Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
Commission file number 0-11113
PACIFIC CAPITAL BANCORP
(Exact Name of Registrant as Specified in its Charter)
California 95-3673456
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 E. Carrillo Street, Suite 300
Santa Barbara, California 93101
(Address of principal executive offices) (Zip Code)
(805) 564-6298
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Title of Class Name of Each Exchange on Which Registered
Common Stock, no par value Not Listed
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 1, 2000, based on the sales prices reported to the
registrant on that date of $29.125 per share:
Common Stock - $652,725,501*
*Based on reported beneficial ownership by all directors and executive officers
and the registrant's Employee Stock Ownership Plan; however, this determination
does not constitute an admission of affiliate status for any of these
stockholders.
As of February 28, 2000, there were 24,554,294 shares of the issuer's common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of registrant's Proxy Statement
for the Annual Meeting of Shareholders on April 25, 2000 are incorporated by
reference into Parts I, II, and III.
INDEX Page
PART I
Item 1. Business
(a) General Development of the Business 3
(b) Financial Information about Industry Segments 3
(c) Narrative Description of Business 3
(d) Financial Information about Foreign and Domestic
Operations and Export Sales 4
Item 2. Properties 4
Item 3. Legal Proceedings 4
Item 4. Submission of Matters to a Vote of Security Holders 4
PART II
Item 5. Market for the Registrant's Common Stock and
Related Stockholder Matters 5
(a) Market Information
(b) Holders
(c) Dividends
Item 6. Selected Financial Data 6
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 6
Item 8. Financial Statements and Supplementary Data 39
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosures 77
PART III
Item 10. Directors and Executive Officers of the Registrant 78
Item 11. Executive Compensation 78
Item 12. Security Ownership of Certain Beneficial
Owners and Management 78
Item 13. Certain Relationships and Related Transactions 78
PART IV
Item 14. Exhibits, Financial Statements and Reports
on Form 8-K 79
Signatures 80
EXHIBIT INDEX 81
PART I
ITEM 1. BUSINESS
(a) General Development of the Business
Operations commenced as Santa Barbara National Bank with one office and 18
employees in 1960. In 1979, the Bank switched to a state charter and changed its
name to Santa Barbara Bank & Trust ("SBB&T"). Santa Barbara Bancorp ("SBB") was
formed in 1982. In 1998, SBB merged with Pacific Capital Bancorp ("PCB"), a bank
holding company that was the parent of First National Bank of Central California
("FNB") and South Valley National Bank ("SVNB"). SBB was the surviving company,
but took the name Pacific Capital Bancorp. Unless otherwise stated, "Company"
refers to this consolidated entity and to its subsidiary banks when the context
indicates. "Bancorp" refers to the parent company only.
SBB&T has grown to 27 banking offices with loan, trust and escrow offices.
Through 1988, banking activities were primarily centered in the southern coastal
region of Santa Barbara County. Two banking offices were added in the merger
with Community Bank of Santa Ynez Valley on March 31, 1989. Five offices in
northern Santa Barbara County were added with the acquisition of First Valley
Bank on March 31, 1997, and three offices in the Santa Clara River Valley region
of Ventura County were added with the acquisition of Citizens State Bank on
September 30, 1997. From 1995 through 1998, six banking offices were opened in
western Ventura County and one in northern Santa Barbara County.
FNB has 10 banking offices in Monterey, Santa Cruz, Santa Clara, and San Benito
Counties. The offices in the latter two counties use the name South Valley
National Bank, which was a separate subsidiary of PCB until it merged with FNB
shortly before PCB merged with SBB. FNB also provides trust and investment
services to its customers.
A third subsidiary, Pacific Capital Commercial Mortgage Company ("PCCM"), was
formed in 1988. This subsidiary, which is now primarily involved in mortgage
brokering services and the servicing of brokered loans, was formerly known as
Sanbarco Mortgage Company.
There is a fourth subsidiary, Pacific Capital Services Corporation, which is
inactive.
(b) Financial Information about Industry Segments
Information about industry segments is provided in Note 20 to the consolidated
financial statements.
(c) Narrative Description of Business
Bancorp is a bank holding company, which as described above, has two bank
subsidiaries and two non-bank subsidiaries, one of which is inactive. Bancorp
provides support services to its subsidiary banks. These include executive
management, personnel and benefits, risk management, data processing, strategic
planning, legal, and accounting and treasury.
The banks offer a full range of commercial banking services to households,
professionals, and small- to medium-sized businesses. These include various
commercial, real estate and consumer loan, leasing and deposit products. The
banks offer other services such as electronic fund transfers and safe deposit
boxes to both individuals and businesses. In addition, services such as lockbox
payment servicing, foreign currency exchange, letters of credit, and cash
management are offered to business customers. The banks also offer trust and
investment services to individuals and businesses. These include acting as
trustee or agent for living and testamentary trusts, charitable remainder
trusts, employee benefit trusts, and profit sharing plans, as well as executor
or probate agent for estates. Investment management and advisory services are
also provided.
Competition: For most of its banking products, the Company faces competition in
its market area from branches of most of the major California money center
banks, some of the statewide savings and loan associations, and other local
community banks and savings and loans. For some of its products, the Company
faces competition from other non-bank financial service companies, especially
securities firms.
Employees: The Company's current workforce is approximately 1,100 full time
equivalent employees. Additional employees would be added if new opportunities
for geographic expansion or other business activities should occur.
(d) Financial Information about Foreign and Domestic Operations and Export
Sales
The Company does not have any foreign business operations or export sales of its
own. However, it does provide financial services including wire transfers,
foreign currency exchange, letters of credit, and loans to other businesses
involved in foreign trade.
ITEM 2. PROPERTIES
The Company maintains its executive and administrative offices in leased
premises at 200 E. Carrillo St., Suite 300, Santa Barbara. Administrative
functions are located in various leased premises in the Santa Barbara area.
Of the 37 branch banking offices, all or a portion of 26 are leased. The
building used by the Real Estate, Consumer Lending and Escrow departments is
owned. Commercial office space is leased for Trust and Investment Services
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
(a) Market Information
The Company's common stock is traded on The Nasdaq Stock Market under the symbol
SABB. At December 31, 1999, ten independent brokerage firms were registered as
market makers in the Company's common stock. The following table presents the
high and low closing sales prices of the Company's common stock for each
quarterly period for the last two years as reported by The Nasdaq Stock Market:
1999 Quarters 1998 Quarters
--------------------------- ---------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
------ ------ ------ ------ ------ ------ ------ ------
Range of stock prices:
High $34.75 $38.00 $31.94 $26.00 $26.50 $34.38 $34.00 $27.88
Low $30.63 $29.63 $20.13 $22.00 $22.50 $22.00 $25.50 $22.13
(b) Holders
There were approximately 10,500 holders of stock as of December 31, 1999. This
number includes an estimate of the number of shareholders whose shares are held
in the name of brokerage firms or other financial institutions. The Company is
not provided with the number or identities of these shareholders, but has
estimated the number of such shareholders from the number of shareholder
documents requested by these firms for distribution to their customers.
(c) Dividends
Dividends are currently declared four times a year, and the Company expects to
follow the same policy in the future. The following table presents cash
dividends declared per share for the last two years:
1999 Quarters 1998 Quarters
--------------------------- ---------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
------ ------ ------ ------ ------ ------ ------ ------
Cash dividends
declared $0.18 $0.18 $0.18 $0.18 $0.18 $0.18 $0.15 $0.15
The dividends paid to shareholders of the Company are funded primarily from
dividends received by Bancorp from the banks. Reference should be made to Note
17 of the Consolidated Financial Statements on page 67 for a description of
restrictions on the ability of the subsidiary banks to pay dividends to Bancorp.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the
Company's Consolidated Financial Statements and the accompanying notes presented
in Item 8.
(amounts in thousands except Increase
per share amounts) 1999 (Decrease) 1998 1997 1996 1995
RESULTS OF OPERATIONS:
Interest income $211,643 $18,004 $193,639 $168,272 $133,536 $120,866
Interest expense 67,856 (257) 68,113 60,590 48,368 44,554
Net interest income 143,787 18,261 125,526 107,682 85,168 76,312
Provision for credit losses 6,375 (2,748) 9,123 8,500 4,949 10,451
Other operating income 41,618 3,397 38,221 30,442 22,102 20,671
Non-interest expense:
Staff expense 51,645 2,367 49,278 43,140 38,016 32,644
Other operating expense 58,744 1,940 56,804 39,913 31,300 28,677
Income before income taxes and
effect of accounting change 68,641 20,099 48,542 46,571 33,005 25,211
Provision for income taxes 24,367 5,392 18,975 16,288 11,301 8,185
Net income $44,274 $14,707 $29,567 $30,283 $21,704 $17,026
DILUTED PER SHARE DATA: (1)
Average shares outstanding 24,790 343 24,447 24,188 24,228 24,123
Net income $1.79 $0.58 $1.21 $1.25 $0.90 $0.71
Cash dividends declared $0.72 $0.06 $0.66 $0.49 $0.36 $0.28
FINANCIAL CONDITION:
Total assets $2,879,282 $229,864 $2,649,418 $2,357,105 $1,920,759 $1,743,213
Total deposits $2,440,181 $110,505 $2,329,676 $2,087,553 $1,660,265 $1,519,528
Long-term debt $85,000 $42,100 $42,900 $38,000 $38,000 --
Total shareholders' equity $234,573 $20,573 $214,000 $190,724 $171,239 $161,550
OPERATING AND CAPITAL RATIOS:
Average total shareholders'
equity to average total assets 8.19% (0.22%) 8.41% 8.64% 9.47% 9.93%
Rate of return on average:
Total assets 1.59% 0.40% 1.19% 1.43% 1.22% 1.08%
Total shareholders' equity 19.44% 5.25% 14.19% 16.55% 12.91% 10.88%
(1) Earnings per share are presented on a diluted basis.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Management's discussion and analysis of the financial condition and results of
operation begins on the following page.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following provides Management's comments on the financial condition and
results of operations of Pacific Capital Bancorp (formerly named Santa Barbara
Bancorp or "SBB") and its subsidiaries. Unless otherwise stated, the "Company"
refers to this consolidated entity and to its subsidiaries when the context
indicates. This discussion should be read in conjunction with the Company's
consolidated financial statements and the notes to the consolidated financial
statements that are presented on pages 43 through 76 of this Annual Report on
Form 10-K. "Bancorp" will be used to refer to the parent company only. "PCB"
will be used to refer to the former Pacific Capital Bancorp, which merged with
SBB at the end of 1998. SBB assumed the Pacific Capital Bancorp name. The
subsidiary banks are Santa Barbara Bank & Trust ("SBB&T") and First National
Bank of Central California ("FNB"). South Valley National Bank ("SVNB"), the
holding company of which merged with PCB in November 1996, itself merged with
FNB in October 1998 and operates under the same national bank charter as FNB.
Pacific Capital Commercial Mortgage Corporation ("PCCM") formerly named Sanbarco
Mortgage Corporation, is a non-bank subsidiary of Bancorp primarily involved in
mortgage brokering and the servicing of brokered loans. The Company also has an
inactive subsidiary, Pacific Capital Services Corporation. Terms with which the
reader may not be familiar are printed in bold and defined the first time they
occur or are defined in a note on pages 37 and 38.
The discussion provides insight into Management's assessment of the operating
trends over the last several years and its expectations for 2000. Such
expressions of expectations are not historical in nature and are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Forward-looking statements are subject to risks and uncertainties that may
cause actual future results to differ materially from those expressed in any
forward-looking statement. Such risks and uncertainties with respect to the
Company include those related to the economic environment, particularly in the
regions in which the Company operates, the products and pricing of competitive
financial institutions, government regulation, government monetary and fiscal
policy, changes in prevailing interest rates, mergers and acquisitions and the
integration of the merged or acquired businesses, credit quality,
asset/liability management, and the availability of sources of liquidity at a
reasonable cost. This discussion is intended to assist readers of the
accompanying financial statements by providing information on the strategies
adopted by the Company to address these risks, and the results of these
strategies. These elements are addressed as they relate to the major asset and
liability components of the Company's balance sheets, and the major income and
expense categories of the Company's statements of income and to significant
changes among them.
OVERVIEW OF EARNINGS PERFORMANCE
The earnings for the Company were $44.3 million in 1999, or $1.79 per share.
This represents a substantial increase over the $29.6 million net income or
$1.21 per share reported for 1998. 1998's reported earnings were significantly
impacted by expenses related to the merger of SBB with PCB. Exclusive of these
merger expenses, the Company's net operating income was $37.9 million and
diluted earnings per share for the year 1998 would have been $1.55. 1999 net
income exceeded the 1998 pro forma amount by 16.9% and 1999 earnings per share
exceeded the 1998 pro forma figure by 15.5%. 1998 pro forma net income was 25.1%
higher than net income for 1997. Since 1995, the Company's net income has
increased at an compound average annual rate of 27.0%.
This average annual rate is not artificially inflated by the sudden inclusion of
the operating results of PCB in 1999 due to the merger. Unlike the acquisitions
of First Valley Bank ("FVB") in Lompoc and Citizens State Bank ("CSB") in
Ventura County during 1997 (described in Note 19 to the consolidated financial
statements), which were accounted for as purchase transactions, the merger with
PCB was accounted for as a "pooling-of-interests." As a result, all amounts in
this discussion and in the consolidated financial statements have been restated
to reflect the results of operations of PCB as if the merger had occurred prior
to the earliest period presented.
Among the reasons for the substantial increase in net income were: (1) the
integration of eight new branch offices through the acquisition of FVB and CSB,
(2) growth in the tax refund anticipation loan ("RAL") and refund transfer
("RT") programs, (3) strong loan demand during the last two years, and (4)
continued growth in trust and investment service fees due to the strong stock
market performance and new customers. In addition, during 1999, the Company
began to realize some of the expected cost savings from the merger with PCB.
However, these savings were more than offset in this first year by the expenses
incurred to complete the integration of the two computer systems.
Loan balances increased $271 million in 1998 and $399 million in 1999. Together
with an expanding RAL program, this growth resulted in an increase of $25.4
million of additional interest income for 1998 over 1997 and an additional $18.0
million of interest in 1999 compared to 1998. Noninterest income increased $7.8
million in 1998 compared to 1997 and $3.4 million in 1999 compared to 1998, of
which increases in trust and investment services fees in 1998 and 1999 accounted
for $1.6 million and $1.4 million, respectively. Increases in RT fees were $1.9
million for 1998 over 1997 and $1.8 million for 1999 over 1998. The balance of
the year-over-year increases came in a variety of accounts.
The amount of provision for credit losses other than those arising from refund
anticipation loans has remained relatively stable at $3.9 million for 1997, $4.2
million for 1998, and $3.6 million in 1999.
There has also been an increase in noninterest expenses as would be expected
with the growth in the Company's average assets and the expansion into new
market areas . These include salary costs, occupancy, marketing, and the
amortization of goodwill from acquisitions. Exclusive of the merger-related
expenses incurred in 1998, the Company's operating efficiency ratio, which
measures how many cents of expense it takes to earn a dollar of operating
income, decreased from 57.2(cent) in 1997 to 55.2(cent) in 1998, but increased
in 1999 to 57.7(cent). The increase in 1999 was primarily due to additional
expenses incurred to prepare for the century date change and to convert the
financial records from the computer system used by PCB to that used by the
Company.
EXTERNAL FACTORS IMPACTING THE COMPANY
The major external factors impacting the Company include economic conditions,
regulatory considerations, and trends in the banking and financial services
industries.
Economic Conditions
From a national perspective, the most significant economic factors impacting the
Company in the last three years have been the steady growth in the economy and
the actions of the Federal Reserve Board ("the Fed") to manage the pace of that
growth. The Fed raised short-term interest rates in late 1997 to slow the pace
of economic growth and forestall inflation. During late 1998, it lowered rates
to keep economic activity up in the face of recession in many other parts of the
world. In late 1999, it again began to raise interest rates to slow economic
growth. These changes impact the Company as market rates for loans, investments
and deposits respond to the Fed's actions.
The local economies in which the Company operates have continued to experience
growth similar to the trends occurring elsewhere in the country. In the region
served by SBB&T, the business climate in general remains healthy. Tourism, which
has long been important to the communities in this market area, remains strong
after some decline in the first half of 1998 related to El Ni-o. Medical
manufacturing and other "hi-tech" businesses have continued to grow. Several
large retail and factory outlet complexes have been built in the last few years.
SBB&T expanded its market areas in 1997 with the acquisitions of FVB and CSB and
they now encompass communities more oriented to agricultural enterprises. This
has helped to diversify the bank's customer base. In the region served by FNB
and SVNB, significant growth has occurred in South Santa Clara County in both
housing and in new businesses. This growth has been a result of the continued
economic expansion in the Silicon Valley, which is adjacent to the market area
served by SVNB. In the Monterey area, tourism has remained strong. There has
been significant downward price pressure for the agriculture-related industries
in the market areas of both banks.
Regulatory Considerations
The Company is impacted by changes in the regulatory environment. Bancorp, as a
bank holding company, SBB&T, as a member of the Federal Reserve Bank (the
"FRB"), and PCCM, as a non-bank subsidiary of a bank holding company, are all
regulated by the FRB. FNB, as a nationally chartered bank, has the Office of the
Comptroller of the Currency (the "OCC") as its primary regulator, but must also
comply with FRB regulations. As a state-chartered commercial bank, SBB&T is also
regulated by the California Department of Financial Institutions.
Changes in regulation impact the Company in different ways. The FRB requires
that all banks maintain cash reserves equal to a percentage of their transaction
deposits. The FRB may increase or decrease the percentage of deposits that must
be held at the FRB to impact the amount of funds available to commercial banks
to lend to their customers. This is done as a means of stimulating or slowing
economic activity.
The Company and its subsidiary banks are also impacted by minimum capital
requirements. These rules are discussed below in the section entitled "Capital
Adequacy." The actions which the various banking agencies can take with respect
to financial institutions which fail to maintain adequate capital and comply
with other requirements are discussed below in the section titled "Regulation."
Competition
The Company faces competition from other financial institutions and from
businesses in other industries that have developed financial products. Banks
once had an almost exclusive franchise for deposit products and provided the
majority of business financing. With deregulation in the 1980s, other kinds of
financial institutions began to offer competing products. Also, increased
competition in consumer financial products has come from companies not typically
associated with the banking and financial services industry, such as AT&T,
General Motors and various software developers. Similar competition is faced for
commercial financial products from insurance companies and investment bankers.
Community banks, including the Company, are working to offset this trend by
developing new products that capitalize on the service quality that a local
institution can offer. Among these are new loan and investment products. The
latter are offered to the Company's retail customers through the Trust &
Investment Management Services Divisions at each bank. The Company's primary
competitors are different for each specific product and market area. While this
offers special challenges for the marketing of our products, it offers
protection from one competitor dominating the Company in its market areas.
RISK MANAGEMENT
The Company sees the process of addressing the potential impacts of the external
factors listed above as part of its management of risk. In addition to common
business risks such as disasters, theft, and loss of market share, the Company
is subject to special types of risk due to the nature of its business. New and
sophisticated financial products are continually appearing with different types
of risk which need to be defined and managed. Also, the risks associated with
existing products must be reassessed periodically. The Company cannot operate
risk-free and make a profit. Instead, the process of risk definition and
assessment allows the Company to select the appropriate level of risk for the
anticipated level of reward and then decide on the steps necessary to manage
this risk. The process of addressing these risks is led by the Company's
Director of Risk Management and the other members of its Senior Leadership Team
under the direction and oversight of the Board of Directors.
The special risks related to financial products are credit risk and interest
rate risk. Credit risk relates to the possibility that a debtor will not repay
according to the terms of the debt contract. Credit risk is discussed in the
sections related to loans. Interest rate risk relates to the adverse impacts of
changes in interest rates. The types of interest rate risk will be explained in
the next section. The effective management of these and the other risks
mentioned above is the backbone of the Company's business strategy.
NET INTEREST MARGIN AND CHANGES IN THE RELATIVE PROPORTIONS OF
ASSETS AND LIABILITIES
The Company earns income from two sources. The primary source is through the
management of its financial assets and liabilities and the second is by charging
fees for services provided. The first involves functioning as a financial
intermediary, that is, the Company accepts funds from depositors or obtains
funds from other creditors and then either lends the funds to borrowers or
invests those funds in securities or other financial instruments. Fee income is
discussed in other sections of this analysis, specifically in "Other Operating
Income" and "Tax Refund Anticipation Loans and Refund Transfers."
Net interest income is the difference between the interest and fees earned on
loans and investments (the Company's earning assets) and the interest expense
paid on deposits and other liabilities. The amount by which interest income will
exceed interest expense depends on two factors: (1) the volume or balance of
earning assets compared to the volume or balance of interest-bearing deposits
and liabilities, and (2) the interest rate earned on those interest earning
assets compared with the interest rate paid on those interest-bearing deposits
and liabilities. The Company's 1999 tax equivalent (Note C) net interest income
of $149.6 million was $18.5 million, or 14.1%, greater than the $131.1 million
of net interest income for 1998. The 1998 amount in turn was $18.4 million, or
16.3%, greater than the 1997 amount.
Net interest margin is net interest income expressed as a percentage of average
earning assets. It is used to measure the difference between the average rate of
interest earned on assets and the average rate of interest that must be paid to
support those assets. To maintain its net interest margin, the Company must
manage the relationship between interest earned and paid. The Company's 1999 net
interest margin was 5.76% compared to 5.65% and 5.67% for 1998 and 1997,
respectively. The decrease from 1997 to 1998 occurred because as interest rates
fell on earning assets during the year due to rate actions by the Fed, the
Company was not able to reduce deposit rates quite as quickly. When the Fed
started to raise rates again in 1999 due to concerns about an overheated
economy, the Company's variable rate loans repriced along with the rise in
external rates, but it was not necessary to increase rates on deposit accounts
as much in order to stay competitive. This created a larger spread between the
rates earned and paid which resulted in an increase in the margin. The net
interest margin is subject to the following types of risks that are related to
changes in interest rates.
Market Risk Relating to Fixed-Rate Instruments
Market risk results from the fact that the market values of assets or
liabilities on which the interest rate is fixed will increase or decrease with
changes in market interest rates. If the Company invests funds in a fixed-rate
long-term security and then interest rates rise, the security is worth less than
a comparable security just issued because the older security pays less interest
than the newly issued security. If the older security had to be sold before
maturity, the Company would have to recognize a loss. Conversely, if interest
rates decline after a fixed-rate security is purchased, its value increases,
because it is paying at a higher rate than newly issued securities. The
fixed-rate liabilities of the Company, like certificates of deposit and
borrowings from the Federal Home Loan Bank ("FHLB"), also change in value with
changes in interest rates. As rates drop, they become more valuable to the
depositor and hence more costly to the Company. As rates rise, they become more
valuable to the Company. Therefore, while the value changes regardless of which
direction interest rates move, the adverse impacts of market risk to the
Company's fixed-rate assets are due to rising interest rates and for the
Company's fixed-rate liabilities they are due to falling rates. In general, for
a given change in interest rates, the amount of the change in value up or down
is larger for instruments with longer remaining maturities. Therefore, the
exposure to market risk from assets is lessened by managing the amount of
fixed-rate assets and by keeping maturities relatively short. However, these
steps must be balanced against the need for adequate interest income because
variable rate and shorter term fixed-rate securities generally earn less
interest than fixed-rate and longer term securities.
Note 14 to the consolidated financial statements discloses the carrying amounts
and fair values of the Company's financial assets and liabilities, its net
financial assets, as of the end of 1999 and 1998. There is a relatively small
difference between the carrying amount of the assets and their fair value due to
credit quality issues. However, the primary difference between the carrying
amount and the fair value of the Company's financial assets is essentially a
measure of how much changes in interest rates have made the assets more or less
valuable to the Company at December 31, 1999 and 1998 than when acquired. The
excess of the carrying amounts of the financial assets over their fair value at
the end of 1999 was $36.7 million compared with an excess of fair value over
carrying amounts of $21.5 million at the end of 1998. Most of this change is due
to increases in market rates in the latter half of 1999.
Because the amount of the Company's fixed-rate liabilities is significantly less
than its fixed-rate assets, and because the average maturity of the fixed-rate
liabilities is substantially less than for the fixed-rate assets, the market
risk relating to liabilities is not as great as for assets. The difference
between the carrying amount and the fair value in the table in Note 14 shows the
impact of changing rates on the Company's liabilities that have fixed-rates.
They are worth $21.9 million less to customers or lenders to the Company at
December 31, 1999 than they were when issued, because on a weighted average
basis, they are paying lower than current market rates. However, this is less
than the $36.7 million by which the carrying amounts of the Company's assets
exceed their fair values because the assets also are paying lower rates than
currently are available for comparable assets.
Mismatch Risk
The second interest-related risk, mismatch risk, arises from the fact that when
interest rates change, the changes do not occur equally in the rates of interest
earned and paid because of differences in the contractual terms of the assets
and liabilities held. A difference in the contractual terms, a mismatch, can
cause adverse impacts on net interest income.
The Company has a large portion of its loan portfolio tied to the national prime
rate. If these rates are lowered because of general market conditions, e.g., the
prime rate decreases in response to a rate decrease by the Fed, these loans will
be repriced. If the Company were at the same time to have a large proportion of
its deposits in long-term fixed-rate certificates, interest earned on loans
would decline while interest expense would remain at higher levels for a period
of time. Therefore net interest income would decrease immediately. A decrease in
net interest income could also occur with rising interest rates if the Company
had a large portfolio of fixed-rate loans and securities that was funded by
deposit accounts on which the rate is steadily rising.
This exposure to mismatch risk is managed by attempting to match the maturities
and repricing opportunities of assets and liabilities. This may be done by
varying the terms and conditions of the products that are offered to depositors
and borrowers. For example, if many depositors want shorter-term certificates
while most borrowers are requesting longer-term fixed rate loans, the Company
will adjust the interest rates on the certificates and loans to try to match up
demand for similar maturities. The Company can then partially fill in mismatches
by purchasing securities or borrowing funds from the FHLB with the appropriate
maturity or repricing characteristics.
Basis Risk
The third interest-related risk, basis risk, arises from the fact that interest
rates rarely change in a parallel or equal manner. The interest rates associated
with the various assets and liabilities differ in how often they change, the
extent to which they change, and whether they change sooner or later than other
interest rates. For example, while the repricing of a specific asset and a
specific liability may occur at roughly the same time, the interest rate on the
liability may rise one percent in response to rising market rates while the
asset increases only one-half percent. While the Company would appear to be
evenly matched with respect to maturities, it would suffer a decrease in net
interest income. This exposure to basis risk is the type of interest risk least
able to be managed, but is also the least dramatic. Avoiding concentration in
only a few types of assets or liabilities is the best means of increasing the
chance that the average interest received and paid will move in tandem. The
wider diversification means that many different rates, each with their own
volatility characteristics, will come into play.
Net Interest Income and Net Economic Value Simulations
To quantify the extent of all of these risks both in its current position and in
transactions it might take in the future, the Company uses computer modeling to
simulate the impact of different interest rate scenarios on net interest income
and on net economic value. Net economic value or the market value of portfolio
equity is defined as the difference between the market value of financial assets
and liabilities. These hypothetical scenarios include both sudden and gradual
interest rate changes, and interest rate changes in both directions. This
modeling is the primary means the Company uses for interest rate risk management
decisions.
The hypothetical impacts of sudden interest rate shocks applied to the Company's
asset and liability balances are modeled quarterly. The results of this modeling
indicate how much of the Company's net interest income and net economic value
are "at risk" (deviation from the base level) from various sudden rate changes.
Although interest rates normally would not change in this sudden manner, this
exercise is valuable in identifying risk exposures. The results for the
Company's December 31, 1999 balances indicate that the Company's net interest
income at risk over a one year period and net economic value at risk from 2%
shocks are within normal expectations for such sudden changes.
Shocked by -2% Shocked by +2%
Net interest income (4.26%) +3.00%
Net economic value +8.84% (6.61%)
For the modeling, the Company has made certain assumptions about the duration of
its non-maturity deposits that are important to determining net economic value
at risk. The Company engaged an outside consultant to gather and study data on
its non-maturity deposits and it has also compared its assumptions with those
used by other financial institutions. The conclusions from these actions have
been incorporated into these latest models.
In addition to applying scenarios with sudden interest rate shocks, net interest
income simulations are prepared at least twice a year using interest rate
projections provided by an outside economic data resource firm. Reflecting the
prevailing interest rate environment over the last year, that firm's most recent
interest rate scenarios continue to project generally rising interest rates. In
addition, the projections call for more normal yield curves than the generally
flat curves projected at the beginning of 1999 (Note F). The three interest rate
projections selected for use in the modeling include what the firm indicates is
the most likely scenario, a lower or less rising scenario, and higher interest
rate scenario. The three interest rate scenarios are applied to expected asset
and liability balances over the next year, and the differences in the results
indicate the amount of net interest income at risk.
The interest rate simulation reports are dependent upon the shape of the
interest rate curves and the volatility of the interest rate scenarios selected
and upon the assumptions of the rates that would be paid on the Company's
administered rate deposits as external yields change. As the year progresses,
the models are revised to make use of the latest available projections.
Under these more realistic scenarios, as in the case of modeling using the
sudden rate shocks, the Company's net interest income at risk in 2000 is well
within normal expectations should either of the two less likely interest rate
scenarios occur. The change in the average expected Fed funds rate is also shown
to give perspective as to the extent of the interest rate changes assumed by the
two scenarios.
Declining Rates Rising Rates
Change in net interest income
compared to most likely scenario (0.43%) +2.72%
Change in average Fed funds rate (1.16%) +1.04%
Asset/Liability Management
The Company monitors asset and deposit levels, developments and trends in
interest rates, liquidity, capital adequacy and marketplace opportunities. It
responds to all of these to protect and enhance net interest income while
managing risks within acceptable levels as set by the Company's policies. In
addition, alternative business plans and contemplated transactions are analyzed
for their impact. This process, known as asset/liability management, is carried
out by changing the maturities and relative proportions of the various types of
loans, investments, deposits and other borrowings in the ways described above.
The Asset/Liability Committee for each bank's Board of Directors has overall
responsibility for asset/liability management.
As an example of this asset/liability management process, the Company determined
in 1999 that it would need to take actions to manage some additional interest
rate risk. This additional risk was due to more customers requesting fixed rate
loans than had been the case in prior years. The Company was concerned about the
prospect of rising rates. If rates increased, interest income on the loans would
be fixed while interest expense on deposits would likely go up. A plan was
approved and executed that involved obtaining additional fixed rate funds from
the FHLB and entering into variable for fixed interest rate swaps. If interest
rates in fact rose, the fixed rate on the borrowings would maintain the
profitable spread on the loans funded with the borrowings. The interest rate
swaps permitted the Company to convert a portion of its interest income from
fixed to variable. With this conversion, if interest rates rise, so would
interest income.
Changes in the dollar amount of interest earned or paid may vary from one year
to the next because of changes in the average balances ("volume") of the various
earning assets and interest-bearing liability accounts and changes in the
interest rates applicable to each category. However, because of overall growth
of the Company, interest income, interest expense and net interest income are
all generally higher each year. The Company's tax equivalent net interest income
of $149.6 million for 1999 was $18.5 million, or 14.1%, greater than during
1998. The 1998 figure of $131.1 million was itself $18.4 million, or 16.3%,
greater than the comparable figure for 1997.
Table 1, "Distribution of Average Assets, Liabilities and Shareholders' Equity
and Related Interest Income, Expense and Rates," sets forth the daily average
balances (Note B) for the major asset and liability categories, the related
income or expense where applicable, and the resultant yield or cost attributable
to the average earning assets and interest-bearing liabilities. Changes in the
average balances and the rates received or paid depend on market opportunities,
how well the Company has managed interest rate risks, product pricing policy,
product mix, and external trends and developments.
TABLE 1-- Distribution of Average Assets, Liabilities, and Shareholders' Equity and Related
Interest Income, Expense, and Rates
(dollars in thousands) 1999 1998 1997
------------------------------ ------------------------------- ------------------------------
Balance Interest Rate Balance Interest Rate Balance Interest Rate
------------------------------ ------------------------------- ------------------------------
Assets:
Loans (Note D):
Commercial $ 489,476 $ 51,472 10.52% $ 406,927 $ 41,865 10.29% $ 358,146 $ 35,623 9.95%
Real estate 1,104,720 86,485 7.83 801,194 72,083 9.00 673,948 62,111 9.22
Consumer 215,208 27,151 12.62 199,274 25,093 12.59 169,300 22,636 13.37
---------------------- ---------------------- ----------------------
Total loans 1,809,404 165,108 9.12 1,407,395 139,041 9.88 1,201,394 120,370 10.02
---------------------- ---------------------- ----------------------
Securities:
Taxable 561,125 33,443 5.96 589,723 35,512 6.02 447,254 27,381 6.12
Non-taxable 137,385 14,441 10.51 138,363 14,455 10.45 116,617 13,096 11.23
Equity 9,063 500 5.52 8,916 493 5.53 8,046 540 6.71
---------------------- ---------------------- ----------------------
Total securities 707,573 48,384 6.84 737,002 50,460 6.85 571,917 41,017 7.17
---------------------- ---------------------- ----------------------
Money market instruments:
BAs and Commercial paper 5,800 336 5.79 15,543 937 6.03 72,090 4,134 5.73
Federal funds sold 74,756 3,590 4.80 158,095 8,653 5.47 129,814 7,136 5.50
Money market funds -- -- 2,950 162 5.49 12,148 663 5.46
Total money market
instruments 80,556 3,926 4.87 176,588 9,752 5.52 214,052 11,933 5.57
---------------------- ---------------------- ----------------------
Total earning assets 2,597,533 217,418 8.37% 2,320,985 199,253 8.58% 1,987,363 173,320 8.72%
---------------------- ---------------------- ----------------------
Non-earning assets 182,783 156,717 130,274
----------- ----------- ----------
Total assets $2,780,316 $2,477,702 $2,117,637
=========== =========== ==========
Liabilities and shareholders'
equity:
Borrowed funds:
Repurchase agreements and
Federal funds purchased $ 37,305 1,761 4.72% $ 23,120 1,098 4.75% $ 31,767 1,510 4.75%
Other borrowings 82,329 4,795 5.82 36,693 2,245 6.12 40,343 2,469 6.12
---------------------- ---------------------- ----------------------
Total borrowed funds 119,634 6,556 5.48 59,813 3,343 5.59 72,110 3,979 5.52
---------------------- ---------------------- ----------------------
Interest bearing deposits:
Savings and interest bearing
transaction accounts 1,080,954 23,544 2.18 1,018,149 26,209 2.57 945,582 25,825 2.73
Time deposits 790,871 37,756 4.77 726,983 38,561 5.30 561,615 30,786 5.48
---------------------- --------------------- ----------------------
Total interest bearing
deposits 1,871,825 61,300 3.27 1,745,132 64,770 3.71 1,507,197 56,611 3.76
---------------------- ---------- ---------
Total interest bearing
liabilities 1,991,459 67,856 3.41% 1,804,945 68,113 3.77% 1,579,307 60,590 3.84%
---------- ---------- ---------
Demand deposits 532,694 439,569 339,018
Other liabilities 28,425 24,801 16,310
Shareholders' equity 227,738 208,387 183,002
----------- ----------- ----------
Total liabilities and
shareholders'equity $2,780,316 $2,477,702 $2,117,637
=========== =========== ==========
Interest income/earning assets 8.37% 8.58% 8.72%
Interest expense/earning assets 2.61 2.93 3.05
------- ------- ------
Net interest margin 149,562 5.76 131,140 5.65 112,730 5.67
Provision for credit losses
charged to operations/earning
assets 6,375 0.25 9,123 0.39 8,500 0.43
---------- ------- ---------- ------- --------- ------
Net interest margin after
provision for credit losses
on tax equivalent basis 143,187 5.51% 122,017 5.26% 104,230 5.24%
======= ======= ======
Less: tax equivalent income
included in interest income
from non-taxable securities
and loans 5,775 5,737 5,170
---------- ---------- ----------
Net interest income $ 137,412 $ 116,280 $ 99,060
========== ========== ==========
Overall Trends in the Balances of Assets and Liabilities
Beginning in late 1998, the Company's loan portfolio began increasing at a rate
significantly higher than deposits. Partly this was due to increased residential
real estate sales activity as well as the continued strong business economy in
the markets served by the Company. As shown in Table 1, average loans increased
$402 million or 28.6% from 1998 to 1999, compared to a 17.1% increase from 1997
to 1998. Average deposits increased $220 million from 1998 to 1999. The
Company's research indicates that the lower rate of deposit growth is not
primarily due to account closings, but rather to customers holding smaller
balances in their accounts. With the stock market indices hitting numerous
all-time highs during 1999, the great attention paid by the media to internet
stocks, and the popularity of 401(k) and other tax-deferred retirement
alternatives, bank deposits are seen as only one of many vehicles for
investments.
