PRELIMINARY DOCUMENT
Used for drafting 10-Q submission
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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 8, 1998 there were 15,306,034 shares of the issuer's
common stock outstanding.
<PAGE>
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets
March 31, 1998 and December 31, 1997
Consolidated Statements of Income
Three Months Ended March 31, 1998 and 1997
Consolidated Statement of Shareholders; Equity
Three Months Ended March 31, 1998 and 1997
Consolidated Statements of Cash Flows
Three Months Ended March 31, 1998 and 1997
Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 1998 and 1997
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Disclosures about quantitative and qualitative market risk are located
in Management's Discussion and Analysis of Financial Condition and
Results of Operations in the section on interest rate sensitivity.
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
All other schedules and compliance information called for by the instructions to
Form 10-Q have been omitted since the required information is not applicable.
<PAGE>
<TABLE>
PART 1
FINANCIAL INFORMATION
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)
(in thousands except share amounts)
<CAPTION>
March 31, 1998 December 31, 1997
-------------- -----------------
<S> <C> <C>
Assets:
Cash and due from banks $ 55,153 $ 67,799
Federal funds sold and securities purchased under
agreement to resell 81,000 48,000
-------------- --------------
Cash and cash equivalents 136,153 115,799
-------------- --------------
Securities (Note 4):
Held-to-maturity 213,667 222,350
Available-for-sale 296,337 286,998
Bankers' acceptances 37,959 49,400
Loans, net of allowance of $25,035 at
March 31, 1998 and $21,148 at
December 31, 1997 (Note 5) 894,870 860,400
Premises and equipment, net (Note 6) 14,607 13,595
Accrued interest receivable 10,063 10,328
Other assets (Note 7) 36,317 33,516
-------------- --------------
Total assets $ 1,639,973 $ 1,592,386
============== ==============
Liabilities:
Deposits:
Noninterest bearing demand deposits $ 268,363 $ 265,751
Interest bearing deposits 1,166,304 1,138,404
-------------- --------------
Total Deposits 1,434,667 1,404,155
Securities sold under agreements
to repurchase and Federal funds purchased 20,394 21,293
Long-term debt and other borrowings 36,500 39,000
Accrued interest payable and other liabilities (Note 8) 24,173 9,772
-------------- --------------
Total liabilities 1,515,734 1,474,220
-------------- --------------
Shareholders' equity
Common stock (no par value; $0.33 per share stated value;
40,000,000 authorized; 15,358,498 outstanding at
March 31, 1998 and 15,162,776 at December 31, 1997) 5,120 5,081
Surplus 33,262 32,790
Accumulated other comprehensive income (Note 9) 433 496
Retained earnings 85,424 79,799
-------------- --------------
Total shareholders' equity 124,239 118,166
-------------- --------------
Total liabilities and shareholders' equity $ 1,639,973 $ 1,592,386
============== ==============
<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,
------------------------------
1998 1997
------------------------------
<S> <C> <C>
Interest income:
Interest and fees on loans $ 26,553 $ 22,770
Interest on securities 7,712 6,577
Interest on Federal funds sold and securities
purchased under agreement to resell 1,187 1,237
Interest on bankers' acceptances 689 951
------------------------------
Total interest income 36,141 31,535
------------------------------
Interest expense:
Interest on deposits 10,723 8,689
Interest on securities sold under agreements
to repurchase and Federal funds purchased 298 475
Interest on other borrowed funds 594 580
------------------------------
Total interest expense 11,615 9,744
------------------------------
Net interest income 24,526 21,791
Provision for loan losses 5,604 4,557
------------------------------
Net interest income after provision for loan losses 18,922 17,234
------------------------------
Other operating income:
Service charges on deposits 1,521 1,195
Trust fees 2,865 2,480
Other service charges, commissions and fees, net 6,150 3,424
Net gain (loss) on securities transactions 53 (360)
Other operating income 161 177
------------------------------
Total other income 10,750 6,916
------------------------------
Other operating expense:
Salaries and benefits 9,515 7,895
Net occupancy expense 1,436 1,137
Equipment expense 968 646
Other expense 5,270 4,474
------------------------------
Total other operating expense 17,189 14,152
------------------------------
Income before income taxes 12,483 9,998
Applicable income taxes 4,554 3,361
------------------------------
Net income $ 7,929 $ 6,637
==============================
Earnings per share - basic $ 0.52 $ 0.44
Earnings per share - diluted $ 0.51 $ 0.43
<FN>
See accompanying notes to consolidated condensed financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SANTA BARBARA BANCORP & SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Unaudited)
(dollars in thousands except per share amounts)
<CAPTION>
For the Three-Month
Periods Ended
March 31,
------------------------------
1998 1997
------------- ------------
<S> <C> <C>
Net income $ 7,929 $ 6,637
Other comprehensive income, net of tax (Note 9): Unrealized gains (loss) on
securities:
Unrealized holding gains (losses) arising during period (48) (345)
Less: reclassification adjustment for gains (losses)
included in net income (15) 25
------------- ------------
Other comprehensive income (63) (320)
============= ============
Comprehensive income $ 7,866 $ 6,317
============= ============
<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,
1998 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 7,929 $ 6,637
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation and amortization 1,118 460
Provision for loan and lease losses 5,604 4,557
Benefit for deferred income taxes (1,909) (2,733)
Net recovery on other real estate owned -- (102)
Net amortization of discounts and premiums for
securities and bankers' acceptances 71 (221)
Net change in deferred loan origination
fees and costs (284) 45
Decrease in accrued interest receivable 265 1,122
Increase in accrued interest payable 26 2
Net (gain) loss on sales and calls of securities (53) 360
Decrease in service fees and other
income receivable 26 258
Increase in income taxes payable 4,554 3,886
Other operating activities 1,918 274
-------------- --------------
Net cash provided by operating activities 19,265 14,545
-------------- --------------
Cash flows from investing activities:
Proceeds from call or maturity of securities 21,136 31,829
Purchase of securities (29,003) (25,509)
Proceeds from sale of securities 15,046 40,027
Proceeds from maturity of bankers' acceptances 26,097 40,235
Purchase of bankers' acceptances (14,670) (59,641)
Net increase in loans made to customers (40,307) (33,926)
Disposition of property from defaulted loans -- 1,431
Purchase or investment in premises and equipment (1,837) (1,130)
-------------- --------------
Net cash used in investing activities (23,538) (6,684)
-------------- --------------
Cash flows from financing activities:
Net increase in deposits 30,512 27,623
Net increase (decrease) in borrowings with
maturities of 90 days or less (899) 8,278
Net decrease in long-term debt and other borrowings (2,500) (2,500)
Proceeds from issuance of common stock 439 782
Payments to retire common stock (943) (1,967)
Dividends paid (1,982) (1,519)
-------------- --------------
Net cash provided by financing activities 24,627 30,697
-------------- --------------
Net increase in cash and cash equivalents 20,354 38,558
Cash and cash equivalents at beginning of period 115,799 121,181
============== ==============
Cash and cash equivalents at end of period $ 136,153 $ 159,739
============== ==============
Supplemental disclosure:
Interest paid during period $ 11,589 $ 9,742
Income taxes paid during period $ -- $ 1,126
Non-cash additions to other real estate owned $ 200 $ --
Non-cash additions to loans $ 317 $ --
<FN>
See accompanying notes to consolidated condensed financial statements
</FN>
</TABLE>
<PAGE>
Santa Barbara Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 1998
(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
Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS
128") became effective for the Company as of December 31, 1997. Earnings per
share for all periods presented in the Consolidated Statements of Income are
computed in accordance with the provisions of this statement, and are based on
the weighted average number of shares outstanding during each year retroactively
restated for stock dividends and stock splits. Diluted earnings per share
include the effect of potential common shares for the Company, which include
only shares issuable on the exercise of outstanding options. SFAS 128 requires
the restatement of earnings per share for all prior periods presented in the
Company's financial statements.
