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 September 30, 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 November 13, 1998 there were 15,430,470 shares of the
issuer's common stock outstanding.
<PAGE>
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997
Consolidated Statements of Income
Nine-Month and Three-Month Periods Ended September 30, 1998 and 1997
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1998 and 1997
Consolidated Statements of Comprehensive Income
Nine-Month and Three-Month Periods September 30, 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>
September 30, 1998 December 31, 1997
-------------------- -------------------
<S> <C> <C>
Assets:
Cash and due from banks $ 46,191 $ 67,799
Federal funds sold and securities purchased under
agreement to resell 127,000 48,000
-------------- --------------
Cash and cash equivalents 173,191 115,799
-------------- --------------
Securities (Note 4):
Held-to-maturity 200,217 222,350
Available-for-sale 329,701 286,998
-------------- --------------
Total securities 529,918 509,348
-------------- --------------
Bankers' acceptances - 49,400
Loans, net of allowance of $24,247
September 30, 1998 and $21,148 at
December 31, 1997 (Note 5) 950,155 860,400
Premises and equipment, net (Note 6) 15,168 13,595
Accrued interest receivable 10,146 10,328
Other assets (Note 7) 35,247 33,516
-------------- --------------
Total assets $ 1,713,825 $ 1,592,386
============== ==============
Liabilities:
Deposits:
Noninterest bearing demand deposits $ 275,422 $ 265,751
Interest bearing deposits 1,238,147 1,138,404
-------------- --------------
Total deposits 1,513,569 1,404,155
-------------- --------------
Securities sold under agreements
to repurchase and Federal funds purchased 22,700 21,293
Long-term debt and other borrowings (Note 9) 31,500 39,000
Accrued interest payable and other liabilities 12,862 9,772
-------------- --------------
Total liabilities 1,580,631 1,474,220
-------------- --------------
Shareholders' equity:
Common stock (no par value; $0.33 per share stated value;
40,000,000 authorized; 15,430,470 outstanding at
September 30, 1998 and 15,242,864 at December 31, 1997) 5,145 5,081
Surplus 33,372 32,790
Accumulated other comprehensive income (Note 8) 3,022 496
Retained earnings 91,655 79,799
-------------- --------------
Total shareholders' equity 133,194 118,166
-------------- --------------
Total liabilities and shareholders' equity $ 1,713,825 $ 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 Nine-Month For the Three-Month
Periods Ended Periods Ended
September 30, September 30,
--------------------------- ---------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Interest income:
Interest and fees on loans $ 70,236 $ 59,358 $ 21,669 $ 18,341
Interest on securities 23,574 19,561 8,006 6,583
Interest on Federal funds sold and securities
purchased under agreement to resell 3,818 3,479 1,592 947
Interest on bankers' acceptances 930 3,237 23 1,204
------------ ------------ ------------ ------------
Total interest income 98,558 85,635 31,290 27,075
------------ ------------ ------------ ------------
Interest expense:
Interest on deposits 32,964 28,399 11,427 9,927
Interest on securities sold under agreements
to repurchase and Federal funds purchased 748 1,178 241 287
Interest on other borrowed funds 1,675 1,833 522 673
------------ ------------ ------------ ------------
Total interest expense 35,387 31,410 12,190 10,887
------------ ------------ ------------ ------------
Net interest income 63,171 54,225 19,100 16,188
Provision for loan losses 6,993 6,980 750 733
------------ ------------ ------------ ------------
Net interest income after provision for loan losses 56,178 47,245 18,350 15,455
------------ ------------ ------------ ------------
Other operating income:
Service charges on deposits 4,660 3,928 1,571 1,361
Trust fees 8,581 7,463 2,900 2,599
Other service charges, commissions and fees 11,339 7,194 2,495 1,601
Net gain (loss) on securities transactions 221 (416) 101 36
Other operating income 529 579 157 240
------------ ------------ ------------ ------------
Total other income 25,330 18,748 7,224 5,837
------------ ------------ ------------ ------------
Other operating expense:
Salaries and benefits 27,362 23,598 8,669 8,033
Net occupancy expense 4,516 3,811 1,613 1,409
Equipment expense 3,201 2,455 1,190 938
Other expense 16,625 13,133 6,048 4,624
------------ ------------ ------------ ------------
Total other operating expense 51,704 42,997 17,520 15,004
------------ ------------ ------------ ------------
Income before income taxes 29,804 22,996 8,054 6,288
Applicable income taxes 10,561 7,581 2,868 2,009
------------ ------------ ------------ ------------
Net income $ 19,243 $ 15,415 $ 5,186 $ 4,279
============ ============ ============ ============
Earnings per share - basic (Note 2) $ 1.25 $ 1.02 $ 0.34 $ 0.28
Earnings per share - diluted (Note 2) $ 1.23 $ 0.99 $ 0.33 $ 0.27
<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 Nine Months Ended September 30,
1998 1997
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 19,243 $ 15,415
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation and amortization 3,623 1,987
Provision for loan and lease losses 6,993 6,980
(Provision)Benefit for deferred income taxes 1,348 (169)
Net writedown on other real estate owned 54 50
Net amortization of discounts and premiums for
securities and bankers' acceptances (2,031) (3,375)
Net change in deferred loan origination
fees and costs (33) 15
(Increase) decrease in accrued interest receivable 182 (552)
Increase in accrued interest payable 198 97
Net (gain) loss on sales and calls of securities (221) 416
Increase in prepaid expenses (858) (267)
Increase (decrease) in accrued expenses 1,096 (1,515)
Net gain on sales of OREO (130) (103)
Decrease (increase) in service fee and other
income receivable (44) 207
Increase (decrease) in income taxes payable 1,257 (3,557)
Other operating activities (2,399) 1,256
------------ ------------
Net cash provided by operating activities 28,278 16,885
------------ ------------
Cash flows from investing activities:
Proceeds from call or maturity of securities 65,539 68,696
Purchase of securities (128,017) (188,514)
Proceeds from sale of securities 49,519 99,225
Proceeds from maturity of bankers' acceptances 63,357 128,601
Purchase of bankers' acceptances (14,671) (132,494)
Net increase in loans made to customers (96,597) (123,458)
Disposition of property from defaulted loans 218 1,654
Purchase or investment in premises and equipment (4,311) (8,458)
Purchase of investment real estate -- (598)
Excess of purchase price over net assets
for purchase of First Valley Bank -- (10,037)
------------ ------------
Net cash used in investing activities (64,963) (165,383)
------------ ------------
Cash flows from financing activities:
Net increase in deposits 109,414 143,673
Net increase in borrowings with
maturities of 90 days or less 1,407 --
Net (decrease) increase in long-term debt and
other borrowings (7,500) 12,443
Proceeds from issuance of common stock 263 3,712
Payments to retire common stock (2,915) (5,539)
Dividends paid (6,592) (5,012)
------------ ------------
Net cash provided by financing activities 94,077 149,277
------------ ------------
Net increase in cash and cash equivalents 57,392 779
Cash and cash equivalents at beginning of period 115,799 121,181
------------ ------------
Cash and cash equivalents at end of period $ 173,191 $ 121,960
============ ============
Supplemental disclosure:
Interest paid during period $ 35,189 $ 31,313
Income taxes paid during period $ 6,445 $ 18,406
Non-cash additions to other real estate owned $ 200 $ 183
Non-cash additions to loans $ 317 $ --
<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)
<CAPTION>
For the Nine-Month For the Three-Month
Periods Ended Periods Ended
September 30, September 30,
------------------------------- -------------------------------
1998 1997 1998 1997
------------------------------- -------------------------------
<S> <C> <C> <C> <C>
Net income $ 19,243 $ 15,415 $ 5,186 $ 4,279
------------ ------------ ------------ ------------
Other comprehensive income, net of tax (Note 8) -
Unrealized gains (loss) on securities:
Unrealized holding gains (losses) arising during period 2,533 318 2,353 277
Reclassification adjustment for (gains) losses
included in net income (7) -- (5) (16)
------------ ------------ ------------ ------------
Other comprehensive income 2,526 318 2,348 261
============ ============ ============ ============
Comprehensive income $ 21,769 $ 15,733 $ 7,534 $ 4,540
============ ============ ============ ============
<FN>
See accompanying notes to consolidated condensed financial statements.
