<PAGE>
As filed with the Securities and Exchange Commission on November 15, 1999
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------
FORM 10-Q
(MARK ONE)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ________ to ________.
Commission File Number: 33-41102
SILICON VALLEY BANCSHARES
(Exact name of registrant as specified in its charter)
Delaware 91-1962278
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3003 Tasman Drive
Santa Clara, California 95054-1191
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 654-7282
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No ___
At October 31, 1999, 20,885,366 shares of the registrant's
common stock ($0.001 par value) were outstanding.
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This report contains a total of 35 pages.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION
ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS 3
CONSOLIDATED STATEMENTS OF INCOME 4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 5
CONSOLIDATED STATEMENTS OF CASH FLOWS 6
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 12
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 34
ITEM 2. CHANGES IN SECURITIES 34
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 34
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 34
ITEM 5. OTHER INFORMATION 34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 34
SIGNATURES 35
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - INTERIM CONSOLIDATED FINANCIAL STATEMENTS
SILICON VALLEY BANCSHARES AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
(Dollars in thousands, except par value) (Unaudited)
- -------------------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Cash and due from banks $ 185,577 $ 123,001
Federal funds sold and securities purchased under
agreement to resell 103,441 399,202
Investment securities, at fair value 1,745,262 1,397,502
Loans, net of unearned income 1,661,016 1,611,921
Allowance for loan losses (70,800) (46,000)
- -------------------------------------------------------------------------------------------
Net loans 1,590,216 1,565,921
Premises and equipment 11,059 11,354
Other real estate owned - 664
Accrued interest receivable and other assets 86,200 47,808
- -------------------------------------------------------------------------------------------
Total assets $3,721,755 $3,545,452
===========================================================================================
Liabilities and Stockholders' Equity:
Liabilities:
Noninterest-bearing demand deposits $1,359,017 $ 921,790
NOW deposits 46,977 19,978
Money market deposits 1,760,790 2,185,359
Time deposits 238,017 142,626
- -------------------------------------------------------------------------------------------
Total deposits 3,404,801 3,269,753
Other liabilities 34,934 21,349
- -------------------------------------------------------------------------------------------
Total liabilities 3,439,735 3,291,102
- -------------------------------------------------------------------------------------------
Company obligated mandatorily redeemable trust preferred
securities of subsidiary trust holding solely junior
subordinated debentures (trust preferred securities) 38,524 38,485
Stockholders' Equity:
Preferred stock, $0.001 par value, 20,000,000 shares
authorized; none outstanding
Common stock, $0.001 par value, 60,000,000 shares authorized;
20,877,388 and 20,711,915 shares outstanding at
September 30, 1999 and December 31, 1998, respectively 21 21
Additional paid-in capital 96,024 94,108
Retained earnings 151,154 123,855
Unearned compensation (2,734) (4,191)
Accumulated other comprehensive income:
Net unrealized gain/(loss) on available-for-sale investments (969) 2,072
- -------------------------------------------------------------------------------------------
Total stockholders' equity 243,496 215,865
- -------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $3,721,755 $3,545,452
===========================================================================================
</TABLE>
See notes to interim consolidated financial statements.
3
<PAGE>
SILICON VALLEY BANCSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the three months ended For the nine months ended
------------------------------ ------------------------------
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
(Dollars in thousands, except per share amounts) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income:
Loans, including fees $41,813 $36,494 $118,872 $ 101,356
Investment securities 24,158 17,757 65,252 47,959
Federal funds sold and securities
purchased under agreement to resell 9,415 5,941 22,340 15,149
- ---------------------------------------------------------------------------------------------------------------------
Total interest income 75,386 60,192 206,464 164,464
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Interest expense:
Deposits 20,997 21,736 63,900 58,669
Other borrowings - - - 3
- ---------------------------------------------------------------------------------------------------------------------
Total interest expense 20,997 21,736 63,900 58,672
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Net interest income 54,389 38,456 142,564 105,792
Provision for loan losses 21,563 10,557 40,334 20,061
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Net interest income after provision
for loan losses 32,826 27,899 102,230 85,731
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Noninterest income:
Letter of credit and foreign
exchange income 4,304 1,795 10,448 5,137
Disposition of client warrants 6,177 705 8,687 4,979
Deposit service charges 729 432 2,073 1,277
Client investment fees 1,241 137 1,719 315
Investment gains/(losses) - 4,149 (243) 4,626
Other 963 498 2,441 1,208
- ---------------------------------------------------------------------------------------------------------------------
Total noninterest income 13,414 7,716 25,125 17,542
- ---------------------------------------------------------------------------------------------------------------------
Noninterest expense:
Compensation and benefits 18,150 10,773 49,071 34,877
Professional services 2,531 2,361 8,426 6,390
Net occupancy expense 1,713 1,394 4,750 3,451
Business development and travel 1,500 1,460 4,356 4,422
Furniture and equipment 1,368 1,320 4,159 5,051
Trust preferred securities distributions 825 825 2,475 1,187
Postage and supplies 618 635 1,850 1,545
Advertising and promotion 474 643 1,808 1,553
Telephone 522 481 1,361 1,600
Cost of other real estate owned - 19 268 (1,229)
Other 2,015 1,152 4,526 2,893
- ---------------------------------------------------------------------------------------------------------------------
Total noninterest expense 29,716 21,063 83,050 61,740
- ---------------------------------------------------------------------------------------------------------------------
Income before income tax expense 16,524 14,552 44,305 41,533
Income tax expense 6,015 6,002 17,006 17,202
- ---------------------------------------------------------------------------------------------------------------------
Net income $10,509 $ 8,550 $ 27,299 $ 24,331
=====================================================================================================================
Basic earnings per share $ 0.51 $ 0.42 $ 1.33 $ 1.20
Diluted earnings per share $ 0.50 $ 0.41 $ 1.30 $ 1.16
=====================================================================================================================
</TABLE>
See notes to interim consolidated financial statements.
4
<PAGE>
SILICON VALLEY BANCSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
For the three months ended For the nine months ended
------------------------------ ------------------------------
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
(Dollars in thousands) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $10,509 $ 8,550 $27,299 $24,331
Other comprehensive income/(loss), net of tax:
Changes in unrealized gains/(losses) on
available-for-sale investments:
Unrealized holding gains arising
during period 9,140 4,873 2,279 7,123
Less: Reclassification adjustment for
gains included in net income (3,892) (2,815) (5,320) (5,571)
- -------------------------------------------------------------------------------------------------------------------
Other comprehensive income 5,248 2,058 (3,041) 1,552
- -------------------------------------------------------------------------------------------------------------------
Comprehensive income $15,757 $10,608 $24,258 $25,883
===================================================================================================================
</TABLE>
See notes to interim consolidated financial statements.
5
<PAGE>
SILICON VALLEY BANCSHARES AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the nine months ended
--------------------------------
September 30, September 30,
1999 1998
(Dollars in thousands) (Unaudited) (Unaudited)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 27,299 $ 24,331
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 40,334 20,061
Depreciation and amortization 2,402 1,187
Net (gain)/loss on sales of investment securities 243 (4,626)
Net gain on sales of other real estate owned - (1,298)
(Increase) decrease in accrued interest receivable (8,286) 1,108
Increase in inventory (8,918) -
Increase in prepaid expenses (456) (924)
Increase (decrease) in unearned income (1,246) 662
Increase (decrease) in accrued liabilities 3,441 (489)
Increase (decrease) in taxes payable (3,938) 3,926
Other, net (2,423) (1,539)
- ------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 48,452 42,399
- ------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from maturities and paydowns of
investment securities 819,707 1,122,228
Proceeds from sales of investment securities 540,725 453,821
Purchases of investment securities (1,713,900) (1,489,814)
Net increase in loans (70,340) (288,165)
Proceeds from recoveries of charged off loans 6,958 2,055
Net proceeds from sales of other real estate owned 400 1,323
Purchases of premises and equipment (2,107) (6,251)
- ------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (418,557) (204,803)
- ------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in deposits 135,047 511,463
Proceeds from issuance of trust preferred securities,
net of issuance costs - 38,472
Proceeds from issuance of common stock,
net of issuance costs 1,873 4,810
- ------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 136,920 554,745
- ------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (233,185) 392,341
Cash and cash equivalents at January 1, 522,203 426,832
- ------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at September 30, $ 289,018 $ 819,173
==================================================================================================================
Supplemental disclosures:
Interest paid $ 63,956 $ 58,528
Income taxes paid $ 29,310 $ 16,306
==================================================================================================================
</TABLE>
See notes to interim consolidated financial statements.
6
<PAGE>
SILICON VALLEY BANCSHARES AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of Silicon Valley Bancshares (the
"Company") and its subsidiaries conform with generally accepted accounting
principles and prevailing practices within the banking industry. Certain
reclassifications have been made to the Company's 1998 consolidated financial
statements to conform to the 1999 presentations. Such reclassifications had no
effect on the results of operations or stockholders' equity. The following is a
summary of the significant accounting and reporting policies used in preparing
the interim consolidated financial statements.
NATURE OF OPERATIONS
The Company is a bank holding company whose principal subsidiary is Silicon
Valley Bank (the "Bank"), a California-chartered bank with headquarters in Santa
Clara, California. The Bank maintains regional banking offices in Northern and
Southern California, and additionally has loan offices in Arizona, Colorado,
Georgia, Illinois, Massachusetts, Minnesota, Oregon, Pennsylvania, Texas,
Virginia, and Washington. The Bank serves emerging growth and middle-market
companies in targeted niches, focusing on the technology and life sciences
industries, while also identifying and capitalizing on opportunities to serve
companies in other industries whose financial services needs are underserved.
Substantially all of the assets, liabilities and earnings of the Company relate
to its investment in the Bank.
