Sometimes, a positive earnings outlook and solid credit quality are not enough.

Silicon Valley Bancshares found that out Tuesday after issuing a mid-quarter update in which the Santa Clara, Calif., company said fourth-quarter earnings per share would be in line with Wall Street estimates - as would its earnings for next year - and painted a rosy picture for credit quality. How then to explain the response from investors, who slammed Silicon Valley shares with a 22% value markdown?

In a word, deposits. Silicon Valley Bank said its deposits in the fourth quarter will likely be about $50 million lower than they were in the third quarter. And deposits are expected to increase 15% next year, against 20% the company forecast at the end of September.

The dip is the clearest sign that the bank - which has had exceptional growth by just about any measure - has been forced to exert itself in the face of market volatility and intense competition for deposit growth.

Analysts have been projecting in recent weeks that a weakening outlook for credit quality and a general slowdown in capital markets activities - particularly in bond and stock underwriting, private equity investing, and merger advisory services - will dampen near-term results for most of the largest U.S. banking companies.

More so than other banking companies, Silicon Valley's fortunes are tied to the boom-and-bust nature of emerging technology companies. Last year and earlier this year, the technology sector was soaring. Silicon Valley Bank was raking in the deposits. Profits mushroomed.

A slump in the tech sector since late spring has put a crimp on the market for initial public offerings for tech companies. That has reduced liquidity in the venture capital community that would be recycled into new equity investments. All of this, the company said, explains why deposit growth is finally slowing.

"It's been a very challenging environment," said Edward Najarian, an analyst at Merrill Lynch & Co. Silicon Valley Bank "didn't get the growth they would have had if the technology companies were doing better."

At the same time, Silicon Valley has maintained a market premium to the big banks that have substantial exposure to technology, trading at 14.3 times earnings as of Monday's close, versus a 10.9 P/E for Chase Manhattan Corp. and 12.9 for FleetBoston Corp.

During a conference call Tuesday, executives from Silicon Valley Bank pledged to boost deposits by getting customers to transfer money that is being held by other institutions. The company also indicated it could change its compensation structure to encourage deposit-gathering.

"We will look more at accounts that are in the hands of competitors that have been weakened by recent events," said Kenneth P. Wilcox, president and chief executive officer. "That could result in significant growth."

But he added, "We cannot guarantee what the markets are going to be like in 2001."

Analysts said they were impressed with Silicon Valley Bank's ability to manage credit quality. Other banking companies have been stung this year by faltering loans. "Despite the recent volatility in the markets, we have seen no deterioration in our loan portfolio," said John C. Dean, chairman.

The bank said its per-share earnings in the fourth quarter are expected to be 67 cents to 69 cents, in line with the Thomson Financial/First Call estimate of 68 cents.

The company said that by the end of November it had identified six loans totaling $14 million that have a higher-than-normal risk of becoming nonperforming. But it said nonperforming loans would be flat from the $18.5 million reported in the third quarter.

It said the largest questionable loan, a $5.5 million credit to a film production company, was fully reserved to protect for losses.

Silicon Valley projected that loans will rise about 10% next year, the same as previous estimates by the company.

The company said lower net interest income from deposits would be offset by gains in income from client investments and a reduction in expenses as the company puts off some consulting projects.

The outlook came late Monday. Shares of Silicon Valley fell sharply in Tuesday-morning trading, falling $9.75 to close at $34.75. The American Banker index of 225 bank stocks fell 1.3%.


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