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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
(MARK ONE)
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/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(FEE REQUIRED)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(NO FEE REQUIRED)
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FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 0-28938
COAST BANCORP
(Exact name of registrant as specified in its charter)
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<S> <C>
CALIFORNIA 77-0401327
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
740 FRONT STREET 95060
(Address of principal (Zip Code)
executive offices)
</TABLE>
SANTA CRUZ, CALIFORNIA
(City and State of principal executive offices)
Registrant's telephone number, including area code (408) 458-4500
--------------------------
Securities to be registered pursuant to Section 12(b) of the Act:
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<S> <C>
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH EACH CLASS IS
TO BE SO REGISTERED TO BE REGISTERED
None None
</TABLE>
Securities to be registered pursuant to Section 12(g) of the Act:
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<S> <C>
COMMON STOCK (NO PAR VALUE) NASDAQ NATIONAL MARKET SYSTEM
(Title of each class) (Name of each exchange on which
registered)
</TABLE>
--------------------------
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/
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing price of its common stock on March 21, 1997,
on the NASDAQ National Market System was $35,873,058.
At March 21, 1997, 2,209,659 shares of the registrant's common stock (no par
value) were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
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<CAPTION>
PARTS OF FORM 10-K
INTO WHICH
DOCUMENTS INCORPORATED INCORPORATED
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Definitive proxy statement for the Company's 1997 Annual Meeting of Shareholders to be filed within
120 days of the end of the fiscal year ended December 31, 1996...................................... Part III
</TABLE>
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THIS REPORT CONTAINS A TOTAL OF PAGES, INCLUDING EXHIBITS.
THE EXHIBIT INDEX IS ON PAGE .
<PAGE>
TABLE OF CONTENTS
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PAGE
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PART I
ITEM 1. BUSINESS........................................................................................... 1
ITEM 2. PROPERTIES......................................................................................... 13
ITEM 3. LEGAL PROCEEDINGS.................................................................................. 14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................................ 14
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.......................... 14
ITEM 6. SELECTED FINANCIAL DATA............................................................................ 15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.............. 16
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................................................ 29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE............... 49
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................................................ 49
ITEM 11. EXECUTIVE COMPENSATION............................................................................ 49
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................... 49
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................................... 49
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.................................. 49
INDEX TO EXHIBITS.......................................................................................... 50
SIGNATURES................................................................................................. 51
</TABLE>
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
Coast Bancorp ("Company") is a California corporation and the bank holding
company for Coast Commercial Bank ("Bank"), located in Santa Cruz, California.
The Bank was incorporated as a California state banking corporation on April 27,
1981, and commenced operations on February 17, 1982. The Company was
incorporated on January 27, 1995 and became the bank holding company for the
Bank on July 25, 1995, pursuant to the Bank Holding Company Act.
GENERAL BANKING SERVICES
The Bank engages in a broad range of financial services activities in its
primary market of Santa Cruz County, and also serves the adjacent areas of San
Benito, Santa Clara and Monterey counties. The City of Santa Cruz, situated 80
miles south of San Francisco and 35 miles southwest of San Jose, is the largest
city in Santa Cruz County.
The Bank emphasizes the needs of local business people and serves
individuals, retailers, professionals and small and medium-sized businesses and
operates through its corporate offices located in Santa Cruz, California and
through its branch offices located in Santa Cruz, Aptos, Scotts Valley and
Watsonville, California. Services offered include a full range of commercial
banking services, including the acceptance of demand, savings and time deposits,
overdraft protection for checking accounts, and the making of commercial, real
estate (including residential mortgage), personal, home improvement, automobile
and other installment and term loans. The Bank is one of the largest Small
Businesses Administration ("SBA") lenders in California and has been granted
status as a "preferred lender", allowing it to make SBA loans without first
having the SBA approve the loan, and is a seller/servicer of Freddie Mac
mortgage loans. It also offers travelers' checks, safe deposit boxes, notary
public services, Visa credit cards, courier service for pick-up of non-cash
deposits, ATM cards usable at many ATM's nationwide and a 24 hour telephone
service for deposit and loan account information. The Bank operates automated
teller machines at its branches and at Seascape Village in Aptos, California.
The Bank also has an Investment Services Department which provides financial
planning services, financial consulting, asset management and the purchase and
sale of stocks and bonds through a third party provider.
The total population base in Santa Cruz County is approximately 248,900
people. Santa Cruz County's economic base has several significant components
including education (e.g., the University of California at Santa Cruz); disk
drive and software companies headquartered in the Northern part of the county
due to its proximity to the high tech base of Silicon Valley in adjacent Santa
Clara County; tourism because of the beaches and Santa Cruz Boardwalk; and
agriculture in the Southern part of the county in and around Watsonville.
The Bank currently has no applications pending to open additional branch
offices, but the Bank may increase the number of its banking facilities in the
Bank's trade areas when such expansion is appropriate. Banking facilities that
may be considered in any future expansion include traditional branch offices and
mini-branch offices as in-fill strategies and loan production offices in
neighboring counties. No such facilities are currently under development. The
Bank's expansion is, of course, dependent on obtaining the necessary
governmental approvals, a continued earnings pattern and absence of adverse
effects from economic conditions, governmental monetary policies or competition.
No assurance can be given that the Bank's expansion can be accomplished without
the Bank being required to raise additional capital in the future.
The Bank is a member of the Federal Deposit Insurance Corporation ("FDIC")
and each depositor's account is insured up to $100,000. The Bank does not
directly offer trust services or international banking services and does not
plan to do so in the near future.
1
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COMPETITION
The Bank's service area consists of Santa Cruz County and extends into the
adjacent areas of San Benito, Santa Clara and Monterey counties. It is estimated
that Santa Cruz County contains 35 competitive banking offices, of which 2
offices are owned by other independent banks. However, the Bank is the only
independent bank headquartered in Santa Cruz County. It is estimated that the
primary service area also contains 20 offices of savings and loan associations,
and 5 offices of credit unions. Based upon total bank deposits as of June 30,
1996 (the last period for which data is available), the Bank is sixth in market
share in Santa Cruz County.
The banking business in California generally, and in the Bank's primary
service area specifically is highly competitive with respect to both loans and
deposits, and is dominated by a relatively small number of major banks with many
offices operating over a wide geographic area. Among the advantages such major
banks have over the Bank are their ability to finance wide ranging advertising
campaigns and to allocate their investment assets to regions of highest yield
and demand. Such institutions offer certain services such as trust services and
international banking which are not offered directly by the Bank (but are
offered indirectly through correspondent institutions) and, by virtue of their
greater total capitalization (legal lending limits to an individual customer are
limited to a percentage of a bank's total capital), they have substantially
higher lending limits than does the Bank. Other entities, both governmental and
in private industry, seeking to raise capital through the issuance and sale of
debt or equity securities also provide competition for the Bank in the
acquisition of deposits. The Bank also competes with money-market funds for
deposits.
In order to compete with major financial institutions and other competitors
in its service areas, the Bank builds and retains its customer base by drawing
upon the experience of its executive and senior officers in serving business
individuals, and upon its specialized services, local promotional activities and
the personal contacts made by its officers, directors and employees. The
officers and employees of the Bank are strongly encouraged to participate in
local civic and charitable organizations and events, which has also served to
promote the Bank's business. For customers whose loan demand exceeds the Bank's
legal lending limit, the Bank may arrange for such loans on a participation
basis with correspondent banks. The Bank's lending limit is 15% of its capital
and allowance for loan losses for unsecured loans and 25% of its capital and
allowance for loan losses for secured loans.
DEPOSITS
Most of the Bank's deposits are attracted from individuals, small and
medium-sized businesses and professionals. A material portion of the Bank's
deposits have not been obtained from a single person or a few persons, the loss
of any one or more of which would not have a materially adverse effect on the
business of the Bank.
LENDING ACTIVITIES
The Bank engages in a full complement of lending activities, including
commercial, real estate, SBA and consumer/installment loans.
According to reports from the SBA for the federal fiscal year ended
September 30, 1996, the Bank is one of the largest lenders in Northern
California in the SBA loan program. The Bank makes SBA loans from $20,000 to
$1,500,000. SBA 7(a) loans are for such purposes as working capital, inventory
and other purposes, and are government-guaranteed up to 80% of the amount of the
loan. The Bank also makes SBA loans for the purchase or construction of owner
occupied real estate which are also guaranteed up to 80%. The SBA loan program
is subject to political and budgetary uncertainty which in recent years has
resulted in a reduction of the guaranteed portion of SBA loans and lower maximum
loan amounts. For example, during the federal fiscal year ended September 30,
1995, budgetary constraints required the SBA to lower the maximum loan amount to
$500,000. In October 1995, legislation restored the maximum loan amount to
$1,500,000 and imposed additional fees on the program's lenders to raise
additional revenue for the SBA.
2
<PAGE>
The Bank makes real estate construction loans for the construction of single
and multi-family residential units, commercial and industrial properties, and
SBA approved owner occupied commercial real estate. These loans typically have
pre-qualified take outs for permanent financing or stand-by commitments and a
maximum loan to value ratio of 70%. The Bank also makes loans for lot or land
development with a maximum loan to value ratio of 60%. Construction loans are
secured by a first deed of trust. As of December 31, 1996, the Bank had
outstanding real estate construction loans of $15,112,000 representing 12% of
the Bank's loan portfolio.
The Bank also makes commercial real estate loans for other purposes such as
the purchase or refinance of offices, warehouses, professional buildings, and
industrial buildings, including SBA loans. A portion of these loans are SBA
loans which are guaranteed by the U.S. government in an amount up to 90% of the
loan. Commercial real estate loans generally are fully amortized over 15 years
or have a 10 year term with a twenty-five year amortization, and typically have
a maximum loan to value ratio of 70%. SBA loans for this purpose have a term of
up to 25 years and a maximum loan to value ratio of 90%. The Bank had
outstanding real estate term loans of $65,208,000 or 53% of the Bank's loan
portfolio at December 31, 1996.
The Bank makes residential mortgage loans which are typically 30 year loans
with either adjustable or fixed interest rates. These loans are sold to Freddie
Mac on a "servicing retained" basis, i.e., the Bank continues to be paid a fee
for collecting payments on the loan and performing other services, or to other
investors on a "servicing released" basis, i.e. the Bank has no further
involvement in the loan.
The Bank makes commercial loans to small-to-medium sized businesses for
working capital, lines of credit, loans secured by inventory and receivables,
and term loans for equipment and for working capital. Typically, the Bank
obtains a security interest in the collateral being financed or in other
available assets of the customer. Loan to value ratios vary but generally do not
exceed 80%. As of December 31, 1996, the Bank had $35,633,000 in loans for these
purposes representing 29% of the Bank's loan portfolio.
Consumer and installment loans are made for household, family and other
personal expenditures on both a secured and unsecured basis. As of December 31,
1996 the Bank had a total of $7,768,000 in consumer and installment loans
representing 6% of the Bank's loan portfolio.
The Bank sells the guaranteed portion of SBA loans which it originates into
the secondary market as a source of liquidity and earnings. Additionally, the
Bank sells residential mortgage loans it originates into the secondary market in
order to divest itself of the interest rate risk associated with these mostly
fixed interest rate products. Through 1995, the Bank accounted for these loans
in accordance with the Emerging Issues Task Force Issues No. 88-11, "Allocation
of Recorded Investment when a Loan is Sold", No. 86-38, "Implication of Mortgage
Prepayments on Amortization of Servicing Rights", and No. 84-21, "Sale of a Loan
with a Partial Participation Retained". No recourse is available to buyers of
these loans after 90 days from the sale. Total loans serviced by the Bank for
other investors were $122,623,000 as of December 31, 1996. For the years ended
December 31, 1996, 1995 and 1994, total loans sold by the Bank were $38,497,000,
$20,835,000 and $34,673,000 respectively.
In May of 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 122, "Accounting for Mortgage
Servicing Rights". This statement eliminates the accounting distinction between
rights to service mortgage loans for others that are acquired through loan
origination activities and those acquired through purchase transactions. Under
this statement, if the Company sells or securitizes loans and retains the
mortgage servicing rights, the Company should allocate the total cost of the
mortgage loan to the loan and the mortgage servicing rights based on their
relative fair values. Any cost allocated to the mortgage servicing rights should
be recognized as a separate asset and amortized over the period of estimated net
service income. The Company adopted this statement on January 1, 1996. The
adoption of SFAS No. 122 did not have a significant effect on the Company's
financial position or results of operations.
3
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See "Accounting Pronouncements" for a discussion of the Financial Accounting
Standards Board's recently issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," which
supercedes SFAS No. 122 effective January 1, 1997.
Credit risk relates to the ability of a borrower to repay the principal and
interest on their loan and is managed by adherence to credit standards and the
taking of collateral to secure most of the Bank's loans. These risks are
inherent in commercial lending generally. Certain risks are specific to
particular types of lending in which the Bank engages such as real estate
lending. The major risk inherent in real estate lending is the potential decline
in the value of the property for market reasons or due to the condition of the
property.
OTHER SERVICES
The Bank has established its own Investment Services Department which
employs 2 investment professionals. The Investment Services Department offers
financial planning services; asset management services through the use of two
unaffiliated investment managers; retirement plans such as 401(k) plans, IRAs
and SEPs; mutual funds; and the purchase and sale of stocks and bonds on an
unsolicited basis.
The Investment Services Department also offers trust services through
Enterprise Trust and Investment Company of Los Gatos, California, an
unaffiliated independent trust company.
SUPERVISION AND REGULATION
The Bank is chartered under the banking laws of the State of California and
is subject to the supervision of, and is regularly examined by, the
Superintendent and the FDIC.
The Company is a bank holding company within the meaning of the Bank Holding
Company Act, "BHC Act", is registered as such with and is subject to the
supervision of the Federal Reserve Board ("FRB").
Certain legislation and regulations affecting the businesses of the Company
and the Bank are discussed below.
GENERAL
As a bank holding company, the Company is subject to the BHC Act. The
Company reports to, registers with, and is examined by the FRB. The FRB also has
the authority to examine the Company's subsidiaries which includes the Bank.
The FRB requires the Company to maintain certain levels of capital. See
"Capital Standards" herein. The FRB also has the authority to take enforcement
action against any bank holding company that commits any unsafe or unsound
practice, or violates certain laws, regulations, or conditions imposed in
writing by the FRB. See "Prompt Corrective Action and Other Enforcement
Mechanisms" herein.
Under the BHC Act, a company generally must obtain the prior approval of the
FRB before it exercises a controlling influence over, or acquires directly or
indirectly, more than 5% of the voting shares or substantially all of the assets
of any bank or bank holding company. Thus, the Company is required to obtain the
prior approval of the FRB before it acquires, merges or consolidates with any
bank, or bank holding company; any company seeking to acquire, merge or
consolidate with the Company also would be required to obtain the FRB's
approval.
The Company is generally prohibited under the BHC Act from acquiring
ownership or control of more than 5% of the voting shares of any company that is
not a bank or bank holding company and from engaging directly or indirectly in
activities other than banking, managing banks, or providing services to
affiliates of the holding company. A bank holding company, with the approval of
the FRB, may engage, or acquire the voting shares of companies engaged, in
activities that the FRB has determined to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto. A bank holding
4
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company must demonstrate that the benefits to the public of the proposed
activity will outweigh the possible adverse effects associated with such
activity.
The FRB generally prohibits a bank holding company from declaring or paying
a cash dividend which would impose undue pressure on the capital of subsidiary
banks or would be funded only through borrowing or other arrangements that might
adversely affect a bank holding company's financial position. The FRB's policy
is that a bank holding company should not continue its existing rate of cash
dividends on its common stock unless its net income is sufficient to fully fund
each dividend and its prospective rate of earnings retention appears consistent
with its capital needs, asset quality and overall financial condition.
Transactions between the Company, the Bank and any future subsidiaries of
the Company are subject to a number of other restrictions. FRB policies forbid
the payment by bank subsidiaries of management fees which are unreasonable in
amount or exceed the fair market value of the services rendered (or, if no
market exists, actual costs plus a reasonable profit). Additionally, a bank
holding company and its subsidiaries are prohibited from engaging in certain
tie-in arrangements in connection with the extension of credit, sale or lease of
property, or furnishing of services. Subject to certain limitations, depository
institution subsidiaries of bank holding companies may extend credit to, invest
in the securities of, purchase assets from, or issue a guarantee, acceptance, or
letter of credit on behalf of, an affiliate, provided that the aggregate of such
transactions with affiliates may not exceed 10% of the capital stock and surplus
of the institution, and the aggregate of such transactions with all affiliates
may not exceed 20% of the capital stock and surplus of such institution. The
Company may only borrow from depository institution subsidiaries if the loan is
secured by marketable obligations with a value of a designated amount in excess
of the loan. Further, the Company may not sell a low-quality asset to a
depository institution subsidiary.
CAPITAL STANDARDS
The FRB, FDIC and other federal banking agencies have risk based capital
adequacy guidelines intended to provide a measure of capital adequacy that
reflects the degree of risk associated with a banking organization's operations
for both transactions reported on the balance sheet as assets, and transactions,
such as letters of credit and recourse arrangements, which are reported as
off-balance-sheet items. Under these guidelines, nominal dollar amounts of
assets and credit equivalent amounts of off-balance-sheet items are multiplied
by one of several risk adjustment percentages, which range from 0% for assets
with low credit risk, such as certain U.S. government securities, to 100% for
assets with relatively higher credit risk, such as business loans.
A banking organization's risk based capital ratios are obtained by dividing
its qualifying capital by its total risk-adjusted assets and off-balance-sheet
items. The regulators measure risk-adjusted assets and off-balance-sheet items
against both total qualifying capital (the sum of Tier 1 capital and limited
amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists of common
stock, retained earnings, noncumulative perpetual preferred stock and minority
interests in certain subsidiaries, less most other intangible assets. Tier 2
capital may consist of a limited amount of the allowance for possible loan and
lease losses and certain other instruments with some characteristics of equity.
The inclusion of elements of Tier 2 capital are subject to certain other
requirements and limitations of the federal banking agencies. Since December 31,
1992, the federal banking agencies have required a minimum ratio of qualifying
total capital to risk-adjusted assets and off-balance-sheet items of 8%, and a
minimum ratio of Tier 1 capital to risk-adjusted assets and off-balance-sheet
items of 4%.