CONSOLIDATION
The interim consolidated financial statements include the accounts of the
Company and those of its wholly owned subsidiaries, the Bank, SVB Capital I and
SVB Leasing Company (inactive). Intercompany accounts and transactions have been
eliminated.
INTERIM CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of Management, the interim consolidated financial statements
contain all adjustments (consisting of only normal, recurring adjustments)
necessary to present fairly the Company's consolidated financial position at
September 30, 1999, the results of its operations and cash flows for the three
and nine month periods ended September 30, 1999, and September 30, 1998. The
December 31, 1998 consolidated financial statements were derived from audited
financial statements, and certain information and footnote disclosures normally
presented in annual financial statements prepared in accordance with generally
accepted accounting principles have been omitted.
The interim consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in the
Company's 1998 Annual Report on Form 10-K. The results of operations for the
three and nine months ended September 30, 1999 may not necessarily be indicative
of the Company's operating results for the full year.
7
<PAGE>
BASIS OF FINANCIAL STATEMENT PRESENTATION
The preparation of financial statements in conformity with generally accepted
accounting principles requires Management to make estimates and judgments that
affect the reported amounts of assets and liabilities as of the balance sheet
date and the results of operations for the period. Actual results could differ
from those estimates. A material estimate that is particularly susceptible to
possible change in the near term relates to the determination of the allowance
for loan losses. An estimate of possible changes or range of possible changes
cannot be made.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents as reported in the consolidated statements of cash
flows includes cash on hand, cash balances due from banks, federal funds sold,
and securities purchased under agreement to resell. The cash equivalents are
readily convertible to known amounts of cash and present an insignificant risk
of changes in value due to maturity dates of 90 days or less.
FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENT TO RESELL
Federal funds sold and securities purchased under agreement to resell as
reported in the consolidated balance sheets includes interest-bearing deposits
in other financial institutions of $441,000 and $202,000 at September 30, 1999,
and December 31, 1998, respectively.
NONACCRUAL LOANS
Loans are placed on nonaccrual status when they become 90 days past due as to
principal or interest payments (unless the principal and interest are well
secured and in the process of collection), when the Company has determined,
based upon currently known information, that the timely collection of principal
or interest is doubtful, or when the loans otherwise become impaired under the
provisions of Statement of Financial Accounting Standards (SFAS) No. 114,
"Accounting by Creditors for Impairment of a Loan."
When a loan is placed on nonaccrual status, the accrued interest is reversed
against interest income and the loan is accounted for on the cash or cost
recovery method thereafter until qualifying for return to accrual status.
Generally, a loan will be returned to accrual status when all delinquent
principal and interest become current in accordance with the terms of the loan
agreement and full collection of the principal appears probable.
STOCK-BASED COMPENSATION
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," and complies with the disclosure
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Under APB
No. 25, compensation expense is based on the difference, if any, on the date of
the grant, between the fair value of the Company's stock and the exercise price.
The Company accounts for stock issued to non-employees in accordance with the
provisions of SFAS No. 123 and Emerging Issues Task Force ("EITF") Issue No.
96-18.
8
<PAGE>
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
<PAGE>
The following is a reconciliation of basic earnings per share (EPS) to diluted
EPS for the three and nine months ended September 30, 1999 and 1998.
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
(Unaudited) (Unaudited)
-------------------------------- ---------------------------------
(Dollars and shares in thousands, Net Per Share Net Per Share
except per share amounts) Income Shares Amount Income Shares Amount
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1999:
Basic EPS:
Income available to common
shareholders $10,509 20,602 $0.51 $27,299 20,535 $1.33
Effect of Dilutive Securities:
Stock options and restricted stock - 625 - - 456 -
- -------------------------------------------------------------------------------------------------------------------
Diluted EPS:
Income available to common
shareholders plus assumed
conversions $10,509 21,227 $0.50 $27,229 20,991 $1.30
==================================================================================================================
1998:
Basic EPS:
Income available to common
shareholders $ 8,550 20,350 $0.42 $24,331 20,227 $1.20
Effect of Dilutive Securities:
Stock options and restricted stock - 630 - - 721 -
- -------------------------------------------------------------------------------------------------------------------
Diluted EPS:
Income available to common
shareholders plus assumed
conversions $ 8,550 20,980 $0.41 $24,331 20,948 $1.16
===================================================================================================================
</TABLE>
3. LOANS
The detailed composition of loans, net of unearned income of $8.8 million and
$10.0 million at September 30, 1999, and December 31, 1998, respectively, is
presented in the following table:
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
(Dollars in thousands) (Unaudited)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Commercial $1,443,667 $1,429,980
Real estate construction 80,533 74,023
Real estate term 71,465 60,841
Consumer and other 65,351 47,077
- ------------------------------------------------------------------------------------------------------------------
Total loans $1,661,016 $1,611,921
==================================================================================================================
</TABLE>
10
<PAGE>
4. ALLOWANCE FOR LOAN LOSSES
The activity in the allowance for loan losses for the three and nine months
ended September 30, 1999 and 1998 was as follows:
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
(Unaudited) (Unaudited)
------------------------------- ---------------------------------
(Dollars in thousands) 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Beginning balance $ 56,300 $ 42,300 $ 46,000 $ 37,700
Provision for loan losses 21,563 10,557 40,334 20,061
Loans charged off (10,253) (17,406) (22,491) (23,916)
Recoveries 3,190 449 6,957 2,055
- -------------------------------------------------------------------------------------------------------------------
Balance at September 30, $ 70,800 $ 35,900 $ 70,800 $ 35,900
===================================================================================================================
</TABLE>
The aggregate recorded investment in loans for which impairment has been
determined in accordance with SFAS No. 114 totaled $34.0 million and $23.2
million at September 30, 1999, and September 30, 1998, respectively. Allocations
of the allowance for loan losses related to impaired loans totaled $13.3 million
at September 30, 1999, and $5.9 million at September 30, 1998. Average impaired
loans for the third quarters of 1999 and 1998 totaled $40.9 million and $30.2
million, respectively.
5. REINCORPORATION
At the Annual Meeting of Shareholders, held on April 15, 1999, the shareholders
of a majority of the Company's outstanding common stock approved a change in the
Company's state of incorporation from California to Delaware. The
reincorporation was effective April 23, 1999 and provided for 60,000,000
authorized shares of common stock with a $0.001 par value per share and for
20,000,000 authorized shares of preferred stock with a $0.001 par value per
share. The accompanying consolidated financial statements have been
retroactively restated to give effect to the reincorporation. Such
reclassifications had no effect on the results of operations or stockholders'
equity.
6. REGULATORY MATTERS
In late September 1999, the Bank entered into an informal arrangement with
the Federal Reserve Bank of San Francisco and the California Department of
Financial Institutions, the Bank's primary banking regulators. Under the
informal arrangement (pursuant to a memorandum of understanding), the Bank
has committed to maintain a Tier 1 leverage ratio of at least 7.25%; obtain
the regulators' consent prior to payment of dividends; further enhance its
credit monitoring and review policies and submit reports to the regulators
regarding credit quality. The Federal Reserve Bank of San Francisco has
directed the Company to obtain its approval before incurring debt, paying
dividends, repurchasing capital stock, or entering into agreements to acquire
any entities or portfolios.
The Company and the Bank believe compliance with this informal arrangement has
not and will not have a material adverse impact on the business of the Bank, its
clients or the Company.
11
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following discussion and analysis of financial condition and results of
operations should be read in conjunction with the Company's interim consolidated
financial statements as presented in Item 1 of this report. In addition to
historical information, this discussion and analysis includes certain
forward-looking statements regarding events and circumstances that may affect
the Company's future results. Such forward-looking statements are subject to
risks and uncertainties that could cause the Company's actual results to differ
materially. These risks and uncertainties include, but are not limited to, those
described in this discussion and analysis, as well as those described in the
Company's 1998 Annual Report on Form 10-K.
The Company wishes to caution readers not to place undue reliance on any
forward-looking statements included herein, which speak only as of the date
made. The Company does not undertake, and specifically disclaims any obligation,
to update any forward-looking statements to reflect unanticipated events and
circumstances occurring after the date of such statements.
Certain reclassifications have been made to the Company's 1998 consolidated
financial statements to conform to the 1999 presentations. Such
reclassifications had no effect on the results of operations or stockholders'
equity.
EARNINGS SUMMARY
The Company reported net income of $10.5 million, or $0.50 per diluted share,
for the third quarter of 1999, compared with net income of $8.6 million, or
$0.41 per diluted share, for the third quarter of 1998. Net income totaled $27.3
million, or $1.30 per diluted share, for the nine months ended September 30,
1999, versus $24.3 million, or $1.16 per diluted share, for the comparable 1998
period. The annualized return on average assets (ROA) was 1.0% in the third
quarter of 1999 versus 1.1% in the third quarter of 1998. The annualized return
on average equity (ROE) for the third quarter of 1999 was 18.0%, compared to
16.6% in the 1998 third quarter. For the first nine months of 1999, ROA was 0.9%
and ROE was 16.2% versus 1.1% and 16.9%, respectively, for the comparable 1998
period.
The increase in net income during the three and nine month periods ended
September 30, 1999, as compared with the prior year respective periods, was
attributable to increases in net interest income and noninterest income,
partially offset by an increase in both the provision for loan losses and
noninterest expense. The major components of net income and changes in these
components are summarized in the following table for the three and nine month
periods ended September 30, 1999 and 1998, and are discussed in more detail
below.
