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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 19, 1999
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER: 33-41102
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SILICON VALLEY BANCSHARES
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-2856336
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3003 TASMAN DRIVE
SANTA CLARA, CALIFORNIA 95054-1191
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 654-7282
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Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock (no par value) Nasdaq National Market
(Title of each class) (Name of each exchange on which registered)
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 ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing price of its common stock on January 31,
1999, on the Nasdaq National Market was $390,300,699.
At January 31, 1999, 20,746,881 shares of the registrant's common stock (no
par value) were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
PARTS OF FORM 10-K
DOCUMENTS INCORPORATED INTO WHICH INCORPORATED
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Definitive proxy statement for the Company's 1999 Annual Meeting
of Shareholders to be filed within 120 days of the end of the
fiscal year ended December 31, 1998 Part III
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This report contains a total of 138 pages, including exhibits.
The Exhibit Index is on page 71.
TABLE OF CONTENTS
PAGE
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PART I
ITEM 1. BUSINESS................................................................................... 3
ITEM 2. PROPERTIES................................................................................. 13
ITEM 3. LEGAL PROCEEDINGS.......................................................................... 13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................................ 13
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.................. 14
ITEM 6. SELECTED FINANCIAL DATA.................................................................... 15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...... 16
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................................ 39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE....... 68
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......................................... 68
ITEM 11. EXECUTIVE COMPENSATION..................................................................... 68
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................. 68
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................. 68
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K........................... 68
SIGNATURES.............................................................................................. 69
INDEX TO EXHIBITS....................................................................................... 71
2
PART I
ITEM 1. BUSINESS
GENERAL
Silicon Valley Bancshares (the "Company") is a California corporation and
bank holding company that was incorporated on April 23, 1982. The Company's
principal subsidiary is Silicon Valley Bank (the "Bank"), a wholly owned
subsidiary of the Company that was organized and incorporated as a California
banking corporation on October 17, 1983. The Bank is a member of the Federal
Reserve System and its deposits are insured by the Bank Insurance Fund (the
"BIF"), as administered by the Federal Deposit Insurance Corporation (the
"FDIC"). SVB Leasing Company, a wholly owned subsidiary of the Company, was
incorporated on November 14, 1984 as a California corporation, and has remained
inactive since incorporation. Additionally, during the second quarter of 1998
the Company issued $40.0 million in cumulative trust preferred securities
through a newly formed special-purpose trust (SVB Capital I).
BUSINESS OVERVIEW
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. The Bank serves
clients across the nation through branches and/or loan offices located in
Arizona, California, Colorado, Georgia, Illinois, Maryland, Massachusetts,
Oregon, Texas, and Washington. Since 1994, the Bank has refined a niche strategy
based on identifying and capitalizing on market niches whose financial services
needs are underserved. By dedicating resources within these niches, the Bank
seeks to provide the highest level of expertise and quality service to its
clients.
TECHNOLOGY AND LIFE SCIENCES NICHE
The Bank's technology and life sciences niche focuses on serving companies
within a variety of technology and life sciences industries and markets across
the nation. These companies are generally liquid, net providers of funds to the
Bank, and often have low utilization of their credit facilities. Lending to this
niche is typically related to working capital lines of credit, equipment
financing, asset acquisition loans, and bridge financing. The following is an
overview of the Bank's technology and life sciences niche practices.
The Communications and Online Services practice serves companies in the
networking, telecommunications and online services industries. The networking
industry includes companies supplying the equipment and services that facilitate
distributed enterprise networks such as local and wide area networks. The
telecommunications industry encompasses the suppliers of equipment and services
to companies and consumers for the transmission of voice, data and video.
Companies included in the online services industry supply access, content,
services, and support to individuals and businesses participating on the
Internet, or in other online activities.
The Computers and Peripherals practice focuses on companies that are engaged
in the support and manufacturing of computers, electronic components and related
peripheral products. Specific markets these companies serve include personal
computers, specialty computer systems, add-in boards, printers, storage devices,
networking equipment, and contract manufacturing.
The Semiconductors practice serves companies involved in the design,
manufacturing and marketing of integrated circuits. This includes companies
involved in the manufacturing of semiconductor production equipment and
semiconductors, testing and related services, electronic parts wholesaling,
computer-aided design, and computer-aided manufacturing.
The Software practice consists largely of companies specializing in the
design of integrated computer systems, computer programming services, and the
development and marketing of commercial and industrial applications as well as
prepackaged software.
The Life Sciences practices serve companies in the biotechnology, medical
devices and health care services industries. The biotechnology industry includes
companies involved in research and development of therapeutics and diagnostics
for the medical and pharmaceuticals industries. The medical devices industry
encompasses companies involved in the design, manufacturing and distribution of
surgical instruments and
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medical equipment. Companies included in the health care services industry deal
with patients, either in a primary care or secondary care role.
In addition to the industry-related practices discussed above, the Bank has
three other practices that provide commercial lending and other financial
products and services to clients associated with the technology and life
sciences industries. The Pacific Rim practice serves technology and life
sciences companies that receive equity funding from Asian (or Asian-based)
venture capital sources, while the Venture Capital practice provides venture
capital firms with financing and other specialized products and services.
Lastly, the Emerging Technologies practice, which was established in 1997,
primarily targets non-venture-backed technology financial relationships in
Northern California, with a primary focus on the software industry.
SPECIAL INDUSTRY NICHES
The Bank has always served a variety of commercial enterprises unrelated to
its technology and life sciences niche. These clients are served through several
special industry niche practices which generally focus their lending in specific
regions throughout the U.S. The Bank's niche strategy evolved from clients
unrelated to the technology and life sciences niche, and the Bank continues to
follow this strategy by identifying industries whose financial services needs
are underserved. The following is a brief summary of the Bank's current special
industry niche practices.
The Real Estate practice is composed of real estate construction and term
loans whose primary source of repayment is cash flow or sales proceeds from real
property collateral. The focus of the Real Estate practice consists of
construction loans for residential and commercial projects, and construction and
mini-permanent loans on retail, industrial and office projects.
The Premium Wineries practice focuses on wineries, which produce select or
exclusive vintages of up to 150,000 cases annually. Lending in this niche
consists of both short-term inventory loans and term loans related to vineyard
acquisition and development, equipment financing and cooperage.
The Entertainment practice serves the independent sector of the
entertainment industry. This practice provides production loans, lines of credit
and term loans for library and other acquisitions.
In addition to serving the niches listed above, the Bank serves a broad
array of industries through its Diversified Industries practice in Northern
California. This practice allows the Bank to continue to evaluate potential
niches by initially identifying and serving a few clients in related industries
or markets.
SPECIALIZED PRODUCTS AND SERVICES
The Bank has several divisions that offer specialized lending products and
other financial products and services to clients in the technology and life
sciences niche as well as the special industry niches discussed above, enabling
the Bank to better serve its clients' wide range of financial services needs.
These divisions include: International, Cash Management, Treasury, Real Estate,
Factoring, Commercial Finance, Corporate Finance, and Executive Banking.
The International Division provides foreign exchange, import and export
letters of credit, documentary collections, and a number of other trade finance
products and services to the Bank's clients, helping them to successfully
operate in international markets. The Bank has been granted delegated authority
by the Export-Import Bank of the U.S. ("EX-IM") and the California Export
Finance Office ("CEFO"), enabling the Bank to provide its clients with EX-IM and
CEFO guaranteed working capital loans to finance foreign receivables and
inventory intended for export, as well as provide purchase order financing.
The Cash Management Division provides services to help the Bank's customers
manage cash collections and disbursements efficiently and cost effectively.
Services provided include wholesale lockbox services, electronic information
reporting, controlled disbursement services, and a variety of other services
designed to meet the banking and cash management needs of the Bank's clients.
Through the Treasury Division, the Bank provides investment services to
assist its clients with managing short-term investments. Investment securities
purchased on behalf of clients include U.S. Treasury securities, U.S. agency
securities, commercial paper, Eurodollar deposits, and bankers' acceptances.
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In addition to being a special industry niche, real estate lending is also a
product offered to the Bank's clients. This product is typically offered to
finance commercial real estate owned and operated by the Bank's client
companies.
Both the Factoring Division and the Commercial Finance Division offer
alternative financing to client companies which do not qualify for the more
traditional financing offered through the Bank's niche practices. The Factoring
Division generally serves the Bank's emerging growth client base by purchasing
clients' accounts receivable at a discount, making operating funds immediately
available to the clients, and then managing the collection of these receivables.
The Commercial Finance Division assists client companies during periods when
profit performance has been interrupted or where greater flexibility is required
by providing credit facilities that involve frequent monitoring of the
underlying collateral, which generally consists of accounts receivable,
inventory and equipment. To the extent that clients of the Factoring and
Commercial Finance Divisions grow and their financial condition strengthens,
they may thereafter be served through the Bank's niche practices.
The Corporate Finance Division pursues opportunities in leasing, mezzanine
lending and debt placements, targeting bank-eligible investment banking
transactions.
The Executive Banking Division focuses on serving the personal banking needs
of senior executives and owners of the Bank's client companies, partners and
senior executives of venture capital firms, attorneys, accountants, and other
professionals whose businesses are affiliated with the Bank's niches.
EMPLOYEES
As of December 31, 1998, 1997 and 1996, the Company and the Bank, in the
aggregate, employed 590, 454 and 384 full-time equivalent personnel,
respectively, consisting of both full-time and permanent part-time employees.
Full-time equivalent is a measurement equivalent to one full-time employee
working a standard day, and is based on the number of hours worked in a given
month. The Company's and the Bank's employees are not represented by any unions
or covered by a collective bargaining agreement. Management of the Company and
the Bank believes that, in general, their employee relations are satisfactory.
