As filed with the Securities and Exchange Commission on August 13, 1998
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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, 1998
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)
California 94-2856336
(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
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At July 31, 1998, 20,578,979 shares of the registrant's common stock
(no par value) were outstanding.
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This report contains a total of 31 pages.
1
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS 3
CONSOLIDATED INCOME STATEMENTS 4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 5
CONSOLIDATED STATEMENTS OF CASH FLOWS 6
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 12
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 29
ITEM 2. CHANGES IN SECURITIES 29
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 29
ITEM 5. OTHER INFORMATION 29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 30
SIGNATURES 31
2
PART I - FINANCIAL INFORMATION
ITEM 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SILICON VALLEY BANCSHARES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
1998 1997
(Dollars in thousands) (Unaudited)
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Assets:
Cash and due from banks $ 143,022 $ 105,059
Federal funds sold and securities purchased under
agreement to resell 548,238 321,773
Investment securities, at fair value 1,066,464 1,013,904
Loans, net of unearned income 1,350,705 1,174,645
Allowance for loan losses (42,300) (37,700)
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Net loans 1,308,405 1,136,945
Premises and equipment 7,010 4,460
Other real estate owned 689 689
Accrued interest receivable and other assets 49,258 42,293
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Total assets $3,123,086 $2,625,123
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Liabilities and Shareholders' Equity:
Liabilities:
Noninterest-bearing demand deposits $ 774,649 $ 788,442
NOW deposits 42,785 21,348
Money market deposits 1,925,794 1,497,996
Time deposits 124,051 124,621
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Total deposits 2,867,279 2,432,407
Other liabilities 19,085 18,235
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Total liabilities 2,886,364 2,450,642
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Company obligated mandatorily redeemable trust preferred securities
of subsidiary trust holding solely junior subordinated debentures
(trust preferred securities) 38,459 -
Shareholders' Equity:
Preferred stock, no par value:
20,000,000 shares authorized; none outstanding
Common stock, no par value:
60,000,000 shares authorized; 20,572,086 and
19,940,474 shares outstanding at June 30, 1998
and December 31, 1997, respectively 90,805 83,009
Retained earnings 110,780 94,999
Unearned compensation (5,235) (5,946)
Accumulated other comprehensive income:
Net unrealized gain on available-for-sale investments 1,913 2,419
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Total shareholders' equity 198,263 174,481
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Total liabilities and shareholders' equity $3,123,086 $2,625,123
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See notes to interim consolidated financial statements.
3
SILICON VALLEY BANCSHARES AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
For the three months ended For the six months ended
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June 30, June 30, June 30, June 30,
1998 1997 1998 1997
(Dollars in thousands, except per share amounts) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
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Interest income:
Loans, including fees $ 33,760 $ 26,589 $ 64,862 $ 49,525
Investment securities 16,205 9,402 30,202 18,123
Federal funds sold and securities
purchased under agreement to resell 4,765 3,729 9,208 6,965
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Total interest income 54,730 39,720 104,272 74,613
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Interest expense:
Deposits 19,331 12,638 36,931 23,674
Other borrowings - - 3 -
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Total interest expense 19,331 12,638 36,934 23,674
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Net interest income 35,399 27,082 67,338 50,939
Provision for loan losses 4,024 2,618 9,505 5,966
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Net interest income after provision
for loan losses 31,375 24,464 57,833 44,973
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Noninterest income:
Disposition of client warrants 1,834 1,082 4,274 4,245
Letter of credit and foreign
exchange income 1,631 1,110 3,342 2,090
Deposit service charges 473 407 846 772
Investment gains 3 44 477 45
Other 494 334 887 655
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Total noninterest income 4,435 2,977 9,826 7,807
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Noninterest expense:
Compensation and benefits 12,483 9,420 24,104 18,476
Professional services 2,602 1,695 4,029 3,131
Furniture and equipment 2,691 763 3,731 1,424
Business development and travel 1,407 1,026 2,962 1,986
Net occupancy expense 1,067 891 2,058 1,653
Telephone 597 330 1,119 634
Advertising and promotion 520 450 910 728
Postage and supplies 478 342 910 702
Trust preferred securities distributions 362 - 362 -
Cost of other real estate owned (1,274) 34 (1,248) 26
Other 840 803 1,741 1,660
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Total noninterest expense 21,773 15,754 40,678 30,420
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Income before income tax expense 14,037 11,687 26,981 22,360
Income tax expense 5,836 4,908 11,201 9,391
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Net income $ 8,201 $ 6,779 $ 15,780 $ 12,969
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Basic earnings per share $ 0.40 $ 0.35 $ 0.78 $ 0.68
Diluted earnings per share $ 0.39 $ 0.34 $ 0.75 $ 0.65
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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
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June 30, June 30, June 30, June 30,
1998 1997 1998 1997
(Dollars in thousands) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
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Net income $ 8,201 $ 6,779 $ 15,780 $ 12,969
Other comprehensive income, net of tax:
Unrealized gain/(loss) on available-for-
sale investments:
Unrealized holding gain arising
during period 422 2,571 2,250 259
Less: Reclassification adjustment for
gain included in net income (1,065) (653) (2,756) (2,488)
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Other comprehensive income (643) 1,918 (506) (2,229)
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Comprehensive income $ 7,558 $ 8,697 $ 15,274 $ 10,740
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See notes to interim consolidated financial statements.
