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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, 2001
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.)
1021 ANACAPA ST. 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
COMMON STOCK, NO PAR VALUE
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 21, 2002, based on the sales prices reported to the
registrant on that date of $29.45 per share:
Common Stock - $731,719,972*
*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 21, 2002, there were 26,182,630 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 23, 2002 are incorporated by
reference into Part III.
INDEX PAGE
PART I
Item 1. Business
(a) General Development of the Business 3
(b) Financial Information about Industry Segments 3
(c) Narrative Description of Business 3
(d) Financial Information about Foreign and Domestic
Operations and Export Sales 4
Item 2. Properties 4
Item 3. Legal Proceedings 4
Item 4. Submission of Matters to a Vote of Security Holders 4
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters 5
(a) Market Information 5
(b) Holders 5
(c) Dividends 5
Item 6. Selected Financial Data 6
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 6
Item 7(a) Quantitative and Qualitative Disclosures About Market Risk 50
Item 8. Financial Statements and Supplementary Data 50
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures 99
PART III
Item 10. Directors and Executive Officers of the Registrant 100
Item 11. Executive Compensation 100
Item 12. Security Ownership of Certain Beneficial Owners and Management 100
Item 13. Certain Relationships and Related Transactions 100
PART IV
Item 14. Exhibits, Financial Statements, and Reports on Form 8-K 101
SIGNATURES 102
EXHIBIT INDEX 103
2
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 29 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. The Company
acquired Los Robles Bank ("LRB") at the end of June, 2000, when the Company
purchased all of the outstanding shares of Los Robles Bancorp, parent of LRB.
LRB was merged with SBB&T in the second quarter of 2001. LRB had three offices.
Two of these became offices of SBB&T and the third was closed because of its
close proximity to one of the existing offices of SBB&T.
FNB has 12 banking offices in Monterey, Santa Cruz, Santa Clara, and San Benito
counties. The offices in Santa Clara County 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. The offices in San Benito County use the name
San Benito Bank ("SBB"). SBB was a separate bank prior to its merger with FNB at
the end of July, 2000. FNB also provides trust and investment services to its
customers.
A third subsidiary, Pacific Capital Commercial Mortgage Company ("PCCM"), was
formed in 1988. This subsidiary, which was primarily involved in mortgage
brokering services and the servicing of brokered loans ceased business and
became inactive in 2001.
There is a fourth subsidiary, Pacific Capital Services Corporation, which is
also inactive.
During the fourth quarter of 2001, the Company applied for and received approval
for a single national banking charter. We anticipate that SBB&T and FNB will be
merged into this single charter at the end of the first quarter of 2002. The
Company will continue to use the brand names of Santa Barbara Bank & Trust,
First National Bank of Central California, South Valley National Bank, and San
Benito Bank in their respective market areas.
(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. As of December 31, 2001, as described above,
it had two bank subsidiaries and two inactive non-bank subsidiaries. Bancorp
provides support services to its subsidiary banks. These services include
executive management, personnel and benefits, risk management, data processing,
strategic planning, legal, accounting and treasury.
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The banks offer a full range of commercial banking services to households,
professionals, and smallto medium-sized businesses. These include various
commercial, real estate and consumer loan, leasing and deposit products. The
banks offer other services such as electronic fund transfers and safe deposit
boxes to both individuals and businesses. In addition, services such as lockbox
payment servicing, foreign currency exchange, letters of credit, and cash
management are offered to business customers. The banks also offer trust and
investment services to individuals and businesses. These include acting as
trustee or agent for living and testamentary trusts, charitable remainder
trusts, employee benefit trusts, and profit sharing plans, as well as executor
or probate agent for estates. Investment management and advisory services are
also provided.
COMPETITION: For most of its banking products, the Company faces competition in
its market area from branches of most of the major California money center
banks, some of the statewide savings and loan associations, and other local
community banks and savings and loans. For some of its products, the Company
faces competition from other non-bank financial service companies, especially
securities firms.
EMPLOYEES: The Company currently employs the equivalent of
approximately 1,200 full time 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 offices in leased premises at 1021 Anacapa
St., Santa Barbara, California. The Trust & Investment Services Division is also
located in this building. The Company leases other premises in the Santa Barbara
area for Information Technology, Operations Support and other administrative
functions.
Of the 41 branch banking offices, all or a portion of 27 are leased. The Company
owns the building used by the Residential Real Estate, Business Services, and
International Banking Units.
ITEM 3. LEGAL PROCEEDINGS
The Company was one of a number of financial institutions named as party
defendants in a patent infringement lawsuit filed in February 2000 by an
unaffiliated financial institution. Generally, the lawsuit relates to the
Company's tax refund program. The plaintiff contends that the program infringes
on certain patents which it holds. The Company retained outside patent
litigation counsel to vigorously defend it in this case. In November 2001, the
plaintiff and the Company tentatively agreed to a settlement of the case. A
final settlement agreement has been prepared and the Company expects that it
will be fully executed in early 2002. The Company believes that the settlement
is a reasonable compromise between the parties. The settlement provides for the
Company to pay a license fee to the plaintiff beginning in 2002 for transactions
processed in 2002 and continuing until the expiration of the patents at
approximately the end of 2007.
The Company is involved in various other litigation of a routine nature which is
being handled and defended in the ordinary course of the Company's business. In
the opinion of Management, based in part on consultation with legal counsel, the
resolution of these litigation matters will not have a material impact on the
Company's financial position.
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.
4
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
(a) MARKET INFORMATION
The Company's common stock trades on The Nasdaq Stock Market under the symbol
SABB. 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:
2001 QUARTERS 2000 QUARTERS
--------------------------------- ---------------------------------
4TH 3RD 2ND 1ST 4TH 3RD 2ND 1ST
Range of stock prices:
High $29.25 $30.15 $30.45 $30.38 $28.63 $28.50 $29.29 $30.69
Low $26.15 $27.57 $25.44 $26.13 $24.13 $25.06 $23.44 $23.75
(b) HOLDERS
There were approximately 10,000 shareholders as of December 31, 2001. 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.
Approximately 21% of the Company's shares are owned by institutional investors
based on filings with the SEC by these investors.
(c) DIVIDENDS
The Company declares dividends four times a year. The following table presents
cash dividends declared per share for the last two years:
2001 QUARTERS 2000 QUARTERS
--------------------------------- ---------------------------------
4TH 3RD 2ND 1ST 4TH 3RD 2ND 1ST
Cash dividends
declared $0.22 $0.22 $0.22 $ - $0.22 $0.22 $0.20 $0.20
Cash dividends
paid $0.22 $0.22 $0.22 $0.22 $0.22 $0.20 $0.20 $0.18
The Company declares cash dividends to its shareholders each quarter. Its policy
is to declare and pay dividends of between 35% and 40% of its net income to
shareholders. In 2001, the Company paid dividends of $0.22 per quarter. However,
it changed the timing of the declaration of the dividend from the month prior to
the quarter end to the first month of each quarter. In December 2000, the
Company declared a dividend of $0.22 per share payable in February 2001. In
April 2001 the Company declared a dividend of $0.22 per share payable in May
2001. In prior years, the dividend payable in May would have been declared in
March. The number of dividends paid and the amount for the dividends paid to
shareholders remains the same, but since only three quarterly dividends were
declared in 2001, there is a smaller amount of dividends reported as declared in
the Consolidated Statements of Shareholders' Equity for 2001 than for the
preceding years.
The Company funds the dividends paid to shareholders primarily from dividends
received from the subsidiary banks.
5
ITEM 6. SELECTED FINANCIAL DATA
The following table compares selected financial data for 2001 with the same data
for the four prior years. The Company's Consolidated Financial Statements and
the accompanying notes presented in Item 8 explain reasons for the year-to-year
differences.
(AMOUNTS IN THOUSANDS EXCEPT INCREASE
PER SHARE AMOUNTS) 2001 (DECREASE) 2000 1999 1998 1997
RESULTS OF OPERATIONS:
Interest income $291,108 $ 1,144 $289,964 $225,127 $205,537 $178,175
Interest expense 97,226 (13,300) 110,526 72,475 72,259 63,726
Net interest income 193,882 14,444 179,438 152,652 133,278 114,449
Provision for credit losses 26,671 12,231 14,440 7,043 9,313 8,700
Noninterest revenue 65,726 15,386 50,340 43,919 39,456 31,375
Operating expense:
Staff expense 69,788 2,584 67,204 55,357 52,380 45,707
Other operating expense 73,362 8,609 64,753 62,068 59,572 42,262
Income before income taxes 89,787 6,406 83,381 72,103 51,469 49,155
Provision for income taxes 33,676 1,751 31,925 25,570 19,970 17,118
NET INCOME $56,111 $4,655 $51,456 $46,533 $31,499 $32,037
DILUTED PER SHARE DATA: (1)
Average shares outstanding 26,639 31 26,609 26,552 26,163 25,878
NET INCOME $2.11 $0.18 $1.93 $1.75 $1.20 $1.24
Cash dividends declared $0.66 ($0.18) $0.84 $0.72 $0.66 $0.49
Cash dividends paid $0.88 $0.04 $0.84 $0.72 $0.66 $0.49
FINANCIAL CONDITION:
Total assets $3,960,929 $283,304 $3,677,625 $3,080,309 $2,825,346 $2,492,793
Total deposits $3,365,575 $262,756 $3,102,819 $2,621,457 $2,488,032 $2,207,483
Long-term debt $175,000 $72,000 $103,000 $85,017 $42,926 $38,000
Total shareholders' equity $325,876 $29,615 $296,261 $253,041 $230,495 $204,972
OPERATING AND CAPITAL RATIOS:
Average total shareholders'
equity to average total assets 8.33% 0.56% 7.77% 8.25% 8.50% 8.76%
Rate of return on average:
Total assets 1.45% 0.05% 1.40% 1.57% 1.20% 1.43%
Total shareholders' equity 17.46% -0.60% 18.06% 19.00% 14.08% 16.32%
The above results of operations and balances for prior years have been restated
to reflect the Company's pooling transactions with the former Pacific Capital
Bancorp and with San Benito Bank.
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.
6
MANAGEMENT'S DISCUSSION AND PACIFIC CAPITAL BANCORP
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS AND SUBSIDIARIES
The following provides Management's comments on the financial condition and
results of operations of Pacific Capital Bancorp and its subsidiaries. Unless
otherwise stated, "we" or "the Company" refers to this consolidated entity. You
should read this discussion in conjunction with the Company's consolidated
financial statements and the notes to the consolidated financial statements.
These statements and notes are presented on pages 54 through 98 of this Annual
Report on Form 10-K. "Bancorp" will be used to refer to the parent company only.
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 47 through 49.
The subsidiary banks are Santa Barbara Bank & Trust ("SBB&T") and First National
Bank of Central California ("FNB"). 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. The Company acquired Los Robles
Bank ("LRB") when it purchased all of the outstanding stock of Los Robles
Bancorp at the end of June 2000. LRB was merged into SBB&T in the second quarter
of 2001. Pacific Capital Commercial Mortgage Corporation ("PCCM") is a non-bank
subsidiary of Bancorp which was primarily involved in mortgage brokering and the
servicing of brokered loans. It ceased business and became inactive in 2001. The
Company has a second inactive subsidiary, Pacific Capital Services Corporation.
This discussion and analysis provides insight into Management's assessment of
the operating trends over the last several years and its expectations for 2002.
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:
o increased competitive pressure among financial services companies;
o changes in the interest rate environment reducing interest margins or
increasing interest rate risk;
o deterioration in general economic conditions, internationally, nationally
or in the State of California;
o the occurrence of future events such as the terrorist acts of September
11, 2001;
o the availability of sources of liquidity at a reasonable cost;
o substantial increases in energy costs in California;
o reduced demand for or earnings derived from the Company's income tax
refund loan and refund transfer programs;
o legislative or regulatory changes adversely affecting the business in
which the Company engages; and
o difficulties integrating acquired operations.
This discussion also provides information on the strategies adopted
by the Company to address these risks, and the results of these strategies.
The acquisitions of SBB and LRB are described in Note 19 to the consolidated
financial statements. We accounted for the merger of SBB with the Company 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 as if this merger had occurred prior to the
earliest period presented. In contrast, the acquisition LRB was accounted for as
a purchase transaction, and its results of operations are included with those of
the Company only from the date of acquisition.
7
OVERVIEW OF EARNINGS PERFORMANCE
In 2001, the net income for the Company was $56.1 million, or $2.11
per diluted share. This represents a 9.0% increase over the $51.5 million net
income or $1.93 per diluted share reported for 2000. Reported net income for
2000 had been significantly impacted by expenses related to the acquisitions of
SBB and LRB. Exclusive of these merger expenses (Note A), 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. Earnings for 2001 were thus
down slightly from the 2000 pro forma earnings.
The primary reasons for the slight decline in net income for 2001 compared to
the pro forma figure for 2000 were the significant declines in interest rates
during 2001 and the additional provision expense necessary to address the credit
quality issues that result from a slowdown in the economy.
2000 pro forma earnings exceeded 1999 earnings by 22.0%, and 2000 pro forma
earnings per share exceeded the 1999 figure by 21.7%. The primary reason for
this increase was the large increase in interest income because of growth in
loans and other earning assets only partially offset by increased interest
expense.
From a longer range perspective, for the five years from 1997 through 2001, the
Company's net income increased at a compound average annual rate of 20.4%. Among
the reasons for this favorable trend of increase in net income have been:
o the integration of ten new branch offices through acquisitions (Note B);
o growth in the tax refund anticipation loan ("RAL") and refund transfer
("RT") programs;
o strong loan demand during the last three years;
o continued growth in service charges and fee income; and
o cost savings related to its mergers.
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. During late 1999, the Fed began to raise interest rates to slow economic
growth and continued with periodic increases until mid-2000. Early in 2001, the
Fed began to lower rates, as the economy showed evidence of significant slowing.
It continued throughout 2001 until it had lowered its target short-term rate by
4.75% to its lowest rate in 40 years. These changes, especially given the
extreme rate of decline in 2001, 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 experienced steady growth
during 1999 and 2000, but started showing signs of slowing in the first and
second quarters of 2001. The more pronounced slowing and recessionary
environment seen in much of the country in the third and fourth quarters of 2001
were more moderately present in our market areas. The hospitality and tourism
sectors were affected by the tragedy of September 11, but showed some
indications of normalization at the close of the year. Agriculture continued to
face price pressures during the year, and the high tech segment showed uncertain
and varying results. Housing markets have shown some slowdown in sales, but
generally prices were stable with the high-end residential properties showing
some volatility. The commercial real estate markets showed some signs of
slowdown, but the increase in vacancy rates, and softening in lease rates
reflected a more normalized environment compared to
8
the unusually strong position in 2000. Other than those mentioned, other small
business and middle market segments showed some growth albeit at a lesser rate
than in 2000.
REGULATORY CONSIDERATIONS
Changes in the regulatory environment and differences in practices between the
various banking regulators impact the Company. As a state-chartered commercial
bank, SBB&T is regulated by the California Department of Financial Institutions
(the "CDFI"). SBB&T is also a member of the Federal Reserve Bank (the "FRB") and
therefore its primary Federal regulator is the FRB. The Office of the
Comptroller of the Currency (the "OCC") is the primary regulator for FNB because
it is a nationally chartered bank. However, it must also comply with FRB
regulations. The FRB is also the regulator for the Bancorp because it is a bank
holding company.
Changes in regulation may 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. This method has not been used in the last decade as
Federal Open Market Committee purchases or sales of securities to manage short
term rates have instead been the preferred method of managing the economy.
The FRB also impacts the Company and its subsidiary banks through 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."
The Company has received approval from the OCC to merge its two bank charters
into one national charter. This merger is expected to occur at the end of the
first quarter of 2002. This merger will help to simplify the regulatory
environment for the Company as it moves to only one primary regulator.
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 1980's, 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, attempt 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, deposit, and investment
products. 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
9
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 Company's
Chief Risk Officer and the other members of its Senior Leadership Council under
the direction and oversight of the Board of Directors lead the risk management
process.
Some of the risks faced by the Company are those faced by most
enterprises-reputational risk, operational risk, and legal risk. 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.
THE IMPACT OF CHANGES IN ASSETS AND LIABILITIES TO NET INTEREST INCOME AND NET
INTEREST MARGIN
The Company earns income from two sources. The primary source is from the
management of its financial assets and liabilities and the second is from
charging fees for services provided. The first source 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. Income is
earned as a spread between the interest earned from the loans or investments and
the interest paid on the deposits and other borrowings. The second source, fee
income, is discussed in other sections of this analysis, specifically in
"Noninterest Revenue" and "Tax Refund Anticipation Loans and Refund Transfers."
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 increase 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.
CHANGES IN NET INTEREST INCOME AND NET INTEREST MARGIN
NET INTEREST INCOME is the difference or spread 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.
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.
Table 1 compares the changes in TAX EQUIVALENT (Note D) net interest income and
tax-equivalent net interest margin from 1999 to 2000 and from 2000 to 2001.
10
TABLE 1-CHANGES IN NET INTEREST INCOME AND NET INTEREST MARGIN
(dollars in thousands)
TAX-EQUIVALENT AVERAGE AVERAGE TAX-EQUIVALENT
NET INTEREST EARNING INTEREST-BEARING NET INTEREST
INCOME ASSETS LIABILITIES MARGIN
1999 $158,739 $2,756,174 $2,127,380 5.76%
Change $26,872 $635,847 $516,973 (0.29%)
% Change 16.9% 23.1% 24.3% 5.00%
2000 $185,611 $3,392,021 $2,644,353 5.47%
Change $13,995 $148,867 $109,019 0.17%
% Change 7.5% 4.4% 4.1% 3.10%
2001 $199,696 $3,540,888 $2,753,372 5.64%
Tax equivalent net interest income increased each year, but at a lower rate from
2000 to 2001 (7.5%) than it had from 1999 to 2000 (16.9%). The Company's net
interest margin decreased from 1999 to 2000, 5.76% compared to 5.47%, and
increased to 5.64% for 2001. The reasons for these changes will be explained
through the remainder of this section of the discussion. Management uses the
information in Tables 2 and 3 to analyze the changes in net interest income and
net interest margin.
Table 2, "Distribution of Average Assets, Liabilities, and Shareholders' Equity
and Related Interest Income, Expense and Rates," sets forth the AVERAGE DAILY
BALANCES (Note E) for the major asset and liability categories, the related
income or expense where applicable, and the resultant yield or cost attributable
to the average earning assets and interest-bearing liabilities. Changes in the
average balances and the rates received or paid depend on market opportunities,
how well the Company has managed interest rate risks, product pricing policy,
product mix, and external trends and developments.
Table 3, "Volume and Rate Variance Analysis of Net Interest Income," analyzes
the changes in net interest income from 1999 to 2000 and from 2000 to 2001. The
analysis shows the impact of volume and rate changes on the major 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 2 shows that for
2000, savings and interest-bearing transaction accounts averaged $1,290 million,
interest expense was $34.0 million and the average rate paid was 2.63%. For
2001, the average balance was $1,325 million, interest expense was $24.6
million, and the average rate paid was 1.86%. Table 3 shows that the $9.3
million net decrease in interest expense was due to a decrease of $10.2 million
from a decrease in the average rate paid offset by a $900 thousand increase in
expense from an increase in balances.
A shift in the relative size of the major balance sheet categories has an 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. In
general, depositors are willing to accept a lower rate on their funds than are
other providers of funds because of the Federal Deposit Insurance Corporation
("FDIC") insurance coverage. To the extent that the Company can fund asset
growth by deposits, especially the lower cost transaction accounts, rather than
borrowing funds from other financial institutions, the average rates paid on
funds will be less, and net interest income more.
THE IMPACT OF OVERALL TRENDS IN THE BALANCES AND RATES OF ASSETS AND
LIABILITIES-1999 TO 2000
The Fed raised interest rates (Note F) in late 1999 and early 2000. Changes in
deposit rates generally lag rate changes in assets. While loan rates rose in
response, rates on deposits rose by a larger proportion as they caught up in
2000 with the loan rate increases from 1999.
