10-K 1 d10k.htm FORM 10-K Form 10-K
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

COMMISSION FILE NUMBER 0-11113

LOGO

(Exact Name of Registrant as Specified in its Charter)

 

California   95-3673456

(State or other jurisdiction of

incorporation or organization)

  (I.R.S. Employer Identification No.)

1021 Anacapa St.

Santa Barbara, California

  93101
(Address of principal executive offices)   (Zip Code)

(805) 564-6405

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

  

Name of Each Exchange on Which Registered

Common Stock, no par value    The NASDAQ Stock Market LLC

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        No   X 

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes        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 registrant’s 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          Accelerated filer   X     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, 2009, based on the sales prices on that date of $2.14 per share: Common Stock—$94,636,109. All directors and executive officers and the registrant’s 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 19, 2010, there were 46,759,587 shares of the issuer’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE: Portions of registrant’s Proxy Statement for the Annual Meeting of Shareholders on April 29, 2010 are incorporated by reference into Part III.


Table of Contents

INDEX

 

               Page
PART I         
   Forward-Looking Statements    3
  

Item 1.

   Business    6
  

Item 1A.

   Risk Factors    15
  

Item 1B.

   Unresolved Staff Comments    27
  

Item 2.

   Properties    27
  

Item 3.

   Legal Proceedings    28
  

Item 4.

  

Reserved

   28

PART II

        
  

Item 5.

  

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   29
  

Item 6.

   Selected Financial Data    31
  

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   32
      Financial Overview and Highlights    32
      Results of Operations    34
      Balance Sheet Analysis    50
      Contractual Obligations and Off-Balance Sheet Arrangements    71
      Capital Resources    71
      Liquidity    74
      Critical Accounting Policies    77
      Regulation and Supervision    82
  

Item 7A.

   Quantitative and Qualitative Disclosures about Market Risk    90
  

Item 8.

   Consolidated Financial Statements and Supplementary Data    94
  

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

   180
  

Item 9A.

   Controls and Procedures    180
  

Item 9B.

   Other Information    180
      Glossary    181
PART III         
  

Item 10.

   Directors, Executive Officers and Corporate Governance    185
  

Item 11.

   Executive Compensation    185
  

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   185
  

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

   185
  

Item 14.

   Principal Accountant Fees and Services    185

PART IV

        
  

Item 15.

   Exhibits and Financial Statement Schedules    186
SIGNATURES    187

EXHIBIT INDEX

CERTIFICATIONS

   188

 

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PART I

Forward-Looking Statements

This Annual Report on Form 10-K contains “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. Pacific Capital Bancorp (the “Company” or “PCB”) intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in these provisions. All statements other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws, including, but not limited to, statements about anticipated future operating and financial performance, financial position and liquidity, business prospects, strategic alternatives, business strategies, regulatory and competitive outlook, investment and expenditure plans, capital and financing needs and availability, acquisition and divestiture opportunities, plans and objectives of management for future operations, and other similar forecasts and statements of expectation and statements of assumptions underlying any of the foregoing. Words such as “will likely result,” “aims,” “anticipates,” “believes,” “could,” “estimates,” “expects,” “hopes,” “intends,” “may,” “plans,” “projects,” “seeks,” “should,” “will,” and variations of these words and similar expressions are intended to identify these forward-looking statements.

Forward-looking statements are based on the Company’s current expectations and assumptions regarding its business, the regulatory environment, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. The Company’s actual results may differ materially from those contemplated by the forward-looking statements. The Company cautions you therefore against relying on any of these forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, the following:

 

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inability to continue as a going concern;

 

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management’s ability to effectively execute the Company’s business plan;

 

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inability to raise additional capital on acceptable terms, or at all;

 

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inability to achieve the higher minimum capital ratios that Pacific Capital Bank, N.A. (the “Bank”) has agreed to maintain with the Office of the Comptroller of the Currency;

 

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inability to receive dividends from the Bank and to service debt and satisfy obligations as they become due;

 

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regulatory enforcement actions to which the Company and the Bank are currently, and may in the future be, subject;

 

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costs and effects of legal and regulatory developments, including the resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations or reviews;

 

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changes in capital classification;

 

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the impact of current economic conditions and the Company’s results of operations on its ability to borrow additional funds to meet its liquidity needs;

 

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local, regional, national and international economic conditions and events and the impact they may have on the Company and its customers;

 

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changes in the economy affecting real estate values;

 

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  ¡  

inability to attract and retain deposits;

 

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changes in the level of non-performing assets and charge-offs;

 

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changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements;

 

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changes in the financial performance and/or condition of the Bank’s borrowers;

 

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effect of additional provision for loan losses;

 

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long-term negative trends in the Company’s market capitalization;

 

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continued listing of the Company’s common stock on The NASDAQ Global Select Market;

 

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effects of any changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board;

 

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inflation, interest rate, cost of funds, securities market and monetary fluctuations;

 

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political instability;

 

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acts of war or terrorism, natural disasters such as earthquakes or fires, or the effects of pandemic flu;

 

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the timely development and acceptance of new products and services and perceived overall value of these products and services by users;

 

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changes in consumer spending, borrowings and savings habits;

 

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technological changes;

 

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changes in the Company’s organization, management, compensation and benefit plans;

 

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competitive pressures from other financial institutions;

 

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continued consolidation in the financial services industry;

 

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inability to maintain or increase market share and control expenses;

 

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impact of reputational risk on such matters as business generation and retention, funding and liquidity;

 

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rating agency downgrades;

 

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continued volatility in the credit and equity markets and its effect on the general economy;

 

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effect of changes in laws and regulations (including laws concerning banking, taxes and securities) with which the Company and its subsidiaries must comply;

 

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effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;

 

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other factors that are described in “Risk Factors”; and

 

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the Company’s success at managing the risks involved in the foregoing items.

Forward-looking statements speak only as of the date they are made, and the Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made, whether as a result of new information, future developments or otherwise, except as may be required by law.

The assets, liabilities, and results of operations of the Company’s tax refund and transfer programs (“RAL and RT programs”) are reported in its periodic filings with the Securities and Exchange Commission (“SEC”) as a segment of its business. Because these are activities conducted by very few

 

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other financial institutions, users of the financial statements have indicated that they are interested in information for the Company exclusive of these programs so that they may compare the results of operations with financial institutions that do not have 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 into the assessment by executive management (“Management”) of the financial condition and results of operations of the Company and its subsidiaries. This discussion should be read in conjunction with the Company’s 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 94 through 179 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 181 through 184. The Company utilizes the term “Core Bank” throughout this Form 10-K. Core Bank is defined as the Company’s consolidated financial results less the financial results from the refund anticipation loan (“RAL”) and refund transfer (“RT”) Programs and is interchangeably referred to as “Excluding RAL and RT”.

 

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ITEM 1. BUSINESS

Organizational Structure and Description of Services

The Company 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 was one of three primary providers nationwide of RALs and RTs at December 31, 2009. On January 14, 2010, the Company sold all of the assets of the RAL and RT Programs segment.

The Company has six wholly-owned subsidiaries. Pacific Capital Bank, National Association (“the Bank” or “PCBNA”), a banking subsidiary, PCB Service Corporation, utilized as a trustee of deeds of trust in which PCBNA is the beneficiary 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 144 of this Form 10-K.

PCBNA has three wholly-owned consolidated subsidiaries:

 

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Morton Capital Management (“MCM”) and R.E. Wacker Associates, Inc. (“REWA”), two registered investment advisors that provide investment advisory services to individuals, foundations, retirement plans and select institutional clients.

 

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SBBT RAL Funding Corp. which was utilized as part of the financing of the RAL program as described in Note 7, “RAL and RT Programs”.

In 2007, PCBNA made an investment in Veritas Wealth Advisors, LLC (“Veritas”), a registered investment advisor. PCBNA made an additional investment of $750,000 in January 2008, for a total investment of $1.0 million or a 20% interest in Veritas.

PCBNA also retains ownership in several low-income housing tax credit partnerships (“LIHTCP”) that are not consolidated into the Company’s Consolidated Financial Statements. For additional information regarding PCBNA’s investment in LIHTCP, refer to Note 1, “Summary of Significant Accounting Policies” of the Consolidated Financial Statements on page 103.

 

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At December 31, 2009, PCBNA conducted its banking services under five brand names at 50 locations. These brand names represent the former names of select acquired independent banks merged into PCBNA.

 

Brand Name   Acronym   Counties Located in  

Year

Founded or

Acquired

  Number of
Locations

Santa Barbara Bank & Trust

  “SBB&T”  

Santa Barbara,

Ventura and

Los Angeles

  1960(1)   34

First National Bank of Central California

  “FNB”  

Monterey and

Santa Cruz

  1998   7

South Valley National Bank

  “SVNB”   Southern Santa Clara   1998   3

San Benito Bank

  “SBB”   San Benito   1998   3

First Bank of San Luis Obispo

  “FBSLO”   San Luis Obispo   2005   3

 

  (1) PCBNA commenced operations in 1960 as Santa Barbara National Bank (“SBNB”). In 1979, SBNB switched from a national charter to a state charter and changed the name to SBB&T. In 2002, PCBNA was created returning the charter to a national bank by consolidating the two subsidiaries of SBB&T and FNB into PCBNA. In 2007, PCBNA locations which were part of Pacific Crest Capital Incorporated (“PCCI”) and acquired with it in 2004 were renamed to the SBB&T brand name.

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 Company’s treasury department.

In early 2008, Management began an evaluation of all administrative and retail branch facilities in an effort to identify opportunities for greater efficiencies in its space utilization. As a result, throughout 2008 and 2009, and continuing into 2010, there are a number of location consolidations and closures related to this expense control initiative to ensure that all locations leased and owned are fully occupied. Additionally, the Company’s review will confirm that all retail branch locations meet its strategic initiatives and continue to meet the needs of the Bank’s customers.

In January 2010 and February 2010, the Commercial and Wealth Management Group’s (“CWMG”) San Jose and Calabasas locations were closed. Also, in February 2010 the Company announced plans to vacate its downtown Santa Barbara headquarters building in the first half of 2010 and is in the process of negotiating with the owners of the building to terminate the operating lease so that the executive and other staff currently occupying the building may move to other underutilized facilities. The Buellton and Vandenberg Village retail branch locations which operate under the SBB&T brand will consolidate into nearby locations in April 2010. There are also several locations that are being evaluated for possible sale, consolidation or closure during 2010.

Three-Year Strategic and Capital Plan

For the past two years, the Company has operated in an exceptionally difficult recessionary environment and has been significantly impacted by the resulting unprecedented credit and economic market turmoil. Deterioration in California’s commercial and residential real estate markets and the related declines in property values, and worsening unemployment, have had a significantly negative impact on the Company’s operating results. The Company also continues to operate under enhanced

 

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regulatory scrutiny. (See the “Regulation and Supervision—Current Regulatory Matters” Section of this Form 10-K.)

In an effort to strengthen the Company’s operations and capital position and enable it to better withstand these continued adverse market conditions, as required by the Office of the Comptroller of the Currency (the “OCC”), the Company has developed a detailed three-year strategic and capital plan (the “Capital Plan”).

Key components of the Capital Plan include:

 

 

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A process to identify and evaluate a broad range of strategic alternatives to strengthen the Company’s capital base and enhance shareholder value.

 

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Building and maintaining a strong capital base.

 

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Improving asset quality through a combination of efforts to reduce the current concentration of classified assets, prudently managing credit risk exposures in the existing loan portfolio, and tightening credit underwriting standards.

 

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A comprehensive review of the Bank’s entire loan portfolio to identify loans that are good candidates for sale. During 2009, the Company sold approximately $383.5 million in real estate secured loans.

 

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Substantial curtailment of the Bank’s commercial real estate lending business pending a reduction in the Bank’s risk profile and significant improvement in market conditions.

 

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Severely limited asset growth, as the Company focuses on improving asset quality and implementing necessary efficiency and risk management initiatives in the Core Bank.

 

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Maintaining prudent levels of liquidity.

 

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Improving earnings.

 

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Strengthening Management and Board of Directors oversight.

 

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Compliance with applicable laws and regulations, including, to the maximum possible extent, regulatory capital requirements and the requirements of regulatory enforcement actions.

 

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Initiatives to improve the Company’s operating efficiency ratio through automation of key systems, process integration, and elimination of redundancies.

 

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Additional expense reduction actions that are targeted to eliminate $25 million in annual operating expenses in 2010 and another $25 million in annual operating expenses in 2011. The initiative will focus on enhancing efficiencies in all business units and reducing expenses in areas such as information technology and corporate real estate.

The Company believes the successful completion of the Capital Plan would substantially improve its operations and capital position. However, no assurances can be made that the Company will be able to successfully complete all, or any portion of the Capital Plan, or that the Capital Plan will not be materially modified in the future. If the Company is not able to successfully complete a substantial portion of its Capital Plan, the Company expects that its business and the value of its securities will be materially and adversely affected, and it will be more difficult for the Company to meet the capital requirements requested by its primary banking regulators.

Segments

The Company had three reportable operating segments at December 31, 2009. These segments are determined based on product line and the types of customers serviced. These reportable operating segments are Community Banking, CWMG and RAL and RT Programs. The CWMG segment is the result of combining two segments that were reported separately in the 2008 Annual Report on Form 10-K. For purposes of the segment reporting in Note 24, “Segments” to the Consolidated Financial Statements, the two segments have been combined for the years ended December 31, 2008 and 2007 as if the segments had been combined as of January 1, 2007.

 

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The administrative and treasury operations of the Company are not considered part of operating activities 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 171.

The Community Banking and CWMG segments represent the traditional banking operations of 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 banks. 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 experienced significant growth in the RAL and RT Programs over the last several years but also had a high amount of credit, reputation and regulatory risk. In an effort to reduce the Company’s risk, the Company sold the RAL and RT Program segment on January 14, 2010. The financial impact of the RAL and RT Programs will be discussed throughout the Management Discussion and Analysis (“MD&A”) section of this document and in Note 7, “RAL and RT Programs” of the Consolidated Financial Statements.

The income generated by these two Core Bank reportable segments is 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 and CWMG segments.

Community Banking

Business units in this segment provide residential real estate loans, home equity lines and loans, consumer loans, small business loans, deposit products, Small Business Administration (“SBA”) 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. In the third quarter of 2008, residential loans began to be originated for sale on a flow basis in addition to booking loans held on the balance sheet. In the second half of 2009, the Company made a strategic decision to only originate loans to be sold into the secondary market.

The Company extends credit based on the underwriting requirements that Freddie Mac and Fannie Mae require so, that the loans can be sold on the secondary market. 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 borrower’s 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 Banking Segment are extended without collateral to small businesses based on historical credit performance of the business and 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 equal to or less than $100,000.

 

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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.

Deposit products include checking, savings, money market accounts, Individual Retirement Accounts (“IRAs”), Certificates of Deposit (“CDs”) and debit cards.

Demand deposit overdraft protection products are offered to customers to provide additional protection against unforeseen deficit balances in a specific account and the fees associated with returned checks. 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.

The Community Banking segment serves customers through traditional banking branches, loan production centers, Automated Teller Machines (“ATM”), through the customer contact call center and online banking.

Commercial and Wealth Management Group

As discussed above, in January 2009 the Commercial Banking and Wealth Management segments were combined into one segment. The new CWMG segment provides the same products and services that were offered prior to being combined, but the combined segment is serving the same customers under one business model.

A majority of the customers served in this segment are middle market companies with business owners who are high net-worth individuals. Combining the segments allows the Bank to serve these customers with one relationship manager. This segment offers a complete line of commercial and industrial and commercial real estate secured loan products and services as well as trust and investment advisory services and private banking lending, deposit services and securities brokerages services through the Bank’s trust and investment management group and through MCM and REWA. The types of products offered in this segment include traditional commercial and industrial and commercial real estate and lines of credit, letters of credit, asset-based lending, foreign exchange services and treasury management. The loan products also include construction loans for commercial and residential development, land acquisition and development loans, secured and unsecured lines of credit and financing arrangements for completed structures.

Loan products are underwritten and customized to meet specific customer needs. The Company considers several factors in order to extend the loan including the borrower’s 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. Due to the high level of charge-offs, impairments and non-accrual loans in the CWMG segment during 2008 and 2009, the lending policies were amended to increase loan approval oversight, reduce approval limits, reduce the risk on the Company’s balance sheet and reduce concentrations of commercial real estate loans. In addition, the origination of

 

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commercial real estate loans in 2009 was very limited and very closely monitored. The Company renewed commercial real estate loans during 2009, but the renewals utilized the new underwriting criteria amended during 2009. The maximum loan-to-value ratios for commercial real estate loans were reduced from 75% to 50% during 2009 and debt service ratios were increased to 1.50 from 1.25. Depending on the product, these loans have fixed or variable interest rates.

