PACIFIC CAPITAL BANCORP /CA/ - 10-Q Quarterly Report

PACIFIC CAPITAL BANCORP
(Exact Name of Registrant as Specified in its Charter)

California (State or other jurisdiction of incorporation or organization)		95-3673456 (I.R.S. Employer Identification No.)
1021 Anacapa St., 3rd Floor Santa Barbara, California (Address of principal executive offices)		93101 (Zip Code)

Not Applicable
Former name, former address and former fiscal year,
if changed since last report.

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 ý No o

Common Stock—As of October 30, 2002 there were 34,778,870 shares of the issuer's common stock outstanding.

FINANCIAL STATEMENTS

PACIFIC CAPITAL BANCORP & SUBSIDIARIES

Consolidated Balance Sheets (Unaudited)

(dollars in thousands except per share amounts)

PACIFIC CAPITAL BANCORP & SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

(dollars in thousands except per share amounts)

PACIFIC CAPITAL BANCORP & SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)

PACIFIC CAPITAL BANCORP & SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

(dollars in thousands)

PACIFIC CAPITAL BANCORP AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements

September 30, 2002

(Unaudited)

The consolidated financial statements include the parent holding company, Pacific Capital Bancorp (Bancorp), and its wholly owned subsidiaries, Pacific Capital Bank, N.A. (the Bank or PCBNA), two service corporations, and two securitization subsidiaries. The activities of one of the service corporations are minimal; the other is inactive. The securitization subsidiaries are used for the transactions described in Note 13. All references to "the Company" apply to Pacific Capital Bancorp and its subsidiaries. "Bancorp" will be used to refer to the parent company only. Material intercompany balances and transactions have been eliminated.

Prior to March 29, 2002, Bancorp had two wholly owned bank subsidiaries, Santa Barbara Bank & Trust ("SBB&T") and First National Bank of Central California ("FNB"). SBB&T and FNB were merged on that date to form PCBNA. "The Bank" is intended to mean SBB&T and/or FNB, as appropriate, when referring to events or situations prior to March 29, 2002. PCBNA uses the brand names of "Santa Barbara Bank & Trust," "First National Bank of Central California," "South Valley National Bank," and "San Benito Bank" in its various market areas.

The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by accounting principles generally accepted in the United States (GAAP) for complete financial statements. In the opinion of Management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair statement have been reflected in the financial statements. However, the results of operations for the three-month periods ended September 30, 2002, are not necessarily indicative of the results to be expected for the full year. Certain amounts reported for 2001 have been reclassified to be consistent with the reporting for 2002.

For the purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, money market funds, Federal funds sold, and securities purchased under agreements to resell.

Earnings per share for all periods presented in the Consolidated Statements of Income are computed based on the weighted average number of shares outstanding during each year. Diluted earnings per share include the effect of the potential issuance of common shares. For the Company, these include only shares issuable on the exercise of outstanding stock options. Stock options with an exercise price greater than the average market price during the period have been excluded from the computations below because they are anti-dilutive.

The computation of basic and diluted earnings per share for the three and nine-month periods ended September 30, 2002 and 2001, was as follows (shares and net income amounts in thousands):

The Company's securities are classified as either "held-to-maturity" or "available-for-sale." Securities for which the Company has positive intent and ability to hold until maturity are 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. If the Company were to purchase securities principally for the purpose of selling them in the near term for a gain, they would be classified as trading securities. The Company holds no securities that should be classified as trading securities.

The amortized historical cost and estimated fair value of debt securities by contractual maturity are shown below. The issuers of certain of the securities have the right to call or prepay obligations before

the contractual maturity date. Depending on the contractual terms of the security, the Company may receive a call or prepayment penalty in such instances.

The amortized historical cost, fair values and gross unrealized gains and losses of securities are as follows:

The Company does not expect to realize any of the unrealized gains or losses related to the securities in the held-to-maturity portfolio. It is the Company's intent to hold these securities to maturity at which time the par value will be received. An exception to this expectation occurs when securities are called by the issuer prior to their maturity. In these situations, gains or losses may be realized.

Gains or losses may be realized on securities in the available-for-sale portfolio as the result of sales of these securities carried out in response to changes in interest rates or for other reasons related to the management of the components of the balance sheet.

The Company has not purchased any securities arising out of highly leveraged transactions, and its investment policy prohibits the purchase of any securities of less than investment grade.

(in thousands)		September 30, 2002		December 31, 2001		September 30, 2001
Real estate:
	Residential	$	739,614	$	728,026	$	704,150
	Non-residential		582,110		593,675		605,261
	Construction		219,922		185,264		180,805
Commercial loans			845,025		874,294		823,900
Home equity loans			111,046		85,025		83,643
Consumer loans			237,652		187,949		176,438
Leases			134,292		126,744		128,875
Municipal tax-exempt obligations			30,415		8,043		8,670
Other loans			10,566		10,072		6,280

	Total loans		2,910,642		2,799,092		2,718,022
Allowance for credit losses			55,341		48,872		43,886

Net loans		$	2,855,301	$	2,750,220	$	2,674,136

The loan balances at September 30, 2002, December 31, 2001 and September 30, 2001 are net of approximately $5,249,000, $4,908,000, and $4,972,000 respectively, in deferred net loan fees and origination costs. The leases reported in the table above are fully financed capital leases of commercial equipment. The Company is not in the business of automobile leasing.

Municipal tax-exempt obligations are loans to cities and special districts. These obligations are not bonded as are the municipal obligations in the securities portfolio.

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 income. Generally speaking, the Company stops accruing interest when the loan has become delinquent by more than 90 days.

Specific kinds of loans are identified as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreements. Because this definition is very similar to that used by Management to determine on which loans interest should not be accrued, the Company expects that most impaired loans will be on nonaccrual status. Therefore, in general, the accrual of interest on impaired loans is discontinued, and any uncollected interest is written off against interest income in the current period. No further income is recognized until all recorded amounts of principal are recovered in full or until circumstances have changed such that the loan is no longer regarded as impaired.

Impaired loans are reviewed each quarter to determine whether a valuation allowance for loan loss is required. The amount of the valuation allowance for impaired loans is determined by comparing the recorded investment in each loan with its value measured by one of three methods. The first method is to estimate the expected future cash flows and then discount them at the loan's effective interest rate. The second method is to use the loan's observable market price if the loan is of a kind for which there is a secondary market. The third method is to use the value of 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 the selected method exceeds the recorded investment in the loan, no valuation allowance for that loan is established. The following table discloses

balance information about the impaired loans and the related allowance (dollars in thousands) as of September 30, 2002, December 31, 2001 and September 30, 2001:

(in thousands)	September 30, 2002		December 31, 2001		September 30, 2001
Loans identified as impaired	$	33,515	$	8,787	$	13,731
Impaired loans for which a valuation allowance has been established	$	32,801	$	8,787	$	13,704
Amount of valuation allowance	$	8,645	$	2,348	$	4,725
Impaired loans for which no valuation allowance has been established	$	714	$	—	$	27

Because the loans currently identified as impaired have unique risk characteristics, the valuation allowance is determined on a loan-by-loan basis. The following table discloses additional information about impaired loans for the three and nine-month periods ended September 30, 2002 and 2001:

	Three-month Periods Ended September 30,				Nine-month Periods Ended September 30,
(in thousands)	2002		2001		2002		2001
Average amount of recorded investment in impaired loans	$	18,715	$	11,273	$	19,769	$	10,272
Collections of interest from impaired loans recognized as interest income	$	163	$	373	$	473	$	454

The Company also provides an allowance for credit losses for other loans. These include: (1) groups of loans for which the allowance is determined by historical loss experience ratios for similar loans; (2) specific loans that are not included in one of the types of loans covered by the concept of "impairment" but for which repayment is nonetheless uncertain; and (3) probable losses incurred in the various loan portfolios, but which have not been specifically identified as of the period end. The amount of the various components of the allowance for credit losses are based on review of individual loans, historical trends, current economic conditions, and other factors. This process is explained in detail in the notes to the Company's Consolidated Financial Statements in its Annual Report on Form 10-K for the year ended December 31, 2001.

Loans that are deemed to be uncollectible are charged-off against the allowance for credit losses. Uncollectibility is determined based on the individual circumstances of the loan and historical trends.

The valuation allowance for impaired loans of $8.6 million as of September 30, 2002 is included within the allowance for credit losses of $55.3 million in the "All Other Loans" column in the statement of changes in the allowance account for the three and nine months ended September 30, 2002 shown

below. The amounts related to tax refund anticipation loans and to all other loans are shown separately.

Property acquired as a result of defaulted loans is included within other assets on the balance sheets. Property from defaulted loans is carried at the lower of the outstanding balance of the related loan at the time of foreclosure or the estimate of the market value of the assets less disposal costs. As of September 30, 2002 and December 31, 2001, the Company held some properties which it had obtained from foreclosure. However, because of the uncertainty relating to realizing any proceeds from their disposal in excess of the cost of disposal, the Company has written their carrying value down to zero.

Included in other assets on the balance sheets at September 30, 2002 and December 31, 2001, are deferred tax assets of $18.2 million and $19.7 million, respectively. Deferred tax assets represent the tax impact of expenses recognized as tax deductible for the financial statements that have not been deducted in the Company's tax returns or taxable income reported on a return that has not been recognized in the financial statements as income. Changes in the amount are primarily related to provision expense. The Company cannot deduct its provision expense in its tax return in the same year in which it is recognized for financial statements.

Goodwill is recorded on the balance sheets in connection with acquisitions of other financial institutions or branches of other institutions. The Company recognized the excess of the purchase price over the estimated fair value of the assets received and liabilities assumed as goodwill. The balance at both September 30, 2002 and December 31, 2001 is $30.0 million. The goodwill is recorded in the Community Banking segment (Note 10). Prior to the effective date of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142), the purchased goodwill was being amortized over 10 and 15 year periods. Amortization expense for goodwill for the third quarter of 2001 was $653,000 or $0.02 per share. For the first nine months of 2001, amortization expense for goodwill was $2.0 million or $0.07 per share. Upon adoption of SFAS 142 on January 1, 2002, the Company discontinued this amortization.

The Company did an initial impairment analysis of the goodwill prior to June 30, 2002 and determined that no impairment had occurred. As part of its accounting practices, periodic reviews for impairment are conducted, but no events have occurred during the third quarter of 2002 which would require a new analysis.

The following table shows the effect of the amortization of goodwill on operating results for the three and nine-month periods ended September 30, 2001 compared with the same periods of 2002.

Also recorded on the balance sheet at September 30, 2002 is an intangible asset of $3.8 million related to the purchase of certain of the assets and liabilities of two branches from another financial institution. These assets and liabilities were moved to nearby branches of the Bank and the other financial institution closed their offices. The purchase was completed on March 29, 2002. The gross amount of this intangible asset is $4.2 million with accumulated amortization of $0.4 million. The Company has determined the $3.8 million must be specifically allocated to the value of the core deposits acquired, and it is recorded in the Community Banking segment.

Amortization expense over the next five years on this core deposit intangible and current other intangibles is expected to be:

Year	(Dollars in thousands)
Remainder of 2002	$	209
2003	$	839
2004	$	839
2005	$	839
2006	$	839
2007	$	209

Intangible assets, including goodwill, have been and will be reviewed each year to determine if circumstances related to their valuation have been materially affected. In the event that the current market values are determined to be less than the current book values (impairment), a charge against current earnings will be recorded. No such impairment existed at September 30, 2002 or December 31, 2001.

	September 30, 2002		December 31, 2001
Federal Home Loan Bank advances	$	177,000	$	99,000
Treasury Tax and Loan amounts due to the FRB		10,028		13,331
Subordinated debt issued by the Bank		36,000		36,000
Senior debt issued by the Bancorp		40,000		40,000

Total	$	263,028	$	188,331

The Federal Home Loan Bank (FHLB) advances have the following maturities: $27.4 million in 1 year or less; $75.6 million in 1 to 3 years, and $74.0 million in more than 3 years. The subordinated debt and senior debt is all due in July 2011. The Treasury Tax and Loan notes are due on demand.

Components of comprehensive income are changes in the equity accounts other than those changes resulting from investments by owners and distributions to owners. Net income is the primary component of comprehensive income. For the Company, the only components of comprehensive income other than net income are the unrealized gain or loss on securities classified as available-for-sale. The aggregate amount of such changes to equity that have not yet been recognized in net income are reported in the equity portion of the Consolidated Balance Sheets as accumulated other comprehensive income.

When an available-for-sale security is sold, a realized gain or loss will be included in net income and, therefore, in comprehensive income. Consequently, the recognition of any unrealized gain or loss for that security that had been included in comprehensive income in an earlier period must be reversed in the current period to avoid including it twice. These adjustments are reported in the Consolidated Statements of Comprehensive Income as a reclassification adjustment for losses included in net income.

The following tables show the individual components of other comprehensive income and the tax impact of each.

While the Company's products and services all relate to commercial banking, the Company has five reportable segments. There are four specific segments: Community Banking, Commercial Banking, Fiduciary, and Refund Programs. The remaining activities of the Company are reported in a segment titled "All Other". Detailed information regarding how the Company determines its segments is provided in Note 20 to the Consolidated Financial Statements included in the Company's Annual Report on Form 10-K. This information includes descriptions of the factors used in identifying these segments, the types and services from which revenues for each segment are derived, charges and credits for funds, and how the specific measure of profit or loss was selected. Readers of these interim statements are referred to that information to better understand the following disclosures for each of the segments.

There have been no changes in the basis of segmentation or in the measurement of segment profit or loss from the description given in the annual report. However, with the merger of the two subsidiary banks into the Bank, the Company is now organized by business line rather than by geographical region. The Company had used six specific segments—Retail Lending, Branch Activities, Wholesale Lending, Fiduciary, Refund Programs, Northern Region—when it originally reported its operations for the three and nine months ended September 30, 2001. Branch Activities included both service operations (tellers and branch management) and relationship management. Wholesale Lending included both commercial lending and private client services. The Northern Region included branch activities, wholesale lending, trust, retail lending, and administration, comparable to the separate segments used for the Southern Region. The activities of these segments for the three and nine month periods ended September 30, 2001 have been restated for comparability as follows to conform to the segments in use since the end of the first quarter of 2002. Retail Lending, the relationship management portion of Branch Activities, and the consumer activities of the Northern Region have been combined into Community Banking. The commercial activities of Wholesale lending and the Northern Region have been combined into Commercial Banking. The trust activities of the Northern Region have been combined with the Fiduciary segment. Refund Programs segment remains unchanged. The investment, branch service operations, and the administrative activities of the Northern Region, and the private client service activities of the wholesale lending segment have been combined with the All Other segment.

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.

The following table reconciles total revenues and profit for the segments to total revenues and pre-tax income, respectively, in the consolidated statements of income for the three and nine-month periods ended September 30, 2002 and 2001.

The Financial Accounting Standards Board (FASB) has finalized new accounting standards covering business combinations, goodwill and intangible assets. On June 30, 2001, the FASB issued Statement of Financial Accounting Standards No. 141, "Business Combinations" (SFAS 141). The Company was required to adopt SFAS 141 upon issuance. As such, all future business combinations which involve the Company must be accounted for as purchase transactions.

As indicated in Note 7, the Company adopted SFAS 142 on January 1, 2002. With the adoption of SFAS 142, goodwill resulting from business acquisitions is no longer subject to amortization over its estimated useful life. Rather, this goodwill is subject to at least an annual assessment for impairment by applying a fair-value-based test. The Company has determined the levels of business at which goodwill impairment will be assessed, specifically, one level below its operating segments as used in Note 10. Additionally, an acquired intangible asset is separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer's intent to do so. Such intangible assets are subject to amortization over their useful lives. The Company has determined that there is no material impact from the adoption of SFAS 142 on existing goodwill and other intangible assets.

The FASB issued Statement of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" in April 2002. This standard rescinds or amends several previous statements. The Company does not expect that adoption of this statement will have any material impact on the Company's results of operations, financial position, or cash flows.

The FASB issued Statement of Financial Accountants Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" in June 2002. The Company is required to adopt this statement by January 1, 2003. The Company has no plans to exit or dispose of any of its segments or lines of business and therefore does not anticipate that adoption of the statement will result in any material impact on the Company's results of operations, financial position, or cash flows.

The Company has a credit-risk sharing agreement with one of the companies that prepares tax returns and through which the Company provides refund anticipation loans. This company franchises its operations. Along with franchisor, the Company has been named in a suit filed by a group of the franchise owners relating to the credit-risk sharing agreement. The suit was filed in Morris County, New Jersey on September 13, 2002. The suit claims that some of the funds initially retained by the Company in a risk pool to cover losses under the agreement and then paid to the franchisor when loan losses proved less than the amount retained should instead have been paid to the franchisees. The Company has no agreement with the franchisees and has paid the funds to the franchisor according to the terms of its contract with the franchisor. The plaintiffs allege that the funds in question total approximately $26-32 million. The Company believes that there is no merit to the claim and intends to vigorously defend itself in this matter.

