PRELIMINARY DOCUMENT
Used for drafting 10-Q submission
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
- - ------ SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000
Commission File No.: 0-11113
OR
- - ------ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ____________
PACIFIC CAPITAL BANCORP
(Exact Name of Registrant as Specified in its Charter)
California 95-3673456
- - -------------------------------------------- -----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 E. Carrillo Street, Suite 300
Santa Barbara, California 93101
(Address of principal executive offices) (Zip Code)
(805) 564-6300
(Registrant's telephone number, including area code)
Not Applicable
Former name, former address and former fiscal year,
if changed since last report.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------------------ ----------------
Common Stock - As of May 10, 2000 there were 24,605,308 shares of the issuer's
common stock outstanding.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets
March 31, 2000 and December 31, 1999
Consolidated Statements of Income
Three-Month Periods Ended March 31, 2000 and 1999
Consolidated Statements of Cash Flows
Three-Month Periods Ended March 31, 2000 and 1999
Consolidated Statements of Comprehensive Income
Three-Month Periods Ended March 31, 2000 and 1999
Notes to Consolidated Financial Statements
The financial statements included in this Form 10-Q should be read with
reference to the Pacific Capital Bancorp's Annual Report on Form 10-K for the
fiscal year ended December 31, 1999.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Disclosures about quantitative and qualitative market risk are
located in Management's Discussion and Analysis of Financial
Condition and Results of Operations in the section on interest
rate sensitivity.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
All other schedules and compliance information called for by the instructions to
Form 10-Q have been omitted since the required information is not applicable.
2
PART 1
FINANCIAL INFORMATION
PACIFIC CAPITAL BANCORP & SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)
(dollars in thousands except share amounts)
March 31, 2000 December 31, 1999
-------------- -----------------
Assets:
Cash and due from banks $ 188,973 $ 121,500
Federal funds sold and securities
purchased under
agreement to resell 475,000 --
Money market funds -- --
----------- -----------
Cash and cash equivalents 663,973 121,500
----------- -----------
Securities (Note 4):
Held-to-maturity 125,571 153,264
Available-for-sale 561,005 528,426
Bankers' acceptances and commercial paper 39,450 --
Loans, net of allowance of $30,844 at
March 31, 2000 and $28,686 at
December 31, 1999 (Note 5) 2,030,854 1,953,193
Premises and equipment, net 37,325 35,175
Accrued interest receivable 17,505 17,345
Other assets (Note 6) 68,927 70,379
----------- -----------
Total assets $ 3,544,610 $ 2,879,282
=========== ===========
Liabilities:
Deposits:
Noninterest bearing demand deposits $ 627,347 $ 546,193
Interest bearing deposits 2,421,289 1,893,988
----------- -----------
Total Deposits 3,048,636 2,440,181
Securities sold under agreements
to repurchase and Federal funds purchased 57,925 80,507
Long-term debt and other borrowings (Note 7) 122,854 98,801
Accrued interest payable and other liabilities 65,082 25,220
----------- -----------
Total liabilities 3,294,497 2,644,709
----------- -----------
Shareholders' equity
Common stock (no par value; $0.33 per
share stated value; 60,000,000 authorized;
24,605,308 outstanding at March 31, 2000
and 24,554,294 at December 31, 1999) 8,203 8,186
Surplus 99,863 99,283
Accumulated other comprehensive income (Note 8) (6,404) (6,447)
Retained earnings 148,451 133,551
----------- -----------
Total shareholders' equity 250,113 234,573
----------- -----------
Total liabilities and
shareholders' equity $ 3,544,610 $ 2,879,282
=========== ===========
<FN>
See accompanying notes to consolidated condensed financial statements.
</FN>
3
PACIFIC CAPITAL BANCORP & SUBSIDIARIES
Consolidated Statements of Income (Unaudited)
(dollars in thousands except per share amounts)
For the Three-Month
Periods Ended
March 31,
--------------------
2000 1999
-------- --------
Interest income:
Interest and fees on loans $ 61,872 $ 43,193
Interest on securities 10,638 11,264
Interest on Federal funds sold and securities
purchased under agreement to resell 4,765 1,970
Interest on commercial paper 184 257
-------- --------
Total interest income 77,459 56,684
-------- --------
Interest expense:
Interest on deposits 22,921 15,277
Interest on securities sold under agreements
to repurchase and Federal funds purchased 671 262
Interest on other borrowed funds 2,085 731
-------- --------
Total interest expense 25,677 16,270
-------- --------
Net interest income 51,782 40,414
Provision for loan losses (Note 5) 5,573 3,719
-------- --------
Net interest income after provision for loan losses 46,209 36,695
-------- --------
Other operating income:
Service charges on deposits 2,361 2,235
Trust fees 3,823 3,409
Other service charges, commissions and fees, net 9,775 8,537
Net (loss) gain on securities transactions (499) (177)
Other operating income 278 267
-------- --------
Total other income 15,738 14,271
-------- --------
Other operating expense:
Salaries and benefits 14,632 12,795
Net occupancy expense 2,769 2,258
Equipment expense 1,440 1,560
Other expense 10,040 10,912
-------- --------
Total other operating expense 28,881 27,525
-------- --------
Income before income taxes 33,066 23,441
Applicable income taxes 13,246 8,920
-------- --------
Net income $ 19,820 $ 14,521
======== ========
Earnings per share - basic (Note 2) $ 0.81 $ 0.60
Earnings per share - diluted (Note 2) $ 0.80 $ 0.59
See accompanying notes to consolidated condensed financial statements.
4
For the Three-Month
Periods Ended March 31,
2000 1999
--------- ---------
Cash flows from operating activities:
Net Income $ 19,820 $ 14,521
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation and amortization 1,591 1,573
Provision for loan and lease losses 5,573 3,719
Net amortization of discounts and premiums for
securities and commercial paper (1,864) (1,663)
Net change in deferred loan origination
fees and costs 170 165
Net (gain) loss on sales and calls of securities 499 178
Change in accrued interest receivable and other assets 976 (8,091)
Change in accrued interest payable and other liabilities 39,907 7,364
--------- ---------
Net cash provided by operating activities 66,672 17,766
--------- ---------
Cash flows from investing activities:
Proceeds from call or maturity of securities 42,449 96,066
Purchase of securities (75,854) (30,404)
Proceeds from sale of securities 29,883 9,881
Proceeds from maturity of commercial paper -- 35,000
Purchase of commercial paper (39,449) (24,868)
Net increase in loans made to customers (83,404) (126,510)
Purchase or investment in premises and equipment (3,382) (1,618)
--------- ---------
Net cash used in investing activities (129,757) (42,453)
--------- ---------
Cash flows from financing activities:
Net increase in deposits 608,455 32,034
Net decrease in borrowings with maturities
of 90 days or less (22,582) (11,126)
Net increase (decrease) in long-term debt and other
borrowings 24,053 12,356
Proceeds from issuance of common stock 552 1,308
Payments to retire common stock -- --
Dividends paid (4,920) (4,358)
--------- ---------
Net cash provided by financing activities 605,558 30,214
--------- ---------
Net increase in cash and cash equivalents 542,473 5,527
Cash and cash equivalents at beginning of period 121,500 185,663
--------- ---------
Cash and cash equivalents at end of period $ 663,973 $ 191,190
========= =========
Supplemental disclosure:
Cash paid for the three months ended:
Interest $ 30,035 $ 16,809
Income taxes $ 327 $ 4,662
Non-cash additions to other real estate owned $ -- $ --
Non-cash additions to loans $ -- $ 142
5
PACIFIC CAPITAL BANCORP & SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Unaudited)
(dollars in thousands except per share amounts)
For the Three-Month
Periods Ended
March 31,
---------------------
2000 1999
-------- --------
Net income $ 19,820 $ 14,521
Other comprehensive income, net of tax (Note 8):
Unrealized loss on securities:
Unrealized holding gains (losses) arising
during period 542 (1,220)
Less: reclassification adjustment for
gains (losses) included in net income (499) (177)
-------- --------
Other comprehensive income (loss) 43 (1,397)
-------- --------
Comprehensive income $ 19,863 $ 13,124
======== ========
See accompanying notes to consolidated condensed financial statements.
6
Pacific Capital Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 2000
(Unaudited)
1. Principles of Consolidation
The consolidated financial statements include the parent holding company,
Pacific Capital Bancorp ("Bancorp"), and its wholly owned subsidiaries, Santa
Barbara Bank & Trust ("SBB&T"), First National Bank of Central California
("FNB") and its affiliate South Valley National Bank ("SVNB"), and Pacific
Capital Commercial Mortgage, Inc. All references to "the Company" apply to
Pacific Capital Bancorp and its subsidiaries. "Bancorp" will be used to refer to
the parent company only. Material intercompany balances and transactions have
been eliminated.
2. Earnings Per Share
Earnings per share for all periods presented in the Consolidated Statements of
Income are computed based on the weighted average number of shares outstanding
during each year. Diluted earnings per share include the effect of the potential
issuance of common shares. For the Company, these include only shares issuable
on the exercise of outstanding stock options.
The computation of basic and diluted earnings per share for the three-month
period ended March 31, 2000 and 1999, was as follows (shares and net income
amounts in thousands):
Three-month Periods
Basic Diluted
Earnings Earnings
Per Share Per Share
------------- ------------
Ended March 31, 2000
Numerator--net income $19,820 $19,820
======= =======
Denominator--weighted average
shares outstanding 24,568 24,568
Plus: net shares issued in
assumed stock option exercises 280
-------
Diluted denominator 24,848
=======
Earnings per share $ 0.81 $ 0.80
Ended March 31, 1999
Numerator--net income $14,521 $14,521
======= =======
Denominator--weighted average
shares outstanding 24,240 24,240
Plus: net shares issued in
assumed stock option exercises 372
-------
Diluted denominator 24,612
=======
Earnings per share $ 0.60 $ 0.59
3. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in a condensed format, and therefore do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of Management, all adjustments (consisting
only of normal recurring accruals) considered necessary for a fair presentation
have been reflected in the financial statements. However, the results of
operations for the
7
three-month period ended March 31, 2000, especially considering the highly
seasonal nature of the Company's income tax refund programs, are not necessarily
indicative of the results to be expected for the full year. Certain amounts
reported for 1999 have been reclassified to be consistent with the reporting for
2000.
For the purposes of reporting cash flows, cash and cash equivalents include cash
and due from banks, money market funds, Federal funds sold, and securities
purchased under agreement to resell.
4. Securities
The Company's securities are classified as either "held-to-maturity" or
"available-for-sale." Securities for which the Company has positive intent and
ability to hold until maturity are classified as held-to-maturity. Securities
that might be sold prior to maturity because of interest rate changes, to meet
liquidity needs, or to better match the repricing characteristics of funding
sources are classified as available-for-sale. If the Company were to purchase
securities principally for the purpose of selling them in the near term for a
gain, they would be classified as trading securities. The Company holds no
securities that should be classified as trading securities.
SBB&T and FNB are members of the Federal Reserve Bank of San Francisco ("FRB").
SBB&T and FNB aremembers of the Federal Home Loan Bank of San Francisco ("FHLB")
and FNB became a member in January 2000. The banks are required to hold shares
of stock in these two organizations as a condition of membership. These shares
are reported as equity securities.
The amortized historical cost and estimated market value of debt securities by
contractual maturity are shown below. The issuers of certain of the securities
have the right to call or prepay obligations before the contractual maturity
date. Depending on the contractual terms of the security, the Company may
receive a call or prepayment penalty in such instances.
