| SVB FINANCIAL GROUP Item 1A Risk Factors Our business faces significant risks, including credit, market/liquidity, operational, legal/regulatory, and strategic/reputation risks |
| The factors described below may not be the only risks we face, and are not intended to serve as a comprehensive listing or be applicable only to the category of risk under which they are disclosed |
| The risks described below are generally applicable to more than one of the following categories of risks |
| Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations |
| If any of the events or circumstances described in the following factors actually occur, our business, financial condition and/or results of operations could suffer |
| Credit Risks If a significant number of clients fail to perform under their loans, our business, profitability, and financial condition would be adversely affected |
| As a lender, the largest risk we face is the possibility that a significant number of our client borrowers will fail to pay their loans when due |
| If borrower defaults cause losses in excess of our allowance for loan losses, it could have an adverse effect on our business, profitability, and financial condition |
| We have established an evaluation process designed to determine the adequacy of the allowance for loan losses |
| While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses are dependent to a great extent on our experience and judgment |
| We cannot assure you that our allowance for loan losses will be sufficient to absorb future loan losses or prevent a material adverse effect on our business, profitability, or financial condition |
| Because of the credit profile of our loan portfolio, our levels of nonperforming assets and charge-offs can be volatile, and we may need to make material provisions for loan losses in any period, which could reduce net income or increase net losses in that period |
| Our loan portfolio has a credit profile different from that of most other banking companies |
| Many of our loans are made to companies in the early stages of development with negative cash flow and no established record of profitable operations |
| In many cases, repayment of the loan is dependent upon receipt of additional equity financing from venture capitalists or others |
| Collateral for many of the loans often includes intellectual property, which is difficult to value and may not be readily salable in the case of default |
| Because of the intense competition and rapid technological change that characterizes the 15 ______________________________________________________________________ companies in our technology and life science industry sectors, a borrower’s financial position can deteriorate rapidly |
| We also make loans that are larger, relative to the revenues of the borrower, than those made by traditional small business lenders, so the impact of any single borrower default may be more significant to us |
| Because of these characteristics, our level of nonperforming loans and loan charge-offs can be volatile and can vary materially from period to period |
| Changes in our level of nonperforming loans may require us to make material provisions for loan losses in any period, which could reduce our net income or cause net losses in that period |
| Market/Liquidity Risks Our current level of interest rate spread may decline in the future |
| Any material reduction in our interest spread could have a material impact on our business and profitability |
| A major portion of our net income comes from our interest rate spread, which is the difference between the interest rates paid by us on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates and fees we receive on interest-earning assets, such as loans extended to our clients and interest rates we receive on securities held in our investment portfolio |
| Interest rates are highly sensitive to many factors beyond our control, such as inflation, recession, global economic disruptions, unemployment and the fiscal and monetary policies of the federal government and its agencies |
| In addition, legislative changes could affect the manner in which we pay interest on deposits or other liabilities |
| For example, Congress has for many years debated repealing a law that prohibits banks from paying interest rates on checking accounts |
| If this law were to be repealed, we would be subject to competitive pressure to pay interest on our clients’ checking accounts, which would negatively affect our interest rate spread |
| Any material decline in our interest rate spread would have a material adverse effect on our business and profitability |
| Additionally, a portion of our loan fee income, a component of loan interest income, is predicated on the receipt of warrant assets |
| If we fail to continue to receive warrant assets our future interest margin may decline |
| Our business is dependent upon access to funds on attractive terms |
| We derive our net interest income through lending or investing capital on terms that provide returns in excess of our costs for obtaining that capital |
| A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs (or trigger obligations under certain existing borrowings and other contracts), or increase the interest rates we pay our depositors |
| Further, our credit ratings and the terms upon which we have access to capital may be influenced by circumstances beyond our control, such as overall trends in the general market environment, perceptions about our creditworthiness or market conditions in the industries in which we focus |
| Warrant, venture capital fund, and direct equity investment portfolio gains or losses depend upon the performance of the portfolio investments and the general condition of the public equity markets, which is uncertain |
| We have historically obtained rights to acquire stock, in the form of equity warrants, in certain clients as part of negotiated credit facilities and for other services |
| In future periods we may not be able to ultimately realize gains from the sale of securities to third parties related to the exercise of warrants, or our realized gains may be materially less than the current level of fair value of derivative equity warrant assets and unrealized gains disclosed in this filing |
| We also have made investments in venture capital funds as well as direct equity investments in companies |
