<PAGE> 1
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, 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 No.: 0-11113
SANTA BARBARA BANCORP
(Exact Name of Registrant as Specified in its Charter)
California 95-3673456
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1021 Anacapa Street, 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 3, 1996 there were 7,637,630 shares of the
issuer's common stock outstanding.
Page One of Thirty-nine
<PAGE> 2
PART 1
FINANCIAL INFORMATION
<TABLE>
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)
(dollars in thousands except per share amount)
<CAPTION>
March 31, December 31,
1996 1995
<S> <C> <C>
Assets:
Cash and due from banks $ 49,825 $ 74,746
Federal funds sold 65,000 65,000
Cash and cash equivalents 114,825 139,746
Securities (Note 4):
Held-to-maturity 283,368 231,730
Available-for-sale 125,000 125,835
Bankers' acceptances 95,469 139,294
Loans, net of allowance of $15,223 at
March 31, 1996 and $12,349 at
December 31, 1995 (Note 5) 541,250 546,452
Premises and equipment, net (Note 6) 7,799 8,149
Accrued interest receivable 9,458 7,981
Other assets (Note 7) 14,170 13,174
Total assets $ 1,191,339 $ 1,212,361
Liabilities:
Deposits:
Demand deposits $ 152,540 $ 158,122
NOW deposit accounts 127,836 148,027
Money Market deposit accounts 421,974 427,198
Savings deposits 92,325 94,124
Time deposits of $100,000 or more 78,774 76,438
Other time deposits 153,792 150,111
Total deposits 1,027,241 1,054,020
Securities sold under agreements
to repurchase and Federal funds purchased 53,229 51,316
Other borrowed funds 994 1,210
Accrued interest payable
and other liabilities 7,543 4,818
Total liabilities 1,089,007 1,111,364
Shareholders' equity (Note 3):
Common stock (no par value; $.67 per share
stated value; 20,000 authorized;
7,638 outstanding at March 31, 1996
and 7,679 at December 31, 1995) 5,092 5,119
Surplus 38,016 39,191
Unrealized loss on securities
available for sale (372) (179)
Retained earnings 59,596 56,866
Total shareholders' equity 102,332 100,997
Total liabilities and
shareholders' equity $ 1,191,339 $ 1,212,361
<FN>
See accompanying notes to consolidated condensed financial statements.
</FN>
</TABLE>
<TABLE>
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Statements of Income (Unaudited)
(dollars in thousands except per share amounts)
<CAPTION>
For the Three Months Ended March 31,
1996 1995
<S> <C> <C>
Interest income:
Interest and fees on loans $ 15,537 $ 15,023
Interest on securities 5,634 5,811
Interest on Federal funds sold 1,095 335
Interest on bankers' acceptances 1,725 820
Total interest income 23,991 21,989
Interest expense:
Interest on deposits:
NOW accounts 361 366
Money Market accounts 4,291 3,877
Savings deposits 538 640
Time deposits of $100,000 or more 871 608
Other time deposits 2,287 1,873
Interest on securities sold under
agreements to repurchase and
Federal funds purchased 705 200
Interest on other borrowed funds 11 19
Total interest expense 9,064 7,583
Net interest income 14,927 14,406
Provision for loan losses 3,215 3,663
Net interest income after
provision for loan losses 11,712 10,743
Other income:
Service charges on deposits 1,118 1,044
Trust fees 2,224 1,765
Other service charges,
commissions and fees, net 2,130 2,468
Net loss on securities transactions (512) 0
Other income 102 78
Total other income 5,062 5,355
Other expense:
Salaries and benefits 6,268 6,185
Net occupancy expense 1,132 1,011
Equipment expense 650 645
Net loss (gain) from
operating other real estate 108 (18)
Other expense 3,177 4,198
Total other expense 11,335 12,021
Income before income taxes 5,439 4,077
Applicable income taxes 1,563 1,101
Net income $ 3,876 $ 2,976
Earnings per share (Note 2) $ 0.51 $ 0.39
<FN>
See accompanying notes to consolidated condensed financial statements.
</FN>
</TABLE>
<TABLE>
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(dollars in thousands)
<CAPTION>
For the Three Months Ended March 31,
1996 1995
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 3,876 $ 2,976
Adjustments to reconcile net income
to net cash provided by operations:
Depreciation and amortization 493 416
Provision for loan losses 3,215 3,663
Benefit for deferred income taxes (1,904) (1,589)
Net amortization of investment securities
discounts and premiums (322) 713
Net change in deferred loan origination and
extension fees and costs 125 51
Decrease (increase) in accrued
interest receivable (1,477) 1,137
Increase in accrued interest payable 11 114
Decrease (increase) in income receivable 843 (347)
Increase in income taxes payable 3,047 2,635
Decrease (increase) in prepaid expenses (252) 118
Decrease in accrued expenses (584) (1,668)
Net loss (gain) on sale of OREO 30 (23)
Net loss on securities transactions 512 0
Other operating activities 332 1,145
Net cash provided by operating activities 7,945 9,341
Cash flows from investing activities:
Proceeds from call or maturity of securities:
Available-for-sale 30,047 14,744
Held-to-maturity 10,725 1,661
Purchase of securities:
Available-for-sale (92,251) 0
Held-to-maturity (61,068) 0
Proceeds from sale of securities:
Available-for-sale 62,131 0
Proceeds from sale or maturity
of bankers' acceptances 128,177 55,693
Purchase of bankers' acceptances (84,750) (19,373)
Net decrease (increase) in loans
made to customers 727 (35,656)
Disposition of property from defaulted loans 864 198
Purchase or investment in
premises and equipment (148) (745)
Net cash provided by (used in)
investing activities (5,546) 16,522
Cash flows from financing activities:
Net decrease in deposits (26,779) (59,125)
Net increase in borrowings with
maturities of 90 days or less 1,907 14,308
Proceeds from issuance of common stock 149 49
Payments to retire common stock (1,471) (57)
Dividends paid (1,126) (1,026)
Net cash used in financing activities (27,320) (45,851)
Net decrease in cash and cash equivalents (24,921) (19,988)
Cash and cash equivalents at
beginning of period 139,746 84,630
Cash and cash equivalents at end of period $ 114,825 $ 64,642
Supplemental disclosure:
Cash paid during the three months ended:
Interest $ 9,075 $ 7,469
Income taxes $ 0 $ 35
<FN>
See accompanying notes to consolidated condensed financial statements.
</FN>
</TABLE>
Santa Barbara Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 1996
(Unaudited)
1. Principles of Consolidation
The consolidated financial statements include the parent holding
company, Santa Barbara Bancorp ("Company"), and its wholly owned
subsidiaries, Santa Barbara Bank & Trust ("Bank") and SBBT
Service Corporation ("Service Corp."). Material inter-company
balances and transactions have been eliminated.
2. Earnings Per Share
Net earnings per common and common equivalent share are computed
based on the weighted average number of shares outstanding during
the period. There are no common stock equivalents that cause
dilution in earnings per share in excess of 3 percent. For the
three-month periods ended March 31, 1996 and 1995, the weighted
average shares outstanding were as follows:
Three-Month Periods
Ended March 31,
1996 1995
Weighted average
shares outstanding7,652,7987,690,581
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 three months ended
March 31, 1996 are not necessarily indicative of the results to
be expected for the full year. Certain amounts reported for 1995
have been reclassified to be consistent with the reporting for
1996.
For the purposes of reporting cash flows, cash and cash
equivalents include cash and due from banks and Federal funds
sold.
4. Securities
The Company's securities are classified as either "held-to-
maturity" or "available-for-sale." Only those securities for
which the Company has the ability and positive intent to hold to
maturity may be classified as held-to-maturity. Securities which
meet these criteria are accounted for at their amortized
historical cost. That is, these securities are carried at their
purchase price adjusted for the amortization of any premium or
discount irrespective of later changes in their market value
prior to maturity. Securities which might be sold for liquidity
purposes, sold in response to interest rate changes, or sold to
restructure the maturities of the portfolio to better match
deposit maturities or complement the maturity characteristics of
the loan portfolio are considered available-for-sale. These
securities are reported in the financial statements at fair
market value rather than at amortized cost. The after-tax effect
of unrealized gains or losses is reported as a separate component
of shareholders' equity. Changes in the unrealized gains or
losses are shown as increases or decreases in this component of
equity, but are not reported as gains or losses in the statements
of income of the Company.
The Company has reclassified a few U.S. agency securities from
"available-for-sale" to "held-to-maturity." As required by
Statement of Financial Accounting Standards No. 115, Accounting
for Certain Investments in Debt and Equity Securities, the
securities were transferred at their then fair value which was
lower than their amortized cost. This unrealized loss net of tax
remains as part of the separate component of capital mentioned
above, and is amortized against the interest income for the
securities over their respective lives. This amount,
approximately $174,000, is the reason that the separate component
of capital exceeds the net unrealized losses related to the
securities classified as "available-for-sale."
During the third quarter of 1995, the Bank became a member of the
Federal Reserve System. As a member, it is required to purchase
stock in the Federal Reserve Bank equal to a percentage of the
Bank's capital. By regulation, this stock is classified as
available-for-sale, but it has no market value other than its
purchase price. Therefore, it is shown on a separate line in the
next table.
<TABLE>
<CAPTION>
(in thousands) Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
<S> <C> <C> <C> <C>
March 31, 1996:
Held-to-maturity:
U.S. Treasury obligations $143,388 $ 180 $ (805) $142,763
U.S. agency obligations 56,947 770 (433) 57,284
State and municipal securities 83,033 13,064 (16) 96,081
Total held-to-maturity 283,368 14,014 (1,254) 296,128
Available-for-sale:
U.S. Treasury obligations 97,790 174 (168) 97,796
U.S. agency obligations 15,004 9 0 15,013
Collateralized mortgage
obligations 11,916 0 (213) 11,703
Equity Securities 488 0 0 488
Total available-for-sale 125,198 183 (381) 125,000
Total Securities $408,566 $ 14,197 $(1,635) $421,128
December 31, 1995:
Held-to-maturity:
U.S. Treasury obligations $ 97,528 $ 775 $ 0 $ 98,303
U.S. agency obligations 51,826 983 (143) 52,666
State and municipal securities 82,376 15,913 0 98,289
Total held-to-maturity 231,730 17,671 (143) 249,258
Available-for-sale:
U.S. Treasury obligations 100,090 316 (122) 100,284
U.S. agency obligations 25,026 37 0 25,063
Equity Securities 488 0 0 488
Total available-for-sale 125,604 353 (122) 125,835
Total Securities $357,334 $ 18,024 $ (265) $375,093
</TABLE>
In November, 1995, the Financial Accounting Standards Board ("the
FASB") issued a guide to implementing SFAS 115. The guide
permitted holders of debt securities a onetime opportunity to
transfer securities from their held-to-maturity classification to
available-for-sale without calling into question the holder's
ability and intent to hold to maturity any securities still
classified as held-to-maturity. Under this "window of
opportunity," the Company transferred securities with an
amortized cost of $144 million from the held-to-maturity
classification to available-for-sale. The unrealized gains and
losses on these securities totaled $683,000 and $986,000,
respectively. $94 million of these reclassified securities were
sold prior to December 31, 1995.
The Company does not expect to realize any significant amount of
the unrealized gains shown above for the held-to-maturity
securities unless the securities are called prior to maturity.
The Company does not expect to realize any of the unrealized
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. Losses
may be realized on securities in the available-for-sale
portfolio.