For the three-month periods ended March 31, 1998 and 1997, the computation of
basic and diluted earnings per share were as follows (shares and net income
amounts in thousands):
Basic Diluted
Earnings Earnings
Per Share Per Share
March 31, 1998
Numerator - net income $ 7,929 $ 7,929
Denominator - weighted average
shares outstanding 15,284 15,284
Plus: net shares issued in
assumed stock option exercises 354
Diluted denominator 15,638
Earnings per share $0.52 $0.51
March 31, 1997
Numerator - net income $ 6,637 $ 6,637
Denominator - weighted average
shares outstanding 15,169 15,169
Plus: net shares issued in
assumed stock option exercises 355
Diluted denominator $15,524
Earnings per share $0.44 $ 0.43
Weighted average shares and net shares issued in assumed stock option exercises
for the three-month periods ended March 31, 1998 and 1997 were adjusted for the
2 for 1 stock split payable on April 16, 1998.
3. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in a condensed format, and therefore do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of Management, all adjustments (consisting
only of normal recurring accruals) considered necessary for a fair presentation
have been reflected in the financial statements. However, the results of
operations for the three months ended March 31, 1998, are not necessarily
indicative of the results to be expected for the full year. Certain amounts
reported for 1997 have been reclassified to be consistent with the reporting for
1998.
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." Securities for which the Company has positive intent and
ability to hold until maturity are classified as held-to-maturity. Securities
which might be sold prior to maturity because of interest rate changes, to meet
liquidity needs, or to better match the repricing characteristics of funding
sources are classified as available-for-sale. If the Company were to purchase
securities principally for the purpose of selling them in the near term for a
gain, they would be classified as trading securities. The Company holds no
securities that should be classified as trading securities.
The Company's securities which are classified as held-to-maturity are carried at
amortized historical cost. That is the purchase price increased by the accretion
of discounts or decreased by the amortization of premiums using the effective
interest method. Discount is the excess of the face value of the security over
the cost. Premium is the excess of cost over the face value of the security.
Discount is accreted and premium is amortized over the period to maturity of the
related securities, or to an earlier call date, if appropriate.
The interest income from securities that are classified as available-for-sale is
recognized in the same manner as for securities that are classified as
held-to-maturity, including the accretion of discounts and the amortization of
premiums. However, unlike the securities that are classified held-to-maturity,
securities classified available-for-sale are reported in the financial
statements at fair market value rather than at amortized cost. The after-tax
effect of unrealized gains or losses is reported as accumulated other
comprehensive income as explained in Note 9. Changes in the unrealized gains or
losses are shown as increases or decreases in this component of equity, but are
not reported as gains or losses in the statements of income of the Company.
The Bank is member of the Federal Reserve System and the Federal Home Loan Bank
("FHLB"). The shares of stock in these organizations required to be purchased as
a condition of membership are reported as equity securities.
The amortized historical cost 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, 1998
Held-to-maturity:
U.S. Treasury obligations $ 73,134 $ 409 $ (43) $ 73,500
U.S. agency obligations 32,434 130 (70) 32,494
State and municipal securities 108,099 14,795 (76) 122,818
----------------------------------------------
Total held-to-maturity 213,667 15,334 (189) 228,812
----------------------------------------------
Available-for-sale:
U.S. Treasury obligations 142,081 515 -- 142,596
U.S. agency obligations 24,935 67 (2) 25,000
Collateralized mortgage obligations 87,546 299 (187) 87,658
Asset backed securities 14,550 66 -- 14,616
State and municipal securities 18,293 58 (26) 18,325
Equity Securities 8,142 -- -- 8,142
----------------------------------------------
Total available-for-sale 295,547 1,005 (215) 296,337
----------------------------------------------
Total Securities $ 509,214 $ 16,339 $ (404) $ 525,149
==============================================
December 31, 1997:
Held-to-maturity:
U.S. Treasury obligations $ 80,714 $ 410 $ (85) $ 81,039
U.S. agency obligations 32,410 112 (106) 32,416
State and municipal securities 109,226 15,847 (79) 124,994
----------------------------------------------
Total held-to-maturity 222,350 16,369 (270) 238,449
----------------------------------------------
Available-for-sale:
U.S. Treasury obligations 162,190 482 -- 162,672
U.S. agency obligations 25,930 38 (14) 25,954
Collateralized mortgage obligations 77,716 338 (6) 78,048
Asset-backed securities 4,000 8 -- 4,008
State and municipal securities 8,205 62 -- 8,267
Equity Securities 8,049 -- -- 8,049
----------------------------------------------
Total available-for-sale 286,090 928 (20) 286,998
----------------------------------------------
Total Securities $ 508,440 $ 17,297 $ (290) $ 525,447
==============================================
</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. Gains or losses may be realized
on securities in the available-for-sale portfolio.
The amortized historical cost and estimated market value of debt securities by
contractual maturity are shown below. 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.
<TABLE>
<CAPTION>
(in thousands) Held-to- Available-
Maturity for-Sale Total
----------------------------------
<S> <C> <C> <C>
March 31, 1998:
Amortized cost:
In one year or less $ 53,439 $ 56,506 $ 109,945
After one year through five years 110,890 210,278 321,168
After five years through ten years 10,639 10,118 20,757
After ten years 38,699 10,503 49,202
Equity securities -- 8,142 8,142
-------------------------------------
$ 213,667 $ 295,547 $ 509,214
=====================================
Estimated market value:
In one year or less $ 53,998 $ 56,646 $ 110,644
After one year through five years 116,635 211,000 327,635
After five years through ten years 13,191 10,055 23,246
After ten years 44,988 10,494 55,482
Equity securities -- 8,142 8,142
-------------------------------------
$ 228,812 $ 296,337 $ 525,149
=====================================
December 31, 1997:
Amortized cost:
In one year or less $ 38,427 $ 47,936 $ 86,363
After one year through five years 133,400 224,384 357,784
After five years through ten years 11,290 5,130 16,420
After ten years 39,233 591 39,824
Equity securities -- 8,049 8,049
-------------------------------------
$ 222,350 $ 286,090 $ 508,440
=====================================
Estimated market value:
In one year or less $ 38,373 $ 48,025 $ 86,398
After one year through five years 139,807 225,163 364,970
After five years through ten years 14,089 5,157 19,246
After ten years 46,180 604 46,784
Equity securities -- 8,049 8,049
-------------------------------------
$ 238,449 $ 286,998 $ 525,447
=====================================
</TABLE>
5. Loans
The balances in the various loan categories are as follows:
<TABLE>
<CAPTION>
(in thousands) March 31, 1998 December 31, 1997
-------------- -----------------
<S> <C> <C>
Real estate:
Residential $ 260,607 $ 246,283
Non-residential 248,739 249,725
Construction 17,795 16,127
Commercial loans 188,804 184,374
Home equity loans 35,571 37,150
Consumer loans 95,340 75,151
Leases 62,803 61,108
Municipal tax-exempt obligations 7,423 7,931
Other loans 2,823 3,699
---------- ---------
Total loans $ 919,905 $ 881,548
========== =========
</TABLE>
The loan balances at March 31, 1998, and December 31, 1997, are net of
approximately $2,498,000 and $2,782,000, respectively, in net loan fees and
origination costs deferred.
The amount reported above for consumer loans as of March 31, 1998, includes
$10.1 million in Tax Refund Anticipation Loans. There were no such loans
outstanding as of December 31, 1997.
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 Management to determine
on which loans interest should not be accrued, the Company expects that most
impaired loans will be on nonaccrual status. Therefore, in general, the accrual
of interest on impaired loans is discontinued, and any uncollected interest is
written off against interest income from other loans in the current period. No
further income is recognized until all recorded amounts of principal are
recovered in full or until circumstances have changed such that the loan is no
longer regarded as impaired.
There are some loans about which there is doubt regarding the collectibility of
interest and principal according to the contractual terms, but which are both
fully secured by collateral and are current in their interest and principal
payments. These impaired loans are not classified as nonaccrual.