5
SILICON VALLEY BANCSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended
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June 30, June 30,
1998 1997
(Dollars in thousands) (Unaudited) (Unaudited)
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Cash flows from operating activities:
Net income $ 15,780 $ 12,969
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 9,505 5,966
Depreciation and amortization 685 655
Net gain on sales of investment securities (477) (45)
Net gain on sales of other real estate owned (1,298) (45)
Increase in accrued interest receivable (4,125) (2,715)
Increase in prepaid expenses (855) (250)
Increase in unearned income 656 1,875
Increase (decrease) in accrued liabilities 546 (3,088)
Increase (decrease) in taxes payable 2,928 (1,389)
Other, net (492) (2,615)
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Net cash provided by operating activities 22,853 11,318
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Cash flows from investing activities:
Proceeds from maturities and paydowns of
investment securities 703,818 670,952
Proceeds from sales of investment securities 94,000 60,555
Purchases of investment securities (849,984) (799,572)
Net increase in loans (183,227) (179,798)
Proceeds from recoveries of charged off loans 1,606 1,837
Net proceeds from sales of other real estate owned 1,298 857
Purchases of premises and equipment (3,373) (222)
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Net cash applied to investing activities (235,862) (245,391)
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Cash flows from financing activities:
Net increase in deposits 434,872 280,712
Proceeds from issuance of trust preferred securities,
net of issuance costs 38,459 -
Proceeds from issuance of common stock,
net of issuance costs 4,106 2,384
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Net cash provided by financing activities 477,437 283,096
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Net increase in cash and cash equivalents 264,428 49,023
Cash and cash equivalents at January 1, 426,832 433,177
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Cash and cash equivalents at June 30, $ 691,260 $ 482,200
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Supplemental disclosures:
Interest paid $ 36,295 $ 23,508
Income taxes paid $ 9,401 $ 11,271
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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 1997 consolidated financial
statements to conform to the 1998 presentations. Such reclassifications had
no effect on the results of operations or shareholders' equity. The following
is a summary of the significant accounting and reporting policies used in
preparing the interim consolidated financial statements.
NATURE OF OPERATIONS
The Company is a bank holding company whose principal subsidiary is Silicon
Valley Bank (the "Bank"), a California-chartered bank with headquarters in
Santa Clara, California. The Bank maintains regional banking offices in
Northern and Southern California, and additionally has loan offices in
Arizona, Colorado, Georgia, Illinois, Maryland, Massachusetts, Oregon, Texas,
and Washington. The Bank serves emerging growth and middle-market companies
in targeted niches, focusing on the technology and life sciences industries,
while also identifying and capitalizing on opportunities to serve companies
in other industries whose financial services needs are underserved.
Substantially all of the assets, liabilities and earnings of the Company
relate to its investment in the Bank.
CONSOLIDATION
The interim consolidated financial statements include the accounts of the
Company and those of its wholly owned subsidiaries, the Bank, SVB Capital I
and SVB Leasing Company (inactive). The revenues, expenses, assets, and
liabilities of the subsidiaries are included in the respective line items in
the interim consolidated financial statements after elimination of
intercompany accounts and transactions.
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, 1998, the results of its operations for the three and six month
periods ended June 30, 1998, and June 30, 1997, and the results of its cash
flows for the six month periods ended June 30, 1998, and June 30, 1997. The
December 31, 1997, 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 1997 Annual Report on Form 10-K. The results of operations for the
three and six month periods ended June 30, 1998, 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 are so near
their maturity that they present insignificant risk of changes in value.
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 $238,000 and $273,000 at June 30,
1998, and December 31, 1997, 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.
RECENT ACCOUNTING PRONOUNCEMENTS
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income." This
statement establishes standards for all entities for reporting comprehensive
income and its components in financial statements. This statement requires
that all items which are required to be recognized under accounting standards
as components of comprehensive income be reported in a financial statement
that is displayed with the same prominence as other financial statements.
Comprehensive income is equal to net income plus the change in "other
comprehensive income," as defined by SFAS No. 130. The only component of
other comprehensive income currently applicable to the Company is the net
unrealized gain or loss on available-for-sale investments. SFAS No. 130
requires that an entity: (a) classify items of other comprehensive income by
their
8
nature in a financial statement, and (b) report the accumulated balance
of other comprehensive income separately from common stock and retained
earnings in the equity section of the balance sheet. This statement is
effective for financial statements issued for fiscal years beginning after
December 15, 1997.
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information."
This statement establishes standards for publicly held entities to follow in
reporting information about operating segments in annual financial statements
and requires that those entities also report selected information about
operating segments in interim financial statements. This statement also
establishes standards for related disclosures about products and services,
geographic areas and major customers. This statement is effective for financial
statements issued for periods beginning after December 15, 1997.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires that an entity
recognize all derivatives as either assets or liabilities in the balance sheet
and measure those instruments at fair value. The statement is effective for
fiscal quarters of fiscal years beginning after June 15, 1999. The Company
expects to adopt this statement on January 1, 2000. The Company will begin
evaluating the impact of its adoption on the Company's consolidated financial
statements.
2. EARNINGS PER SHARE
The following is a reconciliation of basic earnings per share (EPS) to diluted
EPS for the three and six month periods ended June 30, 1998 and 1997. The
number of shares and earnings per share have been restated to reflect a two-for-
one stock split for common shares of record as of April 17, 1998.
9
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
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1998:
Basic EPS:
Income available to common
shareholders $ 8,201 20,262 $ 0.40 $ 15,780 20,164 $ 0.78
Effect of Dilutive Securities:
Stock options and restricted stock - 738 - - 776 -
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Diluted EPS:
Income available to common
shareholders plus assumed
conversions $ 8,201 21,000 $ 0.39 $ 15,780 20,940 $ 0.75
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1997:
Basic EPS:
Income available to common
shareholders $ 6,779 19,163 $ 0.35 $ 12,969 19,076 $ 0.68
Effect of Dilutive Securities:
Stock options and restricted stock - 1,000 - - 1,031 -
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Diluted EPS:
Income available to common
shareholders plus assumed
conversions $ 6,779 20,163 $ 0.34 $ 12,969 20,107 $ 0.65
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3. LOANS
The detailed composition of loans, net of unearned income of $8.7 million and
$8.0 million at June 30, 1998, and December 31, 1997, respectively, is
presented in the following table:
June 30, December 31,
1998 1997
(Dollars in thousands) (Unaudited)
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Commercial $ 1,181,718 $ 1,051,218
Real estate construction 67,642 53,583
Real estate term 56,416 33,395
Consumer and other 44,929 36,449
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Total loans $ 1,350,705 $ 1,174,645
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10
4. ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses for the three and six month
periods ended June 30, 1998 and 1997 was as follows:
Three Months Ended June 30, Six Months Ended June 30,
(Unaudited) (Unaudited)
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(Dollars in thousands) 1998 1997 1998 1997
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Beginning balance $40,400 $36,400 $37,700 $32,700
Provision for loan losses 4,024 2,618 9,505 5,966
Loans charged off (2,560) (2,663) (6,511) (3,203)
Recoveries 436 945 1,606 1,837
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Balance at June 30, $42,300 $37,300 $42,300 $37,300
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The aggregate recorded investment in loans for which impairment has been
determined in accordance with SFAS No. 114 totaled $29.8 million and $15.2
million at June 30, 1998, and June 30, 1997, respectively. Allocations of the
allowance for loan losses related to impaired loans totaled $8.7 million at
June 30, 1998, and $5.6 million at June 30, 1997. Average impaired loans for
the second quarter of 1998 and 1997 totaled $24.3 million and $17.5 million,
respectively.
