UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2009
OR
¨ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
Commission File Number: 000-15637
SVB FINANCIAL GROUP
(Exact name of registrant as specified in its charter)
Delaware | 91-1962278 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
3003 Tasman Drive, Santa Clara, California 95054-1191 | http://www.svb.com | |
(Address of principal executive offices including zip code) |
(Registrants URL) |
Registrants telephone number, including area code: (408) 654-7400
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: |
Name of each exchange on which registered | |
Common Stock, par value $0.001 per share |
NASDAQ Global Select Market | |
Junior subordinated debentures issued by SVB Capital II and the |
NASDAQ Global Select Market |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ¨ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
The aggregate market value of the voting and non-voting common equity securities held by non-affiliates of the registrant as of June 30, 2009, the last business day of the registrants most recently completed second fiscal quarter, based upon the closing price of its common stock on such date, on the NASDAQ Global Select Market was $902,140,701.
At January 31, 2010, 41,354,446 shares of the registrants common stock ($0.001 par value) were outstanding.
Documents Incorporated by Reference |
Parts of Form 10-K Into Which Incorporated | |
Definitive proxy statement for the Companys 2010 Annual Meeting of Stockholders to be filed within 120 days of the end of the fiscal year ended December 31, 2009 |
Part III |
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Forward-Looking Statements
This Annual Report on Form 10-K, including in particular Managements Discussion and Analysis of Financial Condition and Results of Operations under Part II, Item 7 in this report, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Management has in the past and might in the future make forward-looking statements orally to analysts, investors, the media and others. Forward-looking statements are statements that are not historical facts. Broadly speaking, forward-looking statements include, without limitation, the following:
| Projections of our net interest income, noninterest income, earnings per share, noninterest expenses (including professional service, compliance, compensation and other costs), cash flows, balance sheet positions, capital expenditures, and capitalization or other financial items |
| Descriptions of our strategic initiatives, plans or objectives for future operations, including pending acquisitions |
| Forecasts of venture capital/private equity funding and investment levels |
| Forecasts of future interest rates, economic performance, and income from investments |
| Forecasts of expected levels of provisions for loan losses, loan growth and client funds |
| Descriptions of assumptions underlying or relating to any of the foregoing |
In this Annual Report on Form 10-K, we make forward-looking statements, including but not limited to those discussing our managements expectations about:
| Market and economic conditions and the associated impact on us |
| The sufficiency of our capital, including sources of capital, the extent of which capital may be used or required, and in the event of credit or other losses |
| Our liquidity position |
| Our payment of cash dividends on, or our repurchase of, our common stock |
| Our overall investment plans and activities, including venture capital/private equity funding and investments, and our investment of excess liquidity |
| The realization, timing, valuation and performance of equity or other investments |
| The likelihood that the market value of our impaired investments will recover |
| Our intention to sell our investment securities prior to recovery of our cost basis, or the likelihood of such |
| Expected cash requirements of unfunded commitments to certain investments |
| Our overall management of interest rate risk, including managing the sensitivity of our interest-earning assets and interest-bearing liabilities to interest rates, and the impact to earnings from a change in interest rates |
| The credit quality of our loan portfolio, including levels and trends of nonperforming loans |
| The adequacy of reserves (including allowance for loan and lease losses) and the appropriateness of our methodology for calculating such reserves |
| The level of loan balances |
| The level of deposit balances |
| The level of client investment fees and associated margins |
| The profitability of our products and services |
| Our strategic initiatives, including the expansion of operations in China, India, Israel, the United Kingdom and elsewhere |
| The expansion and growth of our noninterest income sources |
| The financial impact of continued growth of our funds management business |
| Our plans to form new managed investment funds and our intention to transfer certain existing investment commitments to new funds; the subsequent reduction in our total unfunded investment commitments upon such transfer and the associated accounting treatment |
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| Distributions of private equity or debt fund investment proceeds; intentions to sell such fund investments |
| The extent to which our products and services will meet changing client needs |
| The changes in, or adequacy of, our unrecognized tax benefits and any associated impact |
| The settlement of convertible debt instruments |
| The repurchase of our warrant issued under the U.S. Treasurys Capital Purchase Program |
| The extent to which counterparties, including those to our forward and option contracts, will perform their contractual obligations |
| The issuance of shares upon exercise of stock options |
| The effect of application of certain accounting pronouncements |
| The effect of lawsuits and claims |
| Regulatory developments, including the expiration of certain FDIC insurance coverage, possible new capital requirements, and the implementation of certain requirements by the Basel Committee |
You can identify these and other forward-looking statements by the use of words such as becoming, may, will, should, predicts, potential, continue, anticipates, believes, estimates, seeks, expects, plans, intends, the negative of such words, or comparable terminology. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we have based these expectations on our beliefs as well as our assumptions, and such expectations may prove to be incorrect. Our actual results of operations and financial performance could differ significantly from those expressed in or implied by our managements forward-looking statements.
For information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see Risk Factors under Part I, Item 1A in this report. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this Annual Report on Form 10-K. All subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements included in this filing are made only as of the date of this filing. We assume no obligation and do not intend to revise or update any forward-looking statements contained in this Annual Report on Form 10-K.
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PART I.
ITEM 1. | BUSINESS |
General
SVB Financial Group is a diversified financial services company, as well as a bank holding company and financial holding company. The Company was incorporated in the state of Delaware in March 1999. Through our various subsidiaries and divisions, we offer a variety of banking and financial products and services. For over 25 years, we have been dedicated to helping entrepreneurs succeed, especially in the technology, life science, venture capital/private equity and premium wine industries. We provide our clients of all sizes and stages with a diverse set of products and services to support them throughout their life cycles.
We offer commercial banking products and services through our principal subsidiary, Silicon Valley Bank (the Bank), which is a California state-chartered bank founded in 1983 and a member of the Federal Reserve System. Through its subsidiaries, the Bank also offers brokerage, investment advisory and asset management services. We also offer non-banking products and services, such as funds management, private equity investment and equity valuation services, through our subsidiaries and divisions. Additionally, we focus on cultivating strong relationships with firms within the venture capital and private equity community worldwide, many of which are also our clients and may invest in our corporate clients.
As of December 31, 2009, we had total assets of $12.8 billion, total loans, net of unearned income of $4.5 billion, total deposits of $10.3 billion and total SVBFG stockholders equity of $1.1 billion.
We operate through 27 offices in the United States, as well as offices internationally in China, India, Israel and the United Kingdom. Our corporate headquarters is located at 3003 Tasman Drive, Santa Clara, California 95054, and our telephone number is 408.654.7400.
When we refer to SVB Financial Group, SVBFG, the Company, we, our, us or use similar words, we mean SVB Financial Group and all of its subsidiaries collectively, including the Bank. When we refer to SVB Financial or the Parent we are referring only to the parent company, SVB Financial Group.
Business Overview
For reporting purposes, SVB Financial Group has four operating segments for which we report financial information in this report: Global Commercial Bank, Relationship Management, SVB Capital and Other Business Services. Financial information, results of operations and a description of the services provided by our operating segments are set forth in Note 21Segment Reporting of the Notes to the Consolidated Financial Statements under Part II, Item 8 in this report, and in Managements Discussion and Analysis of Financial Condition and Results of OperationsOperating Segment Results under Part II, Item 7 in this report.
In July 2007, we reached a decision to cease operations at SVB Alliant, our investment banking subsidiary, which provided advisory services in the areas of mergers and acquisitions, corporate finance, strategic alliances and private placements. After completion of the remaining client transactions, operations at SVB Alliant were ceased as of March 31, 2008. Accordingly, SVB Alliant was no longer reported as an operating segment as of the second quarter of 2008. We have not presented the results of operations of SVB Alliant in discontinued operations for any period presented based on our assessment of the immateriality of SVB Alliants results to our consolidated results of operations.
Global Commercial Bank
Our Global Commercial Bank products and services are provided by the Bank and its subsidiaries. The Bank provides solutions to the financial needs of commercial clients through lending, deposit products, cash
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management services, and global banking and trade products and services. It also serves the needs of our non-U.S. clients with global banking products, including loans, deposits and/or global finance, in key international entrepreneurial markets, where applicable.
Through lending products and services, the Bank extends loans and other credit facilities to commercial clients. These loans are often secured by clients assets. Lending products and services include traditional term loans, equipment loans, asset-based loans, revolving lines of credit, accounts-receivable-based lines of credits and capital call lines of credits.
The Banks deposit and cash management products and services provide commercial clients with short- and long-term cash management solutions. Deposit products include traditional deposit and checking accounts, certificates of deposit, money market accounts and sweep accounts. In connection with deposit services, the Bank provides lockbox and merchant services that facilitate timely depositing of checks and other payments to clients accounts. Cash management products and services include wire transfer and automated clearing house (ACH) payment services to enable clients to transfer funds quickly from their deposit accounts. Additionally, the cash management services unit provides collection services, disbursement services, electronic funds transfers, and online banking through SVBeConnect.
The Banks global banking and trade products and services facilitate clients global finance and business needs. These products and services include foreign exchange services that allow commercial clients to manage their foreign currency needs and risks through the purchase and sale of currencies, swaps and hedges on the global inter-bank market. To facilitate clients international trade, the Bank offers a variety of loans and credit facilities guaranteed by the Export-Import Bank of the United States. It also offers letters of credit, including export, import, and standby letters of credit, to enable clients to ship and receive goods globally.
The Bank and its subsidiaries offer a variety of investment services and solutions to its clients that enable companies to effectively manage their assets. Through its broker-dealer subsidiary, SVB Securities, the Bank offers money market mutual funds and fixed-income securities. Through its registered investment advisory subsidiary, SVB Asset Management, the Bank offers investment advisory services, including outsourced treasury services, with customized cash portfolio management and reporting.
Relationship Management
Relationship Management provides banking products and services through the Bank to our premium wine industry clients, including vineyard development loans, as well as a range of private banking services to targeted high-net-worth individuals.
SVB Wine is a division of the Bank that provides banking products and services to our premium wine industry clients, including vineyard development loans. We offer a variety of financial solutions focused specifically on the needs of our clients premium wineries and vineyards.
SVB Private Client Services is the private banking division of the Bank, which provides a range of credit services to targeted high-net-worth individuals using both long-term secured and short-term unsecured lines of credit. These products and services include mortgages, home equity lines of credit, restricted stock purchase loans, airplane loans, capital call lines of credit, and other secured and unsecured lines of credit. We also help our private clients meet their cash management needs by providing deposit account products and services, including checking accounts, money market accounts and certificates of deposit, and other personalized banking services.
SVB Capital
SVB Capital is the private equity arm of SVB Financial Group, which focuses primarily on funds management. SVB Capital manages venture capital and private equity funds on behalf of SVB Financial Group
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and other third party limited partners. The SVB Capital family of funds is comprised of funds of funds and co-investment funds. SVB Capital generates income for the Company primarily through management fees, carried interest arrangements and returns through the Companys direct investments in the funds. Most of the SVB Capital managed funds are consolidated into our financial statements. See Note 2Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements under Part II, Item 8 in this report.
Other Business Services
The Other Business Services segment is primarily comprised of our Sponsored Debt Funds & Strategic Investments segment, which is comprised of: (i) our sponsored debt funds, Gold Hill Venture Lending funds, which provide secured debt to private companies of all stages, and Partners for Growth funds, which provide secured debt primarily to mid-stage and late-stage clients, and (ii) certain strategic investments held by SVB Financial. Other Business Services also includes the results of SVB Analytics, which provides equity valuation and equity management services to private companies and venture capital firms.
Our Sponsored Debt Funds & Strategic Investments segment and SVB Analytics do not individually meet the separate reporting thresholds as defined in Accounting Standards Codification (ASC) 280 (formerly known as SFAS No. 131) and, as a result, we have aggregated them together as Other Business Services for segment reporting purposes. Previously, our global operations (SVB Global) were aggregated as a part of our Other Business Services segment, but is now included in our Global Commercial Bank segment. The operations of SVB Wine and SVB Private Client Services were previously aggregated as part of our Other Business Services segment, but is now included in our Relationship Management segment. In addition, our sponsored debt funds and certain strategic investments held by SVB Financial were previously included in our SVB Capital segment, but are now included in our Other Business Services segment.
Income Sources
Our total revenue is comprised of our net interest income and noninterest income. Net interest income on a fully taxable equivalent basis and noninterest income for the year ended December 31, 2009 were $384.4 million and $97.7 million, respectively.
Net interest income is primarily income generated from interest rate differentials. The difference between the interest rates received on interest-earning assets, such as loans extended to clients and securities held in our investment portfolio, and the interest rates paid by us on interest-bearing liabilities, such as deposits and borrowings, accounts for the major portion of our earnings. Our deposits are largely obtained from commercial clients within our technology, life science, venture capital and private equity industry sectors. Deposits are also obtained from the premium wine industry commercial clients and from high-net-worth individuals. We do not obtain deposits from conventional retail sources.
Noninterest income is primarily income generated from our fee-based services and returns on our investments. We market our full range of fee-based financial services to our commercial and venture capital/private equity firm clients, including global commercial banking, private client, investment advisory, asset management and equity valuation services. Our ability to integrate and cross-sell our diverse financial services to our clients is a strength of our business model.
We also seek to obtain returns by making investments. We manage and invest in venture capital/private equity funds that generally invest directly in privately held companies, as well as funds that invest in other private equity funds. We also invest directly in privately held companies. Additionally, in connection with negotiating credit facilities and certain other services, we frequently obtain rights to acquire stock in the form of equity warrant assets in certain client companies.
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Industry Niches
In each of the industry niches we serve, we provide services to meet the needs of our clients throughout their life cycles, beginning with the emerging, start-up stage.
Technology and Life Sciences
We serve a variety of clients in the technology and life science industries. Our technology clients generally tend to be in the industries of hardware (semiconductors, communications and electronics), software and related services, and cleantech. Our life science clients generally tend to be in the industries of biotechnology and medical devices. A key component of our technology and life science business strategy is to develop relationships with clients at an early stage and offer them banking services that will continue to meet their needs as they mature and expand. We serve the following technology and life science clients primarily through three practices:
| Our SVB Accelerator practice focuses on serving our emerging or early stage clients. These clients are generally in the start-up or early stages of their life cycles. They are typically privately-held and funded by friends and family, seed or angel investors, or have gone through an initial round of venture capital financing. Typically, they are primarily engaged in the research and development, have little or no revenue and may have brought a few products or services to market. |
| Our SVB Growth practice serves our growing companies, which includes our mid-stage, late-stage and corporate technology clients. These clients are in the intermediate or later stages of their life cycles and are generally privately held, many of which are dependent on venture capital for funding. Some of our corporate technology clients that are in the more advanced stages of their life cycles may be publicly held or poised to become publicly held. Our SVB Growth clients may generally have a solid or more established product or service offering in the market, with more meaningful or considerable revenue. They also may be expanding globally. |
| Our SVB Corporate Finance practice serves primarily our large corporate clients, which are more mature and established companies. These clients are generally publicly-held, have a more sophisticated product or service offering in the market, and significant revenue. They also may be expanding globally. |
Venture Capital/Private Equity
We provide financial services to clients in the venture capital/private equity community. Since our founding, we have cultivated strong relationships with the venture capital/private equity community, particularly with venture capital firms worldwide, many of which are also clients. We serve more than 600 venture capital firms worldwide, as well as other private equity firms, facilitating deal flow to and from these private equity firms and participating in direct investments in their portfolio companies. Unless the context requires otherwise, when we refer to our private equity clients, we mean our clients in the venture capital/private equity community.
Premium Wine
We are one of the leading providers of financial services to premium wine producers in the Western United States, with almost 300 winery and vineyard clients. We focus on vineyards and wineries that produce grapes and wines of high quality.
Competition
The banking and financial services industry is highly competitive, and evolves as a result of changes in regulation, technology, product delivery systems, and the general market and economic climate. Our current competitors include other banks, debt funds and specialty and diversified financial services companies that offer
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lending, leasing, other financial products, and advisory services to our target client base. The principal competitive factors in our markets include product offerings, service, and pricing. Given our established market position with the client segments that we serve, and our ability to integrate and cross-sell our diverse financial services to extend the length of our relationships with our clients, we believe we compete favorably in all our markets in these areas.
Employees
As of December 31, 2009, we employed 1,258 full-time equivalent employees.
Supervision and Regulation
Recent Developments
In response to the recent economic downturn and financial industry instability, legislative and other governmental initiatives have been, and will likely continue to be, introduced and implemented, which could substantially intensify the regulation of the financial services industry (including a possible comprehensive overhaul of the financial institutions regulatory system and enhanced supervisory attention and potential new limitations on compensation arrangements with executives and employees of financial institutions). SVB Financial cannot predict whether or when potential legislation or regulations will be enacted, and if enacted, the effect that it, or any implemented regulations and supervisory policies, would have on our financial condition or results of operations. Moreover, especially in the current economic environment, bank regulatory agencies have been very aggressive in responding to concerns and trends identified in examinations, and this has resulted in the increased issuance of enforcement orders to other financial institutions requiring action to address credit quality, liquidity and risk management and capital adequacy, as well as other safety and soundness concerns. See Risks Relating to Market and Economic Environment in the Risk Factors section under Item 1A of Part I of this report.
Through its authority under the Emergency Economic Stabilization Act of 2008 (the EESA), as amended by the American Recovery and Reinvestment Act of 2009 (the ARRA), the U.S. Treasury (Treasury) implemented the Capital Purchase Program (the CPP), a program designed to bolster eligible healthy institutions, like SVB Financial, by injecting capital into these institutions. We participated in the CPP in December 2008 so that we could continue to lend and support our current and prospective clients, especially during an unstable economic environment. Under the terms of our participation, we received $235 million in exchange for the issuance of preferred stock and a warrant to purchase common stock, and became subject to various requirements, including certain restrictions on paying dividends on our common stock and repurchasing our equity securities, unless the Treasury consented. Additionally, in order to participate in the CPP, we were required to adopt certain standards for executive compensation and corporate governance. During the latter part of 2009, we decided to take steps to exit the CPP, and after consulting with our primary regulator, the Federal Reserve Bank of San Francisco (the Federal Reserve), and the Treasury, we repaid our CPP obligation in full on December 23, 2009. While our warrant currently remains outstanding, we have redeemed all of our preferred stock previously issued to the Treasury. Except for certain disclosure and certification requirements as they pertain to 2009, we are generally not subject to the various restrictions imposed on CPP participants under the EESA, in light of our repayment on December 23, 2009.
General
Our bank and holding company operations are subject to extensive regulation by federal and state regulatory agencies. This regulation is intended primarily for the protection of depositors and the deposit insurance fund, and secondarily for the stability of the U.S. banking system. It is not intended for the benefit of stockholders of financial institutions. As a bank holding company that elected to become a financial holding company in November 2000, SVB Financial is subject to inspection, supervision, regulation, and examination by the Board of Governors of the Federal Reserve System (the Federal Reserve Board) under the Bank Holding Company
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Act of 1956 (the BHC Act). The Bank, as a California state-chartered bank and a member of the Federal Reserve System, is subject to primary supervision and examination by the Federal Reserve Board, as well as the California Department of Financial Institutions (the DFI). In addition, the Banks deposits are insured by the Federal Deposit Insurance Corporation (FDIC). SVB Financials other nonbank subsidiaries are subject to regulation by the Federal Reserve Board and other applicable federal, state and foreign regulatory agencies. SVB Financial, the Bank and their subsidiaries are required to file periodic reports with these regulators and provide any additional information that they may require.
The following summary describes some of the more significant laws, regulations, and policies that affect our operations; it is not intended to be a complete listing of all laws that apply to us and is qualified in its entirety by reference to the applicable laws and regulations. From time to time, federal, state and foreign legislation is enacted and regulations are adopted which may have the effect of materially increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers. We cannot predict whether or when potential legislation or regulations will be enacted, and if enacted, the effect that such legislation or regulations would have on our financial condition or results of operations.
Regulation of Holding Company
Under the BHC Act, SVB Financial is subject to the Federal Reserves regulations and its authority to:
| Require periodic reports and such additional information as the Federal Reserve may require; |
| Require SVB Financial to maintain certain levels of capital (See Regulatory Capital below); |
| Restrict the ability of bank holding companies to obtain dividends or other distributions from their subsidiary banks; |
| Require prior approval for senior executive officer and director changes; |
| Require that bank holding companies serve as a source of financial and managerial strength to subsidiary banks and commit resources as necessary to support each subsidiary bank. A bank holding companys failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of Federal Reserve regulations or both; |
| Terminate an activity or terminate control of or liquidate or divest certain subsidiaries, affiliates or investments if the Federal Reserve believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any bank subsidiary; |
| Regulate provisions of certain bank holding company debt, including the authority to impose interest ceilings and reserve requirements on such debt and require prior approval to purchase or redeem our securities in certain situations; |
| Approve acquisitions and mergers with banks and consider certain competitive, management, financial and other factors in granting these approvals. Similar California and other state banking agency approvals may also be required. |
Bank holding companies are generally prohibited, except in certain statutorily prescribed instances including exceptions for financial holding companies, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or furnishing services to its subsidiaries. However, subject to prior notice or Federal Reserve Board approval, bank holding companies may engage in, or acquire shares of companies engaged in, activities determined by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. SVB Financial may engage in these nonbanking activities and broader securities, insurance, merchant banking and other activities that are determined to be financial in nature or are incidental or complementary to activities that are financial in nature without prior Federal Reserve approval pursuant to our election to become a financial holding company in November, 2000. Pursuant to the Gramm-Leach-Bliley Act of
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1999 (GLBA), in order to elect and retain financial holding company status, all depository institution subsidiaries of a bank holding company must be well capitalized, well managed, and, except in limited circumstances, be in satisfactory compliance with the Community Reinvestment Act (CRA). Failure to sustain compliance with these requirements or correct any non-compliance within a fixed time period could lead to divestiture of subsidiary banks or require all activities to conform to those permissible for a bank holding company.
SVB Financial is also treated as a bank holding company under the California Financial Code. As such, SVB Financial and its subsidiaries are subject to periodic examination by, and may be required to file reports with, the DFI.
Securities Registration and Listing
SVB Financials securities are registered with the U.S. Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934, as amended (the Exchange Act), and listed on the NASDAQ Global Select Market. As such, SVB Financial is subject to the information, proxy solicitation, insider trading, corporate governance, and other requirements and restrictions of the Exchange Act, as well as the Marketplace Rules and other requirements promulgated by the Nasdaq Stock Market, Inc.
The Sarbanes-Oxley Act
SVB Financial is subject to the accounting oversight and corporate governance requirements of the Sarbanes-Oxley Act of 2002, including, among other things, required executive certification of financial presentations, increased requirements for board audit committees and their members, and enhanced disclosure of controls and procedures and internal control over financial reporting.
Regulation of Silicon Valley Bank
The Bank is a California state-chartered bank and a member and stockholder of the Federal Reserve. The Bank is subject to primary supervision, periodic examination and regulation by the DFI and the Federal Reserve, as the Banks primary federal regulator. In general, under the California Financial Code, California banks have all the powers of a California corporation, subject to the general limitation of state bank powers under the Federal Deposit Insurance Act to those permissible for national banks. Specific federal and state laws and regulations which are applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for certain loans. The regulatory structure also gives the bank regulatory agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. If, as a result of an examination, the DFI or the Federal Reserve should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Banks operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, the DFI and the Federal Reserve, and separately the FDIC as insurer of the Banks deposits, have residual authority to:
| Require affirmative action to correct any conditions resulting from any violation or practice; |
| Require prior approval for senior executive officer and director changes; |
| Direct an increase in capital and the maintenance of specific minimum capital ratios which may preclude the Bank from being deemed well capitalized; |
| Restrict the Banks growth geographically, by products and services, or by mergers and acquisitions; |
| Enter into informal or formal enforcement orders, including memoranda of understanding, written agreements and consent or cease and desist orders to take corrective action and enjoin unsafe and unsound practices; |
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| Remove officers and directors and assess civil monetary penalties; and |
| Take possession of and close and liquidate the Bank. |
California law permits state chartered commercial banks to engage in any activity permissible for national banks. Therefore, the Bank may form subsidiaries to engage in the many so-called closely related to banking or nonbanking activities commonly conducted by national banks in operating subsidiaries, and further, pursuant to GLBA, the Bank may conduct certain financial activities in a subsidiary to the same extent as may a national bank, provided the Bank is and remains well-capitalized, well-managed and in satisfactory compliance with the CRA. SVB Asset Management and SVB Securities are financial subsidiaries of the Bank.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank (FHLB) of San Francisco. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region and makes available loans or advances to its members. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. As an FHLB member, the Bank is required to own a certain amount of capital stock in the FHLB. At December 31, 2009, the Bank was in compliance with the FHLBs stock ownership requirement and our investment in FHLB capital stock totaled $25.8 million.