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 the loan is of a kind for which there is a secondary market; or (3) a
valuation of the underlying collateral. A valuation allowance is established for
any amount by which the recorded investment exceeds the value of the impaired
loan. If the value of the loan as determined by the selected method exceeds the
recorded investment in the loan, no valuation allowance for that loan is
established. The following table discloses balance information about the
impaired loans and the allowance related to them (dollars in thousands) as of
March 31, 1998, and December 31, 1997:
March 31, 1998 December 31, 1997
Loans identified as impaired $7,258 $4,980
Impaired loans for which a valuation
allowance has been determined $600 $702
Impaired loans for which no valuation
allowance was determined necessary $6,658 $4,278
Amount of valuation allowance $299 $60
Because the loans currently identified as impaired have unique risk
characteristics, the valuation allowance was determined on a loan-by-loan basis.
Few impaired loans required a valuation allowance at March 31, 1998 and December
31, 1997, because most impaired loans had collateral in excess of the recorded
investment.
The following table discloses additional information (dollars in thousands)
about impaired loans for the three-month periods ended March 31, 1998 and 1997:
Three-month Period
Ended March 31,
1998 1997
Average amount of recorded
investment in impaired loans $7,186 $5,763
Collections of interest from
impaired loans and recognized
as interest income -- --
The Company also provides an allowance for losses for: (1) loans that are not
impaired and (2) losses inherent in the various loan portfolios, 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 $299,000 is included with the
general allowance for loan losses to total the $25.0 million reported on the
balance sheet for March 31, 1998, which these notes accompany, and in the "All
Other" column in the statement of changes in the allowance account for the first
three months of 1998 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, 1997 $ 325 $ 20,823 $ 21,148
Provision for loan losses 5,222 382 5,604
Loan losses charged against allowance 4,458 574 5,032
Loan recoveries added to allowance 1,879 1,436 3,315
----------------------------------
Balance, March 31, 1998 $ 2,968 $ 22,067 $ 25,035
==================================
</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
$823 and $460 for the three-month periods ended March 31, 1998 and 1997,
respectively. The table below shows the balances by major category of fixed
assets:
<TABLE>
<CAPTION>
(in thousands) March 31, 1998 December 31, 1997
------------------------------- ----------------------------------
Accumulated Net Book Accumulated Net Book
Cost Depreciation Value Cost Depreciation Value
------------------------------- ----------------------------------
<S> <C> <C> <C> <C> <C> <C>
Land and buildings $10,932 $ 4,515 $ 6,417 $ 10,902 $ 4,422 $ 6,480
Leasehold improvements 7,228 5,294 1,934 6,961 5,184 1,777
Furniture and equipment 21,929 15,673 6,256 20,392 15,054 5,338
------------------------------- ----------------------------------
Total $40,089 $ 25,482 $ 14,607 $ 38,255 $ 24,660 $ 13,595
=============================== ==================================
</TABLE>
7. Other Assets
Property acquired as a result of defaulted loans is included within other assets
on the balance sheets. As of March 31, 1998, the Company had $200,000 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. As of
December 31, 1997, the Company held some properties which it had obtained in
foreclosures. However, because of the uncertainty relating to realizing any
proceeds from their disposal in excess of the cost of disposal, the Company had
written their carrying value down to zero.
Also included in other assets on the balance sheet for March 31, 1998 and
December 31, 1997, are deferred tax assets and goodwill. In connection with the
acquisitions of First Valley Bank ("FVB") and Citizens State Bank ("CSB"), the
Company recognized the excess of the purchase price over the estimated fair
value of the assets received and liabilities assumed as $17.8 million of
goodwill. The purchased goodwill is being amortized over 15 years. Intangible
assets, including goodwill, are reviewed each year to determine if circumstances
related to their valuation have been materially affected. In the event that the
current market value is determined to be less than the current book value of the
intangible asset, a charge against current earnings would be recorded.
8. Other Liabilities
The Company accounts for securities transactions as of the trade date. That is,
securities are recorded as purchased even if they are not paid for until some
days later, and the Company records a liability for the purchase price owed to
the seller. On March 31, 1998, the Company purchased securities for
approximately $6.4 million which were not paid for until several days later.
Other liabilities at March 31, 1998 also includes approximately $4.7 million in
income tax liabilities paid just before the April 15, 1998 estimated payment due
date.
9. Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income," became effective for the Company as of January 1, 1998. The statement
requires the reporting of components of comprehensive income other than net
income in one of the financial statements. Components of comprehensive income
are changes in equity during a period other than those resulting from
investments by owners and distributions to owners. For the Company, the only
component of comprehensive income other than net income is the unrealized gain
or loss on securities classified as available-for-sale. The aggregate amount of
such changes to equity that have not yet been recognized in net income are
reported in the equity portion of the consolidated balance sheets as accumulated
other comprehensive income.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Summary
Santa Barbara Bancorp (the "Company") posted earnings of $7.93 million for the
quarter ended March 31, 1998, up 19% over the same quarter last year. First
quarter earnings continue the trend of the previous ten quarters in which net
income has been higher than the same quarter of the prior year. Per share
earnings for the first quarter of 1998 were $0.51 compared to $0.43 earned in
the first quarter of 1997. The increase in net income for the quarter compared
to the same quarter of 1997 was due to increases in net interest income and fee
income.
Compared to the first quarter of 1997, net interest income (the difference
between interest income and interest expense) increased by $2.7 million in the
first quarter of 1998. This was due primarily to loan growth in categories other
than the Company's Refund Anticipation Loan ("RAL") program. The Company's
purchase of First Valley Bank ("FVB") and Citizens State Bank ("CSB") in April
and October, 1997, respectively, and the opening of two new offices in Ventura
County resulted in significant growth in loans and deposits. Interest on loans
other than RAL's increased $4.6 million as these loan balances increased from
$710 million at March 31, 1997, to $910 million a year later. $107 million of
this growth in loans was due to the acquisitions. Deposits increased $294
million or 26% over the last 12 months, while interest expense increased 23%.
Noninterest income, exclusive of gains or losses on securities transactions,
increased by $3.4 million over the same quarter of 1997 due primarily to the
increase in Refund Transfer ("RT") fees to $4.3 million compared to $2.2 million
for the first quarter of 1997. In addition, the Trust & Investment Services
Division benefited from the rising stock markets and posted quarterly fee income
of $2.9 million, a 16% gain over the $2.5 million recorded in the prior year's
quarter. The larger number of deposit accounts and greater transaction volume
during the quarter generated additional service charge income of $326,000
compared to the first quarter of 1997.
Delinquent and nonperforming loans were more at the end of the first quarter of
1998 than a year ago. Most of this increase is due to loans acquired in the
above-mentioned transactions. However, because of the net recovery position for
loans other than RAL's, Management recorded a smaller amount of provision for
credit loss than was recorded in the first quarter of 1997.
Noninterest expenses increased in the first quarter of 1998 compared to the same
quarter of 1997, primarily due to the growth in the Company from the
acquisitions. Increases occurred in salary costs, occupancy, equipment and
marketing. During the past twelve months the rate of growth of noninterest
expenses of 21.5% was slightly less than both the 21.7% rate of growth of
average assets, and the combined 22.8% growth rate for net interest income and
noninterest income. The operating efficiency ratio, which measures how many
cents of expense it takes to earn a dollar of operating income, remained
unchanged from the $0.47 figure for the first quarter of 1997. Included in the
first quarter of 1998 was $296,000 in goodwill amortization expense relating to
the two acquisitions which was not present in the first quarter of 1997.
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 System.
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, including factors beyond the Company's control, could cause actual
results to differ materially from those in the forward-looking statements. Such
factors include risks associated with changes in interest rates, underestimation
of credit losses in the refund anticipation loan ("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
The chart below shows the growth in average total assets and deposits since the
fourth quarter of 1995. For the Company, changes in assets are primarily related
to changes in deposit levels, so these also 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.