</FN>
</TABLE>
<PAGE>
Santa Barbara Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 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. All references to "the
Company" apply to Santa Barbara Bancorp and its subsidiaries. "Bancorp" will be
used to refer to the parent company only. 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 the potential issuance of common shares. For the Company,
these include only shares issuable on the exercise of outstanding stock options.
SFAS 128 requires the restatement of earnings per share for all prior periods
presented in the Company's financial statements.
For the nine and three-month periods ended September 30, 1998 and 1997, the
computation of basic and diluted earnings per share were as follows (shares and
net income amounts in thousands):
<TABLE>
<CAPTION>
Nine-month Period Three-month Period
Basic Diluted Basic Diluted
Earnings Earnings Earnings Earnings
Per Share Per Share Per Share Per Share
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
September 30, 1998
Numerator --net income $ 19,243 $ 19,243 $ 5,186 $ 5,186
Denominator --weighted average
shares outstanding 15,340 15,340 15,404 15,404
Plus: net shares issued in
assumed stock option exercises 331 304
Diluted denominator 15,671 15,708
Earnings per share $1.25 $1.23 $0.34 $0.33
September 30, 1997
Numerator --net income $ 15,415 $ 15,415 $ 4,279 $ 4,279
Denominator --weighted average
shares outstanding 15,185 15,185 15,211 15,211
Plus: net shares issued in
assumed stock option exercises 383 402
Diluted denominator 15,568 15,613
Earnings per share $1.02 $0.99 $0.28 $0.27
</TABLE>
Weighted average shares and net shares issued in assumed stock option exercises
for the nine and three-month periods ended September 30, 1998 and 1997 were
adjusted for the 2 for 1 stock split paid 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 nine and three-month periods ended September 30, 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.
Securities which are classified as held-to-maturity are carried at amortized
historical cost. Amortized historical cost is the purchase price increased by
the accretion of discounts or decreased by the amortization of premiums using
the effective interest method. Discount is any excess of the face value of the
security over the cost. Premium is any 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 8. 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 Bank of San Francisco ("FRB") and the
Federal Home Loan Bank of San Francisco ("FHLB"). The shares of stock in these
organizations required to be purchased as a condition of membership are reported
as equity securities.
<PAGE>
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>
September 30, 1998
Amortized cost:
In one year or less $ 48,065 $ 63,891 $ 111,956
After one year through five years 102,168 230,673 332,841
After five years through ten years 11,226 9,127 20,353
After ten years 38,758 12,446 51,204
Equity securities -- 8,329 8,329
-------------------------------------
Total securities $ 200,217 $ 324,466 $ 524,683
=====================================
Estimated market value:
In one year or less $ 48,542 $ 64,376 $ 112,918
After one year through five years 108,764 234,791 343,555
After five years through ten years 14,069 9,385 23,454
After ten years 47,175 12,820 59,995
Equity securities -- 8,329 8,329
-------------------------------------
Total securities $ 218,550 $ 329,701 $ 548,251
=====================================
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
-------------------------------------
Total securities $ 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
-------------------------------------
Total securities $ 238,449 $ 286,998 $ 525,447
=====================================
</TABLE>
The amortized historical cost, market values and gross unrealized gains and
losses 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>
September 30, 1998
Held-to-maturity:
U.S. Treasury obligations $ 57,975 $ 1,272 $ -- $ 59,247
U.S. agency obligations 32,478 398 -- 32,876
State and municipal securities 109,764 16,716 (53) 126,427
-------------------------------------------
Total held-to-maturity 200,217 18,386 (53) 218,550
-------------------------------------------
Available-for-sale:
U.S. Treasury obligations 103,895 1,426 -- 105,321
U.S. agency obligations 90,141 2,327 -- 92,468
Collateralized mortgage obligations 91,464 864 (2) 92,326
Asset backed securities 14,135 142 -- 14,277
State and municipal securities 16,502 478 -- 16,980
Equity securities 8,329 -- -- 8,329
-------------------------------------------
Total available-for-sale 324,466 5,237 (2) 329,701
-------------------------------------------
Total securities $ 524,683 $ 23,623 $ (55) $ 548,251
===========================================
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 by the issuer
prior to their maturity. In these situations, gains or losses may be realized.
Gains or losses may be realized on securities in the available-for-sale
portfolio as the result of sales of these securities carried out in response to
changes in interest rates or for other reasons related to the management of the
components of the balance sheet.
5. Loans
The balances in the various loan categories are as follows:
<TABLE>
<CAPTION>
(in thousands) September 30, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
Real estate:
Residential $ 300,371 $ 246,283
Non-residential 233,639 249,725
Construction 21,234 16,127
Commercial loans 203,528 184,374
Home equity loans 33,193 37,150
Consumer loans 99,431 75,151
Leases 68,692 61,108
Municipal tax-exempt obligations 9,424 7,931
Other loans 4,890 3,699
---------- ----------
Total loans $ 974,402 $ 881,548
========== ==========
</TABLE>
The loan balances at September 30, 1998 and December 31, 1997 are net of
approximately $2,750,170 and $2,782,000, respectively, in deferred net loan fees
and origination costs.
Specific kinds of loans are identified as impaired when it is probable that
interest and principal will not be collected according to the contractual terms
of the loan agreements. 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 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 fully
secured by collateral and for which collection is being actively pursued. These
impaired loans are not classified as nonaccrual.
Impaired loans are reviewed each quarter to determine whether a valuation
allowance for loan loss is required. 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. The first method is to estimate
the expected future cash flows and then discount them at the effective interest
rate. The second method is to use the loan's observable market price if the loan
is of a kind for which there is a secondary market. The third method is to use
the value 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
September 30, 1998 and December 31, 1997:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
Loans identified as impaired $3,835 $4,980
Impaired loans for which a valuation
allowance has been determined $ 310 $ 702
Impaired loans for which no valuation
allowance was determined necessary $3,525 $4,278
Amount of valuation allowance $ 160 $ 60
</TABLE>
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 September 30, 1998 and
December 31, 1997, because for most impaired loans, the collateral is in excess
of the recorded investment.
The following table discloses additional information (dollars in thousands)
about impaired loans for the nine and three-month periods ended September 30,
1998 and 1997:
<TABLE>
<CAPTION>
Nine-month Periods Three-month Periods
Ended September 30, Ended September 30,
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Average amount of recorded
investment in impaired loans $5,450 $3,939 $3,783 $3,001
Collections of interest from
impaired loans and recognized
as interest income $ -- $ 201 $ -- $ 173
</TABLE>
The Company also provides an allowance for losses for: (1) specific loans which
are not included in one of the types of loans covered by the concept of
"impairment" 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 against the allowance
for credit loss. Uncollectibility is determined based on the individual
circumstances of the loan and historical trends.
