FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC. 20549 (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1996 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________________ to _____________________. Commission File Number 0-13528 Pacific Capital Bancorp ------------------------------------------------------ (Exact name of registrant as specified in its charter) California 77-0003875 - ------------------------------- ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1001 S. Main Street, Salinas, California 93901 ------------------------------------------------------ (Address of principal executive offices) (Zip Code) (408) 757-4900 ------------------------------------------------------ (Registrant's telephone number, including area code) N/A ------------------------------------------------------- (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 ---- ---- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at Class November 8, 1996 ----- ---------------- Common stock, no par value 2,600,174 Shares This report contains a total of 18 pages. -1- PART I - FINANCIAL INFORMATION ITEM 1 PAGE PACIFIC CAPITAL BANCORP AND SUBSIDIARIES FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS 3 CONSOLIDATED STATEMENTS OF INCOME 4-5 CONSOLIDATED STATEMENTS OF CASH FLOWS 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 9 - 16 PART II - OTHER INFORMATION ITEM 5 OTHER EVENTS 17 SIGNATURES 18 -2- PART I - FINANCIAL INFORMATION PACIFIC CAPITAL BANCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE AMOUNTS) September 30, December 31, 1996 1995 Assets --------- --------- Cash and due from banks $ 28,482 $ 24,891 Federal funds sold and other short term investments 26,468 17,007 --------- --------- Total cash and equivalents 54,950 41,898 Investment securities: Available-for-sale securities, at fair value 76,829 75,896 Held-to-maturity securities, at amortized cost (fair value of $5,305 and $8,662, respectively) 5,315 8,596 Loans available for sale at cost, which approximates market 5,034 3,876 Loans: Commercial 62,008 49,862 Consumer 12,558 12,108 Real estate - mortgage 144,304 126,048 Real estate - construction 12,183 17,071 Other 24,111 6,501 Less deferred loan fees (320) (246) --------- --------- Total loans 254,844 211,344 Less allowance for possible loan losses (2,188) (2,397) --------- --------- Net loans 252,656 208,947 Premises and equipment, net 9,156 7,523 Accrued interest receivable and other, net 8,570 6,843 --------- --------- Total assets $ 412,510 $ 353,579 ========= ========= Liabilities and shareholders' equity Deposits: Demand, non-interest bearing $ 82,643 $ 71,988 Demand, interest bearing 59,000 56,527 Savings and money market 104,191 97,087 Time certificates 118,888 82,217 --------- --------- Total deposits 364,722 307,819 Accrued interest payable and other liabilities 2,783 2,784 --------- --------- Total liabilities 367,505 310,603 Shareholders' equity: Preferred stock; 20,000,000 shares authorized and unissued -- -- Common stock, no par value; 20,000,000 shares authorized; 2,599,899 and 2,603,839 shares issued and outstanding at September 30, 1996 and at December 31, 1995, respectively 30,961 31,235 Retained earnings 14,377 11,435 Net unrealized (losses) gains on available-for-sale securities (333) 306 --------- --------- Total shareholders' equity 45,005 42,976 --------- --------- Total liabilities and shareholders' equity $ 412,510 $ 353,579 ========= ========= <FN> See accompanying notes to consolidated financial statements </FN> -3- PACIFIC CAPITAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) Nine months Nine months ended ended Sept 30, 1996 Sept 30, 1995 ----------- ----------- Interest income: Interest and fees on loans $ 16,704 $ 15,353 Interest on investment securities 3,860 2,870 Interest on federal funds sold & short-term investments 739 832 ----------- ----------- Total interest income 21,303 19,055 ----------- ----------- Interest expense: Demand, interest bearing 434 422 Savings 2,066 2,082 Time certificates 4,139 2,513 ----------- ----------- Total interest expense 6,639 5,017 ----------- ----------- Net interest income 14,664 14,038 Provision for possible loan losses -- -- ----------- ----------- Net interest income after provision for possible loan losses 14,664 14,038 ----------- ----------- Other income: Service charges 1,062 1,074 Gain on sale of loans 21 15 Mortgage banking fees 123 95 Net gain (loss) on securities transactions 15 (18) Other 295 264 ----------- ----------- Total other income 1,516 1,430 ----------- ----------- Other expenses: Salaries and benefits 5,306 4,852 Occupancy 1,076 1,024 Equipment 800 772 Advertising and promotion 358 326 Stationary and supplies 241 229 Legal and professional fees 535 409 Regulatory assessments 67 373 Other operating 1,110 1,069 ----------- ----------- Total other expenses 9,493 9,054 Earnings before income taxes 6,687 6,414 Income taxes 2,575 2,491 ----------- ----------- Net income $ 4,112 $ 3,923 =========== =========== Net income per share $ 1.50 $ 1.44 =========== =========== Weighted average shares outstanding 2,740,857 2,722,082 =========== =========== <FN> See accompanying notes to consolidated financial statements </FN> -4- PACIFIC CAPITAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) Three months Three months ended ended Sept 30, 1996 Sept 30, 1995 ------------- ----------- Interest income: Interest and fees on loans $ 5,847 $ 5,108 Interest on investment securities 1,524 1,125 Interest on federal funds sold 68 373 ----------- ----------- Total interest income 7,439 6,606 ----------- ----------- Interest expense: Demand, interest bearing 155 145 Savings 691 706 Time certificates 1,533 1,074 ----------- ----------- Total interest expense 2,379 1,925 ----------- ----------- Net interest income 5,060 4,681 Provision for possible loan losses -- -- ----------- ----------- Net interest income after provision for possible loan losses 5,060 4,681 ----------- ----------- Other income: Service charges 356 351 Gain on sale of loans 6 (1) Mortgage banking fees 22 40 Net gain (loss) on securities transactions -- (4) Other 92 92 ----------- ----------- Total other income 476 478 ----------- ----------- Other expenses: Salaries and benefits 1,766 1,645 Occupancy 360 369 Equipment 268 281 Advertising and promotion 132 134 Stationary and supplies 90 75 Legal and professional fees 267 131 Regulatory assessments 23 (1) Other operating 433 375 ----------- ----------- Total other expenses 3,339 3,009 Earnings before income taxes 2,197 2,150 Income taxes 844 839 ----------- ----------- Net income $ 1,353 $ 1,311 =========== =========== Net income per share $ 0.49 $ 0.48 =========== =========== Weighted average shares outstanding 2,737,657 2,720,462 =========== =========== <FN> See accompanying notes to consolidated financial statements </FN> -5- PACIFIC CAPITAL BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Nine months Ended September 30, 1996 and September 30, 1995 (UNAUDITED) (IN THOUSANDS) September 30, September 30, 1996 1995 -------- -------- Cash flows from operating activities: Net income $ 4,112 $ 3,923 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 873 677 Provision for possible loan losses -- -- (Gain) loss on sale of investment securities, net (15) 18 Net originations of loans held for sale (1,158) (1,320) Gain on sale of loans (21) (16) Deferral of loan origination fees (costs) 50 (11) Change in accrued interest receivable and other assets (2,366) (313) Change in accrued interest payable and other liabilities 20 865 -------- -------- Net cash provided by operating activities 1,495 3,823 -------- -------- Investing activities: Net change in loans (43,759) 2,980 Maturities of investment securities 4,158 14,736 Purchases of investment securities (27,680) (46,620) Proceeds from sale of available-for-sale securities 25,695 24,839 Capital expenditures, net (2,316) (718) -------- -------- Net cash used in investing activities (43,902) (4,783) -------- -------- Financing activities: Net increase in deposits 56,903 12,618 Cash paid for retirement of stock (551) (111) Proceeds from exercise of options 277 157 Cash paid for dividends (1,170) (930) -------- -------- Net cash provided by financing activities 55,459 11,734 -------- -------- Net increase in cash and equivalents 13,052 10,774 Cash and equivalents beginning of period 41,898 42,262 -------- -------- Cash and equivalents at end of period $ 54,950 $ 53,036 ======== ======== Supplemental disclosures of cash flow information: Cash paid during the period Interest 7,378 5,707 Income taxes 2,158 2,525 <FN> See accompanying notes to consolidated financial statements </FN> -6- PACIFIC CAPITAL BANCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1 - Basis of Presentation In the opinion of the Company, the unaudited consolidated financial statements, prepared on the accrual basis of accounting, contain all adjustments (consisting of only normal recurring adjustments) which are necessary to present fairly the financial position of the Company and subsidiaries at September 30, 1996 and December 31, 1995, the results of its operations and the statements of cash flows for the periods ended September 30, 1996 and 1995. Certain information and footnote disclosures normally presented in financial statements prepared in accordance with generally accepted accounting principles have been omitted. The results of operations for the period ended September 30, 1996 are not necessarily indicative of the operating results for the full year ending December 31, 1996. In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. Those plans include all arrangements by which employees receive shares of stock or other equity instruments of the employer or the employer incurs liabilities to employees in amounts based on the price of the employer's stock. Examples are stock options, restricted stock, and stock appreciation rights. This statement defines a fair value based method of accounting for an employee stock option or similar equity instrument. Under this method, compensation costs are measured