<PAGE>
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: June 30, 1996 Commission File No.: 0-11113
------------- -------
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from ---------- to ----------
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 July 26, 1996 there were 7,643,877 shares of the issuer's
common stock outstanding.
Page One of thirty-eight
<PAGE>
PART 1
FINANCIAL INFORMATION
<TABLE>
<CAPTION>
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)
(dollars in thousands except per share amount)
June 30, December 31,
1996 1995
------------- ------------
<S> <C> <C>
Assets:
Cash and due from banks......................... $ 59,014 $ 74,746
Federal funds sold.............................. 15,000 65,000
------------- ------------
Cash and cash equivalents................... 74,014 139,746
------------- ------------
Securities (Note 4):
Held-to-maturity.............................. 291,961 231,730
Available-for-sale............................ 152,608 125,835
Bankers' acceptances............................ 29,531 139,294
Loans, net of allowance of $15,541 at
June 30, 1996 and $12,349 at
December 31, 1995 (Note 5).................... 565,694 546,452
Premises and equipment, net (Note 6)............ 7,511 8,149
Accrued interest receivable..................... 9,431 7,981
Other assets (Note 7)........................... 12,699 13,174
------------- ------------
Total assets............................. $ 1,143,449 $ 1,212,361
============= ============
Liabilities:
Deposits:
Demand deposits............................... $ 151,076 $ 158,122
NOW deposit accounts.......................... 144,864 148,027
Money Market deposit accounts................. 373,288 427,198
Savings deposits.............................. 90,106 94,124
Time deposits of $100,000 or more............. 85,911 76,438
Other time deposits........................... 155,998 150,111
------------- ------------
Total deposits.............................. 1,001,243 1,054,020
Securities sold under agreements
to repurchase and Federal funds purchased..... 32,382 51,316
Other borrowed funds............................ 1,000 1,210
Accrued interest payable and other liabilities.. 4,483 4,818
------------- ------------
Total liabilities........................... 1,039,108 1,111,364
------------- ------------
Shareholders' equity
Common stock (no par value; $.67 per share
stated value; 20,000 authorized;
7,656 outstanding at June 30, 1996
and 7,679 at December 31, 1995)............... 5,104 5,119
Surplus......................................... 37,858 39,191
Unrealized loss on securities available for sale (607) (179)
Retained earnings............................... 61,986 56,866
------------- ------------
Total shareholders' equity.................. 104,341 100,997
------------- ------------
Total liabilities and shareholders' equity....... $ 1,143,449 $ 1,212,361
============= ============
<FN>
See accompanying notes to consolidated condensed financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Statements of Income (Unaudited)
(dollars in thousands except per share amounts)
For the For the
Six-Month Periods Three-Month Periods
Ended June 30, Ended June 30,
------------------ ------------------
1996 1995 1996 1995
-------- -------- -------- -------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans ........$ 28,736 $ 27,453 $ 13,201 $ 12,430
Interest on securities ............ 12,315 11,427 6,680 5,616
Interest on Federal funds sold .... 1,835 912 740 577
Interest on bankers' acceptances .. 2,468 1,488 743 668
-------- -------- -------- ---------
Total interest income .......... 45,354 41,280 21,364 19,291
-------- -------- -------- ---------
Interest expense:
Interest on deposits:
NOW accounts ................... 733 726 372 360
Money Market accounts .......... 8,245 7,821 3,955 3,945
Savings deposits ............... 1,069 1,239 530 597
Time deposits of $100,000
or more....................... 1,811 1,327 940 721
Other time deposits ............ 4,593 3,953 2,307 2,081
Interest on securities sold
under agreements to repurchase
and Federal funds purchased ..... 1,164 570 459 368
Interest on other borrowed funds .. 23 48 11 29
-------- -------- -------- ---------
Total interest expense ......... 17,638 15,684 8,574 8,101
-------- -------- -------- ---------
Net interest income ................ 27,716 25,596 12,790 11,190
Provision for loan losses .......... 4,264 4,964 1,049 1,301
-------- -------- -------- ---------
Net interest income after
provision for loan losses ........ 23,452 20,632 11,741 9,889
-------- -------- -------- ---------
Other income:
Service charges on deposits ....... 2,251 2,116 1,133 1,072
Trust fees ........................ 4,246 3,355 2,022 1,590
Other service charges,
commissions and fees, net ........ 3,470 3,610 1,340 1,143
Net loss on securities
transactions .................... (656) (22) (143) (22)
Other income ...................... 222 191 121 113
-------- -------- -------- ---------
Total other income ............. 9,533 9,250 4,473 3,896
-------- -------- -------- ---------
Other expense:
Salaries and benefits ............. 12,621 11,622 6,352 5,437
Net occupancy expense ............. 2,256 2,015 1,124 1,003
Equipment expense ................. 1,286 1,285 636 640
Net loss (gain) from operating
other real estate ................ 91 (16) (17) 2
Other expense ..................... 6,094 7,808 2,922 3,611
-------- -------- -------- ---------
Total other expense ............ 22,348 22,714 11,017 10,693
-------- -------- -------- ---------
Income before income taxes ......... 10,637 7,168 5,197 3,092
Applicable income taxes ............ 2,992 1,899 1,428 799
-------- -------- -------- ---------
NET INCOME ...........$ 7,645 $ 5,269 $ 3,769 $ 2,293
======== ======== ======== =========
Earnings per share (Note 2).........$ 1.00 $ 0.69 $ 0.49 $ 0.30
<FN>
See accompanying notes to consolidated condensed financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(dollars in thousands)
For the Six Months
Ended June 30,
1996 1995
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net Income ...........................................$ 7,645 $ 5,269
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation and amortization ...................... 1,002 882
Provision for loan losses .......................... 4,264 4,964
Benefit for deferred income taxes .................. (1,367) (302)
Net amortization of investment securities
discounts and premiums ............................ (79) 259
Net change in deferred loan origination and
extension fees and costs .......................... 250 53
Decrease (increase) in accrued interest receivable . (1,450) 170
Increase (decrease) in accrued interest payable .... (116) 228
Decrease (increase) in income receivable ........... 454 (1,431)
Decrease in income taxes payable ................... (1,515) (17)
Decrease in prepaid expenses ....................... 93 449
Increase (decrease) in accrued expenses ............ 63 (1,609)
Net loss (gain) on sale of OREO .................... 18 (41)
Net loss on securities transactions ................ 655 22
Other operating activities ......................... 2,243 714
--------- ---------
Net cash provided by operating activities ......... 12,160 9,610
--------- ---------
Cashflows from investing activities:
Proceeds from call or maturity of securities:
Available-for-sale ................................ 45,185 20,766
Held-to-maturity .................................. 11,276 5,117
Purchase of securities:
Available-for-sale ................................ (175,266) --
Held-to-maturity .................................. (69,575) --