COMPETITION
The banking and financial services business environment in California, as
well as the rest of the U.S., is highly and increasingly competitive. The Bank
competes for client loans, deposits and other financial products and services
with other commercial banks, savings and loan associations, securities and
brokerage companies, mortgage companies, insurance companies, finance companies,
money market and other mutual funds, credit unions, and other non-bank financial
services providers. Many of these competitors are much larger in total assets
and capitalization, have greater access to capital markets and offer a broader
array of financial products and services than the Bank. The increasingly
competitive environment is primarily a result of changes in regulation, changes
in technology and product delivery systems, and the accelerating pace of
consolidation among financial services providers. In order to compete with other
financial services providers, the Bank principally relies upon promotional
activities and industry knowledge in its market areas, personal relationships
with clients and other service providers, referral sources established by
officers, directors and employees, and specialized services tailored to meet the
Bank's clients' needs. In those instances where the Bank is unable to
accommodate a client's needs, the Bank will seek to arrange for those services
to be provided by its network of correspondents and other service providers.
ECONOMIC CONDITIONS, GOVERNMENT POLICIES, LEGISLATION, AND REGULATION
The Company's profitability, like that of most other financial institutions,
is primarily dependent on interest rate differentials. In general, the
difference between the interest rates paid by the Bank on interest-bearing
liabilities, such as deposits and other borrowings, and the interest rates
received by the Bank on interest-earning assets, such as loans extended to its
clients and securities held in its investment portfolio, comprise the major
portion of the Company's earnings. These rates are highly sensitive to many
factors that are beyond the control of the Company and the Bank, such as
inflation, recession and unemployment, and the impact that future changes in
domestic and foreign economic conditions might have on the Company and the Bank
cannot be predicted.
5
The Company's business is also influenced by the monetary and fiscal
policies of the federal government and the policies of regulatory agencies,
particularly the Board of Governors of the Federal Reserve System (the "Federal
Reserve Board"). The Federal Reserve Board implements national monetary policies
(with objectives such as curbing inflation and combating recession) through its
open-market operations in U.S. government securities, by adjusting the required
level of reserves for depository institutions subject to its reserve
requirements and by varying the target federal funds and discount rates
applicable to borrowings by depository institutions. The actions of the Federal
Reserve Board in these areas influence the growth of bank loans, investments and
deposits, and also affect interest rates earned on interest-earning assets and
paid on interest-bearing liabilities. The nature and impact on the Company and
the Bank of any future changes in monetary and fiscal policies cannot be
predicted.
From time to time, legislative acts, as well as regulations, are enacted
which have the effect of increasing the cost of doing business, limiting or
expanding permissible activities, or affecting the competitive balance between
banks and other financial services providers. Proposals to change the laws and
regulations governing the operations and taxation of banks, bank holding
companies and other financial institutions are frequently made in the U.S.
Congress, in the state legislatures and by various bank regulatory agencies. The
likelihood of any legislative or regulatory changes and the impact such changes
might have on the Company and the Bank cannot be predicted. See "Item 1.
Business--Supervision and Regulation" for additional discussion on legislative
and regulatory changes.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under both
federal and state law. This regulation is intended primarily for the protection
of depositors and the deposit insurance fund and not for the benefit of
shareholders of the Company. Set forth below is a summary description of certain
laws and regulations, which relate to the operations of the Company and the
Bank. The description does not purport to be complete and is qualified in its
entirety by reference to the applicable laws and regulations.
In recent years, significant legislative proposals and reforms affecting the
financial services industry have been discussed and evaluated by the U.S.
Congress. Such proposals include, but are not limited to, legislation to revise
the Glass-Steagall Act and the Bank Holding Company Act of 1956, as amended (the
"BHCA"), and to expand permissible activities for banks, principally to
facilitate the convergence of commercial and investment banking. Certain
proposals also have sought to expand insurance activities of banks. It is
unclear whether any of these proposals, or any form of them, will be introduced
in the current U.S. Congress and become law. Consequently, it is not possible to
determine what effect, if any, these and other legislative proposals may have on
the Company and the Bank.
THE COMPANY
The Company, as a registered bank holding company, is subject to regulation
under the BHCA and Regulation Y, which has been adopted thereunder by the
Federal Reserve Board. The Company is required to file with the Federal Reserve
Board quarterly, semi-annual and annual reports, and such additional information
as the Federal Reserve Board may require pursuant to the BHCA and Regulation Y.
The Federal Reserve Board may conduct examinations of the Company and its
subsidiaries.
The Federal Reserve Board may require that the Company terminate an activity
or terminate control of, liquidate or divest certain subsidiaries or affiliates
when the Federal Reserve Board believes the activity or the control of the
subsidiary or affiliate constitutes a significant risk to the financial safety,
soundness or stability of any of the Company's banking subsidiaries. The Federal
Reserve Board also has the authority to regulate provisions of certain bank
holding company debt, including the authority to impose interest rate ceilings
and reserve requirements on such debt.
The Company is required by the Federal Reserve Board to maintain certain
minimum levels of capital, and in addition, under certain circumstances, the
Company must file written notice with, and obtain approval from, the Federal
Reserve Board prior to purchasing or redeeming its equity securities. The
Company may engage "de novo" in permissible non-banking activities as listed in
Regulation Y without the approval of the Federal Reserve Board, provided that
the Company and the Bank are "well capitalized" and that certain other criteria
are met. For purposes of determining the capital levels at which a bank holding
company is considered well capitalized under Regulation Y, the Federal Reserve
Board has adopted a minimum total risk-based capital
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ratio of 10% on a consolidated basis and a minimum Tier 1 risk-based capital
ratio of 6% on a consolidated basis. See "Item 1. Business--Supervision and
Regulation--Capital Standards" and "Item 1. Business-- Supervision and
Regulation--Prompt Corrective Action and Other Enforcement Mechanisms" for
additional discussion of capital ratios.
Under the BHCA and regulations adopted by the Federal Reserve Board, a bank
holding company and its non-banking subsidiaries are prohibited from requiring
certain tie-in arrangements in connection with any extension of credit, lease or
sale of property or furnishing of services.
The Company is required to obtain the prior approval of the Federal Reserve
Board for the acquisition of more than 5.0% of the outstanding shares of any
class of voting securities, or substantially all of the assets, of any bank or
bank holding company. Prior approval of the Federal Reserve Board is also
required for the merger or consolidation of the Company and another bank holding
company.
The Company is prohibited by the BHCA, except in certain instances
prescribed by statute, from acquiring direct or indirect ownership or control of
more than 5.0% of the outstanding voting shares of any company that is not a
bank or bank holding company and from engaging directly or indirectly in
activities other than those of banking, managing or controlling banks or
furnishing services to its subsidiaries. However, the Company, subject to the
prior approval of the Federal Reserve Board, may engage in, or acquire voting
shares of companies engaged in, activities that are deemed by the Federal
Reserve Board to be so closely related to banking or managing or controlling
banks as to be a proper incident thereto.
Under Federal Reserve Board regulations, a bank holding company is required
to serve as a source of financial and managerial strength to its subsidiary
banks and may not conduct its operations in an unsafe or unsound manner. In
addition, it is the Federal Reserve Board's policy that in serving as a source
of strength to its subsidiary banks, a bank holding company should stand ready
to use available resources to provide adequate capital funds to its subsidiary
banks during periods of financial stress or adversity and should maintain the
financial flexibility and capital-raising capacity to obtain additional
resources for assisting its subsidiary banks. A bank holding company's failure
to meet its obligations to serve as a source of strength to its subsidiary banks
will generally be considered by the Federal Reserve Board to be an unsafe and
unsound banking practice or a violation of the Federal Reserve Board's
regulations or both.
The Company's ability to pay cash dividends is limited by the California
Corporation Code to the greater of (a) the Company's retained earnings, or (b)
the Company's total assets (net of cash dividends declared) less 150% of the
Company's liabilities. In addition to the aforementioned cash dividend
limitations imposed on the Company, there are statutory and regulatory
limitations on the amount of dividends which may be paid to the Company by the
Bank. See "Item 1. Business--Supervision and Regulation--Dividends and Other
Transfers of Funds" for further discussion regarding limitations on the ability
of the Bank to pay dividends to the Company.
The Company is also a bank holding company within the meaning of Section
3700 of the California Financial Code. As such, the Company and its subsidiaries
are subject to periodic examination by, and may be required to file reports
with, the California Department of Financial Institutions.
The Company's securities are registered with the Securities and Exchange
Commission (the "SEC") under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"). As such, the Company is subject to information reporting,
proxy solicitation, insider trading restrictions, and other requirements and
restrictions as specified in the Exchange Act.
The Company's common stock is listed on the Nasdaq National Market under the
symbol "SIVB", and, as such, the Company is subject to the reporting and other
requirements of the Nasdaq Stock Market.
THE BANK
The Bank, as a California-chartered bank and a member of the Federal Reserve
System, is subject to primary supervision, periodic examination and regulation
by the Commissioner of the California Department of Financial Institutions (the
"Commissioner") and the Federal Reserve Board. If, as a result of an examination
of the Bank, the Federal Reserve Board should determine that the financial
condition, capital resources, asset quality, management, earnings prospects,
liquidity, sensitivity to market risk, or other aspects of the Bank's operations
are unsatisfactory, or that the Bank is violating or has violated any law or
regulation, various remedies are available to the Federal Reserve Board. Such
remedies include the power to: enjoin "unsafe or
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unsound" practices, require affirmative action to correct any conditions
resulting from any violation or practice, issue an administrative order that can
be judicially enforced, direct an increase in capital, restrict the growth of
the Bank, assess civil monetary penalties, remove officers and directors, and
ultimately to terminate the Bank's deposit insurance, which, as a
California-chartered bank, would result in a revocation of the Bank's charter.
