Pacific Capital Bancorp 10-K 2009
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008
COMMISSION FILE NUMBER 0-11113
(Exact Name of Registrant as Specified in its Charter)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes X No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No X
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer X Accelerated filer Non-accelerated filer Smaller reporting company
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes No X
The aggregate market value of the voting stock held by non-affiliates computed June 30, 2008, based on the sales prices on that date of $13.78 per share: Common Stock$601,144,742. All directors and executive officers and the registrants Employee Stock Ownership Plan have been deemed, solely for the purpose of the foregoing calculation, to be affiliates of the registrant; however, this determination does not constitute an admission of affiliate status for any of these stockholders.
As of February 20, 2009, there were 46,618,356 shares of the issuers common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of registrants Proxy Statement for the Annual Meeting of Shareholders on April 30, 2009 are incorporated by reference into Part III.
Certain statements contained in this Annual Report on Form 10-K, as well as some statements by the Company in periodic press releases and some oral statements made by Company officials to securities analysts and shareholders during presentations about the Company, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements. All statements other than statements of historical fact are forward-looking statements for purposes of Federal and State securities laws, including statements that relate to or are dependent on estimates or assumptions relating to the prospects of continued loan and deposit growth, improved credit quality, the health of the capital markets, the Companys de novo branching and acquisition efforts, the operating characteristics of the Companys income tax refund loan and transfer programs and the economic conditions within its markets. These forward-looking statements involve certain risks and uncertainties, many of which are beyond the Companys control. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) increased competitive pressure among financial services companies; (2) changes in the interest rate environment reducing interest margins or increasing interest rate risk; (3) deterioration in general economic conditions, internationally, nationally or in California; (4) the occurrence of terrorist acts; (5) reduced demand for or earnings derived from the Companys income tax refund loan and refund transfer programs; (6) legislative or regulatory changes or litigation adversely affecting the businesses in which the Company engages; (7) unfavorable conditions in the capital markets; (8) challenges in opening additional branches, integrating acquisitions or introducing new products or services; and (9) other risks detailed in reports filed by the Company with the Securities and Exchange Commission (SEC). Forward-looking statements speak only as of the date they are made, the Company does not undertake any obligations to update forward-looking statements to reflect circumstances and or events that occur after the date the forward-looking statements are made.
The assets, liabilities, and results of operations of the Companys tax refund and transfer programs are reported in its periodic filings with the SEC as a segment of its business. As these programs are conducted by very few other financial institutions, users of the financial statements have indicated that they are interested in amounts and ratios for the Company exclusive of these programs so that they may compare the results of operations with financial institutions that have no comparable programs. These amounts and ratios may generally be computed from the information provided in the note to its financial statements that discloses segment information, but are computed and included elsewhere in this Annual Report on Form 10-K for the convenience of the readers of this document.
Purpose and Definition of Terms
The following discussion is designed to provide insight to Managements assessment on the financial condition and results of operations of Pacific Capital Bancorp and its subsidiaries. Unless otherwise stated, the Company refers to this consolidated entity and we refers to the Companys Management. This discussion should be read in conjunction with the Companys Consolidated Financial Statements and the notes to the Consolidated Financial Statements, herein referred to as the Consolidated Financial Statements. These Consolidated Financial Statements are presented on pages 78 through 149 of this Annual Report on Form 10-K, herein referred to as Form 10-K. Specific accounting and banking industry terms and acronyms used throughout this document are defined in the glossary on pages 152 through 155.
Organizational Structure and Description of Services
Pacific Capital Bancorp (the Company or PCB) is a community bank holding company providing full service banking including all aspects of consumer and commercial lending, trust and investment advisory services and other consumer and business banking products through its subsidiaries retail branches, commercial and wealth management centers and other distribution channels to consumers and businesses primarily located in the central coast of California. The Company is one of three primary providers nationwide of refund anticipation loans (RALs) and refund transfer services (RTs).
PCB has five wholly-owned subsidiaries. Pacific Capital Bank, National Association (the Bank or PCBNA), a banking subsidiary and four unconsolidated subsidiaries used as business trusts in connection with issuance of trust-preferred securities as described in Note 14, Long-term Debt and Other Borrowings on page 122 of this Form 10-K.
PCBNA has four wholly-owned consolidated subsidiaries:
In late 2007, PCBNA made an investment in Veritas Wealth Advisors, LLC (Veritas), a registered investment advisor. Veritas was organized in late 2007 and commenced operations in the second quarter of 2008. PCBNAs variable interest of 20% in Veritas includes $1.0 million of equity at risk.
PCBNA also retains ownership in several Low-Income Tax Housing Partnerships that are not consolidated into the Companys Consolidated Financial Statements.
At December 31, 2008, PCBNA conducted its banking services under five brand names at 51 locations:
The brand names retained represent the former names of select acquired independent banks merged into PCBNA. In addition to the retail and business deposits managed by the above banking offices, the Company makes use of brokered deposits and deposits received from the State of California, both of which are administered by the Companys Treasury department.
During 2008, the Bank opened two new retail branches, the Wood Ranch branch located in Simi Valley, and the Casa Dorinda branch located in Santa Barbara, which are both included in the table above as SBB&T. The Bank also sold two retail branches in October 2008, the Santa Paula branch, which was owned by the Bank and the Harvard branch, which was leased by the Bank and are excluded from the table above.
In November 2008, the Bank opened a third commercial and wealth management center in Torrance which is included in the table above as SBB&T. The first two commercial and wealth management centers were opened during 2007 and reside in Glendale and Calabasas which are excluded from the table above since they do not accept deposits. The commercial and wealth management centers are designed like an office and located within office buildings in the Los Angeles area to meet the needs of middle market companies and high net-worth customers. These centers offer specialized products and services and are staffed with experienced personal bankers who are knowledgeable about commercial and trust and advisory products.
The Company had four reportable operating segments at December 31, 2008. These segments are determined based on product line and the types of customers serviced. These reportable operating segments are Community Banking, Commercial Banking, Wealth Management and RAL and RT Programs. The administrative and treasury operations of the Company are not considered part of operating activities of the Company and are reported within the All Other segment for financial reporting. The financial results for each segment are based on products and services provided within
each operating segment with various Management assumptions to calculate the indirect credits and charges for funds which also includes an allocation of certain expenses from the All Other segment. These Management assumptions are explained in Note 24, Segments of the Consolidated Financial Statements beginning on page 142.
The Community Banking, Commercial Banking and Wealth Management segments represent the banking operations for the Company and are referred to as the Core Bank by Management. The banking operations of the Core Bank are similar to the operations of other traditional banks. The Community Banking, Commercial Banking and Wealth Management segments are responsible for collecting deposits, making loans, providing trust and investment advisory services and providing customary banking services. The RAL and RT Programs segment is highly seasonal as a majority of the income is earned in the first quarter of each year. The RAL product generates interest income and the RT product generates non-interest income. The Company has experienced significant growth in RAL and RT Programs over the last several years. The financial impact of the RAL and RT Programs will be discussed throughout the Management Discussion and Analysis (MD&A) section of this document.
The income generated by these four reportable segments are driven by the lending and trust and investment advisory products offered to customers. The primary expenses are interest expense on deposits and funding costs and personnel. Deposit products are provided to the customers of the Community Banking, Commercial Banking and Wealth Management segments. These deposit products include checking, savings, money market and certificates of deposit (CDs). The following segment discussion outlines the products, services and lending policies for each operating segment.
As of January 1, 2009, the Commercial Banking and Wealth Management segments were combined into one operating segment. The combined segment will be called Commercial and Wealth Management segment. Together, the new segment will provide products and services to meet the needs of middle market companies and high net-worth individuals within the existing footprint of the Company and the adjacent markets. The new combined segment currently has three locations which are specifically designed for serving their target customer base. These locations are in Calabasas, Torrance and Glendale, California. The new combined segment will no longer offer SBA loans as these products service small businesses and will be offered through the Community Banking segment.
Business units in this segment provide residential real estate loans, home equity lines and loans, consumer loans, small business loans and lines, and demand deposit overdraft protection products.
Residential real estate loans consist of first and second mortgage loans secured by trust deeds on one to four unit single family homes. The Company has specific underwriting and pricing guidelines based on the credit worthiness of the borrower and the value of the collateral, including credit score, debt-to-income ratio of the borrower and loan-to-value ratio. The Company extends credit up to a maximum of 80% combined loan-to-value of the first trust deed equity value. Maximum borrower debt-to-income ratios range from 40% to 60% and are determined by various factors. Home equity lines of credit are generally secured by a second trust deed on a single one to four unit family home. The interest rate on home equity lines is a variable index rate while term residential mortgage loans can have either variable or fixed interest rates.
Consumer loans and lines of credit are extended with or without collateral to provide financing for purposes such as the acquisition of recreational vehicles, automobiles, or to provide liquidity. The Company has specific underwriting guidelines which consider the borrowers credit history, debt-to-income ratio and loan-to-value ratio for secured loans. The consumer loans typically have fixed interest rates.
Small business loans and lines of credit offered through the Community Bank are extended without collateral to small businesses based on historical credit performance of the business along with the principal owners of the business. The loans and lines of credit can have either variable or fixed interest rates and are extended to small businesses in amounts less than $100,000.
Demand deposit overdraft protection products are offered to demand deposit customers to provide additional protection against unforeseen deficit balances in a specific account and the potential related fees. The Company offers these products based on factors such as the customers credit score and history with the Company. These products have fixed interest rates.
This business segment offers commercial, industrial, corporate, and real estate loan products, including traditional commercial loans and lines of credit, asset based lending, letters of credit, and Small Business Administration (SBA) loans. The Commercial Banking segment also offers the Community Banking segment deposit products as well as deposit products that are for middle market companies such as cash management services, merchant services and certain international services for domestic customers.
Loan products are underwritten and customized to meet specific customer needs. The Company considers several factors in order to extend the loan including the borrowers historical loan re-payment, company management, and current economic conditions, industry specific issues, capital structure, potential collateral and financial projections.
In making commercial real estate secured loan decisions, the Company considers the purpose of the requested loan and nature of the collateral. Maximum loan-to-value ratios for commercial real estate loans are 75%.
Depending on the product, these loans have fixed or variable interest rates.
SBA loans are extended to small businesses for a variety of purposes, including working capital, business acquisitions, acquisition of real estate, growth capital and equipment financing. The Company focuses on 7(a), 504, and Express loan programs. 7(a) loans provide longer term financing, which are guaranteed 75% to 85% by the SBA depending on term and loan size. SBA 504 loans are typically used for the acquisition or construction of large equipment or real property. These are financing packages comprised of a first and second trust deed loan structure where the debt does not exceed 90% combined loan-to-value. Express loans are unsecured lines of credit or term loans of $100,000 or less and are generally guaranteed by the SBA at 50%. Periodically, the Company sells selected SBA loans into the secondary market. The Company retains servicing rights on the sold guaranteed portion of SBA 7(a) loans.
Business units in this segment offer a wide range of trust, investment, fiduciary and wealth management services and solutions, including planning and advice. These solutions are provided by the Banks Trust and Investment Management group, including MCM and REWA.
The Wealth Management group provides high net worth clients a variety of banking solutions and other services. These include Private Capital Advantage deposit solutions, residential mortgages and lines of credit, investment review, analysis and customized portfolio management for separately managed accounts, full service brokerage, trust and fiduciary services, equity and fixed income management and real estate and specialty asset management. Loans are structured to meet the specific needs of high net worth customers but still adhere to the Companys underwriting guidelines. The Companys
underwriting guidelines consider tangible net worth, value of assets that make up this net worth, personal cash flow, past history with the Company, and credit history. These loans may be either secured or unsecured, and may have either fixed or variable interest rates, with lines of credit generally having variable interest rates.
