through the administration of loan policies and monitoring of the portfolio, Management seeks to reduce such risks. The allowance for loan losses is an estimate to provide a financial buffer for losses, both identified and unidentified, in the loan portfolio. Management regularly reviews and monitors the loan portfolio to determine the risk profile of each credit, and to identify credits whose risk profiles have changed. This review includes, but is not limited to, 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. Potential problem credits are identified and, based upon known information, action plans are developed. Management has established an evaluation process designed to determine the adequacy of the allowance for loan losses. This process attempts to assess the risk of losses inherent in the loan portfolio by segregating the allowance for loan losses into three components: "specific," "loss migration" and "general." The specific component is established by allocating a portion of the allowance for loan losses to individual classified credits on the basis of specific circumstances and assessments. The loss migration component is calculated as a function of the historical loss migration experience of the internal loan credit risk rating categories. The general component is an unallocated portion that supplements the first two components and includes: Management's judgment of the effect of current and forecasted economic conditions on the borrowers' abilities to repay, an evaluation of the allowance for loan losses in relation to the size of the overall loan portfolio, an evaluation of the composition of, and growth trends within, the loan portfolio, consideration of the relationship of the allowance for loan losses to nonperforming loans, net charge-off trends, and other factors. While this evaluation process utilizes historical and other objective information, the classification of loans and the establishment of the allowance for loan losses, relies, to a great extent, on the judgment and experience of Management. The allowance for loan losses totaled $70.8 million at September 30, 1999, an increase of $24.8 million, or 53.9%, compared to the $46.0 million balance at December 31, 1998. This increase was due to $40.3 million in additional provisions to the allowance for loan losses, partially offset by $15.5 million of net charge-offs for the nine months ended September 30, 1999. The $40.3 million in loan loss provisions during the first nine months of 1999 was in response to a recent trend of increased quarterly gross charge-offs. The Company incurred $10.3 million and $22.5 million in gross charge-offs during the three and nine months ended September 30, 1999. Gross charge-offs for the 1999 third quarter included $5.8 million related to one commercial credit, which was classified as nonperforming at June 30, 1999, in the Company's computers and peripherals niche. The Company realized recoveries of $3.2 million and $7.0 million for the three and nine months ended September 30, 1999, respectively. 26 Pursuant to a memorandum of understanding with the Bank's primary banking regulators, the Bank has committed to further enhance its credit monitoring and review policies and submit reports to the regulators regarding credit quality. Management believes the allowance for loan losses is adequate as of September 30, 1999. However, future changes in circumstances, economic conditions or other factors could cause Management to increase or decrease the allowance for loan losses as deemed necessary. Nonperforming assets consist of loans that are past due 90 days or more but still accruing interest, loans on nonaccrual status and OREO and other foreclosed assets. The table below sets forth certain relationships between nonperforming loans, nonperforming assets and the allowance for loan losses:
September 30, December 31, 1999 1998 (Dollars in thousands) (Unaudited) (Unaudited) - ----------------------------------------------------------------------------------------------------------------- Nonperforming assets: Loans past due 90 days or more $ 1,553 $ 441 Nonaccrual loans 33,959 19,444 - ----------------------------------------------------------------------------------------------------------------- Total nonperforming loans 35,512 19,885 OREO and other foreclosed assets 694 1,800 - ----------------------------------------------------------------------------------------------------------------- Total nonperforming assets $36,206 $21,685 ================================================================================================================= Nonperforming loans as a percentage of total loans 2.1% 1.2% Nonperforming assets as a percentage of total assets 1.0% 0.6% Allowance for loan losses: $70,800 $46,000 As a percentage of total loans 4.2% 2.8% As a percentage of nonaccrual loans 208.5% 236.6% As a percentage of nonperforming loans 199.4% 231.3%
