-----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, J035Ri+BcNMm7Zz3hJbEGcq9op7r5x33a8HnoclO+dg0hgE5BKjPYEQVEZeyN7Nf MkXgYN/KEwxAuuHXYfYzHg== 0001047469-99-020447.txt : 19990517 0001047469-99-020447.hdr.sgml : 19990517 ACCESSION NUMBER: 0001047469-99-020447 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990514 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: 99622280 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 May 14, 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 March 31, 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 April 30, 1999, 20,766,741 shares of the registrant's common stock ($0.001 par value) were outstanding. - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ This report contains a total of 30 pages. 1 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 29 ITEM 2. CHANGES IN SECURITIES 29 ITEM 3. DEFAULTS UPON SENIOR SECURITIES 29 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 29 ITEM 5. OTHER INFORMATION 29 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 29 SIGNATURES 30
2 PART I - FINANCIAL INFORMATION ITEM 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS SILICON VALLEY BANCSHARES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
March 31, December 31, 1999 1998 (Dollars in thousands) (Unaudited) - ------------------------------------------------------------------------------------------------------------------- Assets: Cash and due from banks $ 134,051 $ 123,001 Federal funds sold and securities purchased under agreement to resell 664,683 399,202 Investment securities, at fair value 1,504,739 1,397,502 Loans, net of unearned income 1,614,335 1,611,921 Allowance for loan losses (47,600) (46,000) - ------------------------------------------------------------------------------------------------------------------- Net loans 1,566,735 1,565,921 Premises and equipment 11,633 11,354 Other real estate owned 400 664 Accrued interest receivable and other assets 56,328 47,808 - ------------------------------------------------------------------------------------------------------------------- Total assets $3,938,569 $3,545,452 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- Liabilities and Shareholders' Equity: Liabilities: Noninterest-bearing demand deposits $ 999,509 $ 921,790 NOW deposits 29,754 19,978 Money market deposits 2,458,807 2,185,359 Time deposits 166,217 142,626 - ------------------------------------------------------------------------------------------------------------------- Total deposits 3,654,287 3,269,753 Other liabilities 22,511 21,349 - ------------------------------------------------------------------------------------------------------------------- Total liabilities 3,676,798 3,291,102 - ------------------------------------------------------------------------------------------------------------------- Company obligated mandatorily redeemable trust preferred securities of subsidiary trust holding solely junior subordinated debentures (trust preferred securities) 38,498 38,485 Shareholders' Equity: Preferred stock, no par value: 20,000,000 shares authorized; none outstanding Common stock, no par value: 60,000,000 shares authorized; 20,761,101 and 20,711,915 shares outstanding at March 31, 1999 and December 31, 1998, respectively 94,477 94,129 Retained earnings 131,691 123,855 Unearned compensation (3,694) (4,191) Accumulated other comprehensive income: Net unrealized gains on available-for-sale investments 799 2,072 - ------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 223,273 215,865 - ------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $3,938,569 $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 -------------------------- March 31, March 31, 1999 1998 (Dollars in thousands, except per share amounts) (Unaudited) (Unaudited) - ------------------------------------------------------------------------------------------------------------------- Interest income: Loans, including fees $37,532 $31,102 Investment securities 18,844 13,997 Federal funds sold and securities purchased under agreement to resell 5,978 4,442 - ------------------------------------------------------------------------------------------------------------------- Total interest income 62,354 49,541 - ------------------------------------------------------------------------------------------------------------------- Interest expense: Deposits 20,952 17,601 Other borrowings - 3 - ------------------------------------------------------------------------------------------------------------------- Total interest expense 20,952 17,604 - ------------------------------------------------------------------------------------------------------------------- Net interest income 41,402 31,937 Provision for loan losses 7,968 5,480 - ------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 33,434 26,457 - ------------------------------------------------------------------------------------------------------------------- Noninterest income: Letter of credit and foreign exchange income 2,669 1,711 Disposition of client warrants 821 2,440 Deposit service charges 667 373 