The valuation allowance for impaired loans of $160,000 is included with the
general allowance for credit losses to total the $24.04 million reported on the
balance sheet for September 30, 1998, which these notes accompany, and in the
"All Other" column in the statement of changes in the allowance account for the
first nine 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 Loans Other Loans Total
---------------------------------------------
<S> <C> <C> <C>
Balance, December 31, 1997 $ 325 $ 20,823 $ 21,148
Provision for loan losses 4,941 2,052 6,993
Loan losses charged against allowance (7,221) (2,127) (9,348)
Loan recoveries added to allowance 2,159 3,295 5,454
------------ ------------ ------------
Balance, September 30, 1998 $ 204 $ 24,043 $ 24,247
============ ============ ============
</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
$2,734 and $1,987 for the nine-month periods ended September 30, 1998 and 1997,
respectively, and $1,003 and $824 for the three-month periods ended September
30, 1998 and 1997, respectively. The following table shows the balances by major
category of fixed assets:
<TABLE>
<CAPTION>
(in thousands) September 30, 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 $10,978 $ 4,631 $ 6,347 $10,902 $ 4,422 $ 6,480
Leasehold improvements 7,513 5,583 1,930 6,961 5,184 1,777
Furniture and equipment 24,060 17,169 6,891 20,392 15,054 5,338
----------------------------- -----------------------------
Total $42,551 $27,383 $15,168 $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 September, 1998, the Company had $57,787 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 September 30 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. 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.
When a security that had been classified as available-for-sale is sold, a
realized gain or loss will be included in net income and, therefore, in
comprehensive income. Consequently, the recognition of any unrealized gain or
loss for that security that had been included in comprehensive income in an
earlier period must be reversed. These adjustments are reported in the
consolidated statements of comprehensive income as reclassification adjustment
for gains (losses) included in net income.
9. Long-term Debt and Other Borrowings
Long-term debt and other borrowings included $30.5 million and $38.0 million of
advances from the Federal Home Loan Bank of San Francisco at September 30, 1998
and December 31, 1997, respectively.
10. New Accounting Pronouncements
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information", was issued on June 30, 1997 and will
become effective for the Company for its 1998 annual report on Form 10-K. This
statement relates to disclosure only and should have no impact on the financial
condition or operating results of the Company.
Statement of Financial Accounting Standards No. 132, "Employers' Disclosures
about Pension and Other Postretirement Benefits", was issued during the first
quarter of 1998 and will become effective for the Company for its 1998 annual
report on Form 10-K. This statement relates to disclosure only and should have
no impact on the financial condition or operating results of the Company.
Statement of Financial Accounting Standards No. 133, "Accounting Derivative
Instruments and Hedging Activities", was issued during the second quarter of
1998 and will become effective for the Company as of January 1, 2000. This
statement is not expected to have a material impact on the operating results or
the financial position of the Company.
11. Merger
On July 20, 1998, the Company signed a definitive agreement with Pacific Capital
Bancorp of Salinas to merge in a pooling of interests transaction. Pacific
Capital Bancorp is the parent company of two banks, First National Bank of
Central California and South Valley National Bank. This combination will create
a multi-bank holding company with approximately $2.57 billion in assets. The
agreement provides for Pacific Capital Bancorp shareholders to receive 1.935
shares of Company common stock in exchange for each of their outstanding common
shares. Subject to shareholder and regulatory approvals, the merger is expected
to close in the fourth quarter of 1998.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SUMMARY
Santa Barbara Bancorp (the "Company") posted earnings of $5.18 million for the
quarter ended September 30, 1998, up 21% over the same quarter last year. Third
quarter earnings continue the trend of the previous twelve quarters in which net
income has been higher than the same quarter of the prior year. Diluted per
share earnings for the third quarter of 1998 were $0.33 compared to $0.27 earned
in the third 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 third quarter of 1997, net interest income (the difference
between interest income and interest expense) increased by $2.9 million in the
third quarter of 1998, an increase of 19%. This was due primarily to growth in
loans. The Company's purchase of Citizens State Bank ("CSB") in October, 1997,
contributed to significant growth in loans and deposits. Interest on loans
increased $3.3 million as the loan balances increased from $804 million at
September 30, 1997, to $974 million a year later. $42 million of this growth in
loans was due to the acquisition. Deposits increased $257 million or 20% over
the last 12 months, while interest expense increased 12.7%.
Noninterest income, exclusive of gains or losses on securities transactions,
increased by $1.3 million over the same quarter of 1997. Trust and Investment
Services fees were up $301,000, service fees for other nondeposit-related
services increased by $894,000, and other service fees earned on the new deposit
accounts gained with the acquisition also added to the increase over 1997.
Delinquent and nonperforming loans which totaled $7.9 million at the end of the
third quarter of 1998 are approximately $680,000 lower than a year ago.
Provision expense for third quarter and first nine months of 1998 was virtually
the same as for the corresponding periods of 1997. The allowance for credit loss
increased from $19.9 million at September 30, 1997 to $24.2 million at September
30, 1998.
Noninterest expenses increased in the third quarter of 1998 compared to the same
quarter of 1997, primarily due to geographic expansion. Three offices were added
in Santa Paula and Fillmore from the acquisition of CSB and three new offices
were opened, two in Ventura County and one in Northern Santa Barbara County. As
a result, increases occurred in salary costs, occupancy, equipment and
marketing. The Company recognized approximately $7.5 million in goodwill from
the CSB acquisition, which will be amortized over a period of 15 years.
Amortization expense in the third quarter of 1998 related to this goodwill was
approximately $125,000. In addition, during the third quarter, the Company
incurred $683,000 of expense relating to its pending merger with Pacific Capital
Bancorp. The 17% growth rate of noninterest expense was slightly lower than the
23% rate of growth in noninterest income (exclusive of gains and losses on
securities) and the 19% rate of growth in net interest income. As a result, the
operating efficiency ratio, which measures how many cents of expense it takes to
earn a dollar of operating income, decreased slightly from $0.65 for the third
quarter of 1997 to $0.64 for the third quarter of 1998.
In comparing the results for the third quarter of 1998 with the same quarter a
year ago, the acquisition of First Valley Bank ("FVB") is not among the reasons
for the increase in earnings because the results of operations for the acquired
branches of FVB were included in the third quarter 1997 amounts. In comparing
the results for the first nine months of 1998 with the same period of 1997, this
acquisition does account for some of the asset and deposit growth and increase
in net income.
As discussed in the section titled "Merger with Pacific Capital Bancorp", the
Company has announced a merger with Pacific Capital Bancorp of Salinas. Pacific
Capital Bancorp is the parent company of First National Bank of Central
California and South Valley National Bank. Subject to approvals, the merger is
expected to close in the fourth quarter of 1998.
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
This analysis contains forward-looking statements with respect to the financial
conditions, results of operations and businesses of Santa Barbara Bancorp and,
assuming consummation of the merger between the two as discussed in the section
entitled "Merger with Pacific Capital Bancorp", a combined Santa Barbara
Bancorp/Pacific Capital Bancorp. These include statements relating to: (a) the
cost savings and accretion to reported earnings that will be realized from the
merger; and (b) the restructuring charges expected to be incurred in connection
with the merger. These forward-looking statements involve certain risks and
uncertainties. Factors that may cause actual results to differ materially from
those contemplated by such forward-looking statements include, among others, the
following possibilities: (1) expected cost savings from the merger are not fully
realized or realized within this expected timeframe; (2) revenues following the
merger are lower than expected; (3) competitive pressure among financial
services companies increases significantly; (4) costs or difficulties related to
the integration of the businesses of Santa Barbara Bancorp and Pacific Capital
Bancorp are greater than expected; (5) changes in the interest rate environment
reduce interest margins; (6) general economic conditions, internationally,
nationally or in the State of California, are less favorable than expected; (7)
changes in the IRS's handling of electronic filing and refund payments adversely
affect the Company's RAL and refund transfer ("RT") programs; and (8)
legislation or regulatory requirements or changes adversely affect the business
in which the combined company will be engaged.