In addition to the risk-based guidelines, federal banking regulators require
banking organizations to maintain a minimum amount of Tier 1 capital to total
assets, referred to as the leverage ratio. For a banking organization rated in
the highest of the five categories used by regulators to rate banking
organizations, the minimum leverage ratio of Tier 1 capital to total assets is
3%. It is improbable, however, that an institution with a 3% leverage ratio
would receive the highest rating by the regulators since a strong capital
position is a significant part of the regulators' rating. For all banking
organizations not rated in the highest category, the minimum leverage ratio is
at least 100 to 200 basis points above the 3% minimum.
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Thus, the effective minimum leverage ratio, for all practical purposes, is at
least 4% or 5%. In addition to these uniform risk-based capital guidelines and
leverage ratios that apply across the industry, the regulators have the
discretion to set individual minimum capital requirements for specific
institutions at rates significantly above the minimum guidelines and ratios.
The following table presents the capital ratios for the Company and the Bank
as of December 31, 1996.
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<CAPTION>
MINIMUM
THE COMPANY THE BANK REQUIREMENT
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Risk-based Capital Ratio:
Tier 1 Capital.......................................................... 15.2% 13.8% 4.0%
Total Capital........................................................... 16.4% 15.0% 8.0%
Tier 1 Capital Leverage Ratio............................................. 9.8% 8.7% 4.0%
</TABLE>
As required by Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"), the federal financial institution agencies solicited comments in
September 1993 on a proposed rule and method of incorporating an interest rate
risk component into the current risk-based capital guidelines, with the goal of
ensuring that institutions with high levels of interest rate risk have
sufficient capital to cover their exposures. Interest rate risk is the risk that
changes in market interest rates might adversely affect a bank's financial
condition. Under the proposal, interest rate risk exposures would be quantified
by weighting assets, liabilities and off-balance-sheet items by risk factors
which approximate sensitivity to interest rate fluctuations. As proposed,
institutions identified as having an interest rate risk exposure greater than a
defined threshold would be required to allocate additional capital to support
this higher risk. Higher individual capital allocations could be required by the
bank regulators based upon supervisory concerns. The agencies adopted a final
rule effective September 1, 1995 which is substantially similar to the proposed
rule, except that the final rule does not establish (1) a measurement framework
for assessing the level of a bank's interest rate exposure; nor (2) a minimum
level of exposure above which a bank will be required to hold additional capital
for interest rate risk if it has a significant exposure or a weak interest rate
risk management process. The agencies also solicited comments on and are
continuing their analysis of a proposed policy statement which would establish a
framework to measure and monitor interest rate exposure.
SAFETY AND SOUNDNESS STANDARDS
FDICIA also implemented certain specific restrictions on transactions and
required the regulators to adopt overall safety and soundness standards for
depository institutions related to internal controls, loan underwriting and
documentation, and asset growth. Among other things, FDICIA limits the interest
rates paid on deposits by undercapitalized institutions, the use of brokered
deposits and the aggregate extension of credit by a depository institution to an
executive officer, director, principal stockholder or related interest, and
reduces deposit insurance coverage for deposits offered by undercapitalized
institutions for deposits by certain employee benefits accounts.
The federal financial institution agencies published a final rule effective
August 9, 1995, implementing safety and soundness standards. FDICIA added a new
Section 39 to the Federal Deposit Insurance Act which required the agencies to
establish safety and soundness standards for insured financial institutions
covering (1) internal controls, information systems and internal audit systems;
(2) loan documentation; (3) credit underwriting; (4) interest rate exposure; (5)
asset growth; (6) compensation, fees and benefits; (7) asset quality, earnings
and stock valuation; and (8) excessive compensation for executive officers,
directors or principal shareholders which could lead to material financial loss.
The agencies issued the final rule in the form of guidelines only for
operational, managerial and compensation standards and reissued for comment
proposed standards related to asset quality and earnings which are less
restrictive than the earlier proposal in November 1993. Unlike the earlier
proposal, the guidelines under the final rule do not apply to depository
institution holding companies and the stock valuation standard was eliminated.
If an agency determines that an institution fails to meet any standard
established by the guidelines, the agency may require the financial institution
to submit to the agency an acceptable plan to achieve compliance with
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the standard. If the agency requires submission of a compliance plan and the
institution fails to timely submit an acceptable plan or to implement an
accepted plan, the agency must require the institution to correct the
deficiency. Under the final rule, an institution must file a compliance plan
within 30 days of a request to do so from the institution's primary federal
regulatory agency. The agencies may elect to initiate enforcement action in
certain cases rather than rely on an existing plan particularly where failure to
meet one or more of the standards could threaten the safe and sound operation of
the institution.
RESTRICTIONS ON DIVIDENDS AND OTHER DISTRIBUTIONS
The power of the board of directors of an insured depository institution to
declare a cash dividend or other distribution with respect to capital is subject
to statutory and regulatory restrictions which limit the amount available for
such distribution depending upon the earnings, financial condition and cash
needs of the institution, as well as general business conditions. FDICIA
prohibits insured depository institutions from paying management fees to any
controlling persons or, with certain limited exceptions, making capital
distributions, including dividends, if, after such transaction, the institution
would be undercapitalized.
The FRB has issued a policy statement that a bank holding company should not
declare or pay a cash dividend to its stockholders if the dividend would place
undue pressure on the capital of its subsidiary banks or if the dividend could
be funded only through additional borrowings or other arrangements that might
adversely affect the financial position of the bank holding company.
Specifically, a bank holding company should not continue its existing rate of
cash dividends on its common stock unless its net income is sufficient to fully
fund each dividend and its prospective rate of earnings retention appears
consistent with its capital needs, asset quality, and overall financial
condition. Further, the Company is expected to act as a source of financial
strength for each of its subsidiary banks and to commit resources to support
each subsidiary bank in circumstances when it might not do so absent such
policy.
The Company's ability to pay dividends depends in large part on the ability
of the Bank to pay management fees and dividends to the Company. The ability of
its subsidiary banks to pay dividends will be subject to restrictions set forth
in the California Banking Law and regulations of the FDIC.
The payment of dividends by a state bank is further restricted by additional
provisions of state law. Under Section 642 of the California Financial Code,
funds available for cash dividend payments by a bank are restricted to the
lesser of: (i) retained earnings; or (ii) the bank's net income for its three
fiscal years (less any distributions to stockholders made during such period).
However, under Section 643 of the California Financial Code, with the prior
approval of the Superintendent, a bank may pay cash dividends in an amount not
to exceed the greater of the: (1) retained earnings of the bank; (2) net income
of the bank for its last fiscal year; or (3) net income of the bank for its
current fiscal year. However, if the Superintendent finds that the stockholders'
equity of the bank is not adequate or that the payment of a dividend would be
unsafe or unsound, the Superintendent may order such bank not to pay a dividend
to stockholders. Currently, it is permissible for the Bank to pay cash dividends
without the Superintendent's prior approval.
Additionally, under FDICIA, a bank may not make any capital distribution,
including the payment of dividends, if after making such distribution the bank
would be in any of the "under-capitalized" categories under the FDIC's Prompt
Corrective Action regulations.
Also, under the Financial Institution's Supervisory Act, the FDIC also has
the authority to prohibit a bank from engaging in business practices which the
FDIC considers to be unsafe or unsound. It is possible, depending upon the
financial condition of a bank and other factors, that the FDIC could assert that
the payment of dividends or other payments in some circumstances might be such
an unsafe or unsound practice and thereby prohibit such payment.
7
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INTERSTATE BANKING AND BRANCHING
On September 29, 1994, the Reigle/Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "Interstate Act") was signed into law. This
Interstate Act effectively permits nationwide banking. The Interstate Act
provides that one year after enactment, adequately capitalized and adequately
managed bank holding companies may acquire banks in any state, even in those
jurisdictions that currently bar acquisition by out-of-state institutions,
subject to deposit concentration limits. The deposit concentration limits
provide that regulatory approval by the Federal Reserve Board may not be granted
for a proposed interstate acquisition if after the acquisition, the acquiror on
a consolidated basis would control more than 10% of the total deposits
nationwide or would control more than 30% of deposits in the state where the
acquiring institution is located. The deposit concentration state limit does not
apply for initial acquisitions in a state and in every case, may be waived by
the state regulatory authority. Interstate acquisitions are subject to
compliance with the Community Reinvestment Act ("CRA"). States are permitted to
impose age requirements not to exceed five years on target banks for interstate
acquisitions.
Branching between states may be accomplished either by merging separate
banks located in different states into one legal entity, or by establishing de
novo branches in another state. Consolidation of banks is not permitted until
June 1, 1997 provided that the state has not passed legislation "opting-out" of
interstate branching. If a state opts-out prior to June 1, 1997, then banks
located in that state may not participate in interstate branching. A state may
opt-in to interstate branching by bank consolidation or by de novo branching by
passing appropriate legislation earlier than June 1, 1997. California has passed
legislation to opt-in to this legislation. Interstate branching is also subject
to a 30% statewide deposit concentration limit on a consolidated basis, and a
10% nationwide deposit concentration limit. The laws of the host state regarding
community reinvestment, fair lending, consumer protection (including usury
limits) and establishment of branches shall apply to the interstate branches.
De novo branching by an out-of-state bank is not permitted unless the host
state expressly permits de novo branching by banks from out-of-state. The
establishment of an initial de novo branch in a state is subject to the same
conditions as apply to initial acquisition of a bank in the host state other
than the deposit concentration limits.
Effective one year after enactment, the Interstate Act permits bank
subsidiaries of a bank holding company to act as agents for affiliated
depository institutions in receiving deposits, renewing time deposits, closing
loans, servicing loans and receiving payments on loans and other obligations. A
bank acting as agent for an affiliate shall not be considered a branch of the
affiliate. Any agency relationship between affiliates must be on terms that are
consistent with safe and sound banking practices. The authority for an agency
relationship for receiving deposits includes the taking of deposits for an
existing account but is not meant to include the opening or origination of new
deposit accounts. Subject to certain conditions, insured saving associations
which were affiliated with banks as of June 1, 1994, may act as agents for such
banks. An affiliate bank or saving association may not conduct any activity as
an agent which such institution is prohibited from conducting as principal.
If an interstate bank decides to close a branch located in a low-or
moderate-income area, it must comply with additional branch closing notice
requirements. The appropriate regulatory agency is authorized to consult with
community organizations to explore options to maintain banking services in the
affected community where the branch is to be closed.
To ensure that interstate branching does not result in taking deposits
without regard to a community's credit needs, the regulatory agencies are
directed to implement regulations prohibiting interstate branches from being
used as "deposit production offices." The regulations to implement this
provision are due by June 1, 1997. The regulations must include a provision to
the effect that if loans made by an interstate branch are less than fifty
percent of the average of all depository institutions in the state, then the
regulator must review the loan portfolio of the branch. If the regulator
determines that the branch is not meeting the credit needs of the community, it
has the authority to close the branch and to prohibit the bank from opening new
branches in the state.
8
<PAGE>
The Caldera, Weggeland and Killea California Interstate Banking and
Branching Act of 1995 (the "Caldera Act"), effective October 2, 1995, amends the
California Financial Code to, among other matters, regulate the operations of
state banks to eliminate conflicts with and to implement the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 discussed above. The
Caldera Act includes (1) an election to permit early interstate merger
transactions; (2) a prohibition against interstate branching through the
acquisition of a branch business unit located in California without acquisition
of the whole business unit of the California bank; and (3) a prohibition against
interstate branching through de novo establishment of California branch offices.
The Caldera Act mandates that initial entry into California by an out-of-state
institution be accomplished by acquisition of or merger with an existing whole
bank which has been in existence for at least five years.
COMMUNITY REINVESTMENT ACT
In October 1994, the federal financial institution regulatory agencies
proposed a comprehensive revision of their regulations implementing the
Community Reinvestment Act ("CRA"), enacted in 1977 to promote lending by
financial institutions to individuals and businesses located in low and moderate
income areas. In May 1995, the proposed CRA regulations were published in final
form effective as of July 1, 1995. The revised regulations included transitional
phase-in provisions which generally require mandatory compliance not later than
July 1, 1997, although earlier voluntary compliance is permissible. Under the
former CRA regulations, compliance was evaluated by an assessment of the
institution's methods for determining, and efforts to meet, the credit needs of
such borrowers. This system was highly criticized by depository institutions and
their trade groups as subjective, inconsistent and burdensome, and by consumer
representatives for its alleged failure to aggressively penalize poor CRA
performance by financial institutions. The revised CRA regulations emphasize an
assessment of actual performance rather than of the procedures followed by a
bank, to evaluate compliance with the CRA. Overall CRA compliance continues to
be rated across a four-point scale from "outstanding" to "substantial
noncompliance," and continues to be a factor in review of applications to merge,
establish new branches or form bank holding companies. In addition, any bank
rated in "substantial noncompliance" with the revised CRA regulations may be
subject to enforcement proceedings.
The regulations provide that "small banks", which are defined to include any
independent bank with total assets of less than $50 million, are to be evaluated
by means of a so-called "streamlined assessment method" unless such a bank
elects to be evaluated by one of the other methods provided in the regulations.
The differences between the evaluation methods may be summarized as follows:
(1) The "streamlined assessment method" presumptively applicable to small
banks requires that a bank's CRA compliance be evaluated pursuant to five
"assessment criteria," including its (i) loan-to-deposit ratio (as adjusted for
seasonal variations and other lending-related activities, such as sales to the
secondary market or community development lending); (ii) percentage of loans and
other lending-related activities in the bank's service area(s); (iii)
distribution of loans and other lending-related activities among borrowers of
different income levels, given the demographic characteristics of its service
area(s); (iv) geographic distribution of loans and other lending-related
activities within its service area(s); and (v) record of response to written
complaints, if any, about its CRA performance.
(2) The "lending, investments and service tests method" is applicable to all
banks larger than $250 million which are not wholesale or limited purpose banks
and do not elect to be evaluated by the "strategic plan assessment method."
Central to this method is the requirement that such banks collect and report to
their primary federal banking regulators detailed information regarding home
mortgage, small business and farm and community development loans which is then
used to evaluate CRA compliance. At the bank's option, data regarding consumer
loans and any other loan distribution it may choose to provide also may be
collected and reported.
Using such data, a bank will be evaluated regarding its (i) lending
performance according to the geographic distribution of its loans, the
characteristics of its borrowers, the number and complexity of its community
development loans, the innovativeness or flexibility of its lending practices to
meet low and
9
<PAGE>
moderate income credit needs and, at the bank's election, lending by affiliates
or through consortia or third-parties in which the bank has an investment
interest; (ii) investment performance by measure of the bank's "qualified
investments," that is, the extent to which the bank's investments, deposits,
membership shares in a credit union, or grants primarily to benefit low or
moderate income individuals and small businesses and farms, address affordable
housing or other needs not met by the private market, or assist any minority or
women-owned depository institution by donating, selling on favorable terms or
provisioning on a rent-free basis any branch of the bank located in a
predominately minority neighborhood; and (iii) service performance by evaluating
the demographic distribution of the bank's branches and ATMs, its record of
opening and closing them, the availability of alternative retail delivery
systems (such as telephone banking, banking by mail or at work, and mobile
facilities) in low and moderate income geographies and to low and moderate
income individuals, and (given the characteristics of the bank's service area(s)
and its capacity and constraints) the extent to which the bank provides
"community development services" (services which primarily benefit low and
moderate income individuals or small farms and businesses or address affordable
housing needs not met by the private market) and their innovativeness and
responsiveness.
(3) Wholesale or limited purpose banks which do not make home mortgage,
small farm or business or consumer loans to retail customers may elect, subject
to agency approval of their status, to be evaluated by the "community
development test method," which assesses the number and amount of the bank's
community development loans, qualified investments and community development
services and their innovativeness and complexity.
(4) Any bank may request to be evaluated by the "strategic plan assessment
method" by submitting a strategic plan for review and approval. Such a plan must
involve public participation in its preparation, and contain measurable goals
for meeting low and moderate income credit needs through lending, investments
and provision of services. Such plans generally will be evaluated by measuring
strategic plan goals against standards similar to those which will be applied in
evaluating a bank according to the "lending, investments and service test
method."
The federal financial institution regulatory agencies issued a final rule
effective as of January 1, 1996 to make certain technical corrections to the
revised CRA regulations. Among other matters, the rule clarifies the transition
from the former CRA regulations to the revised CRA regulations by confirming
that when an institution either voluntarily or mandatorily becomes subject to
the performance tests and standards of the revised regulations, the institution
must comply with all of the requirements of the revised regulations and is no
longer subject to the provisions of the former CRA regulations.
DEPOSIT INSURANCE
On December 11, 1996 the FDIC finalized a rule lowering the rates on
assessments paid to the Savings Association Insurance Fund ("SAIF"), effective
October 1, 1996. As a result of the special assessment required by the Deposit
Insurance Funds Act of 1996 ("Funds Act"), the SAIF must be capitalized at the
target designated reserve ratio ("DRR") of 1.25 percent of estimated insured
deposits on October 1, 1996. Section 7 of the Federal Deposit Insurance Act, as
amended by the Funds Act, requires the FDIC to set assessments in order to
maintain the target DRR. Therefore, the FDIC has lowered the rates on
assessments paid to the SAIF, while simultaneously widening the spread between
the lowest and highest rates to improve the effectiveness of the FDIC's
risk-based premium system. The FDIC also established a process, similar to that
which has applied to the Bank Insurance Fund ("BIF"), for adjusting the rate
schedules for both the SAIF and BIF within a limited range without notice and
comment to maintain each of the fund balances at the targeted DRR. The Funds Act
also separates, effective January 1, 1997, the Financing Corporation ("FICO")
assessment to service the interest on its bond obligations from the SAIF
assessment. The amount assessed on individual institutions by the FICO will be
in addition to the amount paid for deposit insurance according to the FDIC's
risk-related assessment rate schedules.
10
<PAGE>
The final rule establishes a SAIF assessment rate schedule of 0 to 27 basis
points effective for all institutions beginning January 1, 1997, in addition to
a special interim rate schedule for the fourth quarter of 1996. The Funds Act
also provides that the assessment rates for SAIF members may not be less than
the assessment rates for BIF members which pose a comparable risk to the Deposit
Insurance Fund. The Funds Act provides that assessments are authorized only if
necessary to maintain the DRR of a Deposit Insurance Fund. In the event the
balance in a Deposit Insurance Fund is in excess of the DRR of such fund, such
excess amount shall be refunded to insured depository institutions by the FDIC
on such basis as the FDIC determines to be appropriate, taking into account the
factors considered under the risk-based assessment system. In the case of any
payment of an assessment by an insured depository institution in excess of the
amount due to the FDIC, the FDIC may refund the amount of the excess payment to
the insured depository institution or credit such excess amount toward the
payment of subsequent semi-annual assessments until such credit is exhausted.