The Commissioner has many of the same remedial powers.
The deposits of the Bank are insured by the FDIC in the manner and to the
extent provided by law. For this protection, the Bank pays a quarterly statutory
assessment. For additional discussion related to deposit insurance, see "Item 1.
Business--Supervision and Regulation--Premiums for Deposit Insurance." Because
the Bank's deposits are insured by the FDIC, the Bank is also subject to certain
FDIC rules and regulations.
Various requirements and restrictions imposed by state and federal laws and
regulations affect the operations of the Bank. State and federal statutes and
regulations relate to many aspects of the Bank's operations, including, but not
limited to, reserves against deposits, interest rates on deposits and loans,
investments, mergers and acquisitions, borrowings, dividends, and locations of
branch offices. Further, the Bank is required to maintain certain minimum levels
of capital. See "Item 1. Business--Supervision and Regulation--Capital
Standards" for further discussion related to minimum capital guidelines.
DIVIDENDS AND OTHER TRANSFERS OF FUNDS
The Company is a legal entity separate and distinct from the Bank. The Bank
is subject to various statutory and regulatory restrictions on its ability to
pay dividends to the Company. Under such restrictions, the amount available for
payment of dividends to the Company by the Bank totaled $68.3 million at
December 31, 1998. In addition, the Commissioner and the Federal Reserve Board
have the authority to prohibit the Bank from paying dividends, depending upon
the Bank's financial condition, if such payment is deemed to constitute an
unsafe or unsound practice. See "Item 8. Financial Statements and Supplementary
Data--Note 17 to the Consolidated Financial Statements--Regulatory Matters" for
further discussion on dividend restrictions.
The Federal Reserve Board also has the authority to prohibit the Bank from
engaging in activities that, in the Federal Reserve Board's opinion, constitute
unsafe or unsound practices in conducting its business. It is possible,
depending upon the financial condition of the bank in question and other
factors, that the Federal Reserve Board could assert that the payment of
dividends or other payments might, under some circumstances, be an unsafe or
unsound practice. Further, the Federal Reserve Board has established guidelines
with respect to the maintenance of appropriate levels of capital by banks or
bank holding companies under its jurisdiction. Compliance with the standards set
forth in such guidelines and the restrictions that are, or may be, imposed under
the prompt corrective action provisions of federal law could limit the amount of
dividends which the Bank or the Company may pay. The Commissioner may impose
similar limitations on the conduct of California-chartered banks. See "Item 1.
Business--Supervision and Regulation--Capital Standards" and "Item 1.
Business--Supervision and Regulation--Prompt Corrective Action and Other
Enforcement Mechanisms," for a discussion of these additional restrictions on
capital distributions.
The Bank is subject to certain restrictions imposed by federal law on any
extensions of credit to, or the issuance of a guarantee or letter of credit on
behalf of, the Company or other affiliates, the purchase of, or investments in,
stock or other securities thereof, the taking of such securities as collateral
for loans, and the purchase of assets of the Company or other affiliates. Such
restrictions prevent the Company and such other affiliates from borrowing from
the Bank unless the loans are secured by marketable obligations of designated
amounts. Further, such secured loans and investments by the Bank to, or in, the
Company or to, or in, any other affiliate are limited, individually, to 10.0% of
the Bank's capital and surplus (as defined by federal regulations), and such
secured loans and investments are limited, in the aggregate, to 20.0% of the
Bank's capital and surplus (as defined by federal regulations). California law
also imposes certain restrictions with respect to transactions involving the
Company and other controlling persons of the Bank. Additional restrictions on
transactions with affiliates may be imposed on the Bank under the prompt
corrective action provisions of federal law. See "Item 1. Business--Supervision
and Regulation--Prompt Corrective Action and Other Enforcement Mechanisms" for
related discussion regarding restrictions on transactions with affiliates.
8
CAPITAL STANDARDS
The Federal Reserve Board has adopted minimum risk-based capital guidelines
intended to provide a measure of capital that reflects the degree of risk
associated with a banking organization's operations for both transactions
reported on the balance sheet as assets, and transactions, such as commitments,
letters of credit and recourse arrangements, which are recorded as off-balance
sheet items. Under these guidelines, dollar amounts of assets and credit
equivalent amounts of off-balance sheet items are adjusted by one of several
conversion factors and/or risk adjustment percentages.
The federal banking agencies require a minimum ratio of qualifying total
capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to
risk-adjusted assets of 4%. In addition to the risk-based guidelines, federal
banking regulators require banking organizations to maintain a minimum amount of
Tier 1 capital to total quarterly average assets, referred to as the Tier 1
leverage ratio. For a banking organization rated in the highest of the five
categories used by regulators to rate banking organizations, the minimum Tier 1
leverage ratio must be 3%. In addition to these uniform risk-based capital
guidelines and leverage ratio requirements that apply across the industry, the
regulators have the discretion to set individual minimum capital requirements
for specific institutions at rates significantly above the minimum guidelines
and ratios.
The federal banking agencies have adopted a joint agency policy statement
which provides that the adequacy and effectiveness of a bank's interest rate
risk management process and the level of its interest rate exposures are
critical factors in the evaluation of the bank's capital adequacy. A bank with
material weaknesses in its interest rate risk management process or high levels
of interest rate exposure relative to its capital will be directed by the
federal banking agencies to take corrective actions. Such actions may include
recommendations or directions to raise additional capital, strengthen management
expertise, improve management information and measurement systems, reduce levels
of interest rate exposure, or some combination thereof depending upon the
individual financial institution's circumstances.
Financial institutions which have significant amounts of their assets
concentrated in high risk loans or nontraditional banking activities, and who
fail to adequately manage these risks, may be required to set aside capital in
excess of the regulatory minimums. The federal banking agencies have not imposed
any quantitative assessment for determining when these risks are significant,
but have identified these issues as important factors they will review in
assessing capital adequacy.
Future changes in regulations or practices could further reduce the amount
of capital recognized for purposes of capital adequacy. Such changes could
affect the ability of the Company and the Bank to grow and could restrict the
amount of profits, if any, available for the payment of dividends. See "Item 8.
Financial Statements and Supplementary Data--Note 17 to the Consolidated
Financial Statements--Regulatory Matters" for the Company's and Bank's capital
ratios as of December 31, 1998.
PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS
Federal banking agencies possess broad powers to take corrective and other
supervisory action as deemed appropriate on an insured depository institution
and its holding company. Federal laws require each federal banking agency to
take prompt corrective action to resolve the problems of insured depository
institutions, including, but not limited to, those institutions which fall below
one or more of the prescribed minimum required capital ratios. Such laws require
each federal banking agency to promulgate regulations defining the following
five categories in which an insured depository institution will be placed, based
on the level of its capital ratios: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized, and critically
undercapitalized.
The Company's and the Bank's capital ratios were in excess of regulatory
guidelines for a well capitalized depository institution as of December 31,
1998. See "Item 8. Financial Statements and Supplementary Data-- Note 17 to the
Consolidated Financial Statements--Regulatory Matters" for the Company's and
Bank's capital ratios as of December 31, 1998.
A depository institution that, based upon its capital levels, is classified
as well capitalized, adequately capitalized or undercapitalized may be treated
as though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition, or an unsafe or unsound practice, warrants such
treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions. The federal banking agencies,
9
however, may not treat an institution as critically undercapitalized unless its
capital ratios actually warrant such treatment.
In addition to measures taken under the prompt corrective action provisions,
banking organizations may be subject to potential enforcement actions by the
federal regulators for unsafe or unsound practices in conducting their
businesses, or for violation of any law, rule, regulation, condition imposed in
writing by the agency, or term of a written agreement with the agency.
Enforcement actions may include the appointment of a conservator or receiver,
the issuance of a cease and desist order that can be judicially enforced, the
termination of deposit insurance (in the case of a depository institution), the
imposition of civil monetary penalties, the issuance of directives to increase
capital, the issuance of formal and informal agreements, the issuance of removal
and prohibition orders against institution-affiliated parties, and the
enforcement of such actions through injunctions or restraining orders based upon
a judicial determination that the agency would be harmed if such equitable
relief was not granted.
SAFETY AND SOUNDNESS STANDARDS
The federal banking agencies have adopted guidelines to assist in
identifying and addressing potential safety and soundness concerns before
capital becomes impaired. The guidelines set forth operational and managerial
standards relating to: (i) internal controls, information systems and internal
audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) asset
growth, and (v) compensation, fees and benefits. In addition, the federal
banking agencies have more recently adopted safety and soundness guidelines with
respect to asset quality and earnings. The federal banking agencies have also
adopted asset quality guidelines which provide six standards for establishing
and maintaining a system to identify problem assets and prevent those assets
from deteriorating. Under these standards, an insured depository institution
should: (i) conduct periodic asset quality reviews to identify problem assets,
(ii) estimate the inherent losses in problem assets and establish reserves that
are sufficient to absorb estimated losses, (iii) compare problem asset totals to
capital, (iv) take appropriate corrective action to resolve problem assets, (v)
consider the size and potential risks of material asset concentrations, and (vi)
provide periodic asset quality reports with adequate information for management
and the board of directors to assess the level of asset risk. Finally, the
federal banking agencies have adopted earnings guidelines which set forth
standards for evaluating and monitoring earnings and for ensuring that earnings
are sufficient for the maintenance of adequate capital and reserves.
PREMIUMS FOR DEPOSIT INSURANCE
The Bank's deposit accounts are insured by the BIF, as administered by the
FDIC, up to the maximum permitted by law. Insurance of deposits may be
terminated by the FDIC upon a finding that the financial institution has engaged
in unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, rule, order, or
condition imposed by the FDIC or by the financial institution's primary
regulator.