RAL and RT Programs
RALs are a seasonal credit product extended to consumers during the first four months of each calendar year. The purpose of the RAL is to provide consumers with liquidity at the time they file for their tax refund. The Company works with third party tax preparers who facilitate the origination of RALs through an application process. RAL underwriting is based on borrower information as well as certain criteria within the tax return. The source of repayment for the RAL is the Internal Revenue Service (IRS).
The Company subjects the RAL application to an automated credit review process utilizing specific predetermined criteria. If the application passes this review, the Company advances the amount of the refund due on the taxpayers return up to specified amounts based on certain criteria less the loan fee due to the Company and, if requested by the taxpayer, the fees due for preparation of the return. Each taxpayer signs an agreement permitting the IRS to send the taxpayers refund directly to the Company. The refund received from the IRS is used by the Company to pay off the RAL. Any amount due the taxpayer above the amount of the RAL is remitted to the taxpayer. The RAL income is recognized into interest income after the loan balance is collected from the IRS. The fee varies based on the amount of the RAL.
Generally, interest income earned on loans is a function of the outstanding balance multiplied by the rate specified in the loan agreement multiplied by the period of time the loan is outstanding. For RALs, the interest income is unrelated to the length of time the loan is outstanding and there is no explicit interest rate. The flat fee charged is recognized as income when the loan is collected from the IRS. No late fees are charged to customers whose loans are not paid within the expected time frame.
While the loan application form is completed by the taxpayer in the tax preparers office, the credit criteria are set by the Company and the underwriting decision is made by the Company. The Company reviews and evaluates all tax returns to determine the likelihood of IRS payment. If any attribute of the tax return appears to fall outside of predetermined parameters, the Company will reject the application and not make the loan.
The Company has entered into two separate contracts with Jackson Hewitt related to the RAL and RT Programs. One of the contracts with Jackson Hewitt is with Jackson Hewitt Inc. and the other is with Jackson Hewitt Technology Services, Inc. collectively referred to as JH throughout this Form 10-K.
The Company also has an electronic filing of tax return product called a Refund Transfer or RT. The RT product is also designed to provide taxpayers faster access to funds claimed by a taxpayer as a refund on their tax returns. An RT is in the form of a facilitated electronic transfer or check prepared by taxpayers tax preparer.
For more information regarding RALs, refer to Note 7, RAL and RT Programs of the Consolidated Financial Statements beginning on page 113.
At December 31, 2008, the Company employed 1,372 employees. The Companys employees are not represented by a union or covered by a collective bargaining agreement. Management believes that its employee relations are good.
Recent mergers and acquisitions of the Company are disclosed in Note 2, Acquisitions and Dispositions in the Consolidated Financial Statements on page 101. A summary of acquisitions in the last three years is as follows:
In July 2006, PCBNA acquired MCM, a California-based registered investment advisor for an initial cash payment of approximately $7.0 million. MCM is a wholly owned subsidiary of PCBNA which provides wealth management advisory services.
In January 2008, PCBNA acquired REWA, California-based registered investment advisor for an initial cash payment of approximately $7.0 million. REWA is a wholly owned subsidiary of PCBNA which provides personal and financial investment advisory services to individuals, families and fiduciaries.
The Companys branches are located in eight California counties. These counties include Santa Barbara, Ventura, Monterey, Santa Cruz, Southern Santa Clara, San Benito, San Luis Obispo and Los Angeles. The Company uses separate brand names in various counties for community recognition only, all offices are legal branches of PCBNA, and all banking offices are administered under one management structure.
The Company continues to explore opportunities to expand its footprint into strategically selected markets.
The RAL and RT Programs administrative offices are located in San Diego County, California with transactions conducted with taxpayers located throughout the United States.
The Company has no foreign operations. The Company does provide loans, letters of credit and other trade-related services to a number of commercial enterprises that conduct business outside the United States.
The Company does not have any customer relationships that individually account for 10% or more of consolidated revenues.
The banking and financial services business is highly competitive. The increasingly competitive environment faced by banks is a result primarily of changes in laws and regulations (refer to pages 67 through 70 of this Form 10-K), changes in technology and product delivery systems, and the continued consolidation among financial services providers. The Company competes for loans, deposits, trust and investment advisory services and customers with other commercial banks, savings and loan associations, securities and brokerage companies, investment advisors, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers. Many competitors are much larger in total assets and capitalization, have greater access to capital markets, including foreign-ownership, and/or offer a broader range of financial services.
Economic Conditions, Government Policies, Legislation, and Regulatory Initiatives
The Companys profitability, like most financial institutions, is primarily dependent on interest rate differentials. The difference between the interest rates paid on interest-bearing liabilities, such as
deposits and other borrowings, and the interest rates received on interest-earning assets, such as loans to customers and securities held in the investment portfolio, comprise the major portion of earnings. These rates are highly sensitive to many factors that are beyond our control, such as inflation, recession and unemployment, and the impact which future changes in domestic and foreign economic conditions might have on the Company which cannot be predicted. A more detailed discussion of the Companys interest rate risk and the mitigation of interest rate risk begin on pages 62 and 75.
The Companys business is also influenced by the monetary and fiscal policies of the Federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System (FRB). The FRB implements national monetary policies (with objectives such as curbing inflation and combating recession) through its open-market operations in U.S. Government securities, by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target Federal funds and discount rates applicable to borrowings by depository institutions. The actions of the FRB in these areas influence the growth of bank loans, investments, and deposits and also affect interest earned on interest-earning assets and interest paid on interest-bearing liabilities. The nature and impact of any future changes in monetary and fiscal policies on the Company cannot be predicted.
From time to time, Federal and State legislation is enacted which may have the effect of materially increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial service providers. Several proposals for legislation that could substantially intensify the regulation of the financial services industry (including a possible comprehensive overhaul of the financial institutions regulatory system) are expected to be introduced and possibly enacted in the new Congress in response to the current economic downturn and financial industry instability. The Company cannot predict whether or when potential legislation will be enacted, and if enacted, the effect that it, or any implementing regulations and supervisory policies, would have on the Companys financial condition or results of operations. In addition, the outcome of any investigations initiated by state authorities or litigation raising issues such as whether state laws are preempted by Federal law may result in additional laws and regulations that require changes in the Companys operations and increased compliance costs.
Dramatic negative developments in the latter half of 2007 in the subprime mortgage market and the securitization markets for such loans, together with volatility in oil prices and other factors, have resulted in uncertainty in the financial markets in general and a related economic downturn, which continued through 2008 and anticipated to continue through 2009. Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many commercial and residential loans have declined and may continue to decline. General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by many financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer delinquencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Competition among depository institutions for deposits has increased significantly. Bank and bank holding company stock prices have been negatively affected as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to recent years. Bank regulators have been very aggressive in responding to concerns and trends identified in examinations, and this has resulted in the increased issuance of formal and informal enforcement orders and other supervisory actions requiring action to address credit quality, liquidity and risk management and capital adequacy, as well as other safety and soundness concerns.
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (EESA) was enacted to restore confidence and stabilize the volatility in the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. Initially introduced as the Troubled Asset Relief Program (TARP), the EESA authorized the United States Department of the Treasury (U.S. Treasury) to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies. Initially, $350 billion was made immediately available to the U.S. Treasury. On January 15, 2009, the remaining $350 billion was released to the U.S. Treasury.
On October 14, 2008, the U.S. Treasury announced its intention to inject capital into nine large U.S. financial institutions under the TARP Capital Purchase Program (the TARP CPP), and since has injected capital into many other financial institutions, including the Company. The U.S. Treasury initially allocated $250 billion towards the TARP CPP. On November 21, 2008, the Company completed the sale to the U.S. Treasury of $180.6 million of preferred stock and warrants as part of the TARP CPP. Pursuant to the terms of the Securities Purchase AgreementStandard Terms (Securities Purchase Agreement), the Company issued and sold to the U.S. Treasury (i) 180,634 shares of the Companys Series B Fixed Rate Cumulative Perpetual Preferred Stock, having a liquidation preference of $1,000 per share (the Series B Preferred Stock) and (ii) a warrant (the Warrant) to purchase up to 1,512,003 shares of the Companys common stock, no par value. Under the terms of the TARP CPP, the Company is prohibited from increasing dividends on its common stock, and from making certain repurchases of equity securities, including its common stock, without the U.S. Treasurys consent. Furthermore, as long as the preferred stock issued to the U.S. Treasury is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including the Companys common stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions. Restrictions related to the payment of dividends on common stock are disclosed in the Capital Resources section on page 59 of this Form 10-K.
In order to participate in the TARP CPP, financial institutions were required to adopt certain standards for executive compensation and corporate governance. These standards generally apply to the Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers. The standards include (1) ensuring that incentive compensation for named senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to senior executives; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. The Company has complied with these requirements and will continue to comply.
The bank regulatory agencies, U.S. Treasury and the Office of Special Inspector General, also created by the EESA, have issued guidance and requests to the financial institutions that participated in the TARP CPP to document their plans and use of TARP CPP funds and their plans for addressing the executive compensation requirements associated with the TARP CPP. The Company has received and will respond to that request.
On February 10, 2009, the U.S. Treasury and the Federal bank regulatory agencies announced in a Joint Statement a new Financial Stability Plan which would include additional capital support for banks under a Capital Assistance Program, a public-private investment fund to address existing bank loan portfolios and expanded funding for the FRBs pending Term Asset-Backed Securities Loan Facility to restart lending and the securitization markets.
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) was signed into law by President Obama. The ARRA includes a wide variety of programs intended to stimulate the
economy and provide for extensive infrastructure, energy, health, and education needs. In addition, the ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients, including the Company, until the institution has repaid the U.S. Treasury, which is now permitted under the ARRA without penalty and without the need to raise new capital, subject to the U.S. Treasurys consultation with the recipients appropriate regulatory agency.
The AARA executive compensation standards are more stringent than those currently in effect under the TARP CPP or those previously proposed by the U.S. Treasury. The new standards include (but are not limited to); (i) prohibitions on bonuses, retention awards and other incentive compensation, other than restricted stock grants which do not fully vest during the TARP CPP period up to one-third of an employees total annual compensation, (ii) prohibitions on golden parachute payments for departures, (iii) an expanded clawback of bonuses, retention awards, and incentive compensation if payment is based on materially inaccurate statements of earnings, revenues, gains or other criteria, (iv) prohibitions on compensation plans that encourage manipulation of reported earnings, (v) retroactive review of bonuses, retention awards and other compensation previously provided by TARP CPP recipients if found by the U.S. Treasury to be inconsistent with the purposes of TARP CPP or otherwise contrary to public interest, (vi) required establishment of a company-wide policy regarding excessive or luxury expenditures, and (vii) inclusion in a participants proxy statements for annual shareholder meetings of a nonbinding Say on Pay shareholder vote on the compensation of executives.
On February 23, 2009, the U.S. Treasury and the Federal bank regulatory agencies issued a Joint Statement providing further guidance with respect to the Capital Assistance Program announced February 10, 2009, including: (i) that should the stress test assessments of the major banks initiated February 25, 2009 indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital otherwise; the temporary capital buffer will be made available from the government; (ii) such additional government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory; and (iii) previous capital injections under the TARP CPP will also be eligible to be exchanged for the mandatory convertible preferred shares. The conversion of preferred shares to common equity shares would enable institutions to maintain or enhance the quality of their capital by increasing their tangible common equity capital ratios; however, such conversions would necessarily dilute the interests of existing shareholders.
