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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2007
OR
| ¨ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) of the securities exchange act of 1934 |
For the transition period from to .
Commission File Number: 000-15637
SVB FINANCIAL GROUP
(Exact name of registrant as specified in its charter)
| Delaware | 91-1962278 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
| 3003 Tasman Drive, Santa Clara, California 95054-1191 | http://www.svb.com | |
| (Address of principal executive offices including zip code) |
(Registrant’s URL) | |
Registrant’s telephone number, including area code: (408) 654-7400
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class: |
Name of each exchange on which registered | |
| Common Stock, par value $0.001 per share |
NASDAQ Global Select Market | |
| Junior subordinated debentures issued by SVB Capital II and the |
NASDAQ Global Select Market |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨ No x
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. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes ¨ No x
The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2007, the last business day of the registrant’s most recently completed second fiscal quarter, based upon the closing price of its common stock on such date, on the NASDAQ Global Select Market was $1,826,314,282.
At January 31, 2008, 32,364,515 shares of the registrant’s common stock ($0.001 par value) were outstanding.
| Documents Incorporated by Reference |
Parts of Form 10-K Into Which Incorporated | |
| Definitive proxy statement for the Company’s 2008 Annual Meeting of Stockholders to be filed within 120 days of the end of the fiscal year ended December 31, 2007 |
Part III |
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Forward-Looking Statements
This Annual Report on Form 10-K, including in particular “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Part II, Item 7 in this report, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Management has in the past and might in the future make forward-looking statements orally to analysts, investors, the media and others. Forward-looking statements are statements that are not historical facts. Broadly speaking, forward-looking statements include, without limitation, the following:
| • | Projections of our revenues, income, earnings per share, noninterest expenses, including professional service, compliance, compensation and other costs, cash flows, balance sheet, capital expenditures, capital structure or other financial items |
| • | Descriptions of strategic initiatives, plans or objectives of our management for future operations, including pending acquisitions |
| • | Forecasts of private equity funding levels |
| • | Forecasts of future interest rates |
| • | Forecasts of expected levels of provisions for loan losses, loan growth and client funds |
| • | Forecasts of future economic performance |
| • | Forecasts of future income on investments |
| • | Descriptions of assumptions underlying or relating to any of the foregoing |
In this Annual Report on Form 10-K, we make forward-looking statements, including but not limited to those discussing our management’s expectations about:
| • | Business and financial performance of our business |
| • | Future interest rates and the sensitivity of our interest-earning assets and interest-earning liabilities to interest rates, and impact to earnings from a change in interest rates |
| • | Realization, timing and performance of investments in equity securities and investment funds |
| • | Management of federal funds sold and overnight repurchase agreements at appropriate levels |
| • | Development of our later-stage corporate technology lending efforts |
| • | Growth in loan and deposit balances, including levels of interest-bearing deposits |
| • | Credit quality of our loan portfolio, including levels of non-performing loans and charge-offs |
| • | Liquidity provided by funds generated through retained earnings |
| • | Ability to meet our liquidity requirements through our portfolio of liquid assets |
| • | Ability to expand on opportunities to increase our liquidity |
| • | Use of capital |
| • | Volatility of performance of our equity portfolio |
| • | Introduction of new products, including deposit products |
| • | Effect of application of certain accounting pronouncements |
| • | Effect of certain lawsuits and claims |
| • | Impact of changes in tax benefits |
| • | Realization of tax assets |
| • | Performance of obligations by counterparty |
| • | Timing for ceasing operations of SVB Alliant |
You can identify these and other forward-looking statements by the use of words such as “becoming”, “may”, “will”, “should”, “predicts”, “potential”, “continue”, “anticipates”, “believes”, “estimates”, “seeks”, “expects”, “plans”, “intends”, the negative of such words, or comparable terminology. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we have based these expectations on our beliefs as well as our assumptions, and such expectations may prove to be incorrect. Our actual results of operations and financial performance could differ significantly from those expressed in or implied by our management’s forward-looking statements.
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For information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A in this report. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this Annual Report of Form 10-K. All subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements included in this filing are made only as of the date of this filing. We assume no obligation and do not intend to revise or update any forward-looking statements contained in this Annual Report on Form 10-K.
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PART I.
| ITEM 1. | BUSINESS |
General
SVB Financial Group is a diversified financial services company, as well as a bank holding company and financial holding company. The company was incorporated in the state of Delaware in March 1999. Through our various subsidiaries and divisions, we offer a variety of banking and financial products and services. For 25 years, we have been dedicated to helping entrepreneurs succeed, especially in the technology, life science, private equity and premium wine industries. We provide our clients with a diversity of products and services to support them throughout their life cycles, regardless of their size or stage of maturity.
We offer commercial banking products and services through our principal subsidiary, Silicon Valley Bank (the “Bank”), which is a California state-chartered bank founded in 1983 and a member of the Federal Reserve System. Through its subsidiaries, the Bank also offers brokerage, investment advisory and asset management services. We also offer non-banking products and services, such as funds management, private equity investment and equity valuation services, through our other subsidiaries and divisions.
As of December 31, 2007, we had total assets of $6.69 billion, total loans, net of unearned income of $4.15 billion, total deposits of $4.61 billion and total stockholders’ equity of $676.7 million.
We operate through 27 offices in the United States and five internationally in China, India, Israel and the United Kingdom. Our corporate headquarters is located at 3003 Tasman Drive, Santa Clara, California 95054, and our telephone number is 408.654.7400.
When we refer to “SVB Financial Group,” the “Company”, “we,” “our,” “us” or use similar words, we mean SVB Financial Group and all of its subsidiaries collectively, including the Bank. When we refer to “SVB Financial” or the “Parent” we are referring only to the parent company, SVB Financial Group.
Business Overview
For reporting purposes, SVB Financial Group has four operating segments in which we report our financial information in this Annual Report: Commercial Banking, SVB Capital, SVB Alliant, and Other Business Services. Financial information and results of operation for our operating segments are set forth in Note 23 (Segment Reporting) of the “Notes to the Consolidated Financial Statements” under Part II, Item 8 in this report, and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Operating Segment Results” under Part II, Item 7 in this report.
Commercial Banking
Our commercial banking products and services are provided by the Bank and its subsidiaries. The Bank provides solutions to the financial needs of commercial clients through lending, deposit account and cash management, and global banking and trade products and services.
Through lending products and services, the Bank extends loans and other credit facilities to commercial clients. These loans are most often secured by clients’ assets. Lending products and services include traditional term loans, equipment loans, revolving lines of credit, accounts-receivable-based lines of credit and asset-based loans.
The Bank’s deposit account and cash management products and services provide commercial clients with short- and long-term cash management solutions. Deposit account products and services include traditional
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deposit and checking accounts, certificates of deposit, and money market accounts. In connection with deposit accounts, the Bank also provides lockbox and merchant services that facilitate timely depositing of checks and other payments to clients’ accounts. Cash management products and services include wire transfer and Automated Clearing House (“ACH”) payment services to enable clients to transfer funds quickly from their deposit accounts. Additionally, the cash management services unit provides collection services, disbursement services, electronic funds transfers, and online banking through SVBeConnect.
The Bank’s global banking and trade products and services facilitate clients’ global finance and business needs. These products and services include foreign exchange services that allow commercial clients to manage their foreign currency risks through the purchase and sale of currencies on the global inter-bank market. To facilitate clients’ international trade, the Bank offers a variety of loans and credit facilities guaranteed by the Export-Import Bank of the United States. It also offers letters of credit, including export, import, and standby letters of credit, to enable clients to ship and receive goods globally.
The Bank offers a variety of investment services and solutions to its clients that enable companies to better manage their assets. The Bank’s Repurchase Agreement Program, which is targeted to those clients who seek interest income with minimal tolerance for loss of principal, offers the ability to enter into secure overnight investments that are fully collateralized. Through its broker-dealer subsidiary, SVB Securities, the Bank offers money market mutual funds and fixed-income securities. SVB Securities is registered with the U.S. Securities Exchange Commission (“SEC”) and is a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation (“SIPC”). Finally, through its registered investment advisory subsidiary, SVB Asset Management, the Bank offers investment advisory services, including outsourced treasury services, with customized cash portfolio management and reporting.
SVB Capital
SVB Capital is the private equity division of SVB Financial Group. This division focuses primarily on funds management. SVB Capital manages, sponsors and invests in private equity and venture capital funds, as well as invests in portfolio companies, on behalf of SVB Financial and the investors in the funds managed by SVB Capital. The SVB Capital family of funds is comprised of funds its manages, including funds of funds, such as our SVB Strategic Investors funds, and co-investment funds, such as our SVB Capital Partners funds and SVB India Capital Partners fund. It also includes sponsored debt funds, such as Gold Hill Venture Lending funds, which provide secured debt, typically to emerging-growth clients in their earliest stages, and Partners for Growth funds, which primarily provide secured debt to higher-risk, middle-market clients in their later stages. Most of the funds actively managed or sponsored by SVB Capital are consolidated into our financial statements. See Note 2 (Summary of Significant Accounting Policies) of the “Notes to the Consolidated Financial Statements” under Part II, Item 8 in this report.
SVB Alliant
SVB Alliant, a broker-dealer registered with the SEC and a member of the FINRA, was our investment banking division, which provided advisory services in the areas of mergers and acquisitions, corporate finance, strategic alliances and private placements. In July 2007, we announced that we had reached a decision to cease operations at SVB Alliant. We elected to have SVB Alliant complete a limited number of client transactions before finalizing its shut-down. Accordingly, we have classified the results of operations of SVB Alliant as continuing operations in the Consolidated Statement of Income for the year ended December 31, 2007 in Part II, Item 8 in this report. As of the date of this report, all such client transactions have been completed. Other than the completion of wind-down activities, we expect to cease operations by the end of the first quarter of 2008.
Other Business Services
The Other Business Services segment is principally comprised of SVB Private Client Services, SVB Global, SVB Analytics and SVB Wine Division. These business units do not individually meet the separate reporting
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thresholds as defined by Statement of Financial Accounting Standards (“SFAS”) No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS No. 131”) and, as a result, we have aggregated them together as Other Business Services for segment reporting purposes.
SVB Private Client Services
SVB Private Client Services is a division of the Bank that provides a range of credit services to targeted high-net-worth individuals using both long-term secured and short-term unsecured lines of credit. These products and services include home equity lines of credit, secured lines of credit, restricted stock purchase loans, airplane loans, and capital call lines of credit. We also help our private clients meet their cash management needs by providing deposit account products and services, including checking accounts, money market accounts and certificates of deposit.
SVB Global
SVB Global includes our subsidiaries focused on our foreign activities, which facilitate our clients’ global expansion into major technology centers around the world. SVB Global serves the needs of some of our non-U.S. clients with global banking products, including loans, deposits and global finance. SVB Global provides a variety of services, including consulting and business services, referrals, and knowledge sharing, and identifies global business opportunities for us.
SVB Analytics
During the second quarter of 2006, we commenced operations of SVB Analytics, which provides equity valuation and equity management services to private companies. We offer equity management services, including capitalization data management, through eProsper, Inc., a company in which SVB Analytics holds a controlling ownership stake.
SVB Wine Division
SVB Wine Division is a division of the Bank that provides banking products and services to our premium wine industry clients, including vineyard development loans. We offer a variety of financial solutions focused specifically on the needs of our clients’ premium wineries and vineyards.
Income Sources
Our business generates three distinct primary sources of income: interest rate differentials, fee-based services and investments in private equity funds, equity warrant assets and other securities.
We generate income from interest rate differentials. The difference between the interest rates received on interest-earning assets, such as loans extended to clients and securities held in our investment portfolio, and the interest rates paid by us on interest-bearing liabilities, such as deposits and borrowings, accounts for the major portion of our earnings. Our deposits are largely obtained from commercial clients within our technology, life sciences and private equity industry sectors. Deposits are also obtained from the premium wine industry commercial clients and individual clients served by our Private Client Services group. We do not obtain deposits from conventional retail sources and currently have no brokered deposits.
Fee-based services also generate income for our business. We market our full range of financial services to our commercial and private equity firm clients, including commercial banking, private client, investment advisory, asset management, global banking and equity valuation services. Our ability to integrate and cross-sell our diverse financial services to our clients is a strength of our business model.
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We also seek to obtain returns by making investments. We manage and invest in private equity funds that generally invest directly in privately held companies, as well as funds that invest in other private equity funds. We also invest directly in privately held companies. Additionally, as part of negotiated credit facilities and certain other services, we frequently obtain rights to acquire stock in the form of equity warrant assets in certain client companies.
Industry Niches
In each of the industry niches we serve, we provide services to meet the needs of our clients throughout their life cycles, from early stage through maturity.
Technology and Life Sciences
We serve a variety of clients in the technology and life science industries. A key component of our technology and life science business strategy is to develop relationships with clients at an early stage and offer them banking services that will continue to meet their needs as they mature and expand. We define “emerging-growth” clients as companies in the start-up or early stages of their life cycles. These companies tend to be privately held and backed by venture capital; they generally have few employees, are primarily engaged in research and development, have brought relatively few products or services to market, and have little or no revenue. By contrast, we define “mature” or “later-stage” clients as companies that tend to be more established; these companies may be publicly traded.
Our technology clients generally tend to be in the industries of hardware (semiconductors, communications and electronics), software and related services, and cleantech. Our life science clients generally tend to be in the industries of biotechnology and medical devices.
Private Equity
We provide financial services to clients in the private equity community. Since our founding, we have cultivated strong relationships with the private equity community, particularly with venture capital firms worldwide, many of which are also clients. We serve more than 500 venture capital firms in the United States, as well as other private equity firms, facilitating deal flow to and from these private equity firms and participating in direct investments in their portfolio companies.
Premium Wine
We are one of the leading providers of financial services to premium wine producers in the Western United States, with over 300 winery and vineyard clients. We focus on vineyards and wineries that produce grapes and wines of the highest quality.
Competition
The banking and financial services industry is highly competitive, and evolves as a result of changes in regulation, technology, product delivery systems, and the general market and economic climate. Our current competitors include other banks, debt funds and specialty and diversified financial services companies that offer lending, leasing, other financial products, and advisory services to our target client base. The principal competitive factors in our markets include product offerings, service, and pricing. Given our established market position with the client segments that we serve, and our ability to integrate and cross-sell our diverse financial services to extend the length of our relationships with our clients, we believe we compete favorably in all our markets in these areas.
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Employees
As of December 31, 2007, we employed approximately 1,128 full-time equivalent employees.
Supervision and Regulation
General
Our bank and holding company operations are subject to extensive regulation by federal and state regulatory agencies. This regulation is intended primarily for the protection of depositors and the deposit insurance fund, and secondarily for the stability of the U.S. banking system. It is not intended for the benefit of stockholders of financial institutions. As a bank holding company that elected to become a financial holding company in November 2000, SVB Financial is subject to inspection, supervision, regulation, and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) under the Bank Holding Company Act of 1956 (the “BHC Act”). The Bank, as a California state-chartered bank and a member of the Federal Reserve System, is subject to primary supervision and examination by the Federal Reserve Board, as well as the California Department of Financial Institutions (the “DFI”). In addition, the Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”). SVB Financial’s other nonbank subsidiaries are subject to regulation by the Federal Reserve Board and other applicable federal and state agencies, such as the SEC and FINRA, and, for our foreign-based subsidiaries, applicable regulatory bodies, such as those promulgated by the Financial Services Authority in the United Kingdom. SVB Financial, the Bank and their subsidiaries are required to file periodic reports with these regulators and provide any additional information that they may require.
The following summary describes some of the more significant laws, regulations, and policies that affect our operations; it is not intended to be a complete listing of all laws that apply to us. From time to time, federal, state and foreign legislation is enacted and regulations are adopted which may have the effect of materially increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers. We cannot predict whether or when potential legislation will be enacted, and if enacted, the effect that it, or any implementing regulations, would have on our financial condition or results of operations.
Regulation of Holding Company
The Federal Reserve Board requires SVB Financial to maintain minimum capital ratios, as discussed below under “Regulatory Capital.” Under Federal Reserve Board policy, a bank holding company is also 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 bank(s), a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary bank(s) 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 bank(s). A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary bank(s) or to observe established guidelines with respect to the payment of dividends by bank holding companies generally will be considered by the Federal Reserve Board to be an unsafe and unsound banking practice, a violation of the Federal Reserve Board’s regulations, or both.
Bank holding companies are generally prohibited, except in certain statutorily prescribed instances including exceptions for financial holding companies, from acquiring direct or indirect ownership or control of more than 5% 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, subject to prior notice or Federal Reserve Board approval, bank holding companies may engage in, or acquire shares of companies engaged in, activities determined by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper
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incident thereto. Pursuant to our election as a financial holding company, SVB Financial may make acquisitions and engage in these nonbanking and certain other activities without prior Federal Reserve Board approval. Additionally, as a financial holding company, SVB Financial may affiliate with securities firms and insurance companies and engage in other activities determined by the Federal Reserve Board to be “financial in nature” or are incidental or complementary to activities that are “financial in nature,” which include, among other things, merchant banking investments.
In order to elect or retain financial holding company status, all depository institution subsidiaries of a bank holding company must be well capitalized, well managed, and, except in limited circumstances, in satisfactory compliance with the Community Reinvestment Act. Failure to sustain compliance with these requirements or correct any non-compliance within a fixed time period could require us to divest the Bank or to conform all of our activities to those permissible for a bank holding company.
In March 2000, the Gramm-Leach-Bliley Act (the “GLB Act”) or Financial Services Modernization Act of 1999 became effective and created the category of financial holding companies. Under the GLB Act, banks, subject to various requirements, are permitted to engage through “financial subsidiaries” in certain financial activities permissible for affiliates of financial holding companies. However, to be able to engage in such activities banks must also be well capitalized and well managed and have received at least a “satisfactory” rating in its most recent Community Reinvestment Act examination.
SVB Financial is also treated as a bank holding company under the California Financial Code. As such, SVB Financial and its subsidiaries are subject to periodic examination by, and may be required to file reports with, the DFI.
Regulatory Capital
The federal banking agencies have adopted risk-based capital guidelines for bank holding companies and banks that are expected 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, such as loans, and those recorded as off-balance sheet items, such as commitments, letters of credit and recourse arrangements. Under these capital guidelines, banking organizations are required to maintain certain minimum capital ratios, which are obtained by dividing its qualifying capital by its total risk-adjusted assets and off-balance sheet items. In general, the dollar amounts of assets and certain off-balance sheet items are “risk-adjusted” and assigned to various risk categories. Qualifying capital is classified in one of three tiers, depending on the type of capital:
| • | “Tier 1 capital” consists of common equity, retained earnings, qualifying non-cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries (including trust-preferred securities), less goodwill and certain other intangible assets. Qualifying Tier 1 capital may consist of trust-preferred securities, subject to certain criteria and quantitative limits for inclusion of restricted core capital elements in Tier 1 capital. |
| • | “Tier 2 capital” includes, among other things, hybrid capital instruments, perpetual debt, mandatory convertible debt securities, subordinated debt, preferred stock that does not qualify as Tier 1 capital, a limited amount of allowance for loan and lease losses. |
| • | “Tier 3 capital” consists of qualifying unsecured subordinated debt. |
Under the capital guidelines, there are three fundamental capital ratios: a total risk-based capital ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio. The minimum required ratios for bank holding companies and banks are eight percent, four percent and four percent, respectively. Additionally, for SVB Financial to remain a financial holding company, the Bank must at all times be “well-capitalized,” which requires the Bank to have a total risk-based capital ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio of at least ten percent, six percent and five percent, respectively. Moreover, although not a requirement to maintain
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financial holding company status, maintaining the financial holding company at “well-capitalized” status provides certain benefits to the company, such as the ability to repurchase stock without prior regulatory approval. To be “well-capitalized,” the holding company must at all times have a total risk-based and Tier 1 risk-based capital ratio of at least ten percent and six percent, respectively. There is no Tier 1 leverage requirement for a holding company to be deemed well-capitalized. At December 31, 2007, the respective capital ratios of SVB Financial and the Bank exceeded these minimum percentage requirements for “well-capitalized” institutions. See Note 21 (Regulatory Matters) of the “Notes to the Consolidated Financial Statements” under Part II, Item 8 in this report.
SVB Financial is also subject to rules that govern the regulatory capital treatment of equity investments in non-financial companies made on or after March 13, 2000 and held under certain specified legal authorities by a bank or bank holding company. Under the rules, these equity investments will be subject to a separate capital charge that will reduce a bank holding company’s Tier 1 capital and, as a result, will remove these assets from being taken into consideration in establishing a bank holding company’s required capital ratios discussed above. The rules provide for the following incremental Tier 1 capital charges: 8% of the adjusted carrying value of the portion of aggregate investments that are up to 15% of Tier 1 capital; 12% of the adjusted carrying value of the portion of aggregate investments that are between 15% and 25% of Tier 1 capital; and 25% of the adjusted carrying value of the portion of aggregate investments that exceed 25% of Tier 1 capital.
Further, the federal banking agencies have also adopted a joint agency policy statement, which states 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.
The current risk-based capital guidelines are based upon the 1988 capital accord of the International Basel Committee on Banking Supervision. A new international accord, referred to as Basel II, which emphasizes internal assessment of credit, market and operational risk, supervisory assessment and market discipline in determining minimum capital requirements, will become mandatory for large international banks outside the U.S. in 2008, and must be complied with in a “parallel run” for two years along with the existing Basel I standards. Other banks may adopt the Basel II framework, but are not required to do so. The U.S. federal regulatory agencies are expected to release separate rules in 2008 to offer U.S. banks that do not adopt Basel II an alternative “standardized approach under Basel II” option to address concerns that the Basel II framework may offer significant competitive advantages for the largest U.S. and international banks. The U.S. banking agencies have indicated, however, that they will retain the minimum leverage requirement for all U.S. banks.
Prompt Correction Action and Other General Enforcement Authority
Federal banking agencies possess broad powers to take corrective and other supervisory action against an insured bank and its holding company. Federal laws require each federal banking agency to take prompt corrective action to resolve the problems of insured banks.
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Each federal banking agency has issued regulations defining 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. Based upon its capital levels, a bank that 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 bank is subject to more restrictions, including restrictions on the bank’s activities, operational practices or the ability to pay dividends.
In addition to measures taken under the prompt corrective action provisions, bank holding companies and insured banks may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their business, or for violation of any law, rule, regulation, condition imposed in writing by the agency or term of a written agreement with the agency. In more serious cases, enforcement actions may include the appointment of a conservator or receiver for the bank; the issuance of a cease and desist order that can be judicially enforced; the termination of the bank’s deposit insurance; 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 officers, directors, and other 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.
