EX-13.1 3 exhibit13-1.txt ------------------------------------------ [GRAPHIC OMITTED] SVB FINANCIAL SERVICES, INC. ------------------------------------------ ------------------------------------------ [GRAPHIC OMITTED] SVB FINANCIAL SERVICES, INC. ------------------------------------------ Table of Contents 2: SELECTED CONSOLIDATED FINANCIAL INFORMATION 3: LETTER TO THE SHAREHOLDERS 4: CONSOLIDATED BALANCE SHEETS 5: CONSOLIDATED STATEMENTS OF INCOME 6: CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY 7: CONSOLIDATED STATEMENTS OF CASH FLOWS 8: NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 21: REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 22: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SVB FINANCIAL SERVICES, INC. Selected Consolidated Financial Information
As of or For the Years Ended ================================================================================================================ (in thousands except per share data) 2002 2001 2000 1999 1998 ================================================================================================================ INCOME STATEMENT DATA: Interest Income $ 20,848 $ 19,867 $ 17,945 $ 14,412 $ 12,466 Interest Expense 7,471 9,030 7,972 6,093 5,665 ---------------------------------------------------------------------------------------------------------------- Net Interest Income 13,377 10,837 9,973 8,319 6,801 Provision for Loan Losses 455 365 375 440 300 ---------------------------------------------------------------------------------------------------------------- Net Interest Income After Provision for Loan Losses 12,922 10,472 9,598 7,879 6,501 Non-Interest Income 1,732 1,329 991 787 770 Non-Interest Expense 10,764 9,009 8,182 6,496 5,302 ---------------------------------------------------------------------------------------------------------------- Income Before Income Taxes 3,890 2,792 2,407 2,170 1,969 Income Tax Expense 1,435 1,048 900 815 766 ---------------------------------------------------------------------------------------------------------------- Net Income $ 2,455 $ 1,744 $ 1,507 $ 1,355 $ 1,203 ================================================================================================================ BALANCE SHEET DATA: Total Assets $404,984 $328,305 $241,630 $206,107 $185,227 Federal Funds Sold and Other Short Term Investments 28,071 15,104 78 2,400 11,290 Interest Bearing Time Deposits 13,839 9,670 8,075 5,283 4,090 Securities Available for Sale 46,569 29,052 33,303 27,216 21,523 Securities Held to Maturity 56,209 41,509 6,337 5,122 15,052 Loans, Net 235,399 207,280 177,251 151,425 120,176 Deposits 364,422 297,474 222,384 189,562 169,714 Other Borrowings 9,214 5,747 325 -- -- Guaranteed Preferred Beneficial Interest in the Corporation Subordinated Debentures 6,500 4,000 -- -- -- Shareholders' Equity 23,178 19,628 17,366 15,364 14,365 ================================================================================================================ PERFORMANCE RATIOS: Return on Average Assets .65% .61% .67% .69% .75% Return on Average Equity 11.46% 9.49% 9.43% 9.19% 8.82% Net Interest Margin 3.81% 4.02% 4.73% 4.53% 4.46% ================================================================================================================ ASSET QUALITY: Loans Past Due Over 90 Days $ -- $ -- $ -- $ -- $ 5 Non-Accrual Loans 658 510 482 692 96 Net Charge Offs 159 77 102 101 71 Allowance for Loan Losses to Total Loans 1.01% 1.01% 1.02% 1.01% 1.00% ================================================================================================================ PER SHARE DATA (1): Earnings Per Share - Basic $ .68 $ .50 $ .45 $ .40 $ .36 Earnings Per Share - Diluted .67 .49 .43 .39 .34 Book Value 6.35 5.64 5.07 4.50 4.27 ================================================================================================================ CAPITAL RATIOS: Total Risked-Based Capital 11.09% 10.39% 9.68% 10.17% 11.14% Tier I Risked-Based Capital 10.22% 9.50% 8.71% 9.21% 10.24% Leverage Capital 7.53% 7.86% 7.31% 7.56% 8.54% ================================================================================================================
(1) All data has been retroactively restated for stock splits and stock dividends. 2 [PHOTO OMITTED] /s/ John K. Kitchen John K. Kitchen CHAIRMAN OF THE BOARD Dear Shareholders: A new era of uncertainties caused by threats against our homeland, a possibility of our country at war, and a sluggish economy not quite able to manage a sustainable recovery, has forced our nation's businesses to become more agile in their response to these challenges. In meeting these challenges, SVB Financial Services, Inc., through its subsidiary, Somerset Valley Bank has continued to grow, improve its profitability, and flourish by focusing on products and services that have been well received and sought after by its customer base in a very healthy market area. Although our Net Interest Margin contracted slightly from 4.02% in 2001 to 3.81% in 2002 due to further Federal Reserve rate cuts, increased loan volume, fee income, and gains on sales of loans and securities led to an increase of our net income to $2,455,000 or 41% over 2001. This represents the highest earnings reported in the Company's history and validates the course we have followed relative to aggressive but orderly expansion and our focus on cost containment and investment in technology. Our entrance into markets contiguous to our roots in Somerset County has regionalized our presence and our recent branch openings in Bernards Township, Aberdeen, Edison, and Warren Township have helped the Bank reach record deposit and asset levels. Deposits grew from $297,474,000 in 2001 to $364,422,000 in 2002 or an increase of 23%. Total assets reached another milestone breaking $400,000,000 and ending the year at $404,984,000, a 23% increase over $328,305,000 reported for 2001. To augment this exceptional growth in 2002, we have received regulatory approval to open our eleventh banking office on Middlesex Avenue in the Borough of Metuchen and are negotiating for additional sites in late 2003 and early 2004. Both sites will be outside of Somerset County further increasing our penetration into additional markets. Loans continue to drive the growth and profitability of the bank and 2002 produced another double-digit growth rate with net loans reaching $235,399,000, up from $207,280,000 in 2001 or an increase of 14%. Asset Quality remained exceptionally strong with no loan past due over 90 days and loans in a non-accrual status totaled $658,000 or .28% of total loans. To hedge against a potential out flow of deposits when the stock market improves, the Company has embarked on a program of offering non-traditional bank products as allowed by The Gramm-Leach-Bliley Act. We have undertaken the task of retraining customer service representatives to be more skilled in cross-selling bank products and licensed to sell fixed annuities and various insurance products. We also have entered into a strategic alliance with Linsco Private Ledger to enable the Banks through a dual employee arrangement to obtain commissions for the sale of variable annuities, mutual funds, and other investment products. Although this is a relatively new arrangement, we have had significant activity and positive acceptance by both our customers and our staff. This year has provided very positive results for our shareholder value with the stock closing at $16.20 per share, an increase of 70% over December 31, 2001 when the stock closed at $9.53 per share as adjusted for the stock dividend. A fourth consecutive 5% stock dividend was distributed to our shareholders on November 29, 2002. We are confident that our strategic plan for taking the company forward will continue to significantly enhance shareholder value. We would also like to assure you that in light of recent corporate malfeasance and accounting scandals, the company is taking steps, with the advice of counsel, to be sure we are in compliance with all elements of corporate governance requirements imposed upon public companies by the Sarbanes Oxley Act of 2002 and the rules formulated in accordance with that act by NASDAQ, our listing agency. You should also be aware, that banks, unlike most public companies are regulated and examined on a regular basis by the FDIC, the State Department of Banking and Insurance, along with the Banks internal audit firm, and an independent certified public accounting firm chosen by the Bank's Audit Committee. The officers, directors, and staff of your company fully understand the challenges that face us and all companies in the coming months. We are confident that we have the experience, agility, and the dedication to meet those challenges, to recognize both difficulties and opportunities, and to continue to manage the successful growth and viability of your investment. As always we appreciate your continued support and confidence. [PHOTO OMITTED] /s/ Robert P. Corcoran Robert P. Corcoran PRESIDENT AND CHIEF EXECUTIVE OFFICER 3 SVB FINANCIAL SERVICES, INC. Consolidated Balance Sheets AS OF DECEMBER 31, 2002 AND 2001 ================================================================================ (in thousands) 2002 2001 ================================================================================ ASSETS Cash & Due from Banks $ 11,672 $ 16,583 Federal Funds Sold 20,778 9,585 Other Short Term Investments 7,293 5,519 -------------------------------------------------------------------------------- Total Cash and Cash Equivalents 39,743 31,687 -------------------------------------------------------------------------------- Interest Bearing Time Deposits 13,839 9,670 Securities Available for Sale, at Fair Value 46,569 29,052 Held to Maturity, (Fair Value $57,097 in 2002 56,209 41,509 and $41,829 in 2001) -------------------------------------------------------------------------------- Total Securities 102,778 70,561 -------------------------------------------------------------------------------- Loans 238,185 209,592 Allowance for Loan Losses (2,407) (2,111) Unearned Income (379) (201) -------------------------------------------------------------------------------- Net Loans 235,399 207,280 -------------------------------------------------------------------------------- Premises & Equipment, Net 5,660 5,164 Bank Owned Life Insurance 3,000 -- Other Assets 4,565 3,943 -------------------------------------------------------------------------------- Total Assets $404,984 $328,305 ================================================================================ LIABILITIES & SHAREHOLDERS' EQUITY LIABILITIES Deposits Demand Non-interest Bearing $ 54,221 $ 40,993 NOW 73,426 56,965 Savings 41,314 35,200 Money Market 49,951 37,131 Time Greater than $100,000 27,504 26,865 Less than $100,000 118,006 100,320 -------------------------------------------------------------------------------- Total Deposits 364,422 297,474 -------------------------------------------------------------------------------- Other Borrowings 9,214 5,747 Obligation Under Capital Lease 411 419 Guaranteed Preferred Beneficial Interest in the Corporation Subordinated Debentures 6,500 4,000 -------------------------------------------------------------------------------- Total Borrowings 16,125 10,166 -------------------------------------------------------------------------------- Other Liabilities 1,259 1,037 -------------------------------------------------------------------------------- Total Liabilities 381,806 308,677 -------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY Common Stock, $2.09 Par Value: 20,000,000 7,631 6,932 Shares Authorized; 3,651,003 Shares in 2002 and 3,316,724 Shares in 2001 Issued and Outstanding Additional Paid-in Capital 12,041 8,690 Retained Earnings 3,111 3,762 Accumulated Other Comprehensive Income 395 244 -------------------------------------------------------------------------------- Total Shareholders' Equity 23,178 19,628 -------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $404,984 $328,305 ================================================================================ The accompanying notes to consolidated financial statements are an integral part of these statements. 4 SVB FINANCIAL SERVICES, INC. Consolidated Statements of Income FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
=============================================================================================== (in thousands except per share data) 2002 2001 =============================================================================================== INTEREST INCOME Loans $ 16,080 $ 15,872 Securities Available for Sale 1,649 1,592 Securities Held to Maturity 2,227 1,264 Other Short Term Investments 82 38 Interest Bearing Time Deposits 542 546 Federal Funds Sold 268 555 ----------------------------------------------------------------------------------------------- Total Interest Income 20,848 19,867 ----------------------------------------------------------------------------------------------- INTEREST EXPENSE Deposits 6,798 8,820 Other Borrowings 351 60 Obligation Under Capital Lease 31 36 Guaranteed Preferred Beneficial Interest in the Corporation Subordinated Debentures 291 114 ----------------------------------------------------------------------------------------------- Total Interest Expense 7,471 9,030 ----------------------------------------------------------------------------------------------- Net Interest Income 13,377 10,837 PROVISION FOR LOAN LOSSES 455 365 ----------------------------------------------------------------------------------------------- Net Interest Income after Provision for Loan Losses 12,922 10,472 ----------------------------------------------------------------------------------------------- OTHER INCOME Service Charges on Deposit Accounts 842 771 Gains/(Losses) on the Sale of Securities Available for Sale, Net 145 (11) Gains on the Sale of Loans 205 225 Other Income 540 344 ----------------------------------------------------------------------------------------------- Total Other Income 1,732 1,329 ----------------------------------------------------------------------------------------------- OTHER EXPENSE Salaries and Employee Benefits 5,477 4,538 Occupancy Expense 1,591 1,389 Equipment Expense 561 490 Other Expenses 3,135 2,592 ----------------------------------------------------------------------------------------------- Total Other Expense 10,764 9,009 ----------------------------------------------------------------------------------------------- Income Before Provision for Income Taxes 3,890 2,792 Provision for Income Taxes 1,435 1,048 ----------------------------------------------------------------------------------------------- NET INCOME $ 2,455 $ 1,744 =============================================================================================== EARNINGS PER SHARE - BASIC (1) $ .68 $ .50 =============================================================================================== EARNINGS PER SHARE - DILUTED (1) $ .67 $ .49 ===============================================================================================
(1) Amounts have been restated for stock dividends. The accompanying notes to consolidated financial statements are an integral part of these statements. 5 SVB FINANCIAL SERVICES, INC. Consolidated Statement of Changes in Shareholders' Equity FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
ACCUMULATED ADDITIONAL OTHER TOTAL COMMON PAID-IN RETAINED COMPREHENSIVE COMPREHENSIVE SHAREHOLDERS' (in thousands) STOCK CAPITAL EARNINGS INCOME/(LOSS) INCOME EQUITY =========================================================================================================================== BALANCE, JANUARY 1, 2001 $6,490 $7,483 $3,454 $(61) $17,366 --------------------------------------------------------------------------------------------------------------------------- Issuance of Common Stock, Net 118 122 240 5% Stock Dividend 330 1,105 (1,436) (1) Stock Repurchase and Retirement (6) (20) (26) Net Income 1,744 $1,744 1,744 Accumulated Other Comprehensive Income Net of Reclassification Adjustments and Taxes 305 305 305 ------ Total Comprehensive Income $2,049 =========================================================================================================================== BALANCE, DECEMBER 31, 2001 6,932 8,690 3,762 244 19,628 --------------------------------------------------------------------------------------------------------------------------- Issuance of Common Stock, Net 338 612 950 5% Stock Dividend 361 2,739 (3,106) (6) Net Income 2,455 $2,455 2,455 Accumulated Other Comprehensive Income Net of Reclassification Adjustments and Taxes 151 151 151 ------ Total Comprehensive Income $2,606 =========================================================================================================================== BALANCE, DECEMBER 31, 2002 $7,631 $12,041 $3,111 $395 $23,178 ===========================================================================================================================
The accompanying notes to consolidated financial statements are an integral part of these statements. 6 SVB FINANCIAL SERVICES, INC. Consolidated Statements of Cash Flows FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
========================================================================================= (in thousands) 2002 2001 ========================================================================================= OPERATING ACTIVITIES Net Income $ 2,455 $ 1,744 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities Provision for Loan Losses 455 365 Depreciation and Amortization 638 593 Amortization of Securities Premium 561 112 (Gains)/Losses on the Sale of Securities Available for Sale (145) 11 Gains on the Sale of Loans (205) (225) Increase in Other Assets (699) (650) Increase/(Decrease) in Other Liabilities 222 (92) Increase in Unearned Income 178 57 ----------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 3,460 1,915 ========================================================================================= INVESTING ACTIVITIES Increase in Interest Bearing Time Deposits (4,169) (1,595) Proceeds from the Sale of Securities Available for Sale 7,592 767 Proceeds from Maturities of Securities Available for Sale 16,195 20,418 Held to Maturity 31,800 8,237 Purchases of Securities Available for Sale (41,143) (16,439) Held to Maturity (46,849) (43,565) Increase in Loans, Net (28,547) (30,226) Capital Expenditures (1,134) (901) Purchase of Bank Owned Life Insurance (3,000) -- ----------------------------------------------------------------------------------------- Net Cash Used for Investing Activities (69,255) (63,304) ========================================================================================= FINANCING ACTIVITIES Net Increase in Demand Deposits 29,689 28,121 Net Increase in Savings Deposits 6,114 18,504 Net Increase in Money Market Deposits 12,820 14,305 Net Increase in Time Deposits 18,325 14,160 Proceeds of Other Borrowings 3,467 5,422 Decrease in Obligation Under Capital Lease (8) (7) Issuance of Guaranteed Preferred Beneficial Interest in the Corporation Subordinated Debentures 2,500 4,000 Proceeds from the Issuance of Common Stock, Net 950 240 Purchase of Common Stock, Net -- (26) Cash in Lieu of Fractional Shares from Cash Dividend (6) (1) ----------------------------------------------------------------------------------------- Net Cash Provided by Financing Activities 73,851 84,718 Increase in Cash and Cash Equivalents 8,056 23,329 Cash and Cash Equivalents, Beginning of Year 31,687 8,358 ----------------------------------------------------------------------------------------- Cash and Cash Equivalents, End of Year $ 39,743 $ 31,687 ========================================================================================= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash Paid During the Year for Interest $ 7,559 $ 9,133 ========================================================================================= Cash Paid During the Year for Federal Income Taxes $ 1,495 $ 1,043 =========================================================================================