The trust and investment advisory services include 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. The CWMG segment’s underwriting guidelines consider tangible net worth, the nature of assets that make up this net worth, personal cash flow, past history with the Company, and general 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.

Deposit products include checking, savings, money market accounts, IRAs, CDs and debit cards. Overdraft protection is also offered to these customers.

The CWMG segment serves customers through traditional banking branches, loan production centers, ATMs, through the customer contact call center and online banking.

RAL and RT Programs

As disclosed above, on January 14, 2010, the Company sold all of the assets of the RAL and RT Programs segment. However, since the RAL and RT Programs activity continued through December 31, 2009, the products and results of operations of this segment will be discussed throughout this Form 10-K.

RALs are a seasonal credit product extended to consumers during the first four months of each calendar year. The purpose of a 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 taxpayer’s 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 taxpayer’s refund directly to the Company. When received from the IRS, the refund 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 as 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 preparer’s office, the credit criteria are set by the Company and the underwriting decision is made by the Company. The Company

 

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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 the taxpayer’s tax preparer.

For more information regarding RALs and RTs, refer to Note 7, “RAL and RT Programs” of the Consolidated Financial Statements beginning on page 133.

Changes to Segment Reporting in 2010

In January 2010, the Chief Executive Officer (“CEO”) announced further organizational change which changes the structure of the Community Banking and CWMG segments. This organizational change will significantly change the structure of how the Company defines its segments in 2010. Up until December 31, 2009 the segments were defined by the products offered to certain types of customers. This organizational change defines the segments by regional location as well as products offered but all serve the same type of client bases.

Employees

At December 31, 2009, the Company employed 1,164 employees. The Company’s employees are not represented by a union or covered by a collective bargaining agreement. Management believes that its employee relations are good.

Acquisitions

Recent mergers and acquisitions of the Company are disclosed in Note 2, “Acquisitions and Dispositions” in the Consolidated Financial Statements on page 118. In the last three years, the Company has had one acquisition, REWA. In January 2008, PCBNA acquired REWA, a 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.

Market Area

The Company’s 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 RAL and RT Programs administrative offices were located in San Diego County, California with transactions conducted with taxpayers located throughout the United States.

Foreign Operations

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.

 

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Customer Concentration

The Company does not have any customer relationships that individually account for 10% or more of consolidated revenues.

Competition

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 82 through 89 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 non-bank financial service providers. Many competitors are much larger in total assets and capitalization, have greater access to capital markets, including foreign markets, and/or offer a broader range of financial services.

Economic Conditions, Government Policies, Legislation, and Regulatory Initiatives

The Company’s 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 the Company’s control and cannot be predicted, such as inflation, recession and unemployment, and the impact which future changes in domestic and foreign economic conditions might have on the Company cannot be predicted. A more detailed discussion of the Company’s interest rate risks and the mitigation of those risks begins on page 90.

The Company’s 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 services providers. In response to the recent economic downturn and financial industry instability, legislative and regulatory initiatives have been, and will likely continue to be, introduced and implemented, which could substantially intensify the regulation of the financial services industry. These include possible comprehensive overhaul of the financial institutions regulatory system, the creation of a new consumer financial protection agency, and enhanced supervisory attention and potential new restrictions on executive compensation arrangements. The Company cannot predict whether or when potential legislation or new regulations will be enacted, and if enacted, the effect that new legislation or any implementing regulations and supervisory policies would have on the Company’s financial condition or results of operations. Moreover, especially in the current economic environment, bank regulatory agencies have been very

 

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aggressive in responding to concerns and trends identified in examinations, and this has resulted in the increased issuance of enforcement actions to financial institutions requiring action to address credit quality, liquidity and risk management and capital adequacy, as well as other safety and soundness concerns.

Through its authority under the Emergency Economic Stabilization Act of 2008 (“EESA”), as amended by the American Recovery and Reinvestment Act of 2009 (“ARRA”), the United States Department of the Treasury (“U.S. Treasury”) implemented the Troubled Asset Relief Program Capital Purchase Program (“TARP CPP”), a program designed to bolster eligible healthy institutions by injecting capital into these institutions. The Company participated in the TARP CPP and sold to the U.S. Treasury on November 21, 2008 (i) 180,634 shares of the Company’s 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 Company’s 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. Treasury’s 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 Company’s 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 “Regulation and Supervision” section of this Form 10-K and in Note 20, “Regulatory Capital Requirements” of the Consolidated Financial Statements.

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 (“CFO”) and the three next most highly-compensated officers (“Senior Executive Officers” or “SEOs”) and other highly-compensated employees. The standards include (1) ensuring that incentive compensation for the SEOs 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 the SEOs and the next 20 most highly-compensated employees 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 the SEOs and the next five most highly-compensated employees; (4) prohibitions on bonuses, retention awards and other incentive compensation payable to the five most highly-compensated employees, other than restricted stock grants which do not fully vest during the TARP period up to one-third of an employee’s total annual compensation; and (5) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each SEO. The Company has complied with these requirements.

The EESA also increased Federal Deposit Insurance Corporation (“FDIC”) deposit insurance on most accounts from $100,000 to $250,000. This increase was originally scheduled to end in 2009; however, Congress extended the temporary increase until December 31, 2013. The increase is not covered by deposit insurance premiums paid by the banking industry. In addition, the FDIC has implemented two temporary programs under the Temporary Liquidity Guarantee Program (“TLGP”) 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 later extended through June 30, 2010, 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”). 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 have not yet issued any debt under the Debt Guarantee Program.

 

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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 Company’s operations are discussed on pages 82 through 89. This section and Note 20, “Regulatory Capital Requirements” of the Consolidated Financial Statements need to be reviewed in order to understand the regulatory developments affecting the Company in 2009.

Available Information

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 (“Exchange Act”), as amended, and other information related to the Company free of charge, through the Company’s Investor Relations page of this site as soon as reasonably practicable after it electronically files those documents with, or otherwise furnishes them to, the SEC. The Company’s internet website and the information contained therein or connected thereto are not intended to be incorporated into this annual report on Form 10-K.

 

ITEM 1A. RISK FACTORS

RISK MANAGEMENT

Investing in the Company’s common stock involves various risks which are specific to the Company, the Company’s industry and market area. Several risk factors regarding investing in the Company’s common stock are discussed below. This listing should not be considered as all-inclusive. If any of the following risks were to occur, Management may not be able to conduct the Company’s business as currently planned and the financial condition or operating results could be negatively impacted. The Company’s Chief Audit Executive, Chief Risk Officer and Chief Credit Officer in conjunction with other members of the Company’s Management under the direction and oversight of the Board of Directors lead the Company’s 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.

Going Concern Uncertainty

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business. As a result, the accompanying consolidated financial statements do not include any adjustments that may result from the outcome of any extraordinary regulatory action or the Company’s inability to meet its existing debt obligations. The Company has recently incurred significant operating losses, experienced a significant deterioration in the quality of its assets and become subject to enhanced regulatory scrutiny. These factors, among others, were deemed to cast significant doubt on the Company’s ability to continue as a going concern. If the Company cannot continue to operate as a going concern, it is likely that shareholders will lose all or substantially all of their investment in the Company.

The Company is actively considering a broad range of strategic alternatives, including a capital infusion or a merger, in order to address any doubt related to the Company’s ability to continue as a going concern. There can be no assurance that the exploration of strategic alternatives will result in any transaction, or that any such transaction will allow the Company’s shareholders to avoid a loss of all or substantially all of their investment in the Company. The pursuit of strategic alternatives may also involve significant expenses and management time and attention.

 

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Additional Capital

The Company will need to raise additional capital to meet the higher minimum capital levels that PCBNA is obligated to maintain under its agreement with the OCC. In addition, should the Company’s current rate of operating losses continue or should the Company’s asset quality erode and require significant additional provision for credit losses, resulting in additional net operating losses, the Company’s capital levels will decline further and it will need to raise more capital to satisfy its regulatory capital requirements. The Company’s ability to raise additional capital depends on conditions in the capital markets, which are outside the Company’s control, and on the Company’s financial performance. Accordingly, the Company cannot be certain of its ability to raise additional capital on acceptable terms, or at all. If the Company cannot raise additional capital, its results of operations and financial condition could be materially and adversely affected, and it may be subject to further supervisory action. See “Regulatory Risk.” In addition, if the Company were to raise additional capital through the issuance of additional shares, its stock price could be adversely affected, depending on the terms of any shares it were to issue.

Regulatory Risk

During the second quarter of 2009, PCB entered into the Memorandum of understanding with the FRB (“FRB Memorandum”) and PCBNA entered into the Memorandum of understanding with the OCC (“OCC Memorandum”). See “Regulation and Supervision—Current Regulatory Matters” for the discussion of the terms of the FRB Memorandum and OCC Memorandum. If PCB fails to comply with the FRB Memorandum or PCBNA fails to comply with the OCC Memorandum, it may be subject to further supervisory enforcement action, which could have a material adverse effect on its results of operations, financial condition and business. In addition, PCBNA agreed during the second quarter of 2009 to maintain a minimum Tier 1 leverage ratio of 8.5% as of June 30, 2009 and 9.0% from and after September 30, 2009, and a minimum total risk based capital ratio of 11.0% as of June 30, 2009 and 12.0% from and after September 30, 2009. PCBNA had a Tier 1 leverage ratio of 5.5%, 5.6% and 5.7%, respectively, at December 31, 2009, September 30, 2009 and June 30, 2009, and a total risk based capital ratio of 10.7%, 10.8% and 11.2%, respectively, at December 31, 2009, September 30, 2009 and June 30, 2009. While these ratios exceed the minimum ratios required to be classified as “well capitalized” under generally applicable regulatory guidelines, the Tier 1 leverage ratio at December 31, 2009, September 30, 2009 and June 30, 2009 and the total risk based capital ratio at December 31, 2009 and September 30, 2009 were not sufficient to meet the higher levels that PCBNA is obligated to maintain under its agreement with the OCC. As a result, PCBNA may be subject to further supervisory action, which could have a material adverse effect on its results of operations, financial condition and business.

In addition, due to the ongoing economic downturn and the resultant deterioration in the California commercial real estate and commercial business markets and adverse impact on PCBNA’s loan portfolio and financial results, the Company and PCBNA may be the subject of additional regulatory actions in the future and face further limitations on its business. Bank regulatory authorities have the authority to bring enforcement actions against banks and bank holding companies for unsafe or unsound practices in the conduct of their businesses or for violations of any law, rule or regulation, any condition imposed in writing by the appropriate bank regulatory agency or any written agreement with the authority. Possible enforcement actions against the Company and PCBNA could include the issuance of a cease-and-desist order that could be judicially enforced, the imposition of civil monetary penalties, the issuance of directives to increase capital or enter into a strategic transaction, whether by merger or otherwise, with a third party, the appointment of a conservator or receiver for PCBNA, the termination of insurance of deposits, the issuance of removal and prohibition orders against institution- affiliated parties, and the enforcement of such actions through injunctions or restraining orders. The imposition of any such enforcement actions would likely have an adverse effect on the Company’s results of operations, financial condition and business.

 

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No Assurance of Profitability

The Company incurred a net loss of $431.3 million, or $9.24 per diluted common share, for the year ended December 31, 2009, primarily due to a $426.9 million provision for loan losses, a $128.7 million charge for goodwill impairment and the establishment of a $145.9 million net deferred tax asset valuation allowance. Although the Company has taken a significant number of steps to reduce its credit exposure, the Company likely will continue to incur significant credit costs throughout 2010, which Management anticipates will continue to adversely impact the Company’s overall financial performance and results of operations. There can be no assurance that the Company will achieve profitability in the future.

Change in Capital Classification

As of December 31, 2009, the Company and PCBNA each met the minimum ratios required to be classified as “well capitalized” under generally applicable regulatory guidelines. However, there is a substantial risk that the Company and PCBNA will fail to meet such requirements in future periods unless the Company is successful in executing on its three-year capital and strategic plan. If PCBNA’s regulatory capital position were to deteriorate such that it was classified as “adequately capitalized,” it might not be able to use brokered deposits as a source of funds. A “well capitalized” institution may accept brokered deposits without restriction. An “adequately capitalized” institution must obtain a waiver from the FDIC in order to accept, renew or roll over brokered deposits. In addition, certain interest-rate limits apply to the financial institution’s brokered and solicited deposits. Although an institution could seek permission from the FDIC to accept brokered deposits if it were no longer considered to be “well capitalized,” the FDIC may deny permission, or may permit the institution to accept fewer brokered deposits than the level considered desirable. If PCBNA’s level of deposits were to be reduced, either by the lack of a full brokered deposit waiver or by the interest rate limits on brokered or solicited deposits, Management anticipates that PCBNA would reduce its assets and, most likely, curtail its lending activities. Other possible consequences of classification as an “adequately capitalized” institution include the potential for increases in borrowing costs and terms from the Federal Home Loan Bank (“FHLB”) and other financial institutions and increases in FDIC insurance premiums. Such changes could have a material adverse effect on the Company’s results of operations, financial condition and business.

Dividends from the Bank

The principal source of funds from which PCB services its debt and pays its obligations and dividends is the receipt of dividends from PCBNA. The availability of dividends from PCBNA is limited by various statutes and regulations. It is also possible, depending upon the financial condition of PCBNA and other supervisory factors, that the OCC or FRB could restrict or prohibit PCBNA from paying dividends to PCB. In this regard, and as a result of the OCC Memorandum and FRB Memorandum, both OCC and FRB approval will now be required before PCBNA can pay dividends to PCB. In the event that PCBNA is unable to pay dividends to PCB, PCB in turn may not be able to service its debt, pay its obligations or pay dividends on its outstanding equity securities, which would adversely affect PCB’s business, financial condition, results of operations and prospects.

Deferral of Interest on Trust Preferred Securities and Suspension of Cash Dividends on Series B Preferred Stock

In the second quarter of 2009, the Company elected to defer regularly scheduled interest payments on its outstanding $69.4 million of junior subordinated notes relating to its trust preferred securities and to suspend cash dividend payments on its Series B Preferred Stock. During the deferral period, interest will continue to accrue on the junior subordinated notes at the stated coupon rate, including the deferred interest, and the Company may not, among other things and with limited exceptions, pay cash dividends on or repurchase its common stock or preferred stock nor make any payment on outstanding debt obligations that rank equally with or are junior to the junior subordinated notes. As a result of the

 

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Company’s deferral of interest on the junior subordinated notes, it is likely that the Company will not be able to raise funds through the offering of debt securities until the Company becomes current on those obligations or those obligations are restructured. This deferral may also adversely affect the Company’s ability to obtain debt financing on commercially reasonable terms, or at all. As a result, the Company will likely have greater difficulty in obtaining financing and, thus, will have fewer sources to enhance its capital and liquidity position. In addition, if the Company defers interest payments on the junior subordinated notes for more than 20 consecutive quarters, the Company would be in default under the governing agreements for such notes and the amount due under such agreements would be immediately due and payable.

Also during the deferral period, cash dividends on the Series B Preferred Stock will accrue and compound on each subsequent payment date, and the Company may not, among other things and with limited exceptions, pay cash dividends on or repurchase its common stock or preferred stock that ranks equally with or is junior to the Series B Preferred Stock. If the Company misses six quarterly dividend payments on the Series B Preferred Stock, whether or not consecutive, the U.S. Treasury will have the right to appoint two directors to the Company’s board of directors until all accrued but unpaid dividends have been paid.

Rating Agency Downgrades

The major credit agencies regularly evaluate the Company’s creditworthiness and assign credit ratings to the Company and the Bank. The agencies’ ratings are based on a number of factors, some of which are not within the Company’s control. In addition to factors specific to the financial strength and performance of the Company and the Bank, the agencies also consider conditions affecting the financial services industry generally. On July 31, 2009, Moody’s Investor Services (“Moody’s”) downgraded the credit rating for the financial strength of the Bank from D+ to E+ and the short-term debt of the Bank from Prime-3 to Not Prime with the long-term debt of the Bank remaining under review for a possible downgrade. On July 31, 2009, Dominion Bond Rating Service (“DBRS”) downgraded the ratings of the Company from BB (high) to B, the senior debt of the Company from BB (high) to B, and the deposits and senior debt of the Bank from BBB to BB, with all ratings remaining under review with negative implications. On December 24, 2009, Moody’s downgraded the credit ratings of the Company from Caa1 to C and the long term deposits of the Bank from B1 to B3 with the financial strength rating being under review for a possible downgrade. On December 24, 2009, DBRS downgraded their credit ratings for the Company from B to CCC and the deposits and senior debt of the Bank from BB to B with all ratings remaining under review with negative implications. On February 1, 2010, DBRS downgraded the credit ratings for the Company from CCC to CC and the senior debt of the Bank from B to CCC (high). These lower ratings, and any further ratings downgrades, could make it more difficult for the Company and the Bank to access the capital markets going forward, as the cost to borrow or raise debt or equity capital could become more expensive. Although the cost of the Bank’s primary funding sources (deposits and FHLB borrowings) is not influenced directly by the Bank’s credit ratings, no assurance can be given that the Company’s and the Bank’s credit ratings will not have any impact on the Bank’s access to deposits and FHLB borrowings. Long-term debt ratings also factor into the calculation of deposit insurance premiums, and a reduction in the Bank’s ratings would increase premiums and expense.