The Company is a defendant in a class action lawsuit brought on behalf of persons who lost funds from their Individual Retirement Accounts ("IRAs") which were invested with Reed Slatkin. Mr. Slatkin has pled guilty to having operated a fraudulent Ponzi scheme which defrauded hundreds of investors. The Company is the custodian of approximately 30 self-directed IRA accounts. The participants of the accounts specifically directed the Trust Division of the Company to invest their IRA funds in a limited partnership operated by Mr. Slatkin. The participants each signed a written investment direction in which they directed the Company to invest their funds in the Slatkin limited partnership, stated that they had verified the security of the investment and the financial strength of the partnership, and held the Company harmless from any and all claims or loss resulting from the investment. Some of the participants are plaintiffs in this lawsuit which was filed in the Superior Court in Los Angeles. The Company has removed the case to the Federal District Court in Los Angeles. The plaintiffs are seeking compensation from the Company for the loss of funds that were invested in the Slatkin limited partnership at their direction. The Company believes that there is no merit to the claims made in this action and intends to vigorously defend itself.

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. Expenses are being incurred in connection with defending the Company, but in the opinion of Management, based in part on consultation with legal counsel, the resolution of this litigation will not have a material impact on the Company's financial position, results of operations, or cash flows.

Securities totaling approximately $739.6 million and $559.6 million at September 30, 2002 and 2001, respectively, were pledged to secure public funds, trust deposits, bankruptcy deposits, treasury tax and loan deposits, Federal Home Loan Bank (FHLB) advances, customer repurchase agreements, and other borrowings as required or permitted by law.

Loans secured by first trust deeds on residential and commercial property of $604.6 million and $631.6 million at September 30, 2002 and 2001, respectively, were pledged to the FHLB as security for borrowings.

During the second quarter of 2001, the Bank securitized $58.2 million in automobile loans resulting in a gain on sale of approximately $1.4 million. Retained interest held by the Bank upon completion of this securitization was $3.5 million. The transaction was conducted through the Bank Automobile Loan Securitization Corporation, a wholly owned subsidiary of the Bank. The securities offered consisted of two classes, entitled 6.13% Asset-Backed Notes, Class A, Series 2000-A and 6.90% Asset-Backed Notes, Class B, Series 2000-A.

As of September 30, 2002, pertinent data related to this securitization is as follows:

(in thousands)
Principal amount outstanding	$	22,286
Retained interest	$	1,912
Principal amount of delinquencies greater than 30 days	$	260

(in thousands)	From Inception		Three Months Ended September 30, 2002		Nine Months Ended September 30, 2002
Net credit losses	$	446	$	15	$	213
Cash flows received for servicing fees	$	360	$	33	$	116
Cash flows received on retained interests	$	1,433	$	200	$	458

The figures reported above for delinquencies and net credit losses relate to the total principal amount outstanding.

Retained interests are calculated based on the present value of excess cash flows due to the Bank over the life of the securitization. The key assumptions used in determining retained interests are outlined below.

	At Inception	At September 30, 2002
Discount rate	11%	11%
Prepayment rate	26.85%	26.03%
Weighted average life of prepayable assets	51 months	31 months
Default rate	1.00%	1.62%

The impact of changes on these assumptions to the carrying amount of the retained interests have been reflected in the Company's statements of financial position and results of operations.

The calculation of the balance of the retained interest is sensitive to changes in key assumptions as noted below:

(in thousands)				Change in Retained Interest
Retained Interest		$	1,912
Default rate:
	10 basis points higher			$	(46	)
	10 basis points lower			$	68
Discount rate:
	1% higher			$	(25	)
	1% lower			$	25
Prepayment rate:
	4% higher				755
	4% lower				(28	)

The balance of the retained interest is marginally sensitive to the changes in the default rate and the discount rate. The balance is significantly sensitive to increases in the prepayment rate because of the relatively short term of the weighted average life of the loans.

The Company's consumer loan services department acts as the servicer for the securitized automobile loans in compliance with the terms established in the securitization agreements. The servicer is responsible for servicing, managing and administering the receivables and enforcing and making collections on the receivables. The servicer is required to carry out its duties using the degree of skill and care that the servicer exercises in performing similar obligations. This includes payment processing, insurance follow up, loan payoffs and release of collateral. Loan servicing generally consists of collecting payments from borrowers, processing those payments, and delinquent payment collections.

The Company established a special purpose subsidiary corporation in November 2000 named SBB&T RAL Funding Corporation and during the first quarter of 2001 securitized refund anticipation loans (RALs) into a multi-seller conduit, backed by commercial paper in a financing arrangement. The Company acted as the servicer for all such RALs during the securitization period. As of June 30, 2001, all borrowings had been fully repaid and no securitization-related balances were outstanding.

For the 2002 tax season, the Company used the same special purpose subsidiary to securitize RALs in a sale arrangement. Again the Company acted as the servicer for sold loans during the securitization period which lasted from late January 2002 through February 2002. All loans sold into the securitization were either repaid or charged-off by the end of the first quarter of 2002.

The Company has established policies and procedures to permit limited types and amounts of hedges to help manage interest rate risk. At various times beginning in 1999, the Company has entered into several interest rate swaps to mitigate interest rate risk. Under the terms of these swaps, the Company pays a fixed rate of interest to the counterparty and receives a floating rate of interest. Such

swaps have the effect of converting fixed rate financial instruments into variable or floating rate instruments. Such swaps may be related to specific instruments or specifically identified pools of instruments—loans, securities, or deposits with similar interest rate characteristics or terms. Other types of hedges are permitted by the Company's policies, but have not been utilized.

Statement of Financial Accounting Standards No. 133, "Accounting Derivative Instruments and Hedging Activities" (SFAS 133), was issued during the second quarter of 1998 and was adopted by the Company as of January 1, 2001. The statement requires that all derivatives be recorded at their current fair value on the balance sheet. Certain derivatives may be designated as either fair value or cash flow accounting hedges and qualify for the deferral of all or a part of changes in their fair value in the basis of the item being hedged or in accumulated other comprehensive income. Changes in the fair value of derivatives that are not related to specific instruments and do not meet the criteria for hedge accounting and the ineffective portions of derivatives used for hedging are included in net income.

The one swap in place at the end of the third quarter of 2002 is related to a specific loan and qualifies as a fair value hedge. The notional amount of this hedge at September 30, 2002 was $28.9 million with a fair value loss of approximately $1.4 million. This loss is exactly offset by an increase in the value of the loan because the swap and loan have identical terms. The Company had other specific and non-specific hedges in place during 2001. These swaps were entered into prior to 2001 when the Company was concerned about the negative impact on its fixed rate loans from increases in interest rates. With interest rates declining, the Company elected to dispose of these swaps during the third quarter of 2001. The loss on disposal plus the mark to market adjustment for the third quarter was $718,000. Taking the loss on disposal avoided further losses caused by the additional rate drops in periods subsequent to the date of disposal.

In addition to the interest rate swaps the Company has entered into to manage its own interest rate risk, the Company has entered into interest rate swaps with some of its customers to assist them in managing their interest rate risks. As of September 30, 2002, there were swaps with a notional amount of $41.4 million. To avoid increasing its own interest rate risk entering into these swap agreements, the Company entered into offsetting swap agreements with other larger financial institutions. The effect of the offsetting swaps to the Company is to neutralize its position. A fee is charged to the Company's customer that is in excess of the fee paid by the Company to the other financial institution.

On April 23, 2002, the Company's Board of Directors approved a 4 for 3 stock split. The stock split was payable June 11, 2002 to shareholders of record May 21, 2002. All share and per share amounts appearing in the Consolidated Financial Statements which these notes accompany have been restated to reflect this split.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Performance Highlights for the Three and Nine Months Ended September 30, 2002
Compared to the Same Periods of 2001

Pacific Capital Bancorp and its wholly owned subsidiaries (together referred to as "the Company") earned $17.6 million for the quarter ended September 30, 2002, compared to $11.3 million in the third quarter last year, an increase of $6.3 million or 56.2%. Diluted earnings per share for the third quarter of 2002 were $0.50 compared to $0.32 earned in the third quarter of 2001. The Company earned $60.4 million for the nine-month period ended September 30, 2002, up $14.5 million or 31.7% compared to the same period of 2001. Diluted earnings per share for the nine-month period ended September 30, 2002 were $1.72 compared to $1.29 for the comparable period of 2001.

In various sections of this discussion and analysis, attention is called to the significant impacts on the Company's balance sheet and year to date income statement caused by its tax refund and transfer programs. Because these programs are events of the first and second quarters of each year, the results of operations and actions taken by the Company to manage these programs are discussed in detail in the Company's quarterly reports on Form 10-Q for the first and second quarters of 2002. They are also discussed briefly in the section below titled "Refund Anticipation Loan and Refund Transfer Programs." That section specifically explains that there is a significant difference in how some of the fees from Refund Anticipation Loans (RALs) were accounted for in 2002 than in 2001. Included in the explanation are the reasons for this difference and the amounts involved. In brief, the different accounting method employed for some of the RALs meant that the fees related to them were reported as other income rather than interest from loans.

Compared to the third quarter of 2001, net interest income (the difference between interest income and interest expense) on a fully tax equivalent basis (Note A—notes to this discussion may be found at the end of the discussion) for the third quarter of 2002 increased by $4.3 million, an increase of 9.6%. In general, average balances of both earning assets and interest-bearing liabilities increased while rates earned and paid were down significantly compared to the third quarter of 2001. Tax equivalent interest on loans for the third quarter decreased 6.7%, from $55.5 million for 2001 to $51.8 million for 2002. Average loan balances increased from $2.68 billion during the third quarter of 2001, to $2.89 billion during the same quarter of 2002, an 7.7% increase. Average interest-bearing deposits and liabilities increased $142.5 million or 5.2%. Despite the growth in deposits, interest expense decreased $8.0 million or 34.6% due to the lower rate environment in the third quarter of 2002 compared to 2001.

Provision expense for the third quarter of 2002 for loans other than tax refund loans was a negative $846 thousand, compared to the $4.4 million provided in the third quarter of 2001. This decrease was primarily due to improvement in the credit quality of certain specific loans. The lower amount of allowance for credit loss required for these improved loans and the absence of further deterioration in economic conditions in the Company's market areas offset the additional allowance that would ordinarily be needed to cover the growth in the loan portfolios.

Noninterest revenue, exclusive of gains or losses on securities transactions, decreased by $1.8 million in the third quarter or 14.5% from the same quarter of 2001. Operating expense was $34.3million in the third quarter of 2002 compared to $35.9 million in the same quarter of 2001. An explanation of these decreases is presented later in this discussion in the section below titled "Noninterest Revenue and Operating Expense."

The Company's income tax expense was less in the third quarter of 2002 than would ordinarily be expected because of a one time benefit of $689,000 relating to the deductibility of bad debt (provision) expense for California franchise tax.

The above changes resulted in an operating efficiency ratio of 56.93% for the third quarter of 2002 compared to 62.23% for the third quarter of 2001. This ratio measures what proportion of a dollar of operating income it takes to earn that dollar. In 2002, the Company's return on average assets for the quarter was 1.73% compared to 1.18% for the third quarter of 2001, and the return on average equity was 19.80% compared to 13.66%. These annualized ratios are significantly impacted by the highly seasonal tax refund programs. The impact of the RAL/RT programs on the operating efficiency ratio in the third and fourth quarters of each year is negative because the income is all recognized in the first two quarters while some operating expenses continue all year long. Exclusive of the impact of the RAL/RT programs in both periods, ROE and ROA were 19.76% and 1.59%, respectively, for the third quarter of 2002, compared to 14.51% and 1.17%, respectively, for the same period in 2001. Exclusive of the impact of the RAL/RT programs in both periods, the operating efficiency ratio for the third quarter of 2002 was 55.25% and 59.89% in the third quarter of 2001.

The Company is a bank holding company. All references to "the Company" apply to Pacific Capital Bancorp and its subsidiaries. "Bancorp" will be used to refer to the parent company only. At the end of business March 29, 2002, the Company merged its major subsidiaries, Santa Barbara Bank & Trust (SBB&T) and First National Bank of Central California (FNB) including its affiliates South Valley National Bank and San Benito Bank (SBB) into a single nationally chartered bank, Pacific Capital Bank, N.A. (the Bank). "The Bank" is intended also to mean SBB&T and/or FNB, as appropriate, when referring to events or situations prior to March 29, 2002. The Bank will continue to use the four brand names listed above in their respective market areas. The Bank is a member of the Federal Reserve System. The Bank offers a full range of retail and commercial banking services. These include commercial, real estate, and consumer loans, a wide variety of deposit products, and full trust services.

Bancorp has four other subsidiaries. PCB Services Corporation (formerly named Pacific Capital Commercial Mortgage, Inc.) was used through the middle of 2001 to broker commercial mortgages to other financial institutions. SBB&T Automobile Loan Securitization Corporation and SBB&T RAL Funding Corporation are used in the automobile loan and RAL securitizations, respectively, that are described in Note 13. Pacific Capital Services Corporation is an inactive corporation.

This discussion and analysis contains forward-looking statements with respect to the financial condition, results of operation and business of the Company. These include statements that relate to or are dependent on estimates or assumptions relating to the prospects of continued loan and deposit growth, improved credit quality, the trend and intensity of changes in interest rates, and the operating characteristics of the Company's income tax refund programs. The subjects of these forward-looking statements involve certain risks and uncertainties, many of which are beyond the Company's control. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) increased competitive pressure among financial services companies; (2) changes in the interest rate environment reducing interest margins or increasing interest rate risk; (3) deterioration in general economic conditions, internationally, nationally or in the State of California; (4) reduced demand for or earnings derived from the Company's income tax refund loan and refund transfer programs; (5) legislative or regulatory changes adversely affecting the business in which the Company engages; (6) the occurrence of future events such as the terrorist acts of September 11, 2001; and (7) other risks detailed in the Pacific Capital Bancorp 2001 Annual Report on Form 10-K filed with the Securities and Exchange Commission ("2001 10-K"). Forward-looking statements speak only as of the date they are made, and

the Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.

A number of critical accounting policies are used in the preparation of the consolidated financial statements which this discussion accompanies.

The preparation of consolidated financial statements in accordance with Generally Accepted Accounting Principles (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.

An estimate of the amount of the probable losses incurred in the Company's loan portfolio is used in determining the amount of the allowance for credit losses and therefore the periodic charge to income for the provision for credit losses expense. A description of the method of developing the estimate is described in the section below titled "Credit Quality and the Allowance for Credit Losses" and in Note 1 to the Consolidated Financial Statements presented in the Company's Annual Report for 2001 on Form 10-K (the Company's 2001 10-K). If the actual losses incurred in fact materially exceed the estimate of probable losses developed by Management then the Allowance for Credit Losses will be understated and the Company will have to record additional provision expense in future periods as the actual amount of losses are recognized. If the losses currently in the portfolio are materially less than the estimate then the Company will reverse the excess allowance through provision expense in future periods.

The Company's deferred tax assets are explained in the section below titled "Income Tax" and in Note 8 to the Consolidated Financial Statements presented in the Company's 2001 10-K. The Company uses an estimate of future earnings to support its position that the benefit of its deferred tax assets will be realized. If future income should prove non-existent or less than the amount of the deferred tax assets within the tax years to which they may be applied, the assets will not be realized and the Company's net income will be reduced.

The Company uses certain estimates regarding its employees to determine its liability for Post Retirement Health Benefits. These estimates include life expectancy, length of time before retirement, and future rates of growth of medical costs. Should these estimates prove materially wrong such that the liability is understated, the Company will either incur more expense to provide the benefits or it will need to amend the plan to limit benefits.

The Company uses certain estimates in determining the residual value of the securitization of indirect auto loans described in Note 13 to the financial statements which this discussion accompanies. The assumptions and estimates used for the discount, prepayment, and default rates are shown in that note. If later experience shows that the estimates for the prepayment and default rates are too low by a material amount, the Company would have to write down the residual value and a loss would have to be recognized. If later experience shows that the estimates for the prepayment and default rates are too high by a material amount, the Company would write up the residual value and a gain would be recognized.

Certain assets of the Company are recorded at fair value, or the lower of cost or fair value. In some cases, the fair value used is an estimate. Included among these assets are securities that are available for sale investment securities, goodwill and other intangible assets, and other real estate owned and impaired loans. These estimates may change from period to period as they are impacted by changes in interest rates and other market conditions. Losses not anticipated or greater than anticipated could result if the Company were forced to sell one of these assets and discovered that its estimate of fair value had been too high. Gains not anticipated or greater than anticipated could result if the Company were to sell one of these assets and discovered that its estimate of fair value had been too low. Estimates of fair value are arrived at as follows:

Available-for-sale securities: the fair values of most securities classified as available-for-sale are based on quoted market prices. If quoted market prices are not available, fair values are extrapolated from the quoted prices of similar instruments.