12
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
(Unaudited) (Unaudited)
-------------------------------- ------------------------------
(Dollars in thousands) 1999 1998 1999 1998
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net interest income $54,389 $38,456 $142,564 $105,792
Provision for loan losses 21,563 10,557 40,334 20,061
Noninterest income 13,414 7,716 25,125 17,542
Noninterest expense 29,716 21,063 83,050 61,740
- ---------------------------------------------------------------------------------------------------------------
Income before income taxes 16,524 14,552 44,305 41,533
Income tax expense 6,015 6,002 17,006 17,202
- ---------------------------------------------------------------------------------------------------------------
Net income $10,509 $ 8,550 $ 27,299 $ 24,331
===============================================================================================================
</TABLE>
NET INTEREST INCOME AND MARGIN
Net interest income represents the difference between interest earned, primarily
on loans and investments, and interest paid on funding sources, primarily
deposits, and is the principal source of revenue for the Company. Net interest
margin is the amount of net interest income, on a fully taxable-equivalent
basis, expressed as a percentage of average interest-earning assets. The average
yield earned on interest-earning assets is the amount of fully
taxable-equivalent interest income expressed as a percentage of average
interest-earning assets. The average rate paid on funding sources is defined as
interest expense as a percentage of average interest-earning assets.
The following tables set forth average assets, liabilities and stockholders'
equity, interest income and interest expense, average yields and rates, and the
composition of the Company's net interest margin for the three and nine months
ended September 30, 1999 and 1998, respectively.
13
<PAGE>
- -----------------------------------------------------------------------------
AVERAGE BALANCES, RATES AND YIELDS
- -----------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the three months ended September 30,
---------------------------------------------------------------------
1999 1998
(Unaudited) (Unaudited)
------------------------------ ------------------------------
Average Average
Average Yield Average Yield
(Dollars in thousands) Balance Interest Rate Balance Interest Rate
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Federal funds sold and
securities purchased under
agreement to resell (1) $ 730,271 $ 9,415 5.1% $ 423,316 $ 5,941 5.6%
Investment securities:
Taxable 1,589,229 22,798 5.7 1,135,695 16,835 5.9
Non-taxable (2) 136,994 2,092 6.1 79,872 1,418 7.0
Loans:
Commercial 1,373,122 37,193 10.7 1,194,522 31,992 10.6
Real estate construction and term 132,975 3,310 9.9 124,789 3,394 10.8
Consumer and other 59,531 1,310 8.7 48,380 1,108 9.1
- -------------------------------------- --------------------------------- ----------------------------------
Total loans 1,565,628 41,813 10.6 1,367,691 36,494 10.6
- -------------------------------------- --------------------------------- ----------------------------------
Total interest-earning assets 4,022,122 76,118 7.5 3,006,574 60,688 8.0
- -------------------------------------- --------------------------------- ----------------------------------
Cash and due from banks 211,045 143,921
Allowance for loan losses (63,725) (43,295)
Other real estate owned - 681
Other assets 71,735 57,447
- -------------------------------------- ------ --------
Total assets $4,241,177 $3,165,328
====================================== ============ ==========
Funding sources:
Interest-bearing liabilities:
NOW deposits $ 37,776 193 2.0 $ 21,742 101 1.8
Regular money market deposits 386,360 2,546 2.6 353,241 2,434 2.7
Bonus money market deposits 2,095,554 15,900 3.0 1,622,710 17,763 4.3
Time deposits 229,823 2,358 4.1 126,075 1,438 4.5
- -------------------------------------- --------------------------------- ----------------------------------
Total interest-bearing liabilities 2,749,513 20,997 3.0 2,123,768 21,736 4.1
Portion of noninterest-bearing
funding sources 1,272,609 882,806
- -------------------------------------- --------------------------------- ----------------------------------
Total funding sources 4,022,122 20,997 2.1 3,006,574 21,736 2.9
- -------------------------------------- --------------------------------- ----------------------------------
Noninterest-bearing funding sources:
Demand deposits 1,188,773 773,506
Other liabilities 32,694 25,644
Trust preferred securities (3) 38,513 38,460
Stockholders' equity 231,684 203,950
Portion used to fund
interest-earning assets (1,272,609) (882,806)
- ---------------------------------------- ------------ ---------
Total liabilities and stockholders'
equity $4,241,177 $3,165,328
======================================== ========== ==========
Net interest income and margin $55,121 5.4% $38,952 5.1%
======================================== ======= ==== ======= ====
Total deposits $3,938,286 $2,897,274
======================================== ========== ==========
</TABLE>
(1) Includes average interest-bearing deposits in other financial institutions
of $227 and $232 for the three months ended September 30, 1999 and 1998,
respectively.
(2) Interest income on non-taxable investments is presented on a fully
taxable-equivalent basis using the federal statutory rate of 35% in 1999
and 1998. The tax equivalent adjustments were $732 and $496 for the three
months ended September 30, 1999 and 1998, respectively.
(3) The 8.25% annual distributions are recorded as a component of noninterest
expense.
14
<PAGE>
- --------------------------------------------------------------------------------
AVERAGE BALANCES, RATES AND YIELDS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the nine months ended September 30,
----------------------------------------------------------------------
1999 1998
(Unaudited) (Unaudited)
------------------------------ --------------------------------
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Federal funds sold and
securities purchased under
agreement to resell (1) $ 607,892 $ 22,340 4.9% $ 364,544 $ 15,149 5.6%
Investment securities:
Taxable 1,426,444 61,158 5.7 1,027,295 45,699 5.9
Non-taxable (2) 134,827 6,298 6.2 68,419 3,477 6.8
Loans:
Commercial 1,382,358 104,738 10.1 1,113,177 89,257 10.7
Real estate construction and term 136,276 10,351 10.2 112,299 9,097 10.8
Consumer and other 58,004 3,783 8.7 43,943 3,002 9.1
- ---------------------------------------- ------------------------------------ -------------------------------
Total loans 1,576,638 118,872 10.1 1,269,419 101,356 10.7
- ---------------------------------------- ------------------------------------ -------------------------------
Total interest-earning assets 3,745,801 208,668 7.4 2,729,677 165,681 8.1
- ---------------------------------------- ------------------------------------ -------------------------------
Cash and due from banks 182,238 134,861
Allowance for loan losses (54,982) (41,364)
Other real estate owned 242 686
Other assets 66,837 52,901
- ---------------------------------------- ----------- -----------
Total assets $3,940,136 $2,876,761
======================================== ========== ==========
Funding sources:
Interest-bearing liabilities:
NOW deposits $ 27,396 353 1.7 $ 19,463 283 1.9
Regular money market deposits 357,115 7,124 2.7 339,056 6,900 2.7
Bonus money market deposits 2,041,519 50,564 3.3 1,416,124 47,171 4.5
Time deposits 188,618 5,859 4.2 127,913 4,315 4.5
Other borrowings - - - 73 3 5.5
- ---------------------------------------- ------------------------------------ -------------------------------
Total interest-bearing liabilities 2,614,648 63,900 3.3 1,902,629 58,672 4.1
Portion of noninterest-bearing
funding sources 1,131,153 827,050
- ---------------------------------------- ------------------------------------ -------------------------------
Total funding sources 3,745,801 63,900 2.3 2,729,679 58,672 2.9
- ---------------------------------------- ------------------------------------ -------------------------------
Noninterest-bearing funding sources:
Demand deposits 1,034,637 741,798
Other liabilities 27,410 20,666
Trust preferred securities (3) 38,501 18,615
Stockholders' equity 224,940 193,051
Portion used to fund
interest-earning assets (1,131,153) (827,048)
- ---------------------------------------- ------------ ---------
Total liabilities and stockholders'
equity $3,940,136 $2,876,761
======================================== ========== ==========
Net interest income and margin $144,768 5.2% $ 107,009 5.2%
======================================== ======== ==== ========= ====
Total deposits $3,649,285 $2,644,355
======================================== ========== ==========
</TABLE>
(1) Includes average interest-bearing deposits in other financial institutions
of $199 and $248 for the nine months ended September 30, 1999 and 1998,
respectively.
(2) Interest income on non-taxable investments is presented on a fully
taxable-equivalent basis using the federal statutory rate of 35% in 1999
and 1998. The tax equivalent adjustments were $2,204 and $1,217 for the
nine months ended September 30, 1999 and 1998, respectively.
(3) The 8.25% annual distributions are recorded as a component of noninterest
expense.
15
<PAGE>
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.
<TABLE>
<CAPTION>
1999 Compared to 1998
----------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
(Unaudited) (Unaudited)
-------------------------------- -------------------------------
Increase (Decrease) Increase (Decrease)
Due to Change in Due to Change in
------------------------------- --------------------------------
(Dollars in thousands) Volume Rate Total Volume Rate Total
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Federal funds sold and securities
purchased under agreement to resell $ 3,958 $ (484) $ 3,474 $ 8,943 $ (1,752) $ 7,191
Investment securities 7,364 (727) 6,637 20,115 (1,835) 18,280
Loans 5,286 33 5,319 23,164 (5,648) 17,516
- -------------------------------------------------------------------------------------------------------------------
Increase (decrease) in interest income 16,608 (1,178) 15,430 52,222 (9,235) 42,987
- -------------------------------------------------------------------------------------------------------------------
Interest expense:
NOW deposits 83 9 92 101 (31) 70
Regular money market deposits 218 (106) 112 361 (137) 224
Bonus money market deposits 3,589 (5,452) (1,863) 15,491 (12,098) 3,393
Time deposits 1,064 (144) 920 1,886 (342) 1,544
Other borrowings - - - - (3) (3)
- -------------------------------------------------------------------------------------------------------------------
Increase (decrease) in interest expense 4,954 (5,693) (739) 17,839 (12,611) 5,228
- -------------------------------------------------------------------------------------------------------------------
Increase in net interest income $11,654 $ 4,515 $16,169 $34,383 $ 3,376 $37,759
===================================================================================================================
</TABLE>
Net interest income, on a fully taxable-equivalent basis, totaled $55.1 million
for the third quarter of 1999, an increase of $16.2 million, or 41.5%, from the
$39.0 million total for the third quarter of 1998. The increase in net interest
income was the result of a $15.4 million, or 25.4%, increase in interest income,
combined with a $0.7 million, or 3.4%, decrease in interest expense over the
comparable prior year period.