Proceeds from sale of securities:
Available-for-sale ................................ 101,270 --
Proceeds from maturity of bankers' acceptances ..... 211,933 79,380
Purchase of bankers' acceptances ................... (103,270) (29,090)
Net increase in loans made to customers ............ (25,179) (45,437)
Disposition of property from defaulted loans ....... 1,557 198
Purchase or investment in premises and equipment ... (372) (1,384)
--------- ---------
Net cash provided by (used in) investing activities (2,441) 29,550
--------- ---------
Cash flows from financing activities:
Net decrease in deposits ........................... (52,777) (26,340)
Net increase (decrease) in borrowings with
maturities of 90 days or less ..................... (18,934) 23,752
Proceeds from issuance of common stock ............. 468 117
Payments to retire common stock .................... (1,936) (787)
Dividends paid ..................................... (2,272) (2,050)
--------- ---------
Net cash used in financing activities ............. (75,451) (5,308)
--------- ---------
Net decrease in cash and cash equivalents ............ (65,732) 33,852
Cash and cash equivalents at beginning of period ..... 139,746 84,630
--------- ---------
Cash and cash equivalents at end of period ...........$ 74,014 $ 118,482
========= =========
<FN>
Supplemental disclosure: Cash paid during the three months ended:
Interest ...........................................$ 17,522 $ 15,456
Income taxes .......................................$ 5,050 $ 3,110
See accompanying notes to consolidated condensed financial statements
</FN>
</TABLE>
<PAGE>
Santa Barbara Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 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
intercompany 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 six- and three-month periods ended June 30, 1996 and 1995,
the weighted average shares outstanding were as follows:
Six-Month Periods Three-Month Periods
Ended June 30, Ended June 30,
------------------------ ----------------------
1996 1995 1996 1995
---------- ----------- ---------- --------
Weighted average
shares outstanding 7,645,278 7,689,485 7,637,758 7,688,401
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 six months ended June 30, 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 ("SFAS 115"), 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 $195,000 at June 30, 1996 and
$315,000 at December 31, 1995, is the reason that the separate component of
capital does not equal the net unrealized losses related to the securities
classified as "available-for-sale" times the combined Federal and state tax rate
of approximately 41%.
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.
Book and market values of securities are as follows:
<TABLE>
<CAPTION>
Gross Estimated
(in thousands) Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------------------------------------------
<S> <C> <C> <C> <C>
June 30, 1996:
Held-to-maturity:
U.S. Treasury obligations .......$150,675 $ 108 $ (1,645) $149,138
U.S. agency obligations ......... 57,062 538 (760) 56,840
State and municipal securities .. 84,224 12,263 (32) 96,455
-------- -------- -------- --------
Total held-to-maturity ....... 291,961 12,909 (2,437) 302,433
-------- -------- -------- --------
Available-for-sale:
U.S. Treasury obligations ....... 123,104 153 (466) 122,791
U.S. agency obligations ......... -- -- -- --
Collateralized
mortgage obligations ......... 29,718 6 (395) 29,329
Equity Securities ............... 488 -- -- 488
-------- -------- -------- --------
Total available-for-sale ..... 153,310 159 (861) 152,608
-------- -------- -------- --------
Total Securities ..........$445,271 $ 13,068 $ (3,298) $455,041
======== ======== ======== ========
December 31, 1995:
Held-to-maturity:
U.S. Treasury obligations .......$ 97,528 $ 775 $ -- $ 98,303
U.S. agency obligations ......... 51,826 983 (143) 52,666
State and municipal securities .. 82,376 15,913 -- 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 -- 25,063
Equity Securities ............... 488 -- -- 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 one-time 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, consistent with their classification under the provisions of SFAS 115,
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
--------------------------------
<S> <C> <C> <C>
June 30, 1996:
Amortized cost:
In one year or less .............. $ 55,003 $ 35,074 $ 90,077
After one year through five years 195,375 117,748 313,123
After five years through ten years 15,152 -- 15,152
After ten years .................. 26,430 -- 26,430
Equity Securities ................ -- 488 488
-------- -------- --------
$291,960 $153,310 $445,270
======== ======== ========
Estimated market value:
In one year or less .............. $ 55,519 $ 35,063 $ 90,582
After one year through five years 199,331 117,057 316,388
After five years through ten years 19,016 -- 19,016
After ten years .................. 28,567 -- 28,567
Equity Securities ................ -- 488 488
-------- -------- --------
$302,433 $152,608 $455,041
======== ======== ========
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 -- 21,823
After ten years .................. 25,933 -- 25,933
Equity Securities ................ -- 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 -- 27,978
After ten years .................. 29,955 -- 29,955
Equity Securities ................ -- 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. Depending on the contractual terms of the security, the Company may
receive a call or prepayment penalty.
5. Loans
The balances in the various loan categories are as follows:
<TABLE>
<CAPTION>
(in thousands) June 30, 1996 December 31, 1995
------------- ------------------
<S> <C> <C>
Real estate:
Residential ................ $149,261 $142,143
Non-residential ............ 183,186 179,272
Construction ............... 21,727 20,846
Commercial loans ............... 150,533 144,011
Home equity loans .............. 31,839 34,597
Consumer loans ................. 35,427 28,494
Municipal tax-exempt obligations 7,309 7,573
Other loans .................... 1,953 1,865
-------- --------
Total loans ................ $581,235 $558,801
======== ========
</TABLE>
The loan balances at June 30, 1996 and December 31, 1995, are net of
approximately $2,389,000 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 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 not covered by
the statements 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) the loan's observable market
price if it is of a kind for which there is a secondary market; or (3) a
valuation of the underlying collateral. A valuation allowance is that 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 balance information about the impaired loans and the
allowance related to them ($ in thousands) as of June 30, 1996 and December 31,
1995:
June 30, 1996 December 31, 1995
------------- -----------------
Loans identified as impaired $9,384 $13,295
Impaired loans for which a valuation
allowance has been determined 5,133 13,295
Impaired loans for which no valuation
allowance was determined necessary 4,251 --
Amount of valuation allowance 2,113 4,766
The average amounts of the recorded investment in impaired loans for the three
month periods ended June 30, 1996 and 1995 were approximately $9.9 million and
$25.0 million, respectively. Approximately $10.2 million and $25.0 million in
interest was collected from impaired loans in the three and six-month periods
ended June 30, 1996 and recognized as interest income. The corresponding amounts
for the same periods of 1995 were $233,000 and $733,000, respectively.
