Edgar Filing: PACIFIC CAPITAL BANCORP /CA/

Form 10-K

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, 2008

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 X No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No X

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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 X Accelerated filer Non-accelerated filer Smaller reporting company

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes No X

The aggregate market value of the voting stock held by non-affiliates computed June 30, 2008, based on the sales prices on that date of $13.78 per share: Common Stock—$601,144,742. All directors and executive officers and the 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 20, 2009, there were 46,618,356 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 30, 2009 are incorporated by reference into Part III.

INDEX


			Page
PART I
	Forward-Looking Statements		3
	Item 1.	Business	4
	Item 1A.	Risk Factors	13
	Item 1B.	Unresolved Staff Comments	21
	Item 2.	Properties	21
	Item 3.	Legal Proceedings	22
	Item 4.	Submission of Matters to a Vote of Security Holders	22
PART II
	Item 5.	Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	23
	Item 6.	Selected Financial Data	25
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
		Financial Overview and Highlights	26
		Results of Operations	28
		Balance Sheet Analysis	42
		Contractual Obligations and Off-Balance Sheet Arrangements	56
		Capital Resources	57
		Liquidity	60
		Interest Rate Risk	62
		Critical Accounting Policies	63
		Regulation and Supervision	67
	Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	75
	Item 8.	Consolidated Financial Statements and Supplementary Data	78
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures	150
	Item 9A.	Controls and Procedures	150
	Item 9B.	Other Information	150
		Glossary	152
PART III
	Item 10.	Directors, Executive Officers and Corporate Governance	156
	Item 11.	Executive Compensation	156
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	156
	Item 13.	Certain Relationships and Related Transactions, and Director Independence	156
	Item 14.	Principal Accountant Fees and Services	156
PART IV
	Item 15.	Exhibits and Financial Statement Schedules	157
SIGNATURES			158
EXHIBIT INDEX			159
CERTIFICATIONS

PART I

Forward-Looking Statements

Certain statements contained in this Annual Report on Form 10-K, as well as some statements by the Company in periodic press releases and some oral statements made by Company officials to securities analysts and shareholders during presentations about the Company, are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements. All statements other than statements of historical fact are “forward-looking statements” for purposes of Federal and State securities laws, including statements that relate to or are dependent on estimates or assumptions relating to the prospects of continued loan and deposit growth, improved credit quality, the health of the capital markets, the Company’s de novo branching and acquisition efforts, the operating characteristics of the Company’s income tax refund loan and transfer programs and the economic conditions within its markets. These forward-looking statements involve certain risks and uncertainties, many of which are beyond the Company’s control. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) increased competitive pressure among financial services companies; (2) changes in the interest rate environment reducing interest margins or increasing interest rate risk; (3) deterioration in general economic conditions, internationally, nationally or in California; (4) the occurrence of terrorist acts; (5) reduced demand for or earnings derived from the Company’s income tax refund loan and refund transfer programs; (6) legislative or regulatory changes or litigation adversely affecting the businesses in which the Company engages; (7) unfavorable conditions in the capital markets; (8) challenges in opening additional branches, integrating acquisitions or introducing new products or services; and (9) other risks detailed in reports filed by the Company with the Securities and Exchange Commission (“SEC”). Forward-looking statements speak only as of the date they are made, the Company does not undertake any obligations to update forward-looking statements to reflect circumstances and or events that occur after the date the forward-looking statements are made.

The assets, liabilities, and results of operations of the Company’s tax refund and transfer programs are reported in its periodic filings with the SEC as a segment of its business. As these programs are conducted by very few other financial institutions, users of the financial statements have indicated that they are interested in amounts and ratios for the Company exclusive of these programs so that they may compare the results of operations with financial institutions that have no comparable programs. These amounts and ratios may generally be computed from the information provided in the note to its financial statements that discloses segment information, but are computed and included elsewhere in this Annual Report on Form 10-K for the convenience of the readers of this document.

Purpose and Definition of Terms

The following discussion is designed to provide insight to Management’s assessment on the financial condition and results of operations of Pacific Capital Bancorp and its subsidiaries. Unless otherwise stated, “the Company” refers to this consolidated entity and “we” refers to the Company’s Management. 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 78 through 149 of this Annual Report on Form 10-K, herein referred to as “Form 10-K”. Specific accounting and banking industry terms and acronyms used throughout this document are defined in the glossary on pages 152 through 155.

ITEM 1.

BUSINESS

Organizational Structure and Description of Services

Pacific Capital Bancorp (“the Company” or “PCB”) is a community bank holding company providing full service banking including all aspects of consumer and commercial lending, trust and investment advisory services and other consumer and business banking products through its subsidiaries’ retail branches, commercial and wealth management centers and other distribution channels to consumers and businesses primarily located in the central coast of California. The Company is one of three primary providers nationwide of refund anticipation loans (“RALs”) and refund transfer services (“RTs”).

PCB has five wholly-owned subsidiaries. Pacific Capital Bank, National Association (“the Bank” or “PCBNA”), a banking subsidiary and four unconsolidated subsidiaries used as business trusts in connection with issuance of trust-preferred securities as described in Note 14, “Long-term Debt and Other Borrowings” on page 122 of this Form 10-K.

PCBNA has four wholly-owned consolidated subsidiaries:

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.

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

PCB Service Corporation, utilized as a trustee of deeds of trust in which PCBNA is the beneficiary.

In late 2007, PCBNA made an investment in Veritas Wealth Advisors, LLC (“Veritas”), a registered investment advisor. Veritas was organized in late 2007 and commenced operations in the second quarter of 2008. PCBNA’s variable interest of 20% in Veritas includes $1.0 million of equity at risk.

PCBNA also retains ownership in several Low-Income Tax Housing Partnerships that are not consolidated into the Company’s Consolidated Financial Statements.

At December 31, 2008, PCBNA conducted its banking services under five brand names at 51 locations:


Brand Name	Acronym	Counties Located in	Year Acquired	Number of Branch Locations
Santa Barbara Bank & Trust	“SBB&T”	Santa Barbara, Ventura and Los Angeles	1960 ⁽¹⁾	35
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 the Pacific Crest Capital Incorporated (“PCCI”) acquisition of 2004 were renamed to the SBB&T brand name.

The brand names retained represent the former names of select acquired independent banks merged into PCBNA. In addition to the retail and business deposits managed by the above banking offices, the Company makes use of brokered deposits and deposits received from the State of California, both of which are administered by the Company’s Treasury department.

During 2008, the Bank opened two new retail branches, the Wood Ranch branch located in Simi Valley, and the Casa Dorinda branch located in Santa Barbara, which are both included in the table above as SBB&T. The Bank also sold two retail branches in October 2008, the Santa Paula branch, which was owned by the Bank and the Harvard branch, which was leased by the Bank and are excluded from the table above.

In November 2008, the Bank opened a third commercial and wealth management center in Torrance which is included in the table above as SBB&T. The first two commercial and wealth management centers were opened during 2007 and reside in Glendale and Calabasas which are excluded from the table above since they do not accept deposits. The commercial and wealth management centers are designed like an office and located within office buildings in the Los Angeles area to meet the needs of middle market companies and high net-worth customers. These centers offer specialized products and services and are staffed with experienced personal bankers who are knowledgeable about commercial and trust and advisory products.

Segments

The Company had four reportable operating segments at December 31, 2008. These segments are determined based on product line and the types of customers serviced. These reportable operating segments are Community Banking, Commercial Banking, Wealth Management and RAL and RT Programs. The administrative and treasury operations of the Company are not considered part of operating activities of the Company and are reported within the All Other segment for financial reporting. The financial results for each segment are based on products and services provided within

each operating segment with various Management assumptions to calculate the indirect credits and charges for funds which also includes an allocation of certain expenses from the All Other segment. These Management assumptions are explained in Note 24, “Segments” of the Consolidated Financial Statements beginning on page 142.

The Community Banking, Commercial Banking and Wealth Management segments represent the banking operations for the Company and are referred to as the “Core Bank” by Management. The banking operations of the Core Bank are similar to the operations of other traditional banks. The Community Banking, Commercial Banking and Wealth Management segments are responsible for collecting deposits, making loans, providing trust and investment advisory services and providing customary banking services. The RAL and RT Programs segment is highly seasonal as a majority of the income is earned in the first quarter of each year. The RAL product generates interest income and the RT product generates non-interest income. The Company has experienced significant growth in RAL and RT Programs over the last several years. The financial impact of the RAL and RT Programs will be discussed throughout the Management Discussion and Analysis (“MD&A”) section of this document.

The income generated by these four reportable segments are driven by the lending and trust and investment advisory products offered to customers. The primary expenses are interest expense on deposits and funding costs and personnel. Deposit products are provided to the customers of the Community Banking, Commercial Banking and Wealth Management segments. These deposit products include checking, savings, money market and certificates of deposit (“CDs”). The following segment discussion outlines the products, services and lending policies for each operating segment.

As of January 1, 2009, the Commercial Banking and Wealth Management segments were combined into one operating segment. The combined segment will be called Commercial and Wealth Management segment. Together, the new segment will provide products and services to meet the needs of middle market companies and high net-worth individuals within the existing footprint of the Company and the adjacent markets. The new combined segment currently has three locations which are specifically designed for serving their target customer base. These locations are in Calabasas, Torrance and Glendale, California. The new combined segment will no longer offer SBA loans as these products service small businesses and will be offered through the Community Banking segment.

Community Banking

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

Residential real estate loans consist of first and second mortgage loans secured by trust deeds on one to four unit single family homes. The Company has specific underwriting and pricing guidelines based on the credit worthiness of the borrower and the value of the collateral, including credit score, debt-to-income ratio of the borrower and loan-to-value ratio. The Company extends credit up to a maximum of 80% combined loan-to-value of the first trust deed equity value. Maximum borrower debt-to-income ratios range from 40% to 60% and are determined by various factors. Home equity lines of credit are generally secured by a second trust deed on a single one to four unit family home. The interest rate on home equity lines is a variable index rate while term residential mortgage loans can have either variable or fixed interest rates.

Consumer loans and lines of credit are extended with or without collateral to provide financing for purposes such as the acquisition of recreational vehicles, automobiles, or to provide liquidity. The Company has specific underwriting guidelines which consider the 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 Bank are extended without collateral to small businesses based on historical credit performance of the business along with the principal owners of the business. The loans and lines of credit can have either variable or fixed interest rates and are extended to small businesses in amounts less than $100,000.

Demand deposit overdraft protection products are offered to demand deposit customers to provide additional protection against unforeseen deficit balances in a specific account and the potential related fees. The Company offers these products based on factors such as the customers credit score and history with the Company. These products have fixed interest rates.

Commercial Banking

This business segment offers commercial, industrial, corporate, and real estate loan products, including traditional commercial loans and lines of credit, asset based lending, letters of credit, and Small Business Administration (“SBA”) loans. The Commercial Banking segment also offers the Community Banking segment deposit products as well as deposit products that are for middle market companies such as cash management services, merchant services and certain international services for domestic customers.

Loan products are underwritten and customized to meet specific customer needs. The Company considers several factors in order to extend the loan including the 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. Maximum loan-to-value ratios for commercial real estate loans are 75%.

Depending on the product, these loans have fixed or variable interest rates.

SBA loans are extended to small businesses for a variety of purposes, including working capital, business acquisitions, acquisition of real estate, growth capital and equipment financing. The Company focuses on 7(a), 504, and Express loan programs. 7(a) loans provide longer term financing, which are guaranteed 75% to 85% by the SBA depending on term and loan size. SBA 504 loans are typically used for the acquisition or construction of large equipment or real property. These are financing packages comprised of a first and second trust deed loan structure where the debt does not exceed 90% combined loan-to-value. Express loans are unsecured lines of credit or term loans of $100,000 or less and are generally guaranteed by the SBA at 50%. Periodically, the Company sells selected SBA loans into the secondary market. The Company retains servicing rights on the sold guaranteed portion of SBA 7(a) loans.

Wealth Management

Business units in this segment offer a wide range of trust, investment, fiduciary and wealth management services and solutions, including planning and advice. These solutions are provided by the Bank’s Trust and Investment Management group, including MCM and REWA.

The Wealth Management group provides high net worth clients a variety of banking solutions and other services. These include Private Capital Advantage deposit solutions, residential mortgages and lines of credit, investment review, analysis and customized portfolio management for separately managed accounts, full service brokerage, trust and fiduciary services, equity and fixed income management and real estate and specialty asset management. Loans are structured to meet the specific needs of high net worth customers but still adhere to the Company’s underwriting guidelines. The Company’s

underwriting guidelines consider tangible net worth, value of assets that make up this net worth, personal cash flow, past history with the Company, and credit history. These loans may be either secured or unsecured, and may have either fixed or variable interest rates, with lines of credit generally having variable interest rates.

RAL and RT Programs

RALs are a seasonal credit product extended to consumers during the first four months of each calendar year. The purpose of the RAL is to provide consumers with liquidity at the time they file for their tax refund. The Company works with third party tax preparers who facilitate the origination of RALs through an application process. RAL underwriting is based on borrower information as well as certain criteria within the tax return. The source of repayment for the RAL is the Internal Revenue Service (“IRS”).

The Company subjects the RAL application to an automated credit review process utilizing specific predetermined criteria. If the application passes this review, the Company advances the amount of the refund due on the 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. The refund received from the IRS is used by the Company to pay off the RAL. Any amount due the taxpayer above the amount of the RAL is remitted to the taxpayer. The RAL income is recognized into interest income after the loan balance is collected from the IRS. The fee varies based on the amount of the RAL.

Generally, interest income earned on loans is a function of the outstanding balance multiplied by the rate specified in the loan agreement multiplied by the period of time the loan is outstanding. For RALs, the interest income is unrelated to the length of time the loan is outstanding and there is no explicit interest rate. The flat fee charged is recognized as income when the loan is collected from the IRS. No late fees are charged to customers whose loans are not paid within the expected time frame.

While the loan application form is completed by the taxpayer in the tax preparer’s office, the credit criteria are set by the Company and the underwriting decision is made by the Company. The Company reviews and evaluates all tax returns to determine the likelihood of IRS payment. If any attribute of the tax return appears to fall outside of predetermined parameters, the Company will reject the application and not make the loan.

The Company has entered into two separate contracts with Jackson Hewitt related to the RAL and RT Programs. One of the contracts with Jackson Hewitt is with Jackson Hewitt Inc. and the other is with Jackson Hewitt Technology Services, Inc. collectively referred to as “JH” throughout this Form 10-K.

The Company also has an electronic filing of tax return product called a Refund Transfer or RT. The RT product is also designed to provide taxpayers faster access to funds claimed by a taxpayer as a refund on their tax returns. An RT is in the form of a facilitated electronic transfer or check prepared by taxpayer’s tax preparer.

For more information regarding RALs, refer to Note 7, “RAL and RT Programs” of the Consolidated Financial Statements beginning on page 113.

Employees

At December 31, 2008, the Company employed 1,372 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 101. A summary of acquisitions in the last three years is as follows:

In July 2006, PCBNA acquired MCM, a California-based registered investment advisor for an initial cash payment of approximately $7.0 million. MCM is a wholly owned subsidiary of PCBNA which provides wealth management advisory services.

In January 2008, PCBNA acquired REWA, California-based registered investment advisor for an initial cash payment of approximately $7.0 million. REWA is a wholly owned subsidiary of PCBNA which provides personal and financial investment advisory services to individuals, families and fiduciaries.

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 Company continues to explore opportunities to expand its footprint into strategically selected markets.

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

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.

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 67 through 70 of this Form 10-K), changes in technology and product delivery systems, and the continued consolidation among financial services providers. The Company competes for loans, deposits, trust and investment advisory services and customers with other commercial banks, savings and loan associations, securities and brokerage companies, investment advisors, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers. Many competitors are much larger in total assets and capitalization, have greater access to capital markets, including foreign-ownership, and/or offer a broader range of financial services.

Economic Conditions, Government Policies, Legislation, and Regulatory Initiatives

The 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 our control, such as inflation, recession and unemployment, and the impact which future changes in domestic and foreign economic conditions might have on the Company which cannot be predicted. A more detailed discussion of the Company’s interest rate risk and the mitigation of interest rate risk begin on pages 62 and 75.

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 service providers. Several proposals for legislation that could substantially intensify the regulation of the financial services industry (including a possible comprehensive overhaul of the financial institutions regulatory system) are expected to be introduced and possibly enacted in the new Congress in response to the current economic downturn and financial industry instability. The Company cannot predict whether or when potential legislation will be enacted, and if enacted, the effect that it, or any implementing regulations and supervisory policies, would have on the Company’s financial condition or results of operations. In addition, the outcome of any investigations initiated by state authorities or litigation raising issues such as whether state laws are preempted by Federal law may result in additional laws and regulations that require changes in the Company’s operations and increased compliance costs.

Dramatic negative developments in the latter half of 2007 in the subprime mortgage market and the securitization markets for such loans, together with volatility in oil prices and other factors, have resulted in uncertainty in the financial markets in general and a related economic downturn, which continued through 2008 and anticipated to continue through 2009. Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. In addition, the values of real estate collateral supporting many commercial and residential loans have declined and may continue to decline. General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by many financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer delinquencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Competition among depository institutions for deposits has increased significantly. Bank and bank holding company stock prices have been negatively affected as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to recent years. Bank regulators have been very aggressive in responding to concerns and trends identified in examinations, and this has resulted in the increased issuance of formal and informal enforcement orders and other supervisory actions requiring action to address credit quality, liquidity and risk management and capital adequacy, as well as other safety and soundness concerns.

On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted to restore confidence and stabilize the volatility in the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. Initially introduced as the Troubled Asset Relief Program (“TARP”), the EESA authorized the United States Department of the Treasury (“U.S. Treasury”) to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies. Initially, $350 billion was made immediately available to the U.S. Treasury. On January 15, 2009, the remaining $350 billion was released to the U.S. Treasury.

On October 14, 2008, the U.S. Treasury announced its intention to inject capital into nine large U.S. financial institutions under the TARP Capital Purchase Program (the “TARP CPP”), and since has injected capital into many other financial institutions, including the Company. The U.S. Treasury initially allocated $250 billion towards the TARP CPP. On November 21, 2008, the Company completed the sale to the U.S. Treasury of $180.6 million of preferred stock and warrants as part of the TARP CPP. Pursuant to the terms of the Securities Purchase Agreement–Standard Terms (“Securities Purchase Agreement”), the Company issued and sold to the U.S. Treasury (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 “Capital Resources” section on page 59 of this Form 10-K.

In order to participate in the TARP CPP, financial institutions were required to adopt certain standards for executive compensation and corporate governance. These standards generally apply to the Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers. The standards include (1) ensuring that incentive compensation for named senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to senior executives; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive. The Company has complied with these requirements and will continue to comply.

The bank regulatory agencies, U.S. Treasury and the Office of Special Inspector General, also created by the EESA, have issued guidance and requests to the financial institutions that participated in the TARP CPP to document their plans and use of TARP CPP funds and their plans for addressing the executive compensation requirements associated with the TARP CPP. The Company has received and will respond to that request.

On February 10, 2009, the U.S. Treasury and the Federal bank regulatory agencies announced in a Joint Statement a new Financial Stability Plan which would include additional capital support for banks under a Capital Assistance Program, a public-private investment fund to address existing bank loan portfolios and expanded funding for the FRB’s pending Term Asset-Backed Securities Loan Facility to restart lending and the securitization markets.

On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law by President Obama. The ARRA includes a wide variety of programs intended to stimulate the

economy and provide for extensive infrastructure, energy, health, and education needs. In addition, the ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients, including the Company, until the institution has repaid the U.S. Treasury, which is now permitted under the ARRA without penalty and without the need to raise new capital, subject to the U.S. Treasury’s consultation with the recipient’s appropriate regulatory agency.

The AARA executive compensation standards are more stringent than those currently in effect under the TARP CPP or those previously proposed by the U.S. Treasury. The new standards include (but are not limited to); (i) prohibitions on bonuses, retention awards and other incentive compensation, other than restricted stock grants which do not fully vest during the TARP CPP period up to one-third of an employee’s total annual compensation, (ii) prohibitions on golden parachute payments for departures, (iii) an expanded clawback of bonuses, retention awards, and incentive compensation if payment is based on materially inaccurate statements of earnings, revenues, gains or other criteria, (iv) prohibitions on compensation plans that encourage manipulation of reported earnings, (v) retroactive review of bonuses, retention awards and other compensation previously provided by TARP CPP recipients if found by the U.S. Treasury to be inconsistent with the purposes of TARP CPP or otherwise contrary to public interest, (vi) required establishment of a company-wide policy regarding “excessive or luxury expenditures,” and (vii) inclusion in a participant’s proxy statements for annual shareholder meetings of a nonbinding “Say on Pay” shareholder vote on the compensation of executives.

On February 23, 2009, the U.S. Treasury and the Federal bank regulatory agencies issued a Joint Statement providing further guidance with respect to the Capital Assistance Program announced February 10, 2009, including: (i) that should the “stress test” assessments of the major banks initiated February 25, 2009 indicate that an additional capital buffer is warranted, institutions will have an opportunity to turn first to private sources of capital otherwise; the temporary capital buffer will be made available from the government; (ii) such additional government capital will be in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks in a well-capitalized position and can be retired under improved financial conditions before the conversion becomes mandatory; and (iii) previous capital injections under the TARP CPP will also be eligible to be exchanged for the mandatory convertible preferred shares. The conversion of preferred shares to common equity shares would enable institutions to maintain or enhance the quality of their capital by increasing their tangible common equity capital ratios; however, such conversions would necessarily dilute the interests of existing shareholders.

On February 25, 2009, the first day the Capital Assistance Program was initiated, the U.S. Treasury released the actual terms of the program, stating that the purpose of the Capital Assistance Program is to restore confidence throughout the financial system that the nation’s largest banking institutions have a sufficient capital cushion against larger than expected future losses, should they occur due to a more severe economic environment, and to support lending to creditworthy borrowers. Under the terms of the Capital Assistance Program, eligible U.S. banking institutions with assets in excess of $100 billion on a consolidated basis are required to participate in coordinated supervisory assessments, which are forward-looking “stress test” assessments to evaluate the capital needs of the institution under a more challenging economic environment. Should this assessment indicate the need for the bank to establish an additional capital buffer to withstand more stressful conditions, these institutions may access the Capital Assistance Program immediately as a means to establish any necessary additional buffer or they may delay the Capital Assistance Program funding for six months to raise the capital privately. Eligible U.S. banking institutions with assets below $100 billion may also obtain capital from the Capital Assistance Program. The Capital Assistance Program is an additional program from the TARP CPP and is open to eligible institutions regardless of whether they participated in the TARP CPP. The deadline to apply to participate in the Capital Assistance Program is May 25, 2009. Recipients of capital under the Capital Assistance Program will be subject to the same executive compensation requirements as if they had received TARP CPP.

The EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000. In addition, the FDIC has implemented two temporary liquidity programs to (i) provide deposit insurance for the full amount of most non-interest bearing transaction accounts (the “Transaction Account Guarantee”) through the end of 2009 and (ii) guarantee certain unsecured debt of financial institutions and their holding companies through June 2012 under a temporary liquidity guarantee program (the “Debt Guarantee Program” and together the “TLGP”). Financial institutions had until December 5, 2008 to opt out of these two programs. The Company and the Bank have elected to participate in these programs, but has not yet issued any debt under the Debt Guarantee Program.

Regulation and Supervision

The Company and its subsidiaries are extensively regulated and supervised under both Federal and certain State laws. A summary description of the laws and regulations which relate to the Company’s operations are discussed on pages 67 through 75.

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, as amended, and other information related to the Company free of charge, through this site as soon as reasonably practicable after it electronically files those documents with, or otherwise furnishes them to, the SEC. The 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 our common stock involves various risks which are specific to the Company, our industry and our market area. Several risk factors regarding investing in our common stock are discussed below. This listing should not be considered as all-inclusive. If any of the following risks were to occur, we may not be able to conduct the Company’s business as currently planned and the financial condition or operating results could be negatively impacted. The Company’s Chief Audit Executive 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.

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 beginning in the latter half of 2007, with falling home prices and increasing foreclosures, unemployment and underemployment, have negatively impacted the credit performance of mortgage loans and resulted in significant write-downs of asset values by financial institutions. The resulting write-downs to assets of financial institutions have caused many

financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to seek government assistance or bankruptcy protection. Bank failures and liquidation or sales by the FDIC as receiver have also increased.

The capital and credit markets, including the fixed income markets, have been experiencing volatility and disruption for more than fifteen months. In some cases, the markets have produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers’ financial strength.

Many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including to other financial institutions because of concern about the stability of the financial markets and the strength of counterparties. It is difficult to predict how long these economic conditions will exist, which of the 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:

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.