<TABLE>
<CAPTION>
(in thousands) Held-to- Available-
Maturity for-Sale Total
<C>
March 31, 1996: <S> <S> <S>
Amortized cost:
In one year or less $ 49,490 $ 30,126 $ 79,616
After one year through five years 193,490 84,153 277,643
After five years through ten years 15,389 8,218 23,607
After ten years 24,999 2,213 27,212
Equity Securities 0 488 488
$283,368 $125,198 $408,566
Estimated market value:
In one year or less $ 50,169 $ 30,134 $ 80,303
After one year through five years 199,107 84,145 283,252
After five years through ten years 19,589 8,050 27,639
After ten years 27,263 2,183 29,446
Equity Securities 0 488 488
$296,128 $125,000 $421,128
December 31, 1995:
Amortized cost:
In one year or less $ 32,414 $ 55,135 $ 87,549
After one year through five years 151,560 69,981 221,541
After five years through ten years 21,823 0 21,823
After ten years 25,933 0 25,933
Equity Securities 0 488 488
$231,730 $125,604 $357,334
Estimated market value:
In one year or less $ 32,522 $ 55,172 $ 87,694
After one year through five years 158,803 70,175 228,978
After five years through ten years 27,978 0 27,978
After ten years 29,955 0 29,955
Equity Securities 0 488 488
$249,258 $125,835 $375,093
</TABLE>
The book value and estimated market value of debt securities by
contractual maturity are shown above. Expected maturities may
differ from contractual maturities because certain issuers may
have the right to call or prepay obligations with or without call
or prepayment penalties.
5. Loans
The balances in the various loan categories are as follows:
<TABLE>
<CAPTION>
(in thousands) March 31, December 31,
1996 1995
<S> <C> <C>
Real estate:
Residential $ 135,795 $ 142,143
Non-residential 177,136 179,272
Construction 24,075 20,846
Commercial loans 146,294 144,011
Home equity loans 32,228 34,597
Consumer loans 31,709 28,494
Municipal tax-exempt obligations 7,311 7,573
Other loans 1,925 1,865
Total loans $ 556,473 $ 558,801
</TABLE>
The loan balances at March 31, 1996 and December 31, 1995, are
net of approximately $2,264,000 and $1,990,000, respectively, in
loan fees and origination costs deferred under the provisions of
Statement of Financial Accounting Standards No. 91.
Statements of Financial Accounting Standards No. 114, Accounting
by Creditors for Impairment of a Loan, and No. 118, Accounting
by Creditors for Impairment of a Loan--Income Recognition and
Disclosures were adopted on January 1, 1995. At that date, a
valuation allowance for credit losses related to impaired loans
was established. A loan is identified as impaired when it is
probable that interest and principal will not be collected
according to the contractual terms of the loan agreement.
Because this definition is very similar to that used by bank
regulators to determine on which loans interest should not be
accrued, the Company expects that most impaired loans will be on
non-accrual status. Therefore, in general, the accrual of
interest on impaired loans is discontinued, and any uncollected
interest is written off against interest income from other loans
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.
There are some loans about which there is doubt regarding the
collectibility of interest and principal according to the
contractual terms, but which are both fully secured by collateral
and which are current in their interest and principal payments.
These impaired loans are not classified as non-accrual. Not all
types of loans are covered by the provisions of these statements.
Loans of these types may be classified as non-accrual because of
concern for collectibility, but not be reported as impaired.
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: (1) the expected
future cash flows are estimated and then discounted at the
effective interest rate; (2) by the loan's observable market
price if it is of a kind for which there is a secondary market;
or (3) by a valuation of the underlying collateral. A valuation
allowance is computed as any amount by which the recorded
investment exceeds the value of the impaired loan. If the value
of the loan as determined by one of the above methods exceeds the
recorded investment in the loan, no valuation allowance for that
loan is established. The following table discloses information
about the impaired loans and the allowance related to them ($ in
millions) as of March 31, 1996 and 1995:
March 31, 1996 March 31, 1995
Loans identified as impaired $9.2 27.8
Impaired loans for which a valuation
allowance has been determined $7.4 23.2
Impaired loans for which no valuation
allowance was determined necessary $1.9 4.6
Amount of valuation allowance $3.2 5.3
The average amounts of the recorded investment in impaired loans
for the three month periods ended March 31, 1996 and 1995 were
approximately $12.8 million and $25.0 million, respectively.
Approximately $2,429 in interest was collected from impaired
loans in the three month periods ended March 31, 1996 and
recognized as interest income.
The provisions of the statements permit the valuation allowance
reported above to be determined on a loan-by-loan basis or by
aggregating loans with similar risk characteristics. Because the
loans currently identified as impaired have unique risk
characteristics, the valuation allowance was determined on a
loan-by-loan basis.
The Company also provides an allowance for losses for (1) loans
that are not covered by the provisions of SFAS Nos. 114 & 118;
(2) loans which, while of a kind that is covered by the
statements, are not identified as impaired; and (3) losses
inherent in loans of all types which have not been specifically
identified as of the period end. This allowance is based on
review of individual loans, historical trends, current economic
conditions, and other factors.
Loans that are deemed to be uncollectible, whether or not covered
by the provisions of the statements, are charged-off.
Uncollectibility is determined based on the individual
circumstances of the loan and historical trends.
The valuation allowance for impaired loans is included with the
general allowance for loan losses of $12.0 million to total the
$15.2 million reported on the balance sheet for March 31, 1996
which these notes accompany and in the statement of changes in
the allowance account below.
<TABLE>
Allowance for Loan Losses
(in thousands)
<S> <C>
Balance, December 31, 1995 $ 12,349
Provision for tax refund anticipation loans 1,916
Tax refund loan losses charged against allowance --
Tax refund loan recoveries added to allowance 1,150
Provision for loan losses 1,299
Loan losses charged against allowance (1,568)
Loan recoveries added to allowance 77
Balance, March 31, 1996 $ 15,223
</TABLE>
6. Premises and Equipment
Premises and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation is charged to income
over the estimated useful lives of the assets, generally by the
use of an accelerated method in the early years, switching to the
straight line method in later years. Leasehold improvements are
amortized over the terms of the related lease or the estimated
useful lives of the improvements, whichever is shorter.
Depreciation expense (in thousands) was $493 and $416 for the
three-month periods ended March 31, 1996 and 1995, respectively.
The table below shows the balances by major category of fixed
assets:
<TABLE>
<CAPTION>
(in thousands) March 31, 1996 December 31, 1995
Net Net
Accum. Book Accum. Book
Cost Deprec. Value Cost Deprec. Value
<S> <C> <C> <C> <C> <C> <C>
Land and buildings $ 5,607 $ 3,006 $ 2,601 $ 5,607 $ 2,967 $ 2,640
Leasehold
improvements 6,392 4,144 2,248 6,427 3,996 2,431
Furniture and
equipment 13,018 10,068 2,950 12,843 9,765 3,078
Total $25,017 $17,218 $ 7,799 $24,877 $16,728 $ 8,149
</TABLE>
7. Property from Defaulted Loans Included in Other Assets
Property from defaulted loans is included within other assets on
the balance sheets. As of March 31, 1996 and December 31, 1995,
the Company had $1,816,000 and $1,785,000, respectively, in prop-
erty from defaulted loans. Property from defaulted loans is
carried at the lower of the outstanding balance of the related
loan or the estimate of the market value of the assets less
disposal costs.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Company posted its highest quarterly earnings ever during the
first quarter 1996. First quarter earnings of $3.9 million were
up 30 percent, or nearly $1 million, over the comparable period
in 1995, and per share earnings climbed to $0.51, up from $0.39
for the same period in the prior year. Earnings benefited from a
combination of favorable factors during the first quarter,
including increased net interest income and fees compared to the
prior year, and reduced non-interest operating expense, due to
the absence of any FDIC premium expense. Additionally, the
Refund Anticipation Loan and Transfer Program ("RAL") was more
profitable during the first quarter than anticipated, with
restrictive credit criteria permitting a smaller provision for
loan loss than was necessary last year.
The increase in earnings was achieved despite $512,000 in losses
taken on the sale of securities. The securities were sold so
that the proceeds could be reinvested at higher interest rates.
This continues the restructuring of the Company's securities
portfolio initiated in the fourth quarter of 1995. The sale of
depreciated securities and the subsequent repurchasing of other
securities at higher market rates allows the Company to earn more
interest income.
Several key strategic initiatives undertaken during 1995
contributed to the Company's strong performance in the first
quarter. The Company's expansion into Ventura County last year
has generated more than $56 million in deposits since the three
offices were opened and loan production has been strong. The
Trust & Investment Services Division reported trust fee income of
$2.2 million during the quarter, up $460,000 over the first
quarter of 1995. The increase was due principally to the
addition of new products and services during the past year, the
aggressive cultivation of new customers, and higher stock market
levels. The Company has also continued to focus on increasing
loans outstanding and improving asset quality. Sales efforts
were concentrated on prospective commercial loan customers, and
while the results of these contacts may not be fully realized for
several quarters, the response has been favorable. Additionally,
as a result of credit administration changes made in 1995, the
Company has made substantial progress in managing its loan
portfolio, which Management believes will enhance credit quality,
continue to reduce non-performing assets, and strengthen
reserves. The quality of the loan portfolio is addressed in
detail in the "Credit Quality" discussion.
These initiatives are expected to continue to produce favorable
results during the balance of 1996 and beyond. While each
initiative required significant planned expenditures in 1995 in
advance of the anticipated revenues, these moves are critically
important for the long-term viability and profitability of the
Company, and will permit the Company's planned expansion into new
market areas this year and beyond.
Business
The Company is a bank holding company. While the Company has a
few operations of its own, these are not significant in
comparison to those of its major subsidiary, Santa Barbara Bank
and Trust (the "Bank"). The Bank is a state-chartered commercial
bank and is a member of the Federal Reserve Bank. It offers a
full range of retail and commercial banking services. These
include commercial, real estate, and consumer loans, a wide
variety of deposit products, and full trust services. The
Company's second subsidiary is SBBT Service Corporation
("ServiceCorp"). ServiceCorp provides correspondent banking
services such as check processing to other financial institutions
on the Central Coast of California. All references to "the
Company" below apply to the Company and its subsidiaries.
Total Assets and Earning Assets
The chart below shows the growth in average total assets and
deposits since the fourth quarter of 1993. For the Company,
changes in assets are primarily related to changes in deposit
levels, so these have been included in the chart. Dollar amounts
are in millions. Because significant deposits are sometimes
received at the end of a quarter and are quickly withdrawn,
especially at year-end, the overall trend in the Company's growth
is better shown by the use of average balances for the quarters.
[In the printed version of the Form 10Q, a chart appears here
which shows a steady trend in growth in average assets and
average deposits over the last ten quarters. There are slight
decreases in average assets and deposits for the first quarter of
1994 and the second quarter of 1995 from the respective previous
quarters.]
The usual pattern of deposit and asset growth is for the first
quarter averages to be about the same or slightly less than the
last quarter of the prior year. The averages for the second
quarter may be lower than the averages for the first quarter as
deposits tend to decrease during the first quarter. The third
and fourth quarters generally show growth over the earlier
quarters. Averages for the first quarter of 1996 are higher than
the previous quarter because the usual seasonal decrease did not
begin until late in the quarter. It is anticipated that any
decrease in the second quarter will be less than that seen in the
second quarter of 1995. Continued consolidation in the financial
services industry and the three Ventura County offices opened in
1995 have contributed to the continued growth in deposits.
Earning assets consist of the various assets on which the Company
earns interest income. The Company was earning interest on
94.88% of its assets during the first quarter of 1996. This
compares with an average of 82.74% for all FDIC-Insured
Commercial Banks.[1] 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 non-earning 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. Real estate obtained as the
result of foreclosure is aggressively disposed of so that the
Company avoids tying up funds that could be earning interest.
