<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
/X/ Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the Quarterly Period Ended MARCH 31, 1998
--------------
or
/ / Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition Period from _____________ to ___________
Commission File Number: 0-27384
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CAPITAL CORP OF THE WEST
(Exact name of registrant as specified in its charter)
California 77-0405791
(State or other jurisdiction IRS Employer ID Number
of incorporation or organization)
550 West Main, Merced, CA 95340
(Address of principal executive offices)
Registrant's telephone number, including area code: (209) 725-2200
-------------------
Former name, former address and former fiscal year, if changed since last
report: NOT APPLICABLE
----------------
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
---- -----
The number of shares outstanding of the registrant's common stock, no par
value, as of March 31, 1998 was $4,381,975. No shares of preferred stock, no
par value, were outstanding at March 31, 1998.
<PAGE>
CAPITAL CORP OF THE WEST
Table of Contents
<TABLE>
<CAPTION>
<S> <C> <C>
PART I. -- FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
PART II. -- OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of matters to a vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 27
</TABLE>
2
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Capital Corp of the West
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
03/31/98 12/31/97 03/31/97
--------- -------- --------
(In thousands)
<S> <C> <C> <C>
ASSETS
Cash & noninterest-bearing deposits in other banks $ 21,626 $ 21,035 $ 17,967
Federal funds sold 44,900 2,400 -
Time deposits at other financial institutions 1,000 599 1,288
Investment securities available for sale, at fair value 107,210 135,257 46,046
Investment securities held-to-maturity at cost 9,789 12,775 11,456
Loans, net of allowance for loan losses of $3,799,000 at
March 31, 1998; $3,833,000 at December 31, 1997;
and $2,674,000 at March 31, 1997 217,309 214,144 185,381
Interest receivable 2,462 2,741 1,985
Premises and equipment, net 13,167 12,945 8,095
Goodwill and other intangible assets 6,456 6,653 2,310
Other assets 14,042 12,845 11,356
-------- -------- --------
Total assets $437,961 $421,394 $285,884
-------- -------- --------
-------- -------- --------
LIABILITIES
Deposits
Noninterest-bearing demand $ 63,114 $ 58,836 $ 35,179
Negotiable orders of withdrawal 53,509 54,202 35,002
Savings 151,138 143,562 111,903
Time, under $100,000 74,902 69,534 51,082
Time, $100,000 and over 30,557 30,261 14,280
-------- -------- --------
Total deposits 373,220 356,395 247,446
Borrowed funds 21,429 22,049 12,388
Accrued interest, taxes and other liabilities 2,162 2,702 4,381
-------- -------- --------
Total Liabilities 396,811 381,146 264,215
SHAREHOLDERS' EQUITY
Preferred Stock, no par value; 10,000,000 shares
authorized; none outstanding - - -
Common stock, no par value, 20,000,000 shares
authorized; 4,381,975 issued & outstanding at March
31, 1998; 4,376,975 issued & outstanding at December
31, 1997; and 2,606,478 issued & outstanding at 33,978 33,928 15,592
March 31, 1997
Retained earnings 6,962 6,125 6,239
Investment securities unrealized gains(losses), net 210 195 (162)
-------- -------- --------
Total shareholders' equity 41,150 40,248 21,669
-------- -------- --------
Total liabilities and shareholders' equity $437,961 $421,394 $285,884
-------- -------- --------
-------- -------- --------
</TABLE>
3
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Capital Corp of The West
Consolidated Statements of Income
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ending Three Months Ending
(In thousands except share data) 3/31/98 3/31/97
<S> <C> <C>
Interest income:
Interest and fees on loans $5,699 $4,687
Interest on taxable investment securities held to maturity 205 248
Interest on investment securities available for sale:
Taxable 1,794 562
Non-taxable 121 59
Interest on federal funds sold 273 45
------ ------
Total interest income 8,092 5,601
Interest expense:
Deposits:
Negotiable orders of withdrawal 118 78
Savings 1,434 1,122
Time, under $100,000 1,050 660
Time, $100,000 and over 365 139
Other 336 73
------ ------
Total interest expense 3,303 2,072
Net interest income 4,789 3,529
Provision for loan losses 252 240
------ ------
Net interest income after provision for loan losses 4,537 3,289
Other income:
Service charges on deposit accounts 648 337
Income from real estate held for sale or development 22 7
Other 388 390
------ ------
Total other income 1,058 734
Other Expenses:
Salaries and related benefits 1,963 1,544
Premises and occupancy 325 279
Equipment 502 287
Professional fees 154 141
Marketing 102 159
Goodwill and intangible amortization 198 36
Branch purchase 101 -
Supplies 151 98
Other 827 696
------ ------
Total other expenses 4,323 3,240
Income before income taxes 1,272 783
Provision for income taxes 435 270
------ ------
Net income $ 837 $ 513
------ ------
Basic earnings per share $ 0.18 $ 0.19
------ ------
------ -------
Weighted average shares outstanding (000) 4,599 2,724
------ ------
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</TABLE>
4
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Capital Corp of The West
Statement of Consolidated Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
3 months ended 3 months ended
3/31/98 3/31/97
--------------- ---------------
(In thousands)
<S> <C> <C>
OPERATING ACTIVITIES:
Net Income $ 837 $ 513
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 252 240
Depreciation, amortization and accretion, net 752 281
Benefit for deferred income taxes - (65)
Gain on sale of real estate held for sale 22 -
Net (increase) in interest receivable & other assets (367) (415)
Net decrease in mortgage loans held for sale - 880
Net (decrease) increase in deferred loan fees (23) 57
Net (decrease) increase in accrued interest payable
& other liabilities (540) 1,606
------- --------
Net cash provided by operating activities 933 3,097
INVESTING ACTIVITIES:
Investment security purchases (21) (17,788)
Proceeds from maturities of investment securities 15,219 2,899
Proceeds from sales of investment securities 15,615 2,519
Net increase in time deposits in other financial institiutions (401) -
Proceeds from sales of commercial and real estate loans 814 205
Net increase in loans (4,208) (5,428)
Purchases of premises and equipment (637) (2,051)
Net increase in real estate held for sale or development (478) (72)
------- --------
Net cash provided (used) by investing activities 25,903 (19,716)
FINANCING ACTIVITIES:
Net increase (decrease) in demand, NOW and deposits 11,161 (2,661)
Net increase in certificates of deposit 5,664 11,762
Net (decrease) increase in other borrowings (620) 8,493
Issued shares for benefit plan purchases - 176
Exercise of stock options 50 99
------- --------
Net cash provided by financing activities 16,255 17,869
Net increase in cash and cash equivalents 43,091 1,250
Cash and cash equivalents at beginning of year 23,435 16,717
------- --------
Cash and cash equivalents at end of quarter $66,526 $ 17,967
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Investment securities net unrealized gains (losses) $ 15 $ (152)
</TABLE>
5
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Capital Corp of the West
Notes to Consolidated Financial Statements
March 31, 1998, December 31, 1997, and March 31, 1997
(Unaudited)
GENERAL - COMPANY
Capital Corp of the West (the "Company" or "Capital Corp") is a bank
holding company incorporated under the laws of the state of California on
April 26, 1995. On November 1, 1995, the Company became registered as a bank
holding company, and is a holder of all of the capital stock of County Bank
(the "Bank") and all of the capital stock of Town and Country Finance and
Thrift (the "Thrift"). During 1997 the Company formed Capital West Group, a
new subsidiary that engages in the financial institution advisory business
but is currently inactive. The Company's primary asset is the Bank and the
Bank is the Company's primary source of income. The Company's securities
consist of 20,000,000 shares of Common Stock, no par value, and 10,000,000
shares of Preferred Stock. As of March 31, 1998 there were 4,381,975 common
shares outstanding, held of record by approximately 1,300 shareholders.
There were no preferred shares outstanding at March 31, 1998. The Bank has
two wholly owned subsidiaries, Merced Area Investment & Development, Inc.
("MAID") and County Asset Advisors ("CAA"). CAA is currently inactive. All
references herein to the "Company" include the Bank, and the Bank's
subsidiaries, Capital West Group and the Thrift, unless context otherwise
requires.
GENERAL - BANK
The Bank was organized on August 1, 1977, as County Bank of Merced, a
California state banking corporation. The Bank commenced operations on
December 22, 1977. In November 1992, the Bank changed its legal name to
County Bank. The Bank's securities consist of one class of Common Stock, no
par value and is wholly owned by the Company. The Bank's deposits are
insured under the Federal Deposit Insurance Act, by the Federal Deposit
Insurance Corporation ("FDIC") up to applicable limits stated therein. Like
most state-chartered banks of its size in California, it is not a member of
the Federal Reserve System.