Regulatory Capital
The federal banking agencies have adopted risk-based capital guidelines for bank holding companies and banks that are expected to provide a measure of capital that reflects the degree of risk associated with a banking organizations operations for both transactions reported on the balance sheet as assets, such as loans, and those recorded as off-balance sheet items, such as commitments, letters of credit and recourse arrangements. Under these capital guidelines, banking organizations are required to maintain certain minimum capital ratios, which are obtained by dividing its qualifying capital by its total risk-adjusted assets and off-balance sheet items. In general, the dollar amounts of assets and certain off-balance sheet items are risk-adjusted and assigned to various risk categories. Qualifying capital is classified depending on the type of capital:
| Tier 1 capital consists of common equity, retained earnings, qualifying non-cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries (including trust-preferred securities), less goodwill and certain other intangible assets. Qualifying Tier 1 capital may consist of trust-preferred securities, subject to certain criteria and quantitative limits for inclusion of restricted core capital elements in Tier 1 capital. |
| Tier 2 capital includes, among other things, hybrid capital instruments, perpetual debt, mandatory convertible debt securities, qualifying term subordinated debt, preferred stock that does not qualify as Tier 1 capital, and a limited amount of allowance for loan and lease losses. |
| Tier 3 capital consists of qualifying unsecured subordinated debt. |
Under the capital guidelines, there are three fundamental capital ratios: a total risk-based capital ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio. The minimum required ratios for bank holding companies and banks are eight percent, four percent and four percent, respectively. Additionally, for SVB Financial to remain a financial holding company, the Bank must at all times be well-capitalized, which requires the Bank to have a total risk-based capital ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio of at least ten percent, six percent and five percent, respectively. Moreover, although not a requirement to maintain financial holding company status, maintaining the financial holding company at well-capitalized status provides certain benefits to the company, such as the ability to repurchase stock without prior regulatory approval. To be well-capitalized, the holding company must at all times have a total risk-based and Tier 1 risk-based capital ratio of at least ten percent and six percent, respectively. There is no Tier 1 leverage requirement for a holding company to be deemed well-capitalized. At December 31, 2009, the respective capital ratios of
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SVB Financial and the Bank exceeded these minimum percentage requirements for well-capitalized institutions. See Note 20Regulatory Matters of the Notes to the Consolidated Financial Statements under Part II, Item 8 in this report. The federal banking agencies may change existing capital guidelines or adopt new capital guidelines in the future.
SVB Financial is also subject to rules that govern the regulatory capital treatment of equity investments in non-financial companies made on or after March 13, 2000 and held under certain specified legal authorities by a bank or bank holding company. Under the rules, these equity investments will be subject to a separate capital charge that will reduce a bank holding companys Tier 1 capital and, as a result, will remove these assets from being taken into consideration in establishing a bank holding companys required capital ratios discussed above. The rules provide for the following incremental Tier 1 capital charges: 8% of the adjusted carrying value of the portion of aggregate investments that are up to 15% of Tier 1 capital; 12% of the adjusted carrying value of the portion of aggregate investments that are between 15% and 25% of Tier 1 capital; and 25% of the adjusted carrying value of the portion of aggregate investments that exceed 25% of Tier 1 capital.
Further, the federal banking agencies have also adopted a joint agency policy statement, which states that the adequacy and effectiveness of a banks interest rate risk management process and the level of its interest rate exposures are critical factors in the evaluation of the banks capital adequacy. A bank with material weaknesses in its interest rate risk management process or high levels of interest rate exposure relative to its capital will be directed by the federal banking agencies to take corrective actions.
Basel and Basel II Accords
The current risk-based capital guidelines which apply to SVB Financial and the Bank are based upon the 1988 capital accord of the International Basel Committee on Banking Supervision, a committee of central banks and bank supervisors and regulators from the major industrialized countries that develops broad policy guidelines for use by each countrys supervisors in determining the supervisory policies they apply. A new international accord, referred to as Basel II, became mandatory for large or core international banks outside the U.S. in 2008 (total assets of $250 billion or more or consolidated foreign exposures of $10 billion or more). Basel II emphasizes internal assessment of credit, market and operational risk, as well as supervisory assessment and market discipline in determining minimum capital requirements. It is optional for other banks. The Basel Committee is currently reconsidering regulatory-capital standards, supervisory and risk-management requirements and additional disclosures to further strengthen the Basel II framework in response to recent worldwide developments. It is expected that the Basel Committee may reinstitute a minimum leverage ratio requirement.
The U.S. banking agencies have indicated that they will retain the minimum leverage requirement for all U.S. banks, yet it is also possible that higher percentages may be required for each capital category and that a new tangible common equity ratio standard may be added.
Prompt Correction Action and Other General Enforcement Authority
State and federal banking agencies possess broad powers to take corrective and other supervisory action against an insured bank and its holding company. Federal laws require each federal banking agency to take prompt corrective action to resolve the problems of insured banks.
Each federal banking agency has issued regulations defining five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Based upon its capital levels, a bank that is classified as well-capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such
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treatment. At each successive lower-capital category, an insured bank is subject to more restrictions, including restrictions on the banks activities, operational practices or the ability to pay dividends.
In addition to measures taken under the prompt corrective action provisions, bank holding companies and insured banks may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their business, or for violation of any law, rule, regulation, condition imposed in writing by the agency or term of a written agreement with the agency. In more serious cases, enforcement actions may include the appointment of a conservator or receiver for the bank; the issuance of a cease and desist order that can be judicially enforced; the termination of the banks deposit insurance; the imposition of civil monetary penalties; the issuance of directives to increase capital; the issuance of formal and informal agreements; the issuance of removal and prohibition orders against officers, directors, and other institution-affiliated parties; and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.
Safety and Soundness Guidelines
Banking regulatory agencies have adopted guidelines to assist in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines establish operational and managerial standards generally relating to: (1) internal controls, information systems, and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest-rate exposure; (5) asset growth and asset quality; and (6) compensation, fees, and benefits. In addition, the banking regulatory agencies have adopted safety and soundness guidelines for asset quality and for evaluating and monitoring earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves.
Restrictions on Dividends
Dividends from the Bank constitute a primary source of cash for SVB Financial. The Bank is subject to various federal and state statutory and regulatory restrictions on its ability to pay dividends, including the prompt corrective action regulations. In addition, the banking agencies have the authority to prohibit the Bank from paying dividends, depending upon the Banks financial condition, if such payment is deemed to constitute an unsafe or unsound practice. Furthermore, under the federal prompt corrective action regulations, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding companys bank subsidiary is classified as undercapitalized.
It is the Federal Reserves policy that bank holding companies should generally pay dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the organizations expected future needs and financial condition. It is also the Federal Reserves policy that bank holding companies should not maintain dividend levels that undermine their ability to be a source of strength to its banking subsidiaries. Additionally, in consideration of the current financial and economic environment, the Federal Reserve has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.
Transactions with Affiliates
Transactions between the Bank and its operating subsidiaries (such as SVB Securities or SVB Asset Management) on the one hand, and the Banks affiliates (such as SVB Financial, SVB Analytics, or an entity affiliated with SVB Capital) are subject to restrictions imposed by federal and state law, designed to protect the Bank and its subsidiaries from engaging in unfavorable behavior with their affiliates. More specifically, these restrictions, contained in Federal Reserve Board Regulation W, prevent SVB Financial and other affiliates from borrowing from, or entering into other credit transactions with, the Bank or its operating subsidiaries unless the loans or other credit transactions are secured by specified amounts of collateral. All loans and credit transactions and other covered transactions by the Bank and its operating subsidiaries with any one affiliate are limited, in the aggregate, to 10% of the Banks capital and surplus; and all loans and credit transactions and other covered
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transactions by the Bank and its operating subsidiaries with all affiliates are limited, in the aggregate, to 20% of the Banks capital and surplus. For this purpose, a covered transaction generally includes, among other things, a loan or extension of credit to an affiliate; a purchase of or investment in securities issued by an affiliate; a purchase of assets from an affiliate; the acceptance of a security issued by an affiliate as collateral for an extension of credit to any borrower; and the issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate. In addition, the Bank and its operating subsidiaries generally may not purchase a low-quality asset from an affiliate. Moreover, covered transactions and other specified transactions by the Bank and its operating subsidiaries with an affiliate must be on terms and conditions, including credit standards, that are substantially the same, or at least as favorable to the Bank or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. An entity that is a direct or indirect subsidiary of the Bank would not be considered to be an affiliate of the Bank or its operating subsidiaries for these purposes unless it fell into one of certain categories, such as a financial subsidiary authorized under the GLBA.
Loans to Insiders
Extensions of credit by the Bank to insiders of both the Bank and SVB Financial are subject to prohibitions and other restrictions imposed by federal regulations. For purposes of these limits, insiders include directors, executive officers and principal shareholders of the Bank or SVB Financial and their related interests. The term related interest means a company controlled by a director, executive officer or principal shareholder of the Bank or SVB Financial. The Bank may not extend credit to an insider of the Bank or SVB Financial unless the loan is made on substantially the same terms as, and subject to credit underwriting procedures that are no less stringent than, those prevailing at the time for comparable transactions with non-insiders. Under federal banking regulations, the Bank may not extend a loan to insiders in an amount greater than $500,000 without prior board approval (with any interested person abstaining from participating directly or indirectly in the voting). The federal regulations place additional restrictions on loans to executive officers, and generally prohibit loans to executive officers other than for certain specified purposes. The Bank is required to maintain records regarding insiders and extensions of credit to them.
Premiums for Deposit Insurance
The FDIC insures our customer deposits through the Deposit Insurance Fund (the DIF) up to prescribed limits for each depositor. Pursuant to the EESA, the maximum deposit insurance amount has been increased from $100,000 to $250,000 through the end of 2013. The amount of FDIC assessments paid by each DIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other supervisory factors. During 2008 and 2009, there have been higher levels of bank failures which has dramatically increased resolution costs of the FDIC and depleted the deposit insurance fund. In order to maintain a strong funding position and restore reserve ratios of the deposit insurance fund, the FDIC has increased assessment rates of insured institutions and may continue to do so in the future. Pursuant to the Federal Deposit Insurance Reform Act of 2005, the FDIC is authorized to set the reserve ratio for the DIF annually at between 1.15% and 1.5% of estimated insured deposits. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis. In an effort to restore capitalization levels and to ensure the DIF will adequately cover projected losses from future bank failures, the FDIC, in October 2008, proposed a rule to alter the way in which it differentiates for risk in the risk-based assessment system and to revise deposit insurance assessment rates, including base assessment rates. First quarter 2009 assessment rates were increased to between 12 and 50 cents for every $100 of domestic deposits, with most banks between 12 and 14 cents. The FDIC finalized its proposed rule on risk-based assessments in February 2009 and increased second quarter 2009 assessment rates, with most banks between 12 and 16 cents. It also instituted a special assessment of 20 cents for every $100 of domestic deposits to restore the DIF reserves, and reserved the right to charge an additional special assessment of up to 10 cents for every $100 of domestic deposits, should DIF reserves continue to decline. As of December 31, 2009, the Banks assessment rate was between 11 and 14 cents per $100 in assessable deposits. On November 12, 2009, the FDIC adopted a requirement for institutions to prepay in 2009 their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012.
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The FDIC implemented two temporary programs under the Temporary Liquidity Guaranty Program (TLGP) to provide deposit insurance for the full amount of most noninterest-bearing transaction accounts through June 30, 2010 and to guarantee certain unsecured debt of financial institutions and their holding companies through June 2012. The Bank is participating in the deposit insurance program. On October 20, 2009, the FDIC established a limited, six-month emergency guarantee facility whereby, certain participating entities, including the Bank, can apply to the FDIC for permission to issue FDIC-guaranteed debt during the period starting October 31, 2009 through April 30, 2010. The FDIC charges systemic risk special assessments to depository institutions that participate in the TLGP. The FDIC has recently proposed that Congress give the FDIC expanded authority to charge fees to the holding companies which benefit directly and indirectly from the FDIC guarantees. As of December 31, 2009, the Bank has not issued FDIC-guaranteed debt under the TLGP.
We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures or if the FDIC otherwise determines, we may be required to pay even higher FDIC premiums than the recently increased levels. These announced increases and any future increases in FDIC insurance premiums may have a material and adverse affect on our earnings.
All FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (FICO), an agency of the Federal government established to recapitalize the predecessor to the DIF. The FICO assessment rates, which are determined quarterly, averaged 0.0113% of insured deposits in fiscal 2008. These assessments will continue until the FICO bonds mature in 2017.
The FDIC may terminate a depository institutions deposit insurance upon a finding that the institutions financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a risk to the DIF or that may prejudice the interest of the banks depositors. The termination of deposit insurance for a bank would also result in the revocation of the banks charter by the DFI.
USA PATRIOT Act of 2001
The USA PATRIOT Act of 2001 and its implementing regulations significantly expanded the anti-money laundering and financial transparency laws, including the Bank Secrecy Act. The Bank has adopted comprehensive policies and procedures to address the requirements of the USA PATRIOT Act. Material deficiencies in anti-money laundering compliance can result in public enforcement actions by the banking agencies, including the imposition of civil money penalties and supervisory restrictions on growth and expansion. Such enforcement actions could also have serious reputation consequences for SVB Financial and the Bank.
Consumer Protection Laws and Regulations
The Bank is subject to many federal consumer protection statutes and regulations, such as the Community Reinvestment Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the National Flood Insurance Act and various federal and state privacy protection laws. Penalties for violating these laws could subject the Bank to lawsuits and could also result in administrative penalties, including, fines and reimbursements. The Bank and SVB Financial are also subject to federal and state laws prohibiting unfair or fraudulent business practices, untrue or misleading advertising and unfair competition.
In recent years, examination and enforcement by the state and federal banking agencies for non-compliance with consumer protection laws and their implementing regulations have become more intense. Due to these heightened regulatory concerns, the Bank may incur additional compliance costs or be required to expend additional funds for investments in its local community.
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Securities Activities
Federal Reserves Regulation R implements exceptions provided in the GLBA for securities activities which banks may conduct without registering with the SEC as securities broker or moving such activities to a broker-dealer affiliate. Regulation R provides exceptions for networking arrangements with third-party broker-dealers and authorizes compensation for bank employees who refer and assist institutional and high net worth bank customers with their securities, including sweep accounts to money market funds, and with related trust, fiduciary, custodial and safekeeping needs. The current securities activities which the Bank and its subsidiaries provide customers are conducted in conformance with these rules and regulations.
Regulation of Certain Subsidiaries
SVB Asset Management is registered with the SEC under the Investment Advisers Act of 1940, as amended, and is subject to its rules and regulations. SVB Securities is registered as a broker-dealer with the SEC and is subject to regulation by the SEC and the Financial Industry Regulatory Authority (FINRA). SVB Securities is also a member of the Securities Investor Protection Corporation. As a broker-dealer, it is subject to Rule 15c3-1 under the Securities Exchange Act of 1934, as amended, which is designed to measure the general financial condition and liquidity of a broker-dealer. Under this rule, SVB Securities is required to maintain the minimum net capital deemed necessary to meet its continuing commitments to customers and others. Under certain circumstances, this rule could limit the ability of the Bank to withdraw capital from SVB Securities.
Additionally, our international-based subsidiaries are also subject to international laws and regulations, such as those promulgated by the Financial Services Authority in the United Kingdom, the Reserve Bank of India and the China Banking Regulatory Commission.
Available Information
We make available free of charge through our Internet website, http://www.svb.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The contents of our website are not incorporated herein by reference and the website address provided is intended to be an inactive textual reference only.
ITEM 1A. | RISK FACTORS |
Our business faces significant risks, including market and economic environment, credit, market/liquidity, operational, legal/regulatory and strategic/reputation risks. The factors described below may not be the only risks we face and are not intended to serve as a comprehensive listing or be applicable only to the category of risk under which they are disclosed. The risks described below are generally applicable to more than one of the following categories of risks. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations. If any of the events or circumstances described in the following factors actually occurs, our business, financial condition and/or results of operations could suffer.
Risks Relating to Market and Economic Environment
The continuation or worsening of recent market and economic conditions may adversely affect our industry, business, results of operations and ability to access capital.
Overall deterioration in domestic or global economic conditions, especially in the technology, life science, venture capital/private equity and premium wine industry niches or overall financial capital markets may adversely affect our business, growth, results of operations and ability to access capital. A global, domestic or significant regional economic slowdown or recession, could harm us by adversely affecting our clients and
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prospective clients access to capital to fund their businesses, their ability to sustain and grow their businesses, the level of funds they have available to maintain deposits, their demand for loans, their ability to repay loans and otherwise.
The United States has been in a serious economic downturn, as have economies around the world. Financial markets have been volatile, business and consumer spending has declined, and overall business activities have slowed, including a general slowdown in mergers and acquisitions (M&A) and initial public offerings (IPOs) of companiesevents upon which the venture capital and private equity community relies to exit their investments. Overall venture capital financing activity has also slowed in recent periods. There have been limited signs of economic recovery recently, such as a modest increase in the number of IPOs, yet economic conditions continue to be challenging. If current market and economic conditions persist, our clients will continue to be adversely impacted, as will our investment returns, valuations of companies, and overall levels of venture capital and private equity investments, which may have a material and adverse effect on our business, financial condition and results of operations. A worsening of these conditions could likely exacerbate the adverse effect on us.
As a result of recent economic conditions, the capital and credit markets have experienced extreme volatility and disruption. SVB Financial depends on access to equity and debt markets as one of its primary sources to raise capital. There has been some improvement to market conditions, particularly access to equity markets; however, if recent levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
Recent and future legislation and regulatory initiatives to address current market and economic conditions may not achieve their intended objectives, including stabilizing the U.S. banking system or reviving the overall economy.
Recent and future legislative and regulatory initiatives to address current market and economic conditions, such as EESA or the ARRA, may not achieve their intended objectives, including stabilizing or improving the U.S. banking system or reviving the overall economy. EESA was enacted in October 2008 to restore confidence and stabilize the volatility in the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. Treasury and banking regulators have implemented, and likely will continue to implement, various programs and legislation to address capital and liquidity issues in the banking system, including the Troubled Assets Relief Program (TARP). There can be no assurance as to the actual impact that any of the recent, or future, legislative and regulatory initiatives will have on the financial markets and the overall economy. Any failure of these initiatives to help stabilize or improve the financial markets and the economy, and a continuation or worsening of recent financial market and economic conditions could materially and adversely affect our business, financial condition, results of operations, access to capital or credit, and the trading price of our common stock.
Additional requirements under our regulatory framework intended to strengthen the U.S. financial system could adversely affect us.
Recent government efforts to strengthen the U.S. financial system have resulted in the imposition of additional regulatory requirements, such as various executive compensation and corporate governance restrictions on CPP participants, and regulatory fees, such as FDIC assessment increase and prepayment requirements, on financial institutions. Moreover, there has been increasing legislative and other focus on the regulation of financial institutions, which may result in the imposition of additional legislative or regulatory requirements, such as changes to capital minimum guidelines, additional executive compensation restrictions or additional restrictions on non-banking activities, or perhaps, a possible comprehensive overhaul of the financial institutions regulatory system. Current and future requirements may have a material and adverse effect on our business, financial condition, and results of operations and may make it more difficult for us to attract and retain qualified executive officers and employees.
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Credit Risks
If our clients fail to perform under their loans, our business, results of operations and financial condition could be adversely affected.
As a lender, we face the risk that our client borrowers will fail to pay their loans when due. If borrower defaults cause large aggregate losses, it could have a material adverse effect on our business, results of operations and financial condition. We reserve for such losses by establishing an allowance for loan losses, the increase of which results in a charge to our earnings as a provision for loan losses. We have established an evaluation process designed to determine the adequacy of our allowance for loan losses. While this evaluation process uses historical and other objective information, the classification of loans and the forecasts and establishment of loan losses are dependent to a great extent on our subjective assessment based upon our experience and judgment. Actual losses are difficult to forecast, especially if such losses stem from factors beyond our historical experience or are otherwise inconsistent or out of pattern with regards to our credit quality assessments. There can be no assurance that our allowance for loan losses will be sufficient to absorb future loan losses or prevent a material adverse effect on our business, financial condition and results of operations.
Because of the credit profile of our loan portfolio, our levels of nonperforming assets and charge-offs can be volatile. We may need to make material provisions for loan losses in any period, which could reduce net income or increase net losses in that period.
Our loan portfolio has a credit profile different from that of most other banking companies. In addition, the credit profile of our clients varies across our loan portfolio, based on the nature of the lending we do for different market segments. In our portfolios for emerging, early-stage and mid-stage companies, many of our loans are made to companies with modest or negative cash flows and no established record of profitable operations. Repayment of these loans may be dependent upon receipt by borrowers of additional equity financing from venture capitalists or others, or in some cases, a successful sale to a third party or a public offering. In recent periods, due to the overall weakening of the economic environment, venture capital financing activity has slowed, and IPOs and M&A activities have slowed significantly. Despite there being signs of improvement in such activities recently, if economic conditions worsen or do not continue to improve, such activities may slow down even further. Venture capital firms may provide financing at lower levels, more selectively or on less favorable terms, which may have an adverse effect on our borrowers that are otherwise dependent on such financing to repay their loans to us. Moreover, collateral for many of our loans often includes intellectual property, which is difficult to value and may not be readily salable in the case of default. Because of the intense competition and rapid technological change that characterizes the companies in the technology and life science industry sectors, a borrowers financial position can deteriorate rapidly.
Additionally, we may enter into accounts receivable financing arrangements with our company clients. The repayment of these arrangements is dependent on the financial condition, and payment ability, of third parties with whom our clients do business. Such third parties may be unable to meet their financial obligations to our clients, especially in a weakened economic environment.
In our portfolio of venture capital and private equity firm clients, many of our clients have capital call lines of credit, the repayment of which is dependent on the payment of capital calls by the underlying limited partner investors in the funds managed by these firms. These limited partner investors may face liquidity issues or have difficulties meeting their financial commitments, especially during unstable economic times, which may lead to our clients inability to meet their repayment obligations to us.
We have been increasing our efforts to lend to corporate technology and large corporate clients, including some companies with greater levels of debt relative to their equity, and have increased the average size of our loans over time. At December 31, 2009, our gross loan portfolio included a total of $957.6 million, or 20.9 percent, of individual loans greater than $20 million. Increasing our larger loan commitments could increase the impact on us of any single borrower default.
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We lend to targeted high net-worth individual clients through our Private Client Services (PCS) group. These individual clients may face difficulties meeting their financial commitments, especially during a challenging economic environment, and may be unable to repay their loans. As of December 31, 2009, our total gross loans to these targeted individual clients in our PCS loan portfolio was over $350.0 million. In 2009, primarily due to the impact of economic conditions, we experienced a higher level of charge-offs since 2008 with respect to our PCS portfolio. We also lend to premium wineries and vineyards through our SVB Wine group. Repayment of loans made to these clients may be dependent on overall grape supply (which may be adversely affected by poor weather or other natural conditions) and overall wine demand and sales, or other sources of financing or income (which may be adversely affected by a challenging economic environment). As of December 31, 2009, our total gross loans in our premium wine portfolio was $442.1 million. In 2009, charge-offs with respect to this portfolio also increased by $2.8 million compared to 2008. See Loans under Managements Discussion and Analysis of Financial Condition and Results of OperationsConsolidated Financial Condition under Item 7 of Part II of this report below.
For all of these reasons, our level of nonperforming loans, loan charge-offs and allowance for loan losses can be volatile and can vary materially from period to period. Increases in our level of nonperforming loans or loan charge-offs may require us to increase our provision for loan losses in any period, which could reduce our net income or cause net losses in that period. Additionally, such increases in our level of nonperforming loans or loan charge-offs may also have an adverse effect on our credit ratings and market perceptions of us.
The borrowing needs of our clients may be volatile, especially during a challenging economic environment. We may not be able to meet our unfunded credit commitments, or adequately reserve for losses associated with our unfunded credit commitments, which could have a material effect on our business, financial condition, results of operations and reputation.