The FDIC charges an annual assessment for the insurance of deposits, which
as of December 31, 1998, ranged from 0 to 27 basis points per $100 of insured
deposits, based on the risk a particular financial institution poses to its
deposit insurance fund. The risk classification is based on a financial
institution's capital group and supervisory subgroup assignment. At December 31,
1998, the Bank's assessment rate was the statutory minimum assessment of $2,000
per year.
In addition to its normal deposit insurance premium as a member of the BIF,
the Bank pays an amount equal to approximately 1.3 basis points per $100 of
insured deposits toward the retirement of Financing Corporation bonds ("Fico
Bonds") issued in the 1980s to assist in the recovery of the savings and loan
industry. Members of the Savings Association Insurance Fund (the "SAIF"), by
contrast, pay, in addition to their normal deposit insurance premium as members
of the SAIF, approximately 6.4 basis points per $100 of insured deposits toward
the retirement of the Fico Bonds. Under the Economic Growth and Paperwork
Reduction Act (the "Paperwork Reduction Act"), the FDIC is not permitted to
establish SAIF assessment rates that are lower than comparable BIF assessment
rates. Beginning no later than January 1, 2000, the assessment rate paid toward
the retirement of the Fico Bonds will be equal for members of the BIF and the
SAIF. Should the insurance funds be merged before January 1, 2000, the
assessment rate paid by all members of this new fund toward the retirement of
the Fico Bonds would be equal upon the time of merger.
10
INTERSTATE BANKING AND BRANCHING
The BHCA currently permits bank holding companies from any state to acquire
banks and bank holding companies located in any other state, subject to certain
conditions, including certain nationwide and state-imposed concentration limits.
Banks have the ability, subject to certain restrictions, to acquire by
acquisition or merger branches located outside their home state. The
establishment of new interstate branches is also possible in those states with
laws that expressly permit it. Interstate branches are subject to certain laws
of the states in which they are located. Competition may increase further as
banks branch across state lines and enter new markets.
COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS
The Bank is subject to certain fair lending laws and reporting obligations
involving home mortgage lending operations and Community Reinvestment Act
("CRA") activities. The CRA generally requires the federal banking agencies to
evaluate the record of a bank in meeting the credit needs of its local
communities, including low- and moderate-income neighborhoods. A bank may be
subject to substantial penalties and corrective measures for a violation of
certain fair lending laws. The federal banking agencies may take compliance with
such laws and CRA obligations into account when regulating and supervising other
activities.
A bank's compliance with its CRA obligations is measured via a
performance-based evaluation system, which bases CRA ratings on a financial
institution's actual lending service and investment performance. When a bank
holding company applies for approval to acquire a bank or other bank holding
company, the Federal Reserve Board will review the CRA assessment of each
subsidiary bank of the applicant bank holding company, and such records may be
the basis for denying the application. In June 1997, the Federal Reserve Board
rated the Bank "satisfactory" in complying with its CRA obligations.
YEAR 2000 READINESS DISCLOSURE
The Federal Financial Institutions Examination Council (FFIEC), an oversight
authority for financial institutions, has issued several interagency statements
on Year 2000 project awareness. These statements require financial institutions
to, among other things, examine the Year 2000 implications of their reliance on
vendors, determine the potential impact of the Year 2000 issue on their
customers, suppliers and borrowers, and to survey its exposure, measure its risk
and prepare a plan to address the Year 2000 issue. In addition, federal banking
regulators have issued safety and soundness guidelines to be followed by
financial institutions to assure resolution of any Year 2000 problems. The
federal banking agencies have asserted that Year 2000 testing and certification
is a key safety and soundness issue in conjunction with regulatory examinations,
and the failure to appropriately address the Year 2000 issue could result in
supervisory action, including the reduction of the institution's supervisory
ratings, the denial of applications for mergers or acquisitions, or the
imposition of civil monetary penalties.
The Company, following an initial awareness phase, is utilizing a
three-phase plan for achieving Year 2000 readiness. The Assessment Phase was
intended to determine which computers, operating systems and applications
require remediation and prioritizing those remediation efforts by identifying
mission critical systems. The Assessment Phase has been completed except for the
on-going assessment of new systems. The Remediation and Testing Phase addressed
the correction or replacement of any non-compliant hardware and software related
to the mission critical systems and testing of those systems. Since most of the
Bank's information technology systems are off-the-shelf software, remediation
efforts have focused on obtaining Year 2000 compliant application upgrades. The
Bank's core banking system, which runs loans, deposits and the general ledger,
has been upgraded to the Year 2000 compliant version and has been forward date
tested and Year 2000 certified by the Bank. The Year 2000 releases for all of
the Bank's other internal mission critical systems have also been received,
forward date tested and certified. The next step of this phase, testing mission
critical service providers, is anticipated to be substantially completed by
March 31, 1999. During the final phase, the Implementation Phase, remediated and
validated code will be tested in interfaces with customers, business partners,
government institutions, and others. It is anticipated that the Implementation
Phase will be substantially completed by June 30, 1999.
The Company may be impacted by the Year 2000 compliance issues of
governmental agencies, businesses and other entities who provide data to, or
receive data from, the Company, and by entities, such as borrowers, vendors,
customers, and business partners, whose financial condition or operational
capability is significant to
11
the Company. Therefore, the Company's Year 2000 project also includes assessing
the Year 2000 readiness of certain customers, borrowers, vendors, business
partners, counterparties, and governmental entities. In addition to assessing
the readiness of these external parties, the Company is developing contingency
plans which will include plans to recover operations and alternatives to
mitigate the effects of counterparties whose own failure to properly address
Year 2000 issues may adversely impact the Company's ability to perform certain
functions. These contingency plans are currently being developed and are
expected to be substantially completed by June 30, 1999.
If Year 2000 issues are not adequately addressed by the Company and
significant third parties, the Company's business, results of operations and
financial position could be materially adversely affected. Failure of certain
vendors to be Year 2000 compliant could result in disruption of important
services upon which the Company depends, including, but not limited to, such
services as telecommunications, electrical power and data processing. Failure of
the Company's loan customers to properly prepare for the Year 2000 could also
result in increases in problem loans and credit losses in future years. It is
not, however, possible to quantify the potential impact of any such losses at
this time. Notwithstanding the Company's efforts, there can be no assurance that
the Company or significant third party vendors or other significant third
parties will adequately address their Year 2000 issues. The Company is
continuing to assess the Year 2000 readiness of third parties but does not know
at this time whether the failure of third parties to be Year 2000 compliant will
have a material effect on the Company's results of operations, liquidity and
financial condition.
The Company currently estimates that its total cost for the Year 2000
project will approximate $3.0 million. During 1998, the Company incurred $1.5
million in charges related to its Year 2000 remediation effort and expects to
incur $1.5 million in 1999. Charges include the cost of external consulting and
the cost of accelerated replacement of hardware, but do not include the cost of
internal staff redeployed to the Year 2000 project. The Company does not believe
that the redeployment of internal staff will have a material impact on its
financial condition or results of operations.
The foregoing paragraphs contain a number of forward-looking statements.
These statements reflect Management's best current estimates, which were based
on numerous assumptions about future events, including the continued
availability of certain resources, representations received from third party
service providers and other factors. There can be no guarantee that these
estimates, including Year 2000 costs, will be achieved, and actual results could
differ materially from those estimates. A number of important factors could
cause Management's estimates and the impact of the Year 2000 issue to differ
materially from what is described in the forward-looking statements contained in
the above paragraphs. Those factors include, but are not limited to, the
availability and cost of programmers and other systems personnel, inaccurate or
incomplete execution of the phases, results of Year 2000 testing, adequate
resolution of Year 2000 issues by the Company's customers, vendors, competitors,
and counterparties, and similar uncertainties.
The forward-looking statements made in the foregoing Year 2000 discussion
speak only as of the date on which such statements are made, and the Company
undertakes no obligation to update 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for all entities for
reporting comprehensive income and its components in financial statements. This
statement requires that all items which are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income is equal to net income plus the
change in "other comprehensive income," as defined by SFAS No. 130. The only
component of other comprehensive income currently applicable to the Company is
the net unrealized gain or loss on available-for-sale investments. SFAS No. 130
requires that an entity: (a) classify items of other comprehensive income by
their nature in a financial statement, and (b) report the accumulated balance of
other comprehensive income separately from common stock and retained earnings in
the equity section of the balance sheet. This statement is effective for
financial statements issued for fiscal years beginning after December 15, 1997
and was adopted by the Company as of January 1, 1998. See "Item 8. Financial
Statements and Supplementary Data--Note 11 to the Consolidated Financial
Statements--Comprehensive Income."
12
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This statement establishes standards for
publicly held entities to follow in reporting information about operating
segments in annual financial statements and requires that those entities also
report selected information about operating segments in interim financial
statements. This statement also establishes standards for related disclosures
about products and services, geographic areas and major customers. This
statement is effective for financial statements issued for periods beginning
after December 15, 1997 and was adopted by the Company as of December 31, 1998.
See "Item 8. Financial Statements and Supplementary Data--Note 1 to the
Consolidated Financial Statements--Significant Accounting Policies."
SFAS No. 132, "Statement on Employers' Disclosures about Pensions and Other
Post-Retirement Benefits" was issued by the FASB in February 1998. This
statement is effective for financial statements issued for fiscal years
beginning after December 15, 1997. The Company does not have a pension plan or
provide for other post-retirement benefits for employees, and thus this
statement does not have a material impact on the Company's consolidated
financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement requires that an entity
recognize all derivatives as either assets or liabilities in the balance sheet
and measure those instruments at fair value. The statement is effective for
fiscal quarters of fiscal years beginning after June 15, 1999. The Company
expects to adopt this statement on January 1, 2000. The Company has not yet
determined the impact of its adoption on the Company's consolidated financial
statements.