TOTAL ASSETS AND EARNINGS 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 the deposit balances 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.
<PAGE>
Chart 1 GROWTH IN AVERAGE ASSETS AND
DEPOSITS
$1,700
AA
$1,650 AAAA AA
A A A
$1,600 A AAA
A
$1,550 A
A
$1,500 A
A DDD
$1,450 A DD
AAAAAAA DDDDDDDD
$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 2nd 3rd
'95 '96 '96 '96 '96 '97 '97 '97 '97 '98 '98 '98
A = Assets D = Deposits
Continued consolidation in the financial services industry, acquisition of a
leasing portfolio and of FVB and CSB, and the opening in this period of three
offices in Ventura County and one new office in Northern Santa Barbara County
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. These include increases to assets and
deposits from the RAL and RT programs which primarily affect the first quarter
of each year and cash outflows for tax payments which impact the second quarter.
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 and $58.3 million during the first quarter of 1998. Average
assets during the first quarter of 1997 included RAL's of $31.2 million and
during the first quarter of 1998, average assets included $32.3 million in
RAL's. This pattern did not hold for 1997 because $124 million in assets and
$108 million in deposits were obtained in the FVB purchase at the beginning of
the second quarter. Without these 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. The CSB acquisition in the fourth quarter of 1997,
added $93.1 million in assets and $82.2 million in deposits.
Earning assets consist of the various assets on which the Company earns interest
income. On average, the Company earned interest on 95% of its assets during the
first nine months of 1998. This compares with an average of 89% for all
FDIC-Insured Commercial Banks. (See Note 1. Notes to this analysis are found at
the end of this analysis.) 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 nine 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 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 approximately 81% 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 ("10-K MD&A") for a more
complete discussion.
Some of the Company's loans, securities, and deposits have rates of interest
fixed for some term. Market risk is the risk that the market value of these
financial instruments will decrease with changes in market interest rates. This
exposure to market risk is managed by limiting the amount of fixed rate assets
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. The Company's target is stated
as a percentage of total assets and 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 or contractual resetting of their interest rates. 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
and the frequency of changes in external market rates. 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 September 30, 1998,
the gap for this first period is a positive 4.40%. At the end of the fourth
quarter of 1997, the gap was a negative 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 1.11%.
In the third period, after six months but within one year, liabilities exceed
assets by 24.90% of total assets, reflecting the current customer preference for
short-term deposits. The cumulative gap within one year is a negative 19.40% of
assets. Management is planning actions to be taken should this cumulative gap
increase.
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 September 30, 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 $ 369,957 $ 94,886 $ 84,535 $ 356,030 $ 59,124 $ (14,378) $ 950,154
Cash and due from banks -- -- -- -- -- 46,191 46,191
Money market investments 127,000 -- -- -- -- -- 127,000
Securities 124,712 39,173 39,637 252,137 60,696 13,563 529,918
Other assets -- -- -- -- -- 60,562 60,562
---------------------------------------------------------------------- ----------
Total assets 621,669 134,059 124,172 608,167 119,820 105,938 $1,713,825
---------------------------------------------------------------------- ==========
Liabilities and shareholders' equity:
Borrowed funds:
Repurchase agreements and
Federal funds purchased 22,700 -- -- -- -- -- 22,700
Other borrowings 3,500 2,500 5,000 20,500 -- -- 31,500
Interest-bearing deposits:
Savings and interest-bearing
transaction accounts 351,302 -- 422,855 -- -- -- 774,157
Time deposits 168,776 112,585 114,986 65,462 2,179 -- 463,988
Demand deposits -- -- -- -- -- 275,422 275,422
Other liabilities -- -- 8,137 -- -- 4,727 12,864
Shareholders' equity -- -- -- -- -- 133,194 133,194
---------------------------------------------------------------------- ----------
Total liabilities and
shareholders' equity 546,278 115,085 550,978 85,962 2,179 413,343 $1,713,825
---------------------------------------------------------------------- ==========
Interest rate-
sensitivity gap $ 75,391 $ 18,974 $(426,806) $ 522,205 $ 117,641 $ (307,405)
======================================================================
Gap as a percentage of
total assets 4.40% 1.11% (24.90%) 30.47% 6.86% (17.94%)
Cumulative interest
rate-sensitivity gap $ 75,391 $ 94,365 $(332,441) $ 189,764 $ 307,405
Cumulative gap as a
percentage of total assets 4.40% 5.51% (19.40%) 11.07% 17.94%
<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 and securities
purchased under agreements to resell.
</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.
The modeling simulates 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. The hypothetical scenarios include both
sudden and gradual interest rate changes, and interest rate changes in both
directions.
The most recent modeling using other hypothetical scenarios also confirms that
the Company's interest rate risk profile is balanced, and that the results are
within normal expectations.
A standard practice in the industry is to compute the impacts of interest rate
"shocks" applied to the Company's asset and liability balances. Although
interest rates normally would not change suddenly in this manner, this exercise
is valuable in identifying exposures to risk and in providing comparability both
with other institutions and between periods. 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 the rate changes. The results
reported below for the Company's December 31, 1997, and September 30, 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:
<TABLE>
<CAPTION>
Shocked by -2% Shocked by +2%
-------------- --------------
<S> <C> <C>
As of December 31, 1997
Net interest income +1.42% (1.04%)
Net economic value +14.29% (14.08%)
As of September 30, 1998
Net interest income +2.42% +2.06%
Net economic value +19.56% (21.11%)
</TABLE>
For these computations, 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 results 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 changes in net interest income and net economic value resulting from the
hypothetical increases and decreases in rates are not exactly symmetrical in
that the same percentage of increase and decrease in the hypothetical interest
rate will not cause the same percentage change in net interest income or net
economic value. This occurs because various contractual limits and
non-contractual factors come into play. An example of the former is the
"interest rates cap" on loans, which may limit the amount that rates may
increase. An example of the latter is the assumption on how low rates could be
lowered on administered rate accounts. The degree of symmetry changes as the
base rate changes from period to period and as there are changes in the
Company's product mix. For instance, the assumed floors on deposit rates are
more likely to come into play in a 2% decrease if the base rate is lower. The
caps on loan rates which generally are present only in consumer loans would have
more of an impact on the overall result to the extent that consumer variable
rate loans are a larger proportion of the portfolio than in a previous period.