GENERAL - THRIFT
The Company acquired the Thrift on June 28, 1996 for a combination of
cash and stock with an aggregate value of approximately $5.8 million. The
Thrift is an industrial loan company with four offices. It specializes in
direct loans to the public and the purchase of financing contracts. It was
originally incorporated in 1957. Its deposits (technically known as
investment certificates or certificates of deposit rather than deposits) are
insured by the FDIC up to applicable limits.
BANK'S INDUSTRY AND MARKET AREA
The Bank engages in general commercial banking business primarily in
Merced, Tuolumne, Mariposa, Madera and Stanislaus counties. The Bank has
thirteen branch offices: two in Merced with the branch located in north
Merced currently designated as the head office, offices in Atwater, Turlock,
Hilmar, Sonora, Los Banos, Mariposa, Livingston, Dos Palos, Madera and two
offices in Modesto. The Bank relocated its existing administrative office
and existing branch in downtown Merced to a new facility constructed in 1997.
The Thrift engages in the general consumer lending business primarily in
Stanislaus, Fresno, and Tulare counties from its main office in Turlock; and
branch offices located in Modesto, Visalia, and Fresno.
OTHER FINANCIAL NOTES
All adjustments, in the opinion of Management, which are necessary for a
fair presentation of the Company's financial position at March 31, 1998,
December 31, 1997, and at March 31 1997 and the results of operations and
statements of cash flows for the three month periods ended March 31, 1998
and 1997, have been included. These interim statements are not necessarily
indicative of the results for a full year.
6
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The accompanying unaudited financial statements have been prepared on a
basis consistent with the generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X.
Per share information is based on weighted average number of shares of
common stock outstanding during each three-month period after giving
retroactive effect for the five percent stock dividend declared for
shareholders of record May 7, 1998, payable June 1, 1998, the three-for-two
stock split declared for shareholders of record on April 11, 1997, payable on
May 2, 1997. The weighted average number of shares outstanding were
4,599,000 for the three-month period ended March 31, 1998 and 2,724,000 for
March 31, 1997.
Comprehensive Income for Capital Corp of the West for the periods ending
March 31, 1998 and March 31, 1997 were $852,000 or $.19 per share and $606,000
or $.22 per share respectively.
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Board No. 130, "Reporting Comprehensive
Income". Under the provisions of SFAS 130, the Company is required to report
comprehensive income in its financial statements, the term comprehensive
income describes the total of all components of comprehensive income
including net income as well as other revenues, expenses, gains and losses
that are included in comprehensive income but excluded from earnings (net
income). The Company started to report comprehensive income as part of its
notes to financial statements, including other comprehensive income items
added separately to net income resulting in total comprehensive income. SFAS
130 is effective with the year-end 1998 financial statements, however, the
total comprehensive income is required in the financial statements for
interim periods beginning in 1998. The Company adopted SFAS 130 as of January
1, 1998, the adoption of the statement did not have a material impact on the
Company's financial statements.
In June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT SEGMENTS
OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 is effective for
annual periods beginning after December 1, 1997 and is to be applied
retroactively to all periods presented. SFAS No. 131 establishes standards
for the way public business enterprises are to report information about
operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services, geographic
areas, and major customers. SFAS No. 131 supersedes SFAS No. 14, FINANCIAL
REPORTING FOR SEGMENTS OF A BUSINESS ENTERPRISE but retains the requirement
to report information about major customers. Management does not expect that
adoption of SFAS No. 131 will have a material impact on the Company's
consolidated financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A
RESULT OF CERTAIN FACTORS. THESE FACTORS INCLUDE GENERAL RISKS INHERENT TO
COMMERCIAL LENDING; RISKS RELATED TO ASSET QUALITY; RISKS RELATED TO THE
COMPANY'S DEPENDENCE ON KEY PERSONNEL AND ITS ABILITY TO MANAGE EXISTING AND
FUTURE GROWTH; RISKS RELATED TO COMPETITION; RISKS POSED BY PRESENT AND
FUTURE GOVERNMENT REGULATION AND LEGISLATION; AND RISKS RESULTING FROM
FEDERAL MONETARY POLICY.
The following discussion and analysis is designed to provide a better
understanding of the significant changes and trends related to the Company
and its subsidiaries' financial condition, operating results, asset and
liability management, liquidity and capital resources and should be read in
conjunction with the Consolidated Financial Statements of the Company and the
Notes thereto.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 COMPARED WITH THREE MONTHS ENDED MARCH
31, 1997
OVERVIEW. For the three months ended March 31, 1998, the Company
reported net income of $837,000 compared with net income of $513,000 for the
three months ended March 31, 1997. Earnings per share were $.18 and $.19,
respectively. The annualized return on average assets was .78% and .76% for
the first three months of 1998 and 1997, respectively. The Company's
annualized return on average equity was 8.12% and 9.61% for the three months
ended March 31, 1998 and 1997, respectively.
NET INTEREST INCOME. The Company's primary source of income is the
difference between interest income and fees derived from earning assets and
interest paid on liabilities. The difference between the two is net interest
income. Net interest income for the three months ended March 31, 1998
totaled $4,789,000 compared with $3,529,000 for the same period in 1997, an
increase of $1,260,000 or 36%.
Total interest and fees on earning assets were $8,092,000 for the first
three months of 1998, an increase of $2,491,000 or 44% from $5,601,000 for
the same three months in 1997. The level of interest income is affected by
changes in volume of and rates earned on interest-earning assets.
Interest-earning assets consist primarily of loans,
7
<PAGE>
investment securities and federal funds sold. The increase in interest income
in the first three months of 1998 was primarily the result of an increase in
the volume of interest-earning assets. Average interest-earning assets for
the first three months of 1998 were $375,683,000 compared with $240,196,000
for the first three months of 1997, an increase of $135,487,000 or 56%.
Interest expense is a function of the volume of and the rates paid on
interest-bearing liabilities. Interest-bearing liabilities consist primarily
of certain deposits and borrowed funds. Total interest expense was
$3,303,000 for the three months ended March 31, 1998, compared with
$2,072,000 for the three months ended March 31, 1997, an increase of
$1,231,000 or 59%. This increase was primarily the result of an increase in
the volume of interest-bearing liabilities. Average interest-bearing
liabilities were $326,930,000 for the first three months of 1997 compared
with $211,161,000 for the same three months in 1997, an increase of
$115,769,000 or 55%.
The increase in interest-earning assets and interest-bearing liabilities
is primarily the result of the Company's purchase of three branches of Bank
of America in December 1997 and the completion of a successful stock
offering in August 1997. The branch purchase increased deposits by
$60,849,000 (there were no loans purchased) and the stock offering increased
capital by $17,951,000. In addition, two branch offices opened in late 1996
and a third in late 1997 which also contributed to growth.
The Company's net interest margin, the ratio of net interest income to
average interest-earning assets, was 5.17% for the three months ended March
31, 1998 compared with 5.96% for the same period in 1997. Net interest
margin provides a measurement of the Company's ability to employ funds
profitably during the period being measured. The Company's decrease in net
interest margin was primarily attributable to a moderate change in the mix of
interest-earning assets. Loans as a percentage of average interest-earning
assets decreased from 77% for the three months ended March 31, 1997 to 58%
for the three months ended March 31, 1998.
AVERAGE BALANCES AND RATES EARNED AND PAID. The following table
presents condensed average balance sheet information for the Company,
together with interest rates earned and paid on the various sources and uses
of its funds for each of the periods indicated. Nonaccruing loans are
included in the calculation of the average balances of loans, but the
nonaccrued interest on such loans is excluded.