The accompanying notes to consolidated financial statements are an integral part of these statements. 7 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements 1: ORGANIZATION AND NATURE OF OPERATIONS SVB Financial Services, Inc., (the "Company") is a one bank holding company, of Somerset Valley Bank (the "Bank"). The Somerset Valley Investment Company, Inc. is a wholly owned subsidiary of the Bank. West End One Corp. is a wholly owned subsidiary of Somerset Valley Investment Company and is incorporated in the state of Delaware. The Bank is a full service community bank and operates at locations in Somerville, Hillsborough, Bridgewater, Manville, Bernards, Warren, Aberdeen and Edison, New Jersey. The Bank's customers are predominately small and middle market businesses and professionals. The Bank's market area is primarily Somerset County, but it does obtain business from the adjacent counties of Middlesex, Hunterdon, Monmouth, Mercer and Morris. The Bank competes with other banking and financial institutions in its primary market area, including financial institutions with resources substantially greater than its own. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for deposits and for all types of loans. Such institutions, as well as consumer finance and insurance companies, may be considered competitors of the Bank with respect to one or more of the services they render. In addition to being subject to competition from other financial institutions, the Bank is subject to federal and state laws and to regulations of certain federal agencies, and accordingly, it is periodically examined by those regulatory agencies. 2: SIGNIFICANT ACCOUNTING POLICIES BASIS OF FINANCIAL STATEMENT PRESENTATION: The consolidated financial statements include the accounts of the Bank and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation and certain reclassifications are made when necessary to conform the previous years' financial statements to the current year's presentation. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The principal estimate that is particularly susceptible to significant change in the near term relates to the allowance for loan losses. The evaluation of the adequacy of the allowance for loan losses includes an analysis of the individual loans and overall risk characteristics and size of the different loan portfolios, and takes into consideration current economic and market conditions, the capability of specific borrowers to pay specific loan obligations and current loan collateral values. However, actual losses on specific loans, which are also encompassed in the analysis, may vary from estimated losses. These estimates are reviewed periodically, and as adjustments become necessary, they are reflected in operations in the period in which they become known. SECURITIES: The Company accounts for securities in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." A portion of the Company's securities are carried at cost adjusted for amortization of premiums and accretion of discounts using the interest method. These securities are carried at amortized cost because the Company has the ability and intent to hold the securities to maturity and are classified as such. The remainder of the Company's securities are held for indefinite periods of time. These securities which management intends to use as part of its asset/liability strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk, increased capital requirements or other similar factors, are classified as available for sale. These securities are carried at fair value with unrealized gains and losses excluded from earnings and reported as Other Comprehensive Income/(Loss) in a separate component of shareholders' equity, net of income taxes. The net effect of unrealized gains or losses, caused by marking an available for sale portfolio to market, could cause fluctuations in the level of shareholders' equity and equity-related financial ratios as market interest rate changes cause the market value of fixed rate securities to fluctuate. Realized gains and or losses on securities available for sale are determined on a specific identification basis and are included in the consolidated statements of income. The Company had no securities held for trading purposes at December 31, 2002 and 2001. SFAS No. 133, As amended by SFAS No. 138, "Accounting for Certain Derivative Financial Instruments and Certain Hedging Activities," established accounting and reporting standards for derivitive instruments, including certain derivitive instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivitives as either assets or liabilities in the Statement of Financial Position and measure those instruments at fair value. The Company adopted SFAS No. 138 as amended, and the adoption did not have a material impact on its financial position or results of operations. SFAS No. 119 "Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments" requires disclosures about financial instruments, which are defined as futures, forwards, swap and option contracts and other financial instruments with similar characteristics. On-balance sheet receivables and payables are excluded from this definition. The Company did not hold any derivative financial instruments as defined by SFAS No. 119 at December 31, 2002 or 2001. 8 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements LOANS: Loans, which management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal, adjusted for any charge-offs, the allowance for loan losses and any deferred fees or costs on originated loans. Loans are stated at the principal amount outstanding. Net loans represent the principal loan amount outstanding reduced by unearned income and allowance for loan losses. The Company accounts for impaired loans under SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures." This standard requires that a creditor measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. The Bank accounts for its transfers and servicing assets in accordance with SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," which revised the accounting and reporting for transfers and servicing of financial assets and extinguishments of liabilities. SFAS No. 140 was effective for transfers and servicing of financial assets and extinguishments of liabilities after March 31, 2001. The Company periodically sells certain commercial and mortgage loans to other financial institutions without recourse to the Company. The gains and losses are recognized in an amount which approximates the present value of the difference between the effective interest rate to the Company and the net yield to the purchaser, excluding normal future loan servicing fees, when applicable, over the estimated remaining lives of the loans sold. Interest on loans is credited to operations primarily based upon the principal amount outstanding. When management believes there is sufficient doubt as to the ultimate collectibility of interest on any loan, the accrual of applicable interest is discontinued. Loan origination fees and direct loan origination costs are deferred and are recognized over the estimated life of the related loans as an adjustment of the loan yield. The net loan origination fees recognized as yield adjustments are reflected in total interest income in the consolidated statements of income and the unamortized balance of such net loan origination fees is reported in the consolidated balance sheets as part of unearned income. ALLOWANCE FOR LOAN LOSSES: The Company's process for evaluating the adequacy of the allowance for loan losses has three basic elements: First, the identification of problem loans when they occur; second, the establishment of appropriate allowance for loan losses once specific problem loans are identified; and third, a methodology for establishing general loan loss allowances. The identification of problem loans is achieved mainly through review of specific major loans based on delinquency criteria, size of loan and location and value of collateral property. Specific loss reserves are established for identified problem loans based on reviews of current operating financial information and fair value appraisals. A range of loss allowances is estimated based upon consideration of past experience of originated loans by loan type, year of origination, location of collateral property and loan-to-value ratios. Based upon this process, consideration of the current economic environment and other factors, management determines what it considers to be an appropriate allowance for loan losses. Although the Company's management believes it has a sound basis for this estimation, actual write-offs incurred in the future are highly dependent upon future events, including the economy of the area in which the Company lends. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgement of information available to them at the time of their examination. On July 6, 2001, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues." SAB No. 102 provides guidance on the development, documentation, and application of a systematic methodology for determining the allowance for loans and leases in accordance with US GAAP. The adoption of SAB No. 102 did not have a material impact on the Company's financial position or results of operations. PREMISES AND EQUIPMENT: Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed primarily on the straight-line method over the shorter of the estimated useful lives of the assets or the term of the related lease. On January 1, 2002, the Company adopted SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 retains the existing requirements to recognize and measure the impairment of long-lived assets to be held and used or to be disposed of by sale. SFAS No. 144 also changes the requirements relating to reporting the effects of a disposal or discontinuation of a segment of a business. The adoption of SFAS No. 144 did not have an impact on the Company's financial position, results of operations, or cash flows. INCOME TAXES: The Company accounts for income taxes under the liability method. 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 principal types of accounts, resulting in 9 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements differences between assets and liabilities for financial statements and tax return purposes, are the allowance for loan losses, depreciation and accretion of securities discounts. EARNINGS PER SHARE: The Company accounts for earnings per share under the provisions of SFAS No. 128, "Earnings Per Share." SFAS No. 128 eliminated primary and fully diluted earnings per share and requires presentation of basic and diluted earnings per share in conjunction with the disclosure of the methodology used in computing such earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. OTHER REAL ESTATE OWNED: Other real estate owned includes foreclosed real estate which is carried at the lower of cost (lesser of carrying value of loan or fair value at date of acquisition) or estimated fair value less selling costs. Any write-down, at or prior to the dates the real estate is considered foreclosed, is charged to the allowance for loan losses. Subsequent write-downs are recorded in other expenses, and expenses incurred in connection with holding such assets and any gains or losses upon their sale are included in other income and expenses. ADVERTISING COSTS: The Company expenses advertising costs as incurred. STATEMENTS OF CASH FLOWS: For purposes of the consolidated statements of cash flows, the Company considers cash, non-interest bearing amounts due from banks, Federal Funds sold and other short term investments to be cash equivalents. Generally, Federal Funds are sold for a 60 day period or less. STOCK BASED COMPENSATION: The Company accounts for stock options under SFAS No. 123, "Accounting for Stock-Based Compensation," which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, the standard permits entities to continue accounting for employee stock options and similar instruments under Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." Entities that continue to account for stock options using APB Opinion No. 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value based method of accounting defined in SFAS No. 123 had been applied. The Company's stock option plans are accounted for under APB Opinion No. 25. In December 2002, SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure" was issued. SFAS No. 148 amends SFAS No. 123 "accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 is effective for fiscal years beginning after December 15, 2002. The expanded annual disclosure requirements have been provided for the year ended December 31, 2002. The adoption of SFAS No. 148 did not have an impact on the financial condition or results of operations of the Company. At December 31, 2002, the Company had three stock option plans. The 1997 Restated Incentive Stock Option Plan is a non-qualified stock option plan. Under this Plan, the Board of Directors may grant options to officers to purchase the Company's stock. Stock options are issued at prices equal to the fair market value at the date of grant. The stock options have a vesting period of one year from the date of issuance. All options under this Plan were distributed as of December 31, 2002 of which 5,523 remain outstanding. The 2000 Incentive Stock Option Plan is a non-qualified stock option plan. Stock options are issued at prices equal to the fair market value at the date of grant. Shares totaling 173,643 are reserved for issuance under this Plan including 90,459 shares outstanding at December 31, 2002. The 2000 Directors Stock Option Plan is a non-qualified stock option plan. Under this Plan, stock options are issued at prices equal to the fair market value at the date of grant. Shares totaling 69,458 are reserved for issuance under this Plan, including 53,420 outstanding at December 31, 2002. 10 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements There were no options granted during 2002. Had compensation costs for the plan year been determined based on the fair value of the options at the grant dates consistent with the method SFAS No. 123 "Accounting for Stock Based Compensation" the Company's net income and earnings per share, basic and diluted, would have been as reduced to the proforma amounts indictated below: Years Ended December 31, ================================================================================ (in thousands) 2002 2001 ================================================================================ Net Income as Reported $ 2,455 $ 1,744 Less: Stock-Based Compensation Costs Under Fair Value Based Method for all Awards -- (101) ========================== Proforma Net Income $ 2,455 $ 1,643 Earnings Per Share Basic As Reported .68 .50 Proforma .68 .47 Earnings Per Share Basic As Reported .67 .49 Proforma .67 .46 ================================================================================ The fair value of each option granted in 2001 is estimated on the date of the grant using Black Scholes pricing model with the following weighted-average assumptions, no dividend yield; expected volatility of 21.58% a risk free interest rate of 4.54% and an expected life of 4.92 years. COMPREHENSIVE INCOME: The Company follows SFAS No. 130, "Reporting Comprehensive Income." This standard requires entities presenting a complete set of financial statements to include details of comprehensive income or loss. Comprehensive income consists of net income or loss for the current period and income, expenses, gains and losses that bypass the income statement and are reported directly in a separate component of equity. The income tax effects allocated to comprehensive income at December 31, are as follows:
================================================================================================================= 2002 2001 ================================================================================================================= BEFORE NET BEFORE TAX NET TAX TAX OF TAX TAX BENEFIT OF TAX (in thousands) AMOUNT (EXPENSE) AMOUNT AMOUNT (EXPENSE) AMOUNT ================================================================================================================= Unrealized Gains on Securities Unrealized Holding Gains Arising During the Period $ 374 $(127) $ 247 $ 450 $(152) $ 298 Less Reclassification Adjustment for Gains (Losses) Realized in Net Income 145 (49) 96 (11) 4 (7) Other Comprehensive Income, Net $ 229 $ (78) $ 151 $ 461 $(156) $ 305 =================================================================================================================
SEGMENT REPORTING: SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for the way public business enterprises report information about operating sements in annual financial statements. The Company has one operating and, accordingly, one reportable segment, "Community Banking." All of the Company's activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, commercial and industrial lending is dependent upon the ability of the Company to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential and commercial mortgage lending. All significant operating decisions are based upon analysis of the Company as one operating segment. 11 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements 3: SECURITIES Information relative to the Company's securities portfolio are as follows:
========================================================================================= GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR (in thousands) COST GAINS LOSSES VALUE ========================================================================================= 2002 AVAILABLE FOR SALE U.S. Treasury Securities $ 502 $ 3 $ -- $ 505 U.S. Government Agency Securities 13,569 304 -- 13,873 Mortgage-Backed Securities 28,250 332 37 28,545 Other Securities 3,650 47 51 3,646 ----------------------------------------------------------------------------------------- $45,971 $ 686 $ 88 $46,569 ========================================================================================= HELD TO MATURITY U.S. Treasury Securities $ 1,016 $ 2 $ -- $ 1,018 U.S. Government Agency Securities 24,499 401 -- 24,900 Mortgage-Backed Securities 28,033 498 30 28,501 Other Securities 2,479 17 -- 2,496 Municipal Securities 182 0 -- 182 ----------------------------------------------------------------------------------------- $56,209 $ 918 $ 30 $57,097 ========================================================================================= 2001 AVAILABLE FOR SALE U.S. Government Agency Securities $13,171 $ 235 $ 4 $13,402 Mortgage-Backed Securities 12,602 134 42 12,694 Other Securities 2,910 46 -- 2,956 ----------------------------------------------------------------------------------------- $28,683 $ 415 $ 46 $29,052 ========================================================================================= HELD TO MATURITY U.S. Government Agency Securities $25,343 $ 335 $ 16 $25,662 Mortgage-Backed Securities 14,075 72 77 14,070 Other Securities 2,091 11 5 2,097 ----------------------------------------------------------------------------------------- $41,509 $ 418 $ 98 $41,829 =========================================================================================