The Funds Act also provides that the BIF and the SAIF shall be merged into one
Deposit Insurance Fund effective January 1, 1999, if no insured depository
institution is a savings association on that date.
ECONOMIC GROWTH AND REGULATORY PAPERWORK REDUCTION ACT OF 1996
The Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the
"Regulatory Reduction Act"), was enacted in September 1996. The Regulatory
Reduction Act streamlines many banking laws and Federal bank regulatory agencies
are in the process of promulgating regulations to implement the law. The
Regulatory Reduction Act changes: (i) the procedures for merging, acquiring, or
assuming all or a part of another depositary institution have been simplified
for banks with the two highest regulatory ratings. The regulators have
streamlined their internal approval procedures and expedited the review process
for proposals. Top rated banks and well run bank holding companies, qualify for
the expedited treatment; (ii) the new rules eliminate the requirement for well
capitalized and well managed banks to obtain prior approval for investment in
bank premises or the stock of a corporation holding bank premises; (iii) per
branch capital requirements are eliminated for well performing banks as are the
requirement that a bank file a branch application for ATMs; (iv) the approval
requirement for divestitures by well run banks have been eliminated. The process
for acquisition of an interest in certain nonbank activities has been simplified
by eliminating notice requirements for well capitalized and well managed banks.
Acquisitions are still limited to permitted nonbank activities. Permitted
nonbank activities have been greatly expanded. The acquisition is limited in
size to ten percent of the consolidated total risk-weighted assets of the
acquiring bank; (v) a qualified bank holding company may engage in permissible
activities listed in 12 USC 1843(c)(8) without prior notification to its federal
regulator, but must still give notification within 10 days of commencing the
activity; (vi) banks meeting minimum capital requirements may appoint directors
without giving prior notice to their regulator. A bank that does not meet its
minimum capital requirements must give notice to its regulator 30 days prior to
an appointment. Once the notice is received, the federal regulator has 90 days
to file an objection to the appointment; (vii) the prohibitions against dual
service of management officials for large banks have been amended to increase
the size of the bank. The effect of this change is to exempt some of the smaller
banks from this particular part of the management interlock prohibitions. Those
person who were grandfathered under the old regulations have had five years
added to the grandfathering statute; (viii) the requirements for notice to the
regulators and to customers for the closure of an ATM site is eliminated.
Relocation or consolidation of branches no longer require notice if the
relocation or consolidation occurs within the immediate neighborhood or it does
not substantially affect the nature of the business or customers served; (ix)
the Regulatory Reduction Act expanded the eligibility of some banks to qualify
for an 18 month examination schedule by increasing total the asset size for
those banks rated outstanding or good from $175,000,000 to $250,000,000; (x) all
federal regulatory agencies are required to review regulations for outdated or
otherwise unnecessary regulatory requirements not less frequently than once
every 10 years; (xi) in order to encourage self testing and correction of
regulatory errors, the Regulatory Reduction Act establishes a privilege for
information accumulated during self testing of regulatory compliance.
Information obtained by a bank during self testing may not be used in any civil
action, examination or investigation, and generally may not be obtained by any
agency or department for use in such a proceeding. If the bank elects to
disclose this information in connection with
11
<PAGE>
a particular action, it may not be used in any other actions; and (xii) as a
result of the passage of the Regulatory Reduction Act the federal bank
regulators have begun a process of regulatory simplification.
The Real Estate Settlement Procedures Act ("RESPA") regulations and the
Truth-in-Lending Act ("TILA") regulations have been changed to adopt matching
definitions for common terms. Federal regulators recently asked for additional
comments from banks for consolidation and simplification of the consumer
protection regulations. Those comments are to be published sometime in the
Spring of 1997.
ASSET CONSERVATION, LENDER LIABILITY AND DEPOSIT INSURANCE PROTECTION ACT OF
1996
Environmental Protection Agency regulations excluding financial institutions
from liability for the clean up of toxic materials on property held as
collateral for loans were over turned by the federal courts. Due to concerns
expressed by interested parties (owners, realtors and lenders) Congress passed
amendments to the Comprehensive Environmental Response, Compensation and
Liability Act of 1980 ("CERCLA") to reinstate certain safeguards for fiduciaries
and lenders. A bank or other party acting as a fiduciary may hold property in
such capacity and shall have no liability for the release or threatened release
of a hazardous substance in excess of the value of the property held in a
fiduciary capacity. For example, a bank acting as trustee under the terms of a
written trust agreement, will not have any liability in excess of the actual
value of the assets in that particular trust. The assets of the Bank will not be
at risk for a release occurring on property belonging to the trust. This
amendment does not limit the liability of the fiduciary to private parties that
may have a cause of action outside of the scope of CERCLA. Fiduciary as used in
CERCLA includes, trustees, executors, administrators, custodians, guardians,
receivers, conservators, and personal representatives.
The amendments to CERCLA include changes in the definitions contained in 42
USC 9601(20) entitled definitions. A major change in the definition of "owner"
or "Operator" has the effect of limiting the liability of a financial
institution that does not participate in management of an environmentally
impaired property. Section 9607 of CERCLA states that owners and operators of a
vessel or facility are liable for damages arising out of discharge of a
hazardous substance on property. The amendment specifically states that a
financial institution holding a deed of trust on real property that does not
participate in the management of the operations carried out on the property is
not an owner or an operator under the statute. The amendments further state that
a financial institution that forecloses on such property does not incur
liability simply by the act of foreclosing on the property or through the
subsequent sale of the property to a third party.
INTER-COMPANY BORROWINGS
Bank holding companies are also restricted as to the extent to which they
and their subsidiaries can borrow or otherwise obtain credit from one another,
or engage in certain other transactions. The "covered transactions" that an
insured depository institution and its subsidiaries are permitted to engage in
with their nondepository affiliates are limited to the following amounts: (1) in
the case of any one such affiliate, the aggregate amount of covered transactions
of the insured depository institution and its subsidiaries cannot exceed 10% of
the capital stock and the surplus of the insured depository institution; and
(ii) in the case of all affiliates, the aggregate amount of covered transactions
of the insured depository institution and its subsidiaries cannot exceed 20% of
the capital stock and surplus of the insured depository institution. In
addition, extensions of credit that constitute covered transactions must be
collateralized in prescribed amounts.
"Covered transactions" are defined by statute to include a loan or extension
of credit to the affiliate, a purchase of securities issued by an affiliate, a
purchase of assets from the affiliate (unless otherwise exempted by the Federal
Reserve Board), the acceptance of securities issued by the affiliate as
collateral for a loan and the issuance of a guarantee, acceptance, or letter of
credit for the benefit of an affiliate. Further, a bank holding company and its
subsidiaries are prohibited from engaging in certain tie-in arrangements in
connection with any extension of credit, lease or sale of property or furnishing
of services.
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<PAGE>
IMPACT OF MONETARY POLICIES
Banking is a business which depends on interest rate differentials. In
general, the difference between the interest paid by a bank on its deposits and
other borrowings, and the interest rate earned by banks on loans, securities and
other interest-earning assets comprises the major source of banks' earnings.
Thus, the earnings and growth of banks are subject to the influence of economic
conditions generally, both domestic and foreign, and also to the monetary and
fiscal policies of the United States and its agencies, particularly the FRB. The
FRB implements national monetary policy, such an seeking to curb inflation and
combat recession, by its open-market dealings in United States government
securities, by adjusting the required level of reserves for financial
institutions subject to reserve requirements and through adjustments to the
discount rate applicable to borrowings by banks which are members of the FRB.
The actions of the FRB in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates. The nature and timing
of any future changes in such policies and their impact on the Company cannot be
predicted. In addition, adverse economic conditions could make a higher
provision for loan losses a prudent course and could cause higher loan loss
charge-offs, thus adversely affecting a bank's net earnings.
ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has recently issued SFAS No. 125,
"Accounting for Transfer and Servicing of Financial Assets and Extinguishments
of Liabilities" effective for transactions occurring after December 31, 1996.
SFAS No. 125 requires that an asset seller must meet defined conditions to
demonstrate that it has surrendered control over the assets. The failure to meet
these conditions usually results in on-balance-sheet treatment for the assets
and a liability for the sale proceeds received. SFAS No. 125 also requires that
contracts to service are recorded as an asset or a liability based on fair value
or on an allocation of the carrying amount of the financial asset. SFAS 125
covers subsequent accounting, including impairments, and eliminates the
distinction between excess and normal servicing. In December 1996, the FASB
issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of
FASB Statement No. 125" to defer for one year the effective date of
implementation for transations related to repurchase agreements, dollar-roll
repurchase agreements, securities lending and other similar transactions. The
Company does not believe that adoption of these standards will have a
significant impact on its financial position or results of operations.
GENERAL
The Company is not involved in any administrative or judicial proceedings
pursuant to federal, state or local laws or regulations regarding the discharge
of materials into the environment or whose purpose is to protect the
environment.
EMPLOYEES
At December 31, 1996, the Company employed one hundred sixteen (116) persons
including forty-three (43) part-time employees, four (4) executive officers and
twenty-nine (29) other Vice Presidents and Assistant Vice Presidents. None of
the Company's employees is presently represented by a union or covered under a
collective bargaining agreement. Management of the Bank believes that its
employee relations are excellent.
ITEM 2. PROPERTIES
The Bank's main branch is located at 720 Front Street, Santa Cruz,
California in a free standing building consisting of approximately 5,760 square
feet. The lease is for a period of ten (10) years ending on May 31, 1997. The
current rent is $12,060 per month. An option to renew the lease for four (4)
additional sixty month periods is provided. The monthly rental at the
commencement of each renewal period shall be the greater of $11,000 per month or
an amount determined by using a formula based upon increases in the CPI. The
Bank expects to renew the lease before its expiration.
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The Company's and the Bank's administrative offices and Investment Services
Department are located in a mixed use building at 740 Front Street, Santa Cruz,
California, adjacent to the Bank's main branch. The lease is for a ten (10) year
term commencing on November 1, 1988 and contains three (3) options to renew for
five (5) years each. The Bank has leased additional space in the same building
several times under addendum to the lease, and such addendum run concurrently
with the lease. The present rent is $11,954 per month and is increased annually
in October of each year in accordance with increases in the CPI.
The Bank's Soquel Drive branch is located at 1975 Soquel Drive, Santa Cruz,
California and consists of approximately 4,935 square feet plus parking. The
lease is for a ten (10) year term commencing on October 1, 1990 with two (2)
options to renew for five (5) years each. The present rent is $8,548 per square
foot ($1.40 per month) and increases by $.05 per square feet per year until it
reaches $1.50 per square foot in years 8, 9 and 10 of the lease. The rent during
the option periods is to be at a market rate determined at the beginning of each
option period and will be adjusted during the option period in accordance with
increases in the CPI. The Bank also has a right of first refusal to purchase the
building. The Bank has not made a determination regarding the renewal or any
potential purchase of the building.
The Bank's Aptos branch is located at 7775 Soquel Drive, Aptos, California
and contains approximately 1,450 square feet of space. The lease is for a five
(5) year term commencing on July 3, 1996, with an option to renew for five (5)
years. The initial rent is adjusted annually in accordance with increases in the
CPI and at present the rent is $4,142 per month.
The Bank's Scotts Valley branch is located at 203A Mt. Hermon Road, Scotts
Valley, California in a 3,420 square foot area. The lease is for a five (5) year
term beginning on April 1, 1992 with three (3) options to renew for five (5)
years each. The current rent is $4,455 per month and is increased annually in
accordance with increases in the CPI. During the initial options period, annual
increases in rent shall continue to be in accordance with increases in the CPI.
The rent for the first year of the second and third options shall be based upon
market rents in Scotts Valley, and will be adjusted annually during the
remaining four years of each option period in accordance with the CPI. The Bank
expects to renew the lease before its expiration.
The Bank's Watsonville branch is located at 1055 S. Green Valley Road,
Watsonville, California and consists of approximately 2,975 square feet. The
lease is for a ten (10) year term commencing on February 1, 1990 with two (2)
options to renew for five (5) years each. The current rent is $6,075 per month
and is adjusted annually in accordance with increases in the CPI.
The Bank's computer and operations center is located at 140 Dubois Street,
Santa Cruz, California and contains approximately 5,250 square feet. The lease
expires in January, 1998. The rent is currently $6,825 per month.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to routine litigation which is incidental to its
business. As of December 31, 1996, there are no pending legal proceedings to
which the Company is a party which may have a materially adverse effect upon the
Company's business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote by the shareholders of the Company's
common stock during the fourth quarter of 1996.
14
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
A. The Company's Common Stock is trading on the NASDAQ National Market under
the trading symbol "CTBP." The Company's Common Stock began trading on the
NASDAQ National Market on February 19, 1997. Prior to that time, the Company's
Common Stock was listed on the NASDAQ Bulletin Board and was the subject of
limited trading.
The prices indicated below may not necessarily represent actual
transactions.
<TABLE>
<CAPTION>
SALE PRICE OF THE
COMPANY'S COMMON
STOCK
--------------------
QUARTER ENDED 1996 BID ASK
- ---------------------------------------------------------------- --------- ---------
<S> <C> <C>
March 31........................................................ $ 13.00 $ 15.00
June 30......................................................... 14.00 16.25
September 30.................................................... 15.00 17.00
December 31..................................................... 19.00 20.00
QUARTER ENDED 1995
- ----------------------------------------------------------------
March 31........................................................ $ 9.00 $ 10.25
June 30......................................................... 10.62 11.00
September 30.................................................... 10.25 11.00
December 31..................................................... 10.25 14.00
</TABLE>
B. As of March 21, 1997, the approximate number of holders of the Company's
Common Stock was 445.
C. The Company paid a cash dividend of $0.115 per share in the first
quarter of 1997; cash dividends of $0.10 per share in each quarter during 1996;
and cash dividends of $0.09 per share in each quarter of 1995.
There can be no assurances that the Company will pay either cash or stock
dividends in the future.
The Company considers the payment of cash dividends in order to return a
portion of its profits to stockholders. In considering the amount of cash
dividends to be paid, if any, the Company considers the maintenance of a
consistent dividend policy as part of its effort to make the Company's stock
attractive to investors; the amount and frequency of dividends; the payout
ratio; the need of the Company to have sufficient funds available to pay its
expenses; and compliance with applicable laws, regulations and other regulatory
requirements.
California law provides that in order to declare dividends: (i) after a
corporation has paid a dividend to its stockholders, it must be likely that the
corporation will be able to meet its liabilities as they mature; and (ii) the
amount of the corporation's retained earnings immediately prior to the payment
of the dividend must be equal to or exceed the amount of the proposed cash
dividend.
The Company's primary source of revenue is dividends from its subsidiary,
the Bank. The payment of dividends by the Bank is subject to various legal and
regulatory requirements. See Item 1 "Restrictions on Dividends and Other
Distributions."
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ITEM 6. SELECTED FINANCIAL DATA
Presented below is selected financial data for the Company for the last five
years. The Company became the bank holding company for the Bank on July 25,
1995.
The selected consolidated financial data presented below for, and as of the
end of, each of the years in the five-year period ended December 31, 1996 is
derived from the audited consolidated financial statements of the Company. The
following data should be read in conjunction with the consolidated financial
statements, related notes and other financial information included herein and
management's discussion and analysis of financial condition and results of
operations.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT SUMMARY:
Net interest income...................................... $ 13,435 $ 12,366 $ 9,936 $ 8,953 $ 7,770
Provision for credit losses.............................. 900 900 600 850 528
Noninterest income....................................... 4,898 3,558 4,044 5,184 3,892
Noninterest expenses..................................... 10,539 9,855 9,463 8,895 7,591
Income before income taxes............................... 6,894 5,169 3,917 4,392 3,543
Income tax expense....................................... 2,766 2,020 1,479 1,731 1,371
Net income............................................... 4,128 3,149 2,438 2,661 2,172
PERIOD END:
Total loans, gross....................................... $ 123,721 $ 106,840 $ 97,648 $ 92,488 $ 100,731
Assets................................................... 236,915 207,668 175,861 153,129 148,244
Deposits................................................. 185,467 164,046 152,130 135,573 132,785
Stockholders' equity..................................... 23,193 20,984 17,710 16,280 13,776
AVERAGES FOR PERIOD:
Total loans, gross....................................... $ 115,743 $ 99,842 $ 94,273 $ 99,319 $ 95,826
Earning assets........................................... 199,517 167,089 144,093 138,945 120,560
Assets................................................... 217,735 184,977 161,686 155,490 137,281
Deposits................................................. 171,092 151,960 143,195 138,738 123,306
Stockholders' equity..................................... 21,466 19,538 17,113 15,165 12,711
SELECTED RATIOS:
Net interest margin...................................... 6.7% 7.4% 6.9% 6.4% 6.4%
Efficiency ratio......................................... 57.5% 61.9% 67.7% 62.9% 65.1%
Allowance for credit losses to total loans............... 2.6% 2.3% 1.9% 1.9% 1.6%
Return on average assets................................. 1.9% 1.7% 1.5% 1.7% 1.6%
Return on beginning stockholders' equity................. 19.7% 17.8% 15.0% 19.3% 18.1%
Dividend payout ratio.................................... 21.5% 26.0% 28.0% 12.9% --
CAPITAL RATIOS:
Average equity to average assets......................... 9.9% 10.6% 10.6% 9.8% 9.3%
Total risk-based capital ratio........................... 16.4% 16.9% 15.4% 16.1% 13.0%
Tier 1 risk-based capital ratio.......................... 15.2% 15.7% 14.2% 14.9% 11.8%
Tier 1 leverage ratio.................................... 9.8% 10.2% 10.9% 11.1% 9.4%
PER SHARE DATA:
Net income............................................... $ 1.85 $ 1.38 $ 1.07 $ 1.17 $ 0.95
Book value............................................... $ 10.50 $ 9.29 $ 7.78 $ 7.15 $ 6.05
Cash dividends declared.................................. $ .40 $ 0.36 $ 0.30 $ 0.15 --
Weighted average common shares outstanding............... 2,236,134 2,280,285 2,277,999 2,277,999 2,277,999
</TABLE>
16
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
BUSINESS ORGANIZATION
Coast Bancorp (the Company) is a California corporation organized in 1995 to
act as the holding company for Coast Commercial Bank (the Bank), a
California-chartered, FDIC-insured commercial bank opened in 1982 with
headquarters in Santa Cruz and branch offices in Aptos, Santa Cruz, Scotts
Valley and Watsonville. During 1995 the Company acquired through merger all the
outstanding common stock of the Bank. The merger was accounted for similar to a
pooling of interests in that the historical cost basis of Coast Commercial Bank
has been carried forward. The Company currently conducts no significant business
activities other than its investment in the Bank. Consequently, substantially
all of the Company's net income, assets and equity are derived from its
investment in the Bank.
