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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
COMMISSION FILE NUMBER 0-11113
PACIFIC CAPITAL BANCORP
(Exact Name of Registrant as Specified in its Charter)
CALIFORNIA 95-3673456
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 E. CARRILLO STREET, SUITE 300
SANTA BARBARA, CALIFORNIA 93101
(Address of principal executive offices) (Zip Code)
(805) 564-6298
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Title of Class Name of Each Exchange on Which Registered
COMMON STOCK, NO PAR VALUE NOT LISTED
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 20, 2001, based on the sales prices reported to the
registrant on that date of $29.50 per share:
Common Stock - $ 721,394,150*
*Based on reported beneficial ownership by all directors and executive officers
and the registrant's Employee Stock Ownership Plan; however, this determination
does not constitute an admission of affiliate status for any of these
stockholders.
As of February 20, 2001, there were 26,530,202 shares of the issuer's common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of registrant's Proxy Statement
for the Annual Meeting of Shareholders on April 24, 2001 are incorporated by
reference into Parts I, II, and III.
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INDEX
PAGE
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PART I
Item 1. Business
(a) General Development of the Business 3
(b) Financial Information about Industry Segments 3
(c) Narrative Description of Business 3
(d) Financial Information about Foreign and Domestic
Operations and Export Sales 4
Item 2. Properties 4
Item 3. Legal Proceedings 4
Item 4. Submission of Matters to a Vote of Security Holders 4
PART II
Item 5. Market for the Registrant's Common Stock and
Related Stockholder Matters 5
(a) Market Information
(b) Holders
(c) Dividends
Item 6. Selected Financial Data 6
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 6
Item 8. Financial Statements and Supplementary Data 40
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures 79
PART III
Item 10. Directors and Executive Officers of the Registrant 80
Item 11. Executive Compensation 80
Item 12. Security Ownership of Certain Beneficial Owners and Management 80
Item 13. Certain Relationships and Related Transactions 80
PART IV
Item 14. Exhibits, Financial Statements, and Reports on Form 8-K 81
SIGNATURES 82
EXHIBIT INDEX 83
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PART I
ITEM 1. BUSINESS
(a) General Development of the Business
Operations commenced as Santa Barbara National Bank with one office and 18
employees in 1960. In 1979, the Bank switched to a state charter and changed its
name to Santa Barbara Bank & Trust ("SBB&T"). Santa Barbara Bancorp
("SBBancorp") was formed in 1982. In 1998, SBBancorp merged with Pacific Capital
Bancorp ("PCB"), a bank holding company that was the parent of First National
Bank of Central California ("FNB") and South Valley National Bank ("SVNB").
SBBancorp was the surviving company, but took the name Pacific Capital Bancorp.
Unless otherwise stated, "Company" refers to this consolidated entity and to its
subsidiary banks when the context indicates. "Bancorp" refers to the parent
company only.
SBB&T has grown to 27 banking offices with loan, trust and escrow offices.
Through 1988, banking activities were primarily centered in the southern coastal
region of Santa Barbara County. Two banking offices were added in the merger
with Community Bank of Santa Ynez Valley on March 31, 1989. Five offices in
northern Santa Barbara County were added with the acquisition of First Valley
Bank on March 31, 1997, and three offices in the Santa Clara River Valley region
of Ventura County were added with the acquisition of Citizens State Bank on
September 30, 1997. From 1995 through 1998, six banking offices were opened in
western Ventura County and one in northern Santa Barbara County.
FNB has 10 banking offices in Monterey, Santa Cruz, Santa Clara, and San Benito
Counties. The offices in the latter two counties use the name South Valley
National Bank, which was a separate subsidiary of PCB until it merged with FNB
shortly before PCB merged with SBBancorp. FNB added two additional offices in
San Benito County as a result of the merger of San Benito Bank ("SBB") with the
Company. The merger was completed at the end of July, 2000. FNB also provides
trust and investment services to its customers.
A third subsidiary, Los Robles Bank ("LRB"), was acquired by the Company at the
end of June, 2000, when the Company purchased all of the outstanding shares of
Los Robles Bancorp, parent of LRB. LRB has three offices. It is intended that
LRB will be merged with SBB&T in the second quarter of 2001.
A fourth subsidiary, Pacific Capital Commercial Mortgage Company ("PCCM"), was
formed in 1988. This subsidiary, which is now primarily involved in mortgage
brokering services and the servicing of brokered loans, was formerly known as
Sanbarco Mortgage Company.
There is a fifth subsidiary, Pacific Capital Services Corporation, which is
inactive.
(b) Financial Information about Industry Segments
Information about industry segments is provided in Note 20 to the consolidated
financial statements.
(c) Narrative Description of Business
Bancorp is a bank holding company, which as described above, has three bank
subsidiaries and two non-bank subsidiaries, one of which is inactive. Bancorp
provides support services to its subsidiary banks. These include executive
management, personnel and benefits, risk management, data processing, strategic
planning, legal, and accounting and treasury.
The banks offer a full range of commercial banking services to households,
professionals, and small- to medium-sized businesses. These include various
commercial, real estate and consumer loan, leasing and deposit products. The
banks offer other services such as electronic fund transfers and safe deposit
boxes to both individuals and businesses. In addition, services such as lockbox
payment servicing, foreign currency exchange, letters of credit, and cash
management are offered to business customers. The banks also offer trust and
investment services to individuals and businesses. These include acting as
trustee or agent for living and testamentary trusts, charitable remainder
trusts, employee benefit trusts, and profit sharing plans, as well as executor
or probate agent for estates. Investment management and advisory services are
also provided.
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Competition: For most of its banking products, the Company faces competition in
its market area from branches of most of the major California money center
banks, some of the statewide savings and loan associations, and other local
community banks and savings and loans. For some of its products, the Company
faces competition from other non-bank financial service companies, especially
securities firms.
Employees: The Company's current workforce is approximately 1,200 full time
equivalent employees. Additional employees would be added if new opportunities
for geographic expansion or other business activities should occur.
(d) Financial Information about Foreign and Domestic Operations and Export Sales
The Company does not have any foreign business operations or export sales of its
own. However, it does provide financial services including wire transfers,
foreign currency exchange, letters of credit, and loans to other businesses
involved in foreign trade.
ITEM 2. PROPERTIES
The Company maintains its executive and administrative offices in leased
premises at 200 E. Carrillo St., Suite 300, Santa Barbara. Administrative
functions are located in various leased premises in the Santa Barbara area.
Of the 43 branch banking offices, all or a portion of 65 are leased. The
building used by the Real Estate, Consumer Lending and Escrow departments of
SBBT is owned. Commercial office space is leased for Trust and Investment
Services
ITEM 3. LEGAL PROCEEDINGS
The Company is one of a number of financial institutions named as party
defendants in a patent infringement lawsuit filed by an unaffiliated financial
institution. The lawsuit generally relates to the Company's tax refund program.
The Company has retained outside legal counsel to represent its interest in this
matter. The Company does not believe that it has infringed any patents as
alleged in the lawsuit and intends to vigorously defend itself in this matter.
The amount of alleged damages are not specified in the papers received by the
Company. Therefore, Management cannot estimate the amount of any possible loss
at this time in the event of an unfavorable outcome.
There are no other material legal proceedings pending.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
(a) Market Information
The Company's common stock is traded on The Nasdaq Stock Market under the symbol
SABB. At December 31, 2000, ten independent brokerage firms were registered as
market makers in the Company's common stock. The following table presents the
high and low closing sales prices of the Company's common stock for each
quarterly period for the last two years as reported by The Nasdaq Stock Market:
2000 Quarters 1999 Quarters
--------------------------------------------- ---------------------------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
--------- --------- --------- --------- --------- --------- --------- ---------
Range of stock prices:
High $ 28.63 $ 28.50 $ 29.29 $ 30.69 $ 34.75 $ 38.00 $ 31.94 $ 26.00
Low $ 24.13 $ 25.06 $ 23.44 $ 23.75 $ 30.63 $ 29.63 $ 20.13 $ 22.00
(b) Holders
There were approximately 9,000 holders of stock as of December 31, 2000. This
number includes an estimate of the number of shareholders whose shares are held
in the name of brokerage firms or other financial institutions. The Company is
not provided with the number or identities of these shareholders, but has
estimated the number of such shareholders from the number of shareholder
documents requested by these firms for distribution to their customers.
(c) Dividends
Dividends are currently declared four times a year, and the Company expects to
follow the same policy in the future. The following table presents cash
dividends declared per share for the last two years:
2000 Quarters 1999 Quarters
----------------------------------------- -----------------------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
-------- -------- -------- -------- -------- -------- -------- --------
Cash dividends declared $ 0.22 $ 0.22 $ 0.20 $ 0.20 $ 0.18 $ 0.18 $ 0.18 $ 0.18
The dividends paid to shareholders of the Company are funded primarily from
dividends received by Bancorp from the banks. Reference should be made to Note
17 of the Consolidated Financial Statements on page 68 for a description of
restrictions on the ability of the subsidiary banks to pay dividends to Bancorp.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with the
Company's Consolidated Financial Statements and the accompanying notes presented
in Item 8.
(amounts in thousands except Increase
per share amounts) 2000 (Decrease) 1999 1998 1997 1996
---------- ---------- ---------- ---------- ---------- ----------
RESULTS OF OPERATIONS:
Interest income $ 290,916 $ 65,262 $ 225,654 $ 205,537 $ 178,175 $ 142,010
Interest expense 110,526 38,051 72,475 72,259 63,726 50,985
Net interest income 180,390 27,211 153,179 133,278 114,449 91,025
Provision for credit losses 14,537 7,462 7,075 9,313 8,700 5,049
Other operating income 49,388 5,996 43,392 39,456 31,375 22,838
Non-interest expense:
Staff expense 67,204 11,847 55,357 52,380 45,707 40,156
Other operating expense 64,656 2,620 62,036 59,572 42,262 33,246
Income before income taxes and
effect of accounting change 83,381 11,278 72,103 51,469 49,155 35,412
Provision for income taxes 31,925 6,355 25,570 19,970 17,118 12,093
Net income $ 51,456 $ 4,923 $ 46,533 $ 31,499 $ 32,037 $ 23,319
DILUTED PER SHARE DATA: (1)
Average shares outstanding 26,609 57 26,552 26,163 25,878 25,845
Net income $ 1.93 $ 0.18 $ 1.75 $ 1.20 $ 1.24 $ 0.90
Cash dividends declared $ 0.84 $ 0.12 $ 0.72 $ 0.66 $ 0.49 $ 0.36
FINANCIAL CONDITION:
Total assets $3,677,625 $ 597,316 $3,080,309 $2,825,346 $2,492,793 $2,034,596
Total deposits $3,102,819 $ 481,362 $2,621,457 $2,488,032 $2,207,483 $1,760,899
Long-term debt $ 103,000 $ 17,983 $ 85,017 $ 42,926 $ 38,000 $ 38,000
Total shareholders' equity $ 296,261 $ 43,220 $ 253,041 $ 230,495 $ 204,972 $ 183,679
OPERATING AND CAPITAL RATIOS:
Average total shareholders'
equity to average total assets 7.77% (0.48)% 8.25% 8.50% 8.76% 9.64%
Rate of return on average:
Total assets 1.40% (0.17)% 1.57% 1.20% 1.43% 1.25%
Total shareholders' equity 18.06% (0.94)% 19.00% 14.08% 16.32% 12.97%
(1) Earnings per share are presented on a diluted basis.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's discussion and analysis of the financial condition and results of
operation begins on the following page.
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PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following provides Management's comments on the financial condition and
results of operations of Pacific Capital Bancorp (formerly Santa Barbara
Bancorp) and its subsidiaries. Unless otherwise stated, the "Company" refers to
this consolidated entity and to its subsidiaries when the context indicates.
This discussion should be read in conjunction with the Company's consolidated
financial statements and the notes to the consolidated financial statements that
are presented on pages 44 through 79 of this Annual Report on Form 10-K.
"Bancorp" will be used to refer to the parent company only. "PCB" will be used
to refer to the former Pacific Capital Bancorp, which merged with Santa Barbara
Bancorp ("SBBancorp") at the end of 1998. SBBancorp assumed the Pacific Capital
Bancorp name. The subsidiary banks are Santa Barbara Bank & Trust ("SBB&T"),
First National Bank of Central California ("FNB"), and Los Robles Bank ("LRB").
South Valley National Bank ("SVNB") and San Benito Bank ("SBB") were independent
banks that merged with FNB and now operate under the same national bank charter
as FNB. Pacific Capital Commercial Mortgage Corporation ("PCCM") is a non-bank
subsidiary of Bancorp primarily involved in mortgage brokering and the servicing
of brokered loans. The Company also has an inactive subsidiary, Pacific Capital
Services Corporation. Terms with which the reader may not be familiar are
printed in bold and defined the first time they occur or are defined in a note
on pages 38 and 39.
The discussion is intended to provide insight into Management's assessment of
the operating trends over the last several years and its expectations for 2001.
Such expressions of expectations are not historical in nature and are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are subject to risks
and uncertainties that may cause actual future results to differ materially from
those expressed in any forward-looking statement. Such risks and uncertainties
with respect to the Company include those related to the economic environment,
particularly in the regions in which the Company operates, the products and
pricing of competitive financial institutions, government regulation, government
monetary and fiscal policy, changes in prevailing interest rates, mergers and
acquisitions and the integration of the merged or acquired businesses, credit
quality, asset/liability management, and the availability of sources of
liquidity at a reasonable cost. This discussion is also intended to assist
readers of the accompanying financial statements by providing information on the
strategies adopted by the Company to address these risks, and the results of
these strategies.
The merger of PCB with SBBancorp and the merger of SBB with the Company were
recorded using the "pooling-of-interests" method of accounting. As a result, all
amounts in this discussion and in the consolidated financial statements have
been restated to reflect the results of operations of PCB and SBB as if these
mergers had occurred prior to the earliest period presented. In contrast, the
acquisitions of First Valley Bank ("FVB") and Citizens State Bank ("CSB") during
1997, and the acquisition of LRB in 2000 (described in Note 19 to the
consolidated financial statements), were accounted for as purchase transactions.
OVERVIEW OF EARNINGS PERFORMANCE
From 1996 through 2000, the Company's net income has increased at a compound
average annual rate of 17.2%. Among the reasons for this favorable trend of
substantial increase in net income have been: (1) the integration of eight new
branch offices through the acquisition of FVB and CSB; (2) growth in the tax
refund anticipation loan ("RAL") and refund transfer ("RT") programs; (3) strong
loan demand during the last three years; and (4) continued growth in trust and
investment service fees due to the strong stock market performance in the years
prior to 2000 and the addition of new customers. During 1999, the Company
realized cost savings from the merger with PCB. While these initial savings were
more than offset in this first year by the expenses incurred to complete the
integration of the two computer systems, in 2000 the Company realized the full
benefit of the savings.
In 2000, the earnings for the Company were $51.5 million, or $1.93 per diluted
share. This represents a 10.6% increase over the $46.5 million net income or
$1.75 per diluted share reported for 1999. Reported earnings for 2000 were
significantly impacted by expenses related to the acquisitions of SBB and LRB.
Exclusive of these merger expenses, the Company's core or pro forma net
operating income for 2000 was $56.8 million and diluted earnings per share for
the year 2000 would have been $2.13. 2000 pro forma earnings exceeded 1999
earnings by 22.0%, and 2000 pro forma earnings per share exceeded the 1999
figure by 21.7%.
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1999 net income of $46.5 million exceeded the $31.5 million of net income
reported for 1998. The reported earnings for 1998 were significantly impacted by
expenses related to the merger of SBBancorp with PCB. Exclusive of these merger
expenses, the Company's net operating income for 1998 was $39.8 million and
diluted earnings per share would have been $1.54. 1999 net income exceeded the
1998 pro forma net income by 16.8% and 1999 earnings per share exceeded the 1998
pro forma figure by 13.6%.
EXTERNAL FACTORS IMPACTING THE COMPANY
The major external factors impacting the Company include economic conditions,
regulatory considerations, and trends in the banking and financial services
industries.
Economic Conditions
From a national perspective, the most significant economic factors impacting the
Company in the last three years have been the steady growth in the economy and
the actions of the Federal Reserve Board ("the Fed") to manage the pace of that
growth. After raising short-term interest rates in late 1997 to slow the pace of
economic growth and forestall inflation, during late 1998, the Fed lowered rates
to keep economic activity up in the face of recession in many other parts of the
world. In late 1999, it again began to raise interest rates to slow economic
growth and continued with periodic increases until mid-2000. Early in 2001, the
Fed again began to lower rates, as the economy showed evidence of significant
slowing. These changes impact the Company as market rates for loans, investments
and deposits respond to the Fed's actions.
The local economies in which the Company operates have continued to experience
steady growth during the last three years, and the business climates in general
remain healthy going into 2001. Tourism, which has long been important to the
communities in the SBB&T market area, remains strong. Medical manufacturing and
other "hi-tech" businesses have continued to grow. Several large retail and
factory outlet complexes have been built in the last few years. SBB&T expanded
its market areas in 1997 with the acquisitions of FVB and CSB and they now
encompass communities more oriented to agricultural enterprises. This has helped
to diversify the bank's customer base. In the region served by FNB, SVNB and
SBB, significant growth has occurred in South Santa Clara County in both housing
and in new businesses. Much of this growth has been a result of the continued
economic expansion in the Silicon Valley, which is adjacent to the market area
served by SVNB. In the Monterey area, tourism has remained strong.
Agriculture-related industries in the market areas of both banks have continued
to experience price pressure. Business activity in the Thousand Oaks/Westlake
areas of Ventura County served by LRB has continued to be strong.
Regulatory Considerations
The Company is impacted by changes in the regulatory environment and by
differences in practices by the various banking regulators. Bancorp, as a bank
holding company, SBB&T, as a member of the Federal Reserve Bank (the "FRB"), and
PCCM, as a non-bank subsidiary of a bank holding company, are all regulated by
the FRB. FNB, as a nationally chartered bank, has the Office of the Comptroller
of the Currency (the "OCC") as its primary regulator, but must also comply with
FRB regulations. As a state-chartered commercial bank, SBB&T is also regulated
by the California Department of Financial Institutions (the "CDFI"). As a
state-chartered bank that is not a member of the FRB, LRB has the Federal
Deposit Insurance Corporation (the "FDIC") as its primary federal regulator and
is also regulated by the CDFI.
Changes in regulation impact the Company in different ways. The FRB requires
that all banks maintain cash reserves equal to a percentage of their transaction
deposits. The FRB may increase or decrease the percentage of deposits that must
be held at the FRB to impact the amount of funds available to commercial banks
to lend to their customers. This may be done as a means of stimulating or
slowing economic activity, but it has not been used in the last decade as the
Fed has favored changes in interest rates rather than liquidity to manage the
economy.
The Company and its subsidiary banks are also impacted by minimum capital
requirements. These rules are discussed below in the section entitled "Capital
Adequacy." The actions which the various banking agencies can take with respect
to financial institutions which fail to maintain adequate capital and comply
with other requirements are discussed below in the section titled "Regulation."
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Competition
The Company faces competition from other financial institutions and from
businesses in other industries that have developed financial products. Banks
once had an almost exclusive franchise for deposit products and provided the
majority of business financing. With deregulation in the 1980s, other kinds of
financial institutions began to offer competing products. Also, increased
competition in consumer financial products has come from companies not typically
associated with the banking and financial services industry, such as AT&T,
General Motors and various software developers. Similar competition is faced for
commercial financial products from insurance companies and investment bankers.
Community banks, including the Company, are working to offset this trend by
developing new products that capitalize on the service quality that a local
institution can offer. Among these are new loan and investment products. The
latter are offered to the Company's retail customers through the Trust &
Investment Management Services Divisions at each bank. The Company's primary
competitors are different for each specific product and market area. While this
offers special challenges for the marketing of our products, it offers
protection from one competitor dominating the Company in its market areas.
RISK MANAGEMENT
The Company sees the process of addressing the potential impacts of the external
factors listed above as part of its management of risk. In addition to common
business risks such as disasters, theft, and loss of market share, the Company
is subject to special types of risk due to the nature of its business. New and
sophisticated financial products are continually appearing with different types
of risk which need to be defined and managed if the Company chooses to offer
them to its customers. Also, the risks associated with existing products must be
reassessed periodically. The Company cannot operate risk-free and make a profit.
Instead, the process of risk definition and assessment allows the Company to
select the appropriate level of risk for the anticipated level of reward and
then decide on the steps necessary to manage this risk. The process of
addressing these risks is led by the Company's Director of Risk Management and
the other members of its Senior Leadership Team under the direction and
oversight of the Board of Directors.
The special risks related to financial products are CREDIT RISK and INTEREST
RATE RISK. Credit risk relates to the possibility that a debtor will not repay
according to the terms of the debt contract. Credit risk is discussed in the
sections related to loans. Interest rate risk relates to the adverse impacts of
changes in interest rates. The types of interest rate risk will be explained in
the next section. The effective management of these and the other risks
mentioned above is the backbone of the Company's business strategy.
NET INTEREST MARGIN AND CHANGES IN THE RELATIVE PROPORTIONS OF ASSETS AND
LIABILITIES
The Company earns income from two sources. The primary source is through the
management of its financial assets and liabilities and the second is by charging
fees for services provided. The first involves functioning as a FINANCIAL
INTERMEDIARY; that is, the Company accepts funds from depositors or obtains
funds from other creditors and then either lends the funds to borrowers or
invests those funds in securities or other financial instruments. The second,
fee income, is discussed in other sections of this analysis, specifically in
"Other Operating Income" and "Tax Refund Anticipation Loans and Refund
Transfers."
NET INTEREST INCOME is the difference between the interest and fees earned on
loans and investments (the Company's EARNING ASSETS) and the interest expense
paid on deposits and other liabilities. The amount by which interest income will
exceed interest expense depends on two factors: (1) the volume or balance of
earning assets compared to the volume or balance of interest-bearing deposits
and liabilities, and (2) the interest rate earned on those interest earning
assets compared with the interest rate paid on those interest-bearing deposits
and liabilities. The Company's 2000 TAX EQUIVALENT (Note C) net interest income
of $186.6 million was $27.5 million, or 17.3% greater than the $159.1 million of
net interest income for 1999. The 1999 amount in turn was $20.0 million, or
14.4%, greater than the $139.0 million of net interest income for 1998.
NET INTEREST MARGIN is net interest income (tax equivalent) expressed as a
percentage of average earning assets. It is used to measure the difference
between the average rate of interest earned on assets and the average rate of
interest that must be paid on liabilities used to fund those assets. To maintain
its net interest margin, the Company must manage the relationship between
interest earned and paid. The Company's 2000 net interest margin was 5.47%
compared to 5.75% and 5.65% for 1999 and 1998, respectively. The increase from
1998 to 1999 occurred as a result of the Fed's decision to raise rates in 1999
due to concerns about an
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overheated economy. The Company's variable rate loans repriced along with the
rise in external rates, but it was not necessary to increase rates on deposit
accounts as much in order to stay competitive. This created a larger spread
between the rates earned and paid which resulted in an increase in the margin.
The decrease from 1999 to 2000 occurred for three reasons: (1) as the Fed
continued to raise interest rates, rates on deposits eventually had to be
increased; (2) the continued high loan demand required the Company to make
increasing use of funding sources other than deposits, and these were more
expensive; and (3) the rapid growth in the Company's refund loan program
required a large amount of short term funding which had to be raised by using
brokered CDs, a more expensive form of deposits.
The net interest margin is subject to the following types of risks that are
related to changes in interest rates: MARKET RISK, MISMATCH RISK, and BASIS
RISK.
Market Risk Relating to Fixed-Rate Instruments
MARKET RISK results from the fact that the market values of assets or
liabilities on which the interest rate is fixed will increase or decrease with
changes in market interest rates. If the Company invests funds in a fixed-rate
long-term security and then interest rates rise, the security is worth less than
a comparable security just issued because the older security pays less interest
than the newly issued security. If the older security had to be sold before
maturity, the Company would have to recognize a loss. Conversely, if interest
rates decline after a fixed-rate security is purchased, its value increases,
because it is paying at a higher rate than newly issued securities. The
fixed-rate liabilities of the Company, like certificates of deposit and
borrowings from the Federal Home Loan Bank ("FHLB"), also change in value with
changes in interest rates. As rates drop, they become more valuable to the
depositor and hence more costly to the Company. As rates rise, they become more
valuable to the Company. Therefore, while the value changes regardless of which
direction interest rates move, the adverse impacts of market risk to the
Company's fixed-rate ASSETS are due to RISING interest rates and for the
Company's fixed-rate liabilities they are due to falling rates.
In general, for a given change in interest rates, the amount of the change in
value up or down is larger for instruments with longer remaining maturities.
Therefore, the exposure to market risk from assets is lessened by managing the
amount of fixed-rate assets and by keeping maturities relatively short. However,
these steps must be balanced against the need for adequate interest income
because variable rate and shorter term fixed-rate securities generally earn less
interest than fixed-rate and longer term securities.
Note 14 to the consolidated financial statements discloses the carrying amounts
and fair values of the Company's financial assets and liabilities, its NET
FINANCIAL ASSETS, as of the end of 2000 and 1999. There is a relatively small
difference between the carrying amount of the assets and their fair value due to
credit quality issues. However, the primary difference between the carrying
amount and the fair value of the Company's financial assets is essentially a
measure of how much changes in interest rates have made the assets more or less
valuable to the Company at December 31, 2000 and 1999 than when acquired. The
excess of the carrying amounts of the financial assets over their fair value at
the end of 2000 was $32.7 million compared with an excess of carrying amount
over fair value of $39.2 million at the end of 1999. Most of this change is due
to decreases in market rates at the end of 2000.
Because the amount of the Company's fixed-rate liabilities is significantly less
than its fixed-rate assets, and because the average maturity of the fixed-rate
liabilities is substantially less than for the fixed-rate assets, the market
risk relating to liabilities is not as great as for assets. The difference
between the carrying amount and the fair value in the table in Note 14 shows the
impact of changing rates on the Company's liabilities that have fixed-rates.
They are worth $6.3 million more to customers or lenders to the Company at
December 31, 2000, than they were when issued, because on a weighted average
basis, they are paying rates that are slightly higher than current market rates.
Mismatch Risk
The second interest-related risk, MISMATCH RISK, arises from the fact that when
interest rates change, the changes do not occur equally in the rates of interest
earned and paid because of differences in the contractual terms of the assets
and liabilities held. A difference in the contractual terms, a mismatch, can
cause adverse impacts on net interest income.
10
11
The Company has a large portion of its loan portfolio tied to the national prime
rate. If these rates are lowered because of general market conditions, e.g., the
prime rate decreases in response to a rate decrease by the Fed, these loans will
be repriced. If the Company were at the same time to have a large proportion of
its deposits in longer-term fixed-rate certificates, interest earned on loans
would decline while interest expense would remain at higher levels for a period
of time until the certificates matured. Therefore net interest income would
decrease immediately. A decrease in net interest income could also occur with
rising interest rates if the Company had a large portfolio of fixed-rate loans
and securities that was funded by deposit accounts on which the rate is steadily
rising.
This exposure to mismatch risk is managed by attempting to match the maturities
and repricing opportunities of assets and liabilities. This may be done by
varying the terms and conditions of the products that are offered to depositors
and borrowers. For example, if many depositors want shorter-term certificates
while most borrowers are requesting longer-term fixed rate loans, the Company
will adjust the interest rates on the certificates and loans to try to match up
demand for similar maturities. The Company can then partially fill in mismatches
by purchasing securities or borrowing funds from the FHLB with the appropriate
maturity or repricing characteristics.
Basis Risk
The third interest-related risk, BASIS RISK, arises from the fact that interest
rates rarely change in a parallel or equal manner. The interest rates associated
with the various assets and liabilities differ in how often they change, the
extent to which they change, and whether they change sooner or later than other
interest rates. For example, while the repricing of a specific asset and a
specific liability may occur at roughly the same time, the interest rate on the
liability may rise one percent in response to rising market rates while the
asset increases only one-half percent. While the Company would appear to be
evenly matched with respect to the maturities of the specific asset and
liability, it would suffer a decrease in net interest income. This exposure to
basis risk is the type of interest risk least able to be managed, but is also
the least dramatic. Avoiding concentration in only a few types of assets or
liabilities is the best means of increasing the chance that the average interest
received and paid will move in tandem. The wider diversification means that many
different rates, each with their own volatility characteristics, will come into
play.
Net Interest Income and Net Economic Value Simulations
To quantify the extent of all of these risks both in its current position and in
transactions it might take in the future, the Company uses computer modeling to
simulate the impact of different interest rate scenarios on net interest income
and on NET ECONOMIC VALUE. Net economic value or the MARKET VALUE OF PORTFOLIO
EQUITY is defined as the difference between the market value of financial assets
and liabilities. These hypothetical scenarios include both sudden and gradual
interest rate changes, and interest rate changes in both directions. This
modeling is the primary means the Company uses for interest rate risk management
decisions.
Each quarter, the Company models how sudden, hypothetical changes in interest
rate, called SHOCKS, if applied to its asset and liability balances would impact
net interest income and net economic value. The results of this modeling
indicate how much of the Company's net interest income and net economic value
are "at risk" (deviation from the base level) from various sudden rate changes.
Although interest rates normally would not change in this sudden manner, this
exercise is valuable in identifying risk exposures and in comparing the
Company's interest rate risk profile with those of other financial institutions.
The results for the Company's December 31, 2000, balances indicate that the
Company's net interest income at risk over a one-year period and net economic
value at risk from 2% shocks are within normal expectations for such sudden
changes.
Shocked by -2% Shocked by +2%
-------------- --------------
Net interest income (3.72)% +3.65%
Net economic value +12.71% (11.71)%
For the modeling, the Company has made certain assumptions about the duration of
its non-maturity deposits that are important in determining net economic value
at risk. The Company engaged an outside consultant to gather and study data on
its non-maturity deposits, and it has also compared its assumptions
11
12
with those used by other financial institutions. The conclusions from these
actions have been incorporated into these models.
