UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
OR
o TRANSITION REPORT PURSUANT TO 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 |
|
(I.R.S. Employer Identification No.) |
|
|
|
3003 Tasman Drive, Santa Clara, California |
|
95054-1191 |
(Address of principal executive offices) |
|
(Zip Code) |
(408) 654-7400
(Registrants telephone number, including area code)
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 o
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.
Large accelerated filer x Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
At October 31, 2006, 34,317,570 shares of the registrants common stock ($0.001 par value) were outstanding.
TABLE OF CONTENTS
2
PART I - FINANCIAL INFORMATION
ITEM 1. INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SVB
FINANCIAL GROUP AND SUBSIDIARIES
INTERIM CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in thousands, except par value and share data) |
|
September 30, |
|
December 31, |
|
||
Assets |
|
|
|
|
|
||
Cash and due from banks |
|
$ |
305,134 |
|
$ |
286,446 |
|
Federal funds sold, securities purchased under agreement to resell and other short-term investment securities |
|
295,367 |
|
175,652 |
|
||
Investment securities |
|
1,726,499 |
|
2,037,270 |
|
||
Loans, net of unearned income |
|
3,319,515 |
|
2,843,353 |
|
||
Allowance for loan and lease losses |
|
(39,549 |
) |
(36,785 |
) |
||
Net loans |
|
3,279,966 |
|
2,806,568 |
|
||
Premises and equipment, net of accumulated depreciation and amortization |
|
36,236 |
|
25,099 |
|
||
Goodwill |
|
21,243 |
|
35,638 |
|
||
Accrued interest receivable and other assets |
|
208,664 |
|
175,042 |
|
||
Total assets |
|
$ |
5,873,109 |
|
$ |
5,541,715 |
|
|
|
|
|
|
|
||
Liabilities, Minority Interest, and Stockholders Equity |
|
|
|
|
|
||
Liabilities: |
|
|
|
|
|
||
Deposits: |
|
|
|
|
|
||
Noninterest-bearing demand |
|
$ |
2,956,635 |
|
$ |
2,934,278 |
|
Negotiable order of withdrawal (NOW) |
|
30,376 |
|
39,573 |
|
||
Money market |
|
671,968 |
|
961,052 |
|
||
Time |
|
315,481 |
|
317,827 |
|
||
Total deposits |
|
3,974,460 |
|
4,252,730 |
|
||
Federal funds purchased, FHLB advances and securities sold under agreement to repurchase |
|
809,767 |
|
279,464 |
|
||
Contingently convertible debt |
|
148,215 |
|
147,604 |
|
||
Junior subordinated debentures |
|
51,201 |
|
48,228 |
|
||
Other borrowings |
|
2,669 |
|
11 |
|
||
Other liabilities |
|
134,329 |
|
124,921 |
|
||
Total liabilities |
|
5,120,641 |
|
4,852,958 |
|
||
|
|
|
|
|
|
||
Commitments and contingencies |
|
|
|
|
|
||
|
|
|
|
|
|
||
Minority interest in capital of consolidated affiliates |
|
156,690 |
|
119,456 |
|
||
|
|
|
|
|
|
||
Stockholders equity: |
|
|
|
|
|
||
Preferred stock, $0.001 par value, 20,000,000 shares authorized; no shares issued and outstanding |
|
|
|
|
|
||
Common stock, $0.001 par value, 150,000,000 shares authorized; 34,253,880 and 35,103,145 shares outstanding at September 30, 2006 and December 31, 2005, respectively |
|
34 |
|
35 |
|
||
Additional paid-in capital |
|
|
|
8,439 |
|
||
Retained earnings |
|
614,964 |
|
587,713 |
|
||
Unearned compensation |
|
- |
|
(5,792 |
) |
||
Accumulated other comprehensive loss |
|
(19,220 |
) |
(21,094 |
) |
||
Total stockholders equity |
|
595,778 |
|
569,301 |
|
||
Total liabilities, minority interest, and stockholders equity |
|
$ |
5,873,109 |
|
$ |
5,541,715 |
|
See accompanying notes to interim consolidated financial statements (unaudited).
3
SVB
FINANCIAL GROUP AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
|
|
Three Months |
|
Nine Months |
|
||||||||
(Dollars in thousands, except per share amounts) |
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Interest income: |
|
|
|
|
|
|
|
|
|
||||
Loans |
|
$ |
78,686 |
|
$ |
57,825 |
|
$ |
215,053 |
|
$ |
156,587 |
|
Investment securities: |
|
|
|
|
|
|
|
|
|
||||
Taxable |
|
17,720 |
|
21,636 |
|
57,714 |
|
63,316 |
|
||||
Non-taxable |
|
737 |
|
872 |
|
2,341 |
|
2,842 |
|
||||
Federal funds sold, securities purchased under agreement to resell and other short-term investments |
|
3,161 |
|
2,284 |
|
7,731 |
|
7,268 |
|
||||
Total interest income |
|
100,304 |
|
82,617 |
|
282,839 |
|
230,013 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Interest expense: |
|
|
|
|
|
|
|
|
|
||||
Deposits |
|
2,197 |
|
3,141 |
|
6,858 |
|
8,251 |
|
||||
Other borrowings |
|
8,299 |
|
1,752 |
|
16,532 |
|
3,478 |
|
||||
Total interest expense |
|
10,496 |
|
4,893 |
|
23,390 |
|
11,729 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Net interest income |
|
89,808 |
|
77,724 |
|
259,449 |
|
218,284 |
|
||||
Provision for (recovery of) loan and lease losses |
|
2,767 |
|
1,427 |
|
4,895 |
|
(1,573 |
) |
||||
Net interest income after provision for (recovery of) loan losses |
|
87,041 |
|
76,297 |
|
254,554 |
|
219,857 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Noninterest income: |
|
|
|
|
|
|
|
|
|
||||
Client investment fees |
|
11,555 |
|
8,700 |
|
32,164 |
|
23,901 |
|
||||
Gains on derivative instruments, net |
|
4,729 |
|
3,040 |
|
19,683 |
|
16,959 |
|
||||
Letter of credit and standby letter of credit income |
|
2,617 |
|
2,625 |
|
7,609 |
|
7,418 |
|
||||
Deposit service charges |
|
2,747 |
|
2,435 |
|
7,235 |
|
7,317 |
|
||||
Corporate finance fees |
|
1,999 |
|
2,990 |
|
7,212 |
|
14,739 |
|
||||
Gains on investment securities, net |
|
1,645 |
|
1,301 |
|
5,664 |
|
872 |
|
||||
Other |
|
5,676 |
|
3,842 |
|
15,780 |
|
9,485 |
|
||||
Total noninterest income |
|
30,968 |
|
24,933 |
|
95,347 |
|
80,691 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Noninterest expense: |
|
|
|
|
|
|
|
|
|
||||
Compensation and benefits (including share-based payment expense of $5.2, $2.0, $16.8 and $5.5, respectively (in millions)) |
|
45,505 |
|
37,796 |
|
138,701 |
|
122,344 |
|
||||
Professional services |
|
11,363 |
|
6,336 |
|
29,792 |
|
17,059 |
|
||||
Impairment of goodwill |
|
- |
|
- |
|
18,434 |
|
|
|
||||
Net occupancy |
|
4,112 |
|
3,633 |
|
12,615 |
|
12,506 |
|
||||
Furniture and equipment |
|
3,899 |
|
3,278 |
|
11,274 |
|
9,297 |
|
||||
Business development and travel |
|
3,013 |
|
2,748 |
|
8,754 |
|
7,540 |
|
||||
Correspondent bank fees |
|
1,510 |
|
1,429 |
|
4,092 |
|
4,125 |
|
||||
Data processing services |
|
944 |
|
1,098 |
|
2,933 |
|
3,063 |
|
||||
Telephone |
|
1,040 |
|
894 |
|
2,827 |
|
2,844 |
|
||||
(Reduction of) provision for unfunded credit commitments |
|
458 |
|
1,508 |
|
(3,363 |
) |
330 |
|
||||
Other |
|
3,163 |
|
3,263 |
|
13,274 |
|
10,015 |
|
||||
Total noninterest expense |
|
75,007 |
|
61,983 |
|
239,333 |
|
189,123 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Income before minority interest in net (income) loss of consolidated affiliates, income tax expense and cumulative effect of change in accounting principle |
|
43,002 |
|
39,247 |
|
110,568 |
|
111,425 |
|
||||
Minority interest in net (income) loss of consolidated affiliates |
|
919 |
|
(1,281 |
) |
(5,139 |
) |
(468 |
) |
||||
Income before income tax expense |
|
43,921 |
|
37,966 |
|
105,429 |
|
110,957 |
|
||||
Income tax expense |
|
18,751 |
|
14,907 |
|
44,586 |
|
44,066 |
|
||||
Net income before cumulative effect of change in accounting principle |
|
25,170 |
|
23,059 |
|
60,843 |
|
66,891 |
|
||||
Cumulative effect of change in accounting principle, net of tax (1) |
|
|
|
|
|
192 |
|
|
|
||||
Net income |
|
$ |
25,170 |
|
$ |
23,059 |
|
$ |
61,035 |
|
$ |
66,891 |
|
|
|
|
|
|
|
|
|
|
|
||||
Earnings per common share basic, before cumulative effect of change in accounting principle |
|
$ |
0.73 |
|
$ |
0.66 |
|
$ |
1.75 |
|
$ |
1.90 |
|
Earnings per common share diluted, before cumulative effect of change in accounting principle |
|
$ |
0.68 |
|
$ |
0.60 |
|
$ |
1.61 |
|
$ |
1.73 |
|
Earnings per common share basic |
|
$ |
0.73 |
|
$ |
0.66 |
|
$ |
1.75 |
|
$ |
1.90 |
|
Earnings per common share diluted |
|
$ |
0.68 |
|
$ |
0.60 |
|
$ |
1.61 |
|
$ |
1.73 |
|
(1) Represents the cumulative effect of change in accounting principle, net of taxes, on previously recognized share-based compensation for the effect of adopting Statement of Financial Accounting Standards No. 123 (R), Share-Based Payment.
