ITEM 1 BUSINESS
GENERAL
Pacific Capital Bancorp (the "Company") is a California bank holding company headquartered in Salinas, California and incorporated on January 26, 1983. Its principal wholly-owned subsidiaries, First National Bank of Central California (formerly First National Bank of Monterey County ), ("First National") commenced operations on April 2, 1984, and South Valley National Bank, ("South Valley") commenced operations on April 21, 1982.
On November 20, 1996, the Company acquired South Valley Bancorporation ("SVB") and its banking subsidiary, South Valley, headquartered in Morgan Hill, California. Each share of SVB common stock outstanding on November 20, 1996, was converted into .92 shares of the Company's common stock. The Company issued approximately 1,291,000 shares of common stock and cash in lieu of fractional shares for all of the outstanding shares of SVB. The consolidated financial statements of the Company give effect to the merger, which has been accounted for as a pooling-of-interests. Accordingly, the accounts of SVB have been combined with those of the Company for all periods presented.
First National is a full service commercial bank serving Monterey, Salinas, Carmel, Watsonville, and surrounding areas in Monterey and Santa Cruz Counties in California.
South Valley is a full service commercial bank serving Morgan Hill, Gilroy, Holister, San Juan Bautista, and surrounding areas in Santa Clara and San Benito Counties in California.
The Company itself does not engage in any business activities other than the ownership of the banks and the ownership of one other wholly-owned subsidiary, Pacific Capital Services Corporation ("PCSC"). PCSC has no active operations at this time.
First National and South Valley are collectively referred to herein as the "Subsidiary Banks."
General Banking Services
The Subsidiary Banks provides a wide range of commercial banking services to individuals, professionals, and small- and medium-sized businesses. The services provided include those typically offered by commercial banks, such as: checking, interest checking and savings accounts, travelers checks, safe deposit boxes, collection services, night depository facilities and wire and telephone transfers. In addition to the above deposit services, the Subsidiary Banks also provide a full array of loan products including commercial, real estate and consumer loans as well as a variety of government assisted loan programs such as SBA or Rural Economic Community Development Service guaranteed loans. Professional firms, individuals and businesses form the core of the Subsidiary Banks customer and deposit bases.
The Subsidiary Banks maintain lobby hours between 9:00 a.m. and 5:00 p.m., Monday through Thursday and between 9:00 a.m. and 6:00 p.m. on Friday. South Valley's Gilroy and Hollister offices are also open from 9:00 A.M. to 12:00 P.M. on Saturday. In addition to a broad range of retail products and services, the Subsidiary Banks offer courier pick-up service, nationwide ATM access available through the Star(R) system, Cirrus(R), Plus(R) Explore(R) and Ca$h24(R), and point of sale transactions through Explore(R), Maestro(R) and Discover/Novus(R), merchant bank card support with electronic ticket capture, self directed IRA, discount brokerage services and consumer and business credit cards. First National also offers offsite ATM access at the Prunetree Shopping Center, Prunedale, California and at the Monterey Pennisula College, Monterey, Calififornia. The Subsidiary Banks do not offer trust services.
Most of the Subsidiary Banks deposits are obtained from individuals, professionals and small- and medium-sized businesses. As of December 31, 1996 the Subsidiary Banks had a total of 34,524 accounts representing 18,940 interest bearing and non-interest bearing (checking) accounts with an average balance of approximately $11,410 each; 11,434 savings and money market accounts with an average balance of approximately $14,421 each; and 4,150 other time deposits with an average balance of approximately $40,046 each. The Subsidiary Banks are members of the Federal Deposit Insurance Corporation (the "FDIC") and the deposits of each depositor of the Subsidiary Banks are insured up to $100,000.
The Subsidiary Banks engage in a full complement of lending activities, including commercial, consumer/installment and short-term real estate loans, with a particular emphasis on short- and medium-term commercial obligations. Commercial lending activities are directed principally toward small- to medium-sized businesses, such as professional firms, retail, light industry and manufacturing to which the Subsidiary Banks make (a) loans for working capital, (b) loans secured by receivable and inventory, (c) term loans for equipment; and (d) real estate development loans. In addition to conventional commercial lending, the Subsidiary Banks also offer an array of government assisted loan products including SBA guaranteed loans, SBA 504 loans (primarily for commercial real estate transactions), Rural Economic Community Development Services guaranteed loans and loans guaranteed under the State of California guarantee program. The Subsidiary Banks also work to meet the needs of the local municipalities by providing lease financing for a wide variety of equipment purchases including energy retrofit, fire trucks, police cars, portable classrooms, etc. Consumer lending is oriented primarily to the needs of the Subsidiary Banks customers, with an emphasis on automobile financing and real estate loans. Real estate loans include home loans and equity advance loans.
In addition, the Subsidiary Banks offer construction loans, generally for single-family residences and multi-unit projects. Real estate and construction loans are typically secured by first deeds of trust and guarantees from principals of the borrower. The economic viability of the project and the borrower's credit worthiness are primary considerations in the loan underwriting decision. The Subsidiary Banks use independent local appraisers, conservative loan-to-value ratios and close monitoring of the projects during construction phases, and in the absence of rapid declines in real estate values, ultimate collectibilty of these secured loans is considered by the Subsidiary Banks management to be better than the average mix of commercial loans. The Subsidiary Banks do not make long term fixed rate real estate
loans and, therefore, material sustained increases or decreases in general interest rate levels have only a short-term effect on the Subsidiary Banks net yield on real estate loans.
The Subsidiary Banks concentrate their lending activities in the following areas: real estate loans, commercial loans, consumer loans to individuals, and other loans. As of December 31, 1996, these four categories accounted for approximately 60.0%, 29.2%, 5.8%, and 5.0% respectively, of the Company's loan portfolio. As of December 31, 1996, the Company had total loans outstanding of $388,728,000. No material portion of the Subsidiary Bank's loan portfolio is concentrated within a single industry or group of related industries.
The interest rates charged for the various loans made by the Subsidiary Banks vary with the degree of risk, size, and maturity of the loans involved and are generally affected by competition, governmental regulation and by current money market rates.
The Company's consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on the loan portfolio. The Subsidiary Banks follow the policy of non-accrual of interest on a loan when principal or interest is 90 days or more past due unless the loan is well secured and in the process of collection. Interest income from non-accrual loans is not accrued on the books, but rather is recorded only when and if received. When a loan is placed on a non-accrual basis, any previously accrued but unpaid interest is reversed and charged against current income unless there is adequate collateral to assure recovery of the accrued interest.
Correspondent Banks
The Subsidiary Banks have correspondent relationships with Wells Fargo Bank, N.A., Union Bank of California., Bank of America, N.T.& S.A., City National Bank and the Federal Reserve Bank of San Francisco. These relationships are a result of the Subsidiary Banks efforts to obtain a wide range of services for the Subsidiary Banks and its customers and, as net sellers of federal funds (overnight interbank loans), to minimize the risk of an undue concentration of its resources with a few entities. The Subsidiary Banks do not currently serve, nor do they have plans to serve, as a correspondent to other banks.
The correspondent banks perform the following services for the Subsidiary Banks: arrange loan participations; purchase and sell federal funds; obtain lines for letters of credit; buy and sell investment securities; safekeep the Subsidiary Banks investment securities; send and receive foreign wire transactions and data processing services.
Existing Locations
First National currently operates five branch offices: the Monterey branch located at 495 Washington Street, Monterey; the Salinas branch located at 1001 South Main Street, Salinas; the Oldtown office located at 307 Main Street, Salinas; the Carmel branch located in the Carmel Rancho Shopping Center, Carmel; and the Watsonville branch located at 655 Main Street, Watsonville. First National Bank offers offsite 24-hour ATM services and night depository facilities at the Prunetree Shopping Center located in Prunedale, and ATM services located at the Monterey Pennisula College,
Monterey , California. The Company's loan administration department is located at 517 S. Main Street, Salinas. In addition to a banking office, the Oldtown office located at 307 Main Street, Salinas houses all of the Company's administrative functions as well as the Data Processing/Operations department and a Community/Board room.
South Valley National Bank currently operates four branch offices: the Morgan Hill branch located at 500 Tennant Station in Morgan Hill; the Gilroy branch located at 8000 Santa Teresa Boulevard, Gilroy; the Hollister branch located at 1730 Airline Highway, Hollister; and the San Juan Bautista branch located at 301 Third Street, San Juan Bautista.
As of December 31, 1996, the Company and its subsidiaries employed 259 full-time equivalent employees.
Other Information Concerning the Company and the Subsidiary Banks
The Company and its Subsidiary Banks hold no material patents, trademarks, licenses, franchises or concessions except for the written approvals issued by the Office of the Comptroller of the Currency (the "OCC") for the Subsidiary Banks banking offices.
No material expenditures were made by the Company or its Subsidiary Banks during the last three fiscal years on research and development activities relating to the development of services or the improvement of existing services.
Based upon present business activities, compliance with federal, state and local provisions regulating discharge of materials into the environment will have no material effect upon the capital expenditures, earnings and competitive position of the Company or its Subsidiary Banks.
Pacific Capital Services Corporation
PCSC, a wholly-owned subsidiary of the Company, was incorporated on April 22, 1985, to arrange and broker residential, commercial and construction loans and other extensions of credit. PCSC commenced operations on July 1, 1985, with a primary emphasis in the area of residential mortgage loans. In December, 1988, the functions performed by PCSC were taken over by First National and PCSC ceased operations. The Company maintains PCSC as an inactive subsidiary.
SELECTED STATISTICAL INFORMATION
Consolidated statistical information concerning the business of the Company and the Subsidiary Banks is set forth in Management's Discussion and Analysis of Financial Condition and Results of Operations ("Management's Discussion and Analysis") on pages 22 through 45 the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1996, (the "Annual Report") and in Notes 1-14 to the Consolidated Financial Statements on pages 1 through 21 of the Annual Report, which pages of the Annual Report are incorporated herein by reference. This information should be read in
conjunction with the Consolidated Financial Statements and the Notes thereto included in the Annual Report which have been incorporated herein by reference.
