-----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, NJkgEqF0xvzKuJNOCdwRKV65cE0kv7E667HcHdG8+4BfoCauVYVgaYPvxq+tMhTJ kSFSZKBBmFSi4B1DubCr9Q== 0001047469-99-030980.txt : 19990812 0001047469-99-030980.hdr.sgml : 19990812 ACCESSION NUMBER: 0001047469-99-030980 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990811 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: 99683956 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 FORM 10-Q As filed with the Securities and Exchange Commission on August 11, 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 June 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 July 31, 1999, 20,848,384 shares of the registrant's common stock ($0.001 par value) were outstanding. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- This report contains a total of 34 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 32 ITEM 2. CHANGES IN SECURITIES 32 ITEM 3. DEFAULTS UPON SENIOR SECURITIES 32 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 32 ITEM 5. OTHER INFORMATION 33 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 33 SIGNATURES 34 2 PART I - FINANCIAL INFORMATION ITEM 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS SILICON VALLEY BANCSHARES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
June 30, December 31, 1999 1998 (Dollars in thousands, except par value) (Unaudited) - ----------------------------------------------------------------------------------------------------------------- Assets: Cash and due from banks $ 131,250 $ 123,001 Federal funds sold and securities purchased under agreement to resell 752,664 399,202 Investment securities, at fair value 1,593,836 1,397,502 Loans, net of unearned income 1,576,215 1,611,921 Allowance for loan losses (56,300) (46,000) - ----------------------------------------------------------------------------------------------------------------- Net loans 1,519,915 1,565,921 Premises and equipment 11,699 11,354 Other real estate owned -- 664 Accrued interest receivable and other assets 72,062 47,808 - ----------------------------------------------------------------------------------------------------------------- Total assets $ 4,081,426 $ 3,545,452 - ----------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------- Liabilities and Stockholders' Equity: Liabilities: Noninterest-bearing demand deposits $ 1,163,928 $ 921,790 NOW deposits 34,898 19,978 Money market deposits 2,376,407 2,185,359 Time deposits 215,741 142,626 - ----------------------------------------------------------------------------------------------------------------- Total deposits 3,790,974 3,269,753 Other liabilities 24,974 21,349 - ----------------------------------------------------------------------------------------------------------------- Total liabilities 3,815,948 3,291,102 - ----------------------------------------------------------------------------------------------------------------- Company obligated mandatorily redeemable trust preferred securities of subsidiary trust holding solely junior subordinated debentures (trust preferred securities) 38,511 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; 20,851,448 and 20,711,915 shares outstanding at June 30, 1999 and December 31, 1998, respectively 21 21 Additional paid-in capital 95,875 94,108 Retained earnings 140,645 123,855 Unearned compensation (3,357) (4,191) Accumulated other comprehensive income: Net unrealized gain/(loss) on available-for-sale investments (6,217) 2,072 - ----------------------------------------------------------------------------------------------------------------- Total stockholders' equity 226,967 215,865 - ----------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 4,081,426 $ 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 SIX MONTHS ENDED -------------------------- ------------------------ June 30, June 30, June 30, June 30, 1999 1998 1999 1998 (Dollars in thousands, except per share amounts) (Unaudited) (Unaudited) (Unaudited) (Unaudited) - ---------------------------------------------------------------------------------------------------------------- Interest income: Loans, including fees $ 39,527 $ 33,760 $ 77,059 $ 64,862 Investment securities 22,250 16,205 41,094 30,202 Federal funds sold and securities purchased under agreement to resell 6,947 4,765 12,925 9,208 - ---------------------------------------------------------------------------------------------------------------- Total interest income 68,724 54,730 131,078 104,272 - ---------------------------------------------------------------------------------------------------------------- Interest expense: Deposits 21,952 19,331 42,904 36,931 Other borrowings -- -- -- 3 - ---------------------------------------------------------------------------------------------------------------- Total interest expense 21,952 19,331 42,904 36,934 - ---------------------------------------------------------------------------------------------------------------- Net interest income 46,772 35,399 88,174 67,338 Provision for loan losses 10,802 4,024 18,770 9,505 - ---------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 35,970 31,375 69,404 57,833 - ---------------------------------------------------------------------------------------------------------------- Noninterest income: Letter of credit and foreign exchange income 3,474 1,631 6,143 3,342 Disposition of client warrants 1,688 1,834 2,510 4,274 Deposit service charges 677 473 1,344 846 Investment gains/(losses) (374) 3 (243) 477 Other 993 494 1,957 887 - ---------------------------------------------------------------------------------------------------------------- Total noninterest income 6,458 4,435 11,711 9,826 - ---------------------------------------------------------------------------------------------------------------- Noninterest expense: Compensation and benefits 15,720 12,483 30,921 24,104 Professional services 3,552 2,602 5,895 4,029 Net occupancy expense 1,569 1,067 3,038 2,058 Business development and travel 1,524 1,407 2,855 2,962 Furniture and equipment 1,402 2,691 2,790 3,731 Trust preferred securities distributions 825 362 1,650 362 Advertising and promotion 734 520 1,334 910 Postage and supplies 567 478 1,232 910 Telephone 439 597 838 1,119 Cost of other real estate owned (5) (1,274) 268 (1,248) Other 1,470 840 2,513 1,741 - ---------------------------------------------------------------------------------------------------------------- Total noninterest expense 27,797 21,773 53,334 40,678 - ---------------------------------------------------------------------------------------------------------------- Income before income tax expense 14,631 14,037 27,781 26,981 Income tax expense 5,678 5,836 10,991 11,201 - ---------------------------------------------------------------------------------------------------------------- Net income $ 8,953 $ 8,201 $ 16,790 $ 15,780 - ---------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------- Basic earnings per share $ 0.44 $ 0.40 $ 0.82 $ 0.78 Diluted earnings per share $ 0.43 $ 0.39 $ 0.81 $ 0.75 - ---------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------