Investment gains 131 474 Other 964 393 - ------------------------------------------------------------------------------------------------------------------- Total noninterest income 5,252 5,391 - ------------------------------------------------------------------------------------------------------------------- Noninterest expense: Compensation and benefits 15,201 11,621 Professional services 2,343 1,426 Net occupancy expense 1,469 990 Furniture and equipment 1,388 1,039 Business development and travel 1,331 1,555 Trust preferred securities distributions 825 - Postage and supplies 665 432 Advertising and promotion 600 391 Telephone 399 522 Cost of other real estate owned 273 26 Other 1,043 902 - ------------------------------------------------------------------------------------------------------------------- Total noninterest expense 25,537 18,904 - ------------------------------------------------------------------------------------------------------------------- Income before income tax expense 13,149 12,944 Income tax expense 5,313 5,365 - ------------------------------------------------------------------------------------------------------------------- Net income $ 7,836 $ 7,579 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- Basic earnings per share $ 0.38 $ 0.38 Diluted earnings per share $ 0.38 $ 0.36 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
See notes to interim consolidated financial statements. 4 SILICON VALLEY BANCSHARES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three months ended -------------------------- March 31, March 31, 1999 1998 (Dollars in thousands) (Unaudited) (Unaudited) - ------------------------------------------------------------------------------------------------------------------- Net income $ 7,836 $ 7,579 Other comprehensive income, net of tax: Change in unrealized gains/(losses) on available-for-sale investments: Unrealized holding gains/(losses) arising during period (721) 1,827 Less: Reclassification adjustment for gains included in net income (552) (1,690) - ------------------------------------------------------------------------------------------------------------------- Other comprehensive (loss) income (1,273) 137 - ------------------------------------------------------------------------------------------------------------------- Comprehensive income $ 6,563 $ 7,716 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
See notes to interim consolidated financial statements. 5 SILICON VALLEY BANCSHARES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended -------------------------- March 31, March 31, 1999 1998 (Dollars in thousands) (Unaudited) (Unaudited) - ------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 7,836 $ 7,579 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 7,968 5,480 Provision for other real estate owned 264 - Depreciation and amortization 784 321 Net gains on sales of investment securities (131) (474) Increase in accrued interest receivable (6,072) (1,598) Increase in unearned income 607 244 Other, net 271 (1,448) - ------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 11,527 10,104 - ------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Proceeds from maturities and paydowns of investment securities 356,878 385,659 Proceeds from sales of investment securities 520,226 79,688 Purchases of investment securities (986,548) (508,068) Net increase in loans (11,098) (71,563) Proceeds from recoveries of charged off loans 1,709 1,170 Purchases of premises and equipment (1,063) (1,114) - ------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (119,896) (114,228) - ------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Net increase in deposits 384,534 164,793 Proceeds from issuance of common stock, net of issuance costs 366 2,917 - ------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 384,900 167,710 - ------------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 276,531 63,586 Cash and cash equivalents at January 1, 522,203 426,832 - ------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at March 31, $ 798,734 $ 490,418 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- Supplemental disclosures: Interest paid $ 21,030 $ 17,483 Income taxes paid $ 3,457 $ 206 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
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 shareholders' 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, Maryland, Massachusetts, Oregon, Texas, 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 March 31, 1999, the results of its operations and cash flows for the three month periods ended March 31, 1999, and March 31, 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 month period ended March 31, 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 $183,000 and $202,000 at March 31, 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. The statement is effective for fiscal quarters of fiscal years beginning after June 15, 1999. The Company expects to adopt this statement on January 1, 2000. 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 month periods ended March 31, 1999 and 1998.