On February 25, 2009, the first day the Capital Assistance Program was initiated, the U.S. Treasury released the actual terms of the program, stating that the purpose of the Capital Assistance Program is to restore confidence throughout the financial system that the nations largest banking institutions have a sufficient capital cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers. Under the terms of the Capital Assistance Program, eligible U.S. banking institutions with assets in excess of $100 billion on a consolidated basis are required to participate in coordinated supervisory assessments, which are forward-looking stress test assessments to evaluate the capital needs of the institution under a more challenging economic environment. Should this assessment indicate the need for the bank to establish an additional capital buffer to withstand more stressful conditions, these institutions may access the Capital Assistance Program immediately as a means to establish any necessary additional buffer or they may delay the Capital Assistance Program funding for six months to raise the capital privately. Eligible U.S. banking institutions with assets below $100 billion may also obtain capital from the Capital Assistance Program. The Capital Assistance Program is an additional program from the TARP CPP and is open to eligible institutions regardless of whether they participated in the TARP CPP. The deadline to apply to participate in the Capital Assistance Program is May 25, 2009. Recipients of capital under the Capital Assistance Program will be subject to the same executive compensation requirements as if they had received TARP CPP.
The EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000. In addition, the FDIC has implemented two temporary liquidity programs to (i) provide deposit insurance for the full amount of most non-interest bearing transaction accounts (the Transaction Account Guarantee) through the end of 2009 and (ii) guarantee certain unsecured debt of financial institutions and their holding companies through June 2012 under a temporary liquidity guarantee program (the Debt Guarantee Program and together the TLGP). Financial institutions had until December 5, 2008 to opt out of these two programs. The Company and the Bank have elected to participate in these programs, but has not yet issued any debt under the Debt Guarantee Program.
Regulation and Supervision
The Company and its subsidiaries are extensively regulated and supervised under both Federal and certain State laws. A summary description of the laws and regulations which relate to the Companys operations are discussed on pages 67 through 75.
The Company maintains an Internet website at http://www.pcbancorp.com. The Company makes available its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and other information related to the Company free of charge, through this site as soon as reasonably practicable after it electronically files those documents with, or otherwise furnishes them to, the SEC. The Companys internet website and the information contained therein or connected thereto are not intended to be incorporated into this annual report on Form 10-K.
Investing in our common stock involves various risks which are specific to the Company, our industry and our market area. Several risk factors regarding investing in our common stock are discussed below. This listing should not be considered as all-inclusive. If any of the following risks were to occur, we may not be able to conduct the Companys business as currently planned and the financial condition or operating results could be negatively impacted. The Companys Chief Audit Executive and Chief Credit Officer in conjunction with other members of the Companys Management under the direction and oversight of the Board of Directors lead the Companys risk management process. In addition to common business risks such as disasters, theft, and loss of market share, the Company is subject to special types of risk due to the nature of its business.
Difficult Economic Conditions
The Companys success depends, to a certain extent, upon economic and political conditions, local and national, as well as governmental monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond the Companys control may adversely affect the Companys asset quality, deposit levels and loan demand and, therefore, earnings.
Dramatic declines in the housing market beginning in the latter half of 2007, with falling home prices and increasing foreclosures, unemployment and underemployment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions. The resulting write-downs to assets of financial institutions have caused many
financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to seek government assistance or bankruptcy protection. Bank failures and liquidation or sales by the FDIC as receiver have also increased.
The capital and credit markets, including the fixed income markets, have been experiencing volatility and disruption for more than fifteen months. In some cases, the markets have produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers financial strength.
Many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including to other financial institutions because of concern about the stability of the financial markets and the strength of counterparties. It is difficult to predict how long these economic conditions will exist, which of the Companys markets, products or other businesses will ultimately be most affected, and whether Managements actions will effectively mitigate these external factors. Accordingly, the decrease in funding sources and lack of available credit, lack of confidence in the financial sector, decreased consumer confidence, increased volatility in the financial markets and reduced business activity could materially and adversely affect the Companys business, financial condition and results of operations.
As a result of the challenges presented by economic conditions, the Company may face the following risks in connection with these events:
In view of the concentration of the Banks operations and the collateral securing the loan portfolio in California, as well as the concentration in commercial real estate loans, we may be particularly susceptible to the adverse economic conditions in the state of California and in the eight counties mentioned above where the Companys business is concentrated.
Enactment of EESA and ARRA
EESA, which established TARP, was signed into law on October 3, 2008. As part of TARP, the U.S. Treasury established the TARP CPP to provide up to $700 billion of funding to eligible financial
institutions through the purchase of capital stock and other financial instruments for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Then, on February 17, 2009, the ARRA was signed into law as a sweeping economic recovery package intended to stimulate the economy and provide for broad infrastructure, energy, health, and education needs. There can be no assurance as to the actual impact that EESA or its programs, including the TARP CPP, and ARRA or its programs, will have on the national economy or financial markets. The failure of these significant legislative measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect the Companys business, financial condition, results of operations, access to credit or the trading price of its common shares.
There have been numerous actions undertaken in connection with or following EESA and ARRA by the FRB, Congress, U.S. Treasury, the SEC and the Federal bank regulatory agencies in efforts to address the current liquidity and credit crisis in the financial industry that followed the sub-prime mortgage market meltdown which began in late 2007. These measures include homeowner relief that encourages loan restructuring and modification; the temporary increase in FDIC deposit insurance from $100,000 to $250,000, the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the Federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. The purpose of these legislative and regulatory actions is to help stabilize the U.S. banking system. EESA, ARRA and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, the Companys business, financial condition and results of operations could be materially and adversely affected.
Changes in Legislation and Regulation of Financial Institutions
The financial services industry is extensively regulated. PCBNA is subject to extensive regulation, supervision and examination by the OCC and the FDIC. As a holding company, the Company is subject to regulation and oversight by the FRB. The Company is now also subject to supervision, regulation and investigation by the U.S. Treasury and SIGTARP under EESA by virtue of its participation in the TARP CPP. Federal and State regulation is designed primarily to protect the deposit insurance funds and consumers, and not to benefit the Companys shareholders. Such regulations can at times impose significant limitations on the Companys operations. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and assessment of the adequacy of an institutions allowance for loan losses. Proposals to change the laws governing financial institutions are frequently raised in Congress and before bank regulatory authorities. Changes in applicable laws or policies could materially affect the Companys business, and the likelihood of any major changes in the future and their effects are impossible to determine. Moreover, it is impossible to predict the ultimate form any proposed legislation might take or how it might affect the Company.
Strength and Stability of Other Financial Institutions
The actions and commercial soundness of other financial institutions could affect the Companys ability to engage in routine funding transactions. Financial services to institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Company has exposure to different industries and counterparties, and executes transactions with various counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Recent defaults by financial services institutions, and even rumors or questions about one or more financial services institutions or the financial services industry in general, have led to market-wide liquidity problems and could lead to losses or defaults by the
Company or by other institutions. Many of these transactions expose the Company to credit risk in the event of default of its counterparty or client. In addition, the Companys credit risk may increase when the collateral held by it cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due to the Company. Any such losses could materially and adversely affect the Companys results of operations.
Unprecedented Market Volatility
The capital and credit markets have been experiencing volatility and disruption for more than a year. In recent months, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers seemingly without regard to those issuers underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that the Company will not experience an adverse effect, which may be material, on the Companys ability to access capital and on the business, financial condition and results of operations.
The market price for our common shares has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future, including:
Estimating the Allowance for Loan Losses
The allowance for loan losses may not be adequate to cover actual losses. A significant source of risk arises from the possibility that the Company could sustain losses because borrowers, guarantors, and related parties may fail to perform in accordance with the terms of their loans. The underwriting and credit monitoring policies and procedures that the Company has adopted to address this risk may not prevent unexpected losses. These losses could have a material adverse effect on the Companys business, financial condition, results of operations and cash flows. Management maintains an allowance for loan and lease losses to provide for loan defaults and non-performance. The allowance is also appropriately increased for new loan growth. Management believes that the allowance for loan losses is adequate to cover current losses. Management cannot guarantee that the allowance for loan losses will not increase further or that regulators will not require the Company to increase this allowance.
Risks Associated with the RAL and RT Programs
Risks associated with the RAL and RT Programs include credit, the availability of sufficient funding at reasonable rates, risks associated with the IRS, litigation, and regulatory or legislative risk.
The Company has traditionally utilized a securitization facility to fund its RAL and RT Programs. For additional discussion on the securitization facility for the RAL Program refer to page 36 of the MD&A and Note 7, RAL and RT Programs of the Consolidated Financial Statements. For the 2009 RAL season, however, the Company was not able to secure a securitization facility as a result of the current economic conditions and the crisis in the U.S. credit markets. In place of a securitization facility, the
Company purchased $1.28 billion of brokered CDs and entered into a syndicated funding line of approximately $524 million which may be drawn upon as needed throughout the 2009 RAL season. There can be no assurance that the Company will have access to a securitization facility or similar alternative sources of funding in future periods. In addition, while the Company expects that the transaction volumes, product mix and loss rates for the 2009 RAL season will be similar to 2008, the profitability of the RAL and RT Programs in 2009 is expected to be lower than in prior years due to an increase in funding costs and reduced recoveries of prior year charged-off RALs.
There is increased legislative and regulatory focus on RALs, including proposed state and Federal legislation to limit interest rates or fees, to curtail sharing of taxpayer information, to impose additional costs and rules on the RAL business and to otherwise limit or prohibit RALs. State attorneys general have also initiated public inquiries in response to consumer advocate complaints into the RAL product and the practices of the tax preparers offering RALs. We cannot determine whether such legislative or regulatory initiatives will be adopted or predict the impact such initiatives would have on the Companys results.
Liquidity is essential to the Companys business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on the Companys liquidity. The Companys access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact the Companys access to liquidity sources include a decrease in the level of the Companys business activity due to a market downturn or adverse regulatory action against us. The Banks ability to acquire deposits or borrow could also be impaired by factors that are not specific to the Company, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole as the recent turmoil faced by financial institutions in the domestic and worldwide credit markets deteriorates.
Interest Rate Risk
The banking industry is subject to interest rate risk and variations in interest rates may negatively affect the Companys financial performance. A substantial portion of the Banks income is derived from the differential or spread between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. Because of the inherent differences in the maturities and repricing characteristics of the Banks interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. Fluctuations in interest rates could adversely affect the Banks interest rate spread and, in turn, the Companys profitability. In addition, loan origination volumes are affected by market interest rates. Rising interest rates, generally, are associated with a lower volume of loan originations while lower interest rates are usually associated with higher loan originations. Conversely, in rising interest rate environments, loan repayment rates may decline and in falling interest rate environments, loan repayment rates may increase. In addition, in a rising interest rate environment, we may need to accelerate the pace of rate increases on the Banks deposit accounts as compared to the pace of future increases in short-term market rates. Accordingly, changes in levels of market interest rates could materially and adversely affect the Banks net interest spread, asset quality and loan origination volume.