See accompanying notes to interim consolidated financial statements (unaudited).
4
SVB
FINANCIAL GROUP AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
|
|
Three Months |
|
Nine Months |
|
||||||||
(Dollars in thousands) |
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Net income |
|
$ |
25,170 |
|
$ |
23,059 |
|
$ |
61,035 |
|
$ |
66,891 |
|
Other comprehensive income (loss), net of tax: |
|
|
|
|
|
|
|
|
|
||||
Cumulative translation (losses) gains: |
|
|
|
|
|
|
|
|
|
||||
Foreign currency translation gains (losses), net of tax |
|
117 |
|
(25 |
) |
330 |
|
(57 |
) |
||||
Change in unrealized (losses) gains on available-for-sale investment securities: |
|
|
|
|
|
|
|
|
|
||||
Unrealized holding gains (losses), net of tax |
|
15,421 |
|
(12,684 |
) |
(686 |
) |
(14,881 |
) |
||||
Reclassification adjustment for (losses) gains included in net income, net of tax |
|
2,160 |
|
101 |
|
2,230 |
|
(1,189 |
) |
||||
Total other comprehensive income (loss), net of tax |
|
17,698 |
|
(12,608 |
) |
1,874 |
|
(16,127 |
) |
||||
Total comprehensive income |
|
$ |
42,868 |
|
$ |
10,451 |
|
$ |
62,909 |
|
$ |
50,764 |
|
See accompanying notes to interim consolidated financial statements (unaudited).
5
SVB
FINANCIAL GROUP AND SUBSIDIARIES
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
|
|
Nine Months Ended September 30, |
|
||||
(Dollars in thousands) |
|
2006 |
|
2005 |
|
||
|
|
|
|
|
|
||
Cash flows from operating activities: |
|
|
|
|
|
||
Net income |
|
$ |
61,035 |
|
$ |
66,891 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
||
Provision for (recovery of) loan losses |
|
4,895 |
|
(1,573 |
) |
||
Impairment of goodwill |
|
18,434 |
|
|
|
||
Changes in fair values of derivatives, net |
|
(3,428 |
) |
4,612 |
|
||
Gains on investment securities, net |
|
(5,664 |
) |
(872 |
) |
||
Depreciation and amortization |
|
8,751 |
|
5,958 |
|
||
Minority interest |
|
5,139 |
|
468 |
|
||
Tax benefits of share-based compensation and other |
|
8,112 |
|
9,263 |
|
||
Amortization of share-based compensation |
|
16,788 |
|
5,438 |
|
||
Amortization of deferred warrant-related loan fees |
|
(5,605 |
) |
(4,796 |
) |
||
Deferred income tax (benefit) expense |
|
(3,503 |
) |
435 |
|
||
Changes in other assets and liabilities: |
|
|
|
|
|
||
Increase in accrued interest receivable |
|
(4,415 |
) |
(7,413 |
) |
||
Decrease in accounts receivable |
|
2,743 |
|
6,722 |
|
||
Increase in income tax receivable, net |
|
(5,911 |
) |
(2,375 |
) |
||
Decrease in accrued retention, incentive plans, other compensation benefits payable |
|
(14,510 |
) |
(9,388 |
) |
||
(Reduction of) provision for unfunded credit commitments |
|
(3,363 |
) |
330 |
|
||
Other, net |
|
(1,873 |
) |
10,354 |
|
||
Net cash provided by operating activities |
|
77,625 |
|
84,054 |
|
||
|
|
|
|
|
|
||
Cash flows from investing activities: |
|
|
|
|
|
||
Purchases of available-for-sale securities |
|
(24,860 |
) |
(416,827 |
) |
||
Proceeds from sales of available-for-sale securities |
|
126,230 |
|
11,860 |
|
||
Proceeds from maturities and pay-downs of available-for-sale securities |
|
253,501 |
|
348,490 |
|
||
Purchases of nonmarketable securities (cost and equity method accounting) |
|
(22,430 |
) |
(12,175 |
) |
||
Proceeds from sales of nonmarketable securities (cost and equity method accounting) |
|
11,585 |
|
4,379 |
|
||
Proceeds from nonmarketable securities (cost and equity method accounting) |
|
21,694 |
|
3,682 |
|
||
Purchases of nonmarketable securities (investment fair value accounting) |
|
(42,943 |
) |
(54,319 |
) |
||
Proceeds from sales of nonmarketable securities (investment fair value accounting) |
|
9,501 |
|
6,407 |
|
||
Proceeds from nonmarketable securities (investment fair value accounting) |
|
|
|
2,828 |
|
||
Net increase in loans |
|
(487,339 |
) |
(342,314 |
) |
||
Proceeds from recoveries of charged-off loans |
|
8,296 |
|
9,330 |
|
||
Purchase of eProsper, net of cash acquired |
|
(3,994 |
) |
|
|
||
Purchases of premises and equipment |
|
(17,783 |
) |
(14,465 |
) |
||
Net cash used for investing activities |
|
(168,542 |
) |
(453,124 |
) |
||
|
|
|
|
|
|
||
Cash flows from financing activities: |
|
|
|
|
|
||
Net (decrease) increase in deposits |
|
(278,270 |
) |
72,625 |
|
||
Increase in borrowings, net |
|
530,292 |
|
111,761 |
|
||
Capital contributions from minority interest participants, net of distributions |
|
33,170 |
|
38,163 |
|
||
Stock compensation related tax benefits |
|
4,321 |
|
|
|
||
Proceeds from issuance of common stock |
|
34,082 |
|
15,655 |
|
||
Repurchases of common stock |
|
(94,275 |
) |
(77,661 |
) |
||
Net cash provided by financing activities |
|
229,320 |
|
160,543 |
|
||
Net increase (decrease) in cash and cash equivalents |
|
138,403 |
|
(208,527 |
) |
||
Cash and cash equivalents at beginning of year |
|
462,098 |
|
627,218 |
|
||
Cash and cash equivalents at end of period |
|
$ |
600,501 |
|
$ |
418,691 |
|
|
|
|
|
|
|
||
Supplemental disclosures: |
|
|
|
|
|
||
Cash paid during the period for: |
|
|
|
|
|
||
Interest paid |
|
$ |
22,532 |
|
$ |
11,661 |
|
Income taxes paid |
|
$ |
42,407 |
|
$ |
36,761 |
|
See accompanying notes to interim consolidated financial statements (unaudited).
6
SVB FINANCIAL GROUP AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Description of Business
SVB Financial Group and its subsidiaries (which we refer to collectively as we, our or us in this Form 10-Q) offer clients financial products and services through four primary strategic business groups: Commercial Banking, SVB Capital, SVB Alliant, and Other Business Services. Our Other Business Services group includes SVB Global, SVB Private Client Services and certain other business service units (see Note 11. Segment Reporting).
SVB Financial Group, our parent company (which we refer to as SVB Financial Group or the Parent company) is a bank holding company and financial holding company whose principal subsidiary is Silicon Valley Bank (the Bank). The Bank is a California-chartered bank, founded in 1983, and headquartered in Santa Clara, California. We serve more than 11,000 clients worldwide through our 28 regional offices in the United States and four subsidiaries outside the United States. The Company has 13 offices throughout California and operates regional offices across the country in Arizona, Colorado, Georgia, Illinois, Massachusetts, Minnesota, New York, North Carolina, Oregon, Pennsylvania, Utah, Texas, Virginia, and Washington. SVB Financial Group also has four foreign subsidiaries, two in London, England, one in Bangalore, India and one in Shanghai, China.
Through our Commercial Banking business group, referred to as SVB Silicon Valley Bank, which includes the Bank and its subsidiaries, we serve clients in all stages of maturity ranging from emerging-growth companies to established, private and public companies in the technology, life science and premium wine industries. 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 no or little revenue. By contrast, we define established or middle-market clients as companies that tend to be more mature. These companies may be publicly traded and are more established in the markets in which they participate. In 2006, we began using SVB Silicon Valley Bank to refer to our Commercial Banking activities.
SVB Capital focuses on the business needs of our private equity clients, with whom we have established and maintain relationships domestically and internationally. Through this segment, we provide banking services and financial solutions, including traditional deposit and checking accounts, loans, letters of credit and cash management services to private equity clients. SVB Capital also makes investments in private equity firms and in companies in the niches we serve. The group manages five private equity funds and oversees investments, including our investments in several sponsored limited partnerships. These limited partnerships include Gold Hill Venture Lending Partners 03, LP and its parallel funds, which primarily provide secured debt, typically to emerging-growth clients in their earliest stages; and the Partners for Growth funds, which are special situation debt funds that provide secured debt primarily to higher-risk, more established middle-market clients in their later stages.
SVB Alliant, our investment banking subsidiary, provides merger and acquisition advisory services, private placement advisory services, strategic alliance services, and specialized financial studies such as valuations and fairness opinions. SVB Alliant is a broker-dealer registered with the U.S. Securities and Exchange Commission (SEC) and a member of the National Association of Securities Dealers, Inc. (NASD). In 2005, we established SVB Alliant Europe Limited, a subsidiary of SVB Financial Group based in London, England, in order to provide investment advisory services to companies in Europe. SVB Alliant Europe Limited commenced full operations on May 2, 2006, when it received its license from the Financial Services Authority, an independent body that regulates the financial services industry in the United Kingdom.