Chart 1 GROWTH IN AVERAGE ASSETS AND DEPOSITS
$1,650 AAAA
A
$1,600 A
A
$1,550 A
A
$1,500 A
A
$1,450 A
AAAAAAA DDDD
$1,400 A D
A D
$1,350 A DD
AA D
$1,300 A D
A D
$1,250 A D
AA DDDDDDD
$1,200 AAAA A D
A AAAAA A D
$1,150 AAAAA AAAA DDD
D
$1,100 D
D
$1,050 DDD
DDDDDDDDDDDDDDD
$1,000 DDDDD
$950
4th 1st 2nd 3rd 4th 1st 2nd 3rd 4th 1st
'95 '96 '96 '96 '96 '97 '97 '97 '97 '98
A = Assets D = Deposits
Continued consolidation in the financial services industry, acquisition of a
leasing portfolio in December, 1996, FVB, and CSB, and the two Ventura County
offices opened in 1997 have contributed to the longer trend growth in both
deposits and assets.
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 and RT programs which
primarily affects the first quarters of each year and cash outflow for tax
payments which impacts the second quarters. Deposits related to the RAL and RT
programs, i.e. outstanding checks written to taxpayers which have not cleared,
averaged $41.6 million during the first quarter of 1997. Average assets during
the first quarter of 1997 included RAL's of $31.2 million. The absence of these
amounts from subsequent quarters was offset by the addition of $124 million in
assets and $108 million in deposits obtained in the FVB purchase. Without the
acquired assets and liabilities, the averages for the second and third quarters
of 1997 would have been slightly less than those for the first quarter. In the
first quarter of 1998, average deposits included $60.5 million related to RAL
and RT activity, and average assets included $32.2 million in RAL's. It is
likely that assets and deposits will be lower in the second quarter of 1998 than
in the first quarter.
Earning assets consist of the various assets on which the Company earns interest
income. The Company was earning interest on 95% of its assets during the first
three months of 1998. This compares with an average of 89% 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 nonearning assets) are not built up. In this manner, the
interest received can be invested to earn additional interest. The Company
leases most of its facilities under long-term contracts rather than owning them.
This, together with the aggressive disposal of real estate obtained as the
result of foreclosure avoids tying up funds that could be earning interest.
Lastly, the Company has developed systems for clearing checks 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
$95 million more assets earning interest during the first three months of the
year than would be the case if the Company's ratio were similar to its FDIC
peers. The additional earnings from these assets are somewhat offset by higher
lease expense, additional equipment costs, and occasional losses taken on quick
sales of foreclosed property. However, on balance, Management believes that
these steps give the Company an earnings advantage.
Interest Rate Sensitivity
Most of the Company's earnings arise from its functioning as a financial
intermediary. As such, it takes in funds from depositors and then either 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 on the margin as interest
rates change. Because the Company earns interest income on 95% of its assets and
pays interest expense on the majority of its liabilities, these adverse effects
could be material if not managed properly. The three primary risks related to
changes in interest rates are market risk, mismatch risk, and basis risk. The
rest of this section briefly explains these risks and the steps the Company
takes to manage them. Interested readers are referred to Management's Discussion
and Analysis of Financial Condition and the Results of Operations in the
Company's Annual Report on Form 10-K for 1997 for a more complete discussion.
Market risk is the risk that the market value of financial instruments such as
loans, securities, and deposits that have rates of interest fixed for some term
will decrease with changes in market 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. Mismatch risk 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. The Company controls mismatch risk by attempting to
roughly match the maturities and repricing opportunities of assets and
liabilities. Basis 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.
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.
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 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
large 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, 1998, the
gap for this first period is a positive 1.19%. At the end of the fourth quarter
of 1997, the gap was a very small negative gap of (0.20%) of assets.
For the next period, after three months but within six months, there is a
positive excess of assets over liabilities of 1.98%.
In the third period, after six months but within one year, liabilities exceed
assets by 21.88% of total assets, reflecting the current customer preference for
short-term deposits. The cumulative gap within one year of (18.71%) of total
assets is within the Company's acceptable limits.
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, 1998 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 $ 372,431 $ 100,410 $ 95,059 $ 302,777 $ 28,225 $ (4,032) $ 894,870
Cash and due from banks -- -- -- -- -- 55,153 55,153
Money market investments 114,054 4,905 -- -- -- -- 118,959
Securities 59,902 18,753 54,427 249,630 118,361 8,931 510,004
Other assets -- -- -- -- -- 60,987 60,987
--------------------------------------------------------------------------------- -----------
Total assets 546,387 124,068 149,486 552,407 146,586 121,039 $ 1,639,973
--------------------------------------------------------------------------------- ===========
Liabilities and shareholders' equity:
Borrowed funds:
Repurchase agreements and
Federal funds purchased 20,394 -- -- -- -- -- 20,394
Other borrowings 3,500 2,500 5,000 25,500 -- -- 36,500
Interest-bearing deposits:
Savings and interest-bearing
transaction accounts 354,390 -- 394,810 -- -- -- 749,200
Time deposits 139,487 89,103 108,528 79,011 974 -- 417,103
Demand deposits -- -- -- -- -- 268,364 268,364
Other liabilities 9,124 -- -- -- -- 15,049 24,173
Shareholders' equity -- -- -- -- -- 124,239 124,239
--------------------------------------------------------------------------------- -----------
Total liabilities and
shareholders' equity 526,895 91,603 508,338 104,511 974 407,652 $ 1,639,973
--------------------------------------------------------------------------------- ===========
Interest rate-
sensitivity gap $ 19,492 $ 32,465 $ (358,852)$ 447,896 $ 145,612 $ (286,613)
=================================================================================
Gap as a percentage of
total assets 1.19% 1.98% (21.88%) 27.31% 8.88% (17.48%)
Cumulative interest
rate-sensitivity gap $ 19,492 $ 51,957 $ (306,895)$ 141,001 $ 286,613
Cumulative gap as a
percentage of total assets 1.19% 3.17% (18.71%) 8.60% 17.48%
<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>
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.
To quantify the extent of these risks both in its current position and in
transactions it might take in the future, the Company uses computer modeling to
simulate the impact of different interest rate scenarios on net interest income
and on net economic value. Net economic value or the market value of portfolio
equity is defined as the difference between the market value of financial assets
and liabilities. These hypothetical scenarios include both sudden and gradual
interest rate changes, and interest rate changes in both directions.
The Company relies more on this modeling in reaching interest rate risk
management decisions than on gap reports. The most recent modeling confirms that
the Company's interest rate risk profile is balanced, and the results are within
normal expectations.
The hypothetical impacts of sudden interest rate shocks applied to the Company's
asset and liability balances are modeled quarterly. The resulting shock reports
indicate how much of the Company's net interest income and net economic value
are "at risk" (deviation from the base level) from various rate changes.
Although interest rates normally would not change suddenly in this manner, this
exercise is valuable in identifying exposures. The shock reports for the
Company's December 31, 1997, and March 31, 1998 balances indicate that the
Company's net interest income at risk over a one year period and net economic
value at risk from 2% shocks are within normal expectations for such sudden
changes:
Shocked by -2% Shocked by +2%
As of December 31, 1997
Net interest income +1.42% (1.04%)
Net economic value +14.29% (14.08%)
As of March 31, 1998
Net interest income +0.95% (0.24%)
Net economic value +10.64% (11.05%)
For the shock reports, the Company has made certain assumptions about the
duration of its non-maturity deposits that are important to determining net
economic value at risk. The Company engaged an outside consultant to gather and
study data on its non-maturity deposits, and the results of that study have been
incorporated into these latest models. The interest rate simulation reports are
dependent upon the shape and volatility of the interest rate scenarios selected
and upon the assumptions of the rates that would be paid on the Company's
administered rate deposits as external yields change.
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.