In addition to applying scenarios with sudden interest rate shocks, net interest
income simulations are prepared at least twice a year using various interest
rate projections. Reflecting the prevailing interest rate environment and the
recent moves by the Fed to decrease interest rates, the Company's projection for
the most likely scenario includes generally declining interest rates. In
addition, the Company runs simulations based on additional interest rate
projections including a more sharply declining rate scenario, and a stable or
less declining scenario. These interest rate scenarios are applied to expected
asset and liability balances over the next year, and the differences in the
results indicate the amount of net interest income at risk. The projections
anticipate more normal yield curves (Note F) than were experienced in 2000. As
the year progresses, the models are revised to make use of the latest available
projections.
The interest rate simulation reports are dependent upon assumptions relating to
the shape of the interest rate curves, the volatility of the interest rate
scenarios selected, and the rates that would be paid on the Company's
ADMINISTERED rate deposits as external yields change. Administered rate deposit
accounts like NOW, money market deposit accounts ("MMDA"), and savings, are
those products which the institution can reprice at its option based on
competitive pressure and need for funds.
Under these more realistic scenarios, as in the case of the sudden rate shock
model, the Company's net interest income at risk in 2001 is still well within
normal expectations should either of the two less likely interest rate scenarios
occur. The change in the average expected Fed funds rate is also shown to give
perspective as to the extent of the interest rate changes assumed by the two
scenarios.
Rates Lower Rates Higher
Than Most Likely Than Most Likely
---------------- ----------------
Change in net interest income
compared to most likely scenario (2.23)% +0.65%
Change in average Fed funds rate (0.36)% +0.78%
Asset/Liability Management
The Company monitors asset and deposit levels, developments and trends in
interest rates, liquidity, capital adequacy and marketplace opportunities. It
responds to all of these to protect and enhance net interest income while
managing risks within acceptable levels as set by the Company's policies. In
addition, alternative business plans and contemplated transactions are analyzed
for their impact. This process, known as ASSET/LIABILITY MANAGEMENT, is carried
out by changing the maturities and relative proportions of the various types of
loans, investments, deposits and other borrowings in the ways described above.
The Management staff responsible for asset/liability management provides regular
reports to the Asset/Liability Committee for each bank's Board of Directors and
obtains approvals for major actions or occasional exceptions to policy.
As an example of this asset/liability management process, the Company determined
in 1999 that it would need to take actions to manage increasing market and
mismatch risk. The additional risk was due to more customers requesting fixed
rate loans than had been the case in prior years. The Company was concerned
about the prospect of rising rates. If rates increased, interest income on the
loans would be fixed while interest expense on deposits would likely go up. A
plan was approved and executed that involved obtaining additional fixed rate
funds from the FHLB and entering into variable for fixed interest rate swaps. If
interest rates in fact rose, the fixed rate on the borrowings would maintain the
profitable spread on the loans funded with the borrowings. The interest rate
swaps permitted the Company to convert a portion of its interest income from
fixed to variable.
With this conversion, if interest rates rise, so would interest income.
As fixed rate loans remained in demand with borrowers during 2000, the Company
took further actions to prevent exposure to mismatch risk. It purchased another
$28.9 million interest rate swap that paid fixed and received variable to
specifically hedge a fixed-rate loan of the same amount and term. In addition,
the Company borrowed fixed-rate funds from the FHLB, with terms from 2 to 6
years.
Changes in the dollar amount of interest earned or paid may vary from one year
to the next because of changes in the average balances ("volume") of the various
earning assets and interest-bearing liability
12
13
accounts and changes in the interest rates applicable to each category. However,
because of overall growth of the Company, interest income, interest expense and
net interest income are all generally higher each year.
Table 1, "Distribution of Average Assets, Liabilities and Shareholders' Equity
and Related Interest Income, Expense and Rates," sets forth the AVERAGE DAILY
BALANCES (Note B) for the major asset and liability categories, the related
income or expense where applicable, and the resultant yield or cost attributable
to the average earning assets and interest-bearing liabilities. Changes in the
average balances and the rates received or paid depend on market opportunities,
how well the Company has managed interest rate risks, product pricing policy,
product mix, and external trends and developments.
Overall Trends in the Balances of Assets and Liabilities
Beginning in late 1998, the Company's loan portfolio began increasing at a rate
significantly higher than deposits. This was due in part to increased
residential real estate sales activity as well as the continued strong business
economy in the markets served by the Company. As shown in Table 1, average loans
increased $422 million or 28.4% from 1998 to 1999, compared to an increase in
average deposits of $251 million or 8.09%. The Company's research indicates that
the lower rate of deposit growth compared to loan growth during these years is
not primarily due to account closings, but rather to customers holding smaller
balances in their accounts. In 1999, with the stock market indices hitting
numerous all-time highs, the great attention paid by the media to internet
stocks, and the popularity of 401(k) and other tax-deferred retirement
alternatives, bank deposits increasingly began to be seen as only one of many
vehicles for investments.
Because deposits increased less than loans in 1999 compared to 1998, a portion
of the loan growth had to be funded by sources other than deposits. Three
sources of funding were used for this. First, almost all of the proceeds from
maturing securities were made available for loan funding rather than being used
to purchase new securities. The average balance of securities decreased by $19.2
million from 1998 to 1999. The second source was the large balances of overnight
money market investments. In 1999, the Company carried average balances in these
overnight instruments that were $97.4 million less than in 1998. Lastly, the
Company borrowed funds from other financial institutions. The average balance of
other borrowings was $45.8 million more in 1999 than in 1998.
This shift in the relative size of the major balance sheet categories has had
some impact on net interest income and net interest margin. To the extent that
funds invested in securities can be repositioned into loans, earnings increase
because of the higher rates paid on loans. However, additional credit risk is
incurred with loans compared to the very low risk of loss on securities, and the
Company must carefully monitor the underwriting process to ensure that the
benefit of the additional interest earned is not offset by additional credit
losses. As shown in Table 1, the average rate paid on the other borrowings in
1999 was 5.48% compared to the average rate paid on deposits of 3.28%. This
implies that if the growth in loans is not funded by additional deposits with
their lower interest rates, the Company must ensure that the rate earned on
loans funded by other borrowings is high enough to justify the additional cost
of funds.
In 2000, with falling stock markets and significant losses for holders of many
internet stocks, depositors seemed less inclined to withdraw funds from banks to
place in equity investments. Average loans increased $481 million or 25.2% in
2000 over 1999, while average deposits increased $569 million or 22.1%. While
the rate of increase for deposits in 2000 was again less than for loans, the
dollar amount of average deposits increased more than the dollar amount of
average loans. The timing of cash inflows from deposit growth cannot always be
precisely matched with the cash outflows resulting from making loans. Therefore,
while the additional dollars of deposit growth compared to loans permitted
increases in both the average balance of securities and short-term money market
instruments, additional borrowings in 2000 were required compared to 1999.
Each of the major categories of assets and liabilities is discussed in various
sections below. In each of these sections, there is a description of the reason
for significant changes in the balances, how the changes impacted the net
interest income and margin, and how the categories fit into the overall
asset/liability strategy for managing risk.
As shown in Table 1, the net interest margin of 5.75% in 1999 was higher than
the 5.65% net interest margin in 1998. As indicated above, this primarily
reflects the increased proportion of higher yielding loans. The Fed increased
interest rates several times during 1999 and the Company's subsidiary banks
raised their lending rates accordingly. This increased income from variable rate
loans. Deposit rates tend to lag market rates because time deposits reprice only
upon maturity. Due to the lowering of rates in 1997 and 1998, many of the
Company's
13
14
TABLE 1 -- DISTRIBUTION OF AVERAGE ASSETS, LIABILITIES, AND SHAREHOLDERS' EQUITY
AND RELATED INTEREST INCOME, EXPENSE, AND RATES
(dollars in thousands) 2000
------------------------------------------------
BALANCE INTEREST RATE
---------- ---------- ----------
Assets:
Loans (Note D):
Commercial $ 616,467 $ 64,713 10.50%
Real estate 1,439,019 119,077 8.27
Consumer 333,254 45,610 13.69
------------------------------
Total loans 2,388,740 229,400 9.60
------------------------------
Securities:
Taxable 638,272 38,814 6.08
Non-taxable 166,210 16,340 9.83
Equity 13,525 952 7.04
------------------------------
Total securities 818,007 56,106 6.86
------------------------------
Money market instruments:
BAs and Commercial paper 24,386 1,602 6.57
Federal funds sold 172,227 9,870 5.73
Interest bearing deposits 2,186 111 5.08
------------------------------
Total money market instruments 198,799 11,583 5.83
------------------------------
Total earning assets 3,405,546 297,089 8.72%
------------------------------
Non-earning assets 260,869
----------
Total assets $3,666,415
==========
Liabilities and shareholders' equity:
Borrowed funds:
Repurchase agreements and Federal funds purchased $ 76,197 4,247 5.57%
Other borrowings 130,354 7,986 6.13
------------------------------
Total borrowed funds 206,551 12,233 5.92
------------------------------
Interest bearing deposits:
Savings and interest bearing transaction accounts 1,289,779 33,956 2.63
Time deposits 1,148,023 64,337 5.60
------------------------------
Total interest bearing deposits 2,437,802 98,293 4.03
------------------------------
Total interest bearing liabilities 2,644,353 110,526 4.18%
-------
Demand deposits 703,531
Other liabilities 33,657
Shareholders' equity 284,874
----------
Total liabilities and shareholders' equity $3,666,415
==========
Interest income/earning assets 8.72%
Interest expense/earning assets 3.25
----------
Net interest margin 186,563 5.47
Provision for credit losses
charged to operations/earning assets 14,440 0.42
----------
Net interest margin after provision
for credit losses on tax equivalent basis 172,123 5.05%
==========
Less: tax equivalent income
included in interest income from
non-taxable securities and loans 6,173
----------
Net interest income $ 165,950
==========
time deposits maturing in 1999 renewed at lower rates than they had been
previously receiving. This trend started to reverse in 1999, but the average
rate paid on deposits was still substantially lower than in 1998.
While net interest income increased from $159.1 million in 1999 to $186.6
million in 2000 due to the overall growth of the Company, the net interest
margin of 5.47% in 2000 was lower than the margin for 1999. As indicated in the
prior paragraph, deposit rates started to increase in late 1999, and this
continued into 2000. Also as indicated above, the Company had to make increasing
use of nondeposit funding which comes at a higher cost. The average rate earned
on assets increased from 8.37% in 1999 to 8.72% in 2000
14
15
1999 1998
- ---------------------------------------------- ---------------------------------------------
Balance Interest Rate Balance Interest Rate
- ---------- ---------- ---------- ---------- ---------- ----------
$ 523,563 $ 54,939 10.49% $ 436,332 $ 44,760 10.26%
1,155,811 91,880 7.95 837,877 76,327 9.11
228,853 28,568 12.48 212,059 26,359 12.43
- ---------------------------- ----------------------------
1,908,227 175,387 9.19 1,486,268 147,446 9.92
- ---------------------------- ----------------------------
610,918 36,493 5.97 632,568 38,186 6.04
145,089 14,810 10.21 142,800 14,690 10.29
9,674 527 5.45 9,486 518 5.46
- ---------------------------- ----------------------------
765,681 51,830 6.77 784,854 53,394 6.80
- ---------------------------- ----------------------------
5,800 336 5.79 15,543 937 6.03
83,246 4,033 4.84 168,420 9,190 5.46
2,894 155 5.36 5,364 307 5.72
- ---------------------------- ----------------------------
91,940 4,524 4.92 189,327 10,434 5.51
- ---------------------------- ----------------------------
2,765,848 231,741 8.38% 2,460,449 211,274 8.59%
- ---------------------------- ----------------------------
201,599 171,282
- ---------- ----------
$2,967,447 $2,631,731
========== ==========
$ 37,397 1,766 4.72% $ 23,120 1,098 4.75%
82,714 4,815 5.82 36,894 2,256 6.11
- ---------------------------- ----------------------------
120,111 6,581 5.48 60,014 3,354 5.59
- ---------------------------- ----------------------------
1,138,854 24,465 2.15 1,073,606 27,391 2.55
868,415 41,429 4.77 783,384 41,514 5.30
- ---------------------------- ----------------------------
2,007,269 65,894 3.28 1,856,990 68,905 3.71
- ---------------------------- ----------------------------
2,127,380 72,475 3.41% 1,917,004 72,259 3.77%
---------- ----------
565,525 464,952
29,515 26,028
245,028 223,748
- ---------- ----------
$2,967,448 $2,631,732
========== ==========
8.38% 8.59%
2.62 2.94
---------- ----------
159,266 5.76 139,015 5.65
7,043 0.25 9,313 0.38
---------- ----------
152,223 5.51% 129,702 5.27%
========== ==========
6,087 5,737
---------- ----------
$ 146,136 $ 123,965
========== ==========
as average loans increased slightly as a percentage of the balance sheet and as
market rates rose with the Fed action. However the increase in the average rate
earned was not sufficient cover the increase in the average cost of funds, and
the net interest margin declined.
Table 2, "Volume and Rate Variance Analysis of Net Interest Income," analyzes
the changes in net interest income from 1998 to 1999 and from 1999 to 2000. The
analysis shows the impact of volume and rate changes on the major
15
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TABLE 2--VOLUME AND RATE VARIANCE ANALYSIS OF NET INTEREST INCOME (TAXABLE
EQUIVALENT BASIS -- NOTES C & E)
(in thousands) 2000 over 1999 1999 over 1998
---------------------------------- ----------------------------------
VOLUME RATE TOTAL Volume Rate Total
-------- -------- -------- -------- -------- --------
Increase (decrease) in:
Interest income:
Loans
Commercial loans $ 9,722 $ 52 $ 9,774 $ 9,153 $ 1,026 $ 10,179
Real estate loans 23,359 3,838 27,197 26,199 (10,646) 15,553
Consumer loans 14,055 2,987 17,042 2,102 107 2,209
-------- -------- -------- -------- -------- --------
Total loans 47,136 6,877 54,013 37,454 (9,513) 27,941
-------- -------- -------- -------- -------- --------
Investment and other securities
Taxable investment securities 1,644 677 2,321 (1,265) (428) (1,693)
Non-taxable investment securities 2,096 (566) 1,530 235 (115) 120
Equity 245 180 425 10 (1) 9
-------- -------- -------- -------- -------- --------
Total investment securities 3,985 291 4,276 (1,020) (544) (1,564)
-------- -------- -------- -------- -------- --------
Money market investments
BAs and Commercial Paper 1,215 51 1,266 (565) (36) (601)
Federal funds sold 4,980 857 5,837 (4,212) (945) (5,157)
Money market funds (36) (8) (44) (134) (18) (152)
-------- -------- -------- -------- -------- --------
Total money market investments 6,159 900 7,059 (4,911) (999) (5,910)
-------- -------- -------- -------- -------- --------
Total earning assets 57,280 8,068 65,348 31,523 (11,056) 20,467
-------- -------- -------- -------- -------- --------
Liabilities:
Repurchase agreements and
federal funds purchased 2,477 4 2,481 668 -- 668
Other borrowings 2,903 268 3,171 2,671 (112) 2,559
-------- -------- -------- -------- -------- --------
Total borrowed funds 5,380 272 5,652 3,339 (112) 3,227
-------- -------- -------- -------- -------- --------
Interest bearing deposits:
Savings and interest bearing
transaction accounts 3,536 5,955 9,491 1,581 (4,507) (2,926)
Time certificates of deposit 14,871 8,037 22,908 4,278 (4,363) (85)
-------- -------- -------- -------- -------- --------
Total interest bearing deposits 18,407 13,992 32,399 5,859 (8,870) (3,011)
======== ======== ======== ======== ======== ========
Total interest bearing liabilities 23,787 14,264 38,051 9,198 (8,982) 216
======== ======== ======== ======== ======== ========
Net interest margin $ 33,493 $ (6,196) $ 27,297 $ 22,325 $ (2,074) $ 20,251
======== ======== ======== ======== ======== ========
categories of assets and liabilities from one year to the next. The table
explains how much of the difference or variance in interest income or expense
from one year to the next for each major category of assets or liabilities is
due to changes in the balances (volume) or to changes in rates. For example,
Table 1 shows that for 1999, savings and interest-bearing transaction accounts
averaged $1,139 million, interest expense was $24.5 million and the average rate
paid was 2.15%. For 2000, the average balance was $1,290 million, interest
expense was $34.0 million, and the average rate paid was 2.63%. Table 2 shows
that of the $9.5 million increase in interest expense, $3.5 million was due to
the increase in balances and $6.0 million was due to the increase in rates.
There is always action that the Company can take to increase its net interest
income and margin. Tactics may include increasing the average maturity of its
securities portfolios because longer term instruments normally earn a higher
rate; emphasizing fixed-rate loans because they earn more than variable rate
loans; or purchasing lower rated securities or lending to less creditworthy
borrowers to earn higher rates. However, as noted above, banking is a process of
balancing risks, and each of these alternative tactics involves more risk. The
first two involve more market risk, the third more credit risk. Management
intends to continue to use a balanced approach. A fifth tactic, as discussed on
page 31, is limiting the amount of nonearning assets.
SECURITIES
The major components of the Company's earning asset base are the securities
portfolio, the loan portfolio and its holdings of money market instruments. The
Investment Committee has overall responsibility for the management of the
securities portfolios and the money market instruments. The structure and detail
within these portfolios are very significant to an analysis of the financial
condition of the Company. The loan and money market instrument portfolios will
be covered in later sections of this discussion.
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Securities Portfolios
The Company classifies its securities into three portfolios: the "Liquidity
Portfolio" (available-for-sale), the "Discretionary Portfolio"
(available-for-sale), and the "Earnings Portfolio" (held-to-maturity).
The Liquidity Portfolio's primary purpose is to provide liquidity to meet cash
flow needs. The portfolio consists of U.S. Treasury and agency securities. These
securities are purchased with maturities up to three years with an average
maturity of between one and two years.
The Discretionary Portfolio's primary purposes are to provide income from
available funds, to hold earning assets that can be managed as part of overall
asset/liability management, and to support the development needs of communities
within the Bank's marketplace. The Discretionary Portfolio consists of U.S.
Treasury and agency securities, COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOs"),
ASSET-BACKED SECURITIES, MORTGAGE-BACKED SECURITIES (Note H), and municipal
securities.
The Earnings Portfolio's primary purposes are to provide income from available
funds and to support the development needs of communities within the Bank's
marketplace. The Earnings Portfolio consists of long-term tax-exempt
obligations, and U.S. Treasury and agency securities.
Maintaining adequate liquidity is one of the highest priorities for the Company.
Therefore, available funds are first used to purchase securities for the
Liquidity Portfolio. So long as there are sufficient securities in that
portfolio to meet its purposes, available funds are then used to purchase
securities for the Discretionary Portfolio. It is the Company's current
intention to allow existing securities in the Earnings Portfolio to mature, then
reposition the matured proceeds into either of the two "available-for-sale"
portfolios. Accordingly, the balance of the Earnings Portfolio is expected to
decline.
Additional Purposes Served by the Securities Portfolios
The securities portfolios of the Company serve additional purposes: 1) to act as
collateral for the deposits of public agencies and trust customers that must be
secured by certain securities owned by the Company; 2) to be used as collateral
for borrowings that the Company occasionally utilizes for liquidity purposes;
and 3) to support the development needs of the communities within its
marketplace.
Collateral for deposits: The legal requirements for securing specific deposits
may only be satisfied by pledging certain types of the Company's securities. A
large proportion of these deposits may be secured by state and municipal
securities, but some can only be secured by U.S. Treasury securities, so holding
a minimum amount of these securities will always be necessary.
Collateral for borrowing: As covered in other sections of this discussion, the
Company occasionally borrows funds from other financial institutions to manage
its liquidity position. Certain amounts may be borrowed unsecured, i.e. without
collateral, but by pledging some of its securities as collateral, the Company
may borrow more and/or at lower rates.
Community Development: The Company searches actively for investments that
support the development needs of communities within its marketplace. During
2000, for example, the Company purchased five mortgage-backed securities
totaling $9.8 million that consisted of real estate loans to borrowers in its
market areas who have incomes of less than 80% of median area income. In 1999,
1998 and 1997, the Company invested as a limited partner in an affordable
housing fund. The Company also holds several bonds of school districts within
its market areas.
Amounts and Maturities of Securities
As discussed above, the average balance of securities decreased from 1998 to
1999 in order to fund loan growth, but increased from 1999 to 2000. Table 3 sets
forth the amounts and maturity ranges of the securities at December 31, 2000.
Because many of the securities included in the Earnings Portfolio are state or
municipal bonds, much of the income from this portfolio has the additional
advantage of being tax-exempt. Therefore, the tax equivalent weighted average
yields of the securities are shown in Table 3. The average yields on the taxable
securities are significantly lower than the average rates earned from loans as
shown in Table 1. Because of this, taxable securities are purchased for earnings
only when loan demand is weak.
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18
Other Securities Disclosures
Turnover: The accompanying Consolidated Statements of Cash Flows on page 48,
shows there is a relatively large turnover in the securities portfolios. This is
due to the purchase of relatively short-term securities for asset/liability
management purposes, as explained above.
Maturity profile: The Company does not have a trading portfolio. That is, it
does not purchase securities on the speculation that interest rates will
decrease and thereby allow subsequent sale at a gain. Instead, if the purposes
mentioned above are to be met, purchases must be made throughout interest rate
cycles. Rather than anticipate the direction of changes in interest rates, the
Company's investment practice with respect to securities in the Liquidity and
Discretionary Portfolios is to purchase securities so that the maturities are
approximately equally spaced by quarter within the portfolios. The periodic
spacing of maturities provides the Company with a steady source of cash for
liquidity purposes. If the cash is not needed, this steady source minimizes
REINVESTMENT RISK, which is having too much cash available all at once that must
be
TABLE 3--MATURITY DISTRIBUTION AND YIELD ANALYSIS OF THE SECURITIES PORTFOLIOS
After one After five
As of December 31, 2000 One year year to years to Over Non-
(dollars in thousands) or less five years ten years ten years Maturity Total
-----------------------------------------------------------------------------------------
MATURITY DISTRIBUTION:
Available-for-sale:
U.S. Treasury obligations $ 57,655 $ 101,146 $ -- $ -- $ -- $158,801
U.S. agency obligations 88,936 159,584 -- -- -- 248,520
Collateralized mortgage
obligations 6,135 133,781 12,582 6,565 -- 159,063
Asset-backed securities -- 8,952 4,939 -- -- 13,891
State and municipal
securities 2,400 8,967 3,811 62,143 -- 77,321
Equity securities -- -- -- -- 12,035 12,035
-----------------------------------------------------------------------------------------
Subtotal 155,126 412,430 21,332 68,708 12,035 669,631
-----------------------------------------------------------------------------------------
Held-to-maturity:
U.S. Treasury obligations 12,492 -- -- -- -- 12,492
U.S. agency obligations 5,000 15,990 7,968 -- -- 28,958
Collateralized mortgage
obligations 823 7,822 -- -- -- 8,645
State and municipal
securities 13,554 23,813 10,264 41,568 -- 89,199
-----------------------------------------------------------------------------------------
Subtotal 31,869 47,625 18,232 41,568 -- 139,294
-----------------------------------------------------------------------------------------
Total $ 186,995 $ 460,055 $ 39,564 $ 110,276 $ 12,035 $808,925
=========================================================================================
WEIGHTED AVERAGE YIELD
(Tax equivalent--Note C):
Available-for-sale:
U.S. Treasury obligations 5.32% 6.17% -- -- -- 5.86%
U.S. agency obligations 6.02% 6.44% -- -- -- 6.29%
Collateralized mortgage
obligations 6.19% 6.50% 7.01% 7.76% -- 6.58%
Asset-backed securities 6.64% 6.79% -- -- 6.69%
State and municipal
securities 4.32% 4.43% 5.81% 5.79% -- 5.59%
Equity securities -- -- -- -- 7.91% 7.91%
Weighted average 5.74% 6.35% 6.75% 5.98% 7.91% 6.21%
Held-to-maturity:
U.S. Treasury obligations 6.37% -- -- -- -- 6.37%
U.S. agency obligations 5.45% 6.09% 6.18% -- -- 6.00%
Collateralized mortgage
obligations 7.00% 6.53% -- -- -- 6.58%
State and municipal
securities 8.15% 8.23% 6.04% 6.08% -- 6.96%
Weighted average 7.00% 7.23% 6.10% 6.08% -- 6.69%
Overall weighted average 5.96% 6.44% 6.45% 6.02% 7.91% 6.29%
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invested perhaps when rates are low. The Company generally purchases municipal
securities with maturities of 18-25 years because, in the Company's judgment,
they have the best ratio of rate earned to the market risk incurred in
purchasing these fixed rate securities.
Securities gains and losses: Occasionally, the Company will sell securities
prior to maturity to reposition the funds into a better yielding asset. This
usually results in a loss. The Company does not follow a practice of selling
securities to realize gains because future income is thereby reduced by the
difference between the higher rates that were being earned on the sold
securities and the lower rates that can be earned on new securities purchased
with the proceeds. Gains are occasionally recognized when (1) securities are
called by the issuer; (2) the Company needs to reposition the maturities of
securities to manage mismatch risk; or (3) the Company needs to change the
risk-weighting profile of its assets to manage its capital position (see the
section below titled "Capital Resources").
Hedges, Derivatives, and Other Disclosures
The Company has policies and procedures that permit limited types and amounts of
off-balance sheet hedges to help manage interest rate risk.
In early 1999, the Company's interest rate risk modeling indicated that it was
liability sensitive, i.e., net income would be lessened by a rise in interest
rates. This was primarily due to the increased balance of fixed rate loans. The
Company therefore entered into several interest rate swap contracts with another
financial institution whereby it trades a portion of the fixed rate interest
payments it receives for payments that would vary based on changes in interest
rates. If interest rates increase, the payments received from the other
institution increase thereby lessening the interest rate risk incurred in
lending funds at fixed rates. Two of the contracts are loosely associated with
real estate loans that had been added to the Company's balance sheet. The third
is specifically associated with a relatively large commercial loan.
As mentioned above, in 2000, the Company purchased an additional interest rate
swap from another financial institution to hedge a large, fixed-rate loan.
The Company has not purchased any securities arising out of a highly leveraged
transaction, and its investment policy prohibits the purchase of any securities
of less than investment grade or so-called "junk bonds."
MARKET INSTRUMENTS--FEDERAL FUNDS SOLD, SECURITIES PURCHASED UNDER AGREEMENTS TO
RESELL, BANKERS' ACCEPTANCES AND COMMERCIAL PAPER
Cash in excess of amounts immediately needed for operations is generally lent to
other financial institutions as Federal funds sold or as securities purchased
under agreements to resell (for brevity termed "reverse repos"). Both
transactions are overnight loans. Federal funds sold are unsecured; reverse
repos are secured.
Excess cash expected to be available for longer periods is generally used to
purchase short-term U.S. Treasury securities, BANKERS' ACCEPTANCES, or
COMMERCIAL PAPER (Note G). As a percentage of average earning assets, the amount
of these instruments tends to vary based on changes and differences in
short-term market rates. The amount is also impacted in the first quarter of the
year by the large cash flows associated with the tax refund loan and transfer
programs.
As discussed above, the average balances invested by the Company in these
instruments decreased from 1998 to 1999 to fund loan growth, and then increased
from 1999 to 2000, as deposit growth provided more cash inflow than was used to
fund loan growth.
The one-day term of the Federal funds sold and reverse repos means that they are
obviously highly liquid as the funds are returned to the Company the next day
and are not subject to market risk. Bankers' acceptances and commercial paper
are highly liquid as there are active markets for them should the Company desire
to sell before their maturity. However, they are subject to market risk, should
interest rates change while they are held by the Company. As discussed below in
"Liquidity," the Company has developed and maintains numerous other sources of
liquidity than these overnight and short-term funds.
In the years prior to 1998, the Company purchased bankers' acceptances rather
than commercial paper because the yields were more attractive relative to the
risk. Acceptances of only highly rated financial
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institutions are utilized. The only banks issuing these instruments that had
both a high credit rating and sufficient incremental yield were Japanese banks.
During 1997, as economic troubles began to adversely impact the ratings of the
Japanese banks, the Company reduced its purchases and discontinued them after
January 1998. The last acceptance matured in July 1998.
In place of bankers' acceptances, in 1998 the Company began purchasing
commercial paper issued by highly rated domestic companies.
LOAN PORTFOLIO
Table 4 sets forth the distribution of the Company's loans at the end of each of
the last five years.
The amounts shown in the table for each category are net of the deferred or
unamortized loan origination, extension, and commitment fees and the deferred
origination costs for loans in that category. These deferred net fees and costs
included in the loan totals are shown for information at the bottom of the
table. These deferred amounts are amortized over the lives of the loans to which
they relate.
The year-end balance for all loans had increased about $420 million from the end
of 1998 to the end of 1999 and about $427 million from the end of 1999 to the
end of 2000.
Reflective of the strong economy, all of the major categories of loans showed
significant growth during the last year with the exception of construction and
development loans. The Company offers a wide variety of loan types and terms to
customers along with very competitive pricing and quick delivery of the credit
decision.
The Company makes both adjustable rate and fixed rate 1-4 family adjustable rate
mortgage loans. In general, the Company retained the adjustable loans and sold
the fixed rate loans to minimize market risk. In the last several years, the
Company has retained some of the fixed rate loans, hedging a portion of them
with the interest rate swaps mentioned above. The adjustable loans generally
have low initial "teaser" rates. While these loans have interest rate "caps,"
all are repriced to a market rate of interest within a reasonable time. A few
loans have payment caps that would result in negative amortization if interest
rates rise appreciably.