In October 1998, FASB issued SFAS No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise." SFAS No. 134 amends SFAS No. 65, "Accounting for
Certain Mortgage Banking Activities," which establishes accounting and reporting
standards for certain activities of mortgage banking enterprises and other
enterprises that conduct operations that are substantially similar. SFAS No. 134
requires that after the securitization of mortgage loans held for sale, the
resulting mortgage-backed securities and other retained interests should be
classified in accordance with SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities," based on the company's ability and intent to
sell or hold those investments. SFAS No. 134 is effective for the first fiscal
quarter beginning after December 15, 1998. The Company does not expect the
adoption of this statement to have a material impact on the Company's
consolidated financial statements.
ITEM 2. PROPERTIES
In 1995, the Bank relocated its corporate headquarters and main branch and
entered into a 10-year lease on a two-story office building located at 3003
Tasman Drive, Santa Clara, California. In July 1997, the Bank finalized an
amendment to the original lease associated with its corporate headquarters. The
amendment provides for the lease of additional premises, approximating 56,000
square feet, adjacent to the existing headquarters facility. The Company began
occupying the additional premises in August 1998.
In addition to the headquarters lease in Santa Clara, the Bank has entered
into various other leases for properties that serve as branches and/or loan
offices. These properties are located in the following locations within
California: Irvine, Menlo Park, Palo Alto, San Diego, St. Helena, and West Los
Angeles. Offices located outside of California include: Phoenix, Arizona;
Boulder, Colorado; Atlanta, Georgia; Rosemont, Illinois; Rockville, Maryland;
Wellesley, Massachusetts; Beaverton, Oregon; Austin, Texas; and Bellevue,
Washington. All Bank properties are occupied under leases, which expire at
various dates through May 2005, and in most instances, include options to renew
or extend at market rates and terms. The Bank also owns leasehold improvements
and furniture, fixtures and equipment at its offices, all of which are used in
the Bank's business activities.
ITEM 3. LEGAL PROCEEDINGS
There were no legal proceedings requiring disclosure pursuant to this item
pending at December 31, 1998, or at the date of this report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote by the shareholders of the Company's
common stock during the fourth quarter of 1998.
13
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION
The Company's common stock is traded over the counter on the National
Association of Securities Dealers Automated Quotation (Nasdaq) National Market
under the symbol "SIVB."
The following table presents the high and low sales prices for the Company's
common stock for each quarterly period during the last two years, based on the
daily closing price as reported by the Nasdaq National Market. The 1997 stock
prices have been restated to reflect a two-for-one stock split distributed on
May 1, 1998.
1998 1997
-------------------- --------------------
QUARTER LOW HIGH LOW HIGH
- ------------------------------------------------------------------------- --------- --------- --------- ---------
First.................................................................... $ 25.19 $ 31.94 $ 16.13 $ 19.75
Second................................................................... $ 30.47 $ 36.00 $ 16.69 $ 23.00
Third.................................................................... $ 14.81 $ 38.50 $ 20.94 $ 29.88
Fourth................................................................... $ 12.50 $ 26.63 $ 24.57 $ 29.22
SHAREHOLDERS
The number of shareholders of record of the Company's common stock was 721
as of January 31, 1999.
DIVIDENDS
The Company declared no cash dividends in 1997 or 1998, and is subject to
certain restrictions and limitations on the payment of dividends pursuant to
existing and applicable laws and regulations. See "Item 1. Business--Supervision
and Regulation--Dividends and Other Transfers of Funds," and "Item 8. Financial
Statements and Supplementary Data--Note 17 to the Consolidated Financial
Statements--Regulatory Matters" for additional discussion on restrictions and
limitations on the payment of dividends.
14
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the
Company's financial statements and supplementary data as presented in Item 8 of
this report. Certain reclassifications have been made to the Company's prior
years results to conform with 1998 presentations. In addition, the Common Share
Summary information for the prior years has been restated to reflect a
two-for-one stock split distributed on May 1, 1998. Such reclassifications had
no effect on the results of operations or shareholders' equity.
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
(DOLLARS AND NUMBERS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
INCOME STATEMENT SUMMARY:
Net interest income....................... $ 146,615 $ 110,824 $ 87,275 $ 73,952 $ 60,260
Provision for loan losses................. 37,159 10,067 10,426 8,737 3,087
Noninterest income........................ 23,162 13,265 11,609 12,565 4,922
Noninterest expense....................... 83,645 66,301 52,682 47,925 45,599
Income before taxes....................... 48,973 47,721 35,776 29,855 16,496
Income tax expense........................ 20,117 20,043 14,310 11,702 7,430
Net income................................ 28,856 27,678 21,466 18,153 9,066
COMMON SHARE SUMMARY:
Basic earnings per share.................. $ 1.42 $ 1.43 $ 1.17 $ 1.04 $ 0.55
Diluted earnings per share................ 1.38 1.36 1.11 0.99 0.53
Book value per share...................... 10.42 8.75 7.26 5.86 4.54
Weighted average shares outstanding....... 20,268 19,370 18,426 17,494 16,670
Weighted average diluted shares
outstanding............................. 20,923 20,338 19,382 18,288 17,066
YEAR-END BALANCE SHEET SUMMARY:
Loans, net of unearned income............. $ 1,611,921 $ 1,174,645 $ 863,492 $ 738,405 $ 703,809
Assets.................................... 3,545,452 2,625,123 1,924,544 1,407,587 1,161,539
Deposits.................................. 3,269,753 2,432,407 1,774,304 1,290,060 1,075,373
Shareholders' equity...................... 215,865 174,481 135,400 104,974 77,257
AVERAGE BALANCE SHEET SUMMARY:
Loans, net of unearned income............. $ 1,318,826 $ 973,637 $ 779,655 $ 681,255 $ 592,759
Assets.................................... 2,990,548 2,140,630 1,573,903 1,165,004 956,336
Deposits.................................. 2,746,041 1,973,118 1,441,360 1,060,333 877,787
Shareholders' equity...................... 198,675 152,118 119,788 91,710 73,461
CAPITAL RATIOS:
Total risk-based capital ratio............ 11.5% 11.5% 11.5% 11.9% 10.1%
Tier 1 risk-based capital ratio........... 10.3% 10.2% 10.2% 10.6% 8.9%
Tier 1 leverage ratio..................... 7.6% 7.1% 7.7% 8.0% 8.3%
Average shareholders' equity to average
assets.................................. 6.6% 7.1% 7.6% 7.9% 7.7%
SELECTED FINANCIAL RATIOS:
Return on average assets.................. 1.0% 1.3% 1.4% 1.6% 0.9%
Return on average shareholders'
equity.................................. 14.5% 18.2% 17.9% 19.8% 12.3%
Efficiency ratio.......................... 53.8% 55.9% 55.9% 60.6% 68.3%
Net interest margin....................... 5.2% 5.6% 6.1% 7.1% 7.2%
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of financial condition and results of
operations should be read in conjunction with the Company's financial statements
and supplementary data as presented in Item 8 of this report. In addition to
historical information, this discussion and analysis includes certain
forward-looking statements regarding events and circumstances which may affect
the Company's future results. Such forward-looking statements are subject to
risks and uncertainties that could cause the Company's actual results to differ
materially. These risks and uncertainties include, but are not limited to, those
described in this discussion and analysis, as well as those described in Item 1
of this report.
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 prior years
results to conform with 1998 presentations. Such reclassifications had no effect
on the results of operations or shareholders' equity.
RESULTS OF OPERATIONS
EARNINGS SUMMARY
The Company reported net income in 1998 of $28.9 million, compared with net
income in 1997 and 1996 of $27.7 million and $21.5 million, respectively.
Diluted earnings per share totaled $1.38 in 1998, compared to $1.36 and $1.11 in
1997 and 1996, respectively. Return on average equity in 1998 was 14.5%,
compared with 18.2% in 1997 and 17.9% in 1996. Return on average assets in 1998
was 1.0%, compared with 1.3% in 1997 and 1.4% in 1996.
The slight increase in net income for 1998, as compared to 1997, was
primarily attributable to growth in both net interest income and noninterest
income, and was almost entirely offset by a significant increase in the
provision for loan losses and an increase in noninterest expense. The increase
in net income for 1997, as compared with 1996, was largely due to growth in net
interest income, partially offset by an increase in noninterest expense. The
major components of net income and changes in these components are summarized in
the following table for the years ended December 31, 1998, 1997 and 1996, and
are discussed in more detail on the following pages.
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------
1997 TO 1996
1998 TO 1997 INCREASE
1998 1997 INCREASE 1996 (DECREASE)
---------- ---------- ------------ --------- ------------
(DOLLARS IN THOUSANDS)
Net interest income............................. $ 146,615 $ 110,824 $ 35,791 $ 87,275 $ 23,549
Provision for loan losses....................... 37,159 10,067 27,092 10,426 (359)
Noninterest income.............................. 23,162 13,265 9,897 11,609 1,656
Noninterest expense............................. 83,645 66,301 17,344 52,682 13,619
---------- ---------- ------------ --------- ------------
Income before income taxes...................... 48,973 47,721 1,252 35,776 11,945
Income tax expense.............................. 20,117 20,043 74 14,310 5,733
---------- ---------- ------------ --------- ------------
Net income...................................... $ 28,856 $ 27,678 $ 1,178 $ 21,466 $ 6,212
---------- ---------- ------------ --------- ------------
---------- ---------- ------------ --------- ------------
NET INTEREST INCOME AND MARGIN
Net interest income represents the difference between interest earned,
primarily on loans and investments, and interest paid on funding sources,
primarily deposits, and is the principal source of revenue for the Company. Net
interest margin is the amount of net interest income, on a fully
taxable-equivalent basis, expressed as a percentage of average interest-earning
assets. The average yield earned on interest-earning assets is the amount of
taxable-equivalent interest income expressed as a percentage of average
interest-earning assets. The average rate paid on funding sources expresses
interest expense as a percentage of average interest-earning assets.