Regulation of Silicon Valley Bank
The Bank is a California state-chartered bank and a member of the Federal Reserve System. The Bank is subject to primary supervision, periodic examination and regulation by the DFI and the Federal Reserve Bank of San Francisco. If the DFI or the Federal Reserve Board should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory, or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to the DFI and the Federal Reserve Board, depending on the severity of the violation. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to impair SVB Financial’s financial holding company status, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, and to remove officers and directors. In addition, the FDIC may also terminate the Bank’s deposit insurance, which for a California state-chartered bank would result in a revocation of the Bank’s charter. Various requirements and restrictions under the laws of the State of California and the United States affect the operations of the Bank. State and federal statutes and regulations relate to most aspects of the Bank’s operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, investment in nonfinancial enterprises and capital requirements. Further, the Bank is required to maintain certain levels of capital. (See “Regulatory Capital” above.)
Because California permits commercial banks chartered by the state to engage in any activity permissible for national banks, the bank can form subsidiaries to engage in the many so-called “closely related to banking” or “nonbanking” activities commonly conducted by national banks in operating subsidiaries, subject to applicable state or FDIC requirements. However, in order to form a financial subsidiary, the Bank must be “well-capitalized”, “well-managed” and in satisfactory compliance with the Community Reinvestment Act. Further, the Bank must exclude from its assets and equity all equity investments, including retained earnings, in a financial subsidiary, for regulatory reporting purposes. The assets of the subsidiary may not be consolidated with the Bank’s assets. The Bank must also have policies and procedures to assess financial subsidiary risk and protect the Bank from such risks and potential liabilities and is subject to the same capital deduction, risk management and affiliate transaction rules as applicable to national banks. Generally, a financial subsidiary is permitted to engage in activities that are “financial in nature” or incidental thereto, even though they are not permissible for the national bank to conduct directly within the bank. The definition of “financial in nature” includes, among other
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items, underwriting, dealing in or making a market in securities, including, for example, distributing shares of mutual funds.
Restrictions on Dividends
A Federal Reserve Board policy statement provides that a bank holding company may pay cash dividends only to the extent that the holding company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The policy statement also provides that it would be inappropriate for a bank holding company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the federal prompt corrective action regulations, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”
Dividends from the Bank constitute the principal source of cash revenues for SVB Financial. The Bank is subject to various federal and state statutory and regulatory restrictions on its ability to pay dividends. In addition, the banking agencies 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.
Transactions with Affiliates
Transactions between the Bank and its operating subsidiaries (such as SVB Securities, Inc. or SVB Asset Management) on the one hand, and the Bank’s affiliates (such as SVB Financial, SVB Analytics, or an SVB Global entity) are subject to restrictions imposed by federal and state law, designed to protect the Bank and its subsidiaries from engaging in unfavorable behavior with their affiliates. More specifically, these restrictions, contained in Federal Reserve Board Regulation W, prevent SVB Financial and other affiliates from borrowing from, or entering into other credit transactions with, the Bank or its operating subsidiaries unless the loans or other credit transactions are secured by specified amounts of collateral. All loans and credit transactions and other “covered transactions” by the Bank and its operating subsidiaries with any one affiliate are limited, in the aggregate, to 10% of the Bank’s capital and surplus; and all loans and credit transactions and other “covered transactions” by the Bank and its operating subsidiaries with all affiliates are limited, in the aggregate, to 20% of the Bank’s capital and surplus. For this purpose, a “covered transaction” generally includes, among other things, a loan or extension of credit to an affiliate; a purchase of or investment in securities issued by an affiliate; a purchase of assets from an affiliate; the acceptance of a security issued by an affiliate as collateral for an extension of credit to any borrower; and the issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate. In addition, the Bank and its operating subsidiaries generally may not purchase a low-quality asset from an affiliate. Moreover, covered transactions and other specified transactions by the Bank and its operating subsidiaries with an affiliate must be on terms and conditions, including credit standards, that are substantially the same, or at least as favorable to the Bank or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. An entity that is a direct or indirect subsidiary of the Bank would not be considered to be an “affiliate” of the Bank or its operating subsidiaries for these purposes unless it fell into one of certain categories, such as a “financial subsidiary” authorized under the GLB Act.
Loans to Insiders
Extensions of credit by the Bank to insiders of both the Bank and SVB Financial are subject to prohibitions and other restrictions imposed by federal regulations. For purposes of these limits, “insiders” include directors, executive officers and principal shareholders of the Bank or SVB Financial and their related interests. The term “related interest” means a company controlled by a director, executive officer or principal shareholder of the Bank or SVB Financial. The Bank may not extend credit to an insider of the Bank or SVB Financial unless the loan is made on substantially the same terms as, and subject to credit underwriting procedures that are no less stringent than, those prevailing at the time for comparable transactions with non-insiders. Under federal banking
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regulations, the Bank may not extend a loan to insiders in an amount greater than $500,000 without prior board approval (with any interested person abstaining from participating directly or indirectly in the voting). The federal regulations place additional restrictions on loans to executive officers, and generally prohibit loans to executive officers other than for certain specified purposes. The Bank is required to maintain records regarding insiders and extensions of credit to them.
Safety and Soundness Guidelines
Banking regulatory agencies have adopted guidelines to assist in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines establish operational and managerial standards generally relating to: (1) internal controls, information systems, and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest-rate exposure; (5) asset growth and asset quality; and (6) compensation, fees, and benefits. In addition, the banking regulatory agencies have adopted safety and soundness guidelines for asset quality and for evaluating and monitoring earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves.
Premiums for Deposit Insurance
The FDIC merged the Bank Insurance Fund and the Savings Association Insurance Fund to form the Deposit Insurance Fund (“DIF”) in 2006. Through the DIF, the FDIC insures the Bank’s customer deposits up to prescribed limits for each depositor. The Bank is a member of the DIF.
The FDIC has established a system for setting deposit insurance premiums based upon the risks a particular bank poses to the insurance fund. The FDIC has established a risk-based system assessment system to determine the deposit insurance assessment to be paid by insured depository institutions based upon capital levels and supervisory ratings assigned by the Bank’s primary federal regulator, and other risk measures. Assessment rates for the insurance of DIF deposits in 2007 ranged between a minimum of 5 cents for well-managed, well-capitalized banks to a maximum of 43 cents for institutions posing the most risk to the DIF, per $100 in assessable deposits. Institutions in Risk Category I were charged a rate between 5 and 7 cents. The FDIC may increase or decrease the assessment rate schedule quarterly. As of December 31, 2007, the Bank’s assessment rate was between 5 and 7 cents per $100 in assessable deposits. We received a one-time credit from the FDIC to offset assessments in 2007.
In addition, all federally insured institutions are required to pay assessments to the FDIC at an annual rate of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. The assessment rate relating to these bonds effective for 2007 was between 1.14 and 1.22 basis points of assessable deposits. These assessments cannot be offset with any one time credits and are expected to continue until the Financing Corporation bonds mature by 2019.
USA Patriot Act of 2001
As part of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”), Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFATA”). IMLAFATA amended the Bank Secrecy Act (“BSA”) and adopted certain additional measures that established or increased existing obligations of financial institutions, including the Bank, to identify their customers, monitor and report suspicious transactions, respond to requests for information by federal banking regulatory authorities and law enforcement agencies, and, at the option of the Bank, share information with other financial institutions. The U.S. Secretary of the Treasury has adopted several regulations to implement these provisions. Pursuant to these regulations, the Bank is required to implement appropriate policies and procedures relating to anti-money laundering matters, including compliance with applicable regulations, suspicious activities, currency transaction reporting and customer due diligence. Our BSA compliance program is subject to federal regulatory review.
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Consumer Protection Laws and Regulations
The Bank is subject to many federal consumer protection statutes and regulations, such as the Community Reinvestment Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the National Flood Insurance Act and various federal and state privacy protection laws. Penalties for violating these laws could subject the Bank to lawsuits and could also result in administrative penalties, including, fines and reimbursements. The Bank and SVB Financial are also subject to federal and state laws prohibiting unfair or fraudulent business practices, untrue or misleading advertising and unfair competition.
In recent years, examination and enforcement by the state and federal banking agencies for non-compliance with consumer protection laws and their implementing regulations have become more intense. Due to these heightened regulatory concerns, the Bank may incur additional compliance costs or be required to expend additional funds for investments in its local community.
Sarbanes-Oxley Act of 2002
We are subject to the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), which implemented a broad range of corporate governance and accounting measures, generally to increase corporate responsibility, provide for enhanced penalties for accounting and auditing improprieties at publicly-traded companies, and protect investors by improving the accuracy and reliability of disclosures under federal securities laws. Under Sarbanes-Oxley, we are required to file periodic reports with the SEC under the Securities and Exchange Act of 1934. Among other things, Sarbanes-Oxley and/or its implementing regulations have established new membership requirements and additional responsibilities for our audit committee, imposed restrictions on the relationship between us and our outside auditors, imposed additional responsibilities for our external financial statements on our chief executive officer and chief financial officer, expanded the disclosure requirements for our corporate insiders, and required our management to evaluate our disclosure controls and procedures and our internal control over financial reporting. The Nasdaq Stock Market, Inc. has also imposed corporate governance requirements as well.
Regulation of Certain Subsidiaries
Our subsidiaries that are registered as broker-dealers, such as SVB Securities, are subject to regulation by the SEC and FINRA. SVB Asset Management, our investment advisor subsidiary, is registered with the SEC under the Investment Advisers Act of 1940, as amended, and is subject to its rules and regulations.
Our broker-dealer subsidiaries are subject to Rule 15c3-1 under the Securities Exchange Act of 1934, as amended, which is designed to measure the general financial condition and liquidity of a broker-dealer. Under this rule, our broker-dealer subsidiaries are required to maintain the minimum net capital deemed necessary to meet their continuing commitments to customers and others. Under certain circumstances, this rule could limit the ability of the Bank to withdraw capital from SVB Securities.
Additionally, our foreign-based subsidiaries are also subject to foreign laws and regulations, such as those promulgated by the Financial Services Authority in the United Kingdom and the Reserve Bank of India.
Available Information
We make available free of charge through our Internet website, http://www.svb.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The contents of our website are not incorporated herein by reference and the website address provided is intended to be an inactive textual reference only.
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| ITEM 1A. | RISK FACTORS |
Our business faces significant risks, including credit, market/liquidity, operational, legal/regulatory and strategic/reputation risks. The factors described below may not be the only risks we face and are not intended to serve as a comprehensive listing or be applicable only to the category of risk under which they are disclosed. The risks described below are generally applicable to more than one of the following categories of risks. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations. If any of the events or circumstances described in the following factors actually occurs, our business, financial condition and/or results of operations could suffer.
Credit Risks
If our clients fail to perform under their loans, our business, profitability and financial condition could be adversely affected.
As a lender, we face the risk that our client borrowers will fail to pay their loans when due. If borrower defaults cause large aggregate losses, it could have a material adverse effect on our business, profitability and financial condition. We reserve for such losses by establishing an allowance for loan losses, which results in a charge to our earnings. We have established an evaluation process designed to determine the adequacy of our allowance for loan losses. While this evaluation process uses historical and other objective information, the classification of loans and the forecasts and establishment of loan losses are dependent to a great extent on our subjective assessment based upon our experience and judgment. There can be no assurance that our allowance for loan losses will be sufficient to absorb future loan losses or prevent a material adverse effect on our business, profitability and financial condition.
Because of the credit profile of our loan portfolio, our levels of nonperforming assets and charge-offs can be volatile. We may need to make material provisions for loan losses in any period, which could reduce net income or increase net losses in that period.
Our loan portfolio has a credit profile different from that of most other banking companies. Many of our loans are made to companies in the early stages of development with negative cash flows and no established record of profitable operations. In many cases, repayment of the loan is dependent upon receipt of additional equity financing from venture capitalists or others. Collateral for many of our loans often includes intellectual property, which is difficult to value and may not be readily salable in the case of default. Because of the intense competition and rapid technological change that characterizes the companies in our technology and life sciences industry sectors, a borrower’s financial position can deteriorate rapidly. Additionally, we are increasing our lending to larger private equity firms and corporate technology clients, including some companies with greater levels of debt relative to their equity, and have increased the average size of our loans over time. These changes could affect the risk of borrower default and increase the impact on us of any single borrower default. For all of these reasons, our level of nonperforming loans, loan charge-offs and additional allowance for loan losses can be volatile and can vary materially from period to period. Increases in our level of nonperforming loans may require us to increase our provision for loan losses in any period, which could reduce our net income or cause net losses in that period. Additionally, such increases in our level of nonperforming loans may also have an adverse effect on our credit ratings and market perceptions of us.
Market/Liquidity Risks
Our current level of interest rate spread may decline in the future. Any material reduction in our interest rate spread could have a material adverse effect on our business, profitability and financial condition.
A major portion of our net income comes from our interest rate spread, which is the difference between the interest rates paid by us on amounts used to fund assets and the interest rates and fees we receive on our interest-earning assets. We fund assets using deposits and other borrowings. While we offer some interest-bearing deposit
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products, most of our deposit products are non-interest bearing. Our interest-earning assets include loans extended to our clients and securities held in our investment portfolio.
Changes in interest rates impact our interest rate spread. Increases in market interest rates will likely cause our interest rate spread to increase. Conversely, if interest rates decline, our interest rate spread will likely decline. Recent decreases in market interest rates have caused our interest rate spread to decline, which reduces our net income. Unexpected interest rate declines may also adversely affect our business forecasts and expectations. Interest rates are highly sensitive to many factors beyond our control, such as inflation, recession, global economic disruptions, unemployment and the fiscal and monetary policies of the federal government and its agencies.
In addition to general changes in the level of interest rates, increases in the interest rates we pay on amounts used to fund assets or decreases in the interest rates we receive on our interest-earning assets could affect our interest rate spread. For example, since 2006 we have funded our loan growth primarily through short- and long-term borrowings. These funds carry meaningfully higher interest rate costs than our current deposit base. If we significantly increase the amount of our assets that we fund through borrowings rather than deposits, our interest rate spread will likely decline. Similarly, if we significantly increase the amount of our assets that we fund through interest-bearing deposits, or increase the rates we pay on those deposits, our interest rate spread likely would decline. Interest rates paid by us could be affected by competitive, legislative or other developments. For example, in 2007 we introduced two new interest-bearing deposit products, intended to enhance our deposit levels to support our loan growth, and in the future, we may introduce additional interest-bearing deposit products. In addition, Congress has for many years debated repealing a law that prohibits banks from paying interest rates on checking accounts. If this law were to be repealed, we would be subject to competitive pressure to pay interest on our clients’ checking accounts.
The interest rates we receive on our interest-earning assets could be affected by a variety of factors, including market interest rates, competition, a change over time in the mix of loans comprising our loan portfolio and the mix of loans and investment securities on our balance sheet. Any material reduction in our interest rate spread could have a material adverse effect on our business, profitability and financial condition.
Our business is dependent upon access to funds on attractive terms. Consequently, a reduction in our credit ratings could adversely affect our business, profitability and financial condition.
We derive our net interest income through lending or investing capital on terms that provide returns in excess of our costs for obtaining that capital. As a result, our credit ratings are important to our business. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs or increase the interest rates we pay on deposits. Further, our credit ratings and the terms upon which we have access to capital may be influenced by circumstances beyond our control, such as overall trends in the general market environment, perceptions about our creditworthiness or market conditions in the industries in which we focus.
Equity warrant asset, private equity fund and direct equity investment portfolio gains or losses depend upon the performance of the portfolio investments and the general condition of the public equity markets, which are uncertain and may vary materially by period.
We historically have obtained rights to acquire stock, in the form of equity warrant assets, in certain clients as part of negotiated credit facilities and for other services. We also have made investments in private equity funds as well as direct equity investments in companies. The timing and amount of income, if any, from the disposition of equity warrant assets, securities obtained through the exercise of equity warrant assets, private equity funds and direct equity investments, as well as the fair market value of these rights and investments, typically depend upon factors beyond our control, including the performance of the underlying portfolio companies, investor demand for initial public offerings (“IPOs”), fluctuations in the market prices of the
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underlying common stock of these companies, levels of merger and acquisition activity and legal and contractual restrictions on our ability to sell securities and investments. In future periods, we may not be able to continue to obtain equity warrant assets to the same extent we historically have achieved, we may not realize gains from the exercise of equity warrant assets, the gains realized upon the sale of the securities obtained through the exercise of equity warrant assets and the gains realized upon the sale of our fund or direct equity investments may be materially less than the current fair value of equity warrant assets reflected in our financial statements, or the fair market value of some or all of these equity warrant assets could decline. Each of these developments could have a material adverse effect on our profitability and financial condition. All of these factors are difficult to predict. Due to the nature of investing and holding equity warrant assets in private equity venture-backed technology and life science companies, it is likely that investments within our portfolio will become impaired. However, we are not in a position to know at the present time which specific investments, if any, are likely to become impaired or the extent or timing of individual impairments. Therefore, we cannot predict future investment gains or losses with any degree of accuracy, and any gains or losses are likely to vary materially from period to period.
Public equity offerings and mergers and acquisitions involving our clients can cause loans to be paid off early, which could adversely affect our business, profitability and financial condition.
While an active market for public equity offerings and mergers and acquisitions generally has positive implications for our business, one negative consequence is that our clients may pay off or reduce their loans with us if they complete a public equity offering, are acquired by or merge with another entity or otherwise receive a significant equity investment. Any significant reduction in our outstanding loans could have a material adverse effect on our business, profitability and financial condition.
Operational Risks
If we fail to retain our key employees or recruit new employees, our growth and profitability could be adversely affected.
We rely on key personnel, including a substantial number of employees who have technical expertise in their subject matter area and a strong network of relationships with individuals and institutions in the markets we serve. If we were to have less success in recruiting and retaining these employees than our competitors, our growth and profitability could be adversely affected. We believe that our employees frequently have opportunities for alternative employment with other organizations, including competing financial institutions and our clients.
Changes to our employee compensation structure could adversely affect our results of operations and cash flows, as well as our ability to attract, recruit and retain certain key employees.
In May 2006, in an effort to align our option grant rate to that of other financial institutions similar to us, we committed to restrict the total number of shares of our common stock issued under stock options, restricted stock awards, restricted stock unit awards, stock bonus awards and any other equity awards granted during a fiscal year as a percentage of the total number of shares outstanding on a prospective basis. We may in the future consider taking other actions to modify employee compensation structures, such as granting cash compensation or other forms of equity compensation. Our decision to reduce the number of option shares to be granted on a prospective basis, and any other future changes we may adopt in our employee compensation structures, could adversely affect our results of operations and cash flows, as well as our ability to attract, recruit and retain certain key employees.
The occurrence of breaches of security in our online banking services could have a material adverse effect on our business, financial condition and results of operations.
We offer various internet-based services to our clients, including online banking services. The secure transmission of confidential information and execution of transactions over the Internet is essential to protect us and our clients against fraud and to maintain our clients’ confidence in our online services. Increases in criminal
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activity levels, advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology, processes and controls we use to prevent fraudulent transactions and to protect client transaction data, as well as the technology used by our clients to access our systems. Although we have developed systems and processes that are designed to prevent security breaches and periodically test our security, failure to mitigate breaches of security could result in losses to us or our clients, result in a loss of business and/or clients, cause us to incur additional expenses, affect our ability to grow our online services business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations. More generally, publicized security problems could inhibit the growth of the Internet as a means of conducting commercial transactions. Our ability to provide financial services over the Internet would be severely impeded if clients became unwilling to transmit confidential information online. As a result, our business, financial condition and results of operations could be adversely affected.
Business disruptions and interruptions due to natural disasters and other external events beyond our control can adversely affect our business, financial condition and results of operations.
Our operations can be subject to natural disasters and other external events beyond our control, such as earthquakes, fires, severe weather, public health issues, power failures, telecommunication loss, major accidents, terrorist attacks, acts of war, and other natural and man-made events. Our corporate headquarters and a portion of our critical business offices are located in California near major earthquake faults. Such events of disaster, whether natural or attributable to human beings, could cause severe destruction, disruption or interruption to our operations or property. Financial institutions, such as us, generally must resume operations promptly following any interruption. If we were to suffer a disruption or interruption and were not able to resume normal operations within a period consistent with industry standards, our business could suffer serious harm. In addition, depending on the nature and duration of the disruption or interruption, we might be vulnerable to fraud, additional expense or other losses, or to a loss of business and/or clients. We are in the process of implementing our business continuity program, which is a multi-year effort. We began implementing during 2005, but it has not yet been completed. There is no assurance that our business continuity program can adequately mitigate the risks of such business disruptions and interruptions.
Additionally, natural disasters and external events could affect the business and operations of our clients, which could impair their ability to pay their loans or fees when due, impair the value of collateral securing their loans, cause our clients to reduce their deposits with us, or otherwise adversely affect their business dealings with us, any of which could have a material adverse effect on our business, financial condition and results of operations.
We face reputation and business risks due to our interactions with business partners, service providers and other third parties.
We rely on third parties in a variety of ways, including to provide key components of our business infrastructure or to further our business objectives. These third parties may provide services to us and our clients or serve as partners in business activities. We rely on these third parties to fulfill their obligations to us, to accurately inform us of relevant information and to conduct their activities professionally and in a manner that reflects positively on us. Any failure of our business partners, service providers or other third parties to meet their commitments to us or to perform in accordance with our expectations could harm our business and operations, financial performance, strategic growth or reputation.
We face risks associated with the ability of our information technology systems and our processes to support our operations and future growth effectively.
In order to serve our target clients effectively, we have developed a comprehensive array of banking and other products and services. In order to support these products and services, we have developed and purchased or
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licensed information technology and other systems and processes. As our business continues to grow, we will continue to invest in these systems and processes. These investments may affect our future profitability. In addition, there can be no assurance that we will be able to effectively and timely improve our systems and processes to meet our business needs efficiently, whether by improving existing systems and processes or adding or transitioning to new systems and processes. Any interruption, failure or security breach in our information technology systems or processes, or any failure to effectively and timely improve these systems and processes to meet our business needs, could adversely affect our operations, financial condition, results of operations, future growth and reputation.
We depend on the accuracy and completeness of information about customers and counterparties.
In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit, we may assume that a customer’s audited financial statements conform to U.S. generally accepted accounting principles (“GAAP”) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. We also may rely on the audit report covering those financial statements. Our financial condition and results of operations could be negatively affected if we rely on financial statements or other information that do not comply with GAAP or that are materially misleading or inaccurate.
Our accounting policies and methods are key to how we report our financial condition and results of operations. They may require management to make estimates about matters that are uncertain.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with GAAP and reflect management’s judgment of the most appropriate manner to report our financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in our reporting materially different amounts than would have been reported under a different alternative.
Changes in accounting standards could materially impact our financial statements.
From time to time, FASB or the SEC may change the financial accounting and reporting standards that govern the preparation of our financial statements. In addition, the bodies that interpret the accounting standards (such as banking regulators or outside auditors) may change their interpretations or positions on how these standards should be applied. These changes may be beyond our control, can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, or apply an existing standard differently, also retroactively, in each case resulting in our restating prior period financial statements.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results. As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.
If we identify material weaknesses in our internal control over financial reporting or are otherwise required to restate our financial statements, we could be required to implement expensive and time-consuming remedial measures and could lose investor confidence in the accuracy and completeness of our financial reports. This could have an adverse effect on our business, financial condition and results of operations, including our stock price, and could potentially subject us to litigation.