Average Balance Sheet And Analysis of Net Interest Income
<TABLE>
<CAPTION>
Three Months ended Three Months ended
March 31, 1998 March 31, 1997
Average Average
Balance Interest Yield/rate Balance Interest Yield/rate
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Federal funds sold $ 20,041 $ 273 5.52% $ 3,589 $ 45 5.09%
Taxable investment securities: 128,828 1,999 6.29% 47,994 810 6.85%
Nontaxable investment securities (1) 9,215 121 5.33% 4,195 59 5.70%
Loans, gross: (2) 217,599 5,699 10.62% 184,418 4,687 10.31%
--------- ---------- ----------- ----------- ---------- -----------
Total interest-earning assets: 375,683 8,092 8.74% 240,196 5,601 9.46%
Allowance for loan losses (4,073) (2,977)
Cash and due from banks 20,606 10,806
Premises and equipment, net 13,153 7,334
Interest receivable and other assets 22,094 15,516
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Total assets $427,463 $270,875
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LIABILITIES AND SHAREHOLDERS' EQUITY
Negotiable order of withdrawal $ 53,560 $ 118 0.89% $ 33,368 $ 78 0.95%
Savings deposits 148,508 1,434 3.92% 112,564 1,122 4.04%
Time deposits 102,965 1,415 5.57% 59,415 799 5.45%
Other borrowings 21,898 336 6.22% 5,814 73 5.09%
--------- ---------- ----------- ----------- ---------- -----------
Total interest-bearing liabilities 326,930 3,303 4.10% 211,161 2,072 3.98%
8
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Noninterest-bearing deposits 56,419 32,871
Accrued interest, taxes and other liabilities 2,342 5,432
--------- -----------
Total liabilities 385,691 249,464
Total shareholders' equity 41,772 21,411
--------- -----------
Total liabilities and shareholders' equity $427,463 $270,875
--------- -----------
--------- -----------
Net interest income and margin (3) $ 4,789 5.17% $ 3,529 5.96%
-------- ---- --------- ----
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</TABLE>
(1) Interest on nontaxable securities is not computed on a tax-equivalent
basis.
(2) Amounts of interest earned includes loan fees of $343,000 and $233,000 for
March 31, 1998 and 1997 respectively.
(3) Net interest margin is computed by dividing net interest income by total
average interest-earning assets.
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NET INTEREST INCOME CHANGES DUE TO VOLUME AND RATE. The following table
sets forth, for the periods indicated, a summary of the changes in average
asset and liability balances and interest earned and interest paid resulting
from changes in average asset and liability balances (volume) and changes in
average interest rates and the total net change in interest income and
expenses. The changes in interest due to both rate and volume have been
allocated to volume and rate changes in proportion to the relationship of the
absolute dollar amount of the change in each.
Net Interest Income Variance Analysis:
<TABLE>
<CAPTION>
March 31, 1998 compared to
March 31, 1997
Volume Rate Total
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(Dollar amounts in thousands)
<S> <C> <C> <C>
Increase (decrease) in interest income:
Taxable investment securities $ 1,640 (451) 1,189
Tax-exempt investment securities 89 (27) 62
Federal funds sold 224 4 228
Loans 865 147 1,012
------ ---- -----
Total 2,818 (327) 2,491
------ ---- -----
------ ---- -----
Increase (decrease) in interest expense:
Interest-bearing demand 70 (30) 40
Savings deposits 544 (232) 312
Time deposits 598 18 616
Other borrowings 243 20 263
------ ---- -----
Total 1,455 (224) 1,231
------ ---- -----
------ ---- -----
Increase (decrease) in net interest income $ 1,363 $ (103) $ 1,260
------ ---- -----
------ ---- -----
</TABLE>
PROVISION FOR LOAN LOSSES. The provision for loan losses for the first
three months of 1998 was $252,000 compared with $240,000 in the three months
ended March 31, 1997. As of March 31, 1998 the allowance for loan losses was
$3,799,000 or 1.72% of total loans. At March 31, 1998, nonperforming assets
totaled $1,802,000 or .41% of total assets, nonperforming loans totaled
$1,279,000 or .81% of total loans and the allowance for loan losses totaled
297.02% of nonperforming loans. No assurance can be given that nonperforming
loans will not increase or that the allowance for loan losses will be adequate
to cover losses inherent in the loan portfolio. Also see "Memorandum of
Understanding" contained herein.
NONINTEREST INCOME. Noninterest income increased by $324,000 or 44% to
$1,058,000 for the three months ended March 31, 1998 compared with $734,000 in
the same period in 1997. Service charges on deposit accounts increased by
$311,000 or 92%, income from the sale of real estate held for sale or
development increased by $15,000 or 214% and other income decreased by $2,000 or
1%. The increases in service charges are primarily due to general growth of the
Company and the purchases of the branches from Bank of America.
NONINTEREST EXPENSE. Noninterest expenses increased by $1,083,000 or 33% to
$4,323,000 for the three months ended March 31, 1998 compared with $3,240,000
for the same period in 1997. The primary components of noninterest expenses
were salaries and employee benefits, occupancy expenses, furniture and equipment
expenses, and other operating expenses.
For the three months ended March 31, 1998 compared with the three months
ended March 31, 1997, salaries and related benefits increased by $419,000 or
27%, equipment expenses increased $215,000 or 75%, occupancy expenses increased
$46,000 or 17%, marketing expenses decreased by $57,000 or 36% and other
expenses, including professional fees, and supplies increased by $281,000 or
11%. The expense increases were primarily the result of expansion, including
expenses associated with acquisition, operation and staffing of the branches
purchased from Bank of America in December, 1997 and the opening of a new branch
in Madera in late 1997.
10
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PROVISION FOR INCOME TAXES. The Company recorded a $435,000 tax expense
for the three months ended March 31, 1998 compared with $270,000 for the same
three months in 1997. Tax rates were positively affected by the purchase of
limited partnership investments in low-income affordable housing projects
providing the investor with affordable housing income tax credits. The
Company had investments in these partnerships of $4,300,000 as of March 31,
1998 and $2,700,000 as of March 31, 1997, resulting in tax credits of $79,000
and $35,000 respectively.
INTEREST RATE RISK
Interest rate risk is an integral part of managing a banking
institution's primary source of income, net interest income. The Company
manages the balance between rate-sensitive assets and rate-sensitive
liabilities being repriced in any given period with the objective of
stabilizing net interest income during periods of fluctuating interest rates.
The Company considers its rate-sensitive assets to be those which either
contain a provision to adjust the interest rate periodically or mature within
one year. These assets include certain loans and investment securities and
federal funds sold. Rate-sensitive liabilities are those which allow for
periodic interest rate changes within one year and include maturing time
certificates, certain savings deposits and interest-bearing demand deposits.
The difference between the aggregate amount of assets and liabilities that
reprice within various time frames is called the "gap." Generally, if
repricing assets exceed repricing liabilities in a time period the Company
would be deemed to be asset-sensitive. If repricing liabilities exceed
repricing assets in a time period the Company would be deemed to be
liability-sensitive. Generally, the Company seeks to maintain a balanced
position whereby there is no significant asset or liability sensitivity
within a one-year period to ensure net interest margin stability in times of
volatile interest rates. This is accomplished through maintaining a
significant level of loans, investment securities and deposits available for
repricing within one year.
The following tables set forth the interest rate sensitivity of the
Bank's interest-earning assets and interest-bearing liabilities as of March
31, 1998, using the interest rate sensitivity gap ratio. For purposes of the
following table, an asset or liability is considered rate-sensitive within a
specified period when it can be repriced or matures within its contractual
terms.
<TABLE>
<CAPTION>
AT MARCH 31, 1998
-------------------------------------------------------------------------------------
AFTER 3 AFTER 1
BUT YEAR BUT
WITHIN WITHIN WITHIN AFTER NONINTEREST-
3 MONTHS 12 MONTHS 5 YEARS 5 YEARS BEARING TOTAL
-------- --------- --------- -------- ------------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Time deposits at other banks $ 250 $ 750 $ - $ - $ - $ 1,000
Federal funds sold 44,900 - - - - 44,900
Investment securities 3,445 21,181 7,813 84,560 - 116,999
Loans 124,194 27,494 56,087 13,333 - 221,108
-------- --------- --------- -------- ------------ ---------
Total earning assets 172,789 49,425 63,900 97,893 - 384,007
Noninterest-earning assets and allowances
for loan losses - - - - 53,954 53,954
-------- --------- --------- -------- ------------ ---------
Total assets $ 172,789 $ 49,425 $ 63,900 $ 97,893 $ 53,954 $ 437,961
LIABILITIES AND SHAREHOLDERS' EQUITY
Savings, money market and NOW deposits $ 204,647 $ - $ - $ - $ - $ 204,647
Time deposits 18,518 65,590 21,351 - - 105,459
Other interest-bearing liabilities - 18,029 103 3,297 - 21,429
Other liabilities and shareholders' equity - - - - 106,426 106,426
Total liabilities and shareholders' equity 223,165 83,619 21,454 3,297 106,426 $ 437,961
Incremental gap (50,376) (34,194) 42,446 94,596 (52,472)
Cumulative gap $(50,376) $ (84,570) $ (42,124) $ 52,472 $ -
-------- --------- --------- -------- ---------
-------- --------- --------- -------- ---------
Cumulative gap as a % of earning assets (13.1)% (22.1)% (10.9)% 53.9%
</TABLE>
11
<PAGE>
The Company was liability-sensitive with a negative cumulative one-year
gap of $84,570,000 or 22.1% of interest-earning assets at March 31, 1998. In
general, based upon the Company's mix of deposits, loans and investments,
increases in interest rates would be expected to result in a decrease in the
Company's net interest margin.