The Company's exposure to interest rate risk as of December 31, 1997, is
discussed in more detail in Management's Discussion and Analysis included with
the Company's Annual Report for 1997 filed on Form 10-K. There have been no
material changes to this exposure during the first quarter of 1998.
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, the opening of new retail
branch offices, the assumption of deposits in the FVB and CSB acquisitions, and
successfully encouraging former customers of merged financial institutions to
become customers of the Company.
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 1998 have increased $295.6 million or 26.0% from average
deposits a year ago.
<TABLE>
Table 2--AVERAGE DEPOSITS AND RATES
<CAPTION>
1997: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
-------------------- ------------------- ------------------- ------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NOW accounts $ 141.0 1.10% $ 161.7 1.13% $ 161.5 1.15% $ 178.4 1.16%
Money market deposit accounts 436.3 3.80 424.1 3.79 404.9 3.71 417.0 3.75
Savings accounts 90.4 2.30 111.4 2.18 105.6 2.34 126.1 2.22
Time certificates of deposit for
less than $100,000 and IRA's 185.3 5.40 225.9 5.74 239.9 5.67 268.2 5.52
Time certificates of deposit for
$100,000 or more 85.5 5.19 112.1 5.24 124.0 5.75 145.1 5.44
----------- --------- ---------- ---------
Interest-bearing deposits 938.5 3.71% 1,035.2 4.16% 1,035.9 4.21% 1,134.8 3.%1
Demand deposits 199.9 191.5 198.9 225.7
----------- --------- ---------- ---------
Total deposits $ 1,138.4 $ 1,226.7 $ 1,234.8 $ 1,360.5
=========== ========= ========== =========
1998:
NOW accounts $ 179.7 1.18%
Money market deposit accounts 417.5 3.74
Savings accounts 126.7 2.31
Time certificates of deposit for
less than $100,000 and IRA's 269.6 5.53
Time certificates of deposit for
$100,000 or more 146.8 5.38
-----------
Interest bearing deposits 1,140.3 3.%1
Demand deposits 293.7
===========
Total deposits $ 1,434.0
===========
</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 1997 and 1998 were impacted by outstanding checks from the RAL and
RT programs discussed below in "Refund Loan and Transfer Programs."
Approximately $41.6 million of the average balance for noninterest-bearing
demand deposits in the first quarter of 1997 and $60.5 million in the first
quarter of 1998 relate to these programs. There was 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, loan demand has not been so great that the Company would 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 1997 and the first three months of 1998, the spread
between the cost of premium rate CD's and the earnings on their potential uses
would be very small, if not negative. 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 because their terms tend to be relatively longer
than 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 has not utilized any brokered deposits.
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 1996 $684.2 $634.4 $14.9 9.35%
March 1997 719.9 723.0 22.9 12.75
June 1997 788.8 789.0 18.3 9.21
September 1997 803.9 790.7 18.3 9.26
December 1997 881.5 858.8 19.8 9.18
March 1998 919.9 926.8 26.6 11.57
</TABLE>
The end-of-period loan balance as of March 31, 1998, has increased by $38.4
million compared to December 31, 1997, and by $200.0 million compared to March
31, 1997. Residential real estate loans increased $14.3 million, construction
real estate loans increased $1.7 million, commercial loans increased $4.4
million and consumer loans, including home equity loans, increased by $18.6
million from December 31, 1997. Most of the increase in residential real estate
loans is in adjustable rate mortgages ("ARMS") that have initial "teaser" rates.
The yield will increase for these loans as the teaser rates expire. Applicants
for these loans are qualified based on the fully-indexed rate. The Company sells
almost all of its long-term, fixed rate, 1-4 family residential loans when they
are originated. This is done in order to manage market risk and liquidity.
A portion of the increase in the June 1997 and December 1997 balance relates to
the acquisition of FVB and CSB.
The average balance and yield for the first quarters of 1998 and 1997 show the
impact of the RAL loans that the Company makes. The average RAL balance
outstanding for the quarters ended March 31, 1998, and 1997 was $31.2 million
and $32.3 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 for the first quarters of 1998 and
1997 is summarized in the section titled "Refund Anticipation Loan and Transfer
Program" below. Average yields for the first quarters of 1998 and 1997 without
the effect of RAL loans were 9.09% and 9.10%, 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 only has the opportunity to increase yields as new loans are
made. In a declining interest rate environment, these loans tend to track market
rates more closely. This is because the borrower may reset the rate by prepaying
the loan if the current market rate for any specific type of loan declines
sufficiently below the contractual rate on the original loan to warrant the
customer refinancing.
The rates on most commercial and construction loans vary with an external index
like the national prime rate or the one year constant maturity treasury ("CMT")
, 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 CMT usually adjust every year.
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,
1998 1997
---------- ------------
Standby letters of credit $23,537 $ 20,716
Loan commitments 34,652 43,356
Undisbursed loans 55,204 59,069
Unused consumer credit lines 63,067 59,073
Unused other credit lines 131,012 130,347
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.
Credit Quality and the Allowance for Credit Losses
The allowance for credit losses is provided in recognition that not all loans
will be fully paid according to their contractual terms. The Company is required
by regulation, generally accepted accounting principles, and safe and sound
banking practices to maintain an allowance that is adequate to absorb losses
that are inherent in the portfolio of loans and leases, including those not yet
identified. The adequacy of this general allowance is based on the size of the
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 credits and Management's outlook for the local and national economies
and how they might affect borrowers. In addition, generally accepted accounting
standards require the establishment of a valuation allowance for impaired loans
as described in Note 5 to the financial statements.
Table 4 shows the amounts of noncurrent loans and nonperforming assets for the
Company at the end of the first quarter of 1998, and at the end of the last four
quarters (in thousands). Also shown for both the Company and its peers3 are the
coverage ratio of the allowance to total loans and the ratio of noncurrent loans
to total loans. RAL's and the portion of the allowance for credit losses that
specifically relates to RAL's are excluded from the Company's figures and ratios
for the table for comparability. Only three other banks operate national RAL and
RT programs.
<TABLE>
Table 4--ASSET QUALITY
<CAPTION>
March 31, December 31, September 30, June 30, March 31,
1998 1997 1997 1997 1997
------------- ------------- ------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
COMPANY AMOUNTS:
Loans delinquent
90 days or more $ 533 $ 812 $ 480 $ 2,565 $ 683
Nonaccrual loans 11,437 9,095 8,143 6,270 5,967
------------- ------------- ------------- ------------- --------------
Total noncurrent loans 11,970 9,907 8,623 8,835 6,650
Foreclosed real estate 200 0 108 0 325
------------- ------------- ------------- ------------- --------------
Total nonper-
forming assets $ 12,170 $ 9,907 $ 8,731 $ 8,835 $ 6,975
============= ============= ============= ============= ==============
Allowance for credit loss $ 22,067 $ 21,148 $ 19,940 $ 19,174 $ 18,531
============= ============= ============= ============= ==============
COMPANY RATIOS:
Coverage ratio of
allowance for credit
losses to total loans 2.43% 2.40% 2.48% 2.43% 2.61%
Coverage ratio of
allowance for credit
losses to noncurrent loans 184% 213% 231% 217% 279%
Ratio of noncurrent
loans to total loans 1.32% 1.12% 1.07% 1.12% 0.94%
Ratio of nonperforming
assets to total assets 0.74% 0.64% 0.61% 0.62% 0.52%
FDIC PEER
GROUP RATIOS:
Coverage ratio of
allowance for credit
losses to total loans n/a 2.11% 2.19% 2.12% 2.00%
Coverage ratio of
allowance for credit
losses to noncurrent loans n/a 199% 195% 190% 179%
Ratio of noncurrent
loans to total loans n/a 1.06% 1.12% 1.12% 1.12%
Ratio of nonperforming
assets to total assets n/a 0.77% 0.82% 0.82% 0.83%
</TABLE>
Nonperforming assets include noncurrent loans and foreclosed collateral
(generally real estate). With the addition of the FVB and CSB portfolios, total
nonperforming assets have increased by $5.2 million at March 31, 1998, compared
to March 31, 1997. As a percentage of total loans, noncurrent loans increased
from 0.94% at March 31, 1997 to 1.32% at March 31, 1998. Over the last twelve
months, as the Company has had an opportunity to review the loans acquired from
FVB and CSB in more depth, it has recognized some uncertainty regarding ultimate
repayment of a portion of the loans even though they may now not be delinquent.