| The timing and amount of income, if any, from the disposition of client warrants, venture capital funds, and direct equity investments typically depend upon factors beyond our control, including the performance of the underlying portfolio companies, investor demand for initial public offerings, fluctuations in the market prices of the underlying common stock of these 16 ______________________________________________________________________ companies, levels of mergers and acquisitions activity, and legal and contractual restrictions on our ability to sell the underlying securities |
| In addition, our investments in venture capital funds and direct equity investments have lost value and could continue to lose value or become worthless, which would reduce our net income or could cause a net loss in any period |
| All of these factors are difficult to predict, particularly in the current economic environment |
| Additionally, due to the nature of investing in private equity venture-backed technology and life science companies, it is likely that additional investments within our existing portfolio will become impaired |
| However, we are not in a position to know at the present time which specific investments, if any, are likely to be impaired or the extent or timing of individual impairments |
| Therefore, we cannot predict future investment gains or losses with any degree of accuracy, and any gains or losses are likely to vary materially from period to period |
| Public equity offerings and mergers and acquisitions involving our clients can cause loans to be paid off early, which could adversely affect our business and profitability |
| While an active market for public equity offerings and mergers and acquisitions generally has positive implications for our business, one negative consequence is that our clients may pay off or reduce their loans with us if they complete a public equity offering or are acquired or merge with another company |
| Any significant reduction in our outstanding loans could have a material adverse effect on our business and profitability |
| Operational Risks If we fail to retain our key employees, our growth and profitability could be adversely affected |
| We rely on experienced client relationship managers and on officers and employees with strong relationships with the venture capital community to generate new business |
| If a significant number of these employees were to leave us, our growth and profitability could be adversely affected |
| We believe that our employees frequently have opportunities for alternative employment with competing financial institutions and with our clients |
| Changes to our employee compensation structure could adversely affect our results of operations and cash flows, as well as our ability to attract, recruit, and retain certain key employees |
| We account for our employee stock options in accordance with Accounting Principles Board Opinion Nodtta 25 and related interpretations, which provide that any compensation expense relative to employee stock options be measured based on the intrinsic value of the stock options |
| As a result, when options are granted at fair market value of the underlying stock on the date of grant, as is our practice, we incur no compensation expense |
| SFAS Nodtta 123(R) requires us to record compensation expense for all employee share based payments |
| Such expense will have a material impact on our results of operations |
| In October 2004, in an effort to align our option grant rate to that of other financial institutions similar to us, we significantly decreased the number of shares subject to options granted to our employees on a prospective basis |
| We may in the future consider taking other actions to modify employee compensation structures, such as granting cash compensation or other forms of equity compensation |
| Our decision to reduce the number of option shares to be granted on a prospective basis, and any other future changes we may adopt in our employee compensation structures, could adversely affect our results of operations and cash flows, as well as our ability to attract, recruit, and retain certain key employees |
| 17 ______________________________________________________________________ We could be liable for breaches of security in our online banking services |
| We offer various Internet-based services to our clients, including online banking services |
| The secure transmission of confidential information over the Internet is essential to maintain our clients’ confidence in our online services |
| Advances in computer capabilities, new discoveries, or other developments could result in a compromise or breach of the technology we use to protect client transaction data |
| Although we have developed systems and processes that are designed to prevent security breaches and periodically test our security, failure to mitigate breaches of security could adversely affect our ability to offer and grow our online services and could harm our business |
| People generally are concerned with security and privacy on the Internet and any publicized security problems could inhibit the growth of the Internet as a means of conducting commercial transactions |
| Our ability to provide financial services over the Internet would be severely impeded if clients became unwilling to transmit confidential information online |
| As a result, our operations and financial condition could be adversely affected |
| Business interruptions due to natural disasters and other events beyond our control can adversely affect our business |
| Our operations can be subject to natural disasters and other events beyond our control, such as earthquakes, fires, power failures, telecommunication loss, terrorist attacks, and acts of war |
| Our corporate headquarters and a portion of our critical business offices are located in California near major earthquake faults |
| Such events of disaster, whether natural or manmade, could cause severe destruction or interruption to our operations and as a result, our business could suffer serious harm |
| To mitigate these risks we have begun a phased business continuity program, with initial capabilities available in 2005 and additional capabilities to be implemented throughout 2006 |
| Additionally, we announced in January 2006 that we expected to open a support and back-operations facility in Salt Lake City, Utah during the first half of 2006 |
| The facility is part of our business continuity strategy to ensure the continuous availability of critical client operations in the event of an unforeseen disaster |
| We also have a back-up data center in Phoenix, Arizona |
| Nonetheless, there is no assurance that our business continuity program can adequately mitigate the risks of such business interruptions |
| We rely on other companies to provide key components of our business infrastructure |