16
The following table sets forth average assets, liabilities and shareholders'
equity, interest income and interest expense, average yields and rates, and the
composition of the Company's net interest margin for the years ended December
31, 1998, 1997 and 1996.
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
1998 1997 1996
--------------------------------- --------------------------------- --------------------
AVERAGE AVERAGE
YIELD YIELD
AVERAGE AND AVERAGE AND AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST
--------- --------- ----------- --------- --------- ----------- --------- ---------
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Federal funds sold and
securities purchased under
agreement to resell (1)..... $ 396,488 $ 21,305 5.4% $ 312,398 $ 17,264 5.5% $ 244,408 $ 13,106
Investment securities:
Taxable..................... 1,044,918 61,515 5.9 671,390 40,360 6.0 411,743 23,587
Non-taxable (2)............. 78,234 5,034 6.4 33,801 2,320 6.9 8,112 749
Loans: (3), (4), (5)
Commercial.................. 1,157,949 122,708 10.6 858,459 95,304 11.1 658,316 75,750
Real estate construction and
term...................... 115,743 12,364 10.7 78,311 8,063 10.3 81,358 8,471
Consumer and other.......... 45,134 4,064 9.0 36,867 3,473 9.4 39,981 3,672
--------- --------- ----- --------- --------- ----- --------- ---------
Total loans................... 1,318,826 139,136 10.6 973,637 106,840 11.0 779,655 87,893
--------- --------- ----- --------- --------- ----- --------- ---------
Total interest-earning assets... 2,838,466 226,990 8.0 1,991,226 166,784 8.4 1,443,918 125,335
--------- --------- ----- --------- --------- ----- --------- ---------
Cash and due from banks......... 137,096 148,044 126,830
Allowance for loan losses....... (40,055) (37,568) (30,429)
Other real estate owned......... 681 1,192 3,582
Other assets.................... 54,360 37,736 30,002
--------- --------- ---------
Total assets.................... $2,990,548 $2,140,630 $1,573,903
--------- --------- ---------
--------- --------- ---------
Funding sources:
Interest-bearing liabilities:
NOW deposits.................. $ 18,702 348 1.9 $ 15,814 308 1.9 $ 10,256 223
Regular money market
deposits.................... 338,585 9,189 2.7 345,828 9,368 2.7 312,841 8,460
Bonus money market deposits... 1,487,240 63,155 4.3 895,259 40,885 4.6 588,235 26,312
Time deposits................. 131,530 5,917 4.5 107,742 4,587 4.3 69,975 2,801
Other borrowings.............. 66 4 6.0 5 -- 5.0 30 2
--------- --------- ----- --------- --------- ----- --------- ---------
Total interest-bearing
liabilities................... 1,976,123 78,613 4.0 1,364,648 55,148 4.0 981,337 37,798
Portion of noninterest-bearing
funding sources............... 862,343 626,578 462,581
--------- --------- ----- --------- --------- ----- --------- ---------
Total funding sources........... 2,838,466 78,613 2.8 1,991,226 55,148 2.8 1,443,918 37,798
--------- --------- ----- --------- --------- ----- --------- ---------
Noninterest-bearing funding
sources:
Demand deposits............... 769,984 608,475 460,053
Other liabilities............. 22,146 15,389 12,725
Trust preferred securities.... 23,620 -- --
Shareholders' equity.......... 198,675 152,118 119,788
Portion used to fund interest-
earning assets.............. (862,343) (626,578) (462,581)
--------- --------- ---------
Total liabilities and
shareholders'
equity........................ $2,990,548 $2,140,630 $1,573,903
--------- --------- ---------
--------- --------- ---------
Net interest income and
margin........................ $ 148,377 5.2% $ 111,636 5.6% $ 87,537
--------- ----- --------- ----- ---------
--------- ----- --------- ----- ---------
Memorandum: Total deposits...... $2,746,041 $1,973,118 $1,441,360
--------- --------- ---------
--------- --------- ---------
AVERAGE
YIELD
AND
RATE
-----------
Interest-earning assets:
Federal funds sold and
securities purchased under
agreement to resell (1)..... 5.4%
Investment securities:
Taxable..................... 5.7
Non-taxable (2)............. 9.2
Loans: (3), (4), (5)
Commercial.................. 11.5
Real estate construction and
term...................... 10.4
Consumer and other.......... 9.2
-----
Total loans................... 11.3
-----
Total interest-earning assets... 8.7
-----
Cash and due from banks.........
Allowance for loan losses.......
Other real estate owned.........
Other assets....................
Total assets....................
Funding sources:
Interest-bearing liabilities:
NOW deposits.................. 2.2
Regular money market
deposits.................... 2.7
Bonus money market deposits... 4.5
Time deposits................. 4.0
Other borrowings.............. 5.5
-----
Total interest-bearing
liabilities................... 3.9
Portion of noninterest-bearing
funding sources...............
-----
Total funding sources........... 2.6
-----
Noninterest-bearing funding
sources:
Demand deposits...............
Other liabilities.............
Trust preferred securities....
Shareholders' equity..........
Portion used to fund interest-
earning assets..............
Total liabilities and
shareholders'
equity........................
Net interest income and
margin........................ 6.1%
-----
-----
Memorandum: Total deposits......
- ------------------------------
(1) Includes average interest-bearing deposits in other financial institutions
of $240, $306 and $345 in 1998, 1997 and 1996, respectively.
(2) Interest income on non-taxable investments is presented on a fully
taxable-equivalent basis using the federal statutory rate of 35% in 1998,
1997 and 1996. These adjustments were $1,762, $812 and $262 for the years
ended December 31, 1998, 1997 and 1996, respectively.
(3) Average loans include average nonaccrual loans of $26,158, $19,681 and
$22,897 in 1998, 1997 and 1996, respectively.
(4) Average loans are net of average unearned income of $8,299, $6,922 and
$4,169 in 1998, 1997 and 1996, respectively.
(5) Loan interest income includes loan fees of $12,935, $10,567 and $8,176 in
1998, 1997 and 1996, respectively.
17
Net interest income is affected by changes in the amount and mix of
interest-earnings 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 years indicated. Changes relating to investments in non-taxable municipal
securities are presented on a fully taxable-equivalent basis using the federal
statutory rate of 35% in 1998, 1997 and 1996.
1998 COMPARED TO 1997 1997 COMPARED TO 1996
------------------------------- -------------------------------
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO CHANGE IN DUE TO CHANGE IN
------------------------------- -------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Interest income:
Federal funds sold and securities purchased
under agreement to resell.................. $ 4,518 $ (477) $ 4,041 $ 3,757 $ 401 $ 4,158
Investment securities........................ 24,765 (896) 23,869 17,269 1,075 18,344
Loans........................................ 36,418 (4,122) 32,296 21,286 (2,339) 18,947
--------- --------- --------- --------- --------- ---------
Increase (decrease) in interest income......... 65,701 (5,495) 60,206 42,312 (863) 41,449
--------- --------- --------- --------- --------- ---------
Interest expense:
NOW deposits................................. 54 (14) 40 108 (23) 85
Regular money market deposits................ (197) 18 (179) 894 14 908
Bonus money market deposits.................. 25,138 (2,868) 22,270 14,021 552 14,573
Time deposits................................ 1,070 260 1,330 1,608 178 1,786
Other borrowings............................. 4 -- 4 -- (2) (2)
--------- --------- --------- --------- --------- ---------
Increase (decrease) in interest expense........ 26,069 (2,604) 23,465 16,631 719 17,350
--------- --------- --------- --------- --------- ---------
Increase (decrease) in net interest income..... $ 39,632 $ (2,891) $ 36,741 $ 25,681 $ (1,582) $ 24,099
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Net interest income, on a fully taxable-equivalent basis, totaled $148.4
million in 1998, an increase of $36.8 million, or 32.9%, from the $111.6 million
total in 1997. The increase in net interest income was attributable to a $60.2
million, or 36.1%, increase in interest income, offset by a $23.5 million, or
42.5%, increase in interest expense over the comparable prior year period. Net
interest income in 1997, on a fully taxable-equivalent basis, increased $24.1
million, or 27.5%, compared to the $87.5 million total in 1996. This increase in
net interest income was the result of a $41.4 million, or 33.1%, increase in
interest income, offset by a $17.4 million, or 45.9%, increase in interest
expense over the comparable prior year period.
The $60.2 million increase in interest income for 1998, as compared to 1997,
was the result of a $65.7 million favorable volume variance, slightly offset by
a $5.5 million unfavorable rate variance. The $65.7 million favorable volume
variance resulted from a $847.2 million, or 42.5%, 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 average
deposits, which increased $772.9 million, or 39.2%, from 1997 to 1998. The
increase in average interest-earning assets consisted of loans, which increased
$345.2 million, plus a combination of highly liquid, lower-yielding federal
funds sold, securities purchased under agreement to resell and investment
securities, which collectively increased $502.0 million, accounting for 59.3% of
the total increase in average interest-earning assets.
Average loans increased $345.2 million, or 35.5%, in 1998 as compared to
1997, resulting in a $36.4 million favorable volume variance. This growth was
widely distributed throughout the loan portfolio, as reflected by increased loan
balances in all 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.