Continued Listing on The NASDAQ Global Select Market

The Company’s common stock is listed on The NASDAQ Global Select Market. The listing standards of The NASDAQ Global Select Market provide, among other things, that a company may be delisted if the bid price of its stock drops below $1.00 for a period of 30 consecutive business days. The closing price of the Company’s common stock was $1.20 per share on March 1, 2010. However, there were a number of days during the fourth quarter of 2009 that the stock price was below $1.00 per share. If the Company fails to comply with the listing standards applicable to issuers listed on The NASDAQ Global

 

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Select Market, the Company’s common stock may be delisted from The NASDAQ Global Select Market. The delisting of the Company’s common stock would significantly affect the ability of investors to trade the Company’s securities and would likely reduce the liquidity and market price of the Company’s common stock. In addition, the delisting of the Company’s common stock could also materially adversely affect the Company’s ability to raise capital on terms acceptable to the Company or at all. Delisting from The NASDAQ Global Select Market could also have other negative results, including the potential loss of confidence by customers and employees and the loss of institutional investor interest in the Company’s common stock.

Difficult Economic Conditions

The Company’s 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 Company’s control may adversely affect the Company’s asset quality, deposit levels and loan demand and, therefore, earnings.

Dramatic declines in the housing market, with falling 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 asset values by the Company and many other financial institutions. 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. 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.

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 Company’s markets, products or other businesses will ultimately be most affected, and whether Management’s 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 Company’s 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:

 

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Inability of the Company’s borrowers to make timely repayments of their loans, or decreases in value of real estate collateral securing the payment of such loans resulting in significant credit losses, which could result in increased delinquencies, foreclosures and customer bankruptcies, any of which could have a material adverse effect on the Company’s operating results.

 

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Increased regulation of the Company’s industry, including heightened legal standards and regulatory requirements or expectations imposed in connection with EESA and ARRA. Compliance with such regulation will likely increase the Company’s costs and may limit the Company’s ability to pursue business opportunities.

 

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Further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations, may result in an inability to borrow on favorable terms or at all from other financial institutions.

 

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Increased competition among financial services companies due to the recent consolidation of certain competing financial institutions and the conversion of certain investment banks to bank holding companies, which may adversely affect the Company’s ability to market its products and services.

 

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Further increases in FDIC insurance premiums due to the market developments which have significantly depleted the Deposit Insurance Fund (“DIF”) of the FDIC and reduced the ratio of reserves to insured deposits.

In view of the concentration of the Bank’s operations and the collateral securing the loan portfolio in California, as well as the concentration in commercial real estate loans, the Company may be particularly susceptible to the adverse economic conditions in the state of California and in the eight counties where the Company’s business is concentrated.

Legislative and Regulatory Initiatives to Address Market and Economic Conditions

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 Company’s 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. 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 Company’s 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 Office of the Special Inspector General for the Troubled Asset Relief Program (“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 Company’s shareholders. Such regulations can at times impose significant limitations on the Company’s operations. Regulatory authorities have extensive discretion in

 

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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 institution’s allowance for loan losses (“ALL”). 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 Company’s 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 Company’s 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 Company’s 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 Company’s results of operations.

Unprecedented Market Volatility

The capital and credit markets have been experiencing volatility and disruption for more than two years. 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 Company’s ability to access capital and on the business, financial condition and results of operations.

The market price for the Company’s common stock has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future, including:

 

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announcements of developments related to the Company’s business;

 

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fluctuations in the Company’s results of operations;

 

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sales of substantial amounts of the Company’s securities into the marketplace;

 

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general conditions in the Company’s markets or the worldwide economy;

 

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a shortfall in revenues or earnings compared to securities analysts’ expectations;

 

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changes in analysts’ recommendations or projections and

 

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disclosure of adverse regulatory developments.

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 Company’s

 

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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 expects, however, to make additional provisions for loan losses for the next several quarters, through 2010, and possibly beyond, due to the anticipated ongoing deterioration in the local and national real estate markets and economies. In addition, federal regulators periodically evaluate the adequacy of the Company’s allowance for loan losses and may require the Company to increase its provision for loan losses or recognize further loan charge-offs based on judgments different from those of Management.

Liquidity Risk

Liquidity is essential to the Company’s business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on the Company’s liquidity. The Company’s access to funding sources in amounts adequate to finance the Company’s activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact the Company’s access to liquidity sources include a decrease in the level of the Company’s business activity due to a market downturn, adverse regulatory action against the Company or the Bank, a reduction in the Company’s credit ratings, an increase in costs of capital in financial capital markets, or a decrease in depositor or investor confidence in the Company. The Bank’s 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 Company’s financial performance. A substantial portion of the Bank’s 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 Bank’s 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 Bank’s interest rate spread and, in turn, the Company’s 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, Management may need to accelerate the pace of rate increases on the Bank’s 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 Bank’s net interest spread, asset quality and loan origination volume.

Concentration of Commercial Real Estate Loans and Commercial Business Loans

At December 31, 2009, $1.93 billion, or 37.4% of the Bank’s loan portfolio consisted of commercial real estate loans. Commercial real estate loans constitute a greater percentage of the Bank’s loan portfolio than any other loan category, including residential real estate loans secured by one to four family units, which totaled $971.7 million, or 18.8% of the Bank’s total loan portfolio at December 31, 2009. In addition, at December 31, 2009, $977.4 million, or 18.9% of the Bank’s loan portfolio consisted of commercial loans. Commercial real estate loans and commercial loans generally expose a lender to

 

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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 the Company 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 the Bank’s commercial borrowers have more than one loan outstanding with the Company. Consequently, an adverse development with respect to one loan or one credit relationship can expose the Company 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 Management intends to reduce the concentration of such loans in the Bank’s loan portfolio, there can be no assurance that Management will be successful in doing so.

Non Performing Assets

At December 31, 2009, the Bank’s nonperforming loans (which consist of non-accrual loans) totaled $397.8 million, or 7.70% of the Bank’s loan portfolio. At December 31, 2009, the Bank’s non-performing assets (which include foreclosed real estate) were $437.0 million, or 5.79% of assets. In addition, the Bank had approximately $476.7 million in accruing loans that were 30-89 days delinquent at December 31, 2009. The Bank’s non-performing assets adversely affect the Company’s net income in various ways. Until economic and market conditions improve, the Bank expects to continue to incur additional losses relating to an increase in non-performing loans. The Bank does not record interest income on non-accrual loans or other real estate owned, thereby adversely affecting the Bank’s income, and increasing the Bank’s loan administration costs. When the Bank takes collateral in foreclosures and similar proceedings, Management is required to mark the related loan to the then fair market value of the collateral, which may result in a loss. These loans and other real estate owned also increase the Bank’s risk profile and the capital the regulators believe is appropriate in light of such risks. While the Bank has reduced its problem assets through loan sales, workouts, restructurings and otherwise, decreases in the value of these assets, or the underlying collateral, or in these borrowers’ performance or financial conditions, whether or not due to economic and market conditions beyond the Company’s control, could adversely affect the Company’s business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from Management and the board of directors, which can be detrimental to the performance of their other responsibilities. There can be no assurance that the Bank will not experience further increases in nonperforming loans in the future, or that nonperforming assets will not result in further losses in the future.

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 Bank’s 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

 

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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.

FDIC Premiums

FDIC insurance premiums increased substantially in 2009, and the Bank expects to pay significantly higher FDIC premiums in the future. The FDIC has recently been considering different methodologies by which it may increase premium amounts, because the costs associated with bank resolutions or failures have substantially depleted the Deposit Insurance Fund. In November 2009, the FDIC voted to require insured depository institutions to prepay slightly over three years of estimated insurance assessments. While the Bank was able to obtain an exemption from this prepayment requirement due to its current financial condition, the increase in premiums significantly increased the Company’s non-interest expense in 2009, and may continue to do so for the foreseeable future.

Operational Risk

Operational risk represents the risk of loss resulting from the Company’s 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 Company’s 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

Reputation risk, or the risk to the Company’s earnings and capital from negative publicity or public opinion, is inherent in Company’s business. Negative publicity or public opinion could adversely affect the Bank’s ability to keep and attract customers and expose the Company to adverse legal and regulatory consequences. Negative public opinion could result from the Company’s 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.

Restrictions Resulting from Participation in the TARP CPP

Pursuant to the terms of the Securities Purchase Agreement, the Company’s ability to declare or pay dividends on any of the Company’s shares is limited. Specifically, the Company may not declare cash dividends on common shares, junior preferred shares or pari passu preferred shares when 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 its 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. Treasury’s 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 Company’s

 

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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 when 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. Treasury’s 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 SEOs and other highly-compensated employees. The standards include (i) ensuring that incentive compensation plans and arrangements for SEOs do not encourage unnecessary and excessive risks that threaten the Company’s value; (ii) required clawback of any bonus or incentive compensation paid (or under a legally binding obligation to be paid) to the SEOs and next 20 most highly-compensated employees based on materially inaccurate financial statements or other materially inaccurate performance metric criteria; (iii) prohibition on making “golden parachute payments” to SEOs and five most highly-compensated employees; and (iv) agreement not to claim a deduction, for Federal income tax purposes, for compensation paid to any of the SEOs 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 Company’s 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. Treasury’s consultation with the recipient’s 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 payable to the five most highly-compensated employees, other than restricted stock grants which do not fully vest during the TARP period up to one-third of an employee’s total annual compensation, (ii) prohibitions on golden parachute payments payable to the SEOs and five most highly-compensated employees for departure from a company or upon a change in control, (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 participant’s 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 Company’s Board of Directors has the authority, without any vote of the Company’s shareholders, to issue shares of the Company’s authorized but unissued securities, including common shares authorized and unissued under the Company’s stock option plans or additional shares of preferred stock. In the future, the Company may issue additional securities, through public or private offerings, in order to raise additional capital. It is also possible that the

 

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Company’s 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 Company’s securities.

Increased Likelihood of Class Action Litigation and Additional Regulatory Enforcement

The market price of the Company’s common stock has declined substantially over the past year. This decline could result in shareholder class action lawsuits, such as the securities class actions described in Note 18, “Commitments and Contingencies” in the Consolidated Financial Statements in this Form 10-K, even if the activities subject to complaint are not unlawful, and even if the lawsuits are ultimately unsuccessful. Recent events in financial markets and negative publicity may result in more regulation and legislative scrutiny of the Company’s industry practices and may cause additional exposure to increased shareholder litigation and additional regulatory enforcement actions, which would adversely affect the Company’s business.

Reverse Stock Split

At the Company’s special meeting of shareholders held on September 29, 2009, the Company’s shareholders approved a proposal to effect a reverse stock split of the Company’s common stock by a ratio of not less than one-for-three and not more than one-for-ten, with the exact ratio to be set at a whole number within this range as determined by the Company’s Board of Directors in its sole discretion, and authorized the Board of Directors to effect the reverse stock split at any time prior to August 31, 2010 unless the Company’s Board of Directors elects to abandon the reverse stock split after a determination that it is no longer in the best interests of the Company and its shareholders. Reducing the number of outstanding shares of the Company’s common stock through the reverse stock split is intended, absent other factors, to increase the per share market price of the Company’s common stock. However, other factors, such as the Company’s financial results, market conditions and the market perception of the Company’s business, may adversely affect the market price of the Company’s common stock. As a result, there can be no assurance that the reverse stock split, if completed, will result in making the Company’s common stock more attractive to a broader range of institutional and other investors, that the per share market price of the Company’s common stock will increase following the reverse stock split or that the per share market price of the Company’s common stock will not decrease in the future. Additionally, Management cannot assure shareholders that the per share market price per share of the Company’s common stock after the reverse stock split, if completed, will increase in proportion to the reduction in the number of shares of the Company’s common stock outstanding before the reverse stock split. Accordingly, the total market capitalization of the Company’s common stock after the reverse stock split may be lower than the total market capitalization before the reverse stock split.

Anti-Takeover Provisions

Various provisions of the Company’s articles of incorporation and bylaws could delay or prevent a third-party from acquiring the Company even if doing so might be beneficial to the Company’s shareholders. The Bank Holding Company Act of 1956 (“BHCA”), 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 Company’s 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

 

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industry. The process of recruiting personnel with the combination of skills and attributes required to carry out the Company’s 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 Company’s financial success depends to a significant degree on the Company’s ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel and upon the continued contributions of the Company’s management and personnel. In particular, the Company’s success has been and continues to be highly dependent upon the abilities of key executives, including the Company’s President, and certain other employees.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

The Company is currently reviewing all locations to ensure that the locations leased and owned are fully occupied and that the retail branch locations are consistent with the strategic initiatives of the Company and continue to meet the needs of the Bank’s customers.

The Company’s executive offices are located at 1021 Anacapa Street in Santa Barbara, California. Management is currently in the process of negotiating with the owners of the building for an early termination of the operating lease. In addition, the Company occupies six administrative offices 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. As of December 31, 2008, the Company had five administrative offices for support department operations. The increase in administrative offices in 2009 relates to a loan production office that is currently included as an administrative support office in Monterey County that no longer produces loans. As result, this office is now only used for administrative support and included above.

Of the Company’s 50 locations which collect deposits and provide banking services, 37 are leased and 13 are owned. These 50 locations are located in the Los Angeles, Monterey, San Benito, San Luis Obispo, Santa Barbara, South Santa Clara, Santa Cruz, and Ventura Counties.

As of December 31, 2008, the Company had 51 locations. The activity in 2009 included the closure of the North Lompoc and South Broadway branches and the opening of the retail branch location within a retirement community in Santa Barbara County. In addition, the master lease on a retail shopping center where one of its retail branches is located was assigned in July 2009 as disclosed in Note 14, “Long-Term Debt and Other Borrowings” of the Consolidated Financial Statements. As part of the strategic initiatives discussed above, two retail locations in Buellton and Vandenberg Village are being consolidated into nearby locations and are scheduled to close in April 2010 and two CWMG locations in San Jose and Calabasas were closed in January and February 2010, respectively.

The Company also occupies 13 loan production offices that include administrative support. Of the 13 locations, 11 are leased and two are owned. The offices are located in Santa Barbara, Monterey, San Benito, South Santa Clara, San Diego, San Luis Obispo, 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. Included in these 13 loan offices, are two leases for the offices for the RAL and RT Program operations which have subsequently been assumed by the purchaser as part of the sale of the RAL and RT Programs on January 14, 2010. For more information on the RAL and RT Program sale, refer to Note 26, “Subsequent Events” of the Consolidated Financial

 

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Statements. As of December 31, 2008, the Company had 17 loan production offices that include administrative support. The decrease during 2009 is result of the closing of three offices that were located in Monterey, Orange and Sacramento Counties. Also, as mentioned above, there was one office in Monterey that no longer offers loan products.

In addition, the Company has several locations that are leased and owned for storage, parking and administrative support offices that are vacant and are not included in the numbers disclosed above. The administrative offices consist of a building capital lease in Santa Barbara and a CWMG location in Ventura County, both of which are expected to be occupied in 2010.

 

ITEM 3. LEGAL PROCEEDINGS

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 156. 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 Company’s 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 Company’s financial condition or operating results.

 

ITEM 4. RESERVED

 

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PART II

 

ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

The Company’s 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 Company’s common stock for each quarterly period for the last two years as reported by the NASDAQ Global Select Market:

 

     2009 Quarters    2008 Quarters
     Fourth    Third    Second    First    Fourth    Third    Second    First

Range of stock prices:

                       

High

   $ 1.93    $ 3.37    $ 8.86    $ 17.47    $ 21.42    $ 27.99    $ 24.15    $ 23.50

Low

     0.61      1.44      2.05      5.80      11.25      9.88      13.76      16.08

Dividends

The Company has historically declared cash dividends to its shareholders each quarter. In the second quarter of 2009, the Company’s Board of Directors elected to suspend the payment of cash dividends on its common stock to preserve capital.