Goodwill and other intangible assets: As discussed in Note 7 to the Consolidated Financial Statements which this discussion accompanies, the Company must assess goodwill and other intangible assets each year for impairment. This assessment involves estimating cash flows for future periods. If the future cash flows are materially less than the estimates, the Company would be required to take a charge against earnings to write down the asset to the lower fair value.

Other real estate owned and impaired loans: the fair value of other real estate owned or collateral supporting impaired loans is generally determined from appraisals obtained from independent appraisers. The Company also must estimate the costs to dispose of the property. This is generally done based on experience with similar properties. When determining the valuation allowance for impaired loans, the Company may use the discounted cash flow method which may include estimates of borrower revenue, expenses, capital expenditures and disposals of capital assets, along with estimates of future economic conditions including forecasts of interest rates and other economic factors which management believes would impact estimated future customer cash flows.

The accounting and reporting policies of the Company are in accordance with GAAP and conform to practices within the banking industry. As such there are few alternatives available to the Company in its accounting for items of income or expense or for assets and liabilities. The few areas where choices are available are as follows:

Depreciation of fixed assets: The Company selects lives of assets over which to depreciate or amortize the cost based on the expected period it will benefit the Company. The Company's methods of depreciation and the lives of fixed assets are described in Note 1 to the Consolidated Financial Statements presented in the Company's 2001 10-K. If a method is used or a life is chosen that results in a material amount of the cost not having been amortized when the asset provides no further benefit to the Company, then a loss will be incurred for the unamortized cost of the asset when it is disposed of or replaced.

Amortization of the cost of other assets: The Company's methods of amortizing assets other than fixed assets are described in various Notes to the Consolidated Statements this discussion accompanies or in specific notes to these statements or notes in the Company's 2001 10-K as appropriate. As with fixed assets, if the method of amortization or the amortization term results in unamortized cost when the asset has no further value, a loss will be recognized.

Stock options: When the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123) in 1996, it elected to continue to use the method of accounting for stock options that did not recognize compensation expense at the time options were granted. As required by SFAS 123, pro forma amounts of compensation expense and the

pro forma impact on net income and earnings per share are disclosed each year in the Company's Annual Reports on Form 10-K as if the Company had elected to instead use the accounting method that recognizes compensation expense. For the year 2001, had the Company elected the second method of accounting for its stock options, the impact would be to lower net income and earnings per share by approximately 1.5%.

The Company's financial results have been or will be impacted by several new accounting pronouncements. These pronouncements and the nature of their impact are discussed in Notes 11 and 14 to the consolidated financial statements.

The risk environment for the Company changed due to the terrorist attacks of September 11, 2001, as it has for all other banks. The Federal Reserve Bank immediately injected a large amount of liquidity into the country's banking system to assist the clearing of payments between banks. Concurrent with this action was a tightening of procedures to prevent money laundering, increased scrutiny of foreign transactions, and requests from authorities to review customer lists for contacts with certain individuals suspected of connection with the attacks or other acts detrimental to the interests of the United States. Much of the extra liquidity was removed from the system by the beginning of the first quarter of 2002. The Company has been able to adjust to these new changes without material impact.

The attacks occurred at a time when the nation's economy was already slowing. Certain segments of the economy, for example air travel and hospitality, were especially impacted as consumers and companies have cut back on travel. The Company has considered these factors in assessing the adequacy of its allowance for credit loss, but further attacks or more significant economic decline in its markets could cause additional credit deterioration.

Since September 11, 2001 there have been occasional warnings of possible terrorist activity in this country. While no such events have occurred up to the time this document was written, further incidents, especially ones targeting the country's financial systems could have a negative impact on the Company.

The table below shows the growth in average total assets and deposits since 1997. Annual averages are shown for 1997, 1998, and 1999; quarterly averages are shown for 2000, 2001, and 2002. Because significant but unusual cash flows sometimes occur at the end of a quarter and at year-end, the overall trend in the Company's growth is better shown by the use of average balances for the periods.

(dollars in millions)	Average Assets		Average Deposits		Percent of Assets Funded by Deposits
1997	$	2,241	$	1,985	88.5	%
1998		2,631		2,322	88.3
1999		2,780		2,405	86.5
1st Quarter 2000		3,675		3,147	85.6
2nd Quarter 2000		3,516		2,968	84.4
3rd Quarter 2000		3,567		3,032	85.0
4th Quarter 2000		3,633		3,093	85.1
1st Quarter 2001		4,027		3,392	84.2
2nd Quarter 2001		3,808		3,187	83.7
3rd Quarter 2001		3,786		3,163	83.5
4th Quarter 2001		3,821		3,203	83.8
1st Quarter 2002		4,390		3,691	84.1
2nd Quarter 2002		4,045		3,269	80.8
3rd Quarter 2002		4,036		3,318	82.2

Deposit balances also have been included in the table because an important factor in the profitability of the Company is the portion of assets that are funded by deposits. Beginning in 1999, as reflected in Table 1, the Company relied more on nondeposit funding sources, primarily borrowing funds from other financial institutions. This occurred as loan growth in general exceeded deposit growth and because matching the maturities of assets (see "Interest Rate Sensitivity" below) was more easily accomplished by borrowing from the FHLB than by trying to obtain longer term certificates of deposit. Because interest rates on such borrowings are generally higher than the interest rates paid on deposits, the Company must carefully monitor the interest rate earned on the funds borrowed to ensure that the extra expense is covered by the rates earned on the assets acquired. However, as discussed below in the section titled "Other Borrowings, Long-term Debt and Related Interest Expense," such borrowings may have certain advantages in a declining interest rate environment.

While the Company has been making more use of nondeposit funding sources in the last three or four years, the percent of the Company's assets funded by deposits for the third quarter of 2002 of 82.2% is still indicative of substantially less reliance on nondeposit funding sources than the comparable figure of 68.3% for the Company's peers of $1 billion to $10 billion in assets (See Note B).

There are three primary reasons for the overall growth trend shown above for the Company. The first is the acquisition of other financial institutions. Acquisitions in 1997 of First Valley Bank and of Citizen's State Bank, and in 2000 of Los Robles Bank added $377 million to the Company's assets and $333 million to deposits. Because the Company's mergers with FNB and SBB were accounted for by the pooling of interests method, asset and deposit totals for periods prior to the mergers have been restated to include their balances and so do not impact the totals shown in the above table. However, growth at these institutions subsequent to the mergers is reflected in the table above.

Secondly, the Company's experience with acquisitions and mergers has been contrary to the general pattern in which banks tend to lose customers of the acquired institution. Depositors of banks acquired by or merged with the Company have kept their deposits with the Company and new customers have been added. The Company attributes this to its efforts to maintain the acquired institution's character and management in place.

Third, the Bank has opened three new offices in Ventura County and one new office in northern Santa Barbara County during the period covered by the table. The company acquired some of the assets and deposits of two of the branches of another financial institution on March 29, 2002. While

these balances are included in the period-end amounts reported on the Company's Consolidated Balance Sheet as of March 31, 2002, the acquisition occurred too late in the quarter to impact the average balances in the table by more than a minimal amount.

Average assets and deposits increase during the first quarter of each year and then generally decrease in the second quarter. The major reason for this is Company's tax refund loan program. The growth in assets is from the loans held by the Company. The growth in deposits is due both to certificates of deposit used as one of the sources of funding for the refund loans and to the outstanding checks issued for loans and transfers (See Note C).

Banks act as financial intermediaries. As such, they take in funds from depositors and then either lend the funds to borrowers or invest the funds in securities and other instruments. The Company earns interest income on loans and securities and pays interest expense on deposits and other borrowings. Net interest income is the difference in dollars between the interest income earned and the interest expense paid. Net interest income represents approximately 70%-75% of the Company's net revenues.

Tables 2A and 2B show the average balances of the major categories of earning assets and liabilities for the three and nine-month periods ended September 30, 2002 and 2001 together with the related interest income and expense. Table 3, an analysis of volume and rate variances, explains how much of the difference in interest income or expense compared to the corresponding period of 2001 is due to changes in the balances (volume) and how much is due to changes in rates. For example, Table 2B shows that for the first nine months of 2002, real estate loans averaged $1.9 billion, interest income for them was $94.7 million, and the average rate received was 6.74%. In the first nine months of 2001, real estate loans averaged $1.6 billion, interest income for them was $94.6 million, and the average rate received was 7.74%. Table 3 shows that the $40 thousand increase in interest income for these loans from the first nine months of 2001 compared to the first nine months of 2002 is the net result of a $4.4 million increase in interest income due to higher balances in 2002, and a decrease of $4.4 million due to lower rates paid during 2002.

Tables 2A and 2B also disclose the net interest margin for the reported periods. Net interest margin is the ratio of net interest income to average earning assets. This ratio is useful in allowing the Company to monitor the spread between interest income and interest expense from month to month and year to year irrespective of the growth of the Company's assets. If the Company is able to maintain the net interest margin as the Company grows, the amount of net interest income will increase. If the net interest margin decreases, net interest income can still increase, but earning assets must increase at a higher rate. The increased volume of earning assets serves to replace the net interest income that is lost by the decreasing rate.

As shown in Table 2A, the net interest margin—5.24%—and net interest income $49.4 million—for the third quarter of 2002 were higher than the comparable figures—5.13% and $45.0 million—for the third quarter of 2001. However, Table 2B shows that the net interest income for the nine months ended September 30, 2002—$161.8 million—was greater than net interest income for the same period of 2001—$155.1 million—while the net interest margin for the first nine months of 2002—5.62%—was less than the net interest margin for the comparable period of 2001. As noted at the start of this discussion, the RAL and RT programs introduce significant seasonality to the Company's operating results. Specifically impacting the net interest margin is the RAL interest income and the interest expense for the borrowings used to fund the loans. Therefore, it is informative to compare the net interest margin excluding the effect of the RAL balances and interest income and excluding any direct liabilities used to fund the RALs and the related interest expense. Exclusive of the RAL program (the RT program

does not directly impact balances or interest income) the net interest margin for the third quarter of 2002 was 5.23% compared to 5.17% for the second quarter of 2002 (See Note D).

While the net interest margins exclusive of RAL impacts are relatively similar for the third quarters of 2001 and 2002, the interest rate environment during the two quarters was significantly different. The Federal Reserve Bank's (FRB) target Federal funds rate averaged 3.57% in the third quarter of 2001 and averaged 1.75% in the third quarter of 2002. The interest rate yield curve was relatively flat during the third quarter of 2001 and relatively steep during the third quarter of 2002 (See Note E). During 2001 and 2002 the Company made some changes to the composition of assets and liabilities as it responded to an environment that continued to change during the second half of 2001. Though the FRB did not change its target rate during the first nine months of 2002, the Company continued to take steps to protect and improve its net interest margin and/or net interest income.

As explained below, over a one-year time horizon, the Company's net interest income is negatively impacted by declining interest rates. As interest rates dropped during 2001, net interest income and the net interest margin declined as the rates on the Company's overnight funds and prime rate loans immediately dropped while deposit rates were slower to decline. Table 2A shows that tax equivalent net interest income of $49.4 million for the third quarter of 2002 exceeded by $4.3 million the same figure for 2001. Table 3 shows that of the $4.3 million, $0.3 million was due to changes in rates and $4.0 million was due to changes in volume. The positive impact of changes in rates would be consistent with the larger relative decline of 1.26% in the cost of funds from the third quarter of 2001 (3.34%) to the third quarter of 2002 (2.08%) than the 0.92% decline in the average rate earned on assets from the third quarter of 2001 (7.76%) to the third quarter of 2002 (6.84%).

While the Company's net interest margin in the third quarter of 2002 compared to the same quarter a year ago benefited from the relatively larger decrease in cost of funds than the rate earned on assets, the primary reasons the Company was able to improve the net interest margin exclusive of the RAL impacts relate to changes in the balances or volume of the assets and liabilities. The Company increased its average earning assets by $253.7 million from the third quarter of 2001 to the third quarter of 2002 compared to an increase of $142.5 million in interest bearing liabilities. In addition, the increase in earning assets occurred in the loan and securities portfolios while the short term and overnight funds balances decreased.

Part of these volume and product mix changes were the result of a decision in the first quarter of 2002 to retain more of the residential real estate loans that the Company was originating and to purchase additional securities. These actions were funded by reducing the amount of overnight funds carried by the Company and borrowing from the FHLB.

Because such large proportions of the Company's balance sheet are made up of interest-earning assets and interest-bearing liabilities, and because such a large proportion of its earnings is dependent on the spread between interest earned and interest paid, it is critical that the Company measure and manage its sensitivity to changes in interest rates. Measurement is done by estimating the impact of hypothetical changes in interest rates on net economic value and on net interest income over the next twelve months. Net economic value is the net present value of the cash flows arising from assets and liabilities discounted at their acquired rate plus or minus the specified assumed changes in rates.

Estimating changes in net interest income or net economic value from increases or decreases in balances is relatively straight forward. Estimating changes that would result from increases or decreases in interest rates is substantially more difficult. Estimation is complicated by a number of factors: (1) some financial instruments have interest rates that are fixed for their term, others that vary as

market rates change, and still others that are fixed for a period and then reprice using then current rates; (2) the rates paid on some deposit accounts are set by contract while others are priced at the option of the Company according to then current market conditions; (3) the rates for some loans vary with the market, but only within a limited range; (4) consumers may prepay loans if market rates decline or withdraw deposits if interest rates increase, effectively forcing a repricing sooner than would be called for by the contractual terms of the instrument; and (5) external interest rates which are used as indices for various products offered by the Company do not change at the same time or to the same extent as the Federal Reserve Board's target Federal funds rate, the usual reference rate.

To address the complexity resulting from these and other factors, a standard practice developed in the industry is to compute the impacts of hypothetical interest rate "shocks" on the Company's asset and liability balances. A shock is an immediate change in all interest rates. The resulting impacts indicate how much of the Company's net interest income and net economic value are "at risk" (would deviate from the base level) if rates were to change in this manner.

Although interest rates normally would not change suddenly in this manner, this exercise is valuable in identifying exposures to risk and in providing comparability both with other institutions and between periods. The results reported below for the Company's December 31, 2001, June 30, 2002, and September 30, 2002 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 hypothetical sudden changes:

		Shocked by -2%		Base Case (in thousands)		Shocked by +2%
As of December 31, 2001:
	Net interest income	(5.87	)%			+2.33	%
	Net economic value	+24.33	%			(25.94	)%
As of June 30, 2002:
	Net interest income	(9.06	)%			+5.50	%
	Net economic value	+22.91	%			(22.18	)%
As of September 30, 2002:
	Net interest income	(13.86	)%	$	215,445	+7.51	%
	Net economic value	+18.03	%	$	491,124	(19.63	)%

In general, differences in the results from one period to the next are due to changes in (1) the maturities and/or repricing opportunities of the financial instruments held and (2) the assumptions used regarding how responsive the rates for specific instruments are to the hypothetical 2% change in market rates.

Because the measurement period for changes in net interest income is one year, the impact on net interest income from these hypothetical changes in interest rates will depend on whether more assets or liabilities will reprice within the twelve-month period. An asset or liability reprices because either (a) it matures or is sold and is replaced with a new asset or liability priced at current market rates or (b) its contractual terms call for a periodic resetting of the interest rate. If the Company has more assets repricing within one year than it has liabilities, then net interest income will increase with increases in rates and decrease as rates decline. The opposite effects will be observed if more liabilities than assets reprice in the next twelve months.

The Company remains "asset sensitive," i.e. it has more assets than liabilities repricing in the next year. Consequently, its net interest income would decrease if rates were to decline and increase if rates were to rise.

The market value of fixed rate securities or loans increase as rates decline because the fixed rate is then higher than the current market level. Conversely the market value declines when rates rise because the instrument is earning at a lower rate than the current level. In other words, the price of the security or loan changes in response to changes in market rates to bring the effective yield on the instrument equal to the rate on new instruments. The longer the maturity of the asset, the more sensitive is its market value to changes in interest rates, because the mismatch of the instrument's coupon rate will differ from the market rate for a longer time. The market value of fixed rate liabilities changes in exactly the opposite manner. For example, they are less valuable to the Company when rates decline because the Company must continue to pay the higher rate until they mature.

As indicated above, net economic value in this context is the sum of the net present value of the cash flows associated with the Company's financial assets and liabilities. The net economic value of variable rate instruments does not change with increases or decreases in rates because their rates change with the market. Therefore the Company's net economic value increases or decreases as interest rates change depending on the relative proportion and maturities of fixed rate assets and liabilities and the relative terms of these instruments. The Company has more fixed rate assets than liabilities and they generally have longer maturities. Therefore, it is expected that the net economic value of the Company's portfolio will decrease when rates rise and increase when rates decline.

