UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31,1997 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 May 9, 1997 there were 7,581,117 shares of the issuer's
common stock outstanding.
<PAGE>
PART 1
FINANCIAL INFORMATION
<TABLE>
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)
(in thousands except share amounts)
<CAPTION>
March 31, 1997 December 31, 1996
-------------- -----------------
<S> <C> <C>
Assets:
Cash and due from banks $ 46,739 $ 51,181
Federal funds sold and securities purchased under
agreement to resell 113,000 70,000
Cash and cash equivalents 159,739 121,181
Securities (Note 4):
Held-to-maturity 220,102 276,359
Available-for-sale 136,280 141,679
Bankers' acceptances 84,274 64,732
Loans, net of allowance of $23,057 at
March 31, 1997 and $16,572 at
December 31, 1996 (Note 5) 696,846 667,595
Premises and equipment, net (Note 6) 7,518 6,835
Accrued interest receivable 7,381 8,503
Other assets (Notes 5,7 & 8) 31,631 14,436
Total assets $ 1,343,771 $ 1,301,320
Liabilities:
Deposits:
Demand deposits $ 201,273 $ 178,511
NOW deposit accounts 140,108 143,191
Money Market deposit accounts 427,254 438,559
Savings deposits 90,413 88,103
Time deposits of $100,000 or more 104,115 95,172
Other time deposits 177,543 169,547
Total deposits 1,140,706 1,113,083
Securities sold under agreements
to repurchase and Federal funds purchased 41,768 33,490
Long-term debt and other borrowings 36,500 39,000
Accrued interest payable and other liabilities 13,815 8,154
Total liabilities 1,232,789 1,193,727
Shareholders' equity
Common stock (no par value; $0.67 per share stated value;
20,000,000 authorized; 7,581,388 outstanding at
March 31, 1997 and 7,587,800 at December 31, 1996) 5,054 5,059
Surplus 34,235 35,415
Unrealized gain (loss) on securities available for sale (318) 2
Retained earnings 72,011 67,117
Total shareholders' equity 110,982 107,593
Total liabilities and shareholders' equity $ 1,343,771 $ 1,301,320
<FN>
See accompanying notes to consolidated condensed financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Statements of Income (Unaudited)
(dollars in thousands except per share amounts)
<CAPTION>
For the Three Month
Periods Ended
March 31,
----------------------
1997 1996
--------- --------
<S> <C> <C>
Interest income:
Interest and fees on loans $ 22,770 $ 15,537
Interest on securities 6,577 5,634
Interest on Federal funds sold and securities
purchased under agreement to resell 1,237 1,095
Interest on bankers' acceptances 950 1,725
Total interest income 31,534 23,991
Interest expense:
Interest on deposits 8,689 8,348
Interest on securities sold under agreements
to repurchase and Federal funds purchased 475 705
Interest on other borrowed funds 580 11
Total interest expense 9,744 9,064
Net interest income 21,790 14,927
Provision for loan losses 4,716 3,215
Net interest income after provision for loan losses 17,074 11,712
Other operating income:
Service charges on deposits 1,195 1,118
Trust fees 2,479 2,224
Other service charges, commissions and fees, net 3,453 2,130
Net loss on securities transactions (360) (512)
Other operating income 176 102
Total other income 6,943 5,062
Other operating expense:
Salaries and benefits 7,893 6,268
Net occupancy expense 1,137 1,132
Equipment expense 645 650
Net loss (gain) from operating other real estate (75) 108
Other expense 4,418 3,177
Total other operating expense 14,018 11,335
Income before income taxes 9,999 5,439
Applicable income taxes 3,362 1,563
Net income $ 6,637 $ 3,876
Earnings per share $ 0.88 $ 0.51
<FN>
See accompanying notes to consolidated condensed financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(dollars in thousands)
<CAPTION>
For the Three Months Ended March 31,
------------------------------------
1997 1996
--------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 6,637 $ 3,876
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation and amortization 460 493
Provision for loan and lease losses 4,716 3,215
Benefit for deferred income taxes (2,733) (1,904)
Net (recovery) writedown on other real estate owned (102) 30
Net amortization of discounts and premiums for
securities and bankers' acceptances (221) (322)
Net change in deferred loan origination
fees and costs 45 125
Increase (decrease) in accrued interest receivable 1,122 (1,477)
Increase in accrued interest payable 2 11
Net loss on sales and calls of securities 360 512
Decrease in service fee and other
income receivable 258 843
Increase in income taxes payable 3,886 3,047
Other operating activities 115 (504)
Net cash provided by operating activities 14,545 7,945
Cash flows from investing activities:
Proceeds from call or maturity of securities 31,829 40,772
Purchase of securities (25,509) (153,319)
Proceeds from sale of securities 40,027 47,294
Proceeds from maturity of bankers' acceptances 40,235 128,177
Purchase of bankers' acceptances (59,641) (84,750)
Net (increase) decrease in loans made to customers (33,926) 727
Disposition of property from defaulted loans 1,431 864
Purchase or investment in premises and equipment (1,130) (148)
Net cash used in investing activities (6,684) (20,383)
Cash flows from financing activities:
Net increase (decrease) in deposits 27,623 (26,779)
Net increase in borrowings with
maturities of 90 days or less 8,278 1,907
Net decrease in long-term debt and other borrowings (2,500) --
Proceeds from issuance of common stock 782 149
Payments to retire common stock (1,967) (1,471)
Dividends paid (1,519) (1,126)
Net cash provided by (used in) financing activities 30,697 (27,320)
Net increase (decrease) in cash and cash equivalents 38,558 (39,758)
Cash and cash equivalents at beginning of period 121,181 139,746
Cash and cash equivalents at end of period $ 159,739 $ 99,988
Supplemental disclosure:
Cash paid for the three months ended:
Interest $ 9,742 $ 9,075
Income taxes $ 1,126 $ --
<FN>
See accompanying notes to consolidated condensed financial statements
</FN>
</TABLE>
<PAGE>
Santa Barbara Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 1997
(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 Sanbarco Mortgage Corporation. 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 three-month periods ended March 31, 1997 and 1996, the
weighted average shares outstanding were as follows:
Three-Month Periods
Ended March 31,
---------------
1997 1996
Weighted average
shares outstanding 7,584,739 7,652,798
In February 1997, the Financial Accounting Standards Board ("FASB") adopted
Statement of Accounting Standards No. 128, Earnings Per Share, ("SFAS 128"). The
requirements of SFAS 128 include the presentation of both basic and diluted
earnings per share on the income statement. The statement may not be adopted by
the Company prior to the fourth quarter of 1997. At adoption, earnings per share
for prior periods will be restated. Because the Company's outstanding stock
options are the only potentially dilutive common stock equivalents under current
accounting standards and because their dilutive impact is less than 3%, the
Company does not anticipate that the adoption of SFAS 128 will cause a material
dilution of earnings per share for restated periods, including the first quarter
of 1997.
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
notes required by generally accepted accounting principles for complete
financial statements. In the opinion of Management, all adjustments (consisting
only of normal recurring accruals) considered necessary for a fair presentation
have been reflected in the financial statements. However, the results of
operations for the three months ended March 31, 1997 are not necessarily
indicative of the results to be expected for the full year. Certain amounts
reported for 1996 have been reclassified to be consistent with the reporting for
1997.
For the purposes of reporting cash flows, cash and cash equivalents include cash
and due from banks, Federal funds sold, and securities purchased under agreement
to resell.
4. Securities
The Company's securities are classified as either "held-to-maturity" or
"available-for-sale." 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. Changes in the after-tax effect of unrealized gains or losses
are shown as increases or decreases in a separate component of equity, but are
not reported as gains or losses in the statements of income of the Company.
In 1994 and 1995, the Company reclassified certain 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 $48,000 at March 31, 1997 and
$90,000 at December 31, 1996, 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 42%.
The Bank became a member of the Federal Reserve System in 1995. As a condition
of membership, the Bank was required to purchase Federal Reserve Bank stock.
The shares purchased are reported as equity securities.
In 1996, the Bank became a member of the Federal Home Loan Bank (FHLB). As of
March 31, 1997, the Bank held $6,017,000 in FHLB stock which are reported as
equity securities.