There are no significant concentrations of securities (greater than 10% of shareholders' equity) in any individual security issue. There were no losses on securities sold in 2002. The amortized cost and fair value of securities at December 31, 2002, by contractual maturity, are shown in the table at the right for securities to be held to maturity and available for sale. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. ================================================================================ AMORTIZED FAIR (in thousands) COST VALUE ================================================================================ AVAILABLE FOR SALE Due in 1 year or less $ 5,144 $ 5,202 Due after 1 year through 5 years 11,523 11,818 Mortgage-Backed Securities 28,250 28,545 Other Securities 1,054 1,004 -------------------------------------------------------------------------------- $ 45,971 $ 46,569 ================================================================================ HELD TO MATURITY Due in 1 year or less $ 8,122 $ 8,199 Due after 1 year through 5 years 20,054 20,397 Mortgage-Backed Securities 28,033 28,501 -------------------------------------------------------------------------------- $ 56,209 $ 57,097 ================================================================================ At December 31, 2002, securities having a book value of approximately $9.8 million were pledged to secure public deposits and for other purposes as required by law. 12 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements 4: LOANS The composition of outstanding loans is summarized as follows: ================================================================================ (in thousands) 2002 2001 ================================================================================ Secured by Real Estate: Residential Mortgage $ 73,084 $ 67,598 Commercial Mortgage 102,623 75,905 Construction 25,011 21,438 Commercial & Industrial 24,229 28,105 Loans to Individuals for Automobiles 3,732 6,640 Loans to Individuals 8,592 9,249 Other Loans 914 657 -------------------------------------------------------------------------------- $238,185 $209,592 ================================================================================ There were no loans restructured during 2002. Loans totaling $301,000 were restructured during 2001 and as of December 31, 2002 the outstanding balance remaining on these loans was $257,000. There were no loans past due 90 days or more as to principal and interest and $658,000 in a non-accrual status as of December 31, 2002. There were no loans past due 90 days or more as to principal and interest and $510,000 in a non-accrual status as of December 31, 2001. A loan is considered to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. These loans consist primarily of non-accrual loans but may include performing loans to the extent that situations arise which would reduce the probability of collection in accordance with the contractual terms. As a general rule, a loan that is in arrears in excess of 120 days will be charged off unless circumstances exist that would make charge off unnecessary such as the borrower is in the process of refinancing elsewhere or is liquidating collateral within a short period of time. As of December 31, 2002 there were $844,000 of loans deemed to be impaired. A valuation reserve of $242,000 was recorded for these loans. As of December 31, 2001, there were $685,000 of loans deemed to be impaired, a valuation reserve of $174,000 was recorded for these loans. The Company had loans totaling $25.0 million or 10.5% of total loans outstanding to borrowers engaged in construction activity in 2002. Loans totaling $21.4 million or 10.2% of total loans outstanding to borrowers engaged in construction activity in 2001. The Company continues to pursue new lending opportunities while seeking to maintain a portfolio that is diverse as to industry concentration, type and geographic distribution. The Company's geographic lending area is primarily concentrated in Somerset County, but also includes Middlesex, Hunterdon, Mercer, Morris and Monmouth counties. 5: ALLOWANCE FOR LOAN LOSSES An analysis of the allowance for loan losses is as follows: ================================================================================ (in thousands) 2002 2001 ================================================================================ Balance at January 1, $ 2,111 $ 1,823 Provision Charged to Operations 455 365 Charge Offs (206) (109) Recoveries 47 32 -------------------------------------------------------------------------------- Balance at December 31, $ 2,407 $ 2,111 ================================================================================ 6: PREMISES AND EQUIPMENT Premises and equipment consists of the following at December 31, 2002 and 2001: ================================================================================ ESTIMATED (in thousands) USEFUL LIVES 2002 2001 ================================================================================ Construction in Progress -- $ 30 $ 194 Premises & Improvements 5-30 years 5,541 4,827 Furniture & Equipment 3-10 years 2,930 2,536 -------------------------------------------------------------------------------- 8,501 7,557 Less: Accumulated Depreciation and Amortization (2,841) (2,393) -------------------------------------------------------------------------------- $ 5,660 $ 5,164 ================================================================================ Depreciation and amortization charged to operations was $638,000 and $593,000 for the years ended December 31, 2002 and 2001 respectively. 7: DEPOSITS At December 31, 2002, scheduled maturities of certificates of deposit are as follows:
OVER THREE OVER ONE YEAR THREE MONTHS OR MONTHS THROUGH THROUGH THREE OVER THREE (in thousands) LESS TWELVE MONTHS YEARS YEARS TOTAL ========================================================================================================= $100,000 or more $ 9,412 $ 9,331 $ 7,208 $ 1,553 $ 27,504 Less than $100,000 34,281 54,629 19,026 10,070 118,006 =========================================================================================================
13 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements 8: OTHER EXPENSES The major components of other expenses are as follows: ================================================================================ (in thousands) 2002 2001 ================================================================================ Data Processing Services $ 458 $ 413 Marketing & Business Development 308 244 Stationery, Forms & Supplies 302 280 Insurance 112 175 Legal, Examination & Accounting 275 249 Postage & Telephone 289 224 FDIC Insurance Assessment 100 112 Other, Net 1,291 895 -------------------------------------------------------------------------------- $ 3,135 $ 2,592 ================================================================================ 9: COMMITMENTS AND CONTINGENCIES Based on consultation with the Company's legal counsel, management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Company. There are no proceedings pending other than the ordinary routine litigation incident to the business of the Company and its subsidiaries. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Company or its subsidiaries by government authorities. The Company leases its banking facilities under operating leases which expire at various dates through 2007 and thereafter, but which contain certain renewal options. The Somerville facilities are leased from a partnership consisting of, among others, all but one of the Company's directors. The Company leases its Warren branch from a partnership which consists of among others one of the Company's directors. As of December 31, 2002, future minimum rental payments, under all leases are as follows: (in thousands) ================================================================================ Lease Year Minimum Rental Payments ================================================================================ 2003 $ 1,040 -------------------------------------------------------------------------------- 2004 1,035 -------------------------------------------------------------------------------- 2005 1,058 -------------------------------------------------------------------------------- 2006 982 -------------------------------------------------------------------------------- 2007 863 -------------------------------------------------------------------------------- Thereafter 6,545 -------------------------------------------------------------------------------- $ 11,523 ================================================================================ The amounts in the previous table represent minimum rentals not adjusted for possible future increases due to escalation provisions or the exercise of renewal options by the Company. Rent expenses aggregated $881,000 and $760,000 for the years ended December 31, 2002 and 2001, respectively. The Bank, Investment Company, and West End One Corp. have not entered into any interest rate swaps, caps or floors and are not party to any forward or future transactions. However, the Bank is party to various other financial instruments which are not included in the financial statements, but are required in the normal course of business to meet the financing needs of its customers and to assist in managing its exposure to changes in interest rates. Management does not expect any material losses from these transactions, which include standby letters of credit and commitments to extend credit. The Company had outstanding commitments to extend credit of $40.2 million and $40.1 million at December 31, 2002 and December 31, 2001, respectively. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. There is no material difference between the notional amount and estimated fair value of off-balance sheet unfunded loan commitments as of December 31, 2002. 10: BENEFIT PLAN The Company has a 401(k) Pension Plan covering substantially all employees. Under the terms of the Plan, the Company matched 67% of an employee's contribution in 2002 and 2001, up to 6% of the employee's salary. Employees become fully vested in the Company's contribution after five years of service. The Company contributed $93,000 and $88,000 to the Plan in 2002 and 2001, respectively. During 1999, the Company established a Supplemental Executive Retirement Plan. The Plan covers three of the Company's executive officers. One officer is covered under a defined benefit plan while the remaining two officers are covered under a defined contribution plan. The Company expensed $157,000 in 2002 and $151,000 in 2001, in connection with these plans. 11: INCOME TAXES The components of the provision for income taxes are as follows: ================================================================================ (in thousands) 2002 2001 ================================================================================ Current Federal $ 1,481 $ 1,037 State 160 174 Deferred Benefit (206) (163) -------------------------------------------------------------------------------- $ 1,435 $ 1,048 ================================================================================ Deferred income taxes are provided for the differences between the financial reporting basis and the tax basis of 14 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements the Company's assets and liabilities. Cumulative temporary differences at December 31, are as follows: ================================================================================ (in thousands) 2002 2001 ================================================================================ Start-up and Organization Costs $ (1) $ (1) Depreciation 228 241) Accretion of Securities Discount (62) (48) Allowance for Loan Losses 995 878 Unrealized Gain on Securities (203) (125) Deferred Pension 135 -- Other 262 281 -------------------------------------------------------------------------------- Net Deferred Tax Asset, Included in Other Assets $ 1,354 $ 1,226 ================================================================================ A reconciliation of income taxes calculated at the statutory rate of 34% to the actual income tax provision is as follows: ================================================================================ (in thousands) 2002 2001 ================================================================================ Statutory Provision $ 1,323 $ 949 State Taxes on Income, Net of Federal Tax Benefit 106 115 Non-Deductible Expenses (23) (13) Tax Exempt Interest -- 6 Other 29 (9) -------------------------------------------------------------------------------- $ 1,435 $ 1,048 ================================================================================ 12: EARNINGS PER SHARE The following table illustrates the reconciliation of the numerators and denominators of the basic and diluted EPS computations: ================================================================================ FOR THE YEAR ENDED WEIGHTED PER DECEMBER 31, 2002(1) AVERAGE SHARE (in thousands except per share data) INCOME SHARES AMOUNT ================================================================================ EARNINGS PER SHARE - BASIC Income available to Common Shareholders $2,455 3,598 $.68 Effect of Dilutive Securities Stock Options -- 55 (.01) -------------------------------------------------------------------------------- EARNINGS PER SHARE - DILUTED Income available to Common Shareholders plus assumed conversions $2,455 3,653 $.67 ================================================================================ There were no antidilutive options at December 31, 2002. ================================================================================ FOR THE YEAR ENDED WEIGHTED PER DECEMBER 31, 2001(1) AVERAGE SHARE (in thousands except per share data) INCOME SHARES AMOUNT ================================================================================ EARNINGS PER SHARE - BASIC Income available to Common Shareholders $1,744 3,461 $.50 Effect of Dilutive Securities: Stock Options -- 69 (.01) -------------------------------------------------------------------------------- EARNINGS PER SHARE - DILUTED Income available to Common Shareholders plus assumed conversions $1,744 3,530 $.49 ================================================================================ Antidilutive options totaling 55,125 with the exercise price of $9.52 have been excluded in the computation of 2001 diluted EPS because the options exercise prices were greater than the average market price of the common shares. (1) Adjusted for the 5% stock dividend. 13: SHAREHOLDERS' EQUITY On October 31, 2002, and October 25, 2001 the Company declared 5% stock dividends to shareholders of record as of November 14, 2002 and November 6, 2001, respectively. Accordingly, earnings per share, options and weighted-average shares of common stock have been restated to reflect the stock dividends. On August 31, 2000, the Board of Directors adopted a Stock Buy Back Plan. The purpose of the Plan was to systematically purchase the amount of shares necessary to fund a compensation plan for Bank Advisory Board members. Up to 18,000 shares could have been purchased over a period ending on December 31, 2001. During 2000, shares totaling 2,541 were purchased on the open market at prices ranging from $7.98 to $8.21 as adjusted for the 5% stock dividend. During 2001, shares totaling 2,887 were purchased on the open market at prices ranging from $8.21 to $9.52 as adjusted for the 5% stock dividend. 15 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements 14: STOCK BASED COMPENSATION A summary of the status of the Company's option plans as of December 31 are as follows:
2002(1) 2001(1) ===================================================================================================== WEIGHTED-AVERAGE WEIGHTED-AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE ===================================================================================================== Outstanding at beginning of year 318,878 $ 6.93 331,837 $ 5.90 Options granted -- -- 56,779 9.49 Options exercised (167,255) 5.58 (62,503) 3.83 Options expired or canceled (2,221) 5.35 (7,235) 6.63 ----------------------------------------------------------------------------------------------------- Outstanding at end of year 149,402 $ 8.46 318,878 $ 6.93 =====================================================================================================
(1) Amounts have been restated to show effects of a 5% stock dividend. All options in the table were excercisable at December 31, 2002 and 2001. The following table summarizes information about non-qualified stock options at December 31, 2002: ================================================================================ OPTIONS OUTSTANDING AND EXERCISABLE ===================================== RANGE OF OUTSTANDING AND WEIGHTED-AVERAGE WEIGHTED-AVERAGE EXERCISE EXERCISABLE AT REMAINING EXERCISE PRICES DECEMBER 31, 2002 CONTRACTUAL LIFE PRICE ================================================================================ $ 7.77 - $ 7.95 53,420 2.31 years $ 7.77 $ 7.96 - $ 8.04 5,523 2.15 years $ 7.99 $ 8.05 - $ 9.50 37,505 2.95 years $ 8.05 $ 9.51 - $ 9.75 52,954 3.91 years $ 9.52 ------- 149,402 ================================================================================ 15: OTHER BORROWINGS Other Borrowings consist of advances from the Federal Home Loan Bank of New York. These advances are secured by one to four family mortgage loans. Details with respect to these advances are as follows: ($ in thousands) ================================================================================ WEIGHTED-AVERAGE MATURITY AMOUNT RATE ================================================================================ 2003 $ 3,000 3.55% 2004 1,000 3.84% 2005 1,500 4.16% 2006 500 4.64% 2007 1,500 4.57% ================================================================================ In addition, the Company borrowed an amortizing advance, from Federal Home Loan Bank in the amount of $1,750,000, at a rate of 5.03%. The advance matures in 2006 and payments are made monthly based on a 25-year payout. The balance outstanding at December 31, 2002 was $1,714,000. 16: GUARANTEED PREFERRED BENEFICIAL INTEREST IN THE CORPORATION SUBORDINATED DEBENTURES The Company participates in two pooled institutional placements of trust preferred securities arranged by a third party. The Company purchased the common stock of SVB Bald Eagle Statutory Trust I on July 30, 2001 and funding of the trust preferred securities took place on July 31, 2001. This subordinated debenture will be redeemed in the year 2031. At December 31, 2002, the rate paid on this subordinated debenture of $4.0 million based on 3-month LIBOR plus 358 basis points was 5.34% and is adjusted in January, April, July and October. On June 25, 2002, the Company purchased common stock of SVB Bald Eagle Statutory Trust II and funding of the trust preferred securities took place on June 26, 2002. This subordinated debenture will be redeemed in the year 2032. At December 31, 2002, the rate paid on this subordinated debenture of $2.5 million based on 3-month LIBOR plus 345 basis points was 4.85% and is adjusted in March, June, September and December. 16 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements 17: FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, "Disclosure about Fair Value of Financial Instruments," requires the disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate value. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than a forced or liquidation sale. It is the Company's intent and general practice to hold its financial instruments to maturity and not to engage in trading activities. Therefore, significant estimations were used by the Company for the purposes of this disclosure. Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values. Estimated fair values have been determined by the Company using the best available data and an estimation methodology suitable for each category of financial instruments. The estimation methodology used, the estimated fair values and the recorded book balances at December 31, 2002 and 2001 are outlined below. For short term investments, such as cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.