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 SIX MONTHS ENDED -------------------------- ------------------------ June 30, June 30, June 30, June 30, 1999 1998 1999 1998 (Dollars in thousands) (Unaudited) (Unaudited) (Unaudited) (Unaudited) - ---------------------------------------------------------------------------------------------------------------- Net income $ 8,953 $ 8,201 $16,790 $15,780 Other comprehensive income/(loss), net of tax: Changes in unrealized gains/(losses) on available-for-sale investments: Unrealized holding gains/(losses) arising during period (6,227) 422 (6,929) 2,250 Less: Reclassification adjustment for gains included in net income (789) (1,065) (1,360) (2,756) - ---------------------------------------------------------------------------------------------------------------- Other comprehensive loss (7,016) (643) (8,289) (506) - ---------------------------------------------------------------------------------------------------------------- Comprehensive income $ 1,937 $ 7,558 $ 8,501 $15,274 - ---------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------
See notes to interim consolidated financial statements. 5 SILICON VALLEY BANCSHARES AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED ------------------------ June 30, June 30, 1999 1998 (Dollars in thousands) (Unaudited) (Unaudited) - ---------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 16,790 $ 15,780 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 18,770 9,505 Depreciation and amortization 1,618 685 Net (gain)/loss on sales of investment securities 243 (477) Net gain on sales of other real estate owned -- (1,298) Provision for other real estate owned 264 -- Increase in accrued interest receivable (9,149) (4,125) Increase in prepaid expenses (384) (855) Increase (decrease) in unearned income (1,441) 656 Increase (decrease) in taxes payable (7,281) 2,928 Other, net 3,153 54 - ---------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 22,583 22,853 - ---------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Proceeds from maturities and paydowns of investment securities 682,149 703,818 Proceeds from sales of investment securities 539,225 94,000 Purchases of investment securities (1,432,108) (849,984) Net (increase) decrease in loans 24,908 (183,227) Proceeds from recoveries of charged off loans 3,769 1,606 Net proceeds from sales of other real estate owned 400 1,298 Purchases of premises and equipment (1,963) (3,373) - ---------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (183,620) (235,862) - ---------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Net increase in deposits 521,221 434,872 Proceeds from issuance of trust preferred securities, net of issuance costs -- 38,459 Proceeds from issuance of common stock, net of issuance costs 1,527 4,106 - ---------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 522,748 477,437 - ---------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 361,711 264,428 Cash and cash equivalents at January 1, 522,203 426,832 - ---------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at June 30, $ 883,914 $ 691,260 - ---------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------- Supplemental disclosures: Interest paid $ 42,906 $ 36,295 Income taxes paid $ 18,590 $ 9,401 - ---------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------
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, Oregon, 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 June 30, 1999, the results of its operations and cash flows for the three and six months ended June 30, 1999, and June 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 six months ended June 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 $164,000 and $202,000 at June 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 six months ended June 30, 1999 and 1998.
Three Months Ended June 30, Six Months Ended June 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 stockholders $ 8,953 20,513 $ 0.44 $16,790 20,500 $ 0.82 Effect of Dilutive Securities: Stock options and restricted stock -- 394 -- -- 358 -- - -------------------------------------------------------------------------------------------------------------------- Diluted EPS: Income available to common stockholders plus assumed conversions $ 8,953 20,907 $ 0.43 $16,790 20,858 $ 0.81 - -------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------- 1998: Basic EPS: Income available to common stockholders $ 8,201 20,262 $ 0.40 $15,780 20,164 $ 0.78 Effect of Dilutive Securities: Stock Options and Restricted Stock -- 738 -- -- 776 -- - -------------------------------------------------------------------------------------------------------------------- Diluted EPS: Income available to common stockholders plus assumed conversions $ 8,201 21,000 $ 0.39 $15,780 20,940 $ 0.75 - -------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------
3. LOANS The detailed composition of loans, net of unearned income of $8.6 million and $10.0 million at June 30, 1999, and December 31, 1998, respectively, is presented in the following table:
June 30, December 31, 1999 1998 (Dollars in thousands) (Unaudited) - ------------------------------------------------------------------ Commercial $1,381,357 $1,429,980 Real estate construction 80,636 74,023 Real estate term 54,208 60,841 Consumer and other 60,014 47,077 - ------------------------------------------------------------------ Total loans $1,576,215 $1,611,921 - ------------------------------------------------------------------ - ------------------------------------------------------------------
10 4. ALLOWANCE FOR LOAN LOSSES The activity in the allowance for loan losses for the three and six months ended June 30, 1999 and 1998 was as follows:
Three Months Ended June 30, Six Months Ended June 30, (UNAUDITED) (UNAUDITED) --------------------------- ------------------------- (Dollars in thousands) 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------ Beginning balance $ 47,600 $ 40,400 $ 46,000 $ 37,700 Provision for loan losses 10,802 4,024 18,770 9,505 Loans charged off (4,162) (2,560) (12,239) (6,511) Recoveries 2,060 436 3,769 1,606 - ------------------------------------------------------------------------------------------------------ Balance at June 30, $ 56,300 $ 42,300 $ 56,300 $ 42,300 - ------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------
The aggregate recorded investment in loans for which impairment has been determined in accordance with SFAS No. 114 totaled $46.7 million and $29.8 million at June 30, 1999, and June 30, 1998, respectively. Allocations of the allowance for loan losses related to impaired loans totaled $11.2 million at June 30, 1999, and $8.7 million at June 30, 1998. Average impaired loans for the second quarter of 1999 and 1998 totaled $48.2 million and $24.3 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. 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 which 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 $9.0 million, or $0.43 per diluted share, for the second quarter of 1999, compared with net income of $8.2 million, or $0.39 per diluted share, for the second quarter of 1998. Net income totaled $16.8 million, or $0.81 per diluted share, for the six months ended June 30, 1999, versus $15.8 million, or $0.75 per diluted share, for the respective 1998 period. The annualized return on average assets (ROA) was 0.9% in the second quarter of 1999 versus 1.1% in the second quarter of 1998. The annualized return on average equity (ROE) for the second quarter of 1999 was 16.0%, compared to 17.1% in the 1998 second quarter. For the first six months of 1999, ROA was 0.9% and ROE was 15.3% versus 1.2% and 17.0%, respectively, for the comparable prior year period. The increase in net income during the three and six months ended June 30, 1999, as compared with the prior year respective periods, resulted primarily from growth 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 six months ended June 30, 1999 and 1998, and are discussed in more detail below. 12
Three Months Ended June 30, Six Months Ended June 30, (Unaudited) (Unaudited) --------------------------- ------------------------- (Dollars in thousands) 1999 1998 1999 1998 - --------------------------------------------------------------------------------------------------------------- Net interest income $46,772 $35,399 $88,174 $67,338 Provision for loan losses 10,802 4,024 18,770 9,505 Noninterest income 6,458 4,435 11,711 9,826 Noninterest expense 27,797 21,773 53,334 40,678 - --------------------------------------------------------------------------------------------------------------- Income before income taxes 14,631 14,037 27,781 26,981 Income tax expense 5,678 5,836 10,991 11,201 - --------------------------------------------------------------------------------------------------------------- Net income $ 8,953 $ 8,201 $16,790 $15,780 - --------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------
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 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 six months ended June 30, 1999 and 1998, respectively. 13 - ------------------------------------------------------------------------------- AVERAGE BALANCES, RATES AND YIELDS - -------------------------------------------------------------------------------
For the three months ended June 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) $ 581,544 $ 6,947 4.8% $ 344,935 $ 4,765 5.5% Investment securities: Taxable 1,433,357 20,779 5.8 1,042,159 15,529 6.0 Non-taxable (2) 143,961 2,263 6.3 64,066 1,040 6.5 Loans: Commercial 1,380,428 34,620 10.1 1,104,631 29,575 10.7 Real estate construction and term 137,807 3,472 10.1 118,299 3,177 10.8 Consumer and other 68,662 1,435 8.4 44,396 1,008 9.1 - --------------------------------------------------------------------------------------------------------------------------------- Total loans 1,586,897 39,527 10.0 1,267,326 33,760 10.7 - --------------------------------------------------------------------------------------------------------------------------------- Total interest-earning assets 3,745,759 69,516 7.4 2,718,486 55,094 8.1 - --------------------------------------------------------------------------------------------------------------------------------- Cash and due from banks 181,657 132,498 Allowance for loan losses (51,658) (41,390) Other real estate owned 127 689 Other assets 66,078 52,709 - --------------------------------------------------------------------------------------------------------------------------------- Total assets $ 3,941,963 $ 2,862,992 - --------------------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------------------- Funding sources: Interest-bearing liabilities: NOW deposits $ 21,896 85 1.5 $ 21,447 106 2.0 Regular money market deposits 346,161 2,328 2.7 338,467 2,295 2.7 Bonus money market deposits 2,100,758 17,587 3.4 1,403,672 15,491 4.4 Time deposits 188,866 1,952 4.1 127,727 1,439 4.5 - --------------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 2,657,681 21,952 3.3 1,891,313 19,331 4.1 Portion of noninterest-bearing funding sources 1,088,078 827,173 - --------------------------------------------------------------------------------------------------------------------------------- Total funding sources 3,745,759 21,952 2.4 2,718,486 19,331 2.9 - --------------------------------------------------------------------------------------------------------------------------------- Noninterest-bearing funding sources: Demand deposits 996,696 745,237 Other liabilities 25,039 16,808 Trust preferred securities 38,501 16,964 Stockholders' equity 224,046 192,670 Portion used to fund interest-earning assets (1,088,078) (827,173) - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 3,941,963 $ 2,862,992 - --------------------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------------------- Net interest income and margin $ 47,564 5.0% $35,763 5.3% - --------------------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------------------- Memorandum: Total deposits $ 3,654,377 $ 2,636,550 - --------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------
(1) Includes average interest-bearing deposits in other financial institutions of $174 and $248 for the three months ended June 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 $792 and $364 for the three months ended June 30, 1999 and 1998, respectively. 14 - ------------------------------------------------------------------------------- AVERAGE BALANCES, RATES AND YIELDS - -------------------------------------------------------------------------------