The $15.4 million increase in interest income for the third quarter of 1999, as
compared to the third quarter of 1998, was the result of a $16.6 million
favorable volume variance partially offset by a $1.2 million unfavorable rate
variance. The favorable volume variance resulted from a $1.0 billion, or 33.8%,
increase in average interest-earning assets over the comparable prior year
period. The increase in average interest-earning assets resulted from strong
growth in the Company's deposits, which increased $1.0 billion, or 35.9%,
compared to the third quarter of 1998. The increase in average interest-earning
assets consisted of loans, which were up $197.9 million, plus a combination of
highly liquid, lower-yielding federal funds sold, securities purchased under
agreement to resell and investment securities, which collectively increased
$817.6 million, accounting for 80.5% of the total increase in average
interest-earning assets.
Average loans increased $197.9 million, or 14.5%, in the third quarter of 1999
as compared to the 1998 third quarter, resulting in a $5.3 million favorable
volume variance. This growth was widely distributed throughout the loan
portfolio, as reflected by increased loan balances in most
16
<PAGE>
of the Company's technology and life sciences and special industry niche
practices, in specialized lending products, and throughout the Company's loan
offices located across the nation.
Average investment securities for the third quarter of 1999 increased $510.7
million, or 42.0%, as compared to the 1998 third quarter, resulting in a $7.4
million favorable volume variance. The aforementioned strong growth in average
deposits exceeded the growth in average loans over the past year, and generated
excess funds that were largely invested in U.S. agency securities,
mortgage-backed securities and municipal securities.
Average federal funds sold and securities purchased under agreement to resell in
the third quarter of 1999 increased a combined $307.0 million, or 72.5%, over
the prior year third quarter, resulting in a $4.0 million favorable volume
variance. This increase was also a result of the aforementioned strong growth in
average deposits during the past year.
Unfavorable rate variances associated with federal funds sold, securities
purchased under agreements to resell and investment securities in the third
quarter of 1999 resulted in a decrease in interest income of $1.2 million as
compared to the respective prior year period. Short-term market interest rates
have declined on an overall basis during the past year. As a result of this
decline, the Company has earned lower yields on federal funds sold, securities
purchased under agreements to resell and its investment securities, a
significant portion of which were short-term in nature, resulting in this
unfavorable rate variance as compared to the third quarter of 1998
The yield on average interest-earning assets decreased 50 basis points in the
third quarter of 1999 from the comparable prior year period. This decrease
resulted from a shift in the composition of average interest-earning assets
towards a higher percentage of highly liquid, lower-yielding federal funds sold,
securities purchased under agreement to resell and investment securities. This
shift in the composition of average interest-earning assets resulted from the
aforementioned strong growth in deposits which continued to outpace the growth
in loans.
Total interest expense in the 1999 third quarter decreased $0.7 million from the
third quarter of 1998. This decrease was due to a favorable rate variance of
$5.7 million, partially offset by an unfavorable volume variance of $5.0
million. The unfavorable volume variance resulted from a $625.7 million, or
29.5%, increase in average interest-bearing liabilities in the third quarter of
1999 as compared with the third quarter of 1998. This increase was largely
concentrated in the Company's bonus money market deposit product, which
increased $472.8 million, or 29.1%, and was explained by high levels of client
liquidity attributable to a strong inflow of investment capital into the venture
capital community during the past year, and by growth in the number of clients
served by the Company.
Changes in the average rates paid on interest-bearing liabilities had a $5.0
million favorable impact on interest expense in the third quarter of 1999 as
compared to the respective period in 1998. This decrease in interest expense
largely resulted from a reduction in the average rate paid on the Company's
bonus money market deposit product, from 4.3% in the third quarter of 1998 to
3.0% in the third quarter of 1999. The reduction during 1999, in the average
rate paid on the Company's bonus money market deposit product, was largely
attributable to a decline in short-term market interest rates during the second
half of 1998, and to the Company lowering rates paid on the bonus money market
deposit an additional 123 basis points during the third quarter of 1999.
17
<PAGE>
The average cost of funds paid on average interest-bearing liabilities decreased
110 basis points in the third quarter of 1999 versus the comparable prior year
period. This decrease in the average cost of funds was largely due to a decrease
of 130 basis points in the average rate paid on the Company's bonus money market
deposit product.
Net interest income, on a fully taxable-equivalent basis, totaled $144.8 million
for the first nine months of 1999, an increase of $37.8 million, or 35.3%, from
the $107.0 million total for the first nine months of 1998. The increase in net
interest income was the result of a $43.0 million, or 25.9%, increase in
interest income, partially offset by a $5.2 million, or 8.9%, increase in
interest expense over the comparable prior year period.
The $43.0 million increase in interest income for the first nine months of 1999,
as compared to the first nine months of 1998, was the result of a $52.2 million
favorable volume variance partially offset by a $9.2 million unfavorable rate
variance. The favorable volume variance was attributable to growth in average
interest-earning assets, which increased $1.0 billion, or 37.2%, from the
comparable prior year period. The increase in average interest-earning assets
resulted from strong growth in the Company's deposits, which increased $1.0
billion, or 38.0%, compared to the first nine months of 1998, and consisted of
increases in all components of interest-earning assets. The growth in average
loans was widely distributed throughout the loan portfolio, as reflected by
increased loan balances in most of the Company's technology, life sciences and
special industry niche practices, in specialized lending products, and
throughout the Company's loan offices located across the nation. The growth in
average federal funds sold, securities purchased under agreements to resell and
investment securities resulted from the aforementioned strong growth in average
deposits, which exceeded the growth in average loans over the past year.
The $52.2 million favorable volume variance associated with interest-earning
assets was partially offset by a $9.2 million unfavorable rate variance in the
first nine months of 1999 as compared to the respective prior year period. This
unfavorable rate variance was largely attributable to a decline in short-term
market interest rates and a corresponding drop in the prime rate of 75 basis
points during the second half of 1998, partially offset by increases in
short-term market interest rates and the prime rate of 50 basis points in the
third quarter of 1999.
The yield on average interest-earning assets decreased 70 basis points in the
first nine months of 1999 as compared to the respective prior year period.
This decrease resulted from a decline in the average yield on loans, largely
due to a reduction in the Company's prime rate during late 1998, as well as
to a shift in the composition of average interest-earning assets towards a
higher percentage of highly liquid, lower-yielding federal funds sold,
securities purchased under agreements to resell and investment securities.
This shift in the composition of average interest-earning assets resulted
from the aforementioned strong growth in deposits, which continued to outpace
the growth in loans.
Total interest expense in the first nine months of 1999 increased $5.2 million
from the first nine months of 1998 due to a $17.8 million unfavorable volume
variance partially offset by a $12.6 million favorable rate variance. The
unfavorable volume variance resulted from a $712.0 million, or 37.4%, increase
in average interest-bearing liabilities in the first nine months of 1999 as
compared with the first nine months of 1998. This increase was largely
concentrated in the Company's bonus money market deposit product, which
increased $625.4 million, or 44.2%, and was explained by high levels of client
liquidity attributable to a strong inflow of investment
18
<PAGE>
capital into the venture capital community during the past year, and by
growth in the number of clients served by the Company. The $12.6 million
favorable rate variance was largely attributable to a 120 basis points
decrease in the average rate paid on the Company's bonus money market deposit
product, due to a decline in short-term market interest rates during the
second half of 1998 combined with the Company lowering the rates paid on the
bonus money market deposit product an additional 123 basis points during the
third quarter of 1999.
The average cost of funds paid on interest-bearing liabilities decreased 80
basis points in the first nine months of 1999 versus the first nine months of
the prior year. The decrease in the average cost of funds was largely due to a
decrease of 120 basis points in the average rate paid on the Company's bonus
money market deposit product.
In an informal arrangement with the Bank's primary banking regulators (the
Federal Reserve Bank of San Francisco and the California Department of Financial
Institutions) pursuant to a memorandum of understanding entered into in late
September 1999, the Bank has agreed to maintain a Tier 1 leverage ratio of at
least 7.25% (see "Regulatory Matters" for further discussion). By maintaining
fourth quarter 1999 average assets that approximate total assets as of September
30, 1999, combined with increasing Tier 1 capital through internally generated
capital (e.g., net income), the Bank's Tier 1 leverage ratio is expected to
exceed 7.25% at December 31, 1999.
In recent periods, the Company's deposit growth has driven the growth of
interest-earning assets. However, as part of the Company's plans to address the
regulatory concerns described above, the rate paid on the Company's bonus money
market deposit product was lowered by 100 basis points and higher yielding
off-balance sheet private label mutual fund products were emphasized to clients.
As a result, deposit balances decreased approximately $700 million during the
last two weeks of September 1999 and average interest-earning assets (primarily
federal funds sold) in the fourth quarter of 1999 are expected to be less than
the previous quarter's total. Interest-earning assets totaled $3.5 billion at
September 30, 1999, a decrease of $512.4 million, compared to $4.0 billion in
average interest-earning assets for the third quarter of 1999.
The Company's net interest margin for the fourth quarter of 1999 is expected to
increase over the prior quarter's percentage due to an increase in the yield on
interest-earning assets (resulting from a shift in the composition of
interest-earning assets due to the anticipated decline in lower-yielding federal
funds sold) as well as to a decrease in the cost of funds paid on
interest-bearing liabilities (due to the lowering of deposit rates in late
September 1999).
PROVISION FOR LOAN LOSSES
The provision for loan losses is based on Management's evaluation of the
adequacy of the existing allowance for loan losses in relation to total loans,
and on Management's periodic assessment of the inherent and identified risk
dynamics of the loan portfolio resulting from reviews of selected individual
loans and loan commitments.