The Company has therefore determined that the current prudent course of action
is to at least temporarily classify these loans as nonaccrual.
The March 31, 1998, balance of noncurrent 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.
The Company has increased the allowance for credit losses other than RAL's to
$22.1 million at March 31, 1998, from $18.5 million at March 31, 1997. This has
resulted in a coverage ratio of allowance to noncurrent loans of 184%. This is
slightly less than the 199% ratio of its peers. Based on its review of the loan
portfolio, Management considers the current amount of the allowance adequate.
Management identifies and monitors other loans which are potential problem loans
although they are not now delinquent more than 90 days. Table 5 classifies
noncurrent loans and all potential problem loans other than noncurrent loans by
loan category for March 31, 1998 (amounts in thousands).
Table 5--NONCURRENT AND POTENTIAL PROBLEM LOANS
Potential Problem
Noncurrent Loans Other Than
Loans Noncurrent
---------- -----------------
Loans secured by real estate:
Construction and
land development $ 430 $ 1,948
Agricultural 1,251 5,485
Home equity lines 303 1,230
1-4 family mortgage 2,970 1,590
Multifamily -- --
Nonresidential, nonfarm 4,489 6,071
Commercial and industrial 1,677 2,415
Leases 347 --
Other consumer loans 503 234
------- --------
Total $11,970 $ 18,973
======= ========
The following table sets forth the allocation of the allowance for all potential
problem loans by classification as of March 31, 1998 (amounts in thousands).
Doubtful $858
Substandard $1,271
Special Mention $406
The total of the above numbers is less than the total allowance. Most of the
allowance is allocated based on historical trends to loans which are not
currently 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 practically all of the tax-exempt municipal
securities and some 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 Treasury securities. The third portfolio, the "Discretionary
Portfolio," consists of shorter term Treasury securities, collateralized
mortgage obligations, asset-backed securities, and a few municipal securities.
The Company specifies whether the security will be held to maturity--and
therefore placed in the Earnings Portfolio--or available for sale at the time of
purchase. Securities may be transferred between the Liquidity and Discretionary
Portfolios at the Company's option.
Table 6 presents the combined securities portfolios, showing the average
outstanding balances (dollars in millions) and the yields for the last five
quarters. The yield on tax-exempt state and municipal securities has been
computed on a taxable equivalent basis. 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>
1997 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury $ 240.0 5.95% $ 201.5 5.95% $ 196.7 5.93% $ 232.3 5.92%
U.S. agency 48.2 6.36 40.0 5.56 37.4 5.84 48.6 5.84
Collateralized
Mortgage Obligations 33.0 6.11 56.4 6.18 64.4 6.37 67.3 6.31
Tax-Exempt 86.3 12.28 101.0 11.77 108.2 11.67 117.5 11.15
Equity Securities 6.2 5.94 7.2 5.70 7.4 5.76 7.7 7.43
------- ------- ------- -------
Total $ 413.7 7.51% $ 406.1 7.39% $ 414.1 7.47% $ 473.4 7.29%
======= ======= ======= =======
1998
U.S. Treasury $ 222.9 5.85%
U.S. agency 63.8 5.75
Collateralized
Mortgage Obligations 85.5 6.23
Tax-Exempt 118.0 11.25
Equity Securities 8.1 5.37
-------
Total $ 498.3 7.20%
=======
</TABLE>
The average balances of securities increased during the last two quarters as the
Company directed funds away from bankers' acceptances for the reason explained
in the section below titled "Bankers' Acceptances."
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 relatively large
unrealized gains in the first table in Note 5 to the financial statements for
the municipal securities indicate the significant reduction in interest rates
that has occurred since most of these securities were purchased in 1985 and
1986. The unrealized gain is therefore a measure of how much more the Company
will earn on these securities until their maturity than it would on comparable
securities purchased at current market rates.
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 at
a cost of approximately $90,000 to protect against the possibility of rapidly
rising rates. While Management was not predicting that interest rates would
rise, the asset/liability modeling indicated at the time that net interest
income at risk from a significant rise would be more than desired. The notional
amount of the contract is $50 million and the hedge covers a fifteen month
period that began July 1, 1997. The contract would pay the Company the rate by
which the 3-month Libor index rate exceeds 7.0% up to a maximum of 1.5%.
Subsequently, interest rates have declined and the Company is simply amortizing
the $90,000 cost over the fifteen months.
The Company has not purchased any securities arising out of a highly leveraged
transaction, and its investment policy prohibits the purchase of any securities
of less than investment grade or so-called "junk bonds."
Federal Funds Sold and Securities Purchased under Agreements to Resell
Cash in excess of the amount needed to fund loans, invest in securities, or
cover deposit withdrawals is sold to other institutions as Federal funds or
invested with other institutions on a collateralized basis as securities
purchased under agreement to resell ("reverse repo agreements"). These
agreements are investments which are collateralized by high quality 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 reverse repo agreements purchased 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 large amount of Federal funds sold, reverse
repo agreements and bankers' acceptances dictate that the Company include them
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 and repurchase agreements
of the Company and the average yields over the last six 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 1996 $58.3 5.34%
March 1997 94.6 5.30
June 1997 92.2 5.64
September 1997 67.0 5.61
December 1997 81.0 5.75
March 1998 83.7 5.75
The average balance sold into the market in the first quarters of 1998 and 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, in the first quarter of 1997, liquidity was increased in
anticipation of the financing requirements relating to the purchase of FVB.
There is another factor which impacts average balances. When the Company is in a
liability sensitive position as discussed in the section above titled "Interest
Rate Risk," Management is reluctant to purchase large amounts of longer-term
securities beyond the amounts necessary to establish and maintain the Company's
maturity ladders because that action would increase the mismatch risk. The
result is higher average balances of Federal funds sold than would otherwise be
the case.
Bankers' Acceptances
Bankers' acceptances are notes owed by a purchaser of merchandise to a vendor.
The notes have been "accepted" or guaranteed by a bank and sold into the
financial markets and function as short-term debt much like commercial paper.
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 have been an effective instrument for managing the timing of
near-term cash flows. 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 1996 $55.3 5.63%
March 1997 69.3 5.57
June 1997 76.3 5.69
September 1997 82.0 5.83
December 1997 60.8 5.85
March 1998 47.0 5.94
All of the acceptances held by the Company were issued by Japanese banks having
prime short-term credit quality ratings. However, because of uncertainty
regarding the Japanese economy, the Company has not replaced maturing
acceptances and the balance has been declining. The Company continues to monitor
these acceptances closely in light of the economic troubles in Asia. All of the
acceptances held at March 31, 1998, had maturity dates of less than 3 months.
Other Borrowings, Long-term Debt and Related Interest Expense
Other borrowings consist of securities sold under agreements to repurchase,
Federal funds purchased (usually only from other local financial institutions as
an accommodation to them), Treasury Tax and Loan demand notes, and borrowings
from the Federal Reserve Bank ("FRB"). 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 for other borrowings the average balance (dollars in
millions), the rates and the proportion of total assets funded by them over the
last six quarters.
Table 9--OTHER BORROWINGS
Average Average Percentage of
Quarter Ended Outstanding Rate Average Total Assets
------------- ------------- -------- --------------------
December 1996 $ 34.3 4.68% 2.8%
March 1997 43.3 4.50 3.2
June 1997 36.2 4.73 2.5
September 1997 24.1 4.97 1.7
December 1997 27.6 4.98 1.8
March 1998 24.9 4.99 1.5
Long-term debt consists of advances from the Federal Home Loan Bank ("FHLB").