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.

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.

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.

Further increases in FDIC insurance premiums due to the market developments which have significantly depleted the Deposit Insurance Fund 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, we may be particularly susceptible to the adverse economic conditions in the state of California and in the eight counties mentioned above where the Company’s business is concentrated.

Enactment of EESA and ARRA

EESA, which established TARP, was signed into law on October 3, 2008. As part of TARP, the U.S. Treasury established the TARP CPP to provide up to $700 billion of funding to eligible financial

institutions through the purchase of capital stock and other financial instruments for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Then, on February 17, 2009, the ARRA was signed into law as a sweeping economic recovery package intended to stimulate the economy and provide for broad infrastructure, energy, health, and education needs. There can be no assurance as to the actual impact that EESA or its programs, including the TARP CPP, and ARRA or its programs, will have on the national economy or financial markets. The failure of these significant legislative measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect the 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 that followed the sub-prime mortgage market meltdown which began in late 2007. These measures include homeowner relief that encourages loan restructuring and modification; the temporary increase in FDIC deposit insurance from $100,000 to $250,000, the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the Federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. The purpose of these legislative and regulatory actions is to help stabilize the U.S. banking system. EESA, ARRA and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, the 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 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 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. 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 a year. In recent months, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers seemingly without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that the Company will not experience an adverse effect, which may be material, on the Company’s ability to access capital and on the business, financial condition and results of operations.

The market price for our common shares has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future, including:

announcements of developments related to our business;

fluctuations in our results of operations;

sales of substantial amounts of our securities into the marketplace;

general conditions in our markets or the worldwide economy;

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

changes in analysts’ recommendations or projections and

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 business, financial condition, results of operations and cash flows. Management maintains an allowance for loan and lease losses to provide for loan defaults and non-performance. The allowance is also appropriately increased for new loan growth. Management believes that the allowance for loan losses is adequate to cover current losses. Management cannot guarantee that the allowance for loan losses will not increase further or that regulators will not require the Company to increase this allowance.

Risks Associated with the RAL and RT Programs

Risks associated with the RAL and RT Programs include credit, the availability of sufficient funding at reasonable rates, risks associated with the IRS, litigation, and regulatory or legislative risk.

The Company has traditionally utilized a securitization facility to fund its RAL and RT Programs. For additional discussion on the securitization facility for the RAL Program refer to page 36 of the MD&A and Note 7, “RAL and RT Programs” of the Consolidated Financial Statements. For the 2009 RAL season, however, the Company was not able to secure a securitization facility as a result of the current economic conditions and the crisis in the U.S. credit markets. In place of a securitization facility, the

Company purchased $1.28 billion of brokered CDs and entered into a syndicated funding line of approximately $524 million which may be drawn upon as needed throughout the 2009 RAL season. There can be no assurance that the Company will have access to a securitization facility or similar alternative sources of funding in future periods. In addition, while the Company expects that the transaction volumes, product mix and loss rates for the 2009 RAL season will be similar to 2008, the profitability of the RAL and RT Programs in 2009 is expected to be lower than in prior years due to an increase in funding costs and reduced recoveries of prior year charged-off RALs.

There is increased legislative and regulatory focus on RALs, including proposed state and Federal legislation to limit interest rates or fees, to curtail sharing of taxpayer information, to impose additional costs and rules on the RAL business and to otherwise limit or prohibit RALs. State attorneys general have also initiated public inquiries in response to consumer advocate complaints into the RAL product and the practices of the tax preparers offering RALs. We cannot determine whether such legislative or regulatory initiatives will be adopted or predict the impact such initiatives would have on the Company’s results.

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 our 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 or adverse regulatory action against us. 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, we 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, 2008, $2.0 billion or 35.2%, of our loan portfolio consisted of commercial real estate loans, including loans for the acquisition and development of property. Commercial real estate loans

constitute a greater percentage of our loan portfolio than any other loan category, including residential real estate loans secured by one to four family units,(“one to four family”) which totaled $1.1 billion or 19.1%, of our total loan portfolio at December 31, 2008. In addition, at December 31, 2008, $1.2 billion or 20.1%, of our loan portfolio consisted of commercial loans. Commercial real estate loans and commercial loans generally expose a lender to greater risk of non-payment and loss than one to four family loans because repayment of the loans often depends on the successful operation of the property and/or the income stream of the borrower. Commercial loans expose us to additional risks since they are generally secured by business assets that may depreciate over time. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one to four family loans. Also, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one to four family loan. Changes in economic conditions that are out of the control of the borrower and lender could impact the value of the security for the loan, the future cash flow of the affected property or borrower, or the marketability of a construction project with respect to loans originated for the acquisition and development of property. Additionally, any decline in real estate values may be more pronounced with respect to commercial real estate properties than residential real estate properties. While we intend to reduce the concentration of such loans in the Bank’s loan portfolio, there can be no assurance that Management will be successful in doing so.

Competition from Financial Service Companies

The Company faces increased strong competition from financial services companies and other companies that offer banking services. The Company conducts most of its operations in California. Increased competition in its markets may result in reduced loans and deposits. Ultimately, the Company may not be able to compete successfully against current and future competitors as many competitors offer some of the banking services that the Bank offers in service areas. These competitors include national banks, regional banks and other community banks. The Company also faces competition from many other types of financial institutions, including savings institutions, industrial banks, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, the 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 and a range in quality of products and services provided, including new technology-driven products and services. If the Bank is unable to attract and retain banking customers, it may be unable to continue loan growth and level of deposits.

Operational Risk

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 us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or perceived conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.

Goodwill Impairment

At a minimum, Management is required to assess goodwill and other intangible assets annually for impairment. Goodwill is recognized when a Company acquires a business and the purchased assets and liabilities are recorded at fair value. The fair value of most financial assets and liabilities are determined by estimating the discounted anticipated cash flows from or for the instrument using current market rates applicable to each asset and liability. Excess of consideration paid to acquire a business over the fair value of the net assets is recorded as goodwill. The calculation of goodwill and the determination of impairment is an estimate subject to ongoing review based on certain factors such as declines in stock price, adverse economic conditions in the U.S. and international financial markets, unprecedented lack of liquidity, uncertainty regarding future economic policy and banking regulation changes and negative market sentiment towards the banking industry in general, and additional impairment may be assessed in the future periods. If an impairment of goodwill is assessed, this could have a material affect on the Company’s results of operations and capital levels.

Dividends from the Bank

The availability of dividends from PCBNA is limited by various statutes and regulations. It is possible, depending upon the financial condition of PCBNA and other factors, that the OCC could assert that payment of dividends or other payments is an unsafe or unsound practice. In addition, the payment of dividends by other subsidiaries is also subject to the laws of the subsidiary’s state of incorporation, and the Company’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event that PCBNA was unable to pay dividends to the Company, we in turn would likely have to reduce or stop paying dividends on the Company’s common shares. The Company’s failure to pay dividends on the Company’s common shares could have a material adverse effect on the market price of the Company’s common shares. Additional information regarding dividend restrictions is included in the section captioned Regulation and Supervision on page 67.

Restrictions Resulting from Participation in the TARP CPP

Pursuant to the terms of the Securities Purchase Agreement, the Company’s ability to declare or pay dividends on any of the Company’s shares is limited. Specifically, the Company may be unable to declare dividend payments on common shares, junior preferred shares or pari passu preferred shares if the Company is in arrears on the payment of dividends on the Series B Preferred Stock. Further, the Company is not permitted to increase dividends on our common shares above the amount of the last quarterly cash dividend per share declared prior to October 14, 2008 ($0.22 per share) without the U.S. 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

ability to repurchase its shares is restricted. The consent of the U.S. Treasury generally is required for the Company to make any stock repurchase (other than in connection with the administration of any employee benefit plan in the ordinary course of business and consistent with past practice) until November 21, 2011, unless all of the Series B Preferred Stock has been redeemed or transferred by the U.S. Treasury to unaffiliated third parties. Further, common shares, junior preferred shares or pari passu preferred shares may not be repurchased if the Company is in arrears on the payment of Series B Preferred Stock dividends. The terms of the Securities Purchase Agreement allow the U.S. Treasury to impose additional restrictions, including those on dividends and including unilateral amendments required to comply with changes in applicable Federal law.

In addition, pursuant to the terms of the Securities Purchase Agreement, the Company adopted the U.S. 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 Company’s Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers. The standards include (i) ensuring that incentive compensation plans and arrangements for senior executive officers do not encourage unnecessary and excessive risks that threaten the Company’s value; (ii) required clawback of any bonus or incentive compensation paid (or under a legally binding obligation to be paid) to a senior executive officer based on materially inaccurate financial statements or other materially inaccurate performance metric criteria; (iii) prohibition on making “golden parachute payments” to senior executive officers; and (iv) agreement not to claim a deduction, for Federal income tax purposes, for compensation paid to any of the senior executive officers in excess of $500,000 per year. In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of the 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, 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 for departure from a company, (iii) an expanded clawback of bonuses, retention awards, and incentive compensation if payment is based on materially inaccurate statements of earnings, revenues, gains or other criteria, (iv) prohibitions on compensation plans that encourage manipulation of reported earnings, (v) retroactive review of bonuses, retention awards and other compensation previously provided by TARP recipients if found by the Treasury to be inconsistent with the purposes of TARP or otherwise contrary to public interest, (vi) required establishment of a company-wide policy regarding “excessive or luxury expenditures,” and (vii) inclusion in a 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, we may issue additional securities, through public or private offerings, in order to raise additional capital. It is also possible that the 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.

Anti-Takeover Provisions

Various provisions of the Company’s articles of incorporation and bylaws and certain other actions the Company has taken could delay or prevent a third-party from acquiring the Company even if doing so might be beneficial to the Company’s shareholders. These include, among other things, a shareholder rights plan and the authorization to issue “blank check” preferred stock by action of the Company’s Board of Directors acting alone, thus without obtaining shareholder approval. The Bank Holding Company Act of 1956, as amended, and the Change in Bank Control Act of 1978, as amended, together with Federal regulations, require that, depending on the particular circumstances, either regulatory approval must be obtained or notice must be furnished to the appropriate regulatory agencies and not disapproved prior to any person or entity acquiring “control” of a national bank, such as PCBNA. These provisions may prevent a merger or acquisition that would be attractive to shareholders and could limit the price investors would be willing to pay in the future for the 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 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 success depends to a significant degree upon 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’s executive offices are located at 1021 Anacapa Street, Santa Barbara, California. In addition, the Company occupies five administrative premises for support department operations in Santa Barbara, Ventura, Monterey and Los Angeles counties. These offices include human resources, information technology, loan and deposit operations, finance and accounting, and other support functions. In addition, the Company has several locations that are leased and owned for storage and parking, that are not included in the number of leased or owned properties below.

Of the Company’s 51 branches, 38 are leased and 13 are owned. In addition, the Company owns the master lease on a retail shopping center where one of its retail branches offices is located. This lease is classified as a capital lease in the Company’s Consolidated Financial Statements.

The Company also occupies 17 loan production offices that include administrative support. Of the 17 locations, 15 are leased and two are owned. The California offices are located in Santa Barbara,

Monterey, San Benito, South Santa Clara, San Diego, San Luis Obispo, Orange, Sacramento and Los Angeles Counties. These production offices originate various loan products including SBA, RALs, commercial real estate, residential real estate, commercial, consumer and private banking.

The Company continually evaluates the suitability and adequacy of the Company’s offices and has a program of relocating or remodeling them as necessary to maintain efficient and attractive facilities. Management believes that its existing facilities are adequate for its present purposes.

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 131. The Company does not expect that these suits will have any material impact on its financial condition or operating results.

The Company is involved in various other litigation of a routine nature that is being handled and defended in the ordinary course of the 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.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

PART II

ITEM 5.

MARKET FOR THE REGISTRANT’S 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:


	*2008 Quarters*								2007 Quarters
	*Fourth*		*Third*		*Second*		*First*		Fourth		Third		Second		First
Range of stock prices:
High	$	21.42	$	27.99	$	24.15	$	23.50	$	28.79	$	27.49	$	32.63	$	34.46
Low		11.25		9.88		13.76		16.08		16.71		19.70		24.24		29.95

Dividends

The Company declares cash dividends to its shareholders each quarter. The Company’s dividend policy is disclosed in the Capital Resources section on page 59 of this Form 10-K. The following table presents cash dividends declared per share for the last two years:


	*2008 Quarters*								2007 Quarters
	*Fourth*		*Third*		*Second*		*First*		Fourth		Third		Second		First
Cash dividends declared:	$	0.22	$	0.22	$	0.22	$	0.22	$	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 and Regulation and Supervision discussion of “Dividends and Other Transfer of Funds”.

Holders

There were approximately 18,488 shareholders of record at December 31, 2008. This number includes an estimate of the number of shareholders whose shares are held in the name of brokerage firms or other financial institutions. The Company is not provided with the exact number or identities of these shareholders, but has estimated the number of such shareholders from the number of shareholder documents requested by these firms for distribution to their customers.

Based on filings with the SEC by institutional investors, approximately 53.9% of the 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.

Share Repurchase

In August 2007, the Company’s Board of Directors approved a share repurchase program. The share repurchase program authorized the repurchase of $25.0 million of the Company’s common stock and was fully executed by the end of December 2007. This repurchase program replaced the previous share repurchase plan approved in August 2003. At December 31, 2008, there were no shares remaining to be repurchased.

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, 2008 with respect to shares of Company common stock that may be issued under our existing equity compensation plans, including the 2008 Equity Incentive Plan, 2002 Stock Plan and the 2005 Directors’ Stock Plan.


*December 31, 2008*
*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	1,838,975	$26.48	2,578,157
Equity compensation plans not approved by security holders	—	—	—

Total	1,838,975	$26.48	2,578,157

(a)	Included in column (a) are unexercised stock options granted to directors and employees through current and expired option plans. This amount includes unvested restricted stock granted.

(b)	This is the weighted-average exercise price of all stock options and restricted stock that is outstanding.

(c)	Securities remaining available for future issuance are for the 2008 Equity Incentive Plan and the 2002 Stock Plan.

ITEM 6.

SELECTED FINANCIAL DATA

The following table compares selected financial data for 2008 with the same data for the four prior years. The Company’s Consolidated Financial Statements and the accompanying notes presented in Item 8 and Management’s Discussion and Analysis in Item 7 beginning on the next page explain reasons for the year-to-year changes. The following data has been derived from the Consolidated Financial Statements of the Company and should be read in conjunction with those statements and the notes thereto, which are included in this report.


	*Year Ended December 31,*
	*2008*			2007		2006		2005		2004

	(in thousands)

Results of Operations:
Interest income	$	519,333		$	583,609	$	564,526	$	426,157	$	326,181
Interest expense		(178,819)			(222,411)		(190,767)		(111,505)		(69,211)

Net interest income		340,514			361,198		373,759		314,652		256,970
Provision for loan losses		(218,335)			(113,272)		(64,693)		(53,873)		(12,809)
Non-interest income		176,069			184,589		153,408		111,923		75,635
Non-interest expense		(339,568)			(275,442)		(315,064)		(214,405)		(179,906)

(Loss)/income before taxes		(41,320)			157,073		147,410		158,297		139,890
(Benefit)/provision for income taxes		(18,570)			56,185		52,870		59,012		51,946

Net (Loss)/income		(22,750)			100,888		94,540		99,285		87,944

Dividends and accretion of Preferred Stock		1,094			—		—		—		—

Net (loss)/income available to common shareholders	$	(23,844)		$	100,888	$	94,540	$	99,285	$	87,944


Per Share Data:
Average number of common shares - basic		46,273			46,816		46,770		45,964		45,535
Average number of common shares - diluted		46,644			47,082		47,099		46,358		45,911
(Loss)/income per common share - diluted	$	(0.52)	(1)	$	2.14	$	2.01	$	2.14	$	1.92
Book value per common share	$	16.91		$	14.49	$	13.17	$	11.69	$	10.05

Balance Sheet:
Total loans	$	5,635,085		$	5,359,156	$	5,718,833	$	4,897,286	$	4,062,294
Total assets	$	9,574,291		$	7,374,346	$	7,494,830	$	6,876,159	$	6,024,785
Total deposits	$	6,589,976		$	4,963,812	$	5,046,401	$	5,017,866	$	4,512,290
Long-term debt (2)	$	1,740,240		$	1,405,602	$	1,401,172	$	803,212	$	832,252
Total shareholders’ equity	$	788,437		$	668,356	$	617,376	$	545,256	$	459,682

Operating and Capital Ratios:
Leverage ratio		9.2%			8.8%		8.3%		8.1%		7.6%
Return on average total assets		n/a			1.4%		1.3%		1.6%		1.5%
Return on average total shareholder’s equity		n/a			15.3%		16.0%		19.2%		20.3%
Tier 1 capital to Average Tangible Assets ratio		8.8%			8.0%		7.5%		6.6%		6.3%
Tier 1 capital to Risk Weighted Assets ratio		11.8%			9.7%		8.8%		8.0%		8.2%
Total Tier 1 & Tier 2 Capital to Risk Weighted Assets ratio		14.6%			12.3%		11.7%		11.3%		12.1%
Dividend payout ratio		n/a			41.1%		43.8%		36.4%		35.9%

(1)	(Loss)/income per diluted common share for the year ended December 31, 2008 is calculated using basic weighted average shares outstanding.

(2)	Includes obligations under capital lease.

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FINANCIAL OVERVIEW AND HIGHLIGHTS

Pacific Capital Bancorp is a community bank holding company which provides full service banking, trust and investment advisory services and lending through its wholly-owned subsidiaries.

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

FINANCIAL RESULTS HIGHLIGHTS OF 2008

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

The significant factors impacting earnings of the Company during 2008 were:

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 resulted in a decline in the net interest margin from 5.24% at December 31, 2007 to 4.81% at December 31, 2008.

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.

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

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, 2008 throughout the analysis sections of this report.

FINANCIAL RESULTS HIGHLIGHTS 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.

FINANCIAL RESULTS HIGHLIGHTS OF 2006

The significant factors impacting earnings of the Company during 2006 were as follows:

$8.8 million recognized loss recorded on securities that were sold as part of the Company’s balance sheet management strategy in the first quarter of 2007.

$9.3 million asset write-down related to obsolete software.

$1.8 million gain on sale of the Company’s San Diego branch.

Net interest income from the RAL Program increased to $109.8 million from $61.7 million in 2005. In addition to higher transaction volume, this increase was due to the changes in the contract with JH. The offset to this increase in revenue is the non-interest expense increase of $54.7 million for the marketing and technology fee paid to JH in 2006.

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, 2008, 2007 and 2006:


	*Year Ended December 31,*
	*2008*		2007		2006

	(in thousands)

Interest income:
Loans:
Commercial loans	$	73,604	$	91,849	$	83,034
Consumer loans		39,804		58,453		65,996
Tax refund loans		108,762		118,568		118,123
Leasing loans		—		12,642		27,227
Real estate loans - commercial		167,951		172,336		153,536
Real estate loans - residential		67,904		78,127		60,243
Other loans		175		233		189

Total		458,200		532,208		508,348

Investment securities - trading		6,833		—		—
Investment securities - available for sale:
U.S. treasury securities		1,142		1,863		2,880
U.S. agencies		20,168		17,825		9,411
Asset-backed securities		141		162		223
CMO’s and MBS		16,448		17,520		32,018
State and municipal securities		13,276		11,197		11,263

Total		51,175		48,567		55,795

Commercial paper		622		—		—
Interest on deposits in other banks		702		—		—
Federal funds sold and securities purchased under agreements to resell		1,801		2,834		383

Total interest income	$	519,333	$	583,609	$	564,526


	Change 2008 with 2007			Change 2007 with 2006
	$		%	$		%

	(in thousands)
Interest income changes:
Loans:
Commercial loans	$	(18,245)	(19.9%)	$	8,815	10.6%
Consumer loans		(18,649)	(31.9%)		(7,543)	(11.4%)
Tax refund loans		(9,806)	(8.3%)		445	0.4%
Leasing loans		(12,642)	(100.0%)		(14,585)	(53.6%)
Real estate loans - commercial		(4,385)	(2.5%)		18,800	12.2%
Real estate loans - residential		(10,223)	(13.1%)		17,884	29.7%
Other loans		(58)	(24.9%)		44	23.3%

Total		(74,008)	(13.9%)		23,860	4.7%

Investment securities - trading:		6,833	—		—	—
Investment securities - available for sale:
U.S. treasury securities		(721)	(38.7%)		(1,017)	(35.3%)
U.S. agencies		2,343	13.1%		8,414	89.4%
Asset-backed securities		(21)	(13.0%)		(61)	(27.4%)
CMO’s and MBS		(1,072)	(6.1%)		(14,498)	(45.3%)
State and municipal securities		2,079	18.6%		(66)	(0.6%)

Total		2,608	5.4%		(7,228)	(13.0%)

Commercial paper		622	—		—	—
Interest on deposits in other banks		702	—		—	—
Federal funds sold and securities purchased under agreements to resell		(1,033)	(36.5%)		2,451	639.9%

Total interest income	$	(64,276)	(11.0%)	$	19,083	3.4%

Interest income for the year ended December 31, 2008 was $519.3 million, a decrease of $64.3 million or 11.0% when comparing interest income for 2008 to 2007. This decrease was mostly attributable to the FOMC reducing the Federal funds rate by 400 basis points since December 31, 2007 which impacted the entire loan portfolio, except RALs. The increase in nonaccrual loans also contributed to the decrease of interest income for loans. Commercial and consumer loans accounted for $36.9 million of the decrease in interest income due to the large number of those loans having adjustable interest rates. In addition, in 2007, the Company sold the indirect auto and leasing loan portfolios and discontinued the Holiday Loan product, which contributed $22.9 million of interest income in 2007 and $49.7 million of interest income in 2006.

Interest income by operating segment for the year ended 2008 compared to 2007, decreased for all operating segments. The largest decrease in interest income was in the Community Banking segment with a decrease of $43.9 million. This decrease was primarily caused by the sale of the indirect auto and leasing loan portfolios in 2007 and the discontinuation of the Holiday Loan product in 2007.

Interest income for the year ended December 31, 2007 was $583.6 million, an increase of $19.1 million or 3.4% when comparing interest income for 2007 and 2006. This increase was mostly attributable to the growth in commercial and residential real estate loans offset by a reduction in Collateralized Mortgage Obligations (“CMO”) and Mortgage Backed Securities (“MBS”) interest income and balances.

Interest income by operating segment for the year ended 2007 compared to 2006, increased for the Commercial Banking and Wealth Management segments by $27.1 million or 12.8% and $620,000 or 5.6%, respectively. This increase was partially offset by decreased interest income from the Community Banking and RAL and RT Programs segments of $4.3 million and $145,000, respectively.

INTEREST EXPENSE

Interest expense is incurred from interest paid on deposits and borrowings. The following tables present a summary of interest expense and the increases and decreases within the interest expense line items for the three years ended December 31, 2008, 2007 and 2006:


	*Year Ended December 31,*
	*2008*		2007		2006

	(in thousands)
Interest expense:
Deposits:
NOW accounts	$	10,267	$	24,577	$	22,848
Money market deposit accounts		11,824		26,525		20,438
Savings deposits		1,885		3,300		3,594
Time certificates of deposits		67,446		75,326		69,956

Total		91,422		129,728		116,836

Securities sold under agreements to repurchase and Federal funds purchased		13,076		17,997		18,054
Long-term debt and other borrowings:
FHLB advances		74,277		74,610		55,848
Other borrowings		44		76		29

Total		74,321		74,686		55,877

Total interest expense	$	178,819	$	222,411	$	190,767



	Change 2008 with 2007			Change 2007 with 2006
	$		%	$		%

	(in thousands)
Interest expense changes:
Deposits:
NOW accounts	$	(14,310)	(58.2%)	$	1,729	7.6%
Money market deposit accounts		(14,701)	(55.4%)		6,087	29.8%
Savings deposits		(1,415)	(42.9%)		(294)	(8.2%)
Time certificates of deposits		(7,880)	(10.5%)		5,370	7.7%

Total		(38,306)	(29.5%)		12,892	11.0%

Securities sold under agreements to repurchase and Federal funds purchased		(4,921)	(27.3%)		(57)	(0.3%)
Long-term debt and other borrowings:
FHLB advances		(333)	(0.4%)		18,762	33.6%
Other borrowings		(32)	(42.1%)		47	162.1%

Total		(365)	(0.5%)		18,809	33.7%

Total interest expense	$	(43,592)	(19.6%)	$	31,644	16.6%

Interest expense in 2008 was $178.8 million a decrease of $43.6 million or 19.6% when compared to 2007. This decrease is mostly attributable to the FOMC decreasing interest rates by 400 basis points since December 31, 2007 which mainly impacted the interest rates paid on deposits. While the Bank was successful in growing deposits during 2008, the interest paid on deposits decreased by 110 basis points when comparing the year ending December 31, 2008 to 2007.