at the grant date based on the value of the award and are recognized over the service period, which is the vesting period. SFAS No. 123 encourages but does not require employers to adopt the new method in place of the provisions of Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees. This statement applies to fiscal years beginning after December 15, 1995. On January 1, 1996, the Company adopted SFAS No. 123 and has elected to use the method prescribed in APB No. 25. The Company does not anticipate that the required disclosures will have a material impact on the financial condition or results of operations. Note 2 - Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, First National Bank of Central California, (the "Bank"), and Pacific Capital Services Corporation, an inactive subsidiary. All material intercompany accounts and transactions have been eliminated in consolidation. Note 3 - Loans to Directors In the ordinary course of business, the Company has made loans to directors of the Company which at September 30, 1996 amounted to approximately $4,980,000. Note 4 - Commitments The Company had outstanding standby letters of credit of approximately $5,650,000 at September 30, 1996. Note 5 - Net Income Per Share and Dividends Net income per share is computed using the weighted average number of shares of common and common equivalent shares outstanding (as adjusted retroactively to reflect the 5% stock dividend paid on December 1, 1995). On January 23, 1996, April 23, 1996, and July 23, 1996 the Company declared $0.15 per share cash dividends to shareholders of record on March 15, 1996, June 14, 1996, and September 16, 1996 payable on March 29, 1996, June 28, 1996, and September 30, 1996, respectively. -7- Note 6 - Taxes As of September 30, 1996, the Company has a deferred tax asset of approximately $2,022,000. The asset results primarily from the provisions for possible loan losses and depreciation of premises and equipment, which are recognized in the financial statements but are not yet deductible for income tax reporting purposes. Management of the Company believes that the net deferred tax asset is fully realizable through sufficient taxable income within carryback periods and current year taxable income. Note 7 - Proposed Merger On July 18, 1996, the Company entered into an Agreement and Plan of Reorganization ("Agreement") with South Valley Bancorporation (Commission File # 2-78293-LA), ("South Valley") pursuant to which South Valley will merge with and into the Company in a merger transaction expected to be accounted for as a pooling-of-interests. The Company plans to issue .92 shares of Pacific Capital Bancorp common stock for each share of South Valley common stock, subject to certain potential downward adjustments described in the Agreement. It is anticipated that the transaction will be consummated during the fourth quarter of 1996. Based on the outstanding shares of South Valley as of September 30, 1996, and the exchange ratio specified in the Agreement, the Company expects to issue approximately 1,285,000 shares in connection with the merger. As of September 30, 1996, South Valley had total assets of $183,230,000. -8- PACIFIC CAPITAL BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview of Changes in the Financial Statements As used herein, the term Company shall mean the Company or the Bank as the context requires. Net income for the nine months ended September 30, 1996 was $4,112,000 or $1.50 per share compared to $3,923,000 or $1.44 per share during the same period in 1995. This 4.8% increase in net income is due mainly to a $626,000 increase in net interest income partially offset by a $439,000 increase in non-interest expense. The increase in net interest income is due to growth in average total loans of $32,570,000 partially offset an increase in average interest bearing deposits of $39,052,000 as compared to the same 1995 period. Outstanding loans were $254,844,000 at September 30, 1996 compared to $211,344,000 at December 31, 1995, a $43,500,000 or 20.6% increase. The increase in outstanding loans from December 31, 1995 to September 30, 1996 resulted primarily from an increase in real estate mortgage loans of $18,256,000, an increase in commercial loans of $12,146,000 and an increase in other loans of $17,610,000 partially offset by a decrease in real estate construction loans of $4,888,000 Federal Funds Sold and Investment Securities at September 30, 1996 were $108,612,000, a $7,113,000 or 6.5% increase from December 31, 1995. This was primarily due to the increase in total deposits which resulted in an increase in cash invested in Federal Funds. The Company's total deposits at September 30, 1996 were $364,722,000 compared to $307,819,000 at December 31, 1995, a $56,903,000 or 18.5% increase. Non-interest bearing demand deposits increased $10,655,000, interest bearing demand deposits increased $2,473,000 and savings and money market deposit accounts increased $7,104,000 in the first nine months of 1996. Certificates of deposit increased by $36,671,000 or 44.6% during the first nine months of 1996. Management believes that the growth in deposits is a result of the recent strength in the tourism and agribusiness industries within the local economies in which the Company operates. The loan to deposit ratio at September 30, 1996 was 69.9% as compared to 68.6% at December 31, 1995. The Company's total assets as of September 30, 1996 increased 16.7% compared to year end 1995. Loans Outstanding total loans averaged $233,915,000 for the nine months ended September 30, 1996 compared to $201,345,000 for the same period in 1995, an increase of $32,570,000, or 16.2%. This increase in loans is due to increased loan demand from qualified borrowers and reflects the strength of the economy in most of the primary markets which the Company serves. The Company lends primarily to small and medium sized businesses within its markets, which are comprised principally of the Salinas, Watsonville, Monterey and Carmel areas. A majority of the Company's loan portfolio consists of loans secured by commercial, industrial and residential real estate. Quality of Loans The Company follows the policy of discontinuing the accrual of interest income and reversing any accrued and unpaid interest when the payment of principal or interest is 90 days past due unless the loan is both well-secured and in the process of collection. The composition of non-performing loans as of September 30, 1996, December 31, 1995, and September 30, 1995 is summarized in the following table. -9- Nonperforming Loans (Dollars in Thousands) September December September 30, 30, 30, 1996 1995 1995 ---- ---- ---- Accruing loans past due 90 days or more Commercial $ 0 $ 0 $ 0 Consumer 11 1 0 Real Estate 147 140 423 ------ ------ ------ Total $ 158 $ 141 $ 423 Nonaccrual loans Commercial 663 110 229 Consumer 108 136 151 Real Estate 1,195 747 834 ------ ------ ------ Total $1,966 $ 993 $1,214 Total Nonperforming Loans $2,124 $1,134 $1,637 ====== ====== ====== Nonperforming Loans To Total Loans 0.83% 0.54% 0.83% Allowance For Possible Loan Losses To Total Non Performing Loans 103.01% 211.38% 137.14% The increase in non-performing loans is primarily due to one real estate loan for $800,000 which has become delinquent and is consequently on non-accrual status as of September 30, 1996. The Company does not expect to sustain losses from any of the non-performing loans in excess of that specifically provided for in the allowance for possible loan losses. Currently, the Company's level of non-performing loans to total loans is below that of peer banks. In addition to the above, the Company holds six Other Real Estate Owned (OREO) properties, which aggregate $1,344,000. In all cases, the amount recorded represented the lesser of the loan balance or current fair value obtained from a current appraisal less anticipated selling costs; therefore, any identified loss has already been recognized. Inherent in the lending function is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan extended and the creditworthiness of the borrower. To reflect the estimated risks of loss associated with its loan portfolio, additions are made to the Company's allowance for possible loan losses. As an integral part of this process, the allowance for possible loan losses is subject to review and possible adjustment as a result of management's assessment of risk or regulatory examinations conducted by governmental agencies. The Company's entire allowance is a valuation allocation created by direct charges against operations through the provision for possible loan losses. The provision for possible loan losses charged against operations is based upon the actual net loan losses incurred plus an amount for other factors which, in management's judgment, deserve recognition in estimating possible loan losses. The Company evaluates the adequacy of its allowance for possible loan losses on a quarterly basis. For the last several years, the Company has also contracted with an independent loan review consulting firm to evaluate overall credit quality and the adequacy of the allowance for possible loan losses. Both internal and external evaluations take into account the following: specific loan conditions as determined by management; the historical relationship between charge-offs and the level of the allowance; the estimated future loss in all significant loans; known deterioration in concentrations of credit, certain classes of loans or pledged collateral; historical loss experience based on volume and types of loans; the results of any independent review or evaluation of the loan portfolio quality conducted by or at the direction of Company management or by bank regulatory agencies; trends in portfolio volume, maturity and composition; off-balance sheet credit risk; volume and trends in delinquencies and nonaccruals; lending policies and procedures including those for -10- charge-off, collection and recovery; national and local economic conditions and their effects on specific local industries; and the experience, ability