Distribution of Average Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential
The Company's average consolidated balance sheet and an analysis of net interest earnings for the years ended December 31, 1996, 1995 and 1994 is set forth in Management's Discussion and Analysis on page 27 of the Annual Report.
A table setting forth the changes in interest income and interest expense in 1996 and 1995 resulting from changes in volume and changes in rates is set forth in Management's Discussion and Analysis on page 28 of the Annual Report.
Investment Portfolio
The amortized cost and estimated fair values of each category of investment securities at December 31, 1996, and 1995 and the maturities of investment securities at December 31, 1996, are set forth in Note 5 of the Notes to Consolidated Financial Statements on pages 12 and 13 of the Annual Report.
At December 31, 1996, investment securities from the following issuers each totaled over ten percent (10%) of shareholder's equity of the Company:
Amortized Estimated Cost Fair value
Available-for-sale securities:
U.S. Treasury and Agencies $ 64,109,000 $ 64,081,000 Agency Mortgage-Backed Securities $ 45,470,000 $ 45,176,000
Loan and Lease Portfolio
The composition of the loan and lease portfolio for the five years ended at December 31, 1996, is set forth in Management's Discussion and Analysis on page 32 of the Annual Report.
Maturities and sensitivity to changes in interest rates in the loan and lease portfolio, including real estate-mortgage and consumer loans, as of December 31, 1996, are summarized in Management's Discussion and Analysis on page 33 of the Annual Report.
The composition of nonaccrual, past due and restructured loans and leases for the five years ended December 31, 1996, and a discussion of the Company's policy for placing loans on nonaccrual status is set forth in Management's Discussion and Analysis on page 37 of the Annual Report.
Summary of Loan Loss Experience
An analysis of loan loss experience for the five years ended December 31, 1996, and a description of the factors which influenced management's judgment in determining the amount of the additions to the allowance charged to operating expenses in each fiscal period, as well as a discussion of the risk elements in the loan portfolio, are set forth in Management's Discussion and Analysis on page 35of the Annual Report.
Deposits
The average amount of and the average rate paid on major deposit categories for the years ended December 31, 1996, 1995 and 1994 is set forth in Management's Discussion and Analysis on page 39 of the Annual Report.
The maturity of time certificates of deposit of $100,000 or more and other time deposits of $100,000 or more at December 31, 1996, is set forth in Management's Discussion and Analysis on page 39 of the Annual Report.
Financial Ratios
Certain ratios of profitability, liquidity and capital for the years ended December 31, 1996, and 1995 are summarized in the Selected Financial Data on page 1 of the Annual Report.
COMPETITION
In California and in the Subsidiary Banks primary service areas, major banks dominate the commercial banking industry. Among the advantages which these banks have over the Subsidiary Banks are their ability to finance wide-ranging advertising campaigns and to allocate their investment assets, including loans, to regions of higher yield and demand. By virtue of their larger amounts of capital, such institutions have substantially greater lending limits than the Subsidiary Banks and perform certain functions, including trust services and international banking, which are not offered directly by the Subsidiary Banks but are offered indirectly through its correspondent institutions.
First National's primary service area consists of Monterey County and Southern Santa Cruz County and encompasses the cities of Monterey, Carmel, Pacific Grove, Seaside, Marina, Sand City, Del Rey Oaks, Salinas, Prunedale, Watsonville and the unincorporated communities of Pebble Beach, Carmel Valley and North Monterey County. Based on data as of the most recent practicable date, June 30, 1996, there were 82 financial institutions with $3,878.6 million in deposits serving this area. First National's market share at June 30, 1996 was as follows(1):
First National Total Deposits Bank Deposits First National Bank Market Service Area (in thousands) (in thousands) Share - ------------------------------------------------------------------------------- Monterey $1,395,167 $123,007 8.8% Salinas 1,439,932 133,984 9.3% Carmel 432,021 32,640 7.5% Watsonville 611,458 55,255 9.0% - ------------------------------------------------------------------------------- Total $3,878,578 $344,886 8.9% ===============================================================================
South Valley's primary service area is Southern Santa Clara County and San Benito County, which includes the cities of Morgan Hill, Gilroy, Hollister and San Juan Bautista. Based upon data as of the most recent practicable date, June 30, 1996, there were 27 financial institutions with $947.2 million in deposits serving this area. South Valley's market share at June 30, 1996 was as follows(1):
South Valley South Valley Total Deposits Bank Deposits National Bank Service Area (in thousands) (in thousands) Market Share - ----------------------------------------------------------------------- Morgan Hill $308,311 $62,673 20.3% Gilroy 325,585 64,637 19.9% Hollister 299,633 20,905 7.0% San Juan Bautista 13,657 10,803 79.1% - ----------------------------------------------------------------------- Total $947,186 $159,018 16.8% ===================================== ================ ================
(1) Sheshunoff(TM)Information Services Branches of California and Hawaii, June 1996 Data.
Other entities, both governmental and in private industry, seeking to raise capital through the issuance and sale of debt securities, as well as other depository institutions such as thrift and loan companies and credit unions, also provide competition for the Subsidiary Banks in the acquisition of deposits. The Subsidiary Banks also compete with money market funds and other money market instruments which are not subject to interest rate ceilings.
From time to time, legislation is proposed or enacted which has the effect of increasing the cost of doing business, limiting permissible activities or affecting the competitive balance between banks and other financial institutions. It is impossible to predict the competitive impact these and other changes in legislation will have on commercial banking in general or on the business of the Subsidiary Banks in particular.
SUPERVISION AND REGULATION
The Effect of Governmental Policy on Banking
The earnings and growth of the Company and the Subsidiary Banks are affected not only by local market area factors and general economic conditions, but also by government monetary and fiscal policies. For example, the Board of Governors of the Federal Reserve System (the "FRB") influences the supply of money through its open market operations in U.S. Government securities, and adjustments to the discount rates applicable to borrowings by depository institutions and others. Such actions influence the growth of loans, investments and deposits and also effect interest rates charged on loans and paid on deposits. The nature and impact of future changes in such policies on the business and earnings of the Company and the Subsidiary Banks cannot be predicted.
As a consequence of the extensive regulation of commercial banking activities in the United States, the business of the Company is particularly susceptible to federal and state legislation which may have the effect of increasing or decreasing the cost of doing business, modifying permissible activities, or enhancing the competitive position of other financial institutions. Any change in applicable laws or regulations may have a material adverse effect on the business and prospects of the Company.
Regulation and Supervision of Bank Holding Companies
The Company is a bank holding company subject to the Bank Holding Company Act of 1956, as amended ("BHCA"). The Company reports to, registers with, and may be examined by the FRB. The FRB also has the authority to examine the Company's subsidiaries.
The FRB requires the Company to maintain certain levels of capital. See "Capital Standards" herein. The FRB also has the authority to take enforcement action against any bank holding company that commits any unsafe or unsound practice, or violates certain laws, regulations, or conditions imposed in writing by the FRB.
Under the BHCA, a company generally must obtain the prior approval of the FRB before it exercises a controlling influence over, or acquires directly or indirectly, more than 5% of the voting shares or substantially all of the assets of any bank or bank holding company. Thus, the Company is required to obtain the prior approval of the FRB before it acquires, merges or consolidates with any bank or bank holding company. Any company seeking to acquire, merge or consolidate with the Company also would be required to obtain the FRB's approval.
The Company is generally prohibited under the BHCA from acquiring ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than banking, managing banks, or providing services to affiliates of the holding company. A bank holding company, with the approval of the FRB, may engage, or acquire the voting shares of companies engaged, in activities that the FRB has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. A bank holding company must demonstrate that the benefits to the public of the proposed activity will outweigh the possible adverse effects associated with such activity.
Legislation was recently introduced in Congress that would repeal the current statutory restrictions on affiliations between commercial banks and securities firms. Under the proposed legislation, bank holding companies would be allowed to control both a commercial bank and a securities affiliate, which could engage in the full range of investment banking activities, including corporate underwriting. The likelihood of such legislative changes and the impact of such changes might have on the Company and the Subsidiary Banks are imposible to predict.
The FRB generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements that might adversely affect a bank holding company's financial position. The FRB's policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition.
Transactions between the Company and the Subsidiary Banks and any future subsidiaries are subject to a number of other restrictions. FRB policies forbid the payment by bank subsidiaries of management fees which are unreasonable in amount or exceed the fair market value of the services rendered (or, if no market exists, actual costs plus a reasonable profit). Additionally, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit, sale or lease of property, or furnishing of services. Subject to certain limitations, depository institution subsidiaries of bank holding companies may extend credit to, invest in the securities of, purchase assets from, or issue a guarantee, acceptance, or letter of credit on behalf of, an affiliate, provided that the aggregate of such transactions with affiliates may not exceed 10% of the capital stock and surplus of the institution, and the aggregate of such transactions with all affiliates may not exceed 20% of the capital stock and surplus of such institution. The Company may only borrow from depository institution subsidiaries if the loan is secured by marketable obligations with a value of a designated amount in excess of the loan. Further, the Company may not sell a low-quality asset to a depository institution subsidiary.
Bank Regulation and Supervision
As national banks, the Subsidiary Banks are regulated, supervised and regularly examined by the OCC. Deposit accounts at the Subsidiary Banks are insured by the Bank Insurance Fund ("BIF"), as administered by the FDIC, to the maximum amount permitted by law. The Subsidiary Banks are also subject to applicable provisions of California law, insofar as such provisions are not in conflict with or preempted by federal banking law.
Capital Standards
The OCC and other federal banking agencies have risk-based capital adequacy guidelines intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are reported as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off
balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. government securities, to 100% for assets with relatively higher credit risk, such as business loans.
A banking organization's risk-based capital ratios are obtained by dividing its qualifying capital by its total risk adjusted assets and off balance sheet items. The federal banking agencies measure risk-adjusted assets and off balance sheet items against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists of common stock, retained earnings, noncumulative perpetual preferred stock and minority interests in certain subsidiaries, less most other intangible assets. Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses and certain other instruments with some characteristics of equity. The inclusion of elements of Tier 2 capital are subject to certain other requirements and limitations of the federal banking agencies. Since December 31, 1992, the federal banking agencies have required a minimum ratio of qualifying total capital to risk-adjusted assets and off balance sheet items of 8%, and a minimum ratio of Tier 1 capital to risk-adjusted assets and off balance sheet items of 4%.