<PAGE>
Book and market values of securities are as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
(in thousands) Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
March 31, 1997:
Held-to-maturity:
U.S. Treasury obligations $ 101,986 $ 7 $ (1,272) $ 100,721
U.S. agency obligations 32,346 121 (610) 31,857
State and municipal securities 85,770 11,177 (58) 96,889
---------- --------- ---------- ----------
Total held-to-maturity 220,102 11,305 (1,940) 229,467
---------- --------- ---------- ----------
Available-for-sale:
U.S. Treasury obligations 90,402 88 (271) 90,219
Collateralized mortgage obligations 35,842 5 (299) 35,548
Asset backed securities 4,000 8 4,008
Equity Securities 6,505 -- -- 6,505
---------- --------- ---------- ----------
Total available-for-sale 136,749 101 (570) 136,280
---------- --------- ---------- ----------
Total Securities $ 356,851 $ 11,406 $ (2,510) $ 365,747
========== ========= ========== ==========
December 31, 1996:
Held-to-maturity:
U.S. Treasury obligations $ 137,988 $ 178 $ (680) $ 137,486
U.S. agency obligations 52,268 351 (391) 52,228
State and municipal securities 86,103 13,613 -- 99,716
---------- --------- ---------- ----------
Total held-to-maturity 276,359 14,142 (1,071) 289,430
---------- --------- ---------- ----------
Available-for-sale:
U.S. Treasury obligations 105,482 221 (60) 105,643
U.S. agency obligations -- -- -- --
Collateralized mortgage obligations 30,551 132 (135) 30,548
Equity Securities 5,488 -- -- 5,488
---------- --------- ---------- ----------
Total available-for-sale 141,521 353 (195) 141,679
---------- --------- ---------- ----------
Total Securities $ 417,880 $ 14,495 $ (1,266) $ 431,109
========== ========= ========== ==========
</TABLE>
The Company does not expect to realize any of the unrealized gains or losses
related to the securities in the held-to-maturity portfolio because, 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. An
exception to this expectation occurs when securities are called prior to their
maturity, at which time gains may be realized. 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>
March 31, 1997:
Amortized cost:
In one year or less $ 32,951 $ 49,519 $ 82,470
After one year through five years 150,214 80,725 230,939
After five years through ten years 9,246 -- 9,246
After ten years 27,691 -- 27,691
Equity Securities -- 6,505 6,505
-------- --------- ---------
$220,102 $ 136,749 $ 356,851
======== ========= =========
Estimated market value:
In one year or less $ 32,571 $ 49,551 $ 82,122
After one year through five years 148,751 80,224 228,975
After five years through ten years 12,492 -- 12,492
After ten years 35,652 -- 35,652
Equity Securities -- 6,505 6,505
-------- --------- ---------
$229,466 $ 136,280 $ 365,746
======== ========= =========
December 31, 1996:
Amortized cost:
In one year or less $ 49,070 $ 51,495 $ 100,565
After one year through five years 185,092 84,538 269,630
After five years through ten years 14,672 -- 14,672
After ten years 27,525 -- 27,525
Equity Securities -- 5,488 5,488
-------- --------- ---------
$276,359 $ 141,521 $ 417,880
======== ========= =========
Estimated market value:
In one year or less $ 48,825 $ 51,579 $ 100,404
After one year through five years 184,495 84,612 269,107
After five years through ten years 19,479 -- 19,479
After ten years 36,631 -- 36,631
Equity Securities -- 5,488 5,488
-------- --------- ---------
$289,430 $ 141,679 $ 431,109
======== ========= =========
</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) March 31, 1997 December 31, 1996
-------------- -----------------
<S> <C> <C>
Real estate:
Residential $ 186,575 $ 172,846
Non-residential 204,959 199,203
Construction 8,640 10,245
Commercial loans 158,865 154,162
Home equity loans 34,846 34,323
Consumer loans 59,260 43,944
Leases 56,961 58,526
Municipal tax-exempt obligations 7,950 8,658
Other loans 1,847 2,260
---------- ----------
Total loans $ 719,903 $ 684,167
========== ==========
</TABLE>
The loan balances at March 31, 1997 and December 31, 1996, are net of
approximately $2,406,800 and $2,362,000, respectively, in loan fees and
origination costs deferred under the provisions of Statement of Financial
Accounting Standards No. 91.
The amount reported above for consumer loans as of March 31, 1997 includes $10.2
million in Tax Refund Anticipation loans. There were no such loans outstanding
as of December 31, 1996.
A loan is identified as impaired when it is probable that interest and principal
will not be collected according to the contractual terms of the loan agreement.
Because this definition is very similar to that used by bank regulators to
determine on which loans interest should not be accrued, the Company expects
that most impaired loans will be on non-accrual status. Therefore, in general,
the accrual of interest on impaired loans is discontinued, and any uncollected
interest is written off against interest income in the current period. No
further income is recognized until all recorded amounts of principal are
recovered in full or until circumstances have changed such that the loan is no
longer regarded as impaired.
There are some loans about which there is doubt regarding the collectibility of
interest and principal according to the contractual terms, but which are both
fully secured by collateral and are current in their interest and principal
payments. These impaired loans are not classified as non-accrual.
The amount of the valuation allowance for impaired loans is determined by
comparing the recorded investment in each loan with its value measured by one of
three methods: (1) the expected future cash flows are estimated and then
discounted at the effective interest rate; (2) the loan's observable market
price if it is of a kind for which there is a secondary market; or (3) a
valuation of the underlying collateral. A valuation allowance is that amount by
which the recorded investment exceeds the value of the impaired loan. If the
value of the loan as determined by one of the above methods exceeds the recorded
investment in the loan, no valuation allowance for that loan is established. The
following table discloses balance information about the impaired loans and the
allowance related to them ($ in thousands) as of March 31, 1997 and December 31,
1996:
March 31, 1997 December 31, 1996
-------------- -----------------
Loans identified as impaired $5,736 $5,945
Impaired loans for which a valuation
allowance has been determined $4,530 $4,003
Impaired loans for which no valuation
allowance was determined necessary $1,206 $1,942
Amount of valuation allowance $1,215 $1,196
Because the loans currently identified as impaired have unique risk
characteristics, the valuation allowance was determined on a loan-by-loan basis.
The following table discloses additional information ($ in thousands) about
impaired loans for the three-month periods ended March 31, 1997 and 1996:
Three-Month Period
Ended March 31,
1997 1996
---- ----
Average amount of recorded investment
in impaired loans $5,763 $12,800
Collections of interest from impaired loans
and recognized as interest income -- $2
The Company also provides an allowance for losses for: (1) loans that are not
impaired and (2) losses inherent in loans but 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 are charged-off. Uncollectibility is
determined based on the individual circumstances of the loan and historical
trends.
The valuation allowance for impaired loans of $1.2 million is included with the
general allowance for loan losses of $21.9 million to total the $23.1 million
reported on the balance sheet for March 31, 1997 which these notes accompany and
in the statement of changes in the allowance account for the first three months
of 1997 shown below. The amounts related to tax refund anticipation loans and to
all other loans are shown separately.
<TABLE>
<CAPTION>
(in thousands) Refund All
Anticipation Other Total
------------ -------- ---------
<S> <C> <C> <C>
Balance, December 31, 1996 $ 98 $ 16,474 $ 16,572
Provision for loan losses 3,708 849 4,557
Loan losses charged against allowance (389) (900) (1,289)
Loan recoveries added to allowance 1,109 2,108 3,217
--------- --------- ---------
Balance, March 31, 1997 $ 4,526 $ 18,531 $ 23,057
========= ========= =========
</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
$460 and $493 for the three-month periods ended March 31, 1997 and 1996,
respectively. The table below shows the balances by major category of fixed
assets:
<TABLE>
<CAPTION>
(in thousands) March 31, 1997 December 31, 1996
------------------------------ --------------------------------
Accumulated Net Book Accumulated Net Book
Cost Depreciation Value Cost Depreciation Value
-------- ----------- --------- -------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
Land and buildings $ 5,678 $ 3,153 $ 2,525 $ 5,616 $ 3,119 $ 2,497
Leasehold improvements 6,543 4,718 1,825 6,396 4,600 1,796
Furniture and equipment 14,381 11,213 3,168 13,495 10,953 2,542
-------- ---------- -------- ------- ---------- --------
Total $ 26,602 $ 19,084 $ 7,518 $25,507 $ 18,672 $ 6,835
======== ========== ======== ======= ========== ========
</TABLE>
7. Property from Defaulted Loans Included in Other Assets
Property from defaulted loans is included within other assets on the balance
sheets. As of March 31, 1997 and December 31, 1996, the Company had $325,000 and
$1,629,000 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.