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 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 of $2.1 million is included with the
general allowance for loan losses of $13.4 million to total the $15.5 million
reported on the balance sheet for June 30, 1996 which these notes accompany and
in the statement of changes in the allowance account for the first half of 1996
shown below. The amounts related to tax refund anticiption loan and to all other
loans are shown separately.
<TABLE>
Allowance for Loan Losses
(in thousands)
<S> <C>
Balance, December 31, 1995 ..................... $ 12,349
Provision for tax refund anticipation loans .... 1,100
Tax refund loan losses charged against allowance (1,080)
Tax refund loan recoveries added to allowance .. 1,296
Provision for other loan losses ................ 3,164
Other loan losses charged against allowance .... (1,995)
Other loan recoveries added to allowance ....... 707
--------
Balance, June 30, 1996 ......................... $ 15,541
========
</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
$509 and $466 for the three-month periods ended June 30, 1996 and 1995,
respectively, and $1,002 and $883 for the six-month periods ended June 30, 1996
and 1995, respectively. The table below shows the balances by major category of
fixed assets:
<TABLE>
<CAPTION>
(in thousands) June 30, 1996 December 31, 1995
------------------------- -----------------------------
Accumulated Net Book Accumulated Net Book
Cost Depreciation Value Cost Depreciation Value
------------------------ -----------------------------
<S> <C> <C> <C> <C> <C> <C>
Land and buildings $ 5,614 $ 3,043 $2,571 $ 5,607 $ 2,967 $2,640
Leasehold improvements 6,396 4,293 2,103 6,427 3,996 2,431
Furniture and equipment 13,204 10,367 2,837 12,843 9,765 3,078
------- ------- ------- ------- ------- -------
Total $25,214 $17,703 $7,511 $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 June 30, 1996 and December 31, 1995, the Company had $1,422,000
and $1,785,000 respectively, in property from defaulted loans. Property from
defaulted loans is carried at the lower of the outstanding balance of the
related loan at the time of foreclosure or the estimate of the market value of
the assets less disposal costs.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Company posted its highest earnings for a second quarter for the quarter
closing June 30, 1996. Earnings were $3.8 million, up 64 percent over the $2.3
million reported for the comparable period in 1995. Per share earnings for the
second quarter of 1996 were $0.49 compared to $0.30 earned in the second quarter
of 1995. Second quarter 1996 earnings exceeded by $600,000 the earnings for the
second quarter of 1994, previously the best second quarter on record.
Year-to-date earnings for the Company were also higher in the first half of 1996
compared any prior six-month period, increasing 45% from $5.3 million for the
first six months of 1995 to $7.6 million for the first six months of 1996.
Earnings benefited during the second quarter from a combination of favorable
factors, including a 14% increase in net interest income and fees compared to
the prior year, while the increase in non-interest operating expense was held to
3%. Additionally, while fewer customers were served in the Refund Anticipation
Loan and Transfer ("RAL") Program than in 1995, it has proved more profitable.
More restrictive credit criteria permitted a smaller provision for RAL loan
losses than was necessary last year.
The increase in earnings was achieved despite $143,000 in losses taken on the
sale of securities. The securities were sold so that the proceeds could be
reinvested at higher interest rates. The sale of depreciated securities and the
subsequent repurchasing of other securities at higher market rates allows the
Company to earn more interest income in future quarters.
Several key strategic initiatives undertaken during 1995 also contributed to the
Company's strong performance in the second quarter. First, the Company expanded
into adjacent Ventura County last year with the opening of three offices in the
first and second quarters. Deposits in these offices have increased by $46.8
million since June 30, 1995 and loan production has been strong. Second, the
Trust & Investment Services Division reported trust fee income of $2.0 million
during the quarter, up $432,000 over the second 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. Third, the Company has continued to focus on lending and credit
adminstration. Loans have increased 8% in the last year, while non-current loans
have decreased by over $4 million or 28% in the same period.
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
were critically important for the long-term viability and profitability of the
Company, and will permit the Company's planned expansion into new market areas.
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 & 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" 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.
A graphic representation of average total assets and deposits since the fourth
quarter of 1993 is shown here.
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. The increase in
average total assets from the fourth quarter of 1995 to the first quarter of
1996 was larger than occurred from the fourth quarter of 1993 to the first
quarter of 1994 and from the fourth quarter of 1994 to the first quarter of
1995. This was due to a larger than usual increases in deposits Federal funds
purchased occurring late in the fourth quarter of 1995. These increases are
explained below in "Deposits" and "Other Borrowings," respectively. Continued
consolidation in the financial services industry and the three Ventura County
offices opened in 1995 have contributed to the longer trend growth in deposits
and therefore assets.
Earning assets consist of the various assets on which the Company earns interest
income. The Company was earning interest on 94.83% of its assets during the
second quarter of 1996. This compares with an average of 80.72% 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. This, together with the aggressive disposal of real estate obtained
as the result of foreclosure avoids tying up funds that could be earning
interest. Lastly, the Company has developed systems for clearing checks faster
than those used by most banks of comparable size. This permits it to put the
cash to use more quickly. At the Company's current size, these steps have
resulted in about $167.8 million more assets earning interest during the first
half 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 average earning assets.
This ratio is useful in allowing the Company to monitor the spread between
interest income and interest expense from month to month and year to year
irrespective of the growth of the Company's assets. If the Company is able to
maintain the 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 moved higher and then flattened during the first
half of 1995, 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,
but then moved higher throughout the remainder of 1996's first half.
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, because
most fixed-rate interest-bearing liabilities have a shorter maturity than
fixed-rate interest-earning assets, 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. 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 liabilities. 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 rectify
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. As of June
30, 1996, the gap for this first period is a negative 9.32%, within the target
range. At the end of the first fourth quarter of 1996, the gap was a negative
7.09% of assets. The change from last quarter is due to the reinvestment of
proceeds from maturing securities and bankers' acceptances. Last quarter, the
securities were included among assets repricing within three months. This
quarter, the new securities are included in subsequent periods.