11
Interest income increased by $64.8 million as average earning assets increased
by 23.1% from $2.76 billion to $3.39 billion and the average rate earned on
these assets increased from 8.39% to 8.73%. The higher average balance of
earning assets in 2000 than in 1999 resulted in $7.9 million in additional
interest income. The higher rates prevalent in 2000 added $57.0 million in
interest income over the amount earned in 1999. The acquisition of LRB in 2000
added $158 million in earning assets, but the Company was also able to generate
strong growth in customer loans in the robust economy of 2000.
Average loans increased from $1.91 billion in 1999 to $2.39 billion in 2000,
increasing slightly as a proportion of the total and benefiting the most from
rising rates. Average deposits (interest-bearing and noninterest-bearing)
increased by $569 million or 22.1%. With falling stock markets and significant
losses for holders of many internet stocks, depositors seemed less inclined in
2000 than in 1998 and 1999 to withdraw funds from banks to place in equity
investments.
The $431 million increase in interest-bearing deposits resulted in an increase
of $18.4 million in interest expense, while the higher rates added $14.0 million
additional expense. Part of the increases in both balances and rates of
interest-bearing deposits relates to the Company's tax refund loan program. This
program expanded significantly in 2000 over 1999 for reasons explained below in
the section of this discussion titled "Tax Refund Anticipation Loan and Refund
Transfer Programs." This expansion required a large amount of short term funding
which was raised by using brokered Certificates of Deposit ("CDs"). Brokered CDs
are obtained from third parties. There is a higher cost for these deposits and
to get sufficient funds within a short period of time, the Company had to issue
CDs with a longer term than was necessary to fund the refund loans. After the
refund loans were repaid, the funds were invested in other assets, but at rates
either equal to or only slightly higher than the rates paid on the deposits.
While the increase in deposits was significant, it was not enough to fund the
increase in earning and non-earning assets (see "Nonearning Assets" below).
Total average assets increased $699 million. The Company needed to increase its
use of non-deposit sources to fund this growth. These overnight and longer term
borrowings are generally more expensive than deposit funding sources.
The net impact of the above changes from 1999 to 2000 resulted in a $26.9
million or 16.9% increase in tax equivalent net interest income. However, as
shown in Table 1, the net interest margin decreased from 5.76% to 5.47%. The
reason for this seeming contradiction is that interest rates do not move for all
asset and liability categories in a parallel manner (explained more fully in the
section below titled "Interest Rate Risk"). From 1999 to 2000, interest income
increased more than interest expense which increased net interest income.
However, while average interest rates on both assets and liabilities rose, the
rates on liabilities rose more. This caused the net interest margin to decline.
Average interest rates on earning assets increased by 0.34% or 34 basis points.
Average interest rates paid on nondeposit sources of funds also increased 44
basis points, but average interest rates on deposits increased 75 basis points.
This occurred because of the brokered deposits mentioned above and because
average deposit rates continued to increase later in 2000 as time deposits were
renewed at higher rates while loans generally remained at set at the rates of
the last Fed increase in June 2000. The $14.0 million increase in interest
expense on deposits due to rate increases was 43.2% of the total increase in
interest expense on deposits, while the increase in interest income on all
assets from rates was 12.1%. In summary, there was an increase in interest
expense from rate increases on deposits that was more than offset by the
increase in interest income from the increase in the balance of earning assets,
resulting in an increase in net interest income. The increase in the average
rate earned was not sufficient to cover the increase in the average cost of
funds, and the net interest margin declined.
THE IMPACT OF OVERALL TRENDS IN THE BALANCES AND RATES OF ASSETS AND
LIABILITIES-2000 TO 2001
The slower rate of growth in net interest income from 2000 to 2001 than was
experienced from 1999 to 2000 occurred because of the slower rate of growth in
the Company's earning assets and interest-bearing liabilities from 2000 to 2001
compared to the rate of growth from 1999 to 2000.
12
Average earning assets increased by 4.4% compared to 23.1% from 1999 to 2000 and
interestbearing liabilities increased 4.1% compared to 24.3% for the prior year.
The slowdown in the economy in 2001 was the major factor in the reduced rates of
growth in assets and liabilities. A second factor was that there were no
acquisitions in 2001 like LRB in 2000.
As noted above, average rates on loans are usually higher than other assets and
average rates on non-deposit sources of funds are generally higher than on
deposits. Loans continued to grow as a proportion of earning assets, increasing
from 70.4% in 2000 to 75.6% in 2001, helping to offset the effect of lower
rates. Non-deposit sources of funds as a proportion of interest-bearing
liabilities increased as well, but by only one tenth of a percent. These product
mix changes helped to keep total interest income at virtually the same amount as
in 2000, while interest expense declined by $13.3 million.
Each of the major categories of assets and liabilities is discussed in various
sections below. In these sections, there is a description of the reason for any
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.
13
TABLE 2-DISTRIBUTION OF AVERAGE ASSETS, LIABILITIES, AND SHAREHOLDERS' EQUITY
AND RELATED INTEREST INCOME, EXPENSE, AND RATES (Notes D and G)
2001
---------------------------------------
(DOLLARS IN THOUSANDS) BALANCE INCOME RATE
---------------------------------------
Assets
Money market instruments
Commercial paper $ 48,613 $ 2,088 4.30%
Federal funds sold 132,941 5,852 4.40%
-------------------------
Total money market instruments 181,554 7,940 4.37%
-------------------------
Securities:
Taxable 517,256 31,209 6.03%
Non-taxable 163,853 15,401 9.40%
-------------------------
Total securities 681,109 46,610 6.84%
-------------------------
Loans (Note D)
Commercial 675,660 64,076 9.48%
Real estate 1,664,748 125,789 7.56%
Consumer 337,817 52,507 15.54%
-------------------------
Total loans 2,678,225 242,372 9.05%
-------------------------
Total earning assets 3,540,888 296,922 8.39%
-------------------------
Non-earning assets 317,421
----------
Total assets $3,858,309
==========
Liabilities and shareholder's equity
Interest bearing deposits:
Savings and interest bearing
transaction accounts $1,324,595 24,619 1.86%
Time certificates of deposit 1,185,700 58,442 4.93%
-------------------------
Total interest bearing deposits 2,510,295 83,061 3.31%
-------------------------
Borrowed funds:
Repos and fed funds purchased 85,631 3,289 3.84%
Other borrowings 157,446 10,876 6.91%
-------------------------
Total borrowed funds 243,077 14,165 5.83%
-------------------------
Total interest bearing liabilities 2,753,372 97,226 3.53%
---------- ------
Noninterest-bearing demand deposits 725,267
Other liabilities 58,340
Shareholders' equity 321,330
----------
Total Liabilities and shareholder's equity $3,858,309
==========
Interest income/earning assets 8.39%
Interest expense/earning assets 2.75%
-----
Net interest income/margin 199,696 5.64%
Provision for credit losses
charged to operations/earning assets 26,671 0.75%
-----
Net interest margin after provision
for credit losses on tax equivalent basis 173,025 4.89%
=====
Less: tax equivalent income
included in interest income from
non-taxable securities and loans 5,814
--------
Net interest income $167,211
========
14
2000 1999
- ------------------------------------ ------------------------------------
BALANCE INCOME RATE BALANCE INCOME RATE
- ------------------------------------ ------------------------------------
$ 24,386 $ 1,602 6.57% $ 5,800 $ 307 5.29%
172,227 9,870 5.73% 83,246 4,033 4.84%
- ------------------------ ------------------------
196,613 11,472 5.83% 89,046 4,340 4.92%
- ------------------------ ------------------------
640,458 38,925 6.08% 613,812 36,677 5.97%
166,210 16,340 9.83% 145,089 14,810 10.21%
- ------------------------ ------------------------
806,668 55,265 6.86% 758,901 51,487 6.79%
- ------------------------ ------------------------
616,467 64,713 10.50% 523,563 54,939 10.49%
1,439,019 119,077 8.27% 1,155,811 91,880 7.95%
333,254 45,610 13.69% 228,853 28,568 12.48%
- ------------------------ ------------------------
2,388,740 229,400 9.60% 1,908,227 175,387 9.19%
- ------------------------ ------------------------
3,392,021 296,137 8.73% 2,756,174 231,214 8.39%
- ------------------------ ------------------------
274,394 211,274
- ---------- ----------
$3,666,415 $2,967,448
========== ==========
$1,289,779 33,956 2.63% $1,138,854 24,465 2.15%
1,148,023 64,337 5.60% 868,415 41,429 4.77%
- ------------------------ ------------------------
2,437,802 98,293 4.03% 2,007,269 65,894 3.28%
- ------------------------ ------------------------
76,197 4,247 5.57% 37,397 1,766 4.72%
130,354 7,986 6.13% 82,714 4,815 5.82%
- ------------------------ ------------------------
206,551 12,233 5.92% 120,111 6,581 5.48%
- ------------------------ ------------------------
2,644,353 110,526 4.18% 2,127,380 72,475 3.41%
- ---------- ------- ---------- ------
703,531 565,525
33,657 29,515
284,874 245,028
- ---------- ----------
$3,666,415 $2,967,448
========== ==========
8.73% 8.39%
3.26% 2.63%
----- -----
185,611 5.47% 158,739 5.76%
14,440 0.43% 7,043 0.26%
----- -----
171,171 5.05% 151,696 5.50%
===== =====
6,173 6,087
-------- --------
$164,998 $145,609
======== ========
15
TABLE 3-VOLUME AND RATE VARIANCE ANALYSIS OF NET INTEREST INCOME
(Taxable equivalent basis - Notes D and H)
(IN THOUSANDS) 2001 OVER 2000 2000 OVER 1999
--------------------------------- -------------------------------
Increase (decrease) in: RATE VOLUME TOTAL RATE VOLUME TOTAL
--------------------------------- -------------------------------
Interest income:
Money market instruments
Commercial paper $ (697) $ 1,183 $ 486 $ 51 $ 1,215 $ 1,266
Federal funds sold (2,027) (1,991) (4,018) 857 4,980 5,837
Money market funds (20) (90) (110) (8) (36) (44)
--------------------------------- --------------------------------
Total money market investment (2,744) (898) (3,642) 900 6,159 7,059
--------------------------------- --------------------------------
Securities:
Taxable (316) (7,400) (7,716) 677 1,644 2,321
Non-taxable (709) (230) (939) (566) 2,096 1,530
--------------------------------- --------------------------------
Total securities (1,025) (7,630) (8,655) 111 3,740 3,851
--------------------------------- --------------------------------
Loans
Commercial loans (6,572) 5,935 (637) 52 9,722 9,774
Real estate loans (10,832) 17,544 6,712 3,838 23,359 27,197
Consumer loans 6,262 635 6,897 2,987 14,055 17,042
--------------------------------- --------------------------------
Total loans (11,142) 24,114 12,972 6,877 47,136 54,013
--------------------------------- --------------------------------
Total earning assets (14,911) 15,696 785 7,888 57,035 64,923
--------------------------------- --------------------------------
Liabilities:
Interest bearing deposits:
Savings and interest bearing
transaction accounts (10,226) 889 (9,337) 5,955 3,536 9,491
Time certificates of deposit (7,938) 2,043 (5,895) 8,037 14,871 22,908
--------------------------------- --------------------------------
Total interest bearing deposits (18,164) 2,932 (15,232) 13,992 18,407 32,399
--------------------------------- --------------------------------
Borrowed funds:
Repos and fed funds purchased (1,436) 478 (958) 4 2,477 2,481
Other borrowings 1,098 1,792 2,890 268 2,903 3,171
--------------------------------- --------------------------------
Total borrowed funds (338) 2,270 1,932 272 5,380 5,652
--------------------------------- --------------------------------
Total interest bearing liabilities (18,502) 5,202 (13,300) 14,264 23,787 38,051
--------------------------------- --------------------------------
Net Interest Income $ 3,591 $10,494 $ 14,085 $(6,376) $33,248 $26,872
================================= ================================
INTEREST RATE RISK
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 was 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 a higher coupon 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
16
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 2001 and 2000. 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, 2001 and 2000 than when acquired. The
excess of the fair value of the financial assets over their carrying amounts at
the end of 2001 was $65.8 million compared with an excess of carrying amount
over fair value of $32.7 million at the end of 2000. Most of this change is due
to decreases in market rates during 2001.
Because the amount of the Company's fixed-rate liabilities is significantly less
than its fixed-rate assets, and because the average maturity of the fixed-rate
liabilities is substantially less than for the fixed-rate assets, the market
risk relating to liabilities is not as great as for assets. The difference
between the carrying amount and the fair value in the table in Note 14 shows the
impact of changing rates on the Company's liabilities that have fixed-rates.
They are worth $21.9 million more to customers or lenders to the Company at
December 31, 2001, than they were when issued, because on a weighted average
basis, they are paying rates that are 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 on assets and paid on liabilities. This occurs because of
differences in the contractual maturity terms of the assets and liabilities
held. A difference in the maturities, a mismatch, can cause adverse impacts on
net interest income.
The Company has a large portion of its loan portfolio tied to the national prime
rate. If these rates are lowered because of general market conditions, e.g., the
prime rate decreases in response to a rate decrease by the Fed as happened in
2001, these loans will be re-priced. 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.
If the assets of a holder of financial instruments mature or reprice sooner than
its liabilities, then the assets will respond more quickly than liabilities to
changes in interest rates. In this case, the holder is said to be ASSET
SENSITIVE. If liabilities are more responsive to changes in rates than assets,
it is said to be LIABILITY SENSITIVE. If the amounts of assets and liabilities
maturing or repricing in the short-term are approximately the same, it is said
to be NEUTRAL.
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 shorterterm 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.
17
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.
The nonparallel response occurs because various contractual limits and
non-contractual factors come into play. An example of a contractual limit is the
"interest rate cap" on some residential real estate loans, which may limit the
amount that rates may increase. An example of a non-contractual factor is the
assumption on how low rates could be lowered on ADMINISTERED rate accounts.
Administered rate deposit accounts like negotiable order of withdrawal ("NOW")
accounts, money market deposit accounts ("MMDA"), and savings, are the accounts
that do not have a contractually set rate for their term as do certificates of
deposit. The Company can reprice these products at its option based on
competitive pressure and the need for funds.
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.
THE IMPACT OF INTEREST RATE RISK IN 2001
Each of these risks came into play in 2001 as the interest rate environment
changed dramatically. As noted above, there was a substantial change in the fair
value of fixed-rate assets compared to their carrying amount caused by the steep
decline in market rates. This caused a switch from the carrying value being more
than the fair value (depreciation) at the end of 2000 to the carrying value
being less than the fair value (appreciation) at the end of 2001. To a lesser
extent, liabilities were also impacted by this, moving from a position where the
Company was paying less than market rates on some of its liabilities at the end
of 2000, to where the Company was paying more than market rates on some of its
liabilities at the end of 2001.
Over the last several years, with respect to mismatch risk, the Company has
generally been neutral or asset sensitive. As mentioned above, this was a
benefit from mid-1999 to mid-2000 as interest rates were rising. The Company's
assets repriced faster than its liabilities and net interest income increased.
It was a detriment in 2001 as a large proportion of the Company's assets kept
repricing lower with each Fed action lowering rates while a large proportion of
its liabilities lagged in their repricing.
Basis risk also had a substantial impact causing the Company to become
increasingly asset sensitive as the market rates continued to drop. This
occurred because while assets set to prime rate as an index changed with each
decrease in prime and to exactly the same extent as prime, the rates even on
administered rate deposits could not be decreased as frequently or to the same
extent. The rate paid on NOW accounts at year-end 2000 was 50 basis points. It
is clear that the rate on these accounts could not be decreased to the same
extent as the 475 basis points that prime decreased in 2001.
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
18
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, the
very steep decline in interest rates during 2001 make the 2% shock a more
realistic scenario than most observers would have believed a year ago. 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, 2001, 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%
As of December 31, 2000:
Net interest income (3.72%) 3.65%
Net economic value 12.71% (11.71%)
As of December 31, 2001:
Net interest income (5.87%) +2.33%
Net economic value +24.33% (25.94%)
For these measurements, the Company makes certain assumptions that significantly
impact the results. The most significant assumption is the use of a "static"
balance sheet-the Company does not project changes in the size or mix of the
various assets and liabilities. Additional assumptions include the duration of
the Company's non-maturity deposits because they have no contractual maturity,
and the extent to which the Company would adjust the rates paid on its
administered rate deposits as external yields change.
As noted above, financial instruments do not respond in parallel fashion to
rising or falling interest rates. This causes an asymmetry in the magnitude of
changes in net interest income and net economic value resulting from the
hypothetical increases and decreases in rates. In other words, the same
percentage of increase and decrease in the hypothetical interest rate will not
cause the same percentage change in net interest income or net economic value.
In addition, the degree of asymmetry changes as the base rate changes from
period to period and as there are changes in the Company's product mix. For
example, if savings accounts are paying 4% when one measures the impact of a 2%
decrease in market rates, the measured responsiveness of the rate paid on these
accounts to that decrease will be greater than the responsiveness if the current
rate is 3% when the measurement is done. This is because the Company cannot
assume that it will be able to lower the rates paid on these deposits as much
from a 3% base as from a 4% base. Another example of non-contractual factors
coming into play would be that to the extent consumer variable rate loans are a
larger proportion of the portfolio than in a previous period, the caps on loan
rates, which generally are present only in consumer loans, would have more of an
adverse impact on the overall result if rates were to rise.
The change in the results of the analysis shown above between the two
period-ends is due primarily to the substantial decrease in prevailing interest
rates during 2001, which left certain low cost liability products at less than
2% of cost. As such, these products begin to behave as fixed rate products in 2%
shock analysis. In other words, even if rates were to decrease 2%, the rates on
these accounts would drop minimally. The Company has become increasingly asset
sensitive as rates have fallen 4.75% from December 31, 2000 through December 31,
2001.
19
As interest rates change, the assumptions regarding responsiveness to further
change must be reviewed, and any changes will affect the computed results. These
assumptions are reviewed each quarter and are changed as deemed appropriate to
reflect the best information available to Management. Assumptions used for the
measurement at December 31, 2000 are not necessarily the same as those used for
the measurement at December 31, 2001.
The same changes to the balance sheet and assumptions mentioned above in
connection with net interest income also account for the changes in net economic
value. However, the computation of net economic value discounts all cash flows
over the life of the instrument, not only the next twelve months. For example,
in estimating the impact on net interest income of a two-percent rise in rates
on a security maturing in three years, only the negative impact during the first
year is captured in net interest income. In estimating the impact on net
economic value, the negative impact for all three years is captured. Therefore,
the results tend to be more pronounced.
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 that most market interest rates are at their lowest
points in 40 years, but expected continued weakness in the economy for one or
two quarters, the Company's projection for the most likely scenario includes
generally stable interest rates with a slight increase later in 2002. In
addition, the Company expects relatively normal yield curves (Note I). 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.
Under these more realistic scenarios, as in the case of the sudden rate shock
model, the Company's net interest income at risk in 2002 is still well within
normal expectations. 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 1.44% 0.70%
compared to most likely scenario
Change in average Fed funds rate (0.27%) 0.50%
MANAGING INTEREST RATE RISK WITH HEDGING INSTRUMENTS
The steps that the Company takes to mitigate interest rate risk were mentioned
above as each type of interest rate risk was explained. They primarily involve
pricing products to achieve diversification or offsetting risk characteristics.
The Company has also occasionally used hedge instruments, specifically interest
rate swaps, to protect large loans or pools of loans. However, there are
limitations and costs associated with these hedges.
In general, absent the ability to correctly predict the future direction and
extent of changes in interest rates, there is a trade-off between assuming
additional cost and assuming additional risk. For example, the Company can enter
into an interest rate swap whereby it pays a variable rate on a notional amount
to another financial institution in exchange for receiving a fixed rate. This
will protect the Company interest income if rates drop, because it will pay less
as the variable rate adjusts with each decrease in rates while it continues to
pay the same fixed amount over the term of the contract. However, the Company
would lose interest income if rates rise instead of decline as its variable
payment increases. Alternatively, the Company could purchase an option contract
under which it would receive cash from the other party if rates rose or fell by
a specified amount, depending on which direction the Company anticipated rates
to move. This contract avoids incurring risk should
20
rates move against its expectations, but the option fee, a not insignificant
amount, is forfeited if rates do not move as anticipated.