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Legal/Regulatory Risks
We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business.
SVB Financial Group, including the Bank, is extensively regulated under federal and state laws governing financial institutions. Federal and state laws and regulations govern, limit or otherwise affect the activities in which we may engage and may affect our ability to expand our business over time. In addition, a change in the applicable statutes, regulations or regulatory policy could have a material effect on our business, including limiting the types of financial services and products we may offer or increasing the ability of nonbanks to offer competing financial services and products. These laws and regulations also require financial institutions, including SVB Financial and the Bank, to maintain certain minimum levels of capital, which may affect our ability to use our capital for other business purposes. In addition, increased regulatory requirements, whether due to the adoption of new laws and regulations, changes in existing laws and regulations, or more expansive or aggressive interpretations of existing laws and regulations, may have a material adverse effect on our business, financial condition and profitability.
If we were to violate federal or state laws or regulations governing financial institutions, we could be subject to disciplinary action that could have a material adverse effect on our business, financial condition, profitability and reputation.
Federal and state banking regulators possess broad powers to take supervisory or enforcement action with respect to financial institutions. Other regulatory bodies, including the SEC, FINRA and state securities regulators, regulate broker-dealers, including our subsidiaries SVB Alliant and SVB Securities. If SVB Financial Group were to violate, even if unintentionally or inadvertently, the laws governing financial institutions and broker-dealers, the regulatory authorities could take various actions against us, depending on the severity of the violation, such as revoking necessary licenses or authorizations, imposing censures, civil money penalties or fines, issuing cease and desist or other supervisory orders, and suspending or expelling from the securities business a firm, its officers or employees. Supervisory actions could result in higher capital requirements, higher insurance premiums and limitations on the activities of SVB Financial Group. These remedies and supervisory actions could have a material adverse effect on our business, financial condition, profitability and reputation.
SVB Financial relies on dividends from its subsidiaries for most of its cash revenues.
SVB Financial is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its cash revenues from dividends from its subsidiaries, primarily the Bank. These dividends are the principal source of funds to pay operating costs, borrowings, if any, and, should SVB Financial elect to pay dividends. Various federal and state laws and regulations limit the amount of dividends that our bank and certain of our nonbank subsidiaries may pay to SVB Financial. Also, SVB Financial’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors.
Strategic/Reputation Risks
Adverse changes in domestic or global economic conditions, especially in the technology sector, could have a material adverse effect on our business, growth and profitability.
If conditions deteriorate in the domestic or global economy, especially in the technology, life science, private equity and premium wine industry niches, our business, growth and profitability may be materially adversely affected. A global, U.S. or significant regional economic slowdown or recession could harm us by adversely affecting our clients’ and prospective clients’ access to capital to fund their businesses, their ability to sustain and grow their businesses, the level of funds they have available to maintain deposits, their demand for loans, their ability to repay loans and otherwise.
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Decreases in the amount of equity capital available to start-up and emerging-growth companies could adversely affect our business, growth and profitability.
Historically, our strategy has focused on providing banking products and services to emerging-growth companies receiving financial support from sophisticated investors, including venture capitalists, “angels,” and corporate investors. We derive a meaningful share of our deposits from these emerging growth companies and provide them with loans as well as other banking products and services. In some cases, our lending credit decision is based on our analysis of the likelihood that our venture capital or angel-backed client will receive a second or third round of equity capital from investors. If the amount of capital available to such companies decreases, it is likely that the number of new clients and investor financial support to our existing borrowers could decrease, which could have an adverse effect on our business, profitability and growth prospects.
Among the factors that have affected and could in the future affect the amount of capital available to startup and emerging-growth companies are the receptivity of the capital markets IPOs or mergers and acquisitions of companies within our technology and life science industry sectors, the availability and return on alternative investments and general economic conditions in the technology and life science industries. Reduced capital markets valuations could reduce the amount of capital available to startup and emerging-growth companies, including companies within our technology and life science industry sectors. Additionally, such reduced valuations may decrease the value of our investment portfolio, in which we hold direct equity investments and warrants in these companies, as well as investments in funds that invest in these companies, which could have an adverse effect on our financial condition and results of operations.
We face competitive pressures that could adversely affect our business, profitability, financial condition and future growth.
Other banks and specialty and diversified financial services companies and debt funds, many of which are larger than we are, offer lending, leasing, other financial products and advisory services to our client base. In addition, we compete with hedge funds and private equity funds, which currently have very significant amounts of capital available to invest and lend. In some cases, our competitors focus their marketing on our industry sectors and seek to increase their lending and other financial relationships with technology companies, early stage growth companies or special industries such as wineries. In other cases, our competitors may offer a broader range of financial products to our clients. When new competitors seek to enter one of our markets, or when existing market participants seek to increase their market share, they sometimes undercut the pricing and credit terms prevalent in that market, which could adversely affect our market share or ability to exploit new market opportunities. Our pricing and credit terms could deteriorate if we act to meet these competitive challenges, which could adversely affect our business, profitability, financial condition and future growth. Similarly, competitive pressures could adversely affect the business, profitability, financial condition and future growth of our non-banking services, including our access to capital and attractive investment opportunities for our funds business and our ability to secure attractive engagements in our investment banking business.
Our ability to maintain or increase our market share depends on our ability to meet the needs of existing and future clients.
Our success depends, in part, upon our ability to adapt our products and services to evolving industry standards and to meet the needs of existing and potential future clients. A failure to achieve market acceptance of any new products we introduce, a failure to introduce products that the market may demand, or the costs associated with developing, introducing and providing new products and services could have an adverse effect on our business, profitability and growth prospects.
We face risks in connection with our strategic undertakings.
If appropriate opportunities present themselves, we may engage in strategic activities, which could include acquisitions, joint ventures, partnerships, investments or other business growth initiatives or undertakings. There
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can be no assurance that we will successfully identify appropriate opportunities, that we will be able to negotiate or finance such activities or that such activities, if undertaken, will be successful.
In order to finance future strategic undertakings, we might obtain additional equity or debt financing. Such financing might not be available on terms favorable to us, or at all. If obtained, equity financing could be dilutive and the incurrence of debt and contingent liabilities could have a material adverse effect on our business, results of operations and financial condition.
Our ability to execute strategic activities successfully will depend on a variety of factors. These factors likely will vary based on the nature of the activity but may include our success in integrating the operations, services, products, personnel and systems of an acquired company into our business, operating effectively with any partner with whom we elect to do business, retaining key employees, achieving anticipated synergies, meeting management’s expectations and otherwise realizing the undertaking’s anticipated benefits. Our ability to address these matters successfully cannot be assured. In addition, our strategic efforts may divert resources or management’s attention from ongoing business operations and may subject us to additional regulatory scrutiny. If we do not successfully execute a strategic undertaking, it could adversely affect our business, financial condition, results of operations, reputation and growth prospects. In addition, if we were to conclude that the value of an acquired business had decreased and that the related goodwill had been impaired, that conclusion would result in an impairment of goodwill charge to us, which would adversely affect our results of operations.
We face risks associated with international operations.
One component of our strategy is to expand internationally. To date, we have opened offices in China, India, Israel and the United Kingdom. We plan to expand our operations in those locations and may expand beyond these countries. Our efforts to expand our business internationally carries with it certain risks, including risks arising from the uncertainty regarding our ability to generate revenues from foreign operations. In addition, there are certain risks inherent in doing business on an international basis, including, among others, legal, regulatory and tax requirements and restrictions, uncertainties regarding liability, tariffs and other trade barriers, difficulties in staffing and managing foreign operations, differing technology standards or customer requirements, political and economic risks and financial risks, including currency and payment risks. These risks could adversely affect the success of our international operations and could have a material adverse effect on our overall business, results of operation and financial condition. In addition, we face risks that our employees may fail to comply with applicable laws and regulations governing our international operations, including the U.S. Foreign Corrupt Practices Act and foreign laws and regulations, which could have a material adverse effect on us.
Our business reputation is important and any damage to it could have a material adverse effect on our business.
Our reputation is very important to sustain our business, as we rely on our relationships with our current, former and potential clients and stockholders, the private equity community and the industries that we serve. Any damage to our reputation, whether arising from regulatory, supervisory or enforcement actions, matters affecting our financial reporting or compliance with SEC and exchange listing requirements, negative publicity, or our conduct of our business or otherwise could have a material adverse effect on our business.
| Item 1B. | Unresolved Staff Comments |
None.
| Item 2. | Properties |
Our corporate headquarters facility consists of three buildings and is located at 3003 Tasman Drive, Santa Clara, California. The total square footage of the premises leased under the current lease arrangement is approximately 213,625 square feet. The lease will expire on September 30, 2014, unless terminated earlier.
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We currently operate 27 regional offices, including an administrative office, in the United States and five offices outside the United States. We operate throughout the Silicon Valley with two offices in Santa Clara, an office in Menlo Park, and two offices in Palo Alto. Other regional offices in California include Irvine, Woodland Hills, San Diego, San Francisco, St. Helena, Santa Rosa, and Pleasanton. Office locations outside of California within the United States include: Tempe, Arizona; Broomfield, Colorado; Atlanta, Georgia; Chicago, Illinois; Newton, Massachusetts; Minnetonka, Minnesota; New York, New York; Chapel Hill, North Carolina; Beaverton, Oregon; Randor, Pennsylvania; Austin, Texas; Dallas, Texas; Salt Lake City, Utah; Vienna, Virginia; and Seattle, Washington. Our five foreign offices are located in: Shanghai, China; Bangalore and Mumbai, India; Hertzelia Pituach, Israel; and London, England. All of our properties are occupied under leases, which expire at various dates through 2014, and in most instances include options to renew or extend at market rates and terms. We also own leasehold improvements, equipment, furniture, and fixtures at our offices, all of which are used in our business activities.
Our Commercial Banking operations are principally conducted out of our corporate headquarters in Santa Clara, and the lending teams operate out of the various regional offices. SVB Capital principally operates out of our office in Palo Alto. Our other businesses operate out of various offices, including SVB Private Client Services in our Santa Clara office, SVB Global in Palo Alto and our international local offices, and SVB Analytics in San Francisco. Prior to our announcement of the cessation of operations at SVB Alliant in July 2007, SVB Alliant operated out of an office in Palo Alto.
We believe that our properties are in good condition and suitable for the conduct of our business.
| Item 3. | Legal Proceedings |
On October 4, 2007, a consolidated class action was filed in the United States District Court for the Central District of California, purportedly on behalf of a class of investors who purchased the common stock of Vitesse Semiconductor Corporation (“Vitesse”). The complaint asserted claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, against Vitesse, the Bank and other named defendants in connection with alleged fraudulent recognition of revenue by Vitesse, specifically with respect to sales of certain accounts receivable to the Bank. The relief sought under the complaint included rescission of the Vitesse shares held by plaintiffs and other class members or the appropriate measure of damages, as well as prejudgment and post-judgment interest and certain fees, costs and expenses. On January 28, 2008, the court dismissed with prejudice all claims against the Bank under the action.
Additionally, certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against us or our affiliates. Based upon information available to us, our review of such claims to date and consultation with our outside legal counsel, management believes the liability relating to these actions, if any, will not have a material adverse effect on our liquidity, consolidated financial position, and/or results of operations. Where appropriate, as we determine, we establish reserves in accordance with SFAS No. 5, Accounting for Contingencies (“SFAS No. 5”). The outcome of litigation and other legal and regulatory matters is inherently uncertain, however, and it is possible that one or more of the legal or regulatory matters currently pending or threatened could have a material adverse effect on our liquidity, consolidated financial position, and/or results of operation.
| Item 4. | Submission of Matters to a Vote of Security Holders |
None.
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PART II
| Item 5. | Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market Information
Our common stock is traded on the NASDAQ Global Select Market under the symbol SIVB. The per share range of high and low sale prices for our common stock as reported on the NASDAQ Global Select Market, for each full quarterly period over the years ended December 31, 2007 and 2006, was as follows:
| 2007 | 2006 | |||||||||||
| Three Months Ended: |
Low | High | Low | High | ||||||||
| March 31 |
$ | 46.21 | $ | 50.25 | $ | 45.70 | $ | 53.46 | ||||
| June 30 |
47.63 | 54.13 | 44.18 | 54.52 | ||||||||
| September 30 |
46.37 | 54.65 | 44.05 | 46.60 | ||||||||
| December 31 |
$ | 46.61 | $ | 52.74 | $ | 43.91 | $ | 48.60 | ||||
Holders
There were 958 registered holders of our stock as of January 31, 2008. Additionally, we believe there were approximately 43,934 beneficial holders of common stock whose shares were held in the name of brokerage firms or other financial institutions. We are not provided with the number or identities of all of these stockholders, but we have estimated the number of such stockholders from the number of stockholder documents requested by these brokerage firms for distribution to their customers.
Dividends
We have not paid cash dividends on our common stock since 1992. Currently, we have no plans to pay cash dividends on our common stock. Our Board of Directors may periodically evaluate whether to pay cash dividends, taking into consideration such factors as it considers relevant, including our current and projected financial performance, our projected sources and uses of capital, general economic conditions, considerations relating to our current and potential stockholder base, and relevant tax laws. Our ability to pay cash dividends is limited by generally applicable corporate and banking laws and regulations. See “Business-Supervision and Regulation—Restrictions on Dividends” under Part I, Item 1 of this report and Note 21 (Regulatory Matters) of the “Notes to the Consolidated Financial Statements” under Part II, Item 8 in this report for additional discussion on restrictions and limitations on the payment of dividends imposed on us by government regulations.
Securities Authorized for Issuance Under Equity Compensation Plans
The information required by this Item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 of this Annual Report on Form 10-K.
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Stock Repurchases
The following table presents stock repurchases by month during the fourth quarter of 2007:
| Period |
Total Number of Shares Purchased |
Average Price Paid per Share |
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1) |
Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1) | ||||||
| October 1, 2007 – October 31, 2007 |
303,969 | $ | 49.04 | 303,969 | $ | 184,266,350 | ||||
| November 1, 2007 – November 30, 2007 |
315,800 | 49.80 | 315,800 | 168,540,621 | ||||||
| December 1, 2007 – December 31, 2007 |
368,585 | 50.98 | 368,585 | $ | 149,749,798 | |||||
| Total |
988,354 | $ | 50.00 | 988,354 | ||||||
| (1) | On July 26, 2007, our Board of Directors approved a stock repurchase program authorizing us to purchase up to $250.0 million of our common stock. This program replaced all stock repurchase programs previously in place. During 2007, we repurchased 2.9 million shares of our common stock totaling $146.8 million under the current stock repurchase program and the previous program. At December 31, 2007, $149.7 million of shares remained authorized for repurchase under our stock repurchase program. |
Recent Sales of Unregistered Securities
None.
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Performance Graph
The following information is not deemed to be “soliciting material” or “filed” with the SEC or subject to the liabilities of Section 18 of the Exchange Act, and the report shall not be deemed to be incorporated by reference into any prior or subsequent filing by the Company under the Securities Act or the Exchange Act.
The following graph compares, for the period from December 31, 2002 through December 31, 2007, the cumulative total stockholder return on the common stock of the Company with (i) the cumulative total return of the Standard and Poor’s 500 (“S&P 500”) Index, (ii) the cumulative total return of the Nasdaq Composite index, and (iii) the cumulative total return of the Nasdaq Bank Index. The graph assumes an initial investment of $100 and reinvestment of dividends. The graph is not necessarily indicative of future stock price performance.
Comparison of 5 Year Cumulative Total Return*
Among SVB Financial Group, the S&P 500 Index,
the NASDAQ Stock Market-US Index, and the NASDAQ Bank Index
| * | $100 invested on 12/31/02 in stock or index-including reinvestment of dividends |
Fiscal year ending December 31.
Copyright ©2007, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.
| December 31, | ||||||||||||
| 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | |||||||
| SVB Financial Group |
100.00 | 197.64 | 245.59 | 256.66 | 255.45 | 276.16 | ||||||
| S&P 500 |
100.00 | 128.68 | 142.69 | 149.70 | 173.34 | 182.87 | ||||||
| NASDAQ Composite |
100.00 | 149.75 | 164.64 | 168.60 | 187.83 | 205.22 | ||||||
| NASDAQ Bank |
100.00 | 130.51 | 144.96 | 141.92 | 159.42 | 125.80 | ||||||
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| Item 6. | Selected Consolidated Financial Data |
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and supplementary data as presented in Item 8 of this Annual Report on Form 10-K. Information as of and for the years ended December 31, 2007, 2006 and 2005 is derived from audited financial statements presented separately herein, while information as of and for the years ended December 31, 2004 and 2003 is derived from audited financial statements not presented separately within.
| Year ended December 31, | ||||||||||||||||||||
| (Dollars in thousands, except per share amounts and ratios) |
2007 | 2006 | 2005 | 2004 | 2003 | |||||||||||||||
| Income Statement Summary: |
||||||||||||||||||||
| Net interest income |
$ | 380,933 | $ | 352,457 | $ | 299,293 | $ | 229,477 | $ | 183,138 | ||||||||||
| (Provision for) recovery of loan losses |
(16,836 | ) | (9,877 | ) | (237 | ) | 10,289 | 9,892 | ||||||||||||
| Noninterest income |
221,384 | 141,206 | 117,495 | 107,774 | 81,393 | |||||||||||||||
| Noninterest expense excluding impairment of goodwill |
(329,265 | ) | (304,069 | ) | (259,860 | ) | (239,920 | ) | (201,896 | ) | ||||||||||
| Impairment of goodwill |
(17,204 | ) | (18,434 | ) | — | (1,910 | ) | (63,000 | ) | |||||||||||
| Minority interest in net (income)/losses of consolidated affiliates |
(28,596 | ) | (6,308 | ) | (3,396 | ) | (3,090 | ) | 7,689 | |||||||||||
| Income before income tax expense |
210,416 | 154,975 | 153,295 | 102,620 | 17,216 | |||||||||||||||
| Income tax expense |
(86,778 | ) | (65,782 | ) | (60,758 | ) | (38,754 | ) | (4,174 | ) | ||||||||||
| Net income before cumulative effect of change in accounting principle |
123,638 | 89,193 | 92,537 | 63,866 | 13,042 | |||||||||||||||
| Cumulative effect of change in accounting principle, net of tax |
— | 192 | — | — | — | |||||||||||||||
| Net income |
$ | 123,638 | $ | 89,385 | $ | 92,537 | $ | 63,866 | $ | 13,042 | ||||||||||
| Common Share Summary: |
||||||||||||||||||||
| Earnings per common share—basic, before cumulative effect of change in accounting principle |
$ | 3.64 | $ | 2.57 | $ | 2.64 | $ | 1.81 | $ | 0.36 | ||||||||||
| Earnings per common share—diluted, before cumulative effect of change in accounting principle |
3.37 | 2.37 | 2.40 | 1.70 | 0.35 | |||||||||||||||
| Earnings per common share—basic |
3.64 | 2.58 | 2.64 | 1.81 | 0.36 | |||||||||||||||
| Earnings per common share—diluted |
3.37 | 2.38 | 2.40 | 1.70 | 0.35 | |||||||||||||||
| Book value per share |
20.71 | 18.27 | 16.19 | 15.07 | 13.07 | |||||||||||||||
| Weighted average shares outstanding-basic |
33,949,654 | 34,680,522 | 35,114,574 | 35,215,483 | 36,109,404 | |||||||||||||||
| Weighted average shares outstanding-diluted |
36,737,507 | 37,614,646 | 38,489,189 | 37,512,267 | 37,231,250 | |||||||||||||||
| Year-End Balance Sheet Summary: |
||||||||||||||||||||
| Investment Securities |
$ | 1,602,574 | $ | 1,692,343 | $ | 2,037,270 | $ | 2,054,202 | $ | 1,519,935 | ||||||||||
| Loans, net of unearned income |
4,151,730 | 3,482,402 | 2,843,353 | 2,308,588 | 1,987,146 | |||||||||||||||
| Goodwill |
4,092 | 21,296 | 35,638 | 35,638 | 37,547 | |||||||||||||||
| Total assets |
6,692,456 | 6,081,452 | 5,541,715 | 5,145,679 | 4,468,410 | |||||||||||||||
| Deposits |
4,611,203 | 4,057,625 | 4,252,730 | 4,219,514 | 3,666,841 | |||||||||||||||
| Short-term borrowings and other long-term debt |
242,669 | 836,206 | 279,475 | 9,820 | 17,961 | |||||||||||||||
| Senior and subordinated notes (1) |
520,805 | — | — | — | — | |||||||||||||||
| Contingently convertible debt |
149,269 | 148,441 | 147,604 | 146,740 | 145,797 | |||||||||||||||
| Junior subordinated debentures |
52,511 | 51,355 | 48,228 | 49,470 | 49,118 | |||||||||||||||
| Stockholders’ equity |
$ | 676,654 | $ | 628,514 | $ | 569,301 | $ | 541,948 | $ | 457,953 | ||||||||||
| Average Balance Sheet Summary: |
||||||||||||||||||||
| Investment Securities |
$ | 1,364,461 | $ | 1,684,178 | $ | 1,948,178 | $ | 1,753,920 | $ | 1,125,039 | ||||||||||
| Loans, net of unearned income |
3,522,326 | 2,882,088 | 2,368,362 | 1,951,655 | 1,797,990 | |||||||||||||||
| Goodwill |
12,576 | 27,653 | 35,638 | 37,066 | 91,992 | |||||||||||||||
| Total assets |
6,020,117 | 5,387,435 | 5,189,777 | 4,772,909 | 4,056,468 | |||||||||||||||
| Deposits |
3,962,260 | 3,921,857 | 4,166,476 | 3,905,408 | 3,277,566 | |||||||||||||||
| Short-term borrowings and other long-term debt |
472,798 | 418,654 | 77,534 | 16,605 | 40,903 | |||||||||||||||
| Senior and subordinated notes (1) |
313,148 | — | — | — | — | |||||||||||||||
| Contingently convertible debt |
148,877 | 148,002 | 147,181 | 146,255 | 73,791 | |||||||||||||||
| Junior subordinated debentures |
50,894 | 50,223 | 49,309 | 49,366 | 23,823 | |||||||||||||||
| Trust preferred securities (2) |
— | — | — | — | 19,193 | |||||||||||||||
| Stockholders’ equity |
$ | 669,333 | $ | 589,206 | $ | 541,426 | $ | 495,203 | $ | 504,632 | ||||||||||
| Capital Ratios: |
||||||||||||||||||||
| Total risk-based capital ratio |
16.02 | % | 13.95 | % | 14.75 | % | 16.09 | % | 16.83 | % | ||||||||||
| Tier 1 risk-based capital ratio |
11.07 | 12.34 | 12.39 | 12.75 | 12.23 | |||||||||||||||
| Tier 1 leverage ratio |
11.91 | 12.46 | 11.64 | 11.17 | 10.62 | |||||||||||||||
| Average stockholders’ equity to average assets |
11.12 | % | 10.94 | % | 10.43 | % | 10.38 | % | 12.44 | % | ||||||||||
| Selected Financial Results: |
||||||||||||||||||||
| Return on average assets |
2.05 | % | 1.66 | % | 1.78 | % | 1.34 | % | 0.32 | % | ||||||||||
| Return on average stockholders' equity |
18.47 | 15.17 | 17.09 | 12.90 | 2.58 | |||||||||||||||
| Net interest margin |
7.29 | 7.38 | 6.46 | 5.39 | 5.16 | |||||||||||||||
| Net (charge-offs) recoveries to average total loans |
(0.35 | ) | (0.14 | ) | (0.04 | ) | (0.10 | ) | 0.08 | |||||||||||
| Nonperforming assets as a percentage of total assets |
0.14 | 0.27 | 0.25 | 0.29 | 0.28 | |||||||||||||||
| Allowance for loan losses as a percentage of total gross loans |
1.13 | % | 1.22 | % | 1.28 | % | 1.62 | % | 2.49 | % | ||||||||||
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| Year ended December 31, | |||||||||||||||
| (Dollars in millions) |
2007 | 2006 | 2005 | 2004 | 2003 | ||||||||||
| Other Data: |
|||||||||||||||
| Client investment funds: |
|||||||||||||||
| Client directed investment assets |
$ | 13,049 | $ | 11,221 | $ | 8,863 | $ | 7,208 | $ | 7,615 | |||||
| Client investment assets under management |
6,422 | 5,166 | 3,857 | 2,678 | 592 | ||||||||||
| Sweep money market funds |
2,721 | 2,573 | 2,247 | 1,351 | 1,139 | ||||||||||
| Total client investment funds |
$ | 22,192 | $ | 18,960 | $ | 14,967 | $ | 11,237 | $ | 9,346 | |||||
| (1) | Included in our senior and subordinated notes balance are shortcut method adjustments for the corresponding hedging interest rate swaps recorded as a component of other assets on the balance sheet. |
| (2) | Adoption of FASB Interpretation (“FIN”) No. 46 (revised 2003), Consolidation of Variable Interest Entities (“FIN 46R”) in December 2003 and SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS No. 150”) in May 2003 resulted in a change of classification of trust preferred securities distribution expense from noninterest expense to interest expense on a prospective basis. Additionally, the adoption of FIN 46R and SFAS No. 150 resulted in a change of classification of trust preferred securities from noninterest bearing funding sources to interest-bearing liabilities on a prospective basis. Prior to adoption of FIN 46R and SFAS No. 150, in accordance with accounting rules in effect at that time, we recorded trust preferred securities distribution expense as noninterest expense. On October 30, 2003, $50.0 million in cumulative 7.0% trust preferred securities were issued through a newly formed special purpose trust, SVB Capital II. We received $51.5 million in proceeds from the issuance of 7.0% junior subordinated debentures to SVB Capital II. A portion of the net proceeds were used to repay $40.0 million of the 8.25% trust preferred securities. Approximately $1.3 million of deferred issuance costs related to redemption of the $40.0 million of the 8.25% trust preferred securities were included in interest expense in the fourth quarter of 2003. |
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| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Management’s discussion and analysis of Financial Condition and Results of Operations below contain forward-looking statements. These statements are based on current expectations and assumptions, which are subject to risks and uncertainties. See our cautionary language at the beginning of this Annual Report on Form 10-K. Actual results could differ materially because of various factors, including but not limited to those discussed in Item 1A. Risk Factors.