8
(in thousands) Held-to- Available-
Maturity for-Sale Total
------------------------------------------------------
March 31, 2000
Amortized cost:
In one year or less $ 48,334 $ 97,465 $ 145,799
After one year through five years 32,569 408,251 440,820
After five years through ten years 6,988 15,363 22,351
After ten years 37,680 33,538 71,218
Equity securities -- 17,256 17,256
----------------------------------------------------------
Total securities $ 125,571 $ 571,873 $ 697,444
==========================================================
Estimated market value:
In one year or less $ 48,920 $ 97,138 $ 146,058
After one year through five years 34,833 400,628 435,461
After five years through ten years 7,619 14,286 21,905
After ten years 40,635 31,697 72,332
Equity securities -- 17,256 17,256
----------------------------------------------------------
Total securities $ 132,007 $ 561,005 $ 693,012
==========================================================
December 31,1999
Amortized cost:
In one year or less $ 59,920 $ 92,661 $ 152,581
After one year through five years 48,445 376,113 424,558
After five years through ten years 7,080 24,277 31,357
After ten years 37,819 34,848 72,667
Equity securities -- 11,649 11,649
----------------------------------------------------------
Total securities $ 153,264 $ 539,548 $ 692,812
==========================================================
Estimated market value:
In one year or less $ 60,466 $ 92,524 $ 152,990
After one year through five years 51,264 369,999 421,263
After five years through ten years 7,778 22,889 30,667
After ten years 39,642 31,365 71,007
Equity securities -- 11,649 11,649
------------------------------------------------------
Total securities $ 159,150 $ 528,426 $ 687,576
======================================================
9
The amortized historical cost, market values and gross unrealized gains and
losses of securities are as follows:
Gross Gross Estimated
(in thousands) Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------------------------------------------------------------------
March 31, 2000
Held-to-maturity:
U.S. Treasury obligations $ 20,001 $ 7 $ (38) $ 19,970
U.S. agency obligations 12,502 -- (97) 12,405
Mortgage-backed securities 471 5 -- 476
State and municipal securities 92,597 6,571 (12) 99,156
---------------------------------------------------------------------
Total held-to-maturity 125,571 6,583 (147) 132,007
---------------------------------------------------------------------
Available-for-sale:
U.S. Treasury obligations 131,138 107 (1,000) 130,245
U.S. agency obligations 197,064 1 (2,246) 194,819
Mortgage-backed securities 165,383 22 (5,706) 159,699
Asset-backed securities 14,590 2 (119) 14,473
State and municipal securities 46,442 271 (2,200) 44,513
Equity securities 17,256 -- -- 17,256
---------------------------------------------------------------------
Total available-for-sale 571,873 403 (11,271) 561,005
---------------------------------------------------------------------
Total securities $ 697,444 $ 6,986 $ (11,418) $ 693,012
=====================================================================
December 31, 1999
Held-to-maturity:
U.S. Treasury obligations $ 35,043 $ 64 $ (40) $ 35,067
U.S. agency obligations 12,502 -- (87) 12,415
Mortgage-backed securities 556 8 (1) 563
State and municipal securities 105,163 6,235 (293) 111,105
---------------------------------------------------------------------
Total held-to-maturity 153,264 6,307 (421) 159,150
---------------------------------------------------------------------
Available-for-sale:
U.S. Treasury obligations 121,701 49 (691) 121,059
U.S. agency obligations 177,985 -- (2,197) 175,788
Mortgage-backed securities 172,333 21 (4,849) 167,505
Asset-backed securities 10,979 7 (114) 10,872
State and municipal securities 44,901 42 (3,390) 41,553
Equity securities 11,649 -- -- 11,649
---------------------------------------------------------------------
Total available-for-sale 539,548 119 (11,241) 528,426
---------------------------------------------------------------------
Total securities $ 692,812 $ 6,426 $ (11,662) $ 687,576
=====================================================================
The Company does not expect to realize any of the unrealized gains or losses
related to the securities in the held-to-maturity portfolio because it is the
Company's intent to hold them to maturity. At that time the par value will be
received. An exception to this expectation occurs when securities are called by
the issuer prior to their maturity. In these situations, gains or losses may be
realized. Gains or losses may be realized on securities in the
available-for-sale portfolio as the result of sales of these securities carried
out in response to changes in interest rates or for other reasons related to the
management of the components of the balance sheet.
10
5. Loans and the Allowance for Credit Losses
The balances in the various loan categories are as follows:
(in thousands) March 31, 2000 December 31, 1999 March 31, 1999
---------------- ----------------- -----------------
Real estate:
Residential $ 493,613 $ 484,562 $ 432,025
Nonresidential 476,718 435,913 496,821
Construction 150,158 171,870 119,274
Commercial loans 569,275 577,407 368,427
Home equity loans 52,742 49,902 44,588
Consumer loans 154,601 148,051 125,177
Tax refund loans 46,718 -- 18,389
Leases 99,775 93,322 89,057
Municipal tax-exempt obligations 11,915 12,530 8,540
Other loans 6,183 8,322 5,463
---------------- ----------------- -----------------
Total loans $ 2,061,698 $ 1,981,879 $ 1,707,761
================ ================= =================
The loan balances at March 31, 2000, December 31, 1999 and March 31, 1999 are
net of approximately $5,035,000, $4,781,000, and $4,162,000 respectively, in
deferred net loan fees and origination costs.
Specific kinds of loans are identified as impaired when it is probable that
interest and principal will not be collected according to the contractual terms
of the loan agreements. Because this definition is very similar to that used by
Management to determine on which loans interest should not be accrued, the
Company expects that most impaired loans will be on nonaccrual status.
Therefore, in general, the accrual of interest on impaired loans is
discontinued, and any uncollected interest is written off against interest
income in the current period. No further income is recognized until all recorded
amounts of principal are recovered in full or until circumstances have changed
such that the loan is no longer regarded as impaired.
Impaired loans are reviewed each quarter to determine whether a valuation
allowance for loan loss is required. The amount of the valuation allowance for
impaired loans is determined by comparing the recorded investment in each loan
with its value measured by one of three methods. The first method is to estimate
the expected future cash flows and then discount them at the effective interest
rate. The second method is to use the loan's observable market price if the loan
is of a kind for which there is a secondary market. The third method is to use
the value of the underlying collateral. A valuation allowance is established for
any amount by which the recorded investment exceeds the value of the impaired
loan. If the value of the loan as determined by the selected method exceeds the
recorded investment in the loan, no valuation allowance for that loan is
established. The following table discloses balance information about the
impaired loans and the related allowance (dollars in thousands) as of March 31,
2000, December 31, 1999 and March 31, 1999:
March 31, 2000 December 31, 1999 March 31, 1999
-------------- ----------------- --------------
Loans identified as impaired $ 8,355 $9,496 $13,273
Impaired loans for which a valuation
allowance has been determined $ 8,355 $8,221 $ 8,632
Amount of valuation allowance $ 3,370 $3,726 $ 3,342
Impaired loans for which no valuation
allowance was determined necessary $ -- $1,275 $ 4,641
Because the loans currently identified as impaired have unique risk
characteristics, the valuation allowance is determined on a loan-by-loan basis.
The following table discloses additional information (dollars in thousands)
about impaired loans for the three-month periods ended March 31, 2000 and 1999:
11
Three-month Periods
Ended March 31,
2000 1999
---- ----
Average amount of recorded
investment in impaired loans $6,449 $13,368
Collections of interest from
impaired loans and recognized
as interest income $ -- $ --
The Company also provides an allowance for credit losses for other loans. These
include (1) groups of loans for which the allowance is determined by historical
loss experience ratios for similar loans; (2) specific loans that are not
included in one of the types of loans covered by the concept of "impairment" but
for which repayment is nonetheless uncertain; and (3) losses inherent in the
various loan portfolios, but which have not been specifically identified as of
the period end. The amount of the various components of the allowance for credit
losses are based on review of individual loans, historical trends, current
economic conditions, and other factors. This process is explained in detail in
the notes to the Company's Consolidated Financial Statements in its Annual
Report on Form 10-K for the year ended December 31, 1999.
Loans that are deemed to be uncollectible are charged-off against the allowance
for credit losses. Uncollectibility is determined based on the individual
circumstances of the loan and historical trends.
The valuation allowance for impaired loans of $3.4 million is included with the
general allowance for credit losses of $27.6 million and allowance for credit
losses from tax refund loans of $3.2 million reported on the balance sheet for
March 31, 2000, which these notes accompany, and in the "All Other Loans" column
in the statement of changes in the allowance account for the first three months
of 2000 shown below. The amounts related to tax refund anticipation loans and to
all other loans are shown separately.
(in thousands) Refund
Tax Refund Other
Loans Loans Total
-------- -------- --------
Balance, December 31, 1999 $ 488 $ 28,198 $ 28,686
Provision for loan losses 3,631 1,915 5,546
Loan losses charged against allowance (2,869) (5,964) (8,833)
Loan recoveries added to allowance 1,959 3,486 5,445
-------- -------- --------
Balance, March 31, 2000 $ 3,209 $ 27,635 $ 30,844
======== ======== ========
Balance, December 31, 1998 $ 333 $ 28,963 $ 29,296
Provision for loan losses 2,759 960 3,719
Loan losses charged against allowance (3,323) (965) (4,288)
Loan recoveries added to allowance 2,102 679 2,781
-------- -------- --------
Balance, March 31, 1999 $ 1,871 $ 29,637 $ 31,508
======== ======== ========
6. Other Assets
Property acquired as a result of defaulted loans is included within other assets
on the balance sheets. Property from defaulted loans is carried at the lower of
the outstanding balance of the related loan at the time of foreclosure or the
estimate of the market value of the assets less disposal costs. As of March 31,
2000 and December 31, 1999, the Company held some properties which it had
obtained in foreclosures. However, because of the uncertainty relating to
realizing any proceeds from their disposal in excess of the cost of disposal,
the Company had written their carrying value down to zero.
12
Also included in other assets on the balance sheet for March 31, 2000 and
December 31, 1999, are deferred tax assets and goodwill. In connection with
acquisitions of other financial institutions, the Company recognized the excess
of the purchase price over the estimated fair value of the assets received and
liabilities assumed as goodwill. The current balance of this intangible is $16.1
million. The purchased goodwill is being amortized over 10 and 15 year periods.
Intangible assets, including goodwill, are reviewed each year to determine if
circumstances related to their valuation have been materially affected. In the
event that the current market value is determined to be less than the current
book value of the intangible asset, a charge against current earnings would be
recorded .
7. Long-term Debt and Other Borrowings
Long-term debt and other borrowings included $118.5 million and $85.0 million of
advances from the Federal Home Loan Bank of San Francisco at March 31, 2000 and
December 31, 1999, respectively.
8. Comprehensive Income
Components of comprehensive income are changes in equity other than those
resulting from investments by owners and distributions to owners. Net income is
the primary component of comprehensive income. For the Company, the only
component of comprehensive income other than net income is the unrealized gain
or loss on securities classified as available-for-sale. The aggregate amount of
such changes to equity that have not yet been recognized in net income are
reported in the equity portion of the Consolidated Balance Sheets as accumulated
other comprehensive income.
When a security that had been classified as available-for-sale is sold, a
realized gain or loss will be included in net income and, therefore, in
comprehensive income. Consequently, the recognition of any unrealized gain or
loss for that security that had been included in comprehensive income in an
earlier period must be reversed. These adjustments are reported in the
consolidated statements of comprehensive income as reclassification adjustment
for gains (losses) included in net income.
9. Segment Disclosure
While the Company's products and services are all of the nature of commercial
banking, the Company has seven reportable segments. There are six specific
segments: Wholesale Lending, Retail Lending, Branch Activities, Fiduciary, Tax
Refund Processing, and the Northern Region. The remaining activities of the
Company are reported in a segment titled "All Other". Detailed information
regarding the Company's segments is provided in Note 20 to the consolidated
financial statements included in the Company's Annual Report on Form 10-K. This
information includes descriptions of the factors used in identifying these
segments, the types and services from which revenues for each segment are
derived, charges and credits for funds, and how the specific measure of profit
or loss was selected. Readers of these interim statements are referred to that
information to better understand the following disclosures for each of the
segments. There have been no changes in the basis of segmentation or in the
measurement of segment profit or loss from the description given in the annual
report.
The following tables present information for each segment regarding assets,
profit or loss, and specific items of revenue and expense that are included in
that measure of segment profit or loss as reviewed by the chief operating
decision maker.