Nonperforming loans totaled $35.5 million, or 2.1% of total loans, at September 30, 1999, compared to $19.9 million, or 1.2% of total loans, at December 31, 1998. The increase in nonperforming loans from the prior year end was primarily due to one credit in the Company's Financial Services (non-technology) niche which had a balance of approximately $15.0 million at September 30, 1999. This credit had been previously classified as nonperforming at March 31, 1999. As of September 30, 1999, Management believes this credit is adequately secured with collateral and reserves, and that any future charge-offs associated with this loan will not have a material impact on the future net income of the Company. In addition to the loans disclosed in the foregoing analysis, Management has identified three loans with principal amounts aggregating approximately $14.2 million, that, on the basis of information known by Management, were judged to have a higher than normal risk of becoming nonperforming. The Company is not aware of any other loans where known information about possible problems of the borrower casts serious doubts about the ability of the borrower to comply with the loan repayment terms. OREO and other foreclosed assets totaled a combined $0.7 million at September 30, 1999, a $1.1 million decrease from the $1.8 million balance at December 31, 1998. This decrease was primarily due 27 to the sale of the Company's only OREO property during the second quarter of 1999. The OREO and other foreclosed assets balance at September 30, 1999, consisted of one asset which was acquired through foreclosure. This asset consists of a favorable leasehold right under a master lease which the Company acquired upon foreclosure of a loan during the third quarter of 1997. DEPOSITS Total deposits were $3.4 billion at September 30, 1999, an increase of $135.0 million, or 4.1%, from the prior year-end total of $3.3 billion. A significant portion of the increase in deposits during the first nine months of 1999 was concentrated in the noninterest-bearing demand deposit product, which increased $437.2 million, or 47.4%, to a total of $1.4 billion at the end of the September 30, 1999. This increase was explained by high levels of client liquidity attributable to a strong inflow of investment capital into the venture capital community, and by growth during the first nine months of 1999 in the number of clients served by the Company. Despite the high levels of client liquidity, the Company's money market deposits decreased $424.6 million from December 31, 1998, and decreased $615.6 million from June 30, 1999. The decrease in money market deposits was the result of the Company lowering bonus money market deposit rates 123 basis points during the third quarter of 1999 and also emphasizing higher-yielding off-balance sheet private label mutual fund products to clients in order to lower total assets thereby increasing the Tier 1 leverage ratio (see "Regulatory Matters" for further discussion). YEAR 2000 READINESS DISCLOSURE The Federal Financial Institutions Examination Council (FFIEC), an oversight authority for financial institutions, has issued several interagency statements on Year 2000 project awareness. These statements require financial institutions to, among other things, examine the Year 2000 implications of their reliance on vendors, determine the potential impact of the Year 2000 issue on their customers, suppliers and borrowers, and to survey its exposure, measure its risk and prepare a plan to address the Year 2000 issue. In addition, federal banking regulators have issued safety and soundness guidelines to be followed by financial institutions to assure resolution of any Year 2000 problems. The federal banking agencies have asserted that Year 2000 testing and certification is a key safety and soundness issue in conjunction with regulatory examinations, and the failure to appropriately address the Year 2000 issue could result in supervisory action, including the reduction of the institution's supervisory ratings, the denial of applications for mergers or acquisitions, or the imposition of civil monetary penalties. The Company, following an initial awareness phase, is utilizing a three-phase plan for achieving Year 2000 readiness. The Assessment Phase was intended to determine which computers, operating systems and applications require remediation and prioritizing those remediation efforts by identifying mission critical systems. The Assessment Phase has been completed except for the on-going assessment of new systems. The Remediation and Testing Phase addressed the correction or replacement of any non-compliant hardware and software related to the mission critical systems and testing of those systems. Since most of the Bank's information technology systems are off-the-shelf software, remediation efforts have focused on obtaining Year 2000 compliant application upgrades. The Bank's core banking system, which runs loans, deposits and the general ledger, has been upgraded to the Year 2000 compliant version and has been forward date tested and Year 2000 certified by the Bank. The Year 2000 releases for all of the Bank's 28 other internal mission critical systems have also been received, forward date tested and certified. Furthermore, testing of mission critical service providers, has been completed as of June 30, 1999. During the final phase, the Implementation Phase, remediated and validated code was tested in interfaces with customers, business partners, government institutions, and others. As of June 30, 1999 all mission critical testing and implementation of mission critical