The following discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated financial statements and supplementary data as presented in Item 8 of this Annual Report on Form 10-K. Certain reclassifications have been made to our prior years’ results to conform to 2007 presentations. Such reclassifications had no effect on our results of operations or stockholders’ equity.
Overview of Company Operations
SVB Financial Group is a diversified financial services company, as well as a bank holding company and financial holding company. The company was incorporated in the state of Delaware in March 1999. Through our various subsidiaries and divisions, we offer a variety of banking and financial products and services. For 25 years, we have been dedicated to helping entrepreneurs succeed, especially in the technology, life science, private equity and premium wine industries. We provide our clients with a diversity of products and services to support them throughout their life cycles, regardless of their size or stage of maturity.
We offer commercial banking products and services through our principal subsidiary, the Bank, which is a California-state chartered bank founded in 1983 and a member of the Federal Reserve System. Through its subsidiaries, the Bank also offers brokerage, investment advisory and asset management services. We also offer non-banking products and services, such as funds management, private equity investment and equity valuation services, through our other subsidiaries and divisions.
Management’s Overview of 2007 Performance
Our primary or “core” business consists of providing banking products and services to our clients in the technology, life science, private equity and premium wine industries. We believe that this core banking business performed well during 2007, compared to 2006. We grew our earnings to $123.6 million or $3.37 per diluted common share in 2007, compared to $89.4 million or $2.38 per diluted common share in 2006.
We believe that our strong performance in 2007 was a result of our focus on five primary objectives: 1) growing loans to private equity and later-stage corporate technology clients, 2) maintaining credit quality at high levels, 3) new deposit product initiatives, 4) growing noninterest income, and 5) controlling noninterest expense growth.
We experienced strong average loan growth and continued to experience excellent credit quality. Though average deposits grew only slightly in 2007, compared to 2006, we experienced strong growth in period-end deposits primarily due to the introduction of two new deposit products in mid-to-late 2007.
We also had strong growth in noninterest income in 2007 driven by higher gains from investment securities as well as gains from derivative instruments, primarily our equity warrant assets. We also had increases in our core fee-based products, which include client investment fees, foreign exchange fees, deposit services charges and letter of credit income. We controlled our noninterest expense growth in 2007 and improved our operating efficiency ratio. The increase in noninterest expense in 2007 primarily related to higher compensation costs related to our strong financial performance.
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The key highlights of our performance in 2007 and 2006 were as follows:
| December 31, | |||||||||||||
| (Dollars in thousands) |
2007 | 2006 | Change | ||||||||||
| Average loans, net of unearned income |
$ | 3,522,326 | $ | 2,882,088 | 22.2 | % | |||||||
| Average noninterest-bearing deposits |
2,864,153 | 2,785,948 | 2.8 | ||||||||||
| Average interest-bearing deposits |
1,098,107 | 1,135,909 | (3.3 | ) | |||||||||
| Average total deposits |
$ | 3,962,260 | $ | 3,921,857 | 1.0 | % | |||||||
| Period end loans, net of unearned income |
$ | 4,151,730 | $ | 3,482,402 | 19.2 | % | |||||||
| Period end goodwill balance |
4,092 | 21,296 | (80.8 | ) | |||||||||
| Period end noninterest-bearing deposits |
3,226,859 | 3,039,528 | 6.2 | ||||||||||
| Period end interest-bearing deposits |
1,384,344 | 1,018,097 | 36.0 | ||||||||||
| Period end total deposits |
$ | 4,611,203 | $ | 4,057,625 | 13.6 | % | |||||||
| Net interest income |
$ | 380,933 | $ | 352,457 | 8.1 | % | |||||||
| Net interest margin |
7.29 | % | 7.38 | % | (9 | ) | bps | ||||||
| Provision for loan losses |
$ | 16,836 | $ | 9,877 | 70.5 | % | |||||||
| Net charge-offs as a percentage of total gross loans |
0.29 | % | 0.11 | % | 18 | bps | |||||||
| Noninterest income (1) |
$ | 221,384 | $ | 141,206 | 56.8 | % | |||||||
| Noninterest expense (2) |
$ | 346,469 | $ | 322,503 | 7.4 | ||||||||
| Return on average stockholders’ equity |
18.47 | % | 15.17 | % | 21.8 | ||||||||
| Return on average assets |
2.05 | % | 1.66 | % | 23.5 | ||||||||
| Operating efficiency ratio (3) |
56.46 | % | 61.72 | % | (8.5 | ) | |||||||
| Full-time equivalent employees |
1,128 | 1,140 | (1.1 | ) | % | ||||||||
| (1) | Noninterest income included $35.5 million and $9.9 million attributable to minority interests for the years ended December 31, 2007 and 2006, respectively. |
| (2) | Noninterest expense included goodwill impairment charges of $17.2 million and $18.4 million for the years ended December 31, 2007 and 2006, respectively. Noninterest expense also included $10.7 million and $5.9 million attributable to minority interests for the years ended December 31, 2007 and 2006, respectively. |
| (3) | The operating efficiency ratio is calculated by dividing noninterest expense (excluding goodwill impairment charges of $17.2 million and $18.4 million for the years ended December 31, 2007 and 2006, respectively, and noninterest expense attributable to minority interests of $10.7 million and $5.9 million, respectively) by total taxable-equivalent revenue (excluding taxable-equivalent revenue attributable to minority interests of $39.3 million and $12.2 million for the years ended December 31, 2007 and 2006, respectively). |
Critical Accounting Policies and Estimates
Our accounting policies are fundamental to understanding our financial condition and results of operations. We have identified six policies as being critical because they require our management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. We evaluate our estimates and assumptions on an ongoing basis and we base these estimates on historical experiences and various other factors and assumptions that are believed to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions.
Our senior management has discussed the development, selection, application and disclosure of these critical accounting policies with the Audit Committee of our Board of Directors.
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Non-Marketable Securities
Non-marketable securities include investments in funds of funds, co-investment funds, sponsored debt funds and direct equity investments in companies. Our accounting for investments in non-marketable securities depends on several factors, including our level of ownership/control and the legal structure of our subsidiary making the investment. Based on these factors, we account for our non-marketable securities using one of three different methods: (i) investment company fair value accounting; (ii) equity method accounting; or (iii) cost method accounting. The carrying value of our non-marketable securities at December 31, 2007 and 2006 was as follows:
| December 31, | ||||||
| (Dollars in thousands) |
2007 | 2006 | ||||
| Non-marketable securities: |
||||||
| Investment company fair value accounting |
$ | 255,405 | $ | 174,782 | ||
| Equity method accounting |
45,790 | 38,374 | ||||
| Cost method accounting |
42,273 | 33,732 | ||||
| Total non-marketable securities |
$ | 343,468 | $ | 246,888 | ||
Our non-marketable securities carried under investment company fair value accounting are carried at estimated fair value at each balance sheet date based primarily on financial information obtained as the general partner of the fund or obtained from the fund’s respective general partner. Fair value is the amount that would be received to sell the non-marketable securities in an orderly transaction between market participants at the measurement date. We have retained the specialized accounting of our consolidated funds pursuant to EITF Issue No. 85-12, Retention of Specialized Accounting for Investments in Consolidation.
For direct private company investments, valuations are based upon consideration of a range of factors including, but not limited to, the price at which the investment was acquired, the term and nature of the investment, local market conditions, values for comparable securities, current and projected operating performance, exit strategies and financing transactions subsequent to the acquisition of the investment. These valuation methodologies involve a significant degree of management judgment. We consider our accounting policy for our non-marketable securities carried under investment company fair value to be critical as estimating the fair value of these investments requires management to make assumptions regarding future performance, financial condition, and relevant market conditions, along with other pertinent information.
The valuation of our private equity funds is primarily based upon our pro-rata share of the fair market value of the net assets of a private fund as determined by such private fund on the valuation date. There is a time lag of one quarter in our receipt of financial information from the investee’s general partner, which we use as the primary basis for valuation of these investments.
Under our equity method accounting, we recognize our proportionate share of the results of operations of each equity method investee in our results of operations.
Under our cost method accounting, we record investments at cost and recognize as income distributions or returns received from net accumulated earnings of the investee since the date of acquisition.
We review our equity and cost method securities at least quarterly for indications of impairment, which requires significant judgment. Indications of impairment include an analysis of facts and circumstances of each investment, the expectations of the investment’s future cash flows and capital needs, variability of its business and the company’s exit strategy. Investments identified as having an indication of impairment are reviewed further to determine if the investment is other than temporarily impaired. We reduce the investment value when we consider declines in value to be other than temporary and we recognize the estimated loss as a loss on investment securities, which is a component of noninterest income.
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We consider our accounting policy for our non-marketable securities to be critical because the valuation of our non-marketable securities is subject to management judgment. The inherent uncertainty in the process of valuing securities for which a ready market is unavailable may cause our estimated values of these securities to differ significantly from the values that would have been derived had a ready market for the securities existed, and those differences could be material. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in their carrying value, thereby possibly requiring an impairment charge in the future. There can be no assurances that we will realize the full value of our non-marketable securities, which could result in significant losses.
Derivative Assets—Equity Warrant Assets for Shares of Privately- and Publicly-held Companies
As part of negotiated credit facilities and certain other services, we frequently obtain rights to acquire stock in the form of equity warrant assets in certain client companies. Equity warrant assets for shares of private and public companies are recorded at fair value on the grant date and adjusted to fair value on a quarterly basis through consolidated net income. At December 31, 2007, our equity warrant assets totaled $31.3 million, compared to $37.7 million at December 31, 2006.
We account for equity warrant assets with net settlement terms in certain private and public client companies as derivatives. In general, equity warrant assets entitle us to buy a specific number of shares of stock at a specific price within a specific time period. Certain equity warrant assets contain contingent provisions, which adjust the underlying number of shares or purchase price upon the occurrence of certain future events. Our warrant agreements contain net share settlement provisions, which permit us to receive at exercise a share count equal to the intrinsic value of the warrant divided by the share price (otherwise known as a “cashless” exercise). Because we can net settle our warrant agreements, our equity warrant assets qualify as derivative instruments in accordance with the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS No. 133”).
The fair value of the equity warrant assets portfolio is reviewed quarterly. We value our equity warrant assets using a modified Black-Scholes option pricing model, which incorporates the following material assumptions:
| • | Underlying asset value was estimated based on information available, including any information regarding subsequent rounds of funding. |
| • | Volatility, or the amount of uncertainty or risk about the size of the changes in the warrant price, was based on guidelines for publicly traded companies within indices similar in nature to the underlying client companies issuing the warrant. A total of six such indices were used. The volatility assumption was based on the median volatility for an individual public company within an index for the past 16 quarters, from which an average volatility was derived. The weighted average quarterly median volatility assumption used for the warrant valuation at December 31, 2007 was 39.7%, compared to 42.1% at December 31, 2006. |
| • | Actual data on cancellations and exercises of our equity warrant assets was utilized as the basis for determining the expected remaining life of the equity warrant assets in each financial reporting period. Equity warrant assets may be exercised in the event of acquisitions, mergers or IPOs, and cancelled due to events such as bankruptcies, restructuring activities or additional financings. These events cause the expected remaining life assumption to be shorter than the contractual term of the warrants. This assumption reduced the reported value of the warrant portfolio by $11.8 million at December 31, 2007, compared to a reduction of $12.4 million at December 31, 2006. |
| • | The risk-free interest rate was derived from the U.S. Treasury yield curve. The risk-free interest rate was calculated based on a weighted average of the risk-free interest rates that correspond closest to the expected remaining life of the warrant. The risk-free interest rate used for the warrant valuation at December 31, 2007 was 3.2%, compared to 4.8% at December 31, 2006. |
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| • | Other adjustments, including a marketability discount, were estimated based on management’s judgment about the general industry environment, combined with specific information about the issuing company, when available. |
The fair value of our equity warrant assets recorded on our balance sheets represents our best estimate of the fair value of these instruments. Changes in the above material assumptions may result in significantly different valuations. For example, the following table demonstrates the effect of changes in the risk-free interest rate and volatility assumptions:
Valuation of equity warrant assets held by SVB Financial Group active at December 31, 2007 is as follows (1):
| Volatility Factor | |||||||||
| (Dollars in millions) |
10% Lower | Current (39.7%) |
10% Higher | ||||||
| Risk Free Interest Rate: |
|||||||||
| Less 100 basis points |
$ | 28.8 | $ | 30.5 | $ | 32.4 | |||
| Current rate (3.2%) |
29.7 | 31.3 | 33.2 | ||||||
| Plus 100 basis points |
$ | 30.6 | $ | 32.2 | $ | 34.0 | |||
| (1) | The above table does not include equity warrant assets at December 31, 2007 held by Partners for Growth, LP, which were valued at $2.5 million, based on 38.0% volatility and a 3.2% risk-free interest rate. |
The timing and value realized from the disposition of equity warrant assets depend upon factors beyond our control, including the performance of the underlying portfolio companies, investor demand for IPOs, fluctuations in the market prices of the underlying common stock of these companies, levels of mergers and acquisitions activity, and legal and contractual restrictions on our ability to sell the underlying securities. All of these factors are difficult to predict. Many equity warrant assets may be terminated or may expire without compensation and may incur valuation losses from lower-priced funding rounds. We are unable to predict future gains or losses with accuracy, and gains or losses could vary materially from period to period.
We consider accounting policies related to equity warrant assets to be critical as the valuation of these assets is complex and subject to a certain degree of management judgment. Management has the ability to select from several valuation methodologies and has alternative approaches in the calculation of material assumptions. The selection of an alternative valuation methodology or alternative approaches used to calculate material assumptions in the current methodology may cause our estimated values of these assets to differ significantly from the values recorded. Additionally, the inherent uncertainty in the process of valuing these assets for which a ready market is unavailable may cause our estimated values of these assets to differ significantly from the values that would have been derived had a ready market for the assets existed, and those differences could be material. Further, the fair value of equity warrant assets may never be realized, which could result in significant losses.
Allowance for Loan Losses
At December 31, 2007, our allowance for loan losses totaled $47.3 million, compared to $42.7 million at December 31, 2006. The allowance for loan losses is management’s estimate of credit losses inherent in the loan portfolio at a balance sheet date.
We consider our accounting policy for the allowance for loan losses to be critical as estimation of the allowance involves material estimates by our management and is particularly susceptible to significant changes in the near term. Determining the allowance for loan losses requires us to make forecasts that are highly uncertain and require a high degree of judgment. Our loan loss reserve methodology is applied to our allowance for loan losses and we maintain the balances at levels that we believe are adequate to absorb estimated probable losses inherent in our loan portfolios.
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Our allowance for loan losses is established for loan losses that are probable but not yet realized. The process of anticipating loan losses is imprecise. Our management applies a systematic process for the evaluation of individual loans and pools of loans for inherent risk of loan losses. On a quarterly basis, each loan in our portfolio is assigned a credit risk rating through an evaluation process, which includes consideration of such factors as payment status, the financial condition of the borrower, borrower compliance with loan covenants, underlying collateral values, potential loan concentrations, and general economic conditions. The allowance for loan losses is based on a formula allocation for similarly risk-rated loans by client industry sector and individually for impaired loans as determined by SFAS No. 114, Accounting by Creditors for Impairment of a Loan (“SFAS No. 114”), and SFAS No. 5.
Our evaluation process is designed to determine the adequacy of the allowance for loan losses. We assess the risk of losses inherent in the loan portfolio on a quarterly basis by utilizing a historical loan loss migration model, which is a statistical model used to estimate an appropriate allowance for outstanding loan balances by calculating the likelihood of a loan becoming charged-off based on its credit risk rating using historical loan performance data from our portfolio. Loan loss factors for each risk-rating category and client industry sector are ultimately applied to the respective period-end client loan balances for each corresponding risk-rating category by client industry sector to provide an estimation of the allowance for loan losses.
We apply macro allocations to the results we obtained through our historical loan loss migration model to ascertain the total allowance for loan losses. These macro allocations are based upon management’s assessment of the risks that may lead to a future loan loss experience different from our historical loan loss experience. These risks are aggregated to become our macro allocation. Based on management’s prediction or estimate of changing risks in the lending environment, the macro allocation may vary significantly from period to period and includes, but is not limited to, consideration of the following factors:
| • | Changes in lending policies and procedures, including underwriting standards and collections, and charge-off and recovery practices; |
| • | Changes in national and local economic business conditions, including the market and economic condition of our clients’ industry sectors; |
| • | Changes in the nature of our loan portfolio; |
| • | Changes in experience, ability, and depth of lending management and staff; |
| • | Changes in the trend of the volume and severity of past due and classified loans; |
| • | Changes in the trend of the volume of nonaccrual loans, troubled debt restructurings, and other loan modifications; and |
| • | Other factors as determined by management from time to time. |
Finally, we compute several modified versions of the model, which provide additional assurance that the statistical results of the historical loan loss migration model are reasonable. A committee comprised of senior management evaluates the adequacy of the allowance for loan losses based on the results of our analysis.
Reserve for Unfunded Credit Commitments
The level of the reserve for unfunded credit commitments is determined following a methodology that parallels that used for the allowance for loan losses. We consider our accounting policy for the reserve for unfunded credit commitments to be critical as estimation of the reserve involves material estimates by our management and is particularly susceptible to significant changes in the near term. We record a liability for probable and estimatable losses associated with our unfunded credit commitments. Each quarter, every unfunded client credit commitment is allocated to a credit risk-rating category in accordance with each client’s credit risk rating. We use the historical loan loss factors described under our allowance for loan losses to calculate the possible loan loss experience if unfunded credit commitments are funded. Separately, we use historical trends to calculate the probability of an unfunded credit commitment being funded. We apply the loan funding probability factor to risk-factor adjusted unfunded credit commitments by credit risk-rating to derive the reserve for
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unfunded credit commitments. The reserve for unfunded credit commitments may also include certain macro allocations as deemed appropriate by management. Our reserve for unfunded credit commitments totaled $13.4 million and $14.7 million at December 31, 2007 and 2006 respectively, and is reflected in other liabilities on our balance sheet.
Goodwill
Goodwill, which arises when the purchase price exceeds the assigned value of the net assets of an acquired business, represents the value attributable to unidentifiable intangible elements being acquired. At December 31, 2007, our consolidated balance sheet included $4.1 million of goodwill, which related to the acquisition of a majority ownership interest in eProsper in 2006, our equity ownership data management services company. Goodwill at December 31, 2006 totaled $21.3 million, which related to the acquisitions of SVB Alliant and eProsper.
On an annual basis or as circumstances dictate, management reviews goodwill and evaluates events or other developments that may indicate an impairment in the carrying amount. We consider our accounting policy on goodwill to be critical because the valuation methodology for potential impairments is inherently complex and involves significant management judgment in the use of estimates and assumptions.
The impairment tests for goodwill are performed at the reporting unit level and require us to perform a two-step impairment test. First, we compare the aggregate fair value of our reporting unit to its carrying amount including goodwill. If the fair value exceeds the carrying amount, no impairment exists. If the carrying amount of the reporting unit exceeds the fair value, then we perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. We estimate the reporting unit’s implied fair value by using a discounted cash flow approach. These estimates involve many assumptions, including expected results of operations and assumed discount rates. These discount rates are based on standard industry practice, taking into account the expected equity risk premium, the size of the business and the probability of the reporting unit achieving its financial forecasts. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value, then a goodwill impairment is recognized by writing goodwill down to the implied fair value.
Events that may indicate a goodwill impairment include significant or adverse changes in the results of operations of the business, or in the economic or political climate, an adverse action or assessment by a regulator, unanticipated competition, and a more-likely-than-not expectation that a reporting unit will be sold or disposed of. As a result of our annual impairment test for SVB Alliant conducted in the second quarter of 2007, we recognized a pre-tax impairment charge of $17.2 million due to changes in our outlook for SVB Alliant’s future financial performance. Subsequently, in July 2007, we reached a decision to cease operations at SVB Alliant. See Note 10 (Goodwill) of the “Notes to the Consolidated Financial Statements” under Part II, Item 8 in this report.