Despite the trade-offs inherent in using hedge instruments, Management
anticipates making more use of them in the future. As its RAL program continues
to grow, the Company must increasingly structure its balance sheet to provide
the large amount of liquidity needed in the first quarter of each year. This
limits the Company's ability to take some of the natural or on-balance sheet
hedge positions it could otherwise make use of. Hedge instruments may provide
the additional flexibility needed both to maintain the liquidity and protect net
interest income.
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.
SECURITIES PORTFOLIOS
The Company classifies its securities into three portfolios: the "Liquidity
Portfolio," the "Discretionary Portfolio," and the "Earnings Portfolio." The
Liquidity and Discretionary Portfolios are comprised of securities classified in
the financial statements as available-for-sale. The Earnings Portfolio is
comprised of securities that are classified as 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 of 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 and to hold earning assets that can be purchased or sold as part
of overall asset/liability management. The Discretionary Portfolio consists of
U.S. Treasury and agency securities, COLLATERALIZED MORTGAGE OBLIGATIONS
("CMOs"), ASSET-BACKED SECURITIES, MORTGAGE BACKED SECURITIES (Note J), and
municipal securities.
The Earnings Portfolio's primary purpose is to provide income from securities
purchased with funds not expected to be needed for making loans or repaying
depositors until maturity. 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, and
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.
21
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. Such
investments would include mortgageback securities consisting of real estate
loans to lower income borrowers in its market areas. The Company also holds
several bonds of school districts within its market areas.
AMOUNTS AND MATURITIES OF SECURITIES
As discussed above, in addition to providing a ready source of liquidity, the
size of the securities portfolios tends to vary with the relative increase in
loan and deposit balances. The average balance of securities increased from 1999
to 2000 as deposits increased more than loans. The average balance declined from
2000 to 2001 as loans grew more than deposits. Table 4 sets forth the amounts
and maturity ranges of the securities at December 31, 2001. 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 4. The average yields on the taxable securities
are significantly lower than the average rates earned from loans as shown in
Table 2. Because of this, while taxable securities provide liquidity and act as
collateral for deposits and borrowings, they are purchased for earnings only
when loan demand is weak.
OTHER SECURITIES DISCLOSURES
TURNOVER AND MATURITY PROFILE: The accompanying Consolidated Statements of Cash
Flows on page 58 shows there is a relatively large turnover in the Securities
Portfolios-proceeds from the maturity, sale, or call of securities 2001
represented 47.0% of the average balance of securities for the year. This is not
due to trading activity. 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 invested perhaps when rates are low.
The Company generally purchases municipal securities with maturities of 18-25
years because, in its judgment, they have the best ratio of rate earned to the
market risk incurred in purchasing these fixed rate securities. However, to
mitigate this higher interest rate risk, the Company purchases taxable
securities with relatively short maturities. This in turn causes frequent
maturities and what looks like a relatively high turnover rate.
22
TABLE 4-MATURITY DISTRIBUTION AND YIELD ANALYSIS OF THE SECURITIES PORTFOLIOS
AFTER ONE AFTER FIVE
AS OF DECEMBER 31, 2001 ONE YEAR YEAR TO YEARS TO OVER
(DOLLARS IN THOUSANDS) OR LESS FIVE YEARS TEN YEARS TEN YEARS TOTAL
-----------------------------------------------------------------
MATURITY DISTRIBUTION:
Available-for-sale:
U.S. Treasury obligations $ 82,815 $ 72,660 $ - $ - $155,475
U.S. agency obligations 73,313 245,481 5,116 - 323,910
Collateralized mortgage
obligations 11,103 91,556 3,021 - 105,680
Asset-backed securities - 11,660 - - 11,660
State and municipal
securities 3,618 6,142 6,851 85,740 102,351
-----------------------------------------------------------------
Subtotal 170,849 427,499 14,988 85,740 699,076
-----------------------------------------------------------------
Held-to-maturity:
U.S. Treasury obligations - - - - -
U.S. agency obligations - - - - -
Collateralized mortgage
obligations 5 - - - 5
State and municipal
securities 9,589 14,717 12,235 35,421 71,962
-----------------------------------------------------------------
Subtotal 9,594 14,717 12,235 35,421 71,967
-----------------------------------------------------------------
Total $180,443 $442,216 $27,223 $121,161 $771,043
=================================================================
WEIGHTED AVERAGE YIELD (Tax equivalent-Note D):
Available-for-sale:
U.S. Treasury obligations 6.16% 4.13% - - 5.21%
U.S. agency obligations 6.31% 4.61% 4.78% - 5.00%
Collateralized mortgage
obligations 5.32% 6.13% 7.83% - 6.09%
Asset-backed securities - 2.46% - - 2.46%
State and municipal
securities 4.44% 4.42% 5.38% 5.63% 5.50%
------------------------------------------------------------------
Weighted average 6.14% 4.79% 5.67% 5.63% 5.24%
Held-to-maturity:
U.S. Treasury obligations - - - - -
U.S. agency obligations - - - - -
Collateralized mortgage
obligations 2.00% - - - 2.00%
State and municipal
securities 8.52% 8.29% 6.27% 6.27% 6.98%
Weighted average 8.51% 8.29% 6.27% 6.27% 6.98%
Overall weighted average 6.26% 4.91% 5.94% 5.81% 5.40%
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 generally 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:
o the issuer calls the securities;
o the Company needs to reposition the maturities of securities to manage
mismatch risk;
23
o the Company needs to change the risk-weighting profile of its assets to
manage its capital position (see the section below titled "Capital
Resources"); or
o the Company is selling small remaining portions of amortizing securities
to reduce administrative burden.
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.
As mentioned above, the Company has occasionally purchased interest rate swaps
from another financial institution to hedge large, fixed-rate loans or pools of
fixed-rate loans.
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."
MONEY MARKET INSTRUMENTS-FEDERAL FUNDS SOLD, SECURITIES PURCHASED UNDER
AGREEMENTS TO RESELL, 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 securities or COMMERCIAL PAPER. Commercial paper instruments
are short-term notes issued by companies. They are actively traded among
investors after issuance. 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 with securities, the average balances invested by the Company in these
instruments increased from 1999 to 2000 as deposits increased more than loans,
and then decreased from 2000 to 2001 as loan growth exceeded deposits. The new
loans were funded by drawing down the balances of securities and money market
instruments.
The one-day term of the Federal funds sold and reverse repos means that they are
highly liquid as the funds are returned to the Company the next day and are not
subjected to market risk. Commercial paper issued by highly rated domestic
companies is highly liquid as there is an active market for these instruments
should the Company desire to sell them 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.
LOAN PORTFOLIO
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. Table 5
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.
24
The year-end balance for all loans increased about $427 million from the end of
1999 to the end of 2000 and about $282 million from the end of 2000 to the end
of 2001. Though overall growth was lower in 2001, all of the major categories
except leasing showed growth during the year. The balance of consumer loans for
December 31, 2001 reported in the table is lower than the balance at the prior
year-end, but that is because in early January, 2001, the Company sold
approximately $58.2 million of the indirect auto loans included in this category
through a securitization for the purposes of capital management as described in
the section below titled "Capital Resources."
The Company makes both adjustable rate and fixed rate 1-4 family 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.
Net of the sale mentioned above, consumer loans grew $51.6 million or 33.4% in
2000 and $39.0 million or 18.9% in 2001. 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.
TABLE 5-LOAN PORTFOLIO ANALYSIS BY CATEGORY
(IN THOUSANDS) DECEMBER 31
2001 2000 1999 1998 1997
----------------------------------------------------------------
Real estate:
Residential $ 728,026 $ 586,904 $ 494,540 $ 376,871 $ 282,910
Nonresidential 593,675 564,556 457,575 496,050 448,942
Construction and development 185,264 172,331 200,804 131,912 76,448
Commercial, industrial, and agricultural 874,294 775,365 614,897 388,262 322,327
Home equity lines 85,025 71,289 49,902 47,123 56,681
Consumer 187,949 205,992 154,381 129,957 104,645
Leases 126,744 129,159 97,005 84,198 76,515
Municipal tax-exempt obligations 8,043 4,102 12,530 9,286 7,931
Other 10,072 7,406 8,399 6,619 7,482
----------------------------------------------------------------
$2,799,092 $2,517,104 $2,090,033 $1,670,278 $1,383,881
================================================================
Net deferred fees $ 4,908 $ 5,813 $ 5,240 $ 5,002 $ 3,955
This program is neither a factoring nor a flooring arrangement. The individual
customers, not the dealers, are the borrowers and thus there is no large
concentration of credit risk. In addition, there is a review of underwriting
practices of a dealer prior to acceptance into the program. This is done to
ensure process integrity, to protect the Company's reputation, and to monitor
compliance with consumer loan laws and regulations. There were approximately
$124 million of such loans included in the consumer loan total above for
December 31, 2001, as compared with $139 million at December 31, 2000.
Originations did slow some in 2001 with the slower economy and the introduction
by the auto manufacturers of 0% financing, but the balance at the end of 2001
would have been $181 million were it not for the securitization mentioned above.
25
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, 2000, the difference in carrying amount
ofloans, i.e., their face value, is about $41.9 million or 1.7% more than their
fair value. At the end of 2001, the fair value of loans exceeded their carrying
amount by $58.4 million or 2.1%, reflecting the decreases in market rates during
2001.
Table 6 shows the maturity of selected loan types outstanding as of December 31,
2001, and shows the proportion of fixed and floating rate loans for each type.
Net deferred loan origination, extension, and commitment fees are also not shown
in the table. There is no maturity or interest sensitivity associated with the
fees because they have been collected in advance.
TABLE 6-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 $550,147 $ 49,970 $ 11,182
Fixed rate 74,972 88,444 99,579
Real estate-construction and development -
Floating rate 303 3,068 -
Fixed rate 158,000 19,534 4,359
Real estate-residential
Floating rate 82,685 156,698 128,332
Fixed rate 23,356 5,766 331,189
Municipal tax-exempt obligations 1,000 5,154 1,889
-------------------------------------------
$890,463 $328,634 $576,530
===========================================
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. However, they result in lower interest income if rates are falling
because the cash received from monthly principal payments is reinvested at lower
rates. 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, 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 reason 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 assigned and/or 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 10.
26
At year-end 2001, these loans amounted to $138.3 million or 4.9% of the
portfolio. The corresponding amounts for 2000 and 1999 were $58.7 million or
2.3% of the portfolio and $76.9 million or 2.9% of the portfolio, respectively.
The 2001 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. Generally Accepted Accounting Principles ("GAAP") requires
companies engaged in mortgage banking activities to recognize the rights to
service mortgage loans for others as separate
27
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, part of
the upward trend in earnings is attributable to the RAL and RT programs. The
Company is one of three financial institutions which together provide 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.
DESCRIPTION OF THE RAL AND RT PRODUCTS
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
Company subjects the application to an automated credit review process. 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 send 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. However, unlike interest earned on
most loans, it does not vary with the length of time the loan is outstanding.
Nonetheless, because the taxpayer must sign a loan document, the advance on the
refund is considered a loan and the fee is classified as interest income.
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. 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.
The following table shows fees by product for the last three years and the
percentage of growth:
TABLE 7-RAL AND RT FEES
(IN MILLIONS) PRE-TAX
RAL FEES RT FEES INCOME
1999 $8.1 $6.6 $9.4
$ change $10.9 $0.7 $7.3
% change 134.6% 10.6% 77.7%
2000 $19.0 $7.3 $16.7
$ change $7.4 $7.0 $8.4
% change 38.9% 95.9% 50.3%
2001 $26.4 $14.3 $25.1
RAL CREDIT LOSSES
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 and/or safe mailing
28
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 9, these cooperative agreements result in a
relatively high rate of recovery on the prior year's losses, but net losses
remain about four to five times higher than for other loans.
Total net charge-offs in 2001 were $4.2 million compared to $3.2 million in 2000
and $2.7 million in 1999. A significant portion of the 2001 charged-off loans
are expected to be collected in 2002 under the continuing cooperative agreement
between the banks providing this product.
RAL/RT PRODUCT MIX
As shown in Table 7, the increase in RAL fees from 1999 to 2000 was relatively
large compared to the increase in RT fees, while the increase in RT fees from
2000 to 2001 was larger than the increase in RAL fees. These differences in the
rate of increase are the result of substantial shifts in the mix of the two
products in 2000 and again in 2001. RALs increased substantially in 2000 over
1999 because of the re-instatement of a 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 in 2000. 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.
FUNDING AND LIQUIDITY ISSUES
RALs present the Company with some special funding or liquidity needs. Funds are
needed for lending only the very short period of time that RAL loans are made.
The season starts in the middle of January and continues into April, but even
within that time frame, they are highly concentrated in the first three weeks of
February. The first issue then is that the Company must arrange for very short
term borrowings. A portion of the need can be met by borrowing overnight from
other financial institutions through the use of Federal funds purchased
(unsecured) and repurchase agreements (borrowings collateralized by securities
or loans). These two sources match the short term nature of the RALs and
therefore are an efficient source of funding. However, they are not sufficient
to meet the total need for funds, and once other sources must be utilized,
funding becomes more expensive. The Company must make use of other less
efficient sources, specifically some term advances from the FHLB and brokered
deposits. In 2000, the Company issued approximately $415 million in brokered
certificates of deposit in the first quarter of the year. To obtain these funds
In the relatively short period in which the CDs had to be issued, the Company
had to issue them in two, three, and six month terms. This resulted in funding
costs continuing past the point of the specific need, and it negatively impacted
net interest income.
In 2001, the Company arranged for a different type of short term financing
arrangement using the RALs themselves as collateral. This arrangement, in
conjunction with the overnight borrowing,
29
provided a substantial portion of the funding needed more efficiently and
reduced the need for brokered CDs to $130 million.
For 2002, the Company is again using a combination of funding sources including
the arrangement established for the 2001 season. The program is expected to be
even larger and require more funding in 2002, but as of this writing, the
funding sources arranged have been sufficient.
A portion of the cost of the funding is charged to the program, but some of the
costs, specifically the opportunity cost of holding more liquid and therefore
more easily pledged securities is difficult to allocate.
The balances outstanding during each tax filing season are included in the
average balance for consumer loans shown in Table 2, but there are no such loans
included in the Consolidated Balance Sheets as of December 31, 2001 and 2000,
because all loans not collected from the IRS are charged-off at June 30 of each
year. The fees earned on the RALs are included in the accompanying Consolidated
Income Statements for 2001, 2000 and 1999 within interest and fees on loans. The
fees earned on the RTs are included in other service charges, commissions, and
fees.
The Company expects that the programs will continue to increase in volume
because the IRS is encouraging more taxpayers to file electronically.
ALLOWANCE FOR CREDIT LOSS
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 Statements of Income 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 assign
or allocate 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 GAAP and with the methodologies used in estimating the
unidentified losses in the loan portfolio, the allowance is comprised of several
components.
30
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.
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
$250,000 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 fiveyear 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 assignments 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
assignment 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 assignments.
There are several primary reasons that the other components discussed above
might not be sufficient to recognize the losses present in portfolios. The
fourth or "allocated" component of the allowance is used to provide for the
losses that have occurred because of these reasons.
The first reason 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 reason 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 allocated
allowance needed to be provided at December 31, 2001, Management considered the
following:
o With respect to loans to the agriculture industry, Management considered
the effects on borrowers of weather conditions and overseas market
conditions for exported products;
o 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;
31
o With respect to loans to borrowers who are influenced by trends in the
local tourist industry, Management considered the effects of the terrorist
attacks of September 11 on traveling, weather conditions, tourist
preferences, and the competition faced by borrowers from other resort
destinations and tourist attractions;
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, term loans usually have monthly
scheduled payments of principal and interest. With a term loan, a missed or late
payment gives an immediate signal of a decline in credit quality. However, most
of the Company's commercial loans and lines of credit have short-term maturities
and frequently require only interest payments until maturity. 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 perhaps 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 allocate allowance for the above risk
elements in addition to the allowance assigned by specific or historical loss
factors.
ASSIGNMENT TABLE
Table 8 shows the amounts of allowance assigned for the last three years to each
loan type disclosed in Table 5. 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 assigned to them than do loans
which have less risk.
It would also be expected that the amount assigned for any particular category
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 category. Occasionally, changes in the amount assigned 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. In
general, changes in the risk profile of the various parts of the loan portfolio
should be reflected in the allowance assignment.
32
There is no assignment of allowance to RALs at December 31, 2001 because all
loans unpaid are charged-off prior to year-end. At the bottom of Table 8 is the
ratio of the allowance for credit losses to total loans for each year.
TABLE 8-ASSIGNMENT OF THE ALLOWANCE FOR CREDIT LOSSES
(DOLLARS IN THOUSANDS) DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 1999
-------------------------------------------------------------------------------
PERCENT OF PERCENT OF PERCENT OF
LOANS TO LOANS TO LOANS TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
-------------------------------------------------------------------------------
Real estate:
Residential $ 1,749 26.1% $ 1,870 23.4% $ 2,601 23.7%
Nonresidential 3,578 21.2% 2,789 22.4% 3,038 21.9%
Construction
and development 1,000 6.6% 892 6.8% 935 9.6%
Commercial, industrial,
and agricultural 18,780 31.2% 14,616 30.8% 10,851 29.4%
Home equity lines 747 3.0% 290 2.8% 343 2.4%
Consumer 3,707 6.7% 3,288 8.2% 2,954 7.4%
Leases 4,791 4.5% 3,371 5.1% 1,739 4.6%
Municipal tax-exempt
obligations - 0.3% - 0.2% - 0.6%
Other 1,065 0.4% 730 0.3% 663 0.4%
Not specifically allocated 13,455 7,279 7,330
-------------------------------------------------------------------------------
Total allowance $ 48,872 100.0% $ 35,125 100.0% $ 30,454 100.0%
===============================================================================
Allowance for credit loss
as a percentage of
year-end loans 1.75% 1.40% 1.46%
Year-end loans $2,799,092 $2,517,104 $2,090,033
CREDIT LOSSES
Table 9, "Summary of Credit Loss Experience," shows the additions to,
charge-offs against, and recoveries for the Company's allowance for credit
losses. Also shown is the ratio of charge-offs to average loans for each of the
last five years.
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 0.90% for 2001, 0.63% for 2000, 0.68% for 1999, 1.08%
for 1998, and 1.03% for 1997 (Note C).
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.
33
The lower net charge-offs to average loans ratios experienced by the Company in
the years 1997 and 1998 were in large part due to the high levels of recoveries.
At the end of each of the years 1996 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 2000, there were few such potential recoveries aside from RALs.
As expected, recoveries were less in 2000 and net charge-offs higher than in
prior years. Nonetheless, the 2000 ratio without RALs was still only slightly
more than one half that of the Company's peers. As noted in last year's Annual
Report on Form 10-K, the Company had one loan of approximately $7 million, most
of which was charged-off in 1999 and 2000, for which it had some prospect of
recovery. In fact, the Company recovered approximately $3.3 million of this loan
in 2001. No further amount of this loan is expected to be recovered. In 2001,
the Company's net charge-off ratio to total loans is only slightly more than a
third that of its peers.