Other Business Services includes SVB Global, SVB Private Client Services, SVB Analytics and other business service units that are not part of one of the three business groups described above. SVB Global includes three foreign subsidiaries, which facilitate our clients global expansion into major technology centers around the world. SVB Global provides a variety of services, including consulting and business services, referrals, and knowledge sharing, as well as identifying business opportunities for us. SVB Private Client Services provides a wide range of credit services to high-net-worth individuals using both long-term secured and short-term unsecured lines of credit. SVB Private Client Services helps our clients meet their cash management needs by providing deposit account products and services, including checking accounts, deposit accounts, money market accounts, and certificates of deposit. SVB Analytics, a new entity formed in 2006, provides solutions to address the valuation needs of private emerging-growth technology and life sciences companies. SVB Analytics includes eProsper, a company in which SVB Analytics acquired a controlling interest in August 2006, which provides equity ownership data management services.
7
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited interim consolidated financial statements reflect all adjustments (of a normal and recurring nature) that are, in the opinion of management, necessary to fairly present our financial position; results of operations; and cash flows in accordance with accounting principles generally accepted in the United States of America (GAAP). Such interim financial statements have been prepared in accordance with the instructions to Form 10-Q pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The results of operations for the three and nine months ended September 30, 2006 are not necessarily indicative of results to be expected for any future periods. These interim consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2005 (2005 Form 10-K).
The consolidated balance sheet at December 31, 2005 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. The accompanying interim consolidated financial statements have been prepared on a consistent basis with the accounting policies described in Part II, Item 8. Consolidated Financial Statements and Supplementary Data - Note 2. Summary of Significant Accounting Policies presented in our Annual Report on Form 10-K for the year ended December 31, 2005.
The preparation of interim consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Recent Accounting Pronouncements
In December of 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123, Share-Based Payment (Revised 2004) (SFAS 123(R)). SFAS 123(R) requires us to measure all employee share-based compensation awards using a fair value based method, estimate award forfeitures, and record such expense in our consolidated statements of operations. SFAS 123(R) also requires the benefit of tax deductions in excess of recognized compensation cost to be reported in the statement of cash flows as a financing cash flow, rather than as an operating cash flow. SFAS 123(R) supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and amends SFAS No. 95, Statement of Cash Flows. On January 1, 2006, we adopted SFAS 123(R) using the modified prospective method, one of the adoption methods permitted under SFAS 123(R) (see Note 4).
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140 (SFAS 155). Hybrid financial instruments are financial instruments that contain an embedded derivative within a single instrument. SFAS 155 gives entities an option to elect to record hybrid financial instruments at fair value as one financial instrument. Prior to this amendment, hybrid financial instruments were required to be separated into two instruments, a derivative and host, and generally only the derivative was recorded at fair value. SFAS 155 requires that beneficial interests in securitized assets be evaluated for derivatives, either freestanding or embedded. On October 25, 2006, the FASB provided a scope exception for securitized interests that (1) only contain an embedded derivative that is tied to the prepayment risk of the underlying prepayable financial assets and (2) the investor does not control the right to accelerate the settlement. SFAS 155 is effective for all financial instruments acquired or issued after January 1, 2007. Additionally, SFAS 155 provides a one-time opportunity to apply the fair value election to hybrid financial instruments existing at the date of implementation at fair value as one financial instrument, with any difference between the carrying amount of the existing hybrid financial instruments and the fair value of the single financial instrument being recorded as a cumulative-effect adjustment to beginning retained earnings. We are currently assessing the impact of SFAS 155 on our consolidated financial position and results of operations.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets, an amendment of SFAS 140 (SFAS 156). SFAS 156 clarifies when an entity should separately recognize servicing assets and servicing liabilities when it undertakes an obligation to service a financial asset by entering into a servicing contract. SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value and subsequently measured using either the amortization method as previously permitted under SFAS 140 or the fair value measurement method. Entities are permitted to make an election to subsequently re-measure classes of separately recognized servicing assets and liabilities. Once the fair value measurement method is elected for a class, the election should be applied prospectively to all new and existing separately recognized servicing assets and servicing liabilities within that class. The
8
effect of re-measuring an existing class of separately recognized servicing assets and servicing liabilities at fair value would be reported as a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. SFAS 156 is effective as of the beginning of an entitys first fiscal year that begins after September 15, 2006. Earlier adoption is permitted as of the beginning of an entitys fiscal year, provided the entity has not yet issued interim financial statements for that fiscal year. In the first quarter of 2006, we elected not to early adopt this Statement and, accordingly, will adopt it as of January 1, 2007.
In July 2006, the FASB issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 (FIN 48), to clarify the accounting for uncertain tax positions. FIN 48 prescribes that a two-step benefit recognition model be applied initially to recognize and measure the benefit amount of a tax position. The first step requires that a tax benefit be recognized only when the tax position is more-likely-than-not to be sustained based on the technical merits of the position. Assuming the first step is met, the second step requires that the benefit amount be measured at the largest amount that is at least more-likely-than-not likelihood to be the ultimate outcome based on a cumulative-probability approach. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the period in which the threshold is subsequently met, the tax matter is resolved or the statute of limitations for examining the tax position has expired. FIN 48 requires that a previously recognized tax benefit be de-recognized in the period it becomes more-likely-than-not that the tax position would not be sustained on audit. The impact of applying FIN 48 should be recognized as a cumulative-effect adjustment to beginning retained earnings at the adoption date. The Interpretation is effective for fiscal years beginning after December 15, 2006. We are currently assessing the impact of FIN 48 on our consolidated financial position and results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. We are currently assessing the impact of SFAS 157 on our consolidated financial position and results of operations.
In September 2006, the SEC Staff Bulletin issued SAB 108 on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC Staff believes that companies should quantify errors using both a balance sheet and an income statement approach and evaluate whether either of these approaches results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB 108 also describes the circumstances where it would be appropriate for a registrant to record a one-time cumulative effect adjustment to correct errors existing in prior years that previously had been considered immaterial as well as the required disclosures to investors. SAB 108 is effective for periods ending after November 15, 2006. We are currently assessing the impact of SAB 108 on our consolidated financial position and results of operations.
3. Earnings Per Share (EPS)
The following is a reconciliation of basic EPS to diluted EPS for the three and nine months ended September 30, 2006 and 2005:
|
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
|
||||||||||||
(Dollars and shares in thousands, except per share amounts) |
|
Net |
|
Weighted- |
|
Per Share |
|
Net |
|
Weighted- |
|
Per Share |
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
2006: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Basic EPS: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Income available to common stockholders |
|
$ |
25,170 |
|
34,417 |
|
$ |
0.73 |
|
$ |
61,035 |
|
34,813 |
|
$ |
1.75 |
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Stock options, restricted stock awards, restricted stock units and convertible debt |
|
|
|
2,637 |
|
|
|
|
|
3,007 |
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Diluted EPS: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Income available to common stockholders and assumed conversions |
|
$ |
25,170 |
|
37,054 |
|
$ |
0.68 |
|
$ |
61,035 |
|
37,820 |
|
$ |
1.61 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
2005: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Basic EPS: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Income available to common stockholders |
|
$ |
23,059 |
|
34,838 |
|
$ |
0.66 |
|
$ |
66,891 |
|
35,179 |
|
$ |
1.90 |
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Stock options, restricted stock awards, restricted stock units and convertible debt |
|
|
|
3,617 |
|
|
|
|
|
3,390 |
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Diluted EPS: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Income available to common stockholders and assumed conversions |
|
$ |
23,059 |
|
38,455 |
|
$ |
0.60 |
|
$ |
66,891 |
|
38,569 |
|
$ |
1.73 |
|
9
For the three months ended September 30, 2006 and 2005, approximately 5.5 million and 4.5 million average potential common stock equivalents (including stock options, restricted stock and warrants), respectively, were excluded from the calculation, as they were anti-dilutive. For the nine months ended September 30, 2006 and 2005, approximately 5.3 million and 4.6 million average potential common stock equivalents (including stock options, restricted stock and warrants), respectively, were excluded from the calculation, as they were anti-dilutive.
In September 2004, the Emerging Issues Task Force (EITF) reached final consensus on EITF No. 04-8, The Effect of Contingently Convertible Instruments on Diluted Earnings per Share, that contingently convertible debt should be treated as convertible debt and included in the calculation of diluted EPS. The potential dilutive effect of our contingently convertible debt using the treasury stock method was approximately 1.1 million shares and 1.4 million shares for the three months ended September 30, 2006 and 2005, respectively, and 1.3 million shares and 1.2 million shares for the nine months ended September 30, 2006 and 2005, respectively. The assumed proceeds under the treasury stock method were calculated by subtracting the aggregate weighted-average conversion price from the average market price of the shares related to the contingently convertible debt. We included the dilutive effect of the $150.0 million zero-coupon, convertible subordinated notes (see Note 8. Borrowings) in our diluted EPS calculation using the treasury stock method, in accordance with the provisions of EITF No. 90-19, Convertible Bonds With Issuer Option to Settle in Cash Upon Conversion and SFAS No. 128, Earnings Per Share.
4. Share-Based Compensation
Impact of Adopting SFAS 123(R)
Prior to January 1, 2006, we accounted for employee stock-based compensation using the intrinsic value method supplemented by pro forma disclosures in accordance with APB 25 and SFAS 123, Accounting for Stock-Based Compensation. as amended by SFAS No. 148 Accounting for Stock-Based CompensationTransition and Disclosures. Under the intrinsic value method, stock options granted with exercise prices equal to the grant date fair value of our stock have no intrinsic value and therefore no expense was actually recorded for these options under APB 25. For pro forma disclosure only, we measured the fair value of our stock options using the Black-Scholes option-pricing model and expensed the value over the corresponding service period using the straight-line amortization approach. Equity-based awards for which stock-based compensation expense was actually recorded were generally grants of restricted stock awards and restricted stock units which were measured at fair value on the date of grant based on the number of shares granted and the quoted price of our common stock. Such value was then recognized as an expense over the corresponding service period using an accelerated amortization approach in accordance with FASB Interpretation No. 28 Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.