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 amount of transaction deposits that the Company at present
assumes are most likely to be repriced between six and twelve months. This large
negative gap for the third period causes the cumulative gap of a negative 21.73%
for the first three periods to be outside the Company's target range of plus or
minus 15%. 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 certain 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.
<PAGE>
<TABLE>
<CAPTION>
Table 1--INTEREST RATE SENSITIVITY
After three After six After one Non-interest
As of June 30, 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......................... $ 318,296 $ 86,859 $ 41,025 $ 72,930 $53,735 $ 8,390 $ 581,235
Cash and due from banks....... -- -- -- -- -- 59,014 59,014
Federal Funds................. 15,000 -- -- -- -- -- 15,000
Securities:
Held-to-maturity............ 12,510 8,979 33,514 195,375 41,583 -- 291,961
Available-for-sale.......... 5,006 10,047 20,010 117,057 -- 488 152,608
Bankers' acceptances.......... 10,953 18,578 -- -- -- -- 29,531
Other assets.................. -- -- -- -- -- 14,100 14,100
---------------------------------------------------------- ------------
Total assets 361,765 124,463 94,549 385,362 95,318 81,992 1,143,449
---------------------------------------------------------- ------------
Liabilities and
shareholders' equity:
Borrowed funds:
Repurchase agreements and
Federal funds purchased.. 32,382 -- -- -- -- -- 32,382
Other borrowings............ 1,000 -- -- -- -- -- 1,000
Interest-bearing deposits:
Savings and interest-bearing
transaction accounts...... 357,822 -- 250,357 -- -- -- 608,179
Time deposits............... 77,098 54,560 56,067 53,954 309 -- 241,988
Demand deposits............... -- -- -- -- -- 151,076 151,076
Other liabilities............. -- -- -- -- -- 4,483 4,483
Shareholders' equity.......... -- -- -- -- -- 104,341 104,341
---------------------------------------------------------- ===========
Total liabilities and
shareholders' equity........ 468,302 54,560 306,424 53,954 309 259,900 $1,143,449
---------------------------------------------------------- ===========
Interest rate-
sensitivity gap............. $(106,537)$ 69,903 $(211,875)$ 331,408 $95,009 $ (177,908) $
==========================================================
Gap as a percentage of
total assets................ (9.32%) 6.11% (18.53%) 28.98% 8.31% (15.56%)
Cumulative interest
rate-sensitivity gap........ $(106,537)$(36,634)$(248,509)$ 82,899 $177,908 $
Cumulative gap as a
percentage of total assets.. (9.32%) (3.20%) (21.73%) 7.25% 15.56%
<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>
<PAGE>
Gap reports can show mismatches in the maturities and repricing opportunities of
assets and liabilities, but have limited usefulness in measuring or managing
market risk and basis risk. The Company uses interest rate modeling to measure
these risks. This modeling involves applying hypothetical changes in interest
rates to determine their impact on net interest income and 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 financial
liabilities. These interest rate scenarios include both sudden and gradual
interest rate changes, and changes in both directions. The results of this
modeling show that the Company's net interest income is more at risk from an
increase in rates than a decrease. As a result, the Company is reviewing various
actions to reduce the amount of net interest income at risk from an increase in
rates.
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
by over $1 billion from 1989 to the end of 1995. During this time the Company
has increased its market share from 14.1% in 1989 to 30.6% in 1995. The
increases have come by maintaining competitive deposit rates, introducing new
deposit products, and 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 six quarters (dollars
in millions). As shown both in the chart and in Table 2, average deposits for
the second quarter of 1996 have increased $115.6 million or 12.8% from average
deposits a year ago. Average deposits for the three Ventura region offices
tripled and accounted for 43% of the total growth in average deposits. Because
they now have a 2% market share, it is expected that the offices of the Ventura
region will generate relatively higher deposit growth than the Santa Barbara
offices since the latter have already captured over 30% of their market.
<TABLE>
<CAPTION>
Table 2--AVERAGE DEPOSITS AND RATES
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
========= ======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
1996: 1st Quarter 2nd Quarter
------------ -----------
<S> <C> <C> <C> <C>
NOW/MMDA............. $ 555.8 3.35%$ 540.2 3.20%
Savings.............. 94.0 2.37 92.9 2.40
Time deposits 100+... 65.8 5.32 71.2 5.31
Other time deposits.. 163.2 5.67 166.3 5.58
--------- --------
Total interest
-bearing deposits. 878.8 3.82% 870.6 3.74%
Non-interest-bearing. 154.4 150.8
========= ========
Total deposits..... $ 1,033.2 $1,021.4
========= ========
</TABLE>
The average rates that are paid on deposits generally trail behind money market
rates because financial institutions do not try to change deposit rates with
each small increase or decrease in short-term rates. This trailing
characteristic is stronger with time deposits 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.
This lag effect explains the contrast between the relatively stable rates paid
on the NOW/MMDA and savings accounts during 1995 and the increase in the rates
shown for time deposit accounts. The rates paid on the time accounts primarily
reflect increases in market rates that occurred in 1994.
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. During
the second half of 1995, the Company experienced a significant growth in one
particular type of interest-bearing transaction account, the "Personal Money
Master Account." The rate paid on this account was attractive relative to time
deposits which do not have the liquidity afforded by that account. However, as
market rates for mid-term funds (funds with two and three year maturities)
started to increase in 1996, the rates on shorter-term money did not increase.
The Company elected not to match each rise in market rates with increases in the
rate paid on Money Master accounts, but did increase the rates offered on time
deposits. This caused some migration of funds to certificates of deposit,
accounting for the decrease in the NOW/MMDA category from first quarter to
second quarter and in the increase in time deposits.
The average balances for non-interest bearing demand deposits during the first
quarters of 1995 and 1996 are impacted by outstanding checks from the RAL
program. 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 the RAL program. There is relatively little
effect from these checks in other quarters.
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 two 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 through premium rates large
deposits that are not the result of stable customer relationships. If the
deposits are short-term and will be kept by the depositor with the Company only
while premium rates are paid, the Company must invest the funds in very
short-term assets. Since Federal funds sold earn less than 6% during almost all
of 1995 and 1996, the spread between the cost of these funds and the earnings on
their potential uses is very small. Second, a significant portion of the under
$100,000 time deposits are IRA accounts. 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 yields1 over the last seven quarters
(dollars in millions).