Consumer loans grew $24.4 million or 18.8% in 1999 and $51.6 million or 33.4% in
2000. This growth in consumer loans reflects an expanded product line and
continued efforts to make auto loans through dealers. During the last four
years, the Company has entered into indirect financing agreements with a number
of automobile dealers whereby the Company purchases loans dealers have made to
customers. While automobile dealers frequently provide financing to customers
through manufacturers' finance subsidiaries, some customers prefer loan terms
that are not included in the standard dealer packages. Other customers are
purchasing used cars not covered by the manufacturers' programs. Based on
parameters agreed to by the Company, the dealer makes the loan to the customer
and then sells the loan to the Company. This
TABLE 4--LOAN PORTFOLIO ANALYSIS BY CATEGORY
(in thousands) December 31,
----------------------------------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
Real estate:
Residential $ 586,904 $ 494,540 $ 376,871 $ 282,910 $ 204,003
Nonresidential 564,556 457,575 496,050 448,942 363,764
Construction and development 172,331 200,804 131,912 76,448 63,331
Commercial, industrial,
and agricultural 775,365 614,897 388,262 322,327 289,179
Home equity lines 71,289 49,902 47,123 56,681 55,083
Consumer 205,992 154,381 129,957 104,645 70,477
Leases 129,159 97,005 84,198 76,515 72,744
Municipal tax-exempt obligations 4,102 12,530 9,286 7,931 8,658
Other 7,406 8,399 6,619 7,482 11,358
----------------------------------------------------------------------------------
$2,517,104 $2,090,033 $1,670,278 $1,383,881 $1,138,599
==================================================================================
Net deferred fees $ 5,813 $ 5,240 $ 5,002 $ 3,955 $ 3,565
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TABLE 5--Maturities and Sensitivities of Selected
Loan Types to Changes in Interest Rates
Due after
(in thousands) Due in one one year to Due after
year or less five years five years
------------ ----------- ----------
Commercial, industrial, and agricultural
Floating rate $496,316 $ -- $ --
Fixed rate 89,067 99,624 90,358
Real estate--construction and development
Floating rate 156,631 -- --
Fixed rate 9,150 2,745 3,805
Municipal tax-exempt obligations 986 1,744 1,372
------------------------------------------------
$752,149 $104,113 $ 95,536
================================================
program is neither a factoring nor a flooring arrangement. The individual
customers, not the dealers, are the borrowers and thus there is no large
concentration of credit risk. In addition, there is a review of underwriting
practices of a dealer prior to acceptance into the program. This is done to
ensure process integrity, to protect the Company's reputation, and to monitor
compliance with consumer loan laws and regulations. There were approximately
$139.1 million of such loans included in the consumer loan total above for
December 31, 2000, as compared with $99.0 at December 31, 1999. In early
January, 2001, the Company sold approximately $57 million of these loans through
a securitization for the purposes of capital management as described in the
section below titled "Capital Resources."
Although approximately two-thirds of the loans held by the Company have floating
rates of interest tied to the Company's base lending rate or to another market
rate indicator so that they may be repriced as interest rates change, fixed rate
loans still make up a significant portion of the portfolio. The same interest
rate and liquidity risks that apply to securities are also applicable to lending
activity. Fixed-rate loans are subject to market risk: they decline in value as
interest rates rise. The Company's loans that have fixed rates generally have
relatively short maturities or amortize monthly, which effectively lessens the
market risk. Nonetheless, the table in Note 14 to the consolidated financial
statements shows that at December 31, 1999, the carrying amount of loans, i.e.,
their face value, is about $43.4 million or 2.2% more than their fair value,
reflecting the recent increases in market rates during the latter part of 1999.
At the end of 2000, the carrying value of loans exceeded their fair value by
$41.5 million or 1.7%.
Table 5 shows the maturity of selected loan types outstanding as of December 31,
2000, and shows the proportion of fixed and floating rate loans for each type.
The table does not include residential and non-residential mortgage loans. Net
deferred loan origination, extension, and commitment fees are also not shown in
the table. There is no maturity or interest sensitivity associated with the fees
because they have been collected in advance.
The amortization and short maturities generally present in the Company's fixed
rate loans also help to maintain the liquidity of the portfolio and reduce
credit risk, but they result in lower interest income if rates are falling. At
present, except for the specific market risk incurred by the decision to hold
some of the fixed-rate residential and non-residential real estate mortgages
(which are not included in the table above), Management prefers to incur market
risk from longer maturities in the securities portfolios, and avoid such risk in
the loan portfolio. The reason for this preference is that there are more
limited secondary markets for longer-term loans than for longer-term securities.
In the event that the Company should want to sell such loans for either
liquidity or capital management reasons when interest rates are above the
original issue rates, the loss taken would be greater than for the sale of
securities with comparable maturities.
Potential Problem Loans: From time to time, Management has reasons to believe
that certain borrowers may not be able to repay their loans within the
parameters of the present repayment terms, even though, in some cases, the loans
are current at the time. These loans are regarded as potential problem loans,
and a portion of the allowance is allocated, as discussed below, to cover the
Company's exposure to loss should the borrowers indeed fail to perform according
to the terms of the notes. This class of loans does not include loans in a
nonaccrual status or 90 days or more delinquent but still accruing, which are
shown in Table 8.
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At year-end 2000, these loans amounted to $58.7 million or 2.3% of the
portfolio. The corresponding amounts for 1999 and 1998 were $76.9 million or
2.9% of the portfolio and $92.0 million or 5.5% of the portfolio, respectively.
The 2000 amount is comprised of loans of all types.
Other Loan Portfolio Information
Other information about the loan portfolio that may be helpful to readers of the
financial statements follows.
Foreign Loans: The Company does not assume foreign credit risk through either
loan or deposit products. However, the Company does make loans to borrowers that
have foreign operations and/or have foreign customers. Economic and currency
developments in the international markets may therefore affect our domestic
customers' activities.
Participations: Occasionally, the Company will sell or purchase a portion of a
loan to or from another bank. The usual reasons that banks sell a portion of a
loan are (1) to stay within their regulatory maximum limit for loans to any one
borrower; (2) to reduce the concentration of lending activity to a particular
industry or geographical area; and (3) to manage regulatory capital ratios.
Occasionally, a portion of another bank's loan may be purchased by the Company
when the originating bank is unable to lend the whole amount under its
regulatory lending limit to its borrower. However, this would be done only if
the loan represents a good investment for the Company and the borrower or
project is in one of the Company's market areas. In these cases, the Company
conducts its own independent credit review and formal approval prior to
committing to purchase.
Loan to Value Ratio: The Company follows a policy of limiting the loan to
collateral value ratio for real estate construction and development loans.
Depending on the type of project, policy limits range from 60-90% of the
appraised value of the collateral. For permanent real estate loans, the policy
limits generally are 75% of the appraised value for commercial property loans
and 80% for residential real estate property loans. Mortgage insurance is
generally required on most residential real estate loans with a loan to value
ratio in excess of 80%. Such loans, which can reach up to 90% loan to appraised
value, are strictly underwritten according to mortgage insurance standards. The
above policy limits are sometimes exceeded when the loan is being originated for
sale to another institution that does lend at higher ratios and the sale is
immediate; when the exception is temporary; or when other special circumstances
apply. There are other specific loan to collateral limits for commercial,
industrial and agricultural loans which are secured by non-real estate
collateral. The adequacy of such limits is generally established based on
outside asset valuations and/or by an assessment of the financial condition and
cash flow of the borrower, and the purpose of the loan. Consumer loans which are
secured by collateral also have loan to collateral limits which are based on the
loan type and amount, the nature of the collateral, and other financial factors
on the borrower.
Loan Concentrations: The concentration profile of the Company's loans is
discussed in Note 18 to the accompanying consolidated financial statements.
Loan Sales and Mortgage Servicing Rights: The Company sells or brokers some of
the fixed-rate single family mortgage loans it originates as well as other
selected portfolio loans. While originated by the Company, they are sold if the
loan terms are not favorable enough to offset the market risk inherent in
fixed-rate assets. Most of those sold are sold "servicing released" and the
purchaser takes over the collection of the payments. However, some are sold with
"servicing retained" and the Company continues to receive the payments from the
borrower and forwards the funds to the purchaser. The Company earns a fee for
this service. The sales are made without recourse, that is, the purchaser cannot
look to the Company in the event the borrower does not perform according to the
terms of the note. GAAP requires companies engaged in mortgage banking
activities to recognize the rights to service mortgage loans for others as
separate assets. For loans originated for sale, a portion of the investment in
the loan is ascribed to the right to receive this fee for servicing and this
value is recorded as a separate asset.
TAX REFUND ANTICIPATION LOAN AND REFUND TRANSFER PROGRAMS
As indicated in the overall summary at the beginning of this discussion, one of
the reasons for the upward trend in earnings has been the Refund Anticipation
Loan ("RAL") and Refund Transfer ("RT") programs. The Company is one of three
financial institutions providing over 90% of these products on a national basis.
The Company provides these services to taxpayers who file their returns
electronically. RALs are a loan product; RTs are strictly an electronic transfer
service.
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For the RAL product, a taxpayer requests a loan from the Company through a tax
preparer, with the anticipated tax refund as the source of repayment. The
application is subject to an automated credit review process by the Company. If
the application passes this review, the Company advances to the taxpayer the
amount of the refund due on the taxpayer's return up to specified amounts based
on certain criteria less the loan fee due to the Company. Each taxpayer signs an
agreement permitting the Internal Revenue Service (the "IRS") to remit their
refund directly to the Company instead of to the taxpayer. The refund received
from the IRS is used by the Company to pay off the loan. Any amount due the
taxpayer above the amount of the RAL is then sent by the Company to the
taxpayer. The fee is withheld by the Company from the advance, but the fee is
recognized as income only after the loan is collected from the IRS payment. The
fee varies based on the amount of the loan, but it does not vary with the length
of time the loan is outstanding. Nonetheless, because the taxpayer must sign a
loan document, the advance refund is considered a loan and the fee is classified
as interest income.
Total fees earned on the RAL product were $19.0 million in 2000, compared to
$8.1 million in 1999 and $6.8 million in 1998.
Losses are higher for RALs than for most other loan types because the IRS may
reject or partially disallow the refund. The tax preparers participating in the
program are located across the country and few of the taxpayers have any
customer relationships with the Company other than their RAL. Many taxpayers
make use of the service because they do not have a permanent mailing address at
which to receive their refund. Therefore, if a problem occurs with the return,
collection efforts may be less effective than with local customers.
The Company has taken several steps to minimize losses from these loans.
Preparers are screened before they are allowed to submit their electronic
filings; procedures have been defined for the preparers to follow to ensure that
the agreement signed by the taxpayer is a valid loan; and the preparers' IRS
reject rates are monitored very carefully. If a preparer's rejects are above
normal, he or she may be dropped from the program. If rejects are below
expectations, the preparer may be paid an incentive fee.
In addition, the Company has entered into cooperative agreements with the other
banks with RAL programs. Under those agreements, if a taxpayer owing money to
one bank from a prior year applies for a loan from another bank, the second bank
repays the delinquent amount to the first bank before remitting the refund to
the taxpayer. As shown in Table 7, these cooperative agreements result in a
relatively high rate of recovery on the prior year's losses.
Total net charge-offs in 2000 were $3.2 million compared to $2.7 million in 1999
and $4.9 million in 1998. A significant portion of the 2000 charged-off loans
are expected to be collected in 2001 under the continuing cooperative agreement
between the banks providing this product.
The IRS closely scrutinizes returns where a major portion of the refund is based
on a claim for Earned Income Tax Credit ("EIC"). The Company closely monitors
and, in many cases, does not lend on those returns where EIC represents an
overly large portion of the refund. Many taxpayers not qualifying for loans or
not desiring to pay the loan fee still choose to receive their refunds more
quickly by having the refund sent electronically by the IRS to the Company. The
Company then prepares a check or authorizes the tax preparer to issue a check to
the taxpayer. This service is termed a refund transfer.
The Company earned approximately $7.3 million, $6.6 million, and $4.8 million in
fees for 2000, 1999, and 1998, respectively for this refund transfer service.
There is no credit risk associated with the RT product because funds are not
sent to the customer until received by the Company from the IRS.
As indicated by the larger relative increase in RAL fees from 1999 to 2000
compared to the increase in RT fees, there was a substantial shift in the mix of
the two products in 2000. The reason for this is the notification from the IRS
to the banks providing the service of any delinquent amounts for taxes or other
debts owed by the taxpayer to the Federal government. This debt indicator, which
had been provided in a similar form prior to 1995, was instituted as a means of
assisting the taxpayer and the tax preparer. It also assists the banks with
their credit review. With this indicator, losses for the banks would be expected
to be significantly reduced and consequently loan fees reduced. The fees were
reduced and increased numbers of taxpayers availed themselves of the loans. This
was the intended result of the IRS action, because it is under a Congressional
mandate to significantly increase the proportion of the returns filed
electronically.
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The increased volume of loans during a relatively brief portion of the year
required the Company to issue approximately $415 million in brokered
certificates of deposit in the first quarter of the year and to make use of
credit facilities it had established with other financial institutions to
provide the funding for the loans. A portion of the cost of this funding is
charged to the program. Similarly, it is usually several days after the RT
checks are given to customers before they clear. A portion of the interest
earned on these funds is credited to the program.
In 2000, the total pre-tax earnings for these programs was $16.7 million
compared with $9.4 million for 1999 and $4.5 million for 1998.
The balances outstanding during each tax filing season are included in the
average balance for consumer loans shown in Table 1, but there are no such loans
included in the Consolidated Balance Sheets as of December 31, 2000 and 1999,
because all loans not collected from the IRS are charged-off at June 30 of each
year. The fees earned on the loans are included in the accompanying Consolidated
Income Statements for 2000, 1999 and 1998 within interest and fees on loans. The
fees earned on the refund transfers are included in other service charges,
commissions, and fees.
The Company expects that the programs will continue to increase in volume
because the IRS wants to encourage more taxpayers to file electronically.
ALLOWANCE FOR CREDIT LOSSES
Credit risk is inherent in the business of extending loans and leases to
individuals, partnerships, and corporations. The Company sets aside an allowance
or reserve for credit losses through charges to earnings. These charges are
shown in the Consolidated Income Statements as provision for credit losses. All
specifically identifiable and quantifiable losses are immediately charged off
against the allowance. However, for a variety of reasons, not all losses that
have occurred are immediately made known to the Company and of those that are
known, the full extent of the loss may not be able to be quantified. In this
discussion, "loans" include the lease contracts purchased and originated by the
Company.
Determination of the Adequacy of the Allowance for Credit Losses and the
Allocation Process
The Company formally determines the adequacy of the allowance on a quarterly
basis. This determination is based on the periodic assessment of the credit
quality or "grading" of loans. Loans are initially graded when originated. They
are re-graded as they are renewed; when there is a new loan to the same
borrower; when identified facts demonstrate heightened risk of nonpayment; or if
they become delinquent. Re-grading of larger problem loans will occur at least
quarterly. Confirmation of the quality of the grading process is obtained both
by independent credit reviews conducted by firms specifically hired by the
Company for this purpose and by banking examiners.
After reviewing the gradings in the loan portfolio, the second step is to
allocate or assign a portion of the allowance to groups of loans and to
individual loans to cover Management's estimate of their potential loss.
Allocation is related to the grade and other factors, and is done by the methods
discussed below.
The last step is to compare the amounts allocated for estimated losses to the
current available allowance. To the extent that the current allowance is
insufficient to cover the estimate of unidentified losses, Management records
additional provision for credit loss. If the allowance is greater than appears
to be required at that point in time, provision expense is adjusted accordingly.
The Components of the Allowance for Credit Losses
Consistent with generally accepted accounting principles ("GAAP") and with the
methodologies used in estimating the unidentified losses in the loan portfolio,
the allowance is comprised of several components.
First, the allowance includes a component resulting from the application of the
measurement criteria of Statements of Financial Accounting Standards No. 114,
Accounting by Creditors for Impairment of a Loan ("SFAS 114") and No. 118,
Accounting by Creditors for Impairment of a Loan--Income Recognition and
Disclosures ("SFAS 118"). The amount of this component is disclosed in Note 3 to
the consolidated financial statements that accompany this discussion.
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The second component is statistically-based and is intended to provide for
losses that have occurred in large groups of smaller balance loans, the
individual credit quality of which is impracticable to re-grade at each period
end. These loans would include 1-4 family residential real estate, installment
and overdraft lines for consumers, and loans to small businesses generally of
$100,000 and less. The amount allocated is determined by applying loss
estimation factors to outstanding loans. The loss factors are based primarily on
the Company's historical loss experience tracked over a five-year period and
accordingly will change over time. Because historical loss experience varies for
the different categories of loans, the loss factors applied to each category
also differ. In addition, there is a greater chance that the Company has
suffered a loss from a loan that was graded less than satisfactory at its most
recent grading than if the loan was last graded satisfactory. Therefore, for any
given category, a larger loss estimation factor is applied to less than
satisfactory loans than to those that the Company last graded as satisfactory.
The statistical component is the sum of the allocations determined in this
manner.
The third component is needed to address specific characteristics of individual
loans that are not addressed in the statistically determined historical loss
factors that would ordinarily apply. These characteristics might relate to a
variety of factors such as the size of the loan, the industry of the borrower,
or the terms of the loan. When situations warrant, Management will increase the
allocation that would be indicated by the applicable loss estimation factor to
an amount adequate to absorb the probable loss that has occurred. The specific
component is made up of the sum of these specific allocations.
The Unallocated Component
The fourth or "unallocated" component of the allowance for credit losses is a
component that is intended to absorb losses that may not be provided for by the
other components.
There are several primary reasons that the other components discussed above
might not be sufficient to absorb the losses present in portfolios. The
unallocated portion of the allowance is used to provide for the losses that have
occurred because of these reasons.
The first is that there are limitations to any credit risk grading process. The
volume of loans makes it impracticable to re-grade every loan every quarter.
Therefore, it is possible that some currently performing loans not recently
graded will not be as strong as their last grading and an insufficient portion
of the allowance will have been allocated to them. Grading and loan review often
must be done without knowing whether all relevant facts are at hand. Troubled
borrowers may inadvertently or deliberately omit important information from
reports or conversations with lending officers regarding their financial
condition and the diminished strength of repayment sources.
The second is that the loss estimation factors are based on historical loss
totals. As such, the factors may not give sufficient weight to such
considerations as the current general economic and business conditions that
affect the Company's borrowers and specific industry conditions that affect
borrowers in that industry. The factors might also not give sufficient weight to
current trends in credit quality and collateral values and the long duration of
the current business cycle. Specifically, in assessing how much unallocated
allowance needed to be provided at December 31, 2000, Management considered the
following:
- - With respect to loans to the agriculture industry, Management considered
the effects on borrowers of weather conditions and overseas market
conditions for exported products;
- - With respect to loans to the construction industry, Management
considered the market absorption rates for developed properties; the
availability of permanent financing to replace the construction loan;
construction delays, increased costs, and financial difficulties of
contractors, subcontractors, and suppliers resulting from weather; and
the significant concentration in construction lending in the market area
served by FNB;
- - With respect to loans to borrowers who are influenced by trends in the
local tourist industry, Management again considered the effects of
weather conditions, tourist preferences, and the competition faced by
borrowers from other resort destinations and tourist attractions;
- - With respect to all loans, Management considered the potential for
disruption of the normal grading process through diversion of efforts
and attention resulting from the additions to the portfolio of the
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loans from SBB and LRB with the need to integrate different grading
systems, and by the need for the credit risk assessment process to
encompass different markets that could be influenced by unique factors.
Third, neither the loss estimation factors nor the review of specific individual
loans give consideration to loan concentrations, yet this could impact the
magnitude of losses inherent in the portfolios. Specifically, as disclosed in
Note 18 to the consolidated financial statements, there are certain
concentrations with respect to geographical area, industry, and type of
collateral among the loans that the Company has outstanding. Because economic
factors could impact these borrowers as a group, losses inherent in the
portfolio could be greater and more volatile than would be expected if the
Company simply used the loss estimation factors.
Fourth, the loss estimation factors do not give consideration to the seasoning
of the portfolios. Seasoning is relevant because losses are less likely to occur
in loans that have been performing satisfactorily for several years than in
loans that are more recent. In addition, while term loans have payments of
principal and interest scheduled usually for each month, most loans and lines of
credit in the commercial loan portfolio have short-term maturities and
frequently require only interest payments until maturity. With a term loan, a
missed or late payment gives an immediate signal of a decline in credit quality.
Many of the Company's loans are commercial loans that do not require periodic
payments of principal. Because they have shorter maturities and lack regular
principal amortization, the process of seasoning does not occur and the
signaling of the missed principal payment is not available.
Lastly, the loss estimation factors do not give consideration to the interest
rate environment. Most obviously, borrowers with floating-rate loans may be less
able to manage their debt service if interest rates rise. However, there can
also be an indirect impact. For example, a rise in interest rates may adversely
impact the amount of home mortgage lending. This will cause a reduction in the
amount of home building initiated by developers, and this will have an impact on
the credit quality of loans to building contractors in the commercial segment of
the portfolio.
Each of these considerations could be addressed by developing additional loss
estimation factors for smaller, discrete groups of loans. However, the factors
are used precisely so that the losses in smaller loans do not have to be
individually estimated. Segmenting the loan portfolio and then developing and
applying separate factors becomes impracticable and, with the smaller groups,
the factors themselves become less statistically valid. Even for experienced
reviewers, grading loans and estimating possible losses involves a significant
element of judgment regarding the present situation with respect to individual
loans and the portfolio as a whole. Therefore, Management regards it as both a
more practical and prudent practice to assign allowance for the above risk
elements in addition to the allowance allocated by specific or historical loss
factors.
Allocation Table
Table 6 shows the amounts allocated for the last three years to each loan type
disclosed in Table 4. It also shows the percentage of balances for each loan
type to total loans. In general, it would be expected that those types of loans
which have historically more loss associated with them will have a
proportionally larger amount of the allowance allocated to them than do loans
which have less risk.
It would also be expected that the amount allocated for any particular type of
loan will increase or decrease proportionately to both the changes in the loan
balances and to increases or decreases in the estimated loss in loans of that
type. In other words, changes in the risk profile of the various parts of the
loan portfolio should be reflected in the allowance allocation.
Generally the changes in the allowance allocated to the other loan categories
are approximately proportional to the growth in balances for those categories.
Occasionally, however, changes in the amount allocated to a specific loan
category will vary from changes in the total loan balance for that category due
to the impact of the changes in credit rating for larger individual loans.
There is no allocation of allowance to RALs at December 31 because all loans
unpaid are charged-off prior to year-end. At the bottom of Table 6 is the ratio
of the allowance for credit losses to total loans for each year.
CREDIT LOSSES
Table 7, "Summary of Credit Loss Experience," shows the additions to,
charge-offs against, and recoveries for the Company's allowance for credit
losses. Also shown is the ratio of charge-offs to average loans for
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TABLE 6--ALLOCATION OF THE ALLOWANCE FOR CREDIT LOSSES
(dollars in thousands) DECEMBER 31, 2000 December 31, 1999 December 31, 1998
------------------------ ----------------------- -----------------------------
PERCENT OF Percent of Percent of
LOANS TO Loans to Loans to
AMOUNT TOTAL LOANS Amount Total Loans Amount Total Loans
-------------------------------------------------------------------------------------------
Real estate:
Residential $ 1,870 23.3% $ 2,601 23.7% $ 1,304 22.6%
Nonresidential 2,789 22.4% 3,038 21.9 4,005 29.7
Construction
and development 892 6.8% 935 9.6 1,604 7.9
Commercial, industrial,
and agricultural 14,616 30.8% 10,851 29.4 7,343 23.2
Home equity lines 290 2.8% 343 2.4 533 2.8
Consumer 3,288 8.2% 2,954 7.4 1,997 7.8
Leases 3,371 5.1% 1,739 4.6 1,459 5.0
Municipal tax-exempt obligations -- 0.2% -- 0.6 -- 0.6
Other 730 0.3% 663 0.4 1,084 0.4
Not specifically allocated 7,279 7,330 11,170
------------------------------------------------------------------------------------------
Total allowance $ 35,125 100.0% $ 30,454 100.0% $ 30,499 100.0%
==========================================================================================
Allowance for credit loss
as a percentage of
year-end loans 1.40% 1.46% 1.83%
Year-end loans $2,517,104 $2,090,033 $1,670,278
each of the last five years.
There are only two other banks in the country that have national RAL programs.
Therefore, for comparability, net charge-off ratios for the Company are shown
both with and without the RAL net charge-offs. The corresponding ratios for the
Company's FDIC peers are 0.63% for 2000, 0.68% for 1999, 1.08% for 1998, 1.03%
for 1997, and 0.89% for 1996 (Note A).
The Company's concentration in loans secured by real estate--specifically loans
secured by nonresidential properties--and other larger loans in the commercial
category may cause a higher level of volatility in credit losses than would
otherwise be the case. Large pools of loans made up of numerous smaller loans
tend to have consistent loss ratios. A group consisting of a smaller number of
larger loans in the same industry is statistically less consistent and losses
may tend to occur at roughly the same time. Because the amount of loss is not
consistent period to period, the estimate of loss and therefore the amount of
allowance adequate to cover losses inherent in the portfolio cannot be
determined simply by reference to net charge-offs in the prior year or years.
The lower net charge-offs to average loans ratios experienced by the Company in
the years 1996 through 1998 were in large part due to the high levels of
recoveries. At the end of each of the years 1995 through 1998, the Company had a
number of previously charged-off loans that it reasonably had hopes of
recovering, and which were in fact recovered. With these recoveries, net
charge-offs for 1996 through 1998 were relatively low in proportion to the
allowance for credit loss. As of year end 1999, there were few such potential
recoveries aside from RALs, and Management indicated that it expected that in
2000 recoveries would be less and that net charge-offs consequently might be
higher than in prior years. As expected, the ratio of net charge-offs to total
loans (exclusive of RALs) did increase from 0.23% in 1999 to 0.33% in 2000, but
the 2000 figure is still only slightly more than one half that of the Company's
peers. The Company has one loan of approximately $7 million, most of which was
charged-off in 1999 and 2000, for which it has some prospect of recovery.
Recovery of some portion of this loan could substantially reduce net charge-offs
in 2001 and consequently would also reduce provision expense.
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TABLE 7--SUMMARY OF CREDIT LOSS EXPERIENCE
(dollars in thousands) Year Ended December 31,
-----------------------------------------------------------------------------------
2000 1999 1998 1997 1996
----------- ----------- ----------- ----------- -----------
Balance of the allowance for
credit losses at beginning of year $ 30,454 $ 30,499 $ 26,526 $ 21,267 $ 17,130
-----------------------------------------------------------------------------------
Charge-offs:
Real estate:
Residential 112 10 369 498 822
Non-residential 107 252 177 45 1,060
Construction and development -- -- -- -- --
Commercial, industrial,
and agricultural 8,118 4,924 1,893 2,456 1,698
Home equity lines -- 30 -- -- 264
Tax refund anticipation 6,226 5,518 7,221 5,946 1,123
Other consumer 1,910 1,729 1,701 831 545
-----------------------------------------------------------------------------------
Total charge-offs 16,473 12,463 11,361 9,776 5,512
-----------------------------------------------------------------------------------
Recoveries:
Real estate:
Residential 65 175 329 268 172
Non-residential 184 35 1,341 1,876 2,330
Construction and development -- 6 -- -- --
Commercial, industrial,
and agricultural 1,255 1,162 1,192 1,126 442
Home equity lines 26 35 -- 326 28
Tax refund anticipation 3,059 2,857 2,288 1,524 1,437
Other consumer 976 1,105 871 421 191
-----------------------------------------------------------------------------------
Total recoveries 5,565 5,375 6,021 5,541 4,600
-----------------------------------------------------------------------------------
Net charge-offs 10,908 7,088 5,340 4,235 912
Allowance for credit losses recorded
in acquisition transactions 1,139 -- -- 794 --
Provision for credit losses
refund anticipation loans 2,726 2,816 4,941 4,649 1,100
Provision for credit losses
all other loans 11,714 4,227 4,372 4,051 3,949
-----------------------------------------------------------------------------------
Balance at end of year $ 35,125 $ 30,454 $ 30,499 $ 26,526 $ 21,267
===================================================================================
Ratio of net charge-offs to
average loans outstanding 0.46% 0.37% 0.36% 0.33% 0.09%
Ratio of net charge-offs to
average loans outstanding
exclusive of RALs 0.33% 0.23% 0.03% (0.01)% 0.13%
Average Loans $ 2,388,740 $ 1,908,746 $ 1,486,696 $ 1,272,040 $ 980,601
Average RALs (60,437) (12,391) (9,169) (10,079) (2,040)
-----------------------------------------------------------------------------------
Average Loans, net of RALs $ 2,328,303 $ 1,896,355 $ 1,477,527 $ 1,261,961 $ 978,561
===================================================================================
Net Charge-offs $ 10,908 $ 7,088 $ 5,340 $ 4,235 $ 912
RAL Net Charge-offs 3,167 2,661 4,933 4,422 (314)
-----------------------------------------------------------------------------------
Net Charge-offs, exclusive of RALs $ 7,741 $ 4,427 $ 407 $ (187) $ 1,226
===================================================================================
NONACCRUAL, PAST DUE, AND RESTRUCTURED LOANS
Table 8 summarizes the Company's nonaccrual and past due loans for the last five
years.
Past Due Loans: Included in the amounts listed below as 90 days or more past due
are commercial and industrial, real estate, and a diversity of secured consumer
loans. These loans are well secured and in the process of collection. These
figures do not include loans in nonaccrual status.
Nonaccrual Loans: If there is reasonable doubt as to the collectibility of
principal or interest on a loan, the loan is placed in nonaccrual status, i.e.,
the Company stops accruing income from the interest on the loan and reverses any
uncollected interest that had been accrued but not collected. These loans may or
may not be collateralized. Collection efforts are being pursued on all
nonaccrual loans. Consumer loans are an exception to this reclassification.
They are charged-off when they become delinquent by more than 120 days if
unsecured and 150 days if secured. Nonetheless, collection efforts are still
pursued.
Restructured Loans: The Company's restructured loans have generally been
classified as nonaccrual even after the restructuring. Consequently, they have
been included with other nonaccrual loans in Table 8. The only restructured
loans the Company has had at the end of the last five years that have not been
classified as nonaccrual are reported in Table 8 on a separate line.