The Bank engages in commercial and consumer banking, offering a range of
traditional banking products and services to individuals, retailers, small and
medium-sized businesses and professionals, primarily within the Santa Cruz
County area.
The following analysis is designed to enhance the reader's understanding of
the Company's financial condition and the results of its operations as reported
in the consolidated financial statements included in this Form. This discussion
should be read in conjunction with those financial statements and notes.
OVERVIEW
The Company earned net income of $4,128,000 for the year ended December 31,
1996, an increase of 31% from 1995 net income of $3,149,000. Net income reported
for 1995 represented an increase of 29% from 1994 net income of $2,438,000. On a
per share basis, net income for 1996 was $1.85 compared with $1.38 and $1.07 for
the preceding two years. The increase in net income in 1996 over 1995 was caused
by the increases in net interest income and noninterest income exceeding the
increase in noninterest expenses. The change in net income in 1995 over 1994 was
due to an increase in net interest income partially offset by increases in the
provision for credit losses and noninterest expenses and a decrease in
noninterest income.
EARNINGS SUMMARY
NET INTEREST INCOME
Net interest income refers to the difference between interest and fees
earned on loans and investments and the interest paid on deposits and other
borrowed funds. It is the largest component of the net earnings of a financial
institution. The primary factors to consider in analyzing net interest income
are the composition and volume of earning assets and interest-bearing
liabilities, the amount of noninterest bearing liabilities and nonaccrual loans,
and changes in market interest rates.
17
<PAGE>
Table I sets forth average balance sheet information, interest income and
expense, average yields and rates, and net interest income and net interest
margin for the years ended December 31, 1996, 1995 and 1994.
TABLE 1 COMPONENTS OF NET INTEREST INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
1996 1995 1994
---------------------------- ---------------------------- ----------------------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
-------- -------- ------- -------- -------- ------- -------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Assets:
Loans (2)(3).................. $115,743 $12,845 11.1% $ 99,842 $11,804 11.8% $ 94,273 $ 9,961 10.6%
Investment securities:
Taxable..................... 61,817 4,235 6.9% 49,026 3,284 6.7% 33,830 1,666 4.9%
Nontaxable (1).............. 6,025 509 8.4% 6,453 546 8.5% 6,872 580 8.4%
Federal funds sold............ 15,932 832 5.2% 11,768 671 5.7% 9,118 368 4.0%
-------- -------- ------- -------- -------- ------- -------- -------- -------
Total earning assets.......... 199,517 18,421 9.2% 167,089 16,305 9.8% 144,093 12,575 8.7%
Cash and due from banks....... 13,993 13,107 12,626
Allowance for credit losses... (2,882) (2,135) (1,835)
Unearned income............... (1,663) (1,606) (1,387)
Bank premises and equipment,
net......................... 2,200 2,691 3,152
Other assets.................. 6,570 5,831 5,037
-------- -------- --------
Total assets.................. $217,735 $184,977 $161,686
-------- -------- --------
-------- -------- --------
Interest-bearing liabilities:
Deposits:
Demand...................... $ 72,035 1,388 1.9% $ 74,907 1,577 2.1% 73,122 1,450 2.0%
Savings..................... 27,342 819 3.0% 16,854 431 2.6% 18,327 446 2.4%
Time........................ 23,867 1,228 5.1% 19,019 962 5.1% 16,590 546 3.3%
-------- -------- ------- -------- -------- ------- -------- -------- -------
Total deposits................ 123,240 3.435 2.8% 110,780 2,970 2.7% 108,039 2,442 2.3%
Borrowed funds................ 23,528 1,378 5.9% 11,537 783 6.8% 22 -- --
-------- -------- ------- -------- -------- ------- -------- -------- -------
Total interest-bearing
liabilities................. 146,768 4,813 3.3% 122,317 3,753 3.1% 108,061 2,442 2.3%
Demand deposits............... 47,852 41,180 35,156
Other liabilities............. 1,649 1,942 1,356
Stockholders' equity.......... 21,466 19,538 17,113
-------- -------- --------
Total liabilities and
stockholders' equity........ $217,735 $184,977 $161,686
-------- -------- --------
-------- -------- --------
Net interest income and
margin...................... $13,608 6.8% $12,552 7.5% $10,133 7.0%
-------- ------- -------- ------- -------- -------
-------- ------- -------- ------- -------- -------
</TABLE>
- ------------------------
(1) Tax exempt income includes $173,000, $186,000, and $197,000 in 1996, 1995
and 1994, respectively, to adjust to a fully taxable equivalent basis using
the Federal statutory rate of 34%.
(2) Loan fees totaling $974,000, $991,000, and $1,031,000 are included in loan
interest income for the years 1996, 1995 and 1994, respectively.
(3) Average nonaccrual loans totaling $511,000, $883,000, and $1,085,000 are
included in average loans for the years 1996, 1995 and 1994, respectively.
18
<PAGE>
Net interest income is affected by changes in the amount and mix of
interest-earning assets and interest-bearing liabilities, referred to as "volume
change." Net interest income is also affected by changes in yields earned on
interest-earning assets and rates paid on interest-bearing liabilities, referred
to as "rate change." Table 2 presents changes in interest income and interest
expense for each major category of interest-earning assets and interest-bearing
liabilities. The table also reflects the amount of change attributable to volume
and rate changes for the years indicated on a fully taxable equivalent basis.
TABLE 2 RATE/VOLUME ANALYSIS
<TABLE>
<CAPTION>
1996 COMPARED TO 1995 INCREASE 1995 COMPARED TO 1994 INCREASE
(DECREASE) (DECREASE)
DUE TO CHANGE IN DUE TO CHANGE IN
------------------------------- -------------------------------
NET NET
VOLUME RATE CHANGE VOLUME RATE CHANGE
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans........................................ $ 1,880 $ (839) $ 1,041 $ 588 $ 1,255 $ 1,843
Investment securities........................ 853 61 914 815 769 1,584
Federal funds sold........................... 237 (76) 161 107 196 303
--------- --------- --------- --------- --------- ---------
Total interest income........................ 2,970 (854) 2,116 1,510 2,220 3,730
Interest bearing deposits:
Demand....................................... (60) (129) (189) 36 91 127
Savings...................................... 268 120 388 (36) 21 (15)
Time......................................... 245 21 266 84 332 416
--------- --------- --------- --------- --------- ---------
Interest expense on deposits................. 453 12 465 84 444 528
Interest expense on borrowings............... 814 (219) 595 783 -- 783
--------- --------- --------- --------- --------- ---------
Total interest expense....................... 1,267 (207) 1,060 867 444 1,311
--------- --------- --------- --------- --------- ---------
Increase in net interest income.............. $ 1,703 $ (647) $ 1,056 $ 643 $ 1,776 $ 2,419
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</TABLE>
For 1996, net interest income, on a fully taxable-equivalent basis, was
$13,608,000 or 6.8% of average earning assets, an increase of 8% over
$12,552,000 or 7.5% of average earning assets in the comparable period in 1995.
The increase in 1996 reflects higher levels of earning assets partially offset
by lower yields on loans corresponding generally with declining market rates
since the beginning of 1995. Net interest income, on a fully taxable-equivalent
basis, in 1995 increased 24% over $10,133,000 or 7.0% of average earning assets
in 1994. The increase in 1995 is primarily attributable to increased average
earning assets and increased yields on loans corresponding generally with rising
market interest rates over 1994.
Interest income, on a fully taxable-equivalent basis, was $18,421,000,
$16,305,000, and $12,575,000 for 1996, 1995, and 1994, respectively. The
increase in 1996 resulted from the growth in average earning assets while the
significant increase in 1995 is due primarily to the increased yields and growth
in average earning assets. Loan yields averaged 11.1% in 1996, 11.8% in 1995,
and 10.6% in 1994 and generally reflect the increase in market rates from the
cyclical lows in 1993 and the pull back of interest rates in 1995. Approximately
89% of the Bank's loans have variable interest rates indexed to the prime rate.
The Bank's average prime rate was 8.27%, 8.83%, and 7.36% in 1996, 1995, and
1994, respectively. Average earning assets were $199,517,000 for 1996, an
increase of 19% over $167,089,000 in 1995, which increased 16% over $144,093,000
in 1994. The growth in average earning assets resulted from increased levels of
deposits and borrowings which were invested primarily in investment securities
and loans.
The increases in interest income during 1996 and 1995, on a fully
taxable-equivalent basis, were partially offset by increases in interest
expense. The increases were primarily due to increases in borrowed funds in 1996
and 1995 and higher rates paid on time deposit accounts in 1995. The average
rate paid on interest bearing deposits was 2.8% for 1996, 2.7% in 1995, and 2.3%
in 1994.
19
<PAGE>
NONINTEREST INCOME
Table 3 summarizes the sources of noninterest income for the periods
indicated:
TABLE 3 NONINTEREST INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Customer service fees............................... $ 1,808 $ 1,527 $ 1,501
Gain on sale of loans............................... 1,420 678 1,174
Loan servicing fees................................. 958 875 793
Gains (losses) on securities transactions........... 114 (48) 1
Gain on sale of other real estate owned............. 39 65 163
Gain on sale of bank premises and equipment......... 14 13 7
Other............................................... 545 448 405
--------- --------- ---------
Total noninterest income........................ $ 4,898 $ 3,558 $ 4,044
--------- --------- ---------
--------- --------- ---------
</TABLE>
The increase in customer service fees in 1996 relates primarily to higher
merchant credit card processing fees. Gains on sale of loans increased as a
result of increased SBA loan originations during 1996. The decreases in 1995
resulted from a decline in premiums on the sale of SBA loans, related to changes
in guarantee programs of the SBA. Customer service fees, loan servicing fees and
other noninterest income increased consistent with the growth of deposits and
loans serviced for others.
NONINTEREST EXPENSES
The major components of noninterest expenses stated in dollars and as a
percentage of average earning assets are set forth in Table 4 for the periods
indicated.
TABLE 4 NONINTEREST EXPENSES
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1996 1995 1994
-------------------- -------------------- --------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Salaries and benefits...................... $ 5,193 2.60% $ 5,009 3.00% $ 4,658 3.23%
Equipment.................................. 1,142 .57% 1,043 0.62% 1,072 0.74%
Occupancy.................................. 934 .47% 904 0.54% 903 0.63%
Stationery and postage..................... 382 .19% 278 0.17% 290 0.20%
Insurance.................................. 143 .07% 280 0.17% 463 0.32%
Legal fees................................. 93 .05% 200 0.12% 148 0.10%
Other...................................... 2,652 1.33% 2,141 1.28% 1,929 1.34%
--------- --- --------- --- --------- ---
Total noninterest expenses............. $ 10,539 5.28% $ 9,855 5.90% $ 9,463 6.56%
--------- --- --------- --- --------- ---
--------- --- --------- --- --------- ---
</TABLE>
Total noninterest expenses increased $684,000 or 7% to $10,539,000 in 1996
over $9,855,000 in 1995, which increased $392,000 or 4% from $9,463,000 in 1994.
The increases in 1996 and 1995 were primarily related to higher staff costs
and increases in other noninterest expenses partially offset by reductions in
FDIC insurance premiums. The FDIC reduced insurance premiums as the Bank
Insurance Fund reached full funding during 1995 and in 1996 the Bank paid the
minimum insurance fee of $2,000. The increase in noninterest expenses reflects
the growth in total loans, deposits and assets. The decrease in noninterest
expenses as a percentage of average earning assets is the result of the rate of
growth in average earning assets in 1996 and 1995 exceeding the rate of increase
in noninterest expenses.
20
<PAGE>
INCOME TAXES
The Company's effective tax rate was 40.1% for 1996 compared to 39.1% for
1995 and 37.8% for 1994. Changes in the effective tax rate for the Company are
primarily due to fluctuations in the proportion of tax exempt income generated
from investment securities to pre-tax income.
BALANCE SHEET ANALYSIS
Total assets increased to $236.9 million at December 31, 1996, a 14%
increase from the end of 1995. Total assets increased to $207.7 million in 1995,
an 18% increase from the $175.9 million a year earlier. Based on average
balances, 1996 average total assets of $217.7 million represent an increase of
18% over 1995 and 1995 average total assets of $185.0 million represent an
increase of 14% over 1994.
EARNING ASSETS
LOANS
Total gross loans at December 31, 1996 were $123.7 million, a 16% increase
from $106.8 million at December 31, 1995 which was a 9% increase from $97.6
million at December 31, 1994.
Table 5 summarizes the composition of the loan portfolio at December 31, for
the past five years.
TABLE 5 LOANS BY TYPE
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Commercial, financial and agricultural...... $ 35,633 $ 34,263 $ 32,294 $ 36,047 $ 49,288
Installment and other....................... 7,768 7,989 8,437 7,661 8,711
Real estate mortgage........................ 65,208 50,580 41,200 33,221 29,047
Real estate construction.................... 15,112 14,008 15,717 15,559 13,685
--------- --------- --------- --------- ---------
Total loans............................. $ 123,721 $ 106,840 $ 97,648 $ 92,488 $ 100,731
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
Average loans in 1996 were $115,743,000 representing an increase of
$15,901,000 or 16% over 1995 and in 1995 were $99,842,000 representing an
increase of $5,569,000, or 6% over 1994. The 1996 and 1995 increases reflected
growth in average real estate loans which in the opinion of Management is due to
improved local economic conditions.
Real estate mortgage loans were $65,208,000 at December 31, 1996 compared to
$50,580,000 and $41,200,000 at the end of 1995 and 1994, respectively. The
increases of $14,628,000 in 1995 and $9,380,000 in 1994 resulted from the
retained portion of SBA loans and additional loan demand for nonresidential real
estate financing in the Bank's market area. Extensions of credit are based on an
analysis of the borrower's ability to generate debt service, obtain other
financing or sell the property. Advances on nonresidential properties are
limited in general to approximately 70% of the lower of cost or appraised value.
The Bank's construction loan portfolio was $15,112,000 at December 31, 1996,
compared to $14,008,000 and $15,717,000 at the end of 1995 and 1994,
respectively. Construction loans represented 12% of total loans at December 31,
1996 compared to 13% and 16% in 1995 and 1994. The Bank finances the
construction of commercial and residential properties. These loans are at
variable rates, generally have maturities of less than 12 months, and are
secured by first deeds of trust on the underlying properties. Repayment is
expected from the borrower's ability to obtain take-out financing or sell the
property. Advances on residential and commercial projects are limited in general
to the lower of approximately 80% and 70%, respectively, of cost or appraised
value of the collateral.
21
<PAGE>
Real estate mortgage and construction lending entail potential risks which
are not inherent in other types of loans. These potential risks include declines
in market values of underlying real property collateral and, with respect to
construction lending, delays or cost overruns which could expose the Company to
loss. In addition, risks in commercial real estate lending include declines in
commercial real estate values, general economic conditions surrounding the
commercial real estate properties, and vacancy rates. A decline in the general
economic conditions or real estate values within the Company's market area could
have a negative impact on the performance of the loan portfolio or value of the
collateral. Because the Company lends primarily within its market area, the real
property collateral for its loans is similarly concentrated, rather than
diversified over a broader geographic area. The Company could therefore be
adversely affected by a decline in real estate values in the Company's target
market, even if real estate values elsewhere in California generally remained
stable or increased. Risks also include those outlined in the Risk Elements
section below.
Commercial loans were $35,633,000 at the end of 1996 compared to $34,263,000
and $32,294,000 at the end of 1995 and 1994, respecitvely. The Bank makes
commercial loans available to serve the credit demands of small-to-medium sized
businesses for lines of credit, single payment and term debt obligations.
Typically, loans are collateralized by the working capital, inventory,
receivables, or equipment being financed or other assets available to the
borrower. The Bank's commercial loan portfolio consists primarily of short- to
medium-term financing for small- to medium-sized businesses and professionals
located in Santa Cruz County. The Bank's commercial loan portfolio is
diversified as to industries and types of businesses with no material industry
concentrations and a profile which the Company believes generally reflects the
economy of Santa Cruz County. Risks include those outlined in the Risk Elements
section below.
Installment loans were $7,768,000 compared to $7,989,000 and $8,437,000 at
the end of 1996, 1995, and 1994, respectively. The installment loan portfolio
finances customers' household, family and other personal expenditures on both a
secured and unsecured basis. Risks include those outlined in the Risk Elements
section below.
RISK ELEMENTS
Lending money involves an inherent risk of nonpayment. Through the
administration of loan policies and monitoring of the portfolio, management
seeks to reduce such risks. The allowance for credit losses is an estimate to
provide a financial buffer for losses, both identified and unidentified, in the
loan portfolio.
Management strives to achieve a low level of credit losses by continuing
emphasis on credit quality in the loan approval process, active credit
administration and regular monitoring. An important tool in achieving a high
level of credit quality is the loan grading system to assess the risk inherent
in each loan. Additionally, management believes its ability to manage portfolio
credit risk is enhanced by lending personnel's knowledge of the Bank's service
area. Lending personnel live in the communities served by the Bank and senior
management and directors of the Company and Bank are active members of the
communities served by the Bank. Further, senior management of the Bank has
experienced minimal turnover since the inception of the Bank in 1982.