It is also expected that the change in the net economic value resulting from a given change in interest rates would be greater than the change in the net interest income. This occurs because the expected change in net interest income is measured only over the next twelve months while the change in net economic value is the present value of the cash flows over the entire maturity term of the assets and liabilities.

Financial instruments do not respond in parallel fashion to rising or falling interest rates. This can cause an asymmetry in the magnitude of changes in net interest income and net economic value resulting from the hypothetical increases and decreases in rates. In other words, the same percentage of increase and decrease in the hypothetical interest rate will not necessarily cause the same percentage change in net interest income or net economic value. An asymmetrical or nonparallel response occurs because various contractual limits and non-contractual factors come into play. An example of a contractual limit is the "interest rate cap" on some residential real estate loans, which may limit the amount that the loan rate may increase, but not limit the amount it may decrease. An example of a non-contractual factor is the assumption of the extent to which rates paid on administered accounts would be changed by the Company were market rates to go up or down by 200 basis points.

In addition, the degree of asymmetry can change as the base rate changes from period to period and as there are changes in the Company's product mix. For example, if savings accounts are paying 4% when one measures the impact of a 2% decrease in market rates, the measured responsiveness of the rate paid on these accounts to that decrease will be greater than the responsiveness if the current rate is 3% when the measurement is done. This is because the Company cannot assume that it will be able to lower the rates paid on these deposits as much from a 3% base as from a 4% base. Another example of non-contractual factors coming into play relates to consumer variable rate loans that have interest rate caps. To the extent those loans are a larger proportion of the portfolio than in a previous period, the caps on loan rates would have more of an adverse impact on the overall result if rates were to rise.

For these measurements, the Company makes certain assumptions that significantly impact the results. The most significant assumption is the use of a "static" balance sheet—the Company does not project changes in the size or mix of the various assets and liabilities. However, as noted above, the Company does in fact make changes to the size and mix of the various asset and liability balances in response to interest rate changes. Additional assumptions include the duration of the Company's non-maturity deposits because they have no contractual maturity, and the extent to which the Company

would adjust the rates paid on its administered rate deposits as external yields change. In fact with respect to the differences between the December 31, 2001 and the September 30, 2002 results, much of the change is due to changes in assumptions regarding the extent to which deposit rates would be raised or lowered in the event of a 200 basis point increase or decrease.

As interest rates change, the assumptions regarding responsiveness to further change must be reviewed, and any changes will affect the computed results. These assumptions are reviewed each quarter and are changed as deemed appropriate to reflect the best information available to Management.

For the above reasons, the net interest income figure shown in Table 4 for the base case should not be construed as the Company's projection or forecast of net interest income for the next twelve months. The shock testing assumes a static balance sheet, whereas the Company changes its asset and liability mix in response to customer demand and changes in interest rates.

The Company's exposure to interest rate risk and how it addresses this risk is discussed in more detail in the 2001 10-K MD&A.

While occasionally there may be slight decreases in average deposits from one quarter to the next, the overall trend is one of growth as shown in Table 1. As noted in the discussion accompanying the table, there was a significant increase in deposits during the first quarter of each year related to the tax refund programs. These deposits included brokered certificates of deposit used to fund the loans. These deposits bear a higher interest rate than other deposits and the rate paid on time deposits as shown in Table 2B reflect this higher rate.

The table below shows the major categories of deposits as of September 30, 2002 and 2001 and as of December 31, 2001.

As indicated in the table in "Growth Trends in Assets and Deposits" (Table 1), it is not unusual for average deposits in the first quarter to exceed deposits in other quarters due to brokered deposits used to fund a portion of the RAL program. The Company typically experiences only a small amount of core deposit growth in the first half of the year with most deposit growth in the second half. Approximately $158 million in brokered deposits used for funding the RAL program are included in the balance shown above for December 31, 2001. In prior years, issuance of these deposits was not initiated until the first quarter. Issuance was begun earlier for the 2002 season so that the Company could issue more two month certificates. There is less demand in the market for certificates with this maturity term than for longer terms, but they are more beneficial because their shorter term better matches the Company's need for funding.

The table below shows the interest expense for the major categories of deposits for the three and nine-month periods ended September 30, 2002 and 2001.

The table in Note 5 to the Consolidated Financial Statements which this discussion accompanies shows the balances by loan type for September 30, 2002, December 31, 2001, and September 30, 2001. The end-of-period loan balances as of September 30, 2002 have increased by $105.1 million compared to December 31, 2001 and by $181.2 million compared to September 30, 2001. There are no RALs in these totals for 2002 or 2001. All unpaid RALs are charged-off by June 30 each year and the program does not begin until after December 31.

Within the average balance of consumer loans in Table 2B are some of the tax refund loans. About 90% or more of tax refund loans are made in the first quarter of each year with the remainder in the second quarter. Tax refund loans that were sold into the securitization and the fees charged on those loans were excluded from Table 2B.

Without the effect of tax refund loans, average yields for loans for the three and nine-month periods ended September 30, 2002 were 7.10% and 7.17%, respectively, and for the three and nine-month periods ended September 30, 2001 were 8.18% and 8.53%, respectively. The decreases in average rates earned in 2002 compared to 2001 is reflective of the Federal Open Market Committee of the Federal Reserve Board continuing to decrease its target market rates during the last three months of 2001. Along with most other financial institutions, the Company had to decrease its prime rate to reflect the change in market rates.

Most of the residential real estate loans held are adjustable rate mortgages (ARMS) that have initial "teaser" rates. The yield increases for these loans as the teaser rates expire. Applicants for these loans are qualified based on the fully-indexed rate.

In addition to the outstanding loans reported in the accompanying financial statements, the Company has made certain commitments with respect to the extension of credit to customers.

(in thousands)		September 30, 2002		December 31, 2001
Commitments to extend credit
	Commercial	$	618,079	$	553,390
	Consumer	$	122,618	$	98,228
Standby letters of credit		$	44,407	$	40,677

The majority of the commitments are for one year or less. The majority of the credit lines and commitments may be withdrawn by the Company subject to applicable legal requirements. The following table shows the maturity of the commitments as of September 30, 2002.

(in thousands)	Total Available	Maturity Less Than 1 Yr	Maturity 1-3 Yrs	Maturity 4-5 Yrs	Maturity 5+ Yrs
Commercial Lines of Credit	618,079	451,064	75,395	16,183	75,437
Consumer Lines of Credit	122,618	1,303	117	—	121,198
Standby Letters of Credit	44,407	28,448	12,949	—	3,010
Total	785,104	480,815	88,461	16,183	199,645

The Company anticipates that a majority of the above commitments will not be fully drawn on by customers. Consumers do not tend to borrow the maximum amounts available under their home equity lines and businesses typically arrange for credit lines in excess of their expected needs to handle contingencies.

The Company defers and amortizes loan fees collected and origination costs incurred over the lives of the related loans. For each category of loans, the net amount of the unamortized fees and costs are reported as a reduction or addition, respectively, to the balance reported. Because the fees collected are generally less than the origination costs incurred for commercial and consumer loans other than residential real estate loans, the total net deferred or unamortized amounts for these categories are additions to the loan balances.

The allowance for credit losses is provided in recognition that not all loans will be fully paid according to their contractual terms. The Company is required by regulation, generally accepted accounting principles, and safe and sound banking practices to maintain an allowance that is adequate to absorb the probable losses incurred in the portfolio of loans and leases, including those not yet specifically identified. The methodology used to determine the adequacy of the allowance for credit loss is discussed in detail in Note 1 to the Consolidated Financial Statements presented in the Company's Annual Report for 2001 on Form 10-K. This methodology involves estimating the amount of probable credit loss incurred in each of the loan and lease portfolios by taking into account such factors as historical charge-off rates, economic conditions, and concentrations by industry, geography, and collateral type. In addition, generally accepted accounting principles require the establishment of a valuation allowance for impaired loans as described in Note 5 to the financial statements.

Part of the methodology used by the Company to determine the adequacy of the allowance for credit loss involves grading loans. The Company uses a 10 point scale. Grades 1 through 5 are considered "Pass" grades and there are no specific credit concerns regarding the loans to which these grades have been assigned. Grade 6 is also considered a "Pass" grade, but there is some factor which causes the Company to monitor them more closely. Generally this factor does not pertain to the specific loan, but instead relates to the industry or geography in which the customer does business.

Grades 7 and 8 correspond to the regulatory designations of "Special Mention" and "Substandard." They are generally still performing according to contractual terms, i.e. the customer is making principal and interest payments on time, or at most they are one or two months delinquent in their payments. However, even if currently performing, the Company is aware of factors specific to the loans which cause heightened concern regarding eventual payment. Examples of such factors would be declining sales for a business customer or loss of a job for a consumer customer. In the case of a

Grade 7 loan, the factor or situation is potential but if it occurs, it is probable that the customer will not be able to continue to perform according to the contract terms. In the case of a Grade 8 loan, the factor or situation has occurred and continuation of the situation will cause default by the customer. Some of the Grade 8 loans will be classified as nonaccrual, i.e., the Company will not be recognizing interest on the loans and all payments will be applied to principal.

Grade 9 corresponds to the regulatory designation of "Doubtful," and they are three months or more delinquent. Generally the Company has stopped accruing interest on them unless they are well secured and the Company is actively pursuing collection efforts. Grade 10 corresponds to the regulatory designation of "Loss." The only loans graded 10 would be those in the process of being charged-off.

Special considerations apply when loans are determined to be impaired. These considerations, described in Note 5 to the financial statements which this discussion accompanies, affect the amount of allowance that the Company allocates to these loans.

At any point in time there will be some loans in each of the grades 7 through 9. The amount of loan balances in each grade will increase in periods of economic slowdown or recession, but the totals for each grade will not generally increase at the same time. Instead, depending on the pace or intensity of the slowdown and how quickly it impacts customers, there will generally be an increase in grades 7 and 8, later an increase in 9, and later still an increase in charge-offs.

However, not all loans continue to decline in credit quality. As business customers adjust their business plans or consumers adjust their spending levels, their loans may migrate to better grades even if recovery does not occur until later. Other loans will remain in one grade throughout the economic cycle, improving only with the eventual recovery. In addition, different categories of loans migrate through the grades differently when the economy slows or goes into recession. Unsecured loans tend to migrate faster than secured loans and consumer loans tend to migrate to poorer credit quality faster than commercial loans (Note F). Because of these factors—that totals in each grade do not increase at the same time, that loans migrate at different rates, and that some do not migrate or even improve—it is to be expected that credit quality measurements may lag economic indicators. For example, a loan graded 7 because lower sales were anticipated could be downgraded to 8 because the anticipated event occurred even though from a broad perspective, the economy may not appear to be worsening. Similarly, charge-offs, the last step in migration, may be higher as the economy has stabilized or is even improving. These charge-offs are the result of the ability of some customers to pay their debt being so damaged by the economic slowdown that they do not recover even when the economy does.

Generally, more allowance will be allocated to loans as they decline in credit quality. Consequently, as loan balances increase in grades 7 through 9, it would be expected that the allowance would increase through additional charges to provision expense. However, banks seldom provide an allowance of 100% of the loan balance. If the prospects are that poor for repayment, the loan is charged-off. Therefore, charge-offs entail extra provision expense to cover the portion of the loan balance for which allowance had not been provided. Otherwise, the remaining allowance would be insufficient to cover the risk of loss in the other loans.

The Company defines "potential problem loans" as loans graded 7 and loans graded 8 on which the Company is still accruing interest. "Noncurrent loans" are those loans graded 8 that are not accruing interest or are loans 90 days or more delinquent but still accruing interest and loans graded 9. The table below shows total potential problem loans and noncurrent loans as of each of the last six quarters. Also included in the table are the net charge-offs, allowance, and provision expense unrelated

to RALs. The impact of RALs is excluded from these figures because the season patterns of this program are unrelated to the economic cycle.

Table 9—POTENTIAL PROBLEM AND NONCURRENT LOANS, NET CHARGE-OFFS, ALLOWANCE, AND PROVISION (EXCLUSIVE OF RAL)

(dollars in thousands)	September 30, 2002		June 30, 2002		March 31, 2002	December 31, 2001			June 30, 2001
Potential problem loans	$	127,188		$	177,969	$	174,587	$	138,253	$	113,700	$	80,228
Noncurrent loans	$	49,786		$	31,495	$	20,700	$	20,119	$	20,615	$	23,962
Net charge-offs other than RALs	$	2,935		$	1,619	$	3,527	$	3,528	$	2,932	$	1,572
Allowance for credit losses other than RALs	$	55,341		$	59,122	$	54,807	$	48,872	$	43,886	$	41,242
Provision expense for loans other than RALs	$	(846	)	$	5,934	$	9,462	$	8,837	$	5,973	$	3,358

The Company began to experience an increase in potential problem loans beginning with the third quarter of 2001. Certain loans to customers involved in the hospitality industry were quickly downgraded as travel was severely curtailed in the aftermath of the terrorist attacks on New York and Washington D.C. The economy was already starting to slow when those events occurred and charge-offs had been higher than the previous quarter, especially in the consumer and leasing portfolios.

As the impact of the economic slowdown continued into the fourth quarter of 2001, the Company placed more of its commercial and commercial real estate loans in grades 7 and 8 as specific situations that could cause default were identified or actually occurred. However, payments were continuing to be made on time and so there was only a slight increase in noncurrent loans. The Company increased its allowance through additional provision expense to recognize the increase in probable losses incurred in the portfolio. In addition, additional provision expense addressed the increase in charge-offs in the consumer and small business portfolios.

Potential problem loans continued to increase in the first quarter of 2002, but commercial and commercial real estate customers were still making their payments and there was no increase in noncurrent loans. Charge-offs remained virtually identical to the preceding quarter. The Company again increased its allowance to provide for the additional probable losses estimated to be occurring with the increase in the potential problem loans.

During the second quarter of 2002 there was a stabilization in the potential problem loan balances as the loans downgraded into this classification about equaled the amount being upgraded to a pass grade or being classified as nonaccrual because of additional doubt as to the customer's ability to fully pay the debt. Noncurrent loans increased this quarter but charge-offs decreased. The increase in noncurrent loans led to $4.3 million in additional allowance to be provided. However, with the lower charge-off amount, this was provided with the expense charge at roughly two thirds what it had been in the prior two quarters.

In the third quarter of 2002, potential problem loans decreased by $50.7 million. Three loans with total outstanding balances of approximately $30 million were either upgraded or were repaid. This improvement in credit quality or repayment provided approximately $1.7 million in allowance that was then available for other loans. In addition, approximately $2.1 million of other potential problem loans were upgraded. The Company also reclassified $18.3 million from potential problem loans to nonaccrual loans. Approximately $16 million of this increase related to one loan. Weaknesses in this loan had been identified in the first quarter of 2002 and the Company had provided allowance for it in excess of the normal historical loss rate for its then current grade in both the first and second quarters of 2002. When the Company specifically reviews a credit for probable loss, it attempts to estimate both the probability of the loss and the amount of the loss. Based on its modeling during the third quarter

of the probability that loss had occurred in this loan, the Company recognized that while the estimated loss was no greater than its estimate had been in the second quarter, the loss was more certain. It therefore classified the loan as nonaccrual but did not provide more allowance for the loan than it had provided in the second quarter. This situation is not unusual in instances where the loan is collateralized. Better information about the cash flows of the borrower may be obtained such that it becomes more certain that the borrower will default. However, the value of the collateral remains the same and therefore the estimate of the amount of the allowance necessary to cover any loss also does not change. Lastly, there was a net increase in loans outstanding which would normally require an increase in the allowance for credit losses.

The net result of these actions was to lower the amount of the allowance considered necessary to cover probable losses estimated to have been incurred in the loan portfolio. This was accomplished by reversing $846,000 from our allowance for credit losses through a negative provision expense for loans other than RALs.

As explained in detail in the notes to the Company's Consolidated Financial Statements in its Annual Report on Form 10-K for the year ended December 31, 2001 ("2001 10-K"), loans not specifically reviewed each quarter have an allowance provided for them by applying historical loss rates to outstanding balances. These historical loss rates are modified based on a number of factors described in the 2001 10-K. Among these are the Company's judgment of current economic conditions in its market areas, because the historical loss rates cover periods of economic expansion and contraction. For example, if it is the Company's judgment that economic conditions have deteriorated during the quarter, then it will increase the historical loss rates on the assumption that more losses are likely to have occurred in the portfolios than would otherwise be the case. At the end of the third quarter of 2002, the best information available to the Company indicated that while recovery had not begun in its market areas, economic conditions had stabilized. In the Company's methodology for determining an adequate allowance for credit losses, this resulted in a lower need for provision expense compared to prior quarters when the Company had concluded that the economy was deteriorating.