The Company’s Board of Directors has the responsibility for oversight and approval for the declaration of dividends and in January 2009, they adopted a new dividend policy to enhance sound capital management and to take into consideration the guidelines required under the TARP CPP. The new policy gives the CFO the responsibility for recommending dividend payments that meet the Company’s and Bank’s capital objectives within the regulatory and statutory limitations. When quarterly dividends are recommended by the CFO, the following items are taken into consideration: the Company’s near and long-term earnings capacity, current and future capital position, the dividend payout ratio, and dividend yield. The new policy also changes the declaration and payment dates for all prospective dividends to be paid on the last business day of each quarter.

The following table presents cash dividends declared per share for the last two years:

 

     2009 Quarters    2008 Quarters
     Fourth    Third    Second    First    Fourth    Third    Second    First

Cash dividends declared:

   $    $    $    $ 0.11    $ 0.22    $ 0.22    $ 0.22    $ 0.22

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 on page 71, Regulation and Supervision discussion of “Dividends and Other Transfer of Funds” on page 82 and on page 161, Note 20, “Regulatory Capital Requirements” of the Consolidated Financial Statements.

Holders

There were approximately 13,358 shareholders of record at December 31, 2009. 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 29.7% of the Company’s shares are owned by these institutions. These institutions may be investing for their own accounts or acting as investment managers for other investors.

 

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Stock Performance

The following graph shows a five year comparison of cumulative total returns for the Company’s common stock, the Standard & Poor’s 500 stock Index and the NASDAQ Bank Index, each of which assumes an initial value of $100 and reinvestment of dividends.

LOGO

Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information at December 31, 2009 with respect to shares of Company common stock that may be issued under the Company’s existing equity compensation plans.

 

December 31, 2009

Plan category

   Number of
securities to be
issued upon
exercise of
outstanding
options,
warrants and
rights (a)
   Weighted-average
exercise price of
outstanding
options, warrants
and rights (b)
   Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in
column (a)) (c)

Equity compensation plans approved by security holders

   1,589,168    $ 24.12    2,259,663

Equity compensation plans not approved by security holders

          
                

Total

   1,589,168    $ 24.12    2,259,663
                

 

(a) Included in column (a) are unexercised stock options granted to directors and employees through current and expired option plans. This amount includes shares of unvested restricted stock.
(b) This is the weighted-average exercise price of all stock options and restricted stock that is outstanding at December 31, 2009.
(c) Securities remaining available for future issuance are for the 2008 Equity Incentive Plan.

 

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ITEM 6. SELECTED FINANCIAL DATA

The following table compares selected financial data for 2009 with the same data for the four prior years. The Company’s Consolidated Financial Statements and the accompanying notes are presented in Item 8 and MD&A 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.

 

     Year Ended December 31,  
             2009               2008               2007               2006                   2005      
     (dollars and share amounts in thousands, except per share amounts)  

RESULTS OF OPERATIONS:

          

Interest income

   $ 505,516      $ 519,333      $ 583,609      $ 564,526      $ 426,157   

Interest expense

     (165,252     (178,819     (222,411     (190,767     (111,505
                                        

Net interest income

     340,264        340,514        361,198        373,759        314,652   

Provision for loan losses

     (426,936     (218,335     (113,272     (64,693     (53,873

Non-interest income

     135,124        175,946        184,507        153,327        111,898   

Non-interest expense

     (462,876     (339,445     (275,360     (314,983     (214,380
                                        

(Loss)/income before taxes

     (414,424     (41,320     157,073        147,410        158,297   

Provision/(benefit) for income taxes

     6,837        (18,570     56,185        52,870        59,012   
                                        

Net (loss)/income

     (421,261     (22,750     100,888        94,540        99,285   
                                        

Dividends and accretion of preferred stock

     9,996        1,094                        
                                        

Net (loss)/income applicable to common shareholders

   $ (431,257   $ (23,844   $ 100,888      $ 94,540      $ 99,285   
                                        

PER SHARE DATA:

          

Average number of common shares - basic

     46,693        46,273        46,816        46,770        45,964   

Average number of common shares - diluted

     47,197        46,644        47,082        47,099        46,358   

(Loss)/ income applicable per common share - diluted (1)

   $ (9.24   $ (0.52   $ 2.14      $ 2.01      $ 2.14   

Book value per common share

   $ 4.02      $ 13.14      $ 14.49      $ 13.17      $ 11.69   

BALANCE SHEET:

          

Total loans

   $ 5,166,431      $ 5,764,856      $ 5,359,155      $ 5,720,847      $ 4,898,381   

Total assets

   $ 7,542,255      $ 9,573,020      $ 7,374,115      $ 7,490,435      $ 6,871,445   

Total deposits

   $ 5,446,194      $ 6,588,702      $ 4,963,581      $ 5,045,847      $ 5,016,915   

Long-term debt (2)

   $ 1,311,828      $ 1,740,240      $ 1,405,602      $ 1,401,172      $ 803,212   

Total shareholders’ equity

   $ 364,603      $ 788,437      $ 668,356      $ 617,376      $ 545,256   

OPERATING AND CAPITAL RATIOS:

          

Leverage ratio

     7.0     9.2     8.8     8.3     8.1

Return on average total assets

     n/a        n/a        1.4     1.3     1.6

Return on average total shareholder’s equity

     n/a        n/a        15.3     16.0     19.2

Tier 1 capital to Average Tangible Assets ratio

     5.3     8.8     8.0     7.5     6.6

Tier 1 capital to Risk Weighted Assets ratio

     7.8     11.8     9.7     8.8     8.0

Total Tier 1 & Tier 2 Capital to Risk Weighted Assets ratio

     10.4     14.6     12.3     11.7     11.3

Dividend payout ratio

     n/a        n/a        41.1     43.8     36.4

 

(1) (Loss)/income per diluted common share for the years ended December 31, 2009 and 2008 is calculated using basic weighted average shares outstanding.
(2) Includes obligations under capital lease.

 

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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FINANCIAL OVERVIEW AND HIGHLIGHTS

The following discussion should be read in conjunction with the Company’s financial statements and the related notes provided under “Item 8—Consolidated Financial Statements and Supplementary Data.”

FINANCIAL RESULTS OF 2009

Net loss for the Company was $421.3 million or $431.3 million of net loss applicable to common shareholders for 2009 compared to a net loss of $22.8 million or $23.8 million of net loss applicable to common shareholders for 2008. The loss for 2009 was $9.24 per diluted common share compared to $0.52 per diluted common share for 2008. Net loss applicable to common shareholders increased by $407.4 million for the year ended December 31, 2009 compared to 2008.

The significant factors impacting the net loss for the Company during 2009 were:

 

  ¡  

The continued deterioration of the economy caused a decline in asset quality, evidenced by increased net charge-offs of $293.4 million and an increase in non-performing loans of $163.4 million; this decline required an increase in the allowance for loan losses to 5.26% of total loans at December 31, 2009 to adequately provide for Management’s estimate of losses inherent in the loan portfolios;

 

  ¡  

Increased losses and funding costs for the 2009 RAL season;

 

  ¡  

A goodwill impairment charge of $128.7 million was recognized in the second quarter of 2009; and

 

  ¡  

Established a valuation allowance of $145.9 million against the Company’s deferred tax assets.

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 Company’s overall comparative performance for the year ended December 31, 2009 throughout the analysis sections of this report.

FINANCIAL RESULTS OF 2008

Net loss for the Company was $22.8 million or $23.8 million of net loss applicable to common shareholders compared to net income of $100.9 million for 2007. The net loss for 2008 was $0.52 per diluted common share compared to net income of $2.14 per diluted common share for 2007. Net income decreased $123.6 million for fiscal year 2008 compared to 2007.

The significant factors impacting the net loss for the Company during 2008 were:

 

  ¡  

Provision for loan losses of $218.3 million due to the downturn in the economy, which served to i) increase allowance to total loans from 83 basis points to 244 basis points during the year, and ii) cover approximately $121 million in loan net charge-offs or write downs during the year;

 

  ¡  

A 400 basis point decrease in the Federal Open Market Committee of the Federal Reserve System (“FOMC”)’s Federal funds interest rate decreasing from 4.25% at December 31, 2007 to 0.25% at December 31, 2008, which contributed to a decline in the net interest margin from 5.24% at December 31, 2007 to 4.81% at December 31, 2008;

 

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  ¡  

Increased volumes in the RAL and RT Programs products which increased profitability in this segment from $47.1 million of income before tax for the year ended December 31, 2007 to $118.0 million before tax for the year ended December 31, 2008; and

 

  ¡  

A goodwill impairment charge of $22.1 million was recognized in the third quarter of 2008.

FINANCIAL RESULTS OF 2007

The significant factors impacting earnings of the Company during 2007 were:

 

  ¡  

During 2007 the Company implemented strategic balance sheet initiatives which included the sale of its $254.0 million leasing loan portfolio, $221.8 million of its indirect auto loan portfolio and a conversion of $284.5 million of residential real estate loans to securities. Despite these transactions, interest income from loans increased $23.9 million, or 4.7% for 2007 compared to 2006. This increase was primarily due to strong loan growth.

 

  ¡  

Increased cost of funds which resulted in a $31.6 million increase in interest expense for 2007 compared to 2006.

 

  ¡  

A $55.3 million increase in net loan losses related to the RAL program for 2007 compared to 2006 due to increased tax fraud.

 

  ¡  

A 100 basis point decrease in the FOMC’s target Federal funds rate from 5.25% to 4.25%, the combination of a flattening, and even inverted, yield curve and intense competition for both loans and deposits continued to compress interest margins, which resulted in a decline in net interest margin to 5.24% from 5.76%.

 

  ¡  

Company wide efforts to control expenses while striving to improve service levels to customers, which resulted in improvement in the Company’s efficiency ratio to 49.91% for 2007 from 58.13% for the year ended December 31, 2006.

 

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RESULTS OF OPERATIONS

INTEREST INCOME

The Company’s 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, 2009, 2008 and 2007:

 

     Year Ended December 31,
     2009    2008    2007
     (in thousands)

Interest income:

        

Loans:

        

Commercial loans

   $ 49,778    $ 73,604    $ 91,849

Consumer loans

     31,923      39,804      59,253

Tax refund loans (“RALs”)

     151,611      108,762      117,749

Leasing loans

               12,642

Real estate loans - commercial

     158,558      167,951      172,336

Real estate loans - residential

     62,723      67,904      78,127

Other loans

     75      175      233
                    

Total

     454,668      458,200      532,189
                    

Investment securities - trading

     5,131      6,833     

Investment securities - available for sale:

        

U.S. treasury securities

     530      1,142      1,863

U.S. agencies

     16,362      20,168      17,825

Asset-backed securities

     139      141      162

Commercial mortgage obligations (“CMO”) and mortgage backed securities (“MBS”)

     10,937      16,448      17,520

State and municipal securities

     14,791      13,276      11,197
                    

Total

     42,759      51,175      48,567
                    

Commercial paper

          622     

Interest on deposits in other banks

     2,957      702     

Federal funds sold and securities purchased under agreements to resell

     1      1,801      2,853
                    

Total interest income

   $ 505,516    $ 519,333    $ 583,609
                    

 

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    Change 2009 with 2008     Change 2008 with 2007  
    $     %     $     %  
    (dollars in thousands)  

Loans:

       

Commercial loans

  $ (23,826   (32.4 )%    $ (18,245   (19.9 )% 

Consumer loans

    (7,881   (19.8 )%      (19,449   (32.8 )% 

Tax refund loans (“RALs”)

    42,849      39.4     (8,987   (7.6 )% 

Leasing loans

                (12,642   (100.0 )% 

Real estate loans - commercial

    (9,393   (5.6 )%      (4,385   (2.5 )% 

Real estate loans - residential

    (5,181   (7.6 )%      (10,223   (13.1 )% 

Other loans

    (100   (57.1 )%      (58   (24.9 )% 
                           

Total

    (3,532   (0.8 )%      (73,989   (13.9 )% 
                           

Investment securities - trading:

    (1,702   (24.9 )%      6,833        

Investment securities - available for sale:

       

U.S. treasury securities

    (612   (53.6 )%      (721   (38.7 )% 

U.S. agencies

    (3,806   (18.9 )%      2,343      13.1

Asset-backed securities

    (2   (1.4 )%      (21   (13.0 )% 

CMO’s and MBS

    (5,511   (33.5 )%      (1,072   (6.1 )% 

State and municipal securities

    1,515      11.4     2,079      18.6
                           

Total

    (8,416   (16.4 )%      2,608      5.4
                           

Commercial paper

    (622   (100.0 )%      622        

Interest on deposits in other banks

    2,255      321.2     702        

Federal funds sold and securities purchased under agreements to resell

    (1,800   (99.9 )%      (1,052   (36.9 )% 
                           

Total interest income

  $ (13,817   (2.7 )%    $ (64,276   (11.0 )% 
                           

Interest income for the year ended December 31, 2009 was $505.5 million, a decrease of $13.8 million or 2.7% when comparing interest income for the year-ended December 31, 2009 to 2008. The very large increase in interest income from RALs is due to the lack of a securitization funding vehicle in 2009. Rather than recognizing a large gain from the sale of RALs to the securitization participants as in 2008 and 2007, the Bank kept all of the RALs on its balance sheet and all income was recognized as interest income. This large increase in interest income for RALs offset most of a $46.4 million decline in interest income from all other loans compared to 2008. The decrease in interest income from non-RAL loans (also termed “Core Bank” loans) is due to an increase in net charge-offs of $119.1 million, an increase in non-performing loans of $163.4 million and the sale of $401.3 million of loans from the held for investment loan portfolio during 2009. A majority of the non-performing loans are on non-accrual status which means interest income is not getting accrued or paid on those loans. The increase in non-performing loans is mostly in the commercial and commercial real estate secured portfolios which had an increase of $146.0 million for the comparable year to date periods ended December 31, 2009 to 2008. In addition, many of the commercial and commercial real estate loans have adjustable rates which decreased to historically low levels during most of 2009. For additional detailed information on loan sales refer to Note 6, “Loans Sales and Transactions” of the Consolidated Financial Statements. In addition, many of the Bank’s loans have adjustable interest rates and since interest rates remained low throughout 2009, this also impacted interest income in 2009.

Some of the decrease in interest income was also attributable to a decrease in interest income on investment securities. This decrease was mostly due to lower market interest rates on purchased investment securities as Management invested in lower risk and more liquid securities.

 

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Interest income by operating segment for the year-ended 2009 compared to 2008 decreased for all operating segments except the RAL and RT Programs. The largest decrease in interest income was in the CWMG segment with a decrease of $27.0 million while the Community Banking segment decreased by $19.4 million. This decrease was primarily caused by increases in non-performing loans and net charge-offs as well as loan sales throughout 2009 as discussed above. As discussed above the increase in interest income from RALs is attributed to funding all RALs on balance sheet and, not utilizing the securitization facility for the funding of RALs in 2009.

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 the year-ended December 31, 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 most the loan portfolio, except RALs. The increase in non-accrual loans also contributed to the decrease of interest income for loans. Commercial and consumer loans accounted for $37.7 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. The Company also 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 $44.4 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 EXPENSE

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, 2009, 2008 and 2007:

 

     Year Ended December 31,
     2009    2008    2007
     (in thousands)

Interest expense:

        

Deposits:

        

Negotiable Order of Withdrawal (“NOW”) accounts

   $ 6,015    $ 10,267    $ 24,577

Money market deposit accounts

     4,931      11,824      26,525

Savings deposits

     2,842      1,885      3,300

Time certificates of deposits

     81,237      67,446      75,326
                    

Total

     95,025      91,422      129,728
                    

Securities sold under agreements to repurchase and federal funds purchased

     10,135      13,076      17,997

Long-term debt and other borrowings:

        

FHLB advances

     58,885      73,740      74,119

Other borrowings

     1,207      581      567
                    

Total

     60,092      74,321      74,686
                    

Total interest expense

   $ 165,252    $ 178,819    $ 222,411
                    

 

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     Change 2009 with 2008     Change 2008 with 2007  
     $     %     $     %  
     (dollars in thousands)  

Deposits:

        

NOW accounts

   $ (4,252   (41.4 )%    $ (14,310   (58.2 )% 

Money market deposit accounts

     (6,893   (58.3 )%      (14,701   (55.4 )% 

Savings deposits

     957      50.8     (1,415   (42.9 )% 

Time certificates of deposits

     13,791      20.4     (7,880   (10.5 )% 
                            

Total

     3,603      3.9     (38,306   (29.5 )% 
                            

Securities sold under agreements to repurchase and federal funds purchased

     (2,941   (22.5 )%      (4,921   (27.3 )% 

Long-term debt and other borrowings:

        

FHLB advances

     (14,855   (20.1 )%      (379   (0.5 )% 

Other borrowings

     626      107.7     14      2.5
                            

Total

     (14,229   (19.1 )%      (365   (0.5 )% 
                            

Total interest expense

   $ (13,567   (7.6 )%    $ (43,592   (19.6 )% 
                            

Interest expense in 2009 was $165.3 million, a decrease of $13.6 million or 7.6% when compared to 2008. This decrease is mostly attributable to the FOMC keeping interest rates low throughout 2009. The decrease in interest expense on long-term debt and other borrowings was also impacted by the prepayment of many high interest rate FHLB advances during 2009. Interest paid on deposits increased by $3.6 million. While the Bank was able to retain and grow transactional types of deposit accounts during 2009, most of the increase in deposit interest expense was due to the growth in brokered certificate of deposits (“brokered CDs”) which were used to fund RALs in the first quarter of 2009 and, then, in the latter part of 2009, used again to build liquidity for the Company.