34
TABLE 9-SUMMARY OF CREDIT LOSS EXPERIENCE
(DOLLAR IN THOUSANDS)
2001 2000 1999 1998 1997
---------------------------------------------------------------------
Balance of allowance for
credit losses at beginning of year $ 35,125 $ 30,454 $ 30,499 $ 26,526 $ 21,267
---------------------------------------------------------------------
Charge-offs:
Real estate:
Residential 457 112 10 369 498
Nonresidential - 107 252 177 45
Construction and development 127 - - - -
Commercial, industrial,
and agricultural 7,490 8,118 4,924 1,893 2,456
Home equity lines - - 30 - -
Tax refund anticipation 9,189 6,226 5,518 7,221 5,946
Other consumer 6,046 1,910 1,729 1,701 831
---------------------------------------------------------------------
Total charge-offs 23,309 16,473 12,463 11,361 9,776
---------------------------------------------------------------------
Recoveries:
Real estate:
Residential 93 65 175 329 268
Nonresidential 228 184 35 1,341 1,876
Construction and development - - 6 - -
Commercial, industrial,
and agricultural 3,918 1,255 1,162 1,192 1,126
Home equity lines - 26 35 - 326
Tax refund anticipation 4,769 3,059 2,857 2,288 1,524
Other consumer 1,377 976 1,105 871 421
---------------------------------------------------------------------
Total recoveries 10,385 5,565 5,375 6,021 5,541
---------------------------------------------------------------------
Net charge-offs 12,924 10,908 7,088 5,340 4,235
Allowance for credit losses recorded
in acquisition transactions - 1,139 - - 794
Provision for credit losses
refund anticipation loans 4,420 2,726 2,816 4,941 4,649
Provision for credit losses
all other loans 22,251 11,714 4,227 4,372 4,051
---------------------------------------------------------------------
Balance at end of year $ 48,872 $ 35,125 $ 30,454 $ 30,499 $ 26,526
=====================================================================
Ratio of net charge-offs to
average loans outstanding 0.48% 0.46% 0.37% 0.36% 0.33%
Ratio of net charge-offs to
average loans outstanding
exclusive of RALs 0.33% 0.33% 0.23% 0.03% (0.01%)
Average Loans $2,678,225 $2,388,740 $1,908,227 $1,486,696 $1,272,040
Average RALs (58,900) (60,437) (12,391) (9,169) (10,079)
---------------------------------------------------------------------
Average Loans, net of RALs $2,619,325 $2,328,303 $1,895,836 $1,477,527 $1,261,961
=====================================================================
Net Charge-offs $ 12,923 $ 10,908 $ 7,088 $ 5,340 $ 4,235
RAL Net Charges-offs 4,194 3,167 2,661 4,933 4,422
---------------------------------------------------------------------
Net Charge-offs, exclusive of RALs $ 8,729 $ 7,741 $ 4,427 $ 407 $ (187)
=====================================================================
NONACCRUAL, PAST DUE, AND RESTRUCTURED LOANS.
Table 10 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.
35
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 10 on a separate line.
TABLE 10-NONACCRUAL AND PAST DUE LOANS
(DOLLARS IN THOUSANDS)
DECEMBER 31
2001 2000 1999 1998 1997
---------------------------------------------------
Nonaccrual $16,940 $15,975 $15,626 $8,855 $11,709
90 days or more past due 3,179 2,427 715 78 855
Restructured Loans - - 10 - 174
---------------------------------------------------
$20,119 $18,402 $16,351 $8,933 $12,738
===================================================
Total noncurrent loans as percentage
of total loan portfolio 0.72% 0.73% 0.78% 0.53% 0.92%
Allowance for credit losses as a percentage
of noncurrent loans 243% 191% 186% 341% 208%
TABLE 11-FOREGONE INTEREST
(DOLLARS IN THOUSANDS) YEAR ENDED DECEMBER 31
2001 2000 1999
-------------------------
Interest that would have been recorded under original terms $1,296 $2,934 $1,636
Gross interest recorded 593 1,467 772
-------------------------
Foregone interest $ 703 $1,467 $ 864
=========================
Total nonperforming loans increased during 1997 to $12.7 million because of
noncurrent loans in the portfolios of two small banks acquired that year, 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. Despite the slower economy of
2001, and an increase in nonperforming loans of $1.7 million, the ratio of
nonperforming loans to total loans remained the same at the end of 2001 as at
the end of the prior year.
Table 11 sets forth interest income from nonaccrual loans in the portfolio at
year-end that was not recognized.
36
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 12.
TABLE 12-DETAILED DEPOSIT SUMMARY
(DOLLARS IN THOUSANDS) YEAR ENDED DECEMBER 31
2001 2000 1999
---------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
---------------------------------------------------------------------
NOW accounts $ 372,443 0.39% $ 358,921 0.75% $ 321,652 0.70%
Money market deposit accounts 739,040 2.77 707,063 3.85 586,349 3.06
Savings accounts 213,112 1.28 223,795 1.81 230,853 1.86
Time certificates of deposit for
less than $100,000 and IRAs 555,218 5.05 497,230 5.34 478,377 4.74
Time certificates of deposit for
$100,000 or more 630,482 4.82 650,793 5.81 390,038 4.80
---------- ---------- ----------
Interest-bearing deposits 2,510,295 3.31% 2,437,802 4.03% 2,007,269 3.28%
Demand deposits 725,267 703,531 565,525
---------- ---------- ----------
$3,235,562 $3,141,333 $2,572,794
========== ========== ==========
The average rate paid on all deposits, which had increased from 3.28% in 1999 to
4.03% in 2000, decreased in 2001 to 3.31%. The increase from 1999 to 2000 and
the decrease from 2000 to 2001 was primarily due to the changes in interest
rates brought about by Fed actions (Note F). 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.
With time deposit accounts, even when new offering rates are established, the
average rates paid during the year 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 Fed seems to have signaled that there will not be further rate decreases and
the economy is generally expected to recover in mid-2002. Therefore, Management
anticipates that the average deposit rates will be lower in early 2002 than in
2001 as CDs reprice at lower rates while administered rates may start to inch up
later in 2002.
Table 13 discloses the distribution of maturities of CDs of $100,000 or more at
the end of each of the last three years.
TABLE 13-MATURITY DISTRIBUTION OF TIME
CERTIFICATES OF DEPOSIT OF $100,000 OR MORE
(IN THOUSANDS) DECEMBER 31
2001 2000 1999
----------------------------------
Three months or less $451,086 $198,325 $192,347
Over three months through six months 214,821 171,800 121,058
Over six months through one year 118,582 141,109 98,430
Over one year 42,933 60,359 16,225
----------------------------------
$827,422 $571,593 $428,060
==================================
37
The balance of certificates of deposit of $100,000 or more is substantially
higher at the end of 2001 than at year-end 2000. As part of its efforts to fund
the RAL program for 2002, in December 2001 the Company began to issue brokered
certificates with terms of three months or less. As of December 31, 2001, there
were $158 million in short-term certificates that had been issued. In prior
years, the issuance of brokered certificates had not been initiated until
January.
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. Beginning in 1999 and then continuing into 2000, 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, accounting for the increase in the average balances for this
category of asset from 1999 to 2000 in Table 2. There was a slight increase in
average balances from 2000 to 2001 because of an increased use of these
borrowing to fund part of the expansion in the 2001 RAL program. The amounts
outstanding at year end 2001 were less than half the amounts at year-end 2000 as
deposit growth exceeded loan growth during the remainder of 2001.
Information about the balances and rates paid is shown in Note 10 to the
consolidated financial statements. Because these borrowings have only a one-day
maturity, they are extremely responsive to changes in market interest rates. The
average rates paid of 4.66% for 1999, 5.61% for 2000, and 3.64% for 2001 reflect
the pattern of rate changes in Note F after considering that their use is
heavier in the first quarter of the year.
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 shortterm 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 frequently, the Federal funds rate may be quite volatile on the
last day of the year. The higher rate at the end of 1999 than the average for
the year 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. The very low rate at the end of 2001 compared to both the year-end
figure for 2000 and the average rate for 2001 is reflective of the steep decline
in interest rates throughout 2001.
OTHER REAL ESTATE OWNED
Real property owned by the Company that was acquired in foreclosure proceedings
is termed Other Real Estate Owned. As explained in Note 1 to the consolidated
financial statements, the Company held some properties at December 31, 2001 and
2000, 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.
38
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 average nonearning assets to average total assets has increased
during the last three years with an average of 7.12% in 1999, 7.48% in 2000, and
8.23% in 2001. 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. A significant reason for the
increase in 2000 and 2001 has been that after the fire that destroyed the
Company's Administrative Center, additional costs were incurred for leasehold
improvements and furniture related to the new center. The Company completed its
move into a new Operations Center in 2000 and into its new Executive
Headquarters in 2001. 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 also houses SBB&T's Trust and Investment Services division which
had outgrown its former facilities as well. These construction projects coming
within a relatively short space of time have added to the average balance of
nonearning assets. It is not anticipated that there will be a corresponding
increase in 2002. In addition, the Company added approximately $20 million in
nonearning assets due to the goodwill recognized in the LRB acquisition. As of
September 30, 2001, the latest date peer information is available, the average
ratio of nonearning assets to total assets for bank holding companies of
comparable size was 7.56%.
NONINTEREST REVENUE
Fees earned by the Trust and Investment Services Division are a large component
of noninterest revenue, reaching $13.0 million in 2001. Fees decreased by
$821,000 or 6% over fees for 2000 which were in turn $695,000 more than fees in
1999. The market value of assets under administration on which the majority of
fees are based decreased from $2.4 billion at the end of 1999 to $2.1 billion at
the end of 2000, but decreased to $2.0 billion at the end of 2001. 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 and 2001 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 2001 were $957,000 for trusteeship of employee benefit
plans and $1,194,000 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 $14.3 million in 2001 compared to $7.3 million in 2000 and $6.6
million in 1999. 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
39
income in 2002 and beyond. The Company continues to work on increasing
other income and fees due to its importance as a potential contributor to
profitability.
Included in other noninterest income is a gain of $2.9 million from the sale of
the Company's merchant card processing business. There were no assets that were
sold with this business, only the customer relationships. No material costs were
incurred in the disposal. The employees were transferred to other areas. The
Company will share in the revenue from these relationships over the next 10
years. While the sale occurred in 2001, the buyer will not take over all of the
processing until the first quarter of 2002.
OPERATING EXPENSES
Total 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 remained relatively steady
during the last three years. The ratios were 3.96% in 1999, 3.60% in 2000, and
3.71% in 2001.
The ratios for 1999 and 2000 were impacted by some 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. Some of the
increase for 2001 over 2000 is due to increased occupancy expense as the costs
mentioned in "Nonearning Assets" for leasehold improvements began to be
amortized in 2001.
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 54.0 cents in
2001 for each dollar of revenue compared to 59.6 cents for its holding company
peers. In 2000, the ratios were 55.9 cents for the Company and 58.5 cents for
its peers. In 1999, the ratios were 57.9 cents for the Company and 61.2 cents
for its peers. Without the merger expenses of 2000, the Company's ratios would
have been 54.0 cents for 2000.
Within the whole category of operating expense, salary and benefit expenses
increased 26.1% from 1999 to 2001 compared to a 28.5% increase in average
earning assets and a 32.4% growth in net revenues (exclusive of gains or losses
on securities) for the same period.
Net occupancy and equipment expense increased from 1999 to 2001 by 21.2% 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, operations and executive
buildings.
CAPITAL RESOURCES
As of December 31, 2001, 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
40
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%. To be
considered "well-capitalized" the ratio must be at least 10%. At the end of
2001, the Company's ratio was 12.2% The Company also must maintain a Tier 1
capital to risk-weighted asset ratio of 6% and a Tier 1 capital to average
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, 2001 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 10.0% to be considered well-capitalized.
SBB&T's ratio at the end of 2001 was 13.1% and FNB's was 10.6%.
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 increased from 10.5% for year-end 2000 to 12.2%
for year-end 2001. This occurred first as the result of assets growing by 7.7%
from year-end 2000 to year-end 2001 while capital increased by 10.0%. In
addition, the SBB&T issued $36 million in subordinated debt during 2001. While
shown on the 2001 consolidated balance sheet as long-term debt, for the first
half of its term it is included as Tier II capital in the computation of the
Total Capital to Risk-Weighted Asset ratio. In the second half of its 10 year
term, one fifth of the balance will be excluded each year from capitalin this
computation.
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 14.3%. 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 20.4%, 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 12.1%.
During the last several years, the Company has experienced strong loan demand
and expects this to continue. This requires 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 probably
continue to do so in 2002.
The third consideration is that raising additional capital is likely to be
beneficial. 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 additional
41
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 Company, 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.
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 2001, the increase to capital
from the exercise of options (net of shares surrendered as payment for exercises
and taxes) was $2.9 million or 9.8% of the net growth in shareholders' equity in
the year. At December 31, 2001, there were approximately 556,000 options
outstanding and exercisable at less than the then-current market price, with an
average exercise price of $19.98. This represents a potential addition to
capital of $11.1 million, if all options were exercised with cash. Because many
options are likely to be exercised by swapping, some amount less than the $11.1
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.
In 2001, as explained in Note 11 to the consolidated financial statements, the
Company issued $40 million in senior debt. A portion of this was used to repay a
short-term note issued by the Company to partially finance the purchase of LRB.
$20 million of the proceeds was authorized by the Board of Directors to be used
to repurchase stock. Through December 31, 2001, $15.0 million had been used to
purchase in excess of 518,000 shares.
There are no material commitments for capital expenditures or "off-balance
sheet" financing arrangements as of the end of 2001, except as reported in Note
18 to the consolidated financial statements. There are legal limitations on the
ability of the subsidiary banks to declare dividends to the Bancorp based on
earnings over the last three years.
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.
42
The subsidiary banks are required by the provisions of the federal Community
Reinvestment Act ("CRA"), to make significant efforts to ensure that access to
banking services is available to every segment of the community. They are also
required to comply with the provision of various other consumer legislation and
regulations. The Company and the banks must file periodic reports with the
various regulators to keep them informed of their financial condition and
operations as well as their compliance with all the various regulations.
The three regulatory agencies-the FRB for the Company and SBB&T, the California
Department of Financial Institutions for SBB&T, the OCC for FNB-conduct periodic
examinations of the Company and its subsidiary banks to verify that their
reporting is accurate and to ascertain that they are in compliance with
regulations.
A banking agency may take action against a bank holding company or a bank should
it find that the financial institution has failed to maintain adequate capital.
This action has usually taken the form of restrictions on the payment of
dividends to shareholders, requirements to obtain more capital from investors,
and restrictions on operations. The FDIC may also take action against a bank
which is not acting in a safe and sound manner. Given the strong capital
position and performance of the Company and the banks, Management does not
expect to be impacted by these types of restrictions in the foreseeable future.
The Gramm-Leach-Bliley Act was enacted as Federal legislation in late 1999 with
an effective date of March 11, 2000. The provisions of the act permit banking
organizations to enter into areas of business from 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.
43
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 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, at various times strong loan demand
outpaced deposit growth. At these times, the Company had to rely more on
overnight borrowing to maintain immediate liquidity. The rate paid on these
borrowings is more than would be paid for deposits, but aside from this, there
have been no adverse consequences from relying more on borrowing ability than on
holding liquid assets in excess of the immediate amounts needed. The Company's
strong capital position and earnings prospects have meant that these sources of
borrowing have been readily available.
Intermediate liquidity is the ability to raise funds during the next few months
to meet cash obligations over those next few months. Sources of intermediate
liquidity include maturities or sales of commercial paper 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.
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 Statements of Income. 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." 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.
44
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 fullamount 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 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
Nasdaq National Market System.
For the years 2001, 2000, and 1999, the Company has declared cash dividends
which were 32.1%, 40.6%, and 39.0%, respectively, of its net income. The
Company's policy is to pay dividends of approximately 35%-40% of the last 12
months earnings. The lower payout ratio in 2001 was not because the Company
reduced its dividend rate, but because the timing of the declaration of the
quarterly dividends was changed in 2001 as explained in Note 21 to the
consolidated financial statements. Because earnings were significantly reduced
in 2000 by the one-time merger expenses, the ratio for 2000 is higher than
usual. The most recent information for the Company's peers shows an average
payout ratio of 30.0%. 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 ACQUISITIONS
On December 30, 1998, Santa Barbara Bancorp completed its merger with the former
Pacific Capital Bancorp and assumed the name of its merger partner to most
clearly reflect the broad geography of the new multi-bank organization.
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 acquisition was accounted for as a purchase. 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. In the second quarter of 2001, LRB was merged into SBB&T.
45
After the close of business July 31, 2000, the Company completed its merger with
San Benito Bank. 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
San Benito Bank. 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.
In December 2001, the Company signed an agreement with another financial
institution to acquire certain assets and liabilities of two of its branches in
Monterey and Watsonville. The deposits and loans acquired in this transaction
will be combined with FNB's existing branches in those communities. The
transaction is expected to close in the second quarter of 2002.
46
NOTES TO MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
NOTE A
The Company incurred merger related expenses of $7.9 million in 2000 to complete
the acquisition of San Benito Bank and Los Robles Bank. $4.6 million was for
severance, change of control contracts, consulting and computer system
conversion. $3.3 million of provision expense was taken to recognize differences
in loan grading and allowance allocation methods used by the Company and
acquired banks.
NOTE B
Offices obtained in purchase or acquisition transactions are included as a
reason for growth in net income over the last five years, while offices obtained
in pooling or merger transactions are not a reason for growth. This is because
of the difference in the accounting for these two types of business
combinations.
Accounting standards for business combinations accounted for as poolings require
that the figures for prior years be restated as if the combination occurred at
the beginning of the first year presented. Therefore, the assets, deposits, and
net income obtained in pooling transactions are included in both the current
numbers and the prior period numbers and a difference between the two would not
be explained by the transaction. There is no such restatement for prior year
figures for purchase transactions -the balances or net income are included only
from the date of the acquisition.
NOTE C
In various places throughout this discussion, comparisons are made between
ratios for the Company and for its holding company or FDIC peers.
The Bancorp 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 2001, 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 2001,
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 D
For Tables 1, 2, 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
47
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 2 as "Tax equivalent income included
in interest income from non-taxable securities and loans."
NOTE E
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 F
From January 1, 1999 through December 31, 2001, the Fed changed the target rates
for Federal funds as follows:
Amount of New Target
Date Change Rate
June 1999 +0.25% 5.00%
August 1999 +0.25% 5.25%
November 1999 +0.25% 5.50%
February 2000 +0.25% 5.75%
March 2000 +0.25% 6.00%
May 2000 +0.25% 6.50%
January 2001 -0.50% 6.00%
January 2001 -0.50% 5.50%
March 2001 -0.50% 5.00%
April 2001 -0.50% 4.50%
May 2001 -0.50% 4.00%
June 2001 -0.25% 3.75%
August 2001 -0.25% 3.50%
September 2001 -0.50% 3.00%
October 2001 -0.50% 2.50%
November 2001 -0.50% 2.00%
December 2001 -0.25% 1.75%
NOTE G
For purposes of Table 2, loans in a nonaccrual status are included
in the computation of average balances in their respective loan categories.
NOTE H
For purposes of the amounts in Table 3 relating to the volume and rate analysis
of net interest margin, the portion of the change in interest earned or paid
that is attributable to changes in rate is computed by multiplying the change in
interest rate by the prior year's average balance. The portion of the change in
interest earned or paid that is attributable to changes in volume is computed by
multiplying the change in average balances by the prior year's interest rate.
The portion of the change that is not attributable either solely to changes in
volume or changes in rate is prorated on a weighted basis between volume and
rate.
48
NOTE I
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%. By December
31, 2001, the curve started very low at the short end and its shape was quite
steep, as 1 year notes sold at a price that yielded 2.17% and 30 year notes sold
at a price that yielded 5.47%.
NOTE J
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.
49
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have provided the required quantitative and qualitative disclosures about
market risk in Management's Discussion and Analysis on pages 16 through 21.