Because deposits increased less than loans , $182 million of the loan growth had
to be funded by sources other than deposits. Three sources of funding were used
for this. The first is that almost all of the proceeds from maturing securities
were made available for loan funding rather than being used to purchase new
securities. The average balance of securities decreased by $29 million from 1998
to 1999. The second source was the large balances of overnight money market
investments. In 1999, the Company carried average balances in these overnight
instruments that were $96 million less than in 1998. Lastly, the Company
borrowed funds from other financial institutions. The average balance of other
borrowings was $60 million more in 1999 than in 1998.
This shift in the relative size of the major balance sheet categories has had
some impact on net interest income and net interest margin. To the extent that
funds invested in securities can be repositioned into loans, earnings increase
because of the higher rates paid on loans. However, additional credit risk is
incurred with loans compared to the very low risk of loss on securities, and the
Company must carefully monitor the underwriting process to ensure that the
benefit of the additional interest earned is not offset by additional credit
losses. As shown in Table 1, the average rate paid on the other borrowings in
1999 was 5.48% compared to the average rate paid on deposits of 3.27%. The
growth in loans must therefore also be monitored to ensure that the rate earned
on loans funded by other borrowings is high enough to justify the additional
cost of funds.
For the discussion of each of the major categories of assets and liabilities
below, there is a description of the reason for significant changes in the
balances, how the changes impacted the net interest income and margin, and how
the categories fit into the overall asset/liability strategy for managing risk.
As shown in Table 1, the net interest margin of 5.76% in 1999 was higher than
the 5.65% net interest margin in 1998. As indicated above, this primarily
reflects the increased proportion of higher yielding loans. The Fed increased
interest rates several times during 1999 and the Company's subsidiary banks
raised their lending rates accordingly. This increased income from variable rate
loans. Deposit rates tend to lag market rates because time deposits reprice only
upon maturity. Due to the lowering of rates in 1997 and 1998, many of the
Company's time deposits maturing in 1999 renewed at lower rates than they had
been previously receiving. This trend started to reverse in 1999, but the
average rate paid on deposits was still substantially lower than in 1998.
Conversely, the average rate for deposits in 1998 was only slightly lower than
the rate for 1997 as the Company was not able to reduce deposit rates quite as
quickly as market rates were declining.
Table 2, "Volume and Rate Variance Analysis of Net Interest Income," analyzes
the changes in net interest income from 1997 to 1998 and from 1998 and 1999 in
terms of the impact of volume and rate changes on the major categories of assets
and liabilities from one year to the next.
TABLE 2--Volume and Rate Variance Analysis of Net Interest Income (Taxable
equivalent basis -- Notes E)
(in thousands) 1999 over 1998 1998 over 1997
----------------------------------------------------------------------------------
Volume Rate Total Volume Rate Total
----------------------------------------------------------------------------------
Increase (decrease) in:
Interest income:
Loans
Commercial loans $ 8,653 $ 954 $ 9,607 $ 4,990 $ 1,252 $ 6,242
Real estate loans 24,681 (10,279) 14,402 11,486 (1,514) 9,972
Consumer loans 1,998 60 2,058 3,835 (1,378) 2,457
------------ ------------- ------------ ------------- ----------- ------------
Total loans 35,332 (9,265) 26,067 20,311 (1,640) 18,671
------------ ------------- ------------ ------------- ----------- ------------
Investment and other securities
Taxable investment securities (1,716) (353) (2,069) 8,585 (454) 8,131
Non-taxable investment securities (99) 85 (14) 2,316 (957) 1,359
Equity 8 (1) 7 54 (101) (47)
------------ ------------- ------------ ------------- ----------- ------------
Total investment securities (1,807) (269) (2,076) 10,955 (1,512) 9,443
------------ ------------- ------------ ------------- ----------- ------------
Money market investments
BAs and Commercial Paper (565) (36) (601) (3,402) 205 (3,197)
Federal funds sold (4,109) (954) (5,063) 1,556 (39) 1,517
Money market funds (81) (81) (162) (505) 4 (501)
------------ ------------- ------------ ------------- ----------- ------------
Total money market investments (4,755) (1,071) (5,826) (2,351) 170 (2,181)
------------ ------------- ------------ ------------- ----------- ------------
Total earning assets 28,770 (10,605) 18,165 28,915 (2,982) 25,933
------------ ------------- ------------ ------------- ----------- ------------
Liabilities:
Repurchase agreements and
federal funds purchased 663 -- 663 (412) -- (412)
Other borrowings 2,665 (115) 2,550 (224) -- (224)
------------ ------------- ------------ ------------- ----------- ------------
Total borrowed funds 3,328 (115) 3,213 (636) -- (636)
------------ ------------- ------------ ------------- ----------- ------------
Interest bearing deposits:
Savings and interest bearing
transaction accounts 1,525 (4,190) (2,665) 1,933 (1,549) 384
Time certificates of deposit 3,228 (4,033) (805) 8,814 (1,039) 7,775
------------ ------------- ------------ ------------- ----------- ------------
Total interest bearing deposits 4,753 (8,223) (3,470) 10,747 (2,588) 8,159
------------ ------------- ------------ ------------- ----------- ------------
Total interest bearing liabilities 8,081 (8,338) (257) 10,111 (2,588) 7,523
------------ ------------- ------------ ------------- ----------- ------------
Net interest margin $ 20,689 $ (2,267) $ 18,422 $ 18,804 $ (394) $ 18,410
============ ============= ============ ============= =========== ============
There is always action that the Company can take to increase its net interest
income and margin. Tactics may include increasing the average maturity of its
securities portfolios because longer term instruments normally earn a higher
rate; emphasizing fixed-rate loans because they earn more than variable rate
loans; purchasing lower rated securities; and lending to less creditworthy
borrowers at a higher rate. However, as noted above, banking is a process of
balancing risks, and each of these alternative tactics involves more risk. The
first two involve more market risk, the second two more credit risk. Management
intends to continue to use a balanced approach. A fifth tactic as discussed on
page 30 is limiting the amount of nonearning assets.
SECURITIES
The major components of the earning asset base are the Company's securities
portfolios, the loan portfolio and its holdings of money market instruments. The
Investment Committee has overall responsibility for the management of the
securities portfolios and the money market instruments. The structure and detail
within these portfolios are very significant to an analysis of the financial
condition of the Company. The loan and money market instrument portfolios will
be covered in later sections of this discussion.
Securities Portfolios
The Company classifies its securities into three portfolios, the "Liquidity
Portfolio" (available-for-sale), the "Discretionary Portfolio"
(available-for-sale), and the "Earnings Portfolio" (held-to-maturity).
The Liquidity Portfolio's primary purpose is to provide liquidity to meet cash
flow needs. The portfolio consists of U.S. Treasury and agency securities. These
securities are purchased with maturities up to three years with an average
maturity of between one and two years.
The Discretionary Portfolio's primary purposes are to provide income from
available funds, to hold earning assets that can be managed as part of overall
asset/liability management, and to support the development needs of communities
within the Bank's marketplace. The Discretionary Portfolio consists of U.S.
Treasury and agency securities, collateralized mortgage obligations ("CMOs"),
asset-backed securities (Note H), mortgage-backed securities, and municipal
securities.
The Earnings Portfolio's primary purposes are to provide income from available
funds and to support the development needs of communities within the Bank's
marketplace. The Earnings Portfolio consists of long-term tax-exempt
obligations, and U.S. Treasury and agency securities.
Maintaining adequate liquidity is one of the highest priorities for the Company.
Therefore, available funds are first used to purchase securities for the
Liquidity Portfolio. So long as there are sufficient securities in that
portfolio to meet its purposes, available funds are then used to purchase
securities for the Discretionary Portfolio. It is the Company's current
intention to allow existing securities in the Earnings Portfolio to mature, then
reposition the matured proceeds into either of the two "available-for-sale"
portfolios. Accordingly, the balance of the Earnings Portfolio is expected to
decline.
Additional Purposes Served by the Securities Portfolios
The securities portfolios of the Company serve additional purposes: 1) to act as
collateral for the deposits of public agencies and trust customers that must be
secured by certain securities owned by the Company; and 2) to support the
development needs of the communities within its marketplace.
Collateral: The legal requirements for securing specific deposits may only be
satisfied by pledging certain types of the Company's securities. A large
proportion of the deposits may be secured by state and municipal securities, but
some can only be secured by U.S. Treasury securities, so holding a minimum
amount of these securities will always be necessary.
Community Development: The Company searches actively for investments that
support the development needs of communities within its marketplace. During
1999, for example, the Company purchased six mortgage-backed securities totaling
$8.5 million that consisted of real estate loans to borrowers in its market
areas who have incomes of less than 80% of median area income. In 1999, as in
1998 and 1997, the Company also invested as a limited partner in an affordable
housing fund. The Company also holds several bonds of school districts within
its market areas.
Amounts and Maturities of Securities
As discussed above, the average balance of securities decreased from 1998 to
1999 in order to fund loan growth. Table 3 sets forth the amounts and maturity
ranges of the securities at December 31, 1999. Because many of the securities
included in the Earnings Portfolio are state or municipal bonds, much of the
income from this portfolio has the additional advantage of being tax-exempt.
Therefore, the tax equivalent weighted average yields of the securities are
shown in Table 3. The average yields on the taxable securities are significantly
lower than the average rates earned from loans as shown in Table 1. Because of
this, taxable securities are purchased for earnings only when loan demand is
weak.
TABLE 3--Maturity Distribution and Yield Analysis of the Securities Portfolios
After one After five
As of December 31, 1999 One year year to years to Over Non-
(dollars in thousands) or less five years ten years ten years Maturity Total
---------------------------------------------------------------------------------
Maturity distribution:
Available-for-sale:
U.S. Treasury obligations $ 40,064 $ 80,909 $ -- $ -- $ -- $ 120,973
U.S. agency obligations 37,893 137,895 -- -- -- 175,788
Collateralized mortgage
obligations 8,984 133,208 22,034 3,279 -- 167,505
Asset-backed securities 3,971 6,901 -- -- -- 10,872
State and municipal
securities 1,526 11,086 855 28,086 -- 41,553
Time deposits 86 -- -- -- -- 86
Equity securities -- -- -- -- 11,649 11,649
------------------------------------------------------------------ -------------
Subtotal 92,524 369,999 22,889 31,365 11,649 528,426
---------------------------------------------------------------------------------
Held-to-maturity:
U.S. Treasury obligations 22,571 12,472 -- -- -- 35,043
U.S. agency obligations 7,500 5,002 -- -- -- 12,502
Collateralized mortgage
obligations 210 346 -- -- -- 556
State and municipal
securities 29,639 30,625 7,080 37,819 -- 105,163
---------------------------------------------------------------------------------
Subtotal 59,920 48,445 7,080 37,819 -- 153,264
---------------------------------------------------------------------------------
Total $ 152,444 $ 418,444 $ 29,969 $ 69,184 $ 11,649 $ 681,690
=================================================================================
Weighted average yield (Tax equivalent--Note C):
Available-for-sale:
U.S. Treasury obligations 5.84% 5.96% -- -- -- 5.92%
U.S. agency obligations 5.79% 5.82% -- -- -- 5.81%
Collateralized mortgage
obligations 5.91% 6.54% 6.38% 6.48% -- 6.48%
Asset-backed securities 6.77% 6.13% -- -- -- 6.36%
State and municipal
securities 6.81% 7.06% 7.88% 8.98% -- 8.54%
Time deposits 4.65% -- -- -- -- 4.65%
Equity securities -- -- -- -- 5.53% 5.53%
Weighted average 5.88% 6.15% 6.43% 8.71% 5.53% 6.27%
Held-to-maturity:
U.S. Treasury obligations 5.70% 6.38% -- -- -- 5.94%
U.S. agency obligations 5.82% 5.45% -- -- -- 5.67%
Collateralized mortgage
obligations 5.74% 8.03% -- -- -- 7.18%
State and municipal
securities 14.18% 13.54% 10.51% 10.06% -- 11.75%
Weighted average 9.91% 10.82% 10.51% 10.06% -- 9.91%
Overall weighted average 7.46% 6.69% 7.40% 9.45% 5.53% 7.09%
Other Securities Disclosures
Turnover: The accompanying Consolidated Statements of Cash Flows on page 47,
shows there is a relatively large turnover in the securities portfolios. This is
due to the purchase of relatively short-term securities for asset/liability
management purposes, as explained above.
Maturity profile: The Company does not have a trading portfolio. That is, it
does not purchase securities on the speculation that interest rates will
decrease and thereby allow subsequent sale at a gain. Instead, if the purposes
mentioned above are to be met, purchases must be made throughout interest rate
cycles. Rather than anticipate the direction of changes in interest rates, the
Company's investment practice with respect to securities in the Liquidity and
Discretionary Portfolios is to purchase securities so that the maturities are
approximately equally spaced by quarter within the portfolios. The periodic
spacing of proceeds from maturities provides the Company with cash for liquidity
purposes, or if not needed, it minimizes reinvestment risk, which is having too
much cash available all at once that must be invested perhaps when rates are
low. The Company generally purchases municipal securities with maturities of
18-25 years because, in the Company's judgment, they have the best ratio of rate
earned to the market risk incurred in purchasing fixed rate securities.
Securities losses: Occasionally, the Company will sell securities prior to
maturity to reposition the funds into a better yielding asset. This usually
results in a loss.
Hedges, Derivatives, and Other Disclosures
The Company has policies and procedures that permit limited types and amounts of
off-balance sheet hedges to help manage interest rate risk. Although the Company
does not make extensive use of these instruments, it did enter into an interest
rate option contract in January 1997 to protect against the possibility of
rapidly rising rates. While Management was not predicting that interest rates
would rise, the asset/liability modeling indicated at the time that net interest
income at risk from a significant rise would be more than desired. The option
contract had a notional amount of $50 million and covered a fifteen month period
that began July 1, 1997 and ended on October 1, 1998. The contract would have
paid the Company the rate by which the 3-month LIBOR (Note I) index rate
exceeded 7.0% up to a maximum of 1.5%. Interest rates declined after the
purchase and the Company simply amortized the $90,000 cost over the fifteen
month term.
In early 1999, the Company's interest rate risk modeling indicated that it was
liability sensitive, i.e., net income would be lessened by a rise in interest
rates. This was primarily due to the increased balance of fixed rate loans. The
Company therefore entered into several interest rate swap contracts with another
financial institution whereby it trades a portion of the fixed rate interest
payments it receives for payments that would vary based on changes in interest
rates. If interest rates increase, the payments received from the other
institution increase thereby lessening the interest rate risk incurred in
lending funds at fixed rates. Two of the contracts are loosely associated with
the residential real estate loans that had been added to the Company's balance
sheet. The third is specifically associated with a relatively large commercial
loan.
The Company has not purchased any securities arising out of a highly leveraged
transaction, and its investment policy prohibits the purchase of any securities
of less than investment grade or so-called "junk bonds."
MARKET INSTRUMENTS--FEDERAL FUNDS SOLD, SECURITIES PURCHASED UNDER AGREEMENTS
TO RESELL, BANKERS' ACCEPTANCES AND COMMERCIAL PAPER
Cash in excess of amounts immediately needed for operations is generally lent to
other financial institutions as Federal funds sold or securities purchased under
agreements to resell (for brevity termed "reverse repos"). Both transactions are
overnight loans. Federal funds sold are unsecured, reverse repos are secured.
Excess cash expected to be available for longer periods is generally used to
purchase short-term U.S. Treasury securities, bankers' acceptances (Note G), or
commercial paper. As a percentage of average earning assets, the amount of these
instruments tends to vary based on changes and differences in short-term market
rates. The amount is also impacted in the first quarter of the year by the large
cash flows associated with the tax refund loan and transfer programs.
As discussed above, the average balances invested by the Company in these
instruments decreased from 1998 to 1999 to fund loan growth. As discussed below
in "Liquidity," the Company has developed and maintains numerous other sources
of liquidity than these overnight and short-term funds.
In prior years, the Company purchased bankers' acceptances rather than
commercial paper because the yields were more attractive relative to the risk.
While the acceptances of only highly rated financial institutions are utilized,
acceptances have some amount of risk above that of U.S. Treasury securities.
Therefore, the Company required that there be a reasonable spread in the yields
between the bankers' acceptances and U.S. Treasury securities to justify the
assumption of that additional risk. The only banks issuing these instruments
that had both the high credit rating and sufficient incremental yield were
Japanese banks. During 1997, as economic troubles began to adversely impact the
ratings of the Japanese banks issuing these instruments, the Company reduced its
purchases and discontinued them after January 1998. The last acceptance matured
in July 1998.
In place of bankers' acceptances, in 1998 the Company began purchasing
commercial paper issued by highly rated domestic companies.
LOAN PORTFOLIO
Table 4 sets forth the distribution of the Company's loans at the end of each of
the last five years.
TABLE 4--Loan Portfolio Analysis by Category
(in thousands) December 31
1999 1998 1997 1996 1995
----------------------------------------------------------------------------
Real estate:
Residential $ 484,562 $ 368,306 $ 276,014 $ 198,309 $ 169,500
Nonresidential 435,913 477,120 433,835 351,289 287,455
Construction and development 171,870 109,764 57,571 47,743 62,490
Commercial, industrial,
and agricultural 577,407 362,262 298,986 269,904 224,648
Home equity lines 49,902 47,123 56,681 55,083 50,800
Consumer 148,051 123,730 99,943 66,595 52,031
Leases 93,322 78,627 72,970 69,817 4,254
Municipal tax-exempt obligations 12,530 9,286 7,931 8,658 7,573
Other 8,322 6,563 7,433 11,318 4,820
----------------------------------------------------------------------------
$ 1,981,879 $ 1,582,781 $ 1,311,364 $ 1,078,716 $ 863,571
============================================================================
Net deferred fees $ 4,781 $ 4,624 $ 3,586 $ 3,351 $ 2,914
The amounts shown in the table for each category are net of the deferred or
unamortized loan origination, extension, and commitment fees and origination
costs for loans in that category. The total amounts for these net fees are shown
at the bottom of the table. These deferred amounts are amortized over the lives
of the loans to which they relate.
The year-end balance for all loans had increased about $271 million from the end
of 1997 to the end of 1998 and increased about $399 million from the end of 1998
to the end of 1999.
Reflective of the strong economy, the category of loans showing the largest
growth in the last year was commercial, industrial, and agricultural.
Residential mortgages also increased significantly over the last few years
reflecting increased sales activity in the Company's market areas. The Company
offers a wide variety of loan types and terms to customers along with very
competitive pricing and quick delivery of the credit decision.
The Company has historically retained 1-4 family adjustable rate mortgage loans,
which generally have low initial "teaser" rates. While these loans have interest
rate "caps," all are repriced to a market rate of interest within a reasonable
time. A few loans have payment caps that would result in negative amortization
if interest rates rise appreciably.
Consumer and home equity loans grew $14.2 million or 9.1% in 1998 and $27.1
million or 15.9% in 1999. This growth in consumer loans reflects an expanded
product line and continued efforts to make auto loans through dealers. During
the last three years, the Company has entered into indirect financing agreements
with a number of automobile dealers whereby the Company purchases loans dealers
have made to customers. While automobile dealers frequently provide financing to
customers through manufacturers' finance subsidiaries, some customers prefer
loan terms that are not included in the standard dealer packages. Other
customers are purchasing used cars not covered by the manufacturers' programs.
Based on parameters agreed to by the Company, the dealer makes the loan to the
customer and then sells the loan to the Company. This program is neither a
factoring nor a flooring arrangement. The individual customers, not the dealers,
are the borrowers and thus there is no large concentration of credit risk. In
addition, there is a review of underwriting practices of a dealer prior to
acceptance into the program. This is done to ensure process integrity, to
protect the Company's reputation, and to monitor compliance with consumer loan
laws and regulations. There were approximately $99.0 million of such loans
included in the consumer loan total above for December 31, 1999 as compared with
$63.4 million at December 31, 1998 and $41.3 million at December 31, 1997.
Construction and development loans increased during 1999 by $62.1 million while
nonresidential real estate loans decreased by $41.2 million.
Although approximately two thirds of the loans held by the Company have floating
rates of interest tied to the Company's base lending rate or to another market
rate indicator so that they may be repriced as interest rates change, fixed rate
loans still make up a significant portion of the portfolio. The same interest
rate and liquidity risks that apply to securities are also applicable to lending
activity. Fixed-rate loans are subject to market risk as they decline in value
as interest rates rise. The Company's loans that have fixed-rates generally have
relatively short maturities or amortize monthly which effectively lessens the
market risk. Nonetheless, the table in Note 14 to the consolidated financial
statements shows that the carrying amount of loans, i.e., their face value, is
about $42.6 million or 2.2% less than their fair value reflective of the recent
increases in market rates. At the end of 1998, the carrying value and market
value were virtually identical. Rates had been stable since late 1997 and then
declined a bit in late 1998.
Table 5 shows the maturity of selected loan types outstanding as of December 31,
1999, and shows the proportion of fixed and floating rate loans for each type.
The table does not include residential and non-residential mortgage loans. Net
deferred loan origination, extension, and commitment fees are also not shown in
the table. There is no maturity or interest sensitivity associated with the fees
because they have been collected in advance.
TABLE 5--Maturities and Sensitivities of Selected
Loan Types to Changes in Interest Rates
Due after
(in thousands) Due in one one year to Due after
year or less five years five years
-------------------------------------------
Commercial, industrial, and agricultural
Floating rate $ 355,127 $ -- $ --
Fixed rate 61,830 63,271 97,179
Real estate--construction and development
Floating rate 145,330 -- --
Fixed rate 14,181 47 12,314
Municipal tax-exempt obligations 6,885 3,218 2,427
-------------------------------------------
$ 583,353 $ 66,536 $ 111,920
===========================================
The amortization and short maturities generally present in the Company's fixed
rate loans also help to maintain the liquidity of the portfolio and reduce
credit risk, but they result in lower interest income if rates are falling. At
present, except for the specific market risk incurred by the decision to hold
some of the fixed-rate residential and non-residential real estate mortgages
(which are not included in the table above), Management prefers to incur market
risk from longer maturities in the securities portfolios, and avoid such risk in
the loan portfolio.
Potential Problem Loans: From time to time, Management has reasons to believe
that certain borrowers may not be able to repay their loans within the
parameters of the present repayment terms, even though, in some cases, the loans
are current at the time. These loans are regarded as potential problem loans,
and a portion of the allowance is allocated, as discussed below, to cover the
Company's exposure to loss should the borrowers indeed fail to perform according
to the terms of the notes. This class of loans does not include loans in a
nonaccrual status or 90 days or more delinquent but still accruing, which are
shown in Table 8.
At year-end 1999, these loans amounted to $21.7 million or 1.1% of the
portfolio. The corresponding amounts for 1998 and 1997 were $25.8 million or
1.6% of the portfolio and $2.5 million or 0.2% of the portfolio, respectively.
The 1999 amount is comprised of loans of all types.
Other Loan Portfolio Information
Other information about the loan portfolio that may be helpful to readers of the
financial statements follows.
Foreign Loans: The Company does not assume foreign credit risk through either
loan or deposit products. However, the Company does recognize that economic and
currency developments in the international markets may affect our domestic
customers' activities.
Participations: Occasionally, the Company will sell or purchase a portion of a
loan to or from another bank. The usual reason that banks sell a portion of a
loan is to stay within their regulatory maximum limit for loans to any one
borrower. Occasionally, a portion of another bank's loan may be purchased by the
Company from another bank unable to lend the whole amount under its regulatory
lending limit to its borrower. However, this would be done only if the loan
represents a good investment for the Company and the borrower or project is in
one of the Company's market areas. In these cases, the Company conducts its own
independent credit review and formal approval prior to committing to purchase.
Loan to Value Ratio: The Company follows a policy of limiting the loan to
collateral value ratio for real estate construction and development loans.
Depending on the type of project, policy limits range from 60-90% of the
appraised value of the collateral. For permanent real estate loans, the policy
limits generally are 75% of the appraised value for commercial property loans
and 80% for residential real estate property loans. Mortgage insurance is
generally required on most residential real estate loans with a loan to value
ratio in excess of 80%. Such loans, which can reach up to 90% loan to appraised
value, are strictly underwritten according to mortgage insurance standards. The
above policy limits are sometimes exceeded when the loan is being originated for
sale to another institution that does lend at higher ratios and the sale is
immediate, when the exception is temporary, or when other special circumstances
apply. There are other specific loan to collateral limits for commercial,
industrial and agricultural loans which are secured by non-real estate
collateral. The adequacy of such limits is generally established based on
outside asset valuations and/or by an assessment of the financial condition and
cash flow of the borrower, and the purpose of the loan. Consumer loans which are
secured by collateral also have loan to collateral limits which are based on the
loan type and amount, the nature of the collateral, and other financial factors
on the borrower.
Loan Concentrations: The concentration profile of the Company's loans is
discussed in Note 18 to the accompanying consolidated financial statements.
Loan Sales and Mortgage Servicing Rights: The Company sells or brokers some of
the fixed-rate single family mortgage loans it originates as well as other
selected portfolio loans. While originated by the Company, they are sold if the
loan terms are not favorable enough to offset the market risk inherent in
fixed-rate assets. Most of those sold are sold "servicing released" and the
purchaser takes over the collection of the payments. However, some are sold with
"servicing retained" and the Company continues to receive the payments from the
borrower and forwards the funds to the purchaser. The Company earns a fee for
this service. The sales are made without recourse, that is, the purchaser cannot
look to the Company in the event the borrower does not perform according to the
terms of the note. GAAP requires companies engaged in mortgage banking
activities to recognize the rights to service mortgage loans for others as
separate assets. For loans originated for sale, a portion of the investment in
the loan is ascribed to the right to receive this fee for servicing and this
value is recorded as a separate asset.
TAX REFUND ANTICIPATION LOAN ("RAL") AND REFUND TRANSFER ("RT") PROGRAMS
As indicated in the overall summary at the beginning of this discussion, one of
the reasons for the upward trend in earnings has been the RAL and RT programs.
The Company is one of only three financial institutions to provide these
products on a national basis. The Company provides these services to taxpayers
that file their returns electronically. RALs are a loan product; RTs are
strictly an electronic transfer service.
For the RAL product, a taxpayer requests a loan through a tax preparer, with the
expected refund as the source of repayment. The application is subject to an
automated credit review process. If the application passes, the Company advances
to the taxpayer the amount of the refund due on the taxpayer's return up to
specified amounts based on certain criteria less the loan fee due to the
Company. Each taxpayer signs an agreement permitting the Internal Revenue
Service (the "IRS") to remit their refund to the Company instead of to the
taxpayer. The refund received from the IRS is used by the Company to pay off the
loan. Any amount due the taxpayer above the amount of the RAL is then sent by
the Company to the taxpayer. A fee is withheld by the Company from the advance,
but the fee is recognized as income only after the loan is collected from the
IRS payment. The fee varies based on the amount of the loan, but it does not
vary with the length of time the loan is outstanding. Nonetheless, because the
taxpayer must sign a loan document, the advance refund is considered a loan and
the fee is classified as interest income.
Losses are higher for RALs than for most other loan types because the IRS may
reject or partially disallow the refund. The tax preparers participating in the
program are located across the country and few of the taxpayers have any
customer relationships with the Company other than their RAL. Many taxpayers
make use of the service because they do not have a permanent mailing address at
which to receive their refund. Therefore, if a problem occurs with the return,
collection efforts may be less effective than with local customers.
The Company has taken several steps to minimize losses from these loans.
Preparers are screened before they are allowed to submit their electronic
filings, procedures have been defined for the preparers to follow to ensure that
the agreement signed by the taxpayer is a valid loan, and the preparers' IRS
reject rates are monitored very carefully. If a preparer's rejects are above
normal, he or she may be dropped from the program. If rejects are below
expectations, the preparer may be paid an incentive fee.
In addition, the Company has entered into cooperative agreements with the other
two banks with large RAL programs. Under those agreements, if a taxpayer owing
money to one bank from a prior year applies for a loan from another bank, the
second bank repays the delinquent amount to the first bank before remitting the
refund to the taxpayer. As shown in Table 7, these cooperative agreements result
in a relatively high rate of recovery on the prior year's losses.
Total net charge-offs in 1999 were $2.7 million compared to $4.9 million in
1998. A significant portion of the 1999 charged-off loans are expected to be
collected in 2000 under the continuing cooperative agreement between the banks
providing this product.
The IRS closely scrutinizes returns where a major portion of the refund is based
on a claim for Earned Income Tax Credit ("EIC"). The Company does not lend on
those returns where EIC represents an overly large portion of the refund.
Nonetheless, many taxpayers not qualifying for loans still desire to receive
their refunds more quickly by having the refund sent electronically by the IRS
to the Company. The Company then prepares a check or authorizes the tax preparer
to issue a check to the taxpayer. The Company earned approximately $6.6 million,
$4.8 million, and $2.9 million, in fees for 1999, 1998, and 1997, respectively
for this refund transfer service. There is no credit risk associated with the RT
product, because funds are not sent to the customer until received by the
Company from the IRS.
In 1999, the total pre-tax earnings for these programs was $9.4 million compared
with $4.5 million in 1998 and $3.4 million in 1997.
The balances outstanding during each tax filing season are included in the
average balance for consumer loans shown in Table 1, but there are no such loans
included in the Consolidated Balance Sheets as of December 31, 1999 and 1998,
because all loans not collected from the IRS are charged-off at June 30 of each
year. The fees earned on the loans are included in the accompanying Consolidated
Income Statements for 1999, 1998, and 1997 within interest and fees on loans.
The fees earned on the refund transfers are included in other service charges,
commissions, and fees.
The Company expects that the programs will be substantially larger in 2000 than
in prior years because the IRS will be providing additional support to the
program to encourage more taxpayers to file electronically.
ALLOWANCE FOR CREDIT LOSSES
Credit risk is inherent in the business of extending loans and leases to
individuals, partnerships, and corporations. The Company sets aside an allowance
or reserve for credit losses through charges to earnings. These charges are
shown in the Consolidated Income Statements as provision for credit losses. All
specifically identifiable and quantifiable losses are immediately charged off
against the allowance. However, for a variety of reasons, not all losses that
have occurred are immediately made known to the Company and of those that are
known, the full extent of the loss may not be able to be quantified. In this
discussion, "loans" include the lease contracts purchased and originated by the
Company.
Determination of the Adequacy of the Allowance for Credit Losses and the
Allocation Process
The Company formally determines the adequacy of the allowance on a quarterly
basis. This determination is based on the periodic assessment of the credit
quality or "grading" of loans. Loans are initially graded when originated. They
are re-graded as they are renewed, when there is a new loan to the same
borrower, when identified facts demonstrate heightened risk of nonpayment, or if
they become delinquent. Re-grading of larger problem loans will occur at least
quarterly. Confirmation of the quality of the grading process is obtained by
independent credit reviews conducted by firms specifically hired for this
purpose and by banking examiners.
After reviewing the gradings in the loan portfolio, the second step is to
allocate or assign a portion of the allowance to groups of loans and individual
loans to cover Management's estimate of the loss that might exist in them.
Allocation is related to the grade and other factors, and is done by the methods
discussed below.
The last step is to compare the amounts allocated for estimated losses to the
current allowance. To the extent that the current allowance is insufficient to
cover the estimate of unidentified losses, Management records additional
provision for credit loss. If the allowance is greater than appears to be
required at that point in time, provision expense is adjusted accordingly.
The Components of the Allowance for Credit Losses
Consistent with generally accepted accounting principles ("GAAP") and with the
methodologies used in estimating the unidentified losses in the loan portfolio,
the allowance comprises several components.
First, the allowance includes a component resulting from the application of the
measurement criteria of Statements of Financial Accounting Standards No. 114,
Accounting by Creditors for Impairment of a Loan ("SFAS 114") and No. 118,
Accounting by Creditors for Impairment of a Loan--Income Recognition and
Disclosures ("SFAS 118"). The amount of this component is disclosed in Note 3 to
the consolidated financial statements that this discussion accompanies.
The second component is statistically-based and is intended to provide for
losses that have occurred in large groups of smaller balance loans, the
individual credit quality of which is impracticable to re-grade at each period
end. These loans would include 1-4 family residential real estate, installment
and overdraft lines for consumers, and loans to small businesses generally of
$100,000 and less. The amount allocated is determined by applying loss
estimation factors to outstanding loans. The loss factors are based primarily on
the Company's historical loss experience tracked over a four to five year period
and accordingly will change over time. Because historical loss experience varies
for the different categories of loans, the loss factors applied to each category
also differ. In addition, there is a greater chance that the Company has
suffered a loss from a loan that was graded less than satisfactory at its most
recent grading than if the loan was last graded satisfactory. Therefore, for any
given category, a larger loss estimation factor is applied to less than
satisfactory loans than to those that the Company last graded as satisfactory.
The statistical component is the sum of the allocations determined in this
manner.
The third component is needed to address specific characteristics of individual
loans that are not addressed in the statistically determined historical loss
factors that would ordinarily apply. These characteristics might relate to a
variety of factors such as the size of the loan, the industry of the borrower,
or the terms of the loan. When situations warrant, Management will increase the
allocation that would be indicated by the applicable loss estimation factor to
an amount adequate to absorb the probable loss that has occurred. The specific
component is made up of the sum of these specific allocations.
The Unallocated Component
The fourth or "unallocated" component of the allowance for credit losses is a
component that is intended to absorb losses that may not be provided for by the
other components.
There are several primary reasons that the other components discussed above
might not be sufficient to absorb the losses present in portfolios, and the
unallocated portion of the allowance is used to provide for the losses that have
occurred because of these reasons.
The first is that there are limitations to any credit risk grading process. The
volume of loans makes it impracticable to re-grade every loan every quarter.
Therefore, it is possible that some currently performing loans not recently
graded will not be as strong as their last grading and an insufficient portion
of the allowance will have been allocated to them. Grading and loan review often
must be done without knowing whether all relevant facts are at hand. Troubled
borrowers may inadvertently or deliberately omit important information from
reports or conversations with lending officers regarding their financial
condition and the diminished strength of repayment sources.
The second is that the loss estimation factors are based on historical loss
totals. As such, the factors may not give sufficient weight to such
considerations as the current general economic and business conditions that
affect the Company's borrowers and specific industry conditions that affect
borrowers in that industry. The factors might also not give sufficient weight to
current trends in credit quality and collateral values and the long duration of
the current business cycle. Specifically, in assessing how much unallocated
allowance needed to be provided at December 31, 1999, Management considered the
following:
* with respect to loans to the agriculture industry, Management considered the
effects on borrowers of weather conditions and overseas market conditions for
exported products;
* with respect to loans to the construction industry, Management considered the
market absorption rates for developed properties; the availability of
permanent financing to replace the construction loan; and construction
delays, increased costs, and financial difficulties of contractors,
subcontractors, and suppliers resulting from weather; and the significant
concentration in construction lending in the market area served by FNB;
* with respect to loans to borrowers who are influenced by trends in the local
tourist industry, Management again considered the effects of weather
conditions, tourist preferences, and the competition for borrowers from other
resort destinations and tourist attractions;
* with respect to all loans, Management considered the potential for disruption
of the normal grading process through diversion of efforts and attention
resulting from the integration of the Company's computer systems after the
merger, by the need to integrate different grading systems, and by the need
for the credit risk assessment process to encompass different markets that
could be influenced by unique factors.