| Third parties provide key components of our business infrastructure such as internet connections and network access |
| Any disruption in internet, network access or other voice or data communication services provided by these third parties or any failure of these third parties to handle current or higher volumes of use could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business |
| Technological or financial difficulties of a third party service provider could adversely affect our business to the extent those difficulties result in the interruption or discontinuation of services provided by that party |
| We face risks associated with the ability of our information technology systems and our processes to effectively support our growth |
| We have a complex set of information technology systems and processes to support our business |
| Our systems consist of multiple information systems that complicate our processing, reporting and analysis of our business transactions and business information |
| Although we have continuously improved our business systems and processes, as our business grows larger and more complex, our current systems and processes will likely not be able to support the growth effectively |
| In 2006 and forward, there will be a more significant focus towards improving our systems and processes in order to increase our efficiency, including 18 ______________________________________________________________________ upgrading and consolidating our information systems and improving and automating, where appropriate, our processes |
| There is no assurance that we can effectively and timely improve our systems and processes to meet all of our business needs efficiently |
| We depend on the accuracy and completeness of information about customers and counterparties |
| In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information |
| We also may rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors |
| For example, in deciding whether to extend credit, we may assume that a customer’s audited financial statements conform with accounting principles generally accepted in the United States (“GAAP”) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer |
| We also may rely on the audit report covering those financial statements |
| Our financial condition and results of operations could be negatively affected by relying on financial statements that do not comply with GAAP or that are materially misleading |
| Our accounting policies and methods are key to how we report our financial condition and results of operations |
| They may require management to make estimates about matters that are uncertain |
| Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations |
| Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with GAAP and reflect management’s judgment of the most appropriate manner to report our financial condition and results |
| In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in our reporting materially different amounts than would have been reported under a different alternative |
| Changes in accounting standards could materially impact our financial statements |
| From time to time, the Financial Accounting Standards Board (FASB) changes the financial accounting and reporting standards that govern the preparation of our financial statements |
| These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations |
| In some cases, we could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements |
| If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results |
| As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock |
| Our management has determined that as of December 31, 2005, we did not maintain effective internal control over financial reporting based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control—Integrated Framework” as a result of identified material weaknesses in our internal control over financial reporting |
| Specifically, we did not have adequately designed internal controls in our financial reporting process related to the selection and application of generally accepted accounting principles in that (a) accounting policies, procedures and practices were not consistently developed, maintained or updated in a manner ensuring that financial statements were prepared in accordance with US generally accepted accounting principles, (b) these policies and procedures were not designed to consistently ensure the preparation and retention of adequate documentation to support key judgments made in connection with the selection and application of significant accounting policies within our financial reporting process and (c) our policies and procedures 19 ______________________________________________________________________ did not consistently provide for effective analysis, implementation, and documentation of new accounting pronouncements |
| In addition, we did not maintain sufficient levels of appropriately qualified and trained personnel in our financial reporting processes resulting in our inability to establish internal control over financial reporting policies and procedures related to (1) the timely preparation of comprehensive documentation supporting management’s analysis of the appropriate accounting treatment for warrant derivatives or other non-routine or complex transactions, and (2) the review of such documentation by qualified internal staff, assisted by external advisors as deemed necessary, to determine our completeness and the propriety of our conclusions |
| For a detailed description of these material weaknesses and our remediation efforts and plans, see Part II, Items 9A and 9B These control deficiencies resulted in material errors in our financial reporting which resulted in a restatement of our financial statements for the years 2002, 2003 and 2004 |
| This restatement process took five months to complete, required substantial resources and personnel, and included a comprehensive review of our financial statements and accounting practices by our auditors |
| However, we have not yet fully remediated these material weaknesses |
| In response to these material weaknesses in our internal control over financial reporting, we are implementing additional controls and procedures and are incurring additional related expenses |
| We cannot be certain that the measures we have taken to date and are planning to take will sufficiently and satisfactorily remediate the identified material weaknesses in full |
| Furthermore, we intend to continue improving our internal control over financial reporting and the implementation and testing of these efforts could result in increased cost and could divert management attention away from operating our business |