Net Per Share Income Shares Amount (Dollars and shares in thousands, except per share amounts) (Unaudited) (Unaudited) (Unaudited) - ------------------------------------------------------------------------------------------------------------------- Three months ended March 31, 1999: Basic EPS: Income available to common shareholders $7,836 20,488 $0.38 Effect of Dilutive Securities: Stock options and restricted stock - 320 - - ------------------------------------------------------------------------------------------------------------------- Diluted EPS: Income available to common shareholders plus assumed conversions $7,836 20,808 $0.38 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- Three months ended March 31, 1998: Basic EPS: Income available to common shareholders $7,579 20,065 $0.38 Effect of Dilutive Securities: Stock options and restricted stock - 788 - - ------------------------------------------------------------------------------------------------------------------- Diluted EPS: Income available to common shareholders plus assumed conversions $7,579 20,853 $0.36 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
3. LOANS The detailed composition of loans, net of unearned income of $10.6 million and $10.0 million at March 31, 1999, and December 31, 1998, respectively, is presented in the following table:
March 31, December 31, 1999 1998 (Dollars in thousands) (Unaudited) - ------------------------------------------------------------------------------------------------------------------- Commercial $1,412,166 $1,429,980 Real estate construction 75,560 74,023 Real estate term 61,157 60,841 Consumer and other 65,452 47,077 - ------------------------------------------------------------------------------------------------------------------- Total loans $1,614,335 $1,611,921 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
10 4. ALLOWANCE FOR LOAN LOSSES The activity in the allowance for loan losses for the quarters ended March 31, 1999 and 1998 was as follows:
1999 1998 Quarter Ended March 31, (Unaudited) (Unaudited) - ------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Balance at January 1, $46,000 $37,700 Provision for loan losses 7,968 5,480 Loans charged off (8,077) (3,950) Recoveries 1,709 1,170 - ------------------------------------------------------------------------------------------------------------------- Balance at March 31, $47,600 $40,400 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
The aggregate recorded investment in loans for which impairment has been determined in accordance with SFAS No. 114 totaled $51.0 million and $19.3 million at March 31, 1999, and March 31, 1998, respectively. Allocations of the allowance for loan losses related to impaired loans totaled $10.2 million at March 31, 1999, and $7.8 million at March 31, 1998. Average impaired loans for the first quarter of 1999 and 1998 totaled $36.8 million and $26.1 million, respectively. 5. SUBSEQUENT EVENTS At the Annual Meeting of Shareholders, held on April 15, 1999, the shareholders of a majority of the Company's outstanding shares of common stock approved a change in the Company's state of incorporation from California to Delaware. The change was effective April 23, 1999, and resulted in the adoption of a common stock par value of $0.001. On April 26, 1999, the Company filed a Form 8-K with the Securities and Exchange Commission, relating to the reincorporation in the State of Delaware. 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 shareholders' equity. EARNINGS SUMMARY The Company reported net income of $7.8 million, or $0.38 per diluted share, for the first quarter of 1999, compared with net income of $7.6 million, or $0.36 per diluted share, for the first quarter of 1998. The annualized return on average assets (ROA) was 0.9% in the first quarter of 1999 compared with 1.2% in the same period of 1998. The annualized return on average equity (ROE) for the first quarter of 1999 was 14.5%, compared with 16.9% in the first quarter of 1998. The slight increase in net income during the first quarter of 1999, as compared with the first quarter of 1998, was primarily attributable to growth in net interest income, offset by increases 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 quarters ended March 31, 1999 and 1998, and are discussed in more detail below. 12
1999 1998 1999 to 1998 Quarter Ended March 31, (Unaudited) (Unaudited) Increase (Decrease) - ------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Net interest income $41,402 $31,937 $ 9,465 Provision for loan losses 7,968 5,480 2,488 Noninterest income 5,252 5,391 (139) Noninterest expense 25,537 18,904 6,633 - ------------------------------------------------------------------------------------------------------------------- Income before income taxes 13,149 12,944 205 Income tax expense 5,313 5,365 (52) - ------------------------------------------------------------------------------------------------------------------- Net income $ 7,836 $ 7,579 $ 257 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
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 taxable-equivalent interest income expressed as a percentage of average interest-earning assets. The average rate paid on funding sources expresses interest expense as a percentage of average interest-earning assets. The following tables set forth average assets, liabilities and shareholders' equity, interest income and interest expense, average yields and rates, and the composition of the Company's net interest margin for the three months ended March 31, 1999 and 1998. 13