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TABLE 8--NONACCRUAL AND PAST DUE LOANS
(dollars in thousands) December 31,
--------------------------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
Nonaccrual $ 15,975 $ 15,626 $ 8,855 $ 11,709 $ 8,654
90 days or more past due 2,427 715 78 855 1,437
Restructured Loans 0 10 0 174 279
--------------------------------------------------------------------------
Total noncurrent loans $ 18,402 $ 16,351 $ 8,933 $ 12,738 $ 10,370
==========================================================================
Total noncurrent loans as percentage
of the total loan portfolio 0.73% 0.78% 0.53% 0.92% 0.91%
Allowance for credit losses as a percentage
of noncurrent loans 191% 186% 341% 208% 205%
TABLE 9--FOREGONE INTEREST
in thousands) Year Ended December 31,
2000 1999 1998
--------------------------------
Interest that would have been recorded under original terms $2,934 $1,636 $ 963
Gross interest recorded 1,467 772 669
--------------------------------
Foregone interest $1,467 $ 864 $ 294
================================
Total nonperforming loans increased during 1997 to $12.7 million because of
noncurrent loans acquired in the FVB and CSB transactions, but as a percentage
of total loans, noncurrent loans slightly decreased. The total was reduced
during 1998 due principally to a reclassification of a large loan out of
nonaccrual status and to rigorous collection efforts. The total rose again at
the end of 1999 and 2000 with the classification of a few larger loans as
nonaccrual during both years. Some of the loans reclassified in 2000 were
acquired in the SBB and LRB transactions. While amounts in the Company's
financial statements have been restated to include SBB amounts, the loans had
not been classified as nonaccrual by SBB or LRB. As indicated in the above
discussion, it is generally the classification of such larger loans that impacts
the noncurrent total.
Table 9 sets forth interest income from nonaccrual loans in the portfolio at
year-end that was not recognized.
DEPOSITS
An important component in analyzing net interest margin and, therefore, the
results of operations of the Company is the composition and cost of the deposit
base. Net interest margin is improved to the extent that growth in deposits can
be focused in the lower cost core deposit accounts -- demand deposits, NOW
accounts, and savings. The average daily amount of deposits by category and the
average rates paid on such deposits is summarized for the periods indicated in
Table 10.
TABLE 10--DETAILED DEPOSIT SUMMARY
(dollars in thousands) Year Ended December 31,
2000 1999 1998
-----------------------------------------------------------------------------------------
AVERAGE Average Average
BALANCE RATE Balance Rate Balance Rate
-----------------------------------------------------------------------------------------
NOW accounts $ 358,921 0.75% $ 321,652 0.64% $ 299,118 1.03%
Money market deposit accounts 707,063 3.85 586,349 3.03 560,708 3.35
Savings accounts 223,795 1.81 230,853 1.65 213,780 2.02
Time certificates of deposit for --
less than $100,000 and IRAs 497,230 5.34 478,377 4.28 464,684 4.89
Time certificates of deposit for --
$100,000 or more 650,793 5.81 390,038 4.43 318,701 4.98
---------- ---------- ----------
Interest-bearing deposits 2,437,802 4.03% 2,007,269 3.05% 1,856,991 3.49%
Demand deposits 703,531 565,525 467,053
---------- ---------- ----------
$3,141,333 $2,572,794 $2,324,044
========== ========== ==========
The average rate paid on all deposits, which had decreased from 3.49% in 1998 to
3.05% in 1999, increased in 2000 to 4.03%. The decrease from 1998 to 1999 was
primarily due to the decline in market rates in the latter half of 1998. The
average rates that are paid on deposits generally trail behind money market
rates because financial institutions do not try to change deposit rates with
each small increase or decrease in short-term rates. This trailing
characteristic is stronger with time deposits, such as certificates of deposit
that pay a fixed rate for some specified term, than with deposit types that have
administered rates.
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With time deposit accounts, even when new offering rates are established, the
average rates paid during the quarter are a blend of the rates paid on
individual accounts. Only new accounts and those that mature and are renewed
will bear the new rate.
The increase in the average deposit rate paid in 2000 compared to 1999 is due to
market rates increasing in the second half of 1999 and most of 2000. With the
Fed having already lowered rates in early 2001 and more rate decreases expected,
it is anticipated that the average deposit rates will be lower in 2001 than in
2000.
Table 11 discloses the distribution of maturities of CD's of $100,000 or more at
the end of each of the last three years.
TABLE 11--MATURITY DISTRIBUTION OF TIME CERTIFICATES OF DEPOSIT OF $100,000
OR MORE
(in thousands) December 31,
2000 1999 1998
--------------------------------
Three months or less $198,325 $192,347 $178,061
Over three months through six months 171,800 121,058 85,969
Over six months through one year 141,109 98,430 74,353
Over one year 23,079 16,225 18,242
--------------------------------
$534,312 $428,060 $356,625
================================
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND FEDERAL FUNDS PURCHASED
Securities sold under agreements to repurchase ("repos") are a form of borrowing
that is secured by securities owned by the borrower. Banks use these agreements
to borrow from other banks in order to provide temporary liquidity and they may
also be used to provide business customers with a secured alternative to
deposits in excess of the $100,000 insured amount. Prior to 1999, the Company
had almost exclusively used repos for the latter "retail" purpose. Most of the
retail agreements are for terms of a few weeks to 90 days. Like the rate paid on
Federal funds purchased, the interest rate paid on repos is tied to the Federal
funds sold rate. As discussed on page 13, in 2000 and 1999, funds were needed to
make loans in an amount substantially in excess of the amount generated by
deposit growth. Overnight borrowing from other banks was frequently used to
provide this liquidity until securities matured or term borrowings could be
arranged.
Information about the balances and rates paid is shown in Note 10 to the
consolidated financial statements. The average rate paid of 4.66% in 1999 was
higher than the 1998 rate of 4.44%. While market rates on average were lower in
1999 than in 1998, the repurchase agreements with other banks bear higher
interest rates than that paid on the retail repos with customers. The higher
average balance for 1999 also is reflective of their use in 1999 for liquidity
management. The increase in the average rate during 2000 over that paid in 1999
reflects the higher market rates in 2000 for short-term financial instruments
compared to the prevailing rates for 1999.
Federal funds purchased are a second form of overnight borrowing from other
banks. Prior to 1999, the Company primarily used this borrowing to accommodate
other local community financial institutions on the Central Coast that had
excess cash to invest overnight. However, the Company occasionally purchased
additional funds from money center banks to meet liquidity needs, especially
during the RAL season. In 1999, there was an increasing use of this source of
funds to manage short-term liquidity. Information on the balances and rates paid
for these funds is also disclosed in Note 10 to the consolidated financial
statements. Because these are overnight borrowings, the average rate paid to
various parties on any one day may vary substantially from the average rate for
the year, and typically, the Federal funds rate is quite volatile on the last
day of the year. The lower rates at the end of 1998 compared to the average rate
for the year was due more to declining rates during the latter part of the year
than to abnormal rates on the last day. The higher rate at the end of 1999 was
due to rising interest rates during the latter part of that year. The higher
average rate for 2000 compared to the average rate for 1999 was due to increases
in the targeted Fed funds rates announced by the Fed several times during 2000.
OTHER REAL ESTATE OWNED
Real property owned by the Company that was acquired in foreclosure proceedings
is termed Other Real Estate Owned. As explained in Note 1 to the consolidated
financial statements, the Company held some
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properties at December 31, 2000 and 1999, but had written their carrying value
down to zero to reflect the uncertainty of realizing any net proceeds from their
disposal.
As part of the loan application process, the Company reviews real estate
collateral for possible problems from contamination by hazardous waste. This is
reviewed again before any foreclosure proceedings are initiated.
NONEARNING ASSETS
For a bank, nonearning assets are those assets like cash reserves, equipment,
and premises that do not earn interest. The ratio of nonearning assets to total
assets is watched carefully by Management because it represents the efficiency
with which funds are used. Tying up funds in nonearning assets either lessens
the amount of interest that may be earned or it requires the investment of the
smaller earning asset base in higher yielding but riskier assets to achieve the
same income level. Management therefore believes that a low level of nonearning
assets is part of a prudent asset/liability management strategy to reduce
volatility in the earnings of the Company.
The ratio of nonearning assets to total assets has increased during the last
three years with an average of 6.51% in 1998, 6.79% in 1999, and 7.12% in 2000.
Some of the increase in nonearning assets in 1999 was due to holding extra
amounts of cash on hand during November and December in case there was a large
demand for currency as 2000 approached. Also, subsequent to the fire that
destroyed the Company's Administrative Center, additional costs have been
incurred for leasehold improvements and furniture related to the new center. The
Company has also completed its move into a new Operations Center and begun
construction of its new Executive Headquarters. The space available in the old
operations center (initially rented when the Company had assets of less than
$500 million) was inadequate to handle the increasing volume of transactions.
The new Executive Headquarters, when complete in May or June of 2001, will also
house SBB&T's Trust and Investment Services division which has also outgrown its
current facilities. These construction projects coming within a relatively short
space of time have added to the average balance of nonearning assets, and this
will increase in 2001. In addition, the Company added approximately $19 million
in nonearning assets due to the goodwill recognized in the LRB acquisition. As
of September 30, 2000, the average ratio of nonearning assets to total assets
for bank holding companies of comparable size was 8.13%.
OTHER OPERATING INCOME
Fees earned by the Trust and Investment Services Division remain the largest
component of other operating income, reaching $13.8 million in 2000. Fees
increased by $695,000 or 5% over fees for 1999 which were in turn $1.4 million
more than fees in 1998. The market value of assets under administration on which
the majority of fees are based increased from $2.0 billion at the end of 1998 to
$2.4 billion at the end of 1999, but decreased to $2.1 billion at the end of
2000. The majority of fees are based on the market value of the assets under
administration. Most of these assets are held in equity securities, and the
declining stock markets in 2000 reduced the value of the assets. Most of the
reduction in assets came in accounts for which the Company does not manage the
accounts, i.e. does not have investment authority, but is only the custodian.
Included within total fees in 2000 were $1,125,000 for trusteeship of employee
benefit plans and $910,000 from the sales of mutual funds and annuities. The
Company provides assistance to customers to determine what investments best
match their financial goals and helps the customers allocate their funds
according to the customers' risk tolerance and need for diversification. The
mutual funds and annuities are not operated by the Company, but instead are
managed by registered investment companies. The Division also provides
investment management services to individuals and organizations.
Included within other service charges, commissions and fees are service fees
arising from the processing of merchants' credit card deposits, escrow fees, and
a number of other fees charged for special services provided to customers. A
significant source of income in this category is tax refund transfer fee income
which totaled $7.3 million in 2000 compared to $6.6 million in 1999 and $4.8
million in 1998. As explained in the previous discussion on the tax refund
programs, many of the taxpayers not qualifying for loans still had their refunds
sent by the IRS to the Company which then issued the refund check more quickly
than the IRS. The Company began earning substantial fees for this service in
1995. Management expects that this will continue to provide a significant source
of income in 2000 and beyond.
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The Company continues to work on increasing other income and fees due to its
importance as a potential contributor to profitability.
OTHER OPERATING EXPENSES
Total other operating expenses have increased over the last three years as the
Company has grown. These expenses are often calculated as a proportion of
average assets as a means of providing comparisons with other financial
institutions. As a percentage of average assets, these expenses have declined
during the last three years. The ratios were 4.25% in 1998, 3.96% in 1999, and
3.60% in 2000.
The larger amount in 1998 is primarily due to expenses related to the merger
with PCB. The Company incurred $11.7 million in other expenses for the merger.
The nature of these expenses is explained in the section of this Discussion
titled "Merger with Pacific Capital Bancorp." Without these expenses, the ratio
of other operating expense to average assets for 1998 would have been 3.81%.
While the ratio for 1998 was impacted by the merger expenses, the ratios for
1999 and 2000 were also impacted by unusual expenses. In 1999, substantial
consulting expenses were incurred to integrate PCB's processing system into the
Company's system and to address the century date change ("Y2K") issue. In 2000,
the Company incurred $4.5 million in transaction costs, included in other
expenses, to complete the SBB and LRB transactions. Therefore, while these
unusual expenses in 1999 and 2000 had less of an impact on the other expense to
average asset ratio than did the merger expenses in 1998, the ratios still show
a downward trend when the large, unusual expenses in each of the years are
excluded.
Another ratio that is used to compare the Company's expenses to those of other
financial institutions is the operating efficiency ratio. This ratio takes into
account the fact that for many financial institutions much of their income is
not asset-based, i.e., it is based on fees for services provided rather than
income earned from a spread between the interest earned on assets and interest
paid on liabilities. The operating efficiency ratio measures how much
noninterest expense is spent in earning a dollar of revenue irrespective of
whether the revenue is asset-based or fee-based. The Company spent 55.9 cents in
2000 for each dollar of revenue compared to 58.5 cents for its holding company
peers. In 1999, the ratios were 57.9 cents for the Company and 61.2 cents for
its peers. In 1998, the ratios were 62.8 cents for the Company and 62.3 cents
for its peers. Without the merger expenses of 2000 and 1998, the Company's
ratios would have been 54.0 cents for 2000, 57.9 cents for 1999, and 56.2 cents
for 1998.
Within the whole category of other operating expense, salary and benefit
expenses increased 28.1% from 1998 to 2000 compared to a 38.4% increase in
average earning assets and a 39.1% growth in total revenues (exclusive of gains
or losses on securities) for the same period.
Net occupancy and equipment expense increased from 1998 to 2000 by 13.9% because
of some branch office renovation; increases in lease expense; upgrading of
equipment to handle increased transaction volumes and to maintain technological
competitiveness; the addition of new branch offices; and the increase in
depreciation relating to the new administrative and operations buildings.
CAPITAL RESOURCES
As of December 31, 2000, under current regulatory definitions, the Company and
its bank subsidiaries are "well-capitalized," the highest rating of the five
categories defined under the Federal Deposit Insurance Corporation Improvement
Act ("FDICIA").
Capital Adequacy Standards
The primary measure of capital adequacy for regulatory purposes is based on the
ratio of total risk-based capital to risk-weighted assets. This method of
measuring capital adequacy is meant to accomplish several objectives: 1) to
establish capital requirements that are more sensitive to the differences in
risk associated with various assets; 2) to explicitly take into account
off-balance sheet exposure in assessing capital adequacy; and, 3) to minimize
disincentives to holding liquid, low-risk assets.
The Company, as a bank holding company, is required by the FRB to maintain a
total risk-based capital to risk-weighted asset ratio of at least 8.0%. At the
end of 2000, the Company's ratio was 10.4%. The Company also must maintain a
Tier 1 capital to risk-weighted asset ratio of 6% and a Tier 1 capital to
average
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assets of 5% to be considered well-capitalized. The minimum levels established
by the FRB, the minimum levels necessary to be considered well-capitalized by
regulatory definition and the Company's ratios as of December 31, 2000 are
presented in Note 17. It is Management's intent to maintain capital in excess of
the well-capitalized requirement, and as of year-end all ratios exceed this
threshold. SBB&T, FNB, and LRB are also required to maintain a total risk-based
capital to risk-weighted asset ratio of 8.0% to be considered well-capitalized.
SBB&T's ratio at the end of 2000 was 10.3%, FNB's was 10.6%, and LRB's was
11.4%. PCCM has no minimum capital requirements.
The risk-based capital ratio is impacted by three factors: (1) the growth in
assets compared to the growth in capital; (2) the relative size of the various
asset categories; and (3) the composition of the securities and money market
portfolios. The Company's ratio decreased from 11.8% for year-end 1999 to 10.4%
for year-end 2000. This occurred first as the result of assets growing by 19.4%
from year-end 1999 to year-end 2000 while capital increased by 17.1%. Secondly,
securities, cash and overnight funds decreased as a percentage of total assets
from 28.7% to 27.3%. Some of these funds (generally risk-weighted at less than
100%) were used to pay for the increase in nonearning assets (all of which are
risk-weighted at 100%). These two factors, which tended to decrease the capital
ratios, were offset by a change in the composition of the securities portfolios.
At the end of 2000, the Company held a slightly higher proportion of cash and
U.S. Treasury securities to total securities, money market funds, and cash
compared to its holdings at the end of 1999. Cash and Treasuries are assigned a
zero risk weighting while other instruments, such as U.S. agency securities,
state and municipal securities, and Federal funds sold, have a 20% risk
weighting.
Future Sources and Uses of Capital and Expected Ratios
Over the last five years, the Company's assets have been increasing at a
compound annual growth rate of 12.5%. To maintain its capital ratios, the
Company must continue to increase capital at the same rate. Net income, the
major source of capital growth for the Company, has been increasing at a
compound annual growth rate of 17.2%, but 35%-40% of net income has been
distributed to shareholders in the form of dividends. Together with some share
repurchases, this has resulted in capital increasing at a compound annual growth
rate of 9.8%.
During the last several years, the Company has experienced strong loan demand
and expects this to continue. This will require the Company to more closely
monitor its capital position than was necessary in prior years when the
challenge was to effectively utilize excess capital.
The process of managing the capital ratios to remain classified as well
capitalized involves three primary considerations. First, it is essential that
management avoid alternating between being able to make loans and not able to
make loans. Customers are attracted to the Company's subsidiary banks because of
the relationship that is built with the customer, not the individual
transaction. This requires the Company to be able to meet the credit needs of
the borrower when they need to borrow.
The second consideration is that to maintain the ability to provide for those
customers, the Company must be prepared to sell some of the loans it originates.
This involves structuring loans to meet the purchase requirements of secondary
markets, or charging an interest rate premium for those loans that cannot be
sold. As mentioned above, in 2000 and early 2001, the Company has already sold
loans as a means of limiting the rate of asset increase and will continue to do
so in 2001.
The third consideration is that raising additional capital is likely to be
necessary. Because the capital ratios are a regulatory issue, it is not
necessary for the Company to issue more common stock. It is more likely that the
Company would use other forms of regulatory capital like subordinated debt or
Trust Preferred Stock. Interest would need to be paid on this capital, but the
current shareholders would not have their ownership diluted by additional
shares. The Company has had preliminary discussions with investment bankers
regarding the issuance of such capital and has been informed that it could be
accomplished with relative ease.
In addition to the capital generated from the operations of the Bank, over the
years a secondary source of capital growth has been the exercise of employee and
director stock options. The extent of the growth from this source in any one
year depends on a number of factors. These include the current stock price in
relation to the price at the time options were granted and the number of options
that would expire if not exercised during the year.
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The net increase to capital from the exercise of options is lessened by the
ability of option holders to pay the exercise price of options by trading shares
of stock they already own, termed "swapping". In 2000, the increase to capital
from the exercise of options (net of shares surrendered as payment for exercises
and taxes) was $1.4 million or 3.2% of the net growth in shareholders' equity in
the year. This was less than the $11,345,000 or 44.5% percent of capital growth
due to option exercises in 1998. In that year, a larger number of options would
have expired if not exercised than would have expired in 1999 if not exercised.
At December 31, 2000, there were approximately 954,000 options outstanding and
exercisable at less than the then-current market price, with an average exercise
price of $20.43. This represents a potential addition to capital of $19.5
million, if all options were exercised with cash. Because many options are
likely to be exercised by swapping, some amount less than the $19.5 million in
new capital will result from the exercise of options, and the options are likely
to be exercised over a number of years.
In any case, Management intends to take the actions necessary to ensure that the
Company and the subsidiary banks will continue to exceed the capital ratios
required for well-capitalized institutions.
Share Repurchases
In prior years, the Company occasionally repurchased shares of its common stock
to offset the increased number of shares issued as a result of the exercise of
employee stock options. In 1998, because the merger with PCB was accounted for
as a pooling-of-interests, the Company suspended purchases at the initiation of
the merger discussions and repurchased only 150,000 shares compared to the
issuance of 807,000 shares resulting from the exercise of stock options. In
1999, the Company repurchased 68,000 shares to partially offset the issuance of
413,000 shares resulting from the exercise of stock options. There were no
repurchases of shares in 2000.
There are no material commitments for capital expenditures or "off-balance
sheet" financing arrangements as of the end of 2000, except as reported in Note
18 to the consolidated financial statements. Legal limitations on the ability of
the subsidiary banks to declare dividends to the Bancorp are discussed in Note
17.
REGULATION
The Company is strongly impacted by regulation. The Company and its subsidiaries
may engage only in lines of business that have been approved by their respective
regulators, and cannot open, close, or relocate offices without their approval.
Disclosure of the terms and conditions of loans made to customers and deposits
accepted from customers are both heavily regulated as to content. FDICIA,
effective in 1992, required banks to meet new capitalization standards, follow
stringent outside audit rules, and establish stricter internal controls. There
were also new requirements to ensure that the Audit Committee of the Board of
Directors is independent.
The subsidiary banks are required by the provisions of the federal Community
Reinvestment Act ("CRA"), to make significant efforts to ensure that access to
banking services is available to every segment of the community. They are also
required to comply with the provision of various other consumer legislation and
regulations. The Company and the banks must file periodic reports with the
various regulators to keep them informed of their financial condition and
operations as well as their compliance with all the various regulations.
The four regulatory agencies--the FRB for the Company and SBB&T, the California
Department of Financial Institutions for SBB&T and LRB, the OCC for FNB, and the
FDIC for LRB--conduct periodic examinations of the Company and its subsidiary
banks to verify that their reporting is accurate and to ascertain that they are
in compliance with regulations.
A banking agency may take action against a bank holding company or a bank should
it find that the financial institution has failed to maintain adequate capital.
This action has usually taken the form of restrictions on the payment of
dividends to shareholders, requirements to obtain more capital from investors,
and restrictions on operations. The FDIC may also take action against a bank
which is not acting in a safe and sound manner. Given the strong capital
position and performance of the Company and the banks, Management does not
expect to be impacted by these types of restrictions in the foreseeable future.
The Gramm-Leach-Bliley Act was enacted as Federal legislation in late 1999 with
an effective date of March 11, 2000. The provisions of the act permit banking
organizations to enter into areas of business from
34
35
which they were previously restricted. Similarly, other kinds of financial
organizations are permitted to conduct business provided by banks. Management
expects that over the next several years the Company will develop new
opportunities for business and will face increased competition as a result of
the passage of this act.
IMPACT OF INFLATION
Inflation has been minimal for the last several years and has had little or no
impact on the financial condition and results of operations of the Company
during the periods discussed here.
LIQUIDITY
Liquidity is the ability to raise funds on a timely basis at an acceptable cost
in order to meet cash needs. Adequate liquidity is necessary to handle
fluctuations in deposit levels, to provide for customers' credit needs, and to
take advantage of investment opportunities as they are presented in the market
place.
The Company's objective is to ensure adequate liquidity at all times by
maintaining liquid assets, by being able to raise deposits and liabilities, and
by having access to funds via capital markets. Having too little liquidity can
result in difficulties in meeting commitments and lost opportunities. Having too
much liquidity can result in less income because liquid assets usually do not
earn as high an interest rate as less liquid assets.
As indicated in the Consolidated Statements of Cash Flows principal sources of
cash for the Company have included proceeds from the maturity or sale of
securities, and the growth in deposits and other borrowings.
To manage the Company's liquidity properly, however, it is not enough to merely
have large cash inflows; they must be timed to coincide with anticipated cash
outflows. Also, the available cash on hand or cash equivalents must be
sufficient to meet the exceptional demands that can be expected from time to
time relating to natural catastrophes such as flood, earthquakes, and fire.
The Company manages its liquidity adequacy by monitoring and managing its
immediate liquidity, intermediate liquidity, and long term liquidity. Immediate
liquidity is the ability to raise funds today to meet today's cash obligations.
Sources of immediate liquidity include cash on hand, the prior day's Federal
funds sold position, unused Federal funds and repurchase agreement lines and
facilities extended by other banks and major brokers to the Company, access to
the Federal Home Loan Bank ("FHLB") for short-term advances, and access to the
FRB's Discount Window. The Company has established a target amount for sources
of available immediate liquidity. This amount is increased during certain
periods to accommodate any liquidity risks of special programs like RALs.
As discussed in various sections above, continued strong loan demand in 1999
outpaced the deposit growth and required the Company to rely more on overnight
borrowing to maintain immediate liquidity than had been the case in prior years.
The rate paid on these borrowings is more than would be paid for deposits, but
aside from this, there have been no adverse consequences from relying more on
borrowing ability than on holding liquid assets in excess of the immediate
amounts needed. The Company's strong capital position and earnings prospects
have meant that these sources of borrowing have been readily available. In 2000,
deposit growth in dollars kept pace with loan growth.
Intermediate liquidity is the ability to raise funds during the next few months
to meet cash obligations over those next few months. Sources of intermediate
liquidity include maturities or sales of bankers' acceptances and securities,
term repurchase agreements, and term advances from the FHLB. The Company
monitors the cash flow needs of the next few months and determines that the
sources are adequate to provide for these cash needs.
Long-term liquidity is the ability to raise funds over the entire planning
horizon to meet cash needs anticipated due to strategic balance sheet changes.
Long-term liquidity sources include: initiating special programs to increase
core deposits in expanded market areas; reducing the size of securities
portfolios; taking long-term advances from the FHLB, securitizing loans; and
accessing capital markets. The fixed-rate loans the Company borrowed from FHLB
to fund the retention of a portion of the 30-year fixed rate residential real
estate loans is an example of coordinating a source of long term liquidity with
asset/liability management.
35
36
INCOME TAX EXPENSE
Income tax expense is the sum of two components: the CURRENT TAX EXPENSE or
provision and the DEFERRED EXPENSE or provision. Current tax expense is the
result of applying the current tax rate to taxable income.
The deferred tax provision is intended to account for the fact that income on
which the Company pays taxes with its returns differs from pre-tax income in the
accompanying Consolidated Income Statements. Some items of income and expense
are recognized in different years for income tax purposes than in the financial
statements. For example, the Company is only permitted to deduct from Federal
taxable income actual net loan charge-offs, irrespective of the amount of
provision for credit loss (bad debt expense) recognized in its financial
statements. This causes what is termed a "temporary difference" because
eventually, as loans are charged-off, the Company will be able to deduct for tax
purposes what has already been recognized as an expense in the financial
statements. Another example is the ACCRETION of discount on certain securities.
Accretion is the recognition as interest income of the excess of the par value
of a security over its cost at the time of purchase. For its financial
statements, the Company recognizes income as the discount is accreted. For its
tax return, however, the Company can defer the recognition of that income until
the cash is received at the maturity of the security. The first example causes a
deferred tax asset to be created because the Company has recognized as an
expense for its current financial statements an item that it will be able to
deduct from its taxable income in a future year's tax return. The second example
causes a deferred tax liability, because the Company has been able to delay
until a subsequent year the paying of tax on an item of current year financial
statement income.
The Company measures all of its deferred tax assets and liabilities at the end
of each year. The difference between the net asset or liability at the beginning
of the year and the end of the year is the deferred tax provision for the year.
Most of the Company's temporary differences involve recognizing substantially
more expenses in its financial statements than it has been allowed to deduct for
taxes in the return for the year. This results in a net deferred tax asset.
Deferred tax assets are dependent for realization on past taxes paid, against
which they may be carried back, or on future taxable income, against which they
may be offset. If there were a question about the Company's ability to realize
the benefit from the asset, then it would have to record a valuation allowance
against the asset to reflect the uncertainty. Given the amount and nature of the
Company's deferred assets, the past taxes paid, and the likelihood of future
taxable income, realization is assured for the full amount of the net deferred
tax asset and no valuation allowance is needed.
The amounts of the current expense and deferred benefit, the amounts of the
various deferred tax assets and liabilities, and the tax effect of the principal
temporary differences between taxable income and pre-tax financial statement
income are shown in Note 8 to the accompanying consolidated financial
statements.
COMMON STOCK PRICES AND DIVIDENDS
Stock prices and cash dividends declared for the last eight quarters are shown
on page 5. The Company's stock is listed on the Nasdaq National Market System.
The trading symbol is SABB. Stock prices represent trading activity through the
National Market System.
For the years 2000, 1999, and 1998, the Company has declared cash dividends
which were 41.8%, 39.0%, and 48.5%, respectively, of its net income. The
Company's policy is to pay dividends of approximately 35%-40% of the last 12
months earnings. Because earnings were significantly reduced in 1998 and 2000 by
the one-time merger expenses, the ratios for 1998 and 2000 are higher than
usual. The most recent information for the Company's peers shows an average
payout ratio of 29.8%. The Board of Directors periodically increases the
dividend rate in acknowledgment that earnings have been increasing by a
sufficient amount to ensure adequate capital and also provide a higher return to
shareholders. The last increase was declared in the third quarter of 2000.
MERGERS AND ACQUISITION
On December 30, 1998, SBBancorp completed its merger with PCB and assumed the
name of its merger partner to most clearly reflect the broad geography of the
new multi-bank organization.
36
37
The agreement provided for PCB shareholders to receive 1.935 shares of SBBancorp
stock in exchange for each of their shares. Based on the closing price of
SBBancorp stock as of the date of the merger, the value of the merger was
approximately $216 million, 2.8 times the book value of PCB. The transaction was
accounted for as a pooling of interests. As such, all financial results for
periods prior to the merger are reported as if the merger occurred at the
beginning of the earliest period presented.
After the close of business June 30, 2000, the Company completed its acquisition
of Los Robles Bancorp. The shareholders of Los Robles Bancorp were paid cash in
the amount of $23.12 per share for their stock for a total transaction amount of
$32.5 million. The Company recognized goodwill of $20.0 million in the
transaction for the excess of the purchase price over the fair value of the net
assets obtained.
The only subsidiary of Los Robles Bancorp, LRB, became a subsidiary of the
Company. It is anticipated that in the second quarter of 2001, LRB will be
merged into SBB&T.
After the close of business July 31, 2000, the Company completed its merger with
SBB. The merger agreement provided for SBB shareholders to receive 0.605 shares
of the Company's stock in exchange for each of their shares. Based on the
closing price of the Company's stock as of the date of the merger, the value of
the merger was approximately $43.8 million, 2.8 times the book value of SBB. The
transaction was accounted for as a pooling of interests. As such, all financial
results for periods prior to the merger are reported as if the merger occurred
at the beginning of the earliest period presented.
CENTURY DATE CHANGE ("Y2K")
In the years leading up to December 31, 2000, the Company took the required
actions to prepare its computer and other electronic systems for Y2K. As a
result of these preparations, no significant problems were encountered with the
Company's critical systems and the Company is not aware of any significant
problems encountered by its customers or the other financial institutions with
which it does business. The Company did not become aware of any significant
impact on its customers' abilities to repay loans due to problems with their
systems.