Share-Based Compensation
Our share-based compensation expense totaled $14.9 million and $21.3 million in 2007 and 2006, respectively. In accordance with SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”), we measure compensation expense for all employee share-based payment awards using a fair value based method, reduced by estimated award forfeitures, and record such expense in our consolidated statements of operations.
We consider our accounting policy for share-based compensation to be critical as determining the fair value of awards involves the use of significant estimates and assumptions. We use the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase plan shares. The Black-Scholes option-pricing model requires the use of input assumptions, including the expected life, expected price volatility of the underlying stock, expected dividend yield and risk-free interest rate. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. Because our stock options have characteristics significantly different from those of
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traded options, changes to the input assumptions can materially affect the fair value of our employee stock options. SFAS No. 123(R) also requires us to develop an estimate of the number of share-based payment awards which we expect to vest. We consider many factors when estimating expected forfeitures, including the type of award, the employee class and historical experience.
The most significant assumptions impacted by management’s judgment are the expected volatility and the expected life of the options. The expected dividend yield, and expected risk-free interest rate are not as significant to the calculation of fair value. In addition, adjustments to our estimates of the number of share-based payment awards that we expect to vest did not have a significant impact on the recorded share-based compensation expense.
Expected volatility: The value of a stock option is derived from its potential for appreciation. The more volatile the stock, the more valuable the option becomes because of the greater possibility of significant changes in stock price. Our computation of expected volatility is based on a blend of historical volatility of our common stock and implied volatility of traded options to purchase shares of our common stock. Our decision to incorporate implied volatility was based on our assessment that implied volatility of publicly traded options in our common stock is expected to be more reflective of market conditions and, therefore, can reasonably be expected to be a better indicator of expected volatility than historical volatility of our common stock.
Expected life: The expected life also has a significant effect on the value of the option. The longer the term, the more time the option holder has to allow the stock price to increase without a cash investment and thus, the more valuable the option. Further, longer option terms provide more opportunity to exploit market highs. However, employees are not required to wait until the end of the contractual term of a nontransferable option to exercise. Accordingly, we are required to estimate the expected term of the option. When establishing an estimate of the expected life, we bifurcate our option grants into four employee groupings based on exercise behavior and determine the expected life for each group by considering several factors, including historical option exercise behavior, post vesting turnover rates and terms and vesting periods of the options granted.
We review our valuation assumptions at each grant date and, as a result, we are likely to change our valuation assumptions used to value stock based awards granted in future periods. Changes to the input assumptions could materially affect the estimated fair value of our share-based payment awards.
We performed a sensitivity analysis of the impact of increasing and decreasing expected volatility by 10% as well as the impact of increasing and decreasing the weighted average expected life by one year. We performed this analysis on the stock options granted in 2007. The following table shows the impact of these changes on our stock option expense for the options granted in 2007:
| (Dollars in thousands) |
2007 | |||
| Actual stock option expense for 2007 grants |
$ | 4,668 | ||
| Stock option expense increase (decrease) under |
||||
| Volatility decreased by 10% (25.6% to 15.6%) |
(982 | ) | ||
| Volatility increased by 10% (25.6% to 35.6%) |
1,024 | |||
| Average life decreased by 1 year |
(545 | ) | ||
| Average life increased by 1 year |
$ | 500 | ||
Income Taxes
We are subject to income tax laws of the United States, its states and municipalities and those of the foreign jurisdictions in which we operate. Our income tax expense totaled $86.8 million and $65.8 million in 2007 and 2006, respectively.
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Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax-basis carrying amount. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
We consider our accounting policy relating to income taxes to be critical as the determination of current and deferred income taxes is based on complex analyses of many factors including interpretation of federal, state and foreign income tax laws, the difference between tax and financial reporting bases of assets and liabilities (temporary differences), estimates of amounts due or owed, the timing of reversals of temporary differences and current financial accounting standards. Actual results could differ significantly from the estimates due to tax law interpretations used in determining the current and deferred income tax liabilities. Additionally, there can be no assurances that estimates and interpretations used in determining income tax liabilities may not be challenged by federal and state taxing authorities.
In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws. We must also make estimates about when in the future certain items will affect taxable income in the various tax jurisdictions, both domestic and foreign. We evaluate our uncertain tax positions in accordance with FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes (“FIN 48”). We believe that our unrecognized tax benefits, including related interest and penalties, are adequate in relation to the potential for additional tax assessments.
We are also subject to routine corporate tax audits by the various tax jurisdictions. In the preparation of income tax returns, tax positions are taken based on interpretation of federal and state income tax laws as well as foreign tax laws. In accordance with FIN 48, we review our uncertain tax positions quarterly, and we may adjust these unrecognized tax benefits in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact income tax expense in the period in which such determination is made.
Recent Accounting Pronouncements
Please refer to the discussion of our recent accounting pronouncements in Note 2 (Summary of Significant Accounting Policies) of the “Notes to the Consolidated Financial Statements” under Part II, Item 8 in this report.
Results of Operations
Net Interest Income and Margin (Fully Taxable-Equivalent Basis)
Net interest income is defined as the difference between interest earned primarily on loans, investment securities, federal funds sold, securities purchased under agreement to resell and other short-term investment securities, and interest paid on funding sources. Net interest income is our principal source of revenue. Net interest margin is defined as the amount of annualized net interest income, on a fully taxable-equivalent basis, expressed as a percentage of average interest-earning assets. Net interest income and net interest margin are presented on a fully taxable-equivalent basis to consistently reflect income from taxable loans and securities and tax-exempt securities based on the federal statutory tax rate of 35.0 percent.
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Net Interest Income (Fully Taxable-Equivalent Basis)
Net interest income of $382.2 million in 2007 increased by $28.1 million or 7.9 percent, from $354.1 million in 2006, which increased by $52.8 million or 17.5 percent, from $301.3 million in 2005. The increase in net interest income in 2007 was primarily due to a $62.9 million increase in income from our loan portfolio and a $6.7 million increase in income from our short-term investments portfolio, driven primarily by growth in these portfolios. These increases were partially offset by a $27.3 million increase in interest expense and a $14.2 million decrease in interest income from our investment securities portfolio.
The increase in interest income from our loan portfolio in 2007 was primarily related to growth in our loan portfolio and an increase in our average base prime lending rate in 2007, compared to 2006. Average loans outstanding in 2007 totaled $3.52 billion, compared to $2.88 billion in 2006. The increase in average loans outstanding of $640.2 million during 2007 was driven primarily by our commercial loan portfolio, which increased by $554.4 million as a result of our increased focus on serving private equity and later-stage technology clients and loan growth increases from all industry segments we serve, with particularly strong growth in loans to private equity firms and to software clients within the technology sector. Our average base prime lending rate increased to 8.06 percent in 2007 from 7.95 percent in 2006, primarily due to the effect of 2006 rate increases, partially offset by rate decreases in late 2007 in response to Federal Reserve rate cuts. At December 31, 2007, our base prime lending rate was 7.25 percent, compared to 8.25 percent at December 31, 2006. The average yield on our loan portfolio was 10.27 percent in 2007, compared to 10.37 percent in 2006. Loan yields were positively impacted by the full year effect from the Federal Reserve rate increases in 2006. However, these increases were more than offset by increases in loans to our later-stage technology clients and to our private equity clients, which typically earn lower loan yields compared to our other lending products. On an average basis, in 2007, 72.4 percent, or $2.75 billion, of our average outstanding gross loans were variable-rate loans that adjust at a prescribed measurement date upon a change in our prime-lending rate or other variable indices, compared to 74.3 percent or $2.34 billion, for 2006.
The increase in interest income from our short-term investments portfolio in 2007 was primarily driven by higher cash balances available within our portfolios as a result of increase in our deposit products, as well as from the issuance of our long-term debt in May 2007.
The increase in interest expense in 2007 is primarily related to increases in interest expense from long-term debt and deposits, partially offset by a decrease in interest expense from short-term borrowings. Average long-term debt increased by $449.6 million to $665.6 million, primarily due to the issuance of $500 million of long-term debt in May 2007 and the utilization of $150 million of long-term Federal Home Loan Bank (“FHLB”) advances beginning in the fourth quarter of 2006. The proceeds from the long-term debt issued in May 2007 were used to fund loan growth and to pay down our short-term borrowings. As a result, average short-term borrowings decreased by $80.8 million to $320.1 million in 2007, compared to $400.9 million in 2006. Short-term borrowings and FHLB advances were used to fund the growth of our loan portfolio in 2006 and through the first half of 2007. The increase in interest expense from deposits was primarily related to our money market deposit product for early stage clients introduced in May 2007, which bears higher yields compared to our other money market deposit products. For 2007, the average balance of our early stage money market deposit product was $118.7 million and interest expense incurred was $4.1 million. The increase in interest expense from deposits also reflects the initial impact of a Eurodollar sweep deposit product, which is interest-bearing, introduced in late October 2007. For 2007, the average balance of our Eurodollar sweep deposit product was $8.3 million and interest expense incurred was $0.3 million. In addition to interest-bearing deposits, our average noninterest-bearing deposit balances also increased by $78.2 million to $2.86 billion in 2007, compared to $2.79 billion in 2006. The increase in noninterest-bearing deposits was primarily related to increased deposits from our private equity clients in late 2007.
The decrease in interest income from our investment securities portfolio in 2007 reflects lower levels of investment securities due to scheduled maturities and prepayments. Average interest-earning investment
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securities decreased by $319.7 million to $1.36 billion in 2007, compared to $1.68 billion in 2006, as a result of our use of portfolio cash flows to support the growth of our loan portfolio.
The increase in net interest income in 2006, compared to 2005 was primarily due to a $79.7 million increase in income from our loan portfolio, partially offset by a $10.5 million decrease in interest income from our investment securities portfolio and an increase in interest expense of $18.0 million.
The increase in interest income from our loan portfolio in 2006 is primarily related to growth in our loan portfolio as well as the effect of increases in our base prime lending rate during 2006. Average loans outstanding in 2006 totaled $2.88 billion, compared to $2.37 billion in 2005. The increase in average loans outstanding of $513.7 million during 2006 was primarily driven by our commercial loan portfolio, which increased by $450.1 million in 2006 as a result of our increased focus on serving middle-market clients and improvement in economic activity in the markets served by us.
We increased our base prime lending rate four times in 2006, each time by 25 basis points, in response to Federal Reserve rate increases. Our base prime lending rate was 8.25 percent at December 31, 2006, compared to 7.25 percent at December 31, 2005. Our average base prime lending rate increased to 7.95 percent in 2006 from 6.18 percent in 2005. The average yield on our loan portfolio was 10.37 percent in 2006, compared to 9.26 percent in 2005. The increase in interest income from our investment securities portfolio in 2006 was due to higher levels of investment securities, as well as a change in the composition of our investment portfolio.
The increase in interest expense in 2006 was primarily related to increases in short-term borrowings and other long-term debt. Average short-term borrowings increased by $331.4 million in 2006 to $400.9 million while average other long-term debt increased by $9.7 million to $17.7 million.
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Analysis of Interest Changes Due to Volume and Rate (Fully Taxable-Equivalent Basis)
Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as “volume change.” Net interest income is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabilities, referred to as “rate change”. Changes in our prime lending rate also impact the yields on our loans, and to a certain extent our interest-bearing deposits. The following table sets forth changes in interest income for each major category of interest-earning assets and interest expense for each major category of interest-bearing liabilities. The table also reflects the amount of simultaneous changes attributable to both volume and rate changes for the years indicated. For this table, changes that are not solely due to either volume or rate are allocated in proportion to the percentage changes in average volume and average rate.
| 2007 Compared to 2006 | 2006 Compared to 2005 | |||||||||||||||||||||||
| Year Ended December 31, Increase (Decrease) Due to Change in |
Year Ended December 31, Increase (Decrease) Due to Change in |
|||||||||||||||||||||||
| (Dollars in thousands) |
Volume | Rate | Total | Volume | Rate | Total | ||||||||||||||||||
| Interest income: |
||||||||||||||||||||||||
| Federal funds sold, securities purchased under agreement to resell and other short-term investment securities |
$ | 6,208 | $ | 519 | $ | 6,727 | $ | (2,887 | ) | $ | 4,445 | $ | 1,558 | |||||||||||
| Investment securities |
(15,242 | ) | 1,003 | (14,239 | ) | (14,058 | ) | 3,602 | (10,456 | ) | ||||||||||||||
| Loans |
65,808 | (2,906 | ) | 62,902 | 51,249 | 28,469 | 79,718 | |||||||||||||||||
| Increase (decrease) in interest income, net |
56,774 | (1,384 | ) | 55,390 | 34,304 | 36,516 | 70,820 | |||||||||||||||||
| Interest expense: |
||||||||||||||||||||||||
| NOW deposits |
(6 | ) | (7 | ) | (13 | ) | 16 | 1 | 17 | |||||||||||||||
| Regular money market deposits |
(545 | ) | 666 | 121 | (1,515 | ) | 356 | (1,159 | ) | |||||||||||||||
| Bonus money market deposits |
75 | 3,190 | 3,265 | (1,820 | ) | 501 | (1,319 | ) | ||||||||||||||||
| Time deposits |
42 | 681 | 723 | 145 | 288 | 433 | ||||||||||||||||||
| Foreign sweep deposits |
284 | — | 284 | — | — | — | ||||||||||||||||||
| Short-term borrowings |
(4,270 | ) | 61 | (4,209 | ) | 17,146 | 1,287 | 18,433 | ||||||||||||||||
| Contingently convertible debt |
5 | 7 | 12 | 5 | (17 | ) | (12 | ) | ||||||||||||||||
| Junior subordinated debentures |
43 | 150 | 193 | 44 | 837 | 881 | ||||||||||||||||||
| Senior and subordinated notes |
19,619 | — | 19,619 | — | — | — | ||||||||||||||||||
| Other long-term debt |
7,323 | (47 | ) | 7,276 | 464 | 278 | 742 | |||||||||||||||||
| Increase in interest expense, net |
22,570 | 4,701 | 27,271 | 14,485 | 3,531 | 18,016 | ||||||||||||||||||
| Increase (decrease) in net interest income |
$ | 34,204 | $ | (6,085 | ) | $ | 28,119 | $ | 19,819 | $ | 32,985 | $ | 52,804 | |||||||||||
Net Interest Margin (Fully Taxable-Equivalent Basis)
Our net interest margin was 7.29 percent in 2007, compared to 7.38 percent in 2006 and 6.46 percent in 2005. The decrease in net interest margin in 2007 was primarily due to decreases in yields of our loan portfolio as well as increases in rates paid on our interest-bearing liabilities from the issuance of long-term debt in May 2007 and utilization of long-term FHLB advances, as well as the introduction of our two new interest-bearing deposit products, partially offset by decreases in short-term borrowings and increases in yields from our short-term investments portfolio. Our net interest margin was also positively impacted by increases in average balances of our noninterest-bearing demand deposits, a significant source of funding for us, which increased by $78.2 million and $148.9 million during 2007 and 2006, respectively.
The increase in net interest margin in 2006 was largely due to growth and increases in yields of our loan portfolio as well as growth of our noninterest-bearing demand deposits, partially offset by increases in the balances outstanding of our short-term borrowings.
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Average Balances, Yields and Rates Paid (Fully Taxable-Equivalent Basis)
The average yield earned on interest-earning assets is the amount of annualized fully taxable-equivalent interest income expressed as a percentage of average interest-earning assets. The average rate paid on funding sources is the amount of annualized interest expense expressed as a percentage of average funding sources. The following table sets forth average assets, liabilities, minority interest and stockholders’ equity, interest income, interest expense, annualized yields and rates, and the composition of our annualized net interest margin in 2007, 2006 and 2005.
| Year ended December 31, | ||||||||||||||||||||||||||||||
| 2007 | 2006 | 2005 | ||||||||||||||||||||||||||||
| Interest | Interest | Interest | ||||||||||||||||||||||||||||
| Average | Income/ | Yield/ | Average | Income/ | Yield/ | Average | Income/ | Yield/ | ||||||||||||||||||||||
| (Dollars in thousands) |
Balance | Expense | Rate | Balance | Expense | Rate | Balance | Expense | Rate | |||||||||||||||||||||
| Interest-earning assets: |
||||||||||||||||||||||||||||||
| Federal funds sold, securities purchased under agreement to resell and other short-term investment securities (1) |
$ | 357,673 | $ | 17,816 | 4.98 | % | $ | 232,634 | $ | 11,089 | 4.77 | % | $ | 313,266 | $ | 9,531 | 3.04 | % | ||||||||||||
| Investment securities: |
||||||||||||||||||||||||||||||
| Taxable |
1,310,595 | 61,303 | 4.68 | 1,615,807 | 74,523 | 4.61 | 1,900,027 | 83,950 | 4.42 | |||||||||||||||||||||
| Non-taxable (2) |
53,866 | 3,637 | 6.75 | 68,371 | 4,656 | 6.81 | 84,151 | 5,685 | 6.76 | |||||||||||||||||||||
| Loans: |
||||||||||||||||||||||||||||||
| Commercial |
2,973,705 | 321,381 | 10.81 | 2,419,286 | 263,878 | 10.91 | 1,969,204 | 194,018 | 9.85 | |||||||||||||||||||||
| Real estate construction and term |
252,399 | 16,665 | 6.60 | 195,041 | 13,422 | 6.88 | 159,123 | 10,032 | 6.30 | |||||||||||||||||||||
| Consumer and other |
296,222 | 23,857 | 8.05 | 267,761 | 21,701 | 8.10 | 240,035 | 15,233 | 6.35 | |||||||||||||||||||||
| Total loans, net of unearned income |
3,522,326 | 361,903 | 10.27 | 2,882,088 | 299,001 | 10.37 | 2,368,362 | 219,283 | 9.26 | |||||||||||||||||||||
| Total interest-earning assets |
5,244,460 | 444,659 | 8.48 | 4,798,900 | 389,269 | 8.11 | 4,665,806 | 318,449 | 6.83 | |||||||||||||||||||||
| Cash and due from banks |
276,352 | 242,305 | 227,869 | |||||||||||||||||||||||||||
| Allowance for loan losses |
(43,654 | ) | (38,808 | ) | (37,144 | ) | ||||||||||||||||||||||||
| Goodwill |
12,576 | 27,653 | 35,638 | |||||||||||||||||||||||||||
| Other assets (3) |
530,383 | 357,385 | 297,608 | |||||||||||||||||||||||||||
| Total assets |
$ | 6,020,117 | $ | 5,387,435 | $ | 5,189,777 | ||||||||||||||||||||||||
| Funding sources: |
||||||||||||||||||||||||||||||
| Interest-bearing liabilities: |
||||||||||||||||||||||||||||||
| NOW deposits |
$ | 35,020 | $ | 138 | 0.39 | % | $ | 36,999 | $ | 151 | 0.41 | % | $ | 33,196 | $ | 134 | 0.40 | % | ||||||||||||
| Regular money market deposits |
152,550 | 1,796 | 1.18 | 210,933 | 1,675 | 0.79 | 406,843 | 2,834 | 0.70 | |||||||||||||||||||||
| Bonus money market deposits |
577,977 | 8,003 | 1.38 | 569,122 | 4,738 | 0.83 | 792,123 | 6,057 | 0.76 | |||||||||||||||||||||
| Time deposits |
324,250 | 3,064 | 0.94 | 318,855 | 2,341 | 0.73 | 297,286 | 1,908 | 0.64 | |||||||||||||||||||||
| Foreign sweep deposits |
8,310 | 284 | 3.42 | — | — | — | — | — | — | |||||||||||||||||||||
| Total interest-bearing deposits |
1,098,107 | 13,285 | 1.21 | 1,135,909 | 8,905 | 0.78 | 1,529,448 | 10,933 | 0.71 | |||||||||||||||||||||
| Short-term borrowings |
320,129 | 16,922 | 5.29 | 400,913 | 21,131 | 5.27 | 69,499 | 2,698 | 3.88 | |||||||||||||||||||||
| Contingently convertible debt |
148,877 | 941 | 0.63 | 148,002 | 929 | 0.63 | 147,181 | 941 | 0.64 | |||||||||||||||||||||
| Junior subordinated debentures |
50,894 | 3,404 | 6.69 | 50,223 | 3,211 | 6.39 | 49,309 | 2,330 | 4.73 | |||||||||||||||||||||
| Senior and subordinated notes |
313,148 | 19,619 | 6.27 | — | — | — | — | — | — | |||||||||||||||||||||
| Other long-term debt |
152,669 | 8,282 | 5.42 | 17,741 | 1,006 | 5.67 | 8,035 | 264 | 3.29 | |||||||||||||||||||||
| Total interest-bearing liabilities |
2,083,824 | 62,453 | 3.00 | 1,752,788 | 35,182 | 2.01 | 1,803,472 | 17,166 | 0.95 | |||||||||||||||||||||
| Portion of noninterest-bearing funding sources |
3,160,636 | 3,046,112 | 2,862,334 | |||||||||||||||||||||||||||
| Total funding sources |
5,244,460 | 62,453 | 1.19 | 4,798,900 | 35,182 | 0.73 | 4,665,806 | 17,166 | 0.37 | |||||||||||||||||||||
| Noninterest-bearing funding sources: |
||||||||||||||||||||||||||||||
| Demand deposits |
2,864,153 | 2,785,948 | 2,637,028 | |||||||||||||||||||||||||||
| Other liabilities |
191,466 | 115,516 | 114,012 | |||||||||||||||||||||||||||
| Minority interest in capital of consolidated affiliates |
211,341 | 143,977 | 93,839 | |||||||||||||||||||||||||||
| Stockholders’ equity |
669,333 | 589,206 | 541,426 | |||||||||||||||||||||||||||
| Portion used to fund interest-earning assets |
(3,160,636 | ) | (3,046,112 | ) | (2,862,334 | ) | ||||||||||||||||||||||||
| Total liabilities, minority interest and stockholders’ equity |
$ | 6,020,117 | $ | 5,387,435 | $ | 5,189,777 | ||||||||||||||||||||||||
| Net interest income and margin |
$ | 382,206 | 7.29 | % | $ | 354,087 | 7.38 | % | $ | 301,283 | 6.46 | % | ||||||||||||||||||
| Total deposits |
$ | 3,962,260 | $ | 3,921,857 | $ | 4,166,476 | ||||||||||||||||||||||||
| (1) | Includes average interest-bearing deposits in other financial institutions of $52.9 million, $31.0 million and $20.4 million in 2007, 2006 and 2005, respectively. |
| (2) | Interest income on non-taxable investments is presented on a fully taxable-equivalent basis using the federal statutory tax rate of 35.0 percent for all years presented. The tax equivalent adjustments were $1.3 million, $1.6 million and $2.0 million in 2007, 2006 and 2005, respectively. |
| (3) | Average investment securities of $250.8 million, $151.2 million and $157.1 million in 2007, 2006 and 2005, respectively, were classified as other assets as they were noninterest-earning assets. These investments primarily consisted of non-marketable securities. |
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Provision for Loan Losses
Our provision for loan losses is based on our evaluation of the adequacy of the existing allowance for loan losses in relation to total loans and on our periodic assessment of the inherent and identified risk dynamics of the loan portfolio resulting from reviews of selected individual loans. For a more detailed discussion of credit quality and the allowance for loan losses, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” and “—Consolidated Financial Condition—Credit Quality and the Allowance for Loan Losses” under Part II, Item 7 in this report.
| Year ended December 31, | ||||||||||||
| (Dollars in thousands) |
2007 | 2006 | 2005 | |||||||||
| Allowance for loan losses, beginning balance |
$ | 42,747 | $ | 36,785 | $ | 37,613 | ||||||
| Provision for loan losses |
16,836 | 9,877 | 237 | |||||||||
| Loan charge-offs |
(19,378 | ) | (14,065 | ) | (12,416 | ) | ||||||
| Loan recoveries |
7,088 | 10,150 | 11,351 | |||||||||
| Allowance for loan losses, ending balance |
$ | 47,293 | $ | 42,747 | $ | 36,785 | ||||||
| Provision as a percentage of total gross loans |
0.40 | % | 0.28 | % | 0.01 | % | ||||||
| Net charge-offs as a percentage of total gross loans |
0.29 | 0.11 | 0.04 | |||||||||
| Allowance for loan losses as a percentage of total gross loans |
1.13 | % | 1.22 | % | 1.28 | % | ||||||
| Total gross loans |
$ | 4,178,098 | $ | 3,509,560 | $ | 2,868,382 | ||||||
Our provision for loan losses increased by $7.0 million to $16.8 million in 2007, compared to $9.9 million in 2006. The increase in our provision was primarily due to an increased level of loan charge-offs, lower recoveries recognized, partially offset by a decrease in our allowance for loan losses as a percentage of total gross loans as our credit quality remains strong. The increase in provision of $9.6 million in 2006, compared to 2005 was primarily due to the growth in our loan portfolio.