Lastly, the Company has developed systems for clearing checks
faster than those used by most banks of comparable size that
allow it to put the cash to use more quickly. At the Company's
current size, these steps have resulted in about $145.8 million
more assets earning interest during the first quarter 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, but 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 loans the funds to borrowers or
invests the funds in securities and other instruments. The
Company earns interest income on the loans and securities and
pays interest expense on the deposits. Net interest income is
the difference in dollars between the interest income earned and
the interest expense paid. The net interest margin is the ratio
of net interest income to 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 same percentage spread between
interest income and interest expense as the Company grows, the
amount of net interest income will increase.
The Company must maintain its net interest margin to remain
profitable, and must be prepared to address the risks of adverse
effects as interest rates change. Average market interest rates
decreased during the second half of 1995 and early in the first
quarter of 1996 as the Federal Reserve Board ("the Fed") eased
short-term rates in an effort to sustain economic recovery. This
had the impact of lowering the average rates earned and paid on
short-term assets and liabilities. Long-term rates declined even
more and for much of the year the Treasury yield curve was
partially inverse, i.e., rates in the 1-3 year range were less
than overnight and three-month rates. Long-term rates then began
to increase at the end of the first quarter of 1996 while short-
term rates remained steady. This resulted in a more normal yield
curve. Because they occurred late in the quarter, the increased
longer rates are not yet apparent in the deposit rates reported
in Table 2, the loan rates reported in Table 3, nor in the
securities rates reported in Table 6. However, the impact of the
lowering of short-term rates in January can be seen in the
reduced average rate paid on NOW/MMDA accounts and in the loan
rates in Table 3.
Because the Company earns interest income on 94% of its assets
and pays interest expense on the majority of its liabilities, it
is subject to adverse impact from changes in market rates. A
primary economic risk is "market risk;" that is, the market value
of financial instruments such as loans, securities, and deposits
that have rates of interest fixed for some term will increase or
decrease with changes in market interest rates. If the Company
invests funds in a fixed-rate long-term security and interest
rates subsequently rise, the security is worth less than a
comparable security issued after the rise in rates. This is
because it pays less interest than the newly issued security. If
the security had to be sold, the Company would have to recognize
a loss. The opposite is true when interest rates decline; that
is, the market value of the older security would be higher than
that of a newly issued comparable security because the holder of
the older security would be earning interest at a higher rate
than the current market. The same principle applies to fixed
rate certificates of deposit and other liabilities. They
represent a less costly obligation relative to the current market
when interest rates rise (because their rate would be less than
the new higher rate) and a more costly obligation when interest
rates decline (because their rate would be more than the new
lower rate). However, most fixed-rate interest-bearing
liabilities have a shorter maturity than fixed-rate interest-
earning assets and so there is less fluctuation in the market
value of liabilities from changes in interest rates. Therefore,
the exposure to loss from market risk is primarily from rising
interest rates.
This exposure to "market risk" is managed by limiting the amount
of fixed rate assets (loans or securities that earn interest at a
rate fixed when the funds are lent or the security purchased) and
by keeping maturities short. The Company underwrites the largest
proportion of its loans with variable interest rates. While
virtually all of the Company's securities are fixed-rate, it has
generally maintained the taxable portion of its securities
portfolios heavily weighted towards securities with maturities of
less than three years. However, these methods of avoiding market
risk must be balanced against the consideration that shorter term
securities generally earn less interest income than longer term
instruments. Therefore, the Company makes some fixed rate loans
and purchases some longer-term securities, because if it were to
make only variable loans and only purchase securities with very
short maturities, its net interest margin would be significantly
less.
The Company is also exposed to "mismatch risk." This is the risk
that interest rate changes may not be equally reflected in the
rates of interest earned and paid because of differences in the
contractual terms of the assets and liabilities held. An obvious
example of this kind of difference is if a financial institution
uses the proceeds from shorter-term deposits to purchase longer-
term securities or fund longer-term loans. If interest rates
rise significantly, the interest that must be paid on the
deposits will exceed the interest earned on the assets.
The Company controls mismatch risk by attempting to roughly match
the maturities and repricing opportunities of assets and liabili-
ties. For example, if the interest rates start to decrease, the
Company's variable loans will be repriced at lower rates and the
proceeds from securities that mature in the near future will be
reinvested at lower rates. If the Company is well matched, it
should be able to reprice an approximately equal amount of
deposits or other liabilities to lower interest rates within a
short time. Similarly, if interest rates paid on deposits
increase, the Company should be able to protect its interest rate
margin through adjustments in the interest rates earned on loans
and securities. This matching is accomplished by managing the
terms and conditions of the products that are offered to
depositors and borrowers and by purchasing securities with the
right maturity or repricing characteristics to fill in
mismatches.
One of the means by which the Company monitors the extent to
which the maturities or repricing opportunities of the major
categories of assets and liabilities are matched is an analysis
such as that shown in Table 1. This analysis is sometimes called
a "gap" report, because it shows the gap between assets and
liabilities repricing or maturing in each of a number of periods.
The gap is stated in both dollars and as a percentage of total
assets for each period and on a cumulative basis for each period.
As a percentage of total assets, the Company's target is to be no
more than 10% plus or minus in either of the first two periods,
and not more than 15% plus or minus cumulative through the first
year.
Many of the categories of assets and liabilities on the balance
sheet do not have specific maturities. For the purposes of this
table, the Company assigns these pools of funds to a likely
repricing period. However, the assumptions underlying the
assignment of the various classes of non-term assets and
liabilities are somewhat arbitrary in that the timing of the
repricing is often a function of competitive influences. For
example, if other financial institutions are increasing the rates
offered depositors, the Company may have no choice but to reprice
sooner than it expected or assumed in order to maintain market
share.
The first period shown in the gap report covers assets and
liabilities that mature or reprice within the first three months
after quarter-end. This is the most critical period because
there would be little time to correct a mismatch that is having
an adverse impact on income. For example, if the Company had a
significant negative gap for the period--with liabilities
maturing or repricing within the next three months significantly
exceeding assets maturing or repricing in that period -- and
interest rates rose suddenly, the Company would have to wait for
more than three months before an equal amount of assets could be
repriced to offset the higher interest expense on the
liabilities. From quarter to quarter, the gap for the first
period varies between positive and negative. As of March 31,
1996, the gap for this first period is a negative 7.09%, within
the target range. At the end of the fourth quarter of 1995 and
at the end the first quarter of 1995, the gaps were a positive
0.60% and a negative 10.19% of assets, respectively. The change
from last quarter is due to the reinvestment of proceeds from
maturing securities and bankers' acceptances.
The negative gap in the first period, which causes some exposure
to adverse impact on net interest income should short-term rates
rise, is mitigated by the similarly sized positive gap in the
second period, "After three months but within six." If there were
a negative gap in the second period as well as the first, then it
would be even longer before sufficient assets could be repriced
to offset the negative impact of rising rates.
The negative gap for the third period, "After six months but
within one year" is caused by the large amounts of transaction
deposit accounts that the Company at present assumes will not be
repriced sooner than six months. If market interest rates change
substantially, the rates paid on these accounts may have to be
repriced sooner than six months. There would be a negative
impact on earnings from an upward repricing of these deposits.
This impact would be partially offset by the fact that, in an
environment of rising interest rates, short-term assets tend to
reprice more often and to a greater degree than the short-term
liabilities.
The large negative amount for the third period causes the
cumulative gap for the first three periods to be just outside the
Company's target range. Management does not consider this to be
a significant problem in that roughly two-thirds of the
investments in the "After one year but within five" column mature
in years one and two. The maturation of these securities will
provide proceeds for reinvestment at the new rates within a
reasonable time to offset the impact of a rise in rates. If
rates rise enough, the Company's investment policy requires it to
sell the available-for-sale securities before their maturity
dates to reposition the proceeds at the new rates.
The periods of over one year are the least critical because more
steps can be taken to mitigate the adverse effects of any
interest rate changes arising from repricing mismatches.
<TABLE>
Table 1--INTEREST RATE SENSITIVITY
<CAPTION>
After three After six After one Non-interest
As of March 31, 1996 Within months months year but bearing or
(in thousands) three but within but within within After five non-repricing
months six one year five years items Total
<S> <C> <C> <C> <C> <C> <C> <C>
Assets:
Loans $ 304,219 $100,108 $ 29,994 $ 70,140 $ 41,630 $ 10,382 $ 556,473
Cash and due from banks 0 0 0 0 0 49,825 49,825
Federal Funds 65,000 0 0 0 0 0 65,000
Securities:
Held-to-maturity 1,356 12,497 35,637 193,490 40,388 0 283,368
Available-for-sale 0 10,005 20,129 84,145 10,233 488 125,000
Bankers' acceptances 84,662 10,807 0 0 0 0 95,469
Other assets 0 0 0 0 0 16,204 16,204
Total assets 455,237 133,417 85,760 347,775 92,251 76,899 1,191,339
Liabilities and shareholders'
equity:
Borrowed funds:
Repurchase agreements and
Federal funds purchased 53,229 0 0 0 0 0 53,229
Other borrowings 994 0 0 0 0 0 994
Interest-bearing deposits:
Savings and interest-bearing
transaction accounts 407,579 0 234,556 0 0 0 642,135
Time deposits 77,941 44,267 52,149 57,876 333 0 232,566
Demand deposits 0 0 0 0 0 152,540 152,540
Other liabilities 0 0 0 0 0 7,543 7,543
Shareholders' equity 0 0 0 0 0 102,332 102,332
Total liabilities and
shareholders' equity 539,743 44,267 286,705 57,876 333 262,415 $1,191,339
Interest rate-
sensitivity gap $ (84,506) $ 89,150 $ (200,945) $289,899 $ 91,918 $(185,516)
Gap as a percentage of
total assets (7.09%) 7.48% (16.87%) 24.33% 7.72% (15.57%)
Cumulative interest
rate-sensitivity gap $ (84,506) $ 4,644 $ (196,301) $ 93,598 $ 185,516
Cumulative gap as a
percentage of total assets (7.09%) .39% (16.48%) 7.86% 15.57%
<FN>
Note: Net deferred loan fees, overdrafts, and the allowance for loan losses are included in the above
table as non-interest bearing or non-repricing items.
</FN>
</TABLE>
A gap report can show mismatches in the maturities and repricing
opportunities of assets and liabilities, but has limited
usefulness in measuring or managing market risk and basis risk.
To assess the extent of these risks in both its current position
and the potential results of positions it might take in the
future, the Company uses a computer model to simulate the impact
of different interest rate scenarios on net interest income and
on net economic value. Net economic value, or market value of
portfolio equity, is defined as the difference between the market
value of financial assets and liabilities. These hypothetical
scenarios include both sudden and gradual interest rate changes,
and changes in both directions.
Deposits and Related Interest Expense
While occasionally there are slight decreases in average deposits
from one quarter to the next, the overall trend is one of growth.
This orderly growth has been planned by Management and can be
sustained because of the strong capital position and earnings
record of the Company. The overall deposit base for financial
institutions in the Company's Santa Barbara market area has
declined from $4.5 billion in 1989 to $3.1 billion at mid-1995.
During this time the Company has increased its market share from
14.1% in 1989 to 29.6% in 1995. The increases have come by
maintaining competitive deposit rates, introducing of new deposit
products, and by successfully encouraging former customers of
failed or merged financial institutions to become customers of
the Company.