=========================================================================================== 2002 2001 (in thousands) FAIR VALUE CARRYING VALUE FAIR VALUE CARRYING VALUE =========================================================================================== Cash and Cash Equivalents $ 39,743 $ 39,743 $ 31,687 $ 31,687 ===========================================================================================
For securities held in the Company's investment portfolio, fair value was determined by reference to quoted market prices as of December 31.
=========================================================================================== 2002 2001 (in thousands) FAIR VALUE CARRYING VALUE FAIR VALUE CARRYING VALUE =========================================================================================== Available for Sale Securities $ 46,569 $ 46,569 $ 29,052 $ 29,052 Held to Maturity Securities 57,097 56,209 41,829 41,509 ===========================================================================================
For long term assets and liabilities, such as loans and deposits, the Company's policy is to manage its interest rate exposure on deposits with earning assets with matching maturities. Fair values of loans were estimated using the present value of future cash flows expected to be received. Loan rates currently offered by the Company were used in determining the appropriate discount rate. Deposits with stated maturities have been valued using a present value discounted cash flow with a discount rate approximating current market for similar maturities. Deposits with no stated maturities have an estimated rate of fair value equal to the funds outflow as determined by historical trends.
=========================================================================================== 2002 2001 (in thousands) FAIR VALUE CARRYING VALUE FAIR VALUE CARRYING VALUE =========================================================================================== Loans $240,034 $238,185 $213,075 $209,592 Deposits 364,860 364,422 293,570 297,474
The fair value of commitments to extend credit and letters of credit are considered immaterial. 18: BANKED OWNED LIFE INSURANCE (BOLI) During 2002, the Bank has made investments in Bank Owned Life Insurance (BOLI) policies. The Bank's total investment in BOLI as of December 31, 2002 was approximately $3.0 million. Earnings from BOLI are recognized as other income. 17 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements 19: REGULATORY MATTERS The Company and its subsidiary Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios, set forth in the following tables, of total and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2002, that the Company and its subsidiary Bank met all capital adequacy requirements to which they are subject. As of December 31, 2002 the most recent notification from the Bank's regulatory authority categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based; Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. The improvement in the ratios from 2001 to 2002 was due to the issuance of $2.5 million of subordinated debentures, which may be considered components of Tier 1 Capital. The aggregate amount of these securities may not exceed 25% of all Tier 1 elements at any time. At December 31, 2002, the inclusion of these securities of $6.5 million represents 23% of Tier 1 Capital. At December 31, 2001, the inclusion of these securities of $4.0 million represented 18% of Tier 1 capital. The proceeds from the sale of subordinated debentures were invested by the Company into additional common stock of the Bank, thereby, improving the Bank's capital ratio. The Company and its subsidiary Bank's actual capital amounts and ratios are presented in the following tables.
========================================================================================================================= SVB FINANCIAL SERVICES, INC. AND SOMERSET VALLEY BANK TO BE ADEQUATELY TO BE WELL ACTUAL CAPITALIZED CAPITALIZED -------------------- -------------------- -------------------- ($ in thousands) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ========================================================================================================================= SVB FINANCIAL SERVICES, INC As of December 31, 2002 Total Capital to Risk Weighted Assets $30,617 11.09% $22,080 8.00% -- -- Tier 1 Capital to Risk Weighted Assets $28,210 10.22% $11,040 4.00% -- -- Tier 1 Leverage $28,210 7.53% $14,991 4.00% -- -- ========================================================================================================================= As of December 31, 2001 Total Capital to Risk Weighted Assets $24,548 10.39% $18,898 8.00% -- -- Tier 1 Capital to Risk Weighted Assets $22,437 9.50% $ 9,449 4.00% -- -- Tier 1 Leverage $22,437 7.86% $11,415 4.00% -- -- ========================================================================================================================= SOMERSET VALLEY BANK As of December 31, 2002 Total Capital to Risk Weighted Assets $29,998 10.89% $22,044 8.00% $27,555 10.00% Tier 1 Capital to Risk Weighted Assets $27,591 10.01% $11,022 4.00% $16,533 6.00% Tier 1 Leverage $27,591 7.37% $14,976 4.00% $18,720 5.00% ========================================================================================================================= As of December 31, 2001 Total Capital to Risk Weighted Assets $23,652 10.03% $18,871 8.00% $23,589 10.00% Tier 1 Capital to Risk Weighted Assets $21,541 9.13% $ 9,435 4.00% $14,153 6.00% Tier 1 Leverage $21,541 7.56% $11,402 4.00% $14,252 5.00% =========================================================================================================================
18 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements 20: CONDENSED FINANCIAL INFORMATION FOR SVB FINANCIAL SERVICES, INC. (PARENT COMPANY) IS AS FOLLOWS:
BALANCE SHEET (in thousands) DECEMBER 31, 2002 DECEMBER 31, 2001 ========================================================================================================== ASSETS Cash and Due from Banks $ 261 $ 595 Other Assets 245 161 Investment in Subsidiaries 29,278 22,856 Securities Available for Sale 134 180 ---------------------------------------------------------------------------------------------------------- Total Assets $29,918 $23,792 ========================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Other Liabilities $ 38 $ 40 Guaranteed Preferred Beneficial Interest in the Corporation Subordinated Debentures 6,702 4,124 ---------------------------------------------------------------------------------------------------------- Total Liabilities 6,740 4,164 ========================================================================================================== SHAREHOLDERS' EQUITY Common Stock 7,631 6,932 Additional Paid-in Capital 12,041 8,690 Retained Earnings 3,111 3,762 Accumulated Other Comprehensive Income 395 244 ---------------------------------------------------------------------------------------------------------- Total Shareholders' Equity 23,178 19,628 ---------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $29,918 $23,792 ==========================================================================================================
YEARS ENDED STATEMENT OF INCOME (in thousands) DECEMBER 31, 2002 DECEMBER 31, 2001 ========================================================================================================== OPERATING INCOME Interest Income $ 10 $ 35 Losses on the Sale of Securities Available for Sale -- (20) ---------------------------------------------------------------------------------------------------------- Total Income 10 15 ---------------------------------------------------------------------------------------------------------- OPERATING EXPENSE Interest Expense 291 114 Other Expense 124 81 ---------------------------------------------------------------------------------------------------------- Total Expense 415 195 ---------------------------------------------------------------------------------------------------------- Loss Before Equity in Undistributed Income of Subsidiaries (405) (180) Equity in Undistributed Income of Subsidiaries 2,860 1,924 ---------------------------------------------------------------------------------------------------------- NET INCOME $ 2,455 $ 1,744 ==========================================================================================================
19 SVB FINANCIAL SERVICES, INC. Notes to Consolidated Financial Statements
YEARS ENDED STATEMENTS OF CASH FLOWS (in thousands) DECEMBER 31, 2002 DECEMBER 31, 2001 ========================================================================================================== OPERATING ACTIVITIES Net Income $ 2,455 $ 1,744 Adjustments to Reconcile Net Income to Net Cash Used In Operating Activities: Equity in Undistributed Income of Subsidiaries (2,860) (1,924) Amortization of Organization Costs -- 11 Losses on the Sale of Securities Available for Sale -- 20 Increase in Other Assets (68) (126) (Decrease)/Increase Other Liabilities (2) 40 ---------------------------------------------------------------------------------------------------------- Net Cash Used In Operating Activities (475) (235) ========================================================================================================== INVESTING ACTIVITIES Proceeds from the Sale of Securities Available for Sale -- 51 Purchases of Securities Available for Sale (3) -- Payments for Investments and Advances in Subsidiaries (3,378) (4,124) ---------------------------------------------------------------------------------------------------------- Net Cash Used for Investing Activities (3,381) (4,073) ========================================================================================================== FINANCING ACTIVITIES Proceeds from the Issuance of Long Term Debt 2,578 4,124 Proceeds from the Issuance of Common Stock, Net 950 240 Purchases of Common Stock, Net -- (26) Cash in Lieu of Fractional Shares from Cash Dividend (6) (1) ---------------------------------------------------------------------------------------------------------- Net Cash Provided by Financing Activities 3,522 4,337 (Decrease)/Increase in Cash and Cash Equivalents, Net (334) 29 Cash and Cash Equivalents, Beginning of Year 595 566 ---------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents, End of Year $ 261 $ 595 ==========================================================================================================
20 SVB FINANCIAL SERVICES, INC. Report of Independent Certified Public Accountants Grant Thornton [LOGO] Accountants and Business Advisors Report of Independent Certified Public Accountants Board of Directors and Shareholders SVB Financial Services, Inc. We have audited the accompanying consolidated balance sheets of SVB Financial Services, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the two years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of SVB Financial Services, Inc. and subsidiaries as of December 31, 2002 and 2001, and the consolidated results of their operations and their consolidated cash flows for each of the two years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. /s/ Grant Thornton LLP Philadelphia, Pennsylvania January 24, 2003 Suite 3100 Two Commerce Square 2001 Market Street Philadelphia, PA 19103-7080 T 215.561.4200 F 215.561.1066 W www.grantthornton.com Grant Thornton LLP US Member of Grant Thornton International 21 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations Management of SVB Financial Services, Inc. (the "Company") is not aware of any known trends, events or uncertainties that will have or are reasonably likely to have a material effect on the Company's liquidity, capital resources or results of operations. The following discussion and analysis should be read in conjunction with the detailed information and consolidated financial statements, including notes thereto, included elsewhere in this report. This discussion and analysis generally reviews the financial condition and results of operations of the Company for the quarter and year to date periods ended December 31, 2002 and 2001. Some tables may cover more periods to comply with the Securities and Exchange Commission disclosure requirements or to illustrate trends over a longer period of time. The consolidated financial condition and results of operations of the Company are essentially those of the Bank. Therefore, the analysis that follows is directed to the performance of the Bank. Such financial condition and results of operations are not intended to be indicative of future performance. In addition to historical information, this discussion and analysis contains forward-looking statements. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such a difference include, but are not limited to, those discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations." Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES The Company's business is dynamic and complex. Consequently, management must exercise judgment in choosing and applying accounting policies and methodologies. These choices are important; not only are they necessary to comply with accounting principles generally accepted in the United States, they also reflect the exercise of management's judgment in determining the most appropraite manner in which to record and report the Company's overall financial performance. All accounting policies are important, and all policies contained in Note 2 ("Significant Accounting Policies"), which begins on page 8 of this report, should be reviewed for greater understanding of how the Company's financial performance is recorded and reported. In management's opinion, some areas of accounting are likely to have a more significant effect than others on the Company's financial results and expose those results to potentially greater volatility. This is because they apply to areas of relatively greater business importance and/or require management to exercise judgment in making assumptions and estimates that affect amounts reported in the financial statements. Because these assumptions and estimates are based on current circumstances, they may change over time or prove to be inaccurate based on actual experience. For the Company, the area that relies most heavily on the use of assumptions and estimates includes but is not limited to accounting for the allowance for loan losses. Our accounting policies related to these areas are discussed in Note 2 of this report and further described on page 29 under "Allowance for Loan Losses." RESULTS OF OPERATIONS (A SUMMARY) Net income for the year ended December 31, 2002 was $2,455,000 an increase of $711,000 or 41% from the previous year and represents a record for net income during the Company's eleven year history. Net interest income growth of $2,540,000 or 23% was the major contributor to the growth of net income. Net interest income was heavily impacted by the growth in the Company's average earning assets of $82.0 million, which helped to offset a decline in the net interest margin to 3.81% in 2002 from 4.02% in 2001. This is discussed in greater detail under "Net Interest Income." Non-interest income increased $403,000 or 30%. Gains on the sale of securities accounted for $156,000 of the increase. Other income increased $196,000 on the strength of expansion in mortgage origination as well as non bank product sales and loan servicing income. A detailed discussion is included under "Other Income." Other expenses increased $1,755,000 or 19%. There were a number of factors contributing to the increase including the opening of the Warren office in September 2002 as well as the Company's 23% growth in assets. A detailed discussion is included under "Other Expense." NET INTEREST INCOME Net interest income is the difference between the interest earned on the Company's earning assets and the interest paid on its interest bearing liabilities. It is the Company's principal source of revenue. The following table sets forth for the periods indicated the daily average balances of certain balance sheet items, the interest rate earned on earning assets and the average interest rate paid on interest bearing liabilities, net interest income and the net interest margin. The net interest margin is a major indicator of the profitability of the Company's earning assets. 22 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations SUMMARY OF NET INTEREST INCOME