Concentration of Commercial Real Estate Loans and Commercial Business Loans
At December 31, 2008, $2.0 billion or 35.2%, of our loan portfolio consisted of commercial real estate loans, including loans for the acquisition and development of property. Commercial real estate loans
constitute a greater percentage of our loan portfolio than any other loan category, including residential real estate loans secured by one to four family units,(one to four family) which totaled $1.1 billion or 19.1%, of our total loan portfolio at December 31, 2008. In addition, at December 31, 2008, $1.2 billion or 20.1%, of our loan portfolio consisted of commercial loans. Commercial real estate loans and commercial loans generally expose a lender to greater risk of non-payment and loss than one to four family loans because repayment of the loans often depends on the successful operation of the property and/or the income stream of the borrower. Commercial loans expose us to additional risks since they are generally secured by business assets that may depreciate over time. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one to four family loans. Also, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one to four family loan. Changes in economic conditions that are out of the control of the borrower and lender could impact the value of the security for the loan, the future cash flow of the affected property or borrower, or the marketability of a construction project with respect to loans originated for the acquisition and development of property. Additionally, any decline in real estate values may be more pronounced with respect to commercial real estate properties than residential real estate properties. While we intend to reduce the concentration of such loans in the Banks loan portfolio, there can be no assurance that Management will be successful in doing so.
Competition from Financial Service Companies
The Company faces increased strong competition from financial services companies and other companies that offer banking services. The Company conducts most of its operations in California. Increased competition in its markets may result in reduced loans and deposits. Ultimately, the Company may not be able to compete successfully against current and future competitors as many competitors offer some of the banking services that the Bank offers in service areas. These competitors include national banks, regional banks and other community banks. The Company also faces competition from many other types of financial institutions, including savings institutions, industrial banks, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, the Banks competitors include major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous locations and mount extensive promotional and advertising campaigns. Areas of competition include interest rates for loans and deposits, efforts to obtain loan and deposit customers and a range in quality of products and services provided, including new technology-driven products and services. If the Bank is unable to attract and retain banking customers, it may be unable to continue loan growth and level of deposits.
Operational risk represents the risk of loss resulting from the Companys operations, including but not limited to, the risk of fraud by employees or persons outside the Company, the execution of unauthorized transactions, transaction processing errors by employees, and breaches of internal control system and compliance requirements. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation and customer attrition due to negative publicity.
Operational risk is inherent in all business activities and the management of this risk is important to the achievement of the Companys objectives. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, the Company could suffer financial loss, face regulatory action and suffer damage to its reputation. The Company manages operational risk through a risk management framework and its internal control processes. The Company believes that it
has designed effective methods to minimize operational risks. Business disruption could occur in the event of a disaster and there is no absolute assurance that operational losses would not occur.
Reputation risk, or the risk to the Companys earnings and capital from negative publicity or public opinion, is inherent in Companys business. Negative publicity or public opinion could adversely affect the Banks ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or perceived conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.
At a minimum, Management is required to assess goodwill and other intangible assets annually for impairment. Goodwill is recognized when a Company acquires a business and the purchased assets and liabilities are recorded at fair value. The fair value of most financial assets and liabilities are determined by estimating the discounted anticipated cash flows from or for the instrument using current market rates applicable to each asset and liability. Excess of consideration paid to acquire a business over the fair value of the net assets is recorded as goodwill. The calculation of goodwill and the determination of impairment is an estimate subject to ongoing review based on certain factors such as declines in stock price, adverse economic conditions in the U.S. and international financial markets, unprecedented lack of liquidity, uncertainty regarding future economic policy and banking regulation changes and negative market sentiment towards the banking industry in general, and additional impairment may be assessed in the future periods. If an impairment of goodwill is assessed, this could have a material affect on the Companys results of operations and capital levels.
Dividends from the Bank
The availability of dividends from PCBNA is limited by various statutes and regulations. It is possible, depending upon the financial condition of PCBNA and other factors, that the OCC could assert that payment of dividends or other payments is an unsafe or unsound practice. In addition, the payment of dividends by other subsidiaries is also subject to the laws of the subsidiarys state of incorporation, and the Companys right to participate in a distribution of assets upon a subsidiarys liquidation or reorganization is subject to the prior claims of the subsidiarys creditors. In the event that PCBNA was unable to pay dividends to the Company, we in turn would likely have to reduce or stop paying dividends on the Companys common shares. The Companys failure to pay dividends on the Companys common shares could have a material adverse effect on the market price of the Companys common shares. Additional information regarding dividend restrictions is included in the section captioned Regulation and Supervision on page 67.
Restrictions Resulting from Participation in the TARP CPP
Pursuant to the terms of the Securities Purchase Agreement, the Companys ability to declare or pay dividends on any of the Companys shares is limited. Specifically, the Company may be unable to declare dividend payments on common shares, junior preferred shares or pari passu preferred shares if the Company is in arrears on the payment of dividends on the Series B Preferred Stock. Further, the Company is not permitted to increase dividends on our common shares above the amount of the last quarterly cash dividend per share declared prior to October 14, 2008 ($0.22 per share) without the U.S. Treasurys approval until November 21, 2011, unless all of the Series B Preferred Stock has been redeemed or transferred by the U.S. Treasury to unaffiliated third parties. In addition, the Companys
ability to repurchase its shares is restricted. The consent of the U.S. Treasury generally is required for the Company to make any stock repurchase (other than in connection with the administration of any employee benefit plan in the ordinary course of business and consistent with past practice) until November 21, 2011, unless all of the Series B Preferred Stock has been redeemed or transferred by the U.S. Treasury to unaffiliated third parties. Further, common shares, junior preferred shares or pari passu preferred shares may not be repurchased if the Company is in arrears on the payment of Series B Preferred Stock dividends. The terms of the Securities Purchase Agreement allow the U.S. Treasury to impose additional restrictions, including those on dividends and including unilateral amendments required to comply with changes in applicable Federal law.
In addition, pursuant to the terms of the Securities Purchase Agreement, the Company adopted the U.S. Treasurys current standards for executive compensation and corporate governance for the period during which the U.S. Treasury holds the equity securities issued pursuant to the Securities Purchase Agreement, including the common shares which may be issued upon exercise of the Warrant. These standards generally apply to the Companys Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers. The standards include (i) ensuring that incentive compensation plans and arrangements for senior executive officers do not encourage unnecessary and excessive risks that threaten the Companys value; (ii) required clawback of any bonus or incentive compensation paid (or under a legally binding obligation to be paid) to a senior executive officer based on materially inaccurate financial statements or other materially inaccurate performance metric criteria; (iii) prohibition on making golden parachute payments to senior executive officers; and (iv) agreement not to claim a deduction, for Federal income tax purposes, for compensation paid to any of the senior executive officers in excess of $500,000 per year. In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of the Companys compensation programs in future periods.
The adoption of the ARRA on February 17, 2009 imposed certain new executive compensation and corporate expenditure limits on all current and future TARP recipients, including the Company, until the institution has repaid the U.S. Treasury, which is now permitted under the ARRA without penalty and without the need to raise new capital, subject to the U.S. Treasurys consultation with the recipients appropriate regulatory agency. The executive compensation standards are more stringent than those currently in effect under the TARP CPP or those previously proposed by the U.S. Treasury. The new standards include (but are not limited to) (i) prohibitions on bonuses, retention awards and other incentive compensation, other than restricted stock grants which do not fully vest during the TARP period up to one-third of an employees total annual compensation, (ii) prohibitions on golden parachute payments for departure from a company, (iii) an expanded clawback of bonuses, retention awards, and incentive compensation if payment is based on materially inaccurate statements of earnings, revenues, gains or other criteria, (iv) prohibitions on compensation plans that encourage manipulation of reported earnings, (v) retroactive review of bonuses, retention awards and other compensation previously provided by TARP recipients if found by the Treasury to be inconsistent with the purposes of TARP or otherwise contrary to public interest, (vi) required establishment of a company-wide policy regarding excessive or luxury expenditures, and (vii) inclusion in a participants proxy statements for annual shareholder meetings of a nonbinding Say on Pay shareholder vote on the compensation of executives.
Future Sales of Securities
Under certain circumstances, the Companys Board of Directors has the authority, without any vote of the Companys shareholders, to issue shares of the Companys authorized but unissued securities, including common shares authorized and unissued under the Companys stock option plans or additional shares of preferred stock. In the future, we may issue additional securities, through public or private offerings, in order to raise additional capital. It is also possible that the Companys regulators
will require the Company to raise additional capital. Any such issuance would dilute the percentage of ownership interest of existing shareholders and may dilute the per share value of the common shares or any other then-outstanding class or series of the Companys securities.
Various provisions of the Companys articles of incorporation and bylaws and certain other actions the Company has taken could delay or prevent a third-party from acquiring the Company even if doing so might be beneficial to the Companys shareholders. These include, among other things, a shareholder rights plan and the authorization to issue blank check preferred stock by action of the Companys Board of Directors acting alone, thus without obtaining shareholder approval. The Bank Holding Company Act of 1956, as amended, and the Change in Bank Control Act of 1978, as amended, together with Federal regulations, require that, depending on the particular circumstances, either regulatory approval must be obtained or notice must be furnished to the appropriate regulatory agencies and not disapproved prior to any person or entity acquiring control of a national bank, such as PCBNA. These provisions may prevent a merger or acquisition that would be attractive to shareholders and could limit the price investors would be willing to pay in the future for the Companys common stock.
Dependence on Personnel
Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and experience in, the California banking industry. The process of recruiting personnel with the combination of skills and attributes required to carry out the Companys strategies is often lengthy. In addition, EESA, TARP CPP and the ARRA has imposed significant limitations on executive compensation for recipients of TARP funds, such as PCB, which may make it more difficult for the Company to retain and recruit key personnel. The Companys success depends to a significant degree upon the Companys ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel and upon the continued contributions of the Companys management and personnel. In particular, the Companys success has been and continues to be highly dependent upon the abilities of key executives, including the Companys President, and certain other employees.
The Companys executive offices are located at 1021 Anacapa Street, Santa Barbara, California. In addition, the Company occupies five administrative premises for support department operations in Santa Barbara, Ventura, Monterey and Los Angeles counties. These offices include human resources, information technology, loan and deposit operations, finance and accounting, and other support functions. In addition, the Company has several locations that are leased and owned for storage and parking, that are not included in the number of leased or owned properties below.
Of the Companys 51 branches, 38 are leased and 13 are owned. In addition, the Company owns the master lease on a retail shopping center where one of its retail branches offices is located. This lease is classified as a capital lease in the Companys Consolidated Financial Statements.
The Company also occupies 17 loan production offices that include administrative support. Of the 17 locations, 15 are leased and two are owned. The California offices are located in Santa Barbara,
Monterey, San Benito, South Santa Clara, San Diego, San Luis Obispo, Orange, Sacramento and Los Angeles Counties. These production offices originate various loan products including SBA, RALs, commercial real estate, residential real estate, commercial, consumer and private banking.
The Company continually evaluates the suitability and adequacy of the Companys offices and has a program of relocating or remodeling them as necessary to maintain efficient and attractive facilities. Management believes that its existing facilities are adequate for its present purposes.
The Company has been named in lawsuits filed by customers and others. These lawsuits are described in Note 18, Commitments and Contingencies in the Consolidated Financial Statements beginning on page 131. The Company does not expect that these suits will have any material impact on its financial condition or operating results.
The Company is involved in various other litigation of a routine nature that is being handled and defended in the ordinary course of the Companys business. In the opinion of Management, based in part on consultation with legal counsel, the resolution of these litigation matters will not have a material impact on the Companys financial condition or operating results.
There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.
The Companys common stock trades on The NASDAQ Global Select Market under the symbol PCBC. The following table presents the high and low sales prices of the Companys common stock for each quarterly period for the last two years as reported by The NASDAQ Global Select Market:
The Company declares cash dividends to its shareholders each quarter. The Companys dividend policy is disclosed in the Capital Resources section on page 59 of this Form 10-K. The following table presents cash dividends declared per share for the last two years:
The Company funds the dividends paid to shareholders primarily from dividends received from PCBNA. For discussion on restrictions on the declaration and payment of dividends refer to the Capital Resources Section of the MD&A and Regulation and Supervision discussion of Dividends and Other Transfer of Funds.