8. Receivable from Broker Included in Other Assets
As of March 31, 1997, the Company had $14.8 million due from a broker for the
sale of securities that did not settle until two days later. This receivable is
included within other assets on the balance sheet for that date.
9. Acquisition of First Valley Bank
In December 1996, the Company entered into a definitive agreement whereby it
would acquire all of the outstanding shares of First Valley Bank, Lompoc, and
merge it into the Bank. The agreement provided for First Valley Bank
shareholders to receive $58.00 in cash for each of the 450,000 First Valley Bank
shares outstanding for a total price of $26.1 million. The purchase price was
paid from liquid assets of the Company, specifically the Federal funds shown on
the balance sheet for March 31, 1997.
The acquisition was approved by the shareholders of First Valley Bank and
Federal and State regulators and was consummated as of the close of business on
March 31, 1997. The transaction will be accounted for as a purchase and
accordingly the assets and liabilities of First Valley Bank will be included at
their fair market value with those of the Bank as of the beginning of the second
quarter of 1997. There is no restatement of prior periods to include the assets,
liabilities, or results of operations of First Valley Bank.
For the last several quarters, the Company's interest rate risk position has
been one of liability sensitivity. That is, its short-term liabilities maturing
or repricing within one year exceed its short-term assets. This position makes
the Company's net interest income vulnerable to increases in interest rates. The
interest rate position of First Valley Bank as of March 31, 1997 was similar to
that of the Company and the combination would exacerbate the liability
sensitivity of the Company after the acquisition. In anticipation of the
acquisition, the Company identified some of its available-for-sale securities
and some of the securities it would obtain in the acquisition, the sale of which
would help ameliorate the liability sensitivity. However, these actions would
not be sufficient of themselves to maintain the Company's interest rate risk
position.
There are certain conditions under which SFAS No. 115 permits securities which
were originally classified as held-to-maturity to be reclassified as
available-for-sale and sold without calling into question the intent of the
Company with respect to the remaining securities classified as held-to-maturity.
One of these conditions is if a major business combination necessitates the sale
of held-to-maturity securities to maintain the enterprise's existing interest
rate risk position. To maintain the Company's interest rate risk profile to the
position that preceded the acquisition of First Valley Bank, the Company
reclassified to available-for-sale and sold approximately $30 million of its
securities that had originally been classified as held-to-maturity.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Summary
Santa Barbara Bancorp (the "Company") posted its highest quarterly earnings ever
for the quarter ending March 31, 1997. Earnings were $6.6 million, up 71 percent
over the $3.9 million reported for the comparable period in 1996. Per share
earnings for the first quarter of 1997 were $0.88 compared to $0.51 earned in
the first quarter of 1996.
The increase in net income for the quarter compared to the same quarter of 1996
was due to increases in net interest income and fee income. More than for any
previous year, financial results for the first quarter were materially impacted
by the Company's Refund Anticipation Loan ("RAL") and Refund Transfer ("RT")
programs. Compared to the first quarter of 1996, net interest income (the
difference between interest income and interest expense) increased by $7.0
million. This was due primarily to expanded RAL volumes. RAL fees were $4.4
million more for the first quarter of 1997 than for the same quarter last year.
In addition to RAL's, growth and product mix changes contributed to the increase
in net interest income. Interest on loans other than RAL's increased $2.8
million as these loan balances increased from $553 million at March 31, 1996 to
$710 million a year later. $57 million of this growth in loans came from the
Company's purchase of leasing assets from another financial institution in the
fourth quarter of 1996, and these assets generated $1.6 million in interest
income in the first quarter of 1997. While deposits increased 11% over the last
12 months, interest expense increased only 7.5%, as 40% of the growth occurred
in noninterest-bearing deposits.
Noninterest income increased by $1.9 million over the same quarter of 1996 due
primarily to the increase in RT fees to $2.2 million compared to $1.0 million
for the first quarter of 1996. In addition, the Trust & Investment Services
Division posted quarterly fee income of $2.5 million, an 11% gain over $2.2
million recorded in the prior year's quarter. A larger number of accounts and
greater transaction volume during the quarter generated additional service
charge income of $77,000 compared to the first quarter of 1996.
Delinquent and non-performing loans were less at the end of the first quarter of
1997 than a year ago. However, because of some uncertainty regarding the losses
that will arise out of the new leasing portfolio and with the RAL program
substantially expanded--more than $200 million in loans were made in the first
quarter of 1997 compared to $54 million in the first quarter of 1996--the
Company increased its provision for loan loss by $1.5 million compared to the
first quarter of 1996 from $3.2 to $4.7 million.
Noninterest expenses increased in the first quarter of 1997 compared to the same
quarter of 1996. This is a result of increased salary expense related to the
leasing acquisition, the accrual of employee performance incentives tied to the
record earnings realized by the Company during the quarter, and tax preparer
incentives resulting from the large increase in RAL and RT business referred to
the Company.
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 Sanbarco Mortgage
Corporation ("Sanbarco"). The primary business activity of Sanbarco is brokering
commercial real estate loans and servicing those loans for a fee. All references
to "the Company" apply to Santa Barbara Bancorp and its subsidiaries. "Bancorp"
will be used to refer to the parent company only.
Forward-looking Information
The matters discussed in this analysis include historical information and
forward-looking statements. In accordance with the provisions of the Private
Securities Litigation Reform Act of 1995, the Company cautions that important
factors could cause actual results to differ materially from those in the
forward-looking statements. Such factors include risk associated with changes in
interest rates, underestimation of credit losses in the RAL and other loan
programs, increased competition from other major financial institutions as well
as other risks identified in this discussion.
Total Assets and Earning Assets
Chart 1 below shows the growth in average total assets and deposits since the
fourth quarter of 1994. 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.
<PAGE>
Chart 1--GROWTH IN AVERAGE ASSETS AND DEPOSITS
$1,400
$1,350 AA
$1,300
$1,250
AA
$1,200 AA
AA
$1,150 AA AA DD
$1,100 AA
DD
$1,050 AA AA
AA DD DD DD
$1,000 DD
$950 DD
DD DD
$900 DD
$850
$800
$750
$700
4th 1st 2nd 3rd 4th 1st 2nd 3rd 4th 1st
'94 '95 '95 '95 '95 '96 '96 '96 '96 '97
AA = Assets DD = Deposits
Growth in the first quarters of 1996 and 1997 was impacted by the volume
activity related to the RAL and RT programs which cause average loans and
deposits to reflect higher average balances than in subsequent quarters. RAL and
RT activity is discussed in more detail in the section titled "Refund
Anticipation Loan and Loan Transfer Program." Due to the relatively smaller RAL
and RT volumes in the 1st quarter of 1995, growth was not impacted to the extent
realized in 1996 and 1997. In addition, the growth in average assets for the
first quarter of 1997 also reflects the full quarter impact of the $59 million
leasing portfolio acquired in the December of 1996. The averages for the second
quarter tend to be lower than the averages for the first quarter because of
seasonal factors such as the RAL program--which primarily effects the first
quarters--and cash outflow for tax payments which impacts the second quarters.
The third and fourth quarters generally show growth over the earlier quarters.
In 1996, the usual seasonal increase in deposits did not begin until late in the
third quarter. While the average for the third quarter is lower than that for
the second quarter, the period-end deposits were higher than at either of the
two prior quarters and continued to increase subsequent to September 30.
Continued consolidation in the financial services industry, acquisition of the
leasing portfolio and the three Ventura County offices opened in 1995 have
contributed to the longer trend growth in both deposits and assets.
Earning assets consist of the various assets on which the Company earns interest
income. The Company was earning interest on 96.32% of its assets during the
first quarter of 1997. This compares with an average of 83.37% 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 $174.0 million more assets earning interest during the first
quarter of the year than would be the case if the Company's ratio were similar
to its FDIC peers. The additional earnings from these assets are somewhat offset
by higher lease expense, additional equipment costs, and occasional losses taken
on quick sales of foreclosed property, but on balance Management believes that
these steps give the Company an earnings advantage.
Interest Rate Sensitivity
Most of the Company's earnings arise from its functioning as a financial
intermediary. As such, it takes in funds from depositors and then either loans
the funds to borrowers or invests the funds in securities and other instruments.
The Company earns interest income on the loans and securities and pays interest
expense on the deposits and other borrowings. 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 net interest margin 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.