Interest expense in 2007 was $222.4 million, an increase of $31.6 million, or 16.6% over 2006. This increase is due to higher interest rates paid on deposits and a reliance on wholesale borrowings such as Federal Home Loan Bank of San Francisco (“FHLB”) advances and overnight Federal funds purchased

to fund loan growth. Deposit growth was outpaced by loan growth as the Company faced continued competition for deposits from other financial institutions and brokerage firms during 2007 and 2006.

NET INTEREST MARGIN

The net interest margin is reported on a fully tax equivalent (“FTE”) basis. A tax equivalent adjustment is added to reflect that interest earned on certain municipal securities and loans which are exempt from Federal income tax. The following tables set forth the average balances and interest income on a fully tax equivalent basis and interest expense for the previous three years.


	*Year Ended December 31,*
	*2008*					2007
	*Average* *Balance*		*Interest*		Average Yield	Average Balance		Interest		Average Yield

	(in thousands)
Net Interest Margin:
Assets:
Commercial paper	$	22,807	$	622	2.73%	$	—	$	—	0.00%
Interest bearing demand deposits in other financial institutions		150,806		702	0.47%		—		—	0.00%
Federal funds sold		71,652		1,801	2.51%		54,588		2,834	5.19%

Total money market instruments		245,265		3,125	1.27%		54,588		2,834	5.19%

Securities: (1) (2)
Taxable		947,490		44,732	4.72%		801,248		37,370	4.66%
Non-taxable		257,959		18,721	7.26%		208,193		15,886	7.63%

Total securities		1,205,449		63,453	5.26%		1,009,441		53,256	5.27%

Loans: (1) (3)
Commercial (including leasing)		1,186,394		73,805	6.22%		1,206,318		104,592	8.67%
Real estate-multi family & nonresidential		2,718,452		168,442	6.20%		2,376,763		172,511	7.26%
Real estate-residential 1-4 family		1,138,774		67,904	5.96%		1,329,620		78,127	5.88%
Consumer		714,497		148,566	20.79%		1,005,943		177,021	17.60%
Other		3,085		175	5.67%		2,885		233	8.08%

Total loans, net		5,761,202		458,892	7.97%		5,921,529		532,484	8.99%

Total interest-earning assets		7,211,916	$	525,470	7.29%		6,985,558	$	588,574	8.43%

Market Value Adjustment		20,131					19,418
Noninterest-earning assets		659,276					491,852

Total assets	$	7,871,192				$	7,496,828

Liabilities and shareholders’ equity:
Interest-bearing deposits:
Savings and interest-bearing transaction accounts	$	1,981,853	$	23,976	1.21%	$	2,149,706	$	54,402	2.53%
Time certificates of deposit		2,046,064		67,446	3.30%		1,702,621		75,326	4.42%

Total interest-bearing deposits		4,027,917		91,422	2.27%		3,852,327		129,728	3.37%

Borrowed funds:
Repos and Federal funds purchased		394,410		13,076	3.32%		360,622		17,997	4.99%
Other borrowings		1,523,802		74,321	4.88%		1,409,453		74,686	5.30%

Total borrowed funds		1,918,212		87,397	4.56%		1,770,075		92,683	5.24%

Total interest-bearing liabilities		5,946,129		178,819	3.01%		5,622,402		222,411	3.96%

Noninterest-bearing demand deposits		1,094,126					1,118,460
Other liabilities		103,639					98,299
Shareholders’ equity		727,298					657,667

Total liabilities and shareholders’ equity	$	7,871,192				$	7,496,828


Tax equivalent net interest income/margin				346,651	4.81%				366,163	5.24%

Less: non-taxable interest from securities and loans				6,137	0.09%				4,965	0.07%

Net interest income			$	340,514	4.72%			$	361,198	5.17%

Loans excluding RALs	$	5,658,535	$	350,130	6.19%	$	5,593,785	$	413,916	7.40%
Consumer loans excluding RALs	$	611,830	$	39,804	6.51%	$	678,199	$	58,453	8.62%

(1)	Income and yield calculations are presented on a fully taxable equivalent basis.

(2)	Average securities balances are based on amortized historical cost, excluding Statement of Financial Accounting Standard (“SFAS”) 115 adjustments to fair value, which are included in other assets.

(3)	Nonaccrual loans are included in loan balances. Interest income includes related fee income.

(Continued)


	Year Ended December 31,
	2006
	Average Balance		Interest		Average Yield

	(in thousands)
Assets:
Commercial paper	$	—	$	—	0.00%
Interest bearing demand deposits in other financial Institutions		—		—	0.00%
Federal funds sold		8,283		383	4.62%

Total money market instruments		8,283		383	4.62%

Securities: (1) (2)
Taxable		1,068,100		44,532	4.17%
Non-taxable		209,558		17,116	8.17%

Total securities		1,277,658		61,648	4.83%

Loans: (1) (3)
Commercial (including leasing)		1,257,957		110,435	8.78%
Real estate-multi family & nonresidential		2,083,534		153,744	7.38%
Real estate-residential 1-4 family		1,063,618		60,243	5.66%
Consumer		908,475		184,119	20.27%
Other		2,949		189	6.41%

Total loans, net		5,316,533		508,730	9.57%

Total interest-earning assets		6,602,474	$	570,761	8.64%

Market Value Adjustment		(2,953)
Noninterest-earning assets		567,540

Total assets	$	7,167,061

Liabilities and shareholders’ equity:
Interest-bearing deposits:
Savings and interest-bearing transaction accounts	$	2,178,034	$	46,880	2.15%
Time certificates of deposit		1,733,608		69,956	4.04%

Total interest-bearing deposits		3,911,642		116,836	2.99%

Borrowed funds:
Repos and Federal funds purchased		391,123		18,054	4.62%
Other borrowings		1,118,528		55,877	5.00%

Total borrowed funds		1,509,651		73,931	4.90%

Total interest-bearing liabilities		5,421,293		190,767	3.52%

Noninterest-bearing demand deposits		1,164,716
Other liabilities		(10,369)
Shareholders’ equity		591,421

Total liabilities and shareholders’ equity	$	7,167,061


Tax equivalent net interest income/margin				379,994	5.76%

Less: non-taxable interest from securities and loans				6,235	0.10%

Net interest income			$	373,759	5.66%

Loans excluding RALs	$	5,176,579	$	390,607	7.55%
Consumer loans excluding RALs	$	768,521	$	65,996	8.59%

(1)	Income and yield calculations are presented on a fully taxable equivalent basis.

(2)	Average securities balances are based on amortized historical cost, excluding SFAS 115 adjustments to fair value, which are included in other assets.

(3)	Nonaccrual loans are included in loan balances. Interest income includes related fee income.

The following table set forth the change in average balances and interest income on a fully tax equivalent basis and interest expense for the last three years.


	*Year Ended December 31,*
	*2008 versus 2007*						2007 versus 2006

	(in thousands)

	*Changes due to*						Changes due to
	*Rate*		*Volume*		Total Change		Rate		Volume		Total Change
Commercial paper	$	—	$	622	$	622	$	—	$	—	$	—
Interest bearing demand deposits in other financial institutions		—		702		702		—		—		—
Federal funds sold		(1,747)		714		(1,033)		53		2,398		2,451
Investment securities		(317)		10,514		10,197		3,709		(12,101)		(8,392)
Total loans		(26,621)		(46,971)		(73,592)		(27,146)		50,900		23,754

Total interest-earning assets		(28,685)		(34,419)		(63,104)		(23,384)		41,197		17,813

Savings and interest-bearing transaction accounts		(26,465)		(3,961)		(30,426)		8,141		(619)		7,522
Time certificates of deposit		(21,291)		13,411		(7,880)		6,617		(1,247)		5,370

		(47,756)		9,450		(38,306)		14,758		(1,866)		12,892

Repos and Federal funds purchased		(6,479)		1,558		(4,921)		1,399		(1,456)		(57)
Other borrowings		(6,170)		5,805		(365)		3,526		15,283		18,809

		(12,649)		7,363		(5,286)		4,925		13,827		18,752

Total interest-bearing liabilities		(60,405)		16,813		(43,592)		19,683		11,961		31,644

Tax equivalent net interest income	$	31,720	$	(51,232)	$	(19,512)	$	(43,067)	$	29,236	$	(13,831)

Loans, excluding RALs	$	(68,519)	$	4,733	$	(63,756)	$	(7,849)	$	31,158	$	23,309

Note:

Income amounts are presented on a fully taxable equivalent basis.

The change not solely due to volume or rate has been prorated into rate and volume components.

The FTE net interest margin decreased to 4.81% for the year ended December 31, 2008 from 5.24% for the year ended December 31, 2007. The FTE net interest income decreased to $346.7 million in 2008 from $366.2 million in 2007, a decrease of $19.5 million. This decrease was driven by the FOMC’s 400 basis point decrease in the Federal funds rate since December 31, 2007. The FOMC rate decrease primarily impacted the interest-bearing liabilities and loans excluding RALs.

The FTE net interest margin decreased to 5.24% for the year ended December 31, 2007 from 5.76% for the year ended December 31, 2006. The FTE net interest income decreased to $366.2 million in 2007 from $380.0 million in 2006, a decrease of $13.8 million. The significant drivers of these decreases were the increase in loan growth and increased reliance of other borrowings to fund the loan growth and increased rates paid on deposits. The average balance of total net loans increased by $605.0 million. This increase caused interest income on loans to increase $50.9 million while the rates paid on loans decreased, which decreased interest income by $27.1 million. The average balance of other borrowings increased by $290.9 million. This increase accounted for $15.3 million of the $18.8

million increase in interest expense on other borrowings. Interest expense paid on deposits increased by $14.8 million due to increased rates paid on deposits of 38 basis points.

PROVISION FOR LOAN LOSSES

Quarterly, the Company determines the amount of allowance for loan losses (“ALL”) adequate to provide for losses inherent in the Company’s loan portfolios. The provision for loan losses is determined by the net change in the allowance for loan losses. For a detailed discussion of the Company’s allowance for loan losses, refer to the “Significant Accounting Policies” discussion in Note 1, of the Consolidated Financial Statements or in the “Critical Accounting Policies section” starting on page 64.

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


	*Years Ended December 31,*
					Change
	*2008*		2007		$		%

	(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 increased provision for loan losses was driven by the slowing economy which caused the Core Bank’s loan portfolio to experience higher than anticipated loan losses partially offset by increased recoveries for RALs due to enhanced credit screening procedures put in place for the 2008 RAL season. The increase in provision for losses for the Core Bank was driven by net charge-offs of $99.7 million during 2008 and an increase in nonaccrual loans of $148.2 million since December 31, 2007. A majority of the increase in net charge-offs and nonaccrual loans were from the construction loan portfolio. During 2008, the Bank also modified its ALL policy to enhance its use of qualitative factors in determining required allowance levels. These changes were made in large part due to the deteriorating conditions in the economy, which drove a significant portion of the increase in provision.

During 2008, RAL had net charge-offs of $21.8 million compared to $92.0 million of net charge-offs in 2007, a reduction of $70.2 million which is reported in the RAL and RT Program segment. The Commercial Banking segment’s provision for loan losses was $147.7 million, an increase of $138.4 million when comparing the year ended December 31, 2008 to 2007. The Commercial Banking segment holds a majority of the construction loan portfolio causing this increase.

A summary of the provision for loan losses for the comparable years ended December 31, 2007 and 2006 are as follows:


	*Year Ended December 31,*
					Change
	*2007*		2006		$		%

	(in thousands)
Provision for loan losses:
Core Bank	$	21,314	$	28,030	$	(6,716)	(24.0%)
RAL		91,958		36,663		55,295	150.8%

Total	$	113,272	$	64,693	$	48,579	75.1%

The provision for loan losses totaled $113.3 million in 2007, an increase of $48.6 million or 75.1% compared to 2006. The increased provision is due to the increased incidences of fraud in the RAL program which increased by $55.3 million for 2007 compared to 2006. The Company incurred larger than anticipated losses as a result of improved fraud screening by the IRS in 2007. The IRS made changes to its fraud detection system and penalty collection practices for the 2007 tax season which have both contributed to the increased losses on RALs. The RAL pre-file product also experienced higher losses due to the new IRS fraud detection system. The RAL pre-file product is a RAL product that was offered in advance of the taxpayer’s filing of their tax return, primarily in the month of January, for a portion of the anticipated refund amount. A RAL pre-file loan is repaid once a RAL or RT is funded by the IRS. In 2007, the Company decided to no longer offer the RAL pre-file product. The Company has also identified a high concentration of losses associated with certain tax preparers and RAL customers possessing certain characteristics.

The provision for loan losses excluding RALs declined by $6.7 million in 2007 compared to 2006 as a result of the sale of the higher risk indirect auto and leasing portfolios in the second quarter of 2007.

Excluding the RAL and RT Programs discussed above, provision for loan losses for the other operating segments declined by $6.7 million for the year ended 2007 compared to 2006. The Community Banking segment provision declined by $10.5 million but was partially offset by an increase of $3.8 million in provision for the Commercial Banking segment.

NON-INTEREST INCOME

Non-interest income primarily consists of fee income received from servicing deposit relationships, trust and investment advisory fees, RT fees earned from processing tax refunds, fees and commissions earned on certain transactions, unrealized gains and losses on the trading portfolio, impairment of available-for-sale (“AFS”) MBS and realized gains and losses on sold and called securities and gains and losses on the sale or disposal of assets.

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


	*Year Ended December 31,*
	*2008*		2007		2006

	(in thousands)

Non-interest income:
Refund transfer fees	$	68,731	$	45,984	$	44,939
Gain on sale of RALs, net		44,580		41,822		43,163
Service charges		17,607		17,686		16,497
Other service charges, commissions and fees		15,621		23,008		26,157
Trust and investment advisory fees		25,392		24,220		20,284
Gain on leasing portfolio sale, net		—		24,344		—
Loss on securities, net		(3,346)		(1,106)		(8,610)
Other		7,484		8,631		10,978

Total non-interest income	$	176,069	$	184,589	$	153,408


	*Change 2008 with 2007*			*Change 2007 with 2006*
	$		%	$		%

	(dollars in thousands)

Non-interest income changes:
Refund transfer fees	$	22,747	49.5%	$	1,045	2.3%
Gain on sale of RALs, net		2,758	6.6%		(1,341)	(3.1%)
Service charges		(79)	(0.4%)		1,189	7.2%
Other service charges, commissions and fees		(7,387)	(32.1%)		(3,149)	(12.0%)
Trust and investment advisory fees		1,172	4.8%		3,936	19.4%
Gain on leasing portfolio sale, net		(24,344)	(100.0%)		24,344	—
Loss on securities, net		(2,240)	202.5%		7,504	(87.2%)
Other		(1,147)	(13.3%)		(2,347)	(21.4%)

Total non-interest income	$	(8,520)	(4.6%)	$	31,181	20.3%

Total non-interest income was $176.1 million for the year ended December 31, 2008 compared to $184.6 million for the same period in 2007, a decrease of $8.5 million or 4.6%. Excluding the prior year gain on sale of the leasing portfolio in June 2007 of $24.3 million, the non-interest income for the comparable periods increased by $15.8 million for 2008 compared to 2007. This increase was primarily due to increased RT fees of $22.7 million. A summary of the significant activity within non-interest income by type is presented below.

Refund transfer fees

RT fees totaled $68.7 million for the year ended December 31, 2008 compared to $46.0 million in 2007 and $44.9 million in 2006. The increase in RT fees occurred primarily due to increased volume of RTs in 2008 as a result of the increased fraud screening of RALs. When a RAL is not approved for processing, a RT is offered to the taxpayer. The number of RT transactions increased by 1.5 million, or 30.8% when comparing the year ended December 31, 2008 to December 31, 2007.

Net gain on sale of RALs

The following table presents a summary of the gain on sale of RALs for the three years ended December 31, 2008, 2007 and 2006:


	*Year Ended December 31,*
	*2008*		2007		2006

	(in thousands)

Securitized loan fees	$	64,123	$	59,969	$	60,867
Investor securitization costs		(2,309)		(2,383)		(1,796)
Commitment fees		(2,320)		(1,575)		(1,155)
Credit losses, net		(14,914)		(14,189)		(14,753)

Net gain on sale	$	44,580	$	41,822	$	43,163

The Company recorded a net gain on sale of tax refund loans of $44.6 million, $41.8 million and $43.2 million for the years ended December 31, 2008, 2007 and 2006, respectively. These gains relate to the sale of RALs through a securitization and are discussed in Note 7, “RAL and RT Programs” of these Consolidated Financial Statements and below.

The securitization capacity was $1.60 billion in 2008, the largest since the Company started utilizing the securitization facility seven years ago. In 2007 and 2006, the capacity was $1.50 billion and $1.10

billion, respectively. The capacity had increased over the last few years to accommodate the annual increase in RAL balances each year. The gain on the securitization was much larger in 2008, 2007 and 2006 than in prior years due to a contract change with JH beginning with the 2006 RAL season. The gain is calculated in part by the total fees earned by the company on the loans sold into the securitization. Starting in 2006, the Company received 100% of the fees on RALs, while in prior years there was a fee splitting agreement between the Company and JH. Additional expense related to this contract change is recorded in non-interest expense as program and technology fees.

All loans sold into the securitization are either fully repaid or repurchased by the Bank at the termination of the securitization in mid-February of each calendar year, consistent with the terms of the Securitization Agreement. At March 31, these repurchased loans are reported in the balance sheet as RAL loans and become subject to the same charge-off criteria as RALs retained on the balance sheet since origination. Charge-offs and recoveries are recorded through the allowance for loan losses subsequent to the end of the first quarter of each calendar year.

The securitization of RALs also changes how some of the income and expenses are accounted for. All of the cash flows associated with the RALs sold to the Company’s securitization partners are reported net as a gain on sale of RALs. The gain on the securitization of RALs is further explained in Note 7, “RAL and RT Programs” within our Consolidated Financial Statements on page 115.

For the 2009 RAL season, the Company was not able to utilize the same securitization facility as it had in previous years due to the current economic conditions. In place of the securitization, the Bank will utilize lines of credit and brokered CDs. The Company expects that the transaction volumes, product mix and loss rates for the 2009 RAL season to be similar to 2008. However, the profitability is expected to be lower than in prior years due to an increase in funding costs and reduced recoveries of prior year charged-off RALs.

Net gain on sale of leasing portfolio

In June 2007, the Company sold the leasing loan portfolio for a gain on sale of $24.3 million. The gain is disclosed as a separate line item of non-interest income. The details related to this sale are described in Note 6, “Loan Sales and Transactions” of the Consolidated Financial Statements.

Loss on securities, net

Loss on securities, net for the year ended December 31, 2008 was $3.3 million, an increase of $2.2 million compared to 2007. The increase in the loss on securities of $2.2 million was attributed to increased impairment of MBS held in the AFS portfolio of $2.8 million and realized losses on the future positions held of $4.9 million resulting from declining interest rates as described in Note 22, “Derivative Instruments” on page 137 of the Consolidated Financial Statements. These losses were offset by an increase in the market value of trading securities of $5.1 million and realized gain on sale of trading securities of $2.4 million which were caused by the decrease in interest rates during 2008.

Net loss on securities for the year ending December 31, 2007 and 2006 were $1.1 million and $8.6 million, respectively. These losses are mostly attributed to the Company’s impairment losses on securities in the fourth quarter of each year. In December 2007, Management changed intent to no longer hold certain impaired AFS MBS securities to maturity or ultimate recovery. As a result of this decision, a $3.0 million impairment was taken on the $250.4 million AFS MBS portfolio at December 31, 2007. At December 31, 2006, Management made the decision to sell the 2003 and 2004 leveraging strategy portfolio and realized an $8.8 million impairment loss due to a decision to sell this portfolio in 2006. Additional discussion regarding the impairments taken on securities and the activity in the securities portfolio is disclosed in the “Investment Securities” section of the MD&A and in Note 4, “Securities” of the Consolidated Financial Statements.

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,*
	*2008*		2007		2006

	(in thousands)

Non-interest expense:
Salaries and benefits	$	127,893	$	128,259	$	130,749
Refund program marketing and technology fees		46,257		44,500		54,706
Occupancy expense, net		25,440		21,952		19,631
Goodwill Impairment		22,068		—		—
Furniture, fixtures and equipment, net		8,853		9,551		10,492
Other		109,057		71,180		99,486

Total non-interest expense	$	339,568	$	275,442	$	315,064


	*Change 2008 with 2007*			*Change 2007 with 2006*
	$		%	$		%

	(in thousands)

Non-interest expense changes:
Salaries and benefits	$	(366)	(0.3%)	$	(2,490)	(1.9%)
Refund program marketing and technology fees		1,757	3.9%		(10,206)	(18.7%)
Occupancy expense, net		3,488	15.9%		2,321	11.8%
Goodwill Impairment		22,068	—		—	—
Furniture, fixtures and equipment, net		(698)	(7.3%)		(941)	(9.0%)
Other		37,877	53.2%		(28,306)	(28.5%)

Total non-interest expense	$	64,126	23.3%	$	(39,622)	(12.6%)

Non-interest expense is comprised of expense incurred for the operations of the Company. The most significant are those expenses attributed to employee salaries and benefits.

Salaries and benefits

The following table summarizes the components of salaries and benefits expense for the three years ended December 31, 2008, 2007 and 2006.


	*Year Ended December 31,*
	*2008*		2007		2006

	(in thousands)

Salaries	$	93,548	$	93,103	$	89,548
Benefits		11,552		13,019		15,984
Bonuses		10,812		8,944		12,130
Payroll taxes		6,973		6,756		7,360
Commissions		5,008		6,437		5,727

Total	$	127,893	$	128,259	$	130,749

Salaries and benefits were $127.9 million for the year ended December 31, 2008 compared to $128.3 million for the same period in 2007. The slight decrease in salary and benefits is due to a decrease in benefit and commission expense offset by an increase in performance related bonuses of $1.9 million.

The $2.5 million decrease in salary and benefits expense for the year ended December 31, 2007 compared to December 31, 2006 was mostly attributed to decreases in benefit costs and bonus expense of $3.0 million and $3.2 million, partially offset by a $1.7 million increase in severance compensation. The increased severance was primarily due to staff reductions in conjunction with the sale of indirect auto and leasing loan portfolios as well as strategic re-alignments within the business units.

Refund program marketing and technology fees

The refund program and marketing technology fees paid to JH were $46.3 million, $44.5 million and $54.7 million for the years ended December 31, 2008, 2007 and 2006, respectively. The refund program marketing and technology fees are associated with the RAL and RT Programs’ activity. Starting with the 2006 RAL season, a revised contract with JH was entered into where the Company agreed to pay a fixed fee to JH for program and technology services which are reported in this line item. In exchange for paying the program and technology fee to JH the Company received 100% of the interest and fee income related to the RAL and RT Programs and also assumed 100% of the loan losses associated with the RAL Program.

The reduction in the refund program marketing and technology fee paid for 2007 compared to 2006 is due to fewer transactions processed in 2007 than in 2006.

Pursuant to the terms of the Program Agreement, PCBNA pays a fixed annual program fee to JH in exchange for marketing rights. JH designates the number of offices that will process RALs and RTs for PCBNA. The designated group of offices represents the market available to PCBNA in a given year. As the market share may change each year, the program fee is correspondingly adjusted to reflect the value of the market share. The fee is calculated based on forecasted RAL and RT volumes. To the extent volumes are significantly different than forecast, the fees paid under the Program Agreement are adjusted accordingly. PCBNA paid a Program Agreement fee of $23.9 million, $24.0 million and $23.0 million for approximately 68%, 60% and 70% of JH volume in 2008, 2007 and 2006, respectively.

Pursuant to the terms of the Technology Agreement, PCBNA pays a fixed technology fee to JH for processing services. In the event the actual annual business volume acquired by PCBNA is different than the predictive factors used to derive the technology payment, PCBNA has a contractual right to adjust the fees paid under the Technology Agreement. PCBNA paid a fixed technology fee of $21.2 million, $20.5 million and $26.0 million in 2008, 2007 and 2006, respectively.

Net Occupancy Expense

Net occupancy expense increased in 2008 and 2007 by $3.5 million and $2.3 million, respectively. The increase in 2008 is due to the following: new retail branches opened in Wood Ranch in Simi Valley and Casa Dorinda in Santa Barbara; a new commercial and wealth management banking center in Torrance; the addition of REWA office space; and a new office in San Diego for the RAL and RT operations.