The Company's exposure to interest rate risk as of December 31, 1997, is
discussed in more detail in the 10-K MD&A. There have been no material changes
to this exposure during the first nine months 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. The
rate of growth of any financial institution is restrained by the capital
requirements discussed in the section of this analysis titled "Capital Resources
and Company Stock". The orderly growth experienced by the Company 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 seven quarters (dollars
in millions). As shown both in Chart 1 and in Table 2, average deposits for the
third quarter of 1998 have increased $236.9 million or 19.2% 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>
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 4.17% 1,035.9 4.21% 1,134.8 3.81%
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% $ 179.3 1.15% $ 182.6 1.16%
Money market deposit accounts 417.5 3.74 430.4 3.74 444.3 3.72
Savings accounts 126.7 2.31 126.6 2.30 133.6 2.35
Time certificates of deposit for
less than $100,000 and IRA's 269.6 5.53 269.9 5.42 272.8 5.36
Time certificates of deposit for
$100,000 or more 146.8 5.38 145.4 5.27 169.5 5.25
-------- -------- --------
Interest bearing deposits 1,140.3 3.81% 1,151.6 3.77% 1,202.8 3.77%
Demand deposits 293.7 261.5 268.9
-------- -------- --------
Total deposits $1,434.0 $1,413.1 $1,471.7
======== ======== ========
</TABLE>
Table 2 shows that the rates paid on NOW, MMDA, and savings accounts have
remained quite stable over the last four quarters while the rates on time
certificate accounts have declined. The average rates that are paid on deposits
generally trail behind money market rates because financial institutions do not
change interest rates on NOW, MMDA, and savings accounts with each small
increase or decrease in short-term rates. Generally, this trailing
characteristic is stronger with time deposits than with deposit types that have
administered rates like NOW, MMDA, and saving accounts. 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 such as Certificates of deposit. 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.
However, because interest rates on the administered rate accounts have been low
for several years, the Company along with other financial institutions has been
reluctant to decrease rates further.
The average balances for noninterest-bearing demand deposits during the second
quarter 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 $58.3 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 as to create a need for funds such that
the Company would encourage, large deposits through premium rates. 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, such as Federal funds. Since Federal funds sold earned
between 5.30% and 5.80% during 1997 and the first nine 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 yields (Note 2) over the last eight
quarters (dollars in millions),
<TABLE>
Table 3--LOAN BALANCES AND YIELDS
<CAPTION>
EOP Average Interest Average
Quarter Ended Outstanding Outstanding and Fees Yield
- ----------------------- ------------- ------------- ------------ ---------
<S> <C> <C> <C> <C>
December 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
June 1998 938.3 925.5 22.1 9.55
September 1998 974.4 953.1 21.7 9.07
</TABLE>
The end-of-period loan balance as of September 30, 1998, has increased by $92.9
million compared to December 31, 1997, and by $170.5 million compared to
September 30, 1997. Residential real estate loans have increased as a result of
increased purchase activity in the Company's market areas and due to refinancing
activity prompted by the favorable interest rate environment. Most of the
residential real estate loans are adjustable rate mortgages ("ARMS") that have
initial "teaser" rates. The yield increases for these loans as the teaser rates
expire. Applicants for these loans are qualified based on the fully-indexed
rate. Effective June 1, 1998, the Company began retaining a portfolio of long
term, fixed-rate 1-4 family residential loans. These totaled $67.7 million at
September 30, 1998. Previously, the Company had sold almost all of its long
term, fixed-rate residential loans. Commercial loans have increased largely due
to growth in loans to agricultural borrowers. The consumer loan portfolio has
increased primarily because an increased number of indirect auto loans. Indirect
auto loans are loans purchased from auto dealers. The dealers' loans must meet
the credit criteria set by the Company. The Company also acquired a $7.0 million
mobile home portfolio early in 1998.
Portions of the increases in the balance for the quarters ended June 1997 and
December 1997 compared to prior quarters relate to the acquisition of FVB and
CSB, respectively.
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 RAL loans are extended to
taxpayers who have filed their returns electronically with the IRS 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. More information on this program may be found in the section titled
"Refund Anticipation Loan and Transfer Program" below and in the 10-K MD&A.
Average yields for the first quarter 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 that 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.
<TABLE>
<CAPTION>
(in thousands) September 30, December 31,
1998 1997
---- ----
<S> <C> <C>
Standby letters of credit $ 24,493 $ 20,716
Loan commitments 22,216 43,356
Undisbursed loans 56,331 59,069
Unused consumer credit lines 68,133 59,073
Unused other credit lines 140,476 130,347
</TABLE>
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 expected needs to handle contingencies.
The Company has established maximum loan amount to collateral value ratios for
commercial real estate loans ranging from 50% to 75% depending on the type of
project. Maximum loan-to-value ratios for residential real estate loans range
from 65% to 90%. There are no specific maximum 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 collected are
generally less than the origination costs incurred 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 third quarter of 1998, and at the end of the previous
four quarters (in thousands). Also shown for both the Company and its peers
(Note 3) 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 two other banks operate
national RAL and RT programs.
Nonperforming assets include noncurrent loans and foreclosed collateral
(generally real estate). Total nonperforming assets have decreased by $729,000
at September 30, 1998, compared to September 30 1997, and as a percentage of
total loans, noncurrent loans decreased from 1.07% at September 30, 1997 to
0.82% at September 30, 1998.
<TABLE>
Table 4--ASSET QUALITY
<CAPTION>
September 3 June 30, March 31, December 31, September 30,
1998 1998 1998 1997 1997
----------- --------- --------- ----------- -------------
<S> <C> <C> <C> <C> <C>
COMPANY AMOUNTS:
Loans delinquent
90 days or more $ 141 $ 748 $ 533 $ 812 $ 480
Nonaccrual loans 7,803 8,500 11,437 9,095 8,143
-------- -------- -------- --------- ---------
Total noncurrent loans 7,944 9,248 11,970 9,907 8,623
Foreclosed real estate 58 200 200 -- 108
-------- -------- -------- --------- ---------
Total nonper-
forming assets $ 8,002 $ 9,448 $ 12,170 $ 9,907 $ 8,731
======== ======== ======== ========= =========
Allowance for credit loss $ 24,043 $ 23,322 $ 22,067 $ 20,823 $ 19,924
======== ======== ========= ========= =========
COMPANY RATIOS:
Coverage ratio of
allowance for credit
losses to total loans 2.47% 2.49% 2.43% 2.36% 2.48%
Coverage ratio of
allowance for credit
losses to noncurrent loans 303% 252% 184% 210% 231%
Ratio of noncurrent
loans to total loans 0.82% 0.99% 1.32% 1.12% 1.07%
Ratio of nonperforming
assets to total assets 0.47% 0.58% 0.74% 0.64% 0.61%
FDIC PEER
GROUP RATIOS:
Coverage ratio of
allowance for credit
losses to total loans n/a 2.14% 2.16% 2.11% 2.19%
Coverage ratio of
allowance for credit
losses to noncurrent loans n/a 209% 204% 199% 195%
Ratio of noncurrent
loans to total loans n/a 1.03% 1.06% 1.06% 1.12%
Ratio of nonperforming
assets to total assets n/a 0.73% 0.76% 0.77% 0.82%
</TABLE>
The September 30, 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 allowance for credit losses other than RAL's has increased to $24.0 million
at September 30, 1998, from $19.9 million at September 30, 1997. This has
resulted in a coverage ratio of allowance to noncurrent loans of 303%. This is
more than the 209% ratio of its peers as of June 30, 1998. The Federal Reserve
Board and other Regulatory bodies have been publicly warning financial
institutions that the current economic environment is probably close to the high
point of the credit cycle. They have suggested that lenders can expect that
credit quality will again became an issue as borrowers who now appear able to
repay their loans may become delinquent when the economy is not so healthy.
Giving consideration to these comments and 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 September 30, 1998 (amounts in thousands).