<TABLE>
<CAPTION>
Table 3--LOAN BALANCES AND YIELDS
EOP Average Interest Average
Quarter Ended Outstanding Outstanding and Fees Yield
- ------------------ --------- --------- ------- -----
<S> <C> <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
June 1996 581.2 568.4 13.3 9.18
</TABLE>
CHANGES IN LOAN BALANCES
The end-of-period loan balance as of June 30, 1996 has increased by $22.4
million compared to December 31, 1995, and by $40.2 million compared to June 30.
1995. Residential real estate loans increased $7 million, Commercial loans
increased $6.5 million and Consumer loans $7 million from December 31, 1995.
Most of the increase in residential real estate loans is in adjustable rate
mortgages ("ARMS") that have initial "teaser" rates. The yield will increase for
these loans as the teaser rates expire. 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 risk and liquidity.
The average balance and yield for the first quarters of 1996 and 1995 shows the
impact of the RAL loans that the Company makes. The RAL loans 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 and repaid during the first quarter of
the year. The impact of this program on the results of operations is summarized
in the section titled "Refund Anticipation Loan and Transfer Program" below.
Average yields for the first quarters of 1995 and 1996 without the effect of RAL
loans 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.
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) June 30, December 31,
1996 1995
------------ -----------
Standby letters of credit $ 8,939 $12,623
Loan commitments 56,851 46,996
Undisbursed loans 19,761 12,793
Unused consumer credit lines 51,253 53,759
Unused other credit lines 79,461 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
fully 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 second 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. Included in the table in boldface is comparable data2
regarding the Company's peers for the three earlier quarters.
Total non-performing assets have decreased by $3.7 million at June 30, 1996
compared to June 30, 1995. Although there was an increase in non-performing
assets in the first quarter of 1996, the level at June 30, 1996 indicates that
there has been a general stabilization in these asset levels since December 31,
1995, and non-current loans have declined as a percentage of total loans.
Beginning in 1995 the Company strengthened its 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 they 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 foruth quarter of 1995.
With the increase in allowance for loan losses from $11.1 million at June 30,
1995 to $15.5 million at June 30, 1996, the Company's coverage ratio is more
comparable to that of its peers.
<TABLE>
<CAPTION>
Table 4--ASSET QUALITY
June 30, March 31, December 31, June 30,
1996 1996 1995 1995
-------------- --------------- ------------------- -----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Company Company Company Company
Loans delinquent
90 days or more $ 1,401 $ 186 $ 395 $ 5,112
Non-accrual loans 8,827 10,507 8,972 9,146
-------- -------- -------- --------
Total non-current loans 10,228 10,693 9,367 14,258
Foreclosed real estate 1,422 1,816 1,785 1,113
-------- -------- -------- --------
Total non-performing assets $11,650 $12,509 $11,152 $15,371
======== ======== ======== ========
FDIC FDIC FDIC
Peer Peer Peer
Company Company Group Company Group Company Group
Coverage ratio of allowance
for loan losses to non-current
loans and leases 152% 142% 185% 132% 189% 0.78% 154%
Ratio of non-current loans
to total loans and leases 1.76% 1.92% 1.14% 1.68% 1.08% 2.64% 1.08%
Ratio of non-performing
assets to average total assets 0.99% 1.04% 0.88% 1.03% 0.82% 1.44% 0.88%
</TABLE>
The June 30, 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.
Table 5 classifies non-current loans and all potential problem loans other than
non-current loans by loan category for June 30, 1996 (amounts in thousands). As
of June 30, 1996 all RAL loans made in 1996 and still outstanding were charged
off.
Table 5--NON-CURRENT AND POTENTIAL PROBLEM LOANS
Potential Problem
Non-Current Loans Other Than
Loans Non-Current
Loans secured by real estate:
Construction and
land development $ -- $ --
Agricultural -- --
Home equity lines 242 99
1-4 family mortgage 1,757 2,902
Multi-family 369 697
Non-residential, non-farm 6,252 6,423
Commercial and industrial 1,457 1,165
Other consumer loans 151 87
---------- ---------
Total $ 10,228 $ 11,373
========== =========
The following table sets forth the allocation of the allowance for all potential
problem loans by classification as of June 30, 1996 (amounts in thousands).
Doubtful $2,477
Substandard $1,468
Special Mention --
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
Statement of Accounting Standards No. 115, Accounting for Certain Investments in
Debt and Equity Securities, ("SFAS 115") was adopted by the Company in 1994. It
requires 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
reported on the balance sheet at their amortized historical cost. That is, they
are reported 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 reported 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 are not purchased with intention of selling them later at a
gain, but 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.
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. Certain of 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 one-time 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 the fourth quarter of 1995, the Company's Investment Committee approved the
acquisition of up to $30 million of planned amortization class ("PAC")
securities with average lives of two to three years for the Discretionary
Portfolio. PAC's are particular classes of a 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
either 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. At the end of the second quarter of 1996,
the Company held $29.7 million of PAC's. The average outstanding balance during
the second quarter of 1996 was $24.7 million.
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. Each of the PAC's passed the tests at the time of purchase and, as of June
30, 1996, all passed the tests.
As a percentage of total assets, the balances in the Liquidity and Earnings
Portfolios are intended to remain relatively stable. The size of the
Discretionary Portfolio will vary based on loan demand and deposit growth. In
general, the Company uses available funds to purchase securities for the three
portfolios according to the following priorities. Taxable securities, usually
U.S. Treasury or agency, are purchased for the Liquidity or Earnings Portfolio
to maintain the desired size relative to total assets. To the extent tax-exempt
municipals that meet credit quality and yield standards are available, they 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. Treasury
or agency obligations would be purchased for the Discretionary 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 six
quarters. The yield on tax-exempt state and municipal securities has been
computed on a taxable equivalent basis. A 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>
<CAPTION>
Table 6--AVERAGE BALANCES OF SECURITIES AND INTEREST YIELD
1995: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury $236.7 5.60% $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 2nd Quarter
----------- ----------------
<S> <C> <C> <C> <C>
U.S. Treasury $194.6 5.56% $260.6 5.80%
U.S. agency 79.7 5.65 62.9 5.84
Collateralized
Mortgage
Obligations 13.2 5.47 24.7 6.03
Tax-Exempt 82.8 12.15 83.0 12.08
------ --------
Total $370.3 7.04% $431.2 7.03%
====== =======
</TABLE>
Interest rates 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 the securities from the Discretionary and
Liquidity Portfolios and reinvest at the new higher rates and at longer
maturities. The selection of securities for purchase was also done with the aim
of evening out the amount of proceeds that would be received from maturing
securities each quarter. Management believes that this more constant repricing
of the securities in the three portfolios will better protect the average
interest yields and more closely follow market rates. Implementation of this
reinvesmtent plan required realized net security losses of $512,000 for the
first 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.