The total cost of the project was approximately $2,652,000, which included the
cost of outside contract programmers, software and hardware purchased
specifically to be ready for Y2K, and the rental of a generator and other
special equipment for the period surrounding year end. Of this amount,
approximately $1,741,000 was expensed in 1999, with the balance having been
expensed in 1997 and 1998.
37
38
NOTES TO MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
NOTE A
In various places throughout this discussion, comparisons are made between
ratios for the Company and for its holding company or FDIC peers.
The holding company peer is a group of 66 companies with an asset size of $3
billion to $10 billion. The peer information is reported in the Bank Holding
Company Performance Report received from the FRB for the 3rd Quarter of 2000,
the latest quarter for which the report has been distributed as of this writing.
The FDIC peer group comprises 300+ banks with an asset size of $1 billion to $10
billion, and the information set forth above is reported in or calculated from
information reported in the FDIC Quarterly Banking Profile, Third Quarter 2000,
which is the latest issue available. The publication does not report some of the
statistics cited in this report by the separate size-based peer groups. In these
instances, the figure cited is for all FDIC banks regardless of size.
The particular peer group used for comparison depends on the nature of the
information in question. Company data like capital ratios and dividend payout
are compared to other holding companies, because capital is generally managed at
the holding company level and dividends to shareholders are paid from the
holding company, not the individual banks. Expense and revenue ratios are also
compared to other holding company data because many holding companies provide
significant services to their subsidiary banks and may also provide services to
customers as well. These items would not be included in FDIC bank-level data.
Credit information relates to what is generally a bank-level activity, the
making of loans, and the FDIC data in this area is more pertinent.
NOTE B
When comparing interest yields and costs year to year, the use of average
balances more accurately reflects trends since these balances are not
significantly impacted by period-end transactions. The amount of interest earned
or paid for the year is also directly related to the average balances during the
year and not to what the balances happened to be on the last day of the year.
Average balances are daily averages, i.e., the average is computed using the
balances for each day of the year, rather than computing the average of the
first and last day of the year.
NOTE C
For Tables 1 and 3, the yield on tax-exempt state and municipal securities and
loans has been computed on a tax equivalent basis. To compute the tax equivalent
yield for these securities one must first add to the actual interest earned an
amount such that if the resulting total were fully taxed, the after-tax income
would be equivalent to the actual tax-exempt income. This tax equivalent income
is then divided by the average balance to obtain the tax equivalent yield. The
dollar amount of the adjustment is shown at the bottom of Table 1 as "Tax
equivalent income included in interest income from nontaxable securities and
loans."
NOTE D
For purposes of Table 1, loans in a nonaccrual status are included in the
computation of average balances in their respective loan categories.
NOTE E
For purposes of the amounts in Table 2 relating to the volume and rate analysis
of net interest margin, the portion of the change in interest earned or paid
that is attributable to changes in rate is computed by multiplying the change in
interest rate by the prior year's average balance. The portion of the change in
interest earned or paid that is attributable to changes in volume is computed by
multiplying the change in
38
39
average balances by the prior year's interest rate. The portion of the change
that is not attributable either solely to changes in volume or changes in rate
is prorated on a weighted basis between volume and rate.
NOTE F
A yield curve is a graphic representation of the relationship between the
interest rate and the maturity term of financial instruments. Generally,
interest rates on shorter maturity financial instruments are less than those for
longer term instruments. For example, at December 31, 1999, 1 year U.S. Treasury
notes sold at a price that yielded 5.96% while 30 year notes sold at a price
that yielded 6.48%. A line drawn that plots this relationship for a whole range
of maturities will be "steeper" when the rates on long-term maturities are
substantially higher than those on shorter term maturities. The curve is said to
be "flatter" when there is not as much of a difference. At December 31, 2000,
the shape of the curve was partially "inverted" in that 10 year notes sold at a
lower price than either 1 year or 30 year notes. 1 year U.S. Treasury notes sold
at a price that yielded 5.36%, 10 year U.S. Treasury notes sold at a price that
yielded 5.11%, and 30 year notes sold at a price that yielded 5.46%.
NOTE G
Banker's acceptances generally result from the financing of a shipment of goods
between a particular purchaser and seller, in financial markets they function as
a negotiable short-term debt instrument. Commercial paper instruments are
short-term notes issued by companies. They are actively traded among investors
after issuance.
NOTE H
A large number of home mortgage loans may be grouped together by a financial
institution into a pool. This pool may then be securitized and sold to
investors. The payments received from the borrowers on their mortgages are used
to pay the investors. The mortgage instruments themselves are the security or
backing for the investors and the securities are termed mortgage-backed.
Collateralized mortgage obligations are like mortgage-backed securities in that
they involve a pool of mortgages. However, payments received from the borrowers
are not equally paid to investors. Instead, investors purchase portions of the
pool that have different repayment characteristics. This permits the investor to
better time the cash flows that will be received.
Asset-backed securities are like mortgage-backed securities except that loans
other than mortgages are the source of repayment. For instance, these might be
credit card loans or auto loans.
39
40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Audited consolidated financial statements and related documents required by this
item are included in this Annual Report on Form 10-K on the pages indicated:
Management's Responsibility for Financial Reporting 41
Report of Independent Public Accountants--Arthur Andersen LLP 42
Independent Auditors' Report--Deloitte & Touche LLP 43
Consolidated Balance Sheets as of December 31, 2000 and 1999 44
Consolidated Statements of Income for the years ended December 31, 2000, 1999, and 1998 45
Consolidated Statements of Comprehensive Income for the years ended December 31, 2000, 1999, and 1998 46
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2000, 1999, and 1998 47
Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999, and 1998 48
Notes to Consolidated Financial Statements 49
The following unaudited supplementary data is included in this Annual Report on
Form 10-K on the page indicated:
Quarterly Financial Data 79
40
41
PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
MANAGEMENT'S RESPONSIBILITY FOR
FINANCIAL REPORTING
The Management of Pacific Capital Bancorp (the "Company") is responsible for the
preparation, integrity, and fair presentation of the Company's annual
consolidated financial statements and related financial data contained in this
report. With the exception that some of the information in Management's
Discussion and Analysis of Financial Condition and Results of Operations is
presented on a tax-equivalent basis to improve comparability, all information
has been prepared in accordance with accounting principles generally accepted in
the United States and, as such, includes certain amounts that are based on
Management's best estimates and judgments.
The consolidated financial statements presented on pages 44 through 48 have been
audited by Arthur Andersen LLP, who have been given unrestricted access to all
financial records and related data, including minutes of all meetings of
shareholders, the Board of Directors, and committees of the Board. Management
believes that all representations made to Arthur Andersen LLP during the audit
were valid and appropriate.
Management is responsible for establishing and maintaining an internal control
structure over financial reporting. Two of the objectives of this internal
control structure are to provide reasonable assurance to Management and the
Board of Directors that transactions are properly authorized and recorded in our
financial records, and that the preparation of the Company's financial
statements and other financial reporting is done in accordance with generally
accepted accounting principles.
Management has made its own assessment of the effectiveness of the Company's
internal control structure over financial reporting as of December 31, 2000, in
relation to the criteria described in the report, Internal Control--Integrated
Framework, issued by the Committee of Sponsoring Organizations of the Treadway
Commission.
There are inherent limitations in the effectiveness of any internal control
structure, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even an effective internal control
structure can provide only reasonable assurance with respect to reliability of
financial statements. Furthermore, the effectiveness of any internal control
structure can vary with changes in circumstances. Nonetheless, based on its
assessment, Management believes that as of December 31, 2000, Pacific Capital
Bancorp's internal control structure was effective in achieving the objectives
stated above.
The Board of Directors is responsible for reviewing and monitoring the policies
and practices employed by Management in preparing the Company's financial
reporting. This is accomplished through its Audit Committee, which is comprised
of directors who are not officers or employees of the Company. The Committee
reviews accounting policies, control procedures, internal and independent audit
reports, and regulatory examination reports with Management, the Company's
internal auditors, and representatives of Arthur Andersen LLP. Both the
Company's internal auditors and the representatives of Arthur Andersen LLP have
full and free access to the Committee to discuss any issues which arise out of
their examinations without Management present.
/s/ DAVID W. SPAINHOUR /s/ WILLIAM S. THOMAS, JR. /s/ DONALD LAFLER
- -------------------------------- -------------------------------- --------------------------------
David W. Spainhour William S. Thomas, Jr. Donald Lafler
Chairman of the Board and President and Executive Vice President and
Pacific Capital Bancorp Chief Executive Officer Chief Financial Officer
Pacific Capital Bancorp Pacific Capital Bancorp
41
42
PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and the Board of Directors
of Pacific Capital Bancorp:
We have audited the accompanying consolidated balance sheets of Pacific Capital
Bancorp (a California corporation) and Subsidiaries as of December 31, 2000 and
1999, and the related consolidated statements of income, comprehensive income,
changes in shareholders' equity, and cash flows for each of the three years in
the period ended December 31, 2000. These financial statements are the
responsibility of Pacific Capital Bancorp's management. Our responsibility is to
express an opinion on these financial statements based on our audits. We did not
audit the financial statements of San Benito Bank for fiscal years prior to its
acquisition during 2000 by Pacific Capital Bancorp, in a transaction accounted
for as a pooling of interests, as discussed in Note 19 to the accompanying
consolidated financial statements. Such statements are included in the
accompanying consolidated financial statements of Pacific Capital Bancorp and
reflect total assets of 7 percent for 1999 and net income of 5 percent and 6
percent for 1999 and 1998, respectively, of the related consolidated totals.
These statements were audited by other auditors whose report has been furnished
to us and our opinion, insofar as it relates to amounts included for San Benito
Bank prior to the acquisition, is based solely upon the report of the other
auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the report of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Pacific Capital Bancorp and Subsidiaries as of
December 31, 2000 and 1999, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2000 in
conformity with accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
- --------------------------------
ARTHUR ANDERSEN LLP
Los Angeles, California
February 2, 2001
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43
PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders,
Pacific Capital Bancorp:
We have audited the balance sheet of San Benito Bank as of December 31, 1999 and
the related statements of income, stockholders' equity, and cash flows for the
two years ended December 31, 1999 and 1998 (not presented herein). These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of San Benito Bank at
December 31, 1999, and the results of its operations and its cash flows for the
two years ended December 31, 1999 and 1998, in conformity with accounting
principles generally accepted in the United States of America.
/s/ DELOITTE & TOUCHE LLP
- ---------------------------------
Deloitte & Touche LLP
Hollister, California
January 24, 2000
43
44
PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands except stated value) December 31
2000 1999
- ----------------------------------------------------------------------------------------------------------------
ASSETS:
Cash and due from banks (Note 5) $ 176,274 $ 131,422
Federal funds sold 19,500 9,640
Money market funds -- 2,555
Total cash and cash equivalents 195,774 143,617
Securities (approximate market value of $818,073
in 2000 and $744,886 in 1999) (Note 2):
Held-to-maturity 139,294 185,398
Available-for-sale 669,631 555,306
Total securities 808,925 740,704
Loans (Note 3) 2,517,104 2,090,033
Less: allowance for credit losses (Note 4) 35,125 30,454
Net loans 2,481,979 2,059,579
Premises and equipment, net (Note 6) 53,013 37,511
Accrued interest receivable 25,945 18,570
Other assets (Notes 8 & 19) 111,989 80,328
- ----------------------------------------------------------------------------------------------------------------
Total assets $ 3,677,625 $ 3,080,309
================================================================================================================
LIABILITIES:
Deposits (Note 7):
Noninterest bearing demand deposits $ 709,348 $ 583,601
Interest bearing deposits 2,393,471 2,037,856
Total deposits 3,102,819 2,621,457
Securities sold under agreements to repurchase
and Federal funds purchased (Note 10) 105,658 80,507
Long-term debt and other borrowings (Note 11) 129,658 98,801
Accrued interest payable and
other liabilities (Notes 8, 13, and 15) 43,229 26,503
- ----------------------------------------------------------------------------------------------------------------
Total liabilities 3,381,364 2,827,268
================================================================================================================
Commitments and contingencies (Note 18)
SHAREHOLDERS' EQUITY (Notes 9, 13 and 17):
Common stock -- no par value, $0.33 stated value; shares
authorized: 60,000; shares issued and outstanding:
26,481 in 2000 and 26,279 in 1999 8,828 8,761
Preferred stock-- no par value; shares authorized: 1,000
shares issued and outstanding: none -- --
Surplus 115,664 114,336
Accumulated other comprehensive income (loss) (Note 1) 4,472 (6,765)
Retained earnings 167,297 136,709
- ----------------------------------------------------------------------------------------------------------------
Total shareholders' equity 296,261 253,041
- ----------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 3,677,625 $ 3,080,309
================================================================================================================
The accompanying notes are an integral part of these consolidated statements.
44
45
PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except for per share data) Year Ended December 31
2000 1999 1998
- -----------------------------------------------------------------------------------------------------------
INTEREST INCOME:
Interest and fees on loans (Note 3) $ 229,014 $ 174,539 $ 146,819
Interest on securities:
U.S. Treasury obligations 8,925 10,650 14,552
U.S. agency obligations 17,032 12,712 9,538
State and municipal securities 10,553 9,570 9,580
Collateralized mortgage obligations 11,179 12,284 13,381
Asset-backed securities 1,678 848 716
Equity securities 952 527 518
Interest on Federal funds sold and securities
purchased under agreement to resell 9,870 4,033 9,190
Interest bearing deposits 111 184 306
Interest on commercial paper and bankers' acceptances 1,602 307 937
- -----------------------------------------------------------------------------------------------------------
Total interest income 290,916 225,654 205,537
- -----------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Interest on deposits (Note 7) 98,293 65,894 68,905
Interest on securities sold under agreements
to repurchase and Federal funds purchased
(Note 10) 4,247 1,766 1,098
Interest on long-term debt and other
borrowings (Note 11) 7,986 4,815 2,256
- -----------------------------------------------------------------------------------------------------------
Total interest expense 110,526 72,475 72,259
- -----------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 180,390 153,179 133,278
Provision for credit losses (Notes 1 and 4) 14,440 7,043 9,313
- -----------------------------------------------------------------------------------------------------------
Net interest income after provision for credit losses 165,950 146,136 123,965
- -----------------------------------------------------------------------------------------------------------
OTHER OPERATING INCOME:
Service charges on deposit accounts 11,176 9,608 9,292
Trust fees (Notes 1 and 12) 13,827 13,132 11,718
Other service charges, commissions and fees
(Note 12) 21,757 18,717 16,798
Net (loss) gain on sales and calls of securities
(Notes 1, 2, and 8) (143) (268) 228
Other income 2,771 2,203 1,420
- -----------------------------------------------------------------------------------------------------------
Total other operating income 49,388 43,392 39,456
- -----------------------------------------------------------------------------------------------------------
OTHER OPERATING EXPENSE:
Salaries and other compensation (Note 16) 54,931 46,416 42,872
Employee benefits (Notes 13 and 15) 12,273 8,941 9,508
Net occupancy expense (Notes 6 and 18) 11,225 9,822 8,600
Equipment rental, depreciation and
maintenance (Note 6) 7,303 7,185 7,662
Other operating expense (Note 12) 46,225 45,061 43,310
- -----------------------------------------------------------------------------------------------------------
Total other operating expense 131,957 117,425 111,952
- -----------------------------------------------------------------------------------------------------------
Income before provision for income taxes 83,381 72,103 51,469
Provision for income taxes (Note 8) 31,925 25,570 19,970
- -----------------------------------------------------------------------------------------------------------
NET INCOME $ 51,456 $ 46,533 $ 31,499
===========================================================================================================
BASIC EARNINGS PER SHARE (NOTE 16) $ 1.95 $ 1.78 $ 1.23
DILUTED EARNINGS PER SHARE (NOTE 16) $ 1.93 $ 1.75 $ 1.20
===========================================================================================================
The accompanying notes are an integral part of these consolidated statements.
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46
PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(in thousands) Year Ended December 31
2000 1999 1998
- ----------------------------------------------------------------------------------------------------------
Net income $ 51,456 $ 46,533 $ 31,499
- ----------------------------------------------------------------------------------------------------------
Other comprehensive income, net of tax (Note 8) -
Unrealized gain (loss) on securities:
Unrealized holding gains (losses) arising during period 11,094 (10,600) 1,989
Reclassification adjustment for (gains) losses
included in net income 143 268 (228)
- ----------------------------------------------------------------------------------------------------------
Other comprehensive income, net of tax 11,237 (10,332) 1,761
- ----------------------------------------------------------------------------------------------------------
Comprehensive income $ 62,693 $ 36,201 $ 33,260
==========================================================================================================
The accompanying notes are an integral part of these consolidated statements.
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47
PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS' EQUITY
Accumulated
(in thousands except for per Other
share data) Common Stock * Comprehensive Retained
Shares Amount Surplus Income Earnings Total
- ----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 25,026 $ 8,342 $ 99,518 $ 1,806 $ 95,306 $ 204,972
Activity for 1998:
Exercise of stock
options (Note 9) 828 277 11,068 -- -- 11,345
Retirement of
common stock (Note 9) (150) (50) (3,749) -- -- (3,799)
Cash dividends declared
at $0.66 per share -- -- -- -- (15,283) (15,283)
10% stock dividend for
San Benito (Note 9) 147 49 3,143 -- (3,192) --
Changes in unrealized gain
on securities
available-for-sale -- -- -- 1,761 -- 1,761
Net income -- -- -- -- 31,499 31,499
- ----------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 25,851 8,618 109,980 3,567 108,330 230,495
Activity for 1999:
Exercise of stock
options (Note 9) 499 167 6,498 -- -- 6,665
Retirement of
common stock (Note 9) (71) (24) (2,142) -- -- (2,166)
Cash dividends declared
at $0.72 per share -- -- -- -- (18,154) (18,154)
Changes in unrealized loss
on securities
available-for-sale -- -- -- (10,332) -- (10,332)
Net income -- -- -- -- 46,533 46,533
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1999 26,279 8,761 114,336 (6,765) 136,709 253,041
ACTIVITY FOR 2000:
EXERCISE OF STOCK
OPTIONS (NOTE 9) 202 67 1,328 -- -- 1,395
CASH DIVIDENDS DECLARED
AT $0.84 PER SHARE -- -- -- -- (20,868) (20,868)
CHANGES IN UNREALIZED GAIN
ON SECURITIES
AVAILABLE-FOR-SALE -- -- -- 11,237 -- 11,237
NET INCOME -- -- -- -- 51,456 51,456
- ----------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2000 26,481 $ 8,828 $ 115,664 $ 4,472 $ 167,297 $ 296,261
============================================================================================================================
* Preferred stock of 1,000,000 shares is authorized. At December 31, 2000
there are no preferred shares issued and outstanding.
The accompanying notes are an integral part of these consolidated statements.
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PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (NOTE 1): 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 51,456 $ 46,533 $ 31,499
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED BY OPERATIONS:
Depreciation and amortization 7,963 7,309 7,585
Provision for credit lease losses 14,440 7,043 9,313
Gain on sale of loans -- -- (21)
Gain on life insurance -- (348) --
(Benefit) provision for deferred income taxes (2,296) (2,181) 897
Net recovery on other real estate owned -- (6) (122)
Net amortization of discounts and premiums for
securities and bankers' acceptances (7,557) (6,108) (3,412)
Net change in deferred loan origination fees and costs 1,525 165 346
Increase in accrued interest receivable (7,375) (4,684) (3,340)
Increase (decrease) in accrued interest payable 1,481 (62) (588)
Net loss (gain) on sales and calls of securities 143 286 (214)
(Decrease) increase in income taxes payable (3,126) (1,758) 5,804
Other operating activities (9,292) (22,683) 12,048
- -------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 47,362 23,506 59,795
- -------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of common stock of Los Robles Bank (Note 19) (32,500) -- --
Proceeds from sales, calls, and maturities of securities (Note 2) 228,338 253,064 253,319
Purchase of securities (Note 2) (259,294) (133,627) (319,496)
Proceeds from sale or maturity of bankers' acceptances
and commercial paper 9,966 49,896 60,219
Purchase of bankers' acceptances and commercial paper (9,972) (29,805) (34,452)
Net increase in loans made to customers (443,930) (427,684) (291,881)
Disposition of property from defaulted loans 5,565 270 437
Purchase of tax credit investment -- (6,933) (3,688)
Purchase of investment in premises and equipment (22,279) (12,031) (7,285)
Proceeds from sale of equipment -- 45 6
- -------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (524,106) (306,805) (342,821)
- -------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 481,362 133,425 280,549
Net increase in borrowings
with maturities of 90 days or less 19,725 52,711 6,503
Proceeds from other borrowings 189,783 80,100 14,900
Payments on other borrowings (153,500) (26,252) (10,000)
Proceeds from issuance of common stock (Note 9) 1,395 2,424 5,024
Payments to retire common stock (Note 9) -- (2,055) (3,797)
Dividends paid (20,868) (18,091) (12,907)
- -------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 517,897 222,262 280,272
- -------------------------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents 41,153 (61,037) (2,754)
Cash and cash equivalents at beginning of period 143,617 204,654 207,408
Cash and cash equivalents acquired in acquisitions 11,004 -- --
- -------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 195,774 $ 143,617 $ 204,654
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE:
Interest paid during the year $ 94,051 $ 72,238 $ 72,131
Income taxes paid during the year $ 35,090 $ 24,464 $ 16,738
Non-cash additions to other real estate owned (Note 1) $ -- $ 264 $ 236
The accompanying notes are an integral part of these consolidated statements.
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49
PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Pacific Capital Bancorp (the "Company") is a bank holding company organized
under the laws of California. The Company is the surviving corporation resulting
from the merger on December 30, 1998 of Santa Barbara Bancorp ("SBBancorp") and
the former Pacific Capital Bancorp ("PCB"). The merger was accounted for as a
pooling of interests. Accordingly, all historical financial information has been
restated as if the merger had been in effect for all periods presented. To
recognize its newly expanded market areas, the Company assumed the name Pacific
Capital Bancorp.
Nature of Operations
Through its banking subsidiaries, Santa Barbara Bank & Trust ("SBB&T"), First
National Bank of Central California ("FNB"), and Los Robles Bank ("LRB"), the
Company provides a full range of commercial banking services to individuals and
business enterprises. The banking services include making commercial, leasing,
consumer, and Small Business Administration guaranteed loans, and commercial and
residential real estate loans. Deposits are accepted for checking,
interest-bearing checking ("NOW"), money-market, savings, and time accounts. The
banks offer safe deposit boxes, travelers checks, money orders, foreign exchange
services, and cashiers checks. SBB&T also provides escrow services to its
customers. A wide range of wealth management services are offered through the
Trust and Investment Services divisions of SBBT and FNB. The offices of SBB&T
are located in Santa Barbara County and in western Ventura County. Offices of
FNB are located in the counties of Monterey and Santa Cruz. Offices in southern
Santa Clara County are maintained under the name "South Valley National Bank",
an affiliate of FNB, and offices in San Benito County are maintained under the
name "San Benito Bank," ("SBB") also an affiliate of FNB. The offices of LRB are
located in the Ventura County communities of Thousand Oaks, Westlake Village,
and Camarillo.
The Company's fourth subsidiary is Pacific Capital Commercial Mortgage Company.
Its primary business activities are directed to brokering commercial real estate
loans and servicing those loans for a fee. While these activities are not
material in relation to the consolidated financial position or results, they
were organized into a separate company to limit possible risk exposure to the
banks.
A fifth subsidiary, Pacific Capital Services Corporation, is inactive.
Basis of Presentation
The accounting and reporting policies of the Company are in accordance with
accounting principles generally accepted in the United States ("GAAP") and
conform to practices within the banking industry. The consolidated financial
statements include the accounts of the Company and its subsidiaries.
All significant intercompany balances and transactions are eliminated.
The preparation of consolidated financial statements in accordance with GAAP
requires Management to make certain estimates and assumptions which affect the
amounts of reported assets and liabilities as well as contingent assets and
liabilities as of the date of these financial statements. These estimates and
assumptions also affect the reported amounts of revenues and expenses during the
reporting period(s). Although Management believes these estimates and
assumptions to be reasonably accurate, actual results may differ.
Securities
The Company purchases securities with funds that are not needed for immediate
liquidity purposes and have not been lent to customers. These securities are
classified either as held-to-maturity or available-for-sale. This classification
is made at the time of purchase. Only those securities that the Company both
intends and is able to hold until their maturity may be classified as
held-to-maturity. Securities that might be sold prior to maturity because of
interest rate changes, to meet liquidity needs, or to better match the repricing
characteristics of funding sources are classified as available-for-sale. The
Company purchases no securities specifically for later resale at a gain and
therefore holds no securities that should be classified as trading securities.
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50
The Company's securities that are classified as held-to-maturity are carried at
"amortized historical cost". This is the purchase price increased by the
accretion of discounts or decreased by the amortization of premiums using the
effective interest method. Discount is the excess of the face value of the
security over the cost, and accretion of the discount increases the effective
yield for the security above the interest rate for its coupon. Premium is the
excess of cost over the face value of the security, and amortization of the
premium reduces the yield for the security below the coupon rate. Discounts are
accreted and premiums are amortized over the period to maturity of the related
securities, or to earlier call dates, if appropriate. There is no recognition of
unrealized gains or losses for these securities.
For securities that are classified as available-for-sale, the interest income is
recognized in the same manner as for securities that are classified as
held-to-maturity, including the accretion of discounts and the amortization of
premiums. However, unlike the securities that are classified held-to-maturity,
securities classified available-for-sale are reported on the consolidated
balance sheets at their fair value. Changes in the fair value of these
securities are not recognized as a gain or loss in the Company's statements of
income, but are instead reported net of the tax effect on the consolidated
balance sheets as a separate component of equity captioned "Accumulated other
comprehensive income." The changes in fair value are included as elements of
comprehensive income in the consolidated statements of comprehensive income.
Included with loans are receivables structured like leases, but which in
substance are loans.
Loans and Interest and Fees from Loans
Loans are carried at amounts advanced to the borrowers less principal payments
collected. Interest on loans is accrued on a simple interest basis. Loan
origination and commitment fees, offset by certain direct loan origination
costs, are deferred and recognized over the contractual life of the loan as an
adjustment to the interest earned. The net unrecognized fees represent unearned
revenue, and they are reported as reductions of the loan principal outstanding,
or as additions to the loan principal if the deferred costs are greater than
deferred fees. Included with loans are receivables structured like leases, but
which in substance are loans.
Nonaccrual Loans: When a borrower is not making payments as contractually
required by the note, the Company must decide whether it is appropriate to
continue to accrue interest. Generally speaking, loans are placed in a
nonaccrual status, i.e., the Company stops accruing or recognizing interest
income on the loan, when the loan has become delinquent by more than 90 days.
The Company may decide that it is appropriate to continue to accrue interest on
some loans more than 90 days delinquent if they are well-secured by collateral
and collection efforts are being actively pursued. Such loans are categorized as
nonperforming loans.
When a loan is placed in a nonaccrual status, any accrued but uncollected
interest for the loan is written off against interest income from other loans of
the same type in the period in which the status is changed. No further interest
income is recognized until all recorded amounts of principal are recovered in
full or until circumstances have changed such that payments are again
consistently received as contractually required.
Impaired Loans: A loan is identified as impaired when it is probable that
interest and principal will not be collected according to the contractual terms
of the loan agreement. Because this definition is very similar to that of a
nonaccrual loan, most impaired loans will be classified as nonaccrual. However,
there are some loans that are termed impaired because of doubt regarding
collectibility of interest and principal according to the contractual terms, but
which are presently both fully secured by collateral and are current in their
interest and principal payments. These impaired loans are not classified as
nonaccrual. Under GAAP, the term "impaired" only applies to certain types or
classes of loans. Consequently, there are some nonaccrual loans which are not
categorized as impaired.
Allowance for Credit Losses
If a borrower's financial condition becomes such that he or she is not able to
fully repay a loan or lease obligation extended by the Company, a loss to the
Company has occurred. When the Company has determined that such a loss has
occurred, the principal amount of the loan, or a portion thereof, is charged-off
against an established allowance so that the value of the Company's assets are
not overstated by retaining an uncollectible loan at its outstanding balance.
However, because loan officers cannot be in daily contact with each borrower,
the Company almost never knows exactly when such a loss might have occurred.
Therefore, in order to fairly state the value of the loan and leasing
portfolios, it is necessary to make an estimate of the amount of loss inherent
but unrecognized in these credit portfolios prior to the realization of such
losses through charge-off.
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51
GAAP, banking regulations, and sound banking practices require that the Company
record this estimate of unrecognized losses in the form of an allowance for
credit losses. The allowance is increased by the provision for credit losses,
which is a charge to income in the current period. The allowance is decreased by
the charge-off of loans net of any recoveries of loans previously charged-off.
The allowance for credit losses consists of several components. The first is
that portion of the allowance specifically allocated to those loans that are
categorized as impaired under provisions of Statement of Financial Accounting
Standards No. 114, Accounting by Creditors for Impairment of a Loan ("SFAS
114"). The remaining components include a statistically allocated portion, a
specifically allocated portion, and an unallocated portion. These components are
reported together in the allowance for credit loss in the accompanying
consolidated balance sheets and in Note 4. Each of these components of the
allowance for credit losses is maintained at a level considered adequate to
provide for losses that can reasonably be anticipated. However, the allowance is
based on estimates, and ultimate losses may vary from the current estimates.
These estimates are reviewed periodically and, as adjustments become necessary,
they are reported as provisions against earnings in the periods in which they
become known.
Component for Impaired Loans: Under GAAP, the Company is permitted to determine
the valuation allowance for impaired loans on a loan-by-loan basis or by
aggregating loans with similar risk characteristics. Because the number of loans
classified as impaired is relatively small and because special factors apply to
each, the Company determines the valuation allowance for impaired loans on a
loan-by-loan basis.
The amount of the valuation allowance allocated to any particular impaired loan
is determined by comparing the recorded investment in each loan with its value
measured by one of three methods: (1) by discounting estimated future cash flows
at the effective interest rate; (2) by observing the loan's market price if it
is of a kind for which there is a secondary market; or (3) by valuing the
underlying collateral. A valuation allowance is established for any amount by
which the recorded investment exceeds the value of the impaired loan. If the
value of the loan, as determined by one of the above methods, exceeds the
recorded investment in the loan, no valuation allowance for that loan is
established.
