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
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

3003 Tasman Drive, Santa Clara, California

 

95054-1191

(Address of principal executive offices)

 

(Zip Code)

 

(408) 654-7400

(Registrant’s 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 registrant’s common stock ($0.001 par value) were outstanding.

 




TABLE OF CONTENTS

 

Page

PART I - FINANCIAL INFORMATION

3

 

 

 

ITEM 1.

INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

3

 

 

 

 

INTERIM CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2006 AND DECEMBER 31, 2005

3

 

 

 

 

INTERIM CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

4

 

 

 

 

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

5

 

 

 

 

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

6

 

 

 

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

7

 

 

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

26

 

 

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

51

 

 

 

ITEM 4.

CONTROLS AND PROCEDURES

52

 

 

PART II - OTHER INFORMATION

55

 

 

 

ITEM 1.

LEGAL PROCEEDINGS

55

 

 

 

ITEM 1A.

RISK FACTORS

55

 

 

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

62

 

 

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

62

 

 

 

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

62

 

 

 

ITEM 5.

OTHER INFORMATION

62

 

 

 

ITEM 6.

EXHIBITS

62

 

 

SIGNATURE

63

 

 

INDEX TO EXHIBITS

64

 

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,
2006

 

December 31,
2005

 

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
Ended September 30,

 

Nine Months
Ended September 30,

 

(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
Ended September 30,

 

Nine Months
Ended September 30,

 

(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 entity’s first fiscal year that begins after September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s 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
Income

 

Weighted-
Average
Shares

 

Per Share
Amount

 

Net
Income

 

Weighted-
Average
Shares

 

Per Share
Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 Compensation—Transition 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
September 30, 2005

 

Nine Months Ended
September 30, 2005

 

 

 

 

 

 

 

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
Expense

 

Average Expected
Recognition Period –
in Years

 

 

 

 

 

 

 

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 Company’s 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 Company’s 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
September 30, 2006

 

Nine Months Ended
September 30, 2006

 

 

 

Shares

 

Weighted-
Average
Exercise
Price

 

Shares

 

Weighted-
Average
Exercise
Price

 

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-
Average
Exercise
Price

 

Weighted-
Average
Remaining
Contractual Life
in Years

 

Aggregate Intrinsic Value of In-
The-Money Options
($)

 

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-
Average
Remaining
Contractual
Life in Years

 

Weighted-
Average
Exercise
Price

 

Shares

 

Weighted-
Average
Exercise
Price

 

$              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
September 30, 2006

 

Nine Months Ended
September 30, 2006

 

 

 

Shares

 

Weighted-
Average Grant Date
Fair Value

 

Shares

 

Weighted-
Average Grant Date
Fair Value

 

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,
2006

 

December 31,
2005

 

 

 

 

 

 

 

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
Investments

 

Unrealized
Losses

 

Fair Value of
Investments (1)

 

Unrealized
Losses (1)

 

Fair Value of
Investments

 

Unrealized
Losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 Moody’s 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,
2006

 

December 31,
2005

 

 

 

 

 

 

 

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 unit’s 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,
2006

 

December 31,
2005

 

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 Company’s 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 management’s 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
contractual
amount

 

Credit risk
amount (1)

 

Estimated net
fair value -
Asset (liability)

 

 

 

 

 

 

 

 

 

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 swap’s 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 client’s 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 company’s 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 Company’s 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 Company’s 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 counterparty’s 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

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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 client’s 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 period’s 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 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. 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
Banking

 

SVB
Capital

 

SVB
Alliant

 

Other Business
Services

 

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