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 lower
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 interest rates that has
occurred during 1996. At the end of the second quarter in 1996, the market value
of the U.S. Treasury and agency securities held-to-maturity is less than the
amortized cost or "book value" by $1,759,000. The market value of the municipal
securities (of which there were several purchases and calls) also decreased in
market value to 113% of book value at June 30, 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. Though they are not securities, the Company includes
Federal funds sold and bankers' acceptances in its liquidity planning as if they
were components of the Liquidity Portfolio discussed above in "Securities and
Related Interest Income".
Table 7 illustrates the average funds sold position of the Company and the
average yields over the last seven 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
June 1996 56.9 5.23
The average balance sold into the market was greater in the first and second
quarters of 1996 than the comparable quarters in 1995 primarily due to four
factors. First, the Company operated under stricter RAL guidelines in 1996 which
resulted in fewer loans and more refund transfers being made. This meant that
the Company did not need to reduce its Federal funds sold position to fund the
RAL loans. Second, until the interest rates for securities 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. Because of its desire to even out the maturities in its securities
portfolios, management 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 and Related Interest
Income." This selectivity left more of the proceeds to be held in Federal funds.
Third, 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 were
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
interest 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 seven 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
June 1996 55.0 5.43
With their relatively short maturities, bankers' acceptances are an effective
instrument for managing the timing of cash flows. In the first and second
quarters of 1996, the balances of bankers' acceptances were greater than in the
first and second quarters 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
generally shows little variation in total, all of the short-term items have been
combined for the following table. In the first quarter of 1996, the total was
larger than usual. Federal funds purchased averaged $32.1 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 seven 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
June 1996 40.8 4.64 3.5
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 seven 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
June 1996 2,022
Trust customers are charged for the preparation of the fiduciary tax returns.
The preparation generally occurs in the first quarter of the year. This accounts
for approximately $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. Variation is also
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 seven 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
June 1996 1,113 1,340 121
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 may only recognize them as
interest income over the term of the loan, rather than in the period in which
they are collected. If the loan is sold before maturity, any unamortized fees
are recognized as gains on sale rather than as interest income. In a declining
rate environment such as 1995, homeowners are more apt to refinance their homes.
They usually choose fixed rate loans to "lock-in" the lower rates. Because the
Company generally does not keep fixed-rate loans for its portfolio, such
refinancing results in the Company selling more of these loans into the
secondary market and thereby recognizing 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 seven
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
June 1996 4,973 1,379
There is usually some variation in staff expense from quarter to quarter.
Beginning in the first quarter of 1995, staff expense increased due to the three
initiatives undertaken in that quarter that are mentioned in the introduction to
this discussion. 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, staff expense will
usually increase in the first quarter of each year because all officers have
their annual salary review in the first quarter with merit increases effective
on March 1. In 1996, these averaged 3%. In additon, some temporary staff is
added in the first quarter for the RAL program.
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 forecasts during the second quarter of 1995 and near the
end of the year projected net income at amounts less than originally projected.
Therefore a portion of the amounts accrued were reversed in those second and
fourth quarters of 1995. 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 two quarters of 1996 reflect merit increases as discussed above and bonus
accrual estimates 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. The formula provides for 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 income before tax differs from
the forecast and to the extent that actual net charge-offs are substantially
different than the provision for loan loss, an adjustment to accrual will be
made. In the fourth quarter of 1994, and second and fourth quarters of 1995
accrual adjustments were made which reduced the profit sharing contribution for
those quarters.
Payroll taxes also 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. Therefore, the payroll taxes related to
bonuses are accrued in the first quarter. 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 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 seven 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 3,172
June 1996 1,124 636 2,922
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. Like occupancy expense,
this category has been impacted by the opening of the new offices as new
equipment and furniture had to be purchased.
Table 14 shows a detailed comparison for the major expense items in other
expense for the six- and three-month periods ended June 30 (amounts in
thousands).
<TABLE>
<CAPTION>
Table 14--OTHER EXPENSE
Six-Month Periods Three-Month Periods
Ended June 30, Ended June 30,
---------------- ------------------
1996 1995 1996 1995
-------- ------- ------- -------
<S> <C> <C> <C> <C>
FDIC and State assessments $ 38 $1,038 $ 19 $ 510
Professional services 388 385 247 200
RAL processing and incentive fees 368 100 176 (150)
Supplies and sundries 313 311 153 143
Postage and freight 323 365 144 145
Marketing 586 804 298 637
Bankcard processing 811 708 454 360
Credit bureau 153 493 41 50
Telephone and wire expense 384 479 175 170
Charities and contributions 166 216 83 74
Software expense 558 415 284 212
Operating losses (7) 219 (44) 18
Other 2,013 2,275 892 1,242
-------- ------- -------- -------
Total $6,094 $7,808 $2,922 $3,611
======== ======= ======== =======
</TABLE>
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 for
banks 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 proportionally. However, 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. At the end of 1995,
the FDIC announced that well-capitalized banks would be charged only the
statutory minimum, $500 per quarter for the first half of 1996. As a result,
pre-tax income for the first two quarters of 1996 benefited by approximately
$500,000 each compared to 1995 expense levels. This lower rate will also apply
to the second half of 1996.
Marketing expense for both the three- and six-month periods of 1996 are less
than for the comparable periods of 1995 because of the large expenditures
incurred to promote the opening of the Ventura region offices. 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 half of 1995 compared to
1996, 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 later in 1995 for an amount substantially less than the original
estimate.
RAL processing and incentive fees are paid to tax preparers and filers based on
the volume and collectibility of the loans made through them. In the second
quarter of 1995, when the Company found that collectibility of a large number of
the loans was uncertain, it reversed a portion of the accrual it had made in the
first quarter. With collectibility substantially higher in 1996, an additional
amount was accrued in the second quarter above what had been provided in the
first quarter.
The amounts in the final line of Table 14 comprise a wide variety of
miscellaneous expenses, none of which total more than 1% of revenues. The
difference in the amounts shown for the three-month periods ended June 30 is not
caused by large differences in any particular expense account, but by a large
number of small differences.
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 consolidated
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. 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.