In addition to the risk-based guidelines, federal banking agencies require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets is 3%. It is improbable, however, that an institution with a 3% leverage ratio would receive the highest rating since a strong capital position is a significant part of the rating. For all banking organizations not rated in the highest category, the minimum leverage ratio is at least 100 to 200 basis points above the 3% minimum. Thus, the effective minimum leverage ratio, for all practical purposes, is at least 4% to 5%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the federal banking agencies have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.
Restrictions on Dividends and Other Distributions
The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions. Federal law prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions, including dividends, if, after such transaction, the institution would be undercapitalized.
The payment of dividends by a national bank is further restricted by additional provisions of federal law, which prohibits a national bank from declaring a dividend on its shares of common stock unless its surplus fund exceeds the amount of its common capital (total outstanding common shares times the par value per share). Additionally, if losses have at any time been sustained equal to or exceeding a bank's undivided profits then on hand, no dividend can be paid. Moreover, even if a bank's surplus exceeds its common capital and its undivided profits exceed its losses, the approval of the OCC is required for the payment of dividends if the total of all dividends declared by a national bank in any calendar year would exceed the total of its net profits of that year combined with its retained net profits of the two preceding years, less any required transfers to surplus or a fund for the retirement of any preferred stock. A national bank must consider other business factors in determining the payment of dividends. The payment of dividends by the Bank is governed by the Bank's ability to maintain minimum required capital levels and an adequate allowance for loan losses. The federal banking agencies also have the authority to prohibit a depository institution from engaging in business practices which are considered to be unsafe or unsound, possibly including payments of dividends or other payments under certain circumstances even if such payments are not expressly prohibited by statue.
The Company has paid a stock dividend every year since 1986 and cash dividends were paid in 1993, 1994, 1995 and 1996.
Premiums for Deposit Insurance and Assessments for Examinations
As an insured depository institution, the Company is required to pay premiums for FDIC deposit insurance. The FDIC has adopted a risk-based assessment system for deposit insurance premiums. Under this system, depository institutions were charged anywhere from 23 cents to 31 cents for every $100 in insured deposits based on that institution's capital levels and supervisory subgroup assignment.
In May 1995, the BIF achieved its target goal of bringing the ratio of insurance fund reserves to $1.25 for each $100 of insured deposits. Based on this reserve level, the FDIC in September 1995, reduced the range of insurance assessments to a range of $0.04 to $0.31 per $100 in insured deposits. In November 1995, the FDIC further reduced the range of insurance assessment rates from $0.04 to $0.31 to $0 to $0.31 per $100 in insured deposits. Due to these changes in assessment rates, the Company's FDIC assessment expense decreased for 1995 by $316,000 or 94.6%. During 1996, a special one-time assessment was paid by BIF-insured financial institutions to the FDIC for the purpose of assisting in the recapitalization of the Savings Association Insurance Fund (the "SAIF") The SAIF is the insurance fund reserve for savings institutions. In November 1996, the Subsidiary Banks paid $71,000 for this special assessment.
Interstate Banking and Branching
The Riegle-Neal Interstate Banking and Branching Efficiency Act (the "Act"), which was enacted in 1994, codifies the authority of banks to provide specified interstate banking services on an agency basis to customers of affiliate banks as of September 1995. Also, under the act, as of September 1995, bank holding companies may acquire banks in other states, subject to certain deposit concentration limitations. Beginning June 1, 1997, and subject to certain deposit concentration and other limitations, banks may merge with other banks in states that do not "opt out" of the interstate legislation prior to June 1, 1997. Interstate mergers may be conducted prior to June 1, 1997 in states that specifically permit such mergers. In addition, prior to June 1, 1997, certain consolidations are possible using the "30-mile rule," which allows national banks to relocate their headquarters up to 30 miles away, including across state lines. Currently, several states have already "opted in" to the interstate legislation.
Effective October 2, 1995, California opted in early to interstate branching by permitting other state's banks to acquire an entire California bank by merger or purchase and thereby establish one or more California branch offices, provided the acquired bank has been in existence at lease five years.
Accounting Pronouncements
Accounting Pronouncements - During 1996, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards (SFAS) No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. Under this approach, after a transfer of financial assets, an entity recognizes all financial and servicing assets it controls and liabilities it has incurred and derecognizes financial assets it no longer controls and liabilities that have been extinguished. This statement is effective for years ending after December 31,
1996. The Company does not believe this statement will have any significant impact on its consolidated financial statements.
ITEM 2
ITEM 2 PROPERTIES
On December 31, 1996, the Company had 10 offices, of which 4 were owned and 6 were leased by the Company or its Subsidiary Bank's. All of these offices are considered by management to be well maintained and adequate for the purpose intended. See page 23 of the Annual Report incorporated herein by reference for further information on leases.
ITEM 3
ITEM 3 LEGAL PROCEEDINGS
Neither the Company nor its Subsidiary Banks is a party to, nor is any of their property the subject of, any material pending legal proceedings other than ordinary routine litigation incidental to their respective businesses.
ITEM 4
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A special meeting of shareholders of the Company was held on October 22, 1996. The shareholders approved the Agreement and Plan of Reorganization dated July 18,1996, between the Company and SVB providing for the merger of SVB with and into the Company. There were 1,599,455 votes cast for approval, 2,818 votes against or withheld and 38,655 abstentions. There were no broker non-votes.
PART II
ITEM 5
ITEM 5 MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
For information concerning the Company's common stock and related security holder matters, see "Pacific Capital Bancorp Stock Activity" at Page 45 of the Annual Report, which is incorporated herein by reference. For information regarding dividends, see "Restrictions on Dividends and other Distributions" under Part I, Item 1 of this Form 10-K on page 13
As of September 10, 1996, there were 2,063 holders of record of the Company's Common Stock.
ITEM 6
ITEM 6 SELECTED FINANCIAL DATA
For selected financial data concerning the Company, see "Selected Financial Information and Comparative Per Share Data" at Page 1 of the Annual Report, which is incorporated herein by reference.
ITEM 7
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For management's discussion and analysis of financial condition and results of operations, see "Management's Discussion and Analysis" at Pages 22 through 45 of the Annual Report, which pages of the Annual Report are incorporated herein by reference.
ITEM 8
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
For financial statements of the Company, see Pages 2 through 26 of the Annual Report and the "Independent Auditors" Report thereon at Page 49 which pages of the Annual Report are incorporated herein by reference.
ITEM 9
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable. PART III
ITEM 10
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information Concerning Directors and Executive Officers
For information concerning directors and executive officers of the Company, see "ELECTION OF DIRECTORS OF THE COMPANY" in the definitive Proxy Statement for the Company's 1997 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A (the "Proxy Statement"), which is incorporated herein by reference.
Compliance With Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and any persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and greater than ten-percent shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. To the best knowledge of the Company, there are no persons who own more than ten-percent of the Company's Common Stock.
Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Forms 5 were required for those persons, the Company believes
that, for the fiscal year ended December 31, 1996, all filing requirements applicable to its officers and directors have been satisfied.
ITEM 11
ITEM 11 EXECUTIVE COMPENSATION
For information concerning executive compensation, see "EXECUTIVE COMPENSATION" in the Proxy Statement, which is incorporated herein by reference.
ITEM 12
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For information concerning security ownership of certain beneficial owners and management, see "PRINCIPAL SHAREHOLDERS" and "ELECTION OF DIRECTORS OF THE COMPANY" in the Proxy Statement, which is incorporated herein by reference.
ITEM 13
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information concerning certain relationships and related transactions, see "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" and "INDEBTEDNESS OF MANAGEMENT" in the Proxy Statement, which is incorporated herein by reference.
PART IV
ITEM 14
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements.
The consolidated financial statements of Pacific Capital Bancorp and subsidiaries, other financial information and the Independent Auditors' Report on Consolidated Financial Statements appearing at the indicated location in the Annual Report are incorporated by reference into this report.
2. Financial Statement Schedules.
In accordance with Regulation S-X, the financial statement schedules have been omitted because (a) they are not applicable to or required of the Company; or (b) the information required is included in the consolidated financial statements or notes thereto.
With the exception of such information in the 1996 Annual Report incorporated herein by reference, the 1996 Annual Report is not deemed "filed" as part of this report.
3. Exhibits.
See Index to Exhibits at pages 69 - 73 of this Form 10-K.
(b) Reports on Form 8-K.
A report on Form 8-K dated July 24, 1996, was filed with the Commission on July 24, 1996, reporting under Item 5 -- Other Events. The Company's stock repurchase program was amended to increase the price per share at which the Company may repurchase shares of the Company's outstanding common stock at prices ranging from $25.00 per share to $28.00 per share.
A report on Form 8-K dated December 3, 1996, was filed with on December 3, 1996, reporting under Item 2 the Company's acquisition by merger of SVB and its subsidiary, South Valley, which is more fully discussed under Item 1 of this Form 10-K. A report on Form 8-K/A dated January 21, 1997 was filed on January 21, 1997 amending the Form 8-K filed on December 3, 1996 to furnish the information under Item 7 - Financial Statements, Pro Forma Financial Information and Exhibits.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Consolidated Financial Statements
December 31, 1996, 1995, and 1994
(With Independent Auditors' Report Thereon)
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1996, 1995, and 1994
(1) Summary of Significant Accounting Policies
The accounting policies of Pacific Capital Bancorp (the Company) and subsidiaries are in accordance with generally accepted accounting principles and conform to general practices within the banking industry.
The Company - Pacific Capital Bancorp is a California corporation and a multi-bank holding company which was incorporated on January 26, 1983. The Company's subsidiaries, First National Bank of Central California (First National), and South Valley National Bank (South Valley), commenced operations in 1984 and 1983, respectively. First National is a full service commercial bank serving Monterey, Salinas, Carmel, Watsonville, Prunedale and surrounding areas in Monterey and Santa Cruz Counties. South Valley is a full service commercial bank serving Morgan Hill, Gilroy, Hollister, San Juan Bautista and surrounding areas in Santa Clara and San Benito Counties.