The Company's provision for loan losses totaled $21.6 million for the third
quarter of 1999, an $11.0 million, or 104.3%, increase compared to the $10.6
million provision for the third quarter of 1998. The provision for loan losses
increased $20.3 million, or 101.1%, to a total of $40.3 million for the first
nine months of 1999, versus $20.1 million for the comparable 1998 period.
19
<PAGE>
See "Financial Condition - Credit Quality and the Allowance for Loan Losses"
for additional related discussion.
NONINTEREST INCOME
The following table summarizes the components of noninterest income for the
three and nine month periods ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
(Unaudited) (Unaudited)
------------------------- ----------------------
(Dollars in thousands) 1999 1998 1999 1998
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Letter of credit and foreign exchange income $ 4,304 $1,795 $10,448 $5,137
Disposition of client warrants 6,177 705 8,687 4,979
Deposit service charges 729 432 2,073 1,277
Client investment fees 1,241 137 1,719 315
Investment gains (losses) - 4,149 (243) 4,626
Other 963 498 2,441 1,208
- -------------------------------------------------------------------------------------------------------------------
Total noninterest income $13,414 $7,716 $25,125 $17,542
===================================================================================================================
</TABLE>
Noninterest income increased $5.7 million, or 73.8%, to a total of $13.4 million
in the third quarter of 1999 versus $7.7 million in the prior year third
quarter. Noninterest income totaled $25.1 million for the first nine months of
1999, an increase of $7.6 million, or 43.2%, from the $17.5 million recorded in
the comparable 1998 period. The increase in noninterest income was largely due
to increases in income from the disposition of client warrants, letter of credit
fees, foreign exchange fees and other trade finance income, and client
investment fees, partially offset by a decline in gains on sales of investment
securities.
Letter of credit fees, foreign exchange fees and other trade finance income
totaled $4.3 million in the third quarter of 1999, an increase of $2.5 million,
or 139.8%, from the $1.8 million reported in the third quarter of 1998. For the
first nine months of 1999, letter of credit fees, foreign exchange fees and
other trade finance income totaled $10.5 million, an increase of $5.3 million,
or 103.4%, compared to the $5.1 million in the first nine months of 1998. The
growth in this category of noninterest income reflects a concerted effort by
Management to expand the penetration of trade finance-related products and
services among the Company's growing client base, a large percentage of which
provide products and services in international markets.
The Company has historically obtained rights to acquire stock (in the form of
warrants) in certain clients as part of negotiated credit facilities. The
receipt of warrants does not change the loan covenants or other collateral
control techniques employed by the Company to mitigate the risk of a loan
becoming nonperforming, and collateral requirements on loans with warrants are
similar to lending arrangements where warrants are not obtained. The timing and
amount of income from the disposition of client warrants typically depend upon
factors beyond the control of the Company, including the general condition of
the public equity markets as well as the merger and acquisition environment, and
therefore cannot be predicted with any degree of accuracy and are likely to vary
materially from period to period. During the first nine months of 1999, as well
as throughout 1998, a significant portion of the income realized by the Company
from the disposition of client warrants was offset by expenses related to the
Company's efforts to build an infrastructure sufficient to support present and
prospective business activities, as well as evaluate and pursue new business
opportunities, and was also offset by increases to the provision for loan
20
<PAGE>
losses during those periods. The Company realized pre-tax income of $14.5
million from the disposition of client warrants in October 1999. Based on
October 31, 1999 market valuations, the Company had additional potential
pre-tax warrant gains totaling over $29.2 million, of which over $22.9
million related to four clients. The Company is restricted from exercising
many of these warrants until the fourth quarter of 1999 and first quarter of
2000. Further, based on October 31, 1999 market valuations, the Company had a
potential pre-tax gain on a venture capital fund investment of over $14.3
million. The Company is restricted from selling this equity instrument until
the first quarter of the year 2000. Additionally, the Company is precluded
from using any type of derivative instrument to secure the current unrealized
gains associated with these equity instruments. Hence, the amount of income
realized by the Company from these equity instruments in future periods may
vary materially from the current unrealized amount due to fluctuations in the
market prices of the underlying common stock of these companies. Furthermore,
the Company may reinvest some or all of the income realized from the
disposition of these equity instruments in pursuing its business strategies.
Deposit service charges totaled $0.7 million for the three months ended
September 30, 1999, an increase of $0.3 million, or 68.8%, from the $0.4 million
reported in the third quarter of 1998. For the first nine months of 1999 and
1998 deposit service charges totaled $2.1 million and $1.3 million,
respectively. Clients compensate the Company for depository services either
through earnings credits computed on their demand deposit balances, or via
explicit payments recognized as deposit service charges income. The increase in
deposit service charges income was due to both a reduction in earnings credits
resulting from a decrease in short-term money market rates during the second
half of 1998 and growth in the Company's client base.
Client investment fees totaled $1.2 million in the third quarter of 1999
compared to $0.1 million in the 1998 third quarter. For the nine months ended
September 30, 1999, client investment fees totaled $1.7 million versus $0.3
million in the comparable 1998 period. Prior to June 1999, the Company only
earned client investment fees on off-balance sheet funds that were invested by
clients in investment securities such as U.S. Treasuries, U.S. agencies and
commercial paper. Off-balance sheet client funds totaled $1.1 billion at
December 31, 1998. Beginning in June 1999, the Company began offering
off-balance sheet private label mutual fund products to clients. The Company
earns approximately 35 basis points on the average balance in these products. At
September 30, 1999, $3.8 billion in client funds were invested off-balance
sheet, including $1.9 billion in the mutual fund products. The significant
growth in the amount of off-balance sheet client funds was explained by high
levels of client liquidity attributable to a strong inflow of investment capital
into the venture capital community during the past year, and by growth in the
number of clients served by the Company.
The Company realized a $0.2 million loss on investment securities during the
first nine months of 1999, versus a $4.6 million gain on sales of investment
securities during the comparable prior year period. All investment securities
sold were classified as available-for-sale, and all sales were conducted as a
normal component of the Company's asset/liability and liquidity management
activities. For additional related discussion, see the Item 2 section entitled
"Liquidity."
Other noninterest income largely consists of service-based fee income, and
increased $0.5 million, or 93.4%, to $1.0 million in the third quarter of 1999
from $0.5 million in the third quarter of 1998. For the nine month period ended
September 30, 1999, other noninterest income increased $1.2 million, or 102.1%,
to $2.4 million from $1.2 million in the comparable 1998
21
<PAGE>
period. The increase during 1999 was primarily due to a higher volume of cash
management and loan documentation services related to the Company's growing
client base.
NONINTEREST EXPENSE
Noninterest expense in the third quarter of 1999 totaled $29.7 million, an $8.7
million, or 41.1%, increase from the $21.1 million incurred in the comparable
1998 period. Noninterest expense totaled $83.1 million for the first nine months
of 1999, an increase of $21.3 million, or 34.5%, over the $61.7 million total
for the comparable 1998 period. Management closely monitors the level of
noninterest expense using a variety of financial ratios, including the
efficiency ratio. The efficiency ratio is calculated by dividing the amount of
noninterest expense, excluding costs associated with other real estate owned, by
adjusted revenues, defined as the total of net interest income and noninterest
income, excluding income from the disposition of client warrants and gains or
losses related to sales of investment securities. This ratio reflects the level
of operating expense required to generate $1 of operating revenue. The Company's
efficiency ratio for the 1999 third quarter was 48.2% versus 50.9% for the third
quarter of 1998. The Company's efficiency ratio for the first nine months of
1999 was 52.0% versus 55.4% for the comparable 1998 period. The following tables
present the detail of noninterest expense and the incremental contribution of
each line item to the Company's efficiency ratio:
<TABLE>
<CAPTION>
Three Months Ended September 30,
(Unaudited)
----------------------------------------------------------------
1999 1998
------------------------- -----------------------------
Percent of Percent of
Adjusted Adjusted
(Dollars in thousands) Amount Revenues Amount Revenues
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Compensation and benefits $18,150 29.5% $10,773 26.1%
Professional services 2,531 4.1 2,361 5.7
Net occupancy expense 1,713 2.8 1,394 3.4
Business development and travel 1,500 2.4 1,460 3.5
Furniture and equipment 1,368 2.2 1,320 3.2
Trust preferred securities distributions 825 1.3 825 2.0
Postage and supplies 618 1.0 635 1.5
Telephone 522 0.8 481 1.2
Advertising and promotion 474 0.8 643 1.6
Other 2,015 3.3 1,152 2.8
- ------------------------------------------------------------------------------------------------------------------
Total excluding cost of other
real estate owned 29,716 48.2% 21,044 50.9%
Cost of other real estate owned - 19
- ------------------------------------------------------------------------------------------------------------------
Total noninterest expense $29,716 $21,063
==================================================================================================================
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
(Unaudited)
----------------------------------------------------------------
1999 1998
------------------------- -----------------------------
Percent of Percent of
Adjusted Adjusted
(Dollars in thousands) Amount Revenues Amount Revenues
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Compensation and benefits $49,071 30.8% $34,877 30.7%
Professional services 8,426 5.3 6,390 5.6
Net occupancy expense 4,750 3.0 3,451 3.0
Business development and travel 4,356 2.7 4,422 3.9
Furniture and equipment 4,159 2.6 5,051 4.4
Trust preferred securities distributions 2,475 1.6 1,187 1.0
Postage and supplies 1,850 1.2 1,545 1.4
Advertising and promotion 1,808 1.1 1,553 1.4
Telephone 1,361 0.9 1,600 1.4
Other 4,526 2.8 2,893 2.5
- ------------------------------------------------------------------------------------------------------------------
Total excluding cost of other
real estate owned 82,782 52.0% 62,969 55.4%
Cost of other real estate owned 268 (1,229)
- ------------------------------------------------------------------------------------------------------------------
Total noninterest expense $83,050 $61,740
==================================================================================================================
</TABLE>
Compensation and benefits expenses totaled $18.2 million in the third quarter of
1999, a $7.4 million, or 68.5%, increase over the $10.8 million incurred in the
third quarter of 1998. For the first nine months of 1999, compensation and
benefits expenses totaled $49.1 million, an increase of $14.2 million, or 40.7%,
compared to $34.9 million for the comparable 1998 period. The increase in
compensation and benefits expenses was largely the result of an increase in the
number of average full-time equivalent (FTE) personnel employed by the Company
combined with the Company lowering its performance-based compensation in the
third quarter of 1998 in response to an increase in charge-offs during that
quarter. Average FTE were 641 and 623 for the three and nine month periods ended
September 30, 1999, versus 537 and 504 for the respective prior year periods.