- ------------------------------------------------------------------------------------------------------------------------ AVERAGE BALANCES, RATES AND YIELDS - ------------------------------------------------------------------------------------------------------------------------ For the three months ended March 31, ----------------------------------------------------------------------------- 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) $ 509,434 $ 5,978 4.8% $ 324,295 $ 4,442 5.6% Investment securities: Taxable 1,253,046 17,581 5.7 901,459 13,335 6.0 Non-taxable (2) 123,377 1,944 6.4 61,113 1,019 6.8 Loans: Commercial 1,393,750 32,925 9.6 1,038,665 27,690 10.8 Real estate construction and term 138,101 3,568 10.5 93,463 2,526 11.0 Consumer and other 45,667 1,039 9.2 38,950 886 9.2 - ---------------------------------------- ------------------------------------ ------------------------------------ Total loans 1,577,518 37,532 9.6 1,171,078 31,102 10.8 - ---------------------------------------- ------------------------------------ ------------------------------------ Total interest-earning assets 3,463,375 63,035 7.4 2,457,945 49,898 8.2 - ---------------------------------------- ------------------------------------ ------------------------------------ Cash and due from banks 153,377 127,989 Allowance for loan losses (49,406) (39,364) Other real estate owned 605 689 Other assets 62,609 48,443 - ---------------------------------------- ----------- ----------- Total assets $3,630,560 $2,595,702 - ---------------------------------------- ----------- ----------- - ---------------------------------------- ----------- ----------- Funding sources: Interest-bearing liabilities: NOW deposits $ 22,346 76 1.4 $ 15,129 74 2.0 Regular money market deposits 338,296 2,250 2.7 325,151 2,171 2.7 Bonus money market deposits 1,926,388 17,077 3.6 1,217,538 13,917 4.6 Time deposits 146,246 1,549 4.3 129,980 1,439 4.5 Other borrowings - - - 222 3 6.0 - ---------------------------------------- ------------------------------------ ------------------------------------ Total interest-bearing liabilities 2,433,276 20,952 3.5 1,688,020 17,604 4.2 Portion of noninterest-bearing funding sources 1,030,099 769,925 - ---------------------------------------- ------------------------------------ ------------------------------------ Total funding sources 3,463,375 20,952 2.4 2,457,945 17,604 2.9 - ---------------------------------------- ------------------------------------ ------------------------------------ Noninterest-bearing funding sources: Demand deposits 915,443 705,909 Other liabilities 24,404 19,479 Trust preferred securities 38,488 - Shareholders' equity 218,949 182,294 Portion used to fund interest-earning assets (1,030,099) (769,925) - ---------------------------------------- ------------ ------------ Total liabilities and shareholders' equity $3,630,560 $2,595,702 - ---------------------------------------- ----------- ----------- - ---------------------------------------- ----------- ----------- Net interest income and margin $42,083 5.0% $32,294 5.3% - ---------------------------------------- -------- ----- -------- ----- - ---------------------------------------- -------- ----- -------- ----- Memorandum: Total deposits $3,348,719 $2,393,707 - ---------------------------------------- ----------- ----------- - ---------------------------------------- ----------- -----------
(1) Includes average interest-bearing deposits in other financial institutions of $195 and $266 for the three months ended March 31, 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 $680 and $357 for the three months ended March 31, 1999 and 1998, respectively. 14 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.
First Quarter 1999 Compared to First Quarter 1998 --------------------------------------------------- Increase (Decrease) Due to Change in --------------------------------------------------- (Dollars in thousands) Volume Rate Total - ------------------------------------------------------------------------------------------------------------------- Interest income: Federal funds sold and securities purchased under agreement to resell $ 2,172 $ (636) $ 1,536 Investment securities 5,871 (700) 5,171 Loans 9,670 (3,240) 6,430 - ------------------------------------------------------------------------------------------------------------------- Increase (decrease) in interest income 17,713 (4,576) 13,137 - ------------------------------------------------------------------------------------------------------------------- Interest expense: NOW deposits 24 (22) 2 Regular money market deposits 87 (8) 79 Bonus money market deposits 6,284 (3,124) 3,160 Time deposits 172 (62) 110 Other borrowings - (3) (3) - ------------------------------------------------------------------------------------------------------------------- Increase (decrease) in interest expense 6,567 (3,219) 3,348 - ------------------------------------------------------------------------------------------------------------------- Increase (decrease) in net interest income $11,146 $(1,357) $ 9,789 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
Net interest income, on a fully taxable-equivalent basis, totaled $42.1 million for the first quarter of 1999, an increase of $9.8 million, or 30.3%, from the $32.3 million total for the first quarter of 1998. The increase in net interest income was the result of a $13.1 million, or 26.3%, increase in interest income, offset by a $3.3 million, or 19.0%, increase in interest expense over the comparable prior year period. The $13.1 million increase in interest income for the first quarter of 1999, as compared to the first quarter of 1998, was the result of a $17.7 million favorable volume variance offset by a $4.6 million unfavorable rate variance. The favorable volume variance resulted from a $1.0 billion, or 40.9%, increase in average interest-earning assets over the comparable period in the prior year. The increase in average interest-earning assets resulted from strong growth in the Company's deposits, which increased $955.0 million, or 39.9%, compared to the first quarter of 1998. The increase in average interest-earning assets consisted of loans, which were up $406.4 million, plus a combination of highly liquid, lower-yielding federal funds sold, securities purchased under agreement to resell and investment securities, which collectively increased $599.0 million, accounting for 59.6% of the total increase in average interest-earning assets. 