Because the Company earns interest income on 96% 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." 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 is sold, the Company
would have to recognize a loss. The opposite is true when interest rates
decline. 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 for their term
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 15% plus or minus in either
of the first two periods, and not more than 25% 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
March 31, 1997, the gap for this first period is a negative 4.23%, well within
the target range. At the end of the fourth quarter of 1996, the gap was a
negative 4.52% of assets. 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 larger 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.
There is a large block of savings and transaction deposit accounts which the
Company has assigned to the third time period because it assumes that is the
earliest that they might be repriced. Because they are offset by few assets
repricing in the same period, there is a relatively large negative gap for this
third period, "After six months but within one year." This gap for the third
period causes the cumulative gap to be a negative 11.79% for the first three
periods. However, this is still well within the Company's policy limit of plus
or minus 25%. The periods of over one year are less critical because more steps
can be taken to mitigate the adverse effects of any interest rate changes
arising from repricing mismatches.
<TABLE>
Table 1--INTEREST RATE SENSITIVITY
<CAPTION>
After three After six After one Non-interest
As of March 31, 1997 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 $ 324,869 $ 121,763 $ 52,081 $ 188,162 $ 27,649 $ (17,679) $ 696,845
Cash and due from banks -- -- -- -- -- 40,742 40,742
Money market investments 152,305 44,969 -- -- -- -- 197,274
Securities: 11,765 22,555 48,150 197,949 69,927 6,036 356,382
Other assets -- -- -- -- -- 52,528 52,528
-------------------------------------------------------------------------------- ----------
Total assets 488,939 189,287 100,231 386,111 97,576 81,627 $ 1,343,771
-------------------------------------------------------------------------------- ----------
Liabilities and shareholders' equity:
Borrowed funds:
Repurchase agreements and
Federal funds purchased 41,768 -- -- -- -- -- 41,768
Other borrowings 3,500 2,500 5,000 25,500 -- -- 36,500
Interest-bearing deposits:
Savings and interest-bearing
transaction accounts 416,243 5,113 266,987 41,611 261 -- 730,215
Time deposits 75,919 58,682 52,697 21,854 66 -- 209,218
Demand deposits -- -- -- -- -- 201,273 201,273
Other liabilities 8,416 -- -- -- -- 5,399 13,815
Shareholders' equity -- -- -- -- -- 110,982 110,982
---------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity 545,846 66,295 324,684 88,965 327 317,654 $ 1,343,771
-------------------------------------------------------------------------------- ============
Interest rate-
sensitivity gap $ (56,907)$ 122,992 $ (224,453) $ 297,146 $ 97,249 $ (236,027)
================================================================================
Gap as a percentage of
total assets (4.23%) 9.15% (16.70%) 22.11% 7.24% (17.56%)
Cumulative interest
rate-sensitivity gap $ (56,907)$ 66,085 $ (158,368) $ 138,778 $ 236,027
Cumulative gap as a
percentage of total assets (4.23%) 4.92% (11.79%) 10.33% 17.56%
<FN>
Note: Net deferred loan fees, overdrafts, and the allowance for loan losses are
included in the above table as noninterest bearing or non-repricing
items. Money market investments include Federal funds sold, securities
purchased under agreements to resell, and bankers' acceptances.
</FN>
</TABLE>
The third interest-related risk arises from the fact that interest rates rarely
change in a parallel or equal manner. The interest rates associated with the
various assets and liabilities differ in how often they change, the extent to
which they change, and whether they change sooner or later than other interest
rates. For example, while the repricing of a specific asset and a specific
liability may fall in the same period of the gap report, the interest rate
payable on the liability may rise one percent in response to rising market rates
while the interest rate received on the asset increases only one-half percent.
While evenly matched in the gap report, the Company would suffer a decrease in
net interest income. This exposure to "basis risk" is the type of interest risk
least able to be managed, but is also the least dramatic. Avoiding concentration
in only a few types of assets or liabilities is the best means of increasing the
chance that the average interest received and paid will move in tandem. The
wider diversification means that many different rates, each with their own
volatility characteristics, will come into play.
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 applies hypothetical changes in interest rates to
determine the impacts 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. The
hypothetical changes include scenarios that involve immediate, parallel shocks
as well as gradual interest rate changes. The changes are in both directions.
The latest results of this modeling show that the Company's net interest income
and net economic value are more at risk from an increase in rates than a
decrease, but less vulnerable than at the end of December 1996, because of
certain actions taken in 1997. These actions included holding larger balances in
short-term money market investments like Federal funds sold and bankers'
acceptances, the purchase of an interest rate hedge as described in the section
titled "Hedges, Derivatives, and Other Disclosures," setting targets for
administered rate deposits that are less sensitive to changes in market rates
and through the purchase of rate-sensitive securities.
The primary risk the Company has from falling rates is that the relatively low
rates currently paid on administered rate accounts would limit reductions to
match money market declines for assets.
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 as shown in Chart 1.
This orderly growth has been planned by Management and Management anticipates
that it can be sustained because of the strong capital position and earnings
record of the Company. The increases have come by maintaining competitive
deposit rates, introducing new deposit products, 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 five quarters (dollars
in millions). As shown both in Chart 1 and in Table 2, average deposits for the
first quarter of 1997 have increased $105.1 million or 10.2% from average
deposits a year ago.
<TABLE>
Table 2--AVERAGE DEPOSITS AND RATES
<CAPTION>
1996: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
------------------- ----------------- ----------------- ------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NOW/MMDA $ 555.8 3.35% $ 540.2 3.20% $ 521.1 3.13% $ 554.8 3.12%
Savings 94.0 2.37 92.9 2.40 93.9 2.41 93.2 2.41
Time deposits 100+ 65.8 5.32 71.2 5.31 78.3 5.21 82.9 5.18
Other time deposits 163.2 5.67 166.3 5.58 170.9 5.58 176.2 5.57
------------ ---------- --------- ---------
Total interest-bearing
deposits 878.8 3.82% 870.6 3.74% 864.2 3.72% 907.1 3.71%
Noninterest-bearing 154.4 150.8 151.5 158.7
------------ ----------- --------- ---------
Total deposits $ 1,033.2 $ 1,021.4 $1,015.7 $1,065.8
============ =========== ========= =========
1997:
NOW/MMDA $ 577.3 3.19%
Savings 90.3 2.33
Time deposits 100+ 84.7 5.16
Other time deposits 186.2 5.55
------------
Total interest-bearing
deposits 938.5 3.88%
Noninterest-bearing 199.9
------------
Total deposits $ 1,138.4
============
</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 reprices 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.
The average balances for noninterest bearing demand deposits during the first
quarters of 1996 and 1997 are impacted by outstanding checks from the RAL and RT
programs discussed below in "Refund Loan and Transfer Programs." Approximately
$12.3 million of the average balance for noninterest-bearing demand deposits in
the first quarter of 1996 and $41.6 in the first quarter of 1997 relates to
these programs. 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 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, like Federal
funds. Since Federal funds sold earned less than 6% during 1996 and the first
quarter of 1997, the spread between the cost of premium rate CD's and the
earnings on their potential uses would be 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 expect 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. They are generally appropriate only for short-term
funding needs, and the Company has available other, less expensive sources of
such funding.
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 yields2 over the last six quarters
(dollars in millions).
<TABLE>
Table 3--LOAN BALANCES AND YIELDS
<CAPTION>
EOP Average Interest Average
Quarter Ended Outstanding Outstanding and Fees Yield
- ----------------------- --------------- -------------- ------------ ---------
<S> <C> <C> <C> <C> <C>
December 1995 $558.8 $543.8 $12.6 9.32%
March 1996 556.4 565.8 15.5 11.07
June 1996 581.2 568.4 13.2 9.36
September 1996 604.1 585.8 13.3 9.07
December 1996 684.2 634.4 14.9 9.35
March 1997 719.9 723.0 22.9 12.75
</TABLE>
The end-of-period loan balance as of March 31, 1997 has increased by $35.7
million compared to December 31, 1996, and by $163.4 million compared to March
31, 1996. Residential real estate loans increased $17.9 million, commercial
loans increased $4.7 million and consumer loans, including home equity loans,
increased by $15.8 million from December 31, 1996. Most of the increase in
residential real estate loans is in adjustable rate mortgages 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 increase in the period-end balance between the third and fourth quarters of
1996, and the lesser increase in the average balance for the fourth quarter
compared to the third is due to the purchase of $59 million in lease contracts
from another financial institution. These are accounted for as loans.