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 51
Report of Independent Public Accountants-Arthur Andersen LLP 52
Independent Auditors' Report-Deloitte & Touche LLP 53
Consolidated Balance Sheets as of December 31, 2001 and 2000 54
Consolidated Statements of Income for the years
ended December 31, 2001, 2000, and 1999 55
Consolidated Statements of Comprehensive Income for the
years ended December 31, 2001, 2000, and 1999 56
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 2001, 2000, and 1999 57
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000, and 1999 58
Notes to Consolidated Financial Statements 59
The following unaudited supplementary data is included in this Annual Report on
Form 10-K on the page indicated:
Quarterly Financial Data 99
50
MANAGEMENT'S RESPONSIBILITY FOR PACIFIC CAPITAL BANCORP
FINANCIAL REPORTING AND SUBSIDIARIES
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 54 through 58 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 presented in conformity with both accounting
principles generally accepted in the United States and the Federal Financial
Institutions Examination Council Instructions for Consolidated Reports of
Condition and Income. 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, 2001, 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, 2001, 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 President and Executive Vice President and
Pacific Capital Bancorp Chief Executive Officer Chief Financial Officer
Pacific Capital Bancorp Pacific Capital Bancorp
51
REPORT OF INDEPENDENT PUBLIC PACIFIC CAPITAL BANCORP
ACCOUNTANTS AND SUBSIDIARIES
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, 2001 and
2000, 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, 2001. 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 years prior to its merger
during 2000 with Pacific Capital Bancorp in a transaction accounted for as a
pooling of interests, as discussed in Note 19. Such statements are included in
the consolidated financial statements of Pacific Capital Bancorp and
subsidiaries and reflect net income of 5 percent for the year ended December 31,
1999, 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 merger, is based
solely upon the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits and the report of other auditors
provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Pacific Capital Bancorp and subsidiaries as of
December 31, 2001 and 2000, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
- -------------------------
ARTHUR ANDERSEN LLP
Los Angeles, California
February 6, 2002
52
INDEPENDENT AUDITORS' REPORT PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
The Board of Directors and Shareholders,
Pacific Capital Bancorp:
We have audited the statements of income, stockholders' equity, and cash flows
of San Benito Bank for the year ended December 31, 1999 (not presented
separately herein). These financial statements are the responsibility of the
Bank's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit 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 financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of San Benito
Bank for the year ended December 31, 1999, 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
53
CONSOLIDATED BALANCE SHEETS PACIFIC CAPITAL BANCORP
AND SUBSIDIARIES
(AMOUNTS IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS) DECEMBER 31
2001 2000
- ------------------------------------------------------------------------------------------------
ASSETS:
Cash and due from banks (Note 5) $ 136,457 $ 176,274
Federal funds sold and securities purchased under
agreements to resell 94,500 19,500
Total cash and cash equivalents 230,957 195,774
Securities (approximate market value of $778,465
in 2001 and $806,037 in 2000) (Note 2):
Held-to-maturity 71,967 139,294
Available-for-sale 699,076 657,595
Total securities 771,043 796,889
Loans (Note 3) 2,799,092 2,517,104
Less: allowance for credit losses (Note 4) 48,872 35,125
Net Loans 2,750,220 2,481,979
Premises and equipment, net (Note 6) 63,103 53,013
Accrued interest receivable 20,425 25,945
Other assets (Note 8 and 19) 125,181 124,025
- ------------------------------------------------------------------------------------------------
Total assets $3,960,929 $3,677,625
================================================================================================
LIABILITIES:
Deposits (Note 7):
Noninterest bearing demand deposits $ 718,441 $ 709,348
Interest bearing deposits 2,647,134 2,393,471
Total deposits 3,365,575 3,102,819
Securities sold under agreements
to repurchase and Federal funds purchased (Note 10) 45,073 105,658
Long-term debt and other borrowings (Note 11) 188,331 129,658
Accrued interest payable and other
liabilities (Notes 8, 13, and 15) 36,074 43,229
- ------------------------------------------------------------------------------------------------
Total liabilities 3,635,053 3,381,364
- ------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 18)
SHAREHOLDERS' EQUITY (Notes 9, 13 and 17):
Common stock - no par value; $0.33 per share stated value; shares
authorized: 60,000; shares issued and outstanding:
26,207 in 2001 and 26,481 in 2000 8,737 8,828
Preferred stock - no par value; shares authorized: 1,000;
shares issued and outstanding: none - -
Surplus 106,929 115,664
Accumulated other comprehensive income (Note 9) 4,795 4,472
Retained earnings 205,415 167,297
- ------------------------------------------------------------------------------------------------
Total shareholders' equity 325,876 296,261
- ------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $3,960,929 $3,677,625
================================================================================================
The accompanying notes are an integral part of these consolidated statements.
54
CONSOLIDATED STATEMENTS PACIFIC CAPITAL BANCORP
OF INCOME AND SUBSIDIARIES
(IN THOUSANDS, EXCEPT PER SHARE DATA) YEAR ENDED DECEMBER 31
2001 2000 1999
- -------------------------------------------------------------------------------------------------
INTEREST INCOME:
Interest and fees on loans (Note 3) $242,050 $229,014 $174,539
Interest on securities 41,118 49,478 46,248
Interest on Federal funds sold and securities
purchased under agreement to resell 5,852 9,870 4,033
Interest on commercial paper 2,088 1,602 307
- -------------------------------------------------------------------------------------------------
Total interest income 291,108 289,964 225,127
- -------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
Interest on deposits (Note 7) 83,061 98,293 65,894
Interest on securities sold under agreements
to repurchase and Federal funds purchased (Note 10) 3,289 4,247 1,766
Interest on long-term debt and other
borrowings (Note 11) 10,876 7,986 4,815
- -------------------------------------------------------------------------------------------------
Total interest expense 97,226 110,526 72,475
- -------------------------------------------------------------------------------------------------
NET INTEREST INCOME 193,882 179,438 152,652
Provision for credit losses (Note 4) 26,671 14,440 7,043
- -------------------------------------------------------------------------------------------------
Net interest income after provision for credit losses 167,211 164,998 145,609
- -------------------------------------------------------------------------------------------------
NONINTEREST REVENUE:
Service charges on deposit accounts 12,927 11,176 9,608
Trust fees (Notes 1 and 12) 13,006 13,827 13,132
Other service charges, commissions and fees
(Note 12) 31,051 21,757 18,717
Net gain (loss) on sales and calls of securities 309 (143) (268)
Other income (Note 12) 8,433 3,723 2,730
- -------------------------------------------------------------------------------------------------
Total noninterest revenue 65,726 50,340 43,919
- -------------------------------------------------------------------------------------------------
OPERATING EXPENSE:
Salaries and benefits (Notes 13, 15, and 16) 69,788 67,204 55,357
Net occupancy expense (Notes 6 and 18) 12,279 11,225 9,822
Equipment rental, depreciation, and
maintenance (Note 6) 8,327 7,303 7,185
Other expense (Note 12) 52,756 46,225 45,061
- -------------------------------------------------------------------------------------------------
Total operating expense 143,150 131,957 117,425
- -------------------------------------------------------------------------------------------------
Income before provision for income taxes 89,787 83,381 72,103
Provision for income taxes (Note 8) 33,676 31,925 25,570
- -------------------------------------------------------------------------------------------------
NET INCOME $ 56,111 $ 51,456 $ 46,533
=================================================================================================
BASIC EARNINGS PER SHARE (NOTE 16) $ 2.12 $ 1.95 $ 1.78
DILUTED EARNINGS PER SHARE (NOTE 16) $ 2.11 $ 1.93 $ 1.75
=================================================================================================
The accompanying notes are an integral part of these consolidated statements.
55
CONSOLIDATED STATEMENTS OF PACIFIC CAPITAL BANCORP
COMPREHENSIVE INCOME AND SUBSIDIARIES
(IN THOUSANDS) YEAR ENDED DECEMBER 31
2001 2000 1999
- -------------------------------------------------------------------------------------------------
Net income $56,111 $51,456 $ 46,533
- -------------------------------------------------------------------------------------------------
Other comprehensive income, net of tax (Note 8) -
Unrealized gain (loss) on securities:
Unrealized holding gains (losses) arising during period 502 11,154 (10,487)
Reclassification adjustment for (gains) losses
included in net income (179) 83 155
- -------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax 323 11,237 (10,332)
- -------------------------------------------------------------------------------------------------
Comprehensive income $56,434 $62,693 $ 36,201
=================================================================================================
The accompanying notes are an integral part of these consolidated statements.
56
CONSOLIDATED STATEMENTS OF PACIFIC CAPITAL BANCORP
CHANGES IN SHAREHOLDERS' EQUITY AND SUBSIDIARIES
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS) ACCUMULATED
OTHER
COMMON STOCK COMPREHENSIVE RETAINED
SHARES AMOUNT SURPLUS INCOME EARNINGS TOTAL
- ------------------------------------------------------------------------------------------------------------
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, net - - - (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 loss
on securities
available for sale, net - - - 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
Activity for 2001:
Exercise of stock 244 81 6,100 - - 6,181
options (Note 9)
Retirement of (518) (172) (14,835) - - (15,007)
common stock (Note 9)
Cash dividends declared
at $0.66 per share - - - - (17,993) (17,993)
Changes in unrealized loss
on securities
available for sale, net - - - 323 - 323
Net Income - - - - 56,111 56,111
- ------------------------------------------------------------------------------------------------------------
Balance, December 31, 2001 26,207 $8,737 $106,929 $ 4,795 $205,415 $325,876
============================================================================================================
The accompanying notes are an integral part of these consolidated statements.
57
CONSOLIDATED STATEMENTS PACIFIC CAPITAL BANCORP
OF CASH FLOWS AND SUBSIDIARIES
(DOLLARS IN THOUSANDS) YEAR ENDED DECEMBER 31
2001 2000 1999
-----------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 56,111 $ 51,456 $ 46,533
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED BY OPERATIONS:
Depreciation and amortization 10,918 7,963 7,309
Provision for credit losses 26,671 14,440 7,043
Gain on life insurance - - (348)
Benefit for deferred income taxes (7,275) (2,296) (2,181)
Net recovery on other real estate owned - - (6)
Net amortization of discounts and premiums for
securities and bankers' acceptances and
commercial paper (4,074) (7,557) (6,108)
Net change in deferred loan origination fees and costs (905) 1,525 165
Change in accrued interest receivable and other assets 16,630 (7,375) (4,684)
Change in accrued interest payable and other liabilities (1,282) 1,481 (62)
Net loss (gain) on sales and calls of securities (309) 143 286
Decrease in income taxes payable (47) (3,126) (1,758)
Other operating activities - (9,292) (22,683)
- -------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 96,438 47,362 23,506
- -------------------------------------------------------------------------------------------------------------
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 319,779 228,338 253,064
Purchase of securities (289,317) (259,294) (133,627)
Proceeds from sale or maturity of commercial paper 531,343 9,966 49,896
Purchase of commercial paper (531,343) (9,972) (29,805)
Net increase in loans made to customers (294,007) (443,930) (427,684)
Disposition of property from defaulted loans - 5,565 270
Purchase of tax credit investment (7,468) - (6,933)
Net purchase of premises and equipment (18,441) (22,279) (12,031)
Proceeds from sale of equipment - - 45
- -------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (289,454) (524,106) (306,805)
- -------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 262,756 481,362 133,425
Net (decrease) increase in borrowings with maturities
of 90 days or less (60,585) 19,725 52,711
Proceeds from long-term debt and other borrowing 80,955 189,783 80,100
Payments on long-term debt and other borrowing (22,282) (153,500) (26,252)
Proceeds from issuance of common stock (Note 9) 6,181 1,395 2,424
Payments to retire common stock (Note 9) (15,007) - (2,055)
Dividends paid (23,819) (20,868) (18,091)
- -------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 228,199 517,897 222,262
- -------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 35,183 41,153 (61,037)
Cash and cash equivalents at beginning of year 195,774 143,617 204,654
Cash and cash equivalents acquired in acquisitions - 11,004 -
- -------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 230,957 $ 195,774 $ 143,617
=============================================================================================================
SUPPLEMENTAL DISCLOSURE:
Interest paid during the year $ 94,824 $ 94,051 $ 72,238
Income taxes paid during the year $ 33,241 $ 35,090 $ 24,464
Non-cash additions to other real estate owned (Note 1) $ - $ - $ 264
The accompanying notes are an integral part of these consolidated statements.
58
NOTES TO CONSOLIDATED FINANCIAL PACIFIC CAPITAL BANCORP
STATEMENTS AND SUBSIDIARIES
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Pacific Capital Bancorp (the "Company") is a bank holding company organized
under the laws of California. Through its banking subsidiaries, Santa Barbara
Bank & Trust ("SBB&T") and First National Bank of Central California ("FNB"),
the Company provides a full range of commercial banking servicesto 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. A wide range of wealth
management services are offered through the Trust and Investment Services
divisions of SBB&T and FNB. The offices of SBB&T are located in Santa Barbara
and Ventura Counties. 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 Company acquired Los Robles Bank ("LRB") when it purchased
all of the outstanding shares of Los Robles Bancorp in 2000. Initially operated
as a separate banking subsidiary of the Company, LRB was merged into SBB&T at
the end of May 2001.
The Company's third subsidiary is Pacific Capital Commercial Mortgage Company.
Its primary business activities had been directed to brokering commercial real
estate loans and servicing those loans for a fee, but it was made inactive in
2001. A fourth subsidiary, Pacific Capital Services Corporation, is also
inactive.
BASIS OF PRESENTATION
The accounting and reporting policies of the Company are in accordance with 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.
GAAP requires that all amounts and figures presented in the Company's financial
statements be restated for any business combinations that occurred prior to July
1, 2001 that were accounted for as poolings of interest. GAAP does not permit
business combinations after that date to be accounted for as poolings of
interest.
Certain amounts in the 2000 and 1999 financial statements have been reclassified
to be comparable with classifications used in the 2001 financial statements.
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-tomaturity or available-for-sale. This appropriate
classification is decided at the time of purchase.
59
Only those securities that the Company intends to hold and has the ability to
hold until their maturity may be classified as held-to-maturity. Securities that
might be sold prior to maturity because of interest rate changes, to meet
liquidity needs, or to better match the repricing characteristics of funding
sources are classified as available-for-sale. The Company purchases no
securities specifically for later resale at a gain and therefore holds no
securities that should be classified as trading securities.
The Company's securities that are classified as held-to-maturity are reported in
thefinancial statements at "amortized historical cost". This amount 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 is the periodic recognition of interest income above any cash interest
received to increase the carrying amount up to the face value that will be
received at maturity. Accretion thus 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 is a
periodic charge to interest income to reduce the carrying amount to the face
value that will be received at maturity. Amortization reduces the effective
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 securities classified as held to maturity.
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. As the fair value of these securities
changes, the changes are reported net of the tax effect on the consolidated
balance sheets as a separate component of equity captioned "Accumulated other
comprehensive income." The changes in fair value are included as elements of
comprehensive income in the consolidated statements of comprehensive income.
LOANS AND INTEREST AND FEES FROM LOANS
Loans are carried at amounts advanced to the borrowers less principal payments
collected. Interest on loans is calculated on a simple interest basis, that is,
interest is not compounded. The Company collects loan origination and commitment
fees. These fees are not recognized as income when they are collected, but
instead they are offset by certain direct loan origination costs and then
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 the 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 when the loan has become delinquent by more than 90 days.
Nonaccrual status means that the Company stops accruing or recognizing interest
income on the loan. 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 included among 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.
60
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
so that the value of the Company's assets on the financial statements are not
overstated by including within them an uncollectible loan. 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, that is, when a loan becomes
uncollectible. 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.
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 and increased by any recoveries of loans previously
charged-off.
The allowance for credit losses consists of several components. The first
component is that portion of the allowance specifically related 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 determined
portion, a specifically assigned portion, and an allocated portion. These
components are reported together in the allowance for credit loss in the
accompanying consolidated balance sheets and in Note 4. In total, the allowance
for credit losses is maintained at a level considered adequate to provide for
losses inherent in the loan portfolio. 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 for 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.
STATISTICAL OR HISTORICAL LOSS COMPONENT: The amount of this component is
determined by applying loss estimation factors to outstanding loans and leases.
The loss factors are based on the Company's historical loss experience for each
category of credits. Because historical loss experience differs for the various
categories of credits, the loss estimation factors applied to each category also
differ.
61
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 estimate an amount of allowance adequate to absorb the probable
loss that has occurred. The specific component is made up of the sum of these
specific amounts.
ALLOCATED COMPONENT: The allocated component of the allowance for credit losses
is intended to provide for losses that may not be covered by the other
components. Among the considerations addressed by this component are the
following:
o 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;
o the historical loss factors may not give sufficient weight to current
trends in credit quality and collateral values and the duration of the
current business cycle.
o the historical loss factors are not derived in a manner that considers
loan volumes and concentrations and seasoning of the loan portfolio;
o 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
component for impaired loans and specific allocations.
Allocation factors for these considerations are multiplied by the outstanding
balances in the various loan categories to provide for estimated loss.
INCOME TAXES
The Company uses 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. When items of income or
expense are recognized in different years for financial reporting purposes than
for tax return purposes, they represent temporary differences. The Company is
required to provide in its financial statements for the eventual liability or
deduction in its tax return for these temporary differences. The provision is
recorded as they arise in the form of deferred tax expense or benefit,
respectively.
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 and software 3-5 years
TRUST FEES
Fees for most trust services are based on the market value of customer assets,
and the fees are accrued monthly. Fees for unusual or infrequent services are
recognized when the fee can be determined.
62
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 would be used for market repurchases
of shares. The Company receives a tax benefit for the difference between the
market price and the exercise price of non-qualified options. The benefit from
the assumed exercise of options is also assumed to be used to retire 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
business 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
Real estate acquired through foreclosure on a loan or by surrender of the real
estate in lieu of foreclosure is called other real estate owned ("OREO"). OREO
is carried in the Company's financial records 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.
During the time the property is held, all related operating or maintenance costs
are expensed as incurred. Later decreases in the fair value of OREO are charged
to operating expense by establishing valuation allowances in the period in which
they become known. Increases in the fair value may be recognized as reductions
of OREO operating expense but only to the extent that they represent recoveries
of amounts previously written-down. Expenditures related to improvements are
capitalized to the extent that they are realizable through increases in the fair
value of the properties. 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, 2001 and 2000, the Company held real estate properties that had
been acquired through foreclosure, but the value of the property less estimated
disposal costs resulted in no amount being reported on the balance sheets for
those dates.
63
STOCK-BASED COMPENSATION
GAAP permits the Company to use either of two methods for accounting for
compensation cost in connection with employee stock options. The first 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 computes fair value for 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 issuer recognizes
compensation expense regardless of whether the officer or director eventually
exercises the options.
Under the second accounting method, 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 Company believes that the second 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 second method must present pro forma
disclosures of net income and earnings per share as if the first method had been
elected. The Company presents these disclosures in Note 16.
DERIVATIVE FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 133, ACCOUNTING DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS 133"), was issued during the second
quarter of 1998 and was adopted by the Company as of January 1, 2001. The
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.
Derivative financial instruments may be constructed to act as hedges either to
protect against adverse changes in the fair value of or the cash flows
associated with assets, liabilities, firm commitments to purchase or sell
specific assets or liabilities or other probable transactions. The asset,
liability, or firm commitment is referred to as the hedged or underlying item.
The hedge is constructed so that its fair value or cash flows change in response
to certain events in an offsetting manner to the changes in the fair value or
cash flows of the underlying item.
SFAS 133 requires that all derivatives be recorded at their current fair value
on the balance sheet. A change in the fair value of the hedge results in a gain
or loss for the holder, just like changes in the fair value of the underlying
asset or liability being hedged results in a gain or loss for the holder. SFAS
133 specifies how and when the gains and losses relating to both the hedge
itself and the hedged item are recognized. Recognition of the gains and losses
depends on the how the hedge is classified. Under SFAS 133, if certain
conditions are met, derivatives may be specifically classified or designated as
fair value hedges or cash flow hedges.
Fair value hedges are intended to reduce or eliminate the exposure to adverse
changes in the fair value of a specific underlying item. Gains or losses in the
hedging instrument are recognized in the income statement during the period that
the change in fair value occurred. The offsetting gain or loss on the hedged
item which is attributable to the risk being hedged is also recognized in the
income statement for the same period. Hedge ineffectiveness results if the
changes in fair values do not exactly offset. This ineffectiveness is included
in earnings in the period in which it occurs.
Cash flow hedges are intended to hedge exposure to variable cash flows of a
forecasted transaction or an underlying instrument. They are effective to the
extent that the holder receives additional cash flows from the hedge when it
receives lower cash flows from the hedged item and vice-versa. The effective
portion of a hedge gain or loss is initially reported as a component of other
comprehensive income and subsequently reclassified into earnings when the
forecasted transaction affects earnings. The ineffective portion of the gain or
loss is reported in earnings immediately.
64
Hedges meeting certain other criteria may be classified as foreign exchange
hedges. The Company does not currently make use of foreign exchange hedges.
If a hedge does not meet the requirements for designation as one of these
specific categories of hedge, gains or losses associated with changes in its
fair value are immediately recognized in the income statement. The accounting
for the underlying instrument will follow normal accounting policies for the
specific type of asset or liability.
The Company uses interest rate swaps to manage the Company's exposure to
interest rate risks. As of December 31, 2001, the Company held one interest rate
swap designated as a fair value hedge with a notional amount of $28.9 million.
As explained in Note 22, the Company has also entered into covered or offsetting
interest rate swaps with customers and other financial institutions. The
notional amount of these swaps at December 31, 2001 was $16.4 million.