Table 2 presents the average balances for the major deposit
categories and the yields of interest-bearing deposit accounts
for the last five quarters (dollars in millions). As shown both
in the chart and in Table 2, average deposits for the first
quarter of 1996 have increased 12% from average deposits a year
ago. The growth in average deposits was evenly matched between
the Ventura region offices (50%) and the Santa Barbara region
(50%). In general, it would not be expected for the Santa
Barbara offices to experience significant growth when they have
already captured almost 30% of the market.
<TABLE>
Table 2--AVERAGE DEPOSITS AND RATES
<CAPTION>
1995 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NOW/MMDA $ 480.1 3.58% $470.5 3.67% $512.7 3.67% $ 550.6 3.52%
Savings 108.6 2.39% 100.7 2.38% 95.0 2.36% 91.7 2.35%
Time deposits 100+ 53.8 4.58% 56.7 5.10% 59.9 5.26% 63.4 5.34%
Other time deposits 144.9 5.24% 151.6 5.50% 157.7 5.65% 160.1 5.71%
Total interest-
bearing deposits 787.4 3.79% 779.5 3.96% 825.3 4.02% 865.8 3.95%
Non-interest-bearing 135.5 126.3 130.6 135.9
Total deposits $ 922.9 $905.8 $955.9 $1,001.7
1996 1st Quarter
NOW/MMDA $ 555.8 3.35%
Savings 94.0 2.37%
Time deposits 100+ 65.8 5.32%
Other time deposits 163.2 5.67%
Total interest-
bearing deposits 878.8 3.82%
Non-interest-bearing 154.4
Total deposits $1,033.2
</TABLE>
The average rates that are paid on deposits generally trail
behind money market rates because financial institutions do not
try to raise deposit rates with each small increase or decrease
in short-term rates. This trailing characteristic is stronger
with time deposits than with deposit types that have administered
rates. Administered rate deposit accounts are those products
which the institution can reprice at its option based on
competitive pressure and need for funds. This contrasts with
deposits for which the rates are set by contract for a term or
are tied to an external index. Certificates of deposit are time
or term deposits. With these accounts, even when new offering
rates are established, the average rates paid during the quarter
are a blend of the rates paid on individual accounts. Only new
accounts and those which mature and are replaced during the
quarter will bear the new rate.
As market interest rates were rising during 1994 , most banks,
including the Company, raised interest rates paid on their
administered rate transaction accounts only minimally. However,
by late 1994, competitive pressures required increases in the
rates paid on all deposit types. In 1995 interest rates
stabilized during the first half of the year and then began to
decrease thereafter. During the first quarter of 1996 rates were
relatively stable and then began to increase in the latter part
of the period. It is therefore consistent with expectations that
the average rate on time deposits would increase during 1995 to a
greater extent than NOW/MMDA, and then start to stabilize in the
last half of 1995 and the first quarter of 1996. In contrast,
NOW/MMDA accounts reflect a more stable rate environment in the
first half of the year, then begin to decline in the fourth
quarter and continue this trend into 1996.
The growth trends of the individual types of interest bearing
deposits are impacted by the relative rates of interest offered
by the Company and the customers' perceptions of the direction of
future interest rate changes. Compared with the first quarter of
1995, the primary growth in deposits during the last four
quarters came in the interest-bearing transaction accounts
("NOW/MMDA"). Included within this category is the Company's
"Personal Money Master Account." The rate paid on this account is
attractive and the average balance increased to $225 million for
the first quarter of 1996.
Approximately $15.6 million of the average balance for non-
interest-bearing demand deposits in the first quarter of 1995 and
$12.3 in the first quarter of 1996 relates to outstanding checks
from the tax refund anticipation loan program. There is
relatively little effect from these checks in other quarters.
New deposits in the Ventura offices account for $12.1 million of
the $18.9 million increase in demand deposits from the first
quarter of 1995 to the first quarter of 1996.
Generally, the Company offers higher rates on certificates of
deposit in amounts over $100,000 than for lesser amounts. It
would be expected, therefore, that the average rate paid on these
large time deposits would be higher than the average rate paid on
time deposits with smaller balances. As may be noted in Table 2,
however, this is not the case. There are three primary reasons
for this.
First, as indicated in the next section of this discussion, loan
demand has been low during the recession in the California
economy. With less need for funds to lend, the Company has been
reluctant to encourage large deposits that are not the result of
stable customer relationships, because the spread between the
cost of these funds and the earnings on their uses are small.
Therefore the premium offered on these large deposits has been
small. Second, time deposits of $100,000 and over generally have
shorter maturities than the smaller certificates. Therefore, as
a group, they reprice more frequently. In a declining interest
rate environment, their average rate paid will decline faster,
and in a rising rate environment they will rise faster. While
the average rate paid on the smaller time deposits has remained
greater than on the larger deposits over the last four quarters,
the difference contracted from 66 basis points during the first
quarter of 1995 to 35 basis points in the first quarter of 1996,
reflecting a general trend of falling rates during 1995. Third,
there has been an increase in the proportion of IRA accounts
among the under $100,000 time deposits. The Company pays a
higher rate on these accounts than on other CD's. These factors
have served to maintain a higher average rate paid on the smaller
time deposits relative to the average rate paid on larger
deposits.
The Company does not solicit and does not intend in the future to
solicit any brokered deposits or out-of-territory deposits.
Because these types of accounts are highly volatile, they present
major problems in liquidity management unless the depository
institution is prepared to continue to offer very high interest
rates to keep the deposits. Therefore, the Company has taken
specific steps to discourage even unsolicited out-of-territory
deposits in the $100,000 range and above.
Loans and Related Interest Income
Table 3 shows the changes in the end-of-period (EOP) and average
loan portfolio balances and taxable equivalent income and yields [2]
over the last six quarters (dollars in millions).
<TABLE>
Table 3--LOAN BALANCES AND YIELDS
<CAPTION>
EOP Average Interest Average
Quarter Ended Outstanding Outstanding and Fees Yield
<S> <C> <C> <C> <C>
December 1994 499.4 486.3 11.3 9.25
March 1995 534.9 525.5 15.1 11.58
June 1995 541.0 537.8 12.5 9.31
September 1995 532.2 536.0 12.6 9.40
December 1995 558.8 543.8 12.6 9.32
March 1996 556.4 565.8 15.5 10.97
</TABLE>
Changes in Loan Balances
The end-of-period loan balance as of March 31, 1996 has changed
very little compared to December 31, 1995, but has increased from
the balance at March 31, 1995. Residential real estate loans
increased $13.4 million from March 31, 1995 and non-residential
real estate loans increased $9.7 million. The other categories
remained almost unchanged. Most of the increase in residential
real estate loans is in adjustable rate mortgages ("ARMS") that
have initial "teaser" rates. The yield should increase as the
teaser rates expire because current rates are higher than when
most of these loans were made. Applicants for these loans are
qualified based on the fully-indexed rate. The Company sells
almost all of its long-term, fixed rate, 1-4 family residential
loans when they are originated. This is done in order to manage
market and interest rate risks and liquidity.
The average balance for the first quarter 1996 shows the impact
of the tax refund anticipation loans ("RAL's") that the Company
makes. The RAL's are extended to taxpayers who have filed their
returns with the IRS electronically and do not want to wait for
the IRS to send them their refund check. The Company earns a
fixed fee per loan for advancing the funds. Because of the April
15 tax filing date, almost all of the loans are made during the
first quarter of the year and repaid before the end of the
quarter. These loans and their impact on the results of
operations are discussed in the section titled "Refund
Anticipation Loan and Transfer Program" below. Average yields
for the two quarters without the effect of RAL's were 9.27% and
9.24%, respectively.
Interest and Fees Earned and the Effect of Changing Interest
Rates
Interest rates on most consumer loans are fixed at the time funds
are advanced. The average yields on these loans significantly
lag market rates as rates rise because the Company only has the
opportunity to increase yields as new loans are made. In a
declining interest rate environment, these loans tend to track
market rates more closely. This is because the borrower may
reset the rate by prepaying the loan if the current market rate
for any specific type of loan declines sufficiently below the
contractual rate on the original loan to warrant the customer
refinancing.
The rates on most commercial and construction loans vary with an
external index like the national prime rate or the Cost of Funds
Index ("COFI") for the 11th District of the Federal Home Loan
Bank, or are set by reference to the Company's base lending rate.
The base lending rate is established by the Company by reference
to the national prime rate adjusting for local lending and
deposit price conditions. The loans that are tied to prime or to
the Company's base lending rate adjust immediately to a change in
those rates while the loans tied to COFI usually adjust every six
months or less. Therefore, variable rate loans tend to follow
market rates more closely.
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,
1996 1995
Standby letters of credit $ 9,187 $ 12,623
Loan commitments 30,203 46,996
Undisbursed loans 17,081 12,793
Unused consumer credit lines 51,116 53,759
Unused other credit lines 70,382 73,779
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. With the
exception of the undisbursed loans, the Company does not
anticipate that a majority of the above commitments will be drawn
on by customers. Consumers do not tend to borrow the maximum
amounts available under their home equity lines and businesses
typically arrange for credit lines in excess of their immediate
needs to handle contingencies.
The Company has established maximum loan amount to collateral
value ratios for construction and development loans ranging from
65% to 90% depending on the type of project. There are no
specific loan to value ratios for other commercial, industrial or
agricultural loans not secured by real estate. The adequacy of
the collateral is established based on the individual borrower
and purpose of the loan. Consumer loans may have maximum loan to
collateral ratios based on the loan amount, the nature of the
collateral, and other factors.
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 are
generally less than the costs for commercial and consumer loans,
the total net deferred or unamortized amounts for these
categories are additions to the loan balances.
Allowance for Loan Losses and Credit Quality
The allowance for loan losses (sometimes called a "reserve") 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 loan
portfolio, including those not yet identified. The adequacy of
this general allowance is based on the size of the loan
portfolio, historical trends of charge-offs, and Management's
estimates of future charge-offs. These estimates are in turn
based on the grading of individual loans and Management's outlook
for the local and national economies and how they might affect
borrowers. In addition, Statements of Accounting Standards No.
114, Accounting by Creditors for Impairment of a Loan and No.
118, Accounting by Creditors for Impairment of a Loan--Income
Recognition and Disclosures require the establishment of a
valuation allowance for impaired loans as described in Note 5 to
the financial statements.
Table 4 shows the amounts of non-current loans and non-performing
assets for the Company at the end of the first quarter of 1996,
at the end of the prior two quarters and at the end of the same
quarter a year ago (in thousands). Also shown is the coverage
ratio of the allowance to non-current loans, the ratio of non-
current loans to total loans, and the percentage of non-
performing assets to average total assets. Also included in the
table in boldface is comparable data[3] regarding the Company's
Southern California peers for the three earlier quarters.
A trend of increasing non-performing loans began in late 1994.
The Company focused more efforts on monitoring these loans, but
with continued slow economic recovery in California, the number
and amounts of delinquent loans increased. The Company
strengthened the credit review, analysis, and administrative
functions by hiring additional professional staff and established
a Special Assets Committee to give increased attention to the
larger problem loans. The new staff and the committee have
aggressively pursued collection plans with customers that have
resources to repay at least some portion of their loans and have
acknowledged uncollectibility and charged-off other loans. These
efforts are still continuing, and the amount of non-current loans
has remained relatively stable since the third quarter of 1995.
In that quarter, the Company charged-off $3.4 million, including
$0.8 million in RAL's. These charge-offs reduced the ratio of
non-current loans to total loans, but also reduced the ratio of
the allowance to the remaining non-current loans. The ratios
during the fourth quarter of 1995 and the first quarter of 1996
have improved, as the Company continued to add to the allowance.
The substantial collections in 1996 of RAL's charged-off in 1995
has also added to the allowance.