A commitment to extend credit is a formal agreement to lend funds to a client as long as there is no violation of any condition established under the agreement. The actual borrowing needs of our clients under these credit commitments have historically been lower than the contractual amount of the commitments. A significant portion of these commitments expire without being drawn upon. Because of the credit profile of our clients, we typically have a substantial amount of total unfunded credit commitments, which is reflected off our balance sheet. At December 31, 2009, we had $5.3 billion in total unfunded credit commitments. Actual borrowing needs of our clients may exceed our expected funding requirements, especially during a challenging economic environment when our client companies may be more dependent on our credit commitments due to the lack of available credit elsewhere, the increasing costs of credit, or the limited availability of financings from more discerning and selective venture capital/private equity firms. In addition, limited partner investors of our venture capital/private equity fund clients may fail to meet their underlying investment commitments due to liquidity or other financing issues, which may impact our clients borrowing needs. Any failure to meet our unfunded credit commitments in accordance with the actual borrowing needs of our clients may have a material adverse effect on our business, financial condition, results of operations and reputation.
Additionally, we establish a reserve for losses associated with our unfunded credit commitments. The level of the reserve for unfunded credit commitments is determined by following a methodology similar to that used to establish our allowance for loan losses in our funded loan portfolio. The reserve is based on credit commitments outstanding, credit quality of the loan commitments, and managements estimates and judgment, and is susceptible to significant changes. There can be no assurance that our reserve for unfunded credit commitments will be adequate to provide for actual losses associated with our unfunded credit commitments. An increase in the reserve for unfunded credit commitments in any period may result in a charge to our earnings, which could reduce our net income or increase net losses in that period.
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Market/Liquidity Risks
Our current level of interest rate spread may decline in the future. Any material reduction in our interest rate spread, or a sustained period of low market interest rates, could have a material adverse effect on our business, results of operations or financial condition.
A major portion of our net income comes from our interest rate spread, which is the difference between the interest rates paid by us on amounts used to fund assets and the interest rates and fees we receive on our interest-earning assets. We fund assets using deposits and other borrowings. While we are increasingly offering more interest-bearing deposit products, a majority of our deposit balances are from our noninterest bearing products. Our interest-earning assets include outstanding loans extended to our clients and securities held in our investment portfolio. Overall, the interest rates we pay on our interest-bearing liabilities and receive on our interest-earning assets, and our level of interest rate spread, could be affected by a variety of factors, including changes in market interest rates, competition, and a change over time in the mix of loans, investment securities, deposits and other liabilities on our balance sheet.
Changes in market interest rates, such as the Federal Funds rate, generally impact our interest rate spread. While changes in interest rates do not produce equivalent changes in the revenues earned from our interest-earning assets and the expenses associated with our interest-bearing liabilities, increases in market interest rates will nevertheless likely cause our interest rate spread to increase. (While increases in market interest rates will nevertheless likely cause our interest rate spread to increase, due to the current low level of interest rates this is not expected to be the case for the first 75 basis points of increases in the target Federal Funds rate in 2010 or later. Despite the 75 basis point decrease in the target Federal Funds rates in December 2008, we did not lower the Banks prime lending rate in a corresponding manner.) Conversely, if interest rates decline, our interest rate spread will likely decline. Decreases in market interest rates, especially during 2008 and 2009, have caused our interest rate spread to decline significantly, which has reduced our net income. Sustained low levels of market interest rates will likely continue to put pressure on our results of operations. Unexpected interest rate declines may also adversely affect our business forecasts and expectations. Interest rates are highly sensitive to many factors beyond our control, such as inflation, recession, global economic disruptions, unemployment and the fiscal and monetary policies of the federal government and its agencies.
Any material reduction in our interest rate spread or the continuation of sustained low levels of market interest rates could have a material adverse effect on our business, results of operations and financial condition.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.
Liquidity is essential to our business. We require sufficient liquidity to meet our expected, as well as unexpected, financial obligations and requirements. An inability to raise funds through deposits, borrowings, equity/debt offerings and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities, or on terms attractive to us, could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a reduction in our credit ratings, an increase in costs of capital in financial capital markets, a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us, or a decrease in depositor or investor confidence in us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole.
Additionally, our credit ratings are important to our liquidity and our business. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs, and limit our access to the capital markets. Moreover, a reduction in our credit ratings could increase the interest rates we pay on deposits, or adversely affect perceptions about our creditworthiness or our overall reputation.
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Equity warrant asset, venture capital and private equity funds and direct equity investment portfolio gains or losses depend upon the performance of the portfolio investments and the general condition of the public equity markets, which are uncertain and may vary materially by period.
In connection with negotiated credit facilities and certain other services, we frequently obtain equity warrant assets giving us the right to acquire stock in certain client companies. We also make investments through our SVB Capital family of funds in venture capital and private equity funds and direct investments in companies, which are required to be carried at fair value. The fair value of these warrants and investments are reflected in our financial statements and are adjusted on a quarterly basis. Fair value changes are generally recorded as unrealized gains or losses through consolidated net income. The timing and amount of changes in fair value, if any, of these financial instruments depend upon factors beyond our control, including the performance of the underlying companies, fluctuations in the market prices of the preferred or common stock of the underlying companies, the timing of our receipt of relevant financial information, general volatility and interest rate market factors, and legal and contractual restrictions. The timing and amount of our realization of actual net proceeds, if any, from the disposition of these financial instruments depend upon factors beyond our control, including investor demand for IPOs, levels of M&A activity, legal and contractual restrictions on our ability to sell, and the perceived and actual performance and future value of portfolio companies. Because of the inherent variability of these financial instruments and the markets in which they are bought and sold, the fair market value of these financial instruments might increase or decrease materially, and the net proceeds realized upon disposition might be less than the then-current recorded fair market value.
We cannot predict future realized or unrealized gains or losses, and any such gains or losses are likely to vary materially from period to period. Additionally, the value of our equity warrant asset portfolio depends on the number of warrants we obtain, and in future periods, we may not be able to continue to obtain such equity warrant assets to the same extent we have historically achieved.
Public equity offerings and mergers and acquisitions involving our clients or a slowdown in venture capital investment levels may reduce the borrowing needs of our clients, which could adversely affect our business, results of operations and financial condition.
While an active market for public equity offerings and mergers and acquisitions generally has positive implications for our business, one negative consequence is that our clients may pay off or reduce their loans with us if they complete a public equity offering, are acquired by or merge with another entity or otherwise receive a significant equity investment. The current economic conditions reflect a slowdown in such transactions, however if the levels of such transactions were to increase, our total outstanding loans may decline. Moreover, our capital call lines of credit are typically utilized by our venture capital fund clients to make investments prior to receipt of capital called from their respective limited partners. A slowdown in overall venture capital investment levels may reduce the need for our clients to borrow from our capital call lines of credit. Any significant reduction in the outstanding amounts of our loans or under our lines of credit could have a material adverse effect on our business, results of operations and financial condition.
Failure to raise additional funds from third-party investors for our funds managed by SVB Capital may require us to use capital to fund commitments to other funds, which may have a material adverse effect on our business, financial condition and reputation.
From time to time, we form new investment funds through our funds management division, SVB Capital. These funds include funds that invest in other venture capital and private equity funds (which we refer to as funds of funds) and portfolio companies (which we refer to as direct equity funds). Our managed funds are typically structured as limited partnerships, heavily funded by third party limited partners and ultimately managed by us through our SVB Capital division. SVB Financial typically will also make a significant capital commitment to each of these funds as a limited partner.
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Prior to forming a new fund of funds, SVB Financial has made and may make investment commitments intended for the new fund, in order to show potential investors the types of funds in which the new fund will invest. Until these investments are transferred to the new fund, which typically will occur upon the acceptance of binding commitments from third-party limited partners (the closing), these investments are obligations of SVB Financial. If we fail to attract sufficient capital from third-party investors to conduct the closing of a fund, we may be required to permanently allocate capital to these investments when we otherwise had intended them to be temporary obligations. If, under such circumstances, we decide to sell these investments or fail to meet our obligations, we may lose some or all of the capital that has already been deployed and may be subject to legal claims. Any unexpected permanent allocation of capital toward these investments, loss of capital contributed to these investments or legal claims against us could have a material adverse effect on our business and financial condition, as well as our reputation.
The soundness of other financial institutions could adversely affect us.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, and other institutional clients, which may result in payment obligations to us or to our clients due to products arranged by us. Many of these transactions expose us to credit and market risk that may cause our counterparty or client to default. In addition, we are exposed to market risk when the collateral we hold cannot be realized or is liquidated at prices not sufficient to recover the full amount of the secured obligation. There is no assurance that any such losses would not materially and adversely affect our business, results of operations and financial condition.
Operational Risks
If we fail to retain our key employees or recruit new employees, our growth and results of operations could be adversely affected.
We rely on key personnel, including a substantial number of employees who have technical expertise in their subject matter area and/or a strong network of relationships with individuals and institutions in the markets we serve. If we were to have less success in recruiting and retaining these employees than our competitors, for reasons including regulatory restrictions on compensation practices or the availability of more attractive opportunities elsewhere, our growth and results of operations could be adversely affected.
The manner in which we structure our employee compensation could adversely affect our results of operations and cash flows, as well as our ability to attract, recruit and retain key employees.
In May 2006, in an effort to align our equity grant rate to that of other financial institutions similar to us, we committed to restrict the total number of shares of our common stock issued under stock options, restricted stock awards, restricted stock unit awards, stock bonus awards and any other equity awards granted during a fiscal year as a percentage of the total number of shares outstanding on a prospective basis. In light of this restriction, we may in the future consider taking other actions to modify employee compensation structures, such as granting cash compensation or other cash-settled forms of equity compensation, which may result in an additional charge to our earnings.
How we structure our equity compensation may also have an adverse effect on our ability to attract, recruit and retain key employees. Our decision in May 2006 to reduce equity awards to be granted on a prospective basis, and any other similar changes limiting our equity awards that we may adopt in the future, could negatively impact our hiring and retention strategies. Moreover, recent economic conditions have reduced our share price, causing existing employee options and equity awards to have exercise prices higherin some cases, meaningfully higherthan our actual share price. These factors could adversely affect our ability to attract, recruit and retain certain key employees.
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The occurrence of fraudulent activity or breaches of our information security could have a material adverse effect on our business, financial condition and results of operations.
As a financial institution, we are susceptible to fraudulent activity that may be committed against us or our clients, which may result in financial losses to us or our clients, privacy breaches against our clients, or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. In recent periods, there has been a rise in electronic fraudulent activity within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts as they typically contain higher account balances.
Information pertaining to us and our clients are maintained, and transactions are executed, on our internal networks and Internet-based systems, such as our online banking system. The secure maintenance and transmission of confidential information, as well as execution of transactions over these systems, are essential to protect us and our clients against fraud and to maintain our clients confidence. Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our clients and underlying transactions, as well as the technology used by our clients to access our systems. Although we have developed systems and processes that are designed to detect and prevent security breaches and periodically test our security, failure to mitigate breaches of security could result in losses to us or our clients, result in a loss of business and/or clients, cause us to incur additional expenses, affect our ability to grow our online services or other businesses, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.
More generally, publicized information concerning security problems could inhibit the use or growth of the Internet as a means of conducting commercial transactions. Our ability to provide financial services over the Internet would be severely impeded if clients became unwilling to transmit confidential information online. As a result, our business, financial condition and results of operations could be adversely affected.
We face risks associated with the ability of our information technology systems and our people and processes to support our operations and future growth effectively.
In order to serve our target clients effectively, we have developed a comprehensive array of banking and other products and services. In order to support these products and services, we have developed and purchased or licensed information technology and other systems and processes. As our business continues to grow, we will continue to invest in and enhance these systems, and our people and processes. These investments and enhancements may affect our future profitability and overall effectiveness. From time to time, we may change, consolidate, replace, add or upgrade existing systems or processes, which if not implemented properly to allow for an effective transition, may have an adverse effect on our operations, including business interruptions which may result in inefficiencies, revenue losses, client losses, exposure to fraudulent activities, or damage to our reputation. For example, we are in the process of implementing a new universal banking system that will replace our current platform. Or, we may outsource certain operational functions to consultants or other third parties to enhance our overall efficiencies, which if not performed properly, could also have an adverse effect on us. There can be no assurance that we will be able to effectively maintain or improve our systems and processes, or utilize outsourced talent, to meet our business needs efficiently. Any failure of such could adversely affect our operations, financial condition, results of operations, future growth and reputation.
Business disruptions and interruptions due to natural disasters and other external events beyond our control can adversely affect our business, financial condition and results of operations.
Our operations can be subject to natural disasters and other external events beyond our control, such as earthquakes, fires, severe weather, public health issues, power failures, telecommunication loss, major accidents,
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terrorist attacks, acts of war, and other natural and man-made events. Our corporate headquarters and a portion of our critical business offices are located in California near major earthquake faults. Such events of disaster, whether natural or attributable to human beings, could cause severe destruction, disruption or interruption to our operations or property. Financial institutions, such as us, generally must resume operations promptly following any interruption. If we were to suffer a disruption or interruption and were not able to resume normal operations within a period consistent with industry standards, our business could suffer serious harm. In addition, depending on the nature and duration of the disruption or interruption, we might be vulnerable to fraud, additional expense or other losses, or to a loss of business and/or clients. We have implemented a business continuity management program and we continue to enhance it on an ongoing basis. There is no assurance that our business continuity management program can adequately mitigate the risks of such business disruptions and interruptions.
Additionally, natural disasters and external events could affect the business and operations of our clients, which could impair their ability to pay their loans or fees when due, impair the value of collateral securing their loans, cause our clients to reduce their deposits with us, or otherwise adversely affect their business dealings with us, any of which could have a material adverse effect on our business, financial condition and results of operations.
We face reputation and business risks due to our interactions with business partners, service providers and other third parties.
We rely on third parties, both in the United States and internationally in countries such as India, in a variety of ways, including to provide key components of our business infrastructure or to further our business objectives. These third parties may provide services to us and our clients or serve as partners in business activities. We rely on these third parties to fulfill their obligations to us, to accurately inform us of relevant information and to conduct their activities professionally and in a manner that reflects positively on us. Any failure of our business partners, service providers or other third parties to meet their commitments to us or to perform in accordance with our expectations could result in operational issues, increased expenditures, damage to our reputation or loss of clients, which could harm our business and operations, financial performance, strategic growth or reputation.
We depend on the accuracy and completeness of information about customers and counterparties.
In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, under our accounts receivable financing arrangements, we rely on information, such as invoices, contracts and other supporting documentation, provided by our clients and their account debtors to determine the amount of credit to extend. Similarly, in deciding whether to extend credit, we may rely upon our customers representations that their financial statements conform to U.S. generally accepted accounting principles (GAAP) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. We also may rely on customer representations and certifications, or other audit or accountants reports, with respect to the business and financial condition of our clients. Our financial condition, results of operations, financial reporting and reputation could be negatively affected if we rely on materially misleading, false, inaccurate or fraudulent information.
Our accounting policies and methods are key to how we report our financial condition and results of operations. They require management to make judgments and estimates about matters that are uncertain.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with GAAP and reflect managements judgment of the most appropriate manner to report our financial condition and results. In some cases, management must select the
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accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in our reporting materially different amounts than would have been reported under a different alternative.
Changes in accounting standards could materially impact our financial statements.
From time to time, the Financial Accounting Standards Board (FASB) or the SEC may change the financial accounting and reporting standards that govern the preparation of our financial statements. In addition, the bodies that interpret the accounting standards (such as banking regulators or outside auditors) may change their interpretations or positions on how these standards should be applied. These changes may be beyond our control, can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retrospectively, or apply an existing standard differently, also retroactively, in each case resulting in our revising or restating prior period financial statements.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results. As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.
If we identify material weaknesses in our internal control over financial reporting or are otherwise required to restate our financial statements, we could be required to implement expensive and time-consuming remedial measures and could lose investor confidence in the accuracy and completeness of our financial reports. We may also face regulatory enforcement or other actions, including the potential delisting of our securities from NASDAQ. This could have an adverse effect on our business, financial condition and results of operations, including our stock price, and could potentially subject us to litigation.
Legal/Regulatory Risks
We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business.
SVB Financial Group, including the Bank, is extensively regulated under federal and state laws and regulations governing financial institutions, including those imposed by the FDIC, the Federal Reserve and the California Department of Financial Institutions. Federal and state laws and regulations govern, limit or otherwise affect the activities in which we may engage and may affect our ability to expand our business over time. In addition, a change in the applicable statutes, regulations or regulatory policy could have a material effect on our business, including limiting the types of financial services and products we may offer or increasing the ability of nonbanks to offer competing financial services and products. These laws and regulations also require financial institutions, including SVB Financial and the Bank, to maintain certain minimum levels of capital, which may require us to raise additional capital in the future or affect our ability to use our capital resources for other business purposes. In addition, increased regulatory requirements, whether due to the adoption of new laws and regulations, changes in existing laws and regulations, or more expansive or aggressive interpretations of existing laws and regulations, may have a material adverse effect on our business, financial condition and results of operations.
If we were to violate international, federal or state laws or regulations governing financial institutions, we could be subject to disciplinary action that could have a material adverse effect on our business, financial condition, results of operations and reputation.
International, federal and state banking regulators possess broad powers to take supervisory or enforcement action with respect to financial institutions. Other regulatory bodies, including the SEC, NASDAQ, the Financial Industry Regulatory Authority (FINRA) and state securities regulators, regulate broker-dealers, including our
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subsidiary, SVB Securities. If SVB Financial Group were to violate, even if unintentionally or inadvertently, the laws governing public companies, financial institutions and broker-dealers, the regulatory authorities could take various actions against us, depending on the severity of the violation, such as revoking necessary licenses or authorizations, imposing censures, civil money penalties or fines, issuing cease and desist or other supervisory orders, and suspending or expelling from the securities business a firm, its officers or employees. Supervisory actions could result in higher capital requirements or the need for us to raise additional capital, higher insurance premiums, higher levels of liquidity available to meet the Banks financial needs and limitations on the activities of SVB Financial Group. These remedies and supervisory actions could have a material adverse effect on our business, financial condition, results of operations and reputation.
SVB Financial relies on dividends from its subsidiaries for most of its cash revenues.
SVB Financial is a holding company and is a separate and distinct legal entity from its subsidiaries. One of its primary sources of income is cash revenues from dividends from its subsidiaries, primarily the Bank. These dividends are a principal source of funds to pay operating costs, borrowings, if any, and dividends, should SVB Financial elect to pay any. Various federal and state laws and regulations limit the amount of dividends that the Bank and certain of our nonbank subsidiaries may pay to SVB Financial. Also, SVB Financials right to participate in a distribution of assets upon a subsidiarys liquidation or reorganization is subject to the prior claims of the subsidiarys creditors.
Strategic/Reputation Risks
Concentration of risk increases the potential for significant losses.
Concentration of risk increases the potential for significant losses in our business. Our clients are concentrated by industry niches: technology, life science, venture capital/private equity and premium wine. Many of our client companies are concentrated by certain stages within their life cycles, such as early-stage or mid-stage, and many of these companies are venture capital-backed. Our loan concentrations are derived from our borrowers engaging in similar activities or types of loans extended to a diverse group of borrowers that could cause those borrowers to be similarly impacted by economic or other conditions. Any adverse effect on any of our areas of concentration could have a material impact on our business, results of operations and financial condition. Due to our concentrations, we may suffer losses even when economic and market conditions are generally favorable for our competitors.
Decreases in the amount of equity capital available to our portfolio companies could adversely affect our business, growth and profitability.
Our core strategy is focused on providing banking products and services to companies, including in particular to emerging stage to mid-stage companies, that receive financial support from sophisticated investors, including venture capital or private equity firms, angels, and corporate investors. We derive a meaningful share of our deposits from these companies and provide them with loans as well as other banking products and services. In some cases, our lending credit decision is based on our analysis of the likelihood that our venture capital or angel-backed client will receive additional rounds of equity capital from investors. If the amount of capital available to such companies decreases, it is likely that the number of new clients and investor financial support to our existing borrowers could decrease, which could have an adverse effect on our business, profitability and growth prospects.
Among the factors that have affected and could in the future affect the amount of capital available to our portfolio companies are the receptivity of the capital markets, the prevalence of IPOs or M&A activity of companies within our technology and life science industry sectors, the availability and return on alternative investments and general economic conditions in the technology, life science and venture capital/private equity industries. Reduced capital markets valuations could reduce the amount of capital available to our client companies, including companies within our technology and life science industry sectors.
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Because our business and strategy are largely based on this venture capital/private equity financing framework focused on our particular client niches, any material changes in the framework, including adverse trends in investment or fundraising levels, may have a materially adverse effect on our business, strategy and overall profitability.
We face competitive pressures that could adversely affect our business, results of operations, financial condition and future growth.
Other banks and specialty and diversified financial services companies and debt funds, many of which are larger than we are, offer lending, leasing, other financial products and advisory services to our client base. In addition, we compete with hedge funds and private equity funds. In some cases, our competitors focus their marketing on our industry sectors and seek to increase their lending and other financial relationships with technology companies or special industries such as wineries. In other cases, our competitors may offer a broader range of financial products to our clients. When new competitors seek to enter one of our markets, or when existing market participants seek to increase their market share, they sometimes undercut the pricing and credit terms prevalent in that market, which could adversely affect our market share or ability to exploit new market opportunities. Our pricing and credit terms could deteriorate if we act to meet these competitive challenges, which could adversely affect our business, results of operations, financial condition and future growth. Similarly, competitive pressures could adversely affect the business, results of operations, financial condition and future growth of our non-banking services, including our access to capital and attractive investment opportunities for our funds business.
Our ability to maintain or increase our market share depends on our ability to meet the needs of existing and future clients.
Our success depends, in part, upon our ability to adapt our products and services to evolving industry standards and to meet the needs of existing and potential future clients. A failure to achieve market acceptance for any new products we introduce, a failure to introduce products that the market may demand, or the costs associated with developing, introducing and providing new products and services could have an adverse effect on our business, results of operations, growth prospects and financial condition.
We face risks in connection with our strategic undertakings.
If appropriate opportunities present themselves, we may engage in strategic activities, which could include acquisitions, joint ventures, partnerships, investments or other business growth initiatives or undertakings. There can be no assurance that we will successfully identify appropriate opportunities, that we will be able to negotiate or finance such activities or that such activities, if undertaken, will be successful.
In order to finance future strategic undertakings, we might obtain additional equity or debt financing. Such financing might not be available on terms favorable to us, or at all. If obtained, equity financing could be dilutive and the incurrence of debt and contingent liabilities could have a material adverse effect on our business, results of operations and financial condition.
Our ability to execute strategic activities successfully will depend on a variety of factors. These factors likely will vary based on the nature of the activity but may include our success in integrating the operations, services, products, personnel and systems of an acquired company into our business, operating effectively with any partner with whom we elect to do business, retaining key employees, achieving anticipated synergies, meeting managements expectations and otherwise realizing the undertakings anticipated benefits. Our ability to address these matters successfully cannot be assured. In addition, our strategic efforts may divert resources or managements attention from ongoing business operations and may subject us to additional regulatory scrutiny. If we do not successfully execute a strategic undertaking, it could adversely affect our business, financial condition, results of operations, reputation and growth prospects. In addition, if we were to conclude that the
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value of an acquired business had decreased and that the related goodwill had been impaired, that conclusion would result in an impairment of goodwill charge to us, which would adversely affect our results of operations.
We face risks associated with international operations.
One component of our strategy is to expand internationally. To date, we have opened offices in China, India, Israel and the United Kingdom. We plan to expand our operations in those locations and may expand beyond these countries. Our efforts to expand our business internationally carry with them certain risks, including risks arising from the uncertainty regarding our ability to generate revenues from foreign operations. In addition, there are certain risks inherent in doing business on an international basis, including, among others, legal, regulatory and tax requirements and restrictions, uncertainties regarding liability, tariffs and other trade barriers, difficulties in staffing and managing foreign operations, incremental requirement of managements attention and resources, differing technology standards or customer requirements, cultural differences, political and economic risks and financial risks, including currency and payment risks. These risks could adversely affect the success of our international operations and could have a material adverse effect on our overall business, results of operations and financial condition. In addition, we face risks that our employees may fail to comply with applicable laws and regulations governing our international operations, including the U.S. Foreign Corrupt Practices Act and foreign laws and regulations, which could have a material adverse effect on us.
Our business reputation is important and any damage to it could have a material adverse effect on our business.