| If we are unable to remediate the identified material weaknesses discussed above, or if additional material weaknesses are identified in our internal control over financial reporting, our management will be unable to report favorably as to the effectiveness of our internal control over financial reporting and/or our disclosure controls and procedures, and we could be required to further implement expensive and time-consuming remedial measures and potentially lose investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price and potentially subject us to litigation |
| Legal/Regulatory Risks We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business |
| SVB Financial, Silicon Valley Bank, and their subsidiaries are extensively regulated under federal and state law |
| These regulations are intended primarily for the protection of depositors, other clients, and the deposit insurance fund—not for the benefit of stockholders or security holders |
| Federal and state laws and regulations limit or otherwise affect the activities in which SVB Financial, Silicon Valley Bank, and their subsidiaries may engage |
| A change in the applicable statutes, regulations, or regulatory policy may have a material effect on our business and that of our subsidiaries in substantial and unpredictable ways including by placing limitations on the types of financial services and products we may offer or increasing the ability of nonbanks to offer competing financial services and products |
| In addition, SVB Financial, Silicon Valley Bank, and their subsidiaries are required to maintain certain minimum levels of capital |
| Federal and state banking regulators possess broad powers to take supervisory action, as they deem appropriate, with respect to SVB Financial and Silicon Valley Bank |
| SVB Alliant and SVB Securities, both broker-dealer subsidiaries, are regulated by the SEC and the National Association of Securities Dealers, Inc |
| Violations of the stringent regulations governing the actions of a broker-dealer can result in the revocation of broker-dealer licenses, the imposition of censures or fines, the issuance of cease and desist orders, and the suspension or expulsion from the securities business of a firm, its officers or employees |
| Supervisory actions can result in higher capital requirements, higher insurance premiums, and limitations on the activities of SVB Financial, Silicon Valley Bank or their subsidiaries |
| These supervisory actions could have a material adverse effect on our business and profitability |
| Any increased or unanticipated regulatory 20 ______________________________________________________________________ scrutiny or review may impact the conduct of our business and could have a material adverse effect on our business and profitability, since existing resources would be detracted from the current conduct of business and reprioritized to resolve any such review |
| For example, the scope and degree of regulatory scrutiny of Bank Secrecy Act (BSA)/anti-money laundering compliance have expanded significantly following the events of September 11, 2001 and as a result we have been focusing resources to understand our inherent BSA risk and to document our compliance |
| We could also receive regulatory sanctions or be subject to regulatory orders for any failure to comply with laws, regulations or policies, which may damage our reputation |
| SVB Financial relies on dividends from its subsidiaries for most of its revenue |
| SVB Financial is a separate and distinct legal entity from its subsidiaries |
| It receives substantially all of its revenue from dividends from its subsidiaries |
| These dividends are the principal source of funds to pay dividends on SVB Financial’s common and preferred stock and interest and principal on its debt |
| Various federal and/or state laws and regulations limit the amount of dividends that our bank and certain of our nonbank subsidiaries may pay to SVB Financial |
| Also, SVB Financial’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors |
| Our reputation is very important to sustain our business, as we rely on our relationships with our current, former and potential clients and stockholders, the venture capital and private equity community and the industries in which we serve |
| Any damage to our reputation, such as regulatory enforcement actions, downgrade of ratings, loss of customers, late filings of SEC reports and potential delisting actions, could have a material adverse effect on our business |
| Adverse changes in domestic or global economic conditions, especially in the technology sector and particularly in California, could have a material adverse effect on our business, growth, and profitability |
| If conditions deteriorate in the domestic or global economy, especially in the technology, life science, private equity, and premium wine industry niches, our business, growth, and profitability are likely to be materially adversely affected |
| A global or US economic slowdown would harm many of our clients |
| Our clients may be particularly sensitive to disruptions in the growth of the technology sector of the US economy |
| In addition, a substantial number of our clients are geographically concentrated in California, and adverse economic conditions in California could harm the businesses of a disproportionate number of our clients |
| To the extent that our clients’ underlying businesses are harmed, they are more likely to default on their loans |
| Decreases in the amount of equity capital available to start-up and emerging-growth companies could adversely affect our business, profitability, and growth prospects |
| Our strategy has focused on providing banking products and services to emerging-growth and corporate technology companies receiving financial support from sophisticated investors, including venture capitalists, “angels,” and corporate investors |
| In some cases, our lending credit decision is based on our analysis of the likelihood that our venture capital or angel-backed client will receive a second or third round of equity infusion from investors |
| If the amount of capital available to such companies decreases, it is likely that the number of new clients and investor financial support to our existing borrowers could decrease, which would have an adverse effect on our business, profitability and growth prospects |
| 21 ______________________________________________________________________ Among the factors that have and could in the future affect the amount of capital available to startup and emerging-growth companies are the receptivity of the capital markets to initial public offerings or mergers and acquisitions of companies within our technology and life science industry sectors, the availability and return on alternative investments, and general economic conditions in the technology and life science industries |