The Company is reviewing all of the retail branch locations to ensure that they meet the strategic initiatives of the Company and continue to meet the needs of the Bank’s customers. Currently, one of the Santa Maria and one of the Lompoc retail locations are scheduled to close in March and April of 2009, respectively. Both closings are pending regulatory approval and, both communities have retail

branches that are within five miles or less of the locations scheduled to be closed. In addition, with the sale of the Santa Paula and Harvard retail branches in October 2008, the Company anticipates net occupancy expense to decrease in future periods.

The increase in 2007 is the result of opening new locations, including the Madrone Village branch, two new commercial banking offices and three new administrative offices as well as a full year of the Paso Robles location added in 2006.

Goodwill Impairment

In the third quarter of 2008, the Company concluded that goodwill was impaired and recorded $22.1 million impairment. Goodwill is tested for impairment during the third quarter of each year or if Management determines there is a triggering event which may indicate a need to review goodwill for impairment. Given this current economic downturn and the ongoing events within the banking industry, Management has deemed it prudent to assess Goodwill for impairment on a quarterly basis for the foreseeable future. The year-end goodwill analysis did not result in any additional goodwill impairment. All goodwill impairment testing is performed by an independent third party in conjunction with Management.

In order to determine the fair value of each reporting unit in the third quarter of 2008, the Company reviewed the capitalized earnings of each reporting unit, the outlook of the current economic environment and took into consideration the transaction multiples of publicly traded financial institutions adjusted for a change in control. When the fair value of a reporting unit is less than its carrying value, the Company is required to utilize a Step 2 valuation approach in accordance with SFAS 142. All of the Company’s reporting units passed Step 1 of the annual SFAS 142 impairment analysis in the third quarter of 2008, except the Commercial Banking segment. The Step 2 goodwill impairment analysis of the Commercial Banking segment required the Step 1 fair value of the reporting unit to be allocated to all of the fair values of the underlying tangible and intangible assets and liabilities for purposes of calculating the fair value of goodwill. This allocation resulted in a $22.1 million goodwill impairment. The goodwill impairment calculation is an estimate subject to ongoing review as certain circumstances may cause additional impairment to be assessed in the future. For additional information on the accounting and estimates used in the annual review of goodwill, refer to the Critical Accounting Policies within the MD&A of this Form 10-K on page 65 and in Note 1, “Significant Accounting Polices” of the Consolidated Financial Statements.

Other expense

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


	*Year Ended December 31,*
	*2008*		2007		2006

	(in thousands)
Other Expense:
Software expense	$	18,332	$	15,270	$	31,570
Developer performance fees		12,048		4,963		4,613
Consulting and professional services		11,260		11,656		13,478
Customer deposit service and support		7,892		6,555		6,619
Reserve for off balance sheet commitments		6,907		(341)		(238)
Telephone and data		6,570		6,336		6,169
Legal, accounting and audit		5,980		4,343		7,093
Loan origination and collection		5,619		5,342		5,896
Other expense		34,449		17,056		24,286

Total	$	109,057	$	71,180	$	99,486

Other expense was $109.1 million for the year ended December 31, 2008, an increase of $37.9 million or 53.2% compared to the year-ended December 31, 2007. This increase was mostly attributable to increases in other expenses of $17.4 million. The increase in the other expense line item as disclosed above was primarily from the following items: $4.0 million accrued expense related to payments to MCM, a decrease in deferred loan origination expense in accordance with SFAS 91 of $3.3 million, an increase in litigation settlements of $3.0 million which is mostly related to the lawsuit disclosed in Note 18, “Commitments and Contingencies” as the Canieva Hood and Congress of California Seniors v. Santa Barbara Bank & Trust, Pacific Capital Bank, N.A., and Jackson-Hewitt, Inc. lawsuit, an increase in regulatory assessment payments paid to the Office of the Comptroller of Currency (“OCC”) and Federal Deposit Insurance Corporation (“FDIC”) of $2.8 million and an increase of $1.2 million for printed forms and supplies.

The Company recorded additional expense of $7.2 million during 2008 to increase the off-balance sheet reserve due to the downturn of the economy, the reserve was increased for unfunded loan commitments and letters of credits as disclosed in Note 5, “Loans” of this Form 10-K. The increase in RAL and RT developer performance fees of $7.1 million is the result of contractual volume incentives fee due to the increased volume for the 2008 RAL season. The increase in software expense of $3.1 million is mostly attributed to additional depreciation expense associated with capitalized software.

Total other expenses declined by $28.3 million, or 28.5% to $71.2 million for the year ended December 31, 2007 compared to the year ended December 31, 2006. The majority of this decline was generated from the strategic cost cutting initiatives of the Company, specifically declines in software and consulting expenses. Total software expense for 2007 compared to 2006 declined by $16.3 million, or 51.6% mostly from the $9.3 million of capitalized software written off in December 2006 as it was deemed obsolete or no longer in use. Legal, accounting and audit expenses for the comparable periods decreased by $2.8 million, or 38.8%.

PROVISION FOR INCOME TAXES

Provision for income taxes for the year ended December 31, 2008 was a tax benefit of $18.6 million compared to tax expense of $56.2 million for the year ended December 31, 2007. The decrease in tax expense (or increase in tax benefit) of $74.8 million for the comparable periods was primarily the result of lower pretax income. Pretax loss for the year ended December 31, 2008 was $41.3 million compared to pretax income of $157.1 million for the year ended December 31, 2007. This decrease in pretax income for the comparable periods was primarily due to an increased provision for loan losses and to $22.1 million of goodwill impairment in 2008. The decrease in pretax income, combined with an increase in low income housing partnership tax credits, increased the effective tax rate to 44.9% compared with 35.8% for the year ended December 31, 2007.

The effective rates during all periods differed from the applicable statutory Federal (35%) and State (10.84%) tax rates due to various factors, including tax-exempt interest income, the $22.1 million goodwill impairment charge and low income housing partnership tax credits of $5.1 million.

For additional information related to the Company’s provision for income taxes for the years ended December 31, 2008, 2007 and 2006, refer to Note 16, “Income Taxes” of the Consolidated Financial Statements.

BALANCE SHEET ANALYSIS

CASH AND CASH EQUIVALENTS

Cash and cash equivalents was $1.94 billion at December 31, 2008 compared to $141,000 at December 31, 2007. This increase is a result of additional brokered CDs purchased during the fourth quarter of 2008 for the funding of the 2009 RAL season. In addition, the FRB started paying interest on the cash left in the Bank’s correspondent bank account starting in the fourth quarter of 2008. In previous years, a minimal amount of cash was left at the FRB as interest was not paid on the cash so, any excess cash was invested in short-term investments to obtain interest income.

INVESTMENT SECURITIES

The investment security portfolio of the Company is utilized as collateral for borrowings, required collateral for public agencies and trust customers deposits, Community Reinvestment Act (“CRA”) support, and to manage liquidity, capital and interest rate risk.

At December 31, 2008, 2007 and 2006 the Company held the following investment securities.


	*December 31,*
	*2008*		2007		2006

	(in thousands)

Trading:
Mortgage-backed securities	$	213,939	$	146,862	$	—

Total trading securities		213,939		146,862		—

Available for Sale:
U.S. Treasury obligations		37,475		39,997		64,149
U.S. Agency obligations		600,130		479,490		206,232
Collateralized mortgage obligations		17,092		23,861		63,984
Mortgage-backed securities		212,256		382,943		586,295
Asset-backed securities		1,034		2,198		3,030
State and municipal securities		310,756		248,398		243,452

Total available-for-sale securities		1,178,743		1,176,887		1,167,142

Total Securities	$	1,392,682	$	1,323,749	$	1,167,142

Total investment securities held by the Company increased $68.9 million at December 31, 2008 compared to 2007. This increase is mostly attributable to the securities placed in the MBS held in the trading portfolio and purchases of U.S. Agency and municipal securities.

Trading

At December 31, 2008 and 2007, the Company held $213.9 million and $146.9 million, respectively of securities classified as trading. In January 2008 and October 2008, the Company transferred residential real estate loans held in the 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.

The table below summarizes the maturity distribution of the securities portfolio at December 31, 2008.


	*December 31, 2008*
	One year or less		After one year to five years		After five years to ten years		*After* *ten years*		*Total*

	(in thousands)

Maturity distribution:
Trading:
Mortgage-backed securities	$	—	$	73,241	$	93,401	$	47,297	$	213,939

Total trading		—		73,241		93,401		47,297		213,939

Available-for-sale:
U.S. Treasury obligations		25,622		11,853		—		—		37,475
U.S. Agency obligations		261,899		177,304		158,309		2,618		600,130
Mortgage-backed securities and
Collateralized mortgage obligations		4,388		85,050		126,432		13,478		229,348
Asset-backed securities		—		1,034		—		—		1,034
State and municipal securities		4,893		38,568		72,991		194,304		310,756

Total available-for-sale		296,802		313,809		357,732		210,400		1,178,743

Total	$	296,802	$	387,050	$	451,133	$	257,697	$	1,392,682

Tax equivalent weighted average yield:
Trading:
Mortgage-backed securities		—		5.19%		5.32%		5.15%		5.24%
Available-for-sale:
U.S. Treasury obligations		1.33%		2.91%		—		—		1.83%
U.S. agency obligations		1.35%		3.98%		4.66%		5.38%		3.02%
Mortgage-backed securities and
Collateralized mortgage obligations		5.23%		5.35%		5.43%		4.89%		5.37%
Asset-backed securities		—		7.03%		—		—		7.03%
State and municipal securities		9.85%		8.19%		8.71%		8.89%		8.78%

Total available-for-sale		1.54%		4.84%		5.72%		8.59%		4.93%

Overall weighted average		1.54%		4.91%		5.64%		7.96%		4.98%

The timing of the payments for MBS and CMO securities is estimated based on the contractual terms of the underlying loans adjusted for estimated prepayments. Issuers of certain investment securities have retained the right to call these securities before contractual maturity.

The table above presents the tax equivalent weighted average yields of investment securities held by the Company at December 31, 2008. State and municipal securities are tax-exempt for Federal tax purposes and this tax-exempt interest makes up almost all of the amounts shown for the line captioned “non-taxable interest from securities and loans” in the net interest margin table on pages 31 and 32 within the line item, “non-taxable interest from securities and loans” of the net interest margin table. Management is aware of one asset backed security held in the investment portfolio that has some sub-prime loans as the underlying collateral, however, this security is rated AAA, and all principal and interest payments are current.

Sales of Investment Securities

The Company sold $123.6 million and $317.6 million of investment securities during the years ended December 31, 2008 and 2007, respectively. The Company sold no investment securities in 2006. For the years ended December 31, 2008 and 2007, and 2006, net gains or (losses) on the sales and calls of securities were ($127,000), $1.9 million and $151,000, respectively.

In 2008, 2007, and 2006 respectively, $515.0 million, $234.6 million and $128.4 million of investment securities matured or were called prior to contractual maturity. A detailed summary of gains and losses on investment securities is included in Note 4, “Securities” of the Consolidated Financial Statements.

Included in the net loss on securities transactions at December 31, 2008 and 2007 are MBS impairment losses of $5.8 million and $3.0 million, respectively. The impairment loss recognized on these MBS is a result of Management’s change in intent to no longer necessarily hold MBS investment securities classified as available-for-sale in a temporary loss position until full recovery or maturity. This change in intent was to provide more flexibility to manage the Company’s liquidity, capital and interest rate risk. As a result of this change, future unrealized losses on AFS MBS will be recognized as impairment losses in the statement of operations, while unrealized gains will be recognized in other comprehensive income (“OCI”).

In December 2006, the Company decided to sell securities purchased in 2003 and 2004 as part of a leveraging strategy. While not liquidated until early 2007, the Company recognized an $8.8 million impairment loss in the fourth quarter of 2006. By the time the sale was executed in the first quarter of 2007, the securities had recovered a portion of their value due to changes in interest rates and the Company recognized a $1.6 million gain, for a total net loss recognized of $7.2 million. The proceeds from the sale were used to reduce wholesale borrowings and to reinvest in higher yielding securities

The securities portfolios are managed by the finance department to maximize funding and liquidity needs of the Company. The interest income on investment securities is included in the “All Other” segment reported in Note 24, “Segments” of the Consolidated Financial Statements.

Derivative Instruments

The Company has policies and procedures that permit limited types and amounts of derivative instruments to help manage interest rate risk. At December 31, 2008, the Company had $50.0 million of U.S. Treasury future contracts and the Company has entered into interest rate swap agreements with customers to mitigate their interest rate risk exposure associated with the loan they have with the Bank. Refer to Note 22, “Derivative Instruments” of the Consolidated Financial Statements.

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 four operating business segments: Community Banking, Commercial Banking, Wealth Management and RAL and RT Programs. The products offered by these segments include commercial, consumer, commercial and residential real estate loans and SBA guaranteed loans.

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


	*December 31,*
	*2008*		*2007*		*2006*		*2005*		*2004*

	(in thousands)

Real estate:
Residential	$	1,098,592	$	1,075,663	$	1,199,719	$	1,128,318	$	901,679
Multi-family residential		273,644		278,935		287,626		256,857		182,936
Commercial		2,031,790		1,568,336		1,421,877		1,161,056		1,028,278
Construction and land		553,307		651,307		536,443		374,500		286,387
Commercial		1,159,843		1,187,233		1,071,355		934,648		826,684
Home equity lines		448,650		394,331		372,637		319,195		212,064
Consumer		196,482		200,094		527,751		431,542		387,257
Leases		—		—		297,526		287,504		234,189
Other		2,548		3,257		3,899		3,666		2,820

Total loans	$	5,764,856	$	5,359,156	$	5,718,833	$	4,897,286	$	4,062,294

Percent of loans to total loans:
Real estate:
Residential		19.1%		20.1%		21.0%		23.0%		22.2%
Multi-family residential		4.7%		5.2%		5.0%		5.2%		4.5%
Commercial		35.3%		29.1%		24.9%		23.8%		25.3%
Construction and land		9.6%		12.2%		9.4%		7.6%		7.0%
Commercial		20.1%		22.2%		18.7%		19.1%		20.4%
Home equity lines		7.8%		7.4%		6.5%		6.5%		5.2%
Consumer		3.4%		3.7%		9.2%		8.8%		9.5%
Leases		0.0%		0.0%		5.2%		5.9%		5.8%
Other		0.0%		0.1%		0.1%		0.1%		0.1%

Total loans		100%		100%		100%		100%		100%

Net deferred fees included in the amounts above	$	7,705	$	6,881	$	7,069	$	6,208	$	7,116

The loan balances in the above table include net deferred or unamortized loan origination, extension, and commitment fees and deferred loan origination costs. These deferred amounts are amortized over the lives of the loans.

Net Growth in the Loan Portfolio

The loan portfolio at December 31, 2008 was $5.76 billion, an increase of $405.7 million since December 31, 2007. This increase was from the commercial real estate loan portfolio which increased $463.5 million during 2008. This increase was offset with a decrease in the construction and land portfolio of $98.0 million. The commercial real estate loan portfolio is from the Commercial Banking segment as well as a majority of the construction and land loan portfolios. Due to the high concentration of commercial real estate loans, the Company plans to aggressively reduce its concentrations in commercial real estate loans and will make less commercial real estate loans in 2009, participating with other investors when needed. During 2008, the Company sold SBA loans for a gain on sale of $1.2 million, residential real estate loans for a gain on sale of $756,000 and various other types of loans in conjunction with the sale of two branches in October 2008. A more detailed discussion regarding these sales is in Note 6, “Loan Sales and Transactions” of the Consolidated Financial Statements.

The Company’s total loan portfolio decreased by $359.7 million or 6.3% from $5.72 billion at December 31, 2006 to $5.36 billion at December 31, 2007. The majority of this decrease was due to strategic loan sales mostly offset by overall loan growth in the remaining portfolio.

During 2007, the Company completed three significant loan portfolio transactions totaling $761.0 million. All of the loan transactions were from the Community Banking segment. A summary of the loan carrying value at the time of transaction is as follows:

$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 converted 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 converted into MBS in December 2007. A detailed discussion of these loan transactions is included on page 112 within Note 6, “Loan Sales and Transactions” of the Consolidated Financial Statements.

The growth in loans during prior years 2004 through 2006 was primarily from residential real estate loans with increases of $265.4 million, $226.6 million, $92.6 million when comparing each of the respective years 2006, 2005, 2004 respectively. With residential real estate values increasing at rapid rates on the central coast of California during 2004 through 2006, residential real estate had significant growth during those periods. The loan growth was also supplemented with the acquisitions of FBSLO in 2005 and PCCI in 2004.

During 2005 the Company purchased FBSLO, which had approximately $217.2 million of loans, and in 2004 purchased PCCI, which had approximately $419.0 million in loans. Without the acquisition of FBSLO, loan growth would have been $617.8 million or 15.2% in 2005 and without the acquisition of PCCI, loan growth would have been $462.4 million or 14.5% in 2004.

Loans Held for Sale

At December 31, 2008, loans held for sale were $11.1 million. A majority of the loans held for sale were SBA loans. The remainder of the loans were residential real estate loans which were originated for sale. In the third quarter of 2008, the Company began to originate residential real estate loans for sale. All residential real estate loans held for sale at December 31, 2008 were sold by the end of January 2009.

At December 31, 2007, the Company held $68.3 million of loans held for sale. Loans held for sale are reported at the lower of cost or market. All the loans held for sale at December 31, 2007 were residential mortgage loans. The majority of these loans, $68.2 million, related to the transfer of residential real estate loans that were transferred into MBS which settled in January 2008.

Loans by Segments and Category

Community Banking

The Community Banking segment’s assets increased by $249.9 million when comparing December 31, 2008 to December 31, 2007. This increase was partially related to the increase in home equity loans of $54.3 million and residential real estate loans of $22.9 million. In 2007, the Community Banking segment assets decreased by $606.6 million or 16.6% primarily due to the loan transactions of $761.0 million in 2007.

Home equity lines continue to have increases in growth with a majority of the growth occurring in 2008, 2005 and 2004. In 2005, home equity loans saw the largest percentage increase of 50.5%. The increase in home equity loans was attributed to aggressive marketing efforts during 2005 and 2004. FBSLO contributed $15.5 million of the 2005 growth in the home equity category.

Within the consumer loan portfolio were the indirect auto loan portfolio and Holiday loans. Prior to the sale of the indirect auto loan portfolio and discontinuance of the Holiday loan product in 2007, these portfolios were the main sources of growth in consumer loans in prior years. As of December 31, 2006 and 2005, Holiday loans accounted for $86.3 million and $57.6 million of the consumer loans. Holiday loans were seasonal since they are all funded in the fourth quarter of each year and they are either paid off or charged-off during the first quarter of the following year. Holiday loans were offered by professional tax preparers to their clients. After experiencing a high loan loss rate on Holiday loans, the Company decided in 2007 to no longer originate these products.

The leasing portfolio was sold in 2007. Prior to the sale of the leasing portfolio, this portfolio experienced strong growth in 2005.

Commercial Banking

The Commercial Banking segment offers a complete line of commercial and industrial and real estate loan products, including SBA loans, traditional commercial loans and lines of credit, asset based lending, and letters of credit. Business units in this group also serve the real estate industry through land acquisition and development loans, construction loans for development of both commercial and residential subdivisions.

Before making these loans, the Company will review a number of factors including the customer’s historical performance, management, economic conditions facing the customer, capital structure, and any available collateral. Loans in the Commercial Banking segment may have fixed or variable interest rates, depending on the product.

The Commercial Banking segment assets grew by $362.3 million, or 9.8% in 2008 compared to 2007. This growth is mostly attributable to the growth in commercial real estate loans during 2008. When comparing the asset growth in 2007 to 2006, the Commercial Banking segment grew $455.0 million or 14.1%. The loan growth in 2007 and 2006 was across all commercial loan categories with commercial real estate loans leading the loan growth of $146.5 million in 2007 and $260.8 million in 2006.

In 2007, Management determined that the SBA loans should be moved to the Commercial Banking segment from the Community Banking segment. As of December 31, 2008, 2007, and 2006 SBA loans are included in this segment for comparability. In 2009, the SBA loans will be moved back to the Community Banking segment as the Community Banking segment is focusing on servicing small businesses while the Commercial Banking group is focusing on the business relationships within mid-market businesses.

Wealth Management

Business units in this group service customers that meet a certain level of income and liquidity criteria and are considered to have high net-worth. There is not a specific loan category related to Wealth Management segment as the Banks existing loan products are tailored to the meet the needs of the segment’s customers. The Wealth Management segment was combined with the Commercial Banking segment as of January 1, 2009 as both segments work with customers with high net-worth and who are owners of mid-market businesses.

RAL and RT Programs

No RALs were outstanding at December 31 of any year. All RALs are repaid or charged-off at December 31 of each year. RALs are a seasonal credit product extended to consumers during the first four months of any calendar year. The purpose of the RAL is to provide consumers with liquidity at the time they file for their tax refund. The Company works with third party tax preparers who facilitate the origination of RALs through an application process. RAL underwriting is based on information about the borrower as well as certain elements within the tax return. The source of repayment for the RAL is the IRS when it refunds the borrower’s excess tax payments.

In 2006, the Company and JH entered into two new contracts, a program contract and a technology services contract. These contracts provided for JH to reduce the proportion of its transactions directed to the Company from approximately the 80% proportion for 2005 to approximately 75% in the 2008 tax season, and changed the method by which JH was compensated for the services it provides to the Company. The fee-splitting arrangement provided for in the earlier contract is eliminated, and, under the new contracts with JH is compensated for services through fixed fees for program and technology services.

The change in the contracts had a substantial impact on the amount of revenue, but little impact on pre-tax income as the amount of the fixed fees is approximately equal to what would have been shared with JH under the previous contract. While the “economics” are virtually the same under the new contracts as under the old, the presentation is different. Under the previous contract, the fees were recognized net of the amount of the fee split with JH. Under the new contracts, the whole amount of the revenue from the RALs and RTs are recognized by the Company and the program and technology service fees are shown as expenses.

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


	*December 31, 2008*
	Due in one year or less		Due after one year to five years		Due after five years

	(in thousands)
Real Estate:
Residential
Floating rate	$	25	$	34	$	482,475
Fixed rate		2,072		950		613,036
Commercial
Floating rate		50,194		152,100		1,575,738
Fixed rate		27,076		250,481		249,845
Construction and Development
Floating rate		250,682		69,073		40,856
Fixed rate		146,170		23,575		22,951
Commercial, industrial and agricultural
Floating rate		396,335		248,396		281,020
Fixed rate		68,908		97,897		67,287
Home equity lines
Floating rate		4,180		31,190		279,129
Fixed rate		13		995		133,143
Consumer
Floating rate		87,775		19,451		4,707
Fixed rate		7,693		26,919		49,937
Other
Floating rate		—		—		—
Fixed rate		2,548		—		—

Total Loans	$	1,043,671	$	921,061	$	3,800,124

ALLOWANCE FOR LOAN LOSSES

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

Allocation of the Allowance for Loan Loss

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


	*December 31,*
	*2008*		2007		2006		2005		2004

	(in thousands)
Real estate:
Residential	$	16,294	$	3,180	$	3,194	$	2,458	$	2,031
Multi-family residential		3,184		890		932		868		613
Commercial		22,472		5,368		4,939		6,271		5,080
Construction and land		34,050		3,391		2,004		1,465		1,233
Commercial		40,494		22,567		19,538		16,842		22,771
Home equity lines		11,111		2,365		1,657		1,280		797
Consumer		13,303		7,082		17,724		14,640		11,413
Leases		—		—		14,683		11,774		10,039

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

Percent of loans to total loans:
Real estate:
Residential		19.1%		20.1%		21.0%		23.0%		22.2%
Multi-family residential		4.7%		5.2%		5.0%		5.2%		4.5%
Commercial		35.3%		29.1%		24.9%		23.8%		25.3%
Construction and land		9.6%		12.2%		9.4%		7.6%		7.0%
Commercial		20.1%		22.2%		18.7%		19.1%		20.4%
Home equity lines		7.8%		7.4%		6.5%		6.5%		5.2%
Consumer		3.4%		3.7%		9.2%		8.8%		9.5%
Leases		0.0%		0.0%		5.2%		5.9%		5.8%
Other		0.0%		0.1%		0.1%		0.1%		0.1%

Total allowance		100.0%		100.0%		100.0%		100.0%		100.0%

Total allowance for loan losses increased by $96.1 million at December 31, 2008 compared to December 31, 2007. The increase is attributed to the deteriorating economic environment. The primary drivers of the increased ALL are increased historical loss rates due to higher levels of charge-offs and increased problem loans requiring specific ALL reserves. The increased charge-offs and problem loans were mainly from the construction and development loans.

All changes in the risk profile of the various components of the loan portfolio are reflected in the allowance assignment. There is no assignment of allowance to RALs at December 31, 2008 as all unpaid RALs were charged-off prior to year-end.