and depth of lending management and staff. These factors are essentially judgmental and may not be reduced to a mathematical formula. The Company closely monitors the local markets in which it conducts its lending activities. The overall increase in loan demand from qualified borrowers during the past year is indicative of the strength in the local economic climate. The table set forth below summarizes the actual loan losses and provision for possible losses for the periods ended September 30, 1996, December 31, 1995, and September 30, 1995. Charge-Off/Recovery Activity (Dollars in Thousands) Nine months Year Nine months Ended Ended Ended September 30, 1996 December 31,1995 September 30, 1995 ------------------ ---------------- ------------------ Total Loans Outstanding $254,844 $211,344 $197,618 Average Net Loans $233,915 $201,360 $201,345 Allowance Balance Beginning Of Period 2,397 2,438 2,438 Charge-Offs By Loan Category Commercial 151 129 114 Consumer 111 61 49 Real Estate 0 131 130 Other 0 0 0 ------- ------- ------- Total $ 262 $ 321 $ 293 ------- ------- ------- Recoveries By Loan Category Commercial 5 58 28 Consumer 31 38 29 Real Estate 17 49 43 Other 0 0 0 ------- ------- ------- Total $ 53 $ 145 $100 ------- ------- ------- Net Charge-Offs $ 209 $ 176 $ 193 ------- ------- ------- Provision Charged To Expense $0 $135 $0 Allowance Balance End Of Period $ 2,188 $ 2,397 $ 2,245 ======= ======= ======= Allowance For Possible Loan Losses To Total Loans 0.86% 1.13% 1.14% Annualized Net Charge- Offs To Average Loans 0.12% 0.09% 0.13% The Company did not provide an additional provision to the allowance for possible loan losses for the nine months ended September 30, 1996, or September 30, 1995, primarily due to management's recognition of the strength and growth of the local economy, resulting in a lower level of classified loans and the reduced potential of future charge-offs. -11- The provision for possible loan losses charged against earnings is based upon an analysis of the actual migration of loans to losses plus an amount for other factors which, in management's judgment, deserve recognition in estimating possible loan losses. While these factors cannot be reduced to a mathematical formula, it is management's view that the allowance for possible loan losses of $2,188,000 or .86% of total loans was adequate as of September 30, 1996. Results of Operations Nine months Ended September 30, 1996 Compared with Nine months Ended September 30, 1995 Net income for the nine months ended September 30, 1996 was $4,112,000, an increase of $189,000 or 4.8% as compared to the same 1995 period. The increase in net income for the period was due primarily to an increase in net interest income of $626,000 partially offset by an increase in non-interest expense of $439,000. In addition, other income increased by $86,000 over the same period in 1995. The increase in net interest income is due to growth in average total loans of $32,570,000 partially offset by an increase in average interest bearing deposits of $39,052,000 compared to the same 1995 period. The average balance of interest earning assets during the nine months ended September 30, 1996 was $342,446,000, a $44,290,000 or 14.9% increase over the comparable 1995 period. The Company's average yield on earning assets for the nine months ended September 30, 1996 decreased to 8.3% compared to 8.5% during the comparable period in 1995. Total interest income increased $2,248,000 or 11.8% for the nine months ended September 30, 1996 compared to the same 1995 period due to an increase in average interest earning assets of $44,290,000. Average deposits for the Company for the nine months ended September 30, 1996 were $334,172,000, a $44,185,000 or 15.2% increase compared to the period ended September 30, 1995. The Company's average cost of funds for the nine months ended September 30, 1996 was 3.4% which yielded a net interest margin of 5.7%. This compares to an average cost of funds of 3.0% and a net interest margin of 6.3% for the comparable 1995 period. Interest expense of $6,639,000 for the nine months ended September 30, 1996 was $1,622,000 or 32.3% over the comparable 1995 period due to an increase in average interest bearing deposits of $39,052,000 and an increase in the average rate paid on deposits of 0.4%. Net interest income for the nine months ended September 30, 1996 increased $626,000 or 4.5% and resulted from the increase of $2,248,000 in total interest income partially offset by an increase of $1,622,000 in total interest expense. The Company did not make any additional provisions to the allowance for possible loan loss for the nine months ended September 30, 1996 or 1995. The analysis of the loan portfolio completed by the Company indicates that the current allowance for loan losses is adequate based on the Company's calculated provision requirements. Total loans charged-off net of recoveries for the nine months ended September 30, 1996 amounted to $209,000 compared to $193,000 net of recoveries for the same