15 Average loans increased $406.4 million, or 34.7%, in the first quarter of 1999 as compared to the 1998 first quarter, resulting in a $9.7 million favorable volume variance. This growth 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. Average investment securities for the first quarter of 1999 increased $413.9 million, or 43.0%, as compared to the 1998 first quarter, resulting in a $5.9 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, collateralized mortgage obligations and municipal securities. Average federal funds sold and securities purchased under agreement to resell in the first quarter of 1999 increased a combined $185.1 million, or 57.1%, over the prior year first quarter, resulting in a $2.2 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 each component of interest-earning assets in the first quarter of 1999 resulted in a decrease in interest income of $4.6 million as compared to the respective prior year period. Short-term market interest rates declined during the second half of 1998. As a result of this decline, the Company earned lower yields in the first quarter of 1999 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 a $1.3 million unfavorable rate variance as compared to the first quarter of 1998. The average yield on loans in the first quarter of 1999 decreased 120 basis points from the respective prior year period, accounting for the remaining $3.2 million of the total unfavorable rate variance. This decrease was primarily attributable to both increased competition and a decline in the average prime rate charged by the Company during the second half of 1998, as a substantial portion of the Company's loans are prime rate-based. The yield on average interest-earning assets decreased 80 basis points in the first quarter of 1999 from the comparable prior year period. This decrease resulted from a decline in the average yield on loans, largely due to both increased competition and a decline in the Company's prime rate, as well as 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 continuing to outpace the growth in loans. Total interest expense in the 1999 first quarter increased $3.3 million from the first quarter of 1998. This increase was due to an unfavorable volume variance of $6.6 million, partially offset by a favorable rate variance of $3.2 million. The unfavorable volume variance resulted from a $745.3 million, or 44.1%, increase in average interest-bearing liabilities in the first quarter of 1999 as compared with the first quarter of 1998. This increase was largely concentrated in the Company's bonus money market deposit product, which increased $708.9 million, or 58.2%, 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. 16 Changes in the average rates paid on interest-bearing liabilities had a $3.2 million favorable impact on interest expense in the first 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 4.6% in the first quarter of 1998 to 3.6% in the first 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. The average cost of funds paid in the first quarter of 1999 of 2.4% was down from the 2.9% paid in the first quarter of 1998. The decrease in the average rate paid on the Company's bonus money market deposit product more than offset the continuing shift in the composition of average interest-bearing liabilities towards a higher percentage of deposits in that product. 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 $8.0 million for the first quarter of 1999, a $2.5 million, or 45.4%, increase compared to the $5.5 million provision for the first quarter of 1998. 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 quarters ended March 31, 1999 and 1998:
Quarter Ended March 31, 1999 1998 - ------------------------------------------------------------------------------------------------------------------- (Dollars in thousands) Letter of credit and foreign exchange income $2,669 $1,711 Disposition of client warrants 821 2,440 Deposit service charges 667 373 Investment gains 131 474 Other 964 393 - ------------------------------------------------------------------------------------------------------------------- Total noninterest income $5,252 $5,391 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
Noninterest income totaled $5.3 million in the first quarter of 1999, a decrease of $0.1 million, or 2.6%, from the $5.4 million total in the prior year first quarter. The slight decrease was largely due to a $1.6 million decrease in the disposition of client warrants, offset by a $1.0 million increase in letter of credit fees, foreign exchange fees and other trade finance income and a $0.6 million increase other noninterest income. Letter of credit fees, foreign exchange fees and other trade finance income totaled $2.7 million in the first quarter of 1999, an increase of $1.0 million, or 56.0%, from the $1.7 million earned in the first quarter of 1998. The growth in this category of noninterest income reflects a concerted 17 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 quarter 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, and was also offset by increases to the provision for loan losses during those periods. As opportunities present themselves in future periods, the Company may continue to reinvest some or all of the income realized from the disposition of client warrants in furthering its business strategies. Deposit service charges totaled $0.7 million for the first quarter of 1999 compared with $0.4 million for the first quarter of 1998. Clients compensate the Company for depository services either through earnings credits computed on their demand deposit balances, or via explicit payments recognized by the Company 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. The Company realized a nominal gain on sales of investment securities during the first quarter of 1999, compared to a $0.5 million gain on sales of investment securities during the prior year first quarter. 