The decrease in allowance for loan losses of $19.8 million, or 30.7% at December 31, 2007 compared to 2006 was primarily attributed to the loan portfolio sales during 2007. The loan portfolios sold consisted of higher risk loans and contributed a decrease of $20.6 million to the required ALL at the time of sale.

Allowance for Loan Losses—RALs

A RAL is charged-off when Management determines that payment from the IRS is unlikely. The Company does not receive formal notification from the IRS regarding the denial of any tax refund claims. As a result, Management relies on prior years experience with IRS payment patterns to determine expected collection time frames. Prior years experience has indicated that payment from the IRS becomes unlikely after tax refund payments are 4-6 weeks past due from the expected payment date. The IRS payment patterns have varied from year to year, so the Company has utilized the most recent period payment patterns to predict current year payments. As a result of the 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 through a new request procedure from the charged-off RAL customer. Some recoveries on prior year charge-offs occur when the taxpayer returns to a tax preparer that offers RALs or RTs through the Company. If the Company accepts the application for a RAL on the new refund claim or for an RT, the amount of the prior 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,*
	*2008*		2007		2006		2005		2004

	(in thousands)

Beginning balance	$	1,107	$	1,448	$	1,685	$	1,232	$	3,942
Additions, net		6,907		(341)		(237)		453		(2,710)

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

The Company has exposure to credit losses from extending loan commitments and letters of credit as well as from unfunded loans. Because the available funds have not yet been disbursed on these commitments and letters of credit, the face amount is not included in the outstanding balance reported for loans and leases. Consequently, any amount provided for credit losses related to these instruments is not included in the allowance for loan losses reported in the table above, but is instead accounted for as a loss contingency estimate. The changes to this liability have been recorded in other non-interest expense.

The Company recorded additional expense of $6.9 million during 2008 to increase the off-balance sheet reserve due to the downturn of the economy.

LOAN LOSSES

The table below summarizes the charge-offs and recoveries by loan category and credit loss ratios for the years presented:


	*Year Ended December 31,*
	*2008*		2007		2006		2005		2004

	(in thousands)

Balance, beginning of year	$	44,843	$	64,671	$	55,598	$	53,977	$	49,550
Charge-offs:
Real estate:
Residential		7,263		—		4		107		—
Multifamily Residential		740		—		—		—		—
Commercial		1,467		—		—		—		6
Construction and development		49,155		25		91		—		—
Commercial and industrial		32,282		5,433		5,286		4,435		5,985
Agricultural		391		—		216		489		—
Leasing		—		6,276		10,242		7,559		2,504
Home equity lines		7,659		787		—		55		—
RALs		53,752		116,726		60,092		48,955		12,511
Other consumer		8,416		15,169		11,011		9,791		7,266

Total charge-offs		161,125		144,416		86,942		71,391		28,272

Recoveries:
Real estate:
Residential		961		—		—		7		27
Multifamily Residential		—		—		—		—		—
Commercial		—		—		—		—		2
Construction and development		59		—		—		—		513
Commercial and industrial		3,035		1,175		2,119		1,862		6,090
Agricultural		—		529		43		—		1,394
Leasing		—		1,199		1,992		1,318		831
Home equity lines		237		5		—		19		—
RALs		31,984		24,766		23,432		10,745		4,043
Other consumer		3,399		4,265		3,736		3,505		1,847

Total recoveries		39,675		31,939		31,322		17,456		14,747

Net charge-offs		121,450		112,477		55,620		53,935		13,525
Adjustments from loan sales and acquisitions (1)		(820)		(20,623)		—		1,683		5,143
Provision for loan losses RALs		21,768		91,958		36,663		38,210		8,468
Provision for loan and lease losses core bank loans		196,567		21,314		28,030		15,663		4,341

Balance, end of year	$	140,908	$	44,843	$	64,671	$	55,598	$	53,977

(1)	The amounts reported in 2008 and 2007 are from loan sales and transfers. In August 2005, the Company acquired FBSLO and in March 2004 the Company acquired PCCI.


	*Year Ended December 31,*
	*2008*		2007		2006		2005		2004

	(dollars in thousands)

Ratio of net charge-offs to average loans outstanding		2.11%		1.90%		1.05%		1.22%		0.36%
Ratio of net charge-offs to average loans outstanding (core bank)		1.76%		0.37%		0.37%		0.36%		0.14%
Peer ratio of net charge-offs to average loans outstanding		0.85%		0.38%		0.24%		0.34%		0.49%

Average RALs	$	102,667	$	327,744	$	139,954	$	73,940	$	102,769
Average loans, core bank		5,657,082		5,593,598		5,176,579		4,363,905		3,702,100

Average total loans	$	5,759,749	$	5,921,342	$	5,316,533	$	4,437,845	$	3,804,869


Recoveries to charged-off, RALs		59.50%		21.22%		38.99%		21.95%		32.32%
Recoveries to charged-off, core bank loans		7.16%		25.90%		29.39%		29.91%		67.91%
Recoveries to charged-off, total loans		24.62%		22.12%		36.03%		24.45%		52.16%

Allowance for loan loss as a percentage of year-end loans		2.44%		0.84%		1.13%		1.14%		1.33%

Total charge-offs increased $16.7 million, or 11.6% for 2008 compared to 2007. The increased charge-offs were driven by the slowing economy which caused the Core Bank’s loan portfolio to experience higher than anticipated loan losses partially offset by decreased charge-offs for RALs due to enhanced credit screening procedures put in place for the 2008 RAL season. The majority of the Core Bank charge-offs were from the construction loan and commercial and industrial loan portfolios.

Total charge-offs increased by $57.5 million, or 66.1% in 2007 compared to 2006 due to an increase in RAL charge-offs of $56.6 million. The increase in RAL charge-offs was the result of increased losses in the RAL pre-file product and losses related to incidences of tax related fraud affecting RAL loans. Due to the higher loss rates on the RAL pre-file product and holiday loans, the Company discontinued these products. The increased loss rates experienced in the 2007 RAL program also caused Management to modify and enhance its underwriting criteria and fraud identification processes.

The increase in RAL charge-offs in 2004 and 2005 was the result of contract changes with JH. In the revised contract with JH, the Company assumed 100% of the credit risk associated with the RAL Program and, in exchange, the Company received a larger portion of the interest income and fees.

The Company is one of three major banks in the country that have national RAL Programs. Therefore, for comparability, charge-offs amounts and ratios for the Company are shown both with total loans and “other loans” which exclude RALs. In order to compare the ratio of net charge-offs to average loans to our peers, it is best to compare the ratio of net charge-offs to average loans excluding RALs. Exclusive of RALs, the ratio of net charge-offs to average loans over the last five years has varied from 0.14% to 1.76%

The ratio of allowance for loan losses to total loans for the years ended December 31, 2008, 2007 and 2006 was 2.44%, 0.84%, 1.13%, 1.14% and 1.33% , respectively. At December 31 of each year, the Company’s ratio of allowance for loan losses to total loans is lower than in previous quarters throughout the year primarily due to the seasonality of the RAL program.

NONACCRUAL, PAST DUE, AND RESTRUCTURED LOANS

The table below summarizes the Company’s nonaccrual and past due loans for the last five years.


	*December 31,*
	*2008*		2007		2006		2005		2004

	(dollars in thousands)

Nonaccrual loans	$	186,610	$	72,186	$	9,832	$	8,264	$	12,110
Loans past due 90 days or more on accrual status		14,045		1,131		264		1,227		820
Troubled debt restructured loans		33,737		—		7,217		8,326		9,591

Total nonperforming loans		234,392		73,317		17,313		17,817		22,521
Foreclosed collateral		7,100		3,357		2,910		2,910		2,910

Total nonperforming assets	$	241,492	$	76,674	$	20,223	$	20,727	$	25,431


Nonperforming loans as a percentage of total loans held for investment		4.07%		1.37%		0.30%		0.36%		0.55%
Nonperforming assets as a percentage of total assets		2.52%		1.04%		0.27%		0.30%		0.42%
Allowance for loan losses as a percentage of nonperforming loans		60%		61%		374%		312%		240%

Nonaccrual Loans

When a borrower discontinues making payments as contractually required by the note, the Company must determine whether it is appropriate to continue to accrue interest. Generally, the Company places loans in a nonaccrual status and ceases recognizing interest income when the loan has become delinquent by more than 90 days and/or when Management determines that the repayment of principal and collection of interest is unlikely. The Company may decide that it is appropriate to continue to accrue interest on certain loans more than 90 days delinquent if they are well secured by collateral and collection is in process.

When a loan is placed in a nonaccrual status, any accrued but uncollected interest for the loan is reversed out of interest income in the period in which the status is changed. Subsequent payments received from the customer are applied to principal and no further interest income is recognized until the principal has been paid in full or until circumstances have changed such that payments are again consistently received as contractually required. In the case of commercial customers, the pattern of payment must also be accompanied by a positive change in the financial condition of the borrower.

The increase in nonaccrual loans of $114.4 million is mostly attributed to the economic downturn that occurred during the latter part of 2008. A majority of this increase is associated with the construction loan portfolio which had nonaccrual loans of $101.2 million at December 31, 2008. The Company had restructured loans (“TDR”) of $33.7 million compared to no TDR loans at December 31, 2007. The economic downturn has also contributed to this increase. Several of the TDR loans were also from the construction loan portfolio and account for $28.2 million of the restructured loans. The Company had foreclosed collateral of $7.1 million and $3.4 million as of December 31, 2008 and 2007, respectively. The increase in foreclosed collateral is mostly land and commercial buildings which consists of $6.1 million of the $7.1 million balance at December 31, 2008.

The increase in nonaccrual loans of $62.4 million at December 31, 2007 compared to 2006 was mostly attributable to $45.1 million related to two large commercial relationships. At the end of 2008 the balance of these relationships was $24.8 million.

Foreclosed Collateral

Foreclosed collateral consists of other real estate owned (“OREO”) obtained through foreclosure for all five years presented in the table above. The Company held OREO at fair value less estimated costs to sell at December 31, 2008, 2007, 2006, 2005 and 2004 of $7.1 million, $3.4 million, $2.9 million, $2.9 million, and $2.9 million, respectively.

The table below sets forth the amounts of foregone interest income from nonaccrual loans for the last five years.


	*Year Ended December 31,*
	*2008*		2007		2006		2005		2004

	(in thousands)

Contractual interest	$	17,013	$	3,679	$	1,567	$	1,449	$	1,411
Interest collected		6,413		1,728		564		864		241

Foregone interest	$	10,600	$	1,951	$	1,003	$	585	$	1,170

OTHER ASSETS

Other assets at December 31, 2008 were $390.3 million, an increase of $106.1 million since December 31, 2007. This increase is attributed to the following items:

An increase in the deferred tax asset of $51.2 million which is primarily attributable to an increase in the Company’s loan loss provision. The 2008 loan loss provision, while not currently deductible, will result in a future tax benefit as the loans are charged off.

A $24.1 million increase in the carrying value of the interest rate swaps due to an increased number of customer swaps agreements entered into and changes in market values.

An $11.9 million increase in FHLB stock required for the increase in FHLB borrowings.

A $6.0 million addition to corporate taxes receivable resulting from expected refunds from current and amended tax fillings.

An increase in OREO properties of $3.7 million due to the decline in the economy.

Increased investment of low-income housing partnerships of $3.6 million.

DEPOSITS

The average balance of deposits by category and the average effective interest rates paid on deposits is summarized for the years ended December 31, 2008, 2007 and 2006 in the table below.


	*Year Ended December 31,*
	*2008*			2007			2006

	(in thousands)

	*Average*			Average			Average
	*Balance*		*Yield*	Balance		Yield	Balance		Yield
NOW accounts	$	1,069,908	0.96%	$	1,154,287	2.13%	$	1,172,181	1.95%
Money market deposit accounts		654,529	1.81%		721,550	3.68%		686,296	2.98%
Savings accounts		257,416	0.73%		273,869	1.20%		319,557	1.12%
Time certificates of deposit for
$100,000 or more		1,214,797	3.54%		1,004,376	4.96%		964,442	4.50%
Time certificates of deposit for less than $100,000		831,267	2.93%		698,245	3.66%		769,166	3.45%

Interest-bearing deposits		4,027,917	2.27%		3,852,327	3.37%		3,911,642	2.99%
Demand deposits		1,094,126			1,118,460			1,164,716

Total Deposits	$	5,122,043		$	4,970,787		$	5,076,358

Total deposits increased to $6.59 billion at December 31, 2008 from $4.96 billion at December 31, 2007, an increase of $1.63 billion or 32.8%. This increase was primarily from CDs as the Bank had marketing campaigns offering attractive interest rates to increase deposit growth and attract new customers. The Company has also increased Broker CDs by $1.14 billion during the fourth quarter of 2008 in preparation for funding the 2009 RAL Program. The Broker CDs are reported in the time certificates of deposit less than $100,000. In addition, in the fourth quarter of 2008, the Bank became a member of Certificate of Deposit Account Registry Service (“CDARS”) which provides FDIC insurance for large deposits which has also increased deposits in 2008. As disclosed in the table above, the interest rates paid on deposits decreased significantly over 2008 due to the decrease in interest rates by the FOMC.

In October 2008, the Company sold $54.4 million of deposits and associated buildings and equipment from the Santa Paula and Harvard branches. The Company recorded a $3.1 million gain on sale related to this transaction.

Certificates of Deposit of $100,000 or More

The table below discloses the distribution of maturities of Certificates of Deposit of $100,000 or more at December 31, 2008, 2007 and 2006:


	*December 31,*
	*2008*		2007		2006

	(in thousands)

Three months or less	$	617,622	$	573,588	$	553,648
Over three months through six months		420,485		198,849		327,783
Over six months through one year		316,235		230,916		198,054
Over one year		328,632		59,918		57,277

	$	1,682,974	$	1,063,271	$	1,136,762

LONG TERM DEBT AND OTHER BORROWINGS

Long-term debt and other borrowings increased $334.6 million or 23.8% from $1.41 billion at December 31, 2007. This increase was caused by the Bank’s strong loan growth during 2008. Included in this increase are short-term FHLB advances of $230.0 million which are due to be repaid in one year or less.

OTHER LIABILITIES

Other liabilities were $113.5 million at December 31, 2008 compared to $63.9 million at December 31, 2007, an increase of $49.6 million or 77.6%. The significant items attributed to this increase were:

$25.9 million increase in the carrying value of the interest rate swaps due to an increased number of customer swaps agreements entered into and changes in market values,

$8.2 million increase in the post retirement benefits liability due to lower than projected returns on the Voluntary Employees’ Beneficiary Association (“VEBA”) assets and benefit costs increased at a higher rate than projected for 2008,

$7.4 million increase in accrued interest which is mostly from the growth in deposits as average deposits increased $151.3 million for the comparable periods and,

$6.9 million increase in reserve for off balance sheet commitments due to the current economic conditions, the Company has increased this reserve.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

The Company has entered into a number of transactions, agreements, or other contractual arrangements whereby it has obligations that must be settled by cash or contingent obligations that must be settled by cash in the event certain specified conditions occur. The table below lists the Company’s contractual obligations.

December 31, 2008

Total

Less than
one year

One to
three
years

Three to
five years

More than
five years

(in thousands)

Deposits

6,589,976

6,033,228

496,603

59,704

441

Operating lease obligations

89,983

11,966

22,357

15,341

40,319

Capital lease obligations (1)

25,621

453

906

23,356

Long-term debt and other borrowings:

Federal Home Loan Bank advances

1,536,965

732,354

374,272

181,383

248,956

Treasury Tax & Loan amounts due

to Federal Reserve Bank

2,920

—

Subordinated debt issued by the Bank

121,000

—

71,000

50,000

Subordinated debt issued by the Company

69,426

—

69,426

Purchase obligations for service providers

103,923

50,888

53,035

—

Total contractual obligations

8,539,814

6,831,809

947,173

328,334

432,498

(1)	As of December 31, 2008, the Company’s liability associated with the capital lease was $9.9 million, as reported in Note 14, “Long-term Debt and Other Borrowings of the Consolidated Financial Statements. In the table above, the future capital lease obligation is reported.

Other commitments and obligations: In addition to the contractual obligations above, as a financial service provider, we routinely enter into commitments to extend credit to customers. The same credit practices are used in extending these commitments as in extending loans to our customers. These commitments are described in Note 5, “Loans” of our Consolidated Financial Statements. The Company also provides postretirement benefit plans to eligible retirees as described in Note 15, “Postretirement Benefits” of our Consolidated Financial Statements and, there are obligations and commitments associated with those plans.

Off-balance Sheet Reserve: As explained in Note 1, “Significant Accounting Policies” and Note 5, “Loans” of the Consolidated Financial Statements the Company must establish a reserve for off-balance sheet commitments for known or estimated losses relating to letters of credit or other unfunded loan commitments.

The Company has derivative instruments as disclosed in Note 22, “Derivative Instruments” of the Consolidated Financial Statements.

CAPITAL RESOURCES

As of December 31, 2008, the Company and PCBNA exceeded the guidelines and definitions for being deemed “well-capitalized” under the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”).

Capital Adequacy Standards

The Company and PCBNA are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements as specified by the regulatory framework for prompt corrective action could cause the regulators to initiate certain mandatory or discretionary actions that, if undertaken, could have a direct material effect on the Company’s financial statements. For additional information regarding the Company’s capital refer to Note 19, “Shareholders’ Equity” and Note 20, “Regulatory Capital Requirements” of the Consolidated Financial Statements.

The Company’s and PCBNA capital ratios as of December 31, 2008 and 2007 were as follows:


	Total Capital		Tier 1 Capital		Risk- Weighted Assets		Tangible Average Assets		Total Capital Ratio	Tier 1 Capital Ratio	Tier 1 Leverage Ratio

	(dollars in thousands)

December 31, 2008
PCB (consolidated)	$	880,523	$	712,003	$	6,016,764	$	8,107,248	14.6%	11.8%	8.8%
PCBNA		863,613		695,237		6,005,146		8,098,895	14.4%	11.6%	8.6%

December 31, 2007
PCB (consolidated)	$	720,625	$	568,075	$	5,847,905	$	7,126,286	12.3%	9.7%	8.0%
PCBNA		701,225		548,675		5,841,648		7,109,129	12.0%	9.4%	7.7%
Well-capitalized ratios									10.0%	6.0%	5.0%
Minimum capital ratios									8.0%	4.0%	4.0%

The minimum capital ratios the Company must maintain under the regulatory requirements to meet the standard of “adequately capitalized” and the minimum amounts and ratios required to meet the regulatory standards of “well capitalized” are in the table above at December 31, 2008 and 2007. Based on discussions with the OCC following the conclusion of the Bank’s most recent examination, Management expects the OCC to establish a minimum Tier 1 risk based capital ratio of 8.5% and a minimum total risk based capital ratio of 11%. Management expects that the Bank will continue to be deemed well capitalized notwithstanding the establishment of these expected minimum capital ratios.

Management also plans to maintain a capital plan in conjunction with discussions it has held with the OCC. This capital plan will be based on a rolling twelve month forecast, stressed accordingly for market conditions and the Company’s balance sheet conditions. If any capital shortfalls become apparent, Management will immediately activate contingency plans to address any such shortfalls, which may include additional capital raising, asset sales or other means as necessary, including the option of participating in the Capital Assistance Program. At this time, the Company significantly exceeds the expected minimum capital ratios, though conditions could change at any time given industry conditions.

Risk-weighted assets are computed by applying a weighting factor from 0% to 100% to the carrying amount of the assets as reported in the balance sheet and to a portion of off-balance sheet items such as loan commitments and letters of credit. The definitions and weighting factors are all contained in the regulations. However, the capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Pacific Capital Bancorp is the parent company and sole owner of PCBNA. However, there are legal limitations on the amount of dividends, which may be paid by PCBNA to PCB. The amounts, which may be paid as dividends by a bank are determined based on the bank’s capital accounts and earnings in prior years. As of December 31, 2008, PCBNA would have been permitted to pay up to $276.9 million to Pacific Capital Bancorp.

Availability of Capital

As a result of recent market disruptions, the availability of capital (principally to financial services companies) has become significantly restricted. While some companies have been successful in raising additional capital, the cost of the capital has been substantially higher than the prevailing market rates prior to the market volatility. Management cannot predict when or if the markets will return to more favorable conditions.

The Company received $180.6 million pursuant to the TARP CPP on November 21, 2008 as disclosed in Note 19, “Shareholders’ Equity” of the Consolidated Financial Statements.

There are four primary considerations Management must keep in mind in managing capital levels and ratios. The first is the Company must be able to meet the credit needs of our customers when they need to borrow. The second consideration is that the Company must be prepared to sell some of the loans it originates in order to manage capital targets. The third consideration is to divest of underperforming divisions or business lines. The fourth consideration is that as loan demand picks up in an improving economy, raising additional capital may be necessary. Management proactively maintains a capital plan which focuses on maximizing capital through a variety of sources including balance sheet make-up, the accretion or dilution of its various business lines, dividend payout ratios, and additional sources of capital where prudent. In 2008, via Management’s capital planning strategies, the Company raised $7.2 million in capital through the issuance of common stock through its Direct Stock Purchase Plan in the open market. Through the Direct Stock Purchase Plan, the Company has the ability to issue 4,500,000 shares of common stock. In 2007, the Company sold two underperforming divisions, the Indirect Auto Lending business and the Equipment Leasing business in line with its capital planning strategies.

In addition to the capital generated from the operations of the Company, a secondary source of capital growth has been the exercise of employee and director stock options. In 2008, the increase to capital from the exercise of options (net of shares surrendered as payment for exercises and taxes) was $287,000 or 0.2% of the net growth in shareholders’ equity in the year compared to $5.1 million or 10.1% in 2007. At December 31, 2008, there were approximately 1,415,000 options outstanding and

exercisable at less than the then-current market price of $16.88, with an average exercise price of $25.32. This represents a potential addition to capital of $35.8 million, if all options were exercised with cash. In addition, except for those options expiring in 2009, the options are likely to be exercised over a number of years since options generally have a ten year term.

In addition, the Company received $180.6 million pursuant to the TARP CPP on November 21, 2008 as disclosed in Note 19, “Shareholders’ Equity” of the Consolidated Financial Statements.

Dividends

The Company’s Board of Directors (“BOD”) has the responsibility for oversight and approval for the declaration of dividends and in January 2009, they adopted a new dividend policy. The new policy gives the Chief Financial Officer (“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 BOD approved the new dividend policy so to ensure sound capital management and to take into consideration the guidelines required under the TARP CPP.

With the new dividend policy described above, the BOD approved a reduction of the quarterly dividend to $0.11 per share effective for its March 31, 2009 payment date. The Company’s dividend payout ratio over the last three years has been 169.2% for 2008, 41.1% for 2007 and, 43.8% for 2006.

Under the terms of the TARP CPP, for so long as any Series B Preferred Stock remains outstanding, the Company is permitted to declare and pay dividends on its common stock only if all accrued and unpaid dividends for all past dividend periods on the Series B Preferred Stock are fully paid. Until the third anniversary of the sale of the Series B Preferred Stock, unless such shares have been transferred by the U.S. Treasury or redeemed in whole, any increase in dividends on the Company’s common stock above the amount of the last quarterly cash dividend per share declared prior to October 14, 2008 ($0.22 per share) will require prior approval of the U.S. Treasury. The terms of the Company’s agreement with the U.S. Treasury allow for additional restrictions, including those on dividends, to be imposed by the U.S. Treasury, including unilateral amendments required to comply with legislative changes. Under the ARRA, the Company may repay the U.S. Treasury without penalty and without the need to raise new capital, subject to the U.S. Treasury’s consultation with the appropriate regulating agency, in which event these restrictions would no longer apply.

The Bank can make dividend payments to the Company as required to fund the operating needs, debt service, and quarterly dividends of the Company as declared and approved by the Company’s BOD. For additional discussion on restrictions on the declaration and payment of dividends, refer to “Regulation and Supervision, Dividends and Other Transfer of Funds” on page 69

Impact of RAL and RT Programs on Capital Adequacy

Formal measurement of the capital ratios for the Company and PCBNA are done at each quarter-end. However, the Company does more frequent estimates of its capital classification during late January and early February of each year because of the large volume of RALs. RALs are 100% risk weighted and due to the large volume of RALs in January and February, Management monitors the Company’s capital ratios daily during these months. Management estimates that, if a formal computation of capital ratios were done, on certain days during those weeks it and PCBNA may be classified as adequately capitalized, rather than well-capitalized. The Company has discussed this with its regulators and creditors.

Management was not able to set-up a securitization facility for the 2009 RAL season due to the current economic conditions and current credit crisis the U.S. economy is currently experiencing. The securitization assisted in removing RALs from the Bank’s balance sheet to assist with maintaining their 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, broker CDs and entered into a syndicated funding line of $524 million which may be drawn upon as needed throughout the RAL season.