YEARS ENDED DECEMBER 31, ================================================================================================================================ 2002 2001 2000 ============================ ============================ ============================= AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE ($ in thousands) BALANCE RATE INTEREST BALANCE RATE INTEREST BALANCE RATE INTEREST ================================================================================================================================ ASSETS: Federal Funds Sold $ 18,409 1.46% $ 268 $ 15,281 3.58% $ 555 $ 5,478 6.25% $ 348 Other Short Term Investments 4,977 1.65% 82 1,577 2.41% 38 54 5.56% 3 Interest Bearing Time Deposits 12,339 4.39% 542 8,680 6.29% 546 6,918 6.48% 448 Securities Available for Sale 39,022 4.23% 1,649 27,739 5.74% 1,592 28,818 6.24% 1,799 Held to Maturity 50,859 4.38% 2,227 24,124 5.24% 1,264 4,747 6.28% 298 -------------------------------------------------------------------------------------------------------------------------------- Total Securities 89,881 4.31% 3,876 51,863 5.51% 2,856 33,565 6.25% 2,097 Loans (1) 225,814 7.12% 16,080 192,047 8.26% 15,872 164,875 9.13% 15,049 -------------------------------------------------------------------------------------------------------------------------------- Total Interest Earning Assets $351,420 5.93% $20,848 $269,448 7.37% $19,867 $210,890 8.51% $17,945 Cash and Due from Banks 17,175 10,345 9,295 Allowance for Loan Losses (2,208) (1,955) (1,672) Premises and Equipment, Net 5,561 5,079 4,824 Other Assets 3,867 3,412 2,983 -------------------------------------------------------------------------------------------------------------------------------- Total Assets $375,815 $286,329 $226,320 ================================================================================================================================ LIABILITIES AND SHAREHOLDERS' EQUITY: Deposits Savings $ 41,500 1.72% $ 712 $ 22,154 2.81% $ 622 $ 17,190 2.86% $ 492 Money Market 48,838 1.93% 942 28,988 3.05% 883 24,882 3.62% 900 NOW 64,007 .89% 571 44,400 1.85% 822 32,489 2.43% 788 Time 135,171 3.38% 4,573 126,184 5.15% 6,493 100,028 5.75% 5,755 -------------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Deposits 289,516 2.35% 6,798 221,726 3.98% 8,820 174,589 4.54% 7,935 Federal Funds Purchased -- -- -- 4 -- -- 12 8.33% 1 FHLB Advances 8,183 4.29% 351 1,440 4.11% 60 -- -- -- Obligation Under Capital Lease 415 7.47% 31 422 8.53% 36 429 8.39% 36 Guaranteed Preferred Beneficial Interest in the Corporation Subordinated Debentures 5,294 5.50% 291 1,687 6.66% 114 -- -- -- -------------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Liabilities $303,408 2.46% $ 7,471 $225,279 4.01% $ 9,030 $175,030 4.55% $ 7,972 Demand Deposits 49,837 41,236 34,316 Cost to Fund Earning Assets 2.13% 3.35% 3.78% Other Liabilities 1,329 1,429 987 Shareholders' Equity 21,241 18,385 15,987 -------------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $375,815 $286,329 $226,320 ================================================================================================================================ Net Interest Income $13,377 $10,837 $ 9,973 ================================================================================================================================ Net Interest Margin (2) 3.81% 4.02% 4.73% ================================================================================================================================
(1) Non-accrual loans are included in the average loan balances, but interest on non-accrual loans has not been included for purposes of determining interest income. (2) Net interest margin is defined as net interest income divided by total average earning assets. 23 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table presents the approximate changes in net interest income attributable to either a change in volume or a change in rate.
=============================================================================================================== YEARS ENDED DECEMBER 31, 2002 VS 2001 2001 VS 2000 ======================================================= INCREASE (DECREASE) DUE TO CHANGES IN: (in thousands) VOLUME RATE TOTAL VOLUME RATE TOTAL =============================================================================================================== Increase (Decrease) in Interest Income: Federal Funds Sold $ 96 $ (383) $ (287) $ 403 $ (196) $ 207 Other Short Term Investments 59 (15) 44 38 (3) 35 Interest Bearing Time Deposits 190 (194) (4) 111 (13) 98 Securities Available for Sale 544 (487) 57 (66) (141) (207) Held to Maturity 1,200 (237) 963 1,023 (57) 966 --------------------------------------------------------------------------------------------------------------- Total Securities 1,744 (724) 1,020 957 (198) 759 Loans 2,575 (2,367) 208 2,331 (1,508) 823 --------------------------------------------------------------------------------------------------------------- Total Interest Income $ 4,664 $(3,683) $ 981 $ 3,840 $(1,918) $ 1,922 --------------------------------------------------------------------------------------------------------------- Interest Expense: Deposits Savings $ 397 $ (307) $ 90 $ 139 $ (9) $ 130 Money Market 460 (401) 59 137 (154) (17) NOW 276 (527) (251) 247 (213) 34 Time 435 (2,355) (1,920) 1,392 (654) 738 --------------------------------------------------------------------------------------------------------------- Total Interest Bearing Deposits 1,568 (3,590) (2,022) 1,915 (1,030) 885 Federal Funds Purchased -- -- -- (1) -- (1) FHLB Advances 289 2 291 60 -- 60 Obligations Under Capital Lease (1) (4) (5) -- -- -- Guaranteed Preferred Beneficial Interest in the Corporation Subordinated Debentures 202 (25) 177 114 -- 114 --------------------------------------------------------------------------------------------------------------- Total Interest Expense $ 2,058 $(3,617) $(1,559) $ 2,088 $(1,030) $ 1,058 --------------------------------------------------------------------------------------------------------------- Change in Net Interest Income $ 2,606 $ (66) $ 2,540 $ 1,752 $ (888) $ 864 ---------------------------------------------------------------------------------------------------------------
24 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations It is important to note at the outset of this discussion that the years 2002 and 2001 were periods of historically low interest rates. During 2001, the Federal Reserve reduced its target rate for Federal Funds eleven times. The Federal Funds rate began the year at 6.50% and ended the year at 1.75%. Rates remained at this level, the lowest in forty years until November 2002 when the Federal Reserve reduced this target rate again to 1.25%. The Prime Lending Rate which the bank uses to price a large portion of its loan portfolio fell in lockstep with the Federal Funds rate from 9.50% at the beginning of 2001 to 4.25% at the end of 2002, a forty-one year low. These rates were the result of a weakening national economy since 2000 following a significant downturn in the equity markets. During this period of time, the Company experienced significant growth in both its loans and deposits. The deposit growth can be attributed to the continued expansion of its branch network (the tenth branch was opened in 2002), as well as customers choosing the safety of FDIC insured accounts as opposed to the equity markets. Loans continued to increase as the central New Jersey Market continues to see development and expansion of both a commercial and residential nature. Net Interest Income increased $2,540,000 or 23% in comparison to 2001. During this same period the Company's net interest margin was reduced from 4.02% in 2001 to 3.81% in 2002. The growth in the Company's net interest income was attributed to the growth of the Company's earning assets especially its loan portfolio and securities portfolio. Average earning assets increased $82.0 million or 30% from 2001 to 2002. Of this amount $33.8 million was in the form of loans while securities accounted for $38.0 million. The percentage of earning assets represented by loans, which generally yield more than securities and other earning assets, declined from 71% in 2001 to 64% in 2002. This decline coupled with the interest rate reduction mentioned above caused the yield on earning assets to decline from 7.37% in 2001 to 5.93% in 2002. The increase in earning assets was funded mostly by average interest bearing deposit growth of $67.8 million, non interest bearing deposit growth of $8.6 million and an increase in Federal Home Loan Bank advances of $6.7 million. With regard to the increase in interest bearing deposits, $58.8 million was in the form of lower yielding "core deposits" such as savings, NOW and Money Market deposits, as customers opted for liquidity without substantial differential in yield. This change in deposit mix coupled with the decline in rates mentioned above caused the cost to fund earning assets to decline from 3.35% in 2001 to 2.13% in 2002. Of the $2,540,000 increase in net interest income approximately $2,606,000 resulted from the growth of the Company's balance sheet which was offset by an approximately $66,000 reduction resulting from the change in interest rates. For a further discussion of the effect of changes in interest rates on the Company's income statement see "Asset and Liability Management" and "Interest Rate Sensitivity Analysis." For a further discussion of the Company's loan portfolio see "Loans" and "Asset Quality." For a further discussion of the Bank's investment portfolio see "Investment Portfolio." OTHER INCOME A comparison of the major components of other income is included in the following table: ================================================================================ YEARS ENDED DECEMBER 31, (in thousands) 2002 2001 ================================================================================ Service Charges on Deposit Accounts $ 842 $ 771 Gains/(Losses) on the Sale of Securities 145 (11) Gains on the Sale of Loans 205 225 Other Income 540 344 -------------------------------------------------------------------------------- $1,732 $1,329 ================================================================================ Other income increased $403,000 or 30% during 2002 in comparison to 2001. Service charges on deposit accounts increased $71,000 or 9%. Even though fees were not raised in 2002, service charges for both return items and savings increased 26%. In addition, wire transfer charges increased by $18,000 or 35%. Additionally, the Bank generated $45,000 in fees from its commercial sweep account. The Company sold a portion of its securities for a net gain of $145,000. This was a result of realizing opportunities from improved values in the portfolio due to low interest rates. Gains on sale of loans were $205,000 in 2002 compared to $225,000 in 2001, a decrease of $20,000 or 9%. The Company is a preferred SBA lender and as such, originates SBA loans and sells the guaranteed portion in the secondary market while retaining the servicing. SBA loans are not the primary focus of the company and consequently, sales of these loans can vary from period to period depending upon the volume of SBA loans generated. Other income increased $196,000 or 57% in 2002. A major portion of this increase was related to loan origination processing and servicing fees. Also, sales of insurance products resulted in $22,000 of commissions. Finally, miscellaneous income increased by $52,000 of which $51,000 was due to the demutualization of the Company's health insurance carrier. OTHER EXPENSE A comparison of the major components of other expense is included in the following table: ================================================================================ YEARS ENDED DECEMBER 31, (in thousands) 2002 2001 ================================================================================ Salaries and Employee Benefits $ 5,477 $4,538 Occupancy 1,591 1,389 Equipment 561 490 Other Expense 3,135 2,592 -------------------------------------------------------------------------------- $10,764 $9,009 ================================================================================ 25 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations Total other expense increased $1,755,000 or 19% in comparison to 2001. Expenses were impacted by additional personnel, occupancy costs and other expenses relating to the opening of the Warren branch as well as the growth of the Company and a full year of expenses incurred by the Edison Branch, which opened in 2001. Salaries and Benefits increased $939,000 or 21% in 2002. Additional personnel were hired to staff the Warren branch. Other positions were also added to the Company as a result of the significant growth rate. The increase in staff combined with annual salary increases, and an increase in the number of employees qualifying for various benefits, such as, medical, bonus, and 401(k) pension accounted for the variance from 2001. Occupancy expense increased $202,000 or 15% from 2001. Most of the increase resulted from rent, taxes and maintenance for the new branch. Also, Edison and Hillsborough's new location experienced a full year of expenses, and the additional space was leased at 70 East Main Street in December 2002. Other expenses increased $544,000 or 21% from 2001. Much of the increase was related to a rise in costs for outside services. This variance of $172,000 included bank correspondent services and consulting fees. Also, examation costs increased $48,000 or 34%. Furthermore, expenses of $48,000 and $52,000 were a result of the write down of assets for the Hillsborough relocation and operational losses, respectively. Finally, directors fees were increased in the beginning of 2002. INVESTMENT PORTFOLIO The Company's investment portfolio is made up of securities available for sale and securities which it has the ability and the intent to hold to maturity. The securities available for sale are to be used to fund increases in loan demand or possible outflows of deposits. The securities held to maturity may be matched against maturing liabilities in order to attempt to maintain a balance in the repricing of the Company's earning assets and interest bearing liabilities. Maturing securities may also be used to fund increases in loan demand or allow for the outflow of deposits with which they are matched. The following table sets forth the amortized cost and estimated market values of securities in the investment portfolios as of December 31, 2002, 2001 and 2000.