<TABLE>
Table 5--NONCURRENT AND POTENTIAL PROBLEM LOANS
<CAPTION>
Potential Problem
Noncurrent Loans Other Than
Loans Noncurrent
---------- -----------------
<S> <C> <C>
Loans secured by real estate:
Construction and
land development $ -- $ --
Agricultural 106 5,357
Home equity lines 448 --
1-4 family mortgage 1,981 664
Multifamily -- 448
Nonresidential, nonfarm 4,092 4,627
Commercial and industrial 542 19,545
Leases 77 --
Other consumer loans 679 381
Other Loans 19 --
------- -------
Total $7,944 $31,022
======= ========
</TABLE>
The following table sets forth the allocation of the allowance for all potential
problem loans by classification as of September 30, 1998 (amounts in thousands).
Doubtful $ 654
Substandard $ 3,299
Special Mention $ 329
The total of the above numbers is less than the total allowance. Most of the
allowance is allocated to loans which are not currently regarded as potential
problem loans. This allocation is based on historical trends of losses by
category and on current economics conditions. Some of the allowance is not
allocated to any category, 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 for internal
management purposes. 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 and
government-sponsored Agency securities. The third portfolio, the "Discretionary
Portfolio," consists of shorter term Treasury and government-sponsored Agency
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. The reasons for
these portfolios are explained in the 10-K MD&A.
Table 6 presents the combined securities portfolios, showing the average
outstanding balances (dollars in millions) and the yields for the last seven
quarters. The yield on tax-exempt state and municipal securities has been
computed on a taxable equivalent basis. A computation using this basis increases
income shown in the table for these securities 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>
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 36.0 5.53 33.4 5.87 44.6 5.83
Asset-backed securities 0.6 5.54 4.0 5.83 4.0 5.60 4.0 5.90
Collateralized
Mortgage Obligations 32.4 6.11 56.4 6.18 64.4 6.37 67.3 6.31
Tax-Exempt securities 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% $ 200.6 5.89% $ 168.4 5.89%
U.S. Agency 57.5 5.87 74.0 5.82 116.2 5.76
Asset-backed securities 6.3 4.66 14.5 6.13 14.3 6.02
Collateralized
Mortgage Obligations 85.5 6.23 84.2 6.18 80.1 6.20
Tax-Exempt securities 118.0 11.25 127.7 10.72 129.2 10.98
Equity securities 8.1 5.37 8.2 5.41 8.3 5.59
------- -------- --------
Total $ 498.3 7.20% $ 509.2 7.14% $ 516.5 7.19%
======= ======== ========
</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 second table in Note 4 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 was $50 million and the hedge covered a fifteen month
period that began July 1, 1997 and ended October 1, 1998. The contract would
have paid the Company the rate by which the 3-month Libor index rate exceeded
7.0% up to a maximum of 1.5%. Subsequently, interest rates declined and the
Company simply amortized 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."
Statement of Financial Accounting Standards No. 133, "Accounting Derivative
Instruments and Hedging Activities", was issued during the second quarter of
1998 and will become effective for the Company as of January 1, 2000 or earlier
should the Company so choose. The Company expects to implement this reporting on
January 1, 2000. This statement is not expected to have a material impact on the
operating results or the financial position of the Company.
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 agreements to resell ("reverse repo agreements"). These
agreements are investments which are collateralized by securities or loans of
the borrower and mature on a daily basis. The sales of Federal funds are on an
overnight basis as well. The amount of Federal funds sold and reverse repo
agreements purchased during the quarter is an indication of Management's
estimation during the quarter of immediate cash needs, the excess of funds
supplied by depositors over funds lent to borrowers, and relative yields of
alternative investment vehicles.
Though they are not securities, the large amount of Federal funds sold and
reverse repo agreements dictate that the Company include them in its liquidity
planning, discussed below in the section entitled "Liquidity", 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 eight quarters (dollars in
millions).
<TABLE>
Table 7--AVERAGE BALANCES OF FUNDS SOLD AND SECURITIES PURCHASED UNDER
AGREEMENTS TO RESELL AND THEIR RELATED YIELDS
<CAPTION>
Average Average
Quarter Ended Outstanding Yield
------------- ------------------ ---------
<S> <C> <C>
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
June 1998 72.4 5.75
September 1998 108.8 5.80
</TABLE>
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.
The yield curve on Treasury securities became inverted during the third quarter
of 1998, with shorter maturity securities offering higher yields than the longer
maturity securities. The overnight Federal funds and overnight reverse repo
rates were also higher than yields available from one to five year Treasury
securities. Together, these factors meant that the Company was not being paid
for extending maturities, and accordingly the Company increased its position in
overnight funds sold at the higher short-term yields. The Company is continuing
to evaluate its overnight funds position and is also mindful that its overnight
funds position will need to be at a higher level than in past years as it
approaches the 1999 RAL/RT season in mid-January.
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 eight quarters (dollars in millions).
<TABLE>
Table 8--AVERAGE BALANCE OF BANKERS' ACCEPTANCES AND YIELDS
<CAPTION>
Average Average
Quarter Ended Outstanding Yield
------------- ------------------ ---------
<S> <C> <C>
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
June 1998 14.3 6.09
September 1998 1.5 6.23
</TABLE>
All of the acceptances held by the Company in these periods were issued by
Japanese banks having prime short-term credit quality ratings. However, because
of uncertainty regarding the Japanese economy and lowered credit ratings for
these banks, the Company has not replaced maturing acceptances during the last
nine months and the balance therefore declined. All acceptances were paid
according to their terms. At September 30, 1998, the Company held no bankers'
acceptances.
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 eight quarters.
<TABLE>
Table 9--OTHER BORROWINGS
<CAPTION>
Average Average Percentage of
Quarter Ended Outstanding Rate Average Total Assets
------------- ------------------ -------- --------------------
<S> <C> <C> <C>
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
June 1998 18.1 4.12 1.1
September 1998 20.4 4.97 1.2
</TABLE>
Long-term debt consists of advances from the Federal Home Loan Bank of San
Francisco ("FHLB"). 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 per
quarter 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 eight quarters.
<TABLE>
Table 10--LONG-TERM DEBT
<CAPTION>
Average Average Percentage of
Quarter Ended Outstanding Rate Average Total Assets
------------- --------------- ------------- --------------------
<S> <C> <C> <C>
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
June 1998 35.1 6.22 2.2
September 1998 32.6 6.25 2.0
</TABLE>
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 eight
quarters (in thousands).
<TABLE>
Table 11--TRUST INCOME
<CAPTION>
Quarter Ended Trust Income
---------------- -------------------
<S> <C>
December 1996 $2,144
March 1997 2,480
June 1997 2,377
September 1997 2,599
December 1997 2,522
March 1998 2,865
June 1998 2,816
September 1998 2,900
</TABLE>
There are several reasons for the 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 $277,000 of the fees earned in the first quarter of 1997 and
$291,000 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 (until the third quarter of 1998), 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 and securities gains or losses are shown
in Table 12 for the last eight quarters (in thousands).
<TABLE>
Table 12--OTHER INCOME
<CAPTION>
Other Service
Service Charges Charges,
on Deposit Commissions Other
Quarter Ended Accounts & Fees Income
----------------- --------------- ------------ --------
<S> <C> <C> <C>
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
June 1998 1,568 2,694 211
September 1998 1,571 2,495 157
</TABLE>
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." The increase in service charges on deposit accounts is a result of
growth in deposit accounts and the acquisition of accounts from FVB and CSB.
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 eight
quarters (in thousands).