The term "notional amount" is a measure of quantity in a derivative instrument.
In the case of a fair value or cash flow hedge, it will generally be the same
amount as the balance of the underlying asset or liability. In the case of a
nonspecific hedge, the amount may differ from the balance of the underlying
instrument if the Company wishes to hedge risk for only a portion of the
underlying instrument.
GOODWILL
In connection with the acquisition 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, was amortized on the straight-line
method over 15 years. The unamortized carrying amount of the goodwill recorded
for each acquisition was 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, 2001
and 2000.
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS
("SFAS 142"). The Company adopted this statement January 1, 2002 and will change
its accounting for goodwill as described below in the subsection titled
"Accounting for Business Combinations."
COMPREHENSIVE INCOME
Comprehensive income includes all revenues, expenses, gains, and losses that
affect the capital of the Company aside from issuing or retiring shares of
stock. 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. Based on the
Company's current activities, the only other components of comprehensive income
consist 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, 2001,
2000, and 1999 are reported in the Consolidated Statements of Comprehensive
Income. The net change in the cumulative total of the components of other
comprehensive income that are included in equity are reported in the
Consolidated Statements of Changes in Shareholders' Equity for the three years
ended December 31, 2001, 2000, and 1999.
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
65
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
seven reportable segments: Wholesale Lending, Retail Lending, Branch Activities,
Tax Refund Programs, Fiduciary, Northern Region, and All Other. The basis for
this determination and the required disclosure is included in Note 20.
ACCOUNTING FOR BUSINESS COMBINATIONS
The merger of SBB with the Company (Note 19) was 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 combined for each year
presented in the financial statements. The effect of this presentation is as if
the merger had occurred as of the beginning of the earliest period presented.
The assets and liabilities were combined at the amounts carried in the
predecessor company records; there is no restatement to their fair market value,
and consequently no goodwill was 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.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
141, BUSINESS COMBINATIONS ("SFAS 141"). The Company adopted SFAS 141
immediately. Effective for transactions initiated after June 30, 2001, the
statement requires all subsequent business combinations to be accounted for by
the purchase method of accounting.
With the adoption of SFAS 142, goodwill recorded in connection with the
acquisition of a business is no longer subject to amortization over its
estimated useful life. Rather, goodwill will be subject to at least an annual
assessment for impairment by applying a fair-value-based test. The Company will
be required to determine the reporting units at which goodwill impairment will
be assessed. (See Note 20). While the company has not yet conducted its annual
assessment for impairment, we do not believe that any material impairment of
goodwill has occurred. Additionally, an acquired intangible asset will be
separately recognized if the benefit of the intangible asset is obtained through
contractual or other legal rights, or if the intangible asset can be sold,
transferred, licensed, rented, or exchanged, regardless of the acquirer's intent
to do so. Such intangible assets are subject to amortization over their useful
lives. As of January 1, 2002, the Company ceased amortizing the goodwill that
had resulted from purchase transactions entered into prior to the adoption of
SFAS 142.
OTHER RECENT ACCOUNTING PRONOUNCEMENTS
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.
66
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 is 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. The adoption of SFAS 140 did not have a material
impact on the Company's financial position or results of operations.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS. This statement specifies how
the Company is to account for and report costs and obligations resulting from
the retirement of tangible long-lived assets. The statement is intended to
ensure consistency in accounting and reporting for these costs and obligations
and to provide more information about the future cash outflows, leverage and
liquidity of such assets. This statement will become effective for the Company
on January 1, 2003 and is not expected to have a material effect on the
Company's financial position or results of operation.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS ("SFAS
144"). This statement specifies how the Company is to account for and report the
impairment or disposal of long-lived assets. It supercedes or amends previous
pronouncements including Statement of Financial Accounting Standards No. 121,
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO
BE DISPOSED OF, Accounting Principles Board Opinion No. 30, REPORTING THE
RESULTS OF OPERATIONS-REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A
BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND
TRANSACTIONS, and Accounting Research Bulletin No. 51, CONSOLIDATED FINANCIAL
STATEMENTS. The Company adopted SFAS 144 on January 1, 2002. The adoption of
this statement did not have a material effect on the Company's financial
position or results of operation.
67
2. SECURITIES
A summary of securities owned by the Company at December 31, 2001 and 2000, is
as follows:
DECEMBER 31, 2001
-------------------------------------------------------
(IN THOUSANDS) GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------------------------------------------------------
Held-to-maturity:
Collateralized mortgage obligations $ 5 $ - $ - $ 5
State and municipal securities 71,962 7,422 - 79,384
-------------------------------------------------------
71,967 7,422 - 79,389
-------------------------------------------------------
Available-for-sale:
U.S. Treasury obligations 152,911 2,755 (191) 155,475
U.S. agency obligations 320,985 4,844 (1,919) 323,910
Collateralized mortgage obligations 104,251 1,559 (130) 105,680
Asset-backed securities 11,662 4 (6) 11,660
State and municipal securities 100,990 3,228 (1,867) 102,351
-------------------------------------------------------
690,799 12,390 (4,113) 699,076
-------------------------------------------------------
$762,766 $19,812 $(4,113) $778,465
=======================================================
DECEMBER 31, 2000
-------------------------------------------------------
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 (230) 77,320
-------------------------------------------------------
649,607 9,455 (1,467) 657,595
-------------------------------------------------------
$788,901 $19,089 $(1,953) $806,037
=======================================================
The amortized cost and estimated fair value of debt securities at December 31,
2001 and 2000, 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.
68
DECEMBER 31, 2001 DECEMBER 31, 2000
(IN THOUSANDS) HELD-TO- AVAILABLE- HELD-TO- AVAILABLE-
MATURITY FOR-SALE TOTAL MATURITY FOR-SALE TOTAL
--------------------------------- ---------------------------------
Amortized cost:
In one year or less $ 9,594 $167,363 $176,957 $ 31,869 $155,031 $186,900
After one year through five years 14,717 423,763 438,480 47,624 409,528 457,152
After five years through ten years 12,235 14,839 27,074 18,232 21,214 39,446
After ten years 35,421 84,834 120,255 41,569 63,834 105,403
--------------------------------- ---------------------------------
Total Securities $ 71,967 $690,799 $762,766 $139,294 $649,607 $788,901
================================= =================================
Estimated market value:
In one year or less $ 9,686 $170,849 $180,535 $ 31,981 $155,126 $187,107
After one year through five years 16,236 427,499 443,735 49,534 412,430 461,964
After five years through ten years 13,701 14,988 28,689 19,339 21,332 40,671
After ten years 39,766 85,740 125,506 47,588 68,707 116,295
--------------------------------- ---------------------------------
Total Securities $ 79,389 $699,076 $778,465 $148,442 $657,595 $806,037
================================= =================================
The proceeds received from sales orcalls of debt securities and the gross gains
and losses that were recognized for the years ended December 31, 2001, 2000, and
1999 are shown in the next table.
(IN THOUSANDS) 2001 2000 1999
----------------------------- ----------------------------- ---------------------------
GROSS GROSS GROSS GROSS GROSS GROSS
PROCEEDS GAINS LOSSES PROCEEDS GAINS LOSSES PROCEEDS GAINS LOSSES
----------------------------- ----------------------------- ---------------------------
Held-to-maturity:
Sales $ 379 $ 9 $ (4) $ 29,995 $ - $ (33) $ - $ - $ -
Calls $ 1,680 $ 2 $ - $ 7,518 $ 7 $ (2) $ 6,662 $ - $ -
Available-for-sale:
Sales $28,383 $412 $(142) $112,146 $ - $(120) $19,674 $ - $(268)
Calls $45,325 $ 32 $ - $ 11,640 $ 1 $ - $63,340 $ - $ -
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 and FNB are members of the FHLB, and purchased
stock as required of members. While technically these are considered equity
securities, there is no market for the FRB and FHLB stock and the shares are
considered as restricted investment securities and reported among other assets,
on the Consolidated Balance Sheets. Such investments are carried at cost and
periodically evaluated for impairment.
Securities with a book value of approximately $726.5 million at December 31,
2001, and $647.0 million at December 31, 2000, were pledged to secure public
funds, trust deposits and other borrowings as required or permitted by law.
69
3. LOANS
The loan portfolio consists of the following:
(IN THOUSANDS) DECEMBER 31
2001 2000
----------------------------
Real estate:
Residential $ 728,026 $ 586,904
Nonresidential 593,675 564,556
Construction and development 185,264 172,331
Commercial, industrial, and agricultural 874,294 775,365
Home equity lines 85,025 71,289
Consumer 187,949 205,992
Leases 126,744 129,159
Municipal tax-exempt obligations 8,043 4,102
Other 10,072 7,406
----------------------------
$2,799,092 $2,517,104
============================
The amounts above are shown net of deferred loan origination, commitment, and
extension fees and origination costs of $4.9 million for 2001 and $5.8 million
for 2000.
IMPAIRED LOANS
The table below discloses information about the loans classified as impaired and
the valuation allowance related to them:
(IN THOUSANDS) DECEMBER 31
----------------------
2001 2000
Loans identified as impaired $8,787 $9,256
Impaired loans for which a valuation
allowance has been determined $8,787 $9,256
Impaired loans for which no valuation
allowance has been determined $ - $ -
Amount of valuation allowance $2,348 $3,260
YEAR ENDED DECEMBER 31
2001 2000
----------------------
Average amount of recorded investment
in impaired loans for the year $10,175 $7,932
Interest recognized during the year for
loans identified as impaired at year-end $ 72 $ 571
Interest received in cash during the year
for loans identified as impaired at year-end $ 72 $ 571
As indicated in Note 1, a valuation allowance is established for an impaired
loan when the fair value ofthe 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, 2001. The valuation allowance amounts disclosed
above are included in the allowance for credit losses reported in the balance
sheets for December 31, 2001 and 2000 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
70
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 document is signed by the customer, the
Company reports the fees as interest income. These fees totaled $26.4 million in
2001, $19.0 million for 2000, and $8.1 million for 1999. 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, 2001 or 2000.
PLEDGED LOANS
At December 31, 2001 loans secured by first trust deeds on residential and
commercial property with principal balances totaling $80.3 million were pledged
as collateral to the Federal Reserve Bank of San Francisco. At December 31,
2001, loans secured by first deeds on residential and commercial property with
principal balances of $631.6 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
2001 2000 1999
----------------------------------
Balance, beginning of year $ 35,125 $ 30,454 $30,499
Addition of allowance from Los Robles Bank - 1,139 -
Tax refund anticipation loans:
Provision for credit losses 4,420 2,726 2,816
Recoveries on loans previously
charged-off 4,769 3,059 2,857
Loans charged-off (9,189) (6,226) (5,518)
All other loans:
Provision for credit losses 22,251 11,714 4,227
Recoveries on loans previously
charged-off 5,616 2,506 2,518
Loans charged-off (14,120) (10,247) (6,945)
----------------------------------
Balance, end of year $ 48,872 $ 35,125 $30,454
==================================
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 $4.0 million in 2001 and $2.6 million in 2000. 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.
71
6. PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
(IN THOUSANDS) DECEMBER 31
2001 2000
----------------------
Land $ 5,175 $ 5,175
Buildings and improvements 22,043 21,927
Leasehold improvements 25,931 25,754
Furniture and equipment 56,673 51,968
Software 9,715 -
----------------------
Total cost 119,537 104,824
Accumulated depreciation
and amortization (56,434) (51,811)
----------------------
Net book value $ 63,103 $ 53,013
======================
Depreciation and amortization on fixed assets included in operating expenses
totaled $8.3 million in 2001, $6.3 million in 2000, and $5.9 million in 1999.
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
2001 2000 2001 2000 1999
------------------------- --------------------------------
Noninterest bearing deposits $ 718,441 $ 709,348 $ - $ - $ -
Interest bearing deposits:
NOW accounts 386,870 372,136 1,438 2,680 2,250
Money market deposit accounts 730,494 743,268 20,451 27,216 17,914
Other savings deposits 213,018 210,157 2,730 4,060 4,300
Time certificates of $100,000
or more 827,422 571,593 31,958 38,914 18,735
Other time deposits 489,330 496,317 26,484 25,423 22,695
------------------------- --------------------------------
$3,365,575 $3,102,819 $83,061 $98,293 $65,894
========================= ================================
72
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
2001 2000 1999
-------------------------------------
Federal:
Current $29,880 $24,210 $19,251
Deferred (5,500) (1,177) (1,911)
-------------------------------------
24,380 23,033 17,340
-------------------------------------
State:
Current 11,071 9,033 8,500
Deferred (1,775) (141) (270)
-------------------------------------
9,296 8,892 8,230
-------------------------------------
Total tax provision $33,676 $31,925 $25,570
=====================================
Reduction in taxes payable
associated with exercises of
stock options $(1,602) $(1,661) $(3,915)
The total current provision for income taxes includes a debit of $130,000 for
securities gains realized in 2001 and credits of $60,000 for securities losses
realized in 2000 and $113,000 for losses realized in 1999.
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
2001 2000 1999
---------------------------
Tax provision at Federal statutory rate 35.0% 35.0% 35.0%
Interest on securities exempt from Federal taxation (3.8) (4.3) (5.2)
State income taxes, net of Federal income tax benefit 6.6 6.9 8.9
ESOP dividends deductibleas an expense for tax purposes (0.5) (0.5) (0.7)
Goodwill amortization 1.0 0.9 0.9
Merger related costs - 0.8 -
Other, net (0.8) (0.5) (3.4)
---------------------------
Actual tax provision 37.5% 38.3% 35.5%
===========================
As disclosed in the following table, deferred tax assets as of December 31,
2001, and 2000, totaled $25.9 million and $16.7 million, respectively. These
amounts are included within other assets on the balance sheet. The combined
Federal and State deferred tax provision or tax 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 from December 31, 1999 to December 31, 2000 and from
December 31, 2000 to December 31, 2001 are disclosed in the following table.
73
TAX TAX
(IN THOUSANDS) EFFECT EFFECT ACQUIRED
2001 2001 2000 2000 COMPONENTS 1999
-------------------------------------------------------------------
Deferred tax assets:
Allowance for credit losses $20,356 $6,148 $14,208 $1,515 $ 256 $12,437
State taxes 3,585 528 3,057 646 139 2,272
Loan fees 663 (97) 760 261 (10) 509
Depreciation 398 (589) 987 (56) (6) 1,049
Postretirement benefits 500 (206) 706 (39) - 745
Other real estate owned 25 - 25 - - 25
Nonaccrual interest 1,143 854 289 (65) - 354
Accretion on securities (202) (202) - (77) - 77
Accrued salary continuation plan 1,628 (29) 1,657 (163) - 1,820
Change in control payments 942 (79) 1,021 (78) - 1,099
Deferred Compensation 3,008 3,008 - (155) - 155
Gain on demutualization of
of insurance company (160) (160) - 156 - (156)
Accrual for BOLI 508 - 508 508 - -
Other - (472) 473 (318) 461 330
-------------------------------------------------------------------
32,394 8,704 23,691 2,135 840 20,716
-------------------------------------------------------------------
Deferred tax liabilities:
Loan costs 2,283 529 1,754 248 - 1,506
Federal effect of state tax asset 1,903 621 1,282 120 58 1,104
Other 878 279 599 449 - 150
-------------------------------------------------------------------
Total deferred tax liabilities 5,064 1,429 3,635 817 58 2,760
-------------------------------------------------------------------
Net deferred tax asset
before unrealized gains and
losses on securities 27,330 7,275 20,056 1,318 782 17,956
Unrealized (gains) and losses
on securities (1,452) - (3,362) - 223 4,897
-------------------------------------------------------------------
Net deferred tax asset $25,878 $7,275 $16,694 $1,318 $1,005 $22,853
===================================================================
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 because the Company would have received a deduction for
the loss had the securities been sold as of the end of the year. The tax effect
would be a deferred tax liability if there is a net unrealized gain, because the
Company would owe additional taxes had the securities been sold as of the end of
the year. However, changes in the unrealized gains or losses are not recognized
either in net income or in taxable income, and therefore they do not represent
temporary differences between reported financial statement income and taxable
income reported on the Company's tax return. 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.
74
9. SHAREHOLDER'S 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
five 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, whichever is later.
In 1998, the Board of Directors of the Company eliminated this provision.
The remaining plans were established by the former Pacific Capital Bancorp prior
to its merger with the Company and by 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 $2,576,000,
$2,756,000, and $6,747,000 were surrendered in the years ended December 31,
2001, 2000, and 1999, 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, 2001, 2000, and 1999 (adjusted for stock splits and
stock dividends).
75
PER SHARE
OPTIONS PRICE RANGES
2001
Granted 94,817 $26.20 to $30.03
Exercised 372,999 $ 5.17 to $29.98
Cancelled and expired 6,920 $12.63 to $34.71
Outstanding at end of year 1,021,854 $ 5.17 to $34.71
Range of expiration dates 5/1/02 to 2/1/12
Exercisable at end of year 771,622 $ 5.17 to $34.71
Shares available for future grant 1,736,964
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
Exercisable at end of year 954,414 $ 5.17 to $34.71
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
In July 2001, the Board of Directors authorized the use of up to $20 million for
the repurchase of shares of the Company's stock from time to time as Management
deems the price to be favorable. During the 2001, approximately $15.0 million
had been spent in repurchasing 518,000 shares.
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
2001 2000 1999 2001 2000 1999
-------------------------------------- ----------------------------------------
Weighted average interest
rate at year-end 1.29% 5.71% 5.27% 1.63% 6.59% 5.50%
Weighted average interest
rate for the year 3.64% 5.61% 4.66% 4.31% 5.40% 4.94%
Average outstanding
for the year $60,250 $61,772 $29,214 $ 25,381 $14,425 $ 8,183
Maximum outstanding
at any month-end
during the year $79,919 $78,736 $61,085 $141,800 $47,200 $35,100
Amount outstanding
at end of year $35,873 $79,458 $45,407 $ 9,200 $26,200 $35,100
Interest expense $ 2,194 $ 3,468 $ 1,364 $ 1,095 $ 779 $ 402
76
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, 2001, total
outstanding balances to the FHLB were $99 million. There were $16.4 million in
scheduled maturities of the advances of 1 year or less, $44.6 million in 1 to 3
years, and $38.0 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
required quarterly payments of interest and principal with a maturity of June
30, 2001. The note was extended to permit repayment of the remaining $12.5
million from the proceeds of $40 million in senior notes issued by the Company
in July 2001. These notes bear an interest rate of 7.54%, payable semi-annually
and mature in July 2006. SBB&T also issued $36 million in subordinated debt in
July 2001. These notes bear an interest rate of 9.22%, payable semi-annually and
mature in July 2011. As subordinated notes, they are included as Tier II capital
for the risk-based capital ratio computations of the Company and SBB&T as
discussed in Note 17.
Also included in other borrowings at December 31, 2001, are $13.3 million of
Treasury Tax and Loan demand notes issued to the U.S. Treasury and miscellaneous
other borrowings.
During the course of 2001, 2000, and 1999, the Company borrowed funds for
liquidity purposes from the discount window at the Federal Reserve Bank.
12. NONINTEREST REVENUE AND OPERATING EXPENSE
Significant items included in amounts reported in the Consolidated Statements of
Income for the years ended December 31, 2001, 2000, and 1999 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.
DECEMBER 31
(IN THOUSANDS) 2001 2000 1999
------------------------------
Noninterest revenue
Merchant credit card processing $ 8,174 $8,055 $5,925
Refund transfer fees $14,298 $7,291 $6,591
Included in other noninterest revenues is a gain of $2.9 million from the sale
of the Company's merchant card processing business. There were no assets that
were sold with this business, only the customer relationships. No material costs
were incurred in the disposal. The employees were transferred to other areas.
The Company will share in the revenue from these relationships over the next 10
years. While the sale occurred in 2001, the buyer is not anticipated to take
over all of the processing until the first quarter of 2002.
The table below discloses the largest items included in operating expense.
Consultants include the Company's independent accountants, attorneys, and other
management consultants used for special projects.