Noninterest Income
| Year ended December 31, | |||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
||||||||||
| Client investment fees |
$ | 51,794 | $ | 44,345 | 16.8 | % | $ | 33,255 | 33.3 | % | |||||
| Gains on investment securities, net |
46,724 | 2,551 | — | 4,307 | (40.8 | ) | |||||||||
| Foreign exchange fees |
25,750 | 21,045 | 22.4 | 17,906 | 17.5 | ||||||||||
| Gains on derivative instruments, net |
23,935 | 17,949 | 33.4 | 6,750 | 165.9 | ||||||||||
| Deposit service charges |
15,554 | 10,159 | 53.1 | 9,805 | 3.6 | ||||||||||
| Corporate finance fees |
14,199 | 11,649 | 21.9 | 22,063 | (47.2 | ) | |||||||||
| Letter of credit and standby letter of credit income |
11,115 | 9,943 | 11.8 | 10,007 | (0.6 | ) | |||||||||
| Other |
32,313 | 23,565 | 37.1 | 13,402 | 75.8 | ||||||||||
| Total noninterest income |
$ | 221,384 | $ | 141,206 | 56.8 | % | $ | 117,495 | 20.2 | % | |||||
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Table of Contents
Included in noninterest income is income that is attributable to minority interests. As part of our funds management business, we recognize the entire income or loss from funds where we own significantly less than 100%. We are required under GAAP to consolidate 100% of the results of the funds that we are deemed to control. Similarly, we are required under GAAP to consolidate the results of eProsper, of which we own 65%. The relevant amounts attributable to investors other than us are reflected under “Minority Interest in Net Income of Consolidated Affiliates”. Our net income includes only the portion of income or loss that is attributable to our ownership interest. The table below provides a summary of non-GAAP noninterest income, net of minority interest:
| Year ended December 31, | ||||||||||||||||||
| Non-GAAP noninterest income, net of minority interest (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
|||||||||||||
| GAAP noninterest income |
$ | 221,384 | $ | 141,206 | 56.8 | % | $ | 117,495 | 20.2 | % | ||||||||
| Less: amounts attributable to minority interests, including carried interest |
(37,981 | ) | (9,903 | ) | 283.5 | (6,067 | ) | 63.2 | ||||||||||
| Non-GAAP noninterest income, net of minority interest |
$ | 183,403 | $ | 131,303 | 39.7 | % | $ | 111,428 | 17.8 | % | ||||||||
We believe that the above non-GAAP financial measure, when taken together with the corresponding GAAP financial measure, provides meaningful supplemental information regarding our performance by excluding certain items that represent income attributable to investors other than us and our subsidiaries. Our management uses, and believes that investors benefit from referring to, this non-GAAP financial measure in assessing our operating results and when planning, forecasting and analyzing future periods. However, this non-GAAP financial measure should be considered in addition to, not as a substitute for or superior to, financial measures prepared in accordance with GAAP.
Client Investment Fees
We offer a variety of investment products on which we earn fees. These products include sweep money market funds, money market mutual funds, overnight repurchase agreements and fixed income securities available through client-directed accounts and fixed income management services offered through our investment advisory subsidiary.
Client investment fees totaled $51.8 million in 2007, compared to $44.3 million in 2006 and $33.3 million in 2005. The increases of $7.5 million and $11.0 million in client investment fees in 2007 and 2006, respectively, were attributable to growth in average client investment funds, with particularly strong growth in our Repurchase Agreement Program, as a result of increased deposits from our private equity clients, as well as an increase in the number of managed portfolios within our client investment assets under management, as a result of increased deposits from our later-stage technology clients. The following table summarizes average client investment funds for 2007, 2006 and 2005:
| Year ended December 31, | |||||||||||||||
| (Dollars in millions) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
||||||||||
| Client directed investment assets (1) |
$ | 12,356 | $ | 10,605 | 16.5 | % | $ | 8,072 | 31.4 | % | |||||
| Client investment assets under management |
5,651 | 4,364 | 29.5 | 3,328 | 31.1 | ||||||||||
| Sweep money market funds |
2,427 | 2,260 | 7.4 | 1,512 | 49.5 | ||||||||||
| Total average client investment funds (2) |
$ | 20,434 | $ | 17,229 | 18.6 | % | $ | 12,912 | 33.4 | % | |||||
| (1) | Mutual funds and Repurchase Agreement Program assets. |
| (2) | Client funds invested through SVB Financial Group are maintained at third party financial institutions. |
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Gains on Investment Securities, Net
Gains on investment securities, net, were $46.7 million in 2007, compared to $2.6 million in 2006 and $4.3 million in 2005. Net gains on investment securities of $46.7 million in 2007 were mainly attributable to net gains of $30.1 million from three of our managed funds of funds and $12.0 million from one of our sponsored debt funds. Included in the $46.7 million in net gains on investment securities are $23.7 million of net gains from valuation adjustments and $23.0 million of gains from distributions. We expect continued variability in the performance of our consolidated funds. As of December 31, 2007, we held investments, either directly or through our managed investment funds, in 397 private equity funds, 58 companies and three sponsored debt funds.
Gains on investment securities, net, of $2.6 million in 2006 were primarily attributable to net gains of $6.4 million from two of our managed funds of funds, partially offset by a loss of $3.2 million due to the sale of certain available-for-sale securities and net losses of $0.6 million from one of our managed funds of funds. Included in the $2.6 million in net gains on investment securities are $5.9 million of net gains from distributions, partially offset by losses of $3.2 million from the sale of certain available-for-sale securities and $0.1 million of net losses from valuation adjustments.
The following table provides a summary of non-GAAP net gains on investment securities, net of minority interest:
| Year ended December 31, | ||||||||||||||||||
| Non-GAAP net gains on investment securities, net of minority |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
|||||||||||||
| GAAP net gains on investment securities |
$ | 46,724 | $ | 2,551 | — | % | $ | 4,307 | (40.8 | )% | ||||||||
| Less: amounts attributable to minority interests, including carried interest |
(35,449 | ) | (5,032 | ) | 604.5 | (5,743 | ) | (12.4 | ) | |||||||||
| Non-GAAP net gains on investment securities, net of minority interest. |
$ | 11,275 | $ | (2,481 | ) | (554.5 | )% | $ | (1,436 | ) | 72.8 | % | ||||||
We believe that the above non-GAAP financial measure, when taken together with the corresponding GAAP financial measure, provides meaningful supplemental information regarding our performance by excluding certain items that represent income attributable to investors other than us and our subsidiaries. Our management uses, and believes that investors benefit from referring to, this non-GAAP financial measure in assessing our operating results and when planning, forecasting and analyzing future periods. However, this non-GAAP financial measure should be considered in addition to, not as a substitute for or superior to, financial measures prepared in accordance with GAAP.
Foreign Exchange Fees
Foreign exchange fees represent the income differential between purchases and sales of foreign currency exchange on behalf of our clients. Foreign exchange fees totaled $25.8 million in 2007, compared to $21.0 million in 2006 and $17.9 million in 2005. The increase in foreign exchange fees in 2007 and 2006 reflect higher notional volumes converted. Commissioned notional volumes were $6.13 billion in 2007, $4.14 billion in 2006 and $3.18 billion in 2005. Because our clients’ demand for foreign currency is driven by the purchase or sale of goods and services, and because more than 70% of our trades occur in only three currencies (Euro, Pound Sterling, and Canadian Dollar), the higher notional volumes reflect the impact of business conditions in those countries or regions on our clients.
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Table of Contents
Gains on Derivative Instruments, Net
A summary of gains on derivative instruments, net, for 2007, 2006, and 2005 is as follows:
| Year ended December 31, | ||||||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
|||||||||||||
| Gains (losses) on foreign exchange forward contracts, net (1) |
$ | 958 | $ | (219 | ) | (537.4 | )% | $ | 3,410 | (106.4 | )% | |||||||
| Change in fair value of interest rate swap (2) |
(499 | ) | (3,630 | ) | (86.3 | ) | — | — | ||||||||||
| Equity warrant assets: |
||||||||||||||||||
| Gains on exercise, net |
18,690 | 11,495 | 62.6 | 9,010 | 27.6 | |||||||||||||
| Change in fair value (3): |
||||||||||||||||||
| Cancellations and expirations |
(2,643 | ) | (3,963 | ) | (33.3 | ) | (2,952 | ) | 34.2 | |||||||||
| Other changes in fair value |
7,429 | 14,266 | (47.9 | ) | (2,718 | ) | (624.9 | ) | ||||||||||
| Total net gains on equity warrant assets (4) |
23,476 | 21,798 | 7.7 | 3,340 | 552.6 | |||||||||||||
| Total gains on derivative instruments, net |
$ | 23,935 | $ | 17,949 | 33.4 | % | $ | 6,750 | 165.9 | % | ||||||||
| (1) | Represents the change in the fair value of foreign exchange forward contracts executed on behalf of clients and contracts with correspondent banks to economically reduce our foreign exchange exposure risk related to certain foreign currency denominated loans. Revaluations of foreign currency denominated loans are recorded on the line item “Other” as part of noninterest income, a component of consolidated net income. |
| (2) | Represents the change in fair value of our interest rate swap agreement related to our junior subordinated debentures. For 2007 and 2006, the amount represents the net change in the fair value hedge implemented in April 2006. Prior to April 2006, the amount represents the cumulative change in market value of the interest rate swap prior to its designation as a fair value hedge. Please refer to the discussion of our interest rate swap agreement related to our junior subordinated debentures in Note 14 (Derivative Financial Instruments) of the “Notes to the Consolidated Financial Statements” under Part II, Item 8 in this report. |
| (3) | As of December 31, 2007, the Company held warrants in 1,179 companies, compared to 1,287 companies at December 31, 2006 and 1,281 companies at December 31, 2005. |
| (4) | Includes net gains on equity warrant assets held by consolidated investment affiliates. Relevant amounts attributable to minority interests are reflected in the consolidated statements of income under the caption “Minority Interest in Net Income of Consolidated Affiliates”. |
Gains on derivative instruments, net, totaled $23.9 million in 2007, compared to $17.9 million in 2006 and $6.8 million in 2005. The increase of $6.0 million in 2007 was primarily due to gains on exercises of equity warrant assets arising from merger and acquisition activities by certain companies in our warrant portfolio and lower losses associated with the fair value hedge agreement for our junior subordinated debentures. These increases were partially offset by lower gains recognized from valuation adjustments of our equity warrant assets. The net gains on derivatives of $23.9 million for 2007 were due to $18.7 million in net gains from exercised warrants and $5.2 million in net increase in fair value.
The increase of $11.1 million in 2006 was primarily due to favorable changes in the fair value of equity warrant assets, which was partially offset by an unfavorable change in the fair value hedge agreement for our junior subordinated debentures and a decrease in gains from foreign exchange forwards primarily used to reduce our exposure to foreign currency denominated loans.
The change in the fair value of equity warrant assets was primarily attributable to changes in the underlying value of the client companies’ stock, changes in the value of the underlying assumptions used to value the equity warrant assets including changes in the risk-free interest rate, changes in the volatility of market-comparable public companies and changes in the expected life. The methodology used to calculate the fair value of equity warrant assets has been applied consistently.
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The following table provides a summary of non-GAAP net gains on derivative instruments, net of minority interest:
| Year ended December 31, | |||||||||||||||||
| Non-GAAP net gains on derivative instruments, net of minority interest |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
||||||||||||
| GAAP net gains on derivative instruments |
$ | 23,935 | $ | 17,949 | 33.4 | % | $ | 6,750 | 165.9 | % | |||||||
| Less: amounts attributable to minority interests (1) |
(1,070 | ) | (4,297 | ) | (75.1 | ) | — | — | |||||||||
| Non-GAAP net gains on derivative instruments, net of minority interest |
$ | 22,865 | $ | 13,652 | 67.5 | % | $ | 6,750 | 102.3 | % | |||||||
| (1) | Represents gains recognized from the exercise of warrants held by one of our sponsored debt funds. |
We believe that the above non-GAAP financial measure, when taken together with the corresponding GAAP financial measure, provides meaningful supplemental information regarding our performance by excluding certain items that represent income attributable to investors other than us and our subsidiaries. Our management uses, and believes that investors benefit from referring to, this non-GAAP financial measure in assessing our operating results and when planning, forecasting and analyzing future periods. However, this non-GAAP financial measure should be considered in addition to, not as a substitute for or superior to, financial measures prepared in accordance with GAAP.
Deposit Service Charges
Deposit service charges were $15.6 million in 2007, compared to $10.2 million in 2006 and $9.8 million in 2005. The increase in 2007 was primarily attributable to a decrease in our earnings credit rate obtained by clients to offset deposit service charges, which was directly related to decreases in short-term market interest rates, as well as an increase in fee rates and in the volume of transactions. The increase in 2006 was primarily attributable to an increase in fee rates, partially offset by an increase in our earnings credit rate.
Corporate Finance Fees
Corporate finance fees were $14.2 million in 2007, compared to $11.6 million in 2006 and $22.1 million in 2005. The increase in 2007 was primarily a result of higher income from success fees recognized at SVB Alliant driven by the completion of larger-sized deals. In July 2007, we reached a decision to cease operations of SVB Alliant and SVB Alliant Europe Limited. We elected to have SVB Alliant complete a limited number of client transactions before finalizing its shut-down. As of the date of this report, all such client transactions have been completed. Other than the completion of wind-down activities, we expect to cease operations by the end of the first quarter of 2008.
The decrease of $10.5 million in 2006 was primarily driven by the completion of a lower number of deals, principally as a result of changes in staffing at SVB Alliant that occurred in early 2006.
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Other Noninterest Income
A summary of other noninterest income for 2007, 2006, and 2005 is as follows:
| Year ended December 31, | ||||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
|||||||||||
| Fund management fees |
$ | 8,583 | $ | 4,664 | 84.0 | % | $ | 3,436 | 35.7 | % | ||||||
| Credit card fees |
5,802 | 4,564 | 27.1 | 3,691 | 23.7 | |||||||||||
| Service-based fee income |
5,356 | 970 | 452.2 | — | — | |||||||||||
| Gains (losses) on foreign exchange loans revaluation, net |
1,905 | 2,680 | (28.9 | ) | (1,699 | ) | (257.7 | ) | ||||||||
| Other |
10,667 | 10,687 | (0.2 | ) | 7,974 | 34.0 | ||||||||||
| Total other noninterest income |
$ | 32,313 | $ | 23,565 | 37.1 | % | $ | 13,402 | 75.8 | % | ||||||
Other income was $32.3 million in 2007, compared to $23.6 million in 2006 and $13.4 million in 2005. The increase of $8.7 million in 2007 was primarily related to increases in fund management fees and service-based fee income.
The increase in fund management fees of $3.9 million in 2007 was related to the full-year effect of management fees recognized from two of our consolidated funds established in the third quarter of 2006, as well as from an additional consolidated fund established in the second quarter of 2007. In 2007, we received management fees from six consolidated funds, compared to five in 2006 and three in 2005.
The increase in service-based fee income of $4.4 million in 2007 was a result of increased activities from our subsidiary, SVB Analytics, which commenced operations in the second quarter of 2006, and from eProsper, which we acquired a majority ownership in during the third quarter of 2006. SVB Analytics’ revenues increased by $2.7 million to $3.1 million in 2007, compared to $0.4 million in 2006, primarily as a result of an increase in the number of clients to 340 in 2007, compared to 34 in 2006. eProsper’s revenues increased by $1.7 million to $2.3 million in 2007, compared to $0.6 million in 2006, primarily as a result of consolidating a full year of revenue in 2007.
Noninterest Expense
| Year ended December 31, | |||||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
||||||||||||
| Compensation and benefits |
$ | 213,892 | $ | 188,588 | 13.4 | % | $ | 163,590 | 15.3 | % | |||||||
| Professional services |
32,905 | 40,791 | (19.3 | ) | 28,729 | 42.0 | |||||||||||
| Net occupancy |
20,829 | 17,369 | 19.9 | 16,210 | 7.1 | ||||||||||||
| Premises and equipment |
19,756 | 15,311 | 29.0 | 12,824 | 19.4 | ||||||||||||
| Impairment of goodwill |
17,204 | 18,434 | (6.7 | ) | — | — | |||||||||||
| Business development and travel |
12,263 | 12,760 | (3.9 | ) | 10,647 | 19.8 | |||||||||||
| Correspondent bank fees |
5,713 | 5,647 | 1.2 | 5,530 | 2.1 | ||||||||||||
| Telephone |
5,404 | 4,081 | 32.4 | 3,703 | 10.2 | ||||||||||||
| Data processing services |
3,841 | 4,239 | (9.4 | ) | 4,105 | 3.3 | |||||||||||
| (Reduction of) provision for unfunded credit commitments |
(1,207 | ) | (2,461 | ) | (51.0 | ) | 927 | (365.5 | ) | ||||||||
| Other |
15,869 | 17,744 | (10.6 | ) | 13,595 | 30.5 | |||||||||||
| Total noninterest expense |
$ | 346,469 | $ | 322,503 | 7.4 | % | $ | 259,860 | 24.1 | % | |||||||
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Included in noninterest expense is expense that is attributable to minority interests. As part of our funds management business, we recognize the entire income or loss from funds where we own significantly less than 100%. We are required under GAAP to consolidate 100% of the results of the funds that we are deemed to control. Similarly, we are required under GAAP to consolidate the results of eProsper, of which we own 65%. The relevant amounts attributable to investors other than us are reflected under “Minority Interest in Net Income of Consolidated Affiliates”. Our net income includes only the portion of income or loss that is attributable to our ownership. The table below provides a summary of non-GAAP noninterest expense, net of minority interest:
| Year ended December 31, | ||||||||||||||||||
| Non-GAAP noninterest expense, net of minority interest |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
|||||||||||||
| GAAP noninterest expense |
$ | 346,469 | $ | 322,503 | 7.4 | % | $ | 259,860 | 24.1 | % | ||||||||
| Less: amounts attributable to minority interests |
(10,681 | ) | (5,887 | ) | 81.4 | (3,840 | ) | 53.3 | ||||||||||
| Non-GAAP noninterest expense, net of minority interest |
$ | 335,788 | $ | 316,616 | 6.1 | % | $ | 256,020 | 23.7 | % | ||||||||
We believe that the above non-GAAP financial measure, when taken together with the corresponding GAAP financial measure, provides meaningful supplemental information regarding our performance by excluding certain items that represent income attributable to investors other than us and our subsidiaries. Our management uses, and believes that investors benefit from referring to, this non-GAAP financial measure in assessing our operating results and when planning, forecasting and analyzing future periods. However, this non-GAAP financial measure should be considered in addition to, not as a substitute for or superior to, financial measures prepared in accordance with GAAP.
Compensation and Benefits
Compensation and benefits expense totaled $213.9 million in 2007, compared to $188.6 million in 2006 and $163.6 million in 2005. The increase in compensation and benefits expense of $25.3 million in 2007 was largely due to higher incentive compensation costs related to our strong financial performance, as well as increases in the number of average full-time equivalent (“FTE”) employees and higher rates of employee salaries and wages, partially offset by a decrease in share-based payment expense due to a decrease in stock option grants. The average number of FTE personnel was 1,145 in 2007, compared to 1,087 in 2006 and 1,029 in 2005. Share-based compensation expense totaled $14.9 million in 2007, compared to $21.3 million in 2006 and $7.1 million in 2005.
Our compensation plans primarily consist of the Incentive Compensation Plan, Direct Drive Incentive Compensation Plan, SVB Financial Group 401(k) and Employee Stock Ownership Plan (“ESOP”), Retention Program and Warrant Incentive Plan. Total costs incurred under the above plans were $67.4 million in 2007, compared to $41.1 million in 2006. The increase of $26.3 million was primarily related to a $25.8 million increase in our incentive compensation expense, a $2.9 million increase in our 401(k) and ESOP expense, a $1.9 million increase in direct drive compensation expense and a $1.1 million increase in retention compensation expense. These increases were partially offset by a $5.6 million decrease in incentive compensation expense to SVB Alliant employees, as a result of our decision to cease operations at SVB Alliant as announced in July 2007.
The increase of $25.0 million in compensation and benefits expense in 2006 was largely due to increases in average FTE employees, higher rates of employee salaries and wages and an increase in share-based payment expense, partially offset by a decrease in contributions to our incentive compensation plan.
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Professional Services
Professional services expense totaled $32.9 million in 2007, compared to $40.8 million in 2006 and $28.7 million in 2005. The decrease of $7.9 million in 2007 and increase of $12.1 million in 2006 was primarily related to consulting costs incurred in 2006 as part of ongoing efforts to enhance and maintain compliance with various regulations as well as expenses associated with certain information technology (“IT”) projects.
Net Occupancy
Net occupancy expense totaled $20.8 million in 2007, compared to $17.4 million in 2006 and $16.2 million in 2005. The increase of $3.4 million in 2007 was primarily due to $1.7 million of lease exit costs related to consolidation of offices aimed at improving synergy and efficiency across business units and entry into new domestic office lease agreements. The increase of $1.2 million in 2006 was primarily due to the opening of our administrative facility in Salt Lake City in May 2006.