In Note 7, “RAL and RT Programs” in the Consolidated Financial Statements is a description of the securitization that the Company utilized as one of its sources for funding RALs. In 2008, the RAL securitization was a true sale of loans to other financial institutions, and except for the capital that must be allocated for the small-retained interest kept by the Company, the sales reduce the impact of RALs on the capital ratios for the Company.

LIQUIDITY

Liquidity is the ability to effectively raise funds on a timely basis to meet cash needs of our customers and the Company, whether it be to handle fluctuations in deposits, to provide for customers’ credit needs, or to take advantage of investment opportunities as they are presented in the market place.

The Company’s objective, managed through the Company’s Asset and Liability Committee (“ALCO”), is to ensure adequate liquidity at all times by maintaining adequate liquid assets, the ability to raise deposits and liabilities, and having access to additional funds via the capital markets.

The Company manages the adequacy of its liquidity by monitoring and managing its immediate liquidity, intermediate liquidity, and long term liquidity. ALCO monitors and sets policy and related targets to ensure the Company maintains adequate liquidity. The monitoring of liquidity is done over the various time horizons, to avoid over dependence on volatile sources of funding and to provide a diversified set of funding sources. These targets are increased during certain periods to accommodate any liquidity risks of special programs like RALs.

During 2008, liquidity was a major focus of the Bank as traditional sources of liquidity changed. In particular, the securitization market seized in the latter half of the year which was a major funding source for the RAL Program. As a risk management measure to compensate for this and other potential funding and liquidity changes in the future, Management developed and expanded its use of a twelve month rolling cash position analysis so that changes in liquidity sources and related needs could be identified and addressed well in advance of any issues or shortfalls. At this time, no shortfalls have been identified for the foreseeable future, though results could change depending on industry conditions.

Short-term liquidity is the ability to raise funds on an overnight basis. Sources of short-term liquidity include, but are not limited to, Federal funds, FHLB short-term advances, the Federal Reserve Bank Discount Window and repurchase agreements.

Intermediate liquidity is the ability to raise funds during the next few months to meet cash obligations over those next few months. Sources of intermediate liquidity include maturities or sales of securities, term repurchase agreements, broker CDs and term advances from the FHLB.

Long-term liquidity is the ability to raise funds over the entire planning horizon to meet cash needs anticipated due to strategic balance sheet changes. Long-term liquidity sources include: initiating special programs to increase core deposits in expanded market areas; reducing the size of securities portfolios; taking long-term advances with the FHLB; securitizing or selling loans; and accessing capital markets for the issuance of debt or equity.

Federal funds purchased and overnight repos are used to balance short-term mismatches between cash inflows from deposits, loan repayments, and maturing securities and cash outflows to fund loans, purchase securities and deposit withdrawals. During the first quarter of each year, they may also be used to provide a portion of the short-term funding needed for the RAL Program. Beginning in late January, the IRS pays weekly refunds to the Company. This allows the Company to repay up to all of its overnight borrowing and still have an excess of cash that must be invested.

For the Company, the most significant challenge relating to liquidity management is providing sufficient liquidity to fund the large amount of RALs, primarily in late January and early February of each year. In addition to the discussion above the following considerations are kept in mind in providing the needed liquidity:

Using a large number of institutions so as to not become overly reliant on a limited number of sources or a particular type of funding vehicle;

Using a mixture of committed and uncommitted lines so as to assure a minimum amount of funding in the event of tight liquidity in the markets; and

Arranging for approximately 30% more funding than anticipated on the peak-funding days for RALs.

The securitization of RALs has historically assisted in the management of the Company’s capital position during the RAL season by selling some RALs to third parties. In addition, the securitization program represented yet another source of liquidity as the proceeds from the sales are lent out to new RAL customers. For the 2009 RAL season, the Company was not able to secure a securitization facility with the current economic conditions causing difficulty within the credit markets. In place of the securitization facility, the Company purchased $1.28 billion of broker CDs and entered into a syndicated funding through a syndicated funding line of $524 million which is collateralized with RALs and may be drawn upon as needed throughout the RAL season. The Company will also utilize the Bank’s wholesale lending sources.

RALs present the Company with some special funding and liquidity needs. Additional funds are needed for RAL lending only for the very short period of time that RALs are outstanding. The season starts in January and continues into April, but even within that time frame, RAL originations are highly concentrated in the last week of January and first two weeks of February. The Company must arrange for a significant amount of very short-term borrowing capacity. A portion of the need can be met by borrowing overnight from other financial institutions through the use of Federal funds purchased and repurchase agreements. These two sources match the short-term nature of the RALs and therefore are an efficient source of funding. However, they are not sufficient to meet the total need for funds, and other sources like advances from the FHLB and brokered deposits must be used. Extensive funding planning is accomplished prior to the RAL season to make effective and efficient use of various funding sources. The increased use of broker CDs to pre-fund the RAL program expanded the cash position of the Bank by approximately $1.3 billion and contributed to the growth of the balance sheet at December 31, 2008.

As disclosed in Note 7, “RAL and RT Programs” of the Consolidated Financial Statements, the Company has also securitized some of the RALs.

As of December 31, 2008, the Company’s liquidity ratio, which is the ratio of liquid assets of cash and cash equivalents, investment securities from the trading and AFS portfolios, Federal funds sold and loans held for sale divided by short-term liabilities of demand deposits, repurchase agreements and Federal funds purchased was 101.3%, compared to 44.8% at December 31, 2007. The Company’s liquidity ratio increased in December 2008 compared to December 2007 as a result of the funds received from the TARP CPP. Total available liquidity as of December 31, 2008 was $3.34 billion.

At December 31, 2008, the Company had available borrowing capacity of $1.88 billion at the FHLB and $1.01 billion of borrowing capacity with the FRB. This borrowing capacity is utilized to fund loans when loan growth outpaces deposit growth.

Recent Market and Regulatory Developments

Recent market conditions have made it difficult or uneconomical to access the capital markets. As a result, the United States Congress, the U.S. Treasury, and the FDIC have announced various programs designed to enhance market liquidity and bank capital.

In response to the ongoing financial crisis affecting the banking system and financial markets, EESA was signed into law on October 3, 2008, and established TARP. 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 mortgages, mortgage-backed securities, capital stock and other financial instruments for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On November 21, 2008, the Company completed the sale to the U.S. Treasury of $180.6 million of Series B Preferred Stock as part of the TARP CPP.

Separately, the FDIC announced its temporary liquidity guarantee program (“TLGP”) pursuant to which the FDIC will guarantee the payment of certain newly-issued senior unsecured debt of insured depository institutions (“Debt Guarantee”) and funds held at FDIC-insured depository institutions in noninterest-bearing transaction accounts in excess of the current standard maximum deposit insurance amount of $250,000 (“Transaction Account Guarantee”). Both guarantees were provided to eligible institutions, including the Company, at no cost through December 5, 2008. Participation in the TLGP subsequent to December 5, 2008 is optional.

The Company has elected to participate in the TLGP subsequent to December 5, 2008. The Transaction Account Guarantee is effective for the Company through January 1, 2010. Under the Debt Guarantee, qualifying senior unsecured debt newly issued by the Company during the period from October 14, 2008 to June 30, 2009, inclusive, is covered by the FDIC guarantee. The maximum amount of debt that eligible institutions can issue under the guarantee is 125% of the par value of the entity’s qualifying senior unsecured debt, excluding debt to affiliates that was outstanding as of September 30, 2008 (or if no such debt was outstanding at September 30, 2008, then 2% of the entity’s consolidated total liabilities at September 30, 2008), and scheduled to mature by June 30, 2009. The FDIC will provide guarantee coverage until the earlier of the eligible debt’s maturity or June 30, 2012. Based on the Bank’s consolidated total liabilities at September 30, 2008, it may issue up to $139.4 million in debt under the TLGP.

Participants in the Debt Guarantee Program will be assessed an annualized fee of 75 basis points for its participation, and an annualized fee of 10 basis points for its participation in the Transaction Account Guarantee. To the extent that these initial assessments are insufficient to cover the expense or losses arising under TLGP, the FDIC is required to impose an emergency special assessment on all FDIC-insured depository institutions as prescribed by the Federal Deposit Insurance Act.

INTEREST RATE RISK

With such a large proportion of the Company’s income derived from net interest income, it is important to understand how the Company is subject to interest rate risk.

In general, for a given change in interest rates, the amount of the change in value up or down is larger for instruments with longer remaining maturities. For instance, the shape of the yield curve may affect new loan yields and funding costs differently.

The remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change. For example, if long-term mortgage interest rates decline sharply, higher fixed rate mortgages may prepay, or pay down, faster than anticipated, thus increasing cash flows and reducing interest income.

Repricing frequencies and maturity profiles for assets and liabilities may occur at different times. For example, in a falling rate environment, if assets reprice faster than liabilities there will be an initial decline in earnings. Moreover, if assets and liabilities reprice at the same time, they may not be by the same increment. For instance, if the Federal funds rate increased 50 bps, demand deposits may rise by 10 bps, whereas prime based loans will instantly rise 50 bps.

Monthly evaluations, monitoring and management of interest rate risk (including market risk, mismatch risk and basis risk) compare our most likely rate scenario, base case, with various earnings simulations using many interest rate scenarios. These scenarios differ in the direction of interest rate changes, the degree of change over time, the speed of change and the projected shape of the yield curve. These results are prepared by the Company’s Treasury department and presented to the ALCO each month for further consideration. The Company does not have a significant amount of derivative instruments.

Financial instruments do not respond in a parallel fashion to rising or falling interest rates. This causes asymmetry in the magnitude of changes in net interest income and net economic value resulting from the hypothetical increases and decreases in rates. It is therefore mandatory to monitor interest rate risk and adjust our funding strategies to mitigate adverse effects of interest rate shifts on the Company’s balance sheet. While derivative instruments are effective hedging tools, the Company has been successful at maintaining its interest rate risk profile within policy limits strictly from pro-active deposit pricing and funding strategies. In the future, however, other strategies may be implemented to manage interest rate risk. These strategies may include, but may not be limited to, utilizing interest rate derivatives, buying or selling loans or securities, extending maturities of borrowings and deposits and entering into other interest rate risk management instruments and techniques.

For detailed of evaluating net interest income and economic value of equity discussion is in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” beginning on page 75.

CRITICAL ACCOUNTING POLICIES

A number of critical accounting policies are used in the preparation of the Company’s consolidated financial statements. The Company’s accounting policies for significant balance sheet and statement of operation accounts are disclosed in Note 1, “Summary of Significant Accounting Policies” to the Consolidated Financial Statements beginning on page 87. Management believes that a number of these are critical to the understanding of the Company’s financial condition and results of operation because they involve estimates, judgment, or are otherwise less subject to precise measurement and because the quality of the estimates materially impact those results. This section is intended (1) to identify those critical accounting policies used in the preparation of the Consolidated Financial Statements; (2) to clarify the methodology used in determining these estimates; (3) to identify assumptions used in determining these estimates; and (4) to provide insight to the potential impact those estimates have on the presentation of the Company’s financial condition, changes in financial condition and results of operations.

The preparation of Consolidated Financial Statements in accordance with Generally Accepted Accounting Principles (“GAAP”) requires Management to make certain estimates and assumptions that affect the amounts of reported assets and liabilities as well as contingent assets and liabilities as of the date of these financial statements. Some of these critical estimates concern past events that are uncertain or otherwise not subject to direct measurement. Others involve predictions regarding future

events. As events occur and these estimates and assumptions are confirmed or are shown to require adjustment, they affect the reported amounts of revenues and expenses during the reporting period(s). Although Management believes these estimates and assumptions to be reasonably accurate, actual results may differ.

These critical accounting policies include:

Allowance for loan losses

Accounting for income taxes

Goodwill and other intangible assets

RAL and RT Programs

Allowance for loan losses

Credit risk is inherent in the business of extending loans and leases to borrowers. The Company establishes an estimated reserve for these inherent loan losses and records the change in this estimate through charges to current period earnings. These charges are recorded as provision for loan losses. All specifically identifiable and quantifiable losses are charged off against the allowance when realized. The allowance for loan losses is Management’s estimate of loan losses inherent within the loan portfolio at each balance sheet date.

The Company formally determines the adequacy of the allowance on a quarterly basis. This determination is based on the periodic assessment of the credit quality or “grading” of loans. Loans are initially graded when originated. Loans are re-graded at renewal, when identified facts demonstrate change in risk of nonpayment, or if the loan becomes delinquent. Re-grading of larger problem loans will occur at least quarterly.

After reviewing the grades in the loan portfolio, the second step is to assign or allocate a portion of the allowance to groups of loans and to individual loans to cover Management’s estimate of the loss that may be present in these loans. The estimation of probable losses takes into consideration the loan grade and other factors such as:

loan balances

loan pool segmentation

historical loss analysis

identification, review, and valuation of impaired loans

change in the economy upon the lending activities

change in the concentrations of the lending activities

change in the growth of the lending activities

change in the delinquencies and classified loan trends of the lending activities

change in the control environments upon the lending activities

change in the management and staffing effectiveness upon the lending activities

change in the loan review effectiveness upon the lending activities

change in the underlying collateral values upon the lending activities

change in the competition/regulatory/legal issues upon the lending activities

change related to unanticipated events upon the lending activities

change and additional valuation for structured financing and syndicated national credits

GAAP, banking regulations, and sound banking practices require that the Company record this estimate of unrecognized losses in the form of an allowance for loan losses. When loans are determined to be uncollectible, losses are recognized and accounted for as charge-offs against this allowance. A secured consumer loan which includes residential real estate loans that are 120 days past due will be charged-off down to the fair value of the collateral. If a consumer loan is unsecured, after the loan is 120 days past due, the loan will be charged-off. For commercial Loans, these would include commercial and industrial loans and loans secured by commercial real estate, as soon as deterioration of the borrower’s credit quality is identified, the loan is put on nonaccrual. If the commercial loan is secured, the loan is charged-off down to the collateral’s fair value. When the Company recovers an amount on a loan previously charged-off, the recovery increases the amount of allowance for loan losses.

Accounting for Income Taxes

The Company is subject to the income tax laws of the U.S. and those states and municipalities in which it has business operations. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant governmental taxing authorities. The Company must make judgments and interpretations about the application of these inherently complex tax laws when determining the provision for income taxes. Disputes over interpretations of the tax laws may be settled with the taxing authorities upon examination or audit.

The Company regularly assesses the likelihood of assessments in each of the taxing jurisdictions resulting from current and subsequent years’ examinations. In accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, the Company is required to establish reserves for potential losses that may arise from tax audits. The Company has determined that no such reserves are required at this time.

See Notes 16, “Income Taxes” of the Consolidated Financial Statements for additional information relating to income taxes.

Goodwill and Other Intangible Assets

When a Company acquires a business the purchased assets and liabilities are recorded at fair value and intangible assets are identified. The fair value of most financial assets and liabilities are determined by estimating the discounted anticipated cash flows from or for the instrument using current market rates applicable to each asset and liability. Excess of consideration paid to acquire a business over the fair value of the net assets is recorded as goodwill.

At a minimum, Management is required to assess goodwill and other intangible assets annually for impairment. The goodwill impairment calculation is an estimate subject to ongoing review as certain circumstances may cause additional impairment to be assessed in the future. The assessment of goodwill involves reviewing the capitalized earnings of each reporting unit, the outlook of the current economic environment, the transaction multiples of publicly traded financial institutions adjusted for a change in control, estimating cash flows for future periods and estimating the fair value of the reporting unit to which the goodwill is allocated. When the fair value of a reporting unit is less than its carrying value, the Company is required to utilize a Step 2 valuation approach in accordance with SFAS 142.

The Step 2 valuation approach compares the carrying value to the fair values of the underlying tangible and intangible assets and liabilities for purposes of calculating the fair value of goodwill. This process is

the same as when the Company purchases another Company in accordance with SFAS 141, Business Combinations (“SFAS 141”). SFAS 141 provides guidance for allocating the purchase price to assets and liabilities and identifying and qualifying intangible assets.

During the third quarter of 2008, the Company was required to go to Step 2 in accordance with SFAS 142, Goodwill and Other Intangible Assets (“SFAS 142”) for the Commercial Banking segment and this resulted in a $22.1 million goodwill impairment recorded in the third quarter of 2008. The largest component of the Step 2 approach was the valuation of the loan portfolio. When valuing the loan portfolio, there were several factors utilized in calculating the valuation. These factors were the present value of discounted cash flows for the underlying loans based on the contractual terms, prepayments of the scheduled cash flows, discount rates in the current market for the loans, the cost of funds to fund the loans, servicing costs, credit and non-performance risk and liquidity of the underlying loans in the current market.

During the fourth quarter of 2008 and continuing into 2009, our stock price, along with the stock prices of other public regional banking institutions, declined significantly and resulted in a decrease in the Company’s market capitalization subsequent to our annual goodwill impairment testing date. Although changes in market capitalization generally serve as a reasonable indicator of the changes in the aggregate estimated fair value of the reporting units of the Company does not believe that the most recent decline in our market capitalization is indicative or representative of any further potential goodwill impairment. Management believes this decline is primarily attributable to the general adverse conditions in the U.S. and international financial markets, unprecedented lack of liquidity, uncertainty regarding future economic policy and banking regulation changes, and negative market sentiment towards the banking industry in general. Accordingly, Management assessed goodwill for impairment during the fourth quarter of 2008 and concluded that there is no further impairment at December 31, 2008.

A discussion of the Company’s goodwill and other intangible assets is discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations: Non-Interest Expenses—Goodwill Impairment“— earlier in this document, and in Note 10, “Goodwill and Other Intangible Assets” of the Consolidated Financial Statements.

RAL and RT Programs

RAL Interest Income

RAL interest income varies based on the amount of the loan and not the time the loan is outstanding. The larger the loan, the larger the amount at risk from nonpayment and therefore the fee varies by the amount of funds advanced due to the increased credit risk rather than the length of time that the loan is outstanding. Nonetheless, because the customer signs a loan application and note, the Company reports the fees as interest income.

RT Fees

When customers do not choose or do not qualify for a RAL, they may still benefit from an expedited payment of their income tax refund. An RT is an electronic transfer of an income tax refund directly to the taxpayer. The Company acts as a conduit from the IRS to the taxpayer enabling an expedited delivery of the taxpayer’s income tax refund. There is no credit risk or borrowing cost for the Company because RTs are only delivered to the taxpayer upon receipt of the refund directly from the IRS. Payment of an RT is made in one of two ways. The Company either authorizes the tax preparer to provide a check directly to the taxpayer or the Company deposits the refund into a taxpayer’s account. Fees earned on RTs are recognized as fee income within non-interest income.

Refund Anticipation Loan Securitization

The Company has utilized a securitization facility for the last seven years for RALs but will not be using one for the 2009 RAL season. The securitization is active only during the first quarter and terminated prior to the end of the first quarter, there are no balances, retained interests, or servicing assets to be accounted for or disclosed December, 31. There are no balances related to RALs, securitized or otherwise, recorded on the balance sheet at December 31 of each year.

The Company sold some of its RALs through a securitization each year during the months of January and February. The Bank accounted for these sales in accordance with the provisions of SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” To be accounted for as a sale, SFAS 140 requires that (1) assets transferred be isolated from the transferor—put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership; (2) each transferee has the right to pledge or exchange the assets it received; and (3) the transferor does not maintain control over the transferred assets through either (i) an agreement that both entitles and obligates the transferor to repurchase or redeem them before their maturity or (ii) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call.

The first requirement of SFAS 140 is satisfied through the sale of the RALs from the Company to a wholly-owned subsidiary of the Bank, SBBT RAL Funding Corp. This special purpose entity will then sell the loans to other banks. By the structure of the purchase agreements between the Bank and this special purpose entity, the ability of the Company or its creditors to reach the assets is judged to be remote. This conclusion is supported by a legal opinion obtained each year by the Company. The second requirement of SFAS 140 is satisfied because the purchase agreements with SBBT RAL Funding Corp. and the other banks give such other banks the right to pledge or exchange the RALs. The third requirement of SFAS 140 is satisfied because there is no requirement that the Company repurchase RALs other than those that did not meet the underwriting criteria in the purchase agreement and were therefore inadvertently included among the sold loans.

The Company has concluded that the loan sales satisfy the criteria for sale treatment under SFAS 140.

All loans sold into the securitization are either fully repaid or repurchased by the Bank at the termination of the securitization in mid-February of each calendar year consistent with the terms of the Securitization Agreement. At March 31, these repurchased loans are reported in the balance sheet as RAL loans and become subject to the same charge-off criteria as RALs retained on the balance sheet since origination. As such, charge-offs and recoveries are recorded through the allowance for loan losses subsequent to the end of the first quarter of each calendar year.

Loans sold through the securitization are subject to more strict underwriting criteria and their historical loss rates are lower.

REGULATION AND SUPERVISION

General

The Company and its subsidiaries are extensively regulated and supervised under both Federal and certain State laws. Regulation and supervision by Federal or State banking agencies is intended primarily for the protection of depositors and the Deposit Insurance Fund (“DIF”) administered by the FDIC and not for the benefit of Company shareholders. Set forth below is a summary description of key laws and regulations which relate to the Company’s operations. These descriptions are qualified in their entirety by reference to the applicable laws and regulations. The federal and state agencies regulating the financial services industry also frequently adopt changes to their regulations and implementing policies.

The Company

As a bank holding company, the Company is subject to regulation and examination by the FRB under the Bank Holding Company Act of 1956, as amended, (“BHCA”). The Company is required to file with the FRB periodic reports and such additional information as the FRB may require.

The FRB may require the Company to terminate an activity or terminate control of or liquidate or divest certain subsidiaries, affiliates or investments if the FRB believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any bank subsidiary. The FRB also has the authority to regulate provisions of certain bank holding company debt, including the authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain FRB approval prior to purchasing or redeeming its equity securities. Further, the Company is required by the FRB to maintain certain levels of capital.

The Company is required to obtain prior FRB approval for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior FRB approval is also required for the merger or consolidation of a bank holding company with another bank holding company. Similar state banking agency approvals may also be required. Certain competitive, management, financial and other factors are considered by the bank regulatory agencies in granting these approvals.

With certain exceptions, bank holding companies are prohibited from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or furnishing services to subsidiaries. However, subject to prior notice or FRB approval, bank holding companies may engage in, or acquire shares of companies engaged in, those nonbanking activities determined by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

FRB regulations require that bank holding companies serve as a source of financial and managerial strength to subsidiary banks and commit resources as necessary to support each subsidiary bank. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of FRB regulations or both. The FRB’s bank holding company rating system also emphasizes risk management and evaluation of the potential impact of nondepository entities on safety and soundness.

Securities Registration

The Company’s securities are registered with the SEC under the Exchange Act of 1934, as amended. As such, the Company is subject to the information, proxy solicitation, insider trading, corporate governance, and other requirements and restrictions of the Exchange Act.

The Sarbanes-Oxley Act

The Company is subject to the accounting oversight and corporate governance requirements of the Sarbanes-Oxley Act of 2002, including:

required executive certification of financial presentations;

increased requirements for board audit committees and their members;

enhanced disclosure of controls and procedures and internal control over financial reporting;

enhanced controls on, and reporting of, insider trading; and

increased penalties for financial crimes and forfeiture of executive bonuses in certain circumstances.

The Bank

The Bank, as a nationally chartered bank, is subject to primary supervision, periodic examination, and regulation by the OCC. To a lesser extent, the Bank is also subject to certain regulations promulgated by the FRB. If, as a result of an examination of the Bank, the OCC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory or that the Bank or its Management is violating or has violated any law or regulation, the OCC and separately the FDIC as insurer of the Bank’s deposits, have the authority to:

require affirmative action to correct any conditions resulting from any violation or practice

direct an increase in capital and establish higher minimum capital ratios

restrict the Bank’s growth geographically, by products and services or by mergers and acquisitions

enter into informal nonpublic or formal public memoranda of understanding or written agreements; enjoin unsafe and unsound practices and issue cease and desist orders to take corrective action

remove officers and directors and assess civil monetary penalties

take possession and close and liquidate the Bank.

Various requirements and restrictions under the laws of the State of California and Federal banking laws and regulations affect the operations of the Bank. State and Federal statues and regulations relate to many aspects of the Bank’s operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branches and other offices and capital requirements. Furthermore, the Bank is required to maintain certain levels of capital. The regulatory capital requirements, as well as the actual capitalization ratios for PCBNA and for the Company on a consolidated basis as of December 31, 2008 are presented in detail in Note 20, “Regulatory Requirements” in the Consolidated Financial Statements. Also refer to “Capital Resources” discussion starting on page 57 within the MD&A of this 10-K. As of December 31, 2008 both the Company and PCBNA exceeded the minimum capital requirements to be considered “well capitalized”.