| Reduced capital markets valuations could reduce the amount of capital available to startup and emerging-growth companies, including companies within our technology and life science industry sectors |
| We cannot assure that we will be able to maintain our historical levels of profitability in the face of sustained competitive pressures |
| Other banks and specialty and diversified financial services companies, many of which are larger and have more capital than we do, offer lending, leasing, other financial products and advisory services to our client base |
| In some cases, our competitors focus their marketing on our industry sectors and seek to increase their lending and other financial relationships with technology companies, early stage growth companies or special industries such as wineries |
| In other cases, our competitors may offer a broader range of financial products to our clients |
| When new competitors seek to enter one of our markets, or when existing market participants seek to increase their market share, they sometimes undercut the pricing and/or credit terms prevalent in that market, which could adversely affect our market share |
| Our pricing and credit terms could deteriorate if we act to meet these competitive challenges |
| We face risks in connection with completed or potential acquisitions |
| We completed one acquisition in each of 2002 and 2001 and, if appropriate opportunities present themselves, we intend to acquire businesses, technologies, services or products that we believe are strategic |
| There can be no assurance that we will be able to identify, negotiate or finance future acquisitions successfully or integrate such acquisitions with our current business |
| Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, and/or contingent liabilities, which could have a material adverse effect on our business, results of operations, and/or financial condition |
| Any such future acquisitions of other businesses, technologies, services, or products might require us to obtain additional equity or debt financing, which might not be available on terms favorable to us, or at all; and such financing, if available, might be dilutive |
| Upon completion of an acquisition, we are faced with the challenges of integrating the operations, services, products, personnel, and systems of acquired companies into our business, which may divert management’s attention from ongoing business operations |
| In addition, acquisitions of new businesses may subject us to regulatory scrutiny |
| We cannot assure that we will be successful in integrating any acquired business effectively into the operations of our business |
| Moreover, there can be no assurance that the anticipated benefits of any acquisition will be realized |
| The success of our acquisitions is dependent on the continued employment of several key employees |
| If acquired businesses do not meet projected revenue targets, or if certain key employees were to leave the businesses, we could conclude that the value of the businesses has decreased and that the related goodwill has been impaired |
| If we were to conclude that goodwill has been impaired that conclusion would result in an impairment of goodwill charge to us, which would adversely affect our results of operations |
| We face risks associated with international operations |
| A component of our strategy is to expand internationally on a limited basis, which requires management’s attention and resources |
| We already opened offices in the UK, India and China and plan to expand our operations in those locations and are exploring adding other locations |
| In addition to the uncertainty regarding our ability to generate revenues from foreign operations and to expand our 22 ______________________________________________________________________ international presence, there are certain risks inherent in doing business on an international basis, including, among others, legal and regulatory requirements, legal uncertainty regarding liability, tariffs, and other trade barriers, difficulties in staffing and managing foreign operations, differing technology standards or customer requirements, requirements or restrictions relating to making foreign direct investments, difficulties associated with repatriating cash generated or held abroad in a tax-efficient manner, longer payment cycles, different accounting practices, problems in collecting loan or other types of payments, political and economic instability, seasonal reductions in business activity, changes in tax laws and potentially adverse tax consequences, any of which could adversely affect the success of our international operations |
| In addition, in many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by regulations applicable to us, such as the Foreign Corrupt Practices Act |
| Although we implement policies and procedures designed to ensure compliance with these laws, our employees and agents may take actions in violation of our policies |
| Any such violation, even if prohibited by our policies, could have a material adverse effect on our business |
| To the extent we continue to expand our international operations and have additional portions of our international revenues denominated in foreign currencies, we could become subject to increased risks relating to foreign currency exchange rate fluctuations |
| Since we have limited experience in globalizing our service, there can be no assurance that we will be successful in expanding into international markets or that one or more of the factors discussed above will not have a material adverse effect on our business, results of operations, and/or financial condition |
| Maintaining or increasing our market share depends on market acceptance of new products and services |
| Our success depends, in part, upon our ability to adapt our products and services to evolving industry standards and client demands |
| There is increasing pressure on financial services companies to provide products and services at lower prices |
| In addition, the widespread adoption of new technologies, including Internet-based services, could require us to make substantial expenditures to modify or adapt our existing products or services |
| A failure to achieve market acceptance of any new products we introduce, or a failure to introduce products that the market may demand, could have an adverse effect on our business, profitability, or growth prospects |