Effective January 1, 2006, we adopted SFAS 123(R) using the modified prospective transition method and accordingly prior periods have not been restated to reflect the impact of SFAS 123(R). Under SFAS 123(R), stock-based awards that were granted prior to January 1, 2006 are being expensed over the remaining portion of their vesting period under the same amortization method and, for stock options, using the same fair value measurements which were used in calculating pro forma stock-based compensation expense under SFAS 123. Under SFAS 123(R), the fair value of stock options are being measured using the Black-Scholes option-pricing model while the fair value for restricted stock awards and restricted stock units are based on the quoted price of our common stock on the date of grant. For all stock-based awards granted on or after January 1, 2006, stock-based compensation expense is being amortized on a straight-line basis over the requisite service period. SFAS 123(R) requires that the deferred stock-based compensation on the consolidated balance sheet on the date of adoption be netted against additional paid-in capital. As of December 31, 2005, there was a balance of $5.8 million of deferred stock-based compensation that was netted against additional paid-in capital on January 1, 2006.
For the three and nine months ended September 30, 2006, we recorded share-based compensation expense of $5.2 million and $16.8 million, respectively, resulting in the recognition of $1.1 million and $3.6 million, respectively, in related tax benefits. For the three and nine months ended September 30, 2005, we recognized $2.0 million and $5.5 million, respectively, of share-based compensation expense under the intrinsic value method of APB 25, resulting in the recognition of $0.8 million and $2.2 million, respectively, in related tax benefits. As a result of adopting SFAS 123(R) on January 1, 2006, our income before income taxes and our net income for the nine months ended September 30, 2006 was $12.4 million and $10.7 million lower, respectively, than if we had continued to account for share-based compensation under APB 25. Basic
10
and diluted earnings per share for the nine months ended September 30, 2006 were $0.31 and $0.28 lower, respectively, than if we had continued to account for share-based compensation under APB 25.
SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. Stock-based compensation expense was recorded net of estimated forfeitures for the nine months ended September 30, 2006 such that expense was recorded only for those stock-based awards that are expected to vest. Previously under APB 25 to the extent awards were forfeited prior to vesting, the corresponding previously recognized expense was reversed in the period of forfeiture. Upon adoption of FAS 123(R) as of January 1, 2006, we recorded a cumulative adjustment of $0.2 million to account for the expected forfeitures of restricted stock awards and restricted stock units granted prior to January 1, 2006, for which we previously recorded an expense.
Equity Incentive Plans
On May 11, 2006, shareholders approved the 2006 Equity Incentive Plan (the 2006 Incentive Plan). Our existing 1997 Equity Incentive Plan was set to expire in December 2006. The 2006 Incentive Plan provides for the grant of the following types of incentive awards: (i) stock options, (ii) stock appreciation rights, (iii) restricted stock, (iv) restricted stock units, (v) performance shares and performance units, and (vi) other stock awards.
Subject to the provisions of Section 14 of the 2006 Incentive Plan, the maximum aggregate number of shares that may be awarded and sold there under is 3,000,000 shares plus 1,488,361 shares comprising (i) any shares that have been reserved but not issued under our 1997 Equity Incentive Plan as of May 11, 2006, (ii) any shares subject to stock options or similar awards granted under the 1997 Equity Incentive Plan that expire or otherwise terminate without having been exercised in full and shares issued pursuant to awards granted under the 1997 Equity Incentive Plan that are forfeited to or repurchased by us. No further awards will be made under the 1997 Equity Incentive Plan, but it will continue to govern awards previously granted there under.
Restricted stock awards and restricted stock units will be counted against the numerical limits of the 2006 Incentive Plan as two shares for every one share subject thereto. Further, if shares acquired pursuant to any such award are forfeited or repurchased by us and would otherwise return to the 2006 Incentive Plan pursuant to the terms thereof, two times the number of shares so forfeited or repurchased will return to the 2006 Incentive Plan and will again become available for issuance.
Eligible participants in the 2006 Incentive Plan include directors, employees, and consultants. Options granted under the 2006 Incentive Plan generally expire 7 years after the grant date. Options generally become exercisable over various periods, typically 4 years, from date of grant based on continued employment, and typically vest annually. Restricted stock awards generally vest over the passage of time and require continued employment through the vesting period. Restricted stock units generally vest upon meeting certain performance-based objectives, with the passage of time, or a combination of both, and require continued employment through the vesting period. The vesting period for restricted stock units cannot be less than three years unless they are subject to certain performance-based objectives, in which case the vesting period can be 12 months or longer.
Employee Stock Purchase Plan
We maintain an employee stock purchase plan (ESPP) under which participating employees may annually contribute up to 10% of their gross compensation to purchase shares of our common stock at 85% of its fair market value at either the beginning or end of each six-month offering period, whichever price is less. All employees are eligible to participate in the ESPP on the first day of hire. To be eligible, an employee must, among other requirements, be age 18 or above and complete at least one hour of service as an employee of us or any of our affiliates. There were 71,036 shares issued under the ESPP for the nine months ended September 30, 2006. At September 30, 2006, a total of 915,577 shares of our common stock were still available for future issuance under the ESPP. The next purchase will be on December 29, 2006 at the end of the current six-month offering period. Effective January 1, 2006, we began recognizing compensation expense associated with the ESPP in accordance with SFAS 123(R).
Pro forma Information for Periods Prior to the Adoption of SFAS No. 123(R)
Prior to the adoption of SFAS No. 123(R), we provided the pro forma disclosures required under SFAS No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosures. Previously reported amounts have not been restated.
11
(Dollars in thousands, except per share amounts) |
|
Three Months Ended |
|
Nine Months Ended |
|
||
|
|
|
|
|
|
||
Net income, as reported |
|
$ |
23,059 |
|
$ |
66,891 |
|
Add: Stock-based compensation expense, net of tax reported in net income |
|
1,235 |
|
3,154 |
|
||
Less: Total stock-based employee compensation expense determined under fair value based method, net of tax |
|
(5,472 |
) |
(16,381 |
) |
||
Net income, pro forma |
|
$ |
18,822 |
|
$ |
53,664 |
|
|
|
|
|
|
|
||
Earnings per common share basic: |
|
|
|
|
|
||
As reported |
|
$ |
0.66 |
|
$ |
1.90 |
|
Pro forma |
|
0.54 |
|
1.53 |
|
||
Earnings per diluted share diluted: |
|
|
|
|
|
||
As reported |
|
$ |
0.60 |
|
$ |
1.73 |
|
Pro forma |
|
0.50 |
|
1.43 |
|
Unrecognized Compensation Expense
As of September 30, 2006, unrecognized share-based compensation expense is as follows:
|
|
As of September 30, 2006 |
|
|||
(Dollars in thousands) |
|
Unrecognized |
|
Average Expected |
|
|
|
|
|
|
|
|
|
Stock option awards |
|
$ |
17,934 |
|
1.16 |
|
Restricted stock awards |
|
931 |
|
0.78 |
|
|
Restricted stock units |
|
5,963 |
|
2.29 |
|
|
Employee stock purchase plan |
|
64 |
|
0.25 |
|
|
Total unrecognized share-based compensation expense |
|
$ |
24,892 |
|
|
|
Valuation Assumptions
As of September 30, 2006 and 2005, the fair values of share-based awards for employee stock options and employee stock purchases made under our ESPP were estimated using the Black-Scholes option pricing model. The fair values of restricted stock awards and restricted stock units were based on our closing quoted market price on date of grant. The following weighted-average assumptions were used:
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
|
|||||||||
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
Equity Incentive Plan Awards |
|
|
|
|
|
|
|
|
|
||||
Expected term of options in years |
|
5.2 |
|
5.1 |
|
5.3 |
|
5.1 |
|
||||
Expected volatility of the Companys underlying common stock |
|
30.4 |
% |
34.7 |
% |
29.5 |
|
37.1 |
% |
||||
Risk-free interest rate |
|
4.66 |
% |
3.98 |
% |
4.78 |
% |
4.05 |
% |
||||
Expected dividend yield |
|
|
% |
|
% |
|
% |
|
% |
||||
Weighted-average grant date fair value-stock options |
|
$ |
16.43 |
|
$ |
18.68 |
|
$ |
18.57 |
|
$ |
17.61 |
|
Weighted-average grant date fair value-restricted stock awards and restricted stock units |
|
$ |
45.27 |
|
$ |
49.64 |
|
$ |
50.97 |
|
$ |
45.12 |
|
|
|
|
|
|
|
|
|
|
|
||||
ESPP |
|
|
|
|
|
|
|
|
|
||||
Expected term in years |
|
0.5 |
|
0.5 |
|
0.5 |
|
0.5 |
|
||||
Expected volatility of the Companys underlying common stock |
|
19.7 |
% |
19.7 |
% |
21.3 |
% |
22.7 |
% |
||||
Risk-free interest rate |
|
5.24 |
% |
3.38 |
% |
4.76 |
% |
2.94 |
% |
||||
Expected dividend yield |
|
|
% |
|
% |
|
% |
|
% |
||||
Weighted-average fair value |
|
$ |
9.84 |
|
$ |
10.18 |
|
$ |
10.07 |
|
$ |
10.08 |
|
The expected term was based on the implied term of the stock options using a lattice option-pricing model with early exercise factors based on historic employee exercise behavior. The expected volatilities for the 2006 Incentive Plan for the three and nine months ended September 30, 2006 and September 30, 2005 were calculated using a blended rate consisting of equal measures of our historic volatility and our expected volatility over a five-year term. The expected volatilities for the ESPP for the three and nine months ended September 30, 2006 and September 30, 2005 are equal to the historical volatility for the previous six-month periods. The expected risk-free interest rates for all periods were based on the yields of U.S. Treasury Securities, as reported by the Federal Reserve Bank of New York, with maturities equal to the expected terms of the employee stock options.