The average balance and yield for the first quarters of 1997 and 1996 show the
impact of the RAL loans that the Company makes. The average RAL balance
outstanding for the quarter ended March 31, 1997 and 1996 was $31.2 million and
$6.8 million respectively. 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 Programs" below. Average yields for the
first quarters of 1996 and 1997 without the effect of RAL loans were 9.23% and
9.07%, respectively.
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 has the opportunity to increase yields only 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) March 31, December 31,
1997 1996
---- ----
Standby letters of credit $ 16,354 $ 9,202
Loan commitments 17,953 26,083
Undisbursed loans 15,057 15,588
Unused consumer credit lines 54,777 54,904
Unused other credit lines 88,202 82,837
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.
The top portion of Table 4 shows the amounts of non-current loans and
non-performing assets for the Company for the last five quarters (in thousands).
The middle portion shows 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 bottom portion of
the table are comparable data regarding the Company's peers for the four
earlier quarters.
Total non-performing assets have decreased by $5.5 million at March 31, 1997
compared to March 31, 1996, continuing a positive trend of decreasing levels of
non-performing assets since December 31, 1995. In addition, non-current loans
have declined as a percentage of total loans to 0.92% at March 31, 1997 from
1.92% at March 31, 1996. These declines have been the result of more aggressive
collection efforts, a commitment to disposing of foreclosed property quickly,
and an improving economy.
<PAGE>
<TABLE>
Table 4--ASSET QUALITY
<CAPTION>
March 31, December 31, September 30, June 30, March 31,
1997 1996 1996 1996 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
COMPANY:
Loans
delinquent
90 days
or more $ 683 $ 1,420 $ 1,109 $ 1,401 $ 186
Non-accrual
loans 5,967 7,027 8,578 8,827 10,507
------------ ------------ ------------ ------------ ------------
Total non-
current loans 6,650 8,447 9,687 10,228 10,693
Foreclosed
real estate 325 1,629 1,583 1,422 1,816
------------ ------------ ------------ ------------ ------------
Total non-per-
forming assets $ 6,975 $ 10,076 $ 11,270 $ 11,650 $ 12,509
============ ============ ============ ============ ============
COMPANY:
Coverage ratio
of allowance for
loan losses to
non-current
loans 347% 196% 163% 152% 143%
Ratio of non-
current loans to
total loans 0.92% 1.23% 1.60% 1.76% 1.92%
Ratio of non-
performing assets
to average
total assets 0.52% 0.77% 0.96% 1.02% 1.05%
FDIC PEER GROUP:
Coverage ratio
of allowance for
loan losses to
non-current
loans n/a 167% 176% 185% 185%
Ratio of non-
current loans to
total loans n/a 1.19% 1.19% 1.11% 1.14%
Ratio of non-
performing assets
to average
total assets n/a 0.88% 0.89% 0.84% 0.88%
</TABLE>
The March 31, 1997 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. The Company has increased the allowance for loan losses to $23.0
million at March 31, 1997 from $15.2 million at March 31, 1996. This has
resulted in a coverage ratio, 347%, that is higher than that of its peers, 167%.
There are several reasons for this increase. First is that as disclosed in Note
5 to the financial statements, the reported allowance for the Company includes
$4.5 million in allowance that has been provided for RAL's, even though none of
the RAL's are reported as of March 31, 1997 as noncurrent. While repayment is
normally expected in less than 20 days, processing may frequently be delayed as
the IRS reviews the return. The remaining $18.5 million in allowance not
allocated to RAL's represents 279% of noncurrent loans.
Second, as noted above, the Company purchased the leasing portfolio in late 1996
and has significantly expanded its portfolio of indirect automobile loans. These
are new areas of activity for the Company, and until repayment patterns become
more determinable over the next several years, there is a higher degree of
uncertainty regarding the amount of losses inherent in the portfolios though not
yet identified. In addition, non-performing asset ratios move in cycles relative
to the economy and while the current trend has been very favorable, Management
takes into consideration the cyclical nature of these assets when analyzing the
adequacy of loan loss reserves.
Table 5 classifies non-current loans and all potential problem loans other than
non-current loans by loan category for March 31, 1997 (amounts in thousands).
Table 5--NON-CURRENT AND OTHER 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 174 200
1-4 family mortgage 2,123 525
Multi-family 672 257
Non-residential, non-farm 1,584 5,174
Commercial and industrial 1,445 948
Leases 544 --
Other consumer loans 108 68
------ ------
Total $6,650 $7,172
====== ======
The following table sets forth the allocation of the allowance for all potential
problem loans by classification as of March 31, 1997 (amounts in thousands).
Doubtful $1,430
Substandard $1,005
Special Mention --
The total of the above numbers is less than the total allowance because the
majority 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
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 and third portfolios
consist of securities that are all classified as available-for-sale. The second
portfolio, the "Liquidity Portfolio," 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 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, but can transfer securities between the Liquidity and Discretionary
Portfolios at its option.
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, or if sale is necessary to maintain
the Company's interest rate risk position in the event of a major business
combination or disposition. As permitted for this purpose, in conjunction with
the acquisition of First Valley Bank, the Company sold $30 million of long-term
Treasury Notes from its Earnings Portfolio. This action was undertaken as one
component of a plan of action to manage the interest rate risk being assumed by
the purchase of First Valley Bank. The Company also sold securities it had
classified as available for sale and identified securities in the First Valley
Bank portfolio which would be sold as soon as the acquisition was completed.
Federal banking regulations require that all fixed-rate collateralized mortgage
obligations ("CMO's") held by financial institutions be low volatility
investments. A CMO 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 CMO's held by the Company passed the
tests at the time of purchase and, as of March 31, 1997, 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 ("AMT"). Lastly, taxable securities would be
purchased for the Discretionary Portfolio. If sufficient interest rates above
U.S. Treasury obligations can be obtained, the Company currently prefers to
purchase floating rate CMO's or asset backed securities to help mitigate its
liability sensitivity.
Table 6 presents the combined securities portfolios, showing the average
outstanding balances (dollars in millions) and the yields for the last seven
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 42%.
<TABLE>
Table 6--AVERAGE BALANCES OF SECURITIES AND INTEREST YIELD
<CAPTION>
1996 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
------------------ ------------------ ------------------- -------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury $ 194.6 5.56% $ 260.6 5.80% $ 267.1 5.86% $ 244.4 5.94%
U.S. agency 79.7 5.65 62.9 5.84 56.7 5.92 52.2 6.34
Collateralized
Mortgage Obligations 13.2 5.47 24.7 6.03 29.6 6.03 30.0 6.03
Tax-Exempt 82.8 12.15 83.0 12.08 85.1 12.00 86.4 12.04
--------- --------- ---------- --------
Total $ 370.3 7.04% $ 431.2 7.0% $ 438.5 7.04% $ 413.0 7.16%
========= ========= ========== ========
1997
U.S. Treasury $ 240.0 5.95%
U.S. agency 48.2 6.36
Collateralized
Mortgage Obligations 33.0 6.11
Tax-Exempt 86.3 12.28
---------
Total $ 370.3 7.51%
=========
</TABLE>
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 $32.3
million. They are a type of security know 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. All four notes have now passed their final call
dates and have reached their final step.
Unrealized Gains and Losses
As explained in "Interest Rate Sensitivity" above, fixed rate securities are
subject to market risk from changes in interest rates. The first table in Note 4
to the financial statements shows the impact of the rise in interest rates that
has occurred during 1997. At the end of the first quarter in 1997, the market
value of the U.S. Treasury and agency securities held-to-maturity is less than
the amortized cost or "book value" by $1,754,000. The market value of the
municipal securities held-to-maturity also decreased in market value to
$11,119,000 greater than "book value" at March 31, 1997 from $13,613,000 at
December 31, 1996.
Hedges, Derivatives, and Other Disclosures
The Company established policies and procedures in 1996 to permit limited types
and amounts of off-balance sheet hedges to help manage interest rate risk. The
Company entered into an interest rate "Cap Corridor" contract in January 1997 to
protect against rapidly rising rates. The notional amount of the contract is $50
million and the covered period is for fifteen months beginning July 1, 1997. The
contract pays the Company the rate by which the 3-month Libor index rate exceeds
7.0% up to a maximum of 1.5%. The transaction was entered into to reduce the
risk of rising interest rates, specifically to off-set or hedge the increased
interest expense on some of the Company's money market deposit accounts that
would occur if interest rates rise.