Because gains on sales of OREO exceeded the costs in the second quarter of 1996,
net OREO expenses for the second quarter of 1996 were negative $17,000 as
compared to a balance of $2,000 in the same period in 1995.
As disclosed in Note 7 to the financial statements, the Company had $1,422,000
in OREO as of June 30, 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, and maintains credit lines with other financial
institutions upon which it may draw.
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 short-term liquid assets 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 include 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, and therefore might have inadequate liquidity should the
volatile liabilities be withdrawn.
<TABLE>
<CAPTION>
Table 15--LIQUIDITY COMPUTATION COMPONENTS
Net Loans and Long-term
Short-term, Liquid Assets Volatile, Large Liabilities Investments
- ---------------------------------- ------------------------------ ----------------------
<S> <C> <C> <C> <C> <C>
Fixed rate debt Time deposits 100+ $ 85,911 Net loans $565,694
with maturity Repurchase agreements Long-term
less than 1 year $ 90,066 and Federal funds securities 246,660
Treasury securities with purchased 32,382
1-2 year maturities 78,025 Other borrowed funds 1,000
Federal funds 15,000
Bankers' acceptances 29,531
--------- --------- ----------
Total $212,622 Total $119,293 Total $812,354
========= ========= ==========
</TABLE>
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 and Related Interest Income."
As of June 30, 1996, Company's short-term, liquid assets exceeded its volatile,
large liabilities, the "liquidity amount," by $93 million and the liquidity
ratio was 11.49%, using the balances (in thousands) in Table 15. At December 31,
1995 the ratio was 29.4%. During the first and second quarters of 1996, the
Company brought the ratio down through purchases of securities with maturities
ranging from three to five years. However, the current liquidity amount still
exceeds the range that the Company is trying to maintain--from positive $75
million to negative $25 million.
Further purchases of securities would lower the ratio to within the Company's
target range, but would increase the amount by which the Company is outside its
target range for the one year cumulative gap as discussed in "Interest Rate
Sensitivity." In other words, reducing the risk of too much liquidity would
result in pushing the repricing opportunities on some assets further out into
the future. This, however, would increase the mismatch risk from rising interest
rates. Therefore, in balancing off the potential adverse effects of these two
types of risks, Management has favored exceeding the liquidity target rather
than worsening the repricing mismatch of assets and liabilities in the first
year.
CAPITAL RESOURCES AND COMPANY STOCK
Table 16 presents a comparison of several important amounts and ratios for the
second quarters of 1996 and 1995 (dollars in thousands).
<TABLE>
<CAPTION>
Table 16--CAPITAL RATIOS
2nd Quarter 2nd Quarter
1996 1995 Change
----------- ----------- ----------
<S> <C> <C> <C>
Amounts:
Net Income $ 3,769 $ 2,293 $ 1,476
Average Total Assets 1,171,754 1,038,595 133,159
Average Equity 103,955 97,749 6,206
Ratios:
Equity Capital to
Total Assets (period end) 9.13% 9.14% (0.01%)
Annualized Return on Average Assets 1.29% 0.88% 0.41%
Annualized Return on Average Equity 14.50% 9.38% 5.12%
</TABLE>
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 variation quarter by quarter in operating earnings. Areas of uncertainty
include asset quality, loan demand, RAL operations.
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. RAL earnings, occurring almost entirely
in the first quarter, introduce significant seasonality.
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 June 30, 1996, the Company's risk-based capital ratio was
18.89%. The Company must also maintain shareholders' equity of at least 4% to 5%
of unadjusted total assets. As of June 30, 1996, shareholders' equity was 9.13%
of total assets.
The Company applied for listing on the Nasdaq Stock Market in April, 1996 and
began to be listed in the middle of May. The trading symbol is SABB.
The Board of Directors, while not establishing specific goals, has authorized
Management, with certain limits, to purchase shares of the Company's stock at
market. During the first half of 1996, the Company purchased approximately
78,000 shares. These purchases have reduced shareholders' equity by $1.9
million. Trading volume for June, the first full month of trading on Nasdaq, was
99,921 shares.
Aside from these purchases, no significant commitments or reductions of capital
are planned at this time. However, as the Company pursues its stated plans to
expand beyond its current market area, Management will consider opportunities to
form strategic partnerships with other financial institutions that have
compatible management philosophies and corporate cultures and that share the
Company's commitment to superior customer service and community support. Such
transactions, depending on their structure, may be accounted for as a purchase
of the other institution by the Company. To the extent that consideration is
paid in cash rather than Company stock, the assets of the Company would increase
by more than its equity and therefore the ratio of capital to assets would
decrease.
In recognition of the Company's strong earnings performance during the first
half of 1996, the Board of Directors increased the quarterly dividend by 20%, to
$0.18 per share.
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.
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 and the
Bank have the highest capital classification, "well capitalized," given by the
regulatory agencies and therefore is not subject to any restrictions as
discussed above. Management expects the Company and the Bank to continue to be
classified as well capitalized in the future.
REFUND ANTICIPATION LOAN AND TRANSFER PROGRAM
The Company is one of very few financial institutions in the country to operate
a RAL program. This program had significant impacts on the Company's activities
and results of operations during the first half of 1995 and 1996 which are
discussed in various parts of this discussion. This section is intended to
provide a summary of the financial results of the program for the Company for
the 1995 and 1996 filing seasons.
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. During
the filing 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 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.
The Company earned $4.9 million in interest on loans and fees for transfers in
the first half of 1995. However, the EIC change necessitated increased salary,
telephone, and other collection-related expenses to attempt to recover as many
of these loans as possible, and operating expenses of $1.4 million were incurred
during the same period. While the shift from loans to transfers and the
collection efforts were instituted as quickly as possible, the IRS changes
nonetheless substantially increased the amount of delinquencies and resulting
charge-offs. These totaled $3.3 million in the first half of 1995, with another
$793,000 charged-off in the third quarter of that year.
From the beginning of the 1996 filing season, the Company followed the same
restrictive guidelines for loans it instituted during the 1995 filing season.
Although the Company has reduced its credit risk with these restrictions, the
fees received for acting as a transfer agent are less than the fees received for
the loans. During the first half of 1996, the Company made 52,000 RAL loans for
a total of $55.8 million, as compared to 75,600 loans for $75.5 million in the
first half of 1995. Gross revenue for RAL activity was $4.2 million for the
first half of 1996, with operating expenses of $997,000.