There were approximately 18,488 shareholders of record at December 31, 2008. This number includes an estimate of the number of shareholders whose shares are held in the name of brokerage firms or other financial institutions. The Company is not provided with the exact number or identities of these shareholders, but has estimated the number of such shareholders from the number of shareholder documents requested by these firms for distribution to their customers.
Based on filings with the SEC by institutional investors, approximately 53.9% of the Companys shares are owned by these institutions. These institutions may be investing for their own accounts or acting as investment managers for other investors.
In August 2007, the Companys Board of Directors approved a share repurchase program. The share repurchase program authorized the repurchase of $25.0 million of the Companys common stock and was fully executed by the end of December 2007. This repurchase program replaced the previous share repurchase plan approved in August 2003. At December 31, 2008, there were no shares remaining to be repurchased.
The following graph shows a five year comparison of cumulative total returns for the Companys common stock, the Standard & Poors 500 stock Index and the NASDAQ Bank Index, each of which assumes an initial value of $100 and reinvestment of dividends.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table provides information at December 31, 2008 with respect to shares of Company common stock that may be issued under our existing equity compensation plans, including the 2008 Equity Incentive Plan, 2002 Stock Plan and the 2005 Directors Stock Plan.
The following table compares selected financial data for 2008 with the same data for the four prior years. The Companys Consolidated Financial Statements and the accompanying notes presented in Item 8 and Managements Discussion and Analysis in Item 7 beginning on the next page explain reasons for the year-to-year changes. The following data has been derived from the Consolidated Financial Statements of the Company and should be read in conjunction with those statements and the notes thereto, which are included in this report.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL OVERVIEW AND HIGHLIGHTS
Pacific Capital Bancorp is a community bank holding company which provides full service banking, trust and investment advisory services and lending through its wholly-owned subsidiaries.
The following discussion should be read in conjunction with the Companys financial statements and the related notes provided under Item 8 Consolidated Financial Statements and Supplementary Data.
FINANCIAL RESULTS HIGHLIGHTS OF 2008
Net loss for the Company was $22.8 million or $23.8 million of net loss available to common shareholders, or $0.52 per diluted share for 2008 compared to net income of $100.9 million or $2.14 per diluted share for 2007. Net income decreased $123.6 million for fiscal year 2008 compared to 2007.
The significant factors impacting earnings of the Company during 2008 were:
The impact to the Company from these items, and others of both a positive and negative nature, will be discussed in more detail as they pertain to the Companys overall comparative performance for the year ended December 31, 2008 throughout the analysis sections of this report.
FINANCIAL RESULTS HIGHLIGHTS OF 2007
The significant factors impacting earnings of the Company during 2007 were:
FINANCIAL RESULTS HIGHLIGHTS OF 2006
The significant factors impacting earnings of the Company during 2006 were as follows:
Net interest income from the RAL Program increased to $109.8 million from $61.7 million in 2005. In addition to higher transaction volume, this increase was due to the changes in the contract with JH. The offset to this increase in revenue is the non-interest expense increase of $54.7 million for the marketing and technology fee paid to JH in 2006.
The Companys primary source of income is interest income. The following tables present a summary of interest income and the increases and decreases within the interest income line items for the three years ended December 31, 2008, 2007 and 2006:
Interest income for the year ended December 31, 2008 was $519.3 million, a decrease of $64.3 million or 11.0% when comparing interest income for 2008 to 2007. This decrease was mostly attributable to the FOMC reducing the Federal funds rate by 400 basis points since December 31, 2007 which impacted the entire loan portfolio, except RALs. The increase in nonaccrual loans also contributed to the decrease of interest income for loans. Commercial and consumer loans accounted for $36.9 million of the decrease in interest income due to the large number of those loans having adjustable interest rates. In addition, in 2007, the Company sold the indirect auto and leasing loan portfolios and discontinued the Holiday Loan product, which contributed $22.9 million of interest income in 2007 and $49.7 million of interest income in 2006.
Interest income by operating segment for the year ended 2008 compared to 2007, decreased for all operating segments. The largest decrease in interest income was in the Community Banking segment with a decrease of $43.9 million. This decrease was primarily caused by the sale of the indirect auto and leasing loan portfolios in 2007 and the discontinuation of the Holiday Loan product in 2007.
Interest income for the year ended December 31, 2007 was $583.6 million, an increase of $19.1 million or 3.4% when comparing interest income for 2007 and 2006. This increase was mostly attributable to the growth in commercial and residential real estate loans offset by a reduction in Collateralized Mortgage Obligations (CMO) and Mortgage Backed Securities (MBS) interest income and balances.
Interest income by operating segment for the year ended 2007 compared to 2006, increased for the Commercial Banking and Wealth Management segments by $27.1 million or 12.8% and $620,000 or 5.6%, respectively. This increase was partially offset by decreased interest income from the Community Banking and RAL and RT Programs segments of $4.3 million and $145,000, respectively.
Interest expense is incurred from interest paid on deposits and borrowings. The following tables present a summary of interest expense and the increases and decreases within the interest expense line items for the three years ended December 31, 2008, 2007 and 2006:
Interest expense in 2008 was $178.8 million a decrease of $43.6 million or 19.6% when compared to 2007. This decrease is mostly attributable to the FOMC decreasing interest rates by 400 basis points since December 31, 2007 which mainly impacted the interest rates paid on deposits. While the Bank was successful in growing deposits during 2008, the interest paid on deposits decreased by 110 basis points when comparing the year ending December 31, 2008 to 2007.
Interest expense in 2007 was $222.4 million, an increase of $31.6 million, or 16.6% over 2006. This increase is due to higher interest rates paid on deposits and a reliance on wholesale borrowings such as Federal Home Loan Bank of San Francisco (FHLB) advances and overnight Federal funds purchased
to fund loan growth. Deposit growth was outpaced by loan growth as the Company faced continued competition for deposits from other financial institutions and brokerage firms during 2007 and 2006.
NET INTEREST MARGIN
The net interest margin is reported on a fully tax equivalent (FTE) basis. A tax equivalent adjustment is added to reflect that interest earned on certain municipal securities and loans which are exempt from Federal income tax. The following tables set forth the average balances and interest income on a fully tax equivalent basis and interest expense for the previous three years.
The following table set forth the change in average balances and interest income on a fully tax equivalent basis and interest expense for the last three years.
The change not solely due to volume or rate has been prorated into rate and volume components.
The FTE net interest margin decreased to 4.81% for the year ended December 31, 2008 from 5.24% for the year ended December 31, 2007. The FTE net interest income decreased to $346.7 million in 2008 from $366.2 million in 2007, a decrease of $19.5 million. This decrease was driven by the FOMCs 400 basis point decrease in the Federal funds rate since December 31, 2007. The FOMC rate decrease primarily impacted the interest-bearing liabilities and loans excluding RALs.
The FTE net interest margin decreased to 5.24% for the year ended December 31, 2007 from 5.76% for the year ended December 31, 2006. The FTE net interest income decreased to $366.2 million in 2007 from $380.0 million in 2006, a decrease of $13.8 million. The significant drivers of these decreases were the increase in loan growth and increased reliance of other borrowings to fund the loan growth and increased rates paid on deposits. The average balance of total net loans increased by $605.0 million. This increase caused interest income on loans to increase $50.9 million while the rates paid on loans decreased, which decreased interest income by $27.1 million. The average balance of other borrowings increased by $290.9 million. This increase accounted for $15.3 million of the $18.8
million increase in interest expense on other borrowings. Interest expense paid on deposits increased by $14.8 million due to increased rates paid on deposits of 38 basis points.
PROVISION FOR LOAN LOSSES
Quarterly, the Company determines the amount of allowance for loan losses (ALL) adequate to provide for losses inherent in the Companys loan portfolios. The provision for loan losses is determined by the net change in the allowance for loan losses. For a detailed discussion of the Companys allowance for loan losses, refer to the Significant Accounting Policies discussion in Note 1, of the Consolidated Financial Statements or in the Critical Accounting Policies section starting on page 64.
A summary of the provision for loan losses for the comparable years ended December 31, 2008 and 2007 are as follows:
Provision for loan losses was $218.3 million for the year ended December 31, 2008 compared to $113.3 million for the year ended December 31, 2007, an increase of $105.1 million. The increased provision for loan losses was driven by the slowing economy which caused the Core Banks loan portfolio to experience higher than anticipated loan losses partially offset by increased recoveries for RALs due to enhanced credit screening procedures put in place for the 2008 RAL season. The increase in provision for losses for the Core Bank was driven by net charge-offs of $99.7 million during 2008 and an increase in nonaccrual loans of $148.2 million since December 31, 2007. A majority of the increase in net charge-offs and nonaccrual loans were from the construction loan portfolio. During 2008, the Bank also modified its ALL policy to enhance its use of qualitative factors in determining required allowance levels. These changes were made in large part due to the deteriorating conditions in the economy, which drove a significant portion of the increase in provision.
During 2008, RAL had net charge-offs of $21.8 million compared to $92.0 million of net charge-offs in 2007, a reduction of $70.2 million which is reported in the RAL and RT Program segment. The Commercial Banking segments provision for loan losses was $147.7 million, an increase of $138.4 million when comparing the year ended December 31, 2008 to 2007. The Commercial Banking segment holds a majority of the construction loan portfolio causing this increase.
A summary of the provision for loan losses for the comparable years ended December 31, 2007 and 2006 are as follows:
The provision for loan losses totaled $113.3 million in 2007, an increase of $48.6 million or 75.1% compared to 2006. The increased provision is due to the increased incidences of fraud in the RAL program which increased by $55.3 million for 2007 compared to 2006. The Company incurred larger than anticipated losses as a result of improved fraud screening by the IRS in 2007. The IRS made changes to its fraud detection system and penalty collection practices for the 2007 tax season which have both contributed to the increased losses on RALs. The RAL pre-file product also experienced higher losses due to the new IRS fraud detection system. The RAL pre-file product is a RAL product that was offered in advance of the taxpayers filing of their tax return, primarily in the month of January, for a portion of the anticipated refund amount. A RAL pre-file loan is repaid once a RAL or RT is funded by the IRS. In 2007, the Company decided to no longer offer the RAL pre-file product. The Company has also identified a high concentration of losses associated with certain tax preparers and RAL customers possessing certain characteristics.
The provision for loan losses excluding RALs declined by $6.7 million in 2007 compared to 2006 as a result of the sale of the higher risk indirect auto and leasing portfolios in the second quarter of 2007.
Excluding the RAL and RT Programs discussed above, provision for loan losses for the other operating segments declined by $6.7 million for the year ended 2007 compared to 2006. The Community Banking segment provision declined by $10.5 million but was partially offset by an increase of $3.8 million in provision for the Commercial Banking segment.
Non-interest income primarily consists of fee income received from servicing deposit relationships, trust and investment advisory fees, RT fees earned from processing tax refunds, fees and commissions earned on certain transactions, unrealized gains and losses on the trading portfolio, impairment of available-for-sale (AFS) MBS and realized gains and losses on sold and called securities and gains and losses on the sale or disposal of assets.
The following tables present a summary of non-interest income and the related changes between the periods presented:
Total non-interest income was $176.1 million for the year ended December 31, 2008 compared to $184.6 million for the same period in 2007, a decrease of $8.5 million or 4.6%. Excluding the prior year gain on sale of the leasing portfolio in June 2007 of $24.3 million, the non-interest income for the comparable periods increased by $15.8 million for 2008 compared to 2007. This increase was primarily due to increased RT fees of $22.7 million. A summary of the significant activity within non-interest income by type is presented below.