12
Share-Based Payment Award Activity
The table below provides stock option information related to the 1989 Stock Option Plan, the 1997 Equity Incentive Plan and the 2006 Equity Incentive Plan for the three and nine months ended September 30, 2006:
|
Three Months Ended |
|
Nine Months Ended |
|
|||||||
|
|
Shares |
|
Weighted- |
|
Shares |
|
Weighted- |
|
||
Outstanding at beginning of period |
|
5,086,451 |
|
$ |
31.06 |
|
6,023,080 |
|
$ |
28.87 |
|
Granted |
|
18,250 |
|
45.27 |
|
333,097 |
|
51.48 |
|
||
Exercised |
|
(120,753 |
) |
25.00 |
|
(1,167,199 |
) |
23.90 |
|
||
Forfeited |
|
(33,218 |
) |
36.51 |
|
(236,543 |
) |
35.76 |
|
||
Expired |
|
(6,057 |
) |
37.54 |
|
(7,762 |
) |
38.21 |
|
||
Outstanding at September 30, 2006 |
|
4,944,673 |
|
$ |
31.22 |
|
4,944,673 |
|
$ |
31.22 |
|
Exercisable at September 30, 2006 |
|
3,239,604 |
|
$ |
27.30 |
|
3,239,604 |
|
$ |
27.30 |
|
|
Shares |
|
Weighted- |
|
Weighted- |
|
Aggregate Intrinsic Value of In- |
|
|||
Outstanding at September 30, 2006 |
|
4,944,673 |
|
$ |
31.22 |
|
4.27 |
|
$ |
69,188,603 |
|
Exercisable at September 30, 2006 |
|
3,239,604 |
|
$ |
27.30 |
|
4.10 |
|
$ |
56,609,829 |
|
The aggregate intrinsic value of outstanding options shown in the table above represents the pretax intrinsic value as of September 30, 2006. This value is based on our closing stock price of $44.64 as of September 30, 2006. The total intrinsic value of options exercised during the three and nine months ended September 30, 2006 was $2.4 million and $30.5 million, respectively, and the total intrinsic value of options exercised during the three and nine months ended September 30, 2005 was $3.1 million and $15.8 million, respectively. The total fair value of option grants that vested during the three and nine months ended September 30, 2006 was $2.4 million and $20.6 million, respectively, and the total fair value of option grants that vested during the three and nine months ended September 30, 2005 was $2.7 million and $22.9 million, respectively. Cash received from stock option exercises was $3.0 million and $27.2 million during the three and nine months ended September 30, 2006, respectively, and cash received from stock option exercises was $2.7 million and $14.7 million during the three and nine months ended September 30, 2005, respectively. The tax benefit realized from stock options exercised was $0.7 million and $10.1 million for the three and nine months ended September 30, 2006, respectively, and the tax benefit realized from stock options exercised was $1.3 million and $7.0 million for the three and nine months ended September 30, 2005, respectively.
13
The following table summarizes information regarding stock options outstanding as of September 30, 2006:
|
|
Outstanding Options |
|
Vested Options |
|
||||||||||||
Ranges of Exercise Prices |
|
Shares |
|
Weighted- |
|
Weighted- |
|
Shares |
|
Weighted- |
|
||||||
$ 8.25 |
|
$ |
17.07 |
|
|
617,334 |
|
3.65 |
|
$ |
13.75 |
|
522,755 |
|
13.22 |
|
|
17.20 |
|
23.69 |
|
|
505,860 |
|
4.73 |
|
22.36 |
|
484,710 |
|
22.51 |
|
|||
23.90 |
|
25.17 |
|
|
496,190 |
|
2.14 |
|
25.04 |
|
363,459 |
|
25.02 |
|
|||
25.29 |
|
26.40 |
|
|
513,070 |
|
4.81 |
|
26.06 |
|
511,133 |
|
26.07 |
|
|||
26.66 |
|
31.29 |
|
|
508,865 |
|
5.20 |
|
30.94 |
|
490,991 |
|
30.99 |
|
|||
31.40 |
|
35.26 |
|
|
575,650 |
|
2.37 |
|
34.94 |
|
300,756 |
|
34.71 |
|
|||
35.54 |
|
36.46 |
|
|
495,864 |
|
4.45 |
|
35.60 |
|
241,877 |
|
35.61 |
|
|||
36.56 |
|
43.49 |
|
|
671,163 |
|
5.10 |
|
40.86 |
|
210,636 |
|
40.08 |
|
|||
43.62 |
|
53.29 |
|
|
555,177 |
|
5.92 |
|
49.61 |
|
113,287 |
|
48.39 |
|
|||
53.30 |
|
53.30 |
|
|
5,500 |
|
6.51 |
|
53.30 |
|
|
|
|
|
|||
$ 8.25 |
|
$ |
53.30 |
|
|
4,944,673 |
|
4.27 |
|
$ |
31.22 |
|
3,239,604 |
|
$ |
27.30 |
|
We expect to satisfy the exercise of stock options and future grants of restricted stock by issuing new shares registered under the 2006 Incentive Plan. At September 30, 2006, 4,391,611 shares were available for future issuance under the 2006 Incentive Plan.
The table below provides information for restricted stock awards and restricted stock units related to the 1989 Stock Option Plan, 1997 Plan and 2006 Incentive Plan for the three and nine months ended September 30, 2006:
|
Three Months Ended |
|
Nine Months Ended |
|
|||||||
|
|
Shares |
|
Weighted- |
|
Shares |
|
Weighted- |
|
||
Nonvested at beginning of period |
|
321,729 |
|
$ |
44.28 |
|
253,848 |
|
$ |
42.12 |
|
Granted |
|
5,250 |
|
45.27 |
|
153,341 |
|
50.97 |
|
||
Vested |
|
(3,729 |
) |
45.10 |
|
(65,378 |
) |
52.93 |
|
||
Forfeited |
|
(2,099 |
) |
47.94 |
|
(20,660 |
) |
45.74 |
|
||
Nonvested at September 30, 2006 |
|
321,151 |
|
$ |
44.26 |
|
321,151 |
|
$ |
43.91 |
|
The total fair value of restricted stock grants that vested during the three and nine months ended September 30, 2006 was $0.2 million and $3.5 million, respectively, and the total fair value of restricted stock grants that vested during the three and nine months ended September 30, 2005 was $0.1 million and $3.1 million, respectively.
5. Investment Securities
Federal Funds Sold, Securities Purchased under Agreement to Resell and Other Short-Term Investments
Federal funds sold, securities purchased under agreement to resell and other short-term investment securities as reported in the interim consolidated balance sheets include interest-bearing deposits in other financial institutions of $27.1 million and $34.7 million at September 30, 2006 and December 31, 2005, respectively.
14
The detailed composition of our investment securities as of September 30, 2006 and December 31, 2005 is presented as follows:
(Dollars in thousands) |
|
September 30, |
|
December 31, |
|
||
|
|
|
|
|
|
||
Available-for-sale securities, at fair value |
|
$ |
1,501,632 |
|
$ |
1,850,655 |
|
Non-marketable securities (investment company fair value accounting): |
|
|
|
|
|
||
Venture capital fund investments (1) |
|
111,686 |
|
81,280 |
|
||
Other private equity investments (2) |
|
32,477 |
|
26,782 |
|
||
Other investments (3) |
|
15,116 |
|
25,300 |
|
||
Non-marketable securities (equity method accounting): |
|
|
|
|
|
||
Other investments (4) |
|
15,584 |
|
10,985 |
|
||
Low income housing tax credit funds |
|
18,260 |
|
11,682 |
|
||
Non-marketable securities (cost method accounting): |
|
|
|
|
|
||
Fund investments |
|
27,683 |
|
26,924 |
|
||
Other private equity investments |
|
4,061 |
|
3,662 |
|
||
Total investment securities |
|
$ |
1,726,499 |
|
$ |
2,037,270 |
|
(1) Includes $62.2 million and $58.7 million related to SVB Strategic Investors Fund, LP at September 30, 2006 and December 31, 2005, respectively. We have a controlling ownership interest of 12.6% in the fund. Also includes $40.3 million and $22.1 million related to SVB Strategic Investors Fund II, LP, at September 30, 2006 and December 31, 2005, respectively. We have a controlling interest of 8.6% in the fund. Additionally, it includes $9.2 million and $0.5 million related to SVB Strategic Investors Fund III, LP at September 30, 2006 and December 31, 2005, respectively. Currently, we have a controlling interest of 11.7% in the fund. As of December 31, 2005, we had a controlling interest of 100.0% in the fund.
(2) Includes $29.9 million and $26.8 million related to Silicon Valley BancVentures, LP at September 30, 2006 and December 31, 2005, respectively. We have a controlling ownership interest of 10.7% in the fund. Additionally, includes $2.6 million related to SVB Capital Partners II, LP as of September 30, 2006. We have a direct ownership interest of 0.5% and indirect ownership interest of 8.5% in the fund through our ownership of SVB Strategic Investors Fund II, LP.
(3) Represents $15.1 million and $25.3 million related to Partners for Growth, LP at September 30, 2006 and December 31, 2005, respectively. We have a majority ownership interest of approximately 50.01% in the fund.
(4) Includes $6.9 million and $5.6 million related to Gold Hill Venture Lending Partners 03, LLC, the general partner of Gold Hill Venture Lending 03, LP and its parallel funds, as of September 30, 2006 and December 31, 2005, respectively. We have a majority interest of 90.7% in Gold Hill Venture Lending Partners 03, LLC. We have an indirect ownership interest of 4.5% in Gold Hill Venture Lending 03, LP and its parallel funds through Gold Hill Venture Lending Partners 03, LLC. It also includes $6.5 million and $5.4 million related to our direct investment in Gold Hill Venture Lending Partners 03, LP, as of September 30, 2006 and December 31, 2005, respectively. We have a direct ownership interest of 4.8% in the fund. Additionally, it includes $2.2 million to Partners for Growth II, LP as of September 30, 2006. We have an ownership interest of 24.2% in the fund.