================================================================================================================== 2002 2001 2000 ======================= ======================= ======================= AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR (in thousands) COST VALUE COST VALUE COST VALUE ================================================================================================================== AVAILABLE FOR SALE: U.S. Treasury Securities $ 502 $ 505 $ -- $ -- $ -- $ -- U.S. Government Agency Securities 13,569 13,873 13,171 13,402 19,276 19,273 Mortgage-Backed Securities (1) 28,250 28,545 12,602 12,694 11,983 11,918 Other Securities 3,650 3,646 2,910 2,956 2,136 2,112 ------------------------------------------------------------------------------------------------------------------ $45,971 $46,569 $28,683 $29,052 $33,395 $33,303 ================================================================================================================== HELD TO MATURITY: U.S. Treasury Securities $ 1,016 $ 1,018 $ -- $ -- $ -- $ -- U.S. Government Agency Securities 24,499 24,900 25,343 25,662 4,242 4,249 Mortgage-Backed Securities (1) 28,033 28,501 14,075 14,070 1,549 1,568 Other Securities 2,479 2,496 2,091 2,097 -- -- Municipal Securities 182 182 -- -- 546 545 ------------------------------------------------------------------------------------------------------------------ $56,209 $57,097 $41,509 $41,829 $ 6,337 $ 6,362 ==================================================================================================================
Note: (1) With regard to mortgage-backed securities, the Company does not hold any private issue CMOs. As of December 31, 2002, 2001 and 2000, there was not one issuer where the aggregate book value or aggregate market value exceeds ten percent of shareholders' equity. 26 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations The maturity distribution and weighted average yield of the Company's investment portfolio as of December 31, 2002 is as follows:
=============================================================================================== DUE IN DUE AFTER ONE ONE YEAR YEAR THROUGH ($ in thousands) OR LESS FIVE YEARS TOTAL =============================================================================================== AVAILABLE FOR SALE: U.S. Treasury Securities(2) Fair Value $ 505 -- $ 505 Yield 2.79% -- 2.79% U.S. Government Agency Securities(2) Fair Value $ 2,865 $11,009 $13,874 Yield 4.04% 3.95% 3.97% Mortgage-Backed Securities(1) Fair Value $28,545 -- -- $28,545 Yield 4.05% -- -- 4.05% Other Securities Fair Value $ 1,004(3) $ 1,832 $ 809 $ 3,645 Yield 4.28% 4.32% 5.27% 4.52% =============================================================================================== HELD TO MATURITY: U.S. Treasury Securities(2) Book Value $ 1,016 -- $ 1,016 Yield 1.46% -- 1.46% U.S. Government Agency Securities(2) Book Value $ 5,210 $19,289 $24,499 Yield 4.59% 3.34% 3.61% Mortgage-Backed Securities(1) Book Value $28,033 -- -- $28,033 Yield 4.25% -- -- 4.25% Other Securities Book Value $ 1,714 $ 765 $ 2,479 Yield 3.91% 3.11% 3.66% Municpal Securities Book Value $ 182 -- $ 182 Yield 1.46% -- 1.46% ===============================================================================================
Note: (1) Mortgage-backed securities are not included because expected maturities will differ from contractual maturities. Borrowers may have the right to prepay or call obligations with or without call or prepayment penalties. (2) U.S. Government Agency Securities and U.S. Treasury Securities which are callable before their stated maturity are included in the table at their stated maturity. (3) Equity securities. LOANS The following table summarizes the Company's loan portfolio as of December 31, 2002, 2001, 2000, 1999 and 1998.
==================================================================================================== (in thousands) 2002 2001 2000 1999 1998 ==================================================================================================== Secured by Real Estate: Residential Mortgage $ 73,084 $ 67,598 $ 55,357 $ 41,727 $ 30,577 Commercial Mortgage 102,623 75,905 57,223 48,349 42,703 Construction 25,011 21,438 12,561 11,943 6,256 Commercial & Industrial (1) 24,229 28,105 33,429 32,628 22,308 Loans to Individuals for Automobiles 3,732 6,640 8,583 7,907 10,298 Other Loans to Individuals 8,592 9,249 11,721 10,062 8,864 Other Loans 914 657 344 535 468 ---------------------------------------------------------------------------------------------------- $238,185 $209,592 $179,218 $153,151 $121,474 ====================================================================================================
Note: (1) The Company's commercial loans are not concentrated within a single industry or group of related industries. 27 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations The Company had strong growth in the loan portfolio in 2002. The loan portfolio increased by $28.6 million or 14% in 2002. Most of the loan growth was in the form of loans secured by real estate. Commercial mortgages increased $26.7 million or 35%. The Company also experienced growth in residential mortgages which increased $5.5 million and construction loans which grew by $3.6 million. Please see "Asset Quality" for a discussion of the Company's practices with respect to construction lending. Construction loans comprised 10.5% of total loans at December 31, 2002. The Company targets small to medium sized businesses, developers and professionals in its lending area. With the ever changing composition of the banking marketplace, the Company has tried to remain competitive in its pricing of loans, but will not sacrifice loan quality to capture additional volume. It is important to note that 26% of the loans secured by residential real estate as of December 31, 2002, were for commercial purposes. It is common for small business owners to secure commercial loans with their personal residences. The following table sets forth the Company's total loans by maturity and interest rate sensitivity as of December 31, 2002: ================================================================================ MATURITY AFTER WITHIN ONE THROUGH AFTER (in thousands) ONE YEAR FIVE YEARS FIVE YEARS TOTAL ================================================================================ Loans with fixed rates $26,879 $ 95,796 $ 5,157 $127,832 Loans with floating rates 42,937 17,632 49,784 110,353 -------------------------------------------------------------------------------- Total $69,816 $113,428 $54,941 $238,185 ================================================================================ ASSET QUALITY Various degrees of credit risk are associated with substantially all investing activities. The lending function, however, carries the greatest risk of loss. Risk elements include loans past due, non-accrual loans, renegotiated loans, other real estate owned and loan concentrations. The Company closely monitors its loan portfolio to minimize the risk of delinquency and problem credits. As a general rule, a loan that is past due for principal or interest in excess of ninety days is placed on a non-accrual basis unless circumstances exist that would lead management to find that non-accrual is unnecessary (i.e., liquidation of collateral or the borrower has the ability to bring the loan current as to principal and interest). The Company's loan portfolio consists of commercial loans, commercial mortgages, real estate construction loans, residential mortgage loans and consumer loans. The Company's commercial loans are primarily made to small businesses and professionals in its market area with maturities between one and five years. The majority of these loans are collateralized by real estate consisting of single family homes or commercial properties, and/or the assets of the businesses and further secured by personal guarantees. The Company primarily requires that there be a loan to value ratio not exceeding 80% on these loans. The Company also reviews borrower's cash flows in analyzing loan applications. Risks inherent in these loans include risks that a borrower's cash flow generated from its business may not be sufficient to repay the loans, either because of general economic conditions, downturns specific to the borrower's business or interest rate changes which cause deterioration in a borrower's cash flow as well as risks associated with the collateral securing the loans, such as possible deterioration in value of the collateral. Commercial mortgages are made to small businesses, developers and professionals in the market area to purchase commercial real estate for use in their businesses. The Company will generally not finance in excess of 75% of appraised value. In reviewing a borrower's qualifications, the Company pays particular attention to cash flow. In addition, the Company frequently requires personal guarantees. Risk factors associated with these loans include general economic performance which will affect vacancy rates for commercial properties and the ability of businesses to maintain cash flows as well as the resale value which may be yielded on a particular property. The Company originates and retains residential mortgages loans. They are generally written with a three, five or ten year fixed rate which adjusts annually thereafter for the life of the loan, which may be up to 30 years. The Company generally does not lend in excess of 80% of the appraised value. Risks inherent in these loans include the employment stability and earnings potential of the borrower as well as potential resale values associated with the collateral securing these loans. The Company makes construction loans to individuals with expertise in the industry or to owner occupied projects. The loans are generally on projects for which a sale contract has been executed and for which permanent mortgage financing is in place. The Company will generally lend up to 75% of the appraised completed value of the project. Risks inherent with these loans include performance of the general economy which will affect whether the sale of the project actually closes despite its contracted status and the 28 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations risk inherent with whether the construction of a project will actually be completed and completed within budget. Environmental factors may affect whether a project can be completed. However, the Company does environmental due diligence prior to closing. Normally, commercial real estate loans are insured for loss resulting from default which is accompanied by environmental problems. Coverage is currently obtained through an insurance carrier. Based upon the historical data and the Company's underwriting procedures, the carrier determines whether or not it will insure the property. An environmental risk factor is the risk that a site may be contaminated by toxic chemicals, oil, gasoline or like substance. In the event that this occurs, environmental audits must be performed to determine the extent of the problem and cost of cleanup. Excessive cleanup costs may endanger the completion of the project. The Company makes consumer loans on an unsecured basis as personal loans to finance various consumer goods. Automobile loans are also made on a direct basis and through the Company's relationship with area car dealers. Employment, income, credit rating, as well as the potential resale values of automobiles, are the risk factors inherent in these loans. ALLOWANCE FOR LOAN LOSSES The Company maintains an allowance for loan losses at a level deemed sufficient to absorb losses, which are inherent in the loan portfolio at each balance sheet date. Management determines the adequacy of the allowance on a monthly basis to ensure that the provision for loan losses has been charged against earnings in an amount necessary to maintain the allowance at a level that is appropriate based on management's assessment of probable estimated losses. The Company's methodology for assessing the appropriateness of the allowance for loan losses consists of several key elements. These elements include a specific allowance for all commercial loans based upon a risk rating assigned to the loan, an allowance for homogeneous types of loans such as consumer installment loans, residential mortgage loans and home equity loans, an additional allowance for loans deemed to be impaired and an unallocated portion. The Company consistently applies the following comprehensive methodology. All commercial loans are assigned a two digit risk rating at the time of closing. The first digit of the rating refers to the strength of the borrower based on their financial condition and past history. Current economic conditions and the effect on the borrower's business are also taken into account. The second digit refers to the collateral strength and liquidity with zero being assigned to unsecured loans. An allowance amount is then assigned to each risk rating. Since, in its eleven year history, the Company has very little commercial loan loss history, the amount of the allowance is based on the experience of management and their judgement with respect to these types of loans. These allowances assigned to risk ratings may be changed in the future if the conditions or loan losses experience makes that necessary. A risk rating may be changed with the approval of the senior loan officer. A rating change may be requested if the individual loan officer or the Bank's credit analyst is aware of a change in the borrower's financial condition. In addition, approximately 60% of the dollar amount of commercial loans are reviewed on an annual basis by an outside independent loan review firm at which time a change to the risk rating may be recommended. The audit Committee of the Board of Directors reviews the independent loan review firms recommendations on a quarterly basis. The allowance for homogenous loans is established based on a number of factors, including current economic conditions and the loss experience with these types of loans as well as management's judgement. Loans are deemed to be impaired if they are 60 days or more past due for principal or interest or are in a non-accrual status. A loan is placed in a non-accrual status at the time when ultimate collectibility of principal or interest, wholly or partially, is in doubt. Past due loans are those loans which were contractually past due 90 days or more as to interest or principal payments but are well secured and in the process of collection. If there is insufficient collateral to pay the amount of the loan, an allowance is determined over and above the amount required by the risk rating by taking the difference between the carrying amount of the loan and the present value of expected future cash flows discounted at the loans current rate less any amounts already established by the risk rating. The Company also maintains an unallocated allowance. The unallocated allowance is used to cover any factors or conditions, which may cause a potential loan loss but are not specifically identifiable. It is prudent to maintain an unallocated portion of the allowance because no matter how detailed an analysis of potential loan losses is performed, these estimates by definition lack precision. Since all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan losses. The calculation of the estimated provision for loan losses is presented to and discussed with the Company's Board of Directors on a quarterly basis. 29 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table summarizes the composition of the Company's non-performing assets as of the dates indicated:
============================================================================================================================== DECEMBER 31, ========================================================================= ($ in thousands) 2002 2001 2000 1999 1998 ============================================================================================================================== Non-performing assets(1): Non-accruing loans Commercial and Construction $ 442 $ 103 $ 316 $ 599 $ 56 Real Estate 191 209 149 -- -- Installment 25 198 17 93 40 ------------------------------------------------------------------------------------------------------------------------------ Total non-accrual loans 658 510 482 692 96 Restructured loans 257 301 -- -- -- ------------------------------------------------------------------------------------------------------------------------------ Total non-performing loans 915 811 482 692 96 ------------------------------------------------------------------------------------------------------------------------------ Other real estate owned -- -- -- -- -- ============================================================================================================================== Total non-performing assets $ 915 $ 811 $ 482 $ 692 $ 96 ============================================================================================================================== Loans past due 90 days or more(2) $ -- $ -- $ -- $ -- $ 5 ============================================================================================================================== Non-performing loans to total loans 0.38% 0.39% 0.27% 0.45% 0.08% Non-performing assets to total assets 0.23% 0.25% 0.20% 0.34% 0.05% Allowance for loan losses to non-performing loans 263.06% 260.30% 378.22% 223.99% 1261.46% ==============================================================================================================================