The interest rate gaps reported in the tables arise when assets are
funded with liabilities having different repricing intervals. Since these
gaps are actively managed and change daily as adjustments are made in
interest rate views and market outlook, positions at the end of any period
may not be reflective of the Company's interest rate sensitivity in
subsequent periods. Active management dictates that longer-term economic
views are balanced against prospects for short-term interest rate changes in
all repricing intervals. For purposes of the analysis above, repricing of
fixed-rate instruments is based upon the contractual maturity of the
applicable instruments. Actual payment patterns may differ from contractual
payment patterns. The change in net interest income may not always follow
the general expectations of an asset-sensitive or liability-sensitive balance
sheet during periods of changing interest rates, because interest rates
earned or paid may change by differing increments and at different time
intervals for each type of interest-sensitive asset and liability. As a
result of these factors, at any given time, the Company may be more sensitive
or less sensitive to changes in interest rates than indicated in the above
tables. Greater sensitivity would have a more adverse effect on net interest
margin if market interest rates were to increase, and a more favorable effect
if rates were to decrease.
An additional measure of interest rate sensitivity that the Company
monitors through a detailed model is its expected change in earnings. This
model's estimate of interest rate sensitivity takes into account the
differing time intervals and differing rate change increments of each type of
interest-sensitive asset and liability. It then measures the projected
impact of changes in market interest rates on the Company's return on equity.
Based upon the March 31, 1998 mix of interest-sensitive assets and
liabilities, given an immediate and sustained increase in the federal funds
rate of 1%, this model estimates the Company's cumulative return on equity
over the next year would decrease by less than 1%. No assurance can be given
that the actual return on equity would not decrease by more than 1% in
response to a 1% increase in federal funds rate, or that actual return on
equity would not decrease substantially if market interest rates increased by
more than 1%. Also see "Memorandum of Understanding" contained herein. The
Bank's most recent examination, the regulators felt that the current model
that is used by the Bank was not adequate for a bank of its current size and
complexity. The Bank is currently updating the model it uses for interest
rate risk analysis and expects to have this new model in place by June 30,
1998.
FINANCIAL CONDITION
Total assets at March 31, 1998 were $437,961,000, an increase of
$16,567,000 or 4% compared with total assets of $421,394,000 at December 31,
1997, and an increase of $152,077,000 or 53% compared with total assets of
$285,884,000 at March 31, 1997. Net loans were $217,309,000 at March 31,
1998, an increase of $3,165,000 or 2% compared with net loans of $214,144,000
on December 31, 1997, and an increase of $31,928,000 or 17% compared with net
loans of $185,381,000 at March 31, 1997. Deposits were $373,220,000 at March
31, 1998, an increase of $16,825,000 or 5% compared with deposits of
$356,395,000 at December 31, 1997, and an increase of $125,774,000 or 51%
compared with deposits of $247,446,000 at March 31, 1997. The growth of the
Company from March 31, 1997 to March 31, 1998 was primarily the result of the
purchase of three branch offices of Bank of America in December 1997, a
successful capital offering in 1997 and the opening of a branch office of
County Bank in late 1997.
Total shareholders' equity was $41,150,000 at March 31, 1998, an
increase of $902,000 or 2% from $40,248,000 at December 31, 1997, and a 90%
increase from $21,669,000 at March 31, 1997. The growth in shareholders'
equity was primarily due to the issuance of 1,725,000 additional shares of no
par common stock which generated a net addition of $17,951,000 to
shareholders' equity in August 1997.
INVESTMENT PORTFOLIO. The following table sets forth the carrying
amount (fair value) of available for sale investment securities as of March
31, 1998 and 1997, and December 31, 1997.
12
<PAGE>
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
------------------ -----------
1998 1997 1997
--------- ------- -----------
(Dollars in thousands)
<S> <C> <C> <C>
AVAILABLE FOR SALE SECURITIES:
U.S. Treasury and U.S. Government agencies $ 817 $ 5,599 $ 1,824
State and political subdivisions 8,739 4,254 9,640
Mortgage-backed securities 65,393 34,669 68,808
Collateralized mortgage obligations 29,129 0 51,874
Other securities 3,132 1,524 3,111
--------- -------- ---------
Carrying amount and fair value $ 107,210 $ 46,046 $ 135,257
--------- -------- ---------
--------- -------- ---------
</TABLE>
The following table sets forth the carrying amount (amortized cost) and
fair value of held to maturity securities at March 31, 1998 and 1997, and
December 31, 1997.
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
---------------------------- -----------
(Dollars in thousands) 1998 1997 1997
---- ---- ----
<S> <C> <C> <C>
HELD TO MATURITY SECURITIES:
U.S. Treasury and U.S.
Government agencies $ 6,439 $ 11,456 $ 9,442
Mortgage-backed securities 3,350 - 3,333
------------- ----------- ---------
Carrying amount (amortized cost) 9,789 11,456 12,775
------------- ----------- ---------
------------- ----------- ---------
Fair value $ 9,791 $ 11,058 $ 12,780
------------- ----------- ---------
------------- ----------- ---------
</TABLE>
The following table sets forth the maturities of the Company's investment
securities at March 31, 1998 and the weighted average yields of such
securities calculated on the basis of the cost and effective yields based on
the scheduled maturity of each security. Maturities of mortgage-backed
securities are stipulated in their respective contracts. However, actual
maturities may differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call prepayment
penalties. Yields on municipal securities have not been calculated on a
tax-equivalent basis.
<TABLE>
<CAPTION>
AT MARCH 31, 1998
-----------------------------------------------------------------------------------------------
WITHIN ONE YEAR ONE TO 5 YEARS FIVE TO TEN YEARS OVER TEN YEARS TOTAL
------------------ ----------------- ------------------ -------------------------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT
-------- ------- --------- ------- ------- -------- --------- ------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Available for Sale Securities:
Treasury and U.S. Government
agencies $ - - $ 505 5.52% $ - - $ 312 7.40 % $ 817
State and political 420 3.54% 801 3.71 - - 7,517 5.01 8,739
Mortgage-backed securities - - 440 5.94 2,815 6.27% 59,478 6.11 62,734
Collateralized mortgage
obligations - - 16,164 6.72 - - 15,625 6.64 31,789
Other securities - - - - - - 3,132 - 3,132
-------- ------- --------- ------- ------- -------- --------- ------- ---------
Carrying amount and fair value 420 3.54% 17,912 6.53% 2,815 6.27% 86,064 6.12 % 107,210
-------- ------- --------- ------- ------- -------- --------- ------- ---------
-------- ------- --------- ------- ------- -------- --------- ------- ---------
Held to maturity securities:
Treasury and U.S. Government - - - - 4,039 6.95 2,400 7.17 6,439
agency
Mortgage-backed securities - - - - - - 3,350 7.35 3,350
-------- ------- --------- ------- ------- -------- --------- ------- ---------
Carrying amount (amortized cost) - - - - 4,039 6.95 5,750 7.27 9,789
-------- ------- --------- ------- ------- -------- --------- ------- ---------
Total securities $ 420 3.54% $ 17,912 6.53% $ 6,854 6.67% $ 91,813 5.98 % $116,999
</TABLE>
13
<PAGE>
In the above table, mortgage-backed securities and collateralized
mortgage obligations are shown repricing at the time of maturity rather than
in accordance with their principal amortization schedules. The Company does
not own securities of a single issuer whose aggregate book value is in excess
of 10% of its total equity. Also see "Memorandum of Understanding" contained
herein.
LOAN PORTFOLIO. The following table shows the composition of the
Company's loan portfolio at the dates indicated.
<TABLE>
<CAPTION>
AT MARCH 31, AT DECEMBER 31,
--------------------------------------------------- ------------------
1998 1997 1997
----------------------- ------------------------ ------------------
(DOLLARS IN THOUSANDS)
Dollar Amount Percent Dollar Amount Percent of Dollar Percent
Loan Categories: of loans loans Amount of loans
- ---------------- ------------- --------- ------------- ---------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Commercial $ 37,360 17 % $ 28,261 15% $ 34,992 16%
Agricultural 41,337 19 42,633 23 43,558 20
Real estate-construction 13,101 6 14,796 8 12,657 6
Real estate-mortgage 70,711 32 59,869 32 70,802 32
Consumer 58,599 26 42,496 22 55,968 26
-------- ----- -------- --- -------- ---
Total 221,108 100 % $188,055 100% $217,977 100%
Less allowance for loan losses (3,799) (2,674) (3,833)
-------- -------- --------
Net loans $217,309 $185,381 $214,144
-------- -------- --------
-------- -------- --------
</TABLE>
The following tables show the maturity distribution of the loan
portfolio at March 31, 1998.