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 1997 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 1997 consolidated
financial statements to conform to the 1998 presentations. Such
reclassifications had no effect on the results of operations or shareholders'
equity.
EARNINGS SUMMARY
The Company reported net income of $8.2 million, or $0.39 per diluted share,
for the second quarter of 1998, compared with net income of $6.8 million, or
$0.34 per diluted share, for the second quarter of 1997. Net income totaled
$15.8 million, or $0.75 per diluted share, for the six months ended June 30,
1998, versus $13.0 million, or $0.65 per diluted share, for the respective
1997 period. The annualized return on average assets (ROA) was 1.1% in the
second quarter of 1998 versus 1.3% in the second quarter of 1997. The
annualized return on average equity (ROE) for the second quarter of 1998 was
17.1%, compared to 18.7% in the 1997 second quarter. For the first six months
of 1998, ROA was 1.2% and ROE was 17.0% versus 1.3% and 18.4%, respectively,
for the comparable prior year period.
The increase in net income during the three and six month periods ended June
30, 1998, as compared with the prior year respective periods, resulted
primarily from growth in net interest 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 month periods ended June 30, 1998
and 1997, and are discussed in more detail below.
12
Three Months Ended June 30, Six Months Ended June 30,
(Unaudited) (Unaudited)
-------------------------- -------------------------
(Dollars in thousands) 1998 1997 1998 1997
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Net interest income $35,399 $27,082 $67,338 $50,939
Provision for loan losses 4,024 2,618 9,505 5,966
Noninterest income 4,435 2,977 9,826 7,807
Noninterest expense 21,773 15,754 40,678 30,420
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Income before income taxes 14,037 11,687 26,981 22,360
Income tax expense 5,836 4,908 11,201 9,391
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Net income $ 8,201 $ 6,779 $15,780 $12,969
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NET INTEREST INCOME AND MARGIN
Net interest income represents the difference between interest earned,
primarily on loans and investments, and interest paid on funding sources,
primarily deposits, and is the principal source of revenue for the Company.
Net interest margin is the amount of net interest income, on a fully
taxable-equivalent basis, expressed as a percentage of average
interest-earning assets. The average yield earned on interest-earning assets
is the amount of taxable-equivalent interest income expressed as a percentage
of average interest-earning assets. The average rate paid on funding sources
expresses interest expense as a percentage of average interest-earning assets.
The following tables set forth average assets, liabilities and shareholders'
equity, interest income and interest expense, average yields and rates, and
the composition of the Company's net interest margin for the three and six
months ended June 30, 1998 and 1997, respectively.
13
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AVERAGE BALANCES, RATES AND YIELDS
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For the three months ended June 30,
---------------------------------------------------------------------------------------
1998 1997
(Unaudited) (Unaudited)
----------------------------------- -----------------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Rate Balance Interest Rate
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Interest-earning assets:
Federal funds sold and
securities purchased under
agreement to resell (1) $ 344,935 $ 4,765 5.5% $ 267,789 $ 3,729 5.6%
Investment securities:
Taxable 1,042,159 15,529 6.0 609,413 9,206 6.1
Non-taxable (2) 64,066 1,040 6.5 15,208 302 8.0
Loans:
Commercial 1,104,631 29,575 10.7 858,789 23,831 11.1
Real estate construction and term 118,299 3,177 10.8 74,192 1,892 10.2
Consumer and other 44,396 1,008 9.1 39,193 866 8.9
- -------------------------------------- --------------------------------------- ---------------------------------------
Total loans 1,267,326 33,760 10.7 972,174 26,589 11.0
- -------------------------------------- --------------------------------------- ---------------------------------------
Total interest-earning assets 2,718,486 55,094 8.1 1,864,584 39,826 8.6
- -------------------------------------- --------------------------------------- ---------------------------------------
Cash and due from banks 132,498 158,247
Allowance for loan losses (41,390) (37,089)
Other real estate owned 689 1,249
Other assets 52,709 34,482
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Total assets $2,862,992 $2,021,473
- -------------------------------------- --------------------------------------- ---------------------------------------
- -------------------------------------- --------------------------------------- ---------------------------------------
Funding sources:
Interest-bearing liabilities:
NOW deposits $ 21,447 106 2.0 $ 12,953 60 1.9
Regular money market deposits 338,467 2,295 2.7 357,781 2,411 2.7
Bonus money market deposits 1,403,672 15,491 4.4 812,674 9,081 4.5
Time deposits 127,727 1,439 4.5 104,651 1,086 4.2
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Total interest-bearing liabilities 1,891,313 19,331 4.1 1,288,059 12,638 3.9
Portion of noninterest-bearing
funding sources 827,173 576,525
- ------------------------------------- --------------------------------------- ---------------------------------------
Total funding sources 2,718,486 19,331 2.9 1,864,584 12,638 2.7
- ------------------------------------- --------------------------------------- ---------------------------------------
Noninterest-bearing funding sources:
Demand deposits 745,237 575,726
Other liabilities 16,808 11,903
Trust preferred securities 16,964 -
Shareholders' equity 192,670 145,785
Portion used to fund
interest-earning assets (827,173) (576,525)
- ------------------------------------- ------------- ----------
Total liabilities and shareholders'
equity $2,862,992 $2,021,473
- ------------------------------------- ------------- ----------
- ------------------------------------- ------------- ----------
Net interest income and margin $35,763 5.3% $27,188 5.9%
- ------------------------------------- ------- --- ------- ----
- ------------------------------------- ------- --- ------- ----
Memorandum: Total deposits $2,636,550 $1,863,785
- ------------------------------------- ------------- ----------
- ------------------------------------- ------------- ----------
(1) Includes average interest-bearing deposits in other financial
institutions of $248 and $315 for the three months ended June 30,
1998 and 1997, respectively.