The increase in FTE was primarily due to a combination of the Company's efforts
to develop and support new markets through geographic expansion, to develop and
expand products, services and niches, and to build an infrastructure sufficient
to support present and prospective business activities. Further growth in the
Company's FTE is likely to occur during future years as a result of the
continued expansion of the Company's business activities.
Professional services expenses, which consist of costs associated with corporate
legal services, litigation settlements, accounting and auditing services,
consulting, and the Company's Board of Directors, totaled $2.5 million and $8.4
million for the three and nine months ended September 30, 1999, an increase of
$0.2 million, or 7.2%, and $2.0 million, or 31.9%, compared to $2.4 million and
$6.4 million in the comparable 1998 periods. The increase in professional
services expenses primarily related to an increase in consulting fees associated
with several business initiatives, including the Year 2000 remediation project.
The level of professional services expenses during 1999 and 1998 reflects the
extensive efforts undertaken by the Company to continue to build and support its
infrastructure, as well as evaluate and pursue new business opportunities. It
also reflects the Company's efforts in outsourcing several corporate functions,
23
<PAGE>
such as internal audit, facilities management and credit review, where the
Company believes it can achieve a combination of cost savings and increased
quality of service.
Occupancy, furniture and equipment expenses totaled $3.1 million and $8.9
million for the three and nine months ended September 30, 1999, an increase of
$0.4 million, or 13.5%, and $0.4 million, or 4.8%, from the $2.7 million and
$8.5 million for the three and nine months ended September 30, 1998,
respectively. The increase in occupancy, furniture and equipment expenses in
1999 as compared to 1998, was primarily the result of the Company's continued
geographic expansion to develop and support new markets.
Trust preferred securities distributions totaled $0.8 million for the three
months ended September 30, 1999 and 1998. For the first nine months of 1999,
trust preferred securities distributions totaled $2.5 million, an increase of
$1.3 million, or 108.5%, compared to $1.2 million for the comparable 1998
period. These distributions resulted from the issuance of $40.0 million in
cumulative trust preferred securities during the second quarter of 1998. The
trust preferred securities pay a fixed rate quarterly distribution of 8.25% and
have a maximum maturity of 30 years.
During the second quarter of 1998, the Company realized a net gain of $1.3
million in connection with a sale of an OREO property that consisted of multiple
undeveloped lots.
Other noninterest expense totaled $2.0 million and $4.5 million for the three
and nine months ended September 30, 1999, an increase of $0.9 million, or 74.9%,
and $1.6 million, or 56.5%, compared to $1.2 million and $2.9 million for the
respective 1998 periods. This increase was primarily attributable to increased
data processing services related to both the overall growth in the Company's
business and several new business initiatives.
Certain lawsuits and claims arising in the ordinary course of business have been
filed or are pending against the Company and/or the Bank. Based upon information
available to the Company, its review of such claims to date and consultation
with its legal counsel, Management believes the liability relating to these
actions, if any, will not have a material adverse effect on the Company's
liquidity, consolidated financial position or results of operations.
INCOME TAXES
The Company's effective tax rate was 36.4% and 38.4% for the third quarter and
first nine months of 1999, compared to 41.3% and 41.4% in the three and nine
month prior year periods, respectively. The decrease in the Company's effective
income tax rate was principally attributable to an increase in the amount of the
tax exempt interest income received by the Company, as well as to a change in
the Company's multi-state income tax rate.
FINANCIAL CONDITION
The Company's total assets were $3.7 billion at September 30, 1999, an increase
of $176.3 million, or 5.0%, compared to $3.5 billion at December 31, 1998.
24
<PAGE>
FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENT TO RESELL
Federal funds sold and securities purchased under agreement to resell totaled a
combined $103.4 million at September 30, 1999, a decrease of $295.8 million, or
74.1%, compared to the $399.2 million outstanding at the prior year end. This
decrease was attributable to a decrease in the Company's deposits of
approximately $700.0 million during the last two weeks of September 1999. See
"Financial Condition - Deposits" for further discussion.
INVESTMENT SECURITIES
Investment securities totaled $1.7 billion at September 30, 1999, an increase of
$347.8 million, or 24.9%, from the December 31, 1998 balance of $1.4 billion.
This increase resulted from excess funds that were generated by growth in the
Company's deposits outpacing the growth in loans during the first nine months of
1999, and primarily consisted of U.S. agency securities and mortgage-backed
securities.
The increase in short-term market interest rates during the first nine months of
1999 resulted in a pre-tax unrealized loss on the Company's available-for-sale
fixed income securities investment portfolio of $31.5 million as of September
30, 1999. This unrealized loss was offset by a pre-tax unrealized gain of $30.5
million associated with equity securities, which includes the Company's warrant
portfolio and venture capital fund investments. Because of the level of
liquidity maintained by the Company, the Company does not anticipate having to
sell fixed income investment securities and incurring material losses on sales
in future periods for liquidity purposes. Additionally, the Company is
restricted from exercising many of the warrants until the fourth quarter of 1999
and first quarter of 2000. The Company is also precluded from using any type of
derivative instrument to secure the current unrealized gains associated with
these equity instruments. Hence, the amount of income recognized in future
periods by the Company from the disposition of these equity instruments may vary
materially from the current unrealized amount due to fluctuations in the market
prices of the underlying common stock of these companies.
LOANS
Total loans, net of unearned income, at September 30, 1999, were $1.7 billion, a
$49.1 million, or 3.0%, increase compared to the $1.6 billion total at December
31, 1998. While the Company continues to generate new loans in most of the
Company's technology, life sciences and special industry niche practices, as
well as in specialized lending products, the Company's clients, primarily in the
technology niche practices, have experienced high levels of liquidity
attributable to the capital markets and venture capital community. Consequently,
the Company has experienced higher than normal loan paydowns and payoffs, which
has caused total loans to remain relatively unchanged between September 30, 1999
and the prior year end.
CREDIT QUALITY AND THE ALLOWANCE FOR LOAN LOSSES
Credit risk is defined as the possibility of sustaining a loss because other
parties to the financial instrument fail to perform in accordance with the terms
of the contract. While the Bank follows underwriting and credit monitoring
procedures which it believes are appropriate in growing and managing the loan
portfolio, in the event of nonperformance by these other parties, the Bank's
25
<PAGE>
potential exposure to credit losses could significantly affect the Company's
consolidated financial position and earnings.
Lending money involves an inherent risk of nonpayment. Through the
administration of loan policies and monitoring of the portfolio, Management
seeks to reduce such risks. The allowance for loan losses is an estimate to
provide a financial buffer for losses, both identified and unidentified, in the
loan portfolio.
Management regularly reviews and monitors the loan portfolio to determine the
risk profile of each credit, and to identify credits whose risk profiles have
changed. This review includes, but is not limited to, such factors as payment
status, the financial condition of the borrower, borrower compliance with loan
covenants, underlying collateral values, potential loan concentrations, and
general economic conditions. Potential problem credits are identified and, based
upon known information, action plans are developed.
Management has established an evaluation process designed to determine the
adequacy of the allowance for loan losses. This process attempts to assess the
risk of losses inherent in the loan portfolio by segregating the allowance for
loan losses into three components: "specific," "loss migration" and "general."
The specific component is established by allocating a portion of the allowance
for loan losses to individual classified credits on the basis of specific
circumstances and assessments. The loss migration component is calculated as a
function of the historical loss migration experience of the internal loan credit
risk rating categories. The general component is an unallocated portion that
supplements the first two components and includes: Management's judgment of the
effect of current and forecasted economic conditions on the borrowers' abilities
to repay, an evaluation of the allowance for loan losses in relation to the size
of the overall loan portfolio, an evaluation of the composition of, and growth
trends within, the loan portfolio, consideration of the relationship of the
allowance for loan losses to nonperforming loans, net charge-off trends, and
other factors. While this evaluation process utilizes historical and other
objective information, the classification of loans and the establishment of the
allowance for loan losses, relies, to a great extent, on the judgment and
experience of Management.
The allowance for loan losses totaled $70.8 million at September 30, 1999, an
increase of $24.8 million, or 53.9%, compared to the $46.0 million balance at
December 31, 1998. This increase was due to $40.3 million in additional
provisions to the allowance for loan losses, partially offset by $15.5 million
of net charge-offs for the nine months ended September 30, 1999. The $40.3
million in loan loss provisions during the first nine months of 1999 was in
response to a recent trend of increased quarterly gross charge-offs.
The Company incurred $10.3 million and $22.5 million in gross charge-offs during
the three and nine months ended September 30, 1999. Gross charge-offs for the
1999 third quarter included $5.8 million related to one commercial credit, which
was classified as nonperforming at June 30, 1999, in the Company's computers and
peripherals niche. The Company realized recoveries of $3.2 million and $7.0
million for the three and nine months ended September 30, 1999, respectively.
26
<PAGE>
Pursuant to a memorandum of understanding with the Bank's primary banking
regulators, the Bank has committed to further enhance its credit monitoring
and review policies and submit reports to the regulators regarding credit
quality.
Management believes the allowance for loan losses is adequate as of September
30, 1999. However, future changes in circumstances, economic conditions or other
factors could cause Management to increase or decrease the allowance for loan
losses as deemed necessary.