<TABLE>
Table 4--ASSET QUALITY
<CAPTION>
March 31, Dec.31, Sept. 30, March 31,
1996 1995 1995 1995
Company Company Company Company
<S> <C> <C> <C> <C>
Loans delinquent
90 days or more $ 186 $ 395 $ 535 $ 1,671
Non-accrual loans 10,507 8,972 10,588 10,650
Total non-current loans 10,693 9,367 11,123 12,321
Foreclosed real estate 1,816 1,785 1,021 681
Total non-performing assets $12,509 $11,152 $12,144 $13,002
</TABLE>
<TABLE>
<CAPTION>
March 31, December 31, September 30, March 31,
1996 1995 1995 1995
So. Cal So. Cal So.Cal
Peer Peer Peer
Company Company Group Company Group Company Group
<S> <C> <C> <C> <C> <C> <C> <C>
Coverage ratio of
allowance for loan
losses to non-
current loans and leases 122% 132% 118% 104% 102% 133% 95%
Ratio of non-current loans
to total loans and leases 1.92% 1.68% 3.21% 2.09% 3.09% 2.30% 3.76%
Ratio of non-performing
assets to average total 1.04% 1.03% 2.76% 1.11% 2.74% 1.25% 3.28%
</TABLE>
The March 31, 1996 balance of non-current loans does not equate
directly with future charge-offs, because most of these loans are
secured by collateral. Nonetheless, Management believes it is
probable that some portion will have to be charged off and that
other loans will become delinquent. Based on its review of the
loan portfolio, Management considers the current amount of the
allowance adequate. As the cycle of periodic reviews continues
and additional information becomes available, Management will
provide for additional allowance as necessary to address any new
losses when identified. However, Management does not anticipate
the need to provide additional allowance in an amount comparable
to the provision in the third quarter of 1995.
The current amount of the allowance is higher than it is expected
to be at the end of the second quarter of 1996, because $1.9
million in allowance had been provided during the first quarter
of 1996 for RAL's. Although the amount is not known, the Company
plans to charge-off all RAL's still outstanding by June 30, 1996.
Management believes that the current RAL provision is adequate.
As there will be virtually no new RAL loans made between June 30,
1996 and the first quarter of 1997, a new allowance for these
loans will not need to be provided until that quarter.
Table 5 classifies non-performing loans and all potential problem
loans other than non-performing loans by loan category for March
31, 1996 (amounts in thousands).
Table 5--NON-PERFORMING AND POTENTIAL PROBLEM LOANS
Potential Problem
Non-performing Loans Other Than
Loans Non-performing
Loans secured by real estate:
Construction and
land development $ --
$ --
Agricultural 121 --
Home equity lines 50 75
1-4 family mortgage 2,600 934
Multi-family 385 264
Non-residential, non-farm 1,176 1,348
Commercial and industrial 6,311 8,294
Other consumer loans 50 94
Total $10,693 $11,009
The following table sets forth the allocation of the allowance
for all potential problem loans by classification as of March 31,
1996 (amounts in thousands).
Doubtful $3,042
Substandard $2,422
Special Mention $1,036
The total of the above numbers is less than the total allowance
because some of the allowance is allocated to loans which are not
regarded as potential problem loans, and some of the allowance is
not allocated but instead is provided for potential losses that
have not yet been identified.
Securities and Related Interest Income
Generally accepted accounting principles require that securities
be classified in one of three categories when they are purchased.
One category is that of "held-to-maturity." The Company must have
both the intent and the ability to hold a security until its
maturity date for it to be classified as such. Securities
classified as held-to-maturity are carried on the balance sheet
at their amortized historical cost. That is, they are carried at
their purchase price adjusted for the amortization of premium or
accretion of discount. If debt securities are purchased for
later sale, the securities are classified as "trading assets."
Assets held in a trading account are required to be carried on
the balance sheet at their current market value. Changes in the
market value of the securities are recognized in the income
statement for each period in which they occur as unrealized gain
or loss. Securities that do not meet the criteria for either of
these categories, e.g. securities which might be sold to meet
liquidity requirements or to effect a better asset/liability
maturity matching, are classified as "available-for-sale." They
are carried on the balance sheet at market value like trading
securities. However, unlike trading securities, changes in their
market value are not recognized in the income statement for the
period. Instead, the unrealized gain or loss (net of tax effect)
is reported as a separate component of equity. Changes in the
market value are reported as changes to this component.
The Company has created three separate portfolios of securities.
The first portfolio, for securities that will be held to
maturity, is the "Earnings Portfolio." This portfolio includes
all of the tax-exempt municipal securities and most of the longer
term taxable securities. The second portfolio, the "Liquidity
Portfolio," consists of securities that are available for sale
and is made up almost entirely of the shorter term taxable
securities. These securities will be sold if their market value
deteriorates to a predetermined point The third portfolio, the
"Discretionary Portfolio," consists of shorter term securities
that are available for sale but which will not automatically be
sold if their market value deteriorates. The Company specifies
the portfolio into which each security will be classified at the
time of purchase. The Company has no securities which would be
classified as trading securities.
Securities purchased for the Earnings Portfolio will not be sold
for liquidity purposes or because their fair value has increased
or decreased because of interest rate changes. They could be
sold if concerns arise about the ability of the issuer to repay
them or if tax laws change in such a way that any tax-exempt
characteristics are reduced or eliminated.
In November, 1995, the Financial Accounting Standards Board ("the
FASB") issued a guide to implementing SFAS 115. The guide
permitted holders of debt securities a onetime opportunity to
transfer securities from their held-to-maturity classification to
available-for-sale without calling into question the holder's
ability and intent to hold to maturity any securities still
classified as held-to-maturity. Under this "window of
opportunity," the Company transferred securities with an
amortized cost of $144 million from the Earnings Portfolio to the
newly established Discretionary Portfolio. The unrealized gains
and losses on these securities totaled $683,000 and $986,000,
respectively. $94 million of these reclassified securities were
sold prior to December 31, 1995 at an aggregate realized net loss
of $77,000.
In general, the Company uses available funds to purchase
securities for the three portfolios according to the following
priorities. Taxable securities, usually U.S. Government
obligations with maturities of two years to three years, are
purchased for the Liquidity Portfolio or the Discretionary
Portfolio. In addition, the Company's Investment Committee
approved in the fourth quarter of 1995 the acquisition of up to
$30 million of planned amortization class ("PAC'S") securities
with average lives of two years to three years for the
Discretionary Portfolio. PAC's are particular classes of the
larger collateralized mortgage obligation ("CMO") which are
designed to have principal payments occur at designated times.
PAC bondholders have priority over other classes in the CMO issue
in receiving principal payments from the underlying collateral.
The Company's policy requires the underlying collateral to be AAA
rated, guaranteed by the Federal National Mortgage Association,
the Federal Home Loan Mortgage Company, or the United States
Government. The creation of PAC bonds does not make prepayment
risk disappear, it just shifts the vast majority of the risk to
the other bonds in the CMO. Federal banking regulations require
that all fixed-rate CMO's held by financial institutions, even
short-term PAC's be low volatility investments. A PAC must pass
three "stress tests" to be considered a low volatility
investment: an average life test, an average life sensitivity
test, and a price sensitivity test. At the end of the first
quarter of 1996 the company held $11.9 million of PAC's. The
average outstanding balance during the first quarter of 1996 was
$13.2 million.
The size of the Liquidity Portfolio will vary based on loan
demand, deposit growth, and the scheduled maturities of other
securities. To the extent that estimated liquidity needs are
met, tax-exempt municipals that meet credit quality standards
will be purchased for the earnings portfolio up to an amount that
does not trigger the Alternative Minimum Tax. Lastly, taxable
securities, generally U.S. Government obligations with
maturities of two to five years, may be purchased for the
Earnings Portfolio.
The Effects of Interest Rates on the Composition of the
Investment Portfolio
Table 6 presents the combined securities portfolios, showing the
average outstanding balances (dollars in millions) and the yields
for the last five quarters. The yield on tax-exempt state and
municipal securities has been computed on a taxable equivalent
basis. Computation using this basis increases income for these
securities in the table over the amount accrued and reported in
the accompanying financial statements. The tax-exempt income is
increased to that amount which, were it fully taxable, would
yield the same income after tax as the amount that is reported in
the financial statements. The computation assumes a combined
Federal and State tax rate of approximately 41%.
<TABLE>
Table 6--AVERAGE BALANCES OF SECURITIES AND INTEREST YIELD
<CAPTION>
1995 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury $236.7 5.63% $226.8 5.60% $224.5 5.57% $203.1 5.54%
U.S. agency 55.6 4.86 54.8 5.25 77.0 5.51 86.9 5.63
Tax-Exempt 87.6 12.99 84.0 12.69 84.8 12.52 84.1 12.60
Total $379.9 7.22% $365.6 7.18% $386.3 7.08% $374.1 7.14%
</TABLE>
<TABLE>
<CAPTION>
1996 1st Quarter
<S> <C> <C>
U.S. Treasury $194.6 5.56%
U.S. agency 79.7 5.65
Collateralized
Mortgage
Obligations 13.2 5.47
Tax-Exempt 82.8 12.15
Total $370.3 7.04%
</TABLE>
Beginning in the fourth quarter of 1995 the Company modified its
Liquidity Portfolio policies. Previously the Company's practice
was to shorten the average maturity of its investments while
interest rates were rising and to lengthen the average maturity
as rates were declining. The policy currently in effect has a
primary objective of maintaining a more constant level of
maturing securities over the life of the portfolios. The change
in policy is due to the implementation of SFAS 115 which limits
the ability to restructure the parts of the portfolio due to
interest rate changes. Management believes that a more constant
re-pricing of the securities in the Earnings Portfolio coupled
with the shorter terms of the securities in the Liquidity and
Discretionary Portfolios will better protect the average interest
yields and more closely follow market rates. Beginning in the
fourth quarter of 1995 and continuing into the first quarter of
1996, the Company began the implementation process to accomplish
this new policy.
As mentioned above in the section titled "Interest Rate
Sensitivity," longer term rates, those for securities of more
than one year maturity, began to rise at the end of the first
quarter of 1996. This resulted in a more normally sloped yield
curve than had been present for about a year. Management decided
that this was a favorable time to sell some of its securities
from the Discretionary and Liquidity Portfolios and reinvest at
the new higher rates and at longer maturities to accomplish the
more even re-pricing desired under the new policy.
Implementation of this plan required realized net security losses
of $512,000 for the quarter. However, over the life of the
repositioned assets increased interest income will offset these
losses due to the higher rates of the extended maturities, and
the Company receives immediate tax benefit from the losses while
the increased interest income will be taxed over the extended
period.
Because securities generally have a fixed rate of interest to
maturity, the average interest rate earned in the portfolio lags
market rates in the same way as rates paid on term deposits. The
impact of last year's decreases in market rates is seen as a very
gradual decrease in the average rates of taxable securities
during 1995.
Investments in most tax-exempt securities became less
advantageous after 1986 because of the effect of certain
provisions of the Tax Reform Act of 1986 ("TRA"). Those
provisions did not affect securities purchased before the passage
of the act which make up the majority of the Company's tax-exempt
securities. There is still a more than sufficient differential
between the taxable equivalent yields on these securities and
yields on taxable securities to justify holding them to maturity.
The average maturity is approximately eight years. The yield on
these securities is gradually declining as older, higher-earning
securities mature or are called by the issuers.