Thirdly, neither the loss estimation factors nor the review of specific
individual loans give consideration to loan concentrations, yet this could
impact the magnitude of losses inherent in the portfolios. Specifically, as
disclosed in Note 18 to the consolidated financial statements, there are certain
concentrations with respect to geographical area, industry, and type of
collateral among the loans that the Company has outstanding. Because economic
factors could impact these borrowers as a group, losses inherent in the
portfolio could be greater and more volatile than would be expected if the
Company simply used the loss estimation factors.
Fourthly, the loss estimation factors do not give consideration to the seasoning
of the portfolios. Seasoning is relevant because losses are less likely to occur
in loans that have been performing satisfactorily for several years than in
loans that are more recent. In addition, while term loans have payments of
principal and interest scheduled usually for each month, most loans and lines of
credit in the commercial loan portfolio have short-term maturities and
frequently require payments of interest only until maturity. With a term loan, a
missed or late payment gives an immediate signal of a decline in credit quality.
Many of the Company's loans are commercial. Because they have shorter maturities
and lack regular principal amortization, the process of seasoning does not occur
and the signaling of the missed principal payment is not available.
Lastly, the loss estimation factors do not give consideration to the interest
rate environment. Most obviously, borrowers with floating-rate loans may be less
able to manage their debt service if interest rates rise. However, there can
also be an indirect impact. For example, a rise in interest rates may adversely
impact the amount of home mortgage lending. This will cause a reduction in the
amount of home building initiated by developers, and this will have an impact on
the credit quality of loans to building contractors in the commercial segment of
the portfolio.
Each of these considerations could be addressed by developing additional loss
estimation factors for smaller, discrete groups of loans. However, the factors
are used precisely so that the losses in smaller loans do not have to be
individually estimated. Adding additional factors becomes impracticable and with
the smaller groups, the factors themselves become less statistically valid. Even
for experienced reviewers, grading loans and estimating possible losses involves
a significant element of judgment regarding the present situation with respect
to individual loans and the portfolio as a whole. Therefore, Management regards
it as both a more practical and prudent practice to maintain the total allowance
at an amount larger than the sum of the amounts allocated as described above.
Allocation Table
Table 6 shows the amounts allocated for the last three years to each loan type
disclosed in Table 4. It also shows the percentage of balances for each loan
type to total loans. In general, it would be expected that those types of loans
which have historically more loss associated with them will have a
proportionally larger amount of the allowance allocated to them than do loans
which have less risk.
TABLE 6--Allocation of the Allowance for Credit Losses
(dollars in thousands) December 31, 1999 December 31, 1998 December 31, 1997
---------------------------------------------------------------------------------
Percent of Percent of Percent of
Loans to Loans to Loans to
Amount Total Loans Amount Total Loans Amount Total Loans
---------------------------------------------------------------------------------
Real estate:
Residential $ 2,534 24.4% $ 1,258 23.3% $ 1,910 21.0%
Nonresidential 3,038 22.0 4,005 30.1 4,413 33.1
Construction
and development 800 8.7 1,512 6.9 724 4.4
Commercial, industrial,
and agricultural 9,636 29.1 6,517 22.9 4,749 22.8
Home equity lines 343 2.5 533 3.0 620 4.3
Consumer 2,684 7.5 1,813 7.8 1,490 7.6
Leases 1,739 4.7 1,459 5.0 1,246 5.6
Municipal tax-exempt
obligations -- 0.6 -- 0.6 -- 0.6
Other 582 0.4 1,029 0.4 7 0.6
Not specifically allocated 7,330 11,170 10,255
---------------------------------------------------------------------------------
Total allowance $ 28,686 100.0% $ 29,296 100.0% $ 25,414 100.0%
=================================================================================
Allowance for credit loss
as a percentage of
year-end loans 1.45% 1.85% 1.94%
Year-end loans $1,981,879 $1,582,781 $1,311,364
It would also be expected that the amount allocated for any particular type of
loan will increase or decrease proportionately to both the changes in the loan
balances and to increases or decreases in the estimated loss in loans of that
type. In other words, changes in the risk profile of the various parts of the
loan portfolio should be reflected in the allowance allocated.
Occasionally, changes in the amount allocated to a specific loan category will
vary from changes in the total loan balance for that category. For example,
residential loans increased from the end of 1997 to the end of 1998 by 33%. The
amount of allowance allocated to these loans decreased by 34%. The reasons for
this are one, that most of the growth in residential loans occurred in 1-4
family properties, which historically have a relatively low loss rate, and two,
that during 1998, several larger residential loans for which losses were
expected to be recognized were instead paid in full. In 1999, the residential
loans continued to grow and the amount of allowance allocated also increased.
Nonresidential loans had the same kind of change in allocation--the loan balance
was up from 1997 to 1998, but the allocation was lower. The reason for this is
that one relatively large loan was reclassified from nonaccrual status. The
borrower had a history of failing to pay according to the terms of the loan, but
during 1998, payments were made according to terms and the Company significantly
reduced its estimate of loss in the loan.
The changes in the allowance allocated to the other loan categories are
approximately proportional to the growth in balances for those categories.
There is no allocation of allowance to RALs at December 31 because all loans
unpaid are charged-off prior to year-end. At the bottom of Table 6 is the ratio
of the allowance for credit losses to total loans for each year.
CREDIT LOSSES
Table 7, "Summary of Credit Loss Experience," shows the additions to,
charge-offs against, and recoveries for the Company's allowance for credit
losses. Also shown is the ratio of charge-offs to average loans for each of the
last five years. This ratio was adversely impacted in 1995 with the higher
charge-offs in the RAL program and by problems with several large loan
relationships at SBB&T related to commercial real estate.
TABLE 7--Summary of Credit Loss Experience
(dollars in thousands) Year Ended December 31
1999 1998 1997 1996 1995
------------------------------------------------------------------------
Balance of the allowance for
credit losses at beginning of year $ 29,296 $ 25,414 $ 20,244 $ 16,059 $ 16,680
----------------------------------------------------------------------
Charge-offs:
Real estate:
Residential 10 369 498 822 1,202
Non-residential 252 177 45 1,056 4,902
Construction and development -- -- -- -- --
Commercial, industrial,
and agricultural 4,818 1,883 2,335 1,616 1,267
Home equity lines 30 -- -- 264 156
Tax refund anticipation 5,518 7,221 5,946 1,123 4,402
Other consumer 1,649 1,598 724 457 523
----------------------------------------------------------------------
Total charge-offs 12,277 11,248 9,548 5,338 12,452
----------------------------------------------------------------------
Recoveries:
Real estate:
Residential 175 329 268 172 62
Non-residential 35 1,341 1,876 2,330 21
Construction and development 6 -- -- -- --
Commercial, industrial,
and agricultural 1,150 1,188 1,087 441 528
Home equity lines 35 -- 326 28 109
Tax refund anticipation 2,857 2,288 1,524 1,437 383
Other consumer 1,066 861 343 166 277
----------------------------------------------------------------------
Total recoveries 5,324 6,007 5,424 4,574 1,380
----------------------------------------------------------------------
Net charge-offs 6,953 5,241 4,124 764 11,072
Allowance for credit losses recorded
in acquisition transactions -- -- 794 -- --
Provision for credit losses
refund anticipation loans 2,816 4,941 4,649 1,100 2,863
Provision for credit losses
all other loans 3,527 4,182 3,851 3,849 7,588
----------------------------------------------------------------------
Balance at end of year $ 28,686 $ 29,296 $ 25,414 $ 20,244 $ 16,059
======================================================================
Ratio of net charge-offs to
average loans outstanding 0.38% 0.37% 0.34% 0.08% 1.34%
Ratio of net charge-offs to
average loans outstanding
exclusive of RALs 0.24% 0.02% (0.03%) 0.12% 0.86%
Average Loans $ 1,809,404 $1,407,395 $1,201,394 $ 924,896 $ 826,083
Average RALs (12,391) (9,169) (10,079) (2,040) (4,484)
----------------------------------------------------------------------
Average Loans, net of RALs $ 1,797,013 $1,398,226 $1,191,315 $ 922,856 $ 821,599
======================================================================
Net Charge-offs $ 6,953 $ 5,241 $ 4,124 $ 764 $ 11,072
RAL Net Charge-offs 2,661 4,933 4,422 (314) 4,019
----------------------------------------------------------------------
Net Charge-offs, exclusive of RALs $ 4,292 $ 308 $ (298) $ 1,078 $ 7,053
======================================================================
There are only two other banks in the country that have national RAL programs,
so the net charge-off ratios for the Company are not comparable with those of
other institutions unless the RAL net charge-offs are eliminated. The ratios of
the net charge-offs to average loans and losses exclusive of RALs for the years
of 1995 through 1999 are also shown. The corresponding ratios for the Company's
FDIC peers are 0.65% for 1999, 1.08% for 1998, 1.03% for 1997, 0.89% for 1996,
and 0.69% for 1995 (Note A).
The Company's concentration in loans secured by real estate--specifically loans
secured by nonresidential properties-- and other larger loans in the commercial
category may cause a higher level of volatility in credit losses than would
otherwise be the case. Large pools of loans made up of numerous smaller loans
tend to have consistent loss ratios. A group consisting of a smaller number of
larger loans in the same industry is statistically less consistent and losses
may tend to occur at roughly the same time. Because the amount of loss is not
consistent period to period, the estimate of loss and therefore the amount of
allowance adequate to cover losses inherent in the portfolio cannot be
determined simply by reference to net charge-offs in the prior year or years.
The lower net charge-offs to average loans ratios experienced by the Company
since 1995 have in large part been due to the high levels of recoveries. At the
end of each of the years 1995 through 1998, the Company had a number of
previously charged-off loans which it reasonably had hopes of recovering, and
which were in fact recovered. With these recoveries, net charge-offs for 1996
through 1999 have been relatively low in proportion to the allowance for credit
loss. As of year end 1999, there are few such potential recoveries aside from
RALs, and Management therefore expects that in 2000 recoveries will be less and
that net charge-offs consequently may be higher than in prior years.
NONACCRUAL, PAST DUE, AND RESTRUCTURED LOANS
Table 8 summarizes the Company's nonaccrual and past due loans for the last five
years.
TABLE 8--Nonaccrual and Past Due Loans
(dollars in thousands) December 31
1999 1998 1997 1996 1995
--------------------------------------------------------------------
Nonaccrual $ 14,152 $ 8,148 $ 11,245 $ 8,591 $ 11,453
90 days or more past due 80 78 855 1,437 656
Restructured Loans 10 0 174 279 513
--------------------------------------------------------------------
Total noncurrent loans $ 14,242 $ 8,226 $ 12,274 $10,307 $ 12,622
====================================================================
Total noncurrent loans as percentage
of the total loan portfolio 0.72% 0.52% 0.94% 0.96% 1.47%
Allowance for credit losses as a percentage
of noncurrent loans 201% 356% 207% 196% 127%
Past Due Loans: Included in the amounts listed above as 90 days or more past due
are commercial and industrial, real estate, and a diversity of secured consumer
loans. These loans are well secured and in the process of collection. These
figures do not include loans in nonaccrual status.
Nonaccrual Loans: If there is reasonable doubt as to the collectibility of
principal or interest on a loan, the loan is placed in nonaccrual status, i.e.,
the Company stops accruing income from the interest on the loan and reverses any
uncollected interest that had been accrued but not collected. These loans may or
may not be collateralized. Collection efforts are being pursued on all
nonaccrual loans. Consumer loans are an exception to this reclassification. They
are charged-off when they become delinquent by more than 120 days if unsecured
and 150 days if secured. Nonetheless, collection efforts are still pursued.
Restructured Loans: The Company's restructured loans have generally been
classified as nonaccural even after the restructuring. Consequently, they have
been included with other nonaccrual loans in Table 8. The only restructured
loans the Company has had at the end of the last five years that have not been
classified as nonaccrual are reported in Table 8 on a separate line.
Charge-offs, repayments by the borrowers, and strengthened credit
administration, review, and analysis functions account for the decrease from
$12.6 million at the end of 1995 to $10.3 million at year-end 1996. The total
increased at the end of 1997 to $12.3 million because of noncurrent loans
acquired in the FVB and CSB transactions, but as a percentage of total loans,
noncurrent loans slightly decreased. The major change during 1998 was the
reclassification of the large loan mentioned in the section entitled "The
Components of the Allowance for Credit Losses" out of nonaccrual status but the
total was reduced as well by rigorous collection efforts. The total is higher
again at the end of 1999 with the classification of a few larger loans as
nonaccrual during 1999. As indicated in the above, it is generally the
classification of such larger loans that impacts the noncurrent total.
Table 9 sets forth interest income from nonaccrual loans in the portfolio at
year-end that was not recognized.
TABLE 9--Foregone Interest
(in thousands) Year Ended December 31
1999 1998 1997
---------------------------------------
Interest that would have been recorded under original terms $1,587 $ 905 $1,837
Gross interest recorded 771 669 930
---------------------------------------
Foregone interest $ 816 $ 236 $ 907
=======================================
DEPOSITS
An important component in analyzing net interest margin is the composition and
cost of the deposit base. Net interest margin is improved to the extent that
growth in deposits can be focused in the lower cost core deposit accounts:
demand deposits, NOW accounts, and savings. The average daily amount of deposits
by category and the average rates paid on such deposits is summarized for the
periods indicated in Table 10.
TABLE 10--Detailed Deposit Summary
(dollars in thousands) Year Ended December 31
1999 1998 1997
-----------------------------------------------------------------------------------
Average Average Average
Balance Rate Balance Rate Balance Rate
-----------------------------------------------------------------------------------
NOW accounts $ 300,065 0.68 % $ 278,176 1.11 % $ 246,545 1.08 %
Money market deposit accounts 577,693 3.07 552,760 3.40 526,282 3.53
Savings accounts 203,196 1.87 187,213 2.30 159,704 2.44
Time certificates of deposit for --
less than $100,000 and IRAs 430,920 4.75 426,769 5.32 343,905 5.51
Time certificates of deposit for --
$100,000 or more 359,951 4.80 300,215 5.28 230,240 5.42
------------- ------------- -------------
Interest-bearing deposits 1,871,825 3.27 % 1,745,133 3.71 % 1,506,676 3.76 %
Demand deposits 532,694 441,670 339,018
------------- ------------- -------------
$ 2,404,519 $ 2,186,803 $ 1,845,694
============= ============= =============
The average rate paid on all deposits, which had decreased slightly from 3.76%
in 1997 to 3.71% in 1998, continued to decrease in 1999 to 3.27%. This was
primarily due to the decline in market rates in the latter half of 1998. The
average rates that are paid on deposits generally trail behind money market
rates because financial institutions do not try to change deposit rates with
each small increase or decrease in short-term rates. This trailing
characteristic is stronger with time deposits such as certificates of deposit
that pay a fixed rate for some specified term than with deposit types that have
administered rates. Administered rate deposit accounts like NOW, money market
deposit accounts ("MMDA"), and savings, are those products which the institution
can reprice at its option based on competitive pressure and need for funds. With
time deposit accounts, even when new offering rates are established, the average
rates paid during the quarter are a blend of the rates paid on individual
accounts. Only new accounts and those that mature and are replaced will bear the
new rate. With market rates increasing in the second half of 1999 and the early
part of 2000, it is expected that the average deposit rates will be higher in
2000 than in 1999.
Table 11 discloses the distribution of maturities of CD's of $100,000 or more at
the end of each of the last three years.
TABLE 11--Maturity Distribution of Time
Certificates of Deposit of $100,000 or More
(in thousands) December 31
1999 1998 1997
-----------------------------------------------
Three months or less $ 171,518 $ 166,562 $ 114,396
Over three months through six months 109,981 74,518 68,385
Over six months through one year 89,661 65,355 75,386
Over one year 15,485 17,241 23,663
-----------------------------------------------
$ 386,645 $ 323,676 $ 281,830
===============================================
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND FEDERAL FUNDS PURCHASED
Securities sold under agreements to repurchase ("repos") are a form of borrowing
that is secured by securities owned by the borrower. Banks use these agreements
to borrow from other banks in order to provide temporary liquidity and they may
also be used to provide business customers with a secured alternative to
deposits in excess of the $100,000 insured amount. Prior to 1999, the Company
had almost exclusively used repos for the latter "retail" purpose. Most of the
retail agreements are for terms of a few weeks to 90 days. Like the rate paid on
Federal funds purchased, the interest rate paid on repos is tied to the Federal
funds sold rate. As discussed on pages 15 and 16, in 1999, funds were needed to
make loans in an amount substantially in excess of the amount generated by
deposit growth. Overnight borrowing from other banks was frequently used to
provide this liquidity until securities matured or term borrowings could be
arranged.
Information about the balances and rates paid is shown in Note 10 to the
consolidated financial statements. The average rate paid in 1999 of 4.66% was
higher than the 1998 rate of 4.44% and the 4.54% rate for 1997. While market
rates on average were lower in 1999 than in 1998, the repurchase agreements with
other banks bear higher interest rates than the retail repos with customers. The
higher average balance for 1999 also is reflective of their use this year for
liquidity management.
Federal funds purchased are a second form of overnight borrowing from other
banks. Prior to 1999, the Company primarily used this borrowing to accommodate
other local community financial institutions on the Central Coast that had
excess cash to invest overnight. Prior to 1999, the Company occasionally
purchased additional funds from money center banks to meet liquidity needs,
especially during the RAL season. In 1999, there was an increasing use of this
source of funds to management short-term liquidity. Information on the balances
and rates paid for these funds is also disclosed in Note 10 to the consolidated
financial statements. Because these are overnight borrowings, the average rate
paid to various parties on any one day may vary substantially from the average
rate for the year. Typically, the Federal funds rate is quite volatile on the
last day of the year. This accounts for the high rate paid on these funds the
last day of 1997 compared to the average for the year. The Company received
correspondingly higher interest on the Federal funds it sold those days. The
lower rates at the end of 1998 compared to the average rate for the year is due
more to declining rates during the latter part of the year than to abnormal
rates on the last day and the higher rate at the end of 1999 is due to rising
interest rates during the latter part of that year.
OTHER REAL ESTATE OWNED
Real property owned by the Company that was acquired in foreclosure proceedings
is termed Other Real Estate Owned. As explained in Note 1 to the consolidated
financial statements, the Company held some properties at December 31, 1999 and
1998, but had written their carrying value down to zero to reflect the
uncertainty of realizing any net proceeds from their disposal.
As part of the loan application process, the Company reviews real estate
collateral for possible problems from contamination by hazardous waste. This is
reviewed again before any foreclosure proceedings are initiated.
NONEARNING ASSETS
For a bank, nonearning assets are those assets like cash reserves, equipment,
and premises that do not earn interest. The ratio of nonearning assets to total
assets is watched carefully by Management because it represents the efficiency
with which funds are used. Tying up funds in nonearning assets either lessens
the amount of interest that may be earned or it requires the investment of the
smaller earning asset base in higher yielding but riskier assets to achieve the
same income level. Management therefore believes that a low level of nonearning
assets is part of a prudent asset/liability management strategy to reduce
volatility in the earnings of the Company.
The ratio of nonearning assets to total assets has remained very low during the
last three years with an average of 6.15% in 1997, 6.33% in 1998, and 6.57% in
1999. As a result of the two acquisitions noted above, the Company recorded
approximately $17 million in goodwill and approximately $3 million in premises,
equipment and other nonearning assets. Some of the increase in nonearning assets
in 1999 was due to holding extra amounts of cash on hand during November and
December in case there was a large demand for currency as 2000 approached. Also,
subsequent to the fire that destroyed the Company's administrative center,
additional costs have been incurred for leasehold improvements and furniture
related to the new center. As of September 30, 1999, the average ratio of
nonearning assets to total assets for bank holding companies of comparable size
was 6.91%.
OTHER OPERATING INCOME
Fees earned by the Trust and Investment Services Division remain the largest
component of other operating income, reaching $13.1 million in 1999. Fees
increased by $1,419,000 or 12% over 1998. The market value of assets under
administration on which the majority of fees are based increased from $2.0
billion at the end of 1998 to $2.4 billion at the end of 1999. Included within
total fees in 1999 were $1,174,000 for trusteeship of employee benefit plans and
$1,082,000 from the sales of mutual funds and annuities. The Company provides
assistance to customers to determine what investments best match their financial
goals and helps the customers allocate their funds according to the customers'
risk tolerance and need for diversification. The funds and annuities are not
operated by the Company, but instead are managed by registered investment
companies. The Division also provides investment management services to
individuals and organizations.
Included within other service charges, commissions and fees are service fees
arising from the processing of merchants' credit card deposits, escrow fees, and
a number of other fees charged for special services provided to customers. A
significant source of income in this category is tax refund transfer fee income
which totaled $6.6 million in 1999 compared to $4.8 million in 1998 and $2.9
million in 1997. As explained in the previous discussion on the tax refund
programs, many of the taxpayers not qualifying for loans still had their refunds
sent by the IRS to the Company which then issued the refund check more quickly
than the IRS. The Company began earning substantial fees for this service in
1995. Management expects that this will continue to provide a significant source
of income in 2000 and beyond.
The Company continues to work on increasing other income and fees due to its
importance as a potential contributor to profitability.
OTHER OPERATING EXPENSE
Total other operating expenses have increased over the last three years as the
Company has grown. These expenses are often calculated as a proportion of
average assets as a means of providing comparisons with other financial
institutions. As a percentage of average assets, these expenses were 3.92% in
1997, 4.28% in 1998, and 3.97% in 1999.
The increase from 1997 to 1998 is primarily due to expenses related to the
merger with PCB. The Company incurred $11.7 million in other expenses for the
merger. The nature of these expenses is explained in the section of this
Discussion titled "Merger with Pacific Capital Bancorp". Without these expenses,
the ratio of other operating expense to average assets would be 3.81%.
Another ratio that is used to compare the Company's expenses to those of other
financial institutions is the operating efficiency ratio. This ratio takes into
account the fact that for many financial institutions much of their income is
not asset-based, i.e., it is based on fee for services provided rather than
income earned from a spread between the interest earned on assets and interest
paid on liabilities. The operating efficiency ratio measures how much
noninterest expense is spent in earning a dollar of revenue irrespective of
whether the revenue is asset-based or fee-based. The Company spent 57.6 cents in
1999 for each dollar of revenue compared to 59.1 cents for its holding company
peers. In 1998, the ratios were 62.7 cents for the Company and 62.5 cents for
its peers. Without the merger expenses, the Company's ratio would have been 55.8
cents. In 1997, the ratios were 57.8 cents for the Company and 60.0 cents for
its peers.
Within the whole category of other operating expense, salary and benefit
expenses have increased 19.7% from 1997 to 1999 compared to a 30.7% increase in
average earning assets and a 33.3% growth in total revenues (exclusive of gains
or losses on securities) for the same period.
Net occupancy and equipment expense have increased from 1997 to 1999 by 26.0%
because of some branch office renovation, increases in lease expense, upgrading
of equipment to handle increased transaction volumes and to maintain
technological competitiveness, and the addition of new offices.
CAPITAL RESOURCES
Under current regulatory definitions, the Company is "well-capitalized," the
highest rating of the five categories defined under the Federal Deposit
Insurance Corporation Improvement Act ("FDICIA").
Capital Adequacy Standards
The primary measure of capital adequacy for regulatory purposes is based on the
ratio of risk-based capital to risk weighted assets. This method of measuring
capital adequacy is meant to accomplish several objectives: 1) to establish
capital requirements that are more sensitive to the differences in risk
associated with various assets; 2) to explicitly take into account off-balance
sheet exposure in assessing capital adequacy; and, 3) to minimize disincentives
to holding liquid, low-risk assets.
The Company, as a bank holding company, is required by the FRB to maintain a
risk-based capital ratio of at least 8.0%. At the end of 1998, the Company's
ratio was 11.7%. The minimum levels established by the FRB, the minimum levels
necessary to be considered well capitalized by regulatory definition and the
Company's ratios as of December 31, 1999 are presented in Note 17. It is
Management's intent to maintain capital in excess of the well capitalized
requirement, and as of year-end all ratios exceed this threshold. SBB&T and FNB
are also required to maintain a risk-based capital ratio of 8.0%. SBB&T's ratio
at the end of 1999 was 11.0% and FNB's was 11.4%. PCCM has no minimum capital
requirements.
The risk-based capital ratio is impacted not only by the relative size of the
various asset categories, but is also strongly impacted by the management of the
securities portfolios. The Company's ratio decreased from 12.6% for year-end
1997 to 11.8% for year-end 1999. This occurred first as the result of shift in
assets from securities and overnight funds to loans. All loan categories except
1-4 family residential real estate have a risk weighting of 100% which is much
higher than the risk weightings for securities and overnight funds. In addition,
within the securities portfolios, there was a shift in the relative proportions
of the various security types from the U.S. Treasury securities that are
assigned a zero risk weighting to other such as U.S. agency securities, state
and municipal securities, and Federal funds sold that have a 20% risk weighting.
Future Sources and Uses of Capital and Expected Ratios
The Company has been increasing loans as a percentage of total assets in order
to increase net interest income. However, Management intends and expects that
the Company and the subsidiary banks will continue to exceed the standards for
well capitalized institutions because of sustained growth in capital resources.
Net income has provided $104.1 million in capital in the last three years. Of
this amount, $43.1 million, or 41.4% was distributed in dividends.
In addition to the capital generated from the operations of the Bank, over the
years a significant source of capital growth has been the exercise of employee
and director stock options. The extent of the growth from this source in any one
year depends on a number of factors, among them the current stock price in
relation to the price at the time options were granted and the number of options
that would expire if not exercised during the year.
The net increase to capital from the exercise of options is lessened by the
ability of option holders to pay the exercise price of options by trading shares
of stock they already own, termed "swapping". In 1999, the increase to capital
from the exercise of options (net of shares surrendered as payment for exercises
and taxes) was $6.0 million or 28.9% of the net growth in shareholders' equity
in the year. This was less than the $11,057,000 or 47.5% percent of capital
growth due to option exercises in 1998. In that year, a larger number of options
would have expired if not exercised than would have expired in 1999 if not
exercised. At December 31, 1999, there were approximately 754,000 options
outstanding and exercisable at less than the then current market price, with an
average exercise price of $10.65. This represents a potential addition to
capital of $8.0 million, if all options were exercised with cash. Because many
options are likely to be exercised by swapping, some amount less than the $8.0
million in new capital will result from the exercise of options, and the options
are likely to be exercised over a number of years.
Tender Offer and Other Share Repurchase
As disclosed in Note 9 to the accompanying consolidated financial statements, in
1997 the Company offered to purchase up to 1,000,000 shares of common stock duly
tendered by February 21, 1997. The number of shares tendered on that date were
130,494 or 0.9% of the then outstanding shares. The Company paid $15.00 per
share or approximately $2.0 million for the stock tendered, which was accounted
for as a retirement of shares and reduction of capital in 1997. As explained in
the tender offer, this action was taken: 1) to provide shareholders with larger
holdings an opportunity to sell shares if they had not been able to because the
market was not able to absorb larger blocks; and 2) because the significant
earnings growth over the last several years had resulted in an accumulation of
capital in excess of current and anticipated needs.
In prior years, the Company occasionally repurchased shares of its common stock
to offset the increased number of shares issued as a result of the exercise of
employee stock options. In 1998, because the merger with PCB was accounted for
as a pooling-of-interests, the Company suspended purchases at the initiation of
the merger discussions and repurchased only 150,000 shares compared to the
issuance of 807,000 shares resulting from the exercise of stock options. In
1999, the Company repurchased 68,000 shares to partially offset the issuance of
413,000 shares resulting from the exercise of stock options.
There are no material commitments for capital expenditures or "off-balance
sheet" financing arrangements as of the end of 1999, except as reported in Note
18 to the consolidated financial statements. Legal limitations on the ability of
the subsidiary banks to declare dividends to the Bancorp are discussed in Note
17.
REGULATION
The Company is strongly impacted by regulation. The Company and its subsidiaries
may engage only in lines of business that have been approved by their respective
regulators, and cannot open, close, or relocate offices without their approval.
Disclosure of the terms and conditions of loans made to customers and deposits
accepted from customers are both heavily regulated as to content. FDICIA,
effective in 1992, required banks to meet new capitalization standards, follow
stringent outside audit rules, and establish stricter internal controls. There
were also new requirements to ensure that the Audit Committee of the Board of
Directors is independent.
The subsidiary banks are required by the provisions of the federal Community
Reinvestment Act ("CRA"), to make significant efforts to ensure that access to
banking services is available to every segment of the community. They are also
required to comply with the provision of various other consumer legislation and
regulations. The Company and the banks must file periodic reports with the
various regulators to keep them informed of their financial condition and
operations as well as their compliance with all the various regulations.
The three regulatory agencies--the FRB for the Company and SBB&T, the California
Department of Financial Institutions for SBB&T, and the OCC for FNB--conduct
periodic examinations of the Company and its subsidiary banks to verify that
their reporting is accurate and to ascertain that they are in compliance with
regulations.
A banking agency may take action against a bank holding company or a bank should
it find that the financial institution has failed to maintain adequate capital.
This action has usually taken the form of restrictions on the payment of
dividends to shareholders, requirements to obtain more capital from investors,
and restrictions on operations. The FDIC may also take action against a bank
which is not acting in a safe and sound manner. Given the strong capital
position and performance of the Company and the banks, Management does not
expect to be impacted by these types of restrictions in the foreseeable future.
The Gramm-Leach-Bliley Act was enacted as Federal legislation in late 1999. The
effective date of the act is March 11, 2000. The provisions of the act will
permit banking organizations to enter into areas of business from which they
were previously restricted. Similarly, other kinds of financial organizations
will be permitted to conduct business now provided by banks. Management expects
that over the next several years the Company will develop new opportunities for
business and will face increased competition as a result of the passage of this
act.
IMPACT OF INFLATION
Inflation has been minimal for the last several years and has had little or no
impact on the financial condition and results of operations of the Company
during the periods discussed here.
LIQUIDITY
Liquidity is the ability to raise funds on a timely basis at an acceptable cost
in order to meet cash needs. Adequate liquidity is necessary to handle
fluctuations in deposit levels, to provide for customers' credit needs, and to
take advantage of investment opportunities as they are presented in the market
place.
The Company's objective is to ensure adequate liquidity at all times by
maintaining liquid assets, by being able to raise deposits and liabilities, and
by having access to funds via capital markets. Having too little liquidity can
result in difficulties in meeting commitments and lost opportunities. Having too
much liquidity can result in less income because liquid assets usually do not
earn as high an interest rate as less liquid assets.
As indicated in the Consolidated Statements of Cash Flows, the principal sources
of cash for the Company have been interest payments received on loans and
investments, proceeds from the maturity or sale of securities and bankers'
acceptances, and the growth in deposits and other borrowings.
To manage the Company's liquidity properly, however, it is not enough to merely
have large cash inflows; they must be timed to coincide with anticipated cash
outflows. Also, the available cash on hand or cash equivalents must be
sufficient to meet the exceptional demands that can be expected from time to
time relating to natural catastrophes such as flood, earthquakes, and fire.
The Company manages its liquidity adequacy by monitoring and managing its
immediate liquidity, intermediate liquidity, and long term liquidity.
Immediate liquidity is the ability to raise funds today to meet today's cash
obligations. Sources of immediate liquidity include cash on hand, the prior
day's Federal funds sold position, unused Federal funds and repurchase agreement
lines and facilities extended by other banks and major brokers to the Company,
access to the Federal Home Loan Bank for short-term advances, and access to the
Federal Reserve Bank's Discount Window. The Company has established a target
amount for sources of available immediate liquidity. This amount is increased
during certain periods to accommodate any liquidity risks of special programs
like RALs.
As discussed in various sections above, continued strong loan demand in 1999
outpaced the deposit growth and required the Company to rely more on overnight
borrowing to maintain immediate liquidity than had been the case in prior years.
The rate paid on these borrowings is more than would be paid for deposits, but
aside from this, there have been no adverse consequences from relying more on
borrowing ability than on holding liquid assets in excess of the immediate
amounts needed. The Company's strong capital position and earnings prospects
have meant that these sources of borrowing have been readily available.
Intermediate liquidity is the ability to raise funds during the next few months
to meet cash obligations over those next few months. Sources of intermediate
liquidity include maturities or sales of bankers' acceptances and securities,
term repurchase agreements, and term advances from the Federal Home Loan Bank.
The Company monitors the cash flow needs of the next few months and determines
that the sources are adequate to provide for these cash needs.
Long term liquidity is the ability to raise funds over the entire planning
horizon to meet cash needs anticipated due to strategic balance sheet changes.
Long term liquidity sources include initiating special programs to increase core
deposits in expanded market areas, reducing the size of securities portfolios,
taking long-term advances from the Federal Home Loan Bank, securitizing loans,
and accessing capital markets. The fixed-rate loans the Company borrowed from
the Federal Home Loan Bank to fund the retention of a portion of the 30-year
fixed rate residential real estate loans is an example of coordinating a source
of long term liquidity with asset/liability management.
INCOME TAX EXPENSE
Income tax expense is the sum of two components, the current tax expense or
provision and the deferred expense or provision. Current tax expense is the
result of applying the current tax rate to taxable income.
The deferred tax provision is intended to account for the fact that income on
which the Company pays taxes with its returns differs from pre-tax income in the
accompanying Consolidated Income Statements. Some items of income and expense
are recognized in different years for income tax purposes than in the financial
statements. For example, the Company is only permitted to deduct from Federal
taxable income actual net loan charge-offs, irrespective of the amount of
provision for credit loss (bad debt expense) recognized in its financial
statements. This causes what is termed a "temporary difference" because
eventually, as loans are charged-off, the Company will be able to deduct for tax
purposes what has already been recognized as an expense in the financial
statements. Another example is the accretion of discount on certain securities.
Accretion is the recognition as interest income of the excess of the par value
of a security over its cost at the time of purchase. For its financial
statements, the Company recognizes income as the discount is accreted. For its
tax return, however, the Company can defer the recognition of that income until
the cash is received at the maturity of the security. The first example causes a
deferred tax asset to be created because the Company has recognized as an
expense for its current financial statements an item that it will be able to
deduct from its taxable income in a future year. The second example causes a
deferred tax liability, because the Company has been able to delay until a
subsequent year the paying of tax on an item of current year financial statement
income.
The Company measures all of its deferred tax assets and liabilities at the end
of each year. The difference between the net asset or liability at the beginning
of the year and the end of the year is the deferred tax provision for the year.
Most of the Company's temporary differences involve recognizing substantially
more expenses in its financial statements than it has been allowed to deduct for
taxes. This results in a net deferred tax asset. Deferred tax assets are
dependent for realization on past taxes paid, against which they may be carried
back, or on future taxable income, against which they may be offset. If there
were a question about the Company's ability to realize the benefit from the
asset, then it would have to record a valuation allowance against the asset to
reflect the uncertainty. Given the amount and nature of the Company's deferred
assets, the past taxes paid, and the likelihood of future taxable income,
realization is assured for the full amount of the net deferred tax asset and no
valuation allowance is needed.
The amounts of the current expense and deferred benefit, the amounts of the
various deferred tax assets and liabilities, and the tax effect of the principal
temporary differences between taxable income and pre-tax financial statement
income are shown in Note 8 to the accompanying consolidated financial
statements.
COMMON STOCK PRICES AND DIVIDENDS
Stock prices and cash dividends declared for the last eight quarters are shown
on page 5. The Company's stock is listed on the Nasdaq National Market System.
The trading symbol is SABB. Stock prices represent trading activity through the
National Market System.
For the years 1999, 1998, and 1997, the Company has declared cash dividends
which were 39.9%, 54.5%, and 39.2%, respectively, of its net income. The
Company's policy is to pay dividends of approximately 35%-40% of the last 12
months earnings. Because earnings were significantly reduced in 1998 by the
one-time merger expenses, the ratio for 1998 is higher than usual. The most
recent information for the Company's peers shows an average payout ratio of
29.8%. The Board of Directors periodically increases the dividend rate in
acknowledgment that earnings have been increasing by a sufficient amount to
ensure adequate capital and also provide a higher return to shareholders. The
last increase was declared in the third quarter of 1998.