Consolidation - The accompanying consolidated financial statements include the effect of the fourth quarter 1996 acquisition of South Valley Bancorporation which was accounted for as a pooling-of-interests. These financial statements include the accounts of Pacific Capital Bancorp and its subsidiaries, First National Bank of Central California and South Valley National Bank. Accordingly, the financial information included in the consolidated financial statements and notes thereto, present the combined results of operations of Pacific Capital Bancorp and South Valley Bancorporation as if the merger had been in effect for all periods presented. All significant intercompany balances and transactions have been eliminated.
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents - Cash and cash equivalents as reported in the consolidated statements of cash flows includes cash on hand, cash balances due from banks, federal funds sold, and money market mutual funds. The cash equivalents are readily convertible to known cash within 90 days.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Investment Securities - The Company has classified its securities for which it has the positive intent and ability to hold to maturity as held-to-maturity securities. Such securities are reported at amortized cost. The Company has classified certain securities for which it does not have the intent to hold to maturity and which are not held principally for the purpose of selling them in the near term as available-for-sale securities. Such securities are reported at fair value, with unrealized gains and losses, net of income taxes, reported in a separate component of shareholders' equity. The Company does not engage in trading activities.
Amortization of premiums and accretion of discounts arising at acquisition of investment securities are included in income using methods that approximate the level yield method. Gains or losses on the sale of securities are determined based on the specific identification method.
In November 1995, the Financial Accounting Standards Board (FASB) issued a special report, A Guide to Implementation of Statement No. 115, on Accounting for Certain Investments in Debt and Equity Securities Questions and Answers, (the Special Report). The Special Report allowed companies to reassess the appropriateness of the classifications of all securities held and account for any resulting reclassifications at fair value. Reclassifications from this one-time reassessment will not call into question the intent of an enterprise to hold other debt securities to maturity in the future, provided that reclassification was performed by December 31, 1995. The Company adopted the reclassification provision in the Special Report during 1995 and transferred $38,660,000 of held-to-maturity securities into available-for-sale.
Loans - Loans are stated at the principal amount outstanding. Interest on loans is credited to income on a simple interest basis. Loan origination fees and direct origination costs are deferred and amortized to income by a method approximating the level yield interest method over the estimated lives of the underlying loans. Loans contractually past due over 90 days or considered impaired are placed on nonaccrual status, unless they are well-secured by underlying collateral and are in the process of collection. When a loan is placed on nonaccrual status, the accrued interest is reversed against interest income and the loan is accounted for on the cash or cost recovery method thereafter until qualifying for return to accrual status. Generally, a loan will be returned to accrual status when all delinquent principal and interest become current in accordance with the terms of the loan agreement and full collection of the principal appears probable.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The allowance for possible loan losses is a valuation allowance that is maintained at a level estimated to be adequate to provide for future loan losses through charges to current operating expense. The allowance is based upon a continuing review of loans by management which includes consideration of changes in the character of the loan portfolio, current and anticipated economic conditions, past lending experience, loan loss experience, and such other factors which, in management's judgment, deserve recognition in estimating potential loan losses. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for possible loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgment of information available to them at the time of their examination.
Loans Available for Sale - The Subsidiary Banks originate loans that are guaranteed in part by the Small Business Administration. The guaranteed portion of such loans may be sold without recourse. The Subsidiary Banks retain the servicing and credit risk in the remaining unguaranteed portion. Loans available for sale are valued at lower of cost or estimated market value and are comprised of the portion of loans originated for sale, which are guaranteed by the Small Business Administration. When participating interests in loans are sold without recourse, gains are recognized at the time of the sale which are equal to the premium received less estimated future loan servicing costs and profits. Any discounts related to loan interests retained are amortized using methods that approximate the level yield interest method over the remaining life of the loan.
Premises and Equipment - Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are charged to expense over the estimated useful lives of the assets or the lease term on a straight-line basis as follows:
- -------------------------------------------------------------------------------- Buildings 40 years Furniture and equipment 2-5 years Leasehold improvements 5 years Property under capital lease 5 years - --------------------------------------------------------------------------------
Other Real Estate Owned - Real estate and other assets acquired in satisfaction of indebtedness are recorded at the lower of the recorded loan amount or the estimated fair market value net of anticipated selling costs, and any difference between this and the loan amount is treated as a loan loss. Costs of maintaining other real estate owned, subsequent declines in fair value, if any, and gains or losses on sale are reflected in current earnings.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Income Taxes - Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. To the extent that current available evidence about the future raises doubt about the realization of a deferred tax asset, a valuation allowance is established to reduce that deferred tax asset if it is more likely than not that the related tax benefits will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years which those differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Net Income Per Share - Net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year (taking into account the shares issued in connection with the acquisition of South Valley as if these shares were issued for all periods presented) plus shares issuable assuming exercise of all employee stock options, except where antidilutive. The weighted average shares outstanding were 4,239,617, 4,192,297, and 4,113,474 in 1996, 1995, and 1994, respectively. Weighted average shares outstanding and all per share amounts included in the accompanying consolidated financial statements and notes thereto have given effect to all stock dividends.
Dividends - In 1996 the Company paid four cash dividends of $0.15 per share to holders of record on March 15, June 28, September 16, and November 1, payable on March 29, June 28, September 30, and December 9, 1996, respectively. The Company also paid a five percent (5%) stock dividend payable to shareholders of record as of December 1, 1996.
Reclassifications - Certain amounts in the 1995 and 1994 consolidated financial statements have been reclassified to conform to the 1996 presentation.
Accounting Pronouncements - During 1996, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards (SFAS) No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. Under this approach, after a transfer of financial assets, an entity recognizes all financial and servicing assets it controls and liabilities it has incurred and derecognizes financial
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
assets it no longer controls and liabilities that have been extinguished. This statement is effective for years ending after December 31, 1996. The Company does not believe this statement will have any significant impact on its consolidated financial statements.
(2) Merger
On November 20, 1996, the Company acquired South Valley Bancorporation (SVB) and its banking subsidiary, South Valley National Bank, headquartered in Morgan Hill, California. Each share of SVB common stock outstanding on November 20, 1996, was converted into 0.92 shares of the Company's common stock. The Company issued approximately 1,291,000 shares of common stock and cash in lieu of fractional shares for all of the outstanding shares of SVB. The consolidated financial statements of the Company give effect to the merger, which has been accounted for as a pooling-of-interests. Accordingly, the accounts of SVB have been combined with those of the Company for all periods presented. A reconciliation of previously reported net interest income and net income follows:
- ------------------------------------------------------------------------------- (In thousands) Nine months ended Years ended December 31, September 30, 1996 ----------------------------------- Net interest income (Unaudited) 1995 1994 - ------------------------------------------------------------------------------ SVB $7,786 $8,891 $7,985 PABN 14,664 18,816 16,971 - ------------------------------------------------------------------------------ Combined $22,450 $27,707 $24,956 - ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------- (In thousands) Nine months ended Years ended December 31, September 30, 1996 ----------------------------------- Net income (Unaudited) 1995 1994 - ------------------------------------------------------------------------------ SVB $1,460 $1,577 $1,886 PABN 4,112 5,034 4,339 - ------------------------------------------------------------------------------ Combined $5,572 $6,611 $6,225 - ------------------------------------------------------------------------------
(3) Cash and Due from Banks
Cash and due from banks includes approximately $5,659,000 and $5,827,000 as of December 31, 1996 and 1995, respectively, held by the Federal Reserve Bank of San Francisco to meet required reserve balances.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(4) Quarterly Income Statement
The amortized cost and estimated fair values of investment securities as of December 31, 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
As of December 31, 1996 and 1995, securities with carrying values of approximately $26,638,000 and $29,264,000, respectively, were pledged as collateral for such items as deposits of public funds, Federal Reserve Bank borrowings, bankruptcy court accounts, and U.S. Treasury, tax, and loan deposits.
Included in U.S. Agency securities are certain structured notes which are more commonly known as step-up bonds. These bonds, which carry certain call features and potential coupon rate increases, had an estimated fair value of $1,459,000 and an amortized cost of $1,500,000 as of December 31, 1996.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(6) Loans
A summary of loans as of December 31 is as follows:
- ------------------------------------------------------------------------------- (In thousands) 1996 1995 - ------------------------------------------------------------------------------- Commercial $113,428 $82,583 Consumer 22,509 25,604 Real estate - mortgage 195,417 154,572 Real estate - construction 38,014 32,409 Other 20,349 6,501 - ------------------------------------------------------------------------------- 389,717 301,669 Less deferred loan fees 989 774 - ------------------------------------------------------------------------------- $388,728 $300,895 ===============================================================================
The following is an analysis of the allowance for possible loan losses for the years ended December 31:
- ----------------------------------------------------------------------------- (In thousands) 1996 1995 1994 - ----------------------------------------------------------------------------- Balance, beginning of year $3,710 $3,769 $3,753 Provision charged to expense 685 527 479 Loans charged off (1,070) (850) (665) Recoveries on loans previously charged off 347 264 202 - ----------------------------------------------------------------------------- Balance, end of year $3,672 $3,710 $3,769 =============================================================================
Loans for which interest is no longer being accrued totaled $1,564,000, $2,481,000, and $3,283,000 as of December 31, 1996, 1995, and 1994, respectively. Interest that would have been recognized on nonaccrual loans was $149,000, $379,000, and $364,000 during 1996, 1995, and 1994, respectively.
The recorded investment in impaired loans was $1,564,000 and $2,481,000 at December 31, 1996 and 1995, respectively. The average balance of impaired loans during 1996 and 1995 was $2,126,000 and $1,510,000. The Company did not recognize any interest income on impaired loans during the year ended December 31, 1996.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The Subsidiary Banks operate in a geographic region comprising Monterey, San Benito, Santa Clara, and Santa Cruz Counties. The Bank's credit risk is therefore dependent in part to the economic condition of this region. Loans are made on the basis of a secure repayment source, namely the cash flows generated by the borrowing entity, collateral is generally a secondary source for loan qualification. It is the Bank's policy to maintain the loan to value ratio on secured loans below 75%. Management believes this practice tends to mitigate risks caused by the local economy.