For the six months ended June 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) $ 545,688 $ 12,925 4.8% $ 334,672 $ 9,208 5.5% Investment securities: Taxable 1,343,699 38,360 5.8 972,197 28,864 6.0 Non-taxable (2) 133,725 4,206 6.3 62,598 2,059 6.6 Loans: Commercial 1,387,052 67,544 9.8 1,071,831 57,264 10.8 Real estate construction and term 137,953 7,040 10.3 105,949 5,703 10.9 Consumer and other 57,228 2,474 8.7 41,688 1,895 9.2 - -------------------------------------- ----------- ----------- ---- ----------- ----------- ---- Total loans 1,582,233 77,058 9.8 1,219,468 64,862 10.7 - -------------------------------------- ----------- ----------- ---- ----------- ----------- ---- Total interest-earning assets 3,605,345 132,549 7.4 2,588,935 104,993 8.2 - -------------------------------------- ----------- ----------- ---- ----------- ----------- ---- Cash and due from banks 167,595 130,256 Allowance for loan losses (50,538) (40,382) Other real estate owned 365 689 Other assets 64,354 50,588 - -------------------------------------- ----------- ----------- Total assets $ 3,787,121 $ 2,730,086 - -------------------------------------- ----------- ----------- - -------------------------------------- ----------- ----------- Funding sources: Interest-bearing liabilities: NOW deposits $ 22,119 160 1.5 $ 18,306 180 2.0 Regular money market deposits 342,250 4,578 2.7 331,846 4,466 2.7 Bonus money market deposits 2,014,054 34,664 3.5 1,311,119 29,408 4.5 Time deposits 167,674 3,502 4.2 128,847 2,877 4.5 Other borrowings -- -- -- 110 3 6.0 - -------------------------------------- ----------- ----------- ---- ----------- ----------- ---- Total interest-bearing liabilities 2,546,097 42,904 3.4 1,790,228 36,934 4.2 Portion of noninterest-bearing funding sources 1,059,248 798,707 - -------------------------------------- ----------- ----------- ---- ----------- ----------- ---- Total funding sources 3,605,345 42,904 2.4 2,588,935 36,934 2.9 - -------------------------------------- ----------- ----------- ---- ----------- ----------- ---- Noninterest-bearing funding sources: Demand deposits 956,294 725,683 Other liabilities 24,724 18,135 Trust preferred securities 38,494 8,529 Stockholders' equity 221,512 187,511 Portion used to fund interest-earning assets (1,059,248) (798,707) - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 3,787,121 $ 2,730,086 - --------------------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------------------- Net interest income and margin $ 89,645 5.0% $ 68,059 5.3% - --------------------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------------------- Memorandum: Total deposits $ 3,502,391 $ 2,515,801 - --------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------
(1) Includes average interest-bearing deposits in other financial institutions of $184 and $257 for the six months ended June 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 $1,472 and $721 for the six months ended June 30, 1999 and 1998, respectively. 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 June Six Months Ended June 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 $ 2,826 $ (644) $ 2,182 $ 4,997 $ (1,280) $ 3,717 Investment securities 6,882 (409) 6,473 12,751 (1,108) 11,643 Loans 7,961 (2,194) 5,767 17,667 (5,471) 12,196 - --------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in interest income 17,669 (3,247) 14,422 35,415 (7,859) 27,556 - --------------------------------------------------------------------------------------------------------------------------- Interest expense: NOW deposits 2 (23) (21) 28 (48) (20) Regular money market deposits 52 (19) 33 139 (27) 112 Bonus money market deposits 5,836 (3,740) 2,096 12,097 (6,841) 5,256 Time deposits 631 (118) 513 812 (187) 625 Other borrowings -- -- -- -- (3) (3) - --------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in interest expense 6,521 (3,900) 2,621 13,076 (7,106) 5,970 - --------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in net interest income $ 11,148 $ 653 $ 11,801 $ 22,339 $ (753) $ 21,586 - --------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------
Net interest income, on a fully taxable-equivalent basis, totaled $47.6 million for the second quarter of 1999, an increase of $11.8 million, or 33.0%, from the $35.8 million total for the second quarter of 1998. The increase in net interest income was the result of a $14.4 million, or 26.2%, increase in interest income, offset by a $2.6 million, or 13.6%, increase in interest expense over the comparable prior year period. The $14.4 million increase in interest income for the second quarter of 1999, as compared to the second quarter of 1998, was the result of a $17.7 million favorable volume variance partially offset by a $3.2 million unfavorable rate variance. The favorable volume variance resulted from a $1.0 billion, or 37.8%, 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 38.6%, compared to the second quarter of 1998. The increase in average interest-earning assets consisted of loans, which were up $319.6 million, plus a combination of highly liquid, lower-yielding federal funds sold, securities purchased under agreement to resell and investment securities, which collectively increased $707.7 million, accounting for 68.9% of the total increase in average interest-earning assets. Average loans increased $319.6 million, or 25.2%, in the second quarter of 1999 as compared to the 1998 second quarter, resulting in a $8.0 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, 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 second quarter of 1999 increased $471.1 million, or 42.6%, as compared to the 1998 second quarter, resulting in a $6.9 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, mortgage-backed securities and municipal securities. Average federal funds sold and securities purchased under agreement to resell in the second quarter of 1999 increased a combined $236.6 million, or 68.6%, over the prior year second quarter, resulting in a $2.8 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 second quarter of 1999 resulted in a decrease in interest income of $3.2 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 second 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 $1.1 million unfavorable rate variance as compared to the second quarter of 1998. The average yield on loans in the second quarter of 1999 decreased 70 basis points from the respective prior year period, accounting for the remaining $2.2 million of the total unfavorable