period in 1995. Annualized net loan charge-offs as a percentage of average loans for the nine months ended September 30, 1996 was 0.12% compared to 0.13% for the nine months ended September 30, 1995 and .09% for the year ended December 31, 1995. Total other income was $1,516,000 for the nine months ended September 30, 1996, an $86,000 or 6.0% increase compared to the same period of 1995. Gain on sale of investment securities increased by $33,000, other fees increased by $31,000, and mortgage banking fees increased $28,000 for the nine months ended September 30, 1995 partially offset by a decrease in deposit service charges of $12,000 as compared to the same period in 1995. Salaries and benefits expense for the nine months ended September 30, 1996 was $5,306,000, a $454,000 or 9.4% increase over the comparable 1995 period. This variance resulted primarily from normal salary increases and an increase in the Company's health insurance premiums. The Company employed 163 full time equivalent employees at September 30, 1996 compared to 165 full time equivalent employees at December 31, 1995 and 158 full time equivalent employees at September 30, 1995. Total other expenses, excluding salaries and benefits, for the nine months ended September 30, 1996, was $4,187,000, a $15,000 or 0.4% decrease from the comparable 1995 period. This decrease was the result of a decrease in the Company's FDIC Assessment of $306,000 compared to the same period in 1995. In addition, -12- legal and professional fees increased from $409,000 in 1995 to $535,000 in 1996 primarily due to legal and accounting fees incurred due to the pending merger of South Valley Bancorporation with and into Pacific Capital Bancorp. (See Item 5, Other Information) Other variances included occupancy expense which increased $52,000 due to normal rent increases and costs associated with the remodeling of the Company's Salinas Main Branch. Advertising and promotion expense also increased during the nine months ended September 30, 1996 by $32,000 or 9.8% over the comparable period in 1995. Applicable income taxes of $2,575,000 for the nine months ended September 30, 1996 were $84,000, or 3.4% more than the comparable 1995 period. The Company's effective tax rate for the nine months ended September 30, 1996 was 38.5% compared to 38.8% for the same period in 1995. Results of Operations Three Months Ended September 30, 1996 Compared with Three Months Ended September 30, 1995 Net income of $1,353,000 for the three months ended September 30, 1996 increased by $42,000 or 3.2% as compared to the same 1995 period. The increase in net income for the period was due primarily to an increase in net interest income of $379,000 mostly offset by an increase in non-interest expense of $330,000. The average balance of interest earning assets during the three months ended September 30, 1996 was $361,637,000, a $49,578,000 increase over the comparable 1995 period due to a $49,087,000 increase in average loans outstanding during the quarter. The Company's average yield on earning assets for the three months ended September 30, 1996 decreased to 8.2% from 8.4% during the comparable period in 1995. The decrease in average yields is due to a decrease in rates paid on adjustable rate loans within the loan portfolio due to rate decreases in the Prime Rate over the latter part of 1995. Total interest income increased $833,000 or 12.6% for the three months ended September 30, 1996 compared to the same 1995 period due to the increase in average interest earning assets. Average deposits for the Company for the three month period ended September 30, 1996 were $355,621,000, a $52,224,000 or 17.2% increase compared to the three months ended September 30, 1995. The Company's average cost of funds for the three months ended September 30, 1996 was 3.4% which yielded a net interest margin of 5.6%. This compares to an average cost of funds of 3.2% and a net interest margin of 6.0% for the same period in 1995. Interest expense of $2,379,000 for the three months ended September 30, 1996 was $454,000 or 23.6% over the comparable 1995 period due to an increase in average interest bearing deposits of $43,218,000 and, to a lesser extent, an increase in the average rate paid on deposits of 0.2%. Net interest income for the three month period ended September 30, 1996 increased $379,000 or 8.1% and resulted from the increase of $833,000 in total interest income and an increase of $454,000 in total interest expense. Total loan charge-offs net of recoveries for the three months ended September 30, 1996 amounted to $155,000, compared to $177,000 of net recoveries for the same period in 1995. Annualized net loan charge-offs as a percentage of average loans for the three months ended September 30, 1996 was 0.25% compared to 0.35% for the three months ended September 30, 1995. Total other income was $476,000 for the three months ended September 30, 1996, a $2,000 or 0.4% decrease compared to the same period of 1995. Mortgage banking fees decreased by $18,000 or 45.0% during the third