In December 1998, the Company announced that the Bank had discontinued new
loan originations associated with its Religious Financial Resources (RFR)
Division. Started in 1995, the Bank had approximately $175.0 million in
outstanding loans to religious organizations, predominantly for construction of
buildings for
18
worship and education, as of December 31, 1998. Competitive changes within the
religious organizations market affected the Bank's ability to generate its
anticipated loan yield and provide returns that exceed the Company's required
return on capital. The credit quality of the RFR portfolio was not a factor in
the Company's decision to discontinue new RFR loan origination. Since inception,
the Company has not incurred any losses associated with the RFR portfolio. The
discontinuation of new RFR loan origination could have an effect on the future
loan growth of the Company.
Average investment securities for 1998 increased $418.0 million, or 59.3%,
as compared to 1997, resulting in a $24.8 million favorable volume variance. The
aforementioned strong growth in average deposits exceeded the growth in average
loans during 1998, and generated excess funds that were largely invested in U.S.
agency securities, collateralized mortgage obligations and municipal securities.
The growth in the investment portfolio reflected Management's actions to
increase, as well as to further diversify the Company's portfolio of short-term
investments in response to a significant increase in liquidity.
Average federal funds sold and securities purchased under agreement to
resell in 1998 increased a combined $84.1 million, or 26.9%, over the prior
year, resulting in a $4.5 million favorable volume variance. This increase was
largely due to the aforementioned strong growth in average deposits during 1998
coupled with Management's actions to further diversify the Company's portfolio
of short-term investments.
For additional discussion of the Company's liquidity and investment
management activities, see the Item 7 sections entitled "Interest Rate Risk
Management" and "Liquidity."
Unfavorable rate variances associated with each component of
interest-earning assets in 1998 resulted in a decrease in interest income of
$5.5 million as compared to the prior year. Short-term market interest rates
declined during the second half of 1998. As a result of this decline, the
Company earned lower yields in 1998 on federal funds sold, securities purchased
under agreement to resell and its investment securities, a significant portion
of which were short-term in nature, resulting in a $1.4 million unfavorable rate
variance as compared to the prior year. The average yield on loans in 1998
decreased 40 basis points from 1997, accounting for the remaining $4.1 million
of the total unfavorable rate variance. This decrease was primarily attributable
to both increased competition and a decline in the average prime rate charged by
the Company during the second half of 1998, as a substantial portion of the
Company's loans are prime rate-based.
The yield on average interest-earning assets decreased 40 basis points in
1998 from the comparable prior year period. This decrease resulted from a
decline in the average yield on loans, largely due to both increased competition
and a decline in the Company's prime rate, as well as a continuing shift in the
composition of interest-earning assets towards a higher percentage of highly
liquid, lower-yielding federal funds sold, securities purchased under agreement
to resell and investment securities. This shift in the composition of average
interest-earning assets resulted from the aforementioned strong growth in
deposits continuing to outpace the growth in the Company's average loans during
1998.
The $41.4 million increase in interest income for 1997, as compared to 1996,
was due to a $42.3 million favorable volume variance, slightly offset by a $0.9
million unfavorable rate variance. The $42.3 million favorable volume variance
was attributable to growth in average interest-earning assets, which increased
$547.3 million, or 37.9%, from the prior year comparable period. The increase in
average interest-earning assets consisted of increases in each component of the
Company's interest-earning assets, and resulted from significant growth in
average deposits, which were up $531.8 million, or 36.9%, from the comparable
1996 period.
Average loans increased $194.0 million, or 24.9%, in 1997 as compared to
1996. This year-over-year increase was widely distributed throughout the
Company's niches and products, as well as the Company's loan offices located
across the nation.
The increase in average investment securities during 1997, as compared to
1996, of $285.3 million, or 68.0%, was largely invested in U.S. agency
securities, U.S. Treasury securities, mortgage-backed securities, and municipal
securities. This increase resulted from the aforementioned strong deposit growth
in 1997 that exceeded the growth in loans and was the result of Management's
decision to both increase the Company's portfolio of longer-term securities in
an effort to obtain available higher yields, and to increase as well as to
further diversify the Company's portfolio of short-term investments in response
to a significant increase in
19
liquidity. Average federal funds sold and securities purchased under agreement
to resell increased $68.0 million, or 27.8%, in 1997, and was also a result of
the aforementioned strong growth in deposits coupled with Management's actions
to further diversify the Company's portfolio of short-term investments.
In 1997, a $2.3 million unfavorable rate variance associated with loans was
partially offset by a combined $1.4 million favorable rate variance related to
federal funds sold, securities purchased under agreement to resell and
investment securities, resulting in a decrease in interest income of $0.9
million as compared to 1996. The unfavorable rate variance related to loans
resulted from a 30 basis points decline in the average yield on loans from 1996
to 1997, and was largely due to increased competition. The average yields on
federal funds sold, securities purchased under agreement to resell and
investment securities increased in 1997 from the prior year, and resulted from
both an increase in short-term market interest rates and Management's actions to
increase the Company's portfolio of longer-term securities in an effort to
obtain available higher yields.
The total yield on average interest-earning assets declined 30 basis points
in 1997 from the comparable prior year period. This decrease resulted from a
decline in the average yield on loans, largely due to increased competition, and
a shift in the composition of average interest-earning assets towards a higher
percentage of highly liquid, lower-yielding federal funds sold, securities
purchased under agreements to resell and investment securities. This shift in
the composition of average interest-earning assets resulted from the
aforementioned strong growth in average deposits outpacing growth in the
Company's average loans during 1997.
Interest expense in 1998 increased $23.5 million from 1997. This increase
was due to an unfavorable volume variance of $26.1 million, partially offset by
a favorable rate variance of $2.6 million. The unfavorable volume variance
resulted from a $611.5 million, or 44.8%, increase in average interest-bearing
liabilities in 1998 as compared to 1997. This increase was largely concentrated
in the Company's bonus money market deposit product, which increased $592.0
million, or 66.1%, and was explained by high levels of client liquidity
attributable to a strong inflow of investment capital into the venture capital
community during 1998, and by growth in the number of clients served by the
Company.
Changes in the average rates paid on interest-bearing liabilities had a $2.6
million favorable impact on interest expense in 1998 as compared to 1997. This
decrease in interest expense largely resulted from a reduction in the average
rate paid on the Company's bonus money market deposit product from 4.6% in 1997
to 4.3% in 1998. The reduction during 1998 in the average rate paid on the
Company's bonus money market deposit product was largely attributable to a
decline in short-term market interest rates during the second half of 1998.
The average cost of funds paid in 1998 of 2.8% was flat with the prior year.
Although the average rate paid on the Company's bonus money market deposit
product decreased during 1998 as compared to 1997, this was offset by a
continuing shift in the composition of average interest-bearing liabilities
towards a higher percentage of deposits in that product.
The increase in interest expense for 1997 of $17.3 million, as compared to
1996, was due to an unfavorable volume variance of $16.6 million and an
unfavorable rate variance of $0.7 million. The unfavorable volume variance
resulted from a $383.3 million, or 39.1%, increase in average interest-bearing
liabilities in 1997 as compared to 1996. This increase was primarily related to
the Company's bonus money market deposit product, which increased $307.0 million
from the prior year due to the high level of client liquidity attributable to
the strong inflow of investment capital into the venture capital community and
into the public equity markets, and due to growth during 1997 in the number of
clients served by the Company. The year-over-year $0.7 million unfavorable rate
variance was largely attributable to an increase during 1997 in the average rate
paid on the Company's bonus money market deposit product which resulted from an
increase in short-term market interest rates, as well as a shift in the
composition of interest-bearing liabilities towards a higher percentage of
deposits in the bonus money market deposit product.
In 1997, the average cost of funds paid increased to 2.8%, up from 2.6% in
1996. This increase was attributable to both an increase in the average rate
paid on the Company's bonus money market deposit product in response to an
increase in short-term market interest rates, as well as to a shift in the
composition of interest-bearing liabilities towards a higher percentage of
deposits in the bonus money market deposit product.
20
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 $37.2 million in 1998, a
significant increase compared to $10.1 million and $10.4 million in 1997 and
1996, respectively. The large increase in the Company's provision for loan
losses in 1998 was in response to the Company incurring $28.9 million in net
charge-offs in 1998, versus $5.1 million and $7.4 million in 1997 and 1996,
respectively. For a more detailed discussion of credit quality and the allowance
for loan losses, see the Item 7 section entitled "Financial Condition--Credit
Quality and the Allowance for Loan Losses."
NONINTEREST INCOME
The following table summarizes the components of noninterest income for the
past three years:
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
(DOLLARS IN THOUSANDS)
Letter of credit and foreign exchange income................................... $ 7,397 $ 4,512 $ 3,423
Disposition of client warrants................................................. 6,657 5,480 5,389
Investment gains............................................................... 5,240 90 1
Deposit service charges........................................................ 1,730 1,772 1,663
Other.......................................................................... 2,138 1,411 1,133
--------- --------- ---------
Total noninterest income....................................................... $ 23,162 $ 13,265 $ 11,609
--------- --------- ---------
--------- --------- ---------
Noninterest income increased $9.9 million, or 74.6%, in 1998 as compared to
1997. This increase was largely due to a $5.2 million increase in investment
gains, coupled with a $2.9 million increase in letter of credit fees, foreign
exchange fees and other trade finance income and a $1.2 million increase in
income from the disposition of client warrants. Noninterest income increased
$1.7 million, or 14.3%, in 1997 as compared to 1996. This increase was largely
due to a $1.1 million increase in letter of credit fees, foreign exchange fees
and other trade finance income.
Letter of credit fees, foreign exchange fees and other trade finance income
totaled $7.4 million in 1998, an increase of $2.9 million, or 63.9%, from the
$4.5 million total in 1997, and an increase of $4.0 million, or 116.1%, from the
$3.4 million total in 1996. 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.