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. Other noninterest income largely consists of service-based fee income, and increased $0.6 million, or 145.3%, to $1.0 million in the first quarter of 1999 from $0.4 million in the first quarter of 1998. 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 first quarter of 1999 totaled $25.5 million, a $6.6 million, or 35.1%, increase from the $18.9 million incurred in the comparable prior year 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 18 ratio for the first quarter of 1999 was 55.3% versus 54.9% for the same quarter in 1998. The following table presents the detail of noninterest expense and the incremental contribution of each line item to the Company's efficiency ratio:
Three Months Ended March 31, --------------------------------------------------------------- 1999 1998 --------------------------- ----------------------------- Percent of Percent of Adjusted Adjusted (Dollars in thousands) Amount Revenues Amount Revenues - ------------------------------------------------------------------------------------------------------------------- Compensation and benefits $15,201 33.3% $11,621 33.9% Professional services 2,343 5.1 1,426 4.1 Net occupancy expense 1,469 3.2 990 2.9 Furniture and equipment 1,388 3.0 1,039 3.0 Business development and travel 1,331 2.9 1,555 4.5 Trust preferred securities distributions 825 1.8 - - Postage and supplies 665 1.5 432 1.3 Advertising and promotion 600 1.3 391 1.1 Telephone 399 0.9 522 1.5 Other 1,043 2.3 902 2.6 - ------------------------------------------------------------------------------------------------------------------- Total excluding cost of other real estate owned 25,264 55.3% 18,878 54.9% Cost of other real estate owned 273 26 - ------------------------------------------------------------------------------------------------------------------- Total noninterest expense $25,537 $18,904 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
Compensation and benefits expenses totaled $15.2 million in the first quarter of 1999, a $3.6 million, or 30.8%, increase over the $11.6 million incurred in the first quarter of 1998. This 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. Average FTE were 602 for the first quarter of 1999 versus 474 for the prior year first quarter. 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 $2.3 million in the first quarter of 1999, a $0.9 million, or 64.3%, increase from the $1.4 million incurred in the first quarter of 1998. The increase in professional services expenses in the first quarter of 1999 as compared to the same period in 1998, primarily related to an increase in both consulting fees associated with several business initiatives, including the Year 2000 remediation project, and legal fees primarily related to loan consultations and the workout of various commercial credits. The level of professional services expenses during 1999 and 1998 also 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, 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. 19 Occupancy, furniture and equipment expenses totaled $2.9 million in the first quarter of 1999, a $0.9 million, or 40.8%, increase compared to $2.0 million in the same quarter in 1998. The increase in occupancy, furniture and equipment expenses in 1999, as compared to 1998, was primarily the result of an increase in rental expense related to the expansion of the Company's existing headquarters facility in the second quarter of 1998 and new loan offices opened in early 1998. Occupancy, furniture and equipment expenses were also impacted by costs related to investments in computer equipment and software associated with technology upgrades and the Company's aforementioned growth in personnel. The Company intends to continue its geographic expansion into other emerging technology marketplaces across the U.S. during future years. Business development and travel expenses totaled $1.3 million in the first quarter of 1999, a $0.3 million, or 14.4%, decrease from the $1.6 million incurred in the first quarter of 1998. The decrease in business development and travel expenses was largely attributable to reduced business conference expenses. Trust preferred securities distributions totaled $0.8 million for the three months ended March 31, 1999, and 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. For further discussion related to the trust preferred securities, see the Item 2 section entitled "Liquidity." During the first quarter of 1999, the Company incurred a $0.3 million write-down on the last remaining OREO property. 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 40.4% in the 1999 first quarter, compared to 41.4% in the prior year first quarter. The decrease in the Company's effective income tax rate was attributable to an increase in the amount of tax-exempt interest income received by the Company. FINANCIAL CONDITION The Company's total assets were $3.9 billion at March 31, 1999, an increase of $393.1 million, or 11.1%, compared to $3.5 billion at December 31, 1998. FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENT TO RESELL Federal funds sold and securities purchased under agreement to resell totaled a combined $664.7 million at March 31, 1999, an increase of $265.5 million, or 66.5%, compared to the $399.2 million outstanding at the prior year end. This increase was attributable to the Company investing excess funds, resulting from the strong growth in deposits during the first quarter of 1999 having exceeded the growth in loans, in these types of short-term, liquid investments. 