The following table sets forth the allocation of the allowance for all adversely graded loans by classification as of September 30, 2002 and 2001 (amounts in thousands).

		September 30, 2002		September 30, 2001
Doubtful		$	5,113	$	4,881
Substandard			19,621		10,314
Special Mention			5,095		5,806

	Total	$	29,829	$	21,001

Table 11 shows the amounts of noncurrent loans and nonperforming assets for the Company at the end of the third quarter of 2002, and at the end of the previous four quarters. A set of standard credit quality ratios for the Company and its peers is also provided. Nonperforming assets include noncurrent loans and foreclosed collateral (generally real estate). There is no standard industry definition for "potential problem loans" so while the Company's totals for the last six quarters are shown in the Table 9, peer comparisons are not available.

Only two other banks operate national tax refund loan and transfer programs. Therefore, refund loans and the portion of the allowance for credit losses that specifically relates to refund loans are excluded from the Company's ratios in the table for comparability. As explained in "Refund Anticipation Loan and Refund Transfer Programs" below, all delinquent RALs are charged off prior to becoming 90 days delinquent and therefore would never be classified as nonaccrual.

Shown for both the Company and its peers are the coverage ratio of the allowance to total loans and the ratio of noncurrent loans to total loans. While the Company does not determine its allowance for credit losses by attempting to achieve particular target ratios, the Company nonetheless computes its ratios and compares them with peer ratios as a check on its methodology. Also shown for comparative purposes are the Company and peer ratios of noncurrent loans to total loans and nonperforming assets to total assets.

When the economy is changing, comparing the Company's ratios at the end of the current quarter with peers' ratios at the end of the prior quarter must be done cautiously. The Company's allowance as of the end of the current quarter may reflect impacts from the economy on the Company's borrowers which will only become apparent in the peer statistics when they are published near the end of the next quarter. The Company's allowance for credit losses (other than tax refund loans) to total loans at June 30, 2002 (2.05%) was higher (by 13%) than the peer ratio (1.81%) for the same date.

The ratio of allowance for credit loss to noncurrent loans is a common ratio reported for banks. The Company's ratio of allowance for credit loss compared to non-current loans at June 30, 2001 (188%) was higher than the ratio for its peers (173%) and then decreased to 111% at September 30, 2002. This occurred as the total of noncurrent loans increased as explained above. It is important to note however that the allowance is not provided only for noncurrent loans. It is also provided for the potential problem loans as well. Though the Company's allowance for credit losses is lower at June 30, 2002 than at September 30, 2002, as a percentage of potential problem loans and noncurrent loans, the allowance for credit loss increased from 28.2% to 31.3%, respectively. This percentage increase would be expected, because generally more allowance should be provided for noncurrent loans than for loans only potentially regarded as problem credits.

The following table shows the types of loans included among noncurrent and potential problem loans.

(dollars in thousands)			Noncurrent Loans		Potential Problem Loans other than Noncurrent
Loans secured by real estate:
	Construction and land development		$	5,412	$	20,131
	Agricultural			1,134		2,883
	Home equity lines			939		4,273
		1-4 family mortgage		2,954		12,850
	Multifamily			—		1,899
	Non-residential, nonfarm			3,423		30,088
Commercial and industrial				31,277		42,872
Leases				2,898		9,071
Other Consumer Loans				1,749		3,121

	Total		$	49,786	$	127,188

		2002 YTD Annualized		2001		2000		1999		1998
Pacific Capital Bancorp (excl tax refund loans)		0.38	%	0.33	%	0.33	%	0.23	%	0.03	%
FDIC Peers (Note B)		0.82	%	1.03	%	0.68	%	0.68	%	1.02	%

At the date this discussion was prepared, most economic analysts do not seem to expect any significant recovery during the last quarter of 2002. If the pace of recovery is slow, the Company expects that potential problem loans will remain stable and noncurrent loans will remain stable or show slight improvement. Nonetheless, charge-offs are expected to be higher in the last quarter of 2002 than in the third quarter. As noted above, Management believes that the slow or recessionary economy of the last year has lasted long enough that the ability of some customers to pay their loans has been irreparably damaged. The Company has indicated that it anticipates that the ratio of net charge-offs to average loans will be approximately 0.50% for the year 2002. This would imply approximately $5.0-$5.5 million in charge-offs for the last quarter of 2002 compared to $2.9 million for the both the third quarters of 2002 and 2001. The Company is aware of additional loans which are likely to be classified as noncurrent in the fourth quarter of 2002.

The amount of allowance for credit losses allocated to noncurrent loans, potential problem loans, impaired loans and to all other loans are determined based on the factors and methodology discussed in Note 1 to the Consolidated Financial Statements presented in the Company's 2001 10-K. Based on these considerations, Management believes that the allowance for credit losses at September 30, 2002 represents its best estimate of the allowance necessary to cover the probable losses incurred in the loan and lease portfolios as of that date.

Uninvested cash is a nonearning asset, so the Bank strives to maintain the minimum balances necessary for efficient operations. Cash in excess of the amount needed each day to fund loans, invest in securities, or cover deposit withdrawals is sold to other institutions as Federal funds or invested with other institutions on a collateralized basis as securities purchased under agreements to resell ("reverse repurchase agreements"). Federal funds sold are unsecured borrowings between financial institutions. The reverse repurchase agreements are investments which are collateralized by securities or loans of the borrower and mature on a daily basis. The Company requires the investments to be over-collateralized by 102% for securities and 105% for loans. The sales of Federal funds are done on an overnight basis as well. The amount of Federal funds sold and reverse repurchase agreements purchased during the quarter is an indication of Management's estimation during the quarter of immediate cash needs, the difference between funds supplied by depositors compared to funds lent to borrowers, and relative yields of alternative investment vehicles.

As shown in Table 2A, the average balance of these short-term investments for the third quarter of 2002 was less than for the third quarter of 2001. There are two explanations for this. The first is that during the third quarter of 2001, the interest rate curve was slightly inverted in the short maturity range and flat in the long maturity range. This meant that the Company would have received the same or possibly a smaller yield by investing extra cash in financial instruments with a longer maturity. Consequently, the Company tended to keep the funds in overnight instruments. By the fourth quarter of 2001, the yield curve had returned to a more normal shape with longer term instruments earning more than shorter term instruments. This allowed the Company to invest excess cash in longer-term instruments at higher rates than it would earn in overnight funds and the Company followed this course of action.

The second factor for the decrease is that during the last twelve months, loans have been increasing faster than deposits. As discussed in the next section, the Company has funded some of the loan growth not covered by increased deposits through nondeposit sources of funding. However, some has also been funded by carrying less overnight assets.

Federal funds purchased are exactly the converse of Federal funds sold in that they are overnight borrowings from other financial institutions used by the Company's subsidiaries as needed to manage

their daily liquidity positions. At various times during each quarter, the Company may experience loans growing or other cash outflows occurring at a higher rate than cash inflows from deposit growth. In these situations, the Company first uses its short-term investments to provide the needed funds—see the above section of this discussion—and then borrows funds overnight in the form of Federal funds purchased until cash flows are again balanced.

Small amounts of Federal funds are purchased from other local financial institutions as an accommodation to them, i.e. the Company provides the smaller institution with an opportunity to place funds at a better rate, for the relatively small amounts they sell, than they could obtain in the general market. The Company either earns a spread on what it can sell the funds for or reduces the expense on what it would otherwise have to borrow for its own liquidity needs.

As described in the previous section, the Company uses reverse repurchase agreements as a means of investing short-term excess cash. While the Company could borrow money overnight in the same repurchase agreement market that it lends funds, it instead generally uses repurchase agreements as a "retail" product. Funds in amounts that exceed FDIC deposit insurance coverage are borrowed from customers for periods of one week to two months. An exception to this general pattern occurs in the first quarter of each year as the Company uses repurchase agreements to borrow funds from other financial institutions to support the funding needs of the RAL program. Whether the repurchase agreements are with retail customers or other financial institutions, the borrowings are collateralized by securities held by the Company in its investment portfolios.

Table 14 indicates the average balance (dollars in millions), the rates for these borrowings and the proportion of total assets funded by them over the last seven quarters.

Table 14—FEDERAL FUNDS PURCHASED AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Quarter Ended	Average Outstanding		Average Rate		Percentage of Average Total Assets
December 2000	$	91.8	5.59	%	2.5	%
March 2001		135.7	5.00	%	3.4	%
June 2001		92.1	3.10	%	2.4	%
September 2001		70.7	3.45	%	1.9	%
December 2001		69.1	1.47	%	1.8	%
March 2002		151.6	1.32	%	3.5	%
June 2002		90.7	1.49	%	2.2	%
September 2002		57.6	1.75	%	1.4	%

Treasury Tax and Loan demand notes, borrowings from the Federal Reserve Bank (FRB), advances from the FHLB, and the senior and subordinated notes are reported on the Consolidated Balance Sheets as long-term debt and other borrowings.

Treasury Tax and Loan demand notes are amounts received from customers that are due to the Internal Revenue Service for payroll and other taxes. Banks may immediately forward these funds to the IRS, or may retain the funds and pay interest on them. The Company elects to retain these funds.

As a backup source of short-term liquidity, banks may borrow funds from the FRB. The Company borrowed funds from this source only a few times during the quarter.

SBB&T and FNB were both members of the FHLB and could obtain short term advances for liquidity purposes as well as the longer term borrowings they completed for interest rate risk management. With the consolidation of SBB&T and FNB into the Bank at the end of the first quarter of 2002, the bank charters were surrendered and the memberships were terminated. A new application was made by the Bank for membership in the FHLB, but the application could not be processed until financial statements were prepared for the combined entity for the first quarter of 2002. Rather than lose this source of liquidity during the application process, Management had the two banks borrow $50 million in short term advances from the FHLB just prior to the consolidation. This additional borrowing is partially the cause of the higher balances in other borrowings during the second quarter of 2002. These advances were repaid in June when they matured. The Bank's application for membership in the FHLB was also approved in June.

Long-term debt at September 30, 2002 included $177.0 million in advances from the FHLB, $36.0 million in subordinated debt at the Bank, and $40.0 million in senior debt at Bancorp. The scheduled maturities of the advances are $27.4 million in 1 year or less, $75.6 million in 1 to 3 years, and $74.0 million in more than 3 years. The maturity of both the subordinated debt and senior debt is July 2011.

Table 15 indicates the average balances that are outstanding (dollars in millions) and the rates and the proportion of total assets funded by long-term debt over the last seven quarters.

Quarter Ended	Average Outstanding	Average Rate		Percentage of Average Total Assets
March 2001	117.8	5.19	%	2.9	%
June 2001	118.0	6.09	%	3.1	%
September 2001	172.7	6.90	%	4.6	%
December 2001	175.8	6.51	%	4.6	%
March 2002	181.4	6.89	%	4.1	%
June 2002	268.8	5.80	%	6.6	%
September 2002	251.3	6.10	%	6.2	%

The Company uses long-term debt both to supplement other sources of funding for loan growth and as a means of mitigating the market risk incurred through the growth in fixed rate loans. One of the methods of managing interest rate risk is to match repricing characteristics of assets and liabilities. When fixed-rate assets are matched by similar term fixed-rate liabilities, the deterioration in the value of the asset when interest rates rise is offset by the benefit to the Company from holding the matching debt at lower than market rates. Most customers do not want CDs with maturities longer than a few years. The Company can borrow funds from the FHLB at longer terms to match the loan maturities.

The subordinated note and senior note were issued in July 2001 by the Bank and by Bancorp, respectively. The subordinated debt was structured to qualify as Tier II regulatory capital both for the Bank and for the Company. It was issued to permit continued loan growth and expansion of the RAL program at the Bank. The proceeds from the senior debt provided cash to retire some of the Company's outstanding shares, to pay the note mentioned in the succeeding paragraph, and to fund some of the cash dividends during the last few quarters. This avoided the need to fund these dividends through dividends from the bank which would lower its capital.

The Company incurred $20 million in term debt on June 30, 2000 to provide part of the funds necessary to purchase the shares of LRB's parent company, Los Robles Bancorp. The note called for principal reductions of $2.5 million per quarter until June 2001 when the note matured and was paid.

The average balance outstanding each quarter for this note is included in the amounts in Table 15 for the quarters ending December 2000 through June 2001.

Noninterest revenue consists of income earned other than interest. The largest individual component of noninterest revenue is the fees earned on tax refund transfers, about 90% of which occur in the first quarter. These fees and other operating income and expense of the tax refund programs are explained below in the section titled "Refund Anticipation Loan and Refund Transfer Programs." The $10.2 million gain on sale of RALs that occurred in the first quarter of 2002 is also discussed in detail in "Refund Anticipation Loan and Refund Transfer Programs."

Service charges on deposit accounts and trust and investment services fees are the next largest components of noninterest revenue. Service charges have increased along with the growth in deposit balances. Management fees on trust accounts are generally based on the market value of assets under administration, most of which are equity securities. Fees decreased $19,000 or 0.6% from the same quarter a year ago as the equity markets have declined.

Other categories of noninterest revenue include various service charges, fees, and miscellaneous income. In 2001, these included service fees arising from credit card processing for merchants and escrow fees. The Company sold its merchant card processing businesses in 2001, but some income and expenses associated with these portfolios have been recognized in 2002 as the business transitioned to the purchaser. The Company also discontinued its escrow operations in 2001.

Included in other income for the nine months ended September 30, 2001 is a gain of $1.4 million from the sale of some of the Company's indirect auto loans through a securitization as described in Note 13 to the financial statements.

The following table shows some of the major items of noninterest revenue and operating expense for the three and nine months ended September 30, 2002 and 2001 that are not specifically listed in the consolidated statements of income.

Consultant expense in the three and nine month periods ended September 30, 2002 is lower than in corresponding periods of 2001. The Company had a number of special projects in progress in 2001 for which consultants were used. Also, with the slowdown in the economy, the Company has been better able to hire information technology staff than in 2001 when outsourcing had to be used.

The largest component of noninterest expense is staff expense. There usually is some increase in this expense each quarter caused by the addition of staff as the Company continues to grow. Other factors cause some variation in staff expense from quarter to quarter. Staff expense will usually increase in the early part of each year because adjustments arising from the annual salary review for all Company exempt employees are effective March 1. In addition, some temporary staff is added in the first quarter for the RAL program.

Employee bonuses are paid from a bonus pool, the amount of which is set by the Board of Directors based on the Company meeting or exceeding its goals for net income and specific business unit goals. The Company accrues compensation expense for the pool for employee bonuses throughout the year based on projected progress in meeting the goals. The amount accrued each quarter is adjusted as the year progresses and as it becomes clearer whether these goals will be achieved.

Staff size is closely monitored in relation to the growth in the Company's revenues and assets. The following table compares salary and benefit costs as a percentage of revenues and assets for the three and nine-month periods ended September 30, 2002 and 2001.

	Three Months Ended September 30,		Nine Months Ended September 30,
	2002		2001		2002		2001
Salary and benefits as a percentage of net revenues	32.35	%	32.10	%	26.25	%	27.10	%
Salary and benefits as a percentage of average assets	0.47	%	0.48	%	1.37	%	1.41	%

Equipment expense fluctuates over time as needs change, maintenance is performed, and equipment is purchased.

The Company leases rather than owns most of its premises. Many of the leases provide for annual rent adjustments.

The Company moved its information technology and central operations staff into new facilities in the fourth quarter of 2000. The prior operations center had been occupied in the mid-1980s when the volume of business was substantially less. The Company had been in negotiations with the owner of the new facility for several years regarding the extent of the renovation required and resistance to earthquake damage that needed to be provided. In the first quarter of 2001, the Company received the benefit from a $500,000 one-time payment from the owner of the prior facility to leave before the lease expired. This is reported as an offset to occupancy expense for the first nine months of 2001.

Income tax expense is comprised of a current tax provision and a deferred tax provision for both Federal income tax and state franchise tax. The current tax provision recognizes an expense for what must be paid to taxing authorities for taxable income earned this year. The deferred tax provision recognizes an expense or benefit related to items of income or expense that are included in or deducted from taxable income in a period different than when the items are recognized in the financial statements under generally accepted accounting principles. Examples of such timing differences and the impact of the major items are shown in Note 8 to the Consolidated Financial Statements in the Company's Annual Report on Form 10-K.

With each period end, it is necessary for Management to make certain estimates and assumptions to compute the provision for income tax. Management uses the best information available to develop these estimates and assumptions, but generally some of these estimates and assumptions are revised when the Company files its tax return in the middle of the following year. In accordance with generally accepted accounting principles, revisions to estimates are recorded as income tax expense or benefit in the period in which they become known.

Provision for bad debt expense is only deductible for Federal taxes when loans are actually charged-off. Prior to 2002, California had permitted some portion of the provision to be deducted from state taxes in excess of amounts actually charged off, i.e. a reserve could be established through deductions from taxable income. In the third quarter of 2002, legislation was enacted which would conform tax accounting for provision expense with the Federal method. This will be done by requiring one half of the permitted reserve to be recaptured as taxable income in 2002. The remainder will never be recaptured. The Company recognized the one time benefit of $689 thousand from this change in the third quarter of 2002.