In September, 2007, the SEC and the FRB finalized joint rules required by the Financial Services Regulatory Relief Act of 2006 to implement exceptions provided for in the Gramm-Leach-Bliley Act of 1999 (“GLBA”) for securities activities which banks may conduct without registering with the SEC as a securities broker or moving such activities to a broker-dealer affiliate. The FRB’s final Regulation R provides exceptions for networking arrangements with third party broker dealers and authorizes compensation for bank employees who refer and assist retail and high net worth bank customers with their securities, including sweep accounts to money market funds, and with related trust, fiduciary, custodial and safekeeping needs. The final rules, which will not be effective until 2009, are not expected to have a material effect on the current securities activities which the Bank and its subsidiaries now conduct for customers.

Dividends and Other Transfer of Funds

The Company is a legal entity separate and distinct from the Bank. The Company’s ability to pay cash dividends is limited by California law. Under California law, our shareholders may receive dividends

when and as declared by the Board of Directors out of funds legally available for such purpose. With certain exceptions, a California corporation may not pay a dividend to its shareholders unless (i) its retained earnings equal at least the amount of the proposed dividend, or (ii) after giving effect to the dividend, the corporation’s assets would equal at least 1.25 times its liabilities and, for corporations with classified balance sheets, the current assets of the corporation would be at least equal to its current liabilities or, if the average of the earnings of the corporation before taxes on income and before interest expense for the two preceding fiscal years was less than the average of the interest expense of the corporation for those fiscal years, at least equal to 1.25 times its current liabilities.

Dividends from the Bank constitute the principal source of income to the Company. The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends. Under such restrictions, the amount available for payment of dividends to the Company by the Bank without prior regulatory approval totaled $276.9 million at December 31, 2008. In addition, the banking agencies have the authority to prohibit the Bank from paying dividends, depending upon the Bank’s financial condition, if such payment is deemed to constitute an unsafe or unsound practice. Furthermore, under the Federal Prompt Corrective Action regulations, the FRB may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”

Additionally, it is FRB policy that bank holding companies should generally pay dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. It is also FRB policy that bank holding companies should not maintain dividend levels that undermine the company’s ability to be a source of strength to its banking subsidiaries. In consideration of the current financial and economic environment, the FRB has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.

Capital Requirements

At December 31, 2008, the Company and the Bank’s capital ratios exceed the minimum percentage requirements for “well capitalized” institutions. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations; Capital Resources” and Note 20, “Regulatory Capital Requirements” of the Consolidated Financial Statements for further information regarding the regulatory capital guidelines as well as the Company’s and the Bank’s actual capitalization as of December 31, 2008.

The Federal banking agencies have adopted risk-based minimum capital guidelines for bank holding companies and banks which are intended to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance

sheet as assets and transactions which are recorded as off-balance sheet items. The risk-based capital ratio is determined by classifying assets and certain off-balance sheet financial instruments into weighted categories, with higher levels of capital being required for those categories perceived as representing greater risk. Under the capital guidelines, a banking organization’s total capital is divided into tiers. “Tier I capital” includes common equity and trust-preferred securities, subject to certain criteria and quantitative limits. The Series B Preferred Stock issued in conjunction with the TARP CPP also qualifies as Tier 1 Capital. The risk-based capital guidelines require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier I capital to risk-adjusted assets of 4%.

An institution’s risk-based capital, leverage capital and tangible capital ratios together determine the institution’s capital classification. An institution is treated as well capitalized if its total capital to risk-weighted assets ratio is 10.00% or more; its core capital to risk-weighted assets ratio is 6.00% or more; and its core capital to adjusted total assets ratio is 5.00% or more and the institution is not subject to any written agreement, order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. In addition to the risk-based guidelines, the Federal bank regulatory agencies require banking organizations to maintain a minimum amount of Tier I capital to total assets, referred to as the leverage ratio. For a banking organization rated “well-capitalized,” the minimum leverage ratio of Tier I capital to total assets must be 3%.

The current risk-based capital guidelines are based upon the 1988 capital accord of the International Basel Committee on Banking Supervision. A new international accord, referred to as Basel II, which emphasizes internal assessment of credit, market and operational risk; supervisory assessment and market discipline in determining minimum capital requirements, became mandatory for large international banks outside the U.S. in 2008, and is optional for others, and must be complied with in a “parallel run” for two years along with the existing Basel I standards. In January 2009, the Basel Committee proposed to reconsider regulatory-capital standards, supervisory and risk-management requirements and additional disclosures in the final new accord in response to recent worldwide developments.

In July 2008, the U.S. Federal banking agencies issued a proposed rule that would give banking organizations, which do not use the Basel II advanced approaches, the option to implement a new risk-based capital framework. This framework would adopt the standardized approach of Basel II for credit risk, the basic indicator approach of Basel II for operational risk, and related disclosure requirements. While this proposed rule generally parallels the relevant approaches under Basel II, it diverges where United States markets have unique characteristics and risk profiles, most notably with respect to risk weighting residential mortgage exposures. A definitive final rule has not been issued. The U.S. banking agencies have indicated, however, that they will retain the minimum leverage requirement for all U.S. banks.

The Federal Deposit Insurance Act (“FDI Act”) gives the Federal banking agencies the additional broad authority to take “prompt corrective action” to resolve the problems of insured depository institutions that fall within any undercapitalized category, including requiring the submission of an acceptable capital restoration plan. The Federal banking agencies have also adopted non-capital safety and soundness standards to assist examiners in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) asset quality and growth, (v) earnings, (vi) risk management, and (vii) compensation and benefits.

FDIC Deposit Insurance

The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The FDIC insures the Bank’s customer deposits through the DIF up to prescribed limits for each depositor. Pursuant to the EESA, the maximum deposit insurance amount has been increased from $100,000 to $250,000 through 2009. The amount of FDIC assessments paid by each DIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other supervisory factors. Pursuant to the Federal Deposit Insurance Reform Act of 2005, the FDIC is authorized to set the reserve ratio for the DIF annually at between 1.15% and 1.50% of estimated insured deposits. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis. In an effort to restore capitalization levels and to ensure the DIF will adequately cover projected losses from future bank failures, the FDIC, in October 2008, proposed a rule to alter the way in which it differentiates for risk in the risk-based assessment system and to revise deposit insurance assessment rates, including base assessment rates. First quarter 2009 assessment rates were increased to between 12 and 50 cents for every $100 of domestic deposits, with most banks paying between 12 and 14 cents.

On February 27, 2009, the FDIC approved an interim rule to institute a one-time special emergency assessment of 20 cents per $100 in domestic deposits on June 30, 2009, to be collected by September 30, 2009, to restore the DIF reserves depleted by recent bank failures. The interim rule also permits the FDIC to impose an additional special emergency assessment after June 30, 2009 of up-to-10 basis points, if necessary. The FDIC also adopted amendments to its restoration plan for the DIF to implement changes to the risk-based assessment system and set assessment rates to provide that most banks will now pay initial base rates ranging from 12 cents per $100 to 16 cents per $100 on an annual basis, beginning on April 1, 2009. Changes to the assessment system include higher rates for institutions that rely significantly on secured liabilities, which may increase the FDIC’s loss in the event of failure without providing additional assessment revenue. Assessments will also be higher for institutions that rely significantly on brokered deposits but, for well-managed and well-capitalized institutions, only when accompanied by rapid asset growth.

Additionally, by participating in the FDIC’s Temporary Liquidity Guarantee Program, banks temporarily become subject to an additional assessment on deposits in excess of $250,000 in certain transaction accounts and additionally for assessments from 50 basis points to 100 basis points per annum depending on the initial maturity of the debt. Further, all FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (“FICO”), an agency of the Federal government established to recapitalize the predecessor to the DIF. The FICO assessment rates, which are determined quarterly, averaged 0.0113% of insured deposits in fiscal 2008. These assessments will continue until the FICO bonds mature in 2017.

The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a risk to the DIF or that may prejudice the interest of the bank’s depositors. The termination of deposit insurance for the Bank would also result in the revocation of the Bank’s charter by the OCC.

Loans-to-One Borrower Limitations

With certain limited exceptions, the maximum amount of obligations, secured or unsecured, that any borrower (including certain related entities) may owe to a national bank at any one time may not exceed 15% of the unimpaired capital and surplus of the Bank, plus an additional 10%, of unimpaired capital and surplus for loans fully secured by readily marketable collateral. The Bank has established internal loan limits which are lower than these legal lending limits. At December 31, 2008, PCBNA’s loans-to-one-borrower limit was $115.7 million based upon the 15% of unimpaired capital and surplus measurement.

Extensions of Credit to Insiders and Transactions with Affiliates

The Federal Reserve Act and FRB Regulation O place limitations and conditions on loans or extensions of credit to:

a bank or bank holding company’s executive officers, directors and principal shareholders (i.e., in most cases, those persons who own, control or have power to vote more than 10% of any class of voting securities);

any company controlled by any such executive officer, director or shareholder; or

any political or campaign committee controlled by such executive officer, director or principal shareholder.

Such loans:

must comply with loan-to-one-borrower limits

require prior full board approval when aggregate extensions of credit to the person exceed specified amounts

must be made on substantially the same terms (including interest rates and collateral) and follow credit-underwriting procedures no less stringent than those prevailing at the time for comparable transactions with non-insiders

must not involve more than the normal risk of repayment or present other unfavorable features

must in the aggregate not exceed the bank’s unimpaired capital and unimpaired surplus.

The Bank also is subject to certain restrictions imposed by Federal Reserve Act Sections 23A and 23B and FRB Regulation W on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, any affiliates, the purchase of, or investments in, stock or other securities thereof, the taking of such securities as collateral for loans, and the purchase of assets of any affiliates. Affiliates include parent holding companies, sister banks, sponsored and advised companies, financial subsidiaries and investment companies whereby the Bank’s affiliate serves as investment advisor. Sections 23A and 23B and Regulation W generally:

prevent any affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts

limit such loans and investments to or in any affiliate individually to 10.0% of the Bank’s capital and surplus

limit such loans and investments to or in any affiliate in the aggregate to 20.0% of the Bank’s capital and surplus

require such loans and investments to or in any affiliate to be on terms and under conditions substantially the same or at least as favorable to the Bank as those prevailing for comparable transactions with nonaffiliated parties.

Additional restrictions on transactions with affiliates may be imposed on the Bank under the FDI Act prompt corrective action provisions and the supervisory authority of the Federal and State banking agencies.

USA PATRIOT Act and Anti-Money Laundering Compliance

The USA PATRIOT Act of 2001 and its implementing regulations significantly expanded the anti-money laundering and financial transparency laws, including the Bank Secrecy Act. The Bank has adopted comprehensive policies and procedures to address the requirements of the USA PATRIOT Act. Material deficiencies in anti-money laundering compliance can result in public enforcement actions by the banking agencies, including the imposition of civil money penalties and supervisory restrictions on growth and expansion. Such enforcement actions could also have serious reputation consequences for the Company and the Bank.

Consumer Laws

The Bank and the Company are subject to many Federal and State consumer protection statutes and regulations and laws prohibiting unfair or fraudulent business practices, untrue or misleading advertising and unfair competition, including:

The Home Ownership and Equity Protection Act of 1994, or (“HOEPA”), requires extra disclosures and consumer protections to borrowers from certain lending practices, such as practices deemed to be “predatory lending.”

Privacy policies are required by Federal and State banking laws regulations which limit the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties.

The Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act, or the “FACT Act”, requires financial firms to help deter identity theft, including developing appropriate fraud response programs, and gives consumers more control of their credit data.

The Equal Credit Opportunity Act, or (“ECOA”), generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.

The Truth in Lending Act, or (“TILA”), requires that credit terms be disclosed in a meaningful and consistent way so that consumers may compare credit terms more readily and knowledgeably.

The Fair Housing Act regulates many lending practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status.

The CRA, requires insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities; directs the Federal regulatory agencies, in examining insured depository institutions, to assess a bank’s record of helping meet the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices and further requires the agencies to take a financial institution’s record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, mergers or acquisitions, or holding company formations. In its last examination for CRA compliance, as of September 11, 2007, the Bank was rated “outstanding.”

The Home Mortgage Disclosure Act, or “HMDA”, includes a “fair lending” aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes.

The Real Estate Settlement Procedures Act, or “RESPA”, requires lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements and prohibits certain abusive practices, such as kickbacks.

The National Flood Insurance Act, or “NFIA”, requires homes in flood-prone areas with mortgages from a Federally regulated lender to have flood insurance.

The Americans with Disabilities Act , in conjunction with similar California legislation, requires employers with 15 or more employees and all businesses operating “commercial facilities” or “public accommodations” to accommodate disabled employees and customers.

These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans,

and providing other services. Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to enforcement actions, injunctions, fines or criminal penalties, punitive damages to consumers, and the loss of certain contractual rights.

Regulation of Nonbank Subsidiaries

Nonbank subsidiaries may be subject to additional or separate regulation and supervision by other state, federal and self-regulatory bodies.

MCM and REWA, operating subsidiaries of PCBNA, are registered investment advisors subject to regulation and supervision by the SEC. Further, the banking agencies expect banking organizations in their oversight role over functionally regulated subsidiaries, such as registered investment advisors, to assure appropriate controls are maintained that include:

establishing alternative sources of emergency support from the parent holding company, non-bank affiliates or external third parties prior to seeking support from the bank

instituting effective policies and procedures for identifying potential circumstances triggering the need for financial support and the process for obtaining such support

implementing effective controls, including stress testing and compliance reviews

implementing policies and procedures to ensure compliance with disclosure and advertising requirements to clearly differentiate the investments in advised funds from obligations of the bank or insured deposits

ensuring proper management, regulatory and financial reporting of contingent liabilities arising out of its investment advisory activities.

The Company and the Bank have taken appropriate action to implement and audit compliance with these requirements.

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company cannot operate risk-free and make a profit. Instead, the process of risk definition and assessment allows the Company to select the appropriate level of risk for the anticipated level of reward and then decide on the steps necessary to manage this risk. The key risk factors affecting our business are addressed in Item 1A, Risk Factors starting on page 13 of this 10-K. Changes in interest rates can potentially have a significant impact on earnings as well as the Net Interest Income and Economic Value of Equity discussion and graph below.

Net Interest Income (“NII”) and Economic Value of Equity (“EVE”) Simulations

The results of the asset liability model indicate how much of the Company’s net interest income and net economic value are “at risk” (deviation from the base case) from +/- 2% shocks. This exercise is valuable in identifying risk exposures and in comparing the Company’s interest rate risk profile relative to other financial intermediaries.

The EVE and NII results as of December 31, 2008 are displayed in the table below. These figures indicate that the Company’s net interest income at risk over a one-year period and net economic value at risk are well within the adopted ALCO policy ranges.

RATE SENSITIVITY


EVE Shock Summary Report
	(in millions)
	DN 200	Base	UP 200

Total Assets:	$9,846	$9,609	$9,311
Total Liabilities	9,143	8,960	8,585

Net Asset Value:	$ 703	$ 649	$ 726

Current	8.8%	0.0%	12.0%
*Prior year*	*5.3%*	*0.0%*	*-9.0%*
Upper Policy:	-15.0%	-15.0%	-15.0%
Lower Policy:	-10.0%	-10.0%	-10.0%
w/in Limit:	Yes		Yes
NII Shock Summary Report
	(in millions)
	DN 200	*Base*	UP 200

Interest Income	$377.1	$404.7	$468.8
Interest Expense	136.2	139.1	167.2

Net Interest Income:	$240.9	$265.6	$301.6

Current	-9.3%	0.0%	13.5%
*Prior year*	*-0.8%*	*0.0%*	*-3.7%*
Upper Policy:	-10.0%	-10.0%	-10.0%
Lower Policy:	-5.0%	-5.0%	-5.0%
w/in Limit:	Yes		Yes

EVE Summary

Assuming the entire yield curve was to instantaneously increase 200 basis points, our projected EVE at December 31, 2008 would increase by approximately 12.0% from the base. At December 31, 2007 in the up 200 basis point scenario, our EVE was projected to decrease by approximately 9.0% from the base projection. The rates down 200 basis point scenario assumes the yield curve instantaneously decreases 200 basis points where appropriate. When the yield curve is less than 2 percent, the yield curve is assigned a floor of zero. Using this methodology and assuming the entire yield curve shifts down 200 basis points, the projected EVE at December 31, 2008 is forecast to increase by approximately 8.8% from the base. At December 31, 2007, in the down 200 basis point scenario, our EVE was projected to increase by approximately 5.3% from the base projection.

NII Summary

Assuming the entire yield curve was to instantaneously increase 200 basis points, the projected net interest income for the next twelve periods beginning January 1, 2009 would increase by approximately 13.5% from the base projection. At December 31, 2007 in the up 200 basis point scenario, our projected net interest income for the twelve month period beginning January 1, 2008 would have decreased by approximately 3.7% from the base projection. The rates down 200 basis points scenario assumes the yield curve instantaneously decreases 200 basis points where appropriate. When the

yield curve is less than 2 percent, the yield curve is assigned a floor of zero. Using this methodology and assuming the entire yield curve shifts down 200 basis points, our projected net interest income for the twelve month period beginning January 1, 2009 would decrease by approximately 9.3%. At December 31, 2007, in the down 200 basis point scenario, our projected net interest income for the twelve month period beginning January 1, 2008 was projected to decrease by approximately 0.8% from the base projection.

The following have contributed to the improved figures:

Continuous improvements in the asset liability-modeling tool provides greater granularity and improved cash flow computations.

The Bank used broker CDs and wholesale funding to pre-fund the 2009 RAL season, as discussed in the Liquidity section above. This strategy provided the Bank the opportunity to secure liquidity during a time of uncertainty and volatile credit markets, but it also had a positive impact on EVE in all scenarios and NII in the plus 200 basis point scenario. By carrying more cash on the balance sheet, the EVE risk was reduced and net interest income increased in the plus 200 scenario.

The Bank extended the maturities of wholesale borrowings and retail CDs during the fourth quarter of 2008. This had a positive impact on the profile of the EVE and the NII in the plus 200 scenario.

The Bank sold $81.7 million of fixed rate mortgage loans in the fourth quarter of 2008.

Among the assumptions that have been included in the model are those that address optionality. Management has updated and implemented a more robust process surrounding the following examples of optionality:

The option customers have to prepay their loans or the decay rate of non maturing deposits;

The option issuers of some of the securities held by the Company to prepay or call their debt;

The option of the Company to prepay or call certain types of its debt;

The option of the Company to reprice its administered deposits.

Improved incorporation of loan features, including imbedded caps and floors, reset features and other aspects of loan terms and conditions.

Simulation estimates depend on, and will change with the size and mix of the actual and projected balance sheet at the time of each simulation. Management is unaware of any material limitations such that results would not reflect the net interest risk exposures of the Company. Various shortcomings are inherent in both the EVE and NII sensitivity analyses. Certain assumptions may not reflect the manner in which actual yields and costs respond to market changes. Similarly, prepayment estimates and similar assumptions are subjective in nature, involve uncertainties and, therefore, cannot be determined with precision. Changes in interest rates may also affect our operating environment and operating strategies as well as those of our competitors. In addition, certain adjustable rate assets have limitations on the magnitude of rate changes over specified periods of time. Accordingly, although our NII sensitivity analyses may provide an indication of our IRR exposure, such analyses are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and our actual results will differ. There are no material positions, instruments or transactions that are not included in the modeling or included instruments that have special features that are not included.

ITEM 8.

CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Audited consolidated financial statements and related documents required by this item are included in this Annual Report on Form 10-K on the pages indicated:


Reports of Independent Registered Public Accounting Firm—Ernst & Young LLP		79

Consolidated Balance Sheets as of December 31, 2008 and 2007		81

Consolidated Statements of Operations for the years ended December 31, 2008, 2007, and 2006		82

Consolidated Statements of Comprehensive Income for the years ended December 31, 2008, 2007, and 2006		83

Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2008, 2007, and 2006		84

Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007, and 2006		85

Notes to Consolidated Financial Statements		87

The following unaudited supplementary data is included in this Annual Report on Form 10-K on the page indicated:

Quarterly Financial Data		148

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of Pacific Capital Bancorp

We have audited the accompanying consolidated balance sheets of Pacific Capital Bancorp and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pacific Capital Bancorp and subsidiaries at December 31, 2008 and 2007, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Pacific Capital Bancorp’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2009 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Los Angeles, California

February 26, 2009

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of Pacific Capital Bancorp

We have audited Pacific Capital Bancorp’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Pacific Capital Bancorp’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report of Internal Controls Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Pacific Capital Bancorp maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Pacific Capital Bancorp as of December 31, 2008 and 2007 and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008 of Pacific Capital Bancorp and our report dated February 26, 2009 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Los Angeles, CA

February 26, 2009

Pacific Capital Bancorp and Subsidiaries

CONSOLIDATED BALANCE SHEETS


	*December 31,*
	*2008*		2007

	(in thousands, except per share amounts)
Assets:
Cash and due from banks	$	80,135	$	141,086
Interest-bearing demand deposits in other financial institutions		1,859,144		—

Cash and cash equivalents		1,939,279		141,086
Investment securities - trading, at fair value		213,939		146,862
Investment securities - available-for-sale, at fair value; amortized cost of $1,152,060 at December 31, 2008 and $1,147,824 at December 31, 2007		1,178,743		1,176,887
Loans:
Held for sale, at lower of cost or fair value		11,137		68,343
Held for investment, net of allowance for loan losses of $140,908 at December 31, 2008 and $44,843 at December 31, 2007		5,623,948		5,314,313

Total loans		5,635,085		5,382,656
Premises and equipment, net		78,608		86,921
Goodwill and other intangible assets		138,372		155,786
Other assets		390,265		284,148

Total assets	$	9,574,291	$	7,374,346

Liabilities:
Deposits:
Non-interest-bearing demand	$	981,944	$	1,002,281
Interest-bearing		5,608,032		3,961,531

Total deposits		6,589,976		4,963,812
Securities sold under agreements to repurchase		342,157		265,873
Federal funds purchased		—		6,800
Long-term debt and other borrowings		1,740,240		1,405,602
Other liabilities		113,481		63,903

Total liabilities		8,785,854		6,705,990

Commitments and contingencies (Note 18)
Shareholders’ equity:
Preferred stock - no par value; $1,000 per share stated value; 1,000 authorized, 181 issued and outstanding.		175,907		—
Common stock - no par value; $0.25 per share stated value; 100,000 authorized; 46,617 shares issued and outstanding at December 31, 2008 and 46,127 at December 31, 2007		11,659		11,537
Surplus		120,137		103,953
Retained earnings		471,531		537,065
Accumulated other comprehensive income		9,203		15,801

Total shareholders’ equity		788,437		668,356

Total liabilities and shareholders’ equity	$	9,574,291	$	7,374,346

See the accompanying notes.

Pacific Capital Bancorp and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS


	*Year Ended December 31,*
	*2008*		2007		2006

	(in thousands except per share amounts)

Interest income:
Loans	$	458,200	$	532,208	$	508,348
Investment securities - trading		6,833		—		—
Investment securities - available-for-sale		51,175		48,567		55,795
Other		3,125		2,834		383

Total interest income		519,333		583,609		564,526

Interest expense:
Deposits		91,422		129,728		116,836
Securities sold under agreements to repurchase		11,658		10,619		9,719
Federal funds purchased		1,418		7,378		8,335
Long-term debt and other borrowings		74,321		74,686		55,877

Total interest expense		178,819		222,411		190,767

Net interest income		340,514		361,198		373,759
Provision for loan losses		218,335		113,272		64,693

Net interest income after provision for loan losses		122,179		247,926		309,066

Non-interest income:
Refund transfer fees		68,731		45,984		44,939
Gain on sale of RALs, net		44,580		41,822		43,163
Service charges and fees		33,228		40,694		42,654
Trust and investment advisory fees		25,392		24,220		20,284
Gain on leasing portfolio sale, net		—		24,344		—
Loss on securities, net		(3,346)		(1,106)		(8,610)
Other		7,484		8,631		10,978

Total non-interest income		176,069		184,589		153,408

Non-interest expense:
Salaries and employee benefits		127,893		128,259		130,749
Refund program marketing and technology fees		46,257		44,500		54,706
Occupancy expense, net		25,440		21,952		19,631
Goodwill impairment		22,068		—		—
Furniture, fixtures and equipment, net		8,853		9,551		10,492
Other		109,057		71,180		99,486

Total non-interest expense		339,568		275,442		315,064

(Loss)/income before provision for income taxes		(41,320)		157,073		147,410
(Benefit)/provision for income taxes		(18,570)		56,185		52,870

Net (loss)/income		(22,750)		100,888		94,540

Dividends and accretion on preferred stock		1,094		—		—

Net (loss)/income available to common shareholders	$	(23,844)	$	100,888	$	94,540

(Loss)/income per common share - basic	$	(0.52)	$	2.15	$	2.02
(Loss)/income per common share - diluted (Note 3)	$	(0.52)	$	2.14	$	2.01
Average number of common shares - basic		46,273		46,816		46,770
Average number of common shares - diluted (Note 3)		46,644		47,082		47,099
Dividends declared per common share	$	0.88	$	0.88	$	0.88

See the accompanying notes.