(2) Interest income on non-taxable investments is presented on a fully
taxable-equivalent basis using the federal statutory rate of 35% in
1998 and 1997. The tax equivalent adjustments were $364 and $106 for
the three months ended June 30, 1998 and 1997, respectively.
14
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AVERAGE BALANCES, RATES AND YIELDS
- -----------------------------------------------------------------------------------------------------------------------------------
For the six months ended June 30,
----------------------------------------------------------------------------
1998 1997
(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) $ 334,672 $ 9,208 5.5% $ 257,119 $ 6,965 5.5%
Investment securities:
Taxable 972,197 28,864 6.0 597,801 17,747 6.0
Non-taxable (2) 62,598 2,059 6.6 14,519 579 8.0
Loans:
Commercial 1,071,831 57,264 10.8 806,457 44,210 11.1
Real estate construction and term 105,949 5,703 10.9 72,802 3,606 10.0
Consumer and other 41,688 1,895 9.2 38,396 1,709 9.0
- -------------------------------------- --------------------------------- ----------------------------------
Total loans 1,219,468 64,862 10.7 917,655 49,525 10.9
- -------------------------------------- --------------------------------- ----------------------------------
Total interest-earning assets 2,588,935 104,993 8.2 1,787,094 74,816 8.4
- -------------------------------------- --------------------------------- ----------------------------------
Cash and due from banks 130,256 159,735
Allowance for loan losses (40,382) (36,110)
Other real estate owned 689 1,544
Other assets 50,588 34,693
- -------------------------------------- --------------------------------- ----------------------------------
Total assets $2,730,086 $1,946,956
- -------------------------------------- --------------------------------- ----------------------------------
- -------------------------------------- --------------------------------- ----------------------------------
Funding sources:
Interest-bearing liabilities:
NOW deposits $ 18,306 180 2.0 $ 13,789 129 1.9
Regular money market deposits 331,846 4,466 2.7 337,786 4,519 2.7
Bonus money market deposits 1,311,119 29,408 4.5 766,875 17,042 4.5
Time deposits 128,847 2,877 4.5 98,074 1,984 4.1
Other borrowings 110 3 6.0 - - -
- -------------------------------------- --------------------------------- ----------------------------------
Total interest-bearing liabilities 1,790,228 36,934 4.2 1,216,524 23,674 3.9
Portion of noninterest-bearing
funding sources 798,707 570,570
- -------------------------------------- --------------------------------- ----------------------------------
Total funding sources 2,588,935 36,934 2.9 1,787,094 23,674 2.7
- -------------------------------------- --------------------------------- ----------------------------------
Noninterest-bearing funding sources:
Demand deposits 725,683 574,408
Other liabilities 18,135 13,658
Trust preferred securities 8,529 -
Shareholders' equity 187,511 142,366
Portion used to fund
interest-earning assets (798,707) (570,570)
- -------------------------------------- ----------- -----------
Total liabilities and shareholders'
equity $2,730,086 $1,946,956
- -------------------------------------- ----------- ----------
- -------------------------------------- ----------- ----------
Net interest income and margin $68,059 5.3% $51,142 5.8%
- -------------------------------------- -------- ---- -------- ----
- -------------------------------------- -------- ---- -------- ----
Memorandum: Total deposits $2,515,801 $1,790,932
- -------------------------------------- ----------- ----------
- -------------------------------------- ----------- ----------
(1) Includes average interest-bearing deposits in other financial
institutions of $257 and $323 for the six months ended June 30,
1998 and 1997, respectively.
(2) Interest income on non-taxable investments is presented on a fully
taxable-equivalent basis using the federal statutory rate of 35% in
1998 and 1997. The tax equivalent adjustments were $721 and $203 for
the six months ended June 30, 1998 and 1997, 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 1998 and 1997.
1998 Compared to 1997
-------------------------------------------------------------------------------
Three Months Ended June 30, 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 $ 1,066 $ (30) $ 1,036 $ 2,135 $ 108 $ 2,243
Investment securities 7,213 (152) 7,061 12,625 (28) 12,597
Loans 7,863 (692) 7,171 16,053 (716) 15,337
- --------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in interest income 16,142 (874) 15,268 30,813 (636) 30,177
- --------------------------------------------------------------------------------------------------------------------------
Interest expense:
NOW deposits 42 4 46 44 7 51
Regular money market deposits (131) 15 (116) (80) 27 (53)
Bonus money market deposits 6,522 (112) 6,410 12,207 159 12,366
Time deposits 260 93 353 687 206 893
Other borrowings - - - 3 - 3
- ----------------------------------------------------------------------------------------------------------------------------
Increase in interest expense 6,693 - 6,693 12,861 399 13,260
- ----------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in net interest income $ 9,449 $(874) $ 8,575 $17,952 $(1,035) $16,917
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
Net interest income, on a fully taxable-equivalent basis, totaled $35.8
million for the second quarter of 1998, an increase of $8.6 million, or
31.5%, from the $27.2 million total for the second quarter of 1997. The
increase in net interest income was the result of a $15.3 million, or 38.3%,
increase in interest income, offset by a $6.7 million, or 53.0%, increase in
interest expense over the comparable prior year period.
The $15.3 million increase in interest income for the second quarter of 1998,
as compared to the second quarter of 1997, was the result of a $16.1 million
favorable volume variance partially offset by a $0.9 million unfavorable rate
variance. The favorable volume variance resulted from a $853.9 million, or
45.8%, 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 $772.8 million, or
41.5%, compared to the second quarter of 1997. The increase in average
interest-earning assets consisted of loans, which were up $295.2 million,
plus a combination of highly liquid, lower-yielding federal funds sold,
securities purchased under agreement to resell and investment securities,
which collectively increased $558.8 million, accounting for 65.4% of the
total increase in average interest-earning assets.
Average loans increased $295.2 million, or 30.4%, in the second quarter of
1998 as compared to the 1997 second quarter, resulting in a $7.9 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 1998 increased $481.6
million, or 77.1%, as compared to the 1997 second quarter, resulting in a
$7.2 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,
U.S. Treasury securities, mortgage-backed securities, and municipal
securities.