quarter of 1996 compared to the same period in 1995. Other variances include gain on sale of loans which increased by $7,000 and deposit service charges which increased from $351,000 to $356,000 in the third quarter of 1996. Salaries and benefits expense for the three months ended September 30, 1996 was $1,766,000, a $121,000 or 7.4% increase over the comparable 1995 period, and resulted primarily from normal salary increases and an increase in the Company's group insurance premiums. The Company employed 161 full time equivalent employees at September 30, 1996 compared to 165 full time equivalent employees at December 31, 1995 and 158 full time equivalent employees at September 30, 1995. Total other expenses, excluding salaries and benefits, for the three months ended September 30, 1996, was $1,573,000, a $209,000 or 15.3% increase from the comparable 1995 period. The increase resulted primarily from an increase in legal and professional fees of $136,000 principally associated with the pending merger of South Valley Bancorporation with and into Pacific Capital Bancorp. (See Item 5, Other Information) -13- Other expense also increased in the third quarter of 1996 to $433,000 from $375,000 in the same period in 1995 due primarily to expense associated with OREO. Applicable income taxes of $844,000 for the three months ended September 30, 1996 were $5,000, or 0.6% more than the comparable 1995 period. The Company's effective tax rate for the three months ended September 30, 1996 was 38.4% compared to 39.0% for the same period in 1995. Liquidity Management Liquidity represents the ability of the Company to meet the requirements of customer borrowing needs as well as fluctuations in deposit flows. Core deposits, which include demand, savings and interest bearing demand accounts, money market accounts and time deposits of less than $100,000, provide a relatively stable funding base. Core deposits averaged $183,019,000 or 43.1% of average total assets during the three months ended September 30, 1996, as compared to $158,984,000 or 45.9% of average total assets for the same period in 1995. At September 30, 1996 core deposits were $184,672,000 or 44.8% of total assets, compared to $164,574,000 or 46.5% of total assets at year end 1995. The Company's principal sources of asset liquidity are cash and cash due from banks, time deposits with other financial institutions, Federal Funds sold, short term investments, and available-for-sale investment securities. At September 30, 1996 these sources represented $131,779,000 or 36.1% of total deposits compared to $117,794,000 or 38.3% at year end 1995. This increase in liquid assets for the nine months ended September 30, 1996 resulted primarily from an increase in Federal Funds sold and short term investments. In the opinion of management, there are sufficient resources to meet the liquidity needs of the Company at present and projected future levels. Capital Resources Capital management is a continuous process of providing adequate capital for current needs and anticipated future growth. Capital serves as a source of funds for the acquisition of fixed and other assets and protects depositors against potential losses. As the Company's assets increase, so do its capital requirements. The Company and the Bank are subject to Federal Reserve Board guidelines and regulations of the Comptroller of the Currency ("Comptroller"), respectively, governing capital adequacy. The Federal Reserve Board has established final risk-based and leverage capital guidelines for bank holding companies which are the same as the Comptroller's capital regulations for national banks. The Federal Reserve Board capital guidelines for bank holding companies and the Comptroller's regulations for national banks set total capital requirements and define capital in terms of "core capital elements" (comprising Tier 1 capital) and "supplemental capital elements" (comprising Tier 2 capital). Tier 1 capital is generally defined as the sum of the core capital elements less goodwill. The following items are defined as core capital elements: common stockholders' equity, qualifying noncumulative perpetual preferred stock, and minority interests in the equity accounts of consolidated subsidiaries. Supplementary capital elements include: allowance for loan and lease losses (which cannot exceed 1.25% of an institution's risk weighted assets), perpetual preferred stock not qualifying as core capital, hybrid capital instruments and mandatory convertible debt instruments, and term subordinated debt and intermediate-term preferred stock. The maximum amount of supplemental capital elements which qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of goodwill. Risk-based capital ratios are calculated with reference to risk-weighted assets, including both on and off-balance sheet exposures, which are multiplied by certain risk weights assigned by the Federal Reserve Board to those assets. Both bank holding companies and national banks are required to maintain a minimum ratio of qualifying