15
The following table breaks out our unrealized losses on our available-for-sale investment securities portfolio into categories of less than 12 months, or 12 months or longer as of September 30, 2006:
|
|
September 30, 2006 |
|
||||||||||||||||
|
|
Less than twelve months |
|
Twelve months or longer |
|
Total |
|
||||||||||||
(Dollars in thousands) |
|
Fair Value of |
|
Unrealized |
|
Fair Value of |
|
Unrealized |
|
Fair Value of |
|
Unrealized |
|
||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
U.S. Treasury securities |
|
$ |
|
|
$ |
|
|
$ |
9,900 |
|
$ |
(81 |
) |
$ |
9,900 |
|
$ |
(81 |
) |
U.S. agencies and corporations: |
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||
Collateralized mortgage obligations |
|
54,753 |
|
(501 |
) |
590,685 |
|
(14,936 |
) |
645,438 |
|
(15,437 |
) |
||||||
Mortgage-backed securities |
|
25,465 |
|
(190 |
) |
399,572 |
|
(12,703 |
) |
425,037 |
|
(12,893 |
) |
||||||
Discount notes and bonds |
|
29,531 |
|
(467 |
) |
210,579 |
|
(4,414 |
) |
240,110 |
|
(4,881 |
) |
||||||
Asset-backed securities |
|
|
|
|
|
486 |
|
(1 |
) |
486 |
|
(1 |
) |
||||||
Commercial mortgage-backed securities |
|
|
|
|
|
69,408 |
|
(1,766 |
) |
69,408 |
|
(1,766 |
) |
||||||
Total temporarily impaired securities |
|
$ |
109,749 |
|
$ |
(1,158 |
) |
$ |
1,280,630 |
|
$ |
(33,901 |
) |
$ |
1,390,379 |
|
$ |
(35,059 |
) |
(1) As of September 30, 2006, we identified 136 investments totaling $1,280.6 million with unrealized losses of $33.9 million whose fair value has been less than their adjusted cost for a period of time greater than twelve months. A U.S. Treasury note totaling $9.9 million with an unrealized loss of $81 thousand was purchased in July 2005. Securities classified as collateralized mortgage obligations totaling $590.7 million with unrealized losses of $14.9 million were originally purchased between July 1998 and September 2005. Securities classified as mortgage-backed securities totaling $399.6 million with unrealized losses of $12.7 million were originally purchased between June 2003 and April 2004. Securities classified as discount notes and bonds totaling $210.6 million with unrealized losses of $4.4 million were originally purchased between February 2003 and January 2005. An asset-backed security totaling $0.5 million with an unrealized loss of $1 thousand was originally purchased in October 2002. Securities classified as commercial mortgage-backed securities totaling $69.4 million with unrealized losses of $1.8 million were originally purchased between April 2005 and July 2005. All investments with unrealized losses for a period of time greater than twelve months are either rated triple A by Moodys or S&P or are issued by the U.S. Treasury or a government sponsored enterprise. Because these securities are of superior credit quality, the unrealized losses are due solely to increases in market interest rates and we expect to recover the impairment prior to or at maturity, we deem these impairments to be temporary. We have the intent and ability to hold the securities until the market value recovers or until maturity. Market valuations and impairment analyses on assets in the investment portfolio are reviewed and monitored on an ongoing basis.
16
The following table presents the components of gains and losses on investment securities, for the three and nine months ended September 30, 2006 and 2005.
|
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
|
||||||||
(Dollars in thousands) |
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
Gross gains on investment securities: |
|
|
|
|
|
|
|
|
|
||||
Available-for-sale securities, at fair value |
|
$ |
3,692 |
|
$ |
173 |
|
$ |
7,042 |
|
$ |
173 |
|
Marketable securities (investment company fair value accounting) |
|
|
|
1,602 |
|
|
|
1,602 |
|
||||
Non-marketable securities (investment company fair value accounting): |
|
|
|
|
|
|
|
|
|
||||
Private equity fund investments. |
|
2,161 |
|
2,219 |
|
9,341 |
|
7,121 |
|
||||
Other private equity investments |
|
588 |
|
6 |
|
974 |
|
973 |
|
||||
Other investments |
|
|
|
|
|
1,170 |
|
|
|
||||
Non-marketable securities (equity method accounting) |
|
332 |
|
|
|
852 |
|
|
|
||||
Non-marketable securities (cost method accounting): |
|
|
|
|
|
|
|
|
|
||||
Private equity fund investments |
|
103 |
|
289 |
|
465 |
|
816 |
|
||||
Other private equity investments |
|
11 |
|
|
|
120 |
|
171 |
|
||||
Total gross gains on investment securities |
|
6,887 |
|
4,289 |
|
19,964 |
|
10,856 |
|
||||
Gross losses on investment securities: |
|
|
|
|
|
|
|
|
|
||||
Available-for-sale securities, at fair value |
|
|
|
|
|
(3,230 |
) |
(2,274 |
) |
||||
Non-marketable securities (investment company fair value accounting): |
|
|
|
|
|
|
|
|
|
||||
Private equity fund investments |
|
(3,438 |
) |
(1,450 |
) |
(7,294 |
) |
(2,903 |
) |
||||
Other private equity investments |
|
|
|
(479 |
) |
(475 |
) |
(530 |
) |
||||
Other investments |
|
(1,166 |
) |
(425 |
) |
(1,166 |
) |
(425 |
) |
||||
Non-marketable securities (equity method accounting) |
|
(157 |
) |
|
|
(918 |
) |
|
|
||||
Non-marketable securities (cost method accounting): |
|
|
|
|
|
|
|
|
|
||||
Private equity fund investments |
|
(481 |
) |
(634 |
) |
(1,172 |
) |
(3,379 |
) |
||||
Other private equity investments |
|
|
|
|
|
(45 |
) |
(473 |
) |
||||
Total gross losses on investment securities |
|
(5,242 |
) |
(2,988 |
) |
(14,300 |
) |
(9,984 |
) |
||||
Net gains on investment securities |
|
$ |
1,645 |
|
$ |
1,301 |
|
$ |
5,664 |
|
$ |
872 |
|
6. Loans and Allowance for Loan Losses
The detailed composition of loans, net of unearned income of $21.3 million and $20.6 million, as of September 30, 2006 and December 31, 2005, respectively, are presented in the following table:
(Dollars in thousands) |
|
September 30, |
|
December 31, |
|
||
|
|
|
|
|
|
||
Commercial loans |
|
$ |
2,817,077 |
|
$ |
2,410,893 |
|
|
|
|
|
|
|
||
Vineyard development |
|
118,540 |
|
104,881 |
|
||
Commercial real estate |
|
2,906 |
|
20,657 |
|
||
Total real estate construction |
|
121,446 |
|
125,538 |
|
||
|
|
|
|
|
|
||
Real estate term consumer |
|
64,030 |
|
39,906 |
|
||
Real estate term commercial |
|
29,624 |
|
10,694 |
|
||
Total real estate term |
|
93,654 |
|
50,600 |
|
||
|
|
|
|
|
|
||
Consumer and other |
|
287,338 |
|
256,322 |
|
||
Total loans, net of unearned income |
|
$ |
3,319,515 |
|
$ |
2,843,353 |
|
17
The activity in the allowance for loan losses for the three and nine months ended September 30, 2006 and 2005 were as follows:
|
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
|
||||||||
(Dollars in thousands) |
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
|
|
|
|
|
|
|
|
|
|
||||
Beginning balance |
|
$ |
37,907 |
|
$ |
36,372 |
|
$ |
36,785 |
|
$ |
37,613 |
|
Provision for (recovery of) loan losses |
|
2,767 |
|
1,427 |
|
4,895 |
|
(1,573 |
) |
||||
Loans charged off |
|
(3,216 |
) |
(4,437 |
) |
(10,427 |
) |
(10,507 |
) |
||||
Recoveries |
|
2,091 |
|
1,501 |
|
8,296 |
|
9,330 |
|
||||
Ending balance |
|
$ |
39,549 |
|
$ |
34,863 |
|
$ |
39,549 |
|
$ |
34,863 |
|
The aggregate recorded investment in loans for which impairment has been determined in accordance with SFAS No. 114 totaled $9.3 million and $6.5 million at September 30, 2006 and December 31, 2005, respectively. Allocations of the allowance for loan losses specific to impaired loans totaled $7.0 thousand at September 30, 2006, and $0.0 thousand at December 31, 2005. Average impaired loans for the three months ended September 30, 2006 and 2005 totaled $8.9 million and $14.5 million, respectively. Average impaired loans for the nine months ended September 30, 2006 and 2005 totaled $6.9 million and $14.4 million, respectively.
7. Goodwill
The goodwill balance at September 30, 2006 and December 31, 2005 was $21.2 million and $35.6 million, respectively. Goodwill resulted from the acquisition of SVB Alliant, our investment banking subsidiary, and eProsper, our equity ownership data management services company. During the third quarter of 2006, we acquired a 65% ownership stake in eProsper through our wholly owned subsidiary, SVB Analytics. eProsper provides corporate equity administration services, including capitalization table data management to private companies. As a result of the acquisition, we recorded $4.0 million of goodwill.
SFAS No. 142, Goodwill and Other Intangible Assets, requires that we evaluate on an annual basis (or whenever events occur which may indicate possible impairment) whether any portion of our recorded goodwill is impaired. We performed this analysis at the reporting unit level as defined in SFAS No. 142. As discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, this analysis requires management to make a series of critical assumptions to (1) evaluate whether any impairment exists, and (2) measure the amount of impairment. As part of this analysis, SFAS No. 142 requires that we estimate the fair value of our reporting units and compare it with their carrying value. If the estimated fair value of a reporting unit is less than the carrying value, then impairment is deemed to have occurred.