13
Tax
(in thousands) Branch Retail Wholesale Refund Northern All
Activities Lending Lending Programs Fiduciary Region Other Total
------------ ------------ ----------- ---------- ----------- ----------- ------------ -------------
Three months ended
March 31, 2000
Revenues from
external customers $ 2,532 $ 15,150 $ 15,653 $ 24,222 $ 3,821 $ 20,115 $ 13,098 $ 94,590
Intersegment revenues 26,604 52 -- 1,889 850 -- 3,773 33,168
------------ ------------ ----------- ---------- ----------- ----------- ------------ -------------
Total revenues $ 29,136 $ 15,202 $ 15,653 $ 26,111 $ 4,671 $ 20,115 $ 16,871 $ 127,758
============ ============ =========== ========== =========== =========== ============ =============
Profit (Loss) $ 5,587 $ 2,754 $ 4,376 $ 16,788 $ 2,121 $ 6,209 $ (3,376) $ 34,459
Interest income 25 14,827 15,402 17,613 -- 18,428 12,557 78,852
Interest expense 17,272 53 1 -- 771 5,908 1,671 25,677
Internal charge for funds 248 9,726 9,170 2,776 -- -- 11,248 33,168
Depreciation 334 46 26 28 33 270 494 1,231
Total assets 14,536 726,506 660,855 41,257 1,811 946,779 1,152,866 3,544,610
Capital expenditures -- -- -- -- -- 2,579 3,383 5,961
Three months ended
March 31, 1999
Revenues from
external customers $ 2,077 $ 12,227 $ 12,391 $ 13,384 $ 3,401 $ 17,007 $ 11,899 $ 72,386
Intersegment revenues 18,203 53 -- 1,713 620 -- 3,537 24,126
------------ ------------ ----------- ---------- ----------- ----------- ------------ -------------
Total revenues $ 20,280 $ 12,280 $ 12,391 $ 15,097 $ 4,021 $ 17,007 $ 15,436 $ 96,512
============ ============ =========== ========== =========== =========== ============ =============
Profit (Loss) $ 4,582 $ 2,937 $ 4,163 $ 9,535 $ 1,853 $ 5,777 $ (3,975) $ 24,872
Interest income 14 11,918 12,006 7,477 -- 15,636 11,064 58,115
Interest expense 9,862 55 -- -- 556 4,981 816 16,270
Internal charge for funds 199 7,532 6,422 546 -- -- 9,427 24,126
Depreciation 399 37 23 24 36 331 352 1,202
Total assets 13,035 611,099 538,730 13,552 1,408 851,006 671,432 2,700,262
Capital expenditures -- -- -- -- -- 35 1,569 1,604
14
The following table reconciles total revenues and profit for the segments to
total revenues and pre-tax income, respectively in the consolidated statements
of income for the three-month periods ended March 31, 2000 and 1999.
Three Months ended March 31,
2000 1999
--------- ---------
Total revenues for
reportable segments $ 127,758 $ 96,512
Elimination of
intersegment revenues (33,168) (24,126)
Elimination of taxable
equivalent adjustment (1,393) (1,431)
--------- ---------
Total consolidated revenues $ 93,197 $ 70,955
========= =========
Total profit or loss
for reportable segments $ 34,459 $ 24,872
Elimination of taxable
equivalent adjustment (1,393) (1,431)
--------- ---------
Income before income taxes $ 33,066 $ 23,441
========= =========
15
10. New Accounting Pronouncement
Statement of Financial Accounting Standards No. 133, "Accounting Derivative
Instruments and Hedging Activities", was issued during the second quarter of
1998 and will become effective for the Company as of January 1, 2001. This
statement is not expected to have a material impact on the operating results or
the financial position of the Company.
11. Contengencies
The Company is one of a number of financial institutions named as party
defendants in a patent infringement lawsuit recently filed by an unaffilliated
financial institution. The lawsuit generally relates to the Company's tax refund
program.
The Company has retained outside legal counsel to represent its interests in
this matter. The Company does not believe that it has infringed any patents as
alleged in the lawsuit and intends to vigorously defend itself in this matter.
The amount of alleged damages are not specified in the papers received by the
Company. Therefore, Management cannot estimate the amount of any possible loss
at this time in the event of an unfavorable outcome.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SUMMARY
Pacific Capital Bancorp and its wholly owned subsidiaries (together referred to
as the "Company") posted earnings of $19.8 million for the quarter ended March
31, 2000, up $5.3 million over the same quarter last year. Diluted per share
earnings for the first quarter of 2000 were $0.80 compared to $0.59 earned in
the first quarter of 1999.
In various sections of this discussion and analysis, attention is called to the
significant impacts on the Company's balance sheet and income statement caused
by its tax refund and transfer programs. The actions taken by the Company to
manage this program are discussed in a specific section of this discussion
titled "Refund Anticipation Loan and Refund Transfer Programs." Readers are
referred to this section because Management believes that the explanation of the
impacts will be clearer to the reader if those actions are all described in one
place.
Compared to the first quarter of 1999, net interest income (the difference
between interest income and interest expense) increased by $11.4 million in the
first quarter of 2000, an increase of 28.13%. This was due primarily to the
seasonal impact of the income tax refund loan programs and additional interest
on other loans. Loans other than tax refund loans increased 19% from $1.693
billion at March 31, 1999, to $2.018 billion a year later. Interest income from
loans for the quarter was $61.9 million, up $18.7 million or 43%. Of this
increase, $5.7 million related to the substantially expanded refund loan
program.
Deposits increased $686.9 million or 29.1% during the last 12 months, while
interest expense increased $7.6 million. As explained more fully in the section
below covering the tax refund products, approximately $385 million of this
growth was due to issuing certificates of deposits through brokerage firms to
fund the tax refund loans.
Noninterest income, exclusive of gains or losses on securities transactions,
increased by $1.8 million over the same quarter of 1999. Trust and Investment
Services fees were up $414,000.
Provision expense for the first quarter of 2000 for loans other than tax refund
loans was $1,915,000, compared to $960,000 provided in the first quarter of
1999. The provision for tax refund loans for the first quarter of 2000 was
$3,631,000 compared to $2,759,000 for the first quarter of 1999.
Noninterest expenses increased in the first quarter of 2000 compared to the same
quarter of 1999, from $27.5 million to $28.8 million. However, because of the
increases in net interest income and noninterest income, the Company's operating
efficiency ratio, which measures what proportion of a dollar of operating income
it takes to earn that dollar, improved from 48.9% for the first quarter of 1999
to 41.6% for the first quarter of 2000.
The Company earned $0.80 per diluted share in the first quarter of 2000 compared
with $0.59 in the first quarter of 1999.
BUSINESS
The Company is a bank holding company. All references to "the Company" apply to
Pacific Capital Bancorp and its subsidiaries. "Bancorp" will be used to refer to
the parent company only. Its major subsidiaries are Santa Barbara Bank & Trust
("SBB&T") and First National Bank of Central California ("FNB") including its
affiliate South Valley National Bank ("SVNB"). SBB&T is a state-chartered
commercial bank and is a member of the Federal Reserve System. FNB is a
nationally chartered commercial bank and is also a member of the Federal Reserve
System. They offer a full range of retail and commercial banking services. These
include commercial, real estate, and consumer loans, a wide variety of deposit
products, and full trust services. The Company's third active subsidiary is
Pacific Capital Commercial Mortgage, Inc. ("PCCM"). The primary business
activity of PCCM is brokering commercial real estate loans and servicing those
loans for a fee. Bancorp provides support services, such as data processing,
personnel, training, and financial reporting to the subsidiary banks. Bancorp
has one inactive subsidiary, Pacific Capital Services Corporation.
17
FORWARD-LOOKING INFORMATION
This report contains forward-looking statements with respect to the financial
conditions, results of operations and business of the Company. These include
statements about the Company's plans, objectives, expectations and intentions
that are not historical facts. When used in this Report, the words "expects",
"anticipates", "plans", "believes", "seeks", "estimates", and similar
expressions are generally intended to identify forward-looking statements. These
forward-looking statements involve certain risks and uncertainties. Factors that
may cause actual results to differ materially from those contemplated by such
forward-looking statements include, among others, the following possibilities:
(1) competitive pressure among financial services companies increases
significantly; (2) changes in the interest rate environment reduce interest
margins; (3) general economic conditions, internationally, nationally or in the
State of California, are less favorable than expected; (4) changes in the IRS's
handling of electronic filing and refund payments adversely affect the Company's
RAL and refund transfer ("RT") programs; (5) legislation or regulatory
requirements or changes adversely affect the business in which the Company will
be engaged; and (6) other risks detailed in the Pacific Capital Bancorp 1999
Annual Report on Form 10-K filed with the Securities and Exchange Commission.
TOTAL ASSETS AND EARNING ASSETS
The chart below shows the growth in average total assets and deposits since
1996. Annual averages are shown for 1996 and 1997; quarterly averages are shown
for 1998, 1999 and 2000. Because significant but unusual cash flows sometimes
occur at the end of a quarter and at year-end, the overall trend in the
Company's growth is better shown by the use of average balances for the
quarters.
18
Chart 1 GROWTH IN AVERAGE ASSETS AND DEPOSITS ($ in millions)
$3,500 AAA
$3,450
$3,400
$3,350 A
$3,300
$3,250
$3,200 A
$3,150
$3,100
$3,050 A
$3,000 DDD
$2,950 A
$2,900 D
$2,850 AAAAAAA
$2,800 AAA A
A D
$2,750 A A
AAA
$2,700 A
$2,650 D
A
$2,600
AAA
$2,550 A
A D
$2,500 AAA
A
$2,450 DDD
A D DDDDDDD
$2,400 AAAAAAA D D
A D D
$2,350 D DDD
A
$2,300 DDD
D
$2,250 A D
DDD
$2,200 D
A
$2,150 D
A DDDDDDD
$2,100
D
$2,050 A
$2,000 A D
$1,950
A D
$1,900
D
$1,850 A
D
$1,800
AA D
$1,750
$1,700 A D
$1,650 D
$1,600 D
$1,550 DD
$1,500 D
1st 2nd 3rd 4th 1st 2nd 3rd 4th 1st
'96 '97 '98 '98 '98 '98 '99 '99 '99 '99 '00
A = Assets D = Deposits
19
Deposit balances also have been included in the chart because, prior to 1999, as
reflected in Chart 1, changes in assets were primarily related to changes in
deposit levels. As deposit funds were received, they were either lent to
customers or invested in securities. In 1999, the growth in assets was driven
more by increasing loan demand than by deposit growth. As explained below, the
Company funded much of this growth from the proceeds of maturing securities and
by borrowing funds from other financial institutions. This change is reflected
in the chart by assets increasing more than deposits.
The overall growth trend shown above for the Company prior to 2000 is due in
part to the continuing consolidation in the financial services industry. The
Company has obtained new customers as they became dissatisfied when the
character of their local bank was changed by an acquiring institution. The
Company also acquired First Valley Bank ("FVB") and Citizens State Bank ("CSB")
in 1997 and merged them into SBB&T. Contrary to the general pattern of banks
losing customers of the acquired institution, depositors of these two banks have
kept their deposits with SBB&T. The same experience has been seen with the
depositors of FNB and SVNB, namely that deposits have increased since the merger
in December of 1998. Because this merger was accounted for as a pooling of
interests, asset and deposit totals for periods prior to the merger have been
restated to include their balances. SBB&T has also opened three new offices in
Ventura County and one new office in northern Santa Barbara County during the
period covered by the chart. A decrease in average deposits for the second
quarter compared to the first is not unusual although it did not occur in 1997
or 1998. Such decreases are usually the result of tax payments and payments of
holiday bills. In 1999, some of the decrease was probably due to funds being
withdrawn for investment purposes as stock markets have continued their strong
rise.
The major reason for the large increase in assets and deposits during the first
quarter of 2000 was the significant expansion of the Company's tax refund loan
program. The Company issued approximately $405 million in certificates of
deposit to fund these loans. The funding of the program is explained in greater
detail in the section below titled "Refund Anticipation Loan and Refund Transfer
Programs".