MERGER WITH PACIFIC CAPITAL BANCORP
On December 30, 1998, SBB completed its merger with PCB and assumed the name of
its merger partner to most clearly reflect the broad geography of the new
multi-bank organization.
The agreement provided for PCB shareholders to receive 1.935 shares of SBB stock
in exchange for each of their shares. Based on the closing price of SBB stock as
of the date of the merger, the value of the merger was approximately $216
million, 2.8 times the book value of PCB. The transaction was accounted for as a
pooling of interests. As such, all financial results for periods prior to the
merger are reported as if the merger occurred at the beginning of the earliest
period presented.
CENTURY DATE CHANGE ("Y2K")
Beginning in 1997, the Company undertook the significant project of ensuring
that all of its critical systems would be able to function in the year 2000.
These systems included (1) data processing systems; (2) building and facilities
systems like vaults, elevators, and heating and air conditioning systems, and
(3) telecommunication systems. In addition, reviews were conducted of the
response plans of the Company's major customers and other financial institutions
on whom the Company relies as suppliers of funds. The Company also closely
monitored the response plans of the utilities and telecommunication firms on
which it is dependent. The Company underwent a number of reviews by regulatory
agencies of its progress with this project.
As a result of these preparations, no significant problems were encountered with
the Company's critical systems and through the writing of this discussion, the
Company has become aware of no significant problems encountered by its customers
or the other financial institutions with which it does business. The Company has
become aware of no significant impact on its customers' abilities to repay loans
due to problems with their systems. The Company will remain alert to the
potential for problems to arise later in 2000, especially because it will be a
leap year.
The total cost of the project was approximately $2,652,000, which included the
cost of outside contract programmers, software and hardware purchased
specifically to be ready for Y2K, and the rental of a generator and other
special equipment for the period surrounding year end. Of this amount,
approximately $1,741,000 was expensed in 1999, with the balance having been
expensed in 1997 and 1998.
NOTES TO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
NOTE A
In various places throughout this discussion, comparisons will be made between
ratios for the Company and for its holding company or FDIC peers.
The holding company peer is a group of 155 companies with an asset size of $1
billion to $3 billion. The peer information is reported in the Bank Holding
Company Performance Report received from the FRB for the 3rd Quarter of 1999,
the latest quarter for which the report has been distributed as of this writing.
The FDIC peer group comprises 300+ banks with an asset size of $1 billion to $10
billion, and the information set forth above is reported in or calculated from
information reported in the FDIC Quarterly Banking Profile, Third Quarter 1999,
which is the latest issue available. The publication does not report some of the
statistics cited in this report by the separate size-based peer groups. In these
instances, the figure cited is for all FDIC banks regardless of size.
The particular peer group used for comparison depends on the nature of the
information in question. Company data like capital ratios and dividend payout
are compared to other holding companies, because capital is generally managed at
the holding company level and dividends to shareholders are paid from the
holding company, not the individual banks. Expense and revenue ratios are also
compared to other holding company data because many holding companies provide
significant services to their subsidiary banks and may also provide services to
customers as well. These items would not be included in FDIC bank-level data.
Credit information relates to what is generally a bank-level activity, the
making of loans, and the FDIC data in this area is more pertinent.
NOTE B
When comparing interest yields and costs year to year, the use of average
balances more accurately reflects trends since these balances are not
significantly impacted by period-end transactions. The amount of interest earned
or paid for the year is also directly related to the average balances during the
year and not to what the balances happened to be on the last day of the year.
NOTE C
For Tables 1 and 3, the yield on tax-exempt state and municipal securities and
loans has been computed on a tax equivalent basis. To compute the tax equivalent
yield for these securities one must first add to the actual interest earned an
amount such that if the resulting total were fully taxed, the after-tax income
would be equivalent to the actual tax-exempt income. This tax equivalent income
is then divided by the average balance to obtain the tax equivalent yield. The
dollar amount of the adjustment is shown at the bottom of Table 1 as "Tax
equivalent income included in interest income from nontaxable securities and
loans."
NOTE D
For purposes of Table 1, loans in a nonaccrual status are included in the
computation of average balances in their respective loan categories.
NOTE E
For purposes of the amounts in Table 2 relating to the volume and rate analysis
of net interest margin, the portion of the change in interest earned or paid
that is attributable to changes in rate is computed by multiplying the change in
interest rate by the prior year's average balance. The portion of the change in
interest earned or paid that is attributable to changes in volume is computed by
multiplying the change in average balances by the prior year's interest rate.
The portion of the change that is not attributable either solely to changes in
volume or changes in rate is prorated on a weighted basis between volume and
rate.
NOTE F
A yield curve is a graphic representation of the relationship between the
interest rate and the maturity term of financial instruments. Generally,
interest rates on shorter maturity financial instruments are less than those for
longer term instruments. For example, at December 31, 1999, 1 year U.S. Treasury
notes sold at a price that yielded 5.96% while 30 year notes sold at a price
that yielded 6.48%. A line drawn that plots this relationship for a whole range
of maturities will be "steeper" when the rates on long-term maturities are
substantially higher than those on shorter term maturities. The curve is said to
be "flatter" when there is not as much of a difference.
NOTE G
While banker's acceptances generally result from the financing of a shipment of
goods between a particular purchaser and seller, in financial markets they
function as a negotiable short-term debt instrument.
NOTE H
A large number of home mortgage loans may be grouped together by a financial
institution into a pool. This pool may then be securitized and sold to
investors. The payments received from the borrowers on their mortgages are used
to pay the investors. The mortgage instruments themselves are the security or
backing for the investors and the securities are termed mortgage-backed.
Collateralized mortgage obligations are like mortgage-backed securities in that
they involve a pool of mortgages. However, payments received from the borrowers
are not equally paid to investors. Instead, investors purchase portions of the
pool that have different repayment characteristics. This permits the investor to
better time the cash flows that will be received.
Asset-backed securities are like mortgage-backed securities except that loans
other than mortgages are the source of repayment. For instance, these might be
credit card loans or auto loans.
NOTE I
LIBOR is an acronym for London Interbank Offering Rate. Originally a rate used
primarily in international banking, it is now commonly used as an index rate for
many financial transactions.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Audited consolidated financial statements and related documents required by this
item are included in this Annual Report on Form 10-K on the pages indicated:
Management's Responsibility for Financial Reporting 40
Report of Independent Public Accountants--Arthur Andersen LLP 41
Independent Auditors' Report--KPMG LLP 42
Consolidated Balance Sheets as of December 31, 1999 and 1998 43
Consolidated Statements of Income for the years
ended December 31, 1999, 1998, and 1997 44
Consolidated Statements of Comprehensive Income for the
years ended December 31, 1999, 1998, and 1997 45
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1999, 1998, and 1997 46
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998, and 1997 47
Notes to Consolidated Financial Statements 48
The following unaudited supplementary data is included in this Annual Report on
Form 10-K on the page indicated:
Quarterly Financial Data 77
MANAGEMENT'S RESPONSIBILITY FOR
FINANCIAL REPORTING
The Management of Pacific Capital Bancorp (the "Company") is responsible for the
preparation, integrity, and fair presentation of the Company's annual
consolidated financial statements and related financial data contained in this
report. With the exception that some of the information in Management's
Discussion and Analysis of Financial Condition and Results of Operations is
presented on a tax-equivalent basis to improve comparability, all information
has been prepared in accordance with generally accepted accounting principles
and, as such, includes certain amounts that are based on Management's best
estimates and judgments.
The consolidated financial statements presented on pages 43 through 47 have been
audited by Arthur Andersen LLP, who have been given unrestricted access to all
financial records and related data, including minutes of all meetings of
shareholders, the Board of Directors, and committees of the Board. Management
believes that all representations made to Arthur Andersen LLP during the audit
were valid and appropriate.
Management is responsible for establishing and maintaining an internal control
structure over financial reporting. Two of the objectives of this internal
control structure are to provide reasonable assurance to Management and the
Board of Directors that transactions are properly authorized and recorded in our
financial records, and that the preparation of the Company's financial
statements and other financial reporting is done in accordance with generally
accepted accounting principles.
Management has made its own assessment of the effectiveness of the Company's
internal control structure over financial reporting as of December 31, 1999, in
relation to the criteria described in the report, Internal Control--Integrated
Framework, issued by the Committee of Sponsoring Organizations of the Treadway
Commission.
There are inherent limitations in the effectiveness of any internal control
structure, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even an effective internal control
structure can provide only reasonable assurance with respect to reliability of
financial statements. Furthermore, the effectiveness of any internal control
structure can vary with changes in circumstances. Nonetheless, based on its
assessment, Management believes that as of December 31, 1999, Pacific Capital
Bancorp's internal control structure was effective in achieving the objectives
stated above.
The Board of Directors is responsible for reviewing and monitoring the policies
and practices employed by Management in preparing the Company's financial
reporting. This is accomplished through its Audit Committee, which is comprised
of directors who are not officers or employees of the Company. The Committee
reviews accounting policies, control procedures, internal and independent audit
reports, and regulatory examination reports with Management, the Company's
internal auditors, and representatives of Arthur Andersen LLP. Both the
Company's internal auditors and the representatives of Arthur Andersen LLP have
full and free access to the Committee to discuss any issues which arise out of
their examinations without Management present.
/s/David W. Spainhour /s/William S. Thomas, Jr. /s/Donald Lafler
David W. Spainhour William S. Thomas, Jr. Donald Lafler
President and Vice-Chairman and Executive Vice President and
Chief Executive Officer Chief Operating Officer Chief Financial Officer
Pacific Capital Bancorp Pacific Capital Bancorp Pacific Capital Bancorp
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and the Board of Directors
of Pacific Capital Bancorp:
We have audited the accompanying consolidated balance sheets of Pacific Capital
Bancorp (a California corporation) and Subsidiaries as of December 31, 1999 and
1998, and the related consolidated statements of income, comprehensive income,
changes in shareholders' equity, and cash flows for each of the three years in
the period ended December 31, 1999. These financial statements are the
responsibility of Pacific Capital Bancorp's management. Our responsibility is to
express an opinion on these financial statements based on our audits. We did not
audit the financial statements of Pacific Capital Bancorp for fiscal years prior
to its acquisition during 1998 by Santa Barbara Bancorp, in a transaction
accounted for as a pooling of interests, as discussed in Notes 1 and 19 to the
accompanying consolidated financial statements. Such statements are included in
the accompanying consolidated financial statements of Pacific Capital Bancorp
and reflect net income of 33.5 percent for 1997 of the related consolidated
totals. These statements were audited by other auditors whose report has been
furnished to us and our opinion, insofar as it relates to amounts included for
Pacific Capital Bancorp prior to the merger, is based solely upon the report of
the other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 and the report of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Pacific Capital Bancorp and Subsidiaries as of
December 31, 1999 and 1998, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1999 in conformity
with accounting principles generally accepted in the United States.
Los Angeles, California ARTHUR ANDERSEN LLP
February 4, 2000
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Pacific Capital Bancorp:
We have audited the accompanying consolidated statements of income,
shareholders' equity, and cash flows for the year ended December 31, 1997 of the
predecessor Pacific Capital Bancorp and subsidiaries (prior to its merger into
Santa Barbara Bancorp) (the Company). These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit.
We conducted our audit in accordance with generally accepted auditing standards.
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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows of
the predecessor Pacific Capital Bancorp and subsidiaries (prior to its merger
into Santa Barbara Bancorp) for the year ended December 31, 1997, in conformity
with generally accepted accounting principles.
KPMG LLP
Mountain View, California
January 23, 1998
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands except stated value) December 31
1999 1998
---------------------------------
Assets:
Cash and due from banks (Note 5) $ 121,500 $ 114,206
Federal funds sold -- 69,890
Money market funds -- 1,567
Total cash and cash equivalents 121,500 185,663
Securities (approximate market value of $687,576
in 1999 and $808,388 in 1998) (Note 2):
Held-to-maturity 153,264 194,769
Available-for-sale 528,426 596,996
Total securities 681,690 791,765
Bankers' acceptances and commercial paper -- 19,888
Loans (Note 3) 1,981,879 1,582,781
Less: allowance for credit losses (Note 4) 28,686 29,296
Net loans 1,953,193 1,553,485
Premises and equipment, net (Note 6) 35,175 29,916
Accrued interest receivable 17,345 15,944
Other assets (Notes 8 & 19) 70,379 52,757
---------------------------------
Total assets $2,879,282 $2,649,418
=================================
Liabilities:
Deposits (Note 7):
Noninterest bearing demand deposits $ 546,193 $ 498,266
Interest bearing deposits 1,893,988 1,831,410
Total deposits 2,440,181 2,329,676
Securities sold under agreements to repurchase
and Federal funds purchased (Note 10) 80,507 27,796
Long-term debt and other borrowings (Note 11) 98,801 44,953
Accrued interest payable and
other liabilities (Notes 8, 13, and 15) 25,220 32,993
---------------------------------
Total liabilities 2,644,709 2,435,418
---------------------------------
Commitments and contingencies (Note 18)
Shareholders' equity (Notes 9, 13 and 17):
Common stock-- no par value, $0.33 stated value; shares
authorized: 60,000; shares issued and outstanding:
24,554 in 1999 and 24,209 in 1998. 8,186 8,071
Preferred stock-- no par value; shares authorized: 1,000;
shares issued and outstanding: none -- --
Surplus 99,283 95,498
Accumulated other comprehensive income (Note 1) (6,447) 3,496
Retained earnings 133,551 106,935
---------------------------------
Total shareholders' equity 234,573 214,000
---------------------------------
Total liabilities and shareholders' equity $2,879,282 $2,649,418
=================================
The accompanying notes are an integral part of these consolidated balance
sheets.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except for per share data) Year Ended December 31
1999 1998 1997
------------------------------------------------------
Interest income:
Interest and fees on loans (Note 3) $ 164,572 $ 138,537 $ 120,106
Interest on securities:
U.S. Treasury obligations 10,615 14,436 15,229
U.S. agency obligations 9,733 7,023 4,669
State and municipal securities 9,202 9,345 8,312
Collateralized mortgage obligations 12,247 13,337 7,302
Asset-backed securities 848 716 181
Equity securities 500 493 540
Interest on Federal funds sold and securities
purchased under agreement to resell 3,590 8,653 7,136
Interest on money market funds 29 162 663
Interest on bankers' acceptances 307 937 4,134
------------------------------------------------------
Total interest income 211,643 193,639 168,272
------------------------------------------------------
Interest expense:
Interest on deposits (Note 7) 61,300 64,770 56,582
Interest on securities sold under agreements
to repurchase and Federal funds purchased
(Note 10) 1,761 1,098 1,512
Interest on long-term debt and other
borrowings (Note 11) 4,795 2,245 2,496
------------------------------------------------------
Total interest expense 67,856 68,113 60,590
------------------------------------------------------
Net interest income 143,787 125,526 107,682
Provision for credit losses (Notes 1 and 4) 6,375 9,123 8,500
------------------------------------------------------
Net interest income after provision for credit losses 137,412 116,403 99,182
------------------------------------------------------
Other operating income:
Service charges on deposit accounts 8,911 8,660 7,684
Trust fees (Note 1) 13,095 11,676 10,089
Other service charges, commissions and fees
(Note 12) 18,624 16,602 11,868
Net gain (loss) on sales and calls of securities
(Notes 1, 2, and 8) (286) 214 (395)
Other income 1,274 1,069 1,196
------------------------------------------------------
Total other operating income 41,618 38,221 30,442
------------------------------------------------------
Other operating expense:
Salaries and other compensation (Note 16) 43,400 40,178 34,334
Employee benefits (Notes 13 and 15) 8,245 9,100 8,806
Net occupancy expense (Notes 6 and 18) 9,362 8,160 7,430
Equipment rental, depreciation and
maintenance (Note 6) 6,254 6,965 5,380
Other operating expense (Note 12) 43,128 41,679 27,103
------------------------------------------------------
Total other operating expense 110,389 106,082 83,053
------------------------------------------------------
Income before provision for income taxes 68,641 48,542 46,571
Provision for income taxes (Note 8) 24,367 18,975 16,288
------------------------------------------------------
Net income $ 44,274 $ 29,567 $ 30,283
======================================================
Basic earnings per share (Note 16) $ 1.81 $ 1.24 $ 1.29
Diluted earnings per share (Note 16) $ 1.79 $ 1.21 $ 1.25
The accompanying notes are an integral part of these consolidated statements.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands) Year Ended December 31
1999 1998 1997
---------------------------------------
Net income $44,274 $29,567 $30,283
---------------------------------------
Other comprehensive income, net of tax (Note 8)
Unrealized gain (loss) on securities:
Unrealized holding (losses) gains arising during period (10,229) 1,809 1,699
Reclassification adjustment for losses (gains)
included in net income 286 (81) 232
---------------------------------------
Other comprehensive income, net of tax (benefit)
expense of $(4,677), $1,254 and $1,401 for the years
ended December 31, 1999, 1998 and 1997 respectively (9,943) 1,728 1,931
---------------------------------------
Comprehensive income $34,331 $31,295 $32,214
=======================================
The accompanying notes are an integral part of these consolidated statements.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Accumulated
(in thousands except for per Other
share data) Common Stock * Comprehensive Retained
Shares Amount Surplus Income Earnings Total
- - - - - - - ---------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 23,077 $7,693 $82,169 $ (163) $ 81,540 $171,239
Activity for 1997:
Exercise of stock
options (Note 9) 370 123 2,742 -- -- 2,865
Retirement of
common stock (Note 9) (289) (96) (5,326) -- -- (5,422)
5% stock dividend, including
payment of fractional shares 394 131 8,869 -- (9,040) (40)
Cash dividends declared
at $0.49 per share -- -- -- -- (10,132) (10,132)
Changes in unrealized gain
(loss) on securities
available-for-sale -- -- -- 1,931 -- 1,931
Net income -- -- -- -- 30,283 30,283
- - - - - - - ---------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 23,552 7,851 88,454 1,768 92,651 190,724
Activity for 1998:
Exercise of stock
options (Note 9) 807 270 10,787 -- -- 11,057
Retirement of
common stock (Note 9) (150) (50) (3,743) -- -- (3,793)
Cash dividends declared
at $0.66 per share -- -- -- -- (15,283) (15,283)
Changes in unrealized gain
(loss) on securities
available-for-sale -- -- -- 1,728 -- 1,728
Net income -- -- -- -- 29,567 29,567
- - - - - - - ---------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 24,209 8,071 95,498 3,496 106,935 214,000
Activity for 1999:
Exercise of stock
options (Note 9) 413 138 5,818 -- -- 5,956
Retirement of
common stock (Note 9) (68) (23) (2,033) -- -- (2,056)
Cash dividends declared
at $0.72 per share -- -- -- -- (17,658) (17,658)
Changes in unrealized gain
(loss) on securities
available-for-sale -- -- -- (9,943) -- (9,943)
Net income -- -- -- -- 44,274 44,274
- - - - - - - ---------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 24,554 $8,186 $99,283 $(6,447) $133,551 $234,573
===============================================================================================================
* Preferred stock of 1,000,000 shares is authorized. At December 31, 1999 there
are no preferred shares issued and outstanding.
The accompanying notes are an integral part of these consolidated statements.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31
Increase (decrease) in cash and cash equivalents (Note 1): 1999 1998 1997
-----------------------------------------
Cash flows from operating activities:
Net income $ 44,274 $ 29,567 $ 30,283
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation and amortization 6,586 7,033 5,196
Provision for credit lease losses 6,375 9,123 8,500
Net origination of loans available for sale -- -- (4,702)
Gain on sale of loans -- (21) (11)
(Benefit) provision for deferred income taxes (2,092) 1,060 (1,946)
Net recovery on other real estate owned -- (118) 87
Net amortization of discounts and premiums for
securities and bankers' acceptances (6,108) (3,412) (4,449)
Net change in deferred loan origination fees and costs 165 346 570
Increase in accrued interest receivable (2,715) (1,037) (4,790)
(Decrease) increase in accrued interest payable (268) (131) 52
Net loss (gain) on sales and calls of securities 287 (214) 395
(Decrease) Increase in income taxes payable (1,758) 5,804 (1,478)
Other operating activities (20,861) 8,915 488
---------------------------------------
Net cash provided by operating activities 23,885 56,915 28,195
---------------------------------------
Cash flows from investing activities:
Purchase of common stock of First Valley
Bank and Citizens State Bank (Note 19) -- -- (42,270)
Proceeds from sales, calls, and maturities of securities 243,755 227,464 236,319
Purchase of securities (Note 2) (128,161) (276,619) 359,036)
Proceeds from sale or maturity of bankers' acceptances
and commercial paper 49,995 63,358 170,415
Purchase of bankers' acceptances and commercial paper (29,805) (34,452) 155,084)
Net increase in loans made to customers (406,033) (276,803) 126,207)
Disposition of property from defaulted loans -- 264 1,799
Purchase of tax credit investment (6,933) (3,688) --
Purchase of investment in premises and equipment (10,409) (6,841) (7,150)
---------------------------------------
Net cash used in investing activities (287,591) (307,317) 281,214)
---------------------------------------
Cash flows from financing activities:
Net increase in deposits 110,505 242,123 212,404
Net increase (decrease) in borrowings
with maturities of 90 days or less 52,711 6,503 (14,167)
Cash received in connection with branch acquisition -- -- 24,694
Net increase in other borrowings 53,848 4,900 --
Proceeds from issuance of common stock (Note 9) 2,129 4,919 2,825
Payments to retire common stock (Note 9) (2,055) (3,791) (5,422)
Dividends paid (17,595) (12,907) (9,668)
---------------------------------------
Net cash provided by financing activities 199,543 241,747 210,666
---------------------------------------
Net decrease in cash and cash equivalents (64,163) (8,655) (42,353)
Cash and cash equivalents at beginning of period 185,663 194,318 197,426
Cash and cash equivalents acquired in acquisitions -- -- 39,245
---------------------------------------
Cash and cash equivalents at end of period $ 121,500 $ 185,663 $ 194,318
=======================================
Supplemental disclosure:
Interest paid during the year $ 67,588 $ 68,020 $ 61,528
Income taxes paid during the year $ 23,234 $ 15,505 $ 16,269
Non-cash additions to other real estate owned (Note 1) $ -- $ 236 $ 220
Transfer from retained earnings to common stock
due to stock dividends $ -- $ -- $ 9,000
The accompanying notes are an integral part of these consolidated statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Pacific Capital Bancorp (the "Company") is a bank holding company organized
under the laws of California. The Company is the surviving corporation resulting
from the merger on December 30, 1998 of Santa Barbara Bancorp ("SBB") and the
former Pacific Capital Bancorp ("PCB"). The merger was accounted for as a
pooling of interests. Accordingly, all historical financial information has been
restated as if the merger had been in effect for all periods presented. To
recognize its newly expanded market areas, the Company assumed the name Pacific
Capital Bancorp.
Nature of Operations
Through its two principal subsidiaries, Santa Barbara Bank & Trust ("SBB&T") and
First National Bank of Central California ("FNB") the Company provides a full
range of commercial banking services to individuals and business enterprises.
The banking services include making commercial, leasing, consumer, and
commercial and residential real estate loans. Deposits are accepted for
checking, interest-bearing checking ("NOW"), money-market, savings, and time
accounts. The banks offer safe deposit boxes, travelers checks, money orders,
foreign exchange services, and cashiers checks. In addition to the services
provided at both banks, FNB offers Small Business Administration guaranteed
loans to its customers and SBB&T provides escrow services to its customers. A
wide range of wealth management services are offered through the Trust and
Investment Services divisions of SBBT and FNB. The offices of SBB&T are located
in Santa Barbara County and in western Ventura County. Offices of FNB are
located in the counties of Monterey and Santa Cruz. Offices in southern Santa
Clara County and San Benito County are maintained under the name South Valley
National Bank, an affiliate of FNB.
The Company's third subsidiary is Pacific Capital Commercial Mortgage Company
(formerly called "Sanbarco Mortgage Company"). Its primary business activities
are directed to brokering commercial real estate loans and servicing those loans
for a fee. While these activities are not material in relation to the
consolidated financial position or results, they were organized into a separate
company to limit possible risk exposure to the banks.
A fourth subsidiary, Pacific Capital Services Corporation, is inactive.
Basis of Presentation
The accounting and reporting policies of the Company and its subsidiaries are in
accordance with generally accepted accounting principles ("GAAP") in the United
States and conform to practices within the banking industry. The consolidated
financial statements include the accounts of the Company and its subsidiaries.
All significant intercompany balances and transactions are eliminated.
The preparation of consolidated financial statements in accordance with GAAP
requires Management to make certain estimates and assumptions which affect the
amounts of reported assets and liabilities as well as contingent assets and
liabilities as of the date of these financial statements. These estimates and
assumptions also affect the reported amounts of revenues and expenses during the
reporting period(s). Although Management believes these estimates and
assumptions to be reasonably accurate, actual results may differ.
Securities
The Company purchases securities with funds that are not needed for immediate
liquidity purposes and have not been lent to customers. These securities are
classified either as held-to-maturity or available-for-sale. This classification
is made at the time of purchase. Only those securities that the Company both
intends and is able to hold until their maturity may be classified as
held-to-maturity. Securities that might be sold prior to maturity because of
interest rate changes, to meet liquidity needs, or to better match the repricing
characteristics of funding sources are classified as available-for-sale. The
Company purchases no securities specifically for later resale at a gain and
therefore holds no securities that should be classified as trading securities.
The Company's securities that are classified as held-to-maturity are carried at
"amortized historical cost". This is the purchase price increased by the
accretion of discounts or decreased by the amortization of premiums using the
effective interest method. Discount is the excess of the face value of the
security over the cost and accretion of the discount increases the effective
yield for the security above the interest rate for its coupon. Premium is the
excess of cost over the face value of the security and amortization of the
premium reduces the yield for the security below the coupon rate. Discounts are
accreted and premiums are amortized over the period to maturity of the related
securities, or to earlier call dates, if appropriate. There is no recognition of
unrealized gains or losses for these securities.
The interest income from securities that are classified as available-for-sale is
recognized in the same manner as for securities that are classified as
held-to-maturity, including the accretion of discounts and the amortization of
premiums. However, unlike the securities that are classified held-to-maturity,
securities classified available-for-sale are reported on the consolidated
balance sheets at their fair value. Changes in the fair value of these
securities are not recognized as a gain or loss in the Company's statements of
income, but are instead reported net of the tax effect on the consolidated
balance sheets as a separate component of equity captioned "Accumulated other
comprehensive income." The changes in fair value are included as elements of
comprehensive income in the consolidated statements of comprehensive income.
Loans and Interest and Fees from Loans
Loans are carried at amounts advanced to the borrowers less principal payments
collected. Interest on loans is accrued on a simple interest basis. Loan
origination and commitment fees, offset by certain direct loan origination
costs, are deferred and recognized over the contractual life of the loan as an
adjustment to the interest earned. The net unrecognized fees represent unearned
revenue, and they are reported as reductions of the loan principal outstanding,
or as additions to the loan principal if the deferred costs are greater than
deferred fees.
Nonaccrual Loans: When a borrower is not making payments as contractually
required by the note, the Company must decide whether it is appropriate to
continue to accrue interest. Generally speaking, loans are placed in a
nonaccrual status, i.e., the Company stops accruing or recognizing interest
income on the loan, when the loan has become delinquent by more than 90 days.
The Company may decide that it is appropriate to continue to accrue interest on
some loans more than 90 days delinquent if they are well secured by collateral
and collection efforts are being actively pursued. Such loans are categorized as
nonperforming loans.
When a loan is placed in a nonaccrual status, any accrued but uncollected
interest for the loan is written off against interest income from other loans of
the same type in the period in which the status is changed. No further interest
income is recognized until all recorded amounts of principal are recovered in
full or until circumstances have changed such that payments are again
consistently received as contractually required.
Impaired Loans: A loan is identified as impaired when it is probable that
interest and principal will not be collected according to the contractual terms
of the loan agreement. Because this definition is very similar to that of a
nonaccrual loan, most impaired loans will be classified as nonaccrual. However,
there are some loans that are termed impaired because of doubt regarding
collectibility of interest and principal according to the contractual terms, but
which are presently both fully secured by collateral and are current in their
interest and principal payments. These impaired loans are not classified as
nonaccrual. Under generally accepted accounting principles, the term "impaired"
only applies to certain types or classes of loans and therefore, there are some
nonaccrual loans which are not categorized as impaired.
Allowance for Credit Losses
If a borrower's financial condition becomes such that he or she is not able to
fully repay a loan or lease obligation extended by the Company, a loss to the
Company has occurred. When the Company has determined that such a loss has
occurred, the principal amount of the loan, or a portion thereof, is charged-off
against an established allowance so that the value of the Company's assets are
not overstated by retaining an uncollectible loan at its outstanding balance.
However, because loan officers cannot be in daily contact with each borrower,
the Company almost never knows exactly when such a loss might have occurred.
Therefore, in order to fairly state the value of the loan and leasing
portfolios, it is necessary to make an estimate of the amount of loss inherent
but unrecognized in these credit portfolios prior to the realization of such
losses through charge-off.
Generally accepted accounting principles, banking regulations, and sound banking
practices require that the Company record this estimate of unrecognized losses
in the form of an allowance for credit losses. The allowance is increased by the
provision for credit losses which is a charge to income in the current period.
The allowance is decreased by the charge-off of loans net of any recoveries of
loans previously charged-off.
The allowance for credit losses consists of several components. The first is
that portion of the allowance specifically allocated to those loans that are
categorized as impaired under provisions of Statement of Financial Accounting
Standards No. 114, Accounting by Creditors for Impairment of a Loan ("SFAS
114"). The remaining components include a statistically allocated portion, a
specifically allocated portion, and an unallocated portion. These components are
reported together in the allowance for credit loss in the accompanying
consolidated balance sheets and in Note 4. Each of these components of the
allowance for credit losses is maintained at a level considered adequate to
provide for losses that can reasonably be anticipated. However, the allowance is
based on estimates, and ultimate losses may vary from the current estimates.
These estimates are reviewed periodically and, as adjustments become necessary,
they are reported as provisions against earnings in the periods in which they
become known.
Component for Impaired Loans: Under GAAP, the Company is permitted to determine
the valuation allowance for impaired loans on a loan-by-loan basis or by
aggregating loans with similar risk characteristics. Because the number of loans
classified as impaired is relatively small and because special factors apply to
each, the Company determines the valuation allowance for impaired loans on a
loan-by-loan basis.
The amount of the valuation allowance allocated to any particular impaired loan
is determined by comparing the recorded investment in each loan with its value
measured by one of three methods: (1) by discounting estimated future cash flows
at the effective interest rate; (2) by observing the loan's market price if it
is of a kind for which there is a secondary market; or (3) by valuing the
underlying collateral. A valuation allowance is established for any amount by
which the recorded investment exceeds the value of the impaired loan. If the
value of the loan, as determined by one of the above methods, exceeds the
recorded investment in the loan, no valuation allowance for that loan is
established.
Historical Loss Component: The statistical component of the allowance is
intended to provide for losses that occur in large groups of smaller balance
loans, the individual credit quality of which is impracticable to review at each
period end. The amount of this component is determined by applying loss
estimation factors to outstanding loans and leases. The loss factors are based
primarily on the Company's historical loss experience. Because historical loss
experience differs for the various categories of credits, the loss estimation
factors applied to each category also differ.
Component for Specific Credits: There are a number of credits for which an
allowance computed by application of the appropriate loss estimation factor
would not adequately provide for the unconfirmed loss inherent in the credit.
This might occur for a variety of reasons such as the size of the credit, the
industry of the borrower, or the terms of the credit. In these situations,
Management will increase the allocation to an amount adequate to absorb the
probable loss that will be incurred. The specific component is made up of the
sum of these specific allocations.
Unallocated Component: The unallocated component of the allowance for credit
losses is intended to absorb losses that may not be covered by the other
components. For example, the historical loss estimation factors used for
statistical allocation may not give sufficient weight to such considerations as
the current general economic and business conditions that affect the Company's
borrowers or to specific industry conditions that affect borrowers in that
industry. Additionally, the factors may not give sufficient weight to current
trends in credit quality and collateral values and the duration of the current
business cycle. Lastly, the factors are not derived in a manner that considers
loan volumes and concentrations and seasoning of the loan portfolio.
Complete information on the financial condition of the borrower and the current
disposal value of any collateral is not generally available at the time an
estimation of the loss must be made. This introduces significant uncertainty in
the estimation process used to determine the adequacy of specific allocations.
Income Taxes
The Company is required to use the accrual method of accounting for financial
reporting purposes as well as for tax return purposes. However, there are still
several items of income and expense that are recognized in different periods for
tax return purposes than for financial reporting purposes. Appropriate
provisions have been made in the financial statements for deferred taxes in
recognition of these temporary differences.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is charged against income over the estimated useful
lives of the assets. For most assets with longer useful lives, accelerated
methods of depreciation are used in the early years, switching to the
straight-line method in later years. Assets with shorter useful lives are
generally depreciated by straight-line method. Leasehold improvements are
amortized over the terms of the leases or the estimated useful lives of the
improvements, whichever is shorter. Generally, the estimated useful lives of
other items of premises and equipment are as follows:
Buildings and improvements 10-25 years
Furniture and equipment 5-7 years
Electronic equipment 3-5 years
Trust Fees
Fees for most trust services are based on the market value of customer assets,
and an estimate of the fees is accrued monthly. Fees for unusual or infrequent
services are recognized when the fee can be determined.
Earnings Per Share
Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS
128") became effective for the Company as of December 31, 1997. Earnings per
share for all periods presented in the Consolidated Statements of Income are
computed in accordance with the provisions of this statement, and are based on
the weighted average number of shares outstanding during each year retroactively
restated for stock dividends and stock splits.
Diluted earnings per share include the effect of common stock equivalents for
the Company, which include only shares issuable on the exercise of outstanding
options. The number of options assumed to be exercised is computed using the
"Treasury Stock Method." This method assumes that all options with an exercise
price lower than the end-of-period stock price have been exercised and that the
proceeds from the assumed exercise and the tax benefit received for the
difference between the market price and the exercise price would be used for
market repurchases of shares.
Upon implementation, SFAS 128 required the restatement of earnings per share for
all prior periods presented in the Company's financial statements. A
reconciliation of the computation of basic earnings per share and diluted
earnings per share is presented in Note 16.
Statement of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks, Federal funds sold, and securities purchased under agreements to
resell. Federal funds and securities purchased under agreements to resell are
one-day transactions, with the Company's funds being returned to it the next
day.
Postretirement Health Benefits
The Company provides eligible retirees with postretirement health care and
dental benefit coverage. These benefits are also provided to the spouses and
dependents of retirees on a shared cost basis. Benefits for retirees and spouses
are subject to deductibles, copayment provisions, and other limitations. The
expected cost of such benefits is charged to expense during the years that the
employees render service to the Company and thereby earn their eligibility for
benefits.
Other Real Estate Owned
Other real estate owned ("OREO") represents real estate acquired through
foreclosure or deed in lieu of foreclosure. OREO is carried at the lower of the
outstanding balance of the loan before acquisition or the fair value of the OREO
less estimated costs to sell. If the outstanding balance of the loan is greater
than the fair value of the OREO less estimated disposal costs at the time of the
acquisition, the difference is charged-off against the allowance for credit
losses. Any senior debt to which other real estate owned is subject is included
in the carrying amount of the property and an offsetting liability is reported
along with other borrowings.
During the time the property is held, all related operating or maintenance costs
are expensed as incurred and additional decreases in the fair value are charged
to other operating expense by establishing valuation allowances in the period in
which they become known. Expenditures related to improvements are capitalized to
the extent that they are realizable through increases in the fair value of the
properties. Increases in the fair value may be recognized as reductions of OREO
operating expense to the extent that they represent recoveries of amounts
previously written-down. Increases in market value in excess of the fair value
at the time of foreclosure are recognized only when the property is sold.