We conducted our annual valuation analysis of the SVB Alliant reporting unit during the second quarter of 2006. We concluded at that time that we had an impairment of goodwill based on forecasted discounted net cash flows for that reporting unit. As required by SFAS No. 142, in measuring the amount of goodwill impairment, we made a hypothetical allocation of the reporting units estimated fair value to the tangible and intangible assets (other than goodwill) of the reporting unit. Based on this allocation, we concluded that $18.4 million of the related goodwill was impaired and was required to be expensed as a non-cash charge to continuing operations during the second quarter of 2006. Thus, the goodwill balance related to SVB Alliant was reduced from $35.6 million at December 31, 2005 to $17.2 million at June 30, 2006.
8. Borrowings
The following table represents outstanding borrowings at September 30, 2006 and December 31, 2005:
(Dollars in thousands) |
|
Maturity |
|
September 30, |
|
December 31, |
|
||
Federal funds purchased |
|
Overnight |
|
$ |
330,000 |
|
$ |
205,000 |
|
FHLB advances |
|
One Month or Less |
|
135,000 |
|
|
|
||
Securities sold under agreement to repurchase |
|
Less than One Month |
|
344,767 |
|
74,464 |
|
||
Total federal funds purchased, FHLB advances and securities sold under agreement to repurchase |
|
|
|
$ |
809,767 |
|
$ |
279,464 |
|
|
|
|
|
|
|
|
|
||
Contingently convertible debt |
|
June 15, 2008 |
|
$ |
148,215 |
|
$ |
147,604 |
|
Junior subordinated debentures |
|
October 15, 2033 |
|
51,201 |
|
48,228 |
|
||
8.0% Long-term note payable (1) |
|
November 30, 2009 |
|
2,669 |
|
|
|
||
Other borrowings |
|
Overdraft |
|
$ |
|
|
$ |
11 |
|
18
(1) Debt assumed in relation to the acquisition of a 65% interest in eProsper during the third quarter of 2006.
Interest expense related to borrowings was $8.3 million and $1.8 million for the three months ended September 30, 2006 and 2005, respectively, and $16.5 and $3.5 million for the nine months ended September 30, 2006 and 2005, respectively.
Contingently Convertible Debt
The fair value of the convertible debt at September 30, 2006 was $197.8 million, based on quoted market prices. We intend to settle the outstanding principal amount in cash. Based on the terms of the notes, if, at any time before September 15, 2007, the per share stock price on the last trading day of the immediately preceding fiscal quarter was 110% or more of the conversion price, the notes would become convertible. The per share closing price of $45.46 of our common stock on June 30, 2006, was 135.2% of the conversion price of $33.63. Accordingly, during the third quarter of 2006, our note holders held the right, at their option, to convert their notes, in whole or in part, subject to certain limitations, at the conversion price of $33.63. We received conversion notices relating to the notes in an aggregate principal amount of $7.0 thousand during the third quarter of 2006, increasing the total cumulative amount converted to $162.0 thousand. The per share closing price of $44.64 of our common stock on September 30, 2006 was 132.7% of the conversion price of $33.63, so our noteholders hold the right to convert their notes in the fourth quarter of 2006. After September 15, 2007, if the closing sales price of our common stock on the previous trading day is 110% or more of the conversion price of the notes, then the notes would become convertible.
Concurrent with the issuance of the convertible notes, we entered into a convertible note hedge (see Note 9. Derivative Financial Instruments - Derivative Financial Instruments Indexed to and Potentially Settled in a Companys Own Stock).
Available Lines of Credit
As of September 30, 2006, we have available $865.0 million in unsecured federal funds lines of credit, $535.0 million of which were unused. We have reverse repurchase agreement lines available with multiple securities dealers. Reverse repurchase lines allow us to finance short-term borrowings using various fixed income securities as collateral. At September 30, 2006, we borrowed $344.8 million against our reverse repurchase lines. Additionally, we have collateral pledged to the Federal Reserve Bank and Federal Home Loan Bank of San Francisco of which $75.0 million is unused.
9. Derivative Financial Instruments
If held for hedging purposes we designate the derivative when we enter into a derivative contract. The designation may change based on managements reassessment or changing circumstances. Derivative instruments that we obtain or use include interest rate swaps, forward contracts, options and warrants. A swap agreement is a contract between two parties to exchange cash flows based on specified underlying notional amounts, assets or indices. Forward settlement contracts are agreements to buy or sell a quantity of a financial instrument, index, currency or commodity at a predetermined future date, and rate or price. An option or warrant contract is an agreement that conveys to the purchaser the right, but not the obligation, to buy or sell a quantity of a financial instrument (including another derivative financial instrument), index, currency or commodity at a predetermined rate or price during a period or at a time in the future. Option or warrant agreements can be transacted on organized exchanges or directly between parties. The gross positive fair values of derivative assets are recorded as a component of the other assets line item on the balance sheet. The gross negative fair values of derivative liabilities are recorded as a component of the other liabilities line item on the balance sheet.
The total notional or contractual amounts, credit risk amount and estimated net fair value for derivatives as of September 30, 2006 and December 31, 2005 were as follows:
|
|
At September 30, 2006 |
|
|||||||
(Dollars in thousands) |
|
Notional or |
|
Credit risk |
|
Estimated net |
|
|||
|
|
|
|
|
|
|
|
|||
Fair Value Hedge |
|
|
|
|
|
|
|
|||
Interest rate swap |
|
$ |
50,000 |
|
$ |
|
|
$ |
(2,456 |
) |
|
|
|
|
|
|
|
|
|||
Derivatives |
|
|
|
|
|
|
|
|||
Foreign exchange forward contracts |
|
413,851 |
|
2,526 |
|
(1,177 |
) |
|||
Foreign currency options |
|
41,204 |
|
22 |
|
|
|
|||
Equity warrant assets |
|
111,248 |
|
32,420 |
|
32,420 |
|
|||
19
(Dollars in thousands) |
|
At December 31, 2005 |
|
|||||||
|
|
|
|
|
|
|
|
|||
Derivative - Fair Value Hedge |
|
|
|
|
|
|
|
|||
Interest rate swap |
|
$ |
50,000 |
|
$ |
|
|
$ |
(1,314 |
) |
|
|
|
|
|
|
|
|
|||
Derivatives - Other |
|
|
|
|
|
|
|
|||
Foreign exchange forward contracts |
|
432,733 |
|
5,701 |
|
766 |
|
|||
Foreign currency options |
|
18,772 |
|
101 |
|
|
|
|||
Equity warrant assets |
|
108,574 |
|
27,802 |
|
27,802 |
|
|||
(1) Credit risk amounts reflect the replacement cost for those contracts in a gain position in the event of nonperformance by all such counterparties.
Derivative - Fair Value Hedges
Derivative instruments that we hold as part of our interest rate risk management include interest rate swaps and forward contracts. On October 30, 2003, we entered into an interest rate swap agreement with a notional amount of $50.0 million. This agreement hedges against the risk of changes in the fair value associated with the majority of our 7.0% fixed rate, junior subordinated debentures, which management evaluates for effectiveness using the statistical regression analysis approach for each reporting period. For information on our junior subordinated debentures, see Note 8. Borrowings.
The terms of the interest rate swap agreement provide for a swap of our 7.0% fixed rate payment for a variable rate based on the London Inter-Bank Offer Rate (LIBOR) plus a spread. This interest rate swap agreement provided a cash benefit of $30.0 thousand and $0.3 million during the three months ended September 30, 2006 and 2005, respectively, and a cash benefit of $0.3 million and $1.0 million during the nine months ended September 30, 2006 and 2005, respectively, which was recognized in the consolidated statements of income as a reduction in interest expense. The swap agreement largely mirrors the terms of the junior subordinated debentures and therefore is callable by the counterparty anytime on or after October 30, 2008. All components of the swaps gain or loss are included in the assessment of hedge effectiveness. Changes in fair value of the fair value hedge agreement, which is primarily dependent on changes in market interest rates, are recognized in net income as gains or losses on derivative instruments. We recorded a non-cash increase in fair value of the fair value hedge agreement of $0.4 million for the three months ended September 30, 2006, and a non-cash decrease in fair value of $3.3 million for the interest rate swap agreement prior to its designation as a fair value hedge and $0.8 million for the fair value hedge agreement for the nine months ended September 30, 2006, which were reflected in gains on derivative instruments, net.
Derivatives - Other
We enter into various other derivative contracts primarily to provide derivative products or services to customers. These derivatives are not linked to specific assets and liabilities on the balance sheet or to forecasted transactions in an accounting hedge relationship and, therefore, do not qualify for hedge accounting. All of these contracts are carried at fair value with changes in fair value recorded on the statement line item gains on derivative instruments, net.
We enter into foreign exchange forward contracts and non-deliverable foreign exchange forward contracts with clients involved in international trade finance activities, either as the purchaser or seller of foreign currency at a future date, depending upon the clients need. To mitigate the risk of fluctuations in foreign currency exchange rates on these contracts, we enter into opposite way foreign exchange forward contracts and non-deliverable foreign exchange forward contracts with correspondent banks. These contracts are short-term in nature, typically expiring within one year. We have not experienced nonperformance by counterparties and therefore have not incurred related losses. Further, we anticipate performance by all counterparties to such agreements.
We enter into foreign exchange forward contracts with correspondent banks to reduce foreign exchange exposure risk related to certain foreign currency denominated loans. These contracts are short-term in nature, typically expiring within one year. We have not experienced nonperformance by counterparties and therefore have not incurred related losses. Further, we anticipate performance by all counterparties to such foreign exchange forward contracts.