Our reputation is very important to sustain our business, as we rely on our relationships with our current, former and potential clients and stockholders, the venture capital and private equity communities, and the industries that we serve. Any damage to our reputation, whether arising from regulatory, supervisory or enforcement actions, matters affecting our financial reporting or compliance with SEC and exchange listing requirements, negative publicity, or our conduct of our business or otherwise could have a material adverse effect on our business.
Item 1B. | Unresolved Staff Comments |
None.
Item 2. | Properties |
Our corporate headquarters facility consists of three buildings and is located at 3003 Tasman Drive, Santa Clara, California. The total square footage of the premises leased under the current lease arrangement is approximately 213,625 square feet. The lease will expire on September 30, 2014, unless terminated earlier.
We currently operate 27 regional offices, including an administrative office, in the United States as well as offices outside the United States. We operate throughout the Silicon Valley with offices in Santa Clara, Menlo Park, and Palo Alto. Other regional offices in California include Irvine, Sherman Oaks, San Diego, San Francisco, St. Helena, Santa Rosa, and Pleasanton. Office locations outside of California within the United States include: Tempe, Arizona; Broomfield, Colorado; Atlanta, Georgia; Chicago, Illinois; Newton, Massachusetts; Minnetonka, Minnesota; New York, New York; Morrisville, North Carolina; Beaverton, Oregon; Randor, Pennsylvania; Austin, Texas; Dallas, Texas; Salt Lake City, Utah; Vienna, Virginia; and Seattle, Washington. Our international offices are located in: Shanghai and Hong Kong, China; Bangalore and Mumbai, India; Hertzelia Pituach, Israel; and London, England. All of our properties are occupied under leases, which expire at various dates through 2020, and in most instances include options to renew or extend at market rates and terms. We also own leasehold improvements, equipment, furniture, and fixtures at our offices, all of which are used in our business activities.
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Our Global Commercial Bank operations are principally conducted out of our corporate headquarters in Santa Clara, and the lending teams operate out of the various regional and international offices. SVB Capital principally operates out of our office in Palo Alto. Our other businesses operate out of various offices, including SVB Private Client Services in our Santa Clara office, and SVB Analytics in San Francisco. Prior to our announcement of the cessation of operations at SVB Alliant in July 2007, SVB Alliant operated out of an office in Palo Alto.
We believe that our properties are in good condition and suitable for the conduct of our business.
Item 3. | Legal Proceedings |
Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against us or our affiliates. Based upon information available to us, our review of such claims to date and consultation with our outside legal counsel, management believes the liability relating to these actions, if any, will not have a material adverse effect on our liquidity, consolidated financial position, and/or results of operations. Where appropriate, as we determine, we establish reserves in accordance with FASB guidance over contingencies (ASC 450, formerly known as SFAS No. 5). The outcome of litigation and other legal and regulatory matters is inherently uncertain, however, and it is possible that one or more of the legal or regulatory matters currently pending or threatened could have a material adverse effect on our liquidity, consolidated financial position, and/or results of operations.
Item 4. | Reserved |
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PART II
Item 5. | Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market Information
Our common stock is traded on the NASDAQ Global Select Market under the symbol SIVB. The per share range of high and low sale prices for our common stock as reported on the NASDAQ Global Select Market, for each full quarterly period over the years ended December 31, 2009 and 2008, was as follows:
2009 | 2008 | |||||||||||
Three Months Ended: |
Low | High | Low | High | ||||||||
March 31 |
$ | 11.58 | $ | 26.48 | $ | 41.96 | $ | 50.68 | ||||
June 30 |
15.61 | 31.82 | 39.68 | 52.20 | ||||||||
September 30 |
23.63 | 44.63 | 42.88 | 69.90 | ||||||||
December 31 |
36.52 | 45.83 | 23.49 | 63.26 |
Holders
As of February 10, 2010, there were 1,315 registered holders of our stock, and we believe there were approximately 11,968 beneficial holders of common stock whose shares were held in the name of brokerage firms or other financial institutions. We are not provided with the number or identities of all of these stockholders, but we have estimated the number of such stockholders from the number of stockholder documents requested by these brokerage firms for distribution to their customers.
Dividends
SVB Financial has not paid cash dividends on our common stock since 1992. Currently, we have no plans to pay cash dividends on our common stock. Our Board of Directors may periodically evaluate whether to pay cash dividends, taking into consideration such factors as it considers relevant, including our current and projected financial performance, our projected sources and uses of capital, general economic conditions, considerations relating to our current and potential stockholder base, and relevant tax laws. Our ability to pay cash dividends is also limited by generally applicable corporate and banking laws and regulations. See Business-Supervision and RegulationRestrictions on Dividends under Part I, Item 1 of this report and Note 2Regulatory Matters of the Notes to the Consolidated Financial Statements under Part II, Item 8 in this report for additional discussion on restrictions and limitations on the payment of dividends imposed on us by government regulations.
Under the terms of our participation in the CPP from December 12, 2008 to December 23, 2009, we could not, without the prior consent of the Treasury, pay any dividend on our common stock prior to the earlier of December 12, 2011 and the date on which the outstanding shares of Series B Preferred Stock issued to the Treasury had been redeemed in whole or transferred to a third party. We redeemed our Series B Preferred Stock in full on December 23, 2009. Since we have repaid in full our obligation under the CPP, we are no longer under this dividend restriction.
Securities Authorized for Issuance Under Equity Compensation Plans
The information required by this Item regarding equity compensation plans is incorporated by reference to the information set forth in Part III, Item 12 of this report.
Stock Repurchases
SVB Financial did not repurchase any of its common stock during the fourth quarter of 2009. On July 24, 2008, our Board of Directors had previously approved a stock repurchase program authorizing us to purchase up
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to $150.0 million of our common stock, which expired on December 31, 2009. Under the terms of our participation in the CPP from December 12, 2008 to December 23, 2009, subject to certain exceptions, we could not, without the prior consent of the Treasury, repurchase our common stock or other equity securities, prior to the earlier of December 12, 2011 or the date on which the outstanding shares of Series B Preferred Stock issued to the Treasury had been redeemed in whole or transferred to a third party.
The following table presents preferred stock repurchases by month during the fourth quarter of 2009:
Period |
Total Number of Shares Purchased (1) |
Average Price Paid per Share |
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs |
Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs | ||||||
October 1, 2009 October 31, 2009 |
| $ | | | $ | | ||||
November 1, 2009 November 30, 2009 |
| | | | ||||||
December 1, 2009 December 31, 2009 |
235,000 | 1,000 | | | ||||||
Total |
235,000 | $ | 1,000 | | ||||||
(1) | On December 23, 2009, we repaid our CPP obligation in full and redeemed from the Treasury all 235,000 outstanding shares of Series B Preferred Stock, having a liquidation amount equal to $1,000 per share. The aggregate total redemption price paid by us to the Treasury for the Series B Preferred Stock was $235 million. |
Recent Sales of Unregistered Securities and Use of Proceeds
None.
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Performance Graph
The following information is not deemed to be soliciting material or filed with the SEC or subject to the liabilities of Section 18 of the Exchange Act, and the report shall not be deemed to be incorporated by reference into any prior or subsequent filing by the Company under the Securities Act or the Exchange Act.
The following graph compares, for the period from December 31, 2004 through December 31, 2009, the cumulative total stockholder return on the common stock of the Company with (i) the cumulative total return of the Standard and Poors 500 (S&P 500) Index, (ii) the cumulative total return of the Nasdaq Composite index, and (iii) the cumulative total return of the Nasdaq Bank Index. The graph assumes an initial investment of $100 and reinvestment of dividends. The graph is not necessarily indicative of future stock price performance.
Comparison of 5 Year Cumulative Total Return*
Among SVB Financial, the S&P 500 Index, the NASDAQ Stock Market-US Index, and the NASDAQ Bank Index
* | $100 invested on 12/31/04 in stock and index-including reinvestment of dividends. |
Fiscal year ending December 31.
Copyright ©2010 S&P, a division of The McGraw-Hill Companies, Inc. All rights reserved.
December 31, | ||||||||||||||||||
2004 | 2005 | 2006 | 2007 | 2008 | 2009 | |||||||||||||
SVB Financial |
$ | 100.00 | $ | 104.51 | $ | 104.02 | $ | 112.45 | $ | 58.52 | $ | 92.95 | ||||||
S&P 500 |
100.00 | 104.91 | 121.48 | 128.16 | 80.74 | 102.11 | ||||||||||||
NASDAQ Composite |
100.00 | 101.33 | 114.01 | 123.71 | 73.11 | 105.61 | ||||||||||||
NASDAQ Bank |
100.00 | 98.57 | 111.92 | 89.33 | 71.39 | 60.47 |
33
Item 6. | Selected Consolidated Financial Data |
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and supplementary data as presented in Item 8 of this report. Information as of and for the years ended December 31, 2009, 2008 and 2007 is derived from audited financial statements presented separately herein, while information as of and for the years ended December 31, 2006 and 2005 is derived from audited financial statements not presented separately within.
Year ended December 31, | ||||||||||||||||||||
(Dollars in thousands, except per share data and ratios) |
2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||
Income Statement Summary: |
||||||||||||||||||||
Net interest income |
$ | 382,150 | $ | 368,595 | $ | 375,842 | $ | 352,457 | $ | 299,293 | ||||||||||
Provision for loan losses |
(90,180 | ) | (100,713 | ) | (16,836 | ) | (9,877 | ) | (237 | ) | ||||||||||
Noninterest income |
97,743 | 152,365 | 220,969 | 141,206 | 117,495 | |||||||||||||||
Noninterest expense excluding impairment of goodwill |
(339,774 | ) | (312,887 | ) | (329,265 | ) | (304,069 | ) | (259,860 | ) | ||||||||||
Impairment of goodwill |
(4,092 | ) | | (17,204 | ) | (18,434 | ) | | ||||||||||||
Income before income tax expense |
45,847 | 107,360 | 233,506 | 161,283 | 156,691 | |||||||||||||||
Income tax expense |
(35,207 | ) | (52,213 | ) | (84,581 | ) | (65,782 | ) | (60,758 | ) | ||||||||||
Net income before cumulative effect of change in accounting principle |
10,640 | 55,147 | 148,925 | 95,501 | 95,933 | |||||||||||||||
Cumulative effect of change in accounting principle, net of tax |
| | | 192 | | |||||||||||||||
Net income before noncontrolling interests |
10,640 | 55,147 | 148,925 | 95,693 | 95,933 | |||||||||||||||
Net loss (income) attributable to noncontrolling interests |
37,370 | 19,139 | (28,596 | ) | (6,308 | ) | (3,396 | ) | ||||||||||||
Net income attributable to SVBFG |
$ | 48,010 | $ | 74,286 | $ | 120,329 | $ | 89,385 | $ | 92,537 | ||||||||||
Preferred stock dividend and discount accretion |
(25,336 | ) | (707 | ) | | | | |||||||||||||
Net income available to common stockholders |
$ | 22,674 | $ | 73,579 | $ | 120,329 | $ | 89,385 | $ | 92,537 | ||||||||||
Common Share Summary: |
||||||||||||||||||||
Earnings per common sharebasic, before cumulative effect of change in accounting principle |
$ | 0.67 | $ | 2.27 | $ | 3.54 | $ | 2.57 | $ | 2.64 | ||||||||||
Earnings per common sharediluted, before cumulative effect of change in accounting principle |
0.66 | 2.16 | 3.28 | 2.37 | 2.40 | |||||||||||||||
Earnings per common sharebasic |
0.67 | 2.27 | 3.54 | 2.58 | 2.64 | |||||||||||||||
Earnings per common sharediluted |
0.66 | 2.16 | 3.28 | 2.38 | 2.40 | |||||||||||||||
Book value per common share |
27.30 | 23.40 | 20.70 | 18.27 | 16.19 | |||||||||||||||
Weighted average shares outstandingbasic |
33,901 | 32,425 | 33,950 | 34,681 | 35,115 | |||||||||||||||
Weighted average shares outstandingdiluted |
34,183 | 34,015 | 36,738 | 37,615 | 38,489 | |||||||||||||||
Year-End Balance Sheet Summary: |
||||||||||||||||||||
Investment securities |
$ | 4,491,752 | $ | 1,786,100 | $ | 1,602,574 | $ | 1,692,343 | $ | 2,037,270 | ||||||||||
Loans, net of unearned income |
4,548,094 | 5,506,253 | 4,151,730 | 3,482,402 | 2,843,353 | |||||||||||||||
Goodwill |
| 4,092 | 4,092 | 21,296 | 35,638 | |||||||||||||||
Total assets |
12,841,399 | 10,018,280 | 6,692,171 | 6,081,452 | 5,541,715 | |||||||||||||||
Deposits |
10,331,937 | 7,473,472 | 4,611,203 | 4,057,625 | 4,252,730 | |||||||||||||||
Short-term borrowings |
38,755 | 62,120 | 90,000 | 683,537 | 279,475 | |||||||||||||||
Long-term debt (1) |
856,650 | 995,423 | 873,241 | 352,465 | 195,832 | |||||||||||||||
SVBFG stockholders equity |
1,128,343 | 991,356 | 676,369 | 628,514 | 569,301 | |||||||||||||||
Average Balance Sheet Summary: |
||||||||||||||||||||
Investment securities |
$ | 2,282,331 | $ | 1,338,516 | $ | 1,364,461 | $ | 1,684,178 | $ | 1,984,178 | ||||||||||
Loans, net of unearned income |
4,699,696 | 4,633,048 | 3,522,326 | 2,882,088 | 2,368,362 | |||||||||||||||
Goodwill |
1,000 | 4,092 | 12,576 | 27,653 | 35,638 | |||||||||||||||
Total assets |
11,326,341 | 7,418,303 | 6,019,974 | 5,387,435 | 5,189,777 | |||||||||||||||
Deposits |
8,794,099 | 4,896,324 | 3,962,260 | 3,921,857 | 4,166,476 | |||||||||||||||
Short-term borrowings |
46,133 | 304,896 | 320,129 | 400,913 | 69,499 | |||||||||||||||
Long-term debt (1) |
923,854 | 980,694 | 664,581 | 215,966 | 204,525 | |||||||||||||||
SVBFG stockholders equity |
1,063,175 | 720,851 | 669,190 | 589,206 | 541,426 | |||||||||||||||
Capital Ratios: |
||||||||||||||||||||
Total risk-based capital ratio |
19.94 | % | 17.58 | % | 16.02 | % | 13.95 | % | 14.75 | % | ||||||||||
Tier 1 risk-based capital ratio |
15.45 | 12.51 | 11.07 | 12.34 | 12.39 | |||||||||||||||
Tier 1 leverage ratio |
9.53 | 13.00 | 11.91 | 12.46 | 11.64 | |||||||||||||||
Tangible common equity to tangible assets (2) |
8.78 | 7.64 | 10.03 | 9.99 | 9.69 | |||||||||||||||
Tangible common equity to risk-weighted assets (2) |
15.05 | 9.31 | 10.28 | 11.15 | 11.04 | |||||||||||||||
Average SVBFG stockholders equity to average assets |
9.39 | 9.72 | 11.12 | 10.94 | 10.43 | |||||||||||||||
Selected Financial Results: |
||||||||||||||||||||
Return on average assets |
0.42 | % | 1.00 | % | 2.00 | % | 1.66 | % | 1.78 | % | ||||||||||
Return on average SVBFG stockholders equity |
2.68 | 10.38 | 17.98 | 15.17 | 17.09 | |||||||||||||||
Net interest margin |
3.73 | 5.72 | 7.19 | 7.38 | 6.46 | |||||||||||||||
Gross charge-offs to average total gross loans |
3.03 | 1.02 | 0.55 | 0.48 | 0.52 | |||||||||||||||
Net charge-offs to average total gross loans |
2.64 | 0.87 | 0.35 | 0.14 | 0.04 | |||||||||||||||
Nonperforming assets as a percentage of total assets |
0.41 | 0.88 | 0.14 | 0.27 | 0.25 | |||||||||||||||
Allowance for loan losses as a percentage of total gross loans |
1.58 | 1.93 | 1.13 | 1.22 | 1.28 |
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Year ended December 31, | |||||||||||||||
(Dollars in millions) |
2009 | 2008 | 2007 | 2006 | 2005 | ||||||||||
Other Data: |
|||||||||||||||
Client investment funds: |
|||||||||||||||
Client directed investment assets |
$ | 9,693 | $ | 11,886 | $ | 13,049 | $ | 11,221 | $ | 8,863 | |||||
Client investment assets under management |
5,905 | 5,881 | 6,422 | 5,166 | 3,857 | ||||||||||
Sweep money market funds |
| 813 | 2,721 | 2,573 | 2,247 | ||||||||||
Total client investment funds |
$ | 15,598 | $ | 18,580 | $ | 22,192 | $ | 18,960 | $ | 14,967 | |||||
(1) | Included in our senior and subordinated notes balance are shortcut method adjustments for the corresponding interest rate swap hedges recorded as a component of other assets on the balance sheet. |
(2) | See Managements Discussion and Analysis of Financial Condition and Results of OperationsCapital Resources Capital Ratios under Part II, Item 7 in this report for a reconciliation of non-GAAP tangible common equity to tangible assets and tangible common equity to risk-weighted assets. |
Item 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion and analysis of our financial condition and results of operations below contains forward-looking statements. These statements are based on current expectations and assumptions, which are subject to risks and uncertainties. See our cautionary language at the beginning of this Annual Report on Form 10-K. Actual results could differ materially because of various factors, including but not limited to those discussed in Risk Factors, under Part I, Item 1A.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and supplementary data as presented in Item 8 of this Annual Report on Form 10-K. Certain reclassifications have been made to prior years results to conform to the current periods presentations. Such reclassifications had no effect on our results of operations or stockholders equity. In addition, certain amounts in prior years results have been revised to reflect the correction of immaterial errors associated with previously recognized gains and losses on foreign exchange contracts, as well as the adoption of new accounting standards (ASC 470-20, formerly known as FASB Staff Position (FSP) Accounting Principles Board (APB) Opinion No. 14-1). Refer to Note 2Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements under Part II, Item 8 of this report for further details.
Overview of Company Operations
SVB Financial is a diversified financial services company, as well as a bank holding company and financial holding company. The Company was incorporated in the state of Delaware in March 1999. Through our various subsidiaries and divisions, we offer a variety of banking and financial products and services. For over 25 years, we have been dedicated to helping entrepreneurs succeed, especially in the technology, life science, venture capital/private equity and premium wine industries. We provide our clients of all sizes and stages with a diverse set of products and services to support them throughout their life cycles.
We offer commercial banking products and services through our principal subsidiary, the Bank, which is a California-state chartered bank founded in 1983 and a member of the Federal Reserve System. Through its subsidiaries, the Bank also offers brokerage, investment advisory and asset management services. We also offer non-banking products and services, such as funds management, private equity investment and equity valuation services, through our subsidiaries and divisions.
Managements Overview of 2009 Financial Performance
We recorded net income available to common stockholders for the year ended December 31, 2009 of $22.7 million, or $0.66 per diluted common share. Net income available to common stockholders for the year ended December 31, 2009 included a non-tax deductible charge of $11.4 million related to CPP repayment in the fourth
35
quarter of 2009 and a non-tax deductible goodwill impairment charge of $4.1 million recorded in the first quarter of 2009. Excluding these charges, net income for the year ended December 31, 2009 was $38.2 million, or $1.12 per diluted common share. (See non-GAAP reconciliation provided below).
During the first half of 2009, we were generally impacted by continued declines in venture capital and private equity activity, continued pressure on valuations in our venture and private equity-related investments, higher-than-normal credit losses, lower loan demand, and lower income from many of our fee-based products. During the latter half of 2009, we began to see signs of stabilization and relative improvement in our client base. Credit quality appeared to be improving overall, and we were able to resolve a number of borrower specific credit issues. Additionally, during the latter half of 2009 portfolio company valuations appeared to be stabilizing and we experienced higher net interest income resulting from an increase in our fixed income investment portfolio and lower interest expense. Additionally, we continued to see strong deposit growth throughout the year.
Highlights of our 2009 financial results (compared to 2008, where applicable) included the following:
| We issued and sold through a public offering during the fourth quarter of 2009 7,965,568 shares of common stock at an offering price of $38.50 per share, which resulted in net proceeds of $292.1 million. |
| We used a portion of the net proceeds from the public offering to repay in full our obligation under the CPP. On December 23, 2009, we redeemed $235 million in preferred shares, plus accrued and unpaid dividends, which resulted in a non-cash charge of $11.4 million in the fourth quarter of 2009. |
| Growth of 79.6 percent in average deposit balances to $8.8 billion, primarily as a result of our clients preference for the security provided by the FDIC and their desire to maintain short-term liquidity, and the continued low interest rate environment. Our efforts in late 2008 and early 2009 to migrate client sweep balances from our off-balance sheet product to our on-balance sheet products also contributed to this growth. Period-end deposits were $10.3 billion. |
| Growth of $943.8 million in average interest-earning investment securities to $2.3 billion, primarily due to purchases of U.S. agency securities, agency-issued collateralized mortgage obligations and agency-issued mortgage-backed securities, which were purchased with excess liquidity as a result of our continued growth in deposits. Period-end interest-earning investment securities were $3.9 billion. |
| Growth of $66.6 million in average loan balances to $4.7 billion, primarily due to the full year effect of growth in 2008 from all client industry segments. Period-end loans were $4.5 billion. |
| Provision for loan losses of $90.2 million, a decrease of $10.5 million compared to 2008. |
| An increase in net interest income (fully taxable equivalent basis) of $13.5 million, primarily due to an increase in our average interest-earning investment portfolio, as well as lower interest expense on deposits and long-term debt due to the low interest rate environment. |
| A decrease of 199 basis points in our net interest margin to 3.73 percent, primarily due to the current low interest rate environment as our average prime-lending rate decreased by 113 basis points to 4.00 percent for 2009, compared to 5.13 percent for 2008. In addition, a large portion of our deposits were invested in overnight cash with the Federal Reserve earning 25 basis points throughout 2009. |
| A decrease of $54.6 million in noninterest income to $97.7 million, primarily due to a $28.8 million decrease in client investment fees and a $16.4 million increase in net losses on investment securities. |
| An increase of $31.0 million in noninterest expense to $343.9 million, primarily due to a $13.6 million increase in FDIC assessments and a $12.3 million increase in compensation and benefits expense. |
36
The key highlights of our financial performance in 2009 and 2008 were as follows:
Year ended December 31 | |||||||||||||
(Dollars in thousands, except per share data and ratios) |
2009 | 2008 | % Change | ||||||||||
Income Statement: |
|||||||||||||
Diluted earnings per share |
$ | 0.66 | $ | 2.16 | (69.4 | ) | % | ||||||
Net income attributable to SVBFG |
48,010 | 74,286 | (35.4 | ) | |||||||||
Net income available to common stockholders |
22,674 | 73,579 | (69.2 | ) | |||||||||
Net interest income |
382,150 | 368,595 | 3.7 | ||||||||||
Net interest margin |
3.73 | % | 5.72 | % | (199 | ) | bps | ||||||
Provision for loan losses |
90,180 | 100,713 | (10.5 | ) | % | ||||||||
Noninterest income (1) |
97,743 | 152,365 | (35.8 | ) | |||||||||
Noninterest expense (2) |
343,866 | 312,887 | 9.9 | ||||||||||
Balance Sheet: |
|||||||||||||
Average loans, net of unearned income |
$ | 4,699,696 | $ | 4,633,048 | 1.4 | % | |||||||
Average noninterest-bearing deposits |
5,289,288 | 2,946,907 | 79.5 | ||||||||||
Average interest-bearing deposits |
3,504,811 | 1,949,417 | 79.8 | ||||||||||
Average total deposits |
8,794,099 | 4,896,324 | 79.6 | ||||||||||
Ratios: |
|||||||||||||
Return on average common SVBFG stockholders equity (3) |
2.68 | % | 10.38 | % | (74.2 | ) | % | ||||||
Return on average assets (4) |
0.42 | 1.00 | (58.0 | ) | |||||||||
Book value per common share (5) |
27.30 | 23.40 | 16.7 | ||||||||||
Operating efficiency ratio (6) |
71.33 | 59.80 | 19.3 | ||||||||||
Allowance for loan losses as a percentage of total gross loans |
1.58 | 1.93 | (35 | ) | bps | ||||||||
Gross loan charge-offs as a percentage of average total gross loans |
3.03 | 1.02 | 201 | bps | |||||||||
Net loan charge-offs as a percentage of average total gross loans |
2.64 | 0.87 | 177 | bps | |||||||||
Other Statistics: |
|||||||||||||
Average SVB prime lending rate |
4.00 | % | 5.13 | % | (113 | ) | bps | ||||||
Period end full-time equivalent employees |
1,258 | 1,244 | 1.1 | ||||||||||
Non-GAAP measures: |
|||||||||||||
Non-GAAP net income available to common stockholders (7) |
$ | 38,178 | $ | 77,437 | (50.7 | ) | % | ||||||
Non-GAAP diluted earnings per common share (7) |
1.12 | 2.28 | (50.9 | ) | |||||||||
Non-GAAP operating efficiency ratio (8) |
64.56 | % | 56.07 | % | 15.1 | ||||||||
Non-GAAP noninterest income, net of noncontrolling interest (9) |
$ | 122,644 | $ | 160,859 | (23.8 | ) | |||||||
Non-GAAP noninterest expense, net of noncontrolling interest (8) |
327,323 | 297,914 | 9.9 | ||||||||||
Tangible common equity to tangible assets (10) |
8.78 | % | 7.64 | % | 14.9 | ||||||||
Tangible common equity to risk-weighted assets (10) |
15.05 | 9.31 | 61.7 |
(1) | Noninterest income included net losses of $24.9 million attributable to noncontrolling interests for 2009, compared to net losses of $8.5 million for 2008. See Results of OperationsNoninterest Income for a description of noninterest income attributable to noncontrolling interests. |
(2) | Noninterest expense included $12.5 million attributable to noncontrolling interests for 2009, compared to $11.1 million for 2008. See Results of OperationsNoninterest Expense for a description of noninterest expense attributable to noncontrolling interests. |
(3) | Ratio represents consolidated net income available to common stockholders divided by average SVB Financial Group (SVBFG) stockholders equity (excluding preferred equity). |
(4) | Ratio represents consolidated net income attributable to SVBFG divided by average assets. |
(5) | Book value per common share is calculated by dividing total SVBFG stockholders equity (excluding preferred equity) by total outstanding common shares. |
(6) | The operating efficiency ratio is calculated by dividing noninterest expense by total taxable equivalent income. |
37
(7) | See below for a reconciliation of non-GAAP net income and non-GAAP diluted earnings per common share. |
(8) | See Results of OperationsNoninterest Expense for a description and reconciliation of the non-GAAP operating efficiency ratio and non-GAAP noninterest expense. |
(9) | See Results of OperationsNoninterest Income for a description and reconciliation of non-GAAP noninterest income. |
(10) | See Capital ResourcesCapital Ratios for a reconciliation of non-GAAP tangible common equity to tangible assets and tangible common equity to risk-weighted assets. |
Non-GAAP Net Income and Non-GAAP Diluted Earnings Per Common Share
We use and report non-GAAP net income and non-GAAP diluted earnings per common share, which excludes non-cash charges relating to our CPP repayment and impairment of goodwill, as well as the loss from cash settlement of conversion premium of zero-coupon convertible subordinated debentures. We believe these non-GAAP financial measures, when taken together with the corresponding GAAP financial measures, provide meaningful supplemental information regarding our performance by excluding certain items that do not occur every reporting period. Our management uses, and believes that investors benefit from referring to, these non-GAAP financial measures in assessing our operating results and related trends, and when planning, forecasting and analyzing future periods. However, these non-GAAP financial measures should be considered in addition to, not as a substitute for or preferable to, financial measures prepared in accordance with GAAP.