Ultimately, credit quality may be influenced by underlying trends in the
economic and business cycles. Management believes that its lending policies and
underwriting standards will tend to minimize losses in an economic downturn,
however, there is no assurance that losses will be limited under such
circumstances. The Bank's loan policies and underwriting standards include, but
are not limited to, the following: 1) maintaining a thorough understanding of
the Bank's service area and limiting investments outside of this area, 2)
maintaining a thorough understanding of the borrowers' knowledge and capacity in
their field of expertise, 3) basing real estate construction loan approval not
only on marketability of the project, but also on the borrowers' capacity to
support the project financially in the event it does not sell within the
original projected time period, and 4) maintaining conforming and prudent loan
to value and loan to cost ratios based on independent outside appraisals and
ongoing inspection and analysis by the Bank's construction lending officers. In
addition, the Bank strives to diversify the risk inherent in the construction
portfolio by avoiding concentrations to individual borrowers and on any one
project.
22
<PAGE>
Management regularly reviews and monitors the loan portfolio to determine
the risk profile of each credit, and to identify credits whose risk profiles
have changed. This review includes, but is not limited to, such factors as
payment status, the financial condition of the borrower, borrower compliance
with loan convenants, underlying collateral values, potential loan
concentrations, and general economic conditions. When potential problem credits
are identified by management, action plans for each credit are developed for
bank personnel to mitigate the credit risk through measures such as increased
monitoring, debt reduction goals, addition collateral and possible credit
restructuring opportunities.
NONACCRUAL LOANS, LOANS PAST DUE AND OREO
The accrual of interest is discontinued and any accrued and unpaid interest
is reversed when the payment of principal or interest is 90 days past due unless
the amount is well secured and in the process of collection. Income on such
loans is then recognized only to the extent that cash is received and where the
future collection of principal is probable. At December 31, 1996 nonaccrual
loans totaled $159,000 or .1% of total loans compared to $824,000 or .8% at
December 31, 1995 and $848,000 or .9% at December 31, 1994. If the nonaccrual
loans at December 31, 1996 had not been on nonaccrual, $21,000 of interest
income would have been realized during the year ended December 31, 1996. The
Company realized $16,000 on these nonaccrual loans during 1996.
The Company's level of nonperforming assets, in particular nonaccrual loans,
is at historically low levels. Management believes the level of nonperforming
assets, including nonaccrual loans, will fluctuate throughout business and
economic cycles, and there is no assurance the current level of nonperforming
assets can be sustained.
Table 6 presents the composition of nonperforming assets at December 31 for
the last 5 years.
TABLE 6 NONPERFORMING ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Nonperforming Assets:
Loans Past Due 90 Days or More.................... $ 50 $ 3 $ -- $ 871 $ 700
Nonaccrual Loans.................................. 159 824 848 1,427 --
--------- --------- --------- --------- ---------
Total Nonperforming Loans........................... 209 827 848 2,298 700
OREO................................................ 551 830 1,419 364 875
--------- --------- --------- --------- ---------
Total Nonperforming Assets.......................... $ 760 $ 1,657 $ 2,267 $ 2,662 $ 1,575
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Nonperforming Loans as a Percent of Total Loans..... 0.17% 0.77% 0.87% 2.48% 0.69%
OREO as a Percent of Total Assets................... 0.23% 0.40% 0.81% 0.24% 0.59%
Nonperforming Assets as a Percent of Total Assets... 0.32% 0.80% 1.29% 1.74% 1.06%
Allowance for Loan Losses........................... $ 3,158 $ 2,478 $ 1,859 $ 1,723 $ 1,572
As a Percent of Total Loans....................... 2.55% 2.32% 1.90% 1.86% 1.56%
As a Percent of Nonaccrual Loans.................. 1986% 301% 219% 121% --
As a Percent of Nonperforming Loans............... 1511% 300% 219% 75% 225%
</TABLE>
There were no loans at December 31, 1996 where management had serious doubts
about the borrower's ability to comply with loan repayment terms and which may
result in disclosure as a nonaccrual, past due or restructured loan, except as
disclosed in Table 6.
For a discussion of concentrations in the Company's loan portfolio, see Note
10 of Notes to Consolidated Financial Statements.
23
<PAGE>
PROVISION AND ALLOWANCE FOR CREDIT LOSSES
Management has established an evaluation process designed to determine the
adequacy of the allowance for credit losses. This process attempts to assess the
risk of loss inherent in the portfolio by segregating the allowance for credit
losses into three components: "historical losses;" "specific;" and "margin for
imprecision." The "historical losses" component is calculated as a function of
the prior four years loss experience for commercial, real estate and consumer
loan types. The four years are assigned weightings of 35%, 30%, 20% and 15%
beginning with the most recent year. The "specific" component is established by
allocating a portion of the allowance to individual classified credits on the
basis of specific circumstances and assessments. The "margin for imprecision"
component is an unallocated portion that supplements the first two components as
a conservative margin to guard against unforeseen factors. The "historical
losses" and "specific" components include management's judgment of the effect of
current and forecasted economic conditions on the ability of the Company's
borrowers' to repay; an evaluation of the allowance for credit losses in
relation to the size of the overall loan portfolio; an evaluation of the
composition of, and growth trends within, the loan portfolio; consideration of
the relationship of the allowance for credit losses to nonperforming loans; net
charge-off trends; and other factors. While this evaluation process utilizes
historical and other objective information, the classification of loans and the
establishment of the allowance for credit losses, relies, to a great extent, on
the judgment and experience of management. The Company evaluates the adequacy of
its allowance for credit losses quarterly.
The Financial Accounting Standards Board issued SFAS No. 114, "Accounting by
Creditors for Impairment of a Loan" in 1993 and SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan-- Income Recognition and Disclosure" in 1994,
both of which were implemented in the first quarter of 1995. SFAS No. 114
requires the Bank to measure impaired loans based upon the present value of
expected future cash flows discounted at the loan's effective interest rate,
except that as a practical expedient, a creditor may measure impairment based on
a loan's observable market price or the fair value of the collateral if the loan
is collateral dependent. A loan is impaired when, based upon current information
and events, it is probable that a creditor will be unable to collect all amounts
due according to the contractual terms of the loan agreement. SFAS No. 118
amends SFAS No. 114 to allow a creditor to use existing methods for recognizing
interest income on impaired loans and requires certain information to be
disclosed. There were no impaired loans at December 31, 1996. The recorded
investment in impaired loans at December 31, 1995 was comprised of one loan of
$343,000, which had a related allowance of $69,000. Such allowance is a portion
of the allowance for credit losses. The average recorded investment in impaired
loans was $273,000 and $369,000 in 1996 and 1995, respectively. No interest
income was recognized on such loans during the period of impairment.
The allowance for credit losses totaled $3,158,000 or 2.6% of total loans as
of December 31, 1996 compared to $2,478,000 or 2.3% as of December 31, 1995, and
$1,859,000 or 1.9% as of December 31, 1994. It is the policy of management to
maintain the allowance for possible credit losses at a level adequate for known
and future risks inherent in the loan portfolio. Based on information currently
available to analyze loan loss potential, including economic factors, overall
credit quality, historical delinquency and a history of actual charge-offs,
management believes that the loan loss provision and allowance are adequate;
however, no assurance of the ultimate level of credit losses can be given with
any certainty. Loans are charged against the allowance when management believes
that the collectibility of the principal is unlikely. An analysis of activity in
the allowance for credit losses is presented in Table 7.
24
<PAGE>
TABLE 7 ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Total Loans Outstanding..................... $ 123,721 $ 106,840 $ 97,648 $ 92,488 $ 100,731
Average Total Loans......................... 115,743 99,842 94,273 99,319 95,826
Balance, January 1.......................... $ 2,478 $ 1,859 $ 1,723 $ 1,572 $ 1,338
Charge-offs by Loan Category:
Commercial................................ 256 293 304 295 262
Installment and other..................... 96 108 32 73 60
Real Estate construction.................. -- -- 120 400 --
Real Estate-other......................... -- -- 30 -- --
--------- --------- --------- --------- ---------
Total Charge-Offs........................... 352 401 486 768 322
Recoveries by Loan Category:
Commercial................................ 78 79 17 67 24
Installment and other..................... 9 25 3 2 4
Real Estate construction.................. 45 16 -- -- --
Real Estate-other......................... -- -- 2 -- --
--------- --------- --------- --------- ---------
Total Recoveries........................ 132 120 22 69 28
Net Charge-Offs............................. 230 281 464 699 294
Provision Charged to Expense................ 900 900 600 850 528
--------- --------- --------- --------- ---------
Balance, December 31........................ $ 3,158 $ 2,478 $ 1,859 $ 1,723 $ 1,572
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Ratios:
Net Charge-offs to Average Loans.......... 0.20% 0.28% 0.49% 0.70% 0.31%
Reserve to Total Loans.................... 2.55% 2.32% 1.90% 1.86% 1.56%
</TABLE>
The allowance for credit losses is allocated based upon management's review
of credit quality and is presented in Table 8. This allocation should not be
interpreted as an indication of expected amounts or categories where losses will
occur.
TABLE 8 ALLOCATION OF THE ALLOWANCE FOR CREDIT LOSSES
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
-------------------- -------------------- -------------------- -------------------- --------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
OF TOTAL OF TOTAL OF TOTAL OF TOTAL OF TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Commercial......... $ 1,658 28.8% $ 1,338 32.1% $ 1,051 33.1% $ 1,328 39.0% $ 1,237 48.9%
Real estate........ 1,154 64.9% 991 60.4% 705 58.3% 378 52.7% 126 42.4%
Installment and
other............ 346 6.3% 148 7.5% 103 8.6% 17 8.3% 209 8.7%
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
$ 3,158 100.0% $ 2,478 100.0% $ 1,859 100.0% $ 1,723 100.0% $ 1,572 100.0%
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
</TABLE>
The allocation for real estate includes real estate construction and other
real estate loans. Management has historically not allocated the allowance for
credit losses separately for real estate construction and other real estate
loans.
25
<PAGE>
OTHER INTEREST EARNING ASSETS
The average balance of investment securities and federal funds sold totaled
$83,774,000 in 1996, an increase of $16,527,000 from $67,247,000 in 1995. The
average balance of investment securities and federal funds sold increased
$17,427,000 to $67,247,000 in 1995. The 1996 and 1995 increases resulted from
deploying additional liquidity in the investment securities portfolio. Sources
of the additional liquidity were borrowed funds and the excess of the increase
in average deposits over the increase in average loans which was invested.
Management uses borrowed funds to increase earning assets and enhance the
Company's interest rate risk profile.
FUNDING
Deposits represent the Bank's principal source of funds for investment.
Deposits are primarily core deposits in that they are demand, savings, and time
deposits under $100,000 generated from local businesses and individuals. These
sources represent relatively stable, long term deposit relationships which
minimize fluctuations in overall deposit balances. The Bank has never used
brokered deposits. Table 9 presents the composition of deposits for the five
years ended December 31, 1996.
TABLE 9 COMPOSITION OF DEPOSITS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Demand, non-interest...................... $ 56,699 $ 49,575 $ 43,112 $ 31,278 $ 30,156
Demand, interest.......................... 69,305 74,944 77,380 70,060 65,447
Savings................................... 32,296 17,385 17,254 16,637 12,198
Time...................................... 27,167 22,142 14,384 17,598 24,984
--------- --------- --------- --------- ---------
Total..................................... $ 185,467 $ 164,046 $ 152,130 $ 135,573 $ 132,785
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
Deposits increased $21,421,000 from year-end or 13% to $185,467,000 as of
December 31, 1996 and increased $11,916,000 or 8% to $164,046,000 as of December
31, 1995 over 1994. Average total deposits in 1996 of $171,092,000 showed an
increase of $19,132,000 or 13% over the same period in 1995 and in 1995 of
$151,960,000 showed an increase of $8,765,000 or 6% over 1994. During 1996,
average interest-bearing deposits increased $12,460,000 and non-interest bearing
deposits increased $6,672,000 over 1995. The 1995 growth in average deposits
resulted from an increase in non-interest bearing demand deposits of $6,024,000
and an increase of $2,741,000 in interest-bearing deposits from 1994. The
$19,911,000 increase in savings deposits from December 31, 1995 to December 31,
1996 relates primarily to a new customer who retains the right to withdraw the
funds. Management has identified other sources of funds and liquid assets to
cover the potential withdrawal of these funds and believes the withdrawal of the
customer's balances would not have a material adverse impact on the Bank.
Another source of funding for the Company is borrowed funds. Typically,
these funds result from the use of agreements to sell investment securities with
a repurchase at a designated future date, also known as repurchase agreements.
Repurchase agreements are conducted with major banks and investment brokerage
firms. The maturity of these arrangements for the Bank is typically 30 to 90
days. The average balance of borrowed funds was $23,528,000 and $11,537,000
during 1996 and 1995, respectively. The increase in average borrowed funds
reflects management's intent to increase earning assets and minimize the
Company's interest rate risk. The weighted average interest rate for 1996 was
5.9% and for 1995 was 6.8%. The maximum amount of borrowings at any month-end
during 1996 was $24,707,000. The weighted average interest rate on borrowed
funds at December 31, 1996 and 1995 was 5.4% and 6.3%, respectively.
LIQUIDITY AND INTEREST RATE SENSITIVITY
Liquidity management refers to the Bank's ability to provide funds on an
ongoing basis to meet fluctuations in deposit levels as well as the credit needs
and requirements of its clients. Both assets and
26
<PAGE>
liabilities contribute to the Bank's liquidity position. Federal funds lines,
short-term investments and securities, and loan repayments contribute to
liquidity, along with deposit increases, while loan funding and deposit
withdrawals decrease liquidity. The Bank assesses the likelihood of projected
funding requirements by reviewing historical funding patterns, current and
forecasted economic conditions and individual client funding needs. The Bank
maintains informal lines of credit with its correspondent banks for short-term
liquidity needs. These informal lines of credit are not committed facilities by
the correspondent banks and no fees are paid by the Bank to maintain them.
The Bank manages its liquidity by maintaining a majority of its investment
portfolio in liquid investments in addition to its federal funds sold. Liquidity
is measured by various ratios, including the liquidity ratio of net liquid
assets compared to total assets. As of December 31, 1996, this ratio was 14.2%.
Other key liquidity ratios are the ratios of loans to deposits and federal funds
sold to deposits, which were 66.7% and 8.4%, respectively, as of December 31,
1996.
INTEREST RATE SENSITIVITY
Interest rate sensitivity is a measure of the exposure of the Company's
future earnings due to changes in interest rates. If assets and liabilities do
not reprice simultaneously and in equal volumes, the potential for such exposure
exists. It is management's objective to achieve a modestly asset-sensitive
position, such that the net interest margin of the Company increases as market
interest rates rise and decreases when rates decline.
One quantitative measure of the "mismatch" between asset and liability
repricing is the interest rate sensitivity "gap" analysis. All interest-earning
assets and funding sources are classified as to their expected repricing or
maturity date, whichever is sooner. Within each time period, the difference
between asset and liability balances, or "gap," is calculated. Positive
cumulative gaps in early time periods suggest that earnings will increase if
interest rates rise. Negative gaps suggest that earnings will decline when
interest rates rise. Table 10 presents the gap analyses for the Company at
December 31, 1996. Mortgage backed securities are reported in the period of
their expected repricing based upon estimated prepayments developed from recent
experience.
27
<PAGE>
TABLE 10 INTEREST RATE SENSITIVITY
<TABLE>
<CAPTION>
NEXT DAY OVER ONE
AND OVER THREE AND
WITHIN MONTHS AND WITHIN
THREE WITHIN ONE FIVE OVER FIVE
IMMEDIATELY MONTHS YEAR YEARS YEARS TOTAL
----------- --------- ----------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1996
Rate Sensitive Assets:
Federal Funds Sold.................. $ 15,500 $ -- $ -- $ -- $ -- $ 15,500
Investment Securities:
Treasury and Agency Obligations..... -- -- 4,547 1,413 -- 5,960
Mortgage-Backed Securities.......... -- 2,247 6,440 21,474 27,867 58,028
Municipal Securities................ -- 56 272 2,475 3,111 5,914
Other............................... -- -- -- -- 1,275 1,275
----------- --------- ----------- --------- --------- ---------
Total Investment Securities........... -- 2,303 11,259 25,362 32,253 71,177
Loans Excluding Nonaccrual Loans...... 110,283 708 2,617 4,264 5,690 123,562
----------- --------- ----------- --------- --------- ---------
Total Rate Sensitive Assets........... $ 125,783 $ 3,011 $ 13,876 $ 29,626 $ 37,943 $ 210,239
----------- --------- ----------- --------- --------- ---------
----------- --------- ----------- --------- --------- ---------
Rate Sensitive Liabilities:
Deposits:
Money Market, NOW, and Savings.... $ 101,601 $ -- $ -- $ -- $ -- $ 101,601
Time Certificates................. -- 14,593 11,272 1,302 -- 27,167
----------- --------- ----------- --------- --------- ---------
Total Interest-bearing Deposits....... 101,601 14,593 11,272 1,302 -- 128,768
Borrowings............................ -- 24,608 -- -- -- 24,608
----------- --------- ----------- --------- --------- ---------
Total Rate Sensitive Liabilities.... $ 101,601 $ 39,201 $ 11,272 $ 1,302 $ -- $ 153,376
----------- --------- ----------- --------- --------- ---------
----------- --------- ----------- --------- --------- ---------
Gap................................... $ 24,182 $ (36,190) $ 2,604 $ 28,324 $ 37,943 $ 56,863
Cumulative Gap........................ $ 24,182 $ (12,008) $ (9,404) $ 18,920 $ 56,863
</TABLE>
The Company's positive cumulative total gap results from the exclusion from
the above table of noninterest-bearing demand deposits, which represent a
significant portion of the Company's funding sources. The Company maintains a
minor negative cumulative gap in the next day and within three months and the
over three months and within one year time periods and a positive cumulative gap
in all other time periods. The Company's experience indicates money market
deposit rates tend to lag changes in the prime rate which immediately impact the
prime-based loan portfolio. Even in the Company's negative gap time periods,
rising rates result in an increase in net interest income. Should interest rates
stabilize or decline in future periods, it is reasonable to assume that the
Company's net interest margin, as well as net interest income, may decline
correspondingly.
Table 11 presents the contractual maturity distribution of investment
securities and the weighted average yields for each range of maturities. Yields
are presented on an actual basis.