Average federal funds sold and securities purchased under agreement to resell
in the second quarter of 1998 increased a combined $77.1 million, or 28.8%,
over the prior year second quarter, resulting in a $1.1 million favorable
volume variance. This increase was also a result of the aforementioned strong
growth in average deposits during the past year.
The $16.1 million favorable volume variance associated with interest-earning
assets was partially offset by a $0.9 million unfavorable rate variance in
the second quarter of 1998 as compared to the respective prior year period.
This unfavorable rate variance was largely attributable to a $0.7 million
decrease in loan interest income that resulted from a 30 basis points decline
in the average yield on loans primarily due to increased competition.
The yield on average interest-earning assets decreased 40 basis points in the
second quarter of 1998 from the comparable prior year period. This decrease
resulted from a decline in the average yield on loans, largely due to increased
competition, and 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 deposit growth having exceeded the growth in loans.
Total interest expense in the 1998 second quarter increased $6.7 million from
the second quarter of 1997 due to an unfavorable volume variance. The
unfavorable volume variance resulted from a $603.3 million, or 46.8%, increase
in average interest-bearing liabilities in the second quarter of 1998 as
compared with the second quarter of 1997. This increase was largely
concentrated in the Company's bonus money market deposit product, which
increased $591.0 million, or 72.7%, 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.
The average cost of funds paid on interest-bearing liabilities increased 20
basis points in the second quarter of 1998 versus the comparable prior year
period. This increase primarily resulted from a shift in the composition of
average interest-bearing liabilities towards a higher percentage of the
Company's bonus money market deposit product. This shift in the composition
of average interest-bearing liabilities resulted from the aforementioned 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.
Net interest income, on a fully taxable-equivalent basis, totaled $68.1
million for the first half of 1998, an increase of $16.9 million, or 33.1%,
from the $51.1 million total for the first half of 1997. The increase in net
interest income was the result of a $30.2 million, or 40.3%, increase in
17
interest income, offset by a $13.3 million, or 56.0%, increase in interest
expense over the comparable prior year period.
The $30.2 million increase in interest income for the first half of 1998, as
compared to the first half of 1997, was the result of a $30.8 million
favorable volume variance partially offset by a $0.6 million unfavorable rate
variance. The favorable volume variance was attributable to growth in average
interest-earning assets, which increased $801.8 million, or 44.9%, from the
prior year comparable period. The increase in average interest-earning assets
resulted from strong growth in the Company's deposits, which increased $724.9
million, or 40.5%, compared to the first half of 1997, and primarily
consisted of an increase in both average loans and investment securities. 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 investment securities resulted from the
aforementioned strong growth in average deposits, which exceeded the growth
in average loans over the past year, and generated excess funds that were
largely invested in U.S. agency securities, U.S. Treasury securities,
mortgage-backed securities, and municipal securities.
The $30.8 million favorable volume variance associated with interest-earning
assets was partially offset by a $0.6 million unfavorable rate variance in
the first half of 1998 as compared to the respective prior year period. This
unfavorable rate variance was largely attributable to a $0.7 million decrease
in loan interest income that resulted from a 20 basis points decline in the
average yield on loans primarily due to increased competition.
Total interest expense in the first half of 1998 increased $13.3 million from
the first half of 1997 due to a $12.9 million unfavorable volume variance
combined with a $0.4 million unfavorable rate variance. The unfavorable
volume variance resulted from a $573.7 million, or 47.2%, increase in average
interest-bearing liabilities in the first half of 1998 as compared with the
first half of 1997. This increase was largely concentrated in the Company's
bonus money market deposit product, which increased $544.2 million, or 71.0%,
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
$0.4 million unfavorable rate variance was largely attributable to slight
increases in the average rate paid on the Company's various interest-bearing
liabilities.
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 $4.0 million for the second
quarter of 1998, a $1.4 million, or 53.7%, increase compared to the $2.6
million provision for the second quarter of 1997. The provision for loan
losses increased $3.5 million, or 59.3%, to a total of $9.5 million for the
first six months of 1998, versus $6.0 million for the comparable 1997 period.
See "Financial Condition - Credit Quality and the Allowance for Loan Losses"
for additional related discussion.
18
NONINTEREST INCOME
The following table summarizes the components of noninterest income for the
three and six month periods ended June 30, 1998 and 1997:
Three Months Ended June 30, Six Months Ended June 30,
(Unaudited) (Unaudited)
-------------------------- -------------------------
(Dollars in thousands) 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
Disposition of client warrants $1,834 $1,082 $4,274 $4,245
Letter of credit and foreign exchange income 1,631 1,110 3,342 2,090
Deposit service charges 473 407 846 772
Investment gains 3 44 477 45
Other 494 334 887 655
- ----------------------------------------------------------------------------------------------------------------------------
Total noninterest income $4,435 $2,977 $9,826 $7,807
- ----------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------
Noninterest income increased $1.5 million, or 49.0%, to a total of $4.4
million in the second quarter of 1998 versus $3.0 million in the prior year
second quarter. The increase in noninterest income was largely due to both a
$0.8 million increase from the disposition of client warrants and a $0.5
million increase in letter of credit fees, foreign exchange fees and other
trade finance income in the 1998 second quarter as compared to the respective
prior year period. Noninterest income totaled $9.8 million for the first six
months of 1998, an increase of $2.0 million, or 25.9%, from the $7.8 million
in the comparable 1997 period. This increase was largely due to a $1.3
million increase in letter of credit fees, foreign exchange fees and other
trade finance income and a $0.4 million increase in gains on sales of
investment securities.
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 1998, as well as throughout 1997, 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. 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.
Letter of credit fees, foreign exchange fees and other trade finance income
totaled $1.6 million in the second quarter of 1998, an increase of $0.5
million, or 46.9%, from the $1.1 million earned in the second quarter of
1997. For the first six months of 1998, letter of credit fees, foreign
exchange fees and other trade finance income totaled $3.3 million, an
increase of $1.3 million, or 59.9%, compared to the $2.1 million in the first
six months of 1997. The growth in this category of noninterest income
reflects a concerted effort by Management to expand the penetration of trade
finance products and services among the Company's growing client base, a
large percentage of which provide products and services in international
markets.