<TABLE>
<CAPTION>
AT MARCH 31, 1998
--------------------------------------------------------
AFTER 1 BUT
WITHIN 1 YEAR WITHIN 5 YEARS AFTER 5 YEARS TOTAL
------------- -------------- ------------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial and agricultural
Loans with floating interest rates $45,187 $14,083 $ 5,591 $ 64,861
Loans with fixed interest rates 4,671 5,212 837 10,720
------- ------- ------- --------
Subtotal 49,858 19,295 6,428 75,581
------- ------- ------- --------
Real estate-construction
Loans with floating interest rates 6,922 1,279 1,877 10,078
Loans with fixed interest rates 1,617 1,266 137 3,020
------- ------- ------- --------
Subtotal 8,539 2,545 2,014 13,098
------- ------- ------- --------
Real estate-mortgage 5,092 40,273 25,537 70,902
Consumer 30,713 29,888 926 61,527
------- ------- ------- --------
Total $94,202 $92,001 $34,905 $221,108
------- ------- ------- --------
------- ------- ------- --------
</TABLE>
OFF-BALANCE SHEET COMMITMENTS. The following table shows the Company's
undisbursed loan commitments at the dates indicated.
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
------------------- --------------
1998 1997 1997
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Letters of credit $ 2,740 $ 2,267 $ 3,233
Commitments to extend credit 73,191 48,111 55,248
------- ------- -------
Total $75,931 $50,378 $58,481
------- ------- -------
------- ------- -------
</TABLE>
14
<PAGE>
OTHER INTEREST-EARNING ASSETS. The following table relates to other
interest-earning assets not disclosed previously for the dates indicated. This
item consists of a salary continuation plan for the Company's executive
management and deferred retirement benefits for participating board members.
The plan is informally linked with universal life insurance policies for the
salary continuation plan. Income from these policies is reflected in
noninterest income.
<TABLE>
<CAPTION>
AT MARCH 31, AT DECEMBER 31,
---------------------- ----------------
1998 1997 1997
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Cash surrender value of
life insurance $ 3,974 $ 3,172 $ 3,839
---------- -------- --------
---------- -------- --------
</TABLE>
NONPERFORMING ASSETS. Nonperforming assets include nonaccrual loans, loans
90 days or more past due, restructured loans and other real estate owned.
Nonperforming loans are those which the borrower fails to perform in
accordance with the original terms of the obligation and include loans on
nonaccrual status, loans past due 90 days or more and restructured loans.
The Company generally places loans on nonaccrual status and accrued but
unpaid interest is reversed against the current year's income when interest
or principal payments become 90 days or more past due unless the outstanding
principal and interest is adequately secured and, in the opinion of
management, is deemed in the process of collection. Interest income on
nonaccrual loans is recorded on a cash basis. Payments may be treated as
interest income or return of principal depending upon management's opinion of
the ultimate risk of loss on the individual loan. Cash payments are treated
as interest income where management believes the remaining principal balance
is fully collectible. Additional loans not 90 days past due may also be
placed on nonaccrual status if management reasonably believes the borrower
will not be able to comply with the contractual loan repayment terms and
collection of principal or interest is in question.
A "restructured loan" is a loan on which interest accrues at a below market
rate or upon which certain principal has been forgiven so as to aid the borrower
in the final repayment of the loan, with any interest previously accrued, but
not yet collected, being reversed against current income. Interest is reported
on a cash basis until the borrower's ability to service the restructured loan in
accordance with its terms is established. The Company had no restructured loans
as of the dates indicated in the table below.
The following table summarizes nonperforming assets of the Company at March
31, 1998 and 1997 and at December 31, 1997:
<TABLE>
<CAPTION>
March 31, At December 31,
------------------- ---------------
(Dollars in thousands) 1998 1997 1997
---- ---- ----
<S> <C> <C> <C>
Nonaccrual loans $ 823 $5,101 $2,611
Accruing loans past due 90 days or more 456 1,565 131
------ ------ ------
Total nonperforming loans 1,279 6,666 2,742
Other real estate owned 523 1,466 60
------ ------ ------
Total nonperforming assets $1,802 $8,132 $2,802
------ ------ ------
------ ------ ------
Nonperforming assets:
To total loans .81% 4.32% 1.29%
15
<PAGE>
To total assets .41% 2.84% .66%
</TABLE>
Interest income on loans on nonaccrual status during the three months ended
March 31, 1998, and the three months ended March 31, 1997, that would have been
recognized if the loans had been current in accordance with their original terms
was approximately $143,000 and $511,000, respectively.
At March 31, 1998, nonperforming assets represented .41% of total assets,
and nonperforming loans represented .81% of total loans. Nonperforming loans
that were secured by first deeds of trust on real property were $145,000 at
March 31, 1998 and $1,635,000 at December 31, 1997. Other forms of
collateral such as inventory and equipment secured the remaining
nonperforming loans as of each date. No assurance can be given that the
collateral securing nonperforming loans will be sufficient to prevent losses
on such loans.
The decrease in nonperforming loans and nonperforming assets as of March
31, 1998 compared with their levels as of December 31, 1997, was due primarily
to the payoff of a nonperforming commercial real estate loan with a principal
balance of $384,000 and the return of a certain borrower's loans to accrual
status with a principal balance of $478,000.
At March 31, 1998, the Company had $523,000 in two properties acquired
through foreclosure. These properties are carried at the lower of its estimated
market value, as evidenced by an independent appraisal, or the recorded
investment in the related loan, less estimated selling expenses. At
foreclosure, if the fair value of the real estate is less than the Company's
recorded investment in the related loan, a charge is made to the allowance for
loan losses. The Company expects to sell one of these properties during 1998.
No assurance can be given that the Company will sell such property in 1998 or at
any time or the amount for which such property might be sold.
In addition to property acquired through foreclosure, the Company has
investments in residential real estate lots in various stages of development in
Merced County through MAID. MAID held two separate properties for sale or
development at March 31, 1998. These investments were completely written off in
1995, although County Bank still retains title to these properties. In the
first quarter of 1998, one lot was sold for a pre-tax gain of $22,000.
Management defines impaired loans, regardless of past due status on loans,
as those on which principal and interest are not expected to be collected under
the original contractual loan repayment terms. An impaired loan is charged off
at the time management believes the collection process has been exhausted. At
March 31, 1998 and December 31, 1997, impaired loans were measured based on the
present value of future cash flows discounted at the loan's effective rate, the
loan's observable market price or the fair value of collateral if the loan is
collateral-dependent. Impaired loans at March 31, 1998 were $823,000 (all of
which were also nonaccrual loans), on account of which the Company had made
provisions to the allowance for loan losses of $502,000.
Except for loans that are disclosed above, there were no assets as of March
31, 1998, where known information about possible credit problems of the borrower
causes management to have serious doubts as to the ability of the borrower to
comply with the present loan repayment terms and which may become nonperforming
assets. Given the magnitude of the Company's loan portfolio, however, it is
always possible that current credit problems may exist that may not have been
discovered by management.
16
<PAGE>
ALLOWANCE FOR LOAN LOSSES
The following table summarizes the loan loss experience of the Company for the
quarter ended March 31, 1998 and 1997 and for years ended December 31, 1997,
and 1996.