We enter into foreign currency option contracts with clients involved in international trade finance activities, either as the purchaser or seller of foreign currency options, depending upon the clients need. To mitigate the risk of fluctuations in foreign currency exchange rates on these contracts, we enter into opposite way foreign currency option contracts with correspondent banks. These contracts typically expire in less than one year. We have not experienced nonperformance by
20
counterparties and therefore have not incurred related losses. Further, we anticipate performance by all counterparties.
We obtain derivative equity warrant assets to purchase an equity position in a client companys stock in consideration for providing credit facilities and, less frequently, for providing other services. The purpose of obtaining warrants from client companies is to increase future revenue. The change in fair value of equity warrant assets is recorded in gains on derivative instruments, net. The change in fair value of equity warrants resulted in net losses of $1.0 million and $1.8 million for the three months ended September 30, 2006 and 2005, respectively, and net gains of $7.5 million and $0.7 million for the nine months ended September 30, 2006 and 2005, respectively.
Derivative Fair Value Instruments Indexed to and Potentially Settled in a Companys Own Stock
On May 20, 2003, we issued $150.0 million of zero-coupon, convertible subordinated notes at face value, due June 15, 2008, (See Note 8. Borrowings). These notes include a conversion feature that is indexed to and could potentially be settled in our stock. The conversion option is an embedded derivative, which, pursuant to paragraphs 11(a) and 12(c) of SFAS No. 133, qualifies as an embedded derivative indexed to our stock. If it was a freestanding derivative, it would be classified in stockholders equity. Thus, the embedded derivative is not considered a derivative for purposes of SFAS No. 133 and is not recorded on our financial statements at fair value.
Concurrent with the issuance of the $150.0 million principal amount of contingently convertible notes, (See Note 8. Borrowings), we entered into a convertible note hedge (purchased call option) at a cost of $39.3 million, and a warrant transaction providing proceeds of $17.4 million with respect to our common stock, with the objective of decreasing our exposure to potential dilution from conversion of the contingently convertible notes.
At issuance under the terms of the convertible note hedge, upon the occurrence of certain conversion events, we had the right to purchase up to approximately 4,460,610 shares of our common stock from the counterparty at a price of $33.63 per common share. The convertible note hedge agreement will expire on June 15, 2008. We have the option to settle any amounts due under the convertible note hedge either in cash or net shares of our common stock. The cost of the convertible note hedge is included in stockholders equity in accordance with the guidance in EITF 00-19 Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Companys Own Stock. Due to prior conversion events, our right to purchase our stock under the option has been decreased by 4,817 shares.
At issuance under the warrant agreement, the counterparty could purchase up to approximately 4,460,608 shares of our common stock at $51.34 per share, upon the occurrence of certain conversion events. The warrant transaction will expire on June 15, 2008. The proceeds of the warrant transaction were included in stockholders equity in accordance with the guidance in EITF 00-19. Due to prior conversion events, the counterpartys right to purchase our stock under the warrant agreement has been decreased by 4,817 shares. Also see Note 3. Earnings Per Share.
10. Common Stock Repurchase
We currently have in place a program authorizing our repurchase of up to $375.0 million of stock. The repurchase program was initially authorized by our Board of Directors and announced on May 7, 2003 for $160.0 million (with no expiration date), and was subsequently increased by $75.0 million (announced on January 27, 2005), $70.0 million (announced on January 26, 2006 and to be repurchased before September 30, 2007) and $70.0 million (announced on July 20, 2006 and to be repurchased before June 30, 2008). Unless earlier terminated by the Board, the program will expire on June 30, 2008. As of September 30, 2006, we had repurchased 8.5 million shares totaling $297.8 million. During the nine months ended September 30, 2006, we repurchased 1.9 million shares of our common stock totaling $94.3 million. At September 30, 2006, $77.2 million of shares may still be repurchased under the program.
11. Segment Reporting
SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information (SFAS 131), requires that we report certain financial information about our reportable operating segments as well as related disclosures about products and services, geographic areas and major customers. An operating segment is a component of an enterprise whose operating results are regularly reviewed by our chief operating decision maker (CODM) when deciding how to allocate resources and in assessing performance. Our CODM is our Chief Executive Officer (CEO).
We offer clients financial products and services through four primary strategic business groups: Commercial Banking, SVB Capital, SVB Alliant, and Other Business Services. Our Other Business Services group includes SVB Global, SVB Private Client Services and certain other business service units. For descriptive information about the products and services provided by each of our operating segments, please refer to our 2005 Annual Report on Form 10-K, Part I. Item 1. Business Business Overview and Footnote 22 Segment Reporting. Unlike financial reporting, which benefits from the comprehensive structure provided by GAAP, the internal profitability reporting process is highly subjective, as there is no comprehensive, authoritative guidance for management reporting. The management reporting process measures the
21
performance of operating segments based on our internal operating structure and is not necessarily comparable with similar information for other financial services companies. In addition, changes in an individual clients primary relationship designation have resulted, and may in the future result, in the inclusion of certain clients in different segments in different periods. We have reclassified certain prior-period amounts to conform to the current periods presentation.
An operating segment is separately reportable if it exceeds any one of several quantitative thresholds specified in SFAS 131. As of September 30, 2006, of our operating segments, only Commercial Banking, SVB Capital and SVB Alliant were determined to be reportable segments. SVB Global and SVB Private Client Services did not meet the separate reporting thresholds and as a result, in the table below, have been aggregated in a column labeled Other Business Services for segment reporting purposes. The Other Business Services column also reflects other business service units and those adjustments necessary to reconcile the results of operating segments based on our internal profitability reporting process to the consolidated financial statements prepared in conformity with GAAP. Our CODM allocates resources to and assesses the performance of each operating segment using information about net interest income, noninterest income and noninterest expense, which are presented as components of segment operating profit or loss before income taxes. Net interest income is reported, net of funds transfer pricing (FTP). FTP is an internal measurement framework designed to assess the financial impact of a financial institutions 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. In addition, we evaluate assets based on average balances; therefore it is not possible to provide period-end asset balances for segment reporting purposes.
Our segment information at and for the three and nine months ended September 30, 2006 and 2005 are as follows:
(Dollars in thousands) |
|
Commercial |
|
SVB |
|
SVB |
|
Other Business |
|
Total |
|
|||||
Three months ended September 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|||||
Net interest income |
|
$ |
71,710 |
|
$ |
8,305 |
|
$ |
209 |
|
$ |
9,584 |
|
$ |
89,808 |
|
Provision for (recovery of) loan losses (1) |
|
950 |
|
(24 |
) |
|
|
1,841 |
|
2,767 |
|
|||||
Noninterest income (2) |
|
25,037 |
|
3,066 |
|
1,932 |
|
933 |
|
30,968 |
|
|||||
Noninterest expense (3) |
|
58,651 |
|
5,766 |
|
5,061 |
|
5,529 |
|
75,007 |
|
|||||
Minority interest in net loss of consolidated affiliates |
|
|
|
|
|
|
|
919 |
|
919 |
|
|||||
Income (loss) before income tax expense (4) |
|
37,147 |
|
5,629 |
|
(2,920 |
) |
4,065 |
|
43,921 |
|
|||||
Total average loans |
|
2,488,741 |
|
78,603 |
|
|
|
408,693 |
|
2,976,037 |
|
|||||
Total average assets (5) |
|
3,483,804 |
|
673,979 |
|
62,003 |
|
1,185,785 |
|
5,405,571 |
|
|||||
Total average deposits |
|
3,010,288 |
|
631,258 |
|
|
|
192,394 |
|
3,833,940 |
|
|||||
Goodwill at September 30, 2006 |
|
$ |
|
|
$ |
|
|
$ |
17,204 |
|
$ |
4,039 |
|
$ |
21,243 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Three months ended September 30, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|||||
Net interest income |
|
$ |
58,905 |
|
$ |
5,850 |
|
$ |
102 |
|
$ |
12,867 |
|
$ |
77,724 |
|
Provision for loan losses (1) |
|
2,960 |
|
|
|
|
|
(1,533 |
) |
1,427 |
|
|||||
Noninterest income (2) |
|
20,270 |
|
1,636 |
|
2,990 |
|
37 |
|
24,933 |
|
|||||
Noninterest expense (3) |
|
43,457 |
|
4,853 |
|
4,359 |
|
9,314 |
|
61,983 |
|
|||||
Minority interest in net (income) of consolidated affiliates |
|
|
|
|
|
|
|
(1,281 |
) |
(1,281 |
) |
|||||
Income (loss) before income tax expense (4) |
|
32,757 |
|
2,633 |
|
(1,267 |
) |
3,843 |
|
37,966 |
|
|||||
Total average loans |
|
2,077,113 |
|
42,908 |
|
|
|
330,130 |
|
2,450,151 |
|
|||||
Total average assets (5) |
|
3,808,132 |
|
706,397 |
|
75,793 |
|
697,698 |
|
5,288,290 |
|
|||||
Total average deposits |
|
3,357,501 |
|
667,109 |
|
|
|
193,306 |
|
4,217,916 |
|
|||||
Goodwill at September 30, 2005 |
|
$ |
|
|
$ |
|
|
$ |
35,637 |
|
$ |
|
|
$ |
35,637 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Nine months ended September 30, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|||||
Net interest income |
|
$ |
204,256 |
|
$ |
23,271 |
|
$ |
488 |
|
$ |
31,434 |
|
$ |
259,449 |
|
Provision for (recovery of) loan losses (1) |
|
3,057 |
|
(24 |
) |
|
|
1,862 |
|
4,895 |
|
|||||
Noninterest income (2) |
|
70,424 |
|
11,559 |
|
7,142 |
|
6,222 |
|
95,347 |
|
|||||
Noninterest expense, excluding impairment of goodwill (3) |
|
162,160 |
|
15,796 |
|
15,845 |
|
27,098 |
|
220,899 |
|
|||||
Impairment of goodwill |
|
|
|
|
|
18,434 |
|
|
|
18,434 |
|
|||||
Minority interest in net (income) of consolidated affiliates |
|
|
|