At December 31, 1999 and 1998, the Company held real estate properties that had
been acquired through foreclosure, but the value of the property and the
estimated disposal costs were so uncertain that no amount is reported on the
balance sheet for that date.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation ("SFAS 123") became effective January 1, 1996. Under the accounting
method that had been in effect prior to the effective date of this statement, if
options were granted at an exercise price equal to the market value of the stock
at the time of the grant, no compensation expense was recognized. SFAS 123
established a second accounting method for employee stock options under which
issuers record compensation expense over the period they are expected to be
outstanding prior to exercise, expiration, or cancellation. The amount of
compensation expense to be recognized over this term is the "fair value" of the
options at the time of the grant as determined by an option pricing model. The
option pricing model attributes fair value to the options based on the length of
their term, the volatility of the stock price in past periods, and other
factors. Under this method, the Company would recognize compensation expense
regardless of whether the officer or director exercised the options. In SFAS
123, the FASB has indicated its preference for the new method. However, the
statement permits entities to retain the prior method. The Company believes that
the prior method better reflects the motivation for its issuance of stock
options, namely, that they are incentives for future performance rather than
compensation for past performance. Therefore, in adopting SFAS 123 on January 1,
1996, the Company chose to continue to account for its stock option plans in
accordance with the prior method. SFAS 123 requires entities that elect to
retain the prior method to present pro forma disclosures of net income and
earnings per share as if the new method had been applied. The Company presents
these disclosures in Note 16.
Derivative Financial Instruments
Interest rate swaps and interest rate caps and floors may be used to manage the
Company's exposure to interest rate risks. These instruments are specifically
allocated to the assets or liabilities being managed and are recorded in the
financial statements at cost. Net interest income or expense, including premiums
paid or received, is recognized over the effective period of the contract and
reported as an adjustment to interest income or expense. The Company currently
holds interest rate swaps with a notional amount of $34 million.
Goodwill
In connection with the acquisitions of First Valley Bank ("FVB") and Citizens
State Bank ("CSB") as described in Note 19, the Company recognized the excess of
the purchase price over the estimated fair value of the assets received and
liabilities assumed as goodwill. The goodwill is being amortized on the
straight-line method over 15 years. Goodwill was also recognized as a result of
the acquisition of several branches. The unamortized carrying amount of the
goodwill recorded for each acquisition is periodically reviewed by Management in
order to determine if facts and circumstances suggest that it is not
recoverable. This is determined based on expected undiscounted cash flows from
the net assets of the acquired entity, and consequently goodwill for the entity
would be reduced by the estimated cash flow deficiency. No such deduction in
goodwill occurred as of December 31, 1999 and 1998.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income ("SFAS 130") requires that comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. Net income is one component of comprehensive income. The
other components of comprehensive income are revenues, expenses, gains, and
losses that impact the Company's capital accounts but are not recognized in net
income under GAAP. Based on the Company's current activities, other components
of comprehensive net income consist only of changes in the unrealized gains or
losses on securities that are classified as available-for-sale.
The amounts of comprehensive income for the three years ended December 31, 1999,
1998 and 1997 are reported in the Consolidated Statements of Comprehensive
Income. The net change in the cumulative total of the components of other
comprehensive income that are included in equity are reported in the
Consolidated Statements of Changes in Shareholders' Equity for the three years
ended December 31, 1999, 1998 and 1997.
Segment Reporting
Financial Accounting Standard No. 131, Disclosures About Segments of an
Enterprise and Related Information ("SFAS 131"), adopts a new model for segment
reporting, called the "management approach". The management approach is based on
the segments within a company used by the chief operating decision maker for
making operating decisions and assessing performance. Reportable segments are to
be based on such factors as products and services, geography, legal structure,
management structure or any manner by which a company's management distinguishes
major operating units. For purposes of SFAS 131, Management has determined that
the Company has seven reportable segments: Wholesale Lending, Retail Lending,
Branch Activities, Fiduciary, Tax Refund Processing, Northern Region and All
Other. The basis for this determination and the required disclosure is included
in Note 20.
Recent Accounting Pronouncements
In June of 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 133, Accounting for Derivative
Instruments and Hedging Activities ("SFAS 133"). This standard establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions are
met, a derivative may be specifically designated as a hedge, which triggers
specific accounting treatment based on the type of hedge that exists. A
subsequent statement issued by the FASB requires that the Company adopt SFAS 133
no later than the first quarter of 2001, but may adopt earlier. The Company has
not yet determined when it will adopt the statement. Because it does not now
hold nor expect to hold in the foreseeable future a significant number of
derivative instruments, Management does not anticipate that adoption will result
in any material impact to the Company's financial position or results of
operations.
Accounting for Business Combinations
The merger of SBB with PCB (Note 19) was accounted for as a pooling of
interests. Under this method of accounting for a business combination, the
assets and liabilities of the two parties were added together for each year
presented in the financial statements. The effect of this presentation is as if
the merger had occurred as of the beginning of the earliest period presented.
The assets and liabilities were combined at the amounts carried in the
predecessor company records; there is no restatement to their fair market value,
and consequently no goodwill recognized.
The acquisitions of FVB and CSB (Note 19) were accounted for by the purchase
method of accounting for business combinations. Under this method, the assets
and liabilities of the acquired company are combined with the acquirer as of the
date of the acquisition at their fair market value. Any difference between the
net value of the assets and liabilities and the purchase price is recorded as
goodwill. Goodwill is amortized against future earnings. The results of
operations of the acquired company are included with those of the acquirer only
from the transaction date forward.
Reclassifications
Certain amounts in the 1998 and 1997 financial statements have been reclassified
to be comparable with classifications used in the 1999 financial statements.
2. SECURITIES
A summary of securities owned by the Company at December 31, 1999 and 1998, is
as follows:
December 31, 1999
--------------------------------------------------------
(in thousands) Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------
Held-to-maturity:
U.S. Treasury obligations $ 35,043 $ 64 $ (40) $ 35,067
U.S. agency obligations 12,502 -- (87) 12,415
Mortgage-backed securities 556 8 (1) 563
State and municipal securities 105,163 6,235 (293) 111,105
-------------------------------------------------------
153,264 6,307 (421) 159,150
-------------------------------------------------------
Available-for-sale:
U.S. Treasury obligations 121,701 49 (691) 121,059
U.S. agency obligations 177,985 -- (2,197) 175,788
Collateralized mortgage obligations 172,333 21 (4,849) 167,505
Asset-backed securities 10,979 7 (114) 10,872
State and municipal securities 44,901 42 (3,390) 41,553
Equity securities 11,649 -- -- 11,649
-------------------------------------------------------
539,548 119 (11,241) 528,426
-------------------------------------------------------
$692,812 $ 6,426 $(11,662) $687,576
=======================================================
December 31, 1998
-------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------------------------------------------------
Held-to-maturity:
U.S. Treasury obligations $ 57,872 $ 946 $ -- $ 58,818
U.S. agency obligations 22,491 218 -- 22,709
Mortgage-backed securities 715 22 (4) 733
State and municipal securities 113,691 15,483 (42) 129,132
-------------------------------------------------------
194,769 16,669 (46) 211,392
-------------------------------------------------------
Available-for-sale:
U.S. Treasury obligations 147,378 3,112 -- 150,490
U.S. agency obligations 175,780 1,798 (85) 177,493
Collateralized mortgage obligations 217,823 1,634 (302) 219,155
Asset-backed securities 13,849 45 -- 13,894
State and municipal securities 26,333 564 (19) 26,878
Equity securities 9,086 -- -- 9,086
-------------------------------------------------------
590,249 7,153 (406) 596,996
-------------------------------------------------------
$785,018 $23,822 $ (452) $808,388
=======================================================
The amortized cost and estimated fair value of debt securities at December 31,
1999 and 1998, by contractual maturity, are shown in the next table. Expected
maturities will differ from contractual maturities because issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
December 31, 1999 December 31, 1998
---------------------------------- ----------------------------------
(in thousands) Held-to- Available- Held-to- Available-
Maturity for-Sale Total Maturity for-Sale Total
---------------------------------- ----------------------------------
Amortized cost:
In one year or less $ 59,920 $ 92,661 $ 152,581 $ 46,931 $ 128,259 $ 175,190
After one year through five years 48,445 376,113 424,558 97,704 371,370 469,074
After five years through ten years 7,080 24,277 31,357 10,973 62,809 73,782
After ten years 37,819 34,848 72,667 39,161 18,725 57,886
Equity securities -- 11,649 11,649 -- 9,086 9,086
---------------------------------- ----------------------------------
$ 153,264 $ 539,548 $ 692,812 $ 194,769 $ 590,249 $ 785,018
================================== ==================================
Estimated market value:
In one year or less 60,466 92,524 152,990 47,222 128,853 176,075
After one year through five years 51,264 369,999 421,263 103,525 376,919 480,444
After five years through ten years 7,778 22,889 30,667 13,664 63,236 76,900
After ten years 39,642 31,365 71,007 46,981 18,902 65,883
Equity securities -- 11,649 11,649 -- 9,086 9,086
---------------------------------- ----------------------------------
$ 159,150 $ 528,426 $ 687,576 $ 211,392 $ 596,996 $ 808,388
================================== ==================================
The proceeds received from sales or calls of debt securities and the gross gains
and losses that were recognized for the years ended December 31, 1999 and 1998
are shown in the next table.
------------------------------- ------------------------------- --------------------------------
Gross Gross Gross Gross Gross Gross
Proceeds Gains Losses Proceeds Gains Losses Proceeds Gains Losses
-------------------------------------------------------------------------------------------------
Held-to-maturity:
Sales $ -- $ -- $ -- $ 7,490 $ 8 $ -- $ 7,734 $ -- $ (1)
Calls $ 6,662 $ -- $ -- $ 1,670 $ 2 $ (20) $ 2,418 $ -- $ --
Available-for-sale:
Sales $ 19,674 $ -- $(286) $61,450 $ 349 $(144) $ 117,003 $ 54 $(471)
Calls $ 63,340 $ -- $ -- $51,149 $ 12 $ -- $ 22,273 $ -- $ --
After a significant business combination, GAAP permits a company to reclassify
held-to-maturity securities as available-for-sale securities at the time of
purchase, if that action will maintain the holder's interest rate risk profile.
The maturity characteristics of the FVB portfolio were such that when combined
with the Company's portfolio, risks from changes in interest rates were not
within the Company's acceptable risk parameters. Therefore, the Company
reclassified some of its held-to-maturity securities to available-for-sale as a
consequence of the FVB acquisition and subsequently sold them.
SBB&T and FNB are members of the Federal Reserve Bank. As a condition of
membership, they are required to purchase Federal Reserve Bank ("FRB") stock.
The amount of stock required to be held is based on their capital accounts.
Subsequently, as the banks' capital has increased, they have been required to
purchase additional shares. SBB&T also acquired the shares owned by Citizens
State Bank in the transaction described in Note 19. SBB&T is a member of the
Federal Home Loan Bank ("FHLB"), and purchased stock as required of members. The
FRB and FHLB stock are reported as equity securities. Since the stock has no
maturity, it is classified as available-for-sale, even though the Bank is
required to hold the stock so long as it maintains its membership in these
organizations.
Securities with a book value of approximately $557.5 million at December 31,
1999 and $255.0 million at December 31, 1998 were pledged to secure public
funds, trust deposits and other borrowings as required or permitted by law.
3. LOANS
The loan portfolio consists of the following:
(in thousands) December 31
1999 1998
--------------------------------
Real estate loans:
Residential $ 484,562 $ 368,306
Non-residential 435,913 477,120
Construction and development 171,870 109,764
Commercial, industrial, and agricultural 577,407 362,262
Home equity lines 49,902 47,123
Consumer 148,051 123,730
Leases 93,322 78,627
Municipal tax-exempt obligations 12,530 9,286
Other 8,322 6,563
--------------------------------
$1,981,879 $1,582,781
================================
The amounts above are shown net of deferred loan origination, commitment, and
extension fees and origination costs of $4,781,000 for 1999 and $4,624,000 for
1998.
Impaired Loans
The table below discloses information about the loans classified as impaired and
the valuation allowance related to them:
(in thousands) December 31
1999 1998
-------------------------------
Loans identified as impaired $ 9,496 $ 3,286
Impaired loans for which a valuation
allowance has been determined $ 8,221 $ 1,574
Impaired loans for which no valuation
allowance has been determined $ 1,275 $ 1,712
Amount of valuation allowance $ 3,726 $ 98
Year Ended December 31
1999 1998
-------------------------------
Average amount of recorded investment
in impaired loans for the year $ 8,654 $ 5,229
Interest recognized during the year for
loans identified as impaired at year-end $ -- $ --
Interest received in cash during the year for
loans identified as impaired at year-end $ 1,293 $ 132
As indicated in Note 1, a valuation allowance is established for an impaired
loan when the fair value of the loan is less than the recorded investment. As
shown above, no valuation allowance has been determined for the loans totaling
$1.3 million at December 31, 1999 for which market value exceeds the recorded
investment. The valuation allowance amounts disclosed above are included in the
allowance for credit loss reported in the balance sheets for December 31, 1999
and 1998 and in Note 4.
Refund Anticipation Loans
The Company offers tax refund anticipation loans ("RALs") to taxpayers desiring
to receive advance proceeds based on their anticipated income tax refunds. The
loans are repaid when the Internal Revenue Service later sends the refund to the
Company. The funds advanced are generally repaid within several weeks.
Therefore, processing costs represent the major cost of the loan. This contrasts
to other loans for which the cost of funds is the major cost to the Company.
Because of their short duration, the Company cannot recover the processing costs
through interest calculated over the term of the loan. Consequently, the Company
has a tiered fee schedule for this service that varies by the amount of funds
advanced based on the increased credit rather than the length of time that the
loan is outstanding. Nonetheless, because a loan document is signed by the
customer, the Company is required to report the fees as interest income. These
fees totaled $8,081,000 for 1999, $6,818,000 for 1998, and $7,422,000 for 1997.
The loans are all made during the tax filing season of January through April of
each year. Any loans for which repayment has not been received within 90 days
from the expected payment date are charged off. Consequently, there were no
RAL's included in the above table of outstanding loans at December 31, 1999 or
1998.
4. ALLOWANCE FOR CREDIT LOSSES
The following summarizes the changes in the allowance for credit losses:
(in thousands) Year Ended December 31
1999 1998 1997
------------------------------------------
Balance, beginning of year $29,296 $25,414 $20,244
Tax refund anticipation loans:
Provision for credit losses 2,816 4,941 4,649
Recoveries on loans previously charged-off 2,857 2,288 1,524
Loans charged-off (5,518) (7,221) (5,946)
All other loans:
Allowance for credit loss recorded in
acquisition transaction -- -- 794
Provision for credit losses 3,527 4,182 3,851
Recoveries on loans previously charged-off 2,467 3,719 3,900
Loans charged-off (6,759) (4,027) (3,602)
------------------------------------------
Balance, end of year $28,686 $29,296 $25,414
==========================================
The ratio of losses to total loans for the RALs is higher than for other loans.
For RALs, the provision for credit loss, the loans charged-off, and the loans
recovered are reported separately from the corresponding amounts for all other
loans.
5. CASH AND DUE FROM BANKS
All depository institutions are required by law to maintain reserves with the
Federal Reserve Bank ("FRB") on transaction deposits. Amounts vary each day as
the FRB permits banks to meet this requirement by maintaining the specified
amount as an average balance over a two week period. In addition, the banks must
maintain sufficient balances at the FRB to cover the checks written by bank
customers that are clearing through the FRB because they have been deposited at
other banks. The average daily cash reserve balances maintained by SBB&T and FNB
at the FRB totaled approximately $3.3 million in 1999 and $1.1 million in 1998.
6. PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
(in thousands) December 31
1999 1998
----------------------------
Land $ 5,025 $ 5,025
Buildings and improvements 19,674 19,147
Leasehold improvements 12,196 9,150
Furniture and equipment 39,190 35,594
----------------------------
Total cost 76,085 68,916
Accumulated depreciation
and amortization (40,910) (39,000)
----------------------------
Net book value $35,175 $29,916
============================
Depreciation and amortization on fixed assets included in other operating
expenses totaled $5,150,000 in 1999, $5,848,000 in 1998, and $4,459,000 in 1997.
7. DEPOSITS
Deposits and the related interest expense consist of the following:
Interest Expense for the
(in thousands) Balance as of December 31 Year Ended December 31
1999 1998 1999 1998 1997
-----------------------------------------------------------------
Noninterest bearing deposits $ 546,193 $ 498,266 $ -- $ -- $ --
Interest bearing deposits:
NOW accounts 314,910 298,352 2,029 3,091 2,667
Money market deposit accounts 577,676 568,010 17,722 18,804 18,596
Other savings deposits 191,741 215,330 3,792 5,156 4,533
Time certificates of $100,000
or more 404,735 323,676 17,274 21,731 12,298
Other time deposits 404,926 426,042 20,483 15,988 18,488
----------------------------- --------------------------------
$2,440,181 $2,329,676 $61,300 $64,770 $56,582
============================= ================================
8. INCOME TAXES
The provisions (benefits) for income taxes related to operations and the tax
benefit related to stock options that is credited directly to shareholders'
equity are as follows:
(in thousands) Year Ended December 31
1999 1998 1997
-------------------------------------------
Federal:
Current $ 18,350 $ 15,930 $ 13,380
Deferred (1,842) (2,466) (2,134)
-------------------------------------------
16,508 13,464 11,246
-------------------------------------------
State:
Current 8,109 5,837 5,673
Deferred (250) (326) (631)
-------------------------------------------
7,859 5,511 5,042
-------------------------------------------
Total tax provision $24,367 18,975 16,288
===========================================
Reduction in taxes payable associated with
exercises of stock options $ (3,611) $ (4,934) $ (3,694)
The total current provision for income taxes includes provisions (credits) of
($120,000), ($90,000) and $166,000 for net securities gains and losses realized
in 1999, 1998, and 1997, respectively.
Although not affecting the total provision, actual income tax payments may
differ from the amounts shown as current provision as a result of the final
determination as to the timing of certain deductions and credits.
The total tax provision differs from the Federal statutory rate of 35 percent
for the reasons shown in the following table.
Year Ended December 31
1999 1998 1997
--------------------------------------
Tax provision at Federal statutory rate 35.0% 35.0% 35.0%
Interest on securities exempt from Federal taxation (5.2) (7.5) (6.9)
State income taxes, net of Federal income tax benefit 8.9 8.1 6.9
ESOP dividends deductible as an expense for tax purposes (0.7) (0.8) (0.7)
Goodwill amortization 0.9 1.3 0.7
Merger related costs -- 3.5 --
Other, net (3.4) (0.5) --
--------------------------------------
Actual tax provision 35.5% 39.1% 35.0%
======================================
As disclosed in the following table, deferred tax assets as of December 31, 1999
and 1998, totaled $21,758,000 and $11,741,000, respectively. These amounts are
included within other assets on the balance sheet. The deferred tax provision or
benefit disclosed in the first table of this note is equal to the sum of the
changes in the tax effects of the temporary differences. The changes in the tax
effects for the principal temporary differences for the years ending December
31, 1999 and 1998 are also disclosed in the following table.
Tax Tax
(in thousands) Components Effect Components Effect Components
1999 1999 1998 1998 1997
------------------------------------------------------------
Deferred tax assets:
Allowance for credit losses $11,717 $ (325) $12,042 $1,935 $10,107
State taxes 2,236 983 1,253 (535) 1,788
Loan fees 509 202 307 (326) 633
Depreciation 1,006 434 572 379 193
Postretirement benefits 745 (35) 780 98 682
Other real estate owned 25 (17) 42 25 17
Nonaccrual interest 354 2 352 (279) 631
Accretion on securities 77 230 (153) 58 (211)
Accrued salary continuation plan 1,820 (84) 1,904 1,904 --
Change in control payments 1,099 (140) 1,239 1,239 --
Other 256 (402) 658 158 500
------------------------------------------------------------
19,844 848 18,996 4,656 14,340
------------------------------------------------------------
Deferred tax liabilities:
Loan costs 1,506 244 1,262 393 869
Federal effect of state tax asset 1,104 (88) 1,192 602 590
Other 150 (1,400) 1,550 1,084 466
------------------------------------------------------------
Total deferred tax liabilities 2,760 (1,244) 4,004 2,079 1,925
------------------------------------------------------------
Net deferred tax asset
before unrealized gains and
losses on securities 17,084 2,092 14,992 2,577 12,415
Unrealized (gains) and losses
on securities 4,675 (3,251) (1,302)
------------------------------------------------------------
Net deferred tax asset $21,759 $2,092 $11,741 $2,577 $11,113
============================================================
As mentioned in Note 1, the net unrealized gain or loss on securities that are
available for sale is included as a component of equity. This amount is reported
net of the related tax effect. The tax effect is a deferred tax asset if there
is a net unrealized loss and a deferred tax liability if there is a net
unrealized gain. However, because changes in the unrealized gains or losses are
not recognized either in net income or in taxable income, they do not represent
temporary differences. Consequently, the change in the tax effect of the net
unrealized gain or loss is not included as a component of deferred tax expense
or benefit, and there is no entry in the columns labeled "Tax Effect" in the
table above for the change.
The Company is permitted to recognize deferred tax assets only to the extent
that they are able to be used to reduce amounts that have been paid or will be
paid to tax authorities. This is reviewed each year by Management by comparing
the amount of the deferred tax assets with amounts paid in the past that might
be recovered by carryback provisions in the tax code and with anticipated
taxable income expected to be generated from operations in the future. If it
does not appear that the deferred tax assets are usable, a valuation allowance
is established to acknowledge their uncertain value. Management believes a
valuation allowance is not needed to reduce any deferred tax asset because there
is sufficient taxable income within the carryback periods to realize all
material amounts.
9. SHAREHOLDERS' EQUITY
The Company's stock option plans offer key employees and directors an
opportunity to purchase shares of the Company's common stock. Subsequent to the
merger of SBB with PCB, the Company initially had seven stock option plans, four
that had been established at SBB and three that had been established at PCB.
During 1999, the three PCB plans were merged into the SBB plans.
The first of the remaining plans is the Directors Stock Option Plan established
in 1996. Only non-qualified options may be granted under this plan. The second
is the Restricted Stock Option Plan for employees established in January, 1992.
Either incentive or non-qualified options may be granted under this plan. Under
the original provisions of these plans, stock acquired by the exercise of
options granted under the plans could not be sold for five years after the date
of the grant or for two years after the date options are exercised, whichever is
later. In 1998, the Board of Directors of the Company eliminated this provision.
The third and fourth plans were established in 1983 and 1986 for employees and
directors, respectively. All options approved under these plans have been
granted as non-qualified options, and the plans are active now only for the
exercise of options held by employees and directors.
All options outstanding in these plans were granted with an option price set at
100% of the market value of the Company's common stock on the date of the grant.
The grants for most of the employee options specify that they are exercisable in
cumulative 20% annual installments and will expire five years from the date of
grant. The Board has granted some options which are exercisable in cumulative
10% annual installments and expire ten years from the date of grant. The options
granted under the directors' plan are exercisable after six months.
The option plans permit employees and directors to pay the exercise price of
options they are exercising and the related tax liability with shares of Company
stock they already own. The owned shares are surrendered to the Company at
current market value. Shares with a current market value of $6,747,000,
$2,602,000, and $4,282,000 were surrendered in the years ended December 31,
1999, 1998, and 1997, respectively. These surrendered shares are netted against
the new shares issued for the exercise of stock options in the Consolidated
Statements of Changes in Shareholders' Equity.
The following table presents information relating to all of the stock option
plans as of December 31, 1999, 1998, and 1997 (adjusted for stock splits and
stock dividends).
Per Share
Options Price Ranges
------------- ------------------
1999
Granted 548,656 $22.81 to $33.55
Exercised 648,756 $5.17 to $28.71
Cancelled and expired 2,317 $8.48 to $28.71
Outstanding at end of year 1,512,997 $5.17 to $33.55
Range of expiration dates 4/20/00 to 8/23/09
Exercisable at end of year 751,913 $5.17 to $28.71
Shares available for future grant 101,270
1998
Granted 124,476 $23.44 to $28.71
Exercised 998,709 $5.17 to $23.44
Cancelled and expired 38,909 $6.33 to $28.00
Outstanding at end of year 1,615,414 $5.17 to $28.71
Exercisable at end of year 1,098,243 $5.17 to $28.25
1997
Granted 879,209 $13.88 to $23.44
Exercised 590,769 $4.61 to $18.25
Cancelled and expired 58,393 $4.61 to $20.66
Outstanding at end of year 2,528,556 $5.17 to $23.44
Exercisable at end of year 1,585,090 $5.17 to $18.25
10. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND FEDERAL FUNDS PURCHASED
The Company enters into certain transactions, the legal form of which is a sale
of securities under an agreement to repurchase at a later date at a set price.
The substance of these transactions is a secured borrowing by the Company. The
Company also purchased Federal funds from correspondent banks. The following
information is presented concerning these transactions:
(dollars in thousands) Repurchase Agreements Federal Funds Purchased
Year Ended December 31 Year Ended December 31
1999 1998 1997 1999 1998 1997
-------------------------------------------------------------------------------
Weighted average interest
rate at year-end 5.27% 3.75% 4.57% 5.50% 4.50% 6.25%
Weighted average interest
rate for the year 4.66% 4.44% 4.54% 4.94% 5.22% 5.29%
Average outstanding
for the year $29,214 $13,884 $22,659 $ 8,091 $ 9,236 $ 9,149
Maximum outstanding
at any month-end
during the year $61,085 $18,772 $32,216 $35,100 $16,400 $21,485
Amount outstanding
at end of year $45,407 $17,996 $14,813 $35,100 $ 9,800 $ 6,480
Interest expense $ 1,361 $ 616 $ 1,028 $ 400 $ 482 $ 484
11. LONG-TERM DEBT AND OTHER BORROWINGS
As part of the Company's asset and liability management strategy, fixed rate
term advances are borrowed from the FHLB. As of December 31, 1999, total
outstanding balances to the FHLB were $85,000,000. The scheduled maturities of
the advances are $6,000,000 in 1 year or less, $16,400,000 in 1 to 3 years, and
$62,600,000 in more than 3 year.
Also included in other borrowings are $13,801,000 million of Treasury Tax and
Loan demand notes issued to the U.S. Treasury and miscellaneous other
borrowings.
During the course of 1999 and 1998, the Company borrowed funds for liquidity
purposes from the discount window at the Federal Reserve Bank.
12. OTHER OPERATING INCOME AND EXPENSE
Significant items included in amounts reported in the Consolidated Statements of
Income for the years ended December 31, 1999, 1998, and 1997 for other service
charges, commissions, and fees are listed in the table below. The refund
transfer fees are earned for the electronic transmission of tax refunds to
customers to facilitate earlier receipt of their refund.
(in thousands) December 31,
1999 1998 1997
----------------------------------------------
Noninterest income
Merchant credit card processing $ 5,898 $ 3,952 $ 3,200
Trust fees $13,095 $11,676 $10,089
Refund transfer fees $ 6,591 $ 4,821 $ 2,943
Noninterest expense
Marketing $ 2,966 $ 3,028 $ 2,990
Consultants $10,227 $ 7,575 $ 3,364
Merchant credit card clearing fees $ 4,396 $ 2,878 $ 2,116
The table above also discloses the largest items included in other operating
expense. Consultants include the Company's independent accountants, attorneys,
and other management consultants used for special projects. An increase in
consulting expense occurred in 1998 compared to 1997 because of the merger with
PCB and in 1999 compared with 1998 because of the Company's Y2K effort and the
data system conversion for the merger.
13. EMPLOYEE BENEFIT PLANS
At the time of the merger, both SBB and PCB had an Employee Stock Ownership Plan
("ESOP") and each also had a second profit-sharing plan. The plans were combined
during 1999 with the PCB plans .
The remaining ESOP was initiated in January 1985. As of December 31, 1999 the
ESOP held 1,564,000 shares at an average cost of $8.12 per share.
The remaining profit-sharing plan has two components. The Salary Savings Plan
component is authorized under Section 401(k) of the Internal Revenue Code. An
employee may defer up to 10% of pre-tax salary in the plan up to a maximum
dollar amount set each year by the Internal Revenue Service. The Company matches
100% of the first 3% of the employee's compensation that the employee elects to
defer and 50% of the next 3%, but not more than 4.5% of the employee's total
compensation. In 1999, 1998, and 1997, the employer's matching contributions
were $1,272,000, $1,036,000, and $856,000, respectively. The other component is
the Incentive & Investment Plan. It was established in 1966, and permits
contributions by the Company to be invested in various mutual funds chosen by
the employees.
The Company's practice has been to make total contributions to the employee
benefit plans equal to the smaller of (1) 10% of pre-tax profits prior to this
employer contribution, or (2) the amount deductible in the Company's current
year tax return. Deductions for contributions to qualified plans are limited to
15% of eligible compensation. In each of the last three years, the deductible
amount was the limiting factor for the contribution. After providing for the
Company's contribution to the Retiree Health Plan discussed in Note 15 and the
matching contribution to the Salary Savings Plan, the remaining contribution may
be made either to the ESOP or to the Incentive & Investment Plan.
Total contributions by the Company to the above profit sharing plans were
$2,879,000 in 1999, $2,789,000 in 1998, and $3,269,000 in 1997. Aside from the
employer's matching contribution to the Salary Saving Plan, the contributions
went to the ESOP in 1999, 1998 and 1997.
14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
GAAP requires companies to disclose the fair value of those financial
instruments for which it is practicable to estimate that value and the methods
and significant assumptions used to estimate those fair values. This must be
done irrespective of whether or not the instruments are recognized on the
balance sheets of the Company.
There are several factors which users of these financial statements should keep
in mind regarding the fair values disclosed in this note. First, there are
uncertainties inherent in the process of estimating the fair value of financial
instruments. Secondly, the Company must exclude from its estimate of the fair
value of deposit liabilities any consideration of its on-going customer
relationships which provide stable sources of investable funds.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash and Cash Equivalents
The face value of cash, Federal funds sold, and securities purchased under
agreements to resell are their fair value.
Securities and money market instruments
For securities, bankers' acceptances and commercial paper, fair value equals
quoted market price, if available. If a quoted market price is not available,
fair value is estimated using quoted market prices for similar securities. As
explained in Note 1, securities classified as available-for-sale are carried at
fair value.
Loans
The fair value of loans is estimated by discounting the future contractual cash
flows using the current rates at which similar loans would be made to borrowers
with similar credit ratings and for the same remaining maturities. These
contractual cash flows are adjusted to reflect estimates of uncollectible
amounts.
Deposit liabilities
The fair value of demand deposits, money market accounts, and savings accounts
is the amount payable on demand as of December 31 of each year. The fair value
of fixed-maturity certificates of deposit is estimated using the rates currently
offered for deposits of similar remaining maturities.
Repurchase agreements, Federal funds purchased, and other borrowings
For short-term instruments, the carrying amount is a reasonable estimate of
their fair value. For FHLB advances, the only component of debt not considered
short-term, the fair value is estimated using rates currently quoted by the FHLB
for advances of similar remaining maturities.
Standby letters of credit, and financial guarantees written
The fair value of guarantees and letters of credit is based on fees currently
charged for similar agreements. The Company does not believe that its loan
commitments have a fair value within the context of this note because generally
fees have not been charged, the use of the commitment is at the option of the
potential borrower, and the commitments are being written at rates comparable to
current market rates.
The carrying amount and estimated fair values of the Company's financial
instruments as of December 31, 1999 and 1998 are as follows:
As of December 31, 1999 As of December 31, 1998
Carrying Fair Carrying Fair
(in thousands) Amount Value Amount Value
-------------------------------------------------------------
Financial assets:
Cash and due from banks $ 121,500 $ 121,500 $ 114,206 $ 114,206
Federal funds sold -- -- 69,890 69,890
Money market funds -- -- 1,567 1,567
Securities available-for-sale 528,426 528,426 596,996 596,996
Securities held-to-maturity 153,264 159,150 194,769 211,392
Bankers' acceptances and
commercial paper -- -- 19,888 19,924
Net loans 1,953,193 1,910,594 1,553,485 1,558,344
Total financial assets $2,756,383 $2,719,670 $2,550,801 $2,572,319
Financial liabilities:
Deposits $2,440,181 $2,419,457 $2,329,676 $2,333,224
Repurchase agreements,
Federal funds purchased,
and other borrowings 179,308 178,147 72,749 73,680
Total financial liabilities $2,619,489 $2,597,604 $2,402,425 $2,406,904
Unrecognized financial
instruments:
Interest rate swap contracts $ -- $ 321 $ -- $ --
Standby letters of credit $ -- $ 20,811 $ -- $ 21,782
15. OTHER POSTRETIREMENT BENEFITS
Under the provisions of the Retiree Health Plan (the "Plan"), all eligible
retirees may purchase health insurance coverage through the Company. The cost of
this coverage is that amount which the Company pays under the basic coverage
plan provided for current employees. Based on a formula involving date of
retirement, age at retirement, and years of service prior to retirement, the
Plan provides that the Company will contribute a portion of the cost for the
retiree, varying from 60% to 100% at the time the employee retires, with the
stipulation that the cost of the portion paid by the Company shall not increase
by more than 5% per year. The Company recognizes the net present value of the
estimated future cost of providing health insurance benefits to retirees under
the Retiree Health Plan as those benefits are earned rather than when paid.
The Accumulated Postretirement Benefit Obligation
The commitment the Company has made to provide these benefits results in an
obligation that must be recognized in the financial statements. This obligation,
the accumulated postretirement benefit obligation ("APBO"), is the actuarial net
present value of the obligation for 1) fully eligible plan participants'
expected postretirement benefits and 2) the portion of the expected
postretirement benefit obligation earned to date by current employees.
This obligation must be re-measured each year because it changes with each of
the following factors: 1) the number of employees working for the Company; 2)
the average age of the employees working for the Company; 3) increases in
expected health care costs; and 4) prevailing interest rates. In addition,
because the obligation is measured on a net present value basis, the passage of
each year brings the eventual payment of benefits closer, and therefore causes
the obligation to increase. The following tables disclose the reconciliation of
the beginning and ending balances of the APBO, the reconciliation of beginning
and ending balances of the fair value of the plan assets, and the funding status
of the Plan as of December 31, 1999, 1998, and 1997:
(in thousands) Year Ended December 31
1999 1998 1997
----------------------------------------------
Benefit obligation, beginning of year $(4,170) $ (3,666) $ (3,153)
Service cost (315) (274) (188)
Interest cost (270) (253) (223)
Actuarial (losses) gains 111 (28) (159)
Benefits paid 60 51 57
----------------------------------------------
Benefit obligation, end of year (4,584) (4,170) (3,666)
----------------------------------------------
Fair value of Plan assets, beginning of year 4,486 4,081 3,208
Actual return on Plan assets 2,305 265 895
Employer contribution -- 191 35
Benefits paid (60) (51) (57)
----------------------------------------------
Fair value of Plan assets, end of year 6,731 4,486 4,081
----------------------------------------------
Funded Status 2,147 316 415
Unrecognized net actuarial gain (2,867) (771) (848)
Unrecognized prior service cost 1 2 4
----------------------------------------------
Accrued benefit cost $ (719) $ (453) $ (429)
==============================================
Costs of $623,000 for December 31, 1999 and $453,000 for December 31, 1998 are
included within the category for accrued interest payable and other liabilities
in the consolidated balance sheets.
The Components of the Net Periodic Postretirement Benefit Cost
Each year the Company recognizes a portion of the change in the APBO. This
portion is called the net periodic postretirement benefit cost (the "NPPBC").
The NPPBC, included with the cost of other benefits in the Consolidated
Statements of Income, is made up of several components as shown in the next
table.
(in thousands) Year Ended December 31
1999 1998 1997
---------------------------------------
Service cost $ 315 $ 274 $ 188
Interest cost 270 253 223
Return on assets (296) (279) (205)
Amortization cost (24) (34) 1
---------------------------------------
Net periodic postretirement cost $ 265 $ 214 $ 207
=======================================
The first component is service cost, which is the net present value of the
portion of the expected postretirement benefit obligation for active plan
participants attributed to service for the year. The second is interest cost,
which is the increase in the APBO that results from the passage of another year.
That is, because the benefit obligation for each employee is one year closer to
being paid, the net present value increases. The third component, return on
assets, is the income earned on any investments that have been set aside to fund
the benefits. This return is an offset to the first two components.
The fourth component, amortization cost, arises because significant estimates
and assumptions about interest rates, trends in health care costs, plan changes,
employee turnover, and earnings on assets are used in measuring the APBO each
year. Actual experience may differ from the estimates and assumptions may change
resulting in experience gains and losses for increases or decreases in the APBO
or the value of plan assets. The rates used and the amortization of these
experience gains and losses are discussed in the next section of this note.
At the adoption of the Plan, the Company fully recognized the net present value
of the benefits earned by employees for prior service. Had the Company not
recognized this amount, a portion of it would be included in the NPPBC as a
fifth component.
The Use of Estimates and the Amortization of Experience Gains and Losses
The following table discloses the assumed rates that have been used for the
factors that may have a significant impact on the APBO.
December 31
1999 1998 1997
-------------------------------------------
Discount rate 7.71% 6.60% 7.04%
Expected return on plan assets 7.00% 7.00% 7.00%
Health care inflation rate 5.00% 5.00% 5.00%
The discount rate is used to compute the present value of the APBO. It is
selected each year by reference to the current rates of investment grade
corporate bonds. Higher discount rates result in a lower APBO at the end of the
year and the NPPBC to be recognized for the following year, while lower rates
raise both.
While the discount rate has fluctuated with market rates, the Company has
continued to use 7% as its estimate of the long-term rate of return on plan
assets. The APBO is a long-term liability of 30 years or more. The 7% rate is
the assumed average earning rate over an equally long investment horizon. If the
rate of return is greater than this estimate, the Company will have what is
termed an experience gain.
As noted above, the Retiree Health Plan provides for the Company's contribution
for insurance premiums to be limited to an annual increase of 5%. Should
insurance premiums increase at a higher rate, the retirees will need to
contribute a larger portion of the total premium cost. Therefore, 5% has been
set as the assumed cost trend rate for health care. Because of this limitation,
an increase in the actual cost of health care will have no impact on the APBO.
If costs rise at a lesser rate, the Company will have an experience gain.
Rather than recognizing the whole amount of the experience gains or losses in
the year after they arise, under GAAP they are recognized through amortization
over the average remaining service lives of the employees. Amortization over
time is used because many of these changes may be partially or fully reversed in
subsequent years as further changes in experience and/or assumptions occur. At
December 31, 1999 and December 31, 1998, the Company had unamortized or
unrecognized gains of $2,867,000 and $771,000, respectively. These amounts are
reported in the first table of this note.
Funding of the Retiree Health Plan
Employers are allowed wide discretion as to whether and how they set aside funds
to meet the obligation they are recognizing. Under the provisions of the current
Internal Revenue Code, only a portion of this funding may be deducted by the
employer. The funded status of the plan is shown in the first table as the
amount by which the plan assets exceed the APBO.
The Company established a Voluntary Employees' Beneficiary Association ("VEBA")
to hold the assets that will be used to pay the benefits for participants of the
plan other than key executive officers. Most of the plan assets have been
invested in insurance policies on the lives of various employees of the Company.
The current funding policy of the Company is to contribute assets to the VEBA at
least sufficient to pay the costs of current medical premiums of retirees and
the costs of the life insurance premiums. Proceeds from the life insurance
policies payoffs will fund benefits and premiums in the future. As of December
31, 1999, the VEBA was overfunded by $2,635,000. The APBO related to the key
employees of $488,000 is totally unfunded.
16. EARNINGS PER SHARE AND STOCK-BASED COMPENSATION
The following table presents a reconciliation of basic earnings per share and
diluted earnings per share. The denominator of the diluted earnings per share
ratio includes the effect of dilutive securities. The only securities
outstanding that are potentially dilutive are the stock options reported in Note
9.
Under the method of accounting for stock options implemented by the Company, no
compensation expense is recorded if stock options are granted to employees at an
exercise price equal to the market value of the stock at the time of the grant.
Basic Diluted
(amounts in thousands other than per share amounts) Earnings Earnings
Per Share Per Share
------------ -----------
For the Year Ended December 31, 1999
Numerator--net income $44,274 $44,274
Denominator--weighted average shares outstanding 24,417 24,417
Plus: net shares issued in assumed stock options exercises 373
Diluted denominator 24,790
Earnings per share $1.81 $1.79
For the Year Ended December 31, 1998
Numerator--net income $29,567 $29,567
Denominator--weighted average shares outstanding 23,886 23,886
Plus: net shares issued in assumed stock options exercises 561
Diluted denominator 24,447
Earnings per share $1.24 $1.21
For the Year Ended December 31, 1997
Numerator--net income $30,283 $30,283
Denominator--weighted average shares outstanding 23,510 23,510
Plus: net shares issued in assumed stock options exercises 678
Diluted denominator 24,188
Earnings per share $1.29 $1.25
Had the Company recognized compensation expense over the expected life of the
options based on their fair market value as discussed in Note 1, the Company's
pro forma salary expense, net income, and earnings per share for the years ended
December 31, 1999, 1998 and 1997 would have been as follows:
(in thousands) Year Ended December 31
1999 1998 1997
--------------------------------------------
Salary expense:
As reported $43,400 $40,178 $34,334
Pro forma $44,781 $41,314 $35,765
Net income:
As reported $44,274 $29,567 $30,283
Pro forma $43,474 $28,909 $29,449
Earnings per share:
As reported $ 1.79 $ 1.21 $ 1.25
Pro forma $ 1.75 $ 1.18 $ 1.22
Diluted average shares 24,790 24,447 24,189
17. REGULATORY CAPITAL REQUIREMENTS
The Company and its subsidiary banks are subject to various regulatory capital
requirements administered by the Federal banking agencies. Failure to meet
minimum capital requirements as specified by the regulatory framework for prompt
corrective action could cause the regulators to initiate certain mandatory or
discretionary actions that, if undertaken, could have a direct material effect
on the Company's financial statements.
The table below sets forth the actual capital amounts and ratios for the Company
as of December 31, 1999 and 1998. It also shows the minimum amounts and ratios
that it must maintain under the regulatory requirements to meet the standard of
adequately capitalized and the minimum amounts and ratios required to meet the
regulatory standards of "well capitalized".
For the Company, Tier I capital consists of common stock, surplus, and retained
earnings. Tier II capital includes the components of Tier I plus a portion of
the allowance for credit losses. Risk-weighted assets are computed by applying a
weighting factor from 0% to 100% to the carrying amount of the assets as
reported in the balance sheet and to a portion of off-balance sheet items such
as loan commitments and letters of credit. The definitions and weighting factors
are all contained in the regulations. However, the capital amounts and
classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
As of December 31, 1999, both the Company and each of the banks are well
capitalized under the regulatory framework.
Pacific Capital Bancorp ("Bancorp") is the parent company and sole owner of the
banks. However, there are legal limitations on the amount of dividends which may
be paid by the banks to Bancorp. The dividends from SBB&T needed by Bancorp to
pay for the acquisitions of FVB and CSB exceeded the amount allowable without
the prior approval of the California Department of Financial Institutions
("CDFI"). As part of its approval of the acquisitions, the CDFI approved the
excess distributions. During 1999 and 1998, it also approved other dividends
from SBB&T to Bancorp to fund quarterly cash dividends to Bancorp shareholders
and for other incidental purposes.
(dollars in thousands) Pacific Capital Minimums for
Bancorp Capital Adequacy Minimums to be
Actual Purposes Well-Capitalized
----------------------- --------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
----------------------- --------------------- ---------------------
As of December 31, 1999
Total Tier I & Tier II Capital
(to Risk Weighted Assets) $ 251,119 11.8% $170,952 8.0% $ 213,690 10.0%
Tier I Capital
(to Risk Weighted Assets) $ 224,383 10.5% $ 85,476 4.0% $ 128,214 6.0%
Tier I Capital
(to Average Tangible Assets) $ 224,383 7.9% $113,256 4.0% $ 141,570 5.0%
Risk Weighted Assets $2,136,901
Average Tangible Assets $2,831,396
As of December 31, 1998
Total Tier I & Tier II Capital
(to Risk Weighted Assets) $ 215,242 11.7% $147,143 8.0% $ 183,929 10.0%
Tier I Capital
(to Risk Weighted Assets) $ 192,434 10.5% $ 73,571 4.0% $ 110,357 6.0%
Tier I Capital
(to Average Tangible Assets) $ 192,434 7.4% $103,510 4.0% $ 129,388 5.0%
Risk Weighted Assets $1,839,286
Average Tangible Assets $2,587,755
18. COMMITMENTS AND CONTINGENCIES
The Company leases several office locations and substantially all of the office
leases contain multiple five-year renewal options and provisions for increased
rentals, principally for property taxes and maintenance. As of December 31,
1999, the minimum rentals under non-cancelable leases for the next five years
and thereafter are shown in the following table.
(in thousands) Year Ended December 31 There-
2000 2001 2002 2003 2004 after Total
-------------------------------------------------- ---------- ----------
Non-cancellable
lease expense $5,826 $5,173 $4,265 $4,019 $3,787 $12,947 $36,017
Total net rentals for premises included in other operating expenses are
$5,068,000 in 1999, $4,021,000 in 1998, and $3,444,000 in 1997.
The Company leased space from a partnership in which a director has an interest.
In February 1999, the property was destroyed in a fire. The Company is in the
process of renegotiating a lease for this property.
In order to meet the financing needs of its customers in the normal course of
business, the Company is a party to financial instruments with "off-balance
sheet" risk. These financial instruments consist of commitments to extend credit
and standby letters of credit.
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. The Company
has not usually charged fees in connection with loan commitments. Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. The Company charges a fee for
these letters of credit.
The standby letters of credit involve, to varying degrees, exposure to credit
risk in excess of the amounts recognized in the consolidated balance sheets.
This risk arises from the possibility of the failure of the customer to perform
according to the terms of a contract that would cause a draw on the standby
letter of credit by a third party. To minimize the risk, the Company uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments. The decision as to whether collateral
should be required is based on the circumstances of each specific commitment or
conditional obligation. Because of these practices, Management does not
anticipate that any significant losses will arise from such draws.
Changes in market rates of interest for those few commitments and undisbursed
loans which have fixed rates of interest represent a possible cause of loss
because of the contractual requirement to lend money at a rate that is no longer
as great as the market rate at the time the loan is funded. To minimize this
risk, if rates are quoted in a commitment, they are generally stated in relation
to the Company's base lending rate which varies with prevailing market interest
rates. Fixed-rate loan commitments are not usually made for more than three
months.
The maximum exposure to credit risk is represented by the contractual notional
amount of those instruments. As of December 31, 1999 and 1998, the contractual
notional amounts of these instruments are as follows:
(in thousands) December 31
1999 1998
--------------------------------
Commitments to extend credit
Commercial $369,695 $389,408
Consumer $70,744 $63,039
Standby letters of credit $20,811 $21,782
Since many of the commitments are expected to expire without being drawn upon,
the amounts in the table do not necessarily represent future cash requirements.
With the exception of the RAL program mentioned in Note 3, the Company has
concentrated its lending activity primarily with customers in the market areas
served by the branches of its subsidiary banks. The merger has introduced some
geographical diversity as each market area now represents only a portion of the
whole Company. The business customers are in widely diversified industries, and
there is a large consumer component to the portfolio. The Company monitors
concentrations within four broad categories: industry, geography, product, and
collateral. One significant concentration in the loan portfolio is represented
by loans collateralized by real estate; the nature of this collateral, however,
is quite varied: 1-4 family residential, multifamily residential, and commercial
buildings of various kinds. As the economy along the central coast shows
vitality, the underlying value of real estate continues to improve. The Company
has considered this concentration in evaluating the adequacy of the allowance
for credit loss.
The Company has a trust department that has fiduciary responsibility for the
assets that it holds on behalf of its trust customers. These assets are not
owned by the Company and accordingly are not reflected in the accompanying
consolidated balance sheets.
The Company is involved in various litigation of a routine nature which is being
handled and defended in the ordinary course of the Company's business. In the
opinion of Management, the resolution of this litigation will not have a
material impact on the Company's financial position.
19. MERGERS AND ACQUISITIONS
On December 30, 1998, the Company issued 8,756,668 shares of common stock in
exchange for all of the outstanding stock of PCB, a holding company for FNB and
its affiliate SVNB.
The transaction was accounted for as a pooling-of-interest, and accordingly, the
accompanying consolidated financial statements for 1997 have been restated to
include the accounts of Pacific Capital Bancorp for all periods presented. Total
revenues and net income for the separate companies for the periods preceding the
acquisition were as follows:
(in thousands) Year Ended December 31
1998 1997
-----------------------------
Interest income plus noninterest income
Santa Barbara Bancorp $ 164,532 $ 140,485
Former Pacific Capital 64,742 56,560
-----------------------------
Total $ 229,274 $ 197,045
=============================
Net Income
Santa Barbara Bancorp $ 24,379 $ 20,136
Former Pacific Capital 5,188 10,147
-----------------------------
Total $ 29,567 $ 30,283
=============================
On March 31, 1997, the Company acquired all the outstanding stock of FVB for
$26.1 million in cash. Immediately prior to the close, FVB had $123.0 million in
assets and $108.0 million in liabilities.
On September 30, 1997, the Company acquired all the outstanding stock of CSB for
$16.2 million in cash. Immediately prior to the close, CSB had $93.3 million in
assets and $84.3 million in liabilities.
Both acquisitions were accounted for under purchase accounting, with assets and
liabilities recorded at their estimated fair market value at the time of the
acquisition. The excess of the purchase price over the net assets is recorded as
goodwill. Goodwill amortized during the year ended December 31, 1999 relating to
these transactions totaled approximately $1,185,000. The Company issued no stock
in connection with these acquisitions. The following table shows estimated fair
market value of the assets and liabilities of the two banks, the purchase price
paid, and the resulting goodwill.
(in thousands) FMV of FMV of
Assets Liabilities Purchase Goodwill
Acquired Assumed Price Recorded
------------------------------------------------------------------
First Valley Bank $124,967 $109,139 $26,100 $10,272
Citizens State Bank 92,974 84,320 16,170 7,516
------------------------------------------------------------------
Total $217,941 $193,459 $42,270 $17,788
==================================================================
The branches of FVB and CSB were immediately merged into SBB&T on April 1, 1997
and October 1, 1997, respectively. Under the provisions of purchase accounting,
the results of operations of the acquired entity are included in the financial
statements of the acquirer only from the date of the acquisition forward. The
1997 consolidated financial statements of the Company include the assets and
liabilities acquired in the transactions and results of operations from April 1,
1997 for FVB and from October 1, 1997 for CSB.
The following table presents an unaudited pro forma combined summary of
operations of the Company, FVB, and CSB for the year ended December 31, 1997, as
if the acquisitions had been effective January 1, 1997.
(dollars in thousands) Year Ended
December 31,
1997
------------
Interest income $174,337
Interest expense 63,119
-----------
Net interest income 111,218
Provision for credit losses 8,380
Noninterest income 29,391
Noninterest expense 86,261
-----------
Income before provision for income taxes 45,968
Provision for income taxes 16,618
-----------
Net income $ 29,350
===========
Basic earnings per share $ 1.25
Weighted average shares assumed
to be outstanding 23,510
Diluted earnings per share $ 1.21
Weighted average shares assumed
to be outstanding 24,188
The information in the table above combines the historical results of the
Company, FVB, and CSB after giving effect to the amortization of goodwill and
exclusion of an estimated amount of earnings from the consideration paid to the
shareholders of FVB and CSB using the average rate received during the year for
Federal funds sold. No attempt has been made to eliminate the immaterial
intercompany transactions which occurred, nor has an attempt been made to
eliminate the duplicated administrative costs. The figures included in the table
for pro forma combined diluted earnings per share are based on the pro forma
combined net income in the table and the actual average common shares and share
equivalents. Because the consideration paid to the shareholders of FVB and CSB
consisted entirely of cash, the average shares and share equivalents outstanding
are identical to those reported in Note 16.
This unaudited combined pro forma summary of operations is intended for
informational purposes only and is not necessarily representative of the future
results of the Company or of the results of the Company that would have occurred
had the acquisitions actually been transacted on January 1, 1997.
Prior to its merger with SBB, PCB had acquired several branch offices which
resulted in the recording of goodwill. The amortization of goodwill relating to
these transactions amounted to approximately $216,000 in the year ended December
31, 1999.
20. SEGMENT REPORTING
While the Company's products and services are all of the nature of commercial
banking, the Company has seven reportable segments. There are six specific
segments: Wholesale Lending, Retail Lending, Branch Activities, Fiduciary, Tax
Refund Processing, and the Northern Region. The remaining activities of the
Company are reported in a segment titled "All Other".
Factors Used to Identify Reportable Segments
The Company first uses geography as a factor in distinguishing three operating
segments. The discrete market areas served by SBB&T and by FNB (including its
affiliate SVNB) distinguish them as units for which performance must be viewed
separately. The tax refund program serves customers throughout the United
States, and the lack of a defined market area for this program distinguishes it
from other banking activities.
SBB&T is further disaggregated into additional segments. The factors used for
this disaggregaton relate to products and services resulting in segments for
Wholesale Lending, Retail Lending, Branch Activities (deposits), and Fiduciary
(trust services). This level of disaggregaton for SBB&T reflects its specific
management structure in which loan and deposit products are handled by different
organizational units. In contrast to this, FNB and its affiliate, SVNB, have an
organizational structure that generally places both loan and deposit products in
the individual branches.
Types and Services from Which Revenues are Derived
Wholesale Lending: Business units in this segment make loans to medium-sized
businesses and their owners. Loans are made for the purchase of business assets,
working capital lines, investment, the development and construction of
nonresidential or multi-family residential property. Letters of credit are also
offered to customers both to facilitate commercial transactions and as
performance bonds.
Retail Lending: Business units in this segment do small business lending
(including Small Business Administration guaranteed loans) and leasing, consumer
installment loans, home equity lines, and 1-4 family residential mortgages.
Branch Activities: The business of this segment is primarily centered on deposit
products, but also includes safe deposit box rentals, foreign exchange,
electronic fund transfers, and other ancillary services to businesses and
individuals.
Tax Refund Program: The loan products provided in this segment are described in
Note 3. The other product, refund transfers, consists of receipt of tax refunds
from the Internal Revenue Service on behalf of individual taxpayers and
authorizing the local issuance of checks to the taxpayers so that they do not
need a mailing address or to wait for the refund check to be mailed to them.
Fiduciary: This segment provides trust and investment services to its customers.
The Trust and Investment Services Division may act as both custodian and manager
of trust accounts as directed by the client. In addition to securities and other
liquid assets, the division manages real estate held in trust. The division also
sells third-party mutual funds and annuities to customers.
Northern Region: This segment derives its revenues from banking services
provided by FNB and its affiliate SVNB. These include the same type of loan,
deposit, and fiduciary products described for the first three segments described
above. This segment also derives revenues from securities in FNB's securities
portfolios.
All Other: This segment consists of other business lines and support units. The
administrative support units include the Company's executive administration,
data processing, marketing, credit administration, human resources, legal and
benefits, and finance and accounting. The primary revenues are from SBBT's
securities portfolios.
Charges and Credits for Funds and Income from the Investment Portfolios
As noted above, there is a significant difference between the organizational
structures of FNB and SBB&T, with the same business units providing loans and
deposits at FNB and separate business units handling them at SBB&T. This means
that as a segment, the Northern Region is self-contained from a funding
standpoint. That is, the one segment obtains its own funds from its depositors
and lends its own funds to its borrowers. In contrast with this, SBB&T has one
primary segment which provides the funds, Branch Activities, while the lending
segments utilize the funds. To give a fair picture of profitability at the
segment level for the SBB&T segments, it is therefore necessary to charge the
lending segments for the cost of the funds they use while crediting the Branch
Activities segment for the funds it provides.
The securities portfolios of each bank are used to provide liquidity to that
bank and to earn income from funds received from depositors that are in excess
of the amounts lent to borrowers. The interest rates applicable to securities
are lower than for loans because there is little or no credit risk. Foregoing
the higher rates earned by loans is, in a sense, a cost of maintaining the
necessary liquidity, and an opportunity cost for being unable to generate
sufficient loans to make full use of the available funds.
From the standpoint of measuring the performance of the Northern Region, the
loans and deposits of which are organizationally integrated, it is most
appropriate to include the income from the FNB securities portfolios with the
operating segment. Because the Northern Region is self-contained from a funding
standpoint, within the segment as a whole, there are no credits or charges for
funds.
Because in the SBB&T segments, the uses of funds and the provision of funds are
in separate segments, there is no one operating unit to which it is appropriate
to charge the liquidity and opportunity costs related to the investment
portfolios. Instead, each segment that uses funds through lending or investing
is charged for its funds and the Branch Activities segment is credited for the
funds it provides.
Measure of Profit or Loss
In assessing the performance of each segment, the chief executive officer
reviews the segment's contribution before tax. Taxes are excluded because the
Company has permanent tax differences (see Note 8) which do not apply equally to
all segments. In addition, if segments were measured by their net-of-tax
contribution, they would be advantaged or disadvantaged by any enacted changes
in tax rates even though such changes are not reflective of the performance of a
segment.
Specific Segment Disclosure
The following table presents information for each segment regarding assets,
profit or loss, and specific items of revenue and expense that are included in
that measure of segment profit or loss as reviewed by the chief operating
decision maker.
(in thousands) Branch Retail Wholesale Northern All
Activities Lending Lending RAL Fiduciary Region Other Total
----------------------------------------------------------------------------------------------------
Year Ended
December 31, 1999
Revenues from
external customers $ 9,254 $ 54,483 $54,295 $ 14,673 $ 13,201 $ 71,686 $ 41,444 $ 259,036
Intersegment revenues 75,656 216 -- 1,988 2,420 -- 14,137 94,417
----------------------------------------------------------------------------------------------------
Total revenues $84,910 $ 54,699 $54,295 $ 16,661 $ 15,621 $ 71,686 $ 55,581 $ 353,453
====================================================================================================
Profit (Loss) $20,761 $ 13,139 $18,765 $ 9,391 $ 6,538 $ 23,054 $(17,232) $ 74,416
Interest income 73 53,307 53,403 8,081 -- 65,543 37,011 217,418
Interest expense 40,002 221 5 -- 2,121 19,955 5,553 67,856
Internal charge for funds 866 33,076 29,536 641 -- -- 30,298 94,417
Depreciation 1,432 143 93 87 131 1,112 2,152 5,150
Total assets 29,478 708,698 647,104 (487) 1,668 910,466 582,355 2,879,282
Capital expenditures -- -- -- -- -- 1,042 6,914 7,956
Year Ended
December 31, 1998
Revenues from
external customers $10,813 $ 43,514 $46,899 $ 11,638 $ 9,545 $ 66,346 $ 48,842 $ 237,597
Intersegment revenues 73,384 54 -- 991 2,477 -- 11,107 88,013
----------------------------------------------------------------------------------------------------
Total revenues $84,197 $ 43,568 $46,899 $ 12,629 $ 12,022 $ 66,346 $ 59,949 $ 325,610
====================================================================================================
Profit (Loss) $15,855 $ 9,262 $16,885 $ 4,521 $ 5,563 $ 20,662 $(18,469) $ 54,279
Interest income 24 42,156 45,273 6,818 -- 60,680 44,302 199,253
Interest expense 42,453 58 4 -- 2,247 20,593 2,758 68,113
Internal charge for funds 725 25,841 23,936 625 -- -- 36,886 88,013
Depreciation 1,982 236 142 71 213 1,570 1,634 5,848
Total assets 12,532 530,481 520,614 (324) 3,104 840,027 742,984 2,649,418
Capital expenditures -- -- -- -- -- 744 6,093 6,837
Year Ended
December 31, 1997
Revenues from
external customers $ 9,734 $ 34,107 $38,968 $ 10,299 $ 8,158 $ 58,188 $ 44,430 $ 203,884
Intersegment revenues 64,251 452 -- 655 2,360 -- 10,687 78,405
----------------------------------------------------------------------------------------------------
Total revenues $73,985 $ 34,559 $38,968 $ 10,954 $ 10,518 $ 58,188 $ 55,117 $ 282,289
====================================================================================================
Profit (Loss) $13,241 $ 5,657 $12,353 $ 3,444 $ 4,716 $ 18,260 $ (5,930) $ 51,741
Interest income 25 33,427 38,097 7,421 -- 53,179 41,171 173,320
Interest expense 36,793 452 -- -- 2,970 17,385 2,990 60,590
Internal charge for funds 609 20,572 21,830 559 -- -- 34,835 78,405
Depreciation 1,689 221 81 38 144 1,301 985 4,459
Total assets 15,382 420,332 437,310 (324) 1,963 756,899 725,543 2,357,105
Capital expenditures -- -- -- -- -- 853 13,402 14,255
The following table reconciles total revenues and profit for the segments to
total revenues and pre-tax income, respectively, in the consolidated financial
statements.
(in thousands) Year Ended December 31
1999 1998 1997
------------------------------------------
Total revenues for reportable segments $353,453 $325,610 $282,289
Elimination of intersegment revenues (94,417) (88,013) (78,405)
Elimination of taxable equivalent adjustment (5,775) (5,737) (5,170)
------------------------------------------
Total consolidated revenues $253,261 $231,860 $198,714
==========================================
Total profit or loss for reportable segments $ 74,416 $ 54,279 $ 51,741
Elimination of taxable equivalent adjustment (5,775) (5,737) (5,170)
------------------------------------------
Income before income taxes $ 68,641 $ 48,542 $ 46,571
==========================================
For purposes of performance measurement and therefore for the segment disclosure
above, income from tax-exempt securities, loans, and leases are reported on a
fully taxable equivalent basis. Under this method of disclosure, the income
disclosed is increased to that amount which, if taxed, would result in the
amount included in the financial statements.
With respect to the disclosure of total assets for the individual segments,
fixed assets used by the Northern Region segment are included in its asset
totals. Fixed assets used by the other segments are all recorded as assets of
the All Other segment. Depreciation expense of these assets is charged to the
segment that uses them.
The Company has no operations in foreign countries to require disclosure by
geographical area. The Company has no single customer generating 10% or more of
total revenues.
For the Company, the process of disaggregation is somewhat arbitrary. Many of
the Company's customers do business with more than one segment. Because the
Company uses relationship pricing whereby the customer may be given a favorable
price on one product because the other products that he or she makes use of are
very profitable for the Company. To the extent that these products are in
different segments as defined above, one segment may be sacrificing
profitability to another for the sake of the overall customer relationship.
21. SUBSEQUENT EVENT
On February 3, 2000, the Company signed a merger agreement with San Benito Bank
of Hollister, California. The acquisition will be accounted for under the
pooling-of-interest method of accounting for business combinations. Under the
terms of the agreement, each outstanding share of San Benito Bank common stock
will be converted into the right to receive 0.605 shares of Pacific Capital
Bancorp common stock. Based on the closing price of Pacific Capital Bancorp
common stock on February 3, of $30 per share, the transaction is valued at $51.8
million. At December 31, 1999, San Benito Bank reported net income of $2.26
million and assets of $201 million. The transaction, which is subject to
regulatory approval and the approval of the San Benito Bank shareholders, is
expected to close during the second quarter of 2000.
22. PACIFIC CAPITAL BANCORP
The condensed financial statements of the Bancorp are presented on the following
two pages.
PACIFIC CAPITAL BANCORP
(Parent Company Only)
Balance Sheets
(in thousands)
December 31
1999 1998
---------------------------
Assets
Cash $ 931 $ 2,176
Investment in and advances to subsidiaries 224,230 205,362
Loans, net 394 2,966
Premises and equipment, net 4,150 3,507
Other assets 12,041 12,591
---------------------------
Total assets $241,746 $226,602
===========================
Liabilities
Dividends payable $ 4,420 $ 4,358
Other liabilities 2,753 8,244
---------------------------
Total liabilities 7,173 12,602
---------------------------
Equity
Common stock 8,186 8,071
Surplus 99,283 95,498
Unrealized gain on securities available-for-sale (6,447) 3,496
Retained earnings 133,551 106,935
---------------------------
Total shareholders' equity 234,573 214,000
---------------------------
Total liabilities and shareholders' equity $241,746 $226,602
===========================
PACIFIC CAPITAL BANCORP
(Parent Company Only)
Income Statements
(in thousands)
Year Ended December 31
1999 1998 1997
-----------------------------------------------
Equity in earnings of subsidiaries:
Undistributed $28,812 $18,914 $ 6,211
Dividends 17,131 18,575 24,744
Interest income 123 181 43
Other income 87 601 --
Other operating expense (4,715) (13,006) (1,744)
Income tax benefit 2,836 4,302 1,029
-----------------------------------------------
Net income $44,274 $29,567 $30,283
===============================================
PACIFIC CAPITAL BANCORP
(Parent Company Only)
Statements of Cash Flows
(in thousands)
Year Ended December 31
1999 1998 1997
-------------------------------------------
Increase (decrease) in cash and cash equivalents:
Cash flows from operating activities:
Net income $44,274 $29,567 $30,283
Adjustments to reconcile net income to net
cash used in operations:
Equity in undistributed net income
of subsidiaries (45,942) (37,489) (30,955)
Increase in other assets 551 (7,739) (4,409)
Increase in other liabilities (1,883) 8,611 2,209
-------------------------------------------
Net cash used in operating activities (3,000) (7,050) (2,872)
-------------------------------------------
Cash flows from investing activities:
Net (increase) decrease in loans 2,788 (2,238) 834
Capital expenditures (643) -- (386)
Capital contribution to subsidiary -- -- (125)
Purchase of capital stock of First Valley
Bank and Citizens State Bank -- -- (42,270)
Distributed earnings of subsidiaries 17,131 18,575 57,066
-------------------------------------------
Net cash provided by investing activities 19,276 16,337 15,119
-------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock 2,129 8,094 2,779
Payments to retire common stock (2,055) (3,792) (5,468)
Dividends paid (17,595) (12,907) (9,668)
-------------------------------------------
Net cash used in financing activities (17,521) (8,605) (12,357)
-------------------------------------------
Net increase (decrease) in cash and cash equivalents (1,245) 682 (110)
Cash and cash equivalents at beginning of period 2,176 1,494 1,604
-------------------------------------------
Cash and cash equivalents at end of period $ 931 $ 2,176 $ 1,494
===========================================
Supplemental disclosures:
Non-cash investing and financing activities:
Transfer from retained earnings to common
stock due to stock dividend $ -- $ -- $ 9,000
QUARTERLY FINANCIAL DATA (UNAUDITED)
1999 Quarters 1998 Quarters
------------------------------------------------ ------------------------------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
----------- ---------- ----------- ----------- ----------- ----------- ---------- -----------
Interest income $53,914 $51,374 $49,671 $ 56,684 $49,673 $47,478 $46,052 $50,436
Interest expense 18,263 17,113 16,210 16,270 17,227 17,543 16,761 16,582
Net interest income 35,651 34,261 33,461 40,414 32,446 29,935 29,291 33,854
Provision for
credit losses 1,023 793 840 3,719 1,095 1,095 984 5,949
Noninterest income 9,293 8,770 9,284 14,271 8,362 8,700 8,785 12,374
Noninterest expense 28,110 27,399 27,355 27,525 35,872 24,018 23,036 23,156
Income before
income taxes 15,811 14,839 14,550 23,441 3,841 13,522 14,056 17,123
Income taxes 5,036 4,904 5,507 8,920 2,430 5,078 5,065 6,402
Net income $10,775 $ 9,935 $ 9,043 $ 14,521 $ 1,411 $ 8,444 $ 8,991 $10,721
Net earnings per share:
Basic $0.43 $0.41 $0.37 $0.60 $0.06 $0.35 $0.38 $0.45
Diluted $0.43 $0.40 $0.37 $0.59 $0.06 $0.34 $0.37 $0.44
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated herein by reference to the
sections titled "The Board of Directors" and "Executive Officers" in the
Company's definitive Proxy Statement for the annual meeting to be held April 25,
2000 ("Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to the
section titled "Executive Compensation" in the Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference to the
section titled "Beneficial Ownership Chart" in the Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference to the
section titled "Other Information" in the Company's Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K
(a)1. FINANCIAL STATEMENTS
The listing of financial statements required by this item is
set forth in the index for Item 8 of this report.
(a)2 FINANCIAL STATEMENTS SCHEDULES
The listing of supplementary financial statement schedules
required by this item is set forth in the index for Item 8 of
this report.
(a)3. EXHIBITS
The listing of exhibits required by this item is set forth in
the Exhibit Index beginning on page 81 of this report. Each
management contract or compensatory plan or arrangement
required to be filed as an exhibit to this report is listed
under Item 10.1 "Compensation Plans and Agreements," in the
Exhibit Index.
(b) REPORTS ON FORM 8-K
One report on Form 8-K was filed during the fourth quarter of
the fiscal year ended December 31, 1999. The Company reported
the adoption by the Board of Directors of a shareholder rights
plan on Form 8-K filed with the Commission on December 17,
1999.
(c) EXHIBITS
See exhibits listed in "Exhibit Index" on page 81 of this
report.
(d) FINANCIAL STATEMENT SCHEDULES
There are no financial statement schedules required by
Regulation S-X that have been excluded from the annual report
to shareholders.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed by the
undersigned, thereunto duly authorized.
Pacific Capital Bancorp
By /s/ David W. Spainhour February 28, 2000
David W. Spainhour Date
President
Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company and in
the capacities and on the dates indicated.
/s/ Donald M. Anderson Feb.28, 2000 /s/ David W. Spainhour Feb. 28, 2000
Donald M. Anderson Date David W. Spainhour Date
Chairman of the Board President
Director Director
/s/ William S. Thomas Feb. 28, 2000 /s/ Donald Lafler Feb. 28, 2000
William S. Thomas, Jr. Date Donald Lafler Date
Vice Chairman Executive Vice President
Chief Operating Officer Chief Financial Officer
/s/ Edward E. Birch Feb. 28, 2000 /s/ Richard M. Davis Feb. 28, 2000
Edward E. Birch Date Richard M. Davis Date
Director Director
/s/ Dale E. Hanst Feb. 28, 2000 /s/ Harry B. Powell Feb. 28, 2000
Dale E. Hanst Date Harry B. Powell Date
Director Director
/s/ D. Vernon Horton Feb. 28, 2000 /s/ Clayton C. Larson Feb. 28, 2000
D. Vernon Horton Date Clayton C. Larson Date
Vice Chairman Vice Chairman
/s/ William H. Pope Feb. 28, 2000 /s/ Roger C. Knopf Feb. 28, 2000
William H. Pope Date Roger C. Knopf Date
Director Director
/s/ Kathy J. Odell Feb. 28, 2000
Kathy J. Odell Date
Director
EXHIBIT INDEX TO PACIFIC CAPITAL BANCORP FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
Exhibit
Number Description *
- - - - - - - ------ ------------
2. Agreement and Plan of Reorganization by and between Santa Barbara Bancorp
and Pacific Capital Bancorp dated July 20, 1998.(1)
3. Articles of incorporation and bylaws:
3.1 Certificate of Restatement of Articles of Incorporation of
Pacific Capital Bancorp dated January 27, 1999. (2)
3.2 Amended and Restated Bylaws of Pacific Capital Bancorp
effective January 26, 1999. (2)
10. Material contracts
10.1 Compensation Plans and Agreements:
10.1.1 Pacific Capital Bancorp Amended and Restated
Restricted Stock Option Plan as amended effective
December 17, 1996. (3)
10.1.1.1 Pacific Capital Bancorp Restricted Stock
Option Agreement (Incentive Stock Option). (3)
10.1.1.2 Pacific Capital Bancorp Restricted Stock
Option Agreement (Nonstatutory Stock Option -
5 Year). (3)
10.1.1.3 Pacific Capital Bancorp Restricted Stock
Option Agreement (Nonstatutory Stock Option -
10 Year). (3)
10.1.1.4 Pacific Capital Bancorp Restricted Stock
Option Agreement (Incentive Reload Option).
(3)
10.1.1.5 Pacific Capital Bancorp Restricted Stock
Option Agreement (Non-statutory Reload
Option). (3)
10.1.2 Pacific Capital Bancorp Directors Stock Option
Plan (incorporated by reference to Exhibit 4.2 to
Post-Effective Amendment No. One to Santa Barbara
Bancorp's Registration Statement on Form S-8, filed on
June 13, 1995, Registration No. 33-48724).
10.1.3 Pacific Capital Bancorp Incentive & Investment and
Salary Savings Plan, as amended and restated effective
January 1, 1998. (7)
10.1.4 Pacific Capital Bancorp Employee Stock Ownership
Plan and Trust, as amended and restated effective
January 1, 1998. (7)
10.1.5 Santa Barbara Bank & Trust Key Employee Retiree Health Plan
incorporated by reference to Exhibit 10.1.8 to Santa Barbara
Bancorp's Annual Report on Form 10-K (File No. 0-11113) for
fiscal year ended December 31, 1993).
10.1.5.1 First Amendment to Santa Barbara Bank &
Trust Key Employee Retiree Health Plan. (5)
10.1.5.2 Second Amendment to Santa Barbara Bank &
Trust Key Employee Retiree Health Plan. (5)
10.1.6 Santa Barbara Bank & Trust Retiree Health Plan (Non-Key
Employees) (incorporated by reference to Exhibit 10.1.9 to
Santa Barbara Bancorp's Annual Report on Form 10-K (File No.
0-11113) for the fiscal year ended December 31, 1993).
10.1.6.1 First Amendment to Santa Barbara Bank & Trust
Retiree Health Plan (Non-Key Employees). (5)
10.1.6.2 Second Amendment to Santa Barbara Bank &
Trust Retiree Health Plan (Non-Key Employees). (5)
10.1.7 Trust Agreement of Santa Barbara Bank & Trust
Voluntary Beneficiary Association. (5)
10.1.7.1 First Amendment to Trust Agreement of Santa
Barbara Bank & Trust Voluntary Beneficiary
Association. (4)
10.1.8 Santa Barbara Bancorp 1996 Directors Stock Option Plan, as
amended March 24, 1998. (7)
10.1.8.1 Santa Barbara Bancorp 1996 Directors Stock Option
Agreement. (3)
10.1.8.2 Santa Barbara Bancorp 1996 Directors Stock
Option Agreement (Reload Option). (3)
10.1.9 Pacific Capital Bancorp Directors' Stock Option Plan and Form
of Stock Option Agreement (incorporated by reference to
Exhibit 10.25 to Pacific Capital Bancorp's Annual Report on
Form 10-K (File No. 0-13528) for the fiscal year ended
December 31, 1991).
10.1.10 Pacific Capital Bancorp 1984 Stock Option Plan and Forms of
Agreements as amended to date (incorporated by reference to
Exhibit 10.27 to Pacific Capital Bancorp's Annual Report on
Form 10-K (File No. 0-13528) for the fiscal year ended
December 31, 1991).
10.1.11 Pacific Capital Bancorp 1994 Stock Option Plan, as
amended, and Forms of Incentive and Non-Qualified
Stock Option Agreements (incorporated by reference to
Exhibit 4 to Pacific Capital Bancorp's Amendment No. 1
to Registration Statement on Form S-8 (Registration No.
33-83848) filed on November 15, 1994).
10.1.12 Pacific Capital Bancorp Management Retention Plan
as amended through January 11, 1999. (7)
10.1.13 Pacific Capital Bancorp Deferred Compensation Plan dated
December 15, 1999. **
10.1.13.1 Trust Agreement under Pacific Capital Bancorp Deferred
Compensation Plan dated December 15, 1999. **
10.2 Consolidated Agreement dated December 17, 1991 by and between First
National Bank of Central California and Unisys with Equipment Sale
Agreement, Software License Agreement and Product License Agreement
by and between First National Bank of Central California and
Information Technology, Inc. (6)
13. Portions of Annual Report to Security Holders
21. Subsidiaries of the registrant
23. Consents of Experts and Counsel
23.1 Consent of Arthur Andersen LLP with respect to financial
statements of the Registrant
23.2 Consent of KPMG LLP with respect to financial statements of the
Registrant
27. Financial Data Schedule
Shareholders may obtain a copy of any exhibit by writing to:
Carol Kelleher, Corporate Services Administrator
Pacific Capital Bancorp
P.O. Box 1119
Santa Barbara, CA 93102
* Effective December 30, 1998, Santa Barbara Bancorp and Pacific
Capital Bancorp merged and contemporaneously with effectiveness
of the merger, Santa Barbara Bancorp, the surviving entity,
changed its corporate name to Pacific Capital Bancorp.
Documents identified as filed by Santa Barbara Bancorp prior to
December 30, 1998 were filed by Santa Barbara Bancorp.
Documents identified as filed by Pacific Capital Bancorp prior
to December 30, 1998 were filed by Pacific Capital Bancorp as
it existed prior to the merger.
** Filed herewith.
The Exhibits listed below are incorporated by reference to the specified filing.
(1) Filed as Appendix A to Proxy Statement filed by Santa Barbara
Bancorp in Amendment No. 1 to Registration Statement on Form
S-4 (registration No. 333-64093) filed November 4, 1998.
(2) Filed as Exhibits 4.1 and 4.2 to the Registration Statement on
Form S-8 of Pacific Capital Bancorp (Registration No.
333-74831) filed March 18, 1999.
(3) Filed as Exhibits 10.1.1 through 10.1.1.5 and 10.1.10 through 10.1.10.2 to
Annual Report on Form 10-K of Santa Barbara Bancorp (File No.0-11113) for
fiscal year ended December 31, 1996.
(4) Filed as an Exhibit to Annual Report on Form 10-K of Santa Barbara Bancorp
(File No.0-11113) for fiscal year ended December 31, 1995.
(5) Filed as an Exhibit to Annual Report on Form 10-K of Santa Barbara Bancorp
(File No.0-11113) for the fiscal year ended December 31, 1997.
(6) Filed as Exhibits 10.23 through 10.34 to the Annual Report of Pacific
Capital Bancorp on Form 10-K (File No. 0-13528) for the fiscal year ended
December 31, 1991.
(7) Filed as an Exhibit to the Annual Report on Form 10-K of
Pacific Capital Bancorp (File No. 0-11113) for the fiscal year
ended December 31, 1998.
Exhibit 10.1.13
PACIFIC CAPITAL BANCORP
DEFERRED COMPENSATION PLAN
THIS DEFERRED COMPENSATION PLAN (the "Plan") is made and adopted,
effective on the date set forth below, by PACIFIC CAPITAL BANCORP ("Employer"),
with reference to the following facts:
RECITALS:
A. The Employer has elected to adopt this Plan in order to enable a select
group of management or highly compensated employees to elect to defer
compensation in the manner described below.
B. It is the intention of the Employer that (i) this Plan be an unfunded
plan of deferred compensation; (ii) this Plan be exempt from the requirements of
the Employee Income Retirement Security Act of 1974 to the maximum extent
permitted by law; and (iii) the amounts allocated to the "Participant Accounts"
(as defined below) pursuant to the Plan, as well as earnings thereon, not be
included in the income of the Participant until the taxable year in which either
such amount is paid to the Participant, or the Participant has the right to
receive a payment of such amount, pursuant to the Plan.
PLAN:
NOW, THEREFORE, the Employer, intending to be legally bound, does hereby
adopt the following Plan.
1. DEFINITIONS
For purposes of this Plan, each of the following terms shall have the
meaning set forth below:
1.1 "Acquired Company Deferred Compensation Plan" shall mean (a) that certain
Executive Compensation Deferral Plan sponsored by South Valley National Bank, a
California corporation, pursuant to certain resolutions adopted by the Board of
Directors of South Valley National Bank as of March 24, 1998, and (b) that
certain Executive Compensation Deferral Plan sponsored by First National Bank of
Central California as adopted by the Board of Directors of First National Bank
of Central California as of March 24, 1998, and (c) that certain Executive
Compensation Deferral Plan formerly sponsored by Pacific Capital Bancorp, a
California corporation that was acquired by Employer in a transaction that
closed effective December 30, 1998, as adopted by the Board of Directors of such
corporation as of March 24, 1998.
1.2 "Active Insured Employee" shall mean each Participant who dies at the time
such Participant is actively employed by the Employer, and with respect to whom
the Employer owns or maintains on the life of such Participant a policy of life
insurance. A Participant (a) who is employed by the Employer shall be deemed not
to be an Active Insured Employee if such Participant has terminated employment
with the Employer prior to the date of such Participant's death, and (b) shall
be deemed to be "actively employed" by the Employer if such Participant
customarily works for the Employer for at least one thousand (1,000) hours per
year.
1.3 "Administrative Committee" means the Committee constituted by Employer from
time to time to administer this Plan.
1.4 "Affiliate" means each corporation, all the outstanding capital stock of
which is owned by PACIFIC CAPITAL BANCORP, a California corporation.
1.5 "Beneficiary" means each person, as designated by the Participant on the
Participant's Beneficiary Designation Form, who is entitled to receive a
distribution of part or all of the amounts otherwise distributable to the
Participant pursuant to this Plan.
1.6 "Beneficiary Designation Form" means the form prescribed by the Plan
Administrator from time to time for each Participant's use in designating the
Beneficiary entitled to receive a distribution of the Participant's benefits
under this Plan.
1.7 "Code" means the Internal Revenue Code of 1986, as amended from time to
time.
1.8 "Compensation" means the amount of taxable compensation payable by the
Employer to the Participant, and shall include (a) the Employee's taxable salary
or wages, (b) taxable bonuses payable to the Employee from time to time, (c)
taxable income attributable to (i) Employee's exercise of options to acquire
Employer capital stock, and (ii) compensation transfers to Employee of shares of
Employer's capital stock, and (d) with respect to Directors, the amount of fees
payable by the Employer or any Affiliate to the Director in consideration of the
Director's services as a Director.
1.9 "Contributions" means Salary Reduction Contributions,
Employer Matching Contributions, and Employer Discretionary
Contributions.
1.10 "Director" means each person who is a member of the Board of Directors of
Employer or any Affiliate.
1.11 "Disabled" means, with respect to a Participant, that the Participant
suffers from a physical or mental condition, as determined by a licensed medical
doctor selected or approved by the Employer, that renders the Participant
incapable of performing services as an Employee.
1.12 "Earnings" means the deemed income and gain attributable to the deemed
investment of the balance credited to a Participant Account in Investment
Options.
1.13 "Effective Date" means December 15, 1999.
1.14 "Eligible Employee" means each Employee who either (a) was a participant in
an Acquired Company Deferred Compensation Plan and either (i) is named on
Exhibit A to this Plan, subject to the limits on participation imposed by
Section 3.2.1, below, or (ii) elects to roll over into the Trust some or all of
the account credit accumulated for such Employee under the Acquired Company
Deferred Compensation Plan in which such Employee participated, or (b) hereafter
is designated by the Administrative Committee as an "Eligible Employee" under
this Plan.
1.15 "Eligible Person" means (a) each Eligible Employee, and (b)
each Director.
1.16 "Employee" means each person who is a common law employee of
the Employer or any Affiliate.
1.17 "Employer" means (a) PACIFIC CAPITAL BANCORP, a California corporation, and
(b) each Affiliate of PACIFIC CAPITAL BANCORP.
1.18 "Employer Discretionary Account" means the account established pursuant to
Section 4.1(c), below, to which the portion of any Employer Discretionary
Contribution allocated to the Participant shall be allocated.
1.19 "Employer Discretionary Contribution" means the amount, if any, which the
Employer elects, from time to time and in the sole discretion of the Employer,
to contribute to the Plan and allocate to the Participant Accounts of one or
more Participants, as further described in Section 3.4 below.
1.20 "Employer Matching Account" means the account established pursuant to
Section 4.1(b), below, to which the Participant's share of Employer Matching
Contributions and Earnings thereon are allocated.
1.21 "Employer Matching Contribution" means the amount, if any, which the
Employer elects to contribute to the Plan pursuant to Section 3.3, below.
1.22 "ERISA" means the Employee Retirement Income Security Act of 1974, as
amended from time to time.
1.23 "Event of Hardship" means, subject to Section 6.3, below, with respect to
each Participant, a severe financial hardship to the Participant resulting from
the occurrence of one or more of the following circumstances:
1.23.1 Illness. The occurrence of a sudden and unexpected
illness or accident to a Participant or a person who is a
"dependent" of a Participant (as the term "dependent" is defined
in Section 152(a) of the Code);
1.23.2 Casualty. The loss of the Participant's property due
to casualty; or
1.23.3 Other. Any other similar extraordinary and
unforeseeable event arising as a result of events beyond the
control of the Participant.
1.24 "Investment Election Form" means a form prescribed by the Plan
Administrator for use by Participants in designating the manner in which the
balance in each Participant's Account shall be deemed to be invested pursuant to
Section 5, below.
1.25 "Investment Option" means each alternative investment option offered by the
Employer from time to time as an investment vehicle in which the amounts
allocated to each Participant's Accounts may be deemed to be invested.
1.26 "Participant" means each Eligible Person who commences participation in the
Plan in the manner prescribed by Section 2, below. 1.27 "Participant Accounts"
means, with respect to each Participant, the (a) Salary Reduction Account, (b)
Employer Matching Account, and (c) Employer Discretionary Account.
1.28 "Participant Election Form" means the form prescribed by the Plan
Administrator on which each Eligible Person may reflect the election to
participate in this Plan and to make a Salary Reduction Contribution to this
Plan.
1.29 "Pay Period" means (a) with respect to each Eligible Employee, the regular
weekly, bi-weekly, semi-monthly, monthly, or other Pay Period which the Employer
uses in paying Compensation to its Employees, and (b) with respect to each
Director, the regular intervals at which compensation is paid to Directors in
consideration of their services as a Director.
1.30 "Plan" means this Deferred Compensation Plan.
1.31 "Plan Administrator" means the Employer and any other person designated by
the Employer, from time to time, to be the "Plan Administrator" under this Plan.
1.32 "Plan Year" means each period of twelve (12) consecutive months beginning
on January 1 and ending on December 31.
1.33 "Retirement" means the Employee's voluntarily terminating employment with
the Employer following the first date as of which (a) the Participant has
attained at least age 55 and has completed at least eight (8) years of service,
and (b) the sum of the Employee's age plus Years of Service is at least equal to
seventy-five (75).
1.34 "Salary Reduction Account" means the account established pursuant to
Section 4.1(a), below, to which the Participant's Salary Reduction Contributions
are allocated.
1.35 "Salary Reduction Contribution" means, with respect to each Participant,
the amount of the Participant's Compensation which the Participant elects to
contribute to this Plan in accordance with Section 3.2, below.
1.36 "Vested" means the portion of the funds allocated to the Participant's
Accounts which is deemed to be nonforfeitable and owned by the Employee pursuant
to Section 4, below.
1.37 "Year of Service" means:
1.37.1 Service With Employer. Each period of twelve months in which an Employee
works as a full-time Employee of the Employer. Such periods shall be measured
from the date such Employee first becomes an Employee of the Employer, and from
annual anniversaries of such date. All periods of service with the Employer
shall be aggregated.
1.37.2 Credited Service. Each other period of service with
any other employer or person for which the Employer elects, in
its sole and absolute discretion, to credit the Participant under
this Plan.
2. ELIGIBILITY AND PARTICIPATION
2.1 Eligibility. Subject to Section 2.2, below, each Eligible Person shall be
eligible to commence participation in the Plan:
2.1.1 Effective Date. For each person who is an "Eligible Person"
on the Effective Date of this Plan, as of the Effective Date; and
2.1.2 Later. For each other person, an individual who first becomes an Eligible
Person after the Effective Date, immediately after such individual has completed
thirty (30) consecutive days of services as a Director or Employee, as the case
may be.
2.2 Limitation on Elections. Notwithstanding any provisions of
this Plan to the contrary:
2.2.1 Timing. An Eligible Employee may file an election to participate in and
make Salary Reduction Contributions to this Plan only if such election is made
(a) by each individual who is an Eligible Person as of the Effective Date, on or
before such Effective Date, and each Eligible Person who first becomes an
Eligible Person after a Plan Year has begun, within thirty (30) days after such
Eligible Person has received written notification from the Employer that such
individual is an Eligible Person, and (b) thereafter, with respect to each Plan
Year, at least fifteen (15) days prior to the first day of such Plan Year (as
further described in Section 3.2.1, below).
2.2.2 Participants in Acquired Company Plans. Employer has agreed to permit
certain Participants in the Acquired Company Plans to elect to roll into this
Plan the amounts credited to such Participants' accounts under the Acquired
Company Plans. Any such Participant in that Acquired Company Plan who so elects
to effect that rollover in credits shall be entitled to make with respect to
such rolled over credits such deemed investment elections and such distribution
elections under this Plan as would any Eligible Person hereunder.
2.3 Participation. Each Eligible Employee who (a) is an Eligible Employee as of
the Effective Date, may begin making Salary Reduction Contributions as of the
first day of the first Pay Period beginning on or after the Effective Date, (b)
becomes an Eligible Employee after the Effective Date may being making Salary
Reduction Contributions as of the first day of the first Plan Year beginning
after such person becomes an Eligible Employee, if such Eligible Employee timely
files an election for such Plan Year in accordance with Section 2.2, above, and
Section 3.2.1, below.
2.4 Continuation of Participant. Subject to Section 2.5, below, once an
individual has become an "Eligible Person" under this Plan, such individual
shall continue to be an Eligible Person for so long as such individual is a
Director or Eligible Employee of the Employer, notwithstanding whether such
individual thereafter may change the individual's status with the Employer and
Affiliate.
2.5 ERISA Termination. If the Employer determines in good faith that the Plan no
longer would be maintained for a "selected group of management or highly
compensated employees" within the meaning of Sections 201(2), 301(a)(3), and
401(a)(1) of ERISA if the Participant continued to have rights under the Plan,
then:
2.5.1 Termination of Rights. Such Participant no longer shall
have any rights under the Plan; and
2.5.2 Individual Agreement. The Employer shall execute a separate written
agreement with the Participant, providing the Participant such rights with
respect to Vested amounts that are allocated to the Participant's Account (as of
the date the Participant ceased to be a member of "a select group of management
or highly compensated employees," as defined above), as are substantially
identical to those which the Participant then may possess under this Plan.
2.6 Accounts Under Prior Plans. Employer hereby:
2.6.1 Acknowledgment Re Prior Plan. Acknowledges that (a) Pacific Capital
Bancorp, a California corporation ("Old Pacific") and certain of its affiliates
sponsored the Acquired Company Plans, and (b) in transactions that closed
effective December 30, 1998, Old Pacific merged with and into Employer; and
2.6.2 Acceptance of Accounts. Hereby agrees that from and after the Effective
Date, (a) each account maintained under the Acquired Company Plans shall be
deemed to be a "Salary Reduction Account" under this Plan,, and (b) each person
on whose behalf an account was maintained under an Acquired Company Plan (i)
shall have with respect to the deemed investment of such account balance and
distributions from such account all of the rights of "Eligible Persons" under
this Plan with respect to Participant accounts maintained under this Plan for
such Eligible Persons, (ii) shall be deemed to be one hundred percent (100%)
Vested in all amounts allocated to the Participant's Salary Reduction Account
under this Plan; and (iii) shall be eligible to make further Contributions to
this Plan as if such former Participant in an Acquired Company Plan were an
"Eligible Person" with respect to this Plan.
3. CONTRIBUTIONS TO PLAN
3.1 Contributions. The Employer shall contribute to this Plan and allocate to
the Participants' Accounts (a) Salary Reduction Contributions, at the direction
of each Participant, as further described in Section 3.2, below, (b) Employer
Matching Contributions, in the discretion of Employer, as further described in
Section 3.3, below, and (c) Employer Discretionary Contributions, in the
discretion of Employer, as further described in Section 3.4, below.
3.2 Salary Reduction Contributions. The Employer shall
contribute to this Plan on behalf of each Participant the amount
of the Participant's Salary Reduction Contributions.
3.2.1 Election. Each Participant desiring to make Salary Reduction Contributions
to this Plan shall complete and deliver to the Plan Administrator a Participant
Election Form, specifying a uniform amount of money, or a uniform percentage of
the Participant's Compensation, which is to be withheld from the Participant's
Compensation during each Pay Period.
A. For each Plan Year, each Participant electing to make any Salary Reduction
Contribution must elect to contribute at least Five Thousand Dollars
($5,000.00) in Salary Reduction Contributions for such Plan Year.
B. The initial election form for each Participant shall be made
within the appropriate period described in Section 2.2,
above. Each subsequent election form which either is
intended to increase the amount of the Participant's Salary
Reduction Contributions, or is to take effect at a time when
the Participant does not have a currently effective election
in place, shall not take effect prior to January 1 of the
first Plan Year beginning after the Plan Year in which such
election form is filed with and accepted by the Plan
Administrator.
3.2.2 As contemplated by Section 1.8(c)(i), above, such Salary Reduction
Contribution may apply to income attributable to Participant's exercise of
options to acquire the capital stock of Employer. Any Salary Reduction
Contribution attributable to such income shall be made at the time and in the
manner designated by the Plan Administrator from time to time.
A. Once a Participant Election Form has been delivered to and accepted by the
Plan Administrator, the election reflected on that form shall remain in
effect until either (1) it is revoked or modified pursuant to Section
3.2.2, below, or (2) this Plan is terminated.
B. Notwithstanding any other provision of this Plan to the contrary, in no
event may a Participant elect to make an amount of Salary Reduction
contributions to the Plan which would cause the Participant's remaining
Compensation to be less than the amount of social security taxes and other
wage withholding amounts due to cognizant taxing authorities with respect
to the Participant's Compensation.
3.2.3 Irrevocable Elections. A Participant from time to time may reduce the
amount of the Participant's Salary Reduction Contributions, or revoke a prior
election to make Salary Reduction Contributions to the Plan, by delivering to
the Plan Administrator a new Participant Election Form, specifying the new
amount, if any, of the Participant's Salary Reduction Contribution. Any such new
election form shall not be effective prior to the first day of the first Plan
Year beginning at least fifteen (15) days after such form is filed with and
accepted by the Plan Administrator. An election to increase the amount of Salary
Reduction Contributions shall not take effect prior to April 1 of the calendar
year following the calendar year in which such election form is filed with and
accepted by the Plan Administrator.
3.2.4 Allocation. The entire amount of the Salary Reduction Contributions of
each Participant shall be allocated to the Salary Reduction Account of that
Participant at the time required by Section 3.5.1, below.
3.2.5 Suspension of Contributions. The Participant's right to make Salary
Reduction Contributions shall be suspended during the twelve-month period
described in Section 6.3.3, below.
3.3 Employer Matching Contributions. The Employer from time to time may elect,
in its sole and absolute discretion, to make Employer Matching Contributions to
the Plan on behalf of each Participant. If the Employer elects to make such
Contributions for any Plan Year, then the Employer shall contribute to the Plan
in any such Plan Year on behalf of each Participant an Employer Matching
Contribution in an amount equal to such percentage of the Participant's Salary
Reduction Contributions as is determined and announced by the Employer.
3.3.1 Timing. Such Employer Matching Contributions shall be contributed to the
Plan at the same time as the Salary Reduction Contributions with respect to
which the Employer Contributions are being made.
3.3.2 Allocation. The entire amount of the Employer Matching Contributions of
each Participant shall be allocated to the Employer Matching Account of that
Participant.
3.4 Employer Discretionary Contributions. The Employer may elect, from time to
time and in its sole and absolute discretion, to make Employer Discretionary
Contributions to the Plan in such amount, if any, as the Employer deems
appropriate.
3.4.1 Notice to Participants. If the Employer elects to make any such Employer
Discretionary Contributions to the Plan with respect to any Plan Year, then as
soon as practicable after the date on which such Contribution is made by the
Employer, the Employer shall advise the Participants of the amount of such
Contribution and the manner in which such Contribution shall be allocated to the
Employer Discretionary Accounts of the Participants.
3.4.2 Allocation. It is contemplated that the Employer may use Employer
Discretionary Contributions either (a) to encourage Participants to make Salary
Reduction Contributions, (b) to reward selected Participants in varying amounts,
or (c) to reward all Participants generally in a consistent manner. Therefore,
all such Employer Discretionary Contributions shall be allocated to the Employer
Discretionary Accounts of Participants in such manner as the Employer may
announce from time to time, and the Employer shall not be required to use in one
Plan Year the same formula for making such allocations as the Employer used for
making such allocations in any other Plan Year. The Employer shall have the
discretion to direct that such allocations be made:
A. In proportion to the compensation of each Participant;
B. In proportion to the compensation of Participants making
Salary Reduction Contributions during the period with
respect to which the Employer Discretionary Contribution is
made;
C. In accordance with the account balances of all Participants;
D. In proportion to the Salary Reduction Contributions of
Participants making such Contributions during the period
with respect to which the Employer Discretionary
Contribution is being made;
E. Only to the Employer Discretionary Accounts of specifically
named Participants;
F. In a manner combining some one or more of the foregoing
methods; or
G. In such other manner as the Employer, in its sole and
absolute discretion, may select from time to time.
3.4.3 Allocations for Active Insured Participants. In addition to other
allocations permitted or required under this Plan, Employer shall credit to the
Employer Discretionary Account of each Active Insured Participant the amounts
required pursuant to Section 4.2.4(b), below. Such amount shall be credited
within the time period specified in such Section 4.2.4(b).
3.5 Timing of Allocations. Contributions to this Plan shall be
allocated to the each Participant's Accounts as follows:
3.5.1 Salary Reduction Contributions. With respect to Salary Reduction
Contributions, the amount of such contribution for each Participant shall be
allocated to the Salary Reduction Account of the Participant within five (5)
business days after the end of the Pay Period with respect to which such Salary
Reduction Contribution has been withheld from the Compensation of the
Participant.
3.5.2 Employer Matching Contributions. Employer Matching Contributions shall be
allocated to the Employer Matching Account of each Participant at the same time
as the Salary Reduction Contribution with respect to which it is being made is
required to be allocated to the Participant's Salary Reduction Account pursuant
to Section 3.5.1, above.
3.5.3 Employer Discretionary Contributions. With respect to Employer
Discretionary Contributions, the contribution shall be allocated to the Employer
Discretionary Account of each Participant entitled to receive an allocation at
the time designated by the Employer in its notice to Participants regarding such
contribution.
4. ACCOUNTS AND VESTING
4.1 Participant's Accounts. There shall be established on
behalf of each Participant (a) a Salary Reduction Account, (b) an
Employer Matching Account, and (c) an Employer Discretionary
Account.
4.2 Vesting. Each Participant:
4.2.1 Salary Reduction Account. At all times shall be one hundred
percent (100%) Vested in all amounts allocable to the
Participant's Salary Reduction Account pursuant to this Plan.
4.2.2 Employer Matching Account. Shall become Vested in amounts allocated to the
Participant's Employer Matching Account on the basis of completed Years of
Service, at the rate per Year of Service, and over the period of time, specified
by the Employer (in its discretion) at the time it makes such Contributions. The
Employer may, inter alia, apply different Vesting schedules in different years,
and also use different Vesting schedules for different Participants from time to
time.
4.2.3 Employer Discretionary Account. Shall become Vested in
amounts allocated to the Participant's Employer Discretionary
Account at such time, and in such manner, as the Employer (in its
sole discretion) may designate.
4.2.4 Deceased Participant. Upon the death of the Participant (a) automatically
shall become fully Vested in all amounts allocated to the Participant's Accounts
under this Plan, and (b) if such Participant is an Active Insured Employee,
automatically shall receive a credit to such Participant's Employer
Discretionary Account under this Plan a fully vested credit of One Hundred
Thousand Dollars ($100,000.00) effective not later than thirty (30) days
following the date of such Participant's death.
4.3 Adjustments to Account Balances. The balance in each of the
Participant's Accounts shall be:
4.3.1 Increases. Increased by (a) the amount of the Contributions required to be
allocated to such account pursuant to Section 3, above, (b) the amount of
forfeitures allocated to the account pursuant to Section 4.4, below, and (c) the
amount of income, gain, and other earnings allocable to such account in
accordance with the provisions of Section 5, below.
4.3.2 Decreases. Decreased by (a) the amount of distributions deemed to be paid
to the Participant or his Beneficiaries from such account, (b) the amount of
deemed investment losses allocable to such account from time to time in
accordance with Section 5, below, (c) the amount of expenses allocable to such
account from time to time pursuant to Section 7.7, below, (d) the amount of
forfeitures by the Participant pursuant to Section 4.4, below, and (d) with
respect to the Employer Matching Account and the Employer Discretionary Account,
the amount which is forfeited pursuant to Section 4.4, below.
4.4 Forfeiture. If a Participant's employment (or, with respect to a Director,
such Director's status as a Director) with the Employer or an Affiliate (or,
with respect to Directors, is not again elected as a Director of the Employer or
an Affiliate) is terminated for any reason, and the Participant is not
re-employed by the Employer or an Affiliate (or, with respect to Directors, is
not again elected as a Director of the Employer or an Affiliate) with ninety
(90) days after the effective date of such termination, then the Participant
shall forfeit all rights to any amounts allocated to any of the Participant's
Accounts in which the Participant is not then Vested. The amount of any such
forfeitures under this Section 4.4 shall, in the discretion of the Employer
determined annually, either be (a) reallocated to the remaining Participants in
such manner in which the Employer may announce from time to time, or (b) held in
a suspense account and thereafter applied in such manner as the Employer shall
direct.
4.5 Accounting and Reports. Promptly after the end of each calendar quarter
during each Plan Year, the Plan Administrator shall cause to be delivered to
each Participant a statement summarizing transactions with respect to the
amounts allocated to each Participant's Account during, and the balance
allocated as of the last day of, the immediately preceding calendar quarter.
5. DEEMED INVESTMENT OF ACCOUNTS
5.1 Investment Options. The Employer shall designate and notify Participants
from time to time of those Investment Options in which the amounts credited to
the Participants' Accounts may be deemed to be invested.
5.2 Deemed Investments. The balance in each Participant Account
shall be deemed to be invested as follows:
5.2.1 Directed Investment. If and to the extent that the Participant has made an
election to have the balance in the Participant's Accounts invested in one or
more Investment Options, such balance shall be deemed to be invested in such
Investment Options in the manner contemplated by the Participant's Investment
Election Form from time to time.
5.2.2 Default Investment. If the Participant has not timely and properly filed
an Investment Election Form in accordance with this Plan, or if any such form
does not direct the investor of the entire balance in the Participant's account,
then the balance of the Participant's Account (or any portion thereof not
subject to a proper Investment Election Form) shall be deemed to be invested in
such manner, if any, as the Employer may announce from time to time. It is
contemplated that if the Employer elects to treat such portion of the
Participant's Accounts as being invested in a "default" investment, then any
such default investment will generate only minimal deemed returns consistent
with such investment in instruments as short-term money market instruments. The
Company shall not be obligated to invest any monies in any such Investment
Options; rather, such deemed investments are intended merely to provide a basis
for accounting for changes in the amount of Participant's account balance under
this Plan.
5.3 Changes in Investment Elections. A Participant may modify such Participant's
Investment Election Form in order to change the manner in which all or any
portion of the balance in the Participant's Account shall be deemed to be
invested. A Participant may make such an election not more frequently than once
in each calendar month, effective as of the first day of such calendar month,
provided that the Participant delivers written notice of such change (on such
form as the Plan Administrator may specify from time to time) at least five (5)
days prior to the first day of such calendar month.
5.4 Crediting Account Balances. All income, gain, loss, and expense attributable
to an Investment Option shall be deemed to be credited to the balance in a
Participant's account as of the time as of which such amount would have been
credited to such account if the amount deemed invested in such Investment Option
actually had been invested in such Investment Option.
5.5 Change in Options Offered. The Employer from time to time may change the
Investment Options offered to Participants under this Plan. If, as a result of
any such change, an Investment Option previously offered under this Plan is no
longer offered, then the amount then invested in such Investment Option
thereafter shall be deemed to be invested in (a) such other Investment Option as
is selected by the Participant, or (b) in the absence of such a selection, in
such default Investment Option as is offered by the Employer pursuant to Section
5.2.2, above.
6. DISTRIBUTIONS
6.1 Distribution Events. A Participant shall not be entitled to
receive any portion of the amount credited to such Participant's
Accounts prior to the occurrence of any one or more of the
following events:
6.1.1 Death. The death of the Participant;
6.1.2 Disability. The Participant has become Disabled;
6.1.3 Election. As soon as administratively feasible after the
date designated by the Participant as the date on which the
balance in the Participant's Account is to be distributed to the
Participant or his Beneficiary;
6.1.4 Hardship. There has occurred with respect to the
Participant an Event of Hardship.
6.1.5 Retirement. The Retirement of the Participant.
6.2 Timing of Distributions.
6.2.1 Election. Subject to Section 6.2.2, below, when a Participant files an
election to make Salary Reduction Contributions for any Plan Year, the
Participant may elect to receive such Salary Reduction Deferrals and earnings
thereon either (a) upon termination of the Participant's employment or other
service engagement with the Employer or an Affiliate, or (b) at such other time
as the Participant then may designate.
A. If the Participant elects to receive such Contributions and earnings
thereon at termination of employment (or other service engagement) with
the Employer or an Affiliate, then such election shall be irrevocable.
B. If the Participant later terminates employment by reason of
Retirement or Disability, then the amount distributable to
the Participant shall be distributable, at the election of
the Participant, either (i) in substantially equal quarterly
installments over a period of ten (10) years, or (ii) in
substantially equal quarterly installments over a period of
either five (5) or fifteen (15) years, or (iii) in one lump
sum; provided, if the Participant's Participant Account
balance is less than Fifty Thousand Dollars ($50,000.00) as
of the date on which distributions first become payable to
the Participant, then the Participant shall be entitled to
receive such distributions only in a lump sum.
C. If the Participant's employment or other service engagement with the
Employer or an Affiliate terminates other than by reason of the
Participant's Retirement or Disability, then the entire amount
distributable to the Participant shall be paid in a lump sum.
6.2.2 Scheduled In-Service Distributions. If pursuant to Section 6.2.1, above,
the Participant has elected to receive a distribution of the Participant's
account while the Participant is still employed by (or otherwise providing
services to) the Employer or an Affiliate, then:
A. Such distributions shall commence in any year which is at
least two (2) years after the Plan Year in which the Salary
Reduction Contributions are credited to the Participant's
account;
B. The Participant may elect to receive the amount
distributable to the Participant either (i) in one lump sum,
or (ii) in substantially equal quarterly installments over a
period of two (2), three (3), four (4), or five (5) years;
provided, if the total amount distributable to the
Participant is Twenty-five Thousand Dollars ($25,000.00) or
less when amounts first become distributable to the
Participant, then the entire amount shall be paid to the
Participant in one lump sum; and
C. If a Participant is receiving in-service quarterly installment
distributions and while receiving such distributions terminates
employment, then the remainder of the installments will be paid to the
Participant as a lump sum as promptly as practicable after termination of
employment (or other service engagement).
6.2.3 Non-Scheduled In-Service Distributions. Any Participant at any time may
elect, while still employed by the Employer or an Affiliate (or while serving as
a Director), to receive a distribution of such Participant's Vested balance in
the Participant's account under this Plan, subject to the following limitations:
A. Such election may be made only by filing with the Plan Administrator prior
to the end of any calendar month for which a distribution is requested
such early distribution form as the Plan Administrator may specify.
B. By reasons of the forfeiture provision set forth in Paragraph D, below,
the maximum amount of any distribution under this Section 6.2.3 shall not
exceed the amount by which (i) the Participant's Vested account balance
immediately prior to the distribution, exceeds (ii) the amount forfeited
under Paragraph D, below.
C. The amount distributable to the Participant pursuant to this Section 6.2.3
may be paid only in a single cash lump sum as soon as practicable after
the end of the calendar month in which the distribution election is made
and the proper form is filed with the Plan Administrator.
D. Concurrently with the distribution of the amount distributed to the
Participant to this Section 6.2.3, the Participant shall forfeit an amount
equal to ten percent (10.0%) of the gross amount distributed to the
Participant pursuant to this Section 6.2.3, and the Employer shall not
have any further obligations to the Participant or his beneficiary with
respect to such forfeited amount.
E. The Participant thereafter shall not be eligible to make any further
Salary Reduction Contributions to the Plan for the remainder of the Plan
Year in which such distribution is made under this Section 6.2.3 and for
the entire following Plan Year.
6.2.4 Deceased Participant. If:
A. A Participant dies, then the Participant's entire account
balance shall be paid, in one lump sum, to the Participant's
named beneficiary; and
B. A terminated Participant who is receiving distributions dies, then the
beneficiary named by such Participant shall continue receiving the
remainder of the quarterly installments as they become due.
6.3 Event of Hardship. A Participant requesting a distribution by reason of the
occurrence of an Event of Hardship shall submit an application for such
distribution on such form as the Plan Administrator shall prescribe, together
with such additional information reasonably requested by the Plan Administrator.
The Plan Administrator shall endeavor to make, as promptly as practicable, its
determination as to whether the Participant is entitled to receive any
distribution by reason of the occurrence of an Event of Hardship.
6.3.1 Determination by Administrator. The final determination as to whether an
Event of Hardship has occurred, and the extent to which a distribution may be
made by reason of such event, shall be made by the Plan Administrator, in its
sole and absolute discretion, on the basis of the principles set forth in this
Plan. Neither the Employer nor the Plan Administrator shall have any liability
whatsoever with respect to any determination of whether an Event of Hardship may
have occurred.
6.3.2 Determination and Distribution. The determination of whether an Event of
Hardship has occurred, and whether a distribution shall be made by reason of
such event, shall depend upon the particular circumstances surrounding each
situation. A distribution:
A. Shall not be made to the extent that the Participant's severe financial
hardship may be relieved (i) through reimbursement or compensation by
insurance or otherwise, (ii) by liquidation of the Participant's assets,
to the extent the liquidation of such assets would not itself cause severe
financial hardship, or (iii) by cessation of Salary Reduction
Contributions under this Plan.
B. Shall be permitted only to the extent reasonably needed to
satisfy the Participant's emergency needs caused by the
Event of Hardship.
6.3.3 Suspension of Contributions. A Participant who receives a distribution
pursuant to Section 6.1.4, above, shall not be entitled to make further Salary
Reduction Contributions to the Plan for a period of twelve (12) months after the
date of the distribution under Section 6.1.4.
6.4 Change in Distribution Election. Subject to Section 6.2.1A, above, a
Participant who has made an election designating the calendar year in which a
distribution is to be made to the Participant pursuant to Section 6.2.1, above,
may change such election by designating another calendar year for such
distribution, provided (a) such election is made on a form prescribed by the
Plan Administrator, (b) such form is filed by the Participant with the Plan
Administrator prior to the calendar year in which the distribution to the
Participant was to be made pursuant to the previous election form (and prior to
the commencement of any distributions under this Plan), (c) the new date for the
distribution occurs in a calendar year subsequent to the calendar year in which
the Participant is filing the new election form, and (d) the Plan Administrator,
in its sole discretion, consents to the change.
6.5 Crediting Distributions. Unless a Participant elects otherwise, any
distribution of less than the entire amount credited to the Participant's
Accounts of a Participant shall be deducted pro rata from each account and shall
be deducted pro rata within each account in each Investment Option in which the
balance in such account is deemed to be invested.
6.6 Withholding. The amount payable to a Participant or Beneficiary under this
Plan shall be subject to applicable federal and state withholding taxes, and the
Plan Administrator may withhold from the distribution such amount as may be
necessary to comply with applicable tax withholding rules.
6.7 Appeals Procedure. If a claim for benefits under this Plan is wholly or
partly denied by the Plan Administrator, then the Participant may request a
review of that decision by submitting to the Employer, not later than sixty (60)
days after receiving notice of the Plan Administrator's decision, a written
request for review of such decision. Within sixty (60) days of receiving such
application, the Employer shall review the application, hold such hearings as
the Employer, in its sole and absolute discretion, deems appropriate, and advise
the Participant, in writing, of its decision. If the decision on review is not
provided within such sixty-day period, then the application for appeal shall be
deemed to be denied.
7. ADMINISTRATION
7.1 Duties of Plan Administrator. The Plan Administrator shall administer the
Plan in accordance with its terms, for the exclusive benefit of Participants, in
a manner designed to achieve the Employer's objectives of:
7.1.1 Deferral. Deferring until the date of a distribution pursuant to Section
6, above, the year in which each Participant must include in income the balance
credited to the Participant's Accounts under this Plan; and
7.1.2 ERISA Exemption. Limiting participation in the Plan to only a select group
of management and highly compensated employees in order to ensure that the Plan
is exempt from ERISA to the maximum extent permissible.
7.2 Powers of Plan Administrator. The Plan Administrator shall have full power
and authority to administer and carry into effect the terms and conditions of
the Plan, subject to applicable requirements of law. Such power shall include,
but not be limited to, the power to:
7.2.1 Interpret Elections. Interpret election forms delivered by
Participants and to reject or fail to abide by any such form
which the Plan Administrator determines to be incomplete,
incorrect, or ambiguous.
7.2.2 Rules and Regulations. Make and enforce such reasonable rules and
regulations as the Plan Administrator deems necessary or proper for the
efficient administration of the Plan, including the establishment of any claims
procedures that may be required by applicable provisions of law;
7.2.3 Interpretation. Interpret in good faith the terms and
conditions of this Plan;
7.2.4 Resolution. Resolve all questions concerning the Plan and
the eligibility of any Employee to participate in the same; and
7.2.5 Agents. Appoint and retain such agents, counsel, accountants, consultants,
and other persons as may be necessary or appropriate to assist in the
administration of the Plan.
7.3 Inability to Locate Participant. If the Plan Administrator is unable to
locate a Participant within two (2) years after the Participant becomes entitled
to receive a distribution pursuant to Section 6.1, above, and the Plan
Administrator has given to the Participant and any named Beneficiaries of such
Participant (by certified or registered mail, return receipt requested, at the
last known mailing address which such Participant supplied the Plan
Administrator for the Participant and Beneficiaries for purposes of this Plan)
written notice of the Participant's entitlement to receive a distribution
pursuant to this Plan, then at the end of such two-year period the Participant
shall forfeit his right to receive all amounts then credited to the
Participant's accounts and the Employer no longer shall have any obligation to
make any distribution or payment to the Participant or any Beneficiary pursuant
to this Plan.
7.4 Records. The Plan Administrator shall establish and maintain such records as
are necessary or appropriate to the efficient administration of the Plan. Each
Participant, upon reasonable advance notice to the Plan Administrator, shall be
entitled to inspect such of those records as pertain to that Participant.
7.5 Filing. The Plan Administrator shall timely file all forms that may be
required to be filed with respect to the Plan pursuant to the Code, ERISA, or
other provisions of law.
7.6 Indemnification. The Employer shall indemnify, defend, and hold the Plan
Administrator free and harmless from and against any and all liabilities,
damages, costs and expenses, including reasonable attorneys' fees, occasioned by
any actions which the Plan Administrator takes, or fails to take, in good faith,
in connection with the administration of the Plan.
7.7 Expenses. The Employer may charge the Participant's
Accounts with the reasonable costs of maintaining and
administering the Plan.
8. AMENDMENT AND TERMINATION
8.1 Reserved Power. This Plan may be amended or terminated at
any time by a written instrument executed by the Employer.
8.2 Effect of Termination. If the Employer elects to terminate
the Plan, then:
8.2.1 Vested Amounts. Such termination shall not affect the obligation of the
Employer to make distributions to the Participant (or his Beneficiaries) of an
amount equal to (a) the portion of the amounts then credited to the
Participant's Accounts in which the Participant is Vested, and (b) any Earnings
subsequently credited to such Vested balance prior to the time such amount is
distributed to the Participant.
8.2.2 Unvested Amounts. The Employer may elect to occasion the
forfeiture of any portion of the amounts then credited to the
Participant's Accounts in which the Participant is not then
Vested; and
8.2.3 Subsequent Investment Options. The Employer may elect, in connection with
such termination, to designate a single Investment Option in which each
Participant's Vested balance in the Participant's Accounts thereafter shall be
deemed to be invested. The Employer shall not have any duty to select an
Investment Option which maximizes the deemed investment return to the
Participants.
9. MISCELLANEOUS
9.1 Prohibition Against Assignment. No portion of the amount credited to a
Participant's Account under this Plan may be voluntarily or involuntarily
encumbered, attached, garnished, or otherwise involuntarily taken by any
creditor or claimant.
9.2 Unfunded Plan. This Plan is intended to be an unfunded plan of deferred
compensation payable solely from the general assets of the Employer, and the
Employer does not intend to establish any special fund or account from which the
amounts payable under this Plan shall be paid. Neither the establishment and
maintenance of this Plan, any express or implied term of this Plan, nor any
provision of law shall be construed to impose on the Employer any obligation to
establish or maintain any such special fund or account. No Participant or any
other person shall have any right or claim under this Plan, except as an
unsecured creditor of the Employer. Any reference to a "contribution to" this
Plan shall be deemed merely a reference to amounts that are to be allocated to
the account of a Participant under the Plan, and any reference to a
"distribution from" this Plan shall be deemed to be merely a reference to the
amount of the payment which the Participant is entitled to receive under the
terms of this Plan.
9.3 No Employment Rights. Neither the adoption and maintenance
of this Plan, nor any express or implied provision of this Plan,
shall be deemed:
9.3.1 Contract. To constitute a contract between the Employer and
any person, or to be a consideration for or an inducement or
condition of, the employment of any person;
9.3.2 Right. To give any person the right to be retained in the
employ of the Employer;
9.3.3 Discharge. To interfere with the right of the Employer to
discharge any Employee (including any Participant) at any time; or
9.3.4 Continuing Employment. To give the Employer the right to
require an Employee to remain in the employ in the Employer, or
to interfere with an Employee's right to terminate his employment
at any time.
9.4 Application of ERISA. The Employer intends that this Plan shall be exempt
from ERISA to the maximum extent that an employee benefit plan benefiting only a
select group of management or highly compensated employees may be exempt from
ERISA.
9.5 Exclusive Benefit. The Employer shall administer this Plan
for the exclusive benefit of the Participants and Beneficiaries.
9.6 Interpretation. As used in this Plan, the masculine, feminine, and neuter
gender and the singular and plural numbers each shall be deemed to include the
other whenever the context indicates or requires. The captions to various
sections of this Plan are for convenience of reference only, and shall not
affect in any way the meaning or interpretation of this Plan.
9.7 Governing Law. This Plan shall be construed, administered, and enforced in
accordance with the laws of the State of California, and in such manner as is
necessary to permit the Plan to accomplish the objectives of the Employer set
forth in Recital B, above.
IN WITNESS WHEREOF, the undersigned Employer has executed this Plan,
effective as of the Effective Date specified above.
- - - - - - - -----------------------------
Date
"EMPLOYER":
PACIFIC CAPITAL BANCORP, a California corporation
By:__________________________________
Jay D. Smith, Senior Vice President
EXHIBIT A
Participant in Acquired Company Deferred Compensation Plan
Andrews, David
Briscoe, Dirian
Bua, Robert
Burnham, Suzanne
Harner, Mark
Love, Michael
Marandos, Anthony
Morganthaler, Mark
Morris, Penny
Parker, Sandra
Riba, Linda
Exhibit 10.1.13.1
TRUST AGREEMENT UNDER
PACIFIC CAPITAL BANCORP DEFERRED COMPENSATION PLAN
THIS TRUST AGREEMENT UNDER PACIFIC CAPITAL BANCORP DEFERRED COMPENSATION
PLAN (the "Agreement") is made and entered into, effective on the date set forth
below, by and between PACIFIC CAPITAL BANCORP, a California corporation
("Pacific Capital" or "Employer"), and SANTA BARBARA BANK & TRUST, a California
corporation ("Trustee"), with reference to the following facts:
RECITALS:
A. Pacific Capital is the owner of all the outstanding capital stock of
certain "Affiliates," as defined below, and has adopted that certain "Deferred
Compensation Plan" effective as of December 15, 1999 (the "Plan"), to provide
deferred compensation benefits to a select group of management or highly
compensated employees of Pacific Capital and those Affiliates.
B. Pacific Capital has incurred liability, and expects to incur further
liability, under the terms of the Plan, and it is the intention of Pacific
Capital to make contributions to the Trust in order to provide a source of funds
to assist Pacific Capital in meeting its liabilities under the Plan.
C. Pacific Capital wishes to establish a trust (hereinafter called the
"Trust") and Pacific Capital intends to contribute to the Trust and "Subtrusts"
hereunder certain assets that shall be held therein, subject to the claims of
the creditors of Pacific Capital or such Affiliate in the event of the
"Insolvency" (as herein defined) of Pacific Capital or such Affiliate (as the
case may be) which employs any Participant, until paid to participants in the
Plan (the "Participants") in such manner and at such time specified in the Plan
document.
D. It is the intention of Pacific Capital and each Affiliate that this
Trust shall constitute an unfunded arrangement and shall not affect the status
of the Plan as an unfunded plan for the payment of deferred compensation.
AGREEMENTS:
NOW, THEREFORE, the parties hereto do hereby establish the Trust and agree
that the Trust shall be comprised, held, and disposed of as follows:
1. DEFINITIONS
For purposes of this Agreement:
1.1 "Acquired Company Deferred Compensation Plans" shall mean (a) that certain
Executive Compensation Deferral Plan sponsored by South Valley National Bank, a
California corporation, pursuant to certain resolutions adopted by the Board of
Directors of South Valley National Bank as of March 24, 1998, and (b) that
certain Executive Compensation Deferral Plan sponsored by First National Bank of
Central California as adopted by the Board of Directors of First National Bank
of Central California as of March 24, 1998, and (c) that certain Executive
Compensation Deferral Plan formerly sponsored by Pacific Capital Bancorp, a
California corporation that was acquired by Employer in a transaction that
closed effective December 30, 1998, as adopted by the Board of Directors of such
corporation as of March 24, 1998.
1.2 "Affiliate" means all the outstanding capital stock which is
owned by Employer.
1.3 "Insolvency" means that the Participating Company (a) is unable to pay its
debts as they become due, or (b) is subject to a pending proceeding as debtor
under the United States Bankruptcy Code, as amended.
1.4 "Pacific Capital" means PACIFIC CAPITAL BANCORP, a California corporation,
which is the sponsor and a trustor of this Trust.
1.5 "Participant" shall have the meaning ascribed to such term
in the Plan.
1.6 "Participating Company" shall mean Pacific Capital and each
Affiliate.
1.7 "Participating Company Trust" shall mean a separate Trust established for
Pacific Capital and for each of its Affiliates which employs a Participant in
the Plan on whose behalf contributions are made to this Trust.
1.8 "Plan" means the Pacific Capital Bancorp Deferred Compensation Plan dated
effective December 15, 1999, as amended from time to time.
1.9 "Subtrust" shall mean a separate subtrust established for each Participant
pursuant to Section 3.3, below.
Each other capitalized term which appears in this Agreement and is not defined
herein shall have the meaning ascribed to such term in the Plan.
2. ESTABLISHMENT OF TRUST
2.1 Deposit. Pacific Capital hereby deposits with Trustee in trust the sum of
One Dollar ($1.00), which shall become the principal of the Trust to be held,
administered, and disposed of by the Trustee as provided in this Trust
Agreement.
2.2 Irrevocable. The Trust hereby established shall be
irrevocable by any Participating Company.
2.3 Grantor Trust. The Trust is intended to be a grantor trust, of which Pacific
Capital and each Affiliate, in each instance as an Participating Company and
only to the extent of contributions actually made by the Participating Company,
is the grantor, within the meaning of Subpart E, Part I, Subchapter J, Chapter
1, Subtitle A of the Internal Revenue Code of 1986, as amended, and shall be
construed accordingly.
3. FUNDING
3.1 Contributions.
3.1.1 Amount. Each Participating Company shall contribute to the Trust an amount
equal to the amount deferred for the Plan Year by each Participant. Each
Participating Company may also contribute cash to the Trust an amount
approximately equal to the "cost of insurance" (as defined in the pertinent
insurance policy owned by the Participating Company Trust) needed to fund the
death benefits described in Section 4.2.4 of the Plan; provided that such
obligation shall not apply with respect to any insurance policy if the
Administrator has directed the Trustee to discontinue such policy. The
Administrator may direct the Trustee to discontinue the policy for any reason,
without regard to whether Section 4.2.4 of the Plan is in effect, whether a
policy has been issued on the Participant or otherwise.
3.1.2 Principal and Income. Except as otherwise provided herein, all
contributions received pursuant to Section 3.1.1, above, together with the
income therefrom and any increment thereon, shall be held, managed and
administered by Trustee as a Participating Company Trust pursuant to the terms
of this Trust Agreement without distinction between principal and income.
3.1.3 Trust Assets. The principal of the Trust and any earnings thereon shall be
held separate and apart from other funds of Participating Company and shall be
used exclusively for the uses and purposes of Plan Participants and general
creditors as herein set forth. Trust Beneficiaries shall not have any preferred
claim on, or any beneficial ownership interest in, any assets of the Trust prior
to the time such assets are paid to Trust Beneficiaries as benefits as provided
in Section 4, below, and all rights created under this Trust Agreement shall be
mere unsecured contractual rights of Trust Beneficiaries against the
Participating Company or Participating Company Trust. Any assets held by the
Trust will be subject to the claims of the Participating Company's general
creditors under federal and state law in the event of the Insolvency of the
Participating Company, provided however, that the only Trust Assets subject to
the claims of a Participating Employee's general creditors shall be those assets
allocated to the Participating Company Trust maintained for such Participating
Company.
3.2 Participating Company Trusts.
3.2.1 Creation. The Trustee shall establish a separate Participating Company
Trust for each Participating Company and credit the amount of contributions made
by each Participating Company to that Participating Company's Trust. Each
Participating Company Trust shall reflect a Participating Company's interest in
the assets of the Trust Fund and shall not require any segregation of particular
assets.
3.2.2 Asset Rollovers. In addition to holding in such Participating Company
Trusts the contributions made thereto by the Participating Company from time to
time, the Trustee shall deposit into each such Participating Company Trusts the
amounts designated by the Participating Company as rollover assets from trusts
that were created under any Acquired Company Plan to hold assets corresponding
to the accounts of those participants under such Acquired Company Plans who,
pursuant to Section 2.6 of the Plan, have elected to rollover their account
balances from an Acquired Company Plan to the Plan.
3.2.3 Allocations. Following the allocation of assets to the Participating
Company Trusts pursuant to Section 3.2.1, above, the Trustee shall allocate
investment earnings and losses of the Trust Fund among the Participating Company
Trusts in accordance with Section 7.2, below, and as directed by the Employer.
Payments to general creditors pursuant to Section 5, below, shall be charged
against the particular Participating Company Trust and not the Trust as a whole.
3.3 Subtrusts. If directed by the Administrator, the Trustee shall establish a
separate Subtrust for a Participant and credit the amount of such contribution
to that Participant's Subtrust. Each Subtrust shall reflect an individual
interest in the assets of the Trust fund and shall not require any segregation
of particular assets.
3.3.1 Allocations. Following the allocation of assets to Subtrusts pursuant to
this Section 3.3, the Trustee shall allocate investment earnings and losses of
the Trust fund among the Subtrusts in accordance with Section 7, below, and as
directed by Company. Payments to general creditors pursuant to Section 5, below,
shall be charged against the Subtrusts in proportion to their account balances,
except that the payment of benefits to a Trust Beneficiary shall be charged
against the Subtrust established or maintained for such Trust Beneficiary.
3.3.2 Allocations to Subtrust. Amounts allocated to a Participant's Subtrust may
not be utilized to pay benefits to another Participant (or to a Beneficiary of
another Participant). Following payment of a Participant's entire benefit under
the Plan, including payment of a non-scheduled in-service distribution pursuant
to Section 6.2.3 of the Plan (whether by the Trustee pursuant to the terms of
this Trust Agreement or by the Participating Company or by a combination
thereof), any amounts remaining allocated to that Participant's Subtrust shall
be transferred by the Trustee to the Participating Company. In lieu of
transferring such amounts, the Administrator may direct the Trustee to retain
and allocate such amounts in the Trust in accordance with Section 7.3, below.
Following payment of a Participant's entire benefit under the Plan, including
payment of under Section 6.2.3 of the Plan (whether by the Trustee pursuant to
the terms of this Trust Agreement or by the Participating Company or by a
combination thereof), any life insurance policy held with respect to such
Participant shall be transferred by the Trustee to the Participating Company. In
lieu of transferring the policy, the Committee may direct the Trustee to
designate a new beneficiary (which may be the Participating Company) under the
policy or cash in the applicable Policy and cause such proceeds to be retained
in Trust and allocated in accordance with Section 7.3, below.
4. PAYMENTS TO PARTICIPANTS AND BENEFICIARIES
4.1 Payment Schedule. Pacific Capital shall deliver to the Trustee a schedule
(the "Payment Schedule") that (a) indicates the amounts payable to each
Participant and Beneficiary, and (b) provides a formula or other instructions
acceptable to the Trustee for determining the amount so payable, the form in
which such amount is to be paid (as provided for or available under the Plan),
and the time for commencement of payment of such amounts. Except as otherwise
provided in this Agreement, the Trustee shall make payments to the Participants
and Beneficiaries in accordance with such Payment Schedule. If Subtrusts have
been established for Participants, then the payment being made to any
Participant (or his beneficiary) shall be made solely from the Subtrust
established for the benefit of such Participant. The Trustee shall make
provisions for the reporting and withholding of any federal, state or local
taxes that may be required to be withheld with respect to the payment of such
amounts pursuant to the Plan and shall pay amounts so withheld to the
appropriate taxing authorities or determine that such amounts have been
reported, withheld and paid by Pacific Capital.
4.2 Determination of Entitlement. The entitlement of a Participant (or the
Participant's Beneficiaries) to payments under the Plan shall be determined by
Pacific Capital or such party as Pacific Capital shall designate under the Plan,
and any claim for such payments shall be considered and reviewed under the
procedures set out in the Plan.
4.3 Payments by Participating Company. A Participating Company may make payment
directly to the Participants and Beneficiaries of amounts that become due under
the terms of the Plan. The Participating Company shall notify the Trustee of its
decision to make payment of benefits directly prior to the time amounts are
payable to Participants and their Beneficiaries. In addition, if the principal
of the Trust, and any earnings thereon, are not sufficient to make payment of
benefits in accordance with the terms of the Plan, then the Participating
Company shall make the balance of each such payment as it becomes due. The
Trustee shall notify the Participating Company whenever the principal of the
Trust and earnings thereon are not sufficient to make required payments.
5. PAYMENTS UPON PARTICIPATING COMPANY INSOLVENCY
5.1 Insolvent. If any Participating Company becomes Insolvent, then the Trustee
shall cease making payments to any Participants (and their Beneficiaries) from
the Participating Company Trust maintained on behalf of such Participating
Company.
5.2 Claims of General Creditors. At all times during the continuance of this
Trust, the principal and income of each Participating Company Trust shall be
subject under federal and state law to the extent set forth below to claims of
general creditors of the Participating Company on whose behalf such
Participating Company Trust is maintained.
5.2.1 Notice to Trustee. The Board of Trustees and the Chief Executive Officer
of each Participating Company shall have the duty to inform the Trustee, in
writing, if such Participating Company becomes Insolvent.
5.2.2 Claim by Creditor. If a person claiming to be a creditor of a
Participating Employer alleges in writing to the Trustee that such Participating
Company has become Insolvent, then the Trustee shall determine whether such
Participating Company is Insolvent and, pending such determination, the Trustee
shall discontinue payment of benefits to the Participants (and their
Beneficiaries) on whose behalf such Participating Company made contributions to
the Trust.
5.3 Trustee Inquiries and Reliance. Unless the Trustee has actual knowledge of a
Participating Company's Insolvency, or has received notice from a Participating
Company or a person claiming to be a creditor of a Participating Company
alleging that such Participating Company is Insolvent, the Trustee shall have no
duty to inquire whether a Participating Company is Insolvent. The Trustee in all
events may rely on such evidence concerning a Participating Company's solvency
that is furnished to the Trustee and that provides the Trustee with a reasonable
basis for making a determination regarding a Participating Company's solvency.
5.4 Disposition of Assets. If at any time the Trustee has determined that a
Participating Company is Insolvent, then the Trustee shall discontinue payments
from the Participating Company Trust maintained for such Participating Company.
5.4.1 Status of Participants. Nothing in this Trust Agreement in any way shall
diminish any rights of Participants and their Beneficiaries to pursue their
rights as general creditors of any Insolvent Participating Company with respect
to benefits due under the Plan or otherwise.
5.4.2 Resumption of Payments. The Trustee shall resume the payment of benefits
to Participants (and their Beneficiaries) in accordance with Section 4 of this
Agreement only after the Trustee has determined that the Insolvent Participating
Company is not Insolvent (or is no longer Insolvent).
5.5 Post-Insolvency Payment. Provided that there are sufficient assets in the
pertinent Participating Company Trust, if the Trustee discontinues the payment
of benefits from the Trust pursuant to Sections 5.1 or 5.2.2, above, and
thereafter resumes such payments, then the first payment following such
discontinuance shall include the aggregate amount of all payments due to
Participants and their Beneficiaries for the period of such discontinuance, less
the aggregate amount of any payments made to Participants and their
Beneficiaries in lieu of the payments provided for hereunder during any such
period of discontinuance.
6. PAYMENTS TO PARTICIPATING COMPANIES
Except as provided in Section 5, above, neither Pacific Capital nor any
other Participating Company shall have any right or power to direct the Trustee
to return to any such entity or to divert to others any of the Trust assets
before all payment of benefits have been made to Participants and their
Beneficiaries pursuant to the terms of the Plan.
7. INVESTMENT AUTHORITY
7.1 Investment. The Trustee shall invest the assets of the Trust (and each
Subtrust, if any) in such stock, securities, obligations, and other assets as
Pacific Capital shall direct from time to time, provided, in no event shall the
Trustee invest in securities or obligations issued by Pacific Capital (other
than an amounts held in common investment vehicles in which the Trustee may
invest). All rights associated with assets of the Trust shall be exercised by
the Trustee or the person designated by the Trustee in such manner as Pacific
Capital shall direct, but in no event shall any such rights be exercisable by or
rest with Plan Participants.
7.2 Disposition of Income and Losses. Subject to Section 7.3, below, all income
received by the Trust, net of expenses, shall be accumulated and reinvested. Any
income or loss attributable to the amount credited to a Participating Company
Trust in accordance with Section 3.1.2, above, and any income or loss thereon,
shall be credited to such Participating Company Trust and reinvested therein.
Any income or loss attributable to the amount credited to a Subtrust pursuant to
Section 3.3, above, and the income or loss thereon, shall be credited to and
reinvested in such Subtrust.
7.3 Excess Assets. If any assets remain in a Subtrust after death benefits are
paid to a Beneficiary in accordance with the terms of the Plan, such excess
assets which remain in the Trust shall be allocated to the Participating
Company's Trust in such manner as the Administrator may designate.
8. DISPOSITION OF INCOME
During the term of this Trust, all income received by the Trust, net of
expenses and taxes, shall be accumulated and reinvested.
9. ACCOUNTING BY TRUSTEE
The Trustee shall keep accurate and detailed records of all investments,
receipts, disbursements, and all other transactions required to be made,
including such specific records as shall be agreed upon in writing by the
Trustee and Pacific Capital. Within forty-five (45) days following the close of
each calendar year and within forty-five (45) days after the removal or
resignation of the Trustee, the Trustee shall deliver to Pacific Capital a
written account of its administration of the Trust during such year or during
the period from the close of the last preceding year to the date of such removal
or resignation, setting forth all investments, receipts, disbursements, and
other transactions effected by it, including a description of all securities and
investments purchased and sold with the cost or net proceeds of such purchases
or sales (including interest paid or receivable being shown separately), and
showing all cash, securities, and other property held in the Trust at the end of
such year or as of the date of such removal or resignation, as the case may be.
10. RESPONSIBILITY OF TRUSTEE
10.1 Standard of Care. The Trustee shall act with the care, skill, prudence and
diligence under the circumstances then prevailing that a prudent person acting
in a like capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims, provided, however, that the
Trustee shall incur no liability to any person for any action taken pursuant to
a direction, request or approval given by Pacific Capital which is contemplated
by, and in conformity with, the terms of the Plan or this Agreement and is given
in writing by Pacific Capital. In the event of a dispute between Pacific Capital
and any other party regarding the amount payable, the Trustee may apply to a
court of competent jurisdiction to resolve the dispute.
10.2 Attorneys' Fees. If the Trustee undertakes or defends any litigation
arising in connection with this Trust, then Pacific Capital agrees to indemnify
the Trustee against the Trustee's costs, expenses, and liabilities (including,
without limitation, attorneys' fees and expenses) relating thereto, and to be
primarily liable for such payments. If Pacific Capital does not pay such costs,
expenses, and liabilities within sixty (60) days of demand therefor and
presentation of an invoice by the person to whom the payment was made or
incurred, then the Trustee may obtain payment of the same from the Trust assets.
10.3 Agents. The Trustee may consult with legal counsel (who also may be counsel
for Pacific Capital generally) with respect to any of its duties or obligations
under this Agreement. The Trustee may hire agents, accountants, actuaries,
investment advisors, financial consultants, or other professionals to assist in
the performance of any of its duties or obligations under this Agreement.
10.4 Powers. Subject to Section 10.5, below, the Trustee shall have, without
exclusion all powers conferred on Trustee by applicable law, unless expressly
provided otherwise in this Agreement, provided, however, that if an insurance
policy is held as an asset of the Trust, then the Trustee shall have no power to
name a beneficiary of the policy other than the Trust or to assign the policy
(as distinct from conversion of the policy to a different form) other than to a
successor trustee, or to loan to any person the proceeds of any borrowing
against such policy.
10.5 Limitation on Powers. Notwithstanding any powers granted to the Trustee
pursuant to this Agreement or applicable law, the Trustee shall not have any
power that could give this Trust the objective of carrying on a business and
dividing the gains therefrom, within the meaning of Section 301.7701-2 of the
Procedure and Administrative Regulations promulgated pursuant to the Internal
Revenue Code.
11. COMPENSATION AND EXPENSES OF TRUSTEE
Pacific Capital shall pay all administrative and Trustee's expenses. If
such fees and expenses are not paid within forty-five (45) days after
presentation of an invoice therefor, then the amount of the fees and expenses
shall be paid from the Trust assets.
12. RESIGNATION AND REMOVAL OF TRUSTEE
12.1 Resignation. The Trustee may resign at any time by written notice to
Pacific Capital, which shall be effective thirty (30) days after receipt of such
notice by Pacific Capital, unless Pacific Capital and the Trustee agree
otherwise.
12.2 Removal. The Trustee may be removed by Pacific Capital upon thirty (30)
days' notice or upon shorter notice accepted by Trustee.
12.3 Transfer of Assets. Upon the resignation or removal of the Trustee and
appointment of a successor Trustee, all assets of the Trust shall subsequently
be transferred to the successor Trustee. The transfer shall be completed within
forty-five (45) days after receipt of notice of resignation, removal, or
transfer unless Pacific Capital extends such time limit.
12.4 Successor. If the Trustee resigns or is removed, then a successor shall be
appointed, in accordance with Section 13, below, prior to the effective date of
such resignation or removal under Sections 12.4 or 12.2, above. If no such
appointment has been made by such time, then the Trustee may apply to a court of
competent jurisdiction for appointment of a successor or for instructions. All
expenses of the Trustee in connection with such proceeding shall be allowed as
administrative expenses of the Trust.
13. APPOINTMENT OF SUCCESSOR
13.1 Appointment. If the Trustee resigns or is removed in accordance with
Sections 12.1 or 12.2, above, then Pacific Capital may appoint any third party,
such as a bank or trust department or other party that may be granted corporate
trustee powers under state law, as a successor to replace the Trustee upon
resignation and removal. The appointment shall be effective when accepted in
writing by the new Trustee, who shall have all the rights and powers of the
former Trustee, including ownership rights in the Trust assets. The former
Trustee shall execute any instrument necessary or reasonably requested by
Pacific Capital or the successor Trustee to evidence the transfer.
13.2 Examination and Indemnity. The successor Trustee need not examine the
records and acts of any prior Trustee and (subject to the express limitations
imposed by this Agreement) may retain or dispose of existing Trust assets. The
successor Trustee shall not be responsible for and Pacific Capital shall
indemnify and defend the successor Trustee from, any claim or liability
resulting from any action or inaction of any prior Trustee or from any other
past event, or any condition existing at the time it becomes successor Trustee.
14. AMENDMENT OR TERMINATION
14.1 Amendment. This Agreement may be amended by a written instrument executed
by the Trustee and Pacific Capital. Notwithstanding the foregoing, no such
amendment shall conflict with the terms of the Plan or make the Trust revocable
after it has become irrevocable.
14.2 Termination. The Trust shall not terminate until the date on which Plan
Participants and their Beneficiaries no longer are entitled to benefits pursuant
to the terms of the Plan. Upon termination of the Trust, any assets remaining in
the Trust shall be returned to Pacific Capital.
14.3 Ratification. Upon written approval of Plan Participants or Beneficiaries
entitled to payment of Benefits under the Plan, Pacific Capital may terminate
this Trust prior to the time all benefit payments under the Plan have been made.
All assets in the Trust at termination of the Trust shall be returned to Pacific
Capital.
15. MISCELLANEOUS
15.1 Effect of Law. Any provision of this Trust Agreement prohibited by law
shall be ineffective to the extent of any such prohibition, without invalidating
the remaining provisions of this Agreement.
15.2 Prohibition Against Assignment. Any benefits payable to Plan Participants
and their Beneficiaries pursuant to this Agreement may not be anticipated,
assigned (either at law or in equity), alienated, pledged, encumbered or
subjected to attachment, garnishment, levy, execution or other legal or
equitable process.
15.3 Governing Law. This Agreement shall be governed by and is
construed in accordance with the terms of the laws of the State
of California.
16. EFFECTIVE DATE
The effective date of this Agreement shall be December 15, 1999.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement,
effective on the date set forth above.
"PACIFIC CAPITAL:"
PACIFIC CAPITAL BANCORP, a California corporation
By:___________________________________
Jay D. Smith, Senior Vice President
- - - - - - - --------------------------------------
Date
"TRUSTEE:"
SANTA BARBARA BANK & TRUST, a California corporation
By:_____________________________________
Name & Title:
- - - - - - - ----------------------------------------
Date
EXHIBIT 23.1
Consent of Arthur Andersen LLP with respect to financial statements of the
Registrant
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report dated February 4, 2000, included in this Form 10-K, into the previously
filed Form S-8 Registration Statements, File Nos. 33-5493, 2-83293, 33-43560,
33-48724, 333-05117, 333-05119 and 333-74831 of Pacific Capital Bancorp
(formerly known as Santa Barbara Bancorp) and subsidiaries.
Los Angeles, California
March 21, 2000
EXHIBIT 23.2
Consent of KPMG LLP with respect to the financial statements of the Registrant.
The Board of Directors
Pacific Capital Bancorp:
We consent to incorporation by reference in the registration statement Nos.
33-5493, 2-83293, 33-43560, 33-48724, 333-05117, 333-05119, and 333-74831 on
Form S-8 of Pacific Capital Bancorp and subsidiaries of our report dated January
23, 1998, relating to the consolidated statements of income, shareholders'
equity, and cash flows for the year ended December 31, 1997, of the
predecessor Pacific Capital Bancorp (prior to its merger into Santa Barbara
Bancorp) which report appears in the December 31, 1999, annual report on Form
10-K of the new Pacific Capital Bancorp.
Mountain View, California
March 20, 2000