The Subsidiary Banks make loans to executive officers, directors, and their affiliates in the ordinary course of business. Following is an analysis of activity with respect to such loans for the years ended December 31, 1996, and 1995:
- -------------------------------------------------------------------------------- (In thousands) 1996 1995 - -------------------------------------------------------------------------------- Balance, beginning of year $5,002 $6,920 New loan funded 4,394 4,699 Repayments of loans (2,923) 6,617 - -------------------------------------------------------------------------------- Balance, end of year $5,711 $5,002 ================================================================================
(7) Premises and Equipment
Premises and equipment as of December 31 are summarized as follows:
- -------------------------------------------------------------------------------- (In thousands) 1996 1995 - -------------------------------------------------------------------------------- Land $2,752 $2,752 Buildings 9,867 8,641 Furniture and equipment 8,929 7,966 Leasehold improvements 1,421 1,319 - -------------------------------------------------------------------------------- 22,969 20,678 Less accumulated depreciation and amortization 7,669 7,171 - -------------------------------------------------------------------------------- Premises and equipment, net $15,300 $13,507 ================================================================================
(8) Time Deposits
As of December 31, 1996 and 1995, the Company had liabilities of $80,952,000 and $57,285,000, respectively, for time deposits in denominations of $100,000 or more. Interest expense for these deposits was $4,036,000 and $2,819,000 in 1996 and 1995, respectively.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(9) Income Taxes
Components of income tax expense for the years ended December 31, 1996, 1995, and 1994 are as follows:
- -------------------------------------------------------------------------------- (In thousands) 1996 1995 1994 - -------------------------------------------------------------------------------- Current: Federal $3,696 $3,053 $2,756 State 1,457 1,240 1,139 - -------------------------------------------------------------------------------- 5,153 4,293 3,895 - -------------------------------------------------------------------------------- Deferred: Federal (649) (66) (111) State (156) (27) (6) - -------------------------------------------------------------------------------- (805) (93) (117) ================================================================================ Total $4,348 $4,200 $3,778 ================================================================================
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The net deferred tax asset represents recoverable taxes and is included in other assets in the accompanying consolidated balance sheets. The Company believes that the net deferred tax asset is realizable through sufficient taxable income within the carryback period and the current year taxable income.
Actual income tax expense differs from the "expected" tax expense (computed by applying the U.S. federal corporate income tax rate of 34% to earnings before income taxes) for the years ended December 31, as follows:
- -------------------------------------------------------------------------------- (In thousands) 1996 1995 1994 - -------------------------------------------------------------------------------- Computed "expected" tax expense $3,531 $3,702 $3,402 Increase (reduction) in income taxes resulting from: Tax exempt income (368) (335) (354) Franchise taxes, net of federal income tax benefit 858 802 713 Merger and acquisition costs 325 - - Other, net 2 30 18 ================================================================================ $4,348 $4,200 $3,778 ================================================================================
(10) Benefit Plans
Stock Option Plans - The Company has a stock option plan (the 1984 Stock Option Plan) under which incentive stock options or nonqualified stock options were granted to certain key employees or directors to purchase an aggregate of 60,241 shares of authorized, but unissued, common stock of the Company. Unexercised options were granted and outstanding as of December 31, 1996, for an aggregate of 60,241 shares. Options have been granted at an exercise price not less than the fair market value of such stock at the date of grant. All stock options become exercisable at the rate determined by the Company's Board of Directors and expire no later than 10 years after the date of grant.
The Company's 1994 Stock Option Plan (the 1994 Plan) which was a successor to the 1984 Plan, provides for incentive stock options or nonqualified stock options for key employees or directors to purchase an aggregate of 554,154 shares of authorized, but unissued, common stock of the Company. Unexercised options were granted and outstanding as of December 31, 1996, for an aggregate of 228,199 shares with an exercise price equal to the fair market value of the Company's common stock at the date of grant. The 1994 Plan provides that options granted thereunder begin to vest 6 months after the date of grant ratably over 4 years and expire no later than 10 years after the date of grant.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The Company has a Directors Stock Option Plan (the 1991 Directors Plan) under which, nonqualified options may be granted to non-employee directors of the Company and its subsidiaries to purchase an aggregate of 174,225 shares of authorized, but unissued, common stock of the Company according to a formula set forth in the 1991 Plan. Unexercised options were granted and outstanding as of December 31, 1996, for an aggregate of 100,455 shares with an exercise price equal to the fair market value of the Company's common stock at the date of grant. The 1991 Plan provides that options granted thereunder begin to vest 6 months after the date of grant and expire no later than 10 years after the date of grant.
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. This statement defines a fair value based method of accounting for an employee stock option or similar equity instrument. Under this method, compensation costs are measured at the grant date based on the value of the award and are recognized over the service period, which is the vesting period.
The Company applies Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation costs for the Company's three stock option plans been determined consistent with SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
December 31, - -------------------------------------------------------------------------------- (In thousands, except per share) 1996 1995 - -------------------------------------------------------------------------------- Net income As reported $6,039 $6,611 Pro forma $5,883 $6,605
Earnings per share As reported $1.42 $1.58 Pro forma $1.39 $1.58
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 1995, and 1996, respectively: dividend yield of 2.1% and 2.5%, expected volatility of 18% for all years, risk-free interest rates of 5.39% and 5.64%, and expected lives of 5.5 and 6.1 years, respectively.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Below is a summary of stock option activity under all plans during 1996 and 1995:
1996 1995 - -------------------------------------------------------------------------------- Weighted Weighted average average exercise exercise Shares price Shares price - -------------------------------------------------------------------------------- Outstanding at beginning of year 433,474 $14.57 400,967 $14.33 Granted 157,153 19.13 62,321 15.00 Exercised (200,106) 14.69 (22,811) 11.73 Forfeited (1,626) 11.32 (7,003) 13.74 - -------------------------------------------------------------------------------- Outstanding end of year 433,474 $16.37 433,474 $14.57
Options exercise end of year 317,860 348,905
Weighted average fair value of options granted during the year $4.32 $3.27 - --------------------------------------------------------------------------------
Employee Stock Ownership Plan - In 1986, the Company adopted an Employee Stock Ownership Plan (ESOP) covering substantially all employees. Effective March 1, 1991, the Company adopted an amendment to the ESOP to restructure it as a leveraged employee stock ownership plan, which qualifies as a stock bonus plan under the Internal Revenue Code. The Company may make annual contributions to the ESOP in an amount determined by the Board of Directors. Contributions are not intended to exceed an amount estimated to be an allowable deduction for tax purposes. The Company made contributions to the ESOP of $275,000, $292,000, and $332,000 in 1996, 1995, and 1994, respectively.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
401(k) Plan - The Company also has a tax deferred profit sharing plan and thrift plan covering all eligible employees. The Company's contributions amounted to $71,000, $70,000, and $69,000 for the years ended December 31, 1996, 1995, and 1994.
On December 31, 1996, pursuant to the merger between the Company and SVB, the 401(k) and ESOP Plans of SVB were merged with and into the respective plans of the Company.
(11) Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.
Cash and Cash Equivalents - The carrying amount approximates fair value because of the short maturities of these instruments.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Investment Securities - The fair value of investments and mortgage-backed securities, except certain state and municipal securities, is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued.
Loans - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage, and consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.
The fair value of performing fixed rate loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. The fair value of performing variable rate loans is judged to approximate book value for those loans whose rates reprice in less than 90 days. Rate floors and rate ceilings are not considered for fair value purposes as the number of loans with such limitations is not significant.
Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.
Deposit Liabilities - The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, savings and NOW accounts, and money market and checking accounts, approximates the amount payable on demand. The fair value of certificates of deposit is judged to approximate book value for those certificates whose remaining maturities are less than 90 days. For all other certificates, estimated cash flows are discounted using rates currently offered for deposits of similar remaining maturities.
Limitations - Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
the Company's entire holdings of a particular financial instrument. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in many of the estimates.
(12) Commitments and Contingencies
Future minimum rental payments for Bank premises under noncancelable operating leases as of December 31, 1996 are as follows:
- ----------------------------------------------------------------- Minimum lease payments Year ending December 31, (In thousands) - ----------------------------------------------------------------- 1997 $878 1998 911 1999 649 2000 443 2001 207 Thereafter 1,092 - ----------------------------------------------------------------- 4,180 Minimum rentals receivable under noncancelable subleases (621) - ----------------------------------------------------------------- $3,559 =================================================================
Rent expense under operating leases totaled $796,000, $781,000, and $764,000 for the years ended December 31, 1996, 1995, and 1994, respectively. Related sublease rental income totaled $131,000, $82,000, and $99,000, respectively.
In December 1988, the Company entered into an operating lease with a member of its Board of Directors for rental of its administrative headquarters. This lease
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
required payments totaling approximately $192,000, $188,000, and $185,000 for the years ended December 31, 1996, 1995, and 1994, respectively. The lease expires on April 30, 1999.
In the normal course of business, there are outstanding commitments, such as commitments to extend credit, which are not reflected in the accompanying consolidated financial statements. These commitments involve elements of credit and interest rate risk. Management does not anticipate any loss will result from such commitments. As of December 31, 1996, amounts committed to extend credit under normal lending agreements aggregated approximately $140,372,000. Management reviews the risk associated with these credits in evaluating the overall adequacy of the allowance for possible loan losses. Additionally, there are approximately $4,994,000 in outstanding standby letters of credit which, in effect, are guarantees of obligations of customers.
The Company, through the Subsidiary Banks, has borrowing lines of approximately $51,000,000 with primary correspondent banks. There were no borrowings outstanding under these lines as of December 31, 1996.
(13) Regulatory Capital
The Federal Reserve Board and the Comptroller have established a minimum leverage ratio of 3% Tier 1 capital to total assets for bank holding companies and national banks that have received the highest composite regulatory rating and are not anticipating or experiencing any significant growth. All other institutions will be required to maintain a leverage ratio of at least 100 to 200 basis points above the 3% minimum.