(1) Non-performing assets excludes loans past due 90 days or more and still accruing. (2) Loans past due 90 days or more and still accruing. As noted in the previous table, the Company's charge off history shows relatively small percentages of net charge offs. The following table depicts an approximate allocation of the allowance for loan losses as of the dates indicated:
================================================================================================================================ DECEMBER 31, ================================================================================================================================ 2002 2001 2000 1999 1998 ================================================================================================================================ % OF % OF % OF % OF % OF LOANS TO LOANS TO LOANS TO LOANS TO LOANS TO TOTAL TOTAL TOTAL TOTAL TOTAL ($ in thousands) AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS ================================================================================================================================ Commercial (including Construction) $2,225 64.14% $1,892 60.17% $1,612 57.78% $1,345 60.67% $ 986 58.67% Residential Real Estate 80 30.68% 74 32.25% 53 30.89% 57 27.25% 41 25.17% Installment 102 5.18% 145 7.58% 158 11.33% 148 12.08% 184 16.16% -------------------------------------------------------------------------------------------------------------------------------- $2,407 100.00% $2,111 100.00% $1,823 100.00% $1,550 100.00% $1,211 100.00% ================================================================================================================================
30 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations The following table summarizes the activity in the allowance for possible loan losses for the period indicated:
======================================================================================================================== YEARS ENDED DECEMBER 31, ===================================================================== ($ in thousands) 2002 2001 2000 1999 1998 ======================================================================================================================== Balance, January 1 $ 2,111 $ 1,823 $ 1,550 $ 1,211 $ 982 Loans charged off Commercial and Construction -- (3) (21) -- -- Real Estate (20) -- (12) -- -- Installment (186) (106) (104) (115) (80) ------------------------------------------------------------------------------------------------------------------------ Total charge offs (206) (109) (137) (115) (80) ------------------------------------------------------------------------------------------------------------------------ Recoveries of loans previously charged off Commercial and Construction -- -- -- -- 8 Real Estate 12 -- -- -- -- Installment 35 32 35 14 1 ------------------------------------------------------------------------------------------------------------------------ Total recoveries 47 32 35 14 9 ------------------------------------------------------------------------------------------------------------------------ Net Loans charged off (159) (77) (102) (101) (71) ------------------------------------------------------------------------------------------------------------------------ Provision charged to expense 455 365 375 440 300 ------------------------------------------------------------------------------------------------------------------------ Balance, December 31 $ 2,407 $ 2,111 $ 1,823 $ 1,550 $ 1,211 ======================================================================================================================== Net charge offs as a percentage of average loans 0.07% 0.04% 0.06% 0.07% 0.06% Allowance for loan losses to total loans 1.01% 1.01% 1.02% 1.01% 1.00% Allowance for loan losses to non-performing loans 263.06% 260.30% 378.22% 223.99% 1261.46%
DEPOSITS Following is the average balances and rates paid on deposits for the period indicated:
============================================================================================ YEARS ENDED DECEMBER 31, 2002 2001 2000 ====================== ====================== ======================= AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE ($ in thousands) BALANCE RATE BALANCE RATE BALANCE RATE ============================================================================================ Demand $ 49,837 -- $ 41,236 -- $ 34,316 -- Savings 41,500 1.72% 22,154 2.81% 17,190 2.86% Money Market 48,838 1.93% 28,988 3.05% 24,882 3.62% NOW 64,007 0.89% 44,400 1.85% 32,489 2.43% Time 135,171 3.38% 126,184 5.15% 100,028 5.75% -------------------------------------------------------------------------------------------- $339,353 2.00% $262,962 3.35% $208,905 3.80% ============================================================================================
Following is the maturity distribution of time certificates of deposit $100,000 and over: ================================================================================ December 31, (in thousands) 2002 ================================================================================ Three months or less $ 9,412 Over three months through six months 4,521 Over six months through twelve months 4,810 Over one year through three years 7,208 Over three years through five years 1,553 $ 27,504 ================================================================================ LIQUIDITY The Company's liquidity needs arise principally to accommodate possible deposit outflows and meet loan demand. The Company's liquidity is dependent on the successful management of its assets and liabilities so as to meet these needs of both its deposit and loan customers. Liquidity, as represented by cash and cash equivalents, is a product of its operating, investing and financing activities. During 2002, the Company generated $3.5 million cash flow from operations. Net cash used in investing activities was $69.3 million. Purchases of securities, both held to maturity and available for sale, accounted for $88.0 million of cash for 31 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations investing purposes. These purchases were partially funded by $48.0 million of maturities of both held to maturity and available for sale securities and proceeds from the sales of securities of $7.6 million. An increase in loan growth accounted for $28.5 million in cash invested. Net cash provided by financing activities of $73.9 million supplied funding for the above investing activities. Most of these funds, 66% or $48.6 million, were generated by an increase in the Bank's core deposit accounts consisting of demand deposits, savings deposits and money market accounts. Time deposits or certificates of deposits also increased $18.3 million. Overall, cash and cash equivalents increased $8.1 million during 2002. Additionally, the Company can borrow up to $17.8 million as a member of the Federal Home Loan Bank and $3.5 million is available through lines of credit at correspondent banks. As of December 31, 2002, the Company had $9.2 million in total advances with the Federal Home Loan Bank, thereby reducing the available line to $8.6 million. The Company believes its liquidity position is sufficient to provide funds to meet future loan demand or possible outflow of deposits. ASSET AND LIABILITY MANAGEMENT Interest rate risk is defined as the sensitivity of the Company's current and future earnings as well as its capital to changes in the level of market interest rates. The Company's exposure to interest rate risk results from, among other things, the difference in maturities on interest earning assets and interest bearing liabilities. The relationship between the interest rate sensitivity of the Bank's assets and liabilities is continually monitored by the Bank's Asset/Liability Management Committee (the "ALCO"). The purpose of the ALCO is to review and monitor the volume, mix and pricing of the interest earning assets and interest bearing liabilities consistent with the Bank's overall liquidity, capital, growth, profitability and interest rate risk goals. Loans make up the largest portion of the Bank's assets. In making commercial loans, the emphasis is placed on either floating rate loans tied to the prime lending rate or fixed rate loans with prepayment penalties depending upon the Bank's overall rate sensitivity position. Fixed rate commercial loans are generally written so that the rates can be adjusted within 3-7 years with payouts up to 25 years. Mortgage loans are currently written to be adjusted annually after the first 3, 5 or 10 year term with payouts up to 30 years. Home equity lines of credit are tied to the prime lending rate although special promotions may offer a fixed rate for periods of not greater than one year. Fixed rate home equity loans are offered with a maturity of 5 or 10 years, amortizing over a 15 year period. These loans also contain interest rate floors. Installment loans are written at fixed rates amortizing over 1 to 5 years. The Bank also takes into consideration any off-balance sheet items when evaluating and managing its liquidity. At December 31, 2002 off-balance sheet items consisted of unfunded loan commitments and financial standby letters of credit. Generally, when evaluating the Bank's liquidity all unused loan commitments and letters of credit are included in the analysis as estimated drawdowns of 25% of the total commitment. Although economic conditions interest rates and numerous other factors can effect the amount of loans to be drawndown, management feels, through experience, that this is a reasonable estimate to use when evaluating liquidity needs. The Bank utilizes its securities to manage its liquidity and rate sensitivity. Fixed rate agency and corporate securities are purchased for terms of less than 5 years. Adjustable rate securities require an estimated average life at time of purchase of 10 years or less. Callable securities can be purchased for terms of 5 years or less with call period of three months to 2 years. Fixed rate mortgage-backed securities are purchased with estimated average lives at the time of purchase of not more than 5 years. These securities are reviewed for changes in yield and average life resulting from changes in interest rates. The Bank also invests in FDIC insured CDs of other financial institutions with a maturity of three months to three years for amounts up to $100,000. Short term liquidity is also managed through the investment into high quality short term Money Market securities, US Government securities and/or US Treasury securities made available through Money Market funds which can be liquidated at anytime. In general, the day to day liquidity is The following table sets forth the Company's commitments sheet items by maturity date as of December 31, 2002:
============================================================================================ TOTAL LESS COMMITMENTS AMOUNTS THAN 1=3 4=5 OVER 5 (in thousands) COMMITTED 1 YEAR YEARS YEARS YEARS ============================================================================================ Lines of Credit $34,178 $18,933 $ 1,181 $ 30 $14,034 Standby Letters of Credit 3,942 3,924 18 -- -- Guarantees -- -- -- -- -- Standby Repurchase Obligations -- -- -- -- -- Loan Commitments 2,044 2,044 -- -- -- FHLB Advances 7,500 3,000 3,000 1,500 -- Leases 11,523 1,040 2,093 1,845 6,545 -------------------------------------------------------------------------------------------- Total Commitments $59,187 $28,941 $ 6,292 $ 3,375 $20,579 ============================================================================================
32 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations managed through the sale or purchase of Federal Funds from approved correspondent banks. A significant portion of the Bank's assets have been funded with CDs including jumbo CDs. Unlike other deposit products, such as checking and savings accounts, CDs carry a high degree of interest rate sensitivity and therefore, their renewal will vary based on the competitiveness of the Bank's interest rates. The Bank has attempted to price its CDs competitively. Interest rates on savings accounts, NOW and Money Market accounts are variable and can be changed at the discretion of the Company. These accounts are not tied to any particular index. As members of the Federal Home Loan Bank, the Company can borrow advances at a fixed or floating rate and on a non-amortizing or amortizing basis. These advances can be for terms ranging from overnight to up to 30 years. The advances INTEREST RATE SENSITIVITY AT DECEMBER 31, 2002
MATURITY OR REPRICING IN (1) DUE IN BETWEEN NON- 90 DAYS 91 DAYS - AFTER INTEREST (in thousands) OR LESS ONE YEAR ONE YEAR BEARING TOTAL ========================================================================================================================= ASSETS: Securities $ 19,982 $ 34,044 $ 48,752 $ -- $102,778 Federal Funds Sold 20,778 -- -- -- 20,778 Other Short Term Investments 7,293 -- -- -- 7,293 Interest Bearing Time Deposits 1,784 5,580 6,475 -- 13,839 Loans 89,063 28,599 119,345 799 237,806 Valuation Reserve -- -- -- (2,407) (2,407) Non-interest Earning Assets -- -- -- 24,897 24,897 ------------------------------------------------------------------------------------------------------------------------- Total Assets $138,900 $ 68,223 $174,572 $ 23,289 $404,984 ========================================================================================================================= LIABILITIES AND STOCKHOLDERS' EQUITY: Interest Bearing Liabilities Money Market $ 6,495 $ 26,973 $ 16,483 $ -- $ 49,951 NOW 3,672 17,622 52,132 -- 73,426 Savings Deposits 6,198 18,591 16,525 -- 41,314 CDs over $100,000 9,325 9,497 8,682 -- 27,504 Other Time Deposits 34,431 55,475 28,100 -- 118,006 Other Borrowings -- 3,000 6,214 -- 9,214 Obligation Under Capital Lease 5 15 391 -- 411 Guaranteed Preferred Beneficial Interest in the Corporation Subordinated Debentures 6,500 -- -- -- 6,500 ------------------------------------------------------------------------------------------------------------------------- Total Interest Bearing Liabilities 66,626 131,173 128,527 -- 326,326 ------------------------------------------------------------------------------------------------------------------------- Non-interest Bearing Demand Deposits 9,219 8,676 36,326 -- 54,221 Other Liabilities -- -- -- 1,259 1,259 Stockholders' Equity -- -- -- 23,178 23,178 ------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 75,845 $139,849 $164,853 $ 24,437 $404,984 ------------------------------------------------------------------------------------------------------------------------- Interest Rate Sensitivity Gap $ 63,055 $(71,626) $ 9,719 $ (1,148) ------------------------------------------------------------------------------------------------------------------------- Cumulative Gap $ 63,055 $ (8,571) $ 1,148 ------------------------------------------------------------------------------------------------------------------------- Cumulative Gap to Total Assets 15.57% (2.12)% 0.28% =========================================================================================================================