The Bank became a member of the FHLB in fourth quarter of 1996. The Bank
borrowed $38 million in December 1996 for the acquisition of leasing assets and
$10 million in September 1997 for interest rate management. The advances are
structured to amortize at $2.5 million declining to $1.0 million per quarter
through the fourth quarter of 2001.
Table 10 indicates the average balances that are outstanding (dollars in
millions) and the rates and the proportion of total assets funded by long-term
debt over the last six quarters.
Table 10--LONG-TERM DEBT
Average Average Percentage of
Quarter Ended Outstanding Rate Average Total Assets
------------- ------------- -------- --------------------
December 1996 $ 6.6 6.13% 0.5%
March 1997 37.6 6.13 2.8
June 1997 37.2 6.12 2.6
September 1997 42.6 6.20 3.0
December 1997 40.1 6.21 2.6
March 1998 37.6 6.19 2.3
Other Operating Income
Other operating income consists of income earned other than interest. On an
annual basis, trust fees are the largest component of other operating income.
Management fees on trust accounts are generally based on the market value of
assets under administration. Table 11 shows trust income over the last six
quarters (in thousands).
Table 11--TRUST INCOME
Quarter Ended Trust Income
------------- ------------
December 1996 $2,144
March 1997 2,480
June 1997 2,377
September 1997 2,599
December 1997 2,522
March 1998 2,865
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 $291,000 of the fees earned in the first quarter of 1997 and
$284,000 of the fees earned in the first quarter of 1998. 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 amount of the fee is established by the court. After adjustment for
these seasonal and non-recurring items and increasing price levels in the stock
market, trust income has been increasing because of growth in the total number
of accounts and dollar balances under management resulting from 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 12 for the last six
quarters (in thousands).
Table 12--OTHER INCOME Other Service
Service Charges Charges,
on Deposit Commissions Other
Quarter Ended Accounts & Fees Income
-------------- --------------- ------------ -------
December 1996 $1,200 $1,284 $211
March 1997 1,195 3,454 177
June 1997 1,373 2,185 161
September 1997 1,361 1,601 240
December 1997 1,543 2,011 333
March 1998 1,521 6,150 161
The unusually large amounts in other service charges, commissions and fees for
the first quarters of 1998 and 1997 are due to $4.33 million and $2.16 million,
respectively, of fees received for the electronic transfer of tax refunds as
explained in the section titled "Refund Anticipation Loan and Refund Transfer
Programs."
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 13 shows the amounts of staff expense incurred over the last six quarters
(in thousands).
Table 13--STAFF EXPENSE
Salary and Profit Sharing and
Quarter Ended Other Compensation Other Employee Benefits
------------- ------------------ -----------------------
December 1996 $5,614 $1,329
March 1997 5,798 2,097
June 1997 5,987 1,683
September 1997 6,431 1,602
December 1997 7,000 1,229
March 1998 7,933 1,582
When the purchase of FVB was completed in the second quarter of 1997, additional
staff was hired to operate the five new branches. Staff expense increased in the
third quarter of 1997 in preparation of branch openings and in support areas to
handle growth in the volume of transactions. Staff expense in the fourth quarter
of 1997 grew as a result of the acquisition of CSB. Besides 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 1997 and 1998, these
averaged 5% and 4% 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 is 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. During the latter quarters of 1997,
Management revised the accrual amounts as it became apparent that net income
would significantly exceed the projected amount upon which bonus accrual was
originally set. Approximately 1/3 of the net income for the year was earned in
the first quarter. Assuming that a similar pattern may occur in 1998, Management
has accrued a larger amount for bonus expense than would be expected in
subsequent quarters.
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 which is based on pre-tax income, limited by
the amount that is deductible for income taxes. In the years prior to 1997, the
deductible amount was greater than the amount computed by the formula, and so,
assuming that the same would be the case in 1997, the Company accrued
contribution expense relative to pre-tax income. This accounts for most of the
large amount of expense in the first quarter of 1997. As the year progressed,
the pre-tax formula generated an amount that would exceed the deductible amount
and contribution expense was reduced in the fourth quarter. For 1998, it is
expected that Company's contribution will be again be limited by the amount that
can be deducted in its tax return. With this assumption, the Company expects to
accrue contribution expense at approximately the same amount each quarter.
OTHER OPERATING EXPENSES
Table 14 shows other operating expenses over the last six quarters (in
thousands).
Table 14--OTHER OPERATING EXPENSE
Occupancy Expense Furniture & Other
Quarter Ended Bank Premises Equipment Expense
------------- ----------------- ----------- -------
December 1996 $1,162 $ 654 $3,904
March 1997 1,137 646 4,474
June 1997 1,265 872 4,188
September 1997 1,409 938 4,671
December 1997 1,430 1,170 6,357
March 1998 1,436 968 5,270
The Company leases rather than owns most of its premises. Many of the leases
provide for annual rent adjustments. Equipment expense fluctuates over time as
needs change, maintenance is performed, and equipment is purchased. Like
occupancy expense, this category has been impacted by the opening of the new
offices in Ventura County and in the second quarter of 1997 with the acquisition
of new branches with the FVB purchase and in the fourth quarter of 1997 with the
acquisition of the new CSB branches.
Table 15 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 15--OTHER EXPENSE
<CAPTION>
Three-Month Periods
Ended March 31,
------------------------------
1998 1997
------------- -------------
<S> <C> <C>
FDIC and State assessments $ 64 $ 52
Professional services 385 386
RAL processing and incentive fees 225 622
Supplies and sundries 227 183
Postage and freight 311 231
Marketing 333 346
Bankcard processing 607 450
Credit bureau 291 229
Telephone and wire expense 391 286
Charities and contributions 106 94
Software expense 394 333
Operating losses 98 64
Other 1,838 1,198
------------- -------------
Total $ 5,270 $ 4,474
============= =============
</TABLE>
Several of the categories above show increases for the first quarter of 1998
compared to the same period of 1997 because of expenses related to the
acquisition of FVB and CSB. 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.
RAL processing and incentive fees are paid to tax preparers and filers based on
the volume and collectibility of the loans made through them. The decline in
these fees reflects the higher loss ratio estimated for the program this year as
discussed in the section below titled "Refund Anticipation Loan and Refund
Transfer Programs."
The amounts in the final line of Table 15 comprise a wide variety of
miscellaneous expenses, none of which total more than 1% of revenues. Included
among these is the net operating cost or benefit of other real estate owned
("OREO"). 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, or if income is received from the rental of the property while the
Company is attempting to dispose of it, the gain or income that is realized is
credited to this category. The Company recorded a net benefit of $5,000 for the
first quarter of 1998 and $75,000 for the first quarter of 1997.
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 that time period, and
(3) "long term liquidity," which is the ability to raise funds over the entire
planning horizon to meet anticipated cash needs due to strategic balance sheet
changes.
Immediate liquidity is provided by the prior day's balance of Federal funds sold
and repurchase agreements, any cash in excess of the Federal Reserve balance
requirement, unused Federal funds lines from other banks, and unused repurchase
agreement facilities with other banks or brokers. The Company maintains total
sources of immediate liquidity of not less than 5% of total assets. At the end
of March 1998, these sources of immediate liquidity were well in excess of that
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 transactions.
Appropriate action is then taken to cover any anticipated unmet needs. At the
end of March 1998, 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 1998, the Company's long term liquidity was
adequate to meet cash needs anticipated over its planning horizon.
Capital Resources and Company Stock
Table 16 presents a comparison of several important amounts and ratios for the
first quarters of 1998 and 1997 (dollars in thousands).