A reconciliation of GAAP to non-GAAP net income and non-GAAP diluted earnings per common share for 2009 and 2008 is as follows:
Year ended December 31 | ||||||
(Dollars in thousands, except share amounts) |
2009 | 2008 | ||||
Net income available to common stockholders | $ | 22,674 | $ | 73,579 | ||
Impairment of goodwill (1) |
4,092 | | ||||
Loss from cash settlement of conversion premium of zero-coupon convertible subordinated notes (2) |
| 3,858 | ||||
Non-cash charge related to CPP repayment (3) |
11,412 | | ||||
Non-GAAP net income available to common stockholders |
$ | 38,178 | $ | 77,437 | ||
GAAP earnings per common sharediluted |
$ | 0.66 | $ | 2.16 | ||
Impact of impairment of goodwill (1) |
0.12 | | ||||
Impact of loss from cash settlement of conversion premium of zero-coupon convertible subordinated notes (2) |
| 0.12 | ||||
Impact of non-cash charge related to CPP repayment (3) |
0.34 | | ||||
Non-GAAP earnings per common sharediluted |
$ | 1.12 | $ | 2.28 | ||
Weighted average diluted common shares outstanding |
34,182,728 | 34,014,581 |
(1) | Non-tax deductible goodwill impairment charge for eProsper recognized in the first quarter of 2009. |
(2) | Represents the portion of the conversion payment that exceeded the principal amount related to a conversion of $7.8 million of our zero-coupon convertible subordinated notes, which we settled in cash in the second quarter of 2008. This non-tax deductible loss did not have any impact on our tax provision. |
(3) | Non-tax deductible charge related to CPP repayment recognized in the fourth quarter of 2009. |
Critical Accounting Policies and Estimates
Our accounting policies are fundamental to understanding our financial condition and results of operations. We have identified seven policies as being critical because they require our management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.
38
We evaluate our estimates and assumptions on an ongoing basis and we base these estimates on historical experiences and various other factors and assumptions that are believed to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions.
Our senior management has discussed the development, selection, application and disclosure of these critical accounting policies with the Audit Committee of our Board of Directors.
Fair Value Measurements
We use fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. Our marketable investment securities, non-marketable investment securities and derivative instruments are financial instruments recorded at fair value on a recurring basis. We disclose our method and approach for fair value measurements of assets and liabilities in Note 19Fair Value of Financial Instruments of the Notes to Consolidated Financial Statements under Part II, Item 8 in this report.
ASC 820, Fair Value Measurements and Disclosures (formerly known as Statement of Financial Accounting Standards (SFAS) No. 157) defines fair value as the price that would be received to sell an asset or paid to transfer a liability (the exit price) in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data. The three levels for measuring fair value are based on the reliability of inputs and are as follows:
Level 1 |
Valuations based on quoted prices in active markets for identical assets or liabilities that we have the ability to access. Valuation adjustments and block discounts are not applied to instruments utilizing Level 1 inputs. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these instruments does not entail a significant degree of judgment.
Assets utilizing Level 1 inputs include exchange-traded equity securities. | |
Level 2 | Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, directly or indirectly.
Assets and liabilities utilizing Level 2 inputs include: U.S. treasury and agency securities, investment-grade and high-yield corporate bonds, mortgage products, municipal bonds and notes, and Over-the-Counter (OTC) derivative instruments and equity warrant assets for shares of public company capital stock. | |
Level 3 | Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimates of assumptions market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
Assets utilizing Level 3 inputs include: limited partnership interests in private equity funds, direct equity investments in private companies, and equity warrant assets for shares of private company capital stock. |
It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. When available, we use quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that use primarily market-based or
39
independently-sourced market parameters, including interest rate yield curves, prepayment speeds, option volatilities and currency rates. Substantially all of our financial instruments use either of the foregoing methodologies, collectively Level 1 and Level 2 measurements, to determine fair value adjustments recorded to our financial statements. However, in certain cases, when market observable inputs for model based valuation techniques may not be readily available, we are required to make judgments about assumptions market participants would use in estimating the fair value of the financial instrument.
The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. For inactive markets, there is little information, if any, to evaluate if individual transactions are orderly. Accordingly, we are required to estimate, based upon all available facts and circumstances, the degree to which orderly transactions are occurring and provide more weighting to price quotes that are based upon orderly transactions. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, we use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement. Accordingly, the degree of judgment exercised by management in determining fair value is greater for financial assets and liabilities categorized as Level 3.
At December 31, 2009, 34.4 percent of our total assets, or $4.4 billion, consisted of financial assets recorded at fair value on a recurring basis, compared to 18.2 percent of our total assets, or $1.8 billion as of December 31, 2008. Of these assets as of December 31, 2009, 90.7 percent used valuation methodologies involving market-based or market-derived information, collectively Level 1 and 2 measurements, to measure fair value, and 9.3 percent of these financial assets were measured using model-based techniques, or Level 3 measurements. This compares to 79.8 percent and 20.2 percent, respectively, as of December 31, 2008. Almost all of our financial assets valued using Level 3 measurements at December 31, 2009 and 2008 represented non-marketable securities. At December 31, 2009, 0.1 percent of total liabilities, or $15.9 million, consisted of financial liabilities recorded at fair value on a recurring basis, which were valued using market-observable inputs, compared to 0.4 percent, or $32.6 million as of December 31, 2008. There were no material transfers in or out of Level 3 during 2009 or 2008. Our valuation processes include a number of key controls that are designed to ensure that fair value is calculated appropriately. Such controls include a model validation policy requiring models that provide values used in financial statements be validated by qualified personnel and escalation procedures to ensure that valuations using unverifiable inputs are identified and monitored on a regular basis by senior management.
As of December 31, 2009, our available-for-sale investment portfolio, consisting primarily of agency-issued mortgage-backed securities, agency-issued collateralized mortgage obligations, U.S. agency debentures and municipal bonds and notes, represented $3.9 billion, or 89.2 percent of our portfolio of assets measured at fair value on a recurring basis, compared to $1.3 billion, or 72.3 percent as of December 31, 2008. These instruments were primarily classified as Level 2 because their valuations were based on indicator prices corroborated by observable market quotes or pricing models with all significant inputs derived from or corroborated by observable market data. Since our available-for-sale fixed-income investment securities portfolio consisted primarily of fixed rate securities, the fair value of the portfolio is sensitive to changes in levels of market interest rates and market perceptions of credit quality of the underlying securities. Market valuations and impairment analyses on assets in the fixed-income investment portfolio are reviewed and monitored on a quarterly basis.
To the extent available-for-sale investment securities are used to secure borrowings, changes in the fair value of those securities could have an impact on the total amount of secured financing available. We pledge securities to the Federal Home Loan Bank of San Francisco and the discount window at the Federal Reserve Bank. The market value of collateral pledged to the Federal Home Loan Bank of San Francisco (primarily
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comprised of agency-issued mortgage-backed securities) at December 31, 2009 totaled $497.4 million, all of which was unused and available to support additional borrowings. The market value of collateral pledged at the discount window of the Federal Reserve Bank in accordance with our risk management practices at December 31, 2009 totaled $85.7 million, all of which was unused and available to support additional borrowings. We have repurchase agreements in place with multiple securities dealers, which allow us to access short-term borrowings by using fixed income securities as collateral. At December 31, 2009, we had not utilized our repurchase lines to secure borrowed funds.
Financial assets valued using Level 3 measurements consist primarily of our investments in venture capital and private equity funds, direct equity investments in privately held companies and certain investments made by our consolidated sponsored debt fund. Our managed funds and sponsored debt fund that hold these investments are investment companies under the American Institute of Certified Public Accountants (AICPA) Audit and Accounting Guide for Investment Companies and accordingly, these funds report their investments at estimated fair value, with unrealized gains and losses resulting from changes in fair value reflected as investment gains or losses in our consolidated statements of income. Assets valued using Level 3 measurements also include equity warrant assets in shares of private company capital stock.
During 2009 and 2008, the Level 3 assets that are measured at fair value on a recurring basis experienced net unrealized fair value decreases totaling $38.9 million and $6.3 million, respectively, primarily due to lower valuations in underlying fund investments in our managed funds of funds. Realized gains related to the Level 3 assets in 2009 and 2008 of $6.9 million and $15.8 million, respectively, related primarily to gains from distributions from underlying fund investments in our managed funds of funds, as well as from exercises of equity warrant assets in 2008.
The valuation of nonmarketable securities and equity warrant assets in shares of private company capital stock is subject to management judgment. The inherent uncertainty in the process of valuing securities for which a ready market does not exist may cause our estimated values of these securities to differ significantly from the values that would have been derived had a ready market for the securities existed, and those differences could be material. The timing and amount of changes in fair value, if any, of these financial instruments depend upon factors beyond our control, including the performance of the underlying companies, fluctuations in the market prices of the preferred or common stock of the underlying companies, general volatility and interest rate market factors, and legal and contractual restrictions. The timing and amount of actual net proceeds, if any, from the disposition of these financial instruments depend upon factors beyond our control, including investor demand for IPOs, levels of M&A activity, legal and contractual restrictions on our ability to sell, and the perceived and actual performance of portfolio companies. All of these factors are difficult to predict.
Non-Marketable Securities
Non-marketable securities include investments in private equity and venture capital funds, sponsored debt funds, direct equity investments in companies and low income housing tax credit funds. Our accounting for investments in non-marketable securities depends on several factors, including our level of ownership/control and the legal structure of our subsidiary making the investment. Based on these factors, we account for our non-marketable securities using one of three different methods: (i) investment company fair value accounting; (ii) equity method accounting; or (iii) cost method accounting. Our non-marketable securities carried under investment company fair value accounting include amounts that are attributable to noncontrolling interests. We are required under GAAP to consolidate 100% of investments made by our managed funds or consolidated sponsored debt fund that we are deemed to control, even though we may own less than 100% of such entities.
Our non-marketable securities carried under investment company fair value accounting are carried at estimated fair value at each balance sheet date based primarily on financial information obtained as the general partner of the fund or obtained from the funds respective general partner. Fair value is the amount that would be received to sell the non-marketable securities in an orderly transaction between market participants at the measurement date.
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For direct private company investments, valuations are based upon consideration of a range of factors including, but not limited to, the price at which the investment was acquired, the term and nature of the investment, local market conditions, values for comparable securities, current and projected operating performance, exit strategies and financing transactions subsequent to the acquisition of the investment. These valuation methodologies involve a significant degree of management judgment. We consider our accounting policy for our non-marketable securities carried under investment company fair value to be critical as estimating the fair value of these investments requires management to make assumptions regarding future performance, financial condition, and relevant market conditions, along with other pertinent information.
The valuation of our private equity funds is primarily based upon our pro-rata share of the fair market value of the net assets of a private fund as determined by such private fund on the valuation date. We utilize the most recent available financial information from the investee general partner. We account for differences between our measurement date and the date of the fund investments net asset value by using the most recent available financial information available from the investee general partner, for example September 30th, for our December 31st consolidated financial statements, adjusted for any contributions paid during the fourth quarter, distributions received from the investment during the fourth quarter, or significant fund transactions or market events. For investments that have a significant impact on our financial statements, we have communications with the fund managers to determine whether there are significant changes to net asset value that have occurred since the funds last reporting date and make the necessary adjustments to our financial statements.
Under our equity method accounting, we recognize our proportionate share of the results of operations of each equity method investee in our results of operations.
Under our cost method accounting, we record investments at cost and recognize as income distributions or returns received from net accumulated earnings of the investee since the date of acquisition.
We review our equity and cost method securities at least quarterly for indications of impairment, which requires significant judgment. Indications of impairment include an analysis of facts and circumstances of each investment, the expectations of the investments future cash flows and capital needs, variability of its business and the companys exit strategy. Investments identified as having an indication of impairment are reviewed further to determine if the investment is other than temporarily impaired. We reduce the investment value when we consider declines in value to be other than temporary and we recognize the estimated loss as a loss on investment securities, which is a component of noninterest income.
We consider our accounting policy for our non-marketable securities to be critical because the valuation of our non-marketable securities is subject to management judgment and information reasonably available to us. The inherent uncertainty in the process of valuing securities for which a ready market is unavailable may cause our estimated values of these securities to differ significantly from the values that would have been derived had a ready market for the securities existed, and those differences could be material. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in their carrying value, thereby possibly requiring an impairment charge in the future. There can be no assurances that we will realize the full value of our non-marketable securities, which could result in significant losses.
Derivative AssetsEquity Warrant Assets for Shares of Privately- and Publicly-held Companies
In connection with negotiated credit facilities and certain other services, we frequently obtain equity warrant assets giving us the right to acquire stock in certain client companies. Equity warrant assets for shares of private and public companies are recorded at fair value on the grant date and adjusted to fair value on a quarterly basis through consolidated net income. At December 31, 2009, our equity warrant assets totaled $41.3 million, compared to $43.7 million at December 31, 2008.
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We account for equity warrant assets with net settlement terms in certain private and public client companies as derivatives. In general, equity warrant assets entitle us to buy a specific number of shares of stock at a specific price within a specific time period. Certain equity warrant assets contain contingent provisions, which adjust the underlying number of shares or purchase price upon the occurrence of certain future events. Our warrant agreements contain net share settlement provisions, which permit us to receive at exercise a share count equal to the intrinsic value of the warrant divided by the share price (otherwise known as a cashless exercise). Because we can net settle our warrant agreements, our equity warrant assets qualify as derivative instruments in accordance with the provisions of ASC 815, Derivatives and Hedging (formerly known as SFAS No. 133).
The fair value of the equity warrant assets portfolio is reviewed quarterly. We value our equity warrant assets using a modified Black-Scholes option pricing model, which incorporates the following material assumptions:
| Underlying asset value was estimated based on information available, including any information regarding subsequent rounds of funding. |
| Volatility, or the amount of uncertainty or risk about the size of the changes in the warrant price, was based on guidelines for publicly traded companies within indices similar in nature to the underlying client companies issuing the warrant. A total of six such indices were used. The volatility assumption was based on the median volatility for an individual public company within an index for the past 16 quarters from which an average volatility was derived. The weighted average quarterly median volatility assumption used for the warrant valuation at December 31, 2009 was 50.5%, compared to 45.5% at December 31, 2008. |
| Actual data on cancellations and exercises of our equity warrant assets was utilized as the basis for determining the expected remaining life of the equity warrant assets in each financial reporting period. Equity warrant assets may be exercised in the event of acquisitions, mergers or IPOs, and cancelled due to events such as bankruptcies, restructuring activities or additional financings. These events cause the expected remaining life assumption to be shorter than the contractual term of the warrants. This assumption reduced the reported value of the warrant portfolio by $17.4 million at December 31, 2009, compared to a reduction of $17.5 million at December 31, 2008. |
| The risk-free interest rate was derived from the U.S. Treasury yield curve. The risk-free interest rate was calculated based on a weighted average of the risk-free interest rates that correspond closest to the expected remaining life of the warrant. The risk-free interest rate used for the warrant valuation at December 31, 2009 was 1.4%, compared to 0.9% at December 31, 2008. |
| Other adjustments, including a marketability discount, were estimated based on managements judgment about the general industry environment. |
The fair value of our equity warrant assets recorded on our balance sheets represents our best estimate of the fair value of these instruments. Changes in the above material assumptions may result in significantly different valuations. For example, the following table demonstrates the effect of changes in the risk-free interest rate and volatility assumptions on the valuation of equity warrant assets held by SVB Financial Group active at December 31, 2009 (1):
Volatility Factor | |||||||||
(Dollars in millions) |
10% Lower (45.5%) |
Current (50.5%) |
10% Higher (55.6%) | ||||||
Risk Free Interest Rate: |
|||||||||
Less 50 basis points |
$ | 37.4 | $ | 40.4 | $ | 43.5 | |||
Current rate (1.4%) |
37.9 | 40.9 | 44.0 | ||||||
Plus 50 basis points |
38.4 | 41.5 | 44.4 |
(1) | The above table does not include equity warrant assets at December 31, 2009 held by Partners for Growth, LP, which were valued at $0.3 million. |
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The timing and value realized from the disposition of equity warrant assets depend upon factors beyond our control, including the performance of the underlying portfolio companies, investor demand for IPOs, fluctuations in the market prices of the underlying common stock of these companies, levels of mergers and acquisitions activity, and legal and contractual restrictions on our ability to sell the underlying securities. All of these factors are difficult to predict. Many equity warrant assets may be terminated or may expire without compensation and may incur valuation losses from lower-priced funding rounds. We are unable to predict future gains or losses with accuracy, and gains or losses could vary materially from period to period.
We consider accounting policies related to equity warrant assets to be critical as the valuation of these assets is complex and subject to a certain degree of management judgment. Management has the ability to select from several valuation methodologies and has alternative approaches in the calculation of material assumptions. The selection of an alternative valuation methodology or alternative approaches used to calculate material assumptions in the current methodology may cause our estimated values of these assets to differ significantly from the values recorded. Additionally, the inherent uncertainty in the process of valuing these assets for which a ready market is unavailable may cause our estimated values of these assets to differ significantly from the values that would have been derived had a ready market for the assets existed, and those differences could be material. Further, the fair value of equity warrant assets may never be realized, which could result in significant losses.
Allowance for Loan Losses
At December 31, 2009, our allowance for loan losses totaled $72.5 million, compared to $107.4 million at December 31, 2008. The allowance for loan losses is managements estimate of credit losses inherent in the loan portfolio at a balance sheet date.
We consider our accounting policy for the allowance for loan losses to be critical as estimation of the allowance involves material estimates by our management and is particularly susceptible to significant changes in the near term. Determining the allowance for loan losses requires us to make forecasts that are highly uncertain and require a high degree of judgment. Our loan loss reserve methodology is applied to our allowance for loan losses and we maintain the balances at levels that we believe are adequate to absorb estimated probable losses inherent in our loan portfolios.
Our allowance for loan losses is established for loan losses that are probable but not yet realized. The process of anticipating loan losses is imprecise. Our management applies a systematic process for the evaluation of individual loans and pools of loans for inherent risk of loan losses. On a quarterly basis, each loan in our portfolio is assigned a credit risk rating through an evaluation process, which includes consideration of such factors as payment status, the financial condition of the borrower, borrower compliance with loan covenants, underlying collateral values, potential loan concentrations, and general economic conditions. The allowance for loan losses is based on a formula allocation for similarly risk-rated loans by client industry sector and individually for impaired loans as determined by ASC 310, Receivables (formerly known as SFAS No. 114 and SFAS No. 5).
Our evaluation process is designed to determine the adequacy of the allowance for loan losses. We assess the risk of losses inherent in the loan portfolio on a quarterly basis by utilizing a historical loan loss migration model, which is a statistical model used to estimate an appropriate allowance for outstanding loan balances by calculating the likelihood of a loan becoming charged-off based on its credit risk rating using historical loan performance data from our portfolio. Loan loss factors for each risk-rating category and client industry sector are ultimately applied to the respective period-end client loan balances for each corresponding risk-rating category by client industry sector to provide an estimation of the allowance for loan losses.
We apply macro allocations to the results we obtained through our historical loan loss migration model to ascertain the total allowance for loan losses. These macro allocations are based upon managements assessment of the risks that may lead to a loan loss experience different from our historical loan loss experience. These risks are aggregated to become our macro allocation. Based on managements prediction or estimate of changing risks
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in the lending environment, the macro allocation may vary significantly from period to period and includes, but is not limited to, consideration of the following factors:
| Changes in lending policies and procedures, including underwriting standards and collections, and charge-off and recovery practices; |
| Changes in national and local economic business conditions, including the market and economic condition of our clients industry sectors; |
| Changes in the nature of our loan portfolio; |
| Changes in experience, ability, and depth of lending management and staff; |
| Changes in the trend of the volume and severity of past due and classified loans; |
| Changes in the trend of the volume of nonaccrual loans, troubled debt restructurings, and other loan modifications; and |
| Other factors as determined by management from time to time. |
Finally, we compute several modified versions of the model, which provide additional assurance that the statistical results of the historical loan loss migration model are reasonable. A committee comprised of senior management evaluates the adequacy of the allowance for loan losses based on the results of our analysis.
Reserve for Unfunded Credit Commitments
The level of the reserve for unfunded credit commitments is determined following a methodology that parallels that used for the allowance for loan losses. We consider our accounting policy for the reserve for unfunded credit commitments to be critical as estimation of the reserve involves material estimates by our management and is particularly susceptible to significant changes in the near term. We record a liability for probable and estimable losses associated with our unfunded credit commitments. Each quarter, every unfunded client credit commitment is allocated to a credit risk-rating category in accordance with each clients credit risk rating. We use the historical loan loss factors described under our allowance for loan losses to calculate the possible loan loss experience if unfunded credit commitments are funded. Separately, we use historical trends to calculate the probability of an unfunded credit commitment being funded. We apply the loan funding probability factor to risk-factor adjusted unfunded credit commitments by credit risk-rating to derive the reserve for unfunded credit commitments. The reserve for unfunded credit commitments may also include certain macro allocations as deemed appropriate by management. Our reserve for unfunded credit commitments totaled $13.3 million and $14.7 million at December 31, 2009 and 2008 respectively, and is reflected in other liabilities on our balance sheet.