20 INVESTMENT SECURITIES Investment securities totaled $1.5 billion at March 31, 1999, an increase of $107.2 million, or 7.7%, from the December 31, 1998, balance of $1.4 billion. This increase resulted from excess funds that were generated by strong growth in the Company's deposits outpacing the growth in loans during the first three months of 1999, and primarily consisted of U.S. agency securities, collateralized mortgage obligations and municipal securities. The growth in the investment portfolio reflected Management's actions to increase the Company's portfolio of short-term investments in response to a significant increase in liquidity. LOANS Total loans, net of unearned income, at March 31, 1999, were $1.6 billion, a slight increase of $2.4 million compared to the total at December 31, 1998. 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 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 21 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 $47.6 million at March 31, 1999, an increase of $1.6 million, or 3.5%, compared to the $46.0 million balance at December 31, 1998. This increase was due to $8.0 million in additional provisions to the allowance for loan losses, offset by net charge-offs of $6.4 million for the first three months of 1999. The Company incurred $8.1 million in gross charge-offs and had $1.7 million in recoveries during the first three months of 1999. The gross charge-offs were not concentrated in any particular niche and included $1.4 million and $0.9 million in charge-offs related to the Company's bridge and QuickStart portfolios, respectively. The Company's QuickStart product is based in large part on an analysis that indicates that almost all venture capital-backed clients that receive a first round of equity infusion from a venture capitalist will receive a second round. The analysis indicated that the second round typically occurred 18 months after the first round. Hence, proceeds from the second round could be used to pay off the 18 month term loan offered under the QuickStart product. However, the second round has been occurring much sooner than expected and the additional cash infusion has occasionally been depleted before 18 months. The likelihood of a third round occurring is not as great as a second round, therefore the Company expects to continue to incur higher than normal charge-offs related to this product during 1999. Of the total gross charge-offs incurred during the first quarter of 1999, $3.2 million were nonperforming loans at the end of 1998. Recoveries during the first quarter of 1999 included $0.9 million related to a bridge loan charged off in the fourth quarter of 1998. The unallocated component of the allowance for loan losses totaled $16.1 million at March 31, 1999, relatively unchanged from the unallocated balance of $16.3 million at December 31, 1998. In general, Management believes the allowance for loan losses is adequate as of March 31, 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: 22
March 31, December 31, 1999 1998 (Dollars in thousands) (Unaudited) (Unaudited) - ------------------------------------------------------------------------------------------------------------------- Nonperforming assets: Loans past due 90 days or more $ 740 $ 441 Nonaccrual loans 50,993 19,444 - ------------------------------------------------------------------------------------------------------------------- Total nonperforming loans 51,733 19,885 OREO and other foreclosed assets 1,370 1,800 - ------------------------------------------------------------------------------------------------------------------- Total nonperforming assets $53,103 $21,685 - ------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------- Nonperforming loans as a percentage of total loans 3.2% 1.2% Nonperforming assets as a percentage of total assets 1.4% 0.6% Allowance for loan losses: $47,600 $46,000 As a percentage of total loans 2.9% 2.8% As a percentage of nonaccrual loans 93.4% 236.6% As a percentage of nonperforming loans 92.0% 231.3%
Nonperforming loans totaled $51.7 million, or 3.2% of total loans, at March 31, 1999, an increase of $31.8 million, or 160.2%, from the prior year-end total of $19.9 million, or 1.2% of total loans. The increase in nonperforming loans was primarily due to three commercial credits totaling approximately $30.0 million. The first credit, in excess of $7.0 million, is in the Company's Communications practice, and was disclosed as having a higher than normal risk of becoming nonperforming in the Company's 1998 Form 10-K. The second credit is in the Company's Healthcare Services practice, and also has a balance in excess of $7.0 million. The last credit, totaling over $15.0 million, is in the Company's Financial Services (non-technology) niche. As of March 31, 1999, Management believes each of these credits are adequately secured with collateral and the general allowance for loan losses. Therefore, although the allowance for loan losses as a percentage of nonperforming loans decreased from 231.3% at December 31, 1998 to 92.0% at March 31, 1999, the unallocated component of the allowance for loan losses remained relatively constant and additional provisions to the allowance for loan losses were not considered necessary. In addition to the loans disclosed in the foregoing analysis, Management has identified two loans with principal amounts aggregating $11.0 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 $1.4 million at March 31, 1999, compared to $1.8 million at December 31, 1998. The OREO and other foreclosed assets balance at March 31, 1999, consisted of one OREO property, and one other asset that was acquired through foreclosure. The OREO property, acquired by the Company prior to June 1993, consists of multiple undeveloped lots and was written down by approximately $0.3 million in the first quarter of 1999. The other asset acquired through foreclosure, which totaled $1.0 million at 23 March 31, 1999, 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 $3.7 billion at March 31, 1999, an increase of $384.5 million, or 11.8%, from the prior year-end total of $3.3 billion. A significant portion of the increase in deposits during the first three months of 1999 was concentrated in the Company's highest-rate paying deposit product, its bonus money market deposit product, which increased $273.4 million, or 14.9%, to a total of $2.1 billion at the end of the first quarter of 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 quarter of 1999 in the number of clients served by the Company. 