Certain issues of municipal securities may still be purchased
with the tax advantages available before TRA. Such securities,
because they can only be issued in very limited amounts, are
generally issued only by small municipalities and require a
careful credit evaluation of the issuer. In reviewing securities
for possible purchase, Management must also ascertain that the
securities have desirable maturity characteristics, and that the
amount of tax-exempt income they generate will not be enough to
trigger the Alternative Minimum Tax; otherwise the tax advantage
will be lost. Apart from a few small issues that have met the
Company's criteria for purchase, the increase in the average
balance of tax exempt securities is due to the accretion of
discount (the periodic recognition as interest income of the
difference between the purchase cost and the par value that will
be received from the issuer upon maturity).
Included with the balances shown for U.S. Agency securities that
are being held to maturity are four structured notes with a
combined book value of $34.6 million. They are a type of
security known as "step bonds." They were issued at an initial
rate and had one or more call dates. If not called, the interest
rate steps up to a higher level. None of the notes purchased has
been called and two have reached their final steps at 4.50% and
6.61%. The other two notes have one remaining step each with
call dates every 6 months. The first has a current rate of 6.15%
with a future rate of 7.15%. The second has a current rate of
6.00% with a future rate of 7.00%. Only the interest rate on
these notes is contingent; all principal is paid at maturity
unless at a sooner call date. There is no circumstance under
which the interest rates will decline. The current interest rate
for notes of comparable maturity with no call or steps is
slightly above the current rates so there are small unrealized
losses for these notes.
Unrealized Gains and Losses
As explained in "Interest Rate Sensitivity" above, fixed rate
securities are subject to market risk from changes in interest
rates. Footnote 4 to the financial statements shows the impact
of the rise in longer-term interest rates that has occurred
during 1996. At the end of the first quarter in 1996, the market
value of the U.S. Treasury and Agency securities held-to-
maturity is less than the amortized cost by $288,000. The market
value of the municipal securities (of which there were several
purchases and calls) also decreased in market value to 116% of
book value at March 31, 1996 from 120% at December 31, 1995.
Federal Funds Sold
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. The sales are only overnight.
Excess cash expected to be available for longer periods is
generally invested in U.S. Treasury securities or bankers'
acceptances if the available returns are acceptable. The amount
of Federal funds sold during the quarter is therefore an
indication of Management's estimation during the quarter of
immediate cash needs and relative yields of alternative
investment vehicles.
Table 7 illustrates the average funds sold position of the
Company and the average yields over the last six quarters
(dollars in millions).
Table 7--AVERAGE BALANCE OF FUNDS SOLD AND YIELDS
Average Average
Quarter Ended Outstanding Yield
December 1994 $ 30.8 5.13%
March 1995 23.8 5.69
June 1995 38.5 6.01
September 1995 69.8 5.82
December 1995 81.8 5.79
March 1996 81.8 5.39
When interest rates are rising, the Company usually can benefit
by keeping larger amounts in Federal funds because these excess
funds then earn interest that is repriced daily. When rates are
declining, the Company generally decreases the amount of funds
sold and instead purchases Treasury securities and/or bankers'
acceptances. When rates are stable, the balance of Federal funds
is determined more by available liquidity than by policy
concerns. In recent years, excess funds that might otherwise
have been sold as Federal funds were instead invested in short-
term U.S. Treasury securities and bankers' acceptances that
would mature in the first quarter of the year to provide funding
for the RAL program.
The average balance sold into the market was greater in the first
quarter of 1996 than the comparable quarter in 1995 primarily due
to four factors. First, the Company operated under stricter RAL
guidelines in 1996 which resulted in fewer loans being made.
Second, until longer-term rates started to rise in the latter
part of the first quarter of 1996, the Company had to purchase
securities of one and a half to two years to earn more than the
Federal funds rate. Management therefore was selective in the
purchase of new securities with the $94 million in proceeds
generated from the sale of securities initiated under the "window
of opportunity" described in "Securities." This selectivity left
more of the proceeds to be held in Federal funds. Third, other
loan demand, a potential use of the funds, has not kept pace with
the growth in deposits. Lastly, the Company's Trust Division
deposits customers' funds with the Bank before purchasing other
investments. These balances have been higher in the fourth
quarter of 1995 and the first quarter of 1996 than is usual.
Bankers' Acceptances
The Company has used bankers' acceptances as an alternative to
short-term U. S. Treasury securities when pledging requirements
are otherwise met and sufficient spreads to U. S. Treasury
obligations exist. The acceptances of only the highest quality
institutions are utilized. Table 8 discloses the average
balances and yields of bankers' acceptances for the last six
quarters (dollars in millions).
Table 8--AVERAGE BALANCE OF BANKERS' ACCEPTANCES AND YIELDS
Average Average
Quarter Ended Outstanding Yield
December 1994 $ 64.4 5.38%
March 1995 55.7 5.97
June 1995 41.6 6.44
September 1995 35.9 6.11
December 1995 84.1 5.91
March 1996 121.0 5.73
With their relatively short maturities, bankers' acceptances are
an effective instrument for managing the timing of cash flows.
In the first quarter of 1996 the balance of bankers' acceptances
is greater than in the first quarter of 1995 for the same reasons
cited above for the higher balances of Federal Funds sold.
Other Borrowings and Related Interest Expense
Other borrowings consist of securities sold under agreements to
repurchase, Federal funds purchased (usually only from other
local banks as an accommodation to them), Treasury Tax and Loan
demand notes, and borrowings from the Federal Reserve Bank
("FRB"). Because the average total short-term component
represents a very small portion of the Company's source of funds
(less than 5%) and shows little variation in total, all of the
short-term items have been combined for the following table.
Interest rates on these short-term borrowings change over time,
generally in the same direction as interest rates on deposits.
In the first quarter of 1996, Federal funds purchased averaged
$32.5 million versus $8.5 million in the first quarter of 1995
reflecting the strong liquidity positions of local banks whose
Federal funds the Company purchases as described above.
Table 9 indicates the average balances that are outstanding
(dollars in millions) and the rates and the proportion of total
assets funded by the short-term component over the last six
quarters.
Table 9--OTHER BORROWINGS
Average Average Percentage of
Quarter Ended Outstanding Rate Average Total Assets
December 1994 $18.3 4.63% 1.8%
March 1995 16.3 5.47 1.6
June 1995 28.1 5.69 2.7
September 1995 29.5 5.42 2.7
December 1995 38.8 5.37 3.2
March 1996 59.3 4.86 4.9
Other Operating Income
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. Table 10 shows
trust income over the last six quarters (in thousands).
Table 10--TRUST INCOME
Quarter Ended Trust Income
December 1994 $ 1,611
March 1995 1,765
June 1995 1,590
September 1995 1,686
December 1995 1,978
March 1996 2,224
Trust customers are charged for the preparation of the fiduciary
tax returns. The preparation generally occurs in the first
and/or second quarter of the year. This accounts for
approximately $260,000 of the fees earned in the first quarter of
1996 and $236,000 of the fees earned in the first quarter of
1995. Other variation is caused by the recognition of probate
fees when the work is completed rather than accrued as the work
is done, because it is only upon the completion of probate that
the fee is established by the court. After adjustment for these
seasonal and non-recurring items and short-term fluctuations of
price levels in the stock and bond markets, trust income has
increased in the last two quarters because of substantially
enhanced marketing efforts.
Other categories of non-interest income include various service
charges, fees, and miscellaneous income. Included within "Other
Service Charges, Commissions & Fees" in the following table are
service fees arising from credit card processing for merchants,
escrow fees, and a number of other fees charged for special
services provided to customers. Categories of non-interest
operating income other than trust fees are shown in Table 11 for
the last six quarters (in thousands).
Table 11--OTHER INCOME
Other Service
Service Charges Charges,
on Deposit Commissions Other
Quarter Ended Accounts & Fees Income
December 1994 $ 961 $1,013 $152
March 1995 1,044 2,468 78
June 1995 1,072 1,143 113
September 1995 1,056 1,130 169
December 1995 1,083 1,219 194
March 1996 1,118 2,130 102
The Company revised its schedule for most fees in the fourth
quarter of 1994. The full effect of the revision is seen in the
increase in the amount of service charges on deposit accounts in
the succeeding quarters.
The large increases in other service charges, commissions and
fees for the first quarters of 1996 and 1995 is due to $1.05
million and $1.54 million of fees received for the electronic
transfer of tax refunds. As explained in the section below
titled "Refund Anticipation Loan and Transfer Program," the
Company did not advance funds under the RAL loan program in 1995
and 1996 to as large a number of borrowers as it had in 1994
because of the changes in the IRS procedures. Nonetheless, the
Company was able to assist these taxpayers by transferring funds
to them faster than the standard IRS check writing process, and a
fee is charged for this service.
Included in other income are gains or losses on sales of loans.
When the Company collects fees on loans that it originates, it
must defer them and recognize them as interest income over the
term of the loan. If the loan is sold before maturity, any
unamortized fees are recognized as gains on sale rather than
interest income. In a declining rate environment such as 1995
the Company has the opportunity to finance more loans as
customers take advantage of a lower interest rates .This creates
an opportunity for the Company to sell more of these loans into
the secondary market and recognize gains on sale. The amount for
the first quarter of 1996 is lower because in a rising rate
environment the number of loans made is less and there are fewer
sales opportunities.
Staff Expense
The largest component of non-interest expense is staff expense.
Staff size is closely monitored and in most years the rate of
increase in staff is less than the rate of growth in the
Company's assets (if the growth in off-balance sheet fiduciary
assets is also considered).
Table 12 shows the amounts of staff expense incurred over the
last six quarters (in thousands).
Table 12--STAFF EXPENSE
Salary and Profit Sharing and
Quarter Ended Other Compensation Other Employee Benefits
December 1994 $3,834 $1,045
March 1995 4,780 1,405
June 1995 4,422 1,015
September 1995 4,776 1,151
December 1995 4,424 682
March 1996 4,939 1,329
There is usually some variation in staff expense from quarter to
quarter. Beginning in the first quarter of 1995, staff expense
increased due to three initiatives undertaken in that quarter.
First, the Company began hiring staff for the three Ventura
offices. Second, the Company has hired a number of new staff in
lending and credit administration and in loan review to more
closely monitor credit quality. Third, staff was added in the
Trust Division to sell and manage several new products offered in
this area. In addition to the above, the first quarter of each
year will generally would be expected to increase as, all
officers have their annual salary review in the first quarter
with merit increases effective on March 1. These increases
generally average between 3% and 4% annually.
Salary and other compensation decreased in the second and fourth
quarters of 1995. Officer bonuses are paid after the end of each
year from a bonus pool, the size of which has been set by the
Board of Directors based on net income. The Company accrues
compensation expense for the pool for officer bonuses during the
year for which they are paid rather than in the subsequent year
when they are actually paid. The accrual is based on projected
net income for the year. Management's revised forecast during
the second half of 1995 projected net income at an amount less
than originally projected. Therefore a portion of these amounts
accrued were reversed in those two quarters. Had the adjustments
not occurred, staff expense for the second and fourth quarters
would have been comparable to the amount for the first and third
quarters of 1995. Salary and other compensation expense in the
first quarter of 1996 reflects merit increases as discussed above
and a bonus accrual estimate consistent with earnings projections
for this year.
There is also variability in the amounts reported above for
Profit Sharing and Other Employee Benefits. These amounts
include (1) the Company's contribution to profit sharing plans
and retiree health benefits, (2) the Company's portion of health
insurance premiums and payroll taxes, and (3) payroll taxes and
workers' compensation insurance.