<TABLE>
Table 13--STAFF EXPENSE
<CAPTION>
Salary and Profit Sharing and
Quarter Ended Other Compensation Other Employee Benefits
--------------- ------------------ -----------------------
<S> <C> <C>
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
June 1998 7,378 1,800
September 1998 7,086 1,583
</TABLE>
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 also increased in the
fourth quarter of 1997 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
amount of which is set by the Board of Directors based on the Company meeting or
exceeding its 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 one-third of the net income for 1997 was earned in
the first quarter. Assuming that a similar pattern of earnings may occur in
1998, Management accrued a larger amount for bonus expense in the first quarter
than in the second and third 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. 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 the Company's contribution will again be limited by the amount that can be
deducted in its tax return. The contribution expense has varied from quarter to
quarter in 1998 as the Company adjusted its estimation of the contribution for
all of 1998.
OTHER OPERATING EXPENSES
The following table shows other operating expenses over the last eight quarters
(in thousands)
<TABLE>
Table 14--OTHER OPERATING EXPENSE
<CAPTION>
Occupancy Expense Furniture & Other
Quarter Ended Bank Premises Equipment Expense
----------------- ----------------- ----------- -------
<S> <C> <C> <C>
December 1996 $1,162 $ 654 $3,904
March 1997 1,137 646 4,474
June 1997 1,265 872 4,043
September 1997 1,409 938 4,624
December 1997 1,430 1,170 6,357
March 1998 1,436 968 5,270
June 1998 1,467 1,043 5,307
September 1998 1,613 1,190 6,048
</TABLE>
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 and by the acquisition of new branches with the FVB purchase in the
second quarter of 1997 and the CSB purchase in the fourth quarter of 1997.
Table 15 shows a detailed comparison for the major expense items in other
expense for the nine-month and three-month periods ended September 30, 1998 and
1997 (amounts in thousands).
<TABLE>
[Table 15--OTHER EXPENSE
<CAPTION>
Nine-Month Periods Three-Month Periods
Ended September 30, Ended September 30,
--------------------- -------------------
1998 1997 1998 1997
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Professional services 1,994 1,498 1,123 723
RAL processing and incentive fees 300 528 -- (78)
Supplies and sundries 713 641 255 236
Postage and freight 705 586 213 172
Marketing 1,736 1,307 789 509
Bankcard processing 2,145 1,532 780 565
Credit bureau 391 335 56 42
Telephone and wire expense 1,161 861 400 318
Charities and contributions 316 288 107 95
Software expense 1,456 1,035 525 344
Operating losses 254 219 74 116
Armored car services 344 238 117 76
Printing 340 419 109 103
Amortization of goodwill 889 410 296 212
Other 3,881 3,236 1,204 1,191
-- -- -- --
--------- --------- -------- ---------
Total $ 16,625 $ 13,133 $ 6,048 $ 4,624
========= ========= ======== =========
</TABLE>
The increase in Bankcard processing fees is a result of an increase in the
number of merchant card processing transactions and from price increases charged
by processors.
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 for the nine months ended September 30, 1998 compared to the same
period of 1997 reflects the higher loss ratio (prior to recoveries) for the
program this year as discussed in the Quarterly Report on Form 10-Q for the
second quarter of 1998.
The increase in software expense represents costs incurred to upgrade existing
software and purchase new software to meet the technological needs of the Bank.
The investment in technology keeps the Bank competitive with services our
customers demand.
Non-recurring costs of $684,000 associated with the merger with Pacific Capital
Bancorp are included in other expenses. Approximately one-third of these
expenses were acquisition costs and two-thirds were costs incurred for
implementing system changes needed to merge the back office operations.
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.
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.
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. Adequate liquidity is achieved by (1) holding liquid assets, (2)
maintaining the ability to raise deposits or borrow funds, and (3) keeping
access open to capital markets.
As explained below, there is a rough correspondence between these three means of
achieving liquidity and the three time horizons, except that the Company has not
needed to access the capital markets for liquidity purposes.
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, increasing
to higher targets during RAL/RT season. At the end of September 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 within three months, term
repurchase agreements, advances from the Federal Home Loan Bank of San
Francisco, 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
September 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 September 1998, the Company's long term liquidity was
adequate to meet cash needs anticipated over its planning horizon.
CAPITAL RESOURCES AND COMPANY STOCK
The following table presents a comparison of several important amounts and
ratios for the third quarter of 1998 and 1997 (dollars in thousands).
<TABLE>
Table 16--CAPITAL RATIOS
<CAPTION>
3rd Quarter 3rd Quarter
1998 1997 Change
------------ ------------ ----------
<S> <C> <C> <C>
Amounts:
Net Income $ 5,186 $ 4,279 $ 907
Average Total Assets 1,669,306 1,422,446 246,860
Average Equity 131,082 116,012 15,070
Ratios:
Equity Capital to Total Assets (period end) 7.77% 7.93% (0.16%)
Annualized Return on Average Assets 1.24% 1.20% 0.04%
Annualized Return on Average Equity 15.83% 14.75% 1.07%
</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
September 30, 1998, the Company's risk-based capital ratio was 11.00%. The
Company must also maintain a Tier I capital (total shareholder equity less
goodwill and other intangibles) to average assets ratio of at least 4% to 5%. As
of September 30, 1998, Tier I capital was 6.90% of average tangible 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. During the first six months of 1998, approximately 91,000 shares were
repurchased compared with the issuance of approximately 221,000 shares in
connection with the exercise of stock options. No shares were repurchased during
the third quarter. In 1997, the Company had repurchased approximately 135,000
shares to offset the effect of the issuance of approximately 68,000 shares in
connection with the exercise of stock options.
On May 27, 1998, prior to the announcement of the signing of an Agreement and
Plan of Reorganization between the Company and Pacific Capital Bancorp ("Pacific
Capital") discussed below in the section entitled "Announced Merger with Pacific
Capital," the Company had announced a program to repurchase up to $5 million of
its shares for investment purposes. No shares were in fact repurchased under the
program. On July 31, 1998, the Board of Directors suspended the program in light
of the announced transaction between the Company and Pacific Capital.
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 three quarters 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. The Bank will continue to need
to request approval for dividends until earnings for the preceding three years
exceed dividends paid to Bancorp in the same three years. 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 current quarterly dividend rate is $0.18 per share. When annualized, this
represents a payout ratio of approximately 47% of earnings per share for the
trailing 12 months.
REGULATION
The Company is closely regulated by Federal and State agencies. The Company and
its subsidiaries may only engage in lines of business that have been approved by
their respective regulators, and cannot open or close offices without their
approval. Disclosure of the terms and conditions of loans made to customers and
deposits accepted from customers are both heavily regulated as to content. The
Company is required by the provisions of the Community Reinvestment Act ("CRA")
to make significant efforts to ensure that access to banking services is
available to the whole community.
As a bank holding company, 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 generally 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 and to a lesser extent on the second
quarters of 1997 and 1998. A more extended description of these programs may be
found in the 10-K MD&A and the Company's Quarterly Report on Form 10-Q for the
second quarter of 1998. In the third quarter of 1998, the RAL program was
dormant except for receiving recoveries of loans previously charged-off and for
expenses incurred in preparation for the next year.
YEAR 2000
State of readiness - Since early 1997, the Company has been addressing the
impact of the Year 2000 to its data processing systems. Key financial
information and operational systems were assessed and detailed plans were
developed to ensure that Year 2000 systems modifications will be in place by
December 1998 for all critical systems. 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 implemention and initial testing of "Year 2000 Compliant" systems in
1998. Based on information provided by the vendor of the Company's core
processing applications, all modifications to its systems should be complete by
the end of the first quarter of 1999. Full system validation and certification
will be performed in 1999.