Nonperforming assets consist of loans that are past due 90 days or more but
still accruing interest, loans on nonaccrual status and OREO and other
foreclosed assets. The table below sets forth certain relationships between
nonperforming loans, nonperforming assets and the allowance for loan losses:
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
(Dollars in thousands) (Unaudited) (Unaudited)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Nonperforming assets:
Loans past due 90 days or more $ 1,553 $ 441
Nonaccrual loans 33,959 19,444
- -----------------------------------------------------------------------------------------------------------------
Total nonperforming loans 35,512 19,885
OREO and other foreclosed assets 694 1,800
- -----------------------------------------------------------------------------------------------------------------
Total nonperforming assets $36,206 $21,685
=================================================================================================================
Nonperforming loans as a percentage of total loans 2.1% 1.2%
Nonperforming assets as a percentage of total assets 1.0% 0.6%
Allowance for loan losses: $70,800 $46,000
As a percentage of total loans 4.2% 2.8%
As a percentage of nonaccrual loans 208.5% 236.6%
As a percentage of nonperforming loans 199.4% 231.3%
</TABLE>
Nonperforming loans totaled $35.5 million, or 2.1% of total loans, at September
30, 1999, compared to $19.9 million, or 1.2% of total loans, at December 31,
1998. The increase in nonperforming loans from the prior year end was primarily
due to one credit in the Company's Financial Services (non-technology) niche
which had a balance of approximately $15.0 million at September 30, 1999. This
credit had been previously classified as nonperforming at March 31, 1999. As of
September 30, 1999, Management believes this credit is adequately secured with
collateral and reserves, and that any future charge-offs associated with this
loan will not have a material impact on the future net income of the Company.
In addition to the loans disclosed in the foregoing analysis, Management has
identified three loans with principal amounts aggregating approximately $14.2
million, that, on the basis of information known by Management, were judged to
have a higher than normal risk of becoming nonperforming. The Company is not
aware of any other loans where known information about possible problems of the
borrower casts serious doubts about the ability of the borrower to comply with
the loan repayment terms.
OREO and other foreclosed assets totaled a combined $0.7 million at September
30, 1999, a $1.1 million decrease from the $1.8 million balance at December
31, 1998. This decrease was primarily due
27
<PAGE>
to the sale of the Company's only OREO property during the second quarter of
1999. The OREO and other foreclosed assets balance at September 30, 1999,
consisted of one asset which was acquired through foreclosure. This asset
consists of a favorable leasehold right under a master lease which the
Company acquired upon foreclosure of a loan during the third quarter of 1997.
DEPOSITS
Total deposits were $3.4 billion at September 30, 1999, an increase of $135.0
million, or 4.1%, from the prior year-end total of $3.3 billion. A significant
portion of the increase in deposits during the first nine months of 1999 was
concentrated in the noninterest-bearing demand deposit product, which increased
$437.2 million, or 47.4%, to a total of $1.4 billion at the end of the September
30, 1999. This increase was explained by high levels of client liquidity
attributable to a strong inflow of investment capital into the venture capital
community, and by growth during the first nine months of 1999 in the number of
clients served by the Company.
Despite the high levels of client liquidity, the Company's money market deposits
decreased $424.6 million from December 31, 1998, and decreased $615.6 million
from June 30, 1999. The decrease in money market deposits was the result of the
Company lowering bonus money market deposit rates 123 basis points during the
third quarter of 1999 and also emphasizing higher-yielding off-balance sheet
private label mutual fund products to clients in order to lower total assets
thereby increasing the Tier 1 leverage ratio (see "Regulatory Matters" for
further discussion).
YEAR 2000 READINESS DISCLOSURE
The Federal Financial Institutions Examination Council (FFIEC), an oversight
authority for financial institutions, has issued several interagency statements
on Year 2000 project awareness. These statements require financial institutions
to, among other things, examine the Year 2000 implications of their reliance on
vendors, determine the potential impact of the Year 2000 issue on their
customers, suppliers and borrowers, and to survey its exposure, measure its risk
and prepare a plan to address the Year 2000 issue. In addition, federal banking
regulators have issued safety and soundness guidelines to be followed by
financial institutions to assure resolution of any Year 2000 problems. The
federal banking agencies have asserted that Year 2000 testing and certification
is a key safety and soundness issue in conjunction with regulatory examinations,
and the failure to appropriately address the Year 2000 issue could result in
supervisory action, including the reduction of the institution's supervisory
ratings, the denial of applications for mergers or acquisitions, or the
imposition of civil monetary penalties.
The Company, following an initial awareness phase, is utilizing a three-phase
plan for achieving Year 2000 readiness. The Assessment Phase was intended to
determine which computers, operating systems and applications require
remediation and prioritizing those remediation efforts by identifying mission
critical systems. The Assessment Phase has been completed except for the
on-going assessment of new systems. The Remediation and Testing Phase addressed
the correction or replacement of any non-compliant hardware and software related
to the mission critical systems and testing of those systems. Since most of the
Bank's information technology systems are off-the-shelf software, remediation
efforts have focused on obtaining Year 2000 compliant application upgrades. The
Bank's core banking system, which runs loans, deposits and the general ledger,
has been upgraded to the Year 2000 compliant version and has been forward date
tested and Year 2000 certified by the Bank. The Year 2000 releases for all of
the Bank's
28
<PAGE>
other internal mission critical systems have also been received, forward date
tested and certified. Furthermore, testing of mission critical service
providers, has been completed as of June 30, 1999. During the final phase,
the Implementation Phase, remediated and validated code was tested in
interfaces with customers, business partners, government institutions, and
others. As of June 30, 1999 all mission critical testing and implementation
of mission critical systems into the production environment was completed.
June 30, 1999, marked the final FFIEC milestone.
Although the Company has attempted to make every effort to be prepared for the
century date change, it may be affected by the Year 2000 compliance issues of
governmental agencies, businesses and other entities that provide data to, or
receive data from, the Company, and by entities, such as borrowers, vendors,
customers, and business partners, whose financial condition or operational
capability is significant to the Company. Therefore, the Company's Year 2000
project also includes assessing the Year 2000 readiness of certain customers,
borrowers, vendors, business partners, counterparties, and governmental
entities. In addition to assessing the readiness of these external parties, the
Company is developing contingency plans which will include plans to recover
operations and alternatives to mitigate the effects of counterparties whose own
failure to properly address Year 2000 issues may adversely impact the Company's
ability to perform certain functions. Contingency planning and testing of
critical business processes was complete as of June 30, 1999.
If Year 2000 issues are not adequately addressed by the Company and significant
third parties, the Company's business, results of operations and financial
position could be materially adversely affected. Failure of certain vendors to
be Year 2000 compliant could result in disruption of important services upon
which the Company depends, including, but not limited to, such services as
telecommunications, electrical power and data processing. Failure of the
Company's loan customers to properly prepare for the Year 2000 could also result
in increases in problem loans and credit losses in future years. It is not,
however, possible to quantify the potential impact of any such losses at this
time. Notwithstanding the Company's efforts, there can be no assurance that the
Company or significant third party vendors or other significant third parties
will adequately address their Year 2000 issues. The Company is continuing to
assess the Year 2000 readiness of third parties but does not know at this time
whether the failure of third parties to be Year 2000 compliant will have a
material effect on the Company's results of operations, liquidity and financial
condition.
The Company currently estimates that its total cost for the Year 2000 project
will approximate $3.0 million. During the first nine months of 1999, the
Company incurred $1.4 million, bringing the total incurred in 1998 and 1999
for charges related to its Year 2000 remediation effort to $2.9 million. The
Company expects to incur approximately $0.1 million during the remainder of
1999. Charges include the cost of external consulting and the cost of
accelerated replacement of hardware, but do not include the cost of internal
staff redeployed to the Year 2000 project. The Company does not believe that
the redeployment of internal staff has or will have a material impact on its
financial condition or results of operations.
The foregoing paragraphs contain a number of forward-looking statements. These
statements reflect Management's best current estimates, which were based on
numerous assumptions about future events, including the continued availability
of certain resources, representations received from third party service
providers and other factors. There can be no guarantee that these estimates,
including Year 2000 costs, will be achieved, and actual results could differ
materially from those estimates. A number of important factors could cause
Management's estimates and
29
<PAGE>
the impact of the Year 2000 issue to differ materially from what is described
in the forward-looking statements contained in the above paragraphs. Those
factors include, but are not limited to, the availability and cost of
programmers and other systems personnel, inaccurate or incomplete execution
of the phases, results of Year 2000 testing, adequate resolution of Year 2000
issues by the Company's customers, vendors, competitors, and counterparties,
and similar uncertainties.
The forward-looking statements made in the foregoing Year 2000 discussion speak
only as of the date on which such statements are made, and the Company
undertakes no obligation to update any forward-looking statement to reflect
events or circumstances after the date on which such statement is made or to
reflect the occurrence of unanticipated events.
MARKET RISK MANAGEMENT
Interest rate risk is the most significant market risk impacting the Company.
The Company's monitoring activities related to managing interest rate risk
include both interest rate sensitivity "gap" analysis and the use of a
simulation model to measure the impact of market interest rate changes on the
net present value of estimated cash flows from the Company's assets, liabilities
and off-balance sheet items, defined as the Company's market value of portfolio
equity (MVPE). See the Company's 1998 Annual Report on Form 10-K for disclosure
of the quantitative and qualitative information regarding the interest rate risk
inherent in interest rate risk sensitive instruments as of December 31, 1998.
There have been no changes in the assumptions used by the Company in monitoring
interest rate risk, and the Company is in compliance with all interest rate risk
policy guidelines as of September 30, 1999. Other types of market risk affecting
the Company in the normal course of its business activities include foreign
currency exchange risk and equity price risk. The impact on the Company,
resulting from these other two types of market risks, is deemed immaterial. The
Company does not maintain a portfolio of trading securities and does not intend
to engage in such activities in the immediate future.