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
------------------------ ------------------------
1998 1997 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
ALLOWANCE FOR LOAN LOSSES:
Balance at beginning of period $ 3,833 $ 2,792 $ 2,792 $ 1,701
-------- -------- -------- --------
Provision for loan losses 252 240 5,825 1,513
Allowance acquired through merger - - - 148
Charge-offs:
Commercial and agricultural 121 341 1,121 518
Real estate-construction - - 3,458 -
Real estate-mortgage - - - -
Consumer 223 77 471 140
-------- -------- -------- --------
Total charge-offs 344 418 5,050 658
-------- -------- -------- --------
Recoveries
Commercial and agricultural 20 56 155 27
Real estate-construction - - 1 -
Real estate-mortgage - - - -
Consumer 37 4 110 61
-------- -------- -------- --------
Total recoveries 57 60 266 88
-------- -------- -------- --------
Net charge-offs 287 358 4,784 570
-------- -------- -------- --------
Balance at end of period $ 3,799 $ 2,674 $ 3,833 $ 2,792
-------- -------- -------- --------
-------- -------- -------- --------
Loans outstanding at period-end $221,108 $188,055 $217,977 $183,247
-------- -------- -------- --------
-------- -------- -------- --------
Average loans outstanding $217,599 $184,418 $198,140 $157,098
-------- -------- -------- --------
-------- -------- -------- --------
Net charge-offs to average loans .13 % .19 % 2.41 % 0.36 %
Allowance for loan losses
To total loans 1.72 1.42 1.76 1.52
To nonperforming assets 297.02 32.88 136.80 39.69
</TABLE>
The Company maintains an allowance for loan losses at a level considered by
management to be adequate to cover the inherent risks of loss associated with
its loan portfolio under prevailing and anticipated economic conditions. In
determining the adequacy of the allowance for loan losses, management takes into
consideration growth trends in the portfolio, examination of financial
institution supervisory authorities, prior loan loss experience for the Company,
concentrations of credit risk, delinquency trends, general economic conditions,
the interest rate environment and internal and external credit reviews. In
addition, the risks management considers vary depending on the nature of the
loan. The normal risks considered by management with respect to agricultural
loans include the fluctuating value of the collateral, changes in weather
conditions and the availability adequate water resources in the Company's local
market area. The normal risks considered by management with respect to real
estate construction loans include fluctuation in real estate values, the demand
for improved commercial and industrial properties and housing, the availability
of permanent financing in the Company's market area and borrowers' ability to
obtain permanent financing. The normal risks considered by management with
respect to real estate mortgage loans include fluctuations in the value of real
estate. Additionally, the Company relies on data obtained through independent
appraisal for significant properties to determine loss exposure on nonperforming
loans.
The balance in the allowance is affected by the amounts provided from
operations, amounts charged off and recoveries of loans previously charged off.
The Company recorded provisions for loan losses in the first three months of
1998 of $252,000 compared with $240,000 in the same period of 1997.
17
<PAGE>
The Company made provisions to the allowance of $5,825,000 in the year ended
December 31, 1997. The increase in loan loss provisions in 1997 was
primarily due to increased reserves established for the commercial real
estate development loan that was charged off in 1997 and, to a lesser extent,
reserves to support the general loan growth of the Company.
The Company's charge-offs, net of recoveries, were $287,000 for the
three months ended March 31, 1998 compared with $358,000 for the same three
months in 1997. The Company's charge-offs, net of recoveries, were
$4,784,000 in the year ended December 31, 1997. The increase in net
charge-offs for the year ended December 31, 1997 was primarily due to the
write-off of the commercial real estate loan with a balance of $3,458,000.
As of March 31, 1998, the allowance for loan losses was $3,799,000 or 1.72%
of total loans outstanding, compared with $3,833,000 or 1.76% of total loans
outstanding as of December 31, 1997 and $2,674,000 or 1.42% of total loans
outstanding as of March 31, 1997.
From 1992 to 1996, loan losses were relatively low and stable. In 1997,
the Company experienced loan problems and made provisions at levels not
previously experienced. As a result, the Company concluded that its historical
method of determining the appropriate levels for its allowance and provisions
for loan losses should be revised. The Company therefore adopted a new
methodology of determining the appropriate level of its allowance for loan
losses. This method, sometimes known as a migration analysis, applies relevant
risk factors to the entire loan portfolio, including nonperforming loans. The
methodology is based, in part, on the Bank's loan grading and classification
system. The Bank grades its loans through internal reviews and periodically
subjects loans to external reviews which then are assessed by the Bank's audit
committee. Credit reviews are performed on a monthly basis and the quality
grading process occurs on a quarterly basis. The "migration" of loans from
grade to grade is then tracked to help predict future losses and thus more
accurately set allowance levels. Risk factors applied to the performing loan
portfolio are based on the Company's past loss history considering the current
portfolio's characteristics, current economic conditions and other relevant
factors. General reserves are applied to various categories of loans at
percentages ranging up to 1.5% based on the Bank's assessment of credit risks
for each category. Risk factors are applied to the carrying value of each
classified loan: (i) loans internally graded "Watch" or "Special Mention" carry
a risk factor from 1.0% to 2.0%; (ii) "Substandard" loans carry a risk factor
from 3% to 40% depending on collateral securing the loan, if any; (iii)
"Doubtful" loans carry a 50% risk factor; and (iv) "Loss" loans are charged off
100%. The analysis also includes reference to factors such as the delinquency
status of the loan portfolio, inherent risk by type of loans, industry
statistical data, recommendations made by the Company's regulatory authorities
and outside loan reviewers, and current economic environment. Important
components of the overall credit rating process are the asset quality rating
process and the internal loan review process.
The Company will also maintain its allowance at a level consistent with the
requirements of the interagency Statement of Policy. This Statement includes a
benchmark for the allowance to include amounts equal to 50% of loans classified
"doubtful", 15% of loans classified "substandard", and an appropriate percentage
of unclassified loans based upon historical loss experience and other factors.
Also see "Memorandum of Understanding".
The allowance is based on estimates and ultimate future losses may vary
from current estimates. It is always possible that future economic or other
factors may adversely affect the Company's borrowers, and thereby cause loan
losses to exceed the current allowance. In addition, there can be no
assurance that future economic or other factors will not adversely affect the
Company's borrowers, or that the Company's asset quality may deteriorate
through rapid growth, failure to enforce underwriting standards,
18
<PAGE>
failure to maintain appropriate underwriting standards, failure to maintain
an adequate number of qualified loan personnel, failure to identify and
monitor potential problem loans or for other reasons, and thereby cause loan
losses to exceed the current allowance.
<TABLE>
<CAPTION>
MARCH 31, 1998 DECEMBER 31,
-------------- ------------
1998 1997 1997
---- ---- ----
AMOUNT AMOUNT AMOUNT
TO TOTAL TO TOTAL TO TOTAL
LOANS IN LOANS IN LOANS IN
AMOUNT CATEGORY AMOUNT CATEGORY AMOUNT CATEGORY
------ -------- ------ -------- ------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Commercial and agricultural $ 1,833 48% $ 802 30% $ 1,868 48%
Real estate- construction 681 18 1,364 31 640 17
Real estate- mortgage 1,013 27 214 8 1,058 28
Consumer 272 7 294 11% 267 7
------- --- -------- --- -------- ---
Total $ 3,799 100% $ 2,674 100% $ 3,833 100%
------- --- -------- --- -------- ---
------- --- -------- --- -------- ---
</TABLE>
The allocation of the allowance to loan categories is an estimate by
management of the relative risk characteristics of loans in those categories.
No assurance can be given that losses in one or more loan categories will not
exceed the portion of the allowance allocated to that category or even exceed
the entire allowance. See also "Memorandum Of Understanding" contained herein.
EXTERNAL FACTORS AFFECTING ASSET QUALITY. As a result of the Company's
loan portfolio mix, the future quality of its assets could be affected by
adverse economic trends in its region or in the agricultural community. These
trends are beyond the control of the Company.
California is an earthquake-prone region. Accordingly, a major
earthquake could result in material loss to the Company. At times the
Company's service area has experienced other natural disasters such as floods
and droughts. As recently as January of 1997, parts of the Company's market
area experienced severe flooding. The Company's properties and substantially
all of the real and personal property securing loans in the Company's
portfolio are located in California. The Company faces the risk that many of
its borrowers face uninsured property damage, interruption of their
businesses or loss of their jobs from earthquakes, floods or droughts. As a
result these borrowers may be unable to repay their loans in accordance with
their terms and the collateral for such loans may decline significantly in
value. The Company's service areas is a largely agricultural region and
therefore is highly dependent on a reliable supply of water for irrigation
purposes. The area obtains nearly all of its water from the run-off of
melting snow in the mountains of the Sierra Nevada to the east. Although
such sources have usually been available in the past, water supply can be
adversely affected by light snowfall over one or more winters or by any
diversion of water from its present natural courses. Any such natural
disaster could impair the ability of many of the Company's borrowers to meet
their obligations to the Company.
Parts of California experienced significant floods in early 1998. The
Company has completed an analysis of its collateral as a result of the recent
floods. Current estimates indicate that there were no material adverse effects
to the collateral position of the Company as a result of these events. No
assurance can be given that future flooding will not have an adverse impact on
the Company and its borrowers and depositors.
LIQUIDITY. In order to maintain adequate liquidity, the Company must have
sufficient resources available at all times to meet its cash flow requirements.