Earning assets consist of the various assets on which the Company earns interest
income. On average, the Company earned interest on 94.2% of its assets during
the first three months of 2000. This compares with an average of 89.8% for peer
FDIC-Insured Commercial Banks. (See Note A. Notes are found at the end of this
report.) Having more of its assets earning interest helps the Company to
maintain its high level of profitability. The Company has achieved this higher
percentage by several means. Loans are structured to have interest payable in
most cases each month so that large amounts of accrued interest receivable
(which are nonearning assets) are not built up. In this manner, the interest
received can be invested to earn additional interest. The Company leases most of
its facilities under long-term contracts rather than owning them. This, together
with the aggressive disposal of real estate obtained as the result of
foreclosure, avoids tying up funds that could be earning interest. Lastly, the
Company has developed systems for clearing checks which are faster than those
used by most banks of comparable size. These systems permit the Company to put
the cash to use more quickly. At the Company's current size (excluding the extra
assets due to the certificates of deposits added for the tax refund loan
program), these and other steps have resulted in about $141 million more assets
earning interest during the first three months of the year than would be the
case if the Company's ratio were similar to its FDIC peers. The additional
earnings from these assets are somewhat offset by higher lease expense,
additional equipment costs, and occasional losses taken on quick sales of
foreclosed property. However, on balance, Management believes that these steps
give the Company an earnings advantage.
INTEREST RATE SENSITIVITY
Most of the Company's earnings arise from its functioning as a financial
intermediary. As such, it takes in funds from depositors and then either lends
the funds to borrowers or invests the funds in securities and other instruments.
The Company earns interest income on loans and securities and pays interest
expense on deposits and other borrowings. Net interest income is the difference
in dollars between the interest income earned and the interest expense paid.
The following first table shows the average balances of the major categories of
earning assets and liabilities for the three-month periods ended March 31, 1999
and 2000 together with the related interest income and expense. A second table,
an analysis of volume and rate variances, explains how much of the difference in
interest income or expense compared to the corresponding period of 1999 is due
to changes in the balances (volume) and how much is due to changes in rates. For
example, Table 1 shows that for the first quarter of 2000, NOW accounts averaged
$313,284,000, interest expense for them was $545,000, and the average rate paid
was 0.71%. In the first quarter of 1999, NOW accounts averaged $291,216,000,
interest expense for them was $589,000, and the average rate paid was 0.82%.
Table 2 shows that the $44,000 decrease in
20
interest expense for demand deposits from the first quarter of 1999 to the first
quarter of 2000 is the net result of a $45,000 increase in interest expense due
to the higher balances in 2000, offset by a reduction of $89,000 in interest
expense due to the lower rates paid during 2000.
These tables also disclose the net interest margin for the reported periods. Net
interest margin is the ratio of net interest income to average earning assets.
This ratio is useful in allowing the Company to monitor the spread between
interest income and interest expense from month to month and year to year
irrespective of the growth of the Company's assets. If the Company is able to
maintain the net interest margin as the Company grows, the amount of net
interest income will increase. If the net interest margin decreases, net
interest income can still increase, but earning assets must increase at a higher
rate. This serves to replace the net interest income that is lost by the
decreasing rate by increasing the volume.
21
TABLE 1 - AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES
(dollars in thousands) Three months ended Three months ended
March 31, 2000 March 31, 1999
-------------------------------------- --------------------------------------
Average Income/ Yield/ Average Income/ Yield/
Balances Expense Rate Balances Expense Rate
-------------------------------------- --------------------------------------
ASSETS
Short-term investments $362,945 $4,949 5.53% $186,531 $2,227 4.80%
Securities: (2)
Taxable 548,046 8,269 6.12% 606,600 9,000 6.02%
Non-taxable 143,479 3,670 10.23% 134,775 3,553 10.54%
------------ --------- ------------ ----------
Total securities 691,525 11,939 6.97% 741,375 12,553 6.84%
------------ --------- ------------ ----------
Loans and leases: (3)
Commercial 579,753 13,659 9.55% 375,967 8,289 8.94%
Ready equity 53,086 1,251 9.56% 46,685 1,009 8.77%
Real estate 1,097,755 22,701 8.27% 987,080 21,075 8.54%
Installment and consumer loans 172,176 4,666 10.99% 148,178 3,782 10.35%
Leasing 105,874 2,619 10.03% 82,710 2,060 10.10%
Tax refund loans 212,025 17,068 32.65% 42,496 7,120 67.95%
------------ --------- ------------ ----------
Total loans and leases 2,220,669 61,964 11.26% 1,683,116 43,335 10.37%
------------ --------- ------------ ----------
Total earning assets 3,275,139 78,852 9.72% 2,611,022 58,115 8.97%
Allowance for credit losses (31,395) (32,303)
Other assets 231,551 210,403
------------ ------------
TOTAL ASSETS $3,475,295 $2,789,122
============ ============
LIABILITIES
Deposits:
Interest-bearing demand $313,284 545 0.71% $291,216 589 0.82%
Savings and money market 827,253 6,535 3.20% 779,109 5,221 2.72%
Time deposits 1,170,107 15,841 5.49% 785,953 9,467 4.89%
------------ --------- ------------ ----------
Total interest-bearing deposits 2,310,644 22,921 1,856,278 15,277
Borrowed funds 195,175 2,756 5.73% $75,997 993 5.30%
------------ --------- --------- ------------ ---------- -------
Total interest-bearing liabilities 2,505,819 25,677 4.16% 1,932,275 16,270 3.41%
Noninterest-bearing demand deposits 692,215 603,432
Other liabilities 31,634 33,729
------------ ------------
TOTAL LIABILITIES 3,229,668 2,569,436
Shareholders' equity 245,627 219,686
------------ ------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $3,475,295 $2,789,122
============ ============
Net interest rate spread 5.56% 5.56%
NET INTEREST INCOME AND NET
--------- ----------
INTEREST MARGIN $53,175 6.54% $41,845 6.44%
========= ==========
<FN>
(1) Income amounts are presented on a fully taxable equivalent basis. The
federal statutory rate was 35% for all periods presented.
(2) Average securities balances are based on amortized historical cost,
excluding SFAS 115 adjustments to fair value which are included in other assets.
(3) Nonaccrual loans are included in loan balances. Interest income includes
related fees income.
</FN>
22
TABLE 2 - RATE/VOLUME ANAYSIS (1) (2)
(in thousands) Three months ended
March 31, 2000 vs March 31, 1999
----------------------------------------------------------
Change in Change in
Average Income/ Rate Volume
Balance Expense Effect Effect
----------------------------------------------------------
EARNING ASSETS:
Short-term investments $176,414 $2,722 $ 377 $ 2,345
Securities: (3)
Taxable (58,554) (731) 150 (881)
Non-taxable 8,704 117 (106) 223
----------------------------------------------------------
Total securities (49,850) (614) 44 (658)
----------------------------------------------------------
Loans and leases: (4)
Commercial 203,786 5,370 604 4,766
Ready equity 6,401 242 96 146
Real estate 110,675 1,626 (665) 2,291
Installment and consumer loans 23,998 884 244 640
Leasing 23,164 559 (14) 573
Tax refund loans 169,529 9,948 (18,456) 28,402
----------------------------------------------------------
Total loans and leases 537,553 18,629 (18,191) 36,818
----------------------------------------------------------
TOTAL EARNING ASSETS $664,117 20,737 (17,769) 38,504
==============
INTEREST-BEARING LIABILITIES
Deposits:
Interest-bearing demand $22,068 (44) (89) 45
Savings and money market 48,144 1,314 991 323
Time deposits 384,154 6,374 1,747 4,627
----------------------------------------------------------
Total deposits 454,366 7,644 2,649 4,995
Borrowed funds 119,178 1,763 206 1,557
TOTAL INTEREST-BEARING
LIABILITIES $573,544 9,407 2,855 6,552
==============--------------------------------------------
NET INTEREST INCOME (4) $11,330 ($20,624) $31,952
============================================
<FN>
(1) Income amounts are presented on a fully taxable equivalent (FTE) basis. The
federal statutory rate was 35% for all periods presented.
(2) The change not solely due to volume or rate has been prorated into rate and
volume components.
(3) Average securities balances are based on amortized cost, excluding SFAS 115
adjustments to fair value which are included in other assets.
(4) Nonaccrual loans are included in loan balances. Interest income includes
related fee income.
</FN>
23
Because such large proportions of the Company's balance sheet is made up of
interest-earning assets and interest-bearing liabilities, and because such a
large proportion of its earnings is dependent on the spread between interest
earned and interest paid, it is critical that the Company measure and manage its
interest rate sensitivity. Measurement is done by estimating the impact of
changes in interest rates over the next twelve months on net interest income and
on net economic value. Net economic value is the net present value of the cash
flows arising from assets and liabilities discounted at their acquired rate plus
or minus assumed changes.
Estimating changes in net interest income or net economic value from increases
or decreases in balances is relatively straight forward. Estimating changes that
would result from increases or decreases in interest rates is substantially more
difficult. Estimation is complicated by a number of factors: (1) some financial
instruments have interest rates that are fixed for their term, others that vary
with rates, and others that are fixed for a period and then reprice using then
current rates; (2) the rates paid on some deposit accounts are set by contract
while others are priced at the option of the Company; (3) the rates for some
loans vary with the market, but only within a limited range; (4) customers may
prepay loans or withdraw deposits if interest rates move to their disadvantage,
effectively forcing a repricing sooner than would be called for by the
contractual terms of the instrument; and (5) interest rates do not change at the
same time or to the same extent.
To address the complexity resulting from these and other factors, a standard
practice developed in the industry is to compute the impacts of hypothetical
interest rate "shocks" on the Company's asset and liability balances. A shock is
an immediate change in all interest rates. The resulting impacts indicate how
much of the Company's net interest income and net economic value are "at risk"
(would deviate from the base level) if rates were to change in this manner.
Although interest rates normally would not change suddenly in this manner, this
exercise is valuable in identifying exposures to risk and in providing
comparability both with other institutions and between periods. The results
reported below for the Company's December 31, 1999, and March 31, 2000 balances
indicate that the Company's net interest income at risk over a one year period
and net economic value at risk from 2% shocks are within normal expectations for
such sudden changes:
Shocked by -2% Shocked by +2%
-------------- --------------
As of December 31, 1999
Net interest income (4.26%) +3.00%
Net economic value +8.84% (6.61%)
As of March 31, 2000
Net interest income (4.34%) +3.14%
Net economic value +9.27% (7.09%)
The differences in the results are due to changes in the relative size of the
various components of the Company's balance sheet (the product mix) over the
last three months and the changes in the maturities and/or repricing
opportunities of the financial instruments held. Because the effect of changes
on net interest income is measured over the next twelve months, the results will
depend on whether more assets or liabilities will reprice within that period. If
the Company has more assets repricing within one year than it has liabilities,
then net interest income will increase with increases in rates and decrease as
rates decline. The opposite effects will be observed if more liabilities than
assets reprice in the next twelve months. As indicated in several other sections
of this discussion, much of the growth in loans has occurred in types which have
fixed rates for at least several years and much of this growth has been funded
by lowering short-term investments. As indicated, these changes tend to cause
liabilities to reprice sooner than assets and reduce net interest income at
least over the next 12 months. To offset this effect, the Company took several
actions late in the 2nd quarter and throughout the 3rd quarter, including sales
of securities, fixed-rate longer-term borrowing, and entering into
fixed-for-variable interest rate swaps.
The same changes to the balance sheet and mitigating steps 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. Therefore, the
results tend to be more pronounced. For
24
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.
The changes in net interest income and net economic value resulting from the
hypothetical increases and decreases in rates are not exactly symmetrical in
that 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. This occurs because various contractual limits and
non-contractual factors come into play. An example of the former is the
"interest rates cap" on loans, which may limit the amount that rates may
increase. An example of the latter is the assumption on how low rates could be
lowered on administered rate accounts. The degree of symmetry changes as the
base rate changes from period to period and as there are changes in the
Company's product mix. For instance, the assumed floors on deposit rates are
more likely to come into play in a 2% decrease if the base rate is lower. To the
extent that 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.