Premises and Equipment
Premises and equipment expense totaled $19.8 million in 2007, compared to $15.3 million in 2006 and $12.8 million in 2005. The increase in 2007 was primarily related to depreciation of new IT systems, office relocations and from the write-off of an IT loan fee amortization system. The increase in 2006 was primarily related to the opening of our administrative facility in Salt Lake City, office relocations and IT initiatives.
Impairment of Goodwill
In connection with our annual assessment of goodwill of SVB Alliant in the second quarters of 2007 and 2006, we recognized impairment charges of $17.2 million and $18.4 million, respectively, due to impairment of goodwill. The impairment resulted from changes in our outlook for SVB Alliant’s future financial performance. At December 31, 2007, no goodwill remained in SVB Alliant. In July 2007, we reached a decision to cease operations at SVB Alliant.
Business Development and Travel Expense
Business development and travel expense totaled $12.3 million in 2007, compared to $12.8 million in 2006 and $10.6 million in 2005. The increase of $2.2 million in 2006 was attributable to an increase in business development by all of our business units.
Telephone
Telephone expense totaled $5.4 million in 2007, compared to $4.1 million in 2006 and $3.7 million in 2005. The increase of $1.3 million in 2007 was primarily attributable to IT network upgrades.
(Reduction of) Provision for Unfunded Credit Commitments
We calculate the provision for unfunded credit commitments based on the credit commitments outstanding, as well as the credit quality of our credit commitments. We recorded a reduction of provision of $1.2 million to the liability for unfunded credit commitments in 2007, compared to a reduction of provision of $2.5 million in 2006 and a provision of $0.9 million in 2005. The reduction of provision of $1.2 million in 2007 was primarily a result of the positive impact of the decrease in our allowance for loan losses as a percentage of gross loans, which decreased by nine basis points from 1.22 percent in 2006 to 1.13 percent in 2007. This positive impact was partially offset by an increase in our total unfunded credit commitments, which increased by $880.2 million to $4.94 billion in 2007, compared to $4.06 billion in 2006. The reduction of provision in 2007 and 2006 reflects
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our historical credit quality experience. We continue to experience low levels of charge-offs and as our loss experience improved, we have reduced our allowance for loan losses, as a percent of total gross loans.
Other Noninterest Expense
Other noninterest expense largely consisted of postage and supplies expense, tax credit fund amortization expense, dues and publications expense and insurance and protections expense. Other noninterest expense totaled $15.9 million in 2007, compared to $17.7 million in 2006 and $13.6 million in 2005. The decrease of $1.8 million in 2007 was primarily related to a $1.8 million charge recorded during the second quarter of 2006 in connection with the settlement of a litigation matter and a $1.0 million decrease in advertising and promotion expenses, partially offset by a $1.4 million loss recorded in the second quarter of 2007 related to the sale of foreclosed property classified as Other Real Estate Owned (“OREO”). The increase of $4.1 million in 2006 was primarily related to the $1.8 million litigation charge and an increase of $0.9 million related to postage and supplies expense.
Minority Interest in Net Income of Consolidated Affiliates
Minority interest in net income of consolidated affiliates is primarily related to the minority interest holders’ portion of investment gains or losses and management fees in our managed funds (see Note 7 (Investment Securities) of the “Notes to the Consolidated Financial Statements” under Part II, Item 8 in this report.)
| Year ended December 31, | ||||||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
|||||||||||||
| Net interest income (1) |
$ | 1,296 | $ | 2,292 | (43.5 | )% | $ | 1,169 | 96.1 | % | ||||||||
| Noninterest income (1) |
35,504 | 9,903 | 258.5 | 6,067 | 63.2 | |||||||||||||
| Noninterest expense (1) |
(10,681 | ) | (5,887 | ) | 81.4 | (3,840 | ) | 53.3 | ||||||||||
| Carried interest (2) |
2,477 | — | — | — | — | |||||||||||||
| Minority interest in net income of consolidated affiliates |
$ | 28,596 | $ | 6,308 | 353.3 | % | $ | 3,396 | 85.7 | % | ||||||||
| (1) | Represents minority interest share in net interest income, noninterest income, and noninterest expense of consolidated affiliates. |
| (2) | Primarily represents the preferred allocation of income earned by the general partner managing one of our sponsored debt funds. |
Minority interest in net income of consolidated affiliates was $28.6 million in 2007, compared to $6.3 million in 2006 and $3.4 million in 2005. Minority interest in net income of consolidated affiliates of $28.6 million for 2007 was primarily due to noninterest income of $35.5 million, largely due to net investment gains from our consolidated funds, partially offset by noninterest expense of $10.7 million primarily related to management fees paid by our managed funds to the general partners at SVB Capital for funds management.
Income Taxes
Our effective tax rate for 2007 was 41.24 percent, compared to 42.45 percent in 2006 and 39.63 percent in 2005. The decrease in the tax rate in 2007 was primarily attributable to the tax impact of lower amounts of non-deductible share based payment expense on overall pre-tax income. The increase in the tax rate in 2006 was primarily attributable to the tax impact of higher amounts of non-deductible share-based payments on our overall pre-tax income.
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On January 1, 2007, we adopted the provisions of FIN 48, which clarifies the accounting for uncertainty in income taxes recognized in the entity’s financial statements in accordance with SFAS No. 109. Our adoption of FIN 48 did not result in a cumulative effect adjustment to retained earnings.
The total amount of unrecognized tax benefits at January 1, 2007 was $1.1 million, the recognition of which would reduce our income tax expense by $0.3 million.
We recognize interest and penalties related to unrecognized tax benefits as a component of operating expenses. Total accrued interest and penalties at January 1, 2007 were immaterial. At December 31, 2007, our unrecognized tax benefits remained at $1.1 million, which if recognized, would reduce our income tax expense by $0.3 million. Total accrued interest and penalties at December 31, 2007 were $0.1 million.
Operating Segment Results
In accordance with SFAS No. 131, we report segment information based on the management approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of our reportable segments. For reporting purposes, SVB Financial Group has four operating segments in which we report our financial information in this report: Commercial Banking, SVB Capital, SVB Alliant and Other Business Services. Please refer to the discussion of our segment organization under “Business–Business Overview” under Part I, Item 1 in this report.
Our primary source of revenue is from net interest income, which is the difference between interest earned on loans, net of funds transfer pricing (“FTP”), and interest paid on deposits, net of FTP. FTP is an internal measurement framework designed to assess the financial impact of a financial institution’s sources and uses of funds. It is the mechanism by which an earnings credit is given for deposits raised, and an earnings charge is made for funded loans. Accordingly, our segments are reported using net interest income, net of FTP. We also evaluate performance based on noninterest income and noninterest expense, which are presented as components of segment operating profit or loss. Allocated expenses are noninterest expenses allocated from corporate support functions to the business units and include facility costs, general administrative and operational overhead expenses, which include compensation and benefit costs. We do not allocate income taxes to our segments. Additionally, our management reporting model is predicated on average asset balances; therefore, period-end asset balances are not presented for segment reporting purposes. Total average assets equal the greater of total average assets or the sum of total average deposits and total average stockholders’ equity for each segment. The following is our segment information for 2007, 2006 and 2005.
Income generated by banking services and financial solutions provided to private equity clients is included under the Commercial Banking segment effective January 1, 2007. Prior to January 1, 2007, it was included in the SVB Capital segment. Income generated by SVB Wine Division is included under the Other Business Services segment effective July 1, 2007. Prior to July 1, 2007, it was included in the Commercial Banking segment. All prior period amounts have been reclassified to conform to current period presentations.
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Commercial Banking
| Year ended December 31, | ||||||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
|||||||||||||
| Net interest income |
$ | 339,862 | $ | 296,722 | 14.5 | % | $ | 236,918 | 25.2 | % | ||||||||
| (Provision for) recovery of loan losses |
(11,016 | ) | (6,306 | ) | 74.7 | 996 | (733.1 | ) | ||||||||||
| Noninterest income |
138,466 | 103,423 | 33.9 | 86,757 | 19.2 | |||||||||||||
| Noninterest expense |
(241,719 | ) | (223,708 | ) | 8.1 | (181,937 | ) | 23.0 | ||||||||||
| Income before income tax expense |
$ | 225,593 | $ | 170,131 | 32.6 | $ | 142,734 | 19.2 | ||||||||||
| Total average loans |
$ | 2,679,322 | $ | 2,134,901 | 25.5 | $ | 1,736,273 | 23.0 | ||||||||||
| Total average assets |
4,217,228 | 4,161,089 | 1.3 | 4,405,636 | (5.6 | ) | ||||||||||||
| Total average deposits |
$ | 3,689,478 | $ | 3,677,140 | 0.3 | % | $ | 3,956,210 | (7.1 | )% | ||||||||
Commercial Banking’s (“CB”) net interest income increased by $43.1 million in 2007, compared to 2006, primarily related to an increase in income from CB’s loan portfolio and an increase in income from earnings credit received on deposit products. The increase in income from CB’s loan portfolio was primarily related to loan growth, which positively impacted net interest income by $33.6 million, as a result of our increased focus on serving later-stage technology clients and private equity clients. Earnings credit received on deposits increased by $7.9 million, primarily from interest rate increases from the full-year effect of short-term market interest rate increases in 2006, in response to Federal Reserve rate increases, partially offset by rate decreases in late 2007. The increase in earnings credit received on deposits also reflects the initial impact of our money market deposit product for early stage clients introduced in May 2007 and our Eurodollar sweep deposit product introduced in late October 2007.
Noninterest income increased by $35.0 million in 2007, compared to 2006, primarily related to solid fee income growth, largely driven by a $7.6 million increase in client investment fees, a $5.1 million increase in foreign exchange fees and a $5.2 million increase in deposit service charges. The increase in fee income was primarily a result of our continued focus on servicing later-stage technology clients and private equity clients. In addition to fee income, CB recognized $15.0 million in higher net gains from the exercise of equity warrant assets, arising from merger and acquisition activities and initial public offerings of stock by certain companies in CB’s warrant portfolio. We receive equity warrant assets in certain client companies as part of negotiated credit facilities and other client services.
Noninterest expense increased by $18.0 million in 2007, compared to 2006, primarily related to an increase in compensation and benefits expense, both through direct employees of CB’s operations, as well as through allocated expenses from support groups. The increase in compensation and benefits expense was primarily a result of increased incentive and direct drive compensation expense due to better than expected overall financial performance for SVB Financial Group and from increases in the average number of FTE employees at CB, which increased to 686 in 2007, compared to 639 in 2006.
CB’s net interest income increased by $59.8 million in 2006, compared to 2005, primarily driven by higher loan volumes, as a result of our increased focus on serving middle-market clients and improvement in economic activity in the markets served by us, as well as an increase in the earnings credit received on deposits, primarily driven by increases in short-term market interest rates in response to Federal Reserve rate increases in 2006. The increase in earnings credit received on deposits from rate increases were partially offset by a decrease in average deposit volumes, which we believe was primarily due to clients seeking higher returns on deposits as a result of increases in short-term market interest rates.
Noninterest income increased by $16.7 million in 2006, compared to 2005, primarily related to solid fee income growth, largely driven by a $10.7 million increase in client investment fees and a $3.9 million increase in foreign exchange fees.
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Noninterest expense increased by $41.8 million in 2006, compared to 2005, primarily related to an increase in compensation and benefits expense, both through direct employees and allocated expenses from support groups. The increase in compensation and benefits expense was primarily the result of share-based payment expenses recorded from the adoption of SFAS No. 123(R) and from consulting expenses related to compliance initiatives.
SVB Capital
| Year ended December 31, | ||||||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
|||||||||||||
| Net interest income |
$ | 646 | $ | 772 | (16.3 | )% | $ | 819 | (5.7 | )% | ||||||||
| Noninterest income |
20,763 | 10,258 | 102.4 | 4,406 | 132.8 | |||||||||||||
| Noninterest expense |
(14,612 | ) | (10,328 | ) | 41.5 | (10,938 | ) | (5.6 | ) | |||||||||
| Income (loss) before income tax expense |
$ | 6,797 | $ | 702 | 868.2 | $ | (5,713 | ) | (112.3 | ) | ||||||||
| Total average assets |
$ | 292,446 | $ | 212,454 | 37.7 | % | $ | 148,282 | 43.3 | % | ||||||||
SVB Capital’s components of noninterest income primarily include net gains (losses) on investment securities, net of minority interest, fund management fees and net gains (losses) on derivative instruments, net of minority interest. We expect continued variability in the performance of our consolidated funds.
Noninterest income increased by $10.5 million in 2007, compared to 2006, primarily related to increases in net gains on investment securities and fund management fees, partially offset by lower net gains on derivative instruments. Net gains on investment securities, net of minority interest, totaled $13.2 million in 2007, compared to net gains of $0.6 million in 2006. The net gains on investment securities of $13.2 million in 2007 were primarily related to solid investment securities gains from two of our sponsored debt funds and from two of our managed funds of funds. The increase in fund management fees of $3.9 million in 2007 was primarily related to the full-year effect of management fees recognized from SVB Strategic Investors Fund III, LP and SVB Capital Partners II, LP, which were established in the third quarter of 2006, as well as from SVB India Capital Partners I, LP, which was established in the second quarter of 2007. We managed six funds in 2007, compared to five funds in 2006, and received fund management fees of $8.6 million and $4.7 million in 2007 and 2006, respectively. Net gains on derivative instruments, net of minority interest, totaled $1.1 million in 2007, compared to $4.3 million in 2006. Net gains on derivative instruments of $1.1 million in 2007 were primarily related to net gains from the exercise of warrants, arising from merger and acquisition activities and initial public offerings from one of our sponsored debt funds. The decrease in net gains on derivative instruments of $3.2 million in 2007, compared to 2006 was primarily due to higher net gains recognized from the exercise of warrants from one of our sponsored debt funds in 2006.
Noninterest expense increased by $4.3 million in 2007, compared to 2006, primarily related to an increase in compensation and benefits expense. The increase in compensation and benefits expense was primarily a result of increased incentive compensation expense due to better than expected financial performance overall by SVB Financial Group and from increases in the average number of FTE employees at SVB Capital, which increased to 34 in 2007, compared to 28 in 2006.
As we continue to build our funds management business, we expect noninterest income, noninterest expense, and total assets associated with these fund investments to continue to increase.
Noninterest income increased by $5.9 million in 2006, compared to 2005, primarily related to increases in fund management fees and net gains on derivative instruments. Net gains on investment securities, net of minority interest, totaled $0.6 million in 2006 and 2005. The net gains on investment securities of $0.6 million in 2006 was primarily related to net gains of $0.6 million from one of our managed funds of funds. The increase in
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fund management fees of $1.3 million in 2006 was primarily related to the addition of SVB Strategic Investors Fund III, LP and SVB Capital Partners II, LP, which were established in the third quarter of 2006. We managed five funds in 2006, compared to three funds in 2005, and received fund management fees of $4.7 million and $3.4 million in 2006 and 2005, respectively. Net gains on derivative instruments, net of minority interest, totaled $4.3 million in 2006. There were no gains on derivative instruments recognized in 2005. Net gains on derivative instruments of $4.3 million in 2006 were primarily related to net gains from the exercise of warrants, arising from merger and acquisition activities and initial public offerings from one of our sponsored debt funds.
SVB Alliant
| Year ended December 31, | ||||||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
|||||||||||||
| Net interest income |
$ | 854 | $ | 752 | 13.6 | % | $ | 336 | 123.8 | % | ||||||||
| Noninterest income |
14,141 | 11,640 | 21.5 | 22,064 | (47.2 | ) | ||||||||||||
| Noninterest expense, excluding impairment of goodwill |
(14,913 | ) | (22,800 | ) | (34.6 | ) | (22,575 | ) | 1.0 | |||||||||
| Impairment of goodwill |
(17,204 | ) | (18,434 | ) | (6.7 | ) | — | — | ||||||||||
| Loss before income tax expense |
$ | (17,122 | ) | $ | (28,842 | ) | (40.6 | ) | $ | (175 | ) | — | ||||||
| Total average assets |
$ | 53,367 | $ | 67,503 | (20.9 | ) | $ | 74,498 | (9.4 | ) | ||||||||
| Goodwill at period end |
$ | — | $ | 17,204 | (100.0 | )% | $ | 35,638 | (51.7 | )% | ||||||||
We reached a decision in July 2007 to cease operations at SVB Alliant. We elected to have SVB Alliant complete a limited number of client transactions before finalizing its shut-down. As of the date of this report, all such client transactions have been completed. Other than the completion of wind-down activities, we expect to cease operations by the end of the first quarter of 2008.
SVB Alliant’s noninterest income increased by $2.5 million in 2007, compared to 2006, primarily as a result of higher income from success fees recognized at SVB Alliant driven by the completion of larger-sized deals.
Noninterest expense, excluding impairment of goodwill, decreased by $7.9 million in 2007, compared to 2006, primarily due to a decrease in compensation and benefits, specifically salaries and wages expense, in connection with our decision to cease operations at SVB Alliant.
We recognized goodwill impairment charges of $17.2 million and $18.4 million in 2007 and 2006, respectively, based on our annual impairment analyses performed during the second quarters of each year. At December 31, 2007, no goodwill balance remained at SVB Alliant.
SVB Alliant’s noninterest income decreased by $10.4 million in 2006, compared to 2005, primarily driven by the completion of a lower number of deals, principally as a result of changes in staffing at SVB Alliant that occurred in early 2006.
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Other Business Services
| Year ended December 31, | ||||||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
|||||||||||||
| Net interest income |
$ | 35,244 | $ | 33,370 | 5.6 | % | $ | 26,817 | 24.4 | % | ||||||||
| (Provision for) recovery of loan losses |
(1,236 | ) | 2,391 | (151.7 | ) | (2,187 | ) | (209.3 | ) | |||||||||
| Noninterest income |
7,601 | 4,011 | 89.5 | 3,618 | 10.9 | |||||||||||||
| Noninterest expense |
(45,059 | ) | (32,211 | ) | 39.9 | (27,502 | ) | 17.1 | ||||||||||
| (Loss) income before income tax expense |
$ | (3,450 | ) | $ | 7,561 | (145.6 | ) | $ | 746 | 913.5 | ||||||||
| Total average loans |
$ | 807,771 | $ | 715,515 | 12.9 | $ | 624,955 | 14.5 | ||||||||||
| Total average assets |
907,353 | 801,087 | 13.3 | 674,638 | 18.7 | |||||||||||||
| Total average deposits |
257,208 | 222,448 | 15.6 | 186,105 | 19.5 | |||||||||||||
| Goodwill at period end |
$ | 4,092 | $ | 4,092 | — | % | $ | — | — | % | ||||||||
Our Other Business Services group includes SVB Private Client Services, SVB Global, SVB Analytics, and SVB Wine Division.
Net Interest Income – Other Business Services
| Year ended December 31, | |||||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
||||||||||||
| SVB Private Client Services |
$ | 15,037 | $ | 13,545 | 11.0 | % | $ | 10,938 | 23.8 | % | |||||||
| SVB Global |
7,188 | 5,679 | 26.6 | 2,294 | 147.6 | ||||||||||||
| SVB Analytics |
(143 | ) | (48 | ) | 197.9 | — | — | ||||||||||
| SVB Wine Division |
13,162 | 14,194 | (7.3 | ) | 13,585 | 4.5 | |||||||||||
| Total Other Business Services |
$ | 35,244 | $ | 33,370 | 5.6 | % | $ | 26,817 | 24.4 | % | |||||||
The increases in net interest income of $1.9 million in 2007, compared to 2006, and $6.6 million in 2006, compared to 2005, were primarily due to increases for SVB Private Client Services and SVB Global. The increase in net interest income for SVB Private Client Services was primarily due to increased average loan balances due to an increased focus on providing loan solutions to partners of private equity firms. The increase in net interest income for SVB Global was primarily due to an increase in average deposits as a result of increased investment activity by our clients as well as growth in the number of new international venture funds.
Noninterest Income – Other Business Services
| Year ended December 31, | |||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
||||||||||
| SVB Private Client Services |
$ | 803 | $ | 1,386 | (42.1 | )% | $ | 2,525 | (45.1 | )% | |||||
| SVB Global |
1,413 | 1,202 | 17.6 | 563 | 113.5 | ||||||||||
| SVB Analytics |
4,556 | 764 | 496.3 | — | — | ||||||||||
| SVB Wine Division |
829 | 659 | 25.8 | 530 | 24.3 | ||||||||||
| Total Other Business Services |
$ | 7,601 | $ | 4,011 | 89.5 | % | $ | 3,618 | 10.9 | % | |||||
The increase in noninterest income of $3.6 million in 2007, compared to 2006, was primarily due to increases for SVB Analytics, which commenced operations in the second quarter of 2006, and from its subsidiary, eProsper, which we acquired a majority ownership of in the third quarter of 2006. These increases
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were partially offset by a decrease in noninterest income for SVB Private Client Services. SVB Analytics’ revenues increased by $2.7 million to $3.1 million in 2007, compared to $0.4 million in 2006, primarily as a result of an increase in the number of clients to 340 clients in 2007, compared to 34 in 2006. eProsper’s revenues, net of minority interest, increased by $1.1 million to $1.5 million in 2007, compared to $0.4 million in 2006, primarily as a result of consolidating a full year of revenue in 2007. The decrease in noninterest income for SVB Private Client Services in 2007 was primarily due to the sale of its subsidiary, Woodside Asset Management, Inc. in early 2006.
The increase in noninterest income of $0.4 million in 2006, compared to 2005, was primarily due to increases for SVB Analytics, and from its subsidiary, eProsper, partially offset by a decrease in noninterest income for SVB Private Client Services from the sale of Woodside Asset Management, Inc.
Noninterest Expense – Other Business Services
| Year ended December 31, | |||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | % Change 2007/2006 |
2005 | % Change 2006/2005 |
||||||||||
| SVB Private Client Services |
$ | 11,948 | $ | 11,266 | 6.1 | % | $ | 12,502 | (9.9 | )% | |||||
| SVB Global |
11,440 | 6,526 | 75.3 | 5,531 | 18.0 | ||||||||||
| SVB Analytics |
8,563 | 2,899 | 195.4 | — | — | ||||||||||
| SVB Wine Division |
13,108 | 11,520 | 13.8 | 9,469 | 21.7 | ||||||||||
| Total Other Business Services |
$ | 45,059 | $ | 32,211 | 39.9 | % | $ | 27,502 | 17.1 | % | |||||
The increase in noninterest expense of $12.8 million in 2007, compared to 2006, was primarily due to increases for SVB Global and SVB Analytics. Expenses for SVB Analytics, which includes eProsper’s expenses, increased primarily as a result of the development of this division as operations commenced in the second and third quarters of 2006, respectively. The increase in SVB Global’s expense was primarily related to an increase in compensation and benefits expense, both through direct employees of SVB Global’s operations, as well as through allocated expenses from support groups. The increase in compensation and benefits expense was primarily a result of increased incentive compensation expense due to better than expected overall financial performance for SVB Financial Group.