The need for liquidity in a banking institution arises principally to provide
for deposit withdrawals, the credit needs of its customers and to take advantage
of investment opportunities as they arise. A company may achieve desired
liquidity from both assets and liabilities. The Company considers cash and
deposits held in other banks, federal funds sold, other short term investments,
maturing loans and investments, payments of principal and interest on loans
19
<PAGE>
and investments and potential loan sales as sources of asset liquidity.
Deposit growth and access to credit lines established with correspondent
banks and market sources of funds are considered by the Company as sources of
liability liquidity.
The Company reviews its liquidity position on a regular basis based upon
its current position and expected trends of loans and deposits. These assets
include cash and deposits in other banks, available-for-sale securities and
federal funds sold. The Company's liquid assets totaled $171,604,000
$159,291,000 and $65,301,000 on March 31, 1998, December 31, 1997, and March
31, 1997, respectively, and constituted 39.2%, 37.8% and 22.8%, respectively, of
total assets on those dates. Liquidity is also affected by the collateral
requirements of its public deposits and certain borrowings. Total pledged
securities were $47,295,000 at March 31, 1998 compared with $45,812,000 at
December 31, 1997.
When the Company acquired three Bank of America branches in December 1997,
it acquired approximately $60,849,000 in deposits and no loans. In addition, the
capital offering raised additional cash of $17,851,000. The Company initially
invested this cash in liquid assets but intends over time to invest a larger
portion of these funds in higher yielding assets such as loans.
Although the Company's primary sources of liquidity include liquid assets
and a stable deposit base, the Company maintains lines of credit with the
Federal Reserve Bank of San Francisco, Federal Home Loan Bank of San Francisco
and Pacific Coast Bankers' Bank aggregating $22,400,000, of which $16,003,000
was outstanding as of March 31, 1998 and $16,004,000 was outstanding as of
December 31, 1997. The amount of credit outstanding is primarily due to the
Company borrowing against their available line with the Federal Home Loan Bank
to purchase securities. Management believes that the Company maintains adequate
amounts of liquid assets to meet its liquidity needs. The Company's liquidity
might be insufficient if deposit withdrawals were to exceed anticipated levels.
Deposit withdrawals can increase if a company experiences financial difficulties
or receives adverse publicity for other reasons, or if its pricing, products or
services are not competitive with those offered by other institutions.
CAPITAL RESOURCES. Capital serves as a source of funds and helps protect
depositors against potential losses. The primary source of capital for the
Company has been internally generated capital through retained earnings. In
1997, the Company successfully completed a common stock offering which netted
the Company approximately $17,951,000 to add to its capital resources. This
addition to capital was necessary to maintain favorable capital ratios in light
of the Company's purchase of the three branches from Bank of America and to
support internal growth on the Company's balance sheet. The Company's
shareholders' equity increased by $902,000 or 2% from December 31, 1997 to March
31, 1998.
The Company is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate mandatory and possibly additional discretionary
actions by the regulators that, if undertaken, could have a material effect on
the Company's financial statements. Management believes, as of March 31, 1998,
that the Company, the Bank and the Thrift meet all capital requirements to which
they are subject. The Company's leverage capital ratio at March 31, 1998 was
8.03% as compared with 8.58% as of December 31, 1997. The Company's total risk
based capital ratio at March 31, 1998 was 11.94% as compared to 12.78% as of
December 31, 1997.
20
<PAGE>
The Company's and Bank's actual capital amounts and ratios and regulatory
minimums as of March 31, 1998 are as follows.
<TABLE>
<CAPTION>
Minimum
For Capital To Be Well Capitalized
Dollars in thousands Actual Adequacy Purposes Under Prompt Corrective
Action Provisions:
- -----------------------------------------------------------------------------------------------------------------------------------
Consolidated Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of March 31, 1998
Total capital (to risk weighted assets) $ 37,131 13.12% $ 22,683 8.0% $ 28,298 10.0%
Tier 1 capital (to risk weighted assets) 33,787 11.94 11,319 4.0 16,979 6.0
Leverage ratio* 33,787 8.03 16,840 4.0 21,050 5.0
The Bank:
- -----------------------------------------------------------------------------------------------------------------------------------
As of March 31, 1998
Total capital (to risk weighted assets) 29,736 12.06 19,719 8.0 24,649 10.0
Tier 1 capital (to risk weighted assets) 26,649 10.81 9,860 4.0 14,789 6.0
Leverage ratio* $ 26,649 6.98% $ 15,272 4.0% $ 19,090 5.0%
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- The leverage ratio consists of Tier 1 capital divided by quarterly
average assets. The minimum leverage ratio is 3 percent for banking
organizations that do not anticipate significant growth and that have
well-diversified risk, excellent asset quality and in general, are
considered top-rated banks. Most financial institutions are subject
to a minimum leverage ratio of 4% to 5%.
The Company has no formal dividend policy, and dividends are issued solely
at the discretion of the Company's Board of Directors, subject to compliance
with regulatory requirements. In order to pay any cash dividends, the Company
must receive payments of dividends or management fees from the Bank or the
Thrift. There are certain regulatory limitations on the payment of cash
dividends by banks and thrift and loan companies.
DEPOSITS. Deposits are the Company's primary source of funds. At March
31, 1998, the Company had a deposit mix of 41% in savings deposits, 28% in time
deposits, 14% in interest-bearing checking accounts and 17% in
noninterest-bearing demand accounts. Noninterest-bearing demand deposits
enhance the Company's net interest income by lowering its costs of funds.
The Company obtains deposits primarily from the communities it serves. No
material portion of its deposits has been obtained from or is dependent on any
one person or industry. The Company's business is not seasonal in nature. The
Company accepts deposits in excess of $100,000 from customers. These deposits
are priced to remain competitive. At March 31, 1998, the Company had no
brokered deposits.
In December 1997 the Company acquired three branches of Bank of America.
It acquired $60,849,000 in deposits. Deposits in these three acquired branches
as of March 31, 1998 were approximately $61,281,000.
Maturities of time certificates of deposits of $100,000 or more outstanding
at March 31, 1998 and 1997 and December 31, 1997 are summarized as follows:
<TABLE>
<CAPTION>
AT MARCH 31,
-----------------
1998 1997 AT DECEMBER 31, 1997
------ ------ --------------------
(IN THOUSANDS)
<S> <C> <C> <C>
Three months or less $ 6,366 $ 1,915 $ 8,404
Over three to six months 15,107 7,846 7,799
Over six to twelve months 2,197 2,325 7,870
21
<PAGE>
Over twelve months 6,887 2,194 6,188
------- ------- -------
Total $30,557 $14,280 $30,261
------- ------- -------
------- ------- -------
</TABLE>
BORROWED FUNDS
At March 31 1998, 1997 and 1996 the Company's borrowed funds consisted of
the following:
<TABLE>
<CAPTION>
YEAR ENDED
MARCH 31 DECEMBER 31
-------- -----------
1998 1997 1997
(Dollars in thousands)
<S> <C> <C> <C>
Securities sold under agreements to repurchase; dated
March 25, 1998; fixed rate of 5.74%; payable on
March 25, 1999 $ 2,130 $ 6,953 $ 2,459
Unsecured loan from unaffiliated bank dated July 26,
1996; effective interest rate of 9%; interest
payable quarterly at prime + .50%; principal
payable quarterly at $135,714; final payment due on
April 30 1998 - 330 286
FHLB loan, dated December 18, 1997; effective rate of
5.61%; rate reprices monthly based on the 1 month
LIBOR; payable on December 18, 1998 10,900 0 10,900
FHLB loan, dated January 16, 1997; variable rate of
5.68%; rate reprices monthly based on the 1 month
LIBOR; payable on January 25, 1999 5,000 5,000 5,000
FHLB loan, dated July 15, 1994; fixed rate of 7.58%
payable on July 15, 1999 103 105 104
Short-term note from City Redevelopment Agency dated
June 24, 1996; interest free; payable on July 8,
1997 - - -
Long-term note from unaffiliated bank dated December
22, 1997; fixed rate of 7.80%; principal and
interest payable monthly at $25,047; payments
calculated as fully amortizing over 25 years with a
10 year call 3,296 0 3,300
------- ------- -------
Total $21,429 $12,388 $22,049
------- ------- -------
------- ------- -------
</TABLE>
The increase in the borrowings are primarily due to the Company borrowing
funds from its available lines of credit with the Federal Home Loan Bank to
purchase securities and the origination of a loan to assist in financing the new
administrative building and main branch.