Share-Based Compensation
Our share-based compensation expense totaled $14.8 million, $13.6 million and $14.9 million in 2009, 2008 and 2007, respectively. In accordance with ASC 718, CompensationStock Compensation (formerly known as SFAS No. 123(R)), we measure compensation expense for all employee share-based payment awards using a fair value based method, reduced by estimated award forfeitures, and record such expense in our consolidated statements of income.
We consider our accounting policy for share-based compensation to be critical as determining the fair value of awards involves the use of significant estimates and assumptions. We use the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase plan shares. The Black-Scholes option-pricing model requires the use of input assumptions, including the expected life, expected price volatility of the underlying stock, expected dividend yield and risk-free interest rate. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. Because our stock options have characteristics significantly different from those of traded options, changes to the input assumptions can materially affect the fair value of our employee stock options. ASC 718 also requires us to develop an estimate of the number of share-based payment awards which we expect to vest. We consider many factors when estimating expected forfeitures, including the type of award, the employee class and historical experience.
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The most significant assumptions impacted by managements judgment are the expected volatility and the expected term of the options. The expected dividend yield, and expected risk-free interest rate are not as significant to the calculation of fair value. In addition, adjustments to our estimates of the number of share-based payment awards that we expect to vest did not have a significant impact on the recorded share-based compensation expense.
Expected volatility: The value of a stock option is derived from its potential for appreciation. The more volatile the stock, the more valuable the option becomes because of the greater possibility of significant changes in stock price. Our computation of expected volatility is based on a blend of historical volatility of our common stock and implied volatility of traded options to purchase shares of our common stock. Our decision to incorporate implied volatility was based on our assessment that implied volatility of publicly traded options in our common stock is expected to be more reflective of market conditions and, therefore, can reasonably be expected to be a better indicator of expected volatility than historical volatility of our common stock.
Expected term: The expected term also has a significant effect on the value of the option. The longer the term, the more time the option holder has to allow the stock price to increase without a cash investment and thus, the more valuable the option. Further, longer option terms provide more opportunity to exploit market highs. However, employees are not required to wait until the end of the contractual term of a nontransferable option to exercise. Accordingly, we are required to estimate the expected term of the option. When establishing an estimate of the expected term, we bifurcate our option grants into two employee groupings based on exercise behavior and determine the expected term for each group by considering several factors, including historical option exercise behavior, post vesting turnover rates, terms and vesting periods of the options granted.
We review our valuation assumptions at each grant date and, as a result, we are likely to change our valuation assumptions used to value stock based awards granted in future periods. Changes to the input assumptions could materially affect the estimated fair value of our share-based payment awards.
We performed a sensitivity analysis of the impact of increasing and decreasing expected volatility by 10% as well as the impact of increasing and decreasing the weighted average expected term by one year. We performed this analysis on the stock options granted in 2009. The following table shows the impact of these changes on our stock option expense for the options granted in 2009:
(Dollars in thousands) |
2009 | |||
Actual stock option expense for 2009 grants |
$ | 6,020 | ||
Stock option expense increase (decrease) under the following assumption changes: |
||||
Volatility decreased by 10% (58.8% to 48.8%) |
(920 | ) | ||
Volatility increased by 10% (58.8% to 68.8%) |
694 | |||
Average expected term decreased by 1 year (4.5 to 3.5) |
(730 | ) | ||
Average expected term increased by 1 year (4.5 to 5.5) |
461 |
Income Taxes
We are subject to income tax laws of the United States, its states and municipalities and those of the foreign jurisdictions in which we operate. Our income tax expense totaled $35.2 million, $52.2 million and $84.6 million in 2009, 2008 and 2007, respectively.
Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax-basis carrying amount. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
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We consider our accounting policy relating to income taxes to be critical as the determination of current and deferred income taxes is based on complex analyses of many factors including interpretation of federal, state and foreign income tax laws, the difference between tax and financial reporting bases of assets and liabilities (temporary differences), estimates of amounts due or owed, the timing of reversals of temporary differences and current financial accounting standards. Actual results could differ significantly from the estimates due to tax law interpretations used in determining the current and deferred income tax liabilities. Additionally, there can be no assurances that estimates and interpretations used in determining income tax liabilities may not be challenged by federal and state taxing authorities.
In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws. We must also make estimates about when in the future certain items will affect taxable income in the various tax jurisdictions, both domestic and foreign. We evaluate our uncertain tax positions in accordance with ASC 740, Income Taxes (formerly known as FASB Interpretation No. 48 (FIN 48)). We believe that our unrecognized tax benefits, including related interest and penalties, are adequate in relation to the potential for additional tax assessments.
We are also subject to routine corporate tax audits by the various tax jurisdictions. In the preparation of income tax returns, tax positions are taken based on interpretation of federal and state income tax laws as well as foreign tax laws. We review our uncertain tax positions quarterly, and we may adjust these unrecognized tax benefits in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact income tax expense in the period in which such determination is made.
Recent Accounting Pronouncements
Please refer to the discussion of our recent accounting pronouncements in Note 2Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements under Part II, Item 8 in this report.
Correction of an Immaterial Error
During the second quarter of 2009, we determined that we had incorrectly recognized certain gains and losses on foreign exchange contracts in prior periods. The cumulative pre-tax effect of the error was $6.2 million, or $3.8 million after-tax and is considered to be immaterial to the prior periods. However, since the cumulative impact of correcting this error would have been material to the results of the quarter ended June 30, 2009, we applied the guidance of ASC 250-10-S99-1 and S99-2 (formerly known as Staff Accounting Bulletin (SAB) 99 and SAB 108). This guidance requires that the prior financial statements be corrected, even though such revisions were, and continue to be, immaterial to the prior period financial statements. As such, the affected prior period results have been revised as follows: For the three months ended March 31, 2009, net loss increased by $1.2 million, or $0.04 per diluted common share; for the year ended December 31, 2008, net income was reduced by $2.3 million, or $0.07 per diluted common share; and for the year ended December 31, 2007, net income was reduced by $0.2 million, or $0.01 per diluted common share. For further details, please refer to Note 2Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements under Part II, Item 8 in this report.
Results of Operations
Net Interest Income and Margin (Fully Taxable Equivalent Basis)
Net interest income is defined as the difference between interest earned primarily on loans, investment securities, federal funds sold, securities purchased under agreements to resell and other short-term investment securities, and interest paid on funding sources. Net interest income is our principal source of revenue. Net interest margin is defined as the amount of annualized net interest income, on a fully taxable equivalent basis, expressed as a percentage of average interest-earning assets. Net interest income and net interest margin are presented on a fully taxable equivalent basis to consistently reflect income from taxable loans and securities and tax-exempt securities based on the federal statutory tax rate of 35.0 percent.
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Analysis of Interest Changes Due to Volume and Rate (Fully Taxable Equivalent Basis)
Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as volume change. Net interest income is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabilities, referred to as rate change. Changes in our prime-lending rate also impact the yields on our loans, and, to a certain extent, our interest-bearing deposits. The following table sets forth changes in interest income for each major category of interest-earning assets and interest expense for each major category of interest-bearing liabilities. The table also reflects the amount of simultaneous changes attributable to both volume and rate changes for the years indicated. For this table, changes that are not solely due to either volume or rate are allocated in proportion to the percentage changes in average volume and average rate.
2009 Compared to 2008 | 2008 Compared to 2007 | |||||||||||||||||||||||
Year Ended December 31, Increase (Decrease) Due to Change in |
Year Ended December 31, Increase (Decrease) Due to Change in |
|||||||||||||||||||||||
(Dollars in thousands) |
Volume | Rate | Total | Volume | Rate | Total | ||||||||||||||||||
Interest income: |
||||||||||||||||||||||||
Federal funds sold, securities purchased under agreements to resell and other short-term investment securities |
$ | 16,734 | $ | (19,516 | ) | $ | (2,782 | ) | $ | 3,708 | $ | (8,952 | ) | $ | (5,244 | ) | ||||||||
Investment securities (taxable) |
37,336 | (14,266 | ) | 23,070 | (3,257 | ) | 420 | (2,837 | ) | |||||||||||||||
Investment securities (non-taxable) |
(12 | ) | (245 | ) | (257 | ) | 3,046 | (128 | ) | 2,918 | ||||||||||||||
Loans, net of unearned income |
5,174 | (33,560 | ) | (28,386 | ) | 74,263 | (71,974 | ) | 2,289 | |||||||||||||||
Increase (decrease) in interest income, net |
59,232 | (67,587 | ) | (8,355 | ) | 77,760 | (80,634 | ) | (2,874 | ) | ||||||||||||||
Interest expense: |
||||||||||||||||||||||||
NOW deposits |
(20 | ) | (53 | ) | (73 | ) | 51 | 44 | 95 | |||||||||||||||
Regular money market deposits |
(39 | ) | (1,300 | ) | (1,339 | ) | | 291 | 291 | |||||||||||||||
Bonus money market deposits |
735 | (7,028 | ) | (6,293 | ) | 4,400 | (706 | ) | 3,694 | |||||||||||||||
Money market deposits in foreign offices |
378 | (123 | ) | 255 | 161 | | 161 | |||||||||||||||||
Time deposits |
(347 | ) | (1,046 | ) | (1,393 | ) | 677 | 97 | 774 | |||||||||||||||
Sweep deposits |
11,476 | (5,216 | ) | 6,260 | 5,788 | (159 | ) | 5,629 | ||||||||||||||||
Total increase (decrease) in deposits expense |
12,183 | (14,766 | ) | (2,583 | ) | 11,077 | (433 | ) | 10,644 | |||||||||||||||
Short-term borrowings |
(3,186 | ) | (3,488 | ) | (6,674 | ) | (770 | ) | (9,406 | ) | (10,176 | ) | ||||||||||||
Zero-coupon convertible subordinated notes |
(2,418 | ) | | (2,418 | ) | (2,801 | ) | (813 | ) | (3,614 | ) | |||||||||||||
3.875% convertible senior notes |
3,782 | 123 | 3,905 | 10,138 | | 10,138 | ||||||||||||||||||
Junior subordinated debentures |
143 | 774 | 917 | 77 | (933 | ) | (856 | ) | ||||||||||||||||
Senior and subordinated notes |
1,054 | (12,293 | ) | (11,239 | ) | 7,819 | (7,033 | ) | 786 | |||||||||||||||
Other long-term debt |
(1,945 | ) | (1,783 | ) | (3,728 | ) | (319 | ) | (3,251 | ) | (3,570 | ) | ||||||||||||
Total (decrease) increase in borrowings expense |
(2,570 | ) | (16,667 | ) | (19,237 | ) | 14,144 | (21,436 | ) | (7,292 | ) | |||||||||||||
Increase (decrease) in interest expense, net |
9,613 | (31,433 | ) | (21,820 | ) | 25,221 | (21,869 | ) | 3,352 | |||||||||||||||
Increase (decrease) in net interest income |
$ | 49,619 | $ | (36,154 | ) | $ | 13,465 | $ | 52,539 | $ | (58,765 | ) | $ | (6,226 | ) | |||||||||
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Net Interest Income (Fully Taxable Equivalent Basis)
2009 compared to 2008
Net interest income increased by $13.5 million to $384.4 million in 2009, compared to $370.9 million in 2008. Overall, we saw an increase in our net interest income, primarily due to our growing interest-earning investment portfolio, as well as from lower interest expense due to the low interest rate environment, which lowered our costs on deposits and London Interbank Offered Rates (LIBOR) rates underlying interest rate swap agreements for our long-term debt. Although our cost of funding benefited from the low interest rate environment, the decline in interest rates earned on our loan portfolio decreased our net interest income.
The main factors affecting interest income and interest expense for 2009 compared to 2008 are discussed below:
| Interest income for 2009 decreased by $8.4 million due to: |
| A $28.4 million decrease in interest income on loans driven principally by a 71 basis point decrease in loan yields due primarily to the full year effect of decreases totaling 325 basis points in our prime-lending rate during 2008, in response to certain Federal Fund rate decreases. Our average prime-lending rate was 4.00 percent for 2009, compared to 5.13 percent for 2008. This decrease was partially offset by higher income associated with an increase in average loan balances of $66.6 million. |
| A $2.8 million decrease in interest income on short-term investments, primarily driven by decreases in Federal Fund rates in 2008, partially offset by a $2.8 billion increase in average balances. |
These decreases were partially offset by a $22.8 million increase in interest income on interest-earning investment securities, primarily related to the growth in average balances of $943.8 million due to purchases of U.S. agency securities, agency-issued collateralized mortgage obligations and agency-issued mortgage-backed securities, which were purchased with excess liquidity resulting from the growth in deposits.
| Interest expense for 2009 decreased by $21.8 million primarily due to: |
| A decrease in interest expense of $12.6 million related to our long-term debt, primarily due to lower LIBOR rates associated with interest rate swap agreements on our senior and subordinated notes, the maturity of $50 million in Federal Home Loan Bank (FHLB) advances in May 2009 and the prepayment of $50 million in FHLB advances in September 2009 (originally due in November 2009). These decreases were partially offset by the full year effect of our issuance of $250 million in 3.875% convertible senior notes (2008 Convertible Notes) in April 2008, which was used to redeem our $150 million zero-coupon convertible subordinated notes (2003 Convertible Notes), which matured in June 2008. |
| A decrease in interest expense related to our short-term borrowings of $6.7 million, primarily due to declining short-term market interest rates, as well as a decrease in average balances outstanding. Average short-term borrowings decreased by $258.8 million to $46.1 million for 2009, compared to $304.9 million for 2008. This decrease was due to the availability of excess liquidity resulting from the growth in deposit balances. |
| A decrease in interest expense from interest-bearing deposits of $2.6 million, primarily due to decreases in deposit interest rates from declining market rates and our decision to lower rates in the first, third, and fourth quarters of 2009. This decrease was partially offset by a $1.6 billion |
49
increase in average interest-bearing deposits, driven by our clients preference for the security provided by the FDIC and their desire to maintain short-term liquidity, the continued low interest rate environment, and our efforts in late 2008 and early 2009 to migrate client sweep balances from our off-balance sheet product to our on-balance sheet products. |
2008 compared to 2007
Net interest income decreased by $6.2 million to $370.9 million in 2008, compared to $377.1 million in 2007. Overall, we saw a decrease in our net interest income, primarily due to declines in interest rates earned on our short-term investments due to the lower interest rate environment, as well as from an increase in interest expense due to growth in our deposits and long-term debt. These increases were partially offset by lower costs on deposits and LIBOR rates underlying our long-term debt, due to the lower interest rate environment.
The main factors affecting interest income and interest expense for 2008 compared to 2007 are discussed below:
| Interest income for 2008 decreased by $2.9 million primarily due to: |
| A $5.2 million decrease in interest income on short-term investments, primarily driven by declining short-term market interest rates in late 2007 and throughout 2008. |
This decrease was partially offset by a $2.3 million increase in interest income from our loan portfolio driven principally by an increase in average loans of $1.1 billion. This growth was driven primarily by increased loan growth from all client industry segments, with particularly strong growth in loans to software clients, venture capital funds for capital calls, life science clients, and loans to certain high-net-worth individuals. The impact of increased loan balances was partially offset by a 241 basis point decrease in loan yields due primarily to decreases totaling 325 basis points in our prime-lending rate during 2008 in response to certain Federal Fund rate decreases, as well as the full year effect of decreases totaling 100 basis points during the latter half of 2007. While the Federal Reserve cut rates by 400 basis points in 2008, our net interest margin decreased by only 147 basis points. Our average prime-lending rate was 5.13 percent in 2008, compared to 8.05 percent in 2007. Our prime-lending rate at December 31, 2008 was 4.00 percent, compared to 7.25 percent at December 31, 2007.
| Interest expense for 2008 increased by $3.4 million primarily due to: |
| An increase in interest expense of $10.6 million from all interest-bearing deposits, primarily due to an $851.3 million, or 77.5 percent, increase in average interest-bearing deposits as a result of our focus on growing on-balance sheet deposits. This increase was driven by growth from all our interest-bearing deposit products, with particularly strong growth from our money market deposit product for early stage clients introduced in May 2007 and our sweep deposit product introduced in late October 2007, both of which we introduced to provide funding for our loan growth. In 2008, the average balance of our early stage money market deposit product was $486.4 million and interest expense was $7.6 million, compared to $118.7 million and $4.1 million, respectively, for 2007. The average balance of our sweep deposit product in 2008 was $375.6 million and interest expense was $5.9 million, compared to $8.3 million and $0.3 million, respectively, in 2007. |
| An increase of $2.9 million from long-term debt, primarily due to an increase in average long-term debt balances, partially offset by a decrease in average interest rates. Average long-term debt increased by $316.1 million to $980.7 million in 2008, compared to $664.6 million in 2007, due to the full year effect of our issuance of $500 million in senior and subordinated notes in May 2007 |
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and due to the issuance of our 2008 Convertible Notes in April 2008. Average interest rates on long-term debt decreased due to lower LIBOR rates underlying our senior and subordinated notes as well as our junior subordinated debt. |
These increases were partially offset by a $10.2 million decrease in interest expense from short-term borrowings, primarily due to declining short-term market interest rates. Our average cost of short-term borrowings decreased to 2.21 percent in 2008, compared to 5.29 percent in 2007.
Net Interest Margin (Fully Taxable Equivalent Basis)
Our net interest margin was 3.73 percent in 2009, compared to 5.72 percent in 2008 and 7.19 percent in 2007. The decrease in net interest margin in 2009 was primarily due to decreases in yields on our loan portfolio resulting from the full year effect of reductions in our prime-lending rate, which we lowered in response to certain Federal Reserve rate cuts throughout 2008. Additionally, consistent with our liquidity and investment strategies, we invested excess liquidity resulting from our continued growth in deposits in overnight cash with the Federal Reserve earning 25 basis points throughout 2009. These declines in our net interest margin were partially offset by a decrease in interest expense from borrowings due to declining market rates.
The decrease in net interest margin in 2008 was primarily due to decreases in yields on our loan portfolio resulting from reductions in our prime-lending rate, which we lowered in response to certain Federal Reserve rate cuts in late 2007 and throughout 2008. Although the Federal Reserve cut rates by 400 basis points in 2008, our net interest margin decreased by only 147 basis points. The decrease in net interest margin in 2008 was also attributable to increases in rates paid on deposits due primarily to our two interest-bearing deposit products introduced in 2007, partially offset by decreases in rates paid on our short-term borrowings and interest rate swap agreements on selective long-term debt.
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Average Balances, Yields and Rates Paid (Fully Taxable Equivalent Basis)
The average yield earned on interest-earning assets is the amount of annualized fully taxable equivalent interest income expressed as a percentage of average interest-earning assets. The average rate paid on funding sources is the amount of annualized interest expense expressed as a percentage of average funding sources. The following table sets forth average assets, liabilities, noncontrolling interests and stockholders equity, interest income, interest expense, annualized yields and rates, and the composition of our annualized net interest margin in 2009, 2008 and 2007.
(Dollars in thousands) |
Year ended December 31, | ||||||||||||||||||||||||||||||||
2009 | 2008 | 2007 | |||||||||||||||||||||||||||||||
Average Balance |
Interest Income/ Expense |
Yield/ Rate |
Average Balance |
Interest Income/ Expense |
Yield/ Rate |
Average Balance |
Interest Income/ Expense |
Yield/ Rate |
|||||||||||||||||||||||||
Interest-earning assets: |
|||||||||||||||||||||||||||||||||
Federal funds sold, securities purchased under agreements to resell and other short-term investment securities (1) |
$ | 3,333,182 | $ | 9,790 | 0.29 | % | $ | 507,365 | $ | 12,572 | 2.48 | % | $ | 357,673 | $ | 17,816 | 4.98 | % | |||||||||||||||
Investment securities: (2) |
|||||||||||||||||||||||||||||||||
Taxable |
2,179,181 | 81,536 | 3.74 | 1,235,179 | 58,466 | 4.73 | 1,310,595 | 61,303 | 4.68 | ||||||||||||||||||||||||
Non-taxable (3) |
103,150 | 6,298 | 6.11 | 103,337 | 6,555 | 6.34 | 53,866 | 3,637 | 6.75 | ||||||||||||||||||||||||
Total loans, net of unearned income (4) |
4,699,696 | 335,806 | 7.15 | 4,633,048 | 364,192 | 7.86 | 3,522,326 | 361,903 | 10.27 | ||||||||||||||||||||||||
Total interest-earning assets |
10,315,209 | 433,430 | 4.20 | 6,478,929 | 441,785 | 6.82 | 5,244,460 | 444,659 | 8.48 | ||||||||||||||||||||||||
Cash and due from banks |
238,911 | 279,520 | 275,907 | ||||||||||||||||||||||||||||||
Allowance for loan losses |
(107,512 | ) | (54,982 | ) | (43,654 | ) | |||||||||||||||||||||||||||
Goodwill |
1,000 | 4,092 | 12,576 | ||||||||||||||||||||||||||||||
Other assets (5) |
878,733 | 710,744 | 530,685 | ||||||||||||||||||||||||||||||
Total assets |
$ | 11,326,341 | $ | 7,418,303 | $ | 6,019,974 | |||||||||||||||||||||||||||
Funding sources: |
|||||||||||||||||||||||||||||||||
Interest-bearing liabilities: |
|||||||||||||||||||||||||||||||||
NOW deposits |
$ | 42,022 | $ | 160 | 0.38 | % | $ | 46,339 | $ | 233 | 0.50 | % | $ | 35,020 | $ | 138 | 0.39 | % | |||||||||||||||
Regular money market deposits |
149,696 | 748 | 0.50 | 152,568 | 2,087 | 1.37 | 152,550 | 1,796 | 1.18 | ||||||||||||||||||||||||
Bonus money market deposits |
1,034,152 | 5,404 | 0.52 | 969,421 | 11,697 | 1.21 | 577,977 | 8,003 | 1.38 | ||||||||||||||||||||||||
Money market deposits in foreign offices |
62,440 | 416 | 0.67 | 11,570 | 161 | 1.39 | | | | ||||||||||||||||||||||||
Time deposits |
355,602 | 2,445 | 0.69 | 393,963 | 3,838 | 0.97 | 324,250 | 3,064 | 0.94 | ||||||||||||||||||||||||
Sweep deposits |
1,860,899 | 12,173 | 0.65 | 375,556 | 5,913 | 1.57 | 8,310 | 284 | 3.42 | ||||||||||||||||||||||||
Total interest-bearing deposits |
3,504,811 | 21,346 | 0.61 | 1,949,417 | 23,929 | 1.23 | 1,098,107 | 13,285 | 1.21 | ||||||||||||||||||||||||
Short-term borrowings |
46,133 | 72 | 0.16 | 304,896 | 6,746 | 2.21 | 320,129 | 16,922 | 5.29 | ||||||||||||||||||||||||
Zero-coupon convertible subordinated notes |
| | | 69,978 | 2,418 | 3.46 | 147,870 | 6,032 | 4.08 | ||||||||||||||||||||||||
3.875% convertible senior notes |
245,756 | 14,043 | 5.71 | 179,538 | 10,138 | 5.65 | | | | ||||||||||||||||||||||||
Junior subordinated debentures |
55,948 | 3,465 | 6.19 | 53,093 | 2,548 | 4.80 | 50,894 | 3,404 | 6.69 | ||||||||||||||||||||||||
Senior and subordinated notes |
560,398 | 9,166 | 1.64 | 531,523 | 20,405 | 3.84 | 313,148 | 19,619 | 6.27 | ||||||||||||||||||||||||
Other long-term debt |
61,752 | 984 | 1.59 | 146,562 | 4,712 | 3.22 | 152,669 | 8,282 | 5.42 | ||||||||||||||||||||||||
Total interest-bearing liabilities |
4,474,798 | 49,076 | 1.10 | 3,235,007 | 70,896 | 2.19 | 2,082,817 | 67,544 | 3.24 | ||||||||||||||||||||||||
Portion of noninterest-bearing funding sources |
5,840,411 | 3,243,922 | 3,161,643 | ||||||||||||||||||||||||||||||
Total funding sources |
10,315,209 | 49,076 | 0.47 | 6,478,929 | 70,896 | 1.10 | 5,244,460 | 67,544 | 1.29 | ||||||||||||||||||||||||
Noninterest-bearing funding sources: |
|||||||||||||||||||||||||||||||||
Demand deposits |
5,289,288 | 2,946,907 | 2,864,153 | ||||||||||||||||||||||||||||||
Other liabilities |
179,795 | 221,348 | 191,466 | ||||||||||||||||||||||||||||||
Discount on zero-coupon convertible subordinated notes |
| 503 | 1,007 | ||||||||||||||||||||||||||||||
SVBFG Stockholders equity |
1,063,175 | 720,851 | 669,190 | ||||||||||||||||||||||||||||||
Noncontrolling interests |
319,285 | 293,687 | 211,341 | ||||||||||||||||||||||||||||||
Portion used to fund interest-earning assets |
(5,840,411 | ) | (3,243,922 | ) | (3,161,643 | ) | |||||||||||||||||||||||||||
Total liabilities and total equity |
$ | 11,326,341 | $ | 7,418,303 | $ | 6,019,974 | |||||||||||||||||||||||||||
Net interest income and margin |
$ | 384,354 | 3.73 | % | $ | 370,889 | 5.72 | % | $ | 377,115 | 7.19 | % | |||||||||||||||||||||
Total deposits |
$ | 8,794,099 | $ | 4,896,324 | $ | 3,962,260 | |||||||||||||||||||||||||||
Reconciliation to reported net interest income: |
|||||||||||||||||||||||||||||||||
Adjustment for tax-equivalent basis |
(2,204 | ) | (2,294 | ) | (1,273 | ) | |||||||||||||||||||||||||||
Net interest income, as reported |
$ | 382,150 | $ | 368,595 | $ | 375,842 | |||||||||||||||||||||||||||
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(1) | Includes average interest-earning deposits in other financial institutions of $176.5 million, $99.1 million and $52.9 million in 2009, 2008 and 2007, respectively. For 2009 and 2008, balances also include $3.1 billion and $79.1 million, respectively, deposited at the Federal Reserve Bank, earning interest at the Federal Funds target rate. |
(2) | Yields on interest-earning investment securities do not give effect to changes in fair value that are reflected in other comprehensive income. |
(3) | Interest income on non-taxable investment securities is presented on a fully taxable equivalent basis using the federal statutory tax rate of 35.0 percent for all years presented. |
(4) | Nonaccrual loans are reflected in the average balances of loans. |
(5) | Average investment securities of $505.5 million, $380.8 million and $250.8 million in 2009, 2008 and 2007, respectively, were classified as other assets as they were noninterest-earning assets. These investments primarily consisted of non-marketable securities. |
Provision for Loan Losses
Our provision for loan losses is based on our evaluation of the adequacy of the existing allowance for loan losses in relation to total gross loans and on our periodic assessment of the inherent and identified risk dynamics of the loan portfolio resulting from reviews of selected individual loans. For a more detailed discussion of credit quality and the allowance for loan losses, see Managements Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Policies and Estimates and Consolidated Financial ConditionCredit Quality and the Allowance for Loan Losses under Part II, Item 7 in this report. The following table summarizes our provision for loan losses for 2009, 2008 and 2007, respectively:
Year ended December 31, | ||||||||||||
(Dollars in thousands, except ratios) |
2009 | 2008 | 2007 | |||||||||
Allowance for loan losses, beginning balance |
$ | 107,396 | $ | 47,293 | $ | 42,747 | ||||||
Provision for loan losses |
90,180 | 100,713 | 16,836 | |||||||||
Gross loan charge-offs |
(143,570 | ) | (47,815 | ) | (19,378 | ) | ||||||
Loan recoveries |
18,444 | 7,205 | 7,088 | |||||||||
Allowance for loan losses, ending balance |
$ | 72,450 | $ | 107,396 | $ | 47,293 | ||||||
Provision as a percentage of period-end total gross loans |
1.97 | % | 1.81 | % | 0.40 | % | ||||||
Gross loan charge-offs as a percentage of average total gross loans |
3.03 | 1.02 | 0.55 | |||||||||
Net loan charge-offs as a percentage of average total gross loans |
2.64 | 0.87 | 0.35 | |||||||||
Allowance for loan losses as a percentage of period-end total gross loans |
1.58 | 1.93 | 1.13 | |||||||||
Period-end total gross loans |
$ | 4,582,966 | $ | 5,551,636 | $ | 4,178,098 | ||||||
Average total gross loans |
4,739,210 | 4,666,025 | 3,547,333 |
Our provision for loan losses decreased by $10.5 million to $90.2 million in 2009, compared to $100.7 million in 2008.