Historical Loss Component: The statistical component of the allowance is
intended to provide for losses that occur in large groups of smaller balance
loans, the individual credit quality of which is impracticable to review at each
period end. The amount of this component is determined by applying loss
estimation factors to outstanding loans and leases. The loss factors are based
primarily on the Company's historical loss experience. Because historical loss
experience differs for the various categories of credits, the loss estimation
factors applied to each category also differ.
Component for Specific Credits: There are a number of credits for which an
allowance computed by application of the appropriate loss estimation factor
would not adequately provide for the unconfirmed loss inherent in the credit.
This might occur for a variety of reasons such as the size of the credit, the
industry of the borrower, or the terms of the credit. In these situations,
Management will increase the allocation to an amount adequate to absorb the
probable loss that has occurred. The specific component is made up of the sum of
these specific allocations.
Unallocated Component: The unallocated component of the allowance for credit
losses is intended to absorb losses that may not be covered by the other
components. For example, the historical loss estimation factors used for
statistical allocation may not give sufficient weight to such considerations as
the current general economic and business conditions that affect the Company's
borrowers or to specific industry conditions that affect borrowers in that
industry. Additionally, the factors may not give sufficient weight to current
trends in credit quality and collateral values and the duration of the current
business cycle. Lastly, the factors are not derived in a manner that considers
loan volumes and concentrations and seasoning of the loan portfolio.
Complete information on the financial condition of the borrower and the current
disposal value of any collateral is not generally available at the time an
estimation of the loss must be made. This introduces significant uncertainty in
the estimation process used to determine the adequacy of specific allocations.
Income Taxes
The Company is required to use the accrual method of accounting for financial
reporting purposes as well as for tax return purposes. However, there are still
several items of income and expense that are recognized in different periods for
tax return purposes than for financial reporting purposes. Appropriate
provisions have
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been made in the financial statements for deferred taxes in recognition of these
temporary differences.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is charged against income over the estimated useful
lives of the assets. For most assets with longer useful lives, accelerated
methods of depreciation are used in the early years, switching to the
straight-line method in later years. Assets with shorter useful lives are
generally depreciated by straight-line method. Leasehold improvements are
amortized over the terms of the leases or the estimated useful lives of the
improvements, whichever is shorter. Generally, the estimated useful lives of
other items of premises and equipment are as follows:
Buildings and improvements 10-25 years
Furniture and equipment 5-7 years
Electronic equipment 3-5 years
Trust Fees
Fees for most trust services are based on the market value of customer assets,
and an estimate of the fees is accrued monthly. Fees for unusual or infrequent
services are recognized when the fee can be determined.
Earnings Per Share
The computation of earnings per share for all periods presented in the
Consolidated Statements of Income are based on the weighted average number of
shares outstanding during each year retroactively restated for stock dividends,
stock splits and pooling transactions.
Diluted earnings per share include the effect of common stock equivalents for
the Company, which include only shares issuable on the exercise of outstanding
options. The number of options assumed to be exercised is computed using the
"Treasury Stock Method." This method assumes that all options with an exercise
price lower than the average stock price for the period have been exercised and
that the proceeds from the assumed exercise and the tax benefit received for the
difference between the market price and the exercise price would be used for
market repurchases of shares.
A reconciliation of the computation of basic earnings per share and diluted
earnings per share is presented in Note 16.
Statement of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash and
due from banks, Federal funds sold, and securities purchased under agreements to
resell. Federal funds sold and securities purchased under agreements to resell
are one-day transactions, with the Company's funds being returned to it the next
day.
Postretirement Health Benefits
The Company provides eligible retirees with postretirement health care and
dental benefit coverage. These benefits are also provided to the spouses and
dependents of retirees on a shared cost basis. Benefits for retirees and spouses
are subject to deductibles, co-payment provisions, and other limitations. The
expected cost of such benefits is charged to expense during the years that the
employees render service to the Company and thereby earn their eligibility for
benefits.
Other Real Estate Owned
Other real estate owned ("OREO") represents real estate acquired through
foreclosure or deed in lieu of foreclosure. OREO is carried at the lower of the
outstanding balance of the loan before acquisition or the fair value of the OREO
less estimated costs to sell. If the outstanding balance of the loan is greater
than the fair value of the OREO at the time of the acquisition, the difference
is charged-off against the allowance for credit losses. Any senior debt to which
other real estate owned is subject is included in the carrying amount of the
property and an offsetting liability is reported along with other borrowings.
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53
During the time the property is held, all related operating or maintenance costs
are expensed as incurred and additional decreases in the fair value are charged
to other operating expense by establishing valuation allowances in the period in
which they become known. Expenditures related to improvements are capitalized to
the extent that they are realizable through increases in the fair value of the
properties. Increases in the fair value may be recognized as reductions of OREO
operating expense to the extent that they represent recoveries of amounts
previously written-down. Increases in market value in excess of the fair value
at the time of foreclosure are recognized only when the property is sold.
At December 31, 2000 and 1999, the Company held real estate properties that had
been acquired through foreclosure, but the value of the property and the
estimated disposal costs were so uncertain that no amount is reported on the
balance sheet for that date.
Stock-Based Compensation
GAAP permits the Company to use either of two methods for accounting for the
granting of employee stock options. Under the first accounting, if options are
granted at an exercise price equal to the market value of the stock at the time
of the grant, no compensation expense is recognized. The second accounting
method requires issuers to record compensation expense over the period the
options are expected to be outstanding prior to exercise, expiration, or
cancellation. The amount of compensation expense to be recognized over this term
is the "fair value" of the options at the time of the grant as determined by an
option pricing model. The option pricing model attributes fair value to the
options based on the length of their term, the volatility of the stock price in
past periods, and other factors. Under this method, the Company would recognize
compensation expense regardless of whether the officer or director exercised the
options. The Company believes that the first method better reflects the
motivation for its issuance of stock options, namely, that they are incentives
for future performance rather than compensation for past performance. GAAP
requires that issuers that elect the first method must present pro forma
disclosures of net income and earnings per share as if the second method had
been elected. The Company presents these disclosures in Note 16.
Derivative Financial Instruments
Interest rate swaps and interest rate caps and floors may be used to manage the
Company's exposure to interest rate risks. These instruments are specifically
allocated to the assets or liabilities being managed and are recorded in the
financial statements at cost. Net interest income or expense, including premiums
paid or received, is recognized over the effective period of the contract and
reported as an adjustment to interest income or expense. The Company currently
holds interest rate swaps with a notional amount of $62.6 million.
Goodwill
In connection with the acquisitions of LRB as described in Note 19, the Company
recognized the excess of the purchase price over the estimated fair value of the
assets received and liabilities assumed as goodwill. This goodwill, along with
goodwill recognized in earlier acquisitions, is being amortized on the
straight-line method over 15 years. The unamortized carrying amount of the
goodwill recorded for each acquisition is periodically reviewed by Management in
order to determine if facts and circumstances suggest that it is not
recoverable. This is determined based on expected undiscounted cash flows from
the net assets of the acquired entity, and consequently goodwill for the entity
would be reduced by the estimated cash flow deficiency. No such reduction in
goodwill occurred as of December 31, 2000 and 1999.
Comprehensive Income
GAAP requires that comprehensive income be reported in a financial statement
that is displayed with the same prominence as other financial statements. Net
income is one component of comprehensive income. The other components of
comprehensive income are revenues, expenses, gains, and losses that impact the
Company's capital accounts but are not recognized in net income under GAAP.
Based on the Company's current activities, other components of comprehensive
income consist only of changes in the unrealized gains or losses on securities
that are classified as available-for-sale.
The amounts of comprehensive income for the three years ended December 31, 2000,
1999, and 1998, are reported in the Consolidated Statements of Comprehensive
Income. The net change in the cumulative total of
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54
the components of other comprehensive income that are included in equity are
reported in the Consolidated Statements of Changes in Shareholders' Equity for
the three years ended December 31, 2000, 1999, and 1998.
Segment Reporting
GAAP requires that the Company disclose certain information related to the
performance of various segments of its business. Segments are defined based on
the segments within a company used by the chief operating decision maker for
making operating decisions and assessing performance. Reportable segments are to
be based on such factors as products and services, geography, legal structure,
management structure or any manner by which a company's management distinguishes
major operating units. For the purposes of this disclosure, Management has
determined that the Company has eight reportable segments: Wholesale Lending,
Retail Lending, Branch Activities, Fiduciary, Tax Refund Programs, Los Robles
Bank, Northern Region, and All Other. The basis for this determination and the
required disclosure is included in Note 20.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard No. 133, Accounting for Derivative Instruments
and Hedging Activities ("SFAS 133"). This standard establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions are
met, a derivative may be specifically designated as a hedge, which triggers
specific accounting treatment based on the type of hedge that exists. A
subsequent statement issued by the FASB requires that the Company adopt SFAS 133
no later than the first quarter of 2001, but may adopt earlier. The Company
elected to adopt the statement on January 1, 2001. Because it does not now hold
nor expect to hold in the foreseeable future a significant number of derivative
instruments, the adoption of SFAS 133 did not result in any material impact to
the Company's financial position or results of operations. Upon adoption of SFAS
133 on January 1, 2001, the Company was permitted to, and did, transfer
securities totaling unamortized cost of $28.7 million from the held-to-maturity
portfolio to the available-for-sale portfolio.
In September of 2000, the FASB issued Statement of Financial Accounting
Standards No. 140, Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities (SFAS 140). This Statement replaces Statement
of Financial Accounting Standards No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS 125").
SFAS 140 revises the standards for accounting for securitizations and other
transfers of financial assets and collateral and requires certain additional
disclosures. SFAS 140 carries over most of SFAS 125's provisions without
reconsideration. For the transfers and servicing of financial assets and
extinguishments of liabilities, SFAS 140 requires a financial-components
approach that focuses on control. Under that approach, after a transfer of
financial assets, the Company will 1) recognize the financial and servicing
assets it controls and the liabilities it has incurred, 2) derecognize financial
assets when control has been surrendered, and 3) derecognize liabilities when
extinguished.
The Company adopted SFAS 125 in 1997. SFAS 140 is effective for: transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001, and recognition and reclassification of collateral and for
disclosures relating to securitization transactions and collateral for fiscal
years ending after December 15, 2000. The Company does have certain
securitization transactions that occurred during the first quarter of 2001 that
will fall under the requirements of SFAS 140. As such, the Company will be
required to prospectively disclose information related to such securitizations
in regards to accounting policies, volume, cash flows, key assumptions made in
determining fair values of retained interests, and sensitivity of those fair
values for changes in key assumptions. Disclosure of such items and the related
accounting treatments will be presented in the Company's annual reports on Form
10-K for 2001 and subsequent years. Management does not anticipate the adoption
of SFAS 140 to have a material impact on the Company's financial position or
results of operations.
Accounting for Business Combinations
The mergers of SBBancorp with PCB and SBB with the Company (Note 19) were
accounted for by the pooling of interests method of accounting for a business
combination. Under this method, the assets and liabilities of the two parties
were added together for each year presented in the financial statements. The
effect of this presentation is as if the merger had occurred as of the beginning
of the earliest period presented. The assets and
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liabilities were combined at the amounts carried in the predecessor company
records; there is no restatement to their fair market value, and consequently no
goodwill recognized.
The acquisition of LRB (Note 19) was accounted for by the purchase method of
accounting for business combinations. Under this method, the assets and
liabilities of the acquired company are combined with the acquirer as of the
date of the acquisition at their fair market value. Any difference between the
fair value of the assets and liabilities and the purchase price is recorded as
goodwill. Goodwill is amortized against future earnings. The results of
operations of the acquired company are included with those of the acquirer only
from the transaction date forward.
Reclassifications
Certain amounts in the 1999 and 1998 financial statements have been reclassified
to be comparable with classifications used in the 2000 financial statements.
2. SECURITIES
A summary of securities owned by the Company at December 31, 2000 and 1999, is
as follows:
DECEMBER 31, 2000
------------------------------------------------------------------
(in thousands) GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------------------------------------------------------------------
HELD-TO-MATURITY:
U.S. TREASURY OBLIGATIONS $ 12,492 $ 33 $ -- $ 12,525
U.S. AGENCY OBLIGATIONS 28,958 1 (304) 28,655
MORTGAGE-BACKED SECURITIES 8,645 11 (134) 8,522
STATE AND MUNICIPAL SECURITIES 89,199 9,589 (48) 98,740
--------------------------------------------------------------------
139,294 9,634 (486) 148,442
--------------------------------------------------------------------
AVAILABLE-FOR-SALE:
U.S. TREASURY OBLIGATIONS 157,255 1,569 (23) 158,801
U.S. AGENCY OBLIGATIONS 246,749 2,109 (338) 248,520
COLLATERALIZED MORTGAGE OBLIGATIONS 159,231 683 (851) 159,063
ASSET-BACKED SECURITIES 13,913 3 (25) 13,891
STATE AND MUNICIPAL SECURITIES 72,459 5,091 (229) 77,321
EQUITY SECURITIES 12,035 -- -- 12,035
--------------------------------------------------------------------
661,642 9,455 (1,466) 669,631
--------------------------------------------------------------------
$ 800,936 $ 19,089 $ (1,952) $ 818,073
====================================================================
December 31, 1999
--------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------------------
Held-to-maturity:
U.S. Treasury obligations $ 35,543 $ 65 $ (40) $ 35,568
U.S. agency obligations 36,455 1 (1,432) 35,024
Mortgage-backed securities 776 9 (1) 784
State and municipal securities 112,624 6,298 (718) 118,204
--------------------------------------------------------------------
185,398 6,373 (2,191) 189,580
--------------------------------------------------------------------
Available-for-sale:
U.S. Treasury obligations 121,701 49 (691) 121,059
U.S. agency obligations 201,984 -- (2,764) 199,220
Collateralized mortgage obligations 174,798 21 (4,899) 169,920
Asset-backed securities 10,979 7 (114) 10,872
State and municipal securities 44,901 42 (3,390) 41,553
Equity securities 12,604 78 -- 12,682
--------------------------------------------------------------------
566,967 197 (11,858) 555,306
--------------------------------------------------------------------
$ 752,365 $ 6,570 $ (14,049) $ 744,886
====================================================================
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The amortized cost and estimated fair value of debt securities at December 31,
2000 and 1999, by contractual maturity, are shown in the next table. Expected
maturities will differ from contractual maturities because issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
DECEMBER 31, 2000 December 31, 1999
-------------------------------------- --------------------------------------
(in thousands) HELD-TO- AVAILABLE- Held-to- Available-
MATURITY FOR-SALE TOTAL Maturity for-Sale Total
-------------------------------------- --------------------------------------
Amortized cost:
In one year or less $ 31,869 $155,031 $186,900 $ 60,420 $ 92,661 $153,081
After one year through five years 47,624 409,528 457,152 57,660 400,111 457,771
After five years through ten years 18,232 21,214 39,446 23,749 24,277 48,026
After ten years 41,569 63,834 105,403 43,569 37,314 80,883
Equity securities -- 12,035 12,035 -- 12,604 12,604
-------------------------------------- --------------------------------------
$139,294 $661,642 $800,936 $185,398 $566,967 $752,365
====================================== ======================================
Estimated market value:
In one year or less 31,981 155,126 187,107 60,967 92,524 153,491
After one year through five years 49,534 412,430 461,964 60,219 393,431 453,650
After five years through ten years 19,339 21,332 40,671 23,406 22,889 46,295
After ten years 47,588 68,708 116,296 44,988 33,780 78,768
Equity securities -- 12,035 12,035 -- 12,682 12,682
-------------------------------------- --------------------------------------
$148,442 $669,631 $818,073 $189,580 $555,306 $744,886
====================================== ======================================
The proceeds received from sales or calls of debt securities and the gross gains
and losses that were recognized for the years ended December 31, 2000, 1999, and
1998 are shown in the next table.
PACIFIC CAPITAL BANCORP
(in thousands) 2000 1999 1998
--------------------------------- ---------------------------- --------------------------------
GROSS GROSS Gross Gross Gross Gross
PROCEEDS GAINS LOSSES Proceeds Gains Losses Proceeds Gains Losses
--------------------------------- ---------------------------- --------------------------------
Held-to-maturity:
Sales $ 29,995 $ -- $ (30) $ -- $ -- $ -- $ 7,490 $ 8 $ --
Calls $ 7,518 $ 7 $ (2) $ 6,662 $ -- $ -- $ 1,670 $ 2 $ (20)
Available-for-sale:
Sales $112,146 $ -- $ (120) $ 19,674 $ -- $ (286) $ 61,450 $ 349 $ (144)
Calls $ 11,640 $ 1 $ -- $ 63,340 $ -- $ -- $ 51,149 $ 12 $ --
SBB&T and FNB are members of the Federal Reserve Bank. As a condition of
membership, they are required to purchase Federal Reserve Bank ("FRB") stock.
The amount of stock required to be held is based on their capital accounts.
Subsequently, as the banks' capital has increased, they have been required to
purchase additional shares. SBB&T also acquired the shares owned by Citizens
State Bank, when it was acquired in 1997. SBB&T and FNB are members of the
Federal Home Loan Bank ("FHLB"), and purchased stock as required of members. The
FRB and FHLB stock are reported as equity securities. Since the stock has no
maturity, it is classified as available-for-sale, even though the Bank is
required to hold the stock so long as it maintains its membership in these
organizations.
Securities with a book value of approximately $647.0 million at December 31,
2000, and $564.2 million at December 31, 1999, were pledged to secure public
funds, trust deposits and other borrowings as required or permitted by law.
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3. LOANS
The loan portfolio consists of the following:
(in thousands) December 31
2000 1999
--------------------------
Real estate loans:
Residential $ 586,904 $ 494,540
Non-residential 564,556 457,575
Construction and development 172,331 200,804
Commercial, industrial, and agricultural 775,365 614,897
Home equity lines 71,289 49,902
Consumer 205,992 154,381
Leases 129,159 97,005
Municipal tax-exempt obligations 4,102 12,530
Other 7,406 8,399
--------------------------
$2,517,104 $2,090,033
==========================
The amounts above are shown net of deferred loan origination, commitment, and
extension fees and origination costs of $5.8 million for 2000 and $5.2 million
for 1999.
Impaired Loans
The table below discloses information about the loans classified as impaired and
the valuation allowance related to them:
(in thousands) December 31
2000 1999
------- -------
Loans identified as impaired $ 9,256 $10,970
Impaired loans for which a valuation
allowance has been determined $ 9,256 $ 9,695
Impaired loans for which no valuation
allowance has been determined $ -- $ 1,275
Amount of valuation allowance $ 3,260 $ 4,383
Year Ended December 31
2000 1999
------- -------
Average amount of recorded investment
in impaired loans for the year $ 7,932 $ 9,027
Interest recognized during the year for
loans identified as impaired at year-end $ 571 $ 501
Interest received in cash during the year for
loans identified as impaired at year-end $ 571 $ 501
As indicated in Note 1, a valuation allowance is established for an impaired
loan when the fair value of the loan is less than the recorded investment. As
shown above, a valuation allowance has been determined for all loans identified
as impaired at December 31, 2000. The valuation allowance amounts disclosed
above are included in the allowance for credit losses reported in the balance
sheets for December 31, 2000 and 1999 and in Note 4.
Refund Anticipation Loans
The Company offers tax refund anticipation loans ("RALs") to taxpayers desiring
to receive advance proceeds based on their anticipated income tax refunds. The
loans are repaid when the Internal Revenue Service later sends the refund to the
Company. The funds advanced are generally repaid within several weeks.
Therefore, processing costs and provision for loan loss represent the major
costs of the loans. This contrasts to other loans for which the cost of funds is
the major cost to the Company. Because of their short duration, the Company
cannot recover the processing costs through interest calculated over the term of
the loan. Consequently, the Company has a tiered fee schedule for this service
that varies by the amount of funds advanced based on the increased credit rather
than the length of time that the loan is outstanding. Nonetheless, because a
loan
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document is signed by the customer, the Company is required to report the fees
as interest income. These fees totaled $19.0 million in 2000, $8.1 million for
1999, and $6.8 million for 1998. The loans are all made during the tax filing
season of January through April of each year. Any loans for which repayment has
not been received within 90 days from the expected payment date are charged off.
Consequently, there were no RAL's included in the above table of outstanding
loans at December 31, 2000 or 1999.
Pledged Loans
At December 31, 2000 loans secured by first trust deeds on residential and
commercial property with principal balances totaling $72.4 million were pledged
as collateral to the Federal Reserve Bank of San Francisco. At December 31,
2000, loans secured by first deeds on residential and commercial property with
principal balances of $484.6 million were pledged to the Federal Home Loan Bank
of San Francisco.
4. ALLOWANCE FOR CREDIT LOSSES
The following summarizes the changes in the allowance for credit losses:
(in thousands) Year Ended December 31
2000 1999 1998
----------------------------------
Balance, beginning of year $ 30,454 $ 30,499 $ 26,526
Addition of allowance from Los Robles Bank 1,139 -- --
Tax refund anticipation loans:
Provision for credit losses 2,726 2,816 4,941
Recoveries on loans previously charged-off 3,059 2,857 2,288
Loans charged-off (6,226) (5,518) (7,221)
All other loans:
Provision for credit losses 11,714 4,227 4,372
Recoveries on loans previously charged-off 2,506 2,518 3,733
Loans charged-off (10,247) (6,945) (4,140)
----------------------------------
Balance, end of year $ 35,125 $ 30,454 $ 30,499
==================================
The ratio of losses to total loans for the RALs is higher than for other loans.
For RALs, the provision for credit loss, the loans charged-off, and the loans
recovered are reported separately from the corresponding amounts for all other
loans.
5. CASH AND DUE FROM BANKS
All depository institutions are required by law to maintain reserves with the
Federal Reserve Bank ("FRB") on transaction deposits. Amounts vary each day as
the FRB permits banks to meet this requirement by maintaining the specified
amount as an average balance over a two-week period. The average daily cash
reserve balances required to be maintained by the Company's subsidiary banks at
the FRB totaled approximately $2.6 million in 2000 and $3.3 million in 1999. In
addition, the banks must maintain sufficient balances at the FRB to cover the
checks written by bank customers that are clearing through the FRB because they
have been deposited at other banks.
6. PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
(in thousands) December 31
2000 1999
----------------------------
Land $ 5,175 $ 5,175
Buildings and improvements 21,927 21,783
Leasehold improvements 25,754 12,196
Furniture and equipment 51,968 42,594
----------------------------
Total cost 104,824 81,748
Accumulated depreciation
and amortization (51,811) (44,237)
----------------------------
Net book value $ 53,013 $ 37,511
============================
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Depreciation and amortization on fixed assets included in other operating
expenses totaled $6.3 million in 2000, $5.7 million in 1999, and $6.3 million in
1998.
7. DEPOSITS
Deposits and the related interest expense consist of the following:
Interest Expense for the
(in thousands) Balance as of December 31 Year Ended December 31
2000 1999 2000 1999 1998
---------------------------- ----------------------------------------------
Noninterest bearing deposits $ 709,348 $ 583,601 $ -- $ -- $ --
Interest bearing deposits:
NOW accounts 372,136 336,529 2,680 2,250 3,366
Money market deposit accounts 743,268 588,907 27,216 17,914 19,015
Other savings deposits 210,157 217,394 4,060 4,300 5,852
Time certificates of $100,000
or more 570,823 443,629 38,914 18,735 22,706
Other time deposits 497,087 451,397 25,423 22,695 17,966
---------------------------- ----------------------------------------------
$3,102,819 $2,621,457 $ 98,293 $ 65,894 $ 68,905
============================ ==============================================
8. INCOME TAXES
The provisions (benefits) for income taxes related to operations and the tax
benefit related to stock options that is credited directly to shareholders'
equity are as follows:
(in thousands) Year Ended December 31
2000 1999 1998
--------------------------------------------
Federal:
Current $ 24,210 $ 19,251 $ 16,758
Deferred (1,177) (1,911) (2,614)
--------------------------------------------
23,033 17,340 14,144
--------------------------------------------
State:
Current 9,033 8,500 6,190
Deferred (141) (270) (364)
--------------------------------------------
8,892 8,230 5,826
--------------------------------------------
Total tax provision $ 31,925 $ 25,570 $ 19,970
============================================
Reduction in taxes payable
associated with exercises
of stock options $(1,661) $ 3,915 $(5,103)
The total current provision for income taxes includes credits of $60,000 and
$113,000 for securities gains realized in 2000 and 1999, respectively, and a
debit of $96,000 for securities losses realized in 1998.
Although not affecting the total provision, actual income tax payments may
differ from the amounts shown as current provision as a result of the final
determination as to the timing of certain deductions and credits.
The total tax provision differs from the Federal statutory rate of 35 percent
for the reasons shown in the following table.
Year Ended December 31
2000 1999 1998
------------------------------------
Tax provision at Federal statutory rate 35.0% 35.0% 35.0%
Interest on securities exempt from Federal taxation (4.3) (5.2) (7.5)
State income taxes, net of Federal income tax benefit 6.9 8.9 8.1
ESOP dividends deductible as an expense for tax purposes (0.5) (0.7) (0.8)
Goodwill amortization 0.9 0.9 1.3
Merger related costs 0.8 -- 3.5
Other, net (0.5) (3.4) (0.8)
------------------------------------
Actual tax provision 38.3% 35.5% 38.8%
====================================
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As disclosed in the following table, deferred tax assets as of December 31,
2000, and 1999, totaled $16.7 million and $22.9 million, respectively. These
amounts are included within other assets on the balance sheet. The deferred tax
provision or benefit disclosed in the first table of this note is equal to the
sum of the changes in the tax effects of the temporary differences. The changes
in the tax effects for the principal temporary differences for the years ending
December 31, 2000 and 1999 are also disclosed in the following table.
TAX Tax
(in thousands) COMPONENTS EFFECT ACQUIRED Components Effect Components
2000 2000 COMPONENTS 1999 1999 1998
-------------------------------------------------------------------------------------
Deferred tax assets:
Allowance for credit losses $ 14,208 $ 1,515 $ 256 $ 12,437 $ (84) $ 12,521
State taxes 3,057 646 139 2,272 968 1,304
Loan fees 760 261 (10) 509 202 307
Depreciation 987 (56) (6) 1,049 410 639
Postretirement benefits 706 (39) -- 745 (35) 780
Other real estate owned 25 -- -- 25 (17) 42
Nonaccrual interest 289 (65) -- 354 2 352
Accretion on securities -- (77) -- 77 230 (153)
Accrued salary continuation plan 1,657 (163) -- 1,820 (84) 1,904
Change in control payments 1,021 (78) -- 1,099 (140) 1,239
Deferred compensation -- (155) -- 155 52 103
Gain on demutualization of
of insurance company -- 156 -- (156) (156) --
Accrual for BOLI 508 508 -- -- -- --
Other 473 (318) 461 330 (411) 741
-------------------------------------------------------------------------------------
23,691 2,135 840 20,716 937 19,779
-------------------------------------------------------------------------------------
Deferred tax liabilities:
Loan costs 1,754 248 1,506 244 1,262
Federal effect of state tax asset 1,282 120 58 1,104 (88) 1,192
Other 599 449 150 (1,400) 1,550
-------------------------------------------------------------------------------------
Total deferred tax liabilities 3,635 817 58 2,760 (1,244) 4,004
-------------------------------------------------------------------------------------
Net deferred tax asset
before unrealized gains and
losses on securities 20,056 1,318 782 17,956 2,181 15,775
Unrealized (gains) and losses
on securities (3,362) 223 4,897 (3,301)
-------------------------------------------------------------------------------------
Net deferred tax asset $ 16,694 $ 1,318 $ 1,005 $ 22,853 $ 2,181 $ 12,474
=====================================================================================
As mentioned in Note 1, the net unrealized gain or loss on securities that are
available-for-sale is included as a component of equity. This amount is reported
net of the related tax effect. The tax effect is a deferred tax asset if there
is a net unrealized loss and a deferred tax liability if there is a net
unrealized gain. However, because changes in the unrealized gains or losses are
not recognized either in net income or in taxable income, they do not represent
temporary differences. Consequently, the change in the tax effect of the net
unrealized gain or loss is not included as a component of deferred tax expense
or benefit, and there is no entry in the columns labeled "Tax Effect" in the
table above for the change.
The Company is permitted to recognize deferred tax assets only to the extent
that they are able to be used to reduce amounts that have been paid or will be
paid to tax authorities. This is reviewed each year by Management by comparing
the amount of the deferred tax assets with amounts paid in the past that might
be recovered by carryback provisions in the tax code and with anticipated
taxable income expected to be generated from operations in the future. If it
does not appear that the deferred tax assets are usable, a valuation allowance
is established to acknowledge their uncertain value. Management believes a
valuation allowance is not needed to reduce any deferred tax asset because there
is sufficient taxable income within the carryback periods to realize all
material amounts.
9. SHAREHOLDERS' EQUITY
The Company's stock option plans offer key employees and directors an
opportunity to purchase shares of the Company's common stock. The Company has
seven stock option plans.
The first of the plans is the Directors Stock Option Plan established in 1996.
Only non-qualified options may be granted under this plan. The second is the
Restricted Stock Option Plan for employees established in January, 1992. Either
incentive or non-qualified options may be granted under this plan. Under the
original provisions of these plans, stock acquired by the exercise of options
granted under the plans could not be sold for five years after the date of the
grant or for two years after the date options are exercised,
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whichever is later. In 1998, the Board of Directors of the Company eliminated
this provision.
The third and fourth plans were established in 1983 and 1986 for employees and
directors, respectively. All options approved under these plans have been
granted as non-qualified options, and the plans are active now only for the
exercise of options held by employees and directors. The remaining plans were
established by PCB and SBB and are active now only for the exercise of options
held by employees and directors.
All options outstanding in these plans were granted with an option price set at
100% of the market value of the Company's common stock on the date of the grant.