TABLE 11 INVESTMENT MATURITY DISTRIBUTION
DECEMBER 31, 1996
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED WEIGHTED
CARRYING 1 YEAR AVERAGE 1 YEAR TO AVERAGE 5 YEARS TO AVERAGE
VALUE OR LESS YIELD 5 YEARS YIELD 10 YEARS YIELD
----------- ----------- ------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury............... $ 5,960 $ 4,546 5.19% 1,414 6.00%
Mortgage Backed
Securities................ 58,028 342 5.14% 741 6.82% $ 2,065 6.75%
Obligations of States and
Political Subdivisions.... 5,914 160 6.40% 1,716 6.66% 2,232 4.93%
Federal Home Loan Bank...... 1,275
----------- ----------- ----------- -----------
$ 71,177 $ 5,048 $ 3,871 $ 4,297
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
<CAPTION>
WEIGHTED
MORE THAN AVERAGE
10 YEARS YIELD
----------- -------------
<S> <C> <C>
U.S. Treasury...............
Mortgage Backed
Securities................ $ 54,880 6.65%
Obligations of States and
Political Subdivisions.... 1,806 5.38%
Federal Home Loan Bank...... 1,275
-----------
$ 57,961
-----------
-----------
</TABLE>
28
<PAGE>
Table 12 presents the time remaining until maturity for certificates of
deposits in denominations of $100,000 or more as of December 31, 1996.
TABLE 12 CERTIFICATES OF DEPOSIT
DENOMINATIONS OF $100,000 OR MORE
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------
<S> <C>
Time remaining until maturity:
Less than 3 months......................................................... $ 7,680
3 months to 6 months....................................................... 2,286
6 months to 12 months...................................................... 2,581
More than 12 months........................................................ --
-------
Total.................................................................. $ 12,547
-------
-------
</TABLE>
Loan maturities for commercial, financial and agricultural and real estate
construction loans at December 31, 1996, are presented in Table 13.
TABLE 13 LOAN MATURITIES
<TABLE>
<CAPTION>
AFTER ONE
BUT WITHIN AFTER
WITHIN ONE FIVE FIVE
YEAR YEARS YEARS TOTAL
----------- ----------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Commercial, financial and
agricultural........................ $ 21,416 $ 9,074 $ 5,143 $ 35,633
Real estate construction.............. 15,112 -- -- 15,112
----------- ----------- --------- ---------
Total............................. $ 36,528 $ 9,074 $ 5,143 $ 50,745
----------- ----------- --------- ---------
----------- ----------- --------- ---------
</TABLE>
Commercial, financial and agricultural loans at December 31, 1996 maturing
after one year are comprised of fixed rate and variable rate loans as shown
below:
<TABLE>
<CAPTION>
AFTER ONE AFTER
BUT WITHIN FIVE
FIVE YEARS YEARS TOTAL
----------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Fixed rate....................................... $ 36 $ -- $ 36
Variable rate.................................... 9,038 5,143 14,181
----------- --------- ---------
$ 9,074 $ 5,143 $ 14,217
----------- --------- ---------
----------- --------- ---------
</TABLE>
CAPITAL RESOURCES
Management seeks to maintain adequate capital to support anticipated asset
growth and credit risks, and to ensure that the Company and the Bank are in
compliance with all regulatory capital guidelines. The primary source of new
capital for the Company has been the retention of earnings. Stockholders' equity
was $23,193,000 at December 31, 1996, an increase of $2,209,000, or 10.5% from
the $20,984,000 balance at December 31, 1995. This increase was due to 1996
earnings of $4,128,000, offset by cash dividends of $887,000, a decrease in the
net after-tax unrealized gain on securities available-for-sale of $342,000 from
the prior year-end, and the repurchase of common stock of $690,000. The Company
does not have any material commitments for capital expenditures as of December
31, 1996.
The Company pays a quarterly cash dividend on its common stock as part of
efforts to enhance stockholder value. The Company's goal is to maintain a strong
capital position that will permit payment of a consistent cash dividend which
may grow commensurately with earnings growth.
29
<PAGE>
During 1995, the Board of Directors approved a stock repurchase program
authorizing open market purchases of up to 3% of the shares outstanding, or
approximately 68,300 shares, in order to enhance long term stockholder value. As
of December 31, 1996, 68,340 shares had been purchased for a total purchase
price of $952,000. In January 1997, the Company's directors approved a plan to
repurchase up to 3% of shares outstanding, or 66,290 shares, from time to time
in open market transactions.
The Company and the Bank are subject to capital adequacy guidelines issued
by the federal bank regulatory authorities. Under these guidelines, the minimum
total risk-based capital requirement is 10.0% of risk-weighted assets and
certain off-balance sheet items for a "well capitalized" depository institution.
At least 6.0% of the 10.0% total risk-based capital ratio must consist of Tier 1
capital, defined as tangible common equity, and the remainder may consist of
subordinated debt, cumulative preferred stock and a limited amount of the
allowance for loan losses.
The federal regulatory authorities have established minimum capital leverage
ratio guidelines for state member banks. The ratio is determined using Tier 1
capital divided by quarterly average total assets. The guidelines require a
minimum of 5.0% for a "well capitalized" depository institution.
The Company's risk-based capital ratios were in excess of regulatory
guidelines for a "well capitalized" depository institution as of December 31,
1996, 1995 and 1994. Capital ratios for the Company are set forth in Table 14:
TABLE 14 CAPITAL RATIOS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Total risk-based capital ratio.................................... 16.4% 16.9% 15.4%
Tier 1 risk-based capital ratio................................... 15.2% 15.7% 14.2%
Tier 1 leverage ratio............................................. 9.8% 10.2% 10.9%
</TABLE>
Capital ratios for the Bank at December 31, 1996 and 1995 were 15.0% and
14.3% total risk-based capital ratio, 13.8% and 13.1% Tier 1 risk-based capital
ratio and 8.7% and 8.5% Tier 1 leverage ratio. Prior to July 25, 1995, the
Bank's ratios are the same as the Company's ratios.
EFFECTS OF INFLATION
The impact of inflation on a financial institution differs significantly
from that exerted on manufacturing, or other commercial concerns, primarily
because its assets and liabilities are largely monetary. In general, inflation
primarily affects the Company indirectly through its effect of increasing market
rates of interest. However, the Company's earnings are affected by the spread
between the yield on earning assets and rates paid on interest-bearing
liabilities rather than the absolute level of interest rates. Additionally,
there may be some upward pressure on the Company's operating expenses, such as
adjustments in salaries and benefits and occupancy expense, based upon consumer
price indices. In the opinion of management, inflation has not had a material
effect on the consolidated financial statements for the years ended December 31,
1996, 1995 and 1994. Changes in interest rates are highly sensitive to many
factors which are beyond the control of management. Changes in interest rates
will influence the growth of loans, investments and deposits, as well as the
rates charged on loans and paid on deposits. The nature, timing and impact of
future changes in interest rates or monetary and fiscal policies are not
predictable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Audited consolidated financial statements of the Company as of December 31,
1996 and 1995 and for each of the three years in the period ended December 31,
1996 appear on pages 30 thru 47.
30
<PAGE>
COAST BANCORP
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1996 1995
-------------- --------------
<S> <C> <C>
ASSETS
Cash and due from banks.......................................................... $ 22,492,000 $ 18,956,000
Federal funds sold............................................................... 15,500,000 7,000,000
-------------- --------------
Total cash and equivalents................................................... 37,992,000 25,956,000
Securities:
Available-for-sale, at fair value.............................................. 65,486,000 64,888,000
Held-to-maturity, at amortized cost (fair value--1996 $6,021,000, 1995
$6,256,000).................................................................. 5,914,000 6,099,000
Loans:
Commercial..................................................................... 35,633,000 34,263,000
Real estate--construction...................................................... 15,112,000 14,008,000
Real estate--term.............................................................. 65,208,000 50,580,000
Installment and other.......................................................... 7,768,000 7,989,000
-------------- --------------
Total loans.................................................................. 123,721,000 106,840,000
Unearned income................................................................ (1,742,000) (1,631,000)
Allowance for credit losses.................................................... (3,158,000) (2,478,000)
-------------- --------------
Net loans........................................................................ 118,821,000 102,731,000
Bank premises and equipment--net................................................. 2,131,000 2,408,000
Other real estate owned.......................................................... 551,000 830,000
Accrued interest receivable and other assets..................................... 6,020,000 4,756,000
-------------- --------------
TOTAL ASSETS............................................................... $ 236,915,000 $ 207,668,000
-------------- --------------
-------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing demand..................................................... $ 56,699,000 $ 49,575,000
Interest-bearing demand........................................................ 69,305,000 74,944,000
Savings........................................................................ 32,296,000 17,385,000
Time........................................................................... 27,167,000 22,142,000
-------------- --------------
Total deposits............................................................... 185,467,000 164,046,000
Securities sold under agreements to repurchase................................... 24,608,000 20,000,000
Accrued expenses and other liabilities........................................... 3,647,000 2,638,000
-------------- --------------
Total liabilities.......................................................... 213,722,000 186,684,000
STOCKHOLDERS' EQUITY:
Preferred stock--no par value; 10,000,000 shares authorized; no shares issued.... -- --
Common stock--no par value; 20,000,000 shares authorized; shares outstanding:
2,209,659 in 1996 and 2,257,899 in 1995........................................ 11,041,000 11,282,000
Net unrealized gain on securities available-for-sale............................. 130,000 472,000
Retained earnings................................................................ 12,022,000 9,230,000
-------------- --------------
Total stockholders' equity..................................................... 23,193,000 20,984,000
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................. $ 236,915,000 $ 207,668,000
-------------- --------------
-------------- --------------
</TABLE>
See notes to consolidated financial statements
31
<PAGE>
COAST BANCORP
CONSOLIDATED INCOME STATEMENTS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Interest income:
Loans, including fees............................... $12,845,000 $11,804,000 $9,961,000
Federal funds sold.................................. 832,000 671,000 368,000
Securities:
Taxable........................................... 4,235,000 3,284,000 1,666,000
Nontaxable........................................ 336,000 360,000 383,000
---------- ---------- ----------
Total interest income................................. 18,248,000 16,119,000 12,378,000
Interest expense:
Deposits............................................ 3,435,000 2,970,000 2,442,000
Other borrowings.................................... 1,378,000 783,000 --
---------- ---------- ----------
Total interest expense................................ 4,813,000 3,753,000 2,442,000
---------- ---------- ----------
Net interest income................................... 13,435,000 12,366,000 9,936,000
Provision for credit losses........................... 900,000 900,000 600,000
---------- ---------- ----------
Net interest income after provision for credit
losses.............................................. 12,535,000 11,466,000 9,336,000
Noninterest income:
Customer service fees............................... 1,808,000 1,527,000 1,501,000
Gain on sale of loans............................... 1,420,000 678,000 1,174,000
Loan servicing fees................................. 958,000 875,000 793,000
Gains (losses) on securities transactions........... 114,000 (48,000) 1,000
Gain on sale of other real estate owned............. 39,000 65,000 163,000
Gain on sale of bank premises and equipment......... 14,000 13,000 7,000
Other............................................... 545,000 448,000 405,000
---------- ---------- ----------
Total noninterest income.............................. 4,898,000 3,558,000 4,044,000
Noninterest expenses:
Salaries and benefits............................... 5,193,000 5,009,000 4,658,000
Equipment........................................... 1,142,000 1,043,000 1,072,000
Occupancy........................................... 934,000 904,000 903,000
Stationery and postage.............................. 382,000 278,000 290,000
Insurance........................................... 143,000 280,000 463,000
Legal fees.......................................... 93,000 200,000 148,000
Other............................................... 2,652,000 2,141,000 1,929,000
---------- ---------- ----------
Total noninterest expenses............................ 10,539,000 9,855,000 9,463,000
---------- ---------- ----------
Income before income taxes............................ 6,894,000 5,169,000 3,917,000
Provision for income taxes............................ 2,766,000 2,020,000 1,479,000
---------- ---------- ----------
Net income............................................ $4,128,000 $3,149,000 $2,438,000
---------- ---------- ----------
Net income per common and equivalent share............ $ 1.85 $ 1.38 $ 1.07
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See notes to consolidated financial statements
32
<PAGE>
COAST BANCORP
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
NET
INDEBTEDNESS UNREALIZED
OF EMPLOYEE GAIN (LOSS) ON
COMMON STOCK STOCK SECURITIES
----------------------- OWNERSHIP AVAILABLE- RETAINED
SHARES AMOUNT PLAN FOR-SALE EARNINGS TOTAL
---------- ----------- ------------ -------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1994............... 2,277,999 $11,383,000 $(410,000) $ -- $ 5,307,000 $16,280,000
Initial recognition of unrealized gains
on available-for-sale securities...... 46,000 46,000
Cash dividends paid..................... (683,000) (683,000)
Repayment of employee stock ownership
plan loan............................. 219,000 219,000
Net decrease in value of available-
for-sale securities, net of tax of
$387,000.............................. (590,000) (590,000)
Net income.............................. 2,438,000 2,438,000
---------- ----------- ------------ -------------- ----------- -----------
Balances, December 31, 1994............. 2,277,999 11,383,000 (191,000) (544,000) 7,062,000 17,710,000
Cash dividends paid..................... (820,000) (820,000)
Repayment of employee stock ownership
plan loan............................. 191,000 191,000
Net increase in value of available-
for-sale securities, net of tax of
$724,000.............................. 1,016,000 1,016,000
Repurchase of common stock.............. (20,100) (101,000) (161,000) (262,000)
Net income.............................. 3,149,000 3,149,000
---------- ----------- ------------ -------------- ----------- -----------
Balances, December 31, 1995............. 2,257,899 11,282,000 -- 472,000 9,230,000 20,984,000
Cash dividends paid..................... (887,000) (887,000)
Net decrease in value of available-
for-sale securities, net of tax of
$243,000.............................. (342,000) (342,000)
Repurchase of common stock.............. (48,240) (241,000) (449,000) (690,000)
Net income.............................. 4,128,000 4,128,000
---------- ----------- ------------ -------------- ----------- -----------
Balances, December 31, 1996............. 2,209,659 $11,041,000 $ -- $ 130,000 $12,022,000 $23,193,000
---------- ----------- ------------ -------------- ----------- -----------
---------- ----------- ------------ -------------- ----------- -----------
</TABLE>
See notes to consolidated financial statements
33
<PAGE>
COAST BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------
1996 1995 1994
------------- -------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATIONS:
Net income........................................................ $ 4,128,000 $ 3,149,000 $ 2,438,000
Adjustments to reconcile net income to net cash provided by (used
in) operations:
Provision for credit losses..................................... 900,000 900,000 600,000
Depreciation and amortization................................... (83,000) (101,000) 1,074,000
Gain on sale of property........................................ (53,000) (78,000) (7,000)
Losses (gains) on securities transactions....................... (114,000) 48,000 (1,000)
Deferred income taxes........................................... (785,000) (601,000) 36,000
Proceeds from loan sales........................................ 38,497,000 20,835,000 34,673,000
Origination of loans held for sale.............................. (41,925,000) (24,283,000) (31,975,000)
Accrued interest receivable and other assets.................... (236,000) 363,000 (671,000)
Accrued expenses and other liabilities.......................... 1,009,000 808,000 964,000
Increase in unearned income..................................... 1,131,000 875,000 630,000
Other--net...................................................... -- 178,000 --
------------- -------------- --------------
Net cash provided by operations................................... 2,469,000 2,093,000 7,761,000
------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of securities available-for-sale.............. 13,572,000 4,665,000 7,911,000
Proceeds from maturities of securities............................ 17,047,000 9,723,000 5,727,000
Purchases of securities available-for-sale........................ (31,733,000) (42,140,000) (20,237,000)
Net (increase) decrease in loans.................................. (14,259,000) (6,025,000) (10,708,000)
Purchases of bank premises and equipment.......................... (430,000) (418,000) (209,000)
Proceeds from disposals of bank premises and equipment............ 14,000 26,000 19,000
Proceeds from sales of other real estate owned.................... 904,000 475,000 1,331,000
------------- -------------- --------------
Net cash used in investing activities............................. (14,885,000) (33,694,000) (16,166,000)
------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from securities sold under agreements to
repurchase...................................................... 4,608,000 16,000,000 4,000,000
Net increase in deposits.......................................... 21,421,000 11,916,000 16,557,000
Payment of cash dividends......................................... (887,000) (820,000) (683,000)
Repurchase of common stock........................................ (690,000) (262,000) --
------------- -------------- --------------
Net cash provided by financing activities......................... 24,452,000 26,834,000 19,874,000
------------- -------------- --------------
Net increase (decrease) in cash and equivalents................... 12,036,000 (4,767,000) 11,469,000
Cash and equivalents, beginning of year........................... 25,956,000 30,723,000 19,254,000
------------- -------------- --------------
Cash and equivalents, end of year................................. $ 37,992,000 $ 25,956,000 $ 30,723,000
------------- -------------- --------------
------------- -------------- --------------
SUPPLEMENTAL CASH FLOW INFORMATION--CASH PAID DURING THE YEAR FOR:
Interest.......................................................... $ 5,683,000 $ 3,351,000 $ 2,432,000
Income taxes...................................................... 3,867,000 2,393,000 892,000
NON-CASH INVESTING AND FINANCING TRANSACTIONS:
Additions to other real estate owned.............................. $ 586,000 -- $ 2,247,000
</TABLE>
See notes to consolidated financial statements
34
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION--In May 1995, the stockholders of Coast Commercial Bank
approved a plan which provided for the formation of Coast Bancorp (a bank
holding company) and the conversion of each share of outstanding Coast
Commercial Bank common stock into one share of Coast Bancorp common stock.
Effective July 25, 1995 Coast Bancorp issued 2,277,999 shares of its common
stock for all the outstanding shares of Coast Commercial Bank through a merger
which has been accounted for similar to a pooling of interests in that the
historical cost basis of Coast Commercial Bank has been carried forward. As a
result of the merger, Coast Commercial Bank became a wholly-owned subsidiary of
Coast Bancorp.
NATURE OF OPERATIONS--Coast Bancorp (the Company) and its subsidiary, Coast
Commercial Bank (the Bank), operate 5 branches in Santa Cruz County, California.
The Company's primary source of revenue is loans to customers, who are
predominately small and middle-market businesses and middle-income individuals.
BASIS OF PRESENTATION--The accounting and reporting policies of the Company
and the Bank conform to generally accepted accounting principles and to
prevailing practices within the banking industry. The methods of applying those
principles which materially affect the consolidated financial statements are
summarized below. In preparing the financial statements, management is required
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities, as of the dates
of the balance sheets, and revenues and expenses for the periods indicated.
Actual results could differ from those estimates.