Set forth on the following page are the Company's and the Subsidiary Banks' risk-based and leverage capital ratios as of December 31, 1996:
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(14) Pacific Capital Bancorp (Parent Company Only)
The following are the financial statements of Pacific Capital Bancorp:
- -------------------------------------------------------------------------------- BALANCE SHEETS Years ended December 31, - -------------------------------------------------------------------------------- (In thousands) 1996 1995 - -------------------------------------------------------------------------------- Assets Cash and cash equivalents $937 $1,605 Loans 1,042 1,149 Premises and equipment, net 3,022 1,865 Investment in subsidiaries 58,178 55,492 Other assets 910 725 - -------------------------------------------------------------------------------- Total Assets $64,089 $60,836 ================================================================================ Liabilities and Shareholders' Equity Liabilities $443 $303 Shareholders' equity 63,646 60,533 - -------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $64,089 $60,836 ================================================================================
- -------------------------------------------------------------------------------- STATEMENTS OF INCOME Years ended December 31, - -------------------------------------------------------------------------------- (In thousand) 1996 1995 1994 - -------------------------------------------------------------------------------- Equity in income of subsidiaries $3,061 $6,010 $4,257 Cash dividends received from bank subsidiaries 3,993 882 2,216 Interest income and fees on loans 136 214 187 Other expenses (1,151) (495) (435) - -------------------------------------------------------------------------------- Net income $6,039 $6,611 $6,225 ================================================================================
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The ability of the Company to pay dividends will largely depend upon the dividends paid to it by the subsidiary banks. There are legal limitations on the ability of the subsidiary banks to provide funds to the Company in the form of loans, advances, or dividends. Under the National Bank Act, the subsidiary banks may not declare dividends in any calendar year that exceed certain legal limitations. The approximate amount of restricted equity of the Subsidiary Banks as of December 31, 1996 was $45,368,000.
PACIFIC CAPITAL BANCORP
Management's Discussion and Analysis
This document may contain forward-looking statements that are subject to risks and uncertainties, including, but not limited to the local economy, the real estate market in California, and other factors beyond the Company's control. Such risks and uncertainties could cause actual results to differ materially from those indicated. For a discussion of factors that could cause actual results to differ, please see the discussion contained herein. Readers should not place undue reliance on forward-looking statements, which reflect managements view only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect subsequent events or circumstances. Readers are also encouraged to review the Company's publicly available filings with the Securities and Exchange Commission.
The Company
Pacific Capital Bancorp (the "Company") through its wholly owned subsidiaries, First National Bank of Central California ("First National"), and South Valley National Bank ("South Valley") engages in a broad range of financial service activities. First National and South Valley are collectively referred to herein as "Subsidiary Banks," and references to the Company include the Subsidiary Banks.
On November 20, 1996, the Company acquired South Valley Bancorporation (SVB) in a transaction accounted for as a pooling-of-interests. Accordingly, these consolidated financial statements were restated on a combined basis for all periods presented.
The following sections set forth a discussion of the significant operating changes, business trends, financial condition, earnings, capital position, and liquidity that have occurred in the three-year period ended December 31, 1996, together with an assessment, when considered appropriate, of external factors that may affect the Company in the future. This discussion should be read in conjunction with the Company's consolidated financial statements and notes on pages _____ of this annual report.
Summary of Financial Results
Net income for 1996 was $6,039,000 or $1.42 per share, a decrease of $572,000 or $0.16 per share from 1995. This decrease in net income is due to merger-related expenses incurred relating to the merger with South Valley Bancorporation. (See Note 2 to the Consolidated Financial Statements) Net income for 1996 excluding the one-time merger-related expenses was $7,540,000 or $1.78 per share. The Company's net operating income excluding merger-related charges increased significantly for the second straight year in 1996. The Company's net income for 1995 of $6,611,000 or $1.58 per share represented an increase of $386,000 or $0.07 per share over 1994.
In 1996 the Company paid four cash dividends of $0.15 in March, June, September, and December. In 1995, the Company distributed three $0.125 cash dividends in March, June, and September and a $0.15 cash dividend in December. In addition, the Company distributed a 5% stock dividend in each of the years in the three year period ended December 31, 1996. Earnings per share amounts have been retroactively restated to reflect these stock dividends. The return on average shareholders' equity was 9.6% in 1996, compared to 11.4% in 1995 and 11.8% in 1994.
The Company believes that the economies in which it operates, Monterey, Santa Cruz, Santa Clara, and San Benito Counties, have experienced strong growth and favorable economic activity in the past two years. Signs of the strength in these local economies include sustained quality loan demand and strong deposit growth. On a national scale, the Company is forecasting a relatively flat interest rate environment due to minimal inflation prospects and very modest growth.
Certain information concerning the Company's average balances, yields and rates on average interest-earning assets and interest-bearing liabilities is set forth in the following table. Interest yields and amounts earned include net loan fees of $1,211,000, $1,152,000, and $1,178,000 in 1996, 1995, and 1994, respectively.
The net interest margin is expressed as the percentage of net interest income to average total earning assets. The average balance on non-accrual loans is immaterial as a percentage of total loans and as such has been included in total loans. Non-taxable securities and leases have not been calculated on a tax equivalent basis.
Net Interest Income
Net interest income, the difference between interest earned on loans and investments and the interest paid on deposits and other sources of funds, is the principal component of the Company's earnings. The preceding table shows the composition of average earning assets and average interest-bearing liabilities, average yields and rates, and the net interest margin for 1994 through 1996. Interest income increased $5,280,000 or 13.7% from $38,678,000 in 1995 to $43,958,000 in 1996, after increasing $5,648,000 or 17.1% from 1994 to 1995. The increase in 1996 is the result of higher average loan and investment volumes during 1996 partially offset by a slightly
lower yield on the loan portfolio. The increase in 1995 was due mainly to higher average yields on loans and investment securities and an increase in average volumes in loans and investments compared to 1994. Total interest and fees produced a 8.7% yield on average earning assets in 1996, compared to 8.9% and 8.0% yields on average earning assets in 1995 and 1994, respectively. The yield increase in 1995 was the result of several interest rate increases in the Subsidiary Banks' reference rate (the rate charged to the Bank's most creditworthy customers) which took place during the course of 1994 and early 1995.
During 1995, the Company increased its available-for-sale securities portfolio relative to the held-to-maturity portfolio. This shift has resulted in increased liquidity for the Company.
Total interest expense for 1996 was $13,319,000, an increase of $2,348,000 or 21.4% over 1995, compared to an increase of $2,897,000 or 35.9% from 1994 to 1995. The Company's cost of funds (excluding noninterest-bearing demand deposits) experienced a small increase of 0.1% from 1995 to 1996. From 1994 to 1995, the Company's cost of funds increased by 0.72% due to the prevailing rising interest rate environment and a change in the mix of deposits.
Earning Assets
Outstanding total loans averaged $332,421,000 in 1996 compared to $287,906,000 during 1995. This represents an increase of $44,515,000 or 15.5%, compared to an increase of $13,118,000 or 4.8% from 1994 to 1995. The increase in total loans outstanding during 1996 is due to increased loan demand from qualified borrowers and is reflective of the strength of the economy in most of
The Company lends primarily to small- and medium-sized businesses within its markets, which is comprised principally of Monterey, Santa Cruz, Santa Clara, and San Benito Counties.
A majority of the Company's loan portfolio consists of loans secured by commercial, industrial, and residential real estate. As of December 31, 1996, real estate mortgage and construction loans represented $233,431,000 or 60.1% of total loans, an increase of $46,450,000 from the prior year.
Real estate mortgage loans included commercial real estate loans of approximately $146,777,000, one-to-four family home loans of approximately $21,434,000, equity lines of credit of approximately $20,710,000, multifamily dwelling loans of approximately $4,001,000 and farm land loans of approximately $2,495,000. Construction loans totaled $38,014,000 or 9.8% of the loan portfolio as of December 31, 1996, which represents an increase of $5,605,000 or 17.3% from December 31, 1995. Management believes that the Bank does not have any significant loss exposure with respect to such loans, due to the Bank's collateral position. In general, advances do not exceed 65% of appraised value on commercial real estate loans and 75% on residential mortgages. Continued emphasis is placed on this policy and, accordingly, appraisals are periodically updated as conditions change.
The Company finances the construction of residential and commercial real estate properties. These loans are all at variable rates, are secured by first deeds of trust on the underlying properties, and generally have maturities of less than 24 months. Repayment is based on a pre-qualification analysis of the borrower's ability to obtain take-out financing. The Company's construction lending has been in areas which management believes to have favorable market conditions. Advances on residential and commercial projects are limited in general to the lower of approximately 75% and 65%, respectively, of cost or appraised value.
Commercial loans not secured by real estate totaled $113,428,000 or 29.2% of the total loan portfolio at December 31, 1996. This represented an increase of $30,845,000 over 1995. Management believes that this increase in demand is a further indicator of the strength in the local economy.
Consumer loans decreased $3,095,000 or 12.1% during 1996. Consumer loans, as of December 31, 1996, represent 5.8% of the total loan portfolio, compared to 8.5% of the 1995 loan portfolio.
The Company had undisbursed loans totaling $140,372,000 as of December 31, 1996, primarily representing available lines of credit and the unfunded portion of construction loan commitments.
The fixed rate loan categories discussed above mature as follows: $15,223,000 in 1997, $8,118,000 in 1998 $12,353,000 in 1999, $7,229,000 in 2000, and $20,888,000 in 2001, with the remaining $59,087,000 maturing thereafter. The variable loan rate categories discussed above mature as follows: $246,516,000 in 1997, $10,330,000 in 1998, $6,173,000 in 1999, $750,000 in 2000, and $1,067,000 on 2001, with the remaining $994,000 maturing thereafter.
Interest Rate Sensitivity Interest rate sensitivity is the relationship between market interest rates and net interest income due to the repricing characteristics of assets and liabilities. If more liabilities than assets reprice in a given period (a liability sensitive position), market interest rate changes will be reflected more quickly in liability rates. If interest rates decline, a liability sensitive position will benefit net income. Alternatively, where assets reprice more quickly than liabilities in a given period (an asset sensitive position) a decline in market rates will have an adverse effect on net interest income.