For these computations, the Company makes certain assumptions that significantly
impact the results. For example, the Company must make assumptions about the
duration of its non-maturity deposits because they have no contractual maturity,
and about the rates that would be paid on the Company's administered rate
deposits as external yields change. These assumptions are reviewed each quarter
and changed as deemed appropriate to reflect the best information available to
Management.
In addition to the simulations using the sudden rate changes, hypothetical
scenarios are also used that include gradual interest rate changes. The most
recent modeling using these more realistic hypothetical scenarios confirms that
the Company's interest rate risk profile is relatively balanced, i.e., the
negative impact on net economic value from hypothetical changes in interest
rates is not excessive, and that the results are within normal expectations.
However, along with the assumptions used for the shock computations, these
computations using gradual changes require certain additional assumptions with
respect to the magnitude, direction and volatility of the interest rate
scenarios selected which affect the results.
The Company's exposure to interest rate risk is discussed in more detail in the
1999 10-K MD&A.
DEPOSITS AND RELATED INTEREST EXPENSE
While there occasionally may be slight decreases in average deposits from one
quarter to the next, the overall trend is one of growth as shown in Chart 1. As
noted in the discussion accompanying the chart and as discussed in the section
titled "Refund Anticipation Loan and Refund Transfer Programs," there was a
significant increase in deposits during the first quarter of 2000 to fund these
programs. These deposits bear a higher interest rate than other deposits and the
rate paid on time deposits as shown in Table 1 reflect this higher rate.
The rate of growth of any financial institution is restrained by the capital
requirements discussed in the section of this report titled "Capital Resources
and Company Stock". Growth at too rapid a pace will result in capital ratios
that are too low. The normal orderly growth experienced by the Company has been
planned by Management and Management anticipates that it can be sustained
because of the strong capital position and earnings record of the Company. The
increases have come by maintaining competitive deposit rates, introducing new
deposit products, the opening of new retail branch offices, the assumption of
deposits in the FVB and CSB acquisitions, and successfully encouraging former
customers of merged financial institutions to become customers of the Company.
The abnormal growth in deposits related to the tax refund programs was carefully
planned to provide the least expensive source of funding and within the context
of maintaining the Company's well-capitalized classification as measured at each
quarter-end.
LOANS AND RELATED INTEREST INCOME
The end-of-period loan balances as of March 31, 2000, have increased by $79.8
million compared to December 31, 1999, and by $353.9 million compared to March
31, 1999. As shown in the table in Note 5 to the consolidated financial
statements, each one of the categories of loans increased in the last 12 months
except nonresidential real estate.
25
Residential real estate loans have continued to increase but at a slower rate
than was seen in 1998 and 1999. Recent increases in interest rates have reduced
the demand for refinancing. Most of the residential real estate loans held are
adjustable rate mortgages ("ARMS") that have initial "teaser" rates. The yield
increases for these loans as the teaser rates expire. Applicants for these loans
are qualified based on the fully-indexed rate.
The balances of nonresidential real estate loans tend to vary more than other
loan types because the average size is larger than for other loan types and
typically have shorter maturities. Therefore originations and payoffs have a
proportionally larger impact on the outstanding balance.
Construction loans have also grown over the last year. Silicon Valley, which is
adjacent to the Company's northern market areas, has recently seen rapidly
rising housing prices because of limited supply. This has caused new housing
construction activity to increase in areas that are within commuting distance,
and the Company is financing some of this construction.
Commercial loans have shown the largest increase over the last 12 months as
businesses in the Company's market areas continue to benefit from the strong
economy.
The consumer loan portfolio has increased primarily because of an increased
number of indirect auto loans. Indirect auto loans are loans purchased from auto
dealers. The dealers' loans must meet the credit criteria set by the Company.
About 90% or more of tax refund loans are made in the first quarter of each year
with the remainder in the second quarter. The expanded program in 2000 resulted
in $46.7 million of loans outstanding at the end of the quarter compared to
$18.4 million in tax refund loans outstanding at March 31, 1999. There were no
such loans outstanding at December 31, 1999.
The average balances and yields for loans for the first three months of 2000 and
1999 are reported in Table 1. As explained in the section below titled "Refund
Anticipation Loan and Refund Transfer Programs," the fees charged for the tax
refund loans are unrelated to the time they are outstanding and related more to
the cost to process and the credit risk. The yields reported in Table 1 for
these loans therefore are significantly impacted by the length of time they are
outstanding, because the income is annualized. Average yields for the first
three months of 2000 and 1999 without the effect of tax refund loans were 8.96%
and 8.95%, respectively.
The Federal Open Market Committee of the Federal Reserve Board has increased its
target market rates a number of times in the last 12 months. Along with most
other financial institutions, the Company has increased its prime rate to
reflect the change in market rates. Despite these increases, the average rate
earned on loans aside from tax refund loans has remained virtually identical to
the rate in the first quarter of 1999. Among the reasons for this are (1) only
those loans which are indexed to prime are repriced by this change, (2) many
customers have refinanced or repaid their fixed rate loans made in prior years
when rates were higher, and (3) customers are now presented with a number of
nonbank sources from which to borrow. This competition has brought about a
lowering of the rates to attract borrowers.
OTHER LOAN INFORMATION
In addition to the outstanding loans reported in the accompanying financial
statements, the Company has made certain commitments with respect to the
extension of credit to customers.
(in thousands) March 31, December 31,
2000 1999
---- ----
Commitments to extend credit
Commercial $395,386 $369,695
Consumer 72,824 70,744
Standby letters of credit 23,410 20,811
The majority of the commitments are for one year or less. The majority of the
credit lines and commitments may be withdrawn by the Company subject to
applicable legal requirements. The Company does anticipates that a majority of
the above commitments will not be fully drawn on by customers. Consumers do not
tend to borrow the maximum amounts
26
available under their home equity lines and businesses typically arrange for
credit lines in excess of their expected needs to handle contingencies.
The Company defers and amortizes loan fees collected and origination costs
incurred over the lives of the related loans. For each category of loans, the
net amount of the unamortized fees and costs are reported as a reduction or
addition, respectively, to the balance reported. Because the fees collected are
generally less than the origination costs incurred for commercial and consumer
loans, the total net deferred or unamortized amounts for these categories are
additions to the loan balances.
CREDIT QUALITY AND THE ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is provided in recognition that not all loans
will be fully paid according to their contractual terms. The Company is required
by regulation, generally accepted accounting principles, and safe and sound
banking practices to maintain an allowance that is adequate to absorb losses
that are inherent in the portfolio of loans and leases, including those not yet
identified. The methodology used to determine the adequacy of the allowance for
credit loss is discussed in detail in Note 1 to the Consolidated Financial
Statements presented in the Company's Annual Report for 1999 on Form 10-K. This
methodology involves estimating the amount of credit loss inherent in each of
the loan and lease portfolios taking into account such factors as historical
charge-off rates, economic conditions, and concentrations by industry,
geography, and collateral type. In addition, generally accepted accounting
principles require the establishment of a valuation allowance for impaired loans
as described in Note 5 to the financial statements.
Table 3 shows the amounts of noncurrent loans and nonperforming assets for the
Company at the end of the first quarter of 2000, and at the end of the previous
four quarters.
Shown for both the Company and its peers are the coverage ratio of the allowance
to total loans and the ratio of noncurrent loans to total loans. While the
Company does not determine its allowance for credit loss to achieve particular
target ratios, the Company does nonetheless compute its ratios and compares them
with peer ratios as a check on its methodology. Only two other banks operate
national refund loan and transfer programs. Therefore, refund loans and the
portion of the allowance for credit losses that specifically relates to refund
loans are excluded from the Company's figures and ratios for the table for
comparability.
Nonperforming assets include noncurrent loans and foreclosed collateral
(generally real estate).
27
Table 3--ASSET QUALITY
(dollars in thousands)
March 31, December 31, September 30, June 30, March 31,
2000 1999 1999 1999 1999
------- ------- ------- ------- -------
COMPANY AMOUNTS:
Loans delinquent
90 days or more $ 2,784 $ 80 $ 347 $ 122 $ 301
Nonaccrual loans 11,666 14,152 14,313 16,319 17,915
------- ------- ------- ------- -------
Total noncurrent loans 14,450 14,232 14,660 16,441 18,216
Foreclosed real estate -- -- -- -- --
------- ------- ------- ------- -------
Total nonper-
forming assets $14,450 $14,232 $14,660 $16,441 $18,216
======= ======= ======= ======= =======
Allowance for credit losses
other than RALs $27,635 $28,198 $28,404 $29,616 $29,637
Allowance for RALs 3,209 488 -- -- 1,871
------- ------- ------- ------- -------
Total allowance $30,844 $28,686 $28,404 $29,616 $31,508
======= ======= ======= ======= =======
COMPANY RATIOS (Exclusive of RALs):
Coverage ratio of
allowance for credit
losses to total loans 1.37% 1.42% 1.49% 1.63% 1.75%
Coverage ratio of
allowance for credit
losses to noncurrent loans 191% 198% 194% 180% 163%
Ratio of noncurrent
loans to total loans 0.72% 0.72% 0.77% 0.90% 1.08%
Ratio of nonperforming
assets to total assets 0.41% 0.49% 0.51% 0.60% 0.68%
FDIC PEER
GROUP RATIOS:
Coverage ratio of
allowance for credit
losses to total loans n/a 1.82% 1.85% 1.99% 2.06%
Coverage ratio of
allowance for credit
losses to noncurrent loans n/a 221% 210% 223% 209%
Ratio of noncurrent
loans to total loans n/a 0.58% 0.62% 0.89% 0.99%
Ratio of nonperforming
assets to total assets n/a 0.83% 0.88% 0.62% 0.69%
The allowance for credit losses (other than tax refund loans) compared to total
loans remains slightly lower than the corresponding ratios for the Company's
peer group. This is consistent with the fact that the Company generally has a
lower ratio of net charge-offs to average loans as shown in the following table:
Ratio of Net Charge-Offs to Average Loans:
1999 1998 1997 1996 1995
Pacific Capital Bancorp (excl. tax refund loans) 0.24% 0.02% (0.03%) 0.12% 0.86%
FDIC Peers 0.68% 1.08% 1.03% 0.89% 0.69%
28
Management identifies and monitors other loans that are potential problem loans
although they are not now delinquent more than 90 days. Table 4 classifies
noncurrent loans and all potential problem loans other than noncurrent loans by
loan category for March 31, 2000 (amounts in thousands).
Table 4--NONCURRENT AND OTHER POTENTIAL PROBLEM LOANS
Noncurrent Other Potential
Loans Problem Loans
---------------------------
Loans secured by real estate:
Construction and
land development $ -- $ 2,388
Agricultural -- 3,208
Home equity lines 258 749
1-4 family mortgage 2,437 4,471
Multifamily -- 135
Nonresidential, nonfarm 2,803 9,138
Commercial and industrial 7,548 17,939
Leases 364 227
Other consumer loans 1,040 2,115
Other Loans -- --
------- -------
Total $14,450 $40,370
======= =======
The following table sets forth the allocation of the allowance for all potential
problem loans by classification as of March 31, 2000 (amounts in thousands).
Doubtful $4,566
Substandard $4,148
Special Mention $1,279
The total of the above numbers is less than the total allowance. Most of the
allowance is allocated to loans which are not currently regarded as potential
problem loans, but for which, based on the Company's experience, there are
unidentified losses among them. The amounts allocated both to potential problem
loans and to all other loans are determined based on the factors and methodology
discussed in Note 1 to the Consolidated Financial Statements presented in the
Company's Annual Report on Form 10-K. Based on these considerations, Management
believes that the allowance for credit losses at March 31, 2000 was adequate to
cover the losses inherent in the loan and lease portfolios as of that date.