rate variance. This decrease was primarily attributable to a 75 basis points decline in the average prime rate charged by the Company, as a substantial portion of the Company's loans are prime rate based. The Company increased its prime rate by 25 basis points, to 8.0%, effective July 1, 1999. The yield on average interest-earning assets decreased 70 basis points in the second quarter of 1999 from the comparable prior year period. This decrease resulted from a decline in the average yield on loans, largely due to a decline in the Company's prime rate, 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 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 second quarter increased $2.6 million from the second quarter of 1998. This increase was due to an unfavorable volume variance of $6.5 million, partially offset by a favorable rate variance of $3.9 million. The unfavorable volume variance resulted from a $766.4 million, or 40.5%, increase in average interest-bearing liabilities in the second quarter of 1999 as compared with the second quarter of 1998. This increase was largely concentrated in the Company's bonus money market deposit product, which increased $697.1 million, or 49.7%, 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 $3.9 million favorable impact on interest expense in the second 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 4.4% in the second quarter of 17 1998 to 3.4% in the second 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 on interest-bearing liabilities decreased 50 basis points in the second quarter of 1999 versus the comparable prior year period. 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. Net interest income, on a fully taxable-equivalent basis, totaled $89.6 million for the first half of 1999, an increase of $21.6 million, or 31.7%, from the $68.1 million total for the first half of 1998. The increase in net interest income was the result of a $27.6 million, or 26.2%, increase in interest income, offset by a $6.0 million, or 16.2%, increase in interest expense over the comparable prior year period. The $27.6 million increase in interest income for the first half of 1999, as compared to the first half of 1998, was the result of a $35.4 million favorable volume variance partially offset by a $7.9 million unfavorable rate variance. The favorable volume variance was attributable to growth in average interest-earning assets, which increased $1.0 billion, or 39.3%, from the prior year comparable period. The increase in average interest-earning assets resulted from strong growth in the Company's deposits, which increased $986.6 million, or 39.2%, compared to the first half 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 $35.4 million favorable volume variance associated with interest-earning assets was partially offset by a $7.8 million unfavorable rate variance in the first half 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. The yield on average interest-earning assets decreased 80 points in the first half 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 decline in the Company's prime rate, 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 half of 1999 increased $6.0 million from the first half of 1998 due to a $13.1 million unfavorable volume variance partially offset by a $7.1 million favorable rate variance. The unfavorable volume variance resulted from a $755.9 million, or 42.2%, increase in average interest-bearing liabilities in the first half of 1999 as compared with the first 18 half of 1998. This increase was largely concentrated in the Company's bonus money market deposit product, which increased $702.9 million, or 53.6%, 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. The $7.1 million favorable rate variance was largely attributable to a 100 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. The average cost of funds paid on interest-bearing liabilities decreased 80 basis points in the first half of 1999 versus the first half of the prior year. 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 $10.8 million for the second quarter of 1999, a $6.8 million, or 168.4%, increase compared to the $4.0 million provision for the second quarter of 1998. The provision for loan losses increased $9.3 million, or 97.5%, to a total of $18.8 million for the first six months of 1999 versus $9.5 million for the comparable 1998 period. 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 six months ended June 30, 1999 and 1998:
Three Months Ended June 30, Six Months Ended June 30, (Unaudited) (Unaudited) ---------------------------------------------------------------- (Dollars in thousands) 1999 1998 1999 1998 - ------------------------------------------------------------------------------------------------------------------- Letter of credit and foreign exchange income $ 3,474 $ 1,631 $ 6,143 $ 3,342 Disposition of client warrants 1,688 1,834 2,510 4,274 Deposit service charges 677 473 1,344 846 Investment gains/(losses) (374) 3 (243) 477 Other 993 494 1,957 887 - ------------------------------------------------------------------------------------------------------------------- Total noninterest income $ 6,458 $ 4,435 $ 11,711 $ 9,826 - ------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------
Noninterest income increased $2.0 million, or 45.6%, to a total of $6.5 million in the second quarter of 1999 versus $4.4 million in the prior year second quarter. The increase in noninterest income was largely due to a $1.8 million increase in letter of credit fees, foreign exchange fees and other trade finance income in the 1999 second quarter as compared to the respective prior year period. Noninterest income totaled $11.7 million for the first six months of 1999, an increase of $1.9 million, or 19.2%, from the $9.8 million in the comparable 1998 period. This increase was largely due to a $2.8 million increase in letter of credit fees, foreign exchange fees 19 and other trade finance income and a $1.1 million increase in other noninterest income, partially offset by a decrease in warrant income of $1.8 million. Letter of credit fees, foreign exchange fees and other trade finance income totaled $3.5 million in the second quarter of 1999, an increase of $1.8 million, or 113.0%, from the $1.6 million earned in the second quarter of 1998. For the first six months of 1999, letter of credit fees, foreign exchange fees and other trade finance income totaled $6.1 million, an increase of $2.8 million, or 83.8%, compared to the $3.3 million in the first six 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 six 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 losses during those periods. Based on July 31, 1999 valuations, the Company had potential pre-tax warrant gains totaling over $19.7 million, of which over $16.8 million related to three clients. The Company is restricted from exercising these warrants until the third and fourth quarters of 1999, and is unable to use any type of derivative instrument to secure the current unrealized gains associated with these warrants. Hence, the amount of warrant income recognized in future periods by the Company may vary materially from the current unrealized amount due to fluctuations in the market prices of the underlying common stock of these clients. 