LIQUIDITY
The objective of liquidity management is to ensure that funds are available in a
timely manner to meet loan demand and depositors' needs, and to service other
liabilities as they come due, without causing an undue amount of cost or risk,
and without causing a disruption to normal operating conditions.
The Company regularly assesses the amount and likelihood of projected funding
requirements through a review of factors such as historical deposit volatility
and funding patterns, present and forecasted market and economic conditions,
individual client funding needs, and existing and planned Company business
activities. The asset/liability committee of the Bank provides oversight to the
liquidity management process and recommends policy guidelines, subject to Board
of Directors approval, and courses of action to address the Company's actual and
projected liquidity needs.
The ability to attract a stable, low-cost base of deposits is the Company's
primary source of liquidity. Other sources of liquidity available to the Company
include short-term borrowings, which consist of federal funds purchased,
security repurchase agreements and other short-term borrowing arrangements. The
Company's liquidity requirements can also be met through the use of its
portfolio of liquid assets. Liquid assets, as defined, include cash and cash
equivalents in
30
<PAGE>
excess of the minimum levels necessary to carry out normal business
operations, federal funds sold, securities purchased under resale agreements,
investment securities maturing within six months, investment securities
eligible and available for pledging purposes with a maturity in excess of six
months, and anticipated near term cash flows from investments.
Bank policy guidelines provide that liquid assets as a percentage of total
deposits should not fall below 20.0%. At September 30, 1999, the Bank's ratio of
liquid assets to total deposits was 49.0%. This ratio is well in excess of the
Bank's minimum policy guidelines and is slightly lower than the comparable ratio
of 52.5% as of December 31, 1998. In addition to monitoring the level of liquid
assets relative to total deposits, the Bank also utilizes other policy measures
in its liquidity management activities. As of September 30, 1999, the Bank was
in compliance with all of these policy measures.
CAPITAL RESOURCES
Management seeks to maintain adequate capital to support anticipated asset
growth and credit risks, and to ensure that the Company and the Bank are in
compliance with all regulatory capital guidelines. The primary source of new
capital for the Company has been the retention of earnings. Aside from current
earnings, other sources of new capital for the Company have been the issuance of
common stock under the Company's employee benefit plans, including the Company's
stock option plans, defined contribution plans and employee stock purchase plan.
Additionally, during the second quarter of 1998 the Company issued $40.0 million
in cumulative trust preferred securities through SVB Capital I. The trust
preferred securities are presented as a separate line item in the consolidated
balance sheet of the Company under the caption "Company obligated mandatorily
redeemable trust preferred securities of subsidiary trust holding solely junior
subordinated debentures." The securities have a maximum maturity of 30 years and
qualify as Tier 1 capital under the capital guidelines of the Federal Reserve
Board.
Stockholders' equity totaled $243.5 million at September 30, 1999, an increase
of $27.6 million, or 12.8%, from the $215.9 million balance at December 31,
1998. This increase resulted from net income of $27.3 million combined with
capital generated primarily through the Company's employee benefit plans of $3.4
million, partially offset by a decrease in the after-tax net unrealized gain on
available-for-sale investments of $3.0 million from the prior year end. See
"Financial Condition - Investment Securities" for additional discussion on the
net unrealized loss on available-for-sale investments as of September 30, 1999.
The Company and the Bank are subject to capital adequacy guidelines issued by
the Federal Reserve Board. Under these capital guidelines, the minimum total
risk-based capital and Tier 1 risk-based capital ratio requirements are 10.0%
and 6.0%, respectively, of risk-weighted assets and certain off-balance sheet
items for a "well capitalized" depository institution.
31
<PAGE>
The Federal Reserve Board has also established minimum capital leverage ratio
guidelines for state member banks. The ratio is determined using Tier 1 capital
divided by quarterly average total assets. The guidelines require a minimum of
5.0% for a well capitalized depository institution.
The Company's and the Bank's risk-based capital ratios were in excess of
regulatory guidelines for a well capitalized depository institution as of
September 30, 1999, and December 31, 1998. Capital ratios for the Company
are set forth below:
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Total risk-based capital ratio 12.7% 11.5%
Tier 1 risk-based capital ratio 11.5% 10.3%
Tier 1 leverage ratio 6.7% 7.6%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
The improvement in the Company's total risk-based capital ratio and Tier 1
risk-based capital ratio from December 31, 1998, to September 30, 1999, was
attributable to an increase in Tier 1 capital and an increase in the Company's
investments in low or zero risk-weighted assets. The increase in Tier 1 capital
resulted from the aforementioned net income for the first nine months of 1999.
The decrease in the Tier 1 leverage ratio from December 31, 1998, to September
30, 1999, was primarily attributable to an increase in average total assets due
to strong growth in deposits during the first nine months of 1999.
In an informal arrangement with the Bank's primary banking regulators (the
Federal Reserve Bank of San Francisco and the California Department of Financial
Institutions) pursuant to a memorandum of understanding entered into in late
September 1999, the Bank has agreed to maintain a Tier 1 leverage ratio of at
least 7.25% By maintaining fourth quarter 1999 average assets that approximate
total assets as of September 30, 1999, combined with increasing Tier 1 capital
through internally generated capital (e.g., net income), the Bank's Tier 1
leverage ratio is expected to exceed 7.25% at December 31, 1999. The Company is
also contemplating increasing Tier 1 capital through the issuance of equity
instruments.
REGULATORY MATTERS
In late September 1999, the Bank entered into an informal arrangement with
the Federal Reserve Bank of San Francisco and the California Department of
Financial Institutions, the Bank's primary banking regulators. Under the
informal arrangement (pursuant to a memorandum of understanding), the Bank
has committed to maintain a Tier 1 leverage ratio of at least 7.25%; obtain
the regulators' consent prior to payment of dividends; further enhance its
credit monitoring and review policies and submit reports to the regulators
regarding credit quality. The Federal Reserve Bank of San Francisco has
directed the Company to obtain its approval before incurring debt, paying
dividends, repurchasing capital stock, or entering into agreements to acquire
any entities or portfolios.
The Company's and the Bank's capital ratios were in excess of regulatory
guidelines for a well capitalized depository institution as of September 30,
1999. The Bank's Tier 1 leverage ratio has declined since December 31, 1998,
32
<PAGE>
largely the result of the rapid growth in deposits experienced by the Bank
during 1999. The Bank's deposit growth in 1999 has been driven by high levels
of client liquidity attributable to a strong inflow of investment capital
into the venture capital community, and by growth in the number of clients
served by the Bank. In order to slow the growth in deposits due to the Tier 1
leverage ratio capital constraints, the Bank implemented a program during the
third quarter of 1999 to emphasize off-balance sheet products to clients
(e.g., mutual fund products). This has allowed the Bank to continue serving
its clients' needs while restraining balance sheet growth driven by deposits.
The Bank should exceed the 7.25% Tier 1 leverage ratio by year-end 1999 by
maintaining its average assets in the fourth quarter of 1999 at or near third
quarter period-end levels and by increasing Tier 1 capital primarily through
net income. The Company is also pursuing alternative strategies, including
issuance of equity or other capital instruments, to assure that the Bank
complies with the informal agreement with the regulators.
33
<PAGE>
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
There were no legal proceedings requiring disclosure pursuant to this item
pending at September 30, 1999, or at the date of this report.
ITEM 2 - CHANGES IN SECURITIES
None.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5 - OTHER INFORMATION
None.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
None.
(b) REPORTS ON FORM 8-K:
No reports on Form 8-K were filed by the Company during the quarter ended
September 30, 1999.
34
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SILICON VALLEY BANCSHARES
Date: November 15, 1999 /s/ Donal D. Delaney
------------------------------------
Donal D. Delaney
Senior Vice President and Controller
(Principal Accounting Officer)
35
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS, RELATED NOTES AND
MANAGEMENT DISCUSSION AND ANALYSIS CONTINUED IN THE REPORT ON FORM 10-Q FILED BY
SILICON VALLEY BANCSHARES FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 185,577
<INT-BEARING-DEPOSITS> 441
<FED-FUNDS-SOLD> 103,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 1,745,262
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 1,661,016
<ALLOWANCE> 70,800
<TOTAL-ASSETS> 3,721,755
<DEPOSITS> 3,404,801
<SHORT-TERM> 0
<LIABILITIES-OTHER> 34,934
<LONG-TERM> 0
0
0
<COMMON> 21
<OTHER-SE> 243,475
<TOTAL-LIABILITIES-AND-EQUITY> 3,721,755
<INTEREST-LOAN> 118,872
<INTEREST-INVEST> 65,252
<INTEREST-OTHER> 22,340
<INTEREST-TOTAL> 206,464
<INTEREST-DEPOSIT> 63,900
<INTEREST-EXPENSE> 63,900
<INTEREST-INCOME-NET> 142,564
<LOAN-LOSSES> 40,334
<SECURITIES-GAINS> (243)
<EXPENSE-OTHER> 83,050
<INCOME-PRETAX> 44,305
<INCOME-PRE-EXTRAORDINARY> 27,299
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 27,299
<EPS-BASIC> 1.33<F1>
<EPS-DILUTED> 1.30<F2>
<YIELD-ACTUAL> 5.2
<LOANS-NON> 33,959
<LOANS-PAST> 1,553
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 14,200
<ALLOWANCE-OPEN> 46,000
<CHARGE-OFFS> 22,491
<RECOVERIES> 6,957
<ALLOWANCE-CLOSE> 70,800
<ALLOWANCE-DOMESTIC> 34,270
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 36,530
<FN>
<F1>REPRESENTS - BASIC EARNINGS PER SHARE
<F2>REPRESENTS - DILUTED EARNINGS PER SHARE
</FN>
</TABLE>