HEDGES, DERIVATIVES, AND OTHER DISCLOSURES
The Company has established policies and procedures to permit limited types and
amounts of off-balance sheet hedges to help manage interest rate risk. The
Company has entered into several interest rate swaps to mitigate interest rate
risk late in 1999. Under the terms of these swaps, the Company pays a fixed rate
of interest to the counterparty and receives a floating rate of interest. Such
swaps have the effect of converting fixed rate financial instruments into
variable or floating rate instruments. Such swaps may be related to specific
instruments or pools of instruments--loans, securities, or deposits with similar
interest rate characteristics or terms. The notional amount of the swaps in
place at March 31, 2000 was $34 million with a market value of approximately
$512,000.
Statement of Financial Accounting Standards No. 133, "Accounting Derivative
Instruments and Hedging Activities", was issued during the second quarter of
1998 and will become effective for the Company as of January 1, 2001 or earlier
should
29
the Company so choose. The Company expects to implement this reporting on
January 1, 2001. This statement is not expected to have a material impact on the
operating results or the financial position of the Company.
The Company has not purchased any securities arising out of highly leveraged
transactions, and its investment policy prohibits the purchase of any securities
of less than investment grade, the so-called "junk bonds."
FEDERAL FUNDS SOLD AND SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL
Cash in excess of the amount needed to fund loans, invest in securities, or
cover deposit withdrawals is sold to other institutions as Federal funds or
invested with other institutions on a collateralized basis as securities
purchased under agreements to resell ("reverse repo agreements"). These
agreements are investments which are collateralized by securities or loans of
the borrower and mature on a daily basis. The sales of Federal funds are on an
overnight basis as well. The amount of Federal funds sold and reverse repo
agreements purchased during the quarter is an indication of Management's
estimation during the quarter of immediate cash needs, the excess of funds
supplied by depositors over funds lent to borrowers, and relative yields of
alternative investment vehicles.
As shown in Table 1, the average balance of these short-term investments for the
first three months of 2000 was more than for the first three months of 1999. As
explained in the section below titled "Refund Anticipation Loan and Refund
Transfer Programs," the reason for this change is that the Company had to
arrange for a substantial amount of funding for the refund loan program. The
funding could not be arranged for as short a period as was needed for the tax
refund loans, and the Company therefore had an excess amount of funds on hand
for much of the first quarter. Some of this excess was used to purchase
securities, but most was sold as Federal funds or invested with other
institutions in reverse repo agreements.
OTHER BORROWINGS, LONG-TERM DEBT AND RELATED INTEREST EXPENSE
Other borrowings consist of securities sold under agreements to repurchase,
Federal funds purchased, Treasury Tax and Loan demand notes, and borrowings from
the "FRB". Generally, Federal funds have been purchased only from other local
financial institutions as an accommodation to them. However, because of the need
for additional funding this year to support the very strong loan demand, the
Company has purchased additional funds. Nonetheless, because the average total
of other borrowings still represents a very small portion of the Company's
source of funds (less than 5%), all of these short-term items have been combined
for the following table.
Table 5 indicates for other borrowings the average balance (dollars in
millions), the rates and the proportion of total assets funded by them over the
last six quarters.
Table 5--OTHER BORROWINGS
Average Average Percentage of
Quarter Ended Outstanding Rate Average Total Assets
------------- -------------- -------------- ----------------------
December 1998 $33.5 4.40% 1.3%
March 1999 26.7 4.43 1.0
June 1999 44.3 4.54 1.6
September 1999 30.1 4.68 1.1
December 1999 61.7 5.13 2.2
March 2000 82.2 3.81 2.4
The amount of these borrowings rose in the fourth quarter of 1999 as the growth
in loans continued to exceed the growth in deposits and the Company turned to
nondeposit sources to fund the loan growth.
Long-term debt consists of advances from the Federal Home Loan Bank of San
Francisco ("FHLB"). The outstanding advances from the FHLB March 31, 2000
totaled $118.5 million. The scheduled maturities of the advances are $40.5
million in 1 year or less, $15.4 million in 1 to 3 years, and $62.6 million in
more than 3 years.
Table 6 indicates the average balances that are outstanding (dollars in
millions) and the rates and the proportion of total assets funded by long-term
debt over the last six quarters.
30
Table 6--LONG-TERM DEBT
Average Average Percentage of
Quarter Ended Outstanding Rate Average Total Assets
------------- -------------- ------------- ----------------------
December 1998 $35.8 5.96% 1.4%
March 1999 49.3 5.66 1.8
June 1999 67.9 5.73 2.5
September 1999 107.9 5.90 3.9
December 1999 88.4 6.07 3.1
March 2000 112.9 7.02 3.3
The Company has increased this long-term debt over the last two quarters. This
has been done both to provide funding for the loan growth noted above and
because much of the loan growth has been in fixed rate products. FHLB advances
are among the easiest means of mitigating the market risk incurred through the
growth in fixed loans. One of the methods of managing interest rate risk is to
match repricing characteristics of assets and liabilities. When fixed-rate
assets are matched by similar term fixed-rate liabilities, the deterioration in
the value of the asset when interest rates rise is offset by the benefit to the
Company from having the matching debt at lower than market rates.
OTHER OPERATING INCOME AND EXPENSE
Other operating income consists of income earned other than interest. On an
annual basis, trust fees are the largest component of other operating income.
Management fees on trust accounts are generally based on the market value of
assets under administration.
There are several reasons for the variation in fees from quarter to quarter.
Trust customers are charged for the preparation of the fiduciary tax returns.
The preparation generally occurs in the first quarter of the year. This accounts
for approximately $288,000 of the fees earned in the first three months of 1999
and $306,000 of the fees earned in the first three months of 2000. Variation is
also caused by the recognition of probate fees. These fees are accrued when the
work is completed, rather than as the work is done, because it is only upon the
completion of probate that the amount of the fee is established by the court.
Other categories of noninterest operating income include various service
charges, fees, and miscellaneous income. Included within "Other Service Charges,
Commissions & Fees" are the electronic refund transfer fees (described below in
"Refund Anticipation Loan and Refund Transfer Programs"), service fees arising
from credit card processing for merchants, escrow fees, and a number of other
fees charged for special services provided to customers.
The following table shows some of the major items of other operating income and
expense for the three months ended March 31, 2000 and 1999 that are not
specifically listed in the consolidated statements of income.
31
TABLE 7--OTHER OPERATING INCOME AND EXPENSE
(dollars in thousands)
Three Months Ended
March 31,
------------------------
2000 1999
------------------------
Noninterest income
Merchant credit card processing $ 1,745 $ 1,559
Trust fees $ 3,823 $ 3,351
Refund transfer fees $ 6,609 $ 5,808
Noninterest expense
Marketing $ 533 $ 550
Consultants $ 1,343 $ 2,465
Merchant credit card clearing fees $ 1,386 $ 1,214
The largest component of noninterest expense is staff expense. There is some
increase in this expense each quarter caused by the addition of staff. Other
factors cause some variation in staff expense from quarter to quarter. Staff
expense will usually increase in the early part of each year because adjustments
arising from the annual salary review for all Company exempt employees are
effective on either January 1 or March 1. In 2000, these increases averaged
approximately 5%. In addition, some temporary staff is added in the first
quarter for the RAL program.
Employee bonuses are paid from a bonus pool, the amount of which is set by the
Board of Directors based on the Company meeting or exceeding its goals for net
income. The Company accrues compensation expense for the pool for employee
bonuses throughout the year based on projected net income for the year.
Staff size is closely monitored in relation to the growth in the Company's
revenues and assets. The following table compares salary and benefit costs as a
percentage of revenues and assets for the three-month periods ended March 31,
2000 and 1999.
Three Months Ended
March 31,
2000 1999
Salary and benefits as
a percentage of total
revenues 15.7% 18.0%
Salary and benefits as
a percentage of average
assets 0.42% 0.46%
The Company leases rather than owns most of its premises. Many of the leases
provide for annual rent adjustments. Equipment expense fluctuates over time as
needs change, maintenance is performed, and equipment is purchased. Some of the
additional occupancy expense relates to new facilities that were leased
subsequent to the fire at the Company's administrative headquarters which
occurred February 20, 1999. 105 employees that worked in the building needed to
be immediately located to different work locations. Vacant commercial office
space of sufficient size is very limited in the area. In order to provide new
work space for the displaced employees, the Company rented a building much
larger than the former administrative building. In general, the new space is
more expensive than the former building. Insurance will cover the cost for the
same amount of space; however, the additional space may not be reimbursable.
Some of the additional space will be utilized by moving employees from other
leased space and the remainder of the building will be subleased. Occupancy
expense is higher in 2000 than in 1999 because of the additional space.
Eventually, this cost will be offset with subleasing income and the
discontinuation of other lease expense as employees are moved to the new
building.
Included in other noninterest expense is consultant expense for legal and
professional services. The amount incurred in the first quarter of 2000 is
substantially less than that incurred in the first quarter of 1999. A large
proportion of the 1999
32
expenses were consultant fees incurred by the Company's Information Technology
department related to two major technology projects. The first was directed at
ensuring that all of the Company's information systems, operational processes,
and physical facilities were prepared for the Century Date Change (also known as
"Y2K"). The Company began to prepare for this several years previously, but the
intensity of efforts was stepped up in early 1999 to resolve all of the issues
well in advance of January 1, 2000. The second project was the integration of
the information systems of First National Bank/South Valley National Bank with
those used by Santa Barbara Bank & Trust. Specifically, the Company does not
carry staff levels sufficient to handle two complex, infrequent projects like
these along with normal operational demands. In addition, the Y2K project had to
be completed under a rigid time schedule that permitted no slippage from
deadlines. Therefore, the Company engaged outside assistance in the form of
contract programming support to accomplish both of these projects concurrently.
As described in the last two sections of this discussion and analysis, the
Company has announced that reached agreements to merge/acquire two other
financial institutions. Some extra expense may be incurred in connection with
the system integration for these two institutions, but it is not expected that
the projects will be as extensive as was the integration of the First National
Bank/South Valley Bank systems and integration of one of the systems is not
expected until 2001.
INCOME TAX
Income tax expense is comprised of a current tax provision and a deferred tax
provision for both Federal income tax and state franchise tax. The current tax
provision recognizes an expense for what must be paid to taxing authorities for
taxable income earned this year. The deferred tax provision recognizes an
expense or benefit related to items of income or expense that are included in or
deducted from taxable income in a period different than when the items are
recognized in the financial statements under generally accepted accounting
principles. Examples of such timing differences and the impact of the major
items are shown in Note 8 to the Consolidated Financial Statements in the
Company's Annual Report on Form 10-K.
With each period end, it is necessary for Management to make certain estimates
and assumptions to compute the provision for income tax. Management uses the
best information available to develop these estimates and assumptions, but
generally some of these estimates and assumptions are revised when the Company
files its tax return in the middle of the following year. In accordance with
generally accepted accounting principles, revisions to estimates are recorded as
income tax expense or benefit in the period in which they become known.
For the last several years, the effective tax rate (income tax expense divided
by pre-tax income) for the Company has been increasing. The increase in loan
income and the expansion of the tax refund programs in 2000 compared to 1999
increased taxable income at a much higher rate than tax-exempt income increased
over the same period. The effective rate for the first quarter of 2000 was 40.1%
compared to 38.1% for the first quarter of 1999. The Company continues to
purchase tax-exempt securities but the rates on securities purchased over the
last several years have been at lower rates than the rates that applied to the
large amount of municipal securities purchased in the mid-80's many of which
have recently matured.
LIQUIDITY
Liquidity is the ability to raise funds on a timely basis at acceptable cost in
order to meet cash needs, such as might be caused by fluctuations in deposit
levels, customers' credit needs, and attractive investment opportunities. The
Company's objective is to maintain adequate liquidity at all times.