(1) The following are the assumptions that were used to prepare the Interest Rate Sensitivity analysis: (A) Interest rates remain flat during the period covered by the table, i.e. a prime rate of 4.25% and a Federal Funds rate of 1.25%. (B) Callable agency securities are spread at their call dates or maturity date depending upon the relationship of the rate of the securities to the treasury yield curve as dictated by the rates listed in (A) (C) Prepayments on mortgage-backed securities as well as various types of loans are based on estimates in relationship to the rates listed in (A) (D) Loans are spread based on the earlier of their actual maturity date or the date of their first potential rate adjustment. (E) The maturity or decay rate of non-maturity deposits, i.e. Money Market, NOW, savings and non-interest bearing demand deposits is estimated based on historical data. (F) Time deposits are spread based on their actual maturity dates. 33 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations can be matched against various earning assets. At December 31, 2002 and December 31, 2001, the Company had outstanding advances of $9.2 million and $5.8 million respectively, all of which had fixed rates of interest. During 2002, the Company participated in a pooled institutional placement of trust preferred securities of $2.5 million which combined with a similar placement of $4.0 million in 2001, resulted in a total of $6.5 million in trust preferred securities as of December 31, 2002. Both of these subordinated debentures can be redeemed in 30 years from issuance and carry a floating rate of interest based on the 3-month LIBOR plus 345 basis points for the 2002 placement and 358 basis points for the 2001 placement. Both of these rates are adjusted on 3 month intervals. The nature of the Bank's current operations is such that it is not subject to foreign currency exchange or commodity price risk. Additionally, neither the Company nor the Bank owns any trading assets. At December 31, 2002, the Bank did not have any hedging transactions in place. INTEREST RATE SENSITIVITY ANALYSIS One measure of the Bank's interest rate sensitivity is through the use of a sensitivity gap analysis. The interest rate sensitivity gap is defined as the difference between the amount of interest earning assets maturing or repricing within a specific time period and the amount of interest bearing liabilities maturing or repricing within that same time period. A gap is positive when the amount of interest earning assets maturing or repricing exceeds the amount of interest bearing liabilities maturing or repricing within that same period and is negative when the amount of interest bearing liabilities maturing or repricing exceeds the amount of interest earning assets maturing or repricing within the same period. Accordingly, during a period of rising interest rates, an institution with a negative gap position would not be in as favorable a position, compared to an institution with a positive gap, to invest in higher yielding assets. A negative gap may result in the yield on an institution's interest earning assets increasing at a slower rate than the increase in an institution's cost of interest bearing liabilities than if it had a positive gap. During a period of falling interest rates, an institution with a negative gap would experience a repricing of its interest earning assets at a slower rate than its interest bearing liabilities which, consequently, may result in its net interest income growing at a faster rate than an institution with a positive gap position. The ALCO attempts to maintain the Company's cumulative gap ratios at +/-15% for 90 days or less, +/-20% for four to six months and +/-25% for between six months and one year. While gap analysis is a general indicator of the potential effect that changing interest rates may have on net interest income, the gap itself does not present a complete picture of interest rate sensitivity. First, changes in the general level of interest rates do not affect all categories of assets and liabilities equally or simultaneously. Second, assumptions must be made to construct a gap analysis. Management can influence the actual repricing of the deposits independent of the gap assumption. Third, certain securities are callable and therefore repriceable prior to their maturity dates depending on the level of interest rates. The cash flows of certain loans and mortgage-backed securities and the repricing of those cash flows will vary under different interest rates. Fourth, the gap analysis represents a one-day position and cannot incorporate a changing mix of assets and liabilities over time as interest rates change. Volatility in interest rates can also result in disintermediation, which is the flow of funds away from financial institutions into direct investments, such as U.S. Government and corporate securities and other investment vehicles, including mutual funds, which, because of the absence of federal insurance premiums and reserve requirements, generally pay higher rates of return than financial institutions. The decline in the market for equity securities has been a source of new deposits over the past few years. As indicated in the previous table, the Bank has had a positive gap position in the period of 1 to 90 days. During periods of continual increases in short-term rates the Company will generally experience expansion of its net interest margin. Beginning in January 2001 and continuing throughout the year, the Federal Funds rate and Prime lending rates were reduced eleven times for a total of 475 basis points. The Company's net interest margin declined to 4.02%. During 2002, the Federal Funds rate and the Prime lending rate remained flat for 10 months, until they were reduced 50 basis points in November. The net interest margin declined to 3.81% for the year. For further discussion of the net interest margin see "Net Interest Income." Past performance is no indication of future results. The net interest margin can be affected by more than the change in the level of interest rates. Such items as the changes in the mix of assets and liabilities and a change in the competitive factors governing the pricing of assets and liabilities can also greatly impact the net interest margin. An additional analysis of the Bank's interest rate risk is a forecast of changes in the Bank's Market Value of Portfolio Equity (MVPE) under alternative interest rate environments. The MVPE is defined as the net present value of the Bank's existing assets, liabilities and off-balance sheet instruments. The calculated estimated change in MVPE for the Bank at December 31, 2002 is as follows: MVPE $ CHANGE IN INTEREST (in thousands) Amount Change ================================================================================ +200 Basis Points $22,806 $(2,901) Base Amount Rate 25,707 -- -200 Basis Points 26,506 799 ================================================================================ The policy of the Company requires that a parallel shock of +/- 200 basis points may not change the MVPE by more than 1% of total assets. For 2002, this amount would be $4.0 million. It is important to note that as of December 31, 2002, a downward parallel shock of 200 basis points could not be 34 SVB FINANCIAL SERVICES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations applied to all assets and liabilities. For example, the Federal Funds rate at that time was 1.25%. Certain loans rates, such as home equity loans, have contractual floors which at year end 2002 were above the current market rates. In addition, certain deposit rates could not realistically be reduced by 200 basis points. Assumptions were made as to implied floors for these rates. RETURN ON ASSETS AND RETURN ON EQUITY The following table depicts returns on average assets and returns on average equity for the periods indicated: ================================================================================ Years Ended December 31, ========================= 2002 2001 ================================================================================ Return on Average Assets 0.65% 0.61% Return on Average Equity 11.46% 9.49% Average Equity to Average Assets 5.65% 6.42% ================================================================================ CAPITAL RESOURCES Under risk-based capital guidelines, assets and credit equivalent amounts of derivatives and off-balance sheet items are assigned to one of several risk categories according to the obligor, the guarantor or the nature of the collateral. The aggregate dollar amount in each risk category is then multiplied by the risk weight associated with that category. The resulting weighted values are added together to determine the total of risk weighted assets. This total comprises the denominator of the risk-based capital ratios. The Company did not have any derivatives as of December 31, 2002 or 2001. Off-balance sheet items totalled $40.2 million for December 31, 2002 and $ 40.1 million for December 31, 2001 and were made up of unused loan commitments and letters of credit. Subordinated debentures in the amount of $6.5 million in 2002 and $4.0 million in 2001 were included in the numerator of the risk-based capital ratios. Consistent with the U.S. bank holding company capital regulations, these securities may be treated as components of Tier 1 capital as long as they do not exceed 25% of all Tier 1 elements at any time. At December 31, 2002 and 2001 the inclusion of these securities represented 23% and 18% respectively of tier 1 capital. Under the FDIC Improvement Act of 1991, banks are required to maintain a minimum ratio of total capital to risk based assets of 8% of which at least 4% must be in the form of Tier 1 capital (primarily shareholders' equity). The following are the Company's capital ratios at the end of the periods indicated. The Bank's Capital Ratios are not materially different than those of the Company. ================================================================================ Years Ended December 31, ========================== 2002 2001 ================================================================================ Total Capital to Risk Weighted Assets 11.09% 10.39% Tier 1 Capital to Risk Weighted Assets 10.22% 9.50% Leverage Ratio 7.53% 7.86% ================================================================================ It is the Company's intention to retain its earnings in order to provide adequate capital to continue to support its growth. The Company has never paid a cash dividend. A 5% stock dividend was paid in 2002 and in 2001. SUMMARY OF QUARTERLY RESULTS The following summarizes the results of operations during 2002 on a quarterly basis:
================================================================================================= For the Quarters Ended ============================================================ (in thousands) March 31 June 30 September 30 December 31 ================================================================================================= Interest Income $4,938 $5,215 $5,372 $5,323 Interest Expense 1,951 1,876 1,861 1,783 ------------------------------------------------------------------------------------------------- Net Interest Income 2,987 3,339 3,511 3,540 Provision for Loan Losses 100 135 125 95 ------------------------------------------------------------------------------------------------- Net Interest Income After Provision for Loan Losses 2,887 3,204 3,386 3,445 ------------------------------------------------------------------------------------------------- Gains on the Sale of Loans 40 83 26 56 Gains on the Sale of Securities 8 15 50 72 Other Income 321 361 300 400 Other Expense 2,482 2,635 2,726 2,921 ------------------------------------------------------------------------------------------------- Income Before Tax Expense 774 1,028 1,036 1,052 Income Taxes 296 379 386 374 ------------------------------------------------------------------------------------------------- Net Income $ 478 $ 649 $ 650 $ 678 =================================================================================================
35 SVB Financial Services, Inc. and Somerset Valley Bank BOARD OF DIRECTORS John K. Kitchen Chairman of the Board G. Robert Santye Vice Chairman of the Board Bernard Bernstein Robert P. Corcoran Raymond L. Hughes Willem Kooyker Frank Orlando Gilbert E. Pittenger Frederick D. Quick Anthony J. Santye, Jr. Donald Sciaretta Herman C. Simonse Donald R. Tourville SOMERSET VALLEY INVESTMENT COMPANY, INC. BOARD OF DIRECTORS: Vincent C. Canterelli Raymond L. Hughes, II Daniel Soriano, Jr. Esq. WEST END ONE CORP. BOARD OF DIRECTORS: Herman C. Simonse Robert P. Corcoran Keith B. McCarthy SOMERSET VALLEY BANK FOUNDERS ADVISORY COUNCIL: Richard Bradley Albert DiFiore Maureen T. Kruse Matthew Madlinger John Majcher Thomas C. Miller, Esq. Harold T. Moscatiello Edward Rego Sandra L. Runyon Janak Sakaria, MD Helga Schwartz, MD Michael A. Sena Donald Sweeney, MD Frank Tourville SOMERSET VALLEY BANK HILLSBOROUGH ADVISORY COUNCIL: George Christiansen, Jr. Elaine DeMilia Walter J. Dietz, III Vincent P. Lipani Daniel G. Marulli, DDS John Mondoro Dan Pullen, DDS Harry Smith Kevin Sweeney Frank N. Yurasko, Esq. SOMERSET VALLEY BANK MANVILLE ADVISORY COUNCIL: Fred DeCicco Bruce Hartzog John Gluch Oscar Gonzalez Ed Komoroski Steve Selody Thomas Trojanowski Michael Vernoia, Jr. SOMERSET VALLEY BANK ABERDEEN ADVISORY COUNCIL: Michael Cohen, DO James Ferrano Robert Kee, Jr. William Mirkin Joseph Rettagliata Martha Suhayda-Vogt 36 SVB Financial Services, Inc. and Somerset Valley Bank Banking Staff OFFICERS: Robert P. Corcoran President and C.E.O. Keith B. McCarthy Chief Operating Officer and Treasurer Arthur E. Brattlof Executive Vice President Senior Loan Officer Michael A. Novak Senior Vice President Commercial Loans Douglas Robb, Jr. Senior Vice President Retail Investments Kathy E. Ruggiero Senior Vice President Branch Administration Karen L. Zaliwski Senior Vice President Operations Paul J. Bowen Vice President Commercial Loans Dianne Durland Vice President Branch Administration Christopher Fenimore Vice President Consumer Loans Michele Gara Vice President and Manager Suzanne Lennard Vice President and Manager Stephen Miller Vice President Commercial Loans Margaret O'Keeffe Vice President Retail Sales and Marketing John P. Oliver Vice President Commercial Loans Mary E. Rowe Vice President Accounting and Finance Roger W. Russell Vice President Loan Administration Mary Ann Soriano Vice President Operations Elizabeth J. Balunis Corporate Secretary Jeannette A. Capra Assistant Vice President Loan Operations Jeanne G. Hagen Assistant Vice President and Human Resources Director Joanne Jack Assistant Vice President Cary Johnson Assistant Vice President and Manager Christopher Seaman Assistant Vice President Branch Administration Vimala Vimalavong Assistant Vice President and Manager Michelle Callahan Assistant Treasurer Susan Christman Assistant Treasurer and Manager Jennifer Corcoran Assistant Treasurer Paige Johnstone Assistant Treasurer and Manager Scott Ronca Assistant Treasurer Diana S. Valko Assistant Treasurer Kenneth S.B. Wade II Assistant Treasurer Dawn Bonomo Assistant Secretary Sharon Eckel Assistant Secretary Samuel Evans, Jr. Assistant Secretary and Manager Marguerite Eppler Assistant Secretary Lisa A. Giacommara Assistant Secretary Anne Hardgrove Assistant Secretary Yvonne Johnson Assistant Secretary Connie Kirchoff Assistant Secretary James Law Assistant Secretary Kristin Madison Assistant Secretary Nancy McLaughlin Assistant Secretary Nicole M. Moschak Assistant Secretary and Manager Wendy Wheat Assistant Secretary 37 SVB Financial Services, Inc. and Somerset Valley Bank [PHOTO OMITTED] Keith B. McCarthy CHIEF OPERATING OFFICER AND TREASURER Aberdeen Office 1147 State Highway 34 Aberdeen, NJ 07747 Telephone: (732) 583-7300 Fax: (732) 583-7800 Arbor Glen Office 100 Monroe Street Bridgewater, NJ 08807 Telephone: (908) 595-9700 Fax: (908) 526-3418 Bernards Office 578 Allen Road Basking Ridge, NJ 07920 Telephone: (908) 781-5800 Fax: (908) 781-5959 Bridgewater Office 481 North Bridge Street Bridgewater, NJ 08807 Telephone: (908) 725-0033 Fax: (908) 725-0110 Edison Office 1943 Oak Tree Road Edison, NJ 08820 Telephone: (732) 494-8444 Fax: (732) 494-7377 Gaston Avenue Office 91 North Gaston Avenue Somerville, NJ 08876 Telephone: (908) 575-7300 Fax: (908) 575-9395 Hillsborough Office 601 U.S. Highway 206, Unit 46 Hillsborough, NJ 08844 Telephone: (908) 281-4009 Fax: (908) 281-3042 Manville Office 40 North Main Street Manville, NJ 08835 Telephone: (908) 541-0404 Fax: (908) 541-0434 Warren Office 34 Mountain Boulevard Building C Warren, NJ 07060 Telephone: (908) 757-9444 Fax: (908) 757-2992 Corporate Office 70 East Main Street Somerville, NJ 08876 Telephone: (908) 541-9500 Fax: (908) 541-6464 Main Office 103 West End Avenue Somerville, NJ 08876 Telephone: (908) 704-1188 Fax: (908) 704-0273 Coming Soon Metuchen Office 700 Middlesex Ave. Metuchen, NJ 08840 [PHOTO OMITTED] Arthur E. Brattlof EXECUTIVE VICE PRESIDENT AND SENIOR LOAN OFFICER 38 SVB Financial Services, Inc. and Somerset Valley Bank GENERAL COUNSEL: Thomas C. Miller, Esq. Miller, Robertson and Rodgers, P.C. 21 North Bridge Street Somerville, NJ 08876 SECURITIES COUNSEL: Peter D. Hutcheon, Esq. Norris, McLaughlin & Marcus 721 Route 202-206 Bridgewater, NJ 08807 INDEPENDENT PUBLIC ACCOUNTANTS: Grant Thornton LLP 2001 Market Street Philadelphia, PA 19103 TRANSFER AGENT: Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016 FORM 10-KSB: The annual report filed with the Securities and Exchange Commission on Form 10-KSB is available without charge upon written request to: Mr. Keith McCarthy SVB Financial Services, Inc. 70 East Main Street Somerville, NJ 08876 WEB SITE: www.somersetvalleybank.com STOCK SYMBOL: The Company's stock is traded on the NASDAQ National Market under the trading symbol SVBF MARKET MAKERS: Advest, Inc. P.O. Box 733 49 Route 202 Far Hills, NJ 07931 (908) 719-0900 Spear Leeds Kellogg 10 Exchange Place Jersey City, NJ 07302 (212) 425-6670 First Tennessee Securities Corporation 845 Crossover Lane, Suite 150 Memphis, TN 38117 (901) 435-8783 39