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 other internal mission critical systems have also been received, forward date tested and certified. Furthermore, testing of mission critical service providers, has been substantially completed as of March 31, 1999. During the final phase, the Implementation Phase, remediated and validated code will be tested in interfaces with customers, business partners, government institutions, and others. It is anticipated that all mission critical testing will be complete and implementation of mission critical systems will be substantially completed by June 30, 1999. The Company may be impacted by the Year 2000 compliance issues of governmental agencies, businesses and other entities who provide data to, or receive data from, the Company, and by 24 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. These contingency plans are currently being developed and are expected to be substantially completed and tested by 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 quarter of 1999, the Company incurred $0.8 million, bringing the total incurred in 1998 and 1999 for charges related to its Year 2000 remediation effort to $2.3 million. The Company expects to incur approximately $0.7 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 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 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 25 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 as of March 31, 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 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. Additionally, during the second quarter of 1998 the Company issued $40.0 million in cumulative trust preferred securities through a newly formed special-purpose trust (SVB Capital I). The securities had an offering price (liquidation amount) of $25 per security and distributions at a fixed rate of 8.25% are paid by the Company quarterly. The securities have a maximum maturity 26 of 30 years. The Company received proceeds of $38.5 million related to the sale of these securities, net of underwriting commissions and other offering expenses. The proceeds will be used by the Company for general corporate purposes, which may include, without limitation, investments in liquid government and corporate debt securities, and investments in venture capital funds. Bank policy guidelines provide that liquid assets as a percentage of total deposits should not fall below 20.0%. At March 31, 1999, the Bank's ratio of liquid assets to total deposits was 54.1%. This ratio is well in excess of the Bank's minimum policy guidelines and is higher 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 March 31, 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, an additional source of new capital for the Company has 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. Shareholders' equity totaled $223.3 million at March 31, 1999, an increase of $7.4 million from the $215.9 million balance at December 31, 1998. This increase primarily resulted from net income of $7.8 million for the three months ended March 31, 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. 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 March 31, 1999, and December 31, 1998. Capital ratios for the Company are set forth below: 27
March 31, December 31, 1999 1998 (Unaudited) - ------------------------------------------------------------------------------------------------------------------- Total risk-based capital ratio 12.2% 11.5% Tier 1 risk-based capital ratio 11.0% 10.3% Tier 1 leverage ratio 7.2% 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 March 31, 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 quarter of 1999. The decrease in the Tier 1 leverage ratio from December 31, 1998, to March 31, 1999, was primarily attributable to an increase in average total assets due to strong growth in deposits during the first quarter of 1999. 28 PART II - OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS There were no legal proceedings requiring disclosure pursuant to this item pending at March 31, 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: --------- 27.1 Financial Data Schedule. (b) Reports on Form 8-K: -------------------- No reports on Form 8-K were filed by the Company during the quarter ended March 31, 1999. 29 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: May 14, 1999 /s/ Lydia A. Burke ------------------------------------------- Lydia A. Burke Senior Vice President and Controller (Principal Accounting Officer) 30 EX-27.1 2 EXHIBIT 27.1
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS RELATED NOTES, AND MANAGEMENT'S DISCUSSION AND ANALYSIS CONTAINED IN THE REPORT ON FORM 10-Q FILED BY SILICON VALLEY BANCSHARES FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 134,051 183 664,500 0 1,504,739 0 0 1,614,335 47,600 3,938,569 3,654,287 0 22,511 0 0 0 94,477 132,490 3,938,569 37,532 18,844 5,978 62,354 20,952 20,952 41,402 7,968 131 25,537 13,149 7,836 0 0 7,836 0.38 0.38 5.0 50,993 740 0 11,000 46,000 8,076 1,709 47,600 31,536 0 16,064 Represents basic earnings per share Represents diluted earnings per share
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