CONSOLIDATION--The consolidated financial statements include the accounts of
the Company and the Bank. All material intercompany accounts and transactions
have been eliminated.
CASH AND CASH EQUIVALENTS--For purposes of reporting cash flows, cash and
cash equivalents include cash on hand, amounts due from banks and federal funds
sold. Generally, federal funds sold are sold for one-day periods.
SECURITIES--Investments in debt securities are classified as
held-to-maturity and measured at amortized cost only if the Company has the
positive intent and ability to hold such securities to maturity. All other
investments in debt and equity securities are classified as available-for-sale,
which are carried at market value with a corresponding recognition of the
unrealized holding gain or loss as a net amount in a separate component of
stockholders' equity until realized.
Amortization of premiums and accretion of discounts arising at acquisition
of securities are included in income using methods that approximate the interest
method. Market values are based on quoted market prices or dealer quotes. Gains
or losses on the sale of securities are computed using the specific
identification method.
LOANS--Loans are stated at the principal amount outstanding. Loans held for
sale are carried at the lower of cost or market. Interest on loans is credited
to income as earned.
The accrual of interest is discontinued and any accrued and unpaid interest
is reversed when the payment of principal or interest is 90 days past due unless
the amount is well secured and in the process of collection. Income on
nonaccrual loans is then recognized only to the extent that cash is received and
where the future collection of principal is probable.
35
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Loan origination fees and costs are deferred and amortized to income by a
method approximating the effective interest method over the estimated lives of
the underlying loans. Fees received by the Company relating to mortgage loans
held for sale are recognized when the loans are sold.
The Company originates loans that are guaranteed in part by the Small
Business Administration (SBA). The guaranteed portion of such loans can be sold
without recourse. The Company retains the servicing for the portion sold and has
credit risk for the remaining unguaranteed portion. Gains or losses realized on
loans sold are determined by allocating the recorded investment between the
portion of the loan sold and the portion retained based on an estimate of the
relative fair values of those portions as of the date the loan is sold. Sales of
SBA loans totaled $15,472,000, $6,915,000, and $15,807,000 during 1996, 1995 and
1994, respectively. SBA loans serviced for other investors were $79,585,000 and
$71,216,000 at December 31, 1996 and 1995, respectively.
The Company also originates and sells residential mortgage loans to the
Federal Home Loan Mortgage Corporation (FHLMC) and other participants in the
mortgage markets. Sales of residential mortgage loans totaled $23,025,000,
$13,920,000, and $18,866,000 during 1996, 1995, and 1994, respectively.
Residential mortgage loans serviced for other investors were $43,038,000 and
$46,637,000 at December 31, 1996 and 1995, respectively.
ALLOWANCE FOR CREDIT LOSSES--The allowance for credit losses is established
through a provision charged to expense. Loans are charged against the allowance
when management believes that the collectibility of the principal is unlikely.
The allowance is an amount that management believes will be adequate to absorb
losses inherent in existing loans and commitments to extend credit, based on
evaluations of collectibility and prior loan loss experience. The evaluations
take into consideration such factors as changes in the composition of the
portfolio, overall portfolio quality, loan concentrations, specific problem
loans, and current and anticipated local economic conditions that may affect the
borrowers' ability to pay.
In evaluating the probability of collection, management is required to make
estimates and assumptions that affect the reported amounts of loans, allowance
for credit losses and the provision for credit losses charged to operations.
Actual results could differ significantly from those estimates.
BANK PREMISES AND EQUIPMENT--Bank premises and equipment are stated at cost
less accumulated depreciation and amortization. Depreciation and amortization
are computed on a straight-line basis over the estimated useful lives of three
to twenty years.
OTHER REAL ESTATE OWNED--Other real estate owned consists of property
acquired as a result of a foreclosure proceeding or through receipt of a
deed-in-lieu of foreclosure. Other real estate owned is carried at the lower of
cost or fair value minus estimated costs to sell. Any excess of the loan balance
over the fair value when the property is acquired is charged to the allowance
for credit losses. Subsequent declines in fair value, if any, and disposition
gains and losses are included in noninterest income and noninterest expense.
ACCRUED INTEREST RECEIVABLE AND OTHER ASSETS--Accrued interest receivable
and other assets includes the cash surrender value of single premium insurance
policies of $2,350,000 and $1,979,000 at December 31, 1996 and 1995,
respectively.
LONG-LIVED ASSETS--The Company adopted Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets to
be Disposed Of" effective January 1,
36
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
1995. The adoption of this statement had no effect on the Company's financial
position or results of operations.
ACCOUNTING FOR FINANCIAL ASSETS AND LIABILITIES--In June, 1996, the FASB
issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities." This statement is effective for transfers
and servicing of financial assets and extinguishments of liabilities occurring
after December 31, 1996. In December 1996, the FASB issued SFAS No. 127,
"Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125"
to defer for one year the effective date of implementation for transations
related to repurchase agreements, dollar-roll repurchase agreements, securities
lending and other similar transactions. The Company believes the effect of
adoption of these standards will be not material.
INCOME TAXES--Deferred income taxes are provided for temporary differences
between financial statement and income tax reporting.
STOCK-BASED COMPENSATION--The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
NET INCOME PER COMMON AND EQUIVALENT SHARE--Net income per common and
equivalent share is computed using the weighted average shares outstanding plus
the dilutive effect of stock options, using the treasury stock method. The
number of shares used to compute net income per share for the years ended
December 31, 1996, 1995 and 1994 was 2,236,134, 2,280,285, and 2,277,999,
respectively. The difference between primary and fully diluted net income per
share is not significant in any period.
RECLASSIFICATIONS--Certain amounts in the 1994 and 1995 consolidated
financial statements have been reclassified to conform to the 1996 presentation.
These reclassifications had no impact on stockholders' equity or net income.
2. RESTRICTED CASH BALANCES
The Company, through its bank subsidiary, is required to maintain reserves
with the Federal Reserve Bank of San Francisco. Reserve requirements are based
on a percentage of certain deposits. At December 31, 1996 the Company maintained
reserves of $3,581,000 in the form of vault cash and balances at the Federal
Reserve which satisfied the regulatory requirements.
37
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
3. SECURITIES
The amortized cost and estimated market values of securities at December 31,
are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAIN LOSS MARKET VALUE
------------- ------------ ----------- -------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1996
Available-for-sale:
U.S. Treasury and agency securities................... $ 5,960,000 $ 12,000 $ (9,000) $ 5,963,000
Mortgage-backed securities............................ 58,028,000 467,000 (247,000) 58,248,000
Other................................................. 1,275,000 -- -- 1,275,000
------------- ------------ ----------- -------------
Total................................................... $ 65,263,000 $ 479,000 $ (256,000) $ 65,486,000
------------- ------------ ----------- -------------
------------- ------------ ----------- -------------
Held-to-maturity--State and municipal
obligations........................................... $ 5,914,000 $ 128,000 $ (21,000) $ 6,021,000
------------- ------------ ----------- -------------
------------- ------------ ----------- -------------
DECEMBER 31, 1995
Available-for-sale:
U.S. Treasury and agency securities................... $ 11,029,000 $ 20,000 $ (27,000) $ 11,022,000
Mortgage-backed securities............................ 52,489,000 824,000 (165,000) 53,148,000
Other................................................. 562,000 156,000 -- 718,000
------------- ------------ ----------- -------------
Total................................................... $ 64,080,000 $ 1,000,000 $ (192,000) $ 64,888,000
------------- ------------ ----------- -------------
------------- ------------ ----------- -------------
Held-to-maturity--State and municipal
obligations........................................... $ 6,099,000 $ 180,000 $ (23,000) $ 6,256,000
------------- ------------ ----------- -------------
------------- ------------ ----------- -------------
</TABLE>
The amortized cost and estimated market value of debt securities at December
31, 1996, by contractual maturity, are as follows:
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE HELD-TO-MATURITY
---------------------------- ----------------------------
AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST MARKET VALUE COST MARKET VALUE
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1996
U.S. Treasury and agency and state and municipal
securities:
Due within one year................................. $ 4,547,000 $ 4,545,000 $ 160,000 $ 163,000
Due after 1 year through 5 years.................... 1,413,000 1,418,000 1,716,000 1,805,000
Due after 5 years through 10 years.................. -- -- 2,232,000 2,229,000
Due after 10 years.................................. -- -- 1,806,000 1,824,000
------------- ------------- ------------- -------------
5,960,000 5,963,000 5,914,000 6,021,000
Mortgage-backed securities.......................... 58,028,000 58,248,000 -- --
------------- ------------- ------------- -------------
Total............................................... $ 63,988,000 $ 64,211,000 $ 5,914,000 $ 6,021,000
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
Gross realized gains and gross realized losses from sales of securities
available-for-sale were $283,000 and $169,000 in 1996, respectively, $10,000 and
$58,000 in 1995, respectively, and $202,000 and $201,000 in 1994, respectively.
38
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
At December 31, 1996, investment securities with a carrying value of
$35,644,000 were pledged to collateralize public deposits and for other purposes
as required by law or contract.
Effective December 1, 1995, mortgage-backed securities totaling $4,667,000
in amortized cost and $4,665,000 in market value were reclassified from
held-to-maturity to available-for-sale, in connection with the adoption of the
Financial Accounting Standards Board Special Report, "A Guide to Implementation
of Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities."
4. ALLOWANCE FOR CREDIT LOSSES
Changes in the allowance for credit losses are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
Balance, beginning of period........................ $ 2,478,000 $ 1,859,000 $ 1,723,000
Provision charged to expense........................ 900,000 900,000 600,000
Loans charged off................................... (352,000) (401,000) (508,000)
Recoveries.......................................... 132,000 120,000 44,000
------------ ------------ ------------
Balance, end of period.............................. $ 3,158,000 $ 2,478,000 $ 1,859,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
Nonaccrual loans were $159,000, $824,000 and $848,000 at December 31, 1996,
1995, and 1994, respectively.
The Bank measures impaired loans based upon the present value of expected
future cash flows discounted at the loan's effective interest rate, except that
as a practical expedient, an impairment may be measured based on a loan's
observable market price or the fair value of the collateral if the loan is
collateral dependent. A loan is impaired when, based upon current information
and events, it is probable that the Bank will be unable to collect all amounts
due according to the contractual terms of the loan agreement. There were no
impaired loans at December 31, 1996. The recorded investment in impaired loans
at December 31, 1995 was comprised of one loan of $343,000, which had a related
allowance of $69,000. Such allowance is a portion of the allowance for credit
losses. The average recorded investment in impaired loans was $273,000 and
$369,000 for 1996 and 1995, respectively. No interest income was recognized
during the period of impairment.
At December 31, 1996, SBA loans held for sale were $5,389,000 (1995,
$2,206,000). Mortgage loans held by the Company pending completion of their sale
to the FHLMC or other investors were $2,405,000 and $2,204,000 at December 31,
1996 and 1995, respectively. The Company does not anticipate any loss on the
sale of these loans. Loans held for or pending completion of sale are included
in loans in the consolidated balance sheets and are carried at cost, which is
lower than market value.
5. BANK PREMISES AND EQUIPMENT
Bank premises and equipment at December 31 are comprised of the following:
<TABLE>
<CAPTION>
1996 1995
------------- -------------
<S> <C> <C>
Buildings and leasehold improvements............................ $ 2,328,000 $ 2,332,000
Furniture and equipment......................................... 4,717,000 4,244,000
------------- -------------
Total........................................................... 7,045,000 6,576,000
Accumulated depreciation and amortization....................... (4,914,000) (4,168,000)
------------- -------------
Bank premises and equipment--net................................ $ 2,131,000 $ 2,408,000
------------- -------------
------------- -------------
</TABLE>
39
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
5. BANK PREMISES AND EQUIPMENT (CONTINUED)
Certain of the Company's premises are leased under various noncancelable
operating leases expiring in 2001 which have, in certain instances, renewal
options. Future minimum lease payments are as follows:
<TABLE>
<S> <C>
1997............................................................ $ 654,000
1998............................................................ 574,000
1999............................................................ 429,000
2000............................................................ 330,000
2001............................................................ 232,000
---------
Total........................................................... $2,219,000
---------
---------
</TABLE>
Rent expense under operating leases was $637,000, $602,000, and $581,000 in
1996, 1995 and 1994, respectively.
6. INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
Current:
Federal........................................... $ 2,609,000 $ 1,895,000 $ 969,000
State............................................. 942,000 726,000 474,000
------------ ------------ ------------
Total current................................... 3,551,000 2,621,000 1,443,000
------------ ------------ ------------
Deferred:
Federal........................................... (601,000) (471,000) 30,000
State............................................. (184,000) (130,000) 6,000
------------ ------------ ------------
Total deferred.................................. (785,000) (601,000) 36,000
------------ ------------ ------------
Total........................................... $ 2,766,000 $ 2,020,000 $ 1,479,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The effective tax rate differs from the federal statutory rate as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Statutory federal income tax rate.................................... 35.0% 35.0% 35.0%
State income taxes, net of federal tax effect........................ 7.2 7.6 7.3
Tax exempt income.................................................... (1.5) (2.2) (3.0)
Other--net........................................................... (0.6) (1.3) (1.5)
--- --- ---
Total............................................................ 40.1% 39.1% 37.8%
--- --- ---
--- --- ---
</TABLE>
40
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
6. INCOME TAXES (CONTINUED)
The Company's net deferred tax assets are comprised of the following:
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
Deferred tax assets:
Provision for credit losses....................................... $ 1,056,000 $ 870,000
Accelerated depreciation.......................................... 450,000 291,000
State income tax.................................................. 314,000 143,000
Deferred compensation............................................. 102,000 --
Provision for other real estate owned............................. 107,000 --
Other............................................................. 197,000 168,000
------------ ------------
Total deferred tax assets..................................... 2,226,000 1,472,000
Unrealized gains on available-for sale-securities................. (93,000) (336,000)
Deferred tax liabilities--other................................... (37,000) (67,000)
------------ ------------
Total......................................................... $ 2,096,000 $ 1,069,000
------------ ------------
------------ ------------
</TABLE>
7. DEPOSITS
The aggregate amount of time deposits each with a minimum denomination of
$100,000 or more was $12,547,000 and $9,180,000 at December 31, 1996 and 1995,
respectively.
At December 31, 1996, the scheduled maturities of time deposits are as
follows:
<TABLE>
<S> <C>
1997........................................................... $25,619,000
1998 and thereafter............................................ 1,548,000
----------
$27,167,000
----------
----------
</TABLE>
8. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Information concerning securities sold under agreements to repurchase is
summarized as follows:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Average balance during the year.................... $23,528,000 $11,537,000
Average interest rate during the year.............. 5.9% 6.8%
Maximum month-end balance during the year.......... $24,707,000 $20,000,000
Average rate at December 31........................ 5.4% 6.3%
</TABLE>
Mortgage-backed securities were delivered to the broker-dealers who arranged
the transactions to secure the agreements (See Note 3). The agreements at
December 31, 1996 mature within three months.
9. COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, there are outstanding various commitments
and contingent liabilities which are not reflected in the consolidated financial
statements. The Company does not anticipate losses as a result of these
commitments. Undisbursed loan commitments totaled $42,450,000 and standby
letters of credit were $5,123,000 at December 31, 1996. The Company's exposure
to credit loss is limited to amounts funded or drawn.
41
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
9. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Loan commitments are typically contingent upon the borrower meeting certain
financial and other covenants and such commitments typically have fixed
expiration dates and require payment of a fee. As many of these commitments are
expected to expire without being drawn upon, the total commitments do not
necessarily represent future cash requirements. The Company evaluates each
potential borrower and the necessary collateral on an individual basis.
Collateral varies, but may include real property, bank deposits or business or
personal assets.
Standby letters of credit are conditional commitments written by the Company
to guarantee the performance of a customer to a third party. These guarantees
are issued primarily relating to inventory purchases by the Company's commercial
customers and such guarantees are typically short-term. Credit risk is similar
to that involved in extending loan commitments to customers and the Company,
accordingly, uses evaluation and collateral requirements similar to those for
loan commitments. Virtually all of such commitments are collateralized.
10. LOAN CONCENTRATIONS
The Bank's customers are primarily located in Santa Cruz, Monterey and San
Benito counties, an area on the California coast south of San Francisco.
Commercial loans represent 29% of total loans at December 31, 1996, with no
particular industry representing a significant portion. Approximately 12% of the
Company's loans at December 31, 1996 are for real estate construction including
single family residential and commercial properties. Other real estate secured
loans, primarily for commercial properties, represent another 53% of loans at
December 31, 1996. Installment and other loans, primarily automobile and mobile
home loans, represent the remainder of loans. Many of the Company's customers
are employed by or are otherwise dependent on the high technology, tourism,
agriculture and real estate development industries and, accordingly, the ability
of any of the Company's borrowers to repay loans may be affected by the
performance of these sectors of the economy. Virtually all loans are
collateralized. Generally, real estate loans are secured by real property and
commercial and other loans are secured by bank deposits or business or personal
assets. Repayment is generally expected from refinancing or sale of the related
property for real estate construction loans and from cash flows of the borrower
for other loans.
11. RELATED PARTY LOANS
The Bank may make loans to directors and their associates subject to
approval by the Board of Directors. These transactions are at terms and rates
comparable to those granted to other customers of the Company. An analysis of
changes in related party loans for the year ended December 31, 1996 is as
follows:
<TABLE>
<CAPTION>
BEGINNING
BALANCE ADDITIONS REPAYMENTS ENDING BALANCE
- ---------- ----------- ----------- --------------
<S> <C> <C> <C>
$ 170,000 $ 5,000 $ 31,000 $ 144,000
</TABLE>
12. REGULATORY MATTERS
The Company and Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory-- and possibly additional
discretionary--actions by regulators that, if undertaken, could have a direct
material effect on the Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and Bank must meet specific capital
42
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
12. REGULATORY MATTERS (CONTINUED)
guidelines that involve quantitative measures of assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company's and Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined). Management believes, as of December 31,
1996, that the Company and Bank meet all capital adequacy requirements to which
they are subject.