Refund transfer fees
RT fees totaled $68.7 million for the year ended December 31, 2008 compared to $46.0 million in 2007 and $44.9 million in 2006. The increase in RT fees occurred primarily due to increased volume of RTs in 2008 as a result of the increased fraud screening of RALs. When a RAL is not approved for processing, a RT is offered to the taxpayer. The number of RT transactions increased by 1.5 million, or 30.8% when comparing the year ended December 31, 2008 to December 31, 2007.
Net gain on sale of RALs
The following table presents a summary of the gain on sale of RALs for the three years ended December 31, 2008, 2007 and 2006:
The Company recorded a net gain on sale of tax refund loans of $44.6 million, $41.8 million and $43.2 million for the years ended December 31, 2008, 2007 and 2006, respectively. These gains relate to the sale of RALs through a securitization and are discussed in Note 7, RAL and RT Programs of these Consolidated Financial Statements and below.
The securitization capacity was $1.60 billion in 2008, the largest since the Company started utilizing the securitization facility seven years ago. In 2007 and 2006, the capacity was $1.50 billion and $1.10
billion, respectively. The capacity had increased over the last few years to accommodate the annual increase in RAL balances each year. The gain on the securitization was much larger in 2008, 2007 and 2006 than in prior years due to a contract change with JH beginning with the 2006 RAL season. The gain is calculated in part by the total fees earned by the company on the loans sold into the securitization. Starting in 2006, the Company received 100% of the fees on RALs, while in prior years there was a fee splitting agreement between the Company and JH. Additional expense related to this contract change is recorded in non-interest expense as program and technology fees.
All loans sold into the securitization are either fully repaid or repurchased by the Bank at the termination of the securitization in mid-February of each calendar year, consistent with the terms of the Securitization Agreement. At March 31, these repurchased loans are reported in the balance sheet as RAL loans and become subject to the same charge-off criteria as RALs retained on the balance sheet since origination. Charge-offs and recoveries are recorded through the allowance for loan losses subsequent to the end of the first quarter of each calendar year.
The securitization of RALs also changes how some of the income and expenses are accounted for. All of the cash flows associated with the RALs sold to the Companys securitization partners are reported net as a gain on sale of RALs. The gain on the securitization of RALs is further explained in Note 7, RAL and RT Programs within our Consolidated Financial Statements on page 115.
For the 2009 RAL season, the Company was not able to utilize the same securitization facility as it had in previous years due to the current economic conditions. In place of the securitization, the Bank will utilize lines of credit and brokered CDs. The Company expects that the transaction volumes, product mix and loss rates for the 2009 RAL season to be similar to 2008. However, the profitability is expected to be lower than in prior years due to an increase in funding costs and reduced recoveries of prior year charged-off RALs.
Net gain on sale of leasing portfolio
In June 2007, the Company sold the leasing loan portfolio for a gain on sale of $24.3 million. The gain is disclosed as a separate line item of non-interest income. The details related to this sale are described in Note 6, Loan Sales and Transactions of the Consolidated Financial Statements.
Loss on securities, net
Loss on securities, net for the year ended December 31, 2008 was $3.3 million, an increase of $2.2 million compared to 2007. The increase in the loss on securities of $2.2 million was attributed to increased impairment of MBS held in the AFS portfolio of $2.8 million and realized losses on the future positions held of $4.9 million resulting from declining interest rates as described in Note 22, Derivative Instruments on page 137 of the Consolidated Financial Statements. These losses were offset by an increase in the market value of trading securities of $5.1 million and realized gain on sale of trading securities of $2.4 million which were caused by the decrease in interest rates during 2008.
Net loss on securities for the year ending December 31, 2007 and 2006 were $1.1 million and $8.6 million, respectively. These losses are mostly attributed to the Companys impairment losses on securities in the fourth quarter of each year. In December 2007, Management changed intent to no longer hold certain impaired AFS MBS securities to maturity or ultimate recovery. As a result of this decision, a $3.0 million impairment was taken on the $250.4 million AFS MBS portfolio at December 31, 2007. At December 31, 2006, Management made the decision to sell the 2003 and 2004 leveraging strategy portfolio and realized an $8.8 million impairment loss due to a decision to sell this portfolio in 2006. Additional discussion regarding the impairments taken on securities and the activity in the securities portfolio is disclosed in the Investment Securities section of the MD&A and in Note 4, Securities of the Consolidated Financial Statements.
The following tables present a summary of non-interest expense and the related changes between the periods presented:
Non-interest expense is comprised of expense incurred for the operations of the Company. The most significant are those expenses attributed to employee salaries and benefits.
Salaries and benefits
The following table summarizes the components of salaries and benefits expense for the three years ended December 31, 2008, 2007 and 2006.
Salaries and benefits were $127.9 million for the year ended December 31, 2008 compared to $128.3 million for the same period in 2007. The slight decrease in salary and benefits is due to a decrease in benefit and commission expense offset by an increase in performance related bonuses of $1.9 million.
The $2.5 million decrease in salary and benefits expense for the year ended December 31, 2007 compared to December 31, 2006 was mostly attributed to decreases in benefit costs and bonus expense of $3.0 million and $3.2 million, partially offset by a $1.7 million increase in severance compensation. The increased severance was primarily due to staff reductions in conjunction with the sale of indirect auto and leasing loan portfolios as well as strategic re-alignments within the business units.
Refund program marketing and technology fees
The refund program and marketing technology fees paid to JH were $46.3 million, $44.5 million and $54.7 million for the years ended December 31, 2008, 2007 and 2006, respectively. The refund program marketing and technology fees are associated with the RAL and RT Programs activity. Starting with the 2006 RAL season, a revised contract with JH was entered into where the Company agreed to pay a fixed fee to JH for program and technology services which are reported in this line item. In exchange for paying the program and technology fee to JH the Company received 100% of the interest and fee income related to the RAL and RT Programs and also assumed 100% of the loan losses associated with the RAL Program.
The reduction in the refund program marketing and technology fee paid for 2007 compared to 2006 is due to fewer transactions processed in 2007 than in 2006.
Pursuant to the terms of the Program Agreement, PCBNA pays a fixed annual program fee to JH in exchange for marketing rights. JH designates the number of offices that will process RALs and RTs for PCBNA. The designated group of offices represents the market available to PCBNA in a given year. As the market share may change each year, the program fee is correspondingly adjusted to reflect the value of the market share. The fee is calculated based on forecasted RAL and RT volumes. To the extent volumes are significantly different than forecast, the fees paid under the Program Agreement are adjusted accordingly. PCBNA paid a Program Agreement fee of $23.9 million, $24.0 million and $23.0 million for approximately 68%, 60% and 70% of JH volume in 2008, 2007 and 2006, respectively.
Pursuant to the terms of the Technology Agreement, PCBNA pays a fixed technology fee to JH for processing services. In the event the actual annual business volume acquired by PCBNA is different than the predictive factors used to derive the technology payment, PCBNA has a contractual right to adjust the fees paid under the Technology Agreement. PCBNA paid a fixed technology fee of $21.2 million, $20.5 million and $26.0 million in 2008, 2007 and 2006, respectively.
Net Occupancy Expense
Net occupancy expense increased in 2008 and 2007 by $3.5 million and $2.3 million, respectively. The increase in 2008 is due to the following: new retail branches opened in Wood Ranch in Simi Valley and Casa Dorinda in Santa Barbara; a new commercial and wealth management banking center in Torrance; the addition of REWA office space; and a new office in San Diego for the RAL and RT operations.
The Company is reviewing all of the retail branch locations to ensure that they meet the strategic initiatives of the Company and continue to meet the needs of the Banks customers. Currently, one of the Santa Maria and one of the Lompoc retail locations are scheduled to close in March and April of 2009, respectively. Both closings are pending regulatory approval and, both communities have retail
branches that are within five miles or less of the locations scheduled to be closed. In addition, with the sale of the Santa Paula and Harvard retail branches in October 2008, the Company anticipates net occupancy expense to decrease in future periods.
The increase in 2007 is the result of opening new locations, including the Madrone Village branch, two new commercial banking offices and three new administrative offices as well as a full year of the Paso Robles location added in 2006.
In the third quarter of 2008, the Company concluded that goodwill was impaired and recorded $22.1 million impairment. Goodwill is tested for impairment during the third quarter of each year or if Management determines there is a triggering event which may indicate a need to review goodwill for impairment. Given this current economic downturn and the ongoing events within the banking industry, Management has deemed it prudent to assess Goodwill for impairment on a quarterly basis for the foreseeable future. The year-end goodwill analysis did not result in any additional goodwill impairment. All goodwill impairment testing is performed by an independent third party in conjunction with Management.
In order to determine the fair value of each reporting unit in the third quarter of 2008, the Company reviewed the capitalized earnings of each reporting unit, the outlook of the current economic environment and took into consideration the transaction multiples of publicly traded financial institutions adjusted for a change in control. When the fair value of a reporting unit is less than its carrying value, the Company is required to utilize a Step 2 valuation approach in accordance with SFAS 142. All of the Companys reporting units passed Step 1 of the annual SFAS 142 impairment analysis in the third quarter of 2008, except the Commercial Banking segment. The Step 2 goodwill impairment analysis of the Commercial Banking segment required the Step 1 fair value of the reporting unit to be allocated to all of the fair values of the underlying tangible and intangible assets and liabilities for purposes of calculating the fair value of goodwill. This allocation resulted in a $22.1 million goodwill impairment. The goodwill impairment calculation is an estimate subject to ongoing review as certain circumstances may cause additional impairment to be assessed in the future. For additional information on the accounting and estimates used in the annual review of goodwill, refer to the Critical Accounting Policies within the MD&A of this Form 10-K on page 65 and in Note 1, Significant Accounting Polices of the Consolidated Financial Statements.
The table below summarizes the significant items included in other expense.
Other expense was $109.1 million for the year ended December 31, 2008, an increase of $37.9 million or 53.2% compared to the year-ended December 31, 2007. This increase was mostly attributable to increases in other expenses of $17.4 million. The increase in the other expense line item as disclosed above was primarily from the following items: $4.0 million accrued expense related to payments to MCM, a decrease in deferred loan origination expense in accordance with SFAS 91 of $3.3 million, an increase in litigation settlements of $3.0 million which is mostly related to the lawsuit disclosed in Note 18, Commitments and Contingencies as the Canieva Hood and Congress of California Seniors v. Santa Barbara Bank & Trust, Pacific Capital Bank, N.A., and Jackson-Hewitt, Inc. lawsuit, an increase in regulatory assessment payments paid to the Office of the Comptroller of Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) of $2.8 million and an increase of $1.2 million for printed forms and supplies.
The Company recorded additional expense of $7.2 million during 2008 to increase the off-balance sheet reserve due to the downturn of the economy, the reserve was increased for unfunded loan commitments and letters of credits as disclosed in Note 5, Loans of this Form 10-K. The increase in RAL and RT developer performance fees of $7.1 million is the result of contractual volume incentives fee due to the increased volume for the 2008 RAL season. The increase in software expense of $3.1 million is mostly attributed to additional depreciation expense associated with capitalized software.
Total other expenses declined by $28.3 million, or 28.5% to $71.2 million for the year ended December 31, 2007 compared to the year ended December 31, 2006. The majority of this decline was generated from the strategic cost cutting initiatives of the Company, specifically declines in software and consulting expenses. Total software expense for 2007 compared to 2006 declined by $16.3 million, or 51.6% mostly from the $9.3 million of capitalized software written off in December 2006 as it was deemed obsolete or no longer in use. Legal, accounting and audit expenses for the comparable periods decreased by $2.8 million, or 38.8%.