systems into the production environment was completed. June 30, 1999, marked the final FFIEC milestone. Although the Company has attempted to make every effort to be prepared for the century date change, it may be affected by the Year 2000 compliance issues of governmental agencies, businesses and other entities that provide data to, or receive data from, the Company, and by entities, such as borrowers, vendors, customers, and business partners, whose financial condition or operational capability is significant to the Company. Therefore, the Company's Year 2000 project also includes assessing the Year 2000 readiness of certain customers, borrowers, vendors, business partners, counterparties, and governmental entities. In addition to assessing the readiness of these external parties, the Company is developing contingency plans which will include plans to recover operations and alternatives to mitigate the effects of counterparties whose own failure to properly address Year 2000 issues may adversely impact the Company's ability to perform certain functions. Contingency planning and testing of critical business processes was complete as of June 30, 1999. If Year 2000 issues are not adequately addressed by the Company and significant third parties, the Company's business, results of operations and financial position could be materially adversely affected. Failure of certain vendors to be Year 2000 compliant could result in disruption of important services upon which the Company depends, including, but not limited to, such services as telecommunications, electrical power and data processing. Failure of the Company's loan customers to properly prepare for the Year 2000 could also result in increases in problem loans and credit losses in future years. It is not, however, possible to quantify the potential impact of any such losses at this time. Notwithstanding the Company's efforts, there can be no assurance that the Company or significant third party vendors or other significant third parties will adequately address their Year 2000 issues. The Company is continuing to assess the Year 2000 readiness of third parties but does not know at this time whether the failure of third parties to be Year 2000 compliant will have a material effect on the Company's results of operations, liquidity and financial condition. The Company currently estimates that its total cost for the Year 2000 project will approximate $3.0 million. During the first nine months of 1999, the Company incurred $1.4 million, bringing the total incurred in 1998 and 1999 for charges related to its Year 2000 remediation effort to $2.9 million. The Company expects to incur approximately $0.1 million during the remainder of 1999. Charges include the cost of external consulting and the cost of accelerated replacement of hardware, but do not include the cost of internal staff redeployed to the Year 2000 project. The Company does not believe that the redeployment of internal staff has or will have a material impact on its financial condition or results of operations. The foregoing paragraphs contain a number of forward-looking statements. These statements reflect Management's best current estimates, which were based on numerous assumptions about future events, including the continued availability of certain resources, representations received from third party service providers and other factors. There can be no guarantee that these estimates, including Year 2000 costs, will be achieved, and actual results could differ materially from those estimates. A number of important factors could cause Management's estimates and 29 the impact of the Year 2000 issue to differ materially from what is described in the forward-looking statements contained in the above paragraphs. Those factors include, but are not limited to, the availability and cost of programmers and other systems personnel, inaccurate or incomplete execution of the phases, results of Year 2000 testing, adequate resolution of Year 2000 issues by the Company's customers, vendors, competitors, and counterparties, and similar uncertainties. The forward-looking statements made in the foregoing Year 2000 discussion speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. MARKET RISK MANAGEMENT Interest rate risk is the most significant market risk impacting the Company. The Company's monitoring activities related to managing interest rate risk include both interest rate sensitivity "gap" analysis and the use of a simulation model to measure the impact of market interest rate changes on the net present value of estimated cash flows from the Company's assets, liabilities and off-balance sheet items, defined as the Company's market value of portfolio equity (MVPE). See the Company's 1998 Annual Report on Form 10-K for disclosure of the quantitative and qualitative information regarding the interest rate risk inherent in interest rate risk sensitive instruments as of December 31, 1998. There have been no changes in the assumptions used by the Company in monitoring interest rate risk, and the Company is in compliance with all interest rate risk policy guidelines as of September 30, 1999. Other types of market risk affecting the Company in the normal course of its business activities include foreign