Gross loan charge-offs of $143.6 million in 2009 came primarily from our hardware, software and life science client portfolios. Gross loan charge-offs included $56.4 million of loans that were previously classified as nonperforming loans.
Loan recoveries of $18.4 million in 2009 were primarily due to a partial recovery of $11.4 million from a loan within our hardware industry portfolio that was charged-off in the first quarter of 2009. The remaining recoveries of $7.0 million were primarily from our life science, software and hardware client portfolios.
Our allowance for loan losses decreased from $107.4 million at December 31, 2008 to $72.5 million at December 31, 2009. The decrease in allowance for loan losses is reflective of continuing improvement in credit
53
quality trends in our loan portfolio since the second quarter of 2009 as indicated by several factors including the following:
| A 52.7 percent decrease in nonperforming loans from a peak of $111.5 million at June 30, 2009 to $52.7 million at December 31, 2009. |
| A 25 percent decrease in classified loans from the second quarter of 2009 to the fourth quarter of 2009. |
| A majority of the net charge-offs were from nonperforming loans for which they had previously been specifically reserved. For 2009 we identified specific reserves of $51 million and recorded related net charge-offs of $53 million. Other net charge-offs were concentrated in our early-stage portfolio with a small amount of charge-offs coming from our private client services portfolio. |
| In July 2009, an independent asset management firm announced that it had closed its transaction with HRJ Capital (HRJ) to assume the management of HRJs private equity and real estate funds of funds. The transaction included the restructuring of the debt obligations owed to us by HRJ and its affiliates. The finalization of this transaction had a favorable impact on our overall allowance for loan losses and nonperforming loans in the third quarter of 2009. |
Additionally, while loans greater than $10 million represented a significant source of loan losses in 2009, the size of loans added to the classified portfolio during the latter half of 2009 were less than $10 million with the largest addition being $8.8 million and the largest addition to nonperforming loans in the fourth quarter of 2009 was $1.0 million. Our overall percentage of allowance for loan losses decreased from a high of 2.26 percent at June 30, 2009, to 1.58 percent at December 31, 2009 due primarily to the resolution of the large nonperforming loans, and because additions to nonperforming loans have been smaller in size, which is a trend we expect to continue into 2010.
As such, we believe that our current allowance for loan losses of $72.5 million (1.58 percent of total gross loans) is adequate and indicative of ongoing levels of future net charge-offs. The following table provides a summary of our credit quality information:
Year ended December 31, | ||||||||||||
(Dollars in thousands, except ratios) |
2009 | 2008 | 2007 | |||||||||
Allowance for loan losses as a percentage of total gross loans |
1.58 | % | 1.93 | % | 1.13 | % | ||||||
Allowance for loan losses for performing loans as a percentage of total gross performing loans |
1.40 | 1.49 | 1.10 | |||||||||
Allowance for loan losses for nonperforming loans as a percentage of total gross nonperforming loans |
16.83 | 29.70 | 18.22 | |||||||||
Allowance for loan losses |
$ | 72,450 | $ | 107,396 | $ | 47,293 | ||||||
Allowance for loan losses for performing loans |
63,582 | 81,485 | 45,902 | |||||||||
Allowance for loan losses for nonperforming loans |
8,868 | 25,911 | 1,391 | |||||||||
Total gross performing loans |
4,530,283 | 5,464,387 | 4,170,464 | |||||||||
Total gross nonperforming loans |
52,683 | 87,249 | 7,634 |
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Noninterest Income
Year ended December 31, | |||||||||||||||||
(Dollars in thousands) |
2009 | 2008 | % Change 2009/2008 |
2007 | % Change 2008/2007 |
||||||||||||
Foreign exchange fees |
$ | 30,735 | $ | 33,106 | (7.2 | )% | $ | 25,750 | 28.6 | % | |||||||
Deposit service charges |
27,663 | 24,110 | 14.7 | 15,554 | 55.0 | ||||||||||||
Client investment fees |
21,699 | 50,498 | (57.0 | ) | 51,794 | (2.5 | ) | ||||||||||
Letters of credit and standby letters of credit income |
10,333 | 12,006 | (13.9 | ) | 11,115 | 8.0 | |||||||||||
Credit card fees |
9,314 | 6,225 | 49.6 | 5,802 | 7.3 | ||||||||||||
Corporate finance fees |
| 3,640 | (100.0 | ) | 14,199 | (74.4 | ) | ||||||||||
(Losses) gains on derivative instruments, net |
(753 | ) | 18,505 | (104.1 | ) | 23,935 | (22.7 | ) | |||||||||
(Losses) gains on investment securities, net |
(31,209 | ) | (14,777 | ) | 111.2 | 46,724 | (131.6 | ) | |||||||||
Other |
29,961 | 19,052 | 57.3 | 26,096 | (27.0 | ) | |||||||||||
Total noninterest income |
$ | 97,743 | $ | 152,365 | (35.8 | ) | $ | 220,969 | (31.0 | ) | |||||||
Included in net income is income and expense attributable to noncontrolling interests. We recognize, as part of our investment funds management business through SVB Capital and Sponsored Funds and Strategic Investments, the entire income or loss from funds where we own significantly less than 100%. We also recognize, as part of our equity valuation business through SVB Analytics, the results of eProsper, of which we own 65%. We are required under GAAP to consolidate 100% of the results of entities that we are deemed to control, even though we may own less than 100% of such entities. The relevant amounts attributable to investors other than us are reflected under Net Loss (Income) Attributable to Noncontrolling Interests on our statements of income. The non-GAAP tables presented below, for noninterest income and net gains (losses) on investment securities, all exclude noncontrolling interests. We believe these non-GAAP financial measures, when taken together with the corresponding GAAP financial measures, provide meaningful supplemental information regarding our performance by excluding certain items that represent income attributable to investors other than us and our subsidiaries. Our management uses, and believes that investors benefit from referring to, these non-GAAP financial measures in assessing our operating results and when planning, forecasting and analyzing future periods. However, these non-GAAP financial measures should be considered in addition to, not as a substitute for or preferable to, financial measures prepared in accordance with GAAP.
The following table provides a summary of non-GAAP noninterest income, net of noncontrolling interests:
Non-GAAP noninterest income, net of noncontrolling interests |
Year ended December 31, | ||||||||||||||||
2009 | 2008 | % Change 2009/2008 |
2007 | % Change 2008/2007 |
|||||||||||||
GAAP noninterest income |
$ | 97,743 | $ | 152,365 | (35.8 | )% | $ | 220,969 | (31.0 | )% | |||||||
Less: (losses) income attributable to noncontrolling interests, including carried interest |
(24,901 | ) | (8,494 | ) | 193.2 | 37,981 | (122.4 | ) | |||||||||
Non-GAAP noninterest income, net of noncontrolling interests |
$ | 122,644 | $ | 160,859 | (23.8 | ) | $ | 182,988 | (12.1 | ) | |||||||
Foreign Exchange Fees
Foreign exchange fees represent the income differential between purchases and sales of foreign currency on behalf of our clients. Foreign exchange fees were $30.7 million in 2009, compared to $33.1 million in 2008 and $25.8 million in 2007. The decrease in foreign exchange fees in 2009 was primarily due to lower commissioned notional volumes, which decreased to $5.0 billion in 2009, compared to $6.1 billion in 2008. The decrease in commissioned notional volumes was partially offset by higher commission rates as a higher portion of that volume came from trades with notional amounts less than $1 million in 2009, which carry comparatively higher commission rates.
55
The increase in foreign exchange fees in 2008 was primarily due to increased client trading activity. While commissioned notional volumes remained stable at $6.1 billion in both 2008 and 2007, a substantially higher proportion of that volume came from trades with notional amounts less than $1 million in 2008, which carry comparatively higher commission rates.
Deposit Service Charges
Deposit service charges were $27.7 million in 2009, compared to $24.1 million in 2008 and $15.6 million in 2007. The increases were primarily attributable to decreases in the credit received by clients due to decreases in short-term market interest rates in 2008.
Client Investment Fees
We offer a variety of investment products on which we earn fees. These products include money market mutual funds, overnight repurchase agreements and fixed income securities available through client-directed accounts offered through SVB Securities, our broker dealer subsidiary, and fixed income management services offered through SVB Asset Management, our investment advisory subsidiary.
Client investment fees were $21.7 million in 2009, compared to $50.5 million in 2008 and $51.8 million in 2007. The decrease in 2009 was primarily attributable to lower margins earned on certain products owing to historically low rates in the short-term fixed income markets, as well as a decrease in average client investment funds. During the latter half of the fourth quarter of 2008, we discontinued offering a third party off-balance sheet sweep product, primarily due to our decision to utilize our own on-balance sheet sweep product. The following table summarizes average client investment funds for 2009, 2008 and 2007:
(Dollars in millions) |
Year ended December 31, | ||||||||||||||
2009 | 2008 | % Change 2009/2008 |
2007 | % Change 2008/2007 |
|||||||||||
Client directed investment assets (1) |
$ | 10,879 | $ | 12,800 | (15.0 | )% | $ | 12,356 | 3.6 | % | |||||
Client investment assets under management |
5,659 | 6,217 | (9.0 | ) | 5,651 | 10.0 | |||||||||
Sweep money market funds |
56 | 2,573 | (97.8 | ) | 2,427 | 6.0 | |||||||||
Total average client investment funds (2) |
$ | 16,594 | $ | 21,590 | (23.1 | ) | $ | 20,434 | 5.7 | ||||||
(1) | Mutual funds and Repurchase Agreement Program assets. |
(2) | Client investment funds are maintained at third party financial institutions. |
Period-end total client investment funds were $15.6 billion at December 31, 2009, compared to $18.6 billion at December 31, 2008, and $22.2 billion at December 31, 2007.
Credit Card Fees
Credit card fees were $9.3 million in 2009, compared to $6.2 million in 2008 and $5.8 million in 2007. The increase in 2009 was primarily due to the transfer of management and processing of our credit card portfolio in-house from a third-party servicer in the first quarter of 2009, as we began to process our credit card business in-house. Refer to Note 18Off-Balance Sheet Arrangements, Guarantees and Other Commitments of the Notes to the Consolidated Financial Statements under Part II, Item 8 in this report for further details.
Corporate Finance Fees
There were no corporate finance fees in 2009, compared to $3.6 million in 2008 and $14.2 million in 2007. We decided to cease operations at SVB Alliant in July 2007. The $3.6 million in fees in 2008 represented the completion of all remaining client transactions at SVB Alliant as of March 31, 2008.
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(Losses) Gains on Derivative Instruments, Net
A summary of (losses) gains on derivative instruments, net, for 2009, 2008, and 2007 is as follows:
(Dollars in thousands) |
Year ended December 31, | |||||||||||||||||
2009 | 2008 | % Change 2009/2008 |
2007 | % Change 2008/2007 |
||||||||||||||
(Losses) gains on foreign exchange forward contracts, net: |
||||||||||||||||||
Gains on client foreign exchange forward contracts, net (1) |
$ | 1,730 | $ | 4,233 | (59.1 | )% | $ | 1,156 | NM | % | ||||||||
(Losses) gains on internal foreign exchange forward contracts, net (2) |
(2,258 | ) | 5,185 | (143.5 | ) | (198 | ) | NM | ||||||||||
Total (losses) gains on foreign exchange forward contracts, net |
(528 | ) | 9,418 | (105.6 | ) | 958 | NM | |||||||||||
Change in fair value of interest rate swap (3) |
(170 | ) | (1,856 | ) | (90.8 | ) | (499 | ) | NM | |||||||||
Gains on covered call options, net (4) |
| 402 | (100.0 | ) | | 100.0 | ||||||||||||
Equity warrant assets (5): |
||||||||||||||||||
Gains on exercise, net |
933 | 7,188 | (87.0 | ) | 18,690 | (61.5 | ) | |||||||||||
Change in fair value: |
||||||||||||||||||
Cancellations and expirations |
(4,515 | ) | (2,574 | ) | 75.4 | (2,643 | ) | (2.6 | ) | |||||||||
Other changes in fair value |
3,527 | 5,927 | (40.5 | ) | 7,429 | (20.2 | ) | |||||||||||
Total net (losses) gains on equity warrant assets (6) |
(55 | ) | 10,541 | (100.5 | ) | 23,476 | (55.1 | ) | ||||||||||
Total (losses) gains on derivative instruments, net |
$ | (753 | ) | $ | 18,505 | (104.1 | ) | $ | 23,935 | (22.7 | ) | |||||||
NM- Not meaningful
(1) | Represents the net gains for foreign exchange forward contracts executed on behalf of clients. |
(2) | Represents the change in the fair value of foreign exchange forward contracts used to economically reduce our foreign exchange exposure risk related to certain foreign currency denominated loans. Revaluations of foreign currency denominated loans are recorded on the line item Other as part of noninterest income, a component of consolidated net income. |
(3) | Represents the change in the fair value hedge of the junior subordinated debentures. In December 2008, our counterparty called this swap for settlement in January 2009. As a result, the swap was terminated and no longer designated as a hedging instrument. |
(4) | Represents net gains on covered call options by one of our sponsored debt funds. |
(5) | At December 31, 2009, we held warrants in 1,225 companies, compared to 1,307 companies at December 31, 2008 and 1,179 companies at December 31, 2007. |
(6) | Includes net (losses) gains on equity warrant assets held by consolidated investment affiliates. Relevant amounts attributable to noncontrolling interests are reflected in the consolidated statements of income under the caption Net Loss (Income) Attributable to Noncontrolling Interests. |
Losses on derivative instruments, net, were $0.8 million in 2009, compared to net gains of $18.5 million in 2008 and net gains of $23.9 million in 2007. The decrease of $19.3 million in 2009 was primarily due to the following:
| Net losses from foreign exchange forward contracts hedging our foreign currency denominated loans of $2.3 million for 2009, compared to net gains of $5.2 million for 2008. The change was primarily due to the weakening of the U.S. dollar in 2009 against the Pound Sterling, compared to the strengthening of the dollar against the Pound Sterling in 2008. Net losses from foreign exchange forward contracts hedging our foreign currency denominated loans of $2.3 million were used to partially offset net gains of $1.9 million from revaluation of our foreign currency denominated loans, which are included in other noninterest income. |
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| Net gains from the exercise of certain warrant positions of $0.9 million in 2009, compared to net gains of $7.2 million in 2008. The decrease primarily reflects the impact of slowing M&A and IPO markets in late 2008 and throughout 2009 due to the economic environment. In addition, during 2008, we recognized a gain of $3.9 million from the sale of one warrant position. |
| Net losses from warrant cancellations and expirations of $4.5 million in 2009, compared to net losses of $2.6 million in 2008. The increase in warrant cancellations and expirations in 2009 is reflective of the downturn in the overall economy. |
The decrease of $5.4 million in 2008 was primarily due to the following:
| Net gains from the exercise of certain warrants of $7.2 million in 2008, compared to net gains of $18.7 million in 2007. The decrease primarily reflected the impact of slowing M&A and IPO markets in late 2008 due to the economic environment. |
| Net gains from foreign exchange forward contracts hedging our foreign currency denominated loans of $5.2 million for 2008, compared to net losses of $0.2 million for 2007. The change was primarily due to the strengthening of the dollar against the Pound Sterling in 2008. Net gains from foreign exchange forward contracts hedging our foreign currency denominated loans of $5.2 million were used to partially offset net losses of $7.6 million from revaluation of our foreign currency denominated loans, which are included in other noninterest income. |
(Losses) Gains on Investment Securities, Net
We experience variability in the performance of our private equity and venture capital investments from quarter to quarter due to a number of factors, including changes in the values of our investments, changes in the amount of distributions or liquidity events and general economic and market conditions. Such variability may lead to volatility in the (losses) gains on investment securities and cause our results for a particular period not to be indicative of our performance in a future period. The valuation of our investments were affected by a more challenging venture capital environment, a significant slowdown of M&A activities and IPOs among our portfolio companies in 2008 and 2009. The net losses in 2009 were primarily due to lower valuations of private companies as a result of the overall impact of lower than expected operating results and lower comparative valuations from other private companies, reflective of the current economic slowdown throughout the venture capital/private equity community. As a result, we saw more unrealized losses in 2009 compared to 2008 and 2008 compared to 2007. In addition, we experienced realized losses in our other investments in 2009 due to impairment losses primarily from our private equity fund investments, due principally to sustained valuation decreases in underlying portfolio companies. For 2008, realized losses in our other investments were due to sales of our marketable equity securities, which are publicly traded shares acquired upon exercise of equity warrant assets.
The following tables provide a summary of net (losses) gains on investment securities for 2009, 2008 and 2007:
(Dollars in thousands) |
Year ended December 31, 2009 | ||||||||||||||||||
Managed Co-Investment Funds |
Managed Funds Of Funds |
Debt Funds | Other | Total | |||||||||||||||
Unrealized gains (losses) |
$ | 2,327 | $ | (37,730 | ) | $ | 2,334 | $ | 205 | $ | (32,864 | ) | |||||||
Realized (losses) gains |
(4,794 | ) | 8,836 | 2,156 | (4,543 | ) | 1,655 | ||||||||||||
Total (losses) gains on investment securities, net |
$ | (2,467 | ) | $ | (28,894 | ) | $ | 4,490 | $ | (4,338 | ) | $ | (31,209 | ) | |||||
Less: (losses) income attributable to noncontrolling interests, including carried interest |
(2,938 | ) | (24,569 | ) | 869 | | (26,638 | ) | |||||||||||
Non-GAAP net gains (losses) on investment securities, net of noncontrolling interests |
$ | 471 | $ | (4,325 | ) | $ | 3,621 | $ | (4,338 | ) | $ | (4,571 | ) | ||||||
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Year ended December 31, 2008 | |||||||||||||||||||
(Dollars in thousands) |
Managed Co-Investment Funds |
Managed Funds Of Funds |
Debt Funds | Other | Total | ||||||||||||||
Unrealized gains (losses) |
$ | 1,527 | $ | (13,080 | ) | $ | (8,968 | ) | $ | (93 | ) | $ | (20,614 | ) | |||||
Realized gains (losses) |
1,136 | 7,342 | 1,158 | (3,799 | ) | 5,837 | |||||||||||||
Total gains (losses) on investment securities, net |
$ | 2,663 | $ | (5,738 | ) | $ | (7,810 | ) | $ | (3,892 | ) | $ | (14,777 | ) | |||||
Less: income (losses) attributable to noncontrolling interests, including carried interest |
2,183 | (6,227 | ) | (4,885 | ) | | (8,929 | ) | |||||||||||
Non-GAAP net gains (losses) on investment securities, net of noncontrolling interests |
$ | 480 | $ | 489 | $ | (2,925 | ) | $ | (3,892 | ) | $ | (5,848 | ) | ||||||
Year ended December 31, 2007 | ||||||||||||||||
(Dollars in thousands) |
Managed Co-Investment Funds |
Managed Funds Of Funds |
Debt Funds | Other | Total | |||||||||||
Unrealized gains (losses) |
$ | 1,861 | $ | 10,412 | $ | 10,800 | $ | | $ |
23,073 | ||||||
Realized (losses) gains |
(2,025 | ) | 19,730 | 4,324 | 1,622 | 23,651 | ||||||||||
Total (losses) gains on investment securities, net |
$ | (164 | ) | $ | 30,142 | $ | 15,124 | $ | 1,622 | $ |
46,724 | |||||
Less: (losses) income attributable to noncontrolling interests, including carried interest |
(129 | ) | 26,807 | 8,771 | | 35,449 | ||||||||||
Non-GAAP net (losses) gains on investment securities, net of noncontrolling interests |
$ | (35 | ) | $ | 3,335 | $ | 6,353 | $ | 1,622 | $ | 11,275 | |||||
Other Noninterest Income
A summary of other noninterest income for 2009, 2008 and 2007 is as follows:
Year ended December 31, | ||||||||||||||||
(Dollars in thousands) |
2009 | 2008 | % Change 2009/2008 |
2007 | % Change 2008/2007 |
|||||||||||
Fund management fees |
$ | 10,328 | $ | 8,547 | 20.8 | % | $ | 8,583 | (0.4 | )% | ||||||
Service-based fee income (1) |
7,554 | 8,686 | (13.0 | ) | 5,356 | 62.2 | ||||||||||
Gains (losses) on foreign currency loans revaluation, net |
1,945 | (7,567 | ) | (125.7 | ) | 1,905 | NM | |||||||||
Other |
10,134 | 9,386 | 8.0 | 10,252 | (8.4 | ) | ||||||||||
Total other noninterest income |
$ | 29,961 | $ | 19,052 | 57.3 | $ | 26,096 | (27.0 | ) | |||||||
NM- Not meaningful
(1) | Includes income from SVB Analytics and its subsidiary, eProsper. |
Other noninterest income was $30.0 million in 2009, compared to $19.1 million in 2008 and $26.1 million in 2007. The increase of $10.9 million in 2009 was primarily due to net gains on revaluation of foreign currency loans of $1.9 million in 2009, compared to net losses of $7.6 million in 2008. The change was primarily due to the weakening of the U.S. dollar in 2009 against the Pound Sterling, compared to the strengthening of the U.S. dollar against the Pound Sterling in 2008. Net gains from revaluation of foreign currency denominated loans of $1.9 million in 2009 were partially offset by net losses from foreign exchange forward contracts of $2.3 million, which are included in net (losses) gains on derivative instruments.