The grants for most of the employee options specify that they are exercisable in
cumulative 20% annual installments and will expire five years from the date of
grant. The Board has granted some options which are exercisable in cumulative
10% annual installments and expire ten years from the date of grant. The options
granted under the directors' plan are exercisable after six months.
The option plans permit employees and directors to pay the exercise price of
options they are exercising and the related tax liability with shares of Company
stock they already own. The owned shares are surrendered to the Company at
current market value. Shares with a current market value of $2,756,000,
$6,747,000, and $2,602,000 were surrendered in the years ended December 31,
2000, 1999, and 1998, respectively. These surrendered shares are netted against
the new shares issued for the exercise of stock options in the Consolidated
Statements of Changes in Shareholders' Equity.
The following table presents information relating to all of the stock option
plans as of December 31, 2000, 1999, and 1998 (adjusted for stock splits and
stock dividends).
Per Share
Options Price Ranges
--------- -----------------
2000
GRANTED 135,888 $25.16 TO $29.44
EXERCISED 279,270 $5.17 TO $26.00
CANCELLED AND EXPIRED 168,254 $6.05 TO $34.71
OUTSTANDING AT END OF YEAR 1,306,956 $5.17 TO $34.71
RANGE OF EXPIRATION DATES 1/1/01 TO 8/23/09
EXERCISABLE AT END OF YEAR 954,414 $5.17 TO $34.71
SHARES AVAILABLE FOR FUTURE GRANT 1,831,781
1999
Granted 578,906 $22.81 to $34.71
Exercised 734,414 $3.98 to $28.71
Cancelled and expired 4,733 $8.48 to $28.71
Outstanding at end of year 1,618,591 $5.17 to $34.71
Exercisable at end of year 797,593 $5.17 to $28.71
1998
Granted 124,476 $23.44 to $28.71
Exercised 1,019,502 $3.98 to $23.44
Cancelled and expired 38,909 $6.33 to $28.00
Outstanding at end of year 1,778,832 $3.98 to $28.71
Exercisable at end of year 1,215,782 $3.98 to $28.25
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10. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND FEDERAL FUNDS PURCHASED
The Company enters into certain transactions, the legal form of which is a sale
of securities under an agreement to repurchase at a later date at a set price.
The substance of these transactions is a secured borrowing by the Company. The
Company also purchased Federal funds from correspondent banks. The following
information is presented concerning these transactions:
(dollars in thousands) Repurchase Agreements Federal Funds Purchased
Year Ended December 31 Year Ended December 31
2000 1999 1998 2000 1999 1998
--------------------------------------- --------------------------------------
Weighted average interest
rate at year-end 5.71% 5.27% 3.75% 6.59% 5.50% 4.50%
Weighted average interest
rate for the year 5.61% 4.67% 4.44% 5.40% 4.97% 5.22%
Average outstanding
for the year $61,772 $29,214 $13,884 $14,425 $ 8,091 $ 9,236
Maximum outstanding
at any month-end
during the year $78,736 $61,085 $18,772 $47,200 $35,100 $16,400
Amount outstanding
at end of year $79,458 $45,407 $17,996 $26,200 $35,100 $ 9,800
Interest expense $ 3,468 $ 1,364 $ 616 $ 779 $ 402 $ 482
11. LONG-TERM DEBT AND OTHER BORROWINGS
As part of the Company's asset and liability management strategy, fixed rate
term advances are borrowed from the FHLB. As of December 31, 2000, total
outstanding balances to the FHLB were $103 million. The scheduled maturities of
the advances are $0.0 in 1 year or less, $40.4 million in 1 to 3 years, and
$62.6 million in more than 3 years.
The Company borrowed $20 million from another financial institution to partially
finance the purchase of the stock of Los Robles Bancorp. The terms of the loan
require quarterly payments of interest and principal with a maturity of June 30,
2001. $15 million was outstanding at December 31, 2000.
Also included in other borrowings at December 31, 2000, are $9.2 million of
Treasury Tax and Loan demand notes issued to the U.S. Treasury and miscellaneous
other borrowings.
During the course of 2000 and 1999, the Company borrowed funds for liquidity
purposes from the discount window at the Federal Reserve Bank.
12. OTHER OPERATING INCOME AND EXPENSE
Significant items included in amounts reported in the Consolidated Statements of
Income for the years ended December 31, 2000, 1999, and 1998 for other service
charges, commissions, and fees are listed in the table below. The refund
transfer fees are earned for the electronic transmission of tax refunds to
customers to facilitate earlier receipt of their refund.
(in thousands) December 31,
2000 1999 1998
-------------------------------------
Noninterest income
Merchant credit card processing $ 8,055 $ 5,925 $ 3,974
Trust fees $13,827 $13,132 $11,718
Refund transfer fees $ 7,291 $ 6,591 $ 4,821
Noninterest expense
Marketing $ 3,166 $ 3,046 $ 3,100
Consultants $ 7,469 $10,574 $ 7,978
Merchant credit card clearing fees $ 6,412 $ 4,396 $ 2,878
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The table above also discloses the largest items included in other operating
expense. Consultants include the Company's independent accountants, attorneys,
and other management consultants used for special projects.
13. EMPLOYEE BENEFIT PLANS
The Company's Employee Stock Ownership Plan ("ESOP") was initiated in January
1985. In 1999, PCB's ESOP was merged with that of the Company.
As of December 31, 2000, the ESOP held 1,559,000 shares at an average cost of
$8.76 per share.
The Company's profit-sharing plan, initiated in 1966, has two components. The
Salary Savings Plan component is authorized under Section 401(k) of the Internal
Revenue Code. An employee may defer up to 10% of pre-tax salary in the plan up
to a maximum dollar amount set each year by the Internal Revenue Service. The
Company matches 100% of the first 3% of the employee's compensation that the
employee elects to defer and 50% of the next 3%, but not more than 4.5% of the
employee's total compensation. In 2000, 1999, and 1998, the employer's matching
contributions were $1.7 million, $1.3 million and $1.1 million, respectively.
The other component is the Incentive & Investment Plan. It was established in
1966, and permits contributions by the Company to be invested in various mutual
funds chosen by the employees.
The Company's practice has been to make total contributions to the employee
benefit plans equal to the smaller of (1) 10% of pre-tax profits prior to this
employer contribution, or (2) the amount deductible in the Company's current
year tax return. Deductions for contributions to qualified plans are limited to
15% of eligible compensation. In each of the last three years, the deductible
amount was the limiting factor for the contribution. After providing for the
Company's contribution to the Retiree Health Plan discussed in Note 15 and the
matching contribution to the Salary Savings Plan, the remaining contribution may
be made either to the ESOP or to the Incentive & Investment Plan.
Total contributions by the Company to the above profit-sharing plans were
$2,788,000 in 2000, $2,879,000 in 1999, and $2,789,000 in 1998. Aside from the
employer's matching contribution to the Salary Saving Plan, the contributions
went to the ESOP in 2000, 1999 and 1998.
14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
GAAP requires companies to disclose the fair value of those financial
instruments for which it is practicable to estimate that value and the methods
and significant assumptions used to estimate those fair values. This must be
done irrespective of whether or not the instruments are recognized on the
balance sheets of the Company.
There are several factors which users of these financial statements should keep
in mind regarding the fair values disclosed in this note. First, there are
uncertainties inherent in the process of estimating the fair value of financial
instruments. Second, the Company must exclude from its estimate of the fair
value of deposit liabilities any consideration of its on-going customer
relationships which provide stable sources of investable funds.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash and Cash Equivalents
The face value of cash, Federal funds sold, and securities purchased under
agreements to resell are their fair value.
Securities and Money Market Instruments
For securities, bankers' acceptances and commercial paper, fair value equals
quoted market price, if available. If a quoted market price is not available,
fair value is estimated using quoted market prices for similar securities. As
explained in Note 1, securities classified as available-for-sale are carried at
fair value.
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Loans
The fair value of loans is estimated by discounting the future contractual cash
flows using the current rates at which similar loans would be made to borrowers
with similar credit ratings and for the same remaining maturities. These
contractual cash flows are adjusted to reflect estimates of uncollectible
amounts.
Deposit Liabilities
The fair value of demand deposits, money market accounts, and savings accounts
is the amount payable on demand as of December 31 of each year. The fair value
of fixed-maturity certificates of deposit is estimated using the rates currently
offered for deposits of similar remaining maturities.
Repurchase Agreements, Federal Funds Purchased, and Other Borrowings
For short-term instruments, the carrying amount is a reasonable estimate of
their fair value. For FHLB advances, the only component of debt not considered
short-term, the fair value is estimated using rates currently quoted by the FHLB
for advances of similar remaining maturities.
Standby Letters of Credit, and Financial Guarantees Written
The fair value of guarantees and letters of credit is based on fees currently
charged for similar agreements. The Company does not believe that its loan
commitments have a fair value within the context of this note because generally
fees have not been charged, the use of the commitment is at the option of the
potential borrower, and the commitments are being written at rates comparable to
current market rates.
The carrying amount and estimated fair values of the Company's financial
instruments as of December 31, 2000 and 1999, are as follows:
AS OF DECEMBER 31, 2000 As of December 31, 1999
CARRYING FAIR Carrying Fair
(in thousands) AMOUNT VALUE Amount Value
---------------------------------------------------------------------------
Financial assets:
Cash and due from banks $ 176,274 $ 176,274 $ 131,422 $ 131,422
Federal funds sold 19,500 19,500 9,640 9,640
Money market funds -- -- 2,555 2,555
Securities available-for-sale 669,631 669,631 555,306 554,699
Securities held-to-maturity 139,294 148,442 185,398 189,580
Net loans 2,481,979 2,440,099 2,059,579 2,016,800
Total financial assets $ 3,486,678 $ 3,453,946 $ 2,943,900 $ 2,904,696
Financial liabilities:
Deposits $ 3,102,819 $ 3,105,378 $ 2,621,457 $ 2,599,103
Repurchase agreements,
Federal funds purchased,
and other borrowings 223,678 227,449 179,308 178,147
Total financial liabilities $ 3,326,497 $ 3,332,827 $ 2,800,765 $ 2,777,250
Unrecognized financial
instruments:
Interest rate swap contracts $ -- $ (1,336) $ -- $ 321
Standby letters of credit $ -- $ 38,781 $ -- $ 20,811
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15. OTHER POSTRETIREMENT BENEFITS
Under the provisions of the Retiree Health Plan (the "Plan"), all eligible
retirees may obtain health insurance coverage through the Company. The cost of
this coverage is that amount which the Company pays under the basic coverage
plan provided for current employees. Based on a formula involving date of
retirement, age at retirement, and years of service prior to retirement, the
Plan provides that the Company will contribute a portion of the cost for the
retiree, varying from 60% to 100% at the time the employee retires, with the
stipulation that the cost of the portion paid by the Company shall not increase
by more than 5% per year. The Company recognizes the net present value of the
estimated future cost of providing health insurance benefits to retirees under
the Retiree Health Plan as those benefits are earned rather than when paid.
The Accumulated Postretirement Benefit Obligation
The commitment the Company has made to provide these benefits results in an
obligation that must be recognized in the financial statements. This obligation,
termed the accumulated postretirement benefit obligation ("APBO"), is the
actuarial net present value of the obligation for 1) fully eligible plan
participants' expected postretirement benefits and 2) the portion of the
expected postretirement benefit obligation earned to date by current employees.
This obligation must be re-measured each year because it changes with each of
the following factors: 1) the number of employees working for the Company; 2)
the average age of the employees working for the Company; 3) increases in
expected health care costs; and 4) prevailing interest rates. In addition,
because the obligation is measured on a net present value basis, the passage of
each year brings the eventual payment of benefits closer, and therefore causes
the obligation to increase. The following tables disclose the reconciliation of
the beginning and ending balances of the APBO; the reconciliation of beginning
and ending balances of the fair value of the plan assets; and the funding status
of the Plan as of December 31, 2000, 1999, and 1998.
(in thousands) Year Ended December 31
2000 1999 1998
-------------------------------------------
Benefit obligation, beginning of year $(4,584) $(4,170) $(3,666)
Service cost (257) (315) (274)
Interest cost (346) (270) (253)
Actuarial (losses) gains (209) 111 (28)
Benefits paid 70 60 51
-------------------------------------------
Benefit obligation, end of year (5,326) (4,584) (4,170)
-------------------------------------------
Fair value of Plan assets, beginning of year 6,731 4,486 4,081
Actual return on Plan assets (408) 2,305 265
Employer contribution -- -- 191
Benefits paid (70) (60) (51)
-------------------------------------------
Fair value of Plan assets, end of year 6,253 6,731 4,486
-------------------------------------------
Funded Status 928 2,147 316
Unrecognized net actuarial gain (1,624) (2,867) (771)
Unrecognized prior service cost -- 1 2
-------------------------------------------
Accrued benefit cost $ (696) $ (719) $ (453)
===========================================
Costs of $623,000 for December 31, 2000, and $623,000 for December 31, 1999, are
included within the category for accrued interest payable and other liabilities
in the consolidated balance sheets.
The Components of the Net Periodic Postretirement Benefit Cost
Each year the Company recognizes a portion of the change in the APBO. This
portion is called the net periodic postretirement benefit cost (the "NPPBC").
The NPPBC, included with the cost of other benefits in the Consolidated
Statements of Income, is made up of several components as shown in the next
table.
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(in thousands) Year Ended December 31
2000 1999 1998
-------------------------------
Service cost $ 257 $ 315 $ 274
Interest cost 346 270 253
Return on assets (465) (296) (279)
Amortization cost (160) (24) (34)
-------------------------------
Net periodic postretirement cost $ (22) $ 265 $ 214
===============================
The first component is service cost, which is the net present value of the
portion of the expected postretirement benefit obligation for active plan
participants attributed to service for the year. The second is interest cost,
which is the increase in the APBO that results from the passage of another year.
That is, because the benefit obligation for each employee is one year closer to
being paid, the net present value increases. The third component, return on
assets, is the income earned on any investments that have been set aside to fund
the benefits. This return is an offset to the first two components.
The fourth component, amortization cost, arises because significant estimates
and assumptions about interest rates, trends in health care costs, plan changes,
employee turnover, and earnings on assets are used in measuring the APBO each
year. Actual experience may differ from the estimates and assumptions may
change. Differences will result in what are termed experience gains and losses.
These may be increases or decreases in the APBO or in the value of plan assets.
The rates used and the amortization of these experience gains and losses are
discussed in the next section of this note. At the adoption of the Plan, the
Company fully recognized the net present value of the benefits earned by
employees for prior service. Had the Company not recognized this amount, a
portion of it would be included in the NPPBC as a fifth component.
The Use of Estimates and the Amortization of Experience Gains and Losses
The following table discloses the assumed rates that have been used for the
factors that may have a significant impact on the APBO.
December 31
2000 1999 1998
-------------------------------
Discount rate 7.61% 7.71% 6.60%
Expected return on plan assets 7.00% 7.00% 7.00%
Health care inflation rate 5.00% 5.00% 5.00%
The discount rate is used to compute the present value of the APBO. It is
selected each year by reference to the current rates of investment grade
corporate bonds. Higher discount rates result in a lower APBO at the end of the
year and the NPPBC to be recognized for the following year, while lower rates
raise both.
While the discount rate has fluctuated with market rates, the Company has
continued to use 7% as its estimate of the long-term rate of return on plan
assets. The APBO is a long-term liability of 30 years or more. The 7% rate is
the assumed average earning rate over an equally long investment horizon. If the
rate of return is greater than this estimate, the Company will have what is
termed an experience gain.
As noted above, the Retiree Health Plan provides for the Company's contribution
for insurance premiums to be limited to an annual increase of 5%. Should
insurance premiums increase at a higher rate, the retirees are required to
contribute a larger portion of the total premium cost. Therefore, 5% has been
set as the assumed cost trend rate for health care. Because of this limitation,
an increase in the actual cost of health care will have no impact on the APBO.
If costs rise at a lesser rate, the Company will have an experience gain.
Rather than recognizing the whole amount of the experience gains or losses in
the year after they arise, under GAAP they are recognized through amortization
over the average remaining service lives of the employees. Amortization over
time is used because many of these changes may be partially or fully reversed in
subsequent years as further changes in experience and/or assumptions occur. At
December 31, 2000, and December 31, 1999, the Company had unamortized or
unrecognized gains of $1,624,000 and $2,867,000, respectively. These amounts are
reported in the first table of this note.
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Funding of the Retiree Health Plan
Employers are allowed wide discretion as to whether and how they set aside funds
to meet the obligation they are recognizing. Under the provisions of the current
Internal Revenue Code, only a portion of this funding may be deducted by the
employer. The funded status of the plan is shown in the first table as the
amount by which the plan assets exceed the APBO.
The Company established a Voluntary Employees' Beneficiary Association ("VEBA")
to hold the assets that will be used to pay the benefits for participants of the
plan other than key executive officers. Most of the plan assets have been
invested in insurance policies on the lives of various employees of the Company.
The current funding policy of the Company is to contribute assets to the VEBA at
least sufficient to pay the costs of current medical premiums of retirees and
the costs of the life insurance premiums. Proceeds from the life insurance
policies payoffs will fund benefits and premiums in the future. As of December
31, 2000, the VEBA was overfunded by $1,651,000. The APBO related to the Key
Employee Retiree Health Plan of $724,000 is totally unfunded.
16. EARNINGS PER SHARE AND STOCK-BASED COMPENSATION
The following table presents a reconciliation of basic earnings per share and
diluted earnings per share. The denominator of the diluted earnings per share
ratio includes the effect of dilutive securities. The only securities
outstanding that are potentially dilutive are the stock options reported in Note
9.
Under the method of accounting for stock options implemented by the Company, no
compensation expense is recorded if stock options are granted to employees at an
exercise price equal to the market value of the stock at the time of the grant.
Basic Diluted
(amounts in thousands other than per share amounts) Earnings Earnings
Per Share Per Share
------------- -------------
FOR THE YEAR ENDED DECEMBER 31, 2000
NUMERATOR--NET INCOME $51,456 $51,456
DENOMINATOR--WEIGHTED AVERAGE SHARES OUTSTANDING 26,380 26,380
PLUS: NET SHARES ISSUED IN ASSUMED STOCK OPTIONS EXERCISES 229
DILUTED DENOMINATOR 26,609
EARNINGS PER SHARE $ 1.95 $ 1.93
For the Year Ended December 31, 1999
Numerator--net income $46,533 $46,533
Denominator--weighted average shares outstanding 26,103 26,103
Plus: net shares issued in assumed stock options exercises 449
Diluted denominator 26,552
Earnings per share $ 1.78 $ 1.75
For the Year Ended December 31, 1998
Numerator--net income $31,499 $31,499
Denominator--weighted average shares outstanding 25,516 25,516
Plus: net shares issued in assumed stock options exercises 646
Diluted denominator 26,162
Earnings per share $ 1.23 $ 1.20
Had the Company recognized compensation expense over the expected life of the
options based on their fair market value as discussed in Note 1, the Company's
pro forma salary expense, net income, and earnings per share for the years ended
December 31, 2000, 1999, and 1998 would have been as follows:
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(in thousands) Year Ended December 31
2000 1999 1998
----------------------------------------
Salary expense:
As reported $54,931 $46,416 $42,872
Pro forma $56,208 $47,789 $43,994
Net income:
As reported $51,456 $46,533 $31,499
Pro forma $50,716 $45,737 $30,849
Earnings per share:
As reported $ 1.93 $ 1.75 $ 1.20
Pro forma $ 1.91 $ 1.72 $ 1.18
Diluted average shares 26,609 26,552 26,162
17. REGULATORY CAPITAL REQUIREMENTS
The Company and its subsidiary banks are subject to various regulatory capital
requirements administered by the Federal banking agencies. Failure to meet
minimum capital requirements as specified by the regulatory framework for prompt
corrective action could cause the regulators to initiate certain mandatory or
discretionary actions that, if undertaken, could have a direct material effect
on the Company's financial statements.
The table below sets forth the actual capital amounts and ratios for the Company
as of December 31, 2000 and 1999. It also shows the minimum amounts and ratios
that it must maintain under the regulatory requirements to meet the standard of
adequately capitalized and the minimum amounts and ratios required to meet the
regulatory standards of "well capitalized".
For the Company, Tier I capital consists of common stock, surplus, and retained
earnings. Tier II capital includes the components of Tier I plus a portion of
the allowance for credit losses. Risk-weighted assets are computed by applying a
weighting factor from 0% to 100% to the carrying amount of the assets as
reported in the balance sheet and to a portion of off-balance sheet items such
as loan commitments and letters of credit. The definitions and weighting factors
are all contained in the regulations. However, the capital amounts and
classifications are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
(dollars in thousands) Pacific Capital Minimums for
Bancorp Capital Adequacy Minimums to be
Actual Purposes Well-Capitalized
------------------------ ----------------------- ------------------------
Amount Ratio Amount Ratio Amount Ratio
------------------------ ----------------------- ------------------------
AS OF DECEMBER 31, 2000
TOTAL TIER I & TIER II CAPITAL
(TO RISK WEIGHTED ASSETS) $ 292,592 10.5% $ 223,871 8.0% $ 279,838 10.0%
TIER I CAPITAL
(TO RISK WEIGHTED ASSETS) $ 257,610 9.2% $ 111,935 4.0% $ 167,903 6.0%
TIER I CAPITAL
(TO AVERAGE TANGIBLE ASSETS) $ 257,610 7.2% $ 143,956 4.0% $ 179,945 5.0%
RISK WEIGHTED ASSETS $2,798,382
AVERAGE TANGIBLE ASSETS $3,598,896
As of December 31, 1999
Total Tier I & Tier II Capital
(to Risk Weighted Assets) $ 271,527 11.9% $ 181,873 8.0% $ 227,341 10.0%
Tier I Capital
(to Risk Weighted Assets) $ 243,084 10.7% $ 90,936 4.0% $ 136,405 6.0%
Tier I Capital
(to Average Tangible Assets) $ 243,084 8.0% $ 121,369 4.0% $ 151,711 5.0%
Risk Weighted Assets $2,273,409
Average Tangible Assets $3,034,227
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As of December 31, 2000, the most recent notification from the banks' examiners
categorized each of the banks as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized, an
institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1
leverage ratios as set forth in the above table. The following table shows the
three capital ratios for each of the bank subsidiaries at December 31, 2000 and
for SBB&T and FNB at December 31, 1999. There are no conditions or events since
the notification that management believes have changed the banks' category.
Total Tier I and
Tier II Capital to Tier I Capital to Tier I Capital to
Risk Weighted Risk Weighted to Average
As of December 31 Assets Assets Tangible Assets
------------------ ----------------- -----------------
Santa Barbara Bank & Trust
2000 10.28% 9.06% 7.00%
1999 11.00% 9.75% 7.32%
First National Bank
2000 9.30% 10.55% 7.35%
1999 11.39% 10.40% 7.96%
Los Robles Bank
2000 11.42% 10.16% 7.95%
Bancorp is the parent company and sole owner of the banks. However, there are
legal limitations on the amount of dividends which may be paid by the banks to
Bancorp. The dividends from SBB&T needed by Bancorp to pay for the acquisitions
of FVB and CSB in 1997 exceeded the amount allowable without the prior approval
of the California Department of Financial Institutions ("CDFI"). As part of its
approval of the acquisitions, the CDFI approved the excess distributions. During
2000, 1999 and 1998, it also approved other dividends from SBB&T to Bancorp to
fund quarterly cash dividends to Bancorp shareholders, to provide part of the
funds to purchase LRB, and for other incidental purposes.
18. COMMITMENTS AND CONTINGENCIES
The Company leases several office locations and substantially all of the office
leases contain multiple five-year renewal options and provisions for increased
rentals, principally for property taxes and maintenance. As of December 31,
2000, the minimum rentals under non-cancelable leases for the next five years
and thereafter are shown in the following table.
(in thousands) Year Ended December 31 There-
2001 2002 2003 2004 2005 after Total
------- ------- ------- ------- ------- ------- -------
Non-cancellable
lease expense $ 6,043 $ 4,993 $ 4,597 $ 4,328 $ 3,725 $24,930 $48,616
Total net rentals for premises included in other operating expenses are $5.9
million in 2000, $5.1 million in 1999, and $4.0 million in 1998.
The Company leases space from a partnership in which a director has an interest.
In February 1999, the building was destroyed in a fire. In 2000, the Company
renegotiated a lease for this property, which included sharing the costs of
rebuilding and provided for adjustments to future rents to recover the funds
expended by the Company in construction. The terms of this lease were negotiated
with the assistance of an independent, outside appraiser and were approved by
the Company's Board of Directors.
In the ordinary course of business, the Company has extended credit to directors
and employees of the Company totaling $13.6 million at December 31, 2000 and
$8.9 million at December 31, 1999. Such loans are subject to approval by the
Loan Committee and ratification by the Board of Directors, exclusive of the
borrowing director.
In order to meet the financing needs of its customers in the normal course of
business, the Company is a party to financial instruments with "off-balance
sheet" risk. These financial instruments consist of commitments to extend
credit and standby letters of credit.
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Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. The Company
has not usually charged fees in connection with loan commitments. Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. The Company charges a fee for
these letters of credit.
The standby letters of credit involve, to varying degrees, exposure to credit
risk in excess of the amounts recognized in the consolidated balance sheets.
This risk arises from the possibility of the failure of the customer to perform
according to the terms of a contract that would cause a draw on the standby
letter of credit by a third party. To minimize the risk, the Company uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments. The decision as to whether collateral
should be required is based on the circumstances of each specific commitment or
conditional obligation. Because of these practices, Management does not
anticipate that any significant losses will arise from such draws.
Changes in market rates of interest for those few commitments and undisbursed
loans which have fixed rates of interest represent a possible cause of loss
because of the contractual requirement to lend money at a rate that is no longer
as great as the market rate at the time the loan is funded. To minimize this
risk, if rates are quoted in a commitment, they are generally stated in relation
to the Company's prime or base lending rate which varies with prevailing market
interest rates. Fixed-rate loan commitments are not usually made for more than
three months.
The maximum exposure to credit risk is represented by the contractual notional
amount of those instruments. As of December 31, 2000 and 1999, the contractual
notional amounts of these instruments are as follows:
(in thousands) December 31
2000 1999
-----------------------
Commitments to extend credit
Commercial $572,905 $396,350
Consumer $ 87,582 $ 79,502
Standby letters of credit $ 38,781 $ 20,811
Since many of the commitments are expected to expire without being drawn upon,
the amounts in the table do not necessarily represent future cash requirements.
With the exception of the RAL program mentioned in Note 3, the Company has
concentrated its lending activity primarily with customers in the market areas
served by the branches of its subsidiary banks. The merger has introduced some
geographical diversity as each market area now represents only a portion of the
whole Company. The business customers are in widely diversified industries, and
there is a large consumer component to the portfolio. The Company monitors
concentrations within four broad categories: industry, geography, product, and
collateral. One significant concentration in the loan portfolio is represented
by loans collateralized by real estate; the nature of this collateral, however,
is quite varied, namely 1-4 family residential, multifamily residential, and
commercial buildings of various kinds. As the economies along the central coast
continue to show vitality, the underlying value of real estate remains stable.
The Company has considered this concentration in evaluating the adequacy of the
allowance for credit loss.
The Company has a trust department that has fiduciary responsibility for the
assets that it holds on behalf of its trust customers. These assets are not
owned by the Company and accordingly are not reflected in the accompanying
consolidated balance sheets.
The Company is one of a number of financial institutions named as party
defendants in a patent infringement lawsuit filed by an unaffiliated financial
institution. The lawsuit generally relates to the Company's tax refund program.
The Company has retained outside legal counsel to represent its interest in this
matter. The Company does not believe that it has infringed any patents as
alleged in the lawsuit and intends to vigorously defend itself in this matter.
The amount of alleged damages are not specified in the papers received by the
Company. Therefore, Management cannot, based in part on its consultation with
legal counsel, estimate the amount of any possible loss at this time or project
the likelihood of an unfavorable outcome.
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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, the resolution of this litigation will not have a
material impact on the Company's financial position.
19. MERGERS AND ACQUISITIONS
On December 30, 1998, the Company issued 8,756,668 shares of common stock in
exchange for all of the outstanding stock of PCB, a holding company for FNB and
its affiliate SVNB.
The transaction was accounted for as a pooling-of-interest, and accordingly, the
accompanying consolidated financial statements for 1998 have been restated to
include the accounts of PCB for all periods presented. Total revenues and net
income for the separate companies for the periods preceding the acquisition were
as follows:
Year Ended
(in thousands) December 31
1998
-----------
Interest income plus noninterest income
Santa Barbara Bancorp $164,532
Former Pacific Capital 64,742
--------
Total $229,274
========
Net Income
Santa Barbara Bancorp $ 24,379
Former Pacific Capital 5,188
--------
Total $ 29,567
========
After the close of business on June 30, 2000, the Company acquired all the
outstanding stock of Los Robles Bancorp, parent company of LRB, for $32.5
million in cash. Immediately prior to the close, LRB had $159.3 million in
assets and $146.4 million in liabilities.
The acquisition was accounted for under purchase accounting, with assets and
liabilities recorded at their estimated fair value at the time of the
acquisition. The excess of the purchase price over the net assets was recorded
as goodwill. Goodwill amortized during the year ended December 31, 2000,
relating to this transaction totaled approximately $654,000. The Company issued
no stock in connection with this acquisition. The following table shows
estimated fair value of the assets and liabilities of the bank, the purchase
price paid, and the resulting goodwill.
(in thousands) FMV of FMV of
Assets Liabilities Purchase Goodwill
Acquired Assumed Price Recorded
-------- ----------- -------- --------
Los Robles Bank $159,300 $146,400 $32,500 $19,600
At the time of the acquisition, LRB became a subsidiary of the Company. Under
the provisions of purchase accounting, the results of operations of the acquired
entity are included in the financial statements of the acquirer only from the
date of the acquisition forward. The 2000 consolidated financial statements of
the Company include the assets and liabilities acquired in the transactions and
results of operations from July 1, 2000, for LRB.
The following table presents an unaudited pro forma combined summary of
operations of the Company and LRB for the year ended December 31, 2000, as if
the acquisition had been effective January 1, 1998.