The Company's contributions for the profit sharing and retiree
health benefit plans are determined by a formula that results in
a contribution equal to 10% of a base figure made up of income
before tax and before the contribution, adjusted to add back the
provision for loan loss and to subtract actual charge-offs. The
Company begins each year accruing an amount based on its forecast
of the base figure. To the extent that actual net charge-offs
are substantially greater than or less than the provision for
loan loss an accrual adjustment will be made. In the fourth
quarter of 1994, and second and fourth quarters of 1995 accrual
adjustments were made which reduced salary and other compensation
expense for those quarters.
Payroll taxes introduce a seasonality to this expense category.
While bonus expense is accrued as salary expense during the year
to which it relates, the Company is not liable for the payroll
taxes until the bonuses are paid in the first quarter of the
following year. As discussed above, the bonus amounts paid in
1996 for the previous year's results were substantially less than
the amount paid in the first quarter of 1995. Payroll tax
expense was not materially impacted in 1996. Moreover, payroll
tax expense is normally lower in the fourth quarter of each year
because the salaries of the higher paid employees have passed the
payroll tax ceilings by the fourth quarter.
As discussed above in "Loans and Related Interest Income," the
accounting standard relating to loan fees and origination costs
requires that salary expenditures related to originating loans
not be immediately recognized as expenses, but instead be
deferred and then amortized over the life of the loan as a
reduction of interest and fee income for the loan portfolio.
Therefore, compensation actually paid to employees in each of the
above listed periods is higher than shown by an amount ranging
from $125,000 to $275,000, depending on the number of loans
originated during that quarter.
Other Operating Expenses
Table 13 shows other operating expenses over the last six
quarters (in thousands).
Table 13--OTHER OPERATING EXPENSE
Occupancy Expense Furniture & Other
Quarter Ended Bank Premises Equipment Expense
December 1994 $ 950 $634 $3,745
March 1995 1,011 645 4,198
June 1995 1,003 640 3,611
September 1995 1,080 652 1,547
December 1995 1,163 673 3,060
March 1996 1,132 650 3,177
Occupancy expenses increased in the first quarter of 1995 as a
result of the new Ventura County offices and will remain higher
than in prior years. 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.
This category has also been impacted by the opening of the new
offices.
Table 14 shows a detailed comparison for the major expense items
in other expense for the three month periods ended March 31
(amounts in thousands).
Table 14--OTHER EXPENSE
Three-Month Periods
Ended March 31,
1996 1995
FDIC and State assessments $ 19 $ 528
Professional services 188 185
RAL processing and incentive fees 192 250
Supplies and sundries 160 168
Postage and freight 178 220
Marketing 287 167
Bankcard processing 357 348
Credit bureau 112 443
Telephone and wire expense 209 309
Charities and contributions 83 142
Software expense 274 203
Operating losses 40 201
Other 1,078 1,034
Total $3,177 $4,198
Included in other expense is the premium cost paid for FDIC
insurance. The FDIC has converted to a graduated rate for the
premium based on the soundness of the particular institution.
Prior to the third quarter of 1995, the annual rate ranged from
$0.23 to $0.30 per hundred dollars of deposits. On the basis of
its "well-capitalized" position, the Company's rate was $0.23 per
hundred. As deposits increased, this expense increased as well.
In the third quarter of 1995, the FDIC announced that it would
decrease the rates paid by well-capitalized banks to $0.04 per
hundred dollars because the Bank Insurance Fund had been
capitalized to the level specified by statute. The FDIC refunded
premiums paid in advance, and the Company reversed the accrual
that it had made for the expense. This resulted in approximately
$1.3 million less expense for the third quarter of 1995 relative
to what the premium cost would have been had there been no
change. The company had virtually no FDIC premium expense for
deposit insurance during the fourth quarter of 1995 and the first
quarter of 1996. As a result, pre-tax income benefited by
approximately $510,000 compared to 1995 expense levels.
A number of these expense categories have increased due to the
Ventura County expansion. These include marketing, telephone and
wire expense, and charities and contributions. The decrease in
credit bureau expense is almost wholly related to the reduced
credit checks for the RAL program in 1996 compared to 1995. In
the first quarter of 1995, more telephone expense was incurred in
the RAL program to answer questions from applicants for loans
regarding the changes made by the IRS and why the Company would
act as a transferor only. The company did not experience the
same level of customer inquiry in 1996 because of the more
limited focus on RAL originations.
Also in the first quarter of 1995, the Company became aware that
it might have had some responsibility for a large loss suffered
by one of its customers and therefore included with other
operating losses an accrual (approximately $150,000) for the
estimated reimbursement to the customer. This matter was
resolved in 1995 for an amount substantially less than the
original estimate. Operating loss in the first quarter of 1996
was not impacted by this event and reflects a more normal expense
for this category.
RAL processing and incentive fees are paid to tax preparers and
filers based on the volume of loans and the collectibility of the
loans made through them. The first quarter 1996 expenses are
less than last year's due to the reduced volume of RAL loans.
The net cost of other real estate owned ("OREO") is not included
in the preceding table because it appears on a separate line in
the statements of income. When the Company forecloses on the
real estate collateral securing delinquent loans, it must record
these assets at the lower of their fair value (market value less
estimated costs of disposal) or the outstanding amount of the
loan. If the fair value is less than the outstanding amount of
the loan, the difference is charged to the allowance for loan
loss at the time of foreclosure. Costs incurred to maintain or
operate the properties are charged to expense as they are
incurred. If the fair value of the property declines below the
original estimate, the carrying amount of the property is
written-down to the new estimate of fair value and the decrease
is also charged to this expense category. If the property is
sold at an amount higher than the estimated fair value, the gain
that is realized is credited to this category. Net OREO expenses
for the first quarter of 1996 were $108,000 as compared to a
negative balance of $18,000 in the same period in 1995. Gains on
sales of OREO ($23,000) exceeded the costs in the first quarter
of 1995.
As disclosed in Note 7 to the financial statements, the Company
had $1,816,000 in OREO as of March 31, 1996 as compared with
$1,785,000 at December 31, 1995. With the small balance of OREO
being held, Management anticipates that OREO operating expense
will continue to be relatively low. However, the Company has
liens on properties which are collateral for (1) loans which are
in non-accrual status, or (2) loans that are currently performing
but about which there is some question that the borrower will be
able to continue to service the debt according to the terms of
the note. These conditions may necessitate additional
foreclosures during the next several quarters, with a
corresponding increase in this expense.
Liquidity
Sufficient liquidity is necessary to handle fluctuations in
deposit levels, to provide for customers' credit needs, and to
take advantage of investment opportunities as they are presented.
Sufficient liquidity is a function of (1) having cash or cash
equivalents on hand or on deposit at a Federal Reserve Bank
("FRB") adequate to meet unexpected immediate demands, and (2)
balancing near-term and long-term cash inflows and outflows to
meet such demands over future periods.
Federal regulations require banks to maintain a certain amount of
funds on deposit ("deposit reserves") at the FRB for liquidity.
Generally, the Company also maintains a balance of Federal funds
sold which are available for liquidity needs with one day's
notice.
The timing of inflows and outflows to provide for liquidity over
longer periods is achieved by making adjustments to the mix of
assets and liabilities so that expected cash flows are matched.
These adjustments are accomplished through changes in terms and
relative pricing of different products. The timing of liquidity
sources and demands is well matched when there is at least the
same amount of short-term liquid assets as volatile, large
liabilities. It is also important that the maturities of the
remaining long-term assets are relatively spread out. The
Company considers that its the short-term liquid assets as
presented in table 15 consist of : (1) Federal funds sold , (2)
all debt securities with a remaining maturity of less than one
year, (3) treasury securities with a remaining maturity of under
two years that have been purchased for the Liquidity Portfolio
and are therefore classified as available-for-sale (There is an
active market for these securities and the Company follows a
policy of selling them before any loss becomes too great to
materially affect liquidity) and (4) securities from the Earnings
Portfolio with a remaining maturity of one year or less. The
inclusion of these last securities is not predicated on their
possible sale, but rather on the recognition that Management will
be including the proceeds that will be received at maturity in
liquidity planning.
The volatile, large liabilities are time deposits over $100,000,
public time deposits, Federal funds purchased, repurchase
agreements, and other borrowed funds. While balances held in
demand and passbook accounts are immediately available to
depositors, they are generally the result of stable business or
customer relationships with inflows and outflows usually in
balance over relatively short periods of time. Therefore, for
the purposes of this analysis, they are not considered volatile.
A method used by bank regulators to compute liquidity using this
concept of matching maturities is to divide the difference
between the short-term, liquid assets and the volatile, large
liabilities by the sum of the loans and long-term investments,
that is:
Short-term, Liquid Assets - Volatile, Large Liabilities
- -------------------------------------------------- = Liquidity Ratio
Net Loans and Long-term Investments
The numerator of the fraction represents the absolute size of the
mismatch, while the denominator relates the size of the mismatch
to the amount of the longer-term assets. The ratio is designed
to show the extent to which a financial institution might be
using short-term deposits and borrowings to fund long-term
assets.
As of March 31, 1996, Company's short-term, liquid assets
exceeded its volatile, large liabilities, the "liquidity amount,"
by $178 million and the liquidity ratio was 22.4%, using the
balances (in thousands) in Table 15.
<TABLE>
Table 15--LIQUIDITY COMPUTATION COMPONENTS
<CAPTION>
Net Loans and Long-term
Short-term, Liquid Assets Volatile, Large Liabilities Investments
<S> <C> <S> <C> <S> <C>
Fixed rate debt Time deposits 100+ $ 78,774 Net loans $541,250
with maturity Repurchase agreements Long-term
less than 1 year $ 79,625 and Federal funds securities 256,991
Treasury securities with purchased 53,229
1-2 year maturities 71,478 Other borrowed funds 994
Federal funds 65,000
Bankers' acceptances 95,469
Total $ 311,572 Total $ 132,997 Total $798,241
</TABLE>
The current liquidity amount actually exceeds the range that the
Company is trying to maintain -- from positive $75 million to
negative $25 million. Too high a liquidity amount or ratio may
result in reduced earnings because the short-term, liquid assets
generally have lower interest rates. If liquidity is too low,
earnings are reduced by the cost to borrow funds or because of
lost opportunities. The Company generated a very large amount of
immediate liquidity as the result of the restructuring late in
1995 of the securities portfolio as discussed in the section
above titled "Securities." At December 31, 1995 the ratio was
29.4%. During the first quarter, the Company brought the ratio
down through purchases of securities with maturities ranging from
three to five years.
Capital Resources
Table 16 presents a comparison of several important amounts and
ratios for the first quarters of 1996 and 1995 (dollars in
thousands).
Table 16_CAPITAL RATIOS
1st Quarter
1st Quarter
1996 1995
Amounts:
Net Income $ 3,876 $ 2,976
Average Total Assets $1,201,092 $1,042,357
Average Equity $ 102,299 $ 96,043
Ratios:
Equity Capital to
Total Assets
(period end)
8.59% 9.41%
Annualized Return on
Average Assets
1.29% 1.14%
Annualized Return on
Average Equity
15.16% 12.39%
Earnings are the largest source of capital for the Company. For
reasons mentioned in various sections of this discussion,
Management expects that there will be more variation quarter by
quarter in operating earnings. Areas of uncertainty include
asset quality, loan demand, RAL operations and collections.
A substantial increase in charge-offs would 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. If loan demand increases, the Company will be able to
reinvest proceeds from maturing investments at higher rates,
which would positively impact earnings.
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. As of March
31, 1996, the Company's risk-based capital ratio was 18.46%. The
Company must also maintain shareholders' equity of at least 4% to
5% of unadjusted total assets. As of March 31, 1996,
shareholders' equity was 8.59% of total assets. No significant
commitments or reductions of capital are anticipated.