RETURN ON EQUITY AND ASSETS
<TABLE>
<CAPTION>
Three months ended Year ended
March 31 December 31
--------------------------- -----------
1998 1997 1997
---- ---- ----
<S> <C> <C> <C>
Return on average assets .78% .76% .13%
Return on average equity 8.12% 9.72% 1.46%
Dividend payout ratio - - -
Average equity to average assets 9.77% 7.90% 8.76%
</TABLE>
22
<PAGE>
IMPACT OF INFLATION
The primary impact of inflation on the Company is its effect on interest
rates. The Company's primary source of income is net interest income which is
affected by changes in interest rates. The Company attempts to limit
inflation's impact on its net interest margin through management of rate
sensitive assets and liabilities and the analysis of interest rate sensitivity.
The effect of inflation on premises and equipment, as well as on interest
expenses, has not been significant for the periods covered in this report.
REAL ESTATE DEVELOPMENT ACTIVITIES
California law allows state-chartered banks to engage in real estate
development activities. The Bank established MAID in 1987 pursuant to this
authorization. After changes in federal law effectively required that these
activities be divested as prudently as possible but in any event before 1997,
MAID reduced its activities and embarked on a plan to liquidate its real estate
holdings. In 1995 the uncertainty about the effect of the investment in MAID on
the results of future operations caused management to write off its remaining
investment of $2,881,000 in real property development.
At March 31, 1998, MAID held two real estate projects including improved
and unimproved land in various stages of development. MAID continues to develop
these projects, and any amounts realized upon sale or other disposition of these
assets above their current carrying value of zero will result in noninterest
income at the time of such sale or disposition. In the first quarter of 1998,
one lot was sold resulting in noninterest income of approximately $22,000.
Although the Company expects that sale or disposition of its remaining assets
will result in some positive contribution to noninterest income at some time in
the future, no assurance can be given as to whether or when such sales or
dispositions will be completed or that the amounts, if any, that the Company
will ultimately realize on such assets or whether such amounts will exceed the
future expenses required to hold and complete development of the projects. The
amounts, if any, realized on future disposition of these properties will depend
on conditions in the local real estate market and the demand, if any, for new
development. The Company's regulatory deadline for completing its divestiture
of these assets is December 31, 2000.
YEAR 2000
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium (year 2000) approaches. The "year
2000" problem is pervasive and complex as virtually every computer operation
will be affected in some way by the rollover of the two digit year value to 00.
The issue is whether computer systems will properly recognize date sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail.
The Company has a year 2000 compliance plan that has been approved by its
board of directors. The board of directors is updated monthly on the progress
of the plan. The company is utilizing both internal and external resources to
identify, correct or reprogram the systems in order that they be year 2000
compliant. The Bank's core banking system, Jack Henry Associates Inc.
Silverlake, is anticipating a release in August 1998 that will be year 2000
compliant. This will allow adequate time for testing to be completed by mid
1999.
With respect to external systems, the Company is in contact with vendors
and customers in order to monitor the progress with year 2000 compliance efforts
and assess the need for contingency plans, if applicable. To date, most vendors
have provided confirmations that they are either compliant or are making
progress toward planned compliance. Although the Bank was approximately four
months behind
23
<PAGE>
schedule on its year 2000 project as of the time of the examination, as of
the date of this report, Management believes they are now on schedule with
the project.
Based on a preliminary study, the Company expects to spend approximately
$250,000 to bring its information systems into year 2000 compliance. A
significant proportion of these costs are not likely to be incremental costs to
the Company, but rather will represent the redeployment of existing information
technology resources. The expenditures in 1997 were negligible. Also see
"Memorandum of Understanding" contained herein.
MEMORANDUM OF UNDERSTANDING
As a result of a joint examination of the Bank conducted as of January 12,
1998 by the Federal Deposit Insurance Corporation (the "FDIC") and the
Department of Financial Institutions (the "DFI"), the FDIC and the DFI have
indicated that they intend to require the Bank to enter into a Memorandum of
Understanding requiring the Bank to do the following:
1) Conduct a comprehensive management review of the Bank's executive
management to maintain a management structure suitable to its needs in
light of its recent rapid growth.
2) Have and retain qualified management with qualifications and
experience commensurate with their duties and responsibilities at the Bank.
3) Develop a plan to reduce the Bank's economic value of equity exposure
to loss from interest rate changes to acceptable levels.
4) Formulate, adopt and implement a comprehensive risk management process
that will strengthen management expertise and improve securities portfolio
management and management information and measurement systems.
5) Establish and maintain an adequate reserve for loan losses and develop
and revise, adopt and implement a comprehensive policy to ensure the
adequacy of the allowance.
6) Develop, adopt and implement a plan to control overhead and restore
the Bank's profitability.
7) Correct deficiencies relating to the year 2000 project.
8) Furnish written progress reports.
As of the date of this report, the Memorandum of Understanding was not yet
in final form. The Company believes it can comply with the terms of the
agreement.
A Memorandum of Understanding is an enforceable agreement. Failure to
comply with its terms can lead to further enforcement action by bank regulators,
including cease-and-desist orders, imposition of a receiver or conservator,
termination of deposit insurance, imposition of civil money penalties and
removal and prohibition orders against institution-affiliated parties.
24
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a party to routine litigation in the ordinary course of its
business. In the opinion of management, pending and threatened litigation is
not likely to have a material adverse effect on the financial condition or
results of operations of the Company. Also see "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Memorandum of
Understanding." contained herein.
ITEM 2. CHANGES IN SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
No matters were submitted for shareholder vote in the quarter ended March 31,
1998.
ITEM 5. OTHER INFORMATION.
In the opinion of management, there is no additional information relating to
these periods being reported which warrants inclusion in the report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
<TABLE>
<CAPTION>
Exhibits Description of Exhibits
-------- -----------------------
<S> <C>
3.1 Articles of Incorporation, incorporated by reference *
from (filed as Exhibit 3.1 of the Company's September
30, 1996 Form 10Q filed with the SEC on or about
November 14, 1996).
3.2 Bylaws (filed as Exhibit 3.2 of the Company's September *
30, 1996 Form 10Q filed with the SEC on or about
November 14, 1996.)
10 Employment agreement between Thomas T. Hawker and *
Capital Corp.
10.1 Administration Construction Agreement (filed as Exhibit *
10.4 of the Company's 1995 Form 10K filed with the SEC
on or about March 31, 1996).
10.2 Stock Option Plan (filed as Exhibit 10.6 of the *
Company's 1995 Form 10K filed with the SEC on or about
March 31, 1996).
25
<PAGE>
10.3 401 (k) Plan (filed as Exhibit 10.7 of the Company's *
1995 Form 10K filed with the SEC on or about March 31,
1996
10.4 Employee Stock Ownership Plan (filed as Exhibit 10.8 of *
the Company's 1995 form 10K filed with the SEC on or
about March 31, 1996).
</TABLE>
(b) REPORTS ON FORM 8-K
None
* DENOTES DOCUMENTS WHICH HAVE BEEN INCORPORATED BY REFERENCE.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated May 14, 1998
CAPITAL CORP OF THE WEST
(Registrant)
By /s/Thomas T. Hawker
-------------------------------
Thomas T. Hawker
President and
Chief Executive Officer
By /s/ Janey E. Boyce
-------------------------------
Janey E. Boyce
Principal Financial Officer
27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-01-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 21,626
<INT-BEARING-DEPOSITS> 1,000
<FED-FUNDS-SOLD> 44,900
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 12,921
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 104,078
<LOANS> 217,309
<ALLOWANCE> 3,799
<TOTAL-ASSETS> 437,961
<DEPOSITS> 373,220
<SHORT-TERM> 18,030
<LIABILITIES-OTHER> 2,162
<LONG-TERM> 3,399
0
0
<COMMON> 33,978
<OTHER-SE> 6,962
<TOTAL-LIABILITIES-AND-EQUITY> 437,961
<INTEREST-LOAN> 5,699
<INTEREST-INVEST> 2,393
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 8,092
<INTEREST-DEPOSIT> 2,967
<INTEREST-EXPENSE> 3,303
<INTEREST-INCOME-NET> 4,789
<LOAN-LOSSES> 252
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 4,323
<INCOME-PRETAX> 1,272
<INCOME-PRE-EXTRAORDINARY> 435
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 837
<EPS-PRIMARY> .18
<EPS-DILUTED> .18
<YIELD-ACTUAL> 10.62
<LOANS-NON> 823
<LOANS-PAST> 456
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 3,833
<CHARGE-OFFS> 344
<RECOVERIES> 57
<ALLOWANCE-CLOSE> 3,799
<ALLOWANCE-DOMESTIC> 3,799
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