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The decrease of $7.0 million in 2008, compared to 2007, was primarily due to net losses on revaluation of foreign currency loans of $7.6 million in 2008, compared to net gains of $1.9 million in 2007. The change was primarily due to the strengthening of the U.S. dollar in 2008 against the Pounds Sterling. Net losses from revaluation of foreign currency denominated loans of $7.6 million in 2008 were partially offset by net gains from foreign exchange forward contracts of $5.2 million, which are included in net (losses) gains on derivative instruments. This decrease was partially offset by a $3.3 million increase in service-based fee income, primarily due to increased activities from SVB Analytics. SVB Analytics revenues increased by $3.3 million to $6.4 million in 2008, compared to $3.1 million in 2007, primarily as a result of an increase in the number of clients, from 408 in 2007 to 834 in 2008.
Fund management fees were $10.3 million in 2009, compared to $8.5 million in 2008 and $8.6 million in 2007. The increase in 2009 was primarily due to fees associated with a new fund in the SVB Strategic Investors Fund family, which was established and funded in the fourth quarter of 2008 and the first quarter of 2009. Typically, a fund of funds is formed through multiple closing transactions in which limited partners enter into investment commitments.
Noninterest Expense
Year ended December 31, | |||||||||||||||||
(Dollars in thousands) |
2009 | 2008 | % Change 2009/2008 |
2007 | % Change 2008/2007 |
||||||||||||
Compensation and benefits |
$ | 189,631 | $ | 177,315 | 6.9 | % | $ | 213,892 | (17.1 | )% | |||||||
Professional services |
46,540 | 39,480 | 17.9 | 32,905 | 20.0 | ||||||||||||
Premises and equipment |
23,270 | 22,183 | 4.9 | 19,756 | 12.3 | ||||||||||||
Net occupancy |
17,888 | 17,307 | 3.4 | 20,829 | (16.9 | ) | |||||||||||
FDIC assessments |
17,035 | 3,451 | NM | 708 | NM | ||||||||||||
Business development and travel |
14,014 | 15,406 | (9.0 | ) | 12,263 | 25.6 | |||||||||||
Correspondent bank fees |
8,040 | 6,628 | 21.3 | 5,713 | 16.0 | ||||||||||||
Impairment of goodwill |
4,092 | | 100.0 | 17,204 | (100.0 | ) | |||||||||||
Loss from cash settlement of conversion premium of zero-coupon convertible subordinated notes |
| 3,858 | (100.0 | ) | | | |||||||||||
(Reduction of) provision for unfunded credit commitments |
(1,367 | ) | 1,252 | NM | (1,207 | ) | NM | ||||||||||
Other |
24,723 | 26,007 | (4.9 | ) | 24,406 | 6.6 | |||||||||||
Total noninterest expense |
$ | 343,866 | $ | 312,887 | 9.9 | $ | 346,469 | (9.7 | ) | ||||||||
NM- Not meaningful
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We use and report non-GAAP noninterest expense and a non-GAAP operating efficiency ratio, which excludes noncontrolling interests, impairment of goodwill and the loss from cash settlement of conversion premium of our 2003 Convertible Notes. We believe these non-GAAP financial measures, when taken together with the corresponding GAAP financial measures, provide meaningful supplemental information regarding our performance by: (i) excluding certain items that represent expense attributable to investors other than us and our subsidiaries, or certain items that do not occur every reporting period; or (ii) providing additional information used by management that is not otherwise required by GAAP or other applicable requirement. Our management uses, and believes that investors benefit from referring to, these non-GAAP financial measures in assessing our operating results and when planning, forecasting and analyzing future periods. However, these non-GAAP financial measures should be considered in addition to, not as a substitute for or preferable to, financial measures prepared in accordance with GAAP. The table below provides a summary of non-GAAP noninterest expense and non-GAAP operating efficiency ratio, both net of noncontrolling interests:
Year ended December 31, | ||||||||||||||||||
Non-GAAP noninterest expense, net of noncontrolling interests |
2009 | 2008 | % Change 2009/2008 |
2007 | % Change 2008/2007 |
|||||||||||||
GAAP noninterest expense |
$ | 343,866 | $ | 312,887 | 9.9 | % | $ | 346,469 | (9.7 | )% | ||||||||
Less: amounts attributable to noncontrolling interests |
12,451 | 11,115 | 12.0 | 10,681 | 4.1 | |||||||||||||
Less: loss from cash settlement of conversion premium of zero-coupon convertible subordinated notes |
| 3,858 | (100.0 | ) | | | ||||||||||||
Less: impairment of goodwill |
4,092 | | 100.0 | 17,204 | (100.0 | ) | ||||||||||||
Non-GAAP noninterest expense, net of noncontrolling interests |
$ | 327,323 | $ | 297,914 | 9.9 | $ | 318,584 | (6.5 | ) | |||||||||
GAAP taxable equivalent net interest income |
$ | 384,354 | $ | 370,889 | 3.6 | $ | 377,115 | (1.7 | ) | |||||||||
Less: (losses) income attributable to noncontrolling interests |
(18 | ) | 470 | (103.8 | ) | 1,296 | (63.7 | ) | ||||||||||
Non-GAAP taxable equivalent net interest income, net of noncontrolling interests |
384,372 | 370,419 | 3.8 | 375,819 | (1.4 | ) | ||||||||||||
Non-GAAP noninterest income, net of noncontrolling interests |
122,644 | 160,859 | (23.8 | ) | 182,988 | (12.1 | ) | |||||||||||
Non-GAAP taxable equivalent revenue, net of noncontrolling interests |
$ | 507,016 | $ | 531,278 | (4.6 | ) | $ | 558,807 | (4.9 | ) | ||||||||
Non-GAAP operating efficiency ratio |
64.56 | % | 56.07 | % | 15.1 | 57.01 | % | (1.6 | ) | |||||||||
Compensation and Benefits
Compensation and benefits expense was $189.6 million in 2009, compared to $177.3 million in 2008 and $213.9 million in 2007. The increase in compensation and benefits expense of $12.3 million in 2009 was largely due to an increase of $5.3 million in salaries and wages expense, primarily related to an increase in the average number of full-time equivalent (FTE) personnel, which increased to 1,259 in 2009, compared to 1,210 in 2008 and 1,145 in 2007. The increase in average FTE was attributable to increases in sales and advisory positions to support our global commercial bank operations.
The decrease in compensation and benefits expense of $36.6 million in 2008 was largely due to a decrease in performance-based incentive expenses related to our Incentive Compensation Plan and Employee Stock Ownership Plan (ESOP), as a result of actual 2008 annual financial results being below our expectations. These decreases were partially offset by an increase in salaries and wages expense, primarily related to an increase in the average number of FTE.
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Our variable compensation plans primarily consist of the Incentive Compensation Plans, Direct Drive Incentive Compensation Plan (Direct Drive), SVB Financial Group 401(k) Plan, ESOP, Retention Program and Warrant Incentive Plan. Total costs incurred under the above plans were $32.7 million in 2009, compared to $31.5 million in 2008 and $67.4 million in 2007. The decrease of $35.9 million in 2008 was primarily related to a $28.5 million decrease in our incentive compensation expense and a $7.3 million decrease in our ESOP expense.
Professional Services
Professional services expense was $46.5 million in 2009, compared to $39.5 million in 2008 and $32.9 million in 2007. The increase of $7.0 million in 2009 was primarily due to consulting fees related to certain infrastructure projects and legal fees related to a loan workout. The increase of $6.6 million in 2008 from 2007 was primarily due to consulting fees related to certain infrastructure projects.
Net Occupancy
Net occupancy expense was $17.9 million in 2009, compared to $17.3 million in 2008 and $20.8 million in 2007. The decrease of $3.5 million in 2008 was primarily due $1.7 million of lease exit costs recognized in 2007, as we exited three domestic offices in a move to improve synergy and efficiency across business units, as well as increased amortization of leasehold improvements in 2007 due to a change in the remaining lease term of certain domestic leases.
FDIC Assessments
FDIC assessments were $17.0 million in 2009, compared to $3.5 million in 2008 and $0.7 million in 2007. The increase of $13.5 million in 2009 was primarily due to a special assessment fee of $5.0 million, mandated for all banks by the FDIC, an increase in average deposit balances, and an increase in FDIC assessment rates. The increase of $2.8 million in 2008 from 2007 was primarily due to an increase in average deposit balances and an increase in FDIC assessment rates.
Business Development and Travel Expense
Business development and travel expense was $14.0 million in 2009, compared to $15.4 million in 2008 and $12.3 million in 2007. The increase of $3.1 million in 2008 was primarily attributable to our increased focus on global initiatives.
Impairment of Goodwill
We review goodwill for possible impairment on an annual basis, and we also monitor for any impairment triggering events quarterly. As such, as part of our quarterly review of goodwill during the first quarter of 2009, we noted an impairment resulting from a change in our outlook for eProspers future financial performance. As a result, we recognized a non-cash non-tax deductible charge of $4.1 million relating to the impairment of goodwill in the first quarter of 2009. There is no remaining goodwill on our balance sheet as of December 31, 2009.
In connection with our annual assessment of goodwill of SVB Alliant in the second quarter of 2007, we recognized impairment charges of $17.2 million. The impairment resulted from changes in our outlook for SVB Alliants future financial performance. After completion of remaining client transactions, all operations at SVB Alliant were ceased as of March 31, 2008.
Loss from Cash Settlement of Conversion Premium of Zero-Coupon Convertible Subordinated Notes
During the three months ended June 30, 2008, but prior to the maturity date of our 2003 Convertible Notes, we received a conversion notice to convert notes in the total principal amount of $7.8 million. Consistent with prior early conversions, we elected to settle the conversion fully in cash and paid a total of $11.6 million in cash,
62
which included $3.9 million representing the conversion premium value of the converted notes. Accordingly, we recorded a non-tax deductible loss of $3.9 million as noninterest expense. In connection with this early conversion settlement payment, we exercised call options pursuant to our call-spread arrangement and received a corresponding cash payment of $3.9 million from the counterparty which was recorded as an increase in SVB Financials stockholders equity of $3.9 million. As a result, the $3.9 million in noninterest expense we recorded due to this early conversion settlement had no net impact on our total equity.
(Reduction of) Provision for Unfunded Credit Commitments
We calculate the (reduction of) provision for unfunded credit commitments based on the credit commitments outstanding, as well as the credit quality of our loan commitments. We recorded a reduction in the provision of $1.4 million in 2009, compared to a provision of $1.3 million in 2008 and reduction in the provision of $1.2 million in 2007. The reduction in provision in 2009 was primarily reflective of a decrease in the balance of our unfunded credit commitments due to expirations and reductions in credit lines to certain clients, as well as lower utilization of commitments by borrowers, partially offset by an increase in historical loan loss factors applied to our unfunded portfolio. Total unfunded credit commitments were $5.3 billion at December 31, 2009, compared to $5.6 billion at December 31, 2008.
The provision in 2008 was primarily reflective of the expected impact from the continuing deterioration in overall economic conditions. The reduction in the provision in 2007 was primarily a result of the positive impact of the decrease in our allowance for loan losses as a percentage of gross loans, which decreased by nine basis points from 1.22 percent of total gross loans at December 31, 2006 to 1.13 percent at December 31, 2007. This positive impact was partially offset by an increase in our total unfunded credit commitments, which increased by $880.2 million to $4.9 billion at December 31, 2007, compared to $4.1 billion at December 31, 2006.
Other Noninterest Expense
A summary of other noninterest expense for 2009, 2008 and 2007 is as follows:
(Dollars in thousands) |
Year ended December 31, | ||||||||||||||
2009 | 2008 | % Change 2009/2008 |
2007 | % Change 2008/2007 |
|||||||||||
Tax credit fund amortization |
$ | 4,614 | $ | 3,853 | 19.8 | % | $ | 3,173 | 21.4 | % | |||||
Telephone |
4,202 | 5,276 | (20.4 | ) | 5,404 | (2.4 | ) | ||||||||
Data processing services |
3,025 | 4,235 | (28.6 | ) | 3,841 | 10.3 | |||||||||
Postage and supplies |
2,985 | 3,939 | (24.2 | ) | 3,814 | 3.3 | |||||||||
Other |
9,897 | 8,704 | 13.7 | 8,174 | 6.5 | ||||||||||
Total other noninterest expense |
$ | 24,723 | $ | 26,007 | (4.9 | ) | $ | 24,406 | 6.6 | ||||||
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Net Loss (Income) attributable to Noncontrolling Interests
Net loss (income) attributable to noncontrolling interests is primarily related to the noncontrolling interest holders portion of investment gains or losses and management fees in our managed funds. Net interest income attributable to noncontrolling interests represent interest earned on loans held by one of our sponsored debt funds. Noninterest income consists of investment gains and losses from our consolidated funds and gains or losses recognized from the exercise of warrants held by one of our sponsored debt funds. Noninterest expense is primarily related to management fees paid by our managed funds to the Company as the general partner and one of our consolidated sponsored debt funds for funds management. A summary of net loss (income) attributable to noncontrolling interests for 2009, 2008 and 2007 is as follows:
(Dollars in thousands) |
Year ended December 31, | |||||||||||||||||
2009 | 2008 | % Change 2009/2008 |
2007 | % Change 2008/2007 |
||||||||||||||
Net interest loss (income) (1) |
$ | 18 | $ | (470 | ) | (103.8 | )% | $ | (1,296 | ) | (63.7 | )% | ||||||
Noninterest loss (income) (1) |
26,278 | 6,631 | NM | (35,504 | ) | (118.7 | ) | |||||||||||
Noninterest expense (1) |
12,451 | 11,115 | 12.0 | 10,681 | 4.1 | |||||||||||||
Carried interest (2) |
(1,377 | ) | 1,863 | (173.9 | ) | (2,477 | ) | (175.2 | ) | |||||||||
Net loss (income) attributable to noncontrolling interests |
$ | 37,370 | $ | 19,139 | 95.3 | $ | (28,596 | ) | (166.9 | ) | ||||||||
NM- Not meaningful
(1) | Represents noncontrolling interests share in net interest income, noninterest income, and noninterest expense. |
(2) | Represents the change in the preferred allocation of income we earn as general partners managing two of our managed funds of funds and the preferred allocation earned by the general partner entity managing one of our consolidated sponsored debt funds. |
Income Taxes
Effective January 1, 2009, we adopted new accounting standards (ASC 810-10-65, formerly known as SFAS No. 160), which requires us to clearly identify and distinguish between the interests of the Company and the interests of the noncontrolling owners by presenting noncontrolling interests after net income in our consolidated statements of income. As a result, our effective tax rate is calculated by dividing income tax expense by the sum of income before income tax expense and the net loss (income) attributable to noncontrolling interests.
Our effective tax rate for 2009 was 42.3 percent, compared to 41.3 percent for both 2008 and 2007. The increase in the tax rate in 2009 was primarily attributable to the tax impact of the $4.1 million non-tax deductible goodwill impairment associated with eProsper in the first quarter of 2009 as well as the tax impact of higher non-deductible officers compensation expense on overall pre-tax income.
On January 1, 2007, we adopted the provisions of ASC 740 (formerly known as FIN 48). This guidance clarifies the accounting for uncertainty in income taxes recognized in the entitys financial statements. Our adoption of this guidance did not result in a cumulative effect adjustment to retained earnings.
Operating Segment Results
We have four operating segments in which we report our financial information: Global Commercial Bank, Relationship Management, SVB Capital and Other Business Services.
In July 2007, we reached a decision to cease operations at SVB Alliant, our investment banking subsidiary, which provided advisory services in the areas of mergers and acquisitions, corporate finance, strategic alliances and private placements. We elected to have SVB Alliant complete a limited number of client transactions before
64
finalizing its shut-down. As of March 31, 2008, all such client transactions had been completed, and all operations at SVB Alliant were ceased. Accordingly, SVB Alliant was no longer reported as an operating segment as of the second quarter of 2008. The results of operations for SVB Alliant have been included as part of the Reconciling Items column for the current as well as all prior periods presented.
In accordance with ASC 280 (formerly known as SFAS No. 131), we report segment information based on the management approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of our reportable segments. Please refer to the discussion of our segment organization in Note 21Segment Reporting of the Notes to the Consolidated Financial Statements under Part II, Item 8 in this report.
Our primary source of revenue is from net interest income, which is primarily the difference between interest earned on loans, net of funds transfer pricing (FTP), and interest paid on deposits, net of FTP. Accordingly, our segments are reported using net interest income, net of 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. FTP is calculated by applying a transfer rate to pooled, or aggregated, loan and deposit volumes.
We also evaluate performance based on provision for loan losses, noninterest income and noninterest expense, which are presented as components of segment operating profit or loss. In calculating each operating segments noninterest expense, we consider the direct costs incurred by the operating segment as well as certain allocated direct costs. As part of this review, we allocate certain corporate overhead costs to a corporate account. We do not allocate income taxes to our segments. Additionally, our management reporting model is predicated on average asset balances; therefore, period-end asset balances are not presented for segment reporting purposes.
Changes in an individual clients primary relationship designation have resulted, and in the future may result, in the inclusion of certain clients in different segments in different periods. Previously, we reported based on three operating segments: Commercial Banking, SVB Capital, and Other Business Services. Additionally, we made certain changes effective January 1, 2009 as follows: (i) FDIC and state bank assessments are reported in noninterest expense within Global Commercial Bank, whereas previously these were recognized in noninterest expense under the Reconciling Items column; and (ii) we report the provision for loan losses by reportable segments, whereas previously the provision for loan losses was recognized under the Reconciling Items column. We have reclassified all prior period amounts to conform to the current periods presentation.
The following is our segment information for 2009, 2008 and 2007, respectively.
Global Commercial Bank
(Dollars in thousands) |
Year ended December 31, | |||||||||||||||||
2009 | 2008 | % Change 2009/2008 |
2007 | % Change 2008/2007 |
||||||||||||||
Net interest income |
$ | 360,046 | $ | 332,349 | 8.3 | % | $ | 346,523 | (4.1 | )% | ||||||||
Provision for loan losses |
(76,011 | ) | (85,238 | ) | (10.8 | ) | (12,996 | ) | NM | |||||||||
Noninterest income |
107,808 | 131,870 | (18.2 | ) | 116,205 | 13.5 | ||||||||||||
Noninterest expense |
(140,150 | ) | (116,403 | ) | 20.4 | (106,861 | ) | 8.9 | ||||||||||
Income before income tax expense |
$ | 251,693 | $ | 262,578 | (4.1 | ) | $ | 342,871 | (23.4 | ) | ||||||||
Total average loans |
$ | 3,711,943 | $ | 3,663,573 | 1.3 | $ | 2,710,049 | 35.2 | ||||||||||
Total average assets |
3,834,498 | 3,719,872 | 3.1 | 2,740,816 | 35.7 | |||||||||||||
Total average deposits |
8,618,470 | 4,713,768 | 82.8 | 3,815,290 | 23.5 |
NM- Not meaningful
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2009 compared to 2008
Net interest income for Global Commercial Bank (GCB) increased by $27.7 million in 2009, primarily due to an increase in the FTP earned for deposits due to significant deposit growth, decreases in the FTP charge incurred for funded loans due to decreases in market interest rates, as well as an increase in interest income from growth in GCBs loan portfolio. These increases were partially offset by a decrease in the FTP earned for deposits due to decreases in market interest rates, as well as from a decrease in interest income from loans due to a decrease in our average prime-lending rate, which decreased to 4.00 percent in 2009, compared to 5.13 percent in 2008.
The provision for loan losses for GCB of $76.0 million for 2009 was primarily attributable to gross charge-offs primarily from our hardware, software, life sciences, and venture capital/private equity industry portfolios, partially offset by an $11.4 million partial recovery of a single loan that was previously charged off in the first quarter of 2009.
Noninterest income decreased by $24.1 million in 2009, primarily due to a $28.9 million decrease in client investment fees, partially offset by a $3.9 million increase in credit card fees. The decrease in client investment fees was primarily attributable to lower margins earned on certain products owing to historically low rates in the short-term fixed income markets, as well as a decrease in average balances of client investment funds. The increase in credit card fees was primarily due to the transfer of management and processing of our credit card portfolio in-house from a third-party servicer in the end of the first quarter of 2009, as we began to process our credit card business in-house.
Noninterest expense increased by $23.7 million in 2009, primarily due to an increase in FDIC assessments of $13.5 million, an increase in compensation and benefits expense of $5.6 million and an increase in professional services expense of $3.9 million. The increase in FDIC assessments was primarily due to a special assessment fee of $5.0 million, mandated for all banks by the FDIC, an increase in average deposit balances, and an increase in FDIC assessment rates. The increase in compensation and benefits expense was primarily a result of an increase in salaries and wages expense and incentive compensation expense. The increases were primarily due to an increase in the average number of FTE employees at GCB, which increased to 558 in 2009, compared to 531 in 2008. The increase in average FTE was attributable to increases in sales and advisory positions to support our global commercial banking operations. The increase in our incentive compensation expense was driven by the increase in FTE employees at GCB. The increase in professional services fees was primarily due to consulting fees related to certain infrastructure projects, legal fees related to a loan workout, and legal fees incurred on behalf of our clients.
2008 compared to 2007
Net interest income for GCB decreased by $14.2 million in 2008, primarily due to a decrease in interest income from FTP earned for deposits, partially offset by an increase in interest income from the GCBs loan portfolio. The decrease in interest income from FTP earned on deposits was primarily related to decreases in market interest rates, partially offset by increased volumes of deposits from our money market deposit product for early stage clients introduced in May 2007 and our sweep deposit product introduced in late October 2007. The increase in interest income from the GCBs loan portfolio was primarily due to decreases in the FTP charge incurred by the GCB for funded loans and growth in the GCBs loan portfolio, particularly from growth in loans to software clients, venture capital funds for capital calls and life science clients. These increases were partially offset by a decrease in our average prime-lending rate to 5.13 percent in 2008, compared to 8.05 percent in 2007.
The provision for loan losses for GCB of $85.2 million for 2008 was primarily attributable to $23 million in reserves for HRJ credit facilities, with the remaining reflecting the need for increased reserves for the overall loan portfolio due to two factors: (i) the deterioration in the macroeconomic environment and its expected impact on our loan portfolio; and (ii) the increase in actual loans outstanding.
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Noninterest income increased by $15.7 million in 2008, primarily due to fee income growth, largely driven by an $8.5 million increase in deposit service charges and a $7.4 million increase in foreign exchange fees. The increase in deposit service charges was primarily attributable to a decrease in the credit received by clients due to decreases in short-term market interest rates. The increase in foreign exchange fees was primarily due to increased client trading activity.
Noninterest expense increased by $9.5 million in 2008, primarily due to an increase in compensation and benefits expense of $6.4 million, an increase in FDIC assessments of $2.7 million and an increase in professional services expense of $2.4 million, partially offset by a decrease in occupancy expense of $0.9 million. The increase in compensation and benefits expense was primarily a result of a $7.2 million increase in salaries and wages expense, primarily due to an increase in the average number of FTE employees at GCB, which increased to 531 in 2008, compared to 499 in 2007. The increase in average FTE was attributable to increases in sales and advisory positions to support our commercial banking operations. This increase was partially offset by decreases in our incentive compensation plans and ESOP expense, as a result of actual 2008 annual financial results being below our expectations. The increase in FDIC assessments relates primarily to an increase in average deposit balances, and an increase in fee rates. The increase in professional services fees was primarily due to consulting fees related to certain infrastructure projects. The decrease in net occupancy costs was primarily due to lease exit costs recognized in the second quarter of 2007.
Relationship Management
(Dollars in thousands) |
Year ended December 31, | |||||||||||||||||
2009 | 2008 | % Change 2009/2008 |
2007 |