currency exchange risk and equity price risk. The impact on the Company, resulting from these other two types of market risks, is deemed immaterial. The Company does not maintain a portfolio of trading securities and does not intend to engage in such activities in the immediate future. LIQUIDITY The objective of liquidity management is to ensure that funds are available in a timely manner to meet loan demand and depositors' needs, and to service other liabilities as they come due, without causing an undue amount of cost or risk, and without causing a disruption to normal operating conditions. The Company regularly assesses the amount and likelihood of projected funding requirements through a review of factors such as historical deposit volatility and funding patterns, present and forecasted market and economic conditions, individual client funding needs, and existing and planned Company business activities. The asset/liability committee of the Bank provides oversight to the liquidity management process and recommends policy guidelines, subject to Board of Directors approval, and courses of action to address the Company's actual and projected liquidity needs. The ability to attract a stable, low-cost base of deposits is the Company's primary source of liquidity. Other sources of liquidity available to the Company include short-term borrowings, which consist of federal funds purchased, security repurchase agreements and other short-term borrowing arrangements. The Company's liquidity requirements can also be met through the use of its portfolio of liquid assets. Liquid assets, as defined, include cash and cash equivalents in 30 excess of the minimum levels necessary to carry out normal business operations, federal funds sold, securities purchased under resale agreements, investment securities maturing within six months, investment securities eligible and available for pledging purposes with a maturity in excess of six months, and anticipated near term cash flows from investments. Bank policy guidelines provide that liquid assets as a percentage of total deposits should not fall below 20.0%. At September 30, 1999, the Bank's ratio of liquid assets to total deposits was 49.0%. This ratio is well in excess of the Bank's minimum policy guidelines and is slightly lower than the comparable ratio of 52.5% as of December 31, 1998. In addition to monitoring the level of liquid assets relative to total deposits, the Bank also utilizes other policy measures in its liquidity management activities. As of September 30, 1999, the Bank was in compliance with all of these policy measures. CAPITAL RESOURCES Management seeks to maintain adequate capital to support anticipated asset growth and credit risks, and to ensure that the Company and the Bank are in compliance with all regulatory capital guidelines. The primary source of new capital for the Company has been the retention of earnings. Aside from current earnings, other sources of new capital for the Company have been the issuance of common stock under the Company's employee benefit plans, including the Company's stock option plans, defined contribution plans and employee stock purchase plan. Additionally, during the second quarter of 1998 the Company issued $40.0 million in cumulative trust preferred securities through SVB Capital I. The trust preferred securities are presented as a separate line item in the consolidated balance sheet of the Company under the caption "Company obligated mandatorily redeemable trust preferred securities of subsidiary trust holding solely junior subordinated debentures." The securities have a maximum maturity of 30 years and qualify as Tier 1 capital under the capital guidelines of the Federal Reserve Board. Stockholders' equity totaled $243.5 million at September 30, 1999, an increase of $27.6 million, or 12.8%, from the $215.9 million balance at December 31, 1998. This increase resulted from net income of $27.3 million combined with capital generated primarily through the Company's employee benefit plans of $3.4 million, partially offset by a decrease in the after-tax net unrealized gain on available-for-sale investments of $3.0 million from the prior year end. See "Financial Condition - Investment Securities" for additional discussion on the net unrealized loss on available-for-sale investments as of September 30, 1999. The Company and the Bank are subject to capital adequacy guidelines issued by the Federal Reserve Board. Under these capital guidelines, the minimum total risk-based capital and Tier 1 risk-based capital ratio requirements are 10.0% and 6.0%, respectively, of risk-weighted assets and certain off-balance sheet items for a "well capitalized" depository institution. 31 The Federal Reserve Board has also established minimum capital leverage ratio guidelines for state member banks. The ratio is determined using Tier 1 capital divided by quarterly average total assets. The guidelines require a minimum of 5.0% for a well capitalized depository institution. The Company's and the Bank's risk-based capital ratios were in excess of regulatory guidelines for a well capitalized depository institution as of September 30, 1999, and December 31, 1998. Capital ratios for the Company are set forth below:
September 30, December 31, 1999 1998 (Unaudited) - ---------------------------------------------------------------------------------------------------------------- Total risk-based capital ratio 12.7% 11.5% Tier 1 risk-based capital ratio 11.5% 10.3% Tier 1 leverage ratio 6.7% 7.6% - -------------------------------------------------------------------------------------------------------------------
The improvement in the Company's total risk-based capital ratio and Tier 1 risk-based capital ratio from December 31, 1998, to September 30, 1999, was attributable to an increase in Tier 1 capital and an increase in the Company's investments in low or zero risk-weighted assets. The increase in Tier 1 capital resulted from the aforementioned net income for the first nine months of 1999. The decrease in the Tier 1 leverage ratio from December 31, 1998, to September 30, 1999, was primarily attributable to an increase in average total assets due to strong growth in deposits during the first nine months of 1999. In an informal arrangement with the Bank's primary banking regulators (the Federal Reserve Bank of San Francisco and the California Department of Financial Institutions) pursuant to a memorandum of understanding entered into in late September 1999, the Bank has agreed to maintain a Tier 1 leverage ratio of at least 7.25% By maintaining fourth quarter 1999 average assets that approximate total assets as of September 30, 1999, combined with increasing Tier 1 capital through internally generated capital (e.g., net income), the Bank's Tier 1 leverage ratio is expected to exceed 7.25% at December 31, 1999. The Company is also contemplating increasing Tier 1 capital through the issuance of equity instruments. REGULATORY MATTERS In late September 1999, the Bank entered into an informal arrangement with the Federal Reserve Bank of San Francisco and the California Department of Financial Institutions, the Bank's primary banking regulators. Under the informal arrangement (pursuant to a memorandum of understanding), the Bank has committed to maintain a Tier 1 leverage ratio of at least 7.25%; obtain the regulators' consent prior to payment of dividends; further enhance its credit monitoring and review policies and submit reports to the regulators regarding credit quality. The Federal Reserve Bank of San Francisco has directed the Company to obtain its approval before incurring debt, paying dividends, repurchasing capital stock, or entering into agreements to acquire any entities or portfolios. The Company's and the Bank's capital ratios were in excess of regulatory guidelines for a well capitalized depository institution as of September 30, 1999. The Bank's Tier 1 leverage ratio has declined since December 31, 1998, 32 largely the result of the rapid growth in deposits experienced by the Bank during 1999. The Bank's deposit growth in 1999 has been driven by high levels of client liquidity attributable to a strong inflow of investment capital into the venture capital community, and by growth in the number of clients served by the Bank. In order to slow the growth in deposits due to the Tier 1 leverage ratio capital constraints, the Bank implemented a program during the third quarter of 1999 to emphasize off-balance sheet products to clients (e.g., mutual fund products). This has allowed the Bank to continue serving its clients' needs while restraining balance sheet growth driven by deposits. The Bank should exceed the 7.25% Tier 1 leverage ratio by year-end 1999 by maintaining its average assets in the fourth quarter of 1999 at or near third quarter period-end levels and by increasing Tier 1 capital primarily through net income. The Company is also pursuing alternative strategies, including issuance of equity or other capital instruments, to assure that the Bank complies with the informal agreement with the regulators. 33 PART II - OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS There were no legal proceedings requiring disclosure pursuant to this item pending at September 30, 1999, or at the date of this report. ITEM 2 - CHANGES IN SECURITIES None. ITEM 3 - DEFAULTS UPON SENIOR SECURITIES None. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5 - OTHER INFORMATION None. ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: None. (b) REPORTS ON FORM 8-K: No reports on Form 8-K were filed by the Company during the quarter ended September 30, 1999. 34 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SILICON VALLEY BANCSHARES Date: November 15, 1999 /s/ Donal D. Delaney ------------------------------------ Donal D. Delaney Senior Vice President and Controller (Principal Accounting Officer) 35 EX-27.1 2 EX-27.1
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS, RELATED NOTES AND MANAGEMENT DISCUSSION AND ANALYSIS CONTINUED IN THE REPORT ON FORM 10-Q FILED BY SILICON VALLEY BANCSHARES FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 185,577 441 103,000 0 1,745,262 0 0 1,661,016 70,800 3,721,755 3,404,801 0 34,934 0 0 0 21 243,475 3,721,755 118,872 65,252 22,340 206,464 63,900 63,900 142,564 40,334 (243) 83,050 44,305 27,299 0 0 27,299 1.33 1.30 5.2 33,959 1,553 0 14,200 46,000 22,491 6,957 70,800 34,270 0 36,530 REPRESENTS - BASIC EARNINGS PER SHARE REPRESENTS - DILUTED EARNINGS PER SHARE
-----END PRIVACY-ENHANCED MESSAGE-----