Costs - The Company originally estimated that it would spend approximately $1.7
million each in 1998 and 1999 to address the Year 2000 issue. In the process of
identifying the Company's critical systems and determining the extent to which
they must be modified or replaced, Management has found that there are fewer
systems which will need to be replaced or extensively modified than originally
thought and now estimates that the costs to ensure that critical systems will
function as intended is more likely to be approximately $700,000 per year.
However, the impact to operating results for 1998 and 1999 will be less than
this because some of these costs related to the reassigment of internal staff
from other projects and to the purchase of equipment and software, the costs of
which will be amortized over a number of years. Management does not anticipate a
material adverse impact to the Company's results of operations or financial
position.
Risks - The primary risk of failure to adequately address the Year 2000 problem
would be the inability to process loans and deposit transactions for customers.
The Company also is exposed to risk if its customers, funds providers, or
correspondent financial institutions and brokerage firms are unable to
adequately address the Year 2000 dates in their own data processing systems.
The Company has contacted all of its major loan customers and those other
financial institutions with whom it has backup borrowing arrangements to ensure
that these third parties are addressing the issue for themselves and their
customers. The Company's risk with respect to loan customers who do not address
the Year 2000 problem is the risk of non-payment or late payment of loans. The
Company's risk with respect to funds providers is that the Company will be
unable to borrow funds in the event of a shortage of liquidity. The Company's
risk with respect to other financial institutions and brokerage firms is that it
may be unable to settle security transactions.
Contingency Plans - Should the Company's vendor for its core processing
applications fail to provide the modifications necessary to correctly recognize
Year 2000 dates, as a contingency plan for core operations, the Company would
out source its mainframe computer applications. For non-core operations, the
Company will rely on manual processing until modifications or replacement
systems are in place.
MERGER WITH PACIFIC CAPITAL BANCORP
In July 1998, the Company entered into a Definitive Agreement calling for a
merger of equals with Pacific Capital Bancorp, the holding company for First
National Bank of Central California and South Valley National Bank. The
Agreement provides for existing Pacific Capital Bancorp shareholders to receive
1.935 shares of Santa Barbara Bancorp common stock for each of their outstanding
shares of common stock. The merger transaction is being accounted for as a
pooling of interests. As of the date of the Agreement, based on the closing
price per share of Company stock as of the end of the third quarter, the value
of the merger would be estimated to be $228.8 million. However, the final value
will be based on the price per share at the time the transaction closes, which
may result in a value more or less than that stated above. Subject to
shareholder and regulatory approvals, the merger is expected to close in the
fourth quarter of 1998. One-time charges to be taken at the time of closing are
estimated to be $6.5 to $7.5 million after tax. Administrative and operational
support units will be based out of Santa Barbara, creating the merger savings
that will make the transaction accretive to earnings per share in the first full
operating year for the combined company.
At September 30, 1998, Pacific Capital Bancorp reported quarter and year-to-date
net income of $3.3 million and $8.9 million respectively, with total assets of
$853 million, total deposits of $757 million, total loans of $467 million, and
total shareholders' equity of $84 million. First National Bank of Central
California maintains offices in Monterey, Salinas, Carmel Rancho, Watsonville,
and Soledad. South Valley National Bank maintains offices in Gilroy, Morgan
Hill, Hollister, and San Juan Bautista.
- ------------------------------------------------------------------------------
Note 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. Therefore, the published data is always
one quarter behind the Company's information. For this quarter, the peer
information is for the second quarter of 1998. All peer information in this
discussion and analysis is reported in or has been derived from information
reported in this publication.
Note 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 $9.4 million as of September 30, 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 third quarter of 1998 would
be $21.7 million and the average yield would be 9.06%. 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."
Note 3 - Peer data are computed from statistics reported in FDIC Quarterly
Banking Profile, Second Quarter, 1998 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
27.0998 Financial Data Schedule for September 30, 1998
27.0997 Restated Financial Data Schedule for September 30, 1997
The restatement of the Financial Data Schedule gives
effect to the two-for-one (2:1) split of outstanding
shares of Common Stock payable on April 16, 1998 and to
the adoption of Statement of Financial Accounting
Standards No. 128, which changed the computation of
earnings per share.
(b) There were no Forms 8-K filed during the quarter ended September
30, 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: November 13, 1998
-----------------------------
William S. Thomas, Jr.
Vice Chairman
Chief Operating Officer
DATE: November 13, 1998
-----------------------------
Donald Lafler
Senior Vice President
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 46,191
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 127,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 329,701
<INVESTMENTS-CARRYING> 200,217
<INVESTMENTS-MARKET> 0
<LOANS> 925,908
<ALLOWANCE> 24,247
<TOTAL-ASSETS> 1,713,825
<DEPOSITS> 1,513,569
<SHORT-TERM> 23,700
<LIABILITIES-OTHER> 12,862
<LONG-TERM> 30,500
<COMMON> 5,145
0
0
<OTHER-SE> 128,049
<TOTAL-LIABILITIES-AND-EQUITY> 1,713,825
<INTEREST-LOAN> 70,236
<INTEREST-INVEST> 23,574
<INTEREST-OTHER> 4,748
<INTEREST-TOTAL> 98,558
<INTEREST-DEPOSIT> 32,964
<INTEREST-EXPENSE> 35,387
<INTEREST-INCOME-NET> 63,171
<LOAN-LOSSES> 6,993
<SECURITIES-GAINS> 221
<EXPENSE-OTHER> 51,704
<INCOME-PRETAX> 29,804
<INCOME-PRE-EXTRAORDINARY> 29,804
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 19,243
<EPS-PRIMARY> 1.25
<EPS-DILUTED> 1.23
<YIELD-ACTUAL> 5.41
<LOANS-NON> 7,803
<LOANS-PAST> 141
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 31,022
<ALLOWANCE-OPEN> 21,148
<CHARGE-OFFS> 9,348
<RECOVERIES> 5,454
<ALLOWANCE-CLOSE> 24,247
<ALLOWANCE-DOMESTIC> 24,247
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 52,960
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 69,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 212,837
<INVESTMENTS-CARRYING> 229,195
<INVESTMENTS-MARKET> 0
<LOANS> 803,890
<ALLOWANCE> 19,940
<TOTAL-ASSETS> 1,463,372
<DEPOSITS> 1,256,756
<SHORT-TERM> 44,433
<LIABILITIES-OTHER> 5,658
<LONG-TERM> 40,500
<COMMON> 5,081
0
0
<OTHER-SE> 110,944
<TOTAL-LIABILITIES-AND-EQUITY> 1,463,372
<INTEREST-LOAN> 59,358
<INTEREST-INVEST> 19,561
<INTEREST-OTHER> 6,716
<INTEREST-TOTAL> 85,635
<INTEREST-DEPOSIT> 28,399
<INTEREST-EXPENSE> 31,410
<INTEREST-INCOME-NET> 54,225
<LOAN-LOSSES> 6,980
<SECURITIES-GAINS> (416)
<EXPENSE-OTHER> 42,997
<INCOME-PRETAX> 22,996
<INCOME-PRE-EXTRAORDINARY> 22,996
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15,415
<EPS-PRIMARY> 1.02
<EPS-DILUTED> 0.99
<YIELD-ACTUAL> 5.40
<LOANS-NON> 8,143
<LOANS-PAST> 480
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 8,008
<ALLOWANCE-OPEN> 16,572
<CHARGE-OFFS> 7,996
<RECOVERIES> 4,384
<ALLOWANCE-CLOSE> 19,940
<ALLOWANCE-DOMESTIC> 19,940
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