The table on the following page presents the interest rate sensitivity of the Company as of December 31, 1996. For any given period, the structure is matched when an equal amount of assets and liabilities reprice. Any excess of assets or liabilities over these matched items results in the gap, or mismatch, shown at the foot of the table. A negative gap indicates liability sensitivity and a positive gap indicates asset sensitivity.
The Company has remained flexible in determining the point at which to reprice deposits. This flexibility mitigates the Company's liability sensitive position in the under one year category.
Quality of Loans The Company had net loan charge-offs of $723,000 and $586,000 in 1996 and 1995, respectively. Net charge-offs as a percent of average loans has remained relatively constant over the last three years at 0.22%, 0.20%, and 0.17% at December 31, 1996, 1995, and 1994, respectively. Over the last five years, the low amount of net charge-offs to average loans is reflective of management's continued emphasis on credit quality standards in the loan approval process as well as close monitoring of the loan portfolio. The Company's net charge-offs as a percent of average loans have been below most industry averages in each year reflected in the table below.
Management anticipates the Company's charge-off experience in 1997 to be consistent with that experienced in 1996 primarily due to the strength and growth in the local economic areas in which the Company serves. This factor continues to be of importance in assessing the adequacy of the allowance for possible loan losses.
The table on the following page summarizes the actual loan losses and provision for possible loan losses during the last five fiscal years by loan category:
Inherent in the lending function is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan extended and the creditworthiness of the borrower. To reflect the estimated risks of loss associated with its loan portfolio, provisions are made to the Company's allowance for possible loan losses. As an integral part of this process, the allowance for possible loan losses is subject to review and possible adjustment as a result of regulatory examinations conducted by governmental agencies and through management's assessment of risk. The Company's entire allowance is a valuation allocation; that is, it has been created by direct charges against earnings through the provision for possible loan losses.
The Company evaluates the allowance for possible loan losses based upon an individual analysis of specific categories of loans. The adequacy of the allowance can be determined only on an approximate basis, since estimates as to the magnitude and timing of loan losses are not predictable because of the impact of external events. In addition, the Company has for the last several years contracted with an independent loan review consulting firm to evaluate overall credit quality on an ongoing basis. Management then considers the adequacy of the allowance for possible loan losses in relation to the total loan portfolio.
The provision for possible loan losses charged against earnings is based upon an analysis of the actual migration of loans to losses plus an amount for other factors which, in management's judgment, deserve recognition in estimating possible loan losses. These factors include: specific loan conditions as determined by management; the historical relationship between charge-offs and the level of the allowance; the estimated future loss in all significant loans; known deterioration in
concentrations of credit, certain classes of loans or pledged collateral; historical loss experience based on volume and types of loans; the results of any independent review or evaluation of the loan portfolio quality conducted by or at the direction of Company management or by bank regulatory agencies; trends in portfolio volume, maturity, and composition; off-balance sheet credit risk; volume and trends in delinquencies and nonaccruals; lending policies and procedures including those for charge-off, collection, and recovery; national and local economic conditions and downturns in specific local industries; and the experience, ability, and depth of lending management and staff. The Company evaluates the adequacy of its allowance for possible loan losses on a quarterly basis.
While these factors cannot be reduced to a mathematical formula, it is management's view that the allowance for possible loan losses of $3,672,000 or 0.94% of total loans as of December 31, 1996, was adequate. This allowance is compared to $3,710,000 or 1.23% in 1995 and $3,769,000 or 1.30% in 1994. The decrease in the allowance for loan losses as a percentage of total loans from 1995 to 1996 was due to the substantial growth in total loans during 1996 without the same corresponding increase in size of the allowance for loan losses. Management believes that the quality of the loan growth coupled with the decrease in nonperforming loans during this same period warrants the decrease in the level of the allowance relative to the loan portfolio. There are, however, no assurances that in any given period the Company will not sustain charge-offs which are substantial in relation to the size of the allowance. Loans are charged to the allowance for loan losses when the loans are deemed uncollectible. It is the policy of management to make additions to the allowance so that it remains adequate to cover anticipated losses inherent in the Company's loan portfolio.
Nonperforming Loans Interest income on the loan portfolio is recorded on the accrual basis. However, the Company follows the policy of discontinuing the accrual of interest income and
reversing any accrued and unpaid interest when the payment of principal or interest is 90 days past due unless the loan is both well secured and in the process of collection. The Company's Lending Policy provides for strict requirements for exempting loans from nonaccrual status. The composition of nonperforming loans as of the end of the last three fiscal years is summarized in the following table:
- ------------------------------------------------------------------------------ Nonperforming Loans (In thousands) 1996 1995 1994 - ------------------------------------------------------------------------------ Loans accounted for on a nonaccrual basis $1,564 $2,481 $3,283 Other loans contractually past due 90 days or more 17 261 734 Restructured loans 279 513 147 - ------------------------------------------------------------------------------ Total $1,860 $3,255 $4,164 ==============================================================================
Loans accounted for on a nonaccrual basis experienced a substantial decrease in 1996 to $1,564,000 compared to $2,481,000 at December 31, 1995. This decrease was due to management's continuing efforts to resolve significantly past due loans combined with a strong local economy.
Of total nonperforming loans as of December 31, 1996, $726,000 consisted of one real estate loan which was well-secured. In addition, the overall coverage of the allowance as a percent of nonperforming loans is 197.4%. The Company's ratio of nonperforming loans to average loans has been below most industry averages in each year reflected in the table above.
The Company does not expect to sustain losses in excess of that provided for in the allowance for possible loan losses. At December 31, 1996, the Company had $279,000 in loans which were troubled debt restructurings as defined by SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings, and which were not either nonaccrual loans or loans past due 90 days or more and still accruing interest. At December 31, 1996, the Company did not have any loans other than those disclosed as nonaccrual loans, loans past due 90 days or more and still accruing interest and troubled debt restructurings where known information about possible credit problems of the borrowers cause management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms.
Investments The average balance of Federal Funds Sold (overnight investments with other banks) and other short-term investments (primarily money market mutual funds) was $43,823,000 in 1996, $42,617,000 in 1995, and $29,021,000 in 1994. These investments are maintained primarily for the short-term liquidity needs of the Company. The major factors influencing the levels of required liquidity are loan demand of the Company's customers and fluctuations in the Company's level of deposits. The Company's loan to deposit ratio averaged 66.2% in 1996, compared to 67.2% in 1995, and 68.6% in 1994.
Funding Average total deposits increased $70,574,000 or 16.3% during 1996, compared to an increase of $27,928,000 or 6.9% during 1995 and an increase of $21,864,000 or 5.7% in 1994. Average non-interest bearing deposits increased in 1996 by $13,791,000 or 14.4% compared to an increase of $8,908,000 or 10.3% in 1995 an increase of $9,511,000 or 12.3% in 1994. Average interest-bearing deposits increased $56,067,000 or 16.7% in 1996, compared with increases of $19,020,000 or 6.0% in 1995 and $11,112,000 or 3.6% during 1994. Total deposit growth in 1997 is expected to continue but may not increase at the same rate or in the same categories. The Company is able to attract deposits by providing interest rates and services competitive with other institutions located in its market area. The Company does not have any brokered deposits or large concentrations with any one customer. Given the Company's forecast
The table above sets forth information for the last three fiscal years regarding the Company's average deposits and the average rates paid on each of the deposit categories.
The remaining maturities of the Company's certificates of deposit, including public funds, in amounts of $100,000 or more as of December 31, 1996, are indicated in the table below. Interest expense on these certificates of deposit totaled $4,036,000 in 1996.
- ---------------------------------------------------------------------------- (In thousands) 1996 - ---------------------------------------------------------------------------- Three month or less $32,921 Over three through six months 21,841 Over six through twelve months 26,190 Over twelve months - - ---------------------------------------------------------------------------- Total $80,952 ============================================================================
Noninterest Income Total other income increased in 1996 to $3,160,000 from $2,983,000 in 1995. The increase was primarily due to a $181,000 increase in other income partially offset by a decrease in gains on loan sales. In addition, net losses on securities transactions decreased in 1996 to $46,000 from $73,000 in 1995. Noninterest income also increased in 1995 by $112,000 as a result of an increase in service charges of $236,000 partially offset by a decrease in gains on sales of loans of $69,000. The Mortgage Banking Division of the Company is solely a brokerage operation. The Company does not originate, purchase, or sell loans in this area and thus retains no credit or servicing risk.
Noninterest Expense In 1996, total other operating expenses increased 17.4% to $22,727,000, after an increase of $2,007,000 or 11.6% in 1995. Of the $3,375,000 increase in 1996, $1,972,000 was attributable to merger-related expenses. These costs were primarily within the categories of salaries and benefits, equipment expense, and legal and professional expenses. Salaries and benefits expense increased $1,875,000 or 18.8% in 1996, compared to an increase of $1,259,000 or 14.4% in 1995. The increase in salaries and benefits during 1996 was mainly the result of severance costs related to the merger as well as normal salary increases. The increase in 1995 was primarily due to a greater number of employees in 1995 over 1994 and normal salary increases. As a percentage of average earning assets, salaries and benefits were 2.3% in 1996 compared to 2.3% for 1995 and 2.1% in 1994. The Company employed 259 full-time equivalent employees at year-end 1996.
Occupancy expense increased $152,000 or 7.8% in 1996 compared to an increase of $180,000 or 10.1% in 1995. The increases in 1996 and 1995 were due primarily to the expansion of the Salinas office of First National as well as normal rental rate increases.
Income Taxes
The provision for income taxes was $4,348,000 in 1996, compared to $4,200,000 in 1995 and $3,778,000 in 1994. The Company's effective tax rate for 1996 was 41.9%, compared with 38.9% for 1995, and 37.8% for 1994. The increase in 1996 was due to the fact that a majority of the merger-related costs were not tax-deductible.
Capital
Shareholders' equity increased $3,113,000 or 5.1% in 1996. The increase was primarily a result of retention of the Company's 1996 net income and the exercise of stock options, offset in part by a repurchase of outstanding shares and a total cash dividend of $0.60 per share paid during 1996. The Company regularly assesses future capital needs so that it will remain in compliance with the capital adequacy guidelines issued by the Federal Reserve Board for bank holding companies and by the Office of the Comptroller of the Currency (the "OCC") for national banks. The Company's capital plan for 1996 contemplates continued growth in shareholders' equity through the retention of net income.