77
DECEMBER 31
(IN THOUSANDS) 2001 2000 1999
------------------------------
Operating expense
Marketing $3,693 $3,166 $ 3,046
Consultants 5,727 7,469 10,574
Merchant credit card clearing fees 6,453 6,412 4,396
Software expense 3,756 2,551 2,549
Amortization of goodwill 2,564 2,055 1,401
Telephone and wires 4,383 3,304 2,764
The FDIC has established a reserve fund for the purpose of covering the losses
of deposit customers of failed financial institutions. The FDIC may assess
premiums of commercial banks based on the amount of their deposits whenever the
fund is less than a specified percentage of deposits in the banking system. The
FDIC has not assessed these premiums for several years, but it has indicated
that it may do so in 2002 or 2003. It has suggested an annual premium rate of up
to five basis points. That would result in an annual premium charge of
approximately $1.5 million to the Company.
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, 2001, the ESOP held 1,386,369 shares at an average cost of
$9.04 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 2001, 2000, and 1999, the employer's matching
contributions were $2.0 million, $1.7 million and $1.3 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. Through the end of 2001, 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
$3,672,000 in 2001, $2,788,000 in 2000, and $2,879,000 in 1999. Aside from the
employer's matching contribution to the Salary Savings Plan or 401(k) component
of the profit-sharing plan, the contributions went to the Incentive & Investment
Plan in 2001 and to the ESOP in 2000 and 1999.
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.
78
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 certain
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.
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.
Fair values for off-balance-sheet, credit related financial instruments are
based on fees currently charged to enter into similar agreements, taking into
account the remaining terms of the agreements and the counterparties' credit
standing. Fair values for off-balance-sheet derivative financial instruments,
for other than trading purposes, are based upon quoted market prices, except in
the case of certain options and swaps where pricing models are used.
The carrying amount and estimated fair values of the Company's financial
instruments as of December 31, 2001 and 2000, are as follows:
79
AS OF DECEMBER 31, 2001 AS OF DECEMBER 31, 2000
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------------------------- ----------------------------
Cash and due from banks $ 136,457 $ 136,457 $ 176,274 $ 176,274
Federal funds sold 94,500 94,500 19,500 19,500
Securities available-for-sale 699,076 699,076 657,595 657,595
Securities held-to-maturity 71,967 79,389 139,294 148,442
Net loans 2,750,220 2,808,640 2,481,979 2,440,099
Total financial assets $3,752,220 $3,818,062 $3,474,642 $3,441,910
Deposits $3,365,575 $3,376,817 $3,102,819 $3,105,378
Long-term debt, FHLB $ 175,000 $ 185,655 103,000 106,802
Advances
Repurchase agreements,
Federal funds purchased, and
Treasury Tax & Loan 58,404 58,407 132,316 132,286
Total financial liabilities $3,598,979 $3,620,879 $3,338,135 $3,344,466
Unrecognized financial
instruments:
Interest rate swap contracts $ - $ (1,924) $ - $ (1,336)
Standby letters of credit $ - $ 40,677 $ - $ 38,781
15. OTHER POSTRETIREMENT BENEFITS
All eligible retirees may obtain health insurance coverage through the Company's
Retiree Health Plan ("the Plan"). The coverage is provided through basic
coverage plan provided for current employees. The cost of this coverage is that
portion of the total premium paid for the whole which relates to retirees. 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 for retirees. Though the
premiums for retiree health coverage is not paid until after the employee
retires, the Company is required to recognize 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
net present value is that amount which if compounded at an assumed interest rate
would equal the amount expected to be paid in the future.
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) already retired
employees' 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 as this impacts how
soon it would be expected that the Company will begin making payments; (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, like the compounding of interest, 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, 2001, 2000, and 1999.
80
(IN THOUSANDS) YEAR ENDED DECEMBER 31
2001 2000 1999
------------------------------------
Benefit obligation, beginning of year $(5,326) $(4,584) $(4,170)
Service cost (351) (257) (315)
Interest cost (398) (346) (270)
Actuarial (losses) gains (3,849) (209) 111
Benefits paid 72 70 60
------------------------------------
Benefit obligation, end of year (9,852) (5,326) (4,584)
------------------------------------
Fair value of Plan assets, beginning of year 6,253 6,731 4,486
Actual return on Plan assets (1,241) (408) 2,305
Employer contribution - - -
Benefits paid (72) (70) (60)
------------------------------------
Fair value of Plan assets, end of year 4,940 6,253 6,731
------------------------------------
Funded Status (4,912) 928 2,147
Unrecognized net actuarial loss (gain) 3,972 (1,624) (2,867)
Unrecognized prior service cost - - 1
------------------------------------
Accrued benefit cost $ (940) $ (696) $ (719)
====================================
Costs of $940,000 for December 31, 2001, and $696,000 for December 31, 2000, 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, is made up of several components:
o Service cost Each year employees earn a portion of their
eventual benefit. This component is the net
present value of that portion.
o Interest cost Each year the benefit obligation for each
employee is one year closer to being paid and
therefore increases in amount closer to the
eventual benefit payment amount. This component
represents that increase resulting from the
passage of another year.
o Return on assets Income is earned on any investments that have
been set aside to fund the eventual benefit
payments. This component is an offset to the
first two components.
o Amortization cost 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
81
APBO or in the value of plan assets. This
component recognizes a portion of the
experience gains and losses.
o Prior service cost At the adoption of the Plan, the Company fully
recognized the net present value of the
benefits credited to employees for service
provided prior to the adoption of the plan. Had
the Company not recognized this amount, a
portion of it would be included as a fifth
component.
The following table shows the amounts for each of the components of the NPPBC.
The total amount is included with the cost of other employee benefits in the
Consolidated Statements of Income.
(in thousands) YEAR ENDED DECEMBER 31
2001 2000 1999
------------------------------------
Service cost $ 351 $ 257 $ 315
Interest cost 398 346 270
Return on assets (431) (466) (296)
Amortization cost (74) (160) (24)
------------------------------------
Net periodic postretirement cost $ 244 $ (23) $ 265
====================================
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
2001 2000 1999
------------------------------------
Discount rate 7.10% 7.61% 7.71%
Expected return on plan assets 7.00% 7.00% 7.00%
Health care inflation rate for retired
participants 5.00% 5.00% 5.00%
Health care inflation rate for current Graded
employees Rates 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 in any year is greater than this estimate, the Company will have
what is an experience gain, and an experience loss if the rate of return is
less.
As noted above, the Company's contribution for insurance premiums for retirees
is 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 of more than 5% 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.
82
Because of a significant increase in health insurance premiums during 2001, the
Company has changed its assumption for the health care inflation rate for
current employees. The rate assumed for 2002 is 12%. The rates assumed for
subsequent years gradually decrease each year to 5% in 2009 and thereafter. 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, 2001, and December 31, 2000, the Company had unamortized or
unrecognized loss of $3,972,000 and gain of $1,624,000, respectively. These
amounts are reported in the first table of this note.
FUNDING OF THE RETIREE HEALTH PLAN
Employers are allowed wide discretion as to whether and how they set aside funds
to meet the obligation they are recognizing. Under the provisions of the current
Internal Revenue Code, only a portion of this funding may be deducted by the
employer. The funded status of the plan is shown in the first table as the
amount by which the plan assets exceed the APBO.
The Company established a Voluntary Employees' Beneficiary Association ("VEBA")
to hold the assets that will be used to pay the benefits for participants of the
plan other than key executive officers. Most of the plan assets have been
invested in insurance policies on the lives of various employees of the Company.
The current funding policy of the Company is to contribute assets to the VEBA at
least sufficient to pay the costs of current medical premiums of retirees. In
some years the Company also contributes assets to pay the costs of the life
insurance premiums. In those years that the Company does not contribute assets
for the payment of the life insurance premiums, assets in the VEBA are used to
pay the premiums. Proceeds from the life insurance policies payoffs will fund
benefits and premiums in the future. If the assets of the VEBA are more than the
APBO related to employees of the Company not defined as key employees, the VEBA
is overfunded.
If the assets of the VEBA are less than the APBO related to employees of the
Company not defined as key employees, the VEBA is underfunded. As of December
31, 2001, the VEBA was underfunded by $3,453,000. The APBO related to the key
employees of $1,459,000 is totally unfunded.
83
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.
Basic Diluted
Earnings Earnings
(amounts in thousands other than per share amounts) Per Share Per Share
--------- ---------
For the Year Ended December 31, 2001
Numerator - Net Income $56,111 $56,111
Denominator - weighted average shares outstanding 26,508 26,508
Plus: net shares issued in assumed stock option exercises 131
Diluted denominator 26,639
Earnings per share $ 2.12 $ 2.11
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 option 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 option exercises 449
Diluted denominator 26,552
Earnings per share $ 1.78 $ 1.75
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 fair market value of the stock at the time of the
grant.
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, 2001, 2000, and 1999 would have been as follows:
84
YEAR ENDED DECEMBER 31
(in thousands except per share amounts) 2001 2000 1999
--------------------------------
Salary expense:
As reported $56,919 $54,931 $46,416
Pro forma $58,104 $56,208 $47,789
Net Income:
As reported $56,111 $51,456 $46,533
Pro forma $55,424 $50,716 $45,737
Earnings Per Share:
As reported $ 2.11 $ 1.93 $ 1.75
Pro forma $ 2.08 $ 1.91 $ 1.72
Diluted average shares 26,639 26,609 26,552
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, 2001 and 2000. 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 a portion of the allowance for credit losses
and the subordinated debt mentioned in Note 11. 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.
85
(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, 2001
Total Tier I & Tier II Capital
(to Risk Weighted Assets) $ 363,887 12.2% $ 238,038 8.0% $ 297,547 10.0%
Tier I Capital
(to Risk Weighted Assets) $ 290,922 9.8% $ 119,019 4.0% $ 178,528 6.0%
Tier I Capital
(to Average Tangible Assets) $ 290,922 7.7% $ 151,193 4.0% $ 188,991 5.0%
Risk Weighted Assets $2,975,471
Average Tangible Assets $3,779,827
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, 2001, 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 riskbased 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, 2001 and
at December 31, 2000. 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
Risk Weighted Risk Weighted to Average
As of December 31 Assets Assets Tangible Assets
------------------ ----------------- ---------------
SBB&T
2001 13.09% 9.98% 7.72%
2000 10.28% 9.06% 7.00%
FNB
2001 10.56% 9.30% 7.97%
2000 9.30% 10.55% 7.35%
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 amounts which may be paid as dividends by banks are determined
based on the banks' capital accounts and earnings in prior years. As of December
31, 2001, the subsidiary banks would have been permitted to pay up to $71.4
million to Bancorp.
86
18. COMMITMENTS AND CONTINGENCIES
Leases 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, 2001, 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-
2002 2003 2004 2005 2006 after Total
------------------------------------------- -------- -------
Non-cancelable
lease expense $6,946 $5,981 $5,640 $4,810 $4,343 $10,532 $38,252
Total rental expense, net of sublease income for premises included in operating
expenses are $6.0 million in 2001, $5.9 million in 2000, and $5.1 million in
1999. One of the branch offices obtained through acquisition in 2000 is not
currently being used. The property is leased and the Company is evaluating its
potential for reuse as a branch or for sublease. If it is determined that it
cannot be used for the Company's banking activities and cannot be subleased, a
loss may have to be recognized by the Company for the remaining required lease
payments and the unamortized cost of the leasehold improvements.
RELATED PARTIES
In the ordinary course of business, the Company has extended credit to directors
and executive employees of the Company totaling $15.4 million at December 31,
2001 and $13.9 million at December 31, 2000. Such loans are subject to
ratification by the Board of Directors, exclusive of the borrowing director.
Among the office space leased by the Company are two buildings leased from
related parties. The first building is leased from a partnership in which a
company director has an interest. In February 1999, this 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
commercial real estate consultant. As a result of arms length negotiations with
the partnership, the consultant believed that the terms of the transaction were
fair and reasonable to the Company. The terms of the lease were approved by the
Company's Board of Directors.
The second building is leased from a partnership in which a director of one of
the Company's subsidiary banks has an interest. The original terms of the lease
were negotiated with the assistance of two independent, outside appraisers, and
the lease was approved by the board of directors of the former Pacific Capital
Bancorp. That company exercised its option to renew the lease in 1989. In 1994,
the Company renegotiated the lease to receive other rights such as additional
lease option periods and a right of first refusal to purchase the building if it
is offered for sale. A nominal monthly rent increase was agreed to in order to
obtain these benefits, but the actual outlay was reduced in order for the
Company to be reimbursed for advancing the partnership's share of seismic
improvements made to the leased property in 1994. The lease was again amended in
1999 which gave the Company five options to extend the term for 12 months each.
Management believes the terms of the revised and amended lease are comparable
with terms which would have been available from unaffiliated third parties at
the time the negotiations occurred and the terms were approved by the subsidiary
bank's board of directors.
87
LETTERS OF CREDIT
In order to meet the financing needs of its customers in the normal course of
business, the Company is a party to financial instruments with "off-balance
sheet" risk. These financial instruments consist of commitments to extend credit
and standby letters of credit.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. The Company
has not usually charged fees in connection with loan commitments. Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. The Company charges a fee for
these letters of credit.
The standby letters of credit involve, to varying degrees, exposure to credit
risk in excess of the amounts recognized in the consolidated balance sheets.
This risk arises from the possibility of the failure of the customer to perform
according to the terms of a contract. In such a situation the third party might
draw on the standby letter of credit to pay for completion of the contract and
the Company would have to look to its customer to repay these funds to the
Company with interest. To minimize the risk, the Company uses the same credit
policies in making commitments and conditional obligations as it would for a
loan to that customer. 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. These rates vary with prevailing
market interest rates. Fixedrate 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, 2001 and 2000, the contractual
notional amounts of these instruments are as follows:
(IN THOUSANDS) DECEMBER 31
2001 2000
-------------------------------
Commitments to extend credit
Commercial $553,390 $572,905
Consumer $ 98,228 $ 87,582
Standby letters of credit $ 40,677 $ 38,781
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.
The Company has established an allowance for credit loss on letters of credit.
In accordance with GAAP, this allowance is not included as part of the allowance
for credit loss reported on the consolidated balance sheets for outstanding
loans. Instead, the $302,000 allowance is included in other liabilities.
LENDING ACTIVITIES
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. Mergers and acquisitions have
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 -
88
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. While the economies along the Central Coast have
slowed during 2001, the underlying value of real estate has remained stable. The
Company has considered this concentration in evaluating the adequacy of the
allowance for credit loss in the allocated component.
TRUST ACTIVITIES
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.
LEGAL
The Company was one of a number of financial institutions named as party
defendants in a patent infringement lawsuit filed in February 2000 by an
unaffiliated financial institution. Generally, the lawsuit relates to the
Company's tax refund program. The plaintiff contends that the program infringes
on certain patents which it holds. The Company retained outside patent
litigation counsel to vigorously defend it in this case. In November 2001, the
plaintiff and the Company tentatively agreed to a settlement of the case. A
final settlement agreement has been prepared and the Company expects that it
will be fully executed in early 2002. The Company believes that the settlement
is a reasonable compromise between the parties. The settlement provides for the
Company to pay a license fee to the plaintiff beginning in 2002 for transactions
processed in 2002 and continuing until the expiration of the patents at
approximately the end of 2007.
The Company is involved in various other litigation of a routine nature which is
being handled and defended in the ordinary course of the Company's business. In
the opinion of Management, based in part on consultation with legal counsel, the
resolution of this litigation will not have a material impact on the Company's
financial position.
19. MERGERS AND ACQUISITIONS
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, 2001 relating
to this transaction totaled approximately $1,163,000. 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. In 2001,
LRB was merged into SBB&T. This subsequent merger does not change the accounting
for the transaction for 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 transaction and results of operations for
LRB from July 1 through December 31, 2000.
89
The following table presents an unaudited pro forma combined summary of
operations of the Company and LRB for the two years ended December 31, 2000, as
if the acquisition had been effective January 1, 1999.
(UNAUDITED) YEAR ENDED DECEMBER 31
(IN THOUSANDS) 2000 1999
----------------------
Interest income $296,392 $236,284
Interest expense 111,434 75,530
Net interest income 184,958 160,754
Provision for credit losses 14,777 7,423
Noninterest income 51,338 44,897
Noninterest expense 135,219 122,550
-------- --------
Income before provision for income taxes 86,300 75,678
Provision for income taxes 32,747 26,905
Net income $ 53,553 $ 48,773
Basic earnings per share $ 2.03 $ 1.87
Weighted average shares assumed
to be outstanding 26,380 26,103
Diluted earnings per share $ 2.01 $ 1.84
Weighted average shares assumed
to be outstanding 26,609 26,552
The information in the table above combines the historical results of the
Company and LRB. Adjustments have been made to exclude amortization of goodwill,
to include of an estimated amount of interest that would have been earned on the
cash paid to the shareholders of Los Robles Bancorp, and to exclude the interest
paid on the note used to finance a portion of the purchase price. No attempt has
been made to eliminate the duplicated administrative cost. There were no
intercompany transactions that 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, 1999.
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, 2001. Together with the amortization of the goodwill from the purchase of
LRB, this resulted in $2.6 million in goodwill amortization expense.
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:
90
YEAR ENDED DECEMBER 31
(IN THOUSANDS) 2000 1999
----------------------
Interest income plus noninterest income
Pacific Capital Bancorp $328,309 $253,261
San Benito Bank 11,995 15,785
-------- --------
Total $340,304 $269,046
======== ========
Net Income
Pacific Capital Bancorp $ 47,612 $ 44,274
San Benito Bank 3,844 2,259
-------- --------
Total $ 51,456 $ 46,533
======== ========
In December 2001, the Company signed an agreement with another financial
institution to acquire certain assets and liabilities of two of its branches in
Monterey and Watsonville. The deposits and loans acquired in this transaction
will be combined with FNB's existing branches in those communities. The
transaction is expected to close in the second quarter of 2002.
20. SEGMENT REPORTING
While the Company's products and services areall of the nature of commercial
banking, the Company has seven reportable segments. There are six specific
segments: Wholesale Lending, Retail Lending, Branch Activities, Fiduciary, Tax
Refund Programs, and the Northern Region. The remaining activities of the
Company are reported in a segment titled "All Other." A segment for Los Robles
Bank was added for the Company's 2000 Annual Report, but with its merger into
SBB&T in 2001, the 2000 segment information has been restated to be comparable
with 2001 segment information.
FACTORS USED TO IDENTIFY REPORTABLE SEGMENTS
The Company first uses geography as a factor in distinguishing three operating
segments. The discrete market areas served by SBB&T and 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, 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, and 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.
91
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.
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.
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 four segments described
above. This segment also derives revenues from securities in FNB's securities
portfolios.
ALL OTHER: This segment consists of other business lines and support units. The
administrative support units include the Company's executive administration,
data processing, marketing, credit administration, human resources, legal and
benefits, and finance and accounting. The primary revenues are from SBB&T's
securities portfolios.
CHARGES AND CREDITS FOR FUNDS AND INCOME FROM THE INVESTMENT PORTFOLIOS
As noted above, there is a significant difference between the organizational
structures FNB and the organizational structure of SBB&T. The same business
units provide loans and deposits at FNB and separate business units handle them
at SBB&T. This means that as a segment, the Northern Region is self-contained
from a funding standpoint. That is, the one segment obtains its own funds from
its depositors and lends its own funds to its borrowers. In contrast with this,
SBB&T has one primary segment which provides the funds, Branch Activities, while
the lending segments utilize the funds. To give a fair picture of profitability
at the segment level for the SBB&T segments, it is therefore necessary to charge
the lending segments for the cost of the funds they use while crediting the
Branch Activities segment for the funds it provides.
The securities portfolios of each bank are used to provide liquidity to that
bank and to earn income from funds received from depositors that are in excess
of the amounts lent to borrowers. The interest rates applicable to securities
are lower than for loans because there is little or no credit risk. Foregoing
the higher rates earned by loans is, in a sense, a cost of maintaining the
necessary liquidity, and an opportunity cost for being unable to generate
sufficient loans to make full use of the available funds.
From the standpoint of measuring the performance of the Northern Region segment,
the loans and deposits of which are organizationally integrated, it is most
appropriate to include the income from the FNB securities portfolios with the
operating segments. Because 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.
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
92
net-of-tax contribution, they would be advantaged or disadvantaged by any
enacted changes in tax rates even though such changes are not reflective of the
performance of a segment.