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 between year-end 2007 and year-end 2008. This decrease 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 compared to the year ending December 31, 2008 to 2007.

 

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NET INTEREST MARGIN

The following tables set forth the average balances and interest income and interest expense for the previous three years.

 

     For the Twelve-Months Ended December 31,  
     2009     2008  
     Average
Balance
   Income    Rate     Average
Balance
   Income    Rate  
     (dollars in thousands)  

Assets:

                

Commercial Paper

   $    $         $ 22,807    $ 622    2.73

Interest-bearing demand deposits in other financial institutions

     1,076,398      2,957    0.27     152,625      707    0.46

Federal funds sold

     329      1    0.30     71,652      1,796    2.51
                                

Total money market instruments

     1,076,727      2,958    0.27     247,084      3,125    1.26
                                

Securities: (1)

                

Taxable

     941,122      33,099    3.52     947,490      44,732    4.72

Non-taxable (3)

     293,018      14,791    5.05     257,959      13,276    5.15
                                

Total securities

     1,234,140      47,890    3.88     1,205,449      58,008    4.81
                                

Loans: (2)

                

Commercial

     1,088,847      49,778    4.57     1,188,286      73,604    6.19

Real estate - multi family & commercial

     2,785,416      158,558    5.69     2,710,110      167,951    6.20

Real estate - residential 1 - 4 family

     1,077,126      62,723    5.82     1,137,321      67,904    5.97

Consumer

     706,219      183,534    25.99     714,497      148,566    20.79

Other

     9,842      75    0.76     11,427      175    1.53
                                

Total loans, net

     5,667,450      454,668    8.02     5,761,641      458,200    7.95
                                

Total interest-earning assets

     7,978,317      505,516    6.33     7,214,174      519,333    7.20
                                

Market value adjustment

     33,035           20,131      

Non-interest-earning assets

     599,313           636,499      
                        

Total assets

   $ 8,610,665         $ 7,870,804      
                        

Liabilities and shareholders’ equity:

                

Interest-bearing deposits:

                

Savings and interest-bearing transaction accounts

   $ 1,849,044      13,788    0.75   $ 1,981,853      23,976    1.21

Time certificates of deposit

     2,988,218      81,237    2.72     2,045,676      67,446    3.30
                                

Total interest-bearing deposits

     4,837,262      95,025    1.97     4,027,529      91,422    2.27
                                

Borrowed funds:

                

Securities sold under agreements to repurchase and Federal funds purchased

     336,982      10,135    3.01     394,410      13,076    3.32

Other borrowings

     1,487,715      60,092    4.04     1,523,802      74,321    4.88
                                

Total borrowed funds

     1,824,697      70,227    3.85     1,918,212      87,397    4.56
                                

Total interest-bearing liabilities

     6,661,959      165,252    2.48     5,945,741      178,819    3.01
                                

Non-interest-bearing demand deposits

     1,233,281           1,094,126      

Other liabilities

     115,427           103,639      

Shareholders’ equity

     599,998           727,298      
                        

Total liabilities and shareholders’ equity

   $ 8,610,665         $ 7,870,804      
                                        

Net interest income/margin

      $ 340,264    4.26      $ 340,514    4.72
                                

Loans, Core Bank

   $ 5,592,735    $ 303,057    5.42   $ 5,658,974    $ 349,438    6.17

Consumer loans, Core Bank

   $ 632,350    $ 31,923    5.05   $ 611,830    $ 39,804    6.51

 

(1) Average securities balances are based on amortized historical cost. The adjustments for the fair values are reported as “Market value adjustment.”
(2) Non-accrual loans are included in loan balances. Interest income includes related fee income.
(3) Because of the Company’s tax position, the yield on tax exempt investments is not reported on a tax equivalent basis.

 

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     For the Twelve-Months Ended December 31,  
     2007  
     Average
Balance
   Income    Rate  
     (dollars in thousands)  

Assets:

        

Commercial Paper

   $    $      

Interest-bearing demand deposits in other financial institutions

     1,480           

Federal funds sold

     52,876      2,853    5.40
                

Total money market instruments

     54,356      2,853    5.25
                

Securities: (1)

        

Taxable

     801,248      37,370    4.66

Non-taxable (3)

     208,193      11,197    5.38
                

Total securities

     1,009,441      48,567    4.81
                

Loans: (2)

        

Commercial

     1,205,689      104,491    8.67

Real estate - multi family & commercial

     2,366,331      172,336    7.28

Real estate - residential 1 - 4 family

     1,329,433      78,127    5.88

Consumer

     1,005,943      177,002    17.60

Other

     13,316      233    1.75
                

Total loans, net

     5,920,712      532,189    8.99
                

Total interest-earning assets

     6,984,509      583,609    8.36
                

Market value adjustment

     19,418      

Non-interest-earning assets

     488,019      
            

Total assets

   $ 7,491,946      
            

Liabilities and shareholders’ equity:

        

Interest-bearing deposits:

        

Savings and interest-bearing transaction accounts

   $ 2,149,706      54,402    2.53

Time certificates of deposit

     1,702,288      75,326    4.42
                

Total interest-bearing deposits

     3,851,994      129,728    3.37
                

Borrowed funds:

        

Securities sold under agreements to repurchase and Federal funds purchased

     360,622      17,997    4.99

Other borrowings

     1,409,452      74,686    5.30
                

Total borrowed funds

     1,770,074      92,683    5.24
                

Total interest-bearing liabilities

     5,622,068      222,411    3.96
                

Non-interest-bearing demand deposits

     1,115,302      

Other liabilities

     96,909      

Shareholders’ equity

     657,667      
            

Total liabilities and shareholders’ equity

   $ 7,491,946      
                    

Net interest income/margin

      $ 361,198    5.17
                

Loans, Core Bank

   $ 5,592,968    $ 414,440    7.41

Consumer loans, Core Bank

   $ 678,199    $ 59,253    8.74

 

(1) Average securities balances are based on amortized historical cost. The adjustments for the fair values are reported as “Market value adjustment.”
(2) Non-accrual loans are included in loan balances. Interest income includes related fee income.
(3) Because of the Company’s tax position, the yield on tax exempt investments is not reported on a tax equivalent basis.

 

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The following table set forth the change in average balances and interest income and interest expense for the last three years.

 

     Year Ended December 31,  
     2009 versus 2008     2008 versus 2007  
     (in thousands)  
     Change due to     Total
Change
    Change due to     Total
Change
 
     Rate     Volume       Rate     Volume    

Assets:

            

Commercial Paper

   $ (311   $ (311   $ (622   $      $ 622      $ 622   

Interest-bearing demand deposits in other financial institutions

     (399     2,649        2,250        7        700        707   

Federal funds sold

     (843     (952     (1,795     (1,854     797        (1,057

Securities:

            

Taxable

     (11,333     (300     (11,633     485        6,877        7,362   

Non-taxable

     (262     1,777        1,515        (497     2,576        2,079   
                                                

Total securities

     (11,595     1,477        (10,118     (12     9,453        9,441   

Loans:

            

Commercial

     (18,054     (5,772     (23,826     (29,403     (1,484     (30,887

Real estate - multi family & commercial

     (14,001     4,608        (9,393     (27,504     23,119        (4,385

Real estate - residential 1 - 4 family

     (1,668     (3,513     (5,181     1,184        (11,407     (10,223

Consumer

     36,710        (1,742     34,968        28,538        (56,974     (28,436

Other

     (79     (21     (100     (27     (31     (58
                                                

Total loans

     2,908        (6,440     (3,532     (27,212     (46,777     (73,989
                                                

Total interest-earning assets

   $ (10,240   $ (3,577   $ (13,817   $ (29,071   $ (35,205   $ (64,276
                                                

Liabilities:

            

Interest-bearing deposits:

            

Savings and interest-bearing transaction accounts

     (8,661     (1,527     (10,188     (26,465     (3,961     (30,426

Time certificates of deposit

     (13,369     27,160        13,791        (21,289     13,409        (7,880
                                                
     (22,030     25,633        3,603        (47,754     9,448        (38,306
                                                

Borrowed funds:

            

Securities sold under agreements to repurchase and Federal funds purchased

     (1,149     (1,792     (2,941     (6,479     1,558        (4,921

Other borrowings

     (12,508     (1,721     (14,229     (6,170     5,805        (365
                                                

Total borrowed funds

     (13,657     (3,513     (17,170     (12,649     7,363        (5,286
                                                

Total interest bearing liabilities

     (35,687     22,120        (13,567     (60,403     16,811        (43,592
                                                

Net interest income

   $ 25,447      $ (25,697   $ (250   $ 31,332      $ (52,016   $ (20,684
                                                

Consumer loans, Core Bank

   $ (42,307   $ (4,074   $ (46,381   $ (69,857   $ 4,855      $ (65,002

Loans, Core Bank

   $ (9,180   $ 1,299      $ (7,881   $ (14,057   $ (5,392   $ (19,449

The net interest margin decreased to 4.26% for the year ended December 31, 2009 from 4.72% for the year ended December 31, 2008. This decrease was driven by several factors. The first is a continued decrease in interest rates from 2008. The FOMC’s average interest rate in 2009 was at a range of 0% – .25% compared to an average interest rate of 2.09% during 2008. The interest rate on interest bearing assets decreased by 87 basis points when comparing the average interest rate in 2009 to 2008 which was mostly due to a decrease in interest rates from investment securities which decreased 93 basis points. This decrease would have been larger had the Company been able to utilize a securitization vehicle for funding RALs, because much of the RAL interest income would instead have been recognized as a gain on sale. As discussed in the interest income section above, the decrease in net interest margin was also impacted by the increase in non-performing loans which decreased interest income while the average balance for the non-performing balance remained on the balance sheet. Interest rates on Core Bank loans decreased by 75 basis points for the comparable twelve

 

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month periods ended December 31, 2009 and 2008. This decrease was due to the large number of loans that have an adjustable interest rate that is tied to the prime rate which decreased when the FOMC decreased interest rates or when other adjustable rate loans reset with their index during 2009. The decrease in interest rates also benefited the Company from an interest bearing liability perspective. Interest rates paid on interest bearing liabilities decreased by 53 basis points. Interest rates on borrowings decreased by 71 basis points which significantly reduced the borrowing expenses for the year ended December 31, 2009.

The net interest margin decreased to 4.72% for the year ended December 31, 2008 from 5.17% for the year ended December 31, 2007. This decrease was driven by the FOMC’s 400 basis point decrease in the Federal funds rate during 2008. The FOMC rate decrease primarily impacted the interest-bearing liabilities which decreased by 95 basis points and Core Bank loans which decreased by 124 basis points.

PROVISION FOR LOAN LOSSES

Quarterly, the Company determines the amount of allowance for loan losses (“ALL”) that is adequate to provide for losses inherent in the Company’s loan portfolios. The provision for loan losses is determined by the net change in the ALL from one period to another. For a detailed discussion of the Company’s ALL, refer to the allowance for loan loss section of this document which starts on page 58 and the “Critical Accounting Policies” section starting on page 77 of this MD&A section of this Form 10-K and within the Consolidated Financial Statements of this Form 10-K in Note 1, “Summary of Significant Accounting Policies” and in Note 8, “Allowance for Loan Losses”.

A summary of the provision for loan losses for the comparable years ended December 31, 2009 and 2008 are as follows:

 

     Year Ended December 31,  
     2009    2008    Change  
         $    %  
     (dollars in thousands)  

Provision for loan losses:

           

Core Bank

   $ 352,398    $ 196,567    $ 155,831    79.3

RAL

     74,538      21,768      52,770    242.4
                           

Total

   $ 426,936    $ 218,335    $ 208,601    95.5
                           

Provision for loan losses was $426.9 million for the year ended December 31, 2009 compared to $218.3 million for the year ended December 31, 2008, an increase of $208.6 million. This 95.5% increase in provision for loan losses is mostly attributable to the Core Bank which increased $155.8 million while the RAL provision for loan losses increased by $52.8 million.

The provision for loan losses for the Core Bank’s loan portfolio was $352.4 million for the twelve-month period ended December 31, 2009, an increase of $155.8 million compared to the same period in 2008. This increase was attributed to increased charge-offs, non-performing loans, and an unstable economic environment throughout 2009 which reduced collateral values and caused an increase in unemployment and thereby impacted borrowers’ ability to make payments on their loans. The Core Bank had net loan charge-offs of $218.8 million during 2009 compared to $99.7 million during 2008, an increase of $119.1 million. The Core Bank’s non-performing loans have increased to $397.8 million, an increase of $163.4 million since December 31, 2008.

 

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As with most financial institutions, one of the factors used by the Bank in determining the adequacy of the ALL for large pools of similar loans is to estimate future loss rates based on historical loss rates for the various portfolios. In 2008 and 2007, the Bank had used a “look-back” of seven years. Credit losses had been sufficiently low in the preceding years that the Management thought it prudent to use that long a period so as to include some years when loss rates were higher than they had been in recent years. In the second quarter of 2009, Management shortened the period to six quarters so as to give more emphasis or weighting to the higher losses recently incurred, including the elevated charge-offs of the first two quarters of 2009, and eliminate those earlier years with lower credit losses. This resulted in a substantial increase in the allowance and the provision for loan losses. Of the $352.4 million of provision expense for the Core Bank, $276.7 million were from the CWMG segment and, $75.7 million were from the Community Banking segment.

In addition, the 2009 RAL Program experienced higher than anticipated loan losses which required an increased provision for RALs of $74.5 million for the twelve-month period ended December 31, 2009, an increase of $52.8 million from the comparable period ended December 31, 2008. The increase in RAL provision for loan losses is attributed to the first few weeks of the RAL season due to an expanded number of tax refunds under review by the IRS for further documentation. RAL management detected the changes in the IRS payment patterns and adjusted the RAL underwriting criteria to reflect the IRS change in payment. The held back tax returns resulted in more charged-off RALs as many of these RALs were outstanding for more than 60 days, and were required by Company policy to be charged-off. The RAL provision was also impacted by the inability to set-up a securitization facility which had accounted for $14.9 million of provision for loan losses as an offset within the gain on sale of RAL calculation in the first quarter of 2008. The activity for RALs is reported in the RAL and RT Programs segment.

A summary of the provision for loan losses for the comparable years ended December 31, 2008 and 2007 are as follows:

 

     Year Ended December 31,  
     2008    2007    Change  
         $     %  
     (dollars in thousands)  

Provision for loan losses:

          

Core Bank

   $ 196,567    $ 21,314    $ 175,253      822.2

RAL

     21,768      91,958      (70,190   (76.3 )% 
                            

Total

   $ 218,335    $ 113,272    $ 105,063      92.8
                            

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 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 non-accrual loans of $148.2 million since December 31, 2007. A majority of the increase in net charge-offs and non-accrual 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, the Bank had net RAL 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 CWMG segment’s provision for loan losses was $144.0 million, an increase of $134.8 million when comparing the year ended December 31, 2008 to 2007. The CWMG segment holds a majority of the construction loan portfolio causing this increase.

 

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NON-INTEREST INCOME

Non-interest income primarily consists of fee income received from the operations of the Bank. Fee income is generated by servicing deposit relationships, trust and investment advisory fees, RT fees earned from processing tax refunds and fees and commissions earned on certain transactions from Bank operations. The treasury department of the Bank manages the investment securities portfolio. All unrealized gains and losses on the trading portfolio, impairment of available-for-sale (“AFS”) mortgage backed securities and realized gains and losses on sold and called securities are reported as gains and losses on securities. The gains and losses on loan sales are included within the “Other” line item in the table below.