19
Deposit service charges totaled $0.5 million for the three month period ended
June 30, 1998, an increase of $0.1 million, or 16.2%, from the $0.4 million
reported in the second quarter of 1997. For the first six months of both 1998
and 1997 deposit service charges totaled $0.8 million. 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 Company realized a $0.5 million gain on sales of investment securities
during the first six months of 1998, compared to a nominal 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
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 $0.2 million, or 47.9%, to $0.5 million in the second quarter of
1998 from $0.3 million in the second quarter of 1997. For the six month
period ended June 30, 1998, other noninterest income increased $0.2 million,
or 35.4%, to $0.9 million from $0.7 million in the comparable 1997 period.
The increase during 1998 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 1998 totaled $21.8 million, a
$6.0 million, or 38.2%, increase from the $15.8 million incurred in the
comparable 1997 period. Noninterest expense totaled $40.7 million for the
first six months of 1998, an increase of $10.3 million, or 33.7%, over the
$30.4 million total for the comparable 1997 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 1998
second quarter was 60.7% versus 54.3% for the second quarter of 1997. The
Company's efficiency ratio for the first six months of 1998 was 57.9%, versus
55.8% for the comparable 1997 period. The following table presents the detail
of noninterest expense and the incremental contribution of each line item to
the Company's efficiency ratio:
20
Three Months Ended June 30,
------------------------------------------------------------------
1998 1997
-------------------------- --------------------------
Percent of Percent of
Adjusted Adjusted
(Dollars in thousands) Amount Revenues Amount Revenues
- -----------------------------------------------------------------------------------------------------------------------------
Compensation and benefits $12,483 32.9% $ 9,420 32.6%
Furniture and equipment 2,691 7.1 763 2.6
Professional services 2,602 6.8 1,695 5.9
Business development and travel 1,407 3.7 1,026 3.5
Net occupancy expense 1,067 2.8 891 3.1
Telephone 597 1.6 330 1.1
Advertising and promotion 520 1.4 450 1.6
Postage and supplies 478 1.3 342 1.2
Trust preferred securities distributions 362 1.0 - -
Other 840 2.2 803 2.8
- -----------------------------------------------------------------------------------------------------------------------------
Total excluding cost of other
real estate owned 23,047 60.7% 15,720 54.3%
Cost of other real estate owned (1,274) 34
- -----------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $21,773 $15,754
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30,
------------------------------------------------------------------
1998 1997
-------------------------- --------------------------
Percent of Percent of
Adjusted Adjusted
(Dollars in thousands) Amount Revenues Amount Revenues
- -----------------------------------------------------------------------------------------------------------------------------
Compensation and benefits $24,104 33.3% $18,476 33.9%
Professional services 4,029 5.6 3,131 5.7
Furniture and equipment 3,731 5.2 1,424 2.6
Business development and travel 2,962 4.1 1,986 3.6
Net occupancy expense 2,058 2.8 1,653 3.0
Telephone 1,119 1.5 634 1.2
Advertising and promotion 910 1.3 728 1.3
Postage and supplies 910 1.3 702 1.3
Trust preferred securities distributions 362 0.5 - -
Other 1,741 2.4 1,660 3.0
- -----------------------------------------------------------------------------------------------------------------------------
Total excluding cost of other
real estate owned 41,926 57.9% 30,394 55.8%
Cost of other real estate owned (1,248) 26
- -----------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $40,678 $30,420
- -----------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------
21
Compensation and benefits expenses totaled $12.5 million in the second
quarter of 1998, a $3.1 million, or 32.5%, increase over the $9.4 million
incurred in the second quarter of 1997. For the first six months of 1998,
compensation and benefits expenses totaled $24.1 million, an increase of $5.6
million, or 30.5%, compared to $18.5 million for the comparable 1997 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 501 and 488 for the three and six
month periods ended June 30, 1998 versus 402 and 397 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.
During the third and fourth quarters of 1997, the Company granted a total of
209,000 shares of its common stock (restated to reflect a two-for-one stock
split for common shares of record as of April 17, 1998) to numerous
employees, subject to certain vesting requirements and resale restrictions
(restricted stock). For these restricted stock grants, unearned compensation
equivalent to the aggregate $5.9 million market value of the Company's common
stock on the dates of grant was charged to shareholders' equity and will
subsequently be amortized into compensation and benefits expense over the
four-year vesting period.
Professional services expenses, which consist of costs associated with
corporate legal services, litigation settlements, accounting and auditing
services, consulting, and the Company's Board of Directors, totaled $2.6
million and $4.0 million for the three and six month periods ended June 30,
1998, an increase of $0.9 million, or 53.5%, and $0.9 million, or 28.7%,
compared to $1.7 million and $3.1 million in the comparable 1997 periods. The
level of professional services expenses during 1998 and 1997 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, and 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.
Occupancy, furniture and equipment expenses totaled $3.8 million and $5.8
million for the three and six month periods ended June 30, 1998, an increase
of $2.1 million, or 127.2%, and $2.7 million, or 88.1%, from the $1.7 million
and $3.1 million for the three and six month periods ended June 30, 1997,
respectively. The increase in occupancy, furniture and equipment expenses in
1998 as compared to 1997, was primarily the result of 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 were also impacted by costs related to furniture,
computer equipment and other related costs associated with the Company
opening new loan offices in West Los Angeles, California, and Rosemont,
Illinois, in early 1998. The Company intends to continue its geographic
expansion into other emerging technology market places across the U.S. during
future years.
Business development and travel expenses totaled $1.4 million and $3.0
million for the three and six month periods ended June 30, 1998, an increase
of $0.4 million, or 37.1%, and $1.0 million, or 49.1%, compared to the $1.0
million and $2.0 million totals for the comparable 1997 periods. The increase
in business development and travel expenses was largely attributable to
overall
22
growth in the Company's business, including both an increase in the number of
FTE and expansion into new geographic markets.
Total telephone expenses were $0.6 million and $1.1 million for the three and
six month periods ended June 30, 1998, and increase of $0.3 million, or
80.9%, and $0.5 million, or 76.5%, compared to the $0.3 million and $0.6
million totals for the comparable 1997 periods. The increase in telephone
expenses in 1998, as compared to the prior year respective periods, was
largely the result of the aforementioned overall growth in the Company's
business, including both an increase in the number of FTE and expansion into
new geographic markets.
The Company incurred $0.4 million in trust preferred securities distributions
in connection with the sale 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. The future pre-tax expense associated with the trust preferred
securities distributions will be approximately $0.8 million per quarter. 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.