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 three months ended June 30, 1999, an increase of $0.2 million, or 43.1%, from the $0.5 million reported in the second quarter of 1998. For the first six months of 1999 and 1998 deposit service charges totaled $1.3 million and $0.8 million, respectively. 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 $0.2 million loss on investment securities during the first six months of 1999, compared to a $0.5 million gain on sales of investment securities during the first half of the prior year. All investment securities sold were classified as available-for-sale, and all sales were 20 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 101.0%, to $1.0 million in the second quarter of 1999 from $0.5 million in the second quarter of 1998. For the six months ended June 30, 1999, other noninterest income increased $1.1 million, or 120.6%, to $2.0 million from $0.9 million in the comparable 1998 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 second quarter of 1999 totaled $27.8 million, a $6.0 million, or 27.7%, increase from the $21.8 million incurred in the comparable 1998 period. Noninterest expense totaled $53.3 million for the first six months of 1999, an increase of $12.7 million, or 31.1%, over the $40.7 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 second quarter was 53.6% versus 60.7% for the second quarter of 1998. The Company's efficiency ratio for the first six months of 1999 was 54.4%, versus 57.9% for the comparable 1998 period. 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 June 30, ------------------------------------------------------------ 1999 1998 ------------------------------------------------------------ Percent of Percent of Adjusted Adjusted (Dollars in thousands) Amount Revenues Amount Revenues - -------------------------------------------------------------------------------------------------------- Compensation and benefits $ 15,720 30.3% $ 12,483 32.9% Professional services 3,552 6.8 2,602 6.8 Net occupancy expense 1,569 3.0 1,067 2.8 Business development and travel 1,524 2.9 1,407 3.7 Furniture and equipment 1,402 2.7 2,691 7.1 Trust preferred securities distributions 825 1.6 362 1.0 Advertising and promotion 734 1.4 520 1.4 Postage and supplies 567 1.1 478 1.3 Telephone 439 0.8 597 1.6 Other 1,470 2.8 840 2.2 - -------------------------------------------------------------------------------------------------------- Total excluding cost of other real estate owned 27,802 53.6% 23,047 60.7% Cost of other real estate owned (5) (1,274) - -------------------------------------------------------------------------------------------------------- Total noninterest expense $ 27,797 $ 21,773 - -------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------
21
Six Months Ended June 30, ------------------------------------------------------------ 1999 1998 ------------------------------------------------------------ Percent of Percent of Adjusted Adjusted (Dollars in thousands) Amount Revenues Amount Revenues - -------------------------------------------------------------------------------------------------------- Compensation and benefits $30,921 31.7% $24,104 33.3% Professional services 5,895 6.0 4,029 5.6 Net occupancy expense 3,038 3.1 2,058 2.8 Business development and travel 2,855 2.9 2,962 4.1 Furniture and equipment 2,790 2.9 3,731 5.2 Trust preferred securities distributions 1,650 1.7 362 0.5 Advertising and promotion 1,334 1.4 910 1.3 Postage and supplies 1,232 1.3 910 1.3 Telephone 838 0.9 1,119 1.5 Other 2,513 2.6 1,741 2.4 - -------------------------------------------------------------------------------------------------------- Total excluding cost of other real estate owned 53,066 54.4% 41,926 57.9% Cost of other real estate owned 268 (1,248) - -------------------------------------------------------------------------------------------------------- Total noninterest expense $53,334 $ 40,678 - -------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------
Compensation and benefits expenses totaled $15.7 million in the second quarter of 1999, a $3.2 million, or 25.9%, increase over the $12.5 million incurred in the second quarter of 1998. For the first six months of 1999, compensation and benefits expenses totaled $30.9 million, an increase of $6.8 million, or 28.3%, compared to $24.1 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. Average FTE were 618 and 607 for the three and six months ended June 30, 1999 versus 501 and 488 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 $3.6 million and $5.9 million for the three and six months ended June 30, 1999, an increase of $1.0 million, or 36.5%, and $1.9 million, or 46.3%, compared to $2.6 million and $4.0 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, 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. 22 Occupancy, furniture and equipment expenses totaled $3.0 million for the three months ended June 30, 1999, a decrease of $0.8 million, or 20.9%, from the $3.8 million for the three months ended June 30, 1998. This decrease resulted from the Company incurring certain non-recurring costs in connection with the expansion of its existing headquarters facility during the second quarter of 1998. Occupancy, furniture and equipment expenses totaled $5.8 million for the six months ended June 30, 1999 and 1998. Trust preferred securities distributions totaled $0.8 million and $1.7 million for the three and six months ended June 30, 1999, an increase of $0.5 million, or 127.9%, and $1.3 million, or 355.8%, compared to $0.4 million for the comparable 1998 periods. These amounts 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 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 $1.5 million and $2.5 million for the three and six months ended June 30, 1999, an increase of $0.6 million, or 75.0%, and $0.8 million, or 