The following tables present a summary of non-interest income and the related changes between the periods presented:

 

     Year Ended December 31,  
     2009    2008     2007  
     (in thousands)  

Non-interest income:

       

Refund transfer fees

   $ 68,315    $ 68,731      $ 45,984   

Gain on sale of RALs, net

          44,580        41,822   

Service charges

     15,270      17,607        17,686   

Other service charges, commissions and fees

     16,845      17,227        24,957   

Trust and investment advisory fees

     21,247      25,175        23,852   

Gain on leasing portfolio sale, net

                 24,344   

Gain/(loss) on securities, net

     10,970      (3,346     (1,106

Other

     2,477      5,972        6,968   
                       

Total non-interest income

   $ 135,124    $ 175,946      $ 184,507   
                       

 

     Change 2009 with 2008     Change 2008 with 2007  
     $     %     $     %  
     (dollars in thousands)  

Refund transfer fees

   $ (416   (0.6 )%    $ 22,747      49.5

Gain on sale of RALs, net

     (44,580   (100.0 )%      2,758      6.6

Service charges

     (2,337   (13.3 )%      (79   (0.4 )% 

Other service charges, commissions and fees

     (382   (2.2 )%      (7,730   (31.0 )% 

Trust and investment advisory fees

     (3,928   (15.6 )%      1,323      5.5

Gain on leasing portfolio sale, net

                 (24,344   (100.0 )% 

Gain/(loss) on securities, net

     14,316      (427.9 )%      (2,240   202.5

Other

     (3,495   (58.5 )%      (996   (14.3 )% 
                            

Total non-interest income

   $ (40,822   (23.2 )%    $ (8,561   (4.6 )% 
                            

Total non-interest income was $135.1 million for the year ended December 31, 2009 compared to $175.9 million for the same period in 2008, a decrease of $40.8 million or 23.2%. This decrease was primarily due to the inability to set-up the securitization facility for the selling of RALs in 2009 which generated a gain on sale of $44.6 million in 2008. As explained in the section above on Interest Income, this change in the funding arrangements resulted in much more of the RAL-related income being recognized as interest income in 2009. Excluding the impact of the different reporting for the gain on sale of RALs, non-interest income increased $3.8 million. This increase is mostly attributed to the gain on sale of securities of $11.0 million.

 

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Total non-interest income was $175.9 million for the year ended December 31, 2008 compared to $184.5 million for the same period in 2007, a decrease of $8.6 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 line item is presented below.

Refund transfer fees

RT fees totaled $68.3 million for the year ended December 31, 2009 compared to $68.7 million in 2008 and $46.0 million in 2007. The number of RT transactions in 2009 increased by 185,000 or 2.9% when comparing the activity for 2009 to 2008, but the fee collected per a transaction decreased, causing the slight decrease in RT fees in 2009. 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 causing the significant increase in RT fees in 2008. 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, an RT is offered to the taxpayer. The Company sold the RAL and RT Programs on January 14, 2010 as disclosed in Note 26, “Subsequent Events” of the Consolidated Financial Statements.

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, 2009, 2008 and 2007:

 

     Year Ended December 31,  
     2009    2008     2007  
     (in thousands)  

Securitized loan fees

   $    $ 64,123      $ 59,969   

Investor securitization costs

          (2,309     (2,383

Commitment fees

          (2,320     (1,575

Credit losses, net

          (14,914     (14,189
                       

Net gain on sale

   $    $ 44,580      $ 41,822   
                       

The Company recorded a net gain on sale of tax refund loans of $44.6 million and $41.8 million for the years ended December 31, 2008 and 2007, 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.

Management was not able to set-up a securitization facility for the 2009 RAL season due to the economic conditions and credit crisis. The securitization used in prior years removed securitized RALs from the Bank’s balance sheet which helped maintain capital ratios at an adequately capitalized level. In preparation for the 2009 RAL season and to replace the unavailability of a securitization facility, the Bank raised $1.28 billion through wholesale funding sources, brokered CDs and entered into a syndicated funding line of $524 million which was drawn upon as needed throughout the RAL season.

The securitization capacity was $1.60 billion in 2008 compared to $1.50 billion in 2007. The capacity had increased over the last few years to accommodate the annual increase in RAL balances each year. All loans sold into the securitization were 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 were reported in the balance sheet

 

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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.

As noted above, the Company sold the RAL and RT Programs on January 14, 2010 as disclosed in Note 26, “Subsequent Events” of the Consolidated Financial Statements.

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.

Gain/(loss) on securities, net

Gain on securities, net consists of realized gains on securities sold or called net of losses on securities sold or called plus any impairment charge for investments other than temporarily impaired. For the year ended December 31, 2009, there was a net gain of $11.0 million compared to a net loss on securities of $3.3 million for the year ended December 31, 2008. The increase in the gain on securities was attributed to the gain on sale of $3.9 million of U.S. Agency securities and $6.9 million of municipal bonds during the fourth quarter of 2009. These securities were sold due to the large gains that were available due to the market conditions at the time the decision to sell these securities were made. The decision to sell was primarily taken to generate income to offset the credit losses expected to be taken so as to maintain capital levels.

The net loss on securities 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 other than temporary impairment of MBS held in the AFS portfolio of $2.8 million and realized losses of $4.9 million on the future positions held resulting from declining interest rates as described in Note 22, “Derivative Instruments” 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.

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.

Gain/(loss) on sale of loans

Discussion regarding the sale and transfer of loans during 2009, 2008 and 2007 are in Note 6, “Loan Sales and Transactions” of the Consolidated Financial Statements.

 

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NON-INTEREST EXPENSES

The following tables present a summary of non-interest expense and the related changes between the periods presented:

 

     Year Ended December 31,
     2009    2008    2007
     (in thousands)

Non-interest expense:

        

Goodwill impairment

   $ 128,710    $ 22,068    $

Salaries and benefits

     116,814      125,474      122,044

Refund program fees

     47,428      58,378      50,919

Occupancy expense, net

     27,681      26,715      22,875

Furniture, fixtures and equipment, net

     7,928      8,853      9,551

Other

     134,315      97,957      69,971
                    

Total non-interest expense

   $ 462,876    $ 339,445    $ 275,360
                    

 

     Change 2009 with 2008     Change 2008 with 2007  
     $     %     $     %  
     (dollars in thousands)  

Goodwill impairment

   $ 106,642      483.2   $ 22,068        

Salaries and benefits

     (8,660   (6.9 )%      3,430      2.8

Refund program fees

     (10,950   (18.8 )%      7,459      14.6

Occupancy expense, net

     966      3.6     3,840      16.8

Furniture, fixtures and equipment, net

     (925   (10.4 )%      (698   (7.3 )% 

Other

     36,358      37.1     27,986      40.0
                            

Total non-interest expense

   $ 123,431      36.4   $ 64,085      23.3
                            

Non-interest expense was $462.9 million for the twelve month period ended December 31, 2009, an increase of $123.4 million compared to the same period in 2008. This increase is due to the impairment of goodwill of $128.7 million, an increase in regulatory assessments of $14.7 million, an impairment charge of $8.9 million on the LIHTCPs, and increases in loan expense and consulting and professional fees of $9.1 million and $5.1 million, respectively. These increases were offset by decreases in salaries and benefits ($8.7 million), refund program fees ($11.0 million), and software expense ($2.6 million). The following paragraphs explain the major increases and decreases attributed to the increased non-interest expenses over the last three years.

Goodwill Impairment

Goodwill normally was tested for impairment during the third quarter of each year or if Management determined there was a triggering event which may indicate a need to review goodwill for impairment. Given the economic downturn experienced in 2008 and the uncertainty surrounding the banking industry, in the third quarter of 2008 Management concluded that goodwill was impaired and recorded $22.1 million impairment and also deemed it prudent to assess goodwill for impairment on a quarterly basis rather than annual. The year-end goodwill analysis for 2008 did not result in any additional goodwill impairment.

In the second quarter of 2009, Management concluded that the entire balance of goodwill at all reporting units was impaired and recorded a $128.7 million impairment charge. This was due to the increasingly uncertain economic environment, significant continued decline in the Company’s market capitalization, and continued elevated credit losses. The analysis was performed in accordance with

 

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the requirements of accounting principles generally accepted in the United States (“GAAP”), for testing the impairment of intangibles and goodwill. Additional information regarding the determination to impair the Company’s goodwill is in Note 10, “Goodwill and Intangible Assets” of the Consolidated Financial Statements starting on page 140.

Salaries and benefits

The following table summarizes the components of salaries and benefits expense for the years ended December 31, 2009, 2008 and 2007.

 

     Year Ended December 31,
     2009     2008    2007
     (in thousands)

Salaries

   $ 87,138      $ 88,674    $ 85,132

Benefits

     17,396        14,007      14,774

Bonuses

     7,242        10,812      8,945

Payroll taxes

     6,409        6,973      6,756

Commissions

     3,141        5,008      6,437

Gain on benefit curtailment

     (4,512         
                     

Total

   $ 116,814      $ 125,474    $ 122,044
                     

Salaries and benefits were $116.8 million for the year ended December 31, 2009 compared to $125.5 million for the same period in 2008. The decrease of $8.7 million is mostly due to the gain on benefit curtailment and a decrease in commission expense. The gain on benefit curtailment of $4.5 million is due to a reduction in postretirement benefits provided to employees. A detailed explanation discussing the gain on benefit curtailment is in Note 15, “Postretirement Benefits” of the Consolidated Financial Statements starting on page 147. The decrease in commission expense was due to the lower volume of loans originated during 2009 and reduced commissions for trust and investment advisory services.

Salary and benefits expense increased by $3.4 million to $125.5 million for the year-ended December 31, 2008 compared to the same period in 2007. This increase was mostly due to an increase in salary expense of $3.5 million. The increase in salary expense was mostly due to an increase in personnel due to the purchase of REWA, the addition of commercial and wealth personal bankers to expand the number of locations with the new banking platform to grow the commercial and wealth management segment and the addition of two new retail branch locations opened for operations during 2008.

Refund program fees

The refund program and marketing technology fees paid to JH was $47.4 million, $58.4 million and $50.9 million for the years ended December 31, 2009, 2008 and 2007, respectively. The refund program fees are marketing and technology fees associated with JH originated activity in the RAL and RT Programs which are reported in the RAL and RT Programs segment. 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 $25.2 million, $23.9 million and $24.0 million for approximately 75%, 68% and 60% of JH volume in 2009, 2008 and 2007, respectively.

Pursuant to the terms of the Technology Agreement, PCBNA paid a fixed technology fee to JH for processing services. In the event the actual annual business volume acquired by PCBNA is different

 

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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 $22.3 million, $21.2 million and $20.5 million in 2009, 2008 and 2007, respectively.

The Company sold the RAL and RT Programs on January 14, 2010 as disclosed in Note 26, “Subsequent Events” of the Consolidated Financial Statements. As part of the sale, the program and technology agreements with JH were assumed by the purchaser and, therefore the Company will no longer be incurring the refund programs fee expenses in future periods.

Net Occupancy Expense

Net occupancy expense was $27.7 million in 2009 compared to $26.7 million in 2008, an increase of $966,000. The increase in net occupancy expense was mostly attributed to the consolidation of locations which required depreciation expense to be accelerated on the leasehold improvements for one administration office and two retail branch locations that were vacated during 2009.

Net occupancy expense increased in 2008 by $3.8 million when comparing the year-to-date expense in 2008 to 2007. The increase in 2008 is due to the opening of two new retail branches in Simi Valley and in a Santa Barbara area retirement community; 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 Program operations.

The Company is reviewing all of the locations currently occupied to ensure that the locations leased and owned are fully occupied and, that the retail branch locations meet the strategic initiatives of the Company and continue to meet the needs of the Bank’s customers. Currently, the Company is in the process of negotiating out of the lease on its executive offices in downtown Santa Barbara. Two retail locations, Buellton and Vandenberg Village, are scheduled in April 2010 to be consolidated with nearby larger branches and two CWMG locations in San Jose and Calabasas were closed in January 2010 and February 2010, respectively. There are several administrative office locations that are being considered for closure and additional retail branch and CWMG locations are being considered for sale, consolidation, or closure. The Company anticipates net occupancy expense to decrease in future periods due to these actions that are currently in process.

Other expense

The table below summarizes the significant items included in other expense.

 

     Year Ended December 31,  
     2009    2008    2007  
     (in thousands)  

Other Expense:

        

Regulatory assessments

   $ 18,988    $ 4,282    $ 1,470   

Software expense

     15,699      18,332      15,270   

Loan expenses, net

     14,675      5,541      3,885   

Consulting and professional services

     13,905      8,822      9,740   

Customer deposit service and support

     9,500      7,775      6,491   

LIHTCP impairment

     8,876             

Reserve for off balance sheet commitments

     8,245      6,907      (341

Print forms and supplies

     7,379      7,474      6,539   

Legal, accounting, and audit

     7,305      5,981      4,342   

Telephone and data

     6,341      6,570      6,337   

Other expense

     23,402      26,273      16,238   
                      

Total

   $ 134,315    $ 97,957    $ 69,971   
                      

 

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Other Expense was $134.3 million for the year ended December 31, 2009 compared to $98.0 million for the year ended December 31, 2008, an increase of $36.4 million. The significant items comprising of this increase are described below.

The increase in regulatory assessments is due to higher assessments for deposit insurance assessed by the FDIC. Due to the increased number of bank failures these assessments have increased for all banks and in addition, there was an additional a $3.5 million one-time assessment paid in 2009. An other-than-temporary impairment of $8.9 million was recorded related to the LIHTCP as discussed in Note 24, “Fair Value of Financial Instruments” of the Consolidated Financial Statements on page 166. The net loan expenses have increased to $14.7 million compared to $5.5 million for the years ended December 31, 2009 and 2008, respectively due to the increase in other real estate owned (“OREO”), which results from foreclosed loans. The largest component of the OREO expenses are the expenses incurred to maintain the properties and valuation adjustments made throughout the year due to decreases in the value of the various properties. During 2009, $4.8 million of valuation adjustments were made for OREO properties. The additional consulting and professional services expenses incurred were primarily due to various strategic initiatives and assistance to address the regulatory matters discussed in “Regulation and Supervision—Current Regulatory Matters” and disclosed in Note 20, “Regulatory Capital Requirements” in the Consolidated Financial Statements on page 161.

Other expense was $98.0 million for the year ended December 31, 2008, an increase of $28.0 million or 40.0% compared to the year-ended December 31, 2007. This increase was mostly attributable to increases in other expenses of $10.0 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, an increase in litigation settlements of $3.0 million which is mostly related to the lawsuit that was disclosed in Note 18, “Commitments and Contingencies” of the Consolidated Financial Statements of the 2008 Form 10-K as the Canieva Hood and Congress of California Seniors v. Santa Barbara Bank & Trust, Pacific Capital Bank, N.A., and Jackson-Hewitt, Inc. lawsuit which was settled in 2009, an increase in regulatory assessment payments paid to the OCC and 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. This increase is due to the downturn of the economy which increased the reserve for unfunded loan commitments and letters of credit. The increase in software expense of $3.1 million is mostly attributed to additional depreciation expense associated with capitalized software.

PROVISION FOR INCOME TAXES

For the year-ended December 31, 2009, 2008 and 2007, provision for income taxes (benefit) was $6.8 million, ($18.6) million and $56.2 million.

Although the Company had a pre-tax net loss of $414.4 million for the year-ended December 31, 2009, the Company did not record a tax benefit for the majority of the losses incurred during 2009. The Company is permitted to recognize net deferred tax assets (“DTA”) only to the extent that they are expected to be used to reduce amounts that have been paid or will be paid to tax authorities. Management considers all available evidence in determining whether a DTA valuation allowance is needed. Due to deteriorating market conditions and net losses experienced during 2008 and 2009, the Company determined at June 30, 2009 that it was more likely than not that the Company would not generate sufficient taxable income in the foreseeable future to realize all of its DTAs. Based on this determination, the Company recorded a non-cash charge of $145.9 million in 2009, resulting in a remaining net DTA of $2.0 million at December 31, 2009.

 

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The $6.8 million tax expense for the year ended December 31, 2009 is the net result of; 1) a tax benefit of $139.1 million related to the pre-tax loss of $414.4 million offset by a full valuation allowance, 2) the creation of a valuation allowance of $10.8 million relating to existing deferred balances and 3) a tax benefit of $4.1 million for amended tax returns filed for tax years 2005 through 2007. This $6.8 million expense resulted in an effective tax rate of (1.6%).

Management continues to assess the impact of Company performance and the economic climate on the realizability of its DTA on a quarterly basis. The amount of DTAs considered realizable is subject to adjustment in future periods. Management will continue to monitor all available evidence related to the Company’s ability to utilize its DTAs. The income tax expense or benefit in future periods will be reduced or increased to the extent of offsetting decreases or increases to the DTA valuation allowance.

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.