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 Company is required by the provisions of the
Community Reinvestment Act ("CRA") to make significant efforts to
ensure that access to banking services is available to the whole
community. The Bank's CRA compliance was last examined by the
FDIC in the fourth quarter of 1992, and the Bank was given the
highest rating of "Outstanding." As a bank holding company, the
Company is primarily regulated by the Federal Reserve Bank. As a
member bank of the Federal Reserve System that is state-
chartered, the Bank's primary Federal regulator is the FRB and
its state regulator is the California State Department of
Banking. As a non-bank subsidiary of the Company, Service
Corporation is regulated by the FRB. Both of these regulatory
agencies conduct periodic examinations of the Company and/or its
subsidiaries to ascertain their compliance with regulations.
The FRB may take action against bank holding companies and banks
should they fail to maintain adequate capital. This action has
usually taken the form of restrictions on the payment of
dividends to shareholders, requirements to obtain more capital
from investors, and restrictions on operations. The Company has
received no indication that either banking agency is in any way
contemplating any such action with respect to the Company or the
Bank and Management expects no such action.
Refund Anticipation Loan and Transfer Program
The impact of the RAL program on the Company's activities and
results of operations during 1995 and the first quarter of 1996
is discussed in various parts of this analysis.
First, the Company's interest and fee income totals are greater
than would otherwise be the case, especially in the first
quarters of each year, but also to a limited extent in the
second. Operating expenses and loan losses proved to be greater
than expected in the first three quarters of 1995 because of IRS
procedural changes. In prior years, before the Company advanced
funds the IRS provided confirmation that the taxpayer
identification was valid, that there were no liens by the IRS
against the refund, and that the refund would be sent to the
Company instead of the taxpayer. This confirmation was
discontinued for the 1995 tax season. The IRS also placed a
moratorium on payment of that portion of refunds which was
related to the Earned Income Credit ("EIC"). Many of the
taxpayers filing electronically are low income families who do so
to receive the EIC. Without confirmation, and with significant
uncertainty regarding whether the IRS would reimburse the Company
for loans related to EIC, the Company restricted loans only to
those taxpayers who met certain credit standards, and restricted
the amount that it would lend only to the non-EIC related portion
of any refund claim. These changes increased the amount of
delinquencies and resulting charge-offs, and as a result required
a shift in emphasis during the remainder of the 1995 tax season
from making loans to simply acting as a transfer agent for the
refund. Rather than extend funds to the taxpayer and wait for
repayment by the IRS, the Company remitted the payment to the
taxpayer only after receipt from the IRS. Taxpayers still
received the funds sooner than would have been the case had they
waited for a check. These same restrictions were followed for
the 1996 program.
Although the Company has reduced its credit risk, the fees
received while acting as a transfer agent are less than the fees
received for the loans. During the first quarter of 1996, the
company made 51,000 RAL loans for a total of $54.4 million, as
compared to 75,600 loans for $75.5 million in the first quarter
of 1995. Gross income for RAL activity, which includes fees for
making the loans and also for acting as transfer agent, was $3.8
million in the first quarter of 1996 and $4.8 million in the same
period of 1995. RAL charge-offs were $4 million in 1995.
The Company began collection efforts in 1995 to recover as large
a portion of the charge-off amount as could be done cost
effectively. Customers were contacted and repayment agreements
arranged with them. Agreements were also arranged with the other
financial institutions that have similar programs to give
priority to the repayment of past loans. RAL recoveries in the
first quarter of 1996 were $1.2 million. This amount was
credited to the allowance for loan losses. The Company provided
$1.9 million for possible loan losses in the first quarter.
Since all loans outstanding at March 31, 1996 were made in the
first quarter, the Company could only estimate how many might be
delinquent for other than normal processing delay, and there were
no charge-offs. Despite some uncertainty as to whether all of
the changes to the program instituted by the Company would
prevent the large charge-offs experienced in 1995, the Company's
change in emphasis from lending to acting as transfer agent and
the lack of midstream changes to the program by the Internal
Revenue Service, leads Management to conclude that the allowance
is adequate to cover anticipated losses.
Footnotes to Management Discussion and Analysis:
[1] The Company primarily uses two published sources of information
to obtain performance ratios of its peers. The FDIC Quarterly
Banking Profile, Fourth Quarter, 1995, published by the FDIC
Division of Research and Statistics, 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. To obtain information more specific to California, the
Company uses The Western Bank Monitor, published by Montgomery
Securities. This publication provides performance statistics for
_leading independent banks_ in 13 Western states, and further
distinguishes a Southern California subset within which the
Company is included. Both of these publications are based on
year-to-date information provided by banks each quarter. It takes
about 2-3 months to process the information, so the published
data is always one quarter behind the Company's information. For
this quarter, the peer information is for the fourth quarter of
1995. All peer information in this discussion and analysis is
reported in or has been derived from information reported in one
of these two publications.
[2] As required by applicable regulations, tax-exempt non-security
obligations of municipal governments are reported as part of the
loan portfolio. These totaled approximately $7.4 million as of
March 31, 1996. The average yields presented in Table 3 give
effect to the tax-exempt status of the interest received on these
obligations by the use of a taxable equivalent yield assuming a
combined Federal and State tax rate of approximately 41% (while
not tax exempt for the State of California, the State taxes paid
on this Federal-exempt income is deductible for Federal tax
purposes). If their tax-exempt status were not taken into
account, interest earned on loans for the first quarter of 1996
would be $15.4 million and the average yield would be 10.93%.
There would also be corresponding reductions for the other
quarters shown in the Table 3. The computation of the taxable
equivalent yield is explained in the section below titled
"Investment Securities and Related Interest Income."
[3] Reported in Western Bank Monitor, Fourth Quarter, 1995.
PART II
OTHER INFORMATION
Item 1.Legal Proceedings
Not applicable.
Item 2.Changes in Securities
Not applicable.
Item 3.Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Company's annual meeting of shareholders was held on
April 23, 1996. Proxies were solicited by the Company's
management pursuant to Regulation 14 under the
Securities Exchange Act of 1934.
(b) There was no solicitation in opposition to Management's
nominees for directorships as listed in the proxy
statement, and all of such nominees were elected
pursuant to the vote of shareholders. The directors
were elected to one year terms and there are no other
directors whose terms of office as a director continued
after the shareholders' meeting. The votes tabulated
were:
Broker
For Against Abstain Non-votes
Donald M. Anderson 5,704,583 67,572 -- 3,196,701
Frank H. Barranco 5,700,678 71,477 -- 3,196,701
Edward E. Birch 5,705,211 66,944 -- 3,196,701
Richard M. Davis 5,701,841 70,314 -- 3,196,701
Anthony Guntermann 5,700,326 71,829 -- 3,196,701
Dale Hanst 5,705,257 66,898 -- 3,196,701
Harry B. Powell 5,704,179 67,976 -- 3,196,701
David W. Spainhour 5,705,257 66,898 -- 3,196,701
William S. Thomas, Jr. 5,704,027 68,128 -- 3,196,701
(c) Arthur Andersen LLP
was selected as the
Company's independent
public accountant
for 1996. 4,659,093 255,084 183,737 3,203,589
(d) A proposal to approve
the Company's 1996
Directors' Stock
Option Plan was
approved. 4,673,094 438,553 166,568 3,203,589
(e) A proposal to increase
the number of shares
allocated to the
Amended and Restated
Restricted Stock Option
Plan was approved 5,675,495 29,420 67,243 3,196,701
Item 5.Other Information:
Not applicable.
Item 6.Exhibits and Reports on Form 8-K
(a) Exhibit Index:
Sequential
Exhibit Number Item Description Page Number
11 Computation of Per 36
Share Earnings
27 Financial Data Schedule 38
(b) On February 7, 1996, a Current Report on Form 8-K
was filed reporting that the registrant had effected a
3-for-2 stock split by amendment to its Articles of
Incorporation. The stock split was effective for
shareholders of record as of January 24, 1996.
<TABLE>
EXHIBIT 11
SANTA BARBARA BANCORP & SUBSIDIARIES
COMPUTATION OF PER SHARE EARNINGS
<CAPTION>
For the Three-Month Periods Ended March 31,
1996 1995
Primary Fully Diluted Primary Fully Diluted
<S> <C> <C> <C> <C>
Weighted Average
Shares Outstanding 7,652,798 7,652,798 7,690,581 7,690,581
Weighted Average
Options Outstanding 696,376 696,376 678,314 678,314
Anti-dilution adjustment (1) (23,846) 0 (32,987) (32,987)
Adjusted Options Outstanding 672,530 696,376 645,327 645,327
Equivalent Buyback Shares (2) (392,350) (398,178) (456,800) (456,818)
Total Equivalent Shares 280,180 298,198 188,528 188,509
Adjustment for Non-
Qualified Tax Benefit (3) (114,874) (122,261) (77,297) (77,289)
Weighted Average Equivalent
Shares Outstanding 165,306 175,937 111,231 111,220
Weighted Average
Shares for Computation 7,818,104 7,828,735 7,801,812 7,801,801
Fair Market Value (4) $ 25.80 $ 23.87 $ 17.01 $ 17.01
Net Income $3,876,057 $3,876,057 $2,976,476 $2,976,476
Per Share Earnings $ 0.51 $ 0.51 $ 0.39 $ 0.39
<FN>
(1) Options with exercise prices above fair market value are excluded
because of their anti-dilutive effect.
(2) The number of shares that could be purchased at fair market value from
the proceeds if the adjusted options outstanding were to be exercised.
(3) The Company receives a tax benefit when non-qualified options are
exercised. The benefit is equal to the product obtained by muliplying its tax
rate by the difference between the market value of the options at the time of
exercise and the exercise price. The benefit is assumed to be available for
purchase of additional outstanding shares.
(4) Fair market value for the computation is defined as the average market
price during the period for primary dilution, and the greater of that average
or the end-of-period market price for full dilution.
</FN>
</TABLE>
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:
SANTA BARBARA BANCORP
DATE: May 14, 1996
David W. Spainhour
President
Chief Executive Officer
DDATE: May 14, 1996
Donald Lafler
Senior Vice President
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> MAR-31-1996
<CASH> 49,825
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 65,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 125,000
<INVESTMENTS-CARRYING> 283,368
<INVESTMENTS-MARKET> 0
<LOANS> 556,473
<ALLOWANCE> 15,223
<TOTAL-ASSETS> 1,191,339
<DEPOSITS> 1,027,241
<SHORT-TERM> 53,229
<LIABILITIES-OTHER> 994
<LONG-TERM> 0
<COMMON> 5,092
0
0
<OTHER-SE> 97,240
<TOTAL-LIABILITIES-AND-EQUITY> 1,191,339
<INTEREST-LOAN> 15,537
<INTEREST-INVEST> 5,634
<INTEREST-OTHER> 2,820
<INTEREST-TOTAL> 23,991
<INTEREST-DEPOSIT> 8,348
<INTEREST-EXPENSE> 9,064
<INTEREST-INCOME-NET> 14,927
<LOAN-LOSSES> 3,215
<SECURITIES-GAINS> (512)
<EXPENSE-OTHER> 11,335
<INCOME-PRETAX> 5,439
<INCOME-PRE-EXTRAORDINARY> 5,439
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,876
<EPS-PRIMARY> 0.51
<EPS-DILUTED> 0.51
<YIELD-ACTUAL> 5.20
<LOANS-NON> 10,507
<LOANS-PAST> 186
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 11,009
<ALLOWANCE-OPEN> 12,349
<CHARGE-OFFS> 1,568
<RECOVERIES> 1,227
<ALLOWANCE-CLOSE> 15,223
<ALLOWANCE-DOMESTIC> 15,223
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