As of December 31, 1996 and 1995, the most recent notification from the
Federal Deposit Insurance Corporation categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To be categorized
as adequately capitalized the Bank must maintain minimum total risk-based, Tier
I risk-based, and Tier I leverage ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
The Company's and Bank's actual capital amounts and ratios are as follows:
<TABLE>
<CAPTION>
TO BE CATEGORIZED
AS WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES: ACTION PROVISIONS:
------------------ ------------------ ------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
----------- ----- ----------- ----- ----------- -----
<S> <C> <C> <C> <C> <C> <C>
THE COMPANY:
As of December 31, 1996:
Total Capital (to Risk Weighted
Assets)................................ $24,944,000 16.4% $12,144,000 a8.0% N/A N/A
Tier I Capital (to Risk Weighted
Assets)................................ $23,031,000 15.2% $ 6,072,000 a4.0% N/A N/A
Tier I Capital (to Average Assets)...... $23,031,000 9.8% $ 9,415,000 a4.0% N/A N/A
As of December 31, 1995:
Total Capital (to Risk Weighted
Assets)................................ $22,167,000 16.9% $10,474,000 a8.0% N/A N/A
Tier I Capital (to Risk Weighted
Assets)................................ $20,530,000 15.7% $ 5,237,000 a4.0% N/A N/A
Tier I Capital (to Average Assets)...... $20,530,000 10.2% $ 8,013,000 a4.0% N/A N/A
THE BANK:
As of December 31, 1996:
Total Capital (to Risk Weighted
Assets)................................ $22,232,000 15.0% $11,826,000 a8.0% $14,783,000 a10.0%
Tier I Capital (to Risk Weighted
Assets)................................ $20,368,000 13.8% $ 5,913,000 a4.0% $ 8,870,000 a6.0%
Tier I Capital (to Average Assets)...... $20,368,000 8.7% $ 9,415,000 a4.0% $11,768,000 a5.0%
As of December 31, 1995:
Total Capital (to Risk Weighted
Assets)................................ $18,643,000 14.3% $10,407,000 a8.0% $13,001,000 a10.0%
Tier I Capital (to Risk Weighted
Assets)................................ $17,006,000 13.1% $ 5,203,000 a4.0% $ 7,805,000 a6.0%
Tier I Capital (to Average Assets)...... $17,006,000 8.5% $ 8,012,000 a4.0% $10,015,000 a5.0%
</TABLE>
13. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) tax-deferred savings plan under which eligible
employees may elect to have a portion of their salary deferred and contributed
to the plan. The Company is not obligated to, but may contribute to the plan.
During 1996, the Company matched each employee's contribution up to $500,
aggregating $42,000 ($42,000 in 1995 and 1994). Participants may elect several
investment options, including investment in the Company's common stock.
43
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
13. EMPLOYEE BENEFIT PLANS (CONTINUED)
Substantially all employees with at least 1,000 hours of service are covered
by a discretionary employee stock ownership plan (ESOP). The ESOP borrowed
$698,000 during 1991 and 1992 to purchase 82,985 shares of the Company's common
stock at fair market value from certain directors. During 1995 the loan was
fully repaid. The loan had been recorded as a liability of the Company with a
corresponding reduction to stockholders' equity. The ESOP serviced the loan with
contributions from the Company and with proceeds from sale of stock to 401(k)
plan participants. The Company's contribution to the ESOP was $120,000 in 1996,
1995 and 1994.
The Bank has an unfunded salary continuation plan for two officers which
provides for retirement benefits upon reaching age 65. The Bank accrues such
post-retirement benefits over the vesting period of ten years. In the event of a
change in control of the Company, the officers' benefits will fully vest. The
Bank accrued $120,000, $146,000, and $40,000, in 1996, 1995, and 1994,
respectively. The liability under the salary continuation plan was $342,000 and
$222,000 at December 31, 1996 and 1995, respectively. The discount rate used to
measure the liability was 6.95% and 8.0% at December 31, 1996 and 1995,
respectively.
The Bank has a deferred compensation plan whereby certain directors defer
their fees until age 65 or 70. Amounts deferred accrue interest at a rate
determined annually by the Board of Directors (6.6% and 8.8% for 1996 and 1995,
respectively). Accumulated benefits are paid over 8 to 13 years. Total deferred
director fees at December 31, 1996 and 1995 were $341,000 and $247,000,
respectively.
Under the 1995 stock option plan (the Plan) the Company may grant options to
purchase up to 400,000 shares of common stock to employees, directors and
consultants at prices not less than the fair market value at date of grant.
Employee options generally expire 5 to 10 years from the date of grant and
become exercisable over a 5-year period. Under the Plan non-employee directors
of the Company are automatically granted options to purchase 2,000 shares of
common stock at the fair market value at the date of grant each year that such
person remains a director of the Company. Options granted under the plan are
exercisable after 6 months and expire 5 years from the date of grant. The
maximum number of shares which may be issued to an individual director under the
Directors' Plan is 10,000.
Option activity under the plan is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
----------- -----------
<S> <C> <C>
Outstanding, January 1, 1995........................................... -- $ --
Granted (weighted average fair value of $8.56)......................... 14,000 10.25
-----------
Outstanding, December 31, 1995 (14,000 exercisable at a weighted
average price of $10.25)............................................. 14,000 10.25
Granted (weighted average fair value of $5.29)......................... 64,000 14.25
-----------
Outstanding, December 31, 1996 (28,000 exercisable at a weighted
average price of $12.25)............................................. 78,000 $ 13.53
-----------
-----------
</TABLE>
44
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
13. EMPLOYEE BENEFIT PLANS (CONTINUED)
Additional information regarding options outstanding as of December 31, 1996
is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------- OPTIONS EXERCISABLE
RANGE OF WEIGHTED AVERAGE ------------------------------
EXERCISE NUMBER REMAINING CONTRACTUAL WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
PRICES OUTSTANDING LIFE (YRS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- -------------- ----------- ----------------------- ----------------- ----------- -----------------
<S> <C> <C> <C> <C> <C>
$10.25 14,000 3.1 $ 10.25 14,000 $ 10.25
14.25 64,000 7.3 14.25 14,000 14.25
----------- -----------
78,000 6.5 $ 13.53 28,000 $ 12.25
----------- -----------
----------- -----------
</TABLE>
At December 31, 1996, 322,000 shares were available for future grants under
the option plan.
As discussed in Note 1, the Company continues to account for its stock-based
awards using the intrinsic value method in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" and its related
interpretations. Accordingly, no compensation expense has been recognized in the
financial statements for employee stock arrangements.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
disclosure of pro forma net income and earnings per share had the Company
adopted the fair value method as of the beginning of fiscal 1995. Under SFAS
123, the fair value of stock-based awards to employees is calculated through the
use of option pricing models, even though such models were developed to estimate
the fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the calculated
values. The Company's calculations were made using the Black-Scholes option
pricing model with the following weighted average assumptions: expected life,
102 months in 1996 and 60 months in 1995 following vesting; stock volatility,
50% in 1996 and 1995; risk free interest rates, 6.25% in 1996 and 7.34% in 1995;
and 24% dividends during the expected term. The Company's calculations are based
on a single option valuation approach and forfeitures are recognized as they
occur. If the computed fair values of the 1995 and 1996 awards had been
amortized to expense over the vesting period of the awards, pro forma net income
would have been $4,026,000 ($1.80 per share) in 1996 and $3,105,000 ($1.36 per
share) in 1995.
14. DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by using available
market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented are not
necessarily indicative of the amounts that could be realized in a current market
exchange. The use of different market assumptions and/or estimation techniques
may have a material effect on the estimated fair value amounts.
The following table presents the carrying amount and estimated fair value of
certain assets and liabilities held by the Company at December 31, 1996 and
1995. The carrying amounts reported in the consolidated balance sheets
approximate fair value for the following financial instruments: cash and due
45
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
14. DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
from banks, federal funds sold, and demand and savings deposits. See Note 3 for
a summary of the estimated fair value of securities.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------
1996 1995
-------------------------- --------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Loans, net.................................................. $118,821,000 $118,323,000 $102,731,000 $102,413,000
Time deposits............................................... $ 27,167,000 $ 27,172,000 $ 22,142,000 $ 22,155,000
Securities sold under agreements to repurchase.............. $ 24,608,000 $ 24,608,000 $ 20,000,000 $ 20,110,000
</TABLE>
The following methods and assumptions were used by the Company in computing
the estimated fair values in the above table:
LOANS, NET--The fair value of variable rate loans is the carrying value as
these loans are regularly adjusted to market rates. The fair value of fixed rate
loans is estimated by discounting the future cash flows using current rates at
which similar loans would be made to borrowers with similar credit ratings for
the same remaining maturities. The fair value calculations are adjusted by the
allowance for loan losses.
TIME DEPOSITS--The fair value of fixed rate time deposits was estimated by
discounting the cash flows using rates currently offered for deposits of similar
remaining maturities.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE--The fair value of fixed rate
securities sold under agreements to repurchase was estimated by discounting the
cash flows using rates currently offered for these types of borrowings of
similar remaining maturities.
UNUSED COMMITMENTS TO EXTEND CREDIT--The fair value of letters of credit and
standby letters of credit is not significant.
15. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
As described in Note 1 to the consolidated financial statements, the merger
of Coast Commercial Bank with the Company became effective July, 25, 1995. The
condensed financial statements of Coast Bancorp (parent company only) as of and
for the years ended December 31, 1996 and 1995 follow:
<TABLE>
<CAPTION>
1996 1995
------------- -------------
<S> <C> <C>
CONDENSED BALANCE SHEET
Cash............................................................................... $ 2,830,000 $ 3,307,000
Investment in Coast Commercial Bank................................................ 20,380,000 17,665,000
Other assets....................................................................... 28,000 12,000
------------- -------------
Total.......................................................................... $ 23,238,000 $ 20,984,000
------------- -------------
------------- -------------
Liabilities........................................................................ $ 45,000 $ --
Stockholders' equity............................................................... 23,193,000 20,984,000
------------- -------------
Total.......................................................................... $ 23,238,000 $ 20,984,000
------------- -------------
------------- -------------
</TABLE>
46
<PAGE>
COAST BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
15. PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
1996 1995
------------- -------------
<S> <C> <C>
CONDENSED INCOME STATEMENT
Interest income.................................................................... $ 88,000 $ 39,000
General and administrative expenses................................................ (150,000) (53,000)
------------- -------------
Loss before equity in net income of Coast Commercial Bank.......................... (62,000) (14,000)
Equity in net income of Coast Commercial Bank:
Dividends received............................................................... 1,116,000 4,000,000
Equity in net income greater (less) than dividends received...................... 3,058,000 (842,000)
Income tax benefit................................................................. 16,000 5,000
------------- -------------
Net income......................................................................... $ 4,128,000 $ 3,149,000
------------- -------------
------------- -------------
STATEMENT OF CASH FLOWS
Net income......................................................................... $ 4,128,000 $ 3,149,000
Reconciliation of net income to net cash provided by operations:
Equity in net income greater (less) than dividends received...................... (3,058,000) 842,000
Other assets and liabilities..................................................... 30,000 (12,000)
------------- -------------
Net cash provided by operations.................................................... 1,100,000 3,979,000
Financing activities:
Cash dividends paid to shareholders................................................ (887,000) (410,000)
Repurchase of common stock......................................................... (690,000) (262,000)
------------- -------------
Net cash used in financing activities.............................................. (1,577,000) (672,000)
------------- -------------
Net increase (decrease) in cash.................................................... (477,000) 3,307,000
Cash, beginning of period.......................................................... 3,307,000 --
------------- -------------
Cash, end of period................................................................ $ 2,830,000 $ 3,307,000
------------- -------------
------------- -------------
</TABLE>
A principal source of cash for the Company is dividends from its subsidiary
Bank. Banking regulations limit the amount of dividends that may be paid without
prior approval of the Company's regulatory agencies to the lesser of retained
earnings or the net income of the Company for its last three fiscal years, less
any distributions during such period, subject to capital adequacy requirements.
At December 31, 1996, the Company has approximately $3,700,000 available for
payment of dividends which would not require the prior approval of the banking
regulators under this limitation.
47
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
of Coast Bancorp:
We have audited the accompanying consolidated balance sheets of Coast
Bancorp (formerly Coast Commercial Bank) and its subsidiary as of December 31,
1996 and 1995, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 1996. 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 generally accepted auditing
standards. 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 statements. 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, such consolidated financial statements present fairly, in
all material respects, the financial position of Coast Bancorp and its
subsidiary at December 31, 1996 and 1995, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1996 in confomity with generally accepted accounting principles.
Deloitte & Touche LLP
San Jose, California
January 24, 1997
48
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information concerning directors and executive officers of the Company,
see "Election of Directors" and "Compliance with Section 16(a) of the Exchange
Act" in the definitive proxy statement for the Company's 1997 Annual Meeting of
Shareholders to be filed pursuant to Regulation 14A (the "Proxy Statement"),
which is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
For information concerning executive compensation, see "Executive
Compensation" in the Proxy Statement, which is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
For information concerning security ownership of certain beneficial owners
and management, see "Security Ownership of Certain Beneficial Owners" and
"Election of Directors" in the Proxy Statement, which is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
For information concerning certain relationships and related transactions
see "Indebtedness of Management and Other Transactions" in the Proxy Statement,
which is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. and 2.
The financial statements and supplementary data contained in Item 8 of this
report are filed as part of this report.
All schedules are omitted because of the absence of the conditions under
which they are required or because the required information is included in the
financial statements or related notes.
(a) 3.
Exhibits are listed in the Index to Exhibits beginning on page of this
report.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Company during the quarter ended
December 31, 1996.
49
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
* Plan of Reorganization and Merger Agreement dated March 7, 1995 by and between Coast Commercial, Coast
Merger Corporation and Coast Bancorp.
* Articles of Incorporation of Coast Bancorp.
* Bylaws of Coast Bancorp.
* Salary Continuation Agreement dated September 19, 1992 by and between Coast Commercial Bank and Harvey J.
Nickelson.
* Salary Continuation Agreement dated September 19, 1992 by and between Coast Commercial Bank and David V.
Heald.
* Lease by and between Friend, Friend and Friend and Coast Commercial Bank dated November, 1986, for 720
Front Street, Santa Cruz, California.
* Lease by and between Green Valley Corporation and Coast Commercial Bank dated July 12, 1988, for 740
Front Street, Santa Cruz, California.
* Lease by and between Heffernan Family Trust and Coast Commercial Bank dated June 21, 1989, for 1975
Soquel Drive, Santa Cruz, California.
* Lease by and between Martin N. Boone and Robin Sherman and Coast Commercial Bank dated July 16, 1986, for
7775 Soquel Drive, Aptos, California.
* Lease by and between Scott Valley Partners and Coast Commercial Bank dated November 6, 1991, for 203A Mt.
Hermon Road, Scotts Valley.
* Lease by and between Jay Paul and Coast Commercial Bank dated December 1, 1989, for 1055 S. Green Valley
Road, Watsonville.
* Lease by and between Dubois Office Plaza and Coast Commercial Bank dated January 23, 1993, for 140 Dubois
Street, Santa Cruz.
* Coast Commercial Bank Employee Stock Ownership Plan.
* Coast Bancorp 1995 Stock Option Plan.
* Deferred Compensation Agreement with Richard E. Alderson dated November 2, 1992.
* Deferred Compensation Agreement with Douglas D. Austin Dated November 2, 1992.
* Deferred Compensation Agreement with Bud W. Cummings Dated November 2, 1992.
* Deferred Compensation Agreement with Ronald M. Israel Dated November 2, 1992.
* Deferred Compensation Agreement with Malcolm D. Moore Dated November 2, 1992.
* Deferred Compensation Agreement with Gus J.F. Norton Dated November 2, 1992.
* Deferred Compensation Agreement with James C. Thompson Dated November 2, 1992.
</TABLE>
- ------------------------
* Previously filed.
50
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act of
1934, the registrant has duly issued this registration statement to be signed on
its behalf by the undersigned, thereunto duly authorized.
COAST BANCORP
DATE: MARCH 28, 1997
By: /s/ HARVEY J. NICKELSON
-----------------------------------------
Harvey J. Nickelson,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Act of 1934, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ DOUGLAS D. AUSTIN
- ------------------------------ Director March 26, 1997
Douglas D. Austin
/s/ JOHN C. BURROUGHS
- ------------------------------ Director March 26, 1997
John C. Burroughs
- ------------------------------ Director , 1997
Bud W. Cummings
Senior Vice President and
/s/ BRUCE H. KENDALL Chief Financial Officer
- ------------------------------ (Principal Financial and March 26, 1997
Bruce H. Kendall Accounting Officer)
/s/ MALCOM D. MOORE
- ------------------------------ Director March 26, 1997
Malcolm D. Moore
/s/ HARVEY J. NICKLESON
- ------------------------------ President, Chief Executive March 28, 1997
Harvey J. Nickleson Officer and Director
/s/ GUS J.F. NORTON
- ------------------------------ Director March 26, 1997
Gus J.F. Norton
/s/ JAMES C. THOMPSON
- ------------------------------ Chairman of the Board of March 26, 1997
James C. Thompson Directors
- ------------------------------ Director , 1997
Ronald M. Israel
51
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 22,492
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 15,500
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 65,486
<INVESTMENTS-CARRYING> 5,914
<INVESTMENTS-MARKET> 6,021
<LOANS> 121,979
<ALLOWANCE> 3,158
<TOTAL-ASSETS> 236,915
<DEPOSITS> 185,467
<SHORT-TERM> 24,608
<LIABILITIES-OTHER> 3,647
<LONG-TERM> 0
0
0
<COMMON> 11,041
<OTHER-SE> 12,152
<TOTAL-LIABILITIES-AND-EQUITY> 236,915
<INTEREST-LOAN> 12,845
<INTEREST-INVEST> 4,571
<INTEREST-OTHER> 832
<INTEREST-TOTAL> 18,248
<INTEREST-DEPOSIT> 3,435
<INTEREST-EXPENSE> 4,813
<INTEREST-INCOME-NET> 13,435
<LOAN-LOSSES> 900
<SECURITIES-GAINS> 114
<EXPENSE-OTHER> 10,539
<INCOME-PRETAX> 6,894
<INCOME-PRE-EXTRAORDINARY> 6,894
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,128
<EPS-PRIMARY> 1.85
<EPS-DILUTED> 1.85
<YIELD-ACTUAL> .067
<LOANS-NON> 159
<LOANS-PAST> 50
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,478
<CHARGE-OFFS> 352
<RECOVERIES> 132
<ALLOWANCE-CLOSE> 3,158
<ALLOWANCE-DOMESTIC> 3,158
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