The Company began collection efforts in 1995 to recover as large a portion of
the charge-off amount from that year 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. Collection efforts
resulted in RAL recoveries in the first half of 1996 of $1.2 million. This
amount exceeded charged-off loans for the same period, resulting in a net
recovery of $216,000. All remaining outstanding loans were charged-off as of
June 30, 1996, so there will be no further charge-offs in 1996, only recoveries.
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, First
Quarter, 1996, 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 first quarter of
1996. 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 $7.3 million as of June 30, 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 second quarter of 1996 would be $13.2 million
and the average yield would be 9.13%. 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 "Securities
and Related Interest Income."
[3] Peer data are computed from statistics reported
in FDIC Quarterly Banking Profile, First Quarter, 1996 for banks with total
assets from $1-10 billion.
<PAGE>
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
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 35
Share Earnings
27 Financial Data Schedule 37
(b) No reports were filed on Form 8-K.
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT 11
SANTA BARBARA BANCORP & SUBSIDIARIES
COMPUTATION OF PER SHARE EARNINGS
For the Quarter Ended June 30,
-------------------------------------------------------
1996 1995
-------------------------- -------------------------
Primary Fully Diluted Primary Fully Diluted
---------- -------------- --------- ---------------
<S> <C> <C> <C> <C>
Weighted Average
Shares Outstanding 7,637,758 7,637,758 7,688,401 7,688,401
---------- ----------- ---------- -----------
Weighted Average
Options Outstanding 722,346 722,346 665,604 665,604
Anti-dilution adjustment (1) (4,188) (2,825) (8,562) (8,562)
---------- ----------- ---------- -----------
Adjusted Options Outstanding 718,158 719,521 657,042 657,042
Equivalent Buyback Shares (2) (404,507) (393,811) (453,466) (447,474)
---------- ----------- ---------- -----------
Total Equivalent Shares 313,651 325,710 203,576 209,568
Adjustment for Non-Qualified
Tax Benefit (3) (128,597) (133,541) (83,466) (85,923)
---------- ----------- ---------- -----------
Weighted Average Equivalent
Shares Outstanding 185,054 192,169 120,110 123,645
---------- ----------- ---------- -----------
Weighted Average Shares
for Computation 7,822,812 7,829,927 7,808,511 7,812,046
========== =========== ========== ==========
Fair Market Value (4) $25.52 $26.25 $17.76 $18.00
Net Income $3,740,704 $3,740,704 $2,292,991 $2,292,991
Earnings Per Share $0.49 $0.49 $0.30 $0.30
<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 were the adjusted options outstanding to be exercised.
(3) The Company receives a tax benefit when non-qualified options are
exercised equal to its tax rate times the difference between the market
value at the time of exercise and the exercise price. This benefit is
assumed 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>
<TABLE>
<CAPTION>
EXHIBIT 11
SANTA BARBARA BANCORP & SUBSIDIARIES
COMPUTATION OF PER SHARE EARNINGS, CONTINUED
For the Year Ended June 30,
----------------------------------------------------
1996 1995
------------------------ ------------------------
Primary Fully Diluted Primary Fully Diluted
---------- ------------ -------- ------------
<S> <C> <C> <C> <C>
Weighted Average
Shares Outstanding 7,645,278 7,645,278 7,689,485 7,689,485
---------- ---------- ---------- ----------
Weighted Average
Options Outstanding 709,670 709,671 671,924 671,924
Anti-dilution adjustment (1) (3,099) (1,413) (8,562) (8,562)
---------- ---------- ---------- ----------
Adjusted Options Outstanding 706,571 708,258 663,362 663,362
Equivalent Buyback Shares (2) (408,803) (378,374) (467,076) (451,462)
---------- ---------- ---------- ----------
Total Equivalent Shares 297,768 329,884 196,286 211,900
Adjustment for Non-Qualified
Tax Benefit (3) (122,085) (135,253) (80,477) (86,879)
---------- ---------- ---------- ----------
Weighted Average Equivalent
Shares Outstanding 175,683 194,631 115,809 125,021
--------- --------- ---------- ---------
Weighted Average Shares
for Computation 7,820,961 7,839,909 7,805,294 7,814,506
========= ========= ========== =========
Fair Market Value (4) $24.20 $26.25 $16.99 $16.99
Net Income $7,644,275 $7,644,275 $5,269,468 $5,269,468
Earnings Per Share $1.00 $1.00 $0.69 $0.69
<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 were the adjusted options outstanding to be exercised.
(3) The Company receives a tax benefit when non-qualified options are
exercised equal to its tax rate times the difference between the market
value at the time of exercise and the exercise price. This benefit is
assumed 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>
<PAGE>
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: August 12, 1996 /s/ David W. Spainhour
David W. Spainhour
President
Chief Executive Officer
DATE: August 12, 1996 /s/ Donald Lafler
Donald Lafler
Senior Vice President
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> JUN-30-1996
<CASH> 59,014
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 15,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 152,608
<INVESTMENTS-CARRYING> 291,961
<INVESTMENTS-MARKET> 0
<LOANS> 581,235
<ALLOWANCE> 15,541
<TOTAL-ASSETS> 1,143,449
<DEPOSITS> 1,001,243
<SHORT-TERM> 0
<LIABILITIES-OTHER> 4,483
<LONG-TERM> 0
<COMMON> 5,104
<OTHER-SE> 99,237
0
0
<TOTAL-LIABILITIES-AND-EQUITY> 1,143,449
<INTEREST-LOAN> 28,736
<INTEREST-INVEST> 12,315
<INTEREST-OTHER> 4,303
<INTEREST-TOTAL> 45,354
<INTEREST-DEPOSIT> 16,451
<INTEREST-EXPENSE> 17,638
<INTEREST-INCOME-NET> 27,716
<LOAN-LOSSES> 4,264
<SECURITIES-GAINS> (656)
<EXPENSE-OTHER> 22,348
<INCOME-PRETAX> 10,637
<INCOME-PRE-EXTRAORDINARY> 10,637
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,645
<EPS-PRIMARY> 1.00
<EPS-DILUTED> 1.00
<YIELD-ACTUAL> 4.93
<LOANS-NON> 8,827
<LOANS-PAST> 1,401
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 11,373
<ALLOWANCE-OPEN> 12,349
<CHARGE-OFFS> 3,075
<RECOVERIES> 2,003
<ALLOWANCE-CLOSE> 15,541
<ALLOWANCE-DOMESTIC> 15,541
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