Federal Funds Sold and Securities Purchased under Agreements to Resell
Cash in excess of the amount needed to fund loans, invest in securities, or
cover deposit withdrawals is sold to other institutions as Federal funds or
invested with other institutions on a collateralized basis as securities
purchased under agreement to resell ("repurchase agreements"). These repurchase
agreements are investments which are collateralized by government or agency
securities of the borrower and mature on a daily basis. The sales of federal
funds are on an overnight basis as well. Excess cash expected to be available
for longer periods up to six months is generally invested in U.S. Treasury
securities or bankers' acceptances if the available returns are acceptable. The
amount of Federal funds sold and repurchase agreements 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,
repurchase agreements 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 balance of funds sold position of the Company
and the average yields over the last eight quarters (dollars in millions).
Table 7--AVERAGE BALANCES OF FUNDS SOLD AND SECURITIES PURCHASED UNDER
AGREEMENTS TO RESELL AND THEIR RELATED YIELDS
Average Average
Quarter Ended Outstanding Yield
------------- ----------- -----
December 1995 $81.8 5.79%
March 1996 81.8 5.39
June 1996 56.9 5.23
September 1996 37.9 5.35
December 1996 58.3 5.34
March 1997 94.6 5.30
The average balance sold or invested into the market in the first quarter of
1997 reflects the large volume of funds received from the IRS related to the
refund anticipation loans and refund transfers processed by the Company during
that time. In addition, liquidity was increased in anticipation of the financing
requirements relating to the purchase of First Valley Bank. For a description of
the transaction refer to the section titled "First Valley Bank Acquisition." The
average balance in the fourth quarter of 1996 reflects the build up of liquidity
utilized to purchase the $59 million leasing portfolio.
Other factors impacting 1997 and 1996 average balances are discussed below.
First, with the Company in a liability sensitive position as discussed in the
section above titled "Interest Rate Risk," Management has been reluctant to
purchase large amounts of longer-term securities beyond the amounts necessary to
establish and maintain the Company's maturity ladders. The result was higher
average balances of Federal funds sold than would otherwise be the case. Second,
the Company's Trust Division deposits customers' funds with the Bank before
purchasing other investments. These balances were higher in the fourth quarter
of 1995, the fourth quarter of 1996, and the first quarter of 1997 than is
usual.
Bankers' Acceptances
Bankers' acceptances are notes owed by a purchaser of merchandise to a vendor
that have been "accepted" or guaranteed by the purchaser's bank and sold into
the financial markets. The Company has used bankers' acceptances as an
alternative to short-term U.S. Treasury securities when sufficient Treasury
securities are already held to meet the pledging requirements of certain trust
and public deposits and when the rates available are sufficiently higher than
the rates available on comparable U.S. Treasury obligations. With their
relatively short maturities, bankers' acceptances are an effective instrument
for managing the timing of near-term cash flows. Acceptances of only the highest
quality institutions are utilized. Table 8 discloses the average balances and
yields of bankers' acceptances for the last six quarters (dollars in millions).
Table 8--AVERAGE BALANCE OF BANKERS' ACCEPTANCES AND YIELDS
Average Average
Quarter Ended Outstanding Yield
------------- ----------- -----
December 1995 $ 84.1 5.91%
March 1996 121.0 5.73
June 1996 55.0 5.43
September 1996 38.4 5.69
December 1996 55.3 5.63
March 1997 69.3 5.57
The higher than usual average balance for the first quarter of 1996 was related
to a one-time restructuring of the securities portfolios that occurred in 1995
as described in the 1996 annual report.
Long-term Debt, 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"). Long-term debt consists of advances from the Federal Home
Loan Bank ("FHLB"). Because the average total of other borrowings represents a
very small portion of the Company's source of funds (less than 5%), all of these
short-term items have been combined for the following table.
Table 9 indicates the average balances that are outstanding (dollars in
millions) and the rates and the proportion of total assets funded by other
borrowings over the last six quarters.
Table 9--OTHER BORROWINGS
Average Average Percentage of
Quarter Ended Outstanding Rate Average Total Assets
------------- ----------- ---- --------------------
December 1995 $38.8 5.37% 3.2%
March 1996 59.3 4.86 4.9
June 1996 40.8 4.64 3.5
September 1996 31.9 4.51 2.7
December 1996 34.3 4.68 2.8
March 1997 43.3 4.50 3.2
The Bank became a member of the FHLB in fourth quarter of 1996 and borrowed a
portion of the funds needed for the acquisition of leasing assets in December
1996. The average amount borrowed from FHLB was $6.6 million for the fourth
quarter of 1996 and $37.6 million for the first quarter of 1997. The rate on
this debt is 6.13%. The debt amortizes at $2.5 to $1.0 million per quarter
through the fourth quarter of 2001.
Other Operating Income
Trust fees are the largest component of other operating income. Management fees
on trust accounts are generally based on the market value of assets under
administration. Table 10 shows trust income over the last six quarters (in
thousands).
Table 10--TRUST INCOME
Quarter Ended Trust Income
------------- ------------
December 1995 $1,978
March 1996 2,224
June 1996 2,022
September 1996 2,050
December 1996 2,144
March 1997 2,479
There is some variation in fees from quarter to quarter. Trust customers are
charged for the preparation of the fiduciary tax returns. The preparation
generally occurs in the first quarter of the year. This accounts for
approximately $284,000 of the fees earned in the first quarter of 1997 and
$260,000 of the fees earned in the first quarter of 1996. 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 been increasing because of substantially
enhanced marketing efforts.
Other categories of noninterest operating 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 all noninterest
operating income other than trust fees are shown in Table 11 for the last six
quarters (in thousands).
Table 11--OTHER INCOME Other Service
Service Charges Charges,
on Deposit Commissions Other
Quarter Ended Accounts & Fees Income
------------- -------- ------ ------
December 1995 $1,083 $1,219 $194
March 1996 1,118 2,130 102
June 1996 1,113 1,340 121
September 1996 1,144 1,353 121
December 1996 1,200 1,284 211
March 1997 1,195 3,453 176
The large increases in other service charges, commissions and fees for the first
quarters of 1997 and 1996 are due to $2.16 million and $1.03 million,
respectively, of fees received for the electronic transfer of tax refunds. 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.
Staff Expense
The largest component of noninterest expense is staff expense. Staff size is
closely monitored in relation to the growth in the Company's revenues and
assets.
Table 12 shows the amounts of staff expense incurred over the last six quarters
(in thousands).
Table 12--STAFF EXPENSE
Salary and Profit Sharing and
Quarter Ended Other Compensation Other Employee Benefits
------------- ------------------ -----------------------
December 1995 $4,424 $ 682
March 1996 4,939 1,329
June 1996 4,973 1,379
September 1996 5,180 1,409
December 1996 5,614 1,329
March 1997 5,797 2,096
In the fourth quarter of 1996 additional staff was hired to manage the portfolio
of leasing assets which were purchased in December . Beyond the addition of
staff, there is usually some variation in staff expense from quarter to quarter.
Staff expense will usually increase in the first quarter of each year because
all Company exempt employees have their annual salary review in the first
quarter with merit increases effective on March 1. In 1996 and 1997, these
averaged 3% and 5% respectively. In addition, some temporary staff is added in
the first quarter for the RAL program.
Employee 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 meeting or exceeding
the Company's goals for net income. The Company accrues compensation expense for
the pool for employee bonuses during the year for which they are earned 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
third and fourth quarters of 1996 projected net income at an amount more than
originally projected. Therefore, an additional amount was accrued in that
quarter.
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. As with the bonus accrual mentioned above, 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, an adjustment to the accrual
will be made. In the third quarter of 1996 and the first quarter of 1997,
adjustments were made which increased the accrual for these 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 expensed 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 six quarters (in
thousands).
Table 13--OTHER OPERATING EXPENSE
Occupancy Expense Furniture & Other
Quarter Ended Bank Premises Equipment Expense
------------- ------------- --------- -------
December 1995 $ 1,163 $ 673 $ 3,060
March 1996 1,132 650 3,177
June 1996 1,124 636 2,922
September 1996 1,131 623 3,050
December 1996 1,162 654 3,904
March 1997 1,137 645 4,418
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 was impacted in 1995 by the opening of the new
offices in Ventura County as new equipment and furniture had to be purchased,
but the level of expense has remained relatively stable since then.
Table 14 shows a detailed comparison for the major expense items in other
expense for the three-month periods ended March 31 (amounts in thousands).