The Company has defined and manages three types of liquidity: (1) "immediate
liquidity," which is the ability to raise funds today to meet today's cash
obligations, (2) "intermediate liquidity," which is the ability to raise funds
during the next few weeks to meet cash obligations over that time period, and
(3) "long term liquidity," which is the ability to raise funds over the entire
planning horizon to meet anticipated cash needs due to strategic balance sheet
changes. Adequate liquidity is achieved by (a) holding liquid assets that either
will mature within several weeks or can easily be sold, (b) maintaining the
ability to raise deposits or borrow funds, and (c) keeping access open to
capital markets.
Immediate liquidity is provided by the prior day's maturing Federal funds sold
and repurchase agreements, any cash in excess of the Federal Reserve balance
requirement, unused Federal funds lines from other banks, and unused repurchase
agreement facilities with other banks or brokers. The Company maintains total
sources of immediate liquidity of not less than 5% of total assets, increasing
to higher targets during that portion of the first quarter when the tax refund
loan program is active. At the end March 31, 2000, these sources of immediate
liquidity were well in excess of that minimum.
33
Sources of intermediate liquidity include maturities or sales of short-term
money market instruments and securities in the Liquidity and Discretionary
Portfolios, securities in the Earnings Portfolio maturing within three months,
term repurchase agreements, advances from the FHLB, and deposit increases from
special programs. The Company projects intermediate liquidity needs and sources
over the next several weeks based on historical trends, seasonal factors, and
special transactions. Appropriate action is then taken to cover any anticipated
unmet needs. At the end of March 2000, the Company's intermediate liquidity was
adequate to meet all projected needs.
Long term liquidity is to be provided by special programs to increase core
deposits, reducing the size of the investment portfolios, selling or
securitizing loans, and accessing capital markets. The Company's policy is to
address cash needs over the entire planning horizon from actions and events such
as market expansions, acquisitions, increased competition for deposits,
anticipated loan demand, economic conditions and the regulatory outlook. At the
end of March 2000, the Company's long term liquidity was adequate to meet cash
needs anticipated over its planning horizon.
CAPITAL RESOURCES AND COMPANY STOCK
The following table presents a comparison of several important amounts and
ratios for the first quarter of 2000 and 1999 (dollars in thousands).
Table 8--CAPITAL RATIOS
1st Quarter 1st Quarter
2000 1999 Change
-------------- ------------- -------------
Amounts:
Net Income $ 19,820 $ 14,521 $ 5,299
Average Total Assets 3,475,295 2,789,122 686,173
Average Equity 245,627 219,686 25,941
Ratios:
Equity Capital to Total Assets (period end) 7.06% 8.30% (1.24%)
Annualized Return on Average Assets 2.29% 2.11% 0.18%
Annualized Return on Average Equity 32.37% 26.81% 5.56%
The operating earnings of the subsidiary banks are the largest source of capital
for the Company. For reasons mentioned in various sections of this discussion,
Management expects that there will be variations from quarter to quarter in
operating earnings. Areas of uncertainty or seasonal variations include asset
quality, loan demand, and the tax refund loan and transfer programs. A
substantial increase in charge-offs might require the Company to record a larger
provision for loan loss to restore the allowance to an adequate level, and this
would negatively impact earnings. As loan demand has increased, the Company has
been able to reinvest proceeds from maturing investments at higher rates, which
would positively impact earnings. Income from the tax refund loan and transfer
programs, occurring almost entirely in the first quarter, introduce significant
seasonality and cause the return on average assets and return on average equity
ratios to be substantially higher in the first quarter of each year than they
will be in subsequent quarters.
Capital must be managed at both the Company and at the individual bank levels.
The FRB sets minimum capital guidelines for U.S. banks and bank holding
companies based on the relative risk of the various types of assets. The
guidelines require banks to have capital equivalent to at least 8% of risk
adjusted assets. To be classified as "well capitalized", the Company is required
to have capital equivalent to at least 10% of risk adjusted assets. As of March
31, 2000, the Company's risk-based capital ratio was 10.36%. The Company must
also maintain a Tier I capital (total shareholder equity less goodwill and other
intangibles) to risk adjusted assets ratio of 6%, and 5% of average tangible
assets, respectively. As of March 31, 2000, Tier I capital was 9.18% of risk
adjusted assets and 6.92% of average tangible assets.
The ratio of equity capital to total assets has decreased over the last year as
assets have increased at a higher rate than equity capital. This occurred for
several reasons. The first is that the strong loan demand noted above has caused
a high rate of asset growth. The second is that in the fourth quarter of 1998,
the Company's net income was significantly reduced by the one-
34
time costs incurred in connection with the closing of the merger with Pacific
Capital Bancorp. The Company, however, did not reduce its dividend to
shareholders for this quarter and therefore more capital was paid out in
dividends to shareholders than was added to capital from net income. The third,
which is almost totally restricted in its impact to the first quarter of 2000,
is the growth in assets related to the tax refund programs as explained below in
the section titled "Refund Anticipation Loan and Refund Transfer Programs."
While the earnings of its wholly-owned subsidiaries are recognized as earnings
of the Company, specific dividends must be declared and paid by the subsidiary
banks to the parent in order for it to pay dividends to its shareholders. As a
state-chartered bank, California law limits the amount of dividends that may be
paid by SBB&T to Bancorp. As a nationally-chartered bank, FNB's ability to pay
dividends is governed by federal law and regulations.
California law limits dividends that may be paid by a bank without specific
approval by the California Department of Financial Institutions to the lesser of
the bank's retained earnings or the total of its undistributed net income for
the last three years. The dividends needed to be paid by SBB&T to the Bancorp
for the acquisitions of FVB and CSB exceeded the amount allowable without prior
approval of the California Department of Financial Institutions ("CDFI"). As
part of its approval of the acquisitions, the CDFI approved the excess
distributions. During 1998 and 1999, it also approved other dividends from SBB&T
to the Bancorp to partially fund the latter's quarterly cash dividends to its
shareholders and for other incidental purposes. SBB&T was able to pay $3 million
in dividends to Bancorp during the first quarter of 2000 without specific
approval, but will need to request approval for additional dividends that will
be needed during the year, both for its portion of the Bancorp cash dividend
paid to shareholders and for the Los Robles acquisition. Management expects that
approval will continue to be granted due to strong earnings and the
well-capitalized position of SBB&T.
Because the former Pacific Capital's merger with South Valley Bancorporation was
a stock-only transaction, FNB did not have to pay a large dividend to its
holding company as SBB&T did. FNB therefore has ample ability to pay dividends
to the Bancorp for all normal operating needs and for shareholder dividends.
There are no material commitments for capital expenditures or "off-balance
sheet" financing arrangements other than the acquisition of Los Robles Bancorp
planned at this time. However, as the Company pursues its stated plan to expand
beyond its current market areas, Management will consider opportunities to form
strategic partnerships with other financial institutions that have compatible
management philosophies and corporate cultures and that share the Company's
commitment to superior customer service and community support. Such
transactions, depending on their structure, may be accounted for as a purchase
of the other institution by the Company. To the extent that consideration is
paid in cash rather than Company stock, the assets of the Company would increase
by more than its equity and therefore the ratio of capital to assets would
decrease.
The current quarterly dividend rate is $0.20 per share. When annualized, this
represents a payout ratio of approximately 40% of earnings per share for the
trailing 12 months.
REGULATION
The Company is closely regulated by Federal and State agencies. The Company and
its subsidiaries may only engage in lines of business that have been approved by
their respective regulators, and cannot open or close offices without their
approval. Disclosure of the terms and conditions of loans made to customers and
deposits accepted from customers are both heavily regulated as to content. The
subsidiary banks are required by the provisions of the Community Reinvestment
Act ("CRA") to make significant efforts to ensure that access to banking
services is available to all members of their communities. As a bank holding
company, Bancorp is primarily regulated by the Federal Reserve Bank ("FRB"). As
a member bank of the Federal Reserve System that is state-chartered, SBB&T's
primary Federal regulator is the FRB and its state regulator is the CDFI. As a
nationally chartered bank, FNB's primary regulator is the Office of the
Comptroller of the Currency. As a non-bank subsidiary of the Company, Pacific
Capital Commercial Mortgage, Inc. is regulated by the FRB. Each of these
regulatory agencies conducts periodic examinations of the Company and/or its
subsidiaries to ascertain their compliance with laws, regulations, and safe and
sound banking practices.
The regulatory agencies may take action against bank holding companies and banks
should they fail to maintain adequate capital or to comply with specific laws
and regulations. Such action could take the form of restrictions on the payment
of dividends to shareholders, requirements to obtain more capital from
investors, or restrictions on operations. The Company
35
and the subsidiary banks have the highest capital classification, "well
capitalized," given by the regulatory agencies and therefore, except for the
need for approval of dividends paid from SBB&T to Bancorp, are not subject to
any restrictions as discussed above. Management expects the Company and the
subsidiary banks to continue to be classified as well capitalized in the future.
REFUND ANTICIPATION LOAN AND REFUND TRANSFER PROGRAMS
Since 1992, SBB&T has extended tax refund anticipation loans to taxpayers who
have filed their returns electronically with the IRS and do not want to wait for
the IRS to send them their refund check. SBB&T earns a fixed fee per loan for
advancing the funds. The fees are more related to processing cost and credit
risk exposure than to the cost of funding the loans for the length of time that
they are outstanding. Nonetheless, the fees are required to be classified as
interest income. Because of the April 17 tax filing date, almost all of the
loans are made and repaid during the first quarter of the year.
If a taxpayer meets SBB&T's credit criteria for the refund loan product, and
wishes to receive a loan with the refund as security, the taxpayer applies for
and receives an advance less the transaction fees, which are considered finance
charges. SBB&T is repaid directly by the IRS and remits any refund amount over
the amount due SBB&T to the taxpayer.
There is a higher credit risk associated with refund loans than with other types
of loans because (1) SBB&T does not have personal contact with the customers of
this product; (2) the customers conduct no business with SBB&T other than this
once a year transaction; and (3) contact subsequent to the payment of the
advance, if there is a problem with the tax return, may be difficult because
many of these taxpayers have no permanent address.
If the taxpayer does not meet the credit criteria or does not want a loan, SBB&T
can still facilitate the receipt of the refund by the taxpayer through the
refund transfer program. This is accomplished by SBB&T authorizing the tax
preparer to issue a check to the taxpayer once the refund has been received by
SBB&T from the IRS. The fees received for acting as a transfer agent are less
than the fees received for the loans. These fees are reported among "other
service charges, commissions and fees, net" in the consolidated statements of
income.
While SBB&T is one of very few financial institutions in the country to operate
these electronic loan and transfer programs, the electronic processing of
payments involved in these programs is similar to other payment processing
regularly done by the Company and other commercial banks for their customers
such as direct deposits and electronic bill paying. The refund loan and transfer
programs had significant impacts on the Company's activities and results of
operations during the first quarters of 1999 and 2000. These impacts are
discussed in the following six sections.
1. An IRS Change in the Program Caused Expanded Volume:
Prior to 1995, upon receipt of an electronically filed tax return, the IRS would
send a return notice to the filer indicating whether the IRS had a lien
outstanding against any refund due the taxpayer. Such liens might be placed on
refunds because of prior underpayments, delinquent student loans, or unpaid
taxes. Because the primary source of repayment for tax refund loans is the IRS,
not the taxpayer, banks operating loan programs relied on this notice in
determining whether to make a loan to the taxpayer.
In 1995, the IRS discontinued this practice, and banks had to use other means to
determine whether they were likely to have their loans repaid. These other means
added to the costs of making the loans and they were not as reliable in
determining collectibility. Fees for loans were therefore raised to pay for the
additional transaction costs and to cover the higher credit losses.
Congress has given the IRS a mandate to increase the number of returns that are
filed electronically in order to keep IRS costs down. Greater use of the refund
loan and transfer programs helps the IRS to meet this mandate because they are
connected to electronic filing. In 2000, the IRS resumed sending the return
notice indicating whether it would withhold the taxpayer's refund because of
funds owed the Federal government. The banks running national programs decreased
their transaction fees for loans because better credit determinations could be
made at lower cost. This served to encourage more taxpayers to use the products,
especially the loan product. It also permitted the Company and other providers
to lend against a higher proportion of each refund.