The Company and the Bank are aware of the "year 2000" issue and the related
potential risks. The Bank has engaged a third party vendor, a recognized
expert in assisting in all phases of year 2000 compliance, as part of a
multiphase project to assist the Bank with addressing the year 2000 issue.
The first two phases of the year 2000 compliance project, systems inventory
and risk assessment, were completed during the second quarter of 1998. The
expense and related impact on the Company's pre-tax earnings of the first two
phases of the year 2000 compliance project was approximately $250,000. Phase
three, renovation, consists of analysis, remediation and unit testing, began
during the second quarter of 1998 and is projected to be completed by the end
of 1998. The expense and related potential impact on the Company's pre-tax
earnings of phase three of the year 2000 compliance project is expected to
approximate $1,250,000. The fourth and final phase, validation and
implementation, is expected to begin in the first quarter of 1999. Management
has not yet assessed the potential financial impact of the last phase of the
project.
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 41.6% and 41.5% for the second quarter
and first half of 1998, respectively, compared to 42.0% in both the three and
six month prior year periods. The slight decrease in the Company's effective
income tax rate was attributable to adjustments in the Company's estimate of
its tax liabilities.
23
FINANCIAL CONDITION
The Company's total assets were $3.1 billion at June 30, 1998, an increase of
$498.0 million, or 19.0%, compared to $2.6 billion at December 31, 1997.
FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENT TO RESELL
Federal funds sold and securities purchased under agreement to resell totaled
a combined $548.2 million at June 30, 1998, an increase of $226.5 million, or
70.4%, compared to the $321.8 million outstanding at the prior year end. This
increase was attributable to the Company investing excess funds, resulting
from the strong growth in deposits during the first half of 1998 having
exceeded the growth in loans, in these types of short-term, liquid
investments.
INVESTMENT SECURITIES
Investment securities totaled $1.1 billion at June 30, 1998, an increase of
$52.6 million, or 5.2%, from the December 31, 1997, balance of $1.0 billion.
This slight 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 1998, and primarily consisted of U.S. agency securities and
commercial paper investments.
LOANS
Total loans, net of unearned income, at June 30, 1998, were $1.4 billion, a
$176.1 million, or 15.0%, increase compared to the roughly $1.2 billion total
at December 31, 1997. The increase in loans from the 1997 year-end total was
widely distributed throughout the loan portfolio. This diversified growth was
evidenced by increased quarter-end loan balances in many of the Company's
market niches, specialized lending products and loan offices.
CREDIT QUALITY AND THE ALLOWANCE FOR LOAN LOSSES
Credit risk is defined as the possibility of sustaining a loss because other
parties to the financial instrument fail to perform in accordance with the
terms of the contract. While the Bank follows underwriting and credit
monitoring procedures which it believes are appropriate in growing and
managing the loan portfolio, in the event of nonperformance by these other
parties, the Bank's potential exposure to credit losses could significantly
affect the Company's consolidated financial position and earnings.
Lending money involves an inherent risk of nonpayment. Through the
administration of loan policies and monitoring of the portfolio, Management
seeks to reduce such risks. The allowance for loan losses is an estimate to
provide a financial buffer for losses, both identified and unidentified, in
the loan portfolio.
Management regularly reviews and monitors the loan portfolio to determine the
risk profile of each credit, and to identify credits whose risk profiles have
changed. This review includes, but is not limited to, such factors as payment
status, the financial condition of the borrower, borrower compliance with
loan covenants, underlying collateral values, potential loan concentrations,
and general economic conditions. Potential problem credits are identified
and, based upon known information, action plans are developed.
24
The allowance for loan losses totaled $42.3 million at June 30, 1998, an
increase of $4.6 million, or 12.2%, compared to the $37.7 million balance at
December 31, 1997. This increase was due to $9.5 million in additional
provisions to the allowance for loan losses, offset by net charge-offs of
$4.9 million for the first half of 1998. Gross charge-offs for the first half
of 1998 totaled $6.5 million and included a charge-off totaling $3.0 million
related to one commercial credit in the Bank's Diversified Industries
practice.
In general, Management believes the allowance for loan losses is adequate as
of June 30, 1998. 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,
1998 1997
(Dollars in thousands) (Unaudited) (Unaudited)
- -------------------------------------------------------------------------------------------------
Nonperforming assets:
Loans past due 90 days or more $ 1,573 $ 1,016
Nonaccrual loans 29,798 24,476
- -------------------------------------------------------------------------------------------------
Total nonperforming loans 31,371 25,492
OREO and other foreclosed assets 1,858 1,858
- -------------------------------------------------------------------------------------------------
Total nonperforming assets $ 33,229 $ 27,350
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
Nonperforming loans as a percentage of total loans 2.3% 2.2%
OREO and other foreclosed assets as a percentage of total assets 0.1% 0.1%
Nonperforming assets as a percentage of total assets 1.1% 1.0%
Allowance for loan losses: $42,300 $37,700
As a percentage of total loans 3.1% 3.2%
As a percentage of nonaccrual loans 142.0% 154.0%
As a percentage of nonperforming loans 134.8% 147.9%
Nonperforming loans totaled $31.4 million, or 2.3% of total loans, at June
30, 1998, compared to $25.5 million, or 2.2% of total loans, at December 31,
1997. The increase in nonperforming loans from the prior year end was
primarily due to two credits, each in excess of $3.0 million, being placed on
nonaccrual status during the first six months of 1998.
In addition to the loans disclosed in the foregoing analysis, Management has
identified three loans with principal amounts aggregating approximately $16.5
million, that, on the basis of information known by Management, were judged
to have a higher than normal risk of becoming nonperforming. The Company is
not aware of any other loans where known information about possible problems
of the borrower casts serious doubts about the ability of the borrower to
comply with the loan repayment terms.