Income from the disposition of client warrants totaled $6.7 million, $5.5
million and $5.4 million in 1998, 1997 and 1996, respectively. 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 depends 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. Therefore income from
the disposition of client warrants cannot be predicted with any degree of
accuracy and is likely to vary materially from period to period. During the
years ended December 31, 1998, 1997 and 1996, a significant portion of the
income from the disposition of client warrants was offset by expenses related to
the Company's efforts to build an infrastructure sufficient to support present
and prospective business activities, and was also offset by increases to the
provision for loan losses during those years. As opportunities present
themselves in future periods, the Company may continue to reinvest some or all
of the income realized from the disposition of client warrants in furthering its
business strategies.
21
The Company realized $5.2 million in gains on sales of investment securities
during 1998, compared to $0.1 million in gains on sales of investment securities
during 1997, and a nominal gain on sales of investment securities during 1996.
The book value of securities sold during 1998 totaled $433.3 million and
primarily consisted of U.S. Treasury securities, U.S. agency securities,
mortgage-backed securities, and collateralized mortgage obligations. 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.
Income related to deposit service charges totaled $1.7 million, $1.8 million
and $1.7 million in 1998, 1997 and 1996, respectively. Clients compensate the
Company for depository services either through earnings credits computed on
their demand deposit balances, or via explicit payments recognized by the
Company as deposit service charges income.
Other noninterest income is largely composed of service-based fee income,
and totaled $2.1 million in 1998, compared to $1.4 million in 1997 and $1.1
million in 1996, respectively. The increase in 1998, as compared to 1997 and
1996, 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 1998 totaled $83.6 million, a $17.3 million, or
26.2%, increase from 1997. Total noninterest expense was $66.3 million in 1997,
up $13.6 million, or 25.9%, from 1996. Management closely monitors the Company's
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 was 53.8% for 1998, down from 55.9% for both 1997 and 1996. The
following table presents the detail of noninterest expense and the incremental
contribution of each expense line item to the Company's efficiency ratio:
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
PERCENT OF PERCENT OF PERCENT OF
ADJUSTED ADJUSTED ADJUSTED
AMOUNT REVENUES AMOUNT REVENUES AMOUNT REVENUES
--------- ----------- --------- ----------- --------- -----------
(DOLLARS IN THOUSANDS)
Compensation and benefits................ $ 44,232 28.0% $ 40,084 33.8% $ 31,417 33.6%
Professional services.................... 9,876 6.3 6,710 5.7 4,987 5.3
Furniture and equipment.................. 6,667 4.2 3,620 3.1 3,239 3.5
Business development and travel.......... 6,025 3.8 4,514 3.8 2,918 3.1
Net occupancy expense.................... 5,195 3.3 3,410 2.9 3,095 3.3
Postage and supplies..................... 2,225 1.4 1,600 1.3 1,448 1.5
Advertising and promotion................ 2,215 1.4 1,448 1.2 1,183 1.3
Telephone................................ 2,157 1.4 1,444 1.2 1,277 1.4
Trust preferred securities
distributions.......................... 2,012 1.3 -- -- -- --
Other.................................... 4,255 2.7 3,395 2.9 2,720 2.9
--------- ----------- --------- ----------- --------- -----------
Total, excluding cost of other real
estate owned........................... 84,859 53.8% 66,225 55.9% 52,284 55.9%
----------- ----------- -----------
----------- ----------- -----------
Cost of other real estate owned.......... (1,214) 76 398
--------- --------- ---------
Total noninterest expense................ $ 83,645 $ 66,301 $ 52,682
--------- --------- ---------
--------- --------- ---------
Compensation and benefits expenses totaled $44.2 million in 1998, a $4.1
million, or 10.4%, increase over the $40.1 million incurred in 1997. This
increase was largely the result of an increase in the number of average
full-time equivalent (FTE) personnel employed by the Company, from 417 in 1997
to 521 in 1998, partially offset by a decrease in variable-based compensation
expenses associated with the Company's incentive bonus pool and employee stock
ownership plan due to lower than expected net income. Compensation and benefits
22
expenses in 1997 increased $8.7 million, or 27.6%, from the $31.4 million total
in 1996. The increase in compensation and benefits expenses in 1997 was
primarily the result of an increase in the number of average FTE employed by the
Company. Average FTE were 417 in 1997 compared with 363 in 1996. The increase in
FTE from 1996 through 1998 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 $9.9 million
in 1998, a $3.2 million, or 47.2%, increase from the $6.7 million total in 1997.
The Company incurred $5.0 million in professional services expenses in 1996. The
increase in professional services expenses in 1998, as compared to 1997 and
1996, primarily related to an increase in both consulting fees associated with
several business initiatives, including the Year 2000 remediation project, and
legal fees primarily related to loan consultations and the workout of various
commercial credits. The level of professional services expenses during the past
three years further reflects the extensive efforts undertaken by the Company to
continue to build and support its infrastructure, as well as evaluate and pursue
new business opportunities. It also reflects the Company's efforts in
outsourcing several corporate functions, such as internal audit, facilities
management and credit review, where the Company believes it can achieve a
combination of cost savings and increased quality of service.
Occupancy, furniture and equipment expenses totaled $11.9 million in 1998,
$7.0 million in 1997 and $6.3 million in 1996. The increase in occupancy,
furniture and equipment expenses in 1998, as compared to 1997 and 1996, was
largely attributable to the Company incurring certain non-recurring costs in
connection with the expansion of its existing headquarters facility during the
second quarter of 1998 and an increase in recurring expenses associated with
that additional office space. Occupancy, furniture and equipment expenses were
also impacted by costs related to furniture, computer equipment and other
related costs associated with the Company opening new loan offices in West Los
Angeles, California and Rosemont, Illinois in early 1998. The Company intends to
continue its geographic expansion into other emerging technology marketplaces
across the U.S. during future years as opportunities to serve new markets arise.
Business development and travel expenses totaled $6.0 million in 1998, an
increase of $1.5 million, or 33.5%, compared to the $4.5 million total in 1997.
The Company incurred $2.9 million in business development and travel expenses in
1996. The increase in business development and travel expenses during each of
the last two years was largely attributable to overall growth in the Company's
business, including both an increase in the number of FTE and expansion into new
geographic markets.
Postage and supplies expenses totaled $2.2 million, $1.6 million and $1.4
million in 1998, 1997 and 1996, respectively. Total telephone expenses were $2.2
million in 1998, $1.4 million in 1997 and $1.3 million in 1996. The increase in
postage and supplies and telephone expenses during each of the past two years
was largely the result of overall growth in the Company's business, including
both an increase in the number of FTE and expansion into new geographic markets.
Advertising and promotion expenses totaled $2.2 million in 1998, $1.4
million in 1997 and $1.2 million in 1996. The increase in advertising and
promotion expenses in 1998, compared to 1997 and 1996, reflects a concerted
effort by the Company to increase its marketing efforts nationwide.
Trust preferred securities distributions totaled $2.0 million in 1998 and
resulted from the issuance of $40.0 million in cumulative trust preferred
securities during the second quarter of 1998. The trust preferred securities pay
a fixed rate quarterly distribution of 8.25% and have a maximum maturity of 30
years. For further discussion related to the trust preferred securities, see the
Item 7 sections entitled "Liquidity" and "Capital Resources."
Other noninterest expenses totaled $4.3 million, $3.4 million and $2.7
million in 1998, 1997 and 1996, respectively. The increase in other noninterest
expenses in 1998 of $0.9 million, as compared to 1997, was primarily due to an
increase in data processing costs related to both the aforementioned overall
growth in the Company's business and several new business initiatives begun in
1998. In addition, there was an increase in costs associated with certain vendor
provided services resulting from growth in the Company's client base.
23
The $0.7 million increase in other noninterest expenses from 1996 to 1997 was
largely due to expenses associated with both an asset which was acquired through
foreclosure during 1997 and an increase in costs associated with certain vendor
provided services resulting from growth in the Company's client base.
The Company realized a net gain of $1.3 million in connection with the sale
of an other real estate owned (OREO) property during 1998. In 1997, the Company
incurred minimal net costs associated with OREO, and in 1996, $0.4 million in
net OREO-related costs were incurred, primarily due to the write-down of one
property owned by the Company. The Company's net costs associated with OREO
include: maintenance expenses, property taxes, marketing costs, net operating
expense or income associated with income-producing properties, property
write-downs, and gains or losses on the sales of such properties.
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 income tax rate was 41.1% in 1998, compared to 42.0%
in 1997 and 40.0% in 1996. The slight decrease in the Company's effective income
tax rate for 1998, as compared to 1997, was attributable to an increase in the
amount of tax-exempt interest income received by the Company. The increase in
the Company's effective income tax rate from 1996 to 1997, was due to
adjustments in the Company's estimate of its income tax liabilities.
FINANCIAL CONDITION
The Company's total assets were $3.5 billion at December 31, 1998, an
increase of $920.3 million, or 35.1%, compared to $2.6 billion at December 31,
1997.
FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENT TO RESELL
Federal funds sold and securities purchased under agreement to resell
totaled a combined $399.2 million at December 31, 1998, an increase of $77.4
million, or 24.1%, compared to the $321.8 million outstanding at the prior year
end. This increase was attributable to the Company investing excess funds
resulting from the strong growth in deposits during 1998 which exceeded the
growth in loans, in these types of short-term, liquid investments.
INVESTMENT SECURITIES
The following table details the composition of investment securities, all of
which were classified as available-for-sale and reported at fair value, at
December 31, 1998, 1997 and 1996.
DECEMBER 31,
--------------------------------------
1998 1997 1996
------------ ------------ ----------
(DOLLARS IN THOUSANDS)
U.S. Treasury securities................................................ $ 41,049 $ 217,685 $ 75,547
U.S. agencies and corporations:
Discount notes and bonds.............................................. 498,016 462,405 298,488
Mortgage-backed securities......................................