Pacific Capital Bancorp and Subsidiaries

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME


	*Year Ended December 31,*
	*2008*		2007		2006

	(in thousands)

Net (loss)/income	$	(22,750)	$	100,888	$	94,540

Other comprehensive (loss)/income, net:
Unrealized (loss)/gain on securities AFS, net		(4,785)		3,435		6,810
Impairment loss on securities, net		3,333		1,732		5,077
Realized loss/(gain) on sale of securities AFS included in income, net		72		(1,110)		(88)
Postretirement benefit obligation arising during period, net		(5,218)		1,566		—

Net other comprehensive (loss) income		(6,598)		5,623		11,799

Comprehensive (loss)/income	$	(29,348)	$	106,511	$	106,339

Amount of losses reclassified out of accumulated other comprehensive income into earnings for the period was $5.9 million in 2008, $1.1 million in 2007 and $8.6 million in 2006. The income tax benefit related to these losses were $2.5 million, $451,000 and $3.6 million in 2008, 2007, and 2006, respectively.

See the accompanying notes.

Pacific Capital Bancorp and Subsidiaries

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY


	*Preferred Stock*			*Common Stock*					Accumulated Other Compre- hensive Income		Retained Earnings		Total Share- holder’s Equity
	*Shares*	*Amount*		*Shares*	*Amount*		*Surplus*		Accumulated Other Compre- hensive Income		Retained Earnings		Total Share- holder’s Equity

	(in thousands)

Balance, December 31, 2005:	—		—	46,631	$	11,662	$	107,829	$	987	$	424,778	$	545,256
Net income	—		—	—		—		—		—		94,540		94,540
Exercise of stock options	—		—	237		60		4,401		—		—		4,461
Stock-based compensation	—		—	—		—		1,731		—		—		1,731
Restricted stock grants **	—		—	12		3		3,670		—		—		3,673
Cash dividends declared at $0.88 per share	—		—	—		—		—		—		(41,476)		(41,476)
Other comprehensive income, net	—		—	—		—		—		11,799		—		11,799
Adjustment to initially apply FASB Statement No. 158	—		—	—		—		—		(2,608)		—		(2,608)

Balance, December 31, 2006	—		—	46,880		11,725		117,631		10,178		477,842		617,376

Net income	—		—	—		—		—		—		100,888		100,888
Repurchased shares, net	—		—	(1,091)		(273)		(24,671)		—		—		(24,944)
Exercise of stock options	—		—	291		73		5,058		—		—		5,131
Stock-based compensation	—		—	—		—		1,877		—		—		1,877
Restricted stock grants **	—		—	47		12		4,058		—		—		4,070
Cash dividends declared at $0.88 per share	—		—	—		—		—		—		(41,665)		(41,665)
Other comprehensive income, net	—		—	—		—		—		5,623		—		5,623

Balance, December 31, 2007	—		—	46,127		11,537		103,953		15,801		537,065		668,356


Net loss	—		—	—		—		—		—		(22,750)		(22,750)

Issuance of preferred stock and common stock warrants	181		175,907	—		—		4,709		—		(1,094)		179,522

Issuance of common stock	—		—	407		102		7,080		—		—		7,182

Exercise of stock options	—		—	19		4		283		—		—		287

Stock-based compensation	—		—	—		—		1,330		—		—		1,330

Restricted stock grants **	—		—	64		16		2,782		—		—		2,798

Cash dividends declared at $0.88 per share	—		—	—		—		—		—		(41,114)		(41,114)

Adoption of EITF 06-4 Split Dollar Life Insurance	—		—	—		—		—		—		(576)		(576)

Other comprehensive income, net	—		—	—		—		—		(6,598)		—		(6,598)

Balance, December 31, 2008	181	$	175,907	46,617	$	11,659	$	120,137	$	9,203	$	471,531	$	788,437

**	The amount recognized as compensation expense related to restricted stock awards was $2.9 million, $4.1 million and $3.7 million in 2008, 2007 and 2006, respectively.

See the accompanying notes.

Pacific Capital Bancorp and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS


	*Year Ended December 31,*
	*2008*		2007		2006

	(in thousands)

Cash flows from operating activities:
Net (Loss)/income	$	(22,750)	$	100,888	$	94,540
Adjustments to reconcile net (loss)/income to cash provided by operating activities:
Provision for loan losses		218,335		113,272		64,693
Depreciation and amortization		24,552		19,976		39,223
Stock-based compensation		4,205		6,034		5,479
Excess tax benefit of stock-based compensation		(51)		(821)		(1,699)
Deferred income taxes		(50,218)		8,835		(17,046)
Net amortization of discounts and premiums for investment securities		(9,087)		(11,487)		(4,954)
Goodwill impairment		22,068		—		—
(Gains)/Losses on:
Sale of loans, net		(46,571)		(67,750)		(45,192)
Securities, AFS		5,877		1,076		8,610
Futures		4,937		—		—
Sale of branches, net		(3,099)		—		—
Loans originated for sale and principal collections, net		11,137		345		—
Changes in:
Other assets		(56,157)		(21,873)		1,970
Other liabilities		54,265		4,745		5,846
Trading securities, net		(67,077)		(146,864)		—
Servicing rights, net		572		(2,433)		11

Net cash provided by operating activities		90,938		3,943		151,481

Cash flows from investing activities:
Proceeds from loan sales		2,246,519		2,111,798		1,479,631
Proceeds from sale of available-for-sale securities		123,565		317,647		—
Principal pay downs and maturities of available-for-sale securities		567,801		301,703		271,545
Purchase of available-for-sale securities		(692,392)		(326,603)		(52,435)
Loan originations and principal collections, net		(2,681,546)		(2,171,239)		(2,311,606)
Purchase of tax credit investments		(10,488)		(12,875)		(8,070)
Purchase of Federal Home Loan Bank stock		(11,901)		(4,621)		(20,644)
Purchase of premises and equipment, net		(14,163)		(10,079)		(15,263)
Proceeds from sale of other real estate owned, net		420		36		—

Net cash (used)/ provided by investing activities		(472,185)		205,767		(656,842)

Pacific Capital Bancorp and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(continued)


	*Year Ended December 31,*
	*2008*		2007		2006

	(in thousands)

Cash flows from financing activities:
Net increase/ (decrease) in deposits		1,629,704		(82,589)		28,535
Net increase/ (decrease) in short-term borrowings		296,157		(132,169)		55,712
Proceeds from long-term debt and other borrowings		455,000		330,000		717,608
Re-payment of long-term debt and other borrowings		(347,272)		(277,304)		(265,801)
Proceeds from issuance of common stock		7,485		4,446		4,318
Payments to repurchase common stock		—		(24,944)		—
Cash dividends paid on common stock		(41,114)		(41,665)		(41,476)
Excess tax benefit of stock-based compensation		51		821		1,699
Proceeds from issuance of preferred stock and common stock warrants, net		179,522		—		—
Others, net		(93)		598		68

Net cash provided/(used) by financing activities		2,179,440		(222,806)		500,663

Net increase/(decrease) in cash and cash equivalents		1,798,193		(13,096)		(4,698)
Cash and cash equivalents at beginning of year		141,086		154,182		158,880

Cash and cash equivalents at end of year	$	1,939,279	$	141,086	$	154,182

Supplemental disclosure:
Cash paid during the period for:
Interest	$	171,879	$	229,894	$	187,803
Income taxes		45,501		45,975		59,230
Non-cash investing activity:
Net transfers from loans held for investment to loans held for sale	$	153,311	$	68,343	$	—
Transfers from loans held for sale to securities available-for-sale		82,106		285,080		—
Investment tax credit commitments		17,369		50,553		75
Transfers to other real estate owned		4,166		503		—

See the accompanying notes.

Pacific Capital Bancorp and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

PCB is a bank holding company organized under the laws of the state of California. PCB provides a full range of commercial and consumer banking services to households, professionals, and businesses through its wholly-owned subsidiary PCBNA. These banking services include depository, lending and wealth management services. PCBNA’s lending products include commercial, consumer, commercial and residential real estate loans and SBA loans. PCBNA is also one of the largest nationwide providers of financial services related to the electronic filing of income tax returns including the RAL and RT business products. Depository services include checking, interest-bearing checking (“NOW”), money market (“MMDA”), savings, and CD accounts, as well as safe deposit boxes, travelers’ checks, money orders, foreign exchange services, and cashiers checks. PCBNA offers a wide range of wealth management services through the Wealth Management segment which includes two wholly-owned subsidiaries, MCM and REWA and a 20% interest in Veritas. The Wealth Management segment offers a wide range of trust and investment advisory services as well as the same loan and deposit products offered to the Community and Commercial Banking customers.

PCBNA conducts its banking services under five brand names: Santa Barbara Bank & Trust (“SBB&T”), First National Bank of Central California (“FNB”), South Valley National Bank (“SVNB”), San Benito Bank (“SBB”), and First Bank of San Luis Obispo (“FBSLO”). The SBB&T offices are located in Santa Barbara, Ventura and Los Angeles counties. Banking offices are located in eight counties in the central coast of California from Los Angeles to Santa Clara.

Basis of Presentation

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States (“GAAP”) and conform to practices within the financial services industry. The accounts of the Company and its consolidated subsidiaries are included in these Consolidated Financial Statements. All significant intercompany balances and transactions have been eliminated.

The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with GAAP. The preparation of financial statements in conformity to GAAP requires management to make estimates and assumptions that affect the amount of assets and liabilities as well as disclosures of contingent assets and liabilities at the date of the financial statements. Although Management believes these estimates to be reasonably accurate, actual amounts may differ. In the opinion of Management, all adjustments considered necessary have been reflected in the financial statements during their preparation.

Certain amounts in the 2007 and 2006 financial statements have been reclassified to be comparable with classifications used in the 2008 financial statements.

Consolidation of Subsidiaries and Variable Interest Entities

PCB has five wholly-owned subsidiaries. PCBNA, a banking subsidiary and four unconsolidated subsidiaries used as business trusts in connection with issuance of trust-preferred securities as described in Note 14, “Long-term Debt and Other Borrowings” of these Consolidated Financials Statements.

PCBNA has four wholly-owned consolidated subsidiaries:

MCM and REWA, two registered investment advisors that provide investment advisory services to individuals, foundations, retirement plans and select institutional clients.

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

PCB Service Corporation, utilized as a trustee of deeds of trust in which PCBNA is the beneficiary.

PCBNA also retains ownership in several low-income housing partnerships that generate tax credits. These partnerships are considered variable interest entities and are not consolidated into these Consolidated Financial Statements. The Company has invested $55.9 million in limited partnerships that construct low-income housing. The partnerships generate tax credits for the Company. Generally, the Company’s partnership interests are less than 50% of the total interests. Low-Income Tax Housing Partnerships are not required to be consolidated into the Company’s Consolidated Financial Statements.

In late 2007, Veritas was organized. PCBNA made an initial investment of $250,000 in Veritas. An additional investment of $750,000 was made in late January 2008. Veritas commenced operations in the second quarter of 2008. PCBNA’s variable interest in Veritas includes $1.0 million of equity at risk and an $80,000 loss which accounts for a 20% investment share of Veritas’ for 2008. PCBNA’s share of Veritas’ loss is included in the Company’s Consolidated Financial Statements using the equity method. PCBNA is not the primary beneficiary and therefore the Company has not included 100% of Veritas’ financial results into the Company’s Consolidated Financial Statements.

The Company does not have any other entities that should be considered for consolidation.

Cash Reserve Requirement

All depository institutions are required by law to maintain reserves against their transaction deposits. The reserves must be held in cash or with the FRB for their area. The amount of the reserve may vary each day as banks are permitted to meet this requirement by maintaining the specified amount as an average balance over a two-week period. The average daily cash reserve balances required to be maintained by PCBNA totaled approximately $7.9 million in 2008 and $4.3 million in 2007. In addition, PCBNA must maintain sufficient balances to cover the checks written by bank customers that are clearing through the FRB because they have been deposited at other banks.

Investment Securities

All investments reported by the Company as securities are debt securities. Securities may be classified as held-to-maturity, available-for-sale or trading. The appropriate classification is initially decided at the time of purchase. All securities currently held by the Company are classified as AFS or trading. At December 31, 2008 and 2007, the Company did not hold any of its securities in a held-to-maturity portfolio.

Securities classified as AFS and trading are reported as an asset on the Consolidated Balance Sheets at their estimated fair value. When the fair value of the security portfolio increases, the security balance increases and when the fair value declines, the security balance decreases. As the fair value of AFS securities changes, the changes are reported net of income tax as an element of OCI, except for impaired securities. When AFS securities are sold, the unrealized gain or loss is reclassified from OCI to non-interest income. The changes in the fair value of the trading securities are reported in non-interest income.

When the estimated fair value of a security is lower than the book value, a security is considered to be impaired. In Note 4, “Securities” of these Consolidated Financial Statements, the Company is required to disclose whether the impairment is temporary or other than temporary for all securities held in the AFS portfolio. Quarterly, the Company reviews impaired securities to determine whether the impairment is other than temporary. Factors that would be considered in deciding whether the impairment is other than temporary include:

the nature of the investment;

the cause(s) of the impairment;

the severity and duration of the impairment;

the strength of the market for the security;

the length of time the Company intends and is able to hold the security; and

credit ratings for the security and its sector.

If the impairment is determined to be other than temporary, the Company recognizes the impairment by accounting for the loss in the statement of operations within non-interest income in the period in which the impairment occurs. As explained in Note 4, “Securities” of these Consolidated Financial Statements, in December 2007, Management changed their intent to no longer hold certain MBS held in the AFS portfolio until recovery or maturity. Due to the change of intent by Management, the Company recognized unrealized losses for the AFS MBS portfolio through the statement of operations and unrealized gains through OCI.

Interest income is recognized based on the coupon rate and increased by the accretion of discounts earned or decreased by the amortization of premiums paid over the contractual life of the security using the interest method.

PCBNA is a member of both the FRB and the FHLB and, as a condition of membership in both organizations; it is required to purchase stock. In the case of the FRB, the amount of stock that is required to be held is based on PCBNA’s capital. As PCBNA’s capital increased additional stock in the FRB was required to be purchased. The required ownership of FHLB stock is based on the borrowing capacity used by PCBNA. These investments are considered equity securities with no actively traded market. Therefore, the shares are considered restricted investment securities and reported in other assets in the Consolidated Balance Sheets. Such investments are carried at cost, which is equal to the value at which they may be redeemed. The dividend income received from the stock is reported in other income.

Loans, Interest and Fees from Loans

Interest income on loans is accrued daily. Loan fees collected for the origination of loans less direct loan origination costs (net deferred loan fees) are amortized over the contractual life of the loan through interest income. If a loan has scheduled payments, the amortization of the net deferred loan fee is calculated using the interest method over the contractual life of the loan. If the loan does not have scheduled payments, such as a line of credit, the net deferred loan fee is recognized as interest income on a straight-line basis over the contractual life of the loan commitment. Loan fees received for loan commitments are recognized as interest income over the term of the commitment. When loans are repaid any remaining unamortized balances of unearned fees, deferred fees and costs and premiums and discounts paid on purchased loans are accounted for through interest income.

The Company generally holds loans for investment and has the intent and ability to hold loans until their maturity and therefore, they are reported at book value. Periodically, the Company identifies loans

it expects to sell prior to maturity. When loans are identified to be sold, they are reclassified as held for sale and reported at the lower of cost or fair value in the Consolidated Balance Sheets. Included in a loan’s cost are unearned deferred fees and costs and credit discounts specifically relating to the loans held for sale. At December 31, 2008 and 2007, the Company had $11.1 million and $68.3 million, respectively of loans classified as held for sale. Additional information regarding loans classified as held for sale is disclosed in Note 5, “Loans” of these Consolidated Financial Statements.

In September 2008, the Bank started originating mortgage loans for sale. When a mortgage loan is originated for sale, the loan is segregated from the mortgage loans originated for investment. The loans are segregated due to the short period of time they are held and therefore no allowance for loan loss, deferred fees or expenses are reported for loans held for sale. The loans are generally held for less than thirty days. If a loan has been reported as held for sale for more than 60 days, the loan is reclassified as a loan held for investment. Some of the loan commitments which the Bank plans to sell also have interest rate lock commitments for approximately 30 days with potential borrowers. The mortgage rate lock agreements with borrowers qualify as derivatives under Statement of Financial Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS 133”). The value of these derivatives is nominal as rate lock commitments are entered into at current market rates. The Bank does not collect a fee for these interest rate locks. These mortgage rate lock commitments are not material the Company’s Consolidated Financial Statements and, therefore are not recorded. At December 31, 2008 the Company had $18.7 million in notional outstanding mortgage loan rate lock commitments.

Nonaccrual Loans: When a borrower discontinues making payments as contractually required by the note, the Company must determine whether it is appropriate to continue to accrue interest. Generally, the Company places loans in a nonaccrual status and ceases recognizing interest income when the loan has become delinquent by more than 90 days and/or when Management determines that the repayment of principal and collection of interest is unlikely. The Company may decide that it is appropriate to continue to accrue interest on certain loans more than 90 days delinquent if they are well secured by collateral and collection is in process.

Impaired Loans: A loan is identified as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Most impaired loans are classified as nonaccrual. However, there are some loans that are termed impaired because of doubt regarding collectibility of interest and principal according to the contractual terms, but are both fully secured by collateral and are current in their interest and principal payments. These impaired loans are not classified as nonaccrual. A valuation allowance is established for an impaired loan when the fair value of the loan is less than the recorded investment. The Bank determines a loan is impaired in accordance with SFAS 114 utilizing the fair value of the collateral for collateral dependent loans or an analysis of the discounted cash flows.

Troubled Debt Restructured Loans: A loan is restructured when the Bank determines that a borrower’s financial condition has deteriorated but, still has the ability to repay the loan. A loan is considered restructured when the original terms have been modified in favor of the borrower or either principal or interest has been forgiven.

Prepayments: Borrowers may prepay their loans before their contractual maturity. When interest rates are declining, the Company expects the rate of prepayments to increase. Changes in the rate of prepayments impact the amortization of deferred origination fees and costs. The Company recognizes the remaining unamortized amounts into interest income when a loan prepays before the contractual maturity.

RAL and RT Programs

RALs

RALs are short-term consumer loans offered to taxpayers, secured by their anticipated tax refund and subject to an underwriting process prior to approval. At the request of the taxpayer, the refund claim is paid by the IRS to the Bank once the tax return has been processed. This constitutes the source of repayment of the RAL. Funds received from the IRS above the sum of the RAL less associated contractual fees are remitted to the taxpayer by the Bank.

The RAL funds advanced by the Bank are generally repaid by the IRS within several weeks. Therefore, the processing costs and provision for loan loss represent the major costs of these loans. This cost structure is different than for other loans since usually the cost of funds is the major cost for the Company in making a loan. Because of RALs short duration, the Bank cannot recover the processing costs through interest calculated over the term of the loan. Consequently, the Bank has structured the fees to have a fixed component to cover processing costs and a variable component to cover loan losses and the cost of funds. The customer signs a promissory note which requires the Company to report fees received for RALs as interest income.

RAL interest income varies based on the amount of the loan and not the term of the loan. The larger the loan, the greater the amount at risk from nonpayment. Therefore, the fee varies to correspond to the increased credit risk rather than the length of time the loan is outstanding.

RTs

An RT is an electronic transfer of an income tax refund directly to the taxpayer. The Company acts as a conduit from the IRS and State tax authorities to the taxpayer enabling an expedited delivery of the taxpayer’s income tax refund. There is no credit risk or borrowing cost for the Company because RTs are only delivered to the taxpayer upon receipt of the refund directly from the IRS. Payment of an RT is made in one of two ways. The Company either authorizes the tax preparer to provide a check directly to the taxpayer or the Company deposits the refund into a taxpayer’s account.

Fees Earned on RALs and RTs

Income from the RAL/RT Programs consists of the fees earned on these products. Fees earned on RALs are reported in interest income while fees earned on RTs are reported in non-interest income. The Company originates these products through three channels: Jackson Hewitt, other professional tax preparers and self filers. Regardless of the program a basic fee per product is charged. The fees charged for the products differ by source due to varying contractual terms. A description of the different fee structures is provided as follows:

JH: Fees charged on RALs offered through JH include an account handling fee and a finance charge equaling a percentage of the loan amount subject to a maximum and minimum. The RT fee is a fixed amount. The amount of fees is not impacted by the amount of charge-offs related to RALs that were originated by JH.

Other Professional Tax Preparers (“PRO”): Fees charged on RALs offered through other professional tax preparers include an account handling fee and a flat fee based on certain tiered loan amounts. The RT fee is a fixed amount.

Self Filers (“PER”): Fees charged on RALs offered through websites used by self filers include a flat fee for certain tiered loan amounts. The RT fee is a fixed amount. The fees charged for RALs varied as each website used by self filers had a different fee structure.

In 2006, the Company and JH entered into two new contracts, a program contract with Jackson Hewitt, Inc. and a technology services contract with Jackson Hewitt Technology Services, Inc. These contracts provided for JH to reduce the proportion of its transactions directed to the Company from approximately the 80% proportion for 2005 to approximately 75% in the 2008 tax season, and changed the method by which JH was compensated for the services it provides to the Company. The fee-splitting arrangement provided for in the earlier contract was eliminated, and, under the new contracts with JH, JH is compensated for services through fixed fees for program and technology services.

The first change in the 2006 JH contracts did not have a significant impact on the number of transactions directed to the Company. The initial reduction was accomplished not on an individual transaction basis, but instead by directing the transactions from specific JH offices to the other bank with whom JH contracts. This reduction in the proportion of transactions directed to the Company did not have an impact on the number of transactions as the growth in the number of transactions done by the offices still directed to the Company were slightly more than the number of transactions originated.

The second change in the 2006 JH contracts had a substantial impact on the amount of revenue, but little impact on pre-tax income as the amount of the fixed fees is approximately equal to what would have been shared with JH under the previous contract. While the “economics” are virtually the same under the new contracts as under the old, the presentation is different. Under the previous contract, the fees were recognized net of the amount of the fee split with JH. Under the new contracts, the whole amount of the revenue from the RALs and RTs is recognized by the Company and the program and technology service fees are shown as expenses.

Refund Anticipation Loan Securitization

The Company generally sells some of its RALs through a securitization each year during the months of January and February. To qualify as a sale, a transfer of assets must meet the criteria of SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishing of Liabilities” (“SFAS 140”). To be accounted for as a sale, SFAS 140 requires that (1) assets transferred be isolated from the transferor—put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership; (2) each transferee has the right to pledge or exchange the assets it received; and (3) the transferor does not maintain control over the transferred assets through either (i) an agreement that both entitles and obligates the transferor to repurchase or redeem them before their maturity or (ii) the ability to unilaterally cause the holder to return specific assets, other than through a cleanup call.

The second requirement of SFAS 140 is satisfied because the purchase agreements with RAL Funding and the other banks give such other banks the right to pledge or exchange the RALs.

The third requirement of SFAS 140 is satisfied because there is no requirement that the RAL Funding repurchase RALs other than those that did not meet the underwriting criteria in the purchase agreement

and were therefore inadvertently included among the sold loans. RAL Funding is permitted to repurchase loans in a “clean-up call” when the remaining unpaid loans have reached a minimal amount.

The purchase agreement specifically states that it is the intention of all of the parties that the transaction between SBBT RAL Funding Corp. and the participating banks and their conduits be treated as a sale for all purposes, other than for federal and state income tax purposes, and the Company has obtained a legal opinion each year supporting the true sale and legal isolation of the transferred assets from the Company.

The Company has concluded that the securitization of the RALs satisfy the criteria for sale treatment under SFAS 140.

The securitization is active only during the first quarter and terminated prior to the end of the first quarter of each year, there are no balances, retained interests, or servicing assets to be accounted for or disclosed at March 31 of each year. Any RALs outstanding at the end of each quarter are considered as loans held for investment. In February of each year, the Company closes the securitization facility and, once the facility is closed the Company does not re-open the securitization facility until the following year. There are no balances related to RALs, securitized or otherwise, recorded on the balance sheet at December 31 of each year.