OREO and other foreclosed assets totaled a combined $1.9 million at both June
30, 1998, and December 31, 1997. The OREO and other foreclosed assets balance
at June 30, 1998, consisted
25
of one OREO property and one other asset which was acquired through
foreclosure. The OREO property consists of multiple undeveloped lots and was
acquired by the Company prior to June 1993. The one other asset acquired
through foreclosure, which totaled $1.2 million at June 30, 1998, 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 $2.9 billion at June 30, 1998, an increase of $434.9
million, or 17.9%, from the prior year-end total of $2.4 billion. A
significant portion of the increase in deposits during the first half of 1998
was concentrated in the Company's highest-rate paying deposit product, the
bonus money market deposit product, which increased $388.1 million, or 33.9%,
to a total of $1.5 billion at the end of the June 30, 1998. This increase was
explained by high levels of client liquidity attributable to a strong inflow
of investment capital into the venture capital community, and by growth
during the first half of 1998 in the number of clients served by the Company.
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 1997 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, 1997. 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, 1998. 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.
26
The ability to attract a stable, low-cost base of deposits is the Company's
primary source of liquidity. Other sources of liquidity available to the
Company include short-term borrowings, which consist of federal funds
purchased, security repurchase agreements and other short-term borrowing
arrangements. The Company's liquidity requirements can also be met through
the use of its portfolio of liquid assets. Liquid assets, as defined, include
cash and cash equivalents in excess of the minimum levels necessary to carry
out normal business operations, federal funds sold, securities purchased
under resale agreements, investment securities maturing within six months,
investment securities eligible and available for pledging purposes with a
maturity in excess of six months, and anticipated near term cash flows from
investments.
Additionally, during the second quarter of 1998 the Company issued $40.0
million in cumulative trust preferred securities through a newly formed
special-purpose trust (SVB Capital I). The securities had an offering price
(liquidation amount) of $25 per security and distributions at a fixed rate of
8.25% 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, 1998, the Bank's ratio of
liquid assets to total deposits was 53.4%. This ratio is well in excess of
the Bank's minimum policy guidelines and is slightly higher than the
comparable ratio of 52.1% as of December 31, 1997. 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,
1998, 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 a newly formed
special-purpose trust (SVB Capital I), which is a wholly owned subsidiary of
the Company. The trust preferred securities are presented as a separate line
item in the consolidated balance sheet of the Company under the caption
"Company obligated mandatorily redeemable trust preferred securities of
subsidiary trust holding solely junior subordinated debentures." The
securities have a maximum maturity of 30 years and qualify as Tier 1 capital
under the capital guidelines of the Federal Reserve Board.
Shareholders' equity totaled $198.3 million at June 30, 1998, an increase of
$23.8 million, or 13.6%, from the $174.5 million balance at December 31,
1997. This increase resulted from net income of $15.8 million combined with
capital generated primarily through the Company's
27
employee benefit plans of $8.5 million, slightly offset by a decrease in the
after-tax net unrealized gain on available-for-sale investments of $0.5
million from the prior year end.
The Company and the Bank are subject to capital adequacy guidelines issued by
the Federal Reserve Board. Under these capital guidelines, the minimum total
risk-based capital and Tier 1 risk-based capital ratio requirements are 10.0%
and 6.0%, respectively, of risk-weighted assets and certain off-balance sheet
items for a "well capitalized" depository institution.
The Federal Reserve Board has also established minimum capital leverage ratio
guidelines for state member banks. The ratio is determined using Tier 1
capital divided by quarterly average total assets. The guidelines require a
minimum of 5.0% for a well capitalized depository institution.
The Company's and the Bank's risk-based capital ratios were in excess of
regulatory guidelines for a well capitalized depository institution as of
June 30, 1998, and December 31, 1997. Capital ratios for the Company are set
forth below:
June 30, December 31,
1998 1997
(UNAUDITED)
- -------------------------------------------------------------------------------------------
Total risk-based capital ratio 13.2% 11.5%
Tier 1 risk-based capital ratio 11.9% 10.2%
Tier 1 leverage ratio 8.2% 7.1%
- -------------------------------------------------------------------------------------------
The improvement in the Company's total risk-based capital ratio and Tier 1
risk-based capital ratio from December 31, 1997, to June 30, 1998, was
attributable to an increase in Tier 1 capital, partially offset by an
increase in total assets. The increase in Tier 1 capital primarily resulted
from the aforementioned net income and the issuance of $40.0 million in trust
preferred securities during the first six months of 1998.
28
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
There were no legal proceedings requiring disclosure pursuant to this item
pending at June 30, 1998, 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 16, 1998. Each of the
persons named in the Proxy Statement as a nominee for director was elected;
and the appointment of KPMG Peat Marwick LLP as the Company's independent
auditors for 1998 was ratified. The following are the voting results on each
of these matters:
ELECTION OF DIRECTORS IN FAVOR WITHHELD
Gary K. Barr 8,552,794 138,915
James F. Burns, Jr. 8,552,622 139,087
John C. Dean 8,550,305 141,404
David M. deWilde 8,552,794 138,915
Clarence J. Ferrari, Jr., Esq. 8,552,794 138,915
Daniel J. Kelleher 8,453,276 238,433
James R. Porter 8,552,622 139,087
Ann R. Wells 8,460,489 231,220
OTHER MATTERS IN FAVOR OPPOSED ABSTAINED
Ratification of the appointment of
KPMG Peat Marwick LLP as the
Company's independent auditors
for 1998 8,657,406 11,205 23,098
ITEM 5 - OTHER INFORMATION
None.
29
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
4.2 Form of Subordinated Indenture
4.3 Form of Junior Subordinated Debenture
4.6 Form of Amended and Restated Trust Agreement of SVB Capital I
4.7 Form of Trust Preferred Certificate of SVB Capital I (included as an
exhibit to Exhibit 4.6)
4.8 Form of Guarantee Agreement
4.9 Form of Agreement as to Expenses and Liabilities (included as an
exhibit to Exhibit 4.6)
4.10 Form of Common Securities Certificate of SVB Capital I (included as
an exhibit to Exhibit 4.6)
4.11 Form of Officers' Certificate and Company Order
10.38 Promissory Note between Silicon Valley Bancshares and Christopher T.
Lutes, as of June 10, 1998
10.39 The 1998 Venture Capital Retention Program, Amended June 18, 1998
(b) REPORTS ON FORM 8-K:
No reports on Form 8-K were filed by the Company during the quarter ended
June 30, 1998.
30
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 13, 1998 /s/ Christopher T. Lutes
-------------------------------
Christopher T. Lutes
Executive Vice President and
Chief Financial Officer
(Principal Accounting Officer)
31