44.3%, compared to $0.8 million and $1.7 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 38.8% and 39.6% for the second quarter and first half of 1999, respectively, compared to 41.6% and 41.5% for the three and six month prior year periods, respectively. The decrease in the Company's effective income tax rate was attributable to an increase in the amount of the tax-exempt interest income received by the Company. FINANCIAL CONDITION The Company's total assets were $4.1 billion at June 30, 1999, an increase of $536.0 million, or 15.1%, 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 $752.7 million at June 30, 1999, an increase of $353.5 million, or 88.5%, compared to the $399.2 million outstanding at the prior year end. This increase was attributable to the Company 23 investing excess funds, resulting from the strong growth in deposits during the first half of 1999 having exceeded the growth in loans, in these types of short-term, liquid investments. INVESTMENT SECURITIES Investment securities totaled $1.6 billion at June 30, 1999, an increase of $196.3 million, or 14.0%, 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 half of 1999, and primarily consisted of U.S. agency securities and mortgage-backed 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. The increase in short-term market interest rates at the end of the 1999 second quarter resulted in a pre-tax unrealized loss on the Company's available-for-sale fixed income securities investment portfolio of $28.0 million as of June 30, 1999. This unrealized loss was partially offset by a pre-tax unrealized gain of $17.4 million associated with equity securities, which includes the Company's warrant portfolio. Because of the high 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 the warrants generating the unrealized gain associated with equity securities until the third and fourth quarters of 1999. The Company is also unable to use any type of derivative instrument to secure the current unrealized gains associated with these warrants. Hence, the amount of warrant income recognized in future periods by the Company may vary materially from the current unrealized amount due to fluctuations in the market prices of the underlying common stock of these clients. LOANS Total loans, net of unearned income, at June 30, 1999, were $1.6 billion, a slight decrease of $35.7 million, or 2.2%, compared to the 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. This has resulted in the Company experiencing higher than normal loan paydowns and payoffs and a decrease in the overall loan balance from 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 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 24 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 $56.3 million at June 30, 1999, an increase of $10.3 million, or 22.4%, compared to the $46.0 million balance at December 31, 1998. This increase was due to $18.8 million in additional provisions to the allowance for loan losses, offset by net charge-offs of $8.5 million for the first half of 1999. The Company incurred $4.2 million and $12.2 million in gross charge-offs during the three and six months ended June 30, 1999. The gross charge-offs in the first six months of 1999 were not concentrated in any particular niche and included $2.7 million and $1.9 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 half of 1999, $4.6 million were nonperforming loans at the end of 1998. The Company realized recoveries of $2.1 million and $3.8 million for the three and six months ended June 30, 1999, respectively. The unallocated component of the allowance for loan losses totaled $24.7 million at June 30, 1999, an increase of $8.4 million from the unallocated balance of $16.3 million at December 31, 25 1998. This increase resulted from the Company making additional provisions to the allowance for loan losses during the first six months of 1999 in response to an increase in nonperforming loans. In general, Management believes the allowance for loan losses is adequate as of June 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:
June 30, December 31, 1999 1998 (Dollars in thousands) (Unaudited) (Unaudited) - -------------------------------------------------------------------------------------- Nonperforming assets: Loans past due 90 days or more $ 678 $ 441 Nonaccrual loans 46,678 19,444 - -------------------------------------------------------------------------------------- Total nonperforming loans 47,356 19,885 OREO and other foreclosed assets 750 1,800 - -------------------------------------------------------------------------------------- Total nonperforming assets $48,106 $21,685 - -------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------- Nonperforming loans as a percentage of total loans 3.0% 1.2% Nonperforming assets as a percentage of total assets 1.2% 0.6% Allowance for loan losses: $56,300 $46,000 As a percentage of total loans 3.6% 2.8% As a percentage of nonaccrual loans 120.6% 236.6% As a percentage of nonperforming loans 118.9% 231.3%
Nonperforming loans totaled $47.4 million, or 3.0% of total loans, at June 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 four commercial credits, three of which were also nonperforming at the prior quarter end. The first credit totaling approximately $7.0 million, was in the Company's Communications practice, and was repaid in full during July 1999. The second credit is in the Company's Healthcare Services practice. The Company received payments on this credit totaling $2.0 million during the second quarter of 1999 and the credit had a balance of approximately $5.5 million at June 30, 1999. The third credit is in the Company's Financial Services (non-technology) niche and had a balance of approximately $15.0 million at June 30, 1999. The prior three credits had all been previously classified as nonperforming at March 31, 1999. The last credit, in excess of $8.0 million, is in the Company's Computers and Peripherals practice and was disclosed as having a higher than normal risk of becoming nonperforming in the Company's 1999 first quarter Form 10-Q. As of June 30, 1999, Management believes each of these credits is adequately secured with collateral and reserves, and that any future charge-offs associated with these loans will not have a material impact on the future net income of the Company. 