The increase in noninterest expense of $4.7 million in 2006, compared to 2005, was primarily due to increases in expenses for SVB Analytics and the SVB Wine Division. The increase in SVB Analytics is a result of commencement of operations in 2006. The increase for the SVB Wine Division was primarily due to an increase in compensation and benefits expense through allocated expenses from support groups. The increase in compensation and benefits expense was primarily a result of increased incentive and direct drive compensation expense due to better than expected financial performance overall for SVB Financial Group.
Consolidated Financial Condition
Our total assets were $6.69 billion at December 31, 2007, an increase of $611.0 million, or 10.0 percent, compared to $6.08 billion at December 31, 2006.
Securities Purchased under Agreement to Resell, and Other Short-Term Investments
Interest earning deposits, securities purchased under agreement to resell and other short-term investments totaled $358.7 million at December 31, 2007, an increase of $119.4 million, or 49.9 percent, compared to $239.3 million at December 31, 2006. The increase in 2007 was primarily due to higher levels of other short-term investments of $50.7 million and an increase in interest-earning deposits of $47.2 million, as a result of higher levels of deposit balances, which increased by $553.6 million to $4.61 billion at December 31, 2007, compared to $4.06 billion at December 31, 2006.
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Investment Securities
Investment securities totaled $1.60 billion at December 31, 2007, a decrease of $89.8 million, or 5.3 percent, compared to $1.69 billion at December 31, 2006. The decrease in investment securities was primarily related to a $186.3 million decrease in our available-for-sale securities portfolio, primarily due to scheduled maturities and regular prepayments within our portfolio. This decrease was partially offset by a $96.5 million increase in non-marketable securities primarily due to continued investments by SVB Capital. The following table presents a profile of our investment securities portfolio at December 31, 2007, 2006 and 2005:
| December 31, | |||||||||
| (Dollars in thousands) |
2007 | 2006 | 2005 | ||||||
| Available-for-sale securities, at fair value: |
|||||||||
| U.S. Treasury securities |
$ | 20,128 | $ | 29,712 | $ | 29,700 | |||
| U.S. agencies and corporations: |
|||||||||
| Collateralized mortgage obligations |
536,383 | 629,677 | 812,644 | ||||||
| Mortgage-backed securities |
390,978 | 429,156 | 499,452 | ||||||
| U.S. agency debentures |
161,080 | 230,823 | 263,894 | ||||||
| Asset-backed securities |
— | — | 97,481 | ||||||
| Commercial mortgage-backed securities |
61,290 | 69,375 | 69,426 | ||||||
| Obligations of states and political subdivisions |
81,855 | 56,453 | 77,423 | ||||||
| Marketable equity securities |
7,391 | 257 | 633 | ||||||
| Venture capital fund investments |
1 | 2 | 2 | ||||||
| Total available-for-sale securities |
1,259,106 | 1,445,455 | 1,850,655 | ||||||
| Non-marketable securities (investment company fair value accounting): |
|||||||||
| Private equity fund investments (1) |
194,862 | 126,475 | 81,280 | ||||||
| Other private equity investments (2) |
45,907 | 32,913 | 26,782 | ||||||
| Other investments (3) |
14,636 | 15,394 | 25,300 | ||||||
| Non-marketable securities (equity method accounting): |
|||||||||
| Other investments (4) |
21,299 | 15,710 | 10,985 | ||||||
| Low income housing tax credit funds |
24,491 | 22,664 | 11,682 | ||||||
| Non-marketable securities (cost method accounting): |
|||||||||
| Private equity fund investments (5) |
35,006 | 27,771 | 26,924 | ||||||
| Other private equity investments |
7,267 | 5,961 | 3,662 | ||||||
| Total investment securities |
$ | 1,602,574 | $ | 1,692,343 | $ | 2,037,270 | |||
| (1) | Private equity fund investments (funds of funds) at December 31, 2007, 2006 and 2005 include the following investments: |
| December 31, 2007 | December 31, 2006 | December 31, 2005 | ||||||||||||||||
| (Dollars in thousands) |
Amount | Ownership% | Amount | Ownership% | Amount | Ownership% | ||||||||||||
| SVB Strategic Investors Fund, LP |
$ | 68,744 | 12.6 | % | $ | 65,977 | 12.6 | % | $ | 58,699 | 12.6 | % | ||||||
| SVB Strategic Investors Fund II, LP |
81,382 | 8.6 | 47,668 | 8.6 | 22,069 | 8.6 | ||||||||||||
| SVB Strategic Investors Fund III, LP |
44,736 | 5.9 | % | 12,830 | 6.5 | % | 512 | 100.0 | % | |||||||||
| Total private equity fund investments |
$ | 194,862 | $ | 126,475 | $ | 81,280 | ||||||||||||
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| (2) | Other private equity investments (co-investment funds) at December 31, 2007, 2006 and 2005 include the following investments: |
| December 31, 2007 | December 31, 2006 | December 31, 2005 | ||||||||||||||||
| (Dollars in thousands) |
Amount | Ownership% | Amount | Ownership% | Amount | Ownership% | ||||||||||||
| Silicon Valley BancVentures, LP |
$ | 28,068 | 10.7 | % | $ | 29,388 | 10.7 | % | $ | 26,782 | 10.7 | % | ||||||
| SVB Capital Partners II, LP (i) |
14,458 | 5.1 | 3,525 | 8.5 | — | — | ||||||||||||
| SVB India Capital Partners I, LP |
3,381 | 13.9 | % | — | — | % | — | — | % | |||||||||
| Total other private equity investments |
$ | 45,907 | $ | 32,913 | $ | 26,782 | ||||||||||||
| (i) | At December 31, 2007, we had a direct ownership interest of 1.3% and an indirect ownership interest of 3.8% in the fund through our ownership of SVB Strategic Investors Fund II, LP. |
| (3) | Other investments within non-marketable securities (investment company fair value accounting) include our ownership in Partners for Growth, LP, a sponsored debt fund. At December 31, 2007, 2006 and 2005 we had a majority ownership interest of approximately 50.0% in the fund. Partners for Growth, LP is managed by a third party and we do not have an ownership interest in the general partner of this fund. |
| (4) | Other investments (sponsored debt funds) within non-marketable securities (equity method accounting) at December 31, 2007, 2006, and 2005 include the following investments: |
| December 31, 2007 | December 31, 2006 | December 31, 2005 | ||||||||||||||||
| (Dollars in thousands) |
Amount | Ownership% | Amount | Ownership% | Amount | Ownership% | ||||||||||||
| Gold Hill Venture Lending |
$ | 8,161 | 90.7 | % | $ | 6,941 | 90.7 | % | $ | 5,616 | 90.7 | % | ||||||
| Gold Hill Venture Lending 03, LP (i) |
7,754 | 9.3 | 6,565 | 9.3 | 5,369 | 9.3 | ||||||||||||
| Partners for Growth II, LP |
5,384 | 24.2 | % | 2,204 | 24.2 | % | — | 22.9 | % | |||||||||
| Total other investments |
$ | 21,299 | $ | 15,710 | $ | 10,985 | ||||||||||||
| (i) | At December 31, 2007, we had a direct ownership interest of 4.8% in the fund. In addition, at December 31, 2007, we had an indirect ownership interest of 4.5% in Gold Hill Venture Lending 03, LP and its parallel funds through our ownership of Gold Hill Venture Lending Partners 03, LLC. |
| (5) | Represents investments in 324, 302 and 277 private equity funds at December 31, 2007, 2006 and 2005, respectively, where our ownership interest is less than 5%. |
Available-for-Sale Securities
Our fixed income investment portfolio is managed to maximize portfolio yield over the long-term in a manner consistent with our liquidity, credit diversification and our asset/liability strategies. All securities in our fixed income investment portfolio are currently held as available-for-sale. Available-for-sale securities totaled $1.26 billion at December 31, 2007, a decrease of $186.3 million, or 12.9 percent, from $1.45 billion at December 31, 2006, which decreased $405.2 million, or 21.9 percent, from $1.85 billion at December 31, 2005. The decreases in 2007 and 2006 were due primarily to principal prepayments on mortgage-backed securities and collateralized mortgage obligations and scheduled maturities of U.S. agency debentures. Additionally, during the second quarter of 2006, we sold $119.1 million of selected lower-yielding investments. The decrease in 2007 was partially offset by an increase of $25.4 million in investments of obligations of states and political subdivisions and an increase of $7.1 million in our marketable equity securities portfolio, which are equity warrant assets that have been exercised into publicly-traded shares. The duration of our fixed income investment portfolio was 2.3 years at December 31, 2007, compared to 2.5 years at December 31, 2006 and 2.6 years at December 31, 2005. We did not hold any mortgage-backed securities collateralized by sub-prime mortgage loans in 2007, 2006 or 2005.
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Non-Marketable Securities
Non-marketable securities primarily represent investments managed by SVB Capital as part of their funds management business and include funds of funds, co-investment funds and sponsored debt funds, as well as direct equity investments. Non-marketable securities of $343.5 million at December 31, 2007 increased by $96.6 million or 39.1 percent, from $246.9 million in 2006, which increased by $60.3 million or 32.3 percent, from $186.6 million in 2005.
The increase in non-marketable securities of $96.6 million in 2007 was primarily related to a $68.4 million increase in private equity fund investments accounted for using investment company fair value accounting and a $13.0 million increase in other private equity investments accounted for using investment company fair value accounting. The increase of $68.4 million in private equity fund investments was due to additional investments made by each of our managed funds, with particular growth in SVB Strategic Investors Fund II, LP and SVB Strategic Investors Fund III, LP. The increase of $13.0 million in other private equity investments related primarily to additional investments from SVB Capital Partners II, LP and investments from SVB India Capital Partners I, LP.
The increase in non-marketable securities of $60.3 million in 2006 was primarily related to an increase in private equity fund investments accounted for using investment company fair value accounting of $45.2 million, an increase of $6.1 million in other private equity investments accounted for using investment company fair value accounting and an increase of $4.7 million in other investments accounted for using equity method accounting, partially offset by a $9.9 million decrease in other investments accounted for using investment company fair value accounting. The increase of $45.2 million in private equity fund investments was due to additional investments made by our managed funds, SVB Strategic Investors Fund, LP, SVB Strategic Investors Fund II, LP and SVB Strategic Investors Fund III, LP. The increase of $6.1 million in other private equity investments was due to investments from SVB Capital Partners II, LP and additional investments from Silicon Valley BancVentures, LP. The increase of $4.7 million in other investments was primarily related to investments from Partners for Growth II, LP as well as additional investments from Gold Hill Venture Lending Partners 03, LLC and Gold Hill Venture Lending 03, LP. The decrease of $9.9 million in other investments was related to distributions from Partners for Growth, LP.
Investment Concentration
At December 31, 2007 and 2006, we held no investment securities that were issued by a single party that exceeded 10.0% of our stockholders’ equity.
Investment Securities—Remaining Contractual Principal Maturities and Yields (Fully-Taxable Equivalent)
The following table provides the remaining contractual principal maturities and fully taxable-equivalent yields on investment securities as of December 31, 2007. Interest income on certain obligations of states and political subdivisions (non-taxable investments) are presented on a fully taxable-equivalent basis using the federal statutory tax rate of 35.0%. The weighted-average yield is computed using the amortized cost of available-for-sale securities, which are reported at fair value.
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Expected remaining maturities of callable U.S. agency securities, mortgage-backed securities, and collateralized mortgage obligations may differ significantly from their contractual maturities because borrowers have the right to prepay obligations with or without penalties. This risk, known as call risk and prepayment risk, may result in these securities having longer or shorter average lives than anticipated at the time of purchase. As interest rates decline, prepayments generally tend to increase; causing the average expected remaining maturity to shorten. Conversely, as interest rates rise, prepayments tend to decrease causing the average expected remaining maturity to extend. This is most apparent in mortgage-backed securities and collateralized mortgage obligations as contractual maturities are typically 15 to 30 years whereas expected average lives of these securities are significantly shorter and vary based upon structure. Private equity fund investments, other private equity investments, other investments and low income housing tax credit funds are included in the table below as maturing after 10 years.
| December 31, 2007 | ||||||||||||||||||||||||||||||
| Total | One Year or Less |
After One Year to Five Years |
After Five Years to Ten Years |
After Ten Years |
||||||||||||||||||||||||||
| (Dollars in thousands) |
Carrying Value |
Weighted- Average Yield |
Carrying Value |
Weighted- Average Yield |
Carrying Value |
Weighted- Average Yield |
Carrying Value |
Weighted- Average Yield |
Carrying Value |
Weighted- Average Yield |
||||||||||||||||||||
| U.S. Treasury securities |
$ | 20,128 | 4.92 | % | $ | 20,128 | 4.92 | % | $ | — | — | % | $ | — | — | % | $ | — | — | % | ||||||||||
| U.S. agencies and corporations: |
||||||||||||||||||||||||||||||
| Collateralized mortgage obligations |
536,383 | 4.66 | — | — | 130 | 6.38 | 87,163 | 4.44 | 449,090 | 4.71 | ||||||||||||||||||||
| Mortgage-backed securities |
390,978 | 4.91 | — | — | 2,730 | 6.41 | 12,308 | 5.29 | 375,940 | 4.89 | ||||||||||||||||||||
| U.S. agency debentures |
161,080 | 3.86 | 49,693 | 3.11 | 111,387 | 4.20 | — | — | — | — | ||||||||||||||||||||
| Commercial mortgage-backed securities |
61,290 | 4.67 | — | — | — | — | — | — | 61,290 | 4.67 | ||||||||||||||||||||
| Obligations of states and political subdivisions |
81,855 | 6.56 | 20,399 | 6.49 | 17,023 | 7.68 | 3,332 | 5.97 | 41,101 | 6.18 | ||||||||||||||||||||
| Low income housing tax credit funds |
24,491 | — | — | — | — | — | — | — | 24,491 | — | ||||||||||||||||||||
| Marketable equity securities (1) |
7,391 | — | 7,391 | — | — | — | — | — | — | — | ||||||||||||||||||||
| Private equity fund investments |
229,869 | — | — | — | — | — | — | — | 229,869 | — | ||||||||||||||||||||
| Other private equity fund investments |
53,174 | — | — | — | — | — | — | — | 53,174 | — | ||||||||||||||||||||
| Other investments |
35,935 | — | — | — | — | — | — | — | 35,935 | — | ||||||||||||||||||||
| Total |
$ | 1,602,574 | 3.72 | % | $ | 97,611 | 3.95 | % | $ | 131,270 | 4.70 | % | $ | 102,803 | 4.59 | % | $ | 1,270,890 | 3.53 | % | ||||||||||
| (1) | Available-for-sale. |
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Loans
The following table details the composition of the loan portfolio, net of unearned income as of the five most recent year-ends:
| December 31, | |||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | 2005 | 2004 | 2003 | ||||||||||
| Commercial loans |
$ | 3,563,005 | $ | 2,959,501 | $ | 2,410,893 | $ | 1,927,271 | $ | 1,701,903 | |||||
| Real estate construction: |
|||||||||||||||
| Vineyard development |
121,382 | 118,266 | 104,881 | 80,960 | 50,118 | ||||||||||
| Commercial real estate |
44,405 | 13,336 | 20,657 | 18,562 | 12,204 | ||||||||||
| Total real estate construction |
165,787 | 131,602 | 125,538 | 99,522 | 62,322 | ||||||||||
| Real estate term: |
|||||||||||||||
| Real estate term — consumer |
75,149 | 46,812 | 39,906 | 27,124 | 19,213 | ||||||||||
| Real estate term — commercial |
38,849 | 50,051 | 10,694 | 16,720 | 12,902 | ||||||||||
| Total real estate term |
113,998 | 96,863 | 50,600 | 43,844 | 32,115 | ||||||||||
| Consumer and other |
308,940 | 294,436 | 256,322 | 237,951 | 190,806 | ||||||||||
| Total loans, net of unearned income (1) |
$ | 4,151,730 | $ | 3,482,402 | $ | 2,843,353 | $ | 2,308,588 | $ | 1,987,146 | |||||
| (1) | Unearned income was $26.4 million, $27.2 million, $25.0 million, $18.4 million and $18.3 million in 2007, 2006, 2005, 2004 and 2003, respectively. |
A substantial percentage of our loans are commercial in nature, and such loans are generally made to emerging-technologies or growth companies in technology-related industries. The breakdown of total loans and total loans as a percentage of gross loans by industry sector is as follows:
| December 31, 2007 | December 31, 2006 | |||||||||||
| Industry Sector |
Amount | Percentage | Amount | Percentage | ||||||||
| Technology (1) |
$ | 1,948,925 | 46.6 | % | $ | 1,788,785 | 51.0 | % | ||||
| Private Equity |
773,932 | 18.5 | 480,616 | 13.7 | ||||||||
| Life Sciences (1) |
407,856 | 9.8 | 352,220 | 10.0 | ||||||||
| Premium Winery |
375,562 | 9.0 | 375,960 | 10.7 | ||||||||
| Private Client Services |
402,563 | 9.6 | 345,674 | 9.8 | ||||||||
| All other sectors |
269,260 | 6.5 | 166,305 | 4.8 | ||||||||
| Total Gross Loans |
$ | 4,178,098 | 100.0 | % | $ | 3,509,560 | 100.0 | % | ||||
| (1) | Included in the technology and life science niches are loans provided to emerging growth clients, which represent approximately 15 percent of total gross loans at December 31, 2007. |
As of December 31, 2007, our asset-based lending and accounts receivable factoring represented 8.5% and 7.4%, respectively, of total gross loans, compared to 10.3% and 7.1%, respectively at December 31, 2006. Approximately 43.5% and 11.1% of our outstanding gross loan balances as of December 31, 2007 were in the states of California and Massachusetts, respectively, compared to 48.4% and 11.2%, respectively, as of December 31, 2006. There are no other states with balances greater than 10%.
Commercial real estate construction loans, net of unearned income totaled $44.4 million at December 31, 2007, compared to $13.3 million at December 31, 2006. The increase of $31.1 million was primarily due to an increase in our community redevelopment loans. Consumer real estate term loans totaled $75.1 million at December 31, 2007, compared to $46.8 million at December 31, 2006. Included in consumer real estate term loans are loans made to eligible employees through our Employee Home Ownership Plan (“EHOP”), which increased by $13.4 million to $49.0 million at December 31, 2007, compared to $35.6 million at December 31, 2006.
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As of December 31, 2007, 73.0 percent, or $3.05 billion, of our outstanding gross loans were variable-rate loans that adjust at a prescribed measurement date upon a change in our prime-lending rate or other variable indices, compared to 73.1 percent, or $2.57 billion, as of December 31, 2006. The following table sets forth the remaining contractual maturity distribution of our gross loans at December 31, 2007, for fixed and variable rate loans:
| (Dollars in thousands) |
One Year or Less |
After One Year and Through Five Years |
After Five Years |
Total | ||||||||
| Fixed rate loans: |
||||||||||||
| Commercial loans |
$ | 172,822 | $ | 697,761 | $ | 50,833 | $ | 921,416 | ||||
| Real estate construction: |
||||||||||||
| Vineyard development |
— | 41,246 | 61,520 | 102,766 | ||||||||
| Commercial real estate |
12,225 | 13,027 | — | 25,252 | ||||||||
| Total real estate construction |
12,225 | 54,273 | 61,520 | 128,018 | ||||||||
| Real estate term: |
||||||||||||
| Real estate term — consumer |
13,974 | 17,573 | 35,507 | 67,054 | ||||||||
| Real estate term — commercial |
3,528 | 5,079 | 23,723 | 32,330 | ||||||||
| Total real estate term |
17,502 | 22,652 | 59,230 | 99,384 | ||||||||
| Consumer and other |
28 | 17,824 | — | 17,852 | ||||||||
| Total fixed-rate loans |
$ | 202,577 | $ | 792,510 | $ | 171,583 | $ | 1,166,670 | ||||
| Variable-rate loans: |
||||||||||||
| Commercial loans |
$ | 1,575,531 | $ | 1,067,363 | $ | 24,393 | $ | 2,667,287 | ||||
| Real estate construction: |
||||||||||||
| Vineyard development |
503 | 7,967 | 10,432 | 18,902 | ||||||||
| Commercial real estate |
17,675 | 1,749 | — | 19,424 | ||||||||
| Total real estate construction |
18,178 | 9,716 | 10,432 | 38,326 | ||||||||
| Real estate term: |
||||||||||||
| Real estate term — consumer |
8,043 | — | — | 8,043 | ||||||||
| Real estate term — commercial |
3,250 | 1,823 | 1,553 | 6,626 | ||||||||
| Total real estate term |
11,293 | 1,823 | 1,553 | 14,669 | ||||||||
| Consumer and other |
162,368 | 47,983 | 80,795 | 291,146 | ||||||||
| Total variable-rate loans |
$ | 1,767,370 | $ | 1,126,885 | $ | 117,173 | $ | 3,011,428 | ||||
Upon maturity, loans satisfying our credit quality standards may be eligible for renewal. Such renewals are subject to the normal underwriting and credit administration practices associated with new loans. We do not grant loans with unconditional extension terms.
Loan Administration
Authority over our loan policies resides with our Board of Directors. This authority is managed through the approval and periodic review of our loan policies. The Board of Directors delegates authority to the Directors’ Loan Committee to supervise our loan underwriting, approval, and monitoring activities. The Directors’ Loan Committee consists of four outside Board of Director members.
Subject to the oversight of the Directors’ Loan Committee, lending authority is delegated to the Chief Credit Officer and our loan committee, which consists of the Chief Credit Officer, Chief Operating Officer of the Bank, and other senior members of our lending management. Requests for new and existing credits that meet certain size and underwriting criteria may be approved outside of our loan committee by designated senior lenders or jointly with a senior credit officer or division risk manager.
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Credit Quality and Allowance for Loan Losses
The following table presents an analysis of the allowance for loan losses as of the five most recent year-ends:
| Year ended December 31, | ||||||||||||||||||||
| (Dollars in thousands) |
2007 | 2006 | 2005 | 2004 | 2003 | |||||||||||||||
| Balance, beginning of year |
$ | 42,747 | $ | 36,785 | $ | 37,613 | $ | 49,862 | $ | 58,366 | ||||||||||
| Charge-offs: |
||||||||||||||||||||
| Commercial |
(19,278 | ) | (13,865 | ) | (10,882 | ) | (16,196 | ) | (17,723 | ) | ||||||||||
| Real estate |
— | — | (3 | ) | — | (1,252 | ) | |||||||||||||
| Consumer and other |
(100 | ) | (200 | ) | (1,531 | ) | — | — | ||||||||||||
| Total charge-offs |
(19,378 | ) | (14,065 | ) | (12,416 | ) | (16,196 | ) | (18,975 | ) | ||||||||||
| Recoveries: |
||||||||||||||||||||
| Commercial |
7,088 | 8,968 | 11,090 | 13,845 | 19,965 | |||||||||||||||
| Real estate |
— | 1,090 | 261 | 391 | 331 | |||||||||||||||
| Consumer and other |
— | 92 | — | — | 67 | |||||||||||||||
| Total recoveries |
7,088 | 10,150 | 11,351 | 14,236 | 20,363 | |||||||||||||||
| Net (charge-offs) recoveries |
||||||||||||||||||||