PROVISION FOR INCOME TAXES
Provision for income taxes for the year ended December 31, 2008 was a tax benefit of $18.6 million compared to tax expense of $56.2 million for the year ended December 31, 2007. The decrease in tax expense (or increase in tax benefit) of $74.8 million for the comparable periods was primarily the result of lower pretax income. Pretax loss for the year ended December 31, 2008 was $41.3 million compared to pretax income of $157.1 million for the year ended December 31, 2007. This decrease in pretax income for the comparable periods was primarily due to an increased provision for loan losses and to $22.1 million of goodwill impairment in 2008. The decrease in pretax income, combined with an increase in low income housing partnership tax credits, increased the effective tax rate to 44.9% compared with 35.8% for the year ended December 31, 2007.
The effective rates during all periods differed from the applicable statutory Federal (35%) and State (10.84%) tax rates due to various factors, including tax-exempt interest income, the $22.1 million goodwill impairment charge and low income housing partnership tax credits of $5.1 million.
For additional information related to the Companys provision for income taxes for the years ended December 31, 2008, 2007 and 2006, refer to Note 16, Income Taxes of the Consolidated Financial Statements.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents was $1.94 billion at December 31, 2008 compared to $141,000 at December 31, 2007. This increase is a result of additional brokered CDs purchased during the fourth quarter of 2008 for the funding of the 2009 RAL season. In addition, the FRB started paying interest on the cash left in the Banks correspondent bank account starting in the fourth quarter of 2008. In previous years, a minimal amount of cash was left at the FRB as interest was not paid on the cash so, any excess cash was invested in short-term investments to obtain interest income.
The investment security portfolio of the Company is utilized as collateral for borrowings, required collateral for public agencies and trust customers deposits, Community Reinvestment Act (CRA) support, and to manage liquidity, capital and interest rate risk.
At December 31, 2008, 2007 and 2006 the Company held the following investment securities.
Total investment securities held by the Company increased $68.9 million at December 31, 2008 compared to 2007. This increase is mostly attributable to the securities placed in the MBS held in the trading portfolio and purchases of U.S. Agency and municipal securities.
At December 31, 2008 and 2007, the Company held $213.9 million and $146.9 million, respectively of securities classified as trading. In January 2008 and October 2008, the Company transferred residential real estate loans held in the Companys loans held for investment portfolio of $67.6 million and $13.9 million, respectively into MBS increasing the balance in this portfolio. The Company placed these securities into the trading portfolio to provide Management the ability to sell these securities should the Bank require additional liquidity. In December 2007, the Company converted $285.1 million of fixed rate mortgage loans held for investment to $285.1 million of MBS. The Company designated $146.9 million of the securities received as trading which were subsequently sold in January 2008.
The table below summarizes the maturity distribution of the securities portfolio at December 31, 2008.
The timing of the payments for MBS and CMO securities is estimated based on the contractual terms of the underlying loans adjusted for estimated prepayments. Issuers of certain investment securities have retained the right to call these securities before contractual maturity.
The table above presents the tax equivalent weighted average yields of investment securities held by the Company at December 31, 2008. State and municipal securities are tax-exempt for Federal tax purposes and this tax-exempt interest makes up almost all of the amounts shown for the line captioned non-taxable interest from securities and loans in the net interest margin table on pages 31 and 32 within the line item, non-taxable interest from securities and loans of the net interest margin table. Management is aware of one asset backed security held in the investment portfolio that has some sub-prime loans as the underlying collateral, however, this security is rated AAA, and all principal and interest payments are current.
Sales of Investment Securities
The Company sold $123.6 million and $317.6 million of investment securities during the years ended December 31, 2008 and 2007, respectively. The Company sold no investment securities in 2006. For the years ended December 31, 2008 and 2007, and 2006, net gains or (losses) on the sales and calls of securities were ($127,000), $1.9 million and $151,000, respectively.
In 2008, 2007, and 2006 respectively, $515.0 million, $234.6 million and $128.4 million of investment securities matured or were called prior to contractual maturity. A detailed summary of gains and losses on investment securities is included in Note 4, Securities of the Consolidated Financial Statements.
Included in the net loss on securities transactions at December 31, 2008 and 2007 are MBS impairment losses of $5.8 million and $3.0 million, respectively. The impairment loss recognized on these MBS is a result of Managements change in intent to no longer necessarily hold MBS investment securities classified as available-for-sale in a temporary loss position until full recovery or maturity. This change in intent was to provide more flexibility to manage the Companys liquidity, capital and interest rate risk. As a result of this change, future unrealized losses on AFS MBS will be recognized as impairment losses in the statement of operations, while unrealized gains will be recognized in other comprehensive income (OCI).
In December 2006, the Company decided to sell securities purchased in 2003 and 2004 as part of a leveraging strategy. While not liquidated until early 2007, the Company recognized an $8.8 million impairment loss in the fourth quarter of 2006. By the time the sale was executed in the first quarter of 2007, the securities had recovered a portion of their value due to changes in interest rates and the Company recognized a $1.6 million gain, for a total net loss recognized of $7.2 million. The proceeds from the sale were used to reduce wholesale borrowings and to reinvest in higher yielding securities
The securities portfolios are managed by the finance department to maximize funding and liquidity needs of the Company. The interest income on investment securities is included in the All Other segment reported in Note 24, Segments of the Consolidated Financial Statements.
The Company has policies and procedures that permit limited types and amounts of derivative instruments to help manage interest rate risk. At December 31, 2008, the Company had $50.0 million of U.S. Treasury future contracts and the Company has entered into interest rate swap agreements with customers to mitigate their interest rate risk exposure associated with the loan they have with the Bank. Refer to Note 22, Derivative Instruments of the Consolidated Financial Statements.
Through the Companys banking subsidiary, PCBNA, a full range of lending products and banking services are offered to households, professionals, and businesses. The Company offers its lending products through its four operating business segments: Community Banking, Commercial Banking, Wealth Management and RAL and RT Programs. The products offered by these segments include commercial, consumer, commercial and residential real estate loans and SBA guaranteed loans.
The table below summarizes the distribution of the Companys loans held for investment at the year end indicated.
The loan balances in the above table include net deferred or unamortized loan origination, extension, and commitment fees and deferred loan origination costs. These deferred amounts are amortized over the lives of the loans.
Net Growth in the Loan Portfolio
The loan portfolio at December 31, 2008 was $5.76 billion, an increase of $405.7 million since December 31, 2007. This increase was from the commercial real estate loan portfolio which increased $463.5 million during 2008. This increase was offset with a decrease in the construction and land portfolio of $98.0 million. The commercial real estate loan portfolio is from the Commercial Banking segment as well as a majority of the construction and land loan portfolios. Due to the high concentration of commercial real estate loans, the Company plans to aggressively reduce its concentrations in commercial real estate loans and will make less commercial real estate loans in 2009, participating with other investors when needed. During 2008, the Company sold SBA loans for a gain on sale of $1.2 million, residential real estate loans for a gain on sale of $756,000 and various other types of loans in conjunction with the sale of two branches in October 2008. A more detailed discussion regarding these sales is in Note 6, Loan Sales and Transactions of the Consolidated Financial Statements.
The Companys total loan portfolio decreased by $359.7 million or 6.3% from $5.72 billion at December 31, 2006 to $5.36 billion at December 31, 2007. The majority of this decrease was due to strategic loan sales mostly offset by overall loan growth in the remaining portfolio.
During 2007, the Company completed three significant loan portfolio transactions totaling $761.0 million. All of the loan transactions were from the Community Banking segment. A summary of the loan carrying value at the time of transaction is as follows:
The indirect auto loans were sold in May 2007 at a net loss of $850,000. The leasing loan portfolio was sold in June 2007 for a net gain of $24.3 million. The sale of the indirect auto and leasing loan portfolios were part of the Companys strategic balance sheet management in 2007 as well as these products were offered outside the Companys market footprint and relied on third parties for origination of these loans. The residential real estate loans were converted into MBS in December 2007. A detailed discussion of these loan transactions is included on page 112 within Note 6, Loan Sales and Transactions of the Consolidated Financial Statements.
The growth in loans during prior years 2004 through 2006 was primarily from residential real estate loans with increases of $265.4 million, $226.6 million, $92.6 million when comparing each of the respective years 2006, 2005, 2004 respectively. With residential real estate values increasing at rapid rates on the central coast of California during 2004 through 2006, residential real estate had significant growth during those periods. The loan growth was also supplemented with the acquisitions of FBSLO in 2005 and PCCI in 2004.
During 2005 the Company purchased FBSLO, which had approximately $217.2 million of loans, and in 2004 purchased PCCI, which had approximately $419.0 million in loans. Without the acquisition of FBSLO, loan growth would have been $617.8 million or 15.2% in 2005 and without the acquisition of PCCI, loan growth would have been $462.4 million or 14.5% in 2004.
Loans Held for Sale
At December 31, 2008, loans held for sale were $11.1 million. A majority of the loans held for sale were SBA loans. The remainder of the loans were residential real estate loans which were originated for sale. In the third quarter of 2008, the Company began to originate residential real estate loans for sale. All residential real estate loans held for sale at December 31, 2008 were sold by the end of January 2009.
At December 31, 2007, the Company held $68.3 million of loans held for sale. Loans held for sale are reported at the lower of cost or market. All the loans held for sale at December 31, 2007 were residential mortgage loans. The majority of these loans, $68.2 million, related to the transfer of residential real estate loans that were transferred into MBS which settled in January 2008.
Loans by Segments and Category
The Community Banking segments assets increased by $249.9 million when comparing December 31, 2008 to December 31, 2007. This increase was partially related to the increase in home equity loans of $54.3 million and residential real estate loans of $22.9 million. In 2007, the Community Banking segment assets decreased by $606.6 million or 16.6% primarily due to the loan transactions of $761.0 million in 2007.
Home equity lines continue to have increases in growth with a majority of the growth occurring in 2008, 2005 and 2004. In 2005, home equity loans saw the largest percentage increase of 50.5%. The increase in home equity loans was attributed to aggressive marketing efforts during 2005 and 2004. FBSLO contributed $15.5 million of the 2005 growth in the home equity category.
Within the consumer loan portfolio were the indirect auto loan portfolio and Holiday loans. Prior to the sale of the indirect auto loan portfolio and discontinuance of the Holiday loan product in 2007, these portfolios were the main sources of growth in consumer loans in prior years. As of December 31, 2006 and 2005, Holiday loans accounted for $86.3 million and $57.6 million of the consumer loans. Holiday loans were seasonal since they are all funded in the fourth quarter of each year and they are either paid off or charged-off during the first quarter of the following year. Holiday loans were offered by professional tax preparers to their clients. After experiencing a high loan loss rate on Holiday loans, the Company decided in 2007 to no longer originate these products.
The leasing portfolio was sold in 2007. Prior to the sale of the leasing portfolio, this portfolio experienced strong growth in 2005.
The Commercial Banking segment offers a complete line of commercial and industrial and real estate loan products, including SBA loans, traditional commercial loans and lines of credit, asset based lending, and letters of credit. Business units in this group also serve the real estate industry through land acquisition and development loans, construction loans for development of both commercial and residential subdivisions.
Before making these loans, the Company will review a number of factors including the customers historical performance, management, economic conditions facing the customer, capital structure, and any available collateral. Loans in the Commercial Banking segment may have fixed or variable interest rates, depending on the product.