total capital to risk-weighted assets of 8%, at least one-half of which must be in the form of Tier 1 capital. There are presently four risk-weight categories: 0% for cash and unconditionally guaranteed government securities; 20% for conditionally guaranteed government securities; 50% for performing residential real estate loans secured by first liens; and 100% for commercial loans. -14- The Federal Reserve Board and the Comptroller also have established a minimum leverage ratio of 3% Tier I capital to total assets for bank holding companies and national banks that have received the highest composite regulatory rating and are not anticipating or experiencing any significant growth. All other institutions will be required to maintain a leverage ratio of at least 100 to 200 basis points above the 3% minimum. The following tables show the Company's and the Bank's risk-based and leverage capital ratios as of September 30, 1996 and December 31, 1995. As indicated in these tables, the Company's and the Bank's capital ratios significantly exceeded the minimum capital levels required by current federal regulations. Management believes that the Company and the Bank will continue to meet their respective minimum capital requirements in the foreseeable future. Risk Based Capital Ratio (Dollars in Thousands) (Unaudited) Pacific Capital Bancorp September 30, 1996 December 31, 1995 ------------------ ------------------ Amount Ratio Amount Ratio ------ ----- ------ ----- Tier 1 Capital $45,005 14.96% $42,976 17.60% Tier 1 Capital Minimum Requirement 12,035 4.00% 9,765 4.00% ------- ------- Excess $32,970 11.79% $33,211 13.60% ======= ======= Total Capital $47,193 15.69% $45,373 18.59% Total Capital Minimum Requirement 24,070 8.00% 19,529 8.00% ------- ------- Excess $23,123 7.69% $25,844 10.59% ======= ======= Risk Adjusted Assets $300,870 $244,114 ======== ======== First National Bank of Central California September 30, 1996 December 31, 1995 ------------------ ------------------ Amount Ratio Amount Ratio ------ ----- ------ ----- Tier 1 Capital $40,731 13.73% $40,532 16.78% Tier 1 Capital Minimum Requirement 11,864 4.00% 9,662 4.00% ------- ------- Excess $28,867 9.73% $30,870 12.78% ======= ======= Total Capital $42,919 14.47% $42,929 17.77% Total Capital Minimum Requirement 23,728 8.00% 19,325 8.00% ------- ------- Excess $19,191 6.47% $23,604 9.77% ======= ======= Risk Adjusted Assets $296,600 $241,561 ======== ======== -15- Leverage Ratio (Dollars in Thousands) (Unaudited) Pacific Capital Bancorp September 30, 1996 December 31, 1995 ------------------ ------------------ Amount Ratio Amount Ratio ------ ----- ------ ----- Tier 1 Capital to Average Total Assets $45,005 11.15% $42,976 12.00% Minimum Leverage $12,104 to 3.00% to $10,747 to 3.00% to Requirement $20,173 5.00% $17,912 5.00% Excess $24,832 to 6.15% to $25,064 to 7.00% to $32,901 8.15% $32,229 9.00% Average Total Assets $403,452 $358,232 ======== ======== First National Bank of Central California September 30, 1996 December 31, 1995 ------------------ ------------------ Amount Ratio Amount Ratio ------ ----- ------ ----- Tier 1 Capital to Average Total Assets $40,731 10.18% $40,532 11.38% Minimum Leverage $11,999 to 3.00% to $10,685 to 3.00% to Requirement $19,998 5.00% $17,809 5.00% Excess $20,733 to 5.18% to $22,723 to 6.38% to $28,732 7.18% $29,847 8.38% Average Total Assets $399,963 $356,173 ======== ======== Federal banking laws impose restrictions upon the amount of dividends the Bank may declare to the Company. Federal laws also impose restrictions upon the amount of loans or advances that the Bank may extend to the Company. In management's opinion, these do not affect the ability of the Company to meet its cash obligations. -16- PART II -- OTHER INFORMATION Item 5. Other Information On July 18, 1996, the Company entered into an Agreement and Plan of Reorganization ("Agreement") with South Valley Bancorporation (Commission File # 2-78293-LA), ("South Valley") pursuant to which South Valley will merge with and into the Company in a merger transaction expected to be accounted for as a pooling-of-interests. The Company plans to issue .92 shares of Pacific Capital Bancorp common stock for each share of South Valley common stock, subject to certain potential downward adjustments described in the Agreement. It is anticipated that the transaction will be consummated during the fourth quarter of 1996.Based n the outstanding shares of South Valley as of September 30, 1996, and the exchange ratio specified in the Definitive Agreement, the Company expects to issue approximately 1,285,000 shares in connection with the merger. As of September 30, 1996, South Valley had total assets of $183,230,000. -17- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date November 8, 1996 /S/ D. Vernon Horton ----------------- ----------------------- D. Vernon Horton Chief Executive Officer Date November 8, 1996 /S/ Dennis A. DeCius ----------------- ----------------------- Dennis A. DeCius Executive Vice President Chief Financial Officer -18-