SPECIFIC SEGMENT DISCLOSURE
The following table presents information for each segment regarding assets,
profit or loss, and specific items of revenue and expense that are included in
that measure of segment profit or loss as reviewed by the chief executive
officer.
(in thousands) Branch Retail Wholesale Refund Northern All
Activities Lending Lending Programs Fiduciary Region Other Total
---------- ---------- ----------- ---------- ----------- ----------- -------- ----------
Year Ended
December 31, 2001
Revenues from
external customers $ 13,006 $ 81,091 $ 74,199 $ 40,717 $ 12,596 $ 99,136 $ 41,903 $ 362,648
Intersegment revenues 83,194 255 - 3,607 3,289 - 32,626 122,971
-------- ---------- -------- -------- -------- ---------- -------- ----------
Total Revenues $ 96,200 $ 81,346 $ 74,199 $ 44,324 $ 15,885 $ 99,136 $ 74,529 $ 485,619
======== ========== ======== ======== ======== ========== ======== ==========
Profit (Loss) $ 21,919 $ 12,146 $ 16,175 $25,102 $ 5,162 $ 25,855 $(10,758) $ 95,601
Interest income 103 76,447 72,051 26,407 - 86,673 34,760 296,441
Interest expense 46,173 262 7 1,080 3,298 30,202 16,204 97,226
Internal charge for funds 651 49,776 35,789 3,752 - - 33,003 122,971
Depreciation 1,823 232 182 301 114 1,564 4,135 8,351
Total assets 17,039 1,011,456 851,376 4,228 3,105 1,236,274 837,451 3,960,929
Capital expenditures 26 - - - - 721 17,818 18,565
(in thousands) Branch Retail Wholesale Refund Northern All
Activities Lending Lending Programs Fiduciary Region Other Total
---------- ---------- ----------- ---------- ----------- ----------- -------- ----------
Year Ended
December 31, 2000
Revenues from
external customers $ 11,246 $ 66,521 $ 74,639 $ 26,258 $ 13,749 $ 102,632 $ 51,390 $ 346,435
Intersegment revenues 109,791 656 - 2,198 3,920 - 12,411 128,976
-------- ---------- -------- -------- -------- ---------- -------- ----------
Total revenues $121,037 $ 67,177 $ 74,639 $ 28,456 $ 17,669 $ 102,632 $ 63,801 $ 475,411
======== ========== ======== ======== ======== ========== ======== ==========
Profit (Loss) $ 32,204 $ 12,796 $ 18,228 $ 16,692 $ 7,182 $ 23,375 $(20,965) $ 89,512
Interest income 90 65,576 72,806 18,957 - 93,055 46,563 297,047
Interest expense 64,761 662 6 - 3,621 31,170 10,306 110,526
Internal charge for funds 859 42,793 41,205 3,255 - - 40,864 128,976
Depreciation 1,546 210 116 208 135 1,532 2,538 6,285
Total assets 19,672 868,321 919,315 (43) 1,527 1,177,499 691,334 3,677,625
Capital expenditures - - - - - 1,666 20,250 21,916
(in thousands) Branch Retail Wholesale Refund Northern All
Activities Lending Lending Programs 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 5,552 72,475
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
93
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
2001 2000 1999
---------- ---------- ----------
Total revenues for reportable segments $ 485,619 $ 475,411 $ 369,745
Elimination of intersegment revenues (122,971) (128,976) (94,417)
Elimination of taxable equivalent adjustment (5,814) (6,131) (6,282)
---------- ---------- ----------
Total consolidated revenues $ 356,834 $ 340,304 $ 269,046
========== ========== ==========
Total profit or loss for reportable segments $ 95,601 $ 89,512 $ 78,385
Elimination of taxable equivalent adjustment (5,814) (6,131) (6,282)
---------- ---------- ----------
Income before income taxes $ 89,787 $ 83,381 $ 72,103
========== ========== ==========
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 Northern Region segments are included in its asset
totals. Fixed assets used by the other segments are all recorded as assets of
the All Other segment. Depreciation expense of these assets is charged to the
segment that uses them.
The Company has no operations in foreign countries to require disclosure by
geographical area. The Company has no single customer generating 10% or more of
total revenues.
For the Company, the process of disaggregation is somewhat arbitrary. Many of
the Company's customers do business with more than one segment. 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.
21. DIVIDENDS DECLARED
The Company declares cash dividends to its shareholders each quarter. Its policy
is to declare and pay dividends of between 35% and 40% of its net income to
shareholders. In 2001, the Company paid dividends of $0.22 per quarter. However,
it changed the timing of the declaration of the dividend from the month prior to
the quarter end to the first month of each quarter. For example, in April 2001
the Company declared a dividend of $0.22 per share payable in May 2001. In prior
years, the dividend payable in May would have been declared in March. The number
of dividends paid and the amount for the dividends paid to shareholders remains
the same, but since only three quarterly dividends were declared in 2001, there
is a smaller amount of dividends reported as declared in the Consolidated
Statements of Shareholders Equity for 2001 than for the preceding years.
22. HEDGING ACTIVITIES
The Company has established policies and procedures to permit limited types and
amounts of offbalance sheet hedges to help manage interest rate risk. At various
times beginning in 1999, the Company has entered into several interest rate
swaps to mitigate interest rate risk. Under the terms of these swaps, the
Company pays a fixed rate of interest to the counterparty and receives a
floating rate of interest. Such swaps have the effect of converting fixed rate
financial instruments into
94
variable or floating rate instruments. Such swaps may be related to specific
instruments or specifically specified pools of instruments-loans, securities, or
deposits with similar interest rate characteristics or terms. Other types of
hedges are permitted by the Company's policies, but have not been utilized.
The one swap in place at the end of 2001 is related to a specific loan and
qualifies as a fair value hedge. The notional amount of this hedge at December
31, 2001 was $28.9 million with a fair value loss of approximately $1.9 million.
The Company did have other specific and non-specific hedges in place during 2000
and the first nine months of 2001. A charge of $680,000 was taken in the first
quarter of 2001, $320,000 of which was the cumulative effect of marking these
hedges to market upon the adoption of SFAS 133 on January 1, 2001 and $360,000
of which was the market adjustment arising during the first quarter. Additional
charges were taken in the second and third quarters for the market adjustment
that arose during those quarters. These charges were recorded as a reduction of
noninterest income. These swaps were entered into when the Company was concerned
about the negative impact on its fixed rate loans from increases in interest
rates. With interest rates declining and expected to stay low for at least the
next several quarters, the Company elected to dispose of these swaps. The loss
on disposal plus the mark to market adjustment for the third quarter was
$718,000.
In addition to the interest rate swaps the Company has entered into to manage
its own interest rate risk, the Company has entered into interest rate swaps
with some of its customers to assist them in managing their interest rate risks.
As of December 31, 2001, there were swaps with a notional amount of $16.8
million. To avoid increasing its own interest rate risk entering into these swap
agreements, the Company entered into offsetting swap agreements with other
larger financial institutions. The effect of the offsetting swaps to the Company
is to neutralize its position. A fee is charged the Company's customer that is
in excess of the fee paid by the Company to the other financial institution.
23. TRANSFERS AND SERVICING OF FINANCIAL ASSETS
The Company has entered into two securitization transactions. The disclosures
related to securitizations that are required by SFAS 140 are presented below.
INDIRECT AUTO SECURITIZATION
During the first quarter of 2001, SBB&T securitized $58.2 million in automobile
loans resulting in a gain on sale of approximately $566,000. Retained interest
held by SBB&T upon completion of this securitization was $3.5 million. The
transaction was conducted through the SBB&T Automobile Loan Securitization
Corporation, a wholly owned subsidiary of SBB&T. The securities offered
consisted of two classes, entitled 6.13% Asset-Backed Notes, Class A, Series
2000-A and 6.90% Asset- Backed Notes, Class B, Series 2000-A.
As of December 31, 2001, pertinent data related to this securitization is as
follows:
Principal amount outstanding $35.6 million
Retained interest $2.8 million
Principal amount of delinquencies greater than 30 days $675,000
Net credit losses $233,000
Cash flows received for servicing fees $244,000
Cash flows received on retained interests $975,000
The figures reported above for delinquencies and net credit losses relate to the
total principal amount outstanding.
95
Retained interests are calculated based on the present value of excess cash
flows due to SBB&T over the life of the securitization. The key assumptions used
in determining retained interests are outlined below. The impact of changes on
these assumptions to the carrying amount of the retained interests is not
material to the Company's statement of financial position or results of
operations.
Discount rate 8.68%
Prepayment rate 26.85%
Weighted average life of prepayable assets 51 months
Default rate 1%
SBB&T's consumer loan services department acts as the servicer for the
securitized automobile loans in compliance with the terms established in the
securitization agreements. The servicer is responsible for servicing, managing
and administering the receivables and enforcing and making collections on the
receivables. The servicer is required to carry out its duties using the degree
of skill and care that the servicer exercises in performing similar obligations.
This includes payment processing, insurance follow up, loan payoffs and release
of collateral. Loan servicing generally consists of collecting payments from
borrowers, processing those payments, and delinquent payment collections.
Refund Anticipation Loan Securitization
SBB&T established a special purpose subsidiary corporation in November 2000
named SBB&T RAL Funding Corporation and during the first quarter of 2001
securitized RALs into a multi-seller conduit, backed by commercial paper. SBB&T
acted as the servicer for all such RALs during the securitization period. As of
June 30, 2001, all borrowings had been fully repaid and no securitizationrelated
balances were outstanding.
Subsequent to December 31, 2001, the Company entered into agreements with two
other financial institutions to make use of SBB&T RAL Funding Corporation for
the 2002 RAL season.
96
24. 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
2001 2000
---------------------------
ASSETS
Cash $ 1,681 $ 678
Investment in and advances to subsidiaries 328,043 296,604
Securities purchased u/a to resell 14,500 -
Loans, net 234 270
Premises and equipment, net 14,605 6,812
Other assets 24,741 19,163
---------------------------
Total assets $383,804 $323,527
===========================
LIABILITIES
Dividends payable $ - $ 5,826
Bank Debt 40,000 15,000
Other liabilities 17,928 6,440
---------------------------
Total liabilities 57,928 27,266
===========================
EQUITY
Common stock 8,737 8,828
Surplus 106,929 115,664
Unrealized gain on securities available-for-sale 4,795 4,472
Retained earnings 205,415 167,297
---------------------------
Total shareholders' equity 325,876 296,261
---------------------------
Total liabilities and shareholders' equity $383,804 $323,527
===========================
PACIFIC CAPITAL BANCORP
(PARENT COMPANY ONLY)
INCOME STATEMENTS
(IN THOUSANDS)
DECEMBER 31
2001 2000 1999
------------------------------
Equity in earnings of subsidiaries:
Undistributed $33,512 $10,074 $28,812
Dividends 25,550 44,000 17,131
Interest income 467 28 123
Interest expense (1,829) (873) -
Noninterest revenue (225) 108 87
Operating expense (3,231) (3,662) (4,715)
Income tax benefit 1,867 1,781 2,836
------------------------------
Net income $56,111 $51,456 $44,274
==============================
97
PACIFIC CAPITAL BANCORP
(PARENT COMPANY ONLY)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
2001 2000 1999
--------------------------------------------
Increase (decrease) in cash and cash equivalents:
Cash flows from operating activities:
Net income $ 56,111 $ 51,456 $ 44,274
Adjustments to reconcile net income to net
cash provided by (used in) operations:
Equity in undistributed net income
of subsidiaries (59,062) (54,074) (45,942)
Amortization of goodwill 456 654 -
Depreciation expense 1,702 977 -
(Increase) decrease in other assets (3,973) (7,122) 551
Increase (decrease) in other liabilities 11,488 3,687 (1,883)
--------------------------------------------
Net cash provided by (used in) operating activities 6,722 (4,422) (3,000)
--------------------------------------------
Cash flows from investing activities:
Net increase in securities purchased u/a to resell (14,500) - -
Net decrease in loans 36 124 2,788
Capital expenditures (9,633) (3,757) (643)
Purchase of capital stock of Los Robles Bank - (32,500) -
Distributed earnings of subsidiaries 25,550 44,000 17,131
--------------------------------------------
Net cash provided by investing activities 1,453 7,867 19,276
--------------------------------------------
Cash flows from financing activities:
Proceeds from other borrowing 40,000 - -
Proceeds from short term borrowing - 20,000 -
Payments on short term borrowing (15,000) (5,000) -
Proceeds from issuance of common stock 6,181 1,395 2,129
Payments to retire common stock (15,007) - (2,055)
Dividends paid (23,346) (20,093) (17,595)
--------------------------------------------
Net cash used in financing activities (7,172) (3,698) (17,521)
--------------------------------------------
Net increase (decrease) in cash and cash equivalents 1,003 (253) (1,245)
Cash and cash equivalents at beginning of period 678 931 2,176
--------------------------------------------
Cash and cash equivalents at end of period $ 1,681 $ 678 $ 931
============================================
Supplemental disclosures: none
98
QUARTERLY FINANCIAL DATA (UNAUDITED)
(AMOUNTS IN THOUSANDS EXCEPT 2001 QUARTERS 2000 QUARTERS
PER SHARE AMOUNTS) 4TH 3RD 2ND 1ST 4TH 3RD 2ND 1ST
---------------------------------- ----------------------------------
Interest income $61,726 $66,689 $68,522 $94,171 $72,055 $70,032 $67,437 $81,392
Interest expense 18,664 23,109 25,512 29,941 28,147 27,702 27,702 26,975
Net interest income 43,062 43,580 43,010 64,230 43,908 42,330 39,735 54,417
Provision for credit losses 7,007 4,438 3,358 11,868 1,295 5,219 2,230 5,696
Noninterest income 14,313 12,969 14,213 24,231 11,137 11,044 10,997 16,210
Noninterest expense 33,643 35,909 35,548 38,050 35,433 36,108 29,339 30,977
Income before
income taxes 16,725 16,202 18,317 38,543 18,317 12,047 19,163 33,954
Income taxes 6,305 4,923 6,819 15,629 5,994 5,284 7,108 13,539
Net Income $10,420 $11,279 $11,498 $22,914 $12,323 $ 6,763 $12,055 $20,415
Net earnings per share:
Basic $ 0.41 $ 0.42 $ 0.43 $ 0.86 $ 0.47 $ 0.25 $ 0.45 $ 0.78
Diluted $ 0.40 $ 0.42 $ 0.43 $ 0.86 $ 0.46 $ 0.25 $ 0.45 $ 0.77
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
99
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 23,
2002 ("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.
100
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 103 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, 2001.
(c) EXHIBITS
See exhibits listed in "Exhibit Index" on page 103 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.
101
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. March 15, 2002
Jr William S. Thomas, Date
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 March 15, 2002 /s/ William S. Thomas, Jr. March 15, 2002
David W. Spainhour Date William S. Thomas, Jr. Date
Chairman of the Board President
Chief Executive Officer
/s/ Edward E. Birch March 15, 2002 /s/ Richard M. Davis March 15, 2002
Edward E. Birch Date Richard M. Davis Date
Director Director
/s/ Richard S. Hambleton, Jr. March 15, 2002 /s/ Dale E. Hanst March 15, 2002
Richard S. Hambleton, Jr. Date Dale E. Hanst Date
Director Director
/s/ D. Vernon Horton March 15, 2002 /s/ Roger C. Knopf March 15, 2002
D. Vernon Horton Date Roger C. Knopf Date
Vice Chairman Director
/s/ Donald Lafler March 15, 2002 /s/ Clayton C. Larson March 15, 2002
Donald Lafler Date Clayton C. Larson Date
Executive Vice President Vice Chairman
Chief Financial Officer
/s/ Gerald T. McCullough March 15, 2002 /s/ Richard A. Nightingale March 15, 2002
Gerald T. McCullough Date Richard A. Nightingale Date
Director Director
/s/ Kathy J. Odell March 15, 2002
Kathy J. Odell Date
Director
102
EXHIBIT INDEX TO PACIFIC CAPITAL BANCORP FORM 10-K FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2001
Exhibit
Number Description *
- ------ -----------
3. Articles of Incorporation and Bylaws:
3.1 Certificate of Restatement of Articles of Incorporation of
Pacific Capital Bancorp dated January 27, 1999. (1)
3.2 Certificate of Determination for the Series A Preferred
Stock of Pacific Capital Bancorp (incorporated by reference
to Exhibit 3(b) to Pacific Capital Bancorp's Registration
Statement on Form S-4 (Registration No. 333-36298) filed
May 4, 2000).
3.3 Amended and Restated Bylaws of Pacific Capital Bancorp
effective April 25, 2000. (7)
4. Instruments Defining the Rights of Security Holders, including
indentures
4.1 Stockholders Rights Agreements, dated as of December 14,
between Pacific Capital Bancorp and Norwest Bank Minnesota,
N.A., as Rights Agent (incorporated by reference to Exhibit
1 to Pacific Capital Bancorp's Registration Statement on
Form 8-A dated December 14, 1999).
Note: No long-term debt instruments issued by the Company
or any of its consolidated subsidiaries exceeds 10% of the
consolidated total assets of the Company and its
subsidiaries. In accordance with paragraph 4(iii) of Item
601 of Regulation S-K, the Company will furnish to the
Commission upon request copies of long-term debt
instruments and related agreements.
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. (3)
10.1.1.1 Pacific Capital Bancorp Restricted Stock Option
Agreement (Incentive Stock Option). (2)
10.1.1.2 Pacific Capital Bancorp Restricted Stock Option
Agreement (Nonstatutory Stock Option - 5 Year).
(2)
10.1.1.3 Pacific Capital Bancorp Restricted Stock Option
Agreement (Nonstatutory Stock Option - 10 Year).
(2)
10.1.1.4 Pacific Capital Bancorp Restricted Stock Option
Agreement (Incentive Reload Option). (2)
10.1.1.5 Pacific Capital Bancorp Restricted Stock Option
Agreement (Non-statutory Reload Option). (2)
103
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 (Registration No. 33-48724), filed on
June 13, 1995).
10.1.3 Pacific Capital Bancorp Incentive & Investment and Salary
Savings Plan, as amended and restated effective January 1,
1998. (6)
10.1.4 Pacific Capital Bancorp Employee Stock Ownership Plan and
Trust, as amended and restated effective January 1, 1998.
(6)
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. (4)
10.1.5.2 Second Amendment to Santa Barbara Bank & Trust
Key Employee Retiree Health Plan. (4)
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). (4)
10.1.6.2 Second Amendment to Santa Barbara Bank & Trust
Retiree Health Plan (Non-Key Employees). (4)
10.1.7 Trust Agreement of Santa Barbara Bank & Trust Voluntary
Beneficiary Association. (4)
10.1.7.1 First Amendment to Trust Agreement of Santa
Barbara Bank & Trust Voluntary Beneficiary
Association. (3)
10.1.8 Pacific Capital Bancorp, Amended and Restated, 1996
Directors Stock Plan, as amended April 25,2000. (8)
10.1.8.1 Pacific Capital Bancorp 1996 Directors Stock
Option Agreement. (2)
10.1.8.2 Pacific Capital Bancorp 1996 Directors Stock
Option Agreement (Reload Option). (2)
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).
104
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. (6)
10.1.13 Pacific Capital Bancorp Deferred Compensation Plan dated
December 15, 1999. (9)
10.1.13.1 Trust Agreement under Pacific Capital Bancorp
Deferred Compensation Plan dated
December 15, 1999. (9)
10.2 Consolidated Agreement dated December17, 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. (5)
21. Subsidiaries of the registrant **
23. Consents of Experts and Counsel
23.1 Consent of Arthur Andersen LLP with respect to financial
statements of the Registrant **
23.2 Consent of Deloitte & Touche LLP with respect to financial
statements of San Benito Bank - statements not presented
separately **
Shareholders may obtain a copy of any exhibit by writing to:
Carol Kelleher, Corporate Services Administrator
Pacific Capital Bancorp
P.O. Box 60839
Santa Barbara, CA 93160
* 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 (File 0-11113). 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 (File No. 0-13528).
** Filed herewith.
The Exhibits listed below are incorporated by reference to the specified filing.
(1) 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.
(2) 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.
105
(3) 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.
(4) 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.
(5) 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.
(6) 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.
(7) 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.
(8) 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.
(9) 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, 2001.
106