The Commercial Banking segment assets grew by $362.3 million, or 9.8% in 2008 compared to 2007. This growth is mostly attributable to the growth in commercial real estate loans during 2008. When comparing the asset growth in 2007 to 2006, the Commercial Banking segment grew $455.0 million or 14.1%. The loan growth in 2007 and 2006 was across all commercial loan categories with commercial real estate loans leading the loan growth of $146.5 million in 2007 and $260.8 million in 2006.
In 2007, Management determined that the SBA loans should be moved to the Commercial Banking segment from the Community Banking segment. As of December 31, 2008, 2007, and 2006 SBA loans are included in this segment for comparability. In 2009, the SBA loans will be moved back to the Community Banking segment as the Community Banking segment is focusing on servicing small businesses while the Commercial Banking group is focusing on the business relationships within mid-market businesses.
Business units in this group service customers that meet a certain level of income and liquidity criteria and are considered to have high net-worth. There is not a specific loan category related to Wealth Management segment as the Banks existing loan products are tailored to the meet the needs of the segments customers. The Wealth Management segment was combined with the Commercial Banking segment as of January 1, 2009 as both segments work with customers with high net-worth and who are owners of mid-market businesses.
RAL and RT Programs
No RALs were outstanding at December 31 of any year. All RALs are repaid or charged-off at December 31 of each year. RALs are a seasonal credit product extended to consumers during the first four months of any calendar year. The purpose of the RAL is to provide consumers with liquidity at the time they file for their tax refund. The Company works with third party tax preparers who facilitate the origination of RALs through an application process. RAL underwriting is based on information about the borrower as well as certain elements within the tax return. The source of repayment for the RAL is the IRS when it refunds the borrowers excess tax payments.
In 2006, the Company and JH entered into two new contracts, a program contract and a technology services contract. These contracts provided for JH to reduce the proportion of its transactions directed to the Company from approximately the 80% proportion for 2005 to approximately 75% in the 2008 tax season, and changed the method by which JH was compensated for the services it provides to the Company. The fee-splitting arrangement provided for in the earlier contract is eliminated, and, under the new contracts with JH is compensated for services through fixed fees for program and technology services.
The change in the contracts had a substantial impact on the amount of revenue, but little impact on pre-tax income as the amount of the fixed fees is approximately equal to what would have been shared with JH under the previous contract. While the economics are virtually the same under the new contracts as under the old, the presentation is different. Under the previous contract, the fees were recognized net of the amount of the fee split with JH. Under the new contracts, the whole amount of the revenue from the RALs and RTs are recognized by the Company and the program and technology service fees are shown as expenses.
The following table summarizes maturities and interest rates types for each loan category.
ALLOWANCE FOR LOAN LOSSES
The Company established an estimated reserve for inherent loan losses and records the change in this estimate through charges to current period earnings.
Allocation of the Allowance for Loan Loss
The table below summarizes the estimated allowance for loan loss by loan type:
Total allowance for loan losses increased by $96.1 million at December 31, 2008 compared to December 31, 2007. The increase is attributed to the deteriorating economic environment. The primary drivers of the increased ALL are increased historical loss rates due to higher levels of charge-offs and increased problem loans requiring specific ALL reserves. The increased charge-offs and problem loans were mainly from the construction and development loans.
All changes in the risk profile of the various components of the loan portfolio are reflected in the allowance assignment. There is no assignment of allowance to RALs at December 31, 2008 as all unpaid RALs were charged-off prior to year-end.
The decrease in allowance for loan losses of $19.8 million, or 30.7% at December 31, 2007 compared to 2006 was primarily attributed to the loan portfolio sales during 2007. The loan portfolios sold consisted of higher risk loans and contributed a decrease of $20.6 million to the required ALL at the time of sale.
Allowance for Loan LossesRALs
A RAL is charged-off when Management determines that payment from the IRS is unlikely. The Company does not receive formal notification from the IRS regarding the denial of any tax refund claims. As a result, Management relies on prior years experience with IRS payment patterns to determine expected collection time frames. Prior years experience has indicated that payment from the IRS becomes unlikely after tax refund payments are 4-6 weeks past due from the expected payment date. The IRS payment patterns have varied from year to year, so the Company has utilized the most recent period payment patterns to predict current year payments. As a result of the Companys collection experience in conjunction with regulatory requirements, all RALs are charged off prior to December 31 each year.
Recoveries on RALs occur due to unexpected payments from the IRS, the taxpayer directly, or during a subsequent RAL season through a new request procedure from the charged-off RAL customer. Some recoveries on prior year charge-offs occur when the taxpayer returns to a tax preparer that offers RALs or RTs through the Company. If the Company accepts the application for a RAL on the new refund claim or for an RT, the amount of the prior years charged-off loan will be deducted from the proceeds of the current year RAL or RT.
Reserve for Off-Balance Sheet Commitments
The table below summarizes the loss contingency related to loan commitments.
The Company has exposure to credit losses from extending loan commitments and letters of credit as well as from unfunded loans. Because the available funds have not yet been disbursed on these commitments and letters of credit, the face amount is not included in the outstanding balance reported for loans and leases. Consequently, any amount provided for credit losses related to these instruments is not included in the allowance for loan losses reported in the table above, but is instead accounted for as a loss contingency estimate. The changes to this liability have been recorded in other non-interest expense.
The Company recorded additional expense of $6.9 million during 2008 to increase the off-balance sheet reserve due to the downturn of the economy.
The table below summarizes the charge-offs and recoveries by loan category and credit loss ratios for the years presented:
Total charge-offs increased $16.7 million, or 11.6% for 2008 compared to 2007. The increased charge-offs were driven by the slowing economy which caused the Core Banks loan portfolio to experience higher than anticipated loan losses partially offset by decreased charge-offs for RALs due to enhanced credit screening procedures put in place for the 2008 RAL season. The majority of the Core Bank charge-offs were from the construction loan and commercial and industrial loan portfolios.
Total charge-offs increased by $57.5 million, or 66.1% in 2007 compared to 2006 due to an increase in RAL charge-offs of $56.6 million. The increase in RAL charge-offs was the result of increased losses in the RAL pre-file product and losses related to incidences of tax related fraud affecting RAL loans. Due to the higher loss rates on the RAL pre-file product and holiday loans, the Company discontinued these products. The increased loss rates experienced in the 2007 RAL program also caused Management to modify and enhance its underwriting criteria and fraud identification processes.
The increase in RAL charge-offs in 2004 and 2005 was the result of contract changes with JH. In the revised contract with JH, the Company assumed 100% of the credit risk associated with the RAL Program and, in exchange, the Company received a larger portion of the interest income and fees.
The Company is one of three major banks in the country that have national RAL Programs. Therefore, for comparability, charge-offs amounts and ratios for the Company are shown both with total loans and other loans which exclude RALs. In order to compare the ratio of net charge-offs to average loans to our peers, it is best to compare the ratio of net charge-offs to average loans excluding RALs. Exclusive of RALs, the ratio of net charge-offs to average loans over the last five years has varied from 0.14% to 1.76%
The ratio of allowance for loan losses to total loans for the years ended December 31, 2008, 2007 and 2006 was 2.44%, 0.84%, 1.13%, 1.14% and 1.33% , respectively. At December 31 of each year, the Companys ratio of allowance for loan losses to total loans is lower than in previous quarters throughout the year primarily due to the seasonality of the RAL program.
NONACCRUAL, PAST DUE, AND RESTRUCTURED LOANS
The table below summarizes the Companys nonaccrual and past due loans for the last five years.
When a borrower discontinues making payments as contractually required by the note, the Company must determine whether it is appropriate to continue to accrue interest. Generally, the Company places loans in a nonaccrual status and ceases recognizing interest income when the loan has become delinquent by more than 90 days and/or when Management determines that the repayment of principal and collection of interest is unlikely. The Company may decide that it is appropriate to continue to accrue interest on certain loans more than 90 days delinquent if they are well secured by collateral and collection is in process.
When a loan is placed in a nonaccrual status, any accrued but uncollected interest for the loan is reversed out of interest income in the period in which the status is changed. Subsequent payments received from the customer are applied to principal and no further interest income is recognized until the principal has been paid in full or until circumstances have changed such that payments are again consistently received as contractually required. In the case of commercial customers, the pattern of payment must also be accompanied by a positive change in the financial condition of the borrower.
The increase in nonaccrual loans of $114.4 million is mostly attributed to the economic downturn that occurred during the latter part of 2008. A majority of this increase is associated with the construction loan portfolio which had nonaccrual loans of $101.2 million at December 31, 2008. The Company had restructured loans (TDR) of $33.7 million compared to no TDR loans at December 31, 2007. The economic downturn has also contributed to this increase. Several of the TDR loans were also from the construction loan portfolio and account for $28.2 million of the restructured loans. The Company had foreclosed collateral of $7.1 million and $3.4 million as of December 31, 2008 and 2007, respectively. The increase in foreclosed collateral is mostly land and commercial buildings which consists of $6.1 million of the $7.1 million balance at December 31, 2008.
The increase in nonaccrual loans of $62.4 million at December 31, 2007 compared to 2006 was mostly attributable to $45.1 million related to two large commercial relationships. At the end of 2008 the balance of these relationships was $24.8 million.
Foreclosed collateral consists of other real estate owned (OREO) obtained through foreclosure for all five years presented in the table above. The Company held OREO at fair value less estimated costs to sell at December 31, 2008, 2007, 2006, 2005 and 2004 of $7.1 million, $3.4 million, $2.9 million, $2.9 million, and $2.9 million, respectively.
The table below sets forth the amounts of foregone interest income from nonaccrual loans for the last five years.
Other assets at December 31, 2008 were $390.3 million, an increase of $106.1 million since December 31, 2007. This increase is attributed to the following items:
The average balance of deposits by category and the average effective interest rates paid on deposits is summarized for the years ended December 31, 2008, 2007 and 2006 in the table below.
Total deposits increased to $6.59 billion at December 31, 2008 from $4.96 billion at December 31, 2007, an increase of $1.63 billion or 32.8%. This increase was primarily from CDs as the Bank had marketing campaigns offering attractive interest rates to increase deposit growth and attract new customers. The Company has also increased Broker CDs by $1.14 billion during the fourth quarter of 2008 in preparation for funding the 2009 RAL Program. The Broker CDs are reported in the time certificates of deposit less than $100,000. In addition, in the fourth quarter of 2008, the Bank became a member of Certificate of Deposit Account Registry Service (CDARS) which provides FDIC insurance for large deposits which has also increased deposits in 2008. As disclosed in the table above, the interest rates paid on deposits decreased significantly over 2008 due to the decrease in interest rates by the FOMC.
In October 2008, the Company sold $54.4 million of deposits and associated buildings and equipment from the Santa Paula and Harvard branches. The Company recorded a $3.1 million gain on sale related to this transaction.
Certificates of Deposit of $100,000 or More
The table below discloses the distribution of maturities of Certificates of Deposit of $100,000 or more at December 31, 2008, 2007 and 2006:
LONG TERM DEBT AND OTHER BORROWINGS
Long-term debt and other borrowings increased $334.6 million or 23.8% from $1.41 billion at December 31, 2007. This increase was caused by the Banks strong loan growth during 2008. Included in this increase are short-term FHLB advances of $230.0 million which are due to be repaid in one year or less.
Other liabilities were $113.5 million at December 31, 2008 compared to $63.9 million at December 31, 2007, an increase of $49.6 million or 77.6%. The significant items attributed to this increase were:
CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS
The Company has entered into a number of transactions, agreements, or other contractual arrangements whereby it has obligations that must be settled by cash or contingent obligations that must be settled by cash in the event certain specified conditions occur. The table below lists the Companys contractual obligations.