<TABLE>
Table 14--OTHER EXPENSE
<CAPTION>
Three-Month Periods
Ended March 31,
------------------------------
1997 1996
------------ ------------
<S> <C> <C>
FDIC and State assessments $ 52 $ 19
Professional services 386 188
RAL processing and incentive fees 622 192
Supplies and sundries 183 160
Postage and freight 231 178
Marketing 346 287
Bankcard processing 450 357
Credit bureau 229 112
Telephone and wire expense 286 209
Charities and contributions 94 83
Software expense 333 274
Operating losses 64 40
Other 1,142 1,078
------------ ------------
Total $ 4,418 $ 3,177
============ ============
</TABLE>
Several of the categories above show increases for the first three months of
1997 compared to the same period of 1996 because of expenses related to the
acquisition of First Valley Bank. These categories include marketing expense,
professional fees, and training expenses included in "Other."
The increase in Bankcard processing fees is a result of an increase in the
number of merchant card processing transactions. The increase in credit bureau
expense is almost wholly related to the expanded number of credit checks for the
RAL program in 1997 compared to 1996.
RAL processing and incentive fees are paid to tax preparers and filers based on
the volume and collectibility of the loans made through them. Since the volume
of transactions is substantially higher in 1997, the Company has accrued a
correspondingly higher amount . Most of the incentive fees will not be paid
until the second quarter as collectibility is determined, and accordingly, there
may be some adjustment in the second 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 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.
As disclosed in Note 7 to the financial statements, the Company had $325,000 in
OREO as of March 31, 1997 as compared with $1,629,000 at December 31, 1996. 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
Liquidity is the ability to raise funds on a timely basis at acceptable cost in
order to meet cash needs, such as might be caused by fluctuations in deposit
levels, customers' credit needs, and attractive investment opportunities. The
Company's objective is to maintain adequate liquidity at all times. Adequate
liquidity is achieved by (1) maintaining liquid assets, (2) being able to raise
deposits or borrow funds, and (3) having access to capital markets.
The Company has defined and manages three types of liquidity: (1) "immediate
liquidity," which is the ability to raise funds today to meet today's cash
obligations, (2) "intermediate liquidity," which is the ability to raise funds
during the next few weeks to meet cash obligations over those next few weeks,
and (3) "long term liquidity", which is the ability to raise funds over the
entire planning horizon to meet anticipated cash needs due to strategic balance
sheet changes.
Immediate liquidity is provided by the prior day's balance of Federal funds
sold, any cash in excess of the Federal Reserve balance requirement, unused
Federal funds lines from other banks, and unused repurchase agreement facilities
with other banks or brokers. The Company's policy is to maintain total sources
of immediate liquidity that are at least equal to the reserve balance amount
required by the Federal Reserve Bank but not less than 5% of total assets. At
the end of March 1997, these sources of immediate liquidity were well in excess
of that policy minimum.
Sources of intermediate liquidity include maturities or sales of bankers'
acceptances and securities in the Liquidity and Discretionary Portfolios,
securities in the Earnings Portfolio maturing in the next few weeks, term
repurchase agreements, and deposit increases from special programs. The Company
projects intermediate liquidity needs and sources over the next several weeks
based on historical trends, seasonal factors, and special planned events or
transactions. Appropriate action is then taken to cover any anticipated unmet
needs. At the end of March 1997, the Company's intermediate liquidity was
adequate to meet all projected needs.
Long term liquidity would be provided by special programs to increase core
deposits, reducing the size of the investment portfolios, selling or
securitizing loans, and accessing capital markets. The Company's policy is to
plan ahead to address cash needs over the entire planning horizon from actions
and events such as market expansions, acquisitions, increased competition for
deposits, anticipated loan demand, and economic conditions and the regulatory
outlook. At the end of March 1997, the Company's long term liquidity was
adequate to meet cash needs anticipated over its planning horizon.
Capital Resources and Company Stock
Table 15 presents a comparison of several important amounts and ratios for the
first quarters of 1997 and 1996 (dollars in thousands).
<TABLE>
Table 15--CAPITAL RATIOS
<CAPTION>
1st Quarter 1st Quarter
1997 1996 Change
--------------- --------------- --------------
<S> <C> <C> <C>
Amounts:
Net Income $ 6,637 $ 3,876 $ 2,761
Average Total Assets 1,350,318 1,201,092 149,226
Average Equity 111,063 102,299 8,764
Ratios:
Equity Capital to Total Assets (period end) 8.26% 8.59% (0.33%)
Annualized Return on Average Assets 1.97% 1.29% 0.68%
Annualized Return on Average Equity 23.90% 15.16% 8.75%
</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 variations quarter by quarter in operating earnings. Areas of
uncertainty or seasonal variations include asset quality, loan demand, and RAL
and RT 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. To be classified as "well capitalized", the Company is required
to have capital equivalent to at least 10% of risk adjusted assets. As of March
31, 1997, the Company's risk-based capital ratio was 15.66%. The Company must
also maintain shareholders' equity of at least 4% to 5% of unadjusted total
assets. As of March 31, 1997, shareholders' equity was 8.26% of total assets.
In January 1997, the Company offered to purchase up to 500,000 shares of common
stock duly tendered by February 21, 1997. The number of shares tendered on that
date were 65,247 or 0.9% of the outstanding shares at December 31, 1996. The
Company paid $30.00 per share or approximately $2.0 million for the stock
tendered, which was accounted for as a retirement of shares and reduction of
capital. As explained in the tender offer, this action was taken: 1) to provide
shareholders with larger holdings an opportunity to sell shares if they had not
been able to because the market was not able to absorb larger blocks; and 2)
because the significant earnings growth over the last several years had resulted
in an accumulation of capital in excess of current and anticipated needs.
The Company will continue to repurchase shares of its common stock to offset the
increased number of shares issued as a result of the exercise of employee stock
options and also to utilize the accumulation of excess capital generated by the
Company's earnings.
Total capital will not change as a result of the purchase of First Valley Bank
since the transaction is a purchase for cash, not an exchange of shares of the
Company for the shares of First Valley Bank. However, tier 1 capital and total
risked-based capital will be reduced by the amount of goodwill recognized. In
addition, the capital to asset ratios will decrease because of the addition of
the First Valley Bank assets. However, all capital ratios will remain in excess
of the "well-capitalized" minimums.
State law limits the amount of dividends that may be paid by a bank to the
lesser of the bank's retained earnings or the total of its undistributed net
income for the last three years. The primary need for funds to be transferred
from the Bank to the Bancorp is for the payment of dividends to its
shareholders. In the first quarter of 1997, sizable dividends were paid to
Bancorp to provide the funds needed for the acquisition of First Valley Bank and
as a result the state limit on dividends was reached. In order to pay dividends
beyond the limit, approval must be obtained by the Bank from the State
Department of Banking. Management expects that approval will continue to be
granted due to strong earnings and the well-capitalized position of the Bank.
There are no material commitments for capital expenditures or "off-balance
sheet" financing arrangements 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.
The current annual cash dividend rate of $0.92 results in a payout ratio of 38%
of earnings for the last twelve months.
Regulation
The Company is closely regulated by Federal and State agencies. The Company and
its subsidiaries may only engage in lines of business that have been approved by
their respective regulators, and cannot open or close offices without their
approval. Disclosure of the terms and conditions of loans made to customers and
deposits accepted from customers are both heavily regulated as to content. The
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 Bancorp 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, Sanbarco 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 laws, regulations, and safe and
sound banking practices.
The regulatory agencies may take action against bank holding companies and banks
should they fail to maintain adequate capital. 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, except for the
need for approval of dividends paid from the Bank to the Bancorp, are 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 ("RAL") and Refund Transfer ("RT") Programs
Since 1992, the Company has provided loans and refund transfers to taxpayers who
file their income tax returns electronically. These loans and transfers are made
through tax preparers across the country. The Company collects a fee for each
transaction.
If a taxpayer meets the Company's credit criteria for the RAL product, the
taxpayer receives an advance on his or her income tax refund less the
transaction fees. The Company is repaid directly by the IRS and remits any
refund amount over the amount due the Company to the taxpayer.
If the taxpayer does not meet the credit criteria or does not want a loan, the
Company can still facilitate the receipt of the refund by the taxpayer through
the RT program. This is accomplished by the Company authorizing the tax preparer
to issue a check to the taxpayer once the refund has been received by the
Company from the IRS. The fees received for acting as a transfer agent are less
than the fees received for the loans.
While the Company is one of very few financial institutions in the country to
operate these programs, the electronic processing of payments involved in these
programs is similar to other payment processing regularly done by the Company
and other commercial banks such as direct deposits and electronic bill paying.
These programs had significant impacts on the Company's activities and results
of operations during the first quarters of 1996 and 1997 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 first quarters
of 1996 and 1997.
During 1996, the Company made 52,000 RAL loans for a total of $55.8 million and
made 97,000 transfers totaling $197.7 million. Gross revenue for RAL and RT
activity was $4.2 million for the first half of 1996, with operating expenses of
$1.0 million.
Through March 31, 1997, 123,000 loans had been made for a total of approximately
$209 million and 246,000 transfers totaling $584 million. Fees recognized for
RAL's totaled $7.2 million and fees for RT's totaled $2.2 million. Operating
expenses totaled $1.3 million.
There is a higher credit risk associated with RAL's than with other types of
loans because (1) the Company does not have personal contact with the customers
of this product;(2) the customers conduct no business with the Company other
than this once a year transaction; and (3) contact subsequent to the payment of
the advance, if there is a problem with the tax return, may be difficult because
many of these taxpayers have no permanent address.
The Company estimates that by year end about 2.8% of RAL's will not be collected
from the IRS or recovered later from the taxpayer. As of March 31, 1997, the
Company has provided for these potential losses. Some of the RAL's were
charged-off in the first quarter and the Company expects to charge-off any
remaining uncollected RAL's by June 30. These charge-offs may exceed the
estimated rate stated above, but subsequent collections are expected to be
received later in the year which will offset these charge-offs.
There is no credit risk associated with the refund transfers because checks are
issued only after receipt of the refund payment from the IRS.
Acquisition of First Valley Bank
As discussed in Note 9 to the consolidated financial statements, the Bancorp
acquired First Valley Bank of Lompoc ("FVB") as of the close of business March
31, 1997. The acquisition will be accounted for as a purchase. The assets and
liabilities acquired will be contributed by the Bancorp to the Bank and the five
branch offices of FVB will be operated as branch offices of the Bank. Under
purchase accounting, the assets and liabilities are recorded at their fair
market value as of the acquisition. The difference between the purchase price
and the net fair market value is recorded as goodwill.
The Company incurred expenses of consultants, training, travel, marketing,
public relations, and other items during the first quarter of 1997 which are
included in the financial statements which this analysis accompanies. The assets
and liabilities of FVB and the goodwill will be entered in the financial records
of the Company effective April 1, 1997.
The recording of these assets and liabilities and the operations of the five
branches will cause some significant changes in the Company's financial
statements beginning with the second quarter of 1997. The Company's loans and
deposits will increase by approximately $64 million and $108 million,
respectively. FVB had approximately $43 million in securities which were
acquired by the Company. However, the Company sold approximately $20 million
almost immediately as part of its actions to maintain its interest rate risk
position as it was before the acquisition.
Interest income and expenses will increase as a result of the acquired earning
assets and liabilities. Salaries and benefits will increase because of the
approximately 45 former FVB employees hired by the Company. Other employees have
been retained on a temporary basis during the transition. Occupancy and
equipment expense will increase because of the costs of operating the new
branches.
Service charges on deposits and other fees will increase because of the new
account relationships.
FVB earned approximately $1.6 million in 1996, but recorded no provision for
loan loss. The Company may have to add to its allowance for loan loss through
additional provision expense if after more thorough review of the acquired loans
it determines that its current allowance is not sufficient to cover the losses
inherent in the acquired portfolio. The Company expects to see some savings as
efficiencies of scale are realized and administrative functions consolidated. In
addition, the Company expects to be able to provide additional services to
customers in the northern portion of Santa Barbara County because of its broader
product line. The transition is expected to go smoothly with minimal loss of
customers because the Company intends to provide the same high level of personal
service which customers of FVB expect.
<PAGE>
Notes to Management Discussion and Analysis:
1. To obtain information on the performance ratios for its peers, the Company
primarily uses The FDIC Quarterly Banking Profile, published by the FDIC
Division of Research and Statistics. This publication provides information about
all FDIC insured banks and certain subsets based on size and geographical
location. Geographically, the Company is included in a subset that includes 12
Western states plus the Pacific Islands. The information in this publication is
based on year-to-date information provided by banks each quarter. It takes about
2-3 months to process the information, so the published data is always one
quarter behind the Company's information. For this quarter, the peer information
is for the fourth quarter of 1996. All peer information in this discussion and
analysis is reported in or has been derived from information reported in this
publication.
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 $6.2 million as of March 31, 1997. 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 42% (while not tax exempt for the State of
California, the State taxes paid on this Federal-exempt income is deductible for
Federal tax purposes). If their tax-exempt status were not taken into account,
interest earned on loans for the first quarter of 1997 would be $22.8 million
and the average yield would be 12.7%. There would also be corresponding
reductions for the other quarters shown in 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, Fourth Quarter, 1996 for banks with total assets from $1-10 billion.
<PAGE>
<TABLE>
EXHIBIT 11
SANTA BARBARA BANCORP & SUBSIDIARIES
COMPUTATION OF PER SHARE EARNINGS
<CAPTION>
For the Three Months Ended March 31,
1997 1996
Primary Fully Diluted Primary Fully Diluted
------- ------------- ------- -------------
<S> <C> <C> <C> <C>
Weighted Average Shares Outstanding 7,584,739 7,584,739 7,652,798 7,652,798
Weighted Average Options Outstanding 747,153 747,153 696,995 696,995
Anti-dilution adjustment (1) (4,139) (4,139) (24,465) --
Adjusted Options Outstanding 743,014 743,014 672,530 696,995
Equivalent Buyback Shares (2) (437,038) (437,222) (392,350) (398,778)
Total Equivalent Shares 305,976 305,792 280,180 298,217
Adjustment for Non-Qualified Tax Benefit (3) (125,450) (125,375) (114,874) (122,269)
Weighted Average Equivalent Shares Outstanding 180,526 180,417 165,306 175,948
Weighted Average Shares for Computation 7,765,265 7,765,156 7,818,104 7,828,746
Fair Market Value (4) $ 30.55 $ 30.55 $ 22.80 $ 23.87
Net Income $ 6,637,166 $ 6,637,166 $ 3,876,057 $ 3,876,057
Earnings Per Share $ 0.85 $ 0.85 $ 0.50 $ 0.50
<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>
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
Not applicable
Item 5. Other Information:
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Index:
Exhibit Number Item Description
11 Computation of Per
Share Earnings
27 Financial Data Schedule
(b) One report on Form 8-K was filed during the quarter ended March
31, 1997. An offer to purchase for cash up to 500,000 shares of
common stock at $30.00 net per share was reported on Form 8-K
filed with the Commission on January 10, 1997.
<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: May 13, 1997
David W. Spainhour
President
Chief Executive Officer
DATE: May 13, 1997
Donald Lafler
Senior Vice President
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> MAR-31-1997
<CASH> 40,741
<INT-BEARING-DEPOSITS> 939,433
<FED-FUNDS-SOLD> 113,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 136,280
<INVESTMENTS-CARRYING> 220,102
<INVESTMENTS-MARKET> 0
<LOANS> 719,903
<ALLOWANCE> 23,057
<TOTAL-ASSETS> 1,343,771
<DEPOSITS> 1,140,706
<SHORT-TERM> 41,768
<LIABILITIES-OTHER> 14,815
<LONG-TERM> 35,500
<COMMON> 5,054
0
0
<OTHER-SE> 105,928
<TOTAL-LIABILITIES-AND-EQUITY> 1,343,771
<INTEREST-LOAN> 22,770
<INTEREST-INVEST> 6,577
<INTEREST-OTHER> 2,187
<INTEREST-TOTAL> 2,187
<INTEREST-DEPOSIT> 8,689
<INTEREST-EXPENSE> 9,744
<INTEREST-INCOME-NET> 21,790
<LOAN-LOSSES> 4,716
<SECURITIES-GAINS> (360)
<EXPENSE-OTHER> 14,018
<INCOME-PRETAX> 9,999
<INCOME-PRE-EXTRAORDINARY> 9,999
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,637
<EPS-PRIMARY> 0.85
<EPS-DILUTED> 0.85
<YIELD-ACTUAL> 6.70
<LOANS-NON> 5,967
<LOANS-PAST> 683
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 7,172
<ALLOWANCE-OPEN> 16,572
<CHARGE-OFFS> 1,289
<RECOVERIES> 3,217
<ALLOWANCE-CLOSE> 23,057
<ALLOWANCE-DOMESTIC> 23,057
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