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(unaudited) Year Ended December 31
(dollars in thousands) 2000 1999 1998
--------- --------- ---------
Interest income $ 296,392 $ 236,284 $ 215,081
Interest expense 111,434 75,530 76,306
--------- --------- ---------
Net interest income 184,958 160,754 138,775
Provision for credit losses 14,777 7,423 10,003
Noninterest income 51,338 44,897 41,205
Noninterest expense 135,219 122,550 116,661
--------- --------- ---------
Income before provision for income taxes 86,300 75,678 53,296
Provision for income taxes 32,747 26,905 20,825
--------- --------- ---------
Net income $ 53,553 $ 48,773 $ 32,471
========= ========= =========
Basic earnings per share $ 2.03 $ 1.87 $ 1.27
Weighted average shares assumed
to be outstanding 26,380 26,103 25,516
Diluted earnings per share $ 2.01 $ 1.84 $ 1.24
Weighted average shares assumed
to be outstanding 26,609 26,552 26,162
The information in the table above combines the historical results of the
Company and LRB after giving effect to the amortization of goodwill and
exclusion of an estimated amount of earnings from the consideration paid to the
shareholders of Los Robles Bancorp using the average rate received during the
year for Federal funds sold. No attempt has been made to eliminate the
duplicated administrative cost. There were no intercompany transactions which
needed to be eliminated. The figures included in the table for pro forma
combined diluted earnings per share are based on the pro forma combined net
income in the table and the actual average common shares and share equivalents.
Because the consideration paid to the shareholders of Los Robles Bancorp
consisted entirely of cash, the average shares and share equivalents outstanding
are identical to those reported in Note 16.
This unaudited combined pro forma summary of operations is intended for
informational purposes only and is not necessarily representative of the future
results of the Company or of the results of the Company that would have occurred
had the acquisitions actually been transacted on January 1, 2000.
The amortization of goodwill relating to purchase transactions that occurred
prior to 1998 amounted to approximately $1.4 million in the year ended December
31, 2000.
On July 31, 2000, the Company issued 1,735,131 shares of common stock in
exchange for all the outstanding stock of San Benito Bank. The transaction was
accounted for as a pooling-of-interest, and accordingly, the accompanying
consolidated financial statements have been restated to include the accounts of
San Benito Bank for all periods presented. Total revenues and net income for the
separate companies for the periods preceding the acquisition were as follows:
(in thousands) Year Ended December 31
2000 1999 1998
-------- -------- --------
Interest income plus noninterest income
Pacific Capital $328,309 $253,261 $231,860
San Benito 11,995 15,785 13,133
-------- -------- --------
Total $340,304 $269,046 $244,993
======== ======== ========
Net Income
Pacific Capital $ 47,612 $ 44,274 $ 29,567
San Benito 3,844 2,259 1,932
-------- -------- --------
Total $ 51,456 $ 46,533 $ 31,499
======== ======== ========
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20. SEGMENT REPORTING
While the Company's products and services are all of the nature of commercial
banking, the Company has eight reportable segments. There are eight specific
segments: Wholesale Lending, Retail Lending, Branch Activities, Fiduciary, Tax
Refund Programs, Los Robles Bank, and the Northern Region. The segment for Los
Robles Bank was added in 2000. The remaining activities of the Company are
reported in a segment titled "All Other".
Factors Used to Identify Reportable Segments
The Company first uses geography as a factor in distinguishing three operating
segments. The discrete market areas served by SBB&T, LRB, and FNB (including its
affiliates SVNB and SBB) distinguish them as units for which performance must be
viewed separately. The tax refund program serves customers throughout the United
States, and the lack of a defined market area for this program distinguishes it
from other banking activities.
SBB&T is further disaggregated into additional segments. The factors used for
this disaggregation relate to products and services resulting in segments for
Wholesale Lending, Retail Lending, Branch Activities (deposits), and Fiduciary
(trust services). This level of disaggregation for SBB&T reflects its specific
management structure in which loan and deposit products are handled by different
organizational units. In contrast to this, LRB and FNB and its affiliates have
organizational structures that generally place both loan and deposit products in
the individual branches.
Types and Services from Which Revenues are Derived
Wholesale Lending: Business units in this segment make loans to medium-sized
businesses and their owners. Loans are made for the purchase of business assets,
working capital lines, investment, the development and construction of
nonresidential or multi-family residential property. Letters of credit are also
offered to customers both to facilitate commercial transactions and as
performance bonds.
Retail Lending: Business units in this segment engage in small business lending
(including Small Business Administration guaranteed loans) and leasing, consumer
installment loans, home equity lines, and 1-4 family residential mortgages.
Branch Activities: The business of this segment is primarily centered on deposit
products, but also includes safe deposit box rentals, foreign exchange,
electronic fund transfers, and other ancillary services to businesses and
individuals.
Tax Refund Program: The loan products provided in this segment are described in
Note 3. The other product, refund transfers, consists of receipt of tax refunds
from the Internal Revenue Service on behalf of individual taxpayers and
authorizing the local issuance of checks to the taxpayers so that they do not
need a mailing address or to wait for the refund check to be mailed to them.
Fiduciary: This segment provides trust and investment services to its customers.
The Trust and Investment Services Division may act as both custodian and manager
of trust accounts as directed by the client. In addition to securities and other
liquid assets, the division manages real estate held in trust. The division also
sells third-party mutual funds and annuities to customers.
Northern Region: This segment derives its revenues from banking services
provided by FNB and its affiliates SVNB and SBB. These include the same type of
loan, deposit, and fiduciary products in the first three segments described
above. This segment also derives revenues from securities in FNB's securities
portfolios.
Los Robles Bank: This segment derives its revenues from the same type of loan
and deposit products described in the first three segments above.
All Other: This segment consists of other business lines and support units. The
administrative support units include the Company's executive administration,
data processing, marketing, credit administration, human resources, legal and
benefits, and finance and accounting. The primary revenues are from SBB&T's
securities portfolios.
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Charges and Credits for Funds and Income from the Investment Portfolios
As noted above, there is a significant difference between the organizational
structures of LRB and FNB and the organizational structure of SBB&T. The same
business units provide loans and deposits at LRB and FNB and separate business
units handle them at SBB&T. This means that as a segment, Los Robles Bank and
the Northern Region are self-contained from a funding standpoint. That is, the
one segment obtains its own funds from its depositors and lends its own funds to
its borrowers. In contrast with this, SBB&T has one primary segment which
provides the funds, Branch Activities, while the lending segments utilize the
funds. To give a fair picture of profitability at the segment level for the
SBB&T segments, it is therefore necessary to charge the lending segments for the
cost of the funds they use while crediting the Branch Activities segment for the
funds it provides.
The securities portfolios of each bank are used to provide liquidity to that
bank and to earn income from funds received from depositors that are in excess
of the amounts lent to borrowers. The interest rates applicable to securities
are lower than for loans because there is little or no credit risk. Foregoing
the higher rates earned by loans is, in a sense, a cost of maintaining the
necessary liquidity, and an opportunity cost for being unable to generate
sufficient loans to make full use of the available funds.
From the standpoint of measuring the performance of the Los Robles Bank segment
and the Northern Region segment, the loans and deposits of which are
organizationally integrated, it is most appropriate to include the income from
the LRB and FNB securities portfolios with the operating segments. Because the
Los Robles Bank and the Northern Region segments are self-contained from a
funding standpoint, within the segments as a whole, there are no credits or
charges for funds.
Because in the SBB&T segments, the uses of funds and the provision of funds are
in separate segments, there is no one operating unit to which it is appropriate
to charge the liquidity and opportunity costs related to the investment
portfolios. Instead, each segment that uses funds through lending or investing
is charged for its funds and the Branch Activities segment is credited for the
funds it provides.
Measure of Profit or Loss
In assessing the performance of each segment, the chief executive officer
reviews the segment's contribution before tax. Taxes are excluded because the
Company has permanent tax differences (see Note 8) which do not apply equally to
all segments. In addition, if segments were measured by their net-of-tax
contribution, they would be advantaged or disadvantaged by any enacted changes
in tax rates even though such changes are not reflective of the performance of a
segment.
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Specific Segment Disclosure
The following table presents information for each segment regarding assets,
profit or loss, and specific items of revenue and expense that are included in
that measure of segment profit or loss as reviewed by the chief executive
officer.
(in thousands) Branch Retail Wholesale Northern Los Robles All
Activities Lending Lending RAL Fiduciary Region Bank Other Total
- ----------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED
DECEMBER 31, 2000
REVENUES FROM
EXTERNAL CUSTOMERS $ 11,246 $ 66,521 $ 66,917 $ 26,258 $ 13,749 $ 102,632 $ 7,722 $ 51,390 $ 346,435
INTERSEGMENT
REVENUES 109,791 656 -- 2,198 3,920 -- -- 12,411 128,976
------------------------------------------------------------------------------------------------------------
TOTAL REVENUES $ 121,037 $ 67,177 $ 66,917 $ 28,456 $ 17,669 $ 102,632 $ 7,722 $ 63,801 $ 475,411
============================================================================================================
PROFIT (LOSS) $ 32,204 $ 12,796 $ 16,571 $ 16,692 $ 7,182 $ 23,375 $ 1,657 $ (20,965) $ 89,512
INTEREST INCOME 90 65,576 65,737 18,957 -- 93,055 7,069 46,563 297,047
INTEREST EXPENSE 62,867 662 6 -- 3,621 31,170 1,894 10,306 110,526
INTERNAL CHARGE
FOR FUNDS 859 42,793 41,205 3,255 -- -- -- 40,864 128,976
DEPRECIATION 1,418 210 116 208 135 1,532 128 2,666 6,413
TOTAL ASSETS 19,672 868,321 746,497 (43) 1,527 1,177,499 172,818 691,334 3,677,625
CAPITAL
EXPENDITURES -- -- -- -- -- 1,666 -- 20,250 21,916
(in thousands) Branch Retail Wholesale Northern All
Activities Lending Lending RAL Fiduciary Region Other Total
------------------------------------------------------------------------------------------------
Year Ended
December 31, 1999
Revenues from
external customers $ 9,254 $ 54,483 $ 54,295 $ 14,673 $ 13,201 $ 87,978 $ 41,444 $ 275,328
Intersegment revenues 75,656 216 -- 1,988 2,420 -- 14,137 94,417
------------------------------------------------------------------------------------------------
Total revenues $ 84,910 $ 54,699 $ 54,295 $ 16,661 $ 15,621 $ 87,978 $ 55,581 $ 369,745
================================================================================================
Profit (Loss) $ 20,761 $ 13,139 $ 18,765 $ 9,391 $ 6,538 $ 27,023 $ (17,232) $ 78,385
Interest income 73 53,307 53,403 8,081 -- 79,554 37,011 231,429
Interest expense 40,002 221 5 -- 2,121 24,574 5,553 72,474
Internal charge for funds 866 33,076 29,536 641 -- -- 30,298 94,417
Depreciation 1,432 143 93 87 131 1,821 2,152 5,859
Total assets 29,478 708,698 647,104 (487) 1,668 1,111,493 582,355 3,080,309
Capital expenditures -- -- -- -- -- 2,535 6,914 9,449
Year Ended
December 31, 1998
Revenues from
external customers $ 10,813 $ 43,514 $ 46,899 $ 11,638 $ 9,545 $ 79,979 $ 48,842 $ 251,230
Intersegment revenues 73,384 54 -- 991 2,477 -- 11,107 88,013
------------------------------------------------------------------------------------------------
Total revenues $ 84,197 $ 43,568 $ 46,899 $ 12,629 $ 12,022 $ 79,979 $ 59,949 $ 339,243
================================================================================================
Profit (Loss) $ 15,855 $ 9,262 $ 16,885 $ 4,521 $ 5,563 $ 24,089 $ (18,469) $ 57,706
Interest income 24 42,156 45,273 6,818 -- 72,578 44,302 211,151
Interest expense 42,453 58 4 -- 2,247 24,739 2,758 72,259
Internal charge for funds 725 25,841 23,936 625 -- -- 36,886 88,013
Depreciation 1,982 236 142 71 213 2,071 1,634 6,349
Total assets 12,532 530,481 520,614 (324) 3,104 1,015,955 742,984 2,825,346
Capital expenditures -- -- -- -- -- 1,172 6,093 7,265
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The following table reconciles total revenues and profit for the segments to
total revenues and pre-tax income, respectively, in the consolidated financial
statements.
(in thousands) Year Ended December 31
2000 1999 1998
--------- --------- ---------
Total revenues for reportable segments $ 475,411 $ 369,745 $ 339,243
Elimination of intersegment revenues (128,976) (94,417) (88,013)
Elimination of taxable equivalent adjustment (6,131) (6,282) (6,237)
---------------------------------
Total consolidated revenues $ 340,304 $ 269,046 $ 244,993
=================================
Total profit or loss for reportable segments $ 89,512 $ 78,385 $ 57,706
Elimination of taxable equivalent adjustment (6,131) (6,282) (6,237)
---------------------------------
Income before income taxes $ 83,381 $ 72,103 $ 51,469
=================================
For purposes of performance measurement and therefore for the segment disclosure
above, income from tax-exempt securities, loans, and leases is reported on a
fully taxable equivalent basis. Under this method of disclosure, the income
disclosed is increased to that amount which, if taxed, would result in the
amount included in the financial statements.
With respect to the disclosure of total assets for the individual segments,
fixed assets used by the Los Robles Bank and Northern Region segments are
included in their asset totals. Fixed assets used by the other segments are all
recorded as assets of the All Other segment. Depreciation expense of these
assets is charged to the segment that uses them.
The Company has no operations in foreign countries to require disclosure by
geographical area. The Company has no single customer generating 10% or more of
total revenues.
For the Company, the process of disaggregation is somewhat arbitrary. Many of
the Company's customers do business with more than one segment. In these cases,
the Company may use relationship pricing, whereby customers may be given a
favorable price on one product because the other products they use are very
profitable for the Company. To the extent that these products are in different
segments as defined above, one segment may be sacrificing profitability to
another for the sake of the overall customer relationship.
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21. PACIFIC CAPITAL BANCORP
The condensed financial statements of the Bancorp are presented on the following
two pages.
PACIFIC CAPITAL BANCORP
(PARENT COMPANY ONLY)
BALANCE SHEETS
(IN THOUSANDS)
December 31
2000 1999
---------------------------
ASSETS
Cash $ 678 $ 931
Investment in and advances to subsidiaries 276,544 224,230
Loans, net 270 394
Premises and equipment, net 6,812 4,150
Goodwill 18,968 --
Other assets 19,163 12,041
---------------------------
Total assets $ 322,435 $ 241,746
===========================
LIABILITIES
Dividends payable $ 5,826 $ 4,420
Bank Debt 15,000 --
Other liabilities 6,440 2,753
---------------------------
Total liabilities 27,266 7,173
===========================
EQUITY
Common stock 8,828 8,186
Surplus 115,664 99,283
Unrealized gain on securities available-for-sale 4,472 (6,447)
Retained earnings 166,205 133,551
---------------------------
Total shareholders' equity 295,169 234,573
---------------------------
Total liabilities and shareholders' equity $ 322,435 $ 241,746
===========================
PACIFIC CAPITAL BANCORP
(PARENT COMPANY ONLY)
INCOME STATEMENTS
(IN THOUSANDS)
Year Ended December 31
2000 1999 1998
--------------------------------------------
Equity in earnings of subsidiaries:
Undistributed $ 10,074 $ 28,812 $ 18,914
Dividends 44,000 17,131 18,575
Interest income 28 123 181
Other income 108 87 601
Other operating expense (4,535) (4,715) (13,006)
Income tax benefit 1,781 2,836 4,302
--------------------------------------------
Net income $ 51,456 $ 44,274 $ 29,567
============================================
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PACIFIC CAPITAL BANCORP
(PARENT COMPANY ONLY)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Year Ended December 31
2000 1999 1998
--------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS:
Cash flows from operating activities:
Net income $ 51,456 $ 44,274 $ 29,567
Adjustments to reconcile net income to net
cash used in operations:
Equity in undistributed net income
of subsidiaries (54,074) (45,942) (37,489)
Amortization of goodwill 654 -- --
Depreciation expense 977 -- --
Increase in other assets (7,122) 551 (7,739)
Increase in other liabilities 3,687 (1,883) 8,611
--------------------------------------------
Net cash used in operating activities (4,422) (3,000) (7,050)
--------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in loans 124 2,788 (2,238)
Capital expenditures (3,757) (643) --
Purchase of capital stock of Los Robles Bank (32,500) -- --
Distributed earnings of subsidiaries 44,000 17,131 18,575
--------------------------------------------
Net cash provided by investing activities 7,867 19,276 16,337
--------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short term borrowing 20,000 -- --
Payments on short term borrowing (5,000) -- --
Proceeds from issuance of common stock 1,395 2,129 8,094
Payments to retire common stock -- (2,055) (3,792)
Dividends paid (20,093) (17,595) (12,907)
--------------------------------------------
Net cash used in financing activities (3,698) (17,521) (8,605)
--------------------------------------------
Net increase (decrease) in cash and cash equivalents (253) (1,245) 682
Cash and cash equivalents at beginning of period 931 2,176 1,494
--------------------------------------------
Cash and cash equivalents at end of period $ 678 $ 931 $ 2,176
============================================
Supplemental disclosures: none
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QUARTERLY FINANCIAL DATA (UNAUDITED)
2000 QUARTERS 1999 Quarters
---------------------------------------------- ----------------------------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
------- ------- ------- ------- ------- ------- ------- -------
Interest income $72,055 $70,032 $67,437 $81,392 $57,422 $55,131 $53,096 $60,005
Interest expense 28,147 27,702 27,702 26,975 19,566 18,285 17,278 17,346
Net interest income 43,908 42,330 39,735 54,417 37,856 36,846 35,818 42,659
Provision for
credit losses 1,295 5,219 2,230 5,696 1,404 1,016 829 3,794
Noninterest income 11,137 11,044 10,997 16,210 10,155 9,149 9,550 14,538
Noninterest expense 35,433 36,108 29,339 30,977 29,899 29,196 29,156 29,142
Income before
income taxes 18,317 12,047 19,163 33,954 16,708 15,783 15,383 24,261
Income taxes 5,994 5,284 7,108 13,539 5,352 5,246 5,769 9,203
Net income $12,323 $ 6,763 $12,055 $20,415 $11,356 $10,537 $ 9,614 $15,058
Net earnings per share:
Basic $ 0.47 $ 0.25 $ 0.45 $ 0.78 $ 0.43 $ 0.40 $ 0.37 $ 0.58
Diluted $ 0.46 $ 0.25 $ 0.45 $ 0.77 $ 0.42 $ 0.40 $ 0.36 $ 0.57
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated herein by reference to the
sections titled "The Board of Directors" and "Executive Officers" in the
Company's definitive Proxy Statement for the annual meeting to be held April 24,
2001 ("Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference to the
section titled "Executive Compensation" in the Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated herein by reference to the
section titled "Beneficial Ownership Chart" in the Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference to the
section titled "Other Information" in the Company's Proxy Statement.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K
(a)1. FINANCIAL STATEMENTS
The listing of financial statements required by this item is set forth
in the index for Item 8 of this report.
(a)2. FINANCIAL STATEMENTS SCHEDULES
The listing of supplementary financial statement schedules required by
this item is set forth in the index for Item 8 of this report.
(a)3. EXHIBITS
The listing of exhibits required by this item is set forth in the
Exhibit Index beginning on page 83 of this report. Each management
contract or compensatory plan or arrangement required to be filed as an
exhibit to this report is listed under Item 10.1 "Compensation Plans and
Agreements," in the Exhibit Index.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the fourth quarter of the
fiscal year ended December 31, 2000.
(c) EXHIBITS
See exhibits listed in "Exhibit Index" on page 83 of this report.
(d) FINANCIAL STATEMENT SCHEDULES
There are no financial statement schedules required by Regulation S-X
that have been excluded from the annual report to shareholders.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed by the
undersigned, thereunto duly authorized.
Pacific Capital Bancorp
By /s/ William S. Thomas. Jr February 28, 2001
----------------------------------- Date
William S. Thomas, Jr.
President
Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company and in
the capacities and on the dates indicated.
/s/ David W. Spainhour February 28, 2001 /s/ William S. Thomas, Jr. February 28, 2001
- -------------------------- ------------------- ----------------------------- -----------------
David W. Spainhour Date William S. Thomas, Jr. Date
Chairman of the Board President
Chief Executive Officer
/s/ Donald M. Anderson February 28, 2001 /s/ Donald Lafler February 28, 2001
- -------------------------- ------------------- ----------------------------- -----------------
Donald M. Anderson Date Donald Lafler Date
Vice Chairman Executive Vice President
Director Chief Financial Officer
/s/ Edward E. Birch February 28, 2001 /s/ Richard M. Davis February 28, 2001
- -------------------------- ------------------- ----------------------------- -----------------
Edward E. Birch Date Richard M. Davis Date
Director Director
/s/ Dale E. Hanst February 28, 2001 /s/ Richard A. Nightingale February 28, 2001
- -------------------------- ------------------- ----------------------------- -----------------
Dale E. Hanst Date Richard A. Nightingale Date
Director Director
/s/ D. Vernon Horton February 28, 2001 /s/ Clayton C. Larson February 28, 2001
- -------------------------- ------------------- ----------------------------- -----------------
D. Vernon Horton Date Clayton C. Larson Date
Vice Chairman Vice Chairman
/s/ William H. Pope February 28, 2001 /s/ Roger C. Knopf February 28, 2001
- -------------------------- ------------------- ----------------------------- -----------------
William H. Pope Date Roger C. Knopf Date
Director Director
/s/ Kathy J. Odell February 28, 2001
- -------------------------- -------------------
Kathy J. Odell Date
Director
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EXHIBIT INDEX TO PACIFIC CAPITAL BANCORP FORM 10-K FOR THE
FISCAL YEAR ENDED DECEMBER 31, 2000
Exhibit
Number Description *
- ------- -------------
2. Agreement and Plan of Reorganization by and between Santa Barbara
Bancorp and Pacific Capital Bancorp dated July 20, 1998.(1)
3. Articles of incorporation and bylaws:
3.1 Certificate of Restatement of Articles of
Incorporation of Pacific Capital Bancorp dated
January 27, 1999. (2)
3.2 Amended and Restated Bylaws of Pacific Capital
Bancorp effective April 25, 2000. (8)
10. Material contracts
10.1 Compensation Plans and Agreements:
10.1.1 Pacific Capital Bancorp Amended and
Restated Restricted Stock Plan as
amended effective April 25, 2000. (4)
10.1.1.1 Pacific Capital Bancorp Restricted
Stock Option Agreement (Incentive
Stock Option). (3)
10.1.1.2 Pacific Capital Bancorp Restricted
Stock Option Agreement (Nonstatutory
Stock Option - 5 Year). (3)
10.1.1.3 Pacific Capital Bancorp Restricted
Stock Option Agreement (Nonstatutory
Stock Option - 10 Year). (3)
10.1.1.4 Pacific Capital Bancorp Restricted
Stock Option Agreement (Incentive
Reload Option). (3)
10.1.1.5 Pacific Capital Bancorp Restricted
Stock Option Agreement (Non-statutory
Reload Option). (3)
10.1.2 Pacific Capital Bancorp Directors Stock Option Plan
(incorporated by reference to Exhibit 4.2 to
Post-Effective Amendment No. One to Santa Barbara
Bancorp's Registration Statement on Form S-8, filed
on June 13, 1995, Registration No. 33-48724).
10.1.3 Pacific Capital Bancorp Incentive & Investment and
Salary Savings Plan, as amended and restated
effective January 1, 1998. (7)
10.1.4 Pacific Capital Bancorp Employee Stock Ownership
Plan and Trust, as amended and restated effective
January 1, 1998. (7)
10.1.5 Santa Barbara Bank & Trust Key Employee Retiree
Health Plan incorporated by reference to Exhibit
10.1.8 to Santa Barbara Bancorp's Annual Report on
Form 10-K (File No. 0-11113) for fiscal year ended
December 31, 1993).
10.1.5.1 First Amendment to Santa Barbara Bank
& Trust Key Employee Retiree Health
Plan. (5)
10.1.5.2 Second Amendment to Santa Barbara Bank
& Trust Key Employee Retiree Health
Plan. (5)
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84
10.1.6 Santa Barbara Bank & Trust Retiree Health Plan
(Non-Key Employees) (incorporated by reference to
Exhibit 10.1.9 to Santa Barbara Bancorp's Annual
Report on Form 10-K (File No. 0-11113) for the
fiscal year ended December 31, 1993).
10.1.6.1 First Amendment to Santa Barbara Bank
& Trust Retiree Health Plan (Non-Key
Employees). (5)
10.1.6.2 Second Amendment to Santa Barbara Bank
& Trust Retiree Health Plan (Non-Key
Employees). (5)
10.1.7 Trust Agreement of Santa Barbara Bank & Trust
Voluntary Beneficiary Association. (5)
10.1.7.1 First Amendment to Trust Agreement of
Santa Barbara Bank & Trust Voluntary
Beneficiary Association. (4)
10.1.8 Pacific Capital Bancorp, Amended and Restated, 1996
Directors Stock Plan, as amended April 25,2000. (10)
10.1.8.1 Pacific Capital Bancorp 1996 Directors
Stock Option Agreement. (3)
10.1.8.2 Pacific Capital Bancorp 1996 Directors
Stock Option Agreement (Reload
Option). (3)
10.1.9 Pacific Capital Bancorp Directors' Stock Option Plan
and Form of Stock Option Agreement (incorporated by
reference to Exhibit 10.25 to Pacific Capital
Bancorp's Annual Report on Form 10-K (File No.
0-13528) for the fiscal year ended December 31,
1991).
10.1.10 Pacific Capital Bancorp 1984 Stock Option Plan and
Forms of Agreements as amended to date (incorporated
by reference to Exhibit 10.27 to Pacific Capital
Bancorp's Annual Report on Form 10-K (File No.
0-13528) for the fiscal year ended December 31,
1991).
10.1.11 Pacific Capital Bancorp 1994 Stock Option Plan, as
amended, and Forms of Incentive and Non-Qualified
Stock Option Agreements (incorporated by reference
to Exhibit 4 to Pacific Capital Bancorp's Amendment
No. 1 to Registration Statement on Form S-8
(Registration No. 33-83848) filed on November 15,
1994).
10.1.12 Pacific Capital Bancorp Management Retention Plan as
amended through January 11, 1999. (7)
10.1.13 Pacific Capital Bancorp Deferred Compensation Plan
dated December 15, 1999. (11)
10.1.13.1 Trust Agreement under Pacific Capital
Bancorp Deferred Compensation Plan
dated December 15, 1999. (11)
10.2 Consolidated Agreement dated December 17, 1991 by
and between First National Bank of Central
California and Unisys with Equipment Sale Agreement,
Software License Agreement and Product License
Agreement by and between First National Bank of
Central California and Information Technology, Inc.
(6)
13. Portions of Annual Report to Security Holders (Incorporated by
reference to the Annual Report/Form 10-K)
21. Subsidiaries of the registrant (Incorporated by reference to the
Annual Report/Form 10-K, Footnote 1)
23. Consents of Experts and Counsel
23.1 Consent of Arthur Andersen LLP with respect to
financial statements of the Registrant
23.2 Consent of Deloitte & Touche LLP with respect to
financial statements of San Benito Bank - not
presented separately
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Shareholders may obtain a copy of any exhibit by writing to:
Carol Kelleher, Corporate Services Administrator
Pacific Capital Bancorp
P.O. Box 1119
Santa Barbara, CA 93102
* Effective December 30, 1998, Santa Barbara Bancorp and Pacific
Capital Bancorp merged and contemporaneously with effectiveness of the merger,
Santa Barbara Bancorp, the surviving entity, changed its corporate name to
Pacific Capital Bancorp. Documents identified as filed by Santa Barbara Bancorp
prior to December 30, 1998 were filed by Santa Barbara Bancorp. Documents
identified as filed by Pacific Capital Bancorp prior to December 30, 1998 were
filed by Pacific Capital Bancorp as it existed prior to the merger.
The Exhibits listed below are incorporated by reference to the specified filing.
(1) Filed as Appendix A to Proxy Statement filed by Santa Barbara
Bancorp in Amendment No. 1 to Registration Statement on Form S-4
(registration No. 333-64093) filed November 4, 1998.
(2) Filed as Exhibits 4.1 and 4.2 to the Registration Statement on
Form S-8 of Pacific Capital Bancorp (Registration No. 333-74831)
filed March 18, 1999.
(3) Filed as Exhibits 10.1.1 through 10.1.1.5 and 10.1.10 through
10.1.10.2 to Annual Report on Form 10-K of Santa Barbara Bancorp
(File No.0-11113) for fiscal year ended December 31, 1996.
(4) Filed as an Exhibit to Annual Report on Form 10-K of Santa Barbara
Bancorp (File No.0-11113) for fiscal year ended December 31, 1995.
(5) Filed as an Exhibit to Annual Report on Form 10-K of Santa Barbara
Bancorp (File No.0-11113) for the fiscal year ended December 31,
1997.
(6) Filed as Exhibits 10.23 through 10.34 to the Annual Report of
Pacific Capital Bancorp on Form 10-K (File No. 0-13528) for the
fiscal year ended December 31, 1991.
(7) Filed as an Exhibit to the Annual Report on Form 10-K of Pacific
Capital Bancorp (File No. 0-11113) for the fiscal year ended
December 31, 1998.
(8) Filed as Exhibit 3.2 to the Quarterly Report on Form 10-Q of
Pacific Capital Bancorp (File No. 0-11113) for the fiscal quarter
ended June 30, 2000.
(9) Filed as Exhibit 10.1.1 to the Quarterly Report on Form 10-Q of
Pacific Capital Bancorp (File No. 0-11113) for the fiscal quarter
ended June 30, 2000.
(10) Filed as Exhibit 10.1.9 to the Quarterly Report on Form 10-Q of
Pacific Capital Bancorp (File No. 0-11113) for the fiscal quarter
ended June 30, 2000.
(11) Filed as Exhibits 10.1.13 and 10.1.13.1 to the Annual Report on
Form 10-K of Pacific Capital Bancorp (File No. 0-01113) for the
fiscal quarter ended December 31, 2000.
85