36
The consequence of this IRS change was to increase the total volume of
transactions, to increase the proportion of loans compared to transfers, and to
increase the size of the loans made.
2. Seasonality Impact on Earnings:
Because the programs relate to the filing of income tax returns, activity is
concentrated in the first quarter of each year. This causes first quarter income
to average about 30% of each year's net income. Because of the expansion of the
program in 2000, Management expects that net income for the first quarter will
be approximately 38% of net income for the year.
3. Product Mix Impact on Revenues:
In 2000, the product mix between loans and transfers was more heavily weighted
towards loans than it had been since 1995. This meant that interest income
arising from the program was higher both because the overall volume of
transactions in the programs was larger and because more of the transactions
were loans rather than transfers. This resulted in higher net interest income
and net interest margin than would otherwise be expected. Even though the
product mix shifted towards loans, as noted below in the summary of operating
results, the expanded program caused income from transfers to increase as well,
but at a lower rate than loans.
4. Funding Impact on Various Balance Sheet and Income and Expense Accounts:
In prior years, SBB&T funded the loans by first drawing down its overnight
liquid assets and then by borrowing overnight. The borrowing was done through
use of its unsecured Federal funds credit lines with other financial
institutions and by entering into repurchase agreements with other financial
institutions that used SBB&T's securities as collateral for the overnight
borrowings.
Again in 2000, SBB&T used liquid assets and borrowed overnight to fund the
loans. In addition, SBB&T increased its borrowings from the FHLB during this
period. With the larger program, interest expense on these borrowings increased
over the amounts incurred in 1999. However, because of the substantial increase
in the program in 2000, SBB&T could not fund the loans using only these sources.
While it expanded the number and amount of credit lines available to it,
Management decided that the best assured source of funding would be to engage
brokerage firms to sell certificates of deposit. Approximately $385 million of
these CDs were issued with terms of two, three, and six months. Shorter
maturities would have been preferable because the funding need is concentrated
in the only first three weeks of February, but they were not available in
sufficient quantity. The average rate for these CDs was 6.30%. These brokered
CDs account for the increase in the average time deposits outstanding and the
increase in interest expense on these accounts during the first quarter of 2000,
as reported in Table 1, compared to the amounts for the first quarter of 1999.
Among the amounts reported in Note 9 to the financial statements for each
operating segment of the Company are interest expense, internal charges for
funds, and intersegment revenues. Though issued for the refund loan program, the
CDs were booked in the Branch Activities segment, since that is where all
deposit funding is recorded for SBB&T. The proceeds from the CDs were in essence
lent to the Tax Refund Programs segment. This segment reports the cost of
borrowing the funds as an internal charge for funds and the Branch Activities
segment recognizes intersegment revenues in the amount of the charge.
The impact of using this method of funding is that SBB&T had an excess of funds
after the loans began to be repaid by the IRS in substantial quantities. These
funds were initially sold into overnight Federal funds market and reverse repos
with other financial institutions, increasing the average balance of, and the
interest income from, these short-term instruments for the quarter as shown in
Table 1. However, because the rates earned on these overnight investments were
below the interest rate paid on the deposits, the Company began to place the
funds into securities and commercial paper that had maturities matching the CDs
or would be easily salable to provide the funds necessary to redeem the CDs.
These instruments had interest rates more closely matching the CD rates and
therefore the negative carrying cost was reduced.
Other liabilities reported in the consolidated balance sheet were substantially
higher at March 31, 2000 than at December 31, 1999. The primary reason for this
increase relates to one of its contractors in the program. SBB&T collects fees
for this contractor and holds the fees for application against credit losses
incurred on the loans made by this contractor. The amount held at March 31, 2000
for this purpose was $22.4 million.
5. Summary of Operating Results:
37
Gross revenues for the refund loan and transfer programs were $7.5 million and
$5.9 million, respectively, for the first quarter of 1999, with operating
expenses of $1.8 million. The Company added $2.8 million to the allowance for
credit loss for refund loans through a charge to provision expense during the
quarter and added another $2.1 million to the allowance from recoveries on loans
charged off in prior years. The Company charged-off $3.3 million in refund loans
during this quarter of 1999.
During the first quarter of 2000, the Company recognized fees for refund loans
of $17.6 million and fees for transfers of $6.6 million. Operating expenses
totaled $2.3 million.
The Company estimates that about 1.3% of refund loans will not be collected in a
timely fashion from the IRS. Using this estimate, during the quarter ended March
31, 2000, the Company provided for these potential losses by adding $3.6 million
to the allowance for credit loss from refund loans through a charge to provision
expense and adding another $2.0 million to the allowance from recoveries on
loans charged off in prior years. The Company charged-off $2.9 million in RAL's
against this allowance in the first quarter of 2000. Some of these loans may yet
be paid during the remainder of this year or during the 2001 filing season. In
addition, following past practice, the Company expects to charge-off any
remaining uncollected refund loans by June 30.
There is no credit risk associated with the refund transfers because checks are
issued only after receipt of the refund payment from the IRS.
6. Expectations for the Remainder of 2000:
Additional loans and transfers were made between the end of the first quarter of
2000 and the tax filing deadline of April 17. But this activity represents a
small proportion of the total activity for the season. Some additional revenues
will be generated from this activity. Because SBB&T does not recognize interest
income on the loans or transfer income until the IRS has remitted the refunds to
it, there will also be some revenue recognized from loans and transfers made
prior to March 31.
During the first quarter, SBB&T charged off loans that had been outstanding more
than six weeks. In addition it provided an allowance for credit loss in an
amount estimated to cover losses on the remaining outstanding loans. During the
second quarter, SBB&T will likely receive payments on some of these loans that
were charged off and on loans charged off in prior years. In addition, some of
the outstanding loans which appeared collectible at March 31 will become
delinquent and need to be charged off. These activities will require adjustments
to the provision for credit loss by charging or crediting income for the second
quarter. Management does not anticipate that the adjustments will be
significant. As in prior years, still outstanding loans will be charged off at
the end of the second quarter. Collections that are eventually received on these
loans will be added to the allowance for credit losses.
Lastly, during the second quarter, as well as during the rest of 2000, the tax
refund programs will continue to incur expenses for salaries, occupancy, legal,
data processing, etc. These expenses will tend to lower the reported profit for
the segment compared to the figure reported in Note 9. However, these expenses
are not expected to exceed several hundred thousand dollars.
The Company is one of a number of financial institutions named as party
defendants in a patent infringement lawsuit recently filed by an unaffilliated
financial institution. The lawsuit generally relates to the Company's tax refund
program.
The Company has retained outside legal counsel to represent its interests in
this matter. The Company does not believe that it has infringed any patents as
alleged in the lawsuit and intends to vigorously defend itself in this matter.
The amount of alleged damages are not specified in the papers received by the
Company. Therefore, Management connot estimate the amount of any possible loss
at this time in the event of an unfavorable outcome.
YEAR 2000
The Company provided extensive information regarding its preparations for the
Century Date Change in the 1999 10-K MD&A. It was reported in that discussion
that "no significant problems were encountered with the Company's critical
systems and through the writing of this discussion, the Company has become aware
of no significant problems encountered by its customers or the other financial
institutions with which it does business. The Company has become aware of no
significant impact on its customers' abilities to repay loans due to problems
with their systems. The Company will remain alert to the potential for problems
to arise later in 2000, especially because it will be a leap year."
As of the writing of this discussion, the above statements are still correct,
and this topic will not be included in future reports unless problems arise.
38
MERGER WITH SAN BENITO BANK
In February 2000, the Company signed a merger agreement with Hollister,
California-based San Benito Bank. The agreement provides for existing San Benito
Bank shareholders to receive 0.605 shares of Pacific Capital Bancorp common
stock for each of their outstanding shares of common stock. The merger
transaction will be accounted for as a pooling of interests. As of the date of
the agreement, based on the closing price per share of Company stock, the value
of the merger would be estimated to be $51.8 million. However, the final value
will be based on the price per share at the time the transaction closes, which
may result in a value more or less than that stated above. Subject to
shareholder and regulatory approvals, the merger is expected to close in the
third quarter of 2000. One-time charges to be taken at the time of closing are
estimated to be $1.6 million after tax. Administrative and operational support
units will be based out of First National Bank of Central California, creating
the merger savings that will make the transaction accretive to earnings per
share in the first full operating year for the combined company.
At December 31, 1999, San Benito Bank reported net income of $2.3 million, with
total assets of $201million, total deposits of $181 million, total loans of $109
million, and total shareholders' equity of $18 million. San Benito Bank
maintains three offices in the communities of Hollister and San Juan Bautista in
San Benito County, and an office in Gilroy in Santa Clara County.
ACQUISITION OF LOS ROBLES BANCORP
In March 2000, the Company signed a definitive agreement to acquire Thousand
Oaks, California-based Los Robles Bancorp, parent company of Los Robles Bank.
The agreement provides for each outstanding share of Los Robles Bancorp common
stock to be converted into the right to receive $23.12 in cash, and each
outstanding stock option to receive the difference between $23.12 and the
exercise price of the option in cash. The acquisition will be accounted for
under the purchase method of accounting. As of the date of the agreement, the
estimated value of the transaction is approximately $32.5 million, representing
2.73 times Los Robles' book value at December 31, 1999, 15.6 times 1999
earnings. Subject to regulatory approval and the approval of shareholders of Los
Robles Bancorp, the acquisition is expected to close in the third quarter of
2000. One-time charges to be taken at the time of closing are estimated to be
$0.6 million after tax. It is anticipated that Los Robles Bank will be merged
into Santa Barbara Bank & Trust.
At December 31, 1999, Los Robles Bancorp reported year-to-date net income of
$2.0 million and total assets of $149 million. Los Robles Bank operates three
banking offices in Ventura County, one each in Thousand Oaks, Westlake Village,
and Camarillo, and has two loan production offices, one in Thousand Oaks and one
in Orange County.
- - --------------------------------------------------------------------------------
Note A - To obtain information on the performance ratios for peer banks, the
Company primarily uses The FDIC Quarterly Banking Profile, published by the FDIC
Division of Research and Statistics. This publication provides information about
all FDIC insured banks and certain subsets based on size and geographical
location. Geographically, the Company is included in a subset that includes 12
Western States plus the Pacific Islands. By asset size, the Company is included
in the group of financial institutions with total assets from $1-10 billion. The
information in this publication is based on year-to-date information provided by
banks each quarter. It takes about 2-3 months to process the information.
Therefore, the published data is always one quarter behind the Company's
information. For this quarter, the peer information is for the fourth quarter of
1999. All peer information in this discussion and analysis is reported in or has
been derived from information reported in this publication.
39
PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Index:
Exhibit Number Item Description
3 Certificate of Determination of Rights, Preference and Privileges
of Series A Preferred Stock
4
4.1 1998 Amended and Restated Trust Agreement of Pacific Capital
Bancorp Voluntary Employee's beneficiary association.
4.2 1998 Amended and Restated Key Employee Retiree Health Plan
4.3 1998 Amended and Restated Retiree Health Plan
27 Financial Data Schedule for March 31, 2000
(b) Two reports on Form 8-K were filed during the quarter ended March 31,
2000.
The announcement of the Agreement and Plan of Reorganization providing
for the acquisition of the San Benito Bank by Pacific Capital Bancorp
was reported on a Form 8-K filed with the Commission on March 7, 2000.
The announcement of the definitive agreement to acquire Los Robles
Bancorp was reported on a Form 8-K filed with the Commission on April
12, 2000.
40
SIGNATURES
Pursuant to the Securities Exchange Act of 1934, the Company has duly caused
this report to be signed on its behalf by the undersigned thereunto duly
authorized:
PACIFIC CAPITAL BANCORP
/s/ William S. Thomas, Jr.
William S. Thomas, Jr. May 15, 2000
President
Chief Executive Officer
/s/ Donald Lafler
Donald Lafler May 15, 2000
Executive Vice President
Chief Financial Officer
41