For additional information related to the Company’s provision for income taxes for the years ended December 31, 2009, 2008 and 2007, refer to Note 16, “Income Taxes” of the Consolidated Financial Statements and the discussion of income taxes and DTAs in the “Critical Accounting Policies” section of this Form 10-K.

BALANCE SHEET ANALYSIS

Total assets were $7.54 billion at December 31, 2009, a decrease of $2.03 billion or 21.2% since December 31, 2008. In conjunction with this decrease, total liabilities decreased by $1.61 billion. This decrease in total assets was mostly attributed to the preparation for funding the 2009 RAL season on balance sheet during the fourth quarter of 2008. To fund the 2009 RAL season, the Company issued brokered CDs of $1.28 billion which would mature during the second and third quarter of 2009 after the tax season had ended. This caused unusually large balances of both interest-bearing deposits at other banks and interest-bearing deposits at the Bank at December 31, 2008. There were also sales and charge-offs of loans throughout 2009. Shareholders’ equity decreased by $423.8 million during 2009. This decrease in shareholders’ equity is primarily due to the year to date net loss applicable to common shareholders of $431.3 million for the twelve month period ended December 31, 2009. The major components causing these changes within the balance sheets are described in the following sections.

CASH AND CASH EQUIVALENTS

The Company’s cash and cash equivalents decreased by $943.0 million or 48.6% since December 31, 2008 to $995.5 million at December 31, 2009. As explained above, this decrease was due to the Company retaining more than the usual amount of cash at December 31, 2008 to fund the 2009 RAL season. Once the peak of the 2009 RAL season ended, excess cash was used to pay-off debt and, repay maturing brokered CDs purchased to fund the 2009 RAL season. During the latter part of 2009, the Bank again started issuing brokered CDs to increase its liquidity.

 

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SECURITIES

The Company’s security portfolio 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, 2009, 2008 and 2007 the Company held the following investment securities.

 

     December 31,
     2009    2008    2007
     (in thousands)

Trading:

        

Mortgage-backed securities

   $ 5,403    $ 213,939    $ 146,862
                    

Total trading securities

     5,403      213,939      146,862
                    

Available for Sale:

        

U.S. Treasury obligations

     11,432      37,475      39,997

U.S. Agency obligations

     607,930      600,130      479,490

Collateralized mortgage obligations

     113,934      17,092      23,861

Mortgage-backed securities

     169,058      212,256      382,943

Asset-backed securities

     1,271      1,034      2,198

State and municipal securities

     250,062      310,756      248,398
                    

Total available-for-sale securities

     1,153,687      1,178,743      1,176,887
                    

Total securities

   $ 1,159,090    $ 1,392,682    $ 1,323,749
                    

Trading securities

Trading securities were $5.4 million at December 31, 2009, a decrease of $208.5 million since December 31, 2008. This decrease is mostly attributable to the sale of $180.1 million of MBS at a gain on sale of $7.5 million. These securities were sold to reduce the volatility in the income statement since changes in market value for the trading portfolio impact the income statement and, due to the historically low interest rates, the Company could take advantage of the increased market value of these 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 recharacterized residential real estate loans held in the Company’s 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.

Available for sale securities

The balance of available for sale securities has remained fairly consistent over the last three years. However, the composition has changed since December 31, 2008 with MBS and municipal securities decreasing and CMO securities increasing. Management has allowed the MBS securities balance to decrease with regularly scheduled principal payments while the sale of municipal securities occurred during 2009 to generate additional liquidity. Due to the historically low interest rates, the Company could take advantage of the increased market value of these securities and, in the case of the municipal securities, with the current net tax loss position, the Company was not able to realize the benefit of their tax-exempt character. The increase in CMO securities was due to the purchase of

 

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$102.1 million of obligations of Government Sponsored Enterprises which guarantee the collection of principal and interest payments which were issued by Government National Mortgage Association (“GNMA”).

The Company sold $127.6 million, $123.6 million and $317.6 million of investment securities from the AFS portfolio during the years ended December 31, 2009, 2008 and 2007 respectively. During 2009, 2008, and 2007, investment securities which have matured or called prior to contractual maturity were $1.12 billion, $515.0 million and $234.6 million respectively. For the years ended December 31, 2009 and 2008, and 2007, net gains (losses) on the sales and calls of securities were $7.9 million, ($127,000) and $1.9 million, respectively.

As disclosed in Note 1, “Summary of Significant Accounting Policies” of the Consolidated Financial Statements on page 103 the Company adopted the new accounting standard on April 1, 2009 for determining whether or not an AFS is other-than-temporarily impaired (“OTTI”). At adoption of this new standard, a cumulative-effect transition adjustment was required. The after-tax impact of recognizing the noncredit portion resulted in the recognition of a cumulative-effect adjustment that increased retained earnings by $2.9 million, with a corresponding adjustment that decreased Other Comprehensive Income (“OCI”). For additional information on impairment of investment securities, credit ratings of investment securities and, the Company’s investment in the stock issued by the FHLB of San Francisco refer to Note 4, “Securities” of the Consolidated Financial Statements.

Included in the gain (loss) on securities transactions at December 31, 2009, 2008 and 2007 are MBS impairment losses of $4,000, $5.8 million and $3.0 million, respectively. The impairment loss recognized in previous periods were the result of Management’s change in intent to no longer necessarily hold MBS investment securities classified as AFS in a temporary loss position until full recovery or maturity. This change in intent was to provide more flexibility to manage the Company’s liquidity, capital and interest rate risk. Since the adoption of the OTTI accounting standard, the Company is no longer recognizing permanent impairment related to the MBS securities unless any impairment that is other-than-temporary relates to credit.

The securities portfolios are managed by the Bank’s Treasury Department to maximize funding and liquidity needs. The interest income on investment securities is allocated to the operating segments from the “All Other” segment reported in Note 24, “Segments” of the Consolidated Financial Statements.

 

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The table below summarizes the maturity distribution of the securities portfolio at December 31, 2009.

 

     December 31, 2009  
   One year
or less
    After one
year to
five years
    After five
years to
ten years
    After
ten years
    Total  
     (dollars in thousands)  

Maturity distribution:

          

Trading:

          

Mortgage-backed securities

   $ 868      $      $      $ 4,535      $ 5,403   
                                        

Total trading

     868                      4,535        5,403   
                                        

Available-for-sale:

          

U.S. Treasury obligations

     11,432                             11,432   

U.S. Agency obligations

     140,162        419,745        45,346        2,677        607,930   

Mortgage-backed securities and Collateralized mortgage obligations

     1,502        220,878        43,611        17,001        282,992   

Asset-backed securities

            1,271                      1,271   

State and municipal securities

     5,042        30,490        57,221        157,309        250,062   
                                        

Total available-for-sale

     158,138        672,384        146,178        176,987        1,153,687   
                                        

Total

   $ 159,006      $ 672,384      $ 146,178      $ 181,522      $ 1,159,090   
                                        

Tax equivalent weighted average yield:

          

Trading:

          

Mortgage-backed securities

     6.80                   5.04     5.32

Available-for-sale:

          

U.S. Treasury obligations

     2.91                          2.91

U.S. Agency obligations

     0.41     2.12     4.63     5.38     1.93

Mortgage-backed securities and Collateralized mortgage obligations

     3.09     4.99     3.91     4.49     4.78

Asset-backed securities

            7.03                   7.03

State and municipal securities

     10.12     8.07     8.41     8.80     8.65
                                        

Total available-for-sale

     0.93     3.31     5.85     8.36     4.08
                                        

Overall weighted average

     0.96     3.31     5.85     8.25     4.09
                                        

The timing of the payments for MBS and CMO securities in the above table 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.

 

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LOAN PORTFOLIO

Through the Company’s 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 three operating business segments: Community Banking, CWMG and RAL and RT Programs. The products offered by these segments include commercial, consumer, RALs, commercial and residential real estate loans and SBA guaranteed loans.

The table below summarizes the distribution of the Company’s loans held for investment at the year end indicated.

 

     December 31,  
   2009     2008     2007     2006     2005  
   (dollars in thousands)  

Real estate:

          

Residential - 1 to 4 family

   $ 971,725      $ 1,098,592      $ 1,075,663      $ 1,199,719      $ 1,128,318   

Multi-family residential

     275,069        273,644        278,935        287,626        256,857   

Commercial

     1,933,533        2,024,533        1,564,961        1,406,343        1,150,071   

Construction

     397,281        553,307        651,307        536,443        373,128   

Commercial loans

     977,401        1,159,843        1,187,232        1,071,440        934,207   

Home equity loans

     448,026        448,650        394,331        372,637        318,735   

Consumer loans

     161,698        196,482        200,094        533,511        437,323   

Leases

                          293,686        283,741   

Other

     1,698        9,805        6,632        19,442        16,001   
                                        

Total

   $ 5,166,431      $ 5,764,856      $ 5,359,155      $ 5,720,847      $ 4,898,381   
                                        

Percent of loans to total loans

          

Real estate:

          

Residential - 1 to 4 family

     18.8     19.1     20.1     21.0     23.0

Multi-family residential

     5.3     4.7     5.2     5.0     5.2

Commercial

     37.5     35.1     29.1     24.7     23.6

Construction

     7.7     9.6     12.2     9.4     7.6

Commercial loans

     18.9     20.1     22.2     18.7     19.1

Home equity loans

     8.7     7.8     7.4     6.5     6.5

Consumer loans

     3.1     3.4     3.7     9.3     8.9

Leases

                 5.1     5.8

Other

         0.2     0.1     0.3     0.3
                                        

Total

     100.0     100.0     100.0     100.0     100.0
                                        

The loan balances in the above table include net deferred loan origination fees, extension, commitment fees and deferred loan origination costs. These deferred amounts are amortized over the estimated term of the loans. Because all RALs are charged-off prior to each year-end, there are no RALs included within consumer loans in the above table.

Net Changes in the Loan Portfolio Balances

The loan portfolio at December 31, 2009 was $5.17 billion compared to $5.76 billion at December 31, 2008, a decrease of $598.4 million. This decrease was mostly due to sales of loans from the held for investment portfolio of $170.6 million and charge-offs of $228.3 million from the Core Bank loan portfolio. The loan sales were comprised of $77.3 million of residential loans, $87.2 of commercial real estate loans and, $6.1 million of commercial loans. A more detailed analysis of the loans sold is in Note 6, “Loan Sales and Transfers” of the Consolidated Financial Statements. The Bank sold loans during

 

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2009 to reduce the balance sheet and, to a lesser extent, to reduce the concentration of commercial real estate loans. A detailed discussion of the amounts and reasons for charge-offs may be found in the section below on page 63 titled “Loan Losses.”

The loan portfolio at December 31, 2008 was $5.76 billion, an increase of $405.7 million from December 31, 2007. This increase occurred in the commercial real estate loan portfolio which increased $459.6 million during 2008. This increase was offset with a decrease in the construction portfolio of $98.0 million. The commercial real estate loan portfolio is part of the CWMG segment as are a majority of the construction and land loans. Due to the high concentration of commercial real estate loans, the Company began to reduce its concentrations in commercial real estate loans. 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 $774,000 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 Company’s total loan portfolio decreased by $361.7 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:

 

  ¡  

$221.8 million of indirect auto loans sold in May 2007

 

  ¡  

$254.7 million sale of all leasing loans in June 2007

 

  ¡  

$284.5 million of fixed rate residential real estate loans recharacterized to MBS Securities in December 2007

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 Company’s strategic balance sheet management in 2007 as well as these products were offered outside the Company’s market footprint and relied on third parties for origination of these loans. The residential real estate loans were recharacterized into MBS in December 2007. A detailed discussion of these loan transactions is included within Note 6, “Loan Sales and Transactions” of the Consolidated Financial Statements.

The growth in loans from 2005 to 2006 was primarily from commercial real estate and construction loans which increased $256.3 million and $163.3 million. With real estate values increasing at rapid rates on the central coast of California during this time period, loans secured by real estate had significant growth during those periods.

Loans by Segments and Category

The Company’s segment financial statements are in Note 24, “Segments” of the Consolidated Financial Statements which begins on page 171 of this Form 10-K. A description of the segments is in the Consolidated Financial Statements and in Item 1, Business of this Form 10-K.

Community Banking

Business units in this segment provide residential real estate loans, home equity lines and loans, consumer loans, small business loans and lines, SBA loans and lines, deposit products and demand deposit overdraft protection products.

 

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The Community Banking segment’s assets were $2.72 billion at December 31, 2009, a decrease of $647.4 million when comparing the total assets at December 31, 2008. This decrease is mostly due to $310.4 million of loan sales from the Community Banking segment and, charge-offs of approximately $49.7 million which were from the residential real estate, home equity and consumer loan portfolios.

The Community Banking segment’s assets were $3.37 billion at December 31, 2008, an increase of $194.3 million compared to December 31, 2007. This increase was related to the increase in home equity loans of $54.3 million and residential real estate loans of $22.9 million.

Commercial and Wealth Management Group

This segment offers a complete line of commercial and industrial and commercial real estate secured loan products and services as well as trust and investment advisory services and private banking lending, deposit services and securities brokerages services through the Bank’s trust and investment management group and through MCM and REWA. The types of products offered in this segment include traditional commercial and industrial and commercial real estate and lines of credit, letters of credit, asset-based lending, foreign exchange services and treasury management. The loan products also include construction loans for commercial and residential development, land acquisition and development loans, secured and unsecured lines of credit and financing arrangements for completed structures.

The CWMG segment’s assets were $3.46 billion at December 31, 2009 compared to $4.19 billion at December 31, 2008, a decrease of $727.4 million. This decrease is attributable to not renewing many commercial or commercial real estate loans during 2009, the sale of $93.3 million of commercial real estate and commercial loans during 2009 and the charge-off of construction, commercial and commercial real estate loans of $175.6 million.

The CWMG segment’s assets grew by $381.4 million, or 10.0% in 2008 compared to 2007. This growth is mostly attributable to the growth in commercial real estate loans during 2008. The loan growth in 2007 was across all commercial loan categories with commercial real estate loans leading the loan growth of $158.6 million in 2007.

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.

On January 14, 2010, the Company sold the RAL and RT Program segment. Additional information regarding the sale of this segment is in Note 26, “Subsequent Events” of the Consolidated Financial Statements.

 

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The following table summarizes maturities and interest rates types for each loan category.

 

     December 31, 2009
     Due in one
year or less
   Due after one
year to five
years
   Due after five
years
     (in thousands)

Residential real estate- 1 to 4 family

        

Floating rate

   $ 575    $ 27    $ 416,808

Fixed rate

     1,926      2,978      549,411

Commercial real estate (1)

        

Floating rate

     43,007      254,970      1,411,043

Fixed rate

     41,370      231,113      227,099

Construction

        

Floating rate

     236,051      34,336      60,059

Fixed rate

     27,635      35,641      3,559

Commercial loans

        

Floating rate

     408,497      207,700      192,031

Fixed rate

     45,019      88,705      35,449

Home equity loans

        

Floating rate

     3,612      67,050      271,565

Fixed rate

     18      483      105,298

Consumer loans

        

Floating rate

     60,625      8,036      39,553

Fixed rate

     4,120      16,436      32,928

Other

        

Floating rate

              

Fixed rate

     1,698          
                    

Total

   $ 874,153    $ 947,475    $ 3,344,803
                    
(1) Commercial real estate includes multi-family residential real estate loans.

Of all loans shown in the above table, 48% have some variability in their interest rates. They may reset immediately with a short-term index like LIBOR or Prime or they may be fixed for some period after origination and then reset periodically until maturity.

 

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ALLOWANCE FOR LOAN LOSSES

The Company establishes an estimated allowance for inherent loan losses and records the change in this estimate through charges to current period earnings.