26 In addition to the loans disclosed in the foregoing analysis, Management has identified four loans with principal amounts aggregating approximately $8.2 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 $0.8 million at June 30, 1999, compared to $1.8 million at December 31, 1998. This decrease was primarily due to the sale of the Company's only OREO property during the second quarter of 1999. The OREO and other foreclosed assets balance at June 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 3.8 billion at June 30, 1999, an increase of $521.2 million, or 15.9%, from the prior year-end total of $3.3 billion. A significant portion of the increase in deposits during the first half of 1999 was due to increases in both the noninterest-bearing demand and money market deposit products, which increased $242.1 million, or 26.3%, and $191.0 million, or 8.7%, respectively. These increases were 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 half 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 27 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 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 was completed. The Company may be impacted 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 half of 1999, the Company incurred $1.3 million, bringing the total incurred in 1998 and 1999 for charges related to its Year 2000 remediation effort to $2.8 expenses million. The Company expects to incur approximately $0.2 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 28 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 June 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 29 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% will be paid by the Company quarterly. The securities have a maximum maturity 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 June 30, 1999, the Bank's ratio of liquid assets to total deposits was 60.6%. 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 June 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 $227.0 million at June 30, 1999, an increase of $11.1 million, or 5.1%, from the $215.9 million balance at December 31, 1998. This increase resulted from net income of $16.8 million combined with capital generated primarily through the Company's employee benefit plans of $2.6 million, offset by a decrease in the after-tax net unrealized gain on available-for-sale investments of $8.3 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 June 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 30 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 June 30, 1999, and December 31, 1998. Capital ratios for the Company are set forth below:
June 30, December 31, 1999 1998 (Unaudited) - ----------------------------------------------------------------- Total risk-based capital ratio 12.9% 11.5% Tier 1 risk-based capital ratio 11.6% 10.3% Tier 1 leverage ratio 6.9% 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 June 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 half of 1999. The decrease in the Tier 1 leverage ratio from December 31, 1998, to June 30, 1999, was primarily attributable to an increase in average total assets due to strong growth in deposits during the first half of 1999. 31 PART II - OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS There were no legal proceedings requiring disclosure pursuant to this item pending at June 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 The Annual Meeting of Shareholders was held on April 15, 1999. Each of the persons named in the Proxy Statement as a nominee for director was elected; the change in the Company's state of incorporation was ratified; the 1999 Employee Stock Purchase Plan was ratified; and the appointment of KPMG LLP as the Company's auditors for 1999 was ratified. The following are the voting results on each of these matters:
ELECTION OF DIRECTORS IN FAVOR WITHHELD - --------------------- -------- -------- Gary K. Barr 18,215,473 321,041 James F. Burns, Jr 18,215,081 321,432 John C. Dean 18,215,473 321,041 David M. deWilde 18,209,415 327,098 Stephen E. Jackson 18,215,081 321,433 Daniel J. Kelleher 18,211,265 325,248 James R. Porter 18,215,473 321,041 Ann R. Wells 18,211,657 324,857 OTHER MATTERS IN FAVOR OPPOSED ABSTAINED - ------------- -------- ------- --------- The change in the Company's state of incorporation from California to Delaware by means of a merger of Silicon Valley Bancshares into a wholly owned Delaware subsidiary of Silicon Valley Bancshares was ratified and approved 12,835,661 922,773 9,250 The Silicon Valley Bancshares 1999 Employee Stock Purchase Plan was ratified and approved 18,289,543 232,375 14,595
32
OTHER MATTERS IN FAVOR OPPOSED ABSTAINED - ------------- -------- ------- --------- Ratification of the appointment of KPMG Peat Marwick LLP as the Company's independent auditors for 1999 18,496,105 19,569 20,839
ITEM 5 - OTHER INFORMATION None. ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: 3.1 Certificate of Incorporation, as filed with the Delaware Secretary of State on March 22, 1999. Incorporated by reference to Exhibit 4.1 of the Company's report on Form 8-K filed on April 26, 1999 3.2 Bylaws. Incorporated by reference to Exhibit 4.2 of the Company's report on Form 8-K filed on April 26, 1999 22.1 Subsidiaries. The following are Subsidiaries of Silicon Valley Bank which have been incorporated in 1999: Silicon Valley Real Estate Investment Corporation, incorporated in Maryland; and SVB Securities, Inc., incorporated in California. 27.1 Financial Data Schedule (b) REPORTS ON FORM 8-K: A report on Form 8-K was filed on April 26, 1999 whereby the Company gave public notice of a change in its state of incorporation from California to Delaware, as approved by the holders of a majority of the Company's outstanding common stock at the Company's Annual Meeting of Shareholders on April 15, 1999. 33 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: August 11, 1999 /s/ Christopher T. Lutes -------------------------------- Christopher T. Lutes Executive Vice President and Chief Financial Officer (Principal Accounting Officer) 34 EX-27.1 2 EXHIBIT 27.1
9 The unaudited interim consolidated financial statements related notes and management discussion and analysis contained in the report Form 10-Q filed by Silicon Valley Bancshares for the six months ended June 30, 1999. 1,000 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 131,250 164 752,500 0 1,593,836 0 0 1,576,215 56,300 4,081,426 3,790,974 0 24,974 0 0 0 21 230,303 4,081,426 77,059 41,094 12,925 131,078 42,904 42,904 88,174 18,770 (243) 53,334 27,781 16,790 0 0 16,790 0.82 0.81 5.0 46,678 678 0 8,200 46,000 12,239 3,769 56,300 31,556 0 24,744 REPRESENTS BASIC EARNINGS PER SHARE REPRESENTS DILUTED EARNINGS PER SHARE
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