<TABLE>
Table 16--CAPITAL RATIOS
<CAPTION>
1st Quarter 1st Quarter
1998 1997 Change
----------------- ------------------ --------------
<S> <C> <C> <C>
Amounts:
Net Income $ 7,929 $ 6,637 $ 1,292
Average Total Assets 1,642,717 1,350,318 292,399
Average Equity 122,626 111,063 11,563
Ratios:
Equity Capital to Total Assets (period end) 7.58% 8.26% (0.68%)
Annualized Return on Average Assets 1.93% 1.97% (0.04%)
Annualized Return on Average Equity 25.86% 23.90% 1.96%
</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 from quarter to 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 and RT 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, 1998, the Company's risk-based capital ratio was 11.32%. The Company must
also maintain a Tier I capital (total shareholder equity less goodwill and other
intangibles) to average asset ratio of at least 4% to 5%. As of March 31, 1998,
Tier I capital was 10.05% of average assets.
The Company has attempted 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. During the first three months of 1998, approximately 37,000
shares were repurchased compared with the issuance of approximately 152,000
shares in connection with the exercise of stock options.
The dollar amount of total capital did not change as a result of the purchase of
FVB and CSB because the transactions involved only cash consideration, not an
exchange of shares of the Company for the shares of FVB and CSB. However, Tier 1
capital and total risked-based capital were reduced by the $17.8 million of
goodwill recognized. In addition, the capital to asset ratios decreased because
of the addition of the FVB and CSB assets to the denominator of the ratio with
no addition of capital to the nominator. However, all capital ratios 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 dividends needed for the acquisitions of
FVB and CSB exceeded the amount allowable without prior approval of the
California Department of Financial Institutions ("CDFI"). As part of its
approval of the acquisitions, the CDFI approved the excess distributions. During
1997 and for the first quarter of 1998, it also approved other dividends from
the Bank to Bancorp to fund the latter's quarterly cash dividends to its
shareholders and for other incidental purposes. 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 plan 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 most recently declared quarterly cash dividend of $0.15 per share maintains
a ratio for the last twelve months of dividends declared to earnings of 37%.
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, Bancorp is primarily regulated by the Federal Reserve
Bank ("FRB"). 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 CDFI. 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 or to comply with specific laws
and regulations. Such action could take the form of restrictions on the payment
of dividends to shareholders, requirements to obtain more capital from
investors, or restrictions on operations. The Company 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, and
wishes to receive a loan with the refund as security, the taxpayer applies for
and receives an advance less the transaction fees, which are considered finance
charges. The Company is repaid directly by the IRS and remits any refund amount
over the amount due the Company to the taxpayer.
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.
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 electronic loan and transfer programs, the electronic processing
of payments involved in these programs is similar to other payment processing
regularly done by the Company and other commercial banks for their customers
such as direct deposits and electronic bill paying. The RAL and RT programs had
significant impacts on the Company's activities and results of operations during
the first quarters of 1997 and 1998. A more extended description of these
programs may be found in the Company's Form 10-K for 1997.
Gross revenues for the RAL and RT programs were $7.2 million and $2.3 million,
respectively, for the first quarter of 1997, with operating expenses of $1.3
million. The Company added $3.7 million to the RAL allowance for credit loss
through a charge to provision expense during the quarter and added another $1.1
million to the allowance from recoveries on loans charged off in prior years.
The Company charged-off $389,000 in RAL's during this quarter and $5.9 million
for the year.
During the first quarter of 1998, the Company has recognized fees for RAL's of
$6.4 million and fees for RT's of $4.3 million. Operating expenses totaled $1.0
million.
The Company estimates that about 4.25% of RAL's will not be collected in a
timely fashion from the IRS. Using this estimate, during the quarter ended March
31, 1998, the Company provided for these potential losses by adding $5.2 million
to the RAL allowance for credit loss through a charge to provision expense and
adding another $1.9 million to the allowance from recoveries on loans charged
off in prior years. Taking a more aggressive stance with respect to charging-off
loans not repaid within the expected time by the IRS, the Company charged-off
$4.4 million in RAL's against this allowance in the first quarter of 1998. Some
of these loans may yet be paid during the remainder of this year or during the
1999 filing season. In addition, following past practice, the Company expects to
charge-off any remaining uncollected RAL's by June 30.
There is no credit risk associated with the refund transfers because checks are
issued only after receipt of the refund payment from the IRS.
YEAR 2000
The Company is in the process of addressing the possible exposures related to
the impact of the Year 2000. Key financial, information and operational systems
have been assessed and detailed plans have been developed to ensure that Year
2000 systems modifications will be in place by December 1998. As most of the
critical software is purchased from vendors which have either already begun to
make the necessary changes or will be doing so over the next year, the Company
is concentrating its efforts on implementing and initial testing of "Year 2000
Compliant" systems in 1998. Full system testing will be performed in 1999.
Critical software that is not Year 2000 compliant will be replaced. The Company
has budgeted approximately $1.7 million in 1998 to address the Year 2000 issue.
Most of this cost first relates to the assignment of internal staff rather than
the hiring of outside consultants or additional staff and second to the purchase
of equipment and software, the cost of which will be amortized over a number of
years. Management therefore does not anticipate a material impact to the
Company's results of operations or financial position. A similar amount is
likely to be spent in 1999.
- --------
1. To obtain information on the performance ratios for peer banks, the Company
primarily uses The FDIC Quarterly Banking Profile, published by the FDIC
Division of Research and Statistics. This publication provides information about
all FDIC insured banks and certain subsets based on size and geographical
location. Geographically, the Company is included in a subset that includes 12
Western states plus the Pacific Islands. 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 1997. 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 $7.4 million as of March 31, 1998. 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 1998 would
be $26.6 million and the average yield would be 11.46%. There would also be
corresponding reductions for the other quarters shown in the Table 3. The
computation of the taxable equivalent yield is explained in the section titled
"Securities and Related Interest Income."
3. Peer data are computed from statistics reported in FDIC Quarterly Banking
Profile, Fourth Quarter, 1997 for banks with total assets from $1-10 billion.
<PAGE>
PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Index:
Exhibit Number Item Description
27.0398 Financial Data Schedule for March 31, 1998
27.1995 Restated Financial Data Schedule for 1995
27.1996 Restated Financial Data Schedule for 1996
27.0397 Restated Financial Data Schedule for March 31, 1997
The restatements of the Financial Data Schedules give effect to
the stock split mentioned in Item 6(b) below and to the adoption
of Statement of Financial Accounting Standards No. 128, which
changed the computation of earnings per share.
(b) One report on Form 8-K was filed during the quarter ended March
31, 1998. A two-for-one (2:1) split of the outstanding shares of
Common Stock and a corresponding increase in the authorized
number of shares of Common Stock to 40,000,000 was reported on
Form 8-K filed with the Commission on March 10, 1998.
<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 11, 1998
David W. Spainhour
President
Chief Executive Officer
DATE: May 11, 1998
Donald Lafler
Senior Vice President
Chief Financial Officer
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<PERIOD-END> MAR-31-1998
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<OTHER-SE> 119,119
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<INTEREST-DEPOSIT> 10,723
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<S> <C>
<PERIOD-TYPE> YEAR
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<PERIOD-END> DEC-31-1995
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0
0
<OTHER-SE> 95,878
<TOTAL-LIABILITIES-AND-EQUITY> 1,212,361
<INTEREST-LOAN> 52,649
<INTEREST-INVEST> 23,114
<INTEREST-OTHER> 6,425
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<INTEREST-INCOME-NET> 48,605
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<EXPENSE-OTHER> 41,969
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<EPS-PRIMARY> 0.68
<EPS-DILUTED> 0.67
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<FED-FUNDS-SOLD> 70,000
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<INVESTMENTS-CARRYING> 276,359
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<ALLOWANCE> 16,572
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<DEPOSITS> 1,113,083
<SHORT-TERM> 34,490
<LIABILITIES-OTHER> 8,154
<LONG-TERM> 38,000
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0
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<OTHER-SE> 102,534
<TOTAL-LIABILITIES-AND-EQUITY> 1,301,320
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<PERIOD-END> MAR-31-1997
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