The table below summarizes the estimated allowance for loan loss by loan type:

 

     Year Ended December 31,  
   2009     2008     2007     2006     2005  
   (dollars in thousands)  

Real estate:

          

Residential 1-4 family

   $ 23,523      $ 16,294      $ 3,180      $ 3,194      $ 2,458   

Multi-family residential

     5,867        3,184        890        932        868   

Commercial

     44,672        22,472        5,368        4,939        6,271   

Construction

     61,506        34,050        3,391        2,004        1,465   

Commercial loans

     95,546        40,494        22,567        19,538        16,842   

Home equity loans

     22,885        11,111        2,365        1,657        1,280   

Consumer

     18,853        13,303        7,082        17,724        14,640   

Leases

                          14,683        11,774   
                                        

Total allowance

   $ 272,852      $ 140,908      $ 44,843      $ 64,671      $ 55,598   
                                        

Percent of loans to total loans:

          

Real estate:

          

Residential 1-4 family

     18.8     19.1     20.1     21.0     23.0

Multi-family residential

     5.3     4.7     5.2     5.0     5.2

Commercial

     37.5     35.1     29.1     24.7     23.6

Construction

     7.7     9.6     12.2     9.4     7.6

Commercial loans

     18.9     20.1     22.2     18.7     19.1

Home equity loans

     8.7     7.8     7.4     6.5     6.5

Consumer

     3.1     3.4     3.7     9.3     8.9

Leases

                 5.1     5.8

Other

         0.2     0.1     0.3     0.3
                                        

Total allowance

     100.0     100.0     100.0     100.0     100.0
                                        

Total allowance for loan losses was $272.9 million at December 31, 2009 compared to $140.9 million at December 31, 2008, an increase of $131.9 million. This increase is intended to cover the increase in the estimated losses that are inherent in the loan portfolio, but not yet identified. Management made several changes to its methodology for estimating these losses during 2009 to better reflect the continued deterioration of the economic conditions in the Company’s market areas, observed, in part, through elevated charge-offs during the first two quarters of 2009. The increase in ALL was also impacted by the high level of net charge-offs and escalating non-performing loans during 2009. The increase in the provision for loan loss is discussed within the MD&A of this Form 10-K starting on page 41 and, the net-charge-off discussion is on the following pages. The calculation of the ALL includes estimated loss contingencies in accordance with the Accounting Standards Codification (“ASC”) accounting topic, Loss Contingencies (i.e., allowance for non-impaired loans calculated on a loan pool basis).

The increase in the ALL of $96.1 million at December 31, 2008 compared to 2007 was also primarily attributable to the deteriorating economic environment as the country entered recession in late 2007 and early 2008. The decrease in allowance for loan losses of $19.8 million, or 30.7% at December 31, 2007 compared to 2006 was primarily attributable 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.

 

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ALL Model Methodology

A change in the ALL methodology occurred in the second quarter of 2009 when Management shortened the timeframe utilized for estimating historical loss rates from the last seven years to the most recent six quarters in its ALL calculation. The intent in changing the methodology of the ALL calculation was to better capture current risk conditions which had precipitously deteriorated since early 2008 through the first six months of 2009. The shorter time frame, now coupled with less reliance on qualitative factors, was judged to be more responsive to the increasing risk seen in economic conditions and rapidly deteriorating real estate collateral values. This change in methodology in the second quarter of 2009 caused a one-time increase of $113.7 million to the ALL. The shortened timeframe placed more weight in the estimation process on the recent quarters in which the Bank has experienced the highest historical losses in its history. As economic conditions change, the Bank may need to again revise the number of quarters of historical losses included in its ALL model for estimating the amount of loss currently in the portfolio.

In addition to changing the “look-back” period, the Bank has also increased the ALL in conjunction with increases in impaired loans and delinquent loans. The increase in impaired loans was due to decreases in collateral values which required the balances of individual impaired loans to be charged-off to the fair value of the collateral. This increased the historical loss rates, in turn impacting the estimate of losses not yet identified. At December 31, 2009, 2008 and 2007, the Bank had $277.2 million, $157.4 million and $54.2 million of impaired loans, respectively. These impaired loans had specific ALL reserves of $17.5 million, $17.8 million and $3.9 million at December 2009, 2008 and 2007, respectively. For more information regarding impaired loans, refer to page 125 in Note 5, “Loans,” of the Consolidated Financial Statements.

The valuation for real estate-secured loans is based on appraisal by an independent third party appraiser. The Bank’s process of determining when to obtain reappraisals for collateral is as follows:

 

  1. Collateral value deterioration is determined by the monitoring of market conditions based on third party data and data derived from appraisal operations. Management utilizes a quarterly report to determine when a reappraisal of the collateral is necessary during the loan review process. The appraisals for collateral in a deteriorating market are examined for existing validity to determine if revaluation is necessary. Trend monitoring is provided, analyzed and reported by the Bank’s Real Estate Advisory Services department to the Board of Director’s Loan Committee.

 

  2. Portfolio reappraisal screening is based on identifying collateral that represents an elevated risk and performing reappraisals of those properties en masse. A phased approach is undertaken to minimize the impact to Bank operations, but still provide updated information for better risk management practices centered on the transactions representing the greatest risk. Further, as subsequent transactions occur for existing loans, a methodology is employed that covers not only the target property, but other surrounding properties that are collateral for other loans and that may be exposed to similar risk characteristics.

In 2009, the Bank centralized the appraisal process and updated and expanded the appraisal policy. This update put more focus on market deterioration screening and portfolio reappraisal screening, establishing enhanced, risk oriented, appraisal engagement and review practices.

An appraisal management system was developed and deployed that tracks and monitors appraisals, appraisal reviews and other valuations. Information from these sources provides the data for risk management analysis purposes.

Quality control enhancements were made to the residential appraisal process focusing on the acquisition of secondary appraisals of a representative sample of all residential appraisals received. In keeping with best practices, these secondary appraisals are used to validate the conclusions of appraisals relied upon by the Bank.

 

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For the allowance calculation, the ALL model also takes into consideration the following qualitative factors: concentrations, loan growth, control environment, delinquency and classified loan trends, Management and staffing experience and turnover, economic conditions, results of independent loan review, underlying collateral values, competition, regulatory, legal issues, structured finance and syndicated national credits, and other factors. These qualitative factors are applied as adjustments to the historical loss rates when Management believes they are necessary to better reflect current conditions. However, with the 2009 change to a shorter loss horizon that more effectively captures current conditions than the previous methodology the adjustments did not need to be as significant. As a consequence, the portion of the ALL estimated by these qualitative factors decreased by $36.3 million since December 31, 2008. The one exception is the Commercial Real Estate portfolio where Management believes the potential losses have not been fully realized in the historical loss rates, and continues to bolster this portfolio’s allowance with qualitative factors.

Concentration of Credit Risk in Loan Portfolio

All changes in the risk profile of the various components of the loan portfolio are reflected in the allowance assignment. Management groups loans into 14 different loan pools which are determined by loan types when assessing the loans for allowance requirements. Management has been working on reducing concentration risk and been working towards specific percentages of total portfolio balance to total equity to assist with mitigating concentration risk. A summary of each loan portfolio which Management has concentration and credit risk associated with it is summarized by loan portfolio below.

At December 31, 2009, the highest concentration of loans for the Bank was commercial real estate loans. Commercial real estate loans were $1.93 billion or 37.5% of the Bank’s total loan portfolio. Total non-performing commercial real estate loans were 27.1% of total non-performing loans at December 31, 2009. Net charge-offs for the year ended December 31, 2009 was $12.1 million or 0.4% of average commercial real estate loans. The current allowance is 2.3% of the total commercial real estate loan balance. This portfolio has performed relatively well through the economic downturn to date; however non-performing and past due loans have increased three-fold since December 31, 2008, while net loan losses remain limited. However, industry-wide concern suggests 2010 may be the year when commercial real estate loans will suffer material losses. The concentrations plan calls for this portfolio to achieve a 315.0% equity ratio (417.7% at December 31, 2009). Due to these concerns for rising losses and high concentration levels, the Bank added additional allowance through qualitative adjustment factors to supplement its lower historical loss rates. As a consequence, the Bank’s allowance for this loan portfolio has quadrupled over the last four quarters.

At December 31, 2009, commercial loans were $977.4 million or 18.9% of the Bank’s total loan portfolio. Total non-performing commercial loans were 23.6% of total non-performing loans at December 31, 2009, and net charge-offs were approximately 6.1% of average commercial loans for the year ended December 31, 2009. The current allowance for commercial loans is $95.5 million or 9.8% of total commercial loans. Over the past two years, this portfolio has largely suffered from losses on business loans to building contractors. Net charge-offs for commercial loans have increased to $66.6 million for the year ended December 31, 2009 from $29.2 million for the same period in 2008. The concentration plan limits commercial loans to 171.0% of equity. The ratio was 129.8% at December 31, 2009.

The residential real estate loans secured by one to four family units at December 31, 2009 consisted of $971.7 million or 18.8% of the Bank’s total loan portfolio. Total non-performing residential real estate loans were 12.0% of total non-performing loans at December 31, 2009 and net charge-offs were 1.0% of average residential real estate loans for the year ended December 31, 2009. The current allowance for residential real estate is 2.4% of residential real estate total loans. Management does not consider the residential real estate loan portfolio a high risk portfolio, given the relatively low average loan to

 

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value ratio of 65% for the portfolio. This portfolio does not have any option adjustable rate mortgage loans (“option ARMs”) and has only 10 ARMs with negative amortization. The ARMs with negative amortization total $1.2 million or 0.1% of the total residential real estate portfolio. At December 31, 2009, all ten loans were paying as according to the agreed upon terms.

In July 2008, the Bank discontinued offering residential real estate loans originated by brokers because these loans had approximately double the loss rate of loans originated by Bank staff. Additionally, all “stated income” applications were discontinued in September 2008. Concentration limits were established for residential real estate loans in 2009 that have since resulted in reduction of $126.9 million or 11.5% in this portfolio since December 31, 2008. It is expected to continue to contract in 2010. The Bank’s concentration plan calls for this portfolio to be no more than 150.0% of equity ratio. At December 31, 2009 the ratio was 178.3%. Reductions have been achieved through loan sales, with virtually all new loan generation sold at or shortly after origination.

Home equity loans consist of junior lien mortgages which are mostly second trust deeds and some third trust deeds. At December 31, 2009 there were $448.0 million or 8.7% of home equity loans compared to the total loan portfolio. Total non-performing home equity loans were 1.7% of total non-performing loans at December 31, 2009 and net charge-offs were 3.7% of the average home equity loan balance for the year ended December 31, 2009. The allowance for home equity loans was $22.9 million or 5.1% of total home equity loans at December 31, 2009 compared to $11.1 million or 2.5% of total home equity loans at December 31, 2008. Brokered and stated income home equity loans were discontinued in early 2009. The concentration plan calls for this portfolio to achieve a 70.0% of equity ratio. At December 31, 2009, the ratio was 82.3%.

Construction loans include land and land development loans. At December 31, 2009, the construction loan portfolio consisted of $397.3 million or 7.7% of the Bank’s total loan portfolio. Total non-performing construction loans were $123.7 million, $129.4 million and $37.3 million at December 31, 2009, 2008 and 2007, respectively. The percentage of non-performing construction loans to total non-performing loans were 31.1%, 55.2% and 50.9% at December 31, 2009, 2008 and 2007, respectively. Net charge-offs of construction loans were 19.0%, 7.5% and 0.0%, to average construction loans for the years ended December 31, 2009, 2008 and 2007, respectively. This trend is improving for construction loans as the construction loan portfolio experienced the highest level of net charge-offs in the latter part of 2008 and early part of 2009. The allowance for construction loans was $61.5 million or 15.5% of total construction loans at December 31, 2009. This entire portfolio is considered high risk. In the first quarter of 2008, Management began a plan to reduce its concentration of construction loans. Since December 31, 2008 and 2007, construction loans have decreased by $156.0 and $98.0 million or 28.2% and 15.0%, respectively. The concentration plan calls for this portfolio to be no more than 45.0% of equity. The ratio was 79.3% at December 31, 2009).

The ratio of ALL to total loans for the last five years was 5.3%, 2.4%, 0.8%, 1.1% and 1.1% at December 31, 2009, 2008, 2007, 2006 and 2005, respectively.

Allowance for Loan Losses—RALs

There is no assignment of allowance to RALs at December 31, 2009 as all unpaid RALs were charged-off prior to year-end.

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

 

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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 Company’s 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. 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 year’s 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.

 

     Year Ended December 31,
   2009    2008    2007     2006     2005
   (in thousands)

Beginning balance

   $ 8,014    $ 1,107    $ 1,448      $ 1,685      $ 1,232

Additions (reductions), net

     8,245      6,907      (341     (237     453
                                    

Balance

   $ 16,259    $ 8,014    $ 1,107      $ 1,448      $ 1,685
                                    

The Company recorded additional expense of $8.2 million and $6.9 million for the years ended December 31, 2009 and 2008, respectively, to increase the off-balance sheet reserve due to the continued downturn of the economy and the same change in the methodology for estimating the amount of the off-balance sheet reserve as was described above for the ALL. The reserve for off balance sheet commitments uses the same model as the ALL.

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 ALL 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.

 

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LOAN LOSSES

The table below summarizes the beginning and ending balances of the allowance for loan losses and charge-offs and recoveries by loan category and credit loss ratios for the years presented:

 

     Year Ended December 31,
   2009     2008     2007     2006    2005
   (in thousands)

Balance, beginning of year

   $ 140,908      $ 44,843      $ 64,671      $ 55,598    $ 53,977

Charge-offs:

           

Real estate:

           

Residential - 1 -4 family

     12,644        7,263               4      107

Multi-family residential

     1,566        740                   

Commercial

     13,573        1,467                   

Construction

     94,042        49,155        25        91     

Commercial loans

     67,952        32,282        5,433        5,286      4,435

Agricultural loans

     1,445        391               216      489

Leases

                   6,276        10,242      7,559

Home equity loans

     17,269        7,659        787             55

RALs

     99,433        53,752        116,726        60,092      48,955

Other

     19,769        8,416        15,169        11,011      9,791
                                     

Total charge-offs

     327,694        161,125        144,416        86,942      71,391
                                     

Recoveries:

           

Real estate:

           

Residential - 1 - 4 family

     1,800        961                    7

Multi-family residential

     324                          

Commercial

     1,451                          

Construction

     809        59                   

Commercial loans

     1,314        3,035        1,175        2,119      1,862

Agricultural loans

                   529        43     

Leases

                   1,199        1,992      1,318

Home equity loans

     304        237        5             19

RALs

     24,895        31,984        24,766        23,432      10,745

Other

     3,436        3,399        4,265        3,736      3,505
                                     

Total recoveries

     34,332        39,675        31,939        31,322      17,456
                                     

Net charge-offs

     293,362        121,450        112,477        55,620      53,935

Adjustments from loan sales and acquisitions

     (1,630     (820     (20,623          1,683

Provision for loan losses RALs

     74,538        21,768        91,958        36,663      38,210

Provision for loan and lease losses core bank loans

     352,398        196,567        21,314        28,030      15,663
                                     

Balance, end of year

   $ 272,852      $ 140,908      $ 44,843      $ 64,671    $ 55,598
                                     

 

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The following table presents statistical data on net charge-offs and the ALL:

 

     Year Ended December 31,  
   2009     2008     2007     2006     2005  
   (dollars in thousands)  

Ratio of net charge-offs to average loans outstanding

     5.18     2.11     1.90     1.04     1.21

Ratio of net charge-offs to average loans outstanding (core bank)

     3.92     1.76     0.37     0.36     0.36

Peer ratio of net charge-offs to average loans outstanding

     2.31     0.85     0.38     0.24     0.34

Average RALs

   $ 74,715      $ 102,667      $ 327,744      $ 86,407      $ 57,669   

Average loans, core bank

     5,583,948        5,657,521        5,592,781        5,240,384        4,390,948   
                                        

Average total loans

   $ 5,658,663      $ 5,760,188      $ 5,920,525      $ 5,326,791      $ 4,448,617   
                                        

Recoveries to charged-off, RALs

     25.04     59.50     21.22     38.99     21.95

Recoveries to charged-off, core bank loans

     4.13     7.16     25.90     29.39     29.91

Recoveries to charged-off, total loans

     10.48     24.62     22.12     36.03     24.45

Allowance for loan loss as a percentage of year-end loans

     5.28     2.44     0.84     1.13     1.14

Net charge-offs increased to $293.4 million for the year-ended December 31, 2009, an increase of $171.9 million compared to the year-ended December 31, 2008. The increase in net charge-offs were driven by the downturn in economy in 2009. This economic downturn further reduced collateral values and caused businesses to reduce their workforce or close, causing unemployment to increase and making it difficult for many customers to make their payments on their loans with the Bank. The declining collateral values also resulted in further impairment of loans which increased the charge-offs during 2009. Excluding the net charge-offs on RALs of $74.5 million, the net charge-offs for the Core Bank were $218.8 million for the year-ended December 31, 2009 compared to $99.7 million for the year-ended December 31, 2008, an increase of $119.1 million. Most of this increase in net charge-offs occurred with the construction, commercial and consumer loan portfolios and account for $176.8 million of the Core Bank net charge-offs during 2009.

In addition, the 2009 RAL Program experienced higher than anticipated loan losses of $74.5 million for the twelve-month period ended December 31, 2009, an increase of $52.8 million from the comparable period ended December 31, 2008. The increase in RAL provision for loan losses is attributed to the first few weeks of the RAL season due to an expanded number of tax refunds under review by the IRS for further documentation. The additional RAL net charge-offs for the 2009 RAL season is further explained in the MD&A “Provision for Loan Loss” discussion on page 41.

Total ch