The Company and the Subsidiary Banks are subject to the guidelines and regulations of the Federal Reserve Board and the Comptroller, respectively, governing capital adequacy. The Federal Reserve Board has established final risk-based and leverage capital guidelines for bank holding companies which are the same as the Comptroller's capital regulations for national banks.
The Federal Reserve Board capital guidelines for bank holding companies and the OCC's regulations for national banks set total capital requirements and define capital in terms of "core capital elements" (comprising Tier 1 capital) and "supplemental capital elements" (comprising Tier 2 capital). Tier 1 capital is generally defined as the sum of the core capital elements less goodwill. The following items are defined as core capital elements: common stockholders' equity, qualifying noncumulative perpetual preferred stock, and minority interests in the equity accounts of consolidated subsidiaries. Supplementary capital elements include: allowance for loan and lease losses (which cannot exceed 1.25% of an institution's risk weighted assets), perpetual preferred stock not qualifying as core capital, hybrid capital instruments and mandatory convertible debt instruments, and term subordinated debt and intermediate-term preferred stock. The maximum amount of supplemental capital elements which qualifies as Tier 2 capital is limited to 100% of Tier 1 capital, net of goodwill.
Risk-based capital ratios are calculated with reference to risk-weighted assets, including both on and off-balance sheet exposures, which are multiplied by certain risk weights assigned by the Federal Reserve Board or the OCC to those assets. Both bank holding companies and national banks are required to maintain a minimum ratio of qualifying total capital to risk-weighted assets of 8%, at least one-half of which must be in the form of Tier 1 capital. There are presently four risk-weight categories: 0% for cash and unconditionally guaranteed government securities; 20% for conditionally guaranteed government securities; 50% for performing residential real estate loans secured by first liens; and 100% for commercial loans.
The federal banking agencies have issued a joint advance notice of proposed rulemaking to solicit comments on a framework for revising their risk-based capital guidelines to take account of interest rate risk. As required by the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), the notice seeks comment on a proposed method of incorporating an interest rate risk component into the current risk-based capital guidelines, with the goal of ensuring that institutions with high levels of interest rate risk have sufficient capital to cover their exposures. Interest rate risk is a measure of the relationship between a change in market interest rates and
the resultant change in net interest income due to the repricing and/or maturity characteristics of the assets and liabilities of the Company. As financial intermediaries, depository institutions accept interest rate risk as a normal part of their business. They assume this risk whenever the interest rate sensitivity of their assets does not match the sensitivity of their liabilities or off balance sheet positions. Thus, when interest-sensitive assets and liabilities reprice at mismatched intervals, an increase or decrease in interest rates will affect net interest income. Under the proposal, interest rate risk exposures would be quantified by weighing assets, liabilities and off-balance sheet items by risk factors which approximate sensitivity to interest rate fluctuations. Institutions identified as having an interest rate risk exposure greater than a defined threshold would be required to allocate additional capital to support this higher risk. The capital to be allocated would be a dollar amount equal to the percentage by which the risk exceeds the defined threshold multiplied by the institution's total assets. Higher individual capital allocations could be required by the bank regulators based on supervisory concerns.
Federal banking agencies have solicited comments on this proposal but have not yet proposed regulations to implement any interest rate risk component into the risk-based capital guidelines. Accordingly, the ultimate impact on the Bank and the Company of a final regulation in this area cannot be predicted at this time.
Leverage Capital Guidelines
The Federal Reserve Board and the OCC have established a minimum leverage ratio of 3% Tier 1 capital to total assets for bank holding companies and national banks that have received the highest composite regulatory rating and are not anticipating or experiencing any significant growth. All other institutions will be required to maintain a leverage ratio of at least 100 to 200 basis points above the 3% minimum.
Federal banking laws impose restrictions upon the amount of dividends the Subsidiary Banks may declare to the Holding Company (see Note 14 to the accompanying consolidated financial statements). Federal laws also impose restrictions upon the amount of loans or advances that the Subsidiary Banks may extend to the Holding Company. In management's opinion, these do not affect the ability of the Company to meet its cash obligations.
Liquidity
Liquidity represents the ability of the Company to meet the requirements of customer borrowing needs as well as fluctuations in deposit flows.
The Company's principal sources of asset liquidity are cash and due from banks, time deposits with other financial institutions, federal funds sold, short-term investments, and marketable investment securities. As of December 31, 1996 these sources represented $202,453,000 or 37.0% of total deposits, compared to 44.1% in 1995 and 41.0% in 1994. The decrease in 1996 reflects the growth within the loan portfolio of which a small portion was funded by maturities in the investment portfolio. Other sources of asset liquidity are maturing loans and borrowing lines of approximately $51,000,000 with primary correspondent banks. There were no borrowings outstanding under these lines as of December 31, 1996.
The Company guarantees the obligations or performance of its customers by issuing standby letters of credit to a third party. These standby letters of credit are frequently issued in support of third-party obligations, such as retail company transactions and travel agency issuances.
The risk involved in issuing standby letters of credit is essentially the same as the credit risk in extending loans to customers, and they are subject to the same credit origination, maintenance, and management procedures in effect to monitor other credit products. As of December 31, 1996 and 1995, outstanding standby letters of credit totaled $4,994,000 and $2,448,000, respectively.
The Company does not offer or engage in any other off-balance sheet products such as commitments to purchase and sell foreign exchange, interest rate or currency swaps, or financial futures and options.
In the opinion of management, there are sufficient resources to meet the liquidity needs of the Company at present and projected future levels.
Effects of Changing Prices
The most direct effect of inflation is higher interest rates. However, the Company's earnings are not necessarily dependent on the absolute level of interest rates. Instead, earnings are affected by the spread between the yield on loans and investments and the cost of deposits and borrowing money. Another effect of inflation is upward pressure of the Company's operating expenses. It is management's opinion that the effects of inflation on the consolidated financial statements have not been material.
PACIFIC CAPITAL BANCORP AND SUBSIDIARIES PACIFIC CAPITAL BANCORP STOCK ACTIVITY
The common stock of the Company is listed on the NASDAQ National Market under the symbol PABN. This listing became effective on November 20, 1996. Prior to that date, the Company's common stock was listed on the OTC Bulletin Board.
The high and low prices listed below reflect actual trades which occurred in the specified time frames listed. Three brokerage firms effect transactions in the Company's stock: Van Kasper & Co., Sandler O'Neill Partners, L.P.; and Hoefer & Arnett, Inc.
According to the Company's records, there were 2,063 shareholders as of September 10, 1996. In 1996 the Company paid four cash dividends of $0.15 per share to holders of record on March 15, June 28, September 16, and November 1, payable on March 29, June 28, September 30, and December 9, 1996, respectively. The Company also paid a five percent (5%) stock dividend payable to shareholders of record as of December 1, 1996.
For information regarding restrictions on the payment of dividends see Note 14 to the accompanying consolidated financial Statements.
- ------------------------------------------------------------------------------- Ranges of Common Stock Prices - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Quarter Low High - ------------------------------------------------------------------------------- First $24.05 $28.09 Second 25.47 27.63 Third 24.77 26.67 Fourth 25.38 27.63 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Quarter Low High - ------------------------------------------------------------------------------- First $17.69 $18.59 Second 17.23 19.73 Third 20.86 23.13 Fourth 22.22 24.53 - -------------------------------------------------------------------------------
The Corporation
The Company is a California corporation and bank holding company that was incorporated on January 26, 1983. First National and South Valley, wholly owned subsidiaries of the Company, commenced operations in 1984 and 1983, respectively..
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant had duly caused this report to be signed on its behalf of the undersigned, thereunto duly authorized.
Date: March 25, 1997 PACIFIC CAPITAL BANCORP -------------------------------------
By: /S/ Clayton C. Larson ----------------------- CLAYTON C. LARSON President
/S/ Charles E. Bancroft Date: March 25, 1997 - -------------------------------------------- Charles E. Bancroft, Director
/S/ Dennis A. DeCius Date: March 25, 1997 - -------------------------------------------- Dennis A. DeCius Executive Vice President and Chief Financial Officer (principal financial officer and principal accounting officer)
/S/ Gene DiCicco Date: March 25, 1997 - -------------------------------------------- Gene DiCicco, Director
/S/ Lewis L. Fenton Date: March 25, 1997 - -------------------------------------------- Lewis L. Fenton, Director
/S/ Gerald T. Fry Date: March 25, 1997 - -------------------------------------------- Gerald T. Fry, Director
/S/ James L. Gattis Date: March 25, 1997 - -------------------------------------------- James L. Gattis, Director and Secretary
/S/ Hubert W. Hudson Date: March 25, 1997 - -------------------------------------------- Hubert W. Hudson, Director
/S/ Stanley R. Haynes Date: March 25, 1997 - -------------------------------------------- Stanley R. Haynes, Director
/S/ D. Vernon Horton Date: March 25, 1997 - -------------------------------------------- D. Vernon Horton, Chairman of the Board and Director
/S/ William J. Keller Date: March 25, 1997 - -------------------------------------------- William J. Keller, Director
/S/ Eugene R.Guglielmo Date: March 25, 1997 ------------------------------------------- Eugene R. Guglielmo, Director
/S/ Roger C. Knopf Date: March 25, 1997 - -------------------------------------------- Roger C. Knopf, Director
/S/ Clayton C. Larson Date: March 25, 1997 - -------------------------------------------- Clayton C. Larson, President and Director
/S/ William S. McAfee Date: March 25, 1997 - -------------------------------------------- William S. McAfee, Director
/S/ William K. Sambrailo Date: March 25, 1997 - -------------------------------------------- William K. Sambrailo, Director
/S/ Robert B. Sheppard Date: March 25, 1997 - -------------------------------------------- Robert B. Sheppard, Director
/S/ Clyn Smith, Jr. Date: March 25, 1997 - -------------------------------------------- Clyn Smith, Jr., Director
/S/ Mary Lou Rawitser Date: March 25, 1997 - -------------------------------------------- Mary Lou Rawitser, Director