Liquidity is the ability to raise funds on a timely basis at acceptable cost in order to meet cash needs, such as might be caused by fluctuations in deposit levels, customers' credit needs, and attractive investment opportunities. The Company's objective is to maintain adequate liquidity at all times. The Company has defined and manages three types of liquidity: (1) "immediate liquidity," which is the ability to raise funds today to meet today's cash obligations, (2) "intermediate liquidity," which is the ability to raise funds during the next few weeks to meet cash obligations over that time period, and (3) "long term liquidity," which is the ability to raise funds over the entire planning horizon to meet anticipated cash needs due to strategic balance sheet changes. Adequate liquidity is achieved by (a) holding liquid assets, (b) maintaining the ability to raise deposits or borrow funds, and (c) keeping access open to capital markets.

Immediate liquidity is provided by the prior day's balance of Federal funds sold and repurchase agreements, any cash in excess of the Federal Reserve balance requirement, unused Federal funds lines from other banks, and unused repurchase agreement facilities with other banks or brokers. The Company maintains total sources of immediate liquidity of not less than 5% of total assets, increasing

to higher targets during RAL/RT season. At September 30, 2002, the Company's immediate liquidity was substantially in excess of the 5% target.

Sources of intermediate liquidity include maturities or sales of commercial paper and securities classified as available-for-sale, securities classified as held-to-maturity maturing within three months, term repurchase agreements, advances from the FHLB, and deposit increases from special programs. The Company projects intermediate liquidity needs and sources over the next several weeks based on historical trends, seasonal factors, and special transactions. Appropriate action is then taken to cover any anticipated unmet needs. At September 30, 2002, the Company's intermediate liquidity was adequate to meet all projected needs.

Long term liquidity is provided by special programs to increase core deposits, reducing the size of the investment portfolios, selling or securitizing loans, and accessing capital markets. The Company's policy is to address cash needs over the entire planning horizon from actions and events such as market expansions, acquisitions, increased competition for deposits, anticipated loan demand, economic conditions and the regulatory outlook. At September 30, 2002, the Company's long term liquidity was adequate to meet cash needs anticipated over its planning horizon.

As indicated above and in Note 13 of the Consolidated Financial Statements which this discussion accompanies, during 2001 the Company sold $58 million in auto loans through a securitization. This provided additional liquidity during the 2001 RAL season. It was not a necessary part of the liquidity plan for 2001, and no similar securitization transaction occurred in 2002. The Company did sell approximately $23 million of commercial real estate loans in early 2002. These sales were completed to test the liquidity of portions of its loan portfolio. Just as the Company occasionally borrows funds on its uncommitted lines from other financial institutions simply to test the availability of funds under those lines, the Company occasionally sells portions of its loan portfolio it would otherwise keep to test its ability to liquidate that portion of the portfolio should it be necessary.

The following table presents a comparison of several important amounts and ratios for the three and nine-month periods ended September 30, 2002 and 2001 (dollars in thousands).

The operating earnings of the bank are the largest source of capital for the Company. For reasons mentioned in various sections of this discussion, Management expects that there will be variations from quarter to quarter in operating earnings. Areas of uncertainty or seasonal variations include asset quality, loan demand, and the tax refund loan and transfer programs. A substantial increase in charge-offs might require the Company to record a larger provision for loan loss to restore the allowance to an adequate level, and this would negatively impact earnings. Income from the tax refund

loan and transfer programs, occurring almost entirely in the first quarter, introduces significant seasonality and causes the return on average assets and return on average equity ratios to be substantially higher in the first quarter of each year than they will be in subsequent quarters. This seasonality also impacts the year-to-date ratios in subsequent quarters.

Capital must be managed at both the Company and at the bank level. The FRB sets minimum capital guidelines for U.S. banks and bank holding companies based on the relative risk of the various types of assets. The guidelines require banks to have risk-based capital equivalent to at least 8% of risk adjusted assets. To be classified as "well capitalized", the Company is required to have risk-based capital equivalent to at least 10% of risk adjusted assets. As of September 30, 2002, the Company's total risk-based capital ratio was 12.52%. The Company must also maintain a Tier I capital (total shareholder equity less goodwill and other intangibles) to risk adjusted assets ratio of 6%, and 5% of average tangible assets. As of September 30, 2002, Tier I capital was 10.14% of risk adjusted assets and 8.11% of average tangible assets.

The total risk-based capital ratio of 12.52% includes the effect of the $36 million in subordinated debt at the Bank which qualifies as Tier II capital for the Bank and for the Company. As indicated in the discussion of the subordinated note in the section above titled "Other Borrowings, Long-term Debt and Related Interest Expense," this note was issued in the third quarter of 2001 to assist the Company in maintaining the required capital ratios at the Bank as its general loan portfolios and the refund loan program continue to grow.

While the earnings of its wholly-owned subsidiaries are recognized as earnings of the Company, generally dividends must be declared and paid by the subsidiary banks to provide Bancorp with the funds for it to pay dividends to its shareholders. As a nationally-chartered bank, the Bank's ability to pay dividends is governed by federal law and regulations. Generally banks may dividend their earnings from the last three years to their parent company. In its first year of operations, the Bank is limited to 2002 earnings. Earnings to date in 2002 are adequate to meet the cash required to maintain the current declared quarterly dividend rate of $0.18 per share.

In July 2001, the Company also issued $40 million in senior debt at the Bancorp level. These funds were used to repay the note issued to partially fund the purchase of LRB, to pay the quarterly cash dividends to shareholders over the next several quarters, to cover various expenses of Bancorp not reimbursable by the subsidiary banks, and provided some of the funds used to repurchase shares of the Company's stock during the second half of 2001 and the first quarter of 2002. In total, the Company repurchased approximately 917,000 shares at an average price of $21.86 per share.

In the second quarter of 2002, the Board of Directors authorized a second stock buy back plan. The plan provides for up to $20 million to be used to repurchase shares of the Company's stock from time to time as Management deems the price to be favorable. As of September 30, 2002, the Company had repurchased approximately 205,000 shares at an average price of $24.63 per share for a total price of $5.1 million.

Dividends are paid each quarter in February, May, August and November. The current quarterly dividend rate is $0.18 per share. When annualized, this represents a payout ratio of approximately 38% of earnings per share for the trailing 12 months, within the Company's target range of 35%-40%.

There are no material commitments for capital expenditures or "off-balance sheet" financing arrangements planned at this time. However, as the Company pursues its stated plan to expand beyond its current market areas, Management will consider opportunities to form strategic partnerships with other financial institutions that have compatible management philosophies and corporate cultures and that share the Company's commitment to superior customer service and community support. Such transactions, will be accounted for as a purchase of the other institution by the Company. To the extent that consideration is paid in cash rather than Company stock, the assets of the Company would

increase by more than its equity and therefore the ratio of capital to assets would decrease. In addition, depending on the size of the institution acquired, Bancorp might be required to borrow funds for the cash consideration.

On April 23, 2002, the Company's Board of Directors approved a 4 for 3 stock split. The stock split was payable June 11, 2002 to shareholders of record May 21, 2002. All share and per share amounts in this discussion have been restated for this split.

The Company is closely regulated by Federal and State agencies. The Company and its subsidiaries may only engage in lines of business that have been approved by their respective regulators, and cannot open or close branch 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. The Bank is required by the provisions of the CRA to make significant efforts to ensure that access to banking services is available to all members of the communities served.

As a bank holding company, Bancorp is primarily regulated by the FRB. As a nationally-chartered member bank of the Federal Reserve System, the Bank's primary Federal regulator is the Office of the Comptroller of the Currency (OCC). Both of these regulatory agencies conduct periodic examinations of the Company and/or its subsidiaries to ascertain their compliance with laws, regulations, and safe and sound banking practices. The primary reason for the merger of the banking charters of SBB&T and FNB into one nationally-chartered bank was to simplify the regulatory environment for the Company. Prior to the merger, SBB&T had the FRB as its primary Federal regulator and was also regulated by the California Department of Financial Institutions while FNB was regulated by the OCC.

The regulatory agencies may take action against bank holding companies and banks should they fail to maintain adequate capital or to comply with specific laws and regulations. Such action could take the form of restrictions on the payment of dividends to shareholders, requirements to obtain more capital from investors, or restrictions on operations. The Company and the Bank have the highest capital classification, "well capitalized," given by the regulatory agencies and therefore are not subject to any of these restrictions. Management expects the Company and the Bank to continue to be classified as well capitalized in the future.

Since 1992, the Company has extended tax refund anticipation loans to taxpayers who have filed their returns electronically with the IRS and do not want to wait for the IRS to send them their refund check. The Company earns a fixed fee per loan for advancing the funds rather than by applying an interest rate to the balance for the time the loan is outstanding. Nonetheless, the fees are required by SFAS No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases" to be classified as interest income. The Company also provides refund transfers to customers who do not want or do not qualify for loans. The transfer product facilitates the receipt of the refund by the customer by authorizing the customer's tax preparer to print a check for the customer after the refund has been received by the Company from the IRS. Fees for this service are included in non-interest income among other service charges, commissions, and fees. Because of the mid-April tax filing deadline, almost all of the loans and transfers are made and repaid during the first quarter of the year.

If a taxpayer meets the Company's credit criteria for the refund loan product, and wishes to receive a loan with the refund as security, the taxpayer applies for and receives an advance less the

transaction fees, which are considered finance charges. The Company is repaid directly by the IRS and then remits any refund amount over the amount of the loan to the taxpayer.

Congress has given the IRS a mandate to increase the number of returns that are filed electronically in order to reduce IRS processing and storage costs. Greater use of the refund loan and transfer programs helps the IRS to meet this mandate because these programs facilitate electronic filing.

While the Company is one of very few financial institutions in the country which operate these electronic loan and transfer programs, the electronic processing of payments involved in these programs is similar to other payment processing regularly done by the Company and other commercial banks for their customers such as direct deposits and electronic bill paying. The refund loan and transfer programs had significant impacts on the Company's activities and results of operations during the first six months of 2001 and 2002. These impacts and other details of the programs are discussed in the following five sections.

Because the programs relate to the filing of income tax returns, activity is concentrated in the first quarter of each year. This causes first quarter net income to average about 35% to 40% of each year's net income. For 2001, the first quarter's net income was 40.8% of the net income for the year. This seasonality significantly impacts a number of performance ratios, including return on assets (ROA), return on equity (ROE) and the operating efficiency ratio. These impacts are apparent in both the first quarter of each year and the year-to-date ratios in subsequent quarters. The Company provides computations of these ratios without the impact of RAL and RT income and the related direct expenses for better comparability with peer ratios.

As the RAL program has increased in loan volume, the Company has had to use more sophisticated funding arrangements.

Prior to 2000, the Company funded the loans by first drawing down its overnight liquid assets and then by borrowing overnight. The borrowing was done through use of its unsecured Federal funds credit lines with other financial institutions and by entering into repurchase agreements with other financial institutions that used the Company's securities as collateral for the overnight borrowings.

In 2000, the Company again used liquid assets and borrowed overnight to fund the loans. These sources are the least expensive and the most efficient in that the borrowing is done only on the days that it is needed. However, unless the overnight lines are committed lines for which fees are paid, they are subject to availability. Should funds not be available in sufficient quantities, the Company would not be able to meet its commitments. Therefore, Management added three other sources to the funding mix to ensure sufficient funds. First, the Company increased its borrowings from the FHLB during this period. Second, brokerage firms were engaged to sell certificates of deposit. Third, a backup committed credit line was obtained from another financial institution to provide funds if volumes exceeded expectations.

The certificates of deposit were issued with terms of two, three, and six months. Funding exclusively with two month terms would have been preferable because the funding need is concentrated in the only first three weeks of February, but they were not available in sufficient quantity.

The impact of using this method of funding was that the Company had an excess of funds after the loans began to be repaid by the IRS in substantial quantities, which had a negative impact on profitability.

Therefore, for the 2001 season, the Company made arrangements to finance some of the RALs through a securitization. In addition, the Company used its liquid assets, borrowed overnight funds, and issued brokered CDs to fund the remainder of the loans. The securitization had a higher rate of interest, but it was more efficient by providing funds only during the height of the refund season.

The same mix of funding was used in the first quarter of 2002. However, the securitization this year was structured as a sale of the loans. This required a different accounting for fees and expenses related to the loans which were securitized. These loans represented about one half of the total loans. This different accounting is described below. The securitization was completely paid off in the first quarter of 2002.

In general, as the volume of the program has increased, the cost of the funding has increased relative to overnight funds, but it has also become more efficient in better matching the funding to the specific days needed.

The Company does not market these products directly to consumers. Instead, the Company markets to electronic filers, companies which have developed software for use by tax preparers or individuals for the preparation of tax returns. The fees for RALs and RTs vary depending on the contracts with the electronic filers. Taxpayers are provided with a statement of the fees for the two products and, in the case of the RALs, with an Annual Percentage Rate computation for the loan based on an estimate of the time that the loan will be outstanding. If payment by the IRS is delayed past the estimated term, the customer's fee does not change.

The fees for the RAL product are higher than the fees for the RT product because of the credit risk and funding costs involved.

There is a higher credit risk associated with refund loans than with other types of loans because (1) the Company does not have personal contact with the customers of this product; (2) the customers conduct no business with the Company other than this once-a-year transaction; and (3) contact subsequent to the payment of the advance, if there is a problem with the tax return, may be difficult because many of these taxpayers have no permanent address.

Credit risk has been lowered in the last three years because of the debt indicator provided by the IRS. This electronic signal indicates whether the IRS or other Federal agencies have placed liens against the taxpayer's refund because of amounts owed for past taxes, delinquent student loans, etc. The lower credit risk allowed the banks involved with the RAL product to lower their fees. However, the charge-off rate for RALs still remains approximately three times higher than for the rest of the Company's loan portfolios.

As indicated above, the Company borrows substantial funds during the first quarter to lend to RAL customers. With the exception of the use of uncommitted overnight funds, the shorter funding sources are more expensive because the lender needs to recover its costs over the shorter period of time. Consequently fees must usually be paid in addition to daily interest, and the cost to the Company is greater than the typical deposit sources used to fund other loans.

The three main risks in the program are credit risk, the availability of sufficient funding at a reasonable rate, and risks associated with the IRS.

Credit risk is managed by the use of the debt indicator supplied by the IRS supplemented by the use of credit reports. A high proportion of loans charged-off each year are collected in subsequent years. When the customer applies for loan or transfer the following year, any charged-off amount from the prior year(s) is deducted from the amount of the current loan proceeds or transfer amount as permitted by the terms of the original loan agreement.

The Company's liquidity risk is increased during the first quarter due to the RAL program. The Company has committed to the electronic filers and tax preparers that it will make RALs available to their customers under the terms of its contracts with them. This requires the Company to develop sufficient sources of liquidity to fund these loans. The sources of this funding are described above in "Funding Impact on Various Balance Sheet and Income and Expense Accounts." Some of the sources are committed lines and some are uncommitted. In the case of uncommitted sources, the Company arranges for approximately twice the amount expected to be needed to ensure an adequate amount is available.

For many of the taxpayers wishing to use this product, a major portion of the refund is due to eligibility for the Earned Income Tax Credit (EIC). Such returns are subject to more scrutiny by the IRS than refunds that are primarily based on excess withholding. Each year the IRS reviews many of these EIC returns as part of its "revenue protection" program. Such review can cause a delay in payment of a loan made on the return. Such delays reduce the profitability of the program because there is no interest charged for the time the loan is outstanding.

The usefulness of the debt indicator is dependent on the IRS having received data from other Federal agencies on liens to which the refunds are subject.

The Company has been named in a lawsuit filed by certain tax preparers. The suit is described in Note 12 to the Consolidated Financial Statements which this discussion accompanies. The Company does not expect that the suit will have any material impact on its financial condition or operating results.

As indicated above, the securitization arrangement used in 2002 involved a "true" sale of the loans into the securitization vehicle. Under the terms of the securitization, the Company was paid 92% of the face amount of the loans. Any of the sold loans not paid by the IRS were to be charged against the Company's retained 8% interest until that amount was exhausted. Losses on defaulted loans in excess of the 8% interest would be recognized by the securitization purchasers. The loans sold into the securitization are not included in Table 2B and the fees received on them are not included in either Table 2B or Table 3.

The securitization changed how some of the income and expenses of the program were accounted for. All of the cash flows associated with the RALs sold to the Company's securitization partners were reported net as a gain on sale of loans. This gain account is reported as a separate line on the Consolidated Statements of Income for the six-month period ended June 30, 2002. Specifically, these cash flows included $14.0 million in fees, $1.9 million in interest and fees charged by the securitization partners, and $1.9 million in loans charged-off for a net gain of $10.2 million. As noted in various sections of this discussion, this accounting had the effect of causing substantial differences between some items of income and expense for 2002 and 2001.

The following table summarizes operating results for the RAL and RT programs for the three and nine-month periods ended September 30, 2002 and September 30, 2001.

The allowance table in Note 5 to the financial statements shows the activity in the allowance for RAL losses separate from the activity for other loans. Based on experience from prior years, many of the loans may yet be paid during the remainder of this year or during the 2003 filing season. While the charge-offs above do not include the $1.9 million charged-off for RALs sold into the securitization, any recoveries received on those loans accrue to the Company.

Following past practice, the Company charged-off remaining uncollected refund loans as of June 30. There is no credit risk associated with the refund transfers because checks are issued only after receipt of the refund payment from the IRS.

During the last quarter of 2002, the tax refund programs will continue to incur expenses for salaries, occupancy, legal, data processing, etc. Collections are also likely to be received on loans charged-off both in 2002 and in prior years.

Also during the remainder of 2002, the Company is negotiating funding arrangements for the 2003 tax season. The Company expects to use another securitization arrangement in the 2003 tax season similar to the one used in 2002. Several parties in addition to the purchasers for 2002 have expressed an interest in participating as purchasers in 2003. Based on negotiations to date, the Company also expects to obtain funds from a committed Federal funds line from a group of other financial institutions.

Note A—For Tables 2A, 2B 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 and loans 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 Tables 2A and 2B as "Tax equivalent income included in interest income from non-taxable securities and loans."

Note B—To obtain information on the performance ratios for peer banks, the Company primarily uses The FDIC Quarterly Banking Profile, published by the FDIC Division of Research and Statistics. This publication provides information about all FDIC insured banks and certain subsets based on size and geographical location. Geographically, the Company is included in a subset that includes 12 Western States plus the Pacific Islands. By asset size, the Company is included in the group of financial institutions with total assets from $1-10 billion. The information in this publication is based on year-to-date information provided by banks each quarter. It takes about 2-3 months to process the information. Therefore, the published data is always one quarter behind the Company's information. For this quarter, the peer information is for the second quarter of 2002. All peer information in this discussion and analysis is reported in or has been derived from information reported in this publication.

Note C—Most of the loans or transfers are paid to the taxpayer by means of a cashier's check issued by the tax preparer. The Company records the check as a deposit liability when it is issued and then removes the check from the deposit totals when it is paid by the Company.

Note D—The table below shows the balances and amounts of interest income and expense that are excluded in computing the non-RAL net interest margins:

Table 20—RAL AMOUNTS USED IN COMPUTATION OF NET INTEREST MARGIN EXCLUSIVE OF RAL

	Three Months Ended		Nine Months Ended
(in thousands)	9/30/02		9/30/01		9/30/02	9/30/01
Refund loan balances	$	—		$	—	$	90,903	$	78,749
Interest income	$	105		$	275	$	19,207	$	26,326
Certificates of deposit	$	3,089		$	—	$	71,774	$	26,514
Interest expense	$	22		$	—	$	1,582	$	852

Generally, interest income earned on loans is a function of the outstanding balance multiplied by the rate specified in the loan agreement. For RALs, however, the interest income is unrelated to the length of time the loan is outstanding and there is no explicit interest rate. The flat fee charged is instead simply recognized as income when the loan is collected from the IRS. Because relatively few loans are made during the second quarter each year, the average balance of RALs in these quarters is primarily related to the speed of payment by the IRS of loans made in the first quarter and also related to when during the quarter delinquent loans are charged-off.

Note E—Market interest rates available for financial instruments may be plotted on a graph by their maturities, with the rates on the Y axis and maturities on the X axis. The line that connects the points will normally be a curve slopping up to the right because generally short term instruments have lower rates and long term instruments have higher rates. Based on expectations in the markets with respect to interest rate changes, the shape and slope of the curve will change. When there is a wider divergence between short term and long term rates, the slope will become steeper. When there is a narrower difference between short term and long term rates, the slope will become flatter. Occasionally, the slope (or a portion of the slope) inverts and short term rates are actually higher than long term rates.

Note F—In fact, because consumer small business loans including leasing loans are generally charged-off as soon as they become 120 days delinquent, they will frequently migrate directly to loss from a pass or grade 7 classification without appearing from a reporting standpoint, simply because there is only a one in three chance that a quarter-end will occur while they are in nonaccrual status.

The Company has been named in a lawsuit filed by certain customers. This suit is also is described in Note 12 to the Consolidated Financial Statements which this discussion accompanies. The Company does not expect that this suit will have any material impact on its financial condition or operating results.

The Company is involved in various other 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, based in part on consultation with legal counsel, the resolution of these litigation matters will not have a material impact on the Company's financial position.

Exhibit Number		Item Description
None

Carol Kelleher
Assistant Corporate Secretary
Pacific Capital Bancorp
P.O. Box 60839
Santa Barbara, CA 93160-0839

Pursuant to the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized:

PART I. FINANCIAL INFORMATION			3
	Item 1.	Financial Statements:	4
		Consolidated Balance Sheets September 30, 2002 and December 31, 2001	4
		Consolidated Statements of Income Three and Nine-Month Periods Ended September 30, 2002 and 2001	5
		Consolidated Statements of Cash Flows Nine-Month Periods Ended September 30, 2002 and 2001	6
		Consolidated Statements of Comprehensive Income Three and Nine-Month Periods Ended September 30, 2002 and 2001	7
		Notes to Consolidated Financial Statements	8
The financial statements included in this Form 10-Q should be read with reference to the Pacific Capital Bancorp's Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	25
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk
		Quantitative and qualitative disclosures about market risk are located in Management's Discussion and Analysis of Financial Condition and Results of Operations in the section on interest rate sensitivity.
	Item 4.	Controls and Procedures
		Within the 90 days prior to the filing date of this quarterly report, Pacific Capital Bancorp carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in our periodic SEC filings. There have been no significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation.
PART II. OTHER INFORMATION			60
	Item 1.	Legal proceedings	60
	Item 4.	Submission of Matters to a vote of security holders	60
	Item 5.	Other information	60
	Item 6.	Exhibits and Reports on Form 8-K	60
SIGNATURES			61

					September 30, 2002		December 31, 2001
Assets:
	Cash and due from banks				$	135,340	$	136,457
	Federal funds sold and securities purchased under agreements to resell					26,500		94,500

			Cash and cash equivalents			161,840		230,957

	Securities (Note 4):
		Held-to-maturity				65,415		71,967
		Available-for-sale				777,638		699,076
	Loans, net of allowance of $55,341 at September 30, 2002 and $48,872 at December 31, 2001 (Note 5)					2,855,301		2,750,220
	Premises and equipment, net					66,743		63,103
	Accrued interest receivable					19,072		20,425
	Goodwill (Note 7)					30,048		30,048
	Other intangible assets (Note 7)					4,583		520
	Other assets (Note 6)					103,259		94,613

			Total assets		$	4,083,899	$	3,960,929

Liabilities:
	Deposits:
		Noninterest bearing demand deposits			$	773,961	$	718,441
		Interest bearing deposits				2,607,151		2,647,134

			Total Deposits			3,381,112		3,365,575
	Federal funds purchased and securities sold under agreements to repurchase					24,285		45,073
	Long-term debt and other borrowings (Note 8)					263,028		188,331
	Accrued interest payable and other liabilities					38,455		36,074

			Total liabilities			3,706,880		3,635,053

Commitments and contingencies (Note 12)
Shareholders' equity
	Common stock (no par value; $0.25 per share stated value; 80,000 authorized; 34,791 outstanding at September 30, 2002 and 34,941 at December 31, 2001)					8,701		8,737
	Surplus					101,144		106,929
	Accumulated other comprehensive income (Note 9)					19,335		4,795
	Retained earnings					247,839		205,415

			Total shareholders' equity			377,019		325,876

				Total liabilities and shareholders' equity	$	4,083,899	$	3,960,929

			For the Three-Month Periods Ended September 30,					For the Nine-Month Periods Ended September 30,
			2002			2001		2002		2001
Interest income:
	Interest and fees on loans		$	51,540		$	55,422	$	171,837	$	190,844
	Interest on securities			10,717			9,619		32,174		31,205
	Interest on Federal funds sold and securities purchased under agreements to resell			105			590		955		5,478
	Interest on commercial paper			—			1,058		50		1,899

		Total interest income		62,362			66,689		205,016		229,426

Interest expense:
	Interest on deposits			10,954			19,348		36,304		67,471
	Interest on securities sold under agreements to repurchase and Federal funds purchased			254			614		1,084		3,033
	Interest on other borrowed funds			3,890			3,147		10,911		8,064

		Total interest expense		15,098			23,109		48,299		78,568

Net interest income				47,264			43,580		156,717		150,858
Provision/(benefit) for credit losses (Note 5)				(1,505	)		4,438		17,280		19,664

	Net interest income after provision for credit losses			48,769			39,142		139,437		131,194

Non interest revenue:
	Service charges on deposits			3,572			3,236		10,496		9,530
	Trust fees			3,195			3,214		10,228		9,800
	Refund transfer fees			146			126		16,582		14,235
	Other service charges, commissions and fees, net			2,678			4,131		9,275		12,281
	Net gain on sale of tax refund loans			—			—		10,170		—
	Net gain on securities transactions			615			305		684		308
	Other income			1,226			1,957		3,247		5,404

		Total noninterest revenue		11,432			12,969		60,682		51,558

Operating expense:
	Salaries and benefits			18,792			18,056		56,881		54,774
	Net occupancy expense			3,692			3,299		10,350		8,900
	Equipment expense			2,150			2,110		5,981		6,180
	Other expense			9,625			12,444		32,924		39,699

		Total operating expense		34,259			35,909		106,136		109,553

Income before income taxes				25,942			16,202		93,983		73,199
Applicable income taxes				8,326			4,923		33,621		27,369

		Net income	$	17,616		$	11,279	$	60,362	$	45,830

Earnings per share—basic (Note 3)			$	0.51		$	0.32	$	1.73	$	1.29
Earnings per share—diluted (Note 3)			$	0.50		$	0.32	$	1.72	$	1.29
Average number of shares—basic				34,799			35,476		34,838		35,449
Average number of shares—diluted				35,037			35,648		35,020		35,641
Dividends declared per share			$	0.18		$	0.17	$	0.51	$	0.33
Dividends paid per share			$	0.18		$	0.17	$	0.51	$	0.50

				For the Nine-Month Periods Ended September 30,
				2002			2001
Cash flows from operating activities:
	Net Income			$	60,362		$	45,830
	Adjustments to reconcile net income to net cash provided by operations:
		Depreciation and amortization			6,397			8,064
		Provision for credit losses			17,280			19,664
		Net amortization of discounts and premiums for securities and commercial paper			(1,970	)		(7,072	)
		Net change in deferred loan origination fees and costs			340			(842	)
		Net gain on sales and calls of securities			(685	)		(308	)
		Change in accrued interest receivable and other assets			(21,905	)		7,969
		Change in accrued interest payable and other liabilities			2,381			2,011

			Net cash provided by operating activities		62,200			75,316

Cash flows from investing activities:
		Proceeds from sales of AFS securities			114,502			22,669
		Proceeds from calls and maturities of AFS securities			119,401			191,712
		Proceeds from calls and maturities of HTM securities			9,201			40,030
		Purchase of AFS securities			(287,420	)		(119,391	)
		Proceeds from sale or maturity of commercial paper			50,000			461,343
		Purchase of commercial paper			(49,950	)		(459,670	)
		Net increase in loans made to customers			(122,701	)		(210,979	)
		Purchase or investment in premises and equipment			(10,037	)		(8,450	)

			Net cash used in provided by investing activities		(177,004	)		(82,736	)

Cash flows from financing activities:
		Net increase in deposits			15,537			30,421
		Net increase (decrease) in borrowings with maturities of 90 days or less			29,212			(49,983	)
		Proceeds from long-term debt and other borrowing			110,500			79,274
		Payments on long-term debt and other borrowing			(85,803	)		(21,282	)
		Cash paid for retirement of stock			(10,111	)		(8,751	)
		Proceeds from issuance of common stock			4,290			6,014
		Dividends paid			(17,938	)		(17,551	)

			Net cash provided by financing activities		45,687			18,142

	Net (decrease) increase in cash and cash equivalents				(69,117	)		10,722
	Cash and cash equivalents at beginning of period				230,957			195,864

Cash and cash equivalents at end of period				$	161,840		$	206,586

Supplemental disclosure:
		Interest paid during period		$	51,553		$	76,502
		Income taxes paid during period		$	28,900		$	15,846
		Non-cash additions to loans		$	—		$	—

				For the Three-Month Period Ended September 30,						For the Nine-Month Period Ended September 30,
				2002			2001			2002			2001
Net income				$	17,616		$	11,279		$	60,362		$	45,830

Other comprehensive income (Note 9):
	Unrealized gain on securities:
		Unrealized holding gains arising during period			16,436			4,423			24,406			9,662
		Less: reclassification adjustment for gains included in net income			615			305			684			308
		Income tax expense related to items of other comprehensive income			(7,170	)		(1,988	)		(10,550	)		(4,192	)

			Other comprehensive income		9,881			2,740			14,540			5,778

Comprehensive income				$	27,497		$	14,019		$	74,902		$	51,608

	Three-month Periods				Nine-month Periods
	Basic Earnings Per Share		Diluted Earnings Per Share		Basic Earnings Per Share		Diluted Earnings Per Share
Period ended September 30, 2002
Numerator—Net Income	$	17,616	$	17,616	$	60,362	$	60,362

Denominator—weighted average shares outstanding		34,799		34,799		34,838		34,838

Plus: net shares issued in assumed stock option exercises				238				182

Diluted denominator				35,037				35,020

Earnings per share	$	0.51	$	0.50	$	1.73	$	1.72
Anti-dilutive options excluded				70				107
Period ended September 30, 2001
Numerator—Net Income	$	11,279	$	11,279	$	45,830	$	45,830

Denominator—weighted average shares outstanding		35,476		35,476		35,449		35,449

Plus: net shares issued in assumed stock option exercises				172				192

Diluted denominator				35,648				35,641

Earnings per share	$	0.32	$	0.32	$	1.29	$	1.29
Anti-dilutive options excluded				397				472

(in thousands)			Held-to- Maturity		Available- for-Sale		Total
September 30, 2002
Amortized cost:
	In one year or less		$	3,714	$	137,369	$	141,083
	After one year through five years			13,306		458,963		472,269
	After five years through ten years			14,786		23,238		38,024
	After ten years			33,609		124,701		158,310

		Total Securities	$	65,415	$	744,271	$	809,686

Estimated fair value:
	In one year or less		$	3,803	$	139,680	$	143,483
	After one year through five years			14,706		477,135		491,841
	After five years through ten years			18,227		24,442		42,669
	After ten years			42,196		136,381		178,577

		Total Securities	$	78,932	$	777,638	$	856,570

December 31, 2001
Amortized cost:
	In one year or less		$	9,594	$	167,363	$	176,957
	After one year through five years			14,717		423,763		438,480
	After five years through ten years			12,235		14,839		27,074
	After ten years			35,421		84,834		120,255

		Total Securities	$	71,967	$	690,799	$	762,766

Estimated fair value:
	In one year or less		$	9,686	$	170,849	$	180,535
	After one year through five years			16,236		427,499		443,735
	After five years through ten years			13,701		14,988		28,689
	After ten years			39,766		85,740		125,506

		Total Securities	$	79,389	$	699,076	$	778,465

(in thousands)		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
September 30, 2002
Held-to-maturity:
	State and municipal securities	$	65,415	$	13,517	$	—		$	78,932

			65,415		13,517		—			78,932

Available-for-sale:
	U.S. Treasury obligations		87,748		3,200		—			90,948
	U.S. agency obligations		315,711		12,495		—			328,206
	Collateralized mortgage obligations		212,368		4,657		(79	)		216,946
	Asset-backed securities		28,780		607		—			29,387
	State and municipal securities		99,664		12,495		(8	)		112,151

			744,271		33,454		(87	)		777,638

		$	809,686	$	46,971	$	(87	)	$	856,570

December 31, 2001
Held-to-maturity:
	Mortgage-backed securities	$	5	$	—	$	—		$	5
	State and municipal securities		71,962		7,422		—			79,384

			71,967		7,422		—			79,389

Available-for-sale:
	U.S. Treasury obligations		152,911		2,755		(191	)		155,475
	U.S. agency obligations		320,985		4,844		(1,919	)		323,910
	Collateralized mortgage obligations		104,251		1,559		(130	)		105,680
	Asset-backed securities		11,662		4		(6	)		11,660
	State and municipal securities		100,990		3,228		(1,867	)		102,351

			690,799		12,390		(4,113	)		699,076

		$	762,766	$	19,812	$	(4,113	)	$	778,465

(in thousands)	All Other Loans			Tax Refund Loans			Total
For the nine months ended September 30, 2002: Balance, December 31, 2001	$	48,872		$	—		$	48,872
Provision for credit losses		14,550			2,730			17,280
Credit losses charged against allowance		(11,942	)		(6,615	)		(18,557	)
Recoveries added to allowance		3,861			3,885			7,746

Balance, September 30, 2002	$	55,341		$	—		$	55,341

For the quarter ended September 30, 2002: Balance June 30, 2002	$	59,122		$	—		$	59,122
Provision for credit losses		(846	)		(659	)		(1,505	)
Credit losses charged against allowance		(4,811	)		—			(4,811	)
Recoveries added to allowance		1,876			659			2,535

Balance, September 30, 2002	$	55,341		$	—		$	55,341

For the nine months ended September 30, 2001: Balance, December 31, 2000	$	35,125		$	—		$	35,125
Provision for credit losses		13,414			6,250			19,664
Credit losses charged against allowance		(6,681	)		(9,783	)		(16,464	)
Recoveries added to allowance		2,028			3,533			5,561

Balance, September 30, 2001	$	43,886		$	—		$	43,886

For the quarter ended September 30, 2001: Balance June 30, 2001	$	41,242		$	—		$	41,242
Provision for credit losses		5,973			(1,535	)		4,438
Credit losses charged against allowance		(3,794	)		—			(3,794	)
Recoveries added to allowance		465			1,535			2,000

Balance, September 30, 2001	$	43,886		$	—		$	43,886

		For the Three-Month Periods Ended September 30,				For the Nine-Month Periods Ended September 30,
(dollars in thousands except earnings per share)		2002		2001		2002		2001
Reported net income		$	17,616	$	11,279	$	60,362	$	45,830
Add back: Goodwill amortization			—		653		—		1,911

Adjusted net income		$	17,616	$	11,932	$	60,362	$	47,741

Basic earnings per share:
	Reported net income	$	0.51	$	0.32	$	1.73	$	1.29
	Goodwill amortization		—		0.02		—		0.07

	Adjusted net income	$	0.51	$	0.34	$	1.73	$	1.36

Diluted earnings per share
	Reported net income	$	0.50	$	0.32	$	1.72	$	1.29
	Goodwill amortization		—		0.02		—		0.07

	Adjusted net income	$	0.50	$	0.34	$	1.72	$	1.36

				For the Three-Month Period Ended September 30, 2002						For the Three-Month Period Ended September 30, 2001
(dollars in thousands)				Before-Tax Amount		Tax Benefit		Net-of-Tax Amount		Before-Tax Amount		Tax Benefit		Net-of-Tax Amount
Other comprehensive income:
	Net unrealized gain on securities:
		Net unrealized holding gains arising during period		$	16,436	$	6,911	$	9,525	$	4,423	$	1,860	$	2,563
		Less: reclassification adjustment for gains included in net income			615		259		356		305		128		177

			Other comprehensive income	$	17,051	$	7,170	$	9,881	$	4,728	$	1,988	$	2,740

				For the Nine-Month Period Ended September 30, 2002						For the Nine-Month Period Ended September 30, 2001
(dollars in thousands)				Before-Tax Amount		Tax Benefit		Net-of-Tax Amount		Before-Tax Amount		Tax Benefit		Net-of-Tax Amount
Other comprehensive income:
	Net unrealized gain on securities:
		Net unrealized holding gains arising during period		$	24,406	$	10,263	$	14,143	$	9,662	$	4,063	$	5,599
		Less: reclassification adjustment for gains included in net income			684		288		396		308		130		178

			Other comprehensive income	$	25,090	$	10,550	$	14,540	$	9,970	$	4,192	$	5,778

(in thousands)	Community Banking		Commercial Banking		Refund Programs			Fiduciary			All Other			Total
Three months ended September 30, 2002
Revenues from external customers	$	30,195	$	25,819	$	252		$	3,300		$	16,327		$	75,893
Intersegment revenues		6,133		125		31			125			11,602			18,016

Total revenues	$	36,328	$	25,944	$	283		$	3,425		$	27,929		$	93,909

Profit (Loss)	$	8,755	$	16,347	$	(246	)	$	1,906		$	1,279		$	28,041
Interest income		24,685		24,507		105			—			15,163			64,460
Interest expense		10,211		—		22			220			4,645			15,098
Internal charge for funds		7,215		6,761		4			5			4,031			18,016
Depreciation		715		61		126			23			1,206			2,131
Total assets		1,355,833		1,411,032		12			5,013			1,312,009			4,083,899
Capital expenditures		—		—		—			—			3,011			3,011
Three months ended September 30, 2001
Revenues from external customers	$	32,503	$	33,331	$	402		$	3,163		$	11,719		$	81,118
Intersegment revenues		20,939		—		58			(354	)		7,985			28,628

Total revenues	$	53,442	$	33,331	$	460		$	2,809		$	19,704		$	109,746

Profit (Loss)	$	8,549	$	9,644	$	353		$	307		$	(1,191	)	$	17,662
Interest income		26,815		31,450		275			—			9,928			68,468
Interest expense		17,852		2		—			741			4,514			23,109
Internal charge for funds		12,940		8,369		—			—			7,319			28,628
Depreciation		892		51		72			29			1,131			2,175
Total assets		1,350,569		1,335,607		(752	)		1,540			1,060,014			3,746,977
Capital expenditures		172		—		—			—			3,727			3,899

(in thousands)	Community Banking		Commercial Banking		Refund Programs			Fiduciary		All Other			Total
Nine months ended September 30, 2002
Revenues from external customers	$	87,651	$	77,548	$	47,303		$	10,503	$	47,757		$	270,762
Intersegment revenues		23,718		125		850			497		31,726			56,916

Total revenues	$	111,369	$	77,673	$	48,153		$	11,000	$	79,483		$	327,678

Profit (Loss)	$	27,237	$	49,479	$	33,593		$	6,372	$	(17,634	)	$	99,047
Interest income		71,025		75,256		19,207			—		44,592			210,080
Interest expense		33,032		—		1,582			709		12,976			48,299
Internal charge for funds		19,924		21,552		565			16		14,859			56,916
Depreciation		2,092		175		595			238		3,297			6,397
Total assets		1,355,833		1,411,032		12			5,013		1,312,009			4,083,899
Capital expenditures		—		—		—			—		10,037			10,037
Nine months ended September 30, 2001
Revenues from external customers	$	89,608	$	106,319	$	40,562		$	9,785	$	38,941		$	285,215
Intersegment revenues		66,845		—		3,581			2,849		23,736			97,011

Total revenues	$	156,453	$	106,319	$	44,143		$	12,634	$	62,677		$	382,226

Profit (Loss)	$	27,464	$	30,325	$	25,682		$	4,028	$	(10,069	)	$	77,430
Interest income		72,917		101,331		26,326			—		33,083			233,657
Interest expense		60,968		4		852			2,843		13,901			78,568
Internal charge for funds		37,848		41,719		3,752			—		13,692			97,011
Depreciation		2,677		176		201			92		3,127			6,273
Total assets		1,350,569		1,335,607		(752	)		1,540		1,060,014			3,746,977
Capital expenditures		618		22		—			—		7,934			8,574

					Three months ended September 30, 2002								Three months ended September 30, 2001
(dollars in thousands)					Balance		Income			Rate (4)			Balance		Income		Rate (4)
ASSETS:
	Money market instruments:
		Commercial paper			$	—	$	—			0.00	%	$	105,522	$	1,058		3.98	%
		Federal funds sold				20,784		105			2.00	%		65,368		590		3.58	%

			Total money market instruments			20,784		105			2.00	%		170,890		1,648		3.83	%

	Securities: (2)
		Taxable				661,783		8,231			4.93	%		467,108		7,110		6.04	%
		Non-taxable				168,568		4,356			10.34	%		165,144		3,890		9.42	%

			Total securities			830,351		12,587			6.01	%		632,252		11,000		6.90	%

	Loans: (3)
		Commercial				624,450		12,657			8.04	%		680,625		16,425		9.57	%
		Real estate				1,902,618		31,961			6.72	%		1,716,854		32,319		7.53	%
		Consumer				358,049		7,151			7.92	%		281,981		6,757		9.51	%

			Total loans			2,885,117		51,769			7.12	%		2,679,460		55,501		8.22	%

	Total earning assets					3,736,252		64,461			6.84	%		3,482,602		68,149		7.76	%

	Non-earning assets					299,627								303,427

		TOTAL ASSETS			$	4,035,879							$	3,786,029

LIABILITIES AND SHAREHOLDER'S EQUITY:
	Interest bearing deposits:
		Savings and interest bearing transaction accounts			$	1,394,587		2,976			0.85	%	$	1,331,888		5,684		1.69	%
		Time certificates of deposit				1,175,684		7,978			2.69	%		1,160,419		13,664		4.67	%

			Total interest bearing deposits			2,570,271		10,954			1.69	%		2,492,307		19,348		3.08	%

	Borrowed funds:
		Federal funds purchased and repos				57,623		254			1.75	%		70,668		614		3.45	%
		Long-term debt and other borrowings				258,298		3,890			5.97	%		180,692		3,147		6.91	%

			Total borrowed funds			315,921		4,144			5.20	%		251,360		3,761		5.94	%

				Total interest bearing liabilities		2,886,192		15,098			2.08	%		2,743,667		23,109		3.34	%

	Noninterest-bearing demand deposits					747,494								670,512
	Other liabilities					49,155								44,256
	Shareholders' equity					353,038								327,594

	TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY				$	4,035,879							$	3,786,029

Interest income/earning assets											6.84	%						7.76	%
Interest expense/earning assets											1.60	%						2.63	%

Tax equivalent net interest income/margin								49,363			5.24	%				45,040		5.13	%
Provision for credit losses charged to operations/earning assets								(1,505	)		-0.16	%				4,438		0.50	%

Net interest margin after provision for credit losses on tax equivalent basis								50,868			5.40	%				40,602		4.63	%

Less: tax equivalent income included in interest income from non-taxable securities and loans											2,099							1,460

Net interest income										$	48,769						$	39,142

				Three months ended September 30, 2002 vs September 30, 2001												Nine months ended September 30, 2002 vs September 30, 2001
(in thousands)				Change in Average Balance			Change in Income/ Expense			Rate			Volume			Change in Average Balance			Change in Income/ Expense			Rate			Volume
Increase (decrease) in:
Assets:
	Money market instruments:
		Commercial paper		$	(105,522	)	$	(1,058	)	$	(529	)	$	(529	)	$	(53,727	)	$	(1,849	)	$	(608	)	$	(1,241	)
		Federal funds sold			(44,584	)		(485	)		(190	)		(295	)		(86,118	)		(4,523	)		(2,388	)		(2,135	)

			Total money market investment		(150,106	)		(1,543	)		(719	)		(824	)		(139,845	)		(6,372	)		(2,996	)		(3,376	)

	Securities:
		Taxable			194,675			1,121			(1,471	)		2,592			148,072			811			(1,550	)		2,361
		Non-taxable			3,424			466			385			81			8,216			886			295			591

			Total securities		198,099			1,587			(1,086	)		2,673			156,288			1,697			(1,255	)		2,952

	Loans:
		Commercial loans			(56,175	)		(3,768	)		(2,485	)		(1,283	)		(24,900	)		(11,681	)		(9,875	)		(1,806	)
		Real estate loans			185,764			(358	)		(3,694	)		3,336			243,328			40			(4,386	)		4,426
		Consumer loans			76,068			394			(1,244	)		1,638			66,162			(7,261	)		(7,934	)		673

			Total loans		205,657			(3,732	)		(7,423	)		3,691			284,590			(18,902	)		(22,195	)		3,293

Total earning assets					253,650			(3,688	)		(9,228	)		5,540			301,033			(23,577	)		(26,446	)		2,869

Liabilities:
Interest bearing deposits:
	Savings and interest bearing transaction accounts				62,699			(2,708	)		(2,962	)		254			44,223			(12,159	)		(11,959	)		(200	)
	Time certificates of deposit				15,265			(5,686	)		(5,864	)		178			51,309			(19,008	)		(18,514	)		(494	)

		Total interest bearing deposits			77,964			(8,394	)		(8,826	)		432			95,532			(31,167	)		(30,473	)		(694	)

Borrowed funds:
	Federal funds purchased and repos				(13,045	)		(361	)		(263	)		(98	)		(730	)		(1,949	)		(1,925	)		(24	)
	Long-term debt and other borrowings				77,606			744			(471	)		1,215			98,129			2,847			(195	)		3,042

		Total borrowed funds			64,561			383			(734	)		1,117			97,399			898			(2,120	)		3,018

	Total interest bearing liabilities			$	142,525			(8,011	)		(9,560	)		1,549		$	192,931			(30,269	)		(32,593	)		2,324

Tax equivalent net interest income							$	4,323		$	332		$	3,991					$	6,692		$	6,147		$	545

(in thousands)		September 30, 2002		December 31, 2001		September 30, 2001
Noninterest bearing deposits		$	773,961	$	718,441	$	664,318
Interest bearing deposits:
	NOW accounts		423,851		386,870		364,470
	Money market deposit accounts		747,064		730,494		732,249
	Other savings deposits		242,376		213,018		216,073
	Time certificates of $100,000 or more		693,448		827,422		658,437
	Other time deposits		500,412		489,330		497,693

		$	3,381,112	$	3,365,575	$	3,133,240

(dollars in thousands)	September 30 2002			June 30, 2002			March 31, 2002			December 31, 2001			September 30 2001			June 30, 2001
COMPANY AMOUNTS:
Loans delinquent 90 days or more	$	5,958		$	4,056		$	1,609		$	3,179		$	5,474		$	4,335
Nonaccrual loans		43,828			27,439			19,091			16,940			15,141			19,627

Total noncurrent loans		49,786			31,495			20,700			20,119			20,615			23,962
Foreclosed collateral		—			—			—			—			—			—

Total nonperforming assets	$	49,786		$	31,495		$	20,700		$	20,119		$	20,615		$	23,962

Allowance for credit losses other than RALs	$	55,341		$	59,122		$	54,807		$	48,872		$	43,886		$	41,242
Allowance for RALs		—			—			918			—			—			—

Total allowance	$	55,341		$	59,122		$	55,725		$	48,872		$	43,886		$	41,242

COMPANY RATIOS (Exclusive of RALs):
Coverage ratio of allowance for credit losses to total loans		1.90	%		2.05	%		1.93	%		1.75	%		1.61	%		1.56	%
Coverage ratio of allowance for credit losses to noncurrent loans		111	%		188	%		265	%		243	%		213	%		172	%
Ratio of noncurrent loans to total loans		1.71	%		1.09	%		0.73	%		0.72	%		0.76	%		0.91	%
Ratio of nonperforming assets to total assets		1.22	%		0.78	%		0.51	%		0.51	%		0.55	%		0.65	%
Ratio of allowance for credit losses to potential problem loans and noncurrent loans		31.27	%		28.23	%		28.06	%		30.86	%		32.67	%		39.58	%
FDIC PEER GROUP RATIOS: (Note B)
Coverage ratio of allowance for credit losses to total loans		n/a			1.81	%		1.79	%		1.79	%		1.91	%		1.84	%
Coverage ratio of allowance for credit losses to noncurrent loans		n/a			173	%		161	%		168	%		171	%		178	%
Ratio of noncurrent loans to total loans		n/a			1.04	%		1.11	%		1.07	%		1.12	%		1.05	%
Ratio of nonperforming assets to total assets		n/a			0.73	%		0.77	%		0.73	%		0.77	%		0.73	%

		Three-month Periods Ended September 30,									Nine-month Periods Ended September 30,
		2002			2001			Change			2002			2001			Change
Amounts:
	Net Income	$	17,616		$	11,279		$	6,337		$	60,362		$	45,830		$	14,532
	Average Total Assets	$	4,035,879		$	3,786,029		$	249,850		$	4,148,026		$	3,872,607		$	275,419
	Average Total Equity	$	353,038		$	327,594		$	25,444		$	340,080		$	318,416		$	21,664
Ratios:
	Equity to Total Assets (period end)		9.23	%		8.83	%		0.40	%		9.23	%		8.83	%		0.40	%
	Annualized Return on Average Assets		1.73	%		1.18	%		0.55	%		1.95	%		1.58	%		0.37	%
	Annualized Return on Average Equity		19.80	%		13.66	%		6.14	%		23.73	%		19.24	%		4.49	%

PACIFIC CAPITAL BANCORP
	/s/ WILLIAM S. THOMAS, JR. William S. Thomas, Jr. President Chief Executive Officer	November 14, 2002
	/s/ DONALD